Category Archives: Valuation Techniques

Damodaran Valuation Lecture at Google

Valuation Readings:


Or take Buffett’s Course

I don’t understand why business schools don’t teach the Warren Buffett model of investing. Or the Ben Graham model. Or the Peter Lynch model. Or the Martin Whitman model. (I could go on.)

In English, you study great writers; in physics and biology, you study great scientists; in philosophy and math, you study great thinkers; but in most business school investment classes, you study modern finance theory, which is grounded in one basic premise–that markets are efficient because investors are always rational. It’s just one point of view. A good English professor couldn’t get away with teaching Melville as the backbone of English literature. How is it that business schools get away with teaching modern finance theory as the backbone of investing? Especially given that it’s only a theory that, as far as I know, hasn’t made many investors particularly rich.

Meanwhile, Berkshire Hathaway, under the stewardship of Buffett and vice chairman Charlie Munger, has made thousands of people rich over the past 30-odd years. And it has done so with integrity and a system of principles that is every bit as rigorous, if not more so, as anything modern finance theory can dish up.

On Monday, 11,000 Berkshire shareholders showed up at Aksarben Stadium in Omaha to hear Buffett and Munger talk about this set of principles. Together these principles form a model for investing to which any well-informed business-school student should be exposed–if not for the sake of the principles themselves, then at least to generate the kind of healthy debate that’s common in other academic fields.

Whereas modern finance theory is built around the price behavior of stocks, the Buffett model is centered around buying businesses as if one were going to operate them. It’s like the process of buying a house. You wouldn’t buy a house on a tip from a friend or sight unseen from a description in a newspaper. And you surely wouldn’t consider the volatility of the house’s price in your consideration of risk. Indeed, regularly updated price quotes aren’t available in the real estate market, because property doesn’t trade the way common stocks do. Instead, you’d study the fundamentals–the neighborhood, comparable home sales, the condition of the house, and how much you think you could rent it for–to get an idea of its intrinsic value.

The same basic idea applies to buying a business that you’d operate yourself or to being a passive investor in the common stock of a company. Who cares about the price history of the stock? What bearing does it have on how the company conducts business? What’s important is whether you can purchase at a reasonable price a business that generates good returns on capital (Buffett likes returns on equity in the neighborhood of 15% or better) without a lot of debt (which makes returns on capital less dependable). In the best of all worlds, the company will have a competitive advantage that allows it to sustain its above-average ROE for years, so you can hang on to it for a long time–just as you would live in your house–and reap the power of compounding.

Buffett further advocates investing in businesses that are easy to understand–Munger calls it “clearing one-foot hurdles”–so you can come up with more reliable estimates of their long-term economics. Coca-Cola‘s basic business is pretty staid, for example. Unit case sales and ROE determine the company’s future earnings. Companies like Microsoftand Intel–good as they are–require clearing much higher hurdles of understanding because their business models are so dependent on the rapidly evolving world of high tech. Today it’s a matter of selling the most word-processing programs; tomorrow it’s the Internet presence; after that, who knows. For Coke, the challenge is always to sell more cases of beverage.

Buying a business or a stock just because it’s cheap is a surefire way to lose money, according to the Buffett model. You get what you pay for. But if you’re evaluating investments as businesses to begin with, you probably wouldn’t make this mistake, because you’d recognize that a good business is worth buying at a fair price.

Finally, if you follow the Buffett model, you don’t trade your investments just because our liquid stock markets invite you to do so. Activity for the sake of activity begets high transaction costs, high tax bills, and poor investment decisions (“if I make a mistake I can sell it in a minute”). Less is more.

I’m not trying to pick a fight with modern finance theory enthusiasts. I just find it unsettling that basic business-school curricula don’t even consider models other than modern finance theory, even though those models are in the marketplace proving themselves every day.




The Base Rate Book


the-base-rate-view-by-mauboussin  I wonder if readers will find this useful.  We last discussed base rates here:


Portrait of a contrarian; Steel Partners

Notice the flawed thinking and view of history by the “brilliant” bankers. Being laughed at is often a good sign if you are trying to avoid the herd.

Portrait of a contrarian

Steel Partners: Value Investors and Operators.







Is the unit cheap now? What do YOU think and why?  A great blog for NCAV stocks and more!



