Chapter 5 is full of warnings about traps an investor can fall into if operating activities and financing activities are not separated:
- Viewing ROE affected by leverage as an indication of value added
- Rewarding management based on ROE
- Buying low P/E affected by leverage
- Seeing an increase in P/B as added value if it is due to leverage
- Buying earnings growth resulting from leverage
- Viewing an increase in EPS from a stock repurchase as added value
Here is another example of muddled thinking:
The AAA (American Automobile Association) estimated that the cost of owning a car increased 15.4% in 2023 but most of that was due to an increase in the interest rate of auto loans. That is not the cost of owning a car, but the cost of borrowing. New car prices rose only 0.7% in 2023, and the price of gas (petrol) fell significantly (though auto insurance premiums rose 20.6%). (Source: Wall Street Journal February 14, 2024).