In the video, I take the client through everything I do on a preliminary basis. Explain why I look at everything I do. Explain what everything means. And most importantly, why everything I look at is important in the context of evaluating an investment.
Below is an edited transcript of the first part of the video… You can watch the full video further below.
And one last note before getting to the transcript of the video…
The client picked this company for us to do a real-time and real-world analysis on because he was interested in this company as a potential investment.
I’d never seen or evaluated this company before meeting and talking with this client.
Since we’ve already talked about this company a bit on a preliminary basis, I’m doing things differently than I normally would on a preliminary analysis.
I’m also going through this slower than usual so I can explain what everything means.
The first thing I do is go to Morningstar, open up the key ratios tab and the financials tab in another page so I have those handy and ready.
The first thing I want to mention here is that I was able to find its ticker on Morningstar unlike the other day when we were talking.
It’s listed on the Frankfurt exchange on Morningstar under the ticker SGQ.
You’ll notice SGQ lists in Euros on Morningstar as well. Make sure to always notice which currency the company lists on financial sites.
Go to Google Finance, same company but this time the company lists on the Singapore Exchange under the ticker B7K.
I’m going to reference the Google finance listing throughout but I’m going to be using the company’s financials listed on Morningstar because that’s where I do all my preliminary analysis as they have more information.
But because of this difference please keep in mind some of the numbers may be different from the ones you’re seeing.
This is because the Google finance numbers are i n Singaporean Dollars (SGD) and as mentioned above Morningstar lists its numbers in Euros.
The first difference you’ll notice is the difference in market cap of 28.9 million Euros on Morningstar and 44.4 million SGD on Google.
This is likely due to a conversion rate exchange difference and I’ll look at that later.
The next thing I do is get right into the preliminary analysis. The same one I use for every company I evaluate…
To see the full real-time and real world training watch the video below.
And if you’re interested in getting your own one on one Value Investment Coaching please go to the link below.
If you’d like to know what the companies are you need to subscribe to Press On Research. And remember Value Investing Journey free subscribers get a 50% discount on a Press On Research subscription. If you’re a Press On Research subscriber I’m sending an unedited version of the spreadsheet your way.
What does this mean for cumulative full five-year returns now?
Five Full Years Beating Buffett…
I don’t compare myself to Buffett because I want to be the next Buffett. But because everyone knows who he is as he’s regarded by most at the best investor ever.
I want to be known as the first Jason Rivera when my career is over. At the end I want to be known as a better investor and capital allocator than Buffett and to produce better returns over time than he has.
At least for now – five full years into my career – I am achieving this lofty goal by beating Buffett when compared to the first five years of his career.
In the first five years of my career I’ve now produced average – non-compounded – returns of 29.7% each year. Or a total cumulative return of 148.3% over that period.
In the first five years of his career Buffett produced average – non-compounded – returns of 25.4% each year. Or a total cumulative return of 126.9% over that period.
This means in the first five years of our careers I’ve produced returns 4.3 percentage points better each year than Buffett did in the first five years of his career.
But what does this 4.3 percentage point excess return per year mean in dollar terms over this period?
Assuming we both started with an asset base of $10 million at the beginning of the five-year period I would have grown that $10 million into $36.7 million after five years. Buffett would have turned his investors $10 million into $31 million in that time.
This is why every point of excess returns is so important. And why you need to be aware of any fees charged to your account by your money managers.
Over a long period – or in this case five years – “only” an excess 4.3 percentage points each year would have made investors $5.7 million extra.
Not only am I achieving my lofty goal of beating Buffett through this time, but I’m also crushing the market as well.
And Crushing The Market
From 2012 through 2016 the Dow Jones Index produced a total cumulative return of 37.4% for the five years or 7.5% per year on average.
The S&P 500 produced a 43.2% total return for the five years or 8.6% per year on average.
And the Russell 3000 index – closest thing to a small cap index – produced a 43.5% total return or 8.7% per year on average.
I’ve produced returns in excess of these indexes by 21%, 21.1%, and 22.2% points each year over these five years.
Assuming a $10 million asset base I would have produced $21.5 million more for investors over this five-year period than the Russell 3000 index would have.
$36.7 million minus $15.2 million the Russell 3000 would have produced.
I started posting my results publicly in 2012 because this is when I began doing “real”, in-depth, investment research and analysis instead of speculating.
Results have been great thus far… Better than I expected… But there’s still a lot of work and improvement necessary to continue this.
Other Highlights From 2016
Thanks to sales of How To Value Invest and Press On Research subscribers we continued helping Mhicaella and her family in the Philippines.
The last letter we received from her mother told us that Mhicaella is now in kindergarten. She loves P.E., singing, and drawing, and is learning to read and write so she can begin writing letters to us soon.
Here is a recent picture of Mhicaella…
With your help, some of the things we’ve been able to help provide for her and her family over the last year are school supplies, medical and dental care, and Christmas gifts for her entire family.
A percentage of all sales of my books, services, and products sold will continue going towards charities like these well into the future. And I plan to expand and sponsor more kids and families in 2017 now that Rivera Holdings is up and running.
Thank you so much for helping with this.
Other highlights from 2016 are:
Started Rivera Holdings LLC.
Began raising capital.
Grew personal connections by an exponential amount due to capital raising efforts.
Grew from 320 subscribers between Value Investing Journey and Press On Research to now 455 total subscribers between those two services and now also the Rivera Holdings Mailing List.
Read between 50 and 75 books this year.
