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Geoff Gannon June 21, 2015

Driverless Cars and Progressive’s Durability

Value and Opportunity linked to a Bank of England blog I never would have found on my own. The Bank of England blog did a post on how driverless cars could hurt the future of auto insurers. Last year, we did a Singular Diligence issue on U.S. car insurer Progressive (PGR). A big part of the durability section of that issue was about driverless cars.

So, here is the Bank of England blog post on driverless cars.

And here is Singular Diligence’s discussion of Progressive’s durability…


Originally Published: December 2014

DURABILITY: Progressive’s Focus on a Combined Ratio of 96 or Lower Makes it Durable

Auto insurance is a durable industry. The only risk of obsolescence is driverless cars. Car accidents are caused by human error. If all cars on the road were driven by computers – there would be virtually no car accidents. This would eliminate the need for auto insurance. The technical difficulties of developing driverless cars are not the biggest obstacle to their adoption. Even much simpler safety technologies like front air bags, side air bags, electronic stability control, and forward collision avoidance generally took 10 years from the time they were first introduced on a car sold to the public till the majority of new models sold in a given year included these features. So, the “tipping point” of safety feature adoption by manufacturers is usually around a decade. Complete adoption takes about 15 years. The average car in the U.S. is about 11 years old. This number has increased over time. Cars are more durable now than they were in the past. Based on these figures, it is likely that once the first driverless car is introduced by a major auto maker on a popular model it will take another 15 to 20 years before half of all cars are driverless.

Auto insurance is required by state law. States will certainly not eliminate this requirement while the majority of cars are still driven by humans. Total adoption of the technology could take up to 30 years. If enough car owners prefer to drive themselves instead of letting a computer drive their car for them, there could be resistance to any laws limiting human drivers. Without such laws, highways would include a mix of human and computer driven cars. Under such conditions, laws might still equally “fault” driverless cars for accidents involving human drivers. These legal complications mean that auto insurance would probably persist into the early stages of a mostly driverless car society.

Today, there are no commercially available driverless cars. So, the end of car insurance would likely be some point 15 to 30 years after the successful introduction of driverless cars. The vast majority of net present value in a stock comes from returns generated within the first 30 years. Even if driverless cars are successfully introduced in the U.S. soon – and that is a completely speculative assumption – it is very likely that auto insurance will persist as a legal …

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Geoff Gannon June 15, 2015

You Can Afford to Hold Cash

In my last post, I said stocks were too expensive. Instead of putting more of your money into diversified groups of stocks, you should just let cash build up in your brokerage account.

A lot of people have a fear that those lost years of making zero percent on their idle cash can never be made up for.

I’ve created a graph to show how much ground you’d have to make up.


Let’s say you have two choices: one is to invest in an overpriced basket of stocks today and hold that basket from 2015 through 2030. This choice will compound your 2015 money at a rate of 6% a year.

The second choice is to do nothing for all of 2015, 2016, 2017, 2018, and 2019. You just hold cash. That cash earns 0% for those 5 years. In 2020, you finally get an opportunity to make an investment that will return 10% a year from 2020 through 2030.

If your investment horizon extends all the way out from today through 2030, the second approach overtakes the first approach about 15 years from now.

Doing nothing for 5 years and then something smart for 10 years is a better 15 plus year strategy than “just doing anything” today.

Here we define something smart as 10% a year and “just doing anything” as 6% a year. You can decide for yourself whether your something smart is 10% a year or not. That’s subjective. What the “doing anything” returns is a lot more objective. So, let’s talk about that.

Over the last 15 years, the S&P 500 returned about 5% a year. During that time period, the Shiller P/E ratio contracted from 43 to 27. The same percentage contraction – 37% – would be required to get the Shiller P/E down from today’s 27 to a historically “normal” 17.

I see no reason why the S&P 500 should do better from 2015 to 2030 than it did from 2000 to 2015. That means I see no reason why buying the S&P 500 today and holding it through 2030 should be expected to return more than about 5% a year.

(Almost all readers I talk to have a total return expectation for the S&P 500 that is greater than 5% even for periods shorter than 15 years.)

It’s also worth mentioning that while I have no predictions as to when idle cash would earn more than zero percent – the Fed does. And those predictions show cash earning a few percent in 2018 and 2019 instead of zero percent.

For those reasons, the graph in this post is probably an underestimate of how quickly sitting and doing nothing till you can do something smart outperforms continuing to shovel cash into the S&P 500 at today’s prices.

