Notes – A Compilation Of Ideas On Investing

Why I’d Never Pay More Than Book Value For Nokia

You hate to see a group of the top five companies of an industry where they entered the industry at different times; this implies companies are coming and going as they please
You want the company you’re looking at to have a relatively high market share, ie, the company’s market share divided by the next closest competitor is high (1.5+)
The first line of defense in competitive environments is having the most customers relative to the alternatives; being the preferred product
As long as you believe a company’s competitive positions are lasting, you can buy the stock on a P/E basis

Ben Graham Net-Nets That Don’t File With The SEC

The simplest way to separate safe net-nets from unsafe net-nets is the number of consecutive years of profits
Profitable net-nets seem to be especially common candidates for abandoning the responsibilities of a public company without actually getting taken private
If you can’t trust the controlling family, you can’t trust the auditors

Free Cash Flow Isn’t Everything

Buffett-style approximation of unleveraged return on tangible equity: EBIT/(Receivables + Inventory + PPE) – (Accounts Payable + Accrued Expenses)
This represents the net investment; in the example of WMT, it represents their ability to finance $50B in productive assets at 0% interest
Reinvestment in businesses with sustainable double-digit ROIs is superior to receiving dividends (thanks to higher FCF)
It is harder to find companies who can earn high returns on unlevered equity and increase the size of that tangible equity over time than it is to find companies who can earn high returns on unleveraged tangible equity
For looking at return on invested tangible assets: EBITDA/(Receivables + Inventory + PPE) – (Accounts Payable + Accrued Expenses)
- then, go back 15-20 years and find range, median, etc.
- examine how much tends to be converted to net income or FCF to get an idea of profitability
FCF != Owner’s Earnings; only counting the cash available after a company grows will result in you passing up many good, growing businesses simply because they’re growing
If a company is earning good returns on their investments, it’s okay for them to not produce a lot of FCF
Businesses you’re investing in for profitable future growth should be 150% of the growth you think you could provide with another use of the money; the 50% represents margin of safety in your future compounding
Over time, more reliable returns compound better than less reliable returns
The most reliable ROIs tend to be in businesses built around a habit
Habits are the first line of defense in a business
The best business defenses involve:
- defending specific customers
- defending specific locations
- defending specific times
Buffett’s favorites are business which:
- have pricing power
- have the lowest costs (can operate profitably at margins competitors can not)
Your return in a good business, held forever, depends on:
- Growth; what quantity of earnings are you purchasing today?
- ROI; how much room is there for reinvesting those earnings in the future?
- Earnings yield; what will you earn on those reinvested earnings?

Earnings Yield or Free Cash Flow Yield: Which Should You Use?

Look to the story of Hetty Green; don’t put more into an asset unless the return you can get from that addition is better than what you could get elsewhere
A company that grows value doesn’t have to pay anything out; with real Owner’s Earnings, no FCF is necessary
FCF is useful for determining how much money is available for:
- Dividends
- Stock buybacks
- Debt repayment
- Acquisitions
In this case, use FCF/Market Cap to determine your “equity coupon”
Owner’s Earnings is useful for determining: How much bigger will my snowball get this year?
OE are just as valuable as FCF if and only if the future return on retained earnings is comparable to the average of the past; the wider the moat, the more reliable the historical average is
If you think you can earn 10% in your brokerage account:
- a company earning 12% unlevered returns on tangible net assets is probably a wash and it’d be better if they gave them to you
- but a company earning 20% is a different beast altogether– you’re probably better off letting them compound your money for you
If you know ROI will stay above what you could achieve yourself, use a P/E type measure (or EV/EBIT or EV/EBITDA, depending on accounting) to price the stock, don’t use FCF
Valuing businesses by ROI:
- By earnings; reliably above average returns on investment
- By FCF; consistent companies with a mixed or impossible to evaluate ROI situation
- By tangible book; inconsistent companies with an unreliable or poor ROI situation
Stated another way:
- Good, reliable companies are snowballs; worth what it can grow as it travels downhill; dynamic
- Mixed, reliable companies are waterfalls; worth the rate of its flow; constant
- Unreliable, bad companies are rocks; worth its weight; static
Remember– assets produce earnings; earnings become assets; the process repeats
Ask yourself:
- What is the sustainable rate of cash removable from the business?
- What is the value added or subtracted from the business by the resource use decisions of management?
Assume that retained earnings at subpar businesses to be worth less than their stated amount; similarly, retained earnings at above average businesses are worth every penny
With great businesses with favorable long-term prospects, treat earnings as FCF; it’s fine to use the earnings yield
Never make the mistake of thinking depreciation is a provision for the future; it’s a spreading out of the past
At bad businesses, cash is worth much more than inventory, receivables, property, etc.; in these cases, don’t use earnings yield, use FCF yield and asset value

How To Analyze Net-Nets Undergoing Change

As part of a group, you can easily invest in businesses undergoing change
“Managers rarely rush to evacuate excess capital from a sinking ship. Usually, they’re still there trying to save the wreck.”
It’s generally better to invest in a corporation undergoing change than a business undergoing change
With changing customer habits, it can be nearly impossible to predict future earnings
I require at least ten years of history before investing in a company for any reason other than its cash; prefer 15-20 years of history whenever possible
Overcapitalized companies undergoing change are good stocks to follow
Worldwide, there are fewer investors looking at Swedish stocks than US stocks; that’s an advantage if you’re looking at Swedish stocks, so use it

What Broker To Use When Buying International Stocks (Gannon On Investing)

