Written by Miguel Neto. There are some pictures I couldn’t put in this write-up that I included in the write-up I put up on my blog (https://netosnotes.blogspot.com/2019/09/graftech.html) ***** GrafTech (ticker: EAF) has been in operation since 1886. It went public in 2018 when Brookfield sold 15% of the business, after being taken private in 2015. GrafTech is a backward vertically integrated producer of ultra-high power (“UHP”) graphite electrodes (“GE”), an industrial consumable product used primarily in EAF (“electric arc furnace”) steel production. Around...… Read more
Originally posted at www.Gannononinvesting.com on June 01, 2011
by Geoff Gannon
Someone who reads the blog sent me this email:
After thinking long about that, I came to the conclusion, that LEAPS can be viewed as a form of leveraged investment with an insurance against a falling stock price included…So LEAPS would make sense, if you want to leverage your portfolio with relatively low risk.
I’m not endorsing LEAPS.
I think they make sense only in situations where there is a level of catastrophic risk in the underlying stock that is not priced into the option. In general, this means low volatility stocks that nonetheless can fail catastrophically if infrequently.
I would use LEAPS to buy a bank because there is always the risk that a bank will go to zero. In that sense, LEAPS leverage your investment and provide protection – basically an involuntary surrender – where you cut down a huge loss while still betting on a favorable outcome.
The problem with LEAPS is that they aren’t long enough dated. 5-year LEAPS would be good. 10-Year LEAPS would be virtually indistinguishable from a stock in terms of a correct analysis resulting in profit. But 2 years is not long enough for a value investor. If Warren Buffett had bought Washington Post 2-year LEAPS instead of Washington Post stock in the 1970s he would have lost his entire investment. By buying the underlying stock, he had a return of 30% a year compounded over the first 10 years.
I’ve had stocks that didn’t work out for 2 years. But, boy, did they work out over 5 years. I would’ve lost money on the LEAPS.
Any bet that depends on the market recognizing something within 3 years is a bet where a value investor can be completely right in terms of analysis and yet lose everything simply because the clock runs out.
Value investing is largely based on being able to hold a position until the market changes its mind. I’d say it’s very unreliable to assume mean reversion in the market mood on a stock within 3 years.
The exception to this is when you’re diversifying both across a group of separate bets and across a period of time. For example, if you buy one stock a month every month and turn over the portfolio every year (by swapping out one stock each month), you may average an acceptable result because you’re actually making a dozen different bets on a dozen different stocks that depend on prices at a dozen different future moments in time.
That’s not what you’re talking about. You’re talking about making one bet on one stock that will succeed or fail based on whether or not the stock reaches a certain price fast enough.
Personally, I’m not interested in LEAPS.
And I really …Read more
December 23, 2010
A reader sent me this email:
…I was wondering if there was any other advice you had on how to pick what companies I should look into. You mention a few blogs that I should look to for ideas but what about stock screens? Should I employ those in order to get a rough list of stocks and then choose a few and analyze them by reading their 10-K, etc.? I am just worried I am not sure how to get all the stocks to read their 10-K…
You won’t run out of ideas.
Start with one idea and follow that thread wherever it leads. Don’t obsess about any one stock. Just sketch the investment idea quickly in your mind. Does it grab you? No. Then move on.
Use Bloomberg to “watchlist” stocks. Whenever you find an interesting company, go to Bloomberg.com. Type the company name in the blank box in the upper right of the screen. It will give you the symbol (and exchange) of the stock you want. Click on that stock. To the right of the stock price, you’ll see an option that says “+ Add Security to your Watchlist”. Do that. You’ll need to create a Bloomberg.com account for this. It’s free.
The beauty of the watchlist is that Bloomberg tracks the stock’s percentage price move since you watchlisted it. Once a week, log into Bloomberg and just look at the stocks that are red. If the company was interesting when you first saw it, it’s even more interesting now that it’s cheaper.
Bloomberg is the best place to follow foreign stocks. So enter any names you get from reading Richard Beddard’s blog over there. Don’t try to track foreign stocks at sites like Yahoo and Google. Or at your American broker.
That brings me to another point. Pick the right broker. If you’re looking to invest like Benjamin Graham and Warren Buffett, don’t use Charles Schwab. Go with an online discount broker that does international and over the counter stocks well like Noble Trading or Interactive Brokers.
Here’s the big mistake most investors make. They refuse to follow their best ideas!
