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Geoff Gannon April 24, 2020

Otis (OTIS): The World’s Largest Elevator Company Gets the Vast Majority of Its Earnings From Maintenance Contracts With a 93% Retention Rate

Otis Worldwide (OTIS) is the world’s biggest elevator and escalator company. Like Carrier (CARR) – which I wrote up two days ago – it was spun-off from United Technologies. However, shareholders of United Technologies received one share of Carrier for each share of United Technologies they had while they only received half a share of Otis for every one share of United Technologies they owned. As a result, the market caps of Carrier and Otis would be the same if the share price of Otis was twice the share price of Carrier. Otis isn’t trading at double Carrier’s stock price though. It’s at $47.85 versus $16.25 for Carrier. So, closer to three times the price of Carrier than two. Carrier, however, does have more debt than Otis. Nonetheless, as I’ll explain in this article – the bad news is that while I like Otis as a business a lot better than Carrier: Otis is the more expensive stock.

Reported revenues are unimportant at Otis. The company did $13 billion in sales. But, only about $7.4 billion of this comes from service revenue. Service revenue makes up 80% of EBIT while new equipment sales are just 20%. Service revenue is also less lumpy. A major reason for this is that more than $6 billion of the total service revenue is under maintenance contracts. This more than $6 billion in maintenance contracts has a 93% retention rate. The contracts don’t actually require much notice or much in the way of penalties to cancel. However, cancellation is rare. So, a very big portion of the economic value in Otis comes from the roughly 2 million elevators covered by maintenance contracts that bring in about $6 billon in revenue per year. My estimate is that the after-tax free cash flow contribution from these 2 million elevators under contract is anywhere from $1 billion to even as much as $1.2 billion. Basically, if we set aside these maintenance contracts – there is almost no free cash flow beyond the corporate costs etc. that need to be covered at Otis. There is an argument to be made that as much as 20% of the company’s economic value comes from new equipment sales. However, I think it’s trickier to value the company if you count those sales in the period in which they occur. Rather, I think it makes sense to look at the business the way you might a movie studio, book publisher, etc. with a substantial library. Or – if you’d prefer – the way you’d look at an insurer that usually has a combined ratio a bit below 100, but basically makes its money off the return on its “float”. Otis’s service business has very stable revenue, EBIT, and free cash flow from year-to-year. I expect it to rise at least in line with inflation (the company expects better than that). And there are some possible productivity gains here from digital initiatives. Smart elevators, technicians using iPhones, etc. could cut down on the number …

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Geoff Gannon April 22, 2020

Carrier (CARR): A Big, Well-Known Business that Just Spun-off as a Cheap, Leveraged Stock

Carrier (CARR) is a recent spin-off from United Technologies. The company has leading brands in Heating, Ventilation, and Air Conditioning (HVAC), fire & safety, and refrigeration. The best known brand is the company’s namesake: “Carrier”. About 60% of profits come from HVAC. About 30% of  profits come from fire/safety. And about 20% of sales and profits come from refrigeration. Although you may be familiar with the Carrier name in terms of residential air conditioning – there are just under 30 million residential Carrier units in the U.S. right now – the company is skewed much more toward commercial, industrial, and transportation uses than some of its competitors. Carrier’s market position is strongest in “the Americas” where it gets over half of all sales (55%). About three-quarters (72%) of sales are for new equipment and the rest (28%) are some form of parts, maintenance, or other “after-market”. Gross margins for both sales and services are basically the same at around 29%. Gross margin variability seems very, very low here. Return on capital is high. If we use only tangible assets excluding joint ventures accounted for under the equity method of accounting – more on this later – Carrier’s pre-tax return on net tangible assets invested in the business would be greater than 100%. After fully taxing these results and then adjusting for a slightly less than 100% conversion (I’ll assume 90% conversion as the possible low-end of a normal 90-100% of EPS converting to FCF range for the company) you’d still be left with unleveraged cash returns on net tangible assets employed greater than 50%. By any measure, the business is incredibly profitable. But, does that matter?

Does Carrier grow?

