Recently, I've been studying stock selection methods and found that many people don't have a deep enough understanding of the ROE indicator. ROE is the return on equity, simply put, it shows how much profit a company makes using its own money. Many believe that the higher the ROE, the better, but this view is somewhat problematic.

First, let's talk about the basic logic of ROE. Its calculation is straightforward: net profit divided by net assets. For example, Company A has net assets of 1,000 yuan and earned 200 yuan this year, so its ROE is 20%. Company B has net assets of 10,000 yuan and earned only 500 yuan, so its ROE is 5%. From this perspective, Company A's capital utilization efficiency is obviously higher. But this is just superficial; actual stock selection involves much more complex considerations.

I think many people confuse one concept. ROE, ROA, and ROI look similar, but their purposes are completely different. ROA measures the return on total assets, assessing how much the company can earn using all assets (including borrowed money). ROI is the return on investment, mainly focusing on the profit from a specific investment project. ROE is about how much return the shareholders' own invested money can generate, which is the most directly relevant indicator.

Regarding ROE-based stock selection, many people quote Warren Buffett, saying to look for companies with ROE consistently above 20%. But my observation is that there's a trap here. If you break down ROE, it actually equals PB (price-to-book ratio) divided by PE (price-to-earnings ratio). In other words, a high ROE means either PB is too high or PE is too low. Currently, a PE of 20-30 times is considered normal market valuation. If you insist on a particularly high ROE, it implies that PB will be driven very high, which often indicates a bubble in the company.

I've seen many stocks with extremely high ROE, such as a PE of 10 times combined with a PB of 2 times, resulting in an ROE of 20%. But such combinations are generally hard to sustain. Because a very high ROE attracts capital inflows, intensifying competition, and companies lacking strong core competitiveness are easily eliminated. Also, increasing ROE from 2% to 4% is relatively easy, but going from 20% to 40% is much more difficult.

My own stock selection experience suggests that instead of focusing on the ROE figure for a single year, it's better to look at the trend over the past five years. Companies whose ROE remains between 15% and 25% and is continuously rising are worth paying attention to. Many companies that appear to have extremely high ROE are often just a flash in the pan. Conversely, those with stable growth in ROE usually indicate that the company's profitability is continuously improving.

It's also very simple to check a stock's ROE. In the Taiwan stock market, you can sort by ROE on relevant financial websites. For US and Hong Kong stocks, there are specialized screening tools. But after checking the data, the most important thing is to think for yourself and not be fooled by high ROE numbers. When combined with valuation indicators like PE and PB, you can better assess whether a company is truly worth investing in. Ultimately, stock selection still requires independent thinking, finding a logic that suits you, sticking to it long-term, and maintaining a stable mindset.