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Una Postal desde España

March 20, 2019 in MOI Global en Español, Traducciones

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Cuando viajo al extranjero, encuentro que los puntos de vista sobre España son bastante interesantes. Para muchos, España significa diversión, sol, paella, tapas, vinos de La Rioja y La Liga; mientras que otros se centran en el lado más sobrio, y preguntan sobre nuestros extraños políticos, el marco legal inestable, la crisis económica duradera, el alto desempleo… y todos, sin excepción, piensan que una parte esencial de nuestra vida diaria es la siesta.

Acordemos que hay un poco de verdad en ambos puntos de vista. Sin embargo, hay algunas salvedades aquí y allá. Los buscadores de sol deben tener en cuenta que algunas regiones pueden estar heladas en el invierno (no se rían, pero algunos turistas han terminado en el hospital con neumonía); y en lugares muy turísticos, algunos vinos y paellas de La Rioja no son tan buenos… Básicamente, mientras que algunos duermen la siesta, los propietarios y gestores de excelentes compañías están completamente despiertos.

Invexcel ha optado por invertir en esas excelentes compañías, desde el panorama de Small y Mid-Caps españolas que están entregando un gran valor a sus accionistas. Así que pongámonos a trabajar y compartamos algunos resúmenes sobre emocionantes ideas de inversión.

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The Promoter Premium in Indian Equities

March 19, 2019 in Asian Investing Summit, Equities, Ideas

This article is authored by MOI Global instructor Ankit Agarwal, Senior Vice President and Fund Manager at Centrum Capital, based in Mumbai, India.

If one were to look at the performance of onshore funds versus offshore funds – the former tend to outperform the latter. Why would that be, do they have access to less information? Is the sell-side support to foreign institutional investors less than that to domestic funds?

Well, the only thing that probably differentiates an offshore fund from an onshore fund is access to information on the ground and the ability to do regular channel checks.

Figure 1: Comparison of onshore and offshore funds

Source: https://cafemutual.com/news/aif-corner/6693-onshore-hedge-fund-managers-outperform-offshore-india-hedge-funds

If one were to look at the structure of Indian firms – most of them are family-owned businesses where the owner, the so-called “promoter”, is the majority holder in the company. As a result, the fate of the business is linked to how savvy the promoter is, what his long-term thinking about the business is and, most importantly, how he fares on integrity.

Recent occurrences in the Indian stock market linked to some companies seeing governance issues makes the Indian equity market a minefield of possible mishaps. As a result, while the fundamentals of the company are a great starting point for investing in India, an assessment of the promoter and his integrity, is an essential component of analyzing any business.

In this article, I give a brief overview of the steps one can take to reduce the probability of some of these mishaps occurring in their portfolio.

Figure 2: Promoter holdings in BSE 500 index companies

Source: Capitaline

First and foremost, the ability of the promoter is reflected in the way he/she manages the balance sheet and cash flows. The first cracks in the balance sheet appear when the EBITDA does not convert to cash fast enough, the leverage increases, or the company decides to make a significant acquisition in an unrelated business. There are a variety of accounting checks one can make to understand if there is any manipulation in the earnings, for example looking at the EBITDA to (pre-tax) CFO ratios (should be more than 80-90%) and depreciation rates (should have low variability).

Furthermore, high contingent liabilities, low provisioning of doubtful debts that could lead to overstatement of earnings, high capital work-in-progress, low cash taxes payouts, and low dividend payout ratios, are all red flags for the earnings. These can give an idea about the robustness of the reported numbers and also about how minority shareholder friendly the promoter is.

After we have done a thorough analysis of the capital allocation and the balance sheet of the company, one needs to look at the softer aspects. Since most of the companies are promoter-led, succession planning is an important aspect to consider. Who is going to drive the business, are the sons/daughters of the promoter involved in the business, and if so, what are their backgrounds. Many times a change of management from an old patriarch to a new energetic son could make a drastic change in the way the company is run. Companies that are heavily dependent on the promoter or have a weak bench strength have to be looked at skeptically, especially if the promoter is old.

