Be Back Soon
Sorry folks. I'll be back soon. PROMISE!
I appreciate your patience! —Joe
Also Filed Under "Miscellaneous"
Joe Ponzio's F Wall Street
Submitting Your Comment
Please wait while your comment is submitted. (It may take a moment.) Comments on F Wall Street are moderated which means that your comment will appear only after it has been reviewed by Joe. Comments are typically reviewed and approved (or denied) quickly, except between 11:30PM and 5:00AM (CST) – Joe has to sleep some time!
Joe Ponzio's F Wall Street
Thank You For Participating!
Thank you for participating on F Wall Street. Once your comment has been approved, it will appear here. While waiting, check out some other articles on the blog or click here to return to the article.
| Excel 2007 | | | Excel 2003 |
| (ZIP, 168kb) | (ZIP, 138kb) |
Search F Wall Street
Powered by Google
Subscribe to F Wall Street
E-mail or RSS updates. And it's free!
Articles, by Category
Or visit the archives for articles by date
Thu @ 3:33PM | View comment
MinorityStakes said,
A couple comments regarding BBEP's latest communication with shareholders:* 2009 production just about equaled 2008 production even though capex was...
BreitBurn Energy: Playing the Commodities Crash
Sun @ 11:09AM | View comment
Eric T said,
Instead of inventory turnover, I use the cash conversion cycle, or CCC.It is more accurate for companies that manufacture and...
Understanding the True Profit Margin
Sun @ 5:48AM | View comment
Diversification said,
well it all depends on the correlation between the stocks you have choosen many big mutual funds are having the...
The Dangers Of Overdiversification
Sun @ 4:46AM | View comment
sandesh trivedi said,
Very well explained joe. i believe one must also take into account the nature of the product being manufactured while...
Understanding the True Profit Margin
Sat @ 10:19AM | View comment
Ron said,
Hi Joe,Is there a rule of thumb of percentage of net shares sold by insiders where we should start to...
When To Watch Out For Insider Selling
Sat @ 10:18AM | View comment
jan said,
joe, any thoughts on jackson hewitt? what were the risks that played out in your mind when you decided...
BreitBurn Energy: Playing the Commodities Crash
Investor Junkie
Dec 10th, 2009
1 comment
( REPLY | PERMALINK )
Steve
Dec 10th, 2009
( REPLY | PERMALINK )
Alex MacKinnon
Dec 11th, 2009
15 comments
Thanks for all the hard work that you put into this site joe... looking forward to hearing more of your thoughts.
Cheers
( REPLY | PERMALINK )
Adam Davis
Dec 12th, 2009
4 comments
I get an email update from FWallSt. and NO POST!
Seriously, Joe I know you're working your butt off evaluating and buying businesses.
Thankfully we had some inflated prices in 07 and 08..otherwise we might have never gotten such awesome content!
( REPLY | PERMALINK )
Steve
Dec 22nd, 2009
Interested to hear the details on ponzio capital and leaving the meridian business group.
( REPLY | PERMALINK )
Joe Ponzio replied,
No details. I focused on concentrated value investing while my partner focused more on financial planning. We were essentially running two different businesses for a long time, and decided to split into two separate entities, much like we had been operating for a number of years.
( REPLY | PERMALINK )
2/2/10
Alex
Jan 4th, 2010
8 comments
Anyone feel free to chime in here, as well as Joe.
I've read Fwallstreet, and while it provides an easy to follow value investing plan. It mixes buffetts strategy of late, with his early strategy. Which I don't believe is the optimum method of value investing.
The FWallStreet strategy is to buy good businesses, with strong cash flows... At a low value, and sell when they reach fair value.
All well and good.
But... If the bulk of your earnings are from the market re-valuating an out of favor security. Why even look for a good business?
Why not look at bankrupt companies, spin-offs, debt and instead of buying 50 cent dollars... Buy 30 cent dollars like Pabrai/Klarman etc.
If you sell most businesses after 1 or 2 years, when they are at fair value... I would tend to believe you barely benefit from the fact the business is a good business.
Buffett buys good businesses and earns the rate of return of that business, because he has a large amount of capital. If he was stripped of it, I believe he would be looking in the nittier grittier area's, and probably achieving 50% returns.
Thoughts anyone?
Cliffs: Strong cash flow businesses easy to evaluate, but are they the best way of managing a small amount of capital?
( REPLY | PERMALINK )
RelativeFactorAnalysis
Jan 4th, 2010
Yes Alex, it can be much more profitable searching in the areas where there is forced selling and/or strong catalysts. We have the ability to do that until we work with millions of dollars.
The reason why Joe concentrates on great businesses is that it's much easier to predict future cash flows. Mediocre businesses (ie, low margins, low barriers to entry, etc) can lose a lot of their profitability from the entrance of competition. If you expected an 18% growth rate for a company that had 6% profit margins and there were low barriers for competition then another firm would likely come in and directly compete. If it did, let's say that it's profit margins fall from 6% to 4% (this can happen by a 2% decrease in selling cost at equal unit volume) which would decrease your profitability by 33%! This means you might have dramatically overpaid for that stock.
