Fructivore Investments

A brewing crisis is befalling the American financial landscape in the form of a proposed SEC rule that will allow publicly traded companies to switch from quarterly to semiannual reporting. This is exactly as bad as it sounds. And I say this not as a reflexive neophobe, but because of the risk that it will weaken the flow of information to the investment world without having the proposed beneficial effect on the quality of management.

Information, timely and accurate information, is the lifeblood of all investors, and the way to get it is not to rely on what they want to tell you, but what they have to tell you. It is true of the discovery process in litigation and equally true in the investing arena.

It is true that quarterly earnings reports are not to be found in the Constitution or the Bill of Rights. The SEC used to allow semiannual reporting until 1970. However, since 1970 the S & P 500 has returned a cumulative 33,300%. I suppose not all of that increase can be attributed solely to quarterly reporting, but surely some of it can.

You see, the more information investors have, the more confident they are in the reliability of their estimates of future cash flows and other financial figures, and as such they will demand a lower theoretical return on investment. Removing information from them will have the opposite effect.

To put this effect into numbers, it is estimated that even a 1% increase in required return on equity could cost 10-15% of the US market cap, or a total of 7-10 trillion dollars. Since the Commission claims that this switch could save firms only $200,000 a year in compliance costs, or $1.1 billion a year when spread across the roughly 5500 publicly traded companies in America, I find a severe imbalance in the cost-benefit analysis.

The proponents of this rule seem to rely on two arguments, first that companies could be permitted to take a longer term approach without having to manage quarterly earnings, and second based on compliance costs.

On the first point, long term thinking from corporations has a horizon of several years, not six months. And no one would seriously propose changing the financial reporting period from quarterly to quadrennially just to incentivize long term thinking. Also, I would suggest that rational businesses will have projects from three years ago coming into fruition now, and projects now that will come to fruition in three years, so the quarterly returns will have a rolling boost. Present research already links short-termism to lowered return on invested capital, so it is only the irrational businesses that succumb to short-termism in the first place, and this change will give them an additional three months to conceal their irrationality.

As for compliance costs, I cannot deny that they are substantial particularly for smaller firms. But, although I am generally an AI skeptic, I can still see a regime where financial reports can be prepared on arbitrarily short periods, at least without the management discussion and analysis section (which, to be fair, is sometimes useful, but the AI could probably send out a questionnaire to management or just work out its own estimates of the reason for changing figures and the CFO could just proofread it for reliability). More to the point, the large and more economically significant firms benefit from economies of scale in their financial reportage and the burden on them is relatively much smaller on a percentage basis, so they definitely aren’t the ones crying out for relief.

My other concern is that this rule change is a gift for private equity firms, both by the potential one-time price drop caused by the adoption of this new rule, but the owner of a private firm, being an insider, doesn’t have to wait until the quarterly reports are out; a report covering any period, short or long, current or historical, can be produced on demand at any time. Delaying information available to public market participants only further cements this competitive advantage. I have nothing against private equity, but robust public markets are what made this country great and what allows investment analysts have fun and show off rather than allow investment opportunities to be monopolized.

So, what can be done? Well, at the moment the comment period is still open, so any of my loyal readers who share my concerns should submit a comment opposing this rule at

https://www.sec.gov/comments/s7-2026-15/semiannual-reporting#no-back

I am told the SEC is at least required to read them, and although historically speaking commenting does have a good track record in terms of repealing the rule entirely, it can result in delays, modifications, and so forth Perhaps the proposed rule could be confined, as I suggested in my own submitted comment, to small firms that find their regulatory reporting burden to be an actual burden.

The comment period expires on July 6, so by all means hurry up.

Some of my loyal viewers may recall that last year I had an idea to examine investment returns of banks and insurance companies by book value. Because, as some wise financier said, banks have assets that are impossible to value and insurance companies have both assets and liabilities that are impossible to value. I believe the author of this statement was talking about financial crises where valuations swing wildly, but even in a “normal” market situation changing asset prices and actuarial assumptions turn the value of a financial company’s equity into a “reasonably good” estimate. And this being the case, it may be that the book value may be in error, but the error is unbiased, i.e., it has the same odds of being too high as too low. Therefore, the further the market value of the company departs from the book value, the more likely the market value is to be wrong. And indeed I found the 2025 data as much more confirmatory of this hypothesis than in my 2024 study, as detailed below.

When I looked at returns from 2024 the results were mixed at best. Among banks there was no discernible effect at all, and in fact a high price/book ratio was a slight indicator of outperformance. The only confirmatory evidence was among life insurers, where I found an r-squared of .2 and a p value of about .1, meaning that there is roughly a 90% chance that about 20% of investment returns is explained by the price/book ratio. Which is a fairly thin thread to hang a portfolio construction system on, I admit.

However, I am unwilling to take “not statistically significant” for an answer, and I thought I should repeat the experiment in case 2024 was an unusual year. Again, I used the Value Line list of banks, regional banks (which are apparently distinct from other banks), life insurers, and property and casualty insurers, and this time I sought greater accuracy by, instead of using the one year returns from the day I looked at the particular company, I looked at when the company published its end of year book value, usually in the relevant 8-K but occasionally in the 10-K, and then looking at returns until the day before the end of year book value was revealed in the next year.

After some number crunching (and I wish banks would adopt a standard format for their 8-K to include the book value and tangible book value per share in every case in order to avoid some tedious calculation), the results were more encouraging. For the Value Line’s non-regional banks, when looking at book value I got a p value of .000009, indicating virtual certainty that I’m on to something. However, the r-squared was only .11, meaning the explanatory power of this test is highly limited. Eliminating outliers improved the r-squared to 15.8% and knocked another order of magnitude off of my p-value, making me 10 times even more virtually certain. In fact, you can see in the following graphic that for banks with an above average price/book ratio there were over three banks that had below average returns for every bank that had above average returns. The effect was more muted for banks with low price/book ratios, but it still means that the test worked for 107 banks and only failed for 61.

