What do I do with companies like LYL, where I expect them to have a bad year in 2014. I bought them because they were cheap enough, I did not try to time the low point. If they go on to have a bad 2014, just as I expect, and the share price drops even further, do I sell? My underlying assumptions have not changed, everything is going as I expect, what to do?
I am curious of what your previous FA experience tells you. How often did you get out and the price has gone back up? Was it a worthwhile percentage play in your case?
I think a lot of the auto sell comes from background of timing the market. Sell, wait till it goes up, buy again. I have nothing against that approach, but I have long ways to go before I am competent in anything like that. So what are the benefits of it for me, who makes no attempt to time the market?
Thanks Sir O.
I agree it is only with hindsight that we will know which ones continue falling and which ones will bounce back.
But what are the odds? I will ramble on...
Out of 10, or 100, good, financially sound companies - how many continue going down and how many recover? My analysis/experience/reading tells me that selling after a big drop in these kind of companies is not the best strategy.
Furthermore, "good" companies experiencing large drops are very often (but far from always) the very best investment opportunities. Again, I feel experienced human judgement is required rather than an automatic decision.
Another argument is about risk - is the company that dropped in price more volatile and therefore more risky, or is it less risky because it is cheaper?
I agree that selling on substantial decline will further mitigate risk - but I think it will end up being the wrong decision more often than not. For the type of companies I invest in, anyway.
My bolds.But generally, I will only buy companies that have at least some of these:
1. I feel have every chance of being around and doing very well 20 years from now.
2. Company founder or long serving management on board, and owning a large stake in the company.
3. Consistently profitable over many years.
4. Acceptable or higher ROC.
Things I generally won't invest in:
1. Things I don't understand, whether it is the business, the industry, or the annual reports.
2. Companies that are generally not profitable.
3. High debt.
Let's go back to CAB. I bought it 2009 for my super at $6.20. It has recently fallen down to under $4, for reasons we all know. Now, I agree with "the market" that the company is worth less now than a year ago. It has deteriorated. Should I sell? But despite deterioration in value, I still think there's plenty there now that the price has fallen.
If I sold at $4 or under because it's gone down, when do I allow myself to buy back in? Do I time the market?
I am curious of what your previous FA experience tells you. How often did you get out and the price has gone back up? Was it a worthwhile percentage play in your case?
I think a lot of the auto sell comes from background of timing the market. Sell, wait till it goes up, buy again. I have nothing against that approach, but I have long ways to go before I am competent in anything like that. So what are the benefits of it for me, who makes no attempt to time the market?
I hope the above gave you a bit of window into process. Knowing the process now, you could imagine that I looked at BNB like this....I will have to disagree with you on one bit - simple to understand. I looked back on my notes for it and I have just one sentence against it - "I don't understand this business well enough". But that's for me, it's not the kind of company I usually invest in, so other may find it easy to understand.
But that places me in a good position for your experiment because I've done no research on them and can therefore try to guess why you sold:
- got too expensive based on FA analysis
- too many people talking it up, etc.
- fundamentals changed.
Am I close? Or was there a large dip in the price?
There's 1.3bn worth of work in hand, so next year might not be a complete disaster. But depending on how much of that work is newly won, or a carryover from last year's $1.9bn order book, things may start to get messy in the second half of next year.
As long as this company can remain alive without massive share dilutions, I think it will work out well.
OK, I must ask - while they have 1.3bn order book:
- What are the margins like?
- What's the future macro picture look like? (check out mining capex forecasts - you won't like what you see... and yes, they're only forecasts)
- As a result of the above, are the asset valuations on the balance sheet accurate? (i.e. will there be write-downs?)
This is not to say they can't continue on, but you're essentially investing in a company where you're expecting very minimal profits in the next few years and therefore minimal/no cash returned to shareholders.
I personally stay away from miners and mining services because I don't understand the area well enough and they're essentially price takers... but if you're jumping in, you'd want to know the answers to the above questions.
