Progress of watchlist 3

As a follow up post to ‘Progress of watchlist‘ and ‘Progress of watchlist 2‘, I have set up the email alert system some time ago by adding the code into Google Sheets. I surfed around the web for the code and finally found a rudimentary one which worked well enough.

For those who are keen, all that needs to be done is to open up the script editor and go into Tools > Script editor. Thereafter, paste the code below and change the variables in red (without having the brackets).

function [anyNameToIdentifyFunction]()
{
var ss = SpreadsheetApp.getActive();
var sheet = ss.getSheetByName(“[sheetname]“);

var valueToCheck = sheet.getRange(“[cell]“).getValue();
if(valueToCheck > [3])
{
MailApp.sendEmail(“[youremailaddress@gmail.com]“, “[email title]“, “[content]“);
}
}

Where:

  • [anyNameToIdentifyFunction] – Give it a name without having spacings. This will be needed to identify the function when activating the trigger
  • [sheetname] – Name of the sheet/tab
  • [cell] – The cell in which the number would change to trigger an alert eg. E7, G6
  • [3] – Number in [cell] to exceed to trigger an email alert
  • [youremailaddress@gmail.com] – The email which you want the alert to be sent to
  • [email title] – Literally what you want the email’s subject to say
  • [content] – Email content

Thereafter, click on the icon in the screenshot below to set the triggers.

clock

In my case, I prefer to have the alerts come in just once a day at a certain timing and thus, I have set it as such in the screenshot below.

trigger

There are some limitations to it, or rather some hassles involved. For each stock in the watchlist, the code and triggers have to be repeatedly copied and pasted as each function code. It would of course be much better if I could have the coding crafted for a single column so that I could just add on to the watchlist sheet without any further opening up of the script editor and creating a new trigger. However, since I am not much of a programmer, my hands are pretty tied and it’s a small hassle for timely updates when a certain stock crosses the risk-reward ratio I have set.

One of the key question that readers may be – why not just set a stock price alert using some other services such as those brokerages? That is because I try to centralise the running of the calculations of intrinsic values in a single location and in this case, through Google Sheets. By centralising the calculations and alerts in a single place, I would not then have to worry about forgetting to login to a separate service just to change the threshold of the stock price alert each time I had to update the financials of each stock. There will also be greater flexibility in terms of the types of alerts I may want to set in the future, such as thresholds, that I may not be able to do through other simple stock price alert services.

With this, the watchlist’s core functionality is pretty much completed though I’ll definitely be tweaking it along the way from time to time.

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Checklist for QVG opportunities

Under my Investment Philosophy, I spoke about the QGV (Quality, Growth, Value) framework which I adhere to when investing. Below is a 14-point checklist which I use on a DO-CONFIRM basis when assessing ‘compounder’ opportunities.

It certainly is not exhaustive and there are a number of other factors I look out for in a company. However, I wasn’t comfortable having an excessively long checklist since that would be off-putting and defeat the purpose of a checklist if I end up loathing to use it. Instead, the points below are the key ones which I have identified over the years, made the most sense to me and which have served me well.

Just as I have tweaked the checklist over the years, I am sure I’ll continue to adjust, add and remove points in the checklist over time.

Quality

  1. Any risk of accounting gimmicks? (Operating cash flow > net profit)
  2. Any risk of obsolescence or collectability? (Inventory and accounts receivables < Sales growth?)
  3. Does the business have ability to reinvest at high rates of return on capital? (examine incremental ROIC over last 5-10 years)
  4. Are high ROICs due to excessive debt? (Dupont analysis)
  5. How high is the pricing power? (Can it at least beat inflation?)
  6. Can rapidly changing technology damage the business significantly? (moat types and strength of it)
  7. Does management own a substantial stake in the business?
  8. What are the potential reasons the stock price may drop 50% tomorrow (pre-mortem)

Growth

  1. Have revenue and operating cash flow grown in 7 of last 10 years?
  2. Are there ample opportunities for the business to reinvest capital?

Value

  1. Is EV / Maintenance FCF reasonable?
  2. Can I see the stock price doubling in the next 3 years?
  3. Are there any other positions in my portfolio that are more favourable on an overall basis than this?
  4. If the stock price drops 50% tomorrow, will I buy more?

Sapiens – Follow up on licensing revenue

I wrote a post on Sapiens International Corporation N.V. in August 2016, on the company being an investment opportunity. In the post’s closing remarks I mentioned that I was in the midst of finding out why licensing revenue was declining.

In my mind, licensing revenue was supposed to be paid on an annual basis for as long as a customer uses it. If the licensing revenue segment was declining, that should cause some concern, particularly on whether it is a sign that it’s customers are leaving by the droves.

Sapiens’ licensing model is based on a perpetual model. In truth, I misunderstood the term and I should have dug deeper.

To explain the terms, the 2 main licensing models that exist for software companies are ‘perpetual’ and ‘term’. Perpetual meaning that a customer pays the fee once and it is then entitled to use the software forever. Term means that customers pay for the period it uses. In other words, perpetual licenses are non-recurring while term licenses are recurring.

This explains why licensing revenue declined – because customers pay them once and the rate of signing on new customers was slower than the past or the apportioning of new customers’ contracts for licensing and services were tilted towards licensing.

I was told that revenue should be taken in totality in considering Sapiens’ growth since there is certain leeway in apportioning the percentage between services and licensing at the onset of a customer signing on with Sapiens.

