- U.S. Lime and Minerals (USLM)
- Parke Bancorp (PKBK)
- Village Supermarket (VLGEA)
- The Washington Post (WPO)
- Tandy Leather Factory (TLF)
Some appraisals touch on important concepts. A one page appraisal I got recently – about Tandy Leather (TLF) – shows the problem of what to do when you want to value a company that has no publicly traded peers.
The appraisal this person sent in was technically fine. The step-by-step work was good. But the decision of how to frame the problem from the start was not.
The appraisal starts by breaking Tandy into two parts: wholesale and retail. The wholesale business is valued at the same multiples of sales and EBIT as Big Lots (BIG). The retail business is valued at the same multiples as Coach (COH). It’s a mistake. But a mistake that make sense. Especially if you are operating on auto-pilot. The problem is that comparing Tandy to either Big Lots or Coach really tells you nothing. It’s better to focus on what Tandy is – a niche retail business distributing all the way from wholesale to retail and focused on one hobby (leathercrafting) – than focusing on what it isn’t. Sector comparisons are misleading here. What is needed is more metaphorical thinking.
So, here’s my response to this technically excellent but strategically flawed appraisal:
In your one page appraisal of Tandy Leather you followed the approach I used with John Wiley (JW.A) quite closely. Do you think Tandy has peers that are as comparable as Wiley's?
I compared Wiley’s businesses to:
1. Journals (Reed Elsevier)
2. Textbooks (Pearson)
3. Books (Scholastic)
These are far from perfect comparisons. However, an important point to consider is that the comparable business segment is usually superior to the other segments of the public company I chose as a comparison. For example, the Elsevier journal business part of Reed Elsevier is better than the other segments. So, if anything I am being conservative. If you split off Elsevier's journal segment from the rest of the company, the academic journal business might actually trade at a higher multiple than the combined company had. It would certainly trade at a higher multiple than some of the other parts – if those parts traded separately.
The same is true of Pearson. Pearson is not just a textbook business. It has a stake (used to be the whole thing) in Penguin which is a book publisher. It owns the Financial Times (a newspaper) and The Economist (a magazine). The future for newspapers, books, and magazines is much worse than for textbooks. So, Penguin and the FT and The Economist probably weigh down the value Pearson's textbook business would trade at if it got its own multiple because it traded separately from those low multiple businesses.
For the books business, I used Scholastic (SCHL) as a peer. This is not a great comparison. It is unclear whether Scholastic should have a higher sales multiple than Wiley's book business. Maybe it should. Maybe I was not conservative enough here.
But on peers #1 and #2 (which are by far the most important) I had the benefit of much better comparisons. And I was able to err on the side of conservatism because both publicly traded peers have weaker businesses mixed in that weigh down their multiples as public companies.
Now, let's consider using the same approach with Tandy. The problem with that approach is this line from TLF"s 10-K:
"...to our knowledge, there is no direct competitor across our product line." (Page 2 - competition)
Tandy is not comparable to Coach. Coach has leather goods. But they are a fashion company. They face intense competition. There is a built in base for fashion accessories. The situation is reversed for Tandy. Tandy has a small base. It can't steal from competitors. Because it doesn't face competitors.
Let's do a thought experiment here. In terms of product economics, competitive position, and other concerns for a buy and hold owner - is Tandy more like Coach or more like Games Workshop (LON: GAW)?
Is Tandy a fashion business or a hobby shop?
Tandy describes itself as a hobby business. The website makes it look this way too. They don't talk much about competition - except that they acquire mom and pop stores. They talk about building the base. About getting more people into leathercrafting. They sound more like Games Workshop to me. I do not believe they are in any sense comparable to Coach - despite the leather connection.
Also, Coach is a unique business. Or at least a special business. It is tough to use as a peer for anybody. In the case of Wiley, I had a very good comparison in Elsevier. They serve the same customers, their customers see them the same way, they are very similar. It would be like comparing Carnival (CCL) and Royal Caribbean (RCL). One is much bigger than the other. But they aren't taking radically different approaches. They aren’t appealing to entirely separate niches. They share customers and ways of operating. It's a very good comparison.
Coach is not a good comparison for Tandy.
This is not because you made a bad selection for a peer. It's because Tandy has zero peers. You can't value Tandy compared to any other leather company.
That's fine. It's hard for me to value George Risk (RSKIA) to anyone else in the same business (in fact, I can't - they have competitors, but they have totally different approaches from RSKIA).
Likewise, Ark Restaurants (ARKR) is hard to compare to other companies. Generally, all I can do is compare ARKR to competitors that are clearly inferior in terms of ROC, stability of earnings. Most companies don't use their business model. But I can ask - if they trade at 5x EBITDA and I can find 3-5 restaurant stocks that look like inferior businesses and were acquired for 7-8x EBITDA, then maybe I have a margin of safety. That's the best I can do in a case like that because they have a unique operating strategy. It's not totally unique. In fact, they might be a good fit with Landry's because of some of what Landry's already owns. It is hard - and misleading - to compare ARKR to a restaurant concept (Chipotle, Darden, Outback, etc.) because they don't have concepts to expand. They only have 2 restaurants that even use a name in more than one location. They are a location based company. They are more comparable to private restaurants that run one location than anything else. It's just they own a vast collection of such individual locations. And the locations are special. They don't run the kinds of restaurants - just on a street in NYC - they started with. But they still aren’t a concept based restaurant business. And many public restaurant companies are. So, a direct comparison is never perfect. But it’s often better than any comparison you could come up with for Tandy.
