Blog – Page 5 – Focused Compounding

Geoff Gannon August 3, 2020

Libsyn (LSYN): A Pretty Cheap and Very Fast Growing Podcasting Company in an Industry with a Ton of Competition

This is a complicated one. So, I’m going to do my best to boil it down to the things that really matter. That’s a judgment call. And it means I may be focusing on the wrong things. I may not be telling you enough about some things that do matter a lot and fixating instead on some stuff that turns out not to matter as much as I think.

Libsyn is one of the biggest and oldest companies in podcasting. It has been there since the beginning of podcasting basically. And unlike almost every other company in the industry – it’s profitable. It’s been profitable for a while. And it’s likely to continue to stay profitable. This company (Liberated Syndication – ticker LSYN) also owns another Pittsburgh, PA company called “Pair”. Pair is a website host (and domain registrar) that is also very old and also profitable. Pair has been around since the mid-1990s. Libsyn has been around since the mid-2000s. Both have basically been there since the start of their respective industries. As I write this, Libsyn (the podcasting company) accounts for maybe 60% of the gross profit, EBITDA, etc. of the combined company and Pair for the other 40%. However, I’d personally appraise Libsyn as much more than 60% of the combined company’s intrinsic value, because I think it’s likely to be a fast grower.

Why?

Podcasting is a very, very fast growing industry. It’s hard for you to realize just how fast growing it is. As investors, we’re used to thinking in dollar terms. We look at revenue and gross profit and so on in terms of dollars. We aren’t managers and often don’t see the underlying unit growth. Unit growth is the physical – of course, in this case it’s actually intangible – growth in the industry. The number of podcasts, podcast episodes, monthly audience figures, etc. is the “unit growth” in this industry. It’s the growth independent of pricing. Most industries in the U.S. – if they are growing at about the same rate as the overall economy – only grow at a rate equal to population growth plus output per person. So, before inflation, an industry that’s growing at a healthy rate might be doing 3% unit growth a year. This means it will double in real size about every 25 years. A fast growing industry – something more like electric vehicles and hybrids and so on – might be growing at like 7% a year. This means it will double in real size about every 10 years. Podcasting is growing much, much faster than that. In recent years, most of the key metrics that Libsyn tracks have been growing at about 20% a year. This means it doubles in real terms about every 4 years. To put that in perspective, at the rate podcasting is growing in terms of number of shows, number of episodes, number of monthly listenership, etc. we are talking about something that will double in size by 2024, quadruple …

Geoff Gannon July 30, 2020

Avalon Holdings (AWX): An Unbelievably Cheap Controlled Company that Might Stay “Dead Money” For A Long Time

I’ll be doing write-ups on Focused Compounding more frequently now. This means that the quality of the ideas will be lower. Previously, I’d tried to focus on writing up just stocks that looked interesting enough to possibly qualify as some sort of “stock pick” from me. Now, I’m just going to write-up ideas I analyze whether or not they turn out to be anything approaching the level of an actual “stock pick”. So, keep that in mind. Some of these write-ups – and I’d say Avalon falls into this category – are going to be in more of the “not a stock pick” category. Actually, though, Avalon is a really interesting situation – just, a really interesting situation I’m not at all sure I’d actually recommend.

