Stephen Clapham's Blog, page 7
August 21, 2023
Investing’s most neglected clue
It has always surprised me that investors don’t pay greater attention to who they get into bed with. Of course, I am referring to the share register rather than sleeping companions, whom I am sure are (almost) always carefully vetted.
Looking at a share register tells you a lot about a company and even more about the investment. Buying a stock without checking on your fellow shareholders is risky: better than skydiving without a parachute check, but potentially more painful than going to the beach without your sunscreen. Let me explain.
When I talk about the shareholder register, many of my students immediately think of WhaleWisdom and similar websites that use 13-D filings to track investors’ holdings in US stocks. It’s popular to use these as a source of idea generation and it’s not a dumb strategy. Checking the shareholder list is an essential step in my process when I do an initial review of a stock (a process I have coined as the First Pass Financial Profile or FP2)
When I was at hedge funds, I would look at a shareholder register and hope that nobody of note owned the stock, as it meant that we had an undiscovered idea with a greater longer-term upside. Also, the more popular the stock, the less smart I was going to look to my boss – and possibly the less likely that the stock will go into the portfolio. The supposition being that the first gains have been forgone, or even that it’s a crowded trade.
But as a private investor, there is safety and comfort in numbers. You don’t want to be on your own and you certainly don’t need to be. Therefore, when you look at a shareholder register, you should hope to see certain characteristics. I like to see family ownership and I like to understand any external large shareholdings.
1 Concentration of OwnershipFounder-led companies outperform. Credit Suisse found that family-owned companies have outperformed non-family-owned peers on average by 370 basis points a year from 2006 to late 2020, with smaller companies (sub-$3bn market cap) outperforming globally by twice as much as larger companies.
Founder-led businesses outperform
Source: Credit Suisse Research, Thomson Reuters Datastream
Yet one hedge fund manager I know, who has been highly successful, refuses to buy family-owned businesses on the grounds that they are much less likely to be the subject of a takeover bid. Such businesses do carry some different risks from “normal” businesses, notably succession planning and what happens when the founder steps down. Sometimes families find it difficult to agree on the strategic direction of the business. It’s fair to say that the alpha (or outperformance) enjoyed by the group can at times involve some unusual questions for external investors who have to gauge the psychology of a family group. And we all know how families can fall out and become bitter, intransigent and irrational. But the odds are certainly in your favour when buying a family-owned business and you should have some of these in your portfolio.
2 Unusual or Large External ShareholdersI had the idea of writing this after reading a Financial Times article in February 2022 about the possible separation of Porsche from Volkswagen. Now VW, like BMW, is in effect ultimately controlled by the family of the founder – in VW’s case with a more than 50% shareholding, and in the case of the Quandt family, a collective holding of more than 40%.
But VW’s share register is more complicated than the simple family ownership because the State of Lower Saxony has a holding. When the company was privatised, Lower Saxony held a voting share of 20.2 per cent, which gave it the ability to veto major decisions and prevent takeovers by other shareholders, regardless of the extent of the ownership. In 2007, it invested further capital to maintain that voting interest.
Lower Saxony is guaranteed two out of 10 investor seats on Volkswagen’s supervisory board and has been criticised for prioritising jobs in the region and thwarting reforms. Its loose association with the unions means, in effect, that the unions – if not actually in control of the company, as some critics claim – have an even greater influence than at competing manufacturers.
Such a set-up is unlikely to be optimal for quick wins for shareholders and can slow down decision making which in times like these, with the move to electrification, is unlikely to be the most conducive to either short-term share-price performance or longer-term survival.
Companies with more complex capital structures like VW require particular care, as do younger tech companies where the votes may be highly concentrated. It’s important to look at the distribution of votes across the register rather than simply the division of share capital. Because when a crunch comes, it’s the votes that matter.
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August 16, 2023
#25 – The Celebrity Investor
/*! elementor - v3.15.0 - 09-08-2023 */.elementor-widget-text-editor.elementor-drop-cap-view-stacked .elementor-drop-cap{background-color:#69727d;color:#fff}.elementor-widget-text-editor.elementor-drop-cap-view-framed .elementor-drop-cap{color:#69727d;border:3px solid;background-color:transparent}.elementor-widget-text-editor:not(.elementor-drop-cap-view-default) .elementor-drop-cap{margin-top:8px}.elementor-widget-text-editor:not(.elementor-drop-cap-view-default) .elementor-drop-cap-letter{width:1em;height:1em}.elementor-widget-text-editor .elementor-drop-cap{float:left;text-align:center;line-height:1;font-size:50px}.elementor-widget-text-editor .elementor-drop-cap-letter{display:inline-block} Guy Spier is a value investor best known for his $250k lunch with Warren Buffett. He manages the Aquamarine Fund and operates a low risk, low maintenance strategy, designed to protect him from making mistakes.
SUMMARYGuy Spier is a successful value investor and has spent considerable time creating an environment which will protect him and his fund from making mistakes through his own temperamental idiosyncrasies. He talks much more about environment design than valuation which is refreshingly different – I learned a lot.
