Preliminary Analysis Case Study #1 Part 7 – Goodwill, Dilution, And The Cash Conversion Cycle

Preliminary Analysis Case Study #1 Part 7 – Goodwill, Dilution, And The Cash Conversion Cycle

Last week I announced we were going to begin doing a real-world case study on Constellation Brands – Stock Ticker STZ.

Well, after releasing this post, my team reminded me that there was actually a preliminary analysis my client did before this one. So before we get to the STZ case study, we’re doing to take a detour to talk about Canopy Growth Corp –  Stock Ticker WEED.

I didn’t want to skip this one because there’s a lot of context and talk in this discussion that we don’t necessarily go over in the later training sessions because we’ve already talked about them.

This post is a continuation of the prior posts in this ongoing case study.  All parts thus far are below:

Below is his unedited preliminary analysis for reference – without any of my comments – for you to get a  look at.

Canopy Growth Corp – WEED

***

WEED – Canopy Growth Corp (Canadian Company)

All numbers are in millions of CAD unless noted otherwise.

  • FY Ends March 31st, 2017
  • 3,404 market cap (medium)
  • N/A dividend yield.
  • P/B TTM = 4.92
  • TTM Operating Margin is -39.2 and has somewhat increased over last 2 years.
    • 5 year average OM is N/A
  • Share count has done increased from 77 to 119 from FY16 to FY17. Current TTM is 149m.  Statement of shareholder’s equity??
  • Book value per share has increased from 1.34 to 1.55 from FY16 to FY17. Current TTM is 3.73.
  • Morningstar ROIC TTM is -6.58 and a little higher than the last 2 FY’s
    • 5 year average Morningstar ROIC is N/A
  • TTM ROE is -6.45 and a little higher than the last 2 FY’s
    • 5 year average ROE is N/A
  • TTM FCF/sales is -151 and we can’t tell any pattern. See con note on FCF
    • 5 year average FCF/sales is N/A
  • CCC: No info on the payable period (assume the product is cheap to grow) but DIO exploded on FY2017 to 5,494 days (FY2016 and 2015 avg is about 650 days). Research online says cannabis takes up to ½ year to grow so I would need much more investigation on why inventory takes so long to turnover.
  • EV=3,312
  • EV/EBIT is -73.6
  • EV/FCF is -37.6
  • EBIT/EV (earnings yield) -1.3%
  • FCF/EV (earnings yield) -2.6%

Cons

  • Young company – only about 3 years old after name change (used to be Tweed)
  • Note only balance sheet on Morningstar has FY2015 so we need to look at 10K for data.  We cannot really tell any direction with a 2/3 year old history
  • SG&A & Other are over 163% of Revenue
  • SG&A roughly decreasing and “Other” is increasing
  • Op Income and Margin are (-) but are generally decreasing over time
  • Outstanding shares are significantly increasing over time
  • FCF is increasingly negative as both op cash flow and CapEx are also both increasingly negative
  • Not much experience with Canadian companies
  • Goodwill and intangible assets exploded on FY2017
  • Regulation laws in Canada and USA
  • They bought a lot of companies in FY2016

Pros

  • Cash exploded in FY2017
  • FY2017 Cash & Equiv – Total Liabilities = $39
  • Book value/share is generally increasing but only for last 3 years
  • Low Debt (also reflected by the ROE and ROIC being similar numbers)
  • Revenue is increasing over time
  • STZ bought about 10% interest in WEED.  Industry took notice and WEED most likely gained some legitimacy with large companies
  • COGS is only 23% of Revenue (doesn’t take much cost to grow product?)
  • High Working Capital Ratio = 9.8 but this high typically suggests either too much inventory or not investing excess cash…

***

In this video, we talked more about goodwill, dilution, and began to talk about the all-important cash conversion cycle.

For some reason, when I talk, the audio cuts out so I’ve added narration to the video above for context.

If you have any comments or questions, please post them in the comments section below and I’ll answer them.

I’d also love to see your preliminary analysis as well, so feel free to post these in the comments below.

If you’d like more information about the coaching program this client is in, go to this page.

For reference, he’s in the $ 10,000 year-long program, and this is only after 1 month of coaching, doing nine 1 hour training sessions via Skype.

P.S. This analysis is based on the preliminary analysis template I developed over a number of years, and after evaluating thousands of companies. If you’d like a copy of this to do your own preliminary analysis you can get yours for free here.

P.P.S. I put on a FREE webinar last Thursday, teaching The 3 Secrets That Have Helped Me Beat Buffett In The Stock Market, so you can possibly do the same. If you’d like to sign up for FREE to view the replay of the webinar, you can do so here.

