# Return on Equity (ROE): Formula, Calculation, and What It Reveals About a Business Published: 2026-04-04 Author: Warren Team URL: https://www.heywarren.com/blog/return-on-equity --- [Return on equity](/blog/calculate-roe) is one of the most powerful indicators of business quality, it measures how efficiently a company generates profits from its shareholders' invested capital. Warren Buffett has repeatedly identified consistently high ROE as one of the hallmarks of an exceptional business. Here's the formula, how to calculate it, and what it actually tells you. ## What Is Return on Equity (ROE)? Return on equity (ROE) measures how much net income a company generates per dollar of shareholders' equity, the book value of the net assets owned by shareholders. **[ROE Formula](/blog/roe-formula)**: **ROE = Net Income / Average Shareholders' Equity** **Average Shareholders' Equity = (Beginning Equity + Ending Equity) / 2** **Example**: - Net income (annual): $200 million - Beginning shareholders' equity: $800 million - Ending shareholders' equity: $1,000 million - Average equity: $900 million **ROE = $200M / $900M = 22.2%** This company earns $22.20 in profit for every $100 of shareholders' equity, a strong result by most standards. ## What's Considered "Good" ROE? ROE benchmarks vary by industry: | ROE Range | Assessment | |---|---| | < 10% | Generally poor (below [cost of equity](/blog/cost-of-equity-equation) for most businesses) | | 10–15% | Average for most industries | | 15–20% | Good, above the cost of equity, creating value | | 20–30%+ | Exceptional, indicates significant competitive advantage | | > 30% consistently | Rare, powerful, often a "franchise" quality business | The S&P 500's average ROE is approximately 15–20% over most market cycles. **Why 15%+ matters**: Most companies' cost of equity (the return shareholders require to justify investing) is approximately 8–12%. A company consistently earning ROE above its cost of equity is creating economic value; below that, it's destroying it, regardless of growing revenues. ## The DuPont Analysis: Decomposing ROE ROE can be broken into three components using the **[DuPont formula](/blog/dupont-formulas)**, revealing *why* a company has high or low ROE: ![The three DuPont factors multiply together to produce ROE: profit margin, asset turnover, and financial leverage.](data:image/svg+xml,%3Csvg%20xmlns%3D%22http%3A%2F%2Fwww.w3.org%2F2000%2Fsvg%22%20viewBox%3D%220%200%20875%20125%22%20width%3D%22875%22%20height%3D%22125%22%20role%3D%22img%22%3E%3Ctitle%3EFlow%20diagram%3C%2Ftitle%3E%3Crect%20width%3D%22100%25%22%20height%3D%22100%25%22%20fill%3D%22%23f8fafc%22%2F%3E%3Crect%20x%3D%2230%22%20y%3D%2225%22%20width%3D%22170%22%20height%3D%2275%22%20rx%3D%2210%22%20fill%3D%22white%22%20stroke%3D%22%232563eb%22%20stroke-width%3D%222%22%2F%3E%3Ctext%20x%3D%22115%22%20y%3D%2258.5%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2214%22%20font-weight%3D%22600%22%20fill%3D%22%230f172a%22%3ENet%20Margin%3C%2Ftext%3E%3Ctext%20x%3D%22115%22%20y%3D%2278.5%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2211%22%20fill%3D%22%2364748b%22%3EIncome%20%2F%20Revenue%3C%2Ftext%3E%3Cline%20x1%3D%22205%22%20y1%3D%2262.5%22%20x2%3D%22237%22%20y2%3D%2262.5%22%20stroke%3D%22%2364748b%22%20stroke-width%3D%222%22%2F%3E%3Cpolygon%20points%3D%22244%2C62.5%20235%2C57.5%20235%2C67.5%22%20fill%3D%22%2364748b%22%2F%3E%3Crect%20x%3D%22245%22%20y%3D%2225%22%20width%3D%22170%22%20height%3D%2275%22%20rx%3D%2210%22%20fill