Issue #8 - The right ROTC
By total capital, we are interested in how a company is financed.
In an analogical scenario, when one buys a property he/she usually put down a 10% deposit and get a home mortgage loan to pay the remaining 90% of the property selling price, say RM100,000. In this is scenario, he/she owns a 10% equity of property. The remaining 90% is a long term loan. The property is said to have financing structure of 10% equity and 90% long term debt. If the property is rented out for RM400 per month, the annual return of the property is RM4,800. Since the owner of the property put down a 10% deposit (RM10,000) initially, his return on equity (ROE) is 48%. ROE was discussed in previous issue. An ROE of 48% is very attractive not realizing that there is a 90% long term debt attached to the property. This may not be very attractive to investors as those who purchase the property will inherit the long term debt. Taking the debt into account, the same property give a 4.8% return on total capital. Now similar analysis applies in analyzing a company.
Total capital = Shareholder's Equity + Short Term Debt + Long Term Debt (+ Minority Interest)
ROTC = Net Earnings / Total Capital
Key points from "The New Buffettology" (Buffet & Clark, 2002):
1. Companines with a durable competitive advantage will consistently earn both a high rate of return on equity and a high rate of return on total capital.
2. Warren is looking for consistent return on total capital of 12% or better.
The keyword is consistent. Below are ROE & ROTC of SP Setia and IGB Corporation for passed 8 years:
From ROTC point of view, SP Setia does not look quite attractive after all. IGB does not look attractive at all with ROE and ROTC of less than 12%.
In an analogical scenario, when one buys a property he/she usually put down a 10% deposit and get a home mortgage loan to pay the remaining 90% of the property selling price, say RM100,000. In this is scenario, he/she owns a 10% equity of property. The remaining 90% is a long term loan. The property is said to have financing structure of 10% equity and 90% long term debt. If the property is rented out for RM400 per month, the annual return of the property is RM4,800. Since the owner of the property put down a 10% deposit (RM10,000) initially, his return on equity (ROE) is 48%. ROE was discussed in previous issue. An ROE of 48% is very attractive not realizing that there is a 90% long term debt attached to the property. This may not be very attractive to investors as those who purchase the property will inherit the long term debt. Taking the debt into account, the same property give a 4.8% return on total capital. Now similar analysis applies in analyzing a company.
Total capital = Shareholder's Equity + Short Term Debt + Long Term Debt (+ Minority Interest)
ROTC = Net Earnings / Total Capital
Key points from "The New Buffettology" (Buffet & Clark, 2002):
1. Companines with a durable competitive advantage will consistently earn both a high rate of return on equity and a high rate of return on total capital.
2. Warren is looking for consistent return on total capital of 12% or better.
The keyword is consistent. Below are ROE & ROTC of SP Setia and IGB Corporation for passed 8 years:
SP Setia
Years ROE(%) ROTC(%)
2005 12.92 9.48
2004 11.58 7.22
2003 9.94 6.11
2002 11.11 7.33
2001 12.24 9.42
2000 11.99 8.31
1999 19.71 13.87
1998 8.94 7.13
Ave 16.50 8.61
IGB Corporation
Years ROE(%) ROTC(%) NPM(%)
2005 4.43 3.22 17.02
2004 4.41 3.28 20.04
2003 7.03 5.27 27.72
2002 3.49 2.35 16.68
2001 3.88 1.55 24.74
2000 1.75 0.69 6.90
1999 2.12 0.82 19.78
1998 0.55 0.19 7.63
1997 9.24 N/A 18.67
1996 13.44 N/A 20.45
1995 10.56 N/A 16.20
Ave 5.53 2.17 17.80
From ROTC point of view, SP Setia does not look quite attractive after all. IGB does not look attractive at all with ROE and ROTC of less than 12%.
posted by yitping at 11:08 PM
1 Comments:
The keyword is consistent. Below are ROE & ROTC of Sunway City Bhd and IOI Property Bhd for passed 9 and 10 years respectively:
Sunway City Bhd:
Years ROE (%) ROCT (%)
2004 7.97% 6.74%
2003 3.34% 3.50%
2002 16.11% 17.96%
2001 1.04% 1.07%
2000 NIL NIL
1999 3.44% 3.09%
1998 NIL NIL
1997 NIL NIL
1996 13.34% 26.97%
IOI Property Bhd:
Years ROE (%) ROCT (%)
2005 13.54% 40.18%
2004 13.72% 33.65%
2003 11.59% 35.88%
2002 11.55% 30.94%
2001 10.04% 31.45%
2000 7.71% 17.18%
1999 15.78% 32.79%
1998 8.54% 20.55%
1997 11.28% 25.86%
1996 11.51% 27.69%
From ROTC point of view, IOI Property Bhd does look attractive after all than Sunway City Bhd, SP Setia and IGB. IOI Property has the average ROTC of 29.62% for the past 10 years.
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