Recent Articles at GuruFocus

Barnes & Noble (BKS): Anatomy of a Screw Up

Invest with Style

Adapt!: Trial and Error Investing

I’ve gotten a lot of good email questions lately. Usually, my GuruFocus articles are based on questions sent in by people who read the blog.

So if you want to read more articles: Send me your questions!

Ask Geoff a Question about Investing…

Interviews – Street Capitalist, Fat Pitch Financials, SINLetter, Cheap Stocks, and Greenbackd

Interviews

Tariq Ali of Street Capitalist

George of Fat Pitch Financials

Asif Suria of SINLetter.com

Jon Heller of Cheap Stocks

Toby Carlisle of Greenbackd

Talk to Geoff about the Interviews…

CCA Industries – Sardar Biglari

Someone who reads the blog sent me this email:

Geoff,

I see you tweeted about CAW again.  What about that company attracts you?  I don’t see that it is particularly undervalued and I am trying to understand what I am missing.

Sardar Biglari bought into the company. He will now have 2 board seats.

10-year average EBIT is about $5.75 million. So, the long-term average earnings would be about 50 cents a share after tax. Cash and securities is about $1.67. The stock trades around $6. That’s maybe a little less than 10 times earnings (after breaking out the cash).

Here’s the types of business they are in.

• Dietary Supplement: 33%
• Skin Care: 30%
• Oral Care: 20%
• Nail Care: 10%

Free cash flow tends to be equal to or greater than reported earnings. Cap-ex is virtually zero.

High management pay relative to the company’s size hides how profitable the business is.

For example, David Edell and Ira Berman made $2.88 million in 2009. This is against – like we said – an average EBIT of about $5.75 million. So, we’re talking more like $8 million+ in EBIT before these two get paid. Other executives are paid more what you’d expect the top folks at this kind of public company would normally make: $300,000 to $500,000.

I checked out the company’s products at a local drugstore. Though there will always be lawsuits, I thought it was a decent space to compete in. In the past, I’d researched a couple companies with similar business models. They had better brands. But CCA Industries was much cheaper.

Given the circumstances, I felt Biglari’s activism would lead to good things.

It’s coattail investing.

Talk to Geoff about CCA Industries (CAW) and Sardar Biglari…

LEAPS – And a Lack of Good Ideas

Someone who reads the blog sent me this email:

Dear Geoff,

in your article “Should you Buy Microsoft?” on GuruFocus, you said, that it makes sense for some investors to use LEAPS instead of the stock.

After thinking long about that, I came to the conclusion, that LEAPS can be viewed as a form of leveraged investment with an insurance against a falling stock price included…So LEAPS would make sense, if you want to leverage your portfolio with relatively low risk.

I’m not endorsing LEAPS.

I think they make sense only in situations where there is a level of catastrophic risk in the underlying stock that is not priced into the option. In general, this means low volatility stocks that nonetheless can fail catastrophically if infrequently.

Like banks.

I would use LEAPS to buy a bank because there is always the risk that a bank will go to zero. In that sense, LEAPS leverage your investment and provide protection – basically an involuntary surrender – where you cut down a huge loss while still betting on a favorable outcome.

The problem with LEAPS is that they aren’t long enough dated. 5-year LEAPS would be good. 10-Year LEAPS would be virtually indistinguishable from a stock in terms of a correct analysis resulting in profit. But 2 years is not long enough for a value investor. If Warren Buffett had bought Washington Post 2-year LEAPS instead of Washington Post stock in the 1970s he would have lost his entire investment. By buying the underlying stock, he had a return of 30% a year compounded over the first 10 years.

I’ve had stocks that didn’t work out for 2 years. But, boy, did they work out over 5 years. I would’ve lost money on the LEAPS.

Any bet that depends on the market recognizing something within 3 years is a bet where a value investor can be completely right in terms of analysis and yet lose everything simply because the clock runs out.

Value investing is largely based on being able to hold a position until the market changes its mind. I’d say it’s very unreliable to assume mean reversion in the market mood on a stock within 3 years.

