Notes – A Compilation Of Ideas On Investing

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
  1. Open Google Translate
  2. Find the stock on its home stock exchange
  3. Read the company’s annual reports
  4. Study comparable companies in your home country
  5. Enter the stock’s past financials in a Microsoft Excel spreadsheet
  6. Use the past financials and comparison companies to appraise the stock’s value to a private buyer
  7. Compare the stock’s appraised value to its market price
  8. If the market price is more than 75% of the appraised value, forget about the stock
  9. If the market price is less than 50% of the appraised value, focus on the stock
  10. Otherwise: use your best judgment

Another Battle In The Long War: The Solitron Shareholders Meeting

Something that has been impressed upon me over the years as I learn more about business and investing has been the invaluable role that bullshit-detection plays in money dealings. The jungle is everywhere and while man may have found a way to tame his baser desires and impulses enough to enjoy a broad civilization, individual men will always tease the edges of appropriateness by attempting force by other means, namely deceit, misdirection, opacity, feigned confusion, intentional blundering, etc. If you can’t smell bullshit and if you have no means to fight back against a bullshit-peddler, he will run you over and probably try to take you for all you’re worth along the way.

Some people say, “That’s just business!” but that’s been invalidated by numerous contrary, personal experiences where no bullshit occurred and business occurred nonetheless, and more efficiently and for more wealth for both parties, overall. Bullshit is just a grey-area form of aggression, a remnant of the jungle from which we can never fully emerge.

My attendance at the first annual Solitron Devices shareholders’ meeting in nearly 20 years was a descent into that jungle. Here I and several other shareholders came face-to-face with Shevach Saraf, President, Chairman of the Board, CEO, CFO and, among many other titles and distinguishments I should say, a highly intelligent, sophisticated bullshitter.

My personal predisposition is to assume a person is trustworthy until they demonstrate they clearly are not. This is a little different than treating a person as trustworthy– I maintain skepticism and try to be alert at all times, but I don’t start a person at 0 and then work up to 100 on a “trustworthiness” scale, but rather the opposite. As a result, in dealing with Saraf and other representatives of the company in the past, I tried to explain various indiscretions, unkindness and general belligerency displayed by these parties in terms of misjudgments, misperceptions and a potentially historical apprehensiveness, rather than some kind of malintent.

At this point, the veil has been lifted for me and I believe I can confidently state that the bullshit is a calculated tactic and it is laid on, thick, with due purpose.

In the particular case of the shareholders’ meeting, the bullshit started with the “rules for the meeting”, which restricted each participant to a maximum of two questions no longer than one minute in length, with a twenty minute maximum duration. As with most bullshit, this was done in the name of “giving everyone a chance to speak”, but was really a rather naked attempt to intimidate shareholders and prevent them from stating their minds and engaging in significant follow-up questioning. No shareholder present (all 9 of us!) ever demonstrated any concern about domination of the Q&A period by any other shareholder. At the end of the Q&A, Saraf attempted to enforce the twenty minute maximum but was ultimately stymied by a shareholder who requested a longer, informal, follow-up Q&A period, which after 5 minutes of deliberation outside the room with counsel, was ultimately granted.

The second strand of bullshit is woven through the scandalous insinuations that Saraf made of his shareholder base. He deemed it fit to specially remind the gathered investors that he had no plans to do anything illegal and so he would not offer any insider info during the meeting. This is a strawman Saraf seems to trot out often– ask the man anything about the company at all, no matter how innocent and legally-sanctioned it may be, and he proceeds to launch into accusations of villainy aimed at getting an illegal upper hand while putting himself and the company in legal jeopardy. He also made a warning about supposed shadowy elements that were spreading false rumors and lies about the company on the internet, but he did not think to mention who was doing this or what specific claims were made which he could clarify as to their falsity. The impression one is left with is that there are no false rumors or lies being spread and this is yet another attempt to intimidate via bullshit.

