How To Be Right Even If You’re Wrong

How To Be Right Even If You're Wrong

If you've ever golfed you know how frustrating the sport can be.

Even if you have a perfect swing.  Select the perfect club.  Hit the ball on the face of the club where you want to.  And hit the ball with the right amount of speed, if the wind picks up while the ball is in flight.  Or hits a small divot when it lands it can make your "perfect" shot look terrible.

The same is true when investing.

If you evaluate a company and decide after researching it for more than 100 hours that it’s undervalued.  Has great margins.  Produces a ton of cash.  And has little to no debt so you buy it...

And then a major competitor has a breakthrough innovation that derails your company's business.  Or your company has a small problem that turns out to be big later.  These kinds of things can derail your entire investment thesis.

The inverse is also true.

If you evaluate a company and find after putting a ton of time into it that it doesn't fit your required investment thesis so you pass on it.  Then it gets bought out at a premium and you feel like you did something wrong.

If you love golf or investing you have to learn to deal with these kinds of situations or you'll drive yourself crazy.

In golf and investing there is no such thing as playing well - or doing things right - every time.

Even when Tiger Woods was at his best during the 2000 PGA Tour season he "only" won 9 of 20 tournaments he entered.  Or a 45% success rate during his best career year.

When investing and something goes against your investment thesis it pays to remember this.  And also the following quote by investment great Peter Lynch.

But even if the market - or some insane company - proves your investment thesis wrong in the short time.  The decision you made can still be the right one.

Why I'm Still Right On KING

In June and July 2015 I did a case study on Candy Crush Saga Maker King Digital Entertainment (KING) at the request of a reader.

At the end of the case study I found even though they had great margins.  And produced a ton of cash that they had major risks keeping me from buying into them.

For those who want to read my thoughts on KING go here.

For those who don't the major issues were:

  1. KING could reprice options.
  2. It paid company insiders way too much.
  3. It had the most complicated share structure I've ever seen.
  4. And it had some related party transactions that were nefarious.

Any one of the above by themselves are bad enough to keep me from investing.  But all four combined kept me as far away from the company as possible.

And I remain comfortable with this decision even after Activision announced its buying KING out for $5.9 billion today.

Why?  Because the price Activision paid for KING is insane.

Using just one example, Activision paid $2 billion more for KING than what Disney paid  - $4 billion - for Star Wars in 2012.

Does anyone on Earth think Candy Crush, Farm Hero Saga, and KING's various other games and community are more valuable than Star Wars?

But this isn't the main reason I remain comfortable with the decision I made in July.

Developing Your Investment Processes

When I began investing I took each investment decision on a case by case basis.  I had no strict buy or sell criteria.  And every investment decision I made relied on how I felt on that particular day.

This meant most of my decision making process relied on emotion.  The last thing you want to rely on as an investor.

Relying on emotional whims early led to lost money.  Lost opportunity.  And more stress.

The more I learned the more I realized I needed to develop strict buy and sell investment criteria to take emotion out of the equation.

Over time this led to my preliminary analysis checklist.  My selling checklist.  And my general investment checklist to name a few.  And these are why I'm comfortable "losing" out on a 26% gain in a few months.

Just because Activision is willing to waste money.  And yes there is a great likelihood the money they spent on KING will get wasted.  Doesn't mean my decision in June and July was the wrong one.


Because I stuck to my investment thought processes...

Owning KING involved taking on too many major red flags so I decided to pass.  And wouldn't have bought into the company at any price barring an NCAV situation.

Before developing my investment thought processes when seeing the KING buy out it would have frustrated me.  Why?  Because it was at a 26% premium to what I could have bought them at in June/July.

This would have made me feel like I lost a quick and easy 26% opportunity.

But this makes no sense.

How could I have known KING was going to be bought out in a few months time?  And how could I have known Activision would pay such a high price for KING?

I couldn't.  So why dwell on what I couldn't have known. I don't now and instead rely on what my research and processes told me at the time.

I may have been "wrong" in the short-term this time.  But next time the company could go bankrupt.  Could get investigated by the SEC for fraud.  Or could lose all its subscribers in a short time.  All would be disasters for shareholders.

If done right investing shouldn't be gambling.  Buying KING would have been just that.  And this is why even though I was wrong I was still right about KING.

Have you developed your own investment processes?  Do you require strict criteria to be met for any buy or sell decisions?   Would you have regretted not buying KING?  Let me know your thoughts on all in the comments below.


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October Press On Research Issue – The Next GE?

October Press On Research Issue - The Next GE?

I don't hype investments.  And my biggest fear while the investment newsletter was courting me last year was I would have to hype.  Use hyperbole to explain how you'd gain 10,0000% owning XYZ stock in the next three days.  Or even outright lie.

But I got lucky.

While I learned a ton of investment newsletters are terrible.  And will lie and promise returns they can't hope to deliver.  The investment newsletter I worked for wasn't one of those.

One of the biggest rules all analysts had to abide by was "Write about the biggest returns you want and the investment time frame you want.  But you have to be able to prove the investment thesis and returns out or we can't use them."  In other words don't promise what you - or we in that case - can't deliver.

I was relieved when I found out this was one of the biggest rules analysts had to follow the company.  And while I still don't hype investments.  I learned it's not hype if you can prove your thesis out.

Even though you might think a title of The Next GE? for an issue is hype its not. In the October 2015 Press On Research issue releasing today I prove that this company could become the next GE.

If this still isn't enticing enough how about an excerpt from the upcoming issue where I lay the groundwork for my thesis.  The unfinished excerpt below is from the October 2015 Press On Research issue being sent out to subscribers today.

October 2015 Press On Research Issue

By Jason Rivera

Press On Research Volume 1 Issue 7

The Next GE Pays You A 10% Dividend Now

While We Earn 34.5% In The Next Year

If you’ve studied business and management you’ve read or seen GE from the early 1980’s talked about a huge amount.  And have learned how Jack Welch saved the company by introducing a radical concept.

GE was going to number one or two in each business it operated.  Or it was going to sell or close down the businesses.

