The Possibility of Reinvesting More Capital in companies with High Returns on Capital

Bear in mind that the potential for companies with high returns on capital to reinvest a lot of capital are limited, since they tend not be be very capital intensive (e.g. Nestle Malaysia and Dutch Lady).

Furthermore, the market will probably be correctly pricing such gems which are capable of obtaining high returns over time, meaning we must wait for the right moment to acquire them at a reasonable price, because they are rarely gong to come cheap.

If some of these companies with high returns on capital in attractive sectors also offer a certain amount of growth, facilitating reinvestment of capital, then we are looking at a gem, with the added benefit of being coherent with our long term investment philosophy.

If a company can reinvest with a 20% return on investment over the next 20 years and we are able to buy the stock at a reasonable price, then the return on our investment will be close to this annual 20% over 20 years.

Return on Capital Employed

For example:

Capital employed $5 million
Annual profit after tax $1 million
Return on capital employed 20%

The profit may be expressed before or after tax.

Capital employed is the net amount invested in the business by the owners and is taken from the Balance Sheet.

Many people (including Warren Buffett) consider this the most important ratio of all.

It is useful to compare the result with a return that can be obtained outside the business.

If a bank is paying a higher rate, perhaps the business should be closed down and the money put in the bank.

Note that there are 2 ways of improving the return.  In the example above:

• the return on capital employed would be 25% if the profit was increased to $1.25 million.
• it would also be 25% if the capital employed was reduced to $4 million.

The importance of high ROE when selecting your stocks for the long term (Warren Buffett)

In his newsletter to Berkshire Hathaway's shareholders in 1987, Warren Buffett wrote a brilliant piece on his focus on return of equity in his selection of his companies.  Here are some of his notes.


1.   Only 6 out of 1000 had ROE > 30% during previous decade

In its 1988 Investor's Guide issue, Fortune reported that among the 500 largest industrial companies and 500 largest service companies, only six had averaged a return on equity of over 30% during the previous decade.  The best performer among the 1000 was Commerce Clearing House at 40.2%.

(Comment:  6 in 1000 is 0.6%)


2.  Only 25 of 1,000 companies had average ROE > 20% and no year with ROE < 15%, in last 10 years.

This Fortune study also mentioned that only 25 of the 1,000 companies met two tests of economic excellence -

• an average return on equity of over 20% in the ten years, 1977 through 1986, and 
• no year worse than 15%.

These business superstars were also stock market superstars:  During the decade, 24 of the 25 outperformed the S&P 500.

(Comment:  25 in 1000 is 2.5%)

3.  Companies with durable competitive advantage

These companies have two features.

• First, most use very little leverage compared to their interest-paying capacity.  Really good businesses usually don't need to borrow.
• Second, except for one company that is "high-tech" and several others that manufacture ethical drugs, the companies are in businesses that, on balance, seen rather mundane.  Most sell non-sexy products or services in much the same manner as they did ten years ago (though in larger quantities now, or at higher prices, or both). 

The record of these 25 companies confirms that making the most of an already strong business franchise, or concentrating on a single winning business theme, is what usually produces exceptional economics.  

(Comment:  About 20 of 1,000 companies in KLSE, that is, 2%, are investable for the long term.)

4.  Quoting Buffett from his 1987 letter to shareholders of Berkshire Hathaway:

"There's not a lot new to report about these businesses - and that's good, not bad.  Severe change and exceptional returns usually don't mix.  Most investors, of course, behave as if just the opposite were true.  That is, they usually confer the highest price-earnings ratios on exotic-sounding businesses that hold out the promise of feverish change.  That prospect lets investors fantasise about future profitability rather than face today's business realities.  For such investor-dreamers, any blind date is preferable to one with the girl next door, no matter how desirable she may be."

Reference:

http://www.berkshirehathaway.com/letters/1987.html

ROE as a proxy for Competitive Advantage

The DuPont formula

ROE= (Net Profit/ Sales) X (Sales/ Assets) X (Assets/ Equity)

And we are left with:   

ROE = Net Profit/ Equity

The DuPont breakdown goes on to show why ROE is such a critical ratio for analysts and investors alike. 

It basically is combination of three ratios that reflect overall profitability and efficiency of a company. 

This breakdown also shows the bearing of six factors on ROE instead of the usual two that we assume are the beginning and end of it.

ROE as a proxy for Competitive Advantage:

Consistently High RoE figures do indicate that the company has a moat. 

