When investing, I like to choose shares in ASX-listed companies that have been able to consistently generate high returns on equity (ROE).
ROE is a measure of the amount of profit generated by a company, in a given year, relative to the amount of equity which has been contributed by investors. As a company grows it becomes harder to generate high ROE, as bigger companies have greater amounts of capital that need to be invested.
A company that is able to consistently generate high ROE is usually a highly desirable business to own. This is because, for whatever reason, that company has the ability to continually invest its additional capital at high rates. Over the long term this will lead to significant wealth creation for shareholders.
Two ASX 200 companies that generate high ROE
CSL Limited (ASX: CSL) is one ASX-listed company that has been able to generate high ROE over a sustained period. Over the last 5 years, CSL has averaged an ROE in excess of 40%. Over the same time period CSL shares have returned an average annual rate of return to shareholders of more than 25%. This is a demonstration of how rewarding it can be to own a company that generates a ROE.
Lovisa Holdings Ltd (ASX: LOV) is a jewellery retailer that listed on the ASX in 2014. Since listing, Lovisa has averaged an ROE close to 200%. ROE has fallen each year since listing, nerveless, the returns generated have been exceptional. Over the last 3 years Lovisa shares have generated an annual rate of return to shareholders of more than 50%. This is another example of the success investors can have by holding shares in companies that generate high ROE.
Buying shares in companies that produce high ROE over a long period can be a profitable strategy for investors. However, along with ROE there are a number of other factors which should be considered before making an investment. This includes the price of the shares and the debt level of the company. Debt can be used to boost ROE and therefore companies with high ROE and little or no debt are the most desirable.
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Mitchell Perry has no position in any of the stocks mentioned. The Motley Fool Australia's parent company Motley Fool Holdings Inc. owns shares of CSL Ltd. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.