Long-Term Investing: Look at ROE or PE?
Many investors have heard the idea that “long-term compounding ≈ ROE.” This concept was first put forward by Charlie Munger, known as the Munger Rule. In his 1981 shareholder letter, Warren Buffett also pointed out that if PE remains unchanged, a company with 14% ROE will generate a long-term investment compound return of 14% as well. He also endorsed the Munger Rule.
Is compounding only about ROE? Or should we be paying more attention to PE? The answer is: both are correct, but from different angles. $Berkshire Hathaway(BRK.B)$
1. ROE: The “Engine” of Internal Compounding
ROE = Net Income ÷ Shareholders’ Equity
A high ROE means the company can efficiently generate returns on equity, which gives it long-term compounding potential.
This is why Buffett prefers consumer and software companies — light-asset businesses with high ROE.
2. PE: The Investor’s “Price Anchor”
PE (Price-to-Earnings Ratio) = Stock Price ÷ EPS
It represents how much investors are willing to pay for every $1 of profit. Lower PE = better entry price.
But looking at just the current PE is not enough, since it is based on the past 12 months of earnings. That’s where Forward PE (Forward Price-to-Earnings Ratio) comes in:
Forward PE = Stock Price ÷ Next 12 Months’ Forecast EPS
Compared to static PE, Forward PE better reflects market expectations for future earnings.
3. Beyond ROE and PE: Other Indicators for Long-Term Investing
To fully understand compounding, investors should also consider these metrics:
ROIC (Return on Invested Capital)
More comprehensive than ROE since it accounts for both equity and debt. A high ROIC means the company is highly efficient at deploying overall capital.
Profit Margin & Growth Rate
Stable margins and consistent revenue growth are the foundation of sustaining ROE. Without growth, it’s hard for ROE to stay high over the long run.
Free Cash Flow (FCF)
Free cash flow shows whether the company generates “real money” to fund expansion and dividends. Over the long term, discounted cash flow remains the core of valuation.
Before investing in Apple, Buffett asked himself three questions that are highly relevant to long-term investors:
Within the S&P 500, which companies will trade below 15x PE in the next year?
Which companies will earn more over the next 5 years? (with 90% certainty)
Which companies can achieve 7% compound growth? (with 50% certainty)
In essence, this combines Forward PE + earnings growth + compounding potential.
Discussion:
When picking stocks for the long run, do you focus more on ROE or PE? Why?
Do you think ROIC and FCF are more important than ROE in compounding?
If you could only choose one metric for a 10-year investment decision, which one would it be?
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That said, I often give more weight to ROIC and free cash flow. ROIC reflects how efficiently a company uses all capital, not just equity, while free cash flow is the real money available to fund growth, dividends, or buybacks. Together, they provide a clearer picture of whether compounding is sustainable.
If I had to choose only one metric for a 10-year investment, I’d pick ROIC. It balances profitability with capital efficiency and avoids distortions from leverage. PE moves with sentiment, and ROE can be flattered, but high ROIC paired with steady cash flow growth gives me the most confidence in long-term compounding.
@Tiger_comments @TigerStars
它代表了投資者願意爲每1美元的利潤支付多少。較低的市盈率=較好的入場價格。
但僅關注當前的市盈率是不夠的，因爲它是基於過去12個月的收益。就是在那裏遠期PE（遠期市盈率）進來：
遠期PE=股價÷未來12個月預測每股收益
與靜態PE相比，遠期PE更好地反映了市場對未來收益的預期。
1. ROE as a Measure of Business Quality
ROE indicates a company's ability to generate profits from shareholders' equity. Consistently high ROE with limited leverage suggests strong underlying economics.
2. Valuation Matters
Even with high ROE, buying at the wrong Price-to-Earnings (PE) ratio can lead to weak returns. PE reflects market sentiment and valuation.
3. ROIC and Free Cash Flow
ROIC measures capital efficiency, while free cash flow represents the actual funds available for growth, dividends, or buybacks. Together, they provide a clearer picture of sustainable compounding.
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FCF is not that important to me especially in low rate environment though having a safety amount is crucial for maintaining cash flow. ROIC tells me how the company manage and deploy their cash and potential performance.
If I can only choose one metric, I would choose ROE as I want to know that the business remain sound and the returns will continue to compound which would benefit me as a shareholder. @Fenger1188 @DiAngel @Universe宇宙 @Wayneqq @HelenJanet @Kaixiang @LuckyPiggie @Success88 @SR050321 @SPOT_ON come join
不过，ROE也有局限。如果一家公司ROE高，但资本结构非常激进（负债率高）或者利润被非经常性项目撑起，那么ROE高并不等于现金流健康。这时候自由现金流就显得尤其重要。长期投资最怕的不是市值波动，而是企业现金链断裂导致的业务收缩或者被迫融资稀释股东价值。自由现金流能告诉你，公司在不增加负债的情况下，是否能真正产生价值并回馈股东。
相比之下，PE更多反映市场对盈利的估值期望，而非公司运营本身。短期炒作可能让PE高低剧烈波动，但并不能告诉你公司未来十年的成长能力。长期投资追求的是复利效应，所以我更关注能支撑复利的内在指标——ROE和现金流。
如果让我只能选一个指标来做10年的投资决策，我会毫不犹豫选择自由现金流。原因在于，它不仅体现盈利能力，还直接影响公司自我投资和分红能力。即便ROE不算特别高，但现金流持续健康，公司依然可以稳步增长，避免资本链断裂带来的风险。长期来看，这才是复利真正能落地的保障。
总结来说，我的思路是：ROE帮你判断管理层运营效率和盈利质量，而自由现金流决定企业能否真正把利润转化为股东价值。长期投资决策，如果必须取舍，自由现金流无疑是我最看重的核心指标。它告诉你的不是“账面利润有多漂亮”，而是“企业未来十年能不能稳健成长”。