Flirting with Floats: Part III

In Part I of this series on floats, I wrote about how Berkshire Hathaway has been able to create less-than-free float from its insurance operations a key reason for the company’s stupendous success. I also listed a few “general principles” on floats and showed how high-quality floats can become “unencumbered sources of value.”

In Part II, I expanded the discussion on Buffett’s attraction towards floats in a variety of business situations encountered by him in his long career, ranging from floats enjoyed by American Express and Blue Chip Stamps in his early years, to recent structured derivatives contracts created by him.

In this concluding part, I will shift focus away from Buffett (although I will use his thoughts on the subject) to other businesses that enjoy attractive floats.

Hindustan Unilever (HUL)

Let’s start with HUL. Take a look at the company’s summarised balance sheet as on March 31, 2012.

Take a few moments to observe the above statement. I’ll wait for you.

Notice that HUL is debt free. Why? Let’s try to answer this question by reorganising the company’s balance sheet.

Each side of the HUL’s balance sheetassets as well as liabilitiestotals to Rs 11,407 cr. That’s not a co-incidence by the way. 🙂

Let’s focus on the asset side for now. Of the total assets, let’s segregate financial assets. These would be non-current investments (Rs 70 cr.), current investments (Rs 2,252 cr.), and cash and bank balances (Rs 1,996 cr.). These total to Rs 4,318 cr. So the total breakup of financial assets and operating assets is as under:

Financial Assets: Rs 4,318 cr.
Operating Assets: Rs 7,089 cr. (balancing figure)
Total Assets: Rs 11,407 cr.

Now, let’s look at the liability side of the balance sheet which shows how the total assets are financed. Here’s the breakup:

Equity: Rs 3,680 cr.
Debt: Rs Nil.
Float: Rs 7,727 cr. (balancing figure)
Total Liabilities: Rs 11,407 cr.

“Float?” Yes, float. Other People’s Money (OPM) which carries no interest. Hindustan Lever is debt-free because it has access to free money provided by other people. It does not need to borrow any money to finance its operations. That becomes rather obvious by re-looking at the following two figures:

Operating Assets: Rs 7,089 cr.
Float: Rs 7,727 cr.

Since this float, which is cost-less, is more than operating assets, can we infer that all of the company’s operations are financed with free money? Yes!

How could HUL achieve this feat? Let’s find out by quantifying the main contributor of the company’s float. Of the total float of Rs 7,727 cr., trade payables alone are worth Rs 4,844 cr, an amount which is more than sufficient to finance inventories and receivables aggregating to Rs 3,524 cr. Here’s the breakup:

Inventories: Rs 2,667 cr.
Receivables: Rs 857 cr.
Total: Rs 3,524 cr.

Trade payables: Rs 4,844 cr.

What does this mean? It means that HUL obtains trade credit from its vendors which is more than sufficient to finance its investment in receivables and inventory. That is, HUL operates on negative working capital, which is the key source of the company’s float.

How should we determine the importance of this float to HUL’s stockholders? By doing a thought experiment. Just like the importance of the person is realized when he/she is no longer there, let’s figure out the importance of HUL’s float by imagining that it’s not there. Let’s make the float of Rs 7,727 cr disappear. Poof! It’s gone!

But hang on a second. HUL still needs to have Rs 7,089 cr of operating assets, which need to be financed from somewhere and it’s source of free moneyfloat — just evaporated. So, HUL needs to find alternate financing. There are only two sources: Debt and Equity. If HUL had to employ debt to replace float, then at current interest rates of 10% p.a. it would have to pay about Rs 700 cr. as interest, which if we consider, would have reduced its pretax profits from Rs 3,621 cr in FY12 to Rs 2,921. That’s a reduction of 19% in HUL’s pretax earnings.

Alternately, HUL could replace its float by issuing additional shares. Assuming it did so, at its current stock price of Rs 500, then in order to raise Rs 7,089 cr, HUL would need to issue 14 cr additional shares to its existing 216 cr shares. That’s an addition of 6% to its equity capital which would have resulted in no incremental earnings.

Either way we look at it, we can see that presence of float is quite important for HUL’s stockholders. Float prevents the company from the burden of interest-bearing debt. It also prevents the need to dilute equity.


Now’s lets look at another companyNesco Limitedabout which I had written a few years ago. Take a look at Nesco’s balance sheet as on 31 March 2012.

You’ll notice that just like HUL, Nesco too a debt-free company. Why? To answer that question, let’s reorganise Nesco’s balance sheet just as we did in HUL’s case.

Each side of the Nesco’s balance sheetassets as well as liabilitiestotals to Rs 381 cr.

Let’s focus on the asset side for now. Of the total assets, let’s segregate financial assets. These would be current investments (Rs 210 cr.) and cash and bank balances (Rs 4 cr.). These total to Rs 217 cr. So the total breakup of financial assets and operating assets is as under:

Financial Assets: Rs 214 cr.
Operating Assets: Rs 167 cr. (balancing figure)
Total Assets: Rs 381 cr.

Now, let’s look at the liability side of the balance sheet which shows how the total assets are financed. Here’s the breakup:

Equity: Rs 290 cr.
Debt: Rs Nil
Float: Rs 91 cr. (balancing figure)
Total Liabilities: Rs 381 cr.

Nesco’s operating assets of Rs 167 cr. are financed to the extent of Rs 91 cr. by OPM, which carries no interest. Was this float not available, Nesco would necessarily have to raise this money from debt and/or equity. Either alternative would have reduced earnings per share, as was the case in HUL discussed earlier.

So, how could Nesco obtain this float? Let’s find out by quantifying its main contributors. Of the total float of Rs 91 cr., advances & security deposits from customers alone are worth Rs 57 cr and trade payables are worth Rs 8 cr. These two items, which total to Rs 65 cr. are more than sufficient to finance inventories and receivables which total to Rs 13 cr. Here’s the breakup:

Inventories: Rs 5 cr.
Receivables: Rs 8 cr.
Total: Rs 13 cr.

Advances & security deposits from customers: Rs 57 cr.
Trade payables: Rs 8 cr.
Total: Rs 65 cr.

Nesco has three businesses each of which use float.  Exhibition organizers who book Nesco’s exhibition center pay the company advance money to book space for various exhibitions. They also pay security deposits. Similarly, for occupying its commercial buildings, Nesco’s tenants pay security deposits to the company. Finally, for its manufacturing business, the company enjoys trade credit. Moreover, neither the exhibition business nor the commercial building business has any receivable or inventories, so the aggregate of trade credit and advances & security deposits exceed the aggregate investment in inventories and receivables.

Just like in the case of HUL, Nesco too, then, enjoys a negative working capital which is the key source of the company’s float. The only difference between the two situations is that while in HUL’s case, trade credit provided the float, while in Nesco’s case advances & deposits from customers primarily provide the float.

