Thesis: A high ROE is good. So an infinite ROE has to be better, right?A firm that can make money with no net book value at all is often a great long run investment.Historical examples include Coke, Moody's, Yum, Dunkin', Autozone, IBM for a long time.Most often they are reasonably mature firms who have had time to pay out all their equity as dividends and still keep earning because they have asset-light businesses or earnings so steady they can afford to fund themselves with >100% debt and <0% equity.They often have strong pricing power and strong resistance to the entry of viable competitors.(if they didn't, you could open a profitable competitor with no upfront capital!)This was inspired by my high ROE screens starting with the VL database. Great hunting ground.But if a company has positive earnings but negative book, they generally just divide the two and give you a negative ROE figure.This is arithmetically sensible but probably not what you're looking for from an investment point of view.All my VL high-ROE screens were missing these picks.So, the strategy of the day is to look for only these oddities.Value Line 1700 set of stocks.Find those with:Negative or zero book value per share, positive trailing-four-quarter earnings, and positive "Current EPS" On average there are about 31 stocks meeting those three criteria, though occasionally as few as 4.Buy equal dollar amounts of the 15 stocks with the highest projected EPS growth in the next 3-5 years.If there aren't 15 of them (average is 13.6), pad the portfolio with some SPY so no stock position is over 1/15th of the portfolio.Hold for a month. Repeat.Very low turnover; less than one substitution per month.From January 2001 to April 2021, this beat SPY by 11.4%/year after 0.4% trading costs.Remarkably steady too, all things considered. About 3/4 the risk of the S&P on my preferred DDD3 metric. Last 12 months up 122%.Top 20 is almost as nice. Backtest return about 2.9% lower, but somewhat steadier results. Lower risk metric, lower standard deviation of rolling year returns, milder worst rolling year.And of course lower company-specific risk.In fact, the final sort isn't really needed that much. Just buying all of them with negative book and positive earnings measured both ways works pretty well too.It helps to at least require that PEG be positive.For a sense of what it finds, I believe the current picks would be:ATUSSBACSIRILBGDDYWINGPZZASNBRUIBLBDMSCISBUXAZOMTCHFTDRVVVDPZTNLJACKEATThe current top 15 have an average PEG of 24.2%.
A crude first pass at Mungo’s Return on Infinite Equity screen for SIP users in GTR1.Screen from 19970902 CAGR 14.1 SAWR 9.0^S5T from 19970902 CAGR 8.7 SAWR 5.0http://gtr1.net/2013/?~ROE_Infinite:h21r3i126f0.35::styp.a:e...RAM
I don’t understand how a viable company can have negative book, or negative equity. That makes it technically bankrupt, unless we’re looking at a quirk in the data. Elan
Some companies have income producing assets that the accountants undervalue. They try to put the uncountables into Goodwill/Intangibles, but sometimes get it wrong. Some say trying to get an accurate Goodwill number is not worth the effort. Some companies probably don't care what the Goodwill number is.The Challenge of Accounting for Goodwill, November 2019Impact of a Possible Return to Amortization"In summary, over the past eight years, in response to concerns over costs and benefits of the nonamortization approach, FASB has modified and relaxed the initial requirements of its nonamortization approach and allowed private companies the option of using amortization instead of impairment testing. The pendulum seems to be swinging back towards amortization." ... "Recent studies found that over $1 trillion in goodwill was added to public company balance sheets during calendar years 2015–2017, representing a marked increase over the years prior"https://www.cpajournal.com/2019/11/27/the-challenge-of-accou...Companies go bankrupt for 5 reasons:unprofitable over a long time period.not enough profit to cover debt interest payments.short term cash flow problems.product lawsuit.government action.An example:Moody's is profitable, and has enough profit to cover interest payments. In 2016, return on Goodwill was 53%, maybe because Goodwill was undervalued.EBIT/Goodwill = 53%Interest/Long-Term Debt = 4%Moody's (MCO) in 2016: 2052M Cash 887M Receivables 1320M Goodwill 5327M Total Assets 3063M Long-Term Debt 6552M Total Liabilities -1225M Common Stock Equity 695M EBIT 137M Interest 282M Taxes 267M Net IncomeMoody's Corp bought Bureau van Dijk for $3.3B in 2017. Looks like Moody's used $1B cash and $2B long-term debt for the purchase. Goodwill increased by $4B. Moody's was doing fine in 2016 even with the negative equity. Plenty of Cash, investors willing to loan more, and great earnings. 2016 Goodwill was undervalued.Moody's Corp to buy Bureau van Dijk for about $3.3 billion, May 15, 2017https://www.reuters.com/article/us-bureauvandijk-m-a-moody-s...
