Michael Mauboussin: If there is one bit of advice you could give to an investment professional,  what would it be?

 Daniel Kahnemahn: Go down to Duane Reade and buy a notebook for $2 and write down your  decisions. Keep an investment journal. You will be amazed at what you thought. And you will be amazed for the times you did well for the wrong reasons and so forth.

December 28, 2020 - AT&T did a good job refinancing a lot of their debt during the depth of the pandemic. AT&T originally had the following debt schedule before they were able to refinance:

2020: $11B

2021: $11B

2022: $12B

2023: $10B

2024: $11B

2025: $11B

They were then able to refinance to the debt schedule below:

 

2020: $2.3B

2021: $2.8B

2022: $6.5B

2023: $7.7B

2024: $7.8B

2025: $6.4B


This schedule is a lot more manageable over the short-term as it removes much higher liquidity needs over the next 5 years. 

 

Investors should continue to see a 7% dividend yield at the current price but very little if any at all capital appreciation until AT&T can put themselves in a better financial position as their business is seeing headwinds from the coronavirus due to delays in studio production, revenues from their movie releases (Tenant is an example), accelerated loss of cable subscribers and satellite TV subscribers, and other areas such as T-Mobile gaining market share in mobile subscribers, Spectrum entering the mobile phone market and high fixed costs to maintain their networks and infrastructure.

 

In addition, the previous CEO walked away with an incredibly large amount of money despite taking on lots of debt which included wasting lots of capital by overpaying for Direct TV. The new CEO is not an outsider but an insider who worked closely with the old CEO who wasted this money on overpaying for Direct TV and by putting AT&T in the position it is in today so it will remain to be seen if the new CEO can put AT&T in a much better position going forward. 

AT&T doesn't have much growth and I expect them to continue to use a lot of their free cash flow on debt repayment and dividends and I don't expect them to raise the dividend over the next year. They will continue to explore divesting non-core assets to raise cash to lower their debt.

I also expect 5G and cap-ex to consume a lot of their operating cash flow.

I am hesitant to add to my position unless the stock price drops to $25-$27 which would give me a higher margin of safety to compensate for their high net debt position, uncertainty on the new CEO and large capital requirements to run the business.  

*****

December 21, 2020 - Are we in a disruptor bubble?

With 0% interest rates since March and with interest rates close to zero for the last decade following the Great Recession plus all of the debt monetization (QE), the popularity of venture capital, huge innovation in technology culminating from the internet in the 90's and now with the surge of software, cloud, data, networks, cybersecurity and other tech companies, plus the popularity of entrepreneurship from unicorns and social media, it looks like we would have all the ingredients for new innovative companies that would threaten the incumbents (disrupt) to create a disruptor bubble.

Then the coronavirus happened which led to an influx of new investors (mostly retail) who received stimulus money and had more time due to government mandated shutdowns and work-from-home to trade stocks.

 

A lot of the new investors I think realized that the market was in a long bull market from 2010 to the start of 2020 so they waited for an opportunity which finally came in March 2020 when markets around the world were plunging. I don't believe this new influx of money has left the markets and there has also been a lot of money added by the Fed.

It seems like everywhere we look whether its software, cloud, semis, data, cybersecurity, disruptor companies are trading at price-to-revenue multiples of at least 10x.

And I remember thinking back in March and over the summer that I might be able to get Airbnb at a fair valuation like 4-5 times revenue; I was very mistaken. After the first day of trading Airbnb doubled which is a return of 100%... in one day. The stock now trades at a multiple of around 20x revenue.

Has disruption on such a large scale happened before in our history? I would say of course to this question.

The times that come to mind are the 1920's with the innovation of the radio, the huge growth in automobile companies, the innovation of household appliances and I think of the 1990's with the commercialization of the internet. The invention of the railroads was probably another time in the mid 1800s.

I then think, so we have had huge disruption before that has led to large run ups in asset prices and what happened next?

Well there was the collapse of railroad stocks in Ireland and Britain (Railway Mania), the Great Depression that followed the 1920's boom, the Dot Com bubble that led to around a 50% drawdown from 2000-2003 in the S&P (the 9/11 terrorist attack contributed as well to the pessimism toward equities). And the drawdown in the NASDAQ with its 78% drop was much greater than the S&P 500.

So what happens next?

 

If we vaccinate everyone and develop immunity, will the reopening of the whole economy pull over-allocated funds from "disruptor companies" to the "old, boring incumbent companies?", will there be setbacks in distributing the vaccine and/or getting rid of the threat of the coronavirus, will there be lots of unexpected inflation over the next 2 years, will we be in a similar position to Japan after the late 1980's, will there be global conflict that leads to war?

I don't know but if the Fed continues to have very easy monetary policy with 0% interest rates then they can probably keep the disruptor/coronavirus bubble inflated for longer similar to the 1997-2000 period.

For now, I'll wait on buying the "disruptor" companies but will continue to research since I believe that a much better opportunity will come to buy.

And I just realized that as I'm wrapping up my thoughts on this, Tesla will be included in the S&P 500 index later today at the following valuation:

P/S: 23.5x
P/E: 289x 

*****

December 20, 2020 - ASML makes systems and equipment that use extreme ultraviolet light to put circuit patterns on a semiconductor. ASML is paramount to the process of making semiconductors and they're a supplier to all of the big semiconductor manufactures: TSM, Intel and Samsung.

Problem ASML Solves:

In order for technology to progress to the next level, new industries such as AI, robots, internet of everything need more advanced chips. This requires the advancing of Moore's law of doubling the amount of transistors on the same area of silicon roughly every 2 years. ASML's photolithography systems allow Moore's law to continue which in turn allows technology to continue to advance by using extreme ultraviolet light (EUV) to increase the amount of transistors on the same area of silicon.

