What ROE Reveals About a Business
ROE is the equity investor's perspective on profitability. It combines operating efficiency (profit margin), asset utilisation (asset turnover), and financial leverage (equity multiplier) into one number. A business with a consistently high ROE over time is generally creating significant shareholder value.
Warren Buffett famously looks for businesses with consistent ROE above 15% as a signal of durable competitive advantage. Companies with wide economic moats (pricing power, switching costs, network effects) tend to sustain high ROEs because competition cannot easily erode their margins.
DuPont Decomposition
ROE can be decomposed into three drivers (DuPont formula): ROE = Net Profit Margin × Asset Turnover × Equity Multiplier (1 + D/E). This reveals whether high ROE comes from (1) strong profitability (high margins), (2) efficient asset use (high asset turnover), or (3) financial leverage (high debt). Only the first two are truly sustainable; leverage-driven ROE increases financial risk.
ROE and Sustainable Growth Rate
The sustainable growth rate — the growth rate a business can achieve without external financing — equals ROE × retention ratio (1 − dividend payout). A business with 15% ROE that retains 80% of earnings can grow at 12% sustainably. This is a powerful concept: profitability drives growth capacity.
Share buybacks affect ROE by reducing equity, which mechanically increases ROE even if profitability doesn't change. This is why rising ROE over time should be paired with growth in absolute net income to confirm genuine improvement rather than financial engineering.
15%+
Buffett's ROE threshold for quality businesses
12–15%
Typical cost of equity (hurdle rate)
ROE × RR
Sustainable growth rate = ROE × retention ratio
DuPont
Decompose ROE into margin, turnover, leverage