I try to keep you up to date with the most interesting “activist” situations. But, this week the activism is coming far too fast for me to keep up with.
Joe Citarrella is a student at Yale University who began investing as a teenager in order to debunk family myths about the stock market. Joe writes JoeCit – Intelligent Investing, a value investing blog that combines research and advice. Joe is a devoted value investor whose portfolio holdings and results can be seen at the About section of his blog.
Value investing is the practice of buying a security for less than it’s intrinsically worth. Arguably the most important element of successful value investing is the concept of a margin of safety. If you feel a stock is worth $20, for instance, but it sells for $18, that’s simply not enough of a cushion. $10-$15 might be more like it, in my opinion. Looking for the no-brainers is a hallmark of “true” value investing.
3. What is your approach to investing?
On a very broad level, I look for simple, easily understandable businesses that sell for less than they’re worth. Because of their general scarcity, that often means focusing on just a few really good ideas and putting a large chunk of my portfolio to work in just one or two “theses” that I believe have a high probability of outsized returns. In seeking out these opportunities, my approach is a combination of following the so-called paper trail and, occasionally, using quantitative screens to find stocks matching certain filters. In general, I’ll use guiding criteria that, most of the time, lead me to say “no” quite easily. But this narrows the playing field, forces efficient use of time, gets rid of noise, and enhances returns while lowering risk.
4. How do you evaluate a stock?
After a stock passes some basic filters and meets my criteria of a simple business that appears undervalued, I’ll take a look at the most recent 10-K. I’ll read management’s discussion and check the company’s financial position and operating results over the past several years. Normally, before digging very deeply, I’ll already have an idea what the thesis for an investment is.
Naturally, buying a company for half of book value is an entirely different ballgame than buying a company because of its growth potential or operating successes. Because I’ll do both, I need an idea of why I’m looking into the company in the first place. Doing so also allows me to know what to look for and where to look. This seems obvious but it’s often forgotten. Lots of mistakes are made by people who forgot what they were setting out to do.
As I continue digging into the numbers, management, etc., the stock will have to continue passing filters and tests. In the process, I look for reasons to say “no” rather than reasons to say “yes”. When it’s tough or impossible to say “no”, you can be more confident in your affirmative decisions when you make them. Buffett’s twenty punch rule should …
Today, Topps (TOPP) announced it has agreed to be acquired for $9.75 per share in cash in a transaction valued at $385.4 million. The maker of trading cards and confections (Ring Pop, Push Pop, Bazooka gum, etc.) will be acquired by the Tornante Company and Madison Dearborn Partners. The Tornante Company was founded in 2005 by Michael Eisner – it is privately held.
Topps was founded in 1938. Although it was always a chewing gum company, Topps didn’t start selling the products it would become best known for until after the war. Following World War II, the company developed Bazooka Bubble Gum. In 1951, Topps added baseball cards.
The company had annual sales of $298.84 million in fiscal 2006. Topps derives roughly half of its total revenue from each of its two business segments – 49.1% from confections and 50.9% from entertainment.
Total sales have been stagnant for some time now. Sales actually declined slightly during 2005 and 2006. Although sales have grown over the last twelve months (to over $300 million), the company is still far short of the $439.3 million in net sales it registered six years ago.
That recent high water mark was set during the height of the Pokemon craze in 2000 – when those little Japanese monsters brought in $179.6 million (or 40.88%) of Topps’ $439.3 million in total sales. In a single year Pokemon sales plummeted by $155.5 million or 86.58%.
Here it seems right to add (with apologies to Matthew) that all those who live by the fad die by the fad.
As you might expect, Topps had dealings with Disney (DIS) during Eisner’s reign. Whether this previous experience played any part in Eisner’s decision to invest is anybody’s guess.
In the press release announcing the deal, Eisner said only this:
“Topps is a wonderful company with a powerful brand portfolio and a rich history. Topps’ management team and employees are the best in the business, and we look forward to working with all of them to grow the company in new and exciting ways.”
According to the press release, Lehman Brothers served as sole financial advisor to Topps.
