What is return on equity?
The owners of a company contributed money and leave profits in it. Together that is equity. Return on equity tells you what percentage of profit the company makes on it in a year, after interest and taxes.
You can compare it with the interest on a savings account: an owner expects more than a safe investment, because they take a risk.
The formula
Return on equity = profit for the year ÷ equity × 100
Profit (loss) for the year: item 9904. Equity: item 10/15.
Nummo uses equity at the end of the financial year. Some analysts use the average of the start and end of the year, which gives a slightly different figure.
Example: Bakkerij De Zoete Korst
- Step 1
Find the profit
The fictitious bakery made an after-tax profit of €24,000 last year (item 9904).
€24,000 - Step 2
Divide by equity
Equity is €200,000. So every euro from the owners earned about 12 cents.
€24,000 ÷ €200,000 × 100 = 12%
- rule of thumb 10%
Return rose from 8.1% to 12%, while equity grew as well. That is a good sign: profit grew faster than the money invested.
What is a good return on equity?
- Negative: the company made a loss.
- Between 0 and 10%: modest.
- Between 10 and 15%: good.
- Above 15%: strong.
These are rules of thumb Nummo uses, and they differ by sector. A company with many fixed assets, such as a hotel, rarely achieves the return of a consultancy.
Watch the leverage effect
A high return on equity can also come from low equity. Suppose the bakery makes the same profit of €24,000, but with only €80,000 of equity and the rest borrowed. Return then jumps to 30%, while the company is much more vulnerable.
So always look at ROE together with the solvency ratio. Return on assets (operating profit divided by the balance sheet total) does not depend on financing and is a good complement.
In small Belgian companies
In small companies, the director partly decides how much profit remains: a higher director's remuneration is a cost and lowers profit. A low return there does not always mean the business is doing badly. Compare over several years, together with gross margin and EBITDA.
Calculate it yourself
Enter the figures from a set of annual accounts. The item numbers follow the Belgian format, which builds on the European Accounting Directive.