It takes money to make money

Why we stress Return on Equity

ROE usually stands for Return on Equity. ROE has a dual meaning. ROE is a Rule of Engagement; we won’t invest in a company that doesn’t have a long history of double digit returns to its equity capital.
By buying a company’s equity, you provide it with the capital necessary for it to operate. In return, you get a share of its profits. ROE, is a compelling parameter because it uses only these two elements of the shareholder/share issuer arrangement. Furthermore, although simple to calculate, it provides a snapshot of the competence of a corporation’s management team. It is awfully difficult to achieve consistently high ROE by fluke.

So, dividing net income by shareholder equity, and looking at that quotient over a number of years, is, to us, one clear indication of what a company’s management has achieved. After all when we invest, we do so on the basis of what a company is now, not what we hope it might become in the future.

In short, I prefer companies that use a small measure of your equity to provide you with a large profit. That’s why I invest in companies that have a high ROE.