Munger’s Mental Models: http://robdkelly.com/blog/models-frameworks/munger-mental-models/
Lesson-on-Elementary-Worldly-Wisdom-Charlie-Munger
Another Great Blog: http://www.frankvoisin.com/ Search.
All things Montier: http://www.eurosharelab.com/james-montier-resource-page. Follow links to his 2002-2011 papers.
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Pop Quiz
Your boss says to put together a conservative portfolio, so naturally you start flipping through the Value-Line which you do religiously each week–glancing at every page of the 250 pages of Value-Line. You come across BDX_VL.
What two or three things do you notice? for a passing grade what ONE (1) metric should jump out at you! What pile would you put it–investigate, ignore, potential short?
Many “hedgies” and Wall Street “Analysts” miss this but YOU won’t.
Please keep replies short, two or three sentences at most. Prize emailed to the best response.
Reply:
I wanted to see whether you picked out:
- The announced $1.5 billion plan to buy back shares or about 10% of the outstanding shares. Couple that observation with the steady buy back/shrinking of shares with increasing dividend payments. Management is serious about return of capital. They get it. At least they are not empire builders.
- The consistent and high ROC of 15% or more over the past 12 years. Note that the business was barely dented in 2008 and 2009. Sales and cash flows rose. This is a stable business in the face of a credit crisis, so demand for their services/products seems inelastic. Good. They probably have pricing power.
- The company has debt-say around $5 billion but in light of its steady cash flows and 0.89 debt-to-equity ratio, the company is well-financed. Not the difference in capitalization structure with another slow growth franchise: CLX_VL! Management knows that the company has excess capital and slow growth ahead of it, so capital is being returned to shareholders.
- This company is a slow, growth decent business with profitable growth. Probably the moat is not due to proprietary patents. My guess–subject to reading a few years of annual reports and MD&A discussions in the 10-K–is that BDX has a powerful distribution network coupled with some customer captivity.
- Nobody addressed why this might be mispriced (assuming that it is)? Note the dotted line that goes up sharply during 2007/2009 then has dropped for the past 3.5 years. The price has gone “nowhere.” Certainly the stock price has “underperformed” the general market. Why?
Value PER share has been rising and management is set to shrink the share count further at these “reasonable” prices. I can’t say that the current price is attractive for you because of your return requirements. Have reasonable expectations, since I doubt BDX will double in price in the next two years. However, I CAN say, based on the numbers that this company is more stable operationally, generates higher returns than most businesses and near term returns will be driven by return of capital over the next few years, so my risk might be lower–than the average company. Yet, the company is priced at or below a market multiple. Now, even if the long bond Treasury was 6% instead of 2.9%, would this be interesting? Yes.
If I can find 20 to 25 of these companies at moderate discounts (15% to 25%), I might be able to preserve my capital over time. These stable companies rarely provide steep discounts to intrinsic value, but you have the benefit of profitable growth over time. The price you pay, ironically, has to be more precise than when buying a micro-cap due to the moderate price discount.
Prizes will be emailed out. Thanks. Excellent responses. Please take my grades with a large dose of salt 
Let me know if you enjoyed your prizes:
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Cash flow per share increases year over year.
Dividends follow this increase like clock work.
This is a very stable and predictable business.
Investigate pile
Shares out. Investigate.
You are close but you need to add what you mean by shrinking shares out.
C++
As someone who actually does go through VL page-by-page, shrinking shares out is what caught my eye first, encouraging me to read the whole thing. Then high, stable, and slightly increasing margins (and ROC). Everything else seems just to fill in the picture. I’d need to see a 10-K and annual letter to see how this really works, but so far looks like a good business with competent asset allocation in management.
Dear Adib:
OK, but you might not have caught a noticable event–an event that would make me more confident of owning this stock. B-/C+
Well, there’s some interesting things going here. One metric that really jumped out at me pretty much straight away, without having to do any mental calculations, is the high and consistent operating margins. At face value, something good is going on, here. That’s probably not the answer you are looking for, though. High and consistent ROE also got my attention. I immediately think, “hello, that’s interesting”.
