Some Links You’ll Like

Geoff here.

I started this blog on Christmas Eve 2005. Back then, I used to link to things. I’d tell readers what interesting blogs were out there, etc.

I haven’t done that much lately. Mostly because of Twitter. If you aren’t following me on Twitter – you aren’t seeing links to the stuff I’m reading.

But sometimes a few interesting links pile up at once and I decide it’s worth mentioning them on the blog – not just on Twitter.

Today is one of those times.

Practice Truth, Fear Nothing – A Wall of Great Value Investing Posters

The creator of this site – Practice Truth, Fear Nothing – sent me a link to his “wall” of value investing and creative thinking/advertising. He’s in the advertising business. You may or may not like the stuff that applies to advertising. You’ll love that stuff that applies to value investing. Check it out.

Market Folly: Top Finance People to Follow on Twitter

Market Folly is a blog I always read. And I don’t talk about it enough on this site. If you follow me on Twitter, you know I read it. But if you just read this blog – you’d probably never know I read Market Folly.

Hopefully, this will change that. Twitter is a great resource for seeing what other value investors, bloggers, etc. are reading. Whenever I Tweet, there’s a link. I use it mostly to share reading material.

You can get a lot out of using Twitter for your investing. And you can start by following the folks on Market Folly’s list.

Interactive Investor Blog: A Must Read Blog Getting Even Better

I read Market Folly all the time. But I rarely talk about it on this blog. No idea why. I read Richard Beddard’s blog all the time. And I do talk about it on this blog. Again, no idea why one gets mentioned here all the time and the other doesn’t.

I hadn’t given it much thought until writing this post – when I thought about all the people who read this blog but don’t follow me on Twitter.

Anyway, Richard’s blog has been great for years. And I’ve been reading it for years. So I feel kind of silly recommending it over and over again.

That’s changed in the last year or so. Richard’s blog has been getting even better. One of my favorite features is Richard’s two minute drills. These are based on advice Peter Lynch gave.

Peter Lynch is underappreciated by value investors. Maybe his name is too well known or something. Maybe his advice is too simple. I don’t know. The guy always made sense to me.

Like Warren Buffett, Peter Lynch was especially good at thinking about how to think about stocks. He was good at knowing that it wasn’t enough to have the most info – you had to act right on the info you had.

Lynch was always really quick …

Who is this Quan Hoang Guy? – And Why Is He on My Blog?

Someone who reads the blog sent me this email:

Geoff,

Who is this Quan Hoang guy? And why is he in your blog!!!!

Regards,

Gurpreet

Quan Hoang is someone I’ve emailed with since March 2011. So, well over a year now. He was a college student then. When I moved to Texas, Quan wanted to move out here and work with me.

Now, we get together each day and write. I will be blogging every day. And Quan will be writing too. So, you’ll see 2 posts a day at the blog.

The blog will be much more active than usual.

I think you’ll like it.

If you want to get to know Quan better, you can:

• Follow Quan on Twitter
• Talk to Quan

He’ll be a permanent fixture at Gannon On Investing. Which – you may have noticed – has been renamed Gannon (and Hoang) On Investing.…

How Western Digital (WDC) Can Be a Good Investment – Even When It’s Not a Net-Net

Geoff once expressed a controversial opinion that he would only buy Western Digital (WDC) as a net-net. I totally agree with him. I consider buying WDC as one of the mistakes I made during the period that I formed my investment style. But defending his opinion is not the purpose of this post. On the contrary, I think WDC can be a good investment. So, I’m going to ponder over my mistake and talk about what changed my mind.

I bought Western Digital in September 2010 at $26. Without a full understanding of its margin of safety, I bought WDC for these reasons:

• Return on invested capital was always high, even in 2009.
• WDC is the best managed company in the industry.It has a more stable margin than its competitors.
• WDC had steadily grown market share while maintaining high profitability in an extremely competitive market. And became market leader soon after my purchase.
• P/E ratio was low and I thought Mr. Market’s view  would turn once  supply and demand balanced.
• I thought the iPad and other mobile devices are complementary goods, not substitute goods to the PC.
• I thought it would take a long time for solid-state hard drives to replace hard disk drives (HDDs), and WDC would have time to catch up with the first comers.