Joe keeps it simple, great businesses will have less meaningful competition precisely because they are great businesses. Walmart every day low price will still be there generating higher returns tomorrow but joe blow retailer in a small town might be completely whiped out by a new walmart.
If you think you understand all the other factors affecting the company and future profitability and can predict its future cash flows with certainty then you can do just as well investing in mediocre companies. It is just a lot harder to predict them with certainty and margin's of safety can be quickly and sometimes completely eroded.
( REPLY | PERMALINK )
Joe Ponzio replied,
Agreed. What is the definition of a good business? To paraphrase Ben Graham: A good business is one that can survive tough times; so, wait for tough times and then buy a good business.
"Good" (in my opinion) doesn't necessarily mean that it fits all of the commonly accepted criteria for a "good" business (i.e., positive working capital, low debt-to-equity, etc.)
A "good" business is one that is predictable.
There is also a difference between "good businesses" and "good opportunities." When you find a good opportunity in a good business, you've struck gold. That said, you don't have to stick just with good businesses, so long as you squarely focus on good opportunities.
( REPLY | PERMALINK )
2/2/10
Alex
Jan 4th, 2010
8 comments
Yep RelativeFactor, good answer... Though I'd counter that's the reason you need a catalyst. So that the "bad" business doesn't erode it's assets etc.
i.e:
Joe Ponzio Way: Good business strong cash flow
Pabrai/Klarman/Greenblatt etc: Mediocre business catalyst
The Ponzio way is definitely a good starting point, as it is easier to grasp. I'm just wondering what the consensus is on the preferable method ceteris paribus.
( REPLY | PERMALINK )
Eric T replied,
Alex,
your forgetting some of Buffet's rules.
Rule #1 dont lose money. Rule #2 do not forget rule number one.
When you buy a mediocre or poor business, even if you believe it is underpriced, you are putting your capital at more risk. If the business is poor or mediocre, then it likely is either
1. a business with unpredictable and erratic cash flows,
2, has a generally poor business model or balance sheet which cause it to lose money,
3. or has some other random factor in it that makes investing in it more dangerous (low barriers to entry or no moat, bad management, poor returns on capital, etc...).
In any of those cases you are subjecting yourself to much more overpayment risk. Why? Well buying a good or great business as opposed to a mediocre business is sort of a second margin of safety. If you apply a margin of safety just in the price you pay, you might sometimes still overpay if the factors that make your business mediocre intensify. A mediocre can become a poor business much easier and faster than a great business. A business thats hard to understand or predict where it will be in the future or with a bad element to it might not be worth zero now, but it could in the future. There is no way to apply the margin of safety to a stock thats worth zero. So by buying only good businesses, it allows you more room for error in your valuation of the quality of the business.
As for Buffet, even when he was young and running much less money, he never put his capital at great risk. According to Alice Shroeder, who wrote Buffet's Biography, the very first thing he looks at when he encounters a new stock is cat (catastrophe) risk. Most mediocre businesses have that cat risk that could do them in and make their business deteriorate rapidly, even if that risk becoming a reality is slim. Its why Buffet sold Fannie Mae some time ago. Even when Buffet was young and more actively investing, he always looked at cat risk first. Even if the stock was well underpriced, he wouldn't buy it if it had that risk. If you are buying stocks that have that cat risk (aka a mediocre or poor company), you are forgetting Buffet's rule number 1 and rule number 2 (see above). So I think the only time buffet ever bought a mediocre company was if it was trading below liquidation value, or if that cat risk already occured and was priced in, and therefore didn't have it anymore.
Just remember, there are tens of thousands of stocks out there, maybe hundreds of thousands if you look worldwide. Plenty of those are great companies, many are mediocre, and many are poor. There is always enough great companies to keep your money occupied.
I hope that makes sense, I'm not nearly as good at gathering my thoughts as joe is!
PS. This post was about a business as an ongoing concern, not a liquidation, spinoff, distressed debt, or any other type of investment.
( REPLY | PERMALINK )
1/5/10
1 reply
Adam Gaglio
Jan 13th, 2010
4 comments
You're also forgetting that: "Time is the friend of the wonderful company, the enemy of the mediocre."
When you don't know how long it's going to take the market to value your stock fairly, you really don't want to be holding on to a crappy company.
Re-learning Buffett's advice sucks.
( REPLY | PERMALINK )
Billy
Jan 15th, 2010
3 comments
Good discussion but as they say,managing an investment portfolio is equally an art as well as a science and a portfolio can be a mix of turnarounds,fast growers,stalwarts,cyclicals etc etc.Even Joe picked Volt Information Services which he admits is hardly a world class business.
