Value Investing

How to prioritize financial goals

Published on:
May 10, 2020
Reading Time: 4 Minutes.
Last Update:

The rocks, pebbles, and sand story asks us to reflect on what's essential in life. In the story, rocks represent our lives' core values such as relationships and moral standards. The sand represents distractions what Cal Newport describes as shallow work. Shallow work is the new show on Netflix or the mindless wandering in shopping malls. 

If you had a jar, the fable continues, and you fill it first with sand, you won't have room for the rocks. But if you prioritize by first putting the rocks in the jar, then you will have no difficulty in pouring sand afterwards. 


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Financials life has priorities, too. While most of the content on Pen&Paper, at least as of May 2020, is about business analysis, where we look at a company's fundamentals and strive to understand whether to buy into its business model, stock investing is not a priority for most of us. 

What is a priority is to set financial goals and to plan a roadmap on how to achieve them. And the first step is getting rid of any credit card debt, funding an emergency fund, and paying off short term liabilities such as auto and school loans. 

Credit cards

First, get rid of credit card debt. It's tough to get ahead in life when you owe someone a 20% interest rate. Hardly any skilled investor, including those reputable investors that watch businesses every day of the week, compound their capital at that rate of return. 

There is a common rebuttal to the pay-off-your-credit-card debt argument, which is that having credit card debt builds your credit score. While payment history is important, it serves less than 1/3 of the total credit score. Also, there are no benefits to having several credits cards compared to just having one card [1].

In short, the proper way to use credit is to build a payment history. But (1) limit the liability to one credit company, and (2)  pay off the outstanding debt every single month. 

Emergency fund

The second priority is to set up an emergency fund. The purpose of the emergency fund is to allow you to keep your lifestyle as life happens[2].

Typically, your financial advisor will recommend that you set aside three to six months of reserves. If your household has one provider, then six months of reserves are recommended; if there is dual incomes in your home, then, perhaps, three months of reserves suffice. 

The Certified Financial Planner (CFP) board writes:

Saving is the process of putting cash aside in safe, liquid accounts, such as the emergency fund…Only after these reserves are established can you address secondary considerations for the balance of your clients have in savings - namely, keeping pace with inflation by investing.

Whether you set aside three or six months of reserves depends on how quickly you will be able to recover from the life event. It won't take long for a dentist to find employment. But it will take a long for a real estate broker to find work in a downturn. So the amount of reserves is subjective.  

 The emergency funds should be in cash or cash equivalents [3]. I  recommend that you exclude the emergency fund from your net worth. The funds are not to be used for vacation or any home upgrades. 

Pay off auto and school loans

After you paid off the credit card companies and set aside an emergency fund, your third priority is to pay off any short- to mid-term liabilities [4]. These liabilities include auto loans and education loans. 

While mortgage payments are tax-deductible, the interest payment on the school and auto loans is not deductible. There is no benefit of holding these loans - not from a tax perspective and not from a life perspective. 

From my experience, especially when markets rise, it is difficult to pay off current liabilities instead of placing the money in the stock market. I often hear that investors feel that, in effect, they have a low-interest loan where they can earn a higher return in the stock market. But when they need the money, they risk that markets could freeze. 

Save to meet  long term goals 

Equity markets, whether you buy individual stock or ETFs, serve to fund a portion of our long term goals. Those goals include retirement and income planning or buying a home. And then also, individual goals such as gifts to children. 

Again, returning to the CFP board, in their words:

Investing involves using money, or capital, to purchase an asset that offers the probability of generating an acceptable rate of return over time, providing the potential for earnings while assuming more volatility. True investments are backed by a margin of safety, often in the form of assets or owner earnings.


Businesses compete for our time, money, and attention. And it is up to set to prioritize our goals to offset these pressures. To meet our goals, we have to set a road map. And to establish a road map, we have to consider tradeoffs: how one decision compares to the other[5].

Think about that next time you see rocks on the beach.

FOOTNOTES: [1] My credit score is over 780, and I never had more than one credit card. [2] Life events include layoffs, divorce, and significant unplanned events. [3] Cash-equivalents are money market accounts or certificate of deposits. [4] Liabilities that are due within ten years. [5] Yes, a newer car would make the commute more pleasurable. But if you wish to own a home and decide on a 5-year plan how to save for the down payment, owning a new car won't get you there.

A day in the life of a value investor

Published on:
May 2, 2020
Reading time: 3 Minutes.
Last Update:

"There is a difference between solitude and loneliness," explains Mihaly Csikszentmihalyi in Flow. While both experiences result is the same, solitude is a desired state of mind while loneliness is not. In his words: 

"How one copes with solitude makes all the difference. If being alone is seen as a chance to accomplish goals that cannot be reached in the company of others, then instead of feeling lonely, a person will enjoy solitude and might be able to learn new skills in the process." 

He continues: 

"On the other hand, if solitude is seen as a condition to be avoided at all costs instead of as a challenge, the person will panic and resort to distractions that cannot lead to higher levels of complexity." 

This wordy prelude to the difference between solitude and loneliness is my way of introducing a day in my work life. The typical day consists of many hours where I sit, read, and think. And this is done from the quiet of my home office.

A day in the life of a value investor 

As a value investor, I spend most of the time reading. Usually, at 7:00 am, I sift through general business journals such as The Economist, Financial Times, and The Wall Street Journal.  I also subscribe to Barrons, Fortune, and Forbes magazine to keep up with financial news. And about once a week, I'll read about industry-specific publications such as American Banker

After reading a bit of financial news, I move to read reports by individual businesses from their public filings[1]. I find that when annual reports are written for investors, and not to please regulators, they reveal a great deal about an industry, business strategy, and competitive landscape [2].

When annual reports are written for investors, and not to please regulators, they reveal a great deal. 

Next on my reading list are books. My reading list is not structured. The reading list includes anything from autobiographies of CEOs, to marketing and business lessons. While in the early years, I only read books about business and finance, I moved to psychology, philosophy, and history.

General reading, unrelated to business or investing, I believe, makes a difference. I am not sure how to define that difference, but I know that reading about history and human psychology has many benefits and application to capital markets. Reading a broad range of topics also affects my wellbeing. Reading a wide range of topics gives a sense of perspective, reduces the urge to act, and promotes a kinder self.


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I also like to spend an hour or two a day on my portfolio holdings. I own 19 stocks in different industries (from computer hardware chip manufacturer as Micron to the graphite electrode manufacturer Graftech to pharmaceutical companies such as Teva.) So I try to learn something new every day about their business or their industry. 

So, about 4 to 5 hours of my day are used for reading. The remaining hours are for independent thinking[3]. While financial press compresses information and business insights into sound bytes, it takes a long time to understand a business truly.

For example, I heard a reputable investor this week describe his lengthy conversation with Indian regulators. He was attempting to decipher how will regulators behave if (or, rather, when) Indian rating agencies will falter. In short, it takes a long time to understand a business. 

 But it takes even longer time to understand the value of a business. Consider Coke-Cola, for example. The big picture is obvious: here's a company selling a product that consumers are buying. 

But why did Coca Cola survive where others have failed? How come competitors were unsuccessful in copying their business? The answer to these questions, perhaps, a topic for the future essay, requires deep thinking. To answer, we have to delve into branding, distribution, and biology [4].  


"A happy life must be to a great extent a quiet life, for it is only in an atmosphere of quiet that true joy can live," writes Bertrand Russell in The Conquest of Happiness

Because the typical lifestyle of a value investor is so different than that of a day trader, I thought it would be worthwhile to write about briefly. 

To write about a day in the life of a value investor was inspired by a Youtube video I saw last week. Titled A Day in the Life of Day Trader, the Youtuber mentioned the word "markets" 13 times. She explained her trading methods when the markets open. When markets are volatile. When markets close. And how she scans markets for opportunities.  

In a recent CNBC interview, Warren Buffett was asked how Todd Combs will manage a $13 billion portfolio, run Geico, oversee Haven, be on the board of JPMorgan[5]. "Portfolio management is not something you do every day," he explains. "Portfolio management is something you learn over decades." 

FOOTNOTES: [1] Such as 8-k, 10-k, 10-q, and proxy filings. [2] My goal is to read annual reports of the top five businesses in every industry. [3] Charlie Munger once said: "We both insist on a lot of time being available almost every day just to sit and think." [4] You can drink an endless amount of Coke. But you can only drink a glass or two of milk. [5] The interview is two hours long. Skip to 65:45 to see this section. 

Three questions to ask in uncertain times

Published on:
April 11, 2020
Reading time: 3 Minutes.
Last Update:

There is no better time to reflect on portfolio holdings than today [1]. This week's essay is about the three questions you should ask as you spring clean.

The first question is whether the business will survive for the next few years. The second question is whether the company generates free cash flow. And how essential is the business is the third question. To illustrate the concepts, I will use examples from my portfolio. 

The 3- to 5-year survivability 

It is going to be challenging to refinance debt and to raise equity. And any business that relies on capital markets to fund its on-going business operations is going to face a large number of rejections. 

A friend of mine, a founder of a start-up company, told me she is now spending the bulk of her time in understanding  (1) how long can her business run until cash reserves are depleted, and (2) what can she do today to better prepare for that day. 

The same mindset is applicable to portfolio holdings. If you own a company that has a sizeable maturing debt over the next year or two, you should reflect on how likely will it be able to refinance the mortgage, at what terms, and how it will affect operations.

Here is a summary of what I learned about some of the stocks I bought in 2019: 

Graftech reports $1,812 million in long term debt. And on page 80 of the 2019 annual report, you can read that the debt facility will mature on February 12, 2025. In other words, Graftech has five years of breathing room. 

Teva Pharmaceutical reports on $24,562 million of long term debt. The company will have to pay down $5,263 million, an average of $1,023 million each year until 2025. But I don't foresee that an issue as the company has $1,975 million in cash on hand and $5,676 million in receivables.

Micron reports on long term debt of $4,541 million and holds $7,152 million in cash and $3,195 in receivables. And on page 58 of the 2019 annual report, we read that most of Micron's debt is due after 2025. 

Visit my essays on Graftech and Teva Pharmaceutical

Two companies that will face challenging times ahead are Seritage Growth and Gulfport Energy. Seritage Growth Properties reports on $1,598 million in fixed debt with Berkshire Hathaway Life Insurance as the lender. The loan matures July 31, 2023. Gulfport energy reports on $1,978 million in long term debt. Where $329 million in due 2023 and $603 million is due in 2024, and $529 million is due in 2025.

In the case of Gulport, current cash and receivables will not cover the pending debt obligations. So either Gulfport will sell assets (it reports on $10,595 million of oil and natural gas properties), or somehow it will manage to refinance the debt miraculously. 

Visit my essays on Seritage Growth and Gulfport Energy

Free cash flow 

Investors usually accept negative free cash flow when the business promises growth. But future growth always comes with a present cost: either the right side of the balance sheet increases or current shareholders will be diluted. 

Consider Ormat Tech (Ora on Nyse) as an example. The Israeli-based, geothermal company reported negative cash flows between 2015 and 2019 [2]. So, the company issued more debt and diluted shareholders. (Long term debt in 2015 was $856 million and increased to $1,035 in 2019. Common shares were 49 million in 2015 and went up to 51 million in 2019.) 

Yet positive, free cash flow is one of the most useful antidotes to keep a healthy balance sheet. Positive cash flow allows management to remain independent of capital market woes and fury and to grow the business without niceties to lenders. 

There are two ways to find free cash flow. The CFA Institute defines free cash flow [3] as net income plus non-cash charges plus interest minus capital expenditures minus working capital expenditures 

FCFF = NI + NCC + Int(1-T) -FCinv - WCinv  

Another approach is to use cash flows from operations. To find the free cash flow, you take the cash flow from operations, add back interest less capital expenditures. 

FCFF = CFO + Int(1-T) -FCinv

Consider Whirpool as an example. On page 37 of its 2019 annual report to shareholders, management reports on $1,230 in cash provided by operating activities less $532 in capital expenditures. It reports on $912 million in free cash flow

If management does not report on free cash flow, it is because there isn't any.  

Is the business essential? 

If you can't reasonably estimate today where the business will be in ten years, you shouldn't invest in it. The 10-year outlook is important because of two reasons, a pragmatic one and a psychological one. 

The pragmatic reason is that if you can't estimate the business outlook, you can't estimate the earnings. And if you can't estimate the earnings, how could you determine the value of the business? 

The second reason is psychological. When capital markets freeze, when investors are selling, and the quoted price of your stocks drops, understanding the future of the business will allow you to better weather the storm. A few examples will explain this statement. 

I bought Carriage Services in January 2019 for about $20. The stock went up to $28 by year-end 2019 and now trades at $15, a 46% drop from the peak, and a 25% discount from my cost basis. But instead of selling the position, I remind myself that the business outlook for Carriage, who is a funeral home company, is invariably the same. Just because markets are discounting the business does not mean the business fundamentals deteriorated. 

Another example is Teva Pharmaceutical. Two months ago, I explained Teva's tailwinds: 

"Other trends in global healthcare include an aging population, chronic diseases, and growing pressures from governments to provide affordable healthcare solutions." 

I don't believe the tailwinds changed. 

But I have made mistakes by overlooking the 10-year outlook criteria. For example, I bought Weight Watchers in March of last year. I didn't have the slightest idea then, and I don't know how the business will look like in a decade from today. This business falls in the "too complicated" bucket. 

Visit my essays on Carriage Services, Teva Pharmaceutical, Weight Watchers, and L Brands

Another mistake I made was buying L Brands in late 2018. In hindsight, there is no way to predict our clothing preferences in a decade (let alone next season.) Not only is it difficult to correctly predict what color will be fashionable next season. 

FOOTNOTES: [1] As we are ordered to stay home. [2] the 3-year average earnings per share were $2.23, and the 3-year average capital expenditures per share were $4.26. [3] Taken from understanding cash flow statements, chapter 25 level 1.

On the mindset of a discoverer

Published on:
March 7, 2020
Reading time: 3 Minutes.
Last Update:

In The Cherry Orchard, Anton Chekov writes that "if there's any illness for which people offer many remedies, you may be sure that a particular illness is incurable." In this essay, I apply Chekov's principle to business research.

My point is that there are many ways to approach financial analysis. Yet, no single approach is perfect and that for investors, the right mindset is more important than any other particular technique.

The balance sheet

Investors should have a clear understanding of what the business they are buying is worth. Because only when investors understand what the company is worth can they decide whether or not the current price of the stock is over- or under-priced. I offer three approaches to evaluate the value of a business.

First, begin with the balance sheet where assets are reported at cost or market value. And the assets are classified as either short-term assets [1] or long-term assets.

But it is your job to determine what the assets are worth. For example, real estate assets are classified as long-term assets. But in a reasonable economy, any office or apartment building can be quickly sold, at market price, in less than three- to five months. 

The income statement

The second approach to determine value is by looking at the earnings. Value is closely associated with how much cash flow the business generates. If company A generates a million dollars in net earnings while company B makes half-million dollars in net profits, the former will be more valuable than the latter.

