Balance sheet focused analysis

[Shane]

I've read Bruce Greenwald's Value Investing book, there are a few points which I am a bit foggy on and was hoping someone could help me out here.

 

EPV = Adjusted Earnings + 1/WACC = Ok makes sense gives you a reasonable multiple to put on the earnings assuming they are stable.  Then you add the adjusted assets and subtract the adjusted liabilities, here is where I am confused. 

 

Lets say I find a company selling at book value + $10 and the EPV i assign to the business is $10.  So I would say this is a fairly valued business.

 

Now what If i determine the book value is $20 more than what the balance sheet shows.  The business now sells for a substantial discount to Intrinsic value - but unless they are going to sell assets or in some other way show the market that these assets are undervalued who cares?  It will never be brought to light and the stock will continue to trade at old BV + $10 EPV.

 

check out CSWC - this is a business development company selling at .6 BV, and it has consistently been available at a big discount to BV.  I've seen some 13G's where someone wanted management to spin off or separate the companies to bring the price back up... but it does not happen.  It's there for everyone to see bit nobody buys it up to its full price, I think this is called a conglomerate discount.

 

Is this what they call a value trap???

[twacowfca]

I've read Bruce Greenwald's Value Investing book, there are a few points which I am a bit foggy on and was hoping someone could help me out here.

 

EPV = Adjusted Earnings + 1/WACC = Ok makes sense gives you a reasonable multiple to put on the earnings assuming they are stable.  Then you add the adjusted assets and subtract the adjusted liabilities, here is where I am confused.  

 

Lets say I find a company selling at book value + $10 and the EPV i assign to the business is $10.  So I would say this is a fairly valued business.

 

Now what If i determine the book value is $20 more than what the balance sheet shows.  The business now sells for a substantial discount to Intrinsic value - but unless they are going to sell assets or in some other way show the market that these assets are undervalued who cares?  It will never be brought to light and the stock will continue to trade at old BV + $10 EPV.

 

check out CSWC - this is a business development company selling at .6 BV, and it has consistently been available at a big discount to BV.  I've seen some 13G's where someone wanted management to spin off or separate the companies to bring the price back up... but it does not happen.  It's there for everyone to see bit nobody buys it up to its full price, I think this is called a conglomerate discount.

 

Is this what they call a value trap???

 

Not necessarily.  The hypothetical co may not optimalize the extra value hidden in their BS, but the fact that the extra assets are there gives them options or may attract interest from activists.  

 

The biggest value trap that snares many investors is the common situation of a company's having to reinvest most of their profits (including that type of reinvestment that is expensed as R&D) merely to keep from falling behind competitors, losing share to a disruptive change in the market or being swept out to sea by the tide of an ebbing market.

[Guest misterstockwell]

After many years, and many stocks that stagnated in a pool of "value", I came to the conclusion that I would only invest in "value" if there was a catalyst to realize that value in the foreseeable future. Otherwise, you can get stuck forever.

[twacowfca]

After many years, and many stocks that stagnated in a pool of "value", I came to the conclusion that I would only invest in "value" if there was a catalyst to realize that value in the foreseeable future. Otherwise, you can get stuck forever.

 

I agree.  Buying a company merely because it sells below BV or has hidden assets on the BS may have a certain amount of safety, but is apt to be a poor way to make money unless the margin of safety is great and the portfolio diversified.  However, in general, having extra assets on the BS is a plus.

[Myth465]

Shane I think you are making this much harder then it needs to be. I owuld focus on the four filters that Buffett outlined.

[scorpioncapital]

The only value trap is when management turns from being an asset to being a liability. In your example, the assets are worth say 20% more than the market value, but management is presumably a liability for failing to sell them and give you the money, so the liability side of the equation is -20%. Follow the people, know the people, or you can easily get burned.

[Shane]

Myth, I've read you mention EPV before.  Can someone correct me on this really simple valuation?

 

BIP - Brookfield Infrastructure Partners

 

BV - $21.47

 

EPV = 148,000,000 x 1/.08 (AFFOx1/WACC) = $1.8 billion / Units = $11.4 per unit

 

I used AFFO because it appears MLP's structured like this are often evaluated by this instead of earnings.

 

If you add BV + $11.4 per unit you get $33.  So if I think management is good, the business will remain this profitable over time, and the economic conditions are favorable I should consider this undervalued?

 

 

 

[JEast]

Is this what they call a value trap???

 

I spoke with Martin Whitman a few years ago about value traps.  In general, he said that all deep value investors always buy value traps.  They might be traps, they may not.  However and with the right amount of margin of safety -- there is no such thing as a value trap.

