More like that one book was the nail in the coffin. I'll share the list that has changed my perspective:
Financial Fine Print, Profits you can Trust, Financial Shenanigans, The Financial Numbers Game, Quality of Earnings, Valuation, The Quest for Value... and some others. Worth noting that most of these books were written more than a decade and a half ago. The situation's only gotten worse but nobody wants to write books about it. (FWIW, I'm not a fan of all of these books. They just changed the way I viewed certain concepts.)
Pro forma earnings are bad enough and are the most obvious deceptive practice used by corporations. But the fact is that earnings have been slowly getting more irrelevant - just look at the effects of earnings "beats" or "misses" on share prices. It's usually minimal and it's the guidance that sends the share price rocketing.
And now cash flows are also getting manipulated. Hence, you have to adjust them. To me, the adjusted, normalised free cash flow is the equivalent of earnings a century ago. And in fifty years it will be different as investors become smarter. I have no doubt this will be the case.
There's this notion that's come about that free cash flow (unadjusted) can be used to measure whether a company can pay back its debt. I blame Burry for this through his oversimplified tweets. It's led to such poor, sloppy analysis. If a company has a low debt/fcf ratio, it doesn't mean anything unless the quality of that free cash flow is high and sustainable.
Firstly, take out SBC. Secondly, is the company growing, downsizing or maintaining its market position? It matters when it comes to cash flows (i.e downsizing companies will generate higher levels of cash flow) and the working capital cycle. Thirdly, what is average capex? Not maintenance capex. Total capex. If a company is investing for growth, you have to assume that continues. But what about dividends and/or share buybacks? That also has to continue especially if shareholders are getting diluted through employee incentive schemes. Also, you have to take out one-time charges (from litigation that favoured the company etc) that boost cash flows.
Then you can work out the residual. But then you have to account for acquisitions. How can you be sure that management will use that cash flow to pay down debt? If they want to be "opportunistic" in times of stress... OXY is an example (although, the oil industry isn't stressed). I suppose the streaming companies is a better example.
The truth is most companies cannot completely pay down their debt through cash flows, anyway. I maintain that today's cash flow is yesterday's earnings. Most leveraged companies of today will have no choice but to refinance at higher rates or dilute shareholders through equity offerings.
I think the majority of the people on this thread use free cash flow for some analysis. Free cash flow is non-GAAP. Go back to the days of Milken - he evaluated companies to lend to by using cash flows not earnings and was one of the first to make that change. And it's where EBDIT and then EBITDA later on stemmed from. Buffett later criticised such methods but, in certain cases, it's highly useful.
I truly believe that you can make 50%/annum if you're determined enough. But you can't use old tricks. The days of NCAV are over but there's still deep value on offer for those brave enough to find it.
Of course, this is slightly watered down. |