This was a drastic - but necessary decision - because GE had become an inefficient bureaucratic nightmare.

Quoted below from Wikipedia.  Emphasis is mine.

“During the early 1980s he was dubbed "Neutron Jack" (in reference to the neutron bomb) for eliminating employees while leaving buildings intact.

In Jack: Straight From The Gut, Welch states that GE had 411,000 employees at the end of 1980, and 299,000 at the end of 1985.

Of the 112,000 who left the payroll, 37,000 were in businesses that GE sold, and 81,000 were reduced in continuing businesses.

In return, GE had increased its market capital tremendously. Welch reduced basic research, and closed or sold off businesses that were under-performing.”

And this changed fortunes for GE shareholders in a huge way going forward  During Welch’s tenure from 1981 to 2001 the company’s share value rose 4,000%.

That’s not a typo.

Whether you thought his slash and burn tactics were humane or not; for GE shareholders Jack Welch’s tenure was amazing.

And because of how well GE did during his tenure Mr. Welch is regarded as one of the best business leaders of the 20th century.

But why did this approach work so well?

Because it enforced strict competition standards within GE.  It forced every subsidiary to work towards becoming the best company it could be.

GE employees at all subsidiaries knew if they didn’t work towards becoming great.  And achieve those goals.  That its business may be sold to another company.  Downsized.  Or shut down.

This led to more innovation.  Better productivity.  Less bureaucracy and more efficiency at all subsidiaries and GE.  And this led to better margins, compounding of value within the company, and higher returns for shareholders.

But Press On Research is about small, safe, undervalued companies, which have management I can trust.  And we can’t buy GE from the early 80’s today.

So why am I talking about it in Press On Research?

Because today’s recommendation operates using Jack Welch’s rule of being number one or two in each business unit it operates in.  And because of a multi trillion trend within its industry could become the next GE over time.

But before we get to what the company is.  I need to tell you what it does.

Investing In Picks and Shovels

“During the Gold Rush, most would-be miners lost money, but people who sold them picks, shovels, tents and blue-jeans (Levi Strauss) made a nice profit.” Peter Lynch

In the August 2015 Press On Research issue I told you about a great company in the tech sector that works with some of the biggest tech companies in the world.

But it wasn’t a typical tech company…

It didn’t have a social network.  Introduce a new game or app.  Or even improve graphics or processing speed for games and computers.

It operates in what’s referred to as the picks and shovels part of the technology industry.

What does this mean?

The picks and shovels part of any industry is something that’s necessary to the survival of the industry.  But most people don’t think about.

To continue the example from the Peter Lynch quote above; when people flocked to the gold rush they wanted to get rich by focusing on finding gold.

But most people didn’t.  And the people who didn’t lost fortunes and became destitute.

The people who made out best during the Gold Rush were people who sold things like tents, jeans, picks, and shovels.

The same thing is happening in today’s tech arena…

Everyone is focusing on the next big app, game, or social network.  But most of these ventures fail.  And while we have greater social and economic safety nets today than we did in the 1800’s.  Vast fortunes are still being lost today chasing the quick cash.

That is unless you’re in the picks and shovels part of the industry.  And like (NAME REMOVED) from the August 2015 Press On Research issue.  Today’s company operates in that same necessary semiconductor and processor packaging industry.

Handle With Care Part 2

The number one tenant of value investing is buying companies selling at a discount to their intrinsic – or true – value.

This is done so that even when making a mistake in our analysis we still have a good chance of making some money.  Or at least not losing much.

Different value investors also incorporate things like profitability.  Management trustability.  Cash generation.  Trends.  Etc. into their analysis.

But the biggest thing for value investors after buying a company with a margin of safety is the ability to understand the business the company operates in.  And the stability of that industry.

These two concepts are why most value investors keep away from investing in the tech industry.  Where valuations are higher than average.  And the industry changes at a rapid pace.

The best kinds of businesses are ones that are necessary.  Today’s business is.

As with (NAME REMOVED) in August, today’s pick packages microchips and processors for the tech industry.  And as I said in the August 2015 Press On Research issue:

Companies manufacturing parts going into computers and other electronics have to make sure the parts work when finished.

Since most of these hardware manufacturers have assembly lines set up only to make chips, processors, and memory. They have to outsource the testing of their products to third parties

Without third-party specialists like our pick today testing and packaging products.  The part and product manufactures would have to test them in-house.

This would take money away from R&D for new products.

So not only does outsourcing save the tech giants and manufactures money and time.  But it also brought to life an entire specialized packaging, testing, and assembling industry.

Combined this industry does billions of dollars worth of work.  And saves the tech giants billions of dollars.

This industry will experience wild swings when giant chip makers like Intel and Micron slow down.  But it will remain necessary for the foreseeable future.

This is one of the reasons why I have no problem investing in “tech” for the second time as a strict value investor.  But there are a lot more great things about this company.

Today’s pick is a $640 million company.  It has better margins than (NAME REMOVED).  It could turn into the next GE in time.  It’s undervalued by as much as 40% now.  Will pay us a 10% dividend while we wait for its shares to rise.  And produces and has a ton of cash compared to little debt.

All the above combine to make this an ultra safe investment. None of this considers the huge trend that could explode its shares.  And turn the company into the next GE.

But before I tell you what the company is let’s do a quick comparison...

To see the rest of this issue.  Get all six prior issues.  And access to a new Press On Research pick every month over the next 12 months.  Subscribe to the service here.

And remember if you're a Value Investing Journey subscriber you get a 50% discount on a one year Press On Research subscription.

Not only will you get a 50% discount to Press On Research with your Value Investing Journey subscription though.  You'll also get access to free gifts.  Be entered to win prizes.  And get exclusive content.

To subscribe to Value Investing Journey go here.

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*Repost* Why The P/E Ratio Is Useless – And How To Calculate EV

*Repost* Why The P/E Ratio Is Useless - And How To Calculate EV

I'm moving my family across country and am unable to post anything new until settling down in the Tampa area.