Another reason I bought WDC was its better financial position than Seagate (STX), which I bought later after a LBO rumor (another mistake!). I actually made 40% and 25% from WDC and STX, respectively, but those are my biggest mistakes. Why?

Buying The Right Stock is Not Enough – You Have to Hold It Too

Holding WDC and STX was stressful.

I waited for the balance between supply and demand. But then the earthquake in Japan disrupted the supply chain that affected PC sales.

Then data proved that I was wrong about mobile devices. Mobile devices did hurt PC sales. Lesson: don’t ever bet on something uncertain. You can be either right or wrong. I was wrong in this case. Perhaps a diversified portfolio of stocks with higher upside (when we are right) than downside (when we are wrong) will perform well but I think holding such a portfolio is too hard for most humans.

And a bigger problem. A lot of WDC’s assets are tangible assets, which has little use other than producing HDDs. With the condition at the time I bought, WDC  could have been undervalued but what if HDDs became obsolete by the time the stock price returned to intrinsic value? Its plants would become useless. Its past earnings would be meaningless. That’s why buying WDC at lower than net current asset value can provides a margin of safety. I’m not sure buying at a low P/E will.

A more simple risk, what if something bad happens to the plants? Then came the Thai flood which severely interrupted WDC’s operation. I was right about buying WDC as a cyclical. Earnings did increase by double digits. But …

One Ratio to Rule Them All: EV/EBITDA

For understanding a business rather than a corporate structure – EV/EBITDA is probably my favorite price ratio.

Why EV/EBITDA Is the Worst Price Ratio Except For All the Others

Obviously, you need to consider all other factors like how much of EBITDA actually becomes free cash flow, etc.

But I do not think reported net income is that useful. And free cash flow is complicated. At a mature business it will tell you everything you need to know. At a fast growing company, it will not tell you much of anything.

As for the idea of maintenance cap-ex – I have never felt I have any special insights into what that number is apart from what is shown in actual capital spending and depreciation expense.

When looking at something like:

• Dun & Bradstreet (DNB)
• Omnicom (OMC)
• Carbo Ceramics (CRR)

I definitely do take note of the fact they trade around 8x EBITDA – and I think that is not where a really good business should trade. It’s where a run of the mill business should trade.

I guess you could get that from the P/E ratio. But when you look at very low P/E stocks – like very low P/B stocks – you’re often looking at stocks with unusually high leverage. And this distorts the P/E situation.

Which Ratio You Use Matters Most When It Disagrees With the P/E Ratio

The P/E ratio also punishes companies that don’t use leverage.

Bloomberg says J&J Snack Foods (JJSF) has a P/E ratio of 21. And an EV/EBITDA ratio of 8. Meanwhile, Campbell Soup (CPB) has a P/E of 13 and EV/EBITDA of 8. One of them has some net cash. The other has some net debt. J&J is run with about as much cash on hand as total liabilities.

They can do that because the founder is still in charge. But if Campbell Soup thinks it can run its business with debt equal to 2 times operating income – then if someone like Campbell Soup buys J&J, aren’t they going to figure they can add another $160 million in debt. And use that $110 million in cash someplace else.

And doesn’t that mean J&J is cheaper to a strategic buyer than its P/E ratio suggests.

That only deals with the “EV” part. What about the EBITDA part? Why not EBIT?

Don’t Assume Accountants See Amortization the Way You Do

The “DA” part of a company’s financial statements is usually the most suspect. It’s the most likely to disguise interesting, odd situations.

Look at Birner Dental Management Services (BDMS). The P/E is 21. Which is interesting because the dividend yield is 5.2%. That means the stock is trading at 19 times its dividend (1/0.052 = 19.23) and 21 times its earnings. In other words, the dividend per share is higher than earnings per share. Is this a one-time thing?

No. The company is always amortizing past acquisitions. So, the EV/EBITDA of 8 is probably a more honest gauge of …

Best Place to Run Screens: StockScreen123 – Bloomberg.com Underrated

Someone who reads the blog sent me this email:

Geoff – 

Nice article on EV/EBITDA – no qualms here. I’m curious, however, where you run your screens? Being the cheap bastard that I am, I don’t subscribe to any specific data sites, so I’ve typically begun with google finance, which isn’t very helpful when it comes to non-GAAP criteria.