Hi John:

A while back you took my Investment IQ Test questionnaire. As you may recall, it was based on the character traits of the world’s most successful investors I outlined in my book, The Winning Investment Habits of Warren Buffett & George Soros.

Here, very briefly, are a few of the “highpoints” of the investment behaviors that made them so successful.

I trust you enjoy it and I appreciate your comments.

Best regards,

PS: If you prefer to read it in your browser just go here.

7 Investment “Tips” From the World’s Richest Investors

Warren Buffett, Carl Icahn, and George Soros are the world’s richest investors. Their investment styles are as opposite as night and day. Buffett buys companies that he considers to be good bargains; Soros is famous for his speculative forays into the currency markets, which is how he came to be known as “The Man Who Broke the Bank of England.”

But—as I have shown in The Winning Investment Habits of Warren Buffett & George Soros—they both practice the same 23 mental habits and strategies religiously. As do Sir John Templeton, Bernard Baruch, Peter Lynch, and all the other successful investors I’ve ever studied or worked. It doesn’t matter whether you buy stocks, short currencies, trade commodities, invest in real estate, or collect ancient manuscripts: adding these mental strategies to your investment armory will do wonders for your bank account.

To make it easy to get going, I’ve distilled these 23 mental habits into these seven simple (though not always easy to follow) rules:

1. If you’re not certain about what you’re intending to do, don’t do it

Great investors are always certain about what they are doing whenever they put money on the table. If they think something is interesting but they’re not sure about it, they do more research.

So next time, before you call your broker (or go online), ask yourself: “on a scale of 1 to 10, how certain am I that I will make money?” Choose your own cut off point, but if it’s less than a 7 or an 8, you definitely need to spend more mental energy before making a commitment.

Remember: the great investor’s sense of certainty comes from his own experience and research. If your sense of “certainty”doesn’t come from your own research, it’s probably a chimera.

2. Never take big risks

Warren Buffett, George Soros, Peter Lynch . . . they only invest when they are confident the risk of loss is very slight.

Okay, what about that person you heard about who made a bundle of money in copper or coffee futures or whatever by taking on enormous leverage and risk? A few simple questions:

  • Did he make any other big profits like that?
  • Did he do this last year as well, and the year before that, and the year before that?

If not, chances are that’s the only big profit he ever made.

(And what did he do with the money? If he spent his profits before he got his tax bill . . . )

The great investors make money year in year out. And they do it by avoiding risk like the plague.

3. Only ever buy bargains

This is another trait the great investors have in common: they’re like a supermarket shopper loading up on sale items at 50% off.

Of course, the stock exchange doesn’t advertise when a company’s on sale. What’s more, if everybody thinks something is a bargain, the chances are it’s not.

That’s how Benjamin Graham, author of the classic The Intelligent Investor, averaged 17% a year over several decades of investing. He scoured the stock market for what he considered to be bargains—companies selling under their break-up value—and bought nothing else.

Likewise, Warren Buffett. But his definition of a bargain is very different from Graham’s: he will only buy companies he can get at a discount to what he calls “intrinsic value”: the discounted present value of the company’s future earnings. They’re harder to identify than Graham-style bargains. But Buffett did better than Graham: 23.4% a year.

Even George Soros, when he shorted sterling in 1992, was convinced that the pound was so overvalued that there was only one way it could go: down. That’s a bargain of a different kind, but a bargain nonetheless.

4. Do your own leg work

How do they find investment bargains? Not in the daily paper: you might find some good investment ideas there, but you won’t find any true bargains.

The simple answer is: on their own. After all, almost by definition, an investment is only a bargain if hardly anybody knows about it. As soon as the big players discover it, the price goes up.

So it takes time and energy to find an investment bargain. As a result, all the great investors specialize. They have different styles, they have different methods, and they look for different things. That’s what they spend most of their time doing: searching, not buying.

So the only way you’re going to find bargains in the market is the same way: by doing your own legwork.

5. “When there’s nothing to do, do nothing”

A mistake many investors make is to think that if they’re doing nothing, they’re not investing.

Nothing could be further from the truth. Every great investor specializes in a very few kinds of investments. As a result, there will always be stretches of time when he can’t find anything he wants to buy.