Among regional banks, which Value Line formerly identified as Midwestern, I obtained similar results, with a highly certain p value and a low r-squared. In this case tangible book value worked better than normal book value (r-squared of .17 as compared to .14, p value of .0011 instead of .0039), and eliminating outliers made the regression worse. And as we see below, when simply dividing the regional banks by below or above average book value, 40 banks complied with the test as compared to 18 that did not. Certainly encouraging news for one who intends to beat the sector index, low r squared or no low r squared.

For life insurers, which if you’ll recall was the shining star of this test last year, the results were likewise encouraging, with an r squared value of .35 based on ordinary book value and a p value of .071, meaning that this could yet be an unreliable correlation, but when using tangible book value we got an r-squared of .41 and a p value of .047, implying that the book value effect was both large enough to seriously consider and likely enough to be reliable at least as far as inviting further inquiry. Curiously, going by book value as adjusted by the insurance company (for changes in actuarial assumptions, unrealized losses, etc.), the r-squared diminished to .275 and the p value to .12. As I have noted, it seems suspicious and not at all surprising that every insurance company in the Value Line universe improves its book value by these “adjustments;” not a single insurance company has net unrealized gains or actuarial assumptions that worked out in their favor.

Among property insurers, tangible book value was again the most reliable (p value of .032), but rather weak (r-squared of .13). Turning to the quadrant method, we see that the above average price/tangible book value are again reliably more likely to underperform, but curiously the lower price/book ratio companies were in fact more likely to underperform. So even though the formal regression revealed a small r squared, the heuristic of avoiding property insurance companies with high price/book ratios seems to be worthy of consideration.

And overall, although the book value effect is small, it seems fairly reliable if 2025 was a typical year, and if any significant part of returns can be reliably explained by a single and readily available metric, it seems advisable to take it into account in portfolio construction.

There are times when I wonder “what am I missing?” when it comes to an investment, and such a situation is FONAR, a charming very small cap company that based on rough analysis has a free cash flow yield of about 25% when you take excess cash into account (which I do, so there). As with many small cap companies, the founders have tried to keep the company under their control with two share classes, one being publicly traded and the other being privately held by the founders and which have a disproportionate number of votes (25 in this case) as compared to the public shares.

Fonar makes MRIs, particularly “upright” ones that allow the patient to be assessed from a sitting position. However, the bulk of the company’s business is not in the sale of MRIs but in operating various MRI diagnostic centers in New York and Florida. The company owns 6 scanning facilities and operates 38 others, handling pretty much every non-medical aspect of managing the facilities in exchange for a flat monthly fee. Curiously, the company owns only roughly 70% of the facility operations business, with the rest owned by outside investors. The upright MRI that FONAR uses is apparently a niche item, as they are less powerful than the typical one, but apparently they have some useful applications. Curiously, the current CEO of FONAR, Timothy Damadian, is the son of the inventor of the MRI, and also owns three of FONAR’s client facilities, which would normally raise the suspicion of self-dealing but apparently their monthly fees are higher than those of other facilities (although it is possible that the company advantages them somehow (or perhaps they simply run a larger operation than the average facility (I have no evidence on way or another; I’m just speculating out loud))).

What attracted me to the company, however, is that out of its $88 million market cap as of this writing, $54 million of it consists of cash on the balance sheet that has been building up over the last few years, and FONAR apparently sees nothing better to do with it than let it sit there.

In fiscal year 2025 (ending in June), sales were $104 million, operating income was $11.6 million and excess depreciation was .9 million, leaving $12.5 million in operating cash flow. Interest expense is likely to be negligible as the company has no long term debt, and after estimated provision for taxes this works out to $10 million in free cash flow, minus $2.4 million for the outside investors, leaving $7.6 million in free cash flow to equity, or $6.9 on a fully diluted basis (see below), which based on the company’s equity value minus excess cash is a yield of 20.2%, which is fairly impressive. And this year’s figures were further marred by an outsize $2.3 million credit loss reserve from one particular insurer.

In fiscal year 2024 sales were $103 million, operating income was $16.5 million and operating cash flow was $14.1 million owing to lower capital expenditures and a less extreme credit loss provision. Minority interest allocation was $3.5 million, leaving $10.6 million for the equity.

In 2023 sales were $99 million, operating income was $14.8 million, operating cash flow was $15.1 million, or $12 million after taxes, minus $2.8 for noncontrolling interest, leaving $9.2 million for the equity.

In 2022 sales were $98 million, operating income was $22 million owing to lower operating expenses, operating cash flow was also $22 million, or $17.6 million after taxes, minus $4.8 million in noncontrolling interest, leaving $12.8 million for the equity.

As I stated, there are several share classes: 6.2 million shares of common stock, 382.5 thousand shares of the class C controlling stock that has the equivalent of 9.6 million votes, as well as 146 class B shares that seem to exist for nostalgic purposes, and 313.4 thousand preferred shares. The class C shares are individually entitled to just under 1/3 of the dividends paid on the common shares (although the company doesn’t pay dividends and with 2/3 of its market cap being excess cash the company has kind of painted itself into a corner in this regard), and are also convertible into common shares at a ratio of 1 common shares per 3 class C shares. The preferred stock ranks equally with the common shares in terms of dividends, distributions, etc. So, at first approximation there are 6.65 million diluted shares.

Many investors, value or otherwise, look to the possibility of a catalyst to unlock latent value. Last July there was a nonbinding proposal submitted by the founders to take the company private, but the offer was not in any sort of detail and the share price seems to have ignored the news completely. It is not unreasonable for a shareholder to worry that the management can use its control to make that cash balance “disappear,” and more looking into compensation will be in order, but under Delaware law majority shareholders are required to treat the minority shareholders fairly.

Unfortunately, the inability of any outsider to force a change in control of a privately controlled company like FONAR makes the catalyst of a buyout unavailable. I am reminded of a tale of the venerable Benjamin Graham who, in the old days, came upon a railroad company that owned a portfolio of Treasury bonds whose value exceeded the market cap of the entire company. He contacted the management, suggesting that they sell them off and declare a special dividend to see what the market would make of a company with a negative share price. However, the management rebuffed him, saying “If you don’t like how we run our company, feel free to sell your shares.” At which point Graham replied “I don’t want to sell my shares; I want to buy more shares. In fact, I want to buy so many shares I take over the entire company, just so I can fire you.” This didn’t happen, but Graham did get hold of a major shareholder who was able to make them see things Graham’s way for the benefit of all involved.