For more information on how this will affect anything go here.

I hope you enjoy these older posts in the meantime.  And please feel free to contact me.  I'll get back to you when I can.

To subscribe to the Value Investing Journey newsletter go here.

To subscribe to the Press On Research exclusive newsletter go here.

Thanks so much.


Earlier this week I posted a 12:49 video case study part 1 on Armanino Foods (AMNF) showing how I analyzed the company on a preliminary basis.  What everything meant.  And why each metric is important.

But I didn't explain how to calculate EV/EBIT and EV/FCF when I talked about them in the video.  In this post I will.  But before I do that I need to show you why the P/E ratio is useless.  And why you should never rely on it as a long-term value investor.

Why I Hate The P/E Ratio

Last week I got a couple questions from a Press On Research subscriber.  The first question was why I didn't use P/E when detailing the company I recommended. And the second question was how the company could be cheap when it had a P/E of 17.

I won't detail what I said to the subscriber because I would have to reveal the company and industry it's in.  But below I will show you the reasons I hate the P/E.  And why I never use it in my analysis.

P/E Is Turrible

The P/E ratio is two components.  P is price per share and E is earnings per share.

You find price per share by dividing the total market cap of the company by the amount of shares the company has.  And earnings per share is net income divided by the total number of shares a company has.

You then divide the price per share by the company's earnings per share over the last year to find its P/E.  The example below is from

For example, if a company is currently trading at $43 a share and earnings over the last 12 months were $1.95 per share, the P/E ratio for the stock would be 22.05 ($43/$1.95).

Don't worry you won't have to calculate this.  All financial sites report P/E ratio for you when you look up the stock ticker.  And many investors - including me when I started investing - thought this was the best relative valuation to look at.

But it isn't...

The P/E ratio is a misleading and dangerous metric.  And it's one of the worst metrics to rely on as a long-term value investor.


Because of debt, cash, and manipulation...

Why P/E Ratio Is Useless

Below are examples I made up to illustrate why P/E is a useless metric.

Company 1 Company 2
P/E Ratio 10 20

On a P/E basis company one looks better right?  But what happens when you add in important things like cash and debt to the equation?

Company 1 Company 2
P/E Ratio 10 20
P/E stays the same under the below scenario.
Cash and Cash equivalents 0 40
Debt 40 0

Which company would you rather buy now?  The company with a lot of net debt or the company with a lot of net cash?

But this isn't the only reason P/E is misleading...

Earnings Are Easy To Manipulate

The E in the P/E equation is earnings like I showed above.  Another reason I don't like P/E is because earnings are easier to manipulate than EBIT, FCF, and owner's earnings.

One example is a company "smooths" earnings over time to make it look like the company is earning consistent good profits.  Rather than lumpy profits that fluctuate a lot.

This is a huge discussion that goes beyond the scope of this post.  But if you want to learn how companies manipulate earnings read this from Investopedia.  And read the great book Financial Shenanigans.

But these aren't the only downfalls of using P/E...

The earnings part of P/E is after all costs, taxes, and expenditures.  EBIT, FCF, and OE are all after costs and expenditures but before taxes.  Another way companies can manipulate earnings is with the tax rate the company states it has to pay.

If you work hard enough you can make the tax rate whatever you want it to be.  Just ask General Electric (GE).

And because EBIT, FCF, and OE is profit a company makes from its operations.  These metrics show a much truer picture of how profitable a company's operations are.  And if a company is operating in a healthy way.

So P/E is not only a terrible metric to rely on with any company that has debt and cash. Which is of course all companies.  But it's also easier to manipulate than other metrics.  And it doesn't show how profitable and healthy a company's operations are.

This is why I use enterprise value (EV) instead...

So How Do You Calculate Enterprise Value?

I calculate enterprise value as...

  • EV = market cap + preferred shares value (if any) + debt - cash and cash equivalents.

My calculation of EV is the same as the picture above but in easier to understand terms.

Why is EV better than P/E?

Which Metric Is Better?

I love enterprise value when evaluating businesses.  It shows the true picture of what a company should be valued at if you were going to buy the whole business.

This is how I evaluate all businesses for investment.  If I was able to buy the whole company, what price should I pay for it in total?  And per share?  EV helps us find this number.  And when combined with EBIT, FCF, or OE it's also a better relative valuation to use than P/E.

So instead of using the flawed P/E you should use EV/EBIT, EV/FCF, or EV/OE to find what a company is worth on a relative basis.

EV replaces P in the P/E equation.  And operating margin (EBIT), free cash flow (FCF), or Owner's Earnings (OE) takes the place of E in the equation.

EBIT, FCF, and OE can all replace earnings in the P/E equation.  And all three tell you different things when compared against EV.

EV/EBIT shows you what the company is worth compared to its operating profits.  EV/FCF shows you what the company is worth compared to the free cash it generates from operations.  And EV/OE shows you what the company is worth compared to the value you could take out of the company if you owned it.

Let's keep things simple and only worry about EV/EBIT and EV/FCF today though.  I will explain how to calculate owner's earnings when we get to that point in the case study.

Another name for EBIT is operating margin.  But it's also called operating income or operating earnings.  You can find this by going to a company's income statement under the financials tab on Morningstar.  FCF is on the cash flow page under the financials tab on Morningstar.

I use EBIT and FCF because they are harder to manipulate.  And show what a company earns from its operations in the case of EBIT.  Or in the case of FCF - show how much cash the company has left after paying for things to upgrade and improve the business.

So what does this all mean when continuing the example above?

Why I Love EV/EBIT and EV/FCF

If we were to continue the above example we would just need the company's market cap.

Company 1 Company 2
Market Cap 100 100
P/E Ratio 10 20
P/E stays the same under the below scenario.
Cash and Cash equivalents 0 40
Debt 40 0
EV = 140 60
  • Company 1 EV = 100 + 40 - 0 = 140
  • Company 2 EV = 100 + 0 - 40 = 60

Which Company Would You Rather Own?

Now that we have found EV for the made up businesses above.  Let's take this further and see which company is the better buy now...  At least on a relative valuation basis.

