ROE - Return on Equity

[AsleepInYorkshire]

I've recently been looking at this in a little more detail than previously.

Might I ask if there are any traps associated with this particular metric please?

Thank you

AiY(D)

[simoan]

I've recently been looking at this in a little more detail than previously.

Might I ask if there are any traps associated with this particular metric please?

Thank you

AiY(D)

Yes. The big one for me is that it doesn't take into account debt. Companies can artificially boost their ROE by taking on debt and weakening the balance sheet. So I would need to check to make sure you are happy with the balance sheet if the ROE is high.

All the best, Si

[AsleepInYorkshire]

I've recently been looking at this in a little more detail than previously.

Might I ask if there are any traps associated with this particular metric please?

Thank you

AiY(D)

Yes. The big one for me is that it doesn't take into account debt. Companies can artificially boost their ROE by taking on debt and weakening the balance sheet. So I would need to check to make sure you are happy with the balance sheet if the ROE is high.

All the best, Si

Thanks Si. Yes I do look very closely at debt. I'm not a fan of debt but probably don't understand enough about the difference between good and bad debt. So I currently take the view all debt is bad. That aside I'm aware many companies had to take on debt during Covid albeit I have seen some who haven't or have already repaid.

AiY(D)

[simoan]

I've recently been looking at this in a little more detail than previously.

Might I ask if there are any traps associated with this particular metric please?

Thank you

AiY(D)

Yes. The big one for me is that it doesn't take into account debt. Companies can artificially boost their ROE by taking on debt and weakening the balance sheet. So I would need to check to make sure you are happy with the balance sheet if the ROE is high.

All the best, Si

Thanks Si. Yes I do look very closely at debt. I'm not a fan of debt but probably don't understand enough about the difference between good and bad debt. So I currently take the view all debt is bad. That aside I'm aware many companies had to take on debt during Covid albeit I have seen some who haven't or have already repaid.

AiY(D)

I wouldn't go as far as saying all debt is bad. Obviously, balance sheet leverage acts to boost profits in good times but it can also amplify falling profits when times are not so good. Most long-term debt has currently been taken on historically low interest rates, so the main concern is the ability to meet interest payments when that debt is rolled over in future, on what will be much higher interest rates. Generally you will not go far wrong with companies that have a history of high ROE and balance sheets with reasonable debt levels.

All the best, Si

[WickedLester]

I'm not bothered about a high return on equity as a value investor. I like companies with asset heavy balance sheets, particularly where they're freehold property and cash or fairly liquid assets such as debtors.

If a company is on a modest multiple of earnings and those earnings fairly reliably turn to cash then why get fixated on ROE?

A quick scan of my current portfolio suggests that out of 31 holdings 25 have net cash, in some cases this is a very significant proportion of the market cap and in the case of LDG they are trading at a significant discount to net cash as far as I know.

[dealtn]

If a company is on a modest multiple of earnings and those earnings fairly reliably turn to cash then why get fixated on ROE?

So you are talking about companies that you measure a "modest multiple" as a ratio to "earnings" instead? That's not too far away from a Return on Equity/Capital model you realise.

[simoan]

If a company is on a modest multiple of earnings and those earnings fairly reliably turn to cash then why get fixated on ROE?

So you are talking about companies that you measure a "modest multiple" as a ratio to "earnings" instead? That's not too far away from a Return on Equity/Capital model you realise.

To be honest, I don't think it really matters what combination of metrics you use, as long as you use what works for your particular approach to investment. To me, ROE is more a metric to consider for longer-term investors that want to hold a company with good profitability (FWLIW I don't use it). That's completely different to a value investor who's holding time could be considerably shorter once the value is outed. Tbh I didn't really understand the point Wicked Lester was making with regard to this thread. Everyone has their own approach and identifies investment opportunities based on their own metrics. There's more than one way to make money from stock market investing.

All the best, Si

[WickedLester]

If a company is on a modest multiple of earnings and those earnings fairly reliably turn to cash then why get fixated on ROE?

So you are talking about companies that you measure a "modest multiple" as a ratio to "earnings" instead? That's not too far away from a Return on Equity/Capital model you realise.

Surely it's different in that you can have both a low P/E and a low ROE? Also, wouldn't a company with a large cash pile have a lower ROE than a similar company with debt generally? I know which I'd rather have.

Isn't it a desire to chase things like ROE that has all of these companies (particuarly in America AIUI) borrowing money and buying back shares.

[dealtn]

If a company is on a modest multiple of earnings and those earnings fairly reliably turn to cash then why get fixated on ROE?

So you are talking about companies that you measure a "modest multiple" as a ratio to "earnings" instead? That's not too far away from a Return on Equity/Capital model you realise.

Surely it's different in that you can have both a low P/E and a low ROE? Also, wouldn't a company with a large cash pile have a lower ROE than a similar company with debt generally? I know which I'd rather have.

Isn't it a desire to chase things like ROE that has all of these companies (particuarly in America AIUI) borrowing money and buying back shares.

Well its different depending on how you define earnings and returns, and also price and equity. If you adjust equity on the balance sheet to the market value of equity (which some do), and if you look at the E in P/E as "market return" (on equity) you have an almost equivalent metric. Cash and gearing can complicate it, so some look at capital, not equity and/or strip out cash in such analysis.

There is no perfect answer but Value defined as low P/E is a subset of companies that (generally) offer attractive returns on their capital. Investors seeking this type of investment usually look for a P correction to out the value and drive a capital gain. ROE(C) strategists will also invest in those with high P/E (but attractive and growing E) and seek to benefit from both the E, and any market re-pricing of P as the E grows over time.