1980’s
|
Year |
Beg. Equity |
Net Income |
End. Equity |
ROE |
Net Inc. Growth |
|
2000 |
$8,000 |
2,825 |
10,825 |
30% |
|
|
2001 |
10,825 |
3,825 |
14,650 |
30% |
35.4% |
|
2002 |
14,650 |
5,179 |
19,829 |
30% |
35.4% |
|
2003 |
19,829 |
7,012 |
26,841 |
30% |
35.4% |
|
2004 |
26,841 |
9,491 |
36,332 |
30% |
35.4% |
|
2005 |
36,332 |
12,847 |
49,179 |
30% |
35.4% |
|
2006 |
49,179 |
17,390 |
66,569 |
30% |
35.4% |
|
2007 |
66,569 |
23,540 |
90,109 |
30% |
35.4% |
|
2008 |
90,109 |
31,865 |
121,974 |
30% |
35.4% |
|
2009 |
121,974 |
43,130 |
165,104 |
30% |
35.4% |
|
2010 |
165,104 |
58,380 |
223,484 |
30% |
35.4% |
The key to understanding ROEs, Buffett notes, is to make sure that management maximizes use of the extra resources given it. (Source: How to Pick Stocks like Warren Buffett – Timothy Vick)
Robert Bruce: I find it an irony. Warren works so hard to keep his shareholders informed so the market value of Berkshire Hathaway stock does not deviate far ever from the intrinsic value of Berkshire Hathaway’s business. I think that is an admirable goal for him.
The irony for him is that his vehicle of wealth creation has been to buy companies where the market price of the stock is trading below the company’s intrinsic value. The idea here also ties into John Maynard Keynes who talks about the long term yield of an investment over its life. An investment held for its full life. This is the same idea that Warren is talking about.
When you think about the stock market that way, what the stock market is affording you is liquidity. You make an appraisal of the company and an appraisal of the future cash flows for the business, you like the outlook for the business, you like the price and you make an investment.
Now you have two choices:
(1) You can hold the investment for a very long period of time as the cash flows are realized or…
(2) On the other hand, the stock market gives you an opportunity every minute of every day to say, “I won’t wait around for the long run for this business to develop but I will sell it to someone else who will wait around and I will take the present value of the cash flows today.”
In the long run, incorporation has a very long life. So what we try to do in assessing businesses is to figure out which ones we have the capability to figure out the long run cash flow projections. As I said at the outset, some businesses lend themselves to that and others don’t. The idea being this price to value.
If I could offer anybody here a perpetual risk less cash flow of a dollar per year, you would understand that the price you pay for that cash flow would be a significant determinant of the return you would receive. And let’s say you said you would pay me $2 to receive $1 per year for 3 years. This is the important assumption about reinvestment.
The important concept of reinvestment assumptions at a certain rate—Yield-to-Maturity. The same thing is true with common stocks. With stocks the cash flows are unpredictable, but once again, the price you pay determines your return.
Stocks Are Bonds with Less Predictable Coupons
|
Year |
EPS |
Coupon Return on $20 Price |
|
2000 |
$1.00 |
5.0% |
|
2001 |
1.25 |
6.3% |
|
2002 |
1.56 |
7.8% |