I know it should be only 2 or 3 sentences, but I want to bring up a couple of other things. One is Buffett’s prediliction for protecting the downside, and looking for safe and dependable businesses that you might own for 10 years. A couple of days ago, I was reading through my own website, where I had made notes on Ben Graham’s “ten attributes of an undervalued stock”. Under the criteria of a history of stable earnings. they are that earnings have doubles in the most recent 10 years, and no more than 2 declines in earnings of 5% of more in the last 10 years.
Take a look at Tesco. It fits those criteria to a T. And it is on a historically cheap rating. I recalled Buffett’s words that “you don’t have to do many things right, as long as you don’t do many things wrong”. In a way, it’s like being hit by a brick. For all the complexity that analysts like to make of things, it needn’t be hard work. And GUARANTEED there are few few investors following this approach. So, the secret’s out, we now know how to invest like Buffett
But back on topic. I immediately applied this process to Becton. Without resorting to my calculator, I can see that from 2001 to 2011, EPS has indeed at least doubled. 2010 was the only year which recorded a drop in EPS, and that drop was slight. A scan, of less than 5 minutes, would convince me to put this on the “investigate” pile.
John,
How’d I do? Now I’m angry… You were testing me!!
I will send your prize.
Huge share shrink is what I am looking for.
I
1. Excellent return on capital employed/ROE YOY – going up almost every year while retaining only 17% of profits every year.
2. Cash flow increases wrt to capital expenses increases – Increases in cap exp increases sales/profits at good clip.
3. Allocation of capital – Excess cash is returned to shareholders via dividend/share repurchases.
Hi John,
First – $1.5B set to buyback shares this year. (about 10% decrease)
Second – Healthy dividend growth rate of around 10% last few years
Third – Return on total capital down a bit and return on shareholder equity up a bit, so they might be increasing debt.
Gopinath:
A- since you did not mention the recent large planned buy-back (probably to return capital from the sale of one of their divisions).
A date with the EX: http://www.youtube.com/watch?feature=endscreen&v=h6E0Shqba6g&NR=1
Dustin:
A+
Here was my analysis:
First, this is a large company, $15B market cap. I’m not familiar with the company and I am operating off of just what’s on the VL tearsheet, so without knowing much more about its business, industry, etc., I am going to say that while the company has had a healthy record of ever-increasing sales and growth in earnings, because of it’s size this company is not going to be a ten-bagger like it might’ve potentially been when it went from $1.5B to $15B. I have no idea what it’s total opportunity is for growth in the long run but my general assumption is fair/moderate and it should be analyzed as a more mature, slow-grower, not a raging bull of a small or mid-cap up and comer.
The next thing I notice is book value is growing, but this is in part a function of increasing leverage. The company is doing a debt for equity swap. They’ve made substantial share buybacks while increasing debt. In general, this concerns me because I think it’s more conservative to not have debt versus having debt. But in this specific environment, it’s an interesting strategic-financial decision. Interest rates are at all time lows, if a business has reliable earnings and cash flows and a good credit rating they can lever the company up and increase shareholder value cheaply.
They’re definitely getting their debt cheaply– a little less than 5% interest rate. Their earnings coverage is currently 6x, that’s a fairly conservative figure. There’s no preferred or other subordinated debt it looks like, so a nice clean, simple capital structure which I am in favor of.
However, they are a bit debt-heavy. If you add in the leases and pension fund obligations they’re closer to 1:1 debt to equity. That concerns me just from a conservative standpoint.
Their ROE is nice but appears to be juiced by the increasing leverage. My guess is the ROE would be stagnating a little bit without it, which I guess is concerning because it maybe shows that the underlying business is not as robust over time as you’d like– the biz is becoming more capital intensive? In general however, the ROC numbers are nice– this is a good business overall, high quality earning above average returns and it’s quite steady, not really cyclical.
They must do a lot of business overseas or something? They have a seemingly low income tax rate.
The pension shortfall is concerning. I’ve written about this (by channeling an FRMO commentary) recently: http://valueprax.wordpress.com/2012/08/01/the-infinite-regression-investment-philosophy-frmo-dnb-spy-geoffgannon/
This is an ongoing risk. Without knowing the specific parameters and objectives of their plan, I look at that as actual money they’ll have to make up at some point because I highly doubt their plan manager will perform and close the shortfall over the next 10-15 years. That means BV is overstated and the debt position is understated (even though this is “free float” because they’re not paying cash interest on it at the moment).
