Tag Archives: Greenwald

Valuing Growth

Try saying Profits without “Quotation Marks.”

Valuing Growth

A reader, Arden, asked an intelligent question about how I value growth. Since I am on the road and will not post again until Tuesday, I wanted to post Prof. Greenwald’s Lecture Notes on valuing growth.

Valuing Growth_ManagingRisk

Read through these and post your thoughts.

Have a happy Easter!

Greenwald Strategy Notes #1

 “If you don’t read the newspaper, you are uninformed. If you do read the newspaper, you are misinformed.” –Mark Twain

I stayed up all night playing poker with tarot cards. I got a full house and four people died. –Steven Wright

These notes should supplement your reading of Competition Demystified and your case study on Wal-Mart (in Value Vault).

http://www.scribd.com/doc/77722383/Greenwald-Strategy-Class-1

A book on moats and investing

Moats and filters: http://www.lulu.com/spotlight/4filters Neither have I read nor recommend the material on the web-site but I do want you to be aware of the book.

Greatest Company Analysis, Studying Franchises and More………….

“The average person can’t really trust anybody. They can’t trust a broker, because the broker is interested in churning commissions. They can’t trust a mutual fund, because the mutual fund is interested in gathering a lot of assets and keeping them. And now it’s even worse because even the most sophisticated people have no idea what’s going on.” –Seth Klarman

I’m passionate about wisdom. I’m passionate about accuracy and some kinds of curiosity. Perhaps I have some streak of generosity in my nature and a desire to serve values that transcend my brief life. But maybe I’m just here to show off. Who knows? –Charlie Munger

Best Company Analysis

Several experienced investors (including charlie479) have called the lecture in the link below one of the best company analysis ever done. A Charlie Munger speech about worldly wisdom in solving the problem of building a trillion-dollar business almost from scratch.  http://www.scribd.com/doc/76174254/Munger-s-Analysis-to-Build-a-Trillion-Dollar-Business-From-Scratch

Analysis of a Franchise: Linear Technology

An analysis of Linear Technology’s franchise characteristics: http://www.valueinstitute.org/viewarticle.asp?idIssue=1&idStory=109

Do you agree with the above analysis? The five companies below are considered by some to be franchises. Build a database of franchise companies to eventually purchase at the right price for you. Write down what you think are the sources of competitive advantage. Can you arrive at a ball-park value?  If not now, then set aside for future reference. Note the level of ROIC, operating margins, use of excess capital, growth and investment needed for growth and the history of returns.

Linear:                      LLTC 25 Year    LLTC_VL

Balchem:                  BCPC_35 Year   BCPC_VL

Applied Materials: Charts 35 year AMAT  AMAT_VL

Analog Devices:      ADI_35 Year  ADI_VL

Intel:                         INTC_35 Yr   INTC_VL

Now is the time to dig into the Value Vault and read, Competition Demystified by Bruce Greenwald. A study guide is offered here (Thanks Sid): http://competitiondemystified.com/index.htm

Be the Best

To be the best, you will need to have character, be independent and tough like Joker: http://www.youtube.com/watch?v=gYxEIyNA_mk&feature=related

You will need to develop your skill in understanding and recognizing franchises. Eventually you will show skill like this: http://www.youtube.com/watch?v=HwtMPdMFXQA&feature=related or take it to the hoop like Jordan: http://www.youtube.com/watch?v=U17x7gJ33bY&feature=related

I have never held a ball in my hands, but even I know Jordan is practicing magic not basketball–but, then again, he almost didn’t make his high school team.

 A Good Data Source

Accounting, business studies, and data here: http://mgt.gatech.edu/fac_research/centers_initiatives/finlab/index.html

Freedom vs. Tyranny

A satellite view of tyranny vs. freedom: North vs. South Korea    http://mjperry.blogspot.com/2011/12/legacy-of-n-korean-dictator-kim-jong-il.html

Answer to Economic Question Posed in previous post

The European Central Bank (“ECB”) is offering euro zone banks loans of up to 3 years on Dec. 21 at a rate of 1%. A Wall Street/City of London Whiz can buy Spanish paper at plus 2% on money borrowed from the ECB at 1%. Brilliant! This is going to deluge the Euro zone with money and become extremely bullish for the Euro zone markets and price inflationary.  How else do central bankers know how to deal with a financial crisis. Print.