In February of 2005, the board of Topps “authorized the company to pursue, with the assistance of Lehman Brothers, a sale of the candy business, believing such a step might provide value for the stockholders, in light of recent industry transactions at attractive multiples.”
Director Arnaud Ajdler has written a letter to the board which includes these fighting words:
Since the Board of Directors has decided to pursue this transaction over the significant concerns which I have continually and repeatedly voiced to the Board, I intend to actively solicit votes and campaign against the proposed transaction.
I’ll post on this story as it develops (and I have some time …
Robert Freedland has been a stock market enthusiast longer than he has been a practicing physician. Starting at the age of 13 with a single investment he has developed his own investing and trading strategy drawing from value and earnings momentum writers. Sharing both his passion for investing as well as politics, he started writing online in 1998 on the Delphi Boards. His current blog, Stock Picks Bob’s Advice, has been active since 2003.
Quite frankly, value is an important part of my evaluation of stocks, but not the entire driving force behind deciding on a stock pick. I view myself as an eclectic investor, who is part momentum, part value, and part technician. If I can find a stock that fits my other criteria, I am reassured if I can find everything that I am seeking at a reasonable valuation. Even though I look at price/earnings, price/sales, return on equity, balance sheets, and free cash flow, probably I would be best described as a GARP investor, Growth at a Reasonable Price.
2. What is value investing?
In general, I would suggest that a value investor is someone who is interested in the intrinsic value of assets, minus the liabilities, and what a ‘break-up’ valuation might be for a company. They might be interested in buying stock in companies, as they would say, ‘under book’. I also believe that growth investors need to take into consideration valuation when making purchases which simply suggests that instead of a static, or break-up valuation, they also consider future earnings and cash flow in determining an appropriate valuation of a stock.
3. What is your approach to investing?
There really are three parts to my investment approach. First of all, I have chosen to profile the ‘perfect stock’ that meets my criteria of consistency in financial results. I like to find companies that first of all have good momentum on the day I decide to purchase them; that is, they are on the list of top percentage gainers that particular day. After that, I review the most recent quarter expecting them to have increasing revenue and earnings. If they can exceed expectations that is an added plus. Also, if they raise guidance, I give them extra “points” in my evaluation.
Next, utilizing Morningstar’s “5-Yr Restated” financial page, I check to see that revenue growth is persistent, that is it is more than a one quarter event. I also wish to see persistence in earnings growth, an increasing dividend is a plus, a stable number of shares outstanding, positive and if possible growing free cash flow, and a reasonable balance sheet with a current ratio of 1.25 or greater.
I take a look at valuation, looking for a moderate P/E if possible and a PEG between 1.0 and 1.5 if possible. In addition, I check the price/sales ratio relative to other companies in the same industry. I also review the return on equity. …
The following quote from The Confused Capitalist lead me to write this post:
Mr. Fisher’s big opening statement in his book challenges a long-held market axiom that high PE’s denote reduced returns for some period of time into the future. He states that the year immediately following a high PE year has virtually no statistical inverse correlation. While this might be true, it ignores the fact that there is heightened risk of a reduced return into the relatively near term future. Whether that lower return is realized in the immediate year following, Mr. Fisher’s data suggests, no.
However, an investor (rather than a “speculator” or “trader”) would be foolish to ignore the reduced odds of outperformance that this period provides.
After reading this, I decided I had to write a post directly discussing the risk present in extraordinarily high normalized P/E years – because such years are riskier than most years.
I don’t mean to say that an intelligent investor (or more likely trader) can never have a good reason for buying during an obviously expensive year. I do, however, mean to say that anyone who blindly assumes the risks present in an expensive year are comparable to the risks that were present during a typical year in the 20th century is operating under a dangerous delusion.
Furthermore, while I prefer to focus on the long-term, I can not allow others to unthinkingly entertain the pleasing notion that the ill effects of high normalized P/E years are only felt in the long-run. The evidence directly contradicts this particular delusion. A one-year bet on the Dow during a high normalized P/E year is a risky bet quite unlike a one-year bet on the Dow in any other year.
