Thursday, March 23, 2017

Return Per Unit of Time Invested: Anil Tulsiram


In some ways the title of this post could be misleading. The other way to say the same thing would be to ‘Time is precious, decide WHAT NOT TO DO’

Time allocation is as important as capital allocation

Free capital is the book which convinced me that for private investors, focus on time allocation is as important as capital allocation. Almost all the investors in the book highlight how they try to optimize their time.
Focusing on a limited number of sectors leads to “economies of scale in knowledge production” – that is, learning about one company in a sector helps you to understand others in the sector. On the other hand, if you spend all your time looking at a few sectors, you “risk getting stuck at local optima” – that is, miss other sectors with much better opportunities. – Free capital
The scarcest resource for successful investors is not money but attention: how to manage the trade-off between time and rationality to best effect. There is not time in life to find out everything about every potential investment. Investment skill consists not in knowing everything, but in judicious neglect: making wise choices about what to overlook. 
American philosopher William James, had said the same thing more precisely  

“the art of being wise is knowing what to overlook.”

Source: Free Capital
  • Warren Buffet refused Mohnish Pabrai’s offer to work free for him. Recall Buffet’s reply “ I have given a lot of thought to optimal use of MY TIME, and I simply do best by operating by myself. “
  • There is no way for an investment manager to be on top of thousands of businesses, no matter how large the team is.
  • Investment manager has to take short-cuts with or without a team

I messed up big-time with time allocation

When I started my investment journey two years back, the most important mistake I did was not thinking about Return Per Unit of Time Invested. I was clear that I will not invest in any company which I am not comfortable for holding next five years. But I was looking for out of favor stocks [at 52 week low price] at low single digit PE & PB multiple. Majority of the stocks which satisfy both the conditions turned out to be cyclical stocks.
I failed to understand that, even after following detailed investment process for stocks like ZF SteeringGM BreweriesLG Balakrishnan etc., I was not comfortable in allocating more than 2-3% each [click on the link to download mindmaps]. I failed to follow a simple rule that TIME ALLOCATED to a particular idea should be in proportion to the CAPITAL ALLOCATED to that idea.
Matrix
The biggest mistake I was doing was not putting businesses in proper matrix before I begin my detailed research. Abhinav Mansinghka [who along with Niren Parekh maintains an excellent blog here, ] helped me in understanding importance of putting businesses in proper matrix. Abhinav explained me that source of permanent loss of capital is almost always the bad businesses. Unless one pays extraordinarily high price for a high quality businesses, generally one would suffer only opportunity cost and not loss of capital.  

In simple words there is no point is doing DETAILED RESEARCH for bad businesses. Such businesses need WIDE diversification to PROTECT against PERMANENT loss of capital. Don’t get me wrong, I am not saying its wrong to invest in bad businesses at ULTRA CHEAP valuation, but then you cannot be spending months in doing research on one such company.
In the post that follows, I have tried to explain how I am trying to increase Return Per Unit of Time Invested. Of-course, it is tailored to my investment philosophy and personality. But I think you can follow the same steps to create a strategy, which suits to your requirements.

