V09: Calculate ROE like an analyst

If you could learn only one fundamental variable — one to carry with you for the rest of your life as an investor — it would be ROE, return on equity. In the AKM1 model it is V09, and it carries heavy weight for one reason: ROE is the only variable that captures the entire profitability chain in a single number.

The formula

ROE = Profit after tax ÷ Equity

Sounds simple. But as always the keys lie in the details: which profit, which capital, which period?

Three decisions that determine whether your ROE is right

1. Average or closing value? Equity grows during the year (profit is retained). If you use the year-end capital you underestimate the return on the capital that was actually at work. Institutions often use the average of opening and closing equity.

2. Adjusted equity? In Sweden, equity often contains large undistributed reserves (especially in investment companies and owner-led companies). Analysts sometimes adjust — but be consistent between companies.

3. Comparability. ROE for a bank (12–15 %) is not ROE for an industrial company (8–10 %) is not ROE for a SaaS company (it can be negative in the growth phase and still be valuable). Compare only within a sector — and preferably against the company's own 5-year history.

Du Pont: tear ROE apart into three parts

ROE = Margin × Turnover ratio × Leverage

This is the Du Pont equation, and it is worth its weight in gold. Two companies with ROE 15 % can be entirely different businesses:

• A high-margin, low-turnover company with little debt (a quality company — e.g. a niche consulting firm)
• A low-margin, fast-turnover company with high leverage (efficient but fragile — e.g. retail)

Same ROE, entirely different risk. Du Pont shows where the return comes from — and therefore how sustainable it is.

Common mistakes private investors make

Confusing ROE with stock returns. ROE measures the company's capital productivity, not your return as a shareholder. A company with ROE 20 % can be a bad stock if you paid 5 times book value.

Ignoring leverage. ROE driven by debt is no achievement — it is risk. Always check net debt/EBITDA next to ROE (in AKM1: V12 and V13).

Forgetting the timing of fiscal years. A half-year reported ROE × 2 is not annual ROE. Seasons, one-off items, and currencies distort it.

Worked example: Volvo Cars (simplified)

Say a company reports profit after tax of 12,5 bn SEK and equity of 65 bn SEK. Average capital (if opening was 60): 62,5 bn.

ROE = 12,5 ÷ 62,5 = 20 %

Du Pont: net margin ~5 % × turnover ratio ~1,6 × leverage ~2,5. The return is driven by volume and leverage — not by extreme margin. That tells you what you must monitor: margin pressure in price wars and interest rate sensitivity.

(We report exact figures in our full Volvo Cars analysis — these are simplified numbers for the pedagogy.)

How AK1A uses V09

In AKM1, V09 is scored 0–5 against the sector median and the company's trend. Rising ROE with stable leverage gives a high score. Falling ROE despite growth is a warning flag — the company is growing poorer.

Want to practice yourself? The course V09 in the AKM1 series contains chapters with calculation exercises, the Lynch and Graham perspectives, and how AK1 interprets the variable in the wave matrix.

FAQ

Which formula is used for ROE?

ROE = profit after tax ÷ equity. The key choice is which equity you use: the end-of-year value or the average of opening and closing equity. The average is often fairer, because equity grows during the year as profits are retained — institutional analysts use it frequently.

What is the DuPont breakdown?

Du Pont-ekvationen delar ROE i tre delar: nettomarginal × omsättningshastighet × finansiell hävstång. Två bolag med identisk ROE på 15 procent kan därmed ha helt olika drivkrafter — det ena högmarginaligt med liten skuld, det andra lågmarginaligt med hög hävstång. Uppdelningen visar var avkastningen kommer ifrån och hur hållbar den är.

Why does ROE differ between sectors?

Banks (often 12–15 percent), industrial companies (often 8–10 percent) and SaaS companies (sometimes negative during the growth phase) have different capital structures and different needs for balance-sheet capital. That is why ROE is compared within the sector, and preferably against the company’s own five-year history — comparing a bank with a software company rarely offers educational insight.

Är hög ROE samma sak som en bra aktie?

Nej. ROE mäter bolagets kapitalproduktivitet, inte aktieägarens avkastning. Ett bolag med ROE på 20 procent kan vara en dyr aktie om börspriset ligger långt över bokvärdet, och en ROE som drivs av skuld är risk snarare än prestation. Därför kompletteras ROE i AKM1 med värderings- och skuldmått innan analysen är komplett.

This is educational financial analysis, not investment advice.