As seen above in the Dupont breakdown of RoE, a company can have a high RoE 

• either because it is able to sell its goods/services at a high margin 
• or because  increase its returns by either selling its products at a high rate. 

Only the third option is undesirable i.e having a high leverage which would mean high indebtedness . 

Remember, we said a consistently high levels of RoE to be construed as an evidence of a moat. 

This is because the denominator of this ratio includes shareholders equity which in turn consists of   share capital plus retained earnings (also called reserves and surplus)

Share holder's equity= Share capital + Retained earnings

Now as the company generates higher returns on equity, the profits are added to the retained earnings. 

So the denominator of ROE keeps increasing and so either the company has to

•  keep showing growth in its profits or 
• find ways to reduce the denominator. 

The company can do that by 

• either paying higher dividends 
• or buying back shares

- both strategies lead to gains for shareholders. 

http://www.investorwhiz.com/concepts/return-on-equity-roe

Return on Equity (ROE) - the financial metric that investors should use to judge a company's annual performance

Buffett considers earning per share a smoke screen.

Most companies will retain a portion of their previous year's earnings as a way to increase their equity base.

Warren Buffett believes there is nothing spectacular about a company that increases earning per share by 10% if, at the same time, the company is growing its equity base by 10%.

He says this is no different than putting money in a savings account and letting the interest accumulate and compound.

Buffett prefers return on equity to earnings per share when analyzing a company.

He will make appropriate adjustments to the reported earnings to give a clear picture of how returns were generated as a return on business operations.

Buffett believes a business should achieve good return on equity while employing little or no debt.

Most investors judge annual performance by focusing on earnings per share.

According to Buffett, the proper way to judge a company's performance is though focusing on return on equity.

Return on equity is a better measure of annual performance because it takes into consideration a company's growing capital base.

Buffett uses ROE as his preferred financial metric to judge a company's annual performance; investors should do likewise.

Warren Buffett favours companies that increase their ROE or which have consistent levels of ROE.

INVESTMENT DANGERS

There can be dangers in averaging returns over a long period. A company might start with high rates which then fall away, but still have a healthy average. Conversely, a company might be going in the opposite direction. 

As Warren Buffett looks for predictability in a company’s earnings, one would imagine that he would favour companies who increase their ROE or which have consistent levels.

COMPANY ANNUAL RATES OF RETURN

Compare the annual rates of return on equity of the following companies, using summary figures provided by Value Line.

Year	Coca Cola	Gap Inc	Wal-Mart Stores
1993	47.7	22.9	21.7
1994	48.8	23.3	21.1
1995	55.4	21.6	18.6
1996	56.7	27.4	17.8
1997	56.5	33.7	19.1
1998	42	52.4	21
1999	34	50.5	22.1
2000	39.4	30	20.1
2001	35	4.3	19.1
2002	35	13.1	20.4

Warren Buffett's secret - THE COMPOUNDING FACTOR

EXPLANATION

This may be old hat to some readers but it is worth remembering how compounding is one of the keys to Warren Buffett’s investment success.

The compounding factor is easy to understand. Compound interest (or compounding of earnings) is simply the ability of interest (or investment return) earned on a sum of money to earn additional interest (or investment return), thereby increasing the return to the owner of the money or investor. It works like this and we will use interest as the exemplar:

You deposit a sum of money, say $1,000, in a bank or other financial institution that earns interest at the rate of 5 per cent, payable annually. At the end of the first year, you have earned $50 and have the right to get your $1,000 back.

Suppose however that you want to invest the money long-term, for say 10 years. You now have two options.

OPTION A: TAKE INTEREST PAYMENTS

You can have the interest paid to each year, in which case you will receive $50 each year to spend or use as you wish. At the end of the 10-year period, you will get your final interest payment and your $1,000 back.

OPTION B: RE-INVEST INTEREST

You can choose to re-invest your interest and earn interest each year on the accumulated interest payments as well as on the original investment. This means that you do not get annual payments but, at the end of the 10-year period, you will get a lump sum payment of $1625. This is compound interest.

Why this much larger amount? Because your interest earns interest each year like this (calculations rounded to nearest 50 cents). 