For example, a friend of mine specializes in real estate. His rule is to only buy something when he can net 1% per month. He’s a Londoner so—aside from collecting the rent!—he’s been sitting on his thumbs for quite a while.

Is he tempted to do something different? Absolutely not. He’s made money for decades, sticking to his knitting, and every time he tried something different, he lost money. So he stopped.

In any case, his real estate holdings are doing very well right now, thank you very much.

6. If you don’t know when you’re going to sell, don’t buy

This is another rule all great investors follow. It’s a major cause of their success.

Think about it. You buy something because you think you are going to make a profit. You spend a lot of time so you feel sure you will. Now you own it. It drops in price.

What are you going to do?

If you haven’t thought about this in advance, there is a good chance you will panic or procrastinate while the price collapses.

Or . . . what if it goes up—doubles or triples—what then? I’ll bet you’ve taken a profit many times only to see the stock continue to soar. How can you know, in advance, when it’s likely to be the right time to take a profit? Only by considering all the possibilities.

The great investors all have; and will never make an investment without first having a detailed exit strategy. Follow their lead, and your investment returns should soar.

7. Benchmark yourself

It’s tough to beat the market. Most fund managers don’t, on average, over time.

If you’re not doing better than an index fund, then you’re not getting paid for the time and energy you’ve spent studying the markets. Much better to put your money in such a fund and spend your time looking for that handful of investments you are so positive are such great bargains that you’re all but guaranteed to beat the market.

Alternatively, consider the advice from a great trader. When asked what the average trader should do, he replied: “The average trader should find a great trader to do his trading for him, and then go do something he really loves to do.”

Exactly the same advice applies to the average investor.

Find a great investor to do your investing for you, and focus your energy on something you really love to do.

One other thing:

I’ve just published a “mini”-eBook titled How to Make More Money By Sitting on Your Butt.

You can download it here, with my compliments.

By the way, as it is not DRM-protected, you may share it as you wish.

Profitable reading!

If you no longer wish to receive emails like this, simply reply with “unsubscribe” in the subject line.

GPO Box 9444
Hong Kong

What I learned from Ben Graham


As always, I try to also post the criticisms of investing legends:

Victor Niederhoffer, tireless critic of Benjamin Graham, Graham’s investment idea, and Warren Buffett, is blown up once again —to the tune of some 75% losses for his funds —as reported for a story in this week’s The New Yorker. Whereas Niederhoffer’s latest catastrophic losses might serve as schadenfreude for some students of value investing, this self-described Ayn Rand Objectivist is a living testament to the lethal nature of some spectacularly subjective biases, including a disdain for anything resembling a margin of safety.

The New Yorker article is a bit heavy on Niederhoffer’s personal life, but is still worth a read. Here’s the link:

Several years ago, Victor Niederhoffer was questioned during a radio interview about his rejection of the value investment paradigm as espoused by Benjamin Graham. The interviewer asked Niederhoffer how he might then explain the half-century success of Graham students such as Walter Schloss and others, given his rejection of Graham’s ideas. Niederhoffer replied that such success was “random.”

In Niederhoffer’s book, Practical Speculation, an entire chapter is devoted to refuting Graham’s pursuit of bargain issues. Only Niederhoffer hardly gets around to doing so. Instead, this sophisticated statistician attempts to stigmatize Graham and dwells on a small, essentially anecdotal sampling to prove his points about the lameness of value investing. One fellow Niederhoffer knew bought a stock below book value and watched as the stock proceeded to trade lower.

See? Graham’s ideas are useless.

When he is done expounding on the value investment discipline’s futility and ineffectualness, Niederhoffer allows as how he is troubled by the discipline’s ostensibly cynical premise: a dollar bought for fifty cents means that the seller is exploited. It seems odd that this cultivated observer of free-enterprise fails to recognize a couple of cold, hard facts: the business that fails to sell at half-price is likely to be sold for even less, and buyers of these ailing businesses are, in effect, upholding a competitive counterpoint to stronger businesses that might otherwise have a stranglehold in a capitalist system.

