#What is Return on Equity (ROE)?
Return on Equity (ROE) reveals how much profit a company generates with the money shareholders have invested.
Formula: ROE = Net Income / Shareholder's Equity
If a company has $100 million in equity (assets minus liabilities) and makes $20 million in profit, its ROE is 20%.
#Why ROE Matters
High ROE is the defining characteristic of a "Quality" business. It means the company doesn't need much capital to generate profit.
The Compounder Effect Companies with high ROE can reinvest their profits at high rates of return. This leads to exponential compounding over time. - **High Quality (25%+):** Software, dominant consumer brands, efficient monopolies. - **Average (12%):** Typical competitive business. - **Low Quality (<5%):** Capital-intensive industries (airlines, heavy manufacturing) or poorly managed firms.
#The DuPont Analysis
You can break ROE down into three drivers to understand why it's high:
- 1Profit Margin: (Net Income / Sales) — How much claim they keep of every dollar.
- 2Asset Turnover: (Sales / Assets) — How efficiently they use assets to generate sales.
- 3Financial Leverage: (Assets / Equity) — How much debt they use.
Warning: A company can boost ROE simply by taking on massive debt (increasing leverage). This is "bad" ROE. We prefer companies that drive ROE through high margins and efficiency.
#ROE vs. ROIC
ROE looks at return on equity. Return on Invested Capital (ROIC) looks at return on all capital (equity + debt).
- For companies with zero debt, ROE = ROIC.
- For heavily indebted companies, ROIC is a better measure of true operating quality.
#How We Use it in Rankings
Profitability is our extensive factor (30% weight), and ROE is a key component. We look for companies with: 1. High ROE relative to peers. 2. Stable or improving ROE over 5 years. 3. High cash flow confirmation (to prove the earnings are real).
Last updated: February 10, 2026