Blog – Page 26 – Focused Compounding

Andrew Kuhn November 10, 2017

Green Brick Partners Q3 Earnings: It’s still cheap…

Green Brick Partners reported earnings this past week on November 6^th. For those of you who don’t know much about the company, here is a summary that Geoff wrote about the company back in September:

“Green Brick Partners is a homebuilder that is split close to evenly between Dallas Fort-Worth (it builds homes in places like Frisco, which is right by where I live in Plano) and Atlanta. I don’t know the Atlanta housing market. But, I do know the Dallas housing market. The stock trades at about 1.1 times book value. However, in the homebuilding industry, land is usually held for 2-5 years from the time a homebuilder buys it to the time they sell the finished house on that land. Land prices in Dallas Fort-Worth have risen, so the fair value of their holdings would actually somewhat exceed 110% of book value – meaning, the market value of the company’s assets is slightly greater than the market cap of the company. They have enough net operating loss carryforwards to not pay taxes for another 3-5 years depending on how much they grow earnings. The decision maker (Jim Brickman) is a good homebuilding guy and has a meaningful personal stake in the company. Together with David Einhorn’s Greenlight capital (about a 50% owner) and Dan Loeb’s Third Point (about a 17% owner) people who are insiders/long-term investors of some kind hold about 75% of Green Brick Partners. So, the float is probably no more than $125 million. The stock was, in recent memory, a speculative ethanol type company that was used as the public entity to take this Einhorn/Brickman homebuilding entity public. In investors’ minds, the company is probably not “seasoned” as much as it’s going to get in the sense that if I say “Green Brick Partners” today – you may not have recognized the name and if you did you may not have immediately remembered it’s a homebuilder and even if you did remember that you still might not have remembered where it builds home (Dallas and Atlanta). It’s underrecognized. If you buy the stock in 2017 and plan to sell it in 2022, you’ll probably be selling a bigger, more recognized stock with a higher price-to-book multiple that is then starting to pay taxes.

A homebuilder is not the kind of stock I’d usually buy. Green Brick isn’t a capital light pure homebuilder like NVR (NVR). Nor is it more of a marketing machine like LGI Homes (LGIH). It’s something that buys up land, holds it for up to five years, puts a house on it, and then sells the land plus the house. There’s no cash flow that doesn’t go back into buying up more land. Everything it does is tied to residential land values where it operates. So, this is purely an investment in residential land in Dallas and Atlanta. However, the combination of UNTAXED (for now) cash flow from homebuilding activities going back into buying additional land plus the annual appreciation …

Geoff Gannon November 7, 2017

In 2017: What is the Line Between Investment and Speculation?

In a recent post, Richard Beddard mentions Ben Graham’s speech “The New Speculation in Common Stocks” and particularly how it ends with a quote from the Roman poet Ovid:

“You will go safest in the middle course.”

At the end of that talk, Graham adds: “I think this principle holds good for investors and their security-analyst advisors.”

What Graham is saying is that investors should avoid both stocks that are speculative because the underlying enterprise is speculative and stocks that are speculative because the price is speculative.

I agree with Graham on this one. And I think it helps clear up some confusion that readers have with my own approach to investing. I get a lot of questions from investors – each coming from one of the two opposing philosophical camps – that go something like this: “When I look at the stocks you own, I wonder are you really 100% a value investor?” That’s the question from the Ben Graham value camp. And then the other question goes something like: “When I look at the stocks you own, I wonder are you really 100% a wide moat investor?”

My answer to these questions tends to go something like this:

If you look back at all the stocks I’ve bought, how many times in my life have I ever really paid more than about a P/E of 15?

And, if you look back at all the stocks I’ve bought, how many times in my life have I ever really bought into a company with a weak competitive position?

Those – to me – are the two speculations the average investor slides right into without much thought.

1. He speculates that this business he likes is not just better than other businesses but better enough to more than offset paying a higher than average price for the stock (that is, a P/E over 15).

2. And he speculates that this business he likes will withstand the ravages of competition that are an ever-present part of capitalism.