We discuss why the best ideas are simple, yet analysts always want to impress with their understanding of complex situations. Guy talks about his university chums, David Cameron and Chris Hohn and why his father entrusted his life savings to a young man with no investing experience and how that has coloured Guy’s investing approach. And of course we discuss that lunch with Warren Buffett.
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GETTING INTO INVESTINGGuy used to look up stock prices for his dad on the school run (in Iran). And he loved the HP-12C calculator which led him to understand the power of compounding from an early age. He only really became interested in investing age 27, having been “infected” with the efficient market hypothesis. His first job was a disaster with bucket shop DK Blair (no relation to the great firm Wm Blair) and his father then entrusted a young Guy, with very little investing experience with his life savings of $1m. This has led to Guy taking a very cautious approach to investing.
Some takeawaysLunch with BuffettGuy paid $250k for lunch and it has been a great investment for him. He is clearly in awe of Buffett and sees huge value in going to the AGM to be in the same room as him, even with 40,000 others. He talks of how Buffett’s mind works with an extraordinary clock speed and he compares the investment to buying a sports car – you get a few drives and some envious looks and that’s about it (Guy drives a Porsche!). Having lunch with Buffett pays dividends for the remainder of your life.
The lunch helped him to grow in ways he didn’t want to grow. And he points out that spiritual growth happens when pain or discomfort is involved. Healthy relationships involve friction and pain. He points out that highly successful people may well have had some lucky breaks but usually they also possess rare gifts. You can learn a lot from being in the same room as them.
Guy believes that if you want your life to be an adventure, buy low cost lottery tickets and lead a more interesting life – he flew from Zurich to California for a friend’s birthday dinner and is about to visit India for two days.
Why his dad gave him his life savings and its effectGuy’s first job first job with bucket shop DK Blair (no relation to the great firm Wm Blair) was a disaster and his father then entrusted a young Guy, with very little investing experience with his life savings of $1m. Guy explained that his father is very intuitive and has high emotional intelligence and that having served in the Israeli Army and seeing friends die, it wasn’t a difficult decision for him. But it was a scary and heavy responsibility for Guy and has made him more risk averse than he would otherwise be.
His friend Mohnish Pabrai has a very different attitude and is quite relaxed investing in Turkey which is a no-go for Guy. Guy believes that understanding your attitude to money and the history behind it can be helpful to your investing performance.
Guy’s Investing RulesGuy checks stock prices only occasionally. This doesn’t cause him any issues because he only invests in companies which are glacial in their pace of change. He cites Charlie Munger who asked the question “which of the S&P500 will be better businesses in 5 years?”. Guy points out that if you stick to those types of businesses and pay a good price, you should do very well.
He also confesses in the podcast that he has abandoned one of his rules and surprisingly says he was stupid to write that rule in his book. We won’t spoil this by revealing it here, but it’s a tribute to Guy’s flexibility that he is able to change his mind and to reverse a hitherto iron clad rule in his investment approach.
ABOUT Guy Spier
Guy Spier is a Zurich-based investor and the author of The Education of a Value Investor. Since 1997, he has managed Aquamarine’s privately offered investment funds.
Guy previously worked as an investment banker in New York and as a management consultant in London and Paris. He has an MBA from the Harvard Business School, class of 1993, and holds a First Class degree in Politics, Philosophy and Economics from Oxford University. On graduating from Oxford, he was co- awarded the George Webb Medley prize for the best performance that year in economics.
Guy currently lives in Switzerland with his wife Lory and their three children, Eva, Isaac and Sarah.
Pushed to pick out a single investing book, Guy recommends Richer, Wiser, Happier by his close friend, William Green, also a former guest n this podcast. But he advises reading everything and finding the investing style that suits you.
Buy on amazon.com Buy on amazon.co.UK
And don’t forget Guy’s own book: Education of a Value Investor which is a great read.
Buy on amazon.com Buy on amazon.co.UK HOW STEVE KNOWS THE GUESTSteve met Guy in Omaha at a dinner with Chris Bloomstran and a few others and Chris persuaded Guy that he should come on the podcast. We met up on his next visit to London.
PrevWhy Macro’s finally worth talking about
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August 14, 2023
Why Macro’s finally worth talking about
These five factors will define the next era of investing. Here’s what you can do today to prepare.
As most readers will know, I have a podcast with a view to provide some free education and entertainment to the Behind the Balance Sheet community. We started with a series of five podcasts and when they proved highly popular, I decided to continue, starting with a series of macro discussions.
My rationale for talking about macro – it’s too common a subject for podcasts, and usually of limited value – was that we are entering a new era:
· A move from 40 years of falling rates would on its own be sufficient to drive considerable change in equity investment strategies. But it’s much more.
· In the past 30 years, we have enjoyed falling energy prices, which have contributed to disinflation.
· In the past 20 years, we have benefited from globalisation, a major factor in disinflation.
· Meanwhile, tax rates have been steadily falling.
· And financial capital was abundant, leading to increased financial engineering.
