Wednesday, May 29, 2013

Advice for newly minted college graduates

This time of the year is college graduation season, and attending a graduation party this weekend put me into a reflective mode.  I've been thinking about my own trajectory after college, and what things I might do different if I could go back 10 years and re-live my 20s.

In most posts I put a little disclosure at the bottom stating if I'm long a stock or not.  For college advice my disclosure has been moved up top.  I'm not the person to take college advice from, or probably even career advice.  My university was probably glad to have me gone because I was dragging down the student body GPA average.  If school GPA meant anything in life I've be sweeping floors or flipping burgers right now, fortunately it doesn't.

1. Be open minded - Life never goes the way anyone plans, so be open minded and look for new opportunities.

When I graduated 10 years ago I didn't know what a stock or a bond was, and I didn't really care to know.  If someone would have told my then-self what I would be interested in today I would have wondered what happened to interest me in such boring things.  I remember some friends taking finance classes in college, at the time their studies looked like some sort of prison torture.  Now ten years later I enjoy researching and writing about investments.

Interests change, be willing to change with them.  No one's life is pre-destined to go a certain route, no matter what your parents might say.  Be adaptable and be willing to try new things.

2. Get out of debt and stay out - You graduates are deep in the hock, I feel bad, and I'd recommend paying your debt off as quick as possible.  Sure, maybe those loan payments are small and affordable.  Sure, maybe that payment for a brand new car is small and affordable.  Sure, maybe the mortgage is small and affordable.  Small payments start to add up quickly into a large fixed obligation that needs to be paid monthly or else some banker will come and take all of your things.

Being debt free means being flexible.  It gives you the ability to take a lower paying job if you need to, or save more for a rainy day.  Our culture is one of debt and living for today, saving and paying cash are things our grandparents did, it's not a bad habit to get into.  It always seems like the spendthrifts get the last laugh, but to live a debt-fueled life means living with considerable stress.  Remember, if you pay off all your debt and decide it was a mistake you can always borrow again.

Here's something else not many people will tell you.  You just escaped four years of living in a barn, er dorm and with your new found riches want to experience a little luxury.  Don't waste your time keeping up with the Joneses.  All those luxury items you have been craving aren't all that great, the feeling of euphoria wears off quickly.

3. Enjoy your youth - You are only young once, so enjoy it.  This doesn't mean partying late into the night as most people think, but doing things that are best enjoyed while young.  If you have any inclination for endurance sports now is the time to get involved.  As you age your body doesn't recover quite as quickly, and things that used to be easy become harder.

Last year a friend and I decided to ride our bikes to DC in a weekend.  We covered 200 miles in two days, it was a lot of fun, but my body paid the price.  I injured my knee and it's taken almost a year to recover.  I'm back to running and biking again, but I've also realized I'm not 16 or 22 anymore, I now ease into things and build up mileage slowly.

Travel is easier when you're younger and don't have kids.  Almost anything is easier before you have kids, do those things now.

4. Don't marry your job - No matter how hard you work your company will never love you.  All those all-nighters and 80 hour weeks will mean nothing when layoffs come.

Work hard at your job and use it as an opportunity to learn.  When you've learned as much as you can, or feel it's time to move on do so without hesitation.  If the company felt it was time to move on they would eliminate you without hesitation.

5. It's not what you know, but who you know - I went to an entrepreneurship conference back in college and I remember a millionaire entrepreneur walk through this little exercise.  He asked all of the A and B students to stand-up (I continued to sit) and look around at everyone sitting.  He then said "Everyone standing, those sitting will be your future bosses."  His reasoning was that people with lower grades were most likely partying or hanging out building personal connections instead of studying.  In the real world it's the people with the biggest network who get ahead, not the person with the biggest brain.

We're taught all through school that the brightest do the best, and that intelligence is rewarded.  If that were so why aren't scientists rich, or the people from NASA living in the Hamptons?  The truth is if someone has average intelligence but great people skills and some hustle they will do very well for themselves.  Even below average intelligence and above average hustle is a successful combination.

A former boss had some relatives who weren't the brightest, one even had trouble reading.  What these guys lacked in the brain department they had in the hustle and street-smart department.  They turned their summer lawn mowing business into a multi-million dollar landscaping empire.  These guys together are worth close to $10m, yet one of them has to have his wife read him the menu at a restaurant.

For anyone out there who didn't graduate in the top of their class there is hope.  Not having an Ivy League education isn't going to be the hinderance that Ivy League schools try to tell you it will be.