Right now, some people reading this thought: “Really? I have to switch brokers?”
Nutty, I know. But totally true.
Someone will hear about some little company that trades in New Zealand or Denmark and realize Morningstar, GuruFocus, EDGAR, etc. doesn’t have financial data on that stock. Or their broker won’t do a trade there. So they don’t follow up on the idea.
Never limit yourself because you can’t get data on the company. Screens limit you. Pretty soon you’re focusing only on screens that are running in
Some readers have emailed me with questions about exactly how to calculate free cash flow, including: Do you include changes in working capital? Do you really have to use SEC reports instead of finance websites?
Yes. You really do have to use EDGAR. Finance sites can’t parse a free cash flow statement the way a trained human like you can. As you know, I’m not a big believer in abstract theories. I think you learn by doing. By working on problems. By looking at examples.
Here are 5 examples of real cash flow statements taken from EDGAR.
We start with Carnival (NYSE:CCL).
Notice the simplicity of this cash flow statement. It starts with “net income” (top of page) and then adjusts that number to get to the “net cash provided by operating activities” (yellow). To calculate free cash flow in this case you just take “net cash provided by operating activities” (yellow) and subtract “additions to property and equipment” (green). The result is free cash flow.
As you can see, Carnival produces very little free cash flow. Free cash flow is always lower than net income. That’s because cruise lines are asset heavy businesses like railroads. They have to spend a lot of cash to grow. Carnival’s reported earnings tend to overstate the amount of cash owners could actually withdraw from the business in any one year.
Carnival is our example of a “typical” cash flow statement. There’s really no such thing. But this one is simple in the sense that you only have to subtract one line “additions to property and equipment” from “net cash provided by operating activities” to get Carnival’s free cash flow.
Next up is Birner Dental Management Services (OTC:BDMS).
Notice how Birner separates capital spending into two lines called “capital expenditures” and “development of new dental centers”. This is unusual. And it is not required under GAAP (Generally Accepted Accounting Principles). However, it’s very helpful in figuring out maintenance capital spending. If you believe the existing dentist offices will maintain or grow revenues over the years, you only need to subtract the “capital expenditures” line from “net cash provided by operating activities.” But remember, any cash Birner uses to develop new dental centers is cash they can’t use to pay dividends and buy back stock.
Now for two cash flow statements from the same industry. Here’s McGraw-Hill (MHP) and Scholastic (NASDAQ:SCHL).
These are both publishers. And like most publishers they include a line called “prepublication and production expenditures” or “investment in prepublication cost”. Despite the fact that these expenses aren’t called “capital expenditures”, you absolutely must deduct them from operating cash flow to get your free cash flow number. In fact, these are really cash operating expenses.
For investors, this kind of spending isn’t discretionary at all. It’s part of the day-to-day business of publishing. I reduce operating cash flow by the amounts shown here. At the very least, …Read more
Posted by: Warwick Bagnall ALG consists of two main parts; the Dreamworld/White Water World theme park in Queensland, Australia and the Main Event chain of family entertainment centres in the US. I’m interested in ALG mainly to try and understand why it is the largest position (>20% and growing) of a value/activist LIC (Ariadne Australia Ltd, ASX:ARA) which I hold. ALG is cheap compared to its past share price and on a (depressed) P/S basis but it has been loss making since 201. Hence this...… Read more
A Different view on Fannie Mae (FNMA) and Freddie Mac (FMCC), an issue is rather complex. Here I may refer to both institutions as “government-sponsored entities” or (“GSEs”). But YOU as an investor should focus on what’s knowable and controllable.Here is what the market is missing an my variant perspective: “Optionality has value”! Here is my invitation to you investor: see Fannie Mae and Freddie Mac at current price as an option, that could go to $0 or to $17.55 each. You would really be paying for the optionality.You...… Read more
“In lieu of (earnings per share), Malone emphasized cash flow…and in the process, invented a new vocabulary…EBITDA in particular was a radically new concept, going further up the income statement than anyone had gone before to arrive at a pure definition of the cash generating ability of a business…”
- William Thorndike, “The Outsiders”
“I think that, every time you (see) the word EBITDA you should substitute the word bullshit earnings.”
- Charlie Munger
The acronym “EBITDA” stands for Earnings Before Interest, Taxes, Depreciation, and Amortization.
A company’s EPS (which is just net income divided by shares outstanding) is often referred to as its “bottom line”. Technically, EPS is not the bottom line. Comprehensive income is the bottom line. This may sound like a quibble on my part. But, let’s stop and think about it a second.
