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Buffett Up Big on Chinese Investment, Goldman Sachs
We generally don't pay much attention to short-term tallies of whose stocks are up or down, but Warren Buffett's success in picking investments over the past year is notable because the media has been beating up on him about "being too early" for quite some time. We recall several segments on financial television that criticized Buffett's investment in Goldman Sachs because the warrants he obtained quickly went underwater. Well, the naysayers have to move over because Buffett's long-term style has once again produced solid results in the short term, too.
At a time when California’s economic and political foundation appears to be in tatters, it is easy to overlook how the state has often been on the leading edge of cultural changes in American society. Californians need no introduction to the success of In-N-Out Burger, a relatively small and privately held fast food chain that until recently had a presence mainly in Southern California. In-N-Out Burger’s founder invented the fast food drive through, a cultural milestone that changed the landscape of America.
Why should investors really care about the business success of a small and privately held fast food company on the west coast? Primarily because the patterns and practices demonstrated in this business have resulted in the development of a formidable moat. Since the development of an enduring moat is a rare accomplishment, it is useful to examine whether there are any patterns that can predict the potential for moat creation in advance.
Anyone who has been to an In-N-Out location knows that the restaurants are spotlessly clean, always busy, and staffed by friendly employees serving simple and fresh food. The only comparable business that I know of within the fast food industry is Chick-Fil-A which is also privately owned and appears to have a similar operating philosophy and devotion to simple food served by friendly employees in spotless restaurants. These concepts seem so simple, yet they are powerful differentiating factors for two restaurant chains that have developed almost cult-like followings among their customers.
The video below shows the first ten minutes of the fifty minute video. Be sure to click the “Watch Full Program” button at the bottom right of the video to view the rest of the program.
The author of this post, Ravi Nagarajan, is a private investor and writer focused on applying value investing techniques to find securities trading well below intrinsic business value. He is a Manual of Ideas contributor and editor of The Rational Walk.
Interesting interview. Zell slipped in a bombshell statement that slid largely by Bartiromo: Zell expects commercial real estate to turn down in earnest in another 2-3 years if/when interest rates rise.
"over 730,000 counts of suspected financial wrongoing were recorded in America last year, according to recent data from the Treasury Department's Financial Crimes Enforcement Network. Institutions such as banks, insurers and casinos are required by law to report suspicious activities to federal authorities under 20 categories. Financial institutions filed nearly 13% more reports of fraud compared with 2007, accounting for almost half of the increase in total filings. The number of mortgage frauds alone rose by 23% to almost 65,000. But not all categories saw an increase: incidents suspected terrorist financing fell. Just under half of all filings are related to money laundering, a proportion that is little changed in over a decade."
Top activist investors typically look for companies that can unlock significant shareholder value through a specific corporate event, such as a sale, liquidation or recapitalization.
Activists scour the investment landscape for companies that are not controlled, i.e., firms in which senior executives and directors have a relatively small percentage of the overall shareholder vote. This allows aggressive outside investors to pressure corporate incumbents to take the actions required to bring about positive change. If insiders refuse to maximize shareholder value, skilled activists may be able to remove them through a proxy contest or an outright acquisition of the company via an unsolicited tender offer.
We routinely monitor the acitivities of top activist investors, such as Bill Ackman's Pershing Square Capital Management, Dan Loeb's Third Point, David Einhorn's Greenlight Capital, Chris Hohn's Children's Investment Fund, Carl Icahn's Icahn Partners, and Eddie Lampert's ESL Investments. We have also developed a proprietary stock screening methodology that seeks to identify companies ripe for activist shareholder involvement. Such companies typically trade at low multiples of tangible book value, have significant net cashholdings, and have insider ownership of less than 20% of the total voting power.
Several of the companies shown in the following table are already a target of activist investors. These companies include Trident Microsystems (TRID), Facet Biotech (FACT), Adaptec (ADPT), and Nabi Biopharma (NABI).
Investing in companies that may be targeted by activist investors can be a profitable investment strategy. Two weeks ago, our proprietary activist stock screen was topped by QLT (QLTI), a company trading at a significant discount to its holdings of net cash. As of last Friday, QLT shares had appreciated by roughly 50%. Despite the jump, the shares still trade for less than "net net" current assets and are yet again in the top five screen results.
The company topping the latest screen results is Silicon Graphics (SGI), a leader in large-scale clustered computing, high-performance storage, and data center enablement and services. SGI trades at a negative enterprise value, with "net net" current assets equal to 142% of recent market value. While the simple fact that SGI scores well on our activist screen is no guarantee of strong future investment performance, the shares may represent a good place to look for potential outperformance. As always, do your own due diligence prior to investing.
10x45 Bargain Hunter is a proprietary stock screening report published bi-weekly by The Manual of Ideas. Each issue includes ten proprietary stock screens featuring 45 stocks each. Click here for more information.
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Legendary investor Philip A. Fisher was a great believer in the utility of the “business grapevine” when it comes to researching candidates for investment. In Common Stocks and Uncommon Profits, which was reviewed here in April, Mr. Fisher lays out a step by step approach that can be used to identify businesses that are not merely “cheap” but have excellent future prospects. Scuttlebutt is an approach that attempts to gain valuable insights into businesses through multiple channels:
The business “grapevine” is a remarkable thing. It is amazing what an accurate picture of the relative points of strength and weakness of each company in an industry can be obtained from a representative cross-section of the opinions of those who in one way or another are concerned with any particular company. … Go to five companies in an industry, ask each of them intelligent questions about the points of strength and weakness of the other four, and nine times out of ten a surprisingly detailed and accurate picture of all five will emerge. (Common Stocks and Uncommon Profits, page 17)
In addition to competitors, Mr. Fisher suggests approaching vendors, customers, researchers, trade associations, and others who can shed light on the standing of a business within its industry.
For anyone who has attempted to actually put this advice into practice over the past few years, it is likely that some frustration has been encountered because most business executives are not willing to speak to investors due to regulations designed to “level the playing field” for all investors. Many investors also lack the contacts required to seek informal “off the record” input.
How can Twitter be useful for modern scuttlebutt? Many will dismiss this idea entirely since it is often assumed that Twitter is merely a platform for people who wish to share what they had for lunch with the world. I had this attitude until earlier this year when I began to use the service in conjunction with starting this website (follow me on Twitter). Since then, I have found some interesting ways to use Twitter to gain some insight into the “word on the street”. It is amazing how much people are willing to say directly about company developments, morale issues, layoffs, and other topics in what is perceived as an informal and unguarded environment. Here are some steps that can be used to follow tweets on a company you are interested in learning more about.
Search for Keywords
Twitter has a powerful search feature that allows a user to identify tweets containing keywords. For example, I set up this search to follow tweets related to Paychex. If you look at the results, you will see a number of recent tweets related to Paychex:
None of these tweets are particularly earth shattering from an investment insight perspective, but you can see that Paychex is attempting to hire staff at their Rochester headquarters, that someone is not all that pleased with Paychex, and some other tweets that are somewhat meaningless.
You can also see that there are roughly five tweets that have been posted about Paychex in the past day. Similar searches can be set up for Paychex’s ticker symbol, although I have found that searching on ticker symbols typically yields less useful results.
It should be noted that searching for tweets works well on some companies but not on others. Typically the largest companies will have an overwhelming amount of chatter on Twitter and the “noise” makes it less useful than similar searches on smaller companies. For one extreme example, try searching for Microsoft on Twitter. At the time of this writing, there were literally dozens of tweets posted over the past four minutes.
Monitoring Twitter
Although Twitter has a good search interface, it would be highly inefficient to manually search for this information all the time. Luckily, Twitter allows us to set up customized RSS Feeds based on the results of a search. Click on the “Feed for this query” link on the search results page shown below:
Depending on your browser settings, you will see various options related to how the feed results should be delivered to you. I personally use Google Reader to consolidate all of my RSS Feeds in a central location that I monitor on a daily basis. Incidentally, the same approach can be used to keep up with SEC Filings since it is also possible to sign up for RSS feeds for periodic SEC reports.
What About the Noise?
Intelligent investors would never make capital allocation decisions based on what someone is tweeting on a given day. Anyone can set up a Twitter account and stock scam artists and other promoters have been known to misuse the service. To leverage Twitter appropriately from a scuttlebutt perspective, an investor needs to be able to filter out the noise and identify potentially useful tweets that shed light on a business. Usually, reputable people using Twitter will have a reasonable number of followers and will post links and other useful information in addition to 140 character messages. Many also have links to their website and other pertinent information.
Twitter should be viewed as an online water cooler where you can eavesdrop on people talking about all sorts of topics. In some cases, Twitter has been the first communication medium in which layoffs, poor earnings, and other relevant news has been informally reported. While it is always ill advised to make investment decisions based on unverified rumors, I have found that monitoring Twitter can sometimes lead to interesting insights that can be independently verified. Used in this manner, I think that Phil Fisher would approve of Twitter as one of many ways in which today’s investor can seek information on investment candidates.
