Rubalcava Capital Management presentation on Quantitative Float Analysis from the ValueX Vail, June 2015.
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Inspiration - Sanjay Bakshi
In 2012, Professor Sanjay Bakshi gave a lecture called “Floats and Moats.” My presentation is inspired by and builds on themes that Bakshi started.
Floats and Moats - Sanjay Bakshi
In 2012, Professor Sanjay Bakshi gave a lecture called “Floats and Moats.”
My presentation is inspired by and builds on themes that Bakshi started.
- Bakshi argues that Buffett’s career can be marked by the Am Ex investment in 1965. Everything after AmEx was about the search for float.
- AmEx was funded by float. Interest-free, revolving, small denomination, no concentration float. In this case - traveler’s checks!
- Buffett realizes the power of float, then seeks it out obsessively. National Indemnity purchase, Blue Chip Stamps purchase follow shortly.
- We all know float is important, but how to measure it?
- Where can we find float outside of insurance companies?
- Bakshi presentation: http://bit.Iy/1whlw5E
- Bakshi online: fundooprofessorwordpress.com & @Sanjay_Bakshi
Why measure float?
As Bakshi says, the presence of float indicates a moat. I argue the amount of float indicates the size and strength of the moat.
- Float is an artifact of power: To be given money at no price from
customers, suppliers, employees, or other groups, a company must have
some form of power over those groups.
- Float is free: As we know from insurance, float is free if the combined ratio is below 100. There is no combined ratio for other sources of float like accounts payable or deferred revenue, so that type of float always has a combined ratio under 100.
- Free float is a source of competitive advantage: Just as low cost manufacturing can be a source of competitive advantage, low cost financing is a source of competitive advantage. Float > either debt or equity.
- Float ratios are like margins: They tell us the size of the competitive advantage, just like gross margins tell us which companies have low cost operations.
Sources and characteristics of float - not just insurance
Float exists in every business, but value investors typically look for it only in P&C insurance companies. Here’s a few other places to search...
- Customer deposits
- Deferred revenue
- Warranty reserves
- Unredeemed loyalty points
- Accrued compensation
- Accounts payable
- Summarized: all NIBCLs + all LT liabilities with no interest
- Revolving - replenished by ordinary course of business.
- Distributed: One line item on the balance sheet, but thousands of accounts & ledger items consolidated in that line.
- Independent: one customer’s or supplier’s behavior doesn’t influence another’s.
- Accrual vs cash accounting: differences drive float creation
Two ratios - Floating Assets (FA) and Floating Liabilities (FL)
Inspired by Bakshi, I developed two ratios. One measures float against the left side of the balance sheet. The other, as a percent of the right side.
- Floating Assets: Float / (AR + INV + PPE). This measures float against the tangible assets of a company that are required to run its business.
- Cash and goodwill/intangibles are excluded because they reflect management preferences and past capital allocation decisions. We’ll pick up the reasons for this later.
- Floating Liabilities: Float/Total Liabilities.This measures float against the total liabilities carried by the firm.
- FA:FL Ratio: A third ratio to measures the two against each other. Broad archetypes of capital intensity and allocation emerge from this ratio.
- Used together with more standard leverage ratios like Debt/EBITDA, these ratios can aid in fundamental analysis.
- Changes in float drive changes in valuation (anecdotal - but let’s find a quant to backtest this).
American Express: 1964
Using the FA and FL ratios, let’s analyze the Amex balance sheet that Buffett was scrutinizing in 1965.
Contemporary Examples: HD Supply (HDS)
HD Supply is an industrial distribution company. I own it. Let’s look at the FA & FL ratios for a company that is not asset light.
See full presentation below.