“…we have never not bought or bought a business because of any macro feeling of any kind because it doesn’t make any difference.“– Warren Buffett
I’ve been in “Q4 earnings review mode” for the last few weeks and I’m constantly reminded that what really drives buy and sell decisions for me has nothing to do with macro. If I think a company is trading at a discount to intrinsic value, I should never delay buying because I think there soon could be “another leg down” for the market. If that scenario does play out, it’s a chance to buy more. If it doesn’t and the company re-rates sooner than I expected, I’m now left buying at a higher valuation. I have zero confidence in myself to forecast either scenario or anything in between, and therefore for all stocks I think are still below intrinsic value, I’ll dollar cost average in forever*.
The million dollar question on the above of course is “what is intrinsic value”? Buffett also has a good answer for this:
Intrinsic value can be defined simply: It is the discounted value of the cash that can be taken out of a business during its remaining life.– Also Warren Buffett
This is a deceivingly simple definition, as determining the future cash flows of a business is difficult as well as how the business will reinvest the cash flows.
Sometimes management will help you do it though, and this is what this post is about.
To be clear, my experience has been that management never explicitly says “The value of our future cash flows is $X”, but they do often announce their intention to buy back stock and in rationalizing buying back stock will offer hints as to how they value the business.
Here is a shining example from Buffett’s 2020 letter (released yesterday):
My take here is Buffett is signaling through a clear example that share repurchases create shareholder value – ownership of AAPL increased 2% despite Berkshire selling some of the position. Buffett got shareholders more of an amazing company because Tim Cook & co. bought back shares – the emphasis on costless is really deserved.
On top of that, Berkshire bought back shares, compounding the impact of the Apple buyback. Getting 10% more of AAPL for free… that’s a company that walks the talk with shareholder value. Once again – Buffett gave everyone “buy 10 shares of AAPL, get one free” as a bonus of holding Berkshire. Meanwhile, AAPL’s market cap surged and Berkshire also appreciated, meaning ownership increased in a more valuable asset. This is why managers buy back stock – they are anticipating value can be bought cheaply, and if they’re right, you, the shareholder, get costless bumps in ownership.
Finally, Buffett is suggesting Apple and Berkshire will purchase more stock in the future. Track record of excellence – check. Telling shareholders company will keep doing the same thing over and over again that deliver value – check (if results are good, in my opinion boring is good).
Calls / letters may also include commentary on the stock price which I also find valuable. Turning to another company I haven’t written about much on this blog, 180 Degree Capital (TURN) to me is another shareholder-focused management group that says over and over again how they think the stock is below intrinsic value. As background, TURN is an “internally managed investment company” that invests in “undervalued, small publicly traded companies where we believe we can positively impact the business and valuation through constructive activism.” The current management group bought the assets of the old publicly traded TURN with the goal of decreasing exposure in these private assets and building most of the value in publicly traded stocks and cash.
CEO Kevin Rendino’s 2020 letter is a great read, and notice his focus here on the company’s Net Asset Value (NAV) and how he thinks the private / public % of NAV will change:
Rendino here is saying the intrinsic value of the stock is higher than what it trades at, and the public markets will be forced to close the gap as more of the company’s assets become public securities (“the discount our stock trades to NAV should narrow”). He also calls out that the private portfolio contains real assets and the 70% discount to book on the private side is absurd.
He ends the letter reiterating their success changing the composition of NAV and what the stock might look like in the future:
I don’t know of many CEOs openly talking about how realistic a quadrupling of the stock is by simply following the game plan. If that doesn’t say something about management’s opinion on intrinsic value, not sure what does.
I also recommend checking out the company’s history of insider purchases, which I don’t think has a single sell and is honestly unlike anything I’ve ever seen for insider activity.
If you want to see how impressive this is, compare it against your favorite S&P 500 name that trades at a big multiple to sales. There are not C-level suite folks in large cap stocks today activity buying back huge chunks of stock with their personal net worth.
Final example here – Ladder Capital (LADR), a commercial REIT that owns real estate, securities, loans and cash . The stock still trades at a discount to book ($11.44 as of Friday’s close versus $12.21 in GAAP book value and $13.94 excluding depreciation, note many real estate assets sell in excess of original purchase price) and just recently achieved a higher market cap than cash (you’ll see later the CEO express amazement that cash is growing faster than the stock price).
For the last several quarters, Brian Harris (CEO) has consistently said the company’s discount to book isn’t warranted and that their huge cash position will allow them to deploy cash at strong returns (10%+ ROE). If you think LADR can deploy ~$1.4 billion+ of cash at a 10% annual return (which management says it can), the company’s $1.4 billion market cap is cheap. Leaving non-cash assets out of the picture (which accrue cash value through interest paid on loans and potentially sale of those assets), if the company deployed its whole cash position over four years, here’s what the value would look like in 5 years:
Assuming no reinvestment, this is an extra $500mm in book value over 5 years, or about ~$4.15 per share (36% of the market cap).
Here’s what management has to say on those assumptions:
Harris is saying there is an “enormous amount of opportunities” that meet the company’s hurdle rate and would translate to book value growing. He is not only saying that book value could increase, but that free cash flow could allow the dividend to grow. Back to track records – he reminds shareholders the dividend was raised 5 times when rates were on the rise. This to me is a management group that believes the stock trades at a discount to intrinsic value.
Easier said than done, but conviction shouldn’t come from watching the stock – it should come from watching the business, which in part starts with watching management. Does the team running the ship have as much or more skin in the game as shareholders? Are they telling you to buy the stock or are they telling you the stock is rich (issuing shares, share count rising because of employees exercising generous options, questionable M&A decisions backed by stock, etc.)?
It’s fascinating to me how overlooked these questions are in favor of just following price action or top line growth. At the end of the day, the insiders know the most, and it’s obvious their actions and how they’re paid impact the stock price (highly recommend reading the NonGAAP blog for more on this). This fact is one reason I can’t jump aboard the crypto or SPAC train. Crypto doesn’t have a management team; SPACs have management groups that are either partly cashed out or just had their businesses valued at absurd multiples in most cases.
Management tells you about intrinsic value with their words and actions – listening is one way to find companies you don’t mind holding and buying more of through any cycle.
*As a quick side note here, I also have zero confidence in myself to say what merits a better opportunity than another well enough to allocate X% more capital for Opportunity 1 versus 2, so I now allocate my portfolio much closer to equal weight than I used to.