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Strategies & Market Trends : Value Investing -- Ignore unavailable to you. Want to Upgrade?

To: Daniel Chisholm who wrote (8874)	11/3/1999 6:25:00 PM
From: Michael Burry	1 Recommendation Read Replies (1) \| Respond to of 78625

On ROE, first and foremost we must recognize that any debt inflates ROE. Returns on assets, capital, etc... are more conservative. Further on ROE, is high ROE itself the goal? Not at all. A high ROE is only worth something if it is sustainable, and only then as a marker that there should be market power and hence pricing power in the business. What a high return on equity/capital tells you is that there is an increased ability to create something extra out of a given level of investment/assets, thanks to a brand, moat, whathaveyou that allows either monopolist power when dealing with customers or monopsonist power when dealing with suppliers. As an example, WalMart's special attraction as an investment lies in its monopsonist rather than monopolist features. Whenever I see a high ROE that appears sustained, I need to identify the moat before I get too comfortable. If the barrier isn't there, then that high ROE should be a warning sign. The problem with the midwest industrials is that the moat isn't readily identifiable. Hence, nearly by definition, a lot of their super-high ROE's are cyclical, and we are near that peak. So there will be a lot of favorable ROE vs. P/B comparisons as the stock price anticipates a downside and the current earnings still represent the upside. There's no two ways about it for me. Either a high ROE means something because it is proven sustainable with an identifiable moat that gives it market power, or a high ROE means something else. Only the former attracts my interest on the long side, which is of course Buffettesque. Finally, we have recently spoken here of costs of capital in the 8-10% range. Well, if we are assuming that the high returns on equity are meaningful and hence relatively unleveraged, then we should be assuming costs of capital quite a bit higher, as equity is of course typically more expensive than debt. Good investing, Mike

To: Daniel Chisholm who wrote (8874)	11/3/1999 11:19:00 PM
From: cfimx	Read Replies (1) \| Respond to of 78625

>>What I can't get a good analytical handle around is, how much of a premium should I rationally pay for an exceptionally high and sustainable ROE? << i hate to say this but you can get to this figure using a DCF analysis. You would need to plot out the cap ex, d & a, and working capital needs for a number of years. If the high ROE indeed goes out a long way, you will be surprised at what you can pay for a company with these economics, and still have it make economic sense. I use a spreadsheet for this. You know who can do it in his head. <g>.

To: Daniel Chisholm who wrote (8874)	11/4/1999 12:15:00 AM
From: Michael Burry	Read Replies (3) \| Respond to of 78625

"What I can't get a good analytical handle around is, how much of a premium should I rationally pay for an exceptionally high and sustainable ROE? " How do you define premium? With Buffett-like high and sustainable ROE companies, I think looking upon it as a required and expected annualized compounding return on investment above 20% is acceptable. On my ValueStocks.net site, there's a Tools page that has a spreadsheet that does this calculation. On a lot of the already-popular consumer stocks, you'd be surprised how many come out with a ~10% annual expected return despite high ROE's because the price is so high already - effectively, the market is pricing these stocks for average performance. This aspect of the spreadsheet model tells me that it is has worth, if only as an adjunct. Good investing, Mike