Saturday, November 11, 2017 14 comments ++[ CLICK TO COMMENT ]++

A Look at Tripadvisor (TRIP) and its Two Problems

It's hard to find anything that seems cheap in the current bull market but as in any market, some stocks do sell off for various reasons. One of the ones that attracts me is Tripadvisor (TRIP*). As the chart below illustrates, the stock is trading near a 5-year low and is down about 70% from its 2014 peak (share count hasn't changed much and no major return of capital to shareholders).

(* You can also own TripAdvisor indirectly through John Malone's holding company, Liberty TripAdvisor, with ticker symbols LTRPA/LTRPB. You should evaluate this option as well. Sometimes holding companies, especially if it is well run like most Malone companies have historically been, are better; sometimes they are not (there may be additional overhead/fees for the holding company, may have worse shareholder rights (doesn't favour minority shareholders) and market generally places a holding company discount on such shares and they may be illiquid))

I remember looking briefly at TripAdvisor several years ago when it was spun out of Expedia (I was evaluating Expedia at that time--too bad I didn't buy that) and it seemed very expensive at its IPO. I think its P/E at IPO was 50+ and Price/Revenue was 10+. The market was definitely pricing TripAdvisor with expectation of very high growth rates.

Now that the stock has sold off quite a bit, is it cheap?

Well, the revenue has doubled since 2012 from $700M (roughly) to $1.5B now. But its profit has fallen from a peak $226M in 2014 to $120M last year and about $96M TTM. Profit may be temporarily depressed (depends on how you view their current problems).

TripAdvisor is attractive for a few reasons:
  • Massive moat: TripAdvisor has 390+ million unique monthly visitors. This is a massive number and very few internet companies in any industry can reach such numbers. As a customer of TripAdvisor and someone who uses the site quite often for travel, I think the switching costs are very high and I doubt too many other companies can replicate its content for travel planning.
  • Low capex, high ROE: When the company was doing well a few years ago, it had 20%+ ROE. Now it has dropped below 10% but it depends on if you think current profitability is temporary or not. The company has low capex requirement and product/service doesn't become obsolete easily.
  • Good (low to moderate) growth potential: The online travel industry is likely to become more popular over time. Although TripAdvisor may have captured most of the obvious customers, it will still grow, at a minimum I think it will grow at inflation + population growth.

Having said all that, there are two big problems with TripAdvisor...

Strong Moat, Low Profits?

First of all, I have been thinking hard about this company and researching it quite a bit and... is this one of those companies that has a strong moat but low ability to profit from it? Is it another Yelp (YELP)--a dominant restaurant/event/shop review site that has been unable to make much money. TripAdvisor has a lot of online visitors and has tried all sorts of things over the years but hasn't really made much money. As a user of TripAdvisor, I don't think they can easily increase profitability (other than go into adjacent verticals or something).

TripAdvisor vs Priceline/Expedia

Secondly, TripAdvisor appears to have little bargaining power and seems to depend heavily on two companies for almost half of its revenue. From the 2016 10K,
"We derive a substantial portion of our revenue from a relatively small number of advertising partners and rely significantly on our relationships. For example, for the year ended December 31, 2016, our two most significant advertising partners, Expedia and Priceline (and their subsidiaries), accounted for a combined 46% of total revenue."
This is actually listed under the risk factors at the front so it shouldn't be a surprise to most but it still makes me nervous. Basically, online travel agents, Expedia and Priceline, contribute almost half (46%) of their revenue.

To make matters worse, those two are sometimes direct competitors, especially in some recent direct booking services being pursued by TripAdvisor. They are probably best considered frenemies. Apparently TripAdvisor is rolling back those services (probably after Priceline and Expedia started a battle and decimated TripAdvisor).

Furthermore, if I'm not mistaken, TripAdvisor generates less than 5% of Priceline's revenue (probably the same for Expedia). This basically means that Priceline doesn't care if it loses the TripAdvisor revenue; in contrast, TripAdvisor cares very much about Priceline's payments to TripAdvisor.

If you ever studied corporate strategy or Porter's Five Forces or anything like that, you will see that TripAdvisor is in a bad competitive situation here. You just don't want to be in a situation where two entities, who are sometimes your competitors, are responsible for 46% of revenue, while they get less than 5% of their total revenue from you!

Worth Waiting and Seeing

Although the competitive/supplier/customer industry dynamic looks bad for TripAdvisor, it is still worth investigating because some of its advantages are pretty big. I really can't see too many companies (except possibly something like Facebook) being able to capture almost 400 million global travelers who use the site on a regular basis. Even companies like Amazon likely can't (Amazon doesn't have strong brand outside a few regions like North America/India/etc, or outside tech circles). I'm just not sure how well TripAdvisor can monetize its users.

TripAdvisor's heavy reliance on Expedia and Priceline is also largely due to the hotel segment. If TripAdvisor can generate revenue from other travel-related segments (attractions, airlines, train bookings, global/foreign events, etc), it can lessen its dependence. Remains to be seen what the company does.

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Sunday, October 1, 2017 3 comments ++[ CLICK TO COMMENT ]++

First Look: Chipotle Mexican Grill (CMG)

This isn't my type of company.

It isn't in my circle of competence...but I've been researching and studying the industry.

It doesn't have the valuation I like... but that depends on what one thinks is normal earnings.

What it is, is a contrarian, broken, growth stock with very good backward-looking numbers and uncertain future.


Chipotle Mexican Grill (CMG) is a restaurant chain that apparently pioneered and popularized "fast casual" dining--basically a cross between fast-food (e.g. McDonald's, KFC) and casual (eg. TGI Friday's, Chili's, Boston Pizza). The food is Mexican, prepared similar to fast-food restaurants and priced in between fast-food and casual (a burger at a fast-food place might be $4 whereas a burrito at Chipotle will be something like $6).

I don't know much about restaurants and am not really into food--sometimes I wonder if I should even be looking at this company--but from reading numerous articles, it seems that some of the things Chipotle does is somewhat unique and appears to be hard to duplicate (might write more about this and its possible moat (if any) in the future). Chipotle focuses on fresh, organic, ingredients while avoiding processed foods and attempts to prepare as much of the food in the restaurant as possible (this is not the case with fast-food restaurants). I don't know how much this matters to customers but it does appear that Chipotle is on the right side of the organic/healthy-food trend (not sure if  this is a fad or a long-term trend).

Unlike a casual dining restaurant, Chipotle is set up more like a fast-food restaurant and serves customers much faster and at slightly lower prices. Thus, it has very strong profitability and high throughput (orders per minute can be really high).

It's hard to say for sure, and I don't have any solid insight, but my guess is that Chipotle's food category (Mexican/ethnic) is probably a growth area. The US population is becoming a bit more Hispanic and I suspect there is an increasing demand for this type of food. The Mexican-type food is also something "new" and fresh and probably has room to capture market. Strictly speaking, it is nothing new--this stuff seems to be already popular in Southern US; and companies like Taco Bell have been around for decades--but compared to burgers and fries, or pizza, or sandwiches, or whatever, it looks like a different alternative, at least to me.

Why Look at This Now?

Chipotle was a high-growth stock in the mid-2000's up until a few years ago. It was flying high until e-coli sickened numerous customers in 2015 and the stock crashed and burned. Actually it has had several food-safety-related crises, including one norovirus outbreak in mid-2017, so the situation is a bit worse than it seems (it doesn't seem to be just one situation). If you believe this company cannot overcome the food safety issues--say it is systematically related to their business structure and is unfixable--then you should not look into this stock. I'm still researching this to see if they have actually instituted procedures to avoid the same problems in the future.

This is definitely a contrarian stock. The stock is trading near 5-year low and about 60% off its all-time high in 2015.

(As usual on this blog, you can click on any image to get a bigger, more legible, image.)

