So Joel Greenblatt uses ROC as defined in an earlier post, with the base being the tangible capital employed. Warren Buffett seems to use Return on NTA (RONTA), from his See’s Candies example in the Essays of Warren Buffett book. However he is often quoted as using ROE.
[Quick recap: Net Tangible Assets = Total assets – intangible assets – Total liabilities – redemption value of preferred stock]
So, which is the right base to use?
To know the true returns-generating capability of the firm, ROC is the right one to use (see earlier post here). RONTA will be inflated (relative to ROC) by the use of debt. Hence it may be useful to compare the RONTA to the ROC to know the “additional return” obtained due to the use of debt (note: additional return = RONTA – ROC). The “additional return” is comparing the existing leveraged firm, vs its unleveraged version (i.e. if you don’t incur any debt and finance everything with your own money, your return = ROC; if you incur the existing debt hence lowering your own cash outlay, your return = RONTA). You should not use ROE as the base would contain “intangible assets”, which does not require any cash outlay to “finance”/”procure”. Hence the meaning of ROE is kinda warped.