Iolite Partners‘ ValueX presentation by Robert Leitz from 2012 titled, “Financial Ratios: Beware The Oversimplification Trap,” discusses how to analyze oversimplification traps using three financial ratios EV/EBITDA & Capital Intensity, Net Cash & Control Premium, Net Cash & Working Capital and Growth of Book Value & Ponzi Schemes.
Financial Ratios: Beware The Oversimplification Trap
This presentation will analyze oversimplification traps when using the following common three financial ratios
In August, Mohnish Pabrai took part in Brown University's Value Investing Speaker Series, answering a series of questions from students. Q3 2021 hedge fund letters, conferences and more One of the topics he covered was the issue of finding cheap equities, a process the value investor has plenty of experience with. Cheap Stocks In the Read More
- EV/EBITDA & Capital Intensity
- Net Cash & Control Premium
- Net Cash & Working Capital
- Growth of Book Value & Ponzi Schemes
EV/EBITDA & Capital Intensity
Would you rather invest in business A or B
Would you change your mind if you learned that
- EBITDA blends out the capital intensity of a business and is a rather poor indicator of FCF. So why is the whole world (almost only) talking about EV/EBITDA?
- Is it possible to draw any relevant conclusion on valuation levels of a stock market by using EV/EBITDA without having analyzed the industry weighting of the index over time?
Net Cash & Control Premium
Would you go long shares of the following business:
- Net cash: 4,000,000
- FCF (stable): 100,000
- Market cap: 4,000,000
Would you change your mind if net cash is held in
- USD (cash)
- US treasuries
- Japanese Yen (cash)
- Japanese treasuries
- Chinese Renminbi (cash)
Would you rather own a business with
A. good capital allocation at 5x FCF and 0% cash/market cap
B. bad capital allocation at 8x FCF and 50% cash/market cap
Would you put a higher value on the control premium in A or B?
Net Cash & Hidden Leverage
In March 2010, Dart Group, a leisure services aviation and distribution group, was trading at 73% net cash
- Net Cash GBP 51.6 m
- Market Cap GBP 70.0 m
- FCF GBP 41.1 m
Should you discount net cash because working capital is negative?
- Cash GBP 52.2 m
- Inventory GBP 0.3 m
- Receivables GBP 41.9 m
- Payables GBP -23.9 m
- Unearned Revenue GBP -121.4 m (advance payments)
- = Working Capital of GBP -50.9 m
And obviously, as with all airlines, there is high operating leverage (leased airplanes, high fix-cost base but volatile demand)
See full PDF below.