Luckily I didn't buy very much Yellow Media before it fell off a cliff. I guess that I will just have to ride it out. Hopefully it does a surge like SuperMedia did last week.
In the meantime, I picked up some shares of Redline Communications (RDL.TO). Wish me luck!
Don't confuse capital efficiency and "greatness" of the company with valuation.
The High ROE company in your example is a greater company. But in your example it has a terrible valuation. So good company and very bad investment. Evaluate goodness of business and goodness of investment separately.
Who cares I am a crook or what..
I MADE money..THAT is all it matters
and Your high ROE company..throws money to garbage!
You can't deny..Income/Cap tells the difference between a super money machine and a money-wasting machine
NOte: I CAN'T because I only find that $100 spending business opportunity..rest are waiting to be deployed (when i can find 100000000:1 ratio)
You PROBLEM..you assume every capital MUST be deployed from the start!..that's ROE (Return on EVERY CAPITAL)...and make comparison from there...which is totally stupid. because
NO COMPANIES are on the SAME LEVEL playing ground to start with (a low ROE doesn't mean bad..high ROE doesn't mean it's good if they manipulate the earning part)
That's not even REAL in this world...there are over-spending or under-spending..sitting cash for decades waiting for perfect conditions etc.
I understand what you are trying to get at, but the set up you give leaves out too many details. Regarding the super lottery company my questions are:
1) If you spent $100 in stuff and make 1 billion then my guess is that you are the son of a Chinese communist party official, and you made the money by graft, not business skill. I want nothing to do with you or your business. :)
2) Assuming business is honest, then my next question is if you can generate those kinds of returns, why didn't you correctly invest the $50 billion shareholders gave you? Is it because your business runs out of potential after the first billion in revenue? If yes, why did you ask shareholder for $50 billion? Shame on you, and you don't get my money. If your business can successfully invest the $50B and earn even approximately similar returns to what the first $100 got, then maybe you aren't the right manager to be running this business. What's your plan to invest that money successfully?
Assuming this was an honest business and they could convince me that the $50B was really going to be spent and earn similar returns, then of course you would want Leo's company. Personally, I'm betting Leo is either a crook, lucky, or incompetent in asking for so much capital to generate such poor returns, and he won't convince me.
Year 1 equity is $5K
Year 2 equity is $5K + $1K retained earnings + $5K new capital = $11K.
Year 3 equity is $11K + $2K retained earnings + $5K new capital = $18K.
So ROE in year 3 is in decline and every year gets worse, if all earnings are retained.
So return on equity over time ( assuming no accounting gimmicks in income statement, which you do have to watch for ) tells you a lot.
The error in your example is that not every expense is a capital expenditure. I think your idea of counting up free cash flows is very good, and it's interesting to compare that against capitalization of the company, but looking at capital expenditures as you do is going to miss many many situations where something is wrong with company.
I would generally prefer to find good companies (high return on equity and return on assets) that are also selling below their intrinsic value. But I will take a value play like Company B (with P/E below 1) any day.
I agree with your example for Company A. A return on equity of 30 percent with a price to book of 500K means you have a simple return as an investor of 30 percent / 500K = .00006 percent. That's about like Treasury Bills with a lot more risk. Bad investment....
To be continued...
You are a text-book person. Okay..I will give you a scenario question..You just answer my question below..and DON'T comment on the rest (and hopefully you understand what's the difference between competitive advantage & efficiency)
If not, oh well..I invest you can speculate :P
1)Leo's Company (Poor ROE, High Income/Cap)
a)I got 50 billion cash (capital)
b)I spent $100 in stuff and make 1 billion (a SUPER lottery business :P)
Result = ROE (2%), Income/Cap = 10000000:1
NOTE: I put the rest of 50 billion UNDER my pillow and do NOTHING.
2)Your Company (High ROE, Poor Income/Cap)
a)you got 5 billion cash (capital)
b)You spent all 5 billion cash (which will turn out to be trash afterward - no resale value) and make 1 billion
Result = ROE (20%), Income/Cap = 1: 5
Just answer this question: (don't comment on any other things)
*Assuming no price valuation comes in (control variable)
Which company do you pick? the poor ROE or great ROE? (need to pick one)
I am dividing this post into parts to combat Yahoo's insane and sadistic censorship software that is rejecting my post with no error message.
I agree with almost everything you say here.
Yes, a good company does not always make a good investment. And a bad company can sometimes make a great investment. Some of my best returns have been buying bonds of bankrupt companies that were mediocre companies.
To be continued...
I never said management has to use every dollar they are given. A hedge fund normally keeps 20% in cash. They are still responsible to investors for the return on 100% of the money they are given.