Be wary of using Return on Capital (ROC)
Superb companies produce a very high return on capital. But when substantial intangible assets don’t show up on balance sheets, the ROC numbers are unduly flattering to management.
economic performance
How Mr. Market is grappling with intangibles
I think we have become leaders in the value investment industry for buying companies where intangibles have become their largest asset and you can’t see from a price to earnings or price to book how cheap the company is
Income Statements and Balance Sheets have largely lost their relevance for investors
The way things are, the only numbers of use to an investor from a Balance Sheet relate to debt. The expensing of investments in intangibles of lasting value creates a distortion that completely undermines the use of the Income Statement. Reported earnings are not only useless for investors but also misleading for the unwary.
Problems with the most popular indicator of superb companies
From its growing operating cash flow, it is able to fund growing capital spending and also fund growing R&D expenditures. Of note, it seems to be able to maintain and even improve its operating margins. It is easily able to fund the capex needed to maintain it long-term competitive position in its various markets. It is also easily able to fund the capex it chooses to make to grow the company and fund healthy R&D expenditures.
Numbers, financial statements and things that can be counted but may not count
You know, Skippy, if all this bad stuff hadn’t happened, we would be having a pretty good quarter.
Back to basics about free cash flow
Accounting is but an aid to business thinking, never a substitute for it
How to distinguish a superb value creator from an also ran
The best business to own is one that over an extended period can employ large amounts of incremental capital at very high rates of return
Profound errors in interpreting and using ROE and ROC
I find it better to analyze a company’s cash flows, maintenance capex, growth capex and free cash flow in real dollar terms and measure them against the true value of the capital management has use of
The hunt for wonderful businesses
Free cash flow yield can be a better indicator when return on capital (ROC) becomes a vanity metric that unduly flatters economic performance and management. We can charge management with the full cost of Economic Goodwill.
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