“Random”, the quality that Niederhoffer attributes to successful value investors and any successful value investments as defined by Benjamin Graham, might more aptly be attributed to Niederhoffer’s own quest for an intellectually sound speculative framework. This tendency is displayed in living color by Niederhoffer and other participants on, the website Niederhoffer hosts, as these traders engage in frothy examinations of the parallels between non-related phenomena, such as the evolved habits of exotic animals seen while on safari, and “trading”. Niederhoffer himself is especially fond of drawing wisdom from Captain Jack Aubrey, the main hero in Patrick O’Brian’s 18th century British Navy epics, as that wisdom might pertain to the markets. But after reading Practical Speculation, it is painfully obvious that if Captain Aubrey ever sashays into Niederhoffer’s trading-room and hands him a copy of The Intelligent Investor, Niederhoffer will politely accept the book, and promptly throw it overboard when the good Captain is out of site.

It’s easy to take potshots at this outspoken speculator gone off his trolley. But in the spirit of inquiry that Niederhoffer offers in his book, MSN articles and website, it seems reasonable to ask whether two catastrophic losses and one near-catastrophic loss offered to investors over a 10 year investment period —nearly 4 years of which were spent on hiatus— are more or less “random” than the market-beating investment success that Schloss, et al, offered to investors for over 50 years using a value framework. In any case, the simple fact is that the alternatives to a value framework in the securities markets frequently lead to misery, and by all accounts, Victor Niederhoffer is currently altogether miserable. In the manner that Walter Schloss’ 50-plus years of risk-averse investment returns are “random”, it may be safely said that Victor Niederhoffer’s self-inflicted misery is also randomly rendered.


Amazon is Disappearing Says Prof. Greenwald of Columbia GBS


Amazon’s Business Is ‘Disappearing,’ Columbia’s Greenwald Says

December 1, 2011 — 11:25 AM EST Inc. shares are overvalued because its core business of selling books and music online is “disappearing” and it’s competing with larger rival Apple Inc. in tablet devices, according to Columbia University’s Bruce C. Greenwald.

“Amazon trading at 100 times earnings is almost a joke,” Greenwald, a professor of management and asset management at the New York-based university, said today at the Bloomberg Hedge Fund Conference hosted by Bloomberg Link. “If Amazon doesn’t deliver profitability in the long run, it’s not going to stay at 100 times earnings.”

Amazon, based in Seattle, trades at 103 times reported earnings for the past year, down from this year’s peak of 129.8 in October, according to data compiled by Bloomberg. The company’s shares gained 2.5 percent to $197.16 in New York trading, and have climbed 9.4 percent this year.


Bruce Greenwald: Amazon Is Trading on Vapors

Bruce Greenwald: Now, Amazon I think is completely different. I think, if Apple is a current profit machine, Amazon is trading on vapors. [laughs]

They make no reported profit; the whole story is a growth story. They’re buying customers on the theory, presumably, that those customers are going to be profitable in the future. Now, for customers to be profitable you have to dominate segments.

The segment that Amazon has traditionally dominated is, of course, books, music, and video. Well, we know what happened to the music business when it went digital, which is the profit vanished and even Apple doesn’t make any money on iTunes.

The same thing is happening to books, with the connivance, by the way, of Amazon. The same thing is happening to video, so their core business is dying. The business that they dominated, where they made all their money, is dying.

What have they decided to do? Go into a lot of businesses where they have no competitive advantage. First they’ve gone into every variety of retail: TV sets against Wal-Mart and Best Buy, who have better distribution economics…

They can buy the business, but in the long run, unless they can get bigger share than those companies, their pricing is going to be at a disadvantage to those companies, because those companies can distribute the TVs and other devices more cheaply.

Then what did they decide? They said, “Oh, that wasn’t a big enough challenge. Let’s go after the Oracles and the IBMs and all the companies that do cloud computing, and the SAPs and so on, and the Googles,” and they went into that business.

Now, if you think they’ve got a competitive advantage in that business while they’re going after everybody in retail, lots of luck. But then they decided that was not enough, so they decided to go after Apple and the others in the device business.

This looks, to me, like a company that makes no reported profit, which I think is fair, that’s trying to buy growth in all sorts of areas where, because it has no competitive advantage, the growth is going to be value-destroying, not value-creating.

Amazon is on a p/e of 500 – but I’m happy to keep my shares

Amazon launched its first smartphone last week – the Amazon Fire phone.

