Category Archives: Accounting

CASE STUDY on Xerox (XRX)

Posted on March 16, 2012 | 24 comments

There is, finally, the supremely important problem of combating general fluctuations of economic activity and the recurrent waves of large-scale unemployment which accompany them. This is, of course, one of the gravest and most pressing problems of our time. But, though its solution will require much planning in the good sense, it does not — or at least need not — require that special kind of planning which according to its advocates is to replace the market. Many economists hope, indeed, that the ultimate remedy may be found in the field of monetary policy, which would involve nothing incompatible even with nineteenth-century liberalism. Others, it is true, believe that real success can be expected only from the skillful timing of public works undertaken on a very large-scale. This might lead to much more serious restrictions of the competitive sphere, and, in experimenting in this direction, we shall have to carefully watch our step if we are to avoid making all economic activity progressively more dependent on the direction and volume of government expenditure. But his is neither the only nor, in my opinion, the most promising way of meeting the gravest threat to economic security. In any case, the very necessary effort to secure protection against these fluctuations do not lead to the kind of planning which constitutes such a threat to our freedom.–Hayek’s The Road to Serfdom, pp.121-22.

CASE STUDY

Your boss drops XRX’s 10K, www.yousendit.com/download/M3BscHBNTkxTRTdyZHNUQw on your desk. Then he asks, Should we sell out of this position since the company’s market cap is about $11 to $12 billion with $9 billion of debt and an underfunded Pension Fund?

Is this company dangerously over leveraged? Yes or no and why? Please reply in 20 minutes or less. If you feel you can’t adequately answer, then what would you need to find out? State your reply in no more than a sentence or two.

Value-Line Tear Sheet on Xerox for Reference:
http://www.yousendit.com/download/M3BscHBNTkxPSHo0WjhUQw

Prize to be determined.

Long-Term Bonds

The cure (low interest rates) IS the disease: http://mises.org/daily/5164

If you own long-term government bonds then the question you have to ask yourself is……………………..http://www.youtube.com/watch?v=u0-oinyjsk0

Housekeeping

I will post the analysis of Coke/Pepsi Case Study this weekend. And we have one final installment on ROIC before burying that dead horse.

Have a good weekend!

24 Comments

Posted in Accounting, Economics & Politics

Tagged Bonds, Dirty Harry, Interest Rates, Xerox

SNPK Follow-up on Toxic “Death Spiral Convert” Convertible

Posted on March 14, 2012 | 28 comments

It is a fraud to borrow what we are unable to pay.–Publilius Syrus

SNPK Discussion

Yesterday I posted the case study and quiz question here: http://wp.me/p1PgpH-z5 and financial information was posted here: SNPK’s Financials: http://www.scribd.com/doc/85185922/SNPK-Financials

Readers are too astute to be asked whether a company like SNPK is worthy of their time as a potential investment. The company is an obvious promotion.

However, while taking 30 seconds–not a second more–to scan the financials, I saw a debt instrument that I thought had been banned back in the 1990s–a toxic convertible on pages 6 and 7 of the 100+ pages PDF on SNPK. There it was lurking quietly.

If you see a company like SNPK that is cash flow negative, you know to focus on the sources of financing because, without outside funding, this “firm” is defunct. The amount of debt and the terms are what you immediately focus on. Several readers pointed out all the other horrors like insider control, other debt, Panamanian shareholder, Nevada corporation, and who might the CEO be since this is a one-man show (a former broker at FBR). The company has no competitive advantages and about $95,000 in assets (not including liabilities). The convertible note and other debt is what is funding this “company.”

Prize Awarded to all contestants

Anyone who answered will receive an email prize from me this afternoon. Good effort.

Since the wording of my test question may have been poor, I have taken on a new job in penance:http://www.youtube.com/watch?v=jF-CkMpQtlY&feature=related as a Village Idiot.

….OK, back to SNPK

The firm was created as a reverse merger into a shell company:

Through a Share Exchange Agreement

Control

On February 13, 2012, Sunpeaks Ventures, Inc., a Nevada corporation entered into that certain Share Exchange Agreement (the “Share Exchange Agreement”) with Healthcare Distribution Specialists LLC, a Delaware limited liability company, (“HDS”), Mackie Barch, the managing member of HDS, who presently owns 100% of the issued and outstanding membership interests in HDS, and Scott Beaudette, the majority shareholder of the Company. Pursuant to the terms and conditions of the Share Exchange Agreement, HDS shall exchange 100% of the outstanding membership interests in HDS in exchange for: (i) two hundred million (200,000,000) newly-issued restricted shares of the Company’s common stock, par value $0.001 per share and (ii) three million (3,000,000) newly-issued restricted shares of the Company’s Class A Preferred Stock, par value $0.001 per share. The exchange will result in HDS becoming a wholly-owned subsidiary of the Company.

