RORC provides a fast method of determining durable-competitive-advantage business

Return on Retained Capital, RORC is not perfect.

Be careful that the per share earnings figures you employ for this test are not aberrations, but rather are indicative of the company's earning power.

The advantage to this test is that it gives you, the investor, a fast method of determining

• whether it is a durable-competitive-advantage business that lets its management utilize retained earnings to increase shareholders' riches or
• whether it's a price-competitive business that is stuck allocating its retained earnings to maintain its current business.

Remember, this is just one of nine screens that you have at your disposal, so if you find yourself in a gray area, make certain to use the other screens to help you make a clear judgment.

Summary

Durable-competitive-advantage companies wield a one-two punch when it comes to allocating resources. They can better take advantage of retained earnings than price-competitive businesses, which over the long term will make their shareholders a lot richer than those who own stock in price-competitive businesses.

Price-competitive businesses are able to retain earnings, but because of the high costs of maintaining their businesses, they are unable to utilize them in a manner that will cause a significant increase in future earnings. This means that their stock prices end up doing little or nothing.


Also Read:
Return on Retained Capital
Return on Retained Capital Illustrated by Various Companies
Companies that can't profitably deploy retained earnings make lousy investments
RORC provides a fast method of determining durable-competitive-advantage business

Companies that can't profitably deploy retained earnings make lousy investments

By calculating the Return of Retained Capital RORC (click here: Return on Retained Capital Illustrated by Various Companies ), you can tell that H&R Block and Wrigley do an infinitely better job of allocating retained earnings than General Motors or Bethlehem Steel does.

• In fact, if you had invested $100,000 in General Motors stock in 1990 and sold it at its high in 2000, you would have had a net profit of $141,025, which equates to an annual compounding return of approximately 9.1%.
• If you had done the same with Bethlehem Steel, you would have had a loss of approximately $40,000.
• If you had invested $100,000 in Wrigley's in 1990 and sold out at its high in 2000, you would have had a net profit of $566,666, which equates to an annual compounding return of approximately 20%.
• With H&R Block you would have earned a net profit of $299,960, which equates to an annual compounding return of 14.8%.

So which stocks would you rather have owned from 1990 to 2000? The price-competitive businesses General Motors and Bethlehem Steel, or the durable-competitive-advantage businesses Wrigley's and H&R Block? It's not a tough choice.

Also Read:
Return on Retained Capital
Return on Retained Capital Illustrated by Various Companies
Companies that can't profitably deploy retained earnings make lousy investments
RORC provides a fast method of determining durable-competitive-advantage business

Resorts World Bhd

Business Summary

Resorts World Bhd engages in tourist resort business in Malaysia. It offers various leisure and hospitality services, which comprise gaming, hotel, entertainment, and amusement. The company's activities also include land and property development; time share ownership; renting of its apartment and part of its leasehold land; sale and letting of completed apartment units, and land and property; ownership and operation of aircrafts; the condotel, hotel, karaoke, leisure and entertainment, and show agent businesses; and golf resort and property development. In addition, it provides tours and travel related, training, property upkeep, cable car and electricity supply, offshore captive insurance, and water services. The company is based in Kuala Lumpur, Malaysia.

Fundamentals
* in millions
Company Basics
Exchange
Bursa Malaysia
Company Name
Resorts World Bhd
Stock Code
4715
Sectors
Consumer Discretionary
Paid Up Capital *
MYR 590.20
Par Value
- (as at 2008-12-31)
Market Cap *
MYR 16,643.50 (based on value of 2.8200 per share)

