The Analysis & Selection of Equity Bonds

Theodor Tonca

Great Business: Equity Bond

Simple, predictable business

Great underlying economics

Durable competitive advantage

Stable, increasing earnings

Free cash flow

Average Business: Common Stock

Difficult to understand business, complicated structure

Poor underlying economics

No competitive advantage

Constantly fluctuating earnings

Little or no free cash flow

Equity Bonds V. Common Stocks

Equity Bonds Common Stocks

Simple, predictable business

Difficult to understand business

Great underlying economics

Poor underlying economics

Durable competitive advantage

No competitive advantage

Stable, increasing earnings

Constantly fluctuating earnings

Free cash flow

Little or no free cash flow

Case Study: The Simple & Predictable

Easily understandable

Not subject to technological or other obsolescence

Cheap, unloved, un-followed, un-noticed & boring

Straight forward capital structure

Conservative

Example: The Simple & Predictable

Which is easier to understand and whose business is more predictable? Sysco Distributor and marketer of food service products. (The company gets the things you like to eat to your favorite restaurants and supermarkets.) Cisco Systems Designs and sells electronics, voice and communications systems. (Product lineup consists of Borderless Networks, Routers & Switches and Access Points to name a few.)

Example: Not Subject To Obsolescence

Which is more likely to become obsolete? Wrigley

I don't think the internet or any technological development is going to change the way people chew gum.
Yahoo How many people today still use the web directory which Yahoo started in 1994 as David & Jerry's Guide To The World Wide Web?

Example: Straightforward Capital Structure

Company A
Preferred Shares
- Non-cumulative Series W
- Non-cumulative Series AA

Company B Common Shares - 2,269,070 Issued & Outstanding

Common Shares
- 1,424,922,000,000 Issued & Outstanding

Options
- 15,659,000 Issued & Outstanding

Options
- 163,250 Issued & Outstanding Senior Debt - $10,364,000 Outstanding (Three Lines of Credit)

- Non-cumulative Series AB

- Non-cumulative Series AC - Non-cumulative Series AD - Non-cumulative Series AE - Non-cumulative Series AF - Non-cumulative Series AG - Non-cumulative Series AH - Non-cumulative, 5-Year Rate Reset Series AJ - Non-cumulative, 5-Year Rate Reset Series AL - Non-cumulative, 5-Year Rate Reset Series AN - Non-cumulative, 5-Year Rate Reset Series AP - Non-cumulative, 5-Year Rate Reset Series AR - Non-cumulative, 5-Year Rate Reset Series AT - Non-cumulative, 5-Year Rate Reset Series AV - Non-cumulative, 5-Year Rate Reset Series AX

Senior Debt
- $61,224,000,000 Outstanding (Covered Bonds, Senior Deposit Notes, Unsecured Funding, Credit Lines Various Receivables)

Example: Conservative

Un-promotional by nature

Is not dual-listed on multiple stock exchanges

Does not employ a small army of PR & IR personnel

Minimal Excess & Over Indulgence

Case Study: Great Underlying Economics

Stable & Steady

High Operating & Gross Margins

High Return on Shareholder's Equity

Low Debt/Equity Ratio

Negative Share Growth

Case Study: Durable Competitive Advantage

Consistency & Predictability (From a Business, Operations and Financial standpoint)

High Return on Capital (Same as High Return on Shareholder's Equity)

Goodwill & Intangibles

Management

Reasonable Price

Case Study: Stable, Increasing Earnings

Great Business
12
10

Average Business

10
5

0 -$18 -$71 -$123 $82 $55 Net Income

6 Net Income

-5

-10

0 $5,080 $5,981 $5,980 $6,824 $11,809

-15

Case Study: Free Cash Flow

Conclusion

Which would you rather own?