Interesting. So what does he suggest you do after you multiply current cash flow by 10? I’m interested in understanding what this means, but at the moment I don’t get how this gets you to equity value.
I also have to admit I’m unfamiliar with that method Greenwald proposes which you described above. I haven’t read the book you suggested, but in his “Little Book That Beats The Market,” he spends most of the time talking about understanding the earnings power value of a company to guide his investment decisions – namely, that the best investments demonstrate an attractive combination of earnings yield and return on invested capital. That doesn’t sound like what you’ve mentioned above, so I’m curious to understand if there’s a different method that he thinks is effective.
I was quoting the numbers off the cuff but it seems I was pretty accurate. Name is Theragenics (TGX), looked on a block last October (you can see the volume spike on the chart). Looking at the email thread, my boss actually bought some strictly on valuation but we did not take a large cut of the block. Anyway market cap was 43mm (now 69mm), mgmt paid themselves 2.4mm the prior year, resignation upon change in control is 8.9mm (good god that is high for a management team that neither founded the company nor owns any significant amount of stock). They refused a buyout offer at $2.20 (I forgot that) – clearly not trying to maximize value in any way given that the stock has not traded above 2.20 since pre-Lehman, not to mention the fact that their business model doesn’t make sense as a stand alone entity. To flesh out in more detail, CEO said they were waiting for a fair offer and had not received calls, but the fact is they could pick up the phone and sell this thing for way more than 43mm (and in fact almost certainly more than $2.20 as well) but would rather collect outsized comp packages.
To your point, numi, this is pretty a retarded situation for shareholders. But it’s not THAT uncommon for microcaps, many of which are poorly run and in need of an activist. The microcap public company space is definitely NOT efficient, and is even less efficient from an activist stand point because the targets are too small for most firms to pursue and the names are illiquid. Microcap investors typically know which names are shitty but can’t do anything about it, so they either buy at crazy low valuations for a flip (as my boss did – $1.25ish) or just avoid the stock altogether. With a lot of these, you can’t really even short them despite crap mgmt because they don’t trade and because they already bombed out in most cases price-wise. So they’re just dead money, waiting for something to happen, possibly gradually eroding over time.
I did not see any posts on the internet about this particular company (although there was and may still be some pretty awesome stuff on the company webpage about how the CEO loves rodeo (totally unrelated to anything, red flag #1)). My experience with Seeking Alpha is pretty ho-hum from a reader’s perspective, so I am not that surprised. Most of the good research gets passed around by network and traded amongst trusted friends, not posted online (not that anyone probably spent time on TGX because it’s so obviously a dog). And anyway, this is a pretty obscure company with a tiny cap – it’s well under the radar for most people.
Anyway what made me laugh really hard about this company is that after a while you can smell stock pumpers coming from a mile away. I scheduled a call with the CFO and was like, you know, I bet the CEO will hop on the call (even though it wasn’t scheduled to be with the CEO) and start pumping the stock because I bet she has nothing better to do (given that she is clearly not really spending time running the company in any efficacious way). Sure enough, 30 seconds into the call she grabs the polycom and starts pumping it LOL.
The name of the butt pellets is brachytherapy if anyone wanted to know that.
You’re mixing Bruce Greenwald with Joel Greenblatt. I do this all the time too.
I read that book as well, and Greenblatt is actually one of those examples of methods that seem fairly simple but apparently have worked well for extended periods of time.
Bruce Greenwald is the guy who teaches Value Investing at Columbia.
I’m actually looking at the book now so I can stop saying stupid things (9,99 on Kindle, and it is a nice fast read). It was one of the first books I’ve read on investing, and its interesting to have another look at it now that I know a little more.
I’ll skim through it and write a (half-assed) review
Greenwald says data shows that companies that are boring, poor performing, unknown and unloved are better buy son average, since investors overpay for glamour stocks.
He likes small stocks. Besides positive historical data, the argument is that they have more room to growth and, with some growth, they may enter the acceptable range of stocks for many institutional investors, and then they go up.
There is a bunch of little rules like that that would be the filter – after that there is a smaller number of stocks and the valuation begins.
Then he spends a while hating on PV (basically lists and explains limitations)
The valuation:
1 – Value of the assets:
He tries to determine the replacement cost of the assets, based on the most recent balance sheet (I guess ideally you should do this just after its published). Cash and Accounts Receivable will be fully valued (more or less, since they may be spending cash right now or not receiving AR), P&E and inventory will be valued at reproduction costs, and goodwill will be valued as zero. Of course, if the company/industry is going down, a lot of reproduction cost stuff is valued at scrap cost. He goes into much more detail, but it looks like some L2 stuff with some diff views/tips (I’m skimming the book, but this is just to get the idea).
Then he talks about barriers to entry. Basically if the reproduction cost of the assets is a billion, the average firm should be worth around a billion, since anybody can just reproduce the company if they think this will pay off more than a billion. So, if the company has a MV of 2 billion, competition will drive this down (I just realized he’s basically using Tobin’s Q). With barriers to entry (including true competitive advantages – for which he has a specific definition), competition can’t really hurt MV.
