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.
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."
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.
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.
October 20, 2019 - In this interview for the Fall 2019 Graham and Dodd Newsletter, Mohnish Pabrai talks about how he had leveraged financial institutions in his portfolio which he bought during the 08 recession and lots of them went to zero.
He says, "I still have one levered financial institution in my portfolio. When you're an alcoholic, you just can't give it up. So hopefully by talking to you now the lesson is getting seared into my mind: don't go near levered financial institutions."
We all have our bad tendencies in one thing or another. What is your bad tendency in investing likely going to be throughout your lifetime?
It is possible that it could be oil companies and processed food companies. They have compounded well in the past and have paid generous dividend also but the past isn't any indication of the future. Oil isn't likely to play the same role in our global economy over the next 100 years as it has over the previous 100 years due to climate change and electric cars, and processed food companies have more competition with newer generations who are much more health conscious in what they eat. New ways of advertising particularly through the internet and social media are decreasing the barriers to entry advantage of shelf space at grocery stores that food processing companies have had in the past also. Right now, you currently own KHC, MDLZ and GIS.
Here is another good quote I saw from Mohnish Pabrai in that Fall 2019 Newsletter above: "I have never seen Warren Buffett make a dumb bet with levered financial institutions. I think his batting average is 100%. But I've seen him make a ton of mistakes on retailers. If you were to sum up all the Berkshire acquisitions, their records is actually not great. But if you weight them by actual capital deployed, their record is unbelievable."
Tweedy Brown cut their stake in Baidu by 41% last quarter. There are macro headwinds in the Chinese online advertising market and Baidu has been experiencing greater competition, particularly from ByteDance which I also saw that they have been successful in gaining a large user base in the US which now has Facebook's attention. I saw this in an internal memo between Mark Zuckerberg and employees and then I believe in a news notification on Seeking Alpha that said ByteDance is poaching Facebook employees.
I saw an online article that mentioned an internal memo was released by Robin Li who emphasized to employees to be frugal and refrain from travelling business class, staying at 4-star hotels and encouraged employees to only use 1 towel when washing their hands in the bathroom as opposed to more than what is necessary. These acts aren't emphasized in really good times so these signs need to be noted because it is likely - judging from recent quarterly results and what you're reading - that Baidu's moat isn't as strong as it has been in the past. Luckily they have a good balance sheet with cash outweighing debt by a decent amount at the moment.
September 30, 2019 - The retirement of CEO Bob Dudley that was announced today means I need to look deeper into BP.
I initiated a small position in Social Capital Hedosophia this morning.
I believe the next big growth industries are "the internet of things" and "AI". But which companies will win? Does it matter if you can identify the next big growth industries but not the companies in the industries? Does the difficulty of selecting the winners mean you shouldn't at least try?
Two of the big and possibly 3 winners that I think will be in AI and IOT are Google #1, Facebook #2 and possibly Amazon. Your investment in Baidu partially speaks to your guess that AI will be the next big wave of growth technology. Baidu has a good and profitable existing business with a huge market share of search in China and at the current market cap you're getting its AI division (Apollo and Duer) for free.
I've been researching Micron and AMD recently. Will semiconductors be needed to operate all of the other gadgets in the internet of things (refrigerators, billboards, doorbells, etc). My guess is yes, but the companies who win now won't win later, similar to how Intel won PCs but missed mobile phones. (Note: Still have to read Clayton Christensen's book The Innovator's Dilemma)
Look into a company you found today from an interview called Quarterhill.
September 27, 2019 - Social Capital Hedosophia Holdings is a company I have been investigating recently as a "bet on the jockey" company. It is a blank check company that looks for other companies to invest in or merge with. They raised around $600M in a trust fund to invest in other companies. It is set up to be similar to a venture capital firm but the objective of the firm is to make it easier for private companies to IPO. They announced that they will invest $100M in a merger with Virgin Galactic and Chamath will be the Chairman. Social Capital Hedosophia is a very risky investment since they are a blank check company and they will be looking to invest in companies of a similar caliber to what a venture capital firm would invest in. Since the companies they plan to invest in are high-risk, this investment won't be a significant part of my portfolio.
