Many investors believe Warren Buffett was focused primarily on return on equity. But Buffett often referred to return on tangible assets as his preferred indicator of business performance in his writings or even interviews.
When interviewed about Kraft Heinz's write downs in 2019, Buffett touted the company's return on tangible assets.
When interviewed about Kraft Heinz's write downs in 2019, Buffett touted the company's return on tangible assets.
Now the interesting thing about Kraft Heinz, is it's still a wonderful business in that it uses about $7 billion in tangible assets and earns $6 billion pre-tax on it.
Buffett: We "overpaid" in Kraft Heinz deal
In 2007, Buffett praised See's Candy for its high return on tangible assets. Here, he included receivables and inventories in his analysis.
Consequently, the company was earning 60% pre-tax on invested capital. Two factors helped to minimize the funds required for operations. First, the product was sold for cash, and that eliminated accounts receivable. Second, the production and distribution cycle was short, which minimized inventories.
Businesses – The Great, the Good and the Gruesome
In his 1983 discussion on goodwill accounting, Buffett expands the definition of tangible assets.
Throughout this discussion, accounts receivable will be classified as tangible assets, a definition proper for business analysis.
Goodwill and its Amortization: The Rules and The Realities
Buffett further expounds on tangible assets:
In 1972 (and now) relatively few businesses could be expected to consistently earn the 25% after tax on net tangible assets that was earned by See's. . . . It was not the fair market value of the inventories, receivables or fixed assets that produced the premium rates of return.
It seems that Buffett considered all these items—inventories, receivables, and fixed assets—to be tangible assets when analyzing a business.
Yefei Lu's analysis of Buffett's investment in the Dempster Hill Manufacturing Company helped me understand Buffett's expanded definition of tangible assets. Lu explains that Buffett's analysis of Dempster was focused on liquidation of the balance sheet, particularly receivables, inventories, and property, plant, and equipment (or fixed assets). Since these assets could be sold for cash, Buffett included these in his definition of tangible assets.
Now when I assess a company's performance, I look at return on tangible assets, that is, pre-tax earnings divided by the sum of capital invested in receivables, inventories, and fixed assets. And this seems like the right approach. After all, these items represent the assets the company has to invest in to generate its earnings.