Disclosure: The author, Ravi Nagarajan, owns shares of Paychex which is used as an example in the illustrations. No statement or recommendation on Paychex as an investment candidate is being made in this article.
The author of this post, Ravi Nagarajan, is a private investor and writer focused on applying value investing techniques to find securities trading well below intrinsic business value. He is a Manual of Ideas contributor and editor of The Rational Walk.
11 LP July 2009 J MARKETS AT A GLANCE Eric Sprott David Franklin It’s the real economy, stupid We are now in the early stages of a depression. The economic indicators we follow to track real economic activity are all signaling a slowdown of massive proportions. You wouldn’t know it reading the mainstream papers of course – they all focus on the relative decline in the slowdown’s intensity. Reading about the slowdown ‘slowing down’ is not the same as growth however, and does not warrant excitement in our opinion. Our title this month paraphrases one of Bill Clinton’s presidential campaign messages from 1992. As one of the three key themes in Clinton’s campaign, “The economy, stupid” was printed on a sign in his headquarters in Little Rock to help campaign workers stay on message. This month we’re keeping it simple by focusing on the real economy and its implications for the stock market. Here is the real economy summarized in numbers: Industrial Capacity Collapse: US industry used only 68.3% of available capacity in May 2009, according to a monthly report from the Federal Reserve.1 That represents almost one third of all US industrial capacity sitting idle. Prior to the current recession, the lowest rate recorded since the Fed started this series of records in 1967 was 70.9% in December 1982. 2 CHART A depicts worldwide industrial production in a comparison between April 2008 and June 1929. 3 Very similar trajectories. CHART A Sprott Asset Management LP Royal Bank Plaza South Tower 200 Bay Street Suite 2700, P.O Box 27 Toronto, Ontario M5J 2J1 T: 416 943 6707 F: 416 943 6497 Toll Free: 888 362 7172 www.sprott.com Federal Reserve Statistical Release, Industrial Production and Capacity Utilization – G.17 (June 16, 2009). Retrieved on July 10, 2009 from: http://www.federalreserve.gov/releases/G17/Current/default.htm Gallagher, Thomas (June 16, 2009). Industrial Capacity Use Hits Record Low. Retrieved on July 10, 2009 from: http://www.joc.com/node/411908 3 Eichengreen, Barry and O’Rourke (June 4, 2009) A Tale of Two Depressions. Retrieved on July 10, 2009 from: http://www.voxeu.org/index.php?q=node/3421 2 1 1 Government Tax Revenue Declining: 32 of the 46 states whose fiscal year ended midnight July 1, 2009, did not have budgets signed by their Governors. States are grappling with deficits totaling a collective $121 billion, and all states but Vermont require that their budgets be balanced. Personal income tax, which accounts for more than a third of state revenues, dropped by 26% in the first four months of 2009, according to the Albany, New York – based Rockefeller Institute of Government. 4 The US government has spent $2.67 trillion thus far in fiscal 2009, but has only collected $1.59 trillion. The US government collected $685.5 billion in individual income taxes so far this year, a 22% drop from the $877.8 billion the government took in during the first nine months of 2008. US corporate income taxes plunged 57% to $101.9 billion in 2009, down from $236.5 billion in the first nine months of fiscal year 2008.5 Retail Sales Slump: The International Council of Shopping Centers (ICSC)/Goldman Sachs same-store sales tally for June was down 5.1% from June 2008, worse than the latest forecast for a 4.5% decline. Privately held luxury department store Neiman Marcus Group Inc. posted a 20.8% drop in same-store sales. Abercrombie & Fitch Co.'s same-store sales fell 32%, even more than the 26.6% decline Wall Street had projected. 6 Unemployment Catastrophe: The June 2009 jobless rate reached 9.5%, the highest since 1983. 4 million Americans have been looking for work for more than 26 weeks, representing 29% of the unemployed – the most since records began in 1948. During the last 30 years, Americans who lost their jobs took an average 15.8 weeks to find new positions. In June 2009, the average duration of unemployment was 24.5 weeks, the longest since records began in 1948. The number of people collecting unemployment benefits reached a record 6.88 million in the week ended June 27, 2009. Approximately six people are seeking work for every job opening, the most since the government began keeping such records in 2000. A year ago, the ratio was a little more than two-to-one.7 Sprott Asset Management LP Royal Bank Plaza South Tower 200 Bay Street Suite 2700, P.O Box 27 Toronto, Ontario M5J 2J1 T: 416 943 6707 F: 416 943 6497 Toll Free: 888 362 7172 www.sprott.com 4 Randall, Kate (July 1, 2009). US states budget crisis fuel massive spending cuts. Retrieved on July 10, 2009 from: http://www.wsws.org/articles/2009/jul2009/budg-j01.shtml 5 Clifford, Catherine (July 13, 2009). Uncle Sam is $1 trillion in the hole. Retrieved on July 13, 2009 from: http://money.cnn.com/2009/07/13/news/economy/treasury_budget/?postversion=2009071315 6 D'Innocenzio, Anne (July 10, 2009). Weak retail sales in June raise worries. Retrieved on July 11, 2009 from:http://www.google.com/hostednews/ap/article/ALeqM5jEUOBuLQexhEw6Sbb1sU7mSLR6iAD99B0MO01 7 Miller, Rich (July 10, 2009). Obama’s Jobless Safety Net Torn by Rebecca Alvarez (Update1). Retrieved on July 11, 2009 from: http://www.bloomberg.com/apps/news?pid=20601109&sid=atnjG1uvDprY 2 US Housing Market Failure: The annual pace of new home sales is now 342,000, a whopping 32.8% below the rate in May 2008. At the current sales pace, there is 10.2 months worth of inventory overhang sitting on the market, dragging down prices and encouraging potential buyers to wait it out as prices deflate.8 New home sales are down 73% from the all time high of 1,283,000 new homes sold in 2005 (mild recession?). See Chart B.9 CHART B Rail Car Loadings Suffering: For the first 26 weeks of 2009, US railroads reported cumulative volume of 6,806,892 carloads, down 19.2% from 2008.10 An excellent quote included in the June report from the Association of American Railroads stated: “Whenever Americans grow something, eat something, mine something, make something, turn on a light, or get dressed, freight railroads are probably involved somewhere along the line. Unfortunately, right now there’s not enough mining, manufacturing and buying going on. So railroads, like most other business sectors, are suffering because of it.”11 Carloads are down 22.5% from the all time high set in the first 26 weeks of 2006.12 Sprott Asset Management LP Royal Bank Plaza South Tower 200 Bay Street Suite 2700, P.O Box 27 Toronto, Ontario M5J 2J1 T: 416 943 6707 F: 416 943 6497 Toll Free: 888 362 7172 www.sprott.com 8 New Home Sales Stagnate. April Revisions Mitigate May Decline. Retrieved on July 10, 2009 from: http://www.mortgagenewsdaily.com/06242009_new_home_sales_stagnate_april_revisions_mitigate_may_decline.asp 9 US Census Bureau – New Residential Sales. Retrieved on July 13, 2009 from: http://www.census.gov/const/soldann.pdf 10 American Association of Railroads (July 9, 2009). Rail Freight Traffic Remains Down During Holiday Week. Retrieved July 10, 2009 from: http://www.aar.org/NewsAndEvents/PressReleases/2009/07_WTR/070909_Traffic.aspx 11 American Association of Railroads (July 2, 2009). Rail Freight Traffic Down in June. Retrieved on July 10, 2009 from: http://www.aar.org/NewsAndEvents/PressReleases/2009/07_WTR/070209_Traffic.aspx 12 American Association of Railroads (July 6, 2006). Led by Coal and Intermodal, U.S. Rail Traffic Up in June. Retrieved on July 14, 2009 from: http://www.aar.org/NewsAndEvents/PressReleases/2006/07/Led%20by%20Coal%20and%20Intermodal%20U,-d-,S,-d,%20Rail%20Traffic%20Up%20in%20June.aspx 3 Dow Jones Industrial Average: Chart C below plots a return comparison of the Dow Jones Industrial Average between 1929 and 2007. Another frightening comparison to 1929.13 CHART C The big question now is what effect all this bad data will ultimately have on the stock market. Stock valuation can often be wonderfully complex – but it ultimately rests on two main foundations: earnings and investor sentiment. The ‘earnings’ component is concrete; it is a stream of profits that companies expect to generate in the future for their shareholders. The ‘investor sentiment’ component, however, is not concrete. It dictates what investors are willing to pay to buy corporate earnings, and can fluctuate widely depending on perceptions of future growth. The relationship between these two components is vital in gauging market direction. The price-earnings (P/E) ratio is the classic investment fraction that combines these two factors into a usable metric. It deserves mention here because its analysis helps to illustrate the point we are trying to make. In Chart D, we provide data by Robert Shiller that plots the real, inflation-adjusted P/E ratio of the S&P 500 stock index from January 1900 to June 2009.14 As the chart illustrates, as at the end of June 2009, the S&P 500 traded at an inflation adjusted P/E ratio of 16.08, implying that investors were willing to pay an average of 16 times earnings for a share in the S&P 500 index.15 Sixteen times earnings is well below the all time, inflation-adjusted high of December 1999 (44 times), but also well above the lows of 1932 (5.57) and 1982 (6.64). As it turns out, 16 times is almost exactly at the 109-year monthly average P/E ratio – so stocks are trading at their long-term average P/E level in the current environment. Sprott Asset Management LP Royal Bank Plaza South Tower 200 Bay Street Suite 2700, P.O Box 27 Toronto, Ontario M5J 2J1 T: 416 943 6707 F: 416 943 6497 Toll Free: 888 362 7172 www.sprott.com 13 Lundeen, Mark J. (July 3, 2009). Bear Markets and Horror Movies. Retrieved on July 10, 2009 from: http://www.gold-eagle.com/editorials_08/lundeen070509.html 14 Shiller, Robert J (2005) Irrational Exuberance [Princeton University Press 2000, Broadway Books 2001, 2nd ed., 2005]. Data set downloaded on July 3, 2009 from: http://www.econ.yale.edu/~shiller/data.htm 15 Bloomberg reports the P/E for the S&P 500 Index in June 2009 as 14.58. The discrepancy to Shiller’s data is for several reasons: a) Shiller reports using June 10 closing data b) Shiller uses a rolling average value for Real Earnings when calculating the P/E ratio c) Shiller uses extrapolation for estimates of the CPI data when calculating real earnings for June 2009. Despite these minor variances, we found this publicly available data set to be the most complete comprehensive historical review of P/E ratios. 