samedi 25 mars 2017

The power of the ROE (part II)... Have we missed something?

On august 24th, 2016, I wrote a post about the power of the ROE.

The power of the ROE, is a curious thing. Make a one man weep, make another one sing. That's the power of the ROE.

I wanted to see if the recipe worked well. So, I went back to each of the 30 high and steady ROE stocks mentioned in the post and I took a look at their performance.

Here's the stocks:


The performance of those 30 high ROE stocks since august 24th has been 6,2% while the S&P did slightly better with a performance of 7,3%.

Two things:

First, the period is short (7 months).The shorter the period, the lesser the meaning.

Second, the stocks in this selection aren't probably still the highest and steadiest ROE stocks on the market right now. The article referred is 3 years old, so the selection may be a little different now.

At that point, you may ask: Why the fuck are you writing about something not that relevant and probably not up to date?

Well, first, I like to validate if what I wrote before is accurate. If it's not, I like to lapidate myself in public. Sadomasochist syndrom maybe.

Then, my interesting observation is that I've noticed that there's about one great winner among each 7-8 picks. There's not that much great losers, but many stocks do just OK with a few exceptions doing great. It looks to me that this high ROE selection reduces risks. The basement is not as deep as with others stocks.

It's obvious: a stock generating large amounts of money does generally way better than a stock generating a little amount of money.

8 commentaires:

  1. I am curious as to why many US conpanies have ROE > 15% yet the GDP growth is less than 2%.

    1. Return on Equity looks at the profitability of a company as it relates to what the shareholders have invested. It can be improved upon if you apply the DuPont model of ROE which breaks down ROE into separate components.

      net margin (net income / revenues) times asset turnover (revenue / assets) times leverage (assets / equity)

      This shows you where the profits are coming from, margin, asset turnover or debt. Profits from good margins are preferable while to much debt would raise a red flag.

      If you track these variables over a few years you can gain valuable insight into how profitable the company is. Pat Dorsey’s ‘Little book That Builds Wealth’ explains this concept well.

      Return on invested Capital is a similar metric but different as it is the after tax operating income relative to the capital invested in the firm, where capital is defined as the sum of the book value of debt and equity, net of cash and marketable securities. It’s a little more complicated to compute but both ROE and ROIC are good metrics to be aware of.

      As a matter of fact if you wanted to boil things down to just three good metrics to track over time I think they would be ROE / ROIC, Operating Margin and Free Cash Flow. Simple is always best until its not.

    2. Very impressive post, Gavin.

      I downloaded Dorsey's book on my kindle a couple of weeks back. I guess I should give it a read. Afterall, high roe because you have huge debt is very different from high roe because your profit margins are getting fatter.

      Question for you guys: If you study the charts of corporate tax rates in the G20 nations, you find the USA at the very top. they have the highest corporate tax rate which clocks in at about 40% (35% from the federal government and then the states average out to another 4 or 5%).
      If Trump does succeed in drastically cutting corporate tax rates, will the stock market explode on higher earnings (via tax savings)? Has the market priced in to some extent that Trump will slash corporate tax rates? If so, will the market decline if he fails to reduce corporate tax rates?
      The republicans could not agree on healthcare reform...but I can't imagine any republican thinking that reducing their huge corporate tax rate is a bad idea.

    3. Gavin,

      The Walmart low profit margin, very high turnover model used to work well, it produced >20% ROE consistently. Sam Walton competed against giants like Sears and take them down. I think it is a low-cost producer model, like GEICO. The landscape of retailing is changing quickly, I cannot understand the Amazon model, it is very low profit margin, very high turnover, it's ROE is low, but it keeps eating up market share and hurting big retails. Maybe Jeff Bozo is aiming to be the Rockefeller of retailing.


    4. I am confused. If a company earns 15% ROE and reinvests half of its income and earns 15% on that invested capital, it should keep growing at 7.5% per year. If its P/E stays constant, then share-price must, in the long term, increase by 7.5% compounded annually.

      Then, why does the US GDP only increases less than 2% a year? While developed countries like Singapore can sustain a high though bumpy GDP growth.

      A reason I could think of is that the US companies outsource extensively, therefore, 70-90% of its production value is counted as GDP in foreign countries. In other words, the elite cooperate globalists fatten themselves while the US people suffers, losing jobs and buying from China etc. I was always told that globalism is only good, but it seems it benefits the cooperate more. I feel sympathy for the new wave of populism as a backlash against the globalists.

    5. John,

      I suppose its human nature to try to apply a logical reason for things that fall outside of our understanding. I’ve come to accept the fact that you can never know everything about the markets, and if you come across something you don’t understand, its often best to move on to something else you can get your head around.

      Aside from the Stock Market I have a deep interest in metaphysics. Sometimes I believe what is going on inside of my portfolio is just a reflection of what is going inside of myself. Hope I haven’t chased too many people away with my reference to metaphysics.

    6. Agreed to some extent, one time I was depressed, I made stupid decisions and speculated, I lost money and hurt my performance, now I am fine, I have mental discipline and my portfolio is doing fine, so far. I'd like to grind for a while before moving on, my friend talked me into reading about investing, he wanted to learn practical things, he read "Rich Dad Poor Dad", didn't get much from that book and he had since moved on to study engineering, I read that book, and then I read some more and stumbled upon Warren Buffett and then Ben Graham's books, that was a life-changer.

  2. I've been thinking about that myself and I honestly don't know. I try to track the momentum of market breadth to tell me about the current market environment. I tend to not focus on the Geo-Political landscape as I figure the market will discount things in its own time. I'm not really a numbers guy. I have a few hooks I look for in a individual investment. Management ownership is huge for me but I digress.

    Sometimes I think I post too much and risk sounding like a know-it-all but in fact I have so many self-doubts they could fill a room. Focusing on the Geo-Political side I think would turn into a raving schizophrenic.