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Geoff Gannon November 19, 2020

Marcus (MCS): Per Share Value of the Hotel Assets

I’m revisiting Marcus (MCS) with an attempt to appraise the hotel side of the business. Andrew sent me some articles discussing property tax appraisal of Milwaukee hotels (including those owned by Marcus). I looked at some other property tax records. I looked at Penn State’s hotel value index. Andrew spoke with the CFO of Marcus. And I consulted a few other sources. My best guess is that the pre-COVID fair value of Marcus’s hotel assets was around the $235 million to $400 million range. On...

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Geoff Gannon November 16, 2020

Investing in Trusts: Why Andrew and I Don’t Own Them, Why You Probably Won’t Want to Too – And How to Get Started if You’re Sure This is Really an Area You Want to Explore

Investing in Trusts: Why Andrew and I Don’t Own Them, Why You Probably Won’t Want to Too – And How to Get Started if You’re Sure This is Really an Area You Want to Explore

Someone asked me a question about trusts:

“I was watching one of your past podcasts and you mentioned you would not buy dividend stocks for an income portfolio you would buy trusts. How would I go about or is it possible to research and possibly purchase these? I found that idea fascinating.”

The best trusts are usually illiquid and a bit difficult to find. You have to do a little research on them and what backs them. Some examples of the kinds of trusts I was talking about are:

Beaver Coal (BVERS) – Mainly royalties on met coal, timberland, and rental income (variety of business, etc.) in and around Beckley, WV

Mills Music Trust (MMTRS) – Royalties on old songs like “Little Drummer Boy”

Pinelawn Cemetery (PLWN) – Interest in proceeds from sales of burial plots in one cemetery on Long Island, NY

Things like that.

Many investors avoid these because they complicate your taxes. You’ll need an additional form from each trust you own (they should send it to you, if they don’t – you’ll contact them and request the form). And it may sometimes cause you to request late filing of your taxes.

For this reason, partnerships (like the one Andrew and I run) and professional investors running managed accounts (like the ones Andrew and I manage) will avoid buying these trusts simply because they don’t want to lose clients through annoying the client with additional tax work for the client. As a result, many professional investors who may know of and like these trusts (and even own them personally) won’t buy them for clients. This can keep the price of the trusts reasonable. These stock prices (technically they are trust certificates, not stocks) tend to bounce around in price.

It is best to only buy them when the yield on the trust (making sure you check to see if the distribution recently is similar to what it is normally) less the rate you’d pay on taxes still makes it make sense. For example, say you want an 8% annual return in the trust certificate and you pay 30% in taxes on income from a trust, then you don’t want to buy when Distribution/Price is anything worse than 11.5%.

Often, your total return in the trust is not going to be great compared to buying and holding a stock that is actually retaining its earnings.

However, it is true that for income purposes only – these trusts will often yield more than the dividend yield you can get on other kinds of stocks, the yield you can get on preferred stocks, the interest rates you can collect on bonds, etc.

But, keep in mind five things:

1) Owning these will complicate your taxes

2) Income from trusts is usually less tax efficient – …

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Geoff Gannon November 13, 2020

Marcus (MCS): A Movie Theater and Hotel Stock Trading for Less than the Sum of Its Parts

Marcus (MCS) is not an overlooked stock. Despite having a market cap of around $300 million – the level usually defined as the cut-off between a “micro cap” and a “small cap” stock – well over $10 million worth of this company’s stock trades on some days. The stock is liquid. And most of that liquidity is probably highly speculative activity. This is typical for the industry. You can see similar amounts of high share turnover, high beta, etc. at other publicly traded movie theater...

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Geoff Gannon November 11, 2020

Why I Wouldn’t Worry About Risk-Adjusted Discount Rates

Someone asked me a question about using risk-adjusted discount rates when valuing stocks. Here’s my answer.

The discount rate for a stock should be the opportunity cost of putting money in it instead of something else. For your average investor, the next best alternative to where they’d put money instead of this stock would seem to be an index. If they don’t buy this stock, they wouldn’t buy a government bond – they’d buy an index. So, the discount rate shouldn’t be a government bond. It should be an index.

When writing up stocks, the opportunity cost I use is the expected return in the S&P 500. In theory, I think the right discount rate for a stock would just be the return you expected from an index you could otherwise invest in. You could use other measures. For example, it is not really honest for me to use as my discount rate the return I expect on the S&P 500, because the actual returns of stocks I’ve bought since I’ve been investing (20+ years) have not been similar to the return of the S&P 500 during the same time period. So, in theory – I should be calculating opportunity cost as the compound annual growth rate I think I could make with other stocks I could pick. I suppose, in theory, it would be best to tie this to my actual returns over time. However, this isn’t a very good way to talk about stocks with other people. For example, if investor A has averaged 5% a year over his 25 years of investing and investor B has averaged 15% a year and the index has averaged 10% a year all over the same 25 years – I don’t really think the general public should use a 10% rate and our two hypothetical investors should use rates of 5% and 15%. Instead, we should probably try to apply a discount rate that takes into account what we think an index will return in the future. What should that number be? I’m not sure. About 8% would make sense to me. To be on the safe side, 10% would be fine. Indexes haven’t really returned much more than 10% over the very long term. So, unless you had reason to believe the index you are using as a benchmark is incredibly cheap at the moment – it wouldn’t make sense to use a rate greater than 10%. I think using a 10% discount rate as your hurdle would tend to undervalue stocks going forward. But, that’s just an opinion. What I mean is I think that if you buy a stock assuming it will return 10% a year over the next 15 years or so – you’re likely to be getting a better bargain in that stock than if you bought into the S&P 500.