However, with voting control of FONAR securely locked away, this scenario is unavailable. So it may be that an entrenched management is in the nature of an anti-catalyst. Even so, basic finance teaches us that a company is worth the money it has plus the present value of the money it will have, and the money a company has belongs to the shareholders whether or not it is being given to them in the form of dividends or share repurchases. And at some point the market will have to recognize a company’s cash balance, before or after that balance exceeds the market cap of the company (which in FONAR’s case should take about four years).

The chief risk is that FONAR’s management will manage to siphon off that cash balance in a way that a suit under Delaware law would not be worth the money, and indeed the CEO owns three of their client MRI clinics and they are also owned by outside investors whose identities may or may not be other affiliates of FONAR’s management. Also, for somewhat infuriating reasons the company has been a week or two late with the 10-K for many years and the auditors last expressed critical concern about internal controls. At any rate, direct compensation for Timothy Damadian, who owns nearly all the class C shares, has been a fairly reasonable 295k in 2005, 373k in 2024, and 153k in 2023. I should also point out that cash distributions to noncontrolling interests exceeded their share of net income by $3.7 million in 2025, $2.1 million in 2024, $3.0 in 2023, and $1.0 in 2022, and I would appreciate an explanation for this, but it hasn’t been enough to prevent the cash from building up over the years.

So, unless I’m already missing something, FONAR offers a compelling earnings yield and even without a catalyst the cash buildup will have to be recognized by the market at some point. So, for investors with some patience and willingness to deal with very small cap companies, this is an interesting candidate for portfolio inclusion.

Value investors have a preference for income producing assets and concomitantly a particular disdain for gold. Gold, even apart from other commodities, is valued not for its industrial applications or even as a consumable, but specifically because people like to incur storage and insurance costs in order to pile it in a vault and leave it there.

Even so, value investors cannot affect to be wholly unaware of gold’s existence, even in a world with TIPS, REITs, managed futures in non-gold commodities, and publicly traded companies that can pass inflation on to their consumers. And it is commonly alleged that there is a floor to the price of gold, which is the economic cost of mining it because if the price drops below that point miners will simply refuse to mine.

Furthermore, since neither gold nor gold ore spoils, there’s never really a need to sell it to an end user in any length of time, unlike more perishable commodities. Also, even if the world decides that some cryptocurrency or other alternative robs gold of its status as a fear hedge, gold does have industrial applications in electronics and gilding hardcover books and so forth, so eventually the world’s gold stocks will be drawn down to the point where gold will be profitable to mine again. Of course, any financier knows about discounting, so even if the future value of gold in that scenario will be above the cost of mining it, its present value can be well below it.

However, I was throwing around the idea that the cost of producing gold, plus a reasonable profit margin for the miner, could constitute a ceiling for the price of gold. My reasoning is that a person who actually wants gold has two options: one, buy gold; or two, buy a gold mine and exercise some patience. And if the spread between gold and gold miners becomes too great, the latter option becomes more attractive.

The Internet, of course, disagrees with me; it records an incident back in the 70s when gold spiked, but South Africa, which represented the majority of gold production and the vast majority of the First World’s gold production, decided that it would maximize its long term profits by mining lower quality ore instead of mining high quality ore to take advantage of the situation to earn massive windfall profits. Of
course, I wonder if the illustrative quality of this example is limited, considering that gold production is more globally distributed now and there is no OPEC-style cartel for gold producers.

So there is no reason in theory why a lot of gold miners shouldn’t be ramping up production to take advantage of the spike in gold prices; although the Internet informs me that most gold miners don’t fully hedge their output like they did in the bad old days. But since, as of this writing, gold is just over $4000 when it was at $2000 five years ago and at $3000 seven months ago, while the all-in cost of producing gold is hovering around $1500 or less, one can imagine at least some miners to take advantage of a windfall profit.

Even so, I would treat the demand for gold as exogenous, like most economic goods, meaning that the demand is determined by “animal spirits” and is mostly decoupled from supply. In other words, the demand of gold is subjectively determined and the various factors of production must line themselves up to meet it as best they can. So if the cost of production, profits included, serves as a ceiling on the price of gold, it is a very soft ceiling, as miners ramping up production seems like an attractive strategy in the abstract but it also takes time and effort to accomplish in practice, and of course the annual output of gold mines is actually a fairly small percentage of the world’s gold that is available for sale.

At any rate, the situation suggests a strategy that is schizophrenic at first glance but in fact is just hedged. The plan is to buy gold miners, which will be experiencing windfall profits from the spike in gold, and then to either short gold outright or buy puts on it. Ordinarily gold miners represent a leveraged long bet on the price of gold, since they have overhead that magnifies the effect of gold price movements on their profits, so what could be more natural than hedging it with a leverage short on the price of the gold? If gold miners are resistant to hedging the price of their output, let us hedge it for them. In this way we are betting on gold miners’ improved profitability without the inconvenience of the price of gold getting in the way.

And thus, for those of us who do not affect to be pridefully ignorant of gold’s price action, there is a speculative play available.

According to Roman historian Suetonius, in AD 70 Emperor Vespasian of reinstated a tax on the sale of urine, which was used in various tanning and dyeing applications. His son Titus complained to him that this was a nasty way of refilling the treasury, but Vespasian flipped a gold coin to his son, and asked him “That doesn’t smell, does it?”

There is a lesson in this tale for value investors, who are said to look into the unloved corners of the market in search of ignored, disfavored, and often “unsexy” companies, and the money made from them spends better than the money from the latest overinflated fad stock (and often better, because there tends to be more of it).

Unfortunately, Suetonius’s anecdote is not necessarily to be taken literally, as we shall see with Darling Ingredients, perhaps the most euphemistically named company in the world. Darling Ingredients is what I would call an “animal recycler,” in that it collects the byproducts of slaughterhouses and butchers and processes them into animal feed. Specifically, “The process starts with the collection of animal by-products, including fat, bones, feathers, offal and other animal by-products. The animal by-products are ground and heated to evaporate and remove water and separate fats from animal tissue, as well as to sterilize and make the material suitable as an ingredient for animal feed. The separated fats, tallows and greases are then centrifuged and/or refined for purity. The remaining solid product is pressed to remove additional oils to create protein meals. The protein meal is then sifted through screens and ground further if necessary.”