Now, there are other kinds of speculations you can make. Readers are quick to point out that I own NACCO (NC) which is basically a speculation that no more than one of the coal power plants the company supplies will be shut down in the truly near-term future. I also own BWX Technologies (BWXT) which is a speculation that the U.S. Navy will continue to use aircraft carriers, ballistic missile submarines, and attack submarines – and that those 3 classes will be nuclear powered. I own Frost (CFR) which is a speculation on higher interest rates in the sense that if the Fed Funds Rate was never to rise from the level it is at today, my returns in Frost would be middling.

But when you stretch the word “speculation” that far, you demolish any distinction between investment and speculation in the way Graham used those words. The future is always uncertain. But, we have to be able to define the words “investment” and …

Geoff Gannon November 3, 2017

My New 50% Stock Position is NACCO (NC)

Someone on Twitter mentioned it’s been 32 days since I put 50% of my portfolio into a new stock and said: “I’ll reveal the name of this new position on the blog sometime within the next 30 days”. Since, I promised 30 days this time, I’ll reveal the name now. In the future, I think I’m going to wait a full quarter (3 months) between the time I mention a stock on my member site (Focused Compounding) and on the blog. I want to be open with blog readers. But, I also want the people who provide me financial support through their monthly subscriptions to get real value for their money. The only reason I can afford to spend time writing content on this blog for free is because there are subscribers on the member site. So, the member site will always hear about my new stock ideas first.

Anyway….

On the morning of October 2nd, I put 50% of my portfolio into NACCO (NC) at an average cost of $32.50. That was the first day the North American Coal Company was trading separately from Hamilton Beach Brands (HBB).

NACCO operates unconsolidated (their debt is non-recourse to NACCO) surface coal mines that supply “mine-mouth” coal power plants under long-term cost-plus contracts that are indexed to inflation.

You can learn more about NACCO by reading:

The company’s investor presentation

Clark Street Value’s post on NACCO

NACCO’s first earnings report as a standalone company

You can also listen to the company’s earnings call here

Finally, you can buy a book that provides a complete corporate history of NACCO from 1913 through 2013. The title is “Getting the Coal Out”. The author is Diana Tittle. It’s available used at places like Amazon. You may also be able to order it from the company. I’m not sure about that.

Yes, I do own a copy.

My NACCO position was posted immediately on the member site. I’ve written several articles about it there over the last month, mostly in response to questions from Focused Compounding members.

So, as of October 2nd, my portfolio was:

NACCO (NC): 50%

Frost (CFR): 28%

BWX Technologies (BWXT): 14%

Natoco: 7%…

Geoff Gannon November 3, 2017

Buy Unrecognized Wonder; Sell Recognized Wonder

“It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.”

– Warren Buffett

Richard Beddard has an excellent post worrying about whether the stocks in his Share Sleuth portfolio are becoming too popular.

I want to use his post as an opportunity to talk about how an investor – or, at least an investor like me – needs to cycle out of stocks that are getting recognized for what I believe them to be and into stocks that aren’t getting recognized for what I believe them to be.

I like “wide moat”, predictable businesses. But, I can’t afford to pay the kind of prices that stocks with recognized moats and recognized predictability trade for. So, I need to find unrecognized moats and unrecognized predictability.

The top three stocks I own are: NACCO (NC), Frost (CFR), and BWX Technologies (BWXT). The best performer among that group is BWX Technologies. That good performance is the result of increased recognition of what BWX Technologies is. When I bought Babcock & Wilcox pre-spinoff (and then later sold my BW shares but kept my BWXT shares) I was seeing the company differently than the market was. Today, the market sees BWXT the same way I do.

Let’s look at this in chart form.

Today, the market values BWX Technologies about 120% higher than it valued the combined Babcock & Wilcox. The stock you are seeing here spun something off (so it disposed of value) and yet it still more than doubled its market price.