I'm not wanting to sound critical here, just trying to demonstrate the differences in how people (and therefore the market) think, using myself in the role as a commentator/analyser on the stocks you've selected as "good" companies. So far you've indicated that you have purchased CAB, SDL and LYL. Ok let's take a look at one of them and I'll choose CAB because it was the first you purchased and you mention it below. (I haven't looked at CAB for a while - so this should be interesting). This is the normal process I go through, (and for this example will be somewhat superficial - I just want to tell you what I'm thinking)... NOTE - I DO NOT HOLD CAB. THIS IS NOT ADVICE...DON"T MAKE ME GET THE DISCLAIMERS OUT. I MEAN IT. DYOR.
CAB - Mcap 523M 120 Million shares on issue Average of broker consensus - Sell recommendation price target $4.49 current price $4.43 (Ok so with that MCAP the stock is well outside the top end of the market. As such in terms of how I would categorize the stock it does not meet my criteria for a "Blue Chip" portfolio. (It does meet a couple of the requirements, but it fails for me to class it as blue chip {and therefore be prepared to hold the stock on a longer-term - across market cycles - basis}). It would therefore fit into one of the other categories I use to determine the appropriate time to invest in the this type of stock. Income, Growth, Cyclical or Defensive. These are dominant categories - frequently stocks possess attributes across categories. Looking at the stock it would appear to have income characteristics (nominally due to the high payout ratio), but have significant growth/cyclical characteristics. It's greatest optimal entry for a capital growth objective (as opposed to an income objective) would therefore tend to occur in a late cycle of the broader market cycle. Prior to late cycle it would be suitable as a trading position. Are you intending to hold this for yield or growth?
Earnings 0.48
Market 0.98
Sector 0.68
Actual NPAT fall in 2012 Forecast NPAT fall in 2013 2014 Ouch! errr that's not attractive, that's catching a falling sword. There would need to be a significant announcement on the 22nd of August when it releases it's Prelim Report. Taking a look at those numbers immediately turns me off the stock and makes me wonder if there is a short position to be had at the end of August depending upon the prelim report.... we'll see.
It is at this point I would normally go do TA to see if the tech and fund align or if I just got it wrong - but you aren't interested in that. (One quick look tells me that the stock has been neutrally trending since 2009 and in a negative trend since May 2012.....a period of time where the market went from 4088 to +5000... It's trending against the market). Given that you have said that you are benchmarking against the index....How do you feel about that? (given that expectation is fundamental to financial risk).
Top five shareholders hold 48.94% of issued capital Hey that's not half bad...hope none of them pull the pin. In fact I think I might see if any of them have been adjusting their holdings (Looking for either an overhang or predatory behaviour)... Hmm So UBS Australia has been been selling down but UBS London have been buying up as has Aberdeen (based in Singapore) in the last few months....in fact hold about 14% of issued capital... I see them doing this for yield in comparison to yields in their home countries - confirmation of the income characteristics I spoke above.
Hmmm ok so a purchase now would seem to be a contrary to popular opinion but overall Institutions seem keen under an income basis to acquire. On one hand you have an obvious headwind in the short term time-frame you are working against. On the other hand the Insto's tend to be sticky holders and 14% holding isn't insignificant). But I do want to ask.....how does the above match up with...
But generally, I will only buy companies that have at least some of these:
1. I feel have every chance of being around and doing very well 20 years from now.
2. Company founder or long serving management on board, and owning a large stake in the company.
3. Consistently profitable over many years.
4. Acceptable or higher ROC.
My bolds.
It would seem that the market, superficially at least, does not agree with your assessment. But, this is the art of stock selection, finding good companies that are sold well below their intrinsic value, and then allowing the market time to recognize the intrinsic value. I would have said that (without doing any TA) that you were early in your purchase if your objective is capital growth, as an upwards trend of sentiment does not yet exist, but that early signs are there for the possibility, but it may be six to 12 months away. I would start looking at the announcements from here on looking for fundamental stability and news flow.
