Last updated: February 2026 · 14 min read

What Is ROE? Return on Equity Explained

Return on equity is one of the most important profitability metrics for evaluating a company's management quality and capital efficiency. This guide covers everything from the basic formula to advanced DuPont analysis, with practical tips for stock picking.

What Is Return on Equity?

Return on equity (ROE) is a profitability metric that measures how effectively a company uses shareholder capital to generate profits. In the simplest terms, it answers the question: for every dollar shareholders have invested in this company, how much profit does it produce?

ROE is expressed as a percentage. If a company has an ROE of 20%, it means it generates $0.20 of profit for every $1.00 of shareholders' equity. The higher the ROE, the more efficiently the company is converting its equity capital into profit. Warren Buffett has consistently highlighted ROE as one of his favorite metrics, often seeking companies with ROE above 15% sustained over many years.

Shareholders' equity represents the residual interest in a company's assets after all liabilities are subtracted. It is essentially the book value of what shareholders actually own. When a company generates a high return on this capital, it signals that management is deploying resources effectively — building products, expanding markets, and creating value rather than wasting shareholder money on poor investments.

ROE is particularly useful for comparing companies within the same industry, evaluating management quality over time, and identifying businesses with durable competitive advantages. Combined with other metrics from fundamental analysis, ROE helps build a complete picture of a company's financial health and investment potential.

How to Calculate ROE

The ROE formula is straightforward:

Net income is found on the income statement — it is the company's total profit after all expenses, taxes, and interest have been subtracted from revenue. This is the bottom line, the final profit number. Make sure to use net income attributable to common shareholders, which excludes preferred dividends if applicable.

Shareholders' equity is found on the balance sheet. It equals total assets minus total liabilities, or equivalently, the sum of common stock, retained earnings, and additional paid-in capital. Some analysts use the average shareholders' equity (beginning plus ending equity divided by two) for a more accurate picture, especially when equity changes significantly during the year.

Let's walk through an example. Suppose a company reports net income of $500 million and has shareholders' equity of $2.5 billion. The ROE is $500M ÷ $2,500M × 100 = 20%. This means the company generates a 20% return on the capital that shareholders have invested. You can find these numbers in the company's annual financial statements.

It is important to note that ROE can be calculated on an annual basis using the most recent fiscal year, or on a trailing twelve-month (TTM) basis using the most recent four quarters. The TTM approach gives you the most current picture, especially for companies with seasonal earnings patterns. For publicly traded companies, both net income and equity figures are readily available in SEC filings and on financial data platforms.

What Is a Good ROE?

As with most financial metrics, "good" is relative. However, there are general benchmarks that investors use to evaluate ROE across different contexts. The S&P 500 average ROE has historically ranged from 13% to 17%, providing a useful baseline for comparison.

Below 10%: Generally considered weak. The company is not generating strong returns on shareholder capital. This does not automatically make it a bad investment — some capital-intensive industries like utilities naturally have lower ROE — but it warrants investigation into whether management is using capital efficiently.

10-15%: Average. The company is producing acceptable returns but is not standing out from its peers. Many mature, stable companies in sectors like consumer staples and industrials fall in this range.

15-20%: Strong. This indicates good management and efficient capital allocation. Companies consistently in this range often have competitive advantages that allow them to generate above-average returns. This is the sweet spot that many investors target.

20%+: Exceptional. Companies with ROE consistently above 20% are typically market leaders with strong brands, pricing power, or network effects. Think Apple, Microsoft, or Visa. However, extremely high ROE (above 40-50%) can sometimes be a red flag — it may indicate the company has artificially low equity due to massive debt or aggressive share buybacks, rather than genuinely exceptional profitability.

The most important aspect of ROE is its consistency over time. A company with an ROE of 18% every year for the past decade is more attractive than one that swings between 5% and 30%. Consistency signals a durable business model and disciplined management. This is a principle that applies broadly to stock analysis.

ROE vs ROA

Return on equity and return on assets are closely related metrics, but they answer different questions. Understanding the distinction is critical for evaluating a company's financial health accurately.

ROA (Return on Assets) is calculated as net income divided by total assets. It measures how efficiently a company uses all of its assets — both equity and debt-financed — to generate profit. ROA strips out the effect of financial leverage, giving you a pure measure of operational efficiency.

ROE, on the other hand, measures returns specifically on shareholders' equity. Because equity is always a subset of total assets (assets = equity + liabilities), ROE is always higher than ROA for any company with debt. The more debt a company uses, the wider the gap between ROE and ROA.

This is where it gets important. Consider two companies, both with 10% ROA. Company A has no debt and an ROE of 10%. Company B has a 50% debt-to-equity ratio, which boosts its ROE to 15%. At first glance, Company B looks better because its ROE is higher. But the higher ROE is entirely driven by financial leverage — not superior operational performance. In a downturn, Company B faces significantly more risk because it has to service its debt regardless of earnings. Looking at both ROE and ROA together reveals whether a company's returns come from genuine business quality or from financial engineering.

