Warren Buffett's strategy, uses the combination of ROE and ROTC as a powerful filter to identify exceptional businesses.

The Right Rate of Return on Total Capital (ROTC)

https://myinvestingnotes.blogspot.com/2009/06/right-rate-of-return-on-total-capital.html

Warren Buffett looks for a consistent ROTC of 12% or better.

Problem with ROE

The problem with looking at high rates of return on shareholders' equity is that some businesses have purposely shrunk their equity base with large dividend payments or share repurchase programs. They do this because increasing the return on shareholders' equity makes the company's stock more enticing to investors. Thus, you will find companies in a price-competitive business, like General Motors, reporting high rates of return on shareholders' equity. To solve this problem, Warren Buffett looks at the return on total capital (ROTC) to help him screen out these types of companies.


ROTC

ROTC is defined as the net earnings of the business divided by the total capital in the business. (Total capital = Equity + Long-Term Debts + Short-Term Debts).

Warren Buffett is looking for a consistently high rate of ROTC, AND, a consistently high rate of ROE.

General Motors' return on equity for the 10-year period (1992 to 2001) was an average annual rate of 27.2%, which is very respectable but suspect because of the 0% return in 1992. Its total return on capital (ROTC) for the 10-year period shows a different story. Its 9.5% average is not enticing. Compare this to H&R Block, which logged in an average annual rate of ROE of 21.5% and an average annual total return on capital (ROTC) of 20.7%.

Take Home Message

• Companies with a durable competitive advantage will consistently earn both a high rate of ROE and a high rate of return on total capital (ROTC). Again, the key word is CONSISTENT.
• Companies in a price-competitive business, will typically earn a low rate of ROTC.
• Warren Buffett looks for a consistent ROTC of 12% or better.

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Here is a detailed expansion and discussion of the provided text, followed by a concise summary.

Expansion and Discussion

The core message is that while Return on Equity (ROE) is a popular metric for judging a company's profitability, it can be manipulated and is often insufficient on its own. The solution is to use it in conjunction with Return on Total Capital (ROTC), which provides a more holistic view of a company's true operational efficiency.

1. The Problem with ROE: A Flawed King

Return on Equity (ROE) measures how effectively a company generates profits from every unit of shareholders' equity. It's calculated as:

ROE = Net Income / Shareholders' Equity

The Problem: A high ROE can be a mirage. Companies can artificially inflate their ROE not by increasing earnings, but by reducing the denominator—Shareholders' Equity. This is done through two primary methods:

• Large Dividend Payments: This directly transfers equity from the company to shareholders.

• Share Buybacks: When a company repurchases its own shares, the money used is deducted from shareholders' equity, shrinking the equity base.

Why do they do this? A higher ROE makes the company appear more efficient and profitable to investors who rely on this single metric, potentially driving up the stock price. The example of General Motors is perfect. As a capital-intensive, price-competitive business in the auto industry, its underlying profits are not exceptionally high. By shrinking its equity base, it could report a seemingly "very respectable" average ROE of 27.2% over a decade, masking its true competitive weakness.

2. The Solution: ROTC - The True Measure of Efficiency

Return on Total Capital (ROTC) broadens the perspective by considering all the permanent capital used to run the business, not just equity. It is calculated as:

ROTC = Net Earnings / Total Capital
Where Total Capital = Shareholders' Equity + Long-Term Debt + Short-Term Debt

ROTC answers the question: "Regardless of how this business is financed (with equity or debt), how good is it at generating returns on the entire pool of capital employed?"

This metric is much harder to manipulate with financial engineering. A company cannot easily hide its need for debt and equity to fund its operations. When we apply ROTC to General Motors, the story changes dramatically. Its impressive 27.2% ROE collapses into a mediocre 9.5% ROTC. This reveals that GM is not a particularly efficient generator of profits relative to the massive amount of capital (factories, equipment, inventory) it requires to operate.

In contrast, H&R Block shows consistency. Its ROE (21.5%) and ROTC (20.7%) are both high and very close to each other. This indicates that the company is genuinely profitable from its operations and is not relying on debt or equity shrinkage to appear successful. This is a classic sign of a company with a durable competitive advantage (in H&R Block's case, a strong brand and a recurring, essential service).

3. The Take-Home Message: The Buffett Filter

Warren Buffett's strategy, as described, uses the combination of ROE and ROTC as a powerful filter to identify exceptional businesses.

• The Durable Competitive Advantage: Companies with a wide "economic moat" (a strong brand, pricing power, proprietary technology) can consistently earn high returns on both equity and total capital. They don't need to compete solely on price, which erodes margins. Their high ROTC proves their operational excellence, and their high ROE confirms that this excellence translates into strong returns for shareholders. Consistency is key—it shows the advantage is structural, not a one-time event.

