How to Screen for Hidden Champions
- If I could recommend only one book for value investors to read it would be Hidden Champions of the Twenty-First Century
- Reading about Exxon Mobil (XOM) and Apple (AAPL) and Starbucks (SBUX) and thinking you are becoming a business expert is like reading about blue whales and elephants and thinking you are becoming an animal expert. Tiny insects are a lot more common than giant mammals
- Screening for Hidden Champions:
- 10 years consistent >= 15% op margin and market cap < $1B
- 10 years consistent >= 15% ROE and market cap < $1B
- 10 years consistent >= 8% ROA and market cap <$1B
- 10 years consistent EPS increase and market cap < $1B
- If an ultra-conservatively managed family company earns 10% on equity it would probably earn closer to 20% on equity if it was sold to a professionally managed multinational
- Some companies have negative equity, to correct for this, screen for >= 8% ROA regardless of ROE
- The best place to screen for hidden champions in the UK is SharelockHolmes
Backtesting Net-Nets: Does It Matter?
- Net-nets are a symptom of the overall stock market’s health
- You should ignore a net-net for two years after you buy it, at minimum
- The key to a successful NCAV portfolio is to not sell your winners too fast
- If a stock has low institutional ownership, low short interest, no analyst coverage, and a small number of shares outstanding – nobody is looking at the company; buy net-nets where institutions own the fewest shares
- Inactivity is necessary to really judge your net-net selection skills
- If you are just taking a profit (or loss) in a net-net within 1 to 2 years of buying it – I think you’ve basically just traded a stock on a different basis than you analyzed it
- A good net-net is really just a decent business. Why would insiders still control 10% to 50% of a company that has been public for 10 to 30 years?
- Try to buy the “best” net-net available each month with an emphasis on “safe” rather than “cheap”
- Attractive net-net criteria:
- Long history of consistent profitability
- Long tenured CEO
- High insider ownership
- Low leverage
- High cash relative to share price
- Good capital allocation decisions
- Simple business
- Good business
- Lasting business
- Ideally, you don’t want to pay more than the company’s own cash for the stock
- High insider ownership in a newly public company doesn’t have the same meaning as it does at an old company
- Dividends are nice, not because they’re important but because of what dividends are a symptom of
- Retailers are tough net-nets; a retailer that loses some of its competitiveness is a retailer that could be out of business in a matter of years
- How to sabotage a NCAV portfolio: sell too soon; if you sell your winners when they go up, you destroy the performance of a net-net; the big winners are needed to outweigh the big losers and the mediocre performers
- The holding of net-nets is critical
- Slowly assemble a net-net portfolio over a period of a couple years, and don’t sell anything for those first two years
Should You Wait for a Crash – Or Buy Today’s Best Bargain?
- To get consistently good investment results, follow one of two programs:
- Buy companies that are clearly selling for less than their conservatively calculated value to a private owner
- Buy companies that will earn high returns on capital while growing quickly for many, many, many years to come
- During periods of panic, look for obvious mispricings; for example, high quality companies trading at less than 10x FCF; 10x free cash flow is less than stocks are generally worth
- To fill a portfolio in the midst of a market crash, have a shopping list of companies you like but are overpriced ahead of time
- You are very unlikely to cause any sort of catastrophic problem for yourself just by overpaying for the right kind of company. Buying the wrong company is your biggest risk
- Just wait for an obviously wonderful business selling for the kind of price a normal stock sells for in normal times
Warren Buffett Checklist to Invest in a Great Business: KO
- Buffett had 9 criteria he examined when determining whether he was investing in a great business:
- Does the business have an identifiable consumer monopoly?
- Are the earnings of the company strong and showing an upward trend?
- Is the company conservatively financed?
- Does the business consistently earn a high rate of return on shareholders’ equity?
- Does the business get to retain its earnings?
- How much does the business have to spend on maintaining current operations?
- Is the company free to reinvest retained earnings in new business opportunities, expansion of operations, or share repurchases? How good a job does the management do at this?
- Is the company free to adjust prices to inflation?
- Will the value added by retained earnings increase the market value of the company?
Free Cash Flow: Adjusting for Acquisitions, Capital Allocation and Corporate Character
- Make your Ben Graham investments on an EV/EBIT basis
- Make your Warren Buffett investments on a price-to-free-cash-flow (P/FCF or P/OE) basis
How to Read a 10-K: What is the Most Important Part?
- The only 10-K I read from cover to cover is the most recent 10-K
- Print out and mark up a hard copy of the latest 10-K, 10-Q, and 14A
- Check all of the 8-Ks and 13Gs from the last year or so
- If there was a scandal, a proxy battle, legal case, unconsummated merger, etc. – read the 8-Ks and other documents surrounding that time period even if it was many years ago
- Read the oldest 10-K as well as the newest
- Read any shareholder letters ever written that are still available
- Enter Balance Sheet, Cash Flow and Income Statement data into an Excel spreadsheet for every year the company reported to EDGAR
- Always have at least 10 years of data
- Look at the notes to the financial statements most critically
- Ask yourself the following questions:
- What is customer behavior in the industry?
- Why do customers choose what they choose?
- What does management really think? What are they really like?
- Gannon prefers investing in companies where he understands customer behavior the best
How Long Should You Hold a Net-Net?
