Why The Triple S Scorecard Do Not Have The "ROE" Criteria?

After reading this article from the fifth person, I was wondering if it is the right move to not include the ROE as a criteria.

In my initial Scorecard, I did include an analysis of ROE as a criteria. But I remove it for the Triple S Scorecard because of the chapter 21, Market Consistently Underprices Quality, in Show Me The Money Book 2. It basically states mean reversion of ROE does have over a long time. A good ROE will drop and a bad ROE will rise over a long time. (I maybe wrong in my interpretation).

Nevertheless, the question came to my mind after reading the article from the fifth person.

While researching on ROE, I found that ROE can be broken (or remembered) into the Dupont Analysis.

ROE can be broken into Asset Turnover, Operating Margin and Financial Leverage.

If you remember the criteria in the Scorecard, I emphasize that the I do not want a company to have significant liabilities (total liabilities to equity must be less than 2/3) or have a debt to equity ratio of more than 30%. Therefore, I expected the financial leverage of the firm to be low.

In addition, I expect the profit margin to be at least 5% for a period of time. This will allow the operating margin to be at least 5%.

However, there is no way of knowing Asset Turnover.

In this way, there is no way to know if a company that pass the Triple S Scorecard is a stock with high ROE.

Then, we can also look at another formula - ROE / PB

This formula is emphasize as the magic formula in Chapter 9, The "Magic Formula" Still Works, in Show Me The Money Book 2. The chapter stated that a stock that has a high score in this formula will most probably rise within a year.

In addition, this formula is also explained as - ROE / PB = Earning Yields = 1 / PE

With the above explanation, although Triple S Scorecard do not have ROE, but it calculates PB, PE and Earning Yields. It require PB and PE to be low, while Earning Yields to be high in order to score points.

Thus, if the ratios score its respective points, it will mean that ROE for that company should be high, or at least should be of a certain amount that is above the average.

In conclusion, with the breakdown of the 2 formulas above, we can safety assume that a company that pass the Triple S Scorecard has high ROE. With this conclusion, I will not be putting any additional criteria for ROE in the Triple S Scorecard.

To assist you to find good companies, I have come up with the Triple S Scorecard.

If you are interested in my Triple S Scorecard, contact me through my blog or message me on my T.U.B Investing Facebook Page.

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