What is ROE? — formula, interpretation and the AKM1 scoring scale

ROE — Return on Equity — measures how much profit after tax a company creates per krona of equity. The formula: ROE = profit after tax ÷ equity. An ROE of 20 % means the company earns twenty öre per krona the owners have put in. One ratio. One balance sheet. The entire profitability chain. That is why ROE is called the variable that captures all of profitability in a single number — in AKM1's 20 variables it is called V09.

The formula

ROE = Profit after tax ÷ Equity

Three decisions determine whether your ROE is right:

• Which capital? Equity grows during the year, because profit that is not distributed stays in the company. If you use the year-end value you underestimate the return on the capital that was actually at work. Institutional practice: the average of opening and closing equity.
• Which profit? Profit after tax, preferably cleaned of one-off items. The sale of a property is not profitability.
• Which period? The same fiscal year in numerator and denominator. Never mixed.

Break ROE apart with Du Pont

ROE = Profit margin × Turnover ratio × Leverage

This is the Du Pont equation, and it explains why two companies with identical ROE can carry entirely different risk. A niche consulting firm: high margin, low turnover ratio, no debt. A retail company: thin margin, high volume, significant leverage. The same ROE on paper. Independent risk in reality. Du Pont shows where the return comes from — and therefore how sustainable it is.

Worked example: from annual report to number

A company reports profit after tax of 12,5 mdr SEK. Equity was 60 mdr at the beginning of the year and 65 mdr at the end — the average becomes 62,5 mdr. ROE = 12,5 ÷ 62,5 = 20 %.

Then break it apart with Du Pont. Revenue was 200 mdr and total assets 125 mdr. The profit margin: 12,5 ÷ 200 = 6,25 %. The turnover ratio: 200 ÷ 125 = 1,6. The leverage: 125 ÷ 62,5 = 2,0. The check: 6,25 % × 1,6 × 2,0 = 20 %. Margin engine. Fast rotation. Moderate leverage. Now you know what to watch in the next report — the margin, not the interest cost — and you know it before the share price chart has said anything at all.

How ROE is scored in AKM1 (V09)

AKM1 scores each variable 0–5; 20 variables give a maximum of 100 points in total. V09 follows a concave curve with a threshold at the cost of capital — below it the company creates no added value:

• Below 9 % ⇒ 0 points — the company earns less than the capital costs: value destruction regardless of level [est.]
• 9–12 % ⇒ 1 point
• 12–18 % ⇒ 2 points
• 18–25 % ⇒ 3 points
• 25–35 % ⇒ 4 points
• Above 35 % ⇒ 5 points — but only if the 5-year average is also above 35 % and the debt-to-equity ratio is at most 2. Otherwise 4 points: extreme return without proven endurance and without safety mean-reverts.

Why concave? Because return has steps, not a straight line. The difference between 8 and 12 % is qualitative — below or above the cost of capital. The difference between 30 and 33 % is in practice noise. The curve also says something about scepticism: the fifth point must be earned twice, through level and through endurance. A peak reading is a fact. A five-year sequence is proof.

This is how it looks in the research library's latest measurements, with the motivation reported per analysis: Industrivärden ROE 32,3 % ⇒ 4/5, Investor ROE 27,3 % ⇒ 4/5, NP3 Fastigheter ROE 14,5 % ⇒ 2/5. You can verify every score yourself — that is the point of open motivations.

ROE in different company types

The level is never interpreted in a vacuum. A Swedish industrial company at 8–10 % is respectable; a bank is often around 12–15 % because the balance sheet is the business itself; an investment company may need adjusted equity so that large undistributed reserves do not distort the ratio. A SaaS company in a growth phase can show a negative result and still build value — but then it is revenue growth and the margin trajectory that carry the analysis, not ROE. AKM1 scores the level as reported; the comparison is made against the sector median and the company's own five-year history.

Common mistakes

• Confusing ROE with share price return. ROE measures the company's capital productivity, not your return as an owner. A company with ROE 20 % can be an expensive stock if you pay five times book value. Different questions. Different answers.
• Ignoring leverage. ROE driven by debt is borrowed, not created. Always check the debt-to-equity ratio alongside — in AKM1, V10 is calculated before V09 for exactly that reason.
• Comparing across sector boundaries. A bank's ROE is not an industrial company's ROE. Compare against the sector median and the company's own five-year history.
• Trusting a single year. A single year can be carried by one-off items, currencies or a business cycle peak. Three years is a trend. Five years is proof.
• Negative equity. A negative result divided by negative capital gives a positive number. That is not profitability but arithmetic. AKM1 marks the metric as unset when equity is negative.

Go deeper

• The course ROE (Return on Equity) — Profitability: the formula step by step, practice calculations, Lynch and Graham perspectives.
• What is the debt-to-equity ratio? — the leverage check that belongs with ROE.
• The calculator computes ROE and Du Pont on your own numbers — the same formulas the courses teach.

The falsification

If companies with ROE above 35 %, low debt and proven 5-year endurance still systematically fall back below 20 %, the curve's caution is miscalibrated. That is the test — and every new annual report in the library is a new chance to falsify us.

FAQ

What is a good ROE level?

It depends on the sector — but the threshold sits at the cost of capital. Below roughly 9 % the company earns less than its capital costs and creates no added value, while 18–25 % counts as strong on AKM1's scoring scale. Always compare the level with the sector median and the company's own five-year history, never in a vacuum. The course ROE — Profitability walks through every step of the scale.

How do I calculate ROE myself?

Divide profit after tax by equity — but use the average of opening and closing equity, since equity grows during the year, and strip one-off items such as a property sale from the profit. Every figure is found in the annual report, and the calculator performs the same calculation on your own numbers. That is how the method works — the interpretation is then yours.

Why can a high ROE be misleading?

Eftersom hävstången kan bära den. ROE som drivs av skuld är lånat, inte skapat — riv isär siffran med Du Pont-ekvationen (vinstmarginal × omsättningshastighet × hävstång) för att se var avkastningen kommer ifrån. Kontrollera alltid skuldsättningsgraden bredvid; därför räknas V10 före V09 i AKM1. Negativt eget kapital gör dessutom måttet osatt.

What is the difference between ROE and shareholder return?

ROE measures the company's capital productivity — how much profit is created per krona of equity. Shareholder return measures your return as an owner: the change in share price plus dividends. A company with a 20 % ROE can still be an expensive stock if you pay five times book value. Different questions, different answers — both belong in the analysis.

This is educational analysis, not investment advice.