Performance (as at 2008-12-31) *

Total Assets:
MYR 9,422.90
Intangible Assets:
MYR 94.40
Revenue:
MYR 4,886.70
Earnings Before Interest and Taxes:
MYR 1,754.30
EPS (Basic) Inc. Extraordinary Items:
MYR 0.11
PE Inc. Extraordinary Items:
25.49
EPS (Basic) Exc. Extraordinary Items:
MYR 0.11
PE Exc. Extraordinary Items:
25.49
Net Income:
MYR 634.40 (2007: 1555m)
Dividends - Common/Ordinary:
MYR 299.45
Dividends - Total:
MYR 299.45
Goodwill:
-
Minority Interest:
MYR 7.30
Reserves:
-
Return On Assets:
6.73%
Return On Equity:
7.63% (2007: 18.97%)
Shareholder's Equity:
MYR 8,317.80

----

Historical 5 Yr PE 12.1 to 18.4 (EY 8.26% to 5.44%)
Historical 10 Yr PE 12.6 to 22.9 (EY 7.94% to 4.37%)
Present PE based on MR2.82 = 25.49
Earnings Yield = 3.92%
DY = 1.8% (MYR 299.45/MYR 16,643.50 )
ROTC = 634.40/( OE 8691.09 + LTL 90.56 + STL 0) = 7.22% (2007: 18.90%)

Between the end of 1998 and the end of 2007:

• total earnings were $1.177 a share,
• total dividends were $0.283 a share and
• retained earnings were $0.894 per share ($1.177 - $0.283) to add to its equity base.
• the company's per share earnings increased from 8.9c a share to 19.2c, the difference was 10.3c a share.
• return on retained capital/earnings RORC was 10.3/89.4 = 11.52%

Return on Retained Capital Illustrated by Various Companies

Company A:

In 1989, earned $1.16 per share.
Between the end of 1989 and the end of 1999:

• total earnings were $17.14 a share,
• total dividends were $9.34 a share and
• retained earnings were $7.80 per share ($17.14 - $9.34 = $7.80) to add to its equity base.
• company's per share earnings increased from $1.16 to $2.56.

Interpretations:

• We can attribute the 1989 earnings of $1.16 per share to all the capital invested and retained in the company up to the end of 1989.
• We can also argue that the increase in earnings from $1.16 a share in 1989 to $2.56 a share in 2000 was due to the company's durable competitive advantage and management's doing an excellent job of investing the $7.80 a share in earnings that the company retained between 1989 and 1999.
• If we subtract the 1989 per share earnings of $1.16 from the 1999 per share earnings of $2.56, the difference is $1.40 a share.
• Thus, we can argue that the $7.80 a share retained between 1989 and 1999 produced $1.40 a share in additional income from 1999, for a total return of retained capital of 17.9% ($1.40 / $7.80 = 17.9%).

Company B

In 1990, earned $1 per share.

Between the end of 1990 and the end of 2000:

• total earnings were $20.12 a share,
• total dividends were $10.57 a share and
• retained earnings were $9.55 per share ($20.12 - $10.57 = $9.55) to add to its equity base.
• the company's per share earnings increased from $1 a share to $2.90.

Interpretations:

• We can attribute the 1990 earnings of $1 per share to all the capital invested and retained in the company up to the end of 1990.
• We can also argue that the increase in earnings from $1 a share in 1990 to $2.90 a share in 2000 was due to the company's durable competitive advantage and management's doing an excellent job of investing the $9.55 a share in earnings that the company retained between 1990 and 2000.
• If we subtract the 1990 per share earnings of $1 from the 2000 per share earnings of $2.90, the difference is $1.90 a share.
• Thus, we can argue that the $9.55 a share retained between 1990 and 2000 produced $1.90 a share in additional income from 1990, for a total return on retained capital of 19.9% ($1.90 / $9.55 = 19.9%).

Company C

In 1990, earned $42.96 per share.

Between the end of 1990 and the end of 2000:

• total earnings were $42.96 a share,
• total dividends were $10.30 a share and
• retained earnings were $32.66 per share ($42.96 - $10.30 = $32.66) to add to its equity base.
• the company's per share earnings increased from $6.33 a share to $8.50.