The company’s investor relations team thinks it does. They explicitly model faster than the market organic growth. There is, however, no proof of this in the five years of financial data included in the spin-off documents. After adjusting for changes in currency, acquisitions, and one-time pick-ups and drop offs of big business in various units – I really can’t tell if this business was or wasn’t growing under United Technologies. Organically, it looks like it was flattish over the last 5 years. Earnings Before Interest and Taxes (EBIT) ranged from about $2.5 billion to $3.7 billion. The central tendency – to the extent there is one – seems like about $3 billion in EBIT. Just to keep us dealing with nice, round numbers I’ll assume Carrier as a spun-off entity will average about $3 billion in EBIT. Obviously, you shouldn’t expect $3 billion in EBIT during 2020 or 2021, because of the virus. Purchases of everything Carrier makes are very easy to defer. This is all cap-ex. If you don’t need a new refrigerated truck – you don’t need to buy from the refrigeration business unit this year. If you aren’t building new stand alone homes, new townhomes, etc. – you don’t need to put in residential Carrier units. Commercial customers who run everything from …

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Geoff Gannon April 20, 2020

Mills Music Trust (MMTRS): A Pure Play Decades Long Stream of Future Royalties on Old-Timey Songs Available at More Than an 8% Pre-Tax Yield

Mills Music Trust (MMTRS) is an illiquid, over-the-counter stock. In fact, it’s not a stock at all. The security traded is a “trust certificate” that entitles the holder to quarterly distributions from the trust. These “dividends” are not dividends. The trust has not paid taxes on the income. So, you will be taxed on the income received. As a result, you’ll need to adjust the after-tax return on Mills Music Trust as compared to other stocks you might own. Since I don’t know your tax situation, I don’t have a way of doing that.

The trust was created in 1964. Its life may extend till something like 2088. The way it’s written the trust will be dissolved at the end of the calendar year during which the last copyright expires and can not be renewed. Based on a table of the 50 top performing copyrights in the Mills Music Trust catalog – I believe this won’t happen before 2088. However, the trust renegotiated something important with EMI (the publisher that collects royalties on behalf of Mills) that makes the end date for the trust less important. The original trust arrangement required a minimum royalty payment of $167,500 per quarter. This is not a small number when you consider that there is a copyright that won’t expire till 2088. So, the contingent payment made to Mills would presumably have been $670,000 a year in 2087 (and for many, many years before that). Now, it’s likely the dollar will have depreciated quite a bit in the 67 years between today and 2087 – but, $670,000 a year is still a ton more than the songs in the Mills Music Trust catalog will be producing in royalties in that year. This is because the vast majority of the copyrights on valuable songs will expire in about 25-30 years. Mills provides information on when copyrights for songs may expire. But, as most of these songs are all governed by the same copyright law, a pretty good guess is simply date of creation plus 95 years. So, these valuable songs I expect to come off copyright (and go into the public domain) in the next 25-30 years were created in like the 1920s. Almost all of the royalty streams you’ll be getting here are derived from pre-1958 songs. And then, because of the general rule that a song will be off copyright after 95 years (no matter what is done to try to renew it) – we can assume that these songs don’t much pre-date the early 1900s. In fact, almost all the songs of value seem to date from 1922-1958. There’s about a 30-year period where many of these more valuable copyrights were created. And those were the roughly 30 years before the trust was created. Mills gives details on what these songs are. Some of the biggest royalty producing songs for Mills right now are:

Little Drummer Boy

Sleigh Ride

Lovesick Blues


Hold Me, Thrill Me, Kiss Me

It Don’t Mean a

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Andrew Kuhn April 19, 2020

Which Kind of Investor Could You Aspire to Be: Graham, Fisher, Lynch, Greenblatt, or Marks?

Hi Geoff, 


I am very new to investing and I have most of my savings invested in Vanguard S&P 500. I would love to learn more about the world of investing but I just don’t know where to start. Could you please give me a roadmap to begin?


Geoff’s Advice to a Brand New Investor


You Need to KNOW YOURSELF First, So…


It really depends on what approach would work best for you. You should read about the investor who most speaks to the kind of investor you COULD be. In other words, what are your interests, what is your personality, etc.


