Hi Tactician,
Indeed we all do wish we have the luxury of time that you seem to have, and in no way am I implying it’s a negative thing. Quite sensitive aren’t you?
First of all you thought that my initial posting was meant as a direct rebuttal of your initial posting even though I had not even read your posting, and secondly you took a perfectly neutral statement and construed it as an insinuation.
First of all I agree that past earnings cannot be ignored. But past earnings do not in themselves determine the value of a stock; they are merely a component of value. The value of a stock cannot be determined without taking into consideration the strength, certainty and quantum of future cash-flows as well.
According to your logic, Lehmann Brothers would still be a very valuable company today based on historical earnings alone. The reality is that it is worth virtually nothing because it can no longer attain any future earnings nor are its assets accumulated through past earnings now worth anything.
Therefore historical earnings alone cannot determine value; they can only form a component of value. They form a component of value in that the earnings accumulated historically are added to the company in terms of various asset forms, adding in other words to its Net Asset Value.
this juncture, one might therefore be inclined to infer from your argument that a stock is worth at least as much as its book value. There are many stocks in the world today trading at below book value. Are they all undervalued? Some may be; almost certainly not all are undervalued. You cannot determine value without considering future cash-flows.
Future cash-flows is dependent on many factors – market, industry, and company specific. For example, consider market factors. Can we say that a stock trading under book value today would still be undervalued if the world economy went into a depression in the near future? If the world depression then causes future earnings to decrease or even turn into losses, causing a decrease in forward book value, would you then be able to say that this company is still undervalued today?
If a depression one year from now causes the value of its hard assets/property and inventory to depreciate significantly, can you still then say the company trading under book value is undervalued today?
If a depression one year from now causes a company’s distributors to all go bankrupt and be unable to return the cash they owe to the company in the form of receivables, and all the receivables are therefore forfeited, could you then say that the company trading under book value is undervalued today? If you have a bearish macroeconomic (or microeconomic) outlook, you would then estimate that future book value may actually decrease significantly.
Yes of course we cannot be a 100% certain that there will be a depression in the near future, this is just an example. The point I’m trying to make here is that you cannot divorce a company’s value from estimations/predictions of future cash flows. And future cash flows are dependent on many factors – market (macroeconomic), industry and company-specific.
So how can you expand orders and yet reduce receivables and improve cash flows? Simple – if your distributors are making enough profits from selling your products such that they accumulate enough capital not to have to take so much from the company in the form of receivables. If the distributors are making enough profits, you would expect receivables to go down over time and orders to go up since distributors would want to make more money. This has not yet happened now, with receivables increasing significantly over the last 2 years. On top of this they are now offering subsidies to distributors as well. As to who is holding the bargaining chips and who is being forced to take bigger risks, it is difficult to be certain without the precise stats on each individual distributor’s shop’ business but what we do know is that receivables have been growing considerably and now they are introducing subsidies too to support the distributors. I’m not saying that this shows with certainty that receivables will never go down and that distributors are doing badly. Once again with the available information we cannot know for sure, but once again there is a cause for ‘doubt’ (as discussed previously) here where the outcome is uncertain.
There are no 2 apparel companies that are exactly alike. This doesn’t mean they don’t compete for the same consumers. If you look at many of the Eratat Premium products (which incidentally still only form a minority of their overall orderbook), they are comparable to Zara in terms of pricing and ‘smart casual’ style, and it is very unlikely you’ll find many Eratat consumers who wouldn’t consider buying Zara goods instead. There are so many global fashion apparel companies in China now that makes the argument of stiff competition so obvious to most readers that I find it very uninteresting to elaborate on this point. As the Chinese become richer and more westernized, will they start to prefer global brand names like their counterparts in developed Asian countries? Again, another cause for ‘doubt’.
As to the likely amount of subsides to be offered to distributor per store, yes once again we cannot be sure at this point but it’s possible to make a reasonable guess. Eratat has about 1000 stores. $1k per store? If you have a reasonable sense of proportion and the general costs of goods and services in today’s society, even in developing China, 1k would almost certainly be a derisory figure. What’s a reasonable figure? 5k? 10k? That’s 10 million. 20k? That’s 20 million. More than 33% of current market cap. We can’t know for sure, it really depends on your judgment as an investor but once again – doubt and uncertainty. And whatever doubts and uncertainties you have will have an effect on your projection of a company’s future cash flows, which as discussed earlier, is crucial to determining the perceived value of a company.
Are they cooking the books? Again you cannot know for sure. If and when we know for sure, the company would be worth nothing by then. You got to make a judgement based on probabilities with the information you have available. For example, one of the pieces of information we do have that strikes us as strange is why they decided to do a placement and dilute shareholder value by 15% despite apparently having enough cash. Can we infer from this with certainty that there is fraud going on? Certainly not. But again, another cause for doubt.
A the doubts start adding up, and you begin to worry about future cashflows, you got to ask yourself if there are much better opportunities out there to invest in where there are less doubts. Indeed I believe that this is the case, and the opportunity costs of not turning to the alternatives would be too high.
I’ll stop here for now and continue next time. Will be out of the country for quite a few days so don’t expect any immediate replies, but it has nevertheless been nice having this discussion with you thus far.
Cheers,
Ethan