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Intelligent Investing in a World of Accelerating Growth

January 7, 2022 in Best Ideas Conference, Commentary, Letters

This post is authored by MOI Global instructor Ser Jing Chong, portfolio manager and co-founder of Compounder Fund under Galilee Investment Management, based in Singapore.

Ser Jing is an instructor at Best Ideas 2022.

The following article has been excerpted from a letter to Compounder Fund investors.

In 2016, Michael Mauboussin co-wrote a research paper entitled The Base Rate Book. Mauboussin and his co-authors studied the sales growth rates for the top 1,000 global companies by market capitalization since 1950.

They found that it was rare for a company — even for ones with a low revenue base — to produce annualized revenue growth of 20% or more for ten years. For example, of all the companies that started with revenue of less than US$325 million (adjusted for inflation to 2015-dollars), only 18.1% had a ten-year annualized revenue growth rate of more than 20%. Of all the companies that started with inflation-adjusted revenue of between US$1.25 billion and US$2.0 billion, the self-same percentage was just 3.0%.

The table below shows the percentage of companies with different starting revenues that produced annualized revenue growth in excess of 20% for ten years. You can see that no company in the dataset that started with US$50 billion in inflation-adjusted revenue achieved this level of revenue-growth.

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Investment Decisions: The Nexus Between Accounting and Valuation

January 7, 2022 in Best Ideas Conference, Idea Appraisal, Letters, Skills

This post is authored by MOI Global instructor Javier Lopez Bernardo, portfolio manager and senior investment analyst at BrightGate Capital, based in Madrid, Spain.

Javier is an instructor at Best Ideas 2022.

This following article has been excerpted from a letter to BrightGate investors.

I think it is the right time to write some words on how I think about the nexus between accounting and valuation, and how such a framework informs my investment decisions. The summary metrics that I provide [in my letters] usually go unreported in other funds, and here I will argue why these metrics have more informative content than the traditional ones, and how they are indissolubly tied both to a firms’ core business and their accounting. In other words, these metrics are the ones I would like to receive if I were in your place trying to obtain a clear overview of the Fund’s portfolio.

Although it is usually argued that valuation is not a differential part of the investment process, for “everything has already been invented”, I cannot but disagree with such a statement. Although in the end the success of an investment boils down to the knowledge of the business and its own future dynamics, a correct study of the valuation and the accounting allows a better understanding of the business and to avoid serious mistakes later.

The exposition that follows is necessarily a simplification of our financial models, but it will be enough to grasp the conceptual framework. The method that I employ to value business is the residual income model (or economic profits, as they are known in the academic literature), which says that the value of every asset is given by its current book value in the balance sheet plus those future discounted earnings obtained above the cost of capital – residual or economic earnings. If we have an asset with a book value of 100€, and we expect it will yield returns of 7% (7€ of profits at perpetuity), and our cost of capital is 7%, the asset should be valued at book value – no more, no less.

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January 5, 2022 in Twitter

Value-Oriented Investing in the Sustainability Revolution

January 5, 2022 in Best Ideas Conference, Commentary, Letters, Macro

This article is authored by MOI Global instructor Alex Gates, director of research at Clayton Partners, based in Berkeley, California.

Alex is an instructor at Best Ideas 2022.

It has become evident that the public and private sector are now remarkably aligned to achieve the goals of the Paris Climate Accords and a zero carbon economy by 2050. Investment strategies focused on carbon reduction will have a tailwind for the next thirty years. This prompts the question:

Outside of expensive renewables pure plays, and ill-conceived or suboptimal ETFs, how can investors participate in the decarbonization transition?

We found the options to be lacking in both return potential and direct impact to carbon reduction. In response, we created the Clayton Partners Sustainability Strategy (CPS). CPS will invest in a portfolio of companies focused on achievable carbon reduction and value creation based on those initiatives.

A major reason for starting CPS is that the current options for climate investing are not focused on profitability or where the greatest benefit is being created. For most investors, ETFs are the main way to participate. This leaves two options: (1) Environmental, Social and Governance (ESG) focused ETFs and (2) Clean Technology ETFs.

ESG focused ETFs utilize exclusionary criteria to eliminate companies with larger carbon footprints. That results in them being overweight asset-light businesses, like technology companies, and underinvested in heavy industry where the most meaningful change is happening. For example, one of the largest “ESG” mandated ETFs, has a 29% weighting to large cap technology stocks, more than the S&P 500. Most technology companies are inherently low carbon, so supporting them with investment capital is not very impactful.

Clean Technology ETFs focus specifically on environmental or renewable technologies. While a seemingly obvious choice, most of these ETFs are concentrated in unprofitable, unproven, and expensive companies. In fact, the second largest clean tech ETF by market value, has nearly half of its investments in unprofitable companies.