A viewpoint of America’s involvment in the Euro crisis: http://www.thedailybell.com/3379/Ron-Paul-Beware-the-Coming-Bailouts-of-Europe

Have a good evening.

Whitman Critiques Prof. Greenwald’s Value Investing Book.

A reader, the Great Sandesh, alerted me to this. By the way, I am not a fan of Prof. Greenwald’s book, Value Investing — From Graham to Buffett and Beyond written by Bruce C.N. Greenwald, Judd Kahn, Paul D. Sonkin and Michael van Biema. But I do highly recommend his book, Competition Demystified, to learn  strategic analysis.

Whitman discusses the book in his 2001 TAVF Shareholder Letter

http://www.thirdavenuefunds.com/ta/documents/reports/aboutus-reports-01Q4.pdf

There seems to be a general misunderstanding about wealth creation companies in the financial community and in academic circles. First, there is scant recognition of the fact that outside of Wall Street, where one deals with privately owned businesses, the vast majority of economic endeavor involves striving to create wealth in the most tax effective manner. Where control persons have choices, they would rather create wealth by some means other than having ordinary income from operations simply because striving for cash flows or earnings from operations tends to be highly inefficient tax-wise.

Second, in their new book, Value Investing — From Graham to Buffett and Beyond written by Bruce C.N. Greenwald, Judd Kahn, Paul D. Sonkin and Michael van Biema (Greenwald and van Biema are faculty members at Columbia Business School), the authors seem to have trouble identifying, and valuing, net assets. They state, “in the contemporary investment world net-nets are, only with the rarest exceptions, a distant memory.” In fact, though, each of the nine wealth-creation common stocks Third Avenue acquired during the quarter is a net-net by any economic, non-accounting convention, definition of net-nets.

Greenwald, et al define net-nets only by looking at accounting convention, not economic reality. They define net-nets as a common stock available at a price that represents a discount from a company’s current assets after deducting all book liabilities, both short-term and long-term. The problem with this measurement is that for going concerns, much of their current assets are not current assets at all, but rather fixed assets of the most dubious value. For example, Sears Roebuck, like any other retailer, could not stay in business if it did not maintain inventories continually, which in Sears’ case have a carrying value of over $5 billion. In the aggregate, these inventories are a fixed asset for the going concern, not a current asset. Individual inventory items do turn to cash within 12 months and thus are, for accounting purposes, called current assets. In fact, though, Sears’ aggregate $5 billion investment in inventory is a permanent investment, particularly vulnerable to seasonal mark-downs, theft, obsolescence and mislocations.

Contrast this with Forest City’s developed real estate projects. While Forest City’s developed real estate is called a fixed asset, a substantial portion of these assets is really quite current, a source of almost immediate cash through sale or refinancing, without interfering with Forest City as a going-concern. Forest City Common is a true net-net. The same is true for other wealth creation common stocks acquired during the quarter at substantial discounts from readily ascertainable net asset values; — including the probable real estate values in Alexander & Baldwin and Catellus; the probable securities values in Brascan (including real estate), Phoenix Companies, MONY and Toyota Industries; and the probable values of Assets Under Management (AUM) for BKF and Legg Mason.

VALUE INVESTING AT THIRD AVENUE

The back of the Greenwald book describes the investment approaches of a number of highly competent value investors:

— Warren Buffett; Mario Gabelli; Glen Greenberg; Robert H. Heilbrum; Seth Klarman; Michael Price; Walter and Edwin Schloss and Paul D. Sonkin. It’s a worthwhile read. Third Avenue, in its practices, seems to have much in common with these investors. The front of the Greenwald book, though, describes underlying theories about value investing.

These theories seem to have nothing to do with the basic assumptions under which Third Avenue operates. Contrasting the Third Avenue approach with the Greenwald approach ought to be helpful in getting investors to understand the Third Avenue modus operandi.

