Where does ROE actually come from?

We met ROE — return on equity — back in unit one, and flagged a problem: a high ROE can signal a genuinely excellent business, or just a heavily borrowed one. The DuPont analysis solves this by splitting ROE into its parts, so you can see which lever is doing the work. It's the ratio that ties this whole course together.

The three-part split

With a little algebra that cancels cleanly, ROE breaks into three ratios you already know:

ROE = net margin × asset turnover × equity multiplier

• Net margin (net income ÷ revenue) — profitability. How much profit per sales dollar. (Unit one.)
• Asset turnover (revenue ÷ assets) — efficiency. How much sales per asset dollar. (This unit.)
• Equity multiplier (total assets ÷ equity) — leverage. How much asset base each owner-dollar supports. A multiplier of 2 means half the assets are funded by debt and other liabilities. (Unit two.)

Multiply them and revenue and assets cancel out, leaving net income ÷ equity — ROE. So every ROE is the product of how profitable, how efficient, and how leveraged a company is. Three of the four units of this course, in one line.

A worked example: same ROE, opposite businesses

Two illustrative companies both post ROE = 20%.

• Company A (quality): net margin 20% × asset turnover 1.0 × equity multiplier 1.0 = 20%. Highly profitable, decent efficiency, no leverage. The return is earned by the business itself.
• Company B (leverage): net margin 4% × asset turnover 1.0 × equity multiplier 5.0 = 20%. Thin margins, but debt funds four-fifths of the assets, multiplying a modest business into a 20% owner return.

Identical headline ROE; completely different risk. Company A's 20% rests on real profitability. Company B's rests on borrowing — attractive while times are good, fragile the moment earnings dip or lenders tighten. Without DuPont, both just look like "20% ROE." With it, you see the engine.

The professional habit

When you see a rising ROE, DuPont makes you ask the right follow-up: is margin improving, is the company getting more efficient, or is it simply borrowing more? A rising ROE driven by an expanding equity multiplier is a leverage story, not a quality story — and worth flagging as such. This is decomposition, not prediction: it explains where a number comes from, never where it's going.

In the data

All three factors come from one fiscal period: the income statement for net income and revenue, and the balance sheet at the same year end for assets and equity. Apple's two:

Build all three from these six figures and the multiplication closes back to ROE. Take the published trailing profit margin instead of this year's net margin and it will not, because a rolling twelve months and a fiscal-year snapshot are different windows.

Try it now

1. Using the two tables above and nothing else, compute net margin (net income ÷ total revenue), asset turnover (total revenue ÷ total assets), and the equity multiplier (total assets ÷ total shareholder equity).
2. Multiply the three — you should land back on ROE (net income ÷ total shareholder equity). If it ties out, you have decomposed it correctly. Note that it only ties because all six figures came from the same period.
3. Compare each of the three factors to the same company three years ago, and to a peer. The same four inputs, three fiscal years earlier:

And Microsoft's latest year, whose fiscal year ends in June rather than September:

Build the three factors for both. Don't just pick the biggest number — a margin and a multiplier aren't in the same units, so "largest" means nothing. The factor that has moved most, or that differs most from the peer, is what is driving this ROE: a rising equity multiplier is a leverage story, a rising margin a profitability one.