Jurgis:
Hmmm, I understand that buying back shares reduces equity increasing the ROE. However, is that bad to the shareholder and does it reduce shareholder return? In my opinion - unless I am missing something again - no. Why? Because while the growth per company may not be X0%, the growth *per share* is - and that's what matters to the shareholder. The problem may occur if company buys overpriced shares - then the reduction of E does not increase R *per share* enough for shareholders to benefit.
You've captured the essence of how it works. But the distinction I am making is that the ROE represents a sort of ceiling on your "growth rate" whereas the Buffettology method uses that "ceiling" as the actual growth rate. Again, you can see this for yourself by simple observance of the returns on high ROE stocks. Or, here is a little test you can try. Use MRK, SGP, KO, WD-40, or any other high ROE company you can find. Then when you run your simulation, use zero for your tax rate (tax shielded account) and don't worry about the payout ratio (automatic dividend reinvestment). When you do this, you will get a theoretical return equal to the ROE you use if you assume no change in P/E. If you assume a change, fine. Compare that return to the total return for any of the stocks over the past five or ten years.
The Buffettology method, used consistently, can certainly work for you. I'm just pointing out that compounding with high ROEs can give you a misleading result.
- Pirah |
