David Hurwitz — Hope for Growth vs. Real Assets and earnings

SPECIAL VALUE INVESTING CONGRESS NOTES FOR THE IRREGULARS

David Hurwitz of SC Fundamental presented a thought exercise on valuing a steady and boring company versus a rapid grower that has been steadily losing more money on each new sale.

The key is to look at balance sheet — that’s the bedrock the company sits on, earnings can come and go even for very good companies, but if management allocates resources well they can thrive in a downturn.

Pay attention to whether the balance sheet/assets come from retaining earnings or from selling stock to the public. What is cash worth in the hands of a bad allocator?

Think about how consistent profitability is, and whether the competitors are also consistently profitable — is the competition rational, or is it like the airlines?

Be wary when growth is the one thing going for your company.

He went through a couple blind example of numbers from two companies.

First was a company with a consistent and profitable regional business and a ridiculously expensive company. The cheap one is Kisco, which is cheap and trades at a discount to cash, with a negative enterprise value.

PE of 5, price is 16% of tangible book, threading at 1X peak earnings and insiders bought 22% of the company in 2008 at prices 46% higher. Market cap is $116 million, he says it’s extraordinarily cheap. It’s a Korean company, so can’t easily buy it ourselves.

Second, the “growth” company, is Salesforce, which has never made and won’t make money, taxing at 50X tangible book, and they have a billion in cash that they’ll waste. They’re trading for 320 times PEAK earnings. If they grow the top line at 25% a year for the next seven years, which would make 17 years (extremely rare), and double their record profit margin and trade at a big premium PE of 20, you would get a 0% return over seven years. And it’s not likely to do any of those things.

Kisco is cheap for a reason — complicated holding company, small cap, illiquid, in Korea. Will get better, but the construction outlook is also poor and they lost money in 2011, so it’s not great or easy — but that’s why it’s so cheap.

And Salesforce is expensive because revenue is growing rapidly, and “maybe they will figure out a way to make a lot of money.”

It’s a good thought ...

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