It doesn’t represent any sort of leap forward in smartphone technology, according to reviews. So it probably won’t take a huge amount of market share from Apple or Samsung/Google.

Meanwhile, both Apple and Google are eating into one of Amazon’s traditional core businesses, selling music and video content.

So is Amazon’s new smartphone just a desperate bid to preserve market share? Or is it another ballsy, far-sighted move by Amazon’s boss, Jeff Bezos – one that will pay off in the end?

I think it’s the latter. And that’s why I’m willing to hang on to my Amazon shares – even although they trade on an eye-watering price/earnings ratio (P/E) of 500.

You might think I’m mad – but let me try to persuade you otherwise…

What’s Amazon’s new phone like?

I’ve not seen one of Amazon’s phones, but it sounds like they’re pretty similar to your average iPhone, but with two fresh add-ons.

One is a semi-3D capability that has been greeted with a ‘meh’ reaction by most reviewers. In truth, I don’t really understand how this 3D function works – I’ll have to wait and see a phone before I can do that.

The other improvement is a ‘recognition engine’ which has been received much more warmly.  It’s called Firefly and is a sort of audiovisual search tool. It recognises books, various consumer goods, music, video and more. And once the phone has recognised the item, you can immediately put it in your Amazon shopping basket.

“Not only was it effective”, says Gizmodo, “it was kind of beautiful”.

So it’s pretty obvious that Amazon is launching the phone in an effort to sell more stuff. Purchasers of the phone will also get a year’s free membership of Amazon Prime, which normally costs £79.

Prime offers free delivery on many purchases, the opportunity to ‘borrow’ books to read on your Kindle, and access to a wide selection of video titles. Amazon says that Prime customers spend four times as much on Amazon as other users, and that half of Amazon’s sales are to Prime customers.

So if the Fire phone can significantly boost the number of Prime customers, it will probably prove to be a savvy move by Bezos.

Now, not everyone is convinced that the phone launch is a smart move.

For example, Bruce Greenwald, a finance professor at Columbia Business School, made some negative comments to the Guardian. “This sequence of crazy initiatives in areas where they have no competitive advantage is about sustaining an unsustainable stock price… Amazon owns the books market, but what is happening to the value of that monopoly? They have a core business in which they are dominant, it’s going away and they are thrashing around trying to justify their $150bn market capitalisation.”

Is Greenwald right? I don’t think so.

Yes, Amazon faces growing competition. In digital content, it is competing with Apple, Google, music streaming service Spotify, and many others.

And on the physical consumer goods side – in other words, items that are delivered from its warehouses rather than online – the likes of Tesco, Argos and Walmart are all growing smarter about online retail. These chains also benefit from owning large store networks which are useful for customers who like to “click and collect.” Amazon isn’t so well placed for ‘click and collect.’

Greenwald is also right to highlight Amazon’s high valuation. However, I believe that valuation can be justified and that’s why I’m happy to hang onto my shares.

Why Amazon’s ‘crazy’ share rating is justified

No other online retailer offers such a large variety of products for sale. And Amazon is still growing its sales faster than the growth rate for overall e-commerce around the world. Last year, Amazon was the ninth-largest retailer in the world. Consultancy Kantar expects it to be the second-largest by 2018.

Amazon’s network of warehouses is also a very useful asset. It has 106 ‘fulfilment centres’ around the world, of which ten are in the UK. It is also trying to improve its ‘click and collect’ capacity by offering collection points at some London Underground stations.

Amazon also has a great record of investing for the long term. When Amazon launched Amazon Web Services in 2005, many observers doubted that the company could become a major player in this field – providing services to businesses. But, according to The Motley Fool, it now controls more than 30% of infrastructure for the ‘cloud’.

The point is, there will come a time when Amazon can afford to slow down the pace of growth and allow its profits to rise dramatically. When that happens, today’s valuation won’t look so crazy.

I’ll freely admit that Amazon is probably the highest-risk stock in my portfolio, but I’m happy to hold for further growth to come. And the Fire phone will play its part in achieving that growth.

So what do YOU think?  How would you value Amazon?  What major adjustment would you need to make? What is the business trying to do?

