It's the return on incrementally allocated capital that matters. (the two correlate, and ROIIC is hard to estimate, explaining the use of ROE as a short hand)

This one of the most astute observations for good investing. It also closely associates with evidence of the extent of an economic moat.

What matters, for a really good business, is not so much what past deployed equity can produce in current earnings (ROE) but whether you can take those earnings and continue to get a high return on them (RIIC).

A pure example of the converse, a high ROE without strong RIIC opportunity, is Buffett’s purchase of Seas Chocolate. It produced huge cash flows but it couldn’t be reinvested back at the same high rate of ROE. Their expansion attempts were geographically sensitive. Nevertheless such a business can be marvelous investment, even without the high RIIC opportunity, if the cash flow can be taken out and reallocated to another business at a higher return than the business producing those earnings can achieve incrementally. That is also exactly what Buffett did of course.

An example of companies with great RIIC includes firms that have powerful network effects such a Meta or Google. They can produce a new product (or feature) at very low cost, relatively for peanuts, and then apply that produce to their existing network to get a phenomenal return on the investment (such as the increased advertising revenue).

Brookfield Corporation alao had elevated ROIIC as they can adjust the asset class and geography to the higher return situation that happens to be available at the time (esp. where there is a dearth of capital), in which to direct new capital (being gushed out as present earnings). This form of high ROIIC relies on good capital allocation though, for which there are precious few managers who can do that well continuously. Thus my usual preference for business than inherently have a high ROIIC such as the the software firms with massive public reach.

- Manlobbi