Return on Equity (ROE) Explained: How Smart Investors Use This Metric to Pick Winning Stocks

Why ROE Matters (And When It’s Misleading)

If you’ve ever started a side hustle, you already get Return on Equity (ROE) without realizing it.

Say you start selling coffee from your garage. You put in $1,000 for beans, a grinder, and a cheap espresso machine. First month, you make $250 in profit.

Your ROE is
$250 / $1,000 = 25%

So for every dollar you put in, you made 25 cents back.

Now say instead of using all your own money, you borrow $500 from a friend. Now your own money in the business is only $500. If you still make $250 in profit, your ROE is

$250 / $500 = 50%

Same business, same profits, but now your returns look way better because you used less of your own money.

If you’re serious about tracking your stock portfolio and understanding key metrics like ROE, I recommend using Personal Capital to get a full picture of your investments.

How This Applies to Stocks

Companies work the same way. Investors use ROE to see how efficiently a company turns its money into profits.

Take $AAPL (Apple) and $MSFT (Microsoft)

| Stock | ROE (%) | Debt-to-Equity Ratio |
|--------|--------|--------------------|
| $AAPL | ~85.61% | 1.45x |
| $MSFT | ~19.70% | 0.31x |

Apple has a high ROE but also uses more debt. Microsoft has a lower ROE but uses way less leverage.

Now look at $TSLA (Tesla). Their ROE recently hit 30%+, but they also took on billions in debt to expand. If sales slow down and they still owe all that money, their high ROE won’t mean much.

Banks work differently. $JPM (JPMorgan Chase) and $BAC (Bank of America) always report high ROE because their business model is based on lending.

| Stock | ROE (%) | Debt-to-Equity Ratio |
|--------|--------|--------------------|
| $JPM | ~17.39% | Not Specified |
| $BAC | ~16.34% | 1.13x |

Banks take on debt as part of their normal operations. But if a tech company has a banking-level ROE, that’s a red flag.

If you're into undervalued stocks, you might want to check my deep dive on Nu Holdings ($NU), where I break down their financials and future potential.

When a High ROE is a Problem

Companies boost ROE in a few ways
✅ Making more profit
✅ Buying back shares (reducing equity)
✅ Taking on more debt

That last one is where people get fooled. A company with crazy high ROE but loaded with debt might not actually be a great business.

Take $RPRX (Royalty Pharma) for example. I recently analyzed why it’s an undervalued healthcare stock and how its financials stack up.

If you're actively investing and want commission-free stock trades, you can check out Robinhood or Webull for extended trading hours and more technical tools.

Quick Checklist for Due Diligence

1️⃣ Compare ROE to competitors. If one company has a way higher ROE than its peers, find out why.
2️⃣ Look at debt levels. If Debt-to-Equity Ratio is >2x, they’re probably just leveraging up.
3️⃣ Check historical trends. If ROE jumped overnight, maybe it’s just accounting tricks.
4️⃣ Look at profit margins. If margins are shrinking but ROE is rising, something’s off.

If you're interested in growth stocks, you might want to see my analysis on Crocs ($CROX) and whether their ROE actually justifies their current valuation.

Takeaway

ROE is useful, but context matters.

• A company that earns high profits without taking on a ton of debt (like $MSFT) is solid.
• A company with skyrocketing ROE but also drowning in debt (like $TSLA) could be risky.
• Banks will always have high ROE, but it’s normal for their business model.

Numbers don’t lie, but they don’t tell the full story either. Always check under the hood before assuming a high ROE means a great business.

For more on investing metrics, check out my post on What is the P/E Ratio? and how it compares to ROE when evaluating stocks.

If you want real-time stock charts and advanced screeners, I personally use TradingView to analyze stocks before making decisions.

Disclaimer: These numbers are based on data available up to Q3 2024. Always check the latest financials before making investment decisions.

What’s the ROE of the last stock you bought?

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