Selecting Good Companies (ROE, PB and PER)

[mrEngineer]

Just a suggestion to e mods, whether it is move all the wonderful posts on ROE to a new thread? Cos this is somewhat out of topic. It will facilitate easy searching and further development on e discussion of ROE concepts. Thanks!

[Musicwhiz]

Hi Mr. Engineer,

Done! But I had to learn how to toggle the merging haha, at one point I created 3 separate threads....oh well, still new to this Moderation thing.

[donmihaihai]

Thank you for giving few names with none having a 20years record. I leave coca cola and cse global out but i think coca cola has a record of 20 years.

Thinknotleft has a point
the number of company we know that has record of Average(changed from consistently since it is changed)roe of >20% is so few, then the amount of hope is really high. Why? How many company with >20% roe for 10 years can continue for another 10 years? One one hand Think about the number of company we know with a record for 20 years. On another think about how we use the past roe to project into the future.

[yeokiwi]

If you just look at SGX companies alone, I don't think there are lots of companies that were listed for more than 20 years. In 1988, there are only 327 companies listed.

Out of these 327, many of them have been delisted, merged or capsized since.

[thinknotleft]

A P/E of 10 and below does not implies 20% ROE.

Definitely. Your original comment to MW was about deriving the P/B ratio that you're willing to pay for a 20% ROE coy. I'm trying to show that this is simply the same as paying a low P/E for this 20% coy.

I see. Thanks for the clarification.

[mrEngineer]

Hi Mr. Engineer,

Done! But I had to learn how to toggle the merging haha, at one point I created 3 separate threads....oh well, still new to this Moderation thing.

Great work MW!

[mrEngineer]

Since we are at the topic of PB, I have a question on how excessive levels of P/B can we say the company is overvalued? Would we considered P/B of more than 5 quite overvalued? of course one can say it will be industry dependent or so but is there a general value that we can say its too excessive?

The examples that d.o.g gave was in the range of P/B of 1 -2 times.

And what kind of industries that we might expect excessive values of P/B? What is the average value of P/B in such industries?

[Kion]

Actually if u look at buffett partnership letters in the early days, he was buying companies at a huge discount to book value but these days he doesnt mind buying a 2-3X P/B companies...

seems to have become more fisher than graham.

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I personally think it is better to buy a business at 2x book value, if that business can get a 20% ROE, then to buy a business at 1x book value, with a 10% ROE. Assuming the "expensive" business compounds internally at 20% and the "cheap" business compounds internally at 10%, what happens after 10 years?

For the expensive business:

You pay $2 for $1 of book value, which becomes $6.19 of book value. So if the business now sells for 1x book value you've tripled your money. More likely, it will still sell at 2x book value or $12.38, so you've probably sextupled your money. At an in-between valuation of 1.5x book value you get $9.27 which means you still more than quadruplued your money.

For the cheap business:

You pay $1 for $1 of book value, which becomes $2.59 in book value. At book value you've more than doubled your money. But it will probably still sell at book value, so no premium there.

So who has done better - the guy who bought the "expensive" good business, or the guy who bought the "cheap" lousy business? Both guys made money, but the guy who bought the good business has a better chance of becoming seriously rich.

very good insight from d.o.g again

[mrEngineer]

From iphone:

I guess there might be a plausible explanation for the change for strategy. In e past, markets are not so efficient and financial knowledge was not as available widely. Thus it was possible that undervalued companies continue to hide and almost kinda like arbitrage to multi-bag. These days, one might have to look deep beyond e quantitative aspects and take risk in it's qualitative evaluation (fisher style).

I concur that d.o.g post was great. It set me thinking for weeks on how to relate compounding effect of ROE, 70 rule of thumb and BV.

[thinknotleft]

P/B, by itself, is quite meaningless. You have to use P/B with other information like ROE etc. Even in the situation where P/B is more applicable, P/RNAV (or P/Expected book value) is more useful.

Buffet has to be more Fisher-like because of his huge portfolio. Graham-like stocks tend to be of smaller cap, and hence less relevant to Buffet's huge portfolio.

Finally, I wish to reiterate one of my earlier points. It is very seductive to conclude from d.o.g's analogy that one should always buy good business (or high ROE business) at reasonable prices. If you take a step back, the assumption behind d.o.g's analogy is that good business now implies good business in the future. And, this assumption is very tenuous, given the mean-reverting tendency of business performance.