Posts By: Andrew Kuhn

Should I Specialize in an Industry I Know – Even if it’s a Bad One?

A 12-minute read

Hi Geoff,

 

I think you have touched on this before but I will ask a bit more detailed. Do you think it’s better to be an expert on one industry and the stocks within that industry vs knowing a little about many industries? What about if that industry is a “bad” industry like shipping? Would you still think an investor is better off knowing everything about that industry and the stocks vs being a generalist?

I guess that having a deep knowledge and circle of competence you would have an edge compared to other investors. Being a generalist you don’t really have an edge? 

 

I think it’s usually better for an investor to be a specialist than to be a generalist. If you look at some of the investors who have long-term records that are really excellent – I’m thinking specifically of Warren Buffett and Phil Fisher here – their best investments are in specific areas of expertise. Buffett’s biggest successes tended to be in financial services (banks, insurance, etc.), advertiser supported media (newspapers, TV stations, etc.), ad agencies (also very closely connected to media companies), and maybe a few other areas like consumer brands (See’s Candies, Gillette, Coca-Cola, etc.). Other gains he had came from use of float (which is a concept closely tied to insurance and banking – though he also used Blue Chip Stamps to accomplish this) and re-deployment of capital. At times, he liquidated some working capital positions of companies and put the proceeds into marketable securities (a business he knows well). Overall, the Buffett playbook for the home runs he hit is fairly limited. It is very heavy on capital allocation, very light on capital heavy businesses, and it is pretty concentrated in things like media, financial services, and consumer brands. There are some notable and successful exceptions. It seems that Nebraska Furniture Mart (by my calculation) was a very successful investment. However, Buffett’s other retail investments generally were not. By comparison, he hit several home runs in newspapers – Washington Post, Buffalo Evening News, and Affiliated Publications. Several home runs in non-insurance financial services (owned a bank, owned an S&L, invested in GSEs, etc.). Several home runs in insurance (National Indemnity, GEICO, etc.). If you look at Buffett’s record in holdings of more commodity type companies, when he held broader groups of stocks, etc. – it’s not as good. As far as I can tell, the retail/manufacturing parts of Berkshire today don’t have very good returns versus their original purchase prices. It’s not all that easy to be sure of this given the way the company reports. But, I don’t think there are a lot of home runs there.

 

Phil Fisher talks about how he focused on manufacturing companies that apply some sort of technical knowledge. This is interesting, because people think of him as a growth or tech investor – but, he thought of himself as investing in technical manufacturing companies. But, specifically – manufacturing companies. He didn’t …

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Which Kind of Investor Could You Aspire to Be: Graham, Fisher, Lynch, Greenblatt, or Marks?

Hi Geoff, 

 

I am very new to investing and I have most of my savings invested in Vanguard S&P 500. I would love to learn more about the world of investing but I just don’t know where to start. Could you please give me a roadmap to begin?

 

Geoff’s Advice to a Brand New Investor

 

You Need to KNOW YOURSELF First, So…

 

It really depends on what approach would work best for you. You should read about the investor who most speaks to the kind of investor you COULD be. In other words, what are your interests, what is your personality, etc.

 

I would recommend picking from one of five possible investors:

 

1) Ben Graham

2) Phil Fisher

3) Peter Lynch

4) Joel Greenblatt

5) Howard Marks

 

You might want to read one book by each of them. The Ben Graham approach is based on asset values and liquidation value. It is the approach of net-nets, stocks trading below book value, stocks trading at less than 10 times P/E and little debt, etc. You could read the Intelligent Investor (I recommend the 1970s edition – or earlier – but not the edition revised by Jason Zweig. So, find an edition with just Graham’s name on it – not Zweig’s name). I would also recommend reading “There’s Always Something to Do”. This book is about Peter Cundill. It is an easier read than the Intelligent Investor. But, it shows you what the actual work of applying a “Graham and Dodd” approach is. So, to get a taste of the Ben Graham approach I’d recommend reading: First – “There’s Always Something to Do”. If you feel like Cundill’s investing style is one you could copy yourself – then, read “The Intelligent Investor”. If you get something out of “The Intelligent Investor” you can then read the various editions of Security Analysis (1934, 1940, and 1951). Also read: “The Interpretation of Financial Statements”. There are a few other books by Graham that are good (a couple books of his articles and an autobiography called “memoirs”). You can find all of these at Amazon and elsewhere. Buy them used and collect the books for your own review. Keep them forever. Heavily annotate them. Copy the approaches you read about using modern stocks. However: ONLY do this if you read “There’s Always Something to Do” and the Cundill approach resonates with you as something you could do personally. If you read that book – it’s a very breezy read – and don’t feel that approach resonate with you, then skip Graham entirely.

