Tag Archives: Investing

Return on Invested Capital (ROIC)

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  • The ROIC is the operating profit divided by the invested capital. It tells us how much money the company can generate with new capital by investing in profitable projects.
  • The ROIC basically explains how much shareholder wealth could be generated in the future and is oftentimes highly correlated with a high P/E.

Return on invested capital, or ROIC, is a valuable financial ratio  A high ROIC rewards companies that are able to produce the most net operating profit with the least amount of invested capital.

The basics of ROIC are very simple: it basically tells us how much profits are generated (financials statement) compared to how much capital is invested in the company (balance sheet), provided as a percentage. If the ROIC is 10%, it tells us that the company is generating $10 of profits with each $100 that it invested in the company.

ROIC is net operating profit minus taxes minus dividends divided by invested capital:

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ROIC is net operating profit minus taxes minus dividends divided by invested capital:

ROIC is a measure of how much cash a company gets back for each dollar it invests in its business.

ROIC is a much better predictor of company performance than either return on assets or return on equity. In ROA and ROE, the key metric is net income. Net income often has nothing to do with the profitability of a company. Significant expenses are not included in net income such as interest income, discontinued operations, minority interest, etc. which can make a company look profitable when it is not. Also, ROA measures how much net income a company generates for each dollar of assets on its balance sheet. The problem with using this metric is that companies can carry a lot of assets that have nothing to do with their operations, so ROA isn’t always an accurate measure of profitability.

ROE has similar limitations as ROA. ROE is a measure of company profit compared to shareholder equity. Although this might seem a reasonable metric, many companies use financial leverage to raise ROE. Companies often increase debt levels to repurchase shares, thereby increasing ROE. Using this financial leverage to affect ROE does not accurately reflect a company’s profitability, returns or long-term prospects.

Companies with higher-than-median ROIC (when viewed in conjunction with their overall capital-expenditure and operating-expenditure strategy) will deliver better returns.

Valuation biasedness is one of the most common investing errors.

Some investors prefer picking a stock which is “undervalued” rather than buying a more expensive stock with strong long-term fundamentals. As a consequence, they oftentimes end up with “value traps” which actually destroy shareholder value over time. One of the reasons for this is that they know how to “value” a company (via multiples etc.), but lack the ability to determine the quality of a company and its potential to drive long-term value for shareholders.

The most important metric will tell you whether you are buying a good company that is able to generate strong future shareholder wealth: the return on invested capital (“ROIC”).

Basically, investors should look for a high (+10%) and consistent ROIC. In the long run, the ROIC can be a leading indicator of what an investor may expect from longer term stock returns.

References:

  1. https://www.thestreet.com/opinion/10-stocks-with-high-return-on-invested-capital-and-why-you-should-care-13279076

Small Cap Stock Investing

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Small Cap Stocks

The Real Value of Wealth

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Invest first before living like a King and Queen

Asset vs Liability

Son: Dad, may I speak with you?
Dad: Go ahead.
Son: Among all my classmates, I am the only one without a car. It is embarrassing.
Dad: What do you want me to do?
Son: I need a car. I don’t want to feel odd.
Dad: Do you have a particular car in mind?
Son: Yes dad (smiling)
Dad: How much?
Son: $15K
Dad: I will give you the money on one condition.
Son: What is the condition?
Dad: You will not use the money to buy a car but invest it. If you make enough profit from the investment, you can go ahead and buy the car.
Son: Deal.

Then, the father gave him a check of $15K. The son cashed the check and invested it in obedience to the verbal agreement that he had with his father.

Some months later, the father asked the son how he was faring. The son responded that his business was improving. The father left him.

After some months again, the father asked him about his business again and the son told him that he is making a lot of profit from the business.

When it was exactly a year after he gave him the money, the father asked him to show him how far the business has gone. The son readily agreed and the following discussion took place:

Dad: From this I can see that you have made a lot of money.
Son: Yes dad.
Dad: Do you still remember our agreement?
Son: Yes
Dad: What is it?
Son: We agreed that I should invest the money and buy the car from the profit.
Dad: Why have you not bought the car?
Son: I don’t need the car. I want to invest more.
Dad: Good. You have learned the lessons that I wanted to teach you.
– You didn’t really need the car, you just wanted to feel apart of the crowd. That would have placed extra financial obligations on you. It wasn’t an asset then; but a liability.
– Two, it is very important for you to invest in your future before living like a king.
Son: Thanks dad.

Then the father gave him the keys of the latest model of that car.

