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Geoff Gannon December 29, 2010

International Value Investing: Send Geoff Your Favorite Homegrown Stock Idea

Are you a value investor living outside the United States?

If so, you can write for Gannon On Investing.

Seriously, I’m looking for guest posts on stocks outside the United States. The only rule is that you have to write about a stock from the country you live in.

No stock or country is too small.

Payment is zero dollars in the currency of your choice.

Email me your favorite homegrown stock idea and I’ll post it to the blog.

No Americans need apply.

Talk to Geoff About International Value Investing

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Geoff Gannon December 28, 2010

How to Get Started in International Value Investing

A reader sent me this email:

Hi Geoff,

I am a student and am very interested in international value investing. I was wondering if you had any advice for me or if you knew of any people out there who are dedicated to this area (both gurus as well as bloggers). If you could recommend any resources I would highly appreciate it.


Start by limiting yourself. Pick which countries you will invest in and which countries you won’t. I recommend drawing your circle of competence around these 22 countries:

  1. Denmark
  2. New Zealand
  3. Singapore
  4. Finland
  5. Sweden
  6. Canada
  7. Netherlands
  8. Australia
  9. Switzerland
  10. Norway
  11. Iceland
  12. Luxembourg
  13. Hong Kong
  14. Ireland
  15. Austria
  16. Germany
  17. Barbados
  18. Japan
  19. Qatar
  20. United Kingdom
  21. Chile
  22. Belgium

Those are the 22 countries perceived to be less corrupt than the United States according to Transparency International’s yearly index. It’s not a perfect list. But it’s a good list. It’s pretty close to what I’d tell you myself. And it has the benefit of not being one guy’s biased opinion.

Download Google Chrome. And bookmark the CIA World Factbook.

Chrome will translate websites from foreign languages into English for you. And the Factbook is the best guide to the world’s economies.

Make Bloomberg your financial portal. It has the best international ticker search.

Read Hidden Champions of the Twenty-First Century. It’s a good introduction to foreign companies. Mostly from German speaking countries.

American value investing shops that are heavily into foreign stocks include First EagleThird Avenue, and Wintergreen. Thomas Russo also likes foreign stocks. You can watch 3 lectures Russo gave to Professor Greenwald’s class here.

Some of my favorite value investing bloggers aren’t U.S. based. The author of the Interactive Investor Blog is in the U.K. The author of Greenbackd is in Australia. And the author of Variant Perceptions is in Mexico.

You can listen to me interview the author of Greenbackd here.

Richard Beddard of the Interactive Investor Blog isn’t just based in the U.K. He actually focuses on U.K. stocks. His blog is a must read.

Other U.K. blogs include UK Value Investor’s Diary10 Value 10, and The Sunny Day Investor.

A lot of blogs include lists of other blogs the author reads. Go through the list. Click on each blog’s name. Use a feed catcher like Netvibes to subscribe to any of them that interest you. I subscribe to about 50 blogs. You could easily manage several times more.

You can do the same with Twitter. Pick an investing blogger you like who invests outside the U.S. Then use him to find other value bloggers in the same country. Repeat.

Stock exchange sites are insanely difficult to navigate. Usually, you can use the sitemap to find a buried page that lists all the securities alphabetically. For small countries, this is ideal. If you’re looking at New Zealand or Ireland, you want to just go through the whole list the way Warren Buffett flipped

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Geoff Gannon December 28, 2010

Illiquidity and You

swath Damodaran has a post on Asset Selection and Valuation in Illiquid Markets. It’s a fine theoretical discussion of the subject.

But I’d like to talk about practical illiquidity. What does illiquidity have to do with stock picking?

Let’s start with the big question.

Should you apply an illiquidity discount to specific stocks?


My view of illiquidity discounts is basically Warren Buffett’s view of using risk based discount rates. Risk isn’t something you account for in the last step of the process. Risk is something you think about every step along the way. Same with illiquidity.

You start by asking: Is it safe to hold this stock forever? Can I afford to get locked into this stock?

