As from April 2013 my Journey in Investing is to create Retirement Income for Life till 85 years old in 2041 for two persons over market cycles of Bull and Bear.

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This blog is authored by an old multi-bagger blue chips stock picker uncle from HDB heartland!

"The market is not your mother. It consists of tough men and women who look for ways to take money away from you instead of pouring milk into your mouth." - Dr. Alexander Elder

"For the things we have to learn before we can do them, we learn by doing them." - Aristotle

It is here where I share with you how I did it! FREE Education in stock market wisdom.

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Sunday, 23 February 2020

The Power of Retained Earnings: Warren Buffet


The Power of Retained Earnings

In 1924, Edgar Lawrence Smith, an obscure economist and financial advisor, wrote Common Stocks as Long Term Investments, a slim book that changed the investment world. 

Indeed, writing the book changed Smith himself,
forcing him to reassess his own investment beliefs.

Going in, he planned to argue that stocks would perform better than bonds during inflationary periods and that bonds would deliver superior returns during deflationary times. That seemed sensible enough. But Smith was in for a shock.

His book began, therefore, with a confession: “These studies are the record of a failure – the failure of facts to sustain a preconceived theory.” Luckily for investors, that failure led Smith to think more deeply about how stocks should be evaluated.

For the crux of Smith’s insight, I will quote an early reviewer of his book, none other than John Maynard Keynes: “I have kept until last what is perhaps Mr. Smith’s most important, and is certainly his most novel, point.

Well-managed industrial companies do not, as a rule, distribute to the shareholders the whole of their earned profits.

In good years, if not in all years, they retain a part of their profits and put them back into the business. Thus there is an element of compound interest (Keynes’ italics) operating in favour of a sound industrial investment. Over a period of years, the real value of the property of a sound industrial is increasing at compound interest, quite apart from the dividends paid out to the shareholders.”

And with that sprinkling of holy water, Smith was no longer obscure.

It’s difficult to understand why retained earnings were unappreciated by investors before Smith’s book was published. After all, it was no secret that mind-boggling wealth had earlier been amassed by such titans as Carnegie, Rockefeller and Ford, all of whom had retained a huge portion of their business earnings to fund growth and produce ever-greater profits


Throughout America, also, there had long been small-time capitalists who became rich following the same playbook
.
Nevertheless, when business ownership was sliced into small pieces – “stocks” – buyers in the pre-Smith years usually thought of their shares as a short-term gamble on market movements. Even at their best, stocks were considered speculations. Gentlemen preferred bonds.

Though investors were slow to wise up, the math of retaining and reinvesting earnings is now well understood. Today, school children learn what Keynes termed “novel”: combining savings with compound interest works wonders.

************

At Berkshire, Charlie and I have long focused on using retained earnings advantageously. Sometimes this job has been easy – at other times, more than difficult, particularly when we began working with huge and ever growing sums of money.

In our deployment of the funds we retain, we first seek to invest in the many and diverse businesses we already own. During the past decade, Berkshire’s depreciation charges have aggregated $65 billion whereas the company’s internal investments in property, plant and equipment have totaled $121 billion. Reinvestment in
productive operational assets will forever remain our top priority.

In addition, we constantly seek to buy new businesses that meet three criteria. First, they must earn good returns on the net tangible capital required in their operation. Second, they must be run by able and honest managers.

Finally, they must be available at a sensible price. When we spot such businesses, our preference would be to buy 100% of them. But the opportunities to make major acquisitions possessing our required attributes are rare. Far more often, a fickle stock market serves up opportunities for us to buy large, but non-controlling, positions in publicly-traded companies that meet our standards.
Whichever way we go – controlled companies or only a major stake by way of the stock market – Berkshire’s financial results from the commitment will in large part be determined by the future earnings of the business we have purchased. Nonetheless, there is between the two investment approaches a hugely important accounting difference, essential for you to understand.In our controlled companies, (defined as those in which Berkshire owns more than 50% of the shares), the earnings of each business flow directly into the operating earnings that we report to you. What you see is what you get.

In the non-controlled companies, in which we own marketable stocks, only the dividends that Berkshire receives are recorded in the operating earnings we report. The retained earnings? They’re working hard and creating much added value, but not in a way that deposits those gains directly into Berkshire’s reported earnings.


Read? The letter - Berkshire Hathaway Inc.


Read more? Relating to posting on Retained Earning

Read? You Know Company's Balance Sheet In Its Simplest Form???

Why Uncle8888 is NOT a fan of S-REITs for this simple reason - retained earning!






16 comments:

  1. CW,

    Ah! My reasons for poking yield hogs ;)

    Now they coined old wine in new bottle names like perpetual yield hog contraptions or something...

    Snake oils don't selll you what you need; they sell you what you think you need ;)


    P.S. Think. If you are majority owner of a listed company, why on earth would you want to give out money to freeloaders? And if its like this, what's the purpose of you getting listed in the first place?


    ReplyDelete
    Replies
    1. The more dividends given to free loader(s?) the more hard cash pocketed by majority owner too.

      Retained Earnings of course it can be financially engineered.

      So after all being said, why IPOs still existed?

      To profit so called freeloaders?

