Saturday, April 26, 2014

High Yield Reads - 4/26/14

Summary of recents posts and pieces of interest, sometimes enduring, to investors:

  • Josh Peters "Time to Tighten Portfolio Standards" - great reminder that even though its slim pickings on good things to buy to not cave in on quality. Only invest in companies that can make it through the next downturn
  • Morgan Housel - "America's Biggest Edge Over the Rest of the World" demography really matters. Like many important things, its a massively important fact hiding in plain sight. One other edge I would suggest is that the US has the highest percent of its population who got into leaky, disease infested boats and crossed an ocean, so risk taking genes matter, too.
  • James Altucher can really write, in this piece he takes scalpel and skewer to the financial industry, the whole thing is worth reading, like everything he does its all over the map. Two pieces of practicality:
Three types of people:
  1. People who hold stocks FOREVER. Think: Warren Buffett (has never sold a share of Berkshire Hathaway since 1967) or Bill Gates (he sells shares but for 20 years basically held onto his MSFT stock).
  1. People who hold stocks for a millionth of a second (see Michael Lewis’s book “Flash Boys” which I highly recommend.) This is borderline illegal and I don’t recommend it.
  1. People who cheat.

E) What stocks should I hold?Warren Buffett has some advice on this (and I know because I wrote THE book about him. A friend of mine who knows him told me my book was the only book that Buffett thought was accurate about him).
So since I don’t know anything, I will let Warren Buffett take over here.
He says, “if you think a company will be around 20 years from now then it is probably a good buy right now.”
I would add to that, based on what Warren does. It seems to me he has five criteria:
  1. A company will be around 20 years from now.
  1. At some point, company’s management has demonstrated in some way that they are honest, good people. If you can get to know management even better.
  1. The company’s stock has crashed for some reason (think American Express in early 60s, which he loaded up on. Or Washington Post in the early 70s. Or Coca-Cola in the early 80s).
  1. The company’s name is a strong brand: American Express, Coke, Disney, etc.
  1. Demographics play a strong role.

  • Tren Griffin on A Dozen Things He Has Learned from Jeff Bezos - Bezos is really gem.  My favorite thing that he does is attaching his 1997 shareholder in every subsequent year. This is the exact opposite of what most people do - namely throw a dart and then draw a bullseye around where it landed.

    This year's letter contained this little nugget of gold:

    "Pay to Quit is pretty simple. Once a year, we offer to pay our associates to quit. The first year the offer is made, it's for $2,000. Then it goes up one thousand dollars a year until it reaches $5,000. The headline on the offer is "Please Don't Take This Offer." We hope they don't take the offer; we want them to stay. Why do we make this offer? The goal is to encourage folks to take a moment and think about what they really want. In the long-run, an employee staying somewhere they don't want to be isn't healthy for the employee or the company. "

    Think about how many people are totally ineffective in your average company, say 40%? In any company, probably 10-20% actively spread dissent. Someone there has a black belt in organizational jiu jitsu. 

Saturday, April 19, 2014

High Yield Reads - 4/19/14

Summary of recents posts and pieces of interest, sometimes enduring, to investors:

  • Financial Matters - great list by A Wealth of Common Sense of what does and does not matter to investors
  • Charting a Tasty Future for Post -  not a dividend payer, but William Stiritz' history is well told in the excellent book The Outsiders.  The CEOs in The Outsiders are not big on paying dividends, they are more around growing free cash flow. Stiritz delivered returns of 20% over 19 years at Ralston Purina with many deals. He has running the same playbook, it appears, at Post Holdings, most recently with a $2.5B acquisition of Michael's Foods.
  • David Herro says Emerging Markets are Still Overpriced. He cites a systematic overvaluation where countries look cheap on a P/E basis, say a P/E of 10 for Brazil, but then when you look at the more successful companies within those countries that you would want to own they are priced very high, Brazil's drugstore chain, Raia Drogasil, has a P/E of 30.

Friday, April 18, 2014

Three Great Lessons of Income Investing

Charlie Munger has his famous three laws of investing:

In this spirit, I offer my Three Great Lessons for Income Investors:

  1. A great business with a fair yield is superior to a fair business with a great yield
  2. A great business with a fair yield is superior to a fair business with a great yield
  3. A great business with a fair yield is superior to a fair business with a great yield
Where to find these businesses? Here are some analytical tools to get started.

