Deep Dive: What Is Return on Equity (ROE) — How to Calculate It, the DuPont Framework, and What It Reveals About Management Effectiveness
Return on equity is one of the most widely cited profitability metrics in investing — and for good reason. It answers a deceptively simple question: how effectively is a company turning shareholder capital into profit? A business that generates $20 million in net income on $100 million of shareholders' equity earns a 20% ROE, meaning every dollar of equity produces 20 cents of annual profit. That single number captures the intersection of pricing power, cost discipline, asset efficiency, and capital structure decisions. But ROE's simplicity can be misleading. Apple currently reports a trailing annualized ROE above 160%, while Tesla barely manages 4%. Does that make Apple forty times more effective at deploying capital? Not necessarily. Apple's aggressive share buyback program has compressed its equity base to roughly $57 billion despite earning over $90 billion annually — mathematically inflating ROE to eye-popping levels. Meanwhile, Tesla sits on a massive equity cushion with relatively thin margins. Understanding what drives ROE, and when it's telling the truth versus flattering the picture, separates informed investors from those chasing misleading numbers. This guide breaks down ROE from first principles: the formula, the DuPont decomposition that reveals its three hidden drivers, real cross-sector data from eight major companies, and practical frameworks for using ROE alongside its companion metric, return on assets (ROA). Whether you're screening stocks, comparing management teams, or evaluating whether a company's profitability is sustainable, ROE is a tool you'll reach for constantly — but only if you know how to read it properly.