      LOL!

      Delete
    2. Easier to sell investment courses based on money in your pocket. Who doesn't love yield?

      Delete
    3. IPO existed when owners think it is about time to let freeloaders share the risks and rewards of future growth or decay.

      My rich relative for many years keeping profits for themselves and only listed their two companies in SGX when they expanded their biz into HK and Malaysia. Share risks and rewards with freeloaders lor!

      Delete
    4. Ha! Ha!

      IRRC, SO that's why U don't IPO.

      Me i like but very 4Ks with IPO one.

      It means i rarely IPO even i like IPO.

      A paradox isn't it?

      Delete
  2. Retained earnings can be as slippery as an eel to me.

    Of course no retained earnings then no even a dead fish. Never mind about the eel then.

    LOL!

    ReplyDelete
  3. I take buying Reits as being a very,very small property owner.

    Buy the correct ones at reasonable prices, still a chance to have some capital gain.

    Had made some serious money from them when they 1st stated before they became so popular.

    LOL.

    ReplyDelete
  4. Sigh ... This is as desperate as Warren can get in defending his hoarding of USD130+B in warchest & in the process underperforming the S&P500 by the biggest margin in 10 years. (Ok ok the Kraft Heinz debacle also did not help)

    2019 performance:
    S&P500 -- 31.5% (with dividends)
    Berkshire -- 11% according to annual letter (actually from the charts is more like 12.2%)

    I agree wholeheartedly with Warren, Charlie, Smith & Keynes regarding retained earnings ... with a big caveat -- that the managers are smart and/or have integrity enough to make good use of the money. This is obviously not a problem with management like Warren & Charlie (and likely DBS's Piyush Gupta), but can be a big problem if mgmt is like many of the S-chips, or many of our former high-flying GLCs (many coincidentally starting with S in their names LOL!), or companies like that one starting with "H...." :P

    Warren has stated the obvious before -- that companies can only do 3 things (ethically) with their excess money: give dividends, do buybacks, or grow the business either organically or thru M&A.

    Last year, Warren did do 1 of the biggest buybacks in Berkshire history -- USD5B in Berkshire stock buybacks. That's about 18% of 2019's operating earnings + realised stock gains that were utilised. So Warren did "give back" some of his retained earnings to shareholders! :)

    Many of his biggest winners are companies with "addictive" businesses, strong brands & low capex requirements i.e. very high goodwill & strong moats. Companies like Amex, Coke & See's Candies. Coke & See's are basically businesses that can be run by "idiots" & don't need much re-investments or R&D.

    So if you don't want to put too much trust or faith in the ability or integrity of mgmt, then you'd prefer to get as much $$$ back as possible, in as short a time as possible. :P

    Of course this is also good for those who depend a lot on regular dividend cashflows (either psychologically or really need is another thing). As Warren himself said in this annual letter:

    "equities the much better long-term choice for the individual who does not use borrowed money and who can control his or her emotions. Others? Beware!" Emphasis on Others, lol!

    E.g. more great stock sale in the months ahead ... anyone ready & willing to buy??? :)

    ReplyDelete
    Replies
    1. Warren waited until sianz. Manage other people's money still need to answer to shareholders. We manage our own money, answer to ourselves. Can wait till cows come home! LOL!

      Delete
    2. LOL!

      At least he returned $$$$ via buybacks, which does not attract taxes. Warren lives his own life as well as run his company as low tax as possible (main reason why his official salary is still $100K for 30 years liao). ;)

      If give out dividends, foreign shareholders will kena withholding tax. While local resident shareholders will kena the amounts added to their annual income for income tax purpose.

      Delete
  5. Buy back and dividends are quite obvious sure bet.

    Not so sure about others - can be with good motives but nobody sure of the end result.

    I have Koh Brothers since IPO time.

    Not sure what they have been doing with earnings all these years.

    ReplyDelete
    Replies
    1. Unfortunately; you are not tracker of your investment; otherwise you have historical data points to show what is long or wrong term investing

      Delete
  6. Just for fun.

    But really have been waiting for fun to come for too long already.

    Today most SGX stocks's prices head South.

    i think tomorrow still heading South - even more.

    Remember i look at Stocks movements everyday - almost 365 days - but just look only almost all the time. To get the feel, U know.

    But really i am happy to missed buying to day by the difference of 1 cents.

    Tomorrow is another price, another "fun time".

    LOL!

    NB:
    Some stocks i lose money, some i make.

    If over-all make a little by little, that's a BIG O. K.liu.

    Shalom


    ReplyDelete
    Replies
    1. I based on my own simple TA to buy. When it hits. Buy lor. If wrong; just take Panadol.

      Delete
  7. No! No!

    Don't mistaken. No miscom. please.

    It is exactly we only buy base on our own reasons and judgement at that particular time or moment.

    i have bought SIA ENG, Sing Post And Star Hub so many weeks to months earlier.
    Of course now, losing money lah.

    Of course i think i will be able to sell higher later (hopefully).

    Meanwhile i have calculated i can take the panadols like U like to say, lol.

    Please don't mistaken no intention to mean anything for anybody but for myself.

    Only talking loud to myself at your blog.

    ReplyDelete

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