6. Remember your family - This is lower on the list, but the list isn't in any particular order.  Right now you probably only have parents and siblings, no wife or kids.  As you get older family should become a top priority.

Friends will come and go, but your family will always be around.  Make sure to invest in these relationships.  You'll probably come to realize over the next few years that your parents really weren't out of touch, and they are a lot smarter than you ever realized.  This will be hammered home once you have kids.

For most the legacy they leave is their children.  A few very wealthy people build libraries and fancy buildings, the rest of us don't have that.  I'd prefer to touch people's lives rather than have my name plastered on some granite building.  Someone who was influenced remembers you, most people don't actually know what Carnegie or Rockefeller did.  My legacy is the two little boys who greet me each night when I come home.  It's hard to build character in children if you're never around, always traveling or working late.

7. Find your purpose - A person without a purpose in life is like a ship adrift being knocked in any direction with the waves.  Find a purpose and anchor yourself to it.  This is a tough question that most people don't want to face, but it's imperative.  Our purpose is what drives us through life, it gives meaning to what we do, even the mundane.

8. You will make mistakes - No one is perfect, you will mess up, and you will probably mess up big time.  If you strive for perfection you will live a life of disappointment.  Everyone makes mistakes, own up to them quickly and be honest, then work to correct them.

Hopefully something in here will encourage someone!  The truth is some of the ideas in this post will be far more profitable than any company I ever profile on this blog.  These lessons pay dividends for life.

Talk to Nate


Friday, May 24, 2013

A retail turnaround with asset backing, and a catalyst

A struggling retailer with a large amount of fixed real estate assets; a few companies come to mind like JC Penny and Sears Holdings.  While both of those companies fit the stereotype, the company I want to look at in this post is Kirkcaldie & Stains, a New Zealand retailer.

Kirkcaldie & Stains (KRK.New Zealand) is a retailer (department store) that has been in business for 150 years in Wellington, New Zealand.  The company originally owned the building they were located in, but over time sold it off.  The company doesn't actually own the building that holds their flagship retail store, and in 2001 to rectify the situation purchased the building adjacent to themselves.  The company breaks results into two segments, retail and property.  Both have struggled for the past few years, but there are signs things are turning around.

I'm not usually a fan of turnarounds, there are too many variables that need to come together for an investment to work out.  For a retail turnaround to work the retailer either needs to reduce expenses if they're bloated, or more likely bring in new brands and increase store traffic.  For Kirks, who is experiencing declining sales volume, cutting expenses alone won't bring the company to profitability.

In terms of a retail turnaround the company has a lot of low hanging fruit changes that they are implementing in an effort to gain customers.  Up until this past year the company didn't have an online store, they just recently started selling online.  They have also started to carry well known international fashion brands.  In an effort to reduce costs the company moved their back office operations to a lower rent area nearby.  With all of these changes it's hard to know if any one of them will help change the company's sale momentum.  If they do it would be a boon to investors, but if they don't the investment story isn't destroyed.  The story of Kirks is more of an asset story than a retail turnaround story.

As I mentioned above the company owns Harbor Centre which is located in the prime business district of Wellington.  The company purchased the building in 2001 and holds the building on their balance sheet at historical cost.  Typically when a company has an asset worth far more than its balance sheet value the asset is considered hidden.  Harbor Centre's value isn't hidden in the slightest.  The company has the building valued yearly and includes the latest appraisal value in the annual report.  As of the annual report the building had a carrying value of $26.8m but was appraised at $46.5m.

I put together a small summary adjusted balance sheet to show the difference between reported book value, and appraised book value.


The adjusted balance sheet clearly shows that the company is trading at book value for the property company alone.  In investor parlance you buy a building and get a retailer thrown in for "free".  It's worth noting this isn't an empty building, they do have tenants paying rent, vacancy is 9.6%.

At this point in the post the Kirks story is no different than what someone might write about Sears or JC Penny or any other asset heavy struggling retailer.  The difference is that Kirks has been working to monetize their Harbor Centre property.  

The company put Harbor Centre on the market and received a bid last fall.  The bidder wasn't announced but took their time to complete due diligence.  When the sale of the building was announced shares ran up to $3.20, which is about 50% higher than where they trade now.  Once investors realized the company might do something with their undervalued asset they suddenly started to price it closer to reality.  Unfortunately the bidder on the building fell through, and along with it the share price collapsed.

