How to Lose Money: Top Five Mistakes of a Value Investor

May 21, 2018 in Commentary

This article is authored by MOI Global instructor Gary Mishuris, managing partner and chief investment officer of Silver Ring Value Partners.

Gary is an instructor at Wide-Moat Investing Summit 2018.

In my article How to Lose Money in the Stock Market: The Top 5 Mistakes, I sought to teach you what not to do when investing by answering the following question: What is the most certain way to lose the most money investing in stocks?

As a refresher, the five most certain ways to lose money in the stock market that I identified were:

1. Invest in Bad Businesses
2. Invest with Bad Management Teams
3. Invest in Companies with Too Much Debt
4. Pay Too High a Price
5. Focus Only on the Short-Term

Now, I want to share with you my own mistakes in each of these categories from my 15+ years of professional investing experience that have taught me valuable lessons. My hope in sharing these with you is to help you avoid making these mistakes yourself.

Avoid Investing in Bad Businesses

About fifteen years ago, as a young equity analyst, I recommended that the large investment firm that I worked for invest in a company’s stock. It was a cyclical business, and I carefully analyzed the past financial statements and made what I thought was a well-reasoned estimate of the future mid-cycle earnings power of the company. Over a decade hence and with the full benefit of hindsight, I realized that I had been off… by a factor of 10x!

How is it possible to be off by so much? Well, it turned out that the future was quite different from the past that I was relying on in my analysis. While this is always a risk, the magnitude of the deviation from past financial results was driven by the low quality of the business – its operations were in tough industries in which it had only very marginal, if any, competitive advantages. This made it unable to cope with the negative changes that the industry experienced after my investment recommendation, and caused the earnings of the business to permanently collapse.

The lesson learned? A business with no competitive advantage can have future economic characteristics that are drastically different from those it had in the past. What is worse, the direction of any unexpected changes in profitability is likely to be negative. This can make estimating the value of such unpredictable businesses an exercise in overconfidence and futility, and is thus better avoided barring extremely unusual circumstances.

Avoid Investing with Bad Management Teams

While managing the Focused Value strategy at my last firm prior to founding Silver Ring Value Partners, I came across a small consumer goods company. The stock was very inexpensive relative to historical earnings and cash flow, and the business seemed to be good enough, with decent niche brands that had high market share within their categories. As I studied management’s communication and actions over the years, I became somewhat concerned by the lack of focus on maximizing value per share, and instead a focus on growing the business. I put aside that concern, in part because I saw that the two brothers who were the main executives at the firm owned a very large amount of stock. This gave them a fair amount of control over the company, and I thought it would also align their incentives to act rationally. Unfortunately, I was wrong. Management kept underperforming operationally, and what’s worse, it started deploying capital into large acquisitions. Management openly admitted after the last of these deals that they didn’t have any idea what the return on the investment would be. I was forced to reassess the value of the company, and this caused me to sell the stock. Fortunately, the low initial purchase price resulted in this being essentially a break-even investment as opposed to a big loss, but that was still a poor outcome.

The increase in profits that I anticipated never materialized. Looking back on this investment today, the earnings of the company are far lower than I originally thought they would be when I made the purchase, and also lower than the company’s historical profit levels despite a healthy economic environment. The stock is currently ~ 15% lower than when I sold it, despite the overall market increasing substantially during the intervening two years.

The lesson learned? The best predictor of management’s future behavior is its past behavior. When a management team shows lackluster capital allocation skills in the past, it is unlikely to become good at capital allocation in the future. What’s more worrying is that if the business encounters any challenges, the management’s lack of acumen can cause substantial value destruction for the company. While large stock ownership is an important means of aligning incentives with the shareholders, it alone is insufficient to guarantee a management team capable of and interested in maximizing long-term intrinsic value.

Avoid Investing in Companies with Too Much Debt

Also at the beginning of my investing career, I was recommending purchase of another stock. This company had a somewhat stretched balance sheet, but not so much so that I thought it was going to be a problem given that the then current credit metrics were OK. Right before Christmas, the company pre-announced a major earnings disappointment due to weakening demand trends, suspended its dividend, and announced that its expectations for next year’s results were now substantially below last year’s profit levels. With this revised view, the credit metrics were no longer OK at all.

That night, I woke up in the middle of the night very agitated, and I kept repeating just one word: “EBITDA! EBITDA!” (Earnings before Interest, Taxes, Depreciation and Amortization.) As I fully woke up, I remembered the dream that I was having – the bank group which had lent this company money was considering forcing it into bankruptcy due to non-compliance with the loan covenants, and I had been arguing with them for forbearance based on the company’s future levels of profitability.

The lesson learned? When the balance sheet of a business with no competitive advantage carries what seems like an appropriate amount of debt in a benign business environment, it leave no margin of safety for adversity which can quickly impair the company’s profitability and cause the balance sheet to become unhealthy quite rapidly.