Interpretations:

• This company kept $32.66 per shae of shareholders' earnings and allocated it so that per share earnings increased by $2.17.
• This equates to a return on retained capital of 6.6% ($2.17 / $32.66 = 6.6%).
• This is about what you would have earned had you left it in the bank.

Company D

In 1990, earned $0.82 per share.

Between the end of 1990 and the end of 2000:

• total earnings were $4.93 a share,
• total dividends were $0.80 a share and
• retained earnings were $4.13 per share ($4.93 - $0.80 = $4.13) to add to its equity base.
• the company's per share earnings had total losses of $7.48 a share.

Interpretations:

• This means that management had to spend $7.48 a share in additional sums that they either borrowed or took from earnings retained during prior years.
• Since this $7.48 in shareholder capital was depleted, rather than paid out as a dividend, this is added to the $4.13 in retained earnings, giving a total of $11.61 a share that was kept from shareholders.
• Between 1990 and 2000, the company's per share earnings decreased from $0.82 a share to $0.25 a share. We can argue that the decrease in earnings was caused by the company being a price-competitive business that sucks up capital but does nothing to increase shareholders' wealth.
• If we subtract the 1990 per share earnings of $0.82 from the 2000 per share earnings of $0.25 , the difference is a negative $0.57 a share.
• Thus we can argue that the $4.13 a share retained between 1990 and 2000 and the $7.48 depleted during this period produced zero additional income.
• The company is in a tough business (steel) in which to develop a competitive advantage.

Company A: H&R BLOCK

Company B: WM. WRIGLEY JR. COMPANY

Company C: GENERAL MOTORS

Company D: BETHLEHEM STEEL

Also Read:

Return on Retained Capital

Return on Retained Capital Illustrated by Various Companies

Companies that can't profitably deploy retained earnings make lousy investments

RORC provides a fast method of determining durable-competitive-advantage business

Return on Retained Capital

A simple mathematical formula measures the capital requirements of maintaining a company's competitive advantage and management's ability to utilize retained earnings to improve shareholders' wealth. In essense this calculation takes the amount of earnings retained by a business for a certain period and measures its effect on the earning capacity of the company.

With a durable competitive advantage the company will be able to use its retained earnings either to:

• expand its operations,
• invest in new businesses,
• and/or repurchase its shares.

All three should have a positive effect on per share earnings.

On the other hand, a price-competitive business would need to spend its retained earnings to maintain its business to the face of fierce competition from other companies in the same line of business, leaving little or nothing to invest in new operations and/or buying back its shares.

Companies that have a durable competitive advantage usually don't have to spend a high percentage of their retained earnings to maintain their operations. The key word here is maintain. In theory, the more durable a competitive advantage, the less a business has to spend to maintain it. Warren Buffett's perfect business would be one that spends zero on maintaining its competitive advantage. That would free every dollar it earns to be paid out as a dividend or reinvested in the business, which should, in theory, make its shareholders even wealthier.


Also Read:
Return on Retained Capital
Return on Retained Capital Illustrated by Various Companies
Companies that can't profitably deploy retained earnings make lousy investments
RORC provides a fast method of determining durable-competitive-advantage business

ROTC, ROA, ROE and Buffett's Durable Competitive Advantage

1. Warren Buffett has learned that a consistently high return on total capital is indicative of a durable competitive advantage. He is looking for a consistent ROTC of 12% or better.

2. With banks and finance companies he looks at the return of total assets ROA to determine if the company is benefitting from some kind of durable competitive advantage. Warren Buffett looks for a consistent return on assets ROA in excess of 1% (anything over 1% is good, anything over 1.5% is fantastic) and a consistent ROE in excess of 12%.

3. In situations where the entire net worth of the company is paid out, creating a negative net worth, Warren Buffett has only made investments in those companies that show a consistent ROTC of 20% or more. The high ROTC is indicative of a durable competitive advantage.