The company engaged a consultant to advise them on how they could split apart the companies.  Kirks will spin-off the Harbor Centre property and the associated management company into a separately listed company this year.

A lot of readers might be wondering if the company is going to split off their property group, then why is the company so cheap?  The answer is located in the results section of the annual report, the company's returns have been poor to say the least.  On a headline level it's understandable to see why investors are scared and fleeing the stock.

At the retail level the company's sales have been in decline for the last five years, and investors have apparently lost hope.  The company's property division has provided support for earnings up until the New Zealand earthquake.  Since the earthquake the property division has had to invest significant amounts into earthquake strengthening.  They have also invested in an expensive remodeling effort to attract a new client.  While many one time costs will roll off for the property division soon they have also been hit with much higher insurance rates, most likely in connection with the earthquake.

Even with the poor earnings there significant value resides in the Kirks property division.  If the company were to split today I would consider the stock's current price close to fair value for the property division alone.  That means that either the retailer is worth nothing, which is a possibility, or it's a gross mis-pricing.  Usually what sinks retail turnarounds is the company isn't able to right the ship quickly and takes on debt to finance operations.  The company's debt starts small but grows with deteriorating conditions eventually pushing the struggling retailer into bankruptcy.  Kirks has debt on their balance sheet, but it's all associated with the property division.  The Kirks retail division has no associated debt, which gives the company additional runway to recover.

Talk to Nate

Disclosure: No position, although I do intend to buy shares.

Monday, May 20, 2013

Macro & Market Musings..

I've begun to receive a number of emails recently with the market at all time highs questioning the wisdom of keeping money invested at these levels.  As the market races higher it's natural to start to think about when the next downdraft might occur and what it might look like.  The most important point in this post isn't thinking about the future, it's what to do right now, when opportunities appear scarce.

There's a common cliche that value investors are to ignore the macro noise and only look at companies from the bottom up.  I'm not sure where this meme started, but it doesn't seem right.  It seems we should always be aware of the environment we are investing in, but we shouldn't let that awareness dictate our decisions.

The problem with macro focused investing is that one needs to get the forecast correct, but also the timing of the forecast correct.  I remember one story in the Snowball where Buffett's uncle was so worried about the government defaulting it prohibited him from making sound decisions.  I believe he convinced Buffett to purchase a farm just in case something bad happened.  Of course Buffett continued to invest in the face of the fear, and if his uncle would have invested with him he would have been rich, instead he was poor and worried.

With the most recent financial crisis the focus seems to have shifted to investors who had the uncanny ability to predict the future and earn outsized profits.  Guys like Michael Burry, who foresaw a housing crash, and were able to profit from it.  In hindsight everyone "knew" there was a housing bubble.  The human ability to re-write memory is amazing, I can't remember talking to anyone post 2008 who has said "I never saw this coming, I thought we were going to have a soft landing."  Right now in Canada where there appears to be a housing bubble, a familiar pattern emerges.  A few people are predicting a crash, most people are ignoring it, and some cable TV stations have decided to flood viewers with Canadian real estate shows.  Even if housing prices are high, the question is one of timing, when will the market finally pop?

How I think of macro elements as they relate to how I invest might best be described by an analogy.  My house needs a new roof, it's undeniable to anyone who looks at it.  Some of the shingles have lost their grit, and in sunny spots the ends are turned up.  It's been like this for a while, and we haven't had any leaks so far.  I had a roof guy inspect it who said it might last two years, or seven or eight years.  I don't know if it will last five years worth of storms, or two weeks worth of storms.  But since I'm the thrifty type I'd rather ride this roof out until I see signs of failure.  Why upgrade when I don't need to?  In the meantime I'm not putting any housework on hold because of the imminent roof replacement.  We have made changes to rooms directly underneath the roof, it's possible we might get a leak and need to repair it, but it hasn't stopped us.  At some point I will have to fork out a LOT of money for a roof, or get up there and do it myself.

How does my story relate to investing? I think investors always need to be aware of their surroundings, but don't let the cart drive the horse.  At times things might look dire, and maybe it really is worth selling everything and going cash.  But my experience has been that the turning point is usually unexpected and sudden, and impossible to time.  There are a lot of macro related things that are a mathematical certainty.  There is too much debt and not enough money to pay it off, at some point it will need to be reconciled.  At some point Japan will have to face its debt problems.  At some point the US will have to face its debt/pension problems, and at some point Europe will have to decide how to handle their debt problems.  These aren't opinion page ideas, by the math these things will need to be reconciled at some point, either through defaults, inflation, higher taxes, all, none, or something innovative no one has thought of yet.

