In Pen&Paper, I only write about companies I am personally invested in, and on topics, I find it relevant to write on. My focus is on businesses that I expect will be around in ten years. And I pay more attention to principal loss than to earn a few basis points above an index [...]
Buying Teva is the classic contrarian position. There are fears because of management turnover. There is anxiety over declining sales. Mr. Market is selling Teva at $10 a share because of the pending lawsuits while I am buying the stock. Paradoxically, both of us feel we got a bargain! [...]
Even with a well-constructed environment and a robust set of investment rules, we are still going to mess up. The brain is simply not designed to work with meticulous logic thorough all of the possible outcomes of our investment decisions. [...]
Risk relates to what we can measure. And we measure risk with probability and relative frequencies. Uncertainty, however, refers to unknown situations. And Mr. Market refuses to deal with uncertainty.[...]
To properly value REIT stocks, punching numbers in a calculator is not enough. There are intangible variables, such as management's experience and corporate culture, which are at least as important as the variables that we can count [...]
Robo advisor is a software that calculates your risk and return profile. It shows you the right mix between stocks and bonds. It is an algorithm that attempts to answer how much you need to save today to live in retirement comfortably[...]
With themes such as business, philosophy, biographies, history, fiction, nutrition, fitness and self-help, these are the books I read in 2019[...]
Life in equity research is about asking questions. It is about wondering what exactly did Fiserv (FISV on Nasdaq) do over the past ten years that drove the stock price tenfold. It is thinking about how, after 105 years, General Electric lost its place in the Dow Jones Industrial Average.[...]
The best-performing stocks this year were Carriage Services, Stericycle, Weight Watchers, and Hyster-Yale. CSV is up 55% from when I bought it; SRCL is up 51%; WW is up 33%; and HY is up 41%; together, their contributed third quarters of this year's return.[...]
Graphtech trades at a $3.5 billion valuation. Yet the company's earnings by 2022 should be at least that number. So we find a company with net profit margin of 40% trading at a multiple of one.[...]
When bored, I enjoy spreading the EV/EBITDA ratio of portfolio companies owned by asset managers I admire. For example, I looked at the 31 companies Third Street Avenue Capital Management owned as of the second quarter of this year and saw that most companies EV/EBITDA was in the double digits[...]
This article explains the lure of the zero-fee structure and some of the potential pitfalls. I conclude the essay with a practical review of how fees affect returns.[...]
The flagship product is the Value Line Investment Survey, which comes in both print form and digital form. The print version arrives weekly[...]
What causes obesity has valuable lessons for students of the financial markets. The first lesson is that investing requires a lattice work of mental models[...]
The 2018 free cash flow was $15.1 million or $0.57 per share; the 2017 free cash flow was $18.9 million or $0.73 per share. So if the last two years serve as proxy, Town Sports' cash flow will pay back investors their original investment in less than four years [...]
I doubt anyone understands where Gulfport operations will be in five years. Three factors drive the business. And all are practically impossible to predict or to fully understand [...]
The gas and oil industry is not for the faint of heart. The sector halved in price this year. But I speculate that oil price will rise and oil companies market price will follow[...]
Mednax faces three problems. First, the U.S. Government is now tracking medical costs and forcing hospitals to disclose prices. Hospitals, which are Mednax customers, are becoming price-conscious buyers, which will hurt future earnings [...]
My favorite tables shows an investment after 20, 40 and 60 years of operations assuming 7%, 12% and 18% rates of return. How can we not marvel that a 12% rate of return will multiply the original investment by 10 times in 20 years?[...]
While Nautilus' management talks about consolidation, efficiency and transition, Peloton's management reports to shareholders, using Silicon Valley nomenclature such as network effect, economies of scale and disruption[...]
Corporate America cannot stand still. Executive management reports to shareholders on growth expectations and on future strategy. Middle management reports to executive management on upcoming changes to processes and to efficiency measures. And each employee, as anyone who has worked in an office knows, is permanently busy.[...]
The reason for the drop in market value is due to Orchid Paper's Bankruptcy. This is a position with which I started with 4,000 shares in July 2018 and then bought 6,000 more shares in October 2018. While I did not sell my Orchid position, I "wrote down" to zero the Orchid shares in my portfolio. Frontier Communications was the second reason for the market loss.[...]
