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On the attached exhibit, chart one plots revenue vs. return, and chart two plots ROE vs. return.
The questions are:
What are the flaws in just using Revenue? My guess: Does not capture expenses or profit margins.
What are the virtues of using ROE? My guess: Captures both margins and revenue growth.
What are the pitfalls of using ROE? My guess: It is based on book value of equity so return is not what a new investor would get, companies that invest in cap-ex, etc. for growth will show low ROE initially so you’d miss these opportunities with a required ROE hurdle, doesn’t indicate level of risk used to generate ROE.
What is the assurance that the value produced by a high ROE company will flow through to the owners? My guess: The stock price must appreciate and/or dividends must be paid or else the firm will be taken over. Read More