The Maverick Investor

We shop at Whole Foods every once in awhile to pick up some items. The prepared food bar they have is great and hard to pass up for a quick lunch, but some of the items are just too crazy expensive.

The stock (WFM) has been decimated lately, going from a high of near $60 back in early 2015 to a recent $29.72:

One of the items on my checklist is who is the investor base? Value investors are most likely not going to buy high flying tech stocks that may never be profitable (looking at you SNAP) so with those types of companies, once growth slows and the growth investors exit it may take awhile for the stock to find its base.

We can ask the same investor base questions for Whole Foods. This was a high flying (& expensive) stock when it was showing great comp sales and growing fast, but now where are we?

Continue reading “Who’s the investor base?”

The market has been running up for quite some time and with interest rates so low, it makes sense to take on debt. Consumers are definitely taking this to heart.

I don’t want to dampen the positives of today’s economy as unemployment is low and we may enter a time period of less regulation (but who knows what will actually happen).

We do have a few things to keep in mind:

1. Total debt is getting closer to pre-recession highs.
2. Credit card debt is near crisis-era levels as we’re currently at $995b,
3. There has been an increase in the number of players in the personal loan market. Post-crisis, all the major banks had left this market because they didn’t want to put up with the losses anymore. This left room for online competitors such as LendingClub and Prosper. Over the last year or so, banks have gone back into the market. Goldman Sachs through its new consumer business Marcus. SunTrust, Barclays, Discover, and now most recently American Express. Last year (per WSJ), lenders originated $133B of personal loans- the most in at least the last decade.
4. Insider stock buying is at the lowest in three decades and based on last quarter’s results, companies are buying back less as well.

We haven’t had a major increase in delinquent accounts except auto loans have ticked up and student loans are still a problem. What’s interesting is starting during the beginning of 2010, the percentage of delinquent loans (90+ days) for most loan categories started to decline and this makes sense as the country was rebounding. Except student loans- these keep going up.

I ended up selling my position in Associated Capital (AC). This was an interesting spin-off situation from Gabelli (spun-off from GAMCO in November 2015) where GAAP rules were hiding some value. After making adjustments, which the company actually does in its filings, adjusted book value is $40.16. When I first purchased AC it was trading for around $28, a substantial discount to book value.

With the stock now closer to book value, I decided to sell it this morning and book gains. I don’t think this type of security should trade at too much of a premium to book so while I may be leaving some money off the table, I think the extra potential return is not worth the macro/stock risk I’m taking on. In other words, the risk/reward potential is no longer in my favor.

Selling with a gain is an easier mental situation versus selling at a loss. I have a position in Liberty Interactive (QVCA) where I’m in the red right now. I cut back after the last earnings (terrible), but now it’s on the table for me to re-evaluate and honestly I think this may be a mistake. This is turning an analytical error (thinking it’s a value stock with a good risk/reward setup) to a mental error of hanging on to a loss. By cutting back, all I’m doing is limited my upside and downside. It eases the mental pain, but that doesn’t drive returns. I’ll spend the next few hours answering a few questions:

1. Do I have an edge here or can I get one?
2. Is the current risk/reward setup favorable when I include time? This may have an upside of $30, but how long will it take to get there?
3. What’s my overall downside scenario?

If the answers are favorable to my general questions, then cutting back after the call was a mistake and I’ll add to it. If the answers are not very favorable, then it’s time to face the mental pain, sell it, admit I had this one wrong, and most importantly learn from this mistake. I learned from the Associated Capital setup and if there’s another similar situation, I’ll have some pattern recognition to realize that there’s an interesting opportunity. I will learn from the QVCA situation as well. Sometimes the important lessons are not necessarily the ones that will make you money, but limit losses.

 

I started digging into RLGY a little more over the last few days and here were my steps and current thoughts:

• Read their latest 10k and 10q and took notes.
• Read through their last two Investor Day transcripts as well as their last four earnings transcripts. I also read through the Q4 transcripts over the previous three years to get a sense on trends.
• Inputted their last three years of financials into my model template. I’m in the middle of revamping my template, so this was a slight headache. Some tend to automatically download the data and this does save time, but I like to input the numbers so I can get a sense for trends.
• Contacted four agents so far (three via email, one in person) to get their take on the industry and Realogy.

I’m constantly thinking about how do I gain an edge in my research process and I think you can put the potential edge into two buckets. One is an information edge. Maybe the company operates in an obscure industry where I can get an edge by talking to customers and visiting sites. The other bucket is a second-level-thinking edge. This is what Howard Marks and others like to talk about. It’s more about the behavioral aspects of the market and how investors will react to the stock.