Avoid Paying Too High a Price

Three years ago, while managing the Focused Value strategy at my last employer, I came across a company with a very strong brand in the apparel space. The stock had already declined by a meaningful amount, and was now trading at a low ratio relative to its historical profits. As I did additional work, it became apparent that some of the reasons for the decline in profits were not temporary and were the result of structural industry changes and company-specific brand challenges. Management was trying to implement a plan to turn the business around to restore past profitability, and was well incentivized to maximize long-term value. That stock was not yet cheap on the then-current earnings, but I judged it to be substantially undervalued if the turnaround materialized.

I made a small investment in the stock, as the combination of business quality, management quality and a strong balance sheet led me to believe that it was undervalued relative to my range of intrinsic values for the company. Unfortunately, fundamentals continued to deteriorate, and the turnaround has failed to materialize thus far. When I left my prior employer to start Silver Ring Value Partners in 2016, I reassessed all of the investments with a fresh perspective, and this led me to not include this stock in my new portfolio. So far, this has been a good decision as the company has fired its CEO, fundamentals continue to track below expectations, and the stock is down substantially despite the overall market being up.

The lesson learned? Had I been more patient initially and waited for a stock price that was low not just relative to an outcome that I thought was likely, but also low relative to the current trajectory of the business without a turnaround, I would have had a higher margin of safety. This would have allowed me to lose less money even in the scenario where the likely turnaround that I was expecting failed to materialize. Price is the only variable a passive outside investor can fully control, and it is very important to be extremely patient to wait for one that offers a large margin of safety relative to the company’s intrinsic value.

Focus on the Long-Term, not on the Short-Term

When I started investing in my own account while studying at MIT, I came across a brokerage report about a company of a then well-known branded apparel manufacturer. The report highlighted the short-term prospects for sales growth, and the likely upward direction this was going to result in for the stock price. This was shortly before I had the opportunity to listen to Warren Buffett speak on campus and became a value investing convert. Back then, I didn’t really know what I was doing, and I quickly became excited about the company and bought a small number of shares.

The short-term sales growth that the brokerage report touted never materialized, and the business continued to weaken. Its brand became less relevant with customers, and it lost market share and retail shelf space. As a result, its profits declined, and the stock declined as well.

 Lesson learned? Thinking about where the business is heading long-term is more helpful when investing in the stock market than trying to anticipate short-term trends. Additionally, I learned never to rely on the work of others, and always do my own research to validate the attractiveness of an investment

One of my favorite sayings is: “When a man with money meets a man with experience, the man with money leaves with experience and the man with experience leaves with the money.” My hope in sharing some of my mistakes and the lessons that I learned from them with you is that these insights will help you be a better investor and avoid making some of the same errors that I had to learn how to avoid through painful experience. Value investing can be very rewarding when implemented properly, but it is far from easy to do so. Hopefully reading this will help you improve as an investor.

download printable version

The information contained herein is provided solely for informational and discussion purposes only and is not, and may not be relied on in any manner as legal, tax or investment advice or as an offer to sell or a solicitation of an offer to buy an interest in any fund or vehicle managed or advised by Silver Ring Value Partners Limited Partnership (“SRVP”) or its affiliates. It is not to be reproduced, used, distributed or disclosed, in whole or in part, to third parties without the prior written consent of SRVP. The information contained herein is not investment advice or a recommendation to buy or sell any specific security. The views expressed herein are the opinions and projections of SRVP as of May 29th, 2017 unless otherwise noted, and are subject to change based on market and other conditions. SRVP does not represent that any opinion or projection will be realized. The information presented herein, including, but not limited to, SRVP’s investment views, returns or performance, investment strategies, market opportunity, portfolio construction, expectations and positions may involve SRVP’s views, estimates, assumptions, facts and information from other sources that are believed to be accurate and reliable as of the date this information is presented—any of which may change without notice. SRVP has no obligation (express or implied) to update any or all of the information contained herein or to advise you of any changes; nor does SRVP make any express or implied warranties or representations as to the completeness or accuracy or accept responsibility for errors. The information presented is for illustrative purposes only and does not constitute an exhaustive explanation of the investment process, investment strategies or risk management. The analyses and conclusions of SRVP contained in this information include certain statements, assumptions, estimates and projections that reflect various assumptions by SRVP and anticipated results that are inherently subject to significant economic, competitive, and other uncertainties and contingencies and have been included solely for illustrative purposes. As with any investment strategy, there is potential for profit as well as the possibility of loss. SRVP does not guarantee any minimum level of investment performance or the success of any portfolio or investment strategy. All investments involve risk and investment recommendations will not always be profitable. Past performance is no guarantee of future results. Investment returns and principal values of an investment will fluctuate so that an investor’s investment may be worth more or less than its original value.

Media/Telecom: Usual Suspects Still Hated… But CHTR Now a Special Guest

May 19, 2018 in Equities, Letters

This article is authored by MOI Global instructor Patrick Brennan, portfolio manager of Brennan Asset Management.

Investment banking and real estate are the proverbial “cool kids” compared with this ostracized loser in the minds of investors. While we sound like a broken record, we think the following discussion is warranted, given our substantial exposure to this most hated of areas. To quickly recap, Liberty LILAK trades roughly 15-20% below the levels where John Malone purchased $37 million worth of stock last summer and ~7.3x 2018E EBITDA assuming Puerto Rican EBITDA 55% below 2016 levels. Prior to LILAK’s acquisition, Cable & Wireless disposed of a large number of subscale systems far worse than existing holdings at higher multiples…and obviously Chile is worth far more. While periodic blackout announcements suggest that Puerto Rico’s electrical grid is still fragile, substantial progress has been made since the start of the year. LILAK’s commentary regarding its anticipated year-end Puerto Rican run rate was well ahead of our estimates.

