Superinvestor (3) Francis Chou

Francis Chou, his story and his approach

1979, Francis came along a copy of The Intelligent Investor by Benjamin Graham. Once he read it, he was sold into the world of value-investing and hunted for articles and other books on the subject.

What he found out after a while is, to be successful in investing you need a good basic framework on making investing decisions. One of his pillars in his framework is to buy on discount and by that, beat the market - that is the easy part - especially when he started.

One way to find bargains are Graham's Net-Net Working Capital, which is Current Assets minus Current Liabilities and all long-term Liabilities as well, including preferred shares! In the year of 1991, they were plenty of those! And it worked out for him!

(---I just ran a screen on companies with a market cap > $250 million on the 3 major US exchange excluding financial companies and I got that 0.4% or 11 companies out of around 4000 companies were Nets-Nets, i.e. Market Cap is lower than Current Assets - Total Liabilities ---)

After that, Francis's business grew, and he went after "Good companies" as he puts it. When you have good companies, they are more difficult to evaluate compared to Nets-Nets, which is really just some additions and subtractions but for Good Companies, he created a checklist!

Important Questions

Operations

1. Is the business simple and easy to understand in terms of valuing the company, can you quantify them?
2. Does it have a consistent business history, over 5 to 10 years - which includes then as well that Value Investor don't go for IPO 
3. Does the company has favorable longterm prospect, a lot of companies have performed well the previous 10 years, but have difficulties in the coming years

Management

1. Has management be rational with capital allocation
2. How they write to shareholders, have they been candid with their problems
3. How well do they allocate capital - do they get it their investment at a good price to they can make a good deal!?

Qualitative/Quantitative 

1. Good companies must be quantified being good, by just having a good name does not make the company good! 
2. Does it have a decent Return on Equity, e.g. ROE > 15%
3. Good companies see earnings in cash - a lot of companies shows good earnings, but all these earnings go into inventories, receivable, fixed assets and a lot of other stuff that does not increase the intrinsic value - so Important: Does it see its earnings in cash
4. Is the company to highly leveraged. Good companies make money on equities, they do not need leverage to show good results. If they have a lot of leverage, is it worthwhile to buy the debt 

Valuation

1. What is the value of the business
2. Am I buying it at a significant discount to the value of the business