In short
Return on equity is net income divided by average shareholders' equity. It measures the return a company earns on the capital its owners have invested.
Key takeaways
- The DuPont model breaks it into profit margin × asset turnover × financial leverage (equity multiplier).
- More debt raises return on equity when returns exceed borrowing costs, but adds risk.
- Share buybacks reduce equity and can raise it without better operations.
Example
Net income of $120,000 and average equity of $800,000: return on equity is 15%.
Where it's tested
BAR: Financial Statement Analysis — study notes, a five-minute revision sheet and practice questions.
Practise: 3 questions
Question 1 of 3 · 0 answered
Under the DuPont framework, a company's ROE increased from 12% to 18%, driven entirely by an increase in the equity multiplier while margin and asset turnover were flat. What does this indicate?