Also Read:

1. Return on Total Capital (ROTC)
2. The Right Rate of Return on Total Capital (ROTC)
3. ROA of Banks, Investment Banks and Financial Companies
4. Using ROTC Where the Entire Net Worth of the Company has been taken out
5. ROTC, ROA, ROE and Buffett's Durable Competitive Advantage
   

Using ROTC Where the Entire Net Worth of the Company has been taken out

This is rare and can only happen if the earning power of the company is exceptionally strong. On occasion, a company has such a strong durable competitive advantage that its earning power allows it to pay out a portion or all of its entire net worth to shareholders.

• In this situation shareholders' equity decreases, which in turn causes the ROE to increase dramatically - often to 50% or better.
• When the entire net worth is paid out, it creates a negative net worth, which means that the company will not report a return on shareholders' equity even if it is earning a fortune.

Advo is the nation's largest direct-mail marketing company. Think of it as an advertising company. Its competitive advantage is that it is the biggest, the best, and the most cost effective at the direct-mail game. Advo was originally founded in 1929. Talk about durable! Until 1996 it had seen a long and steady growth of its per share earnings and had produced consistent returns on shareholders' equity in the 18% to 20% range. From 1986 to 1996 it carried zero long-term debt. That's right, zero debt. Then in 1996 it added $161 million in debt and paid it out to sharehodlers via a $10-per-share dividend. This effectively wiped out the $130 million in shareholders' equity that it carried on its books and replaced it with debt. Advo can do this because the earning power of the business is so strong and consistent. Few companies can do this, and those than can, almost without exception, benefit from some kind of durable competitive advantage.

In situations like this in which there is no net worth, you need to look at the return on total capital (ROTC). In 2000, Advo posted a 35% ROTC.

Historically, in these situations, Warren has only made investments in companies that show a CONSISTENT ROTC of 20% or better.

Also Read:

Return on Total Capital (ROTC)
The Right Rate of Return on Total Capital (ROTC)
ROA of Banks, Investment Banks and Financial Companies
Using ROTC Where the Entire Net Worth of the Company has been taken out
ROTC, ROA, ROE and Buffett's Durable Competitive Advantage

ROA of Banks, Investment Banks and Financial Companies

Banks, investment banks and financial companies rely on borrowing large amounts of money that they hope to loan out at higher interest rates to businesses and consumers.

A company like Freddie Mac, which deals in residential mortgages, carries $175 billion in short-term debt and $185 billion in long-term debt. If your business is borrowing money at 6% and loaning it out at 7%, there is no way your return on total capital ROTC is going to even approach 12%.

In these instances, Warren Buffett likes to look at what the bank or finance company earned in relation to the total assets under its control. The rule here is, the higher the better. Anything over 1% is good and anything over 1.5% is fantastic.

Learning Point

With banks, investment banks, and financial companies, look for a consistent return on assets ROA in excess of 1% and a consistent return on shareholders' equity ROE in excess of 12%.


Also Read:
Return on Total Capital (ROTC)
The Right Rate of Return on Total Capital (ROTC)
ROA of Banks, Investment Banks and Financial Companies
Using ROTC Where the Entire Net Worth of the Company has been taken out
ROTC, ROA, ROE and Buffett's Durable Competitive Advantage

The Right Rate of Return on Total Capital (ROTC)

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 toal 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.

Also Read:
Return on Total Capital (ROTC)
The Right Rate of Return on Total Capital (ROTC)
ROA of Banks, Investment Banks and Financial Companies
Using ROTC Where the Entire Net Worth of the Company has been taken out
ROTC, ROA, ROE and Buffett's Durable Competitive Advantage

Return on Total Capital (ROTC)

Return on Total Capital (ROTC)

Total Capital = Long-Term Debt + Short-Term Debt + Equity

Return on Total Capital = Net Earnings / Total Capital

The calculation of ROTC is illustrated here: http://files.shareholder.com/downloads/SYY/654431717x0x226567/EC4E58FF-E488-4CBB-A19B-570745E81387/Non-GAAP%20ROTC%20calculation.pdf


It is important to note the numerator and the denominator used in calculating ROTC by various other groups.