The Relative Attractiveness of Floats

We’ll come back to a more detailed discussion about trade credit and customer advances & deposits. For the time being let’s recall how Warren Buffett thinks about float as an attractive source of financing. A key lesson from Buffett on this is:

If you get access to an enduring and free (or less-than-free) floatwhether it comes from insurance underwriting, derivatives contracts, trading stamps, travelers’ cheques, stored value cards, deferred taxes or any other sourcethen assets financed with such a float will become “an unencumbered source of value” for your stockholders. This will happen because (1) the assets financed with such a float would still be valued on the basis of their expected future earning power; but (2) the true value of the liability represented by the float will be far lower than its carrying value, provided the float is both costless and long-enduring.

Those two factors cost and duration  determine how attractive a float it. The lower the cost approaches zero, and the longer the duration approaches eternity, the more the float resembles a perpetual, zero coupon bond which, as I discussed in Part I, will be worth almost nothing as a liability which is really cool because assets financed from the float could be worth a lot, just as happened in the case of Berkshire Hathaway.

Conversely, the higher the cost approaches the cost of alternate financing, and the lower the duration of the float, the less attractive it becomes. Under such circumstances, liabilities which are source of float should be valued fully on the balance sheet of company having access to that float.

Costless and long-enduring floats, then, are a very attractive form of financingmore attractive than debt, and more attractive than additional equity. We saw this in our HUL “thought experiment” above. Buffett agrees with this line of thinking. When asked about the relative attractiveness of low-cost floats vs other forms of financing, he said:

“Our insurance companies have had a terrific experience on cost of float‚ and we’d like to develop it just as fast as we can. Right now we’ve have no interest in issuing a bond because we have more money around than we know what to do with, and it comes from low-cost float. But if a time came when things were very attractive and we’d utilized all the money from our float and retained earnings and we still saw opportunities, we might very well borrow moderate amounts of money in the market. It would cost us more than our float was costing us, but it would still provide us with incremental earnings. But we would try to gain more float under those circumstances, too.

Float = Leverage

The correct way to think about floats, then, is to think of them, simply as a form of leverage. Leverage, however, is traditionally associated with interest-bearing debt. But a free float is also a form of leverage, isn’t it? After all, it’s OPM and that’s what leverage means. Just like low-cost debt can lever up the return on invested capital, a free, or low-cost float can lever up the return on operating assets and that’s what Buffett meant when he wrote:

Any company’s level of profitability is determined by three items:  (1) what its assets earn; (2) what its liabilities cost; and (3) its utilization of “leverage”that is, the degree to which its assets are funded by liabilities rather than by equity.”

“Funded by liabilities rather than equity.” He used the word “liabilities” and not “debt. That’s key. The more of an asset that you can fund with a free float, the less the need to fund it with expensive debt or equity becomes.

Role of Negative Working Capital

Why, then, do businesses ever borrow money to fund their operations? Why don’t they just use free floats? The obvious answer to this question is that most businesses do not operate with a negative working capital. They simply don’t have free floats.

Recall that negative working capital arises when money tied up in inventories and receivables are more than offset by funds provided by customers by way of advances & deposits and also by trade credit. Let’s now return to the discussion of these two important contributors of free floats: Trade credit and advance payments & deposits from customers.

Trade credit is given to a firm by its vendors. Advance payments & deposits are given to a firm by its customers. Why, as was the case with HUL, would a firm enjoy substantial trade credit which more than finances its inventories and receivables? And why, as was the case with Nesco, would a firm get paid in advance by its customers and also receive substantial deposits from them, which, when taken together, more than offset its investment in inventories and receivables?

Market Power

The answer to both these questions is “Market Power” — the power of a firm over its vendors (who give it large amounts of trade credit) and its customers (who give it large amounts of advance payments & deposits) in quantities large enough to ensure that the firm can operate with negative working capital, as we found in the case of Nesco. The super powerful ones can operate with negative net operating assets (where float exceeds investment in inventories, receivables, and fixed assets), as we found in the case of HUL.

Where does this “market power” come from? It primarily comes from two sources: (1) shortages; and (2) moats.

Shortages Don’t Produce Enduring Floats

We have little interest in floats produced from shortages-derived market power. That’s because such floats are likely to be temporary, fair weather friends. To see how, think of a shipping company during a shipping boom when freight rates are sky high and every shipper is drowning in cash. The freight rates are high because of shortage. This shortage delivers market power to the ship owners, who can demand, and obtain, not only high freight rates, but also advance payments from their customers. These advance payments from customers, will temporarily reduce working capital requirements because receivables will turn into advance payments received.

Alas, such a happy environment is unlikely to last. The entry barriers in shipping are low, even though the gestation period is high. It’s only a matter of time when the supply of new ships will create a glut. Such a glut will have two consequences. One, freight rates will fall. And two, power will shift from shipping companies to their customers, who will now refuse to make advance payments and will insist on very lenient credit terms. For shipping companies, advance payments from customers will disappear, and will be replaced by receivables from customers. There will be dire consequences so far as working capital requirements are concerned: When its float disappears, a shipping company will typically find it hard to stay afloat unless it replaces the free source of finance with debt, or equity. This is happening now in global shipping industry.

This kind of power shift in a value chain is not limited to the shipping industry. You will find it in automobile industry, in textiles, in chemicals — in fact, you’ll find it in any commodity industry having low entry barriers.

In such situations, being impressed with temporary low-cost float during good times, could be a costly mistake. The lesson for long-term investors is clear: Beware of floats derived from shortages in commodity-type industries having low entry barriers. Recall, this lesson is consistent with Buffett’s belief that a float is attractive only if its cheap and enduring and a float produced from temporary shortages is anything but.

Moats & Floats

Let’s now talk about the second source of market power — one which is cheap and enduring, and one which should interest us a lot: Moats.

Buffett uses the metaphor of a “moat” to illustrate a business’s superiority “that make life difficult for its competitors.” A truly great business, says Buffett, must have an enduring moat around its economic castle that protects its excellent returns on invested capital. He writes:

“What we’re trying to find is a business that for one reason or another — because it’s the lost-cost producer in some area, because it has a natural franchise due to its service capabilities, because of its position in the consumer’s mind, because of a technological advantage or any kind of reason at all – has this moat around it. And you throw crocodiles and sharks and piranhas in the moat to make it harder and harder for people to swim across and attack the castle.”

Finally, we have reached the point which I wanted to make at the very beginning of this long series! Professors are rarely known for their brevity 🙂

The point is this: Floats and Moats go together.

Think about it. What kinds of companies can operate with negative working capital (e.g. Nesco) or even negative net operating assets (e.g. HUL)? What power do such companies possess over their customers and suppliers, who happily (or even unhappily) finance their working capital (Nesco), or even the entire capital (HUL) employed by the business?

