Forum Archive Index - March 2003

["tennyson@caverock.net.nz" <tennyson@caverock.net.nz>]

Hi Bill,

>
>Philip Morris, the
>tobacco company is the only publicly owned company in the United
>States, possibly, the world (there are certainly none in New Zealand
>or Australia),that has grown its earnings (as measured by earnings
>per share) by more than 15% annually since 1960. So why do many
>companies set targets in excess of this ' very difficult to achieve
>number'.
> 

Personally I haven't seen a major NZ corporate state a goal of 
growing earnings at 15% annually long term.

Warren Buffett's goal of looking for a company that can consistantly 
grow return on equity at 15% is not the same thing for one reason:

1/ If a company is to increase its profits by 15% every year and ROE 
is 15% then that company must retain *all* of earnings, and pay out 
no dividends at all, to grow at that rate.   Most companies do pay 
out at least some dividend.

Warren's other goal, of looking for an 'internal rate of return' of 
15% over ten years can normally only be achieved after that target 
company has gone through a period of crisis.   Because the 
sentiment of 'Mr Market' is near rock bottom when Warren buys, the 
company does not have to increase its earnings by 15% per year to 
satisfy Warren.  A large part of 'Warren's return' will come 
simply from market sentiment returning to normal, or even becoming 
overheated, for that share.

> 
>I have just started reading a NZ Book called"Finance" by Susan
>Hansen. So far only reached page 19 in which she discusses Economic
>Value Added. The Reality of achieving EVA In the past Telecom NZ has
>been applauded as the only NZ company to leap the EVA hurdle since
>1990.It did not achieve this in 2000 and 2001. 
>

EVA is different again.  I like the concept of the idea of figuring 
out whether a company is using its capital wisely.  I don't like the 
implementation via EVA though.   The problem, as I see it, is that 
the EVA method uses volatility as measure of risk.   This means that 
a more volatile share will have a 'higher cost of capital' and so be 
less attractive from the point of view of EVA.

However, as  Buffett style investor I like volatility.   When Mr 
Market gets manic depressive this means I can buy a share cheaply.  
When Mr Market gets over exuberant this means I can sell at a good 
profit above fair value.   To me volatility is one of the prime 
ingredients in the successful investment process.   So penalising a 
company because it has 'high share price volatility' and therefore 'a 
high cost of capital' just doesn't make sense to me.   

The other problem I see with EVA is that is assumes past share price 
volatility is a guide to future share price volatility.   I haven't 
seen any evidence that this is true in practice.   So I don't use 
EVA.

SNOOPY





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