To determine future earnings, you must have (1) a general understanding of the industry dynamics[2], (2) in-depth knowledge of the business margins and business model, and (3) an understanding of the business capital structure and how it may affect operations.


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The intangibles

It is also essential to look at the intangibles of the business, the third part of business valuation. Intangibles include management turnover and board compensation structure, business culture, and human capital, the brand of the company, and its position in the market place [3].

So these are the business intangibles. But there are internal intangibles as well. Internal intangibles are about you, the investor.  You must find the business you invest in to be interesting. It would help if you were passionate about knowing more about the industry. And that you are excited to follow the business in upcoming years.

Stock research is more art than math.

I, for example, made a mistake last year when I bought Frontier Communications. Lured by a what-I-thought-to-be-a-bargain price, I soon learned that now I was a proud owner of a business about which I had no interest in understanding.  In short, stock research is about art, not math. 

Top-down versus bottom-up research

There are two approaches to research businesses. In top-down analysis, investors pick a specific industry and filter out business candidates using criteria such as price to earnings or leverage ratios. For example, the gas and oil industry is distressed. The Down Jones U.S. Oil & Gas Index was 807 five years ago, and today is 463, a drop of almost 11% annually.

But the depressed industry may provide a few opportunities. Continuing with the gas and oil example, I recently looked at Gulfport Energy and Noble Corporation.

In bottom-up research, the second approach to find ideas, investors begin their journey by analyzing an individual business and comparing its valuation metrics and operating metrics to peers. Writing for Nerdwallet, Diana Yochim advises to research stocks by narrowing the focus on specific metrics, such as revenue, earnings, and return on equity.  

In both the top-down approach and the bottom-up approach, investors attempt to understand the business and industry. The main difference between the methods is the road that leads to a specific stock.


The famed historian, David McCullough, laments of his editor's most common question: What will be the theme of his next book? Yet McCullough explains that when he approaches a topic, whether the story of the Wright Brothers or the life of John Adams, he lets the story unravel itself. 

In other words, McCullough takes the mindset of a discoverer. That, too, should be the mindset of investors. When you analyze a company, you should not focus on the potential profit or how smart you may appear to your peers, uncovering a hidden jam. You should not have an agenda at all. Instead, akin to McCullough, more important than anything else, is that you have the mindset of an explorer. 

FOOTNOTES: [1] That can be liquidated in less than one year. [2] For example, are low-cost providers stealing market share?

Why I buy individual businesses

Published on:
February 14, 2020
Reading time: 4 Minutes.
Last Update:

Readers ask me why I buy individual companies, and not passively invest using exchange-traded fund or a mutual fund that tracks a market index.

First - and this is a personal preference, not a universal rule - I am curious about how businesses work. And buying stocks forces a thoughtful understanding on a company. And writing instills - and tests - my conviction.

(If I can't write about the investment idea, then it's not an idea, but a guess.) 

And sharing this story with a broad audience provides (1) a digital record of the original analysis, and (2) provides me with a greater sense of purpose.

I also believe, and historically it has been the case for me, that over a 3- to 5- year period, buying a select group of businesses [1], will have a greater impact on my financial net worth than any passive investing strategy.

And at this point in my life, it simply does not interest me to earn a 3% to 6% compounded annual return. When I buy individual companies, which are often contrarian investments, my goal is a 15% to 25% compounded rate of return over a five year period [2]. It is an aggressive goal, and I take risks to achieve it.

I skipped class in business school when the professor talked about the benefits of diversification.

I have a very concentrated portfolio of stocks. ( I skipped class in business school when the professor talked about the benefits of diversification.) And over 90% of my net worth is vested in six to seven companies.

Because I am the only research analyst, portfolio manager, chief investment officer, and sole benefactor for that matter, I can't focus on more than a few companies at a single point in time. I also never buy stock on margin, nor do I short stocks.

I want to remind readers that I am not a registered investment advisor. I don't manage other people's money, nor do I give specific advice. I will not comment on your specific situation or the suitability of an individual investment for you. For paid-subscribers, I am happy to explain any of the investing topics on Pen&Paper. But you need to form your own decisions.


The problem with subscription-based services

You don't need me to get exposure to equity markets. You can buy an exchange-traded fund that tracks the S&P 500 index [1]. And if you find passive investing to be boring, there are plenty of subscriber-based investment services.

For example, The Motley Fool offers annual stock-picking subscriptions for as low as $200, and Value Line Investment Survey charges investors about $600 and covers about 1,700 stocks (yours truly subscribes to both services.)

But there two problems with these kinds of stock-picking services. The first issue is that you hardly improve your business understanding because their analysis is too shallow.

The second issue is that these services will always find ways to buy investments. Consider the Motley Fool as an example. The subscription-based service offers us recommendations on options trading, dividend stocks, growth stocks, technology stocks, cannabis stocks, Buffett-inspired stocks, international stocks, and you get the point. So long as there is an interest in the marketplace, there are stocks to recommend. But in investing, sometimes, it's best to sit on the sidelines.

In investing, sometimes, it's best to sit on the sidelines.

And I can't get over the fact that these subscribers follow the advice of  managers that have no skin in the game. It is one thing to recommend the purchase of a stock. But as the legendary value investor Walter Scholls once said, you never really know a stock until you own it.

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 if there are no businesses to buy at reasonable prices, I hold cash (right now, about 25% of the portfolio is in cash.) And I focus my attention on mitigating principal loss versus earning a few extra basis points above an index.

The companies I buy are often unpopular in investing circles. (Trust me that none of my colleagues showed any interest when I bought Carriage Services or Stericycle last year.) The companies I buy are either too small in their market capitalization (see my investment in Town Sports or Nautilus). Or are too uncertain for Wall Street (see GrafTech or Teva.)  

I only write about companies I am personally invested in, and on topics, I find it relevant to write on.

And I am shameless about writing about my failures. Readers often tell me they learn more when I talk about mistakes - what I missed or did wrong. And, while I hope never to supply such material, you can read about my omissions of thought at Orchid Paper's right side of the balance sheet, as an illustration.  

Write to me if you have any questions.

When it is best to avoid buying the stocks

If you need the money in your investable account to operate your life over the next three- to five years, you will be making a mistake buying the common publicly traded stocks [3].

By "need the money," I mean you plan to purchase a home. Or you plan Or plan to pay for your children's education. Or you plan to retire and are relying on the funds.

In The Art of Speculation, legendary value investor Philip Carret tells of "dates which every schoolboy should know by heart". Specifically, he refers to 1814, 1837, 1857, 1873, 1884, 1893, 1907, 1921, and 1929.  

Equities markets swing. Keep in mind that between 1973 and 1974, the market dropped by 43%. Between 1999 and 2002 the market dropped by 35%. And between 2008 and 2009, the market dropped a whopping 65%.

Also, if you can't stomach to see the market price of your companies fluctuate by more than third, you should never buy individual stock.

Consider WW International. The stock traded at $30 a share when I bought it in February 2019. A week later, the price dropped to $20 and didn't climb back before September of that year. Towards the end of 2019, WW International traded as high as $45 a share. And the stock dropped to $36 as I type these words in February 2020. Note that none of these price movements reflected material changes the business, but speculative market movements.  

If you have unrealistic return expectations, you will be disappointed. Understand that a 10% compounded annually is an adequate rate of return; an above-average 15% return is excellent; and an incredible return is 25%.

Capitalism is a system that requires us to adapt to a new business landscape quickly. So you need to be a curious person to own shares in publicly traded stocks and to embraces changes.  

In The Five Myths About Stock Investing, I write that "investing is not looking at the price movements of stocks". If you need daily assurance, whether your investment decision is right or wrong - buying stocks will leave you with many sleepless nights. Caveat emptor!

FOOTNOTES: [1]Through the ownership of their common stock. [2] For example, the Vanguard IX FUN/S&P 500 ETF. [3] The stock price has to double every 3 to five years to get that kind of return. [4] Regardless of what your financial advisor says.

The case for an investment checklist

Published on:
February 2, 2020
Reading Time: 8 Minutes.
Last Update:

Investment checklist is a set of questions you go over before making an investing decision. The checklist lessens the emotional aspect of investing by forcing you to think before you act. It results in a better decision making process.

Strangely, academia doesn't talk about the value of checklists. It is also strange that in investment circles, hardly anyone mentions the checklist. Google the term' investment checklist,' and you will only find vague, general, abstract thoughts.

I never heard of the investment checklist while in business school. I even studied for the Chartered Financial Analyst (CFA) designation for five years, and not once did I come across the phrase.

So this essay attempts to correct this missing information. My goal is that you will understand why the investment checklist is essential and that you will have a list of over 50 checklist items to use in your research.

As I wrote in The Hats The Investor Must Wear, knowing which stocks to avoid is the first step in investment research. And checklists help to achieve that first step.

How checklists became popular

In Chapter 11 of The Education of Value Investor, Guy Spier writes:

"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. The complexity of the business world, combined with our irrationality in the face of money-related issues, guarantees that we'll make plenty of dumb mistakes...there is one other investment tool that is invaluable that it merits a chapter it is own: a checklist."

Spier mentions that it was Mohnsih Pabrai that explained to him how valuable was the checklist. And that revelation came to Pabrai after reading Atul Gawande's description of how pilots use checklists. He writes:

"…they came up with an ingeniously simple approach: they created a pilot's checklist, with step-by-step checks for takeoff, flight, landing, and taxiing. Its mere existence indicated how far aeronautics had advanced. In the early years of flight, getting an aircraft into the air might have been nerve-racking, but it was hardly complex. Using a checklist for takeoff would no more have occurred to a pilot than to a driver backing a car out of the garage."

Pabrai [1] followed the technique. And by the second edition of The Checklist Manifesto, Gawande mentioned how Pabrai was using checklists in investment decisions.

An example of a checklist

I keep a checklist in a CODA document [2]. My checklist evolves around items such as balance sheet, income statement, risks, management, product, capital allocation, credit, product, competitive landscape, investment thesis, valuation, and corporate governance.

For example, on liabilities, the following checklist items appear:

-What are the major debt covenants, and is the company meeting those minimum debt requirements?
-What is the company's management experience with capital markets?   
-Is the company placing debt at market terms, or are they forced to raise debt at unfavorable conditions?
-Is there balloon payment over the next five years?
-Does the company have the ability to issue debt, if needed?
-What assets will be used as collateral?
-Is the debt payment floating- or fixed-payments?  
-Has the company's credit ratios improved?
-Does cash flow from operations service the debt payments?
-What is the fair value of the debt?
-What is the peer group's leverage ratios?
-What are the liquidity and capital resources over the years five years?
-What are the debt rating agencies saying?

The uses and drawbacks of investment checklists

"If you want to improve the quality of the decision," said Daniel Kahneman in an interview to Farnam Street, "Use algorithms, whenever you can. If you can replace judgments by rules and algorithms, they'll do better. Indeed, when we write an investment checklist, we reduce the emotional aspect of investing.

Another benefit to the investment checklist is it serves as a starting point.  You don't need to invent the wheel each time you research a stock, just follow the lessons of the past. (More on that in the section below.)

The checklist also grounds you. Many times in the past, I felt a high conviction about a company. And just as I was about to buy the stock, I went over the checklist, only to realize that either (1) I missed out on crucial points, or (2) the position didn't meet the criteria I had set for myself.

But there are two drawbacks to the investment checklist, too. First, the checklist gives a false sense of security. As if buying a stock is akin to boarding a plane; that all we need is a checklist, and we will safely reach our destination.

But the truth is that there are risks that we cannot prepare for. Investing is placing a bet on human psychology just as it is on the fundamentals of the business. And we can't predict human behavior, let alone all the factors that will influence the price of a stock.

Investing is placing a bet on human psychology.

This reminds me of how the Oracle from Omaha was baffled by David Sokol's irrational behavior. In the 2011 Berkshire annual meeting, Buffett said that Sokol had given away to a junior partner four times the amount Sokol purchased Lubrizol. In Buffett's words:  

"I witnessed Dave voluntarily, transfer over 12.5 million dollars - getting no fanfare, no credit whatsoever to his junior partner...what makes it extraordinary is that $3 million, you know, ten or so years later, would have led the kind of troubles that it's led to."

Sokol's forerunning Lubrizol was unpredictable and made no sense. Munger summed it best:

"I think it's generally a mistake to assume that rationality is going to be perfect, even in very able people."

The second drawback to the checklist is that the more you rely on it, the less likely you are to follow your conviction. It is almost like the paradox in game theory that shows that no matter how fast the wolf is, it will not catch up with the turtle if both objects are stationary [3].

Similarly, in my view, there is a point in time where the investment checklist causes more harm than good. It becomes an obstacle. Or an excuse to sit idly. And many investing mistakes are mistakes of omission.


Look for a second opinion, especially when considering big changes to your portfolio or strategy. Unbiased, professional insights can help you reexamine your assumptions and reduce emotional decisions.

Join the waitlist to learn more.


A list of investment checklists by great investors  

Trying to think like great investors is an excellent exercise. One of my favorite past time is to ask what great investors would ask me before I buy a stock.

Having this imaginary investment committee is one of the best ways to stretch investing skills. So I gathered a list of the top questions each great investor would ask:

What Phillip Fisher would ask

1. Does the company have products or services with sufficient market potential to make possible a sizable increase in sales for at least several years?
2. Does the management have a determination to continue to develop products or processes that will still further increase total sales potentials when growth potentials of currently attractive product lines have largely been exploited?
3. How effective are the company's research and development efforts in relation to its size?
4. Does the company have an above-average sales organization?
5. What is the company doing to maintain or improve profit margins?
6. Does the company have the depth to its management?
7. Are other aspects of the business somewhat peculiar to the industry involved, which will give the investor important clues as to how outstanding the company may be in relation to its competition?
8. Does the company have a short-range or long-range outlook regarding profits?
9. In the foreseeable future, will the growth of the company require sufficient equity financing so that the larger number of shares then outstanding will largely cancel the existing stockholder's benefit from this anticipated growth?
10. Does the company have management of unquestionable integrity?

What Walter Schloss would ask

1. What is the value of the company? You are buying shares in a business.
2. Is the value you get worth the price you pay?
3. Are you comfortable holding- and following the stock for five- to ten-years?
4. Is this company using debt to finance its operations? If so, why?
5. Why are you buying the stock?
6. What are the assets you are buying?
7. Are you willing to hold the conviction for a long time? More than two years?
8. What is the true book value of the company after adjustments?
9. Is the price low relative to a few years back?
10. Don't forget to look at the value of the stock before selling.

What Charlie Tian of GuruFocus would ask

1. Do you understand the business?  
2. What is the economic moat that protects the company so it can sell the same or similar product five or ten years from today?  
3. Is this a fast-changing industry?
4. Does the company have a diversified customer base?
5. Is this an asset-light business?
6. Is it a cyclical business?
7. Does the company still have room to grow?
8. Has the company been consistently profitable over the past ten years, through good time and bad?
9. Does the company have a stable double-digit operating margin?
10. Does the company have a higher margin than competitors?