This week I sold 10,000 shares of Diversified Restaurant Holdings (SAUC on NASDAQ) at $0.73 per share. As I type these words, two days after my first stock sell in 2019, SAUC climbed back to $1.03, so not only did I lose money since my original cost basis was $1.40 per share, but also I lost $2,500 by trading on Tuesday instead of Thursday.
I estimated that management would restore the operating margins. The average pre-tax income to revenue ratio was over 10% between April 2004 and April 2012. It steadily declined over the following 7 years. The most recent ratio reported was a minuscule 4%. In addition, the pre-tax income on tangible assets over the past decade was greater than 10%, a reasonable ratio for a company in the distribution business.
Students of financial history will remember that prior to 1982, stock repurchases were illegal. Buyback activity, which is expected to be greater than $800 billion in 2019, was considered a stock market manipulation [...]
A year ago I bragged that buying Frontier Communication did not require much effort. “All one had to do was to compare the past year’s stock price, which was in the triple digits, to the 2018 stock price of $5,” I wrote. A year passed and the stock price more than halved - which issues a few lessons. In this essay I describe these lessons and explain why I am still holding the stock nonetheless.
Over the past decade, the market price dropped for all commodities sold by Gulfport. The oil price per barrel dropped to $49 from $68, natural gas price is down to $0.53 from $0.96, and gas price declined to $2.47 from $6.90 [...]
Since the May 2017 announcement, the market discounted the price of the stock by over 75%. Prior to the acquisition, the company traded as low as $20 and as high as $30. A year after the announcement, the stock traded as low as $15 and as high as $22. It now trades at less than $6 per share.
In Jewish philosophy it is said that where penitents stand, even the wholly righteous cannot stand. I bring this sentence of wisdom as a means of an excuse [...]
I am often asked where I find stock ideas. In this week's essay, I describe the four places I visit most often and provide a few examples.
Ever since Warren Buffett disclosed an ownership stake above 10% in Delta Airlines, Wall Street is mad on airline stocks. Since his announcement, the NYSE Arca airline index, an index that tracks the performance of airline companies, is up by 2.74%.
The radio business model is simple: payments from advertising companies generate revenue for the radio stations. And revenue is the number of ads multiplied by the price per ad. That price in return is the number of location stations, the supply and demand and the size of the market [...]
After adjusting for non-cash expenses, I expect Frontier to report on a billion dollars of after-tax cash flow. The company’s average quarterly revenue was $2.1 billion in 2018, the average quarterly expense for interest was $400 million and the average capital expenditures were $320 million. If we remove non-cash charges, such as depreciation ($480 million each quarter) and goodwill expense ($400 million in the third quarter), we get a quarterly after-tax cash flow of $250 million.
There are different ways to read and to understand stories. Lately I’ve received emails from readers that, it seems to me, read my essays so that they can earn a quick buck. Even worse, they think that the blog’s purpose is money-drive focused on the near term. Yet nothing could be further from the truth. To me, buying stocks to gain money in the short term is an awful investing approach [...]
Described as "the first advertising hedge fund" by Adweek link, MDC buys established marketing companies and lets the original owners decide how to best run their business. MDC defines itself as "a partner company, not a parent company."
Page 3 of Sequoia Fund's annual report to shareholders demonstrates the power of compound interest. Let us imagine that it is now July 15, 1970, you are 25 years of age and you invest $10,000 in the Sequoia. Fast forward to today and your initial $10,000 investment would have been worth $4.3 million [...]
Half of the voting rights are owned by Ms. Oprah Winfrey and the Artal Group. Winfrey needs no further introduction. But the Artal Group does[...]
It is not by accident that I wrote about my paper loss and hardly mentioned the stocks with a paper gain. The reason for the disproportionate attention is that there is nothing to be learned when a stock is purchased less than year ago and is now randomly trading at a higher price. To hold such positions does not take any mental energy.
ETF investing began almost thirty years ago with the goal of reducing active management fees. When I heard John Bogle speak at conference last year, I learned that he was surprised by the immense success of passive investing. He was also worried, mentioning that ETFs serve nowadays as a means to speculate, which is the exact opposite of his initial intention.
