- How to split any ROE into its three drivers
- Which driver is durable and which is borrowed
- How to use the split to tell a brand, a retailer and a leveraged bet apart
ROE is a single number covering three completely different ways of making money. The DuPont decomposition pulls them apart. It looks like algebra; it's really just a way of asking how a company earns its return.
- PAT ÷ Revenue
- net margin — how much of each sale it keeps
- Revenue ÷ Assets
- asset turnover — how much sales each rupee of assets generates
- Assets ÷ Equity
- leverage — how much of those assets were funded by borrowing
The jeweller sells few items but keeps a lot of each — high margin, low turnover.
The supermarket keeps almost nothing per item but sells the same shelf space over and over — low margin, high turnover.
The man with the loan buys a ₹1 crore shop with ₹20 lakh of his own money and ₹80 lakh borrowed. If the shop earns ₹10 lakh, his return on his own ₹20 lakh is 50% — spectacular, until a bad year arrives and the loan still needs paying.
All three can show 20% ROE. Only two of them are businesses.
Read across each row: same destination, entirely different vehicle.
- Brand — margin / turnover / leverage
- 16% × 0.83 × 1.5
- Retailer — margin / turnover / leverage
- 3% × 3.33 × 2.0
- Leveraged co — margin / turnover / leverage
- 5% × 0.80 × 5.0
Reading the three drivers
- Net marginHigh means: Pricing power, brand, differentiationDurability: Most durable. Hard to build, hard to take away.
- Asset turnoverHigh means: Operational excellence — sweating every assetDurability: Durable. Built through execution and systems.
- LeverageHigh means: Borrowed money amplifying returnsDurability: Not durable. Rented, reversible, and dangerous in a downturn.
Margin and turnover are things a company built. Leverage is something a company borrowed. Only the first two survive a bad year.
Same company, four years apart. ROE looks stable. It isn't.
- FY22 — margin / turnover / leverage
- 12% × 1.10 × 1.4
- FY22 — ROE
- 18.5%
- FY25 — margin / turnover / leverage
- 7% × 0.95 × 2.8
- FY25 — ROE
- 18.6%
- 1Get PAT and Revenue from the P&L → net margin.
- 2Get Total assets from the balance sheet → asset turnover = revenue ÷ assets.
- 3Get Equity (share capital + reserves) → leverage = assets ÷ equity.
- 4Multiply the three and check it lands on the reported ROE. Then repeat for four earlier years and read which term moved.
"ROE above 18%" is one of the most-used screening filters in existence, and on its own it reliably surfaces heavily leveraged companies alongside genuinely excellent ones.
Pair it, always: ROE above 18% AND debt-to-equity below 1 removes most of the false positives in a single line. Better still, add ROCE — if ROCE is high too, the returns are coming from the business rather than the balance sheet.
- ☐Split ROE into the three drivers for the latest year.
- ☐Do it again for four or five years back.
- ☐Ask which driver moved — and whether it moved in the direction you'd want.
- ☐If leverage is rising while margin falls, treat stable ROE as a warning, not a comfort.
In one screen
- 1ROE = net margin × asset turnover × leverage.
- 2Margin and turnover are built and durable; leverage is borrowed and fragile.
- 3Two companies with identical ROE can have completely different downside.
- 4A stable ROE with rising leverage and falling margin is a decaying business in disguise.
Check yourself
Nothing is scored or stored — the explanation after each answer is the point.
A company shows net margin 4%, asset turnover 1.0 and leverage 5.0. What's its ROE, and what should you think?
Over five years a company's ROE stays at 19% while margin falls from 14% to 8% and leverage rises from 1.3 to 2.4. What's happening?