I've listened to Chamath Palihapitiya before in interviews and podcasts and I've read his annual letter last year. I think he is a tell-it-like-it-is operator who is intelligent and also bold. He has had success as an executive at Facebook, at his venture capital firm where he was generating around 40% returns (gross) and low 20% net of fees I believe. He has invested in Slack, Box, Palantir and is also an investor in the Golden State Warriors. He owns around 17% of Social Capital Hedosophia. I recall on a podcast how he was looking to set up an investment vehicle similar to Berkshire Hathaway and I think this might be his attempt because this setup will give him better access to permanent capital where he won't have to face the risk of capital withdraws from LPs as he could have been in his venture capital partnership and he won't have to deal with limited partners criticizing his every move. He will still have risks like the manic depressive stock market at times when the economy crashes though and likely will have to answer to Wall St. analysts depending on how he handles guidance. He may choose to not give short-term guidance which I think would probably be the best option since it will help everyone focus on the long-term.
The risks I see are the firm making investments in poor companies, the companies they purchase aren't operated well, I'm wrong about Chamath's investing ability and everything else I can't think of. There are some articles written about Chamath on the internet that he wasn't showing up to work at his previous fund, a lot of people were leaving, and some other stuff which are red flags but I still believe Chamath has the ability to compound capital at high rates and investing in this company would give me an opportunity to invest alongside him.
September 13, 2019 - BP has been a holding of mine which has been relatively flat over the past 5 years ranging between $30 and $46 a share not including the dividend. I don't see this company as a capital compounder but I do believe it makes for a good value idea. BP is issuing a dividend of $2.46 a share and at BP's current price of $37.87 it is yielding 6.5% which is very good. BP has generated positive free cash flow of about $7.7 billion over the last 12 months which is good but it doesn't cover the dividend which is about $8.37B. They have been selling assets to help pay for the oil spill settlement which helped bring in $1B after you account for the PP&E that they purchased as well. Asset sales will continue to help alleviate the settlement payments. Including this $1B, they were able to fund their operations and pay off the dividend without raising capital. WTI oil averaged around $65 a barrel during 2018 and is now at $55 a barrel so covering the dividend might not come as easy this year or the next depending on where oil prices are.
The CEO, Bob Dudley, has done a very good job in my opinion in managing BP. He was able to work out a manageable settlement for BP to pay $18.5 billion dollars over around a decade; he has increased safety to prevent future disasters; he has sold assets every year for around the past 7 to raise cash to pay off the settlement, debt and to better position BP for the risk of low oil prices; bought shale assets from BHP Billiton for what appear to be attractive prices today and he has been able to lower BP's cost of production. BP is now profitable at $55 to $60 per barrel of oil.
I believe that electric vehicles will come someday but predicting the exact timing is difficult. I don't see the infrastructure in place now and believe it would be hard to implement over the next 5 years for a major transition away from ICE cars. Even 10 years would be difficult. There needs to be more electric charging stations, better affordability, and better mile range. Also, the electric power grid still needs to be powered in order to supply the electricity to the charging stations and it is likely that fossil fuels will be supplying this electricity for the next 5 to 10 years. Natural gas is the best option of the 3 major fossil fuels. A transition away from oil for automobiles would still badly hurt BP's business so this should be monitored closely.
I see this company as undervalued with good management and a good balance sheet. I don't see a major shift away from a world powered by oil and natural gas in the near future but do need to monitor this. Look to add to your position if BP drops to $35-$36 per share.
August 14, 2019 - Yield curve inverted today. This has preceded a recession every time since 1980 so Mr. Market got more worried than usual and was selling the biggest 500 businesses in the U.S. for almost 3% less on average than he was yesterday. Last time the yield curve inverted was 2007 and although it has been a good indicator of predicting a recession, the timing hasn't been perfect. The difference between yields on the 2 and 10 year went negative in December 2005 and in May 1998 but the recessions didn't follow in both instances for around 2 years later. Predicting the exact timing of a recession is too difficult.
Germany's economy contracted .1% in the 2nd quarter. Another quarter of contraction would signal a recession.
Argentina's stock market dropped 50 something percent on Monday. I think that is the 2nd largest one day drop in history and is absurd. A 10% or 20% drop in a day is a lot yet alone 50%. Argentina was just able to issue a 100-year bond a little more than 2 years ago. That was issued in 2007 a year after a default.
