Source: Graham & Doddsville
Probably our best ideas over the past ten or 12 years have been ideas that looked cheap and which actually ensnared a lot of value investors.
The investors didn’t realize that these businesses were deteriorating faster than their ability to generate cash.
Eastman Kodak was a great example of that. A few famous value investors were buying it all the way down because they assumed that the decline in the business would be a slow glide that would allow the company to harvest cash flows for the benefit of shareholders.
The fact of the matter is that, for most declining businesses, management tends to redeploy cash flow into things outside of their core competencies in a desperate attempt to save their jobs.
In the case of Kodak, they took some of their patent proceeds and cash flow and invested in a printer business, which is another declining business model.
They ended up being decimated by their own invention of digital photography.
When analyzing Kodak as a short candidate, valuation was almost the last aspect that we considered because,as I said, some of the best short ideas can look cheap from a valuation standpoint.