Avalon is a nano-cap stock. I’ve followed the company in some form for over a decade. It’s often been cheap. But, it’s rarely been as cheap as it is now. Avalon does a bunch of things. It owns some salt water injection wells. Those have been shut down and written off. There’s a ton of info about the court cases around these wells in the 10-Q, 10-K, etc. I’ll leave you to read those for yourself. I’m going to just say the wells are not worth anything positive or negative for the purposes of this write-up. Avalon has a waste management business. There are two parts to this. One is a “captive landfill” run for a customer (on that customer’s land) in Ohio. This is only about 5% of the waste management division’s revenue. And it is just one customer. There isn’t enough info given by the company to evaluate this captive landfill business in any depth. The other thing Avalon owns is a “waste brokerage” business. This is big. Revenue from this is like $45 million. It seems to be about 60% recurring revenue and 40% project revenue (in many years). This waste brokerage business is the source of Avalon’s earnings. In fact, earnings from the waste brokerage business often exceeds reported earnings of the entire company. This is due to losses in the other segments (salt-water injection wells and the “golf” business). Most of the company’s assets are in something it calls the “golf” business. This is potentially a bit of a misnomer. It should just be called “country club”. The company owns 3 golf courses and leases a fourth (Avalon has the right to exercise extensions on that leased property to keep it through 2053). The 4 golf courses are located in Northeastern Ohio and Pennsylvania. The towns they are in are: Warren, OH; Vienna, OH; Sharon, PA; and New Castle, PA. The sites at Warren and New Castle are being renovated right now. New Castle is a new acquisition and very run down. Warren is the company’s oldest location – it’s where the corporate HQ, the hotel, etc. are – and the renovations are to make the resort hotel even more impressive. To the extent Avalon is an asset play …

Geoff Gannon July 30, 2020

Business Momentum: When is a Value Stock a Value Trap?

One of the biggest risks for a value investor is buying into a business with poor momentum. Not momentum in the since of an upward movement in the price of the stock – that is often a problem, but it’s a difficult one for an investor (as opposed to a speculator) to evaluate and then count on – but, poor business momentum. Value investors – because they focus on the P/E ratio, the P/B ratio, EV/EBITDA, and many other measures of price – often find themselves buying into a business that looks cheap based on past measures of profitability rather than being cheap on future measures of profitability. The problem is that everything we know about a business is about that business’s past. And yet, for an investor, everything that matters about a business is that business’s future. In a previous article, I listed a series of stocks that are typical of value stocks. Value stocks can be defined in many ways. I think the simplest is the “Graham Number”. Ben Graham talked about the importance of not overpaying for a stock in terms of either its asset value or its earning power. There is no completely correct number to gauge earnings power. For a cyclical business, this year’s earnings might not be a good guide as to what normal “earning power” really looks like. Nor is there any one completely correct number to gauge asset value.

However, there are some numbers that can be helpful. A stock that trades at a meaningful discount to its tangible book value is more likely to be cheap than most other stocks. The likelihood of its cheapness becomes greater if it also trades at a meaningful discount to what would be a normal multiple of its earning power. Earning power isn’t precisely the “e” in the P/E ratio. But, for many typical value stocks – it could be pretty close. So, if we combine the P/E ratio and the P/B ratio – by multiplying the two factors together – we can sort out those stocks that look especially cheap on a combination of both asset value and earning power value. These stocks – the stocks with some of the lowest Graham Numbers – are most likely to be true value stocks. However, the businesses these stocks are in may sometimes be experiencing a great deal of negative business momentum. In fact, that is one of the most common reasons for a low stock price. There are other reasons. But, decelerating earnings growth or declining earnings or shrinking margins or a hundred other poor business “vital signs” are common reasons for why investors – and speculators – abandon a stock. And that abandonment is what leads to a low stock price. So, our job as value investors should be to find those stocks with low Graham Numbers – low P/E ratios and low P/B ratios – where the business momentum is either not that bad or where it is likely to reverse at some …

Geoff Gannon July 28, 2020

Was Peter Lynch Right? – Does Earnings Performance Drive Stock Performance?

I’m writing today’s Focused Compounding daily from a Best Western in Kansas. By the time you read this, I may already be back in Plano. Today will complete this short – only like four days total – research road trip by me and Andrew. We spent some time in New Mexico, Arizona, and Kansas basically.

While on this trip, I’ve been re-reading some books by a guy who did a lot of these sorts of trips: Peter Lynch. Lynch isn’t exactly a value investor. So, some of the things he says can be particularly interesting for a value investor to hear. One of the most interesting things he says repeatedly is that – in the long run – stock performance tracks earnings performance. So, you just find the stocks that are going to grow earnings a lot over the next 5, 10, 15 years. And then you make sure those stocks don’t have crazy high P/E ratios today. And then you buy them.