Company 1 Company 2
Market Cap 100 100
P/E Ratio 10 20
P/E stays the same under the below scenario.
Cash and Cash equivalents 0 40
Debt 40 0
EV = 140 60
EBIT = 10 10
FCF = 10 10
Company 2 is a lot cheaper when considering EV
EV/EBIT = 14 6
EV/FCF = 14 6

EV above is the estimated price you would have to pay to own the whole company.

Now that we've found EV for both businesses we can bring in EBIT and FCF to find EV/EBIT and EV/FCF.

Now that we've replaced the terrible P/E ratio with EV/EBIT and EV/FCF.  We've got a better look at what the company truly is worth on a relative and intrinsic basis.

This is how business owners evaluate businesses.   And we as long-term value investors should consider ourselves business owners.

Which company looks like the better buy now?  And what is your favorite relative valuation metric? Let me know in the comments below.


Don't forget, if you want to receive two free gifts that will help you evaluate companies faster.  Get all future blog posts. Get future case study information first.  And be entered to win a hard copy of: The Snowball - Warren Buffett and the Business of Life and a $50 AMEX gift card. Sign up for the Value Investing Journey newsletter here.

*Repost My Answer To How Do You Find Stock Opportunity

*Repost My Answer To How Do You Find Stock Opportunity

I'm moving my family across country and am unable to post anything new until settling down in the Tampa area.

For more information on how this will affect anything go here.

I hope you enjoy these older posts in the meantime.  And please feel free to contact me.  I'll get back to you when I can.

To subscribe to the Value Investing Journey newsletter go here.

To subscribe to the Press On Research exclusive newsletter go here.

Thanks so much.


Below is my answer on Quora to someone who asked How Do You Find Stock Opportunities?

*Repost* Why Is Valuation Important?

*Repost* Why Is Valuation Important?

I'm moving my family across country and am unable to post anything new until settling down in the Tampa area.

For more information on how this will affect anything go here.

I hope you enjoy these older posts in the meantime.  And please feel free to contact me.  I'll get back to you when I can.

To subscribe to the Value Investing Journey newsletter go here.

To subscribe to the Press On Research exclusive newsletter go here.

Thanks so much.


Over the past few weeks I've seen a ton of people asking "why valuation is important?"

I've seen others answers, but I want to hear from you...  Do you think valuation is important?  Why or why not?

In the short  57 second video below I start a conversation about valuation.  Next week I'll post my thoughts on this.  And then get back into the case study.

Let me know what you think in the comments below.

*Repost* Don’t Be A One-Legged Person In An Asskicking Contest – My Answer To Why Valuation Is Important

*Repost* Don't Be A One-Legged Person In An Asskicking Contest - My Answer To Why Valuation Is Important

I'm moving my family across country and am unable to post anything new until settling down in the Tampa area.

For more information on how this will affect anything go here.

I hope you enjoy these older posts in the meantime.  And please feel free to contact me.  I'll get back to you when I can.

To subscribe to the Value Investing Journey newsletter go here.

To subscribe to the Press On Research exclusive newsletter go here.

Thanks so much.


Last week I asked your thoughts on valuation.  If you think it's important?  Why or why not?  I asked this because I've seen a lot of discussion on the topic in recent weeks.  This post is my answer to that question.

Asking if valuation is important to deep value investors like us is like asking if we follow the teachings of Ben Graham and Warren Buffett.  The answer of course is yes.  But why is valuation important?

Once we understand how to do valuation most of us never think about this question again. And it's important to understand why.

To show why valuation is important let's continue with an example from the earlier post.  Why The P/E Ratio Is Useless - And How To Calculate EV.

Why Valuation Is Important

Below is an example of two company's made up for the example.

Company 1 Company 2
Market Cap 100 100
P/E Ratio 10 20
P/E stays the same under the below scenario.
Cash and Cash equivalents 0 40
Debt 40 0
EV = 140 60
EBIT = 10 10
FCF = 10 10
Company 2 is cheaper when considering EV
EV/EBIT = 14 6
EV/FCF = 14 6

P/E, EV/EBIT, and EV/FCF are all relative valuations.  Companies that have lower relative valuation multiples are cheaper than others.  And companies that are cheaper are better to buy.  Why is this?

To find out why lets invert both EV/EBIT and EV/FCF to find each companies earnings yield.  I explain earnings yield in the following section.

Earnings Yield Estimates Expected Rate Of Return

For those who don't watch the short video above I'll paraphrase. Earnings yield is the estimated return you should expect to earn in one year on an investment.

The higher this number is the better. This is because the higher this number is the more a company is undervalued.

Company 1 above has an earnings yield of only 7.1%. Not good enough. I look for earnings yields above 10%.

Company 2 above has an earnings yield of 16.7%. 2.35 times company ones earnings yield. And above the 10% I look for when considering an investment.

This means you should earn 2.35 times more if you invest in company two instead of company one. But this isn't all...

By doing the work above with EV and earnings yield, not only do you see that company 2 will get you a higher return. But doing a bit more work allows you to see that company 2 is a less risky investment.

Company 2 is safer because it has no debt, while having a lot of cash. The saying that the more you risk the more you gain is a fallacy. This "advice" needs to die because it leads many investors into unnecessary danger.

But these aren't the only concepts you need to consider when evaluating an opportunity.

EBay And Amazon Businesses

Many of you who've followed this blog for a while know that I also run an EBay and Amazon reselling business.  The example below is something I found and sold last year.

I use the concepts talked about in this article every day.  And you can use them whether you're analyzing a stock.  Or buying something to sell in your business.

Let's say we have two of the same Giorgio Armani jeans.  Same size, color, condition, everything.  And both are real Giorgio Armani jeans.

Each pair of jeans looks brand new but does not have the tags on them still.  These jeans sell for more than $100 brand new.  But for this example let's use $100 because it's an even number.

So both pairs of jeans are the same and sell brand new for the same amount.  But what if I said you could buy one of the pairs for $80 and the other pair for $2.  Which would you buy?

