What is Return on Equity (ROE)?

Definition

Return on Equity (ROE) measures how efficiently a company uses its shareholders' equity to generate profit, expressed as a percentage. It answers: for every dollar of equity investors have entrusted to management, how many cents of profit does the company produce? Warren Buffett treats sustained high ROE as one of the clearest fingerprints of a durable competitive advantage.

The metric is intuitive: if a company holds $100 of equity capital and earns $20 of net income, its ROE is 20 percent. The intuition gets complicated quickly because equity is itself a function of accumulated buybacks, dividends, write-downs, and goodwill. A 30 percent ROE on a balance sheet stripped clean by aggressive buybacks is not the same thing as a 30 percent ROE earned on a conservative balance sheet.

Formula

The DuPont decomposition is the most useful single tool when analysing ROE. It answers the question “where does this high ROE come from?” in three minutes flat. If margins are driving it, the company has pricing power; if turnover is driving it, operational efficiency; if leverage is driving it, financial risk.

Worked example: Costco Wholesale (COST)

Costco is a classic quality compounder. Take an illustrative snapshot with trailing twelve-month net income of approximately $7.4B, revenue of roughly $247B, average shareholders equity of $23B, and average total assets of $67B. [TODO: verify against the latest /stock/COST feed before publishing.]

Costco’s ROE in the low-thirties is impressive but the DuPont decomposition reveals the source. The net profit margin is thin (under 3 percent), reflecting the warehouse-club discount model. Asset turnover is high (close to 4x), reflecting extraordinary inventory efficiency. The equity multiplier is moderate (around 3x), reflecting some financial leverage but not extreme. The conclusion: Costco’s high ROE is genuinely operational, driven by asset efficiency rather than balance- sheet engineering. That is the kind of high ROE Warren Buffett actively hunts for.

Calculate ROE

Enter trailing net income and average shareholders equity. The calculator returns ROE with a quality flag against broad-market norms.

For full DuPont decomposition and 10-year ROE trends, use the per-ticker pages on the Stock Screener.

ROE bands by industry

ROE varies enormously by sector. Capital structure norms, regulatory caps, and asset intensity all shape what counts as a healthy figure. The table below sets out typical ranges for major US sectors.

ROE vs related return metrics

ROE is one of a family of return metrics. Each strips leverage and tax effects differently, and each is useful in different contexts.

For a value investor, the most useful pairing is ROE alongside ROIC. A 25 percent ROE with a 20 percent ROIC indicates genuine operating excellence with sensible leverage. A 25 percent ROE paired with a 10 percent ROIC indicates that leverage is doing half the work — the moat is real but smaller, and the equity returns are more fragile.

How value investors use Return on Equity

Warren Buffett’s framework, summarised in countless Berkshire annual letters, is built around sustained high ROE earned on tangible equity with modest debt. The reasoning is straightforward: if a company can reinvest internally at 20 percent or higher year after year, every retained dollar compounds at that rate. Over a 20-year holding period, a 20 percent reinvestment ROE turns $1 into about $38 — independent of any multiple expansion. Buffett’s preference for See’s Candies, Coca-Cola, and American Express reflects this logic in action.

Three disciplines turn ROE from a screen into a research signal. First, look at a 10-year ROE series, not a single year. A one-time 40 percent ROE driven by a divestiture gain tells you nothing about durable economics. A 10-year median ROE of 25 percent across multiple business cycles is a different story. Second, decompose using DuPont. If high ROE comes from leverage, value the business at a steeper discount; if it comes from margins and turnover, the moat is real. Third, cross-check ROE against ROIC. Sustained high ROIC is the most rigorous quality signal because it strips out the capital-structure noise.

On the ValueMarkers platform, the Stock Screener exposes ROE, 5-year and 10-year ROE CAGR, and the full DuPont split for every covered ticker. A typical Buffett-style screen: filter for 10-year median ROE above 18 percent, debt-to-equity below 0.5, and trailing P/E below 20. The intersection is small but the businesses that survive the filter are almost always worth a closer look. Pair the output with the DCF Calculator to confirm valuation discipline.

[Javier insight: A 35 percent ROE on a 4x equity multiplier is not the same business as a 35 percent ROE on a 1.5x equity multiplier — even if the headline number is identical. The first is a financial machine that needs leverage to look good. The second is an actual moat. I have never lost money buying the second; I have lost money buying the first more times than I care to count. Always look at the DuPont split before you write the cheque.]

Frequently asked questions

Related glossary terms