[cs702]

The amount of capital tied up in fixed assets is only one component of the capital required. Many other short-term and long-term assets can be components. Every business is different.

For example, a consulting firm may have almost no fixed assets, but let's say its customers are mostly large corps that take 90-120 days to pay invoices. When the firm gets hired for a new project it must cover its expenses for 90-120 days until it gets paid. As a going concern, the firm requires capital equal to 90-120 days of revenues to finance its accounts receivable. If the firm's revenues grow from, say, $100M/month to $120M/month, all else remaining the same, the firm will require an additional $60M to $80M in capital = ($120M/month - $100M/month) / 30 days/month * 90 to 120 days to collect.

[baxtr]

Thanks for that.

So in other words: something like amazon is not a good business for Buffet since they have to finance the inventory for a couple of month at least?

[cs702]

Change in inventories is only one component of capital required. There are many other components. There are great businesses that carry lots of inventory. Every business is different.

Amazon, in particular, is a large entity incorporating numerous businesses (AWS, Prime, Alexa, Merchant Services, proprietary brands, etc.) that are different from each other. Each should be analyzed on its own, because their dynamics are different. For example, Merchant Services is a platform for third-party sellers. They, not Amazon, are the ones who pay upfront for the inventory. They pay Amazon to store and manage that inventory. When a product in that inventory sells, Amazon gets to collect the money upfront from consumers. The sellers get paid sometime later.

Here's a decent primer on estimating return on invested capital: https://www.morganstanley.com/im/publication/insights/articl...

[baxtr]

Yeah sorry, I should have said online retailer. I had amazons original business in my mind.

Of course you’re right that it’s a complex business nowadays.

[cs702]

The portion of invested capital tied up in inventory is not sufficient to judge a retailer. What we want to know/estimate is the retailer's return on invested capital (ROIC). A retailer with significant competitive advantages that can generate above-average ROIC for many years to come is a good business. If, on top of that, that retailer can be acquired at a sensible valuation in relation to such future ROICs, it would also be a good acquisition.