Notes on Warren Buffett’s 2011 Letter to Shareholders
You can read my thoughts here.
Talk to Geoff about Warren Buffett’s 2011 Letter to Shareholders…
Read moreFree Cash Flow: Adjusting For Acquisitions, Capital Allocation And Corporate Character
Someone who reads my articles sent me this email:
…. I would appreciate your thoughts on three questions of mine:
When calculating the free cash flow of serial acquirers, should the acquisition costs be factored in?
What are your thoughts on using pre-tax earnings, FCF, etc., yields to evaluate the attractiveness of securities. Intuitively, post-tax is all that matters, but pre-tax numbers allow for a more straightforward comparison between equities and fixed-income securities.
Now for a more company-specific question. Sotheby’s (BID) is inherently a very good business, but management owns only a small sliver of equity and in the past has failed to act prudently in the use of the balance sheet (impairment charges show up on cash flow statement following downturn in art market). The language in the SEC filings since that point is encouraging… which brings me to my question. How can an investor evaluate if management has learned from past missteps? Or is it so time consuming that a more efficient use of time would be to move on to other ideas?
Thanks again,
Patrick
Great questions. I get similar questions a lot. Especially about how to treat cash flows used for acquisitions. Is it really free cash flow? Or is it basically just another form of capital expenditure?
And questions about management changing their stripes are very, very common. That’s a tough question. But since these two questions are connected, I’ll start with the acquisition issue first.
When calculating the free cash flow of serial acquirers, should the acquisition costs be factored in?
Yes. If the company really is a serial acquirer, acquisition costs should be considered equivalent to cap-ex. The issue of acquisitions is always one that can be considered part of cap-ex or not part of cap-ex. If spending on acquisitions is treated as if it is part of cap-ex, then your expectations for that company’s growth would be higher (because they would be growing through acquisitions). If it is not counted as part of cap-ex, then your expectations for that company’s growth should be lower (because you are not treating acquisition spending as a normal part of the company’s year-to-year progress).
Sometimes it may be easier to estimate growth before acquisitions.
For example, a company involved in a mundane business like running hair salons – like Regis (RGS), dentist offices – like Birner Dental (BDMS), grocery stores – like Village Supermarket (VLGEA), or garbage dumps – like Waste Management (WM), may be easy to estimate as essentially a no-growth business.
Sotheby’s would be harder. Because there is not a steady, year-in-year-out kind of demand for their products. And a growth company like Facebook would also be impossibly hard to evaluate this way. There is no normal industry wide rate of growth at those kinds of businesses. You simply have to evaluate them on a company-specific basis. You have to dig into their growth stories the way someone like Phil Fisher would.
But what about…
Read moreWhat to Look for in Japanese Net-Nets
Someone who reads the blog sent me an email asking about a specific Japanese net-net. Rather than trying to choose the best net-nets from among the entire hoard in Japan, I would suggest doing one of two things:
- Bigger investors can simply collect all the Japanese net-nets they find.
- Smaller investors can simply apply a tougher standard than mere net-netness.
In my own portfolio, I went with option #2. I bought 5 Japanese net cash stocks last year. I’ve since sold one of them. I have some cash. And am looking to add a couple more Japanese net cash stocks. Right now, they make up 30% of my portfolio. Again, I’m willing to go as high as 50% in Japan. We’ll see what happens.
But that’s me.
What would I suggest for others interested in Japanese stocks?
Here’s how I would look at Japan. If you can find stocks selling for less than net cash with few/no operating losses in their long-term history, buy them. Don’t so much look for net-nets in general. Start with an even higher standard. Start with profitable, net cash companies. They are close to non-existent in the U.S. But not Japan. After that, I’m not sure I would necessarily just look at net-nets. For example, there are some cheap Japanese gas companies that are not net-nets (most of their assets are PP&E) but are super reasonably priced on an EV/EBIT basis. To me, it is more important to find totally obvious bargains than to get caught up in the definition of what a net-net is or isn’t.
Totally obvious bargains fall into a few categories. Here are 2:
- Stock market says the business is worth more dead than alive (profitable net cash stocks)
- Stock is much cheaper than its peers around the world (gas companies)
In fact, if you really look, you may find some gas companies, grocery stores, etc. that are very cheap on an EV/EBIT or EV/EBITDA basis that you like better than some of the net-nets. That’s fine. Buy the most obvious bargains. The things that are clearly selling for less than they are worth.