What Michael Shearn would ask

1. Do you want to spend a lot of time learning about this business?
2. Who is the core customer of the business?
3. Does the business have a sustainable competitive advantage?
4. What are the fundamentals of the business?
5. Are the accounting standards that management uses conservative or liberal?
6. What type of manager is leading the company?
7. Does the CEO manage the business to benefit all stakeholders?
8. Does the CEO love the money or the business?
9. Does the business grow through mergers and acquisitions, or does it grow organically?
10. Have past acquisitions been successful?

What Peter Lynch would ask

1. Is there a raider in the wings to help shareholders reel the benefits of the assets? (for asset plays)  
2. Are costs being cut?  (for turnover situations)
3. Did the company duplicate its success in more than one city or town, to prove that expansion will work (for fast-growers)
4. What is the company's long-term growth rate, and has it has kept up the same momentum in recent years? (for stalwarts)
5. What percentage of earnings are being paid out as dividends? (for slow -growers)
6. What is the institutional ownership? (the lower, the better)
7. Is the p/e ratio high or low for the company and for similar companies in the same industry?
8. Is the product that's supposed to enrich the company is a major part of the company's business?  
10. How is the company supposed to turn around? (for turnaround situations)

Conclusion & further resources

Before I leave you to write down checklists of your own, I want to emphasize three points. First, checklist items are evolving in nature. What used to be important in the past may be outdated in today's markets.

Second, you may need a different set of checklist items for different scenarios. A specific checklist item may apply to a particular industry or company size, but irrelevant to another. Remember that checklists aren't there to remove the thinking from the investment process, the checklist is there to support it.

Third, make the checklist specific to your experience; to your criteria of investing.  

If you are interested in reading more about checklists, the following resources are a good starting point. Written by Atul Gawande, The Checklist Manifesto provides an excellent overview of industries such as the medical profession use checklists.

More specific to investing, I suggest The Investment Checklist by Michael Shearn. In that book, he provides over 50 checklist items. The Manual of Ideas, written by John Mihaljevic, breaks down the questions you want to ask, depending on your acquisition criteria. Specifically: when you buy Graham-style bargains when you look for hidden assets in a balance sheet, when you look at management, and so so forth.  

FOOTNOTES: [1] Not to be taken for granted that an investment manager is reading the New Yorker. [2] I use CODA and not a regular word document, because CODA allows dividing a page into sections. [3] The Zenos paradox.

The difference between risk and uncertainty

Published on:
January 25, 2020
Reading Time: 3 Minutes
Last Update:

It was in Risk, Uncertainty, and Profit, that economist frank Knight first observed the difference between risk and uncertainty. Knight saw the two words are different. He writes: 

The essential fact is that 'risk' means in some cases a quantity of susceptible of measurement, while at other times it is something  distinctly not of this character; and there are far-reaching and crucial differences in the bearings of the phenomenon depending on which of the two is present.

He continues: 

It will appear that a measurable uncertainty, or 'risk' proper, as we shall use the term, is so far different from an unmeasurable one that it is not in effect an uncertainty at all.

The difference between risk and uncertainty

Risk relates to what we can measure. And we measure risk with probability and relative frequencies. For example, when we hear in the news that 'there is a 50% chance of showers tomorrow', the anchor is expressing a form of risk management. 

Another example is in the medical profession when we hear that '9 of 10 patients recover from the common cold within seven days." It is worthwhile to note that measuring risk is neutral. It can refer to positive or negative events. 

Uncertainty, however, refers to unknown prospects. That is, to outcomes that cannot be understood from experience. The classic example of why the use of risk analysis in futile in an uncertain world is that of the Turkey illusion [1].

Mr. Market's view of risk and uncertainty

But Mr. Market [2] understand risk differently. To Mr. Market, how volatile the price of a stock defines riskiness. All else equal, if stock ABC goes up and down in price while stock XYZ's price is invariably the same, the market deems the latter stock safer than the former. 

Mr. Market also understands risk as a crucial reason for return [Akin to 'no pain, no gain]. With a mindset of 'no risk, no return.'  Also, the investment management profession, through ideas, such as the 'beta' [3] you can reduce risk by negative beta stocks. 

So often, the stock of these companies, especially when fear of recession looms, becomes expensive [4]. In sum, whether we agree or not, Mr.Market has dealt with the definition of risk.  

But Mr. Market refuses to deal with uncertainty. When Wall Street analysts are uncertain about the financial picture of a company, they cannot explain the prospects of the company. And when they cannot identify future outcomes, let alone quantify them, it is impossible to measure the risk the investor will take. And this inability to gauge risk reduces our confidence in their recommendations.

Mr. Market becomes even more worrisome when the uncertainty expands to the macro-level when interest rate guidelines are fuzzy. Or when little is communicated about the foreign policy. Or when there are factors such as geopolitical tensions and trade wars, the prices of publicly-traded businesses drop. 


Look for a second opinion, especially when considering big changes to your portfolio or strategy. Unbiased, professional insights can help you reexamine your assumptions and reduce emotional decisions.

Join the waitlist to learn more.


How auction-driven markets price uncertainty

You rarely buy a house, and after a month of ownership, someone offers you 40% more or less than you paid for it. Real estate, for the most part, is an open marketplace, with relative ease in comparing the price you pay to the value you get. 

But in auction-driven markets [5], mispricing happens more often than you think. I believe the confusion in the definition between risk and uncertainty is the main reason why you can buy a dollar for 40 cents in the stock market.


I suggest reading TEVA's annual report for a current example of the difference between risk and uncertainty. Here is a shortlist of the uncertainty TEVA faces: 

Price-matching lawsuits, lawsuits for the U.S opioid crises, a considerable debt burden as a result of an M&A-gone-bad. TEVA is also in the midst of restructuring plan and turnover in executive management. 

But I bought a few TEVA shares nonetheless. Over the next few weeks, I will write in greater depth about the risk and uncertainty of TEVA. Write to me if you would like to be notified when I upload these essays. 

FOOTNOTES: [1] The belief that every problem should be solved with probability theory. [2] A euphemism of the stock market by Benjamin Graham. [3]The sensitivity of the stock to the market[4] Campbell soup, for example. [5] a market in which buyers indicate the highest price they are willing to pay and sellers indicate the lowest price they are willing to accept.

The books I read this year

Published on:
December 27, 2019
Reading Time: 3 Minutes.
Last Update:


Security analysis (the classic 1934 edition) by Benjamin Graham, Value Investing by Bruce Greenwald, Dear Fellow Shareholders and Value Investing by Marty Whitman, The Manual of Ideas by John Mihaljevic, The Creature from Jekyll Island by G. Edward Griffin, The Investment Checklist by Michael Shearn, The Great Escape by Angus Deaton, One Up On Wall Street by Peter Lynch, and Damn Right! by Janet Lowe.


Working by Robert Cato, Natural Born Heroes by Christopher McDougall, Leonardo da Vinci by Walter Isaacson, The American Spirit and Brave Companions by David McCullough, Ogilvy on Advertising by David Ogilvy, The Rise and Fall...and Rise Again by Gerald Ratner,


To Heal a Fractured World, The Dignity of Difference, Genesis, Exodus, Leviticus, Numbers, and Deuteronomy by Jonathan Sacks, and Here All Along by Sarah Hurwitz.


Freedom and Its Betrayal by Isaiah Berlin, We Hold These Truths by Mortimor Adler, and 21 Lessons for the 21st Century by Yuval Noah Harari.


Kitchen Confidential by Anthony Bourdain, Triple by Ken Follett, Don't Let Go and Home by Harlan Coben, Dark Matter by Blake Crouch, and Papillon by Henri Charriere.


What Doesn't Kill Us by Scott Carney, Willpower by Roy Baumeister, Flow by Mihaly Csikszentmihalyi, Company of One by Paul Jarvis, The Laws of Human Nature by Robert Green, Atomic Habits by James Clear, Words That Hurt, Words That Heal by Joseph Telushkin, and Indistractable by Nir Eyal.


I Contain Multitudes by Ed Yong, How to Change Your Mind by Michael Pollan, and The Body by Bill Bryson.


The Oxygen Advantage by Patrick McKeown, The Obesity Code by Jason Fung, The Big Book of Endurance Training and Racing by Philip Maffetone, and Why We Sleep by Matthew Walker.


The Botany of Desire by Michael Pollan, and Marriage, a History by Stephanie Coontz.


On Writing Well by William Zinsser, and Draft No. 4 by John McPhee, and The Sense of Style by Steven Pinker.

Additional favorites

I  enjoyed a Special Report on South Africa that appeared in The Economist earlier January.

Is Amazon Unstoppable is one of my favorite articles this year. Written by Charles Duhigg, it appeared in the New Yorker on October. I also enjoyed . I enjoyed fall 2019 edition of the Graham and Doddsville newsletter, published by Columbia Business School. You can access Graham and Doddsville Newsletter Archives here.

I enjoyed The Anatomy of a Great Decision, which appeared in Farnam Street this April. Guy Spier published a white paper on Zero Management Fees which I thought was excellent.

Life in equity research

Published on:
December 21, 2019
Reading Time: 4 Minutes.
Last Update:

Life in equity research is about asking questions. It is about wondering what exactly did Fiserv, a financial services company, do over the past decade that drove the stock price tenfold [1]. It is thinking about how, after 105 years, General Electric was part Down Jones Industrial Average, it lost its place.

"If he [Charlie Munger] were teaching finance, he would use the histories of 100 or so companies that did something right or something," writes Jennifer Lowe in Damn Right! Behind the Scenes with Berkshire Hathaway Billionaire Charlie Munger. 
"Finance properly taught should be studied from cases where the investment decisions are easy."

Life in equity research is about understanding businesses. Not academic theories.  

That studying business is at the heart of equity research was not clear to me when I started this journey. When I studied for Chartered Financial Analyst (CFA) exam[2]. During that period, I read investment topics such as the risk management application of option strategies and reviewed foreign exchange concepts such as forward markets and sport markets. While these topics, perhaps, are of interest to the student of finance, they serve little in the hunt for the next Amazon.      

Cultivating relationships

Another subject absent of finance programs is the value of relationships. I believe that none of the legendary investors would achieve success if they didn't have a supporting spouse, a loving family, a community to belong to, and outside interest beyond the passive ownership of equity interests. In other words, developing soft skills is as vital as understanding GAAP accounting.  

One example of a life skill is creating goodwill. It is so much easier to ask someone for help when already you have assisted them in the past. In our time of just-because-what-can-I-lose Linkedin requests, you will gain an advantage over your peers if you carefully develop an ecosystem of friends that genuinely care for one another.

And developing and maintaining relationships requires work. It is about spending time each week thinking about how to bring value to others. It is about small acts of kindness and putting the focus on others. It is about remembering what Viktor Frankl used to say in the name of Kierkegaard. That the 'The door to happiness opens outward.'

The door to happiness opens outward.

Understand: Whether the stock portfolio increases in price over 12 months is mostly dependent on factors beyond your control. But whether you build genuine life-long relationships is entirely up to you.  


Look for a second opinion, especially when considering big changes to your portfolio or strategy. Unbiased, professional insights can help you reexamine your assumptions and reduce emotional decisions.

Join the waitlist to learn more.


Bringing business development efforts to nil

There is tension between investment research and the business of investment management. I estimate money managers use between half to three-quarters of their time in the latter. They travel to meet prospects, they speak at conferences, they interview at any opportunity.

From conversations I had with money managers, I learned that many of them would much prefer to replace the ratio of business development to investment research.

I don't have an answer on how to do that. My personal story is that I saw this inherent tension between the research and business side of things. And I decided to avoid managing other people's money so that I won't have to spend time explaining to them my investment decisions.

Business development becomes crucial when fund managers hire a team of professionals. As I wrote in January of this year,

Hiring a team of analysts will distract the asset manager with tiresome managerial duties. And instead of carefully reading about investments, the manager will eventually sift through the analyst's cliffs notes.

Read more in Mohnish Pabrai's Ten Commandments of Value Investing.

In short, I keep business development efforts to nil and decided to be a team of one. Read Paul Jarvis' Company of One, to learn about this model of work.

The lifestyle of an equity analyst

There is no single formula for life in equity research analysts. Your lifestyle is different when you have young children compared to your lifestyle when they are in college. Not unlike life, the investment life is much different when markets are fully priced compared to market everybody is selling.

While there is no fixed, daily time structure, I find it useful to have a few key performance indicators (KPIs). These KPIs allow us to keep track of progress.

For example, in a particular one month, I will write in my Bujo calendar: "This [Month] I will read [Number] 10-k reports. I will read about the business model of [Number] companies from [Number] investment newsletters; and track the stock activities, via 13-F filings, of [Number] fund managers."

Your lifestyle should drive investing decisions. These decisions should not drive your lifestyle.

Some investment ideas take months to understand. For example, I bought GrafTech (read the GrafTech article) after researching the industry and the competitive landscape for weeks. Others are much faster. I recently bought Micron in less of six hours of research (Write to me if you would like to know why.)

How to measure success

In The Big Book of Endurance Training and Racing, Doctor Philip Maffetone ridicules the 'no pain no gain' fitness concept. He explains that "this is an emotional reaction - one that is based on current trends, often started by advertisements and other marketing - and one that can be irrational."

The 'no pain no gain' attitude is irrational because you should listen to your body's intuition. And the same can be said about the myth of "no risk no reward." (Read more about this myth and other investing myths in The five myths of stock investing.)

Success in the stock market should be about processes. Not about a percentage point more or less compared to the performance benchmark. In the long run, your financial success is the knowledge and wisdom you accumulate about business, the relationships you cultivate, the investing principals you follow, and how you chose to live your life.

You will never hear investors in their later years regret making that they didn't earn a extra percentage points to their investors. More likely that they will lament that they didn't spend enough time with the people they loved and didn't make an effort to make the world a better place.

When asked by William Green, about the key to a fulfilling life, the legendary Irving Kahn remarked:

"For me, the family has been very important. Having a family, healthy children, seeing what we've achieve at the firm. These have all given me great pleasures."

We know that we should explore and travel the world. We should inspire others to lead. And we should remember and recite what former President Theodore Roosevelt said, "I have never in my life envied a human being who led an easy life. I have envied a great many people who led difficult lives and led them well."

And that is life in equity research.

[1] Fiserv stock went up from $12 in 2010 to $117 in 2019
[2] I passed the CFA exam in five years of work.

An update on how I am doing

Published on:
December 14, 2019
Reading Time: 4 Minutes.
Last Update:

The best-performing stocks

Carriage Services (CSV on Nyse), Stericycle (SRCL on Nasdaq), WW International (WW on Nasdaq), and Hyster-Yale (HY on Nyse) are the winner stocks this year.

CSV is up 55%;  SRCL is up 51%; WW is up 33%; and HY is up 41%; Together, they contributed third quarters of this year's return.

The high returns on Carriage and Stericycle are because of the low prices I paid for both companies in the first quarter of this year, and not because of a material change in business fundamentals.