At $44 per share, Stericycle is offered at a much lower price today compared to the past three years. In 2018, SRCL traded between $75 and $45. In 2017, it traded between $88 and $61. And in 2016, the stock traded in the triple digits, between $152 and $111 per share.
Three things are attractive about the waste management business. First, it is a growing industry with a growing need for companies to responsibly handle waste while meeting regulatory requirements. Second, in an economic down cycle, which we are likely to see in the coming years, the demand for recyclables will continue [...]
While a faux pas to buy shares in a company whose industry tailwinds are working against, I decided to buy 1,000 shares of Carriage at a total price of $16,000. My investment thesis is simply: the price is cheap [...]
At a first glance, the funeral business has all the right qualities. Competition from new entrants to the industry is relatively low as recent MBA grads hardly set their career path in the morgue business. The funeral and cemetery business is not the type of profession that would make your mom proud.
To a class of graduate students at Boston College, Mohnish Pabrai facetiously said that the Great Spirit of the Universe had spoken to him. And the Great Spirit confessed to him that the Ten Commandments, originally handed off to Moses, were slightly off. And for the next two hours, Mohnish presented to the class of MBAs the Ten Commandants that were given to him.
Voxx International, a small capitalization stock with a market capitalization of $108 million is controlled by its founder, the 86-year old Mr. John Shalam. Voxx sells audio accessories across the globe and holds an umbrella of 30 brands that it has acquired over the past decade [...]
This is the time of year in which most media websites review and share with their readers their most popular articles. If I was to use the same definition of popularity as the New Yorker - time spent on the article - the list below would be completely different. Instead, I highlighted the articles that I often looked at in 2018 as I found them either useful or simply enjoyable to read.
It will not take you long to learn that Mr. Market is angry with UNFI because of its Animal Spirits. "This transaction accelerates UNFI's growth strategy by immediately enhancing our product range,equipping us to bring an attractive, comprehensive product portfolio to an expanded universe of customers," said Steve Spinner, UNFI's boss."The combination of UNFI and SUPERVALUE provides a substantial premium and delivers certainty of value to our stockholders, meaningful benefits to our customers and expanded opportunities to our employees.
To calculate the adjusted funds from operations, we use the funds from operations less capital expenditures and less any gains on sale. We then adjust for straight-lining of rent and any one-time loss or gain. We then add back amortization related to stock compensation and other deferred costs.
"Learning is the oldest excuse in the book for a failure of execution," wrote Eric Ries in The Lean Startup. "It's what managers fall back on when they fail to achieve the results promised...Entrepreneurs, under pressure to succeed, are wildly creative when it comes to demonstrating what they learned. They can tell a good story when the job, career, or reputation depends on it." Yet as the stock market drops to its lowest level in 2018, what else are we to do as investors but reflect on what we learned this year?
Stock research is less glamorous than you think. Most of us do not get to travel around the world, meeting senior management and inquiring about the business and industry they are in. Most of the phone calls we receive are from sell side analysts, where you can almost hear their employer in the background, inquiring whether or not they are making the sale. The truth is that in investment research, you spend most of the time sitting in a room alone.
The Golden Rule in financial planning is 60/40. That is, if you have $10,000 in savings, your financial adviser would say that $6,000 should be held in stocks and the remaining $4,000 should be used for bond buying. The rationale is that stocks are volatile and risky but offer a higher return than bond investing. Yet bonds are safe and sound and do not fluctuate in value as much.
Three years ago I earned the right to use the CFA charter designation. And while 36 months is probably an insufficient time to write an autobiography about - and frankly, I am pretty sure that none of you would want to read it - it does allow me to reflect on the past. And this is the purpose of this talk. To share with you what I learned: the one thing I'm quite proud of; the one mistake that could have easily been prevented; and the one regret that I hope to correct going forward.
The Voting Machine finds reasons for value in other places than the reported financial statements. The Voting Machine decides, based on growth expectations, whether a company is winning a popularity contest by Wall Street analysts. And there are other psychological factors such as investors who are now buying ARC simply because they believe and hope that other investors will buy ARC from them at a higher price.
My purpose in this meditation is to draw a connection between how an investor conducts his life and the portfolio of stocks in which he chooses to invest in. I believe there is a direct relationship between our choices, actions and behavior. So next time when you visit your financial adviser, watch his book shelf first.
