Return on Equity

Return on Equity (ROE) indicates the efficiency of using equity capital invested in a company to generate profit, i.e., how much profit is earned for every euro of equity capital invested. The DuPont formula breaks down ROE into three components:

1. Profitability,
2. Asset utilization efficiency, and
3. Financial leverage.

ROE is calculated using the following formula:

$$ROE \mmlToken{mo}[linebreak="auto"]{=} $$ $$Profit\; Margin \times Asset\; Turnover \times Financial\; Leverage=$$ $$\frac{Net\; Income}{Revenue} \times \frac{Revenue}{Assets} \times \frac{Assets}{Equity}=$$ $$ROA \times \frac{Assets}{Equity}=$$ $$\frac{Net\; Income}{Equity}$$

To calculate ROE, typically, the net income from the income statement is divided by the total equity from the balance sheet. DuPont analysis allows for distinguishing between three types of companies to achieve acceptable return on equity:

1. High-profit margin companies (e.g., fashion industry, software development, luxury goods sales),
2. High-turnover companies (e.g., retail), and
3. High financial leverage companies (e.g., banking).