A major difference between the Greenwald approach and the Third Avenue approach revolves around valuing a company and valuing a security. Greenwald, et al state, “There is general agreement that the value of a company is the sum of the cash flows it will produce for investors over the life of the company, discounted back to the present.” The Greenwald approach is far too general to be useful for Third Avenue. For TAVF, there exist four factors which contribute to corporate value and three factors which determine the theoretical value of a security.

The four elements of corporate value:

1. Free cash flow from operations available for the security holder: Very few companies ever actually achieve such free cash flows on a reasonably regular basis. While for any individual project to make sense it has to return a cash positive net profit over its life, this is not true for most companies (as distinct from stand-alone projects), especially expanding companies. Most businesses consume cash. TAVF likes to invest in the common stocks of those few companies in a position to create cash flows on a regular basis. The principal area where this takes place in the Fund’s portfolio is in money management companies: — BKF, John Nuveen, Liberty Financial and Legg Mason.

2. Earnings: Most prosperous going concerns create earnings, not free cash flows. Earnings exist where a company creates intrinsic wealth from operations while consuming cash. Since most going concerns consume cash, their earnings streams may be of limited value unless such flows are also combined with access to capital markets, either credit markets or equity markets or both. TAVF, in acquiring the common stocks of earnings companies, limits its acquisitions to businesses with exceptionally strong financial positions. This means, most of time, that the companies have far less need to have access to capital markets during any given period than run-of-the mill, less well capitalized, going concerns. More importantly, though, the companies whose issues the Fund acquires have rather complete control over the timing as to when they want to access debt markets or equity markets. Capital markets are notoriously capricious in terms of both pricing and availability. TAVF tries to avoid investing in the common stocks of less well capitalized companies, in part because such issuers frequently are forced to raise outside capital at the most disadvantageous times. Well-capitalized earnings companies whose common stocks were acquired by TAVF during the quarter include Energizer, Trammell Crow, American Power, Applied Materials, AVX, Credence, Electro Scientific, KEMET, MBIA, Nabors, and Vishay.

Most Wall Streeters and most academics, including Greenwald, et al, subscribe to a primacy of the income account point of view and believe that the dominant, and sometimes even the sole, sources of corporate value are flows from operations: — both cash flows and earnings flows. At TAVF, we have a balanced approach. Indeed, we think more corporate wealth is created in the U.S. by the two factors discussed below than by flows, even though frequently there tends to be a close, symbiotic relationship between flows, whether cash or earnings, on the one hand; and asset values and access to capital markets on the other.

3. Resource conversion activities encompass repositioning assets to higher uses, other ownership or control, or all three; the financing of asset acquisitions, the refinancing of liabilities or both; and the creation of tax advantages. These activities take the form of mergers and acquisitions, contests for control, leveraged buyouts, restructuring troubled companies, spin-offs, liquidations, massive securities repurchases, and acquiring securities in bulk through cash tender offers or exchange offers. Within the Third Avenue portfolio, it appears as if some 3% to 5% of the common stocks held are subject to takeover bids of some sort by control investors every quarter. Common stock issues acquired during the quarter which may very well be involved in getting taken over in the years ahead include Energizer, Phoenix, Alexander & Baldwin, BKF, Catellus and MONY, albeit Fund management has never been really good at identifying which companies will be “in play” at any given time in the future.

4. Access to capital markets at super-attractive prices: There seems little question that far more corporate wealth has been created in this country by taking advantage of attractive access to outside capital than by any other single source. The Greenwald book, and indeed virtually all economic literature,  ignores this factor as a source of wealth, or a source of franchise. Unfortunately, as a passive value investor, the Fund does not often get to benefit from super-crazy prices that exist in equity markets from time to time. To benefit from these super-crazy prices as a price conscious value investor, TAVF would have to become a venture capital investor seeking IPO bailouts; something that seems to be outside Fund management’s sphere of competence. Fortunately though, many of the companies in whose common stocks Third Avenue has invested have super attractive access to credit markets where they are able to obtain low interest, long-term, non-recourse financing for major portions of the projects which they build, or in which they invest. Companies whose common stocks the Fund invested in during the quarter, with such attractive access to capital markets, include Alexander & Baldwin, Brascan, Catellus and Forest City.

