Posts In: Gannon on Investing

Geoff Gannon January 26, 2020

Hilton Food (HFG): A Super Predictable Meat Packer with Long-Term “Cost Plus” Contracts and Extreme Customer Concentration at an Expensive – But Actually Not Quite Too Expensive – Price

Hilton Food Group (HFG) trades on the London Stock Exchange. It qualifies as an “overlooked stock” because it has low share turnover (17% per year) and a low beta (0.28) despite having a pretty high market cap (greater than $1 billion in USD terms). On a purely statistical basis, Hilton Food is one of the most predictable – in fact, in one respect, literally THE most predictable – companies I’m aware of. There’s a reason for this I’ll get into in a second. But, first...

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Geoff Gannon January 2, 2020

Geoff’s Thoughts on Cheesecake Factory (CAKE)

Someone asked me my thoughts on Cheesecake Factory. It’s a stock we’ve looked at before. But, I have written about it recently. The stock hasn’t done well lately. It looks fairly cheap. Here was my answer: “I haven’t followed it lately. I know the stock hasn’t done that well. I did a very quick check of the stock price just now looking at the long-term average operating margin, today’s sales, today’s tax rates, etc. It seems that on an earnings basis (normalized for a normal...

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Andrew Kuhn December 19, 2019

Finding Enough Investment Ideas

SEPTEMBER 30, 2013

by Geoff Gannon

Upon seeing that The Avid Hog is a monthly newsletter, someone asked this question:

…how do you expect to find suitable candidates every month? Is the supply of good companies that large?

The supply of good companies is enormous. If you don’t have any restrictions on market cap or country, there are always good companies out there. Supply is never the problem. Knowing that supply well enough is.

Although I consider myself a value investor, I don’t get ideas the way most value investors do. You can see a good example of how a value investor looks for ideas in this video of Michael Price’s presentation at the London Value Investing Conference. Another good example is this quote from Nate’s latest post at Oddball Stocks:

I value banks like I value companies.  I find a bank that’s clearly undervalued, then I work to either confirm or deny the valuation.  This is the opposite of someone who might research and value a company and once the valuation is done look at the market value.  I start with the market value, I’m not looking for franchise companies, I’m looking for companies that appear cheap, and I want to confirm they actually are cheap, if so I invest.  This means I don’t have a Watchlist of banks or companies I’d like to buy if the price were right.  Rather I continually trawl low P/B stocks and pick up what’s on sale that week or month

Let’s contrast that with the ideal I strive for. In a perfect world, my approach looks more like how Warren Buffett described his analysis of PetroChina to Fox Business. He told Fox Business the important parts of his approach are that:

  1. He tries to look at the business first, without knowing the price
  2. He decides what he would pay for the entire company
  3. He compares the price he would pay to what the entire company is trading for in the market
  4. If the price he would pay is a lot higher than what the whole company trades for in the market, he buys it.

That’s the ideal approach for me. I’ve found personally that it’s the one that works best. If I appraise the entire business with fairly little preconception of where the stock should trade, has traded, etc. and then I compare my appraisal to the market price I’m on the firmest footing in terms of knowing I have a bargain.

The hypothetical I often pose when talking to Quan about a stock is:

Imagine you are running a family holding company. The assets of all your family members are tied up in this company’s stock. You can put 25% of the value of your holding company into buying this business in its entirety. Would you do it?

In other words, is this a business you want to be in forever? Is the price good? And would you be willing to put 25% of the money of the people …

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Andrew Kuhn December 17, 2019

Stock Price Guidelines

by Geoff Gannon

It’s amazing how so many of the deals cluster around the 10x pretax earnings ratio despite these businesses being in different industries with different capital expenditure needs and things like that. Even the BNI acquisition, which many thought was overpriced (crazy / insane deal! Buffett has lost his marbles!) looks normal by this measure; a price that Buffett has always been paying. And yes, right now I’m the guy swinging around a hammer (seeing only nails), but I notice a pattern and think it’s really interesting.

(The Brooklyn Investor)

I’m often asked what’s a fair price to pay for a good business? This is a tough question, because people seem to mean different things when they say “fair price” and different things when they say “good business”.

I will suggest one awfully automatic approach to deciding what stocks are acceptable candidates for long-term investment. The simplest approach I can suggest requires 2 criteria be met. To qualify as a “good business” the stock must:

  1. Have no operating losses in the last 10 years
  2. Be in an industry to the left of “Transportation” in this graph of CFROI Persistence by Industry

In other words, we are defining a good business as a stock in a “defensive” industry with at least 10 straight years of profits.