Grew from 720 followers on Twitter as of the beginning of 2016 to 1,008 now.
Grew from 790 connections on LinkedInas of the beginning of 2016 to 896 now.
For the first time in three years expanded my circle of competence in terms of industries. I now understand and feel comfortable evaluating three new industries – marinas, hotels, and multifamily real estate.
Also expanded knowledge and experience into the private equity/investment arena as well.
As mentioned above the patience of the last two years paid off this year in a big way. Going forward I wouldn’t expect results to continue this trend.
Due to the still ever rising market and valuations it’s become harder to find great cheap companies to buy. I only recommended three companies in 2016 and all those were in the beginning of the year before the market took off again.
Barring a major sell off I expect to add few to no companies again in 2017.
As I’ve mentioned already mentioned to Press On Research subscribers I will only buy something that meets my ultra-strict criteria. Under no circumstances will I buy something because I haven’t bought in a while.
This helps keep us only in great companies and should help us continue producing exceptional returns over time.
No matter what the market continues to do though over time I’m confident we’ll continue to beat the market by a wide margin. And continue to compound our wealth over time.
I’m still raising capital for my new investment holding company so if you’d like more information about how you can invest with me and the market-crushing returns I’ve produced thus far email me at JasonRivera@valueinvestingjourney.com, call me at 605-390-3157, or sign up for the Rivera Holdings mailing list.
As always 2016 wasn’t all great news…
Up next will be a post detailing my major failures in 2016.
Here’s looking forward to an even bigger and better 2017.
Thanks so much for everyone who’s been a part of this journey so far. And please let me know how I can continue to improve things going forward in the comments below.
Rivera Holdings First Acquisition And How You Can Invest
You may have noticed I’ve gone silent in the last month plus. I haven’t posted much on Twitter of Facebook, and haven’t released a new post on the blog since September 29th. This silence is for a great reason though…
Behind the scenes I’ve worked on setting up the legal structure of Rivera Holdings, figured out who can and can’t invest which I’ll talk more about in the coming days, and found two companies to become its first acquisition.
I sent through snail mail and email an activist style letter to a public company stating I was looking to buy them for $20 million, or a 30% premium to its then market value. I’ve still not heard from them at this point. And they will remain a target down the road to acquire because for now I’ve switched gears and found another business to buy that’s even better.
The second company I found by accident as I was readying a Letter of Intent to send to the first company above.
Ever since I found them I’ve done a ton of due diligence on the company and its industry, talked in person with the current owner five times so far, The Seller and Rivera Holdings have agreed to a Letter of Intent on an $8 million purchase for the business, and Rivera Holdings is prequalified for the full $8 million amount in a loan to cover the purchase price.
Below I detail the business target more, detail the loan, and tell how you can invest in Rivera Holdings to become part of this deal.
Rivera Holdings is now officially and legally open for business.
Rivera Holdings has signed a letter of intent and agreed to an $8 million purchase price with a business owner looking to sell.
Rivera Holdings is prequalified for the full $8 million purchase price through debt financing – minus closing costs and what I have to bring to the table.
And Rivera Holdings is now seeking equity investors to finish closing the deal and begin building wealth for us all.
Below I’ll run these developments down one by one and explain how you can make money.
Rivera Holdings is now set up as a Delaware LLC and is ready for business.
Rivera Holdings has agreed to an $8 million acquisition and both us as buyers and the sellers have agreed to a Letter of Intent on terms. This letter also gives us exclusive rights to work on acquiring the business for 60 days from when it was signed by both parties.
Both I and the Sellers agree the deal can be extended as long as we as buyers are showing movement towards getting the deal done.
The one problem with the Letter of Intent is it keeps me from stating exactly which business it is and which industry the company is in. But below I still tell you some great things about the business Rivera Holdings is acquiring.
If you’re willing to sign the NDA further below the current owner of the business agrees I can then share what the business is, what industry it’s in, and our – Rivera Holdings – specific plans for the business upon closing of acquisition.
For now, let’s get to some things about this great business I can share.
It’s on track to produce a little less than $1 million in revenue this year. And since the current owner took over in 2014 it’s increased revenues from $500,000 per year to current level in less than three full years later.
On that almost $1 million in revenue it’s on track to produce an approximate $605,000 in net profit this year. In other words, its net profit margin is on track for an incredible 60% this year.
There is huge room to cut expenses immediately
After meeting with the owner several times so far and doing my own due diligence I’ve found $115,000 worth of expenses that will get cut immediately without hurting sales or profitability.
This would drop to profitability margins and metrics and increase the net profit margin by 16%. Or an increase from the $605,000 projected for full year 2016 to $720,000. This is counting no further cuts we’re likely to find after taking over operations.
It’s got valuable property and equipment on its balance sheet.
As I said above the purchase price for the entire business – land, equipment, operations, etc. – is $8 million. The total value of just the land and equipment by recent appraisal and equipment purchases is $8 to $9 million.
In essence, this means we’re buying the land and equipment and getting a valuable 60% + net profit and excess cash producing business for free.
We’re buying the business at a huge discount to its true value.
As stated above, just the land and equipment is valued between $8 and $9 million. I value current operations between $6 million and $7 million.
This means we’re buying a profitable business, operations, and valuable land and equipment that are worth $15 to $16 million for only $8 million.
There is massive room for sales/profit expansion at little cost to the business.
A part of current business operations are being expanded and will increase revenues by ~$100,000 to $200,000 per year once completed. Expansion is slated to finish within the next 60 days, or around when I can take over the company depending on closing.
