What Is ROE and Why Warren Buffett Wants 20%+

Of all the financial metrics Warren Buffett uses to evaluate companies, Return on Equity (ROE) stands above the rest. In his 1987 shareholder letter, Buffett set two clear standards:

1. Average ROE over 10 years must exceed 20%
2. No single year should fall below 15%

Only 25 of 1,000 Fortune companies met both conditions. That's 2.5%. ROE is the single most effective filter for identifying businesses with what Buffett calls "durable competitive advantages."

What ROE Actually Measures

ROE = Net Income ÷ Shareholders' Equity × 100

In plain language: for every dollar shareholders have invested in the company, how many cents of profit does the business generate each year?

Why 20% Is the Magic Number

The maths behind Buffett's threshold is elegant:

• At 15% ROE, your money doubles every ~5 years
• At 20% ROE, your money doubles every ~4 years
• At 25% ROE, your money doubles every ~3 years

10% ROE

$673

10% ROE grows $100 to $673 over 20 years (market average)

15% ROE

$1,637

15% ROE grows $100 to $1,637 over 20 years (Buffett minimum)

20% ROE

$3,834

20% ROE grows $100 to $3,834 over 20 years (Buffett target)

Over 20 years, the difference is enormous. A company compounding equity at 20% turns $100,000 into $3.8 million. At 10%, that same $100,000 becomes just $673,000. The gap widens exponentially with time — which is why Buffett's favourite holding period is "forever."

Why the 15% Minimum Matters

A company might average 20% ROE over 10 years, but if one year it drops to 5%, that's a red flag. Here's why:

Company A: 20%, 21%, 19%, 22%, 20%, 18%, 21%, 20%, 19%, 20% → Average: 20% ✅

Company B: 35%, 30%, 5%, 40%, 8%, 25%, 35%, 6%, 15%, 1% → Average: 20% ✅

Both average 20%, but Company B is wildly inconsistent. Its profits swing dramatically, suggesting the business has no real competitive protection. When times are good, it performs well. When conditions change, profits collapse.

Buffett's 15% floor catches this pattern. Company A passes. Company B fails — three years below 15%.

The Debt Trap: When High ROE Lies

Here's the most important caveat: ROE can be artificially inflated by debt.

The formula is Net Income ÷ Shareholders' Equity. If a company borrows heavily, its equity base shrinks (since equity = assets minus liabilities), making ROE look higher than the business genuinely earns.

Example:

Company Y looks brilliant — 40% ROE! But it achieves this by loading up on debt, not by being a better business. That debt has to be repaid, with interest, regardless of whether profits hold up.

This is exactly why Buffett pairs ROE with his debt-to-equity check (must be below 0.5). High ROE combined with low debt = genuine business quality. High ROE with high debt = financial engineering.

What ROE Tells Dividend Investors

For dividend investors, ROE is directly linked to dividend sustainability:

1. High ROE = More profit to distribute. Companies with 20%+ ROE generate enough cash to pay dividends AND reinvest in growth — without needing to borrow.

2. Consistent ROE = Predictable dividends. If profits are stable, dividend payments are stable. Wild ROE swings often precede dividend cuts.

3. Growing ROE = Growing dividends. Companies that maintain or improve ROE over time can increase dividends year after year — the holy grail of income investing.

The best dividend stocks combine Buffett's ROE requirements with Barsi's 6% yield threshold. Quality business + reliable income = the complete package.

Industry Context Matters

Not all industries generate the same ROE. Buffett adjusts his expectations accordingly:

A bank with 14% ROE may be exceptional within its industry, even though it wouldn't pass the generic 20% threshold. Our scoring system accounts for these differences — each sector has appropriate benchmarks.

How to Use ROE in Practice

Step 1: Check the 10-year average. Is it above the industry threshold?

Step 2: Check the worst year. Did it stay above 15% (or the industry minimum)?

Step 3: Check debt-to-equity. Is the high ROE genuine, or fuelled by borrowing?

Step 4: Look at the trend. Is ROE stable, improving, or declining?

If all four checks pass, you've found a company with a genuine competitive advantage — the kind of business that can sustain dividends through economic cycles.

Key Takeaways

1. ROE measures profitability per dollar of equity — higher is better
2. 20% average + 15% minimum filters for the top 2.5% of companies
3. Consistency matters as much as the average — one bad year is a red flag
4. Always check debt levels — high ROE with high debt is a warning sign
5. Industry context matters — banks and utilities have lower but still meaningful thresholds

Frequently Asked Questions

What is a good ROE for Australian stocks?

It depends on the industry. Warren Buffett's general threshold is 20%+ average over 10 years, but this varies by sector. Banks typically achieve 12-15% ROE, utilities around 10-12%, and consumer brands 20%+. A stock should be measured against its industry peers, not a universal number.

Can ROE be too high?

Yes. An unusually high ROE (above 40-50%) should be investigated. It may indicate the company is heavily leveraged — using debt to shrink its equity base, which inflates the ratio. Always check debt-to-equity alongside ROE to determine whether returns are genuine.

How is ROE different from ROI or ROIC?

ROE measures profit relative to shareholders' equity (what investors own). ROI (Return on Investment) is a broader measure of total return. ROIC (Return on Invested Capital) includes both equity and debt capital, giving a more complete picture of how efficiently a company uses all capital. Buffett focuses on ROE as his primary filter.

Why does Buffett want 10 years of data for ROE?

Ten years captures at least one full economic cycle — including recessions and expansions. A company that maintains 20%+ ROE through both good and bad times has proven its competitive advantage is durable, not just a product of favourable conditions.

See ROE in Action

Want to see which ASX stocks meet Buffett's ROE standards? Our stock screener applies these exact criteria — including industry-specific thresholds — to 500+ Australian companies. Learn how ROE fits into our complete scoring methodology.

For the complete picture of Buffett's quality assessment, read Warren Buffett's 4 Core Criteria for Quality Stocks. ROE is just one of four tests a company must pass.

Related reading:

• Top 10 ASX Dividend Stocks for 2026 — See ROE in context with other quality and dividend metrics
• CBA vs NAB vs WBC vs ANZ — Compare ROE across Australia's Big 4 banks
• ASX Dividend Investing: A Beginner's Guide — Start with the fundamentals of building a dividend portfolio
• How Franking Credits Work — The tax advantage that makes ASX dividend investing unique
• SMSF Dividend Strategy — Why ROE matters even more inside your super fund

Important: This is general information only, not financial advice. Past performance does not guarantee future results. Always do your own research or consult a licensed financial adviser before making investment decisions. See our full disclaimer.