For those who haven’t read my series on normalized P/E ratios, let me explain how I worked with the data. I measured compound annual point growth in the Dow based on yearly averages for that index. For the sake of simplicity, dividends were ignored entirely – obviously, this omission benefits high normalized P/E years and serves to downplay the normalized P/E effect, because low normalized P/E years tend to have high dividend yields while high normalized P/E years tend to have low dividend yields. For a description of how I calculated normalized P/E ratios read “On Calculating Normalized P/E Ratios“.
With that explanation out of the way I can turn to the issue raised by The Confused Capitalist. Remember, I’m using 15-year normalized P/E ratios which differ somewhat from the P/E ratios you read about on a daily basis. Occasionally, the difference is quite large.
The poster child for such differences between P/E ratios and normalized P/E ratios is 1982, a year with a fairly ordinary looking P/E ratio of 14.26 but an absurdly …
I’ll have many more posts on this project in the days ahead. If you have any questions (or suggestions) about this project, please feel free to comment to this post – or, simply send me an email.…
I’d like to direct you to an excellent Warren Buffett related post written by Jeff Miller of A Dash of Insight. Buffett’s annual letter to shareholders is immediately read, analyzed, and reported on – though not necessarily in that order. Obviously, instant on air reports meant to give you the highlights of the letter within moments of its release should be completely ignored by anyone who has an interest in understanding what Warren wrote.
I excuse such reports, because they don’t even pretend to be serious reporting – they’re instant regurgitation and they look the part. In prior years, Buffett’s annual letter was exempted from such “breaking news” treatment; however, due to SEC regulations this year’s letter was released on Thursday instead of Saturday.
Not surprisingly, coverage of the letter suffered from the early release. But, that’s not what I’m writing about in this post – and that’s not what Jeff Miller wrote about over at A Dash of Insight.
While reading the letter on Thursday, I came across two words I knew would be misinterpreted: “soft landing”. This misinterpretation is somewhat understandable coming from someone with a background in financial reporting and no knowledge of Buffett, since the term “soft landing” is usually used to describe a possible outcome of Federal Reserve tightening.
Unfortunately, if a reporter is somewhat confused about all this, the reader is doubly damned. A quote alone would be confusing enough for someone who doesn’t know Buffett isn’t in the habit of making short-term macro economic calls in his annual letter. When a quote from Buffett’s letter is set within the body of an article authored by someone who isn’t entirely clear on what Buffett meant, the reader has little hope of leaving the article without a misconception.
To be fair, there is nothing factually incorrect about the Reuters story Miller links to.
Unfortunately, readers get more than facts from a news story. The overall impression from this Reuters story doesn’t fit well with the impression created by reading the actual letter. That’s mostly due to the decision to lead with these words:
“Warren Buffett said on Thursday the U.S. economy may not enjoy a ‘soft landing’ because Americans are taking on too much debt as the U.S. trade deficit worsens.”
Although this lead is factually correct, it misinforms the reader. Worse yet, in this electronic era, the Reuters story (rather than a careful reading of Buffett’s actual letter) may serve as the germ for another writer’s story. In this case, the reader who gets his information third hand will be an unwitting participant in a game of telephone – hopefully he has the good sense not to pass the message on.
There is one good thing to come out of such reporting – it may kindle a desire among some investors to consult the primary source. It’s quite a source.
Berkshire Hathaway (BRK.B) released its annual report today – by now I expect most of you have read Warren Buffett’s annual letter to shareholders. I’ll discuss the letter as a whole in another post. For now, I’d like to focus on just one line.
First, I’ll need to include the paragraph that precedes that line. Here’s what Buffett wrote before presenting his familiar table of Berkshire’s top common stock holdings:
“We show below our common stock investments. With two exceptions, those that had a market value of more than $700 million at the end of 2006 are itemized. We don’t itemize the two securities referred to, which had a market value of $1.9 billion, because we continue to buy them. I could, of course, tell you their names. But then I would have to kill you.”