If you’re only going to buy half a dozen Japanese net-nets, you should look for net cash bargains. Once we are talking about receivables, inventory, etc. you need to know more about the business. So it needs to be a simple business or a business you can learn about. That’s harder. For me personally that means it makes sense to buy net cash bargains in Japan and look for net-nets on the basis of receivables, inventory, etc. in the U.S. Because in the U.S., I have a better chance of knowing the difference between a predictable business and an unpredictable business.
If I could find 10 consistently profitable companies selling below net cash in the U.S., I wouldn’t buy any Japanese stock. Because I understand American businesses better. But I also understand that a consistently profitable company selling for less than net cash will work out as …
Read moreWorking for GuruFocus
I finally made the move to Texas. And am now working full-time for GuruFocus.
Here are the articles I’ve written since joining them last week:
Can You Build a Liquid Portfolio with Illiquid Stocks?
Free Cash Flow: Adjusting for Acquisitions, Capital Allocation, And Corporate Character
What Are the Minimum Requirements for a Good Net-Net
Pain and Patience: Net-Nets, Magic Formulas, and Micro Caps
How to Read a 10-K: What is the Most Important Part?
Free Cash Flow vs. Owner Earnings: Which Matters More?
How Long Should You Hold a Net-Net?
You’ve Crunched the Numbers: Now What?
Western Digital (WDC): Ben Graham Bargain or Mispriced Bet?
Understanding an Industry: Is Simple Better than Familiar?
Are Most Net-Nets Uninvestable?
Do Working Capital Reductions Count as Free Cash Flow?
Warren Buffett’s (Modern Day) Margin of Safety
Berkshire Hathaway’s New Buys – And One Really, Really Old One
David Einhorn’s Buys: More Tech and a Return to Yahoo (YHOO)
Glenn Greenberg’s New Buys: Growth Stocks for Value Investors
What Books Should You Read About Ben Graham?
GAAP Accounting: Restatements vs. Realities
Vistaprint (VPRT): The Makings of a Moat?
How Do You Estimate a Stock’s Intrinsic Value?
What Stocks Would Phil Fisher Buy Today?
I also write GuruFocus’s Ben Graham Net-Net Newsletter and GuruFocus’s Buffett/Munger Bargains Newsletter.
All my writing will be done over at GuruFocus from now on. But I’ll still be on Twitter. And you can always email me.
So don’t be a stranger.
Read moreVariation
Someone who reads my blog sent me this email:
Geoff,
Reading your articles. I am confused between standard deviation and coefficient of variation. Standard deviation itself shows how much variation exists from the average then what does coefficient of variation tells us?
Gurpreet
Standard deviation shows the amount of variation. Not related to anything. The variation coefficient shows the relative amount of variation. The standard deviation related to the mean. You should always relate the standard deviation to the mean. Otherwise, you will think height varies a lot among NBA basketball players because they are all tall while height varies little among children because they are all short.
Standard deviation is not a number that ports well. The variation coefficient is. It’s a way of seeing how big the swings above or below the average have been in terms of the average. Have they been one-third of the average? Or have they been the same size as the average?
For example, two companies can both have a standard deviation of 10% in their operating margins over the last 10 years. If one company has an average operating margin of 10% and the other has an average operating margin of 30% – that same 10% swing is going to feel very different. The variation coefficient tells you this. The standard deviation does not.
I need to make two points here. One, I use stats to describe. Not predict. Two, I use stats to compare. To rank. Different people have different reasons for measuring the things they measure.
If your goal – like mine – is to describe the past and compare different company’s pasts to each other, the variation coefficient is the right number to use.
Talk to Geoff About Variation…
Read moreFaith in Net-Nets
My latest net-net article over at GuruFocus includes my clearest explanation of what to look for in net-nets – and more importantly – what it takes to make money investing in net-nets:
If the balance sheet is very liquid and insider ownership is very high – there’s a good chance something will happen. I have no idea what. And I have no idea when. But someday, something will happen to increase the return on those assets…Sometimes it’s as simple as returning the assets to shareholders, using net cash to make a management buyout super cheap, or using net cash to buy a totally different business…When you buy a net-net you are not buying future earnings. You are buying future assets. What I’m talking about here is asset conversion. At some point, you are expecting today’s assets will be converted into something you can profit from. Something a control investor will pay for. Or something the market will reward.
