What Is Return on Equity (ROE)? The DuPont Breakdown (2026)

Quick answer

Return on equity (ROE) is net income divided by average shareholders' equity. It measures how much profit a company earns on the capital its owners have invested or left in the business: an ROE of 15% means $15 of annual profit for every $100 of book equity.

On its own, ROE says nothing about how that return was earned. The DuPont breakdown splits it into profit margin, asset turnover and leverage, which shows whether a high number reflects a strong business or a thin layer of equity under a lot of debt.

Key takeaways

Return on equity (ROE) is net income divided by average shareholders' equity, and it measures how much profit a company earns on the capital its owners have put in or left in the business.
The DuPont breakdown splits ROE into net margin, asset turnover and leverage, which shows whether a high ROE comes from pricing power, efficient use of assets or borrowed money.
The five-step version adds the tax burden and the interest burden, separating operating performance from financing and tax effects.
Buybacks, write-downs and accumulated losses can shrink equity and inflate ROE without any improvement in the business, so equity needs checking before the ratio is trusted.
ROE matters most for valuation when compared with the cost of equity: a company that earns well above it can justify a premium to book value, one that earns below it usually cannot.

Table of contents

The ROE formula
The three-step DuPont breakdown
The five-step DuPont breakdown
Reading ROE over time
When ROE misleads
ROE and valuation
How to use ROE in research
Where this goes wrong
The bottom line

The ROE formula

ROE = net income / average shareholders' equity

Use average equity, the mean of the opening and closing balance sheets, because profit is earned over the whole year. For companies with preferred stock, use net income available to common shareholders and common equity only.

All the inputs are in the 10-K: net income on the income statement and equity on the balance sheet. The statement of shareholders' equity shows what moved equity during the year, including buybacks, dividends and other comprehensive income. Our explainer on the 10-K shows where each statement sits.

The three-step DuPont breakdown

The DuPont method, developed at the chemical company of that name early in the last century, writes ROE as the product of three ratios:

ROE = (net income / revenue) x (revenue / average assets) x (average assets / average equity)

Component	Formula	What it measures	What raises it
Net profit margin	Net income / revenue	Profit kept from each dollar of sales	Pricing power, cost control, lower taxes
Asset turnover	Revenue / average assets	Sales generated per dollar of assets	Lean inventory, high utilization
Equity multiplier	Average assets / average equity	How much of the asset base is financed by debt and other liabilities	Borrowing, buybacks, losses

The revenue and assets terms cancel, leaving net income over equity. The value of the breakdown is that two companies with the same ROE can reach it in very different ways.

The five-step DuPont breakdown

The extended version separates the margin into operating and financing parts:

ROE = (net income / pretax income) x (pretax income / EBIT) x (EBIT / revenue) x (revenue / average assets) x (average assets / average equity)

Tax burden (net income / pretax income): the share of pretax profit kept after tax.
Interest burden (pretax income / EBIT): the share of operating profit left after interest.
Operating margin (EBIT / revenue): profit from the business before financing and tax.
Asset turnover: as before.
Equity multiplier: as before.

The five-step version shows when ROE rose because of a lower tax rate or lower interest costs rather than better operations. A one-off tax benefit can lift ROE for a year without changing the business at all. Our explainer on the interest coverage ratio covers the interest side in more detail.

Reading ROE over time

A single year of ROE says little. Five to ten years show whether returns are stable, rising or falling, and the DuPont components show why. A company whose ROE has held steady while its equity multiplier fell is earning more from the business and less from debt, which is usually a better sign than the reverse.

Look at the years around recessions in particular. A business that keeps ROE near its cost of equity through a downturn is more valuable than one that swings from 25% at the peak to losses at the trough, even if the averages match. When a company announces a turnaround plan, write down the ROE it implies and check each year whether the margin, turnover or leverage leg is doing the work.

When ROE misleads

ROE is only as good as its denominator. Several ordinary events change equity without changing the business:

Buybacks. Repurchasing shares reduces equity. A company that buys back stock heavily can show a rising ROE on flat profits. See when buybacks matter as catalysts.
Write-downs. A large goodwill impairment shrinks equity, so future ROE looks better even though the money was spent. Our explainer on goodwill and impairments covers this.
Accumulated losses. Years of losses can leave equity near zero, which makes ROE very large or negative and not useful.
Leverage. Debt-funded growth lifts the equity multiplier. ROE rises, but so does risk.
Off-balance-sheet items. Obligations not on the balance sheet make equity look larger relative to true liabilities, or smaller, depending on the item. See off-balance-sheet liabilities.