The language used by all academics, including Greenwald, et al, that securities values are a function of the present worth of “cash flows” is unfortunate. From the point of view of any security holder, that holder is seeking a “cash bailout”, not a “cash flow”. One really cannot understand securities’ values unless one is also aware of the three sources of cash bailouts.

A security (with the minor exception of hybrids such as convertibles) has to represent either a promise by the issuer to pay a holder cash, sooner or later; or ownership. A legally enforceable promise to pay is a credit instrument. Ownership is mostly represented by common stock.

There are three sources from which a security holder can get a cash bailout. The first mostly involves holding performing loans; the second and third mostly involve owners as well as holders of distressed credits.

1. Payments by the company in the form of interest or dividends, repayment of principal (or share repurchases), or payment of a premium. Insofar as TAVF seeks income exclusively, it restricts its investments to corporate AAA’s, or U.S. Treasuries and other U.S. government guaranteed debt issues.

2. Sale to a market. There are myriad markets, not just the New York Stock Exchange or NASDAQ. There are takeover markets, Merger and Acquisition (“M&A”) markets, Leveraged Buyout (“LBO”) markets and reorganization of distressed companies markets. Historically, most of TAVF’s exits from investments have been to these other markets, especially LBO, takeover and M&A markets.

3. Control. TAVF is an outside passive minority investor that does not seek control of companies, even though we try to be highly influential in the reorganization process when dealing with the credit instruments of troubled companies.

It is likely that a majority of funds involved in value investing are in the hands of control investors such as Warren Buffett at Berkshire Hathaway, the various LBO firms and many venture capitalists. Unlike TAVF, many control investors do not need a market-out because they obtain cash bailouts, at least in part, from home office charges, tax treaties, salaries, fees and perks.

I am continually amazed by how little appreciation there is by government authorities in both the U.S. and Japan that non-control ownership of securities which do not pay cash dividends is of little or no value to an owner unless that owner obtains opportunities to sell to a market. Indeed, I have been convinced for many years now that Japan will be unable to solve the problem of bad loans held by banks unless a substantial portion of these loans are converted to ownership, and the banks are given opportunities for cash bailouts by sales of these ownership positions to a market.

Greenwald, et al have a monolithic approach to analysis using three tools to analyze all companies — replacement cost of assets, earnings power, and franchise value. TAVF, on the other hand, analyzes different businesses differently, ranging from analyzing strict going concerns by giving heavy weight to earnings power, as for example AVX or Nabors; to analyzing businesses which are really investment companies masquerading as something else. Here, heavy weight is assigned to readily measurable asset values as well as an appraisal of managements’ abilities to increase these net asset values over the long-term. Catellus, Forest City, Hutchison Whampoa, Investor AB, and Toyota Industries are examples of such situations.

Greenwald, et al, like almost all academics, consciously or unconsciously, look at companies as substantively consolidated with shareholders. This tends to be a non-productive approach almost all the time. At the Fund, companies are analyzed as stand-alones or parent-subsidiary. The common stock for TAVF is a different constituency from the company, or its management — separate and apart.

Most academics pay much attention to an artificial calculation: — the Weighted Average Cost of Capital (“WACC”). WACC measures the cost of outside capital to a company as a blend of after-tax interest rates and capitalization values for common stocks based on references to current common stock prices in public markets. Interest is, of course, a cash cost, while capitalization rates for publicly traded common stocks have nothing to do with most companies since they do the bulk of their equity financing by retaining earnings rather than by selling new issues of common stock to the public. More importantly, though, WACC is not very meaningful for companies who have rather complete control of the timing as to when, or if, to access capital markets. Such companies will access outside sources of capital at the time WACC type pricing is most attractive to them. These are the companies in whose common stocks TAVF invests. A contemporaneous calculation of WACC for these companies tends to be not meaningful.