Moat:

ASML has a moat due to their expertise in this area. Their 2 closest competitors are Canon and Nikon but according to Gartner, ASML has 88% of the lithography market. What ASML does is incredibly hard to do and here is are 2 quotes from Brinton Johns and Jon Bathgate of NZS Capital in an interview with Shane Parrish that sums this up:

"These are some of the most complex machines humans have ever built. They're virtually impossible to reverse engineer. And in the case of something like photolithography which allows Moore's law to go ahead, there's only one company that builds the next generation machine that is keeping Moore's law [on] track. It's ASML in the Netherlands."


"ASML, which literally has a monopoly on photolithography, which is probably one of the most kind of complex processes that humankind has ever engineered. I mean, it literally is more difficult than putting a man on the moon or building a 747 or you kind of pick what."

And ASML's very high returns on invested capital over the last 5 years support this:

 

 2019    2018   2017   2016     2015
21.5%   22%    20%   17.8%   19.6%


Financial Position:

 

ASML is in a very solid financial position with cash of $4.1 billion and short-term investments of $1 billion and total debt of $5.37 billion.  This results in a net debt position of $200 million which isn’t concerning to me since ASML has been earning free cash flow of $1.7B in 2017, $2.9B in 2018 and $2.8B in 2019.

Valuation:

 

Valuation is very high in my opinion and this keeps me away from buying at the current price. If the price comes down, I would be more interested in initiating a position. I would be more interested in buying at a P/S ratio of 5-6x and/or a P/E of around 25x. 

 

TTM P/S:     12.3x

Forw P/S:    10.8x

TTM P/E:     51x

Forw P/E:    40x

TTM P/FCF: 66x

Risks: 

 

The semiconductor industry has historically been a cyclical industry and although the internet of things and the ubiquitous presence of electronics being so embedded in our daily lives makes this seem unlikely, this can’t be ruled out.

The implementation of new chips can be complex and can result in delays which would affect ASML since the majority of their revenues come from 3 big suppliers – Samsung, TSM and Intel.

Any risks from ASML’s own suppliers would affect ASML. Their biggest supplier is Zeiss who supplies optical systems to ASML for their lithography equipment.

Although unlikely at the moment due to the complexity and difficulty, the risk of another competitor developing the same technology can't be ruled out also. 

The technology war going on between the US and China has put ASML in the middle since the Netherlands government has limited ASML's ability to sell their equipment to SMIC. Maybe not a big risk now but should be kept in mind since this could limit ASML's future revenue growth while the company is currently selling at a multiple that reflects lots of growth and also ASML is also a big supplier to Taiwan Semiconductor.

*****

September 13, 2020 - "The current return on equity is not the correct "normalized" return on equity. If I can buy low P/E and high normalized ROE, that combination is good. I would want to do that too. When you do current high ROE as a metric, you will tend to pick everything at a cyclical peak. The earnings are above trend so the P/E is low and has a high ROE. You will be buying every commodity or manufacturer (like today, February 2, 2005) at its cyclical peak. Be careful of blind screens."

 

                                                                                                                                                                                                     - Richard Pzena

Source: Joel Greenblatt Special Situation Investing Classes at Columbia Business School

*****

September 8, 2020 -  Decreased my position in PayPal a little this morning. Although I believe Paypal is a great business, I believe the valuation has gotten too high with a price-to-ttm sales ratio of 12 and ttm P/E ratio of 89 or 50 times forward earnings.

The overall future for the company is bright in my opinion but I view the market - mostly certain tech stocks of the market- as pretty overvalued and the sizable drops in the NASDAQ over the last 5 trading days has me believing that the large run up in the market will revert the opposite way now.

I did some reading over the weekend that influenced my thinking most likely.

 

One article was from Ray Dalio in an old Bridgewater Daily Observation article from January 4, 2000. In order to look at where he expected the market to go over the next decade (2000-2010), he had to look back at previous decades going back to 1920. He noticed that the previous decades looked nothing like the next decade.

 

With that being said, it doesn't make me so optimistic about 2020-2030. After all, we've had a huge bull market following the 08-09 Great Recession with little growth and low inflation but I did feel the temperament of the market was pretty cautious and calm. It did start to get a little bit more exuberant from 2016-2020 though but I don't think it's been anything like what we've seen in the last 4 months where there has been so much day trading and speculating.

 

And with all this money printing and my thoughts recently in memory from Ray Dalio's paper I just read over the weekend, my guess is we have another opposite decade for the next one (2020-2030) than the previous one (2010-2020) with a low returning stock market and if not much inflation in the beginning of the decade then the beginning of inflation that really starts to bear it's ugly head sometime from 2027-2029.

My other thought was from the investment manager of Absolute Return Partners in London, Niels Clemen Jensen, whose letters have become some of my favorites to read. I posted an interesting scatterplot that he showed in the images section.

It basically shows what is pretty intuitive - the higher the starting P/E multiple for the S&P 500, the lower the ensuing returns will be over the next decade. What might not be so intuitive was how good of a predictor this was for what the market will do over the next 10 years. Well, the r squared (also known as the correlation coefficient) was .8945 - pretty damn high. And although it's hard to predict earnings due to the effect from the coronavirus, Niels mentions that it seems like the P/E multiple for the S&P 500 right now is around 30 or a little above.

So this has got me wondering about what the market might do next and since I've seen certain tech stocks pretty overvalued over the past couple months I decided to take some profits on PayPal.

*****

September 3, 2020 - Revisiting Wells Fargo:

This position hasn't fared well since I was buying it last year between 40 and 45.

The coronavirus has resulted in higher unemployment, higher bankruptcies, higher delinquencies, lower incomes and the Fed's response has resulted in lower interest rates.

Lower interest rates mean lower interest income for Wells Fargo and the others mean higher credit provisions as Wells estimates what their losses are likely to be on their loans.