Moreover, one needs to assess the promoter’s ambition to grow in a highly competitive market. Promoters who are overly aggressive might take shortcuts to achieve their goals and can lead to earnings manipulation. On the other side overly conservative promoter would not grow enough and may continue to remain a value play for the foreseeable future. Promoter assessment thus becomes an important metric of how companies are evaluated.

Many promoter-driven companies, as they become big, they realize that they have many stakeholders in the firm, many of whom are the sons, daughters, uncles, etc of the original leadership team, and as a result, the company starts entering multiple lines of business as per each family member’s whims and likes. A lot of these new businesses are privately held but would need capital at regular intervals to support and grow them, especially if they are in the infrastructure and real estate businesses.

It happens often that cash from the existing business is diverted into the new companies, or shares of the listed entity are given as pledge to NBFCs (Non-Banking Financial Companies – India’s shadow banking ecosystem) to raise debt to fund those new businesses. In times of stress, the lender might invoke this pledge and can cause severe damage to the minority shareholders of the listed entity.

Moreover, there are times when a part of the business is conducted under the unlisted entity, but a considerably higher cost is accounted for there, leading to an under-accounting of the costs under the listed entity, which in turn leads to an increase in the reported profitability of the company. And so one needs to assess companies with a parallel interest in other business with a fine tooth comb.

One even needs to monitor relationships with some of the companies that have related party transactions with the listed entity. Companies that have a large number of related party transactions can raise some issues concerning the arm’s length transactions that they are doing. A lot of times there could be promoter who could be lending to entities at a significantly higher lending rate (higher than the bank rate) or there could be a high royalty payment to the promoter or even the rentals that might be paid to the promoter owned building where the company resides might be prohibitively high. Related party transactions are again something that needs to examined in close detail while assessing the business.

The composition of the board and incentives of the promoters in the form of compensation, a percentage of profits or royalty payment is an essential indicator of governance. One needs to see if the board is occupied by all “friends and family” or if there are external professionals on it. If the promoter is taking out significant money from the company in the form of salary or royalty payments, then one needs to question whether is it in line with the industry and if the promoter is adding significantly to the brand value of the business such that a royalty payment is warranted. Annual General Meetings are an excellent way to know how independent the board is, who participates in its discussions, and if the others get an opportunity to interact with the shareholders.

However, at the end of the day, there is no better way to become aware of promoter intent than to talk to as many people as possible. Talk with the suppliers of the company, with the dealer distributor network as to how payments are made to them, speak with the consultants who have worked in the industry, the peers who have had the opportunity to see how they view management practices, the market participants who would have dealt with some of these companies in the past, to name a few avenues. And only once you have interacted with these or more people on the street you would understand what are the practices that are followed by the company and if they are going to create long term value for its shareholders.

In summary, promoter assessment is an essential tenet of investing in Indian markets. One should be extremely cautious when investing, especially when using a value approach, because if the promoter integrity is under question then such companies would be value traps and may not see re-rating in the future. Moreover, extremely high-growth companies are also something to be cautious about.

Figure 3: P/E chart for various jewelry firms

Source: Bloomberg

Some companies like Titan command a significant premium over their listed counterparts, and that premium has been maintained over cycles.

The gap between a well-managed asset financing company like M&M Financial and one that has a sketchy track record of performance continues to exist.

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Christopher Tsai on His Philosophy of Investing and Life

March 18, 2019 in Podcast, The Zurich Project, The Zurich Project Podcast

In an episode of The Zurich Project Podcast, presented by MOI Global, Christopher Tsai discusses his philosophy of investing and life.

