Here's How People Get Fooled Into Buying Bankrupt Companies...

Tyler Durden's picture

Authored by Simon Black via SovereignMan.com,

In 1906, American entrepreneur William T. Grant opened his very first “W.T. Grant Co 25 cent store” in a small town outside of Boston.

The store became popular and fairly profitable. So Grant opened another. And another.

Three decades later, Grant’s retail empire was generating $100 million in sales (an enormous sum back then). And by the time of Grant’s death in 1972, there were over 1,000 stores bearing his name.

Investors loved W.T. Grant Company stock for its reliable profits and high dividends.

Many of our subscribers may remember W.T. Grant. The chain was among the largest in the US at its peak.

And then something completely unexpected happened…

In 1976, W.T. Grant Company declared bankruptcy.

At the time, it was the second biggest bankruptcy in US history. And, like the downfall of Lehman Brothers and other big Wall Street institutions at the onset of the 2008 financial crisis, it was a shock to the world.

How could a company as big and profitable as W.T. Grant Co. go bust?

In the autopsy that followed the bankruptcy, accountants found that while the company was generating substantial PROFIT, it was not generating any CASH FLOW.

These two terms sound the same, but they’re dramatically different.

Profit, or more specifically net income, includes all sorts of bizarre accounting rules that don’t actually make sense in the real world.

Due to these rules, companies are often required to adjust revenue and expenses for things like “depreciation”, or “foreign exchange gains and losses”.

These are all merely accounting terms that don’t directly and immediately affect cash balances. But they can dramatically impact “profitability.”

Here’s one example from my own experience: a few years ago, the large agriculture company that I founded here in Chile purchased a farm.

We bought it for far below the property’s market value.

It was a great deal for the business. BUT… accounting rules required that our company record a PROFIT based on the difference between what we paid for the property and what it was worth.

This idiotic rule made it seem like we achieved a profit simply for buying a property.

This makes no sense. In the real world, we would only earn a profit by SELLING the property for a higher amount than we paid. You can’t profit before you sell something.

It’s rules like this that make profit an unreliable metric.

CASH FLOW is much more accurate.

Specifically, OPERATING CASH FLOW tells us how much money a company makes from its business.

It strips out all the silly rules and focuses purely on how much cash a business generates from its operations.

Then there’s FREE CASH FLOW, which is the amount of money left over for investors AFTER a company makes all of the necessary investments it requires for future growth.

Cash flow is what counts. If a company has negative cash flow, it will eventually go under.

Profit can be misleading. And that’s what happened to W.T Grant Co. It was profitable but had negative cash flow.

Today there’s another famous business in similar circumstances– our old friend Netflix.

Quarter after quarter, Netflix reports a profit.

Just yesterday afternoon the company had its quarterly earnings call, posting a profit of $553 million. Not bad.

Yet when anyone dives just a little bit deeper into the numbers, Netflix’s cash flow is absolutely gruesome.

The company’s operating cash flow is negative. In other words, after stripping out all the unrealistic accounting nonsense, Netflix’s core business LOSES MONEY.

In fact Netflix’s operating cash flow has been negative FOR YEARS. And the amount of money its losing is increasing.

Netflix’s business has lost $1.3 billion so far through the first nine months of 2017. That’s 52% worse than the $916 million operating cash flow deficit they suffered in the first nine months of 2016, and nearly three times worse than the $504 million operating cash flow deficit during the first nine months of 2015.

Throughout this period, the number of Netflix subscribers has steadily grown, now well in excess of 100 million.

And every time Netflix reports a big surge in subscribers, the stock price soars.

This is truly bizarre. Just look at the cash flow numbers: as the number of Netflix subscribers has grown over the years, the company losses have grown even more.

It reminds me of that old saying from the 1990s dot-com bubble– “We lose money on every sale, but make up for it in volume.”

But it gets worse.

The company’s negative operating cash flow doesn’t include the billions of dollars that it spends on content.

And on its quarterly earnings call yesterday, executives announced they will spend a whopping $8 billion on original content next year.

That’s $8 billion that they don’t have. And don’t forget the $1.4 billion operating cash flow deficit.

Where are they possibly going to find this money? Simple. Debt. Netflix will pile on more and more debt despite racking up enormous cash flow deficits.

Now, to be fair, it’s not unusual for a business to lose money for a period of time as part of a longer-term plan to generate strong cash flow.

But just look at this industry: it seems like EVERYONE is diving in to this original content game.

Apple. Facebook. Amazon. CBS. Disney. Google. Sony. Time Warner. Hulu. Each of these organizations has developed a streaming service with original content.

