How do you decide which is a higher quality company?

How do you decide which is a higher quality company?

Recently I posted a hypothetical comparison of two different companies in order to illustrate some important investment concepts you need to understand.

If you have attempted the exercise, I am sure you will get a lot more out of it. So here it is again if you have not tried it yet:

Below are 2 potential investments.

Company A:
- Share price $10. (Not bad, almost single digit PE)
- Earns $1 per share in year 1
- Book value per share of $20, (ie only 0.5 times book value! cheap!)
- Pays out 100% of its earnings as a dividend every year, so dividend per share is $1 and the dividend yield is 10%! (Yum!)
- ROE is 5%

Company B:
- Share Price $22 (wah! 22x PE!)
- Earns $1 per share in year 1 (same as Co.A)
- Book value per share $4 (yikes! 5.5x book value!)
- Does not pay any dividends. Earnings are reinvested in the business.
- ROE is 25% (much higher than A, meaning it can make more money for every $ of capital)
ROE means Return on Equity. It is a measure of how much money can be made per dollar of capital invested. If a company makes $1 for every $10 of capital or equity it has, then the ROE is 10%.

Which company would you buy and hold for 10 years? The one that pays you a 10% dividend yield every year for the next 10 years? Or the one that grows much faster but will not pay you any dividends?


Even if you don't have a clue what I am talking about, just make a guess with a reasonable reason?

After you've attempted it, my comments in this article here:

Have fun!

Joshua Fong, CFA

Article by Joshua Fong, CFA

Published 02 Jun 2022