That means you check the stock’s vital signs. What’s the Z-Score and the F-Score? How is the balance sheet? Does it have 10 straight years of positive free cash flow? Does it have minimal cap-ex requirements? Has it earned an above average return on tangible capital over the last 10 or 15 years?


Then you can afford to hold the stock forever. The downside risk of getting locked in the stock is not catastrophic. The stock is safe in the sense that the business itself isn’t going to implode and the intrinsic value isn’t likely to decline over time. At worst, it’s a big time suck. But, if you buy at the right price, you’re risking your opportunity cost instead of your principal.

Next, you calculate if it’s possible to get in and out of the stock. If you’re a patient, individual investor the answer is almost always yes. Even if we take a very illiquid stock like one that on average trades shares worth $5,000 each day, that’s usually enough for an individual investor to make a long-term investment in the stock.

Here’s why.

A stock that trades $5,000 a day trades $100,000 a month (if a month is 20 trading days).

Charlie Munger mentioned that Berkshire Hathaway (BRK.B) bought 30-40% of the daily trading volume in Coca-Cola (KO) when it amassed its stake. Buying micro-caps, I’ve often bought even more than 40% of a stock’s volume. In several cases, I never paid a cent more for any of my shares than the last price the stock traded at before I started buying. Weird, huh?

But totally true. It doesn’t always work that way. Obviously if I’d tried to force it and buy the amount I wanted without regard to price, that’s not what would’ve happened. Instead, I just sat at the same bid for weeks and took whatever shares came down to that price.

I should point out that sometimes it works differently. Sometimes you get your shares the way Berkshire Hathaway got its investment in the Washington Post (WPO). Berkshire got virtually all its stock in the Washington Post from just 4 or 5 large investors. It happened very fast.

I’ve had that happen too. I go in expecting to be buying for a month. And …

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Geoff Gannon December 24, 2010

How to Calculate Free Cash Flow – 5 Illustrated Examples From Actual 10-Ks

Some readers have emailed me with questions about exactly how to calculate free cash flow. Do you include changes in working capital? Do you really have to use SEC reports instead of finance websites? Things like that.

Yes. You really do have to use EDGAR. Finance sites can’t parse a free cash flow statement the way a trained human like you can. As you know, I’m not a big believer in abstract theories. I think you learn by doing. By working on problems. By looking at examples.

Here are 5 examples of real cash flow statements taken from EDGAR.

We start with Carnival (CCL).

Notice the simplicity of this cash flow statement. It starts with “net income” (top of page) and then adjusts that number to get to the “net cash provided by operating activities” (yellow). To calculate free cash flow in this case you just take “net cash provided by operating activities” (yellow) and subtract “additions to property and equipment” (green). The result is free cash flow.

As you can see, Carnival produces very little free cash flow. Free cash flow is always lower than net income. That’s because cruise lines are asset heavy businesses like railroads. They have to spend a lot of cash to grow. Carnival’s reported earnings tend to overstate the amount of cash owners could actually withdraw from the business in any one year.

Carnival is our example of a “typical” cash flow statement. There’s really no such thing. But this one is simple in the sense that you only have to subtract one line “additions to property and equipment” from “net cash provided by operating activities” to get Carnival’s free cash flow.

Next up is Birner Dental Management Services (BDMS).

Notice how Birner separates capital spending into two lines called “capital expenditures” and “development of new dental centers”. This is unusual. And it is not required under GAAP (Generally Accepted Accounting Principles). However, it’s very helpful in figuring out maintenance capital spending. If you believe the existing dentist offices will maintain or grow revenues over the years, you only need to subtract the “capital expenditures” line from “net cash provided by operating activities.” But remember, any cash Birner uses to develop new dental centers is cash they can’t use to pay dividends and buy back stock.

Now for two cash flow statements from the same industry. Here’s McGraw-Hill (MHP) and Scholastic (SCHL).

