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Geoff Gannon May 27, 2018

Value Trading – Does It Ever Make Sense?


I would like to discuss and elicit feedback from our community on the topic of value trading. What I mean by value trading is the purchase and sale of stocks in a shorter time frame than traditional long-term investing, where the buy and sell decisions are driven by the exact same fundamental analysis, margin of safety standards, and owner’s mentality that traditional long-term value investors utilize. In other words, I would like to discuss the idea of a business-oriented investment strategy coupled with the willingness for a short investment holding period in certain situations.


To start, I will simplify the investment landscape by categorizing all stocks into two buckets: slow growers and compounders. Slow growers are businesses where the intrinsic value does not grow especially rapidly, and compounders are businesses where the intrinsic value does grow rapidly. All things equal, purchased at an equivalent price to value (P/V) ratio, compounders should outperform slow growers over long holding periods. This makes intuitive sense, because a large portion of the return in investing in slow growers is the narrowing of the P/V gap, whereas the large portion of the return in investing in compounders is the value itself actually increasing. This is what Charlie Munger is getting at when he said:

Over the long term it’s hard for a stock to earn a much better return than the business that underlies it earns. If a business earns 6% on capital over forty years, you’re not going to make much different than 6% return, even if you buy it at a huge discount. Conversely, if a business earns 18% on capital, you’ll end up with one hell of a return long term, even if you pay an expensive looking price.”

With that in mind, all things equal it makes sense that an investor would prefer the P/V gap to close as quickly as possible for slow growers more so than for compounders. Further, an investor who is open value trading would be more likely to trim or sell investment in slow growers rather than compounders, because with compounders there is a higher risk of selling too early, not getting back in, and missing out on the value creation that occurs for years to come.

This brings me to the practical considerations of value trading. If, as value investors, we buy businesses whose shares are available at large discounts to intrinsic value, and those shares subsequently rise quickly in price, should we hold onto those shares until the gap narrows further, or should we consider selling (at least some of the investment) and reallocating the capital to other attractive businesses with a larger price-value gap, assuming we can find such businesses? Do long-term buy and hold investors at times hurt their returns by simply holding stocks that bounce up and down, with the P/V gap narrowing and widening over time, even as the value may march steadily upwards?

I suggest that in some situation we should be willing …

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Geoff Gannon May 27, 2018

Efficiency vs Reliability

Friday, May 25th – Pandora A/S (PNDORA) by LUKE ELLIOTT
Friday, May 25th – GameStop (GME) by VETLE FORSLAND
Sunday, May 27th – “Value Trading – Does It Ever Make Sense?” by DAVE ROTTMAN
To Focused Compounding members:
Two different Focused Compounding members are to blame for this week’s memo. One is Dave Rottman who wrote an article entitled “Value Trading – Does it Ever Make Sense?”. The other is someone I was talking to this week on Skype. The discussion on Skype centered on the idea that I had said somewhere before that I thought it was possible to achieve 30% annual returns. What I think I meant by this – because I’ve said it elsewhere – is that an investor who puts together a run of 30% annual returns is like a Major League player batting .400. Over a career length period of time 30% annual returns are the highest you’re likely to see. Warren Buffett roughly did it over the years he ran his partnership. Peter Lynch roughly did it over the years he ran Magellan, and Joel Greenblatt did even better at Gotham from 1985-1994. A period of 10-15 years is basically the length of a professional athlete’s career. So, we could say Buffett, Lynch, and Greenblatt were 30% annual return career hitters.

Imagine that you – a very good, but not a truly great value investor – are running a portfolio that has chugged along at 20% a year for the last 15 years. You know that other investors at other times – Buffett, Lynch, and Greenblatt – ran portfolios that chugged along at 30% a year for almost as many years as you’ve been going at this. So, you know your portfolio is running at only two-thirds of its optimal efficiency. Where is the “waste” so to speak? Why aren’t you doing 30% a year? I can think of 4 possible reasons. One, you are making mistakes they did not. Two, you are using less leverage. Three, you are putting less into each stock you own. And four, you are owning each stock longer than they did. A portfolio running at optimal efficiency would be: 1) Free from human error, 2) Leveraged, 3) Concentrated, and 4) Have a high turnover. Why would it have a high turnover? Because the portfolio manager would have more ideas than money. This is also why it would use leverage. The question of leverage brings us to the difference between efficiency and reliability. An investing system that is maxed out for efficiency will – in any given year – achieve the highest return. On the other hand, an investing system that is maxed out for reliability will last the greatest numbers of years. Compound results are a combination of efficiency and reliability. The article published this week on Focused Compounding argues that – if a value investor has enough good, reliable businesses to invest in that he knows very well – he should (like Allan Mecham does) constantly be …