The answer, of course, is companies which possess enduring moats. While, HUL’s moat is derived from the company’s brands and distribution network, Nesco’s moat in its exhibition center business is derived from scarcity.

How Floats Lever Returns

HUL’s moat is much more powerful than Nesco’s and that’s reflected in its negative net operating assets. All of HUL’s operating assets are financed by its float, while only part of Nesco’s assets are. Nevertheless, float in both cases levers up return on invested capital for both the companies.

To see how floats lever up returns on invested capital, consider that one of the consequences of a solid moat is that it enables a business possessing such a moat to earn excellent returns on its invested capital. Earning excellent returns on invested capital, in fact, is a pre-requisite for spotting a moat, according to Buffett. He writes:

“A good moat should produce good returns on invested capital. Anybody who says that they have a wonderful business that’s earning a lousy return on invested capital has got a different yardstick than we do.”

Notice, he used the term “invested capital” which is the capital provided by investors — debt as well as equity — and does not include funds provided by floats. He did not use the term “total assets” although most great businesses possessing enduring moats will have good returns on assets and on invested capital.

How can a business earn excellent returns on invested capital? There are only two ways to do it: (1) maximise the numerator i.e. returns; and/or (2) minimise the denominator i.e. invested capital.

A moat (whether derived through pricing power or a sustainable low-cost advantage) can help the business achieve (1). A free, or a low-cost  float (derived, of course, from an enduring moat) can help it achieve (2). How so? Let’s see how this happens in case of HUL and Nesco.

For FY12, HUL earned pre-tax profits of Rs 3,500 cr. On total assets of Rs 11,407 cr., this translates into a return on assets of 31%, which is fantastic. But, when we recognize that out of total assets of Rs 11,407 cr., float contributed Rs 7,727 cr., leaving only the balance 3,680 cr. to be financed by equity, then the pre-tax profits on equity get levered up to 95%.

Similarly, for FY12, Nesco earned pre-tax profits of Rs 97 cr. On total assets of Rs 381 cr., this translates into a return on assets of 25%. But, when we recognize that out of total assets of Rs 381 cr., float contributed Rs 91 cr., leaving only the balance Rs 290 cr. to be financed by equity, then the pre-tax profits on equity get levered up to 33%.

Think of it this way. A business may employ a large amount of assets, but such a business — because it has an enduring moat may enjoy significant market power over its vendors and customers. The business exercises its power over its vendors by  insisting on, and getting away with, very lenient credit terms from them. In addition, power is also exercised over customers by insisting upon, and getting away with, receiving advance payments & deposits from them. The vendors and customers don’t have a choice. They have to adhere to the terms dictated by the business because for them, there is no other alternative. This market power, exercised in the manner described, results in the ability of the business to operate with negative working capital which reduces, or sometimes even eliminates, the need for stock and bond investors to invest anything in the firm’s operating assets. Invested capital (the denominator) is minimised, which results in a jump in return on that capital.

Let me give you another example — this time from USA.

Each side of the’s balance sheet — assets as well as liabilities — totals to $25 billion.  The breakup of asset side is as under:

Financial Assets (Cash and cash equivalents and marketable securities): $10 billion
Operating Assets: $15 billion (balancing figure)
Total Assets: $25 billion.

Here’s the breakup of the liability side:

Equity: $8 billion
Debt: $ Nil
Float: $17 billion (balancing figure)
Total Liabilities: $25 Billion. enjoys a float of $17 billion even though it employs only $15 billion of operating assets! No wonder it’s a debt-free company. But, how does it get so much float?

The main contributor towards’s float is accounts payable of $11 billion, which, when compared with inventories of $5 billion and accounts receivable of $3 billion result in a negative working capital of $3 billion. By keeping inventories low, by ensuring customers pay quickly, and by taking longer to pay its vendors, has been able to build a huge float. In addition, the successful Amazon Prime service and sale of gift certificates enables the world’s largest online retailer to collect funds from customers in advance.

In 2011, pre-tax earnings were $934 million, which when compared with total assets of $25 billion translate into a return of only 3.7%, but when compared with Equity of $8 billion, gets levered up to 12% ROE. Considering the prevailing low interest rates in USA, that’s not bad at all. is a wonderful example of a situation where return on assets is mediocre, but return on equity is good, simply because the company has access to large amounts  OPM on favourable terms. It’s the float which makes profitable and it’s the float that keep the company debt-free. If you were to value, you’ll have to think very hard about two questions: (1) How likely is it that’s float is truly costless; and (2) How long will it last?

A Pattern and A Few General Principles

if you look carefully at the worlds’s debt-free companies (e.g. look at BHEL, BEL, EIL, Wipro, Infosys, Intuitive Surgical, and Apple) a pattern emerges. Many of these companies will, apart from being debt-free have the following additional characteristics:

  1. Substantial financial assets;
  2. Negative working capital, or sometimes even negative net operating assets arising out of large amounts of trade credit and/or advances from customers as compared to  to investment in inventories and receivables; and
  3. An excellent return on invested capital caused by a high return on assets, which gets further levered up by usage of a free float.

In other words, where there are large enduring floats, you will find moats. This makes moat hunting an objective exercise, doesn’t it? Apart from looking for signs of moats indicated by high switching costs, low-cost advantages, intangible assets, and network effects as Pat Dorsey does in his wonderful book “The Little Book that Builds Wealth,” you may also spot an enduring moat by simply looking for the above pattern.

Finally, in your hunt for long-term high-quality businesses, as you witness the proximity between floats and moats, you will also discover that all floats are not the same. In particular, you will discover the following general principles:

  1. Floats are wonderful if they cost less than nothing. They are also wonderful if they are free or have a very low cost as compared to alternate sources of finance like debt or equity;
  2. Enduring floats which arise due to market power delivered by strong moats are more valuable than floats arising out of temporary shortages;
  3. The true value of a liability represented by an attractive float is far lower than its accounting value and that’s why assets financed by such floats become an unencumbered source of value for stockholders;
  4. Floats may be enduring even though they are classified as current liabilities because what matters is the balance in the account and not the liability towards a given person (e.g. when the security deposit from one customer is replaced by the deposit provided by a new customer);
  5. As a moat narrows, because of technological obsolescence or any other reason (think Kodak, MTNL, RIM), you will notice a gradual decline in the firm’s market power as measured by diminution of negative working capital and gradual increase in debt and/or equity to finance necessary investment in inventories and receivables;
  6. Floats in technology firms are less likely to be enduring as compared to floats generated by dominant FMCG companies; and
  7. Floats provided by millions of small customers (e.g. travellers checks, stored value cards, security deposits for gas connections) are likely to endure for longer than floats provided by a handful of vendors and customers.

Happy Moat Hunting!