Pre-crisis, when earnings were not depressed, the stock used to trade at obscene multiples--something like P/E of 50! So the fact that the stock is down so much doesn't necessarily mean it will go back to what it was. I doubt growth investors will be coming back to this stock, and even if they do, they probably won't attach such high multiples.

The stock is trading at the following ratios (note: figures are rough estimates (I usually just do round numbers and sometimes computed over a period of time). Figures will change depending on what current price is, etc):

P/E: 65
Forward P/E (Wall Street analysts): 27

P/FCF: 54
Forward P/FCF around 25

P/Sales: 2.1
P/Book: 6

Earnings are depressed due to the crisis but even with optimistic forward-looking earnings, P/E and P/FCF are 25+. So it isn't exactly cheap. This is not a classic Graham value stock.

So why still investigate this stock if it seems to trade at high multiples?

Does History Repeat?

Chipotle's sales fell due to the foodborne illness crisis but appears to be recovering. However, note that store count went up quite a bit so some of the revenue increase is from that. Average store sales have declined from what they were in 2015. In any case, the fact that total revenue is sort of getting back to what it was pre-crisis, shows that customers still visit the stores and we may be seeing early stages of the recovery.

As seen above, before the crisis, the company was earning about $400M in profit or FCF (both are close), which is about 10% of sales.

Right now the profit or FCF margin is in the 3% range (based on the Morningstar figures I am looking at, FCF margin is about 3.9% and profit margin is 3.2%).

The question for potential investors is whether the company can go back to 10% profit margin. A lot of qualitative analysis needs to be carried out but I think the company may be able to achieve 7% margin.

The other question to ask, especially for growth companies that are not cheap, is whether it can reinvest profits back into the business and if so, at what rates? Basically, what is the ROE? Or strictly speaking, what is its return on incremental reinvested capital, and what percent of its earnings/free cash flow can it reinvest at those rates?

Chipotle had amazing ROE (20%+) in the past (pre-crisis). This is very good for a company with no debt (i.e. ROE not boosted by debt leverage), but like all restaurants and retailers, it does have sizeable operating lease obligations (so it is being boosted by leases--but this is common for the industry).

Furthermore, it paid no dividends and barely bought back any stock (only material purchase was recently, after the crisis). So it is able to reinvest most of the earnings back into the business. The rapidly increasing store count (pre-crisis) sort of proves that. I need to dig deeper into the SEC filings to make sure it is investing properly but at first glance, this seems like it is able to reinvest almost all its earnings.

It is very rare for a company with an ROE of 20%+ being able to reinvest most of its earnings. No wonder the stock market attached a P/E multiple of 50, or whatever, to the company in the past.

The current market cap is something like $9B so Chipotle can't continue this for very long. However, it does have room to grow and I think if its business is intact and customers desire the food then it can grow for a solid 5-10 years. Compared to established restaurant chains, it is still moderately sized. For example, McDonald's has a market cap of around $100B, while Restaurants Brands International (Canada; Tim Hortons and Burger King) is around $36B, Yum Brands (KFC) is $25B, Starbucks is like $77B, and so on. The business models of these chains are all different--many are franchised whereas Chipotle is not; food types are different; etc--so it isn't a direct comparison but nevertheless, it does sort of give an idea of the potential.

More Homework to Do

Hopefully this post gave a sense of what we are looking at and why Chipotle may be worthy of an investment. I remember briefly looking at this about an year ago when William Ackman made a big investment--his firm owns around 10% of shares--but the stock seemed expensive. It has fallen maybe 20% since then and, although the valuation is still high, it is attractive. I think there are two key things one needs to answer:

i. What caused the food safety problems and will is happen again? Chipotle has rolled out new procedures and altered some food is prepared so what is the impact of this? Costs are probably higher now that there are more food safety procedures. But has the final product been altered to the point that consumers don't value it like they used to (taste? less fresh? etc)?

ii. What is the long-term profitability and growth potential? Can it really reinvest most of its profit at, say, 15% ROE? Is it really worth paying a P/E multiple of around 20-25 for this company?

I'll be thinking about these questions. Stay Tuned...

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Wednesday, September 27, 2017 12 comments ++[ CLICK TO COMMENT ]++

Sold: Cabela's (CAB) Merger Successfully Closed

I haven't had much time to blog and the highly-valued markets are frustrating for any contrarian or anyone waiting for low valuations. I have continued to research some companies and hope to write something up soon but the valuations are not compelling. If anyone has some stock ideas I should investigate, leave a message below or email me (If I am interested in them, I'll research it and write it up).

In any case, the Cabela's (CAB) merger went through. This was a low return, short time-frame, situation and it worked out as expected although it went through a turbulent period. The stock sold off quite a bit after I bought it, possibly due to risk of the financial division sale not going through. That would have been the best time to enter this risk arbitrage position. It kind of seemed like this deal might not close and I would take a loss but fortunately it didn't turn out that way. As is usually the case with risk arbitrage, in hindsight the market always looks like it was wrong (at least for deals that close).

As I mentioned when I first took the position, I made some currency computation errors and ended up with a much larger position than I would have liked. I'm glad the deal closed given that there was a real risk of taking some big losses due to the position sizing mistake.

I'm kind of backing off risk arbitrage positions now (if I like the company being bought out, I will probably still take a position). In some sense, it sort of reminds me of what happened in 2007 when there were a lot of deals being done in late stages of a bull market at high valuations. If you are into risk arbitrage, you should be extra cautious for several reasons:

  • Market valuations are high: One can't generally tell how overvalued a market is, or if it is even in a bubble, except in hindsight. But my opinion is that the market is highly valued and possibly in a big bubble. Risk arbitrage deals are kind of dangerous right now because the buyout deals are happening at high valuations (prices will fall a lot if deal fails), and purchasers will try to weasel their way out of deals (using any legal language permitted in the deals) during bad times (such as when the stock market falls and they realize they have bought something at really high valuation, or if they can't get financing).
  • Unpredictable American presidency: The Trump administration is hard to predict and deal decisions almost seem arbitrary. I would definitely be cautious with foreign buyouts (especially from China, India, Korea, etc).
  • Currency fluctuations: Might not apply to you but if you are Canadian, you have to be careful since the C$ has appreciated against the US$ recently and possibly may continue if FedRes doesn't raise rates but BOC does. It looked like I would lose money on this deal because the US$ fell quite a bit within the last few months, but it rallied in the last few weeks so I ended up only losing about 1% on fx.
  • Risk with numerous sectors: Several industries are facing problems and it's not clear if you are taking positions in areas with potential secular declines. For instance, the retail sector has deteriorated way more than I imagined and I suspect the Cabela stock would have fallen way more than I initially estimated if the deal had broken.

Overall, satisfied with how things turned out.

Price Sold: $61.50
Total Return: 3.8% (annualized (estimate): 25%--not meaningful)
Total Return (C$): 2.8% (annualized (estimate): 18%--not meaningful)

When I was starting out and had smaller portfolio, these small returns would not be worth it but with a moderate portfolio, it can be ok.

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Sunday, September 3, 2017 3 comments ++[ CLICK TO COMMENT ]++

Warren Buffett's Timeless Investing Advice

Even if we are familiar with it or even if it seems blatantly obvious, it is always good to remind ourselves of fundamentals. Here is a short clip I ran across that captures Warren Buffett's timeless advice on his investing philosophy. Pretty much captures the key tenets of his approach: circle of competence, patience, and concentrated portfolio.

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Wednesday, July 19, 2017 1 comments ++[ CLICK TO COMMENT ]++

Purchase: Cabela's (CAB) - Risk Arbitrage Position

Cabela's (CAB) is being bought out by Bass Pro Shops (private) in a cash deal and I took a position in Cabela's. Deal is expected to close by end of Q3. The spread is around 4% and my expected return (based on my probabilities and downside) is about 2%. Not that great but if the deal closes within 3 months, then return is ok.

