persistentone (both by name and by nature, it seems):Here's a...

persistentone (both by name and by nature, it seems):

Here's a tip.

Try thinking about companies in these terms:

One day, someone comes to you and says, "Happy Birthday, Pers! Look what I got you: I bought you a company called WESFARMERS"

So what kind of gift do you have?

Well, let's talk in terms of cash flow.

Every year, you as the owner of the business get a whole stack of Operating Cash Flow. And yes, that OCF is the outworking of a whole lot of historical capital allocation decisions.

Now you - as the company's sole Director and CEO - need to figure out what to do with the CASH FLOW you have just received.

And unfortunately, that's where an element of analytical investment subjectivity comes inevitably into play.

How good a job are you going to do in spending the dough?
Are you going to do so astutely and prudentially?
Or are you going to be an acquisition cowboy?

So you're not ingoring expansion capex and acquisions at all. Or at least you shouldn't be.

As an investor you should be articulating to yourself at some stage of the inveestment process something along the lines of, "...and I think in the future WES will invest growth capital at a rate of return of X, and will make acquistions that will deliver a return of Y, and I'll impute those assumptions into my valuation."

But to simply say ROE is 8.8% and that's what it will always be is simply looking in the rear view mirror at the expense of considering the quality and nature of future growth capex and acqusition spend.

Now there is some inter-relationship between historical capital allocation behaviour and prospective behaviour.

And the inter-relationship is usually one of precedent, i.e. astute capital allocators of the past can reasonably be expected to be good capital allocators in the future.

Of course, sometimes you get disasters like the Coles transaction, and then the element of subjectivity needs to be applied in coming to the view whether or not that sort of gross misallocation of capital might repeat itself, or otherwise.

(Which is kind of what all the wailing of gnashing of teeth is about on this forum...some say ROE is in isolation a sacrosanct measure, and I say it needs to be contextualised and qualified.)

Hope this helps.

Cam