Preliminary Analysis Case Study #1 Part 5 – Balance Sheet Strength, Goodwill, Intangible Assets

Preliminary Analysis Case Study #1 Part 5 – Balance Sheet Strength, Goodwill, Intangible Assets

Last week I announced we were going to begin doing a real-world case study on Constellation Brands – Stock Ticker STZ.

Well, after releasing this post, my team reminded me that there was actually a preliminary analysis my client did before this one. So before we get to the STZ case study, we’re doing to take a detour to talk about Canopy Growth Corp –  Stock Ticker WEED.

I didn’t want to skip this one because there’s a lot of context and talk in this discussion that we don’t necessarily go over in the later training sessions because we’ve already talked about them.

This post is a continuation of the last posts in this ongoing case study.  All parts are below:

Below is his unedited preliminary analysis for reference – without any of my comments – for you to get a  look at.

Canopy Growth Corp – WEED

***

WEED – Canopy Growth Corp (Canadian Company)

All numbers are in millions of CAD unless noted otherwise.

  • FY Ends March 31st, 2017
  • 3,404 market cap (medium)
  • N/A dividend yield.
  • P/B TTM = 4.92
  • TTM Operating Margin is -39.2 and has somewhat increased over last 2 years.
    • 5 year average OM is N/A
  • Share count has done increased from 77 to 119 from FY16 to FY17. Current TTM is 149m.  Statement of shareholder’s equity??
  • Book value per share has increased from 1.34 to 1.55 from FY16 to FY17. Current TTM is 3.73.
  • Morningstar ROIC TTM is -6.58 and a little higher than the last 2 FY’s
    • 5 year average Morningstar ROIC is N/A
  • TTM ROE is -6.45 and a little higher than the last 2 FY’s
    • 5 year average ROE is N/A
  • TTM FCF/sales is -151 and we can’t tell any pattern. See con note on FCF
    • 5 year average FCF/sales is N/A
  • CCC: No info on the payable period (assume the product is cheap to grow) but DIO exploded on FY2017 to 5,494 days (FY2016 and 2015 avg is about 650 days). Research online says cannabis takes up to ½ year to grow so I would need much more investigation on why inventory takes so long to turnover.
  • EV=3,312
  • EV/EBIT is -73.6
  • EV/FCF is -37.6
  • EBIT/EV (earnings yield) -1.3%
  • FCF/EV (earnings yield) -2.6%

Cons

  • Young company – only about 3 years old after name change (used to be Tweed)
  • Note only balance sheet on Morningstar has FY2015 so we need to look at 10K for data.  We cannot really tell any direction with a 2/3 year old history
  • SG&A & Other are over 163% of Revenue
  • SG&A roughly decreasing and “Other” is increasing
  • Op Income and Margin are (-) but are generally decreasing over time
  • Outstanding shares are significantly increasing over time
  • FCF is increasingly negative as both op cash flow and CapEx are also both increasingly negative
  • Not much experience with Canadian companies
  • Goodwill and intangible assets exploded on FY2017
  • Regulation laws in Canada and USA
  • They bought a lot of companies in FY2016

Pros

  • Cash exploded in FY2017
  • FY2017 Cash & Equiv – Total Liabilities = $39m
  • Book value/share is generally increasing but only for last 3 years
  • Low Debt (also reflected by the ROE and ROIC being similar numbers)
  • Revenue is increasing over time
  • STZ bought about 10% interest in WEED.  Industry took notice and WEED most likely gained some legitimacy with large companies
  • COGS is only 23% of Revenue (doesn’t take much cost to grow product?)
  • High Working Capital Ratio = 9.8 but this high typically suggests either too much inventory or not investing excess cash…

***

So, after going through the beginnings of this preliminary analysis process in part 1 and 2 last week, and part 3 earlier this week, here is part 4.

In this video, we talk about the balance sheet, goodwill, intangible assets and more.

For some reason, when I talk the audio cuts out so I’ve added narration to the video above for context.

If you have any comments or questions, please post them in the comments section below and I’ll answer them.

I’d also love to see your preliminary analysis as well, so feel free to post these in the comments below.

If you’d like more information about the coaching program this client is in, go to this page.

For reference, he’s in the $ 10,000, year-long program, and this is only after 1 month of coaching, doing nine 1 hour training sessions via Skype.

P.S.  This analysis is based on the preliminary analysis template I developed over a number of years, and after evaluating thousands of companies.  If you’d like a copy of this to do your own preliminary analysis, you can get yours for free here.