4 CHART D Historical Real Price Earnings Ratio S&P 500 1900 to June 2009 50 December 1999 44.20 40 April 1929 27.57 30 Real P/E Ratio 20 10 June 1932 5.57 July 1982 6.64 June 2009 16.08 0 1900 1920 1940 1960 1980 2000 Year Source: Robert Shiller, Sprott Asset Management LP If this is average – how low is low if investors turn their backs on stocks? There’s the real economy which generates the earnings, and then there’s the investor sentiment/perception which dictates the multiple they are willing to pay for those earnings. We already know that the real economy is in severe decline. What happens if investor sentiment changes? We assess three scenarios below: 1. Earnings stay constant; P/E ratios hit cycle lows: We assume a scenario where investors are nervous, people need to sell stocks to pay for lost wages, or for retirement, but the companies continue to perform as of June 2009. Assuming a P/E of 6, which is close to the all time low, and using an earnings value of $63.04 for the S&P 500 Index, we derive an S&P 500 Index value of 378.16 Earnings get halved; P/E stays constant: Earnings have been half of their current value three times over the last 30 years – so it is entirely within the realm of possibility that they could be halved once again. In the late 1970’s, early 1980’s and early 1990’s the S&P 500 Index generated half the earnings per share that it did this year in 2009 dollars. Using today’s P/E multiple of 16.08 results in an S&P 500 value of 506. Earnings get halved; P/E ratios hit cycle lows: double trouble. If we combine these cases where earnings are cut in half from today and the P/E ratio drops to a cycle low, it implies an S&P 500 Index value of 189 (depression territory). 2. Sprott Asset Management LP 3. Royal Bank Plaza South Tower 200 Bay Street Suite 2700, P.O Box 27 Toronto, Ontario M5J 2J1 T: 416 943 6707 F: 416 943 6497 Toll Free: 888 362 7172 www.sprott.com What about inflation? All three of the above scenarios are calculated using 2009 dollars. Doing so adjusts for the effects of inflationary periods over the last 109 years and allows for the historical comparisons we have discussed. As we mentioned, a stock price is based on pricing the future stream of a company’s profits. Over the long-term, inflation erodes the value of those earnings and with it the multiple that investors are willing to pay for them - ultimately lowering the value of stocks. 16 Bloomberg S&P 500 earnings per share for June 2009 not included in Shiller dataset. 5 CHART E S&P 500 Real Price Earnings Ratio 35 30 25 Real P/E Ratio June 1929 April 2008 20 15 10 5 0 1 3 6 9 12 15 18 21 24 27 30 33 36 39 42 45 48 51 Months Into Crisis Source: Robert Shiller, Sprott Asset Management LP Chart E plots the real P/E ratio of the S&P 500 Index fifty months out from 1929 and compares it to the recent real P/E ratio performance from April 2008 to June 2009. We find the similarity between the 2008 economic collapse and the 1929 economic collapse disturbing. Don’t get sucked in… the real economy is still struggling and the market has yet to reflect this. In 1932, the Dow Jones Industrial Average bottomed 90% below the September 1929 peak. The S&P 500 Index peaked in October 2007 at 1,576, and from our brief analysis above we can easily calculate a drop in the S&P 500 of as much as 88% from that peak using our ‘double trouble’ scenario. At the very least, under all of our scenarios it appears that the S&P 500 Index will test the March 2009 low of 666. Judging by the continued declines we are seeing in the real economy, we expect that test to happen sooner rather than later. In our view, the only thing propping this market up is investor sentiment. Earnings have not improved. Keep it simple, stupid - investing is and has always been about the real economy, and this market is ignoring the hard data. You can invest in sentiment if you want to, but as we have said before, we prefer to invest in real things. Sprott Asset Management LP Royal Bank Plaza South Tower 200 Bay Street Suite 2700, P.O Box 27 Toronto, Ontario M5J 2J1 T: 416 943 6707 F: 416 943 6497 Toll Free: 888 362 7172 www.sprott.com 6 Sprott Asset Management LP Royal Bank Plaza South Tower 200 Bay Street Suite 2700, P.O Box 27 Toronto, Ontario M5J 2J1 T: 416 943 6707 F: 416 943 6497 Toll Free: 888 362 7172 www.sprott.com The opinions, estimates and projections (“information”) contained within this report are solely those of Sprott Asset Management LP (“SAM LP”) and are subject to change without notice. SAM LP makes every effort to ensure that the information has been derived from sources believed to be reliable and accurate. However, SAM LP assumes no responsibility for any losses or damages, whether direct or indirect, which arise out of the use of this information. SAM LP is not under any obligation to update or keep current the information contained herein. The information should not be regarded by recipients as a substitute for the exercise of their own judgment. Please contact your own personal advisor on your particular circumstances. Views expressed regarding a particular company, security, industry or market sector should not be considered an indication of trading intent of any investment funds managed by Sprott Asset Management LP. These views are not to be considered as investment advice nor should they be considered a recommendation to buy or sell. The information contained herein does not constitute an offer or solicitation by anyone in the United States or in any other jurisdiction in which such an offer or solicitation is not authorized or to any person to whom it is unlawful to make such an offer or solicitation. Prospective investors who are not resident in Canada should contact their financial advisor to determine whether securities of the Funds may be lawfully sold in their jurisdiction. 7
Value Investing Seminar: Danilo Santiago Favors Lowe's and Home Depot
Danilo Santiago, founding partner of Rational Asset Management, presented at the Value Investing Seminar last week. Santiago outlined his long thesis on Lowe's (LOW) and Home Depot (HD). Excerpts from his speech follow:
Investment Philosophy
Quote from Homer's Odyssey: "...he sailed past the island of the Sirens, whose song draws men to their death: Odysseus* bid the crew to cover their ears, while he himself was tied to the mast, so that he might listen, yet not be seduced."
Like Odysseus, Rational seeks to avoid the siren’s call… In our case, the cycles of fear and greed and the short term noise of the equity market
Investment Ideas: Lowe's and Home Depot
Current opportunity should not be ignored: Rational's knowledge base has a high number of companies with significant potential for appreciation, which is reflected in the number of long positions currently in the portfolio. Rational's back testing analysis shows that undervaluation relative to the proprietary "fair value" is a strong indicator of future performance.
Market's overly simplistic approach to valuation: "When we superimpose the share price of a stock and the average NTM EPS (Next Twelve Months EPS) estimates from sell-side analysts it is clear that “the market” is using an over-simplistic approach to investing –it uses an almost constant multiple over a short term forecastAlthough this is clearly a wrong approach to investing, it offers a lot of good opportunities for the rational and methodical investorOur analysis indicate that both Lowe’s and Home Depot are currently more than 50% under-valued."
Lowe's margins should rise in the future: "The current recession –which has been focused on the housing sector –has obviously impacted LOW’s margins, but we have good reasons to believe that they will increase from the current low level."
Rational's equivalent square footage concept: "When analyzing a retailer’s growth dynamic it is necessary to adjust calculations of sales and costs (per square foot) given the average age of the storesAt Rational we do what we call an “equivalent square footage” calculation –it shows how many “mature” square feet would be necessary to replicate the current sales levelWhen a retailer stops an accelerated growth pattern, the increase in their “square footage age” will provide a strong tail-wind for margins."