Paid-off and Private Market Value

Additionally, pursuant to the Share Exchange Agreement, Mr. Beaudette shall cancel two hundred million (200,000,000) shares of the Company’s common stock that he currently owns (He was paid on his $5,000 loan to the company–so we have a private market transaction giving a $5,000 worth to the 200 million shares). Perhaps current market value of $100 million plus might be unsustainable?

As you scanned for notes to all the debt outstanding you found: Toxic Convertible on pages 6 and 7.

ITEM 02

UNREGISTERED SALES OF EQUITY SECURITIES.

On March 1, 2012, Sunpeaks Ventures, Inc. (“we” or the “Company”) issued a 10% convertible note in with an original principal amount of $200,000 (the “Note”) to an investor. The Note provides for an interest rate of ten percent (10%) and matures on March 1, 2014. The Note is convertible into shares of our common stock, par value $0.001, based on a conversion price that is equal to a twenty percent (20%) discount to the average market price over a ten (10) day period immediately prior to the conversion date.

The issuance of the Note was offered and sold in reliance upon exemptions from registration pursuant to Section 4(2) of the Securities Act of 1933, as amended.

The convertible note is being “secured” by the stock market fantasy currently being perpetuated on gullible “investors” and/or stock traders. Who is buying during those 100 million share trading days? If you are unclear why the above is so toxic, then read the document provided in the link below.

Toxic Convertible (“death Spiral Converts”)

Used by companies that are in such bad shape, that there is no other way to get financing. This instrument is similar to a convertible bond, but convertible at a discount to the share price at issuance and for a fixed dollar amount rather than a specific number of shares. The further the stock falls, the more shares you get. Popular in the mid to late 1990s. Also known as death spiral convertibles or floorless convertibles.

Death Spiral

A loan that investors give to a publicly-traded company in exchange for convertible bonds. The convertible bonds give the investor a right to buy shares in the company at a low, agreed-upon price. However, issuing these bonds creates more shares outstanding when they are converted, which results in a drop in the share price. The low share price encourages more bondholders to convert their bonds to equity, which causes a further drop in price and the process continues. Because of this disadvantage, companies only engage in death spirals if they badly need cash.

Below is a definitive report on the horror of Toxic Convertibles (34 pages)http://www.law.emory.edu/fileadmin/journals/elj/54/54.1/Nayini.pdf

Of course, you would have noticed another loan, an unsecured promissory note. But the $200,000 (more than twice the reported assets of the “firm”) was all you needed to know. The shareholders will be left holding the bag. This is a $0 in a year or two.

Let’s clean off the slime and grime and return to work.

28 Comments

Posted in Accounting, Competitive Analysis, Investor Psychology, Valuation Techniques

Tagged SNPK, Toxic Convertibles

Case Study, Test, and Prize on SPNK–A Fantasy, Scam, or Fraud? Cheer Up and Look on the Bright Side of Life!

Posted on March 13, 2012 | 21 comments

If everything seems to be going well, you have obviously overlooked something.–Steven Wright

SPNK: Can you Find the ticking bomb?

Anyone who specifically points out in the documents (see link below) where there is guaranteed devastation for the common shareholders will receive an A+ and an email prize.

If someone has posted a reply in the comments section, try not to read it, and think through the case on your own. Why are we in the world of Penny stocks, pump and dump stock schemes and Mafia-controlled companies–far, far away from our cherished franchises like IBM. Colgate, and Stryker? Sometimes if you invert, you can learn more about financial statements and human nature.

Skim through the 115 pages and focus on the critical areas. Tomorrow evening I will post my analysis of this document. The goal is to get you to pick out the danger areas. Obviously, this company has little financial value based on its assets and operations, but what is particularly lethal to any shareholder?

Good luck!

SNPK’s Financials:http://www.scribd.com/doc/85185922/SNPK-Financials

Guess how stocks like SNPK are sold:

http://www.youtube.com/watch?v=4zakyg3thfY

http://www.pennystockresearch.com/nsrs-csoc-pump-and-dump-alerts-february-1-2012/

I just received an email alert:

Dear valued subscribers,

SNPK closed at 70 cents today. Getting one step closer to multi dollar territories. We are absolutely confident of the massive potential this pick holds.

