The Power of Retained Earnings

I have been working on a new spreadsheet template that estimates management’s ability to allocate capital over the long-term. Here is a screenshot example using one of my favorite companies: AutoZone (AZO). I want to highlight one calculation, and then I’ll provide background and context on why this matters to investors. In the cell “S11″ (row 11, column S”), it shows that AutoZone has a Return on Retained Earnings of 14.25% between August 2005 to August 2019. That is a very good performance.

Figure 1: Return on Retained Earnings for AutoZone (AZO), Aug05-Aug19
Financial Data from GuruFocus (

But before we get into the details of this spreadsheet, let’s provide some context.

Every year Warren Buffett writes a letter to the shareholders of Berkshire Hathaway. The company website has letters going back to 1977. Whereas most public company CEOs write a 1-page letter or 2-page letter, Buffett writes much longer detailed letters; last year in 2019, the shareholder letter was 19 pages long. For the first time in many years, he writes on the topic of retained earnings. The section titled “The Power of Retained Earnings” starts from the bottom of page 2 and runs through the end of page 5, comprising 1,156 words to thoroughly and patiently explain the power of retained earnings.

Buffett’s message is that many investors underappreciated the power of retained earnings prior to the publication of an obscure book in 1924 called Common Stocks as Long Term Investments by Edgar Lawrence Smith. But I wonder if even present-day investors underappreciate the power of retained earnings, despite the publication of Mr. Smith’s book and also Mr. Buffett’s letters to shareholders. Prior to the 2019 letter, Buffett also discussed retained earnings in 1978, 1979, 1980, 1981, 1982, 1983, 1984, 1985, and 1994. The topic of retained earnings deserved an annual mention in the years between 1978-1985, but there was a 9-year gap between 1985-1994 and a 15-year gap between 1994-2019. Since retained earnings is such an important topic, I want to discuss in further detail before getting back to the spreadsheet.

“It’s difficult to understand why retained earnings were unappreciated by investors before Smith’s book was published. After all, it was no secret that mind-boggling wealth had earlier been amassed by such titans as Carnegie, Rockefeller and Ford, all of whom had retained a huge portion of their business earnings to fund growth and produce ever-greater profits. Throughout America, also, there had long been small-time capitalists who became rich following the same playbook.”

Warren Buffett, Berkshire Hathaway Letter to Shareholders, 2019

I think the mention of Carnegie, Rockefeller and Ford is signaling a message to shareholder. Understanding the power of retained earnings is no small topic of minimal importance; unlocking the power of retained earnings can produce mind-boggling wealth.

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Conifers 2020-01-24

During the week ending January 24, 2020, we have a conifer with a 29x return on the call-option side, and a 36x return on the put-option side. For names that are S&P 500 component companies, there were 4 companies on the call-option side, and 12 companies on the put option side. For calculations, I assumed buying the option on Tuesday Jan 21st (no data from Monday, options markets must have been closed for MLK holiday) and closing out the option on Friday Jan 24th. Below is a table grouping the calls vs. puts, and S&P 500 names vs. other.

Call OptionsPut Options
S&P 500Arista Networks (ANET)
Broadcom (AVGO)
Consolidated Edison (ED)
Intel Corp (INTC)
AbbVie (ABBV)
Alexion Pharma (ALXN)
Amgen (AMGN)
Bristol-Myers Squibb (BMY)
Carnival Corp (CCL)
CF Industries (CF)
Dow (DOW)
Edwards Lifesciences (EW)
Hess Corp (HES)
Marathon Oil (MRO)
Merck (MRK)
The Mosaic Company (MOS)
Other SLM Corp (SLM)Herbalife Nutrition (HLF)
Momo (MOMO)
Nutrien (NTR)
ProShares Ultra Crude (UCO)
US Oil Fund (USO)
ViacomCBS (VIAC)

A few quick observations. More names on the put-option side vs. call-option side. Most-represented-quadrant is the S&P 500 put options. Least-represented-quadrant is the Other (Non-S&P 500) call options. When a quadrant is over-represented in 10x options returns, then I wonder if that’s the area with the most market surprises. If so, the surprises of the week were S&P 500 names on the downside. Let’s go through these quadrant-by-quadrant.

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Conifers 2020-01-17

Last week’s conifers include a 93-bagger on the call-option side and a 23-bagger on the put-option side. Below is a table of all options bought on Jan 13th and sold on Jan 17th that returned at least 10x profit. The tickers are separated into 4 quadrants: call-options vs. put-options, and S&P 500 components vs. Other.

