Their Return on Equity is over 42%
I know, I wish we had held onto it longer, but it got too expensive for us
Anyway that’s ok, I’m sure our clients all hold Microsoft via their other Passive and Active funds and so we’re diversifying their exposure – no point in all their funds owning the same stuff
And remember that’s Microsoft’s ROE, not “my ROE”
What do you mean?
Well, let’s say you have an amazing business that you started with £100
And it now earns £42
Your ROE is 42%, right?
but I come along and say, “wow, that’s such an amazing business, I want to buy it from you”
and I’m so desperate for it, I pay you £1500 – 15x book value
Still the same business earning £42
except it cost me £1500 to get that £42 of earnings
So whereas your ROE was 42%
because I paid £1500 for those earnings, my ROE is only 2.8% (42/1500)
Ah but I’m not buying the whole of Microsoft
well, you’re buying a share of Microsoft so that means a share of their earnings and a share of their book value, right?
Yes, but it’s a tech company, book value doesn’t mean anything
Well, then why are you quoting ROE if the “E” doesn’t matter?
Yes, but what matters is, “that the earnings yield is higher than the 10-year bond yield”
And that means it’s good value
So earnings divided by the price you’re paying?
Rather useful way to work out “your ROE” don’t you think?
But back to the bond yield comparison,
Are you suggesting that because interest rates are negative in Europe, a 0% earnings yield is therefore attractive and so we can pay an infinite PE for any European company?
Of course, we all want to own the best quality companies, just as we want to own the best quality homes, drive the best quality cars and go on the best quality holidays
Because no one is debating whether or not Microsoft is a quality company, or whether a Knightsbridge apartment is a quality property, or whether Porsche is a quality car
The question is, whether buying any of these quality assets at ANY PRICE is a sound financial investment?
Because as the ROE example illustrates,
and it’s not their return that’s important,