I think the reason people don’t feel secure in waiting for an opportunity to do something smart is that they’re not sure when that opportunity will appear.

Maybe there will be no chance in all

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Geoff Gannon June 14, 2015

Stocks Are Too Expensive

We talk about stock picking on this blog. That means we usually talk about specific stocks. The “market of stocks” not the “stock market”. Today, I’m going to talk about the stock market.

It’s too expensive.

You shouldn’t buy it.

If you have an account where you automatically reinvest your dividends – stop. If you are putting money each month into an index fund, or a stock mutual fund, or a bond mutual fund – stop. Those assets are overpriced. Any basket of stocks or bonds is overpriced. If you are saving money regularly – that newly saved money should now be going into cash instead of stocks or bonds.

The simplest rule in investing is that you never buy an obviously overpriced asset. Stocks generally and bonds generally are obviously overpriced right now. So, you need to stop buying them in a general way.

To put a number on this expensiveness, I think the Shiller P/E ratio is about 27 now. It was about 27 when I wrote my December 2006 post arguing stocks were too expensive. You can read that post later down in this one. Or you can click here to see – via the Wayback Machine – what that post actually looked like on the original site in 2006.

I am writing this post because of 3 separate items I noticed recently.

I came across one while reading an earnings call transcript for Frost (CFR). This is a usually conservatively run bank in Texas. It has a lot more deposits than loans. Deposits have kept growing. So, the company needs to put the money somewhere. And where they’ve put it is “Securities”. Frost now holds more money in securities than loans. These securities are high quality. They aren’t going to default. But they are overpriced. To get a yield near 4% on their securities portfolio – the company had to go pretty far out in terms of the maturities it would buy. In normal economic times – let’s say with a Fed Funds rate of 3% to 4% – these bonds would cost less than what Frost paid for them. At some point, there will be a 3% to 4% Fed Funds rate. I have no idea when that will be. You can look at predictions from the FOMC’s own members and see they thought it would be 3 years down the road or so. Now, if that’s true – you obviously aren’t gaining much by making less than 4% a year for less than 3 years if you will be able to make 4% a year on idle cash at the end of that period. Of course, some events may happen that prevent any increases in the Fed Funds rate for that entire 3 year period. In the 1930s in the U.S. and in the 1990s and 2000s in Japan, investors could have easily overestimated the likelihood that rates would rise within the next 3-5 years to a “normal” level. If something like

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Geoff Gannon June 13, 2015

How to Judge a Business’s Durability

My last post listed examples of threats to a company’s durability. This post will be about how we assess those threats. You can always imagine a threat. Is it a realistic threat? How do you judge that?

There are some industries where durability is pretty much perfect. The business doesn’t change much. Barriers to entry are high. The future development of substitutes is unlikely. Location advantages are big.

A good example is lime. Lime is reactive and has a short shelf life. You don’t store it speculatively. You don’t import it and export it. Customers need to get their lime from a deposit being worked somewhere within a few hundred miles of them. Over the last 100 or so years, the real price of lime hasn’t changed that much (real price volatility compared to other commodities is quite low). The price right now is perfectly in line with the real average price per ton since 1900. Lime consumption in the U.S. was no higher last year than it was in 1998. The industry is more consolidated and perhaps less competitive than it was in 1998. I don’t think capacity is being fully utilized now. And I do think inflation will always be passed on to customers (as it was over the last 100 years). So, if Quan and I were to research a company like United States Lime & Minerals (USLM), we could probably start by assuming that last year’s EBIT would – in real terms – represent that company’s durable earning power. That could be our starting point for a buy and hold analysis.

That’s usually not the case. Even when we find a company that has a long history of being the leader in its field – say Strattec in car locks and keys, H&R Block in assisted tax preparation, etc. – there is a risk of change. In these two cases, we know there will be change in the product. For example, more people will prepare and file their taxes online in the future than they do now. And more drivers will enter and start their cars with the use of electronics instead of physical locks and keys. What we don’t know is how that will affect the companies.

Take H&R Block. The company competes in assisted tax preparation. In the 1990s and 2000s, many people switched to using software and then online products to prepare their taxes. But who were these people?

Most were people who had always prepared their taxes themselves. I use TurboTax and know a lot of people who use TurboTax as well. But, I actually don’t know anyone who used H&R Block even once in their lifetime and now uses TurboTax. Everyone I know who uses TurboTax used to – decades ago – prepare their taxes themselves using a pen and paper and a calculator. They didn’t use a CPA. And they didn’t use H&R Block.