Thanks,

Jay

StockScreen123 is the Best Place to Run Screens – But It Takes Time to Learn

The best place to run screens – for the price – is StockScreen123. It is not user friendly. You need to read about how the functions work, etc. and experiment a bit. But it’s the best site by far.

I highly recommend it.

For U.K. stocks I use Sharelockholmes.

For worldwide, I don’t have a good (cheap) solution. A lot of people use the FT screener.

Bloomberg.com is Actually a Super Handy Site – If You Know What It’s Best At 

Blommberg’s (free) website has great coverage of just about every stock on planet Earth. They don’t have much data. But if you type in a public company name – that trades anywhere in the world – you’ll get basic info like EV/EBITDA.

Here are some obscure examples to prove my point:

• Precia (PREC:FP) 
• Otec (1736)
• Paradise (PARF)
• Watlington Waterworks (WWW:BH)

If they’ve got those companies – they’ve got everything.

So Bloomberg is a great resource when you know a company’s name but you aren’t sure whether it’s public or private, where it trades, etc.

I often start my stock research at Bloomberg.…

How My Investing Philosophy Has Changed Over Time

Someone over at GuruFocus asked me about my background:

Hey Geoff, I recently started listening to some of the audio recordings you posted. You are really knowledgeable, what is your background? 

My educational background is that I am a high school dropout. My investing background is that I got interested investing when I bought my first stock at 14. That’s when I read Ben Graham’s Security Analysis and The Intelligent Investor.

My Investing Approach Has Drifted From Graham Toward Buffett

Over time, based on my own investing results, I probably became less of a Graham type investor and more of a Buffett type investor.

I made the most money by far buying and holding companies with strong competitive positions when they were temporarily priced at 6 or 10 or 12 times earnings. I also buy net-nets, net cash bargains, etc. But generally I like a reliable business with almost no history of losses and a market leading position in its niche. That’s probably more Buffett than Graham.

Hidden Champions of the 21^st Century is My Favorite Book  

My favorite book is: “Hidden Champions of the 21^st Century.”

Technically, it’s a business book – not an investing book. But business books are almost always more informative for investors than finance type books.

If I had to hand 3 books to someone who didn’t know anything about what it takes to be an investor – I’d hand him:

1. You Can Be a Stock Market Genius
2. The Intelligent Investor (1949)
3. Hidden Champions of the 21^st Century

If you aren’t in love with the idea of the treasure hunt after reading those 3 books – I don’t think you’ll ever become a value investor.

All I Really Know – Compounding, Mr. Market, Margin of Safety, Moats

If you know:

• The Berkshire/Teledyne stories
• Ben Graham’s Mr. Market Metaphor
• His margin of safety principle
• And you’ve read “Hidden Champions of the 21^st Century”

You have everything you need to make money snowball in the stock market.

All It Really Takes – Patience, Common Sense, and a Few Sound Principles

My feeling is – and it’s controversial, but it’s right – that if you’ve got those 4 ideas in your head and once a year you buy the very best stock you can and then you forget you own it for at least the next 3 years, you’re gonna do okay in the stock market.

You don’t need to know if you should be 100% in stocks or 100% in bonds – I was 100% in stocks when the dot-com bubble burst – and I’ve made more than 15% a year returns since then.

Most of the Advanced Concepts Are a Distraction – Forget Them

Now, true, I didn’t own any tech in 2000. I owned companies in groceries, snack foods, and video games. But that’s not because I was clairvoyant. It’s because I was a kid. I didn’t know any better. Over …

Can You Screen For Shareholder Composition? – 30 Strange Stocks

Nate Tobik has a terrific blog post about shareholder composition over at Oddball Stocks called “Could Value Investors Be the Reason a Stock’s Cheap?”

I’ve often found companies with unusual shareholder composition to be interesting opportunities. That’s not exactly the point of Nate’s post. He wonders – correctly, I think – whether the sort of catalyst a value stock like George Risk (RSKIA) requires is something that gets folks other than value investors interested in the stock.

A change in the perception of what kind of stock a company is can have a huge influence on where it trades. If you look at Village Supermarket (VLGEA), it went from being a regional grocer valued at a discount to the big guys to being seen as a predictable stalwart of sorts. The increase in the ratio of price-to-earnings, price-to-book, and price-to-sales has been magical. The business has improved. But then Mr. Market has also valued improvement in the business at about 3 times more than he did just 10 to 15 years ago.

