I worked earlier in my career as a writer and reporter so I have some experience interviewing people, a skill that comes in handy when assessing management.
These are three short rules to interviewing management that I learned in my early 20's. It's very basic but essential so as to not waste anyone's time:
1. Ask open ended questions. The inverted way of saying this is: Do not EVER ask "yes" or "no" questions. We all do it. Get in the habit of not doing it, by whatever means necessary. The corollary to that is ...
2. Do not ask leading questions. It traps yourself in your own presumptuousness.
3. Silence is your friend. Don't fall prey to the knee jerk reaction of filling empty space and as much as you can, do NOT finish their answers. Invite them to continue to expound on whatever they are talking about.
I recently read somewhere a suggestion to not interview mgmt b/c it creates biases. I find that a mgmt interview puts qualitative skin around the financial bones so I try to be aware of flattery ("Oh, great question" etc) and all the other bullshit people put forward when they talk to me.
One of the ways I try to avoid those biases is by asking myself ...
"how often do you think they repeat this narrative? do they actually believe it or are they just used to saying it? how can I get them off this narrative and get them to talk about things on the 2nd level"
... insincerity is the enemy of revelation.
Management is such a critical component in the long term success / failure of small companies that not understanding their motivations, their perspective and their imaginations leaves too much to the whipsaw of quarterly results, about which, sometimes even they have no control. But they are responsible for the long term operational maneuverings of a company, and that is the essential key to a company's long term growth and profitability and an investors ability to compound wealth repeatedly.
We all have our own truths, in life and in business, and investing is simply a way to handicap them, to quantify them, to wager on them. I don't profess to know more than anyone nor to have answers about everything. But I have a bit of experience interviewing people and I just wanted to share one tool that I think is essential to learning more about an investment.
-- END --
ALL RIGHTS RESERVED. THIS IS NOT A SOLICITATION FOR BUSINESS NOR A RECOMMENDATION TO BUY OR SELL SECURITIES. THIS IS FOR ENTERTAINMENT PURPOSES ONLY.
Tuesday, November 15, 2016
Sunday, November 13, 2016
EMH and the "CON" in Consensus
Anyone who spends time in business meetings, or on boards, or in any engagement with other people (including even sitting around a table and deciding what to have for dinner), probably recognizes that the efficiency of a meeting - ie the achievement through consensus of an optimal outcome - often declines as more people are involved.
And yet, one of the basic tenets of the efficient market hypothesis is that when it comes to market prices, a larger cohort achieves the most efficiency since the price aggregates information "dispersed amongst individuals within a society." (Recall that "efficient" in EMH isn't fitter / happier / more productive but is more a form of "consensus").
But why should a wider and larger base of participants yield more "efficient" results in the stock market, when so much evidence in other avenues of life exists to the contrary?
Perhaps we should think more productively about how often - and where - its likely to be wrong. I think that's a muscle investors regularly exercise.
***
The trouble with "consensus" - in a meeting and in the stock market - is that people are often anchored on the last comment, or the last stock price, or "what everyone else is doing" - and they mistake these data points as "sources of information" when actually they're forms of biases.
I recall reading once how the last thing Buffett looks at when analyzing a business is its price and chart, preferring to read all other filings first in order to make his own unbiased assessment divorced from the anchoring phenomenon.
It's a useful parable on how to not use consensus. Another is William Goldman's famous saying: "Nobody knows nothing." I say that to myself all the time.
***
The trend towards passive indexing - a massive trend - is supported by three things:
1. Efficient market hypothesis. If you can't beat the market, why bother trying?
2. Active management returns, which "on average" underperforms the market
3. The difficulty of identifying skilled asset managers who consistently outperform the market over long periods.
So the consequence of taking the EMH as fact has trillions of dollars in consequences.
As well, the "poor returns of active investors". But just as a reminder for a moment; investing is a zero sum game. There are two parties to every trade, a buyer and a seller. Reason therefore dictates that in aggregate, the average of all active investors, after fees, should underperform the market, roughly by the delta of fees.
Now, investors who want to follow a benchmark with the most undifferentiated and readily available solution can and should pursue the lowest cost index funds available to them. Anything else - anyone steered to a higher cost model - is a con job.
But investors who want a differentiated solution - who want an experience apart from and are willing to accept results that are different from the market - should either spend time learning how to invest or find someone with experience and skills who can do it for them.
The difficulty of finding that person, the difficulty of separating luck from skill, salespeople from super investors, wheat from chaff, etc. is the third and perhaps largest foundation of the trend towards passive investing.
It's so difficult even for institutions to identify high quality investment managers, and doubly so for individuals.
All in, you have this easy solution (passive investing) that solves / avoids the problem of having to find good managers yet still supports Wall Street's desire to separate you from your money. It plugs perfectly into the rubric of the industry as it already exists.
***
But here's where I think EMH and the passive trend have it all wrong and where the opportunity for good investors grows everyday: Finding high quality capital allocators is the only job within the entire investment ecosystem. I take an almost ideological view on this and I think its where investing shares at least as much with the practices of other art (and ethics) as it does with finance and accounting.
As a steward of capital seeking to invest in publicly traded companies I look for executives who allocate capital wisely. These CEO's and CFO's in turn look for managers who can manage capital (staff, equipment, etc) effectively. They in turn prize employees that convert their labor productively, and on and on.
It's the capital equivalent of turtles all the way down.
But since passive investing disabuses the notion that anyone can outperform the market, and EMH says that prices are all accurate, the conclusion is to ignore the search for better capital allocators and simply spread your bets and diversify.
Which is why the price for capital allocators is going down.
But the value of finding good capital allocators - from the CEO down to the line worker, from the endowment to the startup investment manager, from the QB to the special teams coach - is not going away. And for those who desire exceptional outcomes, it never will.