CPS uses an entirely different approach. Our strategy is focused on carbon reduction for the benefit of climate change. We do NOT have a formulaic approach that excludes certain industries or includes them regardless of valuation.

CPS focuses on profitable companies enabling dramatic carbon reductions using quantifiable methods. The companies will become more profitable and valuable as a direct result of their emissions reductions.

Our focus is on key areas of emissions reduction where valuations generally have not caught up with the opportunity.

A few examples:

Utilities in “Transition”: The need to decarbonize the electric grid and electrify sectors like transportation will require the current world electricity supply to triple by 2050. Utilities will be the ultimate change agents for this thirty-year transformation. Green, or 100% renewable utilities, trade at high prices relative to their peers with diversified generation sources. CPS will focus on the utilities that are making the fastest pivots to 100% renewable power because they offer the highest appreciation potential and the most impact from a net carbon reduction standpoint.

Solar, Wind and Storage: Considered the workhorses of the new electric paradigm, these technologies drive the decarbonization of the world’s electric grids. Although they have grown quickly in the past, wind and solar will need to be deployed at over three times the current pace to reach a decarbonized US grid by 2035. CPS will focus on supporters of these technologies including energy storage, which makes renewable energy projects more viable.

Low and Zero Carbon Fuels: Decarbonizing the transportation sector is a universal goal for all governments focused on net zero emissions. Electric vehicles will play a massive role in this transition, but sectors like heavy trucking, shipping and aviation are decades away from full electrification. CPS will focus on companies enabling scalable biofuels that are ready to deploy today.

Carbon Capture and Waste Solutions: The transition will require large amounts of CO2 removal and storage in the coming decades. This will create opportunities for direct carbon capture and storage (CCS), as well as new recycling and waste infrastructure needs. CPS will focus on companies investing in profitable projects with proven technologies involving CCS, biomass, digesters and waste-to-energy.

Conclusion: A great way to contrast the CPS approach with the alternative options is to compare one of our large holdings, AES Corp, and a large holding of the more popular strategies, Google. AES and Google are both committed to sustainability; however, the magnitude of their impact is quite different.

Google plans to use 10.5GW of green energy to power its data centers by 2030. AES produces over 11GW of green power TODAY and has a pipeline to produce 37GW more, almost five times the amount Google intends to deploy. AES has a market cap of $16B vs. GOOG at $1.9T, more than 100x larger. An incremental dollar invested in AES will clearly have a larger climate impact compared to Google. Regardless, Google is in many sustainable ETFs and AES is not in any. Yet!

Our focus on profitable value creation and the magnitude of environmental benefit positions us to participate in a strong secular trend and support companies making the greatest contributions to the sustainability transition.

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Our Approach to Investing in an Age of Below-Inflation Interest Rates

January 5, 2022 in Best Ideas Conference, Commentary, Equities, Letters

This post is authored by MOI Global instructor Michael Melby, founder and portfolio manager at Gate City Capital Management, based in Chicago.

Mike is an instructor at Best Ideas 2022.

“It’s my money, and I need it now!” –J.G. Wentworth tagline

Readers might recall J.G. Wentworth television advertisements from the early 2000s where actors shouted from windows to encourage viewers to exchange their structured settlement or annuity for upfront cash. While J.G. Wentworth customers all needed cash on the spot, many investors today are often so flush with cash that they are doing the opposite.

Investors continue to lend their cash to the government in exchange for a historically low rate of interest and a promise to return the investment principal at maturity. Not only are investors relinquishing the opportunity to use their cash, but they are also accepting an interest rate that is currently well below the expected rate of inflation, ensuring a loss of purchasing power when their cash is returned.

Rather than agreeing to an interest rate that compensates the lender for both inflation and the time value of money, investors seem to be relying on the Federal Reserve for guidance regarding the interest rate they should be earning.

While individuals could continue to choose to lend money at interest rates below the rate of inflation for the time being, it is unlikely that this wealth-destroying behavior can continue in perpetuity. Given the choice between spending money in exchange for a basket of goods today or lending the money only to receive a smaller basket of goods in the future, most individuals would spend the money today. Consumers with access to credit have the additional opportunity to purchase durable goods such as new homes today by borrowing at low interest rates and repaying the loan in the future with inflated money.

As investors and economists ponder the path of future inflation, it is important to note that central bank policies continue to incentivize spending over savings. Individuals with excess cash or the ability to borrow will look to spend the cash now rather than wait for inflation to erode its value, further contributing to the short supply of goods and services. We find it highly unlikely that these utility-maximizing actions will prove to be transitory.

Our primary macro-economic concern is that market forces will eventually push interest rates higher, resulting in a reduction in lending activity and higher costs of capital for both debt and equity investors. While it would be extremely challenging to eliminate the risk that higher interest rates would have on equity markets, we continue to attempt to mitigate the risk when constructing our portfolio.