Then we had to wade through Saraf’s numerous self-contradictions and general evasiveness in answering questions, most of which began with the expression, “Let me put it this way…”, which in my experience has always preceded a barely-obscured threat, as in, “Let me put it this way, if you don’t do what I am asking you to do, someone might get hurt.” The infamous EPA liabilities which have left the company hamstrung to do anything with the company’s excess capital and which according to regulatory filings earlier in the year seemed to have been extinguished, or due to be extinguished completely, by or around March or April of 2013, were suddenly at one point 30, another point 60 and another time some 72 days away from being resolved.

More bullshit: Solitron has a “sunset technology”, but there’s also the possibility they spend $5M+ of the company’s cash stockpile retooling their factory for new silicon wafer standards; the sequestration has been bad for business, but the company has also gobbled up marketshare from competitors who have gone out of business; the company is at 50% of plant utilization, but wars in Syria and elsewhere are good for business because it means equipment will need to be replaced that Solitron services; the company has struggled with rising inputs costs, but they build everything on spec and have a guaranteed profit-margin built in by the Pentagon; shareholders are now “welcome to contact any board member and ask them questions about the company” but in the past “PLEASE KEEP IN MIND THAT ALL INVESTOR COMMUNICATIONS SHOULD BE DIRECTED TO THE CHAIRMAN OF THE BOARD OF SOLITRON DEVICES, INC.”; Chinese and COTS parts have created huge price competition for the firm, but the firm’s buyers actually require specially-tested, high quality parts only Solitron can produce, and new DNA-marking of chips prevents the use/substitution of foreign knockoff parts, etc. etc.

I could go on and on. The point is it’s just a bunch of bullshit.

And Saraf isn’t the only one peddling it. His vaunted board showed their own knack. Saraf was asked, as a large shareholder, if he was concerned about the price of the company in the open market hovering around cash value. Not only did he evade the question and not answer it, but his new appointee, Mr. Kopperl, piped in with the pithy “Does anyone really know what moves stock prices?” When asked how he makes his investment decisions, Mr. Kopperl said, “Sometimes I buy value, sometimes growth.” But if no one really know whats moves stock prices and you’re philosophically agnostic as to what kind of decisions a company could make that would be good or bad from a valuation standpoint, how could you even invest?

And how would this bolster the company’s claim that the current composition of the board represents people capable of maximizing shareholder value?

It was suggested to Saraf that more disclosures from the company about its business would help the market better understand the company and its prospects and arrive at a fairer valuation. Saraf did not acknowledge whether this transparency would be beneficial to shareholders interested in seeing the marketplace better assess the company’s prospects, but he did say that he wasn’t interested in putting out a press release every time the company got a new certification or secured a contract. Bullshit!

The most puzzling event of the day was the withholding of votes for Schlig and Davis (and their subsequent dismissal with no replacement nominees named), and the approval-by-vote of the two new directors, Gerrity and Kopperl. These guys are black boxes as far as I am concerned. They sound like country club buddies and there was no explanation as to why they were qualified to represent SHAREHOLDER interests though, Saraf was quite clear, their industry experience made them qualified in his mind to represent company interests, which essentially means Saraf’s interests as things have been run so far.

Large shareholders seem to be more confident. They’re convinced Saraf is more cooperative than he seems and that he will do the right thing when it’s the right time to do so. I think the laws of the SEC are a legal cover for bullshitmongers. From where I stand, it’s an almost impenetrable fog. But maybe when you own 5% or more, you have other methods of cutting through the bullshit.

It is indeed going to be a Long War without them.

If you want more, here’s Nate Tobik’s take at OddballStocks.com.

Does Net-Net Investing Work In Japan?

If you took a look at the companies I purchased off my Japanese net-net (“JNet”) worksheet about six months ago, you’d probably conclude net-net investing doesn’t “work” in Japan, at least not over a six month period. The cheap, crappy companies I bought then are cheaper, still crappy companies today.

However, if you took a look at all the companies I didn’t buy from my list, you might get a different impression altogether. While there are a few companies of this group whose fundamentals worsened and/or whose stock price fell, most are up anywhere from 10-15% with several up substantially more, 30-50%. About 10% of the total list seems to have gone private as you can’t find financial info nor trade the symbol any longer, which in my experience in JNet-land typically means they received an MBO.

