Capital allocation help

Hi guys,

Hope all is well.

I've been reading through the 1985 Warren Buffett letter and came across a paragraph that I want to research further.

He says:

"In 1985 they earned an aggregate of $72 million pre-tax. Fifteen years ago, before we had acquired any of them, their aggregate earnings were about $8 million pre-tax.

While an increase in earnings from $8million to $72million sounds terrific - and usually is - you should not automatically assume that to be the case. You must first make sure that earnings were not severely depressed in the base year. If they were instead substantial in relation to the capital employed, an even more important point must be examined: how much additional capital was required to produce the additional earnings?"

So what I'd like to know is how would one examine this? What ratio should one use. Is it return on equity? Return on capital employed?

Many thanks

viciam said:

Hi guys,

Hope all is well.

I've been reading through the 1985 Warren Buffett letter and came across a paragraph that I want to research further.

He says:

"In 1985 they earned an aggregate of $72 million pre-tax. Fifteen years ago, before we had acquired any of them, their aggregate earnings were about $8 million pre-tax.

While an increase in earnings from $8million to $72million sounds terrific - and usually is - you should not automatically assume that to be the case. You must first make sure that earnings were not severely depressed in the base year. If they were instead substantial in relation to the capital employed, an even more important point must be examined: how much additional capital was required to produce the additional earnings?"

So what I'd like to know is how would one examine this? What ratio should one use. Is it return on equity? Return on capital employed?

Many thanks

Click to expand...

thanks v,

A good post

In 1985 one could do projections with reasonable accuracy with simple spreadsheets and algorithms.

I believe we are now in an era of chaos, and to examine your question rationally requires systems akin to strange attractors to make any objective sense of the markets.

Buffet logic may prevail though, but I doubt it.

gg

Thanks for the reply.

That might be but some basics of a analysing a businesses performance still remain valid today and I believe this is one of them.

viciam said:

... Return on capital employed? ...

Click to expand...

ROE vs ROIC

Definition of 'Return On Invested Capital - ROIC'
A calculation used to assess a company's efficiency at allocating the capital under its control to profitable investments. The return on invested capital measure gives a sense of how well a company is using its money to generate returns. Comparing a company's return on capital (ROIC) with its cost of capital (WACC) reveals whether invested capital was used effectively.

Read more:

Garpal Gumnut said:

thanks v,

A good post

In 1985 one could do projections with reasonable accuracy with simple spreadsheets and algorithms.

I believe we are now in an era of chaos, and to examine your question rationally requires systems akin to strange attractors to make any objective sense of the markets.

Buffet logic may prevail though, but I doubt it.

gg

Click to expand...

Buffett logic works without a doubt..most people just dont apply it properly...when you buy shares or business the value do not change every day, it doesn't change because someone trigger a stop loss or margin call or whatever trigger the price to move.... it changes when it going to throw out good earning and cash flow and that takes many months or years not on a daily basis.....people said doesn't works are all the people that want fast bucks or invest in the wrong business....

Long term...business that throw good cash flow with pristine balance sheet ALWAYS deliver capital appreciation and increase dividend...that is not if or but ....it is a certainty...

The good odds are heavily stack against the investors that follow value investment principles over a long period of time It came close to near certainty - ...

Investment is like fashion, short term there are always some theory that said this time it is different, or buying on fundamental doesn't works because market volatility and xxx factors whatever the fashionable word to use at the time...

Those that used value investing principles over several decades will tell you....this stuff works and its magical

viciam said:

Hi guys,

Hope all is well.

I've been reading through the 1985 Warren Buffett letter and came across a paragraph that I want to research further.

He says:

"In 1985 they earned an aggregate of $72 million pre-tax. Fifteen years ago, before we had acquired any of them, their aggregate earnings were about $8 million pre-tax.

While an increase in earnings from $8million to $72million sounds terrific - and usually is - you should not automatically assume that to be the case. You must first make sure that earnings were not severely depressed in the base year. If they were instead substantial in relation to the capital employed, an even more important point must be examined: how much additional capital was required to produce the additional earnings?"

So what I'd like to know is how would one examine this? What ratio should one use. Is it return on equity? Return on capital employed?

Many thanks

Click to expand...

You have to invest in the right business with the right business model that light on capital, cheap to run, simple business that do not need to make money from complex web of derivatives and financial instruments.

Not everyone has the skills to spot these business but if you do stock market place is a enjoyable place and a rewarding experience...

These skills can not be learned in a short period of time but with time it will comes to you....

if you starting out try to learn as much as you can and buy business with strong fundamentals and if you want to dabble in a more exotic stuff like junior mining and biotech and fashionable stocks of the year

They can sometimes provide you invaluable experience ...why is this business not deliver me the right rate of return but this one did....and over time it will slowly change your way of thinking to the value investment approach

So ROIC is the ratio I should look at?

Also something off topic. In mining terms what does it mean by concentrate? Is it better to have high concentrate or low concentrate in a metal that is being mined, say uranium or lithium?

Thank you

viciam said:

So ROIC is the ratio I should look at?

Also something off topic. In mining terms what does it mean by concentrate? Is it better to have high concentrate or low concentrate in a metal that is being mined, say uranium or lithium?

Thank you

Click to expand...

I will offer an opinion on "concentrate".
An ore can be put through a "flotation" process whereby bubbles pick up the mineral ore in question.
Eg Zinc ore at 8% head grade can be raised to say, 70% grade by flotation.
If transported over vast distances to smelters it is obviously advantageous.
Example:
Broken Hill ore is concentrated, then railed to Port Pirie Smelter.

Read more:

Hey burglar, hope you're good.

I read the link but I'm still not understanding whether lower or higher concentration is good. From what I understand high concentration would be good? Since more of the stuff your looking for is available in a certain area size

like 10 grams in 5cm sq

viciam said:

Hey burglar, hope you're good.

I read the link but I'm still not understanding whether lower or higher concentration is good. From what I understand high concentration would be good? Since more of the stuff your looking for is available in a certain area size

like 10 grams in 5cm sq

Click to expand...

The link was complex, but then so is making concentrates.

Higher concentrate is better, transporting less waste, therefore transporting more product.