These are both publishers. And like most publishers they include a line called “prepublication and production expenditures” or “investment in prepublication cost”. Despite the fact that these expenses aren’t called “capital expenditures”, you absolutely must deduct them from operating cash flow to get your free cash flow number. In fact, these are really cash operating expenses. For investors, this kind of spending isn’t discretionary at all. It’s part of the day-to-day business of publishing. I reduce operating cash flow by the amounts shown here. At the very least, you need to lump

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Geoff Gannon December 23, 2010

How to Come Up With Investing Ideas

A reader sent me this email:

Hi Geoff,

…I was wondering if there was any other advice you had on how to pick what companies I should look into. You mention a few blogs that I should look to for ideas but what about stock screens? Should I employ those in order to get a rough list of stocks and then choose a few and analyze them by reading their 10-K, etc.? I am just worried I am not sure how to get all the stocks to read their 10-K…


You won’t run out of ideas.

Start with one idea and follow that thread wherever it leads. Don’t obsess about any one stock. Just sketch the investment idea quickly in your mind. Does it grab you? No. Then move on.

You can use screens. I recommend Magic Formula InvestingGuruFocusMorningstar, and RobotDough.

GuruFocus also has 2 newsletters for subscribers to the site. One is about Ben Graham NCAV bargains. The other is about Warren Buffett / Charlie Munger bargains.

Use Bloomberg to “watchlist” stocks. Whenever you find an interesting company, go to Type the company name in the blank box in the upper right of the screen. It will give you the symbol (and exchange) of the stock you want. Click on that stock. To the right of the stock price, you’ll see an option that says “+ Add Security to your Watchlist”. Do that. You’ll need to create a account for this. It’s free.

The beauty of the watchlist is that Bloomberg tracks the stock’s percentage price move since you watchlisted it. Once a week, log into Bloomberg and just look at the stocks that are red. If the company was interesting when you first saw it, it’s even more interesting now that it’s cheaper.

Bloomberg is the best place to follow foreign stocks. So enter any names you get from reading Richard Beddard’s blog over there. Don’t try to track foreign stocks at sites like Yahoo and Google. Or at your American broker.

That brings me to another point. Pick the right broker. If you’re looking to invest like Benjamin Graham and Warren Buffett, don’t use Charles Schwab. Go with an online discount broker that does international and over the counter stocks well like Noble Trading or Interactive Brokers.

Here’s the big mistake most investors make. They refuse to follow their best ideas!

Right now, some people reading this thought: “Really? I have to switch brokers?”

Nutty, I know. But totally true.

Someone will hear about some little company that trades in New Zealand or Denmark and realize Morningstar, GuruFocus, EDGAR, etc. doesn’t have financial data on that stock. Or their broker won’t do a trade there. So they don’t follow up on the idea.

Never limit yourself because you can’t get data on the company. Screens limit you. Pretty soon you’re focusing only on screens that are running in just the universe …

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Geoff Gannon December 20, 2010

Reed Hastings – CEO of Netflix (NFLX) – Responds to Whitney Tilson’s Short Case

Reed Hastings, the CEO of Netflix (NFLX)wrote a response to Whitney Tilson’s article on why he’s shorting Netflix at $180 a share.

I was working on an article about Tilson’s short position in Netflix for GuruFocus when I saw Reed Hastings’s response.

I’ll probably end up writing an article that talks about both their points.

I don’t short stocks. Never have. Probably never will. There are a few reasons for this. One, I’ve looked at value investors who do short – and in most cases – they could have done at least as well if they never shorted a single stock. That was certainly true for Benjamin Graham. It wasn’t worth the trouble.

And that’s point number two. There are some things I can do in investing that I don’t do simply because the trouble of doing them isn’t worth the reward they bring. Once in a very long while I arbitrage an all cash deal. So far, the success rate has been great. But I haven’t had much fun doing it. It’s an oddly unenjoyable experience, buying into something for a small profit and then following it through a minefield of problems till it comes out the other side. Even when it works, it just makes me want to curl up with the annual report of some quality company I can buy and hold for a bit.

There’s a little of that in why I don’t short. Maybe a lot. I’ve seen people short stocks. And what they go through isn’t something I want to go through.