And if you look at an entirely different list of JNets I generated about two months ago (because all my original picks were no longer JNets), which I finished researching one month ago and which I failed to do anything about until yesterday, the story is even better (or worse, if you’re me). How would you like to see the top pick on your list closed up 25% the day prior and about 40% total since you composed your list? How would you like to see the average company on your list priced 15% or more higher from where you first researched it, meaning you could’ve locked in your 15% annual return for the year in a few months time?!

Once again, this list also had several symbols which no longer trade, presumably because they received buyouts or other going private transactions.

So, in the last few days I learned a few things about JNets:

  1. They “work”
  2. The “M&A activity in Japan, particularly in the small cap space, is a non-starter” claim, is a myth
  3. Even crappy businesses with cash-rich balance sheets are moving like hotcakes in Abenomic Japan
  4. The strengthening of the dollar against the Yen does impact your $ returns, but so far Yen prices on JNets have outpaced the move of the Yen against the dollar
  5. Contrary to my belief that I could take my time allocating idle capital in Japan, it now appears that time is of the essence

My old motto for JNets was, “Steady as she goes.” My new motto is, “Churn and burn” or “Turn and earn.” I’m going to be watching things much more closely than I had before.

To be clear, my experience so far has been frustrating, but it hasn’t been catastrophic as I suggested in my introduction. I have captured some of the windfall moves myself although I continue to have laggards in the portfolio, at least in dollar terms. Very few of the original companies I picked are trading lower than when I bought them, though some have not moved up enough yet to make up for the exchange rate loss. My first portfolio of JNets was bought when the Yen/$ rate was 79. It’s now almost 99 Yen to the dollar and I made my second portfolio purchase around 94 Yen to the dollar.

Overall, in dollar terms my first portfolio is up 5%, with one MBO and apparently another just recently as I found out the stock is up 43% with no ask but I haven’t found a news item explaining why yet. Several others traded above NCAV so I am culling them and putting them into new opportunities. I have not yet determined what the “secret formula” is for picking the JNets that will really take off– oddly, it was mostly the companies whose prospects seemed least fortunate that I neglected to purchase and was in shock to see their stock prices 35% higher or more. As a result, I plan on wider diversification and a more random strategy in choosing between “best” companies and cheapest stocks.

I’m sure many investors have done much better than 5% in Japan in the last half year, and many more have done better still in the US and elsewhere. This isn’t a contest of relative or absolute performance. This is simply an opportunity to settle the score and point out that yeah, Benjamin Graham’s philosophy is alive and well in Japan.

16 Japanese Net-Nets I Put In My Portfolio

Listed below are the 16 Japanese companies that currently compose my “basket” (portfolio-within-the-portfolio) of Japanese net-nets, which I refer to as “JNets”. While most of my picks were classic Benjamin Graham-style companies trading for 2/3rds or less of their Net Current Asset Value (current assets minus total liabilities), some were selected on the basis of being a Net Cash Bargain (trading below the value of the company’s cash minus total liabilities) or as a Cash Bargain (profitable company with no debt trading for less than the cash on the balance sheet).

Strictly speaking, a Net Cash Bargain is a more conservative valuation than a Net Current Asset Value Bargain as there are more assets in front of the liabilities, while a Cash Bargain is a less conservative valuation (it may or may not be an NCAV Bargain) but typically you are getting a higher quality company with stronger earnings power as a result. As Graham noted, equities can be analyzed much like bonds and the true safety of a bond comes from the underlying company’s earnings power, not necessarily the asset values which are a worst-case fall back measure to protect against loss.

The figures in the list below are all in Yen, typically in millions of Yen besides the per share price. At the time of purchase, the approximate exchange value of the dollar against the Yen was 1 USD = 78 JPY. All figures and prices are the most recent available at time of purchase.

For comparative purposes, I summarize at the end of the list the metrics for the entire basket (as if it was a conglomeration of 100% of the equity of all companies included) as well as on an average basis as a representative for an individual company within the basket.

