Graham and Doddsville -- Value Investing In The New Era Message Board

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Strategies & Market Trends : Graham and Doddsville -- Value Investing In The New Era

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To: porcupine --''''> who wrote ()	4/5/1998 8:45:00 PM
From: Freedom Fighter	of 1722

A little more on ROE and Free Cash. I just want to make one point clear. Return on Equity is not an input to any of the standard valuation models used to value businesses that I am aware of. Free Cash Flow is generally calculated looking at the company's financial statements. When I refer to ROE it is because as a general rule, high ROE businesses generate more Free Cash Flow than low ROE businesses. This is because is takes less dollars of investment to produce the same result. For more details look at my web page in the Issues Section. (Why DOES ROE Matter?) members.aol.com As to the present, without knowing the replacement value of all the assets on the books of corporations it is impossible to know exactly what the current ROE of Corporate America is. There are also some controversial areas related to whether you should be looking at tangible book value or include goodwill. None of this really matters though. It is not necessary to know. You can calculate Free Cash Flow without knowing what the TRUE (I stress TRUE) ROE is or any ROE for that matter. Most Analysts refer to ROE in aggregate just to point out whether margins are high or low. In my own investing I only look at the Free Cash Flow levels that I calculate myself. From this I can tell that corporate profitability is very high right now compared to the historical record. The often quoted ROE for the S&P500 or the DOW also suggests this even though we are clearly working with bogus and unknowable numbers. One last suggestion. It is possible to look at the sum of retained earnings for let's say the last 5-10 years and see what increase in earnings was produced by the total amount of retained earnings. This can give you a better estimate of ROE than the usual way of calculating it because the numbers are current and reflect recent investments. This method also indicates that margins are above the long term average at present. Wayne

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