I would never short Netflix. I think it’s an amazing company. I might be biased here since I’m a long-term customer. I’ve basically switched over to instant only – I keep a one DVD plan just so I have that option – but mostly I just watch instantly. And it’s amazing how it’s changed my life.

Amazon (AMZN) is the only other company that comes close. The way they both deal with their customers actually conditions their customers to behave differently. Netflix and Amazon have molded my habits in ways no other company has.

It’s hard to explain. But I know Netflix and Amazon are the two stickiest relationships I have as a customer. They will keep getting my money for a long, long time.

Hastings and Bezos are also the two businessmen that impress me most. That’s outside of the usual suspects – guys like Warren Buffett who are really just investors. I have to admit I’ve gone through the archives and watched both Hastings and Bezos on Charlie Rose.

A few years back, Netflix was trading pretty cheap. It was clearly a Charlie Munger bargain. But it wasn’t trading at a Ben Graham price. And, as you know, I don’t pay up for growth. I don’t pay up for quality. I’ll buy the best stuff that’s quantitatively cheap based on its past numbers and current assets. But I don’t like paying for tomorrow. So I didn’t buy …

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Geoff Gannon December 19, 2010

Should You Learn Investing By Reading or Doing? – Geoff’s Advice to a College Junior

A reader sent me this email:

Hi Geoff,

I am a junior in college who only recently has stumbled upon the realm of value investing.  At this point, I have read Margin of SafetyYou Can Be A Stock Market Genius, parts of The Intelligent Investor, and have recently begun Warren Buffett’s essays.  As a part of my schoolwork, I have taken basic courses in corporate finance, financial accounting, and capital markets.

What I am wondering is how I can best allocate the free time I devote to learning about investing in order to maximize its learning potential, as I am a busy college student now, and will hopefully be a busy employee in the future.  But far from not knowing where to turn, I am rather overwhelmed by the wealth of good resources there are out there concerning value investing, between books, articles, and blogs such as yours.

So my question is: what activity would best serve my education in investing right now, given my elementary exposure to the field?  I am under the impression from my research that the best way to learn about value investing is to do it.  However, value investing is a long and tedious process, involving a lot of searching and reading, often times about company-specific knowledge that in themselves don’t really teach much in terms of the art of investing.  Would it be more educational for me to simply pick good ideas from books and blogs and try to “reverse engineer” the thought process at this point?  Or have I gotten ahead of myself, and should read more classics / take more advanced courses in corporate finance before going further?

Best regards,

Learn by doing.

Don’t worry about abstract theories. Start work on specific stocks. Steal someone else’s ideas and study those stocks. I wrote a post about four microcapsBirner Dental Management Services (BDMS)George Risk Industries (RSKIA)Solitron Devices (SODI), and Bancinsurance (BCIS). Three of those four companies are still around.

Pick one of those three companies. Go to EDGAR and find their latest 10-K. Print it out.

Take the 10-K, a pen, a calculator, and a highlighter to the library. Highlight any phrases that sound worth remembering. Don’t overdo it. Be honest. Just highlight the stuff that sounds like it could swing you one way or another on buying the stock. A good way to do this is to imagine you’re running a conglomerate that is considering buying this business in its entirety. You’ve asked someone working for you to study the company and present the acquisition opportunity to you – in conversation, not a written report – tomorrow morning. What would you want him to highlight?

That’s what you highlight.

Use the pen to write notes in the margin. For me, these are usually questions or calculations.

Don’t take random notes. Follow a thread. Like an interviewer. Imagine the 10-K isn’t just written text but a real person sitting …

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Geoff Gannon December 14, 2010

Sold My Barnes & Noble (BKS) Stock Today

I sold my Barnes & Noble (BKS) stock today. The average sale price was $14.82. I bought Barnes & Noble back in August at an average cost of $15.36 a share. In the meantime, I received $0.50 a share in dividends. The round trip was a loss of 4 cents a share – or 0.26% – while the S&P 500 was up more than 10%.

The reason I sold out of Barnes & Noble is to buy a stock I like better. Since I’m not done buying that stock – and it’s a lot less liquid than BKS – I won’t be telling you about the new stock today.

