Blog – Page 41 – Focused Compounding

Geoff Gannon September 29, 2013

How Did Mohnish Pabrai Not Make Money in Japanese Net-Nets?

This is a serious question. I’m probably not qualified to answer it, because I have a poor understanding of Pabrai’s investment approach.

Here is the blog post that stumped me:

The Pabrai funds invested in a basket of Japanese (net-nets) starting October 2010. Mohnish has exited all the positions with a realized gain of 2.2% including dividends, or 1.4% annualized.

The notes go on to give examples of some stocks Pabrai owned:

Examples include Hibiya Engineering and Ryoyo Electro. Both were trading below NCAV at the time of his investment, generating profits as well as positive and consistent cash flows. Managements of both companies were also repurchasing shares. Hibiya ended up just a little bit profitable and Ryoyo turned out be a -15% loss.

I can’t explain Pabrai’s experience with Japanese net-nets. But I can tell you a little about my own. We have two records of it. One is personal (my own account where I actually bought net-nets and made money). The other is public (a paid report I put out on March 21st, 2011). There is a third record you should check out. Go to Nate Tobik’s Oddball Stocks and read all his Japanese net-net posts. These three experiences are more indicative of what individual American investors would have gotten out of their Japanese net-nets.

I won’t talk a lot about my private record, because it’s private. You can’t verify it. But it’s better than the public record I’m about to show you. Instead of picking 15 Japanese net-nets, I went with no more than 5 at a time. I ended up buying a total of 6. I started with 5 and then added one later to replace a stock (Sanjo Machine Works, which is on the list) that was bought out. Like always, I concentrated a little more than other investors might. In this case, that got me a better personal result than the more diversified group I’m about to show you.

So let’s talk about that group of 15 net-nets. Let’s talk about the public record.

I published a (paid) report on Japanese net-nets on March 21st, 2011. So we have a list of 15 Japanese net-nets we can look back on without the usual biases of a hypothetical backtest. This is an actual observation. We’re working off a dated PDF that went out to buyers.

Here are the returns (in Yen) of those 15 Japanese net-nets since March 21st, 2011.

Zaoh (9986): 84%

Fuji Electric Industry (6654): 23%

Mitsui Knowledge Industry (2665): 28%

ASICS Trading (9814): 82%

Sonton Foods (2898): 47% TAKEOVER

Nisshin Electronics Service (4713): 33%

Daito Gyorui (8044): 9%

Sanjo Machine Works (6437): 186% TAKEOVER

NJK (9748): 67%

Noda Screen (6790): 62% TAKEOVER

M.O. TEC (9961): 41% TAKEOVER

Yasuhara Chemical (4957): 1%

Techno Associe (8249): 71%

Kawasumi Laboratories (7703): 12%

Seiko PMC (4963): 83%

Now, the Yen has fallen 18% against the dollar since March 21st, 2011. So, we will factor that into our results. Taking the currency loss into consideration, here are …

Geoff Gannon September 28, 2013

What is The Avid Hog?

The Avid Hog is a monthly value investing newsletter written by Geoff Gannon and Quan Hoang. It is best suited for buy and hold investors looking for an above average business at a below average price. Each month, Geoff and Quan pick the best buy and hold stock they can find. They discuss that one stock in a series of 9 articles. These 9 articles – each over 1,300 words long – include separate sections on the 7 points that make up Geoff and Quan’s personal buy and hold checklist:

Durability
Moat
Quality
Capital Allocation
Value
Growth
Misjudgment

In addition to 12,000 words of written analysis, each issue of The Avid Hog includes:

Historical financial data
Owner earnings calculation
Intrinsic value appraisal
Margin of safety measurement

The goal of each issue is to provide subscribers with enough information – in the form of facts, quotes, and data – to make their own decision about the stock. Unlike many newsletters, the focus of The Avid Hog is business analysis. The intended minimum investment time frame is 3 years. The stocks profiled are the same stocks that Geoff and Quan are researching for their personal accounts. Geoff and Quan have agreed to limit all future purchases to stocks that have appeared in The Avid Hog. This ensures the idea flow subscribers are seeing is identical to what Geoff and Quan are thinking when it comes to their own money.

The cost is $100 a month.