This part about how earnings performance drives stock performance tends to be true in the very long run. If you look at list of 100-bagger stocks, they are basically lists of 100-bagger businesses in terms of profits and even earnings per share. You don’t have many 100-baggers where earnings went up only 10 times but the stock went up 100 times. Usually, you need the two working together. So, yes, the multiple goes up 5 times, but the earnings go up 20 times. Or, the multiple triples and earnings increase 30-40 times. There aren’t a lot of pure value stocks on a list of 100-baggers. Nor, actually, are there as many pure growth stocks as you’d think. If a growth stock is something with a P/E of 50, or 75, or 100 – that’s not where hundred baggers usually come from. If it’s a very fast growing business with a P/E of 30 – then, yes, plenty of 100-baggers do come from stocks as expensive as that.

The problem for investors – even pretty long-term investors – is that, in some stocks, the tracking of earnings and price is very weak. In an earlier article, I mentioned FICO (FICO). Over the last 10 years, measures of things like sales per share, earnings per share, free cash flow per share, etc. have basically tripled. Meanwhile, the market cap of the stock has increased about 10 times. The P/E went from about 15 to about 50. Price-to-sales from like 1.5 to 7.5.

The risk for the investor is, of course, that he thinks of the multiple expansion the same way as the earnings growth. Investors rarely tell themselves I bought a stock that increased EPS at 15% a year for 10 years and I bought it at a pretty low starting price (let’s say 15 times P/E). So, I’ve done well in this stock because I bought in at a P/E of 15 and it grew EPS at 15% a year for a long time. Instead, they have one …

Geoff Gannon July 26, 2020

Surviving Once a Decade Disasters: The Cost of Companies Not Keeping Enough Cash on Hand

A couple days back, I read Tilman Fertitta’s book “Shut Up and Listen”. The book is short. And it’s full of a lot of basic, good advice especially for someone looking to build a big hospitality business (which is what Fertitta did). What stood out to me is how practical the book is about stuff I see all the time in investing, but rarely gets covered in business books. The best example of this is a chapter on “working capital”. Value investors know the concept of working capital well, because Ben Graham’s net-net strategy is built on it. But, working capital is also important as a measure of liquidity.

A lot of value investors focus on the amount of leverage a company is using. The most common metric used is Debt/EBITDA. Certain Debt/EBITDA ratios are considered safe for certain industries. It might be considered fine to leverage a diversified group of apartment buildings at Debt/EBITDA of 6 to 1 but risky to leverage a single cement plant at Debt/EBITDA of 3 to 1. There is a logic to this. And some companies do simply take on too much debt relative to EBITDA. But, that’s not usually the problem that is going to risk massive dilution of your shares, sales of assets at bad prices, bankruptcy etc. in some investment. The usual issue is liquidity. If you borrow 3 times Debt/EBITDA and keep zero cash on hand and all your debt can be called at any time within 1-2 years from now – that’s potentially a lot riskier than if you have borrowed 4 times Debt/EBITDA and are keeping a year of EBITDA on hand in cash at all times and your debt is due in 3 equal amounts 3, 6, and 9 years from today. The difference between these two set-ups is meaningless in good times. As long as credit is available, investors who focus only on Debt/EBITDA will never have to worry about when that debt is due and how much cash is on hand now. However, at a time like COVID – they will. Times like COVID happen more often than you’d think. Fertitta is in the restaurant business. He’s seen 3 liquidity crunches for restaurants in the last 20 years. There was September 11th, the collapse of Lehman Brothers, and now COVID. He got his start in the Houston area. Not much more than a decade before the first 3 of those events I listed above – there was a collapse of the Texas banking system that resulted in a lot of Texas banks (and all but one of the big ones) closing down. That was also a possible extinction level event for restaurants in the state. So, using Fertitta’s 30-40 years in the restaurant business as an example, extinction level risks that depend on a restaurant company maintaining some liquidity to survive seem to happen as frequently as once every 10 years. When looking at a stock’s record over 30 years – the difference between a …

Geoff Gannon July 21, 2020

The Graham Number: What Makes a Value Stock a Value Stock?