The one that's selling for $2 of course.

But if you had an EBay and Amazon business how would this change things?  You would need to keep thinking...

One pair we bought for $80 and the other we bought for $2. We can resell both for $100. This means we have the potential to make $20 on one pair and $98 on the other.

The pair we bought for $80 and sold for $100 gives us a 20% return. Not bad. But the pair we bought for $2 gets us a return of 4900%. Or a 49 bagger in a short amount of time. We'll get back to the time aspect later... This is a spectacular return. And is why valuation is so important.

All else remaining equal, the cheaper a company is the higher return you should expect in the long-term.

This is why it's important to value businesses. Without doing valuation you can't know if you're getting a good deal. Or taking unnecessary risks with your capital.

In the above example is risking your $80 to make a $20 profit worth your time? Or would you rather buy the $2 pair of jeans and get a 4900% return on the same item while risking far less money on a safer investment?

But there's still more...

You also need to think about the amount of time it will take for your investment thesis to play out. And consider what you can't invest in while you invest in this opportunity.

This last concept is opportunity cost.

The Opportunity Cost of Investing

As investors we have to consider several choices every time we think about buying an investment.

  • Is the investment safe?
  • Am I getting a high enough return compared to the capital I'm risking?
  • Am I getting a high enough return for the amount of time I expect to hold this investment?
  • Do I already own another company that would be a better investment?
  • If I invest in this company now, am I comfortable holding it for the long-term? Another - possibly better- company may come along and I need to be comfortable losing out on that opportunity.

These are just a few of the many things you need to consider when investing. But for now I want to concentrate on the last bullet point.  It's the concept called opportunity cost.

DEFINITION of 'Opportunity Cost'

1. The cost of an alternative that must be forgone in order to pursue a certain action. Put another way, the benefits you could have received by taking an alternative action.

2. The difference in return between a chosen investment and one that is necessarily passed up. Say you invest in a stock and it returns a paltry 2% over the year. In placing your money in the stock, you gave up the opportunity of another investment - say, a risk-free government bond yielding 6%. In this situation, your opportunity costs are 4% (6% - 2%).

Below is a video from giving a real world example of opportunity cost.

The example of choosing between two jobs is too simple.  But it's a good starting point.

The thoughts I would've added to help me decide which is a better job would be: Which job would I be happier at?  Which one has more room for advancement?  How many hours do I have to work at each?  Etc.

When considering an investment you need to consider more than just valuation.

For example: Which one is safer?  Which one is offering a higher return?  Which one do I have more capital tied up in and for how long?  Which company has higher profits and cash flow compared to valuation?  Am I willing to pay up for a better company?  And much more.

This is how you begin to analyze the opportunity cost of an investment.  And get closer to a decision.

But without valuation you're only considering part of the equation.  And without valuation you'll have to rely on gut instinct and emotion.  Two things that will kill you when making investment decisions.

Don't Be A One-Legged Person In An Asskicking Contest

Yes I know when picking businesses and stocks to invest in not everything is equal like in the examples above.  But this is why you need many tools in your mental toolbox while evaluating things.

And if you don't consider valuation, opportunity cost, and the other concepts in this article, you're missing some of the best mental investment tools.  Or as Charlie Munger says:

"If you don't have the proper mental tools then you go through a long life like a one-legged man in an asskicking contest."

To learn more about mental models.  And start adding tools to your mental tool box so you don't go through life like a one-legged person in an asskicking contest, go to the earlier post. Car Wash Psychology, Mental Models, and The Power of Habit.

What do you think about valuation?  And did I miss anything in my explanation?  Let me know in the comments below.


Don't forget, if you want to receive two free gifts that will help you evaluate companies faster.  Get all future blog posts. Get future case study information first.  And be entered to win a hard copy of: The Snowball - Warren Buffett and the Business of Life and a $50 AMEX gift card. Sign up for the Value Investing Journey newsletter here.

*Repost* All About Float

*Repost* All About Float

I'm moving my family across country and am unable to post anything new until settling down in the Tampa area.

For more information on how this will affect anything go here.

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Thanks so much.


Below is an unedited copy of the analysis I did on Unico American Corp (UNAM) in 2012.   And below that are links to the best information I've found to learn about float.

I'm reposting this because the next Press On Research issue comes out on Tuesday.  And a major reason why I'm recommending the company is because of its great margins and profitabilty.  Which in part are magnified by the company operating its entire business with only its cost free float.

Unico American Corp Is A Company I Would Love To Own All Of

Introduction And History

When I first started out reading about Unico American Corporation $UNAM I was expecting to just use this as a learning experience since this is the first insurance company that I have truly evaluated.  I was planning on learning the important insurance industry terms, what they meant, how they affected the company in question, what the float was and how that affected the company’s operations, etc, and analyzing the company using all the knowledge I have gained lately from my recent foray into studying float and put those findings into an article.  I was not expecting to find what I did: A company that is undervalued by EVERY ONE of my estimates of value, a company that has been for a number of years very disciplined and conservative in its estimates, which I found are of utmost importance in the property and casualty insurance business, and a company that has had underwriting profits every year since 2004, which I found out is really hard to do.  If I had the capital available I would love to own this entire company and to build my investment firm with this company at the core, a la Warren Buffett with Berkshire Hathaway and its insurance companies.  However, unless someone out there would like to endow me with nearly $100 million I will just have to be happy buying shares in UNAM and watching my money compound into the future.

UNAM is a relatively small (Current market cap around $65 million) holding company whose main subsidiary, Crusader, is a property and casualty insurance company who writes insurance only in the state of California.  The vast majority of its operations (around 98%) are in commercial multi peril insurance writing.  UNAM also has some other subsidiaries that operate in various insurance related industries, but for this article I am only going to concentrate on Crusader and UNAM as a whole as its other subsidiaries contribute only fractionally to UNAM's results.  UNAM used to write insurance in a number of other states but decided to concentrate only on California as it was generally losing money on its insurance operations in those other states.  UNAM is still licensed to write insurance in several other states so it may choose to expand back into those areas but at this time it appears to be content expanding throughout California.  The below quoted areas are from UNAM's annual reports about the previous business in other states and why its management decided to stop those operations.