At The Avid Hog, we do not offer trial periods. Nor do we make old issues available for free. However, you may sample the current issue of The Avid Hog. Sampling is done on the honor system. You do not need to enter your credit card information. Just call or email Subscriber Services and ask to be sent the current issue. If you are satisfied with your sample, please come back to the site and pay for the product you just enjoyed by clicking the subscribe button. If you are unsatisfied, think of it as an (unwanted) gift.…

Geoff Gannon August 25, 2013

Daily Idea: National Research (NRCIB)

National Research (NRCIB) trades on the Nasdaq. There are two classes of stock. Focus on the Class B shares.

Google Finance

Press Release (“Use of Cash”: 8/21/2013)

14A (Proposal 2: Page 22; Fairness Opinion Page 29)

Annual Reports

SEC Reports

Link

Nuclear Story With an Unexplosive End (free PDF of Grant’s Interest Rate Observer)

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Geoff Gannon August 25, 2013

Punchcard Investing’s Take on Weight Watchers (WTW)

I have 25% of my portfolio in Weight Watchers (WTW). My average cost is $37.68 a share.

A blog I read regularly, Punchcard Investing, took a closer look at Weight Watchers. The card remained firmly unpunched:

At a 6% FCF/EV yield (on 2012 FCF), WTW is not particularly cheap. Further, this seems to be a stock market investment rather than a business investment. Mr. Gannon’s analysis turns on Weight Watchers P/E multiple increasing from 8 to 15. We don’t like to rely on a speculative change in investor sentiment. Instead, we like to rely on improving business results to carry the day. As the name of the blog would suggest, we are not comfortable buying a stock that we would not want to own forever. Otherwise, the risk of a “value trap” is simply too high. Here, WTW simply has no durable competitive advantages. In the turbulent weight management sector, this makes forecasting future cash flows impossible and far too risky of an investment.

(Punchcard Investing) …

Geoff Gannon August 25, 2013

2 Kinds of Cheap: Margin of Safety vs. Annual Return

A stock can be cheap in two ways:

It can have a highmargin of safety.
It can promise a highannual return.

A stock like Weight Watchers (WTW) promises a high annual return. Here is Weight Watcher’s past 11 years of free cash flow data presented as a percentage (yield) of its current market cap ($2.05 billion).

Minimum: 10.3% (2008)

Maximum: 17.4% (2011)

Median: 12.4% (2004)

Mean: 12.8%

Standard Deviation: 2.0%

Variation: 0.16

From a leveraged free cash flow perspective, if 2004 was a normal year for Weight Watchers the stock’s earning power is 12.4% of today’s price. If 2008 was a normal year, the stock’s earning power is 10.3% of today’s price. If 2011 was a normal year, the stock’s earning power is 17.4% of today’s price.

To avoid permanent impairment, a stock’s earning power should be at least 6.67%. This is because stocks often trade at 15 times earnings and 1 divided by 15 is 6.67%. So a 6.67% free cash flow yield is sufficient to support a stock price.

If a stock’s price declines while it persists in delivering 7% or more of your purchase price in free cash flow each year, it’s appropriate to consider your loss a purely “paper loss”. If your intention is to hold the stock indefinitely, you may never need to realize that loss.

Ben Graham defined safety as:

Protection against loss under all normal or reasonably likely conditions or variations.

Since a 7% free cash flow yield is an adequate protection against loss, we can substitute that number for Graham’s phrase “protection against loss”.

We can then define a stock’s safety as its:

Likelihood of delivering annual free cash flow of 7% or more of your purchase price under all normal or reasonably likely conditions or variations.

Leveraged numbers – like free cash flow yield (free cash flow/market cap) – show you annual return possibilities. They do not provide any hints about margin of safety.

Capitalization independent numbers do.

A stock like Weight Watchers does not provide a high (quantitative) margin of safety. Here is Weight Watcher’s past 11 years of EBITDA data presented as a percentage (yield) of its current enterprise value ($4.34 billion).

Minimum: 7.3% (2004)

Maximum: 13.3% (2011)

Median: 9.1% (2006)

Mean: 9.3%

Standard Deviation: 1.8%

Variation: 0.20

EBITDA is cash flow the company has available to make capital expenditures, pay interest, pay taxes, make debt repayments, and finally – only after these other things have been done – buy back stock and pay dividends to shareholders.

