Return on Equity General Question

Water Cooler Investing
#1

in CFA level 2 corporate finance and equity sections we learnt regarding the return on equity and return on assets ratios.

clearly the higher they are the more likely the business is high quality but what I wanted to ask whether anyone knows these two questions:

  1. how can we separate the return on assets that the company already has from past periods and our return on new capital that the company retains from earnings and chooses to reinvest?

  2. how can we determine whether the return on the earnings that are reinvested is attractive? it could be that the ROA and ROE measures show a high return because the “old” assets produce a great return but the new capital is being wasted.

presumably even if the price of the stock is high but we can somehow determine that the new capital is reinvested with a very high return then over a long holding period this will allow the investor to still get a great return but if its the other way around and the return on new reinvested earnings is low then this is a bad investment.

#2

as with most things in finance, sometimes these ratios mean something, sometime they need nothing. Iif you read too much into any one metric you can easily be fooled its more of a use to use them all and form a general picture of the companies health and the direction of changes in these metrics can be used to help determine trajectory of the company/management etc etc.

You can have an extremely high quality business that has low ROA/ROE metrics as its capital intensive and requires lots of capex