Over time, we who search for good capital allocators will get better at it while the competitive field diminishes.
***
I was going to write more about a specific idea I've been working on, but I'm still drawing information on it so I'll close with a brief comment on investing with incomplete information.
The other day I wrote about an inference drawn from one company to learn something incremental about another company. It helped to lock in gains and avoid losses for my clients and since a penny saved is a penny earned, I feel it justified my 1% fee.
The opposite of those inferences is acknowledging and valuing incomplete information when making investment decisions, and compensating for that with price and portfolio positioning.
I think good stockpickers, even when they dig down for that 3rd, 4th or nth piece of information, acknowledge the limits of what they know.
For this reason, I am cautious of detailed checklists, b/c it risks creating a false impression that on completing it, we'll have certainty. There never is certainly. I prefer a broad functionary checklist at the top of which I write in big letters: "What don't I know?"
Even as we dig a bit deeper and contextualize financial data with qualitative information, there are always going to be unknowns and surprises.
There's a value to what we don't know. I believe for "good investments" - and by that I mean investments in companies managed by "quality capital allocators" - time and patience is the best way to manage and offsets the risks of the unknowns. It seems an important concept that EMH totally ignores.
And yet, one of the basic tenets of the efficient market hypothesis is that when it comes to market prices, a larger cohort achieves the most efficiency since the price aggregates information "dispersed amongst individuals within a society." (Recall that "efficient" in EMH isn't fitter / happier / more productive but is more a form of "consensus").
But why should a wider and larger base of participants yield more "efficient" results in the stock market, when so much evidence in other avenues of life exists to the contrary?
Perhaps we should think more productively about how often - and where - its likely to be wrong. I think that's a muscle investors regularly exercise.
***
The trouble with "consensus" - in a meeting and in the stock market - is that people are often anchored on the last comment, or the last stock price, or "what everyone else is doing" - and they mistake these data points as "sources of information" when actually they're forms of biases.
I recall reading once how the last thing Buffett looks at when analyzing a business is its price and chart, preferring to read all other filings first in order to make his own unbiased assessment divorced from the anchoring phenomenon.
It's a useful parable on how to not use consensus. Another is William Goldman's famous saying: "Nobody knows nothing." I say that to myself all the time.
***
The trend towards passive indexing - a massive trend - is supported by three things:
1. Efficient market hypothesis. If you can't beat the market, why bother trying?
2. Active management returns, which "on average" underperforms the market
3. The difficulty of identifying skilled asset managers who consistently outperform the market over long periods.
So the consequence of taking the EMH as fact has trillions of dollars in consequences.
As well, the "poor returns of active investors". But just as a reminder for a moment; investing is a zero sum game. There are two parties to every trade, a buyer and a seller. Reason therefore dictates that in aggregate, the average of all active investors, after fees, should underperform the market, roughly by the delta of fees.
Now, investors who want to follow a benchmark with the most undifferentiated and readily available solution can and should pursue the lowest cost index funds available to them. Anything else - anyone steered to a higher cost model - is a con job.
But investors who want a differentiated solution - who want an experience apart from and are willing to accept results that are different from the market - should either spend time learning how to invest or find someone with experience and skills who can do it for them.
The difficulty of finding that person, the difficulty of separating luck from skill, salespeople from super investors, wheat from chaff, etc. is the third and perhaps largest foundation of the trend towards passive investing.
It's so difficult even for institutions to identify high quality investment managers, and doubly so for individuals.
All in, you have this easy solution (passive investing) that solves / avoids the problem of having to find good managers yet still supports Wall Street's desire to separate you from your money. It plugs perfectly into the rubric of the industry as it already exists.
***
But here's where I think EMH and the passive trend have it all wrong and where the opportunity for good investors grows everyday: Finding high quality capital allocators is the only job within the entire investment ecosystem. I take an almost ideological view on this and I think its where investing shares at least as much with the practices of other art (and ethics) as it does with finance and accounting.
It's the capital equivalent of turtles all the way down.
But since passive investing disabuses the notion that anyone can outperform the market, and EMH says that prices are all accurate, the conclusion is to ignore the search for better capital allocators and simply spread your bets and diversify.
Which is why the price for capital allocators is going down.
But the value of finding good capital allocators - from the CEO down to the line worker, from the endowment to the startup investment manager, from the QB to the special teams coach - is not going away. And for those who desire exceptional outcomes, it never will.
Over time, we who search for good capital allocators will get better at it while the competitive field diminishes.
***
I was going to write more about a specific idea I've been working on, but I'm still drawing information on it so I'll close with a brief comment on investing with incomplete information.
The other day I wrote about an inference drawn from one company to learn something incremental about another company. It helped to lock in gains and avoid losses for my clients and since a penny saved is a penny earned, I feel it justified my 1% fee.
The opposite of those inferences is acknowledging and valuing incomplete information when making investment decisions, and compensating for that with price and portfolio positioning.
I think good stockpickers, even when they dig down for that 3rd, 4th or nth piece of information, acknowledge the limits of what they know.
For this reason, I am cautious of detailed checklists, b/c it risks creating a false impression that on completing it, we'll have certainty. There never is certainly. I prefer a broad functionary checklist at the top of which I write in big letters: "What don't I know?"
Even as we dig a bit deeper and contextualize financial data with qualitative information, there are always going to be unknowns and surprises.
There's a value to what we don't know. I believe for "good investments" - and by that I mean investments in companies managed by "quality capital allocators" - time and patience is the best way to manage and offsets the risks of the unknowns. It seems an important concept that EMH totally ignores.
