## The Stock Market Legend Uses Only One Indicator to Pick Stocks: Do You Truly Understand the Investment Logic Behind the ROE Formula?

Many investors have heard Warren Buffett's famous quote: "If I had to choose one indicator for stock selection, I would choose ROE," but few truly understand the meaning behind this statement. ROE (Return on Equity) seems simple on the surface, but it actually hides complex valuation traps. Today, we will dissect the true nature of this legendary indicator.

## The Essence of the ROE Formula: What Does It Actually Measure?

Net Asset Return = Net Profit ÷ Net Assets

This ROE formula appears straightforward, but many fall into a common misconception—thinking that higher ROE is always better. In reality, by rearranging the ROE formula, you can uncover the truth:

ROE = Net Profit ÷ Net Assets = (Market Cap ) ÷ Net Assets ( ÷ )Market Cap ( ÷ Net Profit ) = PB ÷ PE

This means that ROE is actually determined by valuation multiples. Assuming PE remains within a reasonable range of 20-30 times, increasing ROE requires PB to also soar. When PB is too high, the company's stock often already exhibits obvious bubbles.

## Why Are High ROE Values Often Investment Traps?

For example: a stock with a PE of 10 and a PB of 5 will have an ROE of 50%. It sounds impressive, but such extreme figures are unsustainable. Historically, very few companies can maintain an ROE above 15% long-term, and an ROE of 50% is usually fleeting.

Problems caused by high ROE:
- **Intensified Competition**: Excessively high returns attract大量資本進入，激烈競爭最終會蠶食利潤
- **Limited Room for Growth**: Increasing ROE from 20% to 40% is much harder than from 2% to 4%, due to diminishing marginal returns
- **Core Competitiveness Test**: Companies lacking core advantages are easily replaced by new entrants

## ROE, ROA, ROI: How to Distinguish These Three Indicators?

**ROE (Return on Equity)** = Net Profit ÷ Shareholders' Equity
Measures the efficiency of using shareholders' funds, reflecting the company's profitability of its own capital

**ROA (Return on Assets)** = Net Profit ÷ Total Assets
Measures profit generated per unit of assets, assessing management's ability to utilize all assets

**ROI (Return on Investment)** = Annual Profit ÷ Total Investment × 100%
Measures the economic return of investment activities, straightforward but ignores the time value of money

## How to Use ROE for Stock Selection Without Falling into Traps?

Warren Buffett once said that only companies with ROE "consistently and stably" above 20% are truly good companies. The key words here are "long-term" and "stable," not occasional peaks.

**Practical Stock Selection Tips:**

1. **Look at Long-Term Trends, Not Single-Year Data**
Observe at least 5 years of ROE data to see if it has been steadily increasing. This reflects whether the company's profitability is genuinely improving

2. **ROE Range Should Be Moderate**
A standard range is 15%-25%. Too low indicates inefficient capital use; too high may signal bubbles and unsustainability

3. **Combine with Valuation Metrics**
ROE alone is not enough; consider PE and PB levels. A low PE combined with high ROE is ideal; high PE with high ROE often entails higher risks

4. **Beware of Abnormally High ROE**
If a company's ROE suddenly jumps from 20% to 80%, investigate the reasons thoroughly—possible accounting adjustments or one-time gains

## 2023 Top 3 Market ROE Rankings at a Glance

**Taiwan Stock Top 10 ROE:**
Yongli United(8080) 167.07%, Xu Sun(6409) 68.27%, Shangfan(5278) 60.83%, Taishan(1218) 59.99%, Creative(3443) 59.55%, Xinyang(3293) 58.55%, RunTaiquan(2915) 57.19%, Liwang(3529) 56.68%, LianDe(3308) 55.38%, Hantang(2404) 51.37%

**US Stocks Top 10 ROE:**
Travelzoo(TZOO) 55283.3%, Cellebrite(CLBT) 44830.5%, AmerisourceBergen(ABC) 28805.8%, Motorola Solutions(MSI) 3586.8%, Green Plains Partners(GPP) 2609.7%, Theravance Biopharma(TBPH) 1689.7%, Flexshopper(FPAY) 1260.5%, AON(AON) 973.3%, DAVIDsTEA(DTEAF) 917.8%, Mettler-Toledo(MTD) 889.3%

**Hong Kong Stocks Top 10 ROE:**
Lok Wah Entertainment(02306) 1568.7%, Lishi Group(00526) 259.7%, Shengbai Holdings(02340) 239.2%, Zhuoyue Holdings(00653) 211.4%, Fengsheng Life(00331) 204.9%, Beida Resources(00618) 200.8%, Huayin International(00989) 164.2%, Jiufang Wealth(09636) 151.7%, Liangqing Holdings(08603) 144.6%, Sunshine Energy00757 126.2%

*Data as of August 2023*

## Final Reminder: Independent Thinking Is Needed When Using ROE for Stock Selection

While the ROE formula is powerful, it is not the sole criterion for stock picking. True investing involves:

- Understanding the logic behind ROE, not blindly chasing numbers
- Using multiple indicators for cross-verification, not relying on a single metric
- Observing long-term trends, not short-term fluctuations
- Maintaining a calm mindset and sticking to your own investment logic

Remember, Buffett's greatness is not because he found some magical indicator, but because he truly understands the essence behind the metrics.