Meanwhile, across the pond, press reports confirmed Liberty Global is in talks with Vodafone over certain continental assets (Germany and Central/Europe and maybe 50% of Netherlands JV), yet investors keep selling. Adjusted for its minority interests/tax assets, LGI trades at roughly 7.8x 2018E EBITDA despite the asset sale discussions (and soaring pound and euro). The valuation is more incredible, given that the company sold its smaller Austrian operations for 11x EBITDA and likely will not sell its German operations for less than 11-12x. If LGI manages to sell Germany/CEE/Netherlands and if the share price does not move, the implied “stub” would trade at 5.8-6.2x, depending on assumed multiples. This metric is relevant as LGI will not be bashful in repurchasing shares. And then there is the ever loved DISCA. DISCA’s 2048 bonds still trade at par but somehow this investment grade company trades at ~5x our 2019E free cash flow per share. Meanwhile, formerly popular Charter reported strong fourth quarter results, including adding 15,000 video subscribers, but it has somehow fallen roughly 10% since the start of the year. By purchasing shares through GLIBA (formerly LVNTA), we estimate that we are buying CHTR shares near at an implied value of roughly $245. Please keep that number in mind when we discuss free cash flow per share a couple of years out.

Clearly, a new generation of video consumers watches far less linear television (i.e., a television set) and instead chooses to watch online video, Netflix, YouTube and other programming outside the traditional video cable package. It is also true that above-inflation increases for programming have driven video packages above the threshold of what certain users can afford or are willing to pay. While there is considerable debate on the speed with which these trends progress, there is little doubt they will accelerate over time and put additional pressure on the traditional cable video business. We do not dispute this fact set.

Instead, we simply dispute the degree of exposure to these risks. As discussed in past letters, video costs are vastly different outside the United States. Netflix’s positioning, while formidable, is not nearly as dominant as it is in the United States. Both LGI and LILAK can also drive growth through their broadband offering. Of the owned names, DISCA is the only content company and clearly the name most exposed to the cord cutting risks, but it has several offsets (library/synergies/international exposure, etc.) that we discussed in detail last quarter. We would also note that the tax reform provided a bigger benefit than many realize.

5G vs. Wireless Subscriber Gains: Which Sounds More Threatening?

The recent weakness in CHTR’s stock has been surprising to us. While cord cutting concerns are still present, many investors have previously been willing to accept that CHTR’s vastly higher-margin broadband growth story offers a substantial hedge in case video losses come faster than anticipated. We suspect that the more recent concerns generally center around threats to its broadband business from mobile broadband (5G1) and from some concerns about valuation levels, as CHTR is not as statistically cheap by cable investors’ preferred enterprise value/EBITDA metric.

In our 2017 Q1 letter, we discussed the multiple uncertainties surrounding setting the 5G standard, let alone the cost of any large scale rollout. CHTR executives have noted that the technology works well…when there is little rain, limited tree interference and clear visibility…a back-handed way of describing a fantastic in -the-lab product but perhaps a more difficult real-world application. CHTR CEO Tom Rutledge also noted that a full blown nationwide 5G rollout involving multiple small antenna would likely be as costly as a full fiber rollout. This is quite expensive considering the large dividends that Verizon (VZ) and AT&T (T) maintain, not to mention VZ’s less favorable experience with a fiber rollout (Fios). We also previously noted that it is tougher to interpret T’s planned acquisition of Time Warner or VZ’s reported interest in bidding for CHTR, as strong acts of confidence in the two companies’ standalone ability to compete with cable. Why issue shares if a new product will soon be able to take meaningful share in a ~90% gross margin business? And if this is not enough, Chinese telecom provider Huawei, a 5G pioneer whose supposed dominance in the new technology was cited as one of the justifications for blocking Broadcom’s acquisition of Qualcomm, recently noted at an industry conference that most consumers would not see any material difference between 5G and existing LTE service. Nevertheless, we suspect that Verizon’s rollout of 5G service in Sacramento later this year (quite a convenient location for us!) likely planted some doubt into certain cable investors’ minds. This may prove to be ironic, as it is conceivable that the required fiber backhaul needed for 5G services ends up being a substantial opportunity for the very cable names that the service is supposed to displace. And what if we are completely wrong and Verizon can successfully hit its 30 million home rollout target by 2022? Well, a recent report from Morgan Stanley suggested that roughly 0.5 million subscribers (representing 1% of CHTR’s cable EBITDA) would be threatened…in over 4 years.

