ROE vs. Cost of Equity: Key Differences Every Investor Must Know
ROE measures how efficiently a company turns shareholder money into profit; Cost of Equity is the annual return investors demand for holding that stock.
Investors mix them up because both deal with “what shareholders earn.” ROE looks backward at performance; Cost of Equity looks forward at required reward.
Key Differences
ROE is a company metric—net income ÷ equity—shown on the income statement. Cost of Equity is a market metric—risk-free rate + beta × equity risk premium—used to discount future cash flows.
Which One Should You Choose?
Use ROE to screen profitable firms; choose Cost of Equity to price a stock or judge if future returns beat the hurdle. Together they flag undervalued shares.
Can ROE be higher than Cost of Equity?
Yes. When management earns more than investors require, the stock may be undervalued.
Is Cost of Equity fixed?
No. It moves with interest rates, market risk, and company-specific volatility.
Do both metrics use book or market values?
ROE uses book equity; Cost of Equity uses market value in its beta calculation.