Return on equity measures how effectively a company uses shareholder capital to generate profits. It is one of the most widely used metrics for evaluating management performance and comparing profitability across companies and industries. A higher ROE generally indicates more efficient use of equity capital.

The basic formula is: ROE = Net Income / Shareholder Equity x 100. The DuPont analysis breaks this into three components: ROE = Profit Margin x Asset Turnover x Equity Multiplier. This decomposition reveals whether a high ROE comes from strong margins, efficient asset usage, or heavy financial leverage, each of which carries different risk implications.

For example, a company with $500,000 in net income and $2,500,000 in shareholder equity has an ROE of 20%. Using DuPont analysis with $5,000,000 revenue and $4,000,000 in total assets, we see a 10% profit margin, 1.25x asset turnover, and 1.6x equity multiplier. The product 0.10 x 1.25 x 1.6 = 0.20 or 20% confirms the ROE and shows which drivers are strongest.