Fructivore Investments

I was discussing value investing on a forum I frequent, and an objection someone raised to value investing is that everything that is knowable about a company is rapidly processed and analyzed by people who are smarter than you and have larger resources and bigger staffs. In other words, that markets are efficient, although he didn’t just come out and say that.

I take the position that you don’t need insider information or to find news faster than the other guy in order to gather excess returns. In fact, that sort of thinking is a detriment, since value investing is not a matter of knowing what other people don’t know, so much as it is caring about what other people don’t care about. For example, hardly anyone should care about whether a stock’s earnings for one quarter are a few pennies higher or lower than some analyst believes, and yet stocks gyrate hugely on earnings day because of it. In another example, Windstream commonly appears on Motley Fool and other places as a company that pays too many dividends and is destined for a cut, but most analysts neglect to consider that on top of $330 million in earnings are $240 million in excess depreciation charges, which more than covers $437 million in dividends.

Sometimes it is the complexity of a situation that scares people off; Seth Klarman in Margin of Safety describes a situation where a company was being bought out for either $17 per share in cash or $3 in 12.5% one year notes, $10 in 12.5% fifteen-year notes, 0.2 shares of the acquirer’s preferred stock, and 0.6 warrants for the acquirer’s common stock at one penny a share, but only 57.5% of the shareholders could take the cash option; otherwise the cash would have to be prorated. Unsurprisingly, Klarman would have taken the money, but the point is that after the Crash of 87 the company was selling for $10 a share, so any investor who was not scared off by complexity would do very well by it (in fact, 57.5% of $17 is $9.775, so as long as the rest of the package was worth more than a quarter the alert investor would have done just fine. In other cases, it can be distress; Bon-Ton’s bonds at one point sold for 11 cents on the dollar over bankruptcy fears, despite the fact that based on earnings power the company was worth about $1 billion dollars capitalized at 10%, and there was only $600 million in senior debt ahead of them, so a $400 million bond issue that was looking at $400 million in remaining enterprise value was available for $44 million. But one whiff of the word “bankruptcy” (in the first quarter of 2009 when Bon-Ton would have had plenty of good company in the bankruptcy court) was enough to send investors reeling. And what has happened now? The firm has announced that it foresees a return to profitability next year and the bonds trade virtually at par.

For another example, Conn’s Inc. (CONN) is a retailer in the Texas area that does in-house financing for qualifying customers. Much attention has been paid to the fact that the firm’s receivables have been building up on its balance sheet from almost nothing two years ago to around $200 million today. Normally a buildup of unpaid receivables is associated with weakness, and that is exactly what the tenor of many articles about Conn’s has been. However, they are overlooking the fact that before two years ago Conn’s securitized all its receivables, but the decline in interest in that market coupled with dropping interest rates has allowed Conn’s to secure a line of credit that carries a lower cost of funds than the securitization for at least a portion of its receivables. The only catch is that Conn’s, rather than the financing subsidiary, is the name on the line of credit so their receivables are now on balance sheet rather than the off-balance sheet financing entity. If you look at the sum of the receivables held by Conn’s and the financing subsidiary combined, the total has hardly increased at all over the last couple of years, and that is what people are missing and what, presumably has caused the share price to decline below its net-net working capital. They have also recently concluded an amendment to their line of credit to obtain more breathing space in the face of rising chargeoffs, which is another plus (the amendment, not the chargeoffs themselves).

So, if you have a stock you’re following, and you keep notice that articles about that stock seem to focus on one thing, investigate all the things that are not reported. You might be surprised at what you find.

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Investing by grocca