Acknowledgements: I’d like to thank Priyank Sanghavi and Ankur Jain with whom I had extensive and very helpful interactions on the subject of floats and moats which helped me formulate my thoughts on the subject.

50 thoughts on “Flirting with Floats: Part III”

  1. Dear Sir,
    It is pleasure to read your blogs and learn new things in interesting way about fundamental analysis. I eagerly wait for your blogs. I would like to point out a small typo or error in NESCO’s case. Should not non-current investments be 3 lacs rather than 3 crore as given in NESCO balance sheet?

  2. Excellent post…But as I understand its only Berkshire Hathway whose is able to successfully invest floats with high rates of return over the long term.The rest of companies are not doing much with their float except investing in short term debt.

    Are there any companies who are able to produce high returns on their float?

  3. Sanjay,

    Truly a wonderful post…. Written very well with examples…

    Is this a core reason why diversification is called as diworsification as they cannot build a similar moat in completely unrelated businesses 🙂


  4. Dear Prof.,

    What is your opinion on Vacation Ownership Companies especially Mahindra Holidays who collect membership fees in advance and this forms a sizable float for addition of new rooms to the existing ones without capex from the company (PPFAS presentation on MHRIL).

    Warm Regards,

    Vijay Yadav.

    1. Vijay, that’s an excellent example of a business model that works on float. As of 31 March 2012, the company had advances from customers totalling to Rs 1,069 cr, which on a total balance sheet size of Rs 1,981 cr, translates into 53% of assets. The float keeps the company debt-free.

      You’ll also find floats in other real-estate companies especially those in residential space where customers deposits finance the projects e.g. look at Sunteck Realty, Oberoi Realty, and Ashiana Housing. These companies are either debt-free, or carry very low levels of debt, because they have floats.

      1. Dear Prof.,

        Thanks for your kind reply. Would like to make a remark regarding real estate companies working on Customer advances as float. The escalation and rise in the sales price will not be captured by the company. But then working capital portion can taken be care by booking only a certain no. of flats in advance in the present scenario of low sales and high interest costs.

        Warm Regards,

        Vijay Yadav.

        Sent on my BlackBerry® from Vodafone

      2. I took another look at Mahindra Holidays and found that while the company had, on 31 March 2012, advances from customers totalling Rs 1,069 cr., it also had, on the same date, receivables of Rs 518 cr. Moreover, the company has securitized receivables worth Rs 267 cr, where the banks who had bought the receivables, have recourse to the MHRIL in case of defaults – see contingent liabilities schedule. If you were to mentally cancel the securitization and put them back on the balance sheet (which is the proper thing to do for evaluating the fundamentals of this business), then receivables become a huge Rs 785 cr.

        This kind of a situation – high receivables and high customer advances – is rather unique, but it’s hardly as attractive as situations where customer advances and/or trade credit is far higher than receivables and inventories – resulting in large amounts of negative working capital which, in effect, finances investment in fixed assets. Keep that in mind while evaluating MHRIL or other businesses having similar attributes.

      3. Dear Prof.,

        You are right about businesses being attractive where advances are much higher than receivables.

        In the case of Mahindra Holidays, most of the receivables is in the form of EMI for membership fees taken on installment basis and earning a interest of 14-16%. For financing of fixed assets / WC, these EMI ‘s are securitized. This should be acceptable as long as the interest earned is more than the interest paid which would be like a free / less than free float

        Your valuable comments, pls.

  5. Dear Sir,

    A truly well written post. I just had one query. These businesses agreed have the ability to generate float through the presence of a moat. But over time they accumulate a lot of cash through the presence of a moat. Like even in the case of Nesco, they have 217cr of cash, i believe some of it will go into IT building IV and III construction, but what after that, i mean the cash cannot be deployed in businesses with similar moat/characteristics once the 70acre space is fully used up, the business as it appears lacks scalability beyond the 70acre parcel. Would you be concerned about the future deployment of cash generated from strong moats? Should the investor then believe that once the high ROIC projects with the company are over, the company will either resort to high dividend, share buyback or leverage re-capitalization.How would you as an investor evaluate this?

    1. You’re right to worry about capital allocation decisions of a firm. I would not automatically assume that once the firm has used its single asset to its fullest potential, and all future cash flow will be paid out or used for stock buybacks etc.

      In the case of Nesco, the potential to fully utilise the land is far off, but yes it puts a cap on growth from that asset (except through inflation.)

  6. Prof. Bakshi,

    Thank You for practically explaining the importance of floats! The article contained a wealth of information illustated with apt examples.

    In my view, Gujarat Gas would also qualify as an example. It receives deposits from customers which are refundable only on termination of the connection, implying that the deposits are a float. This coupled with the high switching costs (infrastructure) is a source of an enduring moat. I would appreciate your views on this.

    Once again, kudos to you for this fantastic post!

    1. Thanks Mayank. You’re right about Gujarat Gas. As of end December 2012, the company had deposits of Rs 252 cr from customers. GG also has trade credit of Rs 210 cr. With negligible inventories and receivables of only Rs 183 cr, the company operates with a negative working capital.

  7. Dear Sir,

    Thanks for sharing your views on ‘floats’. Very well articulated and insightful thoughts on the subject. As mentioned by you that the floats generated through vendors and a smaller base of customers are less endurable as compared to security deposit for gas connections, traveller’s cheque or may be insurance floats(if the risks are well managed as Ajit Jain does) . The good thing about such floats is that you may end up paying nothing to the customer and have access to free capital for perpetuity.

    I would like to ask that what is the average duration for which floats of a company like HUL last during a financial year. Like insurance floats, can the float generated through one customer/vendor be adjusted by new vendors/customers in the case of HUL and NESCO ? Can they afford to invest such floats in ‘equities’ or they can only be deployed in short-term fixed income securities ? If Buffett would have owned HUL how he would have utilized the float generated by the company ?

    Warm Regards,
    Saurav Jalan

    1. Saurabh:

      Buffett writes:

      “Our float is deducted in full as a liability in calculating Berkshire’s book value, just as if we had to pay it out tomorrow and were unable to replenish it. But that’s an incorrect way to view float, which should instead be viewed as a revolving fund. If float is both costless and long-enduring, the true value of this liability is far lower than the accounting liability.”

      Focus on the words “revolving fund”. What does that mean? It means that one should focus on overall balance in the account and what not various accountholders are doing. Take, for instance non-interest bearing current account balances with banks. Even if some customers withdraw their funds from such accounts, then if other customers deposit funds in such accounts, then the overall account balance will not go down. If you are virtually sure that the account balance representing float in any business model will not go down, and if it’s costless, then it becomes the functional equivalent of a perpetual, zero coupon bond, isn’t it?

