CHAPTER 8
Stock Research Checklist—Equity
In simple terms, return on equity (ROE) is how much profit the company is generating with the shareholders’ money. As a shareholder, you can earn lot of money over time with a company that has a high ROE.
What Is the Company’s ROE for the Last 10 Years? Does It Trend Upward?
Here is how to calculate ROE:
Warren Buffett monitors ROE compared with earnings per share (EPS). In EPS, management can do some financial engineering to increase the figure over time, without increasing the earnings numbers. If they want to improve the earnings numbers, they can buy back shares, which causes the EPS to start to increase. Buying back shares is a good thing for the company and shareholders. But the intention to increase the EPS alone is not a good thing. If the company uses more debt, it can generate a higher ROE too. Generating a high return on equity with reasonable debt is a good thing.
Now we can calculate the ROE for both of our company comparisons; Coca-Cola’s (KO) ROE for the last 10 years are as follows:
| 2000: 23.1% |
| 2001: 38.5% |
| 2002: 34.3% |
| 2003: 33.6% |
| 2004: 32.3% |
| 2005: 30.2% |
| 2006: 30.5% |
| 2007: 30.9% |
| 2008: 27.5% |
| 2009: 30.2% |
Average ROE for last 10 years = 31.11 percent
Look at the consistency of the ROE every year; it is right around 30 percent. That is a great number. The company is generating an average 31.11 percent profit from shareholder-invested money. ...
