The Analyst’s Course · Forensic Accounting
Why ROE Alone Lies — the DuPont Decomposition
Deriving the identity
ROE = Net Income ÷ Equity. Multiply by (Revenue ÷ Revenue) and (Assets ÷ Assets) — which changes nothing — and rearrange: ROE = (NI÷Revenue) × (Revenue÷Assets) × (Assets÷Equity) = net margin × asset turnover × equity multiplier. Nothing was added; the same number, now with its three sources exposed. A 20% ROE from margin is a pricing-power business. The same 20% from a 5× equity multiplier is a bank wearing a different costume.
Each lever and its trade-off
Net margin (NI÷Revenue) is pricing power and cost discipline — hard to fake, hardest to earn. Asset turnover (Revenue÷Assets) is operational intensity — retailers live here; grocery chains turn assets 10×+ on razor-thin margins. The equity multiplier (Assets÷Equity) is leverage — it amplifies whatever the first two produce, including losses. Critically, buybacks shrink equity, which mechanically inflates ROE without changing the business at all.
Worked example: Apple vs an airline
Apple FY2025: margin 26.9%, turnover 1.16×, multiplier 4.87× → ROE 151.9%. The margin is real; the multiplier is inflated because years of buybacks have shrunk book equity to a fraction of the business. Now contrast a legacy airline: margin ~5%, turnover ~0.8×, multiplier 6×+ → ROE ~24%. Identical-looking ROE, completely different companies: Apple earns its return; the airline borrows it. Only the decomposition reveals this — which is why the panel draws all three bars, not one number.
ROE = Net Margin × Asset Turnover × Equity Multiplier
DuPont identity — (NI/Rev) × (Rev/Assets) × (Assets/Equity). Revenue and Assets cancel — the same ROE, decomposed.
The banks before 2008
In 2006, investment banks like Lehman and Bear Stearns posted healthy ROEs built on equity multipliers of 25–30× — $30+ of assets per dollar of equity. The DuPont third term was doing all the work while the first two (margin, turnover on core operations) eroded. When mortgage assets repriced, the same leverage that manufactured the ROE manufactured the collapse. A DuPont screen weighting margin and turnover while capping multiplier exposure would have ranked them uninvestable years earlier.
What you'll practise
Two firms both earn 20% ROE. Firm A: 25% margin, 0.8× turnover, 1.0× multiplier. Firm B: 3% margin, 0.9× turnover, 7.4× multiplier. Which statement is correct?
3 graded checkpoints · certification exam at the end of the track
Sources
Altman (1968); Beneish (1999); Sloan (1996); company 10-K filings via SEC EDGAR
Learn content is for education only — not individualized financial advice, a recommendation, or a solicitation to buy or sell any security. Options involve substantial risk. Examples are simplified and historical patterns never guarantee future results.