Tag Archives: Greenbackd.com

Question on ROE vs. ROCE; Comprehensive Look at EBITDA


http://greenbackd.com/2014/04/28/median-stock-at-all-time-high-valuation/ and an interesting look at margins here:

Respecting the Reality of Change

The following chart shows CPATAX divided by GDP from 1947 to present.  The black line represents the average from 1947 to 2002, and the green line represents the average from 2003 to 2013.


As you can see in the chart, CPATAX/GDP is wildly elevated at present.  It currently sits 63.3% above its average from 1947 to 2013, and a whopping 75.0% above its average from 1947 to 2002.

As readers of this blog have probably inferred by now, I’m not very patient when it comes to waiting for “mean-reversion” to occur.  In my view, when a variable deviates for long periods of time from a reversion pattern that it has exhibited in the past, the right response is to expect something important to have changed–possibly for the long haul, such that a predictable reversion to prior averages will no longer be readily in the cards.  The task would then be to find out what that something is, and try to understand it. Go here:

http://www.millennialinvest.com/   (Interesting blog)

Reader Question:

Can you help me understand one aspect of ROE? In Indian companies, some of the companies have ROE < ROCE.

Isn’t that a violation of the observation that ROE ~ ROCE times Leverage.

I define ROCE as Return on Capital Employed.

ROCE = EBITDA (1-Tax Rate)/Total Capital Employed (=Debt+Equity)

I use ROCE as a measure of the attractiveness of the industry and the company. High ROCE is good, implying a moat, low ROCE is not.

Some of the reasons I could think of are:

  1.  Exceptional losses, which lead to Net Income << EBIT(1-Tax) *Leverage
  2.  Extremely high interest charges. ( higher than return on the        debt portion) which leads Net Income << EBIT(1-Tax)* Leverage
  3.  There is a slump sale of a division, and thus suddenly huge            amount of profit has come in increasing inordinately the            average shareholder equity. So suddenly the effective leverage        has dropped.

Update May 1: 

I made a mistake in describing ROCE.  In my defense, I dont exactly calculate ROCE and merely use the numbers from screens.
ROCE = EBIT(1-Tax Rate)/ Total Assets and not EBITDA as mentioned before.

Does someone want to have a crack at this? I see issues whenever you use EBITDA without understanding maintenance capex. Please read this: Placing EBITDA into Perspective

More on WMT: A reader posted this in the comment section: http://www.fool.com/investing/general/2014/04/28/why-is-wal-mart-failing-in-emerging-markets.aspx.    Does that article even touch upon the ture nature of WMT’s competitive advantage?  No wonder the obvious is overlooked.

Quantitative Value Investing Lecture Video; Cartoon Book on Why an Economy Grows

Quantitative Value Investing

Money Ball: To get into the mood of quantitative analysis view these short videos on baseball: http://www.youtube.com/watch?v=xn7C6jgl0RI and http://www.youtube.com/watch?v=emwkhGjTWcY

Quant Value Investing: http://greenbackd.com/2012/08/31/presentation-to-uc-davis-mba-value-investing-class-on-quantitative-value-investing/

Also go to www.greenbackd.com

Why an Economy Grows

Thanks to a reader for this cartoon book on how-an-economy-grows

Third Avenue Fund 3Q Letter:TAVF_3Q_2012 Letter


Video on Volatility, Buffett Partnership Letters, Blog and Podcast Links

Buffett’s Partnership Letters

A reader alerted me that this blog has no link to Buffett’s original partnership letters. For shame, here they are:

Links to each original letter: http://www.rbcpa.com/WEB_letters/WEB_Letters_pre_berkshireTURNEDOFF.html

Newly typed Consolidated Letters for easier reading (suggested for ease of study)Complete_Buffett_partnership_letters-1957-70_in Sections

Readings and Videos in Economics



Video on Boone Pickens discussing Natural Gas: http://martinkronicle.com/2012/05/02/boone-pickens-pickens-plan-natural/

Developing skills and understanding your own foibles–Trader and Stock Blogs http://www.brettsteenbarger.com/trader_development.htm  Search for topics of interest.  Often trading blogs focus on the psychological aspects of trading since traders make many more discrete decisions than long-term investors, thus trading blogs can be of use to understanding how we make decisions under pressure and uncertainty.

