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Intermediate · Lesson 3 of 9

Profitability and quality: ROE, ROIC, margins

8 minute read · By Krishna Avadhani, Vestora Academy · Updated 18 October 2026

Return on equity (ROE) is net profit divided by shareholders' equity. It shows how much profit the company makes with owners' money. Many investors look for ROE consistently above 15%, but high debt can inflate ROE, so check it alongside debt.

Return on invested capital (ROIC) uses all capital (debt plus equity). A business that earns ROIC well above its cost of capital for many years usually has a competitive advantage, sometimes called a moat: brand, network effects, switching costs, cost advantages or licences.

Margins show pricing power. Gross margin is revenue minus direct costs; operating margin subtracts overheads; net margin is what is left after everything. Stable or rising margins through a downturn are a strong quality signal.

Formula

ROE = Net profit / Equity
ROIC = NOPAT / (Debt + Equity - Cash)
DuPont: ROE = Net margin x Asset turnover x Equity multiplier

Key takeaways

  • ROE measures profit on owners' money; check it is not just debt-fuelled.
  • ROIC above the cost of capital, for years, suggests a moat.
  • Stable margins in bad times show pricing power.

Check your understanding

1. Company A has ROE 25% with debt/equity 400%. Company B has ROE 18% with no debt. Which is more likely higher quality?

  • A, because ROE is higher
  • B, because its return is not driven by debt
  • They are the same
  • Cannot compare ROE
Show the answer

B, because its return is not driven by debt. Debt can inflate ROE; B earns well without leverage.

2. Which is an example of an economic moat?

  • A one-off asset sale
  • Strong network effects
  • A high share price
  • A large dividend
Show the answer

Strong network effects. Network effects make a product more valuable as more people use it.

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General education only, not financial advice. Examples are illustrations. Rules, tax settings and products change; check official sources.