6 month - 1.92%
1 year - 1.79%
2 year - 1.58%
5 year - 1.51%
7 year - 1.55%
10 year - 1.59%
Tencent reported earnings today and cited a poor advertising market in China. This doesn't bode well for Baidu. Tencent still reported an increase of I believe 20 something percent in operating profit due to cutting expenses and due to revenue from wechat and social gaming. Seems like they aren't as vulnerable to the advertising market as Baidu and Weibo are and this shows in their stock price which has held up more compared to Sina, Weibo, and Baidu.
All of this news is negative which gives you a gauge of the sentiment in the markets today - pessimistic.
Below is a passage written by Howard Marks in his letter "On the Other Hand" discussing the most recent decision from the Fed to cut rates by 25 basis points. Is it good for the markets because a lower Fed Funds rate can mean lower interest rates to discount future cash flows by or despite good economics data, did the Fed lower the rate because they see trouble ahead?
"My point is that a rate cut’s implications aren’t always as simple a matter as they may appear to be. Assuming the Fed is a good diagnostician, a decision to cut rates isn’t necessarily good news. You can argue that, if there’s trouble ahead, we’re better off with a rate cut than without one. But that still doesn’t make it good news. First, it means the Fed thinks trouble is looming. And second, it certainly doesn’t guarantee the problem will be solved. (It’s worth noting that 18 months after that first rate cut in September 2007 – during which time ten more cuts followed, eventually taking the fed funds rate to nearly zero – the S&P 500 finally bottomed out, down more than 50% from where it stood on the day of the first cut.)"
Negative yielding bonds from Charlie Bilello on August 5, 2019: https://twitter.com/charliebilello/status/1158394284917383168
August 7, 2019 - I need to reiterate an obvious investment principle/rule that is obvious in theory to adhere to but is much harder in practice to follow due to my laziness and greed. One must do his own work and own research and never buy on tips. Tips in the old days used to be a recommendation from a friend or an associate and although these obviously still happen today, with the development of the internet there are other ways to get tips such as from investment managers who publish research on a company and submit the research on a website. These ideas can be found in investment letters, 13F filings, websites, blogs, etc. I was recently tempted to buy a stock in a company called Burford capital and put in a very small order to buy 3 days ago. The company is now being accused of being an accounting fraud and the stock has gone from around $17 a share to $6 in only a day. Although it would have only been a small loss for you on paper that wouldn't have had a material affect, it's still important that you must do your own research no matter how good the investor is. Developing bad habits will cause harm for you in the future as it will make you more lazy. You also need to understand the business you're buying. Although you have a broad idea of what the business does, you don't truly understand it and you know this after reading the short report put out today by Muddy Waters as you are reading the way Burford does its accounting you can tell you're still in the researching and learning phrase on this idea.
What does it do: Exchanges litigation financing in lawsuits for a fee and/or a percentage of the winnings in the lawsuits. Most of business is done in the U.S. and there are a lot of lawsuits in the U.S. 80-90% of lawsuits settle before going to court making it easier for Burford who finances the lawsuits to get performance fees since going to trial takes time.
Bull thesis: Lawsuit financing is a growing market without much competition at the moment. CEO is owner operator. Owns between 10-20% of the shares and has experience in the business and seems like he has a passion to be there for the long term.
Bear Thesis: Accounting can be hard to understand. Business involves lots of accounting estimates which can make earnings unreliable. High turnover at the CFO position and the current CEO is the CEO's wife.
Conclusion: it gets put in the too hard pile for now and you do nothing unless you can understand the company better.
As an aside, you bought more Wells Fargo in the mid $35's today. Your thesis from your previous journal entry in July is still intact but the market offered you an opportunity to add to your position today because of the drop in the 10 yr treasury yield. The curve got more inverted and banks are in the business of borrowing short-term and lending long-term so when rates are higher in the short term and lower in the long term (inverted yield curve), this makes for worse business for a bank. No business wants to borrow money at a higher rate and earn money at a rate that is lower than the rate at which they borrowed at.
August 6, 2019 - Added to Fairfax position today between 455-460 a share. Fairfax has a business set up very similar to Berkshire where they own insurance firms and use the premiums and underwriting gains to invest in other companies. In the past, they have made some macro bets on the market but a couple years ago said they won't anymore.
