When Fundamentals Meet Valuation: ROE as a Proxy for the Cost of Equity
DOI:
https://doi.org/10.15611/fins.2026.2.02Keywords:
corporate finance, valuation, return on equity, cost of equityAbstract
Aim: This article examines whether Return on Equity (ROE) can be used as a fundamentals-based proxy for the cost of equity and, consequently, as a discount rate in valuation. The research addressed the uncertainty arising from market-based cost-of-equity estimation, especially when inputs are sensitive to assumptions, sentiment, and market conditions.
Methodology: The empirical analysis used quarterly data from LSEG for companies listed on the Warsaw Stock Exchange over the period 2016Q4–2025Q4. Two variables were examined: estimated cost of equity and ROE. The authors applied descriptive statistics, interquartile range analysis, box-plot comparisons, and the Wilcoxon signed-rank test to assess whether median ROE converges toward median cost of equity over time.
Findings: The research results provide partial support for the convergence hypothesis. In the earlier part of the analysed sample, median ROE and median cost of equity were relatively close, and differences were statistically insignificant. However, from around 2022 onwards, the relationship changed, with statistically significant and persistent divergence between both indicators. ROE also showed substantially higher dispersion, reflecting possible accounting volatility, leverage effects, or extraordinary earnings.
Implications: The findings suggest that ROE should not mechanically replace the cost of equity in valuation models. However, it may function as a benchmark when market-based estimates are unreliable.
Originality/value: This study contributes to literature by directly testing the empirical relationship between ROE and cost of equity. It highlights the potential of ROE as a conditional, fundamentalsbased discount-rate proxy while emphasising its limitations.
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Copyright (c) 2026 Piotr Dąbrowski, Jan Kaczmarzyk
This work is licensed under a Creative Commons Attribution-ShareAlike 4.0 International License.
Accepted 2026-09-14
Published 2026-11-05
