I believe that many investors are very familiar with Buffett’s point of view, which has indirectly contributed to the status of the ROE indicator.

Why does the old gentleman take a fancy to ROE? This needs to start with the calculation logic of ROE.

ROE = Net Profit / Net Assets

As can be seen from the calculation formula, ROE is a comprehensive indicator that can comprehensively reflect the company's ability to create value for shareholders.

From the perspective of assets, net assets are the capital actually invested by the company’s shareholders. The balance after the company’s total assets-total liabilities is the assets that truly belong to shareholders.

From a profit perspective, net profit reflects the company's ability to comprehensively utilize various resources. To dismantle ROE, ROE = net sales profit margin * total asset turnover * equity multiplier (financial leverage).

It comprehensively reflects the utilization efficiency of the company's total assets, the profitability of its products and its ability to leverage financial leverage, and finally the total income results achieved.

Moreover, ROE is closely related to the company's valuation. Only a high return on net assets can support a high valuation premium.

Therefore, Munger also attaches great importance to ROE from the perspective of the long-term value of the enterprise:

According to Buffett's ROE > 20 standard, A-share companies that meet the requirements include Gree Electric Appliances and Guizhou The average annual growth in stock prices of Moutai, Yili, Hengrui Pharmaceuticals, etc. in the past ten years is really amazing.

However, no indicator can perfectly explain a company, so the old man also added a premise: "If you must use an indicator to select stocks." In real investment decisions, the old man must not only look at ROE. This stems from some limitations of ROE itself. 1. Contingency factors of net profit

The numerator of ROE is net profit, but net profit will be affected by many unexpected factors,

fluctuations in tax rates. With the comprehensive tax reduction in 2019, corporate taxes will be greatly reduced. The resulting increase in net profits does not come from the company's own strength.

Non-recurring gains and losses. ST Haima has to sell 400 properties in order to remove its hat. Similarly, Xinhuadu also relies on selling properties and government subsidies to survive. Another example is the former toothpaste boss Liu Mianzhen, and men's clothing giant Youngor, who often rely on investment income to support their business.

The profits created by these non-recurring businesses are difficult to sustain, and they also bring great confusion to investors when looking at ROE. Therefore, when looking at ROE, you should not just look at the ROE of a certain fiscal year, but should conduct continuous analysis and comparison of data for many years to reduce the impact of periodic factors on ROE. 2. Risks of financial leverage

As mentioned in the previous formula, financial leverage can have the effect of amplifying asset returns. Simply put, it means that a company borrows money to make money, as long as the cost of borrowing money is lower than the cost of making money. In the end, financial leverage can create higher ROE for shareholders. However, excessive financial leverage will increase the company's financial risks and may cause a liquidity crisis, such as HNA, which is eager to sell assets.

Therefore, this is what you must pay attention to when looking at ROE. It is necessary to understand the true source of ROE and evaluate the financial risks behind it. 3. Not suitable for evaluating loss-making enterprises

When the enterprise is still in a loss-making state, ROE has no substantial reference significance. However, there are also good companies among the loss-making companies. For example, Amazon has now entered the top three in the U.S. stock market. Before that, Amazon experienced a long period of continuous losses. The same goes for JD.com, which only started to make profits after many years of losses.

Investors recognize the company's business model, firmly believe that there will be room for profit in the future, and continue to invest funds, which leads to the subsequent market value and market position.

If you simply use ROE to screen, you will miss these companies that have huge room for growth in the future.

In addition, the company's cash flow cannot be seen through ROE. "Is profit or cash more important?" is an eternal topic. Pay attention to cash in the short term and look at profits in the long term, but you must not only focus on one of them. item.

Measuring the intrinsic value of a company is a very complicated matter. It depends on the company's current development stage, whether the company's money-making model is sustainable, and more importantly, the company's future cash flow creation. capabilities cannot be fully captured by a single indicator. This is not a flaw of ROE, but a limitation of all indicators themselves.

Indicators are auxiliary, and a more comprehensive analysis system is the basis for truly understanding a company.

(Note: The summary of "Advanced Introduction to the Stock Market" is for learning and exchange only)

First, the return on net assets can reflect the income level of the company's net assets, but it is not comprehensive. Reflects an enterprise's ability to utilize funds. The indicator that comprehensively reflects the overall effect of an enterprise's capital operation should be the return on total assets, not the return on net assets.

Second, since the asset scales of various listed companies are not equal, the absolute value of the income indicators of each enterprise cannot be used to assess its efficiency and management level.

Third, due to differences in corporate debt ratios, for example, some companies have deformed debt, resulting in high ROE for some low-profit companies; while some companies, despite good profits, have low debt due to reasonable financial structures. , but ROE is lower.

Fourth, a company can increase ROE by, for example, using debt to repurchase equity, but in fact, the company's economic benefits and capital utilization have not improved. Such assessment results will undoubtedly have a negative impact on investors' decision-making. 1. ROE in financial reports refers to return on net assets, and DuPont analysis is a good tool to describe its relationship:

Net interest rate on equity = profit after tax / owner’s equity = sales profit margin asset turnover rate Equity multiplier.