Summary: "Lowe’s and Home Depot are probably experiencing the worst downturn on their sector they will ever face. Nevertheless, current market valuation provides a significant margin of safety for both companies even assuming (i) a small increase on real same-store-sales (we actually think that our base-case might be too pessimistic on this driver), (ii) gross-profit per equivalent square foot below long-term historicalsand (iii) room for increase in SG&A per total square foot. As both Lowe’s and Home Depot stop new store expansion, margins will increase due to a tailwind provided by the increase in average age of their stores since “equivalent square footage” (that driver gross-profit dollars) will grow faster than “total square footage” (that drives costs). According to our proprietary analysis both Lowe’s (LOW) and Home Depot (HD) are more than 50% under-valued."
Mr. Danilo Santiago is a founding partner of Rational Asset Management, a long-short hedge fund, which he co-manages with Mr. Cláudio Skilnik (CBS ’02). The fund operations started in April 2008, focusing on publicly traded, liquid US equities. Rational has also firmed a partnership with Turim Investimentos, one of the biggest multi-family offices in Brazil. Rational core strength is its proprietary company analyses – differently from most funds, Rational’s knowledge base is quasi- static, which provides the fund with an extra edge when triggering a new long/short position.
Mr. Santiago has an MBA from Columbia Business School (CBS ‘01) and a bachelor degree in Electrical Engineer from the University of São Paulo (class of 1994). Before founding Rational, Mr. Santiago worked for three years on a multi-billion dollar, fundamental focused hedge fund in New York City. Prior to that Mr. Santiago spent six years at McKinsey & Co, the majority of which at the Corporate Finance Practice, also in New York City.
Value Investing Seminar: Morgan Stanley's Gabriele D'Agosta on Clay Construction Producer Wienerberger
Gabriele D'Agosta, a Morgan Stanley vice president, contributed a presentation on Wienerberger (Frankfurt Stock Exchange: WIB) to the proceedings of the Value Investing Seminar in Molfetta, Italy last week.
Wienerberger, founded in 1819 in Vienna, Austria, is a global leader in the production of clay construction products. It is the world's largest producer of hollow bricks, Europe's largest and America's top two producer of facing bricks, Europe's second-largest producer of roof tiles, and central Europe's second-largest producer of pavers.
Vice President in Morgan Stanley since 2001. In 1998 and 2000 worked for Goldman Sachs in London in the Private Wealth Management as brokerage and asset management. From 2000 through 2001 has worked for Lazard in London in private investor area. He has a degree in Economics from the University Bocconi in 1996 and he is a CFA since 2003.
Roberto Russo, director of project independent advisory in Confin Sim, presented at the Value Investing Seminar in Molfetta, Italy last week. Mr. Russo addressed the topic of bond arbitrage.
Mr. Russo's presentation may be accessed by clicking here.
About Roberto Russo
39 YEARS OLD HAS A DEGREE IN BUSINESS AND ECONOMICS, DIRECTOR OF PROJECT “INDEPENDENT ADVISORY” IN COFIN SIM. Portfolio Manager for Duemme Sgr. (2006-2008), head Manager of Abaxbank Risk Arbitrage Desk (20000-2006). Roberto has also worked as director in Caboto Sim (1999-2000), Banca Monte dei Paschi di Siena (1998-1999) and Banconapoli & Fumagalli-Soldan Sim (1994-1998). He’s an AIAF member since 1998.From 2004 he is on the Board Member of Cattolica Partecipazioni S.p.A.
Making Money in Cement -- Don Fitzgerald on Vicat -- Live Blogging the Value Investing Seminar, Italy
Don Fitzgerald, fund manager of Tocqueville Value Europe, presented at the Value Investing Seminar in Molfetta, Italy today. Fitzgerald highlighted French cement maker Vicat as a buying opportunity. Our notes from his speech follow:
Investment Idea: Vicat (Paris: VCT)
Company Overview
Leader in South East France (~50% of sales) and strong regional positions in mature markets (Western Switzerland, California, South East USA) and in emerging countries (Western Africa, Egypt & Turkey)
60% family controlled.Free float increased from 5% to 40% in 2007
Management strategy is to use group cash-flow to improve vertical integration, diversify from home base and increase exposure to faster growing markets
Barriers to entry: ownership of quarries / environmental constraints; capital intensity; geographic/transport costs; control over import terminals; and vertical integration
Valuation
Earnings-based:
trades on 9x 2009E EPS and 5x 2009E EV/EBITDA --> Don thinks 2009 should represent trough in earnings cycle
FCF-yield on maintenance capex ~15%
trades at ~20% discount to peer group despite better pricing power, stronger balance sheet (net debt ~1.6x EBITDA), superior track record and higher medium term growth prospects
industry-average transaction multiple of 8-9x EBITDA over last 17 years --> Don thinks given family control and cyclical trough a transaction is unlikely but implied equity value ~€75 per share vs current market price of ~€40
Asset-based:
Don estimates current replacement cost of 1M tonne cement plant at €200M in developed markets and €100M in emerging markets
This implies €61 per share of equity value for Vicat (assuming €1.8B of EV for Vicat's cement assets in developed markets, €1.2B in emerging markets and €0.5B EV for aggregates and ready-mix concrete)
Key Risks
Prolonged deeper recession
Price deflation – Don thinks this is mitigated by:industry consolidation; focus of geared players on cash generation, not market share; capacity additions delayed / cancelled; and limited risk of falling prices for Vicat due to market mix
Antitrust enquiries
Co2 compliance costs
How Don Differs from the Consensus View
Consensus concern is industry-wide price deflation –> Vicat protected due to pricing power in key markets
Consensus focus on cyclical downturn, not trough in the earnings cycle
Don thinks next cycle’s earnings power for Vicat should be higher due to: increased earnings from capacity additions; efficiencies from industrial upgrades; and possible acquisitions at bottom of cycle
About Don Fitzgerald
Mr. Fitzgerald joined Tocqueville Finance in February 2007 as a Financial Analyst and has co-managed the Tocqueville Value Europe Fund since February 2008.He previously worked 7 years for Citigroup in Dublin, London, Frankfurt and Paris in different corporate finance roles.Subsequently, he worked as an investor in distressed debt for WestLB in Paris from 2003 to 2006.He is a CFA charterholder and graduated fromTrinity College Dublinin 1996 with a degree in Business Studies and German.
Robert Vinall Highlights German Value Opportunities -- Live Blogging the Value Investing Seminar, Italy
Robert Vinall, founder and managing director of RV Capital, presented at the Value Investing Seminar in Molfetta, Italy today. His presentation was (ambitiously) entitled, How to Come Out of the Financial Crisis as a Winner with Certainty. Our notes from his speech follow:
Rob's Investment Checklist
Is the business within my circle of competence?
Does the business have a sustainable competitive advantage? Can come from cost leadership, network effects, brand, switching costs, licenses/permits/patents, ecosystem effect, culture
Is the company run by honest and talented management? Rob is big believer in being able to tell good managers from bad by using references, track record, ways of communication, a CEO's role models, own behaviour
Does the company have engaged and responsible owners? integral part of research process, skeptical of open share registers where management does not have anyone to answer and owner/manager interests not aligned
Is the valuation attractive? central valuation methodology is "owner earnings yield" defined by dividend yield plus growth; considers 15%+ as attractive
"Invert, Always Invert"
Invoking Charlie Munger, Rob cross-checks above by asking what kind of investment will make you come out as a loser:
buying business you do not understand
buying business that won't be around in 10 years
partnering with people who promise miracles
leveraging yourself up to the hilt
using short term capital to buy long duration assets such as equities
throwing common sense out of the window
trusting your emotions
What to Buy in Germany Now
Rob highlights three investment opportunities:
GrenkeLeasing (XETRA: GLJ):
leading provider of small ticket IT-leasing equipment (<€10k equipment value)
owner-run: Mr. Grenke is founder, CEO and largest shareholder (40%)
attractive valuation: owner earnings yield of 15%+ (3% dividend yield plus 12%+ growth); downside protected by stock trading at close to liquidation value
winner from current crisis: strong double digit growth as competitors retrench
Takkt (XETRA: TTK):
leading B2B mail order company for small business equipment (160k products ranging from sack barrows to designer lamps; ticket size <€1k)
multiple moats: cost leadership from scale, customer switching costs
high management quality
Haniel family (owns 70%) are engaged and responsible owners
attractive valuation: owner earnings yield of 15%+
Beiersdorf (XETRA: BEI):
manufacturer of branded consumer cosmetics
multiple moats: cost leadership from scale, Nivea brand
high management quality
Herz family are engaged and responsible owners
attractive valuation: owner earnings yield of 15%+ driven by growth into new markets and categories
Rob thinks current undervaluation due to market's disappointment with 1Q09 results as Beiersdorf was perceived as a safe haven
About Robert Vinall
Mr. Vinall is the Founder and Managing Director of RV Capital. He is based in Zurich, Switzerland where he lives with his wife and two children. Rob is from the UK and was born in May 1973. He graduated with an honours degree from Cambridge University in 1996 and was awarded the CFA designation in 2000. He began his career in April 1997 at Goldman Sachs Asset Management where he participated in the graduate trainee program. In October 1998, he joined DG Bank which later became DZ Bank where he was a sell side analyst covering the telecoms sector. In October 2004, he moved to Switzerland to join CDL Principal Investors, a boutique consultancy where he sourced investment opportunities in public equity markets which required active ownership.
