Thursday, August 25, 2016

Why Enhanced Triple S Scorecard has no ROE Criteria?

During the 1st and 2nd Sharing Session with T.U.B, the participants had always asked "Why Enhanced Triple S Scorecard has no ROE Criteria?"

ROE = Return On Equity.

Although I had written about this point before, but I realized it was a wrong conclusion.

After thinking for a long time, I came up with a few reasons:

1. Earnings are manipulated.

ROE requires to include earnings as the numerator of the formula. But for anyone whom has attended my Sharing Session with T.U.B will know that I do not use earnings (in this case, net profit) in my calculation because it can be manipulated.

2. Value Not Return.

Rather than looking at "Return" Ratios (ROE, ROI, ROA, etc), my Scorecard is searching for a "Value" Stock. A stock that is undervalued in terms of assets and cashflow.

Furthermore, "Return" Ratios do not incorporate the share price as a factor in the formula. Therefore, in my opinion, these ratios does not really relates to how share price will react.

3. ROE includes Leverage

ROE can be calculated from Du Pont Analysis Formula. This formula states that ROE requires a certain amount of leverage to be huge. Therefore, a high ROE figure may be a result of a high leverage and this can be manipulative as well.


In addition, I hate leverage as well.

4. Scorecard has already about 13 Criteria.

For those, who attended the Sharing Session with T.U.B, will understand that the Enhanced Triple S Scorecard already has 13 Criteria. A stock will need to pass 9 of them to be deem as "value". This already made the Enhanced Triple S Scorecard very hard to pass. An additional Criteria may not be useful.

5. Economic Moat investing Rather than Cigar Butts Investing.

ROE, in my view, is made famous by Warren Buffett in his later years. It was a criteria made by Warren Buffet when he was looking more at "Economic Moat Investing".

For me, my Scorecard is related more towards Warren Buffett's initial Cigar Butts Investing style, which was also made famous by Benjamin Graham, the father of value investing.

 
In Short

My feel about earnings is that it can be manipulative. Moreover, an additional criteria that is not directly linked to the share price may end up being detrimental to the eventual result I am looking for.

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