ROE: Return on Equity
ROE is often called the single most important quality metric. Let's understand why.
The Formula
ROE = Net Income ÷ Shareholders' Equity × 100
In plain English: How much profit does the company generate for every dollar shareholders have invested?
Your Investment Account
You invest $10,000 in a brokerage account.
- After one year, you've earned $1,500 in gains
- Your "ROE" = $1,500 ÷ $10,000 = 15%
For a company, ROE measures the same thing—how well they're using shareholders' money to generate profits.
What ROE Tells You
| ROE Level | Interpretation |
|---|---|
| 25%+ | Excellent — exceptional business |
| 15-25% | Good — above average quality |
| 10-15% | Average — acceptable |
| 5-10% | Below average — mediocre |
| Below 5% | Poor — destroying value |
| Negative | Losing money |
Why ROE Matters
1. Shows Efficiency
High ROE means the company is skilled at turning capital into profits.
2. Indicates Competitive Advantage
Sustained high ROE usually means something protects the business from competition.
3. Predicts Compounding
A company with 20% ROE that reinvests earnings grows faster than one with 10% ROE.
4. Enables Comparison
ROE works across industries (with some caveats).
Key Takeaways
- ROE = Net Income ÷ Shareholders' Equity
- Higher ROE = more efficient use of capital
- Sustained high ROE signals competitive advantages
- Look for ROE above 15% as a quality indicator
The DuPont Analysis
ROE can be broken down into three components:
ROE = Profit Margin × Asset Turnover × Financial Leverage
| Component | What It Measures |
|---|---|
| Profit Margin | How much profit per dollar of sales |
| Asset Turnover | How efficiently assets generate sales |
| Leverage | How much debt amplifies returns |
This breakdown reveals HOW a company achieves its ROE:
- High margin ROE — Premium products, pricing power (best)
- High turnover ROE — Efficient operations, high volume (good)
- High leverage ROE — Lots of debt (risky)
Beware Leverage-Driven ROE
A company can boost ROE by taking on debt. But this is risky—debt must be repaid regardless of performance.
Always check if high ROE comes from genuine profitability or just financial engineering.
ROE by Sector
| Sector | Typical ROE | Notes |
|---|---|---|
| Technology | 15-30% | High margins, low assets |
| Consumer Brands | 20-40% | Brand power |
| Financials | 10-15% | Leverage-dependent |
| Utilities | 8-12% | Regulated returns |
| Industrials | 12-18% | Capital intensive |
| Retail | 15-25% | Varies widely |
ROE Over Time
One year of high ROE isn't enough. Look for:
Consistency
- 5+ years of ROE above 15%
- Stable or improving trend
- No wild swings
Sustainability
- Is the competitive advantage durable?
- Are margins under pressure?
- Is the industry changing?
Example:
| Year | Company A ROE | Company B ROE |
|---|---|---|
| 2020 | 18% | 25% |
| 2021 | 19% | 15% |
| 2022 | 17% | 30% |
| 2023 | 20% | 10% |
| 2024 | 18% | 22% |
Company A's consistent 17-20% is more attractive than Company B's volatile 10-30%.
ROE Limitations
1. Debt Distortion
High debt inflates ROE but increases risk.
2. Negative Equity
Companies with negative equity (losses accumulated) have meaningless ROE.
3. Buyback Effects
Stock buybacks reduce equity, artificially boosting ROE.
4. Industry Differences
Some industries naturally have higher/lower ROE.
ROE Traps
- Chasing high ROE without checking debt levels
- Ignoring ROE trends (one good year isn't enough)
- Comparing ROE across very different industries
- Not understanding the source of high ROE
How ShareValue.ai Uses ROE
We incorporate ROE into the Quality Score by:
- Comparing to sector average — Is ROE high for this industry?
- Checking consistency — Has ROE been stable over time?
- Adjusting for leverage — Is high ROE from debt or operations?
- Combining with other metrics — ROE is one input among several
Next up: Profit margins—another key quality indicator.