This is important to think about because analyzing unique businesses is one of the most valuable experiences you can have as an investor.
My advice is to read the Greenblatt class notes if you haven't already. I linked to them on the blog. Follow that link (it'll take you to csinvesting) and then scroll down to find the notes. They are long. But there's an excellent section where Greenblatt tries to figure out what Moody's (MCO) is worth. What does he compare it to?
What do Coke and Moody’s have in common? How are these companies relateable? Why does he use metaphorical thinking – using Coke as a starting analog for his Moody’s appraisal – instead of picking a random financial services company to Moody’s?
Greenblatt compares Moody’s to Coke because he knows Buffett made that investment and it was a success. This tells him it's something Buffett thought he could analyze. The price paid looked high. But it turned out well. So, Greenblatt used Coke as an analog for Moody's. He used metaphorical thinking.
Buffett himself did this. He never would have bought Coke if he hadn't owned See's Candies. He paid a high price-to-book for that company. And, at first, he didn't even think he wanted to be in the candy business at all. His superficial view was totally wrong. His first instinct was terrible. But then they sent him the past financials.
It is very important when analyzing a company to check whether past results are comparable to other companies that appear superficially to be similar. If, when you get under the company's skin, you find a different story then you need to start employing metaphors. For me, I would want to go and look for metaphorical "peers" like Games Workshop or other hobby shops or companies that wholesale to enthusiasts of some sort. It's hard to screen for something like this. Google Finance may not tell you where to find truly comparable companies. The names they list are based on sector grouping more than anything else. If you look up Mac-Gray (TUC), which rents washers and driers to apartment complexes, you’ll see a list of companies including NutriSystem (NTRI), Regis (RGS), and Whirlpool (WHR).
Whirlpool is the only company that’s actually related (they own Whirlpool machines). NutriSystem has nothing to do with Mac-Gray and couldn’t help you understand the company at all. Regis might because the stability of demand – and importance of location – is important to both laundry room and hair salons. Google Finance doesn’t list any parking companies – like Standard Parking (STAN) – that I would think of as being a better comparison with Mac-Gray. In fact, if you asked me for a company you might want to look at when you’re looking at Mac-Gray – I’d say Standard Parking. Thinking about how the two companies are similar and different – using metaphorical thinking – will help you a lot more than picking random companies that seem comparable based on sector.
What can really help you understand a company? Let’s look at Mac-Gray. I’d give three other public companies you can think about: the company that sells the machines (supplier), the company that rents the machine (customer), and a good potential metaphor (a parking garage operator).
If I was going to spend time thinking about Mac-Gray, I’d be thinking about companies like Whirlpool, apartment owners like Post Properties (PPS), end users (the folks who rent from places like Post and actually use Mac-Gray’s machines), and Standard Parking.
In this case, understanding Whirlpool and Post may help you understand why they would supply and rent from Mac-Gray. It’ll tell you about competitive position. But it won’t give you good valuation comparisons. For that, you want to look for a company with similar product economics.
This is what Joel Greenblatt was trying to do when he compared Moody’s to Coke. He thought Moody’s product economics were at least as good – actually better, since they needed even less capital to grow – then Coke’s. So, if Buffett was justified paying a certain price multiple for Coke, Greenblatt would be justified paying the same multiple for Moody’s.
This isn’t sector based thinking. It’s metaphorical thinking. And it’s often one of the keys to a good appraisal. Especially one where a company occupies a niche or has no publicly traded peers. In those cases, there is no truly comparable company within the sector. So, you need to find another way to do a relative valuation.
As you expand the number of companies you know well, these metaphorical linkages - apt but not obvious analogs - will jump out at you.
So, while I think your approach would work perfectly for a company with peers that operate the same way - it won't tell you anything about Tandy Leather. That's because TLF is different on the inside. Look at Tandy's gross margins, return on capital, etc. and compare to something like Big Lots. Even if the numbers looked similar - we'd have a problem. Tandy is clearly a low-profile specialist retailer. Most of us haven't heard of Tandy. Big Lots is a high profile generalist. I know about Big Lots and I've never shopped there. This means the marketing, etc. must be very, very different.
For example, Big Lots probably has a huge potential base of customers. However, it faces tough competition from other companies that operate much the same way.
Tandy has the opposite situation. They make this very clear throughout their 10-K. The tiny size of their market is a problem. Competition is not. They try to grow their market themselves. They have to be their own trade group of sorts. And they have to use marketing to really push engagement and frequency of purchases with their customers. It sounds like a hobby shop. More comparable to someone selling comics than handbags.
That's great news. A mismatch between hierarchical thinking when you first group stocks together in sectors, industries, etc. by appearances alone and the actual inner workings of the company is one of the best ways to make money. That's what makes Tandy an interesting situation. It may sometimes be neglected, misunderstood, etc. because it is not easy to group with 10 other peers the way general retailers are.
Each stock appraisal requires its own way of framing the problem. A company with no publicly traded peers in its sector – like Tandy – has to be valued differently. A good metaphorical comparison outside the sector is much better than a bad comparison within the sector.