Blog – Page 53 – Focused Compounding

Geoff Gannon January 8, 2011

How to Find Foreign Stocks: 13 Promising Companies from the U.K.

An individual investor from France sent me an email about finding great small cap stocks in other countries:

“These kind of stocks are I think virtually impossible to find for a non-local investor. I would be delighted for instance to find some German small caps but I don’t even know where to start…”

Maybe an example will help.

Let’s put aside the language difference. And just focus on the foreign stock part of the problem.

I’m from the United States. In my entire life, I’ve spent all of 15 days in the United Kingdom. My knowledge of the country is limited to cultural exports from the BBC – half of them sitcoms – and whatever I can glean from the Financial Times and The Economist.

The point is: I know nothing about the United Kingdom.

Like any investor looking at foreign stocks, I’m starting from a position of complete ignorance.

So here’s how I started looking for stocks over there.

I went to the London Stock Exchange website. And browsed the stocks alphabetically.

I went through the A’s and B’s and found 13 potentially promising companies:

1. Admiral Group (ADM:LN) – Reports

2. A.G. Barr (BAG:LN) – Reports

3. Aggreko (AGK:LN) – Reports

4. Andrews Sykes (ASY:LN) – Reports

5. Babcock International (BAB:LN) – Reports

6. Best of the Best (BEST:LN) – Reports

7. Booker (BOK:LN) – Reports

8. Braemar Shipping Services (BMS:LN) – Reports

9. BrainJuicer (BJU:LN) – Reports

10. Brulines (BRU:LN) – Reports

11. Bunzl (BNZL: LN) – Reports

12. Burberry (BRBY:LN) – Reports

13. N Brown Group (BWNG:LN) – Reports

These stocks may or may not be good buys at these prices. I was just looking for potentially promising companies – regardless of price.

That’s how I start looking for stocks in another country. I’m only interested in good businesses I think I can understand. There are always plenty of cheap, mediocre businesses over here in the U.S. There’s no reason to hunt for them overseas. So the bar is a little higher with a foreign stock. Anything that isn’t a good business I throw out right away.

In this case, I used the following steps to find potentially promising companies:

1. I clicked on the “fundamentals” tab in the LSE page for each stock and scrolled down to the return on invested capital. I looked for a positive number that had been in the double-digits each year. Ideally, the company tended to have 20%+ returns on invested capital for the last few years.

2. I looked up the companies that passed step #1 over at Bloomberg. I read Bloomberg’s business description. If it sounded like a business I couldn’t understand (for example, it was a tech company or investment bank) I threw it out. If it sounded like a business that had the potential to earn …

Geoff Gannon January 2, 2011

International Value Investing: Danier Leather (DL:CN) – Canada

A reader sent me this email:

Hey Geoff,

I saw your call for non-US value ideas. One of my favourite ideas right now is Danier Leather, a Canadian retailer that is really cheap and has its downside limited due to its asset-rich and debt-free balance sheet.

Cheers,

Michael

Below is Michael’s write-up on Danier Leather…

***

Danier Leather is a vertically integrated designer, manufacturer and retailer of leather goods in Canada. Danier principally sells leather outerwear (53% of sales) and accessories (37%) through 90 locations in Canada (59 shopping mall and street front stores and 31 power centre stores). Its target market is “value-oriented, fashion-conscious” men and women aged 35-55 with middle to upper class household incomes.

Danier trades under the symbol “DL” on the Toronto Stock Exchange. With a current market price of $13.50 and 4.6mn shares outstanding (1.2mn multiple voting shares and 3.4mn subordinate voting shares), Danier has a market cap of ~$61mn.

The market seems to ignore Danier because of its small market cap, lack of equity research coverage, limited liquidity and dual share structure. However, these factors allow an investor to buy an asset rich, debt-free company at substantially less than its intrinsic value.

Asset Perspective

Looking at Danier from an asset perspective, an investment presents limited downside due to the cash, inventory and real estate on the balance sheet. While cash currently represents ~15% of the company’s market cap, after the Christmas shopping season, much of the company’s inventory should convert into cash and I would expect Danier’s cash level to increase to 30-40% of its current market cap. In addition, Danier owns a 130,000 sf facility in Toronto where it conducts some manufacturing, warehousing and administrative operations. I believe there are a number of options to monetize this facility should the Company wish to do so, including:

A sale/leaseback transaction.
An outright sale, which could involve the Company shifting additional production to Asia and warehousing and administrative functions to leased premises. Currently, over 80% of Danier’s production is from Asia, with the remainder from its Toronto facility.
Conversion to higher use. This facility is located in a predominantly residential area of Toronto and could be sold for, or co-developed into, residential properties.

