Lazy value investing

When I mention that I am a value investor to my colleagues, they usually create an impression that is actually at odds with my investment style. This is partly not their fault, as most financial institutions have defined value investing as:

“Value investors are those who focus on companies with below average sales and earnings growth rates. The holdings generally include stocks with lower price-to-earnings and price-to-book ratios. Stocks generally have higher dividend yields. The fund can potentially benefit from turnaround situations. “

That narrow definition of value investing (or any definition of investing) has always pissed me off. I have called this “lazy value investing”.

Put yourself in a box

While I understand the reasons behind the categorization and generalization of investment styles, it is really unfortunate that this definition centers around the value investing community, especially since the majority of us are unlikely to adhere to this rigorous construct.

But I digress. If you want to know my true definition of value investing, read my article Here where I go into these misunderstandings in great detail.

Why am I bringing up this topic? Well, while doing some research recently, I came across a company that apparently had a lot to offer me. I had discovered a very profitable business with solid margins, zero debt and the best result: The P / E (price / earnings ratio) was only 4.4! What a bargain, right?

Not quite. AP / E of 4 for a store of this quality caught my eye like a fish out of the water.

Here are some ways this might be:

  1. The market just mispriced this company and it is seriously undervalued
  2. The market has recently responded negatively (legitimate or otherwise) to this stock, which could indicate a problem with the company
  3. The company’s financial reporting is inaccurate or tampered with, indicating false profits
  4. The company’s earnings have risen dramatically, and the stock price has not caught up (or vice versa) that surge.

So what is it Let’s dig a little to find out.

Bio-Rad company list

The company in question is Bio-Rad (BIO). Bio-Rad is a $ 16 billion healthcare company that makes medical devices for a variety of medical conditions. Bio-Rad is headquartered in California but is globally diversified. 56% of sales come from international locations.

Bio-Rad also has a diverse customer base with laboratories making up over 60% of sales and other academic, government, and biopharmaceutical organizations earning the remainder of the share.

Source: Bio-Rad Business 2021-2023 Outlook presentation

Bio-Rad also has a large stake (37%) in Sartorius AG, a laboratory and biopharmaceutical supplier.

Bio-Rad divides its results into three different segments: Life Science, Clinical Diagnostics and Other Operations. With over 9,000 different machines, Bio-Rad has an extremely broad portfolio of devices that they sell to their customers.

Source: Bio-Rad Business 2021-2023 Outlook presentation

In fact, Bio-Rad operates a good business model with multiple sources of income. Earnings and sales have grown year after year. What exactly is the problem?

P / E edition of Bio-Rad

To find the problem we’re looking for, we need to look at Bio-Rad’s financial data.

Source: Bio-Rad 2020 annual report

As we can see, Bio-Rad’s net sales and gross profit are showing healthy growth of around 4.5% per year. Spending was kept under control and there were no dramatic jumps. There is nothing to worry about here.

Source: Bio-Rad 2020 annual report

For 2019 and 2020, however, there was a significant increase in net earnings and earnings per share (EPS). In fact, Net Income and EPS have increased over 220% over the past two years!

How can that be? We have already found that sales and gross profit are growing by 4.5%. How did Bio-Rad report such a dramatic increase in profits?

The answer lies in looking at the income statement as a whole.

Source: Bio-Rad 2020 annual report

Here we can see exactly what is causing this jump in profit. It appears Bio-Rad has made some gains over the past few years on some of the stocks it owned and has made a hefty profit of over $ 7 billion. This realization of profits contributed to the bottom line resulting in a profit increase of 220%.

What profit did Bio-Rad make? If we delve further into the annual report, we can see that Bio-Rad has realized its profits from its position in Sartorius AG.

What does that mean? While this realization of profits is not necessarily a bad thing, we can see that the profits are not due to operations but to the sale of securities. This is an important distinction as it is important to understand that Bio-Rad’s real business is not composed at a rate of 220%.

Make adjustments

After doing our research, let’s try to properly calculate a better Bio-Rad revenue ratio based on business operations. We can do this in a number of ways.

Operating profit P / E

Calculating Bio-Rad’s P / E ratio based on business operations is actually pretty straightforward. All we have to do is calculate the operating profit that has already been calculated for us in the statement of comprehensive income.

Source: Bio-Rad 2020 annual report

So if we take the total operating income for 2020 divided by the total number of shares outstanding, we have adjusted earnings per share of $ 13.60. Now let’s just take the current market value per share (which at the time of writing is $ 559.98) and divide it by adjusted earnings per share ($ 13.60), which gives us an adjusted P / E of 41.1.

Now, I don’t have to tell you that a P / E of 41 is a far cry from the P / E of 4 we assumed at face value. I think I just told you …

Accrual rate

Another way to calculate the validity of the result is to use the accrual rate. The accrual rate is a method of calculating how much of the company’s profits come from cash.

The formula used to calculate the accrual rate is: net income – free cash flow / total assets. Bio-Rad’s demarcation rate is currently 0.25, which is not necessarily a good thing (negative numbers are good here).

Simply Wall St. has an article that describes that Bio-Rad’s demarcation situation In detail, I strongly recommend that you do some reading.

Why research is important

Let me make it clear here, Bio-Rad is not a bad deal. They are actually maintaining quality operations by developing machines that have likely saved many lives. Here, too, shareholder value is not necessarily undermined.

However, this Bio-Rad example is viewed by the company as a value investment and is a good reminder of how lazy value investing can actually be detrimental to your returns. Many investors would just look at the P / E, see a low number, and buy without doing further research, believing they are getting a lot. After carefully reviewing the annual report and financial statements, we realized that the story had more to offer.

For this reason, the definition of value investing by most institutions has always put me off. Proper value investing is smart investing. Smart investing means doing in-depth research, buying a stock for less than what it’s worth, and maintaining discipline by sticking to the process.

Value investing = intelligent investing. Maybe I should have named this site Vintage Intelligent Investing?

No, I like that alliteration.


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