Year	Principal sum	Interest earned	New principal sum
1	1000	50	1050
2	1050	52.50	1102.50
3	1102.50	55.00	1157.50
4	1157.50	58	1215.50
5	1212.50	61	1273.50
6	1273.50	64	1337.50
7	1337.50	67	1404.50
8	1404.50	70	1474.50
9	1474.50	74	1548.50
10	1548.50	77	1625

The higher the interest, the bigger the capital gain. At 10 per cent, the sum would increase to $2594.00; at 15 per cent, to $4055.00.

Warren Buffet is said to look at the compounding factor when deciding on investments, requiring a stock investment to show a high probability of compound growth in earnings of at least 10 per cent before making an investment decision.

COMPOUNDING AND RETAINED EARNINGS

Warren Buffett has on several occasions referred to the use by a company of its retained earnings as a test of company management. He tells us that, if a company can earn more money on retained earnings than the shareholder can, the shareholder is better off (taxation aside) if the company retains profits and does not pay them out in dividends. If the shareholder can achieve a higher rate of return than the company, the shareholder would be better off if the company paid out all its profits in dividends (taxation situation again excluded) so that they could use the money themselves.

Put simply, if a company can retain earnings to grow shareholder wealth at better than the market rates available to shareholders, it should do so. If it can’t, it should pay the earnings to shareholders and let them do with them what they wish.

 HIGH RETURNS ON EQUITY

This is why Buffett is interested in companies that have rights rates of earnings on equity and likes them even more where the return rates are increasing. He reasons that, with a company like this, he is better off if the company pays no or little dividends and retains the money to earn even more for its owners.

In addition, where no dividend is received, there is no income tax payable by the shareholder. Instead, the investor gets the value of the increase in value in the shares which will, eventually, rise to reflect the enhanced earnings. The shareholder can then retain the shares, sell them at a time that best suits them, if they wish, and take advantage of the capital gains taxation regime.

It is why potential investors should calculate the company’s history of returns on equity and management of retained earnings.

BERKSHIRE HATHAWAY AND RETAINED EARNINGS

Berkshire Hathaway does not, following Buffett’s mantra, pay dividends to its shareholders and this is one reason why its compound return over the years of Buffett-Munger management has been so high.

The downside of course is that shareholders have not received dividends, meaning, that if they were dependent on money coming in at a given time, their only recourse, in relation to their shareholding, would be to sell the shares or borrow against them.

Having regard to the huge price of a single share over the past few years, this meant that investors may have had to either keep all their shareholding or dispose of it, not always the choice they wanted. Berkshire Hathaway partly catered for this dilemma by introducing B shares, which are in essence a fractional unit of the normal shares.

A POWERFUL FORCE

When asked to nominate the most powerful force on earth, Albert Einstein is reputed to have answered ‘compound interest’. Buffett might well agree.

http://www.buffettsecrets.com/compound-interest.htm

ROA And ROE Give Clear Picture Of Corporate Health

by Ben McClure 

With all the ratios that investors toss around, it's easy to get confused. Consider return on equity (ROE) and return on assets (ROA). Because they both measure a kind of return, at first glance, these two metrics seem pretty similar. Both gauge a company's ability to generate earnings from its investments. But they don't exactly represent the same thing. A closer look at these two ratios reveals some key differences. Together, however, they provide a clearer representation of a company's performance. Here we look at each ratio and what separates them.

ROE
Of all the fundamental ratios that investors look at, one of the most important is return on equity. It's a basic test of how effectively a company's management uses investors' money - ROE shows whether management is growing the company's value at an acceptable rate. ROE is calculated as:

Annual Net Income             Average Shareholders' Equity

You can find net income on the income statement, and shareholders' equity appears at the bottom of the company's balance sheet.

Let's calculate ROE for the fictional company Ed's Carpets. Ed's 2009 income statement puts its net income at $3.822 billion. On the balance sheet, you'll find total stockholder equity for 209 was $25.268 billion; in 2008 it was $6.814 billion.

To calculate ROE, average shareholders' equity for 2009 and 2008 ($25.268bn + $6.814bn / 2 = $16.041 bn), and divide net income for 2009 ($3.822 billion) by that average. You will arrive at a return on equity of 0.23, or 23%. This tells us that in 2009 Ed's Carpets generated a 23% profit on every dollar invested by shareholders.

Many professional investors look for a ROE of at least 15%. So, by this standard alone, Ed's Carpets' ability to squeeze profits from shareholders' money appears rather impressive. (For further reading, see Keep Your Eyes On The ROE.)