If those two business quality criteria are met, what is a fair price to pay for the stock? I suggest three yardsticks:

  1. Market Cap to Free Cash Flow: 15x
  2. Enterprise Value to Owner Earnings: 10x
  3. Enterprise Value to EBITDA: 8x

These are “fair” prices. A value investor likes to pay an unfair price. So, these are upper limits. They are prohibitions on ever paying more than 15 times free cash flow, 10 times owner earnings, or 8 times EBITDA.

At Berkshire, Buffett is willing to pay a fair price – 10 times pre-tax earnings – for 2 reasons:

  1. Berkshire amplifies its returns with leverage (“float”)
  2. Buffett has learned to find a margin of safety in places other than price

For example, Buffett talks about Coca-Cola (KO) as if the margin of safety was the profitable future growth of the company. He was paying a fair absolute price (it was a high price relative to other stocks at the time), because he knew it was a good price relative to earnings a few years out.

Let’s take a look at the 5 guidelines I laid out:

  1. Have no operating losses in the last 10 years
  2. Be in an industry to the left of “Transportation” in this graph of CFROI Persistence by Industry
  3. Market Cap to Free Cash Flow: 15x
  4. Enterprise Value to Pre-Tax Owner Earnings: 10x
  5. Enterprise Value to EBITDA: 8x

Implementation of this – or any – checklist approach requires one additional thing: common sense.

Common sense often finds itself at odds with two other types of sense:

  1. Theoretical Sense
  2. Technical Sense

Technical sense is when you notice that Carnival (CCL) trades at more than 8x EBITDA and

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Geoff Gannon December 14, 2019

Canterbury Park (CPHC): A Stock Selling for Less than the Sum of Two Parts – A Card Casino and 127-Acres of Land (Plus You Get a Horse Track for Free)

Canterbury Park (CPHC) is a sum of the parts stock. After our experiences – and when I say “our”, I mean my decisions to buy – Maui Land & Pineapple, Keweenaw Land Association, and Nekkar – Andrew has a sticky note on his desk that says: “When thinking about SOTP, think STOP”. Canterbury Park (CPHC) is a sum of the parts (SOTP) stock. Since we’re thinking “SOTP” should we also be thinking “STOP”? Yes, Canterbury Park is a sum of the parts stock. But… That...

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Geoff Gannon December 7, 2019

Stella-Jones: Long-Term Contracts Selling Utility Poles and Railroad Ties Add Up to A Predictable, Consistent Compounder that Unfortunately Has to Use Debt to Beat the Market

Stella-Jones mainly provides large customers with pressure treated wood under contractually decided terms. The customers are mainly: U.S. and Canadian railroads, U.S. and Canadian electric companies, U.S. and Canadian phone companies, and U.S. and Canadian big box retailers. Stella-Jones has some other sources of revenue – like selling untreated lumber and logs – that provide revenue but no value for shareholders. The company also has some more niche customers – probably buyers for using wood in things like bridges, piers, etc. – that probably do...

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Andrew Kuhn December 6, 2019

One Ratio to Rule Them All: EV/EBITDA

By Geoff Gannon

06/07/2012

 

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

 

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

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

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

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

When looking at something like:

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

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

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

 

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

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

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

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

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

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

 

Don’t Assume Accountants See Amortization the Way You Do

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

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

No. The company is always amortizing past acquisitions. So, the EV/EBITDA of 8 is probably

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Geoff Gannon December 5, 2019

Points International (PCOM): A 10%+ Growth Business That’s 100% Funded by the Float from Simultaneously Buying and Selling Airline Miles

Points International (PCOM) is a stock Andrew brought to me a couple weeks ago. It always looked like a potentially interesting stock – I’ll discuss why when I get to management’s guidance for what it hopes to achieve by 2022 – but, I wasn’t sure it’s a business model I could understand. After some more research into the business, I feel like I can at least guess at what this company is really doing and at how this helps airlines. My interpretation of what the...

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Andrew Kuhn December 5, 2019

Security Analysis: Introduction (Part 1)

By: Geoff Gannon

July 25, 2008

The introduction to Security Analysis is a treasure trove of Grahamian thought. It is impossible to fully plumb the depths of this Grahamian gold mine in a single post. Therefore, I have separated my comments into two posts. This post explores the opening paragraph of the introduction with special attention to Graham’s style.