We invest primarily in companies with owned assets including, land, buildings, and equipment. This focus served us well in 2021 and should continue to benefit our investors if inflation exceeds expectations.

We also value all portfolio companies on a discounted cash flow basis and have maintained our required rates of return at 12.5% or higher even as long-term interest rates hover near all-time lows.

Historically, we have found some of the worst investment decisions result from either lowering required rates of return or relying on relative value analysis in an overvalued market. We look to mitigate the negative impact that rising discount rates could have on asset prices by maintaining consistent return requirements regardless of the interest rate environment.

Stay Cognizant of Market History, Focus on Cash Flow Over Stories

January 5, 2022 in Best Ideas Conference, Commentary, Equities, Letters

This post is authored by MOI Global instructor Jeff Auxier, president of Auxier Asset Management, based in Lake Oswego, Oregon.

Jeff is an instructor at Best Ideas 2022.

A young generation of investors who have seen essentially nothing but good times for the market are speculating on exciting and high-risk stories. Instead of valuing sustainable earnings and consistent cash flows, many new investors are focusing on small penny stocks and options, hoping for substantial price appreciation in a short period of time.

In February 2021, over-the-counter markets saw 1.9 trillion transactions, an increase of 2,000% from the previous year. As a result of the influx of cash into the markets throughout the year, there were record levels of mergers and acquisitions (M&A) and Initial Public Offering (IPO) activity during the quarter.

Global M&A activity during the [third] quarter [of 2021] was over $1.5 trillion, up 38% over Q3 2020, and was the highest ever recorded for a single quarter (NASDAQ). Year-to-date, M&A transactions surpassed $4.3 trillion which is higher than the $4.1 trillion in annual M&A in 2007.

In just the first nine months of 2021, there have been 770 US IPOs, over three times the 10-year average of 205. The capital raised through US IPOs has surpassed both 1999 and 2008 levels. This means a plethora of supply.

Just as fossil fuels are starved for capital today, many areas of new innovation and technology are incredibly exciting but also lead to dangerous levels of competition and supply. Thematic ETFs like ESG (environmental, social and corporate governance) can lead to gluts and shakeouts.

The euphoria surrounding the legalization of marijuana led to irrationally excessive planting, which has decimated growers.

The history of transportation bubbles dates back to canals, railroads, airlines, bicycles, etc. The first electric car was developed in 1890 and ended by the 1930s. From 1900 to 1919, two thousand companies were involved in the production of autos in the US. Today, largely due to government mandates, many manufacturers are committing to a fully electric future. The massive mandatory capital investment required make it a very high-risk proposition.

In 1999 two popular themes were internet hosting and fiber optic. We flooded the market with fiber optic supply and ended up using less than 20% of the capacity. In the decade from 1999-2009, the S&P 500 was down 9%, but the biggest and most exciting tech stocks fell over 50% during that same time (Financial Times).

This chart from Bloomberg demonstrates how, despite having compelling stories in the year 2000, some of the biggest companies were materially overvalued and experienced substantial multiple compression in subsequent years. In referencing this chart, I remember the period like yesterday. In March of 2000 the level of greed, envy and frenzy was the highest I had ever witnessed. The technology fundamentals looked like they would be growing for years into the future. Then the supply caught up with demand; many stocks with exciting concepts went bankrupt leading to a bursting of the bubble and subsequent 80% decline in the NASDAQ.

The Auxier Focus Fund was up over the three years 2000-2002 while many funds that had doubled in the late 1990s went out of business. As mentioned in our prior letter, AOL and Yahoo, two of the most popular stocks at the time, were sold this past year by Verizon after declining 95% from their 2000 peak.

During the 1999 tech bubble, those who looked past the bubble priced companies and focused on value were rewarded. For example, the deeply discounted energy sector gained nearly 150% during the decade from December 1999 to 2009. That was also the best ten-year period for the Fund in relation to the market, with a gain of 84% vs. -4% for the S&P.

Cryptocurrency Risks Could Lead to Regulation

The cryptocurrency market has exploded in 2021 and reached a total market cap of nearly $2 trillion, a year-to-date gain of 156%. Much of the crypto boom has been due to the growth and popularity of Bitcoin, but alternative options have gained traction as the year has progressed.

At the start of 2021, Bitcoin accounted for approximately 70% of the entire market but it now accounts for only 43%. Companies like Visa and Mastercard have begun to embrace the technology with an eye on potential disruption in the future. Visa has partnered with over 50 crypto platforms to allow their customers to eventually use Visa cards to pay with cryptocurrency. Mastercard has partnered with cryptocurrency firm Bakkt to allow their users to hold and pay for card purchases with cryptocurrencies.