 

Though CSWC is 0.x of BV at $90, it was also 0.x of BV at $65.  Some call this the holding company discount.

 

Turn it any way you want, value investing is the ugly duckling of the wealth management profession.  Ugly and unwanted in the sense that what we practice is the willingness to patiently defer gratification, be contrary, and act unconventionally value trap or not.

 

 

Cheers

JEast

[Myth465]

Myth, I've read you mention EPV before.  Can someone correct me on this really simple valuation?

 

BIP - Brookfield Infrastructure Partners

 

BV - $21.47

 

EPV = 148,000,000 x 1/.08 (AFFOx1/WACC) = $1.8 billion / Units = $11.4 per unit

 

I used AFFO because it appears MLP's structured like this are often evaluated by this instead of earnings.

 

If you add BV + $11.4 per unit you get $33.  So if I think management is good, the business will remain this profitable over time, and the economic conditions are favorable I should consider this undervalued?

 

 

 

 

 

I dont think you should add BV to EPV. They are 2 separate analysis unless the assets arent being used. I cant say SDs oil assets can generate $1 billion and then add that to the current value of the assets. Thats double counting. Listed below is what I do, I dont really do excel or anything fancy.  Its typically very obvious when you buy something cheap. It sticks out like damn I get all that for this price.

 

Also you are correct. You are a passive investor. Unless a takeover is coming, you can buy enough shares to kick out Management, or Management is receptive to your ideas you have a value trap. Plenty of cheap stocks out there with great assets. You need control, or need someone who can take control to really make anything happen. SD is a good example of an asset play - they bought assets for $200 million which could be worth $4 - $5 billion. The dfiference is they are realizing that value by selling it, drilling it, or JVing it. You need management to make it work so you were right there.

 

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I look at things slightly different. Think like an owner but a passive one. Add up the market cap, minus cash, plus debt (in some cases for me). Thats your Enterprise value. Then take a stab at your normalized free cash flow. Then look at the yield and decide whats a fair price for that. If there is growth you pay a bit more, if its shrinking alot less. If you are certain of the cash flow more, uncertain less.

 

Whats a fair return for the risks you are buying? In this rate envirnoment with treasuries paying nothing 7% - 10% is a fair return for equity. So I want to buy something stable with no growth for 14% - 20% and wait for Mr. Market to pay up. Also inmo 75% of time stocks trade around IV. Generally they trade down when everyone is scared or when the stock has something horrible going on.

 

------------------------

 

 

Filter #4 – Does the price make sense?

 

Note - Warren E Buffett "If you understood a business perfectly and the future of the business, you would need very little in the way of a margin of safety. So, the more vulnerable the business is, assuming you still want to invest in it, the larger margin of safety you'd need. If you're driving a truck across a bridge that says it holds 10,000 pounds and you've got a 9,800 pound vehicle, if the bridge is 6 inches above the crevice it covers, you may feel okay, but if it's over the Grand Canyon, you may feel you want a little larger margin of safety…"

No Growth Valuation - Monish Pabrai regarding FCF calculation. "There is no need for Excel. If a business has zero growth and consistent stable cash flow, that business is worth 10x FCF plus any excess capital."  This assumes approximately a 10% discount rate and results in a 10% free cash yield.  

 

Conservative Growth Valuation - Monish Pabrai regarding FCF calculation. If there is growth, depending on how much and how consistent, I’d be willing to value it at 12-15x plus excess cash.

 

----------

 

This quote has really grabbed me and sums up quite nicely what we do. Is Mr. Market right or wrong about RIMM, Dell, MSFT, WDC, SD, ATPG, BRK, MBI, or a whole host of numbers. If he is right then the stock is fairly priced, if not then they are all cheap.

 

Ian Rushbrook - The market does 95% of the work for you - your problem is not to duplicate research but to identify errors of logic in company evaluations.

 

 

[Shane]

Thanks Myth, that is enormously helpful.

 

So instead of market cap you use Enterprise value?  What if the firm has a negative enterprise value, what is the logic behind not using the market cap?

 

So if you can get 14-20% FCF yield (or a 5-7x multiple on FCF) and you like management/company/etc... you consider this a buy... correct?

[Myth465]

Thanks Myth, that is enormously helpful.

 

So instead of market cap you use Enterprise value?  What if the firm has a negative enterprise value, what is the logic behind not using the market cap?

 

So if you can get 14-20% FCF yield (or a 5-7x multiple on FCF) and you like management/company/etc... you consider this a buy... correct?