I would recommend picking from one of five possible investors:


1) Ben Graham

2) Phil Fisher

3) Peter Lynch

4) Joel Greenblatt

5) Howard Marks


You might want to read one book by each of them. The Ben Graham approach is based on asset values and liquidation value. It is the approach of net-nets, stocks trading below book value, stocks trading at less than 10 times P/E and little debt, etc. You could read the Intelligent Investor (I recommend the 1970s edition – or earlier – but not the edition revised by Jason Zweig. So, find an edition with just Graham’s name on it – not Zweig’s name). I would also recommend reading “There’s Always Something to Do”. This book is about Peter Cundill. It is an easier read than the Intelligent Investor. But, it shows you what the actual work of applying a “Graham and Dodd” approach is. So, to get a taste of the Ben Graham approach I’d recommend reading: First – “There’s Always Something to Do”. If you feel like Cundill’s investing style is one you could copy yourself – then, read “The Intelligent Investor”. If you get something out of “The Intelligent Investor” you can then read the various editions of Security Analysis (1934, 1940, and 1951). Also read: “The Interpretation of Financial Statements”. There are a few other books by Graham that are good (a couple books of his articles and an autobiography called “memoirs”). You can find all of these at Amazon and elsewhere. Buy them used and collect the books for your own review. Keep them forever. Heavily annotate them. Copy the approaches you read about using modern stocks. However: ONLY do this if you read “There’s Always Something to Do” and the Cundill approach resonates with you as something you could do personally. If you read that book – it’s a very breezy read – and don’t feel that approach resonate with you, then skip Graham entirely.


Phil Fisher. Read “Common Stocks and Uncommon Profits”. Fisher wrote a few other books too. But, read that one. Especially think about his talk of “scuttlebutt”. Is this something you can do? Is this something you want to do? If so: read Fisher’s other books. Focus on the scuttlebutt approach. During coronavirus, it will be difficult to make company visits. But, you can often speak with people …

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Andrew Kuhn April 18, 2020

What Makes a Business Durable?

What Makes a Business Durable?
Hey Geoff,
I noticed in one of the recent videos you mentioned that the durability of the business matters more then the returns. I believe you were answering a viewer question on return on capital for the subject matter. When you mention durability are you talking about recurring revenue, sustainability of the business going forward (like waste collection industry or railroads etc…)?
Answer: A Good Place to Start is With the Oldest Companies in the Oldest Industries
Yes. So, this is something Buffett has said before too – and it’s true. It’s the reason why I’m not a fan of “The Magic Formula”. The Magic Formula is a system that might work empirically – but, it isn’t based on sound logic. That’s different from something like the Piotroski F-Score or Ben Graham’s 2/3rds of NCAV rule. Both of those approaches are logically sound and then can be tested to see if they work empirically. I don’t think it’s a good idea to use a system that has been back tested to show good results, but that doesn’t seem logically sound. I’m unconvinced of the logic of The Magic Formula – because, it is basically buying high current return on capital stocks without asking if they have a moat. It’s not the Buffett approach. It’s actually very different from Warren Buffett’s approach. His approach is to figure out why a company has had a high return on capital in the past, has a high return in the present, and is likely to have a high return in the future. Once he knows the reason for the high return – the company’s “moat” – he can judge how durable that moat is. This is also similar – though slightly different – from the Phil Fisher approach. Phil Fisher’s approach focused more on the organization and whether it is built for the long run: is it investing enough in marketing, is it investing enough in R&D, does it have good enough people at lower levels in the organization, are the markets the company is in likely to grow for a long time to come, has the company had success releasing new products regularly to replace old products, etc. That’s very similar – though from a different angle – to the Buffett approach. Those two approaches – Buffett and Fisher – are qualitative looks into the future. We can debate how accurately a human being can judge the likely future of a company. But, the logic of trying to do that is sound. The logic of assuming that a currently high return on capital is less likely to decline than a medium or low return on capital makes little sense. There has been some research in this area and the answer is – it depends on the industry. Some industries do show high persistence of relative returns among the firms in those industries. So, for example, the leading movie studio or beverage brand or condiment maker might tend to
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Andrew Kuhn April 14, 2020

In a Market Like This – Is It Better to Buy 10 Stocks Instead of Just My 5 Favorite Stocks?