--
END --
ALL
RIGHTS RESERVED. THIS BLOG IS FOR ENTERTAINMENT ONLY. THIS IS NOT A
SOLICITATION FOR BUSINESS NOR A RECOMMENDATION TO BUY OR SELL SECURITIES. I
HAVE NO ASSURANCES THAT INFORMATION IS CORRECT NOR DO I HAVE ANY OBLIGATION TO
UPDATE READERS ON ANY CHANGES TO AN INVESTMENT THESIS.
Wednesday, November 9, 2016
FTLF and An Investment Manager's Responsibility to Their Clients
On November 1, I sent an email to a friend ...
"I have concerns about FTLF 3Q and shorter term traders should likely lock in gains"
... and I sold shares for clients. The genesis of the caution was my review of GNC's 3Q16 10Q, which stated ...
"[GNC's] Domestic franchise revenue decreased $2.4 million to $85.8 million in the current quarter compared with $88.2 million in the prior year quarter primarily due to lower wholesale sales associated with lower retail same store sales of our franchisees as well as the earlier timing of our annual franchise convention, which resulted in $6.3 million of lower sales in the current quarter as compared with the prior year quarter."
... if GNC domestic franchise sales were impacted by the timing of the convention at the end of June, it made me wonder how much of FTLF's astounding $8.7M in 2Q16 sales were pulled forward as a result of the convention.
So I looked at the timing of the convention in prior years and it didn't take long to see a trend ...
... hard to know precisely how much the "convention bump" impacts sales, but I know that 1Q tends to be the seasonally strongest (b/c of new year's resolutions) and it tapers from there. So I just combined 2Q & 3Q together to get a sense of the typical two-quarter figure relative to seasonally peak 1Q sales.
I saw that in a "normal" year (whatever that means) 2Q + 3Q sales ~ 1.6x to 1.8x of 1Q sales. I used those multiples to back into a presumed 3Q16 sales figure in FTLF and at the high end, it inferred $5M in 3Q16 sales.
My stomach dropped at that moment, about as much as the stock dropped when FTLF preannounced 3Q16 sales of $5.3M.
This being the first time such a "surprise" has happened while managing outside money, it got me wondering about how much information of this information I should share. I decided to do nothing, but it seemed like there was no right answer.
Ideas are the lifeblood of an investment manager. It is their passion, their purse and their intellectual capital. That I have been sharing some of them freely has been a function of my own interest in having an open diary into my thoughts, growth and maturation as an investment adviser managing outside capital.
But as I've grown my AUM and client base - and having just struggled with this uncomfortable situation - maybe it is time to rethink that model and morph towards something different, either a paid subscription / advisory or simply quarterly and annual letters for clients, as others investment mgrs do.
I'm not sure how this will change aspects of what I write about in the future, but over time, all things evolve and I imagine this blog will as well so as to avoid this situation in the future.
Either way, my sole commitment - my fiduciary responsibility - will always be first and foremost to my clients.
-- END --
All rights reserved. This blog is not a solicitation for business nor a recommendation to buy or sell securities. This blog is for entertainment purposes only. I am under no obligation to provide any updates on any position I write about here.
"I have concerns about FTLF 3Q and shorter term traders should likely lock in gains"
... and I sold shares for clients. The genesis of the caution was my review of GNC's 3Q16 10Q, which stated ...
"[GNC's] Domestic franchise revenue decreased $2.4 million to $85.8 million in the current quarter compared with $88.2 million in the prior year quarter primarily due to lower wholesale sales associated with lower retail same store sales of our franchisees as well as the earlier timing of our annual franchise convention, which resulted in $6.3 million of lower sales in the current quarter as compared with the prior year quarter."
... if GNC domestic franchise sales were impacted by the timing of the convention at the end of June, it made me wonder how much of FTLF's astounding $8.7M in 2Q16 sales were pulled forward as a result of the convention.
So I looked at the timing of the convention in prior years and it didn't take long to see a trend ...
... hard to know precisely how much the "convention bump" impacts sales, but I know that 1Q tends to be the seasonally strongest (b/c of new year's resolutions) and it tapers from there. So I just combined 2Q & 3Q together to get a sense of the typical two-quarter figure relative to seasonally peak 1Q sales.
I saw that in a "normal" year (whatever that means) 2Q + 3Q sales ~ 1.6x to 1.8x of 1Q sales. I used those multiples to back into a presumed 3Q16 sales figure in FTLF and at the high end, it inferred $5M in 3Q16 sales.
My stomach dropped at that moment, about as much as the stock dropped when FTLF preannounced 3Q16 sales of $5.3M.
This being the first time such a "surprise" has happened while managing outside money, it got me wondering about how much information of this information I should share. I decided to do nothing, but it seemed like there was no right answer.
Ideas are the lifeblood of an investment manager. It is their passion, their purse and their intellectual capital. That I have been sharing some of them freely has been a function of my own interest in having an open diary into my thoughts, growth and maturation as an investment adviser managing outside capital.
But as I've grown my AUM and client base - and having just struggled with this uncomfortable situation - maybe it is time to rethink that model and morph towards something different, either a paid subscription / advisory or simply quarterly and annual letters for clients, as others investment mgrs do.
I'm not sure how this will change aspects of what I write about in the future, but over time, all things evolve and I imagine this blog will as well so as to avoid this situation in the future.
Either way, my sole commitment - my fiduciary responsibility - will always be first and foremost to my clients.
-- END --
All rights reserved. This blog is not a solicitation for business nor a recommendation to buy or sell securities. This blog is for entertainment purposes only. I am under no obligation to provide any updates on any position I write about here.
Tuesday, October 25, 2016
On the short term activist shaking the ARIS tree
It is an interesting observation that when one types the word "SEVEN" into google search function, it autofills "Seven Deadly Sins" a reflection I suppose on the frequency with which the people check for behavioral affirmations.