In addition they have an asset cap that is preventing them from growing their assets to make up for lost revenue from lower interest income.

I still see value in this bank over the long term though and have added to my position to reduce my cost basis.

I find it more undervalued then last year when I was buying it due to:

Wide moat due to switching costs and economies of scale

Price to tangible book value of .82 and a price to book value of .64.

Cyclically depressed earnings that could increase by a large amount in 3-5 years following the current increases in credit loss provision as vaccines and cures help the world get out of the pandemic.

Lots of stimulus from governments around the world could result in inflation which could increase interest rates and result in higher interest income. At the moment this doesn't look likely though as interest rates are expected to remain around 0% for quite some time.

Some negatives to this thesis are:

 

If interest rates do remain close to 0% like banks in Japan have done for a long time this would result in a value trap. 

Warren Buffett has been substantially reducing his position in Wells for some time. Although many other money managers have increased their position, it's hard to believe that there is an investment manager better at valuing the big banks and has more information about Wells than Warren does. 

*****

June 11, 2020 - When I first started investing a while ago I bought a deep-water oil driller called Transocean.

What have you learned from this mistake?

That just because a stock is beaten down, it doesn’t mean that it will go back up.  When this position was down 67% you told a friend that it doesn’t make sense to sell now at the cyclical bottom. You were wrong. Cyclical stocks trade on fundamentals and economics just as any other company does over the long-term and as you can see there is no guarantee that a cyclical company at or near the bottom of its cycle will come back. And if it does, waiting for it to come back could become a huge opportunity cost.

Just because a company sells on a low price to sales, low price to earnings, low price to book, high div yield and has a big-name money manager buying shares, doesn’t mean the stock is a buy. Qualitative matters more than the quantitative.

You knew this was a mistake 5 or 6 years ago when you wrote about this being a mistake in MOI. Had you sold it the second you knew it was a mistake then you would have saved yourself more capital.

Spend more time understanding the business, how it makes money and what its risks are. Reading the risks section in the annual report can help with this. Also, take more time in understanding the business as opposed to buying too quickly.

Taking a loss can be beneficial to offset gains and lower taxes.

*****

April 21, 2020 - The passage below is transcribed from the Fairfax 2019 annual group meeting hosted online on 4/16/20. Prem Watsa and Andy Bernard don't see a big effect from COVID 19 on their policies. This is a really good sign for shareholders but I have a feeling that governors and lawyers will fight for them to have to pay and this will likely go on for 1-2 years which may keep the stock price range bound. I'm still bullish though and see an opportunity for long term shareholders. The investment portfolio had some big losses though so need to keep an eye on these companies, specifically Atlas Corp. 

Andy Bernard: This is of course is the headline issue I would say with the insurance industry today. How is business interruption going to impact our losses, our experience. In general, it’s our view and certainly the view of the industry that business interruption requires there to be physical damage to property in order to be triggered. That is the standard coverage in the industry for business interruption and that is the coverage that our companies in general provide. It would therefore require an overturning of the contracts in order to open them up to provide broad based business interruption coverage for losses arising from COVID 19. There are isolated exceptions to that general approach. In Fairfax those are very isolated and limited and are not a source of major concern for us. So we will monitor, we are monitoring, we are involved in some of the industry groups that are engaged in this debate going on in the United States but our view, our feeling, is that we are on very strong ground with the position that this is not covered under the general business interruption coverages that are sold in the marketplace.

Prem Watsa: And Andy just to add to that, of course, in the United States with lawyers and governors trying to overturn this and say you have to pay irrespective, as Andy says, we feel very comfortable in saying to you that it is highly unlikely that we will have to pay any significant amounts of money but if the governors try to change this, some of them are retroactively, this will go we think eventually to the supreme court and contract law is very specific. Contracts in the United States are sacred. And we think just like it is in the UK it is highly unlikely that it will be broken but it is an item that is being discussed in the [inaudible] industry.

Source: https://www.gowebcasting.com/events/fairfax-financial-holdings-limited/2020/04/16/fairfax-financial-holdings-limited-annual-meeting-of-shareholders/play

*****

April 7, 2020 - Howard Marks, with the help of his son, Andrew, added the following information to his most recent memo on market swings during the last two recessions which will be very helpful to keep in mind over the next 3-6 months. 

"Markets rarely clear after one massive decline. In 15 bear markets since 1950, only one did not see the initial major low tested within three months... In all other cases, the bottom has been tested once or twice. Since news-flow in this crisis will likely worsen before it improves, a repeat seems likely." This quote is from Gavekal Research's Monthly Strategy

09/01/00-04/04/01    -27%

04/04/01-05/21/01    +19%

05/21/01-09/21/01    -26%

09/21/01-03/19/02    +22%

03/19/02-10-09/02    -33%

10/09/07-03/10/08    -18%

03/10/08-05/19/08    +12%

05/19/08-11/20/08    -47%

11/20/08-01/06/09    +25%

01/06/09-03-09/09    -27%

Although right now it feels like the bottom has already been reached on March 23rd for the S&P after the market has risen 19% since then and FOMO emotions arise, history says that running out and using up all of my dry powder right away probably isn't the most prudent action to take. 

Source:  https://www.oaktreecapital.com/docs/default-source/memos/calibrating.pdf

*****

March 23, 2020 - I added to Fairfax Financial today. This is very similar to my investment in Oaktree Capital where I am investing alongside, in my opinion, one of the best capital allocators. For my investment in Oaktree, I was investing alongside Howard Marks and with this investment in Fairfax I am investing alongside Prem Watsa.

Prem's goal is to compound book value at 15% per year which if he can achieve this then my investment will be doubling every 5 years. There is no guarantee he can do this but he does have a good track record despite his recent sluggish performance from 2011 to 2016 due to the large hedges he put on based on his macro economic outlook.

