Posts By: Geoff Gannon

Why Ad Agencies Should Always Buy Back Their Own Stock

(Excerpt from today’s Focused Compounding article)

“My belief is that the market undervalues the ad agency business model. It doesn’t understand the P/E premium over the market that an ad agency would need to trade at to equalize the likely future return of the ad agency with that of a “normal” business. Every year, an ad agency both grows organically (in line with growth in the ad budgets of its existing clients) and is able to payout 100% of its earnings. Normal businesses can’t do both of these things at the same time. So, they can grow 5% a year, but they can only pay out say 50% of earnings. That means a normal business trading at a P/E of 15 would be priced to return 8.33%. Actual returns in the stock market have not been exactly 8.33%. But, they’ve been close and they’ve been close for the reason I just explained.

The typical stock grows 5% a year organically, it pays out half its earnings in dividends (or share buybacks), and it trades at a P/E of 15. Those conditions will – in the very, very long-run – give you a return of 8.3% a year.

A P/E of 15 is an earnings yield of 1/15 = 6.67%. Half of 6.67% is 3.33%. So, I am saying that to the extent stocks tend to trade at a P/E of 15 and retain 50% of earnings they will tend to have an annual payout (in either the form of dividends or reductions in shares outstanding) of 3.33% of their market price. When you add this “yield” to the growth rate, you get a return for the investor of 8.3%. In some periods, the Shiller P/E – or whatever normalized valuation measure you want to use – will expand and returns may reach 10% or 12% over a certain 15 years. But, in other times valuations may contract and there will be 15 year periods where returns are just 6% or even 4%. For a typical business: what’s really underlying all this is about an 8% to 8.5% increase in intrinsic value (which is normally turned into about 5% sales growth and like 3% to 3.5% dividends and share buybacks).

Now, do the same math with an ad agency and you get a different number. Ad agencies retain no earnings as they grow 5% a year. So, if an ad agency stock trades at the same P/E ratio of 15 as a “normal” stock, it will have a 6.67% yield in terms of what it is going to use on dividends and buybacks. Add that to the growth rate and you get an 11.7% long-term expected return instead of an 8.3% long-term expected return. That’s an inefficient pricing.

How would the market efficiently price ad agency stocks?

The market would need to put a P/E of 30 on ad agencies instead of a P/E of 15. Value investors don’t like hearing this. But, it’s true. If Company A can grow 5% …

Weight Watchers (WTW): Mistakes Made Over 4 Years of (Emotional) Volatility

(Read the full article)

“I lost a lot of money in Weight Watchers. Let’s look at why that was.

As I write this article, Weight Watchers (WTW) stock is at $44.30 a share.

I bought my shares at $37.68 a share in 2013 and sold them (in March of 2017) at $19.40. So, I realized a loss of 49%…

…What’s notable to me looking back at what I wrote then is how little any of the essential analysis changed. Emotions changed. Owning the stock for over 3 years, you might get worn down by the constant barrage of bad news. But, with few exceptions, we laid out what the grim future would be for Weight Watchers over the next couple years and that’s not that different from the grim future that actually materialized….

…In the report, I really laid out a five year thesis – as I pretty much always do – and yet I sold the stock after not much more than 3 years.

Why didn’t I wait another 2 years?

You get tired of sitting through all the volatility in both the business and the stock.

For me, there is also an added difficulty. I don’t just pick stocks for myself. I write about the stocks I pick.

And I get tired of answering emails about the stock. By the time I sold Weight Watchers it was not one of my biggest positions at all, and yet it accounted for probably more email questions from readers than all of my other stock picks combined…It is very unpleasant to write about a volatile stock, a controversial stock, a heavily shorted stock, etc…

…Would I have held my Weight Watchers stock till now if I hadn’t made my investment in the company public?

I don’t know.

But, I do know I’m more likely to sell a controversial stock because I have to write about what I own and talk to people about what I own.

