Hi everyone,
Taking a break from stock analysis/presentation today, to mention two things not mentioned by many investors, reflecting in my opinion their disconnect to the real forces at work in investing, caused by years of tech mania. I am not a professional investor so take these as just my thoughts, but again, this is a very open field.
It is a long note that is not an analysis so excuse me if the form lacks at places.
I will talk a bit more about my approach to analysing companies and investing.
Energy crisis:
As most of the world is still in full technology investing mode, a quiet energy crisis swept through Europe.
The price of gas and wholesale electricity is through the roof. The problem is that it is affecting customers directly with the price of electricity.
It made me realise how vulnerable we are to energy. If a similar rise was to happen in Oil, the bear market would be very terrible, and the economy would go into a forced contraction. It is possible that the high electricity prices already affect the European economy due to factory idling and inflation.
I do not know what would happen to technology stocks, because they do not use a lot of oil, but I know that they would go out of the spotlights for a while, this place would be taken by the newly found energy crisis. Oil stocks would increase earnings and rerate as well due to retail investors buying pressure.
Energy is a risk before being an opportunity in my opinion. Manage the risk first, then, if you are able, benefit from the opportunity.
Due to the risk it creates for the markets and for our personal lifestyles, it is important to have a portion of the portfolio dedicated to traditional energy.
If nothing happens, it will produce generous dividends to support your portfolio and be reinvested.
If something happens, we will all suffer, but it will provide capital appreciation to compensate for other companies we own, and for increased expenses.
Some people prefer to use derivatives to cover their downside risk. I am long only.
Conveniently, the sector is very out of favor and we can find companies with very low production costs and low valuations.
I therefore own various Energy companies in Canada and Russia. I managed to push it to 8% of my portfolio. I also have companies exposed to Oil exporting nations such as Brazil, Saudi Arabia and Nigeria.
Notice that I do not own any European or USA energy company, I view the ESG political risk as too high as it forces these companies to sell assets and reduce their size and production. I am all for new clean energy technologies, but unfortunately the space is very crowded and overpriced. I am actually watching one of such companies that I learned about when I was an investor in Softbank.
Bias of Complexity for compounders bros
I tried sharing my analysis of CK Hutchison on a forum. It got rejected because it was said to be a “copy and paste of the annual report”. Surely that person did not read carefully, but maybe what they meant is that it was too simplistic in form.
That brings a bigger problem. Thesis now tend to be ultra complex. I saw thesis with tables full of numbers but were completely wrong that were published.
Isn’t it the same on Seeking Alpha where some thesis will have tables full of random DCF numbers and quotes from press articles written by someone who knows the company for 30 minutes? I suspect some are automated. At least the style is good.
There are 2 main hypotheses:
you have to explain stuff that is not in the company report/presentation to make an investment worthwhile
You have to build a complex model to make a good value thesis
During the analysis process, we can find weaknesses that the company tries to hide, and see if the weaknesses invalidates the thesis promoted by the company. But the thesis promoted by the company should be the basis. It expresses their strategy and shows on what they think they should be valued.
After years of multiple expansions for compounders bros, it now seems that buying a company because it is cheap and stable is no longer a valid thesis.
Now we need a story!
We need to buy a company because the CEO has nice investors letters, and we need to include quotes from the letter of 2010. Or maybe because the ROIC is high, so we need to chart it for 10 years and 10 years ahead, or because we did a DCF in an Excel sheet using WACC and discount rates that are false precision by definition. (I only used Excel once to model deleveraging in my AB Inbev article).
We need to look at future product patents and launch dates, at the number of chips on the new EV car, at the cloud API types in order to buy a stock. And don’t forget to analyse the TAM of mobile X or Z in 2030.
To me, none of these things are needed in good investing (unless we are looking at a small cap with one product). These are intellectual exercises destined to impress peers. Like many fields, academia and marketing create incentives for complexity. It gets recognition by peers. Complexity is not introduced to buy stocks in mind. It seems to be a goal it itself.
Most of the “telling a great story thesis” or “model growth 10 years out” are for growth companies.
What the legend says
Kind of lost and looking for verification of my personal bias against compounder bros, (I like compounders but based on numbers and reasonable valuation) and giant excel tables thesis, I went back to the intelligent investor to get answers.