1. Sales profit margin: represents the company’s ability to “lay eggs” from its own hens. The higher the profit margin, the more “eggs” it will “lay”.

2. Asset turnover rate: represents the company's ability to "how long does it take for a chicken to lay an egg". The faster the turnover rate, the shorter the "time required for laying an egg". The same time can be compared with other "hens laying an egg". More eggs”.

3. Equity multiplier: represents the company’s ability to “borrow chickens and lay eggs”. Borrow someone else's "hen" and lay some "eggs" and give some to the other party. If there are any remaining "eggs", it is the company's profit. 2. Defects of DuPont analysis

1. The numerator and denominator do not match: sales profit margin, the denominator sales revenue includes the "eggs" (income) generated by all assets (excluding interest-free short-term debt), the denominator Only the "eggs" (profits) belonging to shareholders are included.

2. Failure to differentiate between business activities and financial activities: Which are the “eggs laid by the chicken”? Which are the borrowed "chicken eggs"? Not separated.

3. From the perspective of corporate performance evaluation, DuPont analysis only includes financial information: "egg-laying ability, egg-laying efficiency": it cannot fully reflect the strength of the company and has great limitations. It needs to be paid attention to in actual application and must be analyzed in conjunction with other information of the enterprise. Mainly manifested in:

Overemphasis on short-term financial results may encourage short-term behavior of company management and ignore the long-term value creation of the company: they just want to "lay eggs faster" and wish to "lay two eggs a day". "Egg", ignoring the "physical and mental health" care of the "hen" and "egg quality and type", can the "hen" "lay eggs" for a long time? Ability cannot be guaranteed. Can the "hen egg" remain popular for a long time? Didn't pay attention.

Financial indicators reflect the company's past operating performance: In the past, people were "hens hatching chicks" at home, and they paid attention to "whether the hen laid eggs every day?" Now, times have changed: there are suppliers that specialize in “chicken chicks” and they want you to buy more of them. The technology for raising "chickens" has improved, and more chickens can be "raised" in the same area. Some customers who "buy eggs" hope that the "hens" can exercise more, and some hope that the "hens" can eat "worms or grass." The focus in the past was different from the focus now.

Some people feed "hens" worms, exercise them more, publicize them widely, and even apply for "chicken-raising patents" and registered trademarks. Patents, brands, etc. are all intangible assets and are very important to improve the competitiveness of "chicken factories". Most people give feed to "hens", and there are many such "chickens" in the market. However, DuPont analysis cannot solve the problem of how to value intangible assets such as "chicken patents" and "egg brands". 3. How to improve ROE index?

There are three major ways to increase ROE: profit margin, asset turnover rate, and debt leverage. In the 1977 article "How Inflation Defrauds Stock Investors," Buffett pointed out: "In order to increase return on capital, companies need to use at least one of the following:

1. Increase turnover rate: In the same period of time, each "chicken" can lay more "eggs" than other "chickens"

2. Increase operating profit margin: The same number of "chickens" can lay more "eggs" than others.

3. Cheap debt leverage, higher debt leverage: You need to pay less rent for each chicken than before. ". In this way, the company will have more "eggs" left.

Summary: Those who lay more eggs, lay eggs faster, and borrow chickens to lay more eggs are good chickens and good farms. High operating profit margins and asset turnover Fast, cheap and higher financial leverage is a high-quality company that can bring more returns to investors.

ROE is definitely flawed, but as we all know, stock god Buffett likes this indicator best. Zeng once said: If you can only choose one indicator to measure a company's operating performance, choose ROE.

The ROE calculation formula is to divide net profit after tax by net assets.

For example, if Liu Qiang Dong invested 1 million and opened a milk tea shop, and the net profit was 150,000 a year later, then the ROE of this milk tea shop that year would be net profit 150,000/net assets 1,000,000 = 15, simple right?

Generally, if ROE remains between 15 and 30 all year round, we consider it to be a very good company.

Which companies are selected by this indicator? Those whose ROE has exceeded 20 for 10 consecutive years include Kweichow Moutai, Gree Electric, Hikvision, and Haitian Flavors. These are basically China’s high-quality white horses.

There are also pitfalls to be aware of when selecting ROE companies. That is, some companies have a higher ROE than those in the same industry. On the surface, they may have luxury cars and mansions, but their family background is not clean enough and their debt ratio is very high. At this time, it is necessary to determine whether it has short-term debt repayment.

Most people who like to look at ROE are biased investors, so we have to talk about another indicator, PEG.

PEG is actually the price-to-earnings ratio. The advanced version of PEG supplements the shortcomings of the P/E ratio that ignores the company's growth. The calculation formula is relatively simple, dividing the P/E ratio by the company's profit growth rate in the next three or five years.

PEG was first created by British investment guru Jim. Slater proposed it, but the one who used it to the extreme was Peter Lynch, the best fund manager.