Comparing ROE with return on invested capital is the quickest check. If ROE is far above ROIC, most of the difference comes from leverage.

ROE and valuation

ROE links directly to the price-to-book ratio. A company that earns exactly its cost of equity on book value, year after year, is worth about its book value. One that earns more can justify a premium, and one that earns less tends to trade at a discount.

A simple version of this relationship, for a company with stable returns and growth, is:

Justified price-to-book = (ROE - g) / (cost of equity - g)

where g is the long-term growth rate. With an ROE of 15%, a cost of equity of 10% and growth of 4%, the justified price-to-book is (15 - 4) / (10 - 4), or about 1.8 times. The formula is sensitive to its inputs and works best for steady businesses such as banks and insurers. Our explainer on the price-to-book ratio and our guide on how to value a bank stock apply it.

For special situations, the useful question is often whether ROE is about to change. A company below book value with a depressed ROE can rerate if an asset sale, a cost program or a new management team lifts returns. See our guide on how to value a company below book.

How to use ROE in research

If ROE is high and the equity multiplier is low, the business earns its returns from margin or turnover. Check how durable they are.
If ROE is high and the equity multiplier is high, test what happens to ROE if rates rise or margins fall.
If ROE jumped in one year, run the five-step breakdown to see whether tax or interest drove it.
If equity is small or negative, set ROE aside and use ROIC or return on assets.
If ROE is below the cost of equity for years, a discount to book value may be justified rather than a mistake.

The data platforms in our list of the best stock research tools for individual investors calculate ROE and its components across years, which makes the comparisons faster.

Where this goes wrong

Comparing across industries. Banks, software companies and retailers have very different normal levels of leverage and margin.
Using a single year. Cyclical companies show high ROE at the peak and low ROE at the trough. Use normalized earnings across a cycle.
Ignoring the denominator. Equity distorted by buybacks or write-downs can produce a flattering ratio.
Treating ROE as growth. A high ROE only produces growth if the company can reinvest at similar returns. Many cannot and return the cash instead.

The bottom line

Return on equity is net income divided by average shareholders' equity, the profit earned on the owners' capital. The DuPont breakdown shows whether that return comes from margin, asset turnover or leverage, and the five-step version separates operations from tax and interest. Check the equity balance for buybacks, write-downs and accumulated losses before trusting the ratio. For valuation, the key comparison is ROE against the cost of equity, which explains much of why some companies trade above book value and others below.

Frequently asked questions

What is a good return on equity?

There is no single threshold, because ROE varies by industry and by how much debt companies carry. A useful test is whether ROE is above the company's cost of equity, often estimated in the high single digits to low double digits, and whether it has stayed there through a full business cycle. Compare a company with its own history and with peers that use similar leverage.

How do you calculate ROE?

Divide net income for a year by average shareholders' equity over the same year, usually the average of the opening and closing balances. For a company with preferred stock, use net income available to common shareholders and common equity only. Multiply by 100 to express it as a percentage.

What is the DuPont formula?

The three-step DuPont formula writes ROE as net profit margin times asset turnover times the equity multiplier. Net margin is net income over revenue, asset turnover is revenue over average assets, and the equity multiplier is average assets over average equity. Multiplying the three gives net income over equity.

Can ROE be too high?

A very high ROE can mean an excellent business, but it can also mean equity is unusually small because of heavy debt, large buybacks or past losses. When equity approaches zero, ROE becomes very large and stops being meaningful. Check the equity multiplier and the history of the equity balance before relying on it.

What is the difference between ROE and ROIC?

ROE measures profit to shareholders against shareholders' equity, so it rises with leverage. ROIC measures after-tax operating profit against all invested capital, debt and equity together, so it is largely independent of how the company is financed. Comparing the two shows how much of ROE comes from borrowing.

What does negative ROE mean?

It means either a net loss or negative shareholders' equity. A loss with positive equity is straightforward. Negative equity, which can result from years of buybacks or accumulated losses, makes the ratio meaningless, and analysts switch to measures such as return on invested capital or return on assets.

Why do banks focus on ROE?

Banks are financed mostly with deposits and debt, so equity is the scarce capital that regulators measure. ROE, often on tangible equity, shows how well a bank earns on that capital. Price to tangible book value for banks tends to track how far ROE sits above the cost of equity.

Sources

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By James Whitfield, Head of Equity Research, Dombey Capital

Published November 1, 2026 · 6 min read · Valuation