 

A negative EV is tough to find. I have only seen it in a stub situation. You are saying the company has more cash on its book then debt or MC. Thats awesome if it also has positive FCF. I would sell everything and buy it and probably get a personal loan and go on margin as well lol. Yes regarding the price. If its stable with good management and I understand it I get excited with a 20% yield (with current risk free (or free risk) rates at 1%, if rates were 15% I would want more than a 20% yield). No debt and growing I get gitty like a school girl lol.

 

Sometimes I use Market cap, and sometimes EV. It depends with a REIT I tend to ignore the debt as long as the prices were purchased cheaply. If its a company with extremely stable earnings like a REIT or Utility or FTR, I tend to not be bothered by the debt and focus on the yield. Otherwise I use EV to factor in the debt and to make it apples to apples in terms of a comparison.-

 

HarryLong makes an excellent point. Your competition Mr. Market aggregated is pretty smart. You are basically saying he is wrong when you buy. You must know inmo what he thinks, why he thinks it, and how its wrong. WDC has a great FCF yield. Mr  Market thinks HDDs are dying and Ipads and Iphones will take over. I think he is less right and they will play nice together for quite a while so I buy WDC.

 

ATPG was $8 on the gulf closing due to debt and prospects. Crappy cash flow, tons of debt, but assets worth $80. Would they survive? Its now $19 with the gulf open and permits in hand anyone who bought 2 year leaps is sitting pretty. They were $24 pre spill and are now in much better shape. The list goes on and on. Either you clip coupons or you outsmart Mr. Market on key easy to call bets.

 

You really only get a good price if the company is going through stuff, people are generally panicked, or the company is unknown. Otherwise you are buying things for a 10% yield and clipping coupons or expecting outsized growth.

 

---

 

Forgot to answer your question lol. The logic in using EV vs. Market cap is a company could generate $1 of earnings and have a $1 market cap. You would think great, but what if it had $100 of debt. Not so hot. You to get an idea of what the company makes from Debt and equity. So you add them up. Leverage is nice, but I want to know how the business does pre debt. Then want to know can you pay off that debt.

[indythinker85]

Graham still working after 70 years: Negative Enterprise Value In summary, despite one total loss, the negative EV cohort gained more than 32% over the last five months while the S&P gained just shy of 9%. http://www.valuewalk.com/2014/01/negative-enterprise-value-stocks/

 

Negative Enterprise Value Portfolios After One Year

 

http://greenbackd.com/2013/12/04/negative-enterprise-value-portfolios-after-one-year/

[Ham Hockers]

 

I spoke with Martin Whitman a few years ago about value traps.

 

 

Boy, Marty Whitman really did not like Greenwald's book

[cubsfan]

How funny. I really liked Greenwald's book and did not like Whitman's book at all.

 

I'm sure Marty's book was great - but it's so tough to read.

[Kraven]

How funny. I really liked Greenwald's book and did not like Whitman's book at all.

 

I'm sure Marty's book was great - but it's so tough to read.

 

Whitman's books have some good ideas in them, but they are painful to read.  The writing is terrible and they scream out for a better editor.  He uses tons of weird acronyms, but then goes ahead and defines them over and over again.  For example, instead of shareholders he calls them Outside Passive Minority Investors (OPMI) to distinguish from activist investors, control investors, etc.  But it's a painful term.  Despite having a defined term, he will sometimes write it out.  Whole chunks of text are repeated verbatim numerous times.  He also has a thing with Graham and Dodd and rails against them constantly.  He says Graham stands for things that for the life of me I can't see even though I've read Graham numerous times.  All that being said, if you dig through the crap you can find a few diamonds.

[oddballstocks]

How funny. I really liked Greenwald's book and did not like Whitman's book at all.

 

I'm sure Marty's book was great - but it's so tough to read.

 

Whitman's books have some good ideas in them, but they are painful to read.  The writing is terrible and they scream out for a better editor.  He uses tons of weird acronyms, but then goes ahead and defines them over and over again.  For example, instead of shareholders he calls them Outside Passive Minority Investors (OPMI) to distinguish from activist investors, control investors, etc.  But it's a painful term.  Despite having a defined term, he will sometimes write it out.  Whole chunks of text are repeated verbatim numerous times.  He also has a thing with Graham and Dodd and rails against them constantly.  He says Graham stands for things that for the life of me I can't see even though I've read Graham numerous times.  All that being said, if you dig through the crap you can find a few diamonds.

 

I don't know what you mean (IDKWYM), Whitman's books are not confusing (BANC) at all due to the acronyms.  Maybe he's a great investor because he thinks in acronyms.

