Level 6 · Financial Ratios
ROE
How much profit the company generates on the shareholders' own money.
In this lesson
What you'll be able to do
- Calculate ROE
- Break ROE into its three drivers
- Spot debt-inflated ROE
- Judge a good ROE in context
Think about it
Two companies both report 25% ROE. One is excellent and one is dangerous. What separates them?
Story
Let's picture it
Two friends each start with ₹1 lakh of their own money. The first earns ₹25,000 profit using only that capital. The second borrows another ₹4 lakh, earns ₹25,000 after paying interest, and also reports 25% on his own money. Both look identical on paper. Only one of them stays safe when business slows and the loan still needs servicing.
Visual
DuPont: breaking ROE into three
Net profit margin
Net profit ÷ Revenue, how profitable each sale is
× Asset turnover
Revenue ÷ Assets, how hard the assets work
× Equity multiplier
Assets ÷ Equity, how much leverage is used
= ROE
The three multiplied give return on equity
Plain English
The simple explanation
ROE is net profit divided by shareholders' equity. It answers the owner's core question: what return is the business earning on the money that belongs to me?
The DuPont breakdown is what separates a beginner from an analyst. It splits ROE into margin, efficiency and leverage, so you can see which one is doing the work.
High ROE driven by margin and asset efficiency is high quality. High ROE driven mainly by leverage is borrowed, and it reverses violently in a downturn.
Real world
Asian Paints
Asian Paints has historically maintained a high ROE driven largely by strong margins and efficient asset use rather than heavy borrowing. That combination, high return without high leverage, is what analysts look for when assessing quality.
Watch out
Common mistakes
- Comparing ROE without checking debt levels.
- Ignoring one-off profits that inflate a single year.
- Assuming a higher ROE is always the better business.
Did you know?
A company with negative equity can report a bizarre or negative ROE that means nothing at all, always check the denominator before trusting the ratio.
Your turn
Mini challenge
Calculate ROE for one company, then break it into the three DuPont components. Which drives it?
Quick quiz
1 / 5
Wrap up
Summary
ROE measures return on shareholders' money. Decompose it with DuPont into margin, asset efficiency and leverage before deciding whether the number reflects quality or borrowing.
- ROE = net profit ÷ equity
- DuPont = margin × turnover × leverage
- Leverage-driven ROE is fragile
- Check equity is positive and clean
Revise