I wrote about Carriage Services in January and about Stericycle in February, during those two months the market  bottomed in 2019.

I can't remember where I got the Carriage idea. But I do remember reading about Stericycle from Laura O'Dell, CFA  of Diamond-Hill.

Download O'Dell's report titled Stericycle: Waste Not, Want Not.

Buying Hyster-Yal was a bet that the geopolitical and trade wars will wane away at some point. And that Mr. Market confused risk with uncertainty.

Buying Hyster-Yal was a bet that the geopolitical and trade wars will wane away at some point. And that Mr. Market confused risk with uncertainty.

When I bought HY in May, the stock traded at what is now the 52-week low, about $45 per share. I published an essay on Hyster-Yale in September. (If you are interested in getting live updates on my stock activities, write to me.)

Oprah Winfrey's Weight Watchers traded $30 a share when I wrote about it. And in less than 48 hours after I bought the stock, because of a gloomy earnings call, WW dropped by a third in price.

But in August, WW bounced back to $30 a share and now trades at $39. Weight Watchers has a recognized brand with sophisticated, deep-pocket investors. But WW is not a compounder stock or a long-term hold - I hope to sell the position soon.

The worst-performing stocks

The three worst-performing stocks, which I define as stocks that experienced a price dropped over a third, were Superior Industries (SUP on Nyse), Gulfport Energy (GPOR on Nasdaq), and Beasley Broadcast Group (BBGI on Nasdaq).

I bought Superior at almost $6 a share in May, and SUP now trades at $3 a share. I first hear about SUP from the legendary investor, Mario Gabelli, of GAM Investments. Even the price halved, I like Superior's business model and believe that SUP offers a dollar of value for 50 cents.

I will write a full-length report on Superior in the upcoming months (Write to me if you would like to know when the article is published.)  

Gulfport is another stock that halved in price. After reading the company's recent public filings, which will leave you in state of gloominess, I decided to buy a few GPOR shares only because I thought Firefly Value Investors, an active investor and hedge fund that specializes in a turnaround situation, may revive operations. Read more about Firefly on the SEC's website.

A contrarian position I took was buying BBGI. At $4 a share, I thought it was a Benjamin-Graham-bargain-stock. The Beasley family owns BBGI for the most part. And the family had done a reasonable job in capital allocation decisions over the past years.

A strategy that focused on tailwinds companies is superior to a strategy that looks at companies facing headwinds.

But I don't see a heroic future for the stock and will likely sell the position in 2020. I have little interest in following the economy of radio stations - especially as the industry continues to experience headwinds.

I should have followed Charlie Munger's who said that "one of the lessons management has learned - and unfortunately, sometimes relearns - is the importance of being in businesses where tailwinds prevail rather than headwinds."   

In short, the three companies, which in total represent 10% of my portfolio, fit in the contrarian, cheap buckets. While I don't expect a particular wondrous future for these positions, the stocks were cheap, and so I bought a few shares. In total, the three companies detracted 35% percent from the annual return.

Two stocks I am most proud of

The first company is GrafTech (EAF on Nyse.), which I bought a month ago. The second company is Mednax (MD on Nyse.), which I purchased in April 2019. I believe that over the next three- to five years, these two companies will have a more meaningful role in the portfolio than all the of all other stocks combined.

Both Mednax and GrafTech had little effect on the portfolio results this year. But they have more value of all portfolio companies.

In April, I published an introductory article on Mednax, and last week I wrote a summary about GrafTech. In my view, Mednax has a CEO that is a great capital allocator, and GrafTech has a unique position in the market place; It is a low-cost producer of needle coke, which I estimate will increase in price - and in demand - over the upcoming years.  

Both Mednax and GrafTech had little effect on the portfolio results this year. But they have more value of all portfolio companies.

A review of the performance

I was more active in the stock market this year than  I would have liked. On Average, I placed small bets (less than 2% of the portfolio size) each month and traded 16 times. GrafTech was an exception. This position now represents about 15% of my portfolio.

To fund the purchases, I exited from 8 companies, for a slight gain[2].

In two cases, I bought and sold the position within a few months [3]. The two companies were Signet Jewelry (SIG on Nyse)  and Flexsteel Industries (FLXS on Nasdaq). The net realized gain from activity was negligible.

I overpaid in both circumstances. And there were too many abrupt changes in the industries. In jewelry industry: the lure of diamonds is waning down. And who knows how will we shop for furniture in the future.

To further summarize the performance in numbers, in 2019, my total return was 8%, which included 5% in capital appreciation and a 4% in dividend and interest received. My portfolio now has 16 names, with the largest position being GrafTech.

Finally, let the digital record show that my goal in 2020 is to own a much more concentrated portfolio: with no more than ten companies by year-end.

[1] My focus here is the 2019 performance. I exclude stocks bought in prior years.
[2] Since I didn't buy these positions in 2019, I excluded them from this article.
[3] A practice I am not fond of.

Why I bought GrafTech shares

Published on:
December 7, 2019
Reading Time: 13 Minutes
Last Update:

The first part of this essay is a description of GrafTech (EAF on Nyse), a manufacturer of graphite electrodes and petroleum coke. As much as possible, I keep this part objective, stating facts and not my opinions.  But the second part is subjective. Here I give reasons why I bought GrafTech's common stock.

GrafTech's business

You can tell that GrafTech is manufacturing something (more on that 'something' below) just by glancing at the property, plant, and equipment account (PP&E).

PP&E of $689 million represents about a third of the balance sheet. It is $67 million in the value of buildings, $46 million in land, and $532 million in machinery. The PP&E hints at us that GrafTech makes stuff.

Specifically the company makes graphite electrodes which are a small-but-integral part of the steel manufacturing process. In GrafTech's words:

"Graphite electrodes are an industrial consumable product used primarily in EAF steel production, one of the two primary methods of steel production"

Here is how Brookfield (an asset manager that acquired GrafTech in 2015) describes graphite electrodes:

"Graphite electrodes are 10 to 12 inches in diameter and can be up to nine feet long. They can take up to six months to manufacture, in a multistage process that requires significant technical skill and raw material known as petroleum needle coke. GrafTech is the only graphite electrode produce able to produce its needle coke, a significant competitive advantage."

 GrafTech's five plants are in Mexico,Pennsylvania [1], Texas, Brazil, France, and Spain. The company's headquarters are in Brooklyn Heights, Ohio. It also leases five locations, mainly for sales.

GrafTech's income statement

While GrafTech does not itemize the depreciation expense in the income statement, it is worthwhile data to go over. In total, depreciation expense was $131 million over the past three years.

Between 2018 and 2015, the total capital expenditures were $131 million, too. So if you belong to the group of investors that follows the magic formula investing [2], you would be pleased to see in GrafTech a business that requires little capital improvements.

GrafTech Key Operating Metrics 2018-2017
GrafTech's key operating metrics 2018-2017. Source: public filings.

The table above shows that GrafTech had a dramatic revenue increase in 2018, largely the result of the graphite electrodes price hikes. (Also, bottom line benefited from some operational efficiencies.)

The weighted realized price for graphite electrodes was $9,937 in 2018 compared to $2,945 in 2017. The company produced 185 million tons of it in 2018 compared to 172 million in 2017.

The price of electrode graphite is up threefold. The price was $9,937 in 2018 compared to $2,945 in 2017.

Over the past three quarters of 2019, GrafTech showed high operating margins. The average realized price for electrode graphite was $9,976; the average operating margin was 56%, with an average net income margin of 41%.

I estimate the company will report in 2019 an annual revenue of $1,800 million in revenue and earnings of $767 million, roughly $2.5 to $3.0 per share.

GrafTech's future earnings

"Change is the law of life," former U.S. President John F. Kennedy once said. "And those look only to the past or present are certain to miss the future." Returning to GrafTech, let's focus on future earnings.

GrafTech cumulative profits until 2022
GrafTech cumulative profits until 2022. Source: public filings.

On page 45 of GrafTech's annual report which you can download here, GrafTech shows future contracts  of 674,000 million ton of graphite electodes at about $10,000 per MT. These contracts represent about 65% of the planned capacity. GrafTech writes:

"We have executed three- to five- year take-or-pay contract, representing approximately 674,000 MT, or approximately 60% to 65% of our cumulative expected production capacity from 2018 through 2022. Approximately 90% of the contracted volumes have terms extending to 2022.

These expected earnings will determine GrafTech's future value. And these expected earnings are dependent on (1) the growth in the graphite electrodes industry, (2) the price of graphite electrodes, (3) the production capacity, (4) competition from BOF manufacturing (more on that below), and (5) the cost to produce the product.


Look for a second opinion, especially when considering big changes to your portfolio or strategy. Unbiased, professional insights can help you reexamine your assumptions and reduce emotional decisions.

Join the waitlist to learn more.


Electric arc furnace (EAF) v. basic oxygen furance (BOF)

There are two ways to make steel, the electric arc furance (EAF) method and basic oxygen furnace (BOF) method.

Visually, this is how EAF looks like: 

And this is how BOF looks like this: 

GrafTech writes:

"In the EAF method, steel scrap is melted and recycled to produce liquid steel, while in the BOF method, virgin iron ore is smelted with metallurgical coke, a carbon product derived from metallurgical coal."

GrafTech's competitive advantage

GrafTech is a low-cost producer. In my view, it costs the company about one-fourth to produce the graphite electrodes compared to its peers. To be a low cost producer is good, it is even better in a tight marketplace, where the top five electrode graphite companies [3] of the world hold over 80% of total production.

GrafTech is a low-cost producer.

GrafTech is the only vertically integrated electrode manufacturer. Vertically integrated means that they control the price of needle coke, the main ingredient behind graphite electrodes.  GrafTech writes on page 10 of the 2018 annual report: 

"Seadrift [the needle coke manufacturer] provides a substantial portion of our petroleum needle coke supply needs internally and at a competitive cost and allows us to maximize capacity utilization more efficiently than
competitors, who may be more constrained by petroleum needle coke supply."

GrafTech's peers

There are direct and indirect competitors. The direct competition [3] are four companies that compete with GrafTech . With these  companies, GrafTech competes in production capacity, the price of the product, and the cost to produce the product.

The indirect competition to GrafTech is BOF steelmaking. While the difference between the steel manufacturing method is only exciting to students of mechanical engineering, for this essay suffice to note that if BOF manufacturing decreases, then EAF manufacturing increases. And if EAF manufacturing increases, GrafTech benefits.

If BOF manufacturing decreases, then EAF manufacturing increases. And if EAF manufacturing increases, GrafTech benefits.

That, at least, has been the historical case. According to the steel statistical yearbook, produced by the World Steel Association, Between 1984 and 2011, EAF steelmaking was growing at 3.5% per year.

But this trend was reversed between 2011 and 2015 because of an increase in blast furnace (BOF) steel production that for the most part came from China.

(Write to me if you would like a detailed description of the dynamics in the steel industry.)

The steel industry's gloomy outlook

Value Line ranks the steel industry in 91 of 97 possible ranks. ( Why I read Value Line reports.) According to Value Line, you can't find any worse businesses to invest in over the next few years.

 Here is how much you would have lost if you bought five years ago any of the following steel companies:

AK Steel Holdings loss was 69%; Posco loss was 42%; Timmenksteel loss 83%; and U.S. Steel loss was 53%. In short, if you want to spot a liar, ask someone at a party if they made money on steel stocks over the past few years.

"The main question is the long-term outlook for the company," writes Sven Carlin. "As the main product is steel, electrode prices will depend on steel prices and demand for it, especially for EAF steelmaking." 

Because of the reported declines in both revenue and earnings by practically all publicly traded steel companies, the outlook for the steel industry is gloomy. Paraphrasing Howard Marks [4], there is too much steel chasing too few manufacturers.

There is too much steel chasing too few manufacturers.

Why I bought GrafTech

At a market capitalization of about $3,500 million, GrafTech is trading a multiple of one. As I wrote in the first section of this essay, I estimate GrafTech will report to shareholders of $1,800 in revenue and of $767 million in earnings for 2019.

And since GrafTech sold 674,000 million tons at $9,937 per MT, we can estimate total revenue of $6,700 million and earnings of $2,814 million by 2022.  Adding $767 million and $2,814 million, we find $3,851 million in profits by 2022.

A p/e of one for a company whose 2018 operating margin was 49% and net profit margin was 45%  seemed nonsensical to me.

Careful readers of GrafTech's annual report will see that between 2008 and 2017, the price for electrodes graphite was $4,500, and during the worse year (2016), the price was $2,500 per MT.

At about $10,000 per million ton, GrafTech's operating margins are high. But the operating margins are reasonable at $5,000 per MT, too.

At about $10,000 per million ton, GrafTech's margins are high. But the  margins are reasonable at $5,000, too.

There are also reasons to believe of growth. The first reason is that China will export less steel in upcoming years. In 2019, for example, it exported between 4 to 6 million tons of steel per month. But in 2015, in comparison, China exported about twice as much, between 6 to 10 million tons of steel per month.  

There are two other factors, which I cannot estimate their effect numerically. The first factor is the price of needle coke may jump in the near term as a result of the growth in electric vehicles (EV) sales [5].

And the growth in the EV industry is clear. Five years ago lithium-ion batteries production was 1,00 million tons. And last time I checked it was 60 times as much, about 60,000 million ton.  

The growth in the EV industry is clear. For example, lithium-ion batteries production was 1,00 million tons in 2014. In 2017, it was 60 times as much, 60,000 million ton.  


A reminder for readers: my goal in writing is to share thoughts. None that was said above should be construed as investment advice.

Also, this essay is incomplete; there are many important topics I left out. Among them: GrafTech's management and compensation structure, why Brookfield purchased GrafTech, a detailed analysis of the risks ahead, a peer-company review, and a valuation analysis.

More on that in future essays.

FOOTNOTES: [1] The facility in St. Mary's is warm-idles according to GrafTech. [2] Magic formula investing an investment technique outlined by Joel Greenblatt which puts emphasis on companies with high return on capital. [3]  These five companies are Showa Denko K.K., GrafTech, Graphite India Limited, Tokai Carbon Co., Ltd., and HEG Ltd. [4] For more information, read his 2018 memo titled The Seven Worst Words in the World. [5]  The EV industry uses needle coke for the production of lithium-ion batteries.

Some of the flaws, uses and illustrations

Published on:
November 30, 2019
Reading Time: 3 Minutes.
Last Update:

Enterprise value (ev) is the market value of the debt and equity less cash held by the company. Earnings before interest, taxes, depreciation, and amortization (ebitda) is a proxy for how much cash flow does the business generates. By dividing the enterprise value by ebitda numbers, you discover how long will it take for the company to pay back the initial investment.

The shorter the period the better it is. For example, a business that generates $33,000 a year is more attractive than a business that makes $14,000, assuming both will last and cost the same.

The ev to ebitda ratio represents this idea. "What a ratio of eight times ev to ebitda," writes Michael Shearn in The Investment Checklist, "is that the investment will pay itself in eight years."