• Value Line defines the return on total capital as "annual net profit plus 1/2 of annual long-term interest divided by the total of shareholders’s equity and long term debt." Shareholders’s equity is the net worth of the company.
• Some defines total capital as equity plus long-term debt.

Also Read:
Return on Total Capital (ROTC)
The Right Rate of Return on Total Capital (ROTC)
ROA of Banks, Investment Banks and Financial Companies
Using ROTC Where the Entire Net Worth of the Company has been taken out
ROTC, ROA, ROE and Buffett's Durable Competitive Advantage

Return of capital

Return of capital

A distribution of cash resulting from depreciation tax savings, the sale of a capital asset or securities, or any other transaction unrelated to retained earnings.

Return on Total Assets

Return on Total Assets

Abbreviated as ROTA, refers to a measure of how effectively a firm uses its assets.

Calculated by (income before interest and tax) / (fixed assets + current assets).

Return on Assets

Return on Assets

Abbreviated as ROA, refers to a measure of a firm's profitability, equal to a fiscal year's earnings divided by its total assets, expressed as a percentage.

Return on Investment

Return on Investment

Abbreviated as ROI, refers to a measure of a corporation's profitability, equal to a fiscal year's income divided by common stock and preferred stock equity plus long-term debt.

ROI measures how effectively the firm uses its capital to generate profit; the higher the ROI, the better.

Return on Equity

Return on Equity

Abbreviated as ROE, refers to a measure of how well a firm used reinvested earnings to generate additional earnings, equal to a fiscal year's after-tax income (after preferred stock dividends but before common stock dividends) divided by book value, expressed as a percentage.

It is used as a general indication of the firm's efficiency; in other words, how much profit it is able to generate given the resources provided by its stockholders. investors generally look for firms with returns on equity that are high and growing.

Return on Invested Capital

Return on Invested Capital

ROIC is a calculation used to assess the profitability of a firm by determining how well capital is being allocated into its operations.

By comparing a firm's Return on Investment Capital with its Cost on Capital (WACC), it can be deduced whether or not capital is being used effectively.

The calculation for ROIC is as follows:
Return On Investment Capital - ROIC = (Net Income - Dividends) /(Total Invested Capital)
(typically expressed as a percentage)

A downside of the ROIC calculation is that it does not explain where returns from capital are generated from (i.e. whether they came from one source or from continuing operations). This can lead to misguiding figures that do not accurately explain the overall profitability of a firm.

Return on Capital Employed

Return on Capital Employed

Abbreviated as ROCE. A measure of the returns that a firm is realizing from its capital.

Calculated as profit before interest and tax divided by the difference between total assets and current liabilities.

The resulting ratio represents the efficiency with which capital is being utilized to generate revenue.

Return on Capital

Return on Capital

Abbreviated as ROC, refers to a measure of how effectively a firm uses the money (borrowed or owned) invested in its operations.

Return on Invested Capital is equal to the following:
= net operating income after taxes / [total assets minus cash and investments (except in strategic alliances) minus non-interest-bearing liabilities].

• If the Return on Invested Capital of a firm exceeds its WACC, then the firm created value.
• If the Return on Invested Capital is less than the WACC, then the firm destroyed value.

Where Warren Buffett Discovers Companies with Hidden Wealth

Warren Buffett has discovered 4 basic types of businesses with durable competitive advantages:

1. Businesses that fulfill a repetitive consumer need with products that wear out fast or are used up quickly, that have brand-name appeal, and that merchants have to carry or use to stay in business. This is a huge world that includes every thing from cookies to panty hose.

2. Advertising businesses, which provide a service that manufacturers must continuously use to persuade the public to buy their products. This is a necessary and profitable segment of the business world. Whether you are selling brand-name products or basic services, you need to advertise. It's a fact of life.