 

Marty's thoughts:

 

TSIUV, IHBVGAGE

 

Translated:

This stock is undervalued, it has book value growth and great earnings.

 

I can just see him now running around the office IFACS, IFACS, IFACS.  All his employees are quickly looking the term up on the reams of acronym translation cheap sheets hanging on their cube walls..."ah, he found a cheap stock.."

[CorpRaider]

Hah!  Yeah, I've never made it through the conservative aggressive investor and I'm not a wuss as I made it through some of Dreman's books.  Greenwald's comments in the most important thing were sort of "weak sauce".

[Palantir]

So how do you guys get comfortable in investing in a firm that looks like it has a lot of nice real estate, but operationally it is struggling? I believe it is trading below the value of assets.

 

I tend to stay away from deep value stuff, but am trying to learn just to enhance capabilities.

[oddballstocks]

So how do you guys get comfortable in investing in a firm that looks like it has a lot of nice real estate, but operationally it is struggling? I believe it is trading below the value of assets.

 

I tend to stay away from deep value stuff, but am trying to learn just to enhance capabilities.

 

Here's what I do, just think about things in simple terms.  Imagine you own a piece of land that has property taxes due yearly.  You don't have a job and your savings is dwindling.

 

What are the outcomes?  Either you get a job and keep the land, or you're forced to sell.  A third outcome is you borrow to pay the taxes until you can't borrow anymore.  Then the bank takes the land.

 

The same is true for your scenario, they turn around operations, liquidate the land, or borrow to carry it until they end up in bankruptcy.

[Kraven]

How funny. I really liked Greenwald's book and did not like Whitman's book at all.

 

I'm sure Marty's book was great - but it's so tough to read.

 

Whitman's books have some good ideas in them, but they are painful to read.  The writing is terrible and they scream out for a better editor.  He uses tons of weird acronyms, but then goes ahead and defines them over and over again.  For example, instead of shareholders he calls them Outside Passive Minority Investors (OPMI) to distinguish from activist investors, control investors, etc.  But it's a painful term.  Despite having a defined term, he will sometimes write it out.  Whole chunks of text are repeated verbatim numerous times.  He also has a thing with Graham and Dodd and rails against them constantly.  He says Graham stands for things that for the life of me I can't see even though I've read Graham numerous times.  All that being said, if you dig through the crap you can find a few diamonds.

 

I don't know what you mean (IDKWYM), Whitman's books are not confusing (BANC) at all due to the acronyms.  Maybe he's a great investor because he thinks in acronyms.

 

Marty's thoughts:

 

TSIUV, IHBVGAGE

 

Translated:

This stock is undervalued, it has book value growth and great earnings.

 

I can just see him now running around the office IFACS, IFACS, IFACS.  All his employees are quickly looking the term up on the reams of acronym translation cheap sheets hanging on their cube walls..."ah, he found a cheap stock.."

 

I guess you think you have both know-how and know-who.  I imagine you'll be talking about Graham and Dodd (G&D) and saying that Graham and Dodd (G&D) only talk about outside passive minority investors (OPMI), that is only outside passive minority investors, and believe in the primacy of the income account as opposed to net asset value (NAV). 

 

After that you'll be talking about taking SOTT (something off the top) in the NTM (next twelve months) as opposed to the LTM (last twelve months).  Perhaps you will discuss E&P (exploration and production) companies that engage in E&P (exchange and purchase agreements). 

 

I bet too you are not just a GARP (growth at a reasonable price) investor but a GADCP (growth at dirt cheap price) investor.  It all makes perfect sense.

[Ham Hockers]

How funny. I really liked Greenwald's book and did not like Whitman's book at all.

 

I'm sure Marty's book was great - but it's so tough to read.

 

Whitman's books have some good ideas in them, but they are painful to read.  The writing is terrible and they scream out for a better editor.  He uses tons of weird acronyms, but then goes ahead and defines them over and over again.  For example, instead of shareholders he calls them Outside Passive Minority Investors (OPMI) to distinguish from activist investors, control investors, etc.  But it's a painful term.  Despite having a defined term, he will sometimes write it out.  Whole chunks of text are repeated verbatim numerous times.  He also has a thing with Graham and Dodd and rails against them constantly.  He says Graham stands for things that for the life of me I can't see even though I've read Graham numerous times.  All that being said, if you dig through the crap you can find a few diamonds.

 

I don't know what you mean (IDKWYM), Whitman's books are not confusing (BANC) at all due to the acronyms.  Maybe he's a great investor because he thinks in acronyms.

 

Marty's thoughts:

 

TSIUV, IHBVGAGE

 

Translated:

This stock is undervalued, it has book value growth and great earnings.

