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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.

July 24, 2021 - I've read a lot about Snowflake lately and here are the big ideas I've gathered so far:

Their platform can be used on any of the 3 big cloud vendors (AWS, GCP and Azure) which customers like because they don’t want to be locked into just 1 cloud provider.

Almost all (maybe all??) of Snowflake’s cost of goods sold goes to the 3 big cloud vendors with AWS getting the highest portion of the 3.

Snowflake’s data network allows customers to sell their own data to other Snowflake customers on the snowflake data network.

Retention ratio was 160% last year which means that not only are customers renewing but they are also spending more money.

The platform is very simple to use and customers love it.

The CEO has lots of success after bringing 2 other companies public that he was the CEO of.

Customers are charged based on the compute or data they use which tailors the costs a lot better to the customers’ needs and makes it a lot less costly for them.

So far, all signs point to this being an exceptional company but what about an exceptional stock?

Of course valuation needs to come into play when talking about whether or not Snowflake makes for an exceptional stock and at the prices the stock is currently trading for in the market today, well that is what has been holding me back from buying.

Revenue:     2019         2020        2021        TTM
                   $96.7M   $264.7M   $592M    $712.1M

TTM Price/Revenue Multiple: 111x (waaaay too high)

Optimistic Revenue Scenarios (assuming revenue doubles each year):

                    2022 est.     2023 est.   2024 est.     2025 est.

Revenue      $1.18B        $2.36B       $4.73B         $9.47B

Multiple*          67x              33x             16x               8x
 

*Based on 7/23/21 market cap

Based on 2025 estimated revenue and today’s market cap, the price starts to look a lot better but there is already too much optimism priced in.

 

Especially since the CFO, Mike Scarpelli, has a revenue target of $10B in Snowflake’s 2021 Investor Day Presentation (6/11/2021) not until fiscal year 2029.

With this being said, it’s too hard for me to buy at these prices today but I would be enticed at $150 a share as the upper range where a TTM revenue multiple would still be pretty high at 63x but future revenue multiples based on the trend of revenue doubling each year would be more reasonable at 38x in 2022, 19x in 2023 and 10x in 2024.

*****

June 23, 2021 - Patrick O’Shaughnessy does a great podcast where he brings on a guest that breaks down a business for his listeners to better understand.


One of Patrick’s episodes featured Ro Nagpal who did an amazing job of explaining Twilio’s business and how it’s used by all of its users.


Below is a quote from the interview that briefly describes in simple terms what Twilio does and the difficulty it would take for another company to compete with Twilio. 


“Twilio is software that enables companies to communicate with their customers through SMS, through voice, through video or chat. Some examples of your everyday life, if you get a text that your ride is here from Lyft, that's Twilio. [If you push the call my driver button on Lyft, that's Twilio.] If you get a text from United that your flight is late, that's Twilio. Texts reminding you about your doctor's appointment, that's Twilio….


Prior to Twilio, if you wanted to do this, you would need to go out and hire 10 engineers with a decade of telecom experience that were all super expensive and you'd need to have them sit in your building and spend 12 months making all the connections to Verizon and AT&T to enable you to do this. And what Twilio did is they took that really complicated, old problem that had a lot of people and turned it into a few lines of code. So a developer can go, download Twilio software, implement the code and be up and running, which is the power of what they've created.”


Twilio is a company that is on my watchlist, but the company isn’t much of a secret since the valuation is so high.


TTM P/E: Negative
FORW P/E: Negative
TTM P/R: 31x

Even if revenue doubled from the last 12 months, the TTM price-to-revenue multiple would still be pretty high at a little bit over 15x. 


With that being said, I’ll be a little bit more patient on this company and would prefer buying at 5-10x revenue which is possible if over the next year or two their revenue doubles and the stock price gets cut in half or if revenue doubles over the next 2 years and the share price gets cut by 35%. 


That would put a target price closer to the range of $192.50-$250 a share. 

Source: https://joincolossus.com/episodes/50437644/nagpal-twilio-messaging-margins-and-markets?tab=transcript

*****

April 11, 2021 - I just came across a very interesting company called Evolution Gaming to keep my eye on.

This company is owned by Chris Mayer of Woodblock House Family Capital and he says he believes it has the possibility to be a 100 bagger.

I took a quick look at the company and the first two things that stood out for me are the company’s incredibly high returns on capital and it's very high operating margins.

2020 operating margin: 53.5%
2020 returns on capital: 21.5%

Having very high operating margins aren’t a necessity to be a 100 bagger (although it certainly doesn’t hurt) but high returns on capital are a necessity.

