How hard the owners’ capital is working
Imagine handing a friend $100 to run a market stall. At the end of the year they hand back your $100 plus $20 of profit. That stall earned a 20% return on the capital you left in it. Return on equity is that same question asked of a public company.
The equity part is what shareholders collectively own on paper: everything the company owns minus everything it owes. Return on equity divides annual profit by that figure, and the answer tells you whether management turns owner capital into profit efficiently or lets it sit there doing very little.
Nike, worked through
Nike recently earned in the region of $5.7 billion of annual net profit, against shareholder equity of roughly $14.4 billion. Divide 5.7 by 14.4 and multiply by 100, and you get approximately 39.6%.
That is a strong result. It says that for every $100 of owner capital sitting in the business, Nike generated close to $40 of profit in a year. Businesses that can do that consistently tend to have something protecting them, usually a brand customers will pay extra for.
Rounded recent figures, used to demonstrate the calculation.
The borrowing distortion you must know about
Here is the flaw that catches beginners. Equity is what the owners own after debts are subtracted. Borrow heavily and equity shrinks, which shrinks the bottom of the division and pushes return on equity upward, even though the business earns exactly the same profit.
Consider two companies each earning $10 million a year. The first has $100 million of owner capital and no borrowing, giving a 10% return on equity. The second borrowed aggressively and has only $25 million of owner capital left, giving a 40% return on equity. The second looks four times better by this measure alone, while being the more fragile business if trading turns difficult.
This is why return on equity should never be read by itself. Check the debt to equity ratio at the same time, and treat a high return built on heavy borrowing very differently from one built on genuine efficiency.
Sensible ranges, by industry
There is no universal threshold, whatever a screening tutorial tells you. Software and consumer brand companies often run above 20% because they need little physical equipment to grow. Utilities and heavy manufacturers frequently sit between 8% and 12% because they must fund enormous physical assets, and that is normal rather than poor.
A useful habit is to compare a company against its own five-year record and against direct competitors, never against a company from a different industry. A 12% return on equity may be excellent for a utility and disappointing for a software business.
Building a plan around it in Stax
A practical filter asks for a return on equity above 15% together with borrowings that are not extreme, which weeds out the companies whose impressive figure is really a debt story. That combination describes profitable businesses that are not relying on the bank to look good.
From there, do not simply buy the list. Ask Stax to build a plan around those companies, then replay it over five or more years of real prices. You will see how the rule handled the bad stretches as well as the good ones, and every simulated trade carries the reason it happened.