Warren Buffett Tenet 8 : Focus on High Return on Equity and Low PE and ignore Earning Per Share

Above picture is from 1987 Letter of Warren Buffett to shareholders in which he mentioned how and why ROE is important for company.

What is ROE?

In simple word , ROE is how many dollar/ Rupee company is earning for EACH dollar / Rupee of investors. Here investors money also included Reserve or Undistributed Profit.

The reason Warren Buffett is concentrating is EPS is only for that one Quarter or Year. It is not taking Equity into account. When company come into existence, the company is not distributing all of its Profit. Some part of Profit is there with company.

With taking ROE into account, Warren Buffett is indirectly taking efficiency of management into account. As if management takes wrong Decision, ROE will come Down.

More interesting is DuPont Formula. Which proves why ROE is important.

The Formula is  Profitability * Asset Turnover * Leverage

Out of which Warren Buffett concentrating Profitability. He also mentioned about Leverage and advocate for Low or Zero Debt levels.

This tenet also show the importance of Discount available. Company with high ROE and Low PE is really good investment. And that is what Value investing all about.

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About Ashutosh Tilak

Tracking Indian Capital Market since 2010. Finance Student, On this blog I am writing about finance and Investing. You can contact me analystashu@gmail.com or @androidashu & @InsideFinanc on twitter