If you need a hint:

Does anyone want to bet $200 that Prof Greenwald will NEVER admit he might have miscalculated or misunderstood Amazon’s business?

What if he read their annual report: amazon-shareholderletter97


What caused the above?

The Mining Clock

Mining clock

When to start buying mining shares

Ignore the analysis but note the concept.  The advice to NOT buy the miners was the perfect situation to do the opposite:
mining assets

See the lows put in Jan. 11th in both the HUI Goldbugs index and Freeport McM (FCX). Only six days after the publishing of this article.

When to start buying mining shares

Five years ago, the FTSE 350 Mining index reached a post-financial crisis peak at just over 28,000. It currently sits at 7,134, down 75% at an 11-year low, and share prices remain vulnerable.Global commodities markets remain massively oversupplied and Chinese demand is waning, but there will come a point at which mining shares are a ‘buy’ again.  (You always want to buy commodities and/or commodity stocks at the point of MAXIMUM PESSIMISM or when supply is greatest and demand lowest!).

Investec Securities has built a “Mining Clock”, which brilliantly illustrates the mining cycle, including when to buy and when to sell. It’s a real “cut-out-and-keep” for every investor.

Investec writes:

“Please see the updated Mining Clock below where we indicate that it appears still too early to be buying the mining sector. This is despite five straight years of underperformance from mining equities globally, in every sector, save Australian listed gold equities which outperformed the ASX in 2014 and 2015.” (Where is the article that told you WHEN, exactly, to buy?).  Rearview investing doesn’t work.

The above article proves once again that no one can time a sector–except when (like in this article) there is no hope for a rebound.

GDX LT Chart






Last time I sold a few of my miners back in July


And now over the next few days and weeks, a time to rebuy at the margin.  But if you are in a bull market Sentry__Com_BullishGold_MacLean___E then sitting tight is what you must do.  At most, I think we are in six to seven on the mining clock.  So far, the public is not yet participating except perhaps in the last month.

WHAT do YOU think?

27CHICKENweb04-master675 (1)


P.S.:   Work on yourself!

CASE STUDY Activist Action on Coke 2014 Proxy


We are taking up from the last post

This case study teaches us about reading a proxy, management compensation, board governance, and the struggles of activism.

Mr. David Winters of wintergreen_fund_annual_report_2015_1231 has struggled since inception. From inception on 10/17/2005, Wintergreen has returned 68.73% vs. 113.22% for the S&P 500.   Another fund started in 12/30/2011 returned 15.95% vs. 77% for the S%P 500.   Nevertheless, he has done a service for the investment community by pointing out egregious compensation plans in Wintergreen-TheTerrible10-2-web.  Then note the passiveness of the big index funds in terms of protecting their own shareholders, 20150430-Wintergreen-Advisers-BigIndex.

Mr. Winters began his battle with Coke in 2014. KO_VL Jan 2015. Coke has a fine franchise with high returns on capital, but its cost structure (including management’s compensation) may be far too high considering the competitive pressures that incombents are facing.   Coke has had to make pricey acquisitions to diversify out of brown sugary fizz drinks. Also, all incumbents are facing new pressures like breaching of Gillette’s (P&G) moat–see below

Dollar Shave Club Hurting Gillette


Analysis of Dollar Shave Ads

As a review: Mr. Winter’s on Wealth Track:

Ok, back to Coke’s Proxy and Wintergreen’s battle to have Coke’s Board rescind the 2014 incentive compensation plan.   See the progression of the battle along with the slide presentations: Wintergreen Faults Coca Cola Management (KEY DOCUMENT TO READ!)

Then view Wintergreen’s presentations along with the articles in the link above:

What do you make of Mr. Winter’s struggle?  How can you explain Mr. Buffett’s actions? I was DISAPPOINTED but not surprised.  What did you learn that would be of help to your investing–the key to anything you spend time on?   Note Mr. Winter’s designation of corporate buybacks as another shareholder expense.   I believe shareholder buybacks are a use of corporate resources (a shrinking of the equity capital) that may either be a waste or a good use of resources depending upon whether the purchase price of the shares is below intrinsic value. Mr. Winters stresses that buybacks simply use corporate funds to mop up shareholder dilution. Regardless, Mr. Winter points out the huge shifting of shareholder property to a management that hasn’t performed exceptionally well.  Coke’s Board had granted exceptional awards for middling performance–now that is a travesty.

