In my attempt to limit large valuation mistakes, I prefer normalizing cash flows instead of extrapolating recent corporate operating results far into the future. My preference for normalizing is based on my belief that profit margins and earnings for most businesses are cyclical – influenced by credit and economic cycles. In effect, normalizing helps me avoid valuing businesses on peak or trough cash flows.
To normalize cash flows, it’s important to know where you are in the profit cycle. As such, it’s also important to have an opinion on the economic cycle. As regular readers know, I avoid using government economic data to form my macro views. Instead, I prefer viewing the economy through the eyes of business. Specifically, my economic and profit cycle opinion is developed through the analysis and aggregation of hundreds of company reports and management commentaries.
By focusing on the most recent corporate operating results and management discussions, I believe I’m better able to form a more timely and accurate assessment of the economy versus relying on government data, which is often adjusted and revised multiple times after its initial release. Because the bottom-up data is so fresh and is based on real world operating results and outlooks, I also believe I’m better equipped to discern macro trends before those who rely on government economic data (recent examples include consumer slowdown in 2016 and uptick in inflation in 2017-2018).
Since Q2 2017, I’ve been providing readers with a quarterly summary of the current operating environment of the businesses in my opportunity set (300 small cap stocks). With the help of my former analyst, this quarter’s format has changed and has been placed on a new website.
In an attempt to improve the report, we generated a more detailed and comprehensive summary that incorporates my quarterly review process along with many of the larger cap companies my analyst follows. It’s our attempt to provide an alternative for investors and economists who remain highly dependent on government data to form their macro views and forecasts.
We’re very happy with how the report turned out. We put a lot of work into it and we’re hopeful readers will find it useful. We’ve also completed past quarterly reports since I’ve been providing summaries (beginning Q2 2017). These reports can be found on the website (The Bottom-Up Economist). Given the reports length (19 pages), we include a summary and tear sheet for those who do not have time to read the supporting data and commentary.
I provided a link below to download the report. Your feedback is always welcome and appreciated!