Someone sent Geoff this email:
Hi Geoff,
On regular days your focusing on overlooked stocks makes much sense to me and is the right place to look for good companies at a decent price.
But in this market selloff, wouldn’t it be better to buy blue chip stocks such as Nike, Disney, BrKb, etc.. if they fall to the right price (and I’m not sure they are there yet…).
Also, wouldn’t it be better to diversify? To own 10-12 stocks instead of 5-7.
Answer: It Depends On Which Stocks – Conglomerates like Berkshire and Disney Give You a Lot of Diversification, Some Other Stocks Don’t
(Note from Geoff: I’m going to split this email into two responses – this one will talk about diversification, tomorrow’s response will talk about overlooked versus big cap stocks)
I don’t know about whether it makes sense to own 10-12 stocks instead of 5-7. I’m not sure it does. It depends on which stocks you’d add to the portfolio. Remember, there is a lot of diversification in certain stocks already. So, you mentioned Disney (DIS) and Berkshire (BRK.B). Berkshire already gives you more diversification in terms of its underwriting than many insurers do. Plus, Berkshire has a big stock portfolio. Plus it owns a railroad. Plus it owns an electric utility. You could separately buy other insurers, stocks like Apple (AAPL) and Bank of America (BAC) and Wells Fargo (WFC) and Coke (KO). You could buy a publicly traded railroad. You could buy a regulated utility. If you add up what you’d put in all those stocks if they were in a 12 stock portfolio – maybe you’d put 33% of your portfolio or more into recreating what Berkshire already has. So, should you buy a bank, an insurer, a railroad, a utility, etc. – or just buy Berkshire? I don’t know the answer. If you pick the right bank, insurer, railroad, and utility – I’m sure you could beat just buying Berkshire. But, if you think you’re somehow safer putting 10% each into one bank, one insurer, one railroad, and one utility than 40% in Berkshire – I don’t think that’s true.
Disney is similar. The company is diversified across a couple big entertainment segments. It has a big allocation to parks and resorts. This includes things like cruise ships. But, it’s mainly theme parks. Disney has the most visited theme parks in several parts of several different continents . So, you could buy SeaWorld (SEAS), Six Flags (SIX), or Cedar Fair (FUN) – or you could get a similar allocation by owning 3-5 times more of Disney than you would of any one of those companies. If Disney is say 20-33% parks by value (you’d have to appraise the stock yourself to make this decision) then simply buying a 3-5 times bigger position in Disney and you’d get the same allocation to theme parks you would from buying one of those other stocks. Disney has a big movie business (it is now, by
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Geoff Gannon April 13, 2020

Interpublic (IPG): An Ad Agency Holding Company Trading at 10 times Free Cash Flow and Paying a Nearly 7% Dividend Yield

Interpublic (IPG) is one of the big ad agency holding companies around the world. Other examples include Omnicom (also a U.S. company), WPP (a U.K. company), Publicis (a French company), and Dentsu (a Japanese company). There are countless other publicly traded advertising stocks. Some are affiliated with one of those big groups. Others aren’t. Interpublic might be the first real ad agency holding company. The name Interpublic dates back to 1961. If you read the 10-K, you’ll notice PriceWaterhouse has been auditing Interpublic’s financials since the 1950s. Before the name change in 1961, the company was called McCann-Erikson. Late in the TV series Mad Men this is the agency that buys up the company all the main characters work for. Mad Men ends with the “Hilltop ad” (I’d like to buy the world a Coke) for Coca-Cola. That’s not made up just for the show. McCann-Erikson did make that ad. The McCann-Erikson combination dates back to the 1930s. Each of those two agencies (McCann and Erikson) were founded in the first decade of the 1900s. Omnicom and other advertising agency holding companies that came later were probably based in part on Interpublic in the early 1960s. For decades now, it’s been a common strategy for publicly traded advertising companies to own different agencies and provide certain centralized functions (basic corporate functions, capital allocation, setting compensation of top executives at the agencies, managing conflicts of interest between agencies they own, etc.). To some extent the individual agencies are independent and run sort of like Berkshire Hathaway runs its subsidiaries. But, in other ways they aren’t very independent. For example, Interpublic explicitly says that corporate HQ provides guidance, advice, etc. on both certain human relations stuff and on real estate. The cost structure of ad agencies is very different from most companies. At Interpublic, close to 65% of revenues are spent on base salaries, benefits, rent and office expenses. A huge proportion of the company’s total cost structure is really just base salary and rent. These are both very fixed. This is a pure service business. It’s largely “cost plus” – though how that works is a bit complicated.

