Return on Ordinary Shareholders’ Equity (ROE)

Formula

ROE=(Net Profit After Tax−Preference Dividends)/Avg Ordinary Shareholders’ Equity ×100%

Where:

Ordinary Shareholders’ Equity = Ordinary share capital + Reserves

Average Equity = (Opening equity + Closing equity) ÷ 2

If there are no preference shares, 

ROE = Net Profit After Tax ÷ Ordinary Shareholders’ Equity

Explanation

Return on Ordinary Shareholders’ Equity measures how efficiently a company uses shareholders’ funds to generate profits.

It indicates the rate of return earned by ordinary shareholders on their investment in the company.

A higher ROE suggests:

• Effective use of shareholders’ capital
• Strong management performance
• Attractive returns to investors

A lower ROE may indicate:

• Poor profitability
• Inefficient use of equity
• Excess idle capital

Satisfactory Level

There is no fixed “ideal” ROE, but a satisfactory ROE:

• Is consistently higher than the cost of equity
• Is stable or improving over time
• Compares favourably with competitors

General guideline:

• 15% – 20% → good
• >20% → very strong
• <10% → weak / may concern investors

Industry Norms (Approximate)

Industry	Typical ROE

Manufacturing

12% – 20%

Retail

15% – 25%

Banking & Finance

10% – 15%

Technology

20% – 35%

Utilities

8% – 12%

⚠️ ROE can be inflated by high debt levels, so it should be analysed together with gearing ratios.

Example

• Modern More Sdn. Bhd.
• Net Profit After Tax: RM120,000
• Preference Dividends: RM20,000
• Ordinary Shareholders’ Equity (Opening): RM800,000
• Ordinary Shareholders’ Equity (Closing): RM900,000

Step 1: Calculate Profit attributable to ordinary shareholders

ROE=(Net Profit After Tax−Preference Dividends)/Avg Ordinary Shareholders’ Equity ×100%

Net Profit After Tax−Preference Dividends

120,000−20,000 = RM100,000

Step 2: Calculate Average Ordinary Equity

Avg Ordinary Shareholders’ Equity

(800,000+900,000) ÷ 2 = RM850,000

Step 3: Calculate ROE

ROE = 100,000 / 850,000 × 100% = 11.76%

Interpretation

The company generates approximately 11.8% return on ordinary shareholders’ funds, which is acceptable but could be improved compared to industry benchmarks.

Summary

• ROE focuses on shareholders’ perspective, not total assets
• Always use average equity for better accuracy
• High ROE caused by excessive borrowing may be risky