In a way, the stock market has a similar effect. Every tick in the market can be a behavioral affirmation of one kind or another that can heighten the tension between greed and charity, or diligence and sloth.
I write here however, of the tension between "wrath" (less formally known as "impatience") and its more virtuous partner "patience". I find the latter to be a stellar principle for sound investing but it can be so difficult in practice that even those who speak of "long-term value-oriented investments" find it hard to back up with actions.
This all comes to mind because of the impatience recently expressed by the investor filing a DFAN14A with the SEC on ARI Network Services (ARIS), indicating a desire to solicit the sale of the company, an action that strikes me less as the endeavor of an activist than an expression of impatience and idiocy.
What we know about ARIS need not be rehashed because I've written about it elsewhere, but I'll summarize in three bullets:
Obviously, once a company has gone public it is in principle already sold; shareholders are the owners and the executives are the managers.
This missive is therefore addressed to my fellow owners who like me can see the long road ahead under present management, who don't want to pay taxes on their growth in capital to date and who know how hard it is to find well run companies that can compound growth over time, for what are well run companies but good mgmt teams allocating capital - labor, time and financial - wisely?
When we find them good companies well managed, we should hold onto them for long periods b/c they are few and far between.
I imagine all shareholders know as much as I do and see the same attributes as I see in ARIS, but what do we know about the owner advocating for the sale? I aim here to briefly fill in that gap based on available information so we can judge for ourselves whether his suggestions reflect temperance or gluttony.
This appears to be the third activist endeavor for the owner ...
1. AdCare Health (ADK). Period of activism: 2013 until Present (he is now on the board).
Initial statement from April 2013 says he owns 750k shares at $4.01.
In July 2013 he's advocating they sell the real estate to generate $4 / share cash that they pay as a dividend to shareholders and that the remaining business would be worth $9 / share. In August 2013 he says they should split into a REIT and an operating company. July 2014, the company announces it will end operations and convert into a holding company that would make it attractive to be acquired by a REIT. In November 2015, the Vice Chair has fraud charges filed against him. (I can't keep up!).
ADK now sells for under $2 and is the subject of an activist campaign by Echo Lake Capital / Ephraim Fields. Value investors appear to like the opportunity from the NOL's and the property.
2. Resonant Inc (RESN).
Initial statement of ownership of 300,000 shares in Feb 2015 at $15.47.
Continued to buy through the spring of 2015 such that ownership stake reflects 700,000 shares and the stock is trading at $4.75. In February 2016 he's given a board seat with the stock at $1.80. As of 4/27/16 he owns 1.035M shares.
3. ARI Network Services (ARIS)
1M shares bought b/t October and December 2014 @ $3.67 / share. In December 2015 files letter that company should seek potential sale. In Oct 2016, files proxy that company should consider a sale and that he is nominating himself and some investment banker to the board.
... I dare not speak ill of other investors for it is undoubtedly a function of hubris to think that one is smarter than another.
We all see in companies values - the more divergent the value the greater the opportunity - and I hope the value this investor sees in the shares he owns can be realized. I know nothing about two of them. However, I have experienced two things in life that I can say with certainty:
1. People tend to repeat their patterns of behaviors. Conclusion: Someone who has a prior history of buying small cap companies, getting on the board and overseeing value destruction is likely to do that again. We should aim to keep those with a frequency of such behaviors from coming to near to managing the capital that investors, company employees and managers have worked so hard to produce.
2. When my children ask for things they've done nothing to deserve, I say "no". Conclusion: When your unsolicited proxy arrives, shareholders should do the same here.
-- END --
ALL RIGHTS RESERVED. THIS IS NOT A SOLICITATION FOR BUSINESS OR RECOMMENDATION TO BUY OR SELL SECURITIES.
In a way, the stock market has a similar effect. Every tick in the market can be a behavioral affirmation of one kind or another that can heighten the tension between greed and charity, or diligence and sloth.
I write here however, of the tension between "wrath" (less formally known as "impatience") and its more virtuous partner "patience". I find the latter to be a stellar principle for sound investing but it can be so difficult in practice that even those who speak of "long-term value-oriented investments" find it hard to back up with actions.
This all comes to mind because of the impatience recently expressed by the investor filing a DFAN14A with the SEC on ARI Network Services (ARIS), indicating a desire to solicit the sale of the company, an action that strikes me less as the endeavor of an activist than an expression of impatience and idiocy.
What we know about ARIS need not be rehashed because I've written about it elsewhere, but I'll summarize in three bullets:
- It is an $85M market cap company whose CEO Roy Oliver, since taking the reins in 2008, has grown shareholder equity 33% CAGR.
- In stewardship with his capable CFO Bill Nurthen, who joined the company in 2013, Oliver now runs a cash flow generating business that has reinvested in high return acquisitions, an attribute of a "compounding" company
- By increasing the availability of and access to debt, the company should be able to continue to fund what has hitherto been a successful acquisition strategy into the future.
In my ~15 years in institutional finance, I've rarely seen such strong capabilities in companies above $10B market cap and here I am a shareholder of one that is still below $100M, and with a potentially long runway of growth ahead.
Taken all in, I believe the C-suite team is unusually strong and capable for a company so small (though they are not perfect).
Taken all in, I believe the C-suite team is unusually strong and capable for a company so small (though they are not perfect).
Yet, were the company to sell, we would lose our ownership rights to the company just as the going-got-good and we would lose the benefits of investing in a C-suite team that has performed so admirably. To break up the band, so to speak, seems premature; to nip such success in the bud seems stupid.
Obviously, once a company has gone public it is in principle already sold; shareholders are the owners and the executives are the managers.