This deal is a bit risky since it is a buyout of a retailer that has seen declining revenue and profits in the last few quarters. The whole retail industry is getting clobbered--the street blames Amazon and emergence of online retailing but I think the core problem is a likely decline in consumer spending (consumers have too much debt and have been living outside their means for a decade or more and we may be seeing an adjustment--and Cabela's is no exception. It has been so bad that the buyout price was revised down--goes to show the risk in these arbitrage situations; good thing I didn't take a position earlier--so things are definitely not good. Offsetting the poor performance is the fact that their business is somewhat unique (outdoor/hunting/etc) compared to most retailers. In any case, this is not a company that I would like to own if the deal fails.

Since the spread is so small, this deal is not worth it for you if your holdings are in a different currency and you don't hedge; or have a US$-denominated account. US$ has been weakening recently against C$ and currency fluctuations can wipe out any gains.

After purchasing the stock, I realized that I made a mistake with portfolio sizing (didn't realize some figures were in US$--I work with C$ and US$ and have to combine multiple accounts and it can be confusing--and came to the conclusion my position size is too big). I'm going to try unloading a portion of it if the price rises a little bit.

Purchase price (CAB): $59.25

Return Expectation

Takeover price: $61.50
Purchase price: $59.25

Probability of success (my estimate): 95%
Return on success: 4%
Probability of failure (my estimate): 5%
Return on failure (my estimate): -32% (assume it drops to $40 (sort of the low over the last 5 years--not absolute low)
Expected Return: 2.0%

Buffett's Four Key Questions 
(1) How likely is it that the promised event will indeed occur?  
Deal price was revised down on April 17 2017 from $65.50 to $61.50 due to poor earnings so I think deal will close.

(2) How long will your money be tied up? 
Companies expect deal to close by Q3 2017. The only delay risk I see has to do with Cabela's requirement to sell off its bank division (they have agreement with a bank but it needs to be completed).
(3) What chance is there that something still better will transpire - a competing takeover bid, for example?  
Low probability of anything better materializing. Cabela's is slightly better than other retailers (given its target market) but its business hasn't done too well recently so suitors likely to be limited.

(4) What will happen if the event does not take place because of anti-trust action, financing glitches, etc.?  
Trading at a really high P/E of 22. Will suffer maybe 30% loss if deal fails. Company revenue and income have declined in the last few quarters. In fact, the deal price was revised down due to its recent performance so things are definitely not good. However, this is a somewhat unique retailer (that caters to outdoor/hunting/country lifestyle) with less competition than other retail businesses.

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Saturday, July 15, 2017 0 comments ++[ CLICK TO COMMENT ]++

Bought: Monsanto (MON)

I bought Monsanto (MON) as a risk arbitrage position a few days ago. Potential return is pretty good if you believe the risk is low (spread of about 9%, my expected return of around 7.7%). Deal expected to close by end of this year (maybe worst case Q1 2018).

I find it really hard to invest in this environment. Everything just looks highly valued and there aren't too many areas that are beaten down or appears cheap. I have been researching some out-of-favour industries (like retail, radio broadcasting, oil & gas) but they are not good industries in the long run. I hope my impatience doesn't end up hurting me but I took a really large position in this deal.

I was researching the position for almost an year when the merger spread was much higher (18% as recently as January of 2017). In fact, it looked like an attractive position ever since Berkshire Hathaway took a small position late last year (likely as a risk arbitrage position but with spreads likely more than 20% at that time). However, I didn't take a position since I already had a position in the Syngenta (SYN) merger and this was highly correlated to that one (i.e. if regulators blocked that deal, chances are the Monsanto merger might have been blocked too).

The spread is largely due to regulatory risk as the companies are waiting for European and American regulators (others not expected to be an issue) to approve the deal. I also believe that the spread is a bit larger than what it should be because risk arbitrage funds can't fully participate in this deal (the size is way too big and given the blow-ups last year of some prominent funds, I suspect there is a shortage of capital).

Purchase price (MON): $116.64

Return Expectation

Takeover price: $128
Purchase price: $116.64

Probability of success (my estimate): 95%
Return on success: 10%
Probability of failure (my estimate): 5%
Return on failure (my estimate): -31% (assume it drops to $80 (P/E of 17 on 2017 consensus EPS of $4.70))
Expected Return: 7.7%

Buffett's Four Key Questions   
(1) How likely is it that the promised event will indeed occur?    
Given that regulators already approved the other two agricultural mega-mergers, Syngenta buyout and the Dow-Dupont merger, there is a very high likelihood of this deal closing. If the deal does run into problems, the companies have the option of divesting assets to satisfy regulators (although sometimes this causes the bidder to lower their buyout price). Furthermore, some analysts quoted in the press have suggested that there isn't that much overlap between the Monsanto and Bayer businesses so there shouldn't be as much concern regarding anti-competitive or monopoly power (I haven't done my own research so not sure how much the businesses overlap). There is additional risk this year from the Trump administration in USA which is more politically driven than past Obama or Bush administrations. The CEOs of both companies met the US president early this year and came out with positive views but Trump always flip-flops and gives a message to suit the audience so not sure how supportive the US presidency is for this deal (it results in a major American agricultural power disappearing and being run by Germans). 

(2) How long will your money be tied up?   
Companies expect deal to close by end of 2017. My worst case assumption is Q1 2018.  
(3) What chance is there that something still better will transpire - a competing takeover bid, for example?    
Monsanto went through prior takeover offers and has been rumoured to be under takeover discussions for several years. Unlikely any better deal will materialize.   
(4) What will happen if the event does not take place because of anti-trust action, financing glitches, etc.?    
I wouldn't mind owning this business if deal fails so I am taking a larger position than someone who doesn't care for the business would. Obviously there will be big short-term loss if the deal fails but the underlying business is very solid and I think it has a very large moat (but growth really low). Based on 2017 consensus EPS forecast ($4.70), Monsanto is trading at a P/E of 25. Given Monsanto's dominant position in the world and its intellectual property and history of continuous innovation, it has generally traded above a P/E of 20. Even if you assume the future is worse than the past--likely true given its size--I am assuming its long-term P/E is around 17 (versus S&P 500 long-term around 15). You are only looking at a short-term loss of around 30% if deal fails and the stock trades down to a P/E of 17.

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Sunday Spectacle CCXXIX

Central Bank Money Printing

Central banks generally increase assets by printing money and buying them, so the charts below are indicative of their money printing. Historically, increase in central bank balance sheet (i.e. increase in money printing and supply of money) has led to inflation in goods and services (this is offset by deflation or wealth destruction and a bunch of other factors). Recently most of the money printing has been used to buy financial assets--for instance, the JCB is a big owner of Japanese stocks--so it is not clear to me if the situation will be similar to the inflationary busts we have seen in the past. Beyond inflation, too much central bank asset purchases also distorts the market and crowds out the private sector--not a good thing from a capitalist point of view (private sector makes better capital allocation decisions than the government).

It's interesting how the main 3 developed country central banks have behaved over the last decade.

source: "Central Bank Cash Flood Swells Bond Danger" by Lisa Abramowicz,, June 2 2017

Not visible in the chart below but looking at the interactive chart in the Bloomberg article, we see...

(figures are rounded to nearest 0.1 trillion)

  • In June 2007, ECB assets were $1.6 trillion, JCB was $0.8 trillion and FedRes was $0.9 trillion.

  • As of March 2012, ECB had ramped up its assets to $4.0 trillion, while FedRes was at $2.9 trillion and JCB was $1.7 trillion.

  • By September 2014, FedRes assets had gone up significantly to $4.5 trillion, while ECB was $2.6 trillion and JCB was $2.5 trillion.

