by John Price, published 2011
This book was not what I expected to be and it certainly was not what I had hoped it would be. The reviews I had read of the book left me waiting in eager anticipation of its arrival in the mail because it sounded like it would do two things I had been looking to do: deliver crushing criticisms of various technical and non-value based approaches to investing; and provide a concise “how-to” as far as preparing an intrinsic value-based financial analysis of business or investment idea.
With regards to the former, Price delivers, but not courageously. His breakdown of various analytical approaches, while thorough, ultimately is not very helpful. Each analytical methodology is described and then followed by a list of strengths and weaknesses, but no decisive conclusion is reached. Surely there’s nothing wrong with leaving it to the reader to make up his own mind, but there’s no objective scale provided or suggested for weighing the strengths and weaknesses of each– it’s hard to tell just from reading whether any particular strength outweighs a weakness, or vice versa. I would’ve liked it if Price had added his two cents about each rather than trying to be dry and officiously neutral.
As for a concise how-to on value investing, this was one of those books where you keep turning the page hoping the author is going to get to the point and suddenly you turn the last page and you’re confronted with the back flap of the book and all you can do is shout out in frustration, “That’s it?!”
The title of the book seems contrived in relation to its content. “The Conscious Investor”, as opposed to an unconscious one? I assume Price is suggesting a level of awareness, but there is an important qualitative difference about being aware of many different concepts and actually understanding their meaning and significance. I didn’t find the book to have much strength in that sense.
At one point, Price suggests that part of being a “conscious investor” means thinking about what it is, exactly, that you’re investing in, and what would be the implications of that investment succeeding. For example, say you invest in a company that manufactures ugly clothing. If the company is successful and your investment pays off, you’ll now be living in a world of ugly clothing everywhere you look. Is that the kind of world you want to live in?
It’s an interesting idea but a perhaps more important one is, “If the company is clearly undervalued, and I don’t invest in it for ethical reasons… does that mean no one else will recognize the undervaluation and invest, thereby preventing that world of [ugly clothing] from becoming a reality?” Whatever the answer to this question, this is clearly an aspect of being a “conscientious investor”, not a conscious one, so again I am left a bit perplexed by this book.
My disappointment and griping aside, there was some value in this book and I did highlight and underline a few things I had wanted to record here for future reference. But even at Amazon’s reasonable new book prices, knowing what I know now I see this book as overvalued, meaning I clearly overpaid and thereby suffered a permanent capital loss. But maybe that was what Price was trying to teach me the whole time, as a value investor.
Lesson learned!
Some notes and takeaways:
When reading financial statements and company filings, remember to “follow the money“, and ask (and try to answer) the following questions:
- How much money came in over the reporting period and where did it come from?
- What was it used for?
- How much money did the company manage to keep?
Further, in the Proxy Statement (Form Def 14A), you should attempt to determine
whether the presentation on compensation in the Proxy Statement is clear and easy to understand. The overall level of compensation to management and directors relative to the size and performance of the business is important.
When studying earnings growth, as a common stock investor it is important to look at growth in EPS, not net income, because the company may be issuing large number of shares and diluting current shareholders even if it is successfully growing net income.
The quality of earnings is in doubt when net income substantially exceeds cash flow from operations. Ideally, positive cash flow conditions would yield:
- Cash provided by operations which are positive and trending upward
- Cash flows from operations are more than sufficient to cover cash used for investing (CFO > CAPEX)
If you own shares in a company, but don’t think that it represents value to buy more, then welcoming actions of the company to buy back its own shares is not logical.
Mismatches between net and comprehensive income are also a warning sign.
If in most years the comprehensive income is consistently below the net income… the company has been accumulating losses in comprehensive income aside from the regular income, which may indicate that the economic situation is worse than it would appear from an analysis of the income statement.
A higher current ratio is not always better– sometimes a high current ratio means that inventory is piling up, or the company is extending larger amounts of credit to its customers than it ought to be through growing A/R. A low or downward trending current ratio is almost always a cause for concern, however.
With retail companies, it is important to examine growth of same-store sales to determine whether the company is growing simply through the opening of new stores versus expanding its business within existing stores. Also, high asset turnover is critical in a retail business, which normally has low margins, in order to leverage its returns.
Be vigilant with companies whose primary assets are intangibles, which, if developed internally, may not be represented on the balance sheet. “The smaller the role of intangible assets, the closer to book value a company’s market price is likely to be.”
And a Warren Buffett quote:
Your goal as an investor should simply be to purchase, at a rational price, a part interest in an easily understandable business whose earnings are virtually certain to be materially higher five, ten and twenty years from now. If you aren’t willing to own a stock for ten years, don’t even think about owning it for ten minutes.
Further, according to Price,
Over time, whatever returns a company makes on its equity and capital will be approximately an upper limit on the return made by investing in the company’s stock.
Putting some of this together yields a few “rules” with regards to the P/E ratio:
- Know the history of the P/E ratio
- Do not buy unless the P/E ratio is toward the lower end of its historical range
- Compare the P/E ratio with the P/E ratios of competitors
- Compare the P/E ratio with the average P/E ratio for the same sector or overall market
- Be wary about buying when the P/E ratio is high
- Look at the earnings yield, which suggests a minimum return that can be anticipated if earnings remain steady, with anything more caused by growth in earnings
“Find companies with high and consistent return on equity and not too much debt. Try to determine what is special about them– what economic moats do they have?”
A House Rises 