This missive is therefore addressed to my fellow owners who like me can see the long road ahead under present management, who don't want to pay taxes on their growth in capital to date and who know how hard it is to find well run companies that can compound growth over time, for what are well run companies but good mgmt teams allocating capital - labor, time and financial - wisely?
When we find them good companies well managed, we should hold onto them for long periods b/c they are few and far between.
I imagine all shareholders know as much as I do and see the same attributes as I see in ARIS, but what do we know about the owner advocating for the sale? I aim here to briefly fill in that gap based on available information so we can judge for ourselves whether his suggestions reflect temperance or gluttony.
This appears to be the third activist endeavor for the owner ...
1. AdCare Health (ADK). Period of activism: 2013 until Present (he is now on the board).
Initial statement from April 2013 says he owns 750k shares at $4.01.
In July 2013 he's advocating they sell the real estate to generate $4 / share cash that they pay as a dividend to shareholders and that the remaining business would be worth $9 / share. In August 2013 he says they should split into a REIT and an operating company. July 2014, the company announces it will end operations and convert into a holding company that would make it attractive to be acquired by a REIT. In November 2015, the Vice Chair has fraud charges filed against him. (I can't keep up!).
ADK now sells for under $2 and is the subject of an activist campaign by Echo Lake Capital / Ephraim Fields. Value investors appear to like the opportunity from the NOL's and the property.
2. Resonant Inc (RESN).
Initial statement of ownership of 300,000 shares in Feb 2015 at $15.47.
Continued to buy through the spring of 2015 such that ownership stake reflects 700,000 shares and the stock is trading at $4.75. In February 2016 he's given a board seat with the stock at $1.80. As of 4/27/16 he owns 1.035M shares.
3. ARI Network Services (ARIS)
1M shares bought b/t October and December 2014 @ $3.67 / share. In December 2015 files letter that company should seek potential sale. In Oct 2016, files proxy that company should consider a sale and that he is nominating himself and some investment banker to the board.
... I dare not speak ill of other investors for it is undoubtedly a function of hubris to think that one is smarter than another.
We all see in companies values - the more divergent the value the greater the opportunity - and I hope the value this investor sees in the shares he owns can be realized. I know nothing about two of them. However, I have experienced two things in life that I can say with certainty:
1. People tend to repeat their patterns of behaviors. Conclusion: Someone who has a prior history of buying small cap companies, getting on the board and overseeing value destruction is likely to do that again. We should aim to keep those with a frequency of such behaviors from coming to near to managing the capital that investors, company employees and managers have worked so hard to produce.
2. When my children ask for things they've done nothing to deserve, I say "no". Conclusion: When your unsolicited proxy arrives, shareholders should do the same here.
-- END --
ALL RIGHTS RESERVED. THIS IS NOT A SOLICITATION FOR BUSINESS OR RECOMMENDATION TO BUY OR SELL SECURITIES.
Monday, October 17, 2016
The Half Truths Told About Passive Accounts, And the Whole Truth on Concentrated Patient Investing
Peter Thiel apparently likes to ask an interview question: "Tell me something that's true, that almost nobody agrees with you on."
I prefer the question "Tell me something that's false that everyone believes" and as I've grown older I've gained more confidence in those things that come to mind.
At the top of that list right now is the idea of diversification, (followed closely by Vikings not actually wearing horns on their helmets).
Diversification makes sense b/c it follows the common principle, "don't put all your eggs in one basket".
Ironically however, that principle conflicts with every single one of life's most important decisions; who you marry, what you do as a career, who you work with, etc.
In all the major commitments in life, we by nature put all your eggs in one basket.
I think everyone would do well practicing at least once in awhile putting all their eggs into one basket so they better understand the inputs to and tolerate the consequences of those actions.
Anything else is laziness.
***
This relates to the half truth that we should invest our savings in the market through a diversified basket of low cost index funds as an alternative to buying and selecting individual businesses for investment.
The whole truth is that when asset returns are correlated the presumed benefits of diversification disappear, so why is it better than individual stock selection?
***
I reckon most people don't think about the markets as individual companies. I reckon they think about it more like a flock of starlings in murmuration but those of us who analyze individual companies are like ornithologists who can pick out individual birds.
When you dig deeper into "the market" and look at its components it becomes apparent that sometimes "the market" is really just a few stocks overweighted in an index, impacting the whole.
***
There are a lot of ways to invest in the stock market beyond undifferentiated passive investing. I buy and hold small companies for long periods and limit my portfolio to a handful of what I think are terrific businesses trading at reasonable prices (or better still, unreasonably low prices).
There are plenty of other people who do what I do up and down the market cap spectrum (ie large and small companies) and then there are others who buy bankruptcies, debt, risk / arb, options. There's no lack of variety of investors. Some are more consistent and successfull than others.
Regardless of who those people are, I think I speak for all of them -
every single investor that buys individual securities
- that the underlying trend towards blanket diversification reflects two forms of laziness - intellectual and professional - that has become nearly universally accepted but is just plain wrong.
By intellectual laziness I mean the inherent incongruency that we should prefer market exposure with market risk over business exposure with business risk.
A well researched, thoroughly analyzed, cash flow generating, under-levered and growing business acquired inexpensively should - at any point in time - be a safer investment than a basket of companies arbitrarily selected by their size or industry or valuation, especially when that basket overlaps so many others. And if properly selected it can generate a more meaningful return than that basket.
But finding those companies takes time and effort and its stressful and difficult and it gets in the way of making money that comes from accumulating assets, which is how all money managers get paid regardless of performance.
By professional laziness I mean the things that happen when people ...
1) accept intellectual laziness and call it a service.
