Use access key #2 to skip to page content.

JohnCLeven (81.45)

A Fortune article from 1988 is put to the test...in 2013

Recs

42

May 06, 2013 – Comments (20) | RELATED TICKERS: BRK-A , BRK-B

Greeting Fools,

In this blog post, i'd like to share the results of a small reserach project that I recently undertook, and hopefully, start a good discussion.

I was recently rediscovering some older Berkshire Hathaway shareholder letters, and I discovered an excerpt from the 1987 sharreholder letter that really stuck a chord with me. See that exceprt below: (and I apologize for the formatting issues)

"Here's a benchmark: In its 1988 Investor's Guide issue, Fortune reported that among the 500 largest industrial companies and 500 largest service companies, only six had averaged a return on equity of over 30% during the previous decade.  The best performer among the 1000 was Commerce Clearing House at 40.2%.

Experience, however, indicates that the best business returns are usually achieved by companies that are doing something quite similar today to what they were doing five or ten years ago.  That is no argument for managerial complacency.  Businesses always have opportunities to improve service, product lines, manufacturing techniques, and the like, and obviously these opportunities should be seized.  But a business that constantly encounters major change also encounters many chances for major error.  Furthermore, economic terrain that is forever shifting violently is ground on which it is difficult to build a fortress-like business franchise.  Such a franchise is usually the key to sustained high returns.

     The Fortune study I mentioned earlier supports our view.  Only 25 of the 1,000 companies met two tests of economic excellence - an average return on equity of over 20% in the ten years, 1977 through 1986, and no year worse than 15%.  These business superstars were also stock market superstars: During the decade, 24 of the 25 outperformed the S&P 500.    The Fortune champs may surprise you in two respects.  First, most use very little leverage compared to their interest-paying capacity.  Really good businesses usually don't need to borrow.  Second, except for one company that is "high-tech" and several others that manufacture ethical drugs, the companies are in businesses that, on balance, seem rather mundane.  Most sell non- sexy products or services in much the same manner as they did ten years ago (though in larger quantities now, or at higher prices, or both).  The record of these 25 companies confirms that making the most of an already strong business franchise, or concentrating on a single winning business theme, is what usually produces exceptional economics." - (1987 Berkshire Hathaway Letter)

Inspired by that excerpt, I decided to attempt a modern day re-creation of that same study, and compare results. I went page-by-page, through all 2649 companies that Value Line covers. I screened by hand for companies with: 1) a 10 year average ROE over 20%, AND 2) Zero years in the past deacde with a ROE below 15%.

Just 111 of the 2649 companies (or 4.19%) passed both of these two hurdles from 2003 to 2012.

Those 111 companies were:

***drumroll***

AAP, ABT, ACN, ADP, APH, ATK, AVP, AZN, BAX, BCR, BDX, BF.B, BLL, BTI, CAT, CEC, CHRW, CL, COH, COL, CPB, CPSI, CTSH, DCI, DD, DE, DLTR, DRI, DST, DVA, EAT, EL, EMR, ENR, EV, FAST, FDO, FDS, FII, FRX, GGG, GILD, GIS, GPS, GRMN, GSK, HD, HIBB, HRB, HSY, IBM, IFF, IGT, IMO, INFY, JCOM, JNJ, JW.A, K, KMB, KO, KR, LDR, LH, LXK, LLY, LMT, MAT, MCD, MDT, MHP, MIDD, MKC, MMM, MNST, MSFT, MTD, NKE, NUS, NVO, OMC, ORCL, PAYX, PEP, PETS, PII, POOL, PX, PZZA, QSII, ROL, ROST, SAP, SEIC, SHW, SLGN, STJ, SYK, SYY, TECH, TJX, TTC, TUP, UL, UNH, UPS, VAR, WAT, WDC, WMT, YUM

Quite a list we have here, eh? While there are some bad companies on this list, for sure, and many very good companies that did not make this list, overall this is a solid list IMO.

And here's the data to back it up:

How did these 111 companies do vs the S&P over the past decade?

With the exception of MO, and ABT, which I removed bc the historical share prices were hugely distorted by spin-offs, the other 109 companies had an average 10 year return, not including dividends, of 282.8% vs the S&P 500's 10 year return of 73.9%. These companies, as a group, more than TRIPLED the S&P 500.

84 of the 109 (77%) beat the S&P 500 over the 10 yr span, and 57 of the 109 (52.3%) at least DOUBLED the S&P over that time.

The median 10 year return among those 109 was 164.6%

Even you remove the outliers, the top 20%, and bottom 20%, the remaining middle 60% had an average return of 195.3%.

Now, i'm no expert, but when you consider those numbers vs 73.9% of the S&P 500...i'd say Mr. Buffett was onto something when he cited that Fortune article.

Two important caveats:

1) Ofcourse, you had no idea in 2003 which companies were going to perform so well. Therein lies the hard part. It would appear that IF you can construct a basket of companies that will be on this list in 2023, than you have a very high probability of crushing the market.

