In the realm of investment, there exists an age-old adage that every investor eventually comes to acknowledge: the critical importance of Return on Equity (ROE). Regardless of whether one prefers a high-growth strategy or a high-dividend approach, the underlying essence remains the same—an impressive ROE is the anchor that ensures sustainable successOver the long term, it becomes evident that high ROE is the cornerstone of value investing, a lens through which prudent investors assess the true worth of their holdings.

Recent analyses from brokerage firms have shed light on various stock markets around the globeThe common consensus suggests that U.Sstocks thrive on high-growth trajectories, European stocks emphasize higher ROE, while stocks listed in Hong Kong and mainland China are discerned through their dividend yield

The intricacy of these approaches lies in the fact that without a robust ROE, distributing significant dividends becomes a challengeOne could argue hypothetically that a company could distribute 100% of its profits as dividends, yet if its price-to-book ratio (PB) lingers above 1, achieving long-term annual dividend yields exceeding 3-5% would necessitate an ROE surpassing 3-5%. Moreover, given that typical dividend payouts for publicly listed companies oscillate between 30-60%, we find it reasonable to assert that a ROE of at least 8-10% is imperative for a sustainable strategy, regardless of whether one opts for growth or dividends.

Looking at the giants of the American stock market, we notice a remarkable trend within what is often called the "Seven Sisters" of the tech industryExcluding Tesla, which has experienced significant price declines and maintains the lowest ROE among this group, the remaining companies enjoy an impressive average ROE of 28%. More telling is the fact that over the past year, these stocks have appreciated by an average of over 68%. Leading this charge, Apple, Microsoft, and Nvidia stand out with their exceptionally high ROE figures, which have effectively cemented their status as market darlings over the past decade.

However, it is vital to note that high ROE does not guarantee the presence of top-performing stocks solely; it merely indicates that companies with lower ROE are less predictable and challenging to evaluate

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In long-term investing, the passage of time diminishes the relevance of initial purchase costs while amplifying the significance of ROEThis high ROE often reflects a company's operational consistency, serving as a historical testament to its capacity for excellence, promising support for dividends, buybacks, and further expansion in the future.

This brings us to a crucial question: what differentiates companies capable of sustaining high ROE over the years from those unable to do so? To tackle this, we must scrutinize two core dimensions: competitive capability and the overall competitive landscape within a given niche marketFor instance, the success of the American "Seven Sisters" can largely be attributed to their utilization of technology to carve out a dominant position within vast sectorsThis dominance affords them pricing power and access to substantial profit margins.

Take Apple, for example

Its product ecosystem is relatively insular, distinguishing itself from Android devices to create a loyal consumer base, leading many individuals to purchase expensive productsSimilarly, Microsoft has established near-monopoly status through its dominance in PC operating systems and office software, and it continues to thrive in the cloud services sector, where it boasts a market share exceeding 20%, bolstered further by its strategic investments in OpenAIMeanwhile, Nvidia commands a staggering 90% market share in GPU chips, leading to a situation where high-performance computing resources are currently in high demand.

In contrast, the Chinese stock market has relatively fewer standout companies displaying continued high ROEIn various sectors, intense competition erodes profit margins, illustrated clearly in industries like photovoltaic energy and electric vehicles

The primary reason for this is the insufficient technological barriers to entry, leading to an influx of competitors that instigates fierce price wars, ultimately resulting in industry-wide lossesThe path to restoring high ROE in these sectors often entails a painful process of capacity exit through bankruptcy or mergers and acquisitions, during which leading companies can reclaim their profitability.

Nevertheless, there are indeed some notable companies in the Chinese market that hold significant monopolistic positions, such as Yangtze Power and Kweichow MoutaiHowever, these companies predominantly belong to traditional sectors with relatively stable market dynamics and limited growth prospectsThe market landscape has changed dramatically over the past few years, attracting several new entrants as industries experienced heightened levels of profitability

Yet, it is evident that many industries have not yet completed a full economic cycle, leading to unfavorable competitive dynamics within various niches.

There exist numerous anecdotes from business owners and entrepreneurs lamenting the current situation, citing difficulties in making profits and observing a decline in prices due to fierce competitionConversely, it is crucial to consider that in dire market conditions, the exit of underperforming competitors can create a more favorable environment for those businesses that endure the test of time.

A prime example is the current real estate market, busy undergoing a cleaning processIf, after a year or two, prices stabilize and inventories are sufficiently reduced, the annual sales and development areas may decrease substantially compared to peak levels

However, the number of enterprises operating in this sector could also diminish significantly, leading to a reinstatement of market equilibriumFor those real estate developers who weather this storm, one can anticipate a gradual recovery in ROE.

However, it is essential to realize that monopolistic firms are rare gems in the investment landscapeThe majority of publicly listed companies in China are entrenched in fiercely competitive industries, categorized into two distinct groupsThe first group consists of companies that consistently increase their production and sales year over year, albeit in a highly competitive environment that sees profit margins decline while expenses riseOften, these companies prioritize market share, striving to gain ground against competitors and stave off customers from shifting to rivals.

The second group comprises companies entrenched in industries that have already matured

In these industries, there is an unspoken agreement among peers to refrain from provoking widespread price warsThese companies may not experience substantial growth in production and sales; however, they stabilize their product margins and manage expenses wisely, leading to moderate but favorable ROE that is relatively steady.

Conventional wisdom often suggests that the first group is more attractive, primarily due to their perceived growth potential and ambition to expandHowever, as China moves towards an aging society and the economy evolves into a more mature phase, companies in the second category may become increasingly prevalentThis evolution raises concerns among market players, leading to speculation that future valuations for Chinese A-shares may trend towards pessimism.

Nonetheless, this is not the complete picture

From the perspective of shareholders, ROE takes precedence over mere revenue growth or market shareCompanies in the second category, with advantageous competitive landscapes and robust ROE, present promising investment opportunities that warrant competitive stock valuations.

For instance, data from the National Bureau of Statistics reveals that domestic beer sales peaked in 2013 at nearly 4,983 tons but subsequently dwindled to 3,555 tons by 2023—a decline of 28.7%. However, the beer industry has undergone substantial consolidation, leading to a significant reduction in the number of manufacturers, and a marked increase in high-margin productsIn sharp contrast, profits for major beer companies have rebounded impressivelyFor example, Tsingtao Brewery reported an operating revenue of ¥28.291 billion and a net profit of ¥1.973 billion in 2013. By 2023, these figures surged to ¥33.94 billion in operating revenue and ¥4.268 billion in net profit, effectively catapulting its market capitalization from around ¥70 billion to over ¥160 billion, with shareholder dividends exceeding ¥10 billion over a decade.

Thus, a decline in industry demand does not always spell doom; as long as a company showcases the competitive strength to endure, one can anticipate a resurgence in ROE as time progresses.