• The Price-Competitive Business: Companies in industries like automotive, airlines, or commodity manufacturing typically earn a low ROTC. They are forced to compete on price, and the immense capital required for their operations (factories, fleets of planes) generates relatively low returns. Their profits are cyclical and thin.

• The Benchmark: Buffett looks for a consistent ROTC of 12% or better. This hurdle rate signifies a business that generates more than enough profit to cover its cost of capital and create genuine value for its owners over the long term.

Summary

In essence, the passage warns against relying solely on Return on Equity (ROE), as it can be artificially inflated by share buybacks or dividends, making a company look more efficient than it is. The solution is to also analyze Return on Total Capital (ROTC), which measures profitability against all capital invested (equity + debt), providing a clearer picture of true operational efficiency.

Key Conclusions:

1. A high ROE can be deceptive. Always check if it's driven by a shrinking equity base rather than growing earnings.

2. ROTC is the reality check. A genuinely great business will show both a high ROE and a high ROTC.

3. Consistency is the hallmark of quality. Companies with a durable competitive advantage, like H&R Block in the example, will post consistently high numbers for both metrics.

4. Use them together. By demanding both a consistently high ROE and a consistently high ROTC (Buffett's benchmark is 12%+), an investor can screen out financially engineered mirages and identify truly exceptional, profit-generating machines.

Kelington Group Berhad is a 38x multi-bagger since 2017. How to find a fast grower of Peter Lynch?

 A study of a fast growing stock.

The price of KGB was 14 sen per share in March 2010.  Today it is RM 5.31.   That is a 38x multi-bagger.   The price stayed below 15 sen until January 2017, when it started its steady rise to today.

What is the probability of this Anonymous poster holding onto this stock from 2010 to today?

KGB Financial Information

From 2010 to 2017, Market cap of KGB at 14 sen per share, its market cap was RM 108.7 m. 

(A small cap stock).

How to find a fast grower?

 "Peter Lynch Category." 

Lynch, in his classic book One Up On Wall Street, famously categorized stocks into various types. The "Fast Grower" (or Stalwart) is one of the most sought-after.

What is a "Fast Grower" (Lynch's Stalwart)?

A Fast Grower is a company that is growing earnings consistently at a rate of 20-25% per year. These are not small, speculative startups, but rather established companies that are executing their business model brilliantly and gaining market share. They are the "home run" stocks that can increase in value many times over.

Lynch's key insight is that you can find these companies in your everyday life, before Wall Street analysts catch on. This is the core of his "invest in what you know" philosophy.

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The Method: How to Find a Fast Grower

Here is a step-by-step method combining Lynch's principles with practical tools for today's investor.

Step 1: The "Invest in What You Know" Screen (The Qualitative Filter)

This is your initial, high-level idea generation. Don't start with a stock screener; start with your own observations.

• Look at Your Workplace: What companies are your suppliers or customers? Are they dominating their niche?

• Observe Your Life: What products and services are you and your friends enthusiastically buying? Is there a new restaurant chain everyone loves? A software product that makes your job easier? A clothing brand that's becoming ubiquitous?

• Identify "Boring" Companies with a Niche: Lynch loved companies with a dull name and an exciting business. A company that makes a specialized component for a growing industry can be a perfect fast grower.

Goal: Create a watchlist of companies that have a visible, tangible, and growing demand for their product or service.

Step 2: The Financial Screener (The Quantitative Filter)

Now, take your watchlist and apply hard numbers. You can use any financial website (like Yahoo Finance, Finviz, or Bloomberg) to screen for these criteria.

Key Financial Metrics to Screen For:

1. Consistent Earnings Growth: This is non-negotiable. Look for EPS (Earnings Per Share) growth of 20-25%+ per year for the last 3-5 years. Avoid companies with erratic earnings.

2. Reasonable P/E Ratio Relative to Growth (The PEG Ratio): This was one of Lynch's most important tools.

   • PEG = (P/E Ratio) / (Earnings Growth Rate)

   • Lynch's Rule: A stock is fairly valued if its PEG ratio is 1.0. A PEG below 1.0 is potentially undervalued (a great find), and a PEG significantly above 1.5 might be overpriced.

   • *Example: A stock with a P/E of 30 and earnings growth of 25% has a PEG of 30/25 = 1.2. This is acceptable. The same P/E of 30 with only 15% growth gives a PEG of 2.0, which is expensive.*

3. Strong and Improving Profit Margins: Look for high or, even better, expanding net profit margins. This shows the company has pricing power and is operating efficiently.