MORALS:
1. Always invest first before you start living the way you want.

2. What you see as a need now may become a want if you can take a little time to get over your feelings.

3. Try to be able to distinguish between an asset and a liability so that what you see as an asset today will not become a liability to you tomorrow.

Investing Advice

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Investor Stan Druckenmiller says one of his mentors taught him two crucial things:

• Never invest in the present; look 18 months out.
• The central bank moves the market, not earnings.

“If you invest in the present, you’re going to get run over!”

Compound interest – By saving $10, you are really saving $100 or $1,000 [because of the future compound growth of the $10], and this compounding growth requires a little wait and patience.

https://twitter.com/joincommonstock/status/1661902483147612160?s=61&t=8ACS6bcx2PFMgdLuBnL1JQ

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Billionaire hedge fund manager Paul Tudor Jones II, Tudor Group’s Founder and Chief Investment Officer, is one of the pioneers of the modern-day hedge fund industry.  He is known for his macro trades, particularly his bets on interest rates and currencies.

In 1980, he founded Tudor Investment Corporation, which now manages $13 billion in assets.

Between 1989 to 2014, he generated compounded annual returns of nearly 20% without a single down year.

Tudor considers himself one of the most conservative investors in the world.  He would describe himself as the “single most conservative investor on earth”, and he “absolutely hates losing money.” Once he commented that his grandfather told him at a very early age that “you are only worth what you can write a check for tomorrow.”

Thus, his investment philosophy is that he does not take a lot of risks, instead, he looks “for opportunities with tremendously skewed reward-risk opportunities.” Others describe his strategy as: ‘Don’t be a hero. Don’t have an ego. Always question yourself and your ability. Don’t ever feel that you are very good. The second you do, you are dead”

Source:  https://www.tudor.com/

 

Contrarian Investing

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“The way to make money is to buy when blood is running in the streets.” ~ John D. Rockefeller

Contrarian investing believes that the worse things seem in the market, the better the investing opportunities are for profit.

Contrarians, as the name implies, try to do the opposite of the crowd. They get excited when an otherwise good company has a sharp but undeserved drop in share price. They swim against the current and assume the market is usually wrong at both its extreme lows and highs. The more prices swing, the more misguided they believe the rest of the market to be. (For more on this, read “Finding Profit In Troubled Stocks.”)

Bad Times Make for Good Buys

Contrarian investors have historically made their best investments during times of market turmoil. In the crash of 1987, the Dow dropped 22% in one day in the U.S. In the 1973-’74 bear market, the market lost 45% in about 22 months. The terrorist attacks of Sept. 11, 2001, also resulted in a major market drop. Those are times when contrarians found their best investments.

The 1973-’74 bear market gave Warren Buffett the opportunity to purchase a stake in the Washington Post Co. at a deep discount (the company could have “sold the [Post’s] assets for not less than $400 million.” Meanwhile, the Post had an $80 million market cap), an investment that has subsequently increased by more than 100 times the purchase price–that’s before dividends are included.

Sir John Templeton, founder of the Templeton Growth Fund, was also a serious contrarian investor, buying into countries and companies when, according to his principle, they hit the “point of maximum pessimism.”

As an example of this strategy, Templeton bought shares of every public European company at the outset of World War II in 1939, including many that were in bankruptcy. He did this with borrowed money. After four years, he sold the shares for a very large profit.

But there are risks to contrarian investing. While successful contrarian investors put big money on the line, swam against the current of common opinion and came out on top, they also did some serious research to ensure the investing herd was indeed wrong.

So, when a stock takes a nosedive, this doesn’t prompt a contrarian investor to put in an immediate buy order, but to find out what has driven the stock down and whether the drop in price is justified.

While successful contrarian investors have their own strategy for valuing potential investments, they all have the one strategy in common–they let the market bring the deals to them, rather than chasing after them.

References:

  1. https://www.forbes.com/2009/02/23/contrarian-markets-boeing-personal-finance_investopedia.html

Long-Term Investors vs Day Traders

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Billionaire “Old School” Investors:

1. Carl Icahn
2. Warren Buffett
3. Charlie Munger
4. Howard Marks
5. Nick Sleep

Billionaire Day Traders:

1.
2.
3.
4.
5.

The second list isn’t blank by accident.

For the purposes of this post:

  • Day trading is buying and selling on small price movements in stocks throughout a trading day, often in intervals of seconds or minutes.
  • Old School (Long-term) investing is buying or selling a company’s stock after long periods of holding an investment and being patient for the right price to intrinsic value proposition.