Category Archives: Special Situations

An Insider’s View of Capital Allocation (Corporate Finance and Valuation Case Studies)

Posted on December 8, 2011 | 10 comments

This is includes an important reading found here: http://www.scribd.com/doc/75125923/Capital-Structure-and-Stock-Repurchases-Value-Vault.  Also in the Value Vault.

The 58-page document will start with buy backs from a corporate finance (an insider’s) perspective as described by Mr. Louis Lowenstein, the CEO of Supermarkets General and a Law Professor at Columbia University. Then you will read what the masters, Buffett and Graham had to say on the subject. If, when and how a company buys back its shares says a lot about the business and capital allocation skills of management as the Case Studies of Teledyne Corporation and others will show. You will learn the importance of context and circumstance as the principles of good and bad capital allocation are applied. I hope you find the lessons instructive.

From the introduction

Whether the business is a franchise or not, management has two major jobs: operate the business efficiently which is critical in a non-franchise business since earning the company’s cost of capital is the best outcome and allocating capital effectively. Growth is only profitable in a franchise business, therefore capital allocation is critical for shareholder returns.  If a franchise’s core business is unable to grow, often free cash-flow can’t be redeployed at the same high returns. Capital might need to be returned to shareholders but how much and in what way?

Thinking about what management will do with excess cash is important for your valuation work. Should the excess cash on the balance sheet be discounted heavily because management tends to make poor choices (Greenblatt) or will management buy-in shares, causing the per share value to rise (Duff & Phelps valuation case study)?  You will be given a corporate insider view on these issues.

Share repurchase programs should be an integral part of a company’s capital allocation process, one in which management weighs reinvestment opportunities not only against the alternative of cash dividends but also both of those alternatives against a third alternative, the buyback of common stock. Management has several capital allocation alternatives:

Business Needs: Working capital, Capital expenditures, and Mergers & acquisitions

Return Capital to Shareholders: Dividends, Share buybacks, and Debt repayment

You will gain many insights from your reading.

Supplementary materials from a reader:

http://www.capatcolumbia.com/MM%20LMCM%20reports/Clear%20Thinking%20about%20Share%20Repurchase.pdf

Dividends from an investor’s perspective:

10 Comments

Posted in Search Strategies, Special Situations, Valuation Techniques

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QUIZ. Good Learning Resources: Net Nets, Liquidations and Special Situations

Posted on December 4, 2011 | 8 comments

Net/Nets, Liquidations and Special Situations

I have a large library on special situation investing and eventually all will be posted or in the value vault. However………

The near-term focus of this blog will be strategic logic and valuation, but I want  investors who are starting their journey to have access to resources for asset-based (non-franchise) investing.

You can learn how to invest just as if you were analyzing a company. Start with the balance sheet and work down from simple to complex.  Cash is a more solid asset than a tax asset, for example.

But as you read the following resources always be thinking as a business person. Ask what is the economic reality of this asset or liability.

QUIZ

Can YOU name a fixed asset on a balance sheet that really is economically the same as a current asset, almost as liquid as cash?  Conversely, can you name a situation where a current asset is less liquid than a typical fixed asset?   Hint: Marty Whitman of Third Avenue Value Fund has preached this lesson often. (see links below).

Please take no more than 20 seconds to answer the first question. Prize: A tip from Jim Cramer on CNBC. C’mon, you can’t expect to win much on such a simple quiz!

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This document has several excerpts from Graham, Klarman and Whitman on liquidation values.  A good primer on liquidation analysis.

http://www.scribd.com/doc/74692616/Special-Situation-Net-Nets-and-Asset-Based-Investing-by-Ben-Graham-and-Others

If you are going to pursue asset-based investing then you need to study Marty Whitman. Read his first book (not a breezy read, though)

http://www.amazon.com/Aggressive-Conservative-Investor-Investment-Classics/dp/0471768057/ref=sr_1_1?s=books&ie=UTF8&qid=1323016112&sr=1-1#reader_0471768057

And his shareholder letters: http://www.thirdavenuefunds.com/ta/shareholder-letters-mf.asp

If you are a shareholder or a student you can call his office and ask for his book of shareholder letters: 1990 to 2005.  Highly recommended.

Marty Whitman on value and corporate governance

You can learn from blogs that focus on this type of investing.

My favorites: www.greenbackd.com (excellent. If you read all his posts and analyze past investment ideas you will have a solid grounding in net/nets.)

For podcasts on investing and net/nets from a self-taught investor: www.gannononinvesting.com

Also: http://www.manualofideas.com/blog/

http://www.rationalwalk.com/?p=2472

http://can-turtles-fly.blogspot.com/

Another good overall resource:

http://www.burgundyasset.com/index.asp?Main=FAMinst&Section=Library&SubSection=View&View=normal

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A reader kindly offered to share his resources here: http://motiwalacapital.com/blog/

And he suggested viewing these videos and materials: http://www.bengrahaminvesting.ca/resources/videos.htm–

You are on your way………….

8 Comments

Posted in Investing Gurus, Special Situations, Valuation Techniques

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Pzena (PZN) Disappointment, Despair and Tax Loss Selling

Posted on November 15, 2011 | 19 comments

A reader has asked about search strategies and I plan to do a more indepth post on search strategies including screening techniques.

Some people think of what Thanksgiving may bring while I look for tax loss selling in small, obscure, and deeply disappointing stocks.

Here is one company that might fit the bill:

To understand the depth of the disappointment we might compare PZN to other small caps:

I have had enough

When I go to www.pzena.com and look at their recent press release I see $13.7 million in managed assets so a low-end valuation of assets under management (AUM) might be 2% or (2% of 13.7 billion or $274 million divided by 65 million shares (both A & B) or $4.23. Enterprise value is about $200 million after subtracting $38 million in cash and EBITDA is around $45 million (there isn’t much capex with human capital). If assets stabilize, then perhaps asset values are above enterprise value–I might have a margin of safety.

Mr. Pzena almost blew up his firm with investments in Citigroup (“C”) during the 2008/2009 crisis. His firm’s equity performance since then has been good but he has to maintain good performance to turn his three and five-year performance record to top quintile performance. Go here: www.pzena.com

Ok, so that is a reason I would then go to the 10-K and dig deeper; there is enough here to make it worth my time to spend another hour or two. Please, this is NOT an investment recommendation since there may not be enough of a cushion to have a comfortable margin of safety. Also, there may be more attractive alternative investments than this one.

The main point is to look for disappointment. Now I have no proof that there is tax loss selling but with the company underperforming the Russell 2000 for several years and the recent decline during this tax loss window (Oct. – Dec.), I am making a supposition that some investors are making a tax decision rather than an investment decision.

Let’s revisit this in 6 months to see whether my thesis has more substance.

19 Comments

Posted in Search Strategies, Special Situations

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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 11th 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

  1. 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.

2 Comments

Posted in Accounting, Risk Management, Special Situations

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Lecture 8: LEAPS

Posted on October 13, 2011 | 3 comments

If you take the time to understand LEAPS (long-dated options) and combine this tool with your search for bargains, you can craft specific risk reward investments with 100% to 1,000% upside. In certain situations, you can design much better risk and reward outcome than investing in stock.  When LEAPS work well, they can becoming addictive, so portion control is critical.

The Professor looks at options/LEAPS in a unique way.

Go here: http://www.scribd.com/doc/68687870/Lecture-8-on-LEAPS

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Posted in Risk Management, Special Situations

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