4. Low Debt: Lynch was wary of excessive debt. Look for a Debt-to-Equity (D/E) ratio below 80%, and preferably much lower. A strong balance sheet gives a company resilience during tough times.

Step 3: The Deeper Dive (The "Story" Check)

Once a company passes the screener, you need to understand its business intimately. Lynch called this "knowing the story."

Crucial Questions to Answer (Lynch's Teachings):

• What is the company's "story"? Can you explain its business and its potential for growth in one or two simple sentences?

• What is its sustainable competitive advantage (Moat)? Why can't a competitor easily replicate what it does? (e.g., a strong brand, patents, network effects, low-cost production).

• How does it reinvest its earnings? A great sign is when a company can fund its growth internally without taking on excessive debt.

• Is the stock institutionally "neglected"? Lynch loved finding great companies that had zero or very few Wall Street analysts covering them. This is harder today, but look for mid-cap companies that are under-the-radar.

• Is there a significant insider buying? If management is buying shares with their own money, it's a strong vote of confidence.

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Summary: The Lynchian Fast Grower Checklist

A prime Peter Lynch Fast Grower candidate will look like this:

Category	What to Look For
The "Story"	A simple, understandable business with a clear competitive advantage (a "moat"). You discovered it through everyday life.
Earnings Growth	Consistent annual EPS growth of 20-25%+. No surprises or dips.
Valuation (PEG)	A PEG ratio at or below 1.5, and ideally below 1.0.
Balance Sheet	Low debt (D/E ratio < 80%). The company can fund its own growth.
Profitability	Strong and expanding profit margins.
Insider Activity	Insiders are buying, not selling.

What Peter Lynch Teaches: The Core Philosophy

1. Everyone Can Beat the Pros: You have a powerful advantage in your own field and daily life. Use it.

2. Do Your Homework: Investing isn't gambling. It's about understanding a business better than anyone else.

3. Focus on the Earnings: In the long run, a stock's price follows the company's earnings. Find companies whose earnings are growing rapidly.

4. Favor "Boring" Companies: The flashy, high-concept stocks often disappoint. The boring company in a boring industry with a great growth story is often the winner.

5. Have Patience: A fast grower needs time to grow. Don't panic over short-term price fluctuations. Lynch famously said, "The key to making money in stocks is not to get scared out of them."

Final Warning from Lynch: All Fast Growers eventually slow down. The trick is to hold them while they are in their rapid growth phase and to be alert to signs of deceleration (e.g., inventory piling up, margins shrinking, growth rate falling below 15%). The goal is to sell before the story sours, not after.

Key Commentary on the Full Dataset:

1. Price and Valuation Re-rating: The share price has increased dramatically from RM 0.865 to RM 5.55. This has been accompanied by a massive valuation re-rating, with the P/E ratio expanding from around 16x to over 30x. This indicates the market has grown much more confident in KGB's future growth prospects and is willing to pay a higher premium for its earnings.

2. Profitability and Payout Evolution: The company has transitioned through distinct phases:

   • Early Phase (2015-2018): Characterized by lower but growing earnings (EPS), a volatile and generally low DPO, and a lower, more stable ROE (~15%).

   • High-Growth Phase (2019-2022): This period saw EPS surge. ROE peaked at an exceptional 30.42% in 2021, indicating superb capital efficiency. The DPO ratio also grew significantly as the company shared more of its booming profits with shareholders.

   • Mature/Value Phase (2023-2024): EPS growth has stabilized at a high level. The DPO ratio has jumped notably to over 65%, signaling a shift in strategy towards returning more cash to shareholders, a hallmark of a mature, highly profitable company. Despite the high payout, ROE remains excellent at ~24%.

3. Asset Value vs. Market Value: The P/NTA ratio has skyrocketed from around 2.5x to over 7x. This means the market now values the company at more than seven times its net asset base. This reflects strong investor belief in the value of the company's intangible assets, such as its business model, client relationships, and future earnings potential, which are not captured on the balance sheet.

Conclusion: The data paints a clear picture of KGB's journey from a modestly valued company to a highly valued, mature, and shareholder-friendly enterprise. The recent high dividend payout ratio, coupled with sustained high ROE and elevated valuation multiples, suggests the market views KGB as a high-quality stock that generates substantial cash and returns it to its owners.

Key Observations on CAGRs:

1. Explosive Profit Growth: The most striking finding is the exceptional growth in profitability. The CAGRs for PBT (~29.3%), PAT (~30.3%), and EPS (~30.3%) are approximately double the revenue growth rate (~15.5%). This indicates a dramatic and highly successful improvement in profit margins over the period, driven by operational efficiencies, economies of scale, or a shift to higher-margin services.