My initial thoughts on RLGY is that it will be hard to gain an information edge. The company is massive relative to the overall industry, that it will more or less grow along with the industry. Right now they are in a slight lagging situation because they tend to be more focused on high-end homes, which is going through a tougher time due to an oversupply of homes in certain key areas as well as agent attrition. I do have an idea of how I can get an information edge on this name, but it will take me awhile to see if this is viable.

Now with the second-level bucket. Investors have slammed the stock because NRT (company-owned brokerages targeting higher-end homes) has been a disappointment in 2016 due to a slowdown in growth. Growth comes from the number of sides closed (one transaction = two sides, a buyer and seller) as well as the growth in price. If you have an increase in transactions plus an increase in average prices sold (since this is a commission-based business), you will get a big increase in revenue. In 2015, NRT’s closed sides increased 9%, but average price decreased by 2% so total transaction size increased by close to 7% (where transaction is sides x price). During Q1 of 2016, we had the same trend as sides increased by 6.7% and price declined by 1.9%. But in the next two quarters, we’re seeing something different as sides have been decreasing. Q2 had sides -1.1% and price -1.6% (for total of -2.7%), and Q3 had sides -4.2% (worse than expected) and price +1.3% for a total of -2.9%.

Where does that leave us? My quick thoughts is that this is usually a pretty decent business. You’re always going to need a broker (DIY home sales have been declining) and RLGY’s strong brand names do help attract agents and customers. Are investors saying the NRT concerns will be an ongoing problem? As of right now, it feels that way.

If we look at trailing free cash flow (CFO – capex, not taking into account money spent on acquisitions), RLGY generated about $475m. If we make the assumptions that this is a clean number of what they could generate and that this does not grow for the next three years, RLGY could generate enough to buyback 42% of the company over the next 3 years. This is an oversimplification because I’m assuming cash flow won’t be spent on debt paydowns or acquisitions, but it’s a start.

I’m at a point where I think it’s a relatively good business, I think RLGY does have a strong brand which is a big plus, and I think they will continue to be strong free cash generators. But what will move the stock? They are buying back stock, reducing debt, and paying a dividend but the stock has continued to erode. As of right now, I think the inflection point will come when we see some signs of stabilization in sides for NRT as we’ve had two quarters showing greater declines in the business.

Next steps: getting a better grasp of what’s happening in the high-end markets in select regions by talking with more agents.

Well it’s been awhile and school/family have been keeping me busy. I’m starting to work on a new name (Realogy- RLGY) and I thought it would be interesting to post a series of blog posts detailing my ongoing process.

The Intro

RLGY is a $3.44B real-estate company and while you may not have heard of the name Realogy, you have heard of their brands including 21st Century and Coldwell Banker (among others).

Over the last year the stock has gone from $40 down to $24 and it may be interesting at these levels. What’s attracting me to do some research in the name are the following:

• Should do north of $3/share in FCF and at $24 that means it’s trading for 8x FCF (or equivalently a 12.5% yield).
• It’s a very strong brand name in a fragmented market. RLGY controls about 26% of the brokerage market (not counting home sales sold using no broker).
• Management is focused on capital allocation back to shareholders via their somewhat recently initiated dividend and buybacks.
• I think the real estate market will continue to rebound, but it will probably be a slow rebound.

So why has the stock been declining? They have a few businesses: a franchise model (RFG), company-owned brokerages (NRT), an employee relocation segment (Cartus), and a title/insurance segment (TRG). The recent concerns have been around problems with their company-owned brokerages (NRT).

NRT: here they focus on the higher-end real estate market and several issues are affecting things. One is that while we see headlines of record low inventory levels, this is not the case for high-end real estate where there’s actually an oversupply. The second issue is that they are dealing with higher than usual agent attrition as competitors are courting agents aggressively.

My next post will go through my initial steps so far in the process.

 

“It’s trading for 23.5x forward earnings, why would I buy this? It’s probably a short at some point.”

Someone could have said the above statement numerous times throughout ORLY’s history and each time they would have most likely been wrong. ORLY has always fascinated me as a case study because of their strong performance and how the stock just keeps going up, so let’s dive into some numbers.

O’Reilly Automotive is an automotive aftermarket parts seller with over 4,500 stores to meet the DIY market as well as the professional service market. They compete with AutoZone, Advance Auto Parts, Pep Boys and many other smaller regional competitors.  I would expect that their performance over time is due to a few factors involving the network effect. As they continue to get bigger, they gain more pricing power over the parts suppliers.

I started in 1993 and moved my way up, annually, to 2015. In 1993 they had 145 stores, 40% gross margins, 6% net margins and it was trading for around 116x earnings and 7x revenue. My curiosity started with the question of would I buy this stock in 1993? On the surface, no. But if you ended up buying and holding, ORLY’s market cap till 2015 increased at a 16.1% CAGR. This is outstanding, and it’s also the “worst” year in terms of timing. If you bought in 2002, the CAGR is 25% and in 2008 it’s been 34%.