      If you look at HUL, or other similar companies, you’ll find that they operate with negative working capital year after year. And as their businesses have grown, the size of floats have grown as well. So, even though the “sundry creditors” figure on the liability side of the balance sheets of such companies may be classified as a “current liability” for all practical purposes, is it not a non-interest bearing perpetual liability? If so, then its true value is far lower than its book value.

      The surer you are about the permanency of your float, the more confident you should be about investing the float funds in equities (assuming, of course, you have opportunities) because then you won’t have an asset-liability mismatch. Funds raised from a long-term liability would have been invested in long-term assets. Buffett has been so confident about the permanency of float on BRK’s balance sheet, that he has invested the float funds, not just in equities, but also in totally illiquid operating businesses. So, in my view, it all depends on how sure you are about the durability of the float in your possession.

  8. sir perfect ,

    I am a great admirer of yours crisp thoughts and transformation of learning from great investor to indian market in a simple way

    I have tried ITC also from above learning of HUL out of a ttl balance sheet of 30Kcrs , operating assets are 22.5K cr, which is financed by approx 5.5K float ( deferred tax liabilities , advances from customers ( kirana stores , malls…) which leads to 17K crs of shareholders money financing same and even on 2012 basis profit of 6K almost 30%+ roe ,and big certainity of at least growing these at some % in next 10 years

    but my questions as these are such a wonderful business -what price range should
    an investor to buy same -thumb rule say 20p/e -if dont want to overpay like as your past example buying infosys in 2000 and next decade of wonderfull business growth but investor returns were zero –

    so this is a big unsolved puzzle for me always-what is the range to buy these business ( graham idea helps -double the yield of safest investment-but for that market to crash too much to buy these wonderful business at throwaway price )

    I am learning from your blog and lectures presentations which you had freely posted

    Thanks again for this wonderfull sharing


  9. Hello Prof. Bakshi,
    You are a marvel – truly, many of us are immensely benefited by your efforts in sharing your thoughts and ideas. Knowledge only grows by sharing.
    While your point about the importance and benefits of floats is well made by the HUL example, there is a slight wrinkle when you look into it in a little more detail.
    In the analysis of the liability side of the HUL FY2012 balance sheet,
    Total liabilities: Rs 11,407 cr
    This is comprised of:
    Shareholder’s funds: Rs 3,681 cr
    Non current liabilities: Rs 1,006 cr
    Current liabilities: Rs 6,702 cr
    Minority Interest: Rs 18 cr

    You have classified the entire amount of non current and current liabilities (Rs 1,006 cr + Rs 6,702 cr = Rs 7,708 cr) as float, which by definition is unemcumbered and therefore can provide leverage for free. But out of this Rs 7,708 cr, Other Long Term Liabilities (Rs 332 cr), Long Term Provisions (Rs 674 cr), Other Current Liabilities (Rs 561 cr) and Short Term Provisions (Rs 1294 cr) – all these totalling to Rs 2,861 cr – are for employee related liabilties such as gratuity, pension, medical etc, provident fund, tax deducted at source, provision for dividend, taxes etc. So this amount of Rs 2,861 cr out of Rs 7,708 cr is neither trade credit nor advances from customers. This liability of Rs 2,861 cr is not derived from ‘Market Power’, and while increasing trade credit and advances from customers indicates more ‘Market Power’ and is beneficial to the business, the same cannot be said of increasing employee related liabilties such as pension, gratuity and unpaid dividends. One could go as far as to say that this Rs 2,861 cr of liability is more akin to equity or debt (invested capital in the business) than it is to trade credit/advances from customers (cost free float).
    So one would have to consider only Rs 7,708 cr – Rs 2,861 cr = Rs 4,847 cr as true float for HUL in FY12.

    The exact numbers I have used in the calculations above may be a bit off and approximated, but the point I make trying to make is that the float is not as large as it would seem at first glance (for instance, Rs 4,847 no longer covers the full current assets and fixed assets and thus HUL is not operating with negative net operating assets).

    I do not want to sound like I am nitpicking, and I really appreciate your posts in general and this post in particular. It was a very stimulating read. But while trying to make the task of finding moats objective (by putting things in a excel sheet), I went down this line of thought and in the spirit of sharing, wanted to seek your thoughts on the matter.

    What do you think?

    1. Nirman, that’s a great comment. Thanks. You’re right about my classification of all liabilities, other than interest-bearing debt as float, which may or may not have a cost. I think its important to visualise a balance sheet by treating current liabilities and provisions as a source of financing, just like bonds or debt. But while bonds or debt are valued on a balance sheet, by investors, in present value terms, operating liabilities aren’t. That treatment is wrong, if the operating liabilities are long-lived and have a zero or a low cost, which is the case in HUL.

      For a more detailed analysis of what I call as float and what Prof. Steven Penman of Univ of Columbia called as “operating liabilities,” see “Financial Statement Analysis of Leverage and How It Informs About Profitability and Price-to-Book Ratios,” by Doron Nissim & Steven H. Penman.


      Also see his treatment of operating liabilities in his excellent book, “Financial Statement Analysis and Security Valuation”. In particular, see:

      Section on “Reformulation of Balance Sheet” in Chapter 9
      Section on “Operating Liability Leverage” in Chapter 11

      My basic point in treating current liabilities as float is to show how in some business models (moats), these operating liabilities play a crucial role in leveraging return on assets to deliver an exceptional return on invested capital (which usually is only equity). This float may or may not have a cost. Even if it has a cost, in businesses with solid moats, where return on assets is already exceptional, the presence of low-cost operating liabilities can be an important source of value for stockholders because they help delivering a truly exceptional return on equity.

      But I take your point, that in the case of HUL, not all current liabilities are costless. I do maintain that even if they have a cost, the spread between the return on assets and that cost is quite large, and moreover that cost is less than that of alternate financing. This is similar to the Buffett’s idea when he said that depending on what he could do with the cash (he focuses on return on assets), he may even accept a float at a cost. So, Buffett is not averse to the idea of having an insurance float having a cost provided he can do something intelligent on the asset side (return on assets) and provided that cost is still less than the treasury bond yield.

      Hope this helps.

  10. By the way , what’s great at amazon is its Return on capital employed.
    It employs only $1.8 billion invested capital and has clocked pretax profit of $934 million giving a 52% ROCE. Buffett invested in Walmart many years back because of the retail moat present in it and it churned around 32 % ROCE . That was made possible because of “float”
    excellent article professor !

  11. Kaveri seeds , what a company to own . Advances against sales of 110 crores , out of total asset 217.35. More than 50 % Advances against sales , what a float company enjoys and it is not because of temporary demand supply mismatch . Sir , can’t we say that company is having moat ? It is also growing fast. Top of that company does not have to pay tax since income from “sale of seeds” is consider as agriculture income which is tax free.
    This is dream company to own if there is no corporate governance issue and fraud .
    What is your view sir ?