Further expansions to this line of business can and will be done within five years. And prices can raise within the businesses main line of operations 26.7% in this time frame as well. This is talked about more below.
Another part of business operations are being expanded as we speak, will begin generating revenue within next two weeks, and will increase this business sections revenue by 33% to 38%. Or from $96,000 per year to $144,000 to $156,000 per year.
And on top of this, according to the most recent appraisal of the business and property done in August 2016
“The REMOVED has a FAR (Floor Area Ratio) of 25% indicating the area that could be improved/used for more sales opportunities is 38,600 sq feet.”
The above means ~25% of current business property – total property acreage is just under 3.5 acres – isn’t being properly used by the owner.
By utilizing this square footage better it means we could produce an extra $386,000 to $772,000 on $10 to $20 per square foot estimates on commercial lease rates.
Adding all the improvement numbers above together would add another $630,000 to $1,128,00 to revenues. Most of which would drop to profitability – operating and net margins and cash flow – due to low costs to add these new sales opportunities.
Adding and expanding the above business lines would increase sales from ~$930,000 projected for full year 2016 to between $1,560,000 and $2,058,000 million.
Assuming the same net profit margin of 60% and the cost cut mentioned above we would earn $1,051,000 to $1,349,800 in net profit in 2017 and 2018. Or increases in net profit of 42.4% and 55.1% respectively within two years of our take over.
At these levels I would value operations at $10.5 and $13.5 million by themselves. Plus the ~$8 million in property and equipment would take us to $18.5 and $21.5 million for the entire business in one to two years time.
All for an original purchase price of $8 million for the entire business.
Plus there’s hidden pricing power within the business.
Local and regional businesses selling similar products and services have 26.7% higher prices than current business. And we as new owners will be able to raise prices slowly over several years to reach competitive levels.
One price rise of 8.3% on the company’s major product in the first year will increase monthly revenue by ~$6,000 per month, or $~$72,000 per year. Again, almost all this will drop to profitability.
In the second year, we’d look to raise prices another 4% and in the third year by another 4%. Doing this would further increase revenue on the company’s major product another ~$ 6,000 per month or $72,000 over the two-year period in revenue and profitability.
Using the amounts talked about in the previous section this would increase revenue to $1,632,000 to $2,130,000 million and produce net profits of $1,091,200 to $1,393,000 million in the first year.
In the second year revenues would rise to $1,668,000 to $2,166,000 million and produce net profits of $1,115,800 to $1,414,600.
And in the third year revenues would rise to $1,704,000 to $2,202,000 million and produce net profits of $1,163,200 to $1,465,000 million.
This is with no further cost reductions, further price increases, further marketing – all of which are planned – or adding any other sales opportunities than the ones mentioned above.
At the end of 2019, the end of the above projections, I would value the company’s operations between $11.6 and $14.7 million.
After three years the property and equipment should be worth $10 to $15 million after better utilizing the property and equipment and through land appreciation value.
Adding this value to the value of operations would make the company worth between $21.6 and $29.7 million. In other words, our original $8 million investment will earn us conservative returns between 39.3% and 54.8% each year for three years. Or a cumulative – non-compounded – return after three years of between 117.9% and 164.4%.
At the end of three years we should own a business worth between $21.6 and $29.7 million all for an original $8 million purchase price, with few added costs over the three-year period, little in the way of major new expenses, and still opportunities to grow the company’s operations and profitability further.
And these are ultra conservative estimates because I hate projecting numbers forward like this but have to for business planning purposes.
Barring a major hurricane in the area that would hamper growth, there is no reason the business and land shouldn’t be worth at least $30 million within five years and at least $50 million within 10 years.
All the while producing a ton of excess cash we can use to further enhance this business and buy other businesses. And of course, compound the value of the business and Rivera Holdings private sharesfor the long-term.
But this isn’t all… The next six things protect our investment even further.
The revenue model for the business is long-term renewing contracts.
Customers are only allowed to sign yearlong recurring contracts for the company’s main operations. And commercial leasing opportunities are also on long-term – year plus – contracts.
There’s huge demand for this business in my area.
This business is a 15-minute drive from my house and there’s massive demand for this company’s products in this area. Demand is only growing too as more people move to the Tampa area and more people in the area buy houses.
The business has a government/regulatory moat protecting us from competition.
There is little competition for this business within a 30-minute drive of where the business is. And due to heavy government/regulatory issues within this companies industry, local and federal governments are likely to never let another type of this business be built or started in this area.
Even in the event of a major hurricane destroying the entire business current insurance coverage covers everything…
And when I say everything I mean everything; the full value of all property, improvements, equipment, and even revenue protection for a 12 to 24 month period as we rebuild.
The business requires regular expensive maintenance/upkeep/upgrades.
But all major equipment, maintenance, and necessary expenses and upgrades were completed within the last two years. And most of this equipment has 20 to 40 year expected life cycles.
While the business requires regular upkeep and maintenance, the current owner states there are no major planned expenses or upgrades for the next 10 years. While the two businesses that do compete with us in the area – the only competitors within a 30-minute drive in any direction – both have major multimillion projects planned within the next two years.
We have a huge margin of safety not only in valuation we are buying at but also in a worst case scenario analysis.
In a worst case scenario analysis assuming a drop in sales of 30% – which is what sales dropped in the last recession – combined with an increase in expenses of 25% – which there’s no precedent for – and the company still produces net income of $197,000 for the full year 2016.
