Why does no one pay attention to Buffett's favorite financial measure?

[ratiman]

Buffett has consistently said that the best way to measure a business is return on tangible assets (see video). Likewise Greenblatt's magic formula uses ROTA. Tangible assets (PP&E, inventory, receivables, accrued expenses and some other stuff) minus payables is the amount of capital needed to run the business. And despite Buffett touting this measure for the last fifty years it rarely gets mentioned. For instance the last mention of "return on tangible assets" on X was over a month ago whereas the last mention of "return on invested capital" was an hour ago. The difference between ROTA and ROIC is that ROTA ignores capital structure and intangibles. So why has Buffett's preferred measure been largely ignored? This is especially puzzling when it is much easier to understand than the alternatives.

 

 

 

Edited 11 hours ago by ratiman

[nwoodman]

No one?

[Spooky]

What if your business does not have a lot of tangible assets?

[ratiman]

18 minutes ago, nwoodman said:

No one?

 

I haven't seen a company ever use it in an investor presentation. Banks do use ROTA and Buffett is talking about banks in the clip above, whereas in a normal business I think Buffett would focus on *net* tangible assets. But I don't remember a CEO ever talking about RONTA. I could be completely wrong though.

[ratiman]

15 minutes ago, Spooky said:

What if your business does not have a lot of tangible assets?

Some businesses even have negative tangible assets. These are the truly great businesses, like Chewy.

[73 Reds]

21 minutes ago, ratiman said:

Some businesses even have negative tangible assets. These are the truly great businesses, like Chewy.

Yup.  Almost like creating something out of nothing, but "nothing" being brainpower.

[ratiman]

  Munger & Buffett have mentioned that they did not initially realize how important RONTA was. Does Graham's Security Analysis even mention RONTA? DNA was discovered before investors discovered the important of tangible capital.

 

 

Edited 13 hours ago by ratiman

[Blake Hampton]

ROE is god

[Eldad]

I mean I think your goodwill should count against you. I want to see your return with your acquisitions in there as well. 
 

I typically look at profit margin just because it is easier than calculating ROTA. I can see that ROTA would be slightly better. 
 

If you see a company with a giant profit margin and a low ROIC and ROA, then you know they recently paid a huge multiple for a business. See SPGI. Now if the moat is super strong on what they just bought, eventually the ROA and ROE numbers should catch up. 
 

If you screen for only high ROIC and ROA businesses, you could miss some great businesses, but those may have suspect capital allocation. Time will tell. 
 

 

[ratiman]

Buffett doesn't really care about the company's past investment decisions because he doesn't plan on growing by acquisition. Typically if the business doesn't have reinvestment opportunities Buffett isn't going to do any acquisitions.

[Eldad]

2 hours ago, ratiman said:

Buffett doesn't really care about the company's past investment decisions because he doesn't plan on growing by acquisition. Typically if the business doesn't have reinvestment opportunities Buffett isn't going to do any acquisitions.

Sorry but what are you talking about?

 

Buffett himself doesn’t want to grow Berkshire by acquisitions or he doesn’t want his common stocks to grow by acquisitions? I would argue both of those are obviously wrong. 
 

For example, Buffett says Kraft is still a great business because it has a high ROTA. But it paid way too much for Heinz and so it has been stuck for a decade or so. 
 

OXY, KO, MCO, KR, KHC they all acquire…. a lot. 

[Eldad]

10 minutes ago, Eldad said:

Sorry but what are you talking about?

 

Buffett himself doesn’t want to grow Berkshire by acquisitions or he doesn’t want his common stocks to grow by acquisitions? I would argue both of those are obviously wrong. 
 

For example, Buffett says Kraft is still a great business because it has a high ROTA. But it paid way too much for Heinz and so it has been stuck for a decade or so. 
 

OXY, KO, MCO, KR, KHC they all acquire…. a lot. 

I guess you mean when he buys a business to be wholly owned by BRK. But that is kind of outside of the bounds of “why don’t more investors care about ROTA” since investors by and large are minority owners of stocks. 

[ratiman]

What I meant was that he doesn't consider a poor track record of acquisitions or lack of reinvestment opportunities to be a disqualifier. The Berkshire portfolio is full of brands that have withered while in the BRK portfolio without any reinvestment or acquisitions, like Dairy Queen and Jordan's Furniture. And why would past capital allocation decisions be included in a measure of capital efficiency? It's completely extraneous so it's curious that ROIC is so much more popular than RONTA. What you want to understand is the efficiency of the current business, not the blended measure that includes the effectiveness of past management decisions.

Edited 5 hours ago by ratiman

[whatstheofficerproblem]

12 hours ago, ratiman said:

So why has Buffett's preferred measure been largely ignored? This is especially puzzling when it is much easier to understand than the alternatives

 

Because that is what Wall St sells. Take a NOPAT, divide that by 'Invested Capital' the definition of which is vague by the way, different people/firms use different denominators. Wow, a $500M NOPAT on $2.5B invested capital (most of which by the way is debt & equity) that is a 20% ROIC. buy buy buy! The more sell-side research I read, the more I am disillusioned to the glory of Wall St.

 

Let's say if Evercore's ISI starts using ROTA or RONTA, then there will be a lot of other buy-side shops using the metric. Which will then create demand for that metric on the sell-side and we'll see even more firms covering this until ROTA becomes a household metric much like ROIC is today. Another disappointing fact is that most people just quote Buffett, never follow him. We would have had a few more Berkshires & Fairfaxes had they done so.