At the current price per share of $280 I am investing at a 50% discount to book value. Fairfax is an insurance company that does well when there aren't any natural disasters such as typhoons, hurricanes, earthquakes, etc. Right now we are going through a pandemic related to a virus and I'm unsure how much this is going to affect insurers like Berkshire Hathaway, Markel, and Fairfax. I can't find the answer but I don't think Fairfax's policies insure against this virus so if this guess is correct then this company is even more undervalued since it won't have to pay out policy holders. 

Fairfax currently has a big investment in Atlas Corp which is run by David Sokol who used to be partners with Warren Buffett at Berkshire Hathaway before he resigned due to recommending a stock to Warren without disclosing all of the necessary information that he should have. Despite this setback David has a great track record of compounding capital at his former company Mid American Energy and that is why Prem invested 50% of Fairfax's investment portfolio alongside David. 

Fairfax is very well capitalized but the biggest risk I see with this company is the possibility of poor underwriting and poor investment picks by Prem Watsa. Keep in mind that he's not perfect with his decision to buy Blackberry being one indicator of that and I'm not the biggest fan of his decision to invest in Toys R' Us. Overall he's done very well though and Fairfax also has exposure to India through Fairfax India which is likely to be one of the fastest growing economies over the next 2 decades.

*****

March 20, 2020 - I think ViacomCBS will be a two or three bagger from today's price so I initiated a position today based on the following reasons:

They own lots of valuable content including films such as The Godfather, Top Gun, South Park, Forrest Gump, Titanic (50%), The Wolf of Wall St. (in the U.S.) and Star Trek.

I think the virus will be settled down by the summer and football season will go on therefore CBS should see high advertisement revenue from airing NFL games.

March Madness basketball is canceled this year but I'm expecting high ad revenues next year and beyond as March madness returns.

Owns the BlackRock building at 51 W 52nd street in Manhattan which they're set to sell following the virus.

Own several valuable cable channels including Comedy Central, BET, Showtime, MTV and Nickelodeon.

Insiders are buying including 2 $1M purchases from Shari Redstone over the last 2 months.

Seth Klarman initiated a position in q4 2019 and buying at the current price is a better entry point.

Valuation ratios of TTM P/E of 2.7, P/S of .5, TTM P/FCF of 9 and EV/EBIT of 10.

Return on invested capital has consistently been above 10%.

The market fears that ViacomCBS won't be able to transition to the new streaming environment and they are too leveraged to the old cable business model but in a worse case scenario I see their content as too valuable compared to what the current market price is suggesting. I never invest based on takeovers alone but I do point out that another company acquiring ViacomCBS is an option.

If this goes wrong it's most likely because there is a high debt load arising from the merger of Viacom and CBS last year. 

*****

March 19, 2020 - At the end of the last cycle/bull market (I'm assuming that we're are currently in a recession) I was looking at companies that were less quality businesses because all of the quality businesses were overpriced and the semi-high quality businesses were either overpriced or fully priced.

I bought some due to the limited opportunities available and this resulted in me holding some less quality businesses that I wish I didn't own. I could have used the excess capital to invest in better opportunities right now.

Don't forget this feeling in the next cycle.

Right now I'm focused on companies that have good balance sheets to weather this downturn.  

*****

March 18, 2020 - I looked at Boeing's balance sheet today after I heard both Jim Cramer and Bill Ackman mention that Boeing will need a bailout and won't be able to survive without one.

They have $9.5B in cash and $7.5B in short-term debt. So why won't they be able to survive if they can pay their current debt? 

Because they won't be able to pay their suppliers. Keep this in mind as you research companies because it is important. Boeing also has $51.5B in deferred revenue and I didn't look up what this is in their filings because I'm being lazy but this must be deposits they took from customers for future orders. Right now the last thing the airlines are thinking about is future orders. They may want their deposits back and this would ruin Boeing in addition to all of the accounts payables that needs to be paid.

Although I do think the government will bail this company out, I'm going to pass on this company as an investment.

In contrast to this, Mark Cuban said this morning on CNBC that he is buying stock in two companies: Twitter and Live Nation. I looked up both of their balance sheets and their financial positions are solid. Lots of cash exceeding accounts payable, short-term debt and accrued liabilities.  

*****

March 17, 2020 - Anheuser Busch tapped out their whole credit facility of $9B and I like this decision. It's amazing. Never in my models did I envision a scenario where Anheuser Busch's operations would be operating at such limited capacity.

I thought this company was a bargain at $50-$70 and I never imagined it would be selling for $33-$40 a share. Admit it... you're scared to buy here. Even after everything you've read. And of course I am. I don't know how long this shutdown will last and Anheuser Busch has so much debt there is a lot of uncertainty. Yes, their debt is very spread out with the majority priced in low fixed rates and financed over long periods of time but there are unknowns such as debt covenants. What if there are debt covenants that are based on Anheuser Busch's Debt/EBITDA  ratios that all cause debt to be paid much sooner? This is an unknown that can have a huge effect. Luckily the banks seem to be well capitalized at the moment.  

Anheuser Busch has $7.2B in cash with $5.4B in short-term debt and they just got $9B more from their credit facility. They also have $16B in accounts payable, $1.3 in taxes payable (current liability), and another $6B in accrued liabilities. They're operating at a very limited capacity but it looks like they could get through this year ok now that they tapped their credit facility.

The issue is demand is psychological and just because these shutdowns end it doesn't mean people will be automatically going out as much as they used to. Lots of events will eventually continue such as sporting events which will be a big boost for beer sales but I'm expecting a lag in demand before beer sales reach near the levels they were at in 2018 and 2019 because of the large layoffs the economy is about to see and because there will likely be a delay when consumers rush out to spend money since we're creatures of habit and have been more accustomed to staying at home for weeks.  In testament to this last sentence, consumers in China haven't had a surge in demand following the large drop in cases of coronavirus and the opening up of stores and restaurants.