I am curious of what your previous FA experience tells you. How often did you get out and the price has gone back up? Was it a worthwhile percentage play in your case?
Given the number of transactions I have done over the years this has happened many times. Do I regret any of them...no, would I do it exactly the same again...yes.
I would suggest you then need to look at what your goals and objectives are and think deeply about whether you want to benchmark against the index. Perhaps something more akin to a stated target regardless of market performance would suit you better.
I hope the above gave you a bit of window into process. Knowing the process now, you could imagine that I looked at BNB like this....
1) Is not a blue chip (doesn't meet my requirements)
2) My goal is therefore shorter-term capital gain rather than longer term income/gain
3) The stock is cyclical in nature (like MQG).
4) The market is late cycle.
5) I've had an almost 500% increase on my purchase price.
6) They've spent a lot of the money they've raised on expensive assets late in the cycle.
7) The cash-flow statement looks a bit squiffy.
8) They triggered a technical sell signal (which was ultimately a little early)
All the above = sell, ignore those that said it was going to reach $50.00, go find the next one.
KTP - if you were to do the same, using those simple characteristics above, what part of the cycle are we in, what sort of stock is it, what category does it fit in....what would you come up with for SDI and LYL?
NWH is not a company that enjoy any competitive advantage as far as I can tell.
Another interesting value-based premise - a company that achieves a poor return on capital is:
1. in an industry that is not viable long term
2. has poor management.
3. operates in a temporary industry environment of either under-demand, or over-supply.
My money is on number 3. I think that due to various factors there is less mining related work available in the near future. Long term, however, it is a viable industry that will continue growing. I don't know when it will turn, but I am sure that it will and I am betting money that NWH will be there once it happens.
I think this is the most important part of your analysis and your starting point for valuation.
Arguably, for a company that does not enjoy a competitive advantage, but participates in a stable or growing industry, the valuation should be equal to the reproduction value of its assets. The cavaet to this is, of course, if the entity will continue to be a going concern - you need to answer that question (and it appears that you have above).
The future earnings are irrelevant because the long-term profitability of this business (ie. its return of capital) will not exceed its cost of capital if it does not have a competitive advantage. This means that new entrants and other competitors could enter the same industry and compete on a level-footing if they are willing to stump up the costs of purchasing assets of a similar nature. In other words; how much would a competitor need to spend to derive the same profit that NWH makes?
If you do not understand why this theory almost always works in practice then you need to read more about competitive advantage.
It's mentioned in a lot of the value-investing literature, but my favourite sources for this are Bruce Greenwald and Aswath Damodaran.Hi Ves,
It seems we read the same books
It's mentioned in a lot of the value-investing literature, but my favourite sources for this are Bruce Greenwald and Aswath Damodaran.
Greenwald's "Competition Demystified" is definitely worth a read if you want to explore competitive advantage further.
To be honest, I never understood the distinction between yield and growth. I am there for profit. Yes, arguments can be made mentioning things such as earnings and dividends stability, asset backing, yada, yada. But I generally completely disregard this in my valuations. Whether management distributes cash or re-invests it in the business is an interesting topic and is one of the things I look at when assessing management, but I don't build it into the price.
Yes, quite possibly I am early. But that's the difference in our approaches. I buy when there's enough "value", I don't try to time it.
For share investments, though, I want to learn and get better. Measure against an index is the only way that I know of to properly track your progress.
LYL:
1. Not a blue chip.
2. Stock is cyclical.
3. It is well down from the top of the cycle. The T/A in me says they will fall further. F/A says the price is good enough, better than cash account adjusted for risk.
4. They preserved cash and are prepared the downturn.
Hey TKP,
You broke the rules again? Assume the position. (not serious, just something I say to myself when I'm tempted to break my own trading rules).
OK two things...