 

Phil Fisher. Read “Common Stocks and Uncommon Profits”. Fisher wrote a few other books too. But, read that one. Especially think about his talk of “scuttlebutt”. Is this something you can do? Is this something you want to do? If so: read Fisher’s other books. Focus on the scuttlebutt approach. During coronavirus, it will be difficult to make company visits. But, you can often speak with people …

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What Makes a Business Durable?

What Makes a Business Durable?

Hey Geoff,

I noticed in one of the recent videos you mentioned that the durability of the business matters more then the returns. I believe you were answering a viewer question on return on capital for the subject matter. When you mention durability are you talking about recurring revenue, sustainability of the business going forward (like waste collection industry or railroads etc…)?

Answer: A Good Place to Start is With the Oldest Companies in the Oldest Industries

Yes. So, this is something Buffett has said before too – and it’s true. It’s the reason why I’m not a fan of “The Magic Formula”. The Magic Formula is a system that might work empirically – but, it isn’t based on sound logic. That’s different from something like the Piotroski F-Score or Ben Graham’s 2/3rds of NCAV rule. Both of those approaches are logically sound and then can be tested to see if they work empirically. I don’t think it’s a good idea to use a system that has been back tested to show good results, but that doesn’t seem logically sound. I’m unconvinced of the logic of The Magic Formula – because, it is basically buying high current return on capital stocks without asking if they have a moat. It’s not the Buffett approach. It’s actually very different from Warren Buffett’s approach. His approach is to figure out why a company has had a high return on capital in the past, has a high return in the present, and is likely to have a high return in the future. Once he knows the reason for the high return – the company’s “moat” – he can judge how durable that moat is. This is also similar – though slightly different – from the Phil Fisher approach. Phil Fisher’s approach focused more on the organization and whether it is built for the long run: is it investing enough in marketing, is it investing enough in R&D, does it have good enough people at lower levels in the organization, are the markets the company is in likely to grow for a long time to come, has the company had success releasing new products regularly to replace old products, etc. That’s very similar – though from a different angle – to the Buffett approach. Those two approaches – Buffett and Fisher – are qualitative looks into the future. We can debate how accurately a human being can judge the likely future of a company. But, the logic of trying to do that is sound. The logic of assuming that a currently high return on capital is less likely to decline than a medium or low return on capital makes little sense. There has been some research in this area and the answer is – it depends on the industry. Some industries do show high persistence of relative returns among the firms in those industries. So, for example, the leading movie studio or beverage brand or condiment maker might tend to

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In a Market Like This – Is It Better to Buy 10 Stocks Instead of Just My 5 Favorite Stocks?

Someone sent Geoff this email:

Hi Geoff,

 

On regular days your focusing on overlooked stocks makes much sense to me and is the right place to look for good companies at a decent price.

 

But in this market selloff, wouldn’t it be better to buy blue chip stocks such as Nike, Disney, BrKb, etc.. if they fall to the right price (and I’m not sure they are there yet…).

 

Also, wouldn’t it be better to diversify? To own 10-12 stocks instead of 5-7.

Answer: It Depends On Which Stocks – Conglomerates like Berkshire and Disney Give You a Lot of Diversification, Some Other Stocks Don’t

 

(Note from Geoff: I’m going to split this email into two responses – this one will talk about diversification, tomorrow’s response will talk about overlooked versus big cap stocks)

I don’t know about whether it makes sense to own 10-12 stocks instead of 5-7. I’m not sure it does. It depends on which stocks you’d add to the portfolio. Remember, there is a lot of diversification in certain stocks already. So, you mentioned Disney (DIS) and Berkshire (BRK.B). Berkshire already gives you more diversification in terms of its underwriting than many insurers do. Plus, Berkshire has a big stock portfolio. Plus it owns a railroad. Plus it owns an electric utility. You could separately buy other insurers, stocks like Apple (AAPL) and Bank of America (BAC) and Wells Fargo (WFC) and Coke (KO). You could buy a publicly traded railroad. You could buy a regulated utility. If you add up what you’d put in all those stocks if they were in a 12 stock portfolio – maybe you’d put 33% of your portfolio or more into recreating what Berkshire already has. So, should you buy a bank, an insurer, a railroad, a utility, etc. – or just buy Berkshire? I don’t know the answer. If you pick the right bank, insurer, railroad, and utility – I’m sure you could beat just buying Berkshire. But, if you think you’re somehow safer putting 10% each into one bank, one insurer, one railroad, and one utility than 40% in Berkshire – I don’t think that’s true.

Disney is similar. The company is diversified across a couple big entertainment segments. It has a big allocation to parks and resorts. This includes things like cruise ships. But, it’s mainly theme parks. Disney has the most visited theme parks in several parts of several different continents . So, you could buy SeaWorld (SEAS), Six Flags (SIX), or Cedar Fair (FUN) – or you could get a similar allocation by owning 3-5 times more of Disney than you would of any one of those companies. If Disney is say 20-33% parks by value (you’d have to appraise the stock yourself to make this decision) then simply buying a 3-5 times bigger position in Disney and you’d get the same allocation to theme parks you would from buying one of those other stocks. Disney has a big movie business (it is now, by

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What is a Fair Price to Pay For Omnicom (OMC)?