However, even with increased adoption from reputable businesses, the rapid growth and unpredictability of cryptocurrency has brought with it the risk of increased regulation. In September, the Chinese government announced that all cryptocurrency transactions in the country were illegal. The US has taken a less aggressive approach with Fed chair Jerome Powell saying that he has no intention of banning cryptocurrency. Increased regulation is critical to build confidence and credibility. We are carefully studying the evolution of the blockchain. The decentralized digital ledger could potentially be a disrupter to many centralized cloud-based models.

China Fundamentals

China has $52 trillion in bank assets or 56% of world GDP. Their number two real estate developer, Evergrande, binged on easy money. With $300 billion in liabilities, it now faces bankruptcy. Other major developers are facing a similar challenge. 29% of China’s economy is tied to real estate and construction, with most savings in apartments. Vacant apartments could house as many as 80 million people.

The Chinese government has been aggressive in reigning in excessive borrowing, poor accounting and monopolistic behavior by many of the major platform companies. In addition, they are suffering from severe energy shortfalls. This has led to some bargains in powerful franchises such as Alibaba.

In Closing

We are on pace to see over 104 management teams this year. We strive to know the fundamental earnings power of the companies we own. There is good value in smaller and midsized businesses with high integrity management teams. Most businesses we talk to are seeing robust demand, strong pricing and good margins.

Inflation appears to be up across the board with labor increasing 3.5%. For restaurants, wages are growing around 5.5% and over 10% in hospitality. Government mandates for vaccines and green energy are adding to the shortages for labor and fossil fuels. The service side of the economy is very robust. Companies with strong franchises are able to raise prices and so far, the customers are paying up. Inflation seems to be more persistent as wages are hard to retract and we are seeing rents, which are a large part of the consumer price index, showing double-digit increases coast to coast.

Companies that are executing with proven business models have been rewarded with huge premium valuations. However, higher inflation historically acts to compress valuations for all stocks, especially those speculative names with little earnings. With vaccinations widely available and the potential for the Merck antiviral, economic conditions should continue to recover from the worst pandemic in 100 years.

Politically there remains a sharp divide. Gridlock can be a good thing, as it can mitigate the potential damage of unconstrained government spending and onerous taxation.

A Case Study in Primary Research: Indentifying an Inflection Point

January 3, 2022 in Best Ideas Conference, Equities, Idea Appraisal, Letters, Skills

This article is authored by MOI Global instructor Ari Lazar, senior research analyst at RGA Investment Advisors. Ari is an instructor at Best Ideas 2022.

A major part of my job as an investor is to piece together a view of how the future will play out amidst a backdrop of uncertain information. I, like all humans and investors, have a very limited and clouded view of the future. People who physically struggle to see wear eyeglasses to improve their vision. The equivalent to eyeglasses for me, as an investor trying to see a blurry future, is primary research. It allows me to improve my perception of the future through unique insights that can be gleaned through primary research.

Primary research takes me beyond SEC filings, management presentations, and industry reports. It is rolling up my sleeves to verify or seek out information for myself. Examples include site visits, channel checks, and conversations with employees (present and former), customers, suppliers, competitors, and/or partners. Information uncovered in this manner leads to a clearer and potentially differentiated view into how events may play out. If primary research can lead to strong conviction in a differentiated view, why doesn’t everybody do it?

Unfortunately, primary research is time consuming, expensive, and difficult. It often requires me to filter vast amounts of information. There are many potential conversation paths, and I must, through a combination of luck and skill, arrive at relevant tidbits of information. This must be done within the confines of my professional (or expert) network. I am always working to expand my professional network to get the information that I need. Performing primary research is very similar to being a detective.

I am still sharpening my abilities to effectively perform primary research. For me, some companies and industries are easier than others to obtain insights in. So far in my career, I have found the most success (and luck) finding unique insights on Cognex. My primary research on Cognex allowed me to gain conviction in a revenue inflection ahead of its occurrence.

For those that are not familiar, Cognex provides machine vision hardware and software. Their products capture and analyze visual information needed to automate distribution and manufacturing. Cognex is well positioned as a leader in the machine vision industry alongside Keyence. It is important context that machine vision is traditionally used in cyclical end markets, like consumer electronics and automotive, where large manufacturers employ machine vision engineers to maintain Cognex (or competitor) products. Additionally, logistics was Cognex’s third largest end market in 2019 (low double digit % of revenue).

My primary research on Cognex began unexpectedly on LinkedIn. LinkedIn is an excellent source of insights into product features that are not typically available within SEC filings. Through LinkedIn, I become aware of the Cognex In-Sight ViDi D900 (“D900”) product launch webinar. This webinar opened my eyes to the advanced deep learning product capabilities and sparked a strong motivation to learn more. Following the webinar, a Cognex sales employee called me to see if I had any questions or interest in purchasing the product. This call is part of an excellent sales strategy to fully utilize a webinar designed for potential customers. With full honesty around my intentions as an investor rather than a customer, I was able to have an incredibly helpful conversation with a Cognex employee about the D900.

