Regarding the identification of excellent long-term stock investments, Warren Buffett made the following observation in his 1977 shareholder letter:
“Most companies define ‘record’ earnings as a new high in earnings per share. Since businesses customarily add from year to year to their equity base, we find nothing particularly noteworthy in a management performance combining, say, a 10% increase in equity capital and a 5% increase in earnings per share. After all, even a totally dormant savings account will produce steadily rising interest earnings each year because of compounding.
Except for special cases (for example, companies with unusual debt-equity ratios or those with important assets carried at unrealistic balance sheet values), we believe a more appropriate measure of managerial economic performance to be return on equity capital.”
Generally speaking, the average small American company earns a return on equity of approximately 12%. The average large company, defined as those that have … Read the rest of this article!