Tag Archives: business

Book and Special Situation Readings


As investors, we deceive ourselves a thousand different ways, both small and large. We attribute gains to acumen when they are the product of luck, and we attribute losses to ill fortune when they are often the product of stupidity or inattention. We believe that the market remembers or cares about the price we paid for a stock, or that out stocks will go up when every other stock is going down. But most commonly in markets, we fall in love with a company that is unworthy of our affection.   –Leon Levy

Note: Worrying about macro issues or politics should not distract you as an investor. Our job is to protect and grow our capital.

Better to study quality companies like:BDX_VL and SWK_VL so you are prepared to pounce on the right price to meet your margin of safety.

Book on Corporate restructuring

Creating Value Through Corporate Restructuring – Stuart C. Gilson & Edward I. Altman    A good book on special situations through the eyes of a CFO.

Supplement: Creating Value Through Corporate Restructuring Course-1

Corporate Restructuring Course syllabus

Special Situations

Special Situation are typically viewed (by me) as asset conversion activities. Management is incentivized to unlock undermanaged or mispriced asset values.  The corporate event is what drives returns not necessarily the market in general. When quality companies are not on sale, I look here for opportunities.




American Corporations Worth More Dead than Alive 3 Parts by B Grahams

Stubs Final

Tender Offers

Special Situations and Tender Offers

Stock repurchase by tender offer

Tuck School Research on Tender Offers

Teledyne and a study of an excellent capital allocator_Tender Offers

Rights Offering

What is right about rights_Gabelli


Rights Offering and Over-Subscriptions_Final

Special Situation Investing by Ben Graham

Workouts by Ben Graham from Intelligent Investor


Arbitrage by Buffett_Research

To be proficient in special situation investing you have to look closely at management’s motivations and for uneconomic sellers. Practice and you will grind out decent returns (15% to 25%).

Learning hint: Take a particular technique of corporate restructuring like liquidation or tender offers and try to read as many case studies and articles about that subject as you can. Next develop search words that will help you find opportunities. A good place to view case studies is by looking through old blog posts at www.greenbackd.com.

Have a Great Weekend

Value Vault Update; Approved for Transplant and Emerging Market Value Investing

Value Vault Update

Many have been having troubles opening the Value Vault. The main problem is the size of the folder; there is a 2 Gig limit. Splitting folders means multiple emailing of keys. I get 10 requests a day so time constraints make this a hassle.  Yes, there is Google, Dropbox and many other choices than Yousendit.com.

To make this blog more assessable for learning, I will post the videos up on this blog and the important books. All case studies, documents and more obscure books, I will place in a folder (less than 2 Gigs)  or two and then email out all the keys.

This blog will no longer have advertising on it. The videos will have the corresponding case studies and financials for ease of study.  Once that is up, you have about 10 valuation case studies with videos to develop your skills along with all the prior posts.

I have all your emails, so you won’t be forgotten when I email out the new keys. You will see the videos going up by tomorrow.

I have been finally approved as a kidney donor so I wait for the date of my surgery. More blood samples, CAT scans and X-rays have been taken of me than any lab rat. Ready to go so the recipient doesn’t have to suffer dialysis or death.


Quiz for emerging market value investors

Your company has been given a concession to open a resort on the North coast of Cuba. What recommendation would you make to your investment committee? What should your required rate of return be?

The Old Man and the Tree: A Parable of Valuation; Back to School; and More…

Back to School

Back to school (a classic!) http://youtu.be/YlVDGmjz7eM

Any Columbia Graduate Business School Students attending this–Course on Mental Models and Investment Frameworks? Mental Models Columbia GBS 2012 Syllabus

A Preview to be read for the See’s Case Study (forthcoming….)

The Old Man and the Tree: A Parable of Valuation

Adapted from Solomon, Schwartz & Bauman,
Corporations – Cases and Materials at 143 (3d ed. 1996).