Links in the name of each company take you to their website, if available. Links in the symbol of each company take you to their Bloomberg business bio page, if available.

16 Japanese Bargain Shares (Net-Nets, Net Cash and Cash Value)

Name: Sakai Trading
Symbol: 9967
Industry/product: imports, exports, and wholesales chemical products, synthetic resins, and electronic materials
Market Cap (Ym): 2,210
Share price (Y): 235
Debt (Ym): 0
Cash (Ym): 2,851
EV/EBIT (10yr avg): 12.3x
NCAV (Ym): 4,973
 
Name: Shinko Shoji Co. Ltd
Symbol: 8141
Industry/product: sells electronic parts and equipment such as integrated circuits (IC) and semiconductor devices, liquid crystal (LC) display modules, condensers, ferrite cores, coils, power supplies, thin film transistor (TFT) thermal printers, head magnets, transformers, motors, sensors, and connectors
Market Cap (Ym): 16,905
Share price (Y): 625
Debt (Ym): 3,000
Cash (Ym): 10,610
EV/EBIT (10yr avg): 12x
NCAV (Ym): 41,899
 
Name: KSK Co Ltd
Symbol: 9687
Industry/product: develops computer software for various systems related to telecommunication and LSI (Large Scale Integration), provides data processing services for government and insurance group, sells OA (Office Automation) equipment and computer peripheral
Market Cap (Ym): 3,300
Share price (Y): 450
Debt (Ym): 0
Cash (Ym): 4,461
EV/EBIT (10yr avg): 1.6x
NCAV (Ym): 4,926
 
Name: Daichii Kensetsu
Symbol: 1799
Industry/product: constructs railways mainly for East Japan Railway, constructs infrastructure such as sewage facilities, tunnels, and waterways, builds commercial, institutional, and residential buildings
Market Cap (Ym): 15,124
Share price (Y): 685
Debt (Ym): 151
Cash (Ym): 17,230
EV/EBIT (10yr avg): 2.3x
NCAV (Ym): 19,099
 
Name: Choukeizai Sha
Symbol: 9476
Industry/product: publishes economics, finance, law, accounting, and tax related books and periodical magazines and business related books, operates a planning center which handles advertising on publishes, provides design & production services for sales promotion pamphlets
Market Cap (Ym): 1,434
Share price (Y): 326
Debt (Ym): 0
Cash (Ym): 2,501
EV/EBIT (10yr avg): -0.1x
NCAV (Ym): 2,933
 
Name: CLIP Corp
Symbol: 4705
Industry/product: operates a network of cram schools in Nagoya, operates soccer school and lunch box delivery services
Market Cap (Ym): 4,022
Share price (Y): 886
Debt (Ym): 0
Cash (Ym): 5,029
EV/EBIT (10yr avg): 0.1x
NCAV (Ym): 4,196
 
Name: Noda Screen
Symbol: 6790
Industry/product: processes electrical components such as plastic package substrates and printed circuits boards (PCBs), through a subsidiary, manufactures and sells screen stencils and fluoride chemical products
Market Cap (Ym): 2,849
Share price (Y): 27,000
Debt (Ym): 0
Cash (Ym): 3,641
EV/EBIT (10yr avg): -0.2x
NCAV (Ym): 4,146
 
Name: Kitakei Co Ltd
Symbol: 9872
Industry/product: wholesales housing materials and home furnishings based in the Kansai area, sells housing facility products such as bathroom units, wooden building materials, special wooden products, housing equipment, veneer boards, chemical products, and housing preservative agents
Market Cap (Ym): 2,963
Share price (Y): 296
Debt (Ym): 0
Cash (Ym): 5,045
EV/EBIT (10yr avg): 16.8x
NCAV (Ym): 5,133
 