All these trends look set to reverse over the coming 20 years, which is a seismic shift in the way we need to think about our equity investments. In particular, although most people understand the concept of inflation, very few of today’s practitioners were investing in the inflationary period of the 1970s.
I was keen to interview Mario Gabelli for Real Vision last year for this reason, but I could get little from him on how he invested although he did produce this memorable quote:
“Inflation’s like toothpaste, once it’s out of the tube, it’s difficult to get it back in.”
This was not an original quote, but it’s a powerful one. Yet it still left open the issue of how to invest in an age of inflation, looking at the topic from first principles – and the purpose of the podcasts. Here are the brilliant macro brains you can hear from:
#6 Hugh Hendry, the founder of Eclectica Capital, now renting property on St Bart’s#7 Dylan Grice and Rob Crenian of Calderwood Capital#8 Chris Wood, the highly regarded Jefferies strategistWhen I asked Russell Napier, the financial historian if he would be a guest in our macro mini-series, he suggested that we cover the Capital Cycle in an Age of Financial Repression, which was the subject of his last quarterly newsletter for institutional clients. He suggested that we invite Jeremy Hosking, the former partner of Marathon Asset Management and co-author of the book Capital Account, which introduced the concept of the capital cycle to the investment world. After some gentle persuasion, Jeremy agreed and we had a really interesting discussion.
But before you rush to start the podcast on your favourite host, some explanation may be helpful, as the subject is quite complicated.
The capital cycle concept is now well known – pay more attention to supply than traditional investors, who tend to focus on demand and buy into an industry when capacity is exiting. Yet as we explore here, the capital cycle can be viewed on multiple levels and in a more subtle fashion.
The changes outlined above have enormous implications for equity strategies and I believe that the capital cycle will have to be core, as will thinking with an inflation protection mindset. The de-globalisation trend will require more capital going to traditional industries at a time when capital is less abundant.
We cover a lot of ground in the podcast. These two giants of the investment world discuss the way forward, covering everything from banks to ESG, from Tobin’s Q to excessive liquidity, and from the tragic events in Ukraine to the sinking of the Titanic. One theme is constant, however –the capital cycle, and we discuss in detail its mechanics and the reasons why it’s such an effective investment tool.
Please make sure to listen to the very end. Russell and I have a postscript discussion, as we wanted to tie some of the loose ends together. We both met Greenlight Capital founder David Einhorn shortly after the podcast and I share some of his interesting perspectives on how to invest to protect capital from inflation.
This is, of course, a huge subject and one which I can only touch on in half a dozen or so hours of discussion, particularly as I easily get sidetracked talking to these smart people. Yet make no mistake, this is almost certainly the single most important issue for your portfolio performance over the next 10 years.
Please let me know what you think. I would love to hear your ideas for other guests and on how we should develop the discussion both on the podcast and here in the newsletter.
Podcast link: https://behindthebalancesheet.com/pod...
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August 6, 2023
The Real Headwind for Airline Stocks
Qatar Airways
I read in Bloomberg Businessweek that Airbus and Qatar Airways were set for a court battle. This is pretty surprising – Qatar have been buying a LOT of aircraft, and Boeing and Airbus sales teams will usually do whatever it takes to win an order. Even in industries whose orders don’t have price tags of billions of dollars, it’s not considered good marketing practice to see your customer in court.
Of course, Qatar Airways has been a difficult customer for both manufacturers. One told me how Qatar had complained about every tiny detail on its rival’s last delivery. This is quite normal in the airline industry – you send a team to inspect your new purchase before flying it home. (I did the same for my last new car purchase and noted a paint issue.) But Qatar are particularly exacting customers.
Qatar’s Airbus A350s have a problem with flaking paint. So have everyone else’s deliveries, but Qatar is unusual in that its aviation authority has apparently grounded the aircraft. No other authority has taken similar action, so presumably the issue of the flaking paint is more cosmetic than life-threatening. It is coming to court because Airbus has a full order book and doesn’t want to pay the $700m Qatar is demanding in compensation.
Airbus was even prepared to cancel some of Qatar’s orders and let the airline buy short-haul jets from Boeing – relations must be pretty strained. We shall see how things pan out, although Qatar’s case for compensation for grounded aircraft is weakened in that everybody else seems happy to fly the A350. (Although if my car had been delivered with paint like that, I would have sent it back.)
But what struck me about this article, apart from the unusual nature of the dispute, was the size of the Qatar claim. The magazine article and a related article in the Financial Times said that Qatar were claiming $618.4m from Airbus for the grounding of the 21 aircraft affected, plus $4.2m per day of each day the aircraft were idled. Bloomberg added that the list price of an A350 is $300m.
There is quite an interesting investment takeaway from this which I am going to explain, but perhaps you can think of it first.
Qatar’s A350: Flaking Paint
Source: ReutersNot what I would be hoping to see when I board an aircraft, but likely looks worse than it is.
Qatar is claiming $200,000 a day for the grounding of each aircraft, presumably for the lost revenue. Over a year that amounts to about $73m – quite a lot of revenue for one aircraft, but let’s assume that that is the correct value. Later in life there are more maintenance checks and so on, but let’s round this up to $75m to make the mental arithmetic easier. Let’s assume also that the generous sales teams at Airbus let Qatar buy the A350 for $225m, a 25% discount. I am making these numbers up, but it doesn’t matter.