Someone Geoff  this email ( to ask your own question: just send me an email ) :

My question is a simple one.

“What do you think is a fair price to pay for Omnicom?”

Answer: Omnicom (OMC) Could be Worth Anywhere Between 1 to 1.5 Times Sales – so, About $70 to $100 a Share – But: You Probably Want At Least a 35% Margin of Safety, So Try Not To Pay More than $45 a Share for Omnicom

This is a simple question. But, it’s tougher to answer than it appears. I see 3 big factors to consider:

1) What is the organic growth (or decay) in Omnicom’s business likely to be?

2) How much will stock buybacks drive growth in earnings per share that’s higher than organic growth?

3) How bad and how long will an ad recession be?

Because Omnicom uses so much of its free cash flow to buyback stock, there’s an element of circular logic to valuing the stock. Bizarrely, the cheaper the stock gets today – the more valuable it should be in the future. Assume Omnicom uses 50% of its EPS to buyback stock. I’ll also assume there is 1% share dilution normally before buybacks. This means that the formula that tells us how much Omnicom’s EPS will grow BEYOND its organic growth is:

(0.5 * Earnings Yield) – 1% = Inorganic EPS growth caused by stock buybacks

Let’s run this number for the following P/E ratios:

P/E = 4

P/E = 6

P/E = 8

P/E = 10

P/E = 12

P/E = 14

P/E = 16

P/E = 4 (this would be like 50% cheaper than today’s price) makes the formula…

(0.5 * 25%) – 1% = 11.5% CAGR in EPS

P/E = 6 gives us…

(0.5 * 17%) – 1% = 7.5% CAGR in EPS and so on. The “and so ons” work out as follows..

P/E 4 => 11.50%

P/E 6 => 7.50%

P/E 8 => 5.25%

P/E 10 => 4.00%

P.E 12 => 3.17%

P/E 14 => 2.57%

P/E 16 => 2.13%

Now, if we assume organic growth is equal to 0% – which may or may not be an accurate assumption – then, we can keep the fair value formula pretty simple. In theory, Omnicom should be worth its stream of dividends. EPS can be ignored as a direct thing. Instead we just assume that 50% of EPS is paid out in dividends and 50% is used to do buybacks. Again, I assume 1% is just constant share dilution in the form of stock grants to employees.

That means only two things matter. One is the buyback rate. I’ve shown that above. It ranges from a little over 2% to something like 11-12% a year depending on whether the stock trades as low as a P/E of 4 or as high as a P/E of 16. The dividend yield – if we assume a 50% dividend payout – is really easy to calculate. We just take …

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What Kind of Competition Will Car Dealers Face for the Sale of Used Cars and for Their Parts and Service Business?

Someone sent Geoff this email (to ask your own question: just send me an email):

I think that car dealers face a lot of competition, especially for used cars and service, that I could never thoroughly understand the competitive advantages. But car dealers tend to have very stable margin. So I do think that they have certain competitive advantage thanks to location, long-time presence, as well as customer relationship built up through its new car business. So, I’d like to ask you about your thoughts on the competition for car dealers in:

1. Used cars where car dealers have to compete not only with franchised dealer of another brand in the same area but also with independent used car dealers.

2. Parts and services where car dealers have to compete with independent auto service shops and chains.

Answer: I Think Big Car Dealer Groups Have Certain Advantages in Capturing Additional Profits from a Customer Relationship Based on a New Car Sale – But, the Internet May Change Things Over Time

It’s a good question. I think it’s possible that an independent seller of just used cars might be a better business – especially if it combined locations with a really, really strong internet presence.

Big car dealer groups do have to compete with service shops. And perhaps they have lost share. But, the number of dealer locations relative to the amount of population (and certainly to drivers) has been declining throughout much of the history of the industry. So, I think the business has tended to get better not worse.

What’s the big difference?

I think two things benefit dealers.

Once, they potentially have a better source of leads for their new, used, and service businesses – in the form of a new car territory they control for a brand. So, often, when someone is in the market for a new Toyota they trade in their old Toyota. The dealer can take the trade in (getting a better supply of used cars than others might) and can get the possibility that the owner of the new car will buy financing products etc. through them and – most importantly – stay with them for servicing. So, they are in a better position than some to turn a new car sale into out sources of revenue – a possible service relationship, a good price on a trade-in used car, etc. This is why I think it’d be hard to compete in new cars even if there wasn’t the dealer system that there is. New cars are largely just a good way to have a customer relationship that can make you more money form things over time.

Second – and I think for most dealers, this is the bigger issue – I think dealer groups that include new car sales, used car sales, and servicing in one operation have a lower cost of capital than competitors would. It has been very easy for new competitors in the industry to succeed in stuff

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