While this huge cut in sales and increase in expenses combine to drop net profits by 65% the company is still profitable in this dire situation.
This worst case scenario analysis also assumes not adding or doing any of the positive things mentioned above: no new ancillary sales opportunities, no upgrading of companies main sales operations, no cost cuts, no price rises, etc.
With this gigantic margin of safety there is almost no way to lose money owning this business over the long-term.
The Short and Medium Term Plan
I’ve already found the $8 million to buy the business – more on this below – so why am I reaching out to you?
Because I want you involved in building the company by becoming an early equity holder with super voting rights at a heavily discounted rate while we grow and build Rivera Holdings into a billion dollar plus company.
I’m accomplishing this by raising equity in the parent company of target acquisition Rivera Holdings.
At this point, Rivera Holdings is prequalified for the full $8 million purchase price. The loan will be for $6.8 million and I have to bring $1.5 million to the table including fees, closing costs, and me as the owner having “20% skin in the game on the transaction.”
Having said this I’m selling a 50% equity stake in Rivera Holdings at a $24 million valuation to raise another $12 million as part of this transaction for several reasons.
To allow you and a few others who have helped me along the way to buy equity in Rivera Holdings at a heavily discounted rate to pay you back for your kindness, wisdom, and friendship. Early investors will also have super voting rights. This means nothing until the company goes public, but early investors in Rivera Holdings private shares will have super voting powers shares upon the company going public. Depending on how this is structured down the road – likely five to ten years down the road – Rivera Holdings private shares will have 2 to 10 times the voting power of Rivera Holdings public shares after IPO. Super-voting shares are always more valuable than regular shares so this is another way early investors in Rivera Holdings will have an advantage over later investors.
To help you earn safe returns on your investment capital to compound value well into the future. The end goal being building Rivera Holdings into a billion dollar plus company in time.
Unless a great business falls into our laps at a cheap price I plan to never do another equity sale until we IPO Rivera Holdings. This means you won’t be diluted except in an extremely rare circumstance that’s favorable for us all.
To ensure a huge margin of safety. As a long-term oriented value investor I hate debt in most cases and I plan to use some of the proceeds of the equity sale to pay off in full, or most of, the $6.8 million loan immediately.
Under current plans paying off debt in full or partly would leave $3.7 to $6 million left in cash on Rivera Holdings balance sheet compared to $0 to $2.3 million in debt. And Rivera Holdings would own a subsidiary worth $15 to $16 million immediately upon acquisition. Even though it would show up as $8 million in book value on the balance sheet.
Rivera Holdings balance sheet after acquisition would look something like this: Assets – cash, subsidiary value, etc – worth between $11.7 and $14 million at book value. Again, remember accounting rules don’t care that we value the business a lot higher than the IRS does. With $0 to $2.3 million in liabilities meaning shareholders equity would be between $9.4 and $14 million.
At this point, I would look to get a $5 to $10 million line of credit at the acquired business – subsidiary – in case of emergencies or necessary upgrades to further increase our margin of safety.
With the remaining $3.7 to $6 million at Rivera Holdings I plan to send $1 to $2 million to the bank underneath this acquisition to take advantage of business opportunities as they arise, enter into new sales opportunities mentioned above, for advertising and marketing, and for emergencies/repairs of property and equipment as they arise. With current level of expenditures this money should last more than five years. And this doesn’t include any profits or cash produced by the acquisition in those five years.
The remaining $2 to $4 million will be left at Rivera Holdings and I’m going to invest this money in safe, undervalued, profitable public company stocks as I’ve done over the past five years producing returns of 31.1% on average – not compounded – each year over the last five. Better returns than Buffett produced in the first five years of his career.
I’d continue working this process to compound our value for the long-term.
Over a one to five-year period the plan is to continue to grow the acquisition and build as much value as possible, pay off debt, invest the stock market funds at Rivera Holdings, continue to produce a ton of excess cash flow at the subsidiary acquisition, and compound value of all investments and assets owned.
I wouldn’t look to do another full acquisition within the first two years after the first acquisition closes unless something ultra cheap and attractive falls into our laps.
The plan within the next five to ten years is to either take Rivera Holdings public through an IPO or to buy enough of a public company to do a reverse merger onto the stock market.
There are two ways you can make money owning shares in Rivera Holdings over the long-term:
The first is holding Rivera Holdings private shares while they compound value over the next five to ten years until the company goes public and your shares become worth a lot more.
The second is holding your Rivera Holdings private shares for a few years and then reselling them to Rivera Holdings after they’ve appreciated in value and/or you’ve earned your initial investment back plus a return you’re comfortable with.
This is a fantastic opportunity for us all to buy a massively undervalued business for half of its true worth.
This is a fantastic opportunity to buy into a 60%+ net profit margin business that already produces a ton of excess cash we can use to buy other valuable assets that also has huge room for growth in sales and profitability.
This is a fantastic opportunity to buy into a business that has a gigantic government/regulatory moat built around it.
This is a fantastic opportunity to buy into a business with a huge margin of safety and huge protections around it that give us an even bigger margin of safety.
This is a fantastic opportunity to buy into a business that will grow in value between 39.3% and 54.8% each year for the next three years. Or produce a cumulative – non-compounded – return after three years of between 117.9% and 164.4% over three years.
This is a fantastic opportunity to get in at the early stages towards building a billion dollar plus company.
