During his recent interview with Tobias, Vitaliy Katsenelson, author and CEO of Investment Management Associates discusses his tablecloth to napkin financial analysis model. Here’s an excerpt from the interview:
Tobias Carlisle: So I think that sometimes value investors kind of poo-poo the growth at a reasonable price, but I don’t mind simple rules of thumb for figuring out at a very high level whether something is worth considering further.
Vitaliy Katsenelson: Yes, so when we do analysis. For a company beyond we go to financial model. And this financial model, the first version of it is going to be able to call it a tablecloth model which is going to be evident the second. It’s usually very big and it’s usually we go in depth and if you analyze a drug company we actually going to go through every drug and try to have an opinion on every drug. If the drug company we would actually try to see okay, when is expiration date? When does a patent expire?
Vitaliy Katsenelson: And then we can assume the sales would decline by 90%. But again, we would for the drug company but go one drug by drug, if we analyzing retailer, we actually going to analyze it on a store level, et cetera. But at the end of the day the second model we are going to build is going to be a napkin model. Tablecloth napkin.
Tobias Carlisle: Right.
Vitaliy Katsenelson: We can only really build a napkin model if you really understand the business. Because actually napkin model, to some degree, it’s more difficult to build because at this point you really need to know the drivers of the business. And the one that we found for us, the easiest way for us to get there is start big and then shrink it. And I know we’re going to talk about this, but if you think about my progression in my books, my first book Active Value Investing was 275 pages, I don’t know, whatever. A 70,000 words, 75 charts and tables.
Vitaliy Katsenelson: And my second book, which was The Literal Book of Sideways Markets, all it is, it’s my first book compressed into the little Book. It’s the napkin version of my first book basically. But I tell you I could not write The Little Book without writing the big one, the first one. But at the same time I’m so much more proud of my Little Book because, first of all I was given a second chance as a writer to rewrite some things that five years later or whatever, three years later. But also I was able to throw out things that was not as important. Anyway, so the same thing when it comes to building models. Same thing.
Tobias Carlisle: That’s so funny. I did the same thing with mine. I wrote three; Qualitative Value, Deep Value and then Concentrated Investing and I combined them all. It’s a one and that third book is much, much shorter, much, much easier to read, much, much cheaper. But it’s probably, in my opinion, it’s the best of the one.
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