A 25% ROE looks great until you decompose it. Sometimes it's a dominant moat throwing off cash; sometimes it's a leveraged-up balance sheet pretending to be profitable. DuPont decomposition answers which of those you are buying. ROIC goes one step further and removes the leverage trick entirely.

The DuPont Three-Factor Form

ROE = (Net Margin) × (Asset Turnover) × (Equity Multiplier)

That is: profitability × efficiency × leverage. The same ROE can come from very different mixes — and the mix tells you what kind of business you actually own.

Margin
Net Income / Sales
How much profit per dollar of revenue. High margins typically mean pricing power, brand, or recurring contracts. Software / luxury / dominant brands sit here.
Turnover
Sales / Total Assets
How many sales dollars per dollar of assets. High turnover with low margins is the volume game (retail, distribution). Walmart vs Hermès — same ROE, opposite ends of the curve.
Leverage
Total Assets / Equity
How much asset base per dollar of equity — the borrowing multiplier. Banks and REITs run this lever hard. A high-leverage 25% ROE is structurally fragile compared to a low-leverage 25% ROE.

Why ROIC Is the Cleaner Quality Test

ROIC = NOPAT / Invested Capital — the return on every dollar invested in the business, regardless of whether it came from equity or debt. ROIC strips out the leverage trick: a company that goosed ROE with debt can still have a mediocre ROIC. The only sustainable quality test is ROIC > cost of capital — that is the spread that creates real shareholder value over time.

Two companies in the same industry, both showing 25% ROE: one with 15% net margin × 1× turnover × 1.6× leverage, the other with 5% margin × 1× turnover × 5× leverage. The first is a brand business with pricing power; the second is one rate hike away from pain. The headline ROE is identical.

Field-Test Routine

  1. Pull 5 years of net margin, asset turnover, and equity multiplier. Plot them as three lines.
  2. Identify which factor is doing the heavy lifting. Margin-driven = pricing power story. Turnover-driven = scale / efficiency story. Leverage-driven = financial engineering, treat with caution.
  3. Compute ROIC alongside. If ROIC has been > the company's cost of capital for 5+ years, the moat is real. If ROIC < cost of capital while ROE looks fine, the business is destroying value at the enterprise level — equity holders are just last in line to feel it.

ROE = Margin × Turnover × Leverage
Same ROE can come from very different business models — decompose to know which
ROIC > cost of capital is the only durable test of quality

See per-ticker quality metrics →