This would mean that Qatar is investing $3 (in aircraft alone, not counting all the other fixed equipment) to generate $1 of revenue. Now the airline reported a local currency 1.8bn ($0.5bn) loss on 48bn ($13bn) of revenue in FY2019, later revised to a 4.1bn ($1.1bn) loss, so it’s not possible to calculate the return on that investment.
But let’s assume that they reported a 20% earnings before interest and tax (EBIT) margin – that would be 20c of profit on $1 of revenue against the $3 of fixed assets above. That’s a sub-7% pre-tax return on the value of the fixed assets alone. Of course, to run an airline you need assets beyond aircraft – offices, simulators, maintenance hangars and many more expensive assets, but there is a working capital offset – airlines’ working capital is provided by their customers who pay for tickets in advance; this is an airline’s lifeblood, and one reason why Covid was such an existential threat to many.
Airline IndustryThere are three important financial reasons why airlines have managed to survive in spite of being a highly cyclical, low-return industry:
Most airlines run these significant negative working capital balances, because customers pay before they fly;Banks are keen to end against aircraft assets, as they are easily resold (just fly them to the next user) and have predictable values; andShareholders therefore only need to cough up part of the capital.But this simple example cited in the magazine article tells you all you need to know about investing in the airline industry – if it takes $3 of direct fixed assets to generate $1 of sales and those sales are not super high-margin, super long-lived, or sticky subscription income, chances are it’s not a very good business.
Many new investors trying to educate themselves and improve their skills give up early because they find the financials daunting and accounting confusing. It doesn’t need to be that way. All you need to do is use your common sense. If you own a stock for the long term, then as Warren Buffett’s business partner Charlie Munger said, the most important element is the return on capital employed:
“Over the long term, it’s hard for a stock to earn a much better return than the business which underlies it earns. If the business earns 6% on capital over 40 years and you hold it for that 40 years, you’re not going to make much different than a 6% return—even if you originally buy it at a huge discount.”
More importantly…
“Conversely, if a business earns 18 per cent on capital over 20 or 30 years, even if you pay an expensive looking price, you’ll end up with one hell of a result.”
And that’s what most investors seem to overlook when they focus on valuation. In the long term, return on capital is the key driver so that’s where you should start. And even if you are a new investor and you don’t understand balance sheets, you can use your common sense. If the company needs a lot of fixed assets to generate sales, say three times the level of the sales as we see here, the chances are it’s not going to be a great investment.
Note: if you are a new investor and don’t understand financial statements, check out our How to Read a Balance Sheet (and all the other statements) course.
Whether it’s a restaurant, a shop, or a factory making widgets, start with that fixed assets note and compare it to the turnover. It’s a great starting point. And for paying subscribers, there is a screen of companies to look at and companies to avoid using this metric as well as a look at other airlines. Spoiler, some are better than Qatar, but there is a catch.
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July 25, 2023
Growth Investing for Sceptics
I know you are all value investors now, but remember 2021?
Growth was in vogue, as was quality. Unfortunately, I missed the inaugural Quality-Growth Investor Conference in London, organised by the same group as the Value Investor Conference. The presenters all pay to speak and the audience pay to attend, which must make it a lucrative venture. It also means that the managers are in sales mode, which can help you learn about their process.
I previously looked at quality from a quantitative perspective, trying to understand what constitutes a quality business. So, I thought it would be interesting to see what the fund managers who specialise in the genre say about it.
Regular readers will be aware that I don’t really like the value vs growth monikers and consider myself in neither camp. And I think that the terms are often unhelpful – I recall one specialist hedge fund manager being accused of “just being a value investor” by a client. In response, he pointed out that the portfolio the client was criticising had an average p/e of 60% above the market average.
So what factors do these specialist fund managers consider constitute a quality growth stock?
I went through 15 or so presentations and extracted some of the buzzwords from the fancy powerpoint schematics. But before I go through them, it’s worth noting how few of them discussed valuation. A couple of managers highlighted it as a criterion in their process and one flagged that they used cash flow valuation measures. But surely how you value businesses is a prime differentiator for professional managers (although to be fair, perhaps they spent more time on this in the presentations themselves).
On the positive side, I really liked this slide from Lindsell Train with their investing hypothesis:
“investors undervalue durable cash generative business franchises”
This was clear, understandable and helped explain their philosophy in a sentence. Why more managers don’t do this is a mystery.
Anyway, onto the buzzwords, which I have collected under four headings:
Financial StrengthManagementGrowthQualityFinancial strengthI’ll start here, as I was slightly surprised to see 3 managers highlighting this as one of their criteria.
I think we can take this as a given because without enough cash, a growth company won’t last long. We want to invest in companies that have strong balance sheets. Indeed, as we go into an economic downturn of unknown steepness and duration, this should be considered an even higher priority.
