Whether it's a high-growth strategy or a high-dividend strategy, it ultimately comes down to high ROE (Return on Equity). From a long-term perspective, high ROE is the royal road of value investing.

Recently, a securities firm summarized strategies as follows: invest in high-growth in the US stock market, invest in high ROE in the European stock market, and invest in high-dividend in the Hong Kong and A-share markets.

It is well known that high dividends cannot be separated from a relatively high ROE; otherwise, where would the money for dividends come from? Even if the profit payout ratio reaches 100%, considering that the PB (Price-to-Book Ratio) of most stocks is greater than 1, to achieve a long-term annual dividend yield higher than 3%-5%, the ROE would generally be higher than 3%-5%; and the normal dividend payout ratio of listed companies is around 30%-60%, so the ROE needs to be as high as 8%-10% or more. Clearly, whether it's a high-growth strategy or a high-dividend strategy, it ultimately comes down to high ROE. From a long-term perspective, high ROE is the royal road of value investing.

Among the major US companies, the most popular ones at present are mainly the "Seven Sisters". After excluding Tesla, which has the largest stock price decline and the lowest ROE, the average ROE of the remaining companies is as high as 28%, and their average increase over the past year has also exceeded 68%. Among them, Apple, Microsoft, and Nvidia have the highest ROE, and they are also the big winners of the past decade.

Of course, long-term high ROE does not necessarily mean that there are no big winners with low ROE, but the former is relatively easier to anticipate and judge. In long-term investment, due to the sufficient time, the initial cost of purchase (stock price) will become relatively less important, and the most important position is given to ROE. High ROE itself is sometimes also a kind of operational inertia, because it can usually prove that the company has been excellent in history, and it has more opportunities to continue to be excellent in the future, and it can better support dividends, buybacks, and expansion of reproduction.

Advertisement

From this, a key question arises: why can some companies continue to maintain high ROE for many years, while others cannot? I think there are two dimensions to analyze a company: competitiveness and competitive landscape, and the development prospects of the sub-market in which it is located.

For example, the good performance of the stock prices of the US "Seven Sisters" is key: they rely on technology to form a monopoly or semi-monopoly in a large market field, which means pricing power and the opportunity to get the most lucrative profits. Apple's products are relatively closed and differentiated from Android phones. Even though the prices are set high, many people still pay. Microsoft first monopolized the PC operating system and office software, and later ranked second in the cloud service market with a market share of over 20%. In recent years, it has also been popular because of its investment in OpenAI. Nvidia is mainly because its market share in the GPU chip field is about 90%, and high-performance computing chips are currently in short supply.

There are relatively fewer leading companies with a good competitive landscape and a similar monopoly position in the A-share market, such as Yangtze Power and Kweichow Moutai, but most of them do not belong to the high-tech industry, and the market development prospects are relatively stable, with relatively less imagination.

In the past few years, the prosperity of most industries was quite high, attracting many new entrants, but it is obvious that a complete industrial cycle has not been completed, so the competitive landscape faced by the industry is generally not very good. From time to time, there will be complaints from merchants and entrepreneurs on the Internet, saying that money is not easy to earn now, competition is too fierce, and prices are falling. Looking from the opposite perspective, if the situation is really very bad, some competitors will exit one after another, and the remaining companies can live comfortably.The real estate industry is currently in such a process of clearing out. Assuming that prices bottom out and inventory is cleared in one or two years, the annual sales area and development area may be reduced by more than half compared to the peak, but the number of main companies in the industry may also be reduced by more than half. The market will then return to equilibrium, and the ROE of the surviving real estate development companies will gradually rise.

Monopoly companies are rare and hard to come by. Most listed companies in China are in fully competitive industries, which can be divided into two types. The first type is companies whose product output and sales volume grow year by year, but the industry is highly competitive, with declining gross margins and increasing expenses, so the company's profits may not necessarily grow. These companies often focus more on capturing market share to avoid losing customers to competitors due to price wars. In the past, China's high economic growth rate led to rapid demand growth in various sub-markets, making the strategy of making up for price with quantity quite popular. However, when the market becomes saturated and quantity cannot make up for price, competition within the industry becomes fierce, and the ROE of most companies will be negatively affected, even leading to operating losses, waiting for some companies to exit the game.

The second type is companies in industries that have already gone through the roller coaster, with stable or gradually decreasing demand in sub-markets, and peers reaching an implicit agreement not to easily provoke a full-scale price war. Their product output and sales volume do not grow much, but the product gross margin is stable and increasing, and the three major expenses are effectively controlled. Since there is no growth in output and sales volume, their profits may not necessarily grow, but their ROE is quite considerable and relatively stable.

The traditional view usually considers the first type to be better, after all, revenue has growth potential, the company is ambitious, still expanding reproduction, and deserves a higher valuation level. As China slowly enters an aging society, the market economy continues to mature, and the economic volume continues to grow, the proportion of the second type of company will increase. Some market insiders feel that the valuation level of A-shares in the future will be quite pessimistic.

In fact, this is not the case. From the perspective of shareholders, ROE is the key, not revenue growth, nor even market share. The second type of company faces a better competitive landscape in the industry. If they can maintain a high ROE, they are equally worth investing in and deserve a good stock valuation.

For example, according to data from the National Bureau of Statistics, domestic beer sales decreased from a peak of 49.83 million tons in 2013 to 35.55 million tons in 2023, a drop of 28.7%. However, the beer industry has undergone a series of mergers and acquisitions, significantly reducing the number of manufacturers, and the proportion of high-gross-margin beer products has greatly increased. As a result, the profits of major beer companies have rebounded significantly. Tsingtao Beer's operating income was 28.291 billion yuan in 2013, with a net profit of 1.973 billion yuan, while in 2023, the operating income was 33.94 billion yuan, and the net profit was 4.268 billion yuan. Over the past decade, its market value has risen from about 70 billion yuan to over 160 billion yuan, and it is currently around 100 billion yuan. Moreover, it has paid dividends every year for ten years, with a total dividend of ten billion yuan. Therefore, a decrease in industry demand is not necessarily a bad thing. As long as the company has strong competitiveness and survives to the end, ROE can rebound.