  • Interestingly, jumping to the present (May 2017), FedRes has not increased its asset base which is still around $4.5 trillion, while ECB has gone up to $4.7 trillion and JCB to $4.5 trillion.

The things that stand out to me are:
  • FedRes balance sheet was clean and had low "economic leverage" before the financial crisis. Relative to the size of the economy, FedRes has less assets than in Europe or Japan (do note that I'm being very simplistic here and there are many other things and operations undertaken by central banks which are unique to that region and won't be properly captured in these asset figures). Some people find the FedRes balance sheet alarming (because they look at how it was a decade or two ago) but it actually is the better one of the three above. If I'm not mistaken, the US Federal Reserve has also not intervened directly in the stock market and purchased stocks en masse like the JCB or Swiss Central Bank (not shown above)--this is a good thing for US corporations and the US economy (the less central bank involvement, the better IMO).
  • Once the FedRes hit around $4.5 trillion in 2014, it has stayed the same. In contrast, JCB has significantly ramped up its assets.
  • The ECB seems to tweak its assets more so than others. For instance, its assets were $4 trillion in 2012 but then dropped to $2.6T in 2014 and is now back up to $4.7T in 2017. I'm not sure if this is due to economic events (such as Greek crisis a few years ago) or for some political reason or something else. I also haven't looked to see if the changes are due to currency fluctuations (for example, Euro has declined against the US$ recently).
  • JCB assets seem really high compared to the size of the economy. Japan has always been a mystery and it's not really clear how it is going to play out.

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Sunday Spectacle CCXXVIII

Decline in American C Corporations
the Rise of Pass-through Entities

Catherine Mulbrandon from always does good work on economics and business graphics and this is another great one on American corporations and tax collections. It clearly shows something that is not widely understood by the public at large. Namely, the number of American C corporations--these are the ones that pay corporate taxes*--have declined significantly in the last few decades. The number of pass-through entities--these are ones that don't pay corporate taxes but instead the owner is taxed directly*--has risen. The biggest impact from all this is the reduction in corporate double-taxation (which benefits owners of such companies) and the decline in taxes being collected from corporations (which hurts government/society**).

* I'm being very simplistic here and there is more complexity to the notion of how corporate taxes are paid
** This is only true if you believe government is not too big and tax revenues should not decline

source: "Number of corporations has dropped since the 1980s,"Visualizing Economics May 19 2017. Created by Catherine Mulbrandon at

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Tuesday, May 23, 2017 0 comments ++[ CLICK TO COMMENT ]++

Sold: Syngenta (SYT) -- Tender Offer Accepted

The Syngenta (SYT) buyout successfully closed about a week ago and ChemChina cashed out all shareholders that tendered the shares near the end of last week. If you haven't tendered your shares, you should do so immediately in the next round where they are accepting the shares; who knows how the untendered shares will be treated once the offer ends and you don't want to be in that situation (this is a Swiss company and is an ADR so squeeze-out rules may not be what a typical American or Canadian investor encounters).

Overall, I'm very satisfied with this deal. The returns weren't that great--about 10% from the initial October 2016 position and about 3.6% from the April 2017 position--and the deal got delayed by about a quarter for regulatory reasons but it was a low-risk position and turned out as I was anticipating. This is the kind of risk arbitrage position I would like to take on.

You learn a lot from deals like these. You don't get to see it reading this blog but I was starting to question myself because the spread was so large for so long. For such a publicly visible deal, it is easy to doubt yourself when the spread stays somewhat wide. The question, 'what does the smart money know that you don't' runs through your head a lot. In fact, I still can't figure out why the spread remained at about 3% even after the European regulators, who were the main gatekeepers, approved the deal. That's when I decided to significantly increase my stake (it almost seemed like a risk-free arbitrage at that point). I would have put more money into this deal at that point but it was a bit risky in terms of currency fluctuations (I only have a small portion in US$ and I don't hedge so even though 3% seemed almost risk-free, it could be wiped out by currency changes). Also, it would be in a taxable account so the benefit is diminished.

You also learn something about position sizing in deals like this. I was always thinking about increasing the stake but was a bit too scared. Then after the regulator approved, my confidence increased and I put as much money as I can into this (keeping in mind what I mentioned above: currency risk and tax impact). My portfolio isn't large like some of you but I had around 56% of my portfolio in Syngenta by the end.

I can never be sure but I think the spread remained large because this deal is too big for risk arbitrageurs. Professional risk arbitrageurs tend to have 20+ deals at the same time and don't take big positions unlike amateurs like me (a key reason for this is that you want risk arbitrage to be uncorrelated to the market and not so dependent on company specific risk). This is a massive deal and arbitrageurs likely didn't have enough capital to commit. Furthermore, there were some big blow-ups, including John Paulson's risk arbitrage funds, in 2016 due to big merger failures (particularly several big deals being blocked by regulators in the healthcare sector). I think this limited the capital availability and probably made them limit their exposure to individual deals.

Price sold: US$92.95
Total Return: 6.4% (annualized (estimate): 11% -- not meaningful)

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Sunday Spectacle CCXXVII

Real Estate Contribution to Canadian Provincial GDP

(source: "In Home Capital’s Mortgage Mess, Blame the ‘Unlucky’ Brokers" by Katia Dmitrieva, Bloomberg, May 23 2017)

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Sunday Spectacle CCXXVI

Rise of Indexes vs Stocks

Not sure what is counted as stocks in this graphic by Bloomberg but it's amazing that indexes outnumber stocks. That's beyond crazy. The number one function of stock markets, according to some theorists, is price discovery and wonder how much of that is lost due to the rise of indexes.

Wonder how these indexes are going to behave during a market correction or a crash.

source: "There Are Now More Indexes Than Stocks," Bloomberg, May 12 2017


Sunday Spectacle CCXXV

American Business Creation/Termination

I'm shocked to see such a low number of businesses (overall net) being created in the last decade. I don't know if the data is bad or something is being missed. This is probably good for existing companies but bad for society (since it implies less dynamic and less innovative economy).

(source: 1Q 2017 GMO Quarterly Letter, GMO. URL direct link; URL main website)

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Sunday, April 30, 2017 0 comments ++[ CLICK TO COMMENT ]++

Sunday Spectacle CCXXIV

American Diet from 1971-2014

Here are some interesting facts about food consumption in America. Several other Western countries probably have similar trends, although the actual foods may differ somewhat (I expect Canada to be at least 90% identical to USA). The following charts depict various types of food consumption from 1971 to 2014 (there is also some data for Britain here).

I'm sure there are investment implications but I'm not sure how easy it is to predict such trends. When reading these charts do keep in mind that comparisons are complicated given that there is quantity but there is also price (not shown) i.e. some item may cost 2x what something else does.

Some trends are driven by changing economics of the business. For instance, Americans used to consume less chicken (in terms of weight) in 1971 than beef but now they consume 2x as much chicken. Consumption of chicken has gone up around 2x while beef has declined and this is mostly due to cheaper cost of producing chickens. I'm guessing that the increase in consumption of strawberries, bananas and a few similar things are driven by cheaper production costs as well (including cheaper imports from Mexico and central America). A few trends are probably driven by changing demographics and introduction of new foods/diets (increase in avocado is probably driven by increased Hispanic population and food types).

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Saturday, April 29, 2017 0 comments ++[ CLICK TO COMMENT ]++

Howard Marks: Markets Richly Valued but You Don't Have a Choice

Howard Marks gave his opinion on the markets and I thought it succinctly captured the current state quite nicely. His area of expertise is the credit market but given how stocks and bonds are all at high valuations, the views are applicable across the whole investment universe in my opinion.

He basically says the market is richly valued but does not think it is overvalued or in a bubble. He thinks high-yield spreads--this is the spread between junk bonds and treasuries--needs to be smaller for it to be a bubble, at least in bonds.