If it can just reproduce a fraction of the gains our last pick experienced it would still hit multi dollar levels.

Tomorrow may be one of the last opportunities our members will have to buy SNPK under a dollar.

The company announced this morning that its product, Clotamin, will be sold in about 70 different Discount Drug Mart locations around Ohio. This is on top of the product being available in 9 different states already, and being just picked up by Dakota Drug Inc. for distribution.

Those of you who did buy SNPK a few days ago and are holding are already up a lot.

Those of you who didn’t buy it yet are definitely considering to place an order first thing in the morning.

Do you remember how much our last pick soared? If you had just put $1,000 at our initial alert and and liquidated into near multi dollar levels you could’ve pulled more than $20,000 within 2 months. Not a bad ROI when the S&P returns around 8% a year on avg.

If you invest in anything with 8% return such as the S&P that same $1,000 will take you 40 years to turn into $20,000. As we just mentioned our last pick could have potentially created 40 years’ value in just weeks. Then you could possibly do it all over again with our next pick after it (which in this case is SNPK).

It is already up almost double since our initial alert 4 short days ago. That same gain would take 9 years to produce with the S&P.

The company is in negotiations with a major NBA star to support their products. Let’s stay tuned as this is important information!

SNPK has been steadily climbing every day! Our members couldn’t be happier!

http://www.zdnetasia.com/stock-pump-and-dump-spam-makes-comeback-62301948.htm

Stock pump-and-dump spam makes comeback

By Ellyne Phneah, ZDNet Asia on September 6, 2011News of the global debt crisis is driving pump-and-dump stock scams in volatile markets, enabling spammers to make profits by artificially “pumping” up stock prices so as to sell cheaply purchased stocks, note a new report by Symantec.Released Monday, the Symantec August 2011 Intelligence Reportrevealed that spammers are seeking to reap from fluctuations in the turbulent financial markets, by sending large amounts of spam related to certain “pink sheets” stocks, in an attempt to “pump” the value of these stocks before “dumping” them at a profit.”Pink sheets” are typically over-the-counter stocks of companies that are not required to submit financial statements to the U.S. Securities and Exchange Commission.”With the world still reeling from the recession, the stock markets are now in turmoil from the increasingly global credit crisis and the specter of a ‘double dip recession’, whereby the [world] economy is expected to again tank after a brief rally,” said Samir Patil, a security researcher at Symantec, in a blog post.According to Paul Wood, senior intelligence analyst at Symantec’s cloud business, scammers can make “substantial profits in a matter of days” with well-executed pump-and-dump spam campaigns. “In the current turbulent environment, many people may be convinced to invest in stocks that scammers claim will benefit from the market turbulence,” he pointed out in a statement.

In a typical pump-and-dump stock scam, spammers promote certain stocks to inflate the price as much as possible so they may then be sold before their valuation crashes back to reality, said Symantec. The spam for these scams tries to convince the prospective investor that the cheap or penny stock is actually worth more than its valuation, or that it will soon skyrocket.

However, most of these claims are misleading or false, the vendor warned in its report.

In a successful campaign, the influx of spam will artificially drive the stock’s price to a point where scammers decide to sell their shares. This usually coincides with them ending the spam campaign, which could reduce interest in the stock, helping to drive the valuation back to its original low price, which could also be exploited in the market.

Most of the pump-and-dump spam originate from the United States and China, while a percentage is being generated from other countries in Asia. The majority of the attacks target North American users, Symantec revealed.

The report also noted a deluge of penny stock spam promoting Resource Exchange of America Corp (RXAC.PK) stocks whereby messages were full of irrelevant line breaks and spaces between words.

The e-mail headers contained broken words such as “Stocks” and “money” with poorly translated non sequiturs throughout the message such as “United States still an AAA country, Obama says?!”.

Other examples of e-mail subjects include “Stocks Ready to Bounce?”, “There is a MASSIVE PROMOTION underway NOW!” and “Been right on the money”.

In order to avoid falling prey to e-mail scams such as pump-and-dump scams, users should create a spam filter, never respond to spam and get multiple e-mail addresses for multiple purposes, Stephanie Boo, regional director for Symantec’s cloud business, advised.

