Building a Framework: Week 13 - Taking the Framework Challenge to the Next Level
Happy Sunday, fellow Frameworkers!
I don't want to bury the lead, so let me start with some exciting news.
A few weeks ago, we launched the first framework challenge, where we ran a company through David Gardner's 25-question risk framework. The process was valuable and reemphasized the importance of having a framework.
The best part of the challenge was going through the process with someone else. We could share our work, bounce ideas off each other, and learn about multiple businesses.
It was so much fun we decided to make it a weekly thing. We have added people each week and continue to use popular frameworks to analyze stocks and become better investors. The challenges have accelerated my learning and given me the confidence to continue.
After sharing a few of my findings on Twitter, I received a message from a recent startup company that thinks we might be on to something with this framework challenge. Initially reluctant, I accepted an invitation to meet, and I'm glad I did.
After seeing the resources they have to offer, I've decided to double down and put more energy into the framework challenge. My goal is to build a robust community of like-minded investors who challenge and encourage each other. We'll do this with weekly and monthly challenges that provide a place for investors to build their framework alongside each other.
The goal will be to consolidate information and allow investors to decide what is most important to them by experimenting with different frameworks. The part I'm most excited about is the community. There will be a place to interact with others while building your framework. You can discover new ideas, ask questions, and share what you are learning.
I plan to roll out the first challenge in a few weeks. Let me know if you want to try it out, and I will send you the link when it's ready.
Working My Way Through the Financials
I continue to fumble my way through the company financials. While I am still struggling, I am beginning to learn my way around a 10K and have some advice for others with similar issues.
When in doubt, keep scrolling. I learned that when I have a question about one of the 3 big statements (Income, Balance, and Cash Flow), the answer is usually found by scrolling down a few pages. As you move through the 10K, there are more documents, and they often provide more details and color.
My second piece of advice is to make friends with a CFA. Thanks again, Natalie!
GXO Update
I have been running GXO 0.00%↑ (the largest pure play logistics company), through John Rotonti's Investing Checklist. You can catch up here.
I used the numbers from the latest 10K to tackle two important ratios.
Disclaimer: This your weekly reminder that I am learning and may have made some incorrect calculations. If you are considering GXO as an investment, please do your own work.
Net Debt to Free Cash flow
For a business to grow, it needs to reinvest its cash. If they are saddled with debt, they will have fewer dollars to invest. Because of GXO's recent acquisition, their debt is higher than normal. They did mention a desire to significantly lower the debt by the end of 2023, but it is clear that this business depends on leverage.
Net Debt = $1,311B
Free Cash Flow = $240M
2022 Net Debt to Free Cash flow = 5.46
Interest coverage - EBIT/Interest Expense
EBIT=$242M
Interest Expense = $29M
Interest Coverage = 8.34
For a company with the earnings power of GXO, the interest expense is not a huge concern.
Highlights from the Framework Challenge
Natalie tackled the 3rd question on John Rotonti’s checklist 👇
Ken did some digging on TriNet Group and plans to run it through David's risk framework next week. You can see his introduction to the company here 👇
Something Worth Reading
While there aren't any foolproof measures to prevent you from losing your hard-earned capital, there are some guardrails you can put into place. In 2016, John Rotonti interviewed the portfolio managers at Polen Capital.
They use 5 guardrails when looking for high-quality businesses. Here they are👇
The company must have a balance sheet with very little debt, and preferably a net cash position. For those companies with debt, we are looking for a net debt to free cash flow ratio of less than two times.
It must generate tons of free cash flow that it can either reinvest at high rates of return or return to shareholders through dividends and/or intelligent share repurchases.
It must generate a 20% return on equity and we must believe that the future returns on equity will remain above 20%. This is an indicator of a real, sustainable competitive advantage.
It must have stable, or preferably increasing profit margins.
It must have real, organic revenue growth.
You can find the entire interview here.
That’s all for this week. I’ll put my analysis of GXO on hold while I build out the framework challenge, but I love to see what you’re working on, so please keep sharing your findings.
Have a great week!
Please check the interest coverage ratio, seems incomplete.
Good luck on your journey.