Tuesday, April 15, 2014

Jim Grant's Safer Than a Ten Year Screen

Screens are an essential tool.  I think of them like the distillation process. Just like a master distiller working at Caol Ila takes in the fermented grains, and engineers the distillation process to screen out the water and leaves only the most highly prized flavors at the end of the run.

My favorite screens are simple screen with a specific purpose for each metric. Simplicity does not have to mean unbalanced. One of my favorite screens, which was not designed specifically more income investing but works well, is Jim Grant's Safer than a Ten Year Screen. Its described here under "There'll always be a J&J." In his 2010 article, Mr. Grant posits that not only will companies found in this screen perform better than cash, but they are as income producing, quality companies, safer than cash as well. Those insights were very valuable to me.

The Safer than a Ten Year screen filters are:

  • MarketCap > $5B (Big companies only)
  • ROE  > 15% (high quality companies)
  • Dividend yield > 2% (recurring income stream to you the investor)
  • Debt to Assets Ratio < 35% (sane Balance Sheet)
  • P/E < 15 (Cheap)
Like single malt, screens are subjective, but in my opinion, that's a pretty effective way to capture the essence of what a successful long term investment candidate should be. Some of the most important quality, safety, and value metrics are there.

I ran Grant's screen on Morningstar that yields 17 companies. Note, that I used Debt/Equity ratio, because Morningstar's screener does not have Debt to Assets ratio. I think this still captures the spirit of safety that Mr. grant was after in his screen. One other modification is that I included some results from companies headquartered in non US countries, whereas the original published article excludes non US companies.

Any screen is a starting point, not an end. This list could be further refined. Annaly Capital's absurd yield is cause for major concern, so it can be removed.  Looking outside the screen, payout ratio and coverage metrics can be used to further assess safety. Canadian Oil Sands payout ratio stands at 81% which could be cause for to leave that out. What you are left with then is 15 companies with some interesting characteristics.

Compared to most dividend investing screens which usually set a low bar at 3% yield, the list of companies includes some companies that are not regulars on most income investing screens. Apple and Progressive have relatively low current yields, but they both hold substantial interest as low leverage, high quality companies at cheap prices. 

That's the value of screens in a nutshell, you go in expecting to find an Exxon (and do), but looking objectively also turns up some that you did not expect  that are worth further investigation, distilling for dividends.

After all this talk about dividends and distilling, you might reasonably ask - where's Diageo? Its yield (2.5%) and ROE (38%) qualify it, however its P/E (18) and balance sheet (Debt/Equity 0.9) disqualify it. At least, they still have Caol Ila.

Here is a version of the screen on Google Finance.

Saturday, April 12, 2014

High Yield Reads - 4/12/14

Summary of recents posts and pieces of interest, sometimes enduring, to investors:

  • JP Morgan's annual report is out and worth a read. Brooklyn Investor adds some context. My favorite quote - "Other than in Silicon Valley, failure is severely punished"
  • A group of sixth graders won $5,000 in a stock picking contest beating out college students. The story reinforces the notion that advances math or guru insight is not required to win in the stock market. The 6th graders beat the university clubs by picking stocks like Netflix, Starbucks, Under Armour, Facebook, Amazon, Google and (HT @investimouse)
  • Procter & Gamble raised its dividend by 7% which is ok but not a huge number, however that they raised it for the 58th consecutive year which is a huge track record.
  • Its getting close to the Berkshire annual meeting, looks like they are going with a baseball theme this year

Thursday, April 10, 2014

Markets are made up of people

If you've followed up on Charlie Munger's book recommendations, then you'll know Robert Cialdini. Cialdini is most famous for "Influence", and he joins a cavalcade of authors at the big book signing every year in Omaha at the annual Berkshire meeting.

The story behind how he got involved with the Berkshire network is pretty interesting. Munger was so impressed with Influence, that he sent Cialdini a thank you note and a share of Berkshire stock.  Subsequently, Cialdini began learning more about how Berkshire operates.