While the level of licensing revenue is part of the equation of how fast the business will grow, it is not the entire story. Even without new customers, Sapiens can still grow its revenue through the services segment which does maintenance and additional features/modules for existing customers. Not to mention that the revenue streams from the services segment is highly recurring and sticky, given that relationships between Sapiens and its customers typically last for 10-15 years.

That said, it is definitely prudent to keep an eye on licensing revenue and on announcements of new customers being signed on. If it falls too far below its currently levels, that is something definitely worth factoring into whether the original investment thesis and growth assumptions are sound. Ultimately, the fact of the matter is that Sapiens must replenish its revenue streams to counter the rate of its relationships with existing customers running out.

Pricing power – The rocket fuel to any investment thesis

“If you’ve got the power to raise prices without losing business to a competitor, you’ve got a very good business. And if you have to have a prayer session before raising the price by 10 percent, then you’ve got a terrible business.” – Warren Buffett

I added a column within the Google Spreadsheet Watchlist for “Pricing power”, with the ranking system of 1 to 5 – 1 being weakest and 5 being strongest. This provides an important reminder for myself when evaluating companies, that sufficient pricing power itself can be a margin of safety and may invite unexpected upside.

The beauty of true pricing power acts in such a way that a company can raise its prices (revenue) without a corresponding increase in its cost base (expenses). In other words, the extra boost in revenue falls directly to the bottomline and provides a magical boost to profits without lifting much of a finger. As a simplified example, a company that makes $100 in revenue by selling widgets currently has a cost base of $95. This translate to a net profit of $5. Assuming that it has a significant amount of pricing power so much so that it is able to raise the price of its widget by 20% without losing a single customer, its revenue is now $120 for the same volume of products sold. The cost of manufacturing its widgets and other miscellaneous costs continue to be $95. Instead of earning a net profit of $5, the company now earns $25 ($120 – $95). This effectively means that profits multiplied by 400% (from $5 to $25) even though revenue only increased by 20%.

Imagine now that the company is publicly-listed and was trading at a P/E multiple of 10 times. When it initially earned $5 in net profit, the stock price was $50 ($5 x 10). After flexing its pricing power muscle and assuming its P/E multiple remained at 10 times, its net profit of $25 now translates to a stock price of $250 or a 4 times gain if you sell the stock at this point. If the market decides that it previously overlooked the “hidden” pricing power the company has, that perhaps a 10 times multiple is too low for such a strong business, and that a 15 times P/E multiple is probably more fitting (multiple re-rating), the stock price goes up to $375. From the initial stock price of $50 to $375, one would have made 6.5 times his money from the benefit of a company’s pricing power and the market’s recognition of it.

In the real world of course, the perfect situation of a company as described above is probably rarer than a unicorn, given that most people would have easily recognised the strength of such a business, so much so that the multiple would be way higher than 10 times. Even though it is an extreme example, I hope it clearly illustrates the extra rocket fuel an investment can provide if the underlying business has sufficient pricing power, and given the skewed positive returns it can provide, paying up for quality businesses even at higher multiples can sometimes be very worth it.

The most recent types of businesses or more specifically, a company that has been in the limelight for all the wrong reasons by taking pricing power to the extreme is none other than the pharmaceutical company, Valeant. It worked well for awhile before it all came crashing down when enough people decided Valeant had gone too far in raising its products’ prices. The underlying lesson is that to build a sustainable business, a company that is able to raise its prices above the rate of inflation with such ease without losing a single unit volume, should probably use this privilege sparingly to avoid alienating its customers and risk damaging its long-term viability.

Turning away from Hanwell

This is a followup post on Hanwell, a Singapore-listed stock I wrote about as a potential deep value investment opportunity in an earlier post – A basket case of Graham-type stocks.

I was having dinner with a bunch of friends just the other day and I shared some of my findings on Hanwell. It turned out that one of them, a deep value guy, did extensive work on the other companies that Hanwell’s chairman effectively controls. My friend actually did alot more than just pull the numbers apart. To cut the long story short, based on his findings, he eventually invested a sum of money in those companies. Those companies were trading at such a deep discount to their liquidation value that it was in many orders the magnitude of what Hanwell presently trades at – I estimated Hanwell to have about a 40% margin of safety. He invested, knowing full well of the troubling corporate governance issues that the companies face. At such deep discounts, he found the opportunities hard to resist.

What happened was that he then proceeded to lose his shirt after a series of massive rights issue which made no apparent sense other than perhaps diluting minority shareholders to death.

The underlying lesson he learnt was that there is just no margin of safety that can be applied to bad corporate governance, especially if the perpetrator is the majority shareholder and is part of the senior management team and worse still, a director on the board.

In Hanwell’s case, the chairman is the second largest shareholder. That provides some comfort in that he alone would unlikely he able to pull some massive stunts without the approval of other large shareholders, or at least the largest shareholder. However, the largest shareholder is pretty mysterious and I could not seem to dig up a shred of information on him/her.

To be honest, I am a little torn between pulling the trigger on this as an investment and pulling away from this altogether. One part of me says the conditions in Hanwell’s case are slightly different from the rest of those companies that blew up while the other part says “You can’t make a good deal with a bad person”.

In the end, I decided to give this a miss until a time when conditions point to improvements in corporate governance practices or if event-driven situations arise, such as a tender offer, sale of the chairman’s stake, chairman steps down, initiation of dividend payout, etc.