Core Molding Technologies Inc., which trades on the New York stock exchange, appeared to be a bargain. Management had increased the number of outstanding shares by one percent compounded over the past decade. In 2008 there were 6.8 million common shares outstanding and today there are 7.7 million common shares outstanding. The average 10-year earnings per share were 93 cents, meaning that the stock traded at roughly 9 times the decade-only average earnings per share. The book value per share increased by three-fold during this time. And Benjamin Grahamglossary would be proud of my discovery, I thought.
I argue that one of the best methods to understand a stock is by starting the analysis in the Risk Factors section of the 10-K report. This section of the annual report describes much more than risks - it provides a snapshot of the company, its industry and common stock. In short, the section details that keep management up at night.
You know something is strange when a profitable business reports a deficit in equity. Take L Brands, Inc. (LB on the big board), the American fashion retailer. Between 2008 and 2017, the company profited a total of $9.3 billion. Its yearly profits ranged from as low as $220 million (in 2008) to as high as $1.2 billion (in 2015).
Buying Orchid was a mistake. When I bought the stock, I knew thatthe culprit for the rising cost of debt was not management taking on additionaldebt, but the variable payment nature of the debt itself. And in a rising interest environment, to purchase a stock whose debt is indexed to interestrates was foolish of me. The second mistake was that I was not compensating enough forOrchid's customer concentration. Three customers composed 68% of the 2017sales. And when management informed shareholders that a major customer hasdecided to no longer work with the company, Mr. Market was infuriated.
A question: If the beginning equity balance was $494 million and the company earned $382 million in a period of five years, should the ending equity balance be higher or lower than the beginning balance of $494 million?
When certain stocks are in high demand, Charles Schwab borrows shares from customers and lends them to other clients. On Monday of this week, the brokerage firm wrote to me a request: they would like to borrow the shares I bought in Orchid Paper Company. What really got my attention was the rate of interest Schwab offered: an annual interest rate of 52.5%.
Dear management of Tupperware, I could not believe that your ticker symbol appeared on the list of stocks that traded at a 52-week low. It is known by many investors that Tupperware is a company that is selling a $20 product that costs $2 to make. That Tupperware generates plenty of cash flow; that is had built a remarkable method to sell its products through home Tupperware parties, and that the company needed to invest very little capital expenditure to maintain its operations.
But risk should be defined as a level of uncertainty. And the more uncertain you are about what you invest in, the more risk that you take. For example, it is risky to marry someone that you know little about. And so to successfully achieve a reasonable return in the stock market, you should be aware of what you do not know.
While capital markets focused on the decline in revenue and reported loss, I focused my attention on finding what is the normalized free cash flow. Defined as cash flow from operations less the cost of debt, less fixed capital expenditures, I noticed that 2017 free cash flow was not materially different compared to that of prior years. In 2017, for example, management reported a loss in free cash flow of $1.3 million, and in 2013, it had reported an even steeper loss in free cash flow of $2.5 million.
Without the appropriate experience and education, no one would dare perform brain surgery. Yet for stock purchases, all that one needs are a few extra dollars and a brokerage account. It is so easy to buy stocks nowadays that it is often forgotten that stock investing requires much more than clicking on a few buttons. In this meditation, I will describe the many hats the investor must wear and some of the tasks required.
General Electric's recent annual report left readers scratching their head,. The company operates in nine, materially different segments, and the comments on each segment may have confused the reader, if the reader is expected to understand the risk facing the oil industry and the healthcare industry. To analyze the financial statement of a company with one operating segment is a challenging task; it is exponentially harder in the case of GE
In this meditation, I compare free cash flow to other financial metrics. For such a useful metric, it is strange that free cash flow continues to be a seldom used financial term. Earnings before interest, tax, depreciation and amortization (EBITDA) are tools that allow management to boast on theoretical, imaginative financial results. It is similar to a marathon runner explaining that he or she finished a marathon in less than four hours, if only they had not taken a 25-minute rest in the second hour. EBITDA, by definition, is also always higher than free cash flow and results in a higher valuation for the company and a greater ability to take on debt. It should be of little surprise that it was popular in the ‘80s - the era of leveraged buyouts.
