Return on Equity

Return on equity, or ROE, is net income divided by shareholders' equity. It measures how much profit a company earned on the money owners have put in and left in the business. ROE looks back at a past period, while cost of equity looks forward.

A company with $12 million of net income and $100 million of book equity has a 12% ROE. Against an 11% cost of equity, it earned one point more than shareholders require. An ROE that stays above the cost of equity year after year suggests the business creates value. Banks are a common case, covered in cost of equity for banks.

ROE can be inflated by debt, buybacks or one-time gains, so look at several years. The FAQ explains whether cost of equity is the same as return on equity and whether you can find cost of equity on the balance sheet.