In recent years – and especially recent months – many stocks have gotten a lot more expensive. Especially among bigger U.S. stocks, the “value” category has shrunk. I did a quick check of the biggest stocks in the U.S. – basically the top 40% of stocks by size in the S&P 500 – and I’d say that about 85% of these stocks can now be clearly labeled “non-value stocks”. A non-value stock might not be expensive. It might turn out that Amazon (AMZN) will grow so fast and so profitably for so long to justify an above-average multiple. But, we can’t call something with an above average multiple a “value stock”.

The easiest way to define a value stock is to use what I’ve – a couple times on the podcast now – called the “Graham Number”. This is my word for it. Some people call a different number the Graham number. But, having read Ben Graham’s writings – I’d say this is the number that most deserves his name. It’s a simple product of two factors: 1) The price-to-earnings ratio and 2) The price-to-book ratio. Graham suggested – in the Intelligent Investor – that you shouldn’t buy a stock with a “Graham Number” over 22.5. He probably got this number by using a P/E ratio of 15 as “normal” and then he asked how high or low a P/B is acceptable based on that P/E ratio of 15. So, for example, a stock with a P/E of 15 and a P/B of 1.5 would be considered a “normal” price level for a stock. This would then – through simple multiplication – tell you that a “Graham Number” of 22.5 marks the dividing line between a “value” and a “non-value” stock.

So, let’s start with some extreme examples of clear value stocks. Among stocks I’ve mentioned frequently on the podcast, two stand out. One is NACCO (NC). According to QuickFS.net, NACCO – at about $23 a share – has a P/E of 5.3 and P/B of 0.6. This gives you a Graham number of 3.2. That’s a stunningly low number. Anything under 5 is pretty rare. Is it a good idea to buy stocks with Graham Numbers that low? No. I don’t think you should favor stocks with a super low Graham Number of 5 or less over stocks with a Graham Number of 15. A Graham Number of 15 would equate to a one-third “margin of safety” versus the “normal” Graham number of 22.5. This is because 15/22.5 = 0.67. Graham frequently used a one-third margin of safety as a sort of nice, round figure for what you should look for in a stock. I think it’s fine to do the same. It’s probably better – and, in fact back tests I’ve done for the two decades ending in 2020 show it’s been empirically better – to buy good companies at as high a Graham Number as 15 instead of just focusing on buying everything with a Graham Number …

Geoff Gannon June 17, 2020

BAB (BABB): This Nano-Cap Franchisor of “Big Apple Bagel” Stores is the Smallest Stock I Know of That’s a Consistent Free Cash Flow Generator

This might turn out to be a shorter initial interest write-up than some, because there isn’t as much to talk about with this company. It’s pretty simple. The company is BAB (BABB). The “BAB” stands for Big Apple Bagel. This is the entity that franchises the actual stores (there are no company owned stores). Big Apple Bagel is a chain of bagel stores – mostly in the Midwest – that compete (generally unfavorably) with companies like Einstein Bros Bagels, Panera Bread, and Dunkin’ Donuts. The company owns certain other intellectual properties like: a brand of coffee (Brewster’s) served in its stores (which Andrew tells me is terrible, I haven’t had a chance to taste the coffee myself), “My Favorite Muffin” (a muffin concept similar to Big Apple Bagel), etc. But, the cash flows seem to come mainly from royalties paid to BABB by franchisees in proportion to the sales they make. Like other franchised businesses, the company also maintains a marketing fund that is paid for by franchisee contributions.

Why am I writing about this business? Because I think it may be literally the smallest stock I’m aware of that is a legitimate and decent business. The market cap is closer to $4 million than $5 million. Insiders own some stock. So, the float is even less. And the investment opportunity is limited no matter how willing you are to accumulate shares because there is a poison pill. No one can acquire more than 15% of the company’s shares no matter how patient they are. So, as of the time I’m writing this, that would mean that the biggest potential investment any outsider could make in this company would be about $650,000. Realistically, it’s unlikely any fund or outside investor could manage to put much more than half a million dollars into this stock. And it’s entirely possible management would not be happy to see even that much being put into this stock (since that’d be more than 10% of the share count).