"In 2002 the Company began to substantially reduce the offering of insurance outside of California primarily due to the unprofitability of that business.

In 2004 all business outside of California had ceased.  In 2002, primarily as a result of losses from liquor and premises liability coverage which had rendered much of the Company's business outside of California unprofitable, the Company began placing moratoriums on non-California business on a state-by-state basis. By July 2003, the Company had placed moratoriums on all non-California business. The Company has no plan to expand into additional states or to expand its marketing channels. Instead, the company intends to allocate its resources toward improving its California business rates, rules, and forms.

The Company incurred underwriting losses in 2000, 2001, and 2002. As a result of these underwriting losses, management analyzed and acted upon various components of its underwriting activity. The Company believes that the implementation of these actions contributed to the improved underwriting results. This is reflected in the decrease in the Company's ratio of losses and loss adjustment expenses to net earned premium from 139% in 2001, to 98% in 2002, to 85% in 2003, and to 69% in 2004."

As you will see throughout the rest of this article, UNAM's operations have changed drastically for the better since those decisions were made.

Overview Of Operations

Below are descriptions of UNAM's insurance business taken from its annual reports.  Emphasis is mine.

The insurance company operation is conducted through Crusader. Crusader is a multiple line property and casualty insurance company that began transacting business on January 1, 1985. Since 2004, all Crusader business has been written in the state of California. During the year ended December 31, 2011, approximately 98% of Crusader’s business was commercial multiple peril policies. Commercial multiple peril  policies  provide  a  combination  of  property  and  liability  coverage  for  businesses.  Commercial property coverage insures against loss or damage to buildings, inventory and equipment from natural disasters, including hurricanes, windstorms, hail, water, explosions, severe winter weather, and other events such as theft and vandalism, fires, storms, and financial loss due to business interruption resulting from covered property damage. However, Crusader does not write earthquake coverage. Commercial liability coverage insures against third party liability from accidents occurring on the insured’s premises or arising out of its operation. In addition to commercial multiple peril policies, Crusader also writes separate policies to insure commercial property and commercial liability risks on a mono-line basis. Crusader is domiciled in California; and as of December 31, 2011, Crusader was licensed as an admitted insurance carrier in the states of Arizona, California, Nevada, Oregon, and Washington.

The property casualty insurance marketplace continues to be intensely competitive as more insurers are competing for the same customers. Many of Crusader’s competitors price their insurance at rates that the Company believes are inadequate to support an underwriting profit. While Crusader attempts to meet such competition with competitive prices, its emphasis is on service, promotion, and distribution. Crusader believes that rate adequacy is more important than premium growth and that underwriting profit (net earned premium less losses and loss adjustment expenses and policy acquisition costs) is its primary goal. Nonetheless, Crusader believes that it can grow its sales and profitability by continuing to focus upon three areas of its operations: (1) product development, (2) improved service to retail brokers, and (3) appointment of captive and independent retail agents.

The property and casualty insurance industry, P&C insurance, has been in what is considered a "soft market" since 2004.  UNAM has been disciplined enough during this "soft" insurance market of the past 8 years to achieve underwriting profits every year since 2004.  As I will detail later that feat has been very hard to come by for other P&C insurance companies and is extremely impressive.  The strict discipline to keep prices high enough to retain that underwriting profit has led to loss of business since 2004; net premiums written have dropped from $33 million in 2007 to just under $27 million in 2011.  All numbers throughout this article are in millions $US unless otherwise noted.


The surplus ratio is supposed to be under 300% so UNAM is well underneath that.  The underwriting profit as a % of net premium has consistently been between 9%-20% since 2007.  Very impressive profit margins especially in comparison to some of the other insurance companies I researched and will talk about later who of underwriting losses.  The statutory capital and surplus numbers is the amount of extra money after all liabilities and assets have been properly calculated according to the accounting standards.  Generally the higher the better and the more money the company has to potentially invest and pay out claims with.  Dividends can be paid out of the surplus capital as well.

I estimated what its profit numbers are for the whole of 2012 and I estimate an underwriting profit of 4.92, net premiums written of 33.21 and underwriting profit as a % of net premium of 14.81%.  I did not include those in the above chart because those numbers are not official.

Last week I wrote about my conversation with Mr. Lester Aaron the CFO of the company and wrote my notes in this post.  After thinking about it some more and after further research I am glad that UNAM has taken the attitude it has to be extremely disciplined and conservative in its investments as those decisions have generally paid off as I will show below.  After looking at some of its competitors I also noticed that P&C insurance companies generally invest 5% and less of their investment funds in equities to be sure that they have funds on hand in case of a catastrophic insurance event so UNAM having no investments in equities does not appear to be as out of line with industry norms as I first thought.  However, I think that UNAM should invest its $2 million self imposed limit in equities to earn at least a somewhat better return than the about 1% it is earning now---If UNAM management is interested and listening I could send some ideas to them, companies that I think are good long term bets that are undervalued :) --- or at the very least get a bit more aggressive with buy backs and/or pay out more consistent special dividends with that money so that shareholders can put it to use.  Earning 1% on investments is pretty much useless over the long term so I hope management continues to do or starts doing some of the above things.  In the past several years UNAM has occasionally paid out special dividends and bought back some of its shares.

Float Analysis

Unico American Corporation $UNAM

  • Financial Assets: Total investment 124.84+cash 0.09+accrued investment income 0.27+premium and notes receivable 6.02+unpaid loss and loss adjustment expense 7.81+defered policy acquisition costs 3.93+deferred income taxes 1.84=144.8
  • Operating Assets: PP&E net 0.66+other assets 1.4=2.06
  • Total Assets=146.86


  • Equity of 75.23
  • Debt of 0
  • Float: Unpaid losses and loss adjustment expense 51.03+unearned premiums 16.6+advance premium and premium deposits 0.93+accrued expenses and other liabilities 3.1=71.66

Total liabilities are 71.66

Float/operating assets=71.66/2.06=34.79.  Float is supporting operating assets almost 35X.  Float is considered to be "free money" in this case because UNAM earns an underwriting profit and has since 2004.