I also like how he thinks about the market and talks about how it is what it is and you don't get to pick how you want it to be. He states the market can be highly valued, fairly valued, or undervalued and right now it is highly valued--but you don't really pick how it is.

If you are a professional investor or money manager, you kind of have to be invested in something so it comes down to earning the best out of the various possibilities. It will be difficult to earn high returns and investors will be reluctant to give money to managers (maybe that's one reason passive indexing is taking off?).

The current situation poses a bigger dilemma for small investors (who have more discretion on where and when to invest) and those nearing retirement (who can't afford to lose money; even if markdowns are temporary, they don't have enough time to "make it back"). It's kind of scary to be investing right now because you are basically locking in low future long-term returns. And if you tried going for higher returns, there is high likelihood you are reaching into lower quality securities and possibly increasing risk.

I see numerous amateur investors, including so-called value investors, who appear to be taking on much higher risk in order to aim for higher returns--the worst thing is that I don't think they realize they are doing that. Examples include some who are investing in preferred shares, which are generally poor investments (neither safe as bonds nor provide potentially high returns like stocks) and are better suited for corporations (depending on country, it can be tax-advantageous for corporations to own preferred shares of other companies) and certain special investing styles/strategies. I also see some investing in large-cap or mega-cap companies at P/Es over 20 even though those companies have low growth prospects (since they are so large) and questionable capital allocation (so many are buying back shares at seemingly high valuations).

It's really tough to invest right now. I have been researching a bunch of stocks and hardly anything seems cheap; and the ones that do appear cheap are cyclicals vulnerable to economic recession.

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Sunday, April 23, 2017 0 comments ++[ CLICK TO COMMENT ]++

Sunday Spectacle CCXXIII

Cannabis (Marijuana) Stock Performance

Still not fully legal and market likely to be limited for a few years more but the Bloomberg Intelligence Global Cannabis Competitive Peers Index is worth around $55 billion. Not all stocks are 100% marijuana-related and most of the value is so far in the bio-pharma sector but still indicates market pricing for this emerging industry.

source: "54 Stocks Deep in the Weeds," Laurie Meisler, Bloomberg, April 20, 2017

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Friday, April 21, 2017 0 comments ++[ CLICK TO COMMENT ]++

Sold: Khan Resources (KRI)

Some third party is making an offer (approved by Board) for $0.05 for remaining shares of Khan Resources and I figured the deal was going to be approved by shareholders so I sold out at $0.055. Overall I'm satisfied with this return given how most of the capital was returned very quickly last year. This is an ideal liquidation situation and I would invest most of my money in these situations if I could. Unfortunately the stock was lightly traded and hard to acquire many shares so couldn't build up any meaningful position.

Sale Price: $0.055
Total Return: 5.1% (annualized approx. 10% -- meaningless since less than 1  year holding period)

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Thursday, April 20, 2017 0 comments ++[ CLICK TO COMMENT ]++

Graham and Doddsville 2013 Li Lu Interview

The game of investing is a process of discovering: who you are, what you’re interested in, what you’re good at, what you love to do, then magnifying that until you gain a sizable edge over all the other people.
-- Li Lu, Graham & Doddsville newsletter, Spring 2013
When I first encountered him many years ago, I didn't know how good of an investor Li Lu was. Now, it seems like he is one of the top ones. I don't consider him a superinvestor (yet) but that's partly because his record and his stockpicking is unclear to me. In any case, Charlie Munger is a big fan of him so Li Lu is definitely in the top 25% of the investing world.

I ran across a very good interview with him in the Spring 2013 Graham & Doddsville newsletter (Columbia Business School). Some of you may have seen it already but it was the first time I read it--I was away from investing the last few years around the time of this report--and it is an excellent interview. If you haven't read it before, I highly recommend it. Even if you don't care for Li Lu or his investing style, the content is very insightful.

The good thing about Li Lu is that he is very open and tries to explain his thoughts so newbies and amateur investors can learn a lot. In contrast, there are many other successful investors who don't really say anything insightful and I hardly learn anything from them. In fact, I think this interview might be one of the best investment pieces I have read in my investing career. It covers so many important topics and Li Lu's thoughts are worth pondering. For future historical purposes, I thought I would extract the key points and post briefly about them. I recommend that you read the full interview though.

(as is usually the cast on my blog, anything in bold is by me and my comments within quotes are in square brackets)

On Shorting
G&D (interviewer): You don’t short stocks at Himalaya, correct?

LL (Li Lu): That’s right; not any more. That change occurred nine years ago. Shorting was one of the worst mistakes I’ve made.

G&D: Is your lack of a short book due to your desire to be a constructive third-party for companies and their management teams?

LL: Yes. But also, you can be 100% right, and you could still bankrupt yourself. That aspect of shorting just frustrated me too much! [laughs] Three things about shorting make it a miserable business. On the long side, you have 100% downside but unlimited upside. On the short side, you have 100% upside and unlimited downside. I do not like that math. Second, the best short has some element of fraud. However, a fraud can be perpetrated for a long time. Of course you borrow to short, so they could really just wear you down. That’s why I could be 100% right and bankrupt at the same time. But, you know what, you go bankrupt first! Lastly, it screws up your mind. Shorts just grab your mind and take away from the concentrated effort that is required to do proper long investing. ... economy overall has been really growing at a compounding rate for 200-300 years, ever since the modern science technology era. So, naturally, the economic trend favors long positions rather than short.
I don't short so I don't have much to say. The only time I ever did was through an inverse ETF about 10 years ago--it was more like a bet against a market--and I said that I would never do that ever again. I actually made a positive return and it contributed to better performance during the stock market sell-off in 2008 but it was an unpleasant experience. The problem for me was that I had no idea what was going on (regardless of whether it went up or down) or what  the end result was. It is completely unlike a long position where you have some idea of why a position is rising or falling. The market rises in the long run so you are really fighting against time.

As Li Lu also points out, short selling sort of messes up your mind and is totally distracting. If you are betting against anything--in my case I was betting against the market so it was even worse--it just clouds your long positions and any positive thoughts you may have. For instance, it's easy to second-guess any bullish thought if you also have any sort of short position.

Finally, short selling is very expensive for small investors (whether you are borrowing shares, using inverse ETFs, or buying/writing put/call options). I never actually short sold directly because whenever I inquired, the costs seemed really high. It seemed like it wasn't for small investors. It sort of reminded me of bonds, where I'm quoted really high costs (bid-ask spread for instance) and feel that bonds aren't cost-effective for small investors.

Sourcing Investment Ideas
G&D: Can you talk about your investment process?

LL: Ideas come to me from all sources, principally from reading and talking. I don’t discriminate how they come, as long as they are good ideas. You can recognize good ideas by reading a great deal and also by studying a lot of companies and constantly learning from intelligent people...

G&D: Are the people that you talk to fellow investors or are they people like customers, suppliers, and management?

LL: All of them. I don’t talk to as many investors – very few. I am more interested in talking to people who are actually running businesses and entrepreneurs or CEOs or just good businessmen. I read all of the major newspaper publications and annual reports of the leading companies. I get a lot of ideas out of those too.
One interesting thing is that Li Lu says he doesn't rely on investors for ideas. Instead, he gets ideas from management, media, etc. This is sort of opposite of many others I have read who ignore management and instead rely on other investors. I think this depends on your investment style and your personality and thought processes.

Always Need to Beat Opportunity Cost

I really like how Li Lu thinks about portfolio management:
You start out by holding cash, and that is a pretty good opportunity cost, because it doesn’t go down. So any time you find an investment, it has to be an improvement on an overall risk-adjusted basis. You may find some very interesting things, and now you’ve got a basket of a few interesting securities plus cash. That is a pretty good opportunity cost, and the next time you add another security, it better make the portfolio better than the existing one. You just constantly improve your opportunity cost.
Sounds obvious but I have a feeling many don't think about this much. I see a lot of people just adding money to whatever position or selling something because it has gone up, and then seemingly pursuing even worse ideas. I think people often go off on tangents and weaken their portfolio.