In Hong Kong during the crash,small caps were being valued at the cash on their balance sheet or at net cash plus two times recession hit cash flows so they might not have been world class companies but you picked certain stocks because you were betting against Mr Market that they would be around for more than the two years that they were being valued at.
At such irrational valuations,the odds of an outsized return on your investment is high and guess what,Mr Market repriced them when the panic was over!
I find it interesting that George Soros and Anthony Bolton are opening funds and offices in Hong Kong but the time to have bought was last year - Hong Kong stocks are not overvalued but all the bargains were last year - it is a bit like coming to the party in the last hour when most of the beer and people have gone.
( REPLY | PERMALINK )
Adam Gaglio
Jan 21st, 2010
4 comments
Joe,
Have you considered opening a forum on F Wall Street?
( REPLY | PERMALINK )
Joe Ponzio replied,
I considered it a while back. I agree that we need some extra functionality around here. I'm meeting with the designers next month to discuss another round of updates. Before that meeting, I'll ask the community what you guys and gals would like to add to the site.
( REPLY | PERMALINK )
2/2/10
Alex
Jan 23rd, 2010
8 comments
Should FCF include changes in working captial?
When analysing small companies, often changes in working capital are a large part of free cash flow.
Should these be included or excluded?
If you're going to smooth over cash flows over many years as Joe suggests, then such an element will not matter. But when analyzing the last periods FCF in a comparably unstable company....Should we include or exclude these changes in working capital?
I'd particularly like to hear Joe's take on this if he has a moment...
( REPLY | PERMALINK )
Adam Gaglio
Jan 25th, 2010
4 comments
Hey Alex,
I can't speak for Joe, but Buffett's definition of Owner Earnings is: "These represent (a) reported earnings plus (b) depreciation, depletion, amortization, and certain other non-cash charges...less (c) the average annual amount of capitalized expenditures for plant and equipment..."
Changes in working capital are part of the "other non-cash charges."
Also, Joe does not suggest smoothing over cash flows, but rather "smoothing over" capital expenditures.
I suggest you buy the book for a better explanation of Owner Earnings vs. FCF.
-Adam Gaglio
( REPLY | PERMALINK )
Alex
Jan 25th, 2010
8 comments
Hey Adam,
Thanks for the reply. I had read Buffett's definition of Owner Earnings.
I don't believe he does include changes in working capital.
Take a look:
If we think through these questions, we can gain some insights about what may be called "owner earnings." These represent (a) reported earnings plus (b) depreciation, depletion, amortization, and certain other non-cash charges such as Company N's items (1) and (4) less ( c) the average annual amount of capitalized expenditures for plant and equipment, etc. that the business requires to fully maintain its long-term competitive position and its unit volume. (If the business requires additional working capital to maintain its competitive position and unit volume, the increment also should be included in ( c) . However, businesses following the LIFO inventory method usually do not require additional working capital if unit volume does not change.)
The sentence in the brackets implies he only includes changes in working capital if they were investments in working capital to keep unit production at its normal level (i.e. similar to maintenance cap-ex).
Your thoughts?
( REPLY | PERMALINK )
Ben replied,
Here's a video of mr. mason hawkins, mba, southeast asset management definition of FCF or owner earnings
http://www.bengrahaminves...
( REPLY | PERMALINK )
1/29/10
Adam Gaglio replied,
Crap, That's what I get for acting like a know-it-all. I have always assumed that changes in working capital were like a capital expenditure. They're a necessary expense to keep the business going. And I think this is how Buffett treats them too. The statement in parentheses is just saying that companies using LIFO usually don't have large changes in working capital, not that it shouldn't be included in owner earnings.
-Adam Gaglio
( REPLY | PERMALINK )
1/29/10
1 reply
Suchit replied,
I think Joe includes the changes in the calculation of owners earnings in the book. This and the treatment of deffered taxes for owners earnings purposes have me confused.
( REPLY | PERMALINK )
1/30/10
1 reply
Joe Ponzio replied,
For DCF where you're calculating future "unit volume" increases (or decreases), you would include changes in working capital. If, however, you're not ascribing any value to unit value growth, you would not include it.
For example, in Apple, you would have to consider the investment the company needs/needed to make in working capital to pump out all of those new iPods and iPhones.
( REPLY | PERMALINK )
2/2/10
Allen
Jan 27th, 2010
47 comments
We're still waiting ... patiently ....
( REPLY | PERMALINK )
Alex
Jan 30th, 2010
8 comments
An off topic coment but... I'm currenty wading through Bruce Greenwalds book ("Value Investing from Graham to Buffett") - I'd recommend it to anyone here.
The book attempts to dissuade you from the DCF method and puts forward a "Assets Earnings Power" method of valuing companies.
While I don't think DCF should be written off, the Greenwald method is much more conservative, which I like.
( REPLY | PERMALINK )
Your Name
Mar 12th, 2010