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

Selling Verisign puts

My past experience with options has always been in purchasing call options. About 2 weeks ago, I put through my first trade of selling put options. The key objective for selling options is to generate income for the portfolio. A safe bet tends to be the selling of put options at a strike price which one does not mind owning the underlying stock, in the event the counter party exercises the option.

About Verisign

The underlying stock in question is Verisign which I have held for more than a year. I continue to like the business immensely. Verisign holds the .com domain monopoly – Warren Buffett’s proverbial toll bridge. To put it simply, every company in the world that wishes to register a .com, whether it’s Apple, Google or Microsoft, ultimately has to pay an annual fee indirectly to Verisign.

Recent development

In my investment thesis writeup on Verisign, I noted that the agreement with the Internet Corporation for Assigned Names and Numbers (“ICANN”) to maintain Verisign’s monopoly is ironclad since there is an automatic renewal mechanism as long as Verisign does not screw up its maintenance of the root zone files. On 20 October 2016, that agreement was extended till 2024. The agreement was originally due for extension only in 2018. That it will ultimately be extended isn’t a surprise for me, but to the rest of the market, the renewal probably provided extra clarity and was a nice surprise given how early it got renewed.

That event sent the stock price up 6.5%, from US$76.56 to US$81.56 though it has since came back down to US$76.47 as at 26 December 2016.

The meat

The details of the option in question is a premium of US$3.50 at a strike price of US$65.00 and has its expiry on January 2018 or about 12 to 13 months from now. At the point of selling the put options on 19 December 2016, the stock price was about US$78.20. The stock price has to fall about 21% from US$78.20 to US$61.50 before the puts will be exercised by the counter party.

Given my belief that Verisign’s business will continue to be strong and generate the adjusted free cash flows at more or less the same amount even in bad times, I would be glad and very comfortable owning the stock at lower valuations. The way I see it, Verisign’s stock is a bond-like instrument with a small growth component embedded.

At a stock price of US$78.20, it is trading at a rather acceptable EV / adjusted TTM FCF (excludes stock-based compensation) of 13.9x or a yield of 7.2%.

Should the stock price fall 21% to US$61.50 when the put options become exercisable, the stock’s yield would now be about 9.0%. This compares favourably to the risk-free 10-year and 30-year US government bonds yields of about 2.5% and 3.1% respectively. While I know perfectly well that these are not exactly apples-to-apples  comparison, and that Verisign isn’t risk-free (though I think it comes quite close), I thought it is still useful and a good enough shorthand to know that Verisign will be yielding about 2.9 to 3.6 times that of the risk-free rate.

All in all, the premium collected will amount to an annualised return of about 5.2% based on the capital-at-risk.

Conclusion

5.2% is certainly nothing to shout out about as compared to most option traders’ double digit annualised returns. However, the structure of this trade is one that I can go to sleep at night soundly in even if the put options are exercised. Considering the insomniac I am, I would rather choose this over nail biting and exhilarating option trades that will leave me sleepless at night.

I am not sure if Verisign’s stock price will fall below US$61.50 over the next 12 to 13 months but even if it does, I would be a happy camper, assuming there aren’t significant adverse changes to the nature of the business. In the meantime, I’m glad to sit around and collect my US$3.50 in premiums!

Small Burgers, Huge Discounts – An Investment Idea on An-Shin Food Services

I completed an investment idea write-up today on An-Shin Food Services Co., Ltd (“An-Shin”), a Taiwan-listed company which is the franchisee of the MOS Burger fast food outlets in Taiwan, China and Australia. MOS Burger was originally from Japan and is relatively popular in Asia. In particularly, the MOS Burger brand has more than 1,600 outlets in Japan, Taiwan, Singapore and Hong Kong.

Instead of the usual 1 pager, this write-up was expanded to 2 pages. In reality, the main content still remains on page 1, just that the historical financial figures are now on the second page. In essence, this is an opportunity that has a large margin of safety from:

  • 72.5% of market cap made up of cash and available-for-sale securities; zero debt
  • Profitable business gushing cash
  • Unjustifiably low EV/EBITDA of 1.9x compared to average private market transaction multiple of 9.8x and average listed-peers’ 14.9x

An-Shin is running a great business but it isn’t without problems. Most notably, its China operations are loss making. However, things aren’t as bad as it seems, especially since the China segment’s losses have been narrowing and cash flows have been more than healthy. It is also a relatively unknown and uncovered stock flying below the radar of institutions. With a market cap of just TWD2.44bn or about US$76mn, and its 2 largest shareholders controlling slightly over 50% of the shares outstanding, An-Shin is probably considered an obscure micro-cap without enough liquidity to attract institutions. This of course represents a potentially good opportunity for those investors  without the privilege of managing a couple hundreds of millions or billions to take a bite into An-Shin as an investment.