“The Internet world is a borderless one. Today’s volume and sophistication of threat activities have increased substantially and cybercriminals continue to be motivated by financial gains,” she said in an e-mail. “Pump-and-dump scams are just one of the many tactics that cybercriminals leverage to attack consumers and enterprises alike.”

—

Cheer up and look at the bright side of life

http://www.youtube.com/watch?v=L2Wx230gYJw&feature=related

21 Comments

Posted in Accounting, Competitive Analysis, Investor Psychology, Risk Management, Search Strategies, Valuation Techniques

Tagged Penny Stocks, Pum and Dump, Scams, SNPK

EBITDA leading to EBIT and then to ROIC; Accounting blogs

Posted on March 12, 2012 | Leave a comment

We literally called Jon Corzine. We called Jon Corzine because we knew that he knew about the economy, about the world markets, about how we had to respond.” –Vice President Joe Biden, talking about the people he asked for advice from during the financial crisis.

Jon Corzine recently resigned as the CEO of MF Global. The firm declared bankruptcy after making bad bets on European Sovereign debt.
The bankruptcy was the fourth-largest financial firm in U.S. history, and the eighth largest overall.

EBITDA into Perspective

We will finish our discussion on return on invested capital (ROIC) this week, but first let’s return to fundamentals. Joel Greenblatt uses (EBITDA minus maintenance capital expenditures (“MCX”) as his proxy for Operating Earnings or EBIT.

Many may have not seen the 36-page PDF on placing EBITDA into context*. Once we know MCX, we can subtract that estimated figure from EBITDA to arrive at pre-tax operating income–the bedrock upon which we divide by the amount of capital used to produce such income for calculating ROIC.

We will discuss MCX in another post.

EBITDA mentioned here: http://csinvesting.org/placing-ev-and-ebitda-into-perspective-case-studies/

*Placing EBITDA into perspective (36-page PDF): http://www.scribd.com/doc/66843869/Placing-EBITDA-Into-Perspective

Recent blog discussion on EBITDA: http://blogs.smeal.psu.edu/grumpyoldaccountants/archives/542

Educational Blogs on Accounting and Financial Statement Analysis

http://mgt.gatech.edu/news_room/news/2009/articles/FALreporttaxpayments.html

http://www.10qdetective.blogspot.com/

http://accountingonion.typepad.com/

http://www.footnoted.com/

http://www.thebigdo-over.com/

http://www.proxydemocracy.org/

http://sharesleuth.com/

http://blog.issgovernance.com/

Another Reader’s Question: Any Suggestions on How to Learn How to Invest?

Posted on March 5, 2012 | 18 comments

Index investing outperforms active management year after year.–Jim Rogers

Reader: How Do I learn how to invest? Suggestions?

My reply follows in three parts: What NOT to do, traditional advice, and what I suggest.

What NOT to do

Here is what you should NOT do when learning how to invest.

Ignore the difference between price and value: http://www.youtube.com/watch?v=pMz_sPs11HU

Sit all day watching CNBC so you can be “up on the economy and markets.” http://video.cnbc.com/gallery/?video=3000034368

Buy whatever Cramer recommends:http://www.youtube.com/watch?v=gUkbdjetlY8 but wait until the price pops higher so you can be sure. You remember the adage: “Only buy what goes up, and if it don’t go up, don’t buy it.” If you can find the most popular companies mentioned relentlessly in the news wait until the price has been rising for a several months, then buy. Price is everything. Be part of a group. Ignore any conflicting information in your investments because you won’t be successful being negative. After any purchase, ask friends what they think of the stock. Choose someone randomly and ask them why you own the stocks you have in your portfolio. If they don’t answer, yell at them for their stupidity.

After losses, blame anyone but yourself. Buy as many stock-tip newsletters as you can afford, so you don’t miss anything. If the story sounds good, then buy the stock. Read Barron’s to supplement what you hear on CNBC and buy what the experts think–just do it quickly. Avoid becoming confused by reading the 10-K, proxy, annual reports, product and customer information and/or credit reports. Do what the charts say. Attend expensive training and trading schools like http://www.tradingacademy.com/stamford/ (Click on Video)

Or http://www.wallst-training.com/

You will make so much money that spending $10,000 for a two-day course will be a great “investment.”

Spend as much time learning about Macaulay Duration, efficient frontiers, and predicting the markets as you can. Live by the saying, “Often wrong, but never in doubt.”