The stock now has a P/E of 32. The return here is due to multiple expansion. BWX Technologies – as part of Babcock & Wilcox – went from being valued as an average company (a P/E around 15) to being valued as a wide-moat, predictable company (a P/E around 30). BWXT’s biggest business is being a monopoly provider to the U.S. government under cost plus contracts indexed to inflation. That’s not new information. The market just sees the same old information differently now that BWXT is reporting its own clean, independent EPS and giving long-term guidance for EPS growth as far as 3-5 years out.

The price on this stock (a P/E of 30+) indicates the market sees this business much the way I see this business. If we have the same understanding of the business – it’s time for me to consider selling.

Now, I don’t sell a stock just to have cash. But, if I want to buy anything new – I should buy something that’s a wide-moat, predictable business that has yet be recognized for being that and fund the purchase by selling BWXT which is also a wide-moat, predictable business but is now recognized as such.

The next chart is Frost. You can read an explanation of how I see the stock here.

The stock has about doubled. Here, though, it is not appropriate to use the P/E ratio for

Geoff Gannon November 3, 2017

NACCO (NC): First Earnings Report as a Standalone Company

Two days ago, NACCO (NC) released its first quarterly results as a standalone company. Yesterday morning, the company had its first earnings call as a standalone company. The stock dropped 10% following these events. I’m not going to write about NACCO each quarter. But, some people asked for my thoughts on the quarter and the stock drop. So, I’ll do it this once.

Overall, the earnings call and the stock drop reinforced my belief that it could take a year or more of NACCO trading “cleanly” as a separate company before it’s well understood by investors. More on that at the end of this post.

First, the earnings release. Here, everything was as expected.

You can – and should – read NACCO’s full earnings release here. These are the items I highlighted:

“After the completion of the spin-off, NACCO ended the third quarter with consolidated cash on hand of $93.9 million, debt of $58.7 million and net cash of $35.2 million. The cash on hand included a $35 million dividend received from the housewares business prior to the completion of the spin-off.” So, the company now has $5.13 in net cash per share.
“NACCO’s board of directors will evaluate and determine an ongoing dividend payout rate at its next regularly scheduled meeting in November. When doing so, the board will consider the financial conditions and prospects of NACCO and North American Coal following the spin-off of the housewares-related business.” We’ll see what they decide to start the dividend at. The “financial conditions” are strong. The “prospects” are bleak.
Not a highlight, but a note: The after-tax numbers are meaningless here because of a very unusual tax timing situation. The company had a 44% tax rate on continuing operations. In the future, I expect the normal tax rate for NACCO as a standalone company will be 23%. So, ignore all after-tax numbers.
Centennial is NACCO’s consolidated (so NACCO bears all the risk) failed mine: “Centennial will continue to evaluate strategies to optimize cash flow, including the continued assessment of a range of strategies for its remaining Alabama mineral reserves, including holding reserves with substantial unmined coal tons for sale or contract mining when conditions permit. Cash expenditures related to mine reclamation will continue until reclamation is complete, or ownership of, or responsibility for, the remaining mines is transferred.”
NACCO confirmed that the customer will bear the risks related to the Kemper plant / Liberty mine failure and NACCO will be paid to do the mine closure work: “The terms of the contract specify that Mississippi Power is responsible for all mine closure costs, should that be required, with the Liberty Mine specified as the contractor to complete final mine closure. Should the decision to suspend operations of the gasifier and mine become permanent, it will unfavorably affect North American Coal’s long-term earnings under its contract with Mississippi Power.”
“…capital expenditures are expected to be approximately $21 million in 2018.”
“While the current regulatory environment for development of new

Geoff Gannon November 2, 2017

The Most Interesting Stocks to Start Researching Right Now

NACCO (NC): $35.90 – down 11% today

Cheesecake Factory (CAKE): $42.31 – down 6% today

Omnicom (OMC): $66.41

Under Armour (UA): $10.58 – down 6% today (only consider “UA” shares not “UAA” shares)

Hostess Brands Warrants (TWNKW) – $1.35 (a pair of warrants at $2.70 gives you an option to buy 1 share at $11.50 in 2021)…

Geoff Gannon November 1, 2017

A Note on Under Armour: Always Prefer UA to UAA

Under Armour (UA) stock dropped a lot in the last 24 hours. So, some value investors may be looking at it. If you do look at it, make sure you consider buying only the class “C” shares trading under the ticker “UA” instead of the class A shares trading under the ticker “UAA”. The “UA” and “UAA” shares are identical in all respects except that the UAA shares have 1 vote and the UA shares have no voting rights. As Under Armour is effectively a controlled company (the CEO and founder holds Class B shares with super voting rights that give him a 65% share of total votes), there should be almost no premium on the UAA (voting) shares over the UA (non-voting) shares. However, as I write this, the “UA” shares trade at a price 9% lower than the UAA shares.