Name: Ryosan Co Ltd
Symbol: 8140
Industry/product: distributes electronic components, such as integrated circuits (ICs), electronic tubes, semiconductor elements, and personal computers, manufactures heat sinks
Market Cap (Ym): 47,582
Share price (Y): 1,387
Debt (Ym): 172
Cash (Ym): 36,452
EV/EBIT (10yr avg): 7x
NCAV (Ym): 92,515
 
Name: Daiken Co
Symbol: 5900
Industry/product: manufactures and sells metal and other material parts for building construction and exterior products including curtain rails, exterior panels, garages, and bicycle parking units, provides installation of these products and real estate leasing service
Market Cap (Ym): 2,245
Share price (Y): 376
Debt (Ym): 0
Cash (Ym): 1,753
EV/EBIT (10yr avg): 5.4x
NCAV (Ym): 4,375
 
Name: Ryoyo Electro Corporation
Symbol: 8068
Industry/product: wholesales electronic components including semiconductors, sells workstations, personal computers, and printers, operates offices in Singapore and Hong Kong, trades semiconductors from Mitsubishi Electric
Market Cap (Ym): 22,205
Share price (Y): 771
Debt (Ym): 0
Cash (Ym): 28,443
EV/EBIT (10yr avg): 1.6x
NCAV (Ym): 54,847
 
Name: Nihon Dengi
Symbol: 1723
Industry/product: designs, constructs, and maintains integrated building management systems for air-conditioning, security, and electrical facilities, develops integrated production systems for industrial factories
Market Cap (Ym): 4,805
Share price (Y): 586
Debt (Ym): 0
Cash (Ym): 6,313
EV/EBIT (10yr avg): 4.3x
NCAV (Ym): 8,613
 
Name: Odawara Engineering
Symbol: 6149
Industry/product: manufactures automatic coil winding machines including micro motor, coreless motor, universal motor, and stepping motor type, provides reconstruction, repair, and parts replacement services for its winding machines
Market Cap (Ym): 4,154
Share price (Y): 650
Debt (Ym): 0
Cash (Ym): 5,411
EV/EBIT (10yr avg): 2x
NCAV (Ym): 6,423
 
Name: Natoco Co Ltd
Symbol: 4627
Industry/product: manufactures and sells various types of paints including paints for metals, building materials, and auto repair, manufactures high polymer compounds which are used as material for liquid crystal displays
Market Cap (Ym): 4,414
Share price (Y): 603
Debt (Ym): 0
Cash (Ym): 5,403
EV/EBIT (10yr avg): 5x
NCAV (Ym): 6,967
 
Name: Fuji Oozx
Symbol: 7299
Industry/product: manufactures automobile engine parts such as valves, valve adjusters and rotators, has subsidiaries in Korea, Taiwan, and the United States
Market Cap (Ym): 6,189
Share price (Y): 301
Debt (Ym): 0
Cash (Ym): 6,884
EV/EBIT (10yr avg): 1.6x
NCAV (Ym): 11,623
 
Name: Excel Co Ltd
Symbol: 7591
Industry/product: sells electronic products, such as liquid crystal devices (LCD), semiconductors, and integrated circuits (IC), including thin film transistor (TFT) modules, TFT-LCDs, cellular phones, car navigation systems
Market Cap (Ym): 6,208
Share price (Y): 683
Debt (Ym): 0
Cash (Ym): 6,679
EV/EBIT (10yr avg): 4.7x
NCAV (Ym): 18,574
 
Total Basket
Market Cap (Ym): 129,974
EV (Ym): -15,499
10yr avg EBIT (Ym): 27,046
Debt (Ym): 3,323
Cash (Ym): 148,796
NCAV (Ym): 291,244
EV/EBIT (10yr avg): -0.57x
P/NCAV: 0.45x
P/Net cash: 0.89x
P/Cash: 0.87x
EBIT yield (EBIT/Mkt Cap): 21%
 
Representative Company (Avg)
Market Cap (Ym): 8,123
EV (Ym): -969
10yr avg EBIT (Ym): 1,690
Debt (Ym): 208
Cash (Ym): 9,300
NCAV (Ym): 18,203

