Thread by @unseenvalue

Like bamboo cultivation, the results of strategy & capital allocation are intertwined and outcome may not be known for few years. This is particularly true for biologics, life sciences innovator companies.

Having said that - few basics for good & bad capital allocation are:
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Bad capital allocator:

👉 Extrapolating good times or peak economic cycle to continue longer-than-average

👉 Ambitious debt-funded Capex at peak cycle

👉 Incremental ROCE lower than existing ROCE

👉 Unrelated diversification having no connection with existing business

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In certain FMCGs - outright disruption's unlikely but substitutes & competitive intensity in on the rise!

Think in terms of ROCE trend line...is ~70% ROCE going to stay around the 60-80% range over the next decade or will we likely see a ~30% ROCE in 2030 (that's big drop!)

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On an increasing capital base, if the current high ROCE range is maintained - it validates good capital allocation!

If ROCE starts plummeting, it means bad capital allocation (e.g. Tesco Plc ROCE crashed post-2007, as the incremental capital allocation was ROCE dilutive!)

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Good capital allocator:

👉 Long-term ROCE & Growth focused

👉 Low leverage at the top of the cycle

👉 Midset to acquire distressed asset at lows

👉 No hesitation deploying capital at the bottom of cycle

👉 Aims to deploy on average lower capital over multiple cycles

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Low ROCE getting better over time would be👌
Great investment bets are often those where the starting ROCE is low on the back of value-enhancing Capex (lots of idle capacity not generating returns due to various reasons).

Study why ROCE is low and what +ve future factors?

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