The use of return on equity as a criterion for stock selection in the Indian equity markets

Abstract

As per Dorsey, companies with a sustainable competitive advantage tend to outperform the market benchmarks over time. Companies which have a durable competitive advantage compared with their competitors manage to compound capital at attractive rates of return and such companies tend to grow sales and profits predictably and generate substantial free cash flows. This reflects in their share prices over time. In this paper we have used a measure of Return on Equity as an indicator that a company has a sustainable competitive advantage, and have studied the equity performance of such companies as compared with market performance. We find that companies which have attained Return on Equity greater than 15% each year for the past ten years tend to outperform the market benchmarks over the next five years.