If 2004 was a normal year for Weight Watchers, the company’s EBITDA power is only 7.3% of today’s enterprise value. This EBITDA is what protects both the creditors and owners of the company from impairment. A 7.3% EBITDA/EV yield is low. It’s equivalent to an EV/EBITDA ratio of 13.7x. That’s unsustainable. So someone – like me – who owns Weight Watchers stocks must believe that the company’s future EBITDA will not be as low as it was 10 …

Geoff Gannon August 23, 2013

Daily Idea: Murphy USA (MUSA)

Murphy USA will trade on the NYSE under the ticker “MUSA”.

Google Finance

Form 10-12B

Roadshow Presentation

SEC Reports

Link

Special Situation: The WP Stewart Rights…

Geoff Gannon August 23, 2013

Ben Graham Defines an Investment

An investment operation is one which can be justified on both qualitative and quantitative grounds.An investment operation is one which, upon thorough analysis, promises safety of principal and a satisfactory return.Thorough Analysis: The study of the facts in the light of established standards of safety and value.Safety: Protection against loss under all normal or reasonably likely conditions or variations.Satisfactory Return: Any rate or amount of return, however low, which the investor is willing to accept, provided he acts with reasonable intelligence.

(Security Analysis, 1940)

To have a true investment there must be present a true margin of safety. And a true margin of safety is one that can be demonstrated by figures, by persuasive reasoning, and by reference to a body of actual experience.

(The Intelligent Investor, 1949)

Key Terms

Operation
Qualitative
Quantitative
Thorough Analysis
Safety of Principal
Satisfactory Return
Margin of Safety
Figures
Persuasive Reasoning
Body of Actual Experience

Geoff Gannon August 13, 2013

Daily Idea: Berendsen

Berendsen trades in London under the ticker “BRSN”.

Google Finance

Investor Relations

Annual Reports

Link

Miko NV: Coffee and Plastics – A Tasty Combination

…

Geoff Gannon August 12, 2013

Daily Idea: George Risk (RSKIA)

George Risk trades over the counter under the ticker “RSKIA”.

Google Finance

10-Ks (2009 to present)

10KSBs (1997-2008)

Link

Is it Time to Dump George Risk?…

Geoff Gannon August 3, 2013

Quality, Capital Allocation, Value and Growth

In my last article I talked about the first 3 of the 7 things I look for before buying a stock – understanding, durability and moat. Today, I’ll talk about the other four areas I focus on.

First up is quality. We can look at quality a couple ways. One way – which I remember from reading Greenbackd and the book Quantitative Value Investing (which cites an article on the subject) – is using a metric from high up the income statement. Something like gross profits divided by NTA.

This is a good first check. A business should have high gross profitability. Most of the companies I look at have fairly high gross margins. However, all of these subjects are a little tricky because of the accounting definition of sales. Sales are defined in accounting terms for a company in ways that might not make sense from an economic perspective.

For example, Omnicom (OMC, Financial) doesn’t record billings as sales. Nor does DreamWorks (DWA) record box office as sales. However, some companies that buy and quickly resell – at very, very low margins – do count the transaction as a purchase and sale rather than a contracted service. I’m not knocking any of these approaches to accounting – we need one definite way of measuring sales. But it’s important to keep in mind that you can sometimes restate sales without restating anything – like earnings, cash flow, etc. – that actually matters.

What matters is the economic profits a company earns. Sales can be very useful comparisons between companies that use similar accounting. But, I’m not sure gross profitability means the same thing across all industries. For example, I would not be concerned with gross profits at ad agencies, defense contractors, or drug distribution. This is just common sense. For example, AmerisourceBergen (ABC, Financial) hasn’t posted a gross margin above 5% at any point in the last 10 years. Yet, return on equity has rarely been below 10%. That’s unusual. And it reinforces the need for using common – human – sense rather than relying on a screen.

When looking at a company economically – rather than as an accounting entity – we often want to ask what spending at the end of the chain is on these products, what sales by others dependent or controlled by the company etc.

Economically, a DreamWorks movie should be broken down from the ticket price collected from the moviegoer, then we look at the take for the theater, the agreement with the distributor, and then finally DWA’s revenue number comes into play.

In other words, we can – using widely available data that isn’t in the financial statements – easily create a picture of how a movie makes money. We should do that. Just as we should consider the quality of an auto parts maker in terms of the price of their product relative to the price of the product it’s going into and what it …