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  • leoislion75 leoislion75 Jun 2, 2011 3:41 AM Flag

    Durable Competitive Advantage - Method

    I just want to help little investors out there who might have trouble identifying possible "GREAT" company. That's probably first step in investing.


    Just take (10-year data -> if the company has)

    Net Income
    Capital Expenditure

    1) Take the less of the two, Net Income & Free-Cash-Flow (to be conservative)
    2) Compare with Capital Expenditure..If the ratio is > $2 income: $1 Expenditure

    Then there might be some greatness in company.

    A steel/mining (if commodity price is low) probably don't exhibit greatness because $1 Spending may not generate $2 or more

    Whereas a drug with lots of patents might spend $1 dollar and generate $2 or more

    SortNewest  |  Oldest  |  Most Replied Expand all replies
    • I like step 1.

      I like using 10 years of data.

      But comparing this against capital expenditures is going to get you in trouble. You are going to overrate the company that generates tiny operating margins on huge sales and raises tons of capital to finance its growth, with most of that money getting spent as ordinary business expenses. Your method is going to show large earnings / FCF against tiny capital expenditures. Return on equity and return on assets will quickly show a 10 year declining business that could not generate high returns against large amounts of money raised.

      Another failure of your method is the inability to see large amounts of debt being used to generate poor returns. Rather than comparing to market cap, you should be using enterprise value. And if you use free cash flow, then I guess you have to sanitize that by backing out tax and interest in order to compare a debt free concept (enterprise value) against an earnings stream that did not incorporate interest.

    • Leo

      What do you think of Sino-Forest. I see it recommended in Canada, symbol is TRE or SNOFF. I am not sure this is a good thing. They seem to be capital intensive. I still have to learn about calculations you perform. Thanks


      • 1 Reply to fliujniligui
      • I will guide you step-through-step (just simple addition that's fancy alpha/beta)

        Sino-Forest (10-year history): (just add from 2001-2010)

        Net Income: 1.38 B (i.e., 395+286+229+....+19)
        Capital spending: 2.44B (25+12+687+....+45)
        Free-cash-flow: 864 Mil

        Market Cap: 4.2B

        Why 10-year (preferable)? So you include ups&downs of a company business cycle (inflated/deflated earning in a single year)

        Meaning Behind Numbers: (<---Most Important)
        1)Net-Income >(way larger) FCF : It tells you they are a growth company, spends loads on their equipment/inventory/and every-other-thing (NOTE: So you know the valuation is towards a growth company :P)

        2)Yes, you are right about capital extensive. Spend $1 and get 56 cents back.

        1)Current price, you spend $3 dollar and get $1 dollar..Of course this is a growth company

        But the risk is ...can it earn you GREAT return (it's already capital extensive) to justify that valuation?

        Conclusion: Not my type of investment. My type is:

        1)Capital-Little: At least $1 spend and generate $2
        2)Large margin-of-safety: which mean I will never find bargain within the growth companies (but I still do alright :P)


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