Ciccio Azzollini on Surviving the Financial Meltdown -- Live Blogging the Value Investing Seminar, Italy
Ciccio Azzollini, CEO of Cattolica Partecipazioni SpA and host of the Value Investing Seminar in Molfetta, Italy, gave a presentation today, entitled Surviving: The Name Of The Game. Our notes from his speech follow:
Benjamin Graham's three timeless ideas for investing:
Evaluate stocks as part-ownership in the business
Make Mr. Market your friend by taking advantage of prices he quotes you when these prices deviate substantially from fair value
Invest with a "margin of safety" --> build a bridge able to withstand 15,000 pounds if you're going to drive a 10,000 pound truck across it
Investment-related observations:
Equity markets around the world show disappointing 10-year track records with major indices in US and Europe down 30-50%
Now a good time to look for investments and review value investing toolkit
Ciccio favors "investing with flexibility" meaning can invest in undervalued stocks, risk arbitrage, special situations, distressed securities --> all can have different risk/reward and time horizon profiles but value investing basis for investing is the same (look for situations with motivated sellers and missing buyers leading to large price dislocations)
Understand your edge when making an investment:
Information?
Analysis?
Psychology?
Time horizon?
Do a few things well when evaluating an investment:
Understand the business
Understand the people running the business
Get safety from the price paid
Concentrate on best ideas
Discipline, rationality and patience are key
Investment Idea: Banco Popolare (Milan: BP)
4th largest Italian commercial bank with market share of approx. 10% in 6 regions of northern Italy
Network of approx. 2,200 branches
Business model focused on retail banking
Sound balance sheet and liquidity: loan/deposit ratio of 0.91 as of 3/31/09; funding needs covered until 2011
Asset base is low-risk: focus on local domestic market (where no real estate bubble); merchant banking portfolio valued at market; strong diversification and strict loan provisioning
No investments in toxic assets: no exposure to subprime mortgage sector or structured products
Ciccio estimates intrinsic value per share of €8.5-11 (based on 10-12x normalized EPS of €0.85-0.95 assuming €1.4B of pre-tax, pre-provision earnings, €300-400M of losses, 45% tax rate and 640M shares outstanding) vs. current market price of ~€5 and tangible book value of €7 per share
About Ciccio Azzollini
Beniamino Francesco Azzollini (Ciccio) attended University of Bari and has a degree in Business and Economy. After graduating in 1997, he obtained a diploma as “Financial Analyst” at the European Association of Financial Analysts. He worked from 2001 through 2003 as Fund Manager in “Abax Bank” Milan. Since 2003 he is CEO of Cattolica Partecipazioni S.p.A, an investment vehicle; he is also founder of the first “Value Investing Seminar” in Italy.Ciccio was born in 1974 and lives in Italy, city of Molfetta (Bari) with his wife Linda.
Victor Fasciani Sees Compelling Buy in Contango Oil & Gas (MCF) -- Live Blogging the Value Investing Seminar, Italy
Victor Fasciani, Managing Partner of Praetorian Value Fund, made a compelling case for Contango Oil & Gas (MCF) during his presentation at the Value Investing Seminar in Molfetta, Italy today. Our notes from his speech follow:
Praetorian Value Fund -- Investment Philosophy
Wants to understand every detail of the business (financials, management, industry, competition) --> "leave nothing to chance"
Thinks current market volatility and irrationality presents opportunities across all market cap segments (although traditional small/mid-cap focus)
Diversification is not risk management
Praetorian Value Fund -- Selected Investments
Long (as of 4/30/09):
Alliance Grain Traders (AGT.UN-V.TSX): company in commodity business without commodity-like characteristics
Company focuses on highest ROI part of the value chain: exploration
Founded by CEO Ken Peak in 1999 with $30M of capital (at $43/share current market cap approx. $670M with stable share count since 2001)
Buffet-like company philosophy: give smart people capital, give them large incentives for doing well, and then let them do their thing
Leanest operation in the Gulf of Mexico: 7 employees in small Houston office (everything except planning and idea generation is outsourced)
Underfollowed by sell-side: no analyst coverage
Robust balance sheet: no long-term debt
Motivated and incentivized management: CEO owns 20% of company
Compelling valuation:
$1.3B or $78/share intrinsic value of proved reserves only (based on net present value of after-tax income assuming $7 per Mmbtu natural gas price and $70 per barrel of oil)
Reserves in place for last ~50 million years and not going away
Other assets and free options add up to an additional $30-40/share (MCF bought more than 70 lease blocks in the Gulf at $35M cost basis; Victor thinks this is worth $100M today because of seismic data and the company's successful drill track record of 67%)
Catalysts:
Continue drilling in the Gulf potentially converting probable into proved reserves
Company was for sale in summer 2008 - received offers in the $70-80 range but CEO would not sell as these prices viewed as fire-sale
Assets remain in play and CEO is 65 years of age
Company has $100M stock buyback in place
Reasons for mispricing:
Natural gas stocks trade partly based on spot or front-month natural gas futures price movements --> as 12 month forward curve significantly higher than spot prices (around $5.50 vs. $3.50 per Mmbtu) market seems to ignore the implied increase in prices
Market won't pay for optionality value of assets in oil & gas, especially in current environment
Market doesn't give enough credit to good management teams in this industry
Assets can be easily converted into cash and non-perishable inventory
Currently reserves are cheaper on Wall Street (--> M&A) than in the ground
Ratio of oil to natural gas prices at 16:1 currently vs. 10:1 historically --> Victor convinced of reversion to mean and thinks this will happen by natural gas prices rising from their recent lows in the $3.50 range (thinks long term floor for natural gas prices is around $6 for companies to achieve 10% ROE --> if prices fall below that for long, higher cost onshore wells are shut reducing supply and eventually leading to higher prices again, as happened in fall of 2006)
About Victor Fasciani
Mr. Fasciani is the Managing Partner of Praetorian Value Fund. Praetorian Value Fund utilizes a bottom-up, research driven value approach focusing much attention on small- and mid-cap value opportunties. Mr. Fasciani was a Senior Analyst and Co-Portfolio Manager with Sellers Capital from 2007 through 2009.
Josh Tarasoff Likes Ambassadors Group (EPAX) -- Live Blogging the Value Investing Seminar, Italy
Josh Tarasoff, General Partner of Greenlea Lane Capital Partners, gave a presentation at the Value Investing Seminar yesterday. Tarasoff described his partnership's investment framework and made the case for Ambassadors Group (EPAX), his fund's largest investment. Our notes from his speech follow:
Investment Framework
Runs concentrated portfolio (top 5 positions represent 66% of total fund capital)
Before investing in a business, asks himself if he would be comfortable if the position was his only asset and he could never sell it (ie the only money he would made is the cash taken out of the business)
Employs investment checklist with the following criteria: (1) minimal risk of product obsolescence; (2) minimal financial leverage; (3) high return on incremental capital; (4) strong, sustainable competitive position; (5) pricing power; (6) potential for long-term unit growth; (7) demonstrated propensity to return capital to shareholders; and (8) management economically aligned with shareholders.
Investment Idea: Ambassadors Group (EPAX)
Represents ~20% of Greenlea Lane's equity capital --> single biggest position
EPAX is an educational student travel company (activities incude home stays, community service, meetings with political figures, general tourism)
~90% of revenue represented by international programs travel to >50 countries
2008 geographic breakdown: 60% Europe, 17% Asia, 16% South Pacific, 6% Other
Risks includeworsening economy, operational missteps, terrorism, war and health concerns; also possibility that recent enrollment declines symptomatic of long-term headwinds
Potential catalyst is Q3 earnings release; Josh thinks there is good chance that enrollments will show Y/Y growth based on pent-up demand (due to deferral of trips last year when marketing season coincided with sudden and sharp deterioration in economic environment and consumer confidence) and operational improvements undertaken during past year
First key question: Is it a good business?
Unique, non-replicable brand franchise based on a relationship with a non-profit organization called People to People International (PTPI); one of the core activities of PTPI is The Ambassadors Program which has been outsourced to EPAX since 1983 (this exclusive relationship runs through 2020 on current terms); EPAX is also academically accredited (90% of participants receive high school credit, 10% of participants receive college credit)
Pricing power ($6,300 average price of international programs in 2008 - no competing programs command comparable prices)
High ROIC (little tangible capital needed; only $30M of fixed assets on BS) and minimal need to put up capital as the business grows
Large unit growth potential (29M 11-19 year-olds in the US of which EPAX estimates >20M have financial means to travel; in contrast 2009E enrollments are 35k; marketing domestic programs to students abroad is an untapped market)
Second key question: Why is it cheap?
