Question

One of Warren Buffet’s acquisition criteria is to invest in business “earning good return on equity.” The return on equity formula uses both net income and stockholders’ equity. Why is it important to relate to net income to stockholders’ equity? Why isn’t it sufficient to merely concentrate on companies with the highest net income?

Answer 1

Warren Buffet is one of the biggest names in the global stock market. His one of the acquisition criteria is to invest in business "earning good return on equity". Net income is the portion of company's revenue that remains after it pay all expenses. The relationship between net income and stockholder's equity is through retained earnings, which is an accumulated balance of net income.

It isn't sufficient to merely concentrate on companies with the highest net income because net invome provides the balance after deducting all expenses but includes earnings of preferred stockholders too. Therefore earnings on equity stockholders plays an important role for comapricom of two companies along with net income of the business.