Traditional advice in order of preference:

http://www.aier.org/product/how-invest-wisely-2010 A non-profit research organization on economics and personal investing in Great Barrington, Ma. A good source of independent research for individual investors. Recommended that you view their store on investing materials.
http://news.morningstar.com/classroom2/home.asp?colId=397&CN=COM This site has a series of classes to teach you the simple basics. Not bad for beginners.
American Association of Individual Investors: http://www.aaii.com/
http://www.fool.com/how-to-invest/index.aspx?source=ifltnvpnv0000001
http://finance.yahoo.com/education/begin_investing/article/101181/Advice_for_a_Novice

What I suggest

Any advice I give is from my perspective so what works or worked for me may not fit your personality, goals and situation. With that caveat let me suggest:

First, read the classics: The Intelligent Investor by Ben Graham, Rev. Edition by Zweig. Get a feel for how Graham approaches investing. Next read, Margin of Safety by Seth Klarman (in Value Vault) as a further reinforcement of the value investing approach. You can then read, The Interpretation for Financial Statements by Graham in the Value Vault to give you a basic background for reading 10-Ks.

You will need to read Warren Buffett’s letters to shareholders several times to grasp all the points he is making. A good book, The Essays of Warren Buffett here:http://www.amazon.com/Essays-Warren-Buffett-Lessons-Corporate/dp/0966446119organizes his letters into subjects for easier reading. Or go to http://www.berkshirehathaway.com/letters/letters.html

Second, pick an industry with a simple product that you can understand with a few industry participants and pretend to write a story on the industry. Take the carbonated beverage or beer industry–the product is simple and there are fewer than a dozen major companies in either industry. Read the 135-year history of Coca-Cola, read a book or two about Pepsi. Then take five years of annual reports and proxies from Cott beverages, Pepsi, and Coke and read them.

Third, figure out what their returns on capital are, sales trends, profit margins and company risks. Would you want to buy one of these businesses? At what price? Why are certain companies doing better or worse than their competitors? Have their market shares changed much over the years? Can they raise prices?

You will need to spend about two or three months reading about 30 minutes each day but you will become fairly knowledgeable about beverages. If you don’t like my idea for beverages then choose an industry/business that YOU are really interested in.

Finally, read through Security Analysis by Ben Graham (6th Edition). Note your interest in the readings. If sitting alone for hours is agony or pawing through Security Analysis is unbearable, then that will tell you volumes. Don’t worry if you haven’t the personality or interest to be a self-directed investor, just know your limitations and respect them.

If you struggle with financial statements, take a free internet course on accounting or take a course at a community college. There are plenty of programmed texts so you can learn on your own.

Learn Austrian economics–see prior post on studying financial history here: http://wp.me/p1PgpH-wN.

If you are very ambitious, get a subscription to Grants at http://www.grantspub.com. Then download all the issues since 1983, read all the books mentioned in the issues and try to understand the investment merits or lack thereof in the companies mentioned. You will learn more than going to business school.

Read the commentary in the Value Investors Club at http://www.valueinvestorsclub.com/value2

Learn how investors view various investments. Try to reverse engineer the company recommendation by looking at the original financial statements.

I hope this helps. Let me know how your journey progresses.

18 Comments

Posted in Accounting, Free Courses, Investing Careers

Tagged AAII, AEIR.ORG, beverages, Fool.com, Learn to invest, Trading Academy, Trading Places

More on ROIC……….

Posted on March 2, 2012 | 1 comment

It is not whether you are right or wrong that’s important, but how much money you make when you’re right and how much you lose when you’re wrong.- Stanley Druckenmiller

`ROIC`

First discussed here:http://wp.me/p1PgpH-v0

Greenblatt’s discussion of ROIC plus www.fool.com’s series of articles on ROIC so you can understand different approaches.

http://www.scribd.com/doc/83548528/ROIC-Greenblatt-and-Fool-Articles

For beginners or those who need a refresher, a Khan Academy Video on return on capital:

http://www.khanacademy.org/humanities ---other/finance/core-finance/v/return-on-capital

1 Comment

Posted in Accounting, Search Strategies, Valuation Techniques

Tagged Fool.com, Greenblatt, ROIC

Investment Book Recommendation

Posted on February 13, 2012 | 1 comment

Normally I am not a huge fan of investment books since many are poor substitutes for the classics.