Read how to calculate ev to ebitda ratio on Investopedia or visit corporatefinanceinstitute.com for ways to compare ev to ebitda ratios among companies.

In this essay, I describe the ratio's main weaknesses and how you can better prepare for them. I end the article with a few examples of companies trading at low ev to ebitda ratios. 

The flaws of ev to ebitda 

There is a reason why Charlie Munger called ebitda earnings "bullshit earnings." In his mind, ebitda misses out on two key points: the amount of leverage and the amount of capital expenditures required to maintain the business.

If ebitda portrays a distorted reality, then the ratio that uses ebitda in its denominator must obstruct reality, too.

Another flaw of the ratio is that it looks at a single point in time. But what matters to investors are trends over time. That is, whether earnings will grow in the future is more important than current earnings or last year's earnings. 

For example, in June of this year, I bought the stock of Signet Jewelries (SIG on Nyse) One of the reasons I purchased SIG was because for the prior seven years, the average  was $800 million. But because the 2018  was loss $579 million, the stock had more than halved.  to  cannot pick up such a discrepancy. 

Like most things in life, the problem does not lie in the ev to ebitda ratio but how the user intends to use it. I typically use ev to ebitda ratio to quickly screen for cheap stocks[1]. Other investors use the inverse logic; they use the ratio to estimate how valuable a company is. They assume that the higher the ratio, the more valuable the company. 

The uses of ev to ebitda 

Yet, even with the flaws mentioned, ev to ebitda ratio is widely used, and ebitda figures are widely accepted. Read any loan covenants of a publicly-traded firm and you will see that lender covenants that address  ebitda figures. That is, if ebitda for a quarter falls below a specific number, a higher interest rate will be charged. 

And so, to use Silicon Valley nomenclature, this ratio exhibits a "network effect." One of its strengths is that it is widely used by both companies and by Wall Street analysts.

One of the strengths behind the ev to ebitda ratio is its popularity by both lenders and analysts.

Take, Luca Franza of Ausonio Fund as example.In the now famed investment thesis for Rain Industries, he writes: 

"Rain trades at a P/E of 2.7x and EV/EBITDA multiple of 5.1x. Using cyclically adjusted earnings and EBITDA, which we will assume to be the average over the last five years, Rain trades at a P/E of 1.7x and EV/EBITDA of 4.2x."  

Another use of the ev to ebitda ratio is that it allows us to observe a company's valuation over time. Canterbury Consulting shows, in a quarterly asset class report, that for the Russell 2000, a popular index, /  was 16 times, while the 10-year average ratio was 14 times, and. For the S&P500, Canterbury researchers show that the current TDA was 1mes, while the 10-year average was ten times. You can download the Canturbury report.

When bored, I enjoy finding out the ev to ebitda ratio of portfolio companies owned by asset managers I admire. For example, a few weeks ago, I reviewed Third Street Avenue Capital Management. I saw that for the 31 companies Third Street owned as of the second quarter of this year, most portfolio companies ev to ebitda was in the double digits. Only Carter Bank Trust Advansix Inc. traded at a ratio of six times; MYR Group at a ratio of seven times. The other single-digit companies, at nine times the ev to ebitda, were Seaboard Corporation, Comfort Systems and TRI Pointe Group and Kaiser Aluminum Corporation.


In Pen&Paper, I only write about companies I am personally invested in, and on finance topics, I find it important to share.

Buying a stock is easy. But it requires a lot of effort and discipline to keep track of the company's performance. And no matter how much a stock appreciates, you're not capturing those returns until you sell. Join the waitlist to get real-time updates.


Examples of companies trading at a low ev/ebitda

I often screen for stocks trading at low ev/ebitda. While it is insufficient to make an investment decision based on the ratio, it does serve as a starting point or as a filter mechanism. I conclude this essay with three companies in my portfolio that are trading below three times the ev to ebitda ratio.

EV to EBITDA in my stock portfolio
Some low EV/EBITDA ratio companies in my portfolio

First, the sport-equipment manufacturer Nautilus' enterprise value is $54 million, and ebitda is $31 million. Second, Flexsteel Industries, the sofa manufacture, enterprise value is $102 million, and 2018 ebitda is $33 million. Third, Gulfport Energy, a producer of natural gas, enterprise value is $2,670 million, and 2018 ebitda is $1,046 million.

[1 ] A ratio of EV to EBITDA less than 3 times is considered a bargain valuation.

A Guide to Zero Management Fees

Published on:
October 25, 2019
Reading time: 7 Minutes.
Last Update:

This article gives a reason for the zero-fee structure. I discuss the lure of the structure and some of the potential pitfalls. I conclude the essay with a practical review of how fees, both explicit and implicit costs, affect returns over the long-term. My main point is that there is no way to invest without paying fees.

Zero fee structure in a mutual fund and a fund partnership

Mutual fund

When mutual fund managers declare zero management fees, they are waiving three costs. The initial cost is an asset fee, which typically ranges from 0.50% to 2.0%. The other expenses are load fees. "A load is a type of commission," explains Wikipedia.

The third costs are distribution and service costs, also known under the technical term of 12b-1 fees. These costs compensate mutual fund managers for marketing and for providing shareholder services. Visit distribution and service fee on Wikipedia to learn more.  

Two examples: Third Avenue Management, a mutual fund I admire, charges its shareholders a 0.90% management fee, distribution fees of 0.25% and other expenses of 0.30%. The total annual fund operating expenses are 1.45%. So if you invest $10,000 with Third Avenue, you will be charged $145 per year. Download the Third Avenue Value Fund to read more.

Fidelity funds have no fees. Consider Fidelity ZERO Total Market Index Fund (FZROX) as example. It opened in August 2018, the fund today manages $3.9 billion in assets. It aims to track the performance of large-capitalization U.S. stocks using automatic trading algorithms. Household, large-capitalization companies such as Microsoft, Apple, Amazon, Facebook represent about one-fifth of the fund. Visit ZFROX to learn more.

Hedge funds

Yet when fund managers [1] speak of zero fees, they refer to something entirely else. Fund managers will require at least 1- or 3-year hold time, which means you will not withdraw funds from the partnership during that "lock-up" period.

Another change in the partnership structure as a result of the zero-fee structure is that the manager's fee, known as carried interest [2] is higher. For example, under a one percent fee, the managers' interest in the profits may be 10%. Under zero-fee structure, the manager's compensation may jumpt to 20% of the profits.

What lures about zero-fee structure

The right performance evaluation

How you evaluate performance is essential. And the manager's performance evaluation should be judged using the change in the after-tax market value of your investment.

Payment for value

Under the zero-fee structure, only if the fund performs, the fund manager is paid. That is, you pay the manager only if the fund's fund returns are above a hurdle rate.

But the practice today is that you pay fees irrespective of the fund's performance. With a management fee, a fund may have lost market value during the year, but you still pay the fund manger.  

The zero-fee structure is a value-for-value trade. You only the managers only if you got value.  

The Buffett-Pabrai effect

Zero-fee structure appeals to investors because of great investors. Warren Buffett started the Buffett Partnerships in the 1960s with a similar structure. And Mohnish Pabrai, inspired by Buffett's biography written by Roger Lowenstein, had copied the zero-fee model in the late 90s.

And since both investors performed well for their investors, logic prescribes that a zero-fee structure results in success.

Yet, as the science community knows, there is a difference between causation and association. It is more likely that both Buffett and Pabrai would have achieved high returns regardless of the fee structure.

At least, when a fund manager offers you zero fee structure, you know the manager commits to performance. And that they probably read and studied Buffett and Pabrai - a blessing in itself.


In Pen&Paper, I only write about companies I am personally invested in, and on finance topics, I find it important to share.

Buying a stock is easy. But it requires a lot of effort and discipline to keep track of the company's performance. And no matter how much a stock appreciates, you're not capturing those returns until you sell. Join the waitlist to get real-time updates.


The downside of zero-fee structure

The impracticality of the structure

But after two- to five-years of lousy performance, can we expect of managers to open their doors? Most funds have a hurdle rate. So when capital markets drop, payments to funds managers may not be for a while, six- to eight years of wait time.

Very few managers can wait that long. It remind me of the story of how Benajmin Graham dissolved his fund only after his investors recouped their capital. Or the story of Pabrai, patiently waited for a decade before pulling any money from his fund. But these are out of the ordinary stories, not the rule. I believe that for every one Pabrai, there are over a hundred managers who would walk away from the fund.

For every one Pabrai that stuck around, there are hundred managers that would walk away.

An appetite for risk

Another cause of concern is the fund manager's increased appetite for risk. Knowing the only way to get paid is by stellar performance, managers may take additional risk because of the zero-fee structure.

Marty Whitman once wrote that "an adjective must precede the word 'risk.'" Here I use the word 'risk' in two contexts. One, when fund managers lack time to research and two, when they look for stocks outside of their circle of competence.


Founded in 2004, by Charlie Tian PHD, GuruFocus provides institutional-quality financial stock research for the individual investor.

GuruFocus hosts many value screeners and research tools and regularly publishes articles about value investing strategies and ideas. One of the features I use most is the 30-year financial information on businesses. For example, see how easy it is to review AT&T balance sheet.


Lack of empirical data

Intuition aside, there is little to show that zero management fee structure is superior to any other form of fund arrangement. There are too few zero-fee funds to track. And the fund fee structure is outside of the student of finance scope of interest. Outside of common sense, the argument for zero management fees is unbacked by any data.

I am not sure there ever will be enough data to back the zero-fee structure. A fund performance depends on factors that work at the same time, and that cannot be isolated.

Research does not always support decisions. Among those: the partner we decide to marry and the business venture we choose to take and also the outcome from the principles in life we want to have. Perhaps - and not unlike in real-life -  investment decisions require a leap of faith.

Investing requires a leap of faith.

The cost of fees over the long term

Explicit costs

Page 4 of The Manual of Ideas shows a table the SEC should require fund managers to show their fee-paying customers. The table shows that a 2% management fee will cut the value of your portfolio by 22.2% after ten years; by 39.4% in 20 years; and 52.9% over 30 years. The assumption is of a 5% gross return.

Implicit costs

In a talk [3] given in 1994 to students of the University of Southern California, Charlie Munger retells the story of Federal Express's early days. Employees left packages in the warehouses. Which penalized the company's profits. So management decided to change the worker's compensation from an hourly basis to a shift basis. You got paid when the work you completed the work, not when the clock said it was five o'clock. Unsurprisingly, perhaps, the new structure dramatically changes the number of package deliveries.

In Munger's words:

"As usual in human affairs, what determines the behavior are an incentive for the decision-maker, and 'getting the incentives right' is a very, very important lesson."

Not unlike Federal Express workers, salary structure changes the fund manager's behavior. When the portfolio size determines wages, managers naturally focus on increasing the size of the portfolio. They will talk to CNBC reporters; Work with advertising agencies on brand awareness. It would be better if managers focused their attention to the portfolio needs and no to what the market thinks about the portfolio.  

The fund industry somehow managed to market their services differently. Mutual funds charge you not as a percentage of the actual revenue, but as a percentage of the assets under management. This incentive structure results in much higher management fees.

For example, with a 1% management fee, mutual fund managers will charge you $100 annual management fee for every $10,000 you invest with them. In today's capital markets environment, on average, managers will earn  6% on average on your investment. We find $600 in management fee. But we would expect that they would charge 5% to 7% of that, which is $30 to $40. Yet, since using the investment management's calculation of fees, you will be charged $100, more than three times what a real estate relationship would require.

The investment management industry charges more than three times what a property manager would charge.

Read about this phenomenon in Investment Management Fees are (Much) Higher Than You Think.


You should now be able to assess the benefits and drawbacks of the zero asset management fee. If you would like to add to the article or you still have questions about zero asset management fee, write to me. I always respond.  

For additional information, I suggest that you also read Guy Spier's white paper on zero management fees. Also The New York Times recently published an article this trend. Visit this page to read more.  

FOOTNOTES: [1] Fund managers are managers of either a hedge fund or a private equity fund. [2] Carried interest is the share of profits paid to fund managers. [3] The talk's name is a lesson on elementary, worldly wisdom as it relates to investment management business.

Value Line Investment Survey: A Review

Published on:
October 12, 2019
Reading time: 9 Minutes
Last Update:

Value Line's history

How the Value Line report started is the story of turning setbacks to blessings. Arnold Bernard, the company's founder, was fired at the peak of the Great Recession. "You can have no idea what it meant to be out of a job in 1931," he said. "Nothing like today, when you can read and write, you can get some work - and you can get Social Security too." The Great Crash led him to work on what would eventually become the value line rating theory [1].

Value Line's early days were humble. Bernard reached out to local banks and other financial institutions and could not make a single sale; he valued the product, at the time a book, at $200. But L.L.B. Angas marketed the book for $55. Even at that low ball price, there we no buyers.

Fast forward fifty years. The New York Times wrote about Bernahrd that "His [Bernhard] approach contradicted the 'efficient market hypothesis,' which holds that information is reflected in stock prices so quickly that no attempt to beat the market can succeed in the long run." Indeed, Bernhard was one of the first investment contrarians simply because he was skeptical of the markets being efficient.  

The Value Line company

The Bernhard family still holds 89.34% of the common stock. Value Line became a publicly-traded company in 1983 and trades under the symbol VALU on Nasdaq. Subscription revenue was $28 million in fiscal yearend 2019 [2]. Revenue from print subscribers was $13 million, and revenue from digital subscribers was $15 million. In 2019, Value Line was able to attract 13% new members; renewal fees were 87% of the revenue.

Value Line does not publish the number of subscribers. I estimate the amount of subscribers today is about 70,000 to 80,000 [3]. While a significant number, the company had a much larger subscriber base in the late 80s. In the Bernhard's obituary, written over three decades ago, it was said that the subscriber base was 134,000.  

While the Value Line company is mostly associated with the Value Line Investment Survey, it has substantial investment management services business. In 2019  this business contributed $7 million - about 25 percent of  - the company's revenue. Value Line, through its various mutual funds, oversees over $3 billion has in assets.


Look for a second opinion, especially when considering big changes to your portfolio or strategy. Unbiased, professional insights can help you reexamine your assumptions and reduce emotional decisions.

Join the waitlist to learn more.


The Value Line reports

The flagship product is the Value Line Investment Survey (VLIS), which comes in both print form and digital form. The print version arrives weekly, and the digital version is updated daily. VLIS covers about 1,700 stocks, from small-capitalization stocks to large-capitalization stocks [3]. In a typical Value Line report, you will find coverage of household companies such as Amazon and Apple, but more often than not, you will discover under-the-radar companies such as Raven Industries or Stantec Inc.

The VLIS is a one-page report that covers a lot. It has 15-years' financial information;  it highlights profitability metrics such as net profit margin and returns on equity during; it allows the reader to quickly sift through the company's key growth metrics.; And it shows how much investors valued in the company over the past decade. The bottom section includes details such as recent developments in the company's business and valuation.