Operational trends are negative (critical enrollment season in July-October negatively affected by use of faulty maling list in 2007 and sudden deterioration in consumer confidence in 2008 (led to -20% Y/Y enrollment decline in 2008 and estimated 17% decline in 2009 after 1997-2007 revenue CAGR of 20%)
Premium, discretionary product which is currently out of favor
Third key question: What is it worth?
Student acquisition cost, defined as marketing expenditures/ number of enrollments, a key metric to gauge potential value
Thinks average SAC of $1,045 in 2008-09E should return to its 2003-07 average of ~$620 because causes of recent increase are temporary (faulty purchased list name in 2007, recession will end)
SAC of ~$620 drives FCF/share of $2.38 (5x EV/FCF), whereas SAC of $850 (average of historical and recent) would imply FCF/share of $1.34 (10x EV/FCF); estimated 2009 SAC of $1,167 implies FCF/share of $0.80 (16x EV/FCF)
Expects 15-20% FCF growth over next 10 years (would be similar to performance over last 10 years) and on this basis believes a private buyer with long time horizon would earn very attractive returns buying EPAX at 20x FCF today
Depending on above SAC assumptions, 20x FCF/share of $0.80, $1.34 and $2.38, implies per share fair value of $17, $28 and $49, respectively, vs. current share price of $14
Mr. Tarasoff is the General Partner of Greenlea Lane Capital Partners, LP, a private investment partnership he founded in 2006. Josh graduated from Duke University in 2001, with a degree in philosophy. He has worked at Goldman, Sachs & Co. and has an MBA from Columbia Business School.
Max Otte on Value Investing: The Numbers Should 'Scream At You' -- Live Blogging the Value Investing Seminar, Italy
Max Otte, professor of Corporate Finance at Fachhochschule Worms in Germany, gave a presentation at the Value Investing Seminar in Italy today, entitled Investing Buffett Style: A Simplified Approach. Our notes from his speech follow:
Likes Simple and Robust Valuation Approaches (shares Berkshire Hathaway (BRK.A) chairman Warren Buffett's aversion of calculators and spreadsheets --> answers should "scream at you")
Some Examples of Simple Valuations for Stock Markets include market cap to GDP, P/Es based on 10-year earnings, dividend yields vs. bond yields
Importance of Organizing One's Research According to 1) Reliability (eg current margins are better information than estimated margins 2 years from today) and 2) Underlying Strategic Assumption (does company have competitive advantage?
Valuation Approaches:
Asset-Based Valuation (can be applied to 70% of companies): industry is economically viable but no incumbent competitive advantage --> asset value (replacement costs) = earnings power value
Earnings Power Valuation, Without Growth (can be applied to 20% of companies): industry is viable, firm enjoys sustainable competitive advantage (moat, franchise) but no/low growth
Earnings Power Valuation, With Growth (can be applied to 5% of companies): industry is viable, firm enjoys sustainable competitive advantage (moat, franchise) and exhibits growth
Liquidation Valuation (can be applied to 5% of companies): industry is NOT economically viable
Investment Idea #1: Lufthansa (DLAKY.PK) (Asset Based):
One of the world's leading airlines
Will survive crisis
Valuable Frankfurt hub
Valuation: current market cap at 38% discount to book value of equity
Investment Idea #2: Henkel (HENKY.PK) (Sustainable Earnings, Low Growth Franchise):
Consumer franchise
Depressed earnings
Stable company
Positive family influence but not very dynamic
Valuation: apply 14.3x multiple (assumes cost of capital 9%, growth 2%) on 10-yr average EPS of €3.42 --> €48.9 value per share --> current price of €18.6 per share represents 62% discount to fair value
Investment Idea #3: Siemens (SI) (Sustainable Earnings, Modest Growth):
One of the world's leading infrastructure companies
Huge pent-up demand
Economic warfare by US interests a negative
Valuation: apply 16.7x multiple (assumes cost of capital 10%, growth 4%) on 10-yr average EPS of €3.41 --> €56.8 value per share --> current price of €46.0 per share represents 18% discount to fair value
Investment Idea #4: Fielmann (Sustainable Earnings, Modest Growth Franchise):
Very consistent franchise
Huge moat
Owner manager
No bank debt
Valuation: apply 33.3x multiple (assumes cost of capital 8%, growth 5%) on 10-yr average EPS of €1.71 --> €56.9 value per share --> current price of €45.0 per share represents 21% discount to fair value
AboutProfessor Max Otte
Professor Max Otte, Ph.D., received his doctorate degree from Princeton University. He is a regular professor of Corporate Finance at the Fachhochschule Worms – University of Applied Science and founder of IFVE GmbH, an independent advisory firm that offers financial information services to its clients. Professor Otte is also founder and director of the non-profit organization Zentrum für Value Investing e.V., an association of independent and value-oriented funds managers and investors.Professor Otte has worked as a consultant for over 100 businesses and organizations and is author of many books on finance and economics. His 2006 book “Der Crash kommt”, in which he predicted a financial tsunami caused by the U.S. subprime sector, has become a bestseller.
Bestinver Fund Manager Highlights European Value Investment Opportunities -- Live Blogging the Value Investing Seminar
Alvaro Guzman dé Lazaro Mateos, fund manager at Bestinver, gave a presentation at the Value Investing Seminar in Italy today. Our notes from his speech follow:
Bestinver Investment Philosophy
Seeks profitability in absolute terms and not in relation to benchmark indices.
Considers risk in absolute terms, defining it as the possibility of losing the money invested and not in terms of volatility or deviation with respect to a particular benchmark index.
Are asset managers, not asset gatherers.
Invest in companies that are trading at a reasonable discount to their true economic value.
Patience. Are in it for the long term and like what they do so are prepared to wait (Most of alpha due to patience).
Daily goal is to increase the portfolio’s potential, swapping companies with less upside for others with more, factoring in the time needed to analyse the company (in contrast to the UStax regime, in Europe mutual funds are taxed on capital gains at just 1%, making divestments less inefficient).
Have a very high effective turnover but quite low turnover by name. For example, since the starting of the current drop have seen a 120% effective turnover with only one new company in the global portfolio.
Management vision aligned with Austrian School of Economics, with its deep understanding of human actions and its implications in business cycles, people behaviour, market structures, etc.
Investment Idea #1: Fuchs Petrolub - A High Grower in a Non-Growing Market?
At €39/share, market cap is €923M
Valuation: Normalised FCF of €135M --> trading at 6.8x FCF. Worth €90/share
Description of business: #1 independent lubricant manufacturer worldwide. Fuch’s lubricants are used in a variety of end markets (metallworking fluids, mining specialties, corrosion preventives, car manufacturers, etc..). Sells over 10K products to around 100K clients. 70% of revenues generated from a direct sales force in over 100 countries. Products mainly manufactured where sold (50 plants worldwide).
Market Structure: Market volume in 1990: 40mn Tonnes; 2007: 39mn T. The “big boys” (14 integrated oil majors) hold 60% of the market in volumes, the rest spread out among 700 players (1300 players 5 years ago).
Historical Performance: CAGR in sales, EBITDA, EBIT 01-08 of 6%, 12% and 16% respectively. Never a year of losses in its 75-year history. Key to sales growth is Fuch’s expertise in application engineering (sales people are Engineers with MBA) and a focus on specialties. Systematic emphasis on organic growth with smaller add-on acquisitions. Key to profitability is bargaining power with clients/specialties focus
Management: Third generation of the Fuchs family. Honest, candid, able people. Extremely sound incentive system in place. Focused on the business vs “selling the story”.
Why is Fuchs Undervalued?
Under-researched.
Misunderstood. It has ability to pass on base-oils price rises and keep a lot when they decline (EBIT margin 6% in 2001, 14% in 2007). The product is essential, and attempts to save on it politically risky for clients. Over-emphasized “Auto” exposure.
The 2008-09 “Tsunami” has had an effect on Fuchs: 1Q09 sales down 20%, EBITDA down 40% and very little visibility.
Bestinver xpects volumes will recover and Fuchs will keep expanding market share. Earnings will recover sooner rather than later.
Business is NOT capital intensive. ROCEs have averaged 20% over the last 9 years. Net debt<0,5x EBITDA. R&D is expensed and amounts to 2% sales.
No strategic issues, it is a competitive market. Fuchs’ clients somewhat captive. Fuchs has among the biggest R&D budgets in absolute terms that gets “diluted” over the largest specialties volume. Its management has a culture of austerity one can smell at all parts of the organization.
Bestinver values Fuchs at 15x its stable FCF earning power of 135mn. This implies 8.7x EV/EBITDA, in line with PMV deals involving structurally LESS profitable competitors. The family owns 25% of the shares and has cancelled 10% of its stock through buybacks over the last 3 years.
