Deep Value Course Materials (Updated)

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Course Materials Have Been Updated Here:

Read chapter 3 in DEEP VALUE and Dempster Mills Case Study (Buffett)

Have a good weekend.   

12 responses to “Deep Value Course Materials (Updated)

  1. Can someone help me out here? Pn page 42, it says that See’s was worth between $50m and $48m. How were those numbers worked out?

  2. I’m going to disagree with Carlisle on page 45. He says “if we assume all earnings are paid out … a business returning 20 percent on invested capital in perpetuity … is four times as valuable as another earning 5 percent on invested capital”.

    To be honest, I think that’s just bad maths and reasoning. Say what you want about Damodaran, at least his thinking is clear on this. For starters, you need to separate out assets between “assets in place”, i.e. assets that generate current income, and “growth assets”, i.e. incremental investments that generate future income.

    If a company is paying out all its earnings, then, barring financial engineering (i.e. leverage), it is effectively saying that it has no growth opportunities. How can it, if it is not reinvesting any earnings? It is, in effect, a perpetuity. Now I, as an investor, an outsider, can only then view a potential investment as a perpetuity. I don’t care what the business’s return on capital is, be it 1% or 100%, from my point of view, MY rate of return is the my share of earnings divided my cost.

    Perhaps the saving grace is that bonds are not generally inflation-linked, whereas earnings may be. But, I think, in general, what investors get rewarded for is high incremental returns on capital.

    That’s a reason why I think people should be a little more positive on Damodaran’s work. You have to think about growth, and the drivers of growth, think about how long you expect growth and returns to continue, and then do a DCF to come up with some idea of what the intrinsic value of a company is. If you understand that in principle, then I think you will see that you can’t just make satements like: a business returning 20 % is worth 4 times that earning 5%.

    In his book, Investing Against The Tide, Anthony Bolton expressed his dislike of PEG. Bolton said that given the choice between a company growing at 5% on a PE of 5, and company growing at 20% on a PE of 20, he would pick the former, every time.

    Bolton seems to have been very aware of mean reversion in returns.

    • There is another angle here which Toby hasn’t mentioned.

      The context is that See’s Candies was acquired during the 1970s, an era during which inflation ravaged markets all around the world.

      WEB’s approach to inflation was different from that advocated by others. The general consensus was that, to deal with inflation, you had to invest in “hard assets” and, better still, to use leverage to pass the economic cost of inflation to your lenders.

      WEB saw a different way – he sought businesses with high returns on capital and which required little in the way of capital reinvestment. Provided that your market position was such that you could raise prices to match the general level of inflation, that the extra cashflow wouldn’t be soaked up by additional capital reinvestment (also at generally rising prices). I haven’t expressed this idea very well but see an article written by WEB (possibly in Forbes, I don’t remember) which explains this point much better.

      There is another aspect of the See’s Candies purchase may not have been fully covered by Toby. Briefly, WEB & CTM believed that, given See’s competitive position, there was a realistic prospect that they could raise prices a little quicker than inflation, so as to enhance the profitability of the business. The Schroeder biography provides a little detail here – see the top of page 301 (in the paperback edition) – basically, WEB & CTM thought that they could probably earn say $6.5-7.0 million on the See’s business just by increasing prices a little.


  3. Very interesting at the bottom of page 48: “Most businesses over the course of a full business cycle will do no better than earn their required return. … Reinvestment will appear most attractive in peak years, and
    folly in trough years, but the reverse is usually the case because trough earn-ings follow peak earnings, and vice versa. Capital reinvested in peak years earns sub-normal returns as the business cycle moves toward a trough, and so is typically more valuable in shareholders’ hands.”

    This was my basic argument about Carnival in a previous post. Geoff Gannon was arguing, a couple of years ago, that it was capable of earning adequate returns on capital over a cycle. In June 2014 it was on a high PE ratio with a low return on capital. Greenblatt shorted at that time, essentially falling into what I said I believed to be the exact trap that Carlisle points out. Shares in Carnival shot up after he announced his short. Sometimes, Mr Market isn’t as stupid as he seems!

