Kimly – Missed opportunity, lesson and alerts

As an update to a previous post on Kimly being a potential investment opportunity at S$0.42 and below, its been about 2 weeks since Kimly’s listing. Of course I knew there was no way it would trade anywhere near the IPO price of S$0.25 that day. It surged more than 100% at the opening bell before closing at S$0.44 on the day of the listing. As at 31 March 2017, the stock price was S$0.48.

The only time the stock price reached S$0.42 and below – prices at a margin of safety I was comfortable buying at – was in the morning and early afternoon of 21 March 2017. Unfortunately, I wasn’t able to get my hands on the shares. I was attending a prayer session held for my late grandmother during that time and my usual brokerage’s (Standard Chartered) trading platform was accessible only via a desktop/laptop.

By the time I got to a computer, the opportunity had vanished as the price had climbed back up. The price closed at S$0.46 that day.

I could make all these excuses but the fact was that I wasn’t there to pull the trigger when the opportunity presented itself. While the Standard Chartered platform did not allow trades to be done through a phone app or a mobile site, I could have utilised another brokerage although the fees were higher. I could have put a good-till-cancelled trade through other brokerages days prior even though Standard Chartered didn’t allow it. I could have gotten a close friend who would have been behind a desk at that time to login with my details to Standard Chartered and put through the trade.

The lesson I’ve learnt is this. When I’ve got the conviction to buy at a certain price once I’ve done up the necessary research, it makes sense to be well prepared in the event the trigger needs to be pulled. If there are restrictions, apply a little creativity to seek workarounds.

I’ve set an alert via the SGX app I downloaded. I’ll get a notification on my phone if the price falls to $0.42 and below. This will free me from having to check the stock price and in taking action only when the occasion arises. I also found a useful feature that the app is equipped with. It has a feature that alerts me to specific companies’ announcements when they are released. Instead of the usual ‘pulling’ of announcements as and when I decide to check, they are now ‘pushed’, which makes it more timely than before.

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Favourite Brain Food Links

There are certain corners of the internet I visit on a regular basis to get my dosage of brain food.

Whether the sites’ contents are  investing-related or on other matters, they are almost always thought provoking and well worth the time spent on reading them. I have put together the links to my favourite sites below for easy reference and did a replicated page under the navigation menu (Favourite Brain Food Links page).

Naturally, I will add on to the list going forward. If there are any high quality and interesting sites, please feel free to share under the comment section!

Investing blogs

Investor letters

Mental models

Newsletters

Expounding on ‘Quality’ of the QVG framework

Under the Investment Philosophy page, I mentioned that I assess moat-type investments on a Quality, Valuation and Growth framework (QVG). In this post, I’ll expound in greater detail on the assessment of ‘Quality’.

As different variables and scenarios arise from each investment opportunity, it will be hard  to list each and every condition to determine quality. To simply matters, other than the key conditions I look out for, I have also laid out the ideal situations which would likely lead me to invest in a quality business.

Broadly, I categorise quality into 2 buckets – the qualitative and quantitative aspects.

I have also included a diagram or flow chart of sorts to summarise the below-mentioned points for easy and future reference.

quality-chart

 

Qualitative

One of the first things I try to identify is the type of economic moat(s) a business possess(es).

“So we think in terms of that moat and the ability to keep its width and its impossibility of being crossed as the primary criterion of a great business. And we tell our managers we want the moat widened every year. That doesn’t necessarily mean the profit will be more this year than it was last year because it won’t be sometimes. However, if the moat is widened every year, the business will do very well.” – Warren Buffett

The moat, in a way, refers to competitive advantages. Its usage in the world of investing appears to have caught on after the repeated usage by Warren Buffett in the Berkshire letters and during interviews.

If Warren Buffett was the father to popularising the ‘moat’ term, Pat Dorsey would be the intellectual offspring who expanded the topic on moats. Pat Dorsey was the director of research at Morningstar and wrote the wonderful books, ‘The Five Rules for Successful Stock Investing’; and ‘The Little Book That Builds Wealth’. In these books, he covered in great detail how to analyse moats, what makes them great and has a number of examples to show for.