The following is an estimate of Danier’s book value and liquidation value at September 25, 2010. While I do not think one should value Danier on a liquidation basis, I have included an estimate anyways:

Earnings Perspective

Looking at Danier from an earnings perspective, it is significantly undervalued as it is currently trading at only 2.3x LTM EBITDA. (Note: Given that we are currently in the Christmas shopping season when Danier’s cash is unusually low, I adjusted Danier’s cash balance to be the average of its cash balances over the last four quarters, thereby smoothing out the variance.) Investors can and will argue over what is an appropriate multiple but all would agree that 2.3x is too low, especially for a stable and growing company with a rock-solid balance …

Geoff Gannon December 29, 2010

International Value Investing: Send Geoff Your Favorite Homegrown Stock Idea

Are you a value investor living outside the United States?

If so, you can write for Gannon On Investing.

Seriously, I’m looking for guest posts on stocks outside the United States. The only rule is that you have to write about a stock from the country you live in.

No stock or country is too small.

Payment is zero dollars in the currency of your choice.

Email me your favorite homegrown stock idea and I’ll post it to the blog.

No Americans need apply.

Talk to Geoff About International Value Investing…

Geoff Gannon December 28, 2010

How to Get Started in International Value Investing

A reader sent me this email:

Hi Geoff,

I am a student and am very interested in international value investing. I was wondering if you had any advice for me or if you knew of any people out there who are dedicated to this area (both gurus as well as bloggers). If you could recommend any resources I would highly appreciate it.

Best,
Ben

Start by limiting yourself. Pick which countries you will invest in and which countries you won’t. I recommend drawing your circle of competence around these 22 countries:

Denmark
New Zealand
Singapore
Finland
Sweden
Canada
Netherlands
Australia
Switzerland
Norway
Iceland
Luxembourg
Hong Kong
Ireland
Austria
Germany
Barbados
Japan
Qatar
United Kingdom
Chile
Belgium

Those are the 22 countries perceived to be less corrupt than the United States according to Transparency International’s yearly index. It’s not a perfect list. But it’s a good list. It’s pretty close to what I’d tell you myself. And it has the benefit of not being one guy’s biased opinion.

Download Google Chrome. And bookmark the CIA World Factbook.

Chrome will translate websites from foreign languages into English for you. And the Factbook is the best guide to the world’s economies.

Make Bloomberg your financial portal. It has the best international ticker search.

Read Hidden Champions of the Twenty-First Century. It’s a good introduction to foreign companies. Mostly from German speaking countries.

American value investing shops that are heavily into foreign stocks include First Eagle, Third Avenue, and Wintergreen. Thomas Russo also likes foreign stocks. You can watch 3 lectures Russo gave to Professor Greenwald’s class here.

Some of my favorite value investing bloggers aren’t U.S. based. The author of the Interactive Investor Blog is in the U.K. The author of Greenbackd is in Australia. And the author of Variant Perceptions is in Mexico.

You can listen to me interview the author of Greenbackd here.

Richard Beddard of the Interactive Investor Blog isn’t just based in the U.K. He actually focuses on U.K. stocks. His blog is a must read.

Other U.K. blogs include UK Value Investor’s Diary, 10 Value 10, and The Sunny Day Investor.

A lot of blogs include lists of other blogs the author reads. Go through the list. Click on each blog’s name. Use a feed catcher like Netvibes to subscribe to any of them that interest you. I subscribe to about 50 blogs. You could easily manage several times more.

You can do the same with Twitter. Pick an investing blogger you like who invests outside the U.S. Then use him to find other value bloggers in the same country. Repeat.

Stock exchange sites are insanely difficult to navigate. Usually, you can use the sitemap to find a buried page that lists all the securities alphabetically. For small countries, this is ideal. If you’re looking at New Zealand or Ireland, you want to just go through the whole list the way Warren Buffett flipped

Geoff Gannon December 28, 2010

Illiquidity and You

swath Damodaran has a post on Asset Selection and Valuation in Illiquid Markets. It’s a fine theoretical discussion of the subject.

