Four Unpopular Opinions of Tollymore Investment Partners

July 8, 2020 in Commentary, Equities, Letters, Skills

This article is excerpted from a letter by MOI Global instructor Mark Walker, Managing Partner of Tollymore Investment Partners, based in London.

Tollymore’s raison d’être

Tollymore is a partnership which manages capital on behalf of its principals and a small, special cohort of investment partners who have demonstrated the ability to think unconventionally and act countercyclically. In doing so we make decisions in the interests of long-term results. We expect most of these investment results to come from the internal earnings power growth of the companies we hold, augmented by occasional and sensible portfolio management decisions.

We do not expect superior investment results to come from any IQ advantage, but from the implementation of factors that will allow us to acknowledge ignorance or exercise conviction better than our peers. These factors relate to the consistency of investment horizon, temperament, working environment, incentives, and investment partners’ beliefs and actions.

We believe in the incomparable importance of flourishing relationships in determining enduring contentment. We try to uncover win-win in investing and life.

Four unpopular opinions

1. Holding cash is imprudent

“Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.” –Peter Lynch

2020 has so far been one of the most tumultuous periods in public market history. These episodes are reliable opportunities for clear long-term thinkers to exploit quoted price volatility to improve future investment results. Yet misdirected intellectual energy in the form of market commentary tends to accelerate in periods of market dislocation. The inability to act decisively in these periods, due to capital redemptions, inappropriate capacity constraints, committee-led decision making models, lack of conviction or other source of self-doubt is a barrier to value creation and one of the great shames of our industry.

We have been struck by the broad consternation, and even irritation, at the recovery of equity markets since the nadir in March. A recovery which many market commentators have professed to be disconnected from economic reality. In a scramble to overlay current circumstances over historical precedents[1], market strategists and the media have concluded that the market is dangerously ignoring economic fundamentals. It may be interesting to consider the incentives behind such frustration, particularly for those investors who use cash to time markets, and have been walloped by a double whammy of having fully invested portfolios in the first quarter and meaningful cash holdings in the second. These cash flows are part of the reflexive nature of markets; they contribute to the very factors that drive them. Tollymore’s concentrated portfolio and global opportunity set obviate the need to use a cash weighting as a tool to predict stock market movements. A fully invested portfolio is better for profiting from non-fundamental exacerbation of quoted price changes. Increasing cash allocations without demonstrably reliable market insight is not lowering risk. Especially when the trigger for its subsequent redeployment is typically lower uncertainty, the cost of which is higher prices. The uncontested premise that this sell-low buy-high behaviour is consistent with risk mitigation is staggering. We contend that those with fully invested mandates can profit from it.

It is this ‘de-risking’ behaviour that depresses prices and creates opportunities, some of which we described in our March 2020 letter to partners. The economic consequences of the circumstances that led to this selling come after. And it seems sensible to assume that future price movements will be a function of (1) the second derivative; that is, the relative severity of economic conditions relative to expectations, not relative to the past, and (2) the perceived level of uncertainty, which declines as unknown unknowns become known. To expect weak markets to coincide with weak economies vastly oversimplifies a complex system and contradicts financial history. To scoff at the disconnection between the two, to assume that the aggregate sentiment of the market is missing something so obvious that it is being highlighted by every pundit and commentator, is hubristic and naïve. We can do better by being adequately selfaware to respect the complexity of market and economic forecasting and acknowledge the terrible base rate of success in this endeavour.

2. Dispassionately cutting unprofitable investments is consistent with long term ownership

“The best money managers are also the best quitters. They quit early and they quit often. As soon as they see things turning for the worse, they don’t wait around, they bail.” –Scott Fearon

We are comfortable in averaging down when collapsing share prices clearly improve potential future investment results. But one of the challenges of a fully invested investment programme is identifying the most profitable source of funding for this activity. Without cash holdings, we have two funding options: reduce our ownership of successful investments or exit unsuccessful ones. The former may be the theoretically sound choice. Rising stock prices lower prospective stock returns, all else equal. Yet all else is rarely equal, and it is often a mistake to materially pare back investments in companies which have demonstrated strong fundamental business progress. We have become increasingly comfortable with utilising the latter funding source; that is, to distinguish between those losing investments that deserve our patient capital, and those that do not.

In the absence of clear and substantial overvaluation, selling due to valuation implies an ability to predict near term price movements. In addition, selling a familiar business making positive fundamental strides for an unfamiliar one creates reinvestment risk. We are not playing for 20% upside; we will continue to own businesses which we believe will be worth a lot more in five to ten years. We expect Tollymore’s aggregate long-term results to be determined by a small number of outsized winners and a tong tail of (many) below opportunity cost mistakes.

3. ESG ≠ sustainable investing

“For business to survive and prosper, it must create real long-term value in society through principled behaviour.” –Charles Koch

Institutional investment management is broken. Asset gathering business objectives and goldplated cost structures magnify the imperative to grow AuM. Investment firms led by marketers rather than investment managers create strategies tailored to what will sell rather than what works. Large pools of management fees are required to fund large, expensive, teams designed to convey analytical edge. Pressures to justify high management fees discourage investment professionals from acknowledging ignorance or mistakes and create an action bias that is antithetical to good investment outcomes.

Money management is a very scalable business model. It is possible to raise significant capital without commensurate increases in resources, rapidly increasing the profitability of the investment firm and substantially enriching its owners. Managers’ and investors’ fortunes are typically not aligned. This is a barrier to sound investment decision making. A simple way to weed out the managers that back themselves is to consider the presence and power of incentives. Managers without insider ownership are less incentivised to limit the size of their fund, therefore limiting their achievable investment results. In our view, and in the case of most institutional money managers, the components of stewardship reflect a product to be sold rather than a strong belief in the strategy.

There are ways to enrich the owners of an asset management business that are consistent with compounding investors’ capital. Incentive principles should allow for the enrichment of GPs together with, and not at the expense of, LPs. The manager’s compensation should be driven by the compounding of his own capital in lieu of fees on additional capital. Sharing of investment returns in excess of appropriate hurdles lowers pressure to grow beyond the strategy’s investment capacity. The creation and promotion of investment strategies that will sell result in niche investment universes predicated on analytical edge, primary research methods, or proprietary idea generation funnels, all of which look ‘differentiated’ in a pitchbook. The latest incarnation of this pitchbook mentality comes in the form of ESG investing mandates.

Investors last year ploughed a record $21bn into ‘socially-responsible’ investment funds in the US, almost quadrupling the rate of inflows in 2018. The surge in popularity of companies with the best social, environmental, and governance scores in recent times has resulted in a crop of ESG funds, eager to attract some of the cyclical capital flows to this bucket.

Attempts to quantify art through an obsession with measurement create bubbles, disincentivise first principles thinking, and make capital allocation and manager selection processes less efficient by making them more data driven. But data can be falsely empowering, unaccompanied by thoughtful qualitative review of a manager’s capacity and incentives to do a good job.

The shoehorning of ESG frameworks into existing asset management programmes and the surge in new ESG funds extend the already warped incentives in the investment management industry. Stocks with strong ESG scores are bid up as these capital flows are put to work. Are investment managers, guided by the desire to grow assets and the employment of a quantitative ESG scoring framework, and absent the facility to think independently about the sustainability and reasonable governance of companies, and the investment merits of their equity, being socially responsible by directing endowments’, charities’ and pension funds’ capital to this more richly valued subset of the global investment universe?