Darling Ingredients also processes excess residuals from industrial bakeries so as to have all the macronutrients covered as far as animal feed goes. The company also produces collagen and other animal products such as heparin and bone chips for use in human food, as well as animal intestine castings for sausages, and also produces biodiesel from used cooking oil and some animal fats, and impressively is capable of producing jet fuel in this manner. And, just for the crowning achievement in distasteful work, the company is working on large-scale production of protein for animal feed using the larva of soldier flies.

So clearly the company has the obscure and distasteful side of the equation covered, and according to its SEC filings they are the only company purely in the animal recycling business in the world. However, despite this happy situation, Darling Ingredients seems to have little control over its margins, which is surprising for a company with theoretically so few competitors. It is also surprising considering that at least for its animal feed business, which is 2/3 of its total sales, the majority of its sales are based on the “formula” arrangement, where the sale price is based on the publicly-available price of the end product. One would expect this to make margins more stable, but in fact they collapsed in 2024 as feed prices declined, even though physical volume remained flat.

To be specific, Darling Ingredients has a market cap of $5.2 million as of this writing. In 2024 sales were $5.7 billion and operating income was $468 million, counting the income from the biodiesel joint venture. Excess depreciation came to $214 million, producing operating cash flow of $682 million. Interest expense was $254 million, and after estimated taxes of 21% we get free cash flow of $338 million. In 2023, sales were $6.8 billion, operating income was $950 million and capital expenditures exceeded depreciation by $13 million. Interest expense was $259 million, leaving $536 million after estimated taxes. In 2022 sales were $6.5 billion and operating income was $1029 million, capital expenditures net of depreciation was $198 million. Interest expense was $126 million, resulting in after-tax free cash flow of $557 million.

The reason for the increases in interest expense was owing to several debt-financed acquisitions since 2022: A producer of collagen products in South America and the United States for $1.2 billion; an independent rendering company in Brazil for $563 million, and a chain of American rendering plants in 2022 for $1.18 billion. So far it seems these acquisitions have not been accretive to earnings.

Year to date, sales were $2.86 billion as compared to $2.88 billion last year; operating income was $104 million as opposed to $286 million last year, and excess depreciation was $136 as compared to $34, leaving operating cash flow of $240 million as compared to $320. Interest expense was $110 million as compared to $132 million, leaving free cash flow after taxes of $103 million as compared to $149 million. The chief reversal in Darling’s operating income was its joint venture in biodiesel producing a loss instead of a profit, mainly owing to a reduction in renewable fuel tax credits. And although food ingredients, particularly collagen, were a bright spot in sales growth for 2024, I have concluded from my research that dietary collagen supplements are ineffective if someone’s diet has sufficient protein anyway, and if this view should become generally adopted the company’s prospects will suffer. Darling Ingredients also states that the meat processors of America have been undergoing consolidation of late, and large meat processors are more likely to do their rendering in-house than sell their scraps to others.

Nonetheless, the Value Line is projecting earnings in the next few years to be on par with 2022’s. I wish to share their optimism. Even so, despite the company’s distasteful line of business, I would definitely like to see more assurance that Darling Ingredients will get its margins under control before I will accept that the current dip in earnings is temporary.

Thanks for the opportunity to use the ancient meme.

One of the peculiar risks of value investing is that the underpriced company that you spent all that time and effort analyzing will be bought out from under you before the gap between its price and intrinsic value is resolved. Ordinarily the acquisition comes at a premium to the market price, but sometimes even this premium price is less than one’s calculated value, and ironically the larger the margin of safety and the more attractive the company’s price, the greater the risk is. It happened to me years ago with Qwest, and the Interpublic Group (IPG) acquisition is another example.

Interpublic Group is an advertising company that I ran across some months ago that reflected this situation. Last December it was announced that IPG would be acquired by Omnicom, a slightly larger advertising firm (and what is with advertising companies having sinister names?). The FTC has given its final approval and the merger is likely to close soon, and unfortunately the price has settled somewhat on the low side of fair value.

Actually time has made a fool of this deal; when it was proposed in Dec 9th, each share of IPG was to be exchanged for .344 shares of Omnicom, but Omnicom was at $102 before the merger was announced and $92 immediately afterwards. At the time this implied a price of $31.65 for Interpublic Group. But as of this writing Omnicom is at $72.65 which puts IPG at almost exactly $25, just a tiny premium over the current share price of $24.85 representing the market’s near certainty that the merger will go through as planned.

However, Omnicom itself is slightly underpriced in my view, offering a free cash flow yield of 12% at current levels and it is actually increasing sales (unlike IPG where sales are flat or declining). So Omnicom is committing a more common risk than an inadequate acquisition price. In general, a company that is underpriced should be repurchasing its stock, a company that is fairly priced should be paying dividends, and a company that is overpriced should be using its stock to acquire cheaper companies. Omnicom is doing it backwards.

Interpublic Group is an advertising agency and PR firm operating in traditional and digital media, as well as related services. As of now it has a market cap of $9.1 billion. It has a cash balance of $1.5 billion but its current assets exceed current liabilities by only $600 million. For the last full year, sales were $10.7 billion and operating income was $1.2 billion. There was a goodwill impairment of $232 billion and excess depreciation of $117 million, resulting in operating cash flow of $1.55 billion. Net interest expense was $80 million (as the company maintains a large cash balance there is substantial interest income), resulting in free cash flow of $1.25 billion after estimated taxes. In 2023 sales were $10.9 billion and free cash flow was $1.17 billion, and in 2022 sales were $10.9 billion and free cash flow was $1.08 billion.