- So do you measure your holdings on TSR? (Total Shareholder Return - yield and growth together) - in which case your benchmark is not the All Ords Index, but the All Accumulation Index...mind you I'm still thinking that this is not the way for you to benchmark, but this is your show.
- I asked the question, because it tends to solidify (in my mind at least) the underlying reason for continuing to hold a stock. If my driving motivation is yield...then I know I will be holding the stock for a reasonable period of time. If my objective if growth...I'm holding it until I've made enough money and my decision to sell is more transparent. I was talking to someone last month who put a not inconsiderable portion of an inheritance into Gold. With gold there is no div, when I pointed this out, they clearly realized that their objective had to be growth and focused their decision.
So lets turn that around....why do think I do try and time it? Obviously sometimes I'm going to get it wrong, I'm going to stuff it royally, and kick myself when my analysis was right and there's an event that makes the price jump before I've entered. Why do you think I persist in attempting to time it?
I'm going to talk to you about the three main portfolio's I run personally.
An index is just a number you can measure against, you could just as easily say... I wish to earn better than bank deposit rates... and track your performance against that. If your goal is to learn and get better, setting an unrealistic target will discourage you.
1) So under my systems it would not fit into number 1 or 2 (for reasons I won'y detail). I would only be looking at it from a multi-bagger, system 3 perspective.
2) Being cyclical it does have the dominant characteristics that I'm looking for in system 3...it's cyclical and SHOULD grow during the later part of the share market cycle.
3) No you misunderstood. Where are we now? What part of the cycle are we currently in? This is an environmental big picture look. I hold Blue chips with yield focus because regardless of the time in the cycle, that yield sustains the value over the entire cycle. I buy Outliers, late cycle, because in the balance, there is a higher probability of success of this system only during that part of the cycle.
4) Is great, but will only be transferred to an equity increase, in the kind of way I'm looking for, at a certain part of the cycle.
Can you see how critical point three is to the investment decision and type of share I purchase?
From my perspective, a lot of what you've purchased fit's into number 3....and of all the systems, number three has the greatest volatility associated with it. When something has high volatility, your options are...hold on through it and back yourself that you are right, or attempt to time and use stops, positional sizing, money management etc, to skew the probability in your favor.
You are doing the first one...I do the second one. Here's the sixty thousand dollar question......why do I do the second one?
Cheers
Sir O
CKL has been coming up in my scans for quite some time now. I have also done some fairly in-depth thinking / research on it over the past few weeks in particular.
I am still undecided on it; I agree with much of what you have said. In summary, it's a closely held by astute management, operates in a boring (semi-defensive industry), has fairly well diversified revenue streams across a few industry segments and has achieved adequate long-term returns that support the case of there being some kind of competitive advantage (especially in the pharma packaging business which helps them generate the highest margins out of all of their business segements).
The margin declines (some would say quite dramatic) over the last few years have been due to acquistions (and integration costs) outside of their traditional core pharma business. The expanded business will not be able to generate EBIT margins at tradition levels of around 16% and it will be closer to 8 or 9% at the very most going forward I would have thought.
As you said Amcor and Visy are their biggest competitors. The CHH acquisition enabled them to compete on an even footing against both in the folding cartons space. And they got it dirt cheap.
Also handy to look at vertical integration - Amcor has been winding down or closing their mills; whilst Colorpak seems to be going for the centralisation of their cost base (they also have contracts with NZ mills that may give them a cost advantage in the short and medium term).
I am still not sure about the long-term prospects of this business (see sustainable competitive advantage), but it is definitely at an appealing stage of the capex / rationalisation curve (most of the major spending has been down) and the debt and margin cycles have probably seen the worst.
Price is attractive, but the question of long-term competitive advantage is the key for me, not quite clear enough on that in my own thinking. It means that I may miss opportunities, but my strategy is buy right, hold tight so I am punished if I get the company wrong in the first place.