Prem Watsa has compounded capital and grown book value in the mid to high teens since the company was started in the 1980's. He was making bearish macro bets on the market between 2014-2016 that didn't work out. It cost the firm and its shareholders at least a billion dollars of misallocated capital. Prem Watsa then admitted it was a mistake and that the company will only stick to buying good businesses at good or fair prices. He is the chairman and CEO and is honest and upfront with shareholders. He has the talent for compounding capital but it's important to understand the difficulty of going short and making macro bets on the market. Timing plays too important of a factor in this regard and who in the world could have predicted that this business cycle would have broke the record of the business cycle leading up to 2000. You for sure were wrong in this regard. You didn't for a second think this would be the longest bull market in history. Anyway, mistakes happen and Prem Watsa being a good capital compounder who is aligned with shareholders and admits mistakes and going forward will stick to picking good businesses is my main reason for investing in this company. In other words, I'm betting on the jockey.
Currently the stock price hasn't done much over the last 5 years. It stayed in between $430 and as high as $586. I think some of this is due to the macro bets that Prem made that didn't work out. Now Mr. Market lost some faith in him but I think he will continue to compound capital at rates in the mid to high teens. His company has been looking a lot at India lately which I think will be one of the fastest growing economies for the next 20-30 years. Fairfax set up a holding company called Fairfax India Holdings Corp. to invest in India and the parent company, Fairfax Financial, gets a hedge fund type fee and performance fee on the gains.
Right now, it trades at a fair valuation that I am happy to own at and would be even more happy to buy more if the price were to drop:
Prices to Sales: 0.7
Price to TTM Earnings: 15
Price to 5 yr Average Earnings: 16.5
Price to Forward Earnings: 7 (Morningstar)
Price to Book: 1.0
August 1, 2019 - I've been invested in Kraft Heinz for about a year to two years now and have added a lot to my position through all the negative events - dividend cut, large write down of intangibles and goodwill relating to Oscar Meyers and Kraft, SEC investigation, filing delay of financials, stepping down of CEO, large 4Q 2019 loss, and debt concerns. I think the company has a capital compounder underneath all of this which is Heinz. I still see a lot of Heinz ketchup bottles and some of their other sauces at restaurants, diners, food courts, delis, etc and I still see a strong economic brand there. Without the Heinz brand this company is more of a value trap. Warren has said that he didn't overpay for Heinz at $25b so if I take his word and believe that Heinz could compound capital enough to double its value over the next 10 years (7% minimum cagr) then that would put the value at $50B minimum which exceeds the market price today by $10B. That is one margin of safety that can protect me from permanent loss of capital. And with a current market cap of $40B for KHC I think there is still at least $10B-15B of value today in all of the other brands even though some for sure have lost economic goodwill. Some of the ones I do like are Planters, Philadelphia Cream Cheese, A1, Oscar Meyers bacon, Kraft cheese, and Kraft dressing. (There is bias in that last statement.) Orea Idea and Maxwell house might have some value but I would rather see them sold to reduce debt. I don't think Oscar Meyer cold cuts and bologna has much value. I believe it's concerning that the company is struggling to find a buyer to buy the Orea Idea and Maxwell brands at the price they're looking for. Good news is slowly coming in now that there is a new CEO, the company filed its restated financials for the last 3 years, and on August 8th they will report results for the first 6 months of 2019 before the market opens. Doing it before the market opens is a sign of confidence from the company in my opinion since the price will fluctuate throughout the day based on the results. I think time will help this company clean up the mess they made (note per just-food.com: chairman of 3G, Jorge, acknowledged they screwed up Kraft/Heinz, said he has $10B commitment from investors at the time of writing of the article for a new fund but abandoned plans for a new acquisition to merge with KHC, and will fix the mess they made). If this was a retail company I wouldn't be in it but packaged foods is a solvable problem. Has the industry changed so much where it has become unsolvable? (Ex. e-commerce grocery shopping, processed foods transition, lower barriers to entry) I don't think so and I am betting on it but time will see if I'm correct. So the major concern I have is the debt. Debt due in 2019 is $355M, 2020 is $3B, 2021 is $990M, and 2022 is $3.5B. 2019 is ok but 2020 will be an issue. I'm expecting about 5B-5.5B in ebit and 1.2B-1.5B in int exp so with taxes it can be net income of about $3B and after dividends of $2B there could be a surplus of $1B in cash. They have around $1B in cash and just got about $1B from the sale of their Canadian Cheese unit. If it ends up not being enough to meet 2020's debt obligation, I see options to get around this such as cut dividend, sell assets (brands), refinance with banks, or raise capital. I think they will meet their debt obligation in 2020 even if they have to get a high cost loan from Buffett and 2021 debt isn't too high at 900M. So, it's a time arbitrage bet, 3G/Buffett not giving up, positive ebit generating (4th quarter was accounting write down which is noncash but I acknowledge poor capital allocation), financials are being reported finally after delays, procurement issue is getting solved, SEC issue still under investigation but my guess is it ends in a fine that doesn't cripple KHC, and debt is biggest issue but is solvable. I think fund managers are frightened to be involved partially to career risk and fears their brands are done but I disagree and as good news starts to show up they will slowly begin buying and the stock price can reach low 40's in 2-3 years. Overall, it's undervalued right now at $32 a share with a lot of negative priced in and some good news already trickling in.