%3D%22white%22%20stroke%3D%22%232563eb%22%20stroke-width%3D%222%22%2F%3E%3Ctext%20x%3D%22330%22%20y%3D%2258.5%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2214%22%20font-weight%3D%22600%22%20fill%3D%22%230f172a%22%3EAsset%20Turnover%3C%2Ftext%3E%3Ctext%20x%3D%22330%22%20y%3D%2278.5%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2211%22%20fill%3D%22%2364748b%22%3ERevenue%20%2F%20Assets%3C%2Ftext%3E%3Cline%20x1%3D%22420%22%20y1%3D%2262.5%22%20x2%3D%22452%22%20y2%3D%2262.5%22%20stroke%3D%22%2364748b%22%20stroke-width%3D%222%22%2F%3E%3Cpolygon%20points%3D%22459%2C62.5%20450%2C57.5%20450%2C67.5%22%20fill%3D%22%2364748b%22%2F%3E%3Crect%20x%3D%22460%22%20y%3D%2225%22%20width%3D%22170%22%20height%3D%2275%22%20rx%3D%2210%22%20fill%3D%22white%22%20stroke%3D%22%232563eb%22%20stroke-width%3D%222%22%2F%3E%3Ctext%20x%3D%22545%22%20y%3D%2258.5%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2214%22%20font-weight%3D%22600%22%20fill%3D%22%230f172a%22%3ELeverage%3C%2Ftext%3E%3Ctext%20x%3D%22545%22%20y%3D%2278.5%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2211%22%20fill%3D%22%2364748b%22%3EAssets%20%2F%20Equity%3C%2Ftext%3E%3Cline%20x1%3D%22635%22%20y1%3D%2262.5%22%20x2%3D%22667%22%20y2%3D%2262.5%22%20stroke%3D%22%2364748b%22%20stroke-width%3D%222%22%2F%3E%3Cpolygon%20points%3D%22674%2C62.5%20665%2C57.5%20665%2C67.5%22%20fill%3D%22%2364748b%22%2F%3E%3Crect%20x%3D%22675%22%20y%3D%2225%22%20width%3D%22170%22%20height%3D%2275%22%20rx%3D%2210%22%20fill%3D%22white%22%20stroke%3D%22%232563eb%22%20stroke-width%3D%222%22%2F%3E%3Ctext%20x%3D%22760%22%20y%3D%2258.5%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2214%22%20font-weight%3D%22600%22%20fill%3D%22%230f172a%22%3EROE%3C%2Ftext%3E%3Ctext%20x%3D%22760%22%20y%3D%2278.5%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2211%22%20fill%3D%22%2364748b%22%3ECombined%20result%3C%2Ftext%3E%3C%2Fsvg%3E) *The three DuPont factors multiply together to produce ROE: profit margin, asset turnover, and financial leverage.* **ROE = Net Profit Margin × Asset Turnover × Financial Leverage** Where: - **Net Profit Margin** = Net Income / Revenue (profitability per dollar of revenue) - **Asset Turnover** = Revenue / Average Total Assets (sales efficiency per dollar of assets) - **Financial Leverage** = Average Total Assets / Average Shareholders' Equity (leverage ratio) **Three ways to achieve high ROE**: 1. **High profit margins**: Luxury goods, software, pharmaceuticals, earn a large percentage of every sales dollar as profit (e.g. 25–40% margins) 2. **High asset turnover**: Retailers, fast food, earn modest margins on each transaction but turn assets over many times per year (e.g. 0.5% margin on 60 turns = 30% return) 3. **High financial leverage**: Banks, REITs, use debt to amplify returns (but this also amplifies risk) **Example DuPont comparison**: | Company | Net Margin | Asset Turnover | Leverage | ROE | |---|---|---|---|---| | Apple (approx.) | 25% | 1.1x | 5.5x | ~150%* | | Walmart | 2.4% | 2.3x | 4.0x | ~22% | | JPMorgan Chase | 25% | 0.06x | 10x | ~15% | *Apple's ROE is technically very high due to large buybacks reducing equity to near-zero; the DuPont framework helps explain this ## ROE and Share Buybacks Share buybacks reduce shareholders' equity (the denominator in ROE), which mechanically increases ROE, even without profit improvement. ![A $200M buyback raises ROE from 20% to 33% with no change in net