But I’d like to talk about practical illiquidity. What does illiquidity have to do with stock picking?

Let’s start with the big question.

Should you apply an illiquidity discount to specific stocks?

No.

My view of illiquidity discounts is basically Warren Buffett’s view of using risk based discount rates. Risk isn’t something you account for in the last step of the process. Risk is something you think about every step along the way. Same with illiquidity.

You start by asking: Is it safe to hold this stock forever? Can I afford to get locked into this stock?

That means you check the stock’s vital signs. What’s the Z-Score and the F-Score? How is the balance sheet? Does it have 10 straight years of positive free cash flow? Does it have minimal cap-ex requirements? Has it earned an above average return on tangible capital over the last 10 or 15 years?

Yes.

Then you can afford to hold the stock forever. The downside risk of getting locked in the stock is not catastrophic. The stock is safe in the sense that the business itself isn’t going to implode and the intrinsic value isn’t likely to decline over time. At worst, it’s a big time suck. But, if you buy at the right price, you’re risking your opportunity cost instead of your principal.

Next, you calculate if it’s possible to get in and out of the stock. If you’re a patient, individual investor the answer is almost always yes. Even if we take a very illiquid stock like one that on average trades shares worth $5,000 each day, that’s usually enough for an individual investor to make a long-term investment in the stock.

Here’s why.

A stock that trades $5,000 a day trades $100,000 a month (if a month is 20 trading days).

Charlie Munger mentioned that Berkshire Hathaway (BRK.B) bought 30-40% of the daily trading volume in Coca-Cola (KO) when it amassed its stake. Buying micro-caps, I’ve often bought even more than 40% of a stock’s volume. In several cases, I never paid a cent more for any of my shares than the last price the stock traded at before I started buying. Weird, huh?

But totally true. It doesn’t always work that way. Obviously if I’d tried to force it and buy the amount I wanted without regard to price, that’s not what would’ve happened. Instead, I just sat at the same bid for weeks and took whatever shares came down to that price.

I should point out that sometimes it works differently. Sometimes you get your shares the way Berkshire Hathaway got its investment in the Washington Post (WPO). Berkshire got virtually all its stock in the Washington Post from just 4 or 5 large investors. It happened very fast.

I’ve had that happen too. I go in expecting to be buying for a month. And …

Geoff Gannon December 24, 2010

How to Calculate Free Cash Flow – 5 Illustrated Examples From Actual 10-Ks

Some readers have emailed me with questions about exactly how to calculate free cash flow. Do you include changes in working capital? Do you really have to use SEC reports instead of finance websites? Things like that.

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 (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 (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 (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, you need to lump

Geoff Gannon December 23, 2010

How to Come Up With Investing Ideas

A reader sent me this email:

Hi Geoff,

…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…

Best,
Phil

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.

You can use screens. I recommend Magic Formula Investing, GuruFocus, Morningstar, and RobotDough.

GuruFocus also has 2 newsletters for subscribers to the site. One is about Ben Graham NCAV bargains. The other is about Warren Buffett / Charlie Munger bargains.

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 just the universe …

Geoff Gannon December 20, 2010

Reed Hastings – CEO of Netflix (NFLX) – Responds to Whitney Tilson’s Short Case

Reed Hastings, the CEO of Netflix (NFLX), wrote a response to Whitney Tilson’s article on why he’s shorting Netflix at $180 a share.

I was working on an article about Tilson’s short position in Netflix for GuruFocus when I saw Reed Hastings’s response.

I’ll probably end up writing an article that talks about both their points.

I don’t short stocks. Never have. Probably never will. There are a few reasons for this. One, I’ve looked at value investors who do short – and in most cases – they could have done at least as well if they never shorted a single stock. That was certainly true for Benjamin Graham. It wasn’t worth the trouble.

And that’s point number two. There are some things I can do in investing that I don’t do simply because the trouble of doing them isn’t worth the reward they bring. Once in a very long while I arbitrage an all cash deal. So far, the success rate has been great. But I haven’t had much fun doing it. It’s an oddly unenjoyable experience, buying into something for a small profit and then following it through a minefield of problems till it comes out the other side. Even when it works, it just makes me want to curl up with the annual report of some quality company I can buy and hold for a bit.