ESG’s commonly accepted synonymity with ‘sustainable investing’ is especially perplexing. Who wants to own unsustainable businesses? What is investing if not the purchase of part-ownership of sustainable, flourishing enterprises? What long term business owner, managing capital for investors with long term, sometimes perpetual, investment horizons, would like the company she owns to be run by dishonest, self-serving managers misaligned with company owners, to treat employees poorly, create negative externalities, and exploit its customers? The studious long-term investor must consider the company’s relationship with all its stakeholders. At a minimum, understanding the strength of these relationships is central to mitigating risk of permanent capital erosion. Ideally, these relationships confer a lasting unfair business advantage, difficult to replicate by peers merely paying lip service to regulators and investors requiring the completion of ESG checklists. The items on these checklists must be measurable. This encourages the quantification of factors which are qualitative. How can one quantify, or score, whether, and the extent to which, social media companies exploit their users to the detriment of their health? Can these checklists consider and measure the enormous and compounding positive externalities created by modern platform businesses? An appreciation of the relationship between a company and its stakeholders is a qualitative, subtle, and effortful endeavour. The interrogation of business ethics and the capacity for company managers to make the right long-term decisions are at the heart of serious investment programmes. The employment of an outside analytics firm to bestow credibility on an ESG framework should be no part of this.

Any investor with an interest in owning sustainable businesses must recognise that company boards have broader responsibilities to consider environmental and social issues. They will also understand that these duties do not dilute their fiduciary obligations to equity holders. Rather, they are a necessary part of satisfying them. Decisions to create large positive externalities and forge win-win outcomes – non-zero-sumness – take time and often come at the expense of traditional short-term measures of shareholder return. But these are the decisions that determine corporate vitality and staying power.

The broad disregard for long term win-win outcomes is a function of short holding periods. Company ownership changes hands on average every few months, vs. eight years in the 1960s. This is a by-product of investment constraints deeply embedded in the institutional money management industry, such as short-term capital, manager/investor misalignment, career ris and asset-growth agendas. These constraints cannot be addressed with an ESG checklist.

Just as truly special corporations seek to thrive under the principle of win-win, so must investment management firms create more value that they consume. Incentive structures should make it sensible to forgo additional management fees in lieu of excess returns on insider capital. Frameworks for economic profit-sharing should reward acceptable performance and coordinate manager and investor enrichment. These include the employment of hurdles to make weak performance cheap and strong performance expensive. Investors should receive most of any outperformance generated, not just most of the absolute return. Fee structures should therefore allow fund managers to talk about integrity with some legitimacy. Too many managers charge egregious fees with the sole purpose of enriching themselves at the expense of clients.

Tollymore enjoys trusted relationships with long term investment partners. Partners who can think like business owners rather than stock market traders and understand that a common stock represents a fractional interest in real assets. Great investment partners are a competitive advantage: an evolving, mutually appreciative, and increasingly resilient relationship is an enabler of greater and more sustainable value creation. Our goal is to accumulate wealth by investing in high quality businesses for the long term; it is not to predict share price movements.

With business ownership in the public markets so fleeting, and given the strong economic incentive to raise capital, it is unsurprising that the objective of investing in viable, durable, companies is not evergreen nor widely practised. This is a sombre impeachment of the asset management industry. But it creates opportunity for those investors who recognise that treating stakeholders well is good for business owners. We look for symbiotic value chains; there need not be a trade-off between compounding owners’ capital and the principled consideration of all other lives our companies affect. Managers of the companies we own must look beyond the direct or immediate consequences of their actions to create lasting value. And a long-term outlook is essential, because shorter term sacrifices – ‘the capacity to suffer’ – are often required to create value of any permanence.

4. Successful investing requires intuition

“One’s investment approach [should] be intuitive and adaptive rather than fixed and mechanistic.” –Howard Marks

The emulation of successful investors is dangerous and reductive. Blindly copying the factors that may have driven others’ success is less likely to lead to good outcomes than the introspective examination of one’s own temperament and qualities, and a careful matching of those qualities with our environment.

We believe a behavioural advantage is possible by coordinating the disposition of the firm’s principals, the mentality of its investment partners, physical working environment, methods of internal communication, the time horizon of the strategy, and the implementation of the programme. We spend time thinking about the complementary nature of these aspects of the ecosystem. We spend less time thinking about the individual merits of concentrated vs. diversified portfolios, noisy vs. quiet offices, or short vs. long term decision making. There are lots of ways to invest, but the best results come from thinking about the interdependence of every aspect of an investment organisation.

Investing is an art. Yet money managers attempt to quantify and measure progress and decision making due to an incentive to raise large amounts of institutional capital through the suggestion of repeatability. History’s greatest investors have used intuition to guide their decision making, particularly with respect to idea generation and portfolio management. The highest achievers in another complex, reflexive game – chess grand masters – rely heavily on intuition.

It seems popular nowadays to espouse the benefits of quelling emotion to make more rational choices, thanks to the fantastic work of Daniel Kahneman and Amos Tversky, and studies such as “Lessons from the Brain-Damaged Investor”[2]. While Tollymore is an effort to exploit the behavioural shortcomings and constraints of peers, we are not sure it is possible or even desirable to simply banish emotion. A life without empathy, sorrow, passion, excitement, or joy sounds horribly unfulfilling[3]. Even the desire to avoid negative emotions such as shame or regret make it more difficult to acknowledge and learn from mistakes and can lead to suboptimal investment decisions[4]. Finally, attempts to suppress emotion are highly energy-depleting. This energy is required to form the insights and make the judgements necessary for sound investing practice.

Emotional management is clearly sensible in investing. Market cycles can boil down to fluctuations between participants’ states of happiness and sadness. So, an ability to regulate these emotions is plainly helpful. But there are other aspects to emotional intelligence such as empathy and self-awareness that do not seem to receive the same attention. Avoiding the discomfort associated with an honest evaluation of oneself is a barrier to self-awareness. In this way a military focus on eliminating negative emotions can be counterproductive in making good decisions.

The art of using and perceiving emotion is something we can become better at over time. Trying to improve in these areas in the pursuit of a good life will also make us better investors. By dismissing the opportunity to develop in these areas, we run the risk of abandoning intuition in favour of purely quantitative information processing. This is likely to lower a tolerance for uncertainty which may be one of the only advantages we have as public equity managers. This seems especially relevant today when most ‘investment’ decisions are being made by computers.

We spend most of our time on rational reasoning through independent study of companies and examination of their investment virtues. But fundamental business analysis is table stakes; and it is more commoditised than money managers realise or admit. A disciplined investment process is required to prevent otherwise helpful emotions from becoming unregulated. So too are the people that will help us to stay humble in periods of success and support us in periods of selfdoubt.

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Disclaimer: The contents of this document are communicated by, and the property of, Tollymore Investment Partners LLP. Tollymore Investment Partners LLP is an appointed representative of Eschler Asset Management LLP which is authorised and regulated by the Financial Conduct Authority (“FCA”). The information and opinions contained in this document are subject to updating and verification and may be subject to amendment. No representation, warranty, or undertaking, express or limited, is given as to the accuracy or completeness of the information or opinions contained in this document by Tollymore Investment Partners LLP or its directors. No liability is accepted by such persons for the accuracy or completeness of any information or opinions. As such, no reliance may be placed for any purpose on the information and opinions contained in this document. The information contained in this document is strictly confidential. The value of investments and any income generated may go down as well as up and is not guaranteed. Past performance is not necessarily a guide to future performance.

The Dam Has Broken

July 8, 2020 in Commentary, Equities, Letters, Macro

This article is excerpted from a letter by MOI Global instructor Daniel Gladiš, chief executive officer of Vltava Fund, based in the Czech Republic.

Ideological revolution

I don’t really care much for using grandiose words, because they often are spoken under emotional pressure and may prove exaggerated with hindsight. This time, however, they seem to fit the occasion. In my opinion, what we are living through just now is a time of ideological revolution insofar as monetary and fiscal policies of the world’s key countries are concerned. There are some things that one might perhaps have believed heretofore to be temporary but that will apparently become permanent aspects of the financial world while having great long-term impacts on the values of the main asset classes. Although for investors there is no escape, there nevertheless does exist a defence.

How did we get here?