ROA
Now, let's turn to return on assets, which, offering a different take on management's effectiveness, reveals how much profit a company earns for every dollar of its assets. Assets include things like cash in the bank, accounts receivable, property, equipment, inventory and furniture. ROA is calculated like this:

Annual Net Income             Total Assets

Let's look at Ed's again. You already know that it earned $3.822 billion in 2009, and you can find total assets on the balance sheet. In 2009, Ed's Carpets' total assets amounted to $448.507 billion. Its net income divided by total assets gives a return on assets of 0.0085, or 0.85%. This tells us that in 2009 Ed's Carpets earned less than 1% profit on the resources it owned.

This is an extremely low number. In other words, this company's ROA tells a very different story about its performance than its ROE. Few professional money managers will consider stocks with an ROA of less than 5%. (For further reading, see ROA On The Way.)

Watch: Reture On Assets

The Difference Is All About Liabilities
The big factor that separates ROE and ROA is financial leverage, or debt. The balance sheet's fundamental equation shows how this is true: assets = liabilities + shareholders' equity. This equation tells us that if a company carries no debt, its shareholders' equity and its total assets will be the same. It follows then that their ROE and ROA would also be the same.

But if that company takes on financial leverage, ROE would rise above ROA. The balance sheet equation - if expressed differently - can help us see the reason for this: shareholders' equity = assets - liabilities. By taking on debt, a company increases its assets thanks to the cash that comes in. But since equity equals assets minus total debt, a company decreases its equity by increasing debt. In other words, when debt increases, equity shrinks, and since equity is the ROE's denominator, ROE, in turn, gets a boost. At the same time, when a company takes on debt, the total assets - the denominator of ROA - increase. So, debt amplifies ROE in relation to ROA.

Ed's balance sheet should reveal why the company's return on equity and return on assets were so different. The carpet-maker carried an enormous amount of debt - which kept its assets high while reducing shareholders' equity. In 2009, it had total liabilities that exceeded $422 billion - more than 16 times its total shareholders' equity of $25.268 billion.

Because ROE weighs net income only against owners' equity, it doesn't say much about how well a company uses its financing from borrowing and bonds. Such a company may deliver an impressive ROE without actually being more effective at using the shareholders' equity to grow the company. ROA - because its denominator includes both debt and equity - can help you see how well a company puts both these forms of financing to use.


Conclusion
So, be sure to look at ROA as well as ROE. They are different, but together they provide a clear picture of management's effectiveness. If ROA is sound and debt levels are reasonable, a strong ROE is a solid signal that managers are doing a good job of generating returns from shareholders' investments. ROE is certainly a “hint” that management is giving shareholders more for their money. On the other hand, if ROA is low or the company is carrying a lot of debt, a high ROE can give investors a false impression about the company's fortunes.

by Ben McClure (Contact Author | Biography)

Ben McClure is a long-time contributor to Investopedia.com.

Ben is the director of Bay of Thermi Limited, an independent research and consulting firm that specializes in preparing early stage ventures for new investment and the marketplace. He works with a wide range of clients in the North America, Europe and Latin America. Ben was a highly-rated European equities analyst at London-based Old Mutual Securities, and led new venture development at a major technology commercialization consulting group in Canada. He started his career as writer/analyst at the Economist Group. Mr. McClure graduated from the University of Alberta's School of Business with an MBA.

Ben's hard and fast investing philosophy is that the herd is always wrong, but heck, if it pays, there's nothing wrong with being a sheep.

He lives in Thessaloniki, Greece. You can learn more about Bay of Thermi Limited atwww.bayofthermi.com.

Filed Under: Accounting, Fundamental Analysis, Investing Basics, Stock Analysis, Stocks

http://www.investopedia.com/articles/basics/05/052005.asp

Warren Buffett believes that the return that a company gets on its equity is one of the most important factors in making successful stock investments.

Warren Buffett believes that the return that a company gets on its equity is one of the most important factors in making successful stock investments.

DEFINING EQUITY

Benjamin Graham defines stockholders equity as:

‘The interest of the stockholders in a company as measured by the capital and surplus.’

CALCULATING OWNER’S EQUITY

Investors can think of stockholders equity like this. An investor who buys a business for $100,000 has an equity of $100,000 in that investment. This sum represents the total capital provided by the investor.

If the investor then makes a net profit each year from the business of $10,000, the return on equity is 10%:

10,000 x 100
  100,000

If however the investor has borrowed $50,000 from a bank and pays an annual amount of interest to the bank of $3500, the calculations change. The total capital in the business remains at $100,000 but the equity in the business (the capital provided by the investor) is now only $50,000 ($100,000 - $50,000).