The Investment Checklist The_Investment_Checklist by Michael Shearn (2012) gives new and intermediate investors a more programmed approach to analyzing investments including competitive advantages. I have no affiliation with the author, but I recommend. Is the book perfect? No. Figuring out if management is motivated is harder than the checklist approach would make it seem. However, you will benefit by being relentlessly thorough BEFORE you invest.

Two reviews below.

Anyone wishing to utilize a disciplined method for investing should read this book by Shearn.
Good investing mean avoiding mistakes and taking calculated risks. Identification of risk involves deep thinking about “what can go wrong?”. This is where this book shines, since it forces you to adopt a structured approach of working through a checklist of the possible unknowns. Too many unanswered items? – Take a pass until you can complete the checklist.

What I really liked about the book are the tons of real life examples of exactly what he means. You look at investor conference calls in a different way, as it has an exhaustive section on evaluating management and their responses. Are they honest? Are the overly promotional? What are they trying to hide? You see real life examples of both sides – the good and the bad ones.

The book made me think of many situations in the past that were strong clues about excessive risk.

Another useful aspect of the book is that it provides many outside sources (websites, etc) to check your facts. Investing in teen retailers? Shearn provides a number of free sources to verify and understand trends.

I’ve no doubt that this book will make me better at researching a company.
For anyone not employing a checklist – the Shearn checklist provides a great template to success.

R. Michael Knipp
Private Investor

Good book – a little discussion on valuation would have been nice,January 4, 2012

By Andrew Wesley McDill (Chicago, Illinois United States) – See all my reviews

Overall, I thought the book was very interesting and well written. It did a nice job of helping people learn how to think about businesses from a strategic and competitive point of view. The one thing that would have made the book better would have been some discussion to tie the strategic analysis of the company to some valuation frameworks. There was some mention of what the author and his firm were paying for certain companies when they purchased the stock, but it was not a complete discussion of valuation and the related value investing concept of a margin of safety. With that said, I do think that the anecdotes included in the book were helpful and added good context.

1 Comment

Posted in Accounting, Investing Gurus, Investor Psychology, Risk Management, Search Strategies

Tagged Investment book, Value Investing Resources

Learn Accounting; Industry Metrics; Amazon; Geico Valuation; Klarman, Textbook Pubs. are Toast

Posted on January 31, 2012 | 2 comments

“Your goal as an investor should simply be to purchase, at a rational price, a part interest in an easily understandable business whose earnings are virtually certain to be materially higher five, ten and twenty years from now. Over time, you will find only a few companies that meet these standards – so when you see one that qualifies, you should buy a meaningful amount of stock. You must also resist the temptation to stray from your guidelines: If you aren’t willing to own a stock for ten years, don’t even think about owning it for ten minutes. Put together a portfolio of companies whose aggregate earnings march upward over the years, and so also will the portfolio’s market value.” –Warren Buffett

To the Austrians, economics is not a tool of social control, it’s a framework for helping us understand humanity, its history, and our plight in the world”–Peter Boettke

Accounting and Financial Metrics of Industries

Learn more about accounting and a good source of industry metrics (please don’t share my secrets!)http://mgt.gatech.edu/fac_research/centers_initiatives/finlab/index.html

Heilbroner, a socialist, admits socialism is a total failure: http://reason.com/archives/2005/01/21/the-man-who-told-the-truth

Klarman and the Importance of History

Facing History and Ourselves. I am sure this has been posted before, but if not, view this. http://vimeo.com/32333102

Charlie479 Discusses AMZN

A generous reader shared this: Interesting comments from Charlie479 on AMZN (from VIC). Another example of an investor who thinks strategically and like a business person.

charlie479 12/20/11 11:25 PM AMZN one of the best companies I forgot to say that I chuckled thinking about the analyst making the “I want to buy Amazon at 100x earnings” pitch. I suppose that doesn’t necessarily make it mispriced but the earnings power is certainly higher than current GAAP net income. I think they could easily raise their prices by $0.63 per each $25 order (not exactly the same thing, but if Super Saver shipping was $0.63 instead of free, would that really change shopper behavior?). If they managed the business to maximize current profits like this, that $0.63 increase per $25 would double earnings. If sales grow like they did the past 12 months then suddenly the multiple isn’t looking so crazy. I’m not saying this makes AMZN one of the top half dozen stock investments in the world but the p/e might not be awful if your thesis is right.