*****

 

March 16, 2020 - Added to Shake Shack today. Shake Shack restaurants are always crowded and they have some of the best tasting food thanks to Danny Meyer's great cooking skills and his determination to create the best tasting food.

They're still open for takeout and delivery which should help them stay afloat as the coronavirus takes away a large amount of revenue from the entire industry. Shake Shack has $37M in cash & equivalents, another $36.5M in short term investments and no financial debt. They do have leases on their stores though that they rent out to sell their food. For this year they have $32M due in leases of which about 1/12th of that would be due each month in rent but I expect the virus will calm down during the warmer weather. They also have payables which can be decreased if they need to lay off staff and delay payments on orders for food supplies.

In other words, I see a great company with a short term setback that is very solvable for them which led to the equity being available at a great price for the long term.

*****

February 18, 2020 - This game is hard. You sold Virgin Galactic way too soon and would have realized a lot higher return by being more patient and holding on. This resulted in a sizable opportunity cost for you.

The way to prevent this mistake from happening again is to understand your position a lot more before getting into it. This way you will be able to hold on for the long term without worrying about day-to-day fluctuations. 

*****

February 16, 2020 - The following quotes come from Terry Smith's 2019 annual letter for Fundsmith LLP. He writes why it is better to be a GARP investor instead of a value investor. It comes down to ROIC and how GARP companies compound for long periods of time where value stocks appreciate back to fair value but then need to be sold and the capital needs to find a new place to be invested. This incurs transaction costs and taxes. The hard part about buying GARP companies for value investors is they appear to be expensive rather than cheap but since they are compounding at higher rates they aren't expensive.

"To quote from Investment Adviser ‘Looking at PE ratios there is evidence in abundance that shows that from a relative perspective quality stocks may today be considered expensive.’ The interesting point about that assertion is that it was published on 13th August 2012. A lot of superior returns have been had from those allegedly expensive stocks in the subsequent seven years."

"Value investing has its flaws as a strategy. Markets are not perfect but they are not totally inefficient either and most of the stocks which have valuations which attract value investors have them for good reason — they are not good businesses."

"Moreover, even when the value investor gets it right and this happens, they then need to sell the stock which has achieved this and find another undervalued stock and start again. This activity obviously incurs dealing costs but value investing is not something which can be pursued with a ‘buy and hold’ strategy. In investment you ‘become what you eat’ insofar as over the long term the returns on any portfolio which has such an approach will tend to gravitate to the returns generated by the companies themselves, which are low for most value stocks."

"As Charlie Munger, Warren Buffett’s business partner, said: ‘Over the long term, it’s hard for a stock to earn a much better return
than the business which underlies it earns. If the business earns six percent on capital over forty years and you hold it for that forty years, you’re not going to make much different than a six percent return — even if you originally buy it at a huge discount.
Conversely, if a business earns eighteen percent on capital over twenty or thirty years, even if you pay an expensive looking price,
you’ll end up with one hell of a result.’"

"The biggest flaw in value investing is that is does not seek to take advantage of a unique characteristic of equities. Equities are the only asset in which a portion of your return is automatically reinvested for you. The retained earnings (or free cash flow if you prefer that measure, as we do) after payment of the dividend are reinvested in the business. This does not happen with real estate — you receive rent not a further investment in buildings, or with bonds — you get paid interest but no more bonds. This retention of earnings which are reinvested in the business can be a powerful mechanism for compounding gains."

"Here’s how Buffett explained this change in his 1989 letter to Berkshire Hathaway shareholders: ‘The original 'bargain' price probably will not turn out to be such a steal after all. In a difficult business, no sooner is one problem solved than another surfaces — never is there just one cockroach in the kitchen. [Plus], any initial advantage you secure will be quickly eroded by the low return that the business earns. For example, if you buy a business for $8 million that can be sold or liquidated for $10 million and promptly take either course, you can realize a high return. But the investment will disappoint if the business is sold for $10 million in ten years and in the interim has annually earned and distributed only a few percent on cost. Time is the friend of the wonderful business, the enemy of the mediocre.’"

*****

February 6, 2020 - Following up on my journal entry from February 3rd, Whitney Tilson recently wrote about the possibility of Exxon likely being a value trap following their poor 4th quarter earnings release.

He believes Exxon is hiding the fact that they had to sell assets and take on debt just to afford to pay their dividend.

He also points out that their revenue and operating cash flow has been falling over the past 10 years and that Exxon not including their balance sheet and cash flow statement in their earnings release is likely due to them hiding the deterioration of their business.

Whitney doesn't see them cutting their dividend yet since they can continue to fund the dividend over the next few years with more asset sales and debt plus he also sees it as being really bad for the stock price if they were to cut it.

The switch to alternative forms of more environmental friendly energy like solar and wind and the transition from internal combustion engines to electric vehicles are reasons for revenue to continue to trend down in the future and result in a classic value trap for Exxon.

And if oil and gas prices were to rise then a better play would be to buy a smaller energy company since this would yield a much higher return than Exxon would.

Source: https://empirefinancialresearch.com/articles/exxonmobil-is-a-value-trap-greetings-from-nairobi

*****

February 3, 2020 - What is a value trap?

It is an investment that appears to be undervalued based on financial metrics such as P/E, P/B, P/S, P/FCF, EV/EBIT, etc., but actually isn't undervalued because the cheap price and cheap financial metrics are due to the business' deteriorating earning power. 

Are KHC, Baidu, and oil stocks (BP, XOM, Shell) value traps?

They were once saying MSFT was a value trap in 2011.

