Comparing Different Industries Through Return on Equity

Introduction

You're comparing industries and need a clear, comparable metric, so start with return on equity (ROE) - net income divided by average shareholders equity (here's the quick math: ROE = net income ÷ average shareholders equity) - because it shows how efficiently a company uses shareholder capital to make profit and why investors care about cash returns on invested equity; the objective here is to compare industries on capital efficiency, not to label any sector best overall, since business models, leverage, and accounting choices drive wide variation across sectors, and one-liner: ROE shows how well a business turns equity into profit, but context matters, so use ROE alongside margins, leverage, and growth to make a fair call - defintely square the context before you pick a winner.

Key Takeaways

• ROE = net income ÷ average shareholders' equity - a compact measure of capital efficiency, but context is essential.
• Decompose ROE with DuPont (profit margin × asset turnover × equity multiplier) to identify whether profits, efficiency, or leverage drive returns.
• Expect distinct ROE profiles by industry (e.g., banks high via leverage; tech variable due to intangibles; utilities low/moderate; cyclical industrials); always compare like with like.
• Raw ROE can be distorted by accounting and capital structure (intangibles, leases, pensions, buybacks, debt); normalize equity or use unlevered ROE/ROIC and multi-year medians.
• Use sustainable ROE for valuation (g ≈ ROE × retention), feed into DCF/terminal scenarios, and next steps: compute DuPont, adjust for distortions, and produce a peer‑adjusted 5‑year median ROE table plus three valuation scenarios.

ROE mechanics and the DuPont breakdown

Explain the DuPont formula and how to calculate it

You're trying to know whether a firm's ROE comes from pricing power, operating efficiency, or leverage - not just a single percentage. The DuPont framework splits ROE into three actionable parts: profit margin, asset turnover, and the equity multiplier (leverage).

Write the formula as ROE = profit margin × asset turnover × equity multiplier. Compute each from financial statements using trailing twelve months (TTM) and averages where appropriate: profit margin = net income / revenue; asset turnover = revenue / average total assets; equity multiplier = average total assets / average shareholders equity.

Here's the quick math using a realistic example: profit margin = 12%, asset turnover = 0.8, equity multiplier = 2.5. Multiply: 12% × 0.8 × 2.5 = 24% ROE.

What this estimate hides: timing mismatches (one-off gains), nonrecurring tax items, and accounting policy shifts. Use TTM and 3-5 year averages to reduce noise; if equity swings due to buybacks, prefer average equity. A small typo: defintely adjust for extraordinary items.

One-liner: Break ROE into parts to spot whether margins, efficiency, or leverage drive returns.

Link each DuPont component to strategy and decision-making

Each DuPont leg points to a clear business lever. Profit margin reveals pricing, cost structure, and product mix. Asset turnover shows how intensively a company uses its assets to generate sales. Equity multiplier measures financial leverage and capital structure choices.

Use these practical checks when you analyze strategy: if margin is low, probe pricing, gross margin trends, and SG&A efficiency; if turnover is low, inspect fixed asset intensity, inventory days, and capacity utilization; if the equity multiplier is high, assess debt covenants, interest coverage, and default risk.

• Test pricing power via gross margin trends
• Check inventory days and receivables aging
• Measure interest coverage and covenant headroom
• Compare to industry medians and top peers

Actionable examples: a software firm with 40% gross margin but asset turnover 0.5 should optimize customer onboarding to raise sales per dollar of intangible assets. A utility with margin 8% and turnover 0.3 will instead focus on capex efficiency and regulatory returns.

One-liner: Read each DuPont leg as a strategic dial - price, run assets harder, or change financing.

Practical steps, best practices, and caveats for using DuPont in analysis

Start with clean inputs: use TTM figures, average balance-sheet items, and remove one-offs from net income. If intangibles or R&D are big, test a normalized equity by capitalizing or expensing R&D consistently across peers.

• Use TTM and 3-5 year medians
• Average equity to smooth buybacks
• Adjust for capitalized intangibles
• Run an unlevered ROE or ROIC view
• Stress-test leverage scenarios

Here's the quick procedure: compute the three legs, compare each to peer medians, then re-run ROE with constant leverage to separate operating performance from financing choices. Translate differences into specific follow-ups - pricing review, asset redeployment, or deleveraging plan.