Geoff uses a full service broker, but recommends Interactive Brokers or Noble Trading for most others looking to buy foreign stocks
If going with a full service shop:
- personally know a broker ahead of time
- give him your account with a clear understanding of what it is you want to do; try to negotiate a flat, guaranteed commission structure so you know how much it’ll cost you and he knows you’re worth the trouble
- a good rule of thumb is 1% per roundtrip trade; it’d be greedy for the broker to ask for more than 2%
If a broker promised me it could buy any stock anywhere in the world for 2% of my assets per year, I’d take that deal
I look at my cost in a stock on an after-commission basis
“My broker won’t let me buy that stock” is never a valid excuse; if the broker won’t buy the stock, get a new broker
“Ben Graham said investing is most intelligent when it’s most businesslike. Business often means work”
Never let anything get in the way of buying the best bargains, especially not your broker

How To Find Cheap Foreign Stocks

Online research process for finding foreign stocks:
- Screen for stocks in specific countries using the FT Screener
- Check the business description, EV/EBITDA, etc., at Bloomberg
- Look at the 10-year financial history at MSN Money
- Go to the company’s website and read their annual reports
Bloomberg has the best worldwide coverage of stocks in their database
A good screen to start with at FT.com is a single digit P/E screen– just scoop up the simplest, most obvious bargains
Many European companies that aren’t too tiny trade in Germany
Use Google Translate if you’re having language issues
Beware of accounting differences:
- US uses GAAP; insists on historical cost and does not permit revaluation of non-financial assets; in general, old US companies with lots of land and inventory (using LIFO) are more likely to contain “hidden assets”
- RoW uses IFRS; PPE and investment property less likely to be carried on balance sheet at extremely low stated value; different way of valuing biological assets; never uses LIFO accounting for inventory; less likely to mask an asset’s liquidation value than GAAP
Good screen in the US due to GAAP accounting for depreciation: (Accumulated Depreciation /Tangible Book Value) * (Tangible Book Value/Market Cap) > 1; shows you the cheapest stocks relative to what a competitor would pay to own their assets; produces a real Ben Graham-type list
- should also add: Tangible Book Value > Total Liabilities
- and: Net Income > 0
Due to accounting differences, if you’re new to international investing, focus on earnings bargains, not asset bargains
- It’s okay to buy companies that are cheap P/B if they have 10 yrs of consistent earnings
- Otherwise, stick to low P/10yr avg earnings
Low EV/EBITDA is good to use around the world as it erases some differences in accounting
Good UK-specific screener– SharelockHolmes

How To Find Foreign Stocks: 13 Promising Companies From The U.K. (Gannon On Investing)

I went to the London Stock Exchange website; then I browsed stocks alphabetically
I was looking for potentially promising companies, regardless of price
In other countries, I start by looking for good businesses I can understand; the bar is higher overseas
Use the following process for finding promising companies:
- At the LSE website:
  - clicked “fundamentals” tab
  - scrolled down to ROIC
  - looked for positive number in the double-digits
  - 20%+ ROIC over the last few years
- Look the company up in Bloomberg
  - If you can’t understand the business description, throw it out
  - If it sounds like it has the potential to earn very high returns on capital, proceed
- Looked up the annual report’s cash flow statement
  - CFO > CAPEX in each of the last several years
  - ie, should be generating FCF
- For all the companies that qualify, download the past annual reports into a folder on desktop
- Start reading annual reports from oldest to most recent
- Then, appraise the value of the company, ideally without looking at the price first
  - 10x normal EBIT
  - 15x normal FCF
  - if the company is trading at least 25% below the value you appraised it at and you love the business, consider buying
Searching alphabetically is an old school, Buffett way of stock research
“Having to form your own opinions from scratch does wonders for investment analysis”; searching from scratch puts you in the best mindset to value a stock objectively
Three dependable ways to turn up great stock ideas:
- Go through a list from A to Z
- Read value investing blogs
- Direct, personal experience with the company
Good UK value investing blogs:
“My best investments come from stocks I study and pass on due to price, only to buy the same stock some 4 or 5 years later when it has its Salad Oil Scandal moment”

5 Japanese Net-Nets: And How To Analyze Them

Net-net investing worked in actual practice in the 1930s and 1940s in the US; Japan is similar, but worse
Price and value determine your returns based on four factors:
- Earnings yield (price)
- ROI (profitability)
- Sales growth (growth)
- Dividend yield (dividends)
The lower the yield on the stock, the higher its earnings yield, growth and ROI need to be to justify investment
Japan is experiencing deflation of -0.7% while the US is experiencing inflation of 2.9% so you need to add 3.6% to all Japanese yields to get the equivalent in real terms in the US
A company’s real dividend yield is effectively a reduction in your hurdle rate
Japan is a low/no growth economy, so it makes sense to pay out earnings as dividends or retain them as cash rather than tie them up in low-return, long-term investments such as PPE
The margin of safety in Japanese net-nets is that the dividend yield is a payback unrelated to ROI
With Japanese net-nets, you exchange low growth and low ROI for high dividend yields, deflation (rising cash value) and excess cash
Japanese net-nets offer P/E around 10, dividend yield around 3% and net cash close to market cap, meaning you get three bets:
- the value of the stock’s future retained earnings stream
- the value of the stock’s future dividend stream
- the value of the stock’s future cash pile deployment
The biggest threat to Japanese net-nets is a decline in the value of the yen; this is the best reason for passing on net-nets in Japan
“If half my money is in dollars and half is in something else and all 100% of my portfolio is in some of the cheapest stuff on earth– my results will be fine… over time”
The US in the 1930s is the best illustration of what net-net investing in Japan is like
“I prefer a lot of uncertain opportunities to make money over time to one seemingly certain exit strategy”
The quality of net-nets in the US is not as good as in Japan; most US net-nets are extremely unsafe; this is a consequence of a few good years in the stock market

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