The profit figures also change. The net profit now is only $6500 ($10,000 - $3,500).

The return on capital (total capital employed, equity plus debt) remains at 10%. The return on equity is different and higher. It is now 13%:

6,500 x 100
 50,000

The approach to financing its operations by a company can obviously affect the returns on equity shown by that company.

WHY WARREN BUFFETT THINKS THAT RETURN ON EQUITY IS IMPORTANT

Just as a 10% return on a business is, all other things being equal, better than a 5% return, so too with corporate rates of returns on equity. Also, a higher return on equity means that surplus funds can be invested to improve business operations without the owners of the business (stockholders) having to invest more capital. It also means that there is less need to borrow.

WHAT RATE OF RETURN ON EQUITY DOES WARREN BUFFETT LOOK FOR?

This is a fluctuating requirement. The benchmarks are the return on prime quality bonds and the average rate of returns of companies in the market. In 1981, Buffett identified the average rate of return on equity of American companies at 11%, so an intelligent investor would like more than that, substantially more, preferably. Bond rates change, so the long-term average bond rate must be considered, when viewing a long-term investment.

In 1972, Buffett implied that a rate of return on equity of at least 14% was desirable. Although, at times, Warren Buffett has appeared to downplay the importance of Return on Equity, he constantly refers to a high rate of return as a basic investment principle.

COMPANY RATES OF RETURN ON EQUITY

It is significant that the majority of companies in the Berkshire Hathaway portfolio in 2002 all had higher than average returns on equity over a ten-year period. For example:

Coca Cola	45.05
American Express	20.19
Gillette	40.43

INVESTMENT DANGERS

There can be dangers in averaging returns over a long period. A company might start with high rates which then fall away, but still have a healthy average. Conversely, a company might be going in the opposite direction. As Warren Buffett looks for predictability in a company’s earnings, one would imagine that he would favour companies who increase their ROE or which have consistent levels.

COMPANY ANNUAL RATES OF RETURN

Compare the annual rates of return on equity of the following companies, using summary figures provided by Value Line.

Year	Coca Cola	Gap Inc	Wal-Mart Stores
1993	47.7	22.9	21.7
1994	48.8	23.3	21.1
1995	55.4	21.6	18.6
1996	56.7	27.4	17.8
1997	56.5	33.7	19.1
1998	42	52.4	21
1999	34	50.5	22.1
2000	39.4	30	20.1
2001	35	4.3	19.1
2002	35	13.1	20.4

RETURN ON CAPITAL IS VERY IMPORTANT

The example early on this page shows that debt financing can be used to increase the rate of return on equity. This can be misleading and also problematical if interest rates rise or fall. This is probably one reason why Warren Buffett prefers companies with little or no debt. The rate of return on equity is a true one and future earnings are less unpredictable. A careful investor like Buffett would always take rates of return on total capital into account. The average rates of return of capital in the companies referred to above in Berkshire Hathaway portfolio are:

Coca Cola	39.12
American Express	13.68
Gillette	25.93

A comparison of the rates of return on equity and capital for these three companies is significant and the reader can make their own calculations.

http://www.buffettsecrets.com/return-on-equity.htm

Why Return on Equity Is Important

Historically, one of the best ways to grow wealthy has been to own businesses that generate high returns on equity with little or no debt, paying a fair or low price for your stock. It's been an easy way to shower your family with torrents of cash.


Why Return on Equity Is Important
A business that has a high return on equity is more likely to be one that is capable of generating cash internally. For the most part, the higher a company's return on equity compared to its industry, the better. This should be obvious to even the less-than-astute investor If you owned a business that had a net worth (shareholder's equity) of $100 million dollars and it made $5 million in profit, it would be earning 5% on your equity ($5 ÷ $100 = .05, or 5%). The higher you can get the "return" on your equity, in this case 5%, the better.

Return On Equity (ROE): Find Explosive Momentum Stocks With This Financial Ratio

June 4th, 2009 

Green Mountain Coffee Roasters produced a return of over 113% this year alone. When powerful momentum stocks are charging upwards, it can be difficult to know when to get on board.

But it’s not as difficult as you would believe.

If you want the inside track on the best momentum stocks with ultra-explosive gains, throw on your “x-ray glasses” and focus on one of the most useful financial ratios around.

It’s called return on equity (ROE), but in many ways it tells us so much more.