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Korean Market Offers Opportunity After Tough 2018

March 17, 2019 in Asia, Asian Investing Summit, Commentary, Equities, Letters

This article has been excerpted from a letter by MOI Global instructors Chan Lee and Albert Yong, managing partners of Petra Capital Management, based in Seoul.

The year 2018 was the worst year in our recent memory with almost all equity markets in almost all regions substantially down. In addition, the market was extremely volatile to say the least. After all, a single tweet by President Trump or a slight change in the tone of Fed Chairman’s remarks caused the market to swing significantly in one direction or the other in a single trading day.

The Korean equity market was no exception and declined more than 17% (in Korean won terms) after suffering a tumultuous plunge in October. Many negative issues, including the Fed’s rate hike, trade war, slowdown in China, etc. contributed to the market decline. The U.S.-China trade war was probably the main contributor affecting Korean stocks because the worst outcome of this trade war will certainly hit the Korean economy hard given the country’s high dependency on trade, especially with China and the U.S. While virtually every emerging market registered steep losses, unfortunately, the Korean stock market was one of the worst performing markets in the world in 2018.

Historically, countries which successfully developed economy did so by protecting their market in some ways during the development stage and copied then advanced technology in a way which was probably unfair to existing developed countries. That is why the current actions by both the U.S. and China are totally understandable.

We think China, knowing this too well, is likely to give some concessions if it can save some face and protect its long-term national interest. Also, the U.S. is not likely to go too far because it also knows that its attempt to block China’s rise completely is almost impossible and will hurt the U.S. economy severely (even if it will ultimately hurt China more).

The U.S. stock market’s precipitous decline in December together with Apple’s earning shock citing lackluster China sales is a timely reminder of the significant interconnection and interdependence between the world’s two largest economies. That is why we believe that both countries will act more rationally with the motivation to reach some sort of compromise sooner or later. No rational fighter will try to knock out the opponent if he knows it will cripple himself at the same time.

A steep rate increase orchestrated by the Federal Reserve also contributed to the market decline in 2018. However, with signs of economic slowdown in the U.S. and still relatively low inflation, the Fed is likely to pause and exercise great patience in rate hike moves (after raising the Fed funds rate nine times since late 2015). This could also lead to a less strong U.S. dollar going forward and may take some pressure off emerging markets currencies and interest rates which would be positive news for Korean companies as well. But even if the Fed goes ahead and raises the rate steeply as originally planned, we think the long-term negative effect is already priced into the Korean equity market as evidenced by an ultra-low valuation.

Whenever a negative issue arises, the stock market initially moves assuming the worst case scenario. Thereafter, the market eventually adjusts to an appropriate level after digesting and analyzing all the relevant facts. At the current price levels in Korea, we think that most of the negative issues are already priced into the stock market. That is why we believe the recent market pull back is clearly overdone. If the market’s initial assumptions are incorrect and thus, the worst case scenario does not materialize, stocks are due for a bounce.

On the other hand, even if the market’s initial assumptions are correct, we still have little downside risk because the worst case scenario is fully priced into the market. Alas, the sad reality is that most investors become fearful when the market plunges as all humans are born to respond quickly to avoid danger in front of fear. That is why most investors tend to panic and sell even more after the market downfall without regard to rationality. In today’s environment, money flows seem to trump all other factors in determining stock prices. Therefore, unfortunately, money flows can effectively render fundamental analysis futile in the short-term.

While most of the negative issues we mentioned above affect the market temporarily, the lack of more transparent corporate governance is perennial and by far the biggest reason for the “Korea discount” which has been prevalent in the market for a long time. The improvement has been much slower than most investors hoped. But we have always believed that companies can change only under social pressure. Through many years of the government’s efforts together with several high-profile cases of awful corporate governance at some Korean chaebols, we feel the general public sentiment is finally changing significantly in favor of broader governance reform.

