Return On Assets Is The Hit By Pitch Of Investing

Despite all appearances to the contrary, this is a post about investing not baseball. So, to those of you who love reading about investing but hate reading about baseball: dont be deterred. Its worth reading all the way through.



Return on assets is the hit by pitch of investing. Common sense suggests it isnt a very important measure. Why would any investor care about return on assets when return on equity and return on capital tell you so much more?



You dont have to know a lot about baseball to know that the number of times a batter is hit by a pitch shouldnt tell you much about his value to the team. After all, getting hit by a pitch is a fairly rare occurrence. Even if some players are truly talented when it comes to getting plunked, they still wont get hit enough to make a huge difference, right?



Thats true. In and of itself, the act of getting hit by a pitch is not particularly productive. But (and heres where things get interesting), as a general rule, a simple screen for the batters who get hit most often will yield a list of good, underrated players.



Why? The most likely explanation is that a HBP screen returns a list of players who are similar in other, more important ways. Perhaps batters who get hit more often also tend to walk, double, homer, and fly out more often while grounding into double plays less often. Even a casual baseball fan might suspect this.



Since this blog is about investing rather than baseball, theres no reason for me to discuss whether such a correlation really does exist. Ill just provide a list of the top ten active leaders for HBP: Craig Biggio, Jason Kendall, Fernando Vina, Carlos Delgado, Larry Walker, Jeff Bagwell, Gary Sheffield, Damion Easley, Jason Giambi, and Jeff Kent.



After the top ten, the list is no less impressive. #11 15 are: Derek Jeter, Luis Gonzalez, Alex Rodriguez, Matt Lawton, and Barry Bonds. Since this list is based on career totals for active players, it's biased towards players who remain in the majors and who get a lot of plate appearances. That fact alone means the guys on this list are likely going to be above average players. However, even if you look at the single season HBP list, which includes a few young players (e.g., Jonny Gomes), the guys with high HBP totals still tend to be extraordinarily productive offensively.



Simply put, screening for HBP tends to return a much higher number of bargain batters than youd expect. One explanation for this is that the good things players with high HBP totals do tend to be less conspicuous than the good things other players tend to do.



Might there be a parallel in the world of investing? You bet. So, again I say -



Return on assets is the hit by pitch of investing.



Return on assets is a good screen for high quality, low profile businesses. A high return on equity does not go unnoticed for long. Sometimes, a high return on assets does. Jakks Pacific (JAKK) is one good example of a high ROA stock. Its returns have basically been what youd expect from a toy company. That may not sound like great news to owners of Jakks; but, it is.



Jakks sells at a price to earnings ratio of about 12 and a price to sales ratio of about 1. The company has grown quickly. Over the past five years, revenue has grown at an annual rate of about 25%. Shareholders havent enjoyed the full benefits of that growth, because of share dilution but, thats something best left to a longer discussion of Jakks. The point here is simple.



Jakks may not be anything special as a toy company, but it is a toy company. Jakks past return on assets proves that simply being a toy company is something special. Jakks "normal" ROA of around 5 12% may be nothing extraordinary in the toy business; but, it is far more than what most businesses earn. If there will be any future growth at Jakks, the current P/E of 12 will be shown to have been utterly ridiculous.



If you screen for high returns on equity, you might have missed Jakks. But, if you screen for high returns on assets, youd have caught this apparent bargain. By the way, I believe Joel Greenblatts magic formula would have lead you to Jakks as well.



Village Supermarket (VLGEA) is another stock that has often earned a good return on assets, but has failed to ever earn a high enough return on equity to get much attention. This business is not as cheap as it once was; but, it isnt exactly expensive at these prices either. For at least five years now, Village has looked quite clearly like it should be valued as a mediocre business. Thats saying something, because the market has continually valued VLGEA as a sub par business; which it isnt.



In 2000, you could have bought VLGEA at a 50% discount to book value. In 2001, the average buyer still obtained shares at a greater than 25% discount to book value. By then, anyone who had been monitoring Villages return on assets for the previous five years would have known the stock was cheap.



For the last ten years, Villages return on equity has been nothing more than average; however, the performance of the stock has been anything but average. An investor with one eye on Villages price to book ratio and the other eye on Villages return on assets would have enjoyed the decade long climb without breaking a sweat.



Another one of my favorite high ROA stocks is CEC Entertainment (CEC) better known as Chuck E. Cheese. Recently, the stock has earned a good return on equity. However, a simple screen based on ROE would have brought a lot of less than wonderful businesses to your attention along with Chuck E. Cheese.



Return on assets told a different story. Chuck E. Cheese has consistently earned an extraordinary return on assets for the last decade.



Now, its true that Chuck E. Cheese has earned a very nice return on equity as well. But, if you're an investor who knows what normal ROA numbers look like, one look at CEC's return on assets will blow you away.



Debt can play the role of the fairy godmother. So, an investor needs to look beyond the veil of current performance. Return on assets can often provide a glimpse of what the stroke of midnight will bring. ROA is just one piece of the puzzle. But, its an important piece nonetheless.



A high return on assets doesnt guarantee quality. However, Ive found that Mr. Market has usually offered many more small, growing companies with extraordinary returns on assets than he has offered small, growing companies with extraordinary returns on equity.



Therefore, just as a general manager might want to run a quick screen for a high HBP number, you may want to run a quick screen for a high ROA number. I know its not supposed to be the best indicator of a bargain. But, in my experience, it tends to turn up a lot of neat ideas.



Obviously, a high return on equity is important. Im not saying it isnt. Im just saying a high return on assets is more important than you think.






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