Return on Equity (ROE) answers the most important question in corporate finance: "For every dollar shareholders invest, how many cents of profit does management generate?"
The Formula
ROE = Net Income / Shareholders' Equity × 100
Example: If a company earns $5 billion on $25 billion of equity, ROE = 20%. That's excellent — it means management turns every $1 of your money into $0.20 of annual profit.
ROE Benchmarks
| ROE Range | Interpretation |
|---|---|
| > 20% | Exceptional (wide moat, strong brand) |
| 15% – 20% | Very good |
| 10% – 15% | Average |
| 5% – 10% | Below average |
| < 5% | Poor capital allocation |
The DuPont Analysis: Going Deeper
Warren Buffett doesn't just look at ROE — he decomposes it using the DuPont formula:
ROE = Profit Margin × Asset Turnover × Equity Multiplier
This reveals how a company achieves its ROE:
- High Profit Margin: Premium products (Apple, luxury brands)
- High Asset Turnover: Efficient operations (Walmart, Amazon)
- High Equity Multiplier: Heavy leverage (Banks — risky!)
Warning: A high ROE driven by excessive leverage (high Equity Multiplier) is a red flag. The company is achieving returns by piling on debt, not by running a great business.
ROE Checklist
- Is ROE consistently above 15% for the past 5 years?
- Is ROE driven by profit margins rather than leverage?
- Is ROE improving, stable, or declining?
- How does ROE compare to the industry median?
How Aristockrat Evaluates ROE
We run the DuPont decomposition on every stock automatically, flagging any company where more than 50% of ROE comes from financial leverage. Only "clean" ROE — driven by margins and efficiency — contributes positively to our Quality Score.