If I were writing some kind of academic text, I would have to start much further back in history. I think that for our purpose it is quite enough to start with the last recession in 2008. Its epicentre was in the financial sector. At that time, the central banks came up with a rather innovative solution that involved two main steps: purchasing assets from bank portfolios and reducing interest rates to historically low levels. Their combined effect was very positive, and particularly so in the first few years. They provided liquidity to the markets, brought stability to the financial sector, and spurred economic growth. This did not come for free, of course. Part of the private sector debt was transferred to governments, and their debts grew substantially. The balance sheets of central banks swelled to unprecedented levels while artificially low interest rates distorted prices in financial markets and created the temptation to underestimate risk. Central bankers answered to their critics with the argument that these were only temporary measures, and as soon as the situation in the markets would normalise the central banks would begin to reduce their balance sheets again and interest rates would go back to normal, too. This never happened, however, and it probably never will.

The Fed’s balance sheet, which expanded from USD 900 billion in the autumn of 2008 to USD 4.5 trillion at the end of 2014, started to contract slowly from 2018. But this only lasted for a year and a half, until autumn 2019, when it totalled USD 3.7 trillion. Then, practically overnight, the Fed made an unexpected 180-degree turn and began once again to purchase treasury bonds. It turned out, in fact, that there were not enough buyers in the market who would soak up the newly issued sovereign debt. Foreign investors have not been buying American debt very much in the past five years, and capacity of domestic buyers is not unlimited either. Last year, however, the country ran a deficit of about USD 1 trillion, and this new debt had to be bought up by somebody. The only remaining buyer was the Fed. By February 2020 (and that was still before the virus pandemic), the Fed’s balance sheet had bloated to USD 4.20 trillion.

Then came the virus, and this year’s US budget deficit will be not USD 1 trillion but rather USD 4 trillion, and if there were not enough buyers for the new debt already last year, that is even more so the case this year. The Fed’s balance sheet hit USD 7.00 trillion at the end of June and is still growing. Practically all new debt is now being purchased by the Fed. I am using the USA here as an example, but the situation is similar in all the world’s key economies – in the large countries of the EU, in Britain, Japan, as well as in China. This is a global problem.

What to do about the debt?

There are only three possibilities for settling sovereign debt. The first and best one is rapid economic growth. If an economy grows fast enough and is not burdened by a too-large debt, that debt may decrease as a percentage of GDP. For most of the big countries, however, this solution is outside the realm of reality. Their combination of slow growth and large debt practically excludes this, regardless of what politicians and central banks might say.

The second way of reducing the debt is to cancel it. This is a very common way of resolving the issue, and some countries having their own currencies will continue to use it. The latest big such case is the recent default by Argentina. This, however, is quite a drastic solution that is accompanied by great costs and difficulties and is politically unpopular.

The third way to diminish the debt is to let inflation wipe it away or, generally speaking, to repay it in depreciated currency. History knows many such examples dating back to Ancient Rome. This is and will remain the preferred manner of resolving debts in many high debt countries having their own currencies. This is nothing new, but the extent to which this solution is applied will probably accelerate.

The dam has broken

National budgets are in the hands of politicians. If we take a cynical point of view (or maybe not even a cynical but a realistic one), we can say that the main interest of politicians is to be re-elected. The best path to winning election leads through bribing voters using state budget outlays. There is one unpleasant complication associated with this, and that is that if we want to give something to somebody we must first take it from somebody else. People are pleased to receive things, but they tend to get defensive when we want to take something away from them. What is happening now, however, changes the situation completely. Politicians see that it is possible to scatter money around without the need to take it from somebody else first, because the entire debt is financed by having the central banks print new money. This is nirvana to them. Now, they will shed even the last of their scruples. The result will be that large budget deficits will be predominantly financed by printing new money. “Helicopter money” is here in full strength. The dam has broken, and there is nothing that could stop the flood of new money.

In everyday life, scarcely anybody will raise objections against this. When you boost taxes on people, when they lose their jobs or when debts are cancelled, they protest. They are happy, however, when newly printed money is given away to them. They see only their own immediate benefit. The costs of this entire operation are too distant, abstract, and incomprehensible for them to recognise. It would be naïve, however, to think that these costs do not exist.

The whole thing works thusly: The government runs up large debt over the long term, the debt is underwritten by the central bank, and interest rates paid to the central bank by the government are returned by the central bank to the budget. Who would have any motivation to change this state of affairs? Reductio ad absurdum, the question arises as to whether it makes any sense to collect taxes at all when all the expenses may be paid by printing new money? I think it will not be too long before somebody comes up with this perpetual-motion machine.

And what about the economy?

I have ever greater difficulties with economic theories. When I began enthusiastically to study economics in 1991, I considered it to be a science. Today, I seriously doubt that. An exact natural science for me is physics, for instance. When we reduce water’s temperature towards zero and below, we know what happens with water. It changes its state, volume, and other characteristics. It works the same every time and we all can agree on that. When we decrease interest rates towards zero and below, however, we do not know what will happen. Some economists consider negative interest rates to be very beneficial, some consider it very harmful. There is probably no real proof for either one. So, how can economics be a science?

Economics is right about one thing, though. The saying “There ain’t no such thing as a free lunch” declares that it is not possible to get something for nothing. Financing debt by printing new money truly has its real costs. They may be various – social, political, relating to ownership rights, and so forth. We are most interested in those that may involve financial markets.

The key to further investment considerations in my opinion comes down to two things. First, financing budget deficits by printing new money is now a permanent state of affairs. Second, a great part of this money will go directly to consumers because of the purposes for which the budget deficits are run, and over time this may have a considerable inflationary effect. It used to be that central banks were buying financial assets from institutional market participants, but today, a large part of newly printed money is directed to financing everyday outlays.

How might this influence the markets?

It is thus probable that we will continue to invest in an environment accompanied by negative real interest rates, with nominal interest rates held artificially low, fiscal expansion, rapidly growing money supply, and inflating of central bank balance sheets. There does not occur to me any way how this may greatly change for the better any time soon. We’ve been working in this environment for some time already, but investors should change their thinking in the sense that this environment is not temporary but permanent. This whole trend will tend to accelerate with the speed of change in politicians’ and central bankers’ thinking. I believe it is no exaggeration to speak of an ideological revolution in finance.

The greatest threat to investors

All the worlds’ main currencies have nearly flawless history insofar as their own depreciation is concerned. This trend will very probably even accelerate, and that is the main problem investors need to contend with. When I speak about currency depreciation, I do not mean exchange rates of currencies against one another. This is not a debate about whether it is better to own dollars, euro, pounds or francs. This is a discussion about the fact that all currencies lose value in relation to real assets.

Holding cash has historically been a bad investment choice because its real value is always sinking. Today the situation is even a bit worse, and holding a great part of one’s assets in cash over the long term makes practically no sense. And it may get even worse. Some economists are very seriously recommending to introduce substantially negative interest rates – to start with on the level of −3%. (From the future speech of the Great Economist to the nation: “Dear ordinary people, it gives me great joy to announce that from tomorrow we are introducing negative interest rates in the amount of 3%. Our economic theory clearly demonstrates that this step will bring you enormous benefit. It is true that we will take 3% of your savings each year, but do not forget the most important thing – that at least something will still remain for you. After 20 years, it still will be a bit more than a half.”)

It is a bit depressing to think that a person can work, earn money, and then instead of having and enjoying that money in peace, he or she has to continue investing just to protect the value of the money he had earned. This necessity is becoming ever more urgent even as there are fewer investment opportunities. The majority of debt assets are today essentially out of the game. Their real returns are either very low or they are inadequate relative to the credit risk taken on.

Essentially, the only way of preserving at least the real value of money over the long term remains ownership assets, and particularly shares in companies. Ownership of company shares (stock) should continuously bring greater returns than other investments, and that is for two main reasons: Shares represent the creation of value by human work, and there is opportunity to reinvest capital at higher rates of return.