Limits to accept: accounting rules vary across countries and industries; pension deficits or operating leases can hide risks; and short-term buybacks can inflate ROE without improving business economics. Always annotate your model with the adjustments you made and why.

One-liner: Break ROE, normalize the inputs, and then compare peers on the same footing.

Comparing Different Industries Through Return on Equity

You're sizing industries by ROE to decide where capital works hardest - here's the bottom line: compare ranges, drivers, and distortions before you pick a winner. In practice, look past the headline ROE to the mix of margin, asset intensity, and leverage that creates it.

Banks and financials - high headline ROE from regulated leverage

Banks often post ROE in the 10-15%+ range in 2025 fiscal-year snapshots because they operate with high financial leverage and regulatory capital rules. That high ROE mainly reflects leverage (equity multiplier) and net interest margins, not manufacturing or sales efficiency.

Practical steps and considerations

• Compute ROTCE (return on tangible common equity) - remove goodwill and intangibles.
• Check CET1 (common equity Tier 1) ratios - rising CET1 usually lowers ROE; regulatory moves matter.
• Compare net interest margin (NIM) and non-interest income mix - NIM swings explain short-term ROE moves.
• Adjust for loan-loss provisions and cyclical credit costs - use 5-year medians to smooth credit cycles.
• Use leverage-normalized metrics - unlever ROE to compare to nonfinancial peers.

Best practice: value banks on ROTCE and stress-tested ROE under regulatory capital scenarios; price using dividend/earnings power rather than raw ROE.

One-liner: Banks show strong headline ROE because of leverage and regulation - don't take the number at face value.

Tech and SaaS, plus utilities and telecoms - contrasting capital intensity and accounting effects

Tech and SaaS: ROE is variable. Mature, profitable software firms can show high operating margins but book ROE may be artificially low because balance sheets carry large intangibles, deferred R&D treatment, or negative tangible equity.

Practical steps for Tech/SaaS

• Add back capitalized R&D or treat R&D as an asset when computing adjusted equity.
• Compute ROIC (return on invested capital) and free-cash-flow yield - they often outstrip GAAP ROE for software firms.
• Use gross margin and rule-of-40 (growth + margin) to cross-check sustainability of high ROIC.
• Normalize for share buybacks - persistent buybacks raise ROE via equity shrinkage; model buyback paths explicitly.

Utilities and telecoms: expect ROE around 6-10% in 2025 snapshots - low-to-moderate, stable because of heavy regulated assets and predictable cash flows. Allowed regulatory ROEs and long asset lives set returns more than operating leverage.

Practical steps for Utilities/Telecoms

• Review regulator-allowed ROE, rate base, and weighted-average cost of capital inputs.
• Capitalize maintenance capex consistently; use long-run depreciation assumptions.
• Compare regulated asset base (RAB) growth to ROE to see if regulation resets returns.
• Stress test interest-rate and inflation sensitivity - utility returns are interest-sensitive.

One-liner: Tech needs intangible adjustments and ROIC focus; utilities show lower, regulation-driven ROE - compare apples to apples.

Industrials, materials, consumer/retail and healthcare - cyclical, turnover, and margin mixes

Industrials and materials: expect moderate ROE around 8-12% on 2025-like views, but wide swings occur with commodity cycles and capex waves. ROE here hinges on asset turnover and timing of capital expenditures.

Practical steps for Industrials/Materials

• Use multi-year median ROE and capex-to-depreciation ratios to capture cycle position.
• Adjust book equity for large inventory write-downs or one-off restructurings.
• Model peak-to-trough scenarios - show ROE under high and low commodity prices.
• Compare asset turnover (sales/avg assets) to understand efficiency changes.

Consumer/retail and healthcare: typically mid-range ROE - 8-18% depending on brand strength, inventory intensity, and product mix. Retail relies on turnover; healthcare splits between low-margin providers and high-margin pharma.