Full year 2012 estimate of underwriting profit/total assets=ROA

  • 4.92/146.86=3.37%

Full year estimate of underwriting profit/ (total assets-float) =levered ROA

  • 4.92/75.2=6.54%

Competitors Info And Ratios And Comparison To UNAM

As I found out while researching other insurance companies to compare to UNAM, underwriting profit over a sustained period of years and the discipline to achieve that is very difficult.  I looked at around 5-7 other insurance companies combined ratios and underwriting profits and found that only a couple of them had underwriting profits for more than two out of the last five years, and generally their combined ratios got much worse in the last three years.  All of that makes UNAM's sustained underwriting profits since 2004 all the more impressive.  Below are two of UNAM's competitors that I compared it to and their ratios.



Of particular note is the giant leap in both companies Loss and LAE and combined ratios since 2007.

Those numbers are generally much worse than UNAM's ratios as you will see below.


UNAM's ratios have generally either stayed the same or gotten better since 2007.  A drastic contrast to the other insurance companies I looked at, almost all of whose combined ratios have gotten worse since 2007.

Also of note are how the companies risk based capital ratio compares.


Numbers are supposed to be over 200% or insurance regulators may sanction or even take over the company as the company is deemed to be under potentially serious financial risk if its ratio is below 200%.  Employer's Holding's $EIG does not state what its RBC ratio is and only says that it exceeds the minimum requirement.  I found that a lot of the other insurance companies I looked into also did not state what their RBC ratio was.  As you can see Hallmark Financial $HALL ratio has been under the minimum recommended 200% for a few years now.

I found out pretty quickly into my research that of paramount importance in the insurance industry is management discipline and conservatism.  UNAM's management has shown an impressive amount of both and it has paid off as all of the company’s ratios have improved, sometimes substantially for the better as a lot of its competitors ratios are getting worse.

I found it very curious that pretty much all the insurance companies I looked at said that they were more primarily concerned with underwriting profits even if that meant that the number of premiums written declined.  The reason I found that curious is because almost all of those other companies had underwriting losses going back several years, sometimes while premiums written had been growing.  So in some cases the other companies managements are at worst outright lying to its shareholders or at best being disingenuous with their stated underwriting policy as it relates to profitability.  UNAM's managements focus, discipline, and conservatism appears to be an amazingly exceptional outlier in comparison to the other P&C insurance companies I looked at in terms of producing consistent underwriting profits.

Other Things Of Note

  • Generally there aren't any barriers of entry into the P&C insurance industry.  The main advantage a company can gain is to be the low cost operator, but that sometimes comes with an underwriting loss as well.
  • UNAM is a controlled company as Mr. Erwin Cheldin-former CEO, president, and chairman of the board of UNAM, Founder of UNAM, and father of Cary; Cary L. Cheldin-Chairman of the board, president, and CEO of UNAM, son of Erwin Cheldin; Lester A. Aaron-treasurer, director, and CFO of UNAM; and George C. Gilpatrick-director of UNAM, hold approximately 53.20% of the voting power of the Company and have agreed to vote the shares of common stock held by each of them so as to elect each of them to the Board of Directors and to vote on all other matters as they may agree.
  • Biglari Capital, run by activist investor Sardar Biglari who tries to emulate Warren Buffett, owns 9.48% of UNAM.  His fund has had recent discussions with UNAM.  Nothing to report yet but Mr. Biglari has already tried to buy an insurance company before.
  • Schwartz Value and Ave Marie Catholic Values combined own 8.51% of UNAM.
  • Dimensional Fund Advisors owns 8.73% of UNAM.
  • All of the above shareholders combine to own 79.92% of UNAM.  Combine that with various other funds that own smaller portions of UNAM and probably under 10%, less than 500,000 shares, of the company’s shares are truly outstanding.
  • Cary Cheldin and Lester Aaron, both of whom are executives of UNAM, are also on the company’s competition committee.
  • On September 29, 2003, the Company borrowed $1,000,000 from Erwin Cheldin, director and the Company's principal shareholder, president and chief executive officer, and $500,000 from The Cary and Danielle Cheldin Family Trust. Very dedicated and committed shareholders and owners.
  • Book value per share has been rising.  The nine year average book value per share is $11.36 per share and currently UNAM's TTM book value per share is $14.12 per share.  UNAM is currently selling for less than its book value per share.
  • Revenues have dropped every year since 2004 when the soft insurance market started from a high of 62 down to a present TTM of 33.
  • UNAM has a negative EV, TEV/EBIT, and EV/EBIT.
  • UNAM's AM Best rating is A- which is deemed excellent.  The AM Best rating is a measure of financial strength.
  • UNAM has four reinsurers all of whom have AM Best ratings of A of higher.
  • UNAM looks to be properly covered if a catastrophic insurance event happens as it carries a substantial amount of short term investments, currently worth more than its entire current market cap, it has substantial statutory capital and surplus, also currently worth more than its current market cap, and adequate reinsurance.


These valuations were done by me, using my estimates and are not a recommendation to buy stock in any of the companies mentioned. Do your own homework.

Valuations were done using UNAM's 2011 10K and 2012 third quarter 10Q. All numbers are in millions of US$, except per share information, unless otherwise noted.

Absolute Minimum Valuation

This valuation is expecting 1% interest rates for the long term and no growth in float over time.

  • (float X 10%) + Equity=estimated value/number of shares.
  • (71.66 X 10%) +75.23=82.40/5.3=$15.55 per share.

Base Valuation

  • Float + Equity=estimated value/number of shares.
  • 71.66+75.23=146.89/5.3=$27.72 per share.