Graham on growth funds returns
The authoritative manual entitled Investment Companies, published annually by Arthur Wiesenberger & Company, members of the New York Stock Exchange, computes the annual performance of some 120 such “growth funds” over a period of years. Of these, 45 have records covering ten years or more. The average overall gain for these companies—unweighted for size of fund—works out at 108% for the decade 1961–1970, compared with 105% for the S & P composite and 83% for the DJIA.3 In the two years 1969 and 1970 the majority of the 126 “growth funds” did worse than either index. Similar results were found in our earlier studies. The implication here is that no outstanding rewards came from diversified investment in growth companies as compared with that in common stocks generally.
Graham next arguments is that these funds did just average (due to valuation), while employing the best of the best. Why would the average person beat them? I am not among the best of the best growth analysts and forecasters. But I am smart enough to pick my battles.
Graham then explains at length that buying cheap defensive stocks is a proven method.
He should require an indication of at least reasonable stability of earnings over the past decade or more—i.e., no year of earnings deficit—plus sufficient size and financial strength to meet possible setbacks in the future. The ideal combination here is thus that of a large and prominent company selling both well below its past average price and its past average price/earnings multiplier.
He does recommend to analyse past earnings and to see if future earnings can be at least stable, but not to do compounders bros “how is the meeting culture in the company, do they use powerpoint or chalkboards” type of stock analysis.
One last one about Buffett
Buffett: “We don’t formally have discount rates. Every time we start talking about this, Charlie reminds me that I’ve never prepared a spreadsheet, but I do in my mind. We just try to buy things that we’ll earn more from than a government bond – the question is, how much higher?”
Munger: “Warren often talks about these discounted cash flows, but I’ve never seen him do one. If it isn’t perfectly obvious that it’s going to work out well if you do the calculation, then he tends to go on to the next idea.”
Buffett: “It’s true. If [the value of a company] doesn’t just scream out at you, it’s too close."
I could be missing quotes from Graham, Buffett and Munger where they say the opposite. It is clear to them that stocks still have to be analysed carefully.
Conclusion
Maybe value investing is out of favor, which is a good sign to me.
Or it could come down to a lack of apparent value in developed markets large caps ex energy, making the last remaining bits of value hidden, therefore requiring hidden value thesis and very indirect ways to returns. I see a lot of these special situation thesis.
Or it could be that some people are trying to get or keep a position in the industry by adhering to certain norms.
I will not go into false precision, microscopic analysis. I will go into big picture value, researching hidden gems, and focused on the value as a stock not as a company. This is why my portfolio is diversified.
I will be the rebel hahaha.
Activity update:
With a lack of new ideas recently, I have been working on getting comfortable with Japan. Mostly on getting the method and the resources right. I do not think that there is a great set of obvious value there, and I missed the Buffett 5 trading companies great buy. But there is some small cap value. I will do quick internal review of the trading companies and main Japanese value stocks over the next few months. I do not plan to publish anything unless the opportunity is good enough, but just to get more familiar with these companies for the future.
French nano caps: I now own a French nano cap I was monitoring for a while. There is everything to like about this company, but some uncertainty about 2021 results due to Freight costs. In the end I decided to be part of the story rather than miss the boat. It was at a value price.
After this, I looked at all companies in the French unregulated market, and they were all bad. All that for nothing. I found one that looked too good to be true. It looks really good in terms of prospect with a sales contract 1000 times the market cap. The net revenue for the company would be lower due to it being a consortium but still. I am not decided on the opportunity yet because it comes with large risks, and I do not need it considering the good risk reward of my portfolio.
Stock Analysis:
I am planning to another HK stock analysis/presentation. It is a company I want to know better.
It will be a very interesting one with fast growth and very cheap. Very. But there is always a catch, and a difficult one to assess precisely.
I will surely not make stuff up and present the opportunity as I see it.
Thanks for reading!
Good stuff. For Japan I recommend looking at Ferrotec. 1st mgmt led buyout company in Japan's history (about 15 years ago). Does a lot of tech in China and holds a lot of critical tech patents.
Great insight about complex theses being a way for value investors to flex and I totally agree with the characterisation of false precision.
You might enjoy Lyall Taylor's writing. He's been the biggest influence on my style after Graham. A good example of a very simple thesis and in the second article, explaining why that makes these types of investments good opportunities:
https://lt3000.blogspot.com/2017/02/michael-kors-is-out-of-fashion.html
https://lt3000.blogspot.com/2017/08/michael-kors-215-overnight-and-why.html