Greenwald, et al discuss risk in general but do admit that relative price volatility in the securities market may not be an adequate measure of risk. For TAVF, the word risk cannot be used without putting an adjective in front of it. There is no general risk. There is market risk, investment risk, currency risk, terrorism risk, inflation risk, failure to match maturities risk, commodity risk, etc. The Fund tries to avoid investment risk; i.e., that the companies in whose securities we have invested will suffer permanent impairments. The Fund ignores market risk; i.e. that the trading prices of the securities held will fluctuate.

Greenwald, et al assume, quite properly, that an overpriced common stock will attract new competition. Greenwald, et al, however, ignore something that may be much more important. An overpriced common stock, in the hands of a reasonably competent management, is frequently a most important corporate asset. Much of the small-cap high-tech investments of the Fund are in companies which were able to build up huge cash positions by taking advantage of the crazy prices that existed in IPO markets in the late 1990’s.

I suggest readers heed Mr. Whitman’s comments since he is a practitioner rather than an academic. Also, his comments make sense.

More Value Investing Class Videos (Links)

A generous reader sent me these links of value investing classes circa 2010.

And a generous video wizard downloaded the following videos to the Value Vault which you can gain a key to my emailing me at aldridge56@aol.com and place VALUE VAULT in the subject line and I will send the key.

I haven’t seen them yet. Can’t wait. A treasure trove here.

http://dev7.gsb.columbia.edu/kaltura/node/1297/video

http://dev7.gsb.columbia.edu/kaltura/node/1303/video

http://dev7.gsb.columbia.edu/kaltura/node/1272/video

http://dev7.gsb.columbia.edu/kaltura/node/1305/video

http://dev7.gsb.columbia.edu/kaltura/node/1268/video

Greenwald Video with Gurus like Li Lu. Michael Burry Notes

Two readers/contributors sent me these links. Thanks again.

My two cents, the video is worth viewing, but if you look up the companies in Michael Burry’s research and follow along, you will benefit more. I would rather bet on Michael Burry rather than Li Lu. Be skeptical of any “Guru” and never cease to think for yourself. Many Gurus know a hell of a lot less than you think they know.

I am amazed that no one on the panel discusses the causes of the boom & bust which flattened most money managers in 2008/09.

Professor Greenwald’s Panel Discussion with Li Lu and other “Gurus.”

http://www.gurufocus.com/news/154825/bruce-greenwald-moderates-panel-discussion-that-includes-charlie-munger-favorite-li-lu

Michael Burry Research Report Write-Ups

A contributor, eclecticvalue provides a scribd link here: http://www.scribd.com/doc/74831871/Burry-Writeups

I will place several investor letters and research reports from Michael Burry (a self-taught investor who sits alone in a room and thinks.) in the Value Vault.

For keys to the Value Vault: email me at aldridge56@aol.com with VALUE VAULT in the subject line. You will receive a link and then you can sync to your desk-top.   Thanks for all the contributions to the Value Vault!

Sealed Air Valuation Case Study

This is one of the tougher valuation assignments that you will encounter. Place an approximate value on Sealed Air (SEE) 1998.

Use the 10-K: http://www.scribd.com/doc/74030312/Sealed-Air-1998-10-K

My class notes on valuing Sealed Air are here but avoid viewing until after you complete your valuation. http://www.scribd.com/doc/74030486/Greenwald-Class-Notes-6-Sealed-Air-Case-Study

Class handout on doing the valuation: http://www.scribd.com/doc/74030440/Sealed-Air-Case-Study-Handout

The video on this valuation can be found in the Value Vault.

Just email me at aldridge56@aol.com and put: VALUE VAULT in the heading of your email and I will send you the link to the video on valuing Sealed Air.

My hat is off to you if you are able to do this valuation. If you are stuck then I suggest that you go through this blog and read other postings to learn about valuation.

Good luck!