So, the actual way ad agencies bill can be pretty complicated. Interpublic gets 50-60% of its revenue from its top 100 clients. Usually, client retention rates among big accounts are incredibly high. This is not due to contracts. The industry standard is for all contracts to allow either the agency or the client to fire the other with 30-90 days’ notice. Each of the contracts are customized. So, in theory, profits could vary a lot relative to the amount of revenue booked depending on the client. But, in reality, this does not happen. The contract can be created to involve a lot of cost plus, a lot of commission, flat fees, incentives for hitting certain quantitative targets for the effectiveness of campaigns, etc. If you look at the long-term margins of all different ad agencies around the world that once took very simple …

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Andrew Kuhn April 13, 2020

What is a Fair Price to Pay For Omnicom (OMC)?

Someone Geoff  this email ( to ask your own question: just send me an email ) :

My question is a simple one.

“What do you think is a fair price to pay for Omnicom?”

Answer: Omnicom (OMC) Could be Worth Anywhere Between 1 to 1.5 Times Sales – so, About $70 to $100 a Share – But: You Probably Want At Least a 35% Margin of Safety, So Try Not To Pay More than $45 a Share for Omnicom

This is a simple question. But, it’s tougher to answer than it appears. I see 3 big factors to consider:

1) What is the organic growth (or decay) in Omnicom’s business likely to be?

2) How much will stock buybacks drive growth in earnings per share that’s higher than organic growth?

3) How bad and how long will an ad recession be?

Because Omnicom uses so much of its free cash flow to buyback stock, there’s an element of circular logic to valuing the stock. Bizarrely, the cheaper the stock gets today – the more valuable it should be in the future. Assume Omnicom uses 50% of its EPS to buyback stock. I’ll also assume there is 1% share dilution normally before buybacks. This means that the formula that tells us how much Omnicom’s EPS will grow BEYOND its organic growth is:

(0.5 * Earnings Yield) – 1% = Inorganic EPS growth caused by stock buybacks

Let’s run this number for the following P/E ratios:

P/E = 4

P/E = 6

P/E = 8

P/E = 10

P/E = 12

P/E = 14

P/E = 16

P/E = 4 (this would be like 50% cheaper than today’s price) makes the formula…

(0.5 * 25%) – 1% = 11.5% CAGR in EPS

P/E = 6 gives us…

(0.5 * 17%) – 1% = 7.5% CAGR in EPS and so on. The “and so ons” work out as follows..

P/E 4 => 11.50%

P/E 6 => 7.50%

P/E 8 => 5.25%

P/E 10 => 4.00%

P.E 12 => 3.17%

P/E 14 => 2.57%

P/E 16 => 2.13%

Now, if we assume organic growth is equal to 0% – which may or may not be an accurate assumption – then, we can keep the fair value formula pretty simple. In theory, Omnicom should be worth its stream of dividends. EPS can be ignored as a direct thing. Instead we just assume that 50% of EPS is paid out in dividends and 50% is used to do buybacks. Again, I assume 1% is just constant share dilution in the form of stock grants to employees.

That means only two things matter. One is the buyback rate. I’ve shown that above. It ranges from a little over 2% to something like 11-12% a year depending on whether the stock trades as low as a P/E of 4 or as high as a P/E of 16. The dividend yield – if we assume a 50% dividend payout – is really easy to calculate. We just take …

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Geoff Gannon April 10, 2020

Miller Industries: A Pretty Good, But Very Cyclical Business that Sells its Car Wreckers and Car Carriers Through a Loyal Distributor Base

