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Geoff Gannon October 17, 2017

MSCI

Guest write-up by Jayden Preston.

 

Overview

Spun off from Morgan Stanley in 2007, MSCI is a leading provider of investment decision support tools to investment institutions worldwide. They produce indexes and risk and return portfolio analytics for use in managing investment portfolios.

 

Their flagship products are their international equity indexes marketed under the MSCI brand. They also offer other products that assist investors making investment decisions. These include portfolio analysis by their Barra platform; risk management by their RiskMetrics product; provision of ratings and analysis that institutional investors to integrate environmental, social and governance (“ESG”) factors into their investment strategies; and analysis of real estate in both privately and publicly owned portfolios.

 

Their clients include both asset owners and financial intermediaries.

 

Their principal business model is to license annual, recurring subscriptions to their products and services for a fee, which is, in a majority of cases, paid in advance.

 

They also charge clients to use their indexes as the basis for index-linked investment products such as ETFs or as the basis for passively managed funds and separate accounts. These clients commonly pay MSCI a license fee, primarily in arrears, for the use of the brand name mainly based on the assets under management (“AUM”) in their investment product. Certain exchanges use their indexes as the basis for futures and options contracts and pay them a license fee, primarily paid in arrears, for the use of their intellectual property mainly based on the volume of trades.

 

Clients also subscribe to periodic benchmark reports, digests and other publications associated with their Real Estate products. Fees are primarily paid in arrears after the product is delivered.

 

As a very small part of their business, they also realize one-time fees related to customized reports, historical data sets and certain implementation and consulting services, as well as from certain products and services that are purchased on a non-renewal basis.

 

 

Business Segment

MSCI categories its business segments into the following: 1) Index, 2) Analytics, and 3) All Other.

 

Index Segment

 

This is their key segment. As I will explain below, this is where I believe the lion’s share of value of MSCI lies.

 

MSCI indexes are used in many areas of the investment process, including index-linked product creation and performance benchmarking, as well as portfolio construction and rebalancing. Index-linked product creation generates asset-based fees and the latter is the source of their subscription revenue within the Index segment.

 

MSCI currently calculates over 190,000 global equity indexes, including approximately 7,300 custom indexes.

 

For 2016, Index generated $613.5 million in revenue, or 53% of their total revenue. Adjusted EBITDA from this segment was $431.5 million, or 76% of total EBITDA. You can see that the EBITDA margin from this segment was 70%.

 

Analytics Segmen

This segment uses analytical content to create products and services which offer institutional investors an integrated view of risk and return. A few examples of major offerings under …

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Andrew Kuhn October 9, 2017

A Few Thoughts on Hostess Brands

“Your premium brand had better be delivering something special, or it’s not going to get the business”
-Warren Buffett

For the past few weeks I have been studying and doing research on Hostess Brands, the maker of the classic chocolate cupcake with the squiggly white frosting line and of course the iconic, golden, cream-filled Twinkie. At first glance, the company passed almost all my filters on my investment checklist for a company I would want to be involved with. They claim to have a 90% brand awareness among people in the United States, they benefit and profit on the nostalgia that their products create within people, they are growing internally at a decent rate and they are run by a very capable management team. Before we can dive into the investment case, let’s go back through the history of the company to better understand how we got to the present.

 

Hostess 1.0

The first Hostess cupcake was introduced to the public in 1919, followed by the formation of Interstate Baking company and the introduction of Twinkie in 1930. The company progressed with their normal course of business only to later file for Chapter 11 bankruptcy protection in 2004. For those who don’t know, Chapter 11 bankruptcy gives a company time to re-organize their debts and pay them off without having to “go out of business”. Chapter 7 bankruptcy on the other hand, is when a company or individual must sell off their assets to repay debts; in other words, liquidate. In most events the shareholders get wiped out, but I just wanted everyone to know the difference. Although that sounds terrible at first glance, Interstate Bakeries filing for bankruptcy protection was never due to failure of their brand. It was the result of union issues, zero efficiency within the company (stay with me here, I will go into more detail in a bit), high fixed costs and an excessive amount of debt…. A true recipe for disaster within any company. During this time, the company employed a Direct to Store Distribution Model which meant they needed a high number of employees (more than 33,000), tons of trucks to deliver their products frequently due to a 28-day self-life and 57 bakeries around the country to produce fresh products close enough to the stores that they deliver to. All of this compounded together created a company that, although had great products that people loved, had a structure that economically did not make sense. Their operating and labor costs where through the roof which led them to begin the bankruptcy process.

 

 

 

Hostess 2.0

Interstate Bakeries emerged from bankruptcy in 2009 and changes its name to Hostess Brands. The company gets back to its normal course of business to only again file for bankruptcy in 2012. This time, the company files for Chapter 7 and begins of the process of liquidation. Yet again, the result of them filing for bankruptcy was never due to lack of consumer consumption of their products, but more …

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Andrew Kuhn September 20, 2017

Warren Buffett’s Partnership Letters and My Investing Thought Process

“You can’t predict. You can Prepare.”
-Howard Marks

I have been reading all of Warren Buffett’s old partnership letters the past week or so. These letters are the letters he wrote to his Investors yearly (and then semi-annually) from 1957- 1970 before winding down his partnerships to eventually run Berkshire. I was inspired to do so because I have also been rereading The Snowball by Alice Schroeder’s for the past month, and it’s awesome how it takes you back to the beginning and goes year by year in Warren’s life as the snowball was building up and starting to roll downhill. There are a few books I re-read every year, and The Snowball is one of them. (Also on that list is Poor Charlies Almanack, another book I highly recommend.) The partnership letters are too long to embed in this post, but if you go to this link you should be able to pull them yourself:

http://csinvesting.org/wp-content/uploads/2012/05/complete_buffett_partnership_letters-1957-70_in-sections.pdf