Formulate an investment strategy 

The poet E.B. White believed if your thinking is clear, then your writing will be clear. The same is true of investing, so formulate a strategy and write it down. This discipline will help you zero in on the kinds of companies you want most and avoid getting distracted by situations that are of peripheral interest. Naturally, your investment strategy should match your personality. 
Shrinking the Investing Universe
I’m a practitioner of 80/20 investing. Essentially, this means figuring out the 20% of your investing activities that are delivering 80% of your results. I like to start by asking, “what markets/businesses do I have no chance of investing in?”. Don’t be scared of missing out on a great idea by excluding entire markets/sectors. You will miss a lot of good, even great ideas. But we are on a mission to optimize our investing time.  
“Art of Value Investing” is one of the best book which talks about investment philosophy of various successful investors. These philosophies vary from deep value stocks [diversified portfolio] to buying only high quality stocks [concentrated portfolio]. This book enable us to appreciate that there is NO ONE BEST INVESTMENT STRATEGY. I reproduce below few extracts from the book which highlight the importance of time allocation and is inline with my investment philosophy.
We consider ourselves first and foremost value investors, but we don’t start by looking for cheap stocks. We spend our time following outstanding businesses that we would want to own should they ever become cheap. They’re rarely inexpensive when we start trying to understand them, but we follow them closely so that on the rare occasion they become discounted, we can act right away. Coming at it this way also means we’re not wasting our time chasing statistically cheap companies that we will have no interest in owning. Time is precious in this business. —C.T. Fitzpatrick, Vulcan Value Partners
With the market as volatile as it has been, we’ve been more diligent about maintaining watch lists to catch companies whose stocks trade off sharply for reasons that may be more overall-market related. We’re not looking for short-term trades but, as we learned in late 2008 and early 2009, stocks of even the high-quality companies we want to own can get remarkably cheap quite fastWe want to be prepared for that. —David Nierenberg, D3 Family Funds
It’s very important to define where you’re going to look for opportunities. Time is a precious resource and if you make it your task not to miss anything, you set yourself up for failure. There are too many opportunities out there and, by definition, you will miss many of them. That’s why we narrow where we want to look first by the themes we consider most compelling . We’re not necessarily seeing things others don’t see, but we will likely have a very different view on the magnitude of the trend or the speed at which it happens. —Oliver Kratz, Deutsche Asset Management
We’re deliberately concentrated on 10 to 14 investments, for two reasons related to time. First, it takes considerable time to learn enough about a company, its people, and its industry to develop and maintain a proprietary level of insight information, or knowing more than the Street. My view is that whatever edge I have comes more from knowing where to shop than knowing specifically which of the items I buy will be the best. So I maintain roughly equal stakes to reflect that. —Ralph Shive, Wasatch Advisors
The reality is that we can’t do the level of due diligence we want on each idea and also turn the portfolio over quickly by constantly trading out good ideas for better ones. So we typically hold companies an average of five years. —Steven Romick, First Pacific Advisors
It’s the bias of the information age that people feel isolated when they’re not in touch with what’s going on. To me it’s a good discipline to often say, “I don’t really care what goes on in the market today.” When you do that you can actually get something useful done. Even something simple like saying you’ll only answer e-mails in the morning, at lunch, and at the end of the day sometimes can go a long way toward avoiding unhelpful distractions that tend to arise. —James Montier, GMO
We are typically not attracted to most technology businesses because of cut-throat competition, potential technology obsolescence, short product cycles, and the excessive use of stock options. The return on time is also a problem – you spend so many hours analysing new products and technology trends that 50 percent of your time gets spend on 5 to 10 percent of your portfolio.

 At the same time, technology is an important driver of economic growth and grows at above GDP rates, so we want to have exposure to it. We like to attack difficult industries through the side door. –  Pat English, Fiduciary Management, Inc.

How much research is enough?

He [Vernon] also made the point that it is not worth knowing everything about a company: every investigation has a time opportunity cost. Your aim is not to check all possible hygiene factors, but to check enough to reduce your error rate to a time-efficient acceptable level: a low, but probably not zero, rate of error.
A final skill which Vernon highlighted as important for the self-directed investor was effective time allocation. “Time is a limited resource with strongly diminishing returns. The first hour you spend researching a company is much more important than the tenth hour. Some private investors are management groupies – they spend too much time on their favourite companies, posting on bulletin boards and going to AGMs and all the rest of it. They are squandering time which would be better spent looking for new ideas.” To limit the time resource applied to any one company, he reminds himself of psychological research which suggests that in many contexts decisions are best made with no more than five to seven points of information. Any more information beyond that does not significantly improve decisions, and may even degrade them.
Some investors insist on trying to obtain perfect knowledge about their impending investments, researching companies until they think they know everything there is to know about them. They study the industry and the competition, contact former employees, industry consultants, and analysts, and become personally acquainted with top management. They analyze financial statements for the past decade and stock price trends for even longer. This diligence is admirable, but it has two shortcomings. First, no matter how much research is performed, some information always remains elusive; investors have to learn to live with less than complete information. Second, even if an investor could know all the facts about an investment, he or she would not necessarily profit. This is not to say that fundamental analysis is not useful. It certainly is. But information generally follows the well-known 80/20 rule: the first 80% of the available information is gathered in the first 20% of the time spent. The value of in-depth fundamental analysis is subject to diminishing marginal returns. – Seth Klarman

News is costly

News wastes time. It exacts exorbitant costs. News taxes productivity three ways.  First, count the consumption-time that news demands. That’s the time you actually waste reading, listening to or watching the news. Second, tally up the refocusing time – or switching cost. That’s the time you waste trying to get back to what  you were doing before the news interrupted you. You have to collect  your thoughts. What were you about to do? Every time you disrupt your work to check the news, reorienting yourself wastes more time. Third, news distracts us even hours after we’ve digested today’s hot items. News stories and images may pop into your mind hours, sometimes days later, constantly interrupting your train of thought. Why would you want to do that to yourself?

E-mail, participating on public forums etc

Much of the time you spend in your email inbox produces no return on time invested. You can spend countless hours each day in email, especially if you check your email first thing in the morning.  
One needs to be judicious in participating in various public forums. I have already discussed this in my earlier post on Free Capital, so will avoid repetition.

