A Reader’s Question on Franchise vs. Asset-based Investing


Greetings from Finland,

I have been a long-time reader of your blog as well as member of your Deep Value group. I am studying in a business school and I’ve been investing in stocks since I was 15 (now 23). I have read the basic Graham’s Intelligent Investor and Security Analysis and lately I have found the statistic, Deep Value approach very interesting.
For me it’s very hard to choose between franchise type investment strategy and more statistic, asset based valuation strategy. I acknowledge that my skills for identifying those Buffet- type-compounders at low prices are lacking but I also know that sticking with asset based strategy is mentally difficult. I have been trying to find asset-based valuation strategies from your blog and Deep Value group and wanting to be better at valuating businesses. I also found Tobias Carlisle’s books helpful and encouraging about finding great picks using quite simple ratios such as P/B or Acquirer’s multiple.
I believe my problem is quite common and you hear this quite often. I am really convinced about your knowledge and I find you to as a great teacher. I hope you could email me those books you took off from your blog because of the copyright reasons. And of course if you can give some tips and hints I would be very thankful.
My reply: Yes, your worries/problems are endemic and natural to anyone developing their investment process.  You have two major goals:
  1. How to value a business
  2. How to think about prices

Point 1: In valuing a business you have either an asset or a franchise (or franchise 2% to 5% of businesses or non-franchise) to value.  The terms are not important, but the concepts are.  If you pay over asset value for a business then growth will not bail you out.  Time is not on your side.   Therefore, step one in improving your results is do not mistake a non-franchise business for a franchise business.  You are in the death-zone where you risk a PERMANENT loss of capital.  See below, dead Russian soldier during WWII invasion of Finland.


Examples would be swks vl.   There is almost no way in a competitive world that SWKS’ returns on capital will remain at those levels (20%+) over the next ten years–and that is what speculators (NOT investors) are betting on.

Buying net/nets and working capital bargains (buying at a discount to liquid working capital and paying nothing for fixed assets) is probably the safest type of investment IF done as a group.   For example, Energold, Inc. (EGDFF) is a working capital bargain with a decent balance sheet but if frontier drilling does not increase over the next five to ten years then it could go out of business. If you invest 10% in ten of those net/nets and working capital bargains, then the ODDS are with you. This is NOT a recommendation for Energold, inc. because it is just a fair business in a hugely cyclical industry, but it is cheap based on its balance sheet.


The bottom-line is that you need to practice and DO valuation all the time.   Value a company every day or every week.   Go through a Moody’s manual or value-line (or the equivalent in Finland) and look at a lot of companies.  Reading about sex, or sky-diving or war is not the same as participating.  Yes, go ahead and read, but request annual reports from all the companies in Finland and start valuing them. If you have trouble, then set aside and come back later when you have more knowledge.  Don’t be afraid to call up the companies.   If you find a company that is really cheap, ask the CFO why doesn’t he sell his home to buy more stock?  The point is to be ACTIVELY valuing companies ALL THE TIME.   Practice, practice.

Take KO VL Last I looked Coke was trading at about 16 times EV-to-EBITDA while HNRG trades at 4 times EV-to-EBIDA (deduct $1 per share for subs.). Cheap!?  Well, hold on, for every dollar of sales Coke makes about 80 to 85 cents in free cash flow while for Hallador Energy (Coal Producer) every dollar of sales generates about 15 cents of free cash-flow right now. I expect that to rise to 20 cents but you can see that Mr. Market handicaps each business properly–usually (but not always).  Hallador has unused capacity and can grow profitably but to a certain limit.   I would characterize Hallador as a non-franchise but with quality assets compared to its competitors in the coal industry (second on cost curve behind Foresight Energy (FELP).

When you buy a franchise then you must expect that barriers to entry will hold-off regression to the mean. The strategy is almost opposite to buying assets where you expect regression to the mean to occur.

Point 2: How to think about prices.    This comes down to knowing yourself?  How do you think, how do you react under stress? Only YOU (not me or other “experts”).  Here is an example of a true value investor:

You have to keep a log of your investments and decisions.  What patterns do you see.  Are you patient?   How will you develop patience.  If you have $1,000 US dollars, then if you make 5 investments of $200 each, write-up each investment–its value, why you made the investment, what would cause you to sell and/or abandon the investment. Then keep meticulous journal entries.   You buy at $10 then the price rises to $15 then declines to $8.   Will you buy more?  Why or why not?   The famous Seth Klraman, sells some at $15 because he knows he will be too upset to buy at $10 or $8 if he hasn’t sold some of his stock. The point is that Mr. Klarman has found a method that fits HIS personality.

Spend more time in introspection and practicing investing.   Let me know your progress and GOOD LUCK.


John Chew

More readings

Strategies used by Munger Buffett and Davis to outperform

Has Buffett Lost the Midas Touch



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