Forget ROE. This Is the Metric That Actually Matters
My entire analysis framework changed after I discovered this metric...
Hi, Investor 👋
I’m Jimmy, and welcome back to Jimmy’s Journal. This week, we’re taking a closer look at a classic question: how do you know if a company’s truly creating value?
ROE is popular, easy to calculate, and widely used - but it can mislead more than it reveals. Today, I’ll show you a smarter way to spot real value creation - not just accounting wins.
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There was a time when I thought a high ROE meant a high-quality business.
After all, a 25% return on equity sounded amazing - until I realized I was looking at the wrong thing.
Return on Equity is popular because it’s easy to calculate and widely taught.
But that simplicity hides a problem: it doesn’t actually tell you whether a company is creating value.
That’s when I discovered EVA (Economic Value Added), and my entire framework shifted…
The Problem With ROE:
Let’s start with the basics.
ROE = Net Income / Shareholders’ Equity
It tells you how much profit the company generates for each dollar of equity.
But what most investors ignore is that it can be manipulated (and hide a lot beneath the surface).
A company can increase ROE simply by taking on more debt (which lowers equity).
It can repurchase shares aggressively, reducing equity (not necessarily a bad thing, but it can be).
ROE doesn’t penalize a business for the cost of the capital it uses.
It just shows the return - not whether that return is above or below expectations.
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EVA: Economic Value Added
EVA is a performance metric that asks a much more important question:
Is the company generating returns above the cost of capital? And how much?
The formula:
EVA = NOPAT – (Capital Invested × WACC)
Let’s break it down:
NOPAT: Net Operating Profit After Tax - basically, the true operational earnings.
Capital Invested: equity + interest-bearing debt - the money used to run the business.
WACC: Weighted Average Cost of Capital - what the market demands as a fair return on that capital.
So, EVA measures the economic profit - not the accounting profit.
When Profit Isn’t Enough:
Here’s the key insight:
A company can be profitable in accounting terms - but destroy value economically.
If ROIC < WACC, the business is earning less than its cost of capital. Every dollar reinvested destroys shareholder value, even if net income looks fine.
Example:
Company A earns $100M in net income on $500M equity. ROE = 20%.
Sounds great…
But if the company uses $2B in total capital and has a WACC of 10%, the math looks different:
ROIC = 5%
WACC = 10%
EVA = Negative.
It’s not creating value. It’s consuming it.
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ROIC vs. WACC: The True Signal
This is why I stopped using ROE as a standalone metric.
What really matters is value creation over time - not just on shareholder equity, but on all the capital the business uses.
That means calculating:
ROIC = NOPAT / Capital Invested
WACC = (% debt × cost of debt) + (% equity × cost of equity)
If ROIC > WACC → value creation.
If ROIC < WACC → value destruction.
This is the foundation of EVA.
It tells you whether the business is actually earning more than it costs to operate.
Real-World Example: American Airlines
Let’s take a real case.
We’ve even talked about this sector before here in the newsletter.
American Airlines (AAL) often shows high ROE in recovery cycles - sometimes above 25%.
At first glance, that looks like strong performance.
But once you dig deeper:
Debt/Equity is over 5x - extremely leveraged.
ROIC is low due to the capital-intensive nature of the business.
WACC is relatively high - cyclical, risk-heavy industry.
In reality, ROE is being inflated by leverage, not by genuine value creation.
The market might buy the ROE story in a good quarter - but over time, the lack of economic value becomes impossible to hide.
As the old man Warren Buffett would say:
“Only when the tide goes out do you discover who’s been swimming naked.”
How to Approximate EVA Yourself:
Most companies don’t publish EVA directly.
But you can build an estimate:
Get operating income (EBIT) and adjust for taxes → NOPAT.
Add equity + net debt → capital invested.
Estimate WACC based on sector risk, cost of debt, and equity beta.
Compare ROIC to WACC over time - value creation shows up in the spread.
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ROE vs. ROIC vs. EVA: Quick Comparison Table
What Actually Matters:
If you're thinking long-term, EVA helps you see things most investors miss.
It filters out the noise, puts capital allocation in perspective, and reminds you to look at businesses the way real owners do.
So the next time you come across a flashy ROE, pause for a second and dig deeper.
Numbers tell stories - but some of them are fiction.
That’s it for today.
Let me know what you think.
Thanks for reading this far.
Cheers,
Jimmy
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Really solid post, love how you broke down why ROE can be misleading and made a strong case for focusing on ROIC vs. WACC. EVA is such an underrated concept and you explained it in a super clean way. One thing I would add is maybe a quick note that EVA can vary a lot across industries, and it might not always apply well to early-stage or fast-growth companies. But overall, this is the kind of post that actually helps people think deeper. Keep writing ✍️ - Best Regards, Ronak
Instead of ROE, look at 5Y ROCE. It’s a metric which tells you a lot about the business