It wasn't a value trap because Microsoft's core business (Windows operating system) was still throwing off lots of free cash flow and when you looked around, computers with the Windows operating system were in universities and offices all around and they were still being bought due to the inconvenience that users would have had to endure if they had to relearn a new operating system (switching moat). The catalyst was it still had this moat and the company was able to use these cash flows to successfully invest in other growth areas like cloud to avoid being a value trap.

Will BP, XOM, and Shell be able to reinvest their cash flows from petroleum into other areas like renewable energy to avoid being a value trap? Since oil and gas are commodities this makes the question harder to answer because there isn't much of a moat compared to Microsoft. I guess the answer is I can't say with as much confidence as I was able to with Microsoft. 

Will Baidu be able to successfully reinvest their cash flows from search into AI and cloud despite heavy competition from Alibaba, Tencent, and ByteDance? I think so because the advertising market in China is so huge that I think all 4 can have their share. Plus I think Baidu has a strong enough moat in search to retain market share for the time being.

Will Kraft Heinz be able to successfully reinvest their cash flows from Heinz to pay off debt and reinvest in the Kraft and Oscar Meyers brands that are in desperate need of R&D and advertising dollars? Will they be able to correctly decipher which brands can and can't be fixed? I think Oscar Meyers cold cuts (not the bacon) is mostly a value trap but most of the other brands like Planters, Philadelphia, A1, Capri Sun, Lunchables, Kraft Dressing, Kraft Cheese, Velveeta and Kraft Mac & Cheese can be turned around.

*****

January 27, 2020 - Exited Virgin Galactic with an overall gain despite realizing a loss on November 7, 2019.  Not sure of the long-term prospects of the business at the moment despite sell side analysts picking up coverage on the stock and giving a bullish outlook.

 

I thought this would be a part investment for Chamath Palihapitiya's holding company but all of my shares were converted to Virgin through a SPAC instead. I adjusted my position on November 7th to reflect what I thought would have been my allocation had this been the setup that I originally thought it was going to be.

I planned on holding it long-term but then my emotions got the best of me as I saw a gain in the company but wasn't sure how confidently I could value this company due to the uncertainty of what the future business prospects will look like. I'm content with the outcome now because I did realize a quick gain but am not happy that I didn't have the emotion to do what I originally intended to do - hold this long term.

Setting up a system that prevents me from checking stock prices too often would be very helpful for me but then again I am comfortable holding my other positions long term so perhaps my uneasiness with holding this one for the long term was a sign that I needed to sell.

"If you don't feel comfortable owning a stock for 10 years, you shouldn't own it for 10 minutes."

                                                                                                                                             -  Warren Buffett 

*****

January 16, 2020 - 8 quotes from a part of Saber Capital Management's great investment letter:

1. "In total, we had five main holdings which made up about 80% of the fund’s assets."

2. "Homebuilders tend to have cash flow statements that look a lot like energy producers: they earn cash from the sale of a finished home, but that home sits on land that has to be replaced, and so the profit has to be constantly reinvested into new land. Like an oil well that slowly bleeds dry and requires a new well to maintain production levels, builders are constantly pouring their cash flow back into the ground in order to stay in business. I think of these types of business models like hamster wheels: the minute you stop running, the wheel stops turning. Businesses like homebuilders, energy producers (and maybe even video streaming companies) have to keep pouring cash in or else their business “wheel” stops turning."

3. "Lesson: Anchoring on a previous price is a mistake that I’ve often made, and I hope to do a better job guarding against this bias going forward."

4. "There will be lots of mistakes going forward, from stocks we missed and also from stocks we did buy but shouldn’t have, but I try to think of mistakes like capital expenditures that are necessary education costs that pave the way to greater returns in the future (I’ll be sure to remind you of this glass-half full mindset next time our fund has a bout of underperformance)."

5."All of this means missed opportunities will be our biggest source of mistakes, and I’ll do my best to minimize this cost going forward."

6. "Over the past 5 years, with exceptions that you could probably count on two hands, Apple has outperformed the entire hedge fund industry, every one of the 10,000+ mutual funds, the passive funds at Vanguard and Blackrock, the most prestigious private equity funds, and the vast majority of venture capital funds in Silicon Valley. We’re talking about many trillions of dollars in all kinds of investment vehicles with all kinds of fees, managed by extremely smart people with unlimited research budgets and super smart employees, who all work extremely hard, and are all highly incentivized to produce great results. And Apple beat nearly every last one of them, including Saber Investment Fund, LP."

7."I’ve compiled a lengthy investment journal devoted solely to Apple in my files, with many different observations on the business, its products, its customers, the competition, its competitive advantages, and its vulnerabilities. But one overarching takeaway is humans overreact to short-term news, forcing stock prices away from their true value – even when the company is the largest in the world. Of course, there will always be stocks that outperform the portfolios of virtually everyone at times, but it’s important to remember that these outperformers don’t necessarily have to come from the best hidden, most complicated, or least understood companies. Sometimes bargains hide in plain sight."

8."Facebook had a great year, as revenue grew by nearly 30%. I wrote about an email that Jeff Raikes sent to Warren Buffett in 1996, outlining why Microsoft was such a great business. One factor was that Microsoft was able to earn profits off of capital investments that someone else (IBM) made. Facebook is a modern day example: Verizon and AT&T spent tens of billions to deliver internet to our homes, and Facebook (among others) took the lion’s share of the profits that stemmed from that invested capital. But Facebook goes one step further because not only does it leverage someone else’s capital, but it also has a business model where its own users produce their own content for each other to consume."

Source: https://sabercapitalmgt.com/saber-capitals-q4-investor-letter-highlights/

*****

January 2, 2020 - Luckin Coffee is an interesting company that has seen a lot of growth recently. It is riding a coffee consumption wave in China that looks to be in its very early stages due to coffee consumption being so low in China compared to other areas of the world like Europe, Japan, and the US.