For example, even a few years ago, shareholder-friendly policy itself was thought to be detrimental to growth and viewed negatively by local investors. In the past, large Korean institutional investors typically either abstained or voted for whatever agenda forwarded by management at the shareholder meetings. But with the recent adoption of a Korean stewardship code by Korean institutional investors such as the National Pension Service, they are now bounded by stricter fiduciary duties and obliged to vote against management’s agenda which is not beneficial to minority shareholders. That is why we feel more sanguine that many Korean companies will finally begin returning more cash to shareholders. Although the pace of change may be much slower than we desire, the most important factor may be the change of direction itself. Also, we noticed that several local activist funds have sprung up recently. We expect the Korean market to re-rate the valuation upwards if this trend continues.

The Korean stock market has been one of the cheapest markets in the world in terms of valuation. After a large decline in 2018, the Korean market valuation looks even more compelling for long- term value investors. In sum, as we explained above, all the negative issues that we had last year are unlikely to turn out to be as assumed even in the worst case scenario. Also, it is extremely hard to find anyone who draws a rosy picture in Korea nowadays. In fact, fear definitely prevails in the current market. However, as Sir John Templeton once famously said, “bull markets are born on pessimism”, we have a contrarian view of a higher price for Korean equities in 2019. As an intelligent investor, we will use Mr. Market’s mood to our benefit.

We bought many undervalued stocks during the past few years when a great many value investors have suffered. In a market dominated by money flows, the stocks of mundane companies were abandoned for those that offered more growth. In other words, “hot” sectors kept rising because investors were buying rising stocks instead of undervalued stocks. Therefore, many value stocks kept going down because investors shunned these stocks.

As a result, many value managers experienced poor performance, resulting in investor outflows. This led to more selling – cheap stocks became cheaper while expensive stocks continued to rise. However, after the market plunge last year, we believe that the market environment has finally turned in favor of value investors like us as indiscriminate selling provides a great opportunity to buy competitive companies with strong cash flow at attractive price levels.

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Berkshire’s Distinctive Shareholders and Corporate Longevity

March 17, 2019 in Commentary

The following article is authored by Lawrence Cunningham, Professor of Law at George Washington University.

Shareholder composition matters less than many think, according to a research summary by Stanford’s Rock Center. In a paper released last week, the authors Anne Beyer, David Larcker, and Brian Tayan explain that while executives care about who their shareholders are, little evidence shows that shareholder demographics affect corporate decision making. While people pay a premium for block shares, voting power does not systematically translate into value.

An important exception to these general findings is Berkshire Hathaway, whose shareholder demographics do make a difference in decision making and value. Indeed, as I explain in my book, Berkshire Beyond Buffett: The Enduring Value of Values, Berkshire’s durability is reinforced by a shareholder body that shares the principles Buffett injected into the company.

For starters, despite being a massive public corporation, Berkshire’s shareholder character is that of partnership. Buffett forged that conception by stating it repeatedly in his annual letters and acting like the managing partner of a partnership. He explains business decisions candidly, admits mistakes, and catalogues the events that have defined Berkshire culture.

Reciprocally, the owners of the company’s equity act more like partners in a private firm than shareholders of a public company. Berkshire shares are owned by many people for whom Berkshire is among their largest holdings.

In the past decade, share turnover has been less than one percent compared to three to five percent for other conglomerates, large insurance companies, or Berkshire’s formerly-public subsidiaries. (I provide detailed tables in the book.)

Berkshire’s low share turnover ties in to another unusual feature: most Berkshire shares are owned by individuals and families, not firms and funds. Typically, large public companies see seventy to eighty percent of their shares controlled by institutional investors. Investment decisions are often made by committee and based on financial models and forecasts that can lead to trading the stock for reasons unrelated to the company.

In contrast, at Berkshire a large portion of the voting power and economic interest are controlled by individuals and families, who focus on its specific economic and cultural characteristics.

Berkshire shareholders flock to its annual meetings. Attendance has risen from 7,500 in 1997 (the first year I attended) to 21,000 in 2004; 35,000 in 2008; and 40,000 in 2013. They study Berkshire’s annual report, Buffett’s shareholder letters, and other reference materials.

