How Charlie Dreifus Uncovers Absolute Value
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“I have very much an absolute return mentality. I really hate losing money. So I want to buy a stock at a level that will not only be inexpensive to the market and inexpensive to peers, but inexpensive in an absolute sense. Much like a private equity or strategic buyer would look at that, because of my risk-averse nature.
I also believe, although I can’t prove it, that absolute value ultimately translates into absolute return. Now, you can find companies that are inexpensive in an absolute sense, but they’re not necessarily good businesses. So I want to own companies—as Buffett would describe them—with moats around them, that are niches; that are franchises.”
“Then the other primary metric that I use is a measure of cash conversion. By that I mean how much cash the company generates in relation to what they report as net income.
So, over a business cycle I’d like for the company to have close to parity, if not parity, of funds from operation that’s cash from operations, minus capital expenditures as it relates to reported net income. By doing that you come up with two conclusions: First of all, you’re avoiding the Enrons of the world because the company actually has produced the cash, and secondly you have companies that have the capacity of doing value accretive things, particularly companies that can and do increase their cash dividends annually.”
“Those are the quantitative measures of my process. There’s a very important qualitative measure, which is the deep dive into the financial statements that I do, which has been described by some others as my ‘secret sauce.’ And I always tell people the credit should go to the chef, Abe Briloff, who was my accounting professor in graduate school. He’s been known over four, five decades as being this super critic of companies but, more importantly, of their accountants that allow them to portray their numbers in an aggressive fashion, which doesn’t square with the reality.
Abe’s contention, basically, is that the auditor should be ombudsmen and they should insist that companies present the numbers in accordance with the economic reality, rather than some fiction.”
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