When I think of Coke, a great franchise that is not currently super cheap, I think of other “stable” franchise stocks like Campbell Soup or Kellogg’s.  The market has bid these up so your future returns will be low.  Do not misunderstand me, these companies are massive, slow-growth franchises, but if you pay too much, then you may have lower future returns for many years.

CMP Soup

CMP Soup



Lie with statistics


Op. Leverage; Geico and Berkshire Case Study; In Gold We Trust; Overconfidence


Mauboussin on Operating Leverage is a review on margins and operating leverage.  I recommend reading pages 19 to 21 in addition to my prior post: ROIC and more

Berkshire CS_wedgewood partners 1st quarter 2016 client letter

geico case study and presentation 2016


Do not focus on forecasts but learn from history and economics about gold: In_Gold_we_Trust_2016-Extended_Version

In_Gold_we_Trust_2015-Extended_Version (Referenced in 2016 Ed. Why miners struggled to gain investor respect.)

Avoid Overconfidence

A lesson in trading

A lesson in valuation

It is never different this time

Happy Fourth of July Holiday.  

I will answer the option questions upon return.

Returns of 100 to 1? First Understand Returns on Incr. Capital; Reader’s Question

Cap investments

The best long-term investments tend to be companies that can reinvestment over and over again at high rates of return.  Those high rates of return attract competitors so you must also understand barriers-to-entry.  But first study how to calculate incremental returns on capital or marginal returns on invested capital (“MROIC”).   There are several links and documents below to help you.  The effort is worth it if you can find: WMT_50 Year SRC Chart (up to 2000). WMT had regional economies of scale until it out-grew them. 

From John Huber of Base Hit Investing

  1. Eridon855 says:

May 30, 2016 at 10:44 am

Is there a way to calulate return on reinvested earnings?

  • John Huber says:

May 30, 2016 at 2:57 pm

One quick and dirty way is to look at the amount of capital the business has added over a period of time, and compare that to the amount of incremental growth of earnings. Last year Walmart earned $14.7 billion of net income on roughly $125 billion debt and equity capital, or just under 12% return on capital. Not bad, but what we really want to know if we are going to buy Walmart is a) how much of their earnings will they retain and reinvest in the business going forward? and b) what will the return on that reinvested capital be?

10 years ago in fiscal 2006, Walmart earned $11.2 billion on roughly $83 billion of capital, or around 13.5%. But in the subsequent 10 years, they invested roughly $42 billion of additional debt and equity capital ($125b invested in 2016 and $83b invested in 2006), and using that incremental $42 billion they were able to grow earnings by about $3.5 billion (earnings grew from $11.2 billion in 2006 to around $14.7 billion in 2016). So in the past 10 years, Walmart has seen a rather mediocre return on the capital that it has invested during that time (roughly 8%).

We can also look at the last 10 years and see that Walmart has retained roughly 35% of its earnings to reinvest back in the business (the balance has been primarily used for buybacks and dividends). As I’ve mentioned before, a company will see its intrinsic value will compound at a rate that roughly equals the product of its ROIC and its reinvestment rate. So if Walmart can retain 35% of its capital and reinvest that capital at an 8% return, we’d expect a modest growth of intrinsic value of around 3% per year. Stockholders will see total returns higher than that because of dividends, but the value of the enterprise will likely compound at roughly that rate. And we can see that over the previous 10 years, Walmart’s stock has grown around 45% not including dividends. So unless you are banking on an increase in P/E ratios, you’re unlikely to achieve a great result buying a business that can only invest a third of its earnings at 8% returns.

This is a really rough measure, and this back of the envelope method works okay with a large, mature company like Walmart. But what you really want to know is what will the business retain going forward and what will the return be on the capital it retains and reinvests? Of course, there are different ways to measure returns (you might use operating income, net income, free cash flow, etc…) and there are many ways to measure the capital that is employed. But hopefully this is a helpful example from a general point of view.

Calculating Incremental Returns on Capital

ALSO, read and study these articles:

For extra study go here:

Reader’s Question

Hi John,
I love the “no hope” strategy for finding ideas. See

I suppose there is always headline risk with things that have been in multi-year bear markets.

