jeudi 31 mars 2016

ROE VS EPS growth

It's been written here and elsewhere before, but ROE is very important. That measure shows how efficient a business is to make money.

A high ROE is much better than high EPS growth. Because with high ROE and low EPS growth, a business gets much more money than with low ROE and high EPS growth.

For example, you have two businesses. The first one is growing very fast. It's EPS growth rate is 100% each year. However, the worth of the assets of that business is 1 billion dollars and that business generates 1 million dollars of net earnings each year.

The second one is not growing at all (stable revenues). So, it's EPS growth rate is 0%. But the worth of the assets is 1 billion dollars and that business generates 500 million dollars of net earnings each year.

Unless you've had a lack of oxygen at birth, you'll probably have much more interest towards the second business than towards the first one.

Because that second business gets a lot of money every year and with money come opportunities (stock buyback, dividend increase, build more stores, buy other companies, etc...).

The first business may excite a lot of people on the stock market with an incredible growth rate. However, that business doesn't generate a lot of money. All they can do, if they really excite the market, is to issue more stock to get more money, which is not a good thing.

I've done the exercise of checking most of the investments I've made in the past. It appears that the biggest part of high ROE stocks I've owned have produced good or great return over time. There's some exceptions, but the average result is pretty good.

So, here's a list of most of my investments made over the last 6 years.

2009: Scotia Bank, Royal Bank, Cominar, Transcanada

2010: Johnson and Johnson, TD Bank, SNC Lavalin

2011: BMTC Group, MTY Food Group, Apple, Grainger, Intel, Home Capital Group, Mastercard, Boyd Group

2012: RPC, Accenture, HNZ Group, Cummins, Teva, Canadian National, Constellation Software, Advance Auto Parts, Oracle, Coach, Nu Skin, Dollar Tree, Ross Stores, Paladin Labs

2013: Horizon North Logistics, Rifco, Biosyent, Valeant, Loyalist Group, CGI Group, Directcash payments, Macro Enterprises, Cipher Pharma, Questcor Pharma, Alimentation Couche-Tard, United Therapeutics, Carfinco, NTG Clarity Networks

2014: Portfolio recovery and associates, Dorman Products, Gilead, Avigilon, Concordia Healthcare,
Vecima Networks

And now, here's the companies with high ROE when I bought them (the ROE may have dropped a lot since then). I've written the ROE at the beginning of the year of purchase and the performance since the beginning of the year of purchase (my calculations are based on january 1st of each year). And the exchange rate isn't considered.

ROE in 2010: 26
Performance since 2010:  67%

ROE in 2011: 27
Performance since 2011: 35%

ROE in 2011: 64
Performance since 2011: 913%

ROE in 2011: 38
Performance since 2011: 131%

ROE in 2011: 42
Performance since 2011: 328%

ROE in 2012: 56
Performance since 2012: -34%

ROE in 2012: 29
Performance since 2012: -21%

ROE in 2012: 46
Performance since 2012: 144%

ROE in 2012: 26
Performance since 2012: -57%

ROE in 2012: 65
Performance since 2012: 117%

ROE in 2012: 42
Performance since 2012: 130%

ROE in 2012: 77
Performance since 2012: 562%

ROE in 2012: 24
Performance since 2012: 59%

ROE in 2013: 23
Performance since 2013: -83%

ROE in 2013: 57
Performance since 2013: -66%

ROE in 2013: 76
Performance since 2013: 634%

ROE in 2013: 21
Performance since 2013: 254%

ROE in 2013: 30
Performance since 2013: 111%

ROE in 2014: 30
Performance since 2014: 22%

There's some pretty bad performances up there, like Horizon North Logistics and Rifco. There's also Coach and Nu Skin that have produced bad results.

But, think about it: Horizon North Logistics was very linked to natural resources (housing for workers in the oil/gas industry). Rifco was very linked to Alberta (almost the same as HNL).

Then, Coach is a brand and brands can easily go out of fashion. Then, Nu Skin was a company full of controversy (and still is).

Most of the other names are "boring" companies that aren't linked to natural resources or a specific geographic place.

So, to conclude:

1- Chose high ROE businesses;
2- Avoid sectors like fashion, natural resources, oil and gas, companies for which you have doubts about honesty of the management;
3- Buy these businesses at a fair price (forward PE between 10-20 times earnings);
4- Build a balanced 15-20 stocks portfolio;
5- You'll do well.

8 commentaires:

  1. Excellent Pen!
    ROE and EPS growth are 2 core metrics of the best capital allocator... That's why when best CEOs are seeing unused capital, they are using the cash to repurchase some shares if the price make sense... Doing that they are decreasing the Equity- boosting the return on a smaller Equity and increasing EPS with a smaller number of shares... If management is able to grow sales and margins organically and by acquisitions on top of that, you will see a multiple bagger after a while in your portfolio.

    Do you have a bunch of multi-baggers in your portfolio?
    I had VRX ;-( , I have also ORLY, ATD.b, MRU, MHK & WFC...


  2. I have GIB, ATD-B, CSU, DLTR, ROST that are all baggers or multi-baggers.

  3. It is easy to goose your ROE by taking on a heavy debt load. Be careful to include an examination of a companies debt because ROE alone does not tell the story.

  4. Yeah, right. I haven't written that precision but to me, it's obvious that the debt level should be considered.

  5. if you don't mind sharing, what sources do you use to determine ROE at a particular point in time?

  6. Disnat. But I think Morningstar offers the information.

  7. I do think that Jason Donville is a good investor .. but the best to myself Mawer management you shall take à look at the mawer new canada fund .. 14 %/year over 28 yrs .. i am taking a lot of my investments ideas here .. and i own a full bag of maw150 :) Regards

    1. I agree. I keep a short list of really good small cap funds and Mawer New Canada is probably the best of them all and have an outstanding long term record. Martin Ferguson who was interviewed in Speziale's new book recently retired from leading the fund and has left it in the hands of disciple, Jeff Mo.