Once there was an old, wise man who owned an apple tree. It was a fine tree. With modest care it yielded a crop of apples which he sold for $100 each year. The man wanted money for new pursuits and thought of selling the tree. So, hoping to teach a good lesson, he placed an ad in the Business Opportunities section of the Wall Street Journal: “For sale, apple tree – best offer.”

The Old Man and the Tree or a Parable of Valuation

Readings and Viewing

http://blog.marketpsych.com/ and http://www.marketpsych.com/blog.php

Do not criticize the government (Marine sent to mental ward): http://www.lewrockwell.com/lewrockwell-show/2012/08/24/303-psycho-state-targeted-brandon-raub/


Vail Value Conference: Some Case Studies

After spending many years in Wall Street and after making and losing millions of dollars I want to tell you this: It never was my thinking that made the big money for me. It always was my sitting. Got that? My sitting tight!   –Jesse Livermore.

Many presentations found in this summary of the Vail Value Conference: http://contrarianedge.com/2012/08/01/thoughts-from-valuex-vail-2012-conference/

Several of the presentations are worth studying. See if you can analyze the companies below and then compare your conclusions with the presentations. Do you agree or disagree with the valuation. I included the Value-Line Tear Sheet as reference. You can download the financials of each company from their web-sites. Try the simplier businesses like PSUN or Staples.

Dream_Works-ValueXVail-2012-Barry-Pasikov  and DWA_VL

PSUN-ValueXVail-2012-Shane-Calhoun and PSUN_VL

Staples-ValueXVail-2012-Adrian-Mak and Staples_VL

SS_CNW-ValueXVail-2012-Dan-Amoss and CNW_VL

AMZN-ValueXVail-2012-Josh-Tarasoff and AMZN_VL


Kill the Rich, Confiscate All S&P 500 Profits, and Pay the Debt?




The National Debt and Federal Budget Deficit Deconstructed – Tony Robbins

Tony Robbins deconstructs our debt and deficit problem. How long could we fund our government if we took 100% of all income and assets of the rich and the S&P 500 companies? Two Years? Ten Years?  The answer would shock you–five months. But then what would we do the following year after all the wealth has been confiscated and sold? A fascinating 19 minute video with Tony Robbins: http://www.youtube.com/watch?v=jboTeS9Okak

A Tip for Beginners in Learning An Industry: Cruise Ships

Using this Blog

www.csinvesting.org has an eclectic mix of posts on valuation, competitive analysis and accounting. Use the search box in the upper right corner for relevant posts on subjects that interest you. For example, if you want to learn more about EBITDA as a cash flow metric then type those words into the search box and you will see several posts like this one: Placing EBITDA into perspective: http://wp.me/p1PgpH-yS.

Value Vault

Also, there are over 60 books, many case studies and 30 videos on investing in the VALUE VAULT. Email me at Aldridge56@aol.com with (only) VALUE VAULT in the subject line. Within 48 hours, I will do my best to send you the keys to the cloud-based folder so you can download anything you might like to study. No reply? Just email me a reminder. I know this blog needs better organization and all the information can be overwhelming for new investors. The trick to developing skill is to cut through all the noise to focus on the key issues that will drive the success of the investment. Practice reading original 10-Ks and 10-Qs and Proxies.  Look at profitability, margins, trends, ownership, and the history of the industry. Take and keep notes. What are you learning?

Other blogs

A self-taught investor with excellent examples http://www.gannonandhoangoninvesting.com/     

Another for beginners: http://www.oldschoolvalue.com/blog/



APPLY, APPLYBut YOU must apply what you read to the actual world. Practice.

Investing is something that you DO. OK, you are a beginner and you have read a basic book

on accounting (Go to the folder called BOOKS in the VALUE VAULT and choose

How to Read a Financial Statement. Next ask yourself,

“Would I want to invest in the cruise ship industry?” (Find out)

“Can I understand what drives profitability? What factors can the

companies control? Is there a better company than the others?” Compare the

two (CCL and RCL -see below) using common-size financial statements to

see trends or indications of strength or weaknesses. Common-size financial statements:


Read through two years of annual reports and proxies for both companies,

noting what you don’t understand–then go look up and research the answers.