In The Conquest of Happiness, before Bertrand Russell discusses happiness, he explains - in nine chapters - what makes us unhappy. Using the same structure of thought in this meditation, I write about stock ideas best to be avoided and followed by a few examples of what I think are better methods to find stock ideas.
Animal Spirits may be a reason why an investor would prefer to franchise a Buffalo Wild Wings restaurant as opposed to simply purchasing the stock of Diversified Holding Restaurants, Inc (SAUC). Below is an argument for the former option using a simple, cost-benefit analysis between the two alternatives.
The market value of my portfolio is $40,906 compared to my cost basis of $39,018. This represents an appreciation of 4.83% on my cost basis and a difference of 6.13% compared to the S&P 500. I will remind new readers that to track the S&P 500 index, I bought one share of VOO, an exchange traded fund by Vanguard. I paid $253 for the ETF in the last week of 2017, and as of the second quarter of this year, it is worth $249. Including the $1.51 of dividend I received, the S&P 500 index declined by 1.50%.
When Wall Street analysts hear the word “uncertainty" a punishment to the stock price soon follows. Since that August 2017 earnings call, the stock price has been declining each month and now trades at a 12-month low of $37. It traded for $65 prior to that call.
The purpose of the liquidation value strategy is to find stocks. Yet sometimes, the real value behind this strategy is telling us which stocks to avoid.
Stock investors often define themselves as either value-oriented or growth-oriented, where in the former definition, the investor focuses on accounting fundamentals, and in the latter, the investor focuses on the product and whether it will become popular in time. But I think the two definitions are not mutually exclusive but complementary - a great investor looks at both the numbers and the product behind them.
I opened my brokerage account at Charles Schwab because commission from trading is a small percentage of the company's annual revenue. It means that the company focuses on other sources of income rather than getting customers to trade excessively. To me, that is a positive quality from a broker.
Another unusual story I came across this week relates to the stock of Orchids Paper Products Company (TIS). Headquartered in Pryor, Oklahoma, the company is in the business of converting bulk tissue paper into paper towels, bathroom tissue and paper napkins. Over two thirds of its product is sold to just three retailers: Dollar General, Walmart and Family Dollar. Orchids Paper is a U.S.-based company with 2017 sales of $162 million, of which it generated $6.67 million in profits, with an unheroic profit margin of less than 5%.
To find the return on invested capital, I take the free cash flow and divide it by the average stockholder equity balance. For simplicity’s sake, free cash flow is the cash flow from operations less capital expenditures, and the average stockholder equity is the sum of the beginning and year-end balances divided by two.
Two guiding principles should lead your stock investing decisions. First, you will make mistakes that will result in the loss of money. Second, accounting and business models constantly change. So, you will need to adapt and develop new mental models. In a recent interview, Warren Buffett discussed how people's views of Coke and Ketchup are changing and how it affects their business valuation.
The management of Patterson Companies (NASDAQ:PDCO) had to address a tough quarter: "The results we report today clearly do not meet our expectations," said Mr. Mark Walchirk, boss of PDCO. "They fall short of what we know the business is capable of achieving." Here are a few disappointing facts:
"At Berkshire what counts most are increase in our normalized per-share earning power. That metric is what Charlie Munger, my long-time partner, and I focus on - and we hope that you do, too." Commentary: it is so easy to get side tracked by vanity metrics such growth in EBITDA, increase in sales or a one-time gains. But those often do not translate to earnings over the long term.
In this article, I detail my activities in the stock market over the past three months. I explain why I bought and sold common stocks and how my stock portfolio performed in comparison to the performance of the S&P 500 index.
You don't need to be a capital market expert to see the ominous outlook for shopping mall REITs. All you need to do is look at the stock price history of a few companies operating in the sector. In 2017, Simon Property Group (SPG) traded as high as $188 and as low as $150. It now trades at $154. Realty Income (O) traded between $64 and $53 during the same period; it now trades at $52. GGP Incorporated (GGP) traded between $26 and $19, and now trades at $20. And Seritage Growth Properties (SRG), a real estate company in which I invested last week, traded in 2017 between $50 and $38. It now trades at $35.