I’ll let you know the name when I’m done buying the stock.

But, for now, just know that I have sold out of Barnes & Noble.…

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Geoff Gannon December 10, 2010

Tariq Ali of Street Capitalist Interviews Dave Carlson About Insurance Stocks

Tariq Ali of Street Capitalist has a great interview with Dave Carlson of Tourmaline Advisors about insurance stocks. You may remember, I interviewed Tariq a while back.

The interview is full of helpful advice, like when Tariq asked Dave what metrics investors should use to analyze insurance stocks:

Price to book and combined ratio are good starting points. Return on equity, underwriting leverage ratio and investments to equity are other metrics that I look at. On combined ratio, it is also useful to look at the difference between what is reported on a GAAP basis and what is reported on a statutory basis. The “stat” basis is more conservative than GAAP, it’s what the regulators look at, and is a better measure.

Dave mentions 3 insurance stocks: Penn Millers (PMIC)Donegal Group (DGICA), and Seabright Holdings (SBX).

He also talks a bit about Prem Watsa’s Fairfax Financial Holdings (FFH):

As for relying on investment income, yes, Fairfax does rely on it more than most. In their annual report, Prem Watsa mentions the net premiums written to statutory surplus ratio, a.k.a. the underwriting leverage ratio. The ratio at the end of 2009 was around 0.5 for Fairfax whereas most insurers are well over 1.0 and closer to 1.5. Watsa has purposely structured Fairfax so that the underwriting contributes less to results. That’s a good thing because it is a lousy business! This also means that the Fairfax insurance companies are overcapitalized relative to premiums written. Once they satisfy the regulatory/rating requirements for safe investments, they are free to invest the excess capital in things besides bonds. The Fairfax business plan comes straight from Buffett.

Read the full interview at Street Capitalist.

Talk to Geoff About Insurance Stocks

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Geoff Gannon December 9, 2010

ayback Machine Archive For Gannon On Investing: Geoff’s Posts From 2005-2008

Today I’m going to do something scary. I’m going to take you back in time. Way back.

Over at Gurufocus – where I spend most my time writing daily articles – someone asked about an old post I wrote. When I say old, I mean old. Real old. Like 5 years.

The first thing I ever wrote on the internet was on Christmas Eve 2005. This fellow was asking about a post I wrote just two weeks later. To show you how much my posts have changed – I was under the impression blogging meant tons of short, opinionated posts – here’s my January 2006 post “On Chicken Stocks”:

Chicken stocks were in the news yesterday as Pilgrim’s Pride warned of poor earnings. These stocks may appear cheap, but appearances can be deceiving. It is not a question of if margins will contract; it is a question of when margins will contract. Some value investors will take Pilgrim’s announcement as a buying opportunity. It may be just that.

However, I wouldn’t be buying Pilgrim’s Pride (PPC). When trouble comes, the much smaller, much more conservatively financed Sanderson Farms (SAFM) will be in the stronger position. Sanderson Farms has the better recent record when it comes to earning a good return on capital. On the other side of the scales, Sanderson Farms does trade at a higher price to sales ratio than Pilgrim’s Pride. In a business like this, price to sales can be an important number, because there is little reason to expect any one company to consistently maintain a wider profit margin than the rest of the industry.

I won’t pretend I understand this industry. I don’t. I won’t pretend I have any clue as to what these firms will earn over the next few years. I don’t. What I do know is that if I were looking at chicken stocks, I’d start with Sanderson Farms. I suggest you do the same.

You’ll notice there are no numbers in that post. Back then, I thought readers hated numbers. Do they? I’m still not sure. All I know is that I love writing numbers. So readers will have to take my posts with numbers mixed in or go find themselves another blog to read. You’ll also notice there are no dashes in the post. There’s even a semicolon. Maybe I was going through a Herman Melville stage. Yes, even my punctuation has changed. Half a decade of writing for the internet will do that.

Anyway, here is the Wayback Machine archive for Gannon On Investing. You can read my old posts and see all the things I got wrong. History is a harsh mistress.

Talk to Geoff About his Old Posts

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