Geoff Gannon Digest #5 – A Compilation Of Ideas On Investing

Why I Concentrate On Clear Favorites And Soggy Cigar Butts

  • Graham and Schloss had >50 stocks in their portfolio for much of their career
  • They turned over their portfolios infrequently; probably added one position a month
  • To avoid running a portfolio that requires constant good ideas:
    • increase concentration
    • increase hold time
    • buy entire groups of stocks at once
  • With his JNets, Gannon purchased a “basket” because he could not easily discriminate between Japanese firms which were both:
    • profitable
    • selling for less than their net cash
  • Portfolio concentration when investing abroad is based upon:
    • which countries do I invest in?
    • how many cheap companies can I find in industries I understand?
    • how many family controlled companies can I find?
  • Interesting businesses are often unique

How Today’s Profits Fuel Tomorrow’s Growth

  • To elements to consider with any business’s returns:
    • How much can you make per dollar of sales?
    • How much can you sell per dollar of capital you tie up?
  • Quantitative check: Gross Profit/ ((Receivables + Inventory + PP&E) – (Payables + Accrued Expenses))
  • Once an industry matures, self-funding through retained earnings becomes a critical part of future growth; it’s the fuel that drives growth
  • A company with high ROIC isn’t just more profitable, it can more reliably grow its own business
  • Maintaining market share usually means increasing capital at the same rate at which the overall market is growing
  • Higher ROIC allows for the charting of a more reliable growth path
  • Industries where ROIC increases with market share present dangers to companies with low market share or low ROIC
  • The easiest place to get capital is from your own successful operations; tomorrow’s capital comes from today’s profits

Why Capital Turns Matter — And What Warren Buffett Means When He Talks About Them

  • Capital turns = Sales/Net Tangible Assets
  • Buffett nets tangible assets against A/P and accrued expenses; gives companies credit for these zero-interest liabilities, rather than assuming shareholders pay for all of a company’s assets
  • Buffett’s businesses tend to have higher sales per dollar of assets
  • Companies with higher sales per dollar of assets have higher ROIC than competitors even if they have the same margins
  • There’s more safety in a business in an industry with:
    • adequate gross margins
    • adequate capital turns
  • Industries dependent upon margins or turns open themselves to devastating attacks from the player who can maximize key variables you control:
    • price
    • cost
    • working capital management
    • etc.
  • Companies often compete on a specific trait; it has to be a trait that is variable and can be targeted for change

How to Lose Money in Stocks: Look Where Everyone Else Looks — Ignore Stocks Like These 15

  • It’s risky to act like everyone else, looking at the same stocks everyone else looks at, or by entering and exiting with the crowd
  • Don’t worry about which diet is best, worry about which diet you can stick to; find an adequate approach you can see through forever
  • Having Buffett-like success requires every day commitment
  • You should aim to earn 7% to 15% a year for the rest of your investing life if you aren’t going to fully commit like Buffett did
  • A good investment:
    • reliable history of past profitability
    • cheap in terms of EV/EBITDA
    • less analyst coverage
  • A list of such stocks:
    • The Eastern Company (EML)
    • Arden (ARDNA)
    • Weis Markets (WMK)
    • Oil-Dri (ODC)
    • Sauer-Danfoss (SHS)
    • Village Supermarket (VLGEA)
    • U.S. Lime (USLM)    
    • Daily Journal (DJCO)
    • Seaboard (SEB)
    • American Greetings (AM)
    • Ampco-Pittsburgh (AP)
    • International Wire (ITWG)
    • Terra Nitrogen (TNH)
    • Performed Line Products (PLPC)
    • GT Advanced Technologies (GTAT)

Interview With David Baran Of Tokyo-Based LBO Fund Symphony

This is worth watching if you’re a value-investor interested in the Japanese equity market.

Description of the video from YouTube:

David Baran, Co-Founder of Symphony Financial Partners, has over 20 years of experience investing in Asia. He has lived in Asia and Japan for nearly 3 decades and is fluent in Japanese.

Baran’s SFP Value Realization Fund was launched in September 2003 when Nikkei was about 9,500. The index has fallen since then, yet his fund is still up 56% after fees.

