Three rules. Reading an ROE without falling for the headline.
A return number is a multiplication of three businesses' worth of decisions. These three checks take ten minutes per company and survive every market cycle.
01
Decompose before comparing.
Two 20 pct ROEs from different levers are two different bets. A compounder earning the number through margin sits beside a leveraged industrial earning it through debt. The first survives a flat year. The second waits for the next rate move. Comparing them on the headline alone is an apples and grenades trade.
02
Leverage amplifies the cycle. Both directions.
A 4x equity multiplier is fine in a flat year and fatal in a bad one. A 20 pct revenue drop on the same operating base shows up as a 40 pct earnings drop on the way out. The same multiplier converts a 20 pct revenue surprise into a 40 pct beat on the way in. The earnings line is the operating return times the leverage. Read both before you price the multiple.
03
Asset turnover is the hardest to fake.
Margins can be padded with cost cuts and a tight operating quarter. Leverage can be ratcheted up in a year. Asset turnover requires real operating discipline year after year. Rolling 10Y standard deviation on Nifty 200 cohorts sits near 40 bps for turnover, 250 bps for margin, 80 bps for leverage. Of the three levers, the one that earns the right to be called quality is the one that does not move when you stress it.
Closer
ROE is the headline. The decomposition is the verdict. Two companies with the same 20 pct can be a compounder and a hand grenade. The math says so.