And some of them (especially Google and Facebook) have an endless war chest thanks to their cash-gushing core businesses.

Google’s parent company (Alphabet) reported free cash flow of $11.6 billion in the second quarter alone. So it could easily outspend Netflix and still have billions of dollars left over.

All of this competition is going to be great for consumers; these companies are collectively spending tens of billions of dollars to entertain us. And they’re going to lose money doing it.

But for investors this is sheer madness. Don’t be the sucker paying for other people’s entertainment.

And to continue learning how to safely grow your wealth, I encourage you to download our free Perfect Plan B Guide.

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adr's picture

Kind of the same reason people buy Bitcoin. Promises of riches for buying in. 

The greater fool theory always works, until it doesn't. 

HRClinton's picture

You're an uninformed moron, who projects his own biases into others. 

 

max2205's picture

The gubermint has terrific cashflow  usps dod fnma irs ect 

hestroy's picture

Lol! I just love brainwashed fools like you.

chicmagnet's picture

These Bitcoin Bugs are a nasty bunch. 

johngaltfla's picture

So what Simon is saying is that Tesla is a good stock to buy out of the money calls on.

Got it.

Or not.

Took Red Pill's picture

Pentagon fears hackers will crash the stock market. Are they preparing us for something?

https://www.rt.com/usa/407036-pentagon-hackers-crash-stock-market-darpa/...

YUNOSELL's picture

Goldman's got my back -- they wouldn't sell me some shitty investment just to increase their profits -- that would be a public relations nightmare if it were ever found out and would without doubt put them out of business. 

weburke's picture

short squeezing must be the game.

Forbes's picture

It wasn't a mystery that W.T. Grants went bankrupt if you shopped there, or had seen their stores. Dusty, decrepit, and no bargains--the variety store format was over done and unappealing. 

VWAndy's picture

 401k fund managers is my guess. Calpers is pretty good at it also.

johngaltfla's picture

I wonder how many SHLD bonds those idiots hold...

VWAndy's picture

 Ill take OPM for the win.

Oldwood's picture

Everybody knows that you never invest in yourself, always place your bets on other, bigger, more impressive companies that hire countless accountants and marketers to make sure we see them as the genius and us as the idiots only barely smart enought to pick a winning stock.

How could we ever go wrong? Even the Vegas shooter was smart enought ot know he could only get rich in the casinos, right?

1 Alabama's picture

he was playin slots and laundering money, now if thats what you call rich, i got a cop shop i'd like to sell ya

Oldwood's picture

If you can't tell, I'm not a great believer in casinos of any stripe. He was as likely to become rich in a casino as I am....which is fucking NEVER.

There are so many scams going on simultaneously that we never have a chance to figure out what it really going on....deliberately so. Buying into another something for nothing WHICH IS ALL THE MARKETS ARE NOW, is doomed.

1 Alabama's picture

hey the whole of the human race is cooked, failure is baked into the cake, trying to figure things out at this late moment, is futile. Save yourself the pain in the neck and fuck the system, thats where the money is

Oldwood's picture

Contentment and satisfaction seldom come from money. Money as it is today is a drug, an addictive narcotic that only creates NEED for more. Greed IS that need and few can distinguish the difference between its utility and addiction. Abandoning any sense of principles simply to satiate an unsatiable need actually defeats the entire purpose of satisfaction and leads to our self destruction.

The wealthy man is the one who needs nothing. Neither poverty nor riches...peace and contentment.

For many of us we need little but our anxiety comes from fear of loss, fear of losing our contentment, and while for many of us that contentment comes from self sufficiency, aging slowly robs that away from us. Our abilities diminish with time and MONEY is the only equalizer....that and a gun.

Currently the war is on wealth, and its pretense is on "the rich" which so many can rally around, but in reality, "the rich" can afford protections that we will never have, so it falls upon everyone who has ANYTHING to be the target of economic justice, the destruction and redistribution of wealth, ultimately NOT to the poor but to the rich and powerful who legislate and enforce our laws.

Fuck the system indeed, unfortunately we are fucking ourselves in the belief we are fucking others worse. Their game.

1 Alabama's picture

i never liked the democrats, and never knew how to play their little games, just like they dont know how to compete w/ mine

24Richie's picture

A large reason for the collapse of W.T. Grant was its choice to extend credit to customers without doing anything to determine if they could repay.

Oldwood's picture

They were victims of bad timing.

Today unpayable debt is considered the best asset you can own given no debt can now default, it simply stays on the books forever. 