2) do what everyone else does and call it "unique" or "proprietary"
3) take vast sums of money from endowments, pension funds, retirement funds, government entities, etc and put it into instruments that behave like index funds simply b/c it's too hard to allocate them otherwise, and with no consideration of or responsibility for those whose retirement depends on the wise allocation of said capital.
... the alternative in all cases involves work that is difficult and differentiated but could be more meaningful to clients; identifying a handful of undervalued securities and owning them.
***
I've been investing personally since the late-1990's, starting with 10 to 100 share lots when it was easy and you could read Buffett at night and still buy www.something.com during the day and be up 10x the next and none of it made sense, but it was fun.
The investing structure of Graham and Buffett resonated with me nonetheless and I fell in love with it, slowly transitioning from my prior work as a writer / reporter to institutional research (with stints as a PI and in PE in between) then working for nearly 15 years on the sell side (with an MBA squeezed in) covering mostly industrials and services related companies up until I was laid off in 2012.
Here's a small collection of books I used to teach myself about investing ...
... I have a whole other shelf of text books from my MBA plus it's incredible what's available online now (and at the library).
***
Ironically, b/c I worked on the sell side, I had little time to spend thinking about my own investments and b/c of Eliot Spitzer I couldn't own the stocks I covered, so my personal accounts (I managed three) were fairly haphazard.
I had three primary accounts: One mostly held companies where friends of ours worked (a quasi Lynchian approach), one was concentrated in micro caps I'd read about in trade journals or found on screens, and one was diversified with large companies.
I tracked returns extensively on Quicken on an early generation Macbook but i gave that up when i started working in the industry. It was okay for me that some stocks went up more than others went down.
When I was let go, and looking for work on the buying side, I figured I should start reflecting on my personal returns. I could only go back as far as the end of 2007 since E*Trade only kept returns for a certain period and here's what I did over that time period.
Nothing earth shattering ... but it dawned on me that owning a handful of random micro-caps in concentrated positions for long periods led to 2x outperformance of the major indices, and with a pretty a low correlation.
What if I just focused on that area of the market, not buying "random micro caps that sounded interesting" but fully understanding the businesses, the managers and executives, the customers, analyzing these tiny companies as I'd analyzed mid- and large-cap companies in my coverage sector, and making big bets in the best ones I could find, while saying "no" a whole lot more?
I decided that's my business, not just b/c of the outperformance over an arbitrary time period, but b/c I liked finding gems overlooked by others and most importantly b/c it would be easier to compound a small sum of money in smaller companies than it would be in larger companies.
Since that time, noting the end dates for the other two accounts which have been moved, that small cap concentrated account is up 18% CAGR. It seems to validate the thesis.
The downside of focus on small caps, which I've talked about with a few institutional PM's who run small cap funds, is that the strategy maxes out at a certain AUM, which caps compensation.
That's fine. That's why so few people do it. It is good enough for now to experience the ego gratification of investing in deliciously inexpensive well run company employing great people doing interesting work satisfying the needs of hungry customers, and doing it with integrity for myself, my clients and the companies I own.
***
This the most differentiated approach to investing requires patience. It is sometimes quick and exciting, sometimes slow and frustrating, but its always enervating and enlightening way engage the world around me.
The opposite end of the investing is the most undifferentiated mass marketed passive movement. They will charge you the least fees but you get the mass strategy. Someday this institutional passive investing will resemble the equivalent of cheap protein, including i fear, even the slaughterhouse.
-- END --
ALL RIGHTS RESERVED. THIS IS NOT A SOLICITATION FOR BUSINESS. ALL OPINIONS ARE MINE ALONE, EVEN THE ONES I SAID WERE EVERYONE ELSE'S. THESE ARE UNAUDITED TIME WEIGHTED RETURNS OF A PERSONAL INVESTOR BASED ON MONTHLY STATEMENTS AND CALCULATED IN EXCEL.
I prefer the question "Tell me something that's false that everyone believes" and as I've grown older I've gained more confidence in those things that come to mind.
At the top of that list right now is the idea of diversification, (followed closely by Vikings not actually wearing horns on their helmets).
Diversification makes sense b/c it follows the common principle, "don't put all your eggs in one basket".
Ironically however, that principle conflicts with every single one of life's most important decisions; who you marry, what you do as a career, who you work with, etc.
In all the major commitments in life, we by nature put all your eggs in one basket.
I think everyone would do well practicing at least once in awhile putting all their eggs into one basket so they better understand the inputs to and tolerate the consequences of those actions.
Anything else is laziness.
***
This relates to the half truth that we should invest our savings in the market through a diversified basket of low cost index funds as an alternative to buying and selecting individual businesses for investment.
The whole truth is that when asset returns are correlated the presumed benefits of diversification disappear, so why is it better than individual stock selection?
***
I reckon most people don't think about the markets as individual companies. I reckon they think about it more like a flock of starlings in murmuration but those of us who analyze individual companies are like ornithologists who can pick out individual birds.
When you dig deeper into "the market" and look at its components it becomes apparent that sometimes "the market" is really just a few stocks overweighted in an index, impacting the whole.
***
There are a lot of ways to invest in the stock market beyond undifferentiated passive investing. I buy and hold small companies for long periods and limit my portfolio to a handful of what I think are terrific businesses trading at reasonable prices (or better still, unreasonably low prices).
There are plenty of other people who do what I do up and down the market cap spectrum (ie large and small companies) and then there are others who buy bankruptcies, debt, risk / arb, options. There's no lack of variety of investors. Some are more consistent and successfull than others.
Regardless of who those people are, I think I speak for all of them -
every single investor that buys individual securities
- that the underlying trend towards blanket diversification reflects two forms of laziness - intellectual and professional - that has become nearly universally accepted but is just plain wrong.
