Jim Chanos has been a golden boy of the short-selling game since his Baldwin Piano call in 1983.
So when he started dishing to Barron’s about his observations about the value investing game over the past 20 years, our ears perked up.
One really specific thing Chanos mentioned was that, especially now, in the digital age, companies that were once considered value stocks are getting left behind… fast (think: Kodak).
That means investors need to be careful of companies whose prices don’t just decline, they dive off a cliff.
One of the differences in the value game now versus, say, 15 or 20 years ago, is that declining businesses, while they often throw off cash early in their decline, find that cash flow actually reaches a tipping point and goes negative much faster than it used to.
So, in the past, value investors looked at declining free cash flows and put some discount rate on that. And then they got a value, and then they would say, “Gee, there is the possibility of a call-option value of the business inherent to all its other opportunities. So, if I can buy it at some discount to that present value, I’m in good shape.” But we’ve seen time and time again where the cash flows do not gradually decline. Nor do managements seem very willing to pay out cash flows when they are in a declining business. They often use them to make acquisitions, trying to save the business on a Hail Mary basis. The advent of digitization in lots of businesses also means that the timing gets compressed, meaning that you need to move quickly or you are roadkill on the digital highway. That’s true whether you look at companies like Eastman Kodak [ticker: EKDKQ], or Blockbuster, or the newspapers. Value investors have been drawn to these companies like moths to the flame, only to find out that the business has declined a lot faster than they thought and that the valuation cushion proved to be anything but.
So yeah, pay attention — no one wants to be roadkill.
And of course, we can’t help but think he’s talking about one of his latest coups when he mentions Hail Marys.