It’s very hard to imagine these events ahead of time. But you can still bet on them:
That’s the uncertainty in net-nets. Most of the best net-nets have this certain/uncertain duality. It is certain the stock is selling for less than it’s worth. It is uncertain how the stock will ever sell for what it’s worth.
Remember what Ben Graham told the U.S. Senate:
The Chairman: When you find a special situation and you decide, just for illustration, that you can buy for 10 and it is worth 30, and you take a position, and then you cannot realize it until a lot of other people decide it is worth 30, how is that process brought about – by advertising or what happens?
Mr. Graham: That is one of the mysteries of our business, and it is a mystery to me as well as to everybody else. We know from experience that eventually the market catches up with value. It realizes it one way or another.
Talk to Geoff about Faith in Net-Nets
Read moreInvestor Questions Podcast: All Interviews and Episodes
Someone who reads the blog sent me this email:
Hey Geoff,
Thanks for posting up your old podcast episodes! Any chance you can put up the interview series episodes as well? Thanks!
-Drew
Sure. Here are links to all the interviews and episodes. Remember, they are old. So any references to stock prices, market conditions, etc. are out of date.
Interviews
Tariq Ali of Streetcapitalist (Interview/Site)
George of Fat Pitch Financials (Interview/Site)
Asif Suria of SINLetter (Interview/Site)
Jon Heller of Cheap Stocks (Interview/Site)
Toby Carlisle of Greenbackd (Interview/Site)
Episodes
Talk to Geoff About the Podcast…
Read more3 Net-Net Articles
Here are the 3 net-net articles I’ve written over at GuruFocus:
When Is a Bad Business a Good Net-Net?
Expect a new net-net article each Friday. The net-net newsletter comes out once a month. The next issue is set for January 6th. The newsletter picks one net-net a month. And holds each pick for one year. Starting in April, I’ll be writing about the performance of each net-net as it exits the portfolio. So you’ll get to judge the newsletter’s results for yourself.
So far they’ve been ugly. 2011 was not a good year for net-nets. At least not in the U.S.
On the bright side, it looks like one of my Japanese net-nets – Sanjo Machine Works – is going to be bought out.
Even though Sanjo is just one-fifth of my Japanese net-net portfolio the 140% return on Sanjo will end up making 2011 a good year for the group despite my other four Japanese net-nets doing absolutely nothing pricewise.
Read moreNet-Net Series Starts at GuruFocus
Today, I wrote the first of what will be a weekly series of net-net articles over at GuruFocus.
The article is called “How Many Net-Nets Are There?”
And the answer is 142.
By the way, a new issue of GuruFocus’s net-net newsletter comes out tonight. It’s free for GuruFocus Premium Subscribers.
The weekly articles are – of course – free for everyone.
The articles will appear each Friday. The newsletter comes out on the first Friday of each month.
Read moreJapanese Net-Nets: 6 Months Later
It’s been about 6 months since I bought a basket of 5 Japanese net-nets.
A couple people have asked about how my Japanese net-nets have done. I started making these investments around April of this year. I wrote the “Buy Japan” post before buying my 5 Japanese net-nets. And it took me about a month of bidding for these micro caps to get my orders filled.
Since then, in dollar terms, the 5 stocks are up: 6.41%, 7.53%, 12.80%, 18.35%, and 20.88%.
You can use the March 16th date of my “Buy Japan” post as a convenient way of measuring the influence the Japanese Yen / U.S. Dollar exchange rate has had on the performance of those stocks. For Japanese investors, your results would obviously not include these Dollar exchange rate changes.
Let’s just say these Japanese net-nets have done better than my U.S. net-nets this year. It doesn’t matter if you are calculating returns in local currency or dollars. My Japanese net-nets have been my best performers this year.
I will re-evaluate the positions around June of next year.
I generally hold net-nets for at least a year before considering whether they should be sold. This gives them time to run.
Most people sell net-nets too fast because they dislike the underlying businesses and are not used to having such large gains in a single year.
Of course, the truth is that a net-net that rises 50% or even 100% is usually still a very cheap stock. So it’s silly to sell a net-net just because it’s gone up.
Talk to Geoff About His Japanese Net-Nets…
Read more