I've just looked at what I thought was possible if they aimed for organic growth, price competition and the business cycle over the long term. They appear to me to have focussed on lower margin growth over the past few years because they already hold a high market share in their phrama packaging operations. I expect this to continue.How did you arrive at your future EBIT margin of 8-9%? Is it your general feeling of industries future, competitor numbers, or the CKL's trend over the past few years?
Hi Ves,
That's a great summary, thanks for posting it up.
How did you arrive at your future EBIT margin of 8-9%? Is it your general feeling of industries future, competitor numbers, or the CKL's trend over the past few years?
It's very difficult thing to get a grasp on at the moment. As a result of the acquisition, they obviously inherited some unprofitable contracts that they still had to fulfill and that reduced their margins the last 2 years. I believe they've now fulfilled all those contracts and either renegotiated them to a better rate, or let the customers go.
Prior to that, they spent a couple of years buying lots of new eqiupment, heavy capital spending.
This coming year should be more or less return to the baseline, apart from $2.5m plant relocation cost.
Management stated that after 2014 capital expenditure should be in line with depreciation for a "few years", which tells me there are no forthcoming needs to replace outdated equipment or anything like that.
My thinking was along the lines of:
-Their 2013 EBIT margin was 7.8%, on EBIT of $13.8m.
-$2.5m plant relocation is expected to pay itself off within 12 months, so we can add $4.5m (EBIT/NPAT).
-All bad acquisition contracts coming off the books after this year, let's say that will reduce Revenues by $10m, with no effect on EBIT.
- Further efficiency improvements are expected in 2015, I'll assume another $2m to EBIT.
Assuming no new revenue streams, gives me revenues of $167m and EBIT of $20.3m. Margin = 12.1%.
Their long term prospects were my biggest question mark as well and that's why I spent the last 2 months bypassing them in favour of another stock every time. In the end, I decided that at the current price, they don't need great long term prospects, they just need to remain competitive for a few more years. Should they grow as well, it will be a very welcome upside.
Sounds like our strategies are a little different too - I look for companies that I can hold, but have nothing against finding opportunities to exploit temporary mispricings and getting out afterwards. CKL is somewhere between those two - like yourself, I do not have a firm view of where they may be long term.
I've just looked at what I thought was possible if they aimed for organic growth, price competition and the business cycle over the long term. They appear to me to have focussed on lower margin growth over the past few years because they already hold a high market share in their phrama packaging operations. I expect this to continue.
I'm not given the impression that they will shed too much more revenue, most of the fat appears to be gone.
EBIT post-rationalisation I think will be around $16m (give or take a bit in terms of the plant rationalistion in Victoria, but I'm not sure it adds $4.5m per year). I usually discount any management estimates of rationalised or synergised cost savings!
Base line revenue is around $174m - I'd actually expect it to grow slightly after they have renegotiated and retained existing contracts and tried to win business against lessor competitors post Amcor's mill closulres... hence EBIT margins falling somewhere between 8-9%.
All of that being said... short and medium term is pretty meaningless to me if they don't have a moat that allows them to retain their profitability going forward.
KTP – you’re more optimistic than me – I’m around 8% Ebit Margin next year and 9% by 2016 on flat to slightly increasing revenue. Accounting treatment of the uneconomical contracts has been a boost to the current numbers – no such tail wind next year. How much of the benefits from the plant relocation will stick to CKL’s ribs in a competitive industry?
Amcor closing their paperboard mill is the significant story here to me. The big questions: Does CKL now have a competitive advantage in raw material sourcing because of the relationship with CHH? What happens to imported prices for competitors with the dollar decline? Will Amcor look for higher margins now that the packaging business can’t be cross subsidised with the board manufacture.
Tough competitive, capital intensive industry – Appears some potential that industry conditions may move in favour of participants (short to mid term play) – but all in all for this lazy long term investor, I’m with Ves – it doesn’t warrant a spot on my team.
If the industry conditions are in fact easing – I hope you complete a timely trade and make some nice bucks. It’s refreshing that you have sparked a bit more in-depth research then ASF normally sees.
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