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Geoff Gannon May 25, 2018

Gamestop (GME): A Risky Stock that Just Might be the Cheapest Billion Dollar Stock in Today’s Market

Member write-up by Vetle Forsland


Business Overview

GameStop is the number one video game retailer in the world, the largest AT&T retailer, the largest Apple products reseller and one of the world’s largest sellers of collectibles. The company had 7,276 stores as of February 3, 2018 all over the world, with over 5,200 of them in the US. They are also one of the world’s biggest buyers and sellers of used games. That means that people buy physical video games from a shop like GameStop, and when they are tired of playing the game, they can sell the game to GameStop at a discounted price. GameStop sells these games at a higher price, which allows gamers to buy used physical games at a big discount to new games. This segment makes up the largest proportion of GameStop’s gross profit, with 32% of all gross profits, but only 23% of sales, as a result of their terrific margins.


The video game segment of the brand had about 5,900 stores as of February this year, whereas 70% of these stores were located in the US. Most of these stores are GameStop-branded, but they also own store brands like EB Games, Micromania, ThinkGeek and Zing Pop Culture. Furthermore, they own Game Informer, which is the leading video game magazine in the world, and is actually the fourth most popular magazine in the world, with over 7 million monthly paid subscribers per month. It’s also the largest digital publication in the world.


GameStop’s “Technology Brands” contains 1,329 AT&T branded retail stores, where they sell AT&T services, DIRECTV service and electronic products. This segment also consists of 48 Simply Mac branded stores which sell and repair Apple products. Their technology brands make up 8.7% of sales and 19.5% of gross profits. It was a part of their attempt a couple of years ago to diversify away from the video game industry, and it has since been deemed unsuccessful as they recently wrote off about $360 million from the technology brands business. GameStop was pressed to decrease the equity value of the investment as they realized phone owners won’t switch models as frequently as in the past, which makes sense; newer phones aren’t evolving as drastically in quality as they used to.


The consensus today is that GameStop’s business – a video game retailer – is redundant in an age of online shopping. GameStop’s flagship “products” have always been hardware like the newest consoles and physical video games. However, PC Gamers have almost exclusively stopped buying physical video games, as only 20% of all PC games were sold in physical form last year. GameStop shareholders fear that the same will happen to console games and consoles. These two segments, if we include their used games segment, made up 57% of gross profit in 2017. So, I guess in an absolute worst case scenario, where all console gamers switch to digital, GameStop will lose around 60% of their value. The stock has fallen 80% …

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Andrew Kuhn May 25, 2018

Pandora A/S (CPH: PNDORA)

Member Write-up by Luke Elliot


Note: Sponsored ¼ share ADRs also trade under “PANDY” in U.S. Dollars






Pandora A/S is the largest jewelry maker in the world 

Overview Pandora is a vertically integrated jewelry maker that has rapidly grown from a local Danish Jeweler’s shop to the world’s largest jewelry manufacturer, producing more than 100 million pieces of jewelry in 2017. The original jeweler’s shop in Copenhagen, Denmark, was opened by goldsmith Per Enevoldsen and his wife Winnie in 1982. The company quickly transformed from a local shop, to a wholesale retailer, to a fully integrated global behemoth that designs, manufactures, directly distributes (in most markets), and retails its own jewelry. The company now sells in more than 100 countries through 7,800 points of sale. If you’ve ever been to a grade-A mall during Christmas or Valentine’s Day, you’ve probably witnessed the crazy lines snaking out of their small glass stores. Jewelry makers are segmented by price: Affordable (less than 1,500 USD), Luxury (1,500-10,000 USD) and High-End (greater than 10,000 USD). Pandora is in the affordable category by price but claims to have an ‘affordable-luxury’ brand. The company gets a little less than half (48%) its sales from EMEA (with 71% coming from UK, Italy, France, and Germany), about one-third (31%) from Americas (with 74% from US) and one-fifth (21%) from APAC (with 43% from Australia and 28% from China). The company’s sales are geographically diverse and in mature markets. To make it easy, let’s break down Pandora’s business model into two main retail formats:

1) Concept Stores (about one-third owned and operated by the company and two-thirds franchised): Concept stores are full-blown branded Pandora stores which only carry Pandora products and displays.


2) Other: other points of sale consist of “shop-in-shops” which are clearly defined spaces in other stores (think a little kiosk in an airport Duty-free) that only carry Pandora products and 3rd party distributors which can be either multi-branded retailers or non-branded retailers.


Pandora currently gets 66% of its sales from Concept Stores (plus online) and 34% from “other.”



We’ve discussed where the company sells and how they sell……..but What do they sell?


Pandora is the world leader in charms and charm bracelets. It’s their bread and butter. It’s estimated they own about 30% of the charm market and 75% of their revenues are generated from this category. Estimates are that charms and charm bracelets make up only 6% of the total jewelry market. In essence, Pandora sells you a bracelet for somewhere between $80-150 and then you fill the bracelet up with charms that are $50-150 each. Pandora sells 73 million charms per year (200,000 per day) and 14.5 million bracelets per year (40,000 per day). Pandora’s brand and leadership position in the charm niche is by far its most important asset.



  The most prevalent risks to the durability of the company are a decline in the popularity of charm bracelets or a
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Geoff Gannon May 20, 2018

Human Nature is the Ultimate Hidden Fee

Tuesday, May 15th – Box (BOX) by Jayden Preston
To Focused Compounding members:
In an interview this week with Barron’s, Vanguard founder Jack Bogle cited stats that showed the average investor’s annual return from index funds was 8.4% from 2005 to 2017, from actively managed funds it was 7.2%, and from ETFs it was just 5.5%. ETFs and index funds are invested in much the same things. So, investors are charging themselves a 2.9% annual fee in the form of bad timing. The same Barron’s article quotes BlackRock’s Larry Fink as saying: “..long-termism is better than short-termism. But people need financial instruments for different reasons.” This is the common argument for the existence of ETFs, long-short hedge funds, etc. But, it’s wrong. We’re talking about a drag of 3% a year between investors staying in a representative sample of U.S. public companies and investors trading in and out of those same assets. This past week, Andrew and I announced we’ll be handling managed accounts. People who have called in have mostly wanted to talk about the fee. I like a 2.5% fixed fee because the math that matters is easy for me to do in my head. We should only accept money when we feel we can still beat the market by more than 2.5% a year after taking on that sum. Different kinds of investment vehicles have different kinds of hidden fees. These fees often add up to more than the amount you’re actually being charged. I spent a good part of last week warning Andrew about the performance drag we’d experience if we either: 1) Held more stocks or 2) Managed more assets. Both would create big performance drags. For ETFs, the hidden fee is bad timing. Investors want the freedom to trade in and out of an ETF. And that freedom costs them 3% a year. For accounts like Andrew and I will be running – the hidden fee is size. I guarantee you you’ll be better off when we are running $1 million instead of $10 million or $10 million instead of $100 million. Andrew and I won’t be better off. But, you will be. Here’s the thing. When money managers charge a percent of profits, they like to say their interests and their clients’ interest are aligned. But, the truth is that the manager’s interest and the client’s interest are never aligned on the one question that matters most: “Should we gather more assets?” The bigger a fund gets, the worse its performance will be. The more an investor trades in and out of ETFs, the worse his performance will be. Hidden fees like these often add up to more than the actual fee you’re charged. Whatever fees a fund is charging you, it’s going to be very hard to overcome the hidden cost of either high turnover or a large amount of assets to actively deploy. Small, active funds can work well. And giant, inactive funds can work well. Everything in between that tends …

