January 5, 2018

Friday’s action had the S&P 500 up another 0.7% and the Dow up 0.9%. The gains have continued to come fast and easy on Wall Street. Toronto, however, was down 0.4%.

Toll Brothers was up another 2.2% to $51.21. This company has worked out as a decent way to benefit from the recovery in the U.S. housing market.

TFI International was down 2.2% giving back some of the recent gains.

Yesterday I mentioned my new calculation that breaks out the contributors to the total equity value of a company. Most of the companies that we have on the list here have a history of making profits. Most of them have positive retained earnings even even after paying dividends and any stock buy backs. In addition because most of them earn double digit ROEs, in a world where a 10 year government bond yields just 2.1%, the market values them at some premium to book value. Many of the companies on our list have been prodigious creators of value over the years.

As an example, the equity market cap value Linamar Inc. can be broken out as 3% (remaining after any stock buy backs) original share owner investment, 58% retained earnings and the remaining 38% of the market cap represents the premium the market has found to be appropriate over and above the book value. Linamar is therefore valued at $100 for every $3 of original owner money that it took in and most of that value was generated by making and retaining profits.

Linamar pays only a modest dividend (recently only 6% of its trailing earnings). And I suspect it has bought back few if any of its own shares. The fact that its original share owner invested money is so much smaller than retained earnings reflects many years of retained earnings and also is due to the fact that Linamar seldom or never issues shares in acquisitions. It also apparently has not issued huge amounts of stock options. Only 38% of Linamar’s value represents a premium over and above book value which is relatively modest. If the market believed that Linamar could continue to earn its five year average ROE of 20% then the premium would logically be far higher. Basically, these figures indicate that Linamar has done what we would want any company to do: It took in investor money, and made profits and reinvested and compounded those profits at a high rate of return and has earned a market value that is at a premium to the invested/retained capital. Not every company can make either of those two claims. Usually, if past profits have represented an attractive ROE the market will award a premium to book value. Exceptions could occur when the future is seen to be bleak for some reason.


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