2. Strong Share Price Appreciation: The share price delivered an impressive ~22.9% CAGR, significantly outperforming the revenue growth. This shows that the market has rewarded the company's explosive profit growth.

3. Valuation Multiple Expansion: The share price CAGR (22.92%) is slightly lower than the EPS CAGR (30.27%). This implies that while the P/E ratio has expanded (as seen in previous analyses), the primary driver of the share price increase has been the phenomenal growth in underlying earnings per share. The price has risen because the company has become much more profitable.

Summary Commentary:

The data reveals a powerful transformation:

• Massive Margin Expansion: Both PBT and PAT margins have more than doubled over the decade, indicating a dramatic improvement in operational efficiency and cost control. The company now converts a much larger portion of each ringgit of revenue into profit.

• Exceptional Returns to Shareholders: The ROE has seen a remarkable ascent. After a period of stability around 15-16%, it exploded to a peak of over 30% in 2021. While it has moderated slightly since then, the current levels of ~24% are considered excellent and indicate that KGB is highly effective at generating returns from shareholder equity.

• The Inflection Point: The period from 2020 to 2022 was pivotal, where both profitability margins and ROE saw their most significant jumps, signaling the company's successful transition to a higher-performance business model. The recent years show a stabilization at these new, elevated levels of performance.

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Analyzing KGB against Peter Lynch's well-known investing framework reveals a compelling profile. Here is a categorisation of KGB based on Peter Lynch's criteria.

Peter Lynch's Six Company Categories

Based on the financial data and growth trajectory, KGB would be classified as a Fast Grower that is showing early signs of maturing into a Stalwart.

Primary Classification: Fast Grower
Evolving Into: Stalwart

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Justification for Categorization

Here's how KGB's performance aligns with Lynch's principles for these categories:

1. Key Traits of a "Fast Grower"

• Rapid Earnings Growth: This is the most defining characteristic. Lynch looks for companies growing earnings at a rate of 20-25% per year or more.

  • KGB Fit: Perfect Fit. KGB's Adjusted EPS grew at a CAGR of 30.27% over the last 9 years, far exceeding the threshold for a fast grower.

• Strong, Predictable Growth: The growth should be driven by the business's expansion, not just industry cycles.

  • KGB Fit: Strong Fit. The consistent, multi-year expansion in revenue, margins, and EPS suggests this is a company on a strong, structural growth path, not just a cyclical upturn.

2. Key Traits of a "Stalwart"

• Large, Established Company: Stalwarts are big, well-known companies that are leaders in their industry.

  • KGB Fit: Becoming Relevant. While likely not a giant multinational, its market capitalization (implied by a share price of RM 5.55 and ~735 million shares) places it as a significant player on Bursa Malaysia, likely a leader in its niche.

• Solid but Slower Growth: They grow earnings at a more modest, dependable rate of 10-15% per year.

  • KGB Fit: Evolving. The most recent years show EPS growth stabilizing after its explosive run, suggesting it is entering a phase of more mature, sustainable growth.

• Shareholder-Friendly (Dividends): Stalwarts are known for paying consistent and growing dividends.

  • KGB Fit: Excellent Fit. The dividend payout ratio (DPO) has surged to over 65% in 2024, and the DPS CAGR is a massive 42.81%. This is a classic sign of a company maturing and returning excess cash to shareholders, a key Stalwart behavior.

Lynch's Other Cardinal Rules Applied to KGB

1. The P/E Ratio: Lynch was wary of stocks whose P/E ratio was much higher than their growth rate. He favored stocks with a P/E ratio at or below the earnings growth rate (a PEG ratio close to or below 1).

   • KGB Analysis: This is a point of caution. With a P/E of ~30x and an EPS growth rate that has moderated from its peak, the PEG ratio is likely above 1. This suggests the stock is not cheap and the market has already priced in high expectations. Lynch might say it's "priced for perfection."

2. Favorable Financials:

   • Strong Balance Sheet: A low Debt-to-Equity ratio is preferred.

     • KGB Fit: While not explicitly provided, the steadily growing Net Worth (Equity) is a positive indicator of a healthy balance sheet.

   • High Profit Margins and ROE: Lynch loved companies with high and expanding margins.

     • KGB Fit: Excellent Fit. The expansion of PBT and PAT margins and the consistently high ROE (often above 20-25%) are exactly what Lynch looked for. It signals a "great business."