Practical steps for Consumer/Retail/Healthcare

• For retail, focus on same-store sales, inventory days, and margin trends - a small margin change amplifies ROE via turnover.
• For healthcare, separate providers (asset-heavy, lower ROE) from pharma/biotech (IP-heavy, potential high ROIC but low book equity).
• Adjust for intangible-heavy biotech by using EV/EBITDA or EV/Revenue where ROE is distorted.
• Smooth ROE across 3-5 years to avoid over-weighting one-off FDA wins or cyclical spikes.

One-liner: Expect distinct ROE ranges by industry - compare like with like and adjust for cycles and intangibles.

Next step (you): build a peer-adjusted ROE table using 5-year median ROE, ROTCE/ROIC columns, and one leverage-normalized scenario; Finance: produce the table by Friday-defintely useful for valuation inputs.

Accounting, capital structure, and comparability pitfalls

You're comparing ROE across industries and worried raw numbers will mislead your decision-good. Below I show the common accounting and capital-structure traps, practical fixes, and step-by-step checks you should run on FY2025 numbers so your comparisons actually mean something.

One-liner: Raw ROE can mislead unless you adjust for accounting and leverage.

Intangible assets and R&D capitalization distort equity and ROE

Intangibles (goodwill, capitalized R&D, patents) shrink or swell shareholders equity depending on accounting policy, and that changes ROE mechanically. You need to treat FY2025 reported equity as a mixed bag.

Steps to adjust

• Identify accumulated capitalized R&D and other intangibles on the FY2025 balance sheet.
• Decide treatment: either add back the carrying amount to equity (to reflect invested capital) or capitalize and amortize R&D into operating income for all firms in the peer set.
• Recompute adjusted equity and ROE. Example: if net income FY2025 = $150m and reported equity = $600m, reported ROE = 25.0%. If accumulated capitalized R&D = $300m and you add it to equity, adjusted equity = $900m, adjusted ROE = 16.7%.
• Document assumptions: amortization life (3-10 years typical), tax effect, and whether you treat goodwill separately.

Best practices

• Use the same R&D capitalization policy across peers for FY2021-FY2025 history.
• Flag large one-off impairment charges in FY2025-don't let a write-off hide sustainable returns.
• Prefer return on invested capital (ROIC) after you restate invested capital for intangibles.

What this hides: capitalization choice affects both denominator (equity) and numerator if you amortize R&D into operating profit; state both adjusted and unadjusted ROE for transparency. A small typo: defintely call out policy differences in notes.

One-liner: Capitalized intangibles can cut reported ROE by double-digit percentage points once you normalize.

Off-balance-sheet leases, pension liabilities, and tax differences

Off-balance-sheet items and accounting timing change equity, leverage, and reported profits. For FY2025 you must hunt these down in notes and adjust consistently across the peer group.

Practical checklist

• Leases: restate operating leases as right-of-use assets and lease liabilities per IFRS 16 / ASC 842 if the company still reports them off-balance. Add the present value of future lease payments to invested capital.
• Pensions: recognize underfunded defined-benefit obligations that reduce equity. If FY2025 pension deficit = $150m, reduce reported equity by that amount before computing ROE.
• Taxes: compute after-tax operating profit using a normalized effective tax rate (use a 3-5 year median). For example, pre-tax operating income $200m taxed at 21% gives net operating profit $158m; taxed at 15% gives $170m. That swing changes ROE materially.

Concrete adjustments

• Add ROU assets and lease liabilities to the balance sheet for FY2025.
• Subtract pension deficits from equity; add funded pension assets if significant.
• Normalize tax rate when translating operating earnings into net income for ROE comparisons.

Best practices: pull FY2025 notes, build a one-line reconciliation showing reported equity → adjusted equity → adjusted ROE. Flag any remaining off-balance exposures as qualitative risk items.

One-liner: Treat leases, pensions, and tax regimes as hidden capital or hidden liabilities that move ROE in opposite directions.

Buybacks and varying debt levels change equity base and ROE

Share repurchases and changes in debt levels change the equity denominator and the interest drag on net income. FY2025 buyback activity often explains big jumps in ROE that aren't operational improvements.

