## The Essential ROE Stock Selection Logic for Investors: Unveiling the Truth Behind Return on Equity Through Buffett's Strategy

ROE (Return on Equity) is the single most favored stock selection indicator by the stock god Warren Buffett, but many investors only have a superficial understanding of this metric—thinking that higher ROE is always better, unaware of the many pitfalls hidden behind it.

## What Does ROE Actually Measure?

The core logic of ROE is simple: divide a company's after-tax profit by its net assets to get a percentage. In simple terms, it measures how much profit a company can earn with each dollar of shareholders' equity.

This indicator consists of two parts—direct investments from shareholders (capital stock, capital reserves, retained earnings) and borrowed funds. Companies can leverage financial leverage to amplify returns, but excessive leverage also significantly increases risk.

The calculation looks straightforward: **ROE = Net Profit ÷ Net Assets**. However, in practical stock market applications, it needs to be calculated using a weighted average, considering changes in net assets during the reporting period (such as new share issuance, cash dividends, share buybacks, etc.).

## How Does ROE Differ from ROA and ROI?

Investors often confuse three similar indicators:

**ROE (Return on Equity)** focuses on the return rate of shareholders' equity, only looking at how much profit is generated from shareholders' invested capital.

**ROA (Return on Assets)** has a broader perspective: it includes all of the company's assets (including borrowed money), measuring how much net profit each unit of assets can generate. The calculation is **Annual Profit ÷ Total Assets**, reflecting management's efficiency in utilizing all resources.

**ROI (Return on Investment)** is more specific, focusing on the returns from a particular investment activity, calculated as **Annual Profit ÷ Total Investment × 100%**. Its advantage is simplicity, but it has obvious drawbacks—ignoring time costs and failing to reflect the impact of construction cycles, investment methods, and other complex factors.

These three indicators emphasize different aspects, so choosing among them depends on the specific application scenario.

## Why High ROE Doesn't Always Mean a Good Stock?

This is the most common pitfall. If you manipulate the ROE formula: **ROE = PB ÷ PE** (where PB is the Price-to-Book ratio, PE is the Price-to-Earnings ratio), the truth becomes clear.

Assuming the market's PE valuation of a stock remains relatively stable (within a reasonable long-term range), the only way to make ROE soar is to also push PB higher. But if PB becomes too high, it indicates the market perceives the company as overvalued, with bubble risks.

Even more painfully, a stock showing a "low PE, high PB" combination corresponds to an abnormally high ROE. For example, a stock with a PE of 10 and a PB of 5 might have an ROE of up to 50%—sounds attractive, but such ROE is almost impossible to sustain. Historically, only a few companies can maintain a 15% ROE long-term, let alone 50%.

Moreover, high ROE tends to attract large capital inflows into the industry, intensifying competition. Companies lacking strong core competitiveness are easily overtaken by new entrants. Additionally, once ROE reaches a high level, further growth becomes limited—raising from 2% to 4% is much easier than from 20% to 40%.

## How to Use ROE Correctly for Stock Selection?

Buffett recommends: look for companies with ROE consistently above 20%. However, this standard is too strict for most investors.

A more practical benchmark is: **companies with ROE between 15%-25% are worth close attention**. But even more important is the trend—at least review the past 5 years of ROE data to ensure it has been steadily rising rather than just a fleeting spike.

Historical data cannot predict the future, but it can reflect whether a company's genuine earning power is strengthening. A company whose ROE gradually rises from 8% to 18% is more trustworthy than one that suddenly jumps to 45% and then declines.

## How to Quickly Check and Filter ROE?

To find out a single stock's ROE, you can use Google Finance, Yahoo Finance, or local brokerage websites.

If you want to identify the top ROE stocks in the market, there are dedicated screening tools. Here is the list of leading ROE performers in various markets in 2023:

### Taiwan Stock Market Top 20 ROE

| Stock Code | Name | ROE | Market Cap (Billion TWD) |
|--------------|--------------|--------------|---------------------|
| 8080 | Yuanli United | 167.07% | 2.48 |
| 6409 | Xun Sun | 68.27% | 1360.1 |
| 5278 | Shangfan | 60.83% | 39.16 |
| 1218 | Taishan | 59.99% | 131.75 |
| 3443 | Creative | 59.55% | 1768.96 |

(more rankings available in the original table)

### US Stock Market Leading ROE

The US market features some stocks with extremely high ROE, often due to special circumstances (such as very low net assets):

| Stock Code | Name | ROE | Market Cap (Billion USD) |
|--------------|--------------|--------------|---------------------|
| TZOO | Travelzoo | 55283.3% | 1.12 |
| CLBT | Cellebrite | 44830.5% | 14.4 |
| ABC | AmerisourceBergen | 28805.8% | 377.4 |

(more rankings available in the original table)

### Hong Kong Stock Market Top ROE

| Stock Code | Name | ROE | Market Cap (Billion HKD) |
|--------------|--------------|--------------|---------------------|
| 02306 | Lok Wah Entertainment | 1568.7% | 43.59 |
| 00526 | Lisi Group Holdings | 259.7% | 3.54 |
| 02340 | Shengbo Holdings | 239.2% | 1.04 |

(more rankings available in the original table)

## Ultimate Advice for ROE-Based Stock Selection

ROE is a good indicator, but not an all-powerful one. Truly smart investors use it as follows:

**Step 1**: Filter for stocks with ROE between 15%-25% and a consistent upward trend over the past 5 years.

**Step 2**: Don't blindly trust extremely high ROE figures; be cautious of the "super high ROE + low market cap" combination, which often hides risks.

**Step 3**: Combine with other valuation metrics like PE and PB for comprehensive judgment—don't rely on a single indicator.

**Step 4**: Think independently, establish your own profit model, and maintain a good mindset—this is the true path of investing.

ROE is not a tool for short-term trading but a compass to identify long-term, stable companies capable of continuously creating value.