 

I can just see him now running around the office IFACS, IFACS, IFACS.  All his employees are quickly looking the term up on the reams of acronym translation cheap sheets hanging on their cube walls..."ah, he found a cheap stock.."

 

I guess you think you have both know-how and know-who.  I imagine you'll be talking about Graham and Dodd (G&D) and saying that Graham and Dodd (G&D) only talk about outside passive minority investors (OPMI), that is only outside passive minority investors, and believe in the primacy of the income account as opposed to net asset value (NAV). 

 

After that you'll be talking about taking SOTT (something off the top) in the NTM (next twelve months) as opposed to the LTM (last twelve months).  Perhaps you will discuss E&P (exploration and production) companies that engage in E&P (exchange and purchase agreements). 

 

I bet too you are not just a GARP (growth at a reasonable price) investor but a GADCP (growth at dirt cheap price) investor.  It all makes perfect sense.

 

I'm laughing out loud (LOL).

 

Despite the terrible writing, I do find Whitman's stuff more useful than Greenwald's, which seems like hand waving a lot of the time. His core ideas are a bit more innovative too, in my opinion (IMO). Sorry, couldn't help myself.

[Guest wellmont]

How funny. I really liked Greenwald's book and did not like Whitman's book at all.

 

I'm sure Marty's book was great - but it's so tough to read.

 

Whitman's books have some good ideas in them, but they are painful to read.  The writing is terrible and they scream out for a better editor.  He uses tons of weird acronyms, but then goes ahead and defines them over and over again.  For example, instead of shareholders he calls them Outside Passive Minority Investors (OPMI) to distinguish from activist investors, control investors, etc.  But it's a painful term.  Despite having a defined term, he will sometimes write it out.  Whole chunks of text are repeated verbatim numerous times.  He also has a thing with Graham and Dodd and rails against them constantly.  He says Graham stands for things that for the life of me I can't see even though I've read Graham numerous times.  All that being said, if you dig through the crap you can find a few diamonds.

 

couldn't agree more. he takes simple concepts and makes them confusing.

[oddballstocks]

How funny. I really liked Greenwald's book and did not like Whitman's book at all.

 

I'm sure Marty's book was great - but it's so tough to read.

 

Whitman's books have some good ideas in them, but they are painful to read.  The writing is terrible and they scream out for a better editor.  He uses tons of weird acronyms, but then goes ahead and defines them over and over again.  For example, instead of shareholders he calls them Outside Passive Minority Investors (OPMI) to distinguish from activist investors, control investors, etc.  But it's a painful term.  Despite having a defined term, he will sometimes write it out.  Whole chunks of text are repeated verbatim numerous times.  He also has a thing with Graham and Dodd and rails against them constantly.  He says Graham stands for things that for the life of me I can't see even though I've read Graham numerous times.  All that being said, if you dig through the crap you can find a few diamonds.

 

I don't know what you mean (IDKWYM), Whitman's books are not confusing (BANC) at all due to the acronyms.  Maybe he's a great investor because he thinks in acronyms.

 

Marty's thoughts:

 

TSIUV, IHBVGAGE

 

Translated:

This stock is undervalued, it has book value growth and great earnings.

 

I can just see him now running around the office IFACS, IFACS, IFACS.  All his employees are quickly looking the term up on the reams of acronym translation cheap sheets hanging on their cube walls..."ah, he found a cheap stock.."

 

I guess you think you have both know-how and know-who.  I imagine you'll be talking about Graham and Dodd (G&D) and saying that Graham and Dodd (G&D) only talk about outside passive minority investors (OPMI), that is only outside passive minority investors, and believe in the primacy of the income account as opposed to net asset value (NAV). 

 

After that you'll be talking about taking SOTT (something off the top) in the NTM (next twelve months) as opposed to the LTM (last twelve months).  Perhaps you will discuss E&P (exploration and production) companies that engage in E&P (exchange and purchase agreements). 

 

I bet too you are not just a GARP (growth at a reasonable price) investor but a GADCP (growth at dirt cheap price) investor.  It all makes perfect sense.

 

So awesome!

[Hielko]

A negative EV is tough to find. I have only seen it in a stub situation. You are saying the company has more cash on its book then debt or MC. Thats awesome if it also has positive FCF. I would sell everything and buy it and probably get a personal loan and go on margin as well lol.

Seems like it's time to find a loan: http://finance.yahoo.com/q/ks?s=EDS+Key+Statistics

[DoddDisciple]

That's a fairly large negative enterprise stock. Any reason why they stopped doing quarterly filings but remain on the NASDAQ?