Return on Equity (ROE) measures the profitability generated by a company for its shareholders by dividing net income by equity. It is one of the most closely monitored financial performance indicators by investors, bankers and business valuators, as it directly expresses how efficiently management creates value from the resources contributed by shareholders.

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Its formula is: ROE = Net income / Average equity. A ROE of 15% means that each franc of invested equity generates 15 cents of annual net income. The DuPont decomposition allows analysis of the drivers: ROE = Net margin × Asset turnover × Financial leverage. This decomposition reveals whether profitability stems from high margins, intensive asset use or financial leverage.

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In business valuation and LBO analysis, ROE is used to validate structural coherence: a structural ROE below the cost of equity (Ke) indicates value destruction. Conversely, a durably higher ROE — often associated with a positive economic goodwill — justifies a valuation premium over book value.

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Example: a Swiss SME reports net income of CHF 1.1 million on equity of CHF 6.5 million, giving a ROE of 16.9%. The CAPM cost of equity is estimated at 12%. The 4.9% differential indicates genuine value creation — justifying a valuation multiple above book value.

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At Hectelion, we systematically analyse ROE and ROCE in our business valuations to validate historical value creation and the sustainability of financial projections.