I perceive every company as a living organism wherein people endeavour to create value by their work – contributing their ideas, efforts, creativity and common everyday labours. It may not succeed every time, but, on average and over the long term, this influence is very positive and, most of all, it is not eroded by the decreasing value of money.

Just about everybody will recognise, for instance, that the influence of Jeff Bezos on the value of Amazon is huge. The same could be said about the influence of Steve Jobs on the value of Apple. Both of them, together with other people in these companies, contributed crucially to the fact that the value of each of these companies exceeds USD 1 trillion today. We need not go so far to find examples of creating value by human work. Great creators of value in our Czech homeland, for example, were Tomáš Baťa, Emil Škoda, František Křižík and Emil Kolben. The names of great Czech value creators from the present need not be mentioned here, we all know them, even though in fact only one of these companies (Avast) is today publicly traded. It is one of the best examples of how people create value. Initially, the main creators of value were probably its founders Pavel Baudiš and Eduard Kučera, today they are almost two thousand employees.

People are simply the main instigators of value in a company, and so it is at all levels. These need not be gigantic corporations, either, not at all. People create value also on a smaller scale, in small firms, services and trade, for example. Every one of us either knows these examples from our own surroundings or is striving to do it himself or herself.

The influence of human activity on the value of a company is absolutely fundamental. People cannot by their work influence the value of other asset classes, like cash or gold or bonds, or they may be limited by the possibilities offered by such assets, as in the case of land or real estate, for example. In the case of companies, they have the greatest room, flexibility, and largest opportunity to adapt to changing conditions. This is the first and main reason why ownership of shares brings – and over the long term must bring – higher returns than can ownership of other asset classes. Nothing should change this in the future.

The second main reason why ownership of stocks should bring greater returns than ownership of other asset classes lies in the higher returns obtained from reinvestment of earned capital. Companies function over the long term by striving to reinvest earned capital into further growth and expansion. Reinvested capital increases the total sum of capital a company has at its disposal for doing business, and this should also bring increase in absolute returns. Capital reinvestment is of course possible also in cases of owning bonds, land or real estate, but in the case of companies the returns are much higher and the opportunities broader. For example, the average return on equity in the case of American publicly traded companies is around 12%. The companies may, on average, reinvest their own earned capital for that same rate of return. We scarcely can expect to attain such high returns when reinvesting into bonds, land or real estate. In long-term investing, when it is important how quickly the compounding returns accumulate, the difference between reinvested returns from stocks and reinvested returns from other asset classes is decisive.

None of these ideas is new or surprising. What has changed is the environment within which we invest. Some barriers that have existed up to now have been broken, and the degree of urgency to direct investments into ownership assets has increased. If you were to ask me if I like the hand that has been dealt, I would be very critical of many things and developments, but this has no influence on our investing. It is not important whether or not we like how things are developing. It is necessary to take things as they are, accommodate to them, and think about which stocks will benefit most in such an environment.

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Disclaimer: Our projections and estimates are based on a thorough analysis. Yet they may be and sometimes will be wrong. Do not rely on them and take your own views into consideration when making your investment choices. Estimating the intrinsic value of the share necessarily contains elements of subjectivity and may prove to be too optimistic or too pessimistic. Long-term convergence of the stock price and its intrinsic value is likely, but not guaranteed. This document expresses the opinion of the author as at the time it was written and is intended exclusively for promotional purposes. The investor should base his or her investment decision on consideration of comprehensive information about the Fund. Only a qualified investor pursuant to § 272 of Act No. 240/2013 Coll. may become a shareholder of the Fund. Persons who are not qualified investors pursuant to the aforementioned provision of the Act shall not be allowed to invest. The value of an investment may increase and decrease. Neither return of the amount originally invested nor increase in the value of such investment is guaranteed. The Fund’s past performance is not a reliable indicator of future investment returns. The information contained in this letter to shareholders may include statements that, to the extent they are not recitations of historical fact, constitute forward-looking statements within the meaning of applicable securities legislation. Forward-looking statements may include financial and other projections, as well as statements regarding our future plans, objectives or financial performance, or the estimates underlying any of the foregoing. Any such forward-looking statements are based on assumptions and analyses made by the Fund based upon its experience and perception of historical trends, current conditions and expected future developments, as well as other factors we believe are appropriate in the given circumstances. However, whether actual results and developments will conform to our expectations and predictions is subject to a number of risks, assumptions and uncertainties. In evaluating forward-looking statements, readers should specifically consider the various factors which could cause actual events or results to differ materially from those contained in such statements. Unless otherwise required by applicable securities laws, we do not intend, nor do we undertake any obligation, to update or revise any forward-looking statements to reflect subsequent information, events, results or circumstances or otherwise. Before subscribing, prospective investors are urged to seek independent professional advice as regards both Maltese and any foreign legislation applicable to the acquisition, holding and repurchase of shares in the Fund as well as payments to the shareholders. The shares of the Fund have not been and will not be registered under the United States Securities Act of 1933, as amended (the “1933 Act”) or under any state securities law. The Fund is not a registered investment company under the United States Investment Company Act of 1940 (the “1940 Act”). The Fund is registered with the Czech National Bank as a foreign alternative investment fund for offer only to qualified investors (not including European social entrepreneurship funds and European venture capital funds) and managed by an alternative investment fund manager. Investment returns for the individual investments are not audited, are stated in approximate amounts, and may include dividends and options.

Highlights from Wide-Moat Investing Summit 2020

July 3, 2020 in Equities, Featured, Ideas, Wide-Moat Investing Summit, Wide-Moat Investing Summit 2020, Wide-Moat Investing Summit 2020 Featured

We are delighted to bring you the following investment idea highlights from Wide-Moat Investing Summit 2020, held LIVE online on July 2-3.

The idea snapshots below have been provided by the respective instructors or compiled by MOI Global using information provided by the instructors. For the full investment theses, please review the slide presentations and replay the conference sessions.

Please note: This post covers selected sessions only. Browse all sessions.

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The following is provided for educational purposes only and does not constitute a recommendation to buy or sell any security.

Benjamin Beneche, Senior Investment Manager, Pictet Asset Management

FANUC (Japan: 6954) specializes in automation. Since becoming independent in 1972, the business has grown to become a market leader in three important robotics verticals: numerical controllers (29% sales), industrial robots (37%), and machine tools (16%). Within each of these businesses, FANUC has best-in-class contribution margins, enabled by a combination of technological, cultural, and cost-based competitive advantages.

The favorable underlying economics have been masked by significant investment in new capacity and R&D, which has contributed to EBIT margins declining from 40.8% in 2015 to 17.4% last year. As capex begins to normalize and plant utilization improves from the current sub-30% level (estimated), the business appears poised for significant improvement in both sales and margins, with steady-state ROCE of 25.2%.

R&D spending has largely focused on an edge-based software stack called FIELD, which offers tools such as predictive maintenance and zero-downtime applications to clients. Although still in the early stages, the ROI offered to clients appears high, with a bull case scenario of FIELD stand-alone potentially worth 140% of the company’s recent market cap. Even assuming no value here, the shares recently traded at 17x Ben’s normalized FCF estimate, a reasonable margin of safety for a business of this quality.

Rodrigo Lopez Buenrostro, Investment Principal, KUE Capital

OTIS (US: OTIS) manufacturers, installs, and services the most critical component of any building — the elevator. As a spin-out from UTC in April 2020, OTIS offers an opportunity to invest in a market leader with a great business model. The company has “the best of both worlds”: it services a large installed base of elevators in Europe and the US and benefits from growth in emerging markets, particularly China, through the installation of new equipment.

OTIS is more profitable than its peers, with ROIC of 21% (vs 16%), for a simple reason: It boasts the highest market share of the service business, with 19%, which provides recurring revenue, long-term client contracts, sticky relationships (93% retention rates), and attractive EBIT margins of 20-22%.

