Quote Originally Posted by patsy View Post

When you apply your Buffet spreadsheets to a company to reach a suggested share price, you are purely valuing the equity. ROE is the indicator that allows to do that. ROE does not lead you by itself to reach to the value of the firm.
Quite correct

Snoopy wrote:
If you buy shares in Telecom you become a shareholder and you get your slice of shareholders equity - that's true. However you cannot buy shareholders equity on its own. You also have to buy your fair share of shareholder debt which is included in the purchase price of the Telecom shares you buy. You have to buy the shareholders equity AND debt, which together add up to the sum of the company assets, as part of one purchase package.


Snoopy - If a competitor took over Telecom as a company, your assertion is correct. But if you buy its equity, or a share of its equity, then you are not buying its respective debt. There is a distinction between the "value of the firm" versus the "value of equity" - the difference between both being the "value of debt".
I may have been a bit loose with my words here.

Think of it this way. A company has no debt and you buy say 10% of its shares on the sharemarket. That means you now own 10% of the shareholders equity as well and none of the debt (because there is no debt). I trust we agree so far.

Now lets say there is a company with $100m in assets which was initally funded through shareholders equity of $50m and a bank loan of $50m. Once gain you buy 10% of the shares in this company 'on the market'. What do you consider you have actually bought?

Well, you have 10% of the company with shareholders equity of $50m. So you now control

0.10 x $50m = $5m

of shareholders equity. I hope we still agree up to this point.

Whatever you do as a shareholder does not affect the bank loan. The bank is still owed $50m no matter who the shareholders are. I think this is the point you were making Patsy(?)

However, who do you think is responsible for ultimately paying back this loan? It is the shareholders isn't it? No matter who the shareholders are at any particular time? What I am trying to say is this.

When you buy shares in a company you are buying a 'slice of a pie'. That pie contains two ingredients: shareholders equity and an obligation to pay back your owners share of the bank loan. You are correct Patsy in saying that when you buy shares you do not actually buy a share of the bank loan. The bank continues to own that. But you *do* buy into the obligation to pay off that loan, in proportion to your shareholding. If this wasn't true then I can present you with an excellent money making proposition, courtesy of ten of your friends.

Let's say you own a nice house valued at $1m in which you have $100k in equity and funding from a $900k bank loan. You decide to float it on the sharemarket as 'Patsy House Ltd.' You find 10 keen friend shareholders all of who can see the value of the house and all agree to put up $100k each for a 10% share. You take the $1m in payment for your house from the ten new shareholders, and you are out of there. You buy a yacht with the proceeds and set sail for your new home in Monaco. Now the bank decides to call the loan in. There are now ten owners on the title deed (the new shareholder owners). Who do you think the bank will ask to pay the loan money back? Do you expect the bank to set sail and come after you? Do you think that because the 10 shareholders who bought your house only put up equity themselves they now 'own the house outright' and the bank will just write off the $900k loan you put in place when you set up 'Patsy House Ltd.'?

SNOOPY