Recent CNBC Munger Interview http://video.cnbc.com/gallery/?video=3000088395

Podcast on Steve Case’s book, The Indomitable Investor. Why people on main street do not understand how Wall Street works. His main point, “Bad investors think of ways to make money and good investors think of ways not to lose money.” http://martinkronicle.com/2012/04/02/steve-sears-indomitable-investor/

www.greenbackd.com is back posting with great articles on Greenblatt’s Magic Formula and more.

Fascinating 5 minute Video on Stock Market Volatility:

Artemis Capital Management LLC is pleased to present “Volatility at World’s End: Two Decades of Movement in Markets” a unique visualization of implied and realized stock market volatility from 1990 to 2011. The video was originally shown as part of Christopher Cole’s speech at the 2012 Global Derivatives and Risk Management Conference in Barcelona Spain on April 17th.

The movement of stock prices has been an obsession for generations of speculators and traders. On a higher level mathematicians believe that modern markets are an extension of the same fractal beauty found in nature. Visualized these stock markets may take the shape of a turbulent ocean with waves made of human hopes, dreams, greed, and fear. Merging the world of high-finance and high-art Artemis Capital Management LLC is proud to present a creative visualization of stock market volatility over the last two decades.

Volatility at World’s End: Two Decades of Movement in Markets is a depiction of real stock market volatility using trading data from 1990 to 2011. The visuals are designed from S&P 500 index option data replicating the implied volatility wave (or variance swap curve) extending to an expiration of one year. The front of the volatility wave contains the same data used to calculate the CBOE VIX index. The movement of this wave demonstrates changing trader expectations of the future stock market volatility. As the wave moves through time the expected (or implied) volatility surface transforms into a realized volatility surface derived from historical S&P 500 index movement. The transition represents what professional traders call “volatility arbitrage”. The color variation in the volatility waves show the volatility-of-volatility or internal movement of the wave. The track underneath the volatility wave represents underlying S&P 500 index prices.

Volatility at World’s End: Two Decades of Movement in Markets VIDEO (5 minutes) http://www.artemiscm.com/research/volitility-at-worlds-end-two-decades-of-movement-in-markets/

Readers’ Questions and more


A reader from Norway: May I ask a couple of more questions please?

  •  What would you do differently if you had the opportunity to go back in time when you first audited Columbia Business School classes, how would you approach the learning material differently? How would you accelerate the learning process and absorb the material?

I stumbled upon Joel Greenblatt’s book, You Can Be a Stock Market Genius, and became hooked. My author search led me to Columbia’s GBS where he was teaching a class. I hopped on the train to 125th street in NYC and sat in on his classes. He graciously allowed in 1999 for auditors to sit in like Ben Graham allowed back in the 1940s and 50s. In fact, there were more non-students than graduate students in Graham’s classes.  I already had worked on Wall Street—useless for understanding how businesses worked or how to value them—but I had started companies so my background was applicable.

I would approach the material in the same way like learning how to fly a plane or develop any skill. You learn the theory, you practice in controlled situations (case studies) then you apply what you have learned in the market and then reflect on what you did right or wrong.  Read voraciously from many sources.

  •  What was you biggest learning/insight/eureka moment from Greenblatt and Greenwald?

There are no secrets. You need to be comfortable with uncertainty and limited knowledge. You have to work hard to find and value businesses. Not all businesses are able to be valued by you, so walk away; be selective.  Investing is doing, so apply your knowledge to the opportunities in front of you (or wait for tomorrow for better ones to tumble at your feet). Investing is a solo activity. The key moment was realizing no guru can show you the way; you will have to think for yourself and apply the principles to the world around you. I don’t visit investment conferences anymore because I don’t want to hear other people’s ideas; I prefer to spend time uncovering my own. Time is precious, thus choices have to be made. You can’t watch other investors, mimic them or just copy; you have to be unique in your own way in seeking bargains. You have to be your own analyst. Yes, you should listen to others like: https://www.lmcm.com/OwnWords.asp?f=Sam_Peters_LMCMs_Philosophy_Process.wmv&d=869180 but time is better spent reading your own pile of 10-Ks.