Interestingly, the fear over 5G has likely diverted investor attention away from the substantial competition coming in the wireless space as CMCSA (currently) and CHTR (later this year) execute mobile virtual network operator (MVNO) agreements with Verizon to essentially rent their network and offer mobile services to subscribers.2 As we have previously noted, the mobile offering can substantially reduce churn and thus can be priced more aggressively versus a company trying to maintain 40%+ margins in order to protect its sacrosanct dividend. While one can read about pricing in analyst reports and stare at Excel models, we find it helpful to experiment with the underlying product. We recently became Comcast mobile subscribers after spending several hours on the phone with the company and its various competitors. We show the cost of unlimited versus shared plans for two people in the chart below:

All plans are pre-tax unless otherwise noted and are quoted for 2 lines and assume auto pay; per GB based upon data offering available (i.e., some offer 4GB, others 5G, others 8G).
1 Per GB=$100 for 5G
2 Per GB=$85 for 4G or $105 for 8G
3 Receive $10.99 Netflix subscription per month taking unlimited down to $109 – taxes are included. Including the value of each, the price would be approximately $100
4 Tmobile would not initially sell per gig; when we asked on CMCSA pricing, they offered us two lines for $100 at 2G per line or $25 per G
5 The “unlimited” plan covers 23G of data
6 Per GB=$65 for 4G; If a customer goes beyond 4G, he/she can purchase 1G for $15. Sprint fiscal year ends 03/31
7 CMCSA margins are for its cable business

As one might imagine, there are hurdles3 for the initial rollout, and CMCSA does not have its “A” marketing game together currently. There are separate bills for mobile versus cable, and CMCSA representatives were often less knowledgeable about their own product and even sent us to Xfinity stores that couldn’t handle mobile. That said, CMCSA’s offering is 31% cheaper than Verizon’s price on an unlimited basis and 9-44% on a per GB basis with the CMCSA plan having more flexibility to swap offerings. Again, CMCSA is using Verizon’s network for its service, so the two products are identical4. These marketing kinks strike us as far easier to work out versus a time consuming 5G rollout, especially when there are still concerns about whether the technology actually works. It is true that wholesale revenue will offset some of these customer losses, but not every carrier will have this revenue stream. If mobile prices decline industry-wide, it seems reasonable to believe that valuations will follow. If the cable companies can build any scale in mobile, perhaps they will have an opportunity to eventually snag wireless assets on the cheap. In Europe, LGI has achieved enormous savings in the markets (Belgium and Netherlands) where it replaces MVNO wholesale arrangements with an owned network.

The mobile companies are certainly not blind and will discount to protect their core business. VZ will offer content with its mobile product, while T will meaningfully discount DirectTV or HBO (the latter, assuming the TWX deal goes through). Both companies will lay some fiber and package their products in overlapping areas, but both need to keep substantial powder in order to continue funding the large dividends. Additionally, unlike Europe, US cell phone companies do not have nationwide fixed networks and generally have less densely populated coverage areas. If consumers are primarily interested in receiving higher-speed broadband offerings, it could prove challenging to attract and maintain customers no matter how much one discounts the copper. As just one example (often repeated across the country), we currently have download speeds of over 400 Mbps with our standard triple-play CMCSA package versus a comparable offering of 30 Mbps through AT&T. The offerings are simply incomparable, and therefore it makes a switch challenging, even at 50+ percent discount levels.

While it is far from clear that VZ could actually acquire CHTR (or that CHTR would have any interest in accepting…or that VZ could trump possible other bids for CHTR), it is worth considering which of the following is a worse outcome from VZ’s standpoint:

  • Making a wildly overvalued bid for CHTR, but securing a differentiated product offering (and longer-term dividend coverage)?
  • Facing questions from a coupon clipping shareholder base about dividend security if cable companies secure meaningful wireless market share?

We encourage readers to give some thought to the above when viewing cell phone bills.

How to Value an Unregulated Utility?

But what about valuation? CHTR currently trades at ~9.5x 2018E EBITDA, a level at the high end of historical trading ranges and above that of other cable companies. When CHTR first announced the acquisition of TWC in 2015, one could see a path towards substantial free cash flow as synergies were realized and capex declined over time. Given the owners, this cash flow stream was likely going to be used for share repurchases and therefore the per share metrics would skyrocket. Since that time, tax reform was passed, which not only lowered the underlying corporate tax rate to 21%, but also allowed the immediate expensing for tax purposes of the substantial capital investments. Or said differently, not only would the domestic cable companies pay a lower rate, but the actual amount of income subject to taxes was less because of the capex shield.

To go deeper into the weeds, say CHTR can generate something close to $18-$19 billion in EBITDA by 2020. CHTR had roughly $10.5 billion in depreciation last year, including $3-4 billion of non-deductible merger-related amortization that runs off at a declining rate. We show capex dropping to roughly $6-$ 6.5 billion by that time. This might imply that roughly 60-70% of income is shielded from taxes before applying the interest deduction, let alone the significantly lower tax rate. One caveat to this analysis is that there are differences between the tax and GAAP depreciation schedules and investors do not have access to this level of detail. But, our quick analysis suggests that the tax assets might shield the company from most cash taxes beyond the preliminary 2021 guidance. This reform has occurred while CHTR has refinanced debt at lower levels and while the stock has now declined over the past year. To be intellectually honest, we assume that CHTR would be forced to repurchase shares at substantially higher share prices to roughly match our anticipated ~20-25% IRR. After recalibrating the starting repurchase price and after adjusting for the tax law changes, we think it is possible that CHTR ultimately earns closer to $40 per share in free cash flow by 2021 versus an original assumption of $30-$33.

