Here’s what I’ve been reading the past three months: Continue Reading…
For decades, a company’s market cap was used in valuation ratios but it has a fatal flaw. It can be misleading for companies with piles of debt. So enterprise value emerged as an alternative.
The advantage of enterprise value is that it’s a closer approximation of what a business might cost if it was bought outright. When you buy a business, you get everything — the business, its assets, and its debts. So enterprise value includes the company’s market cap, plus its outstanding debts (including preferred stock), then subtracts out the cash.
Including debt can dramatically change the valuation of a company. A company might look cheap based on market cap alone. But if it’s sitting on piles of debt, it will look expensive based on enterprise value. It’s not perfect, but using enterprise value makes for a better comparison between different companies.
The value metrics below are built using enterprise value. All tests were run with the following setup: Continue Reading…
Investors have a long history of wanting to know what the market does next. And why wouldn’t they? It’s the quickest way to riches.
That demand has had a constant supply of people foretelling the future. cAnd what stories they sell. They weave confident tales around a few data points that prove what the stock market or the economy will do next.
Except, it’s never that simple.
Take inflation. Its rate is tied to billions of people making financial decisions every day. Decisions tied to the income they want to make versus what their job will pay. Decisions tied to the number of products a company makes versus how many their customers will buy. Decisions tied to the price a store charges versus what consumers will pay. Decisions tied to how wealthy they feel that day or healthy or safe or afraid.
It’s a complex mess. There are too many unknowns — the Fed can’t even predict it. Yet, there are folks arrogant enough to think they can not only predict inflation but what the Fed will do about it. And it doesn’t end there.
There are specialized soothsayers for everything. We got gold bugs, inflationistas, doomsayers, permabulls, and more offering their niche opinion on the future. And if you pay attention long enough, you’ll realize they repeat the same thing year after year. It’s like a broken record. Continue Reading…
Arthur Rock made a habit of financing great businesses. He was venture capital before venture capital was a thing.
It all started in 1961. Rock left a cushy job at Hayden Stone to team up with Tommy Davis to invest in new companies.
Their first investment was Teledyne. Henry Singleton’s conglomerate would go on to make a fortune for shareholders. That was quickly followed by investments in Scientific Data Systems, Intel, Intersil, and more.
His partnership with Davis lasted until 1968. Over that seven-year period, Rock invested $3 million and earned $100 million in returns.
What was the secret to his success? First, his timing was impeccable. He was practically the only person investing in Californian startups at the time.
Second, he looked for opportunities that appeared to have no limits. The business should have the ability to capture a large share of a giant market. Continue Reading…
The rise in popularity of new financial products often coincides with the rising popularity of stocks. And if one takes off, you’re bound to get more.
One of the first examples of this in the U.S. was investment trusts in the 1920s. Investment trusts are a type of fund that got their start in the U.K. in the 1860s.
The first trust of any significance was created in the U.S. in 1924. One of the main selling points was the benefit of professional management. It was not an immediate hit. By 1927, only $175 million were in investment trusts. That would all change within a year. The number jumped to $790 million in 1928. Then it hit $2.25 billion in 1929 and represented 22% of all stock issues.
But the love affair investors had with investment trusts was short-lived. Like many investment fads, there are always a few bad apples that spoil the bunch.
Of all the investment trusts, one stands out as the most egregious. Goldman Sachs Trading Corp. (GSTC) launched in 1928. Within a year, its stock was up 70%, trading at a premium to its asset value.
GSTC was so successful that the directors behind GSTC — Walter Sachs, Sidney Weinberg, and Waddill Catchings — looked to replicate it. They announced two new trusts in 1929 — Shenandoah Corp. and Blue Ridge Corp. Though, the setup was unique. Continue Reading…
Early value metrics were dependent on information that was easy to find. Price/Earnings and Price/Book came out of that era. Both did a decent job of capturing value’s outperformance.
But as financial statements became more widely available, it spawned other value metrics that performed even better. Cash flow-based value metrics are a good example of this.
The cash flow metrics tested below are built using market cap (enterprise value metrics will be next). All tests were run on the following assumptions:
- No OTC stocks or ADRs.
- No stocks trading below $1/share.
- No low-volume stocks.
- Market cap greater than $50 million.
- Deciles are equal-weighted, as is the Universe.
- Benchmarked against the Russel 3000 total return index (It’s a cap-weighted benchmark. The universe of qualifying stocks is included for a better comparison).
- Stocks are bought on January 1st of each year, held for one year, then sold. Rolling backtests are done at four-week intervals with a similar one-year holding period.
- Assume all metrics are based on trailing twelve months (TTM) unless indicated.
- Data are from 2000 to 2020, sourced from Portfolio123.
For the metrics below, higher is cheaper and lower is more expensive. Each one follows a similar pattern where the cheapest decile outperforms the most expensive by a wide margin. The cheapest decile also outperforms the universe and the benchmark. Though, some do a better job of it than others. Continue Reading…