As the segment leader, OTIS also generates market-leading FCF, which allows the company to pay down debt (investment-grade rating), pay a dividend, invest in technology R&D, and consolidate the fragmented services business in order to increase network scale and density.

Management is well-aligned with investors to maximize EBIT and FCF. Although the peers recently traded at an average estimated FCF yield of 3.7% and EV/EBITDA of 17x, and a close German peer (Krupp) was recently taken private by a private equity group at 19x EBITDA, the market recently appeared to undervalue OTIS, with an FCF yield of 5.5%.

Stefan Ćulibrk, Managing Partner, Highway One Asset Management

Interactive Brokers (US: IBKR) is a low-cost, high margin, electronic brokerage business. IBKR’s clients are individuals, financial advisors, introducing brokers, hedge funds, and proprietary trading firms. IBKR offers attractive rates on margin loans, deposits, and low commissions to its global client base. Most of the company’s revenue comes from interest income collected on client assets. Thomas Peterffy owns 73% of the company he founded in the late 1970s. The company is conservatively financed, carrying billions more than the regulator is asking for, and multiples more than peers.

Stefan expects IBKR to double the number of accounts, client equity, and earnings power over the next five years. A normalization of interest rates should turn earnings power into cash flow.

Robert Deaton, Managing Principal, Fat Pitch Capital

Liberty Sirius XM (US: LSXMK): Sirius XM provides satellite radio services, primarily in audio systems in cars and trucks. 80% of new cars sold in America are enabled to deliver satellite radio. New car buyers are typically given a trial period. 40% of trial subscribers become self-pay subscribers. Sirius is a well-established company with 34.8 million subscriptions. Liberty Sirius XM owns over 70% of Sirius XM. By buying shares of Liberty Sirius XM, an investor can get exposure to Sirius XM at a sizable discount.

Alex Gates, Research Analyst, Clayton Partners

Clean Energy Fuels Corp. (US: CLNE) owns and operates the largest footprint of natural gas fueling stations in the US. The growth of renewable fuels has transformed the company into a profitable, cash-rich business focused on reducing carbon emissions in the trucking industry.

Clean Energy distributes 50+% of all renewable natural gas (RNG) in the US through 550 stations, which Alex estimates would take more than ten years and $2+ billion to replicate. Clean Energy’s stations are the only scalable pathway to monetize highly valuable federal and California state environmental credits from RNG usage.

The company will end the year with ~15% of the recent market cap in cash and no debt. Alex expects 2020 EBITDA of $45 million to triple in three years as the growth of RNG continues at the current pace. By 2025 the company will distribute 100% renewable fuel, potentially garnering attention from ESG investors.

The equity would be valued at $3.50 per share assuming 8.5x 2022 EBITDA. However, if we value the company at a comparable gas station operator multiple of 12x, the equity could be worth $6 per share.

Hunter Hayes, Vice President and Portfolio Manager, Intrepid Capital Management

Take-Two Interactive Software (US: TTWO) is a popular video game publisher with a wide moat, substantial growth opportunities, and excellent management. The company owns or licenses the intellectual property behind some of the best-selling entertainment series of all time, including Grand Theft Auto, Red Dead Redemption, and NBA 2K.

During the COVID pandemic, engagement across the company’s franchises has shattered previous records. TTWO is one of the “Big Three” video game publishers in the US, with the lowest operating margins (despite competitive gross margins) as the company has not yet scaled to the same extent as Electronic Arts (US: EA) and Activision Blizzard (US: ATVI).

The equity recently traded at ~$138 per share, which Hunter views as an attractive discount for a company with premium intellectual property, ROIC in excess of 20%, and the potential to generate annual FCF of $10 per share in the next few years.

Management owns a substantial amount of stock and the company’s developers receive stock-based compensation, creating an aligned, shareholder-friendly incentive structure across the organization.

Charles Hoeveler, Managing Partner, Norwood Capital Partners

Rimini Street (Nasdaq: RMNI) is the leading independent support provider for enterprise software systems, a ~$16 billion industry. RMNI features a “coder culture” of software engineering expertise combined with a service orientation to deliver a compelling value proposition to customers. The industry is expected to triple over the next four years as global enterprises become aware that there is an alternative to the abusive pricing and poor service of SAP and Oracle.

RMNI has a long runway for growth, is ~10x larger than its next-largest independent competitor, ~99% recurring revenue, and valued at a fraction of business service and software peers.

Jonathan Isaac, President and Portfolio Manager, Quilt Investment Management

Exponent, Inc. (US: EXPO) is a multidisciplinary consulting firm providing scientific and technical services to organizations to address and prevent failures. Like Coca-Cola in the mid-to-late 1980s, Exponent has a dominant position in its core market—reacting to failures—while being able to grow organically within that market, and in new markets. Coke from that period and Exponent both exhibit how a highly profitable, relatively non-cyclical business with a sticky customer base can accelerate organic growth through boosting its instances of use throughout the average day of the customer. For Coke, this meant expanding the Coke Megabrand of soft drinks in order to take market share from water, and moving towards the adoption of fountain and vending channels internationally. For Exponent, this means flipping the script from helping firms react to failures, to helping them prevent potentially costly failures. In an increasingly complex technological world, Exponent’s expertise in battery consulting and the interactivity between humans and machines (what Exponent calls “Human Factors”), positions Exponent to further leverage its historic customer relationships to drive organic growth.

Disclaimer/Disclosure: Accounts managed by Quilt Investment Management, LLC currently own shares of Exponent, Inc. (EXPO), and may transact in the shares, or in any other security mentioned, without future updates. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of specific securities, investments, or investment strategies. Additionally, the information should not be construed as Quilt Investment Management, LLC’s solicitation to effect the rendering of personalized investment advice for compensation, over the internet or otherwise. This is not a research report and/or a recommendation. The mention of any security does not constitute a recommendation. Investments involve risk and, unless stated otherwise, are not guaranteed. Always be sure to first consult with a qualified financial adviser and/or a tax professional before investing, and to verify any information deemed to be accurate. Past performance is not indicative of future performance.

Arvind Mallik, Co-Managing Partner, KMF Investments

ViacomCBS (Nasdaq: VIAC) is a “new” company resulting from the December 2019 an all-stock merger of Viacom and CBS. The company is controlled by the family of billionaire media mogul Sumner Redstone and has a dual-share structure: VIAC and VIACA. The stock has sold off post-merger and Covid-19 pandemic, trading at $25 per share recently, or an equity market cap of ~$15 billion. At a P/E multiple of only 5x, ViacomCBS is one of the most undervalued media giants. Merger savings of ~$750 million could add more than $1 to EPS.

The post-merger ViacomCBS has improved its scale and customer captivity moats in both the streaming and traditional businesses. The company plans to divest non-core assets (real estate, book publisher Simon and Schuster) where there is no significant moat or synergy. ViacomCBS’s vast content library surpasses even those of powerhouses like Netflix, Amazon, and Disney, allowing opportunistic “arms dealer” monetization. The global reach of the company provides a platform for growth and monetization of content.

While the company’s debt is significant, ViacomCBS maintains a manageable leverage ratio and healthy interest coverage. Even during Covid-19, the company successfully refinanced its near-term maturities and retained access to a $3.5 billion revolver, which remains undrawn.

Chairwoman Shari Redstone stated at the May 2020 annual meeting, “We totally believe the stock is dramatically undervalued. The market is looking for us to prove we can execute our strategy.” Redstone purchased $2 million of VIAC non-voting stock in February and March. Potential success in streaming could change investor perceptions of the company’s value.

Gary Mishuris, Chief Investment Officer, Silver Ring Value Partners

Covetrus (US: CVET) is a spinoff that combines two animal-health related businesses whose economics are still not fully understood and whose financials do not adequately reflect the earnings power of the company. The company’s legacy animal health distribution business operates in an oligopoly and is in the process of being turned around by a new CEO, with initial evidence of progress. The second business is the leading software-as-a-service (SaaS) platform for vet practices to fulfill orders online. It is growing 40+%, has a meaningful ramp for future growth, and has much higher incremental margins than the distribution business.