How should this be valued? If we assume that CHTR should never trade above 9x EBITDA, this would imply that shares would ultimately trade at 8-10% free cash flow yields (and “only” mid-teen IRRs). Does this make sense? Some investors would argue yes, citing the company’s debt levels. Others (ourselves included) would question how an unregulated utility could trade so far below the broader market (~20x) on a price/free cash flow basis. Thought of another way, we project that CHTR will grow EBITDA at least 7% on a CAGR basis over the next 4 years versus a current cash interest expense (with a weighted average tenor of over 9 years) of just 5.7%. These two numbers are interesting when thinking about Dr. Malone’s quip that “if you grow faster than your interest cost, your value is infinite.” At the very least, it is tougher to see how this capital structure is irrational. Depressingly, we must concede that while cable faces far fewer risks than content companies, if investment grade DISCA can trade at 20% free cash flow yields, then 10% levels are possible for cable companies. That said, no pep talk is required for this team to repurchase stock. Finally, investors should remember that four different parties expressed interest in acquiring CHTR.

In summary, we remain frustrated with the stock prices of some of our holdings, but we do believe value is being created and that discounts to intrinsic value will not last forever. We do not have sentimental attachments to any of the names mentioned above and we will change our opinion if the facts change. We would like to conclude the letter by thanking Larry Cunningham for letting us participate in his latest in his last project The Warren Buffett Shareholder: Stories from Inside the Berkshire Hathaway Annual Meeting. Larry is an astute financial observer and fantastic writer. We got to know him through The Creighton Value Investing Panel during Omaha’s Berkshire weekend. We’ve been fortunate to work with Larry on a couple of Liberty Media themed articles and we hope to continue our collaboration on a larger project. We believe value investing aficionados will surely enjoy the book’s collection of essays.

1 5G is the term used to describe the next generation of mobile networks beyond the 4G LTE mobile networks of today.
2 On April 20, 2018, CMCSA and CHTR announced a partnership agreement to develop back-end software to support services for their Xfinity and Spectrum mobile offerings.
3 Up until the start of this year, CMCSA mobile customers would have to purchase a new phone to be eligible for a mobile offering. This policy changed earlier this year as customers could swap carriers on certain phones. For AT&T customers, old iPhones (6) worked but newer iPhones already on the T network did not, nor did Android devices. These restrictions were not a problem for VZ customers looking to swap to CMCSA mobile.
4 While our sample size is small, it is less clear that VZ representatives we spoke with were clear that CMCSA was using the VZ network for its service.

download printable version

Disclaimer: BAM’s investment decision making process involves a number of different factors, not just those discussed in this document. The views expressed in this material are subject to ongoing evaluation and could change at any time. Past performance is not indicative of future results, which may vary. The value of investments and the income derived from investments can go down as well as up. It shall not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities mentioned here. While BAM seeks to design a portfolio which reflects appropriate risk and return features, portfolio characteristics may deviate from those of the benchmark. Although BAM follows the same investment strategy for each advisory client with similar investment objectives and financial condition, differences in client holdings are dictated by variations in clients’ investment guidelines and risk tolerances. BAM may continue to hold a certain security in one client account while selling it for another client account when client guidelines or risk tolerances mandate a sale for a particular client. In some cases, consistent with client objectives and risk, BAM may purchase a security for one client while selling it for another. Consistent with specific client objectives and risk tolerance, clients’ trades may be executed at different times and at different prices. Each of these factors influences the overall performance of the investment strategies followed by the Firm. Nothing herein should be construed as a solicitation or offer, or recommendation to buy or sell any security, or as an offer to provide advisory services in any jurisdiction in which such solicitation or offer would be unlawful under the securities laws of such jurisdiction. The material provided herein is for informational purposes only. Before engaging BAM, prospective clients are strongly urged to perform additional due diligence, to ask additional questions of BAM as they deem appropriate, and to discuss any prospective investment with their legal and tax advisers.

Quarterly Snapshot of Superinvestor Portfolio Activity

May 18, 2018 in Equities, Portfolio Management, The Manual of Ideas

We are pleased to bring you our quarterly analysis of the just-filed 13F-HR portfolio holdings of the superinvestors we track.

“Signal Value” as Opposed to “Noise”

We present the holdings of 100+ of the world’s best investors. We typically look for investors who have amassed impressive track records and manage a fairly concentrated portfolio. We choose these investors carefully to avoid the noise inherent in most 13F-HR filings.

The following analysis is based on Forms 13F-HR (institutional holdings report) filed with the SEC for the most recent quarter.

MOI Signal Rank answers the question, “What are this investor’s top ten ideas now?” Rather than simply presenting each investor’s largest holdings, our methodology ranks the portfolio holdings based on an investor’s current level of conviction in each holding, as judged by The Manual of Ideas.

Our proprietary methodology takes into account a number of variables, including the size of a position in an investor’s portfolio, the size of a position relative to the market value of the corresponding company, the most recent quarterly change in the number of shares owned, and the change in the stock price of a position since the most recent quarterly filing date.