Step-by-step adjustments

• Record FY2025 share repurchases and issuance. If a company repurchased $200m of shares and cash fell accordingly, subtract $200m from equity for a pre-repurchase comparison or add it back for a pre-capital-returns view.
• When buybacks are debt-funded, include incremental interest expense. Example: $200m debt at 5% interest = $10m extra interest. If net income pre-buyback = $120m, cash-funded repurchase gives ROE = 30.0% (120/400). Debt-funded gives net income ≈ $110m, ROE ≈ 27.5% (110/400).
• For cross-sector comparison, compute an unlevered ROE or ROIC: replace equity with invested capital (book debt + equity - cash) and use NOPAT (net operating profit after tax) in the numerator.

Decision rules

• Prefer ROIC or unlevered ROE for capital-intensive sectors where leverage varies widely.
• When buybacks are material in FY2025 (>5-10% of equity), show ROE with and without buybacks and disclose funding source.
• Use a leverage-neutral view: compute ROE at a constant equity multiplier (e.g., peer median) to isolate operational performance.

Quick math example: reported FY2025 net income $120m, reported equity $600m → ROE 20.0%. After a $200m cash buyback, equity = $400m → ROE 30.0%. If buyback financed by debt with $10m extra interest, net income ≈ $110m → ROE 27.5%.

One-liner: Buybacks and leverage shift ROE mechanically-always show a leverage-neutral comparator.

Action for you: produce a peer-adjusted FY2025 ROE table that shows reported ROE, adjusted-for-intangibles ROE, and leverage-neutral ROE; owner: you (analyst).

Normalization and analytic fixes for fair comparison

Takeaway: Raw ROE misleads - normalize the equity base, neutralize leverage, and compare multi‑year peer medians so you measure operating performance, not accounting or financing quirks.

Normalize equity: add back excess intangibles and adjust for buybacks and issuance

You're comparing companies that report equity differently; start by creating an adjusted shareholders' equity line for FY2025 and use that consistently across peers.

Steps to normalize equity (practical):

• Identify reported shareholders' equity from the FY2025 balance sheet.
• Capitalise R&D and internally developed software if management expensed it - capitalise over useful life (e.g., 5 years) and add the net present value back to equity.
• Add back acquired intangibles and goodwill that aren't impairment-prone, or treat excess goodwill separately as a reconciling item.
• Subtract excess cash and marketable securities (non‑operating cash) from equity; treat pension deficits as equity reductions.
• Adjust for cumulative buybacks and issuance during FY2025 by using beginning- and ending‑average equity or by reconstructing pre-buyback equity.

Example (FY2025, illustrative): reported equity $10,000m; capitalised R&D (5‑yr NPV) $1,200m; excess cash $800m. Adjusted equity = $10,000m + $1,200m - $800m = $10,400m. What this hides: R&D capitalization assumptions and useful life materially change the result, so document choices.

Adjust ROE via constant leverage: compare unlevered ROE or use ROIC (return on invested capital)

Leverage (equity multiplier) can double or halve ROE. To compare operating performance, strip financing effects and use an unlevered metric like ROA or ROIC (NOPAT / invested capital).

Practical steps and formulas:

• Compute ROE = Net income / Adjusted equity (use the equity from step 1).
• Compute equity multiplier = Average total assets / Average adjusted equity (FY2025).
• Derive ROA = ROE / equity multiplier, or compute ROIC = NOPAT / (Debt + Adjusted equity - excess cash).
• To compare at constant leverage, pick a peer median debt/EBITDA or target equity multiplier and re‑leverage each company's ROA: Re‑levered ROE = ROA × target equity multiplier.
• Document the target leverage (e.g., peer median FY2025 debt/EBITDA = 2.0x) and run sensitivity +/- 0.5x.

Example (illustrative): Company A FY2025 ROE = 18%, equity multiplier = 2.5x → ROA = 7.2%. If peer target multiplier = 1.8x, comparable ROE = 7.2% × 1.8 = 13.0%. Note: unlevering removes financing risk-use ROIC when capital structure effects matter for valuation.

Use multi-year medians and peer groups to smooth cyclical noise

ROE swings with cycles, one‑off gains, and accounting events. Use multi‑year medians (preferably 5 years ending FY2025) and tight peer groups to find durable performance.