Don’t own anything that has a lot of debt – or that needs to refinance a decent slug of debt – as there is a reasonable probability that financing will not be available at acceptable terms, let alone at recent rates.
ManagementThis was cited by four of the group who talked about “trusted management“ (this was a Chinese company), “management”, “good management” and capital allocation. Of course, you need to invest with managers who are honest stewards of the capital you entrust them with. Please check out my book where I go into more detail. (I also explain there why I have enjoyed investing with crooks as their stocks are considered untouchable and the stock price can often do well as they are rehabilitated, but I don’t suggest you try that at home).
But the interesting thing about management is that it’s difficult to form a judgment.
S&P500 CEOs are not shy and retiring people. They know how to sell, so I have some sympathy with the view – held by people as diverse as James Montier at GMO and Terry Smith of Fundsmith – that you should not meet them. Personally, I would always take the chance that I would be charmed on the basis that I might also find something out. Again, let’s park the issue of management as it’s uncontroversial and it’s a given that it should form a part of the research process. (Joseph who works with me thinks we should publish our content on assessing management as a separate course – would you be interested? Let me know by replying.)
GrowthThis, of course was a popular term – “growth”, “runway for growth”, “secular growth” and similar – as these people were all quite growthy. I didn’t see much emphasis on the cost of growth – there was not one mention in the slides of customer acquisition cost, of capital required for growth or even the dreaded churn. Despite this, tech stocks featured heavily in the portfolios, which I will cover in the section for paying subscribers. And in that type of industry, the cost of growth should be a prime focus for investors.
The topic of capital discipline should also be uppermost in these investors’ minds.
I am no expert in semiconductors but I know it’s a highly cyclical industry. It’s certainly a growth industry and was probably over-represented in these investors’ portfolios; but the capital being deployed in this industry is huge – several $100bn over the next 5 or so years. Meanwhile, we have recently emerged from the Covid period, in which everyone who needed to surely bought a new laptop/phone/device, and we are entering an economic slowdown where such purchases may be a lower priority.
The only relevant slide I saw looked at semi equipment companies, which presented forecast CFROI for the sector of 27-28% and an implied return of 22% in 2026, post the enormous capital investment. This industry has seen zero or negative returns three times in the last 20 years but apparently it’s less cyclical today.
The bottom line for me is that growth investing has significant downside risk and the cost of growth is something I would pay close attention to, as is the capital cycle. The latter is under-rated and you can learn more in my podcast with Russell Napier and Jeremy Hosking and in this article.
QualityThe single most repeated quality factor in all the presentations was competitive advantage.
One investor called this “competitive positioning” and about half cited it as a key factor in their process. None explained how they decided whether a company had a real or sustainable competitive advantage (the sustainable qualifier was used by two of the presenters).
Perhaps this is part of the secret sauce which they don’t want to give away, or maybe it’s just a difficult thing to explain. These funds were investing across a really broad spectrum from healthcare to soft drinks, with a concentration in the tech sector. The qualities which convey competitive advantage would vary widely from company to company.
In my view, the characteristics of a company with competitive advantage are
Pricing powerHigh gross marginsHigh and growing EBIT marginsRevenue growth superior to the sector averageHigh, possibly increasing and potentially stable returns on capitalCompetitive advantage is an easy factor to cite in an investor presentation as everyone understands it. But it’s much harder to define, and a sustainable advantage is even more difficult to identify reliably.
The only quantitative quality factor cited by the managers was high returns, but predictably, none of the investors defined it, although one used Holt CFROI in its charts. Holt is a great system but it is expensive and I intend to cover the issue of returns in a future article. There is a lot of misunderstanding here.
Other quality factors cited were:
Economies of scaleCashflow predictabilityPricing powerRisk of disruptionMacro sensitivityRepeat revenuesNothing wrong with any of these. I think true economies of scale which confer a real and sustainable advantage are quite rare – Amazon and WalMart are examples where their scale is at a different level from competitors, but I struggle to think of many more.
Cash flow predictability is a characteristic of a stable business – a utility or consumer staple. Pricing power is a major differentiator for companies now, especially in an inflationary environment (although it is equally helpful in deflationary times).
Macro sensitivity and risk of disruption are notable risk factors, and I was surprised that more presenters did not identify what excluded a business from qualification as a quality investment. I often find it easier to think of what should be excluded.
Finally, repeat revenues are highly valued by the stock market and subscription businesses have seen a significant rerating especially in the tech sector. The good news here is that there are warning signals in the financial statements if trouble is brewing here, something I shall cover in my upcoming Forensic Accounting Course. (Email info@behindthebalancesheet.com to get on the waiting list and be notified of launch).
For paying subscribers, I have set out some of the most popular quality growth stocks owned by the funds presenting.
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July 18, 2023
#24 – The Family Office CIO
Beth Lilly is a value investor with a specialism in small caps. She is highly successful, manages money for a billionaire family yet she drives a 12 year old car. She explains why.
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SUMMARYBeth Lilly is a highly successful value investor and an amazing woman. She has set up two asset management firms, worked with and learned from some of the most famous and some of the most successful value investors in the world, and now runs money for the multi-billion Pohlad family in Minnesota.