There’s a little of that in why I don’t short. Maybe a lot. I’ve seen people short stocks. And what they go through isn’t something I want to go through.

I would never short Netflix. I think it’s an amazing company. I might be biased here since I’m a long-term customer. I’ve basically switched over to instant only – I keep a one DVD plan just so I have that option – but mostly I just watch instantly. And it’s amazing how it’s changed my life.

Amazon (AMZN) is the only other company that comes close. The way they both deal with their customers actually conditions their customers to behave differently. Netflix and Amazon have molded my habits in ways no other company has.

It’s hard to explain. But I know Netflix and Amazon are the two stickiest relationships I have as a customer. They will keep getting my money for a long, long time.

Hastings and Bezos are also the two businessmen that impress me most. That’s outside of the usual suspects – guys like Warren Buffett who are really just investors. I have to admit I’ve gone through the archives and watched both Hastings and Bezos on Charlie Rose.

A few years back, Netflix was trading pretty cheap. It was clearly a Charlie Munger bargain. But it wasn’t trading at a Ben Graham price. And, as you know, I don’t pay up for growth. I don’t pay up for quality. I’ll buy the best stuff that’s quantitatively cheap based on its past numbers and current assets. But I don’t like paying for tomorrow. So I didn’t buy …

Geoff Gannon December 19, 2010

Should You Learn Investing By Reading or Doing? – Geoff’s Advice to a College Junior

A reader sent me this email:

Hi Geoff,

I am a junior in college who only recently has stumbled upon the realm of value investing. At this point, I have read Margin of Safety, You Can Be A Stock Market Genius, parts of The Intelligent Investor, and have recently begun Warren Buffett’s essays. As a part of my schoolwork, I have taken basic courses in corporate finance, financial accounting, and capital markets.

What I am wondering is how I can best allocate the free time I devote to learning about investing in order to maximize its learning potential, as I am a busy college student now, and will hopefully be a busy employee in the future. But far from not knowing where to turn, I am rather overwhelmed by the wealth of good resources there are out there concerning value investing, between books, articles, and blogs such as yours.

So my question is: what activity would best serve my education in investing right now, given my elementary exposure to the field? I am under the impression from my research that the best way to learn about value investing is to do it. However, value investing is a long and tedious process, involving a lot of searching and reading, often times about company-specific knowledge that in themselves don’t really teach much in terms of the art of investing. Would it be more educational for me to simply pick good ideas from books and blogs and try to “reverse engineer” the thought process at this point? Or have I gotten ahead of myself, and should read more classics / take more advanced courses in corporate finance before going further?

Best regards,
Vincent

Learn by doing.

Don’t worry about abstract theories. Start work on specific stocks. Steal someone else’s ideas and study those stocks. I wrote a post about four microcaps: Birner Dental Management Services (BDMS), George Risk Industries (RSKIA), Solitron Devices (SODI), and Bancinsurance (BCIS). Three of those four companies are still around.

Pick one of those three companies. Go to EDGAR and find their latest 10-K. Print it out.

Take the 10-K, a pen, a calculator, and a highlighter to the library. Highlight any phrases that sound worth remembering. Don’t overdo it. Be honest. Just highlight the stuff that sounds like it could swing you one way or another on buying the stock. A good way to do this is to imagine you’re running a conglomerate that is considering buying this business in its entirety. You’ve asked someone working for you to study the company and present the acquisition opportunity to you – in conversation, not a written report – tomorrow morning. What would you want him to highlight?

That’s what you highlight.

Use the pen to write notes in the margin. For me, these are usually questions or calculations.

Don’t take random notes. Follow a thread. Like an interviewer. Imagine the 10-K isn’t just written text but a real person sitting …

Geoff Gannon December 14, 2010

Sold My Barnes & Noble (BKS) Stock Today

I sold my Barnes & Noble (BKS) stock today. The average sale price was $14.82. I bought Barnes & Noble back in August at an average cost of $15.36 a share. In the meantime, I received $0.50 a share in dividends. The round trip was a loss of 4 cents a share – or 0.26% – while the S&P 500 was up more than 10%.

The reason I sold out of Barnes & Noble is to buy a stock I like better. Since I’m not done buying that stock – and it’s a lot less liquid than BKS – I won’t be telling you about the new stock today.

I’ll let you know the name when I’m done buying the stock.

But, for now, just know that I have sold out of Barnes & Noble.…