Recently, someone asked me how to analyze ROE for stock selection, and I realized that many people don't fully understand this indicator. ROE is the return on equity, in simple terms, it shows how much profit can be earned with the shareholders' invested money. In straightforward terms, the ROE calculation formula is net profit divided by net assets. The higher this number, the more efficiently the company is using its own capital, in theory.

Warren Buffett once said that if he could only choose one indicator for stock selection, he would choose ROE. This statement sounds very absolute, but I later found that there are some details worth considering. Many people think that the higher the ROE, the better, but that's not always the case. Let me break down why.

If you manipulate the ROE formula, you'll find that ROE actually equals PB divided by PE. PB is the average price-to-book ratio, and PE is the price-to-earnings ratio; both are valuation indicators. Generally, when buying stocks, we want both numbers to be as low as possible to reduce risk. Now, assuming PE remains unchanged, to make ROE soar, PB must also increase. But a very high PB could mean the company might be overvalued or in a bubble.

In reality, companies that can maintain an ROE above 15% over the long term are quite rare. I've seen some stocks with low PE and high PB, where ROE looks impressive, but such situations are often unsustainable. For example, a PE of 10 times with a PB of 2 times yields an ROE of 20%; if PE is 10 and PB is 5, ROE can even reach 50%. But maintaining these levels is very difficult.

Moreover, an excessively high ROE can attract capital inflows, intensifying competition. If the company's core competitiveness isn't strong enough, new entrants can easily replace it. Going from 2% to 4% ROE is relatively easy, but going from 20% to 40% is much harder because the industry environment at those levels is completely different.

Therefore, my advice is to look at the long-term performance of ROE when selecting stocks, preferably over the past five years. Don't aim for too high or too low; a continuous upward trend is the best signal. A reference range of 15% to 25% is ideal, as it can help identify truly competitive companies without being misled by bubbles.

Regarding the ROE calculation formula, in the stock market, it's actually more complex than simply net profit divided by net assets. Listed companies usually use a weighted average return on equity, considering factors like beginning-of-period net assets, new net assets, and reduced net assets, calculated on a monthly basis. This approach provides a more accurate reflection of the company's true capital utilization efficiency.

If you want to check a stock's ROE, you can visit Google Finance, Yahoo Finance, or the websites of local brokerages. There are also specialized screening tools to find stocks with the highest ROE, where you can set parameters based on the market and your preferences.

Finally, I want to say that while ROE is indeed an important indicator for analyzing a company's value, it is not the only one. Combining it with other financial metrics and applying your own independent judgment will lead to better investment decisions. Stock picking has no shortcuts; it still depends on diligent research and patience.