Market Cap - $39,700M
Minority Interest - $118M
Debt - $31,100M
Cash - $1,130
Total E/V - $69,788
EBIT (est.) - $5,000M
EV/EBIT - 14 (Balance Sheet #'s as of Dec. 2018)
July 24, 2019 - Tweedy Brown released their 13F filing today for the 2nd quarter with additions to Baidu, Alcon, and Sina. This catches my attention because Baidu is one of my larger positions and Tweedy increased their position by 40%. Also, Alcon is a company I'm interested in buying but have been waiting for a better entry price. I missed the entry price when it first IPO'd and dropped to mid 50's because I wasn't prepared. 13Fs are filed for each calendar year and the fund has 45 days following the end of the quarter to submit their 13F form. That means somewhere between 4/1/19 and 6/30/19 Tweedy bought shares of Baidu between the price range of $110 and $180, bought Alcon between the price range of $54 and $63, and bought Sina between $40 and $64. Sina was only increased by 1.2% and I didn't really know anything about it before seeing this 13F filing today but have researched it since this afternoon and it is cheap in my opinion. Sina has a net cash position of $1 billion, owns around 47% of Chinese Twitter (Weibo) which has a market cap of around $9B, so their ownership stake in Weibo is worth close to $4.5B meanwhile the market cap of Sina is only $2.9B. Weibo looks to be a good asset but with the trade war and fears over a possible slowing down of China's economy, there is a risk that Weibo's advertising revenues go down. Sina doesn't appear to have as much value besides Weibo since their media assets have been compared more to Yahoo. I don't think Yahoo is that bad but regardless, the valuation here is so cheap. Weibo has about 300M users and is profitable. Sina is profitable as well but I didn't figure out yet how much of that is due to Weibo or if they are profitable as a standalone company. I will continue to research but not buy yet as I don't feel like I know enough about the company since I just started researching today.
July 23, 2019 - Alcon is a great business that provides eye care services. The business came to my attention because they were just spun off and I use their contacts lens solution called Opti Free. Warren Buffett had a quote about Juicy Fruit gum where he mentioned the power of the brand name by alloting to the notion that the mouth is a very sensitive place and you're just not going to pick up another piece of gum from a company you're not familiar with and put it in your mouth.
This quote reminds me of Alcon because the eye to me is a lot more sensitive of a place than the mouth and I'm going to be very cautious of what I put there. Alcon has some other business segments as well besides just contacts solution like equipment used for lasik surgery and contacts lenses. Now although I use the contacts lense solution from Alcon, I don't use the contacts. I use the contacts from Johnson and Johnson instead so that is notable for competition and moat purposes. The price is around $60 per share as I write this and I looked at the stock price a couple weeks ago and it was around the same price then also. I think it's a little overpriced at the moment. I like it at low 50's but I will revisit it in the mid 50's to possibly think about initiating a position.
From Alcon's form 20F:
1.2B operating income
29.2B market cap (7/23/19 close of market)
+ 500M cash
- 3.5B debt
32.2B ÷ 1.2B = 26.83 EV/EBIT Multiple
Operating income before depreciation last year and the year before was $1.3B while being mismanaged under Novartis. Core operating margin as per prospectus was 17% in 2018, 16% in 2017, and 17% in 2016. Revenues averaged at $7b so assuming a 20% operating margin that would be $1.4B. At $1.4B operating income and a 20x EV/EBIT multiple that is an EV of $28B or market value of $25B or $51.22 a share. With $1.2B operating income (more conservative estimate) and a 20x EV/EBIT multiple and $3B net debt that is a $21B market cap or $43 a share. In summary, don't buy yet. Wait for hopefully low $50's to initiate a position or maybe mid $50's depending on how it is trading.
