ROE = Net Income / Shareholders' Equity can be decomposed into three drivers: net profit margin (profitability), asset turnover (efficiency), and the equity multiplier (leverage). This DuPont identity reveals whether a high ROE comes from a genuinely profitable business, efficient asset deployment, or simply heavy borrowing. Two companies posting 20% ROE can be profoundly different: one earns 20% because margins are high and assets are efficiently deployed; the other earns 20% because it has borrowed aggressively against a mediocre business.

The quality hierarchy is: margin-driven ROE > turnover-driven ROE > leverage-driven ROE. A technology platform with 30% net margins and low asset requirements achieving 25% ROE with minimal debt is a fundamentally different investment than a retailer with 3% margins and 8x equity leverage achieving the same 25% ROE. Decompose before concluding. When you see ROE above 20%, the first question is always: which of the three components is driving it, and is that driver sustainable?

Warren Buffett has consistently used ROE above 15% sustained over a full business cycle as his primary filter for identifying durable competitive advantages. His reasoning: high ROE without high leverage implies the business earns excess returns on equity capital — and excess returns attract competition. If ROE stays high despite that competition, the business has structural protection that competitors cannot easily replicate. This is the moat made quantitative. The stability of ROE across recessions, competitive cycles, and industry disruptions matters more than any single-year level.

Buffett's evolution from pure statistical cheapness to quality at a fair price — largely influenced by Charlie Munger — placed ROE stability at the center of his quality framework. He actively avoids businesses with high single-year ROE driven by unusual items or leverage. The test is simple: can this business maintain 15%+ ROE over a 10-year period that includes at least one recession? Companies that pass this test with minimal debt are the canonical compounders — Coca-Cola, American Express, See's Candies — that Berkshire Hathaway built its reputation on.

ROE is distorted by financial leverage in ways that can be deeply misleading. A company can achieve a 30% ROE by borrowing 80% of its capital — the equity slice is thin, so net income divided by it looks impressive, but the underlying business might be earning only 8-10% on total invested capital. ROIC (Net Operating Profit After Tax / Invested Capital) measures return on all capital deployed in the business — debt plus equity — and strips away the financing decision. ROIC is therefore the cleaner measure of business quality independent of capital structure choices.

The comparison framework: when ROIC consistently exceeds the weighted average cost of capital (typically 8-12% for most businesses), the company is creating value for shareholders. When ROIC is below WACC, the company is destroying value even if it is growing. A company can report strong ROE and growing earnings while simultaneously destroying economic value if it is deploying capital at returns below its cost of capital. This distinction — between accounting performance and economic performance — is what separates sophisticated financial analysis from surface-level screening.