If EBITDA is “bullshit earnings” because it is earnings before:
- Depreciation and
Then shouldn’t we call EPS “bullshit earnings”, because it is earnings before:
- unrealized gains and losses on available for sale securities
- unrealized currency gains and losses
- and changes in the pension plan?
I think we should. I think both EBITDA and EPS are “bullshit earnings” when they are the only numbers reported to shareholders.
Of course, EPS and EBITDA are literally never the only numbers reported to shareholders. There is an entire income statement full of figures shown to investors each year.
Profit figures further down the income statement are always more complete – and therefore less “bullshit” – than profit figures further up the income statement.
- EBITDA is always less bullshit than gross profit.
- EBIT is always less bullshit than EBITDA.
- EPS is always less bullshit than EBIT.
- And comprehensive income is always less bullshit than EPS.
Maybe this is why Warren Buffett uses Berkshire’s change in per share book value (which is basically comprehensive income per share) in place of Berkshire’s EPS (which is basically net income per share). Buffett wants to report the least bullshit – most complete – profit figure possible.
So, if profit figures further down the income statement are always more complete figures, why would an investor ever focus on a profit figure higher up the income statement (like EBITDA) instead of a profit figure further down the income statement (like net income)?
At most companies, items further up the income statement are more stable than items further down the income statement.
I’ll use the results at Grainger (GWW) from 1991 through 2014 to illustrate this point. The measure of stability I am going to use is the “coefficient of variation” which is sometimes also called the “relative standard deviation” of each series. It’s just a measure of how scattered a group of points are around the central tendency of that group. Imagine one of those human shaped targets at a police precinct shooting range. A bullet hole that’s dead center in the chest would rate a 0.01. A bullet hole that …Read more
By GEOFF GANNON
A Focused Compounding member asked me this question:
“Have you any thoughts on why U.S. banks are so profitable (the better ones at least)? I’ve looked at banks in other countries (the U.K. and some of continental Europe) and banks there really struggle to earn the spreads and returns on equity of high quality U.S. banks. This is particularly strange as the U.S. banking market is actually pretty fragmented, certainly more so than the U.K. which is dominated by a few giant banks and has a pretty non competitive deposit market. But U.S. banks seem to earn far better returns.
I was discussing this recently with someone who is a consultant to banks advising them in regulatory capital (among other things) and he said that it was down to the regulatory capital requirements being looser in the U.S. I’m really not convinced by that explanation though.
Is this something you’ve thought about at all?”
I don’t know if the regulatory requirements are looser really. There’s one aspect of regulation nothing about outside the U.S.: fees. It may be that U.S. banks are better able to earn non-interest income on fees (not sufficient funds fees, charging monthly fees for accounts below a certain minimum, etc.) then banks in some countries, because there might be tougher consumer protection rules in some other countries. However, from what I know of U.S. regulatory rules as far as capital requirements versus banks in other countries – I don’t really agree. It’s not that common for me to feel a bank in another country is a lot safer than large U.S. banks. So, if it’s a regulation advantage. It doesn’t seem to be an advantage due to forcing banks in other countries to be too safe.
The U.S. has FDIC. I don’t know what programs in other countries are like. Obviously, the FDIC program in the U.S. – combined with some other rules – helps minimize rivalry for deposits. An unsafe bank shouldn’t be able to draw deposits away from a safe bank just by offering high interest rates on deposits. And depositors shouldn’t abandon a bank they like just because they learn it may be about to fail. Obviously, before the FDIC and other rules – those were concerns which could mean the weakest operators in the industry would lower profitability for the strongest operators through irrationally intense rivalry for deposits.
Negative rates are bad for banks. There could be cyclical reasons for why you are seeing poor results in parts of Europe, because of that.
However, I need to warn you that it’s NOT true that small U.S. banks are more profitable than banks in other countries. They aren’t. It’s ONLY banks with good economies of scale in the U.S. that even earn their cost of capital. My estimate when I looked at U.S. banks as a group is that since about World War Two, they haven’t earned their cost of capital and they have earned returns below the S&P …Read more
By GEOFF GANNON
We did a Focused Compounding Podcast episode that was 100% dedicated to bank investing:
In that podcast notice that I analyze banks completely differently than most value investors. I don’t believe price-to-book is an especially important metric. I value banks based on the amount of their share price, their deposits per share (so P/Deposits so to speak), their growth in deposits, and finally the profitability of those deposits (how low cost are they, how “sticky” are they).