Below is a chart illustrating this. At a 20% rate of return – far below the 31.1% I’ve produced each year for the last five years not compounded – and with no new capital contributions, it will take us only 22 years to compound a capital base of $20 million into more than $1 billion.
And I want you to become part of this fantastic opportunity for long-term wealth creation and appreciation as we build something great.
If you’re interested in learning more about the great business we’re acquiring please sign and return to the below email address the short two page NDA to receive more information about the target acquisition.
By signing the below agreement The Seller of acquisition target has agreed to let me tell potential Rivera Holdings investors more information about the target acquisition. This includes what the business is, what industry it operates in, more specifics about its operations, and our – Rivera Holdings – plans after acquisition of target business closes.
For convenience the NDA can also be downloaded and printed off by clicking the following link.
THIS AGREEMENT is made and entered into as Nov 7, 2016 (“Effective Date”), remains effective until the close of acquisition and/or Rivera Holdings and The Sellers agree to not do sale, by and between Rivera Holdings, (“the Disclosing Party”) and _____________________________ Your Name In Space, (“the Recipient”) (collectively, “the Parties”).
Purpose for Disclosure (“Business Purpose”): The purpose of this agreement is to protect both The Seller, Rivera Holdings, and yourself (potential investor) from breaching any legal, competitive, or fiduciary agreements made between the parties prior to acquisition of target company.
The Parties hereby agree as follows:
For purposes of this Agreement, “Confidential Information” shall mean any and all non-public information, including, without limitation, technical, developmental, marketing, sales, operating, performance, cost, know-how, business plans, business methods, and process information, disclosed to the Recipient. For convenience, the Disclosing Party may, but is not required to, mark written Confidential Information with the legend “Confidential” or an equivalent designation.
All Confidential Information disclosed to the Recipient will be used solely for the Business Purpose and for no other purpose whatsoever. The Recipient agrees to keep the Disclosing Party’s Confidential Information confidential and to protect the confidentiality of such Confidential Information with the same degree of care with which it protects the confidentiality of its own confidential information, but in no event with less than a reasonable degree of care. Recipient may disclose Confidential Information only to its employees, agents, consultants and contractors on a need-to-know basis, and only if such employees, agents, consultants and contractors have executed appropriate written agreements with Recipient sufficient to enable Recipient to enforce all the provisions of this Agreement. Recipient shall not make any copies of Disclosing Party’s Confidential Information except as needed for the Business Purpose. At the request of Disclosing Party, Recipient shall return to Disclosing Party all Confidential Information of Disclosing Party (including any copies thereof) or certify the destruction thereof.
All right title and interest in and to the Confidential Information shall remain with Disclosing Party or its licensors. Nothing in this Agreement is intended to grant any rights to Recipient under any patents, copyrights, trademarks, or trade secrets of Disclosing Party. ALL CONFIDENTIAL INFORMATION IS PROVIDED “AS IS”. THE DISCLOSING PARTY MAKES NO WARRANTIES, EXPRESS, IMPLIED OR OTHERWISE, REGARDING NON-INFRINGEMENT OF THIRD PARTY RIGHTS OR ITS ACCURACY, COMPLETENESS OR PERFORMANCE.
The obligations and limitations set forth herein regarding Confidential Information shall not apply to information which is: (a) at any time in the public domain, other than by a breach on the part of the Recipient; or (b) at any time rightfully received from a third party which had the right to and transmits it to the Recipient without any obligation of confidentiality.
In the event that the Recipient shall breach this Agreement, or in the event that a breach appears to be imminent, the Disclosing Party shall be entitled to all legal and equitable remedies afforded it by law, and in addition may recover all reasonable costs and attorneys’ fees incurred in seeking such remedies. If the Confidential Information is sought by any third party, including by way of subpoena or other court process, the Recipient shall inform the Disclosing Party of the request in sufficient time to permit the Disclosing Party to object to and, if necessary, seek court intervention to prevent the disclosure.
The validity, construction and enforceability of this Agreement shall be governed in all respects by the law of the Delaware. This Agreement may not be amended except in writing signed by a duly authorized representative of the respective Parties. This Agreement shall control in the event of a conflict with any other agreement between the Parties with respect to the subject matter hereof.
IN WITNESS WHEREOF, the Parties have executed this Agreement as of the date first above written.
The goal of this blog is to help us all improve as investors and thinkers so we’re a little wiser every day. The hope being that our knowledge will compound over time so we’ll have huge advantages over other investors in the future.
The aim of today’s post is to continue this process by talking about a topic few investors know about. And even fewer understand.
Most people overlook float when evaluating companies because they either don’t know what it is. Don’t know the power it can have within a business. Or don’t know how to evaluate it.
This won’t be an issue here.
Press On Researchsubscribers already know this as I talk a lot about float in many of the issues I’ve written. But I want to begin talking about it more here because float is one of the most powerful and least understood concepts of business analysis.
Today’s post is a continuation of the earlier posts:
Today we’re going to talk about how float affects valuation. The issue brought up way back in part 1 of this series linked above. But before we get to this let’s go back to On Float Part 4 to continue this talk about valuation with those companies.
Insurance Company Float and Valuation
Below is the unedited float analysis I did on an insurance company I wrote about in the April 2016 Press On Research issue.
All numbers below are in USD $ millions unless noted.