The historical financials are misleading due to spinoff accounting and because the SaaS business is not yet contributing significantly to earnings. The balance sheet has been strengthened with a recent preferred offering and, given the low cyclicality of both businesses, is in little danger regardless of the way that COVID or economic crises unfolds.

The shares recently traded at ~60% of Gary’s base-case value estimate, despite the meaningful recent run-up in the stock price. Catalysts include (1) continued turnaround progress at the distribution business, and (2) the high growth of the SaaS business starting to meaningfully flow through to net income.

Felix Narhi, Chief Investment Officer and Portfolio Manager, PenderFund Capital Management

Stitch Fix (US: SFIX) is an innovative online apparel retailer with attractive unit economics supported by durable competitive advantages, led by a mission-driven founder and available at a sensible price. The company combines data science and proprietary data with human judgment to deliver hyper personalization at scale, transcending traditional brick-and-mortar and most undifferentiated e-commerce retail experiences. The apparel market is massive. As online shopping continues to take share from offline, Stitch Fix should continue to outpace the market through increasing share of wallet, acquiring new clients, and expanding its addressable market.

The company has developed a proven, scaled financial model with headroom for growth. Stitch Fix is at the early stages of expanding beyond its successful “beachhead” clothing box model and into larger markets. Its new Direct Buy initiative provides existing and new clients a low-commitment and low-friction path to personalized shopping. This market is not only larger, but potentially has more attractive unit economics once at scale. It is an opportune time to launch stay-at-home services as e-commerce adoption is surging due to COVID19 while numerous bricks-and-mortar peers struggle to remain viable.

Stitch Fix hit management’s long-term operating margin targets first in FY15. Income from more mature segments is funding new, promising initiatives, thereby obscuring reported profitability. Trading at ~$24 per share, SFIX is a compounder available at a sensible multiple of about 10x “steady state” operating profit.

Ryan O’Connor, President and Portfolio Manager, Crossroads Capital Partners

Orchid Island Capital (NYSE: ORC) is an “agency mREIT” that invests solely in mortgage-backed securities (MBS) issued by government-sponsored agencies such as Fannie Mae, Freddie Mac, and Ginnie Mae.

While not all mREITs are created equal, they are the same in one respect: All are in essence simple spread businesses that use extreme leverage to borrow money short term in order to lend long term, augmenting returns as a result. These returns are then paid out as dividends to income-seeking investors stretching for yield. Simplistically, the difference between an mREIT’s “interest income” (i.e., mortgage rates) and “interest expense” (i.e., repurchase funding rates) equals “net interest income”. Subtract hedging costs and operating expense, and what’s left can be distributed to holders as dividends. (It can earn this spread because long-term rates are usually higher than short-term rates).

While mREITs take existential risks, typically blowing up once a cycle in times of severe distress, government agencies cannot default on agency MBS, insulating agency mREITs like ORC from credit risk. Predictably, recent turmoil in short-term funding markets caused panic selling during the COVID pandemic, indiscriminately crushing the share prices of mREITs and agency mREITs alike, creating a rare opportunity to buy shares of agency mREITs like ORC at steep discounts.

Soon after the crash, the Fed stepped in to get the market back on track, cutting short-term rates to zero and announcing it would buy essentially unlimited quantities of agency MBS — two actions that directly benefit ORC’s business, leading to wider net interest margins and higher earnings, while removing the possibility of reflexive negative feedback loops that get mREITs into trouble for at least the next 18 months.

ORC’s Q1 2020 repo expense averaged 1.68% of AUM, but that cost will fall to 12.5 bips in the aftermath of a 0% Fed funds rate brought about by COVID-related distress. As a result, a simple back-of-the-envelope model (see slide 9 of Ryan’s presentation) acts as a proxy for ORC’s forward-looking earnings power: On a $3.4 billion investment portfolio earning a 341 basis point spread that is 9x levered, that is $116 million in normalized net interest income. After subtracting operating expenses, it should have $95 million available to distribute to shareholders, or roughly $1.64 per share on a stock that recently traded at $4.36 per share. Assuming ORC pays out 90% of net interest income going forward as required by the IRS, that puts its normalized annual dividend paying capacity at ~33% annually, or ~$0.12 per share per month.

Danilo Santiago, Portfolio Manager, Rational Investment Methodology

Herman-Miller (US: MLHR) and Steelcase (US: SCS), the two most significant manufacturers of office furniture in the US (and worldwide), recently traded below Danilo’s base-case fair-value estimate. The more undervalued of the two companies, MLHR, offers an estimated IRR of ~14% to the buy-and-hold investor. An investor achieving such a return would double her capital in less than six-and-a-half years.

Mr. Market appears to have focused on short-term EPS expectations variabilities. As it became clear that the COVID-19 crisis would bring normal life to a halt, the purchase of office furniture was put into pause. The occasional sale to a quick upgrade to home-offices was not sufficient to bring revenue expectations back from shallow levels. Manufacturers face inevitable operational deleveraging. Hence the short-term impact on EPS.

What should matter to the long-term investor are overall sales of office furniture to MLHR’s core customer groups, along with the company’s market share and ability to deliver margins not far from historical averages. Assuming no permanent modus operandi change by office workers, Herman-Miller should generate substantial cash flow to owners in the long run.

Dave Sather, President, Sather Financial Group

Unilever (US: UL, UN) is a 150 year-old food, beauty, and home care business that sells products to 2.5 billion people daily across 190+ countries. Despite its long history, interesting changes and catalysts have allowed this highly consistent and predictable business to grow EPS by 9-11% annually over the past decade. Despite Unilever’s stability and above-average cash flow, the shares have recently been available at a fair price.

Elliot Turner, Managing Director, RGA Investment Advisors

Twitter (US: TWTR) is the world’s most important information network. The user side of the network has never been stronger at Twitter, demonstrating accelerating growth for six straight quarters and registering its fastest quarterly growth ever in Q1 2020. These successes are lost amidst the slower evolution of the business side of the network and lackluster efforts to monetize the platform.

For the first time in its history, Twitter management is prioritizing revenue opportunities and has a revamped, engaged board with the experience and knowhow in order to guide the process. From the accelerated user growth and a modest normalization in the advertising environment by 2022, Twitter today could be trading at 8-9x EV/2022 EBITDA, with enhanced monetization offering meaningful upside to earnings from there.

Todd Wenning, Senior Investment Analyst, Ensemble Capital

Masimo (US: MASI) is a medical technology company best known for its highly accurate pulse oximetry sensors used in critical care settings. Masimo’s mission is to improve patient outcomes while reducing system-wide costs, which is a rare strategy in the healthcare industry.

Most medical device companies are healthcare companies that use technology and are thus motivated to maintain the status quo of adding cost to the system. Masimo inverts this and is a technology company that focuses on healthcare. As such, Masimo starts with first principles when solving problems and creates solutions that are win-win-win for hospitals, medical professionals, and patients.

Jim Zimmerman, Founder & Portfolio Manager, Lowell Capital Management

Transcontinental, Inc. (Canada: TCL-A) engages in the flexible packaging business in Canada, the U.S., Latin America, the U.K., Australia, and New Zealand. It operates through three segments: Packaging, Printing, and Other. The packaging segment engages in the extrusion, lamination, printing, and converting packaging solutions as well as manufacturing flexible plastic and paper products. The printing segment provides integrated services for retailers, such as pre-media services, flyer, and in-store marketing product printing.

TCL has ~87 million shares outstanding at C$14 per share, for a market cap of C$1.2 billion, and a net debt position of C$950 million as of April 2020, for an enterprise value of C$2.1 billion. TCL recently traded close to 4x adjusted EBITDA.