I’ve occasionally wondered if someone could beat Amazon if they had $80 billion. I don’t think they could take over the #1 spot but I do think they could become competitive in a lot of areas. I would probably use the $80 billion to start several category-specific internet retailers, develop a large selection within that category, and drive turnover by capturing mind share as the expert in that category and as the lowest price seller, initially at losses. This is more or less the Amazon playbook, and companies like Diapers.com (before being bought), Newegg, and Blue Nile have managed to carve out niches. I bet there will be more. I think if VCs or public markets are willing to lose enough money for awhile, it isn’t that hard to replicate the warehouse network and other logistical moats.

Another reason to temper the who-needs-another-pipeline thought I posed in the previous comment is that consumers sometimes choose retailers for reasons other than price and selection. Certain bricks and mortar retailers will always have an advantage in terms of convenience (e.g. convenience stores, insightful eh?). And customers like to touch and try on certain products, like clothes, so I don’t see Amazon getting anything close to 50% share in those categories. Freshness matters, too, so it’s not clear grocery can be effectively penetrated by Amazon, and I bet that is a large portion of the Global Retail sales denominator. So, perhaps the current internet retail number at 3% is lower than what most people think, but maybe the maximum theoretical internet retail percentage is also lower than what most people think.

charlie479 12/20/11 10:47 PM AMZN one of the best companies

I think Amazon is one of the most admirable companies in the world. It has the expense advantages in rent and labor over B&M retailers that you mention, and it has cost advantages over other internet retailers as well. The massive sales volume makes the fixed cost percentages very low, and the inventory turnover in many products is so high that it can accept lower gross margins and still generate higher ROIC than competitors who charge a larger markup. The lower markup attracts more customers and generates more volume, which only reinforces the edge. It is the higher-turn/lower-markup Borsheim’s dynamic that Buffett describes.

The advantages aren’t limited to cost either. The high turnover also allows them to carry a huge number of SKUs at adequate ROIC, so they can offer customers the widest selection in many categories. For certain categories, after I browse Amazon and then Wal-Mart, I’ll come away feeling that Wal-Mart doesn’t have much of a selection. It’s hard to make Wal-Mart look narrow. Amazon is the first/last place many people shop because they know it has the widest selection and it’s likely to have that selection in stock.

Another non-price advantage is that they’re the most trusted internet retailer. I actually think those customer satisfaction ratings might be understating the difference. Their return policy and customer service is great. Even if a product is available from discountworldxyz.com at a slightly cheaper price, I’ll pay more to get it through Amazon because I know it’ll be the product I ordered, or else I’ll be able to return it. Who wants to deal with negotiating shipping costs or return policies with anyone else? I don’t think this is simply Amazon being more generous than discountworldxyz.com. They have the low-cost structure described in paragraph #1 that allows them to accept higher return costs while still generating better ROICs. I also suspect that their extensive review database reduces some of the likelihood of returns.

I think many retailers like Best Buy are at such a severe selection and cost disadvantage (even adjusting for sales tax) that their businesses are in trouble in the long-term. I even worry about beloved Costco. I no longer have no-price-comparison-needed-let’s-just-buy faith when walking down the aisles at Costco because Amazon has better prices frequently enough to make me doubt. More broadly, as someone who is cheering for the Costcos (no financial rooting interest, I just root for them because I admire them), I worry that Amazon will get to such scale one day that it’ll be a more efficient overall system for one UPS guy to drive from the Amazon warehouse and cruise through your neighborhood dropping off everything you and your neighbors need for the week. That might sound crazy but the current system of having you and all your neighbors separately drive SUVs 15-20 minutes to Costco to each walk through the aisles hand-picking and then checking out, doesn’t sound that efficient by comparison. I haven’t read anything about Bezos explicitly saying that’s his endgame but I wouldn’t be surprised if that’s in the 10 year wish list. If they end up with the cheapest and widest pipeline, there might not be much need for other pipelines.

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Tagged AAPL, AMZN, charlie479, Fisher Investments, GA Financial Lab, GEICO, Heilbroner, History, Klarman, Socialism

The Best Blog for Behavioral Investing and Improving Your Thinking

Posted on December 5, 2011 | Leave a comment

The best blog for improving your thinking: www.simoleonsense.com. You will learn about your own psychology and how you think—essential knowledge for becoming a better investor. The material on this blog has excellent links.