Calculating Capex–MCX and Growth Capex

This post responds to a reader’s question from Lecture #1:

http://csinvesting.org/2011/09/09/lecture-1-an-introduction-to-value-investing/

The question

Lumilog | October 21, 2011 at 8:46 am

I’ve been wondering more about the estimate of Maintenance Capex Greenwald gives on slides 13-14 and its reliance on revenue.  A company could theoretically grow revenue, but due to higher costs, end up with about the same EBITDA.  In that case, I’d want to assume that all was Maintenance Capex despite the revenue growth.  So I’m wondering if it might be better to estimate Growth Capex from the delta in EBITDA that CapEx produces, not the delta in revenue.

Reply

From page 96, fn. 1: Value Investing From Graham to Buffett and Beyond by Bruce C. Greenwald

Companies generally report capex in their statement of cash flows. We assume that each year, a part of this outlay supports the business at its sales level for the prior year, and part is needed for whatever increase e in sales it has achieved. Companies generally have a stable relationship between the level of sales and the amount of plant, property, and equipment (PPE) it takes to support each dollar of sales. We then multiply this ratio by the growth (or decrease) in sales dollars the company has achieved in the current year. The result of that calculation is capex. We then subtract it from total capex to arrive at maintenance capex.

Also, you can simply ask the company’s CFO what amount of total capex goes to maintenance capital expenditures.  Certain companies like Iron Mountain “IRM”(Document Storage-physical and digital) will specifically break out the two type of capital expenditures.  In IRM’s case, its maintenance capital expenditures are low compared to revenues or any other accounting metrics because their storage facilities have long lives with minimal upkeep.

To: Lumilog, you do not want to assume in your example (A company could theoretically grow revenue, but due to higher costs, end up with about the same EBITDA.  In that case, I’d want to assume that all CapEx was Maintenance Capex despite the revenue growth) that all capex is maintenance capital expenditures (“MCX”) because you want to segment the company’s capital spending. You could have non-productive growth capex with stable MCX.   For example, what does it cost to maintain old stores at their current sales level vs. the cost to build and develop new stores?   

True MCX

Another point, you have to understand the industry and competitive forces to calculate/estimate true MCX.  Take, Iridium, the satellite company that is launching new satellites into orbit, for example. That company may need to replace their new satellites sooner than expected due to new technology in competing telecom industries.  Investors who own Iridium could be vastly underestimating MCX and therefore, overestimating normalized earnings. Earning power value and thus asset value may be lower than what current investors estimate.

Hope that helps……….

Valuing Assets: Hudson General Valuation Case Study

When you look at a business, glance at the financial summary to gain a feel for the financial characteristics of the business, then go to the balance sheet. Or you can start with the balance sheet. Wall Street analysts often spend too much time on the income statement without looking at quantity and QUALITY of the assets that generate the income and cash flow.

Below is the link to the 1997 10-K of Hudson General Company.  Try to value this business and show your work.

http://www.scribd.com/doc/66990171/HUDSONGENERALCO10K405-1997

If you struggle, you can go to the book: Value Investing from Graham to Buffett and Beyond by Bruce C. N. Greenwald and read Chapter 4 starting on page 51.

The complete analysis will be posted in a few days.

June 4, 2012: Here is the analysis. (DON’T CHEAT. Try on your own first)

Hudson General Case Study_Read this Second

Valuing Hudson General and Analysis

Good luck

Greenwald Investing Process

The links below connect to lecture notes on An Investment Process.  Think through how these notes can help you.  I suggest glancing at them, then reading the books suggested in the first link. Once you have read the two books, come back to these notes. The second link (Gabelli) has a link in the document that will take you to a video of Greenwald’s lecture. Read, listen and then reread his lecture.

http://www.scribd.com/doc/65528340/Greenwald-VI-Process-Foundation     62 pages (1999)

http://www.scribd.com/doc/65530349/Greenwald-2005-IP-Gabelli-in-London  40 pages

http://www.scribd.com/doc/65530485/Principles-of-VI  17 pages

http://www.scribd.com/doc/65530893/Overview-of-VI    24 pages

http://www.scribd.com/doc/65531201/Valuing-Growth-Managing-Risk    35 pages

Let me know if the above is enlightening………..