Why does Warren Buffett care more about how much profit he makes from his investment than just how much money he earns?
Image: Jonathunder, CC BY-SA 3.0, via Wikimedia Commons
Buffett's annual letters consistently emphasize
Why does Warren Buffett care more about how much profit he makes from his investment than just how much money he earns?
Imagine you've bought a lemonade stand. You want to know if you're doing well, not just if you're making money, but how much you're actually earning compared to what you've invested.
It's like comparing the amount of lemonade you sell to the money you spent on lemons, sugar, and cups. The better this ratio is, the more efficient your lemonade stand is. The technical term for this efficiency ratio is ROE (Return on Equity).
Example
If you spent 100 on supplies and made 150 in sales, your lemonade stand's efficiency ratio is 150/100 = 1.5, meaning you earned 1.5 times what you invested.
Remember this
Warren Buffett prefers ROE because it shows how effectively he's using his invested capital to generate profits.
Text adapted from Wikipedia, licensed under CC BY-SA 4.0.
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Educational content, not financial advice.
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