More Than You Know by Michael J Mauboussin

Author:Michael J Mauboussin [Mauboussin, Michael J]
Language: eng
Format: epub
ISBN: 9780231513470
Publisher: Columbia University Press
Published: 2010-07-02T04:00:00+00:00

In this piece I take a closer look at the latter two questions, drawing on empirical data from the technology and retail industries to bring the points to life.

Death, Taxes, and Reversion to the Mean

One microeconomic theory that is well documented empirically is the notion that a company’s return on investment reverts to the cost of capital over time.6 The theory, and intuition, is straightforward. Companies that generate high returns attract competition and capital, which drive returns toward opportunity-cost levels. Similarly, capital flees poor-return industries—through bankruptcy, disinvestment, or consolidation—lifting returns back to the cost of capital.

Exhibit 25.1 shows this process for a sample of over 450 technology companies from 1979 to 1996. (The analysis stops at 1996 to avoid issues related to the Internet bubble.)7 Credit Suisse ranked companies by quartiles based on their cash flow return on investment (CFROI), and followed the return patterns. Because CFROI is a real, after-tax measure, the time series is unaffected by the potentially distorting shifts in interest rates and inflation.

EXHIBIT 25.1 U.S. Technology CFROI Fade

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