Whatever the fuck you do, do NOT go around suggesting that credit should simply be awarded based upon if it can be repaid. That shit there will KILL this economy!

DaveA's picture

Thus when China and Germany lend money to other countries so that their citizens can buy goods made in China or Germany, I call it the "W.T. Grant strategy".

Instead of e.g. buying Greek bonds so that Greek citizens can buy BMWs, it would be cheaper for the German government to cut off all credit to foreigners, buy up the unsold BMWs, and sink them in the North Sea.

Sudden Debt's picture

In Belgium, they want to institute a 15% penalty for savings on your bankaccount of over 5000 euro's!!!!

15%!!!

 

WHY???

 

Because they think it's a waste of money and they want to encourrage people to invest in the stockmarket!!!

NOW!!!! WHEN WE'RE AT AN INSANE TOP!!!

 

They don't care if companies are bankrupt! The numbers add to the GDP and that's all every country cares about!

SAVINGS DO NOT ADD TO THE GDP!

Oldwood's picture

When are we going to start measuring and publicizing Gross Domestic WEALTH? I'm sure the South had a pretty good GDP with all those slaves picking cotten, but for some reason I don't think the slaves saw that as a positive.

Sudden Debt's picture

The north made a lot more money with the whites who worked in their factories for peanuts. 

It's cheaper to pay scraps as a salary and let the worked handle their own shit. In the south, they had to house them and take care of them.

 

Look to Saudi Arabia that still has slaves. Sure they're rich but it's not because of their slaves!

A while ago, a Saudi princess was arrested in Belgium for having 2 slaves who had to sleep on the ground.

http://www.dw.com/en/eight-arab-princesses-go-on-trial-in-belgium/a-3879...

 

I wonder why it doesn't really make the press in a big way.... and still America dances to the Saudi's tunes...

Oldwood's picture

Yours is the point that many slave owners of the time were trying to make, that THEY were doing God's work, caring for ignorant slaves incapable of caring for themselves. They DID however fail to mention that the slaves were largely ignorant because they were DENIED an education and those that did get educated generally escaped and became free and self sufficient. Southerners claimed that those working in factories of the north were far more unfairly treated, not even provided a place to sleep...while ignoring the fact that most of these people came here of their own free will.

It is a waste of time to attempt to find justice in end results as progressives do. It is our CHOICE that makes us free, not our homes or income. If we are deliberately deprived of choice, THAT is SLAVERY and is WHY it should be denied.period.

It is important and relevant to note also that it is the left who tried to keep the blacks ignorant and dependent upon the plantation, just as they do today. I think there may well be predisposition within blacks to more easily succumb to dependency given their history, but NO ONE is immune, as progressives seek to prove to us every day.

1 Alabama's picture

who came here of their own free will? the slaves? not true, they were brought here and almost sent back if not for the emancipation proclamation, yeah they were discriminated against educationally, but so did you.

Oldwood's picture

Workers in northern factories were immigrants who came here of their free will. Slaves were never privy to free will beyond dying in protest or escape.

"yeah they were discriminated against educationally, but so did you" Unclear to your meaning.

Was I deprived of an education? I don't THINK so.

1 Alabama's picture

i beg to differ on the education, above you spoke of aging and division of money by classes, in tomorrows world, it dont pay to die.

bluez's picture

So-called "free will" is purely a religious concept. Just like "eternal life after death".

There is absolutely no scientific way to prove that something called "free will" actually exists. This idea of "free will" is simply programmed into us starting even before we go to kindergarten. It is merely the central idea of the religion of modernism.

Oldwood's picture

I do not believe that choice or lack there of is religious or modern. Free will is the ability to effect choice,, to decide. I don't think that is some new age construct.

bluez's picture

Consider: "We must believe in free will. We have no choice." -- Isaac B. Singer

Yes I said free will was the religion of modernity, but it has also been the religion of antiquity. In fact it was the first religion. Remember the old days when men needed to club women over the head and drag them into caves? Then one day this girl invented the concept of the deal: "I will go into the cave if you promise to give me a bowl of that mammoth stew". This was the first "contract" and contracts require consent and consent implies free will.

Every social relationship that came after that was based on some kind of contract, and contracts mean nothing without free will. And free will was actually an extension of the concept of time; a contract from the past and a fulfillment in the future. Sex trade, tribal commitment, property ownership, government, religion -- all these things depend upon the notion of contracts and thus, free will.

Yet this free will is a complete illusion that doesn't even exist.

Sort of like Bitcoin.