We discuss the power of compounding, Beth’s research process and how she conducts company meetings. We disagree on the attractiveness of the auto dealership industry, and Beth explains how she approaches the management of inter-generational wealth, how she decides much cash to hold and we debate private equity.
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GETTING INTO INVESTINGFrom an early age, Beth Lilly always wanted to be an investor. Her grandparents gave her 7 shares in local company 3M, value $70, which she still holds today, value $70,000. She has had a varied and interesting career working with some great investors. She started outat Goldman Sachs, but wanted to invest herself so moved to the Fireman’s Fund, working for Bob Bruce, an outstanding but less well known investor. She recalls a younger Warren Buffett stopping by for lunch!Beth then set up on her own back in St Paul Minnesota with two partners and sold that firm to Mario Gabelli. She then set up on her own before joining the Pohlad Companies as CIO, which seem to be her perfect job.
The Pohlad CompaniesWith an initial focus in banking, the Pohlad Companies organisation now spans several sectors: commercial real estate; automotive; robotic automation, engineering and material handling; sports and entertainment; including the Major League Baseball franchise the Minnesota Twins; and private investing. More than 2,000 professionals are employed in more than 20 companies operating across the United States. Marquette Companies serves as the holding company for many of the operating units. The family also have a charitable foundation which focuses on housing stability for families and youth in Minneapolis-Saint Paul.
The patriarch had 3 sons who are all involved in the family office and the third generation has seven children. The brothers were Twin Cities Business magazine’s 2022 People of the Year, and were honoured for their commitments to alleviate poverty, bolster racial justice, and rejuvenate downtown Minneapolis.
Robert Pohlad is a non-executive director of Pepsico, having previously been responsible for the family-owned Pepsi bottler which was the second largest in the world with a turnover of c.$4.5bn in 2007. He is also a director of several of the family companies including some of the car dealerships.
Bill Pohlad is a film producer (including 12 years a Slave and Brokeback Mountain) and he directed the Beach Boys myopic. River Road Entertainment is part of the family business.
Jim Pohlad is a director of the Minnesota Twins basketball team which is owned by the family. They also have a stake in the Minnesota MLS soccer team.
The family has a number fo private equity investments where it holds minority stakes. Sectors represented include consumer products, insurance, food and drink, logistics and distribution, healthcare, manufacturing, and tech, including an investment in Spotify now exited.
Their website.
Some TakeawaysAuto dealershipsThe family, like many families in the US, as Beth pointed out owns a number of auto dealerships which made for an interesting discussion. Steve is concerned about the EV threat which poses a risk to inter-generational long term value because:
EVs don’t have many moving parts and need less maintenance. Parts and service are probably 30% of a dealership’s revenue, he guesses.This isn’t a high margin activity because new and used car sales are highly competitive, commodity businesses and median margins today are 5% vs 4% 5 years ago. Lose the maintenance business and they will be much less profitable.New EV manufacturers are cutting out the intermediary. Even if the legacy auto makers continue in their current mode of business, the new entrants – Tesla, Rivian etc – will shrink dealers’ TAM.Beth is bullish as they are highly cash generative, stable franchises because of the OEM relationship and attractively valued. And she pointed out that with 15m cars being sold each year, there will be plenty of service revenue for a long long time to come.
We should also recognise that it’s a very fragmented industry with a stock like Lithia Motors, with a market cap of $8bn, having just 300 outlets out of 17k in the US. The largest players may have 1% or less market share making acquisition led growth attractive. And it’s a huge, $2tn industry, one of the largest retail segments anywhere.
Steve acknowledges that the EV threat will take time to play out, but is concerned that it’s difficult to know when the market’s discounting mechanism will get concerned about the long term risk to margins.
Beth’s ProcessBeth has refined her research process over decades of investment experience. She places great emphasis on meeting management and visiting their operations as well as HQ. She cited two mistakes she made many years ago from not interpreting these signals as well as she should have and they make for great lessons to learn.
Tips for Young Potential AnalystsBeth recommended a book, see below, but had three wonderful tips for a young woman thinking of becoming an analyst, but which Steve himself has already adopted:
Carry a notebook at all times.Write thank-you letters.Believe in yourself.She expresses it much more eloquently – listen to the end of the show.
ABOUT Beth LillyElizabeth M. Lilly is Chief Investment Officer and Executive Vice President for The Pohlad Companies and Pohlad Companies, LLC. She oversees the public and private investments for the Pohlad family and provides leadership and management of their investment team.
Beth began her career with Goldman Sachs in 1985 in New York. In 1988, Beth joined Fund American Companies in Greenwich Connecticut where she worked as an analyst learning the merits of Value Investing. In 1997, she co-founded Woodland Partners in Minneapolis which focused on investing in small capitalization equities. In 2002, Woodland Partners was acquired by GAMCO Investors where she went on to serve as a Senior Vice President and Portfolio Manager of the $1.4 billion Teton Westwood Mighty Mites Fund and as a member of the value portfolio management team. In 2017, Beth founded Crocus Hill Partners to focus on investments in small and micro capitalization equities.
