I Will Gladly Pay You Tuesday…

Investing should be simple.  The best way to make it simple is to think about a large business as if it were a small one and you were the only owner.

Enter Wimpy.  The timeless character from the classic Popeye cartoons.  His famous line is “I will gladly pay you Tuesday for a hamburger today.”

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Let’s think about a business that caters solely to Wimpy and his family of hamburger eaters.

Day One:

Wimpy buys one hamburger for $1, while agreeing, of course, to pay you Tuesday.

Let’s create some financials for this business—simplistic financials, of course.

Income Statement:

Sales: $1

Cost of Goods Sold: $0.80

Profit: $0.20

Balance Sheet:

Accounts Receivable: $1 (amount owed by Wimpy for hamburger sold today)

Debt: $0.80 (we will assume you borrowed money from your Parents to start this hamburger joint and used the first 80 cents to buy ingredients to sell Wimpy his first hamburger).

We will ignore the equity for our purposes.

Cash Flow Statement:

Cash Flow from Operations: Negative $(0.80)  This would show up as an increase in accounts receivable.  Wimpy is a customer who owes you $1.00 cents for a product that you already sold him.

Cash Flow from Financing: $.80 –Debt raised from Parents

This is simple enough so far.

Day Two:

Wimpy comes back the next day with the same proposition.  I will gladly pay you Tuesday for a hamburger today.  You realize, however, that you have a great product.  Obviously, it is your product that is great because Wimpy is coming back for more (not due to your lavish extension of credit).  So, your economics class teaches you to raise prices.  You charge him $1.10 for the hamburger.

How do your financials look now (year to date):

Income Statement:

Sales: $2.10

Cost of Goods Sold: $1.60 (cost of hamburger remains the same)

Profit: $0.50

Balance Sheet:

Accounts Receivable: $2.10 (amount owed by Wimpy for hamburger sold today)

Debt: $1.60 (Needed to raise another 80 cents from your Parents)

Cash Flow Statement:

Cash Flow from Operations: $(1.60)

Cash Flow from Financing: $1.60 –Debt raised from Parents

Day Three:

Wimpy brings his family this time, cousins and all.  Your product is great, so you raise your prices again.  Another 10%, $1.21 per hamburger.

10 Hamburgers are sold

Day 3 Tallies:

Revenue: 10×1.21=$12.10

Costs: .80×10=$8.00

Additional Debt Raised=$8.00

Income Statement:

Sales: $14.20

Cost of Goods Sold: $9.60 (cost of hamburgers remains the same)

Profit: $4.60

Balance Sheet:

Accounts Receivable: $14.20 (amount owed by Wimpy and family for hamburgers sold)

Debt: $9.60 (Needed to raise another $8.00 cents from your Parents)

Cash Flow Statement:

Cash Flow from Operations: $(9.60)

Cash Flow from Financing: $9.60 –Debt raised from Parents

The most interesting thing about this exercise is to see what happens if you create press releases for this imaginary company.

The company can show very large Same Store Sales increases.  Gross margins will expand (charging more for the same product).  All of these “metrics” are the apple of Wall Street’s collective eyes wide shut.  Look here, not there.  A lesson from magic applies to financial statement analysis.

The metric to focus on instead is cash flow generation.  $0. (more accurately negative) Debt and accounts receivable fuel the growth of sales.

Amazingly, this company actually exists in real life.  Wimpy isn’t their only customer, but there are plenty of Wimpys out there, and if word gets out that you can have a product today for payment “the second Tuesday of next week,” an ironclad law of business is as follows: give away stuff for free and your sales will rise.

Real Company

Sales:

2004: $567m

2013: $1,194m

Accounts Receivable:

2004: $26m

2013: $579m

Debt:

2004: $5m

2013: $536m

Cash Flow during Ten Year Prior Period: Negative $92m

Sales have roughly doubled, but accounts receivable have risen 22x and debt has grown 107x and cash flow is negative “a lot.”

Amazingly, once again, this company really exists, and was valued earlier this year, hold your breath, at $2.89B…as in billions of dollars.  Roughly $3B dollars for a company that has produced negative $92 million in cash flow over the past ten years.

I would tell you the name of this company, but you wouldn’t believe me.  The name is simply too ironic to actually be real, but I assure you it is.

Ok, I relent.  Conn’s, as in this must be a con, right?  Nope, not joking.

Currently this company is now only worth only $1B, but my faith in the irrationality of the markets remains firm.  As an example of companies being wildly overvalued, Conn’s is certainly one of the best.  My hope is to find an equally attractive, yet irrationally undervalued company.  Irrationality works both ways.

 

 

 

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