For example, an investor might have the most conviction in a position that is only the tenth-largest position in such investor’s portfolio. This might be the case if a fund invests in a small company, resulting in a holding that is simply too small to rank highly based on size. Such a holding might amount to 19.9% of the shares outstanding of the subject company, suggesting a high level of conviction. Our estimate of the conviction level would rise further if the company had a 20% poison-pill threshold, thereby suggesting that the investor had bought as much of the equity as is practically feasible.

Members, log in below to access the restricted content.

Not a member?

Thank you for your interest.  Please note that MOI Global is closed to new members at this time. If you would like to join the waiting list, complete the following form:

The Biggest Question of Them All: Why Now?

May 18, 2018 in Diary, Letters

This article is authored by MOI Global instructor and Zurich Project participant Bogumil Baranowski, co-founder and partner of Sicart Associates, a New York-based investment advisory firm serving families and entrepreneurs.

Bogumil discussed his book, Outsmarting the Crowd, on The Zurich Project Podcast.

When John asked me about my takeaways from Berkshire Hathaway’s meeting, my first thought was that I usually care more about what I didn’t hear rather than about what I heard. Somehow that quality has helped me tremendously in my equity research all these years.

I’m the biggest fan of Warren Buffett and Charlie Munger, no question about it. I don’t think there is anyone who can put the complexity of the financial and economic world in simpler terms – I doubt they will ever stop to impress me. I also credit them both for my career choice of being a lifelong stock picker aspiring to wisely compound capital over the next hundred years, but I do have a big, glaring question that remains unanswered.

The big question I have is – why now? — and it pertains to the recent high profile, even bigger acquisition of Apple shares at an all-time high. Apple’s success has been no secret to hundreds of millions of consumers, and possibly most stock investors, I even used it as a familiar brand example in my recent TEDx Talk, but the timing of Berkshire’s Apple purchase is what leaves me wondering.

Whenever I look at a new idea or someone recommends an investment to me, the first question I always ask myself and others is – why now? In my mind, if there is no good answer, there is no investment case. Any security I don’t have to buy today — I can buy another time, any security I haven’t bought — I don’t mind waiting to see a better price. As investors with very long-term investment horizon guiding multi-generational families with their wealth growth and preservation, the one thing we have is — time.

Berkshire Hathaway was built to last for generations, and they too have time, and as patient, long-term value contrarian investor, I would have the hardest time to convince myself to buy even a wonderful company at an all-time high.

Again, why now is the question that is on my mind.

Is it just me?

download printable version

Disclaimer: This article is not intended to be a client‐specific suitability analysis or recommendation, an offer to participate in any investment, or a recommendation to buy, hold or sell securities. Do not use this report as the sole basis for investment decisions. Do not select an asset class or investment product based on performance alone. Consider all relevant information, including your existing portfolio, investment objectives, risk tolerance, liquidity needs and investment time horizon. This report is for general informational purposes only and is not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally.

Deserving Success

May 18, 2018 in Commentary, Featured

This article is authored by MOI Global instructor and Zurich Project participant Michael Lee, managing member of Hypotenuse Capital, based in North Hollywood, California.

What makes an investment successful? 

There are many factors that can drive the price of a stock higher.  Sometimes the fundamentals of the underlying business improve and earnings grow; with such cash flow growth a proportionate increase in valuation is rational.  At other times the price of a stock may go up simply because the market grows more enthusiastic or positive about the company.  Such shifts in sentiment can drive large swings in the price the market is willing to pay for a company even if the underlying earnings of the company do not change materially.  Although it is possible to analyze historical market sentiment patterns, it is nonetheless very difficult to predict with any accuracy when and by how much sentiment will vary. 

On the other hand, a company’s ability to successfully grow its earnings should be eminently analyzable and, in some cases, foreseeable.

How can we know what businesses will be successful before the fact? This is quite literally the million dollar question. Although we can’t turn back the clock and invest retroactively, we can study the past to search for clues as to what characteristics will lead to a company’s future success and prosperity. One case study that comes to mind is GEICO.

The Flame that Still Burns [1]

“GEICO, the company that set my heart afire 66 years ago (and for which the flame still burns).” —Warren Buffett, Berkshire Shareholder Letter, 2016

In his [2017] annual letter, The Oracle of Omaha reminisces about a car insurance company as if it were a hot crush from his adolescence. While it’s not unusual for Warren to wax effusively about a company he admires, his adulation for GEICO goes a step beyond, almost into the realm of romantic poetry. And there is good reason; GEICO, indeed, was like his first love. He first set eyes on the company at the tender age of 20 while studying under Ben Graham at Columbia Business School.

So immediate was his infatuation, he soon hopped on a train to Washington D.C. on a winter Saturday and presented himself, unannounced, at the front door of the company’s downtown headquarters which was closed for the weekend. Like a star-crossed Romeo, he pined away below the balcony and pounded on the locked front door until a confused custodian finally answered his calls and granted him entry to the chambers within. There he met Lorimer Davidson, who would later become GEICO’s CEO, and then the courtship began in earnest.