For small investors, it's probably better to follow some rigid approach that forces you to think about whether you are actually improving your opportunity cost. I like some of the things Geoff Gannon has said, such as limiting yourself to five stocks at a time or one new stock purchase per year (this is along the same line as Warren Buffett's thinking that small investors should limit themselves to 20 picks--punches in a punchcard--over their life). Even if you don't follow that perfectly, some approach like that will definitely force you to think about whether you are indeed improving your overall portfolio.

Change & High Technology Companies
G&D: How to you get comfortable with the risk/ reward of a high tech company like BYD that is undergoing pretty rapid technological change? Do you think you have a good sense of what BYD will look like 10 years from now?

LL: Most businesses are subject to change if you stay with them long enough. There’s not a single business that I know of that will never change. ... Every company in today’s age is a technology company somehow, but the technology may not be on the cutting edge, and may not play an important role in the success or failure of the overall business. ... So culture really plays an important role in those faster-changing environments, enabling certain companies to always surge ahead of everybody else.
Many value investors mistakenly think that it is high-tech (or similar) companies that change rapidly but as Li Lu alludes to, almost every industry can change. In fact, right now, I think the retail industry is going through even faster change than most technology companies. There is probably more innovation and disruption at Macy's and Ralph Lauren and Under Armour than at Oracle, Alphabet or Intel.

One thing I learned from Bill Miller is that some technology companies actually don't change much, even if they appear to. The products might change but their market share doesn't. In other words, just because some company introduces a new product every year doesn't mean the company is changing rapidly. A company like Intel might introduce a new microprocessor every few years but it isn't really changing much and the relationship with customers isn't really changing.

When to Sell
G&D: How do you make your sell decisions?

LL: One should make sell decisions on one of three occasions.
Li Lu goes over three reasons one should sell:
Number one, if you make a mistake, sell as fast as you can, even if it’s a correct mistake...Let’s say you go into a situation with 90% confidence that things will work out one way and a 10% chance they work out another way, and that 10% event happens. You sell it. Then there’s a mistake that your analysis is completely wrong. You thought it was 99% one way but it was actually 99% the other way. When you realize that, sell as fast as you can. Hopefully at not too much of a loss, but even if it is a loss it doesn’t matter – you have to sell it.
Easy to say but many people, including me, hang on to mistakes way too long. I haven't done it but one thing I plan to do, based on advice from others, is to write down why I would sell (the negative scenario) and do it if that scenario develops. Easier to think about it when you buy the stock than trying to do it when the adverse scenario is unfolding.
The second time you want to sell is when the valuation swings way too much to the other end of the extreme. I don’t sell a security because it’s a little overvalued, but if it is way overboard on the other side into euphoria, then I will sell it.
Warren Buffett obviously doesn't sell even if the valuation is extremely high (likely to preserve his reputation and relationships e.g. Coca-Cola in late 1990's) but most other investors should.
The third occasion when to sell is when you find something that is better. Essentially, a portfolio as I said is opportunity cost. Your job as a portfolio manager is to constantly improve on your basket. You start with a high bar. You want to increase the bar higher and higher.

Li Lu's Intellectual Honesty
The most important thing in our business is intellectual honesty. What I mean is four different things: know what you know, know what you don’t know, know what you don’t have to know, and realize that there is always a possibility that “you don’t know that you don’t know.” Those four things are distinctly different. In a crisis, things emerge that test you on all four categories.
That’s why people freeze in the midst of a crisis. People freeze because they were not intellectually honest before. They never quite distinguished certain issues or questions and put them into the appropriate basket.
Christopher Davis’s grandfather used to say that you make the most money out of a bear market financial panic – you just don’t know it at the time.
Probably the hardest thing for newbie investors like me is to understand what I know and what I don't know. This is probably the hardest thing to develop and probably takes time and experience.

Macro Thoughts or Lack Thereof
G&D: How do you view the overall attractiveness of equities today?

LL: I also put that into "too hard" and "I know I don’t have to know." ...

G&D: A lot of smart people believe that renewable energy is the next big revolution. You’ve done a lot of work on battery technology and BYD, so is that something that you think about beyond batteries? What do you think the energy revolution will look like?

LL: I pay attention to those macro trends only in the hope that I can have comfort that they’re a tailwind as opposed to a headwind. Now, how much they can help if they’re a tailwind, or how much they can hurt if they’re in my face, I don’t know. But I want such macro trends to be behind me rather than in front of me. So that’s the extent that I want to know mega trends.
You could tell Li Lu is a pure value investor: he doesn't really care about the macro situation or where market valuation is at. The advantage of ignoring macro stuff is that you don't get confused by macro thoughts and don't waste time sifting through macro data/arguments/etc. The downside is that you are vulnerable to macro-driven "storms," such as when many value investors suffered huge losses on real estate and financials in the financial crisis (many macro investors were bearish on housing due to price run-up in mid-2000s but value investors piled into financials/homebuilders/etc because they were very cheap), or how numerous value investors were exposed badly to oil&gas a few years ago but many macro-oriented investors were very concerned.

I don't think being macro-oriented is necessarily better. One just needs to figure out what they are good and try to get good at it. Macro is definitely distracting and confuses you more.

Parting Words

Advice for upcoming investors:
LL: Understand one business and what really makes it tick: how it makes money, how it organizes its finances, how management makes its decisions, how it compares to the competition, how it adjusts to the environment, how it invests extra cash, and how it finances the business.
The way I categorize what Li Lu is saying is sort of like the following:
  • how it makes money [business model, business analysis]
  • how it organizes its finances [structure of the corporation, financial analysis]
  • how management makes its decisions [corporate culture, management incentives]
  • how it compares to the competition [competitive landscape, moat]
  • how it adjusts to the environment [employee capabilities, culture]
  • how it invests extra cash [capital allocation, ownership]
  • how it finances the business [capital structure]
These are all important things one should keep in mind! If I get some time, I might write a post on this alone. I think I'm going to incorporate this into all my future investment evaluations. I should use this as a broad checklist going forward.

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Sunday, April 16, 2017 0 comments ++[ CLICK TO COMMENT ]++

Sunday Spectacle CCXXII

Source of American Government Funding

Ever wondered how taxation has changed in America over the last 100+ years?

Following charts show the sources of government revenue in America from 1873 to 1940. Other developed countries are somewhat similar from a long-term perspective.

Until the early 1900's, there was really no personal income taxes or corporate income taxes. Most of the revenue in the distant past was through customs levies and tobacco/liquor taxes. So basically nearly all government tax was consumption tax. The amount government collected was very small by modern standards (US government collected no more than 800 million in taxes in the 1800's whereas it generated 3+ billion by 1918).

Government wasn't large and it didn't provide much in the 1800's (there was no standing armies for a long time, not to mention any notion of social welfare, public education, large-scale healthcare, no major public infrastructure projects, and so forth.) Government became very large in the 1900's and started providing way more services (particularly public education and healthcare). I would guess that large government probably didn't have as much positive impact on economic growth but it probably increased standard of living by orders of magnitude (which isn't really captured in GDP or other economic measures).

Chart stops in 1940 but my opinion is that, by the 2000's, government in most countries, certainly developed countries like USA or Canada, have gotten too large. I think the pendulum has swung too much towards larger government and government needs to shrink. I don't think we should go back to the 1800's but society will likely benefit if government were, say, 1/3 smaller.