Financial Assets: Fixed maturity securities of 94.3 + equity securities of 4.9 + trading securities of 0.1 + loans of 1.9 + cash and cash equivalents of 6.8 + accrued investment income of 0.8 + premiums and other receivables of 11.3 + deferred income tax assets of 3.8 = 123.9
Operating Assets: Deferred policy acquisition costs of 8.5 + PP&E net of 2 + other assets of 13.9 = 24.4
Total Assets = 148.3
Equity of 44.9
Short-term debt of 0.9 and long-term debt of 17.4 = 18.3
Float: Future policy benefits of 35.2 + policyholder funds of 1.6 + unearned premiums of 29.9 + taxes payable of 0.1 + other liabilities of 18.3 = 85.1
Total liabilities are 103.4
Float/operating assets 85.1/24.4 = 3.49.
Float supports operating assets 3.49 times.
And Float is “free money” because (NAME REMOVED) earns consistent underwriting profits as it’s earned underwriting profits in six of the last nine years.
Pretax profits have changed to underwriting profit below because normal pretax profits mean nothing for insurance companies.
(NAME REMOVED) had an underwriting profit – profit from operations before taxes here – for the full 2015 year of 6.4.
If I were to rely only on Morningstar to get estimates for margins (NAME REMOVED)looks below average at only 3.2%.
Yes I know this isn’t an apples to apples comparison. But normal profit metrics mean nothing for insurance companies.
When considering underwriting profit. Its ROA is a still below average 4.3%.
But (NAME REMOVED) float magnifies its ROA higher.
When considering float, its levered ROA goes up to 10.1%. Or 43% higher than what I calculate it’s normal ROA as.
Having a levered ROA of 10.1% isn’t great compared to normal companies I invest in… But for an insurance company this is a great margin.
One of my investment icons the great insurance investor Shelby Davis looked for insurance companies having an ROA above 10% so this meets his threshold.
Another important metric for insurance companies is ROE. Most great insurance companies fall in the 10 – 15% ROE range.
I calculate (NAME REMOVED) ROE – underwriting profits/shareholders equity – as 14.3% not levered by any float. Compared to Morningstar’s ROE estimate of 10.7. This puts (NAME REMOVED) into the great insurance company category. And there’s still more.
I continue on from here detailing this great small insurance company but now let’s get back to talking about how float affects valuation.
The unedited valuations below are from the April 2016 Press On Research issue except for the removal of the company name and ticker.
My notes talking about float now are bolded and capitalized.
How Does Float Affect Valuation?
As Warren Buffett once said, “Price is what you pay, value is what you get.”
The price of a company is what the market says it is. But how do I establish value?
When I recommend a stock, I try to find its “intrinsic value.” Intrinsic value measures a company’s true value considering tangible and intangible assets and the company’s operations.
Think of intrinsic value this way: What would this company be worth if we were to buy it outright? It’s like appraising the value of a house or car.
If I find the intrinsic value of a company to be higher than its market price, that’s a good sign of an undervalued stock.
I valued (NAME REMOVED) four ways.
The first is by assuming 1% interest rates for the long-term. And that (NAME REMOVED) float won’t grow over time.
The second is an asset reproduction valuation.
The third is adding the reproduction value of (NAME REMOVED) to 1/5th of its float and then dividing by its number of shares.
And the fourth is adding (NAME REMOVED) float and equity together then dividing this by its number of shares.
Valuations done using (NAME REMOVED) 2016 10K. All numbers are in millions of US$, except per share information, unless otherwise noted.
(NAME REMOVED) current market cap is (REMOVED; BELOW $100 MILLION) and its current share price is $15.20 per share.
Float X 1% Interest Rate + Equity 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.
(84.9 X 10%) + 44.9 = 53.4/2.5 = $21.36 per share.
This valuation is the minimum (NAME REMOVED) should sell for because interest rates won’t stay as low as they are forever. And it still shows (NAME REMOVED) is selling at a 28.8% discount.
(NAME REMOVED) has consistent underwriting profits and conservative managers so float should grow over time as well.
JUST THIS COMPANIES FLOAT EQUALS $33.96 A SHARE. OR 223% HIGHER THAN ITS THEN TOTAL SHARE PRICE. REMEMBER THOUGH THIS NEEDS TO BE DISCOUNTED IN MOST CASES BECAUSE OF THE LONG TERM NATURE OF MOST FLOAT AND BECAUSE THEY’RE LIABILITIES. WE’LL TALK ABOUT THIS FURTHER BELOW.
Next up is the asset reproduction valuation.
Asset Reproduction Valuation
Fixed Maturity Securities
Cash and Cash Equivalents
Accrued Investment Income
Premiums and Other Receivables
Deferred Policy Acquisition Costs
Deferred Income Tax Assets
Future Policy Benefits
I could have discounted this even further since its not necessary for insurance companies to carry debt. This would have made reproduction value even higher below.
The note above also explains why reproduction value is higher than net asset value. This is rare when I find this.
Divided By Shares
Current share price =
Discount to current share price =
This valuation does not take into account any of (NAME REMOVED) float. This is an asset – at least in the short-term – because of (NAME REMOVED) long sustained history of underwriting profits.
And as mentioned throughout this issue these act as a cost-free form of positive leverage which boosts (NAME REMOVED) value.
Even in this still ultra conservative valuation (NAME REMOVED) is selling at a 36% discount to its current share price.
Asset Reproduction + 1/5 of Float Valuation
Add float (1/5 of float after reading this discussion in part 1 of the On Floatseries here) asset reproduction value gets us to:
59.5 + (84.9 X 20% = 16.98) = 76.48/2.5 = $30.59 per share. Or more than a double from its current $15.00 share price.