I direct your attention to line nine of the table (listed alphabetically) which reads:
3,486,006 POSCO 4.0 572 1,158
Okay. Now, what does this mean? The best way to follow along with this post is to go to Berkshire’s website and open the letter for yourself. The table appears on page 15 of the letter – which is available only as a PDF.
Obviously, this line means that Berkshire owns stock in the South Korean steelmaker, POSCO (PKX). Using an appositive in the previous sentence may be grammatically incorrect, but it is rhetorically honest as POSCO is the South Korean steelmaker. No one refers to it as “aSouth Korean steelmaker”.
Anyway, this stake in Posco (I don’t capitalize the name, because English speaker don’t capitalize such mixed acronyms – it would actually be “PoSCo” if you used our usual practice and “PoSCo” just looks too weird to print) isn’t all that surprising. From past statements, we knew that Berkshire (had once) owned some Posco, that Buffett was comfortable enough with the name to cite it specifically when referring to South Korean stocks, and that in such statements he more or less said it wasn’t going to go out of business tomorrow.
We also knew that Posco was dirt cheap. Everyone knew that. Every analysis I read that ended with “don’t buy Posco” didn’t argue it was fairly priced, just that it was Korean, a steel company, etc. The argument most often used was that it wasn’t the right time in the cycle to buy Posco. The one argument I never read was that Posco was fairly priced when the ADRs were trading below $65 a share.
Even now, most articles I read trying to explain the improvement in Posco’s share price don’t make much mention of just how cheap this stock was – and it ain’t exactly expensive today, even after quite a run up.
However, I did read one interesting comment today. Apparently, “an official at Posco” told Reuters that Posco didn’t know when Berkshire bought shares in the company. That remark is interesting solely because it suggests (though obviously does not guarantee) that Posco’s management did not approach …
After as memorable a market move as yesterday’s (made all the more memorable by the lack of such days over the past half decade), I would love to be able to write that you have nothing to be worried about. Many other bloggers have written as much and they’re right to do so. Despite the fireworks, nothing much has changed. If you were completely comfortable owning stocks on Monday you should be completely comfortable owning stocks today.
I’m comfortable with the stocks I own. I just wouldn’t be comfortable owning a representative sample of the overall market. I wouldn’t be comfortable owning the Dow or the S&P; 500, because they are trading at uncomfortablevaluations.
I started this blog on Christmas Eve 2005 intending to publish a quarterly newsletter. After just two quarters, I had to close up shop for a very simple reason. During the third quarter of 2006, the trickle of good ideas slowed to the point where there was no longer something worth printing every quarter.
This blog is free. You can come and skim it as you like when you like. It’s a nice, casual arrangement that lets me write about interesting stocks without feeling like I’m holding any particular stock out as the absolute best opportunity of the moment. I’ve taken advantage of that – in fact, you may have noticed that during the second half of 2006 my posts on individual companies tended to end with more ambivalent conclusions. There’s a simple explanation: it has become much harder to find stocks I can write about with conviction.
At the end of last year, I started writing about the market in general. I presented my thoughts in a roundabout way through a series of posts on normalized P/E ratios. The most important of these posts was the one entitled “In Defense of Extraordinary Claims” which concluded with these words:
Stocks are not inherently attractive; they have often been attractive, because they have often been cheap. The great returns of the 20th century occurred under special circumstances – namely, low normalized P/E ratios. Today’s normalized P/E ratios are much, much higher. In other words, the special circumstances that allowed for great returns in equities during the 20th century no longer exist.
So, don’t use historical returns as a frame of reference when thinking about future returns – and do lower your expectations!
The long-term earnings growth rate of such a large group of big businesses simply can’t be all that fast. We can argue over whether earnings can grow 9% in any given year, but we know they won’t grow 9% in the long-run. That was the point behind my normalized P/E series. The idea that buying in at these levels will provide you with the kind of historical returns seen during the 20th century is absurd.
Stocks were a lot cheaper a lot more often than most people realize. Buying stocks at today’s prices may provide adequate returns and may be the …
