random thoughts on a rainy Friday in LA

are the stay-at-home stocks bottoming?

I don’t know. But I’ve noticed that names like Zoom or Roku, which have fallen by 80%+ since their highs, appear to me to be having a relatively good–at least to the previous year or more–stock market performance. Have they bottomed? I don’t know. But if they have, that would be good for overall market sentiment, I think. I’m not rushing out to buy either one, or even to take a look at their financials, but their stabilization would suggest sunnier weather is in prospect, not only for them but for the market as a whole.

dollar stores

There’s an intricate market-share dance among: department stores, Target, Walmart and the dollar stores. Generally speaking, in good times, consumer tend to shift their spending from right to left; in bad times, they reverse course and go from left to right. So bad news for the dollar stores–who appear to be reporting disappointing earnings for the most recent quarter–may be good news for the economy as a whole. Again, I haven’t investigated. I did listen, though, to a Yahoo Finance explanation of results for Dollar general and Odd Lots.

The “analysis” was all about margin contraction, and was jaw-droppingly bad. The assumption was that higher margins are, in themselves, a good thing–which I what I want to comment about. This completely ignores the fact that high margins are kind of like blood in shark-infested waters–they draw competition. Another, typically less noticed thing is that margins have to be taken in tandem with inventory turnover. Take two businesses, each with $1 million in inventory:

–business A marks up by 100% and turns its inventory once a year–think, furniture store. It makes $1 million in gross profit a year

–business B marks up by 20% and turns its inventory 20x a year–think, pharmaceutical distributor. It makes $4 million in gross profit a year

All other things being equal, which would you rather be?


Yesterday, I read a curious commentary by Cathie Wood about her investment strategy.

It starts with a critique of ebitda as a measure of a company’s value. Ebitda is after-tax earnings to which you add back interest expense, taxes and depreciation/amortization, and use as a measure of a company’s value, sort of like PE or price/cash flow.

I’m not a fan of ebitda. Neither is Ms. Wood, but for different reasons.

I’m old-fashioned. My objection is that companies are shaped by their managers in ways that are designed to maximize their profit potential. They do borrow money, they do pay taxes and they do own plant and equipment (so there should be a charge for wear-and-tear). Yes, these choices may end up subtracting value rather than adding. And in an M&A situation, a cash-rich rival with extra plant and equipment may acquire a company, repay its debt, sell its plants, do better tax planning and end up capturing the entire ebitda and then some. But change of control is not always possible. Anti-monopoly laws are the traditional barrier. Much more important in today’s world is the dual share structure of many companies (think: META) that allow founders to stay long beyond their best by dates and prevent hostile takeover approaches. I think it’s better to look at companies as they are, warts and all.

Just as important, probably considerably more so, I think, is the market structure in which a company operates. How big is the addressable market? how fast is it growing? are there substitutes? is our company gaining or losing market share? is this a market with three main companies, each with a third of the market (implying bruising competition), or does ours have half the market, with mom-and-pops making up the rest (implying much less competition).

Ms. Wood’s approach is the opposite. Her idea is that one gets true earnings by taking ebitda and adding back research and development spending, some (?) sales and marketing expense, stock-based compensation and deferred revenue (advance payments by customers).

I understand that doing so makes cash flow look better. Still, companies do dilute eps to some degree with stock-based compensation, and I’m not sure that capitalizing sales expense and R&D is the right way to look at things. In fact, the latter practice was disallowed a generation ago after a history of substantial abuse by tech companies (meaning considerably overstated earnings) came to light. There’s also the question whether a high level of R&D and S&M are luxuries or the bare minimum that one has to do to stay in the game and keep from falling behind rivals.

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