Weekly Summary
Quote, Mental Model, Twitter Thread and Return on equity.
Quote
“Nobody ever figures out what life is all about, and it doesn't matter. Explore the world. Nearly everything is really interesting if you go into it deeply enough.”
― Richard P. Feynman
Mental Model
Deprival Super reaction tendency: Have you ever lost something when you were very close to getting the result that you wanted? I have, and it hurts more than if you were to lose outright. In cricket or any sport, any team faces more pain if they lose in the final compared to the team that gets knocked out early. The thought of being close to winning but not winning makes us very sad. If I were to define this tendency I couldn’t do it so I have turned to my best resource ChatGPT; “This tendency refers to the idea that people experience greater disappointment and negative emotions when they are deprived of something they desire or expect to have, compared to if they had never expected or desired it in the first place.” This bias is a thing that all of us are bound to have. As an investor also this bias has an important role to play. We hold on to our losers for too long thinking they will win or sometimes when we sell a winner too early we feel this bias kick in. What can be a great antidote to this bias then? I think safalniveshak does a better job explaining.
Twitter Thread
Return on Equity (ROE)
Return on equity is a ratio that is used often. Many investors consider it to be really important to see the ROE of the business. Why and what is ROE? The formula for ROE is as follows:
So, equity means all the invested capital in the business. This ratio shows us what the return is on the shareholder’s equity. It shows us how efficiently a business generates profit from its shareholder’s equity. What we as investors want is a high number which is consistent not a company which has a fluctuating ROE. This is because a fluctuating ROE shows the business does not have stable earnings. The higher the ROE the better but ensure to compare it to the industry peers and also check if the debt is low/nil sometimes that increases the number. Let’s continue with last time’s example of Clothing Connect. This business has equity(since I own the entire company this would be my contribution) of Rs 10,00,000 and it has a net profit of around 2,50,000. Hence, the business earns an ROE of 25%. This means for every 1 rupee of capital you will get 0.25 rupees back. This is a good return on equity. Hope this was helpful and now you understand what ROE is. If you want to read more read here.
You made it to the end! Thank you for reading the whole article it means a lot hope you have a great weekend. Until next time.