Now, this is anecdotal. But, if I hadn’t asked the question “who are these people” …

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Geoff Gannon June 11, 2015

You Can Always Come Up With a Reason For Why the Stock You Are Researching is Actually About to Go Out of Business

Someone who reads the blog sent me an email asking how Quan and I judge qualitative factors like a company’s durability.

For most stocks, you can easily imagine a future condition that would obsolete the entire business model.

I’ve decided to make this post nothing but a series of examples.


John Wiley

Open access journal articles.

There is a whole Wikipedia page about this one. The idea here is that someone else will pay the cost of publishing journals in place of the subscriber.


Weight Watchers


Dieters will use free apps like MyFitnessPal to count calories instead of going to meetings or using websites like Weight Watchers.



Illegal marketing.

Without aggressive marketing aimed at old people – would this product even exist? You can read about the FCA (a U.K. regulator) fine imposed on HomeServe and the reasons for it here.


Ark Restaurants

Leases expire.

Ark may not renew its leases because the casino or other landlord would want to charge a lot more rent now that the location and the restaurant is a proven success. So, Ark as a corporation has a finite lifespan except insofar as management reallocates capital to new sites.


Village Supermarket

Online groceries.

Traditional supermarkets have 3 durability risks people raise: 1) Online groceries 2) Wal-Mart 3) Organic and fresh competitors: The Fresh Market, Whole Foods, etc.


America’s Car-Mart


America’s Car-Mart sells used cars so it can collect interest on high risk auto loans. The difficult parts of the business are underwriting and collecting loans. If this could be centralized – as it is in lower risk subprime auto loans – then the loans would become commodities.



Online dog food.

The two concerns here are that places like Wal-Mart can sell more dog food and websites like Petflow can sell more dog food.


Atlantic Tele-Network

Guyana can take away their monopoly.



British shoppers will stop frequenting high streets. Or, they will eat healthier food instead.



Self-driving cars will eliminate accidents and therefore the need for auto-insurance.


Babcock & Wilcox

U.S. utilities will shift away from coal power plants – which use boilers – toward natural gas, wind, and solar power plants which don’t use boilers.

The U.S. Navy could stop using: nuclear powered aircraft carriers, nuclear powered ballistic missile submarines, and nuclear powered attack submarines.



People will wear products like the Apple Watch instead.






Same. Plus, Michael Kors may be a fad.


Western Union

Online competitors like Xoom can replace agent location based money transfers.


Hunter Douglas

Big box retailers like Home Depot and Lowe’s can sell blinds in their stores. Blinds can be sold online. As a result, people will stop going to the independent dealers that Hunter Douglas gets all its sales through.



Smart keys and push to start ignitions can eliminate the need for locks and keys used in car doors and the steering column.


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Geoff Gannon June 9, 2015

Babcock & Wilcox Sets Spin-Off Dates

Babcock & Wilcox (BWC) has set the dates for its spin-off. Those who own the stock on June 18th will get their spin-off shares on June 30th:

“As a result of the spin-off, Company stockholders can expect to receive as a dividend one share of New B&W common stock for every two shares of the Company’s common stock held as of 5:00 p.m. EST on June 18, 2015, the record date. The distribution of New B&W shares is expected to occur on June 30, 2015 and is expected to be tax-free. “

Shareholders will then own two separately traded stocks. The stock with the “BWXT” ticker will be the government business. The stock with the “BW” ticker will be the power plant business.

The press release gives an accurate description of what “BWXT” will be:

“BWXT is the sole manufacturer of naval nuclear reactors for submarines and aircraft carriers; provides nuclear fuel to the U.S. government; provides technical, management and site services to aid governments in the operation of complex facilities and environmental remediation activities; and supplies precision manufactured components and services for the commercial nuclear power industry.”

It gives a poor description of what “BW” will be:

“New B&W will continue to be a leader in clean energy and environmental technologies for the power and industrial sectors. New B&W also will provide one of the most comprehensive platforms of aftermarket services to a large global installed base of power generation facilities.”

BW is really the boiler business. They build boilers and related equipment for power plants. Some of those plants are clean energy plants – but a great many are actually coal power plants.

Babcock & Wilcox was a Singular Diligence stock pick. I own the stock personally. Quan does not. I plan to keep both my “BWXT” shares and “BW” shares indefinitely.

I’ll let you know if that changes.…

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