The exception to this is when you’re diversifying both across a group of separate bets and across a period of time. For example, if you buy one stock a month every month and turn over the portfolio every year (by swapping out one stock each month), you may average an acceptable result because you’re actually making a dozen different bets on a dozen different stocks that depend on prices at a dozen different future moments in time.

That’s not what you’re talking about. You’re talking about making one bet on one stock that will succeed or fail based on whether or not the stock reaches a certain price fast enough.

Personally, I’m not interested in LEAPS.

And I really don’t think it makes sense to buy LEAPS on a …

Asset-Earnings Equivalence

Someone who reads the blog sent me this email:

When it comes to valuing a business, do you believe more in asset valuations or earning? Earnings aren’t guaranteed to be there in the future (depending on the industry, of course), but assets are only worth what you can sell them to somebody else for. Do you think a pizza shop should be analyzed based on how much pizza they sell or the value of its real estate & bank account? Should they all be assessed when determining a value for the business? This is the question i’ve been thinking about in trying to understand valuation…

I think earnings and asset valuation are kind of the same, because operating (earning) assets generate earnings. So the value of those earning assets are the present value of future expected earnings (owners’ earnings) generated by those assets…Then I think we need to add things like real estate, cash, marketable securities which i think are non-earning or non-operating (core) assets, then subtract liabilities to arrive at value of the firm as a whole.

Assets and earnings are equivalent.

You can always restate an asset in terms of earnings. And you can always restate earnings in terms of an asset.

You can always ask: what would this asset have to earn to be worth what the balance sheet says it’s worth? And you can always ask what someone would pay for a certain amount of earnings. If they’d pay that amount that means they’d trade you cash today for those earnings. And that means earnings can be thought of as being worth their (cash) sale value. So earnings can always be thought of as if they were an asset.

In physics, mass is a measure of the energy content of a body.

In investing, value is a measure of the earning content of a specific instance of capital.

When I say a business will provide earnings of 40 cents a share pre-tax and a business is worth $4.00 a share – I’m really saying the same thing under special conditions (certain interest rates).

Intrinsic value is always relative.

You can’t value anything without a reference point.

There are two ways you can value an asset. You can value it in static terms by comparing it to other assets and valuing the asset against them. This uses other assets as your reference point. Or you can value an asset by restating it as a flow of earnings and comparing that flow to the price-to-free cash flow multiples of other businesses. This uses other cash flows as your reference point.

Really, you’re just valuing the same thing – capital – in two different states.

This is very obvious if you look at businesses over time. Or if you look at special situations. Or deals of any kind.

Basically, capital starts its life in a business with no earnings and a lot of potential. Then it gets put into all sorts of specific forms (real estate, inventory, receivables, …

How Does Warren Buffett Apply His Margin of Safety?

My Investing Checklist

Risks

1. Catastrophic Loss
2. Failure to Snowball

Numbers

1. Altman Z-Score
2. Piotroski F-Score
3. Free Cash Flow Margin
4. Return on Capital
5. Free Cash Flow Margin Variation
6. Return on Capital Variation
7. Enterprise Value/10-Year Real Free Cash Flow
8. Enterprise Value/10-Year Real Earnings Before Interest and Taxes
9. Price/Net Current Asset Value
10. Price/Tangible Book Value

Questions

1. Is it crazy cheap?
2. Has it been profitable for a long, long time?
3. Does it do the same thing year after year?
4. Are folks who use the service happy to leave some cash crumbs on the table?
5. Is the value the company provides intangible?
6. Will existing customers stay even if a competitor lowers its price?

Talk to Geoff About His Investing Checklist…

Stock Analysis Process – How Geoff Researches Stocks

Someone who reads the blog sent me this email:

I’m interested to know when you analyse a company, do you follow a particular order? Do you always start from a screen? Do you look at its overall business and competition landscape before diving into its financials? And when you look at its financials, do you follow a particular order? Do you look at its income statement first and then balance sheet?

I don’t have a particular order for finding a stock/company. I do screens and stuff like that. I read blogs. I look at company’s competitors. I just go through some foreign stock exchanges from A to Z. Or some states from A to Z. Or some industries from A to Z.