Year to date, sales declined by 3.5% year over year, most significantly in the UK and Asia. I can attribute part of that to the impending merger interrupting client acquisition. At any rate, operating cash flow (net of merger-related restructuring charges) comes to $441 million as compared to $416 million last year. Impressively, expenses declined faster than revenues so margins improved. So, based on a 10% return on investment and flat growth, it would appear that IPG is underpriced or on the low end of fairly priced.

Meanwhile, over at Omnicom, there is a substantial cash balance but no excess cash. For 2024 sales were $15.7 billion and operating income was $2.27 billion. Excess depreciation of $101 million and net interest expense of $147 million produces free cash flow of $1.76 billion. For 2023 sales were $14.7 billion, operating income of $2.10 billion and free cash flow of $1.74 billion, and for 2022 sales were $14.3 billion, operating income was $2.08 billion, and free cash flow was $1.65 billion.

This year to date, sales increased from $7.7 billion from $7.5 billion, operating income was $892 million compared to $989 million, plus excess depreciation of $46 million as compared to $58 million, interest expense of $70 million versus $68 million, leaving free cash flow of $686 million versus $773 million. This includes nearly $100 million in acquisition-related costs. At any rate, based on the 2024 results Omnicom has a free cash flow yield on the order of 12.5%, suggesting that the company is somewhat underpriced.

Furthermore, Omnicom also announced that it is expecting $750 million in synergies, mostly in the form of cost savings, and studies (https://knowledge.wharton.upenn.edu/article/how-to-get-mergers-and-acquisitions-right/) show that cost savings are more reliable than other types of synergies and are realized at an average rate of 60-90%. It does seem surprising that a merger (net of severance costs some of which are yet to be realized) could produce billions of value simply by consolidating some redundant departments, but even if a fraction of the synergies are realized this would enhance the value of an already underpriced company.

So, even though this merger is not the ideal outcome from a value investing perspective, either Interpublic Group or Omnicom would seem to be an enticing candidate for portfolio inclusion.

It is always difficult being a minority shareholder. Well, obviously most people reading this are not going to be the majority shareholder of a public company (and if you are, I am available for consultation at reasonable rates).

But I mean a minority shareholder of a company that has a such majority holder or group that has the power to control the entire company. The defects in such an arrangement are two-fold, one being the fact that the officers and management cannot be replaced for incompetence. For this reason, publicly traded companies with an entrenched majority often trade at a discount that varies according to the market’s perception of management quality.

The other disadvantage in this arrangement is the possibility that the majority holders will enrich themselves at the expense of the outside shareholders. Although Delaware law offers some protection for shareholders against this possibility, this requires costly litigation and in the absence of a clear-cut case there may be some reluctance to pursue this outcome.

Which brings us to GoodRx, a company with two classes of shares, one publicly traded and one not so much. The company is in the business of discount prescription drugs, operating in the shadows of the health insurance industry to provide an alternative nexus between pharmaceutical companies and the public. The company came to my attention during a routine flipping through the Value Line, but the figures in most finance data aggregators doesn’t account for GoodRx’s two classes of shares. Yahoo! Finance, for example, records a market cap of $1.74 billion as of this writing, which corresponds to 361 million outstanding shares. However, the class A shares, which are publicly traded, number only 104 million, and the remaining 257 million are class B shares, which are not publicly traded and have 10 votes instead of one for the class A shares, so the actual float of the company is only $500 million. The class B shares can be converted into class A shares at will, but the holders have only done so in order to engage in share repurchases, for which use the company has expended a considerable amount of the company’s cash.

At least the company has not concealed this intent; GoodRx’s latest 10-K states: “There have been no material changes in the expected use of the net proceeds from our IPO as described in our
Registration Statement. As of December 31, 2024, we estimated we had used approximately $586.4 million of the net proceeds from our IPO: (i) $164.4 million for the acquisition of businesses that complement our business; (ii) $262.0 million for the repurchases of our Class A common stock; and (iii) $160.0 million for the repayment of our outstanding debt obligations. As of December 31, 2024, we had $300.5 million estimated remaining net proceeds from our IPO…” and indeed the balance sheet shows $301 million in cash.

I should point out that the registration statement’s “Use of proceeds” section doesn’t mention share repurchases; it mentions acquisition of businesses and general corporate purposes and only a desultory mention that “We may find it necessary or advisable to use the net proceeds for other purposes….” such as, say, providing an exit strategy for a cabal of private equity firms when the share price has declined dramatically since the IPO. (It took me a while to write this article because I was trying to strike the right balance between expressing my opinion and avoiding libel suits).

Actually, what tripped my sensors for GoodRx was its high operating cash flow, which only arises because of the massive amounts of share-based compensation; in fact, the share-based compensation is comparable in magnitude to the quantity of share repurchases in a given year. There are two possible explanations for this, neither of them particularly encouraging. One, the company is finding ways to justify its shareholder repurchases with massive stock grants for some nefarious purpose I’m not quite clear on. Or two, the company is unprofitable enough that it has to pay its employees in stock rather than cash. Normally at this point I would compare GoodRx with its competitors to find an answer, but it seems that they don’t have any publicly traded competitors.

Either way, maybe in 2028 all the class B shares will convert into class A shares so the group may be getting out while the getting’s good, although at the current rate of repurchases the company will have burned through its remaining excess cash by then.

Looking at the figures, operating margins have improved since 2022, as have sales. For 2024 sales were $792 million, operating income was $66 million, net of $99 million in share-based compensation. Depreciation and amortization equaled capitalized software, so by my usual calculation operating cash flow remained at $66 million, and interest expense for the year was a whopping $53 million. The company also finished the year with $450 million in cash on which it earned $23 million in interest, so the interest coverage situation is not desperate, although it seems rather dire for my taste. This leaves $36 million before estimated taxes, or $29 million after taxes. For a float of $500 million this is not unreasonable, although too low for my taste, but let us recall that the company founders, not satisfied with the $150 million in share repurchases they have received this year, are also entitled to about 72% of this money based on their ownership percentages.

In the first quarter of 2025 the company had operating earnings of $23.4 million as compared to $7.4 million the previous year, stock-based compensation expense of $19.2 million as compared to $25 million, net interest expense of $6.7 million as compared to $7.1 million, producing earnings of $12.5 million before estimated taxes, or $10 million after, as compared to $300 thousand and $225 thousand. There were also stock repurchases of $100 million and $153 million last year; I suppose the company is in the habit of doing its repurchases early in the year.

