Whitney Tilson Talks at Google [SLIDES] + Checklist

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Here’s and excerpt from the Google talk where Whitney Tilson discusses his four steps that he looks at when looking at a potential business to invest in (emphasis added):

WHITNEY TILSON: Well, I use a four-step—I actually have it taped to the wall next to my desk. My four-step process is first, when I look at any new stock is circle of competence. Do I know something about this industry? Is it knowable? Is the future predictable here? It’s almost like a yes or no thing. There is some gray area where maybe I don’t know it very well, but I think I can do some research and get some. So circle of competence. Then it’s: Do I like the company? And I look at financial characteristics, cash flows, return on equity, et cetera. So I evaluate the company. And by the way, I’ll invest in sort of crummy companies if it’s cheap enough. But ideally I’m looking for higher quality businesses that I can compound over time. Then I look at the industry, because a good company in a crummy industry, is going to struggle. So it’s a company and industry analysis, then management. And that’s really important. Both, do they run the business well? Do they allocate capital well? And do they treat shareholders well? And here’s the thing. I can find, right now I can find hundreds of companies that I understand really well, great industry and company dynamics, wonderful management, treats shareholders great. So what’s the problem? The stock’s not cheap. Everybody else on earth can understand it and likes the company and the industry and the management, and therefore, the stock price reflects it. The real key is to then just sit there and sit there and sit there and sit there and be super patient until I can find a situation where the stock price is well below what I think it should be, based on my analysis. And usually what that requires is for there to be some—the market thinks one thing, the variant perception that John talked about. To make money investing you only need to do two things. You need to bet against the crowd—that’s the easy part. And then you just have to be right. That’s the hard part. (Source: Talks at Google)

TILSON’S CHECKLIST

  1. Circle of competence
    1. Do I know something about this industry?
    2. Is it knowable?
    3. Is the future predictable here?
  2. Company & Industry Analysis 
    1. Do I like the company?
    2. Financial characteristics, cash flows, return on equity, et cetera?
    3. Higher quality business able to compound over time?
    4. Good or a bad industry?
  3. Management
    1. Do they run the business well?
    2. Do they allocate capital well?
    3. Do they treat shareholders well?
  4. Price
    1. Is the stock cheap?

Click image below for full PDF of slides from Tilson’s Google talk.

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Tilson on Google (emphasis added):

And when you think about Google, by the way, if Google were to separate itself out and spin off Google Fiber and the self-driving car stuff, like Google is—a lot of those expenses are investing in things that are currently not generating any revenue. It’s just straight out losses. Like if you actually, I think a reasonable way to think about Google would be to sort of take out all the money losing stuff where—these pie in the sky thing—where Google actually has a pretty darn good track record of developing really valuable things down the road. And I might give Google credit for that, and say, how much is their core business really earning, x-ing out all these expenses. And it might be quite a bit of expenses, and you might actually say Google’s core business trading for 15 times earnings or something like a market multiple, and then you’re getting a free call option on stuff that—self-driving cars. If you guys nail that, that could change the world. That’s a worldwide game changer, and you guys will own it. I’m not sure I’d give Microsoft much credit for that. They have a horrible track record of just pissing money away over the years, and projects and acquisitions that just create no value. And Microsoft shareholders are sort of rebelling. But you guys seem to be a lot better at that. So again, that would be the argument for owning Google stock is that it’s really not as expensive as it appears because they’re expensing a lot of their expenses, their core business is even much more profitable than it appears. One of the world’s greatest businesses. And then they’re investing in a lot of new stuff where their’s likelihood to pay off. (Source: Talks at Google) 

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The Enron Fraud & the “Not So Smart Guys” In the Room

“It’s good to learn from your mistakes.
It’s better to learn from other people’s mistakes.”
Warren Buffett

“More money, it has been noted, has been
stolen with the point of a pen than at the point of a gun.”
Warren Buffett

This weekend I watched the documentary Enron: The Smartest Guys in the Room. See the bottom of this post for a link to YouTube

I have seen it once before, a few years back. But this one is definitely worth watching again.

After finishing the movie I ordered the books The Smartest Guys In the Room and Power Failure: The Inside Story of the Collapse of Enron, both of which I have not read before. Still waiting for the books to come!

So, take a look at the documentary and maybe read some (or both) of the books if you haven’t already done that.

Here is Enron’s annual report for fiscal year 2000. In the annual report Jeffrey K. Skilling (President and CEO) together with Kenneth L. Lay (Chairman) began the shareholder letter in the following (kind of pretty optimistic) way.

