canadiananalyst

Palantir Wrote:
-------------------------------------------------------
> I think it's especially useful in screening if you
> look at RoA side by side with RoE. If a firm has
> historically generated RoA and RoE of say between
> 10-15 very consistently, I think you can make
> confident projections of earnings down the line.
>
>
> Another thing to keep in mind while screening is
> to also be looking at how much cash they have per
> share as well as debt. Cash brings down the
> displayed RoA/E, but it could really be masking a
> much higher one. I like to look for firms that
> have a lot of cash+equivalents on hand, but with a
> relatively meager RoA.

I agree with this. I always screen for both ROE and some measure of balance sheet strength. Gearing is one factor in computing ROE (ala DuPont analysis which you mentioned) so you want to look for companies with high ROE but low levels of debt. One way to do that is to screen for high ROE and ROIC (or ROA if you like) simultaneously. That eliminates your second reservation.

ROE is a good indicator of the efficiency of a company I think. Firms with high ROE and high ROIC (say >15% over the medium term) will tend to have some sort of competitive advantage which should imply that earnings and cashflow are of a high quality and are likely to be sustainable into the future. That's not always the case of course, but ceteris paribus it is a good indicator.

And if that doesn't convince you that ROE is a good metric to look at, remember that it is one of the first things Warren Buffet looks at and he is a pretty sharp investor.