The company’s remaining cash balance, as I said, was $300 million, and normally, as with BorgWarner I would consider it as non-operating and available to the shareholders, but based on GoodRx’s history I think that money is available primarily to the class B controlling shareholders, not the poor outside investors with the publicly traded shares with their claim on only 28% of the company’s earnings.

Obviously I don’t recommend GoodRx; the free cash flow yield is somewhat anemic even setting aside the two tiers of stock, and without setting that aside the yield is certainly not fair compensation for the minority status. It’s more of an object lesson in the dangers of an entrenched majority owner and the foibles of stock screening.

…but nobody to know what it is. This line was originally chosen to describe a company that was floated alongside the South Sea Bubble in England. And although unfortunately this company seems to be fictitious, there are certainly businesses who could stand to be a little more helpful in describing what products or services they are selling.

And so it is with OpenText, which does the following:

OpenText is an Information Management company that provides software and services that empower digital businesses of all sizes to become more intelligent, connected, secure and responsible….With critical tools and services for connecting and classifying data, OpenText accelerates customers’ ability to deploy Artificial Intelligence (AI), automate work, and strengthen productivity…Our products are fundamentally integrated into the operations and existing software systems of our customers’ businesses, so customers can securely manage the complexity of information flow end-to-end. Through automation and AI, we connect, synthesize and deliver information when and where needed to drive new efficiencies, experiences and insights. We make information more valuable by connecting it to digital business processes, enriching it with insights, protecting and securing it throughout its entire lifecycle and leveraging it to create engaging digital experiences….Our solutions also enable organizations and consumers to secure their information so that they can collaborate with confidence, stay ahead of the regulatory technology curve and identify threats across their endpoints and networks…

And this is in their 10-K, so all of the above is true under penalty of perjury.

The trouble is that if we don’t quite know what a company does, we don’t know if they’re any good at it, or if their competitors might be better at it. Warren Buffett famously claims that he never invests in businesses that he doesn’t understand, which includes high technology. And normally software companies have anemic free cash flows anyway, so a value investor would have no interest in them. My theory is that because writing code is considered an operating expense rather than a capital expenditure (with the exception of a product that is somewhere between commercially viable and fully developed (but not post-development updating or maintenance (which tends to be important for business clients))), the company shows a high return on invested capital (unless there has been an acquisition in which case there is a lot of goodwill on the balance sheet), which attracts a lot of algorithm-minded portfolio managers. Furthermore, as a software company can essentially replicate its product indefinitely at no cost, there is a lottery ticket effect for a company that comes up with the next “disruptive” or “killer” app, as the kids say. Even so, for a larger company in a saturated space such as Microsoft or Alphabet, the odds of developing a product big enough to move the bottom line are quite small.

At any rate, OpenText provides exciting cloud services to businesses, including content management, cybersecurity, automation of applications, and IT operations, and derives its income from cloud services and support contracts. The company is a serial acquirer in the field, having most recently purchased Micro Focus in 2023, a company that provides “technology and services that help customers accelerate digital transformations.” This acquisition was for $5.6 billion, mostly funded by debt, while the company’s current market cap is a mere $7.2 billion at this moment. However, last year OpenText resold a large portion of Micro Focus back to a private equity firm for $2.2 billion and used the proceeds to pay down some of the acquisition debt. So far the acquisition seems to be working out well in terms of free cash flow, which is a rare accomplishment for a merger between two evenly-sized companies, per Damodaran’s Investment Fables.

Turning to the figures, in fiscal year 2024 sales were 5.77 billion, operating earnings were 887 million, plus 808 in depreciation and amortization, minus investing activities of 159, producing operating cash flow of 1536 million. Interest expense was 536 million, leaving $1 billion, or 740 million after estimated taxes, making a reasonable 10% yield of free cash flow. Their fiscal year ends in June for presumably Canadian reasons.

This calculation does not include the $429 million gain on the sale of part of Micro Focus, which OpenText does not consider to be operating even though mergers and acquisitions are part of the company’s core strategy so it may as well be. This stands in positive contrast to Helen of Troy, which considered the sale and leaseback of its premises to be operating even though they’re in the cosmetics and household products business, not the real estate business. At any rate, the gain on sale raises accounting questions; it is surprising that OpenText would be able to turn a 19% profit on assets it held for less than a year, but considering the substantial depreciation and amortization charges that the company takes, it is possible that many of these gains are simply reversals of depreciation charges. Obviously it is in the interest of OpenText to load the divested unit up with as many high priced assets as feasible, to relieve itself of both capital gains and ongoing depreciation charges, but there are limits even to aggressive accounting and I suppose the company should be congratulated for not courting shenanigans.

This figure also does not include the income from the $1.28 billion in cash on OpenText’s balance sheet, which came to $49 million before taxes for the year. Now, on paper, OpenText’s current liabilities exceed its current assets by nearly $400 million, and so not only is there no excess cash available for distribution to the shareholders (which was the happy situation for BorgWarner that many simple-minded editors could not understand), but in theory the company is also going to have to come up with $400 million within the year, so the value of the equity should be reduced by that amount. However, $1.5 billion of OpenText’s current liabilities consist of “deferred revenue.” This category of liability denotes the fact that OpenText’s customers have paid the company up front for services that are to be performed over time, and given the company’s profit margins, even under the worst case scenario of having all of the costs pertaining to this deferred revenue as having yet to be incurred, there should be no additional pressure to come up with more money based on deferred revenues. At any rate, OpenText is in the habit of keeping about $1.2 billion in cash in reserve, so even if it should not be considered available for distribution the income from it should not be ignored.

In 2023 sales were 4.48 billion, operating earnings were 516 million, depreciation was 657 million, capital expenditures 124 million, resulting in 1049. Interest was 364, leaving 685 or $507 after taxes. I should also note that between this fiscal year and 2024 there were charges of nearly $150 million to integrate Micro Focus with OpenText that are in theory nonrecurring but OpenText’s strategy involves frequent acquisitions, though most are not this large.

