There will be no new content for the blog or podcast for a little over a week. I’m spending next week on Martha’s Vineyard – and I’ve decided I wouldn’t mind taking a vacation from my computer as well. So, I’ll be completely incommunicado.
New content will appear around the 26th or 27th of June.
Until then…
Happy Hunting…
Read moreThere was an interesting comment posted in response to last Thursday’s podcast. I gave three replies. I’ve reproduced them below, with questions interspersed:
Maintenance Cap-Ex
The nice thing about having low capital spending, is the pleasant surprise it creates. You find a company that is earning more (economically) than other companies with the same GAAP numbers. So, the P/E ratio tends to exaggerate how expensive the business is.
This is kind of like finding a business with excess cash. While it’s true that a business can have too much cash from an efficiency point of view, finding more cash on the balance sheet than you expected is always a good thing, right? The point in each case is that the headline numbers (EPS, P/E, etc.) sometimes lie – and an inordinate number of bargains are found where such “lies” exist – simply, because others aren’t looking there (it’s a less conspicuous bargain).
“Wouldn’t it mean the company wasn’t reinvesting in P&E;?”
Some businesses have a very strong relationship between the value of the assets in the business and earnings.
Others have almost no correlation between the two. For an example of a business that will likely have very different ROAs from year to year (and longer-term) look at Forward Industries (FORD). A less extreme example is Craftmade International (CRFT), further down the spectrum (but still very asset light) you have companies like Timberland (TBL) and K-Swiss (KSWS).
For an example of a business, that long-term at least, has to add to assets to add to earnings look at Village Supermarket (VLGEA). In this case (as in the case of most retailers), the long-term correlation between assets and earnings is somewhat obscured by operating leverage; however, logically at least, you do recognize that a supermarket’s earnings will be determined in large part by the number (and size) of the stores being operated.
Also on this side of the spectrum (businesses with a strong long-term correlation between assets and earnings) you have various businesses that own distinct, identifiable assets such as: theme parks, pipelines, parking lots, bowling alleys, golf courses, hotels, etc. Of course, you also have asset-heavy manufacturing businesses, especially in price sensitive, commodity-like products.
Both of these types of businesses tend to have more predictable returns on assets (at least on the margins). I add the qualifier, because it’s a rare business that is both capital intensive and highly profitable – although I’m sure you could name a handful of such conglomerates.
Some asset-light businesses have predictable returns on assets – not so much because there is a strong correlation between assets and earnings, but rather because there is the absence of disruptive change and some real protection from price competition. An example from this podcast would be McCormick (MKC) – a business that has a fairly predictable ROA largely because it’s simply a great business (albeit a slow growth business).
One of the greatest investing conundrums is the fact that it is usually …
Read moreIn this latest podcast episode, I answer email questions from listeners. Topics include book value bargains and how to value an insurance company. The discussion of Peter Lynch’s book will be pushed back a full week (until next Thursday), because this podcast episode already ran long (39 minutes).…
Read moreHere are some of my personal favorites over at Fat Pitch News (to read the complete story, click the blue URL just below the green banner):
When Buffett Gambles, He Gambles Big: Warren Buffett’s Berkshire Hathaway is becoming “the last resort” for the largest companies seeking hurricane insurance. Berkshire is using its financial strength to take on more risk, just as many other insurers are reducing their exposure to single events. Buffett has always said Berkshire would risk large losses on a single event and the “lumpy” returns they produce, if the price was right. Apparently, the 2006 prices are right for Buffett.
Homebuilders Ready For Contrarians?: Bill of Absolutely No DooDahs looks at homebuilders, a group that currently trades at very low price-to-earnings ratios even after one adjusts for the expected near-term earnings decline.
I Value My Homeys: Bill of Absolutely No DooDahs discusses discount rates, inflation, and how to value equities. He then attempts to use what was discussed to value the homebuilders covered in his previous post. An excellent post – as is the first post (above) that discussed homebuilders.
Bank Stock Moats: George of Fat Pitch Financials looks at competitive advantages in banking. He refers to my post: “On Banks” and an earlier Morningstar article. If you enjoyed my series of posts on banks, you’ll enjoy reading George’s take on the subject.
Read moreThis is the first new episode in quite some time. It’s mainly a discussion of per-share historical data in general and the Value Line Investment Survey in particular. The episode ran a little long (34 minutes); so, my discussion of Peter Lynch’s “One Up On Wall Street” will be part of Thursday’s episode instead. I hope you enjoy the podcast. As always, comments and questions are welcome.
Listen to the Gannon On Investing Podcast: “Value Line”…
Read moreFat Pitch News continues to provide worthwhile value investing links. George recently created a Feed Flare that lets webmasters include a link to bid up their stories on Fat Pitch News. You can read about the flare here.