Jim believes the company can sustainably generate FCF of C$250+ million, which would result in an unlevered FCF yield of 12%. TCL has an improving balance sheet, with net debt reduced from C$1.4 billion after the Coveris acquisition in mid-2018 to about C$950 million as of April 2020. TCL could achieve adjusted EBITDA of C$500 million by 2022 and trade for 6x adjusted EBITDA or C$3 billion less C$800 million of net debt for a market cap of about C$2.2 billion or C$25 per share, as compared to a recent stock price of C$14 per share. TCL pays C$0.87 per share in annual dividends (7% yield), which appears sustainable based on strong cash flow.

TCL-A achieved a strong quarter for April 2020, with both the packaging and printing segments showing resilient performance amid COVID. The packaging segment expects organic growth in H2 2020, and the printing segment is recovering with a reopening of Canada’s economy. The printing segment is a stronger business than the market is giving it credit for, as its flyers are an essential tool for major retailers to drive sales.

Jim believes TCL’s recent market valuation misprices the resiliency of both the packaging and the printing segments. Packaging companies trade at much higher multiples, and as TCL’s packaging segment grows, TCL’s multiple should move up accordingly.

This is not an offer to sell or the solicitation of an offer to buy any security in any jurisdiction. The content is distributed for informational purposes only and should not be construed as investment advice or a recommendation to sell or buy any security or other investment, or undertake any investment strategy. There are no warranties, expressed or implied, as to the accuracy, completeness, or results obtained from any information set forth on this website. BeyondProxy’s officers, directors, employees, principals and/or contributing authors may have positions in and may, from time to time, make purchases or sales of the securities or other investments discussed or evaluated on this website.

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Stitch Fix: Owner-Operated Online Retailer with Solid Unit Economics

July 3, 2020 in Audio, Consumer Cyclical, Equities, Ideas, Mid Cap, North America, Wide Moat, Wide-Moat Investing Summit 2020, Wide-Moat Investing Summit 2020 Featured

Felix Narhi of PenderFund Capital Management presented his in-depth investment thesis on Stitch Fix (US: SFIX) at Wide-Moat Investing Summit 2020.

Thesis summary:

Stitch Fix is an innovative online apparel retailer with attractive unit economics supported by durable competitive advantages, led by a mission-driven founder and available at a sensible price. The company combines data science and proprietary data with human judgment to deliver hyper personalization at scale, transcending traditional brick-and-mortar and most undifferentiated e-commerce retail experiences. The apparel market is massive. As online shopping continues to take share from offline, Stitch Fix should continue to outpace the market through increasing share of wallet, acquiring new clients, and expanding its addressable market.

The company has developed a proven, scaled financial model with headroom for growth. Stitch Fix is at the early stages of expanding beyond its successful “beachhead” clothing box model and into larger markets. Its new Direct Buy initiative provides existing and new clients a low-commitment and low-friction path to personalized shopping. This market is not only larger, but potentially has more attractive unit economics once at scale. It is an opportune time to launch stay-at-home services as e-commerce adoption is surging due to COVID19 while numerous bricks-and-mortar peers struggle to remain viable.

Stitch Fix hit management’s long-term operating margin targets first in FY15. Income from more mature segments is funding new, promising initiatives, thereby obscuring reported profitability. Trading at ~$24 per share, SFIX is a compounder available at a sensible multiple of about 10x “steady state” operating profit.

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About the instructor:

Felix Narhi is the Chief Investment Officer of Pender and the Portfolio Manager of the Pender US All Cap Equity Fund and the Pender Strategic Growth and Income Fund, and Co-Manager of the Pender Value Fund. Prior to joining Pender in July 2013, Mr. Narhi spent over nine years at an independent and value-oriented investment firm in Vancouver. Mr. Narhi holds a Bachelor of Commerce degree from the University of British Columbia. He earned his Chartered Financial Analyst (CFA) designation in 2003 and is a member of CFA Vancouver. Mr. Narhi advocates a business-like approach to investing. Sound investing is the process of determining the value underlying a security and then buying it at a considerable discount to that value. The greatest challenge is to maintain the necessary balance between patience, emotional fortitude and discipline to only buy when prices are attractive and to sell when they are dear, while avoiding the short-term “noise” that consumes most market participants.

The content of this website is not an offer to sell or the solicitation of an offer to buy any security in any jurisdiction. The content is distributed for informational purposes only and should not be construed as investment advice or a recommendation to sell or buy any security or other investment, or undertake any investment strategy. There are no warranties, expressed or implied, as to the accuracy, completeness, or results obtained from any information set forth on this website. BeyondProxy’s officers, directors, employees, principals and/or contributing authors may have positions in and may, from time to time, make purchases or sales of the securities or other investments discussed or evaluated on this website.

Masimo: Improving Patient Outcomes While Reducing System-Wide Costs

July 3, 2020 in Audio, Equities, Health Care, Ideas, Large Cap, North America, Wide Moat, Wide-Moat Investing Summit 2020, Wide-Moat Investing Summit 2020 Featured

Todd Wenning of Ensemble Capital Management presented his in-depth investment thesis on Masimo (US: MASI) at Wide-Moat Investing Summit 2020.

Thesis summary:

Masimo is a medical technology company best known for its highly accurate pulse oximetry sensors used in critical care settings. Masimo’s mission is to improve patient outcomes while reducing system-wide costs, which is a rare strategy in the healthcare industry.

Most medical device companies are healthcare companies that use technology and are thus motivated to maintain the status quo of adding cost to the system. Masimo inverts this and is a technology company that focuses on healthcare. As such, Masimo starts with first principles when solving problems and creates solutions that are win-win-win for hospitals, medical professionals, and patients.

Listen to this session:

slide presentation audio recording

About the instructor:

Todd Wenning is a senior investment analyst at Ensemble Capital. Before joining Ensemble, Todd was an analyst at Johnson Investment Counsel, where he worked on the firm’s SMID cap strategy. Prior to that, Todd was a sell-side analyst at Morningstar, where he led Morningstar’s equity stewardship methodology and covered companies in the basic materials, industrials, and consumer sectors. Earlier in his career, Todd worked for The Motley Fool, SunTrust Asset Management, and Vanguard. He holds a BA in History from Saint Joseph’s University in Philadelphia and the Chartered Financial Analyst designation.

The content of this website is not an offer to sell or the solicitation of an offer to buy any security in any jurisdiction. The content is distributed for informational purposes only and should not be construed as investment advice or a recommendation to sell or buy any security or other investment, or undertake any investment strategy. There are no warranties, expressed or implied, as to the accuracy, completeness, or results obtained from any information set forth on this website. BeyondProxy’s officers, directors, employees, principals and/or contributing authors may have positions in and may, from time to time, make purchases or sales of the securities or other investments discussed or evaluated on this website.

Twitter: Unique Internet Asset, With Improving Monetization

July 3, 2020 in Audio, Equities, Ideas, Large Cap, North America, Wide Moat, Wide-Moat Investing Summit 2020, Wide-Moat Investing Summit 2020 Featured

Elliot Turner of RGA Investment Advisors presented his in-depth investment thesis on Twitter (Nasdaq: TWTR) at Wide-Moat Investing Summit 2020.

Thesis summary:

Twitter is the world’s most important information network. The user side of the network has never been stronger at Twitter, demonstrating accelerating growth for six straight quarters and registering its fastest quarterly growth ever in Q1 2020. These successes are lost amidst the slower evolution of the business side of the network and lackluster efforts to monetize the platform.

For the first time in its history, Twitter management is prioritizing revenue opportunities and has a revamped, engaged board with the experience and knowhow in order to guide the process. From the accelerated user growth and a modest normalization in the advertising environment by 2022, Twitter today could be trading at 8-9x EV/2022 EBITDA, with enhanced monetization offering meaningful upside to earnings from there.

