Trying to determine which ASX shares to buy can be a tough and time-consuming process.
To speed things up, I suggest only focusing on companies which have consistently produced high returns on equity while maintaining little or no debt. Companies which fit these criteria are, in my opinion, usually a pretty good bet over the long-term. Unfortunately, this is not a fool-proof method, but by significantly reducing the number of potential investments there will be more time for in-depth analysis.
What’s so good about high return on equity and low debt?
Return on equity is a measure of how well a company has been able to use shareholder capital to generate profit. A company with a high return on equity has been able to generate a large profit relative to the amount of capital invested, while a company with a low return on equity has not.
Debt can help a company increase its level of return on equity, but it can also increase the risk of owning that company. I believe a company that is able to generate a high return on equity while holding little debt is economically superior to those companies that cannot. These are the companies I would prefer to own.
ASX shares with high ROE and low debt
There are a number of ASX listed shares which fit the criteria I have outlined. They include Altium Limited (ASX: ALU), Bellamy’s Australia Ltd (ASX: BAL), Pro Medicus Limited (ASX: PME) and Regis Resources Limited (ASX: RRL). All of these ASX shares have generated significant returns back to shareholders over the past 5 years. In particular, Altium and Pro Medicus shares have both produced an average rate of return in excess of 70% per annum. Unfortunately, I don’t believe any of these shares are available for fair prices.
I believe focusing on companies with high returns on equity and low debt is the fastest way to identify high-quality ASX shares. Holding shares in companies with these characteristics has the potential to provide investors with excellent returns.
Unfortunately, this method is not perfect and is best used as a way to narrow down the search. Additionally, an investor will still need to spend time assessing when is a good time to buy and what is an appropriate price to pay for each share. Waiting for an affordable entry price will help maximise returns over the long-term.
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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 Altium. The Motley Fool Australia's parent company Motley Fool Holdings Inc. recommends Pro Medicus Ltd. The Motley Fool Australia owns shares of and has recommended Pro Medicus Ltd. The Motley Fool Australia has recommended Bellamy's Australia. 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.