1/ The worst business in the world grows while earning a low return on net tangible assets.
This business is incapable of paying anything out to you.
And the only way it can even return 7% a year or better if you buy it at a P/E of 15 is if...
2/ ....it grows fast enough ON A PER SHARE BASIS – after issuing the stock it needs and taking on the debt it needs to grow.
The second worst business in the world would be something that has high or even infinite returns on net tangible assets but can’t grow at all.
The second worst business in the world would be something that has high or even infinite returns on net tangible assets but can’t grow at all.
3/ This business can only pay out its earnings yield to you (you can only make 6% to 7% buying at a P/E of 15, 10% buying at a P/E of 10 and so on).
The good news is that while this business can’t grow what it pays out to you, it will never need more money from you.
The good news is that while this business can’t grow what it pays out to you, it will never need more money from you.
4/ I would recommend avoiding all businesses that sometimes earn 15% a year or worse on their net tangible assets.
I would recommend focusing your search for businesses on those that almost always earn 30% a year or more on their net tangible assets.
I would recommend focusing your search for businesses on those that almost always earn 30% a year or more on their net tangible assets.
5/ If you do that, any growth you do get will be very valuable growth.
At rates between 15% and 30% pre-tax it gets a little tricky.
Businesses that grow faster even at slightly lower returns might be better.
At rates between 15% and 30% pre-tax it gets a little tricky.
Businesses that grow faster even at slightly lower returns might be better.
6/ However, businesses with high consistency (very, very few years of sub 15% pre-tax returns on net tangible assets) may work out better than companies that are growing faster right now but generate unacceptable returns at the bottom of each cycle.
7/ What you’re looking for is a business where you are confident that:
* There will be growth
* And that growth will be very profitable
And what you really want is for those two facts to hold true in almost every year you hold the stock.
* There will be growth
* And that growth will be very profitable
And what you really want is for those two facts to hold true in almost every year you hold the stock.
8/ I’ll let Warren Buffett sum up:
“Leaving the question of price aside, 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”
That isnt necessarily going to be the biz with the highest ROTA.
“Leaving the question of price aside, 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”
That isnt necessarily going to be the biz with the highest ROTA.
9/ But, it’ll never be a business with average or below average returns on net tangible assets.
So, you always want to start by demanding above average returns on unleveraged assets.
Once you know you have that, you can start worrying about growth.
$GEOFF
So, you always want to start by demanding above average returns on unleveraged assets.
Once you know you have that, you can start worrying about growth.
$GEOFF
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