Return on Equity (ROE)

Return on equity is net income divided by shareholders' equity — the annual profit generated per dollar of the owners' capital in the business. A company earning $150M on $1B of equity runs a 15% ROE.

ROE is the classic quality screen: a business that compounds equity at 20% for a decade is doing something structurally right. The long-run S&P 500 average sits in the low-to-mid teens, so consistent readings above that suggest a durable advantage — or leverage.

That is the caveat. Because debt shrinks the equity base without shrinking profits, a leveraged company can post a high ROE on a mediocre business. Cross-check with return on assets: if ROE is 25% but ROA is 3%, borrowing is doing most of the work.