    1. Vikas, see my comments on Mahindra Holidays below where high receivables and accompanied with high customer advances. In case of Kaveri, we have high inventories accompanied with high customer advances…

  12. Thank you Prof. Bakshi for the link, reading references and clarifications. I was just reading Buffett’s 1977 Fortune article on inflation (How inflation swindles the equity investor – I get a similar feeling when reading what you write as I do when reading what Buffett writes – a feeling of awe for how well the author understands and simplifies issues to make them appear straight-forward and obvious in retrospect but most of the rest of us still need to be prodded to think along these lines. A relatively large spread between the long term cost of the liabilities and the sustainable return on the assets are symptomatic of a good business (and possibly of a moat).
    In fact, I was trying to diagnose this symptom from historical financials captured in an Excel spreadsheet in an attempt to ‘make moat hunting an objective exercise’ as you put it. I am currently using the following three metrics as yardsticks –
    a) the annual return on invested capital (operating cash flow / (total assets – current liabilities))
    b) the annual retained earnings on year start capital ((earnings – incremental investments in current year)/invested capital at start of current year and
    c) the cumulative earnings over a long period of time divided by the incremental total capital invested during the period (the current value of 1 rupee invested in the business over a long period)

    If a and b average high rates (>20%) consistently over multiple years, and c is above 2, then you might have a very interesting business to investigate and understand at your hands.

    On a slightly different note, I should probably also admit that I have ridden your coattails (wtih Piramal for instance) in the past and from purely selfish reasons, would like to urge you to please keep up this endeavour of posting your current thinking and cumulative learning on a regular basis.

    Thanks for all the stimulation for long, wonderful hours of introspection.

  13. Excellent thesis Sir. I have two questions for you Sir.

    1) As you have written that the attractiveness of a float depends on two factors – Duration and Cost. Well as far estimating the duration of a float is concerned, I believe it is more a matter of judgment – we have to judge how powerful is the company’s “market power” and moat. But coming to the Cost aspect, how do you exactly calculate the cost of moat.
    In case of Berkshire, Buffett wrote in his letter that as far as Berkshire earns an underwriting profits i.e. it pays less claims and expenses than the premiums it receives, then the float may be considered as cost-free or rather they are being paid for holding the float.
    Similarly, in case of CASA deposits of banks, the cost of float can be determined by the rate of interest it pays on deposits (though banks pay nothing on current accounts – and it explains the moat enjoyed by HDFC Bank).
    But how do we calculate the cost for other kinds of floats – like trade credits, security deposits, customer advances, franchisee deposits etc.

    2) Since float is similar to kinds of financing viz. Debt & Equity, does this mean that floats will be less attractive in times of low interest rates as is the case in the U.S. right now. Because then we can avail of debt or equity cheaply.


    1. Those are good questions Mukesh. To answer the first question, let’s put ourselves in the shoes of three people.

      The first fellow is a NSE Member, who when he became a member of NSE, gave an interest-free deposit to the exchange. See:

      For potential members of NSE it’s a “take it or leave it” situation.” They must either accept NSE’s terms of membership and give this interest-free deposit, but if they don’t accept those terms, they can forget about becoming a member. NSE’s ability to give this “take it or leave it” ultimatum arises out of the “market power” it commands, which is derived from its moat. Now assume that MCX – a competing exchange, which was recently allowed by SEBI to start equity and derivative trading, offers better terms to its members and in order to prevent desertion of members, NSE starts offering interest on the deposits. Why would NSE do this? Obviously, it would it do it as a protective measure because its moat is getting eroded – and it is losing market power, and accordingly, its ability to deliver “take it or leave it” ultimatums.

      The same logic applies to interest free deposits taken by strong FMCG companies from their distributors. These distributors are happy to give these deposits because it gives them exclusive distribution rights over a region. How much would you pay Nestle as an interest-free deposit to get a right to exclusively distribute maggie noodles in Punjab? You will pay a large sum because the money you earn from the distributorship will be large enough to offset the interest forgone. But if health concerns or competitive threats made consumers move away from maggie noodles to home made wheat based soba noodles (as I have btw), then Nestle’s maggie moat will be threatened and its ability to take, large interest-free deposits will be impaired. It may even have to pay interest on those deposits.

      Now, let’s shift focus to the second guy – who is a vendor to a rice trading company, which is a competitive business having no moat. This vendor offers his produce to the rice trader on credit, because the rice trading business works on credit. Now, simply because the rice trading business works on credit, and in addition, no explicit interest is being charged by the vendor from the rice trader, it does not mean that the float from trade credit for the rice trader is free. There is an element of implicit interest cost here. The credit obtained from the vendor by the rice trader comes at a cost, even though you won’t see that cost on its P&L. That’s because the vendor offers two choices to the rice trader: (1) Either pay me upfront and I will charge a lower price for the rice; or (2) pay me later, and I will charge full price. The vendor has taken choice 2 and had obtained a float, but one with a cost. The cost of the float is implicit interest as derived from the difference between the prices charged under the two options.

      If this was not the case of a rice trader, but that of Wal-Mart, then Wal-Mart would use its market power to obtain float from vendors in the form of trade credit with no cost. It would tell its vendors: “We will buy large quantities from you, but we will pay you later than other buyers will. But if you want an earlier payment, be prepared for a hefty price cut. Take it or leave it.” Most vendors take it because the margin they make on the business of selling to Wal-mart is so low that it does not allow them to take another price cut to get paid early and still make money. And Wal-Mart knows this, and uses this information for the benefit of its customers and stockholders in the form of low prices and a free or very cheap float.

      So, it all depends on market power. The more the power you have, the more the ability to deliver “take it or leave it” ultimatums to vendors.

      The same logic can be applied in the case of advance from customers. If you were a customer of a company which made something special that you want and that you can’t get from anyone else, you may have to pay an interest-free advance – one which has no implicit interest element because the company isn’t offering the two choices of paying now and getting a lower price, or paying later and getting a higher price. If you really want its product, you have to pay upfront and earn no interest on advance payment- explicit or implicit. But if the company from whom you were buying, operated in a competitive market, then most likely you will have those choices and if you had paid an advance, you would have earned implicit interest.

      In the end, as I mentioned in my post, it boils down to the power you command over your vendors and your customers which will determine the cost of the float. This power, moreover can weaken or strengthen over time. Just like moats weaken or strengthen over time, so do floats. Indeed, my thesis is that to track the power of a moat, one should measure the quality and the quantum of its float. If floats are deteriorating over time, its a sign of an eroding moat. So you get a quantitative criteria to evaluate the changes in the fundamentals of a company over time. Which is awesome. Just take a look at NBCC. In FY2002 the company had huge debt, and an interest cover of 1.5, huge receivables and positive working capital. Now, the company has zero debt, and a hugely negative working capital, thanks to its very large advances from customers. So, something happened to the quality of NBCC over this time and it’s worth looking into, and thinking about how long will this last.

