How to Calculate Return-On-Equity (ROE)

Return-on-equity, RoE, is a measure of profitability for a business, perhaps the most important one since in my view it can make or break an investment decision. RoE shows how efficient a business proposition is at creating a profit.

Return-on-equity can be calculated on a per-share basis or on a whole figure basis.

On a per-share basis RoE is calculated by dividing Earnings Per Share, EPS, by Book Value. Earnings Per Share are calculated by dividing the Net Profit After Tax, NPAT, by the number of shares outstanding for the company. Book Value is the business Equity divided by the number of shares outstanding in it. It is also called Equity Per Share.

As an example, Qantas EPS are $0.398 while its Book Value is $3.12. RoE can be calculated as follows: 0.398/3.12*100 = 12.76%. Because RoE is a percentage figure if must by multiplied by 100.

On a whole figure basis, RoE is calculable by dividing NPAT by Equity.

To know how much Return-on-equity you should be demanding, RoE has been statistically found to be on average 12 per cent in the US. So, you could take that as a benchmark.

On the other hand, when appraising an investment decision, you should find out how much return alternative investments such as bank deposits or bonds are offering and compare it with your company’s RoE.

There are other measures of profitability such as Return-on-capital, RoC. Since when you start a business you often use debt besides equity it makes sense to take that into account and find out how much the business is faring on that basis.

RoC is calculated by dividing NPAT by Equity plus Long-Term Debt multiplied by 100. RoC should be lower than RoE.

Still using Qantas as an example, NPAT is $719.4 million, Equity is $6189.1 million and Long-Term Debt is $4978.7 million. So, RoC is: 719.4/(6189.1+4978.7)*100 = 6.44%.

Another measure of profitability is Return-on-assets, RoA. This is especially important for businesses which have great asset requirements such as the automobile industry and manufacturing generally. RoA is calculated by dividing the NPAT by the Assets of the company and multiplying by 100.

The reader could find the information to seed these calculations from the websites of the companies in question. Just look for Corporate and download their latest Annual Report where you can find all the necessary financial information. Additionally, you could find the required financial data from online databases accessible through this and other websites.