For the sake of jotting down my current thoughts and to keep track of how the business investment pans out, I would be comfortable with holding or adding to the position as long as:

  • Continues to generate the kind of operating and free cash flows over the past few years, which would eventually increase the ‘undervaluedness’ of the stock, as cash  holdings builds up
  • Healthy levels of dividends continue to be paid out (eg. 3% and above)
  • Losses in China continue to narrow
  • Measured store expansion pace, particularly in China and Australia

Even if one of the points does not ultimately come to fruition, it wouldn’t mean that it would be a deal breaker to the thesis behind investing in An-Shin. It would however, definitely be a red-flag that requires greater investigation to assess whether the quality of the business has deteriorated substantially.

To do your own due diligence of An-Shin’s financial statements, you can visit their investor relations website, which thankfully has English-translated versions. However, the earliest translated versions date back to 2014 while the traditional Chinese-based financial statements go further back to 2011 when An-Shin was listed. To view my write-up, you can click here.

As this write-up was completed over the Christmas holidays, I wasn’t able to put through a purchase order for the stock since the brokerages (Singapore) are only open tomorrow at the earliest. As such, I’m hoping to put through the order first thing tomorrow morning. If the last trading day’s volume of about 15,000 shares or about TWD1.1mn in value traded (US$35.1k) are of any indication, it should be sufficient for my order to hopefully be fulfilled.

Merry Christmas and a Happy New Year to all!

Exiting Ebix

I sold the last of my stock position in Ebix on 1 December 2016 at US$58.45. In this post, I look back on the journey and the lessons drawn.

The backstory as to how I first came across the investment idea was reading it off the September 2013 issue of Value Investor Insight. I subsequently jotted down my thoughts in a write-up on 14 March 2014

Before I continue with the rest of the backstory, I thought it would be good to bring the lessons learnt in point-form upfront for my easy future reference:

  • It is important to look for behaviourial clues beyond financials such as the manner in which a deal is structured. To consider who benefits from the deal. Incentives matter
  • Sell in stages rather than everything at one go. This leaves room to capture further upside, especially when the market starts to get really in love with the stock – reverse dollar cost averaging. Similarly, and in converse, take advantage of the market’s pessimism to buy and dollar cost average down when prices start to decline for no good reason
  • Even if the price has marched upwards by a large amount, if fundamentals remain sound and earnings have kept pace such that valuations remain compelling, the right move is to buy rather than anchoring on the initial purchase price

At that time, Ebix received some really bad press, in particular, a short seller report by Gotham Capital alleged that Ebix was laundering money, evading taxes and had a host of accounting issues. Needless to say, the stock took a beating and was among the most shorted stock in the US.

At the initial stages, my thesis was that an investment in Ebix was going to be a binary outcome. It was either a giant fraud and will go to zero or it is an extremely misunderstood opportunity whereby the potential returns are going to be pretty great. I thought it was more likely that Ebix was misunderstood than it being a fraud. If it was a fraud, my investment was going to zero no matter what instruments I use. However, if I am right about Ebix, I wanted my returns to be asymmetrically skewed towards the sky. As such, I structured the investment accordingly by purchasing options in November 2013 at US$2.80 with a strike price of US$11.00, expiring in June 2014. At that point in time, the stock price was US$11.87. I then sold the 6-month option about 5 months later in April 2014 for US$6.01 for a 115% gain to lock in profits and as there was a relatively short duration left before expiry. I would have gladly bought LEAPs to let the investment stretch out over a longer period of time but as it was a small cap company then, there were no LEAPs available.

As I dug deeper into Ebix, I realised that the investment case was not as binary as I initially thought it to be. Beyond my thoughts jotted down in my write-up on 14 March 2014, I realised there was a quirk in the buy-out deal Ebix made with Goldman Sachs that was most interesting and gave me the confidence to then plough the proceeds generated from the sale of the Ebix options into the stock. Despite the negative news swirling around Ebix, Goldman Sachs continued on with the due diligence and came out saying they would proceed. That proved short lived. While the deal eventually fell apart, it appeared to be mainly due to mounting public pressure and embarrassment by association rather than any tangible business negativity they found in Ebix.

The interesting quirk that I mentioned was the fact that the going-private deal had a provision which enabled Ebix’s CEO to increase his stake rather significantly in Ebix AFTER it has gone private. Why would the architect of Ebix who allegedly perpetuated money laundering, tax fraud and cooked the books increase his stake in a sinking ship? That did not make sense to me. I would have thought the CEO, Robin Raina, would have been very keen to sell out his entire stake if there was any truth in the allegations. However, the market did not seem to take much notice of it. Along with the strength of Ebix’s financials and business, and with this important bit of information, I took the contrarian view and started purchasing the stock.

Over the past few years, I added to the position at different stages with the price ranging from US$16.10 all the way up to US$28.70. The stock price went way beyond my initial conservative price target of US$21.10 but the business remains sound and earnings, along with the price multiple outgrew what I initially assessed it to do.

