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Ugo Ume
Ugo Ume
Articles (24)  | Author's Website |

2016 MaziValue Portfolio Performance and Brexit-Onomics

The portfolio returned 25% for the calendar year

The portfolio returned 3.34% and 24.76% in the fourth quarter and calendar year 2016 and underperformed the comparable indices. The screenshot below comes from Interactive Broker's portfolio analyst and represents the portfolio's performance since its inception on Dec. 10, 2015. Both the Russel and the Dow had tremendous runs in the fourth quarter following the election of President Donald Trump.

2016 Performance

Individual Security Performance

Individual PerformanceNote: Dec. 31 price represents either the price as of Dec. 31 or the price for which the security was sold some time during the fourth quarter but not necessarily as of Dec. 31.

The best performer was Avnet (NASDAQ:AVT), which returned 22% during my holding period in the fourth quarter. I sold Avnet after an early morning pop. I still like what it's about and will be happy to jump back in if it treads the low 40s. The TS segment sale should unlock a lot of cash that will hopefully be returned to shareholders. I sold off Gamehost (GHIFF), Flanigan's Enterprises (BDL) and Advent Wireless (AVDWF) as well in the fourth quarter. The portfolio currently comprises of Syntel (NASDAQ:SYNT) and MIND C.T.I. (NASDAQ:MNDO) at 16.6% and 16%.

Volatility and risk

Risk

I generally abstain from discussing volatility, but I figured I'd post about it for once, and once only since I'm closing out my first year. As I have stated in the past, I do not believe volatility and risk are in any way correlated. The portfolio performed OK during the volatile periods, especially during the beginning of 2016, as you can see in the "Since Inception" chart. This happened not because I have some proprietary risk management strategy, not because I have some quantum multivariable stochastic beta-neutral anti-volatility quant model, not because I am any better at managing risk than anyone else. It happened primarily because the portfolio has held 50% cash since inception.

My risk management arsenal is and will always be to pay less for a security – the less I pay, the less risk I am exposed to. I don't know how to control volatility, and I make no attempt to do so. I guess the advantage of being an individual investor over an institutional is that you get to do whatever you want with your portfolio without having to worry about investors breathing down your neck. My portfolio is also more concentrated than the average investor's, and so volatility should be expected. Clearly, a less volatile portfolio is advantageous, but the only way I have found to consistently control it is to buy put options on one's long positions. This would be counterproductive but would work exceptionally well if one is a clairvoyant market timer, which I am not.

2017 Mazi Value goals

Reading

I fell short of my reading goals in 2016 because I didn't have much time. Every time I feel like I have learned everything I need to about value investing I get humbled by a new book or a speech on YouTube by one of the greats there is always something new to learn. From my experience thus far, knowledge, like stocks, compounds over the long run. Education is paramount. In an age where world-class professors post their finance MBA courses online at no cost, where PDFs are easily accessible, where new, reviewed books are easy to find, there is no excuse. Burry and Buffett did not get to read reviews of a book on Amazon (NASDAQ:AMZN) before purchasing in the early '40s to '90s nor did they have access to online classes at no cost; they had no way to filter and simply read as much as they could, which makes their accomplishments even more impressive. The goal is to knock out at least one book every month. February's book is "Billion Dollar Lessons" by Paul Carroll.

The antithesis of value

One other thing I want to accomplish is to start analyzing companies' traditional value investors tend to ignore. Companies such as Amazon, Facebook (NASDAQ:FB), etc., you know, the traditional companies that are generally written off as expensive or "bubblicious" because of their expensive multiples. I want to get out of my comfort zone and actually learn about these companies though I probably won't buy them.

Syntel

I am not a fan of making quarter-to-quarter or year-to-year EPS predictions because mine are rarely ever accurate. But because the sell-side 2017 guidance looks a bit suspect to me, it would be appropriate to make my own forecast in this case since I recently recommended the stock (you should take everything I say with a grain of salt, of course.) Analysts are expecting, on average, $2.32 per share or approximately $189 million. That's a bit too optimistic. I would agree with the expectations on a normalized basis, but it would require that revenues stabilize next quarter given the degree of operating leverage the company carries. The concentrated nature of its clients makes it difficult to figure out exactly when this will happen it could be next quarter or could be later on in the year.

Also, given how commoditized the industry is, it is reasonable to expect that revenue growth will trace that of its competitors over the long run, which in this case is still thankfully >0%. I think there is short-term price risk so I have trimmed my position to 16.6% which is still quite sizable by industry standards. The goal is to average down at a lower price if the company misses the 2017 sell-side guidance and my expectations remain intact.

