MOI Global - Chris Bloomstran on His Philosophy, Annual Letters, and Berkshire
The discussion explores why returns on equity (ROE) have historically been higher than stock market returns. It highlights that while businesses should theoretically earn the ROE if owned long enough, investors often see lower returns due to accounting practices. A significant factor is the annual write-offs and write-downs of assets, which average 15% of earnings, reducing the effective ROE from 13% to about 11%. Additionally, the video discusses the impact of pension plan assumptions, where expected returns on plan assets have been historically overestimated. By adjusting these assumptions to a more realistic 4% return, the analysis shows a significant impact on financial statements. These adjustments, including write-offs and pension adjustments, account for a substantial charge per S&P 500 share, aligning adjusted ROE more closely with long-term stock market averages.
Key Points:
- ROE is typically higher than stock market returns due to accounting practices.
- Annual write-offs and write-downs average 15% of earnings, reducing effective ROE.
- Pension plan return assumptions are often overestimated, impacting financials.
- Adjustments for write-offs and pensions align ROE with long-term market averages.
- Valuations and economic cycles influence perceived returns and actual ROE.
Details:
1. 📈 Historical ROEs vs. Stock Market Returns
- Historical ROEs consistently outperform stock market returns, indicating a robust measure of business performance.
- For instance, if a company maintains an ROE of 15% over several years, while the market return is 10%, shareholders are effectively gaining more value from holding the stock long-term.
- Theoretical expectations suggest that owning a business over the long term should generate returns equivalent to the business's ROE, assuming the equity is retained and reinvested effectively.
- Investors should focus on companies with strong and consistent ROEs as a strategy to ensure returns that surpass typical market performance.
2. 🔍 Data Analysis and Findings on ROEs
2.1. Historical ROE Data Insights
2.2. Challenges in Data Collection
3. 📉 Accounting Practices Impact on Earnings
3.1. Impact of Accounting Practices on Earnings
3.2. Cyclical Nature and Historical Trends
4. 📊 Pension Plans and Accounting Adjustments
- Historically, the expected returns on plan assets have been overestimated, necessitating an adjustment to a 4% rate of return expectation to align with actual outcomes.
- 20 years ago, the average return assumption for defined benefit plans was 8.5%, which has been drastically adjusted to a more conservative 4% to reflect realistic financial conditions.
- The number of S&P 500 companies offering defined benefit plans has decreased from 350 to 325, indicating a shift in retirement planning strategies among large corporations.
- Adjustments involve processing a 5% return differential (between the initially assumed 9% and the revised 4%) through the P&L, impacting both pre-tax and after-tax earnings.
- For underfunded plans, there is an assumption they would reach full funding within a 5-year period, highlighting proactive financial management strategies.