As a rule of thumb, investors should be cautious when ROE is significantly higher than ROA, especially if the gap is widening over time. This pattern often indicates that the company is taking on more debt to artificially inflate shareholder returns. The ideal scenario is a company with both high ROE and high ROA, which signals that the business itself is highly profitable and that leverage is used responsibly.

DuPont Analysis

DuPont analysis is a powerful framework that decomposes ROE into three component parts, revealing exactly what is driving a company's return on equity. It was developed by the DuPont Corporation in the 1920s and remains one of the most widely used analytical tools in finance.

Profit Margin (Net Income ÷ Revenue) tells you how much of each dollar of revenue the company keeps as profit. High profit margins indicate pricing power, cost control, and operational efficiency. Companies like Microsoft and Visa have profit margins above 30%, while grocery chains may operate on margins below 3%.

Asset Turnover (Revenue ÷ Total Assets) measures how efficiently the company uses its assets to generate revenue. A higher asset turnover means the company is getting more revenue per dollar of assets. Retail companies tend to have high asset turnover (they sell a lot relative to their asset base), while capital-intensive industries like utilities have low asset turnover.

Equity Multiplier (Total Assets ÷ Shareholders' Equity) reflects the degree of financial leverage. A higher equity multiplier means more debt relative to equity. An equity multiplier of 2.0 means half the company's assets are financed by debt. While leverage can boost ROE, it also increases financial risk.

The power of DuPont analysis lies in diagnosis. If a company's ROE is rising, DuPont tells you whether it is because the company is becoming more profitable (margins improving), more efficient (asset turnover increasing), or more leveraged (taking on more debt). The first two are positive; the third is a warning sign. Similarly, if ROE is declining, you can pinpoint exactly where the deterioration is occurring. This level of insight is invaluable for stock valuation and fundamental research.

Limitations of ROE

While ROE is a powerful metric, it has important limitations that investors must understand to avoid being misled.

Debt inflation. The biggest caveat with ROE is that it can be artificially inflated by debt. When a company borrows heavily, shareholders' equity decreases relative to total assets, which mechanically increases ROE. A company with an ROE of 30% might look impressive until you discover that 80% of its assets are debt-financed. This is why DuPont analysis and checking the debt-to-equity ratio alongside ROE is critical.

Negative equity distortion. Companies with negative shareholders' equity — caused by accumulated losses exceeding paid-in capital, or aggressive share buybacks funded by debt — produce a negative denominator in the ROE formula. This can generate misleading positive or negative ROE figures. McDonald's and Starbucks are examples of major companies that have had negative equity due to massive buyback programs, making their ROE technically meaningless.

One-time items. Large one-time gains (asset sales, legal settlements) or charges (restructuring, write-downs) can cause net income to spike or plunge in a given period, making ROE temporarily misleading. Always look at ROE trends over multiple years and check whether the underlying earnings are sustainable. Read more about identifying these items in our earnings reports guide.

Industry comparability. ROE varies dramatically across industries due to differences in capital intensity, business models, and debt levels. Comparing the ROE of a tech company to that of a bank is not meaningful. Banks are inherently leveraged businesses, so their ROE is structured differently than a software company operating with minimal assets. Always compare ROE to sector peers for valid insights.

Growth company blind spot. Companies in heavy investment phases — building new factories, expanding internationally, investing in R&D — may report lower ROE because their equity base is growing faster than their profits. This does not necessarily mean they are poorly managed; it may mean they are investing for future returns. Fast-growing companies sometimes have lower current ROE but are building the foundation for higher future profitability. Our guide on growth vs value stocks explores this trade-off in depth.

Using ROE for Stock Picking

ROE becomes a powerful stock-picking tool when combined with other fundamental metrics and applied systematically. Here is a practical framework for incorporating ROE into your investment process:

Screen for consistency. Look for companies with ROE above 15% for at least five consecutive years. One year of high ROE can be a fluke; five years of it signals a genuine competitive advantage. Inconsistent ROE — swinging from 5% to 25% and back — suggests the business is cyclical or management is not reliably generating returns.

Run DuPont analysis. Before investing in any company with high ROE, decompose it using the DuPont framework. You want to see ROE driven primarily by profit margins and asset turnover, not by high leverage. A company with a 25% ROE, 15% net margin, and moderate leverage is far more attractive than one with a 25% ROE, 3% net margin, and extreme leverage.

Compare to sector peers. Rank a company's ROE against its direct competitors. If a bank has an ROE of 12% while its peers average 10%, it is outperforming. But that same 12% ROE would be below average for a software company. Context matters enormously when evaluating ROE as a competitive metric.

Combine with valuation. A high ROE alone does not make a stock a buy — price matters too. A company with a stellar 25% ROE trading at 50 times earnings might be overvalued, while one with a solid 17% ROE at 12 times earnings might be a bargain. Pair ROE analysis with P/E ratio analysis to find quality companies at reasonable prices. Our undervalued stocks guide covers how to identify these opportunities systematically.

Watch for deterioration. A declining ROE trend — especially when driven by shrinking margins rather than equity growth — is often an early warning sign that a company's competitive position is eroding. Track ROE quarterly and investigate any sustained decline. Use our AI stock analyzer to monitor these metrics automatically across your watchlist.