ROE is one of the best measures of a corporation’s profitability. It shows you how much profit the company generates with the money shareholders have invested. Let me show you how to easily pull this number out – and how profitable it can be.

How to Calculate Return On Equity (ROE)

You calculate return on equity (ROE) by dividing net income by a shareholder’s equity. The higher the number, the more effective a company is at turning its assets and employees into piles of money for investors.

For instance, between 1998 and 2003, Dell Computer’s highly efficient direct sales and high profit-margin strategy paid off in terms of strong earnings growth and a double-digit ROE of 46%. During that same period Dell shares soared 91.95% raining money on shareholders.

ROE explains why Green Mountain Coffee Roasters (Nasdaq: GMCR) posted a 92.86% return while the S&P500tanked, -34.37%, over the last year. It’s been a horrific time for most investors, but GMCR shareholders have had lots to smile about as management skillfully squeezed out a 27.85% return on equity.

It’s made Green Mountain one of the few really safe harbors for the investors to ride out the market’s “storm of the century.”

The ROE ratio looks like this:

The only way this ratio can stay high or increase is by maintaining or increasing the bottom line net income through good management. If executives try to hose investors by sucking profit away – issuing more shares through a seasoned equity offering – you’ll catch them by the drop in this ratio.

Other investors who solely focus on net income won’t know the jig is up, because it will stay the same. That’s why ROE is a much better indicator of management effectiveness at bringing home the bacon.

How to Track Return On Equity (ROE)

Return on equity (ROE) is easy to track through many free financial websites – I like to use Yahoo! Finance. First, type the stock symbol of the company you’re looking for into the “Get Quotes” form on the upper left part of the web page.

When the page for the company’s information comes up, click on the “Key Statistics” link. Then on the same page in the “Management Effectiveness” section you’ll see the value for “Return on Equity (ttm).” This tells you how well management is generating profits for shareholders.

Just look at how their shares have soared…

We can also pull up the amount of institutional shareholders of this company. One of the other interesting things we can access on Yahoo! is the amount of institutional ownership of GMCR. Today it’s almost 27.85% of the company shares.

Institutions are some of the biggest drivers of price movements on the markets and a low institutional ownership means that this stock could have much more to go. By comparison, Starbucks has an institutional ownership of 66% – and a ROE of 3.47%.

Return On Equity (ROE) – How Well Is Management Doing?

Quite simply, a higher return on equity (ROE) number tells us how well management is doing, and if a company is undervalued.

It’s imperative you watch closely how ROE changes over time – ideally you want it to increase. Print off and save the Yahoo Finance web page for “Key Statistics” each week and you’ll see for yourself how return on equity is changing. If return on equity is double-digit and increasing you might want to consider buying the stock.

If a momentum stock like Green Mountain keeps on increasing its ROE, the stock should continue rising as well. So watch for the new ROE numbers for GMCR on June 28.

It all starts with education,

Dr. Scott Brown
Investment U

http://jutiagroup.com/2009/06/04/return-on-equity-roe-find-explosive-momentum-stocks-with-this-financial-ratio/

ROE in Action

ROE in Action

Using Value Line as the source, IBM's ROE was a paltry 5% in the 1991-1993 timeframe. At that point, now-retired chairman and CEO Louis Gerstner took over. Through a balanced combination of profitability, productivity and capital structure initiatives, ROE rose quickly to the 20-25% range in 1995, and has been over 30% for most years since. Even maintaining ROE at a steady figure requires performance improvement, unless all returns are paid to shareholders.

Share buybacks have been one of the keys to ROE performance. When Gerstner took over, IBM had about 2.3 billion shares outstanding. Today, that figure hovers at about 1.5 billion - IBM has retired about a third of its shares. Meanwhile, per-share cash flow has risen from about $3 to over $10 per share.

Looking at IBM's track record, it's clear that Gertsner placed particular emphasis on managing ROE and its components. He managed the owner's bottom line - not just sales growth, earnings reports, and image. He took the concept of ROE to heart.

2008

-----

One of the best ways to understand a concept or approach to investing is by example. It's hard to find a "pure" example of strategic financial excellence culminating in a world-class ROE performance.

Companies may perform well and indeed have ROE in their sights, but difficult business conditions or changing markets make actual performance in all areas and "drivers" a mixed bag.

A search of typical "value" businesses, even in the Buffett/Berkshire portfolio, yields mostly mixed results.