Hi Scott, some more ROE stuff: The 5-factor ROE can be reduced to a 3 factor ROE, which is: Capital turnover x Profit Margin x Leverage. Change any one of these and ROE changes.
There are several measures of each component, but take out the leverage and you have ROA. Two companies with the same ROE can arrive at it in entirely different ways, which may or may not be operationally efficient in their particular industry.
Low margins are the status-quo in some industries, so it's not fair to lump them in with the universe of all companies and make comparisons based on ROE. There are plenty of extremely well run, consistent companies that live their lives in the low margin camp.
High debt is the status quo in some industries, so it's again not fair to make across the board comparisons. There are good arguments that not to employ any leverage (debt) at all (assuming some financing IS needed, not JUST to take on debt) is as negligent as any other poor operational decision by management.
But too much debt and the risk of default on debt service in a down cycle or poor interest rate environment is high, and that scares the market (even if the current conditions are favorable).
So in closing, a company with (relative to its industry peers, not the market average) high ROE, high margins, and a prudent level of debt, as well as an ability to sustain these advantages over time, is an O.K. quickie screen for an industry leader. But a mediocre software company is likely to look better in all those numbers than, say, a leader in the food products group, yet the leader in the food products group would probably be a better long-term buy because of the industry dynamics.
Broad market averages of financial data at a point in time just seem so useless as a standard of comparison because there are so many industry-specific operational constraints that aren't being considered. But it's so easy to calculate stupid statistics anymore that anything can be made to look ugly or attractive at the press of a button. Change a few parameters, and what was once ugly turns beautiful. Guess it keeps somebody busy.
Oh yeah, I said "in closing" a while back, didn't I :o)
dh |