Over time, I realized that after each Cognex webinar that I signed up for, a different employee or external sales partner would reach out to me directly. This allowed me to have many useful conversations about Cognex and piece together tidbits of information related to the company. Some of the calls were very insightful while others were dead ends. Finally, I was also able to use my professional network to commence a conversation with an employee of a competitor to verify some of the information that I had learned. The culmination of my traditional research on Cognex, the LinkedIn webinars, and my primary research was summarized in the following tweet thread eight months ago.

I had gained high levels of conviction that Cognex was on the verge of an inflection to revenue growth. When @TheMuffinMan28 asked me “Why would rev growth accelerate from pre Covid levels? I know everyone has been hoping for that for a while” I provided five reasons supporting my prediction. The following two insights were essential to my conviction and learned directly from my primary research.

Four months after posting this thread, my research received feedback. Cognex reported “substantial revenue growth” and described the D900 product launch as “among our most successful new product launches ever” in their Q3 2020 earnings release. The strong momentum has continued into Q4 2020 and through Q1 2021 guidance. The primary research that I performed greatly helped clarify my view on Cognex’s future. I enjoyed the process and hope to continue to improve both my research abilities and my network. My goal is to obtain the same level of insights and conviction behind every company that I cover.

As a final thought, it is important to remember that luck always plays a role in determining how events play out. Luck can be good or bad. I humbly note that my thesis was aided by good luck because at the time, I had no insights into the increased consumer electronics end market demand until the company mentioned as much in July. I believe that this was a secondary factor in how events played out. It is a great reminder that luck can just as easily be negative and more than offset positive insights from excellent primary research. In the long run I have to believe that luck cancels itself out and that doing high quality primary research will improve investing results.

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Small- and Mid-Cap Investing in Emerging Markets; China vs. India

January 3, 2022 in Asia, Best Ideas Conference, Equities, Letters

This post is authored by MOI Global instructor James Fletcher, founder of Ethos Investment Management, based in Salt Lake City.

James is an instructor at Best Ideas 2022.

The following article has been excerpted from a recent Ethos letter.

We believe that investing in high-quality businesses with sustainable growth prospects, led by excellent management teams that are purchased at reasonable prices, will achieve excess returns over a complete market cycle. We take a long-term, business-owners, approach to investing and invest only in our highest conviction 30-50 ideas.

Investing in Emerging Markets

Why am I focusing on EM small and mid-cap stocks (SMID)? The short answer is that over my 17-year career in investing, I have found this opportunity set of EM SMID to be the most attractive and inefficient (i.e. opportunistic for alpha) in terms of finding excellent structural growth companies trading at attractive valuations.

Emerging markets is home to 85% of the world’s population, now accounts for over 59% of the world’s GDP, yet comprise only 12% of global market cap and less than 6% of global institutional investors’ allocations.[1] Over time, I expect these numbers to continue to converge in favor of EM. As structural growth trends continue of a rising EM middle class, growth in innovation sectors, and access to capital, EM seems poised to continue its growth trajectory. What is especially exciting to see is that while developed markets have seen the total number of companies listed on exchanges decline over the past decades as fewer companies go public and more delist, EM has seen the number of companies listed in Consumer, Technology, and Healthcare sectors more than triple over the past decade (from 455 in 2010 to 1,622 in 2020).

Over the past 20 years, starting Nov 2001 to Nov 2021, all Indices, both EM and DM have delivered nearly identical annualized USD returns. (EM has delivered 9.85% IRR since 2001, EM SMID has delivered 9.81%, compared to S&P500 at 9.31% IRR, in USD). This is despite the recent underperformance in EM.

In terms of valuations, EM is currently trading at historical record discounts now to their counterparts in US and Europe, trading at over 60% discount on a P/E basis.

I feel that we are getting a great entry point into emerging markets right now and expect we can buy some high-quality businesses with long-term structural growth at good valuations which equates to better than average expected future returns. Of course, there are risks. Rising inflation, heightened regulatory, and geopolitical risks in China and other countries, the ongoing COVID-19 pandemic, and global supply chain shortages are all key risks that we need to weigh in the balance when underwriting any investment into the portfolio.

China vs. India

The underlying dynamics are leading us to have higher exposure than the EM Index in China, Taiwan, and Brazil. And leading us to have lower than market exposure in Southeast Asia, slightly lower in India and lower in Eastern Europe. Below I have highlighted China and India.