A matter of fact, high returns on capital and the ability to reinvest new capital at high rates of return on capital are the biggest necessities to become a 100 bagger.

And Evolution Games certainly does look like it qualifies so it makes sense to me why Chris Mayer thinks Evolution Games could be a 100 bagger.

Although not a big necessity, valuation still does matter and I will get to that in a little bit but first let's look at returns on capital.

Here are Evolution Gaming's returns on capital for the last 5 years from quickfs.net:

2016    2017    2018    2019    2020

 89%    113%   107%   145%   21%

As you can see, they’re very high. But does it make sense that they're very high?

Yes, it does and here's why.

Evolution Gaming is a software company and software companies usually have higher returns on capital because after you spend the money and the time to develop the software, you can distribute the software for a very low cost to a very wide user base.

And Evolution Gaming is the largest software maker for online live casinos. They create the software for live casino games for poker, online slots, roulette, blackjack and other games.

They also own Ezugi which is another big online live casino.

So Evolution earns high returns on capital but can the capital be generated at these high rates in the future?

Well it's likely that a competitor will try and challenge their market share since returns are so high but Evolution Gaming looks like they already have relationships with many of the casinos already and it could be hard to break this relationship.

Plus Evolution Gaming just opened up a studio in NJ two years ago and a studio in Pennsylvania last year because gambling is starting to be legalized more widely in the US so this creates an additional opportunity for Evolution Gaming to invest more capital at high rates of return.

And as state budgets suffer from deficits that only got worse from the coronavirus it could be possible that more states legalize online gambling as well. And as more online casinos open up, it is very likely they will continue to use Evolution Gaming’s software.

I'm not going to rush out and buy this company though because the market has already caught on to this company.

It trades at around 44x price-to-revenue and 100x earnings. The stock price went from a high of around $43.50 per share in Feb 2020 to $158 today.

So I think this company checks a lot of boxes as a great company to own, but I think the valuation is too high for me right now although I think it’s important to keep in mind that I will eventually have to pay a premium to own this company because of how good its economics look so I can’t be too cheap when determining which price to buy it at.

*****

February 13, 2021 - 2020 was a very memorable year for all companies including Fairfax Financial.

 

At the end of March 2020 they were looking at a loss in their investment portfolio of $1.5 billion but finished 2020 with a gain of $300 million in their investment portfolio meaning that the investment portfolio gained $1.8 billion from the end of March 2020 to December 31, 2020 - a truly historic rise as acknowledged by Fairfax management and all other investors who witnessed probably the quickest recovery on record for markets following what was probably the quickest drawdown on record. 

I just finished reading the 2020 earnings call and I want to write down some of Prem Watsa's remarks from the call.

"As mentioned in our 2019 annual report, we will never short stock indices or individual companies again."

"As I've said previously, long-term value investing has gone through a very difficult time for many years now. Valuations of value-oriented stocks versus growth stocks, particularly technology have never been so extreme, exceeding even the extremes of the dot com era in 2000. As the economy normalizes we expect a reversion to the mean and value oriented stocks coming to the fall. After the Pfizer vaccine was announced in early November 2020, we started to see this taking place.

Two examples very quickly will make it clear here for you. Fairfax India was selling at $6.80 per share at the end of the third quarter while its book value was more than $16 per share. Today it’s up to $12.40 per share. We think it's only a matter of time [before] Fairfax India exceeds its 2020 high and does exceptionally well as the Indian economy recovers from COVID-19. The Indian government came up with an exceptionally user-friendly budget recently.

Atlas Corp. was another one that I mentioned to you run by David Sokol and Bing Chen closed 2019 at $14 per share, went down to $6.30 per share in March, today it’s at $12.70 per share. Atlas is financially very strong, has great management, and we think it's only a matter of time before it exceeds its previous high. We expect a significant return on our stock portfolio as the economy continues to normalize."

And here is a remark from Fairfax's CFO, Jen Allen, about their covid losses:

"As noted in 2020, we reported COVID-19 losses of $669 million which were comprised primarily of business interruption exposure, approximately 35% primarily from our international businesses, and event cancellation coverage of approximately 34%. The COVID-19 losses principally comprised of incurred but not reported that represented 51% of the net losses, and the net losses were primarily recorded at Brit $270 million, Odyssey Group $140 million and Allied World at $113 million."

So covid losses seem to be a lot lower than what was originally expected back in March 2020 and April 2020 but covid isn't over yet and there is still a lot of litigation that needs to take place.

*****

January 29, 2021 - Bloomberg is already asking the question of whether or not the 2020s will "roar" like the Roaring 1920's with their most recent Bloomberg Businessweek cover. 

