Book: The Manual of Ideas
Author: John Mihaljevic
What Long-Term Investing Is: Long-term investing is when investors believe that the return on the investment will come from return on equity rather than the sale of the security. This is inline with what Buffett says when asks investors to imagine that the secondary market does not exist.
When an investor is betting on an event to make an investment (assuming that an earnings report will beat the consensus estimate, for example), the investor is in tacit agreement with the market’s underlying valuation of the business. This is betting on an incremental change in the stock price and isn’t anything like buying an undervalued business.
Ben-Graham Style “Net-Net” Investing:
- How do these opportunities come by: These opportunities arise because of various reasons, but a common one is where the price of the product is decided by the market, and is reliably mean-reverting, but investors become too fearful at the bottom, undervaluing the assets at the bottom of the cycle.
- How to find them: They lend themselves easily to screens.
- What’s not good about these: these are high-turnover investments, which is not only inefficient from tax purposes but requires the investor to keep looking for new investments. Patience is not a virtue when investing in these poor businesses with valuable assets. In most cases, these businesses have poor reinvestment value, and hence getting cash out of these business is very important, and the management can often impede the process.
- Value creation: in these investments, it is highly correlated with an upswing in the business sector in which the business lies.
- Other considerations:
- Marty Whitman “Net-Net” screen: takes into account long-term assets such as retail assets that can be easily monetized but won’t be classified as current assets because of accounting rules.
- Insider buying is usually more correlated with operating experience and less with valuation, and given that, insider buying in such cases is a bigger signal than it would be with other companies. Similarly, insider selling may be a big negative as greater informational asymmetry exists between insiders and investors in this underflowed part of the market.
- In a liquidation scenario, smaller companies, which end up in this group, need to be given bigger liquidation discounts than would be appropriate for similar assets of larger companies.
Sum-of-the-Parts Investing: (my view is that these are good checks but do not uncover significant investing opportunities on their own)
- How do these opportunities come by: Sometimes operating performance of one segment can be hidden by one or more segments
- How to find them: no easy way to find them, only people familiar with the company and the businesses can pick these out.
- Areas of specific opportunity:
- Thrift conversions: shares outstanding are materially lower than that reported by the company because a captive mutual holding company (MHC) sometimes owns a large %age of shares.
- Retail/hospitality businesses holding valuable real estate
- Company with large NoL carry-forwards
Jockey Stocks: (making money alongside good managers)
- “Commoditization is correlated with management impact. If you’re the manager of a retailer, an insurance company, a commodity company, a miner, or a bank, you can have a huge impact on whether your business is great or good. If you’re managing a business that already has a wide moat, you’re more of a caretaker. Your job is not to screw up. Your job is not to roll out the New Coke.” – Pat Dorsey
- Chief Executives can distinguish themselves in two major ways: business value creation or smart capital allocation. People usually think of the first characteristic, but rarely think of capital allocation, which is very important if the CEO has a sufficiently long tenure.
- CEOs tend to treat reinvesting capital as the default choice, which is a terrible option if the company has a flat or declining business. (I think it is VERY VERY hard to find a very good capital allocator, because no one got in the business to be a great capital allocator–they got there because the they wants to be a great business-person in that business and got promoted to the title because of their business skills. Also no one is getting recognized on a rag cover because (s)he is a great capital allocator.)
- Ideally, a CEO should own stock (not options) with a market value at least several years of annual cash compensation.
- Management ability is well-reflected in RoCE, growth of capital employed (per share), margin profile, asset turnover and capital expenditure trends.
- Dividends are good not only because they remove capital from management but because its imposes certain discipline on management as they have to actively think about capital allocation, and as the boards thinks about paying a dividend, they become more acutely aware of the various capital allocation choices available to it.
- Need to make a list of great and poor capital allocators (sadly, easier to build).
Special Situations Investing
- Some ways to uncover special situations using a stock screener are –
- look for stock price changes in the preceding few months (will show IPO)
- inorganic jump in revenue (may be a transformational acquisition)
- number of shares outstanding (big drop may be a repurchase, and big increase may be an stock-based acquisition).
- More than in other plays, it is important to find a path to value creations (e.g. asset sales in case of distressed equity)
International Value Investing: The book has a long list of value investor in various countries (not shown here).
Other: A way to clearly think is something is to think in extremes. For example, if we’re ignoring the contribution of mortgage notes in calculation of TEV of a REIT, would we ignore this if the REIT had no real estate assets and only mortgage notes.