Navigating Risk and Uncertainty
Uncovering undervalued investment opportunities, and thinking through risk, uncertainty and the pursuit of truth.
Nucor Corporation (NUE: $152/share) is a stock I discovered while studying CMC. Like CMC, its executive compensation aligns shareholder and management interests. It has the added advantage of generating free cash flows (FCF) in such abundance that...
CMC (CMC: $52/share), formerly known as the Commercial Metals Company, has a history of profitable growth, thanks to its competitive advantages, the alignment of shareholder and management interests and a focus on value creation. The stock earns an...
In the last five years, investment advisor and fund administrator, Diamond Hill Investment Group, Inc. (DHIL: 156.60/share), has been far from being a market darling. Both growth and profitability have been challenged, with profits see-sawing along...
Amidst a global stock sell-off, Meta Platforms' Q2 earnings proved an excellent redoubt, reminding investors of the firm’s remarkable growth and profitability. If Mark Zuckerberg’s present dalliance with generative AI turns out to be a more expensive...
Using a model I built to forecast 10-year S&P 500 total returns leads to an awful number: 1.16%, the average total returns that are likely, if the predictive value of the model holds, over the 2024-2033 decade, a return lower than that available by...
Superficially, a valuation methodology exists to help an investor estimate, within a reasonable range, how much something is worth. Investing, however, is not merely an intellectual exercise. The fundamental problem that an investor faces is that...
An investment is a choice to foregore present consumption in favour of future consumption, in exchange for which the investor is given a return which can simply be referred to as “interest”. The interest promised to the investor is either...
Free cash flow (FCF) is the cash that is available to all investors, whether debt holders or shareholders, after taxes have been paid. This is the after-tax cash flow that would be earned if a business was entirely equity financed. Consequently, it...
Annual reports are not merely long, and complex, with often abstruse language that seems calculated to befuddle the reader, they are also structured in ways that unintentionally disguise operating performance. To start with, financial statements are...
Annual reports are not merely long, and complex, with often abstruse language that seems calculated to befuddle the reader, they are also structured in ways that unintentionally disguise operating performance. To start with, financial statements are...
Unconsolidated subsidiaries, also referred to as investments in associates, investments in affiliated companies, and equity investments, are businesses wherein a firm has a significant stake that falls short of control, which equates to a 20% to 50%...
Firms use a portion of their cash and cash equivalents and investments as operating cash for the running of the business, and any cash beyond this amount is excess cash and a non-operating asset. As a rule of thumb, I assume that operating cash is...
The logic of discontinued operations is that they are not a component of core operations and therefore, not only do their earnings not belong in a calculation of net operating profit after tax (NOPAT), they also do not belong in a calculation of the...
Deferred compensation is that portion of employee compensation that has been set aside for future payment. Firms create plans to manage the assets that will be used to settle these liabilities. Consequently, deferred compensation assets are a...
Deferred tax accounts arise because of differences in how firms and the government account for taxes. For example, whereas the government uses accelerated depreciation to calculate taxes owed, firms employ straight-line depreciation. The taxes the...
As I discussed in “Overfunded Pension Plan Assets, an Invested Capital Adjustment”, under SFAS 158, companies are obliged to report the net funded status of their pensions, which is the difference between the fair value of their pension plan assets...
The adjusted total debt of a firm is the sum of the fair value of all its short and long-term obligations, on-balance sheet and off-balance sheet. For example, in 2023, the combination of Meta Platform’s on-balance sheet debt and its operating...
When a company has majority control of a subsidiary but does not own 100 percent, the entire subsidiary must be consolidated on the parent company’s balance sheet. The funding other investors provide for this subsidiary is recognised on the parent...
Preferred stock is a form of hybrid financing that has the qualities of both equity and debt. In terms of claims on assets and cash flows, preferred stock is senior to ordinary shares, but below bonds, and may have priority over ordinary shares when...
Deferred compensation is that portion of employee compensation that has been set aside for future payment. Firms create plans to manage the assets that will be used to settle these liabilities. Consequently, deferred compensation assets are a...
Effective 2005, the IASB required employee stock options (ESO) to be expensed in the income statement, with the FASB following a year later. Until then, firms could treat ESO compensation as if it was not a cost, inflating their reported earnings...
Unconsolidated subsidiaries, also referred to as investments in associates, investments in affiliated companies, and equity investments, are businesses wherein a firm has a significant stake that falls short of control, which equates to a 20% to 50%...