Read about the industry BEFORE you read this article (click on link):

Case Study for Beginners Study an Industry Cruise Ships.

Background on Carnival Corporation

CCL_VL  CCL_Morn   CCL_2011 Annual Report

Royal Caribbean

RCL_VL    RCL_Morn   RCL_Investor Relations Presentation March 2012

Then read the article and see if you agree or can reverse engineer

what the writer did. I think you will have more fun and make your learning more relevant.

 Have a Great Weekend!

Zeke Ashton Teaches a Lesson in How to Learn–A Mistake Not Made

Entrepreneurs making a new market!

Centaur Value Fund:



 A Mistake Not Made

We have long been devoted to the practice of maintaining written research on each of our Fund’s investment ideas as a way to document our thoughts and expectations for each idea. Generally, our research should explain why a given investment should work, the risks that might keep it from working, and define a range of plausible scenarios that we use to formulate our valuation assumptions.

As ideas play out, we document the interim events and any decisions we make along the way. If an investment doesn’t work out, we try to determine whether there is a lesson to be learned that will benefit us in our future decisions.

While this research process is time-consuming, over the years we have come to believe in the approach even though there can be periods where the process doesn’t seem like it is helping our performance. Even worse, we occasionally succumb to mistakes that we should have recognized from prior experience, usually after sufficient time has passed to take the sting out of the prior event. Recently, however, we encountered a situation where we did benefit from having documented our experience with a similar investment many years ago.

Betting on the Jockey Rather than the Horse

As part of our search for promising investments, we look for management teams with great long term track records and that are strongly aligned with common shareholders. Over time, however, we have learned that so-called “jockey” investments can be a form of a value trap in certain conditions. Often, the reputation and track record of a manager or team can overshadow the quality and value of the underlying business. An investment based on faith that a given management will create value without careful analysis of the assets in place can be dangerous, and such stocks are prone to a “halo effect” that lasts until something goes wrong. It is easy as investors to become infatuated with a great management team to the extent that one might be willing to buy a stock without being entirely sure of getting great value for the underlying business. It is therefore quite common for businesses with well-known and well-regarded management to trade for a significant premium to comparable peers.

What we’ve learned is that while we very much prefer to have great “jockeys” directing our investment horses, it is usually a mistake to pay a premium for the privilege. It is usually far better to patiently wait until the stock gets cheap enough to eliminate any management premium. By not paying extra for management, we protect ourselves from the same types of errors in judgment that can occur when assessing business quality or business valuation. When the management team either turns out not to be as good as hoped or alternatively where good management simply makes what turns out to be a mistake that impairs investment value, capital is protected to some degree by ensuring that we do not overpay for the underlying assets or business.

Back in 2006, we decided to make an exception to the above rule of buying the assets at a discount and getting the management for free. The stock was Sears Holdings, and the “jockey” was Edward Lampert.

At the time, we wrote an internal research document arguing that Lampert’s track record was so good that we should purchase Sears Holdings even though we couldn’t make a strong and convincing case that the stock was undervalued. Rather, we made the case that the risk of missing out on the potential benefits of such an obviously great manager in his prime would be the greater sin. In essence, we were willing to pay up for value that hadn’t yet been created because we were so sure it would be. We realized our mistake a year or so later and sold the stock. We never had any real idea what Sears Holdings was worth, and we still don’t.

(CSInvesting: an honest, brave assessment of a permanent loss of capital)

Recently we were struggling with the temptation to invest in a new idea featuring many of the same ingredients: a management team with impressive credentials that is highly incentivized to create value for shareholders taking over a business that has been performing poorly relative to peers, making it ripe for a management turnaround. The stock was JC Penney, which was trading for about $35 at the time of our initial analysis.

After working through several iterations of the potential valuation case, we still couldn’t come up with a clear picture of what the business is worth with any high level of conviction. Still, the idea seemed to pull at us, until we asked ourselves a simple question: if this idea doesn’t work out, is there an obvious mistake that we will be able to point to and kick ourselves for having made? The answer was yes – that we would be making the Sears Holdings “jockey” mistake. We decided against the investment.