So, this is a very, very limited investment opportunity. And yet: it is a real investment opportunity. This is a real business. You can travel the country eating at each of these franchised locations. You can call up the owners of the franchised stores and talk with them about the business. You can read 10-Ks on this company going back a couple decades. The company is an “over-the-counter” stock. But, it isn’t dark. It files with the SEC. That’s very unusual for a company with a market cap of less than $5 million. Public company costs are significant. This company would be making more money if it was private. Management costs are also significant here too. The CEO, general counsel, and CFO were paid: $250,000, $175,000, and $120,000 (respectively) last year. That adds up to $550,000.

They own 33% of the stock. I mention this because if we compare the value of the stock they own to the value of the salaries they draw – it’s true …

Geoff Gannon June 8, 2020

Dover Motorsports (DVD): Two Racetracks on 1,770 Acres and 65% of the TV Rights to 2 NASCAR Cup Series Races a Year for Just $60 million

I mentioned this stock on a recent podcast. This is more of an initial interest post than usual. It’s likely I’ll follow this post up with one that goes into more detail. Two things I don’t analyze in this write-up are: 1) What this company will look like now that it is once again hosting races at Nashville (in 2021) and cutting back races at Dover. 2) What the normal level of free cash flow is here. I discuss EBITDA. But, I think normalized free cash flow is the far better measure. And I don’t discuss that at all here. Finally, I haven’t dug deeply into NASCAR as a sport to get enough of a feel for whether it is durable and likely to increase or decrease in popularity in the years ahead. This is critical to analyzing the investment. And it’s the next logical step. But, this write-up was already getting long. So, better to do a deeper follow-up later and stay at the more superficial level for this first analysis.

Dover Motorsports is a $60 million market cap New York Stock Exchange listed company. It has two classes of stock. The super voting shares are owned by Henry B. Tippie (the now over 90-year old chairman). That leaves about $30 million worth of float in the common stock. Enterprise value is similar to – maybe a bit lower than – the $60 million market cap. As of March 31^st, 2020 – the company had $5 million in cash on hand. Liabilities are generally stuff like deferred revenue (cash received that’ll be earned when a race is hosted later this year). The one exception is a bond issue I’ll discuss in a minute. The balance sheet shows about $4 million in liability related to that bond issue. The reality is that there could be another $10 million owed on those bonds. Or – as seems more likely now – the company could invest in some cap-ex instead and even that $4 million liability might go away. Why is that?

The liability is tied to bonds issued by the Sports Authority of Wilson County, TN. These bonds were issued as part of the funding of the Nashville Superspeedway. It’s a racetrack about a 40-minute drive from Nashville that was built by Dover Motorsports 20 years ago. The racetrack is big. It was originally on 1,400 acres of owned land, now down to 1,000 acres of land that hasn’t been sold off. It’s also – if you look at a list of where NASCAR and non-NASCAR races are held – much more in line with NASCAR type tracks in terms of the construction of the track (concrete), its length (1.33 miles), and the amount of seating. However, the track had never held a NASCAR Cup Series (think of this as the “major leagues” of U.S. auto racing) race. Without hosting such a race, it never made money. And, in fact, it hasn’t been operated in any way for close …

Andrew Kuhn May 27, 2020

Should I Specialize in an Industry I Know – Even if it’s a Bad One?

A 12-minute read

Hi Geoff,

I think you have touched on this before but I will ask a bit more detailed. Do you think it’s better to be an expert on one industry and the stocks within that industry vs knowing a little about many industries? What about if that industry is a “bad” industry like shipping? Would you still think an investor is better off knowing everything about that industry and the stocks vs being a generalist?

I guess that having a deep knowledge and circle of competence you would have an edge compared to other investors. Being a generalist you don’t really have an edge?