2) Remeber, valuation played zero role in this reserach. I'm sure many of these companies were expensive in 2003, and many cheap in 2003.  But, imagine the EPIC returns you could have gotten if you had this kind of foresight AND bought the fair-to-cheap priced companies. (I'm salivating at the mere thought.)

Hypothetical conclusion: If you are a skilled business analyst, and can reasonably predict which companies will still be consistently sporting extraordinarily high returns on equity, from now through 2023, you can very possibly double or triple the S&P 500 over the next decade.

If you can succeed in that difficult task, AND buy those companies when they are at fair-to-cheap prices...LOOK OUT...you may be about to compound wealth at a truly mind-boggling rate.

Thanks for reading, and please share your thoughts and comments!

-John

p.s. i'm sure there will be at least a mistake or two in this research, so let me know if spot any errors. Thanks!

20 Comments – Post Your Own

#1) On May 06, 2013 at 10:23 PM, JohnCLeven (81.45) wrote:

Greetings*

(I couldn't even get passed the first word without making a typo)

Report this comment
#2) On May 06, 2013 at 11:46 PM, Mega (99.96) wrote:

http://www.advisorperspectives.com/commentaries/knight_82112.php 

http://csinvesting.org/wp-content/uploads/2012/06/gmo_wp_-_2012_06_-_profits_for_the_long_run_-_affirming_quality.pdf 

Good post.

GMO and others have analyzed the persistance of ROE and made a convincing case for investing in higher (trailing) ROE companies.

Report this comment
#3) On May 07, 2013 at 11:40 AM, NewAlchemist (33.91) wrote:

Great blog post and a REC from me.

I agree with point #2.  Remeber, valuation played zero role in this reserach. I'm sure many of these companies were expensive in 2003, and many cheap in 2003.  But, imagine the EPIC returns you could have gotten if you had this kind of foresight AND bought the fair-to-cheap priced companies.

Look at the quality of the companies listed, THEY should be the basis for further due dilligence.  Now there is going to be some survior bias and some of these companies will NOT beat the market but on average you have a group of winners there.

What I also see is a lot of my favorite dividend growth investments!

Report this comment
#4) On May 07, 2013 at 11:47 AM, Mega (99.96) wrote:

From your list, I find CHRW, COH, CTSH, DE, INFY, VAR, WAT and WDC most interesting.

CH Robinson looks like a great Buffett style company. Even backing out one-time earnings, it's trading at it's lowest valuation ever.


Report this comment
#5) On May 07, 2013 at 12:53 PM, JohnCLeven (81.45) wrote:

Thanks for the feedback guys!

I'm currently interested by CHRW as well, also VAR, BCR, IBM, and JW.A,

Also, 4 of my 5 current real-life positions in my portfolio made this list:

1) COH (Most recent purchase, originally bought in about 8 months ago, and doubled down about 6 weeks ago I think, cost basis at $53), 2) MCD (bought in one big chunk at $83 a few months back), 3) AAP (bought in one chunk at $68 a few months back), 4) UPS (bought in one big chunk at $77 almost a year ago). My other position is BRK.B which I bought almost a year ago at $79.

Allocation is COH (24%), BRK.B (23%), MCD (21%), AAP (18%), and UPS (14.4%)

I have only been investing in real life for about 11 months. I've returned 18.7%, including dividends, since June 2012, so i'm off to an okay start.

Since i'm now primarily saving $ for school, my real-life investing has been temporarily paused. However, if we got a nice big correction, i'd probably buy some stocks anyway.

Report this comment
#6) On May 07, 2013 at 2:14 PM, NovaTodd (72.82) wrote:

You performed this screen manually? That's some serious sitzfleisch. I probably would have ended up spending more time trying to build a google spreadsheet to do the work for me. 

NVO frequently turns up on another screen I run for companies that consistently repurchase shares and increase their dividend year after year; I may have to take a closer look at that one.

If only there were an ETF that purchased nothing but these ROE superstars..

Report this comment
#7) On May 07, 2013 at 2:16 PM, EnigmaDude (95.78) wrote:

Very interesting indeed!  Nice post, and good work.  You have the makings of a very successful investor in your future!

Report this comment
#8) On May 07, 2013 at 3:02 PM, NewAlchemist (33.91) wrote:

You sound like you are young.  A lot of people would tell you to diversify and that you are carrying a lot of risk by only owning 5 holdings.  What happens if Buffett steps down or if the US economy slips back into recession, what happens to $300 handbag sales?  Would you sell at a loss, would it prevent you from going to school?  These are things you have to ask yourself.

Everybody starts out a stock picker, and then a 2008 comes along and you become more macro focused when everything gets flushed down the toliet together.

 

Report this comment
#9) On May 07, 2013 at 3:21 PM, JohnCLeven (81.45) wrote:

@NewAlchemist

Thanks for the comment.

I am fairly young.

However, I believe excessive diversification is madness, and would probably never own more than 10 companies.

If prices drop significantly, i'll almost certainly buy more, assuming the quality of the companies remain intact. The only reason that I would ever sell for a loss is if I was COMPLETELY incorrect in my original assessment of a business, and was convinced that said company would not grow earnings/cash flows in the future.