In any event, JCP now trades at a much lower price than when we first looked at it, and the market no longer views the management through the same rose-colored lenses it did even three months ago. While we still have a very high regard for the management team at JCP, we haven’t been able to get any more comfortable with our ability to value the business. So even at the much lower price, JC Penney is not an easy call for us.

While we won’t be surprised to see JC Penney work out as an investment – particularly from the recent $20 price – we simply have been unable to get to the point where we have great conviction in the idea. Until we do, we will leave it to others who may understand it better — and we won’t kick ourselves if it turns out to be a money maker for someone else. We are grateful, however, for the benefit of having documented a mistake we made back in 2006 so that we did not repeat it in 2012.



CSInvesting: This is an example of how you can learn from your investing experience. The author recorded his investment, then honestly assessed how it developed and used what he learned to avoid a future loss.

Austrian Economist Savagely Devastates Paul Krugman in a Debate

Thanks PB for the heads up.

If you had any waivers about Keynesian (establishment/conventional) economics vs. the Austrian perspective then view the video in the link below.

Professor Pedro Schwartz uses facts, theory and irrefutable cause and effect evidence to destroy Krugman’s advice to get out of crisis.  The introductions are in Spanish but the debate is in English.  I do believe Krugman is ignorant about time in the structure of production, thus he esposes an endless injection of stimulus to increase aggregate demand.

I remember driving through a subdivision in 2010 twnety-five miless outside of Las Vegas wondering who would build four hundred homes for nobody? Tumbleweeds and rattlesnakes…..Had a neutron bomb struck the development? Try stimulating that.


Krugman Destroyed In Debate By Jeff Harding, on July 9th, 2012

This comes from Luis Martin of TrugmanFactor, a blog located in Spain that translates and publishes Daily Capitalist articles. You can skip the intro in Spanish and get to Krugman’s lecture (0:09:19). But the real stuff starts at 0:35:25 where Professor Pedro Schwartz responds to Krugman’s comments in excellent English. Professor Schwartz is a distinguished and well known Austrian theory economist. And in Luis’s words, “completely destroys Krugman.” In fact Schwartz tweeted later that Krugman refused to shake his hand afterward. Enjoy.

Another Krugman Debate

Robert Murphy, an Austrian Economist, explains the Austrian Business Cycle to Krugman using a Sushi Capital Theory analogy: http://mises.org/daily/4993


PS: a reader apologized for disagreeing with me. Don’t. I like disagreements or hearing another point of view or discovering that I am just plain wrong. As a fallible human, I hope to always be aware of my fallibility. We are all trying to learn.

A Reader Asks What is the Best Way to Learn Using the Resources Here.

How Best to Learn?

An intelligent reader and I have had an exchange on how to approach using the resources on this blog to learn most efficiently. There are many resources on this blog and in the Value Valut–just email me at aldridge56@aol.com to request a key)–but the orgainization can be improved upon.

Ben Graham was right when he said a conservative investor can do better than average through using a disciplined, rational approach here: http://www.grahaminvestor.com/

Benjamin Graham always tried to buy stocks that were trading at a discount to their Net Current Asset Value. In other words he buy stocks that were undervalued and hold them until they became fully valued.

“The determining trait of the enterprising investor is his willingness to devote time and care to the selection of securities that are both sound and more attractive than the average. Over many decades, an enterprising investor of this sort could expect a worthwhile reward for his extra skill and effort in the form of a better average return than that realized by the passive investor.” Ben Graham in “The Intelligent Investor”, 1949.

The problem is how difficult it is to perform much better than average. You have to expand your skills and circle of competence while keeping the costs of your learning to a minimum.

I will be traveling the next few day (until Tuesday), but I will think carefully on my answer to his question. Other readers, please feel free to offer your experiences, thoughts and suggestions. The quality of readership here is outstanding.