Luckin has a very simple business model that I think they were able to have so much success because of their understanding of the Chinese culture.

Luckin Coffee leases very small shops and hires only 2 or 3 workers per store. Luckin has a mobile app where consumers (mostly office workers with modest to high incomes looking for quick service) order on the app and then go to the small shop and pick up their coffee and leave. The ordering and paying are done on the app.

I've added it to my watchlist but I won't buy now.

I think the company will attract competition due to the limited barriers of entry since the business model is really just a small leased space, an app, and coffee sales. Not a hard-to-replicate business model and I think Starbucks will copy this strategy, although they already have a different strategy where consumers order and drink their coffee in Starbucks coffee shops. I just don't think Starbucks will continue to watch Luckin gain so much market share while Starbucks misses out on a big opportunity that isn't hard to copy. Luckin's idea will likely attract other competitors as well in my opinion. Hopefully they will be able to grow fast enough and build a brand name to help them in the meantime though. 

Also, the valuation looks way too expensive for me now at 18 times sales and no profits. 

*****

 

December 30, 2019 - Read a really good report about Naspers so I added Naspers to my watchlist. I haven't done much deep research on the company but I am familiar with it due to its large holding in Tencent which I have been researching a lot lately.

Naspers has been up around 20% over the last 3 months so it looks like the market did see a bargain when Naspers was trading at $28 a share.

Naspers is a media company that is based in South Africa but they also hold a lot of ownership interests in growing tech companies. Management has done very well at identifying high growth tech companies and investing in them in their early stages.

They currently have investments in classifieds, payments & fintech, food delivery, travel and social & internet platforms.

They spun off a lot of their ownership interests in their growing tech companies into a company called Prosus which they own 74% of. Some of the companies in Prosus' portfolio are Tencent, mail.ru, delivery Hero, Ctrip, Emag, Payu, Olx, Avito, Dubizzle, and Letgo.

The spinoff company (Prosus) trades at a discount to its sum of the parts valuation and Naspers which owns 78% of Prosus also trades at a discount to its sum of the parts valuation. From what I read there is no capital gains tax for selling the shares. I need to do more research but I think this company will outperform over the next 10 years. Until I do more research and hopefully get a lower price (I'm probably anchoring here on the price since I looked at the 1 and 5 year price chart), I won't invest. 

 

*****

 

December 18, 2019 - I think Kraft Heinz will be a turnaround story and the majority of their brands will recover. I think the Q3 2019 results already showed that a turnaround is already starting to go in the right direction and I believe that 2020 will be a turnaround year for the company. If not 2020, then I see a 2-3 year time frame to turn it around.

Here are the reasons why:

There is a new CEO and CFO. Miguel Patricio has experience in marketing and turning around brands at Amheuser-Busch. He is what Kraft needs. He also understands that more capital need to be allocated to marketing and innovation for existing brands. They also replaced their CFO which I feel gives the company more experience in that position.

Debt repayment - Kraft has already started to repay debt with their debt decreasing by 2-3B over the past 2 years and they also just sold their Canadian cheese brand to raise funds for debt restructuring. They also bought back debt in September. I don't believe that Kraft will engage in any M&A that will hurt their debt position in the near future since management has emphasized that debt reduction is a priority.

Kraft still has some good brands like Heinz, Quero and Philadelphia which had positive organic sales growth this year. I also believe other brands like Planters, Kraft Macaroni & Cheese, Velveeta, Kraft Cheese (but not singles) Capri Sun, A1 and some others aren't bad and will recover after increases in marketing and R&D expense.

Asset sales - Kraft is looking to sell more brands to raise money for debt reduction but aren't doing it at irrational prices. Pulled back on Maxwell House most likely because they couldn't get a reasonable price due to negative outlook from media.

 

Lots of insider buys. The Chairman of 3G Capital, Jorge, bought close to $100M of stock in the direct market and a director on the board bought around $7M. Meanwhile, Warren Buffett's stake is still the same as it was when he first merged the 2 companies and 3G Capital still holds a large stake as well of about 20% of the outstanding shares. 

Current price - $31.60
Target price - $41.66 
Timeframe - 1-3 years 
  

*****

November 20, 2019 - Initiated a position in Alcon today. I bought this one at a high valuation. I'm applying the cliche "buy a great business at a fair price" here because I see Alcon as a great business. My analysis here is somewhat 80% qualitative, 10% technical and 10% quantitative.

The 10% technical is because the stock has had a very strong support level at $55 per share since its IPO in April 2019.


The 10% quantitative is because the company is trading at 29x 2019 earnings, 3.7 price to sales ratio, and EV to EBIT of around 24 times which is a little bit expensive.

The 80% qualitative part is because Alcon is one of the leading eye care companies in the world. They have a strong market position in ocular surgical supplies and contact lenses. I purchase their contact lenses solution and it works well. I see a brand moat here due to the eye being a sensitive place so once you find a product that works well you don't want to switch. There are some competitors like Cooper, Johnson and Johnson, and Bausch & Lomb which make it somewhat of a competitive market but there are lots of people who need help with their vision. This includes cataract surgery and vitreoretinal surgery which Alcon manufactures equipment for. Glass eyewear isn't part of Alcon's business model but contact lenses and Lasik are and both have large markets.

Now that Alcon is separated from Novartis, Alcon can focus on growing their business much better. Since the eye doctors have a huge influence on what their patients use (my eye doctor recommended Alcon contacts solution and Johnson and Johnson contact lenses), Alcon I think can help their business a lot by focusing on forming good trustworthy relationships with them. I think Colgate did a wonderful job forming relationships with dentists and building lots of shareholder value for their shareholders. 

