A member commented to the write-up I did yesterday on Pendrell. I think the comment and my response are worth making into a full follow-up “memo”. So, here they are: “Geoff, This company definitely seems promising. I saw the blog post from Hidden Value that you retweeted and ended up buying a small starter position in the company after reading the 10k. That was before even seeing that you ended up writing a post on it. I’m struggling to decide how to size the position...… Read more
I lost a lot of money in Weight Watchers. Let’s look at why that was. As I write this article, Weight Watchers (WTW) stock is at $44.30 a share. I bought my shares at $37.68 a share in 2013 and sold them (in March of 2017) at $19.40. So, I realized a loss of 49%. I also tied up money for about 3.5 years. During this same time period, the S&P 500 returned about 12% a year. I probably could have found something...… Read more
Focused Compounding includes a “Library” with 27 stock reports. I co-wrote those stock reports with Quan Hoang between 2013 and 2016. Although Quan and I no longer work together, he agreed to put his thoughts on that experience in writing for our community members to read. I think reading Quan’s “Reflections” will help you put each of those 27 reports in better context. Quan’s Reflections Geoff asked me to write a reflection on my experience writing The Avid Hog (a newsletter we later renamed...… Read more
“In lieu of (earnings per share), Malone emphasized cash flow…and in the process, invented a new vocabulary…EBITDA in particular was a radically new concept, going further up the income statement than anyone had gone before to arrive at a pure definition of the cash generating ability of a business…”
- William Thorndike, “The Outsiders”
“I think that, every time you (see) the word EBITDA you should substitute the word bullshit earnings.”
- Charlie Munger
The acronym “EBITDA” stands for Earnings Before Interest, Taxes, Depreciation, and Amortization.
A company’s EPS (which is just net income divided by shares outstanding) is often referred to as its “bottom line”. Technically, EPS is not the bottom line. Comprehensive income is the bottom line. This may sound like a quibble on my part. But, let’s stop and think about it a second.
If EBITDA is “bullshit earnings” because it is earnings before:
- Depreciation and
Then shouldn’t we call EPS “bullshit earnings”, because it is earnings before:
- unrealized gains and losses on available for sale securities
- unrealized currency gains and losses
- and changes in the pension plan?
I think we should. I think both EBITDA and EPS are “bullshit earnings” when they are the only numbers reported to shareholders.
Of course, EPS and EBITDA are literally never the only numbers reported to shareholders. There is an entire income statement full of figures shown to investors each year.
Profit figures further down the income statement are always more complete – and therefore less “bullshit” – than profit figures further up the income statement.
- EBITDA is always less bullshit than gross profit.
- EBIT is always less bullshit than EBITDA.
- EPS is always less bullshit than EBIT.
- And comprehensive income is always less bullshit than EPS.
Maybe this is why Warren Buffett uses Berkshire’s change in per share book value (which is basically comprehensive income per share) in place of Berkshire’s EPS (which is basically net income per share). Buffett wants to report the least bullshit – most complete – profit figure possible.
So, if profit figures further down the income statement are always more complete figures, why would an investor ever focus on a profit figure higher up the income statement (like EBITDA) instead of a profit figure further down the income statement (like net income)?
At most companies, items further up the income statement are more stable than items further down the income statement.
I’ll use the results at Grainger (GWW) from 1991 through 2014 to illustrate this point. The measure of stability I am going to use is the “coefficient of variation” which is sometimes also called the “relative standard deviation” of each series. It’s just a measure of how scattered a group of points are around the central tendency of that group. Imagine one of those human shaped targets at a police precinct shooting range. A bullet hole that’s dead center in the chest would rate a 0.01. A bullet hole that …Read more