I think it’s usually better for an investor to be a specialist than to be a generalist. If you look at some of the investors who have long-term records that are really excellent – I’m thinking specifically of Warren Buffett and Phil Fisher here – their best investments are in specific areas of expertise. Buffett’s biggest successes tended to be in financial services (banks, insurance, etc.), advertiser supported media (newspapers, TV stations, etc.), ad agencies (also very closely connected to media companies), and maybe a few other areas like consumer brands (See’s Candies, Gillette, Coca-Cola, etc.). Other gains he had came from use of float (which is a concept closely tied to insurance and banking – though he also used Blue Chip Stamps to accomplish this) and re-deployment of capital. At times, he liquidated some working capital positions of companies and put the proceeds into marketable securities (a business he knows well). Overall, the Buffett playbook for the home runs he hit is fairly limited. It is very heavy on capital allocation, very light on capital heavy businesses, and it is pretty concentrated in things like media, financial services, and consumer brands. There are some notable and successful exceptions. It seems that Nebraska Furniture Mart (by my calculation) was a very successful investment. However, Buffett’s other retail investments generally were not. By comparison, he hit several home runs in newspapers – Washington Post, Buffalo Evening News, and Affiliated Publications. Several home runs in non-insurance financial services (owned a bank, owned an S&L, invested in GSEs, etc.). Several home runs in insurance (National Indemnity, GEICO, etc.). If you look at Buffett’s record in holdings of more commodity type companies, when he held broader groups of stocks, etc. – it’s not as good. As far as I can tell, the retail/manufacturing parts of Berkshire today don’t have very good returns versus their original purchase prices. It’s not all that easy to be sure of this given the way the company reports. But, I don’t think there are a lot of home runs there.

Phil Fisher talks about how he focused on manufacturing companies that apply some sort of technical knowledge. This is interesting, because people think of him as a growth or tech investor – but, he thought of himself as investing in technical manufacturing companies. But, specifically – manufacturing companies. He didn’t …

Geoff Gannon April 24, 2020

Otis (OTIS): The World’s Largest Elevator Company Gets the Vast Majority of Its Earnings From Maintenance Contracts With a 93% Retention Rate

Otis Worldwide (OTIS) is the world’s biggest elevator and escalator company. Like Carrier (CARR) – which I wrote up two days ago – it was spun-off from United Technologies. However, shareholders of United Technologies received one share of Carrier for each share of United Technologies they had while they only received half a share of Otis for every one share of United Technologies they owned. As a result, the market caps of Carrier and Otis would be the same if the share price of Otis was twice the share price of Carrier. Otis isn’t trading at double Carrier’s stock price though. It’s at $47.85 versus $16.25 for Carrier. So, closer to three times the price of Carrier than two. Carrier, however, does have more debt than Otis. Nonetheless, as I’ll explain in this article – the bad news is that while I like Otis as a business a lot better than Carrier: Otis is the more expensive stock.

Reported revenues are unimportant at Otis. The company did $13 billion in sales. But, only about $7.4 billion of this comes from service revenue. Service revenue makes up 80% of EBIT while new equipment sales are just 20%. Service revenue is also less lumpy. A major reason for this is that more than $6 billion of the total service revenue is under maintenance contracts. This more than $6 billion in maintenance contracts has a 93% retention rate. The contracts don’t actually require much notice or much in the way of penalties to cancel. However, cancellation is rare. So, a very big portion of the economic value in Otis comes from the roughly 2 million elevators covered by maintenance contracts that bring in about $6 billon in revenue per year. My estimate is that the after-tax free cash flow contribution from these 2 million elevators under contract is anywhere from $1 billion to even as much as $1.2 billion. Basically, if we set aside these maintenance contracts – there is almost no free cash flow beyond the corporate costs etc. that need to be covered at Otis. There is an argument to be made that as much as 20% of the company’s economic value comes from new equipment sales. However, I think it’s trickier to value the company if you count those sales in the period in which they occur. Rather, I think it makes sense to look at the business the way you might a movie studio, book publisher, etc. with a substantial library. Or – if you’d prefer – the way you’d look at an insurer that usually has a combined ratio a bit below 100, but basically makes its money off the return on its “float”. Otis’s service business has very stable revenue, EBIT, and free cash flow from year-to-year. I expect it to rise at least in line with inflation (the company expects better than that). And there are some possible productivity gains here from digital initiatives. Smart elevators, technicians using iPhones, etc. could cut down on the number …