V09: ROE (Return on Equity) — how to analyse it

ROE is Warren Buffett's favourite. High ROE = the company is good at reinvesting profit. Buffett looks for companies with ROE > 15% sustained. Low ROE = the company destroys value.

This is V09 — ROE (Return on Equity) in the AKM1 model: one of the 20 variables that together determine whether a company is an institutional quality stock or a collection of stories. In this article you get the variable explained, how to compute it yourself, and how three of history's greatest investors would have interpreted it.

Why the variable exists

ROE as a concept is as old as the corporate form itself. As early as the 1600s, when the VOC (Dutch East India Company, 1602) issued stocks, investors computed 'return on invested capital' — an early form of ROE. The modern ROE concept was formalised in the middle of the 1900s through Benjamin Graham and David Dodd's 'Security Analysis' (1934). They emphasised that 'return on equity' was one of the most important indicators of company quality. In the 1920s DuPont Corporation developed the DuPont decomposition to break ROE down into three components — this was an internal tool for assessing performance in DuPont's various divisions, but later spread to the entire financial world.

ROE — the ultimate profitability indicator

What ROE really measures ROE (Return on Equity) measures return on equity — how much profit the company creates per krona the shareholders have invested. Formula: ROE = Net profit / Equity × 100. ROE is the most complete profitability indicator because it captures three dimensions at once: 1) Operating profitability — can the company generate profit from its operations? 2) Capital efficiency — can the company generate revenue from its assets? 3) Financial leverage — can the company use liabilities to amplify the return? A company with ROE 25% creates 25 öre of profit per krona of equity — every year. Over 10 years that becomes 25% × 10 = 250% profit growth, assuming all profit is reinvested. This is compounding — ROE is its engine. Warren Buffett has said: 'We look for companies with ROE above 15% sustained over 5+ years.' This is his primary quality filter. Assa Abloy has ROE ~16% sustained over 10 years — the Buffett requirement met. Electrolux has ROE ~10% — below the requirement.

Computing ROE in practice

Find the numbers in the annual report ROE requires two lines: Net profit and Equity. You find net profit on the last line of the income statement — 'Result for the year' or 'Net profit'. You find equity in the capital part of the balance sheet — 'Equity' with sub-items (share capital, funds, retained profit). The total value is what you should use. Example Assa Abloy 2023: Net profit 14 943 MSEK, Equity 94 700 MSEK. ROE = 14 943 / 94 700 × 100 = 15,8%. This gives score 4 (15-25%) on the AKM1 scale — meets the Buffett requirement. Sampo 2023: Net profit 1 953 MEUR, Equity 11 628 MEUR. ROE = 1 953 / 11 628 × 100 = 16,8%. Score 4. Atlas Copco 2023: Net profit 23 700 MSEK, Equity 95 000 MSEK. ROE = 23 700 / 95 000 × 100 = 24,9%. Score 4 (upper part of 15-25%). Hexagon 2023: Net profit 1 393 MEUR, Equity 7 027 MEUR. ROE = 1 393 / 7 027 × 100 = 19,8%.

Three perspectives on ROE (Return on Equity)

Peter Lynch: Lynch preferred companies with a stable high ROE (>15%) but warned against extremely high ROE achieved through liabilities. 'A company with 30% ROE and 200% debt load is not better than one with 15% ROE and 0% debt.' Lynch combined ROE with the debt-to-equity ratio — 'You cannot understand ROE without knowing how it is financed.'

Benjamin Graham: Graham required ROE > 10% to even consider a company. He argued that low ROE over a long time indicates a bad business, regardless of how cheap the stock is. 'A bad company at a low price is still a bad deal.' Graham combined ROE > 10% with P/B < 1.5 and P/E < 15.

AK1's interpretation: AKM1 weight 6%. ROE is powerful but can be manipulated via debt. We break ROE down with the DuPont formula: ROE = gross margin × capital turnover × debt leverage. AKM1 assesses ROE in three ways: (1) level, (2) trend, (3) quality — high ROE via debt = warning, high ROE via margin and revenue = good. We combine V09 with V10 (debt load).

Go deeper

Want to practise with worked examples, chapter by chapter? The course ROE (Return on Equity) (V09) contains 6 chapters, Lynch and Graham perspectives and how AK1 uses the variable in the wave matrix. See also the complete guide to Swedish stock analysis for how all 20 variables fit together.

FAQ

What is ROE?

ROE (Return on Equity) measures the return on equity — how much profit the company creates per krona the shareholders have invested. The formula is net income ÷ equity × 100. Because the measure captures operating profitability, capital efficiency and financial leverage at the same time, it is often called the most complete profitability indicator. The course ROE (V09) explains the variable with calculation exercises.

How do I calculate ROE in practice?

Hämta årets resultat från resultaträkningens sista rad och det totala egna kapitalet (aktiekapital, fonder och balanserad vinst) från balansräkningens kapitaldel. Dividera resultatet med kapitalet och multiplicera med 100. I exemplet ovan ger nettoresultat 14 943 MSEK och eget kapital 94 700 MSEK en ROE på cirka 15,8 procent.

Can a high ROE be a warning sign?

Yes — a high ROE can be created with leverage instead of operations. A company that lifts its ROE through heavy debt amplifies the return but also the risk, especially when interest rates rise. The DuPont formula (ROE = gross margin × capital turnover × debt leverage) shows where the return comes from, which is why V09 in AKM1 is combined with leverage variables.

What ROE level is considered good?

As an educational reference, Warren Buffett has mentioned companies with ROE above 15 percent for at least five years as a quality filter, and Benjamin Graham used above 10 percent as a baseline requirement. The level must always be seen in its industry context and against the company’s own trend, though. No single figure is a recommendation — it is an entry point for further analysis.

This is educational financial analysis, not investment advice.