"I'll gladly pay you Tuesday for a hamburger today." -- J. Wellington Wimpy

Ikiru's picture

Well said Oldwood. Might not want to make this comment on the Marc Faber board. The racists are having a field day there--Soros would be happy. It's EXACTLY what people like him want--for us to think of everyone as part of races or groups--rather than as individuals. He doesn't support BLM because he likes BLM. He supports BLM because he knows whites will hate it.

1 Alabama's picture

at least they had food and a roof over their head, today we live in tents, sub ways, park benches, and live on twinkees and cup cakes

Oldwood's picture

I live in a predominantly black neigborhood and I can promise you they are NOT living under bridges. There are many of all races that are. But I do not think slavery is the solution. Education and independence would go a long way towards resolution, but there is NO absolute solution for the HUMAN condition.

1 Alabama's picture

no there isnt, because education in this country, sucks, it is on the wrong side of nature, over too long a period of time, and now the cost of living has skyrocketed, their is no political or military solution, only a private one

oldschool's picture

There is, in fact, exactly one absolute solution for the human condition -- and it is neither political nor economic.

Cash Is King's picture

How about M2? Greeny dropped that like a college girlfriend in ‘05-‘06? I wonder why?

Village-idiot's picture

Your logic only applies in a Keynesian world.

In a normal world your savings are lent out and it collects interest.

In today's insane world the currency needed is created in a computer and it's lent out.

Savings are not needed. Why pay interest to a depositor when you can create the currency and pay no interest? That way it's all profit.

Cash Is King's picture

You don’t get it do you? SD, you’re smarter than that! The musics’ still playing and the elected morons are pettlying the dope they are told to pettle! We don’t have public servants only serpents who serve the public to the wolf.

Sudden Debt's picture

And for the NETFLIX crap??

 

I USED TO BE FORBIDDEN FOR A COMPANY TO SELL PRODUCTS WITH A LOSS!!

that was a law to make sure competition is fair and large companies don't destroy the little once.

NOW?? THAT LAW IS GONE!

Oldwood's picture

You mean that all this shit we have been buying at below cost from China for the last twenty years is actually HARMING our economy?

I don't believe it!

Amazon is our new China, funded by the greed of the great casino.

Tulips, get your tulips. Never been a better time to buy TULIPS!

Sudden Debt's picture

Chinese workers used to be paid 50 dollars a month.

And that crap you buy from China usually has a markup of over 400% on profits.

 

A Chinese will never sell you something at a loss. If you barter a discount with them, they just pull out parts untill they make the profit they wanted at the start.

traders know that all to well and know that "golden samples" are very very hard to get before a deal is struck.

 

Oldwood's picture

I have no facts, just like you. What I can tell you is that you can buy something like furniture from China, MADE in China, shipped here in a box to your door step for less that I can have a box of similar size and weight shipped across town. 

My father in law is looking at buying a swivel recliner with ottoman, wood and leather, online, shipped here in two cartons, to his door, for $269.

I BUILD furniture for a living and I can't buy the materials for that, much less build it, finish it, carton it, and I can fucking promise you I cannot hire UPS to come pick it up and deliver it across town for $269, much less from China or their distribution warehouse. And how much did the online reseller get paid?

SO, while I have no proof I would suggest to you and anyone else willing to simply THINK about it, they ABSOLUTELY are selling at below cost. LIke Amazon they don't need profit when they have a steady supply of money coming in as debt. Further thinking will inform you that much of their production is done through automation now...the exact same automation we have access to yet they STILL kill us in price and they can still manufacture much of their consumption goods and ship them here cheaper that we can simply ship them. Now you may suggest that they never lose, but we know their economy has a massive debt that has gone directly to these factories that we KNOW have been LYING for years on their profits and production numbers.

 

1 Alabama's picture

not true, the unsustainablitiy of the pension system has prevented fair competition across many industries, w/o pension obligations both public and private, we would kick their butt in short order acreoss the board

Oldwood's picture

Bullshit. I own and operate a furniture busness, have for forty years. I have no pension obligations and even if I paid no taxes AT ALL, could not compete with Chinese prices. Have you ever made anything?

1 Alabama's picture

all that stuff you spoke about buying to make your furniture, the taxes being paid, the electrical use, the list goes on and on about the rising cost of living and where those costs are derived, you are not looking deep enough into the problem, you are skimming your surface and applying it globally

Oldwood's picture

I know what my costs are and wood is wood, hardware is hardware and if China is selling finished products for less that those items cost everyone else in the world, they are selling below cost.