Final Categorization and Investment Perspective

KGB is a "Fast Grower" that is successfully transitioning into a "Stalwart."

• Its Past: It perfectly fits the "Fast Grower" mold with its explosive, multi-bagger earnings growth.

• Its Present & Future: It is now maturing, characterized by its high and rising dividend payout, stabilization of growth at a high level, and market leadership. This is the evolution Lynch described.

From a Peter Lynch perspective:
An investor would have made a fortune buying this stock a decade ago as a "Fast Grower." Today, it represents a high-quality, mature company that is likely to provide solid, dependable returns driven by both earnings and dividends. The main question for a new investor, following Lynch's principles, would be whether the current high P/E ratio is justified by its ability to sustain its high growth rate, or if it has become fully valued for its new phase as a Stalwart.

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Based on a systematic analysis using Warren Buffett's key investment criteria, KGB can be classified as a Good Business with exceptional qualities that, if sustained, could see it be regarded as Great.

It is far from Gruesome; it is a high-quality company. Here is a breakdown based on Buffett's principles:

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Buffett's Criteria Analysis of KGB

1. Does the business have a durable competitive advantage (a wide "moat")?

• Indicator: Consistently high and rising Return on Equity (ROE) without excessive leverage.

• KGB's Data: ROE has been spectacular, rising from ~15% to a peak of over 30% and settling at a very strong ~24%. This is a prime indicator of a moat. The company is generating exceptional returns on the capital shareholders have invested.

• Verdict: Strong evidence of a moat. The company has proven it can fend off competition and maintain superior profitability.

2. Consistently high profit margins?

• Indicator: Strong and expanding net profit margins.

• KGB's Data: Net Profit Margin (PAT Margin) has more than tripled from 3.86% (2015) to 11.59% (2024). This demonstrates pricing power, cost control, and operational excellence.

• Verdict: Excellent. This is a hallmark of a great business, not just a good one.

3. Strong and predictable earnings growth?

• Indicator: A long track record of growing earnings per share (EPS).

• KGB's Data: Adjusted EPS grew at a CAGR of 30.27% over 9 years. The growth has been explosive and consistent in its upward trajectory.

• Verdict: Exceptional. The earnings growth is both strong and highly predictable in its long-term trend.

4. Does it generate high returns on equity with little or no debt?

• Indicator: High ROE driven by profits, not debt.

• KGB's Data: The analysis shows a soaring ROE. While the exact debt level isn't provided, the fact that Net Worth (Equity) has grown consistently at a 25.07% CAGR suggests that retained earnings (profits) are the primary driver of growth, not heavy borrowing. The high profit margins also support this.

• Verdict: Likely Good to Great. The data strongly suggests the high ROE is profit-driven, which is what Buffett seeks.

5. Management's capital allocation skills (Retention of Earnings Test)

• Indicator: For every ringgit retained by the company, does it create at least one ringgit of market value?

• KGB's Data: This is a key test. Let's compare the increase in EPS to the increase in share price:

  • EPS Growth: 1.58 sen (2015) → 17.26 sen (2024). Increase of 15.68 sen.

  • Share Price Growth: RM 0.865 (2015) → RM 5.55 (2024). Increase of RM 4.685.

  • For every 1 sen of increased earnings, the market value of the company increased by ~RM 0.30 (4.685 / 15.68). This is a very strong result, indicating the market highly values the earnings growth management has delivered.

• Verdict: Excellent. Management has demonstrably created significant shareholder value through superb capital allocation.

6. Shareholder-friendly (Rationality)

• Indicator: A sensible dividend policy and clear reinvestment opportunities.

• KGB's Data: The dividend payout ratio has recently jumped to ~65%. This is a clear signal that the company is maturing and generating more cash than it needs for high-return reinvestment. Returning excess cash to shareholders is a rational, shareholder-friendly act.

• Verdict: Good. Management is acting rationally by not hoarding cash and sharing the wealth with owners.

Final Categorization: Good to Great Business

Conclusion:

KGB exhibits nearly all the financial characteristics of a Great Business: a powerful moat (high ROE), fantastic and expanding margins, explosive yet consistent earnings growth, and rational, value-creating management.

The reason it sits at the top end of "Good" and is knocking on the door of "Great" is the question of long-term durability and scale. Buffett wants to see this performance sustained over decades and through different economic cycles. KGB has a phenomenal 10-year track record. If it can maintain its high ROE and moat for another decade as a larger, more mature company, it would unequivocally be a Great Business.

For an investor today, based on this data, KGB is a High-Quality, Good Business with exceptional attributes. The only thing preventing a "Great" label outright is the test of time at its new, larger scale.