Who Owns a Stock Matters

I think shareholder composition often helps explain why a stock is cheap. However, it’s not always just a matter of whether the folks who own the stock are value investors, growth investors, etc.

Shares Are Sometimes Spread Around in Weird Ways

Sometimes – like at Solitron Devices (SODI) – shareholders are former creditors.

I read a recent blog post where someone had commented wondering why Solitron is a public company. That’s easy. Solitron was once a big public company. It went bankrupt. It just never went private.

The company you see today bears little resemblance to the company that went public. Instead, it’s the company that emerged from bankruptcy in the 1990s.

Other times, shareholders have become “lost” over the years. They’ve forgotten they own the stock. And they don’t trade it. This was the situation at George Risk.

And George Risk has made a point in its SEC filings of saying that paying a dividend on the stock helped remind “lost” shareholders about the stock – and helped them get these shareholders to offer shares on the open market. Where the company is a buyer of its own shares.

I once read an interview with the CEO of a family controlled, thinly traded bank. When asked why the company went public he said they wanted local businessmen to have a stake in the bank. They went public as something of a local PR ploy.

Warren Buffett Made Money on Stocks With Oddly Distributed Shares

Two of Warren Buffett’s big successes – National American Fire Insurance and Blue Chip Stamps – were stocks with very oddly distributed shares.

Warren Buffett and National American Fire Insurance

I told the story of National American Fire Insurance in “How Warren Buffett Made His First $100,000”:

This company was controlled by Howard Ahmanson. It’s a strange story. The original stock was pretty much worthless. It ended up being …

Notes on Warren Buffett’s 2011 Letter to Shareholders

You can read my thoughts here.

Talk to Geoff about Warren Buffett’s 2011 Letter to Shareholders…

What to Look for in Japanese Net-Nets

Someone who reads the blog sent me an email asking about a specific Japanese net-net. Rather than trying to choose the best net-nets from among the entire hoard in Japan, I would suggest doing one of two things:

1. Bigger investors can simply collect all the Japanese net-nets they find. 
2. Smaller investors can simply apply a tougher standard than mere net-netness.

In my own portfolio, I went with option #2. I bought 5 Japanese net cash stocks last year. I’ve since sold one of them. I have some cash. And am looking to add a couple more Japanese net cash stocks. Right now, they make up 30% of my portfolio. Again, I’m willing to go as high as 50% in Japan. We’ll see what happens.

But that’s me.

What would I suggest for others interested in Japanese stocks?

Here’s how I would look at Japan. If you can find stocks selling for less than net cash with few/no operating losses in their long-term history, buy them. Don’t so much look for net-nets in general. Start with an even higher standard. Start with profitable, net cash companies. They are close to non-existent in the U.S. But not Japan. After that, I’m not sure I would necessarily just look at net-nets. For example, there are some cheap Japanese gas companies that are not net-nets (most of their assets are PP&E) but are super reasonably priced on an EV/EBIT basis. To me, it is more important to find totally obvious bargains than to get caught up in the definition of what a net-net is or isn’t.

Totally obvious bargains fall into a few categories. Here are 2:

1. Stock market says the business is worth more dead than alive (profitable net cash stocks)
2. Stock is much cheaper than its peers around the world (gas companies)

In fact, if you really look, you may find some gas companies, grocery stores, etc. that are very cheap on an EV/EBIT or EV/EBITDA basis that you like better than some of the net-nets. That’s fine. Buy the most obvious bargains. The things that are clearly selling for less than they are worth.

If you’re only going to buy half a dozen Japanese net-nets, you should look for net cash bargains. Once we are talking about receivables, inventory, etc. you need to know more about the business. So it needs to be a simple business or a business you can learn about. That’s harder. For me personally that means it makes sense to buy net cash bargains in Japan and look for net-nets on the basis of receivables, inventory, etc. in the U.S. Because in the U.S., I have a better chance of knowing the difference between a predictable business and an unpredictable business.

If I could find 10 consistently profitable companies selling below net cash in the U.S., I wouldn’t buy any Japanese stock. Because I understand American businesses better. But I also understand that a consistently profitable company selling for less than net cash will work out as …