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Geoff Gannon May 15, 2018

Box (BOX): Negative Earnings and Free Cash Flow Disguise Beautiful Customer Economics

Member write-up by Jayden Preston




Founded in 2005, Box offers a cloud content management platform, as a subscription-based service, that enables organizations of all sizes to securely manage and access files from anywhere, on any device. The company initially offered a free version in hopes of growing their user base rapidly, leading them to surpass 1 million registered users by July 2007. The Company realized that their users started bringing their solutions into the workplace and businesses were eager for a solution to empower user-friendly content sharing and collaboration in a secure, manageable way. In 2007, Box then made the strategic decision to focus more on the enterprise market by investing heavily to enhance the security of their platform and building an enterprise sales team. In 2012, Box introduced Box OneCloud platform and Box Embed framework to encourage developers and independent software vendors to build applications that connect to Box, creating an ecosystem of applications. The Company has also formed alliances with numerous software companies, bringing about more than 1,400 integrations with offerings from Google, Office 365, IBM and so on. This continual evolution of their platform features allowed the Company to sell into increasingly larger organizations.


Today, Box has a user base of over 58 million users. As of January 31, 2018, over 17% of their registered users, or close to 10 million, were paying users who registered as part of a larger enterprise or business account or by using a paid personal account. The Company has over 82,000 paying corporates. Around 70% of the Fortune 500 companies are their clients. In FY2018, Box generated $506 million in revenue, in which 96% is recurring.


Durability and Moat


With cloud content management business being the newer technology and current disrupter, it is difficult to see what would come and disrupt this business in the next decade or two.


The value proposition of cloud content management should be strong. Not only does the cloud allow for higher flexibility in accessing content and collaboration among colleagues, it also helps corporates cut costs through streamlining the content management process. Increasingly, through more integrations with other software offerings, the value proposition of cloud content management should only increase.


Complementing the above is Box’s strategic focus on the enterprise market. During the sales process of convincing a large enterprise to sign up as a client, Box often finds the need to tailor its offerings to the needs of the enterprise. This should increase the switching costs for the users. It is quite expensive to acquire such customers. For instance, by the end of FY2017, Box had 71,000 customers, covering 64% of the Fortune 500. The Company spent $303 million on sales and marketing in FY2018, during which the number of corporate customers increased by around 12,840. (Here I assume FY2017 year-end number of customers decreased by 4%. The difference between this number and the FY2018 year-end figure should equal to the number of new customers added) Assuming …

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Geoff Gannon May 13, 2018

Goodness vs. Soundness

Tuesday, May 8th, Industrial Logistics Properties Trust (ILPT) by George Baxter
To Focused Compounding members:
Ben Graham wrote: “Confronted with a…challenge to distill the secret of sound investment into three words, we venture the motto, MARGIN OF SAFETY…all experienced investors recognize that the margin of safety concept is essential to the choice of sound bonds.”

Note the word I bolded: “sound”. As I sat down to write this memo, I thought immediately of chess. Can a good chess move be an unsound chess move? Can you win a game because you made a move that actually gives you a negative margin of safety? We know you can. After playing a game of online chess, humans often have a computer chess engine analyze their game. At each point along the way, the computer evaluates the position and states the advantage for black or white in terms of hundredths of a pawn. The computer can also suggest “lines” – or series of moves – where the game would have worked out differently. So, a computer can tell you what move your opponent should have made and whether or not you had a real advantage under “best play”. A move that wins against a human with limited time to think but would fail against a computer with infinite time to think may not be a bad move – but, it is a speculative move. The English word speculation comes from a Latin word – a language Graham knew well – that basically means “to look out for”. A speculation is future focused. It depends on stuff you have to look out for. In chess, to judge whether or not your speculative move was a good one you can look at the result of your game. However, to judge whether or not your speculative move was a sound one you have to sit down – perhaps with a computer, but certainly with a lot of time – and analyze what would have happened had a different move been played in response. Perhaps Graham’s most important quote on the topic of margin of safety is this one:
“The function of margin of safety is, in essence, that of rendering unnecessary an accurate estimate of the future.”
A sound move is one that works well enough whatever your opponent plays. A sound investment is one that works well enough whatever the future holds. But, just as some “unsound” chess moves work more often than not when playing against a human – some speculations have awfully good odds.

