Xplain Frankie.
I’d like to jump in, if you wanna hear it.
in the long run, they’re the same…but we’re talking long long run…
a stock can’t be “that great” if the underlying is weak as the best hedge against erosion of capital is a great company…
So you are late for a meeting driving down a two-lane road when you hit a stop light with a Ferrari in one lane and a garbage truck in the other. Of course you are going to pull behind the Ferrari because there is no way the garbage truck is going to be faster off the light. If there are now 20 cars behind the Ferrari and none behind the garbage truck will you still pick the Ferrari? At some point the Ferrari, while superior to the garbage truck, is not the better pick. The same goes for good companies trading at too high of a price.
^^What chad said.
As an example, there’s a company that we traded in that earned really crappy returns on capital. Operating margins in the 5-10% range, and they would turn their operating assets like…one half turn a year. We’re talking about super low returns on their operating assets here, basically. BUT! They had some non-operating assets - They owned a stake in a spin-off that they were carrying (because of accounting rules) at a ridiculously low accounting value. This spin-off has earned dynamite returns - operating margins of like 15-20%, they turn their operating assets almost 1.5x a year, and they’re run very, very well. They recieve dividends from this owned company ever year that amount to just about triple their own operating results, and this revenue stream is growing at about a 20%+ growth rate over the past 5 years.
So, is the core company a good company? Nope, not really. But because of a valuation that wasn’t appropriate, it’s been a dynamite stock (up a little more than 100% over TTM). The key is valuation - theoretically, every company is a great stock at one price, a so-so stock at another price, and a losing investment at another price.
Please. Everyone should jump in. I get it for ye most part, but I want to hearhow the smart people describe it.
what exactly was the accounting treatment specifically?
They were carrying it at equity method (they owned between 20-50%), bringing in their share of net income on the income statement, and stating the value on the balance sheet as their share of net assets for the company, with adjustments for the income / dividends / losses they had recieved. However, this spin-off was publicly listed and right below the carrying value explanation in footnotes, they explained that the market value of the position was about three times higher than their carrying value. Nothing crazy or fraudulent, just a dumb way to carry a position that has level 1 quotes. You wouldn’t have noticed anything weird if you were looking at it using a screener tool (price to stated book, etc) or in bloomberg, but when you looked at the historical performance of this position they owned and the fact that their quoted stake was worth about 3-4x what they had it on the books at, my eyebrows went to the roof.
As I said, their core business was mediocre (I’d give it a C-, in terms of profitability and outlook), but discovering that they owned a big slice of this very profitable other company (which was probably like an ‘A-’) was just awesome. That’s all the good company / bad stock saying refers to - all we’re doing when we’re investing is looking for a mismatch between the company, and the price.
Facebook is a great company as far as profitability (anyone else read their IPO docs?), but the insane valuations put on it make it, in my opinion, likely to be a so-so stock. On the flip side, this company I mentioned is definitely a pretty weak company, but the valuation made it a great stock.
haven’t seen the IPO docs but from what i read on news sources, FB is just ok…their earnings are still fresh so not sure how durable they’re and I don’t use facebook so can’t confirm anything…$100b valuation on FB to me is a bit ridiculous…
Monkey wrench. Does one use quantitative analysis for a stock and qualitative analysis for a company?
In the context we’re using them in, you’re using both. Basically, the way we’ve been using our terms in this discussion:
“Company” - the business enterprise you’re investing in. Qualitative and quantitative stuff. What’re their historical returns like, what’s their outlook like, how’s the competitive advantage, projected growth of their market size and share of that market, who are their competitors and how does our target company stack up against them? Who’s the management, how have they done so far, how are they compensated?
“Stock” - the nominal and relative price that the “company” is available for in the marketplace. This part is usually more quantitative, but it should involve qualitative considerations too. If you told me that two companies were both available at the exact same valuations and earnings multiples, with identical balance sheets, but one of them was operated by, for example, Henry Singleton (excellent manager, historically) and one of them was operated by Joe Schmoe whoever, I’d prefer the company run by Singleton. That’s a made up case to demonstrate a qualitative consideration, but my point is that even when you’re thinking about the “Stock” part of the equation (the valuation) you want to keep the “Company” part of your work in mind.
Another example - if Nucor and US Steel were available at roughly similar valuations, you’d have to be a damned fool to pick US Steel. Heck, if they were both available at reasonable valuations but Nucor was 50% more than US Steel, you’d still probably want to go with it, because it’s a vastly better company in the same industry. However, you’d only know that if you had done both qualitative and quantitative work on the company.
Supersadface - love your posts btw, but I have a question for you…
How do you find those opportunities? I typically use a stock screener mainly looking for mid small cap companies with high ROE and CF/share but i dont think they would capture a stock like that. So how did you do it, if you dont mind me asking?
There’s a Timex watch and if you purchase a $5 ticket, you get it.
There’s a Rolex watch and if you purchase a $2 Million ticket, you get it.
Which is the better watch to have?
Which is the better ticket to buy?
“Timex is the better watch and $2 million is the better ticket.”
- Avg investor
We get ideas from really boring, simple sources: Checking the new lows list, running screens that we have for various metrics (some based on profitability, some based on valuation). Recently found a great company because we were doing work on [what we thought] would be a target company for us, but when I was doing work on the market they operated in, we found a way better company in the same industry. That’s less common, but possible. I’ll also read the quarterly letters of managers we have respect for and coattail occasionally - if there’s a name that one of them has started buying, and it’s in our universe, we’ll probably poke around the company to see if there’s something that jumps out at us.
This particular company had come up on one of our screens for another reason (I think it was on the new low list? Not even sure at this point). I was doing my full report on them and discovered this hidden asset.
Keep your screens broad, and remember that NO particular screen will turn up all the value stocks out there (or growth stocks, or whatever, for that matter). There are lots of ways a stock can be a “value” stock. A stock with hidden assets will probably not make your screen if you’re only using stated price-to-book, because the stated book value is inaccurate. A company trading at a discount to net cash will probably look like garbage if you’re screening only on return on equity (the company has tons of non-operating assets and is underleveraged as a result) . A company that just took a massive goodwill writedown may have negative earnings for the trailing twelve months, even if it’s actually a great cash generator. So no one screen will capture everything - the screens are just a starting point to get some names in our hopper.
Yeah, that’s interesting… it’s cool to HAVE the two million ticket, but it’s not cool to BUY the two million ticket. It is cool to have others think you can afford the two million ticket, though, and so many people buy it anyway.
I meant more that some people like crappy companies with high valuations simply because they have gone up a lot already. Everyone loves a winner…
I’ve bookedmarked this thread. Thanks!
Glad you liked my response and my posts. When I’m not writing ‘joke’ responses, I actually do attempt to be helpful, so it’s nice to hear that someone’s reading my walls-of-text.
It’s appreciated, by the way which manager’s do you follow? I obviously like Buffet, Seth Klarman is pretty much a god in my book, I like Michael Price and I like to read John Hussman and Bill Gross’s commentary because I like the way their minds work. I think Soros is pretty cool and I like Marc Faber because he’s a nutcase even though I hate gold as an investment(because its not one imo).