When the easy opportunities start to dry up my radar goes up with regards to the level of the market.  Right now the selection of net-nets in the US is poor at best.  Outside of some unlisted net-nets the pickings are very slim.  This isn't some sort of timing indicator, but it's just a general acknowledgement of the environment we're in.  Instead of going to cash I continue to look for opportunities in offbeat places.  Right now there are plenty of banks that are cheap, as well as plenty of unlisted and foreign stocks.

My only caution in the current environment is to ensure that what appears to be a margin of safety is a true margin of safety.  A lot of value investors were wiped out in financials in 2008.  They thought they had a margin of safety but didn't forecast what would happen.  A good gut check is to ask what would need to happen to put a potential investment out of business.  I have some companies with so much cash they could operate for more than a decade at current levels with zero revenue.  Debt is a margin of safety killer, beware of it, it's not always bad, but it can be worse than it initially appears on a balance sheet.

When I first started to get interested in investing a common theme that re-appeared in books was that investors needed patience.  Patience to purchase stocks and hold them through thick and thin for the long term.  Growth investors are always being stereotyped into being short term focused watching for the latest earnings beat or surprise news.  Value investors are no different, we've been hooked on the notion of a catalyst.  A catalyst is a substitute for patience.  When we don't have patience to actually hold a company for years we look for one with a catalyst that will hopefully shorten the holding period.

Investors need more patience, patience to wait for value to be realized, and patience to wait for more opportunities.  I think a market like the current one is a great test of patience.  It's hard to hold cash and wait for better opportunities in a rising market.  It's also hard to hold flat or declining stocks when seemingly everything is heading higher.

Use the rising market as a gut check, assess each company in the portfolio and re-evaluate their margin of safety.  If it doesn't exist anymore, or the company is fairly valued then sell into the rising market and move on.  If the daily new highs are worrisome, or if macro fears are causing panic I would recommend closing down the computer and taking a walk outside.  The weather has turned and it's a beautiful time of the year to get outside and relax.  After-all, if your portfolio is full of safe and cheap stocks watching the market minute by minute won't change a thing, except to raise your blood pressure.

One final note, as things like this always go I'm sure the market will probably crash in a few weeks or Japan will default, or in the US rates will spike and someone will email me "I told you so!"  Maybe that will happen, or maybe nothing will happen for another three years as we drift higher.  I don't know, and anyone who claims to know is lying.

Talk to Nate

Thursday, May 16, 2013

Anacomp at 1x earnings?

Sometimes it seems pointless trolling through tiny little no-name stocks looking for value.  A friend sent me an email recently saying that one thing that stuck out to him from the Buffett shareholder letters was that Buffett found drop-dead cheap ideas.  There wasn't any question that the things he was buying at the time were undervalued, it was so obvious all one had to do was buy and wait.  The company in today's post illustrates that there is significant value in unlisted companies, and that that drop-dead cheap companies still exist in today's market.

Explaining why Anacomp is cheap could easily be done on a napkin, if I were to write it on a napkin I'd write:

  • Earned $.75 p/s last year, trades at $.75, 1x earnings
  • $.61 p/s in FCF, 1.22x FCF
  • $27 p/s in NOLs
  • Deleveraging, building cash
First off Anacomp (ANCPA) is not a Chinese company, a reverse merger or anything shady as far as I can tell.  For curious readers the company's RFP's are available online, I was able to find some contracts in a government database as well.  The company is simply small and forgotten, trading far on the fringes of the market.

Anacomp is a document management company that's been in existence for 40 years.  The company's business is fairly simple, they scan in documents for customers and provide indexing and online document management services.  This is especially important for customers that are paper heavy, such as the government (who happens to be their largest customer.)  The company provides a valuable service in centralizing document digitalization, storage, and retrieval.  Clients can continue to be paper heavy but offer digital copies if necessary.  The company has two locations, one in Washington DC, the other in Southern California.

With a company trading at 1x earnings not much time needs to be spent determining that they're actually cheap.  Most research time should be spent evaluating what could go wrong, and if the price is low enough to compensate for any problems, known and unknown.

Anacomp is far from perfect, there is plenty of hair on this investment, but go back and read the little thesis again before each hairy item, they look a little less scary each time.  I'm going to go through the biggest issues I see one by one and knock them out.