By intellectual laziness I mean the inherent incongruency that we should prefer market exposure with market risk over business exposure with business risk.
A well researched, thoroughly analyzed, cash flow generating, under-levered and growing business acquired inexpensively should - at any point in time - be a safer investment than a basket of companies arbitrarily selected by their size or industry or valuation, especially when that basket overlaps so many others. And if properly selected it can generate a more meaningful return than that basket.
But finding those companies takes time and effort and its stressful and difficult and it gets in the way of making money that comes from accumulating assets, which is how all money managers get paid regardless of performance.
By professional laziness I mean the things that happen when people ...
1) accept intellectual laziness and call it a service.
2) do what everyone else does and call it "unique" or "proprietary"
3) take vast sums of money from endowments, pension funds, retirement funds, government entities, etc and put it into instruments that behave like index funds simply b/c it's too hard to allocate them otherwise, and with no consideration of or responsibility for those whose retirement depends on the wise allocation of said capital.
... the alternative in all cases involves work that is difficult and differentiated but could be more meaningful to clients; identifying a handful of undervalued securities and owning them.
***
I've been investing personally since the late-1990's, starting with 10 to 100 share lots when it was easy and you could read Buffett at night and still buy www.something.com during the day and be up 10x the next and none of it made sense, but it was fun.
The investing structure of Graham and Buffett resonated with me nonetheless and I fell in love with it, slowly transitioning from my prior work as a writer / reporter to institutional research (with stints as a PI and in PE in between) then working for nearly 15 years on the sell side (with an MBA squeezed in) covering mostly industrials and services related companies up until I was laid off in 2012.
Here's a small collection of books I used to teach myself about investing ...
... I have a whole other shelf of text books from my MBA plus it's incredible what's available online now (and at the library).
***
Ironically, b/c I worked on the sell side, I had little time to spend thinking about my own investments and b/c of Eliot Spitzer I couldn't own the stocks I covered, so my personal accounts (I managed three) were fairly haphazard.
I had three primary accounts: One mostly held companies where friends of ours worked (a quasi Lynchian approach), one was concentrated in micro caps I'd read about in trade journals or found on screens, and one was diversified with large companies.
I tracked returns extensively on Quicken on an early generation Macbook but i gave that up when i started working in the industry. It was okay for me that some stocks went up more than others went down.
When I was let go, and looking for work on the buying side, I figured I should start reflecting on my personal returns. I could only go back as far as the end of 2007 since E*Trade only kept returns for a certain period and here's what I did over that time period.
Nothing earth shattering ... but it dawned on me that owning a handful of random micro-caps in concentrated positions for long periods led to 2x outperformance of the major indices, and with a pretty a low correlation.
What if I just focused on that area of the market, not buying "random micro caps that sounded interesting" but fully understanding the businesses, the managers and executives, the customers, analyzing these tiny companies as I'd analyzed mid- and large-cap companies in my coverage sector, and making big bets in the best ones I could find, while saying "no" a whole lot more?
I decided that's my business, not just b/c of the outperformance over an arbitrary time period, but b/c I liked finding gems overlooked by others and most importantly b/c it would be easier to compound a small sum of money in smaller companies than it would be in larger companies.
Since that time, noting the end dates for the other two accounts which have been moved, that small cap concentrated account is up 18% CAGR. It seems to validate the thesis.
The downside of focus on small caps, which I've talked about with a few institutional PM's who run small cap funds, is that the strategy maxes out at a certain AUM, which caps compensation.
That's fine. That's why so few people do it. It is good enough for now to experience the ego gratification of investing in deliciously inexpensive well run company employing great people doing interesting work satisfying the needs of hungry customers, and doing it with integrity for myself, my clients and the companies I own.
***
This the most differentiated approach to investing requires patience. It is sometimes quick and exciting, sometimes slow and frustrating, but its always enervating and enlightening way engage the world around me.
The opposite end of the investing is the most undifferentiated mass marketed passive movement. They will charge you the least fees but you get the mass strategy. Someday this institutional passive investing will resemble the equivalent of cheap protein, including i fear, even the slaughterhouse.
-- END --
ALL RIGHTS RESERVED. THIS IS NOT A SOLICITATION FOR BUSINESS. ALL OPINIONS ARE MINE ALONE, EVEN THE ONES I SAID WERE EVERYONE ELSE'S. THESE ARE UNAUDITED TIME WEIGHTED RETURNS OF A PERSONAL INVESTOR BASED ON MONTHLY STATEMENTS AND CALCULATED IN EXCEL.
Friday, September 30, 2016
A Brief Description of the Kinds of Stocks I'm Wary Of
Here's one type at least: The "heroic / satanic savior"
That's where "BNI's" (ie "brand name investors") with terrific financial backgrounds but no industry experience swoop-in heroically with the imprimatur of "financial stewardship" ... and destroy value.
That's where "BNI's" (ie "brand name investors") with terrific financial backgrounds but no industry experience swoop-in heroically with the imprimatur of "financial stewardship" ... and destroy value.
I speak specifically in this case on $CDI, now trading near net / net valuation, but there are so many examples I've seen where this happens.
In this case, some ex-Eddie Lampert / Sears / Lehman folks joined the company in Oct 2014, and since that time, shareholder equity is down 25% and total debt is up 10-fold.
I imagine their compensation reflects the skills required to achieve such a distinction. In fact the word "compensation" shows up a quite astounding 385 times in the most recent proxy statement, though you'd have to scroll to page 24 to see the actual discussion on executive compensation (by that point, they've already mentioned the term 107 times).