Although Warren invests completely differently now, there are still a lot of takeaways you can pull for yourself from his writings. One thing I found interesting is on page 20 in his 1961 letter where Warren goes over his different types of Investment Categories. I’ll let him explain:

 

“The first section consists of generally undervalued securities (hereinafter called “generals”) where we have nothing to say about corporate policies and no timetable as to when the undervaluation may correct itself. Over the years, this has been our largest category of investment, and more money has been made here than in either of the other categories. We usually have fairly large positions (5% to 10% of our total assets) in each of five or six generals, with smaller positions in another ten or fifteen. Sometimes these work out very fast; many times they take years. It is difficult at the time of purchase to know any specific reason why they should appreciate in price. However, because of this lack of glamour or anything pending which might create immediate favorable market action, they are available at very cheap prices. A lot of value can be obtained for the price paid. This substantial excess of value creates a comfortable margin of safety in each transaction. This individual margin of safety, coupled with a diversity of commitments creates a most attractive package of safety and appreciation potential. Over the years our timing of purchases has been considerably better than our timing of sales. We do not go into these generals with the idea of getting the last nickel, but are usually quite content selling out at some intermediate level between our purchase price and what we regard as fair value to a private owner. The generals tend to behave market-wise very much in sympathy with the Dow. Just because something is cheap does not mean it is not going to go down. During abrupt downward movements in the market, this segment may very well go down percentage-wise just as much as the Dow. Over a period of …

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Geoff Gannon August 29, 2017

The Market is Overpriced: These 3 Stocks Aren’t

Most stocks are now overpriced.

Historically, a normal price for a stock has been about a P/E of 15.

And historically, stocks have outperformed other assets.

Therefore, it makes sense to buy above average businesses when their shares trade at a P/E of 15.

Right now, I see 3 above average businesses trading at about a P/E of 15:

  • Cheesecake Factory (CAKE)
  • Omnicom (OMC)
  • Howden Joinery

I’m not buying any of these stocks personally right now.

However, if you asked me right now whether or not I think you should buy a certain stock, I’d say “no” to 99% of the stocks you can name.

Those 3 belong to the 1% of stocks I’d say “yes” to.

I’ve never seen a time when it’s as difficult to find a good stock to buy without overpaying as what I see right now.

But, I don’t think that means you should be 100% in cash. I think it means you should be in stocks like:

  • Cheesecake Factory (at $41 as I write this)
  • Omnicom (at $73 as I write this)
  • And Howden Joinery (at 412 pence as I write this)

If the market as a whole is overpriced, it will fall. And when it does fall: it will take stocks like Cheesecake, Omnicom, and Howden with it.

In time, they will recover.

And you will be able to look back – 5 years or more down the road – and say that buying stocks like these at today’s “not overpriced” levels and holding them wasn’t a mistake.

You don’t need to get out of the market.

But, you do need to be more selective than ever now that the market is more expensive than ever.…

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Andrew Kuhn June 13, 2017

A Blast from the Past: Warren Buffett’s 1977 Shareholder Letter

Whenever someone comes to me asking for advice on how to get started in investing, the first place I direct them to is reading all Warren Buffett’s Berkshire shareholder letters. It is no secret that his letters have tons of golden investing-wisdom nuggets laid upon them. I have read them many times but interestingly enough, I always take something new away from them every time I reread them. In this series, we’re going to go all the way back and start from the beginning and review all of Berkshires’ Investor letters and all the significant passages, starting with 1977; a cool 19 years before I was born.

Focus on Return on Invested Capital, instead of EPS growth

“Most companies define “record” earnings as a new high in earnings per share. Since businesses customarily add from year to year to their equity base, we find nothing particularly noteworthy in a management performance combining, say, a 10% increase in equity capital and a 5% increase in earnings per share. After all, even a totally dormant savings account will produce steadily rising interest earnings each year because of compounding. Except for special cases (for example, companies with unusual debt-equity ratios or those with important assets carried at unrealistic balance sheet values), we believe a more appropriate measure of managerial economic performance to be return on equity capital. In 1977 our operating earnings on beginning equity capital amounted to 19%, slightly better than last year and above both our own long-term average and that of American industry in aggregate. But, while our operating earnings per share were up 37% from the year before, our beginning capital was up 24%, making the gain in earnings per share considerably less impressive than it might appear at first glance. We expect difficulty in matching our 1977 rate of return during the forthcoming year. Beginning equity capital is up 23% from a year ago, and we expect the trend of insurance underwriting profit margins to turn down well before the end of the year. Nevertheless, we expect a reasonably good year and our present estimate, subject to the usual caveats regarding the frailties of forecasts, is that operating earnings will improve somewhat on a per share basis during 1978.”

Warren is talking about looking through the noise and thinking about how a business has gotten to present day. What does Warren mean by this? Well, let’s look at a disastrous investment example to illustrate.

Valeant was the darling of Wall Street for quite some time, and everyone reading this blog will be familiar with what happened to them. The most alarming thing for me when I did some due-diligence on Valeant when it was in the $200’s, was their exploding debt followed by declining operating/net earnings… A true recipe for disaster. Growing revenue is good, but you want to understand how they got to where they are. The whole Valeant saga was, and still is, a case study in action. Standing from the sidelines, I have …

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