Beth received her BA in Economics from Hobart/William Smith College where she graduated with High Honors. She received her CFA designation in 1989. Beth currently serves on the Board of Directors for Apogee Enterprises and The Ordway Center for the Performing Arts. She is also a member of the Investment Committee of the University of Minnesota Endowment. Beth and her family live in St. Paul.
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Buy on amazon.com Buy on amazon.co.UK
HOW STEVE KNOWS THE GUESTSteve met Beth in Omaha. Mario Gabelli sponsors a dinner in aid of Columbia University and Beth was one of the speakers. Steve went up afterwards and charmed her into doing the podcast.
PrevSteve’s article was included in Grant Williams’ TTMYGHThe post #24 – The Family Office CIO appeared first on Behind The Balance Sheet.
7 Ways To Judge A CEO
In a recent post, I highlighted that several presenters at a Quality Growth Conference in London, all professional managers of such funds, said that assessing management is a key factor in how they find high quality companies.
I have always found such commentary interesting, as management is one of the hardest factors for the analyst to assess. To do it, there are a number of techniques of varying effectiveness:
Check their CVLook at their track record in prior rolesPeruse their social media accountsAsk peers or the sell-side how they rate themMeet management and make your own assessmentAssess their strategyAssess their capital allocation performanceCheck their CVFew investors bother to look closely at managements’ CVs. They have in effect outsourced the due diligence to the company’s HR function. While investors and the sell-side might have a quick glance at the manager’s bio, short sellers are the only people I have seen do proper due diligence in this respect. A great example is the former CEO of Samsonite, Ramesh Tainwala.
I once went to a lunch with Tainwala, as I had an interest in Samsonite (not my best ever recommendation, but it performed OK for us). The lunch was best described as weird. I left with a friend who works as a global manager for a $1tn+ manager and we agreed that we felt uncomfortable with the CEO.
Tainwala spent a large part of lunch talking about the company’s Tumi acquisition and how Japanese clients insisted that each pocket of the Tumi backpack (lots of compartments) should have a designated function. It really was strange, given that I remember it so clearly, among hundreds of such lunches. Here is his bio, taken from the company’s website:
Source: Samsonite.comIn this biography, Tainwala is referred to as Mr, and only his Indian Masters is listed as a qualification. Elsewhere, he claimed that he was Dr Tainwala and had a PhD from Cincinnati University. Short seller Blue Orca Capital attacked Samsonite for spurious comments in its financial filings and some related parties transactions that looked odd but not material. But Blue Orca really struck home on the doctorate. Tainwala was forced to admit that his CV was fake and then resigned as CEO.
If the company’s HR department cannot be bothered to check that the CEO’s qualifications are real, I’m not sure there is much that can be done. I don’t think investors have either the time or the inclination to check that management are honest and haven’t lied on their CVs. But it’s probably worth looking at the CV and ensuring there is nothing obvious – too many roles, gaps between roles etc. If there is no detailed bio on the company website or via Google, you can best do this by perusing the executive’s LinkedIn page, although it’s easy to omit roles or fudge dates on there. I don’t think any such CV review would be conclusive.
Extract from Blue Orca Report
Source: Blue Orca Capital Report on SamsoniteTrack Record In Prior RolesI recall meeting one of Bill Ackman’s team who explained that he had spent a month assessing a new CEO, appointed to lead a company in which their fund had invested. He explained that he as an expert in this, as he had a background in private equity. I asked him what criteria he considered especially relevant and he explained proudly:
“ROIC.”
When I questioned him more closely on how he assessed this, there was a lot of confusion and extended explanations. I don’t think ROIC is a good way to assess a CEO’s ability to achieve an operational turnround (which this business required). A positive result on ROIC might reflect managerial skill, or that the business was levered up, or that the earnings were made up or that the tax rate was manipulated or a combination of all three (only one of these was tested by that analyst).
It’s important to check the record against a relevant peer group, assessing margin performance and relative returns. But you need to look at the record under this executive’s leadership vs prior leaderships. If you walk into the job at a market leader – think Coca Cola or similar – and don’t do much, the chances are that the returns will still look pretty good. But that doesn’t make you a great leader or able to transition.
And this issue of transition is important – a CEO might look brilliant in one industry and not cope well in another; or outperform in one geography and fail in a second (think UK retail transferring to the US for example). A manager could also deliver in one style of business but do less well in another which has a different capital intensity, for example.
Social Media FollowingIf you think you are safe with someone because they have a lot of followers on LinkedIN or Twitter, think again. Charlatans who will defraud you or simply cause massive wealth destruction often have large followings.
Wirecard had 117k followers on Twitter and 90k on LinkedIN. A high follower count tells you that a company or individual is effective at attracting a following, but this can be achieved through promotion or through bots. Many younger people are mesmerised by follower count and honestly, it’s not that important (says @steveclapham with 11k Twitter followers, not sore). And it’s certainly not relevant to making money in equities.
