Mental Models discussed in this podcast:
- Enterprise Value
- Return on Invested Capital
- Weighted Average Cost of Capital
- Net Cash vs Net Debt
- Leverage
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You can find out more information by listening to episode 11 of this podcast.
Show Outline
Enterprise Value Definition
Enterprise Value = Market Cap + Net Debt or Market Cap – Net Cash
Key Thesis: Instead of using Enterprise Value, I would rather use Market Capitalization and have excess cash be part of my margin of safety.
When Cash > Debt use Market Cap.
When Debt > Cash use Enterprise Value.
This is a conservative approach.
Why is Enterprise Value useful?
Corporate takeovers because you have to assume the debt, not just buy out the equity. On the flip side, if you take over a company you get access to the cash box.
This doesn’t apply to minority shareholders.
“Net Cash or Skip” Investing Approach
- Should you calculate ROIC with cash or without cash?
- Is Excess Cash Bad?
- Does a company holding excess cash mean the company is a poor capital allocator?
- WACC is BS
- Why ever bother valuing debt?
- I don’t trust capital allocation at companies to be what I want it to be.
Solution: Be Conservative
- Buy companies with net cash, but value them as if they had none.
- Buy companies with growth, but value them as if they had none.
- Buy companies with good capital allocation, but value them as if they did not.
- Buy companies with good management, but assume management is only average. (Because someday it will be)
Summary:
Be conservative when valuing companies. Don’t give managers credit where they don’t deserve it. Enterprise value should only be used when companies hold debt. Yet, you should only buy companies with net cash.