    I think it’s worth highlighting perhaps another area of opportunity. I remember, a few years ago in the UK, housebuilders were in a mess. Jim Rogers at the time said he wouldn’t invest in housebuilders because it could take 5 years before there was a recovery. I was very surprised by Rogers statement, because he is known as being a contrarian, and it was about the optimal time to invest. Sometimes, even great investors forget their own insights. But anyway, I digress … at the time, housebuilding was in a mess, and some were facing stresses so severe that they were forced into rights issues.

    Now, on the one hand, having a rights issue at a market bottom is probably the worst capital allocation decision you can make. That’s were the cost of capital is the highest. Now, I’ve thought about that, and I think it prevents interesting opportunities. When companies announce rights issues at steep discounts, their share price usually dive. My idea is largely this: look at bombed out sectors, and look for patterns of companies making rights issues. Wait awhile, and then consider investing in those companies that have had them. You are likely to be buying dirt cheap, in a sector that is likely to experience mean reversion, plus a rights issue probably means that a company’s finances are on a firmer footing.

  4. Your idea about rights issues is a good one. A few years ago, I made about 150% return on a small company in just such a situation.

    However, your idea works best by looking at rights issues in which insiders put up a substantial amount of new money into the company, whether by exercising the rights they are issued, by purchasing renounceable rights in the secondary market or by acting as underwriters/sub-underwriters.


  5. Just curious: did either of you (Nemo & Mcturra) buy the Liberty Broadband
    rights ?

    • No, I didn’t. But I’m sure we’d all be interested in it as a case study! I might take a look at them, now that you mention it.

      I have only become interested in spin-offs very recently. I am a UK investor, and there is very little in the way of spin-off activities. It is something that US companies are much more active in.

      My first ever spin-off was HYH (Halyard Health). I’m up 25% since purchase since December, but I think that might beginners luck. Here’s how I looked at it … the company had equity of about $2079m (although I think that may be mistated due to a one-time payment to KMB) . At the time, it had a market cap of $1755m. Working on the basis that it would generate about $1677m in revenues, its mkt cap to revenues was about 1.047 – considerably below a cohort that I chose which worked out at about a mean of 3.558. Similarly, if you looked at market to operating profit, HYH was trading at a ratio of 7.79, compared to a mean of 19.83.

      I figured that even if HYH took on some debt to fuel growth, it could probably sustain it giving the cash-generative nature of the business.

      I may have got my analysis completely wrong, of course, which is why I didn’t take a big position.

      Other factors I considered were:
      * the spinoff was small in relation to the parent, which is usually considered a good sign
      * even if you think the market is in a bit of a bubble, I tracked down the decade PSR (Price to Sales Ratio) of SN. (Smith & Nephew), a company in a similar’ish line, and its mean was 2.92. So I don’t think HYH is overvalued.

      Since spin-offs usually perform even better in years 2 and 3, I am tempted to stick around. These kind of businesses can also be pretty good compounders. I suspect that the business will generate good returns on capital, and plus, due to its small size, may well find a lot of growth avenues.

      It’s all speculation on my part, of course. Someone may point something out that would make me completely change my mind.

      Anyway, that’s how I looked at it. It would be interesting to hear of anyone else who bought in, and what their thought processes were.

      I started to write a PDF on HYH as a case study, which you can find here:
      I expect to flesh it out further as time progresses and events unforld.

  6. Thanks John,
    These Course Materials are outstanding. After downloading them last night, this morning I woke up at 4:40am so excited to get started. I was not disappointed — although I am a little sleepy.

  7. Hi,

    Is there any way you can update the amterial again, please? The materials are not available any more.


  8. Hello John,

    C0uld you please update the link or/and provide the key to the materials. Cannot figure out where to find them. checked the vaults, deep value group and here and so far did not succeed to find the course materials.

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