Return on Equity (ROE)

ROE measures how effectively a company uses shareholders' equity to generate profit.

Formula

ROE = Net Income ÷ Shareholders' Equity × 100

DuPont decomposition

Break ROE into three components to understand what drives it:

ROE = Profit Margin × Asset Turnover × Equity Multiplier

• Profit margin: Net income ÷ revenue (profitability)
• Asset turnover: Revenue ÷ total assets (efficiency)
• Equity multiplier: Total assets ÷ equity (leverage)

Interpretation

• Above 15%: Generally strong
• 10–15%: Good for most industries
• Below 10%: May indicate poor capital allocation

Important caveats

• High ROE from high leverage is riskier than high ROE from high margins
• Share buybacks reduce equity, artificially inflating ROE
• Negative equity (from accumulated losses) makes ROE meaningless
• Always compare ROE within the same industry

Practical use

ROE is one of Warren Buffett's favorite metrics. He looks for companies with consistently high ROE (above 15%) driven by genuine business quality, not financial engineering.