Intricacies of a balance sheet
I have been contacted by a recruiter seeking to hire a senior analyst for a consumer team.
They stressed that one of the most important traits of a successful candidate would be "an ability to understand the intricacies of a balance sheet and what they mean, in terms of business performance/quality". They mentioned it a couple of times in a short conversation, so it got me thinking.
For me it means:
- net debt/leverage (xEBITDA) - safety cushion for hard times, firepower for opportunistic M&A, flexibility to take on significantly more inventory with surprisingly strong demand, drag of interest payments on the P&L
- capital efficiency/ROIC - basically good/efficient the business is in utilizing their capital, how much cash do they have left to redistribute after capex
- goodwill - while goodwill impairments are not impacting cash earnings, if there's a big goodwill position on the bs, it's always an opportunity to make a big write-off, which could signal a deterioration of the acquired business and poor managerial skills
- basic working cap ratios - inventory turnover, payable/receivable turnover - mostly to check whether there are any worrying trends, like slowing inventory turnover signaling that the product is losing relevance
- net working capital drag or contribution to FCF - measurement of the bargaining strength of the co., the ability to force business partners to extend favorable payment terms
Any other ideas?
Thanks!
Capital structure probably
Adjusted working capital and cash conversion cycle are key.
Sounds like a lot of fun - I’m sure there’s a ton of alpha in you understanding working cap better than another pod monkey at Citadel.
Intricacies?? Someone’s quite full of themselves.
I’ve never met anyone who was an expert in projecting working capital. Sure we can all get a sense of direction/seasonality but WC quantums are hard.
I’m guessing their web page says some other BS about how they apply a private approach to the public markets?
Blanket statements like this are silly
Usually working capital dynamics don’t matter, except the times when they matter a lot. There are plenty of those cases where overlooked/modelable trends in WC can be a source of alpha. Travel companies booking trends, consumer names inventories, payables build, inventory mix, lifo/fifo, warranty manipulation.
People tend to be so dismissive of anything that’s not suited to their primary mandate/approach. There are sources of alpha in all shapes and sizes and time horizons. Some ideas are found in minutiae and some are big picture.
Adding detailed understanding of working capital analysis into your toolbox will help you be the kind of flexible researcher/investor/trader/analyst that can adapt to changing opportunity sets and varying roles. People who think there’s ‘one way’ and the ‘other ways’ are dumb are the guys getting blown out whenever their ‘go-to’ style is out of favor (value guys whining about Fed for a decade, growth guys buying anything with a TAM story and crooning about how they’re super special biznizzz-analysts).
Yes you should have an intimate knowledge of balance sheet and working capital mechanics and modeling. Usually you won’t need to spent time there, but you’ll be able to spot opportunities in the trends/manipulation and develop an internal sense of the magnitude of FCF sensitivity. It matters especially for real-economy names like consumer, aero, travel, retail, industrial. If you’re buying growth names on 2030 AI TAM, it’s useless but ofc so is your whole model
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