This group of Wall Street tycoons is very interesting. Buffett likes ROE, and Peter Lynch likes PEG.

He has a famous conclusion: If any company is reasonably priced, its price-to-earnings ratio will be equal to its earnings growth rate, that is, if we take 1 as the critical point, the smaller the PEG, the more investment the company will make. The greater the value.

How to understand it? For example, junior high school classmates Li Lei and Han Meimei got the same score in the high school entrance examination and met again in the same class of the same high school. Yes, it was such a coincidence. The same score in the high school entrance examination shows that their learning starting points are similar; but after passing the high school entrance examination, who can win when facing the college entrance examination three years later? What if I tell you: Student Li Lei is getting by every day, and her monthly test scores are getting worse; while student Han Meimei is proactive and full of positive energy every day. At this time, whose future are you more optimistic about? Even if the final result may be unexpected, most people should be more optimistic about Han Meimei, because from Han Meimei, we can at least see the desire to work hard and grow upward.

In fact, Li Lei and Han Meimei can be compared to two companies in our stock market. Li Lei is in a traditional industry, and Han Meimei is a high-tech growth company. The current price-earnings ratio may be similar, but Han Meimei's performance every year is If it can maintain sustained growth, high growth will digest high valuations, thus making the PEG smaller, which means that investment is more cost-effective.

This example may not be so appropriate, but I mainly want to tell you that if the P/E ratio considers a company's current valuation level, then PEG will cover its future growth ability on this basis. When using this indicator to screen stocks, the most critical thing is to predict the company's future profit growth rate.

Buffy said: Investment does not require top IQ or extraordinary business acumen, but requires a stable thinking framework as the basis for decision-making. The most important thing is the ability to control one's emotions.

If you chase companies with a PE of 70, 80 or even hundreds of dollars but no performance growth, buy stocks whose logic you don’t understand at all, and chase various themes, you may be lucky this time. , but it is impossible to be lucky all the time. In the end, the money earned will still be lost based on strength.

ROE=net profit/shareholders' equity

However, both net profit and shareholders' equity will be affected by false data in financial statements.

In other words, the RoE indicator is easily manipulated by management.

1. Net profit is too easy to be manipulated

The reason for the falsification of net profit is that the management must make this in order to highlight management capabilities or for equity incentives and other reasons. The indicators are better; in addition, when preparing the income statement on an accrual basis, management can reasonably manipulate profits.

I won’t go into detail here about the difference between accrual basis and cash basis.

Under the accrual basis, as long as the profit is determined by sales, it can be reflected in the income statement, even if no sales cash is received

2. Shareholders' equity is manipulated

Shareholders' equity = total assets - total liabilities

Total assets are unreliable because most assets in accounting financial statements use the historical cost accounting method.

The historical cost accounting method is based on the historical cost of assets when depreciating, which is not the fair value.

It will cause the total assets to fail to reflect the current true value.

Shareholders’ equity = paid-in capital, excess paid-in capital, retained earnings – treasury shares

What can falsify shareholders’ equity is retained earnings and treasury shares; retained earnings = Net profit - dividends

Listed companies can adjust retained earnings by adjusting dividends. For example, increasing dividends will lead to a decrease in retained earnings and an increase in ROE.

Therefore, when we use ROE, we cannot completely rely on it to make your investment decisions. You need to be familiar with the management, understand their past, and understand the operating history of the listed company.

1. The return on net assets of each business is meaningful. The profits of a company can be divided into businesses, but the net assets cannot. Therefore, roe is just a result.

You won't understand why it is high or why it is low. At this time, you need to combine the gross profit margin of the business by project.

2. ROE can be achieved by borrowing more debt. But if interest rates rise in the interest rate market, or the sales side goes from bad to worse. Then the more money you borrow, the more you will lose. So this indicator is misleading.

3. Pursue short-term indicators. The hardest thing to define in fraud is the cutoff. That is to transfer future profits to this year. It looks like your performance is pretty good, but you are actually calculating your profits in the next few years in advance. Then choose a year and record all losses in that year.

4. Net assets should consider the nature of equity instruments and financial assets. Outsiders can't do it. For example, if convertible bonds are used as debt, the net assets will decrease; if they are used as equity instruments, the net assets will increase. Since professional judgment is added to this part, no matter whether it is gambling or open stocks and real debts, there are always people manipulating it.

In short, RoE matches the overall cash flow of a company, excluding non-profits, and actual operating conditions. It should not be an indicator to observe alone. The best way to test RoE is to calculate the average RoE over a period of more than ten years and look at it spread over time. Of course, you still need to understand the company's business, such as Kodak film. Historically, RoE was very good, but in the digital age, is its RoE still useful? Therefore, the key is to look at the main business based on data.

ROE is a very effective indicator through which expected valuation can be calculated. Through observing statistical results over the past few years, I have come to a rather ideal conclusion (for most blue chip stocks). Some stocks start to skyrocket around the valuation I calculated, then peak and then fall back, showing a trend of adjustment.