As a retail investor/speculator I
really like to picture myself as a dairy farmer, and the companies I want to
invest in or have invested in as a dairy cow capable of producing milk to
nourish the life of the investor/farmer for an extra extended period. And this
dairy cow is kept in the custody of some bunch of guys called management whose
job is to take care of the cow on my behalf. And because I love numbers, and I know
this game is all about numbers, I like to break down the ability of the
custodians to make my dairy cow to produce milk well into the future into numbers
and the number that allows me to gauge the performance of the cow and
management is the return on equity numbers (ROE). Return on equity is a
measurement of management performance; it tells the number savvy investor how
well a company has used the capital from the shareholders to generate profit.
It goes
without saying that some managers and cows are natural born losers or mediocre,
it’s in their DNA, no matter how well management nurture and feeds their cow they
won’t produce a drop of milk, while some have a natural competitive advantage
which makes them born winners, with little oversight they are capable of
filling the silo with milk while some are in between, weather and environment
determines their performance, this ones can best be classified as moody dairy
cow. I don’t know of any dairy farmer who likes to keep a poorly producing cow
on is farm, so why should you keep a poorly performing company in your portfolio.
So as an investor that likes to
take advantage of the numbers, how do you identify and separate a born winner
from a moody and mediocre company. The answer is in the consistency of the
return on equity generated by each company over time or if you like, the
consistency and quality of milk produced by the dairy cow over time.
Take a look at the return on
equity of some NSE listed banks (dairy cow milk production in litre/yr)
Dairy cow
1
|
Dairy cow
2
|
Dairy cow
3
|
Dairy cow
4
|
Dairy cow
5
|
Dairy cow
6
|
|
2007
|
27.43
|
15.52
|
9.59
|
24.68
|
12.86
|
10.14
|
2008
|
15.64
|
13.75
|
12.03
|
10.42
|
10.11
|
12.63
|
2009
|
14.43
|
5.59
|
9.99
|
3.73
|
-4.43
|
9.78
|
2010
|
17.82
|
9.51
|
11.11
|
8.43
|
5.86
|
109.44
|
2011
|
22.46
|
11.10
|
8.12
|
5.23
|
-15.96
|
-113.81
|
2012
|
30.58
|
21.75
|
11.86
|
17.40
|
20.31
|
-394.32
|
2013
|
27.09
|
18.72
|
21.40
|
4.84
|
21.28
|
3.86
|
2014
|
26.24
|
18.00
|
28.66
|
15.84
|
12.19
|
5.42
|
2015
|
24.04
|
17.78
|
14.64
|
2.58
|
2.64
|
5.05
|
2016
|
26.20
|
18.40
|
20.26
|
6.81
|
1.54
|
5.84
|
AVERAGE
|
23.19
|
15.01
|
14.77
|
9.99
|
6.64
|
-34.60
|
A true investor the type that
likes to take advantage of the numbers will be highly interested in dairy cow
1, then dairy cow 2 and partially in dairy cow 3. Dairy cow 1return
consistently above 20% ROE year on year with an average of 23.19, which could
be indicative of a company that is benefiting or having a durable competitive
advantage (strong DNA), this is a born winner, while dairy cow 2 returns above
15% ROE consistently with an average of 15.01 % and it is closely followed by
dairy cow 3 with an average of 14.77%. Dairy cow 4 and 5 has an erratic ROE
which is all over the place with occasional high years with an average of 9.99%
and 6.64 respectively which is best classified as a moody dairy cow whose
performance is subject to weather and the environment. Dairy cow 6 is a born loser.
Dairy cow 6 is representative of a consistent poorly performing management (Defective
DNA). When taking advantage of the numbers through the use of ROE, it is better to
compare companies in the same industry or sector and to compare over long
period of time, least being five years (compare specie with specie). A company
that shows a consistently high ROE of over 15% on average for ten years has
long lasting durable competitive advantage in that industry that can enable it
to absorb and recover quickly from industry recession or an economic shock or
more like saying a dairy cow with a strong DNA capable of withstanding disease outbreak
(economic recession), drought (cheap finance), and poor diet (bad management).
The main gist about ROE
The cow must show a high and
preferably double digit ROE
The ROE must be consistent year
on year and not erratic
Lastly, don’t forget, this game
is all about the numbers
Note
Dairy cow 1=GT Bank, dairy cow 2=
zenith bank, dairy cow 5= Diamond bank, dairy cow 6= WEMA Bank
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