China

China, is expected to be our second largest market in the portfolio, behind Taiwan. While 2021 has been a tumultuous year for many listed Chinese equities, with heightened regulatory risks in sectors such as education, e-Commerce, and health care being negatively impacted, the long-term trends in China remain promising. We find that many great, high-quality businesses with low regulatory risks and high pricing power are now trading at attractive valuations in China. I’ve personally been travelling to and investing in China for nearly two decades and having lived in Hong Kong for the past five years, I’ve seen both bull and bear cycles over the period, including the bear markets of 2008, 2015, and 2018 in China. Despite the cycles, China has remained undaunted in its structural growth, rising urbanization trends, investment in innovation and access to capital benefitting from a large consumer market, high domestic savings rates, and low external debt levels. Many are surprised to know that since the year 2000, China has created more unicorns than any other country in the world, including the US.[2]

It has been an imperative that companies are aligned with President Xi’s “common prosperity” goals. As part of our ESG and Quality Scorecards, we do deep dives into the regulatory risks, pricing power, and societal risks of all the businesses that we analyze. This has helped us avoid many of the problematic sectors that were exposed in 2021 such as property and education, where we had no exposure. In the end, China and President Xi have been clear in their statements and 5-Year plans that that will continue to encourage economic growth, but they want businesses and regulators to promote:

  • Fairer competition
  • Reducing income inequality
  • Social well-being
  • Data Protection

In my opinion, these are not absurd goals. In fact, Charlie Munger was recently questioned at the Sohn Australia Conference about China’s crackdown on speculation and corruption, and he said “China is right to step out, step hard on booms and to not let them go too far. The extent that my country doesn’t do that, we’re inferior to China. They’re acting in a more adult fashion”.[2]

Whether “adult” or not, what we can’t dispute is China has undergone incredible economic growth over the past two decades, and we still see a market full of innovation, access to capital, and long-term strategic thinking. There are high-quality businesses in China that succeed in meeting all of Xi’s priorities and that we believe benefit from long-term structural growth trends in the market. And currently, many of them are trading at quite attractive valuations, due to the recent selloff.

India

India has had an exceptionally strong run in 2021, as YTD through 30 November, the India SMID Cap Index is up +41.7% in USD. We believe India has a lot of attractive long-term characteristics: a large and entrepreneurial population, a rising middle class, ongoing structural reforms led by Prime Minister Modi, and global leadership in sectors such as pharma, technology, and healthcare.

We find numerous businesses in India that we think are exceptionally high quality led by great managements with long-term growth potential. We expect our exposure to be slightly underweight India relative to the Index due to heightened valuation levels (India is 15% of the Index). The graph below shows that MSCI India now trades at a 10 year high relative to MSCI China and MSCI EM on a P/Book basis.

[1] Data is obtained from FactSet, MSCI and eVestment, as of December 2020.
[2] https://fortune.com/2019/10/22/china-us-unicorns-beijing-silicon-valley/

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A Long-Term Investor’s Perspective on the Opportunity in Cannabis

January 3, 2022 in Best Ideas Conference, Equities, Industry Primers, Letters

This post is authored by MOI Global instructor Aaron Edelheit, chief executive officer of Mindset Capital, based in Santa Barbara, California.

Aaron is an instructor at Best Ideas 2022.

The following article has been excerpted from The Cannabis Manifesto.

Imagine an opportunity to invest in a mythical $100 billion market on its way to $200 billion in which capital is scarce, institutional participation is tiny and where many publicly traded companies involved are not listed in any major index or traded on any major US exchange.

Now imagine that these publicly traded companies have defensible moats, strong management teams and possess ten years of growth and re-investment opportunities ahead.

Then imagine that this magical sector has crazy inefficiencies where similar companies trade at wildly different multiples for no apparent reason and where you can buy industry leading companies growing at over 50% while trading for single digit cash flow multiples with little if any leverage.

This is the reality of the US cannabis industry. Thanks to the conflict between state legality and Federal illegality, a US company that “touches the cannabis plant” cannot trade on any major US exchange and instead trades on secondary and tertiary Canadian exchanges. Add in concerns regarding custody issues with major brokerages and prime brokers, and you are left with little institutional involvement (estimated at a measly 4%), no index involvement and thus a wonderful opportunity.

And it is for this reason, I’m launching the Mindset Value Cannabis Fund, which will be solely dedicated to investing in publicly traded cannabis companies that are focused on the US cannabis market.

The Health and Wellness Benefit to Society is Massive

Cannabis is not just a great investment but is fundamentally a big positive for society. Specifically, we are attracted to the enormous health and wellness benefits of cannabis. Consumers of cannabis have been shown to binge drink less, use less opioids and use less powerful prescription drugs. The medical benefits are numerous including the ability to quit opioid addiction, tolerating powerful cancer medications, migraine pain relief, pain relief in general without the risk of addiction, and helping with insomnia and post-traumatic stress disorder.

Studies show that cannabis users are surprisingly active and recover from injury more quickly. Athletes have long used cannabis and are now becoming more vocal about the surprising anti-inflammatory properties of cannabis and the ability to heal quicker and bounce back faster. It’s interesting to read how ultramarathoners are running faster and longer with cannabis and how cannabis edibles are taking over the running world.