In 2022 sales were 3.49 billion, operating earnings were 645 million, depreciation was 504 million, capital expenditures came to 93 million, producing 1056. Interest was 151, leaving 905 or 670. There was another acquisition funded by debt in this year.

Year to date 2025, sales are $3.86 billion as compared to $4.41 billion for the first three quarters of 2024, and operating income is $711 million versus $694 million, as expenses are declining faster than sales (which is another promising sign that the Micro Focus acquisition and partial disposition was a good move). Amortization of 480 million and expenditures of 109 produce $1082 in operating cash flow versus $1205 for 2024. However, interest expense was $267 million versus $425 million, leaving $815 versus $780 in pretax free cash flow, or $603 million versus $577 million in after-tax free cash flow, which would be $804 million on a full-year basis.

Interest expense is better covered than before, although the company is still rated BB+ and the outlook is only stable. Unfortunately the gulf between a BB+ bond, which is subinvestment grade, and a BBB- bond, which is investment grade, is roughly as wide as that between Dives and Lazarus, so a credit rating upgrade would be a truly momentous event.

Furthermore the company has made non-trivial amounts of share repurchases this year, so conceivably management sees OpenText as both undervalued and in a state mature enough that its cash needs are predictable enough to allow for repurchases.

So, can we recommend OpenText? Much of the revenue is recurring and the cost of switching IT providers is high enough that companies would not do it lightly. And it is unusual to find a technology company this cheap, although the Software as a Service model is theoretically more difficult to scale than the pure software company model of a company releasing its product into the wild and hoping it finds a habitat and reproduces wildly (if such a model ever existed). Also, the share repurchases suggest the possibility that the company is stabilizing and so even with some opacity as to the company’s operations and competitive niche, OpenText is worthy of consideration for one’s portfolio.

I’m sure someone other than me has observed that a value investment is a value trap that worked out and a value trap is a value investment that didn’t work out. At any rate, it seems to me that it takes more than a high earnings yield to make a value stock. A low P/E can be justified if the company is risky or in terminal decline, which are not inherently disqualifying for a stock, but when combined with a lack of competitive moat a low multiple is well-deserved and is unlikely to signal an opportunity.

Which brings us to Helen of Troy (HELE). This knife has been falling since 2022 when it had a share price of about $245; it consolidated at around $97 between October of 2022 and June of 2023, went up a bit and then back down and then fell off another cliff in June of 2024 to about $55 or $60, drifted sideways for a bit, and then collapsed again because of the tariffs to $24 and change as of this writing, and has not shared in the post-tariff rally. The question becomes at what point, if any, we can declare this share price decline to be overdone.

Actually, that’s the wrong question. First of all, historical stock prices are widely believed to have no predictive power, and obviously the people who thought the company was worth $245 in 2022 are no longer around and willing to act on their belief by bidding the company back up. Second, a company is fairly or incorrectly priced based on its earnings power, not by the path it took to arrive at that price. And third it is entirely possible for the fair price to be zero, particularly in the presence of debt. It may or may be not be a bit harsh to apply this criterion to HELE, as we shall see.

Helen of Troy is a supplier of kitchenware, insulated beveragewear and coolers, and outdoor carrier packs; and also cosmetics, home health care products, and also heaters, fans, air purifiers, etc. to both online and physical retailers. This somewhat chaotic mix of household goods is the result of several acquisitions over the years and whatever competitive advantage Helen of Troy brings from its distribution network is questionable, as sales have been declining in recent years. The company has been focusing on rationalizing its brand portfolio and has incurred significant restructuring charges in recent years, which one is often tempted to treat as nonrecurring but for a serial acquirer undergoing business difficulties I anticipate that Helen of Troy will be in a constant state of restructuring for the foreseeable future.

Helen of Troy’s product lines are largely commoditized, meaning that their products tend to compete on price more than product differentiation. The cosmetics I’m not so worried about for even with recession fears in the market, make-up is about the last thing women will cut from their budget, and generally they are considered consumer staples rather than discretionary. On the other hand, even if people will continue to buy cosmetics, it is not a given that they will continue to buy them from Helen of Troy. Sales in the US account for 3/4 of total sales, and as 63% of their products came from China in fiscal year 2025 (fiscal year ends in February), the tariff concern is not unjustifiable.

Turning now to the figures, just about 47% of Helen of Troy’s sales in 2025 came from Home & Outdoor and 53% from Beauty and Wellness. Sales in the former declined by 1.1% as compared to 2024, and in the latter, 10%, not counting the effect of a new acquisition.

I am often in the practice of counting acquisitions as growth capital rather than maintenance capital for purposes of computing free cash flow, but I think this approach is more justifiable for industrial companies and other capital-intensive businesses where an acquisition can add a new product line or supplier and at any rate it represents its own source of sales and earnings. But in HELE’s case, acquisitions of brand names are part of the company’s innate strategy and generally results in acquiring intangibles, so I think acquisitions might well be charged against free cash flow, particularly as they have resulted in occasional goodwill writeoffs. At any rate, given the size of Helen of Troy’s recent acquisitions relative to its current market cap, the acquisitions should at least be noted.

The figures are further complicated by a gain on the sale and leaseback of certain premises in 2024 which the company credited to cost of goods sold for some reason, and the expense of complying with an EPA ruling in 2023, both of which I have adjusted out. Counting the gains from the sale of property as operating income borders on an accounting shenanigan to me, as the company is not in the business of buying and selling real estate and this gain is not part of the company’s recurrent business activity.

In 2025: Sales $1908 million, gross margin $914 million, operating income (not counting impairments) $188 million, depreciation and amortization $55 million and capital expenditures $30 million, producing operating cash flow of $213 million. Interest expense $52 million, leaving $161 million or $128 million after 20% estimated taxes. There was also a $229 million acquisition, so if that is counted free cash flow was actually negative in fiscal year 2025.

In 2024 sales were $2005 million, gross margin $949 million, operating income (adjusted for real estate gains) was $224 million. Depreciation and amortization was $51 million and capital expenditure was $37 million, leaving $238 million in operating cash flow. Interest expense was $53 million, leaving $183 million, or $146 million after estimated taxes. There were no acquisitions this year.