3. Businesses that provide repetitive consumer services that people and businesses are consistently in need of. this is the world of tax preparers, cleaning services, security services, and pest control.

4. Low-cost producers and sellers of common products that most people have to buy at some time in their life. This encompasses many different kinds of businesses from jewelry to furniture to carpets to insurance.

PETRONAS Dagangan Berhad

Business Summary

PETRONAS Dagangan Berhad engages in the marketing of petroleum products and operation of service stations. The company markets a range of petroleum products, including motor gasoline, aviation fuel, kerosene, diesel, fuel oil, bunker fuel, lubricants, liquefied petroleum gas (LPG), and asphalt to motorists, households, airlines, shipping lines, transporters, plantations, processing and manufacturing plants, power stations, and commercial enterprises in Malaysia. It markets its products directly to customers, as well as through its network of service stations, LPG dealers, and industrial dealers. The company was incorporated in 1982 and is based in Kuala Lumpur, Malaysia. PETRONAS Dagangan Berhad is a subsidiary of Petroliam Nasional Berhad.

Exchange
Bursa Malaysia
Company Name
Petronas Dagangan
Stock Code
5681
Sectors
Paid Up Capital *
MYR 993.45
Par Value
- (as at 2008-03-31)
Market Cap *
MYR 7,848.29 (based on value of 7.9000 per share)

Performance (as at 2008-03-31) *
Total Assets:
MYR 8,609.61
Intangible Assets:
MYR 23.40
Revenue:
MYR 22,301.58
Earnings Before Interest and Taxes:
MYR 908.16
EPS (Basic) Inc. Extraordinary Items:
MYR 0.67
PE Inc. Extraordinary Items:
11.86
EPS (Basic) Exc. Extraordinary Items:
MYR 0.67
PE Exc. Extraordinary Items:
11.86
Net Income:
MYR 661.67
Dividends - Common/Ordinary:
MYR 332.91
Dividends - Total:
MYR 332.91
Goodwill:
MYR 23.40
Minority Interest:
MYR 46.73
Reserves:
-
Return On Assets:
7.69%
Return On Equity:
16.89%
Shareholder's Equity:
MYR 3,917.42

---

Historical 5 Yr PE 11.3 to 15.8

Historical 10 Yr PE 9.8 to 14.0

Present PE based on 7.90 = 11.9

Earnings Yield = 8.4%

DY = 4.24% (MYR 332.91/MYR 7,848.29 )

ROTC = 16.89%

Between the end of 1998 and the end of 2007:

• total earnings were $3.129 a share,
• total dividends were $1.09 a share and
• retained earnings were $2.039 per share ($3.129 - $1.09 = $2.039) to add to its equity base.
• the company's per share earnings increased from $0.216 a share to $0.645, the difference was $0.426 a share.
• return on retained capital/earnings RORC was 0.426/203.9 = 21%

---

I like this company. It is a company that I can relate to. Petronas service stations are sprouting all over the place. It has a virtual monopoly supplying energy to certain niche sectors. Its revenue has been good and profitable. It generates a lot of free cash flow. It has been reinvesting into its business regularly, and the return on the equity is a 16.89% which is one of the my investing criteria. Its ROTC is 16.89%, as this company has no borrowings. Its earnings yield is at least 2x that of the risk free FD interest rate. Its dividend has been increasing over the years and I do not anticipate any decrease in future dividend despite the poor economic environment. In fact, it is predicted that the future earnings should continue to show an uptrend, and growth is encouraging with new Petronas stations opening up in new locations funded by self generated profit. The company is debt free.

At 7.90, its PE of 11.86 is at the lower end of its historical 5 year and 10 year PEs. There is safety of capital with a reasonable potential for moderate return (low risk with moderate return) for those with a longer term investing horizon. Just loudly sharing my view, you will need to make your own investing decision based on your personal assessment.