Basically, I’m looking through lists of companies the way I figure Warren Buffett flipped through Moody’s Manuals. I’m moving quickly to see if the company is really cheap compared to past earnings and current tangible assets and current sales. But I’m not doing any math, I’m just using websites like GuruFocus or Morningstar or MSN Money or the stock exchange sites, or the company’s 5-year or 10-year financial summaries. You can find something like that online for a lot of companies and then you quickly just run your eyes over those numbers. Are they pretty ordinary looking? If so, just move on. If something pops, stop and look at the stock.

If any number catches my eye – like a ton of excess cash, or low p/b, or low p/s, or low EV to past EBIT, FCF, etc. I look at the company description. Usually I’ll use Bloomberg for this or the company’s own website. What does the company say it does? If it says it invests in real estate, copper mining, is an investment bank, etc. I drop it there. If it says it does something I think I can visualize if I work real hard at it, then I keep going. I look for words like “niche”, “specialized”, etc. I look for business descriptions that sound non-capital intensive. Do you test or monitor or score or report? That’s good. Do you make capital goods? That’s bad. Do you make something cheap and repeat purchased, that’s good? Do you distribute? Good. Produce? Bad. Do revenues sound recurring? Are you a one of a kind company? A possible “hidden champion“?

This is all from the one paragraph description. Some are pretty inaccurate. But a lot aren’t. You get interested in Bunzl real fast when you read about it, because of what the business does. This is the Bloomberg description for Bunzl:

Bunzl plc is a distribution group supplying a range of non-food consumable products for customers to operate their businesses but which they do not actually sell. The Company partners with both suppliers and customers in providing outsourcing solutions and service oriented distribution. Bunzl’s main customer markets include grocery, foodservice, cleaning and safety.

Really, those are the only words I saw. They distribute. …

Why Don’t You Write About Spin-offs? – Why “You Can Be a Stock Market Genius” is So Great

A Different Perspective on Japanese Stocks

Someone who reads my blog sent me this email:

Geoff,

I came from Japan to US for business school in 2001. I became extremely intrigued by Buffett’s value investment philosophy. I wanted to read everything available about his philosophy and became more and more familiar with his investment philosophy. And I personally pick stocks too.

Anyway, about investment in Japan, I read your “Japanese stocks: Now 34% of My Portfolio – Plan to hold Them For At Least 1 Year“, I see one part in “Buy Japan“, you are talking about “Japan is barely a capitalist country.” I see that you see Japan pretty well. They care much less about generating profits to shareholders than people do here in US. I imagine, that US investors who invest in Japan would feel slighted. They should be the boss, but not in Japan actually.

Here is the key point why I wrote. You say “It’s definitely the most investor unfriendly place on the planet – excluding a few countries that seize private property”. In my view, Japan is a country that would seize private property away from you. Not by legitimate ways, but more subtle but practical ways. Who has the largest control over Japanese economy? The system of capitalism?  Absolutely no. Bureaucrats have. They have tremendous control over businesses with both explicit laws and implicit powers.

They have ways to drag down companies performance that they don’t like. If a business is strong enough and brave enough to openly fight against bureaucrats, like Softbank did in the past, there is chance to win. But most businesses are afraid of this structural, chronic bully that deprives Japan of economic flexibility over the years. But interesting thing to me is, this chronic inefficiency sometimes works well, but sometimes doesn’t. Like it worked in our 70s to 80s. But not in the later decades. My father always tells me that this is just like fascism that drove Japan in WWII all the way to final disaster. When it works well, we are invincible, but once the ship turns to a wrong way, we are unstoppable. Being said that, I wonder how, like you mentioned, pre-war southern states unraveled their woven bonds and connections and became part of the rest of the capitalism world. Losing the war changed their way of business life completely? Then, maybe Japan also needs dramatic change like that.

In my view, the Japanese have strong fear of sticking out. If you stay in a crowd, you are invisible and no one would say anything. But if you stick out too much, bureaucrats will get you. Rising stars in business are always the easiest to go after for bureaucrats who are influenced by competitors. In US capitalism holds the power. This is the rule of the game and it seems that even the government cannot defy this rule. In Japan, bureaucrats rule the market most definitely.

And most obviously, this system is not working for