      As for your second question: The higher the interest rates in the economy, the more valuable free floats become as sources of unencumbered value for stockholders.

      Hope this helps.

  14. Thanks Sir , Kaveri seed is not having that much attractive float as I thought . Company is having seasonal business and it generates 80 % business in APR-JUN quarter so if company change financial year starting from July (similar to Symphony) then inventories will be far less , but same time advances from customer will be also far less than current figures.

  15. Exceptional delight to read this post, wonderful clarity! I then read your post “when a dollar is not a dollar”, which left me wondering if one shouldn’t account for non-surplus cash when comparing float with operating assets? Thanks a lot for sharing your insights.

  16. Sir – Just wanted to get your feedback on National Building Construction Corporation. Here is a company which looks quite undervalued and ticks many of your boxes (cash bargain, debt capacity bargain).

    1. Looks like the company has a sustainable moat based on the objective criteria mentioned by you.

    At the end of FY 2012

    Operating assets – 2,144 cr. (including inventory – 450 cr, trade receivables – 852 cr)
    Financial assets – 1,491 cr. (including cash – 1,325 cr, current investments – 166 cr)
    Total assets – 3,635 cr.

    Equity – 795 cr.
    Debt – NIL
    Float – 2,840 cr.

    2. Cash bargain

    Right now the market capitalization (1,206 cr is less than cash on the books)

    3. Debt capacity bargain

    Although cash flows are only available for the last two years, looks like it is a debt capacity bargain as net profit seems like a good proxy for the CFO in this case. The capex is almost negligible.

    Why is this company with a moat quoting at such low valuations. Am i missing something here ?

    1. Take a look at contingent liabilities Kashif. Apart from that, I haven’t been able to determine the durability of the company’s float. Take a look at the company just 5 years ago. It was a very different company then…

      1. Sir – Actually i did take a look at the contingent liabilities. I might be wrong but this is how I worked out the nos.

        The major contingent liability – 1,005 cr. (counter claims against this – 529 cr.)

        Then there is a contingent liab. for 382 cr. which is for “Bank Guarantees for performance, EMD and Security Deposit.” I figured bank guarantees would be issued by the company (since it in in construction consulting) in the normal course of business. So i did not include these in my calculations.

        The company has been debt free since 2008.
        2007, 08 and 09 were very good years for the company like many others with net profit margins of 5.3%, 13.8% and 7.8% and ROE of 53%, 83% and 35% respectively. Profit margins and returns have since moderated to 3.8%, 4.3% and 5.3% in 2010, 11 and 12 respectively. ROEs – 21%, 21% and 24%.

        So not taking into account the extraordinary profits of 2008 and 09. Average profit for 2010, 11 and 12 – 150 cr. The debt capacity accordingly comes at 496 cr. (150/0.3)

        Cash and current investments – 1,491 cr. (cash has steadily increased over the years)
        Assuming the company has to pay out 80% of the contingent liab of 1005 cr. and doesnt get any counter claim.

        Conservative estimate of the value of the company (with no growth prospects taken into account) – 496 + 1,491 – 80%*1005 = 1,183

        Major negatives which I have been able to figure out

        1. Contingent liabilities
        2. Large work force and history of labor unrest
        3. Dependence on govt. contracts


        1. Revenue visibility. Work order in hand – 13,200 cr
        2. Land bank of 125 acre. Real estate which doesnt contribute much to the topline right now can be a growth driver in the future.
        3. The company has grown its revenues for each of the past 10 years at a CAGR of 21%

        1. Those are very good points Kashif. And obviously, if the contingent liabilities do not become real (and assuming that there are no more cockroaches in the kitchen), the stock is statistically cheap and I’d okay it for a small position in a portfolio of statistical bargains. But to build a larger position, one has to have deep conviction about the moat this company has. It’s clear that the moat is not because of any intellectual property or execution skills (projects are outsourced). The moat comes from connections, or rather preferred treatment given by govt in awarding contracts. In just a few years the company has gone from being highly leveraged to debt-free with huge float. How sustainable is it? It’s hard for me to predict that.

          This is a murky business, and getting 10% commissions for projects which are outsourced to others may deliver solid earnings for a while but is this model sustainable? I am not too sure…

          But I have a friend who is very optimistic about this stock. You can connect with him on to compare notes. He has met the management, and owns a position in the stock. He agrees with your thoughts on the real estate angle… Connect with him.


  17. Thanks for your valuable feedback sir, much appreciated. Would get in touch with Pratik.

    Totally agree with you about the sustainability of the moat of the company. But as Graham has said, price changes everything, and at a low enough price even a mediocre business becomes a good investment. Was trying to figure out that price in this case.

    1. Dear Professor,
      More than a decade ago, NBCC had a different character but isn’t a decade long enough for a company’s character and business model to change. For at least last 10 years data that I looked at — NBCC had Float in excess of operating assets – every single year. Float to operating assets ratio has ranged between 1.12 and 1.57 over FY03-FY12 with average of 1.39. If NBCC has sustained Float greater than Operating Assets for so long, it is highly likely that this is sustainable. Though, an understanding of what will sustain this is required by investors and that will come from an understanding of the business. ROE and ROCE have been 25% plus in all these years.

      1. On 31 March 1989, NBCC’s Balance sheet looked like this:

        Capital: Rs 207 cr.
        Debt: Rs 217 cr.
        Equity: -Rs 10 cr.

        Float represented by Sundry credits, Deposits, and Advance from clients included in Current Liabilities was Rs 89 cr.

        Ten Years later, by the end of March 1999, the company’s balance sheet looked like this:

        Capital: Rs 115 cr.
        Debt: Rs 133 cr.
        Equity: – Rs 18 cr.

        Float represented by Sundry credits, Deposits, and Advance from clients included in Current Liabilities was Rs 349 cr.

        Clearly the company, even with negative equity was living on other people’s money.

        Soon thereafter Arup Roy Choudhury became the company’s CMD. The company’s first balance sheet under his tenure, as on 31 march 2001 looked like this:

        Capital: Rs 149 cr.
        Debt: Rs 153 cr.
        Equity: -4 cr.

        Float represented by Sundry credits, Deposits, and Advance from clients included in Current Liabilities was Rs 341 cr.

        So that’s what Arup Roy Choudhary inherited.

        By the end of March 2010, the balance sheet (the last one signed by Arup Roy Choudhary, who left NBCC to become CMD for NTPC) looked like this:

        Capital: Rs 546 cr.
        Debt: Nil
        Equity: Rs 546 cr.

        Float represented by Sundry credits, Deposits, and Advance from clients included in Current Liabilities was Rs 2,193 cr.