So hot was Warren’s passion for GEICO that, upon returning home to Omaha after graduating from Columbia, he penned a public letter of his affection, entitled “The Security I Like Best”, which he published in a leading financial periodical. Apparently, Buffett had no problem with long-distance relationships or public displays of affection. He pitched the shares to anyone who would listen and bought a substantial position for his own account over the course of 1951; according to his own records, at the end of that year he held 350 shares accumulated at a cost of $10,282.

As with so many young romances, Warren’s initial affair with GEICO was short-lived. He sold the shares in 1952 for handsome proceeds of $15,259 or a 50% gain over his cost. While the profits of this early episode with GEICO were objectively material, Warren himself acknowledges his misdeed here:

“This act of infidelity can partially be excused by the fact that Western [the interloper that seduced Buffet into dumping GEICO] was selling for slightly more than one times its current earnings, a P/E ratio that for some reason caught my eye. But in the next 20 years, the GEICO stock I sold grew in value to about $1.3 million, which taught me a lesson about the inadvisability of selling a stake in an identifiably-wonderful company.”

Warren is understandably harsh on himself for his “infidelity” in this fling as his choice cost him dearly. All was not lost in the relationship though as the two would come together again a quarter of a century later in 1976 when GEICO found itself lost in a quagmire of underwriting losses and teetering towards insolvency. Buffett’s friend, Kay Graham of the Washington Post, arranged a reunion of sorts between Buffett and newly-appointed GEICO CEO, Jack Byrne, at her Georgetown home. The tryst rekindled the flame and Buffett was once again buying shares of GEICO the very next morning. Soon Berkshire Hathaway would own over a third of GEICO’s shares.

A decade later in 1987, Buffett informed his shareholders that GEICO, amongst others, should be considered a “permanent” holding; in other words, “‘til death do we part.” Finally, in 1995, Buffett committed himself wholly to the relationship and Berkshire Hathaway bought out the remaining shares of GEICO that it did not already hold.

What was it exactly that made the Oracle of Omaha fall so hard for an insurance company? It is one thing for someone to fall for a first love at a young age but to be so adoring of a single company almost 70 years later is a truly unique kind of affection.

The Key to Success

At the core of Buffett’s adulation for GEICO is its simple ability to deliver a product to its customers at a substantially lower cost than its competitors. As Buffett explains in his shareholder letters:

“When I was first introduced to GEICO in January 1951, I was blown away by the huge cost advantage the company enjoyed compared to the expenses borne by the giants of the industry. It was clear to me that GEICO would succeed because it deserved to succeed.” [The emphasis is Buffett’s own.]

GEICO has a distinguishing feature which sets it apart from the rest of the industry: it sells directly to customers. By avoiding the cost of supporting a network of independent commission-carrying sales agents, GEICO has a considerably more efficient operation than other insurers. In fact, GEICO’s expense-to-premiums written ratio is approximately 15%, versus 25% for the average auto insurance carrier. This significant cost advantage allows GEICO to price its product at a level that almost no other competitor can profitably sustain. As Buffett explained in 1976:

“I always have been attracted to the low-cost operator in any business and, when you can find a combination of (i) an extremely large business, (ii) a more or less homogenous product, and (iii) a very large gap in operating costs between the low-cost operator and all of the other companies in the industry, you have a really attractive investment situation.”

I will note that although GEICO is an industry leader when it comes to cost, the company doesn’t just skimp on quality. According to, GEICO receives customer satisfaction ratings of 94 and 89 for claims experience and customer service, respectively. 87% of reviewers would recommend GEICO to a friend. GEICO’s product is not only low cost but also high quality.

Deviant Behavior

Of course, the relationship between price and quality has always been a useful framework for people looking to buy something.  This is why websites like Yelp, TripAdvisor and Amazon are so popular: it’s extraordinarily useful to know the quality of a product or service prior to purchase. And generally, one expects that as a product’s quality increases, so too does its price. Thus, if one were to plot a two-dimensional chart with quality on the x-axis and price on the y-axis, one would expect that a line representing a given product’s expected price would be upwardly sloping to the right as quality increases.

Now, an inherent tension exists in that a typical business that is trying to maximize profits in the short-term is incentivized to raise prices but lower costs.  Of course, it is difficult to cut costs without sacrificing quality. Hence many firms tend to migrate towards the upper left-hand quadrant of the chart (low quality, high price). This is a rational decision for any firm trying to maximize profits in the short-term but it creates challenges over the long-run since no one likes to pay a lot of money for a shoddy product.

On the other hand, there are companies that pride themselves upon crafting extraordinarily high-quality products and will charge exorbitant prices for them (think of luxury goods makers like Hermès). Economists and business school professors might argue that this is the mark of a successful firm: significant pricing power and the ability to realize above average profit margins and returns on investment.

It is entirely understandable and common for firms to move up the price dimension of our chart; conversely, firms that try to move down the price dimensions are rare, and even more unusual are the firms that do so while also moving to the right on the quality dimension. Such companies are “deviants” in a competitive world typically obsessed with expanding profit margins. Yet this is the domain where GEICO operates and it is a fundamental driver of why the company has been so successful.