- All we need to do is make sure that the stocks we buy are clearly worth more than we pay for them
- Forget about trading a net-net a full year after buying it and instead focus on the two things that matter most:
- Picking the right stock (company)
- Holding that stock regardless of what the market does
- Never sell a net-net in less than one year unless:
- You made a mistake
- You need to buy something else (that’s better)
- A one to five year holding period is the right length for net-nets
- Never sell a net-net just because it reached NCAV; NCAV is still really, really cheap
How to Get a Job in Value Investing
- Look for someone trying to build a research team from scratch
- The best combination is often when the position is brand new and the right person was impressed ahead of time
- Do lots of research for free and then let it get into the hands of someone who can hire an analyst
- Talk to everybody whose work you respect by sending them an email; share your best ideas with them
- Set aside time to writing and reading about value investing every single day
- Don’t send your casual thoughts to those you’re trying to impress; you want them to think of you as a thorough, insightful researcher
What is the Buffett/Munger Bargains Newsletter?
- Investing in net-nets is the best way for a dedicated, “do-it-yourself” individual investor to beat the market
- The newsletter’s strategy is to find companies with the following attributes:
- Simple business
- Favorable long-term prospects
- Able and honest management
- Consistent earnings
- Good ROE
- Little debt
- Very attractive price
- It is modeled on the Buffett/Munger of the 1970s
- “Really good businesses usually don’t need to borrow… they make the most of an already strong business franchise or concentrate on a single winning business theme” -Buffett
- Use the higher of today’s interest rates and long-term average interest rates when considering valuations
How I Pick Stocks for the Ben Graham Net-Net Newsletter
- Traditionally, big net-nets have been poor performers
- The ratio of insider ownership to institutional ownership is actually one of the best predictors of the future stock market performance of a net-net
- What makes for a good net-net?
- High insider ownership / Low institutional ownership
- High F-Score
- Consistent earnings
- Simple business
- Decent ROE
- Decent long-term prospects
- The idea is to get the best business for the lowest price
How Should You Divide Your Research Time?
- I put my energy towards whatever is most clearly undervalued
- I keep cash close to 0% when I have good ideas
- The important thing is picking the exact right company and then picking the approximately right price
- I spent probably half a year thinking about buying DWA before I put in my buy order
- A typical net-net for me is a 10% position held for just over a year
- I spend almost half my time looking at net-nets and almost half my time looking at high quality companies
- I look longer at each high quality company I research
- Required reading:
- Warren Buffett’s Letter to Shareholders (1977-Present)
- Warren Buffett’s Letter to Partners (1959-1969)
- The Snowball: Warren Buffett and the Business of Life
- Buffett: The Making of An American Capitalist
- Poor Charlie’s Almanack
- Common Stocks and Uncommon Profits (by Phil Fisher)
- The Interpretation of Financial Statements (by Ben Graham)
- The Intelligent Investor (1949 Edition)
- Security Analysis (1940 Edition)
- Benjamin Graham on Investing
- Benjamin Graham: The Memoirs of the Dean of Wall Street
- One Up on Wall Street (by Peter Lynch)
- Beating the Street (by Peter Lynch)
- You Can Be a Stock Market Genius (by Joel Greenblatt)
- The Little Book That Beats the Market (by Joel Greenblatt)
- There’s Always Something to Do (about Peter Cundill)
- The Money Masters
- Money Masters of Our Time
- Hidden Champions of the Twenty-First Century
- Jim Collins Books: Built to Last, Good to Great, How the Mighty Fall, and Great by Choice
- Distant Force (about Henry Singleton)
- Kuhn’s The Structure of Scientific Revolutions and The Essential Tension
- Specific reading on extreme market conditions:
- The Big Short
- Too Big to Fail
- This Time is Different
- When Genius Failed
- The Panic of 1907
- Knowing about historical episodes is understanding what the paper looked like every morning to folks who were as blind to the future as you are now
- Case studies of investments made by investors whose books, letters, etc., the student has read
- Side-by-side comparisons of stocks with the names of the companies omitted, for example:
- Buffett’s investment in GEICO, Wells Fargo, Coca-Cola, Gilette, etc.
- Graham’s investment in Northern Pipeline, DuPont/GM (long/short), etc.
- Phil Fisher’s examples in his book
- Joel Greenblatt’s examples from his books
- Peter Cundill’s investments in his biography
- Peter Lynch’s investments in his books
- MSFT at different points in its history, WMT versus Costco, present day modern US railroads, present day comparison of high-quality large versus high-quality small company, comparison of present-day hated companies and historical Warren Buffett equivalent
- Value investing is mostly about doing original research alone
- New value investors love reading books on theory and technique; they spend too lite time studying specific stocks
- Open Google Translate
- Find the stock on its home stock exchange
- Read the company’s annual reports
- Study comparable companies in your home country
- Enter the stock’s past financials in a Microsoft Excel spreadsheet
- Use the past financials and comparison companies to appraise the stock’s value to a private buyer
- Compare the stock’s appraised value to its market price
- If the market price is more than 75% of the appraised value, forget about the stock
- If the market price is less than 50% of the appraised value, focus on the stock
- Otherwise: use your best judgment
A House Rises 