The two ratios
Some analysts use the average of equity or assets between the start and end of the year instead of the year-end figure, since profit was earned over the whole year. What matters is using the same method when comparing.
Debt can lift ROE
Picture two companies with the same assets and the same business. The first is funded mostly by shareholders, the second mostly by loans. The second pays more interest, so it earns less, but its equity is much smaller, so its ROE comes out higher.
Reading them together
If ROE and ROA are close, the company has few liabilities relative to its assets. If ROE is far above ROA, a large share of assets is funded by liabilities. The most useful comparison is the same company over several years, or companies in the same sector, since a bank's balance sheet looks nothing like a factory's. Debt itself is covered in debt and leverage.
See a real ROE
Open any stock page; under "Stock data" you will find ROE when available. Compare it with the debt in the latest balance sheet.
Check yourself
1. Net profit 40 million, equity 200 million. What is ROE?
2. ROE is 30% and ROA 5%. What does that usually mean?
Summary
- ROE = net profit ÷ equity; ROA = net profit ÷ assets.
- Debt can raise ROE without the business improving.
- Read the two together, and compare the same company or sector.