I’ve added it to all of my blog posts at the bottom of the permalink page. So, if you click on the word “permalink” at the bottom of any of my posts, you’ll be able to bid up the story on Fat Pitch News by clicking a link at the bottom of the post.
Here are some of my personal favorites over at Fat Pitch News (to read the complete story, click the blue URL just below the green banner):
The 38 Stocks in the Buffett Portfolio: A comprehensive list that includes some very old positions that have not been sold. You may have forgotten about a few of the smaller names.
Overstock.com Analysis on Money Central: You’ve read my take on Overstock.com (OSTK), now read someone else’s.
Tribune Good News: Media conglomerate Tribune (TRB) announced a $2 billion stock buyback as well as plans to sell at least $500 million in non-core assets. Ratings agencies drastically cut the company’s credit rating, because of the added risk from the leveraged buyback. However, Tribune’s debt currently remains investment grade.
Claire’s Stores at Value Discipline: Rick looks at Claire’s Stores (CLE). It’s an interesting business. The stores sell cheap accessories to young girls. That’s not the kind of business where competitive pricing is a big concern.
International Speedway at MoneyMarketLetter.com: A post discussing an often overlooked wide-moat company, track operator International Speedway (ISCA).
Sleeping With an Elephant – Emerging Markets – How Diversified Are You?: Rick of Value Discipline discusses the possibility that simply picking a superficially diverse group of international securities may not insulate you against problems in the U.S.
Brunswick – Bargain Basement Boating?: Value Discipline profiles Brunswick (BC), a big player in boating and marine related recreation. The company also manufactures other (non-marine) recreational products and operates bowling alleys.
Funeral Pallor: What’s wrong with the funeral business? Burials are exactly the kind of highly fragmented, slow growth industry that should be highly profitable for the consolidators. Lately, that hasn’t been the case.
Coke Trying to Stay Fresh: You may have seen this story elsewhere. Coca-Cola (KO) is developing new specialty drink recipes by using restaurants as a test lab. The plan seems to be to increase the use of Coke in restaurants. I doubt it’ll lead to big results relative to Coke’s total sales, but it makes more sense than many of the marketing pushes for mature beverage brands.
Read moreI recently concluded the week long series of posts on specific banks earning above average returns. The idea was to look at each bank’s business and ask why it is capable of earning above average returns. For a discussion of why banks, on average, earn returns above those of many other public companies, see my earlier post: “On Banks”.
Here are the five posts:
Read moreWells Fargo & Company (WFC) is a huge Western and Midwestern bank that provides a diverse array of financial services to its more than 23 million customers. The company employs more than 150,000 people at its over 6,000 locations nationwide. Wells Fargo has about $500 billion in assets.
While the company continues to derive more than half its revenues from interest income (about $26 billion), its activities are not limited to collecting deposits and lending money. Wells Fargo engages in other businesses such as brokerage services, asset management, and investment banking. The company also makes venture capital investments.
Over the last ten years, Wells Fargo has averaged a 1.57% return on assets and an 18.19% return on equity.
Location
Wells Fargo is closely associated with California in the minds of most investors. The company now operates in 23 different states. However, the concentration in California remains.
Mortgage lending in California accounts for approximately 14% of Wells Fargo’s total loan portfolio. Commercial real estate loans in California account for another 5% of the company’s total loans. No other single state accounts for a similarly sized portion of total loans. In fact, neither mortgage lending nor commercial real estate lending in any other state accounts for more than 2% of Wells Fargo’s total loans.
Cross-Selling
Wells Fargo’s focus on cross-selling is well known. The company has a stated goal of doubling the number of products the average consumer and business customer has with Wells Fargo to eight products per customer (from the current four products per customer).
Cross-selling increases customer stickiness. It also helps increase profitability by decreasing expenses relative to revenues. The need for a large physical footprint is reduced – as is the need for a large number of bankers. Instead, the existing infrastructure is able to provide additional revenue from the same customers.
Wells Fargo’s Chairman & CEO, Richard Kovacevich, explains the importance of the company’s cross-selling in the “Vision & Values” section of the corporate website:
… Read moreCross-selling — or what we call “needs-based” selling — is our most important strategy. Why? Because it is an “increasing returns” business model. It’s like the “network effect” of e-commerce. It multiplies opportunities geometrically. The more you sell customers the more you know about them. The more you know about them the easier it is to sell them more products. The more products customers have with you the better value they receive and the more loyal they are. The longer they stay with you the more opportunities you have to meet even more of their financial needs. The more you sell them the higher the profit because the added cost of selling another product to an existing customer is often only about ten percent of the cost of selling that same product to a new customer. This gives us—as an aggregator — a significant cost advantage over one product or one channel companies. Cross-selling re-invents how financial services are aggregated and sold to customers — just like other aggregators
Fifth Third Bancorp (FITB) is a large, decentralized Midwestern bank with a strong history of focusing on cost controls. The company operates over 1,100 branches spread across ten different states: Ohio, Kentucky, Indiana, Michigan, Illinois, Florida, Tennessee, West Virginia, Pennsylvania, and Missouri. Fifth Third has over $100 billion in assets.