All earnings, no assets - This isn't the biggest ding against the company, but it's a fairly large one.  The company has $4.3m in cash, and $2.2m in accounts receivable, current assets are $7.1m.  The company's current liabilities aren't all that terrible either at $2.5m.  The company has a pension and some debt that negate any positive value from their assets.  Total shareholder deficit is -$759,000.

The company has something peculiar with regards to their pension, the pension that's zero-ing out assets.  The pension is held for an in-active German subsidiary with a liability of $8.8m.  The pension has $5.8m in assets, mostly bills, bonds and insurance, which is disallowed by GAAP.  It appears that the company purchased annuities for some pensioners, that's what the insurance contracts are.  Under GAAP insurance isn't a valid pension asset, so the company appears to have a $8m pension shortfall even though they have taken care of most pensioners via annuities.  The real shortfall is $3m, although it could be considerably less.  The company's discount rate and expected return are both very low at 3.5%.

Debt - I alluded to this in the above bullet point.  The company has $3.6m in debt related to an acquisition.  It appears the company struggled to integrate the acquisition which led to operating performance problems.  The company had trouble repaying the promissory note on the original repayment schedule.  They were able to re-negotiate and extend the terms twice.  The company is now on track, paying down the debt, and appears able to pay it off with cash on hand currently.

Earnings clarity - The US Government accounts for 99% of the company's business.  According to the notes it appears that sales are locked up for the next two years.  If this is true that the next two years look like the most recent this would mean that the company will have earned over $4m, repaid most of their debt, and would have a positive book value of over $3m in 2015.

The biggest issue investors have is there is no earnings clarity beyond two years.  If the government decides to not renew, Anacomp will be generating losses and looking to hit up the credit markets to survive.  Fortunately this dire scenario presumes that management is completely idle and happy to milk the cash cow for two more years before deciding their next steps.  Since the company's annual report came out there have been a flurry of news items on the company's website.  They inked a five year deal with the VA, earned an award with Northrup Grumman and hired a healthcare executive to sell to health organizations.

Instead of sitting idle management appears to be pro-active in searching out new business opportunities.  I don't know if it'll be enough to replace the current revenue and earnings, but with two years of runway there is plenty of time.

Final Thoughts

The question investors need to ask themselves is whether at 1x earnings Anacomp is cheap enough to compensate for all of the above risk factors?  I think it is, my margin of safety is in the low earnings multiple.  If earnings drop 50% I still own a stock with a P/E of 2.  If earnings drop 75% the stock would have a P/E of 4x.  It would be hard for anyone to argue that at a P/E of 4x a company is fairly valued.

I didn't discuss the NOLs in my post outside of the brief mention in the thesis.  The company won't be paying taxes on any earnings for a very long time, so long that they most likely won't ever use them up unless earnings significantly grow.  The bonus here is that management might find a way to structure a deal so that those NOLs take on tangible value.  If that were the case there is a lot of room for this to be re-valued.

I have no idea what a fair value for Anacomp is, but I know it's not 1x earnings, even 5x earnings seems low.  If the market ever revalues this company, even just a little bit investors could experience some massive gains.  I'm along for the ride on this one..


Disclosure: Long Anacomp



Thursday, May 9, 2013

I passed on these two, now they're worth considering

Information, investors are starved for information.  What were sales last month?  How many items shipped?  Did costs rise or fall?  The more detail the better, the more granular the better, investors crave as much information as possible.  The biggest hurdle for most investors to investing in small unknown companies is the illiquidity, but that's a false argument for many.  Most investors aren't running millions of dollars, and buying and building a $25,000 position is possible in every stock I've ever written about.  The real hesitation comes from the lack of information, current and frequent information is a security blanket for investors.  It seems unbelievable that anyone could invest in a company that only publishes an annual report once a year.

As a blogger my goal isn't to cover the universe of overlooked stocks with exhaustive write-ups.  While this blog provides a good amount of analysis it also provides something else, something more valuable, detailed information on companies that are so hidden that some don't even have websites.  I view myself as a cross between an analyst and a journalist.  I uncover interesting opportunities and analyze them, yet at the same time I convey a story about the company to readers.  I recognize that maybe 1-5% of my readers might be interested in investing in any given idea, I provide enough for them to get started and hit the main points.  Yet I try to keep the attention of the other 95-99% by explaining why this company is worth looking at, and why certain items are important.

