The power of the ROE

Recently, someone sent me the link to a very interesting article about ROE champions.

The article is here, on motley fool.

Here's a few interesting lines:

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Experience, however, indicates that the best business returns are usually achieved by companies that are doing something quite similar today to what they were doing five or ten years ago. That is no argument for managerial complacency. Businesses always have opportunities to improve service, product lines, manufacturing techniques, and the like, and obviously these opportunities should be seized. But a business that constantly encounters major change also encounters many chances for major error. Furthermore, economic terrain that is forever shifting violently is ground on which it is difficult to build a fortress-like business franchise. Such a franchise is usually the key to sustained high returns.

Inspired by that excerpt, every year, I conduct a modern day re-creation of that same study, by going page-by-page, through all the companies that Value Line covers. I screened by hand for companies with: 1) a 10 year average ROE over 20%, AND 2) Zero years in the past decade with a ROE below 15%.

Just 145 out of 1705 companies (or 8.5%) passed both of these two hurdles from 2004-2013.

***

When I was studying at the magnificient Université Laval, my statistics teacher told us that we could get a very good approximation of a population by selecting randomly 30 subjects.

So, to understand the real power of the ROE, here’s 30 randomly selected stocks among those 2004-2013 ROE champions and their results for the last 5 years and the last 10 years (from 2011 to 2016 and from 2006 to 2016). At the end, we can see the performance of the TSX/S&P overt the same period. 

I haven’t done the test, but the results would probably have been very similar if I’d pick 30 other stocks among the list.

As you can see below, very few high ROE stock achieve poor performance. Out of 30 stocks, only two achieved a loss over a 5 years period and one stock achieved a loss over a 10 years period.

Ticker	Perf. 5 years	Perf. 10 years
ADP	93	92
AMGN	233	161
BDX	127	153
BLL	139	310
BOH	86	43
CI	218	264
COH	-16	26
COKE	158	167
CSCO	104	44
DD	68	85
EL	107	419
GPS	67	62
IDXX	202	397
JCOM	136	170
K	57	67
KMB	104	118
LH	79	101
MDT	182	94
MIDD	460	899
MMP	148	281
MSFT	141	126
NUS	65	248
OMC	129	94
ROK	121	96
SBUX	223	274
STRA	-40	-50
TUP	11	280
VAR	81	82
WMT	38	63
YUM	81	273
Average (%)	120,1	181,3
TSX (%)	20	21

You see, Joel Greenblatt was right. You just have to select randomly among the business that get the highest ROE and that's all (however, Greenblatt said that a low PE was very important, which is not the case here).

In this example, you’ve beaten the market by 100% over 5 years and by 160% over 10 years.

Why should you care about moat and margins and all that fucking shit when you can get a 16-17% yield each year with such a recipe? Why bother with « dogs of the dow » strategy or any other strategy? Select the companies that get the more money year after year and that’s it. That's so fucking obvious and simple. 

That's the power of the ROE.