What does it mean if return on equity increases?
Henry Morales
Published Feb 17, 2026
A rising ROE suggests that a company is increasing its profit generation without needing as much capital. It also indicates how well a company’s management deploys shareholder capital. A higher ROE is usually better while a falling ROE may indicate a less efficient usage of equity capital.
What causes a change in return on equity?
The big factor that separates ROE and ROA is financial leverage or debt. But since equity equals assets minus total debt, a company decreases its equity by increasing debt. In other words, when debt increases, equity shrinks, and since equity is the ROE’s denominator, ROE, in turn, gets a boost.
How does leverage increase return on equity?
At an ideal level of financial leverage, a company’s return on equity increases because the use of leverage increases stock volatility, increasing its level of risk which in turn increases returns. However, if a company is financially over-leveraged a decrease in return on equity could occur.
What does return on equity indicate?
Return on equity (ROE) is a ratio that provides investors with insight into how efficiently a company (or more specifically, its management team) is handling the money that shareholders have contributed to it. In other words, it measures the profitability of a corporation in relation to stockholders’ equity.
What is good return on equity?
ROEs of 15–20% are generally considered good. ROE is also a factor in stock valuation, in association with other financial ratios.
How do you increase ROA and ROE?
Here’s how return on equity works, and five ways a company can increase its return on equity.
- Use more financial leverage. Companies can finance themselves with debt and equity capital.
- Increase profit margins.
- Improve asset turnover.
- Distribute idle cash.
- Lower taxes.
What happens when ROE decreases?
Declining ROE suggests the company is becoming less efficient at creating profits and increasing shareholder value. To calculate the ROE, divide a company’s net income by its shareholder equity.
What are the effects of leverage?
The leverage effect describes the effect of debt on the return on equity: Additional debt can increase the return on equity for the owner. This applies as long as the total return on the project is higher than the cost of additional debt.