As the price kept marching upwards, I assessed the valuation and grew increasingly nervous. I started selling the stock in May 2016 till December 2016 between the price range of US$45.84 to US$61.10. I felt that the FCF/EV yield was getting stretched and at a trailing-12-months yield of 3.3% given the stock price of US$59.70, I thought the stock price has gone way ahead of its fair value and it was time to completely sell-out for reinvestment into areas where the risk-reward ratio are more attractive.

I continue to love Ebix’s highly recurring revenue business model of charging its customers on a per transaction scheme rather than the conventional systems set-up model. While I doubt the valuation will ever come back to levels reached in 2013, if valuation starts moving towards a FCF/EV yield of 6% or better, I will definitely start to be interested again.

Between the first purchase of the option when the price was at US$11.87 till the highest price I sold the stock at US$61.10, it moved upwards by 415%. While the number is not entirely representative of the total returns generated as I bought and sold along the way, the 3 years journey culminates in probably the best percentage and absolute returns generated on my portfolio thus far on an overall basis. I highly doubt I’ll ever be able to see one of my positions move upwards in such a dramatic manner. The conditions at the point of purchase that set up this successful investment were unique and unlikely to be repeated in the exact same way again. However, the lessons drawn from this episode certainly are valuable and it would benefit me to keep them close to heart.

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.

Trumped

The day before the presidential elections when Trump was declared President-elect of the USA, I went through an internal struggle on whether to hedge my portfolio. A significant portion of my portfolio is denominated in US Dollars (“USD”) and the stocks are listed in the country. I believe that for most of the people residing outside of the US, they would have hoped for Clinton to win the elections. The prevailing view appeared ot be that a Clinton administration would bring about stability to the global markets.

However, hoping versus reality are 2 very different matters, as I found out for myself when Brexit happened. I didn’t think the UK would leave the European Union but it didn’t matter what I thought. The votes spoke for themselves and the British did vote to leave, never mind the current on-going twists and turns with the British government and the courts’ fight over bringing the ‘Leave’ decision to the parliament. Given that I had a fair percentage of investments denominated in British Pounds (“GBP”), I was caught with my pants down when the value of the GBP dropped against other major currencies. Needless to say, I did not hedge my positions prior to Brexit and had to watch my stock positions in the UK and my excess cash held in GBP, crumble. The good news was that my largest GBP-denominated position was YouGov. As a large portion of YouGov’s business were derived from outside of the UK, coupled with good financial results during the subsequent quarter, the rise in its stock price more made up the currency devaluation over time. This was definitely attributable to good luck, with zero skill involved.

This time around with the potential prospect of Trump being the 45th President of the United States, I converted my remaining excess cash denominated in USD into my local currency to avoid the same from happening again. I hedged a portion of my USD and US stock exposure by buying a gold instrument. This is the first time I have ever bought anything that is closely related to gold, largely because I am in Warren Buffett’s camp – in that he says gold by itself doesn’t produce cash flow and doesn’t have intrinsic merit. I agree with him that over the long-term, gold can’t compound value the way businesses can. I very much doubt he owns gold or its derivatives. However, where I take different approach and depart from this, is that I believe gold can be a good protector of constant value over the short-to-medium-term, particularly in times of uncertainty, such as these Brexit and Trump-entering-the-White-House events. As such, I will only utilise gold in my portfolio very sparingly an in rare occasions.

Anyhow, the US market (both stock and currency) did not react as violent as I or most other people thought. In fact, the S&P ended up a 1.11% higher on 9 Nov 2016 and most of my US-listed stocks turned out OK. The very next day, Asia markets rebounded strongly, with the largest gain coming from Japan, where the Nikkei 225 rose 6.72% and Nippon Paint (a stock I own) jumping 8.73%. To be fair, the Nikkei 225 was also among the largest losers the previous day. Thus, the strong rebound was pretty much a catch-up. With gold price coming off in the past day, I am a couple of percentage points down on my hedge while on a portfolio basis, the cost is less than half a percentage point. I still think the insurance was absolutely necessary. Although it ultimately wasn’t necessary in the end, it served its purpose well and helped me get through the day with much less worries.

As to why the markets reacted the way it did, I think a friend summed it up well:

“I think there is a difference between Brexit and US elections, and hence a difference in market reaction. Brexit is directly an economic event (Britain leaving an economic bloc).

US elections is largely a political event, although it can have economic consequences (which are still unknown as of now)”

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.

HC Surgical IPO’s first day trading

My buy order for HC Surgical at S$0.371 per share, which was put through last night failed to go through when the opening bell struck at 9am this morning.

Boy did it fail. The stock opened at about S$0.550 and closed at the same price at end-day. That represented slightly more than 100% of gains in a single day, up from the IPO price of S$0.270. The whopping return is great news for investors who managed to get their hands on the placement tranche.

As for me I’ll just have to hold on tight,  await for better opportunities especially if HC Surgical’s stock price falls, and reassess HC Surgical when there are new developments  with the business.

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!