Don’t you look at the neighborhood in which you plan to purchase a home? You also probably look for answers to questions, such as: what was the average price for homes in that neighborhood over the past year? Or, how long did it take to sell a home? Or, how many homes are for sale right now? Or, what is the typical size of a home? And, is there a plan to develop a large amount of homes in the near future? Outside of the neighborhood, you probably speak with lenders and inquire about mortgage terms [...]
It is a misconception to think that each stock purchase involves an elaborate, detailed analysis. If you would have asked me how to analyze a company immediately after my business school days, my answer would be: "First, you HAVE to understand the balance sheet and income statement. Then you NEED to make sure that the cash flow statements reconcile to the balance sheet. After that, you MUST prepare a SWOT analysis, KNOW the competition, LISTEN to analyst calls with management and then READ everything Wall Street has to say." [...]
While it is intuitive that there should be a relationship between the economy and stock values, I think it is less clear whether it is a direct or an inverse relationship. Does a growing economy increase stock values? Or is it the other way around?
Is ARC trading at less than 10 times the adjusted earnings per share? To arrive at the adjusted earnings per share, I changed the reported figures. I added back the depreciation expense and goodwill impairment expense to net income. From that number, I deducted the annual capital expenditure to arrive at what I estimated were normal earnings for the company [...]
This week, quite bored from hearing about the new CEO of Chipotle, I doodled a list of companies, using their 2017 return on equity ratio as a ranking criteria. The return on equity of two companies stood out [...]
Today, there is an "obvious" relationship between risk and reward. But the focus should be on the relationship between effort and return. That is, the more effort you put into analyzing companies and understanding their financial statements, the more likely you will be able to understand the truth behind reported earnings [...]
Curious where finance theory will be in the 21st century? Adaptive Markets by Andrew Lo is an insightful read about one of the options. According its author, researchers will gain insight from evolutionary biology, neuroscience and genomics, and will likely construct a new model of a stock investor [...]
Anything within a mile radius of a shopping mall is now considered toxic on Wall Street. Toys 'R' Us, an American toy retailer, plans to close over 180 stores this year (a quarter of its stores) after it filed bankruptcy on September of last year [...]
A hundred years ago, an unknown and austere looking Austrian medical professor set up a private practice where he could closely observe and study the human condition. From that humble beginning, the field of psychoanalysis was born and terms Freud invented, such as "ego" and "subconscious," are now widely used [...]
Ask the person next to you at an investment conference for his or her thoughts about companies that own many operating divisions (conglomerates in business jargon) and you will get a love-it-or-hate-it type of answer. Those who love conglomerates will most likely point you in the direction of the synergy and the cost cutting benefits [...]
Confident about the U.S economy future, I bought the Vanguard 500 Index Fund Investor Shares (VFINX) mutual fund to prove it. There are added benefits too. For example, the Oracle from Omaha suggested VFINX an adequate place to park savings [...]
The day I became an Amazon Prime member was the last day I visited a shopping mall. No more waiting in line to be assisted by a disgruntled teenager; no more mindlessly spending my hard earned cash at the Apple Store; no more having to remember where I parked the car. While the problems related to physical shopping disappeared, digital problems crept up [...]
The image above consists of two pictures. The picture on the left shows the spirit of a home owner who decided to share his fortune with others by allowing surfers to rinse off. But the picture on the right shows a different approach to life. In the picture you see a private path, accessible only to members of that gigantic household. And while the two home owners are only a few blocks from one another, they are a world apart.The two images well represent the world of business. There are those who operate secretly, solely for their benefit. And there are others that take great joy in sharing their knowledge and experience. I like to think that I am on the latter camp.
So that’s how I found Caesarstone this week. Caesarstone (CSTE) profited an average of $1.90 over the past five years. During that time, its stock traded at an earnings multiple between 20 to 43 times the earnings with an average earnings multiple of 22 times. With Caesarstone at a price of about $22 it is trading at 12 times the earnings multiple. So I became interested in knowing more about the company. My first two questions were: how much leverage does the company have and why is the company trading at a 52-week low. II learned that the company hardly uses debt. As of the third quarter of 2017, the company could pay all its debt obligations with its cash in the bank. Its operating earnings represented over 10 times the interest expense. As a comparison, our average household income to debt in the U.S. is less than 2.5 times the interest expense. The company’s stock traded at a 52-week low because (1) operating gross margins are down, (2) legal fees are up, and (3) unsurprisingly, perhaps, earnings per share are down to $0.92 as of the third quarter, compared to $1.70 last year.