Hi John,

Just a quick question regarding your suggested learning methodology.

I am currently working through your lectures (blog and Value Vault) and there are a number of useful book recommendations. Would you suggest reading the books before moving on, to appreciate and understand the subsequent lectures? e.g. In lecture two, you quote, “The professor (Joel Greenblatt in his Special Situations Investing Class at Columbia GBS) stressed studying carefully the essays of Warren Buffett.”

I do have the book and was wondering whether to take a break from the lectures and study the book, then return to the lectures. Given you’ve been through the learning process already, what would you recommend?

I’d be very interested to hear your thoughts. Keep up the good work, it is really appreciated.

My reply: Dear Reader please tell me about your background, how you became interested in investing and how YOU think is the best way to learn.

What drives your interest in investing? Then I can better frame my answer.


That is a very good question and I’ll try to be as clear and honest as possible.

Background: I am from the UK, 42 years old, married, with one child.

Job: Sales & Marketing Director for a small Manufacturing Company selling custom robotics/automation machines/systems to pharmaceutical and petro/chemical industries.

Professional Background: I am a Chartered Mechanical Engineer.

Education: 2001 – First Class Honours Degree in Mechanical Engineering.

2006 – MBA from XXXXX Business School.

2010 – MSc module Valuation with Professor Glen Arnold at Salford University (10 week semester). Glen is author of “Value Investing” and other related investing/corporate finance titles (FT Pearson).

2012 – Professional Certificate in Accounting (Open University). This was a distance learning course done over two years in financial accounting (year 1) and management accounting (year 2).

Background: Hard to say how I started out, but I invested in Thatcher’s UK privatisation initiatives in the mid 80s. I made a small amount of money on this purchase of UK utility company British Gas and I was hooked. I was 16 years old.

Since then I had limited free capital due to mortgage, pension and so on. About seven years ago, I became interested again and read “The Motley Fool Investment Guide” on investing which basically advocated index/mutual funds. I did this for a couple of years, invested mainly in Fidelity funds, UK, China, India, US index funds and by sheer good fortune sold out near the top of the market to buy a house (May 2007). Shortly after I had a brief spell spread betting (futures), with limited success, actually no success! I wanted to get rich quick and attended numerous trading seminars in London. I shorted one of the worst hit UK banks (RBS) during the banking crisis and still lost money because of the volatility (and my ineptitude). Imagine losing money shorting Lehman! It was that bad.

I managed to stay out of the market for 2008 and started to reinvest in 2009, mainly FTSE100 companies that are mostly popular (by volume e.g. Vodafone, Royal Bank Scotland) but with no analysis or reason to invest other than a ‘gut feel’ that they would go up! They did, but so did everything else…I later sold once I became interested or aware of small cap value.

I’ve read (once only) many classic investment books (Graham, Dreman, Lynch, Greenwald, Glen Arnold, Montier, Shefrin, Buffett partnership letters, Greenblatt, Pabrai etc.). As you know there are many references in these books to the accounting numbers and having read them I realized I didn’t know that much about accounting despite my MBA education. As a side note, I did the part-time Executive MBA and it was way too hurried to absorb the vast amount of information, so my finance learning was minimal. I oculd calculate WACC, CAPM etc., but didn’t understand the context. And so I decided to embark on an accounting distance learning course which I recently passed a couple of months ago.

After reading these books and several biographies on Buffett, I became more and more interested in the value philosophy (low P/E, P/BV etc.). I stumbled across various value oriented blogs such as Richard Beddard in the UK, Geoff Gannon and your own blog. Since reading these blogs I started to follow the UK small cap scene. (John Chew Small-caps have the tendency to be more over-or-undervalued for liquidity and informational reasons). The reasons for this philosophy are mainly based on Buffett’s early days, Greenwald, Beddard and Glen Arnold’s teachings. I can also relate to the idea that they are under researched, too small for the institutions and are a lot easier to understand.

