Joel Greenblatt's special situations class at Columbia Business School featuring Rob Goldstein, partner at Gotham Capital on Moody's
Joel Greenblatt literally wrote the book on special situation investing, so it's fitting that he teaches the Value & Special Situation Investment class at Columbia Business School.
This particular lecture is interesting because it encompasses a wide spectrum of the value framework; a special situation (spin-off) and a wonderful business (Moody's). It is also caught my attention because it features Rob Goldstein, partner at Gotham Capital. Before this lecture I was familiar with just one-half of Gotham's high performing investment partnership.
Goldstein does a case study of Moody's (MCO), which went public via spin off from Dunn & Bradstreet (DNB) in September 2000. The challenge is paying up for quality. To find a comp., the Gotham team used Buffett's 1988 Coke (KO) investment as an example of paying a premium for quality.
I have a fond opinion of Moody's as when I was a credit analyst, Moody's was was the more conservative of the rating agencies, and I used the "Moody's medians" as the benchmark for much of my coverage ratios.
The second half of this 2 hour+ video is Greenblatt lecturing on "The Little Book" to his CSB class. That will be the second of two posts from this video.
As usual, if you don't want to watch an hour of video, my notes are below. All the charts I've included go to the time of the lecture November 2006, for proper perspective.
Coke as a comp:
ROE's and Growth Rates:
I hope you enjoy Klarman's presentation as much as I did. It's is a bit long but worth the time.
Like Greenwald says in the beginning, the founder of Baupost Group needs no introduction. Klarman's remarks begin around the five minute mark. If you aren't familiar, he also wrote this book (link).
As usual, my notes are below. You may find Baupost Group 13F here, but it represents only a fraction of total firm AUM.
Most people would say Warren Buffett, the famously tech-adverse investor who seeks "Wonderful Businesses", would never touch the biotechnology sector. However I believe this is simply a function of his circle of competence principal. Simply, if he doesn't fully understand a business, he won't allocate it his capital.
Do some investor's circle of competence include biotech? Of course, but does the biotech sector contain "Wonderful Businesses"? Let's find out.
Time is the friend of the wonderful business, the enemy of the mediocre.
So what is a Wonderful Business? Investopedia has a nicesummary of Buffett's wonderful business criteria:
Buffett's criteria for "wonderful businesses" include, among others, the following:
For the purposes of this post, I am going to focus on the factors we can easily quantify, specifically items one and three. Return On Invested Capital, item one, is certainly the most important. It's also worth noting that this criteria works.
"Leaving the question of price aside, the best business to own is one that over an
There are many "cheap" companies, but not many that earn high returns on capital. Let's look at Berkshire Hathaway's publicly traded holdings to see what Buffett considers an acceptable ROIC.
For those who completely dismiss The Oracle's interest in biotech, I will point to Berkshire Hathaway's quarterly 13F filing. As of December 31, 2013 Bershire owned shares in Sanofi Aventis and Johnson & Johnson. Although these are "pharma" and not "biotech", the truth is that the distinction between the two sectors has been getting blurrier every year. Biotech is simply next-generation pharma. Case in point, J&J is the world's fifth largest biologics company, and Sanofi's Tuberculin for diagnosis of tuberculosis is a Purified Protein Derivative.
Let's check out the ROIC's of Berkshire Hathaway's healthcare companies. (Yes, I know DaVita is not Buffett's position, but rather Ted Weschler's) Also, they recently sold out of GSK, but it's worth noting for our purposes.
So we've established that Berkshire Hathaway, and by extension Buffett, has invested (to a limited extent) in companies that sell biotechnology products. But what about the criteria outlined above? What about a pure play biotech company?
Gilead Sciences is the second largest component of the NASDAQ Biotechnology Index at 8.4%. This maker of Hepatitis and HIV antiviral drugs was founded in 1987 and then went public in January 1992.
Gilead has followed the path of many growing companies, operating at a loss for the first several years before finding success. It wasn't until the second quarter of 2002 that Gilead earned a profit, and since then it has earned an excellent average ROIC of 26.9% over the past five years, nearly as much as Buffett's fourth largest holding IBM.
Below I've shown regular ROIC, and Cash Return on Capital Invested, to smooth out some accounting charges that do not impact cash.
What about criteria number three, profits as cash flow? Turns out Gilead is pretty good there too, with the same exceptions of some accounting write downs, Earnings and Cash Flow from Operations have tracked each other very closely.
So we've established that biotechnology can, quantitatively, meet the definition of a "Wonderful Business".
Interesting side notes:
It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.
All data from ycharts.com
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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 whose stock is mentioned in this article.
This is the personal blog of Emory Redd.
This blog is not investment advice. This is not a solicitation to invest. Don't take candy from strangers.
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