Miller Industries (MLR) has a lot of things to like about it. But, the timing of buying this stock now definitely isn’t one of them. Miller is in a very cyclical, highly durable capital good industry – it produces “car wreckers” and “car carriers” – that depends heavily on business confidence and especially access to capital. It is very easy to defer the purchase of a new wrecker or carrier. And it is very hard – impossible, really – to sell wreckers or carriers without easily available credit. To give you some idea of how important credit is in this industry – Miller Industries is currently promising lenders to its distributors (these are all technically “independent distributors”) that it will buy back up to $74 million of its own wreckers and carriers if the lender repossess that collateral from the distributor. Miller makes this kind of promise all the time. In recent years, it has not had to buy back any of its equipment. But, you see the problem. It might have to do so. And, the fact that distributors are using financing that depends on the lender getting a promise from Miller (the original equipment manufacturer) gives you some idea of how important credit is in this industry. The distributors – there are 80 of them in the U.S., and Miller estimates that about 68 of them don’t actually sell any wreckers or carriers other than Miller products – rely heavily on floorplan financing.

The industry is also very cyclical. In the last economic cycle, Miller’s sales peaked at $409 million in 2006 and bottomed out at $238 million (down 42%) in 2009. Gross profit dropped by the same percentage (42%). Operating profit – however – went from $33 million in 2006 to $7 million in 2008 (down 80%). Could the same thing happen in this recession?

Yes, it could.

So, Miller’s P/E, P/S, etc. ratios are all very suspect right now. Maybe price-to-tangible book value would be a better guide to the company’s valuation. The good news is that the P/E and P/S ratios here are low. But, that’s what you’d expect with a cyclical stock that everyone now knows is at the very top of its cyclical (the recession has already started as I write this, and Miller reported earnings less than a month ago that were its best ever – so, we can call this the official peak). The P/E ratio on those peak earnings is between 7 and 8. The P/S ratio is about 0.4 times. The company has a tangible book value of $21.60. As I write this – the stock is trading at $25.89. So, the P/B ratio here is 1.2 times. That makes it pretty easy to compare this company’s long-term history with its current stock price. Miller probably doesn’t convert all its reported earnings into cash. So, if stocks generally return say 8-10% a year – and we use that as the hurdle rate you, as an investor are looking for …

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Andrew Kuhn April 8, 2020

What Kind of Competition Will Car Dealers Face for the Sale of Used Cars and for Their Parts and Service Business?

Someone sent Geoff this email (to ask your own question: just send me an email):
I think that car dealers face a lot of competition, especially for used cars and service, that I could never thoroughly understand the competitive advantages. But car dealers tend to have very stable margin. So I do think that they have certain competitive advantage thanks to location, long-time presence, as well as customer relationship built up through its new car business. So, I’d like to ask you about your thoughts on the competition for car dealers in:
1. Used cars where car dealers have to compete not only with franchised dealer of another brand in the same area but also with independent used car dealers.
2. Parts and services where car dealers have to compete with independent auto service shops and chains.
Answer: I Think Big Car Dealer Groups Have Certain Advantages in Capturing Additional Profits from a Customer Relationship Based on a New Car Sale – But, the Internet May Change Things Over Time
It’s a good question. I think it’s possible that an independent seller of just used cars might be a better business – especially if it combined locations with a really, really strong internet presence.
Big car dealer groups do have to compete with service shops. And perhaps they have lost share. But, the number of dealer locations relative to the amount of population (and certainly to drivers) has been declining throughout much of the history of the industry. So, I think the business has tended to get better not worse.
What’s the big difference?
I think two things benefit dealers.
Once, they potentially have a better source of leads for their new, used, and service businesses – in the form of a new car territory they control for a brand. So, often, when someone is in the market for a new Toyota they trade in their old Toyota. The dealer can take the trade in (getting a better supply of used cars than others might) and can get the possibility that the owner of the new car will buy financing products etc. through them and – most importantly – stay with them for servicing. So, they are in a better position than some to turn a new car sale into out sources of revenue – a possible service relationship, a good price on a trade-in used car, etc. This is why I think it’d be hard to compete in new cars even if there wasn’t the dealer system that there is. New cars are largely just a good way to have a customer relationship that can make you more money form things over time.
Second – and I think for most dealers, this is the bigger issue – I think dealer groups that include new car sales, used car sales, and servicing in one operation have a lower cost of capital than competitors would. It has been very easy for new competitors in the industry to succeed in stuff
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