*****

 

November 19, 2019 - Chris Mayer gave a presentation on 100 baggers at the MicroCap Leadership Summit in September 2016. He told an interesting story about a friend of his whose wife bought a painting for $150,000. His friend then hung the painting in his living room and however many years later he went to sell it at an auction. The painting sold at the auction for $2.3 million, much more than what he believed he could sell it for. This caused Chris's friend to then think to himself how he was able to realize this return and he realized the reason was because it hung in his living room the whole time and no body offered him a price to buy it. If someone offered to buy it for $500,000, $800,000, or even $1,000,000 he very likely would have sold it and so he would have never allowed it to reach $2.3 million.

The stock market works very different. 5 days a week between 9:30 AM and 4 PM you can get your stocks priced from the market. The temptation to look is what doesn't allow us to realize the full potential of our returns on the securities we own.

If there was a recommendation I could give to my online broker it would be to create a "hide" function inside my online portfolio therefore every time I log on I can hide the prices of the securities I own so I'm less tempted to act when I should be doing nothing.

Here is the summary of what Chris Mayer said 100 baggers have in common:

1. Start small (he must be talking about market cap)
2. You've got to hold for a long time
3. Low multiples preferred (price to earnings)
4. High returns on capital are really important (because to go up 100x it has to be a good business)
5. Owner-operators preferred (but not required)

Without doing any research, a company that comes to mind if I had to pick one that I think will be a 100 bagger during my lifetime starting from today's market cap would be Shake Shack. Although it technically doesn't meet all of the qualifications above to be a 100 bagger so maybe it's more of just a gut feeling of mine. (Shake Shack has a high P/E multiple of 90 and low ROIC)

*****

November 7, 2019 - You had to take your 2nd realized loss today because of a mistake you made.

You bought IPOA because you thought it was a holding company that Chamath Palihapitiya was going to use to invest in high growth companies similar to what he did at his previous venture capital fund. You knew one of his investments was going to be Virgin Galactic (SPCE) but you didn't know that all of the funds raised for IPOA were going to be used in the reverse merger with Virgin Galactic. So what you ended up with was a position that you felt you were overly allocated to and a company that you are very uncertain of on the long-term economics of the business.

Virgin Galactic caters to the super wealthy with a price of $250,000 to sign up for space flight.  It's a limited market and although it has the market to itself as of now and already has reservations from people who already booked, there could be possible competition from Blue Origin, Space X and possibly others soon. It is also not cheap to fly spacecraft which is going to result in very high maintenance costs to service the operations of the business and high insurance costs. As an investment with a far out time frame I'm OK with the investment provided that I'm properly allocated to it.

Therefore, I trimmed my position by 70% to reflect a more comfortable allocation which is slightly higher than what I originally thought Social Capital Hedosophia was going to be allocated to Virgin. This trimming resulted in the second loss that you had to take as an investor.  

What you learned is that it is better to be patient and gather more information and facts than to rush into a position. 

*****

 

October 24, 2019 - On dataroma.com I saw that Mohnish Pabrai added a company called GrafTech to his portfolio with a 16% position in 2nd quarter of 2019. I wondered why he added this very little known company to his portfolio but found out in the Fall 2019 Graham and Dodd Newsletter.

In summary:

GrafTech is a manufacturer of high-performance electrodes which go into electric furnaces that are used in mini mills to make steel. Nucor is a customer. There are only 3 or 4 other producers of these electrodes in the world and it takes 3-5 years to build a new manufacturing facility so there shouldn't be an unforeseen abundance of supply out of no where over the next 3 years.

A main input cost of making these electrodes is a raw material called needle coke and that has a limited number of suppliers as well with GrafTech themselves owning their own needle coke facility to protect themselves from disruptions in their manufacturing line.

Prices for these electrodes went crazy so GrafTech went to 100's of their customers and locked in 70% of their  production over the next couple years at take-or-pay contracts set at a fixed price to ease the uncertainty for their customers.

Mohnish sees limited downside due to these locked in prices with contracts that take 70% of their production and the other 30% will be priced at the market. The 70% take or pay contracts is the margin of safety and what limits the downside, meanwhile the 30% of production with prices at the spot price are what create the upside. Of course there is no guarantee that the 30% will be bought at high prices but if they are then GrafTech can be a double or triple. If they aren't bought at high prices but low prices instead, the take-or-pay contracts should provide enough income over the next couple of years to support the share price that Mohnish bought at.

I write this in my journal not to copy Mohnish's idea but to look back one day and see how this idea and analysis plays out. I've decided I'm not going to take ideas from others that I don't truly understand because most importantly I won't know when to sell or if the thesis changes, I know that I wont be comfortable having my capital locked into this stock for a long period of time. Mohnish gives this idea a 5-year time frame to develop and I don't see myself willing to be that patient with a company I don't understand that well nor have much interest to learn and follow.

I just saw a commercial for Domino's Pizza during the Thursday night football game and boy was I wrong about that stock. I remember when I was somewhere between the age of 23-26, I would ignore Domino's as an investment just because I didn't think they had any competitive moat because there were limited barriers to entry. It just isn't hard to set up a pizza company.  There are a lot of mom and pop small business pizza companies and a lot of them are good. Especially a lot located by me. Over the past 10 years, Domino's has doubled revenue and tripled operating income.  That's impressive since they have not had a losing year of net income over the last 10 years also. The folly in my thinking was that I didn't dig deep enough into the company enough although I enjoyed the taste of all of their food that I tried. Their chicken kickers, cheesy bread, sweet bread, regular pizza and thin crust are all good. It turns out having scale along with a low cost business model (cheese, bread, sauce, small stores) with great tasting recipes can create a lot of shareholder value for its investors. Especially if the majority of the value created is reinvested back into the business and further compounded. 

© 2018 Mike Gorlon                                                                                                                                                                                                                                         Amazon Affiliate