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buylowersellhigh

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    valuing cash flows based on floating rate index

    in General Discussion

    Posted

    CofBF,

     

    How does one go about valuing a portfolio of loans whose cash flows are based on a floating rate index? So a bunch of commercial loans based on LIBOR plus a fixed spread.

     

    What is the methodology to determine the discount rate in this instance? Does the spread on the underlying loans have any reflection on the discount rate used?

     

    TIA,

    BLSH

     

    Stock Price

    in Fairfax Financial

    Posted

    Rishig,

     

    What do you think of FFH here? 

     

    TIA,

    BLSH

     

     

    It might also be partly due to the cluster$%^% that is India (at the moment).  Prem's bullishness there is all about  PM Modi reforming the economy.  For this to happen Modi needs to last more than one term 

     

    http://www.zerohedge.com/news/2016-11-17/indian-economy-grinds-halt-after-cash-ban-demonetisation-has-shaken-our-faith-moneta

     

    cheers

     

    nwoodman

     

    More on this topic:

    Life is Crazy or Ask Scott About Life

    in General Discussion

    Posted

    W/R/T investing generally: one thing that I see way too often with value investors is that they focus far too much on a company's financial statements without giving real thought to underlying business economics.

     

    This statement may apply to me.  Guilty as charged, if I understand you correctly!

     

    But do I understand you correctly?  Would you be saying the same if you hadn't evolved into a more GARPish style?

     

    In terms of value investing gurus, would you say you're less Ben Graham (of whom I am more of) and now more Phil Fisher/Peter Lynch?

     

    Anyway, thanks, Scott, for this unique and most refreshing thread.

     

    No, I wouldn't be.

     

    My statement there comes down to efficient allocation of capital. What does having free cash flow mean? That cash is piling up in the bank, essentially. That cash can be used for a number of different things - dividends, share repurchases, acquisitions, debt repayment, and so on.

     

    That sounds unambiguously like a good thing, and generally it is. The trouble comes when you have very high quality businesses that can invest at high rates internally. For example, Chipotle Mexican Grill has amazing unit economics. Their restaurants have something like 27% operating margins on over about $2.5 million of sales each.

     

    It costs Chipotle something like $843k to open a new restaurant, so, the returns there are pretty damn amazing. Somewhere in the mid-to-high double digits

     

    That's a crazy amount of money, and each store provides Chipotle with a lot of cash flow. That's great. What isn't so great is letting that sort of money pile up when CMG can reliably earn returns stock investors can only dream of by putting it to work opening new stores. Ideally, Chipotle would have no free cash flow because it would be able to continually reinvest with those economics.

     

    Unfortunately, we don't live in Candyland, and there are major bottlenecks towards opening new stores. They have to scout locations, train employees to ensure the quality is what consumers expect, and so on. So they can only allocate a portion of their cash flow to new locations each year. But if they could get away with it, they'd be nuts not to spend as much as possible on new locations so long as they can continue scaling.

     

    And here's the thing. That would make the company's financials look ugly. There'd be no cash flow. Sure, they'd be generating profits, but none of it would make its way to the bank. And that'd turn a lot of investors off. But really, if that were to happen, they should be salivating over the returns their capital is earning.

     

    For an even better example, look at Netflix. I haven't looked at it in a while, but they were acquiring customers for somewhere between $30 and $40 just a few years ago. And those folks stay with them for a long time, delivering, generally, multiples of that value back to the company over the life of their subscriptions. And those subscriptions? They can last for years.

     

    All of the hundreds of millions they're throwing at acquiring customers? It's expenses on day one, as advertising typically is. There are narrow exceptions to this granted, but as a rule of thumb, advertising is expenses. It's not amortized. Think about that for a moment. They're buying members, many of who stick around for years. But the ad spend shows up as an expense entirely in the first year.

     

    What are the implications of that for Netflix as a business? It means that, so long as the company keeps growing, its income statement will lag the true economics the company is generating. That's true of all subscription businesses, and is why looking at profitability and free cash flow alone for them is absurd.

     

    They're buying a stream of cash flows. A stream. More money for years. And that ad spend makes each year they grow look like shit, but what do they care? They're creating a lot of lifetime value for their business by doing it.

     

    Put it more simply... if I gave you the opportunity to shell out $100 for income streams that would pay you $50 per year indefinitely, would you snap at it? Think of how that translates to GAAP, though. If you had to expense that like Netflix does its advertising, you'd show a loss.

     

    And if you doubled the amount of income streams you bought each year, you'd keep showing losses. Even though you'd be creating a ton of wealth for yourself, you'd be showing losses and negative cash flow. In other words, your financial statements would be completely divorced from economic reality.

     

    This happens in business more often than most people think. It can be in land acquired long ago, or it can be in things like Netflix, SaaS companies, or any other growing business that is creating long term customer relationships that require money upfront to create.

     

    And these can be enormously profitable for shareholders over time, regardless of what the financial statements say.

     

    This is why, for many businesses, I'd rather they not generate cash flow. Because if they earn great economics and can scale their concept nearly infinitely (Amazon) they'd be insane to do so. Not only will they take a tax hit on earning profits, they'll be letting good money sit idle and lose out on some amazing compounding magic.

     

    That's basically what I meant.

     

    No opinion on any of the stocks mentioned, except Amazon, which I own.

     

    As for Ben Graham vs. Phil Fisher: maybe? My style is my own, and adapts concepts from Warren Buffett, Peter Lynch, John Malone, Jeff Bezos, and my employers (the Gardner brothers), among others. Most of my insights come more from great business creators than great investors, to be honest.

     

    Happy you find the thread interesting.

     

    Scott,

     

    What are the reasons you don't own any CMG or NFLX?

     

    Blsh

     

    Stocks you own but NOT discussed on board - yet

    in General Discussion

    Posted

    ENTA.....biotech, nuff said

     

     

     

    I'm curious what shares people own that they are able to follow on this board but more interestingly, I'm curious what stocks board members own but no one started a thread on yet. 

     

    Also, while most posters on this board likely fall into the "value investor" camp, I don't see any great harm in such investors holding the odd growth and even highly speculative (lottery ticket) stocks if the investor knows the risks.  So it would sure be interesting to see how some of the "unknown" positions are viewed by the holders.

     

    For instance, here's one I just searched for and no mention of it turned up:

     

    Not of Corner of Berkshire and Fairfax:

    IMRIS (IM). Purely speculative  (A buy and sell position of mine.  Recently bought back into the stock)

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