July 16, 2019 - Wells Fargo dropped to the mid 45's today so I initiated my position this afternoon. Wells beat on both eps and revenue so I was surprised it went down so much (3%) today although Wells did open higher at .7% pre-trading. It seems the market was more concerned about Wells' net interest income declining which beget concerns over the low interest environment we are in. Net interest margin fell due to higher deposit costs. Management also said that expenses will be in the high end for 2019 which is usually the case after a scandal. Chipotle had higher expenses after their ebola scandal also in order to clean up the issue then the stock price eventually recovered. Despite headwinds of higher expenses, lower interest rates, inverted yield curve signaling recession, scandal, and no CEO, I will continue to monitor Wells to add to my position at lower prices and average my cost basis down.
July 15, 2019 - Why I think Wells Fargo is a good risk/reward investment now. Wells Fargo has been one of the best managed banks for the last 100 years but it recently had an issue where they were incentivizing employees to open up new accounts for customers without their consent. These fraudulent accounts were discovered partly by customers who noticed new credit or debit cards for their accounts that they were unfamiliar with and by customers who noticed account fees that they didn't understand what they were for. Following the scandal, the CEO was removed and was replaced by a new CEO that later departed in early 2019. They are still looking for a replacement CEO since I believe March 2019.
This looks like a solvable problem to me. I believe they did the correct first step in replacing management and changing the bad incentives which caused employees to open up fraudulent accounts. Their deposits have also been pretty stable despite the scandal because of their switching-cost moat. It's not so easy to change banks. Following this scandal, the stock is down about 30% from its high. It is capitalized very well and was just approved by the Fed to return $23.1B in capital to shareholders through a share buyback and increase the dividend following the Feds annual compliance review and analysis. This gives investors a 10% return of capital via share buyback ($23b buyback/$200b market cap) and a 4.3% dividend yield (new divided is .51 a quarter). Average net income over the last 5 years of $21B to $23B gives Wells a P/E ratio of 9 to 10 (undervalued) but important to keep in mind that there is no growth since the Fed capped the amount of assets they can have. They can't increase current asset base (take in deposits) until they get approval.
What got me looking closer at Wells Fargo was an idea written by John Huber from Saber Capital on Sum Zero. I agreed with his research and thoughts, so I have been watching this stock since he wrote the report on July 6th. It's undervalued now but I've been cheap. It's been mostly trading between $47.00 and the low $48's until today. Luckily for me it traded down into the high 46's today. WFC reports earnings tomorrow. Is the market saying today that it doesn't expect Wells to report good earnings tomorrow? Am I violating a principle that Jessie Livermore in Reminisces of a Stock Operator talked about: "Don't quiver over 1/5's, 1/4's, 1/2's of a point." Despite this concern of being cheap, I'm still going to wait for a wider margin of safety and hope this company gets into the 45's before I initiate my position. There has been a floor at $44 and if it breaks through that floor I will look to add more between $40 and $43.
July 10, 2019 - Why I think Baidu shares will appreciate: Wide-moat (Intangible assets & network effect) with 73% market share in search. A search engine is a high-demand service to be supplied to a country in the digital world that we all live in. (In other words, Baidu services a purpose) “Google of China” and Google has been one of, if not the most successful company in the U.S so it’s the idea of finding what works in one of the best developed markets (U.S.) and applying it to one of the best developing markets (China). Robin Li is owner-operator with large ownership % (16% of shares) so aligns his interest well with me as a shareholder. After deducting iQIYI, Ctrip, and net cash position, I am getting core search at a great price (probably 10-20x net profit) and then getting AI (Apollo, DuerOS) and cloud for free. China has only a 57% internet penetration ratio so has more room to grow which should mean more eyeballs for desktop/mobile advertising dollars. P/E, P/S, P/FCF ratios are all trading at bottoms so puts the risk/reward in my favor. Opportunity is available because the market is way too short-term focused on Baidu’s Q1 results of investing for the future and the cyclical nature of the advertising market due to a slowing down of China’s economy which brought down operating and net earnings. Sell side mostly agrees it is short-term and not long term.
What can go wrong that comes to mind: Politics of China, VIE in Cayman Islands, competition (BABA, Tencent), Debt Bubble in China bursts making China’s recession comparable to Japan in late 80’s, and/or poor management where too much capital is burned on high growth investments and marketing.