In this post I want to follow up on two companies I wrote about over the past year, both were worth further investigation.  Over the course of the past year the results from both companies are considerably better than expected and each company is probably a better purchase now rather than when I first posted about them.  Without further ado…

CoStar

Back on January 10th I wrote about Costar, a company that produces security related products such as cameras and surveillance systems.  For this post I re-read my January 10th post and I'll be honest I'm not that proud of it.  In a lot of ways I think I disagree with myself from January.  The essence of the post was why I avoided Costar.  The items in the post are all true, and they probably all make sense, but looking back I realize why I really passed on the company.  In early January my youngest son was in the hospital for a period of time, during that time I read the Costar filings on my iPad while he napped.  Trying to focus on an investment idea while a baby is in a perilous situation is not wise.  I don't think I was in the right frame of mind to truly reflect on Costar as an investment, or think clearly about the situation.  Additionally there was the emotional link of this company to sitting in the ICU.  For inquiring readers my son is a perfectly healthy 10mo old now, for that I'm extremely thankful.

I'm glad I took a look again, their annual report is out and the company looks very interesting.  Here are the highlights:

  • NCAV of $3.89 against a last trade of $2.06.
  • They earned $.41 a share last year
  • P/E of 5
  • FCF of $1.88 p/s in 2012
  • The company used all of their free cash flow to repay debt.
One of the biggest issues I had against the company was their debt, management wisely repaid it and cleaned up the balance sheet.  Additionally sales and earnings are growing.  It appears the company's operating leverage is now working in their favor, sales grew 12% and operating income grew 1459%.

Not much else has changed except that the company is in much better shape financially than they were five months ago.  There is no reason this company should be trading below NCAV, as a stretch they might even be worth book value ($5.55).

Randall Bearings

If there is a poster child for unlisted companies, Randall Bearings is it.  The company is cheap beyond reason, in my post last year I noted that without a LIFO reserve they would have earned $4.04 a share, double the market price at the time.  Over the past year the stock price has also doubled, my $200 position became $400, beer money as some call it, maybe if they're drinking Chimay.

Randall Bearings is a manufacturing company located in Lima Ohio.  They manufacture bronze machined parts.

Here's why they're interesting:
  • Book value of $14.20 p/s vs. $4.60 last trade.
  • EV/EBIT 4.48
  • EPS $2.58 p/s
  • P/E 1.78
I passed for a number of reasons the three biggest being, the debt, their reincorporation, and a shareholder lawsuit.

The company's debt situation has become worse over the past year.  The company added $1.55m in additional debt.  The company invested $1.5m into their facilities to position themselves for future growth.  In theory the new debt should pay for itself with increased earnings.  Unfortunately it appears no matter how much the company earns the market doesn't care.

The second item holding me back was the company's reincorporation from Delaware to Ohio.  As a commenter on the last post noted, Ohio has stringent anti-takeover laws.  I have done further research on this point, and talked to someone with a copy of the shareholder register.  From what I understand now there is no possibility for any merger or corporate action unless the CEO himself initiates it.  The CEO and the largest shareholder, which is also the company's largest supplier own more than 50% of the company.

The last issue pertains to a shareholder lawsuit that entangled the company for years.  A shareholder sued the company with a records request lawsuit in the Delaware courts.  The suit dragged on for years with the resolution being that Randall is required by the court to distribute an annual report to shareholders yearly.  More than anything the lawsuit speaks to the quality of management at the company.  When a CEO is willing to use company resources and fight shareholders, who have a legal right to financials it speaks volumes.  

With all these things considered it's still worth noting how cheap the stock is.  The company has $2-4 p/s of earning power on a conservative basis.  Randall is easily a two pillar stock, one where earnings and book value support each other.  It's conceivable that Randall could be worth $15-20 a share.

It seems that management has no interest in unlocking value for shareholders, but that doesn't mean they aren't focused on growing value.  Management has continued to grow book value, and is focused on growing earnings as well.  If shareholders can get comfortable with managers who are only focused on themselves they might be able to ride along for a wild ride.

Final Thoughts

I want to spend a minute talking about the role stocks of these type play in an investor's portfolio.  I am not a believer in investing concentration unless the investor has a control position at a company.  If they don't I believe it's wise to spread investments across many holdings with similar return profiles.  Companies like Randall and Costar could fit in a portfolio where there are numerous other deep value or net-net type investments.  In a portfolio with 10 such holdings it's reasonable to think that one position might reach full value each year.  It might seem crazy to wait 10 years for full value, but if that means a stock might quintuple, maybe it's worth the wait.


