Return on Equity (ROE) - the financial metric that investors should use to judge a company's annual performance
Most companies will retain a portion of their previous year's earnings as a way to increase their equity base.
Warren Buffett believes there is nothing spectacular about a company that increases earning per share by 10% if, at the same time, the company is growing its equity base by 10%.
He says this is no different than putting money in a savings account and letting the interest accumulate and compound.
Buffett prefers return on equity to earnings per share when analyzing a company.
He will make appropriate adjustments to the reported earnings to give a clear picture of how returns were generated as a return on business operations.
Buffett believes a business should achieve good return on equity while employing little or no debt.
Most investors judge annual performance by focusing on earnings per share.
According to Buffett, the proper way to judge a company's performance is though focusing on return on equity.
Return on equity is a better measure of annual performance because it takes into consideration a company's growing capital base.
Buffett uses ROE as his preferred financial metric to judge a company's annual performance; investors should do likewise.
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