This also considers no growth in float. Any rise in interest rates. Or a turn to a better insurance market. All which will help (NAME REMOVED) shares explode but this valuation still shows it’s selling at a 50.3% discount.
REMEMBER THE DISCOUNTING TALKED ABOUT ABOVE? HERE IT IS.
USING ONLY 1/5TH OF THIS COMPANIES FLOAT – OR $6.79 PER SHARE – FLOAT ADDS SUBSTANTIAL VALUE TO THE COMPANY.
IN THE CASE OF THIS VALUATION 22.2% TO THE COMPANIES VALUE. 1/5TH OF FLOAT MAKES UP 45% OF THE COMPANIES THEN CURRENT SHARE PRICE.
AS TALKED ABOUT THROUGHOUT THE APRIL 2016 PRESS ON RESEARCH ISSUE THIS COMPANY IS CONSISTENTLY PROFITABLE AS WELL. AND THIS VALUATION DOESN’T COUNT ITS VALUABLE OPERATIONS AT ALL.
I DON’T WHEN EVALUATING INSURANCE COMPANIES BUT IF I WERE TO ADD A MULTIPLE OF ITS TTM UNDERWRITING PROFIT TO THIS VALUATION SO THE VALUE OF ITS OPERATIONS ARE CONSIDERED IN THIS VALUATION IT WOULD BE WORTH…
6.4 x 8 + 76.48 = 127.68/2.5 = $51.07
THIS IS A CONSERVATIVE ESTIMATE OF THE COMPANIES REAL INTRINSIC VALUE. THE VALUE A CONTROL INVESTOR MAY EXPECT THE COMPANY TO BE WORTH WHEN ACQUIRING THE WHOLE COMPANY.
PROFITABLE OPERATIONS COMBINED WITH LOW COST OR COST FREE FLOAT HAS IMMENSE VALUE AS SEEN FROM THIS VALUATION.
AND REMEMBER THIS ALSO ASSUMES NO GROWTH IN FLOAT GOING FORWARD.
AGAIN, THIS IS THE POWER OF FLOAT ILLUSTRATED. THIS WILL ALL HELP COMPOUND THE VALUE WITHIN THE COMPANY OVER THE LONG-TERM BARRING SUDDEN POOR MANAGEMENT.
Float + Equity Valuation
Float + Equity = estimated value/number of shares.
59.5 + 44.9 = 129.8/2.5 = $51.92 per share.
This high end valuation doesn’t discount float at all. But also doesn’t expect any growth over time. And still shows (NAME REMOVED) is selling at a 71% discount to its current share price.
So not only is (NAME REMOVED) an ultra conservative and safe to own insurance company. But it’s also undervalued by as much as 71%. And we should expect to earn at least 28.8% owning them.
But there’s still more that makes (NAME REMOVED) a safe investment…
From here I continue detailing the company in the issue but let’s finish talking about the insurance company above.
All insurance companies have a lot of float that makes up the value of the company. This is because most of any insurance company’s balance sheet and operations are based on float.
Now let’s go to the non insurance company talked about in On Float Part 4 to see the contrast here. And also that float can still add substantial value to non insurance companies.
Non Insurance Company Float and Valuation
All numbers below are in millions of dollars unless noted.
Financial Assets: Cash and cash equivalents of 2.7 + deferred tax assets of 1.9 = 4.6
Operating Assets: Accounts receivable of 39.1 + Inventories of 12.6 + prepaid expenses of 1.1 + other CA of 0.3 + net PP&E of 73.7 + goodwill of 2.4 + other IA of 0.6 = 129.8
Total Assets = 134.4
Equity of 86.2
Debt of 14.4
Float = Accounts payable of 13.3 + Taxes Payable of 0.5 + accrued liabilities of 8.9 + other CL of 1.3 + deferred tax liabilities of 1.4 + pensions and other benefits of 8 = 33.1
Total liabilities 47.5
Float/operating assets = 33.1/129.8 = 25.5%. This means (NAME REMOVED) float supports 25.5% of its operating assets.
Now that we remember this let’s continue to show how float affects this companies valuation.
The information below is an unedited excerpt from the January 2016 Press On Research issue except for the removal of the company name and ticker.
As Warren Buffett once said, “Price is what you pay, value is what you get.”
The price of a company is what the market says it is. But how do I establish value?
When I recommend a stock, I try to find its “intrinsic value.” Intrinsic value measures a company’s true value considering tangible and intangible assets. And the company’s operations.
Think of intrinsic value this way: What would this company be worth if we were to buy it outright? It’s like appraising the value of a house or car.
If I find the intrinsic value of a company is higher than its market price, that’s a good sign of an undervalued stock.
I valued (NAME REMOVED) five ways.
The book value per share valuation talked about above. An asset reproduction valuation. A float plus equity valuation. A 8 and 11 times EBIT + cash – debt valuation. And a combined asset reproduction and 8 and 11 times EBIT + cash – debt valuation.
Book Value Per Share Valuation
The first way I valued (NAME REMOVED) from earlier shows (NAME REMOVED) should be worth $11.18 a share. An 11.5% premium to what its selling at now at $9.90 a share at the time of this writing.
This is the absolute minimum (NAME REMOVED) should be selling for because it doesn’t count any of its valuable and profitable operations at all. Or any growth.
Next up is the asset reproduction valuation below.