So far my learning process has evolved from trying to understand quantitative financial analysis through books and working my way backwards, i.e. if I don’t understand something in a book or on a blog, I know I have to educate myself rather than think I know what I’m doing. I’d like to think I recognize my behavioral failings e.g. overconfidence, which I hear a lot in investing. My current thinking is to learn financial statement analysis first, along with valuation and then I can focus on the qualitative factors such as competitive advantage etc.

I believe that to buy a company cheap, you should know its intrinsic value and so I have become more interested in valuation and the teachings of Damodaran. I have just started to look at his Spring 2012 lectures. At the same time I saw his course mentioned in your first lecture. Not long after reading your first lecture, my question occurred to me, i.e. if John is recommending these resources – does he suggest that the reader works through those recommendations first before proceeding with the lectures. I realize that if you read and did everything you posted, it would take a lifetime, so although I am definitely not looking for shortcuts, I would appreciate advice on the case study approach to learning. My intention is to work through the lectures and stop at the point a book is recommended. However there are about five or six books mentioned in lecture one alone. I’ve just started, Essays of Warren Buffett by Cunningham. I also understand there is no substitute for getting your hands dirty and reading the financial reports of the companies you’ve either screened or shortlisted for some reason. I suppose I’m at the stage where I’m not sure what ratios are important, profitability vs financial strength etc. Do I look at a company qualitatively first or do I screen based on PBV, P/E, Yield, ROIC, ROE, EV/EBITDA etc.? I’m conscious that I need to avoid value traps, so maybe look at F-Score, Z-Score, solvency.

I realize you can never stop learning, but I just need some direction from a person who’s been there already. Once I have the right approach in mind, I will study and ultimately learn from my mistakes akin to Kolb’s experiential learning theory.

What drives my interest in Investing?

I suppose this could be answered with a quote from the Guy Thomas book, Free Capital:-

“Wouldn’t life be better if you were free of the daily grind – the conventional job and boss – and instead succeeded or failed purely on the merits of your own investment choices? Free Capital is a window into this world.” Guy Thomas – Free Capital.

That quote would sum it up for me. I can cope with not being rich, but being free would be pretty good! In addition, I actually love the game of investing and the intellectual challenge interests me enormously. I read investing books for fun, much to my wife’s disapproval!

I hope the above gives you enough to answer my original question and thank you for your time and help.

Valuation from a Strategic Perspective, Part 1: Shortcomings of the NPV Approach to Valuation


For beginners and a review of Present Value—see these 10 minute videos: http://www.khanacademy.org/finance-economics/core-finance/v/introduction-to-present-value and  http://www.khanacademy.org/finance-economics/core-finance/v/present-value-2 and http://www.khanacademy.org/finance-economics/core-finance/v/present-value-3

and Discounted Present Value: http://www.khanacademy.org/finance-economics/core-finance/v/present-value-4–and-discounted-cash-flow

Prof. Damodaran’s Handout on NPV:DCF Basics by Damodaran

Prof. Greenwald Lecture Notes (See pages 10-13 on NPV Valuation):OVERVIEW Value_Investing_Slides

And The Dangers of Using DCF (Montier and Mauboussin)

CommonDCFErrors (Montier) and dangers-of-dcf (Mauboussin)

Part I: What are the three major shortcomings of using the Net Present Value Approach (“NPV”) to valuing companies?

The NPV approach has three fundamental shortcomings. First, it does not segregate reliable information from unreliable information when assessing the value of a project. A typical NPV model estimates net cash flows for several years into the future from the date at which the project is undertaken, incorporating the initial investment expenditures as negative cash flows. Five to ten years of cash flows are usually estimated explicitly. Cash flows beyond the last date are usually lumped together into something called a “terminal value.” A common method for calculating the terminal value is to derive the accounting earnings from the cash flows in the last explicitly estimated year and then to multiply those earning by a factor that represents an appropriate ratio of value to earnings (i.e., a P/E ratio). If the accounting earnings are estimated to be $12 million and the appropriate factor is a P/E ratio of 15 to 1, then the terminal value is $180 million.

