Mauboussin On Economic Returns, Reversion to the Mean

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Credit Suisse Global Financial Strategies managing director and head Michael J. Mauboussin and Dan Callahan, CFA have a look on the economic returns, reversion to the mean, and total shareholder returns. Michael Mauboussin has authored books, Think Twice: Harnessing the Power of Counterintuition and More More Than You Know: Finding Financial Wisdom in Unconventional Places.

“. . . we draw two morals for our readers:

1. Obvious prospects for physical growth in a business do not translate into obvious profits for investors.

2. The experts do not have dependable ways of selecting and concentrating on the most promising companies in the most promising industries.”

Benjamin Graham The Intelligent Investor, 4th Edition

  • Simply buying the best or worst businesses does not guarantee excess shareholder returns.
  • The market rewards improvement and punishes decline in economic returns.
  • There’s no systematic way to correctly anticipate that a company will do better or worse than that implied by the price, but competitive strategy analysis is a good place to start when trying to anticipate revisions.
  • Corporations and investors should focus on returns on capital first and growth second. Earnings growth by itself tells us little about value creation.

Mauboussin : What Reversion Means for Stocks

Our recent report, “How to Model Reversion to the Mean: Determining How Fast, and to What Mean, Results Revert,”2 argued that investors should take reversion to the mean into account when modeling the key drivers of corporate performance. These key drivers include sales growth, operating profit margins, and cash flow return on investment (CFROI). However, the report did not consider the implications of the patterns of reversion to the mean for shareholder returns. This report addresses that gap. We look at how changes in CFROI correlate with total shareholder returns (TSR) for more than 1,000 companies. TSR is the annual shareholder gain including share price appreciation and dividends. Our goal is to understand the link between corporate performance and stock price in order to help investors anticipate future sources of excess returns.

Mauboussin: Follow the Leader or the Laggard?

Our analysis is based on a sample of 1,355 U.S. companies from the Credit Suisse HOLT database. The sample excludes financial companies, regulated utilities, and any company that lacked annual CFROI data for each year from 2002 to 2012. We sorted our sample into quintiles based on 2002 fiscal year CFROI, creating five portfolios with each stock receiving an equal weight. The first quintile is the 20 percent of the sample with the highest CFROIs in 2002, and the fifth quintile is the 20 percent with the lowest CFROIs. We held the portfolios constant through 2012 and tracked the TSR for each.

See full PDF here: Mauboussin On Economic Returns, Reversion to the Mean

Original link here.

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