TIP526: Quality Investing: Lessons from Terry Smith
We Study Billionaires - The Investor’s Podcast Network
Importance of sustainable returns in value investing
Understanding the importance of sustainable returns for value creation in investing is crucial. Simply looking at a company's revenue and earnings growth can be misleading, as it's possible for a company to grow its earnings per share while actually destroying shareholder value. Value creation occurs when a company delivers returns above the cost of capital used to generate them. Companies that consistently make returns above their cost of capital become more valuable, while those that don't create value may actually decrease shareholder wealth. It's important for shareholders to prefer that companies retain part of their profits to reinvest at attractive rates of return, rather than distributing them as dividends or for share buybacks. However, accurately defining or computing the cost of capital can be challenging, which is why some investors solely focus on the growth in earnings per share over time.
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