Investment Idea #2: Esprinet - True Competitive Advantage + Turned-Around Operation at 5x FCF?
At €6.6/share, market cap is €337M
Valuation: Normalised FCF €50M. Worth €16/share.
Description of business: Italian leader in IT distribution with 3x the market share of the next competitor. The best margins of the European peer group (Also, Actebis, Ingram, Tech Data). A classic example of “regional economies of scale”.
Why the market share differential? Optimal logistics and an internet focus has allowed Esprinet to carry a big number of references and a big service ratio at competitive prices. Profited big time from 02-03 crisis.
Why the margin differential? Better purchasing terms with vendors, better working capital management, more efficient SG&A.
Why a true sustainable competitive advantage? Very difficult-to-replicate logistic set-up, economies of scale, switching costs for clients.
Spanish expansion: Expanded into Spain by buying 2 companies at peak of the cycle. Had several operating problems: '06 EBIT was €23M and '08 EBIT a NEGATIVE €8M. Today the operation has recovered service levels, enjoys the highest market share, and is streamlined after massive restructuring. Bestinver only relies on HALF the historic EBIT levels as remain pessimistic on Spain.
Why is Esprinet undervalued?
Market correctly penalized Esprinet as the first profit warnings from Spain started to be released. The base for the share price fall was a 17x near-term FCF multiple= the stock got crucified and fell from €17 to €2 in less than 2 years. Management lost credibility, but in Bestinver's view they’re only liable from not “timing” Spain.
Italian operation kept outperforming and now faces a GREAT consolidation opportunity AGAIN as it did in the previous crisis.
As badly-timed as the Spanish purchase was, they are now outperfoming the market significantly and reported “black EBIT” again in Spain in 1Q09. Plus they’ve learned many lessons about what capital allocation means!
Market has partly recognized the improvements, but still, the Italian operation is worth €12-13 per share or 2x current price. Spain is a free option. Balance sheet is debt-free.
Business has a ROCE close to 30%. Management is excellent as an operator, and capital allocation wise.
Stable shareholder base and management also a shareholder with a SIGNIFICANT personal stake.
Business + people + a very good price = a safe good, undervalued business.
About Bestinver
Incorporated in 1987
Shareholder structure: 100%-owned by Acciona
Investment decision-making independent of Acciona
Focused on returns nor volumes under management
Spain´s leading independent fund manager
€3,1Bn and 30,000 customers
Investment philosophy based on “Value Investing”
90% of managed assets are in equities
Largest Spanish equities fund (Bestinver Bolsa)
About Alvaro Guzman dé Lazaro Mateos
Born in 1975, Mr. Guzman dé Lazaro Mateos began his career in 1994 as an auditor for Arthur Andersen in Madrid. He continued his career at Bankers Trust in Paris, where he eventually headed the Middle Office at the early age of 21. In 1997 he started as a stock market analyst at a Frankfurt fund management company (Value Management) founded by a former employee of the legendary Peter Lynch. Subsequently, he returned to Spain, where he worked as a financial analyst at Spanish broker Beta Capital and later Banesto Bolsa. In 2003, he joined Bestinver to work with Francisco García Paramés, with whom he had frequently exchanged investment ideas since 1998, given their common liking for the "value school of investing". Alvaro speaks Spanish, French, English and German.
Guy Spier on Navigating Between Fear and Greed Using Investment Checklists -- Live Blogging the Value Investing Seminar, Italy
Noted value investor Guy Spier, CEO of Aquamarine Capital, gave a presentation at the Value Investing Seminar in Italy today, entitled Navigating Between Fear & Gread Using Checklists. Our first-hand notes from his speech follow:
Importance of Neurology in Investing
Human brain has different parts, each leading to different behavioral responses when engaged, eg the neocortex elicits a rational response whereas the "reptilian" part of the brain responds to greed and fear
Great investors (Soros, Buffett, Klarman etc) are "wired" to engage the necortex while others are susceptible to enaging the reptilian brain when faced with the same situation
Value investing is the art of using the neocortex
Studies have shown that when thinking about making money, for most people the same part of the brain responds as when thinking about gambling, drugs, sex
A lot of very smart investors lose money because they lose discipline and become guided by their reptilian brain (eg Isaac Newton's losses in the South See bubble in early 18th century)
Examples of Companies "Targeting" the Reptilian Brain
Below examples are all about companies/management who have figured out different ways to tap into our reptilian brain ranging from nearly criminal to very subtle.
Interactive Services Worldwide (delisted): serial promotions and spreading of hype through frequent press releases about partnership deals (eg with Sportingbet) that are not value-creating upon closer evaluation
EVCI Career Colleges (delisted): Management manipulated enrollments and published information that portrayed the performance of the business better than it actually was
DeVry (DV): Reputable management but was overconfident about operating performance of the business and communicated to investors rosy forecasts for enrollments based on hope, not actual underlying facts
American Express (AXP): Reputable company and management, but again company communication about estimated write-offs in lending business too optimistic
What to Do? - Use of Checklists in Investing
Investors' intellectual understanding of the fallacies of the reptilian brain is not sufficient --> a behavioral change is required!
Examples of behavioral change from the non-investing world: 1) Losing wallet in NYC taxi: Train yourself to stop and look before exiting taxi; 2) Infections in hospitals: Include regular washing hands after each patient contact as a routine; 3) Airline pilots: Creation of to-do checklist in emergency situations
Use checklists in investing to help brake reptilian brain responses to specific situations: For example, ask yourself what type of data am I looking at: data that can be manipulated by humans (eg loan write-offs) or facts (eg meat consumption in rich versus poor countries)
Checklists will help in situations susceptible to a response driven by greed and fear (usually stirred up by media)
Investment Idea: London Mining plc
$146M market cap, $316M cash --> company trades significantly below cash (important: cash position cannot easily be manipulated
Strong management team with proven track record
Shareholder value creation to come from developing mines for the global energy and steel industries
About Guy Spier
Since 1995 Guy Spier has been running Aquamarine Capital Management, LLC. Investors include friends and family, high net worth individuals, and private banks investing on behalf of their clients. The fund has market beating returns - and has received mentions by Lipper and Nelson's world's best money managers. The investees can be obscure or they can also be very well known. The fund has also done well owning the shares of less understood, but very high quality, cash generative businesses. It currently owns several credit rating companies as well as several post secondary education companies. The ratings business (whether of debt securities, or of individuals, through education) is one of the best businesses that Guy has ever seen, and is consistently underestimated by investors. Guy is also an Advisory Board Member of the Dakshana Foundation, which is a philanthropic foundation that focuses on providing world-class educational opportunities to gifted but economically and socially disadvantaged children.
Read New Issue of Downside Protection Report (and see complete scorecard)
The acclaimed monthly investment newsletter of the Manual of Ideas is now available for the month of July.
Downside Protection Report features the latest top two stock picks by John Mihaljevic, CFA, editor of the report. In the new issue, Mihaljevic highlights two companies judged to have strong downside protection and above-average upside potential.
Nadav Manham on Why Some Vornado Shareholders Have Got It Wrong
The WSJ reports that Vornado Realty Trust is seeking to raise a $1bn distressed real estate fund to use as its "exclusive vehicle for real-estate and real-estate-related investments."
The article wonders why a publicly-traded REIT like Vornado would choose to raise money from private investors rather than in the public market. To do the former, the article argues, "risks dismaying shareholders who hoped Vornado would use its investing expertise to do deals on its own balance sheet," and quotes Mike Kirby of Green Street Advisors as follows:
Most smart observers feel like the cheapest capital for the next few years is going to be in the public market, not the private market.
I guess the real question is: cheapest capital for whom? For companies themselves--ie existing investors--or for new investors?
As a publicly traded entity, Vornado's management has a duty to its existing shareholders, which includes the duty not to dilute them. As a REIT, even in good times it is capital-constrained, because by law it must distribute at least 90% of its taxable income as dividends. To do deals and grow it must constantly raise money, both debt and equity, and if you read Vornado's annual letter, chairman Steven Roth often praises Wendy Silverstein (Executive VP-Capital Markets) for her ability to do that. If a company has a duty not to dilute existing shareholders, yet must also constantly raise new money, with every new capital raise it must ask itself "Does this new capital create value for existing shareholders?" In its long history, Vornado has shown that its answer to this question has mostly been "yes."
In times of distress/opportunity a company like Vornado is even more capital-constrained. It sees many more deals it wants to do than it has capital to do them with. The "traditional" solution, to just raise new equity, is unattractive because Vornado's stock is down. My strong guess is that Vornado has concluded that any equity raise at current prices would be too dilutive to current shareholders--it would allow new shareholders to buy into Vornado's existing portfolio of assets at a bargain price, and at the expense of existing shareholders. So it has opted for an untraditional solution, raising private money in a PE fund structure, maybe even at 2 and 20, to give it the capital it needs to do all the deals it will want to do.