        The next two years were also good, even after Arup Roy Choudhary’s departure. The company turned around under the helm of Mr. Choudhary. His departure has not yet hurt the company. It seems Mr. Choudhury worked very hard in getting contracts on favorable terms for NBCC and he succeeded – he has written extensively about how he turned around the company in the annual reports. And therein lies the problem.

        In such companies quality of management has to be excellent. If future management teams are as good, NBCC has an excellent future and the stock is cheap. But if management falters in getting contracts for the company, then it could go back to bad old days of 1989. No?

        My point is simple: NBCC’s moat comes from govt contracts with an influential CMD who can get them in the first place. It does not come from any sources independent of management. If we remove the high-quality management and replace it with mediocre management, how sure are we that the company will continue to prosper?

  18. Good Morning.

    Couple of points re: Nesco.

    1) Floats need to be sustainable. And should allow the business to make a cash profit. Sometimes the whole competitive adv seems disappear overnight. Case in point – Nesco made a cash flow from ops of 41 Lacs for 08-09. Which was a fraction of what it made the previous years. One factor for low cash flow from ops was the trade receivables shot up. Needless to say HUL cash flow from ops was sustainable during the same period.

    2) Wise men sayeth – never invest in over capacity. You just have to go past the nesco it bldg 3 at night. Its an epitome of overcapacity and darkness. From the annual report of 08-09 “This building is expected to be completed around April 2010”. About two and a half years later – it still seems like no is using the space. And in the vicinity there are more commercial development well under way. May be 2-3 million sqft which will hit the market in a couple of years. I dont think it is totally far fetched to imagine that at some point the landlords will have give back the interest accrued on the deposits back to the tenants.

    I know that you have(or used to have) a position in Nesco. Confirmation bias?


    1. Rishi,

      Nesco suffered in FY09 because of November 2008 terrorist attacks in Mumbai, resulting in cancellation of many exhibitions.

      And IT building III is not leased out yet because the management is holding out for higher rents. I don’t know if that’s rational or not but I do know that they can afford to wait because of absence of debt which gives them “staying power.” As for float, the advances from customers have only increased over the years as per figures below:

      FY 09: Rs 40.08 cr.
      FY10: Rs 38.22 cr.
      FY11: Rs 53.20 cr.
      FY12: Rs 57.48 cr.

      The company’s treasury has also increased over the years. At the end of FY09, investments parked in mutual funds (net of debt) were Rs 94 cr. By the end of FY12 this figure had soared to Rs 210 cr. This increase in cash occurred despite (1) the capex spent on IT Building III (since no debt was taken); and (2) the horrible environment in which real estate sector has been.

      Also, despite the fact that Nesco stock is one of the best performing real estate stocks in India over the last 4 years, it cannot be compared with businesses like HUL.

      1. Good evening.

        Good point. Yes, FY09 was the perfect stress test for Nesco. Mumbai attacks + The great recession. And unlikely to repeat. But, it does show how the demand for exhibition is fungible. And, as you rightly pointed out, this is no HUL.

        Playing devils advocate here. About the treasury being what it is – it can be argued that the float is not being used very efficiently.

        What follows is probably less to do with floats and more to do with my concerns regarding nesco.

        Nesco will generate above normal return on capital invested because of the under utilised land bank. However the re-investement rate and therefore utilisation rate of its land is likely to remain low for a really long time because of excess supply of commercial real estate in the vicinity.

        Nesco’s management has been very conservative. That’s something I have really admired. But, they have extended the same conservatism to dividends. As they say in corporate finance, the bladder is getting bigger.

        1. Rishi,

          I agree with you on dividend policy. Nesco should pay a MUCH larger dividend. In fact, it can carry modest amounts of debt to save some taxes too. It’s a great case for bonus debentures in my view where without laying out significant cash, the company can have a more tax-efficient capital structure, and deliver to stockholders an instrument with an independent and high market value, plus a stock which sells at a smaller discount (if any) to resulting fully diluted intrinsic value.

          As you to another point in your earlier comment where you wrote “Wise men sayeth – never invest in over capacity,” I don’t agree with that. Why wouldn’t you invest in over capacity, if it’s free and if when it becomes utilised will result in large incremental earnings? Why would you not want to own an under-utilised gas pipeline or under-utilized road where current earning power itself more than explains the market value of those assets?

          Thanks for your inputs.

  19. Sure. Rules of thumb will have exceptions. However, talking specifics, as you have implied and I agree, Nesco is fairly valued as per the current earnings. However, given overcapacity, it might not be able to grow its earnings/profit in the next few years. I am guessing about 3-5 years. And given the run up of price, I do not view this as “cheap” anymore. Not to come across as a trader(I have held on to this for about 4 years now). But, I think its time to move on. Time to save up for later.

    And thank you for your thoughts! Its great fun reading your posts!

    1. Dear Prof.,

      Your views on the following points –

      1) Prospective Clients / Customers for IT Parks is narrowed down to IT companies / Divisions of IT companies doing domestic business because IT companies doing international business have the option of both IT Park as well as IT SEZ’s for their new businesses.

      SEZ’s offer (a) lesser corporate taxes (MAT) and (b) duty benefits on the office infra. All other things being equal, lease rentals in SEZ are higher compared to IT Parks.

      Secondly, the government may propose changes in the SEZ policy to make it more attractive. One of the points being reduction of the minimum size of sector specific SEZ to 10 acres from existing 25 acres.

      This may make NSECO explore the option of SEZ, if they have not already done it. Then both alternatives of IT Park and IT SEZ can be offered to the prospective customers.

      2) Large IT companies block space but occupy it in a phased manner extending upto more than a year with deferred rentals as per the commencement of the occupation.

      Warm Regards,

      Vijay Yadav.

      (Invested in NESCO for the long term)

  20. Professor- fantastic series of posts. Just wondering, do you have a copy of the 1964 American Express annual report that you could re-post? The earlier link is dead. Thank you for sharing your insights.



  21. Hi,
    Excellent Post. But will HUL be able to continue with the float in future especially as (a) sub-contractors/vendors have more options to supply to (ITC, P&G etc..) leading to lower creditor days and (b) higher receivables as and when big scale organised retailers start to form higher portion and are in position to demand credit?

  22. Dear Prof.,

    Thank you so much for your wonderful posts on float.

    Is it possible to share your thoughts on how to value float then? You explain clearly that when a float is sustainable and at a low cost, it should not be a liability as big as shown on the balance sheet. But how would you estimate the true liability? For a company like Berkshire, given the fact that their float has been nicely growing for many years and with underwriting profits, does that mean the liability should be valued at zero? But there will always be a chance that the float has to come down for a few years or the float starting to incur some cost, how should we factor in such difficult to estimate factors into the valuation of the float?

    Thanks, sir.

    Best wishes,

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