A few resources referenced by Elliot during this session:

  • Elliot’s open letter in support of Jack Dorsey, March 2020
  • Alex Danco’s article on Twitter’s role in science, February 2020
  • AdExchanger article on the ad stack bug that hurt 3Q19 revenue
  • Jack Dorsey interview with Rolling Stone, January 2019
  • Jack Dorsey interview with Bill Simmons, January 2019

Replay this LIVE session:

slide presentation audio recording

As background, replay Elliot’s session on Twitter from Wide-Moat Investing Summit 2017. In addition, if you would like to get to know Twitter CEO Jack Dorsey a little better, you may enjoy this interview with him from May 2020.

About the instructor:

Elliot Turner is a co-founder and managing director at RGA Investment Advisors, LLC. RGA Investment Advisors runs a long-term, low turnover, growth at a reasonable price investment strategy seeking out global opportunities. Elliot focuses on discovering and analyzing long-term, high quality investment opportunities and strategic portfolio management. Prior to joining RGA, Elliot managed portfolios at at AustinWeston Asset Management LLC, Chimera Securities and T3 Capital. Elliot holds the Chartered Financial Analyst (CFA) designation as well as a Juris Doctor from Brooklyn Law School.. He also holds a Bachelor of Arts degree from Emory University where he double majored in Political Science and Philosophy.

The content of this website is not an offer to sell or the solicitation of an offer to buy any security in any jurisdiction. The content is distributed for informational purposes only and should not be construed as investment advice or a recommendation to sell or buy any security or other investment, or undertake any investment strategy. There are no warranties, expressed or implied, as to the accuracy, completeness, or results obtained from any information set forth on this website. BeyondProxy’s officers, directors, employees, principals and/or contributing authors may have positions in and may, from time to time, make purchases or sales of the securities or other investments discussed or evaluated on this website.

Take-Two Interactive: Premium IP, High ROIC, and Growing FCF

July 3, 2020 in Audio, Equities, Ideas, Large Cap, North America, Technology, Wide Moat, Wide-Moat Investing Summit 2020, Wide-Moat Investing Summit 2020 Featured

Hunter Hayes of Intrepid Capital Management presented his in-depth investment thesis on Take-Two Interactive Software (US: TTWO) at Wide-Moat Investing Summit 2020.

Thesis summary:

Take-Two Interactive is a popular video game publisher with a wide moat, substantial growth opportunities, and excellent management. The company owns or licenses the intellectual property behind some of the best-selling entertainment series of all time, including Grand Theft Auto, Red Dead Redemption, and NBA 2K.

During the COVID pandemic, engagement across the company’s franchises has shattered previous records. TTWO is one of the “Big Three” video game publishers in the US, with the lowest operating margins (despite competitive gross margins) as the company has not yet scaled to the same extent as Electronic Arts (US: EA) and Activision Blizzard (US: ATVI).

The equity recently traded at ~$138 per share, which Hunter views as an attractive discount for a company with premium intellectual property, ROIC in excess of 20%, and the potential to generate annual FCF of $10 per share in the next few years.

Management owns a substantial amount of stock and the company’s developers receive stock-based compensation, creating an aligned, shareholder-friendly incentive structure across the organization.

Listen to this session:

slide presentation audio recording

About the instructor:

Hunter Hayes is a Portfolio Manager at Intrepid Capital Management. Prior to joining Intrepid Capital, he was an Associate on the High Yield team at Eaton Vance and a Consultant at Deloitte Advisory. Mr. Hayes graduated from Auburn University with a BS BA degree in Finance and a BM degree in Piano Performance. Besides his passion for value investing, Hunter is also an avid runner and recently finished his first Boston Marathon.

The content of this website is not an offer to sell or the solicitation of an offer to buy any security in any jurisdiction. The content is distributed for informational purposes only and should not be construed as investment advice or a recommendation to sell or buy any security or other investment, or undertake any investment strategy. There are no warranties, expressed or implied, as to the accuracy, completeness, or results obtained from any information set forth on this website. BeyondProxy’s officers, directors, employees, principals and/or contributing authors may have positions in and may, from time to time, make purchases or sales of the securities or other investments discussed or evaluated on this website.

Orchid Island: Agency mREIT with Temporary Moat Due to Fed Action

July 3, 2020 in Audio, Equities, Financial, Ideas, Micro Cap, North America, Wide Moat, Wide-Moat Investing Summit 2020, Wide-Moat Investing Summit 2020 Featured

Ryan O’Connor of Crossroads Capital Partners presented his investment thesis on Orchid Island Capital (NYSE: ORC) at Wide-Moat Investing Summit 2020.

Thesis summary:

Orchid Island Capital is an “agency mREIT” that invests solely in mortgage-backed securities (MBS) issued by government-sponsored agencies such as Fannie Mae, Freddie Mac, and Ginnie Mae.

While not all mREITs are created equal, they are the same in one respect: All are in essence simple spread businesses that use extreme leverage to borrow money short term in order to lend long term, augmenting returns as a result. These returns are then paid out as dividends to income-seeking investors stretching for yield. Simplistically, the difference between an mREIT’s “interest income” (i.e., mortgage rates) and “interest expense” (i.e., repurchase funding rates) equals “net interest income”. Subtract hedging costs and operating expense, and what’s left can be distributed to holders as dividends. (It can earn this spread because long-term rates are usually higher than short-term rates).

While mREITs take existential risks, typically blowing up once a cycle in times of severe distress, government agencies cannot default on agency MBS, insulating agency mREITs like ORC from credit risk. Predictably, recent turmoil in short-term funding markets caused panic selling during the COVID pandemic, indiscriminately crushing the share prices of mREITs and agency mREITs alike, creating a rare opportunity to buy shares of agency mREITs like ORC at steep discounts.

Soon after the crash, the Fed stepped in to get the market back on track, cutting short-term rates to zero and announcing it would buy essentially unlimited quantities of agency MBS — two actions that directly benefit ORC’s business, leading to wider net interest margins and higher earnings, while removing the possibility of reflexive negative feedback loops that get mREITs into trouble for at least the next 18 months.

ORC’s Q1 2020 repo expense averaged 1.68% of AUM, but that cost will fall to 12.5 bips in the aftermath of a 0% Fed funds rate brought about by COVID-related distress. As a result, a simple back-of-the-envelope model (see slide 9 of Ryan’s presentation) acts as a proxy for ORC’s forward-looking earnings power: On a $3.4 billion investment portfolio earning a 341 basis point spread that is 9x levered, that is $116 million in normalized net interest income. After subtracting operating expenses, it should have $95 million available to distribute to shareholders, or roughly $1.64 per share on a stock that recently traded at $4.36 per share. Assuming ORC pays out 90% of net interest income going forward as required by the IRS, that puts its normalized annual dividend paying capacity at ~33% annually, or ~$0.12 per share per month.

Listen to this session:

slide presentation audio recording

About the instructor:

Ryan O’Connor is the President and Portfolio Manager of Crossroads Capital, LLC. Prior to founding Crossroads, Ryan was a portfolio manager at Three Arch Opportunity Fund, a value-centric investment partnership based in San Francisco. Prior to that, Ryan co-managed portfolios at Whetstone Capital and CUSH Capital, two Kansas City based investment partnerships focused on public equities investing. Before life as a securities analyst, Mr. O’Connor studied Economics at Indiana University (Bloomington), spent time as a top producing financial advisor for AG Edwards & Sons (now Wells Fargo) and an options trader on the Chicago Mercantile Exchange. Ryan’s proven history of generating compelling risk-adjusted returns has led to his membership in several elite investing associations, including Joel Greenblatt’s Value Investors Club, a highly selective idea-sharing site where global membership is capped at 500 buy-side analysts. He has also been recognized by SumZero, the world’s largest community of professional investors, as being in the top 1% of the approximately 12,000 buy-side analysts active on the site.

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