I don’t understand how a viable company can have negative book, or negative equity. That makes it technically bankrupt, unless we’re looking at a quirk in the data.Seemed impossible to comprehend when mungo posted this so I looked around and it is indeed a quirk in accounting data. Goggle “companies with negative book value” and you will come up with some interesting takes. Example: The price-to-book ratio has a problem. More and more U.S. companies report negative book value, the result of accounting rules and structural changes in the market. This creates broad confusion and problems for the famous value factor, and indexes or strategies which rely on it as a measure of cheapness. Negative equity companies are often written off as distressed, but after reporting negative equity, most of them survive for years and have, as a group, outperformed the market 57% of the time. Negative Equity, Veiled Value, and the Erosion of Price-to-Book | O'Shaughnessy Asset Management (osam.com)RAM
Seemed impossible to comprehend when mungo posted this so I looked around and it is indeed a quirk in accounting data.It's not so much a quirk in the accounting data as a real world phenomenon about how business works.In a way, being "technically bankrupt" should be the goal...provided the earnings keep going.A company that makes a buck requiring assets is not as good a company to own as one that makes the same buck WITHOUT requiring a pile of assets.Some companies, usually only a few of the very best, have business franchises that are so good that they can continue to make make a lot of money on a regular basis with no net assets.They probably have some gross assets (though not necessarily very many), but can easily support in along term sustainable way the debt that allows them eventually to pay out all the equity as dividends.The earnings stream generally has to be well protected, or nobody will lend them that much.A typical negative equity firm that is still making good money year in and year out will be able to borrow pretty well.IBM has a lot of debt, but even with their recent bad few years they have no problems making a whole lot of money with no net equity, and no problems supporting their debt.(It can also be done with sufficient buybacks rather than dividends, though that's qu9ite a bit rarer.It takes a slopton of buybacks to move the needle that much.Every buyback at a high multiple of book will reduce the book value of equity somewhat.That's somewhat more like an accounting quirk than the dividend approach which is simply "pay it all out")It's not just something at the negative extreme of book value.Very high P/B firms outperform low P/B firms on average, too.Those are firms that merely have few new assets (so far) rather than no assets.Think of it this way: two typical firms might trade at similar multiples of earnings in a typical year.One has a high return on assets (a luxury goods firm, perhaps), the other has a low return on assets (a steel firm, maybe).The one with a high return on assets is probably the better business to be in.It's not capital intensive, and more importantly the steadily high return on assets/equity means that for some reason they aren't being undercut by new entrants competing with them.It the P/E ratios are similar, the better business will be the one trading at the higher P/B or higher multiple of gross assets.Firms that have negative equity because they're in trouble, typically because they just lost a huge amount of money, are a different kettle of fish.They generally don't show up on the screen because they aren't making money and aren't seeing high earnings growth expectations.This has interesting implications for the banking industry.A lot of people value banks on multiple of book, but book doesn't really matter. Tangible or not.A bank can be happily profitable indefinitely with no net asset value at all.(heck, if you can run with 20:1 leverage you can run with 20:0 leverage)The only reason they need some positive net assets is to stay attractive to the lenders they'll need to keep sweet, and to keep the regulators sweet.Jim
Buy equal dollar amounts of the 15 stocks with the highest projected EPS growth in the next 3-5 years.Thank you, Jim, for sharing your research and ideas. I've learned a lot reading your posts describing your thought processes.I attempted to run the screen you describe today with the June 11 VL data. My screen found 47 tickers. I got all of the tickers you list, but in a different order due to the "Proj 3-5 Yr EPS" final sort.For example, in my VL version for this week, the Proj 3-5 Yr EPS for WING is 3.25, putting WING at #35 on my list. Similarly, the Proj 3-5 Yr EPS for SIRI is 1, next to last on my list.Do you have any ideas as to what I may be doing differently? Here is my list in descending Proj 3-5 Yr EPS order.AZOTDGDPZUIMSCILIIMCDMSISNBRABCJACKVRSNPMTNLYUMLBEATHLFSBACCHHSBUXALTMSBGITENPOLYPZZAHPQNAVWOTISMTCHCDKMSGNFTDRWINGGDDYATUSUISVVVWWDBDBLBDPPDSHLXWOWSIRIENDPThanks for any help.Chip
For example, in my VL version for this week, the Proj 3-5 Yr EPS for WING is 3.25, putting WING at #35 on my list. Similarly, the Proj 3-5 Yr EPS for SIRI is 1, next to last on my list.It appears that you're sorting on Projected EPS which is a dollar figure, instead of sorting on Proj EPS Growth Rate.Elan
Thank you, Elan. You are correct. That fixed my problem.
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