Disclosure: Long Randall, I might buy Costar shares.

Thursday, May 2, 2013

What's holding you back?

Ever find yourself over analyzing a trivial purchase?  We all do this, spend hours reading Amazon reviews and looking at dozens of different models of some item where the difference between models is irrelevant.  What I find fascinating is I will research some product to death before spending $100 to purchase it, then I'll turn around and read a few annual reports and invested thousands into a company.  There are companies in my portfolio where I spent more time researching baby video monitors than I did researching them.  Why is that?

I read a blog post about six months ago where the author praised procrastination.  They stated that anytime someone procrastinates there is an underlying reason that they don't want to proceed.  Maybe the task is boring, or they don't have all the information, but there's always a reason.  I'm not sure if this is true or not, but it was something to think about.  I've continued to think about it within the context of investing.

Many times I have researched a company, had them check out on paper, and then fail to initiate an investment.  If a computer were to follow my criteria and look at these investments the computer would have purchased.  For some inexplicable reason I never proceeded with the purchase because something didn't "feel right."  Often I'd invent a flimsy excuse as to why I passed "a net-net selling Paris Hilton perfume won't do well" (Parlux), of course it's not going to do well, it's selling below liquidation value.  But these excuses helped satisfy me as I walked away from perfectly good investments.

I've recently been thinking about this phenomenon within the context of procrastination.  Of the last few companies I've looked at and purchased two I hesitated on.  As I hesitated I spent a day or two asking myself what exactly was it that was giving me hesitation?  If it was some actual item I could research it further.  In the first case I was concerned by the strange listing situation the company had, but after further reading on the company's history I was satisfied.

I've also had many times where I hesitate on some item, research further and then avoid the investment. Some of these avoided investments end up going to the moon with me sulking in the distance.  The truth is whether or not an investment works out isn't how we should measure if our decision was correct.  Benjamin Graham states that investors are right when their facts and reasoning are right, not their results.

Something I've observed amongst value investors is they use a feeling of hesitation to over-research a company.  You might be asking, how is it possible to over-research something?  I feel that something is being over-researched when the data and details overwhelm the actual investing thesis.  Case in point someone sent me a link to a writeup on a net-net a month ago.  The writeup was probably 10-12 pages long, it detailed all sorts of industry trends, and contained historical results from seemingly the beginning of time.  Towards the end there was a brief mention that the company was selling for less than NCAV.  Instead of spending hours inputting data into Excel they should have started off asking: is this company truly worth NCAV or more, or is it fairly valued?  When a company is selling for less than book value the first two things I want to know are why, and is it even worth book value?  If an elaborate justification is required to show that book value is obtainable I'm most likely not interested.  Somewhere beyond two or three assumptions any prediction becomes worthless.

Before my next paragraph I want to point out the caveat that some investors have a complexity edge.  They can research bankruptcy filings or rat nests of obfuscated transactions and discover a nugget of gold lying on the ground.  I don't have the time or the brain power to handle those things.  So to the types of people who enjoy Trivial Pursuit and can answer who won the mens doubles championship in the 1936, complex situations are probably for you, while this post is for the rest of us.

The tendency to over-research is strong, for many investors over-research is more a form of professional job insurance rather than a desire to understand the underlying details of a company.  Over-research can also lead to confirmation bias, or the bigger problem in my view, analysis paralysis.  People get into binds where they feel that if they can't fully understand a company they can't invest.  Here's a wake up call, no investor can fully understand a company they're invested, if they believe they can they're lying.  Not even the CEO knows everything happening at their company unless it's a one man operation.  Desiring to know every nitty gritty detail about an investment is a faulty attempt to control something uncontrollable.  Investors believe that if they know all the details then they'll make better decisions or their investment ideas won't fail.  No matter how much you know about a company your knowledge can never prevent failure, especially if humans are involved.  Never underestimate the amount of destruction a negligent or careless employee can wreak on a company.

I know this post is rambling, I will cut to the essence of my message:

1. Strive for simplicity, look for investments that are easy to understand and easy to explain.  The reason for investing should not require much justification.

2. Know when enough is enough, at some point research hits diminishing returns.  I am guilty of this, I've burned many nights Googling mid-level managers at potential investments, or reading feel good news stories about company charity donations.  These things have never helped me, except to convince some part of myself that I made a good decision.

3. Identify the cause of your hesitation.  Are you hesitating because there is a missing piece of vital information?  If so go find it.