All of this is well documented and might be a shock to most people who grew up in the reefer madness era in which people believed that cannabis led to decadence or worse sitting on your couch and wasting your life away. Cannabis has been falsely demonized mainly for racial reasons, first as a tool to fight Mexican immigration into the U.S. and later to discriminate against African Americans.

But all of that is coming to an end as state after state legalizes either medical marijuana or full adult use and as the benefits to consumers, society and the economy become too powerful to ignore. Cannabis already exists as an illegal market, so why not just tax and regulate it in a safe and efficient manner? This is leading to soaring tax revenue and job creation in every state that legalizes cannabis. An estimated 321,000 Americans now work in the cannabis industry, with growth of 80,000 new jobs in 2020 alone. Many cities and states are seeing cannabis tax revenues make up budget shortfalls. Cannabis taxes are easy targets and take much less effort to enact than other forms of taxation that are deeply unpopular with voters.

Maybe the craziest data point in favor of cannabis legalization is that worker compensation claims go down in states after they legalize cannabis. Why would that be? When cannabis is illegal, people turn to other more powerful, more dangerous drugs such as opioids to self-medicate their ailments and these drugs have significantly harsher consequences to job performance. And finally worries about soaring teenage use are now confirmed to just be worries as teenage use has proven to fall in states that have legalized cannabis.

So, if the benefits are real both to health and to the economy, why not legalize it? In this regard, states are moving faster than the Federal government, but even faster is how cannabis is being normalized. Almost 70% of all Americans believe cannabis should be legalized.

Personally, I’ve benefitted as well. I have suffered from insomnia at different points in my life. It is awful and I wouldn’t wish it on my worst enemy. Now with a cannabis tea or a low dose gummy, I can reset my sleep system and sleep soundly. And that pales in comparison to the relief that some of my relatives who use cannabis creams and other products to help with knee, back and migraine pain feel. We are eternally grateful that cannabis helps so effectively with so few side effects.

Cannabis is Reminiscent of the Beginnings of the Single-Family Rental Industry

The investment opportunity in cannabis is reminiscent of the opportunity in single-family rentals. In 2009, I launched a small fund to buy single-family foreclosed homes, fix them up and rent them out. I started with 16 and ended up buying 2,500 homes. We sold the company in 2015 to a publicly traded real estate investment trust, in what was then the largest single transaction of homes ever in the US.

My investment thesis on buying foreclosed homes was that the US could not continue to produce only 400,000 homes a year, and instead needed to be constructing more than 1 million homes a year. If the country continued to produce such few homes, it would eventually find itself with a massive shortage of homes. The only question was when this would occur. I also quickly realized that this was not a trade but an industry. Yes, scattered site was more expensive to manage, but the turnover was less than multi-family, so the result was similar overall margins to apartment buildings.

It’s fun to watch the whole investment world now recognize and invest in single-family as an asset class when ten years earlier people looked at me as if I had a third eyeball or told me it would never work as an ongoing business.

And the same thing is happening in cannabis. For many reasons, professional investors are ignoring the cannabis space, just like they ignored single-family homes. I hear either indifference or comments that cannabis is an agricultural commodity or even more bizarre is when investors lump it into the same bucket as crypto currencies (maybe this is because there is uncertainty around the regulations of both?).

Regardless, if an investor has patience, you can see what is coming, which is some form of legalization. When that happens, companies will trade at wildly different multiples than where they currently trade, on what will be a much larger industry than it is now.

Consider Verano Holdings (Canada: VRNO, OTC: VRNOF). This company should earn approximately $1.3 billion in revenue and close to $600 million in EBITDA in 2022. At slightly less than $4 billion in market cap, Verano trades at 3x revenue and less than 7x EBITDA unlevered. That is with a company with a 3-year CAGR (compounded annual growth rate) of over 50% with over 40% EBITDA margins and in a net cash position. It’s possible that if the growth Verano is experiencing continues that the company could be trading at 4x 2024/2025 EBITDA.

When Verano is allowed to list on US exchanges, it could easily go up more than five times in value. There are other companies that are similarly well run and undervalued that could go up even more, such as AYR Wellness (Canada: AYR.a, OTC: AYRWF).

Prominent consumer goods companies and alcohol companies are lucky to be seeing 3-4% growth and trade north of 20x EBITDA.

An even better example is sports betting. Once illegal, publicly traded sports gambling companies trade at absurd multiples. Draftkings (NASDAQ: DKNG) for example sports a market cap of over $20 billion and trades at more than 40x 2024 EBITDA. When investors get access and are excited about a sector, valuations can go sky high.