Call OptionsPut Options
S&P 500 Abbott Laboratories (ABT)
American Electric Power (AEP)
American Water Works (AWK)
Cardinal Health (CAH)
CarMax (KMX)
Carnival Corporation (CCL)
The Cooper Companies (COO)
Duke Energy (DUK)
Entergy (ETR)
Fox Corporation (FOXA)
The Home Depot (HD)
McKesson (MCK)
Mohawk Industries (MHK)
Morgan Stanley (MS)
PepsiCo (PEP)
Perrigo (PRGO)
Sempra Energy (SRE)
The Southern Company (SO)
TransDigm Group (TDG)
Visa (V)
YUM! Brands (YUM)
OtherAlcon (ALC)
The Blackstone Group (BX)
Dave & Buster’s (PLAY)
Entegris (ENTG)
Forty Seven (FTSV)
Ichor Holdings (ICHR)
Mallinckrodt (MNK)
Momenta Pharma (NTA)
NovoCure (NVCR)
Nutanix (NUT)
Pinterest (PINS)
Shake Shack (SHAK)
Signet Jewelers (SIG)
Sunrun (RUN)
Thor Industries (THO)
ProShares UltraShort Nat Gas (KOLD)
XBiotech (XBIT)
XPO Logistics (XPO)
Zai Lab (ZLAB)
Criteo (CRTO)
First Solar (FSLR)
MGP Ingredients (MGPI)
Sanderson Farms (SAFM)
Ubiquiti (UI)
U.S. Nat Gas Fund (UNG)

A few quick observations. There were no put-options on S&P component companies that returned at least 10x profit. I guess that means either the S&P 500 components did not drop very much, or put-options were already priced rich thereby limiting the return from out-of-the-money (OTM) options. Also I noticed natural gas ETFs showed up on both the call and put side, although the call option was for an “UltraShort” ETF. The non-S&P put-options included a few companies in biotech/pharma. I’m not going to cover all of these tickers, but let’s get into a few of them by looking at charts.

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Conifers 2020-01-10

The new year (2020) has barely started, and someone could have already made a 76x return in conifers. I introduced a new topic of conifers for this blog, borrowing from “The Dao of Capital” by Mark Spitznagel. The general idea is to track a certain unconventional class of investment that is shows underperformance the vast majority of the time, but occasionally has a chance to thrive and overtake traditional investment classes. The imagery is inspired by the survival strategy of conifer plants, which include Christmas trees, but in our case involve buying out-of-the-money (OTM) options. For today’s post, I am highlighting options that could have been purchased on January 2nd and sold on January 10th (year 2020). Let’s get into it:

Restructuring Energy Company


Source: (

Apache Corporation (APA) is an energy company headquartered in Houston Texas, and a component of the S&P 500 Index. On Jan 9th, the company announced the decision to close its San Antonio facility later this year. The stock was trading below 26 prior to the announcement and jumped above 32 after the announcement. There was a call option on APA with strike price at 28.50, expiring at Jan 10th, available ask price of $0.05 on Jan 2nd. The same option on Jan 10th had available bid price of $3.85. Assuming active trading on both sizes of the trade (taking the ask, hitting the bid), the total return was a 76x net return.

Source: Yahoo Finance
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Introducing Conifers

As we begin a new year in 2020, I want to write about a new topic that I will refer to as “conifers”. Conifers are discussed in Mark Spitznagel’s book “The Dao of Capital”, to explain an unusual investment strategy. Conifers (also known as gymnosperms) are a family of plants which include Christmas trees, that compete for resources against flowering plants (also known as angiosperms). These two families of plants (conifers vs. flowering plants) have two completely different strategies for surviving and multiplying in nature. Most of the time flowering plants thrive in normal growing conditions, while conifers severely under-perform. But certain conditions cause flowering plants to get wiped out, while conifers takeover scarce resources. Spitznagel explores the conifer as a teaching tool for a roundabout investment strategy.

For today’s discussion we can think of conifers as investments that under-perform in normal times, but occasionally have an opportunity to takeover scarce resources. A good example of the conifer strategy is investing in out-of-the-money (OTM) options. Most of the time, OTM options will expire worthless, but occasionally have an opportunity to overtake resources. For example in November 2019, there was a “conifer” with a 27,500% return in one month (that’s a 275x return). I have long been fascinated with out-of-the-money (OTM) options. My brother previously traded futures and options in the NYBOT pit. And after I briefly traded Eurodollar (short-term interest rates) futures on screens in 2007, I realized that OTM options could hedge a relative-value strategy during massive market dislocations.


Source: (

Source: Yahoo Finance

But first let’s talk about 3 books: Taleb (2001), Drobny (2006), and Spitznagel (2013).