In fact, I would LOVE a big correction. I'd love to buy BF.B, NKE, or PM at a rock bottom valuation. 

Due to upcoming school expenses, I keep my portfolio very small in proportion to my cash hoard. (I keep $4 in cash for every $1 in investments) This prevents me from getting squeezed if the market crashes. My portfolio could go to $0 and I would still be able to complete my education.

I was not an investor in 2008, but I strongly believe that, no matter what happens, i'll always be a "bottom-up" investor in individual business. I don't really care for the macro stuff...and probably never will.

Report this comment
#10) On May 07, 2013 at 3:25 PM, JohnCLeven (81.45) wrote:

@Nova

The screen was manual bc finding free 10yr data on the internet is tricky, and I trust Value Line bc it has less errors, especially omissions, than most computer screens I typically use.

I did use a spread sheet, but I looked up the info in the issue, not online.

 

@Enigma

Thanks a lot for the kind words!

I hope you are correct in that assessment.

Report this comment
#11) On May 07, 2013 at 6:06 PM, CCharing (89.18) wrote:

chrw is cratering in AH, maybe check on the earning call and pick some up tomorrow if there's sufficient blood in the streets...

Report this comment
#12) On May 07, 2013 at 7:09 PM, Teacherman1 (57.22) wrote:

Good post John.

I may start a Teacherman3 CAPS page and pick the 109 companies to see how it does over time.

I am a little old to be thinking in terms of returns over decades, but it would be interesting to track.

Who knows, I might even buy some of them.:)

Good luck with you investing.

Report this comment
#13) On May 08, 2013 at 2:24 AM, valuemoney (99.99) wrote:

Glad to see you posted this! 

Report this comment
#14) On May 08, 2013 at 2:43 AM, valuemoneygreen (85.32) wrote:

O I was also going to say u should check out COL for your own caps page pick. Idk maybe you already have. Looks good for at least the next 5 years out. Airbus and Boeing should add nicely to the bottom line along with share repurchases even if defense gets cut a little. I would surely thing it would beat market returns over a 5 year time horizon.

Report this comment
#15) On May 08, 2013 at 7:04 AM, JohnCLeven (81.45) wrote:

@valuemoneygreen

Thanks for the tip! Always appreciated.

I am aware of COL's existence, however, I haven't really looked into them deeply bc of 59% of sales were to the government.

I will def take another look though. Companies w/ 30+% returns on total capital are ALWAYS worth another look lol.

With that said...you have 99 active picks between your two accts...why haven't you upthumbed COL?

Report this comment
#16) On May 08, 2013 at 11:17 AM, JohnCLeven (81.45) wrote:

CHRW down 7% today!

I wonder if MegaShort or Valuemoney will be buying/adding in real life today?

 

 

Report this comment
#17) On May 15, 2013 at 2:22 PM, hk2 (< 20) wrote:

The question for me is, of the companies in that had met the screening criteria 10 years ago, how have they done since then.

Report this comment
#18) On May 15, 2013 at 2:52 PM, Teacherman333 (40.43) wrote:

John

I have set up a CAPS page under Teacherman333 where I have posted your list, all 111.

I am putting a standardized pitch by each one, showing the latest ROE, PE, PB and Div (if any).

This is for future reference and to allow others who might want to, to have a place to make comments, add any favorite indicators that I may have left out, and to try and preserve your hard work and efforts when your blog gets pushed down into faded memory.

I hope my using your list is ok with you. I credit you for the list in the profile section.

I have made pitches on a couple of dozen so far, and will do the rest over time.

I am concentrating on those that have quarters ending in March, and will go back and pick up the rest later.

If you would rather I not use your list, just tell me and I will delete them, but I thought it might be a good source of ideas for others here in CAPS over time.

Again, thanks for the list and good luck in your investing.

hk2, it was over a ten year period, not ten years ago.

Report this comment
#19) On May 15, 2013 at 10:14 PM, JohnCLeven (81.45) wrote:

Wow, thanks Teacherman!

I'm so glad you found the list worthwhile. I'm humbled that you went to the trouble of making a new page. Please feel free to use whatever you want.

However, I have one suggestion to add...

...how about you put a check mark next to all those on the list, and at the end of every year, remove the check mark from those companies that fail to continue to meet the stanards of the screen (10 yr roe avg>20%, and no years below 15%)

It would be intersting, to me, to see which companies will still be on this list in 3, 5, or 10 years, and how they do comparably.

I'm hopefully gonna try to maintain this list like the guy who maintains the dividend achievers list, updating annually.

Thanks again.

Report this comment
#20) On May 20, 2013 at 4:27 PM, ikkyu2 (99.32) wrote:

I just wanted to say I have been pondering this blog post for the last couple weeks and intend to keep analyzing and thinking about it until it results in a couple additions to my portfolio.  Nothing really to add; there's a huge amount of insightful work here, elegantly explained, and it speaks for itself.

Report this comment

Featured Broker Partners


Advertisement