Investors talk about a circle of competence, I say strive for a circle of simplicity.  Look for simple investments with minimal assumptions.  Look for similar patterns of simplicity that worked well in the past.  Everyone claims to know that simply buying low P/E or P/B or P/FCF or EV/EBITDA stocks beat the market, so why are we complicating things so much?

Talk to Nate

Wednesday, May 1, 2013

Does it get any more stereotypical than this?

I've come to appreciate that it's not losses that investors avoid, it's dead money.  Investors will line up like pigs for a slaughter for an investment that is almost a sure loser if someone shouts that it has a small chance of tripling or more.  The losses are chalked up as the cost of doing business with investor proclaiming "just imagine if it did triple or quadruple, then it would have been worth it."  A high risk high reward investment will always have people edging each other out to get a piece of the action.  The types of investments that even company management is embarrassed to associate with are the dead money investments.

Show someone a clearly undervalued company with a history of undervaluation and no catalyst and even the most veteran value managers will turn and run the other way.  A strong bias exists against net-nets with the perception that all of them are dead money, whether or not that's actually true.  I remember listening to a podcast with Geoff Gannon and Jon Heller of Cheap Stocks where Jon mentioned that he thought Audiovoxx was a perennial net-net and might never trade above NCAV.  I owned Audiovoxx at the time and remember grimacing when I heard that.  If this guy who was clearly more experienced in this market thought this investment was dead what do I do?  I didn't do anything, within six months it hit a bout of momentum and traded up to NCAV and then well above, I took advantage of the enthusiasm and sold.

I took a walk at lunch today with my friend Dave, the author of OTCAdventures.  At some point the conversation turned to complex investment thesis and Dave pointed out the simplicity of net-nets, something is worth $2 and you can buy it for $1, nothing more, nothing less.

Net-nets exhibit a return profile that's enviable, in theory buying something for 50% off means a double if the asset reprices.  While the returns are nice the attraction to the theory is investor asset protection.  I realize that by purchasing cash boxes and net-nets I will probably never have world beating investment returns.  Investors buying growing companies at 3x EV/EBITDA will beat the pants off my returns without a doubt.  I'm fine with that, my goal isn't to maximize my returns, but to minimize my losses.  All of the money I have invested is money I saved from working, when I look at my portfolio I can see many stressful projects and remember the hard work required to enable the purchase of my portfolio.

All of this sets the stage for the company I want to talk about in this post, Jemtec (JTC.Canada).  Jemtec is a Canadian company that has staked out a fairly unique niche, they lease out GPS transceivers to monitor prisoners and citizens placed under house arrest.  Jemtec goes to show that having a niche alone doesn't guarantee wild profits and a successful business.  The company has steadily lost money over the past few years.  While the company has lost money at an increasingly slower pace it's still a concern.

The company's management has cut expenses as revenue has dropped.  At first glance it appears the company is grossly over compensating executive management until one realizes that the only employees left at the company are executives.

Jemtec could be classified as a stereotypical net-net, a pile of cash, a poor business, no catalyst, and dead money as far as the eye can see.  Investors are justified in running for the exits on Jemtec as the company slowly circles the drain towards a tax losses.

The company trades for slightly more than 50% of NCAV and losses are so steady that management has predicted down to the thousands how much they'll lose next year!  The company is headline bad, but behind the scenes they aren't as terrible.  While the company lost $138k last year they only had an operating cash outflow of $3800.  Considering that the company has slightly more than $3m in cash, they have close to 100 years of runway to figure out what to do next.

In my view the absolute worst case scenario, and the one most investors are scared of is one where management somehow finds a way to squander or run away with the cash.  Considering that management hasn't done this already, rather they've cut costs in an attempt to save the company, I don't think this merits much concern.  The worst case scenario for management is that they're forced to liquidate and return cash to shareholders, if that happened investors would end up with twice the money they initially invested.

The truth is I, and no one else has any idea what happens next.  An investment like Jemtec is impossible to model, there is no model that handles infinite possibilities.  The company is just as likely to wind down as they are to start selling slap bracelets or pet rocks.  That's the beauty of a net-net though, investors are provided asset protection while they wait to be surprised.  Maybe the company will discover a new way to market their product driving earnings.  Or maybe they'll acquire a completely different company that provides earnings, we just don't know.  As long as whatever happens next isn't as terrible as the market expects the company's stock could react favorably.

Talk to Nate about Jemtec

Disclosure: No position