Definition
ROE is a headline profitability metric popularized by Warren Buffett as one of his favorites. It answers: for every dollar of shareholder equity, how many cents of profit does the business generate? Consistent ROE above 15% typically indicates a high-quality business with pricing power or capital efficiency. ROE can be decomposed via the DuPont Framework: ROE = Net Profit Margin × Asset Turnover × Financial Leverage. This reveals whether high ROE comes from operational excellence (good) or excessive debt (risky). Compare ROE within an industry: banks and utilities often have naturally lower ROE due to regulatory capital requirements; consumer brands and asset-light software often exceed 25%. A rising ROE trend with stable leverage is a strong quality signal.
ROE = Net Income / Shareholder Equity × 100%
Use average equity over the period (beginning + ending / 2) for more accuracy. Watch for buybacks — they shrink equity and inflate ROE.
Example
Apple FY2023: Net Income ~$97B, average Shareholder Equity ~$65B. ROE = 97/65 = 149% — extraordinary, driven by aggressive buybacks (which shrink equity denominator). For most businesses 15-25% is very good; 5% is weak.
Frequently Asked Questions
What is a good ROE?
15%+ is generally strong, 20%+ is excellent, 25%+ often indicates competitive moat or aggressive buybacks. Below 10% may signal capital allocation issues. Always compare within the industry — utilities and banks are naturally lower.
Can ROE be misleading?
Yes. High leverage (debt) inflates ROE without improving business quality. Also, buybacks shrink equity and mechanically raise ROE. Always check the DuPont decomposition to understand where ROE comes from.
Should I prefer high-ROE stocks?
Generally yes for buy-and-hold investors — companies compounding at 20%+ ROE tend to outperform over decades. But high ROE with excessive leverage or declining margins is a warning, not a green light.