Cialdini's observation captures an important component of the Berkshire approach - “They know that markets are not made up of econometric models. They're made up of people.” And that perspective is at the heart of what behavioral investing is trying to investigate further. The numbers matter obviously, but beyond that human behavior matters at least as much, they matter to market dynamics, company actions, and investor behavior.

Sunday, April 6, 2014

Post Boomerang Stock Market Performance

This tweet by Jesse Livermore got me thinking:

It got me thinking about Michael Lewis' last book Boomerang, which as ever was very well written. It has some pretty scary stories with Greece and Ireland as two of the worst case studies. The book calls them the new third world, effectively layering gloom on top of boom about state of the markets. I ran a quick chart on YCharts from the publication date of Boomerang (Oct 3, 2011) til now. The markets that rightly calls disastrous economic situations in the book have shown a fair amount of resiliency since Boomerang came out

Since Boomerang came out in October 2011, Ireland (EIRL) +107%, Greece (GREK) + 64%, Germany (EWG) +54%, and  S&P +48%. Not bad.

I enjoyed Boomerang, and I am not saying that its a contrary indicator, you would have required a very high risk tolerance to buy things in those markets. Still any book and one by a skilled storyteller especially should be taken with heaping buckets of salt. Jim Collins' Good to Great is another example. Companies that were studied as almost evergreen in the book later turned out to be in need of bail outs Fannie Mae and bankrupt (Circuit City).

Obviously there was real risk to what Lewis captured, but at the same time publication could also be viewed as a sign of John Templeton's maximum pessimism.

Saturday, April 5, 2014

High Yield Reads - 4/5/14

Summary of recents posts and pieces of interest, sometimes enduring, to dividend investors:

  • Base Hit Investor on Markel - as you might guess from the title, I am main interested in dividend stocks, but there are one or two exceptions, Berkshire comes to mind. Another exception is the so called Baby Berkshire: Markel. This write up is a very good overview of what makes Markel tick, including excellent underwriting, and investment track record. In addition, Markel launched Markel Ventures which is wholly owned companies that do sexy things like dredging canals and slicing hamburger buns for McDonald's. I attended the Markel brunch in Omaha last year the day after the BRK meeting and they look at Ventures as a small but growing part of the business, Tom Gayner said then "we have never been more liquid."
  • On a related note its worth studying Markel's holdings for ideas, many of which are excellent dividend growth opportunities, included in their top 10 holdings: 3rd largest holding: Diageo, 8th  Walmart, 9th Exxon Mobil
  • Timothy McAleenan Jr picks up an interesting thread comparing the history of tobacco stocks (off the charts) to the future of beverages. I, for one, hope he is right.
  • Quality matters in dividend investing. Another post by Mr. McAleenan; is Colgate the best dividend stock in the world?
    • You can very easily find higher yields elsewhere. It’s not what Colgate does for you now that is so impressive, but rather, what it does for you as a lifetime partner that causes jaws to drop....In 1983, Colgate yielded 1.8%. Nothing impressive. Yet, every $1,000 you invested in Colgate back then would be paying out $6,483 in annual dividends. Every 56 days, Colgate would generate as much dividend income for you as your entire initial investment. The catch is that it took 32 years to do that. It’s not every day you meet someone that thinks, let alone acts, in terms of decades, but it is nice to know that sweet rewards await those who wrap up diligence, patience, and money into a giant ball of delayed gratification and let it roll
(Related to that, here are my three rules of dividend investing. 1) quality matters in dividend investing 2) quality matters in dividend investing 3) quality matters in dividend investing)

  • Todd Wenning connects the dots on a recent Fidelity article with 4 things to know about dividend investing. The Elf story is a great way to reinforce what the yield isn't telling you. Just leave the gum, Buddy.
  • China Cash Shortage Brings IOUs to the Fore (WSJ) - quite a scary statement on the health of China's banks and companies stacking debt on top of more debt. Corporate debt is surging and its not backed by cash but IOUs, what could go wrong? 
  • But Martin Wolf thinks it may not end in tears, instead he expects the government to lead reform efforts that end with a whimper not a bang.