This brings us to Entercom (ETM). Last week, this minnow that swallowed the whale called CBS Radio was the subject of an excellent write-up by Vetle Forsland. A lot of members have asked for my comments on the stock. And a lot of members are clearly excited by the opportunity. Here’s the thing: If I had to come up with one and only one “line” that is most likely to be played out over the next few years, it …

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Geoff Gannon May 8, 2018

An Illiquid Lunch

To Focused Compounding members:
There are a couple sayings every modern investor and econ student has had drummed into him over and over again. One is: “there’s no such thing as a free lunch.” It sounds like the kind of thing an economist would come up with. Though it’s not. In the 1970s, an economics writer (Milton Friedman) took the saying from a science fiction writer (Robert Heinlein) who had – in the 1960s – simply transplanted an old 1940s saying to the moon. The actual marketing ploy of giving a free lunch dates back to 1800s America. Some bars in the U.S. offered a free lunch to new customers as a loss leader to drive sales of booze. The marketing ploy has long been forgotten. But, modern economists have embraced the saying, with Gregory Mankiw – in a textbook that has, no doubt, earned him tens of millions of dollars in royalties – describing the principle as: “To get one thing that we like, we usually have to give up another thing that we like. Making decisions requires trading off one goal against another.” That’s not as catchy as saying “there’s no such thing as a free lunch.” But, it’s a lot more honest. Because, there is – of course – such a thing as a free lunch. It’s called trade. Two centuries back, David Ricardo explained comparative advantage, a concept which basically boils down to the maxim that: “if two parties can trade with each other, it’s best for each party to focus on the thing they themselves do best.” The thing you should train yourself to get best at is learning to hold illiquid stocks. I know of no simpler way to improve your lifetime rate of compounding than to accept lower liquidity in exchange for higher returns. Lucky for you, there’s always someone willing to take the other side of that trade. In a 1990s episode of a series in the Star Trek franchise, a character from a very capitalistic species of alien traders explains his people’s belief that:

“…there are millions upon millions of worlds in the universe, each one filled with too much of one thing and not enough of another. And the Great Continuum flows through them all, like a mighty river, from ‘have’ to ‘want’ and back again. And if we navigate the Continuum with skill and grace, our ship will be filled with everything our hearts desire.”

Well, there are millions upon millions of traders out there looking to buy and sell many of the same stocks you are looking to buy and sell. And the one thing they all want – and you’ve got – is liquidity. Like the case for trade, the case for investing in illiquid stocks is backed up by the historical record. Those of you who follow me on Twitter (@GeoffGannon) saw me retweet a table of historical returns from the 1970s through today which showed that even within each market cap size – …

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George Baxter May 8, 2018

Industrial Logistics Properties Trust (ILPT)

Industrial Logistics Properties Trust (Nasdaq: ILPT)

Summary: ILPT is a busted REIT spin/IPO with high-quality assets trading at a 35% discount to NAV. As a recent spin, ILPT has limited coverage and buy-side recognition. The company’s assets, which are located in Hawaii and the Mainland US, are 99.9% leased with an average lease duration of 11.2 years, and contractual rent-resets provide a clear pathway for modest organic growth. ILPT’s leverage of 2.6x net debt/EBITDA is less than half the peer median of 5.3x, and it’s 6.4% dividend is double the peer set median and conservatively covered by cash flow. ILPT is cheap on a nominal and relative basis, trading at only 12.3x 2018E FFO vs an industrial REIT average of 22.4x, as well as a deep discount to NAV. At the current price you’re essentially buying the Hawaiian assets at a fair price and getting the Mainland logistics assets for free. We believe the stock will return 44% over the next 12 months in our base case, with nearly 100% upside in our bull case based on the recent PLD/DCT transaction, and 15% downside in our bear case.