The VLIS report's brevity allows the reader to understand an industry and its key players quickly. Consider the human resources industry.  The Value Line report covers 12 companies in this line of business. Reviewing the one-page reports allows the reader to quickly answer questions such as what is the operating margin for the industry as a whole? Are sales increasing? Which company has been growing the most? What is the current valuation of the Human Resources Industry compared to a decade ago?

Value Line Investment Survey allows the reader to quickly understand an industry's operating fundamentals.

Value Line offers other niche products. Since June 2011, it sells readers a report focused on dividend and growth companies. This report aims to find companies expected to provide above-average earnings yield glossary.

In May 2017, Value Line began to publish a report which recommends the best exchange-traded funds (Write to me if you would like to know more about exchange-traded funds.)

The company also offers a special situation report which aims to find undervalued small- and mid-cap stocks with upside potential.

The print version of the Value Line report costs $598 a year. Adding digital access will increase the annual price to $718. The dividend income & growth, which is a separate report, costs $795. The Value Line Select ETF costs $395. The Value Line Special Situations costs $198.

Download .PDF version of the Value Line report to experience the look and feel.

How Value Line is different from Morningstar

Three features make Value Line different from Morningstar. First is the design of the product itself. Or what can also be understood as 'The medium is the message', a term the late Marshall McLuhan coined in Understanding Media: The Extensions of Man. His main point was to understand a message you need first to understand the medium. The logic applies here.

Value Line reports resembles a book. Not a trading floor.

The Value Line Report was designed for print while Morningstar was intended for the web. Print content cultivates patience. Digital content rushes us to act. And today, more than ever, "Patience is the thing in short supply," said value investor Joel Greenblatt told to the Wall Street Journal in A Value Investor Defends Value Investing.

Visit the Morningstar website, and you will see the flashing color of red and green, various calls to "act now or miss out." Value Line, on the other hand, with its dull, plain black and white format, resembles a book, not a trading floor quote.

Morninstar website has too much information
Too much information on Morningstar.

Another difference is that Value Line allows us to understand an industry while Morningstar's emphasis is on individual companies. For instance, if you believe the investment management industry is experiencing tailwinds [4] then Value Line allows you to sift through the key players in the investment management industry and to compare their operating fundamentals.

The fourth difference between Value Line and Morningstar is scope. Value Line focuses on U.S. based companies, specifically on the common stock of these businesses. The philosophy behind Value Line is that individual investors can understand enterprises and can decide on their own.

Readers of Morningstar, however, have a broader interest in capital markets. Morningstar covers capital markets topics from fixed income products to option trading. And Morningstar's philosophy is that investors are best to let investment professionals make the decisions.

Hence, Morningstar's emphasis on rating mutual funds and their yearly performances. Ultimately, this chase after the best performing funds leaves investors with poor results. Visit Business Insider's discussion on the topic: past performance of a mutual fund is not an indicator of future outcomes.

Valueline will fit nicely in a value-investor's desk
Valueline will fit nicely in a value-investor's desk

How to use the Value Line Investment Survey

To me, the Value Line Investment Survey is a stock screener. Every week I review about 50 one-page reports and typically find a company or two that I would like to understand more [5].

For every 50 one-page reports, I typically find three- to five companies that have great business models but are just too expensive to buy. So I add these companies to a list called inventory of ideas, an idea I copied from Michael Shearn's excellent book, The Investment Checklist.

My secondary use of the Value Line Investment Survey is just game-playing. I like to compare and argue with Value Line analysts' estimate of what the company will be worth in three- to five years. For example, Simon Shoucair of Value Line estimated that Ethan Allen (ETH on Nyse) would show $39.6 in revenue per share by 2022 to 2024, a 5-year CAGR of 6.5%. But to me, that was odd assumption since in 2014, revenue per share was $25.81, and in 2018 revenue per share was $28.9, merely a 5-year CAGR of 2.5%.

Reviewing competitors on the Value Line Investment Survey is now an integral part of my onboarding process [6]. Not unlike real life, it is easy to fall in love. If I spend a week or two researching a particular stock, it is difficult not to buy the stock since I invested so much time and effort in understanding the business and its management.

But that is a mistake. So now, I read about competitors while researching a specific business. The constant comparison allows me to find similar companies that are trading at a comparable price with, perhaps, better growth opportunities.

Finally, the Value Line Investment Survey is an educational tool. It exposes the reader to unpopular industries. Value Line not only comments on the industry as a whole but allows us to compare the industry's fundamentals via a review of the major players. I don't know of a better resource for that academic exercise.

I have other uses of the Value Line Investment Survey. Write to me if you would like the complete list.


Founded in 2004, by Charlie Tian PHD, GuruFocus provides institutional-quality financial stock research for the individual investor.

GuruFocus hosts many value screeners and research tools and regularly publishes articles about value investing strategies and ideas. One of the features I use most is the 30-year financial information on businesses. For example, see how easy it is to review AT&T balance sheet.


Who else uses the Value Investment Survey  

In the Berkshire Hathaway 1998 annual meeting, Marc Gerstein asked Warren Buffett how does he manage to review the whole spectrum of choices in equity markets. Buffett's answer was:

"I have yet to see a better way, including fooling around on the internet or anything, that gives me the information as quickly. I can absorb the information on - about a company - most of the key information you can get - and probably doesn't take more than 30 seconds in glancing through Value Line, and I don't have any other system that as good."

Charlie Munger added:

"Well, I think the Value Line charts are a human triumph. It's hard for me to imagine a job being done any better than is done in those charts. An immense amount of information is put in a very usable form. And if I were running a business school we would be teaching from Value Line charts."

I learned about Value Line while reading Mohnish Pabrai's The Dhandho Investor. There he wrote that "Value Line publishes a weekly summary of the stocks that have lost the most value in the preceding 13 weeks.

The Value Line Investment Effect

Not unlike Berkshire Hathaway, The Value Line Investment Effect is considered a market anomaly [7]. In 1982, researchers Copeland and Mayers found that between 1965 and 1978, the Value Line rankings showed statistically significant abnormal returns when compared to the market model. Researchers David Porras and Melissa Griswold then extended their work to the period between 1982 to 1995 and found that indeed, the market anomaly held. Read their findings in The Value Line Enigma Revisited.

Not unlike the performance pf Berkshire Hathaway, The Value Line Investment Effect is considered a market anomaly.

What Porras and Griswold found was that Value Line did well in picking out "winner stocks" but did excellent work in removing "loser stocks." The loser group of stocks had deteriorating financials. If there one thing you take from this article, it is that Value Line keeps the reader informed.

Staying informed is important. It is quite easy to buy a stock; it is much harder to hold it and mainly when to sell the stock. For Marty Whitman, founder of Third Avenue Management, one of the selling triggers was an impairment loss. On page 110 of Value Investing, ✨ he wrote:

"Permanent impairment means that there has been a fundamental deterioration of the business: good finances have been dissipated, new products and new competitors are beaten up, and the industry is becoming obsolete, key management members are lost, and so on."

A few concerns about the Value Line report

The Value Line report overlooks global markets. And to look at U.S.- based companies only is akin to searching for something where it is easiest to look, the streetlight effect. (Write to me if you would receive a few resources on global investing.)

Value Line proprietary ranking for Timeliness and Safety is not absolute. There is no universal definition of what an attractive stock is. What may be appropriate for a 40-year investor may not be right for a 70-year old investor. Value Line readers must come up with their own, unique ranking for what constitutes an appropriate investment.  

Readers of Value Line should have their own ranking system.

For example, when I wrote about Bon Ton stores I defined cheap stocks 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."

Finally, the one-page report should serve as the starting point and not as the endpoint. Today, in our service-oriented economy, the book value of companies reveals little about their economic worth. For instance, you will not find the value of Google's engineers and company culture [8] in their reported book value. Also, investors must understand the quality of earnings and not just the reported earnings.

Reported earnings are subjective. They include too many assumptions: from loan loss projections for financial institutions to impairment loss. The only way to get closer to the economic truth is to read the notes to the financial statements found in the publicly-available annual reports and to understand the earnings quality.


Value Line did not sponsor any of the content written in this article. Pen&Paper is independently and wholly-owned by Noam Ganel, C.F.A.

Our freedom allows us to write about what we believe may be valuable to you. We don't earn affiliate marketing revenue without letting you first know about it.  And when we do, for example, if you purchase any of the books mentioned in this article, we give back 100% of the proceeds. Contact us if you have any questions.

We also don't have any positions in the common stock of Value Line. This article, like many others, is part of what constitutes the value- investor mindset: sharing with the community valuable information.

Or, as Charles Schwab said, "making investing accessible to all." 

FOOTNOTES: [1] The rating theory uses regression analysis to value stocks. [2] Value Line fiscal year ended April 30, 2019. [3] Capitalization is the number of outstanding shares multiplied by the share price. [4] If the wind is at your back, helping you to move forward, you experience tailwinds. [5] Understanding means reading the 10-K, 10-Q and 8-K financials, among other things. [6] The onboarding process is a set of checklist items I go through before buying a stock.[7] Market anomaly demonstrates inefficient markets. [8] Company culture is one of Google's competitive advantage rankings such as Timeliness and Safety.

Projecting quarterly earnings hurts the long term view

Published on:
August 10, 2019
Last Update:

My favorite tables shows the power of compounding. Taken from the Aquamarine 2017 annual report, the table has just three columns and four rows. The table shows what happens to 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?

Taken from Aquamarine 2017 annual report

Glancing at the table every once in a while, I am reminded that (1) stock investing is a long term game, (2) not losing money is more important than maximizing return and (3) a reasonable rate of return, say 7% to 10%, will result in a wonderful investment outcome over a long period of time.

Yet it is unbelievably difficult to focus on year 2039 and beyond. The anticipation of whether a company will report higher sales numbers or net earnings is just too exciting to pass on and it results in both wide mood swings and in swinging market prices.

It is a self-fulling prophecy: if investors expect stock prices to move as a result of quarterly projections then -whether the business fundamental changed what so ever - the stock price indeed moves.

According to Warren Buffett and Jamie Dimon, the quarterly projection of earnings per share is bad both to shareholders and to the economy as a whole. In an Op-Ed to the Wall Street Journal, they write:

Companies frequently hold back on technology spending, hiring and research and development to meet quarterly earnings forecasts that may be affected by factors outside of the company's control.

A few examples from my own portfolio: When Weight Watchers', which I bought in March, management reported to investors in April 2019 of expected softening in sales, the stock dropped to $17 from $27 in less than 24 hours. Yet when the same management reported last week of an expected uptick in sales, the stock immediately jumped to $30. Another example is Hyster-Yale which I bought a few months ago. Here too when management reported on an uptick in sales, the stock climbed to $63 from $55. In short, when management projects earnings, capital markets do what they do best - they react.

Yet between stimulus and response there is space[1]. And I argue that the price movement after a quarterly announcement is the wrong response. Can we reasonably expect a company such as Mednax for example, which I wrote about last week, with over 16,000 employees and a fresh senior executive leadership[2], to make meaning changes in 90 days?

Today's reporting standards

Wall Street certainly expects more reporting today. In The Art of Speculation, written in 1930 ,the legendary investor Phillip Carrett, writes that "many companies publish annual statements that confine themselves to balance sheets and even those publishing income statements omit many details."

More remarkable than the little amount of information companies reported back then is that investors were drawn to the stock market just as much as they are today.

But today's companies report much more. Consider Hawaiian Airline’s management, which provides guidance on expected gallons of jet fuel consumed (expected to be 1.0 to 2.0% less); that available seat miles will be up between 1.5% and 2.5%. It further breaks down the quarterly earnings report by available operating revenue per ASM of 13.81 cents, compared to 14.25 cents a year ago.

This level of reporting takes much energy. I can only imagine how much time senior management spends in preparing for analysts’ questions and how both legal counsel and public relations people advise them. Legal counsel may ask them to use words such as "we believe" or "it is likely that" while public relations people will tell them to emphasize words such as "we exceeded" and "we are positive" and "we see growth."


Research[3] shows that daily meditation or religious practice assists in developing more tolerant, kind behavior. People who have such daily practices are less prone to get upset while driving and are more kind to random strangers.

And just as spiritual meditation on why we are here, how did we get here and how we should live our lives is helpful, I believe that a quarterly- let alone daily - outlook on stock movements is harmful.

To that I suggest three remedies: First, to develop meta-rules, such as "will not sell a stock for at least two years." This will reinforce the attitude that a quarter is just one piece of the puzzle.

Second, to garden. There is no better reminder that change takes time than nature. That There are simply no shortcuts.

My friend's Tomer vegetable garden

Third, cut, paste, print and regularly view and meditate on the Aquamarine table.

[1] Viktor Frankl writes that space is our power to choose our response. In our response lie our growth and our freedom. This is taken from his seminal book, Man's Search for Meaning.
[2] The 25-year president of the company recently retired
[3] Read American Grace: How Religion Divides and Unites Us by Robert Putnam for more on this topic. The book is about two of the most comprehensive surveys ever conducted on religion in public life in America.

The four places I look for stocks ideas

Published on:
April 28, 2019
Last Update:

Where to look for stock ideas? In this week's essay, I describe the four places I visit most often.

13-F filings  

Investors who manage over $100 million in the U.S. report to the U.S. Securities and Exchange Commission (SEC) on their trading activity every quarter. The 13-F form includes the name of the companies bought and sold and the number of shares the fund owned as of the the filing date.

While this information - the trading activities of investors - is not a call to blindly follow their steps, it serves as an idea generation tool. A starting point to look at the kind of stocks knowledgeable investors are buying and the industries in which they are looking at. It is also an intellectual activity to think what drove them to buy a specific stock in the first place.

Most of the time I can't figure it out. The price may seem too high or the company debt position may be too aggressive. But occasionally there are investable ideas. Seritage Growth Properties, a stock I bought in April of last year is one recent example. I had never heard of Seritage prior to reading that Fairholme Funds, a concentrated, value-oriented fund headed by Bruce Berkowitz, had bought the stock. Later on, I learned that Warren Buffett was an investor, too.  

Annual reports to shareholders

Voltaire once said that the secret to being a bore is to tell everything. But today, with social media websites such as Instagram, with best selling books titled Radical Transparency, the appeal of secrecy faded away. Yours truly, who you will not find tweeting or scrolling, has no other option but to embrace this culture. The detailed annual reports to shareholders of funds managers are a good outcome of the transparency trend.    

A few of these fund managers share enough information so that the reader can under their decision-making process. If 13-F filings allow us the see numbers (how many shares were bought), the annual reports to shareholders explain the rationale. I find the latter both very educational and very important.

Two examples. First, I recently bought the stock of Superior Industries International (SUP)  because I noticed that six months prior, Mario Gabelli, the legendary value, paid a price that was twice as high.

I also bought the stock of Stericycle link in January of this year because of Laura O'Dell’s (of Diamond Hill) description of the strong franchise and business model link.


With about 109,000 publicly traded companies worldwide and about 3,700 in the U.S. alone, stock screeners narrow the list of investable stocks. I filter out companies with market capitalization less than $100 million and greater than $2 billion. I filter out any company trading at above 10 times the earnings per share and any stock that shows a big increase in outstanding shares, which I define as over 10% compounded annually over a five-year period.