The secret to achieving returns in Japan is that you’ll have to do more than just long-only investing. The unloved, under-covered nature of the Japanese market creates opportunities that ordinary fund managers are not capable of pursuing because it’s too hard to extract the value. Many Japanese firms, particularly the smaller ones, can boast about 40+% operating profits and 30+% EBITDA margins. They can have net cash positions and trade at 50+% net cash to market cap. Hundreds actually trade at over 100% net cash to market — which means the market is valuing these viable businesses at zero.

“Investors in the U.S. equity markets would be falling over themselves to invest in a company like these – net cash, strong business moat and growth prospects,” says Baran. But being “cheap” isn’t enough — you need catalysts to unlock the value.

M&A activity flourishing in Japan

Corporate activity is such a catalyst. MBOs have an average premium of 50% (!) and sometimes reach triple digit numbers. Many of the large Japanese conglomerates started to buy back listed subsidiaries. Baran also advises on the Sinfonietta Asia Macro hedge fund, one of the best performing Asian hedge funds in 2001.

Hear David speak about:

* The 8 reasons why management buyouts are gaining popularity

* Why you need catalysts to unlock value in Japan equities

* What investors are missing by considering Japan as an “asset class”

* How to avoid “value traps”

* Considering tail risk: Why Baran’s Sinfonietta hedge fund is “geared towards a disorderly market”

Thoughts On Diversification & Ideal Portfolio Management: A Reply

I’ve been having a constructive conversation on the topic of diversification fellow value investor Nate Tobik of OddballStocks.com.

Now, this conversation all started because of an e-mail I sent entitled “why isn’t AAPL cheap?”, the point of which was to discuss the reasons why a company that looks like it is cheap statistically (AAPL has a low P/E, outstanding balance sheet, huge FCF generation, etc.) still might not be. The diversification discussion arose organically and orthogonally. I mention this only because reading Nate’s comments is kind of like jumping into the middle of a conversation– that’s not his fault.

Below, I reproduce several of his e-mails (with his permission) and add my own commentary as well:

The other thing is most companies I end up investing in are small caps and they do one thing. So I can look at a OPST or MPAD and read the annual report in 20m. Keeping up with them probably requires 45m a year and I can explain them quickly. So having a stable of companies like this isn’t really a big deal at all. Contrast that with how much time it would take to look at BAC or AIG, it’s crazy. I can probably look at 15 small caps in the same amount of time as I’d spend looking at AIG.

My comment: In this first quote, Nate is explaining why he feels comfortable having a diversified portfolio. While I am worrying about scaling the number of positions in my portfolio down, Nate admits he is looking forward to celebrating his 50th pick one day.

I think Nate raises a valid point here. A company like BAC or AIG is so incredibly complicated, it’s hard to imagine how you’d have time to analyze anything else you might want to add to your portfolio after researching and fully understanding the risks of one of them. On the other hand, a lot of these net-nets we look at are simple businesses and while they have risks, the risks are easy to understand and keep track of for the most part. This is a fair response to the challenge I raised in my first post in which I suggested that diversification may add risk to a portfolio by creating confusion and dividing the attention of the portfolio manager.

Yeah, I’m not married to the idea of a single best idea, I mean what is that? Well America Movil has grown the most for me so is that my best idea? What about Mastercard a 10-bagger since 2006. Here’s the problem, when I purchased both of those I had no idea they’d do as well as they would, I just figured they were worth more than I paid.

[…]

In my view as long as every position I buy meets my return characteristics buying one more position doesn’t diworsify me because that next stock added has the same potential return as all the others. So holding 200 stocks that I think are all worth 50-100% more, or are compounding at 10-15% a year is fine, I would be happy with that. The reality is that many probably don’t exist.

My comment: This is probably true. But at the same time, there is nothing being added by diversification. The free lunch remains elusive. If you have 20 positions that all have a 15% per annum return potential with similar risk, you really just have 1 position with a 15% per annum return potential.