income.](data:image/svg+xml,%3Csvg%20xmlns%3D%22http%3A%2F%2Fwww.w3.org%2F2000%2Fsvg%22%20viewBox%3D%220%200%20800%20210%22%20width%3D%22800%22%20height%3D%22210%22%20role%3D%22img%22%3E%3Ctitle%3EComparison%3C%2Ftitle%3E%3Crect%20width%3D%22100%25%22%20height%3D%22100%25%22%20fill%3D%22%23f8fafc%22%2F%3E%3Ctext%20x%3D%22230%22%20y%3D%2257.5%22%20text-anchor%3D%22end%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2214%22%20font-weight%3D%22600%22%20fill%3D%22%230f172a%22%3EBefore%20Buyback%3C%2Ftext%3E%3Crect%20x%3D%22240%22%20y%3D%2225%22%20width%3D%22272.72727272727275%22%20height%3D%2255%22%20rx%3D%226%22%20fill%3D%22%232563eb%22%2F%3E%3Ctext%20x%3D%22524.7272727272727%22%20y%3D%2257.5%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2214%22%20font-weight%3D%22700%22%20fill%3D%22%232563eb%22%3E%2520%3C%2Ftext%3E%3Ctext%20x%3D%22230%22%20y%3D%22152.5%22%20text-anchor%3D%22end%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2214%22%20font-weight%3D%22600%22%20fill%3D%22%230f172a%22%3EAfter%20Buyback%3C%2Ftext%3E%3Crect%20x%3D%22240%22%20y%3D%22120%22%20width%3D%22450%22%20height%3D%2255%22%20rx%3D%226%22%20fill%3D%22%237c3aed%22%2F%3E%3Ctext%20x%3D%22702%22%20y%3D%22152.5%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2214%22%20font-weight%3D%22700%22%20fill%3D%22%237c3aed%22%3E%2533%3C%2Ftext%3E%3C%2Fsvg%3E) *A $200M buyback raises ROE from 20% to 33% with no change in net income.* **Example**: A company earns $100M with $500M in equity: ROE = 20%. The company repurchases $200M in shares (equity falls to $300M). Next year, it still earns $100M. New ROE = $100M / $300M = **33%**, without any improvement in underlying profitability. For companies with extensive buyback programs (Apple, Microsoft, many S&P 500 companies), ROE can be misleadingly high because equity has been compressed by repurchases. The DuPont leverage factor captures this, very high leverage in non-bank companies often reflects equity compression from buybacks rather than debt. ## ROE vs. ROIC: The Better Metric? **Return on Invested Capital (ROIC)** is often preferred by sophisticated analysts: **ROIC = NOPAT / Invested Capital** Where NOPAT = Net Operating Profit After Tax; Invested Capital = Equity + Debt (excluding cash and non-operating assets) ROIC advantages over ROE: - Not affected by capital structure (leverage is excluded), measures operating performance - Not distorted by buybacks - Can be compared across companies with different leverage ratios A company with high ROE but low ROIC is achieving its ROE through leverage, not operational excellence. ## Sustainable Growth Rate: Linking ROE to Growth The **sustainable growth rate**, how fast a company can grow without external financing, depends on ROE and retained earnings: ![A $100 book value compounding at 15% sustainable growth reaches $405 over ten years.](data:image/svg+xml,%3Csvg%20xmlns%3D%22http%3A%2F%2Fwww.w3.org%2F2000%2Fsvg%22%20viewBox%3D%220%200%20800%20149%22%20width%3D%22800%22%20height%3D%22149%22%20role%3D%22img%22%3E%3Ctitle%3ETimeline%3C%2Ftitle%3E%3Crect%20width%3D%22100%25%22%20height%3D%22100%25%22%20fill%3D%22%23f8fafc%22%2F%3E%3Cline%20x1%3D%22120%22%20y1%3D%2255%22%20x2%3D%22680%22%20y2%3D%2255%22%20stroke%3D%22%23cbd5e1%22%20stroke-width%3D%223%22%2F%3E%3Ccircle%20cx%3D%22120%22%20cy%3D%2255%22%20r%3D%2224%22%20fill%3D%22white%22%20stroke%3D%22%23cbd5e1%22%20stroke-width%3D%222%22%2F%3E%3Ctext%20x%3D%22120%22%20y%3D%2260%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2215%22%20font-weight%3D%22700%22%20fill%3D%22%230f172a%22%3E1%3C%2Ftext%3E%3Ctext%20x%3D%22120%22%20y%3D%22101%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2212%22%20font-weight%3D%22600%22%20fill%3D%22%230f172a%22%3EYear%200%3C%2Ftext%3E%3Ctext%20x%3D%22120%22%20y%3D%22119%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2210%22%20fill%3D%22%2364748b%22%3E%24100%20book%20value%3C%2Ftext%3E%3Ccircle%20cx%3D%22260%22%20cy%3D%2255%22%20r%3D%2224%22%20fill%3D%22white%22%20stroke%3D%22%23cbd5e1%22%20stroke-width%3D%222%22%2F%3E%3Ctext%20x%3D%22260%22%20y%3D%2260%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2215%22%20font-weight%3D%22700%22%20fill%3D%22%230f172a%22%3E2%3C%2Ftext%3E%3Ctext%20x%3D%22260%22%20y%3D%22101%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2212%22%20font-weight%3D%22600%22%20fill%3D%22%230f172a%22%3EYear%203%3C%2Ftext%3E%3Ctext%20x%3D%22260%22%20y%3D%22119%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2210%22%20fill%3D%22%2364748b%22%3E%24152%3C%2Ftext%3E%3Ccircle%20cx%3D%22400%22%20cy%3D%2255%22%20r%3D%2224%22%20fill%3D%22white%22%20stroke%3D%22%23cbd5e1%22%20stroke-width%3D%222%22%2F%3E%3Ctext%20x%3D%22400%22%20y%3D%2260%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2215%22%20font-weight%3D%22700%22%20fill%3D%22%230f172a%22%3E3%3C%2Ftext%3E%3Ctext%20x%3D%22400%22%20y%3D%22101%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2212%22%20font-weight%3D%22600%22%20fill%3D%22%230f172a%22%3EYear%205%3C%2Ftext%3E%3Ctext%20x%3D%22400%22%20y%3D%22119%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2210%22%20fill%3D%22%2364748b%22%3E%24201%3C%2Ftext%3E%3Ccircle%20cx%3D%22540%22%20cy%3D%2255%22%20r%3D%2224%22%20fill%3D%22white%22%20stroke%3D%22%23cbd5e1%22%20stroke-width%3D%222%22%2F%3E%3Ctext%20x%3D%22540%22%20y%3D%2260%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2215%22%20font-weight%3D%22700%22%20fill%3D%22%230f172a%22%3E4%3C%2Ftext%3E%3Ctext%20x%3D%22540%22%20y%3D%22101%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2212%22%20font-weight%3D%22600%22%20fill%3D%22%230f172a%22%3EYear%207%3C%2Ftext%3E%3Ctext%20x%3D%22540%22%20y%3D%22119%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2210%22%20fill%3D%22%2364748b%22%3E%24266%3C%2Ftext%3E%3Ccircle%20cx%3D%22680%22%20cy%3D%2255%22%20r%3D%2224%22%20fill%3D%22%232563eb%22%20stroke%3D%22%232563eb%22%20stroke-width%3D%223%22%2F%3E%3Ctext%20x%3D%22680%22%20y%3D%2260%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2215%22%20font-weight%3D%22700%22%20fill%3D%22white%22%3E5%3C%2Ftext%3E%3Ctext%20x%3D%22680%22%20y%3D%22101%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2212%22%20font-weight%3D%22600%22%20fill%3D%22%230f172a%22%3EYear%2010%3C%2Ftext%3E%3Ctext%20x%3D%22680%22%20y%3D%22119%22%20text-anchor%3D%22middle%22%20font-family%3D%22system-ui%2C-apple-system%2Csans-serif%22%20font-size%3D%2210%22%20fill%3D%22%2364748b%22%3E%24405%3C%2Ftext%3E%3C%2Fsvg%3E) *A $100 book value compounding at 15% sustainable growth reaches $405 over ten years.* **Sustainable Growth Rate = ROE × (1 − Dividend Payout Ratio)** **Example**: ROE = 20%, payout ratio = 25% (75% of earnings reinvested): - Sustainable growth = 20% × (1 − 25%) = 20% × 75% = **15% per year** A company with 20% ROE reinvesting most of its earnings can sustainably grow book value at 15% annually. Over a decade, a $100 book value per share grows to $405 at 15% compound. If the market continues to apply the same P/B multiple, the stock price roughly tracks book value growth. This is why Buffett and Munger look for companies