Thursday, September 27, 2012

The F-Score

At the risk of being burned at the stake, I am going to speak some heresies about the F-Score.  

First, statistics -- F-score, NCAV, magic formula, P/B, golden cross, whatever -- may be useful for stocks taken two handfuls at a time, but they are not, by themselves, useful for evaluating any individual stock.

Second, the F-score is a momentum indicator. It has only the most occasional and coincidental relationship with quality or value. 

Look at any of the indicators/criteria, and they are, with the exception of CFO>Net income, flimsy at best, nonsensical at worst: 

  • no net pension liabilities, 
  • no changes in net pension liabilities as a result in changes in the prices of securities prices, 
  • no leases, 
  • negative working capital is bad, 
  • excess cash is bad, 
  • dilution is always bad, etc. 

Terrible stuff. It is what Baudrillard, bless him, would call a third order simulacrum.

To my mind, the F-score relies on two things: (a) selling into hype; and (b) timing of cylicals. 

Nothing else. 

Compare it to the most well-known of momentum strategies and I think you'll see what I mean:

 Data source:

Where there is no danger of overexcited buyers -- Japan, for example -- it doesn't work.

Still, I get it. I see its appeal in the same way that I see the appeal of buying stocks whose 50 MA crosses the 200 MA, or whose relative price strength is greater than 1, or whatever else.

But, in my view, it is a mistake to use the F-score at the level of an individual stock just as it is incorrect to think of it as a proxy for quality. 

Wednesday, September 26, 2012

Silver Chef -- Equipment Leasing

Silver Chef is an Australian company with a straightforward business model. 

Hospitality start-ups – new restaurants – are often starved for cash. They need to invest in professional cooking equipment but purchasing it outright is risky and ties up more working capital than they can spare. The typical piece of equipment costs $10,000. Silver Chef offers them a lease-try-buy option. They commit to leasing, for example, a Middleby convection oven and Silver Chef then buys it and rents it to them. The minimum lease term is one year, and they pay rent monthly, in advance. Banks require Director guarantees, Silver Chef doesn’t. If they can’t pay, the oven is repossessed.   

If their business succeeds, they have the option to buy that piece of equipment and are credited for some of the rental fees they’ve paid. Some do buy but most don’t – they continue to lease because the rent is off-balance sheet.

One can see how it’s a win-win for both parties. Besides, banks concentrate on large businesses, Silver Chef concentrates on small enterprises.

Silver Chef succeeds in making this model work. No one customer constitutes more than 1% of revenue, thereby limiting risk. It grows fast and grows profitably. 

It has the bright idea that the best customers may be franchisees of well-known, fast-growing brands, and it now targets the franchisees of Dominos Pizza, Subway, The Coffee Club, Nandos, Outback Jack’s Bar & Grill,   Gloria Jean’s, and Wendys (an ice cream franchise, not the hamburger chain). These customers subsequently make up a substantial share of its business, are lower risk, and present excellent growth opportunities.

Better, once embedded in these brands, word of mouth makes it likely that there would be some protection from  price competition waged by potential entrants into the equipment leasing space.

The next bight idea: since this model works well in hospitality, why not extend it to other sectors? Silver Chef establishes GoGetta in 2008 and does very well indeed. Earth movers, gym equipment, cash registers, hydraulic pipe benders, trailers, you name it. Same value proposition, same sized businesses, different sectors.

Anyway, here are the financials:

 (NB: Silver Chef's been in business since 1986, went public in 2005, and I don't have access to 2004 balance sheet information).

The above somewhat understates the profitability of Silver Chef's business. The cash recovery rate captures it better:

As an aside, I am convinced that, when Buffett looks at a stock, its CRR is what he calculates first, because it is so quick and so reliable. Consider, for example, this discussion of his investment in Mid-Contental Tab Card Co.

In any case, Silver Chef is in the business of turning purchased assets into cash and one can see from the table above is that it does that quite well and it's getting better at it as it grows.

So, that's where we are: Silver Chef is a simple easy-to-understand business, with a CAGR of 45% over the last eight years, earning its cost of capital, with an as yet 3% penetration of its potential market. It is selling in the market at a yield of 11.65%.

It's no growth value, at an 8.5% cost of capital, is close to AUD$5.15.  If you ask a Buffett-like question -- "Will I earn 15% on $170m of sales?" -- the answer is much more likely to be "yes" than it is to be "no". 

I'd venture that Silver Chef's minimum true value is in the neighborhood of AUD$12.

Disclosure: No position.