At most large public companies, individual shareholders are rationally apathetic. They skip reading the reports and rarely attend meetings, which verge on formal ritual. Meanwhile, substantive business discussion takes place at Berkshire’s annual meeting where the passion for the company is palpable.

Berkshire is not a family company in the same way that Cargill, Mars or S. C. Johnson are, but many families treat Berkshire shares as prized parts of their financial picture to be preserved by successive generations. They are led by the examples at the top.

Howard Buffett’s Berkshire shares give him 0.12% of the voting power and 0.07% of the economic interest. Charlie Munger’s brood—eight children and dozens of grandchildren—owns more than 1.00% of the voting power and nearly 1.00% of the economic interest, with instructions from the patriarch to hold them forever.

Certain owners of substantial amounts of Berkshire stock also manage institutions whose clients, wealthy individuals and families, are large Berkshire holders. Berkshire director Sandy Gottesman, for example, personally owns shares yielding 2.02% of Berkshire’s voting power and 1.29% of its economic interest. Clients of First Manhattan, the firm he formed in 1964 where his son Robert W. Gottesman is a senior manager, command another 1.91% of the voting power and 1.22% of the economic interest.

Most Berkshire directors own meaningful stakes, especially Bill Gates, who personally owns Class A shares with 0.45% of the voting power and 0.26% of the economic power. Meryl Witmer bought seven Class A shares shortly after being elected a director in 2013 and is part-owner of Eagle Capital, whose holdings include Class B shares with 0.16% of the voting power and 0.53% of the economic interest.

Managers of Berkshire’s subsidiaries also own considerable Berkshire stock. Most are independently wealthy and many own greater stakes in Berkshire than all but the most-invested directors do. Like the board, they believe in Berkshire culture and eat their own cooking.

Sophisticated investors generally follow conventional wisdom to avoid concentrating portfolios in the stock of one company. Among holders who publicly disclose stakes, for instance, few of the largest hundred shareholders of blue chip companies allocate more than five percent of their portfolios to that company’s stock. In contrast, many Berkshire shareholders concentrate in its stock, following the example of Berkshire’s own portfolio concentration. (The book presents several tables providing details.)

America’s blue chip companies tend to have the same largest shareholders, chiefly big banks, investment advisors, and money managers. For example, institutions like Blackrock, Fidelity, State Street, and Vanguard own two to five percent of the stock of such companies, dominating their shareholder lists. While many also own Berkshire, they are not Berkshire’s dominant shareholders.

Berkshire shareholders are also collegial, generous, and informed, as I confirmed when conducting shareholder surveys and interviews for the book. The Berkshire community embraced the research and offered their help. For example, MOI Global introduced me to several Berkshire shareholders who generously shared their views—among some 500 others, I specifically thank a dozen more in the book’s acknowledgements (see below).

As the Stanford research suggests, Berkshire’s shareholder body is unusual in corporate America. An affiliation of readily coordinated shareholders with a meaningful percentage of the voting power, it’s a group of stalwart shareholders with a partnership conviction about Berkshire and faith in its owner orientation. True, their fondness for Buffett overflows and they believe that no one can replace him. Yet they appreciate what he built and believe in its durability beyond him. The voting power they wield will help shape Berkshire’s future.

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* In my acknowledgements and here I again I thank the following Berkshire shareholders for completing my survey and/or fruitful notes or discussions: Charles Akre; J. Jeffrey Auxier; Christopher M. Begg; Robert W. Deaton; Jean-Marie Eveillard; Thomas S. Gayner; Timothy Hartch; Buck Harzell; Andrew Kilpatrick; Paul Lountzis; Nell Minnow; Blaine Lourd; Mohnish Pabrai; Larry Sarbit; Dave Sather; Guy Spier; and Timothy P. Vick.