A bill was recently introduced in the House of Representatives with the intention of increasing the H1B visa minimum salary to $130,000, or to the 85th percentile of the median annual wage for Computer and Mathematical Occupations per the Department of Labor in order to encourage hiring Americans over other nationalities. The bill also diverts 20% of all new H1B visas issued to small businesses with 50 or fewer employees; 14% of Syntel's billable consultants worldwide use visa work permits. Even if we assumed that 100% of permits were H1Bs in the U.S., it's still not that big of a deal. Syntel will likely take a small hit on its margins but nothing particularly substantial, say maybe 100 to 200 bps, tops.

Value digging

Australian local media

Local news companies in Australia look fairly attractive. I've been watching some of them for a few months but I have been reluctant to buy because I cannot figure out an appropriate topline decay rate. Lack of access to the appropriate data, and my urge to buy in the worst-case scenario kept me from pulling the trigger. For Prime Media Group (ASX:PRT), which currently exhibits a double-digit dividend yield, my entry target was 18 cents, a price that assumes that earnings would decline at a CAGR of 17%, perpetually. The stock traded as low as 3.5x last year's earnings and bottomed intraday at 24 cents; it now sits around 30 cents. If it treads down to the 19-cent to 20-cent level, then I think it's worth a look.

Advertisers are flocking head over heels to capture the millennial media crowd that is clearly moving online. Given that Australia is the world's largest exporter of iron ore, the Chinese construction slowdown and iron ore crash translated to lower advertising expenditures around the area. Though the commodity performed sensationally in 2016, it still trades ~56% below its 2010-2011 peak. While I agree that the local traditional media business will decline terminally from here on out, the market's assumption looks a bit too pessimistic. The management team seems adept at capital allocation and realizes that the industry will not grow and so they are paying out earnings rather than scouting out high-flying tech media stocks to drive "growth." Again, any asset moat or no moat is investable at the right price.

Contemporary Australian media laws and industry consolidation

A bill was recently introduced and is currently in the pipeline for the 45th Australian Parliament. It has been passed by the House and is now in the Senate. The purpose of the law is to alleviate the media control and ownership restrictions that were put in place in 1992 under the Broadcasting Services Act to prevent monopoly control of the media. The restrictions to be alleviated are as follows:

  • 75% audience reach prohibits commercial television broadcasting licensees from controlling licenses whose combined license area populations exceed 75% of the population of Australia. This resulted in regional and metropolitan networks.
  • The two out of three rule prohibits control over more than two out of three regulated media platforms in any one commercial radio license area. A company can own a newspaper and a radio license but is prohibited from TV broadcasting in the same license area.

Online news organizations do not face the same restrictions and so these laws disproportionately affect local, traditional news organizations. Companies do not set up shop in a terminal industry and so the passage of this law will lead to industry consolidation because replacement costs likely exceed the current valuations. If valuations of these companies remain depressed and the law is passed, they will become LBO/industry consolidation targets and Prime Media Group will likely get scooped up by one of its competitors.

The U.K. and Brexit

Recruiting companies as a whole in Britain look attractive; my favorite one so far is Gattaca PLC (LSE:GATC). The company recently made an acquisition, and the noncash amortization should provide an extra $2 million free cash flow that won't show up on the income statement: FCF > net income. That is significant for a company with a market cap <100 million pounds ($124.4 million). I was hoping to buy, as I had mentioned in the third-quarter performance report in March in accordance with the formal article 50 trigger but the stock has rallied a bit this year. The 2.30 pounds level was my entry target ,but it bottomed around the mid-2.5 pounds and rallied. If it pulls back to the 2.3 pounds level, I think it's worth a look.

U.K. economic history

Ben Graham was once asked if Wall Street professionals are more accurate in shorter or longer term forecasts and his response was:

"Our studies indicate if you have your choice between tossing a coin and taking the consensus of expert opinion, the result is just about the same in each case."

I recently came across one of the most amusing anecdotes about economics and forecasting called "Fiedler's Forecasting Rules" (which I posted here) in Paul Dickson's "The Official Rules." It's quite interesting and I'd recommend it to anyone. Given that the Pound Sterling was one of the hottest FX trades last year, I figured I'd close the year off with some commentary on Britain.

The 1981 budget debacle

The U.K. entered a recession shortly after Margaret Thatcher was elected in 1979. Per the 1979 Conservative General Election Manifesto, Thatcher's economic priority was twofold: tame the double-digit inflation and grow the economy. In 1981, Thatcher proposed a budget that came to be one of the most controversial in U.K. history; she chose to raise taxes to the tune of 4 billion pounds, or approximately 2% of the GDP at the time. This was a period when Britain was in a recession, and fiscal tightening in a recessionary environment defied the logic of the economic theorists; 364 prominent economists from the academic community penned a letter to her:

"We, who are all present or retired members of the economics staffs of British universities, are convinced that:

(A) present politics will deepen the depression, erode the industrial base of our economy and threaten its social and political stability;

(B) there is no basis in economic theory or supporting evidence for the government's belief that by deflating demand they will bring inflation permanently under control and thereby induce an automatic recovery in output and employment;

(C) there are alternative policies; and

(D) the time has come to reject monetarist policies and consider urgently which alternative offers the best hope of sustained recovery."