I am curious if you have any thoughts about political consequences of increased isolationist sentiment in the US and Europe?   Reply: Actually, the recent sell-off in the shippers this past week (June 17th, 2016) has partially been (I believe) due to Brexit.  You always want to look where sentiment is the worst and then try to determine if the price reflects the known news.   So on the one hand the rising fears over isolation give me comfort that a lot of bad news is being priced in.  Also, if the EU breaks up, why should trade go down?   Britain already sells more to the EU than it imports.   Switzerland isn’t in the EU and it has one of the strongest economies in Europe.   The EU makes no logical economic sense–how can central planning EVER work?  Nations have a natural interest to trade with each other since individuals benefit. What Trump says and can do (even if elected) are two separate issues.   I really don’t know how to handicap.   What I want is terrible news to encourage ship owners not to order new ships and to scrap the ones that they have.  

Also curious about your thoughts on the surge in low-cost vessels that came from Chinese ship makers in the last several years.   Reply:  This has been one of the reasons this shipping cycle has been the worst in forty years.   Easy credit/subsidized loans created a boom in Chinese ship builders (See May 7th, 2016 Economist issue and  Now some Chinese ship builders are close to bankruptcy.   So, yes, this oversupply will make this cycle–already a long one–drag out, but who knows for how long?.

I subscribed to Trade Winds (shipping trade magazine) a couple of years ago, to keep abreast of the industry and try to find when industry sentiment started to pick up. So far, it’s still been abysmal, although this years spike in iron ore was pretty interesting. Especially because Wall Street analysts are still telling everyone iron ore is going lower and this is just a blip.  Reply: Wall Street just tells you AFTER the fact or projects the trend/obvious.    As one ship owner said (Diana Shipping) said, “The bulk shipping market will turn when no one believes it will turn.”   

Ordered the book just now. Really interested to learn more about the industry, and it’s cool that it’s in novel form. I think some of these shippers may start getting close to scrap value pretty soon.  Reply: The Shipping Man was an educational and enjoyable read.   I may even search for other book like Viking_Raid_Excerpt


Just remember that the shipping industry has big demarcations. A company like Navigators’ Holdings (an LPG shipper) has different market dynamics than a dry-bulk shipper like Scorpio Bulkers.   One shipper operates in more of a oligopoly market than a purely competitive one though both, obviously, are cyclical.

I highly recommend the 800 page opus, Maritime Economics (3rd Edition) by Martin Stopford. If you wish to dig into the shipping industry, then read the annual reports/presentations of several shippers.   I have a ways to go to understand this market. The author:

Speculating in shippers is a bit like playing poker.  You don’t want the ship owners to start ordering new ships if freight rates start to rise.   You want the other owners to disbelieve a sustained rise.  When supply is constrained for a few years coupled with a spike in demand, the shipping market explodes like in 2007–no wonder a large supply of ships eventually came into the market and the boom went to bust.  The SIZE of the prior boom has led the depth of this bust.

A Reader’s Question on Modelling (Munger and Buffett’s View)



Just wanted to shoot you a quick email applauding you for putting together the “Ultimate Investor Checklist.”  investment_principles_and_checklists_ordway This may be the most valuable word document I have on my computer.


Quick question, I’m a huge fan of Charlie Munger (currently am reading Poor Charlies Almanack)- In the checklist when he describes being a business owner Charlie says:

      • Ignores modeling forecasts for the next quarter, next year, or next ten years.
      • Ignores forecasting completely. (Search through this link on Munger’s Mental Models.

If Charlie Ignores modeling and forecasting, how does he go about estimating Intrinsic Value? I know Charlie has said in the past that he has never seen Warren Buffett use DCF, so how do they go about estimating Intrinsic Value?

John Chew: A good question.  First, a model is not reality but a metaphysical description of reality.   You probably should build a simple spread-sheet of sales, capex, taxes, etc. to understand the economic model of the business you are looking at–we are not all geniuses like Buffett or Munger.

But rather than have me say what I think Buffett would say, read the source. Note his analysis of Coke and Sees Candies:

Buffett_Lecture_Fla_Univ_Sch_of_Business_1998  Hope that helps!

Arbitrage by Buffett_Research  (just for Buffaholics)