Type of moat(s); 2 is better than 1

To keep the long story short, Pat Dorsey identified 4 economic moats that exist in strong companies generating excess profits:

  1. Intangible assets – Brand, patent, license (eg. Coca-Cola)
  2. Customer switching costs (eg. Adobe)
  3. Network effect (eg. Facebook)
  4. Economies of scale (eg. Walmart)

Plenty has been written about the topic so I shall not go into the nitty gritty details of each moat. I have included in brackets above, my own examples of well-known companies that fall into each categories.

Over the years, I came to realise that for a business to be truly great, 1 standalone moat is insufficient. Although one moat is typically more dominant than the other, there usually needs to be a strong combination of at least 2 moats concurrently driving the business. As an example, while Coca-Cola definitely has the dominant intangible – brand moat driving its success, its operations also has huge economies of scale at the global level. This helps the company to generate greater profits (stemming from lower cost per unit) in excess of what another strong beverage brand that is just a small local player may otherwise achieve.

Sustainability of moat(s)

Once the type(s) of moat(s) is/are ascertained, the next step – which is a crucially important step – is to assess how sustainable the moat(s) is/are likely, measured in number of years. The more sustainable the moat is, the longer the duration of excess cash flows flowing into the business that will ultimately benefit shareholders.

Determining the duration is not an exact science and there is a large element of guesswork. However, there is one clue to this. The reality is that the most likely source of disruptive force affecting any business stems from technology.

As such, one of the key questions I seek to answer for each investment case is the chance of technology disrupting the dynamics of the core business. In the case of gum chewing, the internet and pace of technology change is unlikely to disrupt consumers’ habits. In my opinion, I think there is a high degree of certainty that in 10 to 20 years from now, I will continue to chew pretty much the same Wrigley’s gum I do today as I did decades ago.

In comparison, I cannot be certain my laptop will be from Acer. In fact, given the pace of change in the field of electronics, I cannot even be sure I’ll be using a laptop in the next 10 to 20 years, not to mention that I already have an iPad tablet. In short, the further away the core product of a business is away from having a remote possibility of being affected by high technology, the slower the rate of change and the higher the odds of investments being safe.

That said, I am not advocating staying away from all technology-related stocks. That would be foolish since technology is going to feature in a larger part of our lives in the future. There are some truly great businesses that have stood the test of time, such as Microsoft and Adobe. As an example, Sapiens International, a insurance software provider which I wrote up on, has its software deeply embedded in its clients’ core operations. Once the mission-critical software is installed and the employees of its customers are trained on it, it becomes very hard for the software to be ripped out without its clients’ suffering downtime. Thus, while Sapiens International is a technically a technology firm, these huge switching costs and the customer stickiness that comes with it, should extend the business’ sustainability and correspondingly, the duration of the cash inflows.

Ideally, the sustainability of a great business’ moat should last at least 20 years.

The ultimate test – pricing power

“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

Ultimately, the essence of assessing the strength and sustainability of moats boils down to finding out if the business has pricing power. Strong pricing power, in my opinion, is the true test of a business’ quality. I have found it useful in answering early in the analysis, the question of whether a business has pricing power. It acts as a quick sorting filter on the quality of businesses

As shared previously in the post, ‘Pricing power – The rocket fuel to any investment thesis’, businesses with true pricing power has the advantage of ‘raising 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.’

 

Quantitative

Income statement and cash flow

It goes without saying that in an ideal situation, a quality business would see revenue, profit and operating cash flows rise annually at a good clip over at least the past 5 to 10 years, and is expected to do so going forward. The definition of good clip could at times be subjective. Generally, I would be satisfied with a consistent 5% to 15% annual growth rate for the top-line and a correspondingly similar or higher clip for the bottom-line. Too low and it may call into question how good the business and the sector really are; too high and it will surely attract excessive competition that will eventually drive down returns.