High Valuation

Assets: Book Value: Reproduction Value:
Fixed Maturity Securities



Short Term Investments



Premiums and Other Receivables



Deferred Policy Acquisition



Deferred Income Taxes



PP&E Net



Other Assets



Total Assets



Number of shares are 5.3

Reproduction Value

  • 128/5.3=$24.15 per share.

This valuation does not take into account any of UNAM's float at all.  Add float onto that asset reproduction value gets us to:

  • 128+71.66=199.66/5.3=$37.67 per share.

Valuation Thoughts

  • Current share price is $12.25 per share.
  • UNAM appears to be massively undervalued.  There is a 22% margin of safety to my absolute minimum estimate of intrinsic value.  I actually think UNAM's true intrinsic value is somewhere in the $25-$35 range which would either be a double or triple from today's prices.  These estimates of value do not even count the companies potential future growth in float, premiums, and investable money over time.  My estimates of value also do not count on the insurance industry as a whole improving either, which will happen eventually.
  • UNAM's downside is at least somewhat protected by its investments as well as it is currently selling for less than just the value of its short term investments, which mostly consist of cash, cash equivalents, and CDs.  Current per share value of short term investment is $14.72 per share.
  • I also found UNAM to be undervalued with every one of my other valuations.
  • UNAM is selling for less than just what its float is worth per share at book value, $13.52 per share.
  • UNAM is selling for less than the per share value of just its net assets after subtracting all liabilities including float, $14.15 per share.


  • UNAM is undervalued by every one of my estimates of intrinsic value.  As an example, UNAM's per share price is lower now than the per share value of JUST its short term investments.
  • UNAM's management looks to be very disciplined and conservative, which I found is of absolute importance in the insurance industry.
  • Sardar Biglari, an activist investor, has recently bought just fewer than 10% of UNAM and may look to buy it outright as Mr. Biglari has already tried to buy an insurance company before.  At the very least he could try to help unlock some of the value of UNAM's shares by working with management and has already had contact with UNAM management.
  • UNAM has a negative enterprise value.  This article from Greenbackd explains why that can be a good thing for shareholders as a negative enterprise value can mean a value dislocation.
  • UNAM has earned an underwriting profit every year since 2004.  More impressive is that 2004 started a soft market in the insurance industry which generally means it is harder to earn an underwriting profit.
  • Even though UNAM is only earning 1% on its investments currently, UNAM still should have enough funds on hand to pay claims if a catastrophic insurance event happens as its surplus and statutory capital has grown substantially in recent years.  UNAM actually has more in just statutory capital and surplus than its current total market cap.  UNAM also has more in short term investments than its current entire market cap and it also looks to be adequately reinsured.
  • Book value per share has been rising in recent years.
  • UNAM's management seems to be dedicated to the company as the current CEO and his wife loaned the company money in 2003 when it was having some problems.
  • Although UNAM's CEO and CFO are on its compensation committee, their pay seems to be fair to me.
  • The former CEO, former president and founder, current CEO and president, and CFO own substantial portions of UNAM.
  • In recent years UNAM has bought back some of its shares and paid special dividends on occasion because “We think that the shareholders can put the dividends to better use than I think that we can currently in the market.”  Very shareholder friendly.
  • My entire conversation that I had with Mr. Aaron that I linked to above gave me confidence in management and laid some of my concerns to rest.
  • All of UNAM's risk and insurance industry related ratios are far in excess of what they need to be and far better than its competitors that I looked at.
  • UNAM's float should be considered as free money and looked at as kind of a revolving fund since it earns, and has earned since 2004, underwriting profits.
  • UNAM has no debt.  Some of the other insurance companies I looked at had to take on debt just to keep their operations out of regulators hands in recent years.


  • Revenue and premiums written have generally dropped every year since 2004.
  • UNAM is currently only earning 1% on its investments.  This could mean that if a catastrophic insurance event happens in the future that UNAM may not have enough money to pay claims.
  • UNAM may be too conservative with the investments it owns and the company seems to have a lot of excess capital not being utilized at all currently.
  • The current CEO and CFO are on UNAM's compensation committee.
  • Some would say that UNAM's special dividends in recent years are just being paid to further pay the insiders of the company who own large portions of the company.


  • Mr. Biglari could try to influence UNAM's management to help unlock some of the value of its shares, or buy the company outright as Mr. Biglari has already tried to buy an insurance company before.
  • An improvement in the overall insurance industry could help unlock the value of UNAM.
  • A catastrophic insurance event in California would harm UNAM's results.


This experience of learning about float over the last month or so has been an amazingly rewarding experience. As a relatively new investor I am always looking for opportunities to learn new things and expand my circle of competence and I think that I will look back years from now and see that this time period of my value investing journey was a turning point in getting me closer to my ultimate goals of opening up my own investment firm.  As icing on the cake I also ended up finding another company to invest in as UNAM is a company that is undervalued by every one of my estimates of intrinsic value, has potential catalysts in place to help unlock value, has had underwriting profits since 2004, and has very focused, disciplined, and conservative management.  For all of the reasons I list above, UNAM is a company that I would like to own all of and build my investment firm around.

Update as I was getting ready to publish the article.

After I finished up writing the article at the end of last week I started reading The Davis Dynasty and realized I had a lot more I needed to learn about the insurance industry as a whole before being comfortable enough with my knowledge to make the decision to buy into UNAM.  At this point I do not think that I have enough overall insurance industry knowledge to be able to make a definitive buy or sell decision so for now I am going to continue to learn about the insurance industry and when I feel I have enough knowledge, at that point I will make a definitive buy or sell decision about UNAM.

Hopefully UNAM's shares do not pop before I gain more knowledge as they are by far the best insurance company I have found up to this point but I do not want to repeat some of the mistakes I made in the past and buy something before I fully understand the business and industry.


How To Value Float

The Float of the Companies I Own

Floats, Moats, And My Plans For The Year

Fundoo Professor-Presentation on Moats and Floats.  Also read the comments section.

Fundoo Professor - All About Floats: Parts 1, 2, and 3.  Make sure to read the comments section as the discussion there goes quite deep into the inner workings of float.


In the comments below let me know if I missed anything about float.

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