The Longer Legalization Takes the Better for the Top Cannabis Companies

To the patient investor, the longer legalization takes, the better it is for the leading US public cannabis companies. Why? Because they have access to capital that their smaller competitors do not. This means they can grow, solidify their footprint, invest in their infrastructure, acquire smaller competitors, and gain size and scale advantages.

I estimate that there are only a dozen or so publicly traded companies that have access to capital. The longer legalization takes, the more time these companies have to establish themselves, to create footprints and moats and the more valuable they become. Anyone trying to follow them will either be shut out, will have to partner with them or buy them.

Consider all the barbarians at the gate, like Big Tobacco, leading alcohol companies or consumer packaged goods companies are holding off on entering the industry due to fears of reprisal from the Federal government. British Tobacco has a strategic plan called “Beyond Nicotine” and tens of billion in free cash flow in the next five years to invest. Pray tell, what in the world is after nicotine other than cannabis?

When I was buying foreclosed homes on the Gwinnett County, Georgia courthouse steps in 2011, it was a dream. I would compete against mom-and-pop investors, and we would buy homes left and right at prices that seem silly now, like $45,000 for a safe suburban 3-bedroom home. That all changed seemingly overnight when Colony Capital and Blackstone entered in May and June of 2012. Prices increased over 50% overnight. The minute the institutional investors believe it is safe to enter the industry, valuations and prices will change overnight.

Risks

There are many risks associated with investing in cannabis. The greatest is obviously that it is currently illegal federally to sell cannabis or to touch the plant in anyway. So, even though the IRS collects federal taxes (excessive taxes due to rules like 280e) from cannabis companies, the federal government still considers it illegal. This is the reason most institutions won’t touch US cannabis companies.

Beyond that risk, the other risk is one of timing. It may take much, much longer than expected for the industry to become legalized. It could also be legalized in a way that is very detrimental to the industry or the stocks the fund owns.

Summary

When I first identified the opportunity to buy, fix and rent homes, I saw a long-term opportunity to invest in the absolute bottom of housing. My mistake in hindsight was that it would have been much more lucrative and easier to simply research and buy the best housing related stocks like Home Depot (NYSE: HD), Lennar (NYSE: LEN) and others.

The opportunity to invest in the cannabis industry is just beginning. This is a generational investment opportunity in an industry with phenomenal growth and limited access to capital. We aim to invest before full legalization occurs and believe that patient capital will be well rewarded in the years to come.

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Bill Cummings: Lessons and Legacy — A Worthy Path in Business and Life

January 2, 2022 in Explore Great Books Podcast, Full Video, Interviews, Member Podcasts, North America, Real Estate, Real estate (privately held), Transcripts

We had the great pleasure of speaking with Bill Cummings, founder of Cummings Properties, a developer, owner, and operator of commercial real estate. Since its founding in 1970, Cummings Properties has grown to 11 million square feet of commercial real estate in 11 cities and towns north of Boston.

Bill’s charitable foundation has roughly $2 billion in assets. Bill and his wife Joyce are signatories of The Giving Pledge. Read their pledge letter.

Bill is also the author of the book, Starting Small and Making It Big: An Entrepreneur’s Journey to Billion-Dollar Philanthropist, published in 2018.

The interview was conducted by Alex Gilchrist, research director at MOI Global.

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Bill Cummings founded Cummings Properties in 1970, serving as president and, later, chairman. Although he is in the office most days, he currently spends more of his time on the work of Cummings Foundation.

Bill grew up in Medford and, in 1958, graduated from Tufts University. After holding sales positions with Vick’s VapoRub of Greensboro, North Carolina and Gorton’s Seafoods of Gloucester, he acquired, built up, and eventually sold Old Medford Foods, a well-established firm manufacturing fruit juice beverage bases. He got his start in commercial real estate with just one small building, which he built next door to Old Medford Foods, and then led Cummings Properties’ expansion into a 11 million-square-foot portfolio, now managed by more than 350 team members.

In 1986, Bill and his wife, Joyce, established Cummings Foundation, which has grown to be one of the three largest private foundations in New England. They were the first Massachusetts couple to join the Giving Pledge, an international philanthropic organization founded by Bill and Melinda Gates and Warren Buffett, and they have been honored to receive dozens of community accolades and honorary degrees.

Among Bill’s many honors are Real Estate Entrepreneur of the Year for New England from Ernst & Young, Edward H. Linde Public Service Award from the National Association of Industrial and Office Properties (NAIOP), and Real Estate Visionary of the Year from Boston Business Journal. He and Joyce were also inducted into the Greater Boston Chamber of Commerce’s Academy of Distinguished Bostonians.

In 2020, Bill released the latest edition of his self-written memoir, Starting Small and Making It Big: An Entrepreneur’s Journey to Billion-Dollar Philanthropist, which includes thoughtful reflections on the lessons he has learned about business, entrepreneurship, and philanthropy.

MOI Global