where to from here, page-53

MJS:

Hallelujah!

Someone who gets it and is able to articulate it.

Thank you!

Very few people are aware of, or understand, the non-linear relationship between Price-to-Book Equity and Return on Equity.

That's why asset writedowns make no difference to the valuation of a listed company.

(Reducing the value of the book will indeed "improve" ROE, but the Price-to-Book ratio will simply rise commensurately.)

[Interestingly, someone in an investor group in which I participate called me frantically on the day earlier this week that Rio Tinto announced the $14bn writedown of the carrying value of goodwill related to the Alcan acquisition. He was a RIO shareholder and was worried that the share price was going to fall by a value of $14bn. He thought that $14bn of value was being "destroyed". I explained to him that the "destruction" of the value had already occured at the time of the transaction, and that what was happening now was merely the formality of recording that fact in the accounts of the company. He thought I was nuts me when I said the RIO stock price would probably go up.]

Your point 2), in particular, is very significant (the one that deals with the improvement in ROE for WES).

Indeed, you might be aware of a significant body of qualitative research which concludes that is is not the absolute LEVEL of ROE that matters for the creation of intrinsic value, but it is the RATE OF CHANGE in ROE that drives growth in intrinsic value.


But your point 3) is THE defining one and I'll take the liberty of repeating it here for emphasis:

"Where you expect cash flow, profit, and dividends to go in the future is much more important than simple ROE and the like. At the end of the day, if cash flow will increase and ever increasing dividends can be paid (without being debt funded) that will bode well for the cash returns the shareholders receive and in the long run the share price will also reflect."

Exactement!


Cam