In addition to its banking operations, Fifth Third also operates one of the Midwest’s largest money managers and one of the nation’s largest EFT processors.
Over the last ten years, the company has averaged a 1.68% return on assets and an 18.34% return on equity.
Location
The vast majority of Fifth Third’s total assets are provided by affiliates in five states: Ohio, Michigan, Illinois, Indiana, and Kentucky.
Fifth Third focuses on smaller markets with below average population growth. The company seeks to operate more efficiently than its local competitors and thereby obtain a dominant share of each market.
The unattractive demographics of the largely Midwestern markets in which Fifth Third operates partially insulates the company from the ravages of competition. Many banks seek out pockets of above average population growth and high concentrations of wealth instead of expanding into one of Fifth Third’s markets.
Decentralization
Fifth Third consists of nineteen affiliates operating in ten different states. The company’s three largest affiliates account for approximately a third of the company’s total assets. These three largest affiliates are located in Cincinnati, Chicago, and Western Michigan. None of the other sixteen affiliates accounts for more than 7% of Fifth Third’s total assets.
The company is well-known for its highly decentralized affiliate banking model. Fifth Third’s President and CEO, George Schaefer explained this model in a May 22nd, 2000 interview with The Wall Street Transcript:
All of our lines of business, for example, in Indianapolis, Indiana, report into our CEO in that market. He’s in charge of the commercial business, he’s in charge of the retail business, he’s in charge of the trust business, the investment business and the processing business in his area.
This decentralized approach has helped Fifth Third compete in each local market, despite the very real differences between the various communities in which the company operates.
Fifth Third now has branches in larger markets as well as the small, slow-growing markets the company is normally associated with. Those smaller markets remain an important part of Fifth Third’s business; but, if the company hopes to continue its strong growth, it will need to increase its rather small share of some of these larger markets.
The autonomy granted to the CEOs of the various affiliates should better position Fifth Third for growth in both types of markets. Such autonomy frees local branches from any sort of institutional uniformity imposed upon them by some distant corporate office. This allows for the development of different solutions to similar problems based on the specific circumstances of each particular profit center.
Costs
Despite its decentralized operations, Fifth Third is more efficient than its peers. The company has …
Read moreCascade Bancorp (CACB) operates branches under the Bank of the Cascades name in Oregon and the Farmers and Merchants name in Idaho. The company has 21 branches in Oregon and 11 branches in Idaho. Cascade Bancorp has total assets of $1.35 billion and deposits of $1.16 billion.
Over the last ten years, the company has averaged a 2.08% return on assets and a 22.89% return on equity.
Location
Over a third of Cascade Bancorp’s total deposits are in the company’s six Bend, Oregon branches. Cascade has a 31% market share in Bend. Several larger banks have much smaller positions within the town. No other bank has a share of the market equal to more than half of Cascade’s share.
Cascade’s CFO, Gregory Newton, explained the attraction of Bend in an October 10th, 2005 interview with The Wall Street Transcript:
The economy in Central Oregon has been quite strong, mainly because of in-migration of baby boomers and active retirees. Central Oregon has better weather than most of the Northwest and has an abundance of recreational opportunities that draw quality of life seekers from large metros along the West Coast and increasingly from other parts of the country.
Cascade has a strong position both in the city of Bend itself (population: 50,000) and Deschutes County as a whole. Over half of Cascade’s deposits come from the company’s ten branches in Deschutes County. Cascade has a 33% market share within the county. The two nearest competitors each have a market share that is well under half of Cascade’s.
Despite Cascade’s strong penetration in Deschutes County, the company has a less than 2.5% share of the statewide market. The company earns above-average returns on both assets and equity by dominating a very small (and very lucrative) geographic niche.
People
Cascade’s limited geographic reach (and strong penetration within its territory) allows the company to focus on attracting the best employees. The company recently completed a large acquisition relative to its small size. However, Cascade has usually focused on de novo expansion within its chosen geographic niche (central Oregon).
In the same interview with The Wall Street Transcript, Mr. Newton explained the importance of Cascade’s staff:
People are our biggest asset and differentiating factor. Quality bankers are hard to come by these days and their prices are being bid up. So we are investing in developing skill levels of existing staff. In addition, we believe we are an attractive alternative to bankers who are with big banks where they have less ownership interest.
Executives at some local banks, including Cascade, have expressed concern that there are not enough good loan officers in Central Oregon. Part of the problem seems to be demographics. An increase in retirees does nothing to improve the quality of the labor pool these banks draw from. At the same time, the growing retiree population greatly increases the demand for loan officers.
As a result, some local banks have had to extensively train …
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