How to implement:

• Select a peer group (same end‑market, similar capital intensity, similar business model).
• Compute annual adjusted ROE for each peer for FY2021-FY2025, then take the median and interquartile range.
• Winsorize or remove outliers beyond the 5th/95th percentiles to avoid one‑off distortions.
• Report both median ROE and median unlevered ROE (or ROIC) so you can see whether high ROE is structural or leverage-driven.
• Run scenario medians: base (5‑yr median), optimistic (top quartile last 3 years), downside (bottom quartile over cycle).

Example series (illustrative Company B ROE FY2021-FY2025 = 3%, 8%, 15%, 20%, 10% → 5‑yr median = 10%). What this estimate hides: sector breakpoints and structural changes (M&A, regulation) - flag regime shifts.

Adjust and decompose ROE, then compare peers on the same footing.

You: produce a peer‑adjusted ROE table and three valuation scenarios (base/optimistic/downside) using FY2025 adjusted equity and ROIC assumptions by Dec 5, 2025.

Using ROE in valuation and portfolio decisions

Translate sustainable ROE into growth

You want to turn an observed ROE into a realistic growth rate for modeling and valuation, so start with the identity

g ≈ ROE × retention ratio where retention ratio (plowback) = 1 - payout ratio.

Steps to apply this

• Pick a stable ROE: use a 3-5 year median or an adjusted ROE that strips one-off gains.
• Measure true retention: combine dividends plus net share issuance; treat buybacks separately because they lift EPS but don't necessarily fund organic growth.
• Compute g: multiply ROE by retention. Example math: ROE 12%, payout 30% → retention 70% → g = 8.4%. Here's the quick math: 12% × 0.70 = 8.4%.

What this estimate hides

• Assumes ROE stays constant; if ROE trends down as the business scales, g will be overstated.
• Buybacks and financial engineering can raise ROE without increasing operating growth; separate EPS growth from revenue/cash-growth forecasts.

Practical fixes

• Model two growth paths: organic g (from reinvestment) and buyback-fueled EPS uplift.
• Convert required reinvestment to capex and working-capital needs: reinvestment rate = g / ROE.

One-liner: Use ROE × retention to get a first-pass sustainable growth rate-then stress-test it for changing margins, capital intensity, and buybacks.

Incorporate ROE into DCF assumptions and terminal value sensitivity tests

ROE guides both the reinvestment schedule in the explicit forecast and the long-run growth (g) used in terminal value calculations.

Concrete steps

• Translate g from ROE for the terminal: if you use equity cash flows (FCFE), use cost of equity in the Gordon model; if using firm cash flows (FCFF), convert ROE-based g into a reinvestment plan for ROIC and use WACC for discounting.
• Cap long-term g to a sustainable macro floor-generally below long-run nominal GDP; a common guardrail is 0%-4% depending on market and country.
• Run a sensitivity grid: vary terminal g and discount rate (or terminal ROE) across plausible ranges and record valuation swings.

Worked example (quick math)

• Assume year‑n FCFF = 100, WACC = 8%, terminal g = 3%. Terminal value = 100×(1.03)/(0.08-0.03) = 103/0.05 = 2,060. That's a simple check of material sensitivity.
• To check reinvestment consistency: if target g = 3% and ROE = 12%, required reinvestment = 3%/12% = 25% of earnings; model capex and working capital to match that.

Best practices and limits

• Don't let optimistic ROE + high retention imply perpetual high g; cap g conservatively and map reinvestment to realistic capital needs.
• Use separate scenarios: conservative (low ROE convergence), base, and optimistic (higher durable ROE from competitive advantage or structural change).
• Document where ROE comes from-margin, turnover, or leverage-and alter terminal assumptions accordingly.

One-liner: Use ROE to set reinvestment rates and terminal g, then stress-test valuations across plausible discount rates and growth caps.

Rank sectors by durable ROE, but weight by risk, capital needs, and macro sensitivity

You need sector-level ROE ranks, but don't take top ROE at face value-adjust for leverage, cyclicality, and capital intensity.

Steps to build a ranked, investable view

• Compute peer median ROE over 5 years, then unlever to an operating ROE or convert to ROIC to remove financing effects.
• Score each sector on three axes: durability of ROE (competitive moat), capital intensity (capex and asset turnover), and macro/cyclical sensitivity.
• Weight scores into a sector rank and attach a risk multiplier for valuation (higher risk → higher discount or lower terminal g).