This commitment to providing a high-quality product at a bargain price is an unusual ethos but one that drives a decidedly virtuous cycle. Customers who buy a high-quality product at a low price delight at their fortune of getting a good bargain. They return as repeat customers and recommend the product to their friends. As such a company grows and benefits from economies of scale; the deviant can continue to offer even lower prices and even better service, thus allowing it to capture even more market share.

This ability to march down and to the right on the cost-quality curve creates an ever-widening and durable moat which competitors cannot cross. Deviants make their money not by squeezing every last penny of margin out of any given customer and supplier, but by operating at extraordinarily low margins where the competition cannot follow.  The scale benefits rewarded to deviants by happy customers make it still harder for competitors to retrace a deviant’s footsteps.  Deviants may sacrifice profits on an individual unit basis but make up for it in sheer volume.

Today, GEICO is a powerhouse within the insurance industry. GEICO is the second largest auto insurer in the nation with 12% market share, which is up from 2.5% when Berkshire took control of it in 1995. GEICO is creeping up on the country’s leading auto insurer, State Farm, which has about 18% share. GEICO wrote $26 billion in premiums in 2016 up from $21 billion just two years prior.

GEICO provides a hoard of cash for Buffett to invest in the form of its $17 billion float while also operating at an underwriting profit. GEICO’s continually increasing success is undeniable and very much “deserved.”

There are other examples of deviant low-cost high-quality ethos companies who have earned dramatic success. Consider Costco, which by rule will never markup merchandise more than 14% above cost and earns less than a 1% pretax operating margin on its retail sales, even on “luxury” items like fine wines, handbags and diamonds. Today, Costco has a fanatical membership base and is one of the most successful and prosperous retailers in the world. 

Think of Southwest Airlines, which started as a misfit regional air carrier serving just three cities in Texas, and became one the largest air carriers in the U.S., all based on the proposition of providing a wonderful flying experience at a lower price.

Contemplate the prosperity of fast food chain In-N-Out Burger, which for decades has provided freshly made, never frozen hamburgers at an absurdly low cost. To this day, the queues for the drive-through at In-N-Out often snake through the parking lot and spill into the street.

These companies have earned the right to succeed because the deviant ethos of low-price, high-quality is a winning one-two knockout proposition for the consumer. In short, these companies deserve to succeed and consequently have delivered remarkable returns for their owners.

Most companies try to find ways to make their stock prices go up. Many of them do so by trying to grow profits by lowering costs and raising prices. A few might be pushing the boundaries of higher quality but still expect higher prices as a reward for their efforts.

It takes a contrarian mentality to steer a business down the deviant path of lower prices while offering higher quality. Such players are forgoing profits in the near-term to win over the long-term. They don’t get fat off of excessive margins but rather reinvest in delivering superior value to their customers.  They stay lean and run ever faster on behalf of their clients.  These are a unique and rarely seen breed.

Not every successful company will be a deviant, nor will every investment we make fall under this criteria; yet when deviants do present themselves, they can prove to be astoundingly successful businesses and, by extension, wonderful investments.

An Oracle and his Gecko

A parting observation about GEICO’s deserved success revolves around its reptilian spokesperson, who has also earned Warren Buffett’s affection and admiration. Buffett wrote in his 2014 shareholder letter:

“Our gecko never tires of telling Americans how GEICO can save them important money. The gecko, I should add, has one particularly endearing quality – he works without pay. Unlike a human spokesperson, he never gets a swelled head from his fame nor does he have an agent to constantly remind us how valuable he is. I love the little guy.”

The witty lizard certainly does seem like the ideal employee.  However, given that he is a computer rendering, perhaps it’s not really that remarkable. What is remarkable is the resemblance the gecko bears to another important Berkshire Hathaway employee: the Chairman himself. Consider that Buffett has worked for over five decades at a nominal salary ($100k annually) with no bonus, and no equity grants or stock options. He’s never complained about the size of his paycheck and certainly has never called on an agent to negotiate his contract.

Despite his fortune and fame, Buffett keeps a low profile and his ego in check (how many billionaires still drive themselves through the McDonald’s drive-through on the way to work every morning?). Buffett’s adoration of the gecko is well-placed but Buffett himself certainly did more than his fair share to position Berkshire itself to succeed.

[1] Much of the factual information regarding Buffett’s history with GEICO comes from David A. Rolfe of Wedgewood Partners who wrote a wonderfully in-depth paper on the subject.  While I am indebted to him for the original source documents and analyses he provided, he deserves no blame for gratuitous stylistic embellishments in this discussion; that burden is mine alone to shoulder.

download printable version


My Investment Thesis on

May 16, 2018 in Asia, Equities, Ideas, Large Cap, Services, Technology, Wide Moat

This article is authored by MOI Global member Theodore Rosenthal. is a great business trading at a fair price wrapped in a special situation in way of a spinoff of JD Finance, partial spinoff of JD Logistics and reorganization of the business over the next 2-3 years.

Members, log in below to access the restricted content.

Not a member?

Thank you for your interest.  Please note that MOI Global is closed to new members at this time. If you would like to join the waiting list, complete the following form: