Persistentone I will first comment on the statement, “. . ....

Persistentone

I will first comment on the statement, “. . . because their earnings can be easily manipulated by over investing in debt that has poor long term returns.” It is not that they over invest, it is usually that they under amortise, and as an accounting result, pad their Balance Sheets.

Investing in debt (buying PDLs) is not reflected in any of the earnings' metrics, because their accounting entries occur in the Balance Sheet – basically, credit cash, and debit PDLs. Obviously, if a company reduces PDL purchases, then future years will suffer for the want of PDLs to generate future collections. If a company in bad shape, for reasons given at Point A below, cannot purchase PDLs for the want of the wherewithal to do so, they would be inclined to put out a different reason – e.g., “We think prices are too high”, so learn what their competitors say and do.

It is the collections that give rise to P&L entries – the entries are:

1. debit cash, and credit income; then
2. credit PDL asset by an amortisation value, and debit PDL amortisation as a cost.

The pair of entries at Point 1 are obvious. The shenanigans take place via the entries at Point 2, and these can be described as follows:

1. If a debt-collection company wants to create the impression that it is doing well, it can understate PDL amortisation, and the resultant good earnings-related metrics would tend to ramp up the management bonuses and the SP. Those in the know are often the same folk who get the bonuses, and if they sell their shares and retire, they may make good capital gains to boot. Using a high SP to raise capital to buy a large share of founding-directors' shares has the same effect.
2. In contrast, a debt-collection company can easily over amortise, which in the short term will lower earnings-related metrics and the value of assets in the Balance Sheet. This gives management hidden reserves that can be used in difficult times. However, the value cannot be hidden for ever, so there comes a time when the underlying profitability manifests itself, and this is, I think, where CCP now finds itself.

In summary, assuming all the companies are competent, and they buy PDLs at reasonable prices, an investor should when comparing similar companies consider the following:

• Collections.
• PDL amortisation.
• PDL investments (to secure long-term earnings).
• The usual metrics like ROE, debt/equity ratio, growth, bearing in mind that for a few years these metrics can be manipulated via low PDL amortisation. CCP's high ROE could in part be explained if its Equity were understated because its assets are understated.
• Management ability and integrity (the former without the latter is bad news, so look for a company that fits B above, and not A). I am prepared to aver that CCP fits into category B.