How can raising money in the private market at 2 and 20--where investors literally pay up front for the privilege of being able to invest alongside Vornado's management team--be more expensive than raising new public equity, with the stock down over 50% from its highs and where Vornado would itself have to pay almost 9% in dividends as an inducement?
I think Vornado is simply doing its job here, and doing it well. If I were a Vornado shareholder I would not be "dismayed," I would be happy. If I were an institutional investor being pitched Vornado's new PE fund, the smart thing to do might be to say no to the fund and simply invest in the stock. Most institutional investors are not set up this way though--they decide in advance "We're going to allocate X to 'distressed real estate opportunity funds'" and don't have the flexibility to invest in a potentially superior mousetrap that targets the identical asset class. You might say Vornado is making an institutional rigidity arbitrage bet here.
The author of this post is Nadav Manham, president of Elera Advisors LLC, an investment advisory company focused on value-oriented manager selection. Mr. Manham is a Manual of Ideas contributor and editor of The Investor's Consigliere.
Ravi Nagarajan on Book Value and Valuing Berkshire Hathaway
In today’s edition of Barron’s, Andrew Bary presents a bullish case for Berkshire Hathaway with a target price of $110,000 per share based on a valuation of 1.4 times Barron’s estimate of Berkshire’s book value per share in one year. Please click on this link for a preview of the Barron’s article which is only available in full to paid subscribers.
There are many different valuation models for Berkshire Hathaway and much controversy regarding which valuation approach is appropriate. At best, a valuation approach can only come up with a very rough estimate of intrinsic value. I came up with my own valuation approach which is heavily influenced by the earnings power of Berkshire’s insurance float. There are online calculators, such as the Berkshire Hathaway Intrinsivaluator that permit changing numerous variables to come up with a valuation.
How Meaningful is Berkshire’s Book Value?
Warren Buffett has encouraged shareholders to carefully examine book value per share and highlights the importance of the measure by providing a table showing growth in book value per share compared with the results of the S&P 500 over time. However, Mr. Buffett has clearly stated in shareholder letters that Berkshire Hathaway’s intrinsic value per share “far exceeds” book value per share (see, for example, Warren Buffett’s 1999 Chairman’s Letter.)
Why would intrinsic value “far exceed” book value? After all, isn’t book value per share a reflection of the value of Berkshire’s business interests including current values of marketable securities and reflecting historical retained earnings?
If Berkshire Hathaway consisted of only marketable securities that are marked to market for each accounting period, book value would indeed provide a relatively accurate reflection of intrinsic value and substantial premiums over book value would need to be justified based on the superior investment track record displayed over the years. However, Berkshire has a large and growing collection of operating companies that have shown steady growth over the years. While the retained earnings from these businesses have been reflected in Berkshire’s book value, the growth in the likely market value of subsidiaries has not.
What about goodwill reflected on the balance sheet? Doesn’t Berkshire have a large amount of goodwill and doesn’t this reflect the additional economic value of the operating subsidiaries? It is important to remember that accounting goodwill on the balance sheet reflects the excess amount paid for the business over tangible book value of the subsidiary at the time of purchase. Goodwill used to be subject to annual amortization which, for many years, further distorted the usefulness of book value as a valuation metric. While goodwill is no longer amortized, it is still tested for impairment annually. However, in no case is accounting goodwill adjusted upwards in cases where a subsidiaries economic moat has grown over time.
Mr. Bary’s article in Barron’s partially makes this point when he estimates the value of GEICO at $15 billion, a value far exceeding the purchase price of GEICO (for a full account of the GEICO purchase, I highly recommend reading the 1995 Chairman’s Letter). The example of GEICO is one of many. Another famous and obvious example involves See’s Candies, a subsidiary purchased in 1972 for $25 million which is now worth many multiples of the original purchase price.
Book Value Provides Directional Clues
Obviously, I am not suggesting that Berkshire’s accounting goodwill should be “marked up” as the economic goodwill of subsidiaries increase over time. This is absurd and would be subject to every kind of fraud, not at Berkshire but at many other companies, if codified into accounting conventions.
What I am suggesting is that book value per share is only useful in the sense that it provides directional clues regarding the change in intrinsic value of Berkshire over a period of time. To the extent that observers attempt to place a multiple on book value to arrive at intrinsic value, it is critical to understand that the multiple has to increase over time to compensate for the additional economic goodwill that would be reflected in the market value of operating subsidiaries if they were to be evaluated as stand alone businesses.
What is an Appropriate Multiple?
What is an appropriate price to book value multiple for Berkshire Hathaway today? I personally do not favor using this type of valuation metric, but I have trouble reconciling a 1.2 price to book value ratio based on an objective evaluation of the quality of the operating subsidiaries and I would note that I doubt that Mr. Buffett was referring to a 20% premium over book value when he stated that intrinsic value “far exceeds” book value.
Tha author of this post, Ravi Nagarajan, is a private investor and writer focused on applying value investing techniques to find securities trading well below intrinsic business value. He is a Manual of Ideas contributor and editor of The Rational Walk.
Disclosure: The author owns shares of Berkshire Hathaway.
Live Blogging -- 6th Value Investing Seminar, Italy, July 2009
Can't Make It to Italy? No Problem! Tune In For Our Live Blogging of the Upcoming Value Investing Seminar, July 14-15
The Manual of Ideas will be attending what has become the premier event for value-oriented investors in Europe, held in Molfetta, Italy from July 14-15. Visit this blog regularly on those days for our first-hand notes, featuring the investment approaches and the top ideas of some of the most respected European value investors.
Here are some of the investors presenting at this year's event:
Mateos Álvaro Guzmán de Lázaro - Bestinver Asset Management, Spain
Max Otte - Professor of Finance in Worms, Germany
Danilo Santiago - Rational Asset Management Company, USA/Brazil
Guy Spier - Aquamarine Fund, USA
Josh Tarasoff - Greenlea Lane Capital, USA
Robert Vinal - RV Capital GmbH, Germany
Roberto Russo - Italy e ALTRI
Where do these speakers get their ideas? We are pleased to count several of them among the subscribers to our idea-oriented research publications. Find out more.
It's always nice to see one's analytical work validated by the unfolding of real-life events. We're pleased that we could bring our subscribers Gravity Co. (GRVY) as an idea before the market realized that the company had turned solidly profitable.
A Conversation with Pete Peterson (via Charlie Rose)
Background: Peter George Peterson is an American businessman, investment banker, fiscal conservative, author, and politician whose most prominent political position was as United States Secretary of Commerce. He is Chairman of the Council on Foreign Relations, and Senior Chairman of the private equity firm, the Blackstone Group. In 1969, he was invited to chair a Commission on Foundations and Private Philanthropy, which became known as the Peterson Commission.
Peterson is a co-founder of the prominent private equity and investment management firm, the Blackstone Group and was a co-founder of the Concord Coalition. He was named as a member of the Bi-Partisan Commission on Entitlement and Tax Reform and also serves as Co-Chair of The Conference Board Commission on Public Trust and Private Enterprises.
Abstract: Dual-classes of shares with equal cash flow rights often trade at significantly different prices. Buying underpriced shares and shorting overpriced shares provides large and significant abnormal returns, hence differences in voting rights or liquidity do not explain the mispricing. Unmargined long positions in the underpriced class earn significant abnormal returns after transactions costs, so short sale restrictions do not prevent traders from exploiting the mispricing. An examination of the trades reveals that investors shift their trading patterns to take advantage of mispricing. One-sided trades are more important for bringing prices into line than long/short arbitrage trades.
Conclusions: This paper documents a very important and useful anomaly in the stock market. From this work we can conclude that exploiting the mispricings of dual-class companies is significantly profitable. However there is likely much more potential to this anomaly than the paper suggests. Because the authors neglect any opportunities on the short side, the 8.8% alpha they find would likely be much larger for the investor that implements pair trades involving both the undervalued and overvalued share classes. Such an approach would not only take advantage of the mispricing in both directions, but would also allow the investor to hedge the portfolio by taking a market-neutral approach.
Danilo Santiago, founding partner of Rational Asset Management, presented at the 
Gabriele D'Agosta, a Morgan Stanley vice president, contributed a presentation on Wienerberger (Frankfurt Stock Exchange: WIB) to the proceedings of the 
Roberto Russo, director of project independent advisory in Confin Sim, presented at the 
Don Fitzgerald, fund manager of 
Robert Vinall, founder and managing director of RV Capital, presented at the 
Victor Fasciani, Managing Partner of Praetorian Value Fund, made a compelling case for Contango Oil & Gas (
Josh Tarasoff, General Partner of 
Max Otte, professor of Corporate Finance at Fachhochschule Worms in Germany, gave a presentation at the 
Noted value investor Guy Spier, CEO of 
The acclaimed monthly investment newsletter of the Manual of Ideas is now available for the month of July. 
