Lesson 3.2 · 2 of 5 · The quality of a business
ROE and ROIC: what they show, how to calculate them, when they mislead
ROE shows how much profit a company makes from its shareholders’ money; ROIC, from all the capital in the business, from shareholders and lenders alike. A very high ROE can come from debt or a small equity base after years of buybacks. ROIC above the cost of capital, year after year, points to a business creating value.
Terms in this lesson
What ROE is and how to calculate it
Definition
How is ROE calculated?
Net profit divided by average shareholders’ equity over the year.
ROE stands for return on equity. You met shareholders’ equity in the lesson on the balance sheet: assets minus liabilities. Use the average of the opening and closing figures, because the profit was earned over the whole year. Microsoft, financial year 2026: net income $133.7bn; equity of $343.5bn at the start and $442.4bn at the end, an average of $392.9bn. ROE = 133.7 ÷ 392.9 = 34.0%.
Microsoft’s ROE, financial year 2026: 34.0%.
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Create a free accountWhen ROE is inflated: debt and buybacks
ROE can rise in two ways: profit goes up, or equity goes down. The second does not make the business any better. Equity shrinks when a company funds itself more with debt, or when it hands shareholders more through buybacks and dividends than it earns.
Columns showing Apple’s ROE, on average shareholders’ equity, for financial years 2016-2025, ending in late September: 36.9%, 36.9%, 49.4%, 55.9%, 73.7%, 147.4%, 175.5%, 171.9%, 157.4% and 171.4%. The big jump comes in 2021, when net income rose from $57.4bn to $94.7bn while equity was already small.
Between financial years 2016 and 2025 Apple’s net income grew 2.5 times, from $45.7bn to $112.0bn. Over the same period its shareholders’ equity fell by 43%, from $128.2bn to $73.7bn, because Apple returned more to shareholders than it earned. In financial year 2025 alone: $90.7bn of buybacks and $15.4bn of dividends. The net margin rose only from 21.2% to 26.9%, yet ROE jumped from 36.9% to 171.4%. Most of the leap comes from the denominator.
Real case
McDonald’s: big profits, negative equity
At every year end from 2016 to 2025, McDonald’s shareholders’ equity was below zero.
At the end of 2015 McDonald’s had shareholders’ equity of $7.1bn. In 2016 it spent $11.2bn on buybacks and $3.1bn on dividends, against net income of $4.7bn. By the end of the year its equity stood at -$2.2bn. At the end of 2025 it was still negative, at -$1.8bn, with net income of $8.6bn. With a negative denominator ROE stops making sense: the formula produces a negative number even though the company is earning well.
From McDonald’s Form 10-K annual reports.
ROIC and the cost of capital (WACC)
Definition
How is ROIC calculated?
Operating profit after tax divided by invested capital.
ROIC, return on invested capital, looks at all the money tied up in the business, not just the shareholders’. The top line (NOPAT) is operating profit after tax, leaving out the effect of interest. The bottom line is invested capital: equity plus borrowings (here, long-term debt including the part due within a year), minus cash and short-term investments. Microsoft, financial year 2026: $155.2bn operating income × (1 - 19.4% effective tax rate) = $125.1bn. Invested capital: $292.1bn at the start, $405.8bn at the end, an average of $349.0bn. ROIC = 35.9%. Definitions vary between sources (some do not deduct cash, others add leases), so only compare figures worked out the same way.
Definition
What is WACC?
The average cost of the money a company works with.
Lenders receive interest, which reduces corporation tax. Shareholders expect a higher return, because they take more risk. WACC averages the two costs, weighted by how much of the funding comes from each. Example: 70% of the money comes from shareholders who want 10% a year, 30% from loans at 5% interest, with a 20% tax rate. WACC = 0.7 × 10% + 0.3 × 5% × 0.8 = 8.2%. WACC is not in the report: it is estimated, and estimates differ from one analyst to the next.
- ROIC above WACCEach dollar reinvested earns more than it costs: growth creates value.
- ROIC below WACCEach dollar reinvested earns less than it costs: growth destroys value, even if profit rises.
ROE at banks: how to read it
Real case
JPMorgan Chase, 2025
ROE of 17%, with assets about 12 times shareholders’ equity.
JPMorgan Chase reported net income of $57.0bn for 2025, a return on equity of 17% and a return on tangible common equity of 20%, which leaves out goodwill and other intangible assets. At 31 December 2025 it had $4.4 trillion of assets and $362bn of shareholders’ equity, so assets were about 12 times equity. Its return on assets was therefore only around 1.3%. At a bank a high ROE comes naturally from leverage: most of the money it works with is customers’ deposits, not shareholders’ capital.
JPMorgan Chase, full-year 2025 results (13 January 2026). Return on assets worked out on year-end assets.
At a bank, the same business can show a higher ROE simply because it runs on less capital. That is why a bank’s ROE is read alongside ROA and the capital ratios regulators require, as in the lesson on company debt.
Lessons are educational. They are not a recommendation to buy or sell. Investing involves risk and you can lose money. Sources: Microsoft, Form 10-K for the financial year ended 30 June 2026 (net income $133,749m, operating income $155,237m, income before tax $165,934m, tax $32,185m, equity $343,479m and $442,387m, long-term debt $2,999m + $40,152m and $9,227m + $31,067m, cash and short-term investments $94,565m and $76,843m); Costco, Form 10-K for the financial year ended 31 August 2025 (net income $8,099m, equity $23,622m and $29,164m); Apple, Form 10-K annual reports for financial years 2016-2025 (net income and shareholders’ equity at each year end; for 2025: buybacks $90,711m, dividends $15,421m); McDonald’s, Form 10-K annual reports for 2015-2025 (equity $7,088m at 31 December 2015, -$2,204m at 31 December 2016, -$1,791m at 31 December 2025; buybacks $11,171m and dividends $3,058m in 2016; net income $4,687m in 2016 and $8,563m in 2025); JPMorgan Chase, fourth-quarter and full-year 2025 earnings release (13 January 2026, SEC): net income $57.0bn, ROE 17%, ROTCE 20%, assets $4.4 trillion and equity $362bn at 31 December 2025.