(click on image for a larger version; note that top graph scale is different from bottom one)

source: Extracted from the book, Wall Street Waltz (Ken Fisher, 2007)

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Sunday, April 9, 2017 0 comments ++[ CLICK TO COMMENT ]++

Sunday Spectacle CCXXI

American Retail Bankruptcies
(to Q1 2017)

So far, retail industry is on pace to set a post-financial-crisis peak. Retail is definitely overbuilt in America and consumer debt is also too high, so the shrinking of the industry is not a huge surprise to me (the industry is growing overall but most of it is in Internet sales and the number of retailers are shrinking). Internet cannibalization is also hurting retail but I think that is a slow long-term threat; the real issue is overbuilt retail with way too many retail chains, not to mention malls/shopping centers/etc.

Retail is a tough industry for investors--generally no barrier to industry of any kind, and driven a lot by unpredictable hits, fads and trends (sort of like the consumer technology industry)--but I wonder if the current situation presents an opportunity.

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Friday, April 7, 2017 0 comments ++[ CLICK TO COMMENT ]++

Purchase: Syngenta (SYT)

Added more to my risk arbitrage position in Syngenta (SYT). American and more importantly, European regulators approved the buyout a few days ago and I think this deal will close (a few other countries like China and India still need to approve but they generally don't challenge such deals). There is still a spread of a few percent and I figure it is a low risk bet. I think the spread should be smaller and not sure why it still exists (there is the possibility that this deal is too big and all risk arbitrage firms are tapped out; it's also complicated by the fact that the underlying shares trade in Switzerland).

Purchase Price: $89.70

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Sunday, April 2, 2017 0 comments ++[ CLICK TO COMMENT ]++

Sunday Spectacle CCXX

Forbes 2000 Largest Companies in the World (2016)

Top public companies in the world according to Forbes, which uses a combination of revenue, profits, assets, and market value.

source: "The World's Largest Companies 2016,", May 25, 2016.

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Tuesday, March 28, 2017 0 comments ++[ CLICK TO COMMENT ]++

Canadian Real Estate Lender, Home Capital Group, Terminates CEO

Not sure if this an isolated event or a symptom of a possible Canadian housing bubble, but Home Capital Group (TSX: HCG), just terminated its CEO. I don't follow Canadian financials so not sure but I think HCG may be the largest alternative real estate lender in Canada. CBC News reports (Mar 28 2017):

Home Capital announced Monday after stock markets had closed that that Martin Reid, its president and CEO, was out, effective immediately.

Investors responded by sending shares of Home Capital down $2.66 to finish at $25.06 on the TSX.

Reid has been replaced by Bonita Then, a member of Home Capital's board of directors, until a new permanent CEO can be hired.

"Home Capital requires leadership that can bring to bear a renewed operational discipline, emphasis on risk management and controls, and focus on improving performance," said Kevin P.D. Smith, the chair of company's board, in a statement.

In February, Home Capital said it had received an enforcement notice from the Ontario Securities Commission related to its disclosure in 2014 and 2015 about the impact of the company's findings that income information submitted on some loan applications had been falsified, and its subsequent move to suspend some brokers and brokerages.

The company said in February that the OSC issued a preliminary conclusion that Home Capital. failed to meet its continuous disclosure obligations during that period in 2014 and 2015. Home Capital has said it believes its disclosure met requirements.

Home Capital also announced on March 14 that several company officers and directors had also received enforcement notices from the OSC.
HCG has been under attack by short-sellers for a few years now but as someone living in Canada, it's not entirely clear what is going on with real estate.

Canadian residential real estate--not sure about commercial real estate but might be worth looking into that if you are thinking of shorting (likely easier and less costly short for small investors)--looks like a blatant bubble if you look at traditional metrics like price vs rent, price vs household income, average mortgage duration (to pay off mortgage), etc. The numbers make little sense if you look at income or any sort of serviceability metric.

But a lot of the prevalent causes of the American real estate bubble a decade ago (or some of the other ones in Europe) don't appear to be present in Canada. Part of the reason is that everyone (particularly lenders and investors) has learned from the financial crisis and watch for those signs. In other cases, due to the structure in Canada, the same thing doesn't apply. For instance, secrutization was never big in Canada. You also don't have a multitude of lenders/mortgage insurers/etc that was common in USA (partly because Canadian banking is an oligopoly and difficult for smaller/new lenders to survive).

Market is likely pricing in a lot of the negativity surrounding HCG. It is trading close to book value (versus big banks at multiples of book) and P/E is something like 7 if I remember. But then again a lot of the crisis-stricken firms during the financial crisis trading at low valuations as well (the most notable in my eyes was the homebuilders who were trading at really low valuations). One big red flag I see is that the CEO has apparently been in the role for less than an year (although he was president for many years) and the board references "risk management" which is a big concern given how leveraged financials are.

Remains to be seen if the issues faced by HCG are something isolated to the company or a harbinger of something bigger...

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Monday, March 27, 2017 0 comments ++[ CLICK TO COMMENT ]++

Sold: BCE (via MBT merger)

BCE (TSX: BCE) buyout of Manitoba Telecom Services (TSX: MBT) was successfully completed. I ended up with a return of about 1.8%, which is satisfactory.

The best case outcome (if payment was 100% cash) of about 2.1% didn't materialize; instead, I ended up with a mix of cash and stock (original expectation was 0.7% but BCE shares rose (and I didn't hedge) so I gained about a percent from it).

I wouldn't entertain these situations in the past but my portfolio is a little bit larger and transaction costs have come down a lot in a decade, so it is worthwhile for the time being.

Sold: $59.06

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Is the Market Overvalued?

We are in a very unusual time in my opinion. Presently valuations are high--whether you look at P/E (or the inverse, earnings yield), P/Sales, stock market valuation to GDP, Q ratio, or whatever else you want to use--but many argue it is not a bubble.

Generally, the majority can make seemingly plausible arguments for high valuations during the bubble (otherwise you wouldn't end up in a bubble in the first place) so the fact that consensus says there is no bubble doesn't mean much. However, what is different right now, is that the contrarians and those that believe we are in a bubble, can't seem to make a strong case. I think the reason is due to there being no psychological or behavioural elements that are driving the bubble--the mania is missing.

I think what is happening is that the mania is not in stocks but in bonds. The bond market, which is larger than the stock market, has a big bubble. Investors are literally buying bonds without any regard for yield, with big chunks of capital being deployed at less than 2% yields (including some very close to negative yield). Long-term inflation in USA is around 3% so you are essentially look at a loss in real terms. Basically, the mania is in bonds.

The bond mania is impacting stocks hence it is not directly observable in the stock market. That's my view right now.

In any case, if you are a contrarian or macro-oriented, you might want to check out this piece by James Montier of GMO, "Six Impossible Things Before Breakfast" (Mar 2017) [main page link]. Montier is in the minority and doesn't share the general consensus (i.e. enthusiasm for stocks). He goes over 6 things he feels investors are assuming that are likely false. I don't necessarily agree with everything he says--is secular stagnation really due to policy?--but do share his overall stance. I'll just list the 6 items he addresses and leave it up to you to read the piece if you are interested.

In order to make sense of today’s pricing, you need to believe in six impossible (okay, I’ll admit some of them are just very improbable as opposed to impossible) things.

1. Secular stagnation is permanent and rates will stay low forever. As we have argued at length elsewhere, secular stagnation is a policy choice and we could exit it reasonably quickly by implementing appropriate policies.

2. The discount rate for equities depends on cash rates. This is nothing more than a belief. It has no foundation in data and not a scrap of evidence exists that supports this hypothesis.

3. Growth rates and discount rates are independent. This is a very questionable assumption. If, as I believe, it is false, then it makes the “Hell” outcome Ben has discussed in previous Quarterly Letters less likely, unless the first two beliefs hold completely.

4. Corporates carry out buybacks ad nauseum, raising EPS growth despite low economic growth. This would imply rising leverage, which is already close to all-time highs. Remember Minsky: Stability begets instability.