To rediscover investing principles, I plan to read again Benjamin Graham’s book. His principles endured from the lure of investing in conglomerate companies in the 80s to investing in tech stocks in the late 90s. The same principles, written in the late-40’s, apply to us almost 70 years later. Besides, the principles are pragmatic. I bought shares in Famous Dave and Terra Nitrogen, only because I was looking for companies that Graham would find agreeable to invest in.
When Bertrand Russell wrote about how to find happiness, he first commented on what makes us unhappy. In The Conquest of Happiness, he provided us with a checklist of habits to avoid before he addressed what may make us happy. In that spirit, in this article, I will focus on what to avoid when purchasing stocks. First, paying over the fairly valued price of a stock. If a stock is fairly valued - that is, the value you get equals the cost of the stock -then the stock trades at the average earnings multiple and average earnings per share over the past decade. Let’s look at the following three examples: Campbell Soup Company (CPB), Kellogg Company (K) and Williams-Sonoma (WSM). For Campbell, the 10-year average earnings per share was $2.26 and the average multiple over that period ranged from 21 to 16 times the earnings. The fairly valued range is between $47 and $36. Because Campbell trades at about $48 per share, it followed the definition of a fairly valued stock.
It is time to reflect on stock purchases. Over the past six months, I bought a total of 6,000 shares in 16 very different companies, at a total cost of $24,756. If we add their profits, the companies earned a total $1,012 and had a book value of $20,561. On the portfolio level, I paid a hefty price of about 20 times the past earnings and a more reasonable price to book value of 1.2 times. I invested in these companies for three reasons. First, companies such as Bon Ton Department Stores and Famous Dave traded at a valuation below their competitors. I expect that their values will align with the competition in the future.
A week ago I attended the annual CFA Charterholder ceremony in San Diego, California. I was asked to say a few words to new charterholders and wanted to share with you the experience. As you will soon read, my talk’s two main themes were that (1) the CFA Institute provides a roadmap of the “right things to do” as investment professionals, and (2) that passing the CFA program should be viewed as an opportunity, not an award.
There is little glamour in the business of fertilizing soil. The product, whether it be ammonia or nitrate solutions, is a commodity. There are many competitors, both inside and outside of America, that demonstrate a similar industrial capacity. Buyers are known to be thrifty and bargain-hunters and over the past decade the industry has seen a higher level of scrutiny and red tape by governmental agencies. In short, if you are in the business of selling soil nutrients, you are most likely not bragging about it over a cocktail party. But that doesn't mean it is an unimportant industry in the present nor an unprofitable enterprise in the future.
Until recently, capital markets placed much higher value on the movie experience in AMC Theatres (AMC) compared to the movie experience in Regal Cinemas or Edwards Theaters (two of the three brands owned by Regal Entertainment Group (RGC)). At year-end 2016, one dollar of earnings for AMC was valued at an earnings multiple of 31 times. Compare that to the earnings multiple of 19 times for RGC. Yet the hefty valuation is no longer with us, as AMC’s stock price had declined to $13 from $35 this and RGC stock price declined to $15 from $21. This dramatic change in valuation peaked my interest recently and I wondered: what made AMC so valuable compared to RGC in the first place?
While most companies, even at a 52-week low, are fairly valued, Vitamin Shoppe (VSI) is an exception. Let us define “fairly valued” as a common stock that trades within the range of the average 10-year earnings per share and the average earnings multiple range. For example, if the 10-year average earnings per share was $1 and the earnings multiple was between 10 to 15 times, then the fairly valued range would be $15 to $10. With that in mind, I sampled a few stocks that traded at a 52-week low. Only Vitamin Shoppe traded below the “fairly valued” range.
