Investing's Rosetta Stone

February 27, 2014

In 1797, Napoleon Bonaparte had just returned to Paris following a successful Italian campaign. Having kicked butt and taken names, Napoleon was an overnight celebrity. A conquering hero. A man of letters, wealth and distinction.
Immediately, he was commissioned to invade England. Napoleon, the master tactician, persuaded his bosses that an incursion against English assets in North Africa, specifically Malta and Egypt, would be more successful.
Financed by Swiss gold, young Bonaparte sent twenty one demi-brigades and 300 ships to war.
Having eluded the Royal Navy, the French overcame Malta and landed in Alexandria, Egypt, on a sultry July afternoon. It take them long to occupy the entire country. Napoleon entered Cairo three weeks later.
The French busied themselves establishing printing plants. Creating the Institute of Egypt, where they organized the country's scholars under the monikers of mathematics, physics, political economy, literature and arts. They built hospitals. Improved sanitary conditions and reduced epidemics. Citizens were disarmed. Streetlights installed. And, of course, taxes reinstated.
Among the many archaeological interests the French pursued, one in particular was key to unlocking the trove of Egyptian intellectual treasures.
The Rosetta Stone, named after the village in which it was found, measured roughly four feet by two-and-a-half feet, was eleven inches thick, and weighed nearly a ton.
The stone was covered in inscriptions for three languages. Greek. Egyptian. And Demotic, an ancient Egyptian text derived from Hieroglyphs and dating back to 643 B.C.
While the first two languages were easily deciphered, the Demotic was, well, Greek to them. Entirely untranslatable. And with so many of Egypt's ancient secrets ciphered in this ancient text, its translation was critical.
In 1822, 23 years after its discovery, a French scholar translated the stone's Hieroglyphic inscriptions and unlocked the secrets of Egypt. Science. Mathematics. Literature. And more. All begotten by the discovery and translation of the Rosetta Stone.
Of course, Napoleon had long ago returned to France. Lacking his talent for ass-kicking, leadership and municipal management, his predecessors had not exactly improved upon what he left. In fact, Egypt had been largely cut of from France by the English and Turks. Whom, working in concern, laid siege to Alexandria, expelled the French and claimed their booty. Another story, entirely.
The point? In discovering the Rosetta Stone, and unlocking its code, the French, English and Turks were able to reveal a trove of ancient logic, knowledge and truth.
Consider the failure of most investors to achieve anything resembling their goals. Investors, both individual and institutional, too often find themselves chasing a Holy Grail, as opposed to working out the codes of their individual financial autonomy. Assuming too much risk in pursuit of fleeting treasure. Vacating any real chance of achieving peace of mind.
While there are a myriad of heuristics used by successful investors, there is one secret that, if used systematically, can lead to consistent, market-beating returns.
That Rosetta Stone for investors? Capital efficient businesses.
Warren Buffett, one of the richest men in the world, earned his entire fortune by investing in capital efficient companies. Had you invested $10,000 with Buffett in 1956, and left it to his value-driven methodology through 2007, your $10,000 would have become $366 million.
Buffett's secret? Capital efficiency. Investing in companies possessing unusually high returns on net tangible assets (book value). Employing maximum capital efficiency, even in the face of well-financed competition. Forgoing large and reoccurring capital expenditures. Providing investors with sustainable, unusually high returns on assets, and returning excess capital to investors.
Galileo's epiphany began with an apple falling upon his head. So awakening him to the ideas already stirring his imagination.
Us? No such moment. Nor do we take credit for any original thinking on this topic. Many investors having employed this Rosetta Stone for years, having made a lot of money.
Still, I've one point to make.
In my decade-plus spent with Smith Barney (now Morgan Stanley), not to mention the aggregate years my colleagues spent with Merrill Lynch, UBS and Morgan Stanley, never did we hear the term "capital efficiency" employed within those brokerage offices. Not once.
The only sure-fire means of enabling one to glean market beating returns, practiced by some of history's most renown investment luminaries -- Warren Buffett, Benjamin Graham, Seth Klarman, Walter Schloss, Irving Kahn and Peter Lynch. And in our more than fifty aggregate years spent within the nation's largest brokerage firms, never was this Rosetta Stone even whispered.
No wonder we are in such dire retirement straights.
Were the brokerage firms' advisors-cum-salesmen to begin worrying about the tenets of fundamental analysis, like capital efficiency ratios, it would degrade from their attention to selling and gathering more assets. The primary concern of our publicly traded financial behemoths.
Recently, Morgan Stanley reported record quarterly profits (here). Largely on the back of its wealth management unit. When the world's largest wealth management business, working with Main Street's retirement capital, reports record profits and with plans to improve upon that next quarter, there is a fundamental problem. Not to mention a glaring conflict of interest.
Though the Rosetta Stone of investing is not part of their playbook. But it should be part of yours.
Find companies that possess outrageously high returns on net tangible assets. Whose management teams are committed to returning excess capital to shareholders. Do so consistently, for the long run, and you will always make money in stocks.

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