What is ROE (Return on Equity)?
ROE (Return on Equity), or return on shareholders' equity, measures how much net income a company generates for each euro of equity made available by its shareholders. It answers the question: "at what rate of return are the funds invested by shareholders working?"
An ROE of 20% means that for every €100 of equity, the company generates €20 of annual net income. It is the equivalent of a rate of return — and, as with any return, you have to compare it to the cost of capital to know whether value is genuinely being created.
Warren Buffett and ROE: Buffett long used ROE as his primary criterion for identifying companies with an economic "moat". He looks for companies able to sustain an ROE above 15% over 10 years without resorting to excessive debt — which signals a structural rather than a cyclical competitive advantage.
How to calculate ROE
A worked example
A small business listed on Euronext Growth:
- Net income: €2.4M
- Shareholders' equity: €14M
- ROE = 2.4 ÷ 14 × 100 = 17.1%
This ROE of 17.1% is above the 15% threshold generally considered good — the company generates a return above the typical cost of equity for a small cap.
Trailing (TTM) ROE vs annual ROE
The TTM ROE (Trailing Twelve Months) uses net income over the last rolling 12 months rather than the most recent full year. It is more responsive to recent developments, and it is the version built into the Screener Small Caps ML model.
What is ROCE (Return on Capital Employed)?
ROCE (Return on Capital Employed) measures the return on all the capital invested in the business — equity AND long-term debt. It is often the preferred ratio for industrial companies or those with significant debt.
In the screener: ROCE is calculated exactly this way — EBIT ÷ (totalAssets − totalCurrentLiabilities) — using public data. A ROCE above 15% earns 10 of 25 points in the Quality pillar of the composite score.
ROE vs ROCE: when to use which?
- Measures the return for the shareholder only
- Based on shareholders' equity
- Can be inflated by debt (the leverage effect)
- Ideal for companies with little debt
- Favoured by long-term value investors
- Measures the return on all invested capital
- Based on total assets − current liabilities
- Neutralises the financial leverage effect
- Ideal for indebted or industrial companies
- Favoured by M&A and credit analysts
The practical rule: for Euronext Growth small caps with significant debt (net debt / EBITDA > 1.5x), favour ROCE. For companies with little debt or that are cash-positive, the two ratios converge and ROE is enough.
ROE and ROCE calculator
Interpreting ROE and ROCE
| Level | ROE — Interpretation | ROCE — Interpretation | Screener score |
|---|---|---|---|
| > 15% | Excellent — likely competitive advantage | Excellent — capital very well allocated | ROE: 7/7 · ROCE: 10/10 |
| 10 — 15% | Good — satisfactory profitability | Good — above the cost of capital | ROE: 5/7 · ROCE: 7/10 |
| 5 — 10% | Moderate — to watch | Moderate — close to the cost of capital | ROE: 2/7 · ROCE: 4/10 |
| < 5% | Low — capital poorly remunerated | Low — likely value destruction | ROE: 0/7 · ROCE: 0/10 |
ROCE above the WACC = value creation
The real test of value creation for a company is not a high ROCE in absolute terms, but a ROCE above the weighted average cost of capital (WACC). If ROCE is 12% and WACC is 8%, the company creates 4 points of value per euro of invested capital. If ROCE is 6% and WACC is 9%, it destroys value even though it is profitable in absolute terms.
On European small caps, WACC is generally estimated between 8% and 12% (depending on sector risk and the liquidity premium). A ROCE above 15% therefore offers a comfortable margin of safety.
The DuPont decomposition: understanding the sources of ROE
DuPont analysis breaks ROE down into three multiplicative factors, helping you understand why an ROE is high or low:
This decomposition reveals three distinct profiles of high ROE:
- ROE driven by margin (e.g. SaaS companies, pharma) — high net margins but moderate asset turnover.
- ROE driven by turnover (e.g. distribution, retail) — thin margins but very efficiently used assets (high turnover).
- ROE driven by leverage — heavy debt that amplifies the return. Beware: this ROE is fragile and can collapse if financing conditions deteriorate.
A common trap: a very high ROE (> 30%) on a Euronext Growth small cap can be misleading if equity is very low because of a history of losses or intensive share buybacks. Always check the absolute level of equity and the net debt / EBITDA ratio before concluding that a competitive advantage exists.
Why the 5-year ROE trend matters
As with the EBITDA margin, the 5-year ROE trend is a key feature of the Screener Small Caps ML model (roe_trend, calculated by OLS regression). A rising 5-year ROE trend often signals an upcoming repricing by the market — the company is structurally improving its efficiency and the market has not yet fully incorporated that improvement into the share price.
| ROE trend profile | Meaning | Strategy |
|---|---|---|
| High ROE + stable trend | Consolidated competitive advantage — the market knows it | Premium quality, often expensive |
| Moderate ROE + rising trend | Improvement underway — the market underestimates it | A repricing opportunity |
| High ROE + declining trend | Advantage eroding — risk of a negative re-rating | Watch competitive pressure |
| Low ROE + stable trend | Low-return model with no visible improvement | Avoid or wait for a catalyst |
ROE, ROCE and European small caps
A few important specifics on Euronext Growth:
Low equity = volatile ROE
On small caps, equity can be relatively low, making ROE very sensitive to a good or bad year. A company with €3M of equity and €0.5M of net income has an ROE of 16.7% — but if it loses €0.2M the following year, ROE drops to -6.7%. That is why we favour the TTM ROE (rolling 12 months) and track it over 3 to 5 years.
ROCE and capital intensity
ROCE is particularly useful for distinguishing industrial companies (heavy assets, large capital employed) from services companies (few assets, small capital employed). A services company with a ROCE of 25% is not necessarily "better" than an industrial company at 12% — what matters is the sector comparison.
Go further: the Fundamental Analysis cluster
New to screening European small caps? See the European small-cap stock screener guide and the glossary.