Thursday, April 3, 2014

Why Moats Matter

Morningstar posted a great video overview of the five kinds of moats they use in analysis. It runs around 20 minutes and its well worth your time to listen in to hear from the analysts describes the moat types and how they use them to identify investment opportunities.

For me, the moat concept goes together with dividend investing like curry and chutney. Dividends require long term holding periods to maximize their effectiveness. You cannot assume a long term holding period unless the company has some kind of moat, the wider the better.

How can you assess a company's value for a quality income strategy? Quantitatively, dividend metrics like FCF are essential, but those quantitative factors only matter if there is a moat that can defend them over the long haul. So a hybrid solution is in order, the qualitative moat assessment matters, too, to ensure that the moat is sustainable over, say, a ten year time period.

Wednesday, April 2, 2014

HFT Drama Versus Dramatically Lower Costs

Michael Lewis launched his HFT book, did Sixty Minutes on Sunday, and here we are on Wednesday and HFT is still dominating the news cycle. Whatever you think of HFT, Lewis has already won. In our ADHD society, that we are still talking about his book three days later is a great achievement.

Not that there was much doubt that Lewis' book would find a big audience. He is a great story teller, I've really enjoyed his work over the years. He can cover a lot of conceptual and in the case of Boomerang, geographic, territory.

But how big an issue is HFT for investors, meaning people with multi year time horizons? Maybe not such a big one.

Clifford Asness and Michael Mendelson wrote in WSJ today that Lewis and IEX were talking their book, in Lewis' case literally. They did note "The biggest concern we have with modern markets is their complexity and the associated operational risks. The market structure that enables the HFTs and provides us with their benefits may also be one that risks technological calamity."

The poster child for lower trading costs and standing up for the individual investor is Vanguard. I am inclined to agree with Gus Sauter who said

"There are literally hundreds of strategies that are high-frequency trading, ranging all the way from those that really perform much of a market-making and liquidity-providing function to perhaps some on the opposite end of the spectrum, where they are abusive and trying to manipulate the market, " he said.

"Obviously, we need to get rid of those types of high-frequency traders, but I think the bulk of them are creating liquidity and reducing spreads for us, which has dramatically reduced costs."

Indeed for all the HFT drama, dramatically lowered costs are a boon for investors. Consider Tadas Viskanta's trenchant observation that this is the best time to be an individual investor:

1. Easier:  Investors today can with a brokerage account and a computer is now only a few mouse clicks away from a globally diversified portfolio of ETFs that in terms of expenses rivals what institutions paid a decade ago.  For all intents and purposes the expense ratio on the big ETFs is closer to 0.0% that 1.0%.  Many brokers now allow online trading of individual bonds and overseas securities.

2. Cheaper:  Brokerage commissions continue to get driven towards $0 over time.  In fact, many brokers today provide commission-free trading of a range of ETFs.  Options strategies that would have been cost-prohibitive a few years ago are now viable strategies today.  Do you remember when you used to have to pay extra for real-time quotes?  Today real-time quotes are a commodity.

History matters, too. Jason Zweig:

First of all, as Viskanta also pointed out, there was never a golden age when the financial markets were safe or when investors were always represented by people who behaved liked angels.

As I wrote in my 2005 introduction to Fred Schwed’s classic book, Where Are the Customers’ Yachts?, the individual investor has always been “situated at the very bottom of the food chain, a speck of plankton afloat in a sea of predators.”

That was true in Exchange Alley in London in 1720. It was true when A.L. Bleecker and John Pintard started auctioning stocks in their Wall Street coffee house in 1791. It was true after Ferdinand Pecora and FDR and the newborn Securities and Exchange Commission flushed out the Street in the 1930s. It was true in the long bull markets of Eisenhower and Reagan. And it is still true.

The era we invest in today, however, is as good as any ever has been. 

Zweig goes into all the shenanigans, time, unpredictability and gyrations that accompanied his first trade in 1976. With commissions and long distance phone calls eating up around 50% of his profits. Its a great history lesson that concludes - "Yes, Wall Street is still a dangerous place. But it used to be worse."

It makes sense for investors to manage their risk, but the first step here is already a long term time horizon which negates much of the concern around HFT. There are policy and structural concerns as Asness points out, but the net result of the latest Lewis book is probably more drama than necessary for individual investors.