In a way, when it comes to assessing financials, I prefer a Goldilocks approach, not too cold and not too hot.

On profit margins, I am agnostic on whether it is low or high on a standalone basis. Profit margins by themselves do not tell much about the quality of a business as the levels are very much dependent on the nature of the industry and business. For example, even though a supermarket business has low margins, it should not warrant striking it out as a potential investment. The nature of a supermarket business (eg. Walmart) is that of low margin, high volume. In comparison, a luxury goods business (eg. Tiffany’s) has the exact opposite features – high margin, low volume. Both can be fantastic businesses.

When it comes to assessing margins, the real test is to benchmark them to its peers within the sector and industry. Needless to say, a high quality business’s margin should be within the top quartile of its group.

To draw inspiration from Lord of the Rings, the one financial metric to really rule them all is the businesses’ returns on capital (“ROC”). ROC, in my opinion, the one metric that will tell a strong business from a mediocre one, regardless of whether the nature of a business is high or low margin. The topic will be further discussed under the section below.

It has been said that profit is opinion, cash is fact. To avoid companies with potentially aggressive profit recognition, accounting gimmicks and to seek out businesses with good working capital management, operating cash flows should ideally exceed net profit in most years.

Balance sheet; and return on capital (“ROC”) – The one financial metric to rule them all

The safest of scenarios from a balance sheet perspective would be a net cash position. Very often, it is not the case and I am not averse to investing in companies with a net debt position. I do not have a thing against net debt on the balance sheet. It is just that the levels have to be reasonable. My general rule of thumb is that it should not exceed 3.5 times normalised free cash flow (adjusted to exclude growth capex).

On other aspects of the balance sheet, it is hard to pinpoint specific measures due to balance sheet items differing from industry to industry. However, one of the more general metrics I assess would be whether inventory and account receivables drastically exceed that of revenue growth. These are usually respective tell-tale signs of excessive inventory build-ups that could translate to impairments from obsolescence; and disproportionate rise in account receivables that could spell bad debt write-offs coming soon.

In the previous section on ‘Income statement and cash flow’, I mentioned the ideal situation of a quality company having rising top and bottom-lines. That condition doesn’t exist in a vacuum. After all, capital is not free. With unlimited capital thrown into a business, almost any business can grow its revenue and spin a favourable-looking set of financials that is low quality in reality.

The key differentiating factor is the capital structure and the efficiency derived from the capital employed. Truly great businesses should have the ability to generate high returns with little or at least, reasonable amounts of capital. In particular, the high quality capital-type should come in the form of retained earnings rather than from debt. Rocketing debt levels that accompany revenue and profit growth are certainly red flags that deserve greater scrutiny.

This brings us to the next point – ROC. One of the quickest filter to screen for quality businesses would probably be high ROC, which is a hybrid metric that utilises income statement and balance sheet figures. The key difference between ROC and return on equity (ROE) is that ROC takes into account the full capital structure, which includes interest bearing liabilities – debt.

ROC performance is usually one of the key metrics I look out for, since over the long run, ROCs have to exceed the business’ cost of capital in order for value to be created.

An example of a great business with the trait of utilising little capital while generating disproportionate cash flows and growth is Moody’s. In the 10-year period from 2005 to 2015, Moody’s generated about US$7.5 billion in total free cash flows as compared to only investing additional capital of merely about US$0.8 billion. In reality, very few businesses in the world can do this. The public knows this and the valuation of such businesses are usually bid up sky-high. However, every once in a while, when uncertainties arise such as in the case of the US government suing Standard & Poor (“S&P”) over its role in being less than honest about the ratings it gave to clients, there could be opportunities to load up on S&P and its counterpart, Moody’s, when the stock price got beat down over fears of astronomical fines they may have to incur.

I typically start to get interested in a business when the ROCs consistently exceed 15% annually. In the most ideal situation, ROCs would have increased over the years and are expected to continue growing. At the very least, ROCs should at least be stable.