Overall, the valuation of the company in the market is fair to rich. I don’t know the structure of the balance sheet in terms of goodwill but I am guessing tangible book is even less than book and this thing is trading at strong multiples above both values. On an earnings basis it’s the same thing… at approx 15 p/e (higher if youre looking at average 5 or 10yr earnings to be more conservative) youre not really giving yourself a lot of room for multiple expansion and a capital gain on the investment.
Sorry, didn’t mean to post that as a reply. Whoops
Working Capital goes from $2.8bn in 2011 to a projected $900 in 2015-17. Increasing the CF, FCF and ROIC of the business. Why? Not sure if this has to do with the sale of the Discovery Labware business. I would follow-up with this one.
Oh crap, the share price has increased 134% since December of 2001, but the market cap only increased 70%. Half of your return was from the shrinking share count. VL only expects a modest 3.6% share count reduction from 2011 to 2015-17! Forget my previous post.
Could be totally on Mars with this but thought Operating Margin was consistent and growing? Leads me to believe this company has a viable “moat” It also translates into increasing Net Margin as well. I would put this into “investigate” pile. Will read other comments to see if I’m even on the right track…
Warren: Forget what Value-Line says do your own thinking. B plus a date with the EX http://www.youtube.com/watch?feature=endscreen&v=h6E0Shqba6g&NR=1
I think this would be a company to investigate.
1) I noticed sales/sh went up 3-4x but earnings even faster at 5-6x since 1996.
2) Shares o/s also seem to have been coming down consistently in addition to a decent dividend. Does anyone know off hand why shares o/s actually increased from ’96-’02? Was this due to acquisitions paid in stock or employee options?
3) High and stable margins and returns.
High ROC
Solid 10 year growth in cash flow
Priced at 9.75 times FCF
Investigate
John,
You mention 250 pages of Value-Line weekly. Do you recommend a yearly subscription and following this process of reading through the reports weekly? I am familiar with Buffett screening companies similarly but I suppose I am skeptical with all the “training” work to do (case studies, new pitches, news, etc.) whether valueline is worth adding to the list.
Just thinking aloud, any advice is appreciated. Thanks!
Mike,
You can often get VL for free at your local library. At mine they have the physical copy in one branch, plus you can access it online from anywhere by signing in using your library card/account.
I confess I sometimes can’t get into the library every week but then I do double time the next week. Do you live near a major library. I have yet to be in a moderately sized town’s library that didn’t have access to Value-Line.
don’t shell out $$. There must be one available to you. The points are:
you get a tremendous amount of info on one page, you have a long 10 to 14 years of historical results, and there is little commentary (stories to influence you). The big advantage is that you get a big “Feel” for valuations, business metrics, different industries, and expectations.
Look at all the Value-Lines for airlines. Except for one or two, the land of pain so don’t go there!
But as you go through the Value-Lines, you will quickly know what to discard.
Few people do it consistently. Is it no surprise that Buffett has more than the Value-line database in his head. He can instantly know what is interesting.
posititive
1-stable and steady growth in sales and earnings
2-high & stable RoC
3-Excellent Capital Allocation (div+Shr. Repurchase)
Negative
Stock Option Dilution
i will investigate stock option as directe result of share repurchase .other than this every thing in this company looks excellent to me.
OK, I will post my reply in the body of the post in a few minutes.
An emailed prize will still go out to all, including those with dates.
Not what John asked for, but I’d remind everyone not to automatically assume those share repurchases were a good thing. The 10-K says they spent $1.5B to purchase 18.4M shares in 2011. That’s $81.52 per share they paid but today BDX trades at $75.50.
A one year time horizon is short though. Usually I put the repurchases going back 4-5 years in a table to see how those “investments” have done to present day vs. if the company had just given me the money to put into VFINX.
An excellent point, which I recently covered in some depth here: http://valueprax.wordpress.com/2012/08/25/a-record-of-some-misgivings-dwa-dis-frmo-whopperinvest-valueinvesting/
Excellent point. Time will tell whether they bought below intrinsic value. Valueprix is right, you need a few years to see how they have done.