  • In relation to your CBS class mates, what surprised you the most? What did they do wrong, did most of them maximize their learning opportunity?

I saw several playing video games. They didn’t care who Joel Greenblatt was or what he was teaching. They were there to fill a requirement to get an MBA and a high paying job.  I believe there course load is quite heavy so they might not have had the time to go more in depth into investing ideas and concepts. Again, if you want to be focused on investing, business school is not the place. You learn how to become a manager and you leave with a network. But I do not judge them. Many should not waste their time and talent on just investing.   Many are not suitable to the lonely journey of investing.

  • How did you manage to transcribe every word from the Greenblatt lectures? (the transcribed documents from Greenblatt > Greenblatt videos).

I taped the lectures then sent the clips to India to be transcribed. I sat in on classes for five years (1999 to 2003). If you are diligent, you could have taken Greenblatt’s book, Stock Market Genius and recreate from SEC filings of all his past investments just as if you were in his classes. Joel reminds me of Columbo, the TV detective (https://www.lmcm.com/OwnWords.asp?f=Sam_Peters_LMCMs_Philosophy_Process.wmv&d=869180). Joel makes investing seem so simple, but there is a lot of experience, knowledge and skill behind his actions.

  •  A reader from Uruguay asks, “How can I use the magic formula?” How do you calculate ROIC?

Go to www.magicformulainvesting.com and go to www.greenbackd.com to learn more.

Another reader asks:

I just finished Competition Demystified by Bruce Greenwald and it was an excellent book. This book has really opened my eyes and I can honestly say I have never approached investing from that point of view.

  •  I just need to try to apply it consistently. When you evaluate and investment and determine its a franchise, do you go through the steps he lays out in Chapter 2?

I try to understand the qualitative sources of competitive advantage so I can learn the company/industry. For example, I saw amazing share stability with title insurance companies stretching back 100 years, but cyclical and sometimes low profitability—why?  Most of the value accrues to the sales agent in a title insurance transaction, but due to regulation and databases, there are only three or four national title insurers. The process helps you break apart the sources of profitability for companies. The more you can understand, the better you will be able to normalize earnings or determine sustainability of growth.



Notes from Buffett’s Shareholder Meeting:Berkshire_Hathaway_Annual_Meeting_Notes_2012 and Berkshire_Hathaway_Annual_Meeting_2012

How to write a research report by Buffett (GEICO):The_Security_I_Like_Best_Buffett_1951

Do not forget to read: www.marketfolly.com for interesting presentations.

www.greenbackd.com as several recent articles on the Magic Formula.

If Value Investing Works, Why do Value Investors Underperform?

Value investing works, so why do value investors underperform? The evidence for activist value investors.

Visit the great blog www.greenbackd.com


The Research Paper is here:Do Value Investors Underperform

The author doesn’t know why value investors either under or outperform in my opinion.

The Paper’s Conclusion

Value investing comes in many stripes. First, there are the screeners, who we view as the direct descendants of the Ben Graham school of investing. They look for stocks that trade at low multiples of earnings, book value or revenues, and argue that these stocks can earn excess returns over long periods. It is not clear whether these excess returns are truly abnormal returns, rewards for having a long time horizon or just the appropriate rewards for risk that we have not adequately measured. Second, there are contrarian value investors, who take positions in companies that have done badly in terms of stock prices and/or have acquired reputations as poorly managed or run companies.

They are playing the expectations game, arguing that it is far easier for firms such as these to beat market expectations than firms that are viewed as successful firms. Finally, there are activist investors who take positions in undervalued and/or badly managed companies and by virtue of their holdings are able to force changes in corporate policy or management that unlock this value. What, if anything, ties all of these different strands of value investing together? In all of its forms, the common theme of value investing is that firms that are out of favor with the market, either because of their own performance or because the sector that they are in is in trouble, can be good investments.

What inspired Ron Paul: Mises Lecture on Socialism

http://bastiat.mises.org/2012/04/audio-of-the-mises-lecture-that-inspired-ron-paul/  Amazing audio lecture on why and how Socialism has to fail economically (no ability to use prices and thus allocate resources efficiently)