Price: 21.30

Total Diluted Shares 65MM

Market Cap: 1.38BN

Cash: 20MM

Debt: 351MM

EV: $1.711 BN

2018E, 2019E, 2020E FFO Per Share: 1.68 12.3X, 1.75 11.8X, 1.77 11.6X

2018E, 2019E, 2020E EBITDA & EV/EBITDA: $123MM 13.2X, $137MM 12.2X, $148MM 11.3X



Industrial Logistics Properties Trust (ILPT) is an industrial/logistics REIT that spun-out/IPO’d on January 12th, 2018. ILPT owns two sets of assets: Hawaiian and Mainland US. The company has owned the HI assets since 2003, and occupancy at those properties has never dropped below 98% during that time. The mainland assets were primarily purchased in 2015 and are 100% leased with Amazon as the largest customer. The company’s assets were formerly owned by Select Income REIT (SIR), who continues to own 69% of ILPT common stock. As many of you likely know, SIR and ILPT are RMR managed REITs, not exactly a compliment in the REIT world. The RMR family of REITs is managed by the Portnoy family, who had a very pubic and nasty fight with Corvex and Related over Commonwealth REIT. The rub on the Portnoy family of REITs was that they were vehicles to enrich the family while not doing much for outside shareholders. We believe the risk of this happening at ILPT is largely mitigated by the company’s compensation structure, which only really pays off for management if ILPT outperforms the REIT index by a significant margin. The idea behind the ILPT spin was the high-quality Hawaiian and Mainland assets would get a premium valuation compared to the legacy SIR office assets. With little in the way of leverage, management could continue to acquire high-quality mainland logistic assets at ILPT. As the company acquires mainland logistics assets, coupled with contractual rate increases at the legacy properties, NOI and the dividend will grow over time.

The ILPT IPO could not have come at a worse time, which …

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Geoff Gannon May 6, 2018

The Urgent and the Important

Tuesday, May 1st – North American Energy Partners by Alex Middleton
Wednesday, May 2nd – Entercom Communications by Vetle Forsland
To Focused Compounding members:
This is the time of year when value investors flock to Omaha and come the closest to being a religious sect. It’s a good time to think about both what value investors preach and what value investors practice. The day-to-day practical work of investing that becomes habitual to you is what matters most. This is what you should care most about shaping. And yet it is the thing that is least likely to become memetic.

What spreads – copied from one person’s mind to another’s to another’s – are things like quotes. I use quotes in this memo each week. And Warren Buffett certainly quotes others a lot when presenting a concept. It’s a lot easier to spread a quote around – online or offline – than to spread around a habit. I’ve talked before about the importance of reading a 10-K a day. It is important. But, I don’t know how to make that concept something that is easy to spread. A soundbite is easy to spread.
This is the time of year when value investing ideas spread fast. You now have video of Warren Buffett and Charlie Munger at the annual meeting. You have video of Warren Buffett on CNBC. You have transcripts. You have soundbites. And you have those transcripts and soundbites broken down into quotes the length of a tweet that can be re-tweeted again and again. We’ve had all that before. What’s new this year?

CNBC’s “Warren Buffett Archive”. CNBC describes this archive as:
• 25 annual meetings, going back to 1994, with a highlight reel for each year
• 130 hours of searchable video, synchronized to 2,600 pages of transcripts
• 500 video clips covering scores of subjects

Now, there is a lot to learn from Warren Buffett. But, I recently recorded an interview with Andrew where I said that although I often call “You Can Be a Stock Market Genius” the best investing book out there – there is a second contender. And that second contender is the “book” made up of the chapters of Alice Schroeder’s biography of Warren Buffett, “The Snowball”, that discuss Buffett’s investing life in the 1950s, 1960s, and 1970s. And as I listened to Buffett’s annual meeting preamble where he talked about how he and Charlie Munger would probably get a lot of questions about current events instead of the truly long view – I started to think about whether I really thought someone’s time would be better spent watching that annual meeting Q&A or re-reading those chapters of “The Snowball”.

The annual meeting seems more important because it is more urgent. It is happening now. It’s news.
But how important is news to investors? Over time, I’ve come to believe news isn’t something that investors should seek out. Not because news isn’t important. But because news will be served up to you on …

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