I think that really says something about these current times based on the monetary and fiscal policy approach that the government took since March 2020 in response to the coronavirus pandemic.

It makes me wonder about Ray Dalio's quote from an old Bridgewater letter he wrote to his investors on how we continue to extrapolate the recent past so we almost always think the last decade will be the same as the next, but it never is.

Here is a summary from that old letter he wrote:

 

"1920s = "roaring" - slow growth early building to a boom later, low inflation, extreme inventiveness, stock market boom.

1930s = "depression" - basically the opposite of the 1920's, bad for stocks and good for government bonds.

1940s = "war/post war" - the economy and markets were classically war dominated.

1950s = "stability" - good stock and bond markets.

1960s = "economic acceleration" - greater optimism and prosperity; good for stocks.

1970s = "stagflation" - good for inflation hedge assets and bad for stocks and bonds.

1980s = "disinflation" - bad for inflation hedge assets and good for stocks and bonds.

1990s = "roaring" - slow growth early leading to a boom later, low inflation, extreme inventiveness, stock market boom."

But his letter didn't include the 2000s and 2010s because it was written before those decades played out so below would be my own summary of those 2 decades: 

2000s = dotcom bubble and great recession - very poor for stocks

2010s = deleveraging, money printing, low interest rates, low inflation - great for stocks and bonds

2020s = ???


I find it very hard to believe that the 2020s will be like the 2010s - filled with low interest rates and low inflation, which would be 2 great ingredients for a "Roaring 20s" -  but more with higher interest rates and higher inflation.

*****

January 29, 2021 - I ask myself why I missed GameStop as such a low risk/high reward opportunity because it was in plain sight for me.

I knew the company as I've bought many video games there when I was younger.

I saw that they did have lots of cash on their balance sheet that exceeded their financial debt which didn’t include leases on their retail stores though.

I saw that Michael Burry, who has a great track record as a value investor, was buying the company for his fund and it had lots of signal value because it was one of his larger positions.

What I didn’t though see was the short interest and how this could be such an important catalyst.

This tweet does a great job of giving the backstory going back over a year of what led up to the epic short squeeze in GameStop:


https://twitter.com/endtwist/status/1354547622133051393?s=19

And this tweet does a great job of figuring out the problem of why Robinhood limited trading for its clients:

https://twitter.com/KralcTrebor/status/1354952686165225478?s=19

The reasoning for what made GameStop such a high reward/low risk bet was the high probability of a short squeeze possibly happening.

I don’t remember when exactly the short interest exceeded 100% but my guess was it's been pretty high for a while. Probably at least 50% meanwhile I consider 20% short interest high.

And as a learning exercise I do remember very well why I didn't buy the stock (a silly decision of course with hindsight being 20/20):

1. GameStop did have a lot of cash on hand but they also had leases on their stores which make up a large portion of their business. I don’t recall if they were capitalized on the balance sheet at the time when I was looking at it but leases do complicate the balance sheet if they aren’t capitalized since leases do very much act as debt - there is a consistent cash payment over a term, with a maturity date and depending on the quality of the borrower, the leases can require some form of collateral.

2. The company was and still is most likely a melting ice cube where their business will slowly fade toward bankruptcy. They did just recently make a strategic decision to hire some directors from chewy.com to help their online business but if video games are sold directly on the console to consumers and can be downloaded very quickly by cutting out the middleman, and if GameStop can’t adapt to this which I don’t think they will, then they will be toast.

3. I was looking at this company during coronavirus when much of the economy was shutdown making it difficult for their stores to remain open. I do recall them making "contactless" adjustments in spite of the mandated lockdowns and I viewed this as more of them being closer to their end as they were defying the shutdown mandates.

4. Lastly, I didn’t view this as a capital compounder but a value investment at best similar to Warren Buffett’s cigar butt investments. I thought GameStop could maybe survive part of one more business cycle before the full transition to direct video game sales over the internet but that in the end leads to .50 going to $1 instead of capital compounders which goes from $1.30 to $5 or more.

In the end, this is a great case study in how markets can become irrational and inefficient at times. The stock didn't really do anything for at least a year but when Ryan Cohen from Chewy.com joined GameStop's board that was the huge catalyst that the longs needed.

Perhaps, the short squeeze will force Wall St. to have to deleverage from their more high quality names thus resulting in lower prices for better companies.... or maybe this is just my wishful thinking.

But as I write these thoughts down, it makes me think more and more about how unpredictable the world is and how poor we humans are at predicting it. Therefore, putting yourself in the right position, not just in the markets but in real life as well, to give yourself big opportunity and less risk can go a long way.

*****

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