Canadian Focus Investors
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Historically Profitable
Focus on return on equity, not earnings per share.
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Timothy P. Vick is the senior analysit with Arbor Capital Management. a nationally recognized investment analyst and business valuation expert. He is the founder and editor of the newsletter Today's Value Investor and has contributed to Dow Theory Forecasts, one of the oldest and most influential market newsletters in the U.S.
The return on equity (ROE) is a convenient measure of a company's profitability and is defined as the net (after tax) income divided by the shareholders equity. When you buy the common shares of a company, what you are actually buying is a proportionate share of the company's equity, based on the number of shares you buy. Therefore, the higher the return on equity, the greater the profitability of your investment.
The historic returns on shareholder equity have been highlighted, on a portion of the Value Line Investment Survey (VLIS) report for Sun Life Financial, dated May 3, 2024. As shown, the ROE ranges from a low value of 9.7% in 2020 to a maximum of 14.4% in 2021, with most of the values being between 10% and 11%. Ideally, we would like to see ROE values greater than about 15%, although lower values may be acceptable, under some circumstances, for example if the company dominates its economic sector or if there are reasons to expect its profitabilty to improve once capital expansion projects have been completed.
Here is a summary of the current ROE values for the companys I currently hold in my portfolio as reported by their respective Value Line Investment Surveys reports. The low ROE values for Telus and Enbridge are considered acceptable, because these companies are expanding their distribution networks and it is expected that their ROE values will increase, once the additional networks are in operating.
A Note of Caution:
You should be cautious if a company you are considering buying has an ROE that is significantly higher than its peers, because a company can increase its ROE by increasing the amount of debt it carries. This may be acceptable, provided the company has the ability to cover the interest payments on the debt, in the event of an economic downturn. The higher the debt, the greater the risk that the company will default on its debt payments and become insolvent. In particular, you should be cautious about investing in a company for which the value of the short and long term debt is greater the shareholders' equity.
Fortunately, as discussed in the next webpage, the VLIS reports provide a financial safety rating of each company, relative to the other companies in the VLIS coverage universe. You should consider the VLIS financial risk rating, along with the ROE, before you consider investing in any company.
1. Vick, T. 2001. How to Pick Stocks Like Warren Buffet. Profiting from the Bargain Hunting Strategies of the World's Greatest Value Investor. McGraw-Hill, New York, NY pp 135 to 145