From there on, you'd see there a quite intense amount of description of a comp plan that focuses on "shareholder value," which is mentioned only eight times in the report. (Perhaps a new investment analysis is the ratio of "compensation" to "shareholder value" in the proxy statement).
As for what drives "shareholder value": The company believes "... that if CDI consistently attains or exceeds its target levels of operating profit and RONA, shareholder value will increase over the long term. Our targets are intended to be challenging, yet realistic and achievable at the time they are established."
Since RONA excludes goodwill, that comp plan essentially incentivizes management to lever up and make acquisitions in order to grow operating profit. You can imagine that's the plan. Scorpions gonna do what scorpions do.
But this is a business where the assets walk out the door every night and I can cite many more levered acquisitions in the people business that have not worked than those that have. (My experiences are in the investment banking world where it never works).
Still, the horse is out of the barn. They've already made their first purchase paying $35M cash for "EdgeRock Technologies" a company that supplies project managers for ERP rollouts. Plus, they have a new $100M credit facility to borrow for future transactions and given that they're under levered relative to other staffing firms, they have plenty of borrowing capacity available.
But if they can't maintain or grow the operations, it potentially leaves long term investors holding the proverbial bag.
Staffing is not a complicated business: manage your bill / pay spread, keep overhead as low as possible, and hire high energy, terrific salespeople. But it is also a brutal business characterized by:
The good news is, these are just two of the tens of thousands of companies that trade everyday in the public market, with a bid on all of them.
If I wanted to own a services rollup, I'd be more keen on companies run by managers with a rabid dog mentality towards selling and collecting vs financial mgmt. I'm just not the type of deep value investor that can step in front of a business unless success is paved with operating excellence.
-- END --
I imagine their compensation reflects the skills required to achieve such a distinction. In fact the word "compensation" shows up a quite astounding 385 times in the most recent proxy statement, though you'd have to scroll to page 24 to see the actual discussion on executive compensation (by that point, they've already mentioned the term 107 times).
From there on, you'd see there a quite intense amount of description of a comp plan that focuses on "shareholder value," which is mentioned only eight times in the report. (Perhaps a new investment analysis is the ratio of "compensation" to "shareholder value" in the proxy statement).
As for what drives "shareholder value": The company believes "... that if CDI consistently attains or exceeds its target levels of operating profit and RONA, shareholder value will increase over the long term. Our targets are intended to be challenging, yet realistic and achievable at the time they are established."
Since RONA excludes goodwill, that comp plan essentially incentivizes management to lever up and make acquisitions in order to grow operating profit. You can imagine that's the plan. Scorpions gonna do what scorpions do.
But this is a business where the assets walk out the door every night and I can cite many more levered acquisitions in the people business that have not worked than those that have. (My experiences are in the investment banking world where it never works).
But if they can't maintain or grow the operations, it potentially leaves long term investors holding the proverbial bag.
Staffing is not a complicated business: manage your bill / pay spread, keep overhead as low as possible, and hire high energy, terrific salespeople. But it is also a brutal business characterized by:
- Cyclicality. Staffed employees are first in and first out.
- Low barriers to entry. All you need is an internet connection.
- Incredible competitiveness
- Disintermediated by technology
This is the second staffing company I've looked at recently trading at or near net / net valuation ($HSON is the other one) where some BNI's have come in to "turn it around" ... and they haven't.- Low barriers to entry. All you need is an internet connection.
- Incredible competitiveness
- Disintermediated by technology
The good news is, these are just two of the tens of thousands of companies that trade everyday in the public market, with a bid on all of them.
If I wanted to own a services rollup, I'd be more keen on companies run by managers with a rabid dog mentality towards selling and collecting vs financial mgmt. I'm just not the type of deep value investor that can step in front of a business unless success is paved with operating excellence.
-- END --
THIS IS NOT A RECOMMENDATION TO BUY / SELL SECURITIES NOR A SOLICITATION FOR BUSINESS. ALL RIGHTS RESERVED.
Thursday, September 29, 2016
A Comparison b/t C&I loan growth and the ratio of multi family to single family housing permits
Been looking at a lighting company that gets half its revenues from multi-family residential new construction.
Though a different company than TAYD, both are exposed in some way to institutional or commercial construction.
This chart shows changes in C&I loan growth (commercial and industrial loans) - the blue area graph - via FRB layered on top of housing permit data, specifically, the ratio of multifamily permits (five or more units) to single family permits.
I think the takeaway is that multi family construction permits really ramp relative to single family later in a cycle, and that there was a period of under building of multi-family units during the housing bubble.
My sense is that business is passed the peak, at least for the current cycle (yes Virginia, there is a business cycle, no matter how skewed it may be by interest rate policy).
Or maybe slowing C&I loan growth is from uncertainty about future policy and rates, due to the election.
I'm not a macro-investor I just love comparing things.
-- END --
THIS IS NOT A SOLICITATION FOR BUSINESS OR A RECOMMENDATION TO BUY OR SELL SECURITIES.
Though a different company than TAYD, both are exposed in some way to institutional or commercial construction.
This chart shows changes in C&I loan growth (commercial and industrial loans) - the blue area graph - via FRB layered on top of housing permit data, specifically, the ratio of multifamily permits (five or more units) to single family permits.
I think the takeaway is that multi family construction permits really ramp relative to single family later in a cycle, and that there was a period of under building of multi-family units during the housing bubble.
My sense is that business is passed the peak, at least for the current cycle (yes Virginia, there is a business cycle, no matter how skewed it may be by interest rate policy).
Or maybe slowing C&I loan growth is from uncertainty about future policy and rates, due to the election.
I'm not a macro-investor I just love comparing things.
-- END --
THIS IS NOT A SOLICITATION FOR BUSINESS OR A RECOMMENDATION TO BUY OR SELL SECURITIES.
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