• 1993 gross margins were 40.1%, by 2015 they expanded to 52.3%. For a retailer selling (somewhat) commoditized parts, this is incredible margin expansion. I believe it’s a combination of moving towards higher margin products and using their size when dealing with their suppliers.
• 1993 EBIT margins were 9.2% and by 2015 were 19%
• Average sales per square foot increased from $208 to $244
• They had 18 straight years of double digit revenue growth. This is a function of store growth, but they have also historically had strong comp sales in the mid-single digit range for years.
• Lately growth has slowed to high single digits.

On valuation, the lowest EV/EBIT was 11x back in 2002 (if you bought and held, this turned out to be a 25% CAGR). for the last 15 years, ORLY has been trading at an average P/E multiple of 21x.

This is a case where at no point in 22 years (!) where it would have screened as “cheap”. It’s a great stock to look into for the qualitative factors of investing, which can definitely be the tougher part. It shows the powerful effects of being in a market with room to grow, taking advantage of this to grow, network effects, and pricing power over suppliers. When your suppliers rely on you and customers also rely on you, it can lead to great things. Going back to 1993, would you have bought ORLY?

Wow, it’s been awhile. I had to dust off the WordPress site and I see I have 847 spam comments to delete- fun times.

My plan was to take a quick break from updating the blog to focus on my transition to business school, but that quick break turned into much longer than expected. I’m back to re-focusing on the blog, but before getting back into investment posts I wanted to share some thoughts on my first year of business school (almost done, six weeks to go).

• You need to love group work! Each class is heavy on group work and I’ve been fortunate enough to have some great groups. My core group was a great mix of a former banker, marine, non-profit strategist, and an architect. I’ve definitely learned how to manage different personalities and work ethic.
• I’ve been incredibly impressed with the level of faculty. I’ve had a few so-so classes, but generally I’ve been very happy with our faculty as well as our course work.
• I remember when I first started, a second-year mentioned I was going to be very busy. I’m used to working long hours and I love it because I get to spend time researching great companies, but this is a different version of busy. The norm is take take three classes per semester and while that sounds easy, my calendar is completely full throughout the day with meetings, interesting talks to go to, and networking events.
• I have been able to stay active within research. My team made the finals for the biggest MBA stock picking competition (UNC Alpha Challenge) and I was just elected co-president for our asset management club. Next year will be busy as we continue to build up the club and work with incoming students.
• Recruiting is a full-time job! I definitely racked up the frequent flier miles visiting companies across the U.S. It’s been a great experience and I was able to meet a lot of great alums and go through different interview processes. I may post on this later so I’ll keep this one short. Right now I’m deciding about two different offers, and I’m looking forward to the summer.

That’s it for now. I’ll be back posting more often, sharing some thoughts, and blogging more about my journey to becoming a great investor.

I made a big decision a few months back and that is to go to business school. In two days I’ll be headed off on a long cross country trip before arriving on the east coast in order to start a new adventure.  Once I unpack and get settled, I’ll start to regularly post more content but until then I need to tape up some more boxes.

This blog will still be about value investing news/education, but I’ll also post more thoughts on b-school as well as start-ups and venture capital.

 

Time for a new chapter!

When I’m researching a company, part of my process always involves talking with someone in management. If it’s a smaller company, I’ll sometimes talk with the CFO. If it’s a larger company, then I’ll talk to Investor Relations. Prior to my call, I’ll have already done a decent amount of preliminary research and while doing this research I keep a list of questions. My goal is to have at least the majority of these questions answered during my initial call with the company.

I wanted to focus on one question I always ask the management team: what is your visibility? With some companies, the competitive landscape is changing incredibly fast and while this can be a positive, it can also leave management sort of flying blind. One key function of management teams is forecasting results (either units sold, contracts awarded, etc.) and having some sense of visibility makes things much easier.

A few years ago I was looking into Mellanox Technologies (MLNX) and I remember talking with IR and when I got to my visibility question, he basically said 3 to 4 months. This wasn’t necessarily a bad thing, but it was an important detail for me to note. When companies give guidance, investors place some level of trust that the management team is giving a realistic view on the upcoming quarter or year. When a company like MLNX is in a business where they don’t have great visibility, this just causes me to be cautious with any sort of guidance they give. In fact, during this time they continued to miss and lower their guidance. The lowered guidance was partly due to this lack of visibility. A more seasoned team (at the time they were a relatively new company, and can probably still be labeled that way) would be more conservative with their guidance. Of course, this is easier said than done as MLNX was in a growth-tech area. Investors want to see those double digit top-line growth guidance numbers, so why disappoint them now? The investors ended up getting disappointed and burned later, when the lack of visibility came into picture.

My go-to questions for management continue to evolve, but asking about visibility will always be a keeper.