The exception that I will make on ROCs being below 15% is when ROCs have been on an uptrend over the past few years. This trend could be a clue that operations are improving. Importantly, it would warrant further work on investigating if the business has an emerging moat. If it is indeed the case, beyond being just an emerging quality business, this could be an opportunity to get in at the ground floor of a business that may be a compounder for a long time to come.

I would usually go a step further and utilise the DuPont analysis to determine if the source of stable, rising or declining ROCs – margins, turnover and/or leverage. The highest quality of the source of rising ROCs would undoubtedly be margin expansion (most sustainable and in part relates to pricing power) and asset turnover (efficiency in managing resource), followed by the usage of leverage to finance its operations which would be the lowest quality of sources.

ROC.PNG

Value Investor Insight featured investments reference sheet

As a subscriber of Value Investor Insight (“VII”) (I previously wrote about in this post), which serves as my learning tool and an avenue for idea generation, I have also found the newsletters useful in that it acts as quick reference when I chance upon a potential opportunity. For example, if I come across a company such as Hertz hitting its 52-week high/low or it appears on a 13F, etc, and I needed a quick understanding of what credible investors have thought about it, I could look through VII and trace an investor’s pitch on it. That provides some context and short circuits the preliminary work to be done.

The only problem is that VII does not seem to have an available list of all companies that were ever featured in the newsletters. That means one would have to look through each copy manually or rely on memory as to whether a company was mentioned. To solve that problem, I rolled up my sleeves and pulled out the companies’ names and month the newsletter was published, and dumped them into Google Sheets. It was a little tedious but with some spreadsheet shortcuts, that alleviated some of the heavy lifting, and I believe it will be rather worth the time and effort when the list is required.

I have done up the list between October 2016 till January 2012 – 5 years. The first issue of VII goes all the way back to 2005. I will try to continue pulling the data out till the very first issue and update the sheet accordingly.

For those who are keen, I’ve kept the list public and can be viewed below. It can also be found under a new section in the navigation menu – Resources > VII Featured Investments – for ease of reference.

Idea generation and investing systematically

I came across 2 videos from The Manual of Ideas this morning that provided some good food for thought. Good points for me to take note of in terms of idea generation and further systematising my investing approach.

Idea generation

The first was on Wesley Gray of Alpha Architect. In it, he talked about how as part of his dissertation for his PHD, he back-tested the results of one the great idea repositories which happens to be an open secret of the investing world – Joel Greenblatt’s Value Investor Club (“VIC”). He noted that the back-tested returns of ideas on small cap stocks, written-up by  investors in VIC beat the market. I visit VIC periodically over the years but have not done so recently. That there is empirical evidence to show value investing works is definitely good news and backs up what most of us already know – that the efficient market hypothesis is really just a hypothesis.

VIC is an exclusive club (actually, it’s more of an old school message board) where value investors globally pitch their ideas on the platform and the ideas are then rated and commented on by other members. To gain membership, a would-be member has to post an idea. The idea is then reviewed and if it is deemed good enough, you get admitted to the hallowed walkways of VIC where many of the top investors across the world are members, though they are typically anonymous on the message boards. It used to be that the membership count is capped at 250 and those who do not contribute a minimum of 2 ideas (but has to be less than 6) annually were pruned from the club to keep the quality of the ideas high. However, the cap of 250 may now have been removed, according to Whitney Tilson. The good news is that even though it is hard as hell to gain membership, the ideas from admitted members are available on a lagged basis. While admitted members can view new ideas in real time, the public can only view them but on a basis of a 45 days lag time. Since VIC isn’t exactly a momentum stock chasing idea forum, but rather, a more long-term idea sanctuary, the 45 days lag usually isn’t too big of an issue for the public.

I submitted the Billabong idea on VIC about 3 years ago and it was a bummer I didn’t get in. On the bright side, the idea made me good money so I can’t really complain either. 🙂 Anyhow, I’m glad I came across a mention of VIC again and will surely visit it on a more regular basis. In my iPhone’s calendar, I have just set a recurring reminder every 2 weeks, to visit VIC. In doing so, I hope to read more, learn more and and hopefully find some great new ideas.

