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Author: trepanne Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 441  
Subject: Re: Any thoughts on SAB Date: 11/23/2004 11:03 AM
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stevnfool,

i regret that i don't currently have the mental bandwidth to treat your analyses here more fully. however, if you're looking for feedback on analytical methods, i can provide a little.

As Warren Buffet says, "Are you
getting at least one dollar of value for each dollar re-invested by the
company". New management took over this company in 2000. So the period
of greatest interest is from the end of 2000 to date. One way to look
is to see how the tangible value of the company has increased and add
that to dividend to see the return of this company.


i know of two main graham/buffett-style tests of retained earnings.

the first is to check that over a period of years, the claimed earnings, less dividends, actually increase the book value dollar for dollar. the problem is that companies can (for example) run good stuff through the income statement, and then find ways of having the bad stuff directly write down balance sheet accounts without going through the income statement. if they do so, they will flunk the "earnings increase book value 1:1" test. the purpose of this analysis is to verify the earnings power of the company, in order to apply P/E type capitalization multiples.

note the difference with what you're doing - you're only counting increase in net current assets. "net/net" analyses are of liquidation value, not going-concern value, which is what graham's retained earnings test was driving at.

to check an increase in working capital against retained earnings doesn't make much sense to me. a company with perfectly valid earnings could be plowing them back into capital expenditures for expansion, rather than increased inventory or what have you, and still have good earnings power... and yet it would flunk your test.

the second test of retained earnings you might be thinking about is a *market-based* (not balance sheet based) test. buffett has suggested checking that, over a period of years, every $1 of retained earnings has been rewarded in the market by an increase of at least $1 in equity cap... otherwise, you have a pretty good red flag that management is destroying value.

trp
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