Sunday, April 27, 2008

Francis Chou Speech notes

These are notes from two speeches given by Francis Chou of Chou associates at the Ben Graham Center for Value Investing of the Richard Ivey School of Business in 2006 and 2007.

I have merged the notes I took from both speeches together.

SEARCH STRATEGIES
When you are value investing you want to look at new lows.
Rejection rates are likely to be 90% for most companies you are looking at and that will be done in about a few mins.
Get to know an industry well.
It takes about six months to get to know an industry - high-tech is more time consuming as product cycle obsolescence means it requires a lot of and continuous work, retail is one of the easiest.
You don't have to be everywhere to have great returns, you just gotta know what you're good at. I.e. circle of competence.

Retailer Valuation
For retailing management has to be outstanding as it is a very tough business. (Keep your eye on the jockey)
Focus on:
i) Accts rec in days - 60 days is average for U.S.
ii) Inventory turnover vs. COGS
High inventory turnover is good.


VALUATION
Valuation doesn't have to be very precise - you are gonna take a range instead.
Just have a MOS on the value range
If you get close to 60% of your picks right you are doing extraordinarily well
You should also try and minimize the damage from the 40% that go wrong
How you minimize mistakes is what guarantees your performance
Be diversified when you begin investing.

Balance sheet analysis is very important - you want to look at inventory and receivables control, especially, for retailers.

Is this a good company or a bad company? Valuation approaches for the two categories will be different.
With crap companies if you pick them up at 5-6x earnings they have already priced in so much bad news that they can be quite profitable even when they do not grow.
For good companies the emphasis is on FCF generation, you don't wanna buy above 10x FCF.


GOOD COMPANIES
The holding period for will be longer for good companies than for cigar butts.
Good companies can grow intrinsic value at 10-15% pa so you can see your investments double or triple in about four or five years, and as long as they are compounding it is worth holding on to.
Achieving value for heavily discounted and downtrodden companies can take 2-4 years anyway.

When you 1st start off checklists are very useful.
Good company checklist:
Is the business simple and easy to understand?
Does it have consistent business history over the past 5-10 years?
Will it have favorable long term prospects?
Is management chasing revenue for the sake of revenue?
Is earnings all wrapped up in inventory, receivables etc?
Is it highly leveraged?
Good companies don't need leverage they can fund from equity - if it is highly leveraged then you may want to look at buying the debt.
Capital allocation by the management is very important if the management leaves that is a big concern.
Remember to focus on the jockey not just the horse.
What has the company been doing with shares?
Have they been buying back shares and hiking dividends? This is always a good sign.
Having cash on the bal sheet as a cushion for tough times.
10-20% of shareholder's equity as cash is nothing bad.


BAD COMPANIES
Net-net is nice and easy way to start investing -It's a brain-dead approach and it really works.
You must play these as baskets as they tend to be troubled companies
20 basket is ideal. 3/10 will probably explode.

Always start with the balance sheet in v.investing and particularly net-nets.
Make sure you are not buying a lot of inventory and receivables, cash is best
Look at tangible book value to share and EV to sales as well
Check on current and quick ratios and cash ratio
Be careful about accounts receivable and inventory measures too (in days) - these can be marked down, unlike cash
Income statement is impt but not that impt for net-nets
Look at capital structure is there debt coming due?
Perhaps they have really cheap debt worth buying or convertibles? Check out the YTM it may be fantastic.
Don't buy into companies about to liquidate as this entails loads of costs that eat up NWC.

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