I look at three screeners each week. The first screen is for companies trading at the 52-week low. Famous Dave is a stock I found as a result of this list. Its market price was $4 when I bought it and for no apparent reason jumped to $7 in less than six months.

The second screen looks at stocks trading at discount to reported book value of at least 20%. Like the first screen, this list often returns companies in too much distress or industries which I cannot understand (read: any industry that ends with a "techs": biotech, fintech and hitech), but once in a while a jewel appears. A fond memory was Regal Entertainment. I bought the stock at 45% discount to book value and sold the position at par nine months after.  

The third screen is the experimental one. One week I may look for companies trading at high pre-tax earnings to reported assets. In a different week, I may focus on companies with management that is buying back the common stock. And in another week, I may look for companies with a negative equity balance which sometimes arises due to accounting rules and not losses per se. Read the excellent The Manual of Ideas If you are looking for further stock screen ideas.


I also like to keep a certain sense of wonder. I am not fixated on a specific way of finding stocks. Instead I leave room for ideas to come to subconscious or unplanned sources. As Blaise Pascal once said, "The heart has its reasons, which reason knows nothing of."

My purchase of Tupperware serves as illustration. In 24 hours, three things happened: first, my best friend's mom, a Tupperware fanatic, called me out of the blue and asked how I was doing. Second, I was reading Guy Spier's The Education of Value Investor  where he uses Tupperware as an example. Third, I lost two of my Rubbermaid lunch boxes and was in the market for a Tupperware myself.

Not as mystical but certainly unusual, I like to research the stock of companies that fall off a widely known index. In the third quarter of 2018, when it was announced that GE was no longer part of the Dow Jones, I read its annual report for the first time (but decided against buying shares - the business is too complicated for me.) But I felt I can reasonably understand the business of Patterson Companies, a $2.0 billion in market capitalization company that fell from the S&P 500 in the first quarter of 2018. I bought Patterson's stock two months after.

So there you have it - four places I visit every week to find bargain stocks. Unfortunately, not unlike your everything-for-99-cents retail store, the stocks offered are often no bargain at all.

The Most Useful Articles

Published on:
December 28, 2018
Last Update:

This is the time of year in which most media websites share with readers the most popular articles. If I was to use the same definition of popularity as the New Yorker - which is time spent on the article - the list below would be completely different. Instead, I highlighted the articles that readers had mentioned were either useful or simply enjoyable to read.    

First article

5 Myths About Stock Investing: How to Avoid Faulty Assumptions About the Stock Market

In February 16 I wrote about four stock myths. The first myth is the association of risk and return. To achieve a higher return you need to research stocks and to understand business models. The second myth is the definition of risk, which should be the probability of losing money and not whether a stock price is up or down. The third myth is that a financial advisor will change your financial destiny. I argue instead for self-ownership and accountability in financial decisions. Finally, I explain why you should care little whether the stock market is up or down. I argue for a yearly plan of stock investing and sticking to it.  

Second article

Written in March 2, Treasury Stock: If the Return on Equity Is Too Good to Be True, was an unpopular, barely read article. But it is one of my most important essays of 2018. In this somewhat technical article, I describe the adjustment of treasury stock and how the reported financials hide an economic truth. The point of the article is to remind you that reported financials are the starting point to understanding a company's economic reality.    

Third article

Written in March 23, in Frontier Communications: Where the Financials Statement Reveals Little Economic Reality, I described why I bought the common stock of Frontier Communications. This article serves as a reminder that I need to spend more time reading financial footnotes. While in the article I focused on the goodwill impairment charge and the change in dividend policy, I hardly looked at Frontier's right side of the balance sheet. I was eager to buy the stock and this was a mistake that cost me a lot on paper. My cost basis is about $6 a share and the stock is now trading for $2.50. Ouch.

Fourth article

If I was told that I could take only one profitability ratio to a remote island, it would be the return on invested capital ratio. Written in May 25, in Return on Invested Capital: An Incredible Ratio to Examine Profitability and Performance I show how companies that demonstrate a consistent positive return result in an uptick in the stock price, and that the inverse is true as well. When companies return on invested capital ratio is poor, their stock price is penalized.

Fifth article

Who would have thought that buying stocks would make me more health conscientious? Written in August, In Lifeway Foods: Why I Am Long Probiotics, I mentioned the purchase of LWAY simply because I loved the product and because LWAY stock was listed in the 52-week low list, just as I was reading about the benefits of Microbiomes. Lifeway is run by honest management that is heavily invested in the company and carries little leverage, and I could not be happier about the purchase. Even though I noticed the other day that Trader Joe is now selling its own brand of Kefir milk.

Sixth article

Make Equity Great Again: The Case of L Brands is one of my favorite reads of 2018 because, in the 1,000 or so words, I incorporated most of my investing philosophy. In the article I describe why I think that reported financials hide an economic truth and how adjusting the intangible assets we still get a conservatively leveraged company. The article includes topics such as return on invested capital and treasury stocks, topics that I discussed in more depth in other articles.

Seventh article

Readers of Pen & Paper know that if there is one advice I have for students who are interested in the investment management profession, it is to register for the CFA program. It is a three-year rigorous study plan that will forever change how you manage time and how you understand and advise on investments. In this talk to the new CFA charterholders of San Diego from November 16, titled Watch Your Step! My Thoughts for New CFA Charterholders, I discuss what I learned about investing from the CFA program and how it changed my life.  

Eighth article

It is one of my guilty pleasures to read self-help books. The typical flow is that I read the advice the author is encouraging the reader to follow; I get excited about how it may change the way I think, feel and act in the world and the guilt parts comes in - when I realize that few weeks have passed and nothing has been done on my part. But Cal Newport's book, Deep Work, is different. Written in December 1, in Begin with the End In Mind: How to Use Deep Work in Stock Research, I assure the reader that I will follow through. That it's been weeks since I read the book and have yet to execute on a single action item is a different story.

Defining popularity by time spent reading

Finally, for the curious reader, if I was to sort the list by popularity as defined by the time spent on each article, the following list would arise:

Tupperware Company: A quality product. But shareholders should be wary of the debt level

Adaptive Markets: A new theory to replace the efficient market theory

General Electric Company: GE's world is a fairy tale story that will not end well  

Free Cash Flow: Revenue is vanity. Profit is sanity. And cash is reality

Return On Invested Capital: An incredible ratio to examine profitability and performance

5 answers to the most common questions: This article is about why I am doing

Vanguard 500 Index Fund investor shares: Why I bought one share

Seritage Growth Properties: Financials metrics are worth more than a thousand words

A Few Red Flags You Should Know About

Published on:
October 28, 2018
Last Update:

Gordon Gekko could be easily identified. He combed his slick dark hair back; wore white
shiny suspenders; and certainly had an evil and malicious look. But to identify such sleazy characters in real life is not as simple.

I came across financial advisors, charged indicted and by the SEC, with crimes that ranged from insider trading to the creation of fraudulent financial statements, and some of them were the nicest looking people. 

 We need more than Hollywood characters to know which stock products or services to avoid.  BrokerCheck, by Finra is a website aimed to help you make informed choices about brokers and brokerage firms. But I doubt how many investors actually know of its existence and use it regularly to check on their financial advisors. 

The psychologist Jordan Peterson observed that most people take care of their dogs better than they take care of themselves; that most investors rarely investigate enough the custodians is an example of how little we take care of ourselves.

This meditation describes a few warning signals of bad financial advice.   

 Red Flag #1: Quick and Effective Cure-All

Just as there are no shortcuts to a happy life, there are no shortcuts to stock investing. To become successful at stock investing, you need to exhibit a stoic patience and to develop a long-term perspective. By definition, these qualities require time. 

And there is no single investing formula that will work in all economic cycles. What works when the markets are down will not necessarily be logical to follow when the markets are rising. How how you should invest in stocks in your twenties is not the same as how you should invest in your sixties. And if you are planning to sell your stock portfolio in three years or thirty years makes a big difference.  

 Red Flag # 2: A One-Size-Fits-All Formulas and Miraculous Breakthroughs

Except for the adage "Live within your owns," there are no axioms when it comes to stock investing. One investor may be comfortable in placing big bets on the direction of a foreign currency (imagine a George Soros) while another investor, who is just as skilled and smart, may be appalled by that investing strategy. Instead, that investor may focus solely on commodities such as gold (think James Grant).

 Not only is there no single formula for stock investing, logic dictates that if there was one, no rational person would share that information with you. When a business hires a consultant, he or she is expected to provide research. But it would be outlandish to think that the consultant is expected to explain to the business owner how to make a profit. 

Red Flag #3: Act Now!

"Necessity never made a good bargain,” said our founding father, Benjamin Franklin. And what was true over two centuries ago is relevant today. A wise investor compares among brokerage companies, assesses the possible outcome of a stock purchase and carefully analyzes the companies prior to investing in their stock. 

When a speaker for a commercial advertisement explicitly implores you to make a decision now, the speaker implicitly suggests that you should not think at all. And an omission of thought is one of the leading causes of accidents. The linguist Steven Pinker notes that "accidents are the fourth leading cause of death in the Unites States, after heart disease, cancer and respiratory diseases."  

 Red Flag #4: "Sophisticated" and Greek-Laden Language

Delta measures the degree to which a stock option is exposed to shifts in the price of the underlying asset. Gamma is the rate of change in an options delta per one point move in the underlying asset's price. And beta is a measure of a stock's volatility in relation to the market. And while these are interesting terms to explore if you pursue a doctoral thesis in finance, the prudent investor is better off to leave these terms to academia.

One of my pet peeves is the term "risk adjusted return," often found in a prospectus. What the authors of the prospectus mean to say is that they feel the expected return is adequate for the given amount of risk that they take. But an adequate return should be defined by the investor, not by the manager of a fund.

And so too should be the definition of risk. The American food author Michael Pollan suggested that we should not eat food that our grandmother would not recognize as food. His rule of thumb applies to stocking investing, too.  

Red Flag #5: A Claim of a Risk Free Investment

Marrying another person requires a leap of faith. Going through a medical procedure may have unwanted results. And when you invest in stocks, you may lose money. The term "risk free" is as real as the character Tyler Durden.

Instead of focusing on the sisyphean task of eliminating risk completely, what the investor should ask is what are the benefits compared to costs, and how the two weigh against each other. I argue that risk free investments are fairly tales. But the advisors who offer that schemes do exist in real life.


"Please let there be no strife between me and you, and between my herdsmen and your herdsmen," Said Abraham to Lot. "For we are kinsmen. Is not all the land before you? Please separate from me: if you go left, then I will go right, and if you go right, then I will go left."  

If you come across a financial advisor who claims any of the above mentioned red flags, my suggestion is to turn the other way and to follow Abraham's words.

Buying Stocks is not Stock Investing

Published on:
August 10, 2018
Last Update:

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 associated with these jobs. 

Avoiding certain stocks

The first task is to know which stocks to avoid. Most readers of Berkshire Hathaway’s annual report memorized the term circle of competence. I would also add that you should refrain from buying stocks that do not match with your value system.

For example, I read last week about Signet Jewelers (SIG), a diamond jewelry retailer with a market capitalization of $3.6 billion. At first sight, Signet appeared to have all the ingredients of an undervalued stock: The company showed a high return on capital invested; had increased earnings per share since 2009; and the stock price had recently halved.

While I am fond of such stories, I did not feel comfortable with Signet’s business model. Reading its annual report, I found that the company had financed over sixty cents of every dollar of sales. In other words, Signet not only leverages its balance sheet (for every dollar of tangible assets, Signet had more than 70 cents of liabilities), but also finances its customers to buy the product.

That was against my value system. If a person finances a car acquisition so that he or she can get to work or school, I regard the debt obligation as a proper investment for a better future. But when a company is providing finance so that a young man can impress his young fiance with a wedding ring he cannot truly afford, I think it’s a bad start for a healthy marriage and a bad recipe for our society as a whole. 

Preparing a watch list

Another weekly ritual of the serious stock investor is finding stock candidates and adding them to a watch list. A watch list is composed of several companies that the investor would be interested in purchasing shares in future time, at the right price of course. Often companies on the watch list performed better than their peers; are managed by honest and capable people with a solid track record in business; with a product or service that has a competitive advantage - but with a current stock price that is just too dear.

The Mosaic Company (MOS] is on my watch list for example. Based in Plymouth, Minnesota, Mosaic mines and produces phosphate and potash fertilizers. Consider its stock price. Over the past decade, the stock traded as low as $10 and as high as $89 per share. The 10-year average price range was $58 to $33; the company 10-year average earnings were $3, and 2017 was the first year it reported on a loss in the income statement in over a decade. To me, at a current price of $29, the stock is too high. However, if the stock price will drop to the low $20s level, I will be rushing to buy it.

Portfolio management

Just as a business owner is expected to review the operating financials of a business he or she invested in, the same is expected of the cautious investor. The investor must ask and assess whether management is acting on behalf of shareholders and whether the investor would repeat the stock purchase, if the investor had not already been a shareholder.

One method to monitor and assess management is by watching their acquisition behavior. Some of the questions the investor must ask are: Is management overpaying? Is management financing the acquisition with debt or is it using the company’s stock (and diluting current shareholders)? Because the nature of managing a corporation is that the more assets, the easier it is to justify a higher salary or bonus. Often you will find careless, senseless acquisitions. 

Finding creativity

The investor is expected to think outside the box to find bargain stocks. I know stock investors who refuse to read stock reports written by brokerage companies, as they feel there is too much misaligned of interest. I also know investors who refuse to speak to management because they are concerned that management will influence their decision making process.

I like to find stocks using four main methods. First, I glance each week at a list of stocks that are trading at a 52-week low (I use a free stock screen provided by Guru focus). Second, I read the 13-F filings written by investors such as Guy Spier or Bruce Berkowitz and try to reverse engineer their thought process. Third, I glance at stocks that cut their dividend rate - read Who Cut Dividends in March 2018? as an example. And finally every year I watch for companies that left the S&P 500.

When Patterson Companies (PDCO) announced that it would be leaving the S&P 500 index in March of this year, in a course of one day, its stock fell from $32 to $24, a 22% decline. So I decided the buy the stock and you can read why in The One Advantage of Short Term Thinking? A Cheap Stock Price.    

Selling stocks

While there is no rule or given law to determine when is the right time to sell a stock, there are a few invariable considerations. Taxes are one. If in a certain year the investor is expecting a large taxable income, it may be sensible to sell certain stocks that lost value, to offset the taxable income.

But the main reason to sell a stock is when the investor believes that the sale price aligns with the value of the stock, and ideally, that there are other immediate companies where the investor can allocate the sale proceeds to. When I make a stock purchase, I write down using a pen and paper what would be the price that I would sell the stock. To me, it takes away the emotional aspect of owning a stock and replacing it with meeting an objective I had set for myself.