Chamath Palihapitiya is certainly super smart and has 1.6m followers on Twitter; yet investors in Virgin Galactic are down >90% from the peak or >50% from the SPAC price. Admittedly, he isn’t the CEO of that company, but he was the promoter. He has cleverly capitalised on his following and personally made serious money on that transaction.
I am not suggesting you ignore social media. Looking at an executive’s posts might give you some insight into the way they think, although often the posts are managed by the PR team (or even a secretary, as one leading entrepreneur admitted to me recently). I like to look but remain sceptical. This applies beyond social media of course.
Ask peers or the sell-sideMany portfolio managers talk to other fund managers or even sell-side analysts to form or confirm an opinion on management. The problem is knowing how much weight to put on someone’s opinion. An old friend of mine is a top head-hunter. He is really smart; he knows his clients intimately and he spends several hours one to one with each candidate, as well as doing intensive background checks and deep research. He reckons he is outstanding at assessing talent. I used to be inclined to believe my friend’s rhetoric, as he has always made a lot of money and he is quite persuasive. But I have always wondered how much of his success came from sales acumen and how much was genuine talent scouting ability.
Fund managers are rarely great judges of management talent. One successful manager I know admitted to me that he was useless at it. Another claims (in his marketing literature) that it’s one of his great skills, yet he has invested in more companies that have gone bust than some VC investors.
The skills that make a great fund manager – confidence in their own ability; ability to ignore the noise of the market; vision of the future; analytical talent; and ability to understand numbers – are not necessarily conducive to fantastic inter-personal skills nor to ability in assessing management. One area where many managers are skilled is in watching body language and judging if someone is lying. But it’s far from a given that portfolio managers will be as competent at assessing management teams as they are at assessing share price potential.
Meet them yourselfJames Montier at GMO thinks that it’s dangerous to meet management. CEOs of Fortune 500 companies are often charismatic, persuasive and great salespeople. They are experienced in persuasion, having succeeded in rising to the top of these organisations. Their IR teams produce convincing arguments, persuasive bullet points and attractive PowerPoint presentations on strategy. How much chance does an investor have? Terry Smith follows a similar argument – you don’t need to meet the management as the answers are all in the numbers.
As ever with investing, you must do what suits your personal style and recognise your own abilities and limitations. Paying subscribers can read about my approach to meeting management at the end. Private investors may not be able to meet managers one to one, but they can watch capital market day presentations or similar, while maintaining a sceptical stance.
Assess their strategyWhen a CEO of a large public company discusses strategy, it has usually been pored over by internal management – and quite possibly external consultants like McKinsey – and been honed into a powerful presentation. It really should be bulletproof and no investor should be able to pick holes in it. But it’s surprising how often a simple question on returns can wrong-foot an able executive.
I recall one hapless airline CEO who was unable to predict the business/leisure mix after the introduction of more upscale business class and premium economy products. They hadn’t really thought through the increased dependence on corporate travel, at a time when budgets were likely to come under pressure.
Most of the time, the manager should be able to convince you of the strategy – if they cannot, you really ought to consider whether you can continue the position. If nothing else, you will kick yourself if the strategy which you didn’t believe in turns out badly and the share price suffers.
Assess their capital allocation performanceDiscussing the strategy isn’t a brilliant method and it can only take you so far. It’s better to try and understand if this management team has been effective at making capital allocation decisions in the past. I look at three elements of capital allocation:
OrganicBuybacksAcquisitionsThe impact of a new CEO’s organic capital allocation decisions depends on returns and dividend payout. For some CEOs, these decisions will take several years to impact the overall return of the group; while for others, returns can change more quickly. I shall return to this important subject in a future article.
Simplest and often critically important is issuing and buying back stock at the right times. Some managers are good at this and should be backed; some are awful and should only be backed if the valuation or growth opportunity provides extra protection.
I am more ambivalent about acquisitions. It’s tempting to bin the stock run by an idiot who has done a daft deal, but it may not be a great strategy.
The post 7 Ways To Judge A CEO appeared first on Behind The Balance Sheet.
July 11, 2023
The first investing skill you need
Learning to analyse companies and choose your own stocks can be daunting.
After all, sound investing requires a lot of different skills. So many skills that it can be hard to know where to start learning.
Fortunately, there’s one investing skill that makes the rest of it so much easier.
And that skill is… learning how to read financial statements properly.
Once you can read a balance sheet, an income statement and a cash flow statement, your calibre as an investor instantly cranks up a gear.
Here’s why:
Instead of buying and hoping, you become a highly informed investor.Instead of taking management’s word as gospel, you’re able to test their narrative against the numbers.Instead of needing to trust other people’s analysis, you’re able to do your own work and come to your own conclusions.If you’d like to learn how to read financial statements, my online course How To Read A Balance Sheet is here to help.
The course lets you look over my shoulder as I analyse all three financial statements for a real life company. By doing so, you’ll learn a process that you can use to analyse any set of accounts.
Click here to learn more about the course. If you’re serious about picking your own stocks, you need to have these skills in your locker.
Kind regards,
Steve Clapham
The post The first investing skill you need appeared first on Behind The Balance Sheet.