A few weeks ago I purchased common shares in Rait Financial Trust (RAS). I had looked at the 10-year free cash flow and figured that with an average $1.44 of free cash flow per share, alongside an average stock price of about $6 over the past five years, I didn’t need to read any public filings since the $2 price tag stock price would eventually correct itself. The only effort I exercised was a quick Google search where I learned that the company was founded in 1997. From that, I rashly deduced that management must be capable since it survived the Great Crash of 2007. I happily called my broker and ordered 500 shares at-what-I-thought-to-be-a no-brainer-price of $2.
Fool.com suggested that I buy the following five stocks this week: Apple (AAPL), Canadian National Railway (CNI), Corning (GLW), Stamps.com(STMP), and Vail Resorts (MTN). Their investment reports explained that now would be a good time to purchase shares in the companies because of their expected future growth in sales or their stellar historical earnings trend. Yet the reports left me baffled, as no attention was paid to whether price paid for a share was justified relative to the value given in return. I think that purchase price as an investment criteria lost popularity. And if we live in an investing world where purchase price is no longer relevant, your financial advisor may argue that paying attention to peak price today is nonsense since in the future, the peak price will be higher.
In theology, if you acted sinfully, you got punished. In the world of business, if management loses shareholders' money, then management is punished by a devaluation of the company by the marketplace. So, it is unsurprising that the common share of Famous Dave (NASDAQ:DAVE), a barbecue restaurant chain, has plummeted recently. The company had earned over $110 million in revenue for nine consecutive years - between 2007 and 2015. And in 2016, sales dropped to about $99 million, a record low. As you can imagine, the drop in sales did not go unnoticed. The drop in sales was about 10%. How much should the stock decline be? 10%? 30%? 50%? If markets are logical and efficient, then stock prices should relate to expected earnings. So, we should be able to see a somewhat close relationship between a decline in sales and operating margins and a decline in stock price. In practice, that rarely occurs. So, I thought of an arbitrary rule of thumb.
Investors typically have different definitions of cheap stocks. One investor may look at the price quoted in the marketplace and argue that a stock that trades at a dollar per share is cheaper than a stock that trades at ten dollars per share. Another investor may define a cheap stock as one that has fallen below its 52-week price range. There are many more definitions. But in this post, I will attempt to define a cheap stock as a stock that trades: (1) at an earnings multiple that is lower compared to its earnings multiple over the past decade, (2) at a substantially lower earnings multiple compared to its peer companies, and (3) at a purchase price below its net tangible asset per share.
Tardiness in filing financial statements is often seen as a red flag. Implicitly, capital markets tend to suspect that late filing is more than a timing issue, and rather, is some dark, flawed accounting practice, or some questionable managerial capability. Explicitly, late-filing almost never looks good for the price of the common share. This week, I visited datasimply.com, a website that among other things reports on such companies. Out of a list of 32 companies, I took a random sample of 5 with varying lines of business, and compared their current price to the share price a day before the late notice was given. All companies lost value.
Should there be a relationship between the value of a company and its dividend distribution policy? A practical illustration may guide our thinking. Say you purchased an apartment building early in the year and profited $100,000. The market value of your apartment building is independent whether you chose to take the $100,000 from your checking account or not (and the IRS will take its share of your taxable income regardless of your decision). Similarly, how management allocates profit should be of little importance to the overall value of the company.
Let us estimate $0.60 of dividends per share over the next three years and a share price of $13.80 in 2019. And with a discount rate of 10%, Capstead Mortgage (NYSE:CMO) is trading at 90% its estimated present value. Not bad for a mortgage REIT that invests in securities backed by the full faith and credit of the U.S. government.
Office REITs are trading at a dear valuation. Over 90% of the office companies that compose the NAREIT index are trading at higher multiples than book value. And to purchase a position in an office REIT, at the current average multiple of 15 times the funds from operations, would leave thin room for error and should serve as a reminder of the past. Since the '80s, the only time REITs traded at a multiple higher than 15 times was in 2006-2007. The exorbitant market price is not due to a stellar performance. In total, office REITs' average return on equity was 10% in the past two years. Risk is looming. First, oversupply is apparent in major metropolitan markets. In Washington, DC, there is twice the development activity and available office space than demand, reports JLL, a real estate brokerage firm. Second, future monetary pressures (read: inflation) may increase the interest rate environment, squeezing profits. Third, competition from shared-office companies, such as WeWork and Mindspace, continues to challenge the traditional business model.