In 2023 sales were $2073 million, gross margin was $899 million, operating income (adjusted for EPA compliance costs) were $235 million. Depreciation and amortization were $45 million, and capital expenditures were $175 million, leaving $105 million. Interest expense was $41 million, leaving $64 million, or $49 million after estimated taxes. There was also $146 million in acquisitions that year.

In 2022 sales were $2223 million, gross margin was $953 million, operating income was $273 million. Depreciation and amortization was $36 million and capital expenditures were $78 million, producing operating cash flow of $231 million. Interest expense was $13 million, leaving $218 million, or $176 million after estimated taxes. There was also $411 million in acquisitions that year.

The alert reader will note that the acquisitions were not covered by Helen of Troy’s operating cash flows, which were funded by borrowings. And yet despite these acquisitions, sales and earnings have been declining. I should note in 2025 the company repurchased $103.2 million in shares at an average price of $99.34, and in 2024, $55.2 million at an average price of $127.67. Helen of Troy also repurchased $188 million in shares in 2022 at an average price of $220 per share and $203 million in 2021 at an average price of $197. Even allowing that the company can be forgiven for not anticipating the collapse in share prices, three of the repurchases were made with borrowed money. Some companies do recapitalize by swapping debt for equity, but those are generally maturing companies moving from their growth to their mature phase, not ones in such a precarious position as Helen of Troy, which has declining sales, $560 million in market cap, and $900 million in long term debt.

So, returning to our original question of whether the collapsing stock price of Helen of Troy is overdone, $146 million in free cash flow for 2025 gives us free cash flow yield of 26%. If we demanded a 10% return on investment, and we could be assured that earnings would decline at no more than 16% a year in perpetuity, we could in theory find a satisfactory purchase. However, as we have said, Helen of Troy imports 63% of its products from China and even before the tariff announcement the company was seeing weakening demand for its products, which as I have said are commoditized and therefore compete largely on price even though HELE’s strategy seems to involving acquiring brands. Therefore, I find it difficult to predict if sales will decline at 10% or 16% or 26% or more (or less, admittedly), and I would not care to take the risk of guessing wrong.

I could take the backup approach and value the company largely on its balance sheet, but owing the company’s acquisitive nature, most of its long term assets consist of goodwill and intangible assets. Tangible assets total $1.382 billion, while the company’s total liabilities come to $1.449 billion. So, when I asked how much further the share price has to fall, all the way to zero is not the trivial answer it first appeared. Furthermore, even if the company is coming up with $146 million in free cash flows every year, a prudent company would shoring up its balance sheet by paying down debt (and an imprudent company is an unattractive proposition in itself), so it could be years before that cash flow would be genuinely available to the shareholders.

Wherefore I can say that even if catching a falling knife were a desirable strategy in general, I think catching this one strikes me as an unattractive proposition, despite the considerable free cash flow yield, and so I cannot recommend it as a candidate for portfolio inclusion.

I had a surprisingly bad experience at a certain investing website that accepts user submissions and I thought I would speak of it. Last week I spoke highly of BorgWarner and thought a wider audience might benefit from my views, so I submitted my last post to them.

I proposed that the equity was worth $4.8 billion, plus $2.1 billion in the company’s excess cash, plus about $400 million in the present value of the company’s below market interest rate, total $7.3 billion. My editors, including two managing editors, though, argued that if I wanted to add the company’s excess cash to the equity, I would have to remove the company’s long term debt from it as well. Naturally, I found this quite confusing because I thought I already deducted it from the assets to arrive at the equity in the first place, and that under their rules the company was worth less money with the excess cash than without it, but they weren’t having it.

Now, the formula for Enterprise Value is EV = Equity + debt – cash. This equation is so ubiquitous that I can’t really think of a citation for it, so let’s just say The CFA Curriculum (any level), vol. 2. The equation can easily be rewritten as Equity = EV – debt + cash. Now, the equation that the editors are using, equity = EV – debt + cash – debt, I am quite unable to find a citation for.

I think it was the “- cash” part that was throwing them off, because I am a firm believer in the concept of excess cash, of which BorgWarner has $2.1 billion based on the usual formula. And for the sake of avoiding double counting, I scrupulously removed any of the interest on the excess cash, so that $4.8 billion is what the equity of BorgWarner would be worth if the company had no cash at all.

We may check the math as follows: Enterprise value is also the free cash flow to firm discounted at the weighted average cost of capital. The weighted average cost of capital is the long term debt weight of 5.7% * 3.7 billion, plus 12.5% * 4.8 billion/8.5 billion, or just about 9.5%, and $811 million per year capitalized at 9.5% is $8.5 billion again (unsurprising since I’m just reversing the weighted average cost of capital formula). The value of the equity is based on a discount of the free cash flow to the equity at 12.5% and matches the one computed from the enterprise value equation (as it should since I supplied the numbers myself), and now the cash must be dealt with somehow. In fact, the enterprise value equation does not distinguish between excess and non-excess cash so the raw equation is even more generous to my point of view.

And here, again, is where my editors insist for whatever reason that I subtract the debt again, which, in addition to being based on the equation conjured from their own fevered brains, also messes up the enterprise value based on weighted average cost of capital as it essentially assumes that the company will pay off its long term debt and yet continue to pay interest on that debt for some reason.

In fairness, a company cannot operate with no cash at all, and even though BorgWarner is cash flow positive and has an untapped $2 billion line of credit it may find it useful to keep some cash on hand. A rule of thumb is 2% of annual sales, which in BorgWarner’s case works out to $280 million, but the company could give up at least the $1.8 billion in cash left over. And obviously a company can have excess debt, current or long-term, and any cash used to pay that down would be unavailable to the shareholders, but BorgWarner is not such a company and therefore there is no reason to assume that its long-term debt will be paid off at any point in the foreseeable future.

I was trying to explain my reasoning, although perhaps not as well as I might because I was still stunned into inarticulacy that they were using the special EV = equity + 2*debt – cash formula that their editorial policy has apparently forced on them, when they declared their decision was final. Suffice to say, I will not be renewing my trial membership.