Typical durable ROE ranges and considerations (industry heuristics)

How to weight ROE in portfolio decisions

• Score expected excess return = durable ROE - cost of equity; require a margin for uncertainty.
• Reduce target allocations for sectors needing heavy capital (utilities, industrials) unless ROIC sustainably exceeds cost of capital.
• Apply macro overlays: increase caution for export‑driven cyclicals in a slow global GDP scenario.

One-liner: Use ROE to set realistic growth and capital-return assumptions for valuation, then tilt allocations by durability and capital risk.

Next step: you (analyst) - produce a peer-adjusted ROE table and three valuation scenarios (conservative, base, upside) by Friday.

ROE action checklist and owner

Restate why ROE matters and how to use it

ROE is a compact signal of how well equity capital becomes profit; when you break it into components and normalize for accounting and leverage, it reliably points to durable business economics.

One-liner: ROE is powerful when decomposed, normalized, and compared across peers.

Read ROE as three drivers: profit margin (pricing and cost), asset turnover (asset intensity), and equity multiplier (leverage). Use the DuPont decomposition to tell whether a high ROE comes from sustainable operating performance or from temporary leverage or accounting shifts.

Keep this front of mind: a 15% ROE that's all leverage is not the same as 15% from wide margins and efficient assets - treat them differently in valuation and risk limits.

Practical next steps: calculate, adjust, and benchmark

Follow these concrete steps to make ROE comparable and actionable.

• Collect fiscal ROE inputs for the last five years (fiscal years 2021-2025): net income and average shareholders equity.
• Compute DuPont for each year: ROE = Profit margin × Asset turnover × Equity multiplier. Profit margin = net income / revenue; Asset turnover = revenue / average total assets; Equity multiplier = average total assets / average shareholders equity.
• Normalize equity for intangibles: capitalize reported R&D and unamortized development as an asset and increase equity by the net book value removed. Method: sum R&D capex five-year total and amortize straight-line over 5 years; add the unamortized balance to both assets and equity.
• Adjust leases and pensions: add present value of operating lease liabilities and underfunded pension obligations to debt and to invested capital before recomputing asset turnover and leverage.
• Neutralize buybacks: when buybacks materially reduced shares/equity, present a pro-forma equity series that smooths share capital changes (add back cumulative net buybacks to equity for ROE trend analysis).
• Compute unlevered performance: use ROIC = NOPAT / Invested capital (NOPAT = operating income × [1 - tax rate]; invested capital = equity + interest-bearing debt + capitalized leases - excess cash). Compare ROIC to normalized ROE to isolate leverage impact.
• Use medians: report a 5-year median ROE and median DuPont components by peer group (same industry and business model) to smooth cyclical noise.
• Document assumptions: state amortization period, tax rate, treatment of excess cash, and any off-balance adjustments clearly in the model notes.

One-liner: Compute the DuPont, adjust for intangibles and debt, and use a 5-year median by peer group to compare apples to apples.

Owner, deliverables, and immediate next steps

You (analyst) own the execution and delivery. Produce a peer-adjusted ROE table and three valuation scenarios: bear, base, and bull.

• Deliverable 1 - Peer-adjusted ROE table: include fiscal 2021-2025 ROE, DuPont components, unlevered ROIC, and adjusted equity for each peer. Present medians and interquartile ranges.
• Deliverable 2 - Three valuation scenarios: build DCFs with scenario-specific assumptions for sustainable ROE, retention ratio, and terminal growth. Use g ≈ ROE × retention ratio; give worked examples (for instance, ROE 12% × retention 60% → g ≈ 7.2%) so the math is explicit.
• Deliverable 3 - Sensitivity table: show terminal value sensitivity to sustainable ROE ± 200 bps and retention ± 10 percentage points.
• Timing: prepare the peer-adjusted ROE table draft by 2025-12-05 and final DCF scenarios by 2025-12-12. Review with strategy by 2025-12-15.
• Acceptance criteria: median ROE and DuPont components documented, adjustments footnoted, and scenario assumptions defensible with source links to filings (10-K/20-F) for each peer.

One-liner: You: produce the peer-adjusted ROE table and three valuation scenarios on the dates above - own the numbers and the sources.