Return on Equity

Return on equity answers a fundamental question: how well is management deploying the capital shareholders have entrusted to it? A high ROE signals that a company can grow earnings without requiring constant infusions of new equity capital, which is the hallmark of a great business. If a company earns $5 billion in net income on $25 billion of shareholders' equity, its ROE is 20% — meaning it generates 20 cents of profit for every dollar of equity on the books.

Warren Buffett has repeatedly cited consistent ROE above 15% as a key screen for durable competitive advantages. Companies like Apple, Visa, and Mastercard have delivered ROE figures well above 30% for sustained periods, reflecting their pricing power, asset-light models, and the compounding effect of their retained earnings. Such high returns are only possible when a business has a genuine economic moat that competitors cannot easily replicate.

The DuPont decomposition breaks ROE into three components: net profit margin (how much of each revenue dollar becomes profit), asset turnover (how efficiently assets generate revenue), and the equity multiplier (financial leverage). This decomposition reveals whether high ROE is driven by genuine operational excellence or simply by borrowing a lot of money. A bank can achieve high ROE primarily through leverage, which is a very different risk profile than a software company achieving high ROE through fat margins.

Share buybacks complicate ROE interpretation. When a company repurchases its own shares, shareholders' equity on the balance sheet falls, which mechanically boosts the ROE even without any improvement in profitability. Apple's ROE is in the hundreds of percent partly because its aggressive buyback program has left shareholders' equity very low. Analysts often adjust for this effect or look at return on invested capital (ROIC) instead, which treats buybacks differently.

For cyclical industries like steel or semiconductors, ROE fluctuates wildly with the business cycle; analysts prefer to average ROE over a full cycle rather than focusing on a single year. Consistent, high ROE across multiple years — especially through downturns — is the strongest signal that a company's advantage is real and enduring.