So, when you think Under Armour always think of the ticker as “UA” and never “UAA”.…

Geoff Gannon November 1, 2017

The Best Investing Books for a Budding Value Investor to Read

Value and Opportunity just reviewed a book “100 Baggers” that I’ve read (and didn’t particularly like) which is basically an update of another book I own called “100 to 1 In the Stock Market” (which is outdated, not available on Kindle, but I probably like better). The fact that I’ve read both these books reminded me that I actually do read a lot of investing books and yet I don’t write much about books on this blog.

There’s a reason for that.

I get a lot of questions about what investing books people should read. My advice to most is to stop reading books and start doing the practical work of slogging your way through 10-Ks, annual reports, etc. There seems to be a tremendous appetite for passive reading among those who email me and no appetite for active research. It’s better to read a 10-K a day than an investing book a day.

But, there are good investing books out there. And, yes, I read a lot of books. Still, I’m going to give you a simple test to apply to yourself: if you’re reading more investing books than 10-Ks, you’re doing something wrong.

Assume you’re reading your fair share of 10-Ks. Then you can read some investing books on the side. Which should you read?

Practical ones.

How to Read a Book

A book is only as good as what you get out of it. And there’s no rule that says you have to get out of a book what the author intended. The best investing books give you plenty of case studies, examples, histories, and above all else – names of public companies. While you read a book, highlight company names, names of other investors, and the dates of any case studies. You can look into these more on your own later. Also, always read the “works cited” or “bibliography” at the back of any book you read. This will give you a list of related books you can read next. Since I was a teen, I’ve always read the works cited or bibliography to come up with a list of related titles. And I’ve realized talking to other people as an adult, that most people ignore those pages. They’re very useful. Read them.

My Personal Favorite: “You Can Be a Stock Market Genius”

If you follow my Twitter, you know I re-tweeted a picture of ”You Can Be a Stock Market Genius” that my website co-founder, Andrew Kuhn, posted. It’s one of his favorite books. And it’s my favorite. If you’re only going to read one book on investing – read “You Can Be a Stock Market Genius”. The subject is special situations. So, spin-offs, stub stocks, rights offering, companies coming out of bankruptcy, merger arbitrage (as a warning), warrants, corporate restructurings, etc. The real appeal of this book is the case studies. It’s a book that tells you to look where others aren’t looking and to do your own work. It’s …

Geoff Gannon October 25, 2017

Cimpress (CMPR)

Guest Write-up by Jayden Preston

Introduction

Vistaprint was founded in 1994 by Robert Keane, on the idea that there was a market for producing business cards cheaply for companies too small to order in large quantities. Through utilizing the internet, creating better software and printing technologies to make such mass customization cost effective and efficient, the business has turned out to be a huge success.

23 years later, Vistaprint has become a clear leader in mass customization of marketing materials for small businesses. It has also increased its portfolio of businesses and target markets through acquisitions and now offers thousands of products that customers can customize to their needs. It was renamed to Cimpress in 2014 to reflect their growing number of business units.

Business Summaries

Cimpress has changed their business segmentation a number of times in the past. We look at their current segmentation below:

1. Vistaprint

This is still their core business. Vistaprint currently operates globally, with a special focus on North America, Europe, Australia and New Zealand markets. Their Webs-branded business is also grouped under Vistaprint.

The target customers of Vistaprint are micro businesses, i.e. companies with fewer than 10 employees. Since they are small operations without marketing expertise, they rely heavily on the software technologies provided by Vistaprint when designing and making their marketing materials.

