See Through Roe

Wen/Fujtie

You know I have a model called FCV model, which is a piece of the model that evaluates the texture of the enterprise, the enterprise texture can be decomposed into four pieces: growth, profitability, stability, security, which, the evaluation of profitability is broken down into a number of financial indicators, but the most important indicator is the return on net assets (ROE). Buffett once said: "Successful management performance is to obtain a higher return on net assets, rather than just the continuous increase in earnings per share." "So be obedient and listen to the words of Buffett." Recently announced the 2-quarter personal position, you find that I hold 13 companies only 1 enterprises annual ROE Less than 20%, 13 shares of the average annual roe of 34%.

There are countless Chinese translations of Roe, such as the rate of return of shareholders, the rate of returns to shareholders, the ratio of returns to shareholders, the rate of return on net assets, Roe, equity returns, etc., which is a gimmick, we have no standard translation of the proper terminology of financial class so far, so simply forget how to translate, how simple to call , it's called Roe.

I do not think investors are unfamiliar with Roe, but most investors do not fully thoroughly understand Roe, I find many investment books are mentally retarded, the author will simply tell you that Roe is more than 15%, or 20% is good business. Roe itself is not the higher the better, the good or bad of the ROE is not a single figure can be judged, we have to understand its structure, to get a relatively objective judgment. The analysis of Roe should be the DuPont formula, the formula ages, so far has a century of history, the inventor is an electrical engineer, called F. Donaldson Brown, who joined DuPont's finance department in 1914. Of course none of this matters, you don't have to test, but you have to know the DuPont formula decomposes the ROE into three blocks: Net interest rate, turnover, leverage.

The usual explanation for ROE is the following formula:

Roe= Net profit/shareholder equity

The DuPont formula is:

roe= Net interest rate x turnover x leverage.

The two formulas are different and the results are the same. Why the same? We can decompose net interest rate, turnover rate and leverage ratio to get 3 formulas:

Net interest rate = Net profit/sales income turnover rate = sales revenue/Total Assets leverage = Total assets/Shareholder Equity

Substituting the decomposed formula into the ROE is:

roe= Net profit/Sales revenue X (sales revenue/Total assets) x (total assets/shareholder equity)

Then the final two sales revenue and total assets after the conversion into the first formula, so two formulas are equal, but the DuPont formula is more meaningful. We study the enterprise's roe, we must pay attention to its net interest rate, turnover rate, leverage trend of continuous change.

First look at the net interest rate, net interest rate is you sell the same product or service, you really earn the portion of the amount of money accounted for, it is different from gross profit margin, gross margin is tax, net interest rate is deducted all costs and taxes. This indicator is important for enterprises with brand value, the higher the net interest rate, the higher the value of the brand, if an enterprise in the peer net interest rate is far higher than the competitor, then obviously, its brand construction is very successful, said the bad point, it is good concept, such as Yanghe hit the Blue classic concept, the taste is called soft type, The concept played a very successful, sustained high growth in the last few years, net interest rate basically in 30%, market capitalization is close to Wuliangye; Maotai concept is more, National wine concept, collection concept, investment concept, its net interest rate is nearly 50%, we do not have to control what concept is not concept, as long as the net interest rate goes down sharply , it is necessary to beware, it is possible that the brand value of the enterprise is weakening.

Look at the turnover rate, this turnover rate is a narrow sense of turnover, only refers to the total asset turnover, meaning you whether to borrow money or borrow equipment or their own equipment, anyway you rely on all of your existing assets to create products, services, and finally you receive the money in the end accounted for the amount of all your assets. A company's turnover is high, it is clear that its operating efficiency is high, this indicator is small profits and quick turnover enterprise's lifeblood, such as wholesale and retail industry is typical, we analyze the wholesale and retail industry, we must focus on turnover. The so-called quick turnover, this multi-pin can be understood as turnover, if you can't sell more, then the turnover is very low, such as Hualian Super, we see its turnover rate from 2005 to 2.25 to last year's 1.75, it is a small profit margins of enterprises, so poor performance.

Finally look at the leverage ratio, the leverage ratio in fact, with the shareholder equity ratio, the assets and liabilities ratio to analyze things is one thing, nothing but the formula, the results are different, I do not know why to make so many indicators, for me, these three indicators as long as the invention of one is enough, the rest is a mixture. Leverage is the inverse of the shareholder equity ratio, your own assets if you have 1 billion, and borrowed 2 billion, then the leverage is (20+10)/10=3. This indicator measures whether an enterprise is radical or conservative. Do you think it's good to be conservative or aggressive? Of course all is not good, so the leverage rate to have a degree, it is like human body temperature, 37 degrees best, then exactly how to grasp this degree, the degree is art is not science, cannot express, you have to experience. It should be said that the index of leverage is priceless, if you find that a company's ROE continues to rise, then you have to check whether the leverage continues to rise, if a company's ROE continues to rise is high leverage to bring up, then the increase of ROE is risky, so the improvement of ROE is the best net interest rate and turnover increase. There are some companies that use high leverage to get high roe in a a-share market, such as some mechanical stocks, so while I personally re-position the machine, I am observing it dynamically.

In addition, the ROE itself has a reasonable range, I agree with Patte Dorcy in the "real rules of the stock market" in the upper limit, is 40%, usually more than 40% of the Roe are useless, such as the company from the parent company, or the company buy back the stock, or the product price increases, or excessive high leverage, Are financial distortions, if a company's ROE more than 40%, then you need to be careful, to look carefully, do not be fooled by high Roe. and the lower limit of Roe, usually in Europe and the United States to take 10%, but put to the Chinese market, I think it is better than 15%, Chinese enterprises overall profitability is higher than the European and American mature market.

In fact, the ROE is like a jewel box, and you only have to open the box to know if the jewels are worth it. In the final analysis, high Roe may not be good, you have to dissect it. Most people say that making investment is easy, difficult to insist on, in fact, this sentence is the biggest lie, do investment is not easy, you have to spend time and energy to carefully analyze the financial results, you need to know that Buffett buy Coke, look over the hundred years of Coke earnings, this is as investors must pay, you have to thoroughly understand the enterprise, you have confidence , with confidence, there is no question of persistence.

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See Through Roe