I’ve been thinking about this topic for three reasons:
1. Someone emailed me asking how to create a good investment write-up for their own use.
2. Nate posted a “good idea, boring write-up” type stock at Oddball Stocks.
3. Value and Opportunity has a very interesting write-up – which ends with the decision not to buy the stock.
Yesterday, I mentioned two stocks that would make wonderful write-up subjects – Carnival (CCL) and DreamWorks Animation (DWA). I also said both were pretty hard to actually come to a decision on. It wouldn’t be easy to decide whether or not to buy them. In the case of DreamWorks, I thought intrinsic value would prove squishy and the deciding factor would be certain speculative issues – like the value of their eventual TV(Netflix) series business and their operations in China. With Carnival, I said that the price of oil was a major factor in the success of that investment long-term. I consider that a speculative concern. If you knew what the price of oil would be with any great certainty – there are a lot of ways other than investing in Carnival where you could make money.
But it would be easy to write pages and pages and pages of analysis about both companies. The industries are very public. You can easily gather data on every ship Carnival owns, every movie DreamWorks has ever made, etc. There are easy comparisons with other public companies. Books have been written about the companies. The economics, accounting, etc. of the businesses are interesting subjects to dig into. They are fascinating companies. They’d make for great write-ups. But would they be my first choice as an investment?
No. We can see this in the two stocks – both of which are much less interesting to read about – that I do own. They are George Risk (RSKIA) and Ark Restaurants (ARKR). The rest of my money is in cash. Right now, cash is about half of my account. That’s unusual. But it’s happened before.
An investment analysis of George Risk – at the time I bought it – wouldn’t be very interesting. In fact, you can read the 2009 write-up at Rational Walk for yourself. That’s a pretty good snapshot of the investment case for the company – although the author concludes (in that blog post) that it’s not a good investment because it lacks a catalyst. By the way, the last part has proven true. In the following 4 years, there was no catalyst to unlock value. The stock rose 75% and paid out a lot – like another 20% of the purchase price – in dividends since then.
This is a pretty good lesson on catalysts as well. They are obviously important since they can greatly increase your annualized results by speeding up your holding time and getting you the same end result. But are they a good subject for a write-up? Should you spend a lot of time on catalysts?
In my experience, the answer is almost always no.
I bought Barnes & Noble (BKS) in 2010. I went to great lengths to look at the proxy fight, Burkle, etc. Riggio won the proxy fight. Barnes & Noble invested much, much more heavily into the Nook than I expected. After those two events, I judged that the risk to the stock had increased a lot. I sold. A few years later – in 2013 – Barnes & Noble decided to scrap direct investment in the Nook. And Riggio has said he wants to buy the company.
You see the problem. In 2010, you could have been asking yourself who will win the proxy fight? Will Burkle try to buy the company? Will Riggio? And so on. You might be right or wrong. Personally, I think no one could have predicted exactly how that proxy fight would end. It was one of the closest – especially when you consider how some institutions decided to vote their shares – I’ve ever seen. You probably could have predicted parts of it. There was a poison pill and a court case on that issue. Those are things you can research and see what is likely. But that was a proxy fight that was almost as hard to call as a political contest. And – if you remember – it could have ended at the last moment with a negotiated settlement between the parties, granting some board seats, etc.
I just think a catalyst like a proxy fight – while fascinating to read about – is awfully hard to factor into your analysis. Its existence is relevant. It’s worth mentioning that anything could happen as a result. And – if you’re dealing with a truly cheap company – action that stirs things up in any way can be a positive. But most of the words that’ll be spent on the topic will be more interesting than informative to an actual investor. The important parts are whether or not the stock is cheap, whether it is a strategic asset in the industry, whether one or more parties are interested in buying it, and whether a contest is underway.
Sticking with the Barnes & Noble case, you’ll then remember that – subsequent to my investment – there were 3 other investors interested in owning part of the company: John Malone, Microsoft (MSFT), and Pearson.
Could this have been foreseen?
I don’t think so. Not in exact terms. Again, the idea of Barnes & Noble as having some strategic value – beyond pure financial interest for some companies – was clear. I mentioned that idea when I wrote about the company. I felt that Amazon (AMZN) and Barnes & Noble were the avenues other folks would need to get their books sold either in print or digital. Especially as Borders was a much weaker competitor. And then Borders failed completely. If anything, consolidation increased as shelf space for books decreased at general retailers, etc. So the strategic value was something worth thinking about. But could you have guessed which partners might be involved, on what terms, etc?
