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The week's question
In March 2025, in the thread "Re: OT, out", Umm asked the members: "Do you think it is because America is made up of magical soil that makes businesses based in America magically profitable?" This week it is put to everyone again. The button below opens the small thread re-asking it - read what others have said so far, then give your own answer as an ordinary reply.
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Investment Strategies / Mechanical Investing
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Author: mungofitch ✹✺🐝 SILVER
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Number: of 6243 
Subject: Re: return on equity / mungofitch?
Date: 09/25/26 12:24 PM
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Just saw this post.

My question is quite simple. Some businesses have highly cyclical ROE. UK housebuilders just now for example, ROE is extremely low; in boom times, it's very high.
How are you calculating ROE? Are you focusing on non-cylical sectors (medical devices!) or are you making a trend adjustment of some kind for cyclicals?


I love the five year average ROE figure at the FT global screener. They also have five year average ROA. But I don't have a way to backtest using that info, so I have to just trust that it's a great idea.

For backtests, when I use ROE I am usually looking at a fairly broad slate, not just a few firms, so the outliers (bad companies with just one good year) don't matter that much to the average, so I have generally just used the one-year ROE figure from Value Line because that's what I have. Which is I believe updated only once a year, but still offers a surprising amount of value.

e.g., 1998-2025 inclusive, using a universe which is a Russell 1000 proxy (top 1000 by market cap among those with US domicile):
Top 50 by ROE: CAGR S&P + 4.6%
Bottom 50 by ROE: CAGR S&P - 3.9%
Gap: 8.5%/year, nothing to be sneezed at for something so simple.

This doesn't mean that the few firms with the very highest ROE will be the best, but it's a good test just to skew your odds. Never turn down a tailwind.

One of my favourite simple screens, based on the observation that another good "general purpose" metric is sales growth:
S&P 500 proxy universe (largest 500 in the VL database with US domicile)
Ensure 5-year sales growth per share is positive, as is ROE
ROE * sales growth top 15
1997-2025, this beat the S&P by 6.3%/year.
Narrow it down to the 10 of those closest to their 52 week highs and it rises to an advantage of 8.9%/year. In backtest!

Same sort is nice among the Nasdaq 100.
e.g., Nasdaq 100 proxy
price to 52 week high top 50%, just to crowdsource away from the potential losers
ROE * sales growth top 5 or 10.
e.g., top 5 1998-2025 backtests at 9.4%/year better than the S&P.
That screen was put together in 2019; in the six years post discovery to 2025, top 5 returned 9.9%/year more than the S&P, suggesting it wasn't just a fluke of overtuning. Top 10 beat by 5.9%/year out of sample.
Rather remarkably, a gambler's screen of top 3 in those six years returned 29%/year and beat the S&P in all six individual calendar years. That won't continue, but it seems like a good omen, especially as the stretch 2020-2025 covers quite a variety of market conditions.

I don't run quant screens any more myself because I generally don't invest in the US any more--I'm down to only one US stock and a few derivatives, no cash or fixed income in USD. But I still like the MI art form.

Jim
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This community has written 6,224 posts about Mechanical Investing. The article-length ones it recommended most:
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