Conclusion

Selection by elimination process 
Choosing the right investment is really a process of elimination. A minority of the thousands of publicly traded companies in which you could conceivably invest have authentic earnings power and even in this select group fewer still will qualify as an Earnings Power Staircase company. If you are a long-term cautiously greedy investor looking for that single wonderful business, most companies are not worth touching; your focus must be on identifying firms that have the potential to be great growth stocks for the next several years without exposing you and your portfolio to excessive risk.
Aim for specialized expertise and helpful shortcuts.
Many investors think they’re smart enough to master anything, or at least they act that way. Further, they believe the world is constantly changing, and you have to be eclectic and change your approach to adapt, racing to stay up with the latest wonder. The trouble with this is that no one really can know everything, it’s hard to constantly retool and learn new tricks, and this mindset prevents the development of specialized expertise and helpful shortcuts. Warren, on the other hand, knows what he doesn’t know, sticks to what he does know, and leaves the rest for others.
 Howard Mark, Foreward to Warren Buffet Way, third edition

Big Oil Replaces Rigs With Wind Turbines


Big oil is starting to challenge the biggest utilities in the race to erect wind turbines at sea.
Royal Dutch Shell PlcStatoil ASA and Eni SpA are moving into multi-billion-dollar offshore wind farms in the North Sea and beyond. They’re starting to score victories against leading power suppliers including Dong Energy A/S and Vattenfall AB in competitive auctions for power purchase contracts, which have developed a specialty in anchoring massive turbines on the seabed.
The oil companies have many reasons to move into the industry. They’ve spent decades building oil projects offshore, and that business is winding down in some areas where older fields have drained. Returns from wind farms are predictable and underpinned by government-regulated electricity prices. And fossil fuel executives want to get a piece of the clean-energy business as forecasts emerge that renewables will eat into their market.
“It is certainly an area of interest for us because there are obvious synergies with the traditional oil and gas business,” said Luca Cosentino, the vice president of energy solution at the Italian oil producer Eni, which is working with General Electric Co. on renewables. “As the oil and gas industry we know, we cannot get stuck where we are and wait for someone else to take this leap.”
Even as oil production declined in the North Sea over the last 15 years, economic activity has been buoyed by offshore windmills. The notorious winds that menaced generations of roughnecks working on oil platforms have become a boon for a new era of workers asked to install and maintain turbines anchored deep into the seabed. About $99 billion will be invested in North Sea wind projects from 2000 to 2017, according to Bloomberg New Energy Finance. A decade ago, the industry had projects only a fraction of that size.
While crude still supplies almost a third of the world’s energy, oil executives are starting to adjust to demands for cleaner fuels. Even so, emerging fossil-fuel alternatives including wind and solar power are starting to limit growth in oil demand.
Those technologies and electric cars may displace as much as 13 million barrels of oil a day from global demand by 2040, more than is currently being produced by Saudi Arabia, according to Bloomberg New Energy Finance. 

Shell’s Interest

Shell, whose CEO Ben van Beurden has said oil demand may peak in the second half of the next decade, has set up a business unit to identify the clean technologies where it could be most profitable, according to Sinead Lynch, the company’s chair for U.K. businesses. Wind farms are especially interesting to Shell because they can power electrolysis reactions that make hydrogen, which the company says may be a major fuel for cars in the coming decades.
It’s exploring new opportunities across Europe in offshore wind after winning contracts from the Dutch government to build the Borssele III and IV wind farms in December. Shell’s bid marked the second cheapest cost for the technology worldwide, according to Lynch, who said the oil major’s big advantage in renewables may be its expertise in marketing.
“It’s also about marketing energy,” Lynch said. “Once you produce your wind, you need to market the power and we have a phenomenally strong marketing and trading business.”

Statoil’s Costs

Oil majors are also changing the offshore wind industry by driving down costs, Statoil Senior Vice President Stephen Bull wrote in an email.
The Norwegian oil major’s Dudgeon wind farm off England’s east coast will be 40 percent cheaper than a neighboring plant built six years ago, Bull said. It’s also creating floating offshore wind foundations that eliminate the costly step of anchoring windmill masts into the seabed. In addition to the U.K., the company is developing projects in Germany and Norway and won a December auction to build an offshore wind farm in New York.  
Cost cuts for offshore wind are helping the technology start to compete with traditional forms of energy, especially nuclear, according to Bloomberg New Energy Finance. Current projects entering operation are delivering power at about half the price of farms finished in 2012 thanks to larger turbines and more competition. Costs could fall another 26 percent by 2035, according to the London-based researcher.
The entry of oil majors into renewables is part of “a longer term trend,” according to Nick Gardiner, head of offshore wind at U.K. Green Investment Bank, who notes that companies with the scale of Shell and Eni have the clout to finance projects more cheaply than many of their competitors.
“I don’t think they are doing this just for investor-relation purposes,” said Gunnar Groebler, head of wind at Sweden’s Vattenfall AB, one of the top five offshore wind developers who welcomed the added competition. “Given that these projects are billion-euro investments, I just assume that they will have done their assessments very thoroughly.”