We should begin with the most general point made in Graham’s introduction: It is impossible to completely separate analysis and action, theory and practice. Therefore, while the title of Graham’s book is Security Analysis, the scope is necessarily wider:

Although, strictly speaking, security analysis may be carried on without reference to any definite program or standards of investment, such specialization of functions would be quite unrealistic. Critical examination of balance sheets and income accounts, comparisons of related or similar issues, studies of the terms and protective covenants behind bonds and preferred stocks – these typical activities of the securities analyst are invariably carried on with some practical idea of purchase or sale in mind, and they must be viewed against a broader background of investment principles, or perhaps of speculative principles.

This is vintage Graham. In many ways, it is a sort of cold open into the book and the mind of the man who wrote it. He begins with a logical and overly literal opening sentence; to Graham, “strictly speaking” means speaking strictly – nothing more or less. He adds a word we wouldn’t think necessary – “definite” – but in Graham’s mind it is a necessary and meaningful modifier. Finally, he interjects his personality with the word “quite”, which we will see repeated again and again throughout Security Analysis (Graham was born in Britain).

Next, we have a catalogue. The activities Graham lists are all activities he’ll cover in Security Analysis. If you wonder what Graham means by security analysis, look no further than these lines. He lists three main activities: “critical examination” of corporate financial statements, “comparisons of related or similar issues”, and finally “studies of the terms” of senior securities.

This is an especially excellent introduction for the modern reader, because we learn just how different Graham and his book are from what we might expect – and we learn our lesson well within the first few sentences.

What is the most unusual feature of this paragraph? Can you find the words almost no other writer would have included?

I’ll give you a hint. In Graham’s list of activities undertaken by the security analyst, there are two words that stick out like a sore thumb – a seemingly redundant sore thumb – can you find them?

Here they are:

“Critical examination of balance sheets and income accounts, comparisons of related or similar issues, studies of the terms…”

These two words tell you more about Graham and Security Analysis than anything else in that opening paragraph.

Why?

Because they are peculiar. What tells most is often what is said least. The appearance of these extra words

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Geoff Gannon November 25, 2019

Sydney Airport: A Safe, Growing and Inflation Protected Asset That’s Leveraged to the Hilt

Today’s initial interest post really stretches the definition of “overlooked stock”. I’m going to be talking about Sydney Airport. This is one of the 20 to 25 biggest public companies in Australia. It has a market cap – in U.S. dollar terms (the stock trades in Australian Dollars) – of about $13 billion. It also has a lot of debt – including publicly traded bonds. So, not what you’d normally consider “overlooked”. On the other hand, Andrew and I have a couple standard criteria we use (low beta and low share turnover) to judge whether a stock might be overlooked. And Sydney Airport happened to score just barely well enough on these two measures of “overlooked-ness” that it wasn’t automatically eliminated by our screens. For this reason, I left the stock on a watchlist that went out on our email list. While a lot of people mentioned the stock definitely wasn’t overlooked – a lot of other people also mentioned they’d like to hear my thoughts on the stock. So, here they are.

Sydney Airport was suggested to me by my former newsletter co-writer Quan Hoang. He’s from Vietnam originally. And he’s now spent time in Australia. He was looking at stocks and sent me over some financial data of Sydney Airport. A few things jump out about this company immediately. One: it pays out basically everything it can afford to in dividends. Two: it uses a high amount of debt (close to 7 times Net Debt/EBITDA – at one time that number was closer to 11 times Net Debt/EBITDA). However, this isn’t a distressed company in any way. The debt is spaced out – about half of it matures within the next 5 years and the other half after the next 5 years. The bonds are rated by Moody’s and S&P. Sydney Airport intends to maintain an investment grade rating. That’s usually not easy when you have well over 6 times Net Debt / EBITDA. But, this is an airport.

The problem with the debt here is not solvency risk. It’s that the stock price with the debt added – so, the enterprise value relative to various earnings power measures – creates a pretty high future growth hurdle that needs to be cleared. On a dividend yield basis, the stock looks cheap. It yields 4.3%. However, you need to be careful with that number. Consider, for example, Vertu Motors in the U.K. It also yields 4.2%. But, instead of having more than 6 times Net Debt / EBITDA – it has basically no net debt. It also pays out only about 1/3rd of its earnings as dividends. I’m not saying Vertu Motors is a better stock than Sydney Airport – though, at this point, I do own Vertu and don’t own Sydney Airport – but, I am saying that it’s a lot easier for Vertu to cover its dividend and grow it over time than it is for Sydney Airport. Basically, if Sydney Airport doesn’t want to increase …

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