How to Avoid Faulty Assumptions About the Stock Market

Published on:
February 23, 2018
Last Update:

Myth #1: The greater the risk, the higher the return. 

 “No pain, no gain,” said Jane Fonda in one of her workout exercise videos. Somehow, the investment world has followed Jane’s advice. Today, the “obvious” relationship between risk and reward is hardly even worth the mention.

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 that your see a higher return.

Let me restate the above paragraph in its negative form. The less effort you put into understanding the stocks you invest in, the more likely it is that you will lose money. Unfortunately, I learned this lesson the hard way. As I wrote in The Lessons Learned in Investing in Bon Ton Storesand in How Rait Financial Taught Me A Lesson, there is a price to be paid when financial information is overlooked or when notes to the financial statement are not read carefully. (You should read management's notes and disclosurelike you would read a lover letter: where you never want to miss a word).       

Myth correction: There is a relationship between how much effort you put into stock research and your investment results.

Myth #2: Risk is the change in a stock’s market value. 

Ask any MBA graduate how they were taught to understand risk and they will tell you that risk is the change in the quoted market price of a stock. For example, if the market price of stock A ranged between $17 and $20 while the market value of stock B ranged between $20 to $10, then stock B is riskier than stock A. But I propose to view risk as simply the likelihood of losing money.

Here is a thought-game to illustrate the idea. Meet George, who recently purchased a home. George is likely to sell his home in two years due to a job relocation. Now meet Benjamin, the proud owner of a home nearby. But, as opposed to George’s situation, Benjamin owns a dentistry practice near his home. And Benjamin intends to live in that home for at least another decade. It should be obvious to you that George has taken a substantially greater risk and is exposed to changes in the real estate market.  

Myth correction: The definition of risk is how likely it is that you will lose money.

Myth #3: Future growth is more important than current price.

 Investment advisors (spoiler alert: the topic of the next myth) often reason a hefty premium on earnings, say, anything above 25 times last year’s earnings per share, with the rationale that future growth in earnings will justify the current premium paid. And the great investing gurus have often stuck to that logic which further supports the myth. But for many of us it is the short term that dictates our investing behavior.   

Take Goodyear Tire & Rubber Company as an example. Let us say that you had bought the stock in 2007 and had paid as low as $21 or as high as $37. Prior to your purchase, the company had shown earnings in five of the seven prior years. But the largest U.S. manufacturer of tires reported losses in both 2008, 2009 and 2010. And if you were to sell your position in 2011, you would receive as low as $8 and as high as $18. Very few of us would be able to hold the position for another decade.

In the Intelligent Investor, Benjamin Graham described the investor and his “short-termism:”

“His frame of mind, his hopes and apprehensions, his satisfactions or discontent with what he has done, above all his decision what to do next, are all determined not in the retrospect of a lifetime of investment but rather by his experience from year to year." 

Myth correction: current price is more important than future growth.

Myth #4: You will profit by listening to investment advisors. 

Walk down Main Street in any town in America and you will not find a single store that sells profitable business ideas. And if an entrepreneur reads this and decides to venture out and to establish such an enterprise, common sense would dictate that if the entrepreneur truly knows how to earn a profit, would he or she not attempt to profit for him or herself?

But this common sense convention - that truly profitable ideas are rarely shared - is hidden by the naiveté of investors who rely on investment advisors to help them choose stocks that will (hopefully) increase their fortunes.

(To be clear: this is not a rant against investment advisors. Many of them are professionals who assist clients in retirement planning and by preventing their clients from making dire mistakes in the stock market. That is a praiseworthy work).

Myth correction: the role of a financial adviser should be to supply information and offer suggestions. 

Myth #5: A hot stock market signals that you should sell stocks.

I will make the argument that to ignore short term market movement is one of the best decisions you will make as an investor.  As I wrote earlier this year in Why I am Doing This, my plan for 2018 is to allocate $20,000 to the U.S stock market (effectively all my expected savings). I plan to allocate $5,000 each quarter and to find one stock to invest in about once a month. For most of us, it is very difficult to be oblivious to a declining stock market, so forming habits and goals (such as investing in stocks, regardless of where the market is) is one way to handle our investing nature that often acts against us. In the words of an ancient poet, “Habit’s but long practice, and this becomes men’s nature in the end.”

Myth correction: make a yearly plan of stock investing and stick to it.

This article is about why I am doing this

Published on:
January 5, 2018
Last Update:

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.

What is your blog about? 

I write about companies and businesses. I write about why I invest in a certain company and keep the reader informed on my purchase as time progresses. In the articles, I explain why I purchased a certain stock and why I sold the stock.

 There are four common reasons for selling a stock:

1. When the market value of the company is about where it should be and I don’t see a potential gain in holding the stock. For example, when I purchased Famous Dave I was quite certain that the stock was worth more than its July 2017 quoted stock price of $3. Now, at about $8 a share, I am less confident of any future gain and will probably sell my Famous Dave stock soon.  

2. I sell a stock when the it did not perform as expected; within, say, a holding period of two years. When I paid for Hudson Pacific Trust $35.72 on January of 2016, I wrote:

Hudson Pacific Properties should grab your attention. Over the past 5 years, real estate per share increased to $67 from $36, while liabilities per share increased to $29 from $15. Its income statement entails a similar tale. Revenue increased to $5.90 from $3.77, while operating expenses remained at $2.65. Given the alternatives, a share in Hudson may be a reasonable location to park cash.

I estimated that by the first quarter of 2019, the company stock would trade at over $40. But as of the first week of 2018, the stock is trading at about $34, I am most likely wrong and will probably sell the position in a year’s time. 

3. Tax planning. In December 2017, I finally sold my position in Rait Financial Trust, a position where I lost 80 cents of every dollar. So, I sold the position on the last week of 2017 to offset the taxes.Visit How Rait Financial Trust Taught Me A Lesson if you want to know more. 

4. A position is sold when another company buys the company. Two recent illustrations come to mind: I purchased stock in Care Capital Properties for $24.85 in February 2017. But in August of last year, Sabra Health Care REIT acquired Care Capital. So I found myself owning Sabra Health without ever signing up for it and I plan to sell the stock in 2018.

Another example, a joyful one, relates to Regal Entertainment Group (RGC). I purchased shares in Regal at $14.89 on August of 2017. Cineworld, a Eurpoean-based competitor recently announced that it is acquiring Regal for $3.6 billion, or $23 a share in cash. Regal now trades at $22.91 and I will sell the position in the first quarter of 2018 (as soon as I find a better place to park the proceeds – I am still looking.)

What made you start a blog and why did you call it Pen&Paper?

I started the blog to provide a unique perspective on investing. I could not find resources that were transparent on the minutiae of stock investing and I wanted to fill the gap. The blog is also a way for me to give back. I learned so much from other professionals that dedicate some of their time to share their experience and I wanted to follow in their footsteps. Ran Regal, a designer genius from Israel is one from whom I learned much and greatly admire. His vlog is about design.

Besides, it is rewarding for me to get warm feedback from readers. Last month, one reader wrote to me: “your article was absolutely invaluable as an education tool. I’m sharing it with my investing friends, and saving it for when my kids get older to share with them.”

Finally, all of my investment decisions are made using a pen and paper (okay, at times I cheat by using an HP12C calculator). I find sensible investing to be simple and within the aptitude of anyone. So I named the blog Pen&Paper to emphasize that the tools for sensible investing are available for us all.     

What do you do for a living and what is your educational background?

I provide debt and raise equity on U.S. commercial real estate properties. I work for Silvergate Bank, a commercial bank. You can see some of my work by clicking here.

While I have a bachelor and a master degree in business administration, I attribute my theoretical and practical understanding of the investment profession to the CFA Institute and its members. Only when I earned the Chartered Financial Analyst (CFA) certification did I begin to understand the scope of the investment management profession.

How do you measure success in stock investing?

I compare the growth in the market value of my portfolio of stocks to  the growth in the S&P 500 index over a five-year span.

Yet comparing my investing performance to the S&P 500 index is a fairly new metric for me. In the past as long as the market value of my portfolio of stocks was higher than my cost basis, I felt I was doing fine. But I decided recently to change that system of measurement.

So on the first week of 2018 I purchased one share in a Vanguard’s ETF and its mutual fund, both track the performance of the S&P 500.  Please write to me if you would like to know more about the world of ETFs and mutual funds and why I decided to compare my performance to them.

How will the stock market and real estate market perform in 2018?

I don’t have the slightest idea. It also does not matter to me. 

For me, purchasing stock is similar to savings where, in the short term, the real goal is to save and in the long term, it is to have more than you originally saved.

In 2018, I plan to keep a portfolio of 15 to 20 companies. My goal is to allocate an additional $20,000 in the stock market; that is, as long as the companies in which I invest meet my criteria for investments (which is a reasonable price for a wonderful business that I can understand.)

 My final goal in 2018 is to improve this blog. So if you have a topic you would like me to cover, or, perhaps, a suggestion for me to improve the website features (one reader mentioned I should add market quotes on portfolio companies but daily market quotes to be distracting), I would be happy to hear from you.

A Review of The Stocks I Purchased Over The Past Six Months

Published on:
December 9, 2017
Last Update:

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. 

Second, other companies I found were trading below their 10-year historical multiple to earnings. Take Regal Entertainment Group, as an example. Over the past decade, the average earnings multiple was between 28 and 19 times. I purchased the position at 17 times the 10-year average earnings per share. 

The third category for stock purchases was dividend yield. Capstead Mortgage and Terra Nitrogen fit in this category wtih an expected dividend yield of 7% and 6%, respectively.

I would get back 93 cents for every dollar I invested in the portfolio of companies if I was to trade my portfolio of companies for cash. I experienced a substantial decline in market value with Vitamin Shoppe and RAIT Financial Trust. While the latter lost 32% in market value and the former lost 85% (ouch, that was painful to write), their overall negative effect on the portfolio was 5% and 4%, respectively. I received $388 in dividends from these companies to date and expect to receive an additional $848 in 2018, an expected yield of 3.5%.

While I am indifferent to a 7% decline in market value, I have one regret. I should never have purchased a position in RAIT Financial Trust. As I wrote to you, the company had a tremendous amount of liabilities with little equity. And while it was fairly easy to see that, I led myself to believe otherwise. I plan to keep this position in 2018 - just to remind myself of the potential, dire consequences of rash decisions.

Two lessons can be observed from these recent purchases. The first lesson is one stock should rarely represent more than 15% of your portfolio. By having this rule of thumb, the steep decline in value for RAIT Financial Trust had less than a 5% effect on the portfolio.

It is a popular cliché that the only assurance in life are death and taxes. I would add that mistakes are of certainty as well. So diversification, defined as an equity position in 15 to 30 companies, is one of the tools I use to allow for future mistakes.

The second lesson is that market fluctuations should be taken lightly. As long as you don't invest using a margin account or develop the bad habit of shorting stocks (some would argue that shorting stocks is a vice), the practical effect of the changes in the quoted prices, assuming you plan to hold them for three- to five-years, is nil.

If a person runs down your street, frantically yelling that he is willing to purchase all the homes on your block for 60 cents on the dollar, how would you react? Would you immediately sell your home? 

My guess is that you wouldn’t.  And similarly, quoted prices on stocks you purchase, if you are confident in your analysis and investment, are best to be ignored.

What's next? Other than to research and to write about investment topics, I don't expect much investment actions. Over the next months, I plan to write about the tools I use to find stocks, how I research stocks and what my criteria are to purchase a position in a company. 

If you would like to be notified when I post articles, please leave you email address below and if you have any questions, just write to me. It may take me awhile, but I reply to all emails. 

For now - Happy Holidays! 

Brings Joy To Both Omnivores And Vegans

Published on:
August 4, 2017
Last Update:

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. 

Here it is: a reasonable price decline, following a loss in sales, should be close to the difference between the 10-year average earnings and the current earnings. If the price decline is higher, then market price has been penalized too heavily. For Famous Dave, the average 10-year net earnings after capital expenditures, was $0.61. The 2016 net earnings after capital expenditures was $0.37, a decline of about 40%. The stock price, however, lost 72%.

The price decline seemed harsh, I thought. But a bearish price may be the result of the restaurant industry economics, unrelated to the operations of a specific company. And it is obvious that the industry is fraught with an increasing amount of risk. 

Have you lately tried to open in California a restaurant? The amount of red tape and regulation you will experience will leave you with a similar outcome as that of a boat buyer. Where your happiest day will be when you sell the business. But red tape for the restaurant industry is not the only problem.

Ask anyone in the restaurant business and they will tell you of flaky clientele, of increased competition and of the client’s palate that follows whatever the current nutrition gurus say. Today, owners of restaurants will tell you that to differentiate your restaurant, you should focus on organic produce; yet five years ago, all you had to do was avoid high fructose corn syrup; and before that, it was trans fats. 

In short, to budget your ingredients for the next fad will be difficult. But I have side tracked from our topic of discussion. So, before I further advise you to eat only what your grandparents would recognize as food (Michael Pollan talks about it in his wonderful book, “In Defense of Food”), let us get back to the analysis of Famous Dave.

Purchasing a common share at Famous Dave at about 6 times the 10-year average net earnings after capital expenditures met my cardinal rule of investing, which is that I rarely pay above 10 times the earnings per share. Yet, as I told you, I felt the decrease in market valuation was due to industry trends. 

So, I played the following game thought: How much would I have earned, over the past three years, if I had owned the competition (which I subjectively defined as DineEquity (DIN) that franchises and operates Applebee’s, Denny's (DENN), Nathan’s Famous (NATH), and Brinker International (EAT) that owns Chilli’s) versus owning a share in Famous Dave. The answer was about 9% earnings yield for the competition and about 20% earnings yield for Famous Dave. 

Put differently, without any price appreciation, I would get my money back in four years with Famous Dave, while it would take about nine years with the competition. That was enough for me to make a decision.

In short, I bought some common shares in Famous Dave. I did not make the purchase because Famous Dave won the 2013 “Best in the West Cook-Off” national competition; frankly, I have never been to a Famous Dave. I hardly eat meat and am somewhat allergic to barbecue sauce. 

But I felt the price of the stock was low enough compared to the company’s past valuation and compared to its peer competition. And, perhaps, this purchase was less rational than I care to admit: perhaps I wanted to please my mom as she often nags me with “Did you get any meat this week?”

And now for the usual disclaimer: please remember to read this article as a starting point. My goal is to share with you the stocks that are on my mind and…well…pockets. But not by any means to encourage you to follow blindly what I do. You should research the company, industry and its prospects on your own. Investing is an art as much as it is a science, and just as you and I may not share the same enthusiasm for, say, the Impressionism movement, our opinions on companies may not be the same. 

Besides, Seeking Alpha has for you other excellent commentators on the company, with a line of reasoning that differs from mine. For example, the author using the pseudonym Courage & Conviction will provide you with their impression of the company after attending its annual shareholder meeting. And Mark Gottlieb questioned Famous Dave’s management as to why they still owned a few of their restaurant (37 to be exact) and did not transform their business to be franchised restaurants only.