How does one arrive at the appropriate factor, the proper price to earnings ratio? That depends on the characteristics of the business, whether a project or a company, a terminal date. It is usually selected by finding publicly traded companies whose current operating characteristics resemble those forecast for the enterprise in its terminal year, and then looking at how the securities markets value their earnings, meaning the P/E at which they trade. The important characteristics for selecting a similar company are growth rates, profitability, capital intensity, and riskiness.

This wide range of plausible value has unfortunate implications for the use of NPV calculations in making investment decisions. Experience indicates that, except for the simplest projects focused on cost reduction, it is the terminal values that typically account for by far the greatest portion of any project’s net present value. With these terminal value calculations so imprecise, the reliability of the overall NPV calculation is seriously compromised, as are the investment decisions based on these estimates.

The problem is not the method of calculating terminal values. No better methods exist. The problem is intrinsic to the NPV approach. A NPV calculation takes reliable information, usually near-term cash flow estimates, and combines that with unreliable information, which is the estimated cash flows from a distant future that make up the terminal value. Then after applying discount rates, it simply adds all these cash flows together. It is an axiom of engineering that combining good information with bad information does not produce information of average quality. The result is bad information, because the errors from the bad information dominate the whole calculation. A fundamental problem with the NPV approach is that it does not effectively segregate good from bad information about value of the project.

A second practical shortcoming of the NPV approach to valuation is one to which we have already alluded. A valuation procedure is a method from moving from assumptions about the future to a calculated value of a project which unfolds over the course of that future. Ideally, it should be based on assumptions about the future that can reliable and sensibly be made today. Otherwise, the value calculation will be of little use.

For example, a sensible opinion can be formed about whether the automobile industry will still be economically viable twenty years from today. We can also form reasonable views of whether Fort or any company in the industry is likely. Twenty years in the future, to enjoy significant competitive advantages over the other automobile manufacturers (not likely). For a company such as Microsoft, which does enjoy significant competitive advantages today, we can think reasonable about the chances that these advantages will survive the next twenty years, whether they will increase, decrease, or continue as is.

But it is hard to forecast exactly how fast Ford’s sales will grow over the next two decades, what its profit margins will be, or how much will be requires to invest per dollars of revenue. Likewise, for a company like MSFT, projecting sales growth and profit margins is difficult for its current products and even more difficult for the new products that it will introduce over that time. Yet these are the assumptions that have to be made to arrive at a value based on NPV analysis. (See page 10 of Greenwald notes-link on blog post).

It is possible to make strategic assumptions about competitive advantages with more confidence, but these are not readily incorporated into an NPV calculation. Taken together, the NPV approach ‘s reliance on assumptions that are difficult to make and its omission of assumptions that can be made with more certainty are a second major shortcoming.

A third difficulty with the NPV approach is that it discards much information that is relevant to the calculation of the economic value of a company. There are two parts to value creation. The first is three sources that are devoted to the value creation process, the assets that the company employs. The second part is the distributable cash flows that are created by these invested resources. The NPV approach focused exclusively on the cash flows. In a competitive environment, the two will be closely related. The assets will earn ordinary –the cost of capital—returns. Therefore, knowing the resource levels will tell a good deal about likely future cash flows.

But if the resources are not effectively, then the value of the cash flows they generate will fall short of the dollars invested. There will always be other firms that can do better with similar resources, and competition from these firms will inevitably produce losses for the inefficient user. Even firms efficient in their use of resource may not create excess value in their cash flows,  so long as competition from equally environment, resource requirements carry important implications about likely future cash flows, and the NPV approach takes no advantage of this information.

All these criticisms of NPV would be immaterial if there were no alternative approach to valuation that met these objections. But in fact there is such an alternative. It does segregate reliable from unreliable information; it does incorporate strategic judgments about the current and future state competition in the industry; it does pay attention to a company’s resources. Because this approach had been developed and applied by investors in marketable securities, starting with Ben Graham and continuing through Warren Buffett and a host of others, we will describe this alternative methodology in the context of valuing a company as a whole in Part II.