When I read “Fooled by Randomness” by Nassim Taleb in the early 2000s, this book opened my mind to heuristics and fallacies, and how rare events can have a “life-changing” impact. At the time, I was learning to play small-limit poker in the underground casinos in New York, and so I was familiar with probabilities and expected values. I understood math in the context of poker strategies. But Taleb was talking about something different than “hitting a poker draw with pot odds” … he was talking about the equivalent of winning the World Series of Poker (an unlikely event that would be a life-changer). Taleb had built a career investing in “black swans”, which is almost like an extreme version of venture capital (where a single investment could return the entire value of portfolio). “Fooled by Randomness” is where the OTM options topic all started for me. I still think this book is Taleb’s best work, with “Antifragile” as my distant second favorite.

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Oct 2019: Atmos Energy (ATO)

Time is a Friend

I like the company Atmos Energy (ATO). I understand the business model: a natural gas pipeline and storage company with major operations in Texas. The company is a member of the S&P 500 index. The perspective I use with ATO is the way I would evaluate a long-term business partner for me, by looking at the 30-year history of ATO’s financial performance. ATO has a pretty incredible dividend story (both in terms of long-term growth and recent payout ratios), so dividends are an important topic to discuss. I don’t try to predict ATO’s stock price or forecast ATO’s future financial results. I have no special secret knowledge about ATO. Everything I like about ATO is based on information out in the open.

ATO only joined the S&P 500 index in Feb 2019, and as a result it slipped underneath my radar screen this year. I launched the Hardy Stocks Newsletter in Mar 2019, but actually spent many months beforehand preparing the analytics and strategy. The initial ticker screener was based on a list of S&P 500 component companies from Dec 2018, and for the first few months I continued to use the same outdated list of 2018 S&P 500 companies, as a result ATO did not show up on the initial analytics screens. I published an article about a component of the S&P Midcap index in Jun 2019 and the S&P Smallcap index in Jul 2019 … by then ATO did not show up on the new analytics screens either because it was no longer in the Midcap index. Only when I decided to revisit the S&P 500, ATO appeared on the analytics screen out of nowhere this month. If I had noticed ATO when it joined the S&P 500 in Feb 2019 (when the stock was trading around $100 … currently it’s trading around $111), an investment in ATO would have gained 11% in 8 months (vs. 6.5% gain in S&P 500 during same period, for 4.5% of “alpha”) … painful way to learn the lesson to pull fresh data often instead of re-using an old stock screener.

ATO is one of the most consistently improving companies in the S&P 500 based on 30 years of history, especially for the past 14 years from 2004 to 2018. Let’s start by looking at the diluted earnings-per-share (EPS), my favorite metric:

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Jul 2019: CVB Financial (CVBF)

Later Than Usual

Sorry for posting later in the month than usual. I usually like to publish around the middle of the month, especially after non-farm payrolls which can move markets. But this month I am publishing at the end of the month because I am in the process of switching jobs (from healthcare to automotive data science) and due to a short vacation to visit my brother in Dallas, Texas. Two interesting excursions I was able to do in Dallas with my brother: (a) eat at Texas Roadhouse – the subject of last month’s blog post, and (b) visit a Nebraska Furniture Mart – the famous retailer owned by Berkshire Hathaway. Both were super-fun excursions, of interest to value investors! More to come on those excursions later!

Smallcap Treat

Following last month’s decision to take a break from writing about the S&P500 (focused on component of S&P Midcap 400 instead), this month I will be writing about a component of the S&P Smallcap 600. Smallcaps need to be evaluated even more gently than midcaps, because these are smaller companies and usually earlier in their stage of growth and maturity. I found a few companies worth writing about, and maybe someday a few of these companies will “graduate” to the midcap and largecap universe.

Time is a Friend

I like the company CVB Financial (CVBF). It is a holding company for a bank called “Citizens Business Bank” headquartered in Ontario, California (not to be confused with a different bank in Rhode Island with a similar name). In case you are wondering where the name (“CVB”) comes from, Citizens Business Bank used to be called “Chino Valley Bank” (CVB) and originally catered to milk farmers in Southern California. Looking back at the financial results to 1989, there is evidence of consistency and improvement (a bit rockier than other companies written about on this blog), but nonetheless impressive given the company’s size, dividend history, and industry sector (banks and financials tend to be affected by the short-term credit cycle). I do not try to forecast CVBF’s future stock price and/or future financial results, and I have no special secret knowledge about CVBF. Everything I like about the company is based on information out in the open. You can verify everything here by yourself.

