ROE VS EPS growth

It's been written here and elsewhere before, but ROE is very important. That measure shows how efficient a business is to make money.

A high ROE is much better than high EPS growth. Because with high ROE and low EPS growth, a business gets much more money than with low ROE and high EPS growth.

For example, you have two businesses. The first one is growing very fast. It's EPS growth rate is 100% each year. However, the worth of the assets of that business is 1 billion dollars and that business generates 1 million dollars of net earnings each year.

The second one is not growing at all (stable revenues). So, it's EPS growth rate is 0%. But the worth of the assets is 1 billion dollars and that business generates 500 million dollars of net earnings each year.

Unless you've had a lack of oxygen at birth, you'll probably have much more interest towards the second business than towards the first one.

Because that second business gets a lot of money every year and with money come opportunities (stock buyback, dividend increase, build more stores, buy other companies, etc...).

The first business may excite a lot of people on the stock market with an incredible growth rate. However, that business doesn't generate a lot of money. All they can do, if they really excite the market, is to issue more stock to get more money, which is not a good thing.

I've done the exercise of checking most of the investments I've made in the past. It appears that the biggest part of high ROE stocks I've owned have produced good or great return over time. There's some exceptions, but the average result is pretty good.

So, here's a list of most of my investments made over the last 6 years.


2009: Scotia Bank, Royal Bank, Cominar, Transcanada

2010: Johnson and Johnson, TD Bank, SNC Lavalin

2011: BMTC Group, MTY Food Group, Apple, Grainger, Intel, Home Capital Group, Mastercard, Boyd Group

2012: RPC, Accenture, HNZ Group, Cummins, Teva, Canadian National, Constellation Software, Advance Auto Parts, Oracle, Coach, Nu Skin, Dollar Tree, Ross Stores, Paladin Labs

2013: Horizon North Logistics, Rifco, Biosyent, Valeant, Loyalist Group, CGI Group, Directcash payments, Macro Enterprises, Cipher Pharma, Questcor Pharma, Alimentation Couche-Tard, United Therapeutics, Carfinco, NTG Clarity Networks

2014: Portfolio recovery and associates, Dorman Products, Gilead, Avigilon, Concordia Healthcare,
Vecima Networks


And now, here's the companies with high ROE when I bought them (the ROE may have dropped a lot since then). I've written the ROE at the beginning of the year of purchase and the performance since the beginning of the year of purchase (my calculations are based on january 1st of each year). And the exchange rate isn't considered.

JNJ
ROE in 2010: 26
Performance since 2010:  67%

HCG
ROE in 2011: 27
Performance since 2011: 35%

BYD-UN
ROE in 2011: 64
Performance since 2011: 913%

AAPL
ROE in 2011: 38
Performance since 2011: 131%

MA
ROE in 2011: 42
Performance since 2011: 328%

COH
ROE in 2012: 56
Performance since 2012: -34%

NUS
ROE in 2012: 29
Performance since 2012: -21%

ROST
ROE in 2012: 46
Performance since 2012: 144%

HNZ
ROE in 2012: 26
Performance since 2012: -57%

ACN
ROE in 2012: 65
Performance since 2012: 117%

AAP
ROE in 2012: 42
Performance since 2012: 130%

CSU
ROE in 2012: 77
Performance since 2012: 562%

ORCL
ROE in 2012: 24
Performance since 2012: 59%

HNL
ROE in 2013: 23
Performance since 2013: -83%

RFC
ROE in 2013: 57
Performance since 2013: -66%

RX
ROE in 2013: 76
Performance since 2013: 634%

ATD-B
ROE in 2013: 21
Performance since 2013: 254%

UTHR
ROE in 2013: 30
Performance since 2013: 111%

GILD
ROE in 2014: 30
Performance since 2014: 22%


There's some pretty bad performances up there, like Horizon North Logistics and Rifco. There's also Coach and Nu Skin that have produced bad results.

But, think about it: Horizon North Logistics was very linked to natural resources (housing for workers in the oil/gas industry). Rifco was very linked to Alberta (almost the same as HNL).

Then, Coach is a brand and brands can easily go out of fashion. Then, Nu Skin was a company full of controversy (and still is).

Most of the other names are "boring" companies that aren't linked to natural resources or a specific geographic place.

So, to conclude:

1- Chose high ROE businesses;
2- Avoid sectors like fashion, natural resources, oil and gas, companies for which you have doubts about honesty of the management;
3- Buy these businesses at a fair price (forward PE between 10-20 times earnings);
4- Build a balanced 15-20 stocks portfolio;
5- You'll do well.