Return on Equity: Shareholder Efficiency

§ 01Apple's ROE and debt-to-equity, live

§ 02The return-on-equity formula

ROE = Net Income / Shareholders' Equity

§ 03Reading an ROE figure, and Buffett's benchmark

An ROE of 20% means the company earns $0.20 for every $1 of equity. Buffett targets companies with ROE consistently above 15%.

§ 04DuPont: the three drivers behind ROE

DuPont decomposition splits ROE into three drivers: ROE = Net Margin × Asset Turnover × Equity Multiplier (leverage). In plain terms: asset turnover is how many dollars of sales the company generates from each dollar of assets (Revenue / Total Assets), a measure of operating efficiency; the equity multiplier is how many dollars of assets it carries per dollar of shareholders' equity (Total Assets / Equity), which rises as the company funds itself with more debt — it is the leverage lever. The same 25% ROE can come from a wide-moat compounder (high margin) or a thin-margin business levered to the hilt — these are not the same investment.

§ 05Why high debt can inflate ROE

Watch out: high debt can artificially inflate ROE by shrinking the equity denominator. Always check Debt/Equity alongside ROE.

§ 06Check ROE against debt-to-equity

§ 07Which 25% ROE is more impressive?

§ 08ROE quality depends on how it is funded

ROE tells you how well management uses shareholder capital. But context matters: a 25% ROE funded by prudent operations is worth far more than one propped up by aggressive borrowing.