So the idea is that the company should worth at least the replacement value of its assets, unless management is burning the company down and won’t be replaced.
If the value of the assets is a very clear buy (with margin of safety), that’s probably enough. This is the most reliable piece of data and so this is what he likes the most.
2 – Earnings power
My previous description really sucked. At least I’ll have the opportunity to correct that now.
He does a bunch of adjustments to earnings. Like before, seems to be L2 stuff modified for his views/tips. It ends up looking like his own version of FCFE.
Then he finds his “Earnings Power Value” (EPV) by doing Adjusted Earnings x 1/R. So, if the cost of capital is 10%, he multiplies by 10 (I remembered this example before instead of the real thing – sorry)
So he uses the most recent earnings and try to adjust that to make them into a proxy for “sustainable levels of distributable cash flow” and actually discounts them (silly me) by the CURRENT cost of capital. He also doesn’t use CAPM – he has a couple of methods, but the basic idea is to ask around what the company would have to offer in dividend plus capital gains to attract new money. You can also take a look at long term equity yields and adjust that by earnings volatility (less volatile has a smaller cost of equity - it seems to be almost a guess though - I feel he deliberately avoids looking for precision and tries to rely mostly on finding margins of safety - everybody likes that).
The rational is that he really hates the unpredictability of forecasts, so he reasons that current data is less crazy than forecasted data into the future. Note that growth is zero (he talks a lot about how growth may not mean anything + how hard it is to forecast).
EPV is used as a confirmation to Asset Value. If EPV is equal, it’s an average firm with no barriers to entry. If EPV is smaller, management sucks (so better value from EPV just in case the asset value can’t be “released”). If EPV is bigger, management may be good, or there may be some barrier to entry/competitive advantage – the key is to uncover if the barrier to entry is really sustainable, and in that case the intrinsic value should be bigger than the asset value.
It’s all very conservative. He has his chapter on valuing growth, but he doesn’t really recommend to bet on growth.
Gotta go to dinner with the wife now. I hope the info above is not too badly explained. If anybody is interested, it is a short book and easy to read – lots of overlap with CFA and Porter’s work, but an interesting view on some stuff – I’ll re-read it in full later.
After explaining the method, he does profiles for many value investors. I don’t recall much about it, but it seems kind of interesting.
I like the Greenblatt book. It makes a lot of sense to me.
Basically he tries to break a company value down in three ways:
How much would it take to build a competing company from scratch. This is basically the book value of assets at market value, with a few adjustments.
How much would the company be worth if it generates its current earnings into perpetuity. That’s th current earnings value.
How much is the growth portion of the company worth. This is basically the spread between earnings growth anthe cost of equity or revenue growth and the cost of capital discounted.
Each of these is a separate estimate of the company’s value, ranked from the most conservative to the least. By having all three of these available, you have a sense of where you can have firmer conviction in e results.
That’s actually a much better and concise way to describe it.
Just so I’m not confused, you’re talking about Greenwald’s, right? I think Greenblatt is about the magic formula - ranking companies on return on capital and earnings yield and choosing the best combinations.
I get Greenwald and Greenblatt mixed up a lot. They’re both Green-persons who teach at Columbia.
The book at beats the market basically says to choose companies that are fundamentally good, using ROIC (alternately ROA) as a metric for good performance, then choose among them on valuation, using low P/B (or maybe it was low P/E). I forget whether you took a low valuation in absolute terms, or if it was on a historical basis. Different industries tend to have different ranges of P/B, so I think it would have to be either industry specific or each company relative to its own history.
Importantly, it says to exclude all financials, because you can’t trust the value of the assets (I forget if he says that explicitly, or just implies non-trustworthiness strongly).
Considering what we did on this thread, I can only imagined how these guys get annoyed by random people mixing them up in real life - maybe at the schools’ cafeteria and what not.
I actually have Greenblatt’s book with me. So in the appendix, explaining the Magic Formula, he uses Return on Capital as EBIT/(Net Working Capital + Net Fixed Assets) and Earnings Yield is EBIT/Enterprise Value. He thinks calculating Earnings Yield this way better allows to compare “companies with different levels of debt and different tax rates”. He reasons through it with some other stuff, but the main idea is what you posted, or even just buy profitable companies at good prices.
Of course if we want to follow his method blindly we gotta have faith, cause some of the companies that will be screened will look a lot like dogs - he says we should buy them anyway, and diversification will save us in the end, or something like that.
Getting back to Valuation in general, does any of you have any familiarity with the website below?
They basically have mostly value ideas from members (the ideas are brief analysis, mostly for stocks). I just saw this today, but it’s interesting to see how some of those guys approach their valuation. I’m not sure how knowledgeable are the members on average, but this seems way more solid than the average website with the anonymous hot stock “tips” and all the nonsense.
You gotta be a member to read the most recent stuff, but it seems to be an interesting way to taste some different ways to approach possible investments.
Ah yes, it was earnings yield as the valuation metric, not PE (though conceptually, it’s the same thig, just inverted). I personally prefer earnings yield myself because plenty of companies have zero or negative earnings and the yield behaves better and more consistently for those companies (even if maybe you don’t want them).