with **consistently high ROE combined with high reinvestment rates**, the compounding engine is exceptionally powerful. ## ROE Limitations **Negative equity**: Companies with years of losses or massive buybacks can have negative equity. Negative equity produces negative ROE, mathematically nonsensical for performance measurement. **Highly leveraged companies**: A company with 90% debt and 10% equity might show 40% ROE simply because of leverage. This ROE doesn't indicate business quality, it indicates risk. **Accounting distortions**: One-time impairments, restructuring charges, large deferred tax items, all distort net income in the numerator, creating misleading single-year ROE readings. Use multi-year average ROE for more reliable assessment. **Different asset-intensity**: Asset-light businesses (software, insurance) naturally earn higher ROE than asset-heavy businesses (utilities, manufacturing). Comparing software company ROE to utility ROE is meaningless without acknowledging the capital structure and business model differences. ## Practical Application: Screening for Quality Warren Buffett's investment framework emphasizes: 1. Companies with consistently high ROE (15%+) over multiple years, not just one good year 2. This ROE should be achieved *without* excessive leverage (check ROIC alongside ROE) 3. Management should be able to reinvest retained earnings at or near the current ROE, the true test of durable competitive advantage Screening for companies with: - 5-year average ROE > 15% - Debt-to-equity < 1.5x - Consistent positive [free cash flow](/blog/cashflow-free) ...typically produces a shortlist of genuinely high-quality businesses. ## Authoritative Sources For deeper background and primary-source data on this topic, the following authoritative sources are useful starting points: - [U.S. Small Business Administration](https://www.sba.gov/) - [IRS, Businesses](https://www.irs.gov/businesses) ## Conclusion Return on equity is a foundational measure of capital efficiency and business quality. High, consistent ROE (15%+) over multiple years, especially when not dependent on excessive leverage, indicates a business with genuine competitive advantages and pricing power. The DuPont framework lets you dissect *why* a company achieves its ROE, revealing whether it comes from operational excellence, asset efficiency, or financial leverage. Combined with ROIC analysis, ROE gives you a comprehensive picture of whether management is genuinely compounding shareholder value over time. For related financial analysis topics, see our guides on [calculating return on assets (ROA)](/blog/calculate-roa), [profit and loss statements](/blog/profit-and-loss-statement), and [EBITDA to EV](/blog/ebitda-to-ev). Warren at [heywarren.com](https://heywarren.com) screens for high-ROE compounders and evaluates capital allocation quality to help you find genuinely excellent businesses. --- ## Related Reading **More from Warren**: - [EPS Formula: How to Calculate Earnings Per Share and Why It Matters](/blog/eps-formula) - [Rental Return: How to Calculate ROI on Rental Property and Whether It's Worth Investing](/blog/rental-return) - [CAGR Formula: How to Calculate Compound Annual Growth Rate](/blog/cagr-formula) **Authoritative sources**: - [SEC EDGAR, Company Filings](https://www.sec.gov/edgar/searchedgar/companysearch) - [Federal Reserve Economic Data (FRED)](https://fred.stlouisfed.org/) - [Bureau of Labor Statistics, Data Tools](https://www.bls.gov/data/)