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Below is an overview and discussion of Enron’s net income compared to a calculation of owner earnings (Source: FWallstreet.com). From this its clear that net income not really match owner earnings.

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A great book is Financial Shenanigans: How to Detect Financial Gimmicks & Fraud In Financial Reports written by Howard M. Shilit and Jeremy Perler. In the book the authors discuss the Enron case awarding Enron for “Most Outrageous Financial Shenanigans”, see image below.

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The discussion of the Enron case in Financial Shenanigans and the financial shenanigans is summed up as follows.

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The Enron Scandal

Here is some background about what came to be known as the Enron scandal. (Source: Wikipedia)

“The Enron scandal, revealed in October 2001, eventually led to the bankruptcy of the Enron Corporation, an American energy company based in Houston, Texas, and the de facto dissolution of Arthur Andersen, which was one of the five largest audit and accountancy partnerships in the world. In addition to being the largest bankruptcy reorganization in American history at that time, Enron was attributed as the biggest audit failure.

Enron was formed in 1985 by Kenneth Lay after merging Houston Natural Gas and InterNorth. Several years later, when Jeffrey Skilling was hired, he developed a staff of executives that, by the use of accounting loopholes, special purpose entities, and poor financial reporting, were able to hide billions of dollars in debt from failed deals and projects. Chief Financial Officer Andrew Fastow and other executives not only misled Enron’s board of directors and audit committee on high-risk accounting practices, but also pressured Andersen to ignore the issues.

Enron shareholders filed a $40 billion lawsuit after the company’s stock price, which achieved a high of US$90.75 per share in mid-2000, plummeted to less than $1 by the end of November 2001. The U.S. Securities and Exchange Commission (SEC) began an investigation, and rival Houston competitor Dynegy offered to purchase the company at a very low price. The deal failed, and on December 2, 2001, Enron filed for bankruptcy under Chapter 11 of the United States Bankruptcy Code. Enron’s $63.4 billion in assets made it the largest corporate bankruptcy in U.S. history until WorldCom’s bankruptcy the next year.

Many executives at Enron were indicted for a variety of charges and were later sentenced to prison. Enron’s auditor, Arthur Andersen, was found guilty in a United States District Court, but by the time the ruling was overturned at the U.S. Supreme Court, the company had lost the majority of its customers and had ceased operating. Employees and shareholders received limited returns in lawsuits, despite losing billions in pensions and stock prices. As a consequence of the scandal, new regulations and legislation were enacted to expand the accuracy of financial reporting for public companies. One piece of legislation, the Sarbanes-Oxley Act, increased penalties for destroying, altering, or fabricating records in federal investigations or for attempting to defraud shareholders. The act also increased the accountability of auditing firms to remain unbiased and independent of their clients.”

The (Smartest) Guys in the Room

In his 2003 letter to shareholder Warren Buffett recommended the book The Smartest Guys in the Room, written by Bethany McLean and Peter Elkind.

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Another book written about the Enron collapse is Power Failure: The Inside Story of the Collapse of Enron.

“Power Failure is the electrifying behind-the-scenes story of the collapse of Enron, the high-flying gas and energy company touted as the poster child of the New Economy that, in its hubris, had aspired to be “The World’s Leading Company,” and had briefly been the seventh largest corporation in America.

Written by prizewinning journalist Mimi Swartz, and substantially based on the never-before-published revelations of former Enron vice-president Sherron Watkins, as well as hundreds of other interviews,Power Failure shows the human face beyond the greed, arrogance, and raw ambition that fueled the company’s meteoric rise in the late 1990s.” (Source: Amazon.com)

There has also been a documentary made about Enron and its demise.

“Enron: The Smartest Guys in the Room is a 2005 documentary film based on the best-selling 2003 book of the same name by Fortune reporters Bethany McLean and Peter Elkind, a study of one of the largest business scandals in American history. McLean and Elkind are credited as writers of the film alongside the director, Alex Gibney.

The film examines the 2001 collapse of the Enron Corporation, which resulted in criminal trials for several of the company’s top executives during the ensuing Enron scandal; it also shows the involvement of the Enron traders in the California electricity crisis. The film features interviews with McLean and Elkind, as well as former Enron executives and employees, stock analysts, reporters and the former Governor of California Gray Davis.

The film won the Independent Spirit Award for Best Documentary Feature and was nominated for Best Documentary Feature at the 78th Academy Awards in 2006.” (Source: Wikipedia)

So, never forget to “Ask why”.

Disclosure: I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company or individual mentioned in this article. This article is informational and is in my own personal opinion.