Note, however, that this means if you are aiming for much higher returns – you’d kind of be using a higher discount rate. I don’t …

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Geoff Gannon November 10, 2020

Why Appraising a Stock Based on “Relative Valuation” vs. Peers Isn’t Enough to Guarantee You’re Getting a Bargain

Someone asked me a question about relative valuations:

“There are a couple of instances when we can value the stock based on comparables. However, for me, I feel that there is something in the middle that I can’t figure out. There is a big assumption that the stock with the cheaper valuation will go up to get close to the market. Is there an embedded assumption such as, if the stock being compared are similar in growth/roe, or basically we just are hoping for mean to reversion?

I found two similar companies in the same sector in the different country…P/B ratios are (1.5-2.0) and (2.0-3.0). P/E ratio range for the past 3 years are (9-15) and (40-60). ROE 14% vs 7% (yes, the first company has a better ROE and yet is cheaper). Both are growing at similar rate.

If I said that stock A is a good buy, because it is much cheaper in relation to B, do I miss anything in the middle? Since the investment return is largely reliant on the stock A being rerated higher.

How do you approach the relative valuation then?”

So, yes, I do use relative valuation. For example, I’ve mentioned before I own Vertu Motors (VTU). It is a U.K. car dealer. I believe the core economics of car dealer groups in the U.K. and U.S. are similar. I wasn’t able to find much evidence of differences in the way the businesses work, how they make money, how much they make, etc. There are legal differences. But, I couldn’t find any evidence these legal differences translate into actual differences in the economics, because the legal stuff didn’t seem to be the primary reason for the competitive advantages of certain incumbents in each market. A lot of the other economics seemed the same. Like, the scale economics seemed the same. The sales mix of what each dealer is selling and how much sales of other products (financing, warranties, etc.) they are doing and stuff like that seemed to work the same in one country vs. the other. A lot of the unleveraged returns on capital for similarly situated companies in each country seemed the same. It didn’t seem obvious to me that there was a material advantage to owning a U.S. based car dealer vs. a U.K. based car dealer. However, the U.S. based car dealer stocks traded at much higher relative valuations (higher P/B ratios, EV/EBITDA, ratios, etc.). Why?

One, the U.S. car dealers sometimes had greater scale. So, you would have to adjust for that. The market had – historically – seemed to reward companies sort of after the fact for scale. So, if you had improving margins, returns on capital, etc. now because you’d begun scaling up earlier – the market seemed to reward the companies when the actual earnings per share growth and such came in. They would then give them higher multiples. They wouldn’t necessarily give higher multiples to smaller dealer groups that said they’d scale up, even …

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Geoff Gannon November 9, 2020

Since It’s One of Warren Buffett’s “Inevitables”: Is it Okay to Pay a High P/E Ratio for Low Growth Coca-Cola (KO)?

Someone asked me this question:

“Warren Buffett had commented that Coca-Cola has a durable competitive advantage. It is one of his ‘inevitables’. I am curious what is your thought on the investment merit of a business that may not grow much in an absolute sense, but has a durable competitive advantage like Coca-Cola?

Coca-Cola may not have be able to grow their sales at 10% a year like in the 1990s, but would it make sense to focus on sales per share going forward? Assuming the free cashflow margin is stable and predictable in the long-term because of its durable competitive advantage, the company can reduce the shares outstanding over time and still benefit shareholders.”

I am not a big fan of investing in a business like Coca-Cola (KO) today. It does make sense to focus on sales per share (assuming free cash flow margin stays pretty stable). The problem that I see with something like Coca-Cola – no matter how inevitable it is – is that the company has only grown like 2-4% a year over the last 10+ years. Basically, it has grown at the rate of inflation. I’ve talked before about the idea of “free cash flow plus growth”. What I mean by this is that your return in a stock can be calculated where you ask “how much growth will I get each year in this stock?” and “what is the free cash flow yield I am getting in this stock”. This is a way of thinking of a stock like a perpetual bond. A perpetual bond would be something that pays a “coupon” each year (so $40 on a $1,000 face bond would be a 4% coupon rate) but never matures. So, in the example I just gave of a $1,000 face value bond that pays you $40 a year forever – you never get the $1,000 back.

Imagine this was the case with Coke. Say Coke stock is 100% safe with no risk of going to zero, no risk of earnings ever declining, etc. Okay. Most stocks and even bonds have some risk we have to account for. But, if this was truly as risk free a coupon as like a perpetual government bond then we could imagine that if you want to compound your money at 10% or better a year forever – all you have to do is buy a Coca-Cola type “earning coupon” at 10x earnings (this is a 10% earnings yield).

Because stocks retain part of their earnings, you can actually afford to pay a price-to-free cash flow higher than 10x. But, how much higher.

If the growth we are about to talk about was truly perpetual growth – it will never slow down or turn negative, then we can do a calculation that’s very simple:

Desired Rate of Return < Free Cash Flow Yield + Growth — then, buy the stock and hold forever

Say you want a 10% return. Then, free cash flow yield plus growth must be …

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