New York Times Article on the Khan Academy

As previously mentioned, the Khan Academy is a great learning resources for you and for kids. Brush up on statistics, for example.

http://www.nytimes.com/2011/12/05/technology/khan-academy-blends-its-youtube-approach-with-classrooms.html?_r=1&scp=1&sq=khan%20academy&st=cse

Referred to here:http://csinvesting.org/placing-ev-and-ebitda-into-perspective-case-studies/

A Protest at the Federal Reserve

http://www.newschannel5.com/story/16181894/protestors-disgruntled-with-federal-reserve-bank. Expect many more of these protests as our currency debasement continues.

Attack on the Austrian View of the Great Depression

I like to read theories, thoughts, or facts contrary to what I think is correct. You test your thinking and, God forbid, you could be wrong. The Great Depression will help you understand the biggest business cycle and depression of the past two centuries. Read: mises.org/rothbard/agd.pdf (Copy and paste into your browser.)

An article on the Austrian view of the Great Depression and the criticism of that view: http://mises.org/daily/5826/Defending-the-Austrian-Explanation-of-the-Great-Depression-from-an-Internet-Attack

Planning Curriculum

I will start this week planning the curriculum to study strategic logic while developing the building blocks for valuation, then tying the two together.

Lecture 11: Balance Sheet Analysis and How to Learn Accounting

Posted on October 18, 2011 | 2 comments

This lecture focuses on the balance sheet and how to spot warnings.

Go here to download the lecture: http://www.scribd.com/doc/69296625/Lecture-11-Balance-Sheet-Analysis-Duff-Phelps-ROE-vs-ROC

The Professor and Great Investor (“GI”) in this 11^th lecture recommends two books to learn how to read a financial statement.

(1.) The First book is Ben Graham’s: Interpretation of Financial Statements (Basic)

http://www.amazon.com/Interpretation-Financial-Statements-Benjamin-Graham/dp/0887309135/ref=sr_1_1?=books&ie=UTF8&qid=1318951113&sr=1-1

(2.) The second book is Thornton O’Glove’s Quality of Earnings which has good case studies (recommended).

http://www.amazon.com/Quality-Earnings-Thornton-L-Oglove/dp/0684863758/ref=sr_1_1?s=books&ie=UTF8&qid=1318951199&sr=1-1

You need an intermediate level of accounting knowledge to be firmly grounded. You can take classes at a community college or you can read beginning and intermediate accounting textbooks, but you must have the particular text’s student guide to work the accounting problems or else you will not grasp all the concepts.

The two best books (I have found) for corporate finance and financial statement analysis are:

(1.) Analysis for Financial Management by Robert C. Higgins (Corporate Finance)

http://www.amazon.com/Analysis-Financial-Management-subscription-card/dp/007325858X/ref=pd_rhf_se_p_t_1

The Student Guide for your review and preview is here:

http://highered.mcgraw-hill.com/sites/0073382310/student_view0/powerpoint_presentations.html

Financial Statement Analysis and Security Analysis by
Stephen N. Penman is excellent though the acronyms I found difficult at first. This text will help you understand how to value growth–a critical part of investing. Make sure you have the edition that corresponds to the Student Guide so you can study the problem sets found here:

http://highered.mcgraw-hill.com/sites/0073379662/student_view0/chapter4/

Once you have mastered those texts you can find case studies and further review here:

Financial Shenanigans: How to Detect Accounting Gimmicks & Frauds in Financial Reports (3rd. Edition) by Howard Shillit

http://www.amazon.com/Financial-Shenanigans-Accounting-Gimmicks-Reports/dp/0071703071/ref=sr_1_2?ie=UTF8&qid=1318951047&sr=8-2

You can also go to short-seller blogs that have many examples of their work for you to study.

An Australian Hedge Fund manager who has been uncovering Chinese Frauds and whom you can learn from is here: http://www.brontecapital.com/ (an excellent blog).

Off Wall Street Consulting, Inc. provides samples of their research here: http://www.offwallstreet.com/research.html

I recommend that you download their reports and also download the 10-Ks or annual reports of the companies mentioned in their research reports (and year corresponding to the date of the research report). Try to critique their research; can you follow the analysis from reading the financial statements yourself?

You will be learning from skilled professionals with a track record. Yes, it is work to download 10-Ks, research reports, and then read several thousands of pages, but you will learn more than sitting in an MBA classroom on how to value businesses.

You will know the strengths and weaknesses of financial statements, how to spot frauds and how to convert accounting numbers into useful information to find bargains or avoid blow-ups. Not bad for a few hundred dollars and a few months in deep study.