 

Investing systematically

The second video featured Christopher Crawford of Crawford Fund Management. In it, he described how he and his team stick to a fairly disciplined investing framework. The process is systematised, particularly on the qualitative aspects of opportunities, which are individually force ranked. Investments currently owned are also force ranked. Ultimately, he is seeking a portfolio that is weighted by investments that has the combination of the greatest upside (attractive thesis), high on qualitative scores and importantly, those with lower spectrum of variable outcomes. In other words, opportunities that are both attractive and has certainty of outcomes make the cut.

Crawford’s idea of having a set framework to help guide the investment process appeals strongly with me. Very often, I see how friends jump on investment gravy trains without having a clear thought process and set criteria that governs qualitative and quantitative aspects of investments. I used to be lost when deciding which investments to make but over the years, it has gotten much better as I institutionalise the key aspects to look out for when assessing current investments, potential opportunities, position sizing and entry points. I am still trying to improve on my process everyday.

Learning, idea generation and newsletters

I read a couple of newsletters on a monthly / quarterly basis to get new investment ideas and to learn more about the thought processes behind some of the best in the industry.

My favourite is Value Investor Insight (“VII”), which is co-founded by Whitney Tilson of Kase Capital. The VII format interviews several fund managers in the value and growth investing circles on a monthly basis, where the interviewees share their history, investment philosophy, processes and the thesis behind a few current ideas they are vested in. The newsletter is usually less than 20 pages long and the drawback to VII is that it is a paid service. However, considering the value I extracted from it, the price of the newsletter has been paid many times over. It was from VII’s Sep 2013 issue which interviewed Jim Larkins of Wasatch Advisors that I found Ebix as an idea that turned out to be a really good investment. Sapiens was another which I found in VII and invested in. The idea was pitched by Ori Eyal in the Aug 2016 edition.

Another newsletter I read is ROE Reporter by noted Canadian investor, Jason Donville. It is published free on a quarterly basis and he covers his thoughts and the stocks within his portfolio. I first came across the newsletter in February 2016 and more recently, read an interview with Donville in the wonderful book that profiled Canadian investors – Market Masters – by Robin R. Speziale. Donville’s philosophy is that ROE is probably the single best indicator of whether a company is going to be a great compounder. In the newsletter, he ranks listed Canadian companies by highest ROE and lowest P/E ratios in his list of shortlisted opportunities which somewhat reminds me of Joel Greenblatt’s much talked about Magic Formula. Although the newsletter is usually just a couple of pages, I enjoy reading them and am going through the past ones currently. In the last one year, his fund has taken a drubbing from his stock picks such as Concordia (the smaller version of Valeant) and Home Capital Group. Both have high ROEs and are highly leveraged (Home Capital Group’s business is in mortgages) but each have their own set of unique problems that contributed to their downfall. The underlying lesson for me is that while debt may not be the single factor that kills you, it is what will fuel the flames to spread across the rest of your business if any part of the business blows up. That said, Donville’s long term track record remains good and I am sure he will bounce back from this. It was from ROE Reporter that I found an investment opportunity – CRH Medical Corporation, a Canadian company in the gastrointestinal part of the healthcare industry, more specifically in the treatment of hemorrhoids and provides anesthesia services.

The other free newsletter I read on a quarterly basis is the excellent Graham & Doddsville newsletter, an investment newsletter from the Columbia’s Student Investment Management Association (Columbia Business School). The name of the newsletter is of course a play on the term used by Warren Buffett who wrote the seminal letter in 1984 called ‘The Superinvestors of Graham-and-Doddsville’. In each issue, the newsletter profiles investors, a number of whom are alumni of the mecca and school of the original value investors – Columbia Business School, following which the newsletter sometimes include stock pitches by current students. It is a great read each and every time and at about 50 pages for each issue, holds plenty of wisdom and investing nuggets for readers.

I hope you will enjoy reading the above mentioned newsletter as much as I have. If there are any great ones, do feel free to share!

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.