In FY2017, Vistaprint served 17 million micro businesses and generated $1.3 billion in revenue, representing 60% of Cimpress’s overall revenue. Adjusted net segment operating profits were $165 million, for a margin of 12.6%. This is a depressed margin though. The two-year average from FY2015 and FY2016 is higher than 17%.

2. Upload and Print

This segment is mostly built up through acquisitions. Companies/brands in this segment include: druck.at, Easyflyer, Exagroup, Pixartprinting, Printdeal, Tradeprint, and WIRmachenDRUCK businesses. These companies mostly focus on Europe.

Some companies that have more resources would look for professional graphic designers, ranging from local printers, print resellers and graphic artists to advertising agencies and other customers with professional desktop publishing skill sets, for their marketing needs. The segment focuses on serving such graphic professionals.
As a group, they generated $589 million in revenue in 2016, which is 28% of the total. Adjusted net segment operating profits were $64 million, for a margin of 10.9%

3. National Pen

This business was acquired at the end of 2016. Given its scale and vertical integration, National Pen is the leading provider of a wide array of customized writing instruments for small- and medium-sized businesses in more than 20 countries. The company also sells other promotional products, including travel mugs, water bottles, tech gadgets and trade show items.

It serves about a million small business customers through a successful direct mail marketing and telesales approach, as well as a small growing e-commerce business.

The business generates around $113 million in revenue.

4. All Other Businesses

This segment includes the recently sold Albumprinter, Most of World, and Corporate Solutions businesses. These businesses have been combined into one reportable segment based on …

Geoff Gannon October 25, 2017

Seeking Out Strange Stocks: How to Create a Value Investing Basket that MIGHT Get Decent Returns Even When the Market Falls

Someone emailed me this question:

“I know you are a stock only person.

But just for a minute I need your knowledge…I don’t look for 15% per year. I look for 6% a year for the next 5-7 years…on my money.

What would be the best/safest way to get it? Will a certain ETF, a dividend stock? SPY? Japan ETF? India or Russia?”

I don’t know of anything that can safely guarantee you anything like 6% a year. To give you some idea, even junk bonds now yield about 5.5%.

And I wouldn’t call junk bonds safe. Their prices would fall as interest rates rose and the economy entered a recession. Both of these things will happen at some point. Will it be in the next 5-7 years? I don’t know. But, you can’t buy assets like that at today’s prices if you’re hoping to make 5-7% a year over the next 5-7 years even if the stock market does badly.

However, you can certainly find things that should return at least 5% to 7% a year over the next 5-7. It’s just that:

1) Some of them will be specific stocks – not ETFs

2) Some of them may return a lot more than 5% to 7%

3) Some of them will lose money

4) It will take a lot of work on your part to find them

5) You will need to use a basket approach

6) Actually: I’m going to recommend a “basket of baskets” approach

I don’t diversify widely. But, if you’re looking to find something that will return 5% to 7% a year over the next 5-7 years, your best bet is to own a basket of very cheap (probably obscure) stocks. If these stocks are cheap, small, obscure, illiquid, etc. – it’s less likely they will move with the overall market. Special situations (like spinoffs and other things mentioned in Joel Greenblatt’s “You Can Be a Stock Market Genius”) should also help get you closer to your goal of 5% to 7% annual returns over 5-7 years no matter what the market does.

The reason I’m starting off a discussion with “cheap, small, obscure, and illiquid stocks” is that I’m not at all confident I can find an entire stock market for you that will return 5% to 7% a year over 5-7 years given today’s starting price. Although, in a moment we will discuss the possibility of putting 20% to 40% of your portfolio in things that are either directly or indirectly “funds” rather than specific stocks. More on that later.

But, first, let’s start with the specific stocks.

If you aren’t doing a lot of intense stock picking that results in you only owning maybe 3-5 stocks at once (like me), you need a process for finding investments that is a more formulaic, “wide-net” approach.

A fund manager has to worry about putting large amounts of money to work. So, they lean in the direction of owning even more …