The previous post discussed the investment philosophy of Thomas Rowe Price, Jr., and his conviction that investors should focus primarily on the business merits of the company, and on finding well-run businesses positioned in front of fertile fields for future growth, and then should consider owning those selected companies through the inevitable ups-and-downs of market cycles.
This approach was a stark contrast to the much more prevalent investment styles, both in Rowe Price's day and in the present day, of trying to predict different turns in the economic cycle or the market cycle, and trying to jump in and jump out of different stocks, sectors, geographies, currencies, or other asset classes based on those predicted inflections (we've written about the problems with this approach many times in the past, including here, here, and here).
In the past, we've published several short profiles of companies that we own in the portfolios that we manage and that exhibit the classic growth-stock characteristics that Thomas Rowe Price and Richard Taylor sought out, and that we have owned through the cycles of relative popularity or unpopularity on Wall Street, often with happy results for our clients (see lists in these previous posts, here and here and here).
An example of a Taylor Frigon growth company which we have owned for many years and which often falls in or out of favor with Wall Street based on the popular attempts to predict different turns in economic cycles is PRA Group, a specialty finance company providing accounts receivable management*. "Accounts receivable" is an accounting term referring to an asset in which another party has yet to pay for a good or a service, and therefore owe some payment, which the asset owner expects to someday receive -- hence, a "receivable."
PRA Group helps to encourage the payment of the receivable payment: simply put, PRA Group performs debt collection. The business model that PRA follows is fairly straightforward. It buys the receivables of companies who have given up on trying to collect on those receivables and who just want to get something for them rather than nothing. PRA can buy these defaulted receivables for literally "pennies on the dollar," because the originator of the accounts has basically despaired of getting anything on them at all. PRA then assigns their own experienced and well-trained teams to work on getting some of the receivables.
PRA has tremendous experience in valuing and purchasing the debt that they believe they can still collect on, and because they have now paid off the first lender, if they are able to recover more than what they paid for the receivable that amount will belong to PRA. They thus perform a service for the original owner of the receivable (who would prefer to get something back on a defaulted extension of credit to another person) and often to the party who owes the money as well, since simply continuing to not pay is often not the best choice unless bankruptcy is imminent.
In some cases, PRA will work on a "contingency" basis, in which they do not actually purchase the receivables from the originator, but instead will perform the collection services on a contingency basis, keeping a percentage of the collections as a fee from the originator who has chosen for whatever reason to outsource the collection instead of making all the calls themselves.
Although this business model is fairly straightforward, that does not mean it is easy to be successful at it: PRA has seen most of their competitors in the same field drop out of the business. Many of their competitors relied on borrowing huge amounts of money (leverage ratios well above 1) in order to finance their own purchase of receivables, and/or on bundling up and "securitizing" the receivables that they themselves bought, to sell them to Wall Street as a security to sell to investors. PRA Group relied on neither of these two strategies, and have watched many of their competitors who did use these approaches exit the business or fail. This has left PRA Group in the enviable position of dominating a market with little competition -- and while there are not necessarily that many barriers to entry, history has shown that succeeding in the market can be difficult.
PRA Group has managed to grow operating earnings by a compound annual rate of 28.7% for the past five years. The company's return on assets is approximately 10.9%, and return on equity is approximately 17.1% (on total debt-to-assets of 0.46). This previous post cited some of the "hurdles" in some of those departments that Thomas Rowe Price used to look for in a company, and PRA exceeds the standard in each category by a wide margin.
Some investors may have some qualms about investing in a company which performs debt collection services, on the grounds that consumer credit problems are often a major burden to individuals and families in difficult circumstances and difficult economies, which is a valid concern (and one that is tied to the larger problems of erroneous neo-Keynesian economic theory and excessive central bank "perpetual emergency stimulus" policy).
However, while we agree that this is a serious issue and a serious problem, it would be foolish to argue that credit or receivables are not very important aspects of an economy. Without such mechanisms, no one would be able to start restaurants or dry cleaning businesses unless they had enough cash of their own before they even opened their doors (which would exclude all but a very small percentage of the population). There are many other examples of places in which purchases using credit can be appropriate and prudent.
If we grant that receivables have an important role to play, then it stands to reason that the recovery of receivables is an important task as well. We would also hasten to point out that PRA Group approaches this necessary task in a professional manner, and can be held to account in doing so by the fact that they depend on their reputation for business -- and for investors!
While the economy has gone through many gyrations since we first invested in PRA Group, we believe that it is better to own good companies through cycles than to try to predict when things will be better or worse for their specific industry and try to "jump in" and "jump out." The name is up well over 230% since we first invested in PRA Group.
We believe that this is a valuable example of a well-run business operating in a market with significant potential for future growth -- and an even more valuable example of a name that many investors would be tempted to trade based on predictions about economic cycles, but that proves the value of the Growth Stock Investment Philosophy's emphasis on owning good companies through the inevitable cycles.
* At the time of publication, the principals of Taylor Frigon Capital Management owned securities issued by PRA Group (PRAA).