So if I looked and had to tell you what had the best prospects I really don’t know, and that’s not because I question my judgement, it’s because in my experience it’s impossible to tell. I could tell you what is growing on my basis the quickest, or what is the cheapest, but absolute best idea, I don’t know. I don’t think that’s in my investor DNA.

I’ll say though when I see something crazy cheap I will try to keep buying up to a limit, I’ll usually max out at 5% or so.

My comment: Nate is responding to my argument in the previous post that, instead of diversifying, you should put everything into your “best idea”, whatever that may be at the time (best defined as highest return potential for lowest risk out of all alternatives being considered). And he’s definitely correct that you can’t know ahead of time which investment out of a “crop” will realize the highest “yield” ahead of time. I agree there.

But my point was slightly different– that if you’ve got three different plants, say, and one of them looks the healthiest of the other two, water that one, a lot. Don’t water all three, a little, and see what happens.

I think this is where Nate’s comments on the subject are weakest. I think he’s essentially making my point (one of my points, anyway), for me. In contrast, where I think his comments are strongest are just below.

So here’s my thinking on ‘best idea’ and diversification. There is merit to it with a big “BUT.” So for you, say you take over the business, you have the ability to affect change, to run it as you like. You can only own the one business and nothing else and that’s fine, plenty of business owners do that. In a classic sense you have no diversification but it doesn’t matter because you have control.

I don’t control anything I own, and there is a limited amount someone can know about a business from the outside. So if your business sent me the financial statements I could learn a lot, but I would never know as much as you because you’re inside. Even if you don’t have statements you know more, you see salesmen walking around, you know if they’re selling a lot or not by their attitude. You know if the carpet has been replaced recently or if the furniture is getting old. All those little intangibles add up. I could go visit every company I invest in and try to learn this, some people do. That is the point of the sleuth investor, he gets to know the customers, sleuths the company, gets to know the employees. he basically gets to know everything you can know without being an insider, then he loads up. So the idea has merit.

I don’t do any of that, I’m reading statements from my basement and even when I get involved in a company all I get back is a nice letter saying thanks they’ll look into it. So I need to diversify my ignorance, I have a 5% rule because I initially don’t want to go crazy on a new position. I let positions run, at one point Mastercard and America Movil were 50% of my portfolio. I know the companies, I didn’t care, I’ve sold them down so they’re about 25% now, but still. I like to scale into something as I get to know it better. A company I’ve owned for five years I know a lot better than a company I just researched no matter how much reading I did on it.

My comment: This makes sense. Essentially what Nate is saying is that you’re taking an undue risk putting 100% into a non-control situation. There are probably few and rare opportunities where the situation is so clear cut and the risks of total concentration so minimal that you can get away with full concentration (zero diversification, or “non-portfolioization” as I put it before).

This has me “stumped.” I don’t have a great response for this (not that I need to… this is an argument about being right, it’s a discussion about merits and lack thereof). Intuitively it makes sense because my belief all along has been that the more information you have and the more conviction you have about an idea, the more you should be concentrated in it, with the extreme being 100%. But Nate is pointing out that the only place where you can be “certain” or have full knowledge of the business itself, have full conviction about what the world looks like from the business’s perspective, is if you have control of the business. So, outside of that condition, you should not concentrate 100% in normal circumstances.

As Nate mentioned later in an e-mail, he is a “serial investor”, meaning, he is looking at ideas one at a time and evaluating if that investment meets his hurdle. He is not usually comparing multiple investment ideas at once and then picking the “best idea” of the bunch.

This reminds me of a section from early in The Snowball where Schroeder says that Buffett was typically fully invested but, for the first time in his life in the mid-1960s, he was finding the bargain pool to be dried up and felt forced to sit in cash as opposed to deploying his capital.

I think in that situation, you’re forgiven for “diversifying” into cash. But short of that, this “I am holding some cash ‘just in case'”, where the “just in case” is interpreted as “just in case I come across a great bargain or the market crashes” doesn’t hold water. What if that crash never comes, or the bargains you see right now are as good as they’ll get?

Why be “diversified” in cash at that point?