I spend very little time on the asset side of the bank except to see if I think it is safe enough for me. I just assume – and this assumption isn’t 100% correct or anything – that money is a commodity, so banks will make roughly similar amounts over time on whatever they lend out, buy bonds with, etc.
However – at least among U.S. banks – you have banks that pay very different amounts on their deposits (in interest), and even MORE important very, VERY different amounts in terms of non-interest expenses per dollar of deposits. There are banks in the U.S. that have $50 million per branch and pay HIGHER interest on most deposits compared to banks that have $200 million per branch. The bank with 4 times the deposits per branch brought in with MORE non-interest bearing accounts is going to have such a “all-in” cost advantage over the other bank that it can make fewer loans and buy more bonds, it can make safer loans that yield less, it can buy shorter-term bonds that yield less, etc. and it’ll still make more money than the bank that has to hustle to make the highest yielding loans, buy the highest yielding bonds, etc.
My belief is that a strong, durable advantage on the deposits side in terms of economies of scale at the customer level and the branch level especially is what creates value in banking.
It’s not impossible to create value in other ways. Prosperity Bank has done this. But, taking in a lot of small deposits from a lot of less wealthy people at a lot of different branches means the only way you can succeed would be extreme penny pinching on the deposit side and then really good lending on the asset side. You’d have to be cheaper than the other guys when it comes to running a customer oriented business and/or you’d have to be smarter, more driven, etc. lenders. I think that’s tough.
Recently, I also wrote-up Truxton (TRUX). You can see the same focus on economies of scale here, because:
1) Truxton operates BOTH a wealth management business and a private bank out of the location that is ALSO ITS HEADQUARTERS
2) Truxton has about 8x more deposits per branch (it only has one branch) than U.S. banks generally
3) Truxton focuses on RICH clients (this means Truxton might get 10x the dollar amount of deposits from each depositor …Read more
By Geoff Gannon
December 8, 2017
Someone emailed me this question about tracking portfolio performance:
“All investors are comparing their portfolio performance with the S&P 500 or DAX (depends were they live). I have asked a value investor why he compared the S&P 500 performance with his portfolio performance…for me as a value investor it makes no sense. A value investor holds individual assets with each of them having a different risk…it’s like comparing apples and oranges.
The value investor told me that…Warren Buffett compares his performance with the S&P 500. But I believe he did it, because other investors…expect it or ask for such a comparison.
How do you measure your portfolio success? Do you calculate your average entry P/E and compare it with S&P500 or Dow P/E to show how much you (over)paid for your assets? Or do you avoid such a comparison and calculate only the NAV of your portfolio?”
I don’t discuss my portfolio performance on this blog.
And I think it’s generally a good idea not to track your portfolio performance versus a benchmark.
It’s certainly a bad idea to monitor your performance versus the S&P 500 on something as short as a year-by-year basis.
Well, simply monitoring something affects behavior. So, while you might think “what’s the harm in weighing myself twice a day – that’s not the same thing as going on a diet” – in reality, weighing yourself twice a day is a lot like going on a diet. If you really wanted to make decisions about how much to eat, how much to exercise, etc. completely independent of your weight – there’s only one way to do that: never weigh yourself. Once you weigh yourself, your decisions about eating and exercising and such will no longer be independent of your weight.
Knowing how much the S&P 500 has returned this quarter, this year, this decade, etc. is a curse. You aren’t investing in the S&P 500. So, tethering your expectations to the S&P 500 – both on the upside and on the downside – isn’t helpful. The incorrect assumption here is that the S&P 500 is a useful gauge of opportunity cost. It’s not.
Let me give you an example using my own performance. Because of when the 2008 financial crisis hit, we can conveniently break my investing career into two parts: 1999-2007 and 2009-2017.
Does knowing what the S&P 500 did from 1999-2007 and 2009-2017 help me or hurt me?
It hurts me. A lot.
Because – as a value investor – the opportunities for me to make money were actually very similar in 1999-2007 and 2009-2017. In both periods, I outperformed the S&P. However, my outperformance in 2009-2017 was small while my outperformance in 1999-2007 was big. In absolute terms, my annual returns were fairly similar for the period from 1999-2007 and 2009-2017. It is the performance of the S&P 500 that changed.
Many value investors have a goal to outperform the S&P 500. But, is …Read more