When a company is bought, its purchase price, debts and other long-term liabilities are fully absorbed by the acquirer’s balance sheet. However, only the income it earns for its acquirer is added to the income statement. This has the effect of...
The Financial Accounting Standards Board (FASB) eliminated goodwill amortisation from 2002 and the International Accounting Standards Board (IASB) followed in 2005. Before that, goodwill, the capitalised value of the excess of purchase price over...
Firms use a portion of their cash and cash equivalents and investments as operating cash for the running of the business, and any cash beyond this amount is excess cash and a non-operating asset. As a rule of thumb, I assume that operating cash is...
This Statement improves financial reporting by requiring an employer to recognize the overfunded or underfunded status of a defined benefit postretirement plan (other than a multiemployer plan) as an asset or liability in its statement of financial...
Deferred tax accounts arise because of differences in how firms and the government account for taxes. For example, whereas the government uses accelerated depreciation to calculate taxes owed, firms employ straight-line depreciation. The taxes the...
Asset write-downs occur when the fair value of an asset, what it would fetch on the market, falls below its carrying value, the cost of an asset less accumulated depreciation or amortisation, forcing the book value, what appears on the balance sheet...
Accumulated other comprehensive income (OCI) is a sea into which various unrecognized gains and losses are poured. In the United States, largely consists of currency adjustments, unrealized gains and losses on available for sale securities, gains and...
Under both IFRS and US GAAP, assets and liabilities held for sale are reported separately on the balance sheet and their income and loss from them, or the result of their sale, are reported as discontinued operations separate from continuing...
Companies create reserves in anticipation of probable future costs or losses whose amounts can be reasonably estimated, as happens with inventory reserves and loan-loss provisions, or, in order to ensure comparability across accounting methods as...
Taxes incorporate operating, non-operating and financing items. One wants to assess the core operations of a business, free of any financing effects, in order to estimate net operating profits after tax (NOPAT), and so, one must break off operating...
These are the result of currency revaluations or devaluations and do not appear on the face of the income statement. These currency fluctuations force firms to assume non-recurring charges or gains. An example is the $12 million Tesla gained in 2013...
Reported net non-operating charges and gains are those non-operating items reported on the face of the income statement. According to the paper, “Core Earnings: New Data and Evidence” by Ethan Rouen, Eric So, and Charles C.Y. Wang, they are “similar...
The Financial Accounting Standards Board (FASB) eliminated goodwill amortisation from 2002 and the International Accounting Standards Board (IASB) followed in 2005. Before that, goodwill, the capitalised value of the excess of purchase price over...
Under both IFRS and US GAAP, assets and liabilities held for sale are reported separately on the balance sheet and their income and loss from them, or the result of their sale, are reported as discontinued operations separate from continuing...
While operational excellence should be the lodestar guiding managers, there is a great temptation to use reserves to manage earnings. In order to ward off the effects of earnings management, ensure comparability across business, and reveal timing of...
Firms, in order to attract and retain talent, offer one of two kinds of retirement plans for their workers, the defined benefit plan, and defined contribution plan. A defined benefit plan, as the name suggests, guarantees a set benefit to its workers...
Non-operating income is the complement of non-operating expenses, and are special items and one-time earnings that are not reported on the face of the income statement, and are instead hidden in other line items. The most common types of hidden...
Non-operating expenses, such as asset write-downs, which I discussed in a separate post, are special items and one-time charges that are not reported on the face of the income statement, and are instead hidden in other line items. The most common...
Asset write-downs are nothing short of shareholder destruction. If wealth, as I contend, tends toward destruction in the long run, an investor has two choices: not to invest, or, to do something that shifts the odds in one’s favour. Not taking into...
The reader should read this post in conjunction with a Google spreadsheet I have created on Meta Platforms’ operating, variable, and not-yet commenced leases. If wealth, as I contend, tends toward destruction in the long run, an investor has...
What follows is a framework for understanding digital firms, a framework that emerged as I edited an article on Meta Platforms, an article to be posted next week Tuesday. There are three main elements to this framework: firstly, that competition is a...
Risk is inextricably bound up with wealth destruction, and yet, risk measures are agnostic, treating risk as if investors are indifferent to gains and losses. This tortured contradiction is recognised by investors and managers, who intuitively...