Signed by 364 university economists

Source: Institute of Economic Affairs

The letter prompted the "Were all 364 Economists Wrong" volume from the Institute of Economic Affairs. The U.K. economy got out of the recession a few months after that letter was published and grew at a pace of 2.7% in the ensuing decade – a far cry from the consensus economists' predicted depression. Inflation peaked in 1980 at 18% and fell to 5% at the end of 1982.

Black Wednesday and the Exchange Rate Mechanism

The European Exchange Rate Mechanism (ERM) was established 1979 to facilitate exchange rate stability among its members in order to improve trade relations between them. It was a precursor to the euro. Per the Federal Reserve Bank of St. Louis, Britain declined to partake in the ERM in 1979 because she believed that the risk of an inflexible currency outweighed the benefits. This was a period when Britain was in a recession and needed more control over the value of the pound to remain competitive, as I discussed above. Britain eventually joined the ERM in 1990 and subsequently pegged the pound to the Deutsche Mark at 2.95 DM to 1 pound sterling. The idea was that the British government would intervene if the exchange rate fell below 2.773.

In 1992, Britain found itself in a recession while stuck in the ERM and pegged to a strong Deutsche Mark. The Brits needed a weaker currency while Germany was doing fine. Currency speculator George Soros (Trades, Portfolio) among others recognized the vulnerability in the pound sterling and realized that Britain would be forced to exit the ERM and thus, he sold the pound sterling short. Other speculators eventually realized this and began selling the pound as well.

The Bank of England went on a buying spree with foreign reserves attempting to hold up the value of the pound to keep the U.K. in the ERM but eventually succumbed to the speculators. Britain was forced to exit the ERM. Economists at the time, though, were worried about the risks of leaving the ERM and all the benefits that Britain would leave behind. They assumed that the exit would push the U.K. into a deeper recession. This is even more evident by the actions of the Bank of England which attempted to fight off currency speculators to avoid the devaluation required for the exit.

The exit from the ERM and the subsequent pound sterling devaluation was credited with Britain's economic revival. The U.K's economy grew at an annualized rate of about 3% from the ERM exit until the recent great recession. Why would the Bank of England fight to keep the currency strong in the ERM if it knew that the devaluation and an ERM exit would swiftly pull it out of the recession and generate an envious real GDP growth rate of 3%? It didn't.

Brexit

Once again, the same consensus economists and bureaucratic institutions are predicting recessions/depressions as a result of Brexit. I have a hard time rationalizing why corporations would choose to redomicile their operations into an anti-business environment with higher taxes, more regulations, and a stronger currency over Britain where they would get the opposite. Philip Hammond, chancellor of the Exchequer the equivalent of the U.S. Treasury Secretary recently stated that if Britain was not able to strike a deal with the EU, it would turn into a corporate tax haven which the EU vehemently opposes re: Apple/Ireland tax issue.

Ironically, the eurozone faces the same issue Britain faced in 1992 – Germany is propping up and benefiting from the currency while the other countries that require weaker currencies are struggling with deflation and prolonged recessions. Although these countries are well aware (I hope they are) that they need devaluations to revive their economies, they are being fearmongered by virtually every bureaucratic institution into believing that a depression awaits them if they exit the eurozone. And because the devil you do know supersedes the devil you don't, these countries choose to remain in the eurozone.

I should stress that I am not implying that the economists will be wrong once again and I certainly do not have the answer. The point is that there is no historical precedent that indicates economists or the bureaucratic institutions are any better at predicting economic trends than a coin flip. One only has to look at the IMF's and the ECB's eurozone growth forecasts since 2008. While they all attempt to make economic predictions, it is important to note that there is always a positive bias embedded within actions accepted by the status quo and a negative bias when actions deviate from the expectations of the status quo. I say this with great respect for the field of economics and its participants.

If Thatcher had succumbed to the pressure from the consensus economists, what might have happened to the British economy in 1981? If the British government had its way with the ERM, how would the British economy have fared? Would Britain have joined the now awful eurozone? I guess we'll never know. What I do know is that I am bullish on the U.K. economy - the actions the British government has taken and continues to take should offset the negatives arising from Brexit.

In theory, theory and practice are the same. In practice, they are not. – Unknown

Disclaimer: Nothing mentioned in this article is investment advice or a recommendation to sell, buy, or hold any securities. Contact your investment adviser before making any investment decisions.

Disclosure: I am long MIND C.T.I. and Syntel.

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About the author:

Ugo Ume
I run an investing blog at mazivalue.com. Follow me on twitter @maziume

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