CVBF is one of the most consistently improving companies in the S&P Smallcap 600 based on the past 30 years of financial results (with the exception of the 2007-2012 timeframe). Although the company did not grow during that 6-year period between 2007-2012, the earnings were still positive and the company consistently paid out dividends to shareholders. If this were a largecap company in the S&P 500, I might throw out this company from consideration, but since this is a smallcap company I will be much more forgiving due to CVBF’s other admirable traits (and comparison with other smallcaps). The first place I like to look is the historical diluted earnings-per-share (EPS). Diluted EPS is the simplest easiest way to check historical resilience, because it includes the dilutive effects of stock options and stock based compensation. Some management teams hide compensation costs by diluting the shareholders, so it’s important to account for that dilution, rather than simply looking at basic earnings-per-share.

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Jun 2019: Texas Roadhouse (TXRH)

Midcap Interlude

This month I have decided to take a break from the S&P 500, and instead write about a company in the S&P 400 Midcap Index. Midcaps tend to be smaller and less-established than largecaps, so we are going to evaluate with a lighter touch than usual. Having said that, midcaps probably have a longer runway ahead of them, if they turn out to be great companies. According to this article in Jan 2019, the midcap index has a great 25-year track record when compared to other indices. There are 400 companies in the index, and I found a few worth focusing on. Someday these companies may “graduate” to the S&P 500, as they increase in market capitalization. Next month, I may write about a company in the S&P 600 Smallcap Index, but I haven’t made a final decision about that yet.

Time is a Friend

I really like the company Texas Roadhouse (TXRH). I understand the business model: a casual steak restaurant with an American Western theme. TXRH is currently a member of the S&P 400 Midcap index. The company runs its own restaurants but also has a franchise model to license others to operate a location. Each restaurant has its own butcher onsite. (I have never been to a Texas Roadhouse, so I asked my brother — who lives in Texas — what the restaurant is like. He notes that each customer can hand-select the steak from a display case, and apparently (I found this video) the bread rolls are really delicious especially with the cinnamon butter. He says the steak quality is similar to an Outback Steakhouse, with a fun casual vibe and reasonably priced menu.) I evaluated TXRH as I would evaluate a long-term partnership, looking back at 18 years of historical financial results publicly available. The company only has results going back to 2001, so we won’t be able to look at the usual 30 year histories. TXHR pays out a significant part of earnings as dividends, so we need to talk about dividends. I don’t try to predict TXRH’s stock price, nor do I try to forecast their future financial results. I have no special secret knowledge of TXRH. Everything I like about the company is based on information out in the open. You can verify everything yourself.

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May 2019: Omnicom (OMC)

Time is a Friend

I like the company Omnicom (OMC). I understand the business model: an advertising agency that helps large clients run advertising campaigns. OMC is currently a member of the S&P 500 index. The perspective I use with OMC is the way I would evaluate a long-term business partner to manage an important venture for me, by looking at the 30-year history of OMC’s financial performance. OMC pays out a significant portion of earnings as dividends, so dividends are an important topic to discuss in order to understand this company. I don’t try to predict OMC’s stock price or forecast OMC’s future financial results. I have no special secret knowledge about OMC. Everything I like about OMC is based on information out in the open.

OMC is one of the most consistently improving companies in the S&P 500 based on 30 years of history, although it has experienced a few setbacks in recent years. Let’s start by looking at the diluted earnings-per-share (EPS), my favorite metric:

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Apr 2019: TJX Companies (TJX)

Time is a Friend

I really like the company The TJX Companies (TJX). I understand the business model: they sell discount clothes and home furnishings, often brand-name and designer products that are liquidated/clearance inventory from other retailers. TJX is currently a member of the S&P 500 index. (TJX runs a bunch of stores where I’ve shopped: TJMaxx, HomeGoods, Marshalls. I don’t do all of my shopping at these stores, but if I happen to find something worthwhile, the price is unbeatable. We have shopped at Marshall’s for my son’s toys, socks, shirts … at HomeGoods we found a great bench for our garage, and a stylish-looking full-length mirror.) I evaluate TJX as I would evaluate a long-term business partnership, with the lens of looking at 30 years of their historical financial performance. I don’t try to predict TJX’s stock price, nor do I try to forecast their future financial results. I have no special secret knowledge of TJX. Everything I like about the company is based on information out in the open.

TJX is one of the most consistently improving companies currently in the S&P 500, based on the past 30 years of performance. The first place I look is at the historical diluted earnings-per-share. Diluted EPS takes into account stock options that can be exercised, and that might dilute the shares outstanding in the future. This potential dilution is why I prefer looking at diluted EPS instead of basic EPS. Some companies issue lots of stock options to executives and employees, and so it’s important to account for that dilution when looking at earnings per share.

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