ROE is very important. No not fish eggs (although very tasty on a cracker), but Return on Equity.
In fact according to the big kahuna of investing Warren Buffett Return on Equity is one of THE most important fundamentals that you need to look at before you fork over your hard earned.
And of course, it’s one of my rules. The 2nd one actually.
ROE measures how much profit that the company makes with the money that shareholders give them. Soo, if a company has a good ROE it means that it has a good management structure in place because they are able to balance their profitability with the financial leverage shareholders give them, giving you a better return for your bucks.
It’s calculated by dividing the shareholders equity by the company’s net income.
Errggh Maths, I know. Don’t worry you don’t actually have to figure it out yourself, it’s always listed right there on the company’s fundamentals page. Phew huh!
It’s pretty easy to find the ROE for any company; this is Exxon Mobil’s ROE showing it as 23.43%.
Ok, so what is a good Return on Equity to look for?
My rule is that the company has to have at least a 15% ROE. That’s about the same level as Warren Buffett says he looks for and we can’t argue with the big man. Well you could, but you’d look pretty silly since his methods have earned him billions.
Once you have your list of the top companies to choose from, the next step is to go and find out the ROE of them all. Don’t worry it doesn’t’ take long. Well, not too long anyway.
I like to put them in a spreadsheet so that I can keep track of all the fundamentals in my rules. I find this just makes things easier (well for me anyway because I’m always losing scraps of paper that I write down things on – sorry guys who gave me their numbers over the years but them’s the facts).
Currently out of the thirty companies listed in the Dow Jones Industrial Average twenty of them have ROE’s over 15%. That means that these 20 companies would qualify for my 2nd rule for investing in the stock market.
Then it’s only three more rules to go to narrow down these further and you’ve found your winners.