In their latest episode of the VALUE: After Hours Podcast, Taylor, Brewster, and Carlisle discuss How Relevant Is ROE? Here’s an excerpt from the episode:
Jake: Yeah. Well, it’ll be very interesting to see, one of the big differences in that analogy is the returns on equity of the businesses. Japanese businesses over that time period were very anemic when it came to returns on equity. The longer you hold, the more return on equity matters for your expected return. So, if you are trading more like a value guy on a shorter term, like, active turnover of a portfolio, ROEs don’t matter as much. But you’re playing a relative kind of cheapness spread. But if you’re longer-term holder, then ROEs start to matter. US businesses in the last 30 years have had phenomenal ROEs and especially relative to other time periods.
Actually, Buffett was talking about it in 1998, 1999 and saying they were shocked at how high ROEs were even then, and I think they’re climbed, I think they’re higher than they were back then. If that’s the case, well, one, it’s hard to imagine getting another bite of that Apple of the ROE Apple. We’ve seen taxes come down a bunch, we’ve seen intangibles and the growth rates of intangibles, I guess that could keep going for longer and that’s possible.
It’s hard to imagine taxes getting lower on businesses from here. I don’t know whether levers you have to pull more debt, the companies have levered up a fair amount already as it is. I don’t know how many more levers there are a pull in this equation to get higher ROEs from here. If anything, you have to fade that a little bit I think if history is any guide, but it will matter materially over the next 20 to 30 years what ROEs look like.
Tobias: Do you know what Japanese ROEs were like peak cycle?
Jake: In 1989? What were they like?
Tobias: Oh, yeah.
Jake: I don’t know what they were in the 80s. I have to imagine they were pretty high because there was– You are just like, everything’s working, every real estate thing you’re buying is going up and marking your mark to market your book. So, your book values are growing like crazy. I have to think they were looked good. That’d be my guess, although, I don’t know the answer to that.
Tobias: Because I thought the issue was always that all the cross shareholdings bit made it hard for anybody to take them over and to shake them up, but it also probably you’re holding stuff is not really economic yet. You’re probably overpaying for it and eventually that’s going to suppress ROEs.
Jake: Right. If there’s no cleansing bloodletting bankruptcy to really, actually transfer capital from the hands of those who made poor decisions to the hands who will make better decisions, then you end up with, I think, zombie companies and low ROEs.
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