Net profit margin
Net income divided by revenue. Measures pricing power, cost discipline, and the underlying economics of the business model.
Definition
What is ROE?
ROE, return on equity, is net income divided by shareholder equity, expressed as a percent. It measures the profit a company earns on each dollar of book equity. Sustained ROE above 15 percent signals quality, but watch carefully for debt-inflated ROE where leverage drives the headline.
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Short answer
ROE is the original quality screen but it is trivial to manufacture with debt. A company can buy back stock with borrowed money, shrink the equity base, and produce a higher ROE without earning a dollar more. The DuPont decomposition exists precisely to expose this distortion.
The DuPont decomposition of ROE
Du Pont accountants in the 1920s broke ROE into three components. Looking at all three together reveals what is actually driving profitability.
Asset turnover
Revenue divided by total assets. Measures capital intensity. High turnover means the business sweats its assets; low turnover means heavy reinvestment needs.
Equity multiplier
Total assets divided by equity. The leverage component. High multiplier can lift ROE artificially. Always inspect this number before trusting a high ROE.
A worked example
Home Depot earned roughly 15 billion dollars in net income against equity of around 5 billion dollars. ROE is 15 divided by 5, or 300 percent. The number is real but entirely a function of years of aggressive buybacks that shrunk the equity base. ROIC tells the truer story: roughly 40 percent. Both metrics matter; reading only one gives a misleading picture.
Related
- Buffett-Fit methodology - ROE feeds the moat and financial-health pillars of the Buffett-Fit rubric.
- Top Buffett-fit stocks today - the live ranking of US-listed stocks with sustained high ROE under the Buffett rubric.
See ROE in framework reasoning
invest-like surfaces ROE alongside leverage and ROIC so the quality picture is never a single number.
Educational only. invest-like is not a registered investment adviser; nothing here is personalised investment advice. Always do your own research and consider your individual circumstances.