The truth is that there isn’t really that much to say about Weight Watchers other than what I said in that 2013 report…there’s been big changes in my emotions and in the stock price and there’s been some changes with the business – most notably, Oprah’s investment – but if I was going to make a decision to buy, sell, or hold Weight Watchers today I would still base 90% of my decision on what I wrote in 2013.”…

The Market is Overpriced: These 3 Stocks Aren’t

Most stocks are now overpriced.

Historically, a normal price for a stock has been about a P/E of 15.

And historically, stocks have outperformed other assets.

Therefore, it makes sense to buy above average businesses when their shares trade at a P/E of 15.

Right now, I see 3 above average businesses trading at about a P/E of 15:

• Cheesecake Factory (CAKE)
• Omnicom (OMC)
• Howden Joinery

I’m not buying any of these stocks personally right now.

However, if you asked me right now whether or not I think you should buy a certain stock, I’d say “no” to 99% of the stocks you can name.

Those 3 belong to the 1% of stocks I’d say “yes” to.

I’ve never seen a time when it’s as difficult to find a good stock to buy without overpaying as what I see right now.

But, I don’t think that means you should be 100% in cash. I think it means you should be in stocks like:

• Cheesecake Factory (at $41 as I write this)
• Omnicom (at $73 as I write this)
• And Howden Joinery (at 412 pence as I write this)

If the market as a whole is overpriced, it will fall. And when it does fall: it will take stocks like Cheesecake, Omnicom, and Howden with it.

In time, they will recover.

And you will be able to look back – 5 years or more down the road – and say that buying stocks like these at today’s “not overpriced” levels and holding them wasn’t a mistake.

You don’t need to get out of the market.

But, you do need to be more selective than ever now that the market is more expensive than ever.…

My Investing Goal

Someone emailed me this question:

“For the past months I’ve dug into your posts on Gurufocus…in this article you write about Warren Buffett’s early years:

‘Warren Buffett was thinking about compounding wealth. He was interested in getting rich.’ 

This sentence piqued my curiosity a little. What (are) your goals and objectives in the stock market? Is it getting rich, saving for retirement, or something not money related?”

I have zero interest in getting rich. Investing is a purely intellectual exercise for me. I love writing and I love investing. My only financial goal is to make enough money so I never have to do any work that isn’t either writing or investing.

A lot of people email me asking if I’d ever be interested in managing money.

The answer is no.

If I was interested in getting rich, the answer would be yes. The way to get rich in the stock market is to manage other people’s money and manage it well. That’s what Buffett did.

For myself, I’d be really happy if I could:

• Save some money every year
• Put all the money I saved that year into just one new stock
• Keep that stock for the rest of my life
• Repeat annually till dead

I can do the likely compound math and see that would ensure an adequate result in my case. I’d like the intellectual challenge of picking one and only one stock a year and never being able to reverse that decision. But what I’d really love would be never being troubled by the constant irritation of active portfolio management.

The only thing I like about investing is picking stocks. Nothing else about it appeals to me.

So, those bullet points are the routine I’d follow if I was just investing for myself and not having to write about it for anyone else.…

Did You Invest in Weight Watchers (WTW)? Call for Quotes/Comments: Weight Watchers Re-Visit

I planned to do a quick re-visit of my own experience investing in Weight Watchers (WTW). However, since announcing my plan to do that, I’ve gotten a lot of emails from people telling me about their own experience either investing in that stock on their own or following me into it.

So, I’ve decided to do a post that includes those experiences. If you owned Weight Watchers stock – or even considered buying the stock but ultimately deiced to pass – at any time between 2013 and 2017, please send me an email detailing your experience.

Try to include:

1.       How did you first find out about the stock? (Was it my blog, my newsletter, someone else’s write-up online, a news report, your own experience trying to lose weight, Oprah’s investment, etc.)

2.       When did you buy the stock? (what date, at what price, etc. – to the best of your memory)

3.       What factors drove your buy decision?

4.       When did you sell the stock? (what date, at what price, etc. – to the best of your memory)

5.       What factors drove your sell decision?

6.       And most importantly: How did holding this stock make you FEEL? (what emotions did you cycle through and what influence did these emotions have on your decision to buy, hold, or sell?)

