Quality is multidimensional

Summary: No single ratio can capture business quality on its own; each can mislead in its own way. This column explains why NJ Mutual Fund’s quality framework combines multiple measures that correct each other's blind spots and why the lens itself shifts between lenders and non-financial businesses.

Summary: No single ratio can capture business quality on its own; each can mislead in its own way. This column explains why NJ Mutual Fund’s quality framework combines multiple measures that correct each other's blind spots and why the lens itself shifts between lenders and non-financial businesses. Warren Buffett has often judged businesses by an economic question: How much can they earn on capital and how much additional capital do they need to keep growing? It is a useful way to think about quality because it goes straight to the business’s economics. ​However, the trouble begins when we try to measure it systematically. ‘Quality’ does not appear as a line item in the accounts. We have to infer it from what the business reports. That sounds obvious, yet it has an important consequence: no single ratio can carry the whole burden. One ratio can only tell a part of the story Take return on equity (ROE). A company that earns Rs 20 on every Rs 100 of shareholders’ equity appears more productive than one that earns Rs 8. But one unusually good year tells us little about what