Balance sheet first approach to small caps
The guests argued that focusing on a company's balance sheet and cash from operations is the most effective way to protect downside risk and identify durable compounders.
The argument
The guests emphasized that Wall Street often ignores the balance sheet until a crisis occurs. By focusing on companies with 'Fort Knox' balance sheets and high returns on capital, they aim to avoid leverage and ensure the business can survive economic downturns.
The thesis, stress-tested
✓ What validates it
- ✓Sustained or growing cash from operations over multiple quarters
- ✓Reduction of debt and initiation of share buybacks
▸ Risks discussed
- ▸Value traps where cash is high but capital allocation is poor
- ▸Temporary COVID beneficiaries whose cash generation may not be sustainable
Hear it yourself
"So, that's An interesting, anecdote from the last Berkshire meeting was, and I'd never heard Buffett say this before, but he said that the first thing he looks at when he's looking at a company is ten years worth of balance sheets, which I think puts him in a very small minority of people who take that kind of balance sheet first…"
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