5. Corporate cash piles make the world a safer place. Cash levels aren’t high by historic standards, and valuations are extreme even when cash is fully accounted for.

6. The “Hell” scenario is the most probable outcome. This requires “this time is different” to be true and, unlike Jeremy Grantham, I am not yet ready to assign this exceptionally useful rule of thumb to the waste bin of history. Put another way, Hell requires that stock prices have reached a “permanently high plateau,” and I’m not about to embrace that statement.

Sunday, March 26, 2017 0 comments ++[ CLICK TO COMMENT ]++

Sunday Spectacle CCXIX

Plastics & Pollution

A new environmental scourage created over the last 50 years has arisen due to the invention of plastics. Very useful and unique but plastics don't degrade in nature very easily. Unfortunately, they are starting to pollute the oceans on a large scale...

source: "The World's Oceans Are Infested With Plastic" (Niall McCarthy,, Mar 22, 2017)

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Saturday, March 25, 2017 0 comments ++[ CLICK TO COMMENT ]++

The Thing About Healthcare...

Adam Davidson of The New Yorker had a good opinion piece about why healthcare is so important and unlike anything else and I thought I would highlight some of his points here. I struggle with healthcare spending and government policy because, on the one hand, healthcare is spiraling out of control and growing way beyond inflation or economic growth (not just in USA but in Canada and most of the developed world actually); but on the other hand, it is so important that as Davidson alludes to below, it should really be thought of more as an investment in the long-run future of the country rather than an expenditure per se.

Titled "What the G.O.P. Doesn't Get about Who Pays for Healthcare" (Mar 23 2017) and directly addressing the Republican Party in USA, Adam Davidson writes (as usual, bolds are by me):

In economics, when a person has some money, they can do one of two things: invest it or use it to buy something they want to consume. Most of the time, they consume. That can mean buying a slice of pizza, or “consuming” a vacation, a movie, or a new car. Health care is typically classified as a form of consumption. But if my relative spent some of his money with a back-pain specialist, who could teach him exercises that would prolong his working life by another decade, shouldn’t that be considered an investment? He would be choosing to forego paying for something that he actually wants today so that he can make more money in the future.
This is a very important point that is largely ignored in all the arguments and shouting matches: a big chunk of healthcare spending actually contributes to the economy in the long run. It's not like discretionary consumption spending whose benefits are very temporary.
In 1993, the economic historian Robert Fogel wrote an influential paper (it was his Nobel Prize acceptance speech) in which he demonstrated that improvements in health accounted for fully half of the economic growth in the United Kingdom in the first two centuries of the industrial revolution. Because of improvements in sanitation, food production, and medical treatment, people were living longer and spending much less time incapacitated by illness and hunger. Health was more important than railroads, electricity, mass production, and every other technology we more readily associate with economic success.
Wow! Until reading this, I never knew that half of the benefit of the industrial revolution was healthcare-related. It sort of makes sense when one thinks about it but it's still not well appreciated. I think things like railroads and mass production probably contributed to the improvement in healthcare (it's hard to isolate causes and effects of specific technologies and scientific advances) but, nevertheless, the main point that improvement in, say, sanitation, contributed mightily to the improvement in society is widely ignored.
If we deny someone care today, we will be paying that cost later, in the form of more expensive treatment or lost years of productive employment.
I think people who try to reform healthcare, often by blindly cutting costs, are completely ignorant of the point above. Namely, long-term productivity is sacrificed and completely ignored.

Having said all that, I think healthcare costs are spiraling out of control and need to be reigned in--this goes for Canada too even though no one is complaining yet (my province, Ontario, spends about 40% of its budget on healthcare, whereas 30 years ago, most of that was spent on building roads, airports, electricity grid, etc--no wonder there is no money for that now). However, I think anyone trying to reform healthcare shouldn't focus blindly on costs. Cutting healthcare has adverse long-term outcomes.

I think the reformers and politicians need to separate out the healthcare costs that prolong people's lives past 70 years (or whatever number you want to pick). This isn't going to be popular with Baby Boomers but the reality is that such healthcare spending has low (to almost zero) long-term societal benefits. I think people should try to cut those costs. Unfortunately that's not going to happen any time soon since the Baby Boomers control most of the voting power in most developed countries.

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Thursday, March 23, 2017 0 comments ++[ CLICK TO COMMENT ]++

The Bizarre Case of Sears Holdings

Concerns that Sears (SHLD) is headed toward bankruptcy have been reignited. The company's shares closed Wednesday down more than 12 percent, falling below $8, after the struggling department store expressed doubt about its future as a retailer. "Our historical operating results indicate substantial doubt exists related to the company's ability to continue as a going concern," Sears said in an annual filing with the Securities and Exchange Commission. (source: "Sears tells investors nothing's changed, despite 'going concern' statement," Krystina Gustafson, CNBC, Mar 22 2017)
Headed for bankruptcy, right? Yet...
Hopes raised by a chairman’s letter on future strategy March 9 were crushed Wednesday when Sears Holdings listed a “going concern” statement in its annual report. The same day, Bruce Berkowitz increased his position in the dying retailer 2.05% in his third purchase of the month. (source: "Bruce Berkowitz Buys More Shares of Sears," Holly LaFon, GuruFocus, Mar 23 2017)

An insider, who owns about 26% of the shares and also owns some loans(?)/debt, adds more common shares*.

Not just that, it is one of the best investors over the last few decades**.

And, he happens to be a value investor***.

I have been thinking about this a lot lately...

Are we looking at a Bill Miller buying Bear Stearns in 2008 (or me buying Ambac)? Or is this one of the rare buying opportunities of our lifetime--Berkowitz used those same words to justify his Sears purchase a few years ago with disastrous outcome?

* Given the precarious situation Sears is in, and the somewhat low prices the bonds are trading at, he could have just bought those (which are trading way below par and will likely earn at least 15% annualized return for the next 10 years if the company doesn't go bankrupt).

** I'm not a huge fan of Bruce Berkowitz--quite frankly, I don't understand his thinking and strategies, from the more recent Fannie/Freddie preferreds to the older bets on St. Joe, and yes, Sears--but he still has one of the best records of any public investor and I admire him as a master contrarian.

*** If this were a different type of investor, say a short-term trader, quant investor, special situation investor, and so forth, it may not signal much. Even with most hedge fund investors, it may not mean much (since they could be hedging or something). But mutual fund value investors tend to buy undervalued stocks so it means a lot.

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Don't Blindly Accept SEC Filings

Matt Levine of Bloomberg highlights how anyone can file anything on EDGAR, the SEC online report dissemination system (same thing probably can happen in other countries as well?). The person may still be criminally liable depending on what they file but that is after-the-fact, so one shouldn't blindly accept regulatory filings:

The Securities and Exchange Commission's Edgar system for making securities filings is notoriously prone to hacking. "Hacking" maybe isn't the word; it's very low-tech. You submit an application to the SEC, have a notary stamp it, and get back your Edgar ID. Then you can just make whatever filings you want on Edgar. Want to say that you just bought Facebook Inc.? Sure, whatever, go right ahead, knock yourself out. Want to buy stock in a smallish public company, make an Edgar filing claiming that it's being taken over, and then sell your stock on the reaction to the fake news? Yeah that can sometimes work, though not as well as you'd hope
Anyway here's a funny story about a guy who said on Edgar that he had sold his art company to Alphabet Inc. for $3.6 trillion of Alphabet stock. He doesn't seem to have made any money off the fake filing; he just did it for fun, or for art. I don't mind that so much.
Yes, you can literally file anything, including this guy who claimed he is the richest man on earth ;) That was a joke but some people do try to manipulate it for personal gain, which is generally illegal (depending on what they do). Worth checking out the main Bloomberg story.

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