I think those questions would be way too hard to answer.
Barnes & Noble had a lot of catalysts and a lot of complexity. But maybe that’s specific to one company. Let’s revisit a few of my other investments and see.
I owned a stock called IMS Health. I bought it on a pretty simple basis. I figured it was a wide moat – really a monopoly in parts – business that was buying back its own shares using its high free cash flow yield. That’s all. It had a double-digit free cash flow yield. And it was buying back almost as much stock as its free cash flow would allow. This was in early 2009 – when many companies were putting buybacks on hold. The stock was – for such a wide moat business – very cheap. It probably sold for about half of what a company of that quality sells for in normal times.
IMS Health never got to buy back most of those shares. Instead, they went private in an LBO. What had been planned as a long-term investment – certainly something more like 3-5 years, as Obamacare was in the news at this time and there was some other legal issues specific to privacy concerns in some states – turned out to be more like 3 to 5 months. One sad part of this story is the tax treatment. It was impossible for me – even holding till the deal closed – to make it past a one year holding period.
Normally, if I hold a stock for less than one year it means I failed. I sold Barnes & Noble within one year, because I was wrong. I was wrong about the risks and especially about their willingness to lose large amounts of money – to burn cash – investing in Nook. So, I sold the stock. I’ve held plenty of stocks for less than one year. They’ve rarely been winners.
I can give you one example of a case where the stock was a winner, I held it for less than one year, it had a catalyst, and that catalyst could be analyzed.
That stock was Bancinsurance. To give you some idea of how I’d analyze it, you can see my letter to the Board of Directors. I never talk to management of a company. Never, never, never. It’s just something I feel isn’t necessary. And it’s obviously something you can do at microcaps. Many microcap investors – Nate at Oddball Stocks, Richard Beddard at Share Sleuth, etc. like to do it. And they may be right to do it. But I don’t do it.
If I don’t talk to management, you can bet I don’t write letters to boards. I did in that one special case. I’m sure it had zero influence on the outcome. Regardless, it was a good outcome relative to the original offer.
In that case, there was a clear catalyst. The CEO had made an offer to buy the company. I didn’t feel it was a realistic offer in the sense that anyone could possibly appraise the company’s value in a negotiated sale – to someone other than the CEO – at such a low level. That didn’t mean the sale wouldn’t go through. There was a risk it would go through at that price (but you wouldn’t lose money if it did – just time), there was a risk it wouldn’t go through (in which case, the stock price would fall, but you’d be holding a stock trading well below intrinsic value), and then there was a possible reward that you’d get in the form of an increased bid and a deal closing quickly (like within a year and resulting in a high annualized return).
That is one case where I see how a write-up breaking down the situation in such probabilistic terms – or at least laying out the possibilities – would make sense. As it turned out, such an analysis would match actual events. You can see this by considering what kind of write-up you’d create when the CEO first made the offer and then compare this to the board’s discussion – in the merger document found at EDGAR – of the actual process, questions considered, offers made, etc.
Bancinsurance was a special situation and could be analyzed as one. You could foresee the short-term future in the sense that you could list some possibilities.
I never expected the actual outcome. It was much fairer to minority shareholders than I anticipated. In my own mind – I put the odds of a deal at a token increase over the initial offer as being the most likely outcome. So, I’m not sure I could have done a really accurate write-up. But I could have laid out the possibilities that actually did come into play.
Next, let’s consider my basket of Japanese net-nets. There was no way I could do a write-up of any of the companies involved in that one. It was a purely statistical exercise. It was a total Ben Graham basket. It made sense to me. And it made sense to me to represent those investments – to myself – as a simple pair of two rules:
1. Negative enterprise value (Cash > Market Cap)
2. 10 straight years of profits (No operating losses in the last decade)
And then a summary of each stock’s balance sheet and 10-year history. I knew what industries they were in, what their dividend yields were, etc. But no decisions were made on that basis. And attempting a write-up in words would have been intellectually dishonest. Those investments were made using two rules, a couple rows of data, and a group approach. They are best explained written in pen on a napkin not typed out over a few thousand words with charts and graphs.
I think that’s usually true. Warren Buffett says you should be able – before buying a stock – to write out your reasons for buying it on one sheet of paper.
It’s probably one sheet of paper or less. It rarely makes for riveting reading. But if you are simple in your math, clear in your logic, and honest about your emotions – nobody needs more than a page to explain a great investment.
Talk to Geoff about Great Investments Making Boring Write-Ups