P.P.S.  I put on a FREE webinar on Thursday, teaching The 3 Secrets That Have Helped Me Beat Buffett In The Stock Market, so you can possibly do the same.  If you’d like to sign up for FREE to view the replay of the webinar, you can do so here.

Throwback Thursday – Why P/E Is Useless And How To Calculate EV

Throwback Thursday – Why P/E Is Useless And How To Calculate EV

***

This is the second post in our new Throwback Thursday’s Series where we share posts from the blogs past with you to bring you as much value as possible.

I’m reposting this today about P/E because with the stock market STILL reaching all-time highs on an almost daily basis. It helps to know which metrics are important and which are completely useless.

Other than some minor edits and updates, this is the same exact post as originally published in 2015.

Jason

***

Why P/E Is Useless – And How To Calculate EV

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 of 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 number of shares the company has. 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 Investopedia.com.

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. 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. it’s one of the worst metrics to rely on as a long-term value investor.

Why?

Because of debt, cash, and manipulation…

Why P/E 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.

P.S. In making this post I realized I never took the next step and explained the differences between EV and Total Enterprise Value or TEV. We’ll get to this soon.

P.P.S  I’m putting on a live webinar tonight at 6 PM EST where I’ll be teaching you the 3 Secrets That Helped Me Beat Buffett In The Market so you possibly can too.  If you want to sign up to this webinar for FREE, you can do so here.

Preliminary Analysis Case Study #1 Part 2 – Release of Client’s 1st Preliminary Analysis

Preliminary Analysis Case Study #1 Part 2 – Release of Client’s 1st Preliminary Analysis

On Monday I announced we were going to begin doing a real-world case study on Constellation Brands – Stock Ticker STZ in this post here.

Well after releasing this post, my team reminded me that there was actually a preliminary analysis my client did before this one so before we get to the STZ case study we’re doing to take a detour to talk about Canopy Growth Corp –  Stock Ticker WEED.

I didn’t want to skip this one because there’s a lot of context and talk in this discussion that we don’t necessarily go over in the later training sessions because we’ve already talked about them.

Below is his unedited preliminary analysis – without any of my comments – for you to get a  look at.

Canopy Growth Corp – WEED

***

WEED – Canopy Growth Corp (Canadian Company)

All numbers are in millions of CAD unless noted otherwise.

  • FY Ends March 31st, 2017
  • 3,404 market cap (medium)
  • N/A dividend yield.
  • P/B TTM = 4.92
  • TTM Operating Margin is -39.2 and has somewhat increased over last 2 years.
    • 5 year average OM is N/A
  • Share count has done increased from 77 to 119 from FY16 to FY17. Current TTM is 149m.  Statement of shareholder’s equity??
  • Book value per share has increased from 1.34 to 1.55 from FY16 to FY17. Current TTM is 3.73.
  • Morningstar ROIC TTM is -6.58 and a little higher than the last 2 FY’s
    • 5 year average Morningstar ROIC is N/A
  • TTM ROE is -6.45 and a little higher than the last 2 FY’s
    • 5 year average ROE is N/A
  • TTM FCF/sales is -151 and we can’t tell any pattern. See con note on FCF
    • 5 year average FCF/sales is N/A
  • CCC: No info on the payable period (assume the product is cheap to grow) but DIO exploded on FY2017 to 5,494 days (FY2016 and 2015 avg is about 650 days). Research online says cannabis takes up to ½ year to grow so I would need much more investigation on why inventory takes so long to turnover.
  • EV=3,312
  • EV/EBIT is -73.6
  • EV/FCF is -37.6
  • EBIT/EV (earnings yield) -1.3%
  • FCF/EV (earnings yield) -2.6%

Cons

  • Young company – only about 3 years old after name change (used to be Tweed)
  • Note only balance sheet on Morningstar has FY2015 so we need to look at 10K for data.  We cannot really tell any direction with a 2/3 year old history
  • SG&A & Other are over 163% of Revenue
  • SG&A roughly decreasing and “Other” is increasing
  • Op Income and Margin are (-) but are generally decreasing over time
  • Outstanding shares are significantly increasing over time
  • FCF is increasingly negative as both op cash flow and CapEx are also both increasingly negative
  • Not much experience with Canadian companies
  • Goodwill and intangible assets exploded on FY2017
  • Regulation laws in Canada and USA
  • They bought a lot of companies in FY2016

Pros

  • Cash exploded in FY2017
  • FY2017 Cash & Equiv – Total Liabilities = $39m
  • Book value/share is generally increasing but only for last 3 years
  • Low Debt (also reflected by the ROE and ROIC being similar numbers)
  • Revenue is increasing over time
  • STZ bought about 10% interest in WEED.  Industry took notice and WEED most likely gained some legitimacy with large companies
  • COGS is only 23% of Revenue (doesn’t take much cost to grow product?)
  • High Working Capital Ratio = 9.8 but this high typically suggests either too much inventory or not investing excess cash…

***

And since I screwed up, I’m going to begin releasing my thoughts on this company today.