7.       Do you think you learned anything from this experience?

I will quote from the emails sent to me. I will edit only for clarity and brevity.

Please rest assured: I will anonymize all quotes. Your name will not appear anywhere in the post.

I’m in the midst of summer vacation. So, you have till the end of August to send in your personal history investing in Weight Watchers stock. I will post this at the start of September regardless of how much feedback I get. I don’t want to hold off any longer than that. So, if you want to submit – submit now.

If you invested in Weight Watchers, please do consider submitting your thoughts.

I think you’ll find the experience of summarizing your experience and sending it off to me to be cathartic.…

The Two Things Every Stock Picker Needs to Learn: Independence and Arrogance

I get a lot of emails from people asking how to become a better investor. They usually have very specific ideas about what would help them improve. For example, they think they need to get better at reading 10-Ks and that would fix their problem. Or they think they need to get better at deciding which stock to research in the first place. The truth is that most of the people I’ve talked with and tried to help improve as investors suffer from the same mental block.

They think there is a right way and a wrong way to analyze a stock. They have – whether they realize it or not, and I think usually they do not – a kind of moralistic view of how investing ought to be done. They believe that if you do what you’re supposed to do, work hard, etc. you will get a good outcome. Investing doesn’t work like that. Stock analysis doesn’t work like that. It really doesn’t matter whether you are a very hard working, diligent researcher of stocks or a lazy but brilliant one. There are no points for effort. Nor is there any degree of difficulty modifiers. Often, the best ideas are easy to come up with. They don’t take much time to research. They are 99% inspiration and 1% perspiration type ideas.

So, what do you need to be a good stock analyst? What is the key to hunting for and finding the right ideas to bet big on?

You need a different, better way of seeing the stock than most investors do. I’ve talked about the importance of “framing” an investment problem before. In my discussions with readers, I’ve realized they really underestimate the importance of this. Yes, I read the footnotes to financial statements, and I take notes on the 10-K, and I put together Excel spreadsheets. But there’s really nothing in any investment thesis that’s going to flip the correct answer of whether to buy a certain stock from a “no” to a “yes” or vice versa depending on whether the P/E is 14 or 18, the projected future growth rate is 4% or 6%, the Net Debt / EBITDA ratio is 1.5 or 2.5. If something as small as that can change your decision to invest – this stock probably isn’t worth your time.

The investment ideas really worth having are all “framing” problems. You have to find a stock where the way you frame the entire problem of analysis and appraisal is different from the way other people frame that same problem.

Let’s start with two examples from my own portfolio. Right now, I have 40% of my portfolio in Frost (CFR) and 25% of my portfolio BWX Technologies (BWXT). No other stock accounts for more than 6% of my portfolio. So, these are really the only two stocks that matter in my portfolio. In both cases, I framed the problem of appraising those stocks differently than most investors probably did.

Let’s start …

Guesses About My Next Purchase

Blog readers emailed me guessing I would buy one of four stocks this week: Howden Joinery, Omnicom, Hunter Douglas, or MSC Industrial.

I MIGHT Buy a New 20% Position This Week

It’s very possible I will purchase a new 20% position this week (29% of my portfolio is in cash and 6% is in a stock I’d happily eliminate).

If I do buy the stock, I’ll announce it on the paid site (Focused Compounding) first and then mention the stock’s name here a week or two later.

Anyone who wants to guess what the stock is can email me at [email protected]

There are no prizes for a correct guess. But, it might be a fun exercise.…

What My Portfolio Looks Like Right Now – July 3rd, 2017

Frost (CFR): 42%

BWX Technologies (BWXT): 23%

Natoco: 6%

Cash: 29%…

Examining Your Past Sell Decisions: Nintendo

Here is a blogger doing what I recommended: examining one of your past sell decisions…

Blog Post: What I Learned Selling My Nintendo Stock

YouTube Video: Do I Regret Selling Those Stocks?

My Original Post: “Over the Last 17 Years: Have My Sell Decisions Really Added Anything?”…