Asset Reproduction Valuation
Cash and Cash Equivalents
Deferred Income Taxes
Short Term Debt
Pensions And Other Benefits
Divided By Shares
While (NAME REMOVED) is selling above its reproduction valuation – and it should since it’s a great company – it’s selling below its net asset valuation. The middle bar above.
This is also an ultra conservative valuation that shows (NAME REMOVED) is undervalued by 14.2% now.
Float Plus Equity Valuation
The third way I valued (NAME REMOVED) was by adding float to equity and then dividing by its numbers of shares.
33.1 + 86.2 = 119.3/7.6 = $15.70 per share.
This again is an ultra conservative valuation because it doesn’t include cash. Or (NAME REMOVED) valuable and profitable operations.
But this still shows (NAME REMOVED) is undervalued by 37% now.
The fourth way I valued (NAME REMOVED) is by using its TTM EBIT. Multiplying this by eight and 11. Adding cash. Subtracting debt. Then dividing this by the number of diluted shares outstanding.
8X 19 + cash of 2.7 – 14.6 = 140.1/7.6 = $18.43. This means (NAME REMOVED) is undervalued by 46.3% now. Almost a double from current share price.
11X 19 + 2.7 – 14.6 = 197.1/7.6 = $25.93. Or undervalued by 61.8% now. Or more than a double from current prices.
Yet again this doesn’t show the whole story because this valuation doesn’t include its valuable assets.
EBIT Plus Reproduction Valuation
Adding in the net value – after debt – of its estimated reproduction assets gets us values of:
140.1 + 62.4 = 202.5/7.6 = $26.64 per share. Or 2.69 times higher than its current share price.
197.1 + 62.4 = 259.5/7.6 = $34.14 per share. Or 3.45 times higher than its current share price. Or a 3.45 bagger from current prices.
THIS COMPANIES THEN CURRENT SHARE PRICE WAS $10. ITS FLOAT EQUALS $4.36 PER SHARE. THIS MEANS JUST ITS FLOAT MADE UP 43.6% OF ITS THEN CURRENT SHARE PRICE.
IN OTHER WORDS FOR ONLY $5.64 YOU GET THIS COMPANIES CONSISTENTLY PROFITABLE GREAT MARGINS, ASSETS, OPERATIONS AND EVERYTHING ELSE OTHER THAN FLOAT.
WHEN EVALUATING NON INSURANCE COMPANIES I DON’T INCLUDE FLOAT IN THE VALUATIONS MOST OF THE TIME BECAUSE AS ALWAYS I LIKE TO BE AS CONSERVATIVE AS POSSIBLE.
BUT IF I WERE TO ADD 1/5TH OF THIS COMPANIES FLOAT ($6.62 MILLION OR $0.87 PER SHARE) TO THE EBIT PLUS REPRODUCTION VALUATION THIS WOULD GET US VALUES OF $27.51 AND $35.01 RESPECTIVELY ABOVE.
1/5TH OF FLOAT ADDS ~3% TO THIS COMPANIES VALUE. NOT MUCH IN THE SHORT TERM BUT REMEMBER IF FLOAT IS USED WELL OVER A LONG TIME IT COMPOUNDS AND COMPOUNDS THE VALUE WITHIN THE COMPANY.
MOST PEOPLE DON’T CONSIDER FLOAT AT ALL WHEN EVALUATING NON INSURANCE COMPANIES.
AT THE TIME THE COMPANY WAS A ~$75 MILLION COMPANY. IF THE COMPANY CONTINUES TO COMPOUND FLOAT AT 3% OVER 10 YEARS THE COMPANIES INTRINSIC VALUE WILL COMPOUND BY ~$26 MILLION TO $101 MILLION.
AND THIS ASSUMES NO GROWTH IN FLOAT. NO GROWTH FROM ITS VALUABLE OPERATIONS. AND NO ADDITIONS OF NEW CAPITAL FOR 10 YEARS. ALL SHOULD CONTINUE TO GROW AT THIS GREAT COMPANY.
THIS COMBINED AFFECT OF COMPOUNDING FLOAT, INTERNAL VALUE, AND OPERATIONAL PROFITABILITY COULD EXPLODE THIS COMPANIES SHARES OVER TIME.
BUT I DON’T COUNT ANY OF THIS POSSIBILITY IN ANY VALUATIONS DUE TO CONSERVATISM.
THIS IS WHY FLOAT IS IMPORTANT EVEN FOR NON INSURANCE COMPANIES. IT CAN ADD SUBSTANTIAL VALUE TO A COMPANY EVEN IF ITS ONLY ICING ON THE CAKE AS I OFTEN VIEW IT.
The above means that we’re buying (NAME REMOVED) at a massive discount to its true value.
Again, from here I continue detailing this great company. For now let’s sum this all up before moving on to the next part of this now extended series. Is Float Ever Bad? On Float Part 6.
If I’ve explained everything well enough in the series so far we should understand –
What float is.
Why its important.
How companies can use float as positive leverage.
How Buffett got so rich using float.
How to find float on a balance sheet.
How to evaluate float.
How float affects a company and its margins.
Maybe the most important thing why float affects a company and its margins.
And how float affects a company’s value.
In the next and sixth chapter – yes I’ve now added two more parts to this now extended series – I’ll answer the question is float ever bad.
Knowing what we know now we should have a gigantic advantage over other investors who either don’t know about float. Or aren’t willing to put in the time to learn what it is and what it can do for a company and investment.
If you have any questions, concerns, or comments on float up to this point please let me know in the comments section below.
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