Warren Buffet each year tells us in the annual report of Berkshire Hathaway, the type of companies he is looking for, one of which is “businesses earning good returns on equity while employing little or no debt.”
Companies with LOW return on equity (ROE) are best to avoid. Professor Price tells us to think of ROE as a measure of how well management is using the money (or equity) that they have.
As a shareholder, this is very important – why would you want to align your investment growth with management that only produces a low return on what they have to work with.
But companies with low ROE are very common on the ASX. For example with a healthy ROE, ABC Learning Centres was listed in 2001. Over the next few years more debt and equity was raised (and used to pay inflated prices for more child care centres in Australia and USA. ROE fell to single digits, but was not the reason the company went into liquidation, but the ROE showed this was unlikely to be a satisfactory investment.
For more information and examples of investing lessons, as well as whether self managed super is for you, come to a free meeting – see the up-coming seminar listed above for more details. See http://ow.ly/4olRZ .