The video below is part one of our exclusive discussion from one of our coaching sessions about this company.

For some reason, when I talk, the audio cuts out so below each shorter video, I’ve created a video where I’m rehashing what I told the client during our training session.

And my context with the missing sound in the above video here…

Again, as I say in the video, I’m not sure why my sound cut out and since all of my past videos are like this – we’ve just fixed the sound issue today, hopefully for good – this is how I’ve got to improvise things.

What do you think of the preliminary analysis above?  Does it make for a possible good or bad investment?  Did he miss anything in his analysis?  What are the important points in the analysis above and why? What the hell is CCC?

I’ll begin answering the above questions and more on Friday.

If you have any comments or questions, please post them in the comments section below and I’ll answer them.

I’d also love to see your preliminary analysis as well, so feel free to post these in the comments below.

And if you’d like more information about the coaching program this client is in, go to this page.

For reference, he’s in the $ 10,000, year-long program, and this is only after 1 month of coaching via nine 1-hour training sessions via Skype.

P.S.  This analysis is based on the preliminary analysis template I developed over a number of years, and after evaluating thousands of companies.  If you’d like a copy of this to do your own preliminary analysis, you can get yours for free here.

P.P.S.  I’m putting on a FREE live webinar tomorrow at 12 PM EST teaching The 3 Secrets That Have Helped Me Beat Buffett In The Stock Market, so you can possibly do the same.  If you’d like to sign up for free to view the live webinar, you can do so here.

Preliminary Analysis Case Study #1 Part 1- Constellation Brands

Preliminary Analysis Case Study #1 Part 1 Constellation Brands

Years ago, I would spend hours researching one company on a preliminary basis so I could figure out if I wanted to do further research on it and possibly invest in it.

And I would do this full hours long process on a company no matter what I found out during the preliminary analysis.

Not only was this a massive waste of time spent researching companies I knew I wasn’t going to invest in, but this process only allowed me to go through one company on a preliminary basis in an hour or two.

With more than 20,000 companies available to research worldwide, I knew I needed to streamline this process a lot.

I needed to get rid of crap companies faster and evaluate more companies in a shorter time.

By doing these two things it would not only allow me to find potentially great investments faster but I’d also learn more industries and business models faster as well.

So out of necessity came my preliminary analysis checklist you can get by subscribing to Value Investing Journey for FREE here.

After developing this process I can now go through 5 – 10 companies in an hour and learn an immense amount about one company in just a few minutes.

Why am I telling you about all this?

Because one of my $10,000 coaching clients, in less than a month, went from minimal value investment knowledge to doing these full preliminary analysis on companies by himself.

He now knows what everything on the checklist means and he now wants to help others as he’s learning.  Here’s the kicker:

He graciously offered to post his first ever full preliminary analysis here on the Value Investing Journey blog so that not only can he get feedback from you to help him improve.  But also so that we could all help each other grow our value investing knowledge by doing real-world value investment case studies together.

The company he chose to evaluate is…

Constellation Brands – Stock Ticker STZ

Here’s the brief profile of Constellation Brands from its own company profile…

Simply put, we produce and market high-end beer and premium wine and spirits brands that consumers love.

Whether at home relaxing, in a restaurant marking a special occasion – or at a concert, a ball game or a day at the beach – our brands are front and center.

We understand our consumers and strive, not only to meet their current drinking preferences, but to anticipate and respond to what they’ll be reaching for next.

If you’d like to participate in this case study yourself all you’ll need is the exclusive Value Investing Journey Preliminary Analysis Checklist you can get for FREE here and Internet access to go to Morningstar.com.  That’s it.

You’ll learn best if you do your preliminary analysis before Wednesday when I release the preliminary analysis he did on this company.

And on Friday, I’m going to release part one of our exclusive training session explaining why everything is on the preliminary analysis worksheet and more importantly what everything means in terms of analyzing the company.

If you have any comments or questions please post them in the comments section below and I’ll answer them.

I’d also love to see your preliminary analysis as well so feel free to post these in the comments below.