Porsche eyes expansion with digital showrooms


As Porsche launched its sixth model in just over a year on Wednesday, the sports luxury car brand is creating its brand presence felt in the country with hundreds of organised drives for customers and by creating digital showrooms.
While 2016 didn’t fare too well for the luxury car market, Porsche did considerably well despite being in the higher end of the luxury segment.
“While the luxury car market declined by about 6 per cent last year, we were able to maintain almost flat growth through 2016, thanks to the new launches with the help of which we now have a complete portfolio,” Pavan Shetty, Director, Porsche India, told BusinessLine.
In 2015, Porsche sold 408 cars in the country, while in 2016, it sold 401, most of which were priced well over ₹1 crore.
But just launches were not enough for the German brand, which has been focusing on creating stronger connect with the customer.
“We did close to 140 customer events last year. We also started doing brunch drives for Porsche owners. It is getting people together. It is a mandate for all six dealerships to have such drives at least once in two months. All of this are showing benefits now as people want to be a part of such exclusive clubs are interested in buying a Porsche to do that,” Shetty said.
Porsche is also expanding its footprint by launching dealerships in Chennai and Hyderabad in the next two months.
To reach other parts of the country, the company is looking at building digital showrooms wherein small pop-up stores could be created with minimal investments.
“Instead of focusing on higher numbers, we want to focus on profitability while ensuring happy customers and stronger customer satisfaction, creating a structure for the future — getting digital experience solution at places where customers don’t have access to a dealership,” Shetty said.
Last year, Porsche entered into the sub-one crore segment with the launch of Porsche Macan, which is bringing more buyers into the Porsche domain. Shetty feels if there are any positive changes made in the tax structure for luxury cars, the market which is less than one per cent of the overall car market in India, will explode.
On Wednesday Porsche launched its fully redeveloped second generation Panamera Turbo in India for price starting ₹1.93 crore ex-showroom Maharashtra.
“The only three things common in the old and the new Panamera are the name, the idea of having a sports car in the luxury saloon segment and the Porsche crest-rest everything has changed,” Shetty said.
The car comes with a new display wherein touch-sensitive surfaces replace classic hard keys, and high-resolution displays merge into the interior.
The Panamera Turbo engine has been redesigned to produce more power, whilst improving fuel economy and reducing emissions. Panamera Turbo’s new 4.0-litre twin-turbo V8 develops 550 hp at 5,750 rpm, with a maximum torque of 770 Nm between 1,960 and 4,500 rpm. It has 30 hp more than its predecessor as well as a torque increase of 70 Nm. The vehicle accelerates to 100 km/h in 3.8 seconds, whilst with the Sport Chrono Package the sprint time is down to 3.6 seconds.
The new turbo model features a top speed of 306 km/h.

Monday, March 20, 2017

Vodafone, Idea Agree on Merger to Create India Mobile Leader


Vodafone Group Plc’s Indian unit agreed to merge with Idea Cellular Ltd. to create a wireless company that’s more than twice as big as AT&T Inc. by subscribers -- and a new leader in a market that’s so competitive after India’s richest man offered phone calls for free. 
Vodafone will own 45.1 percent of the combined company, after selling a 4.9 percent stake in the new entity to billionaire Kumar Mangalam Birla’s holding companies, according to a stock exchange filing Monday. Birla’s companies will take a 26 percent holding, with the remainder being held by the public. The new company is worth $23.2 billion, based on the enterprise value of $12.4 billion for Vodafone India and $10.8 billion for Idea Cellular. Shares of Idea Cellular jumped as much as 14 percent in Mumbai.
The enlarged wireless operator would have 395 million subscribers, exceeding those of market leader Bharti Airtel Ltd. Vodafone would gain a listing in the world’s second-largest wireless market, which it has been considering since at least 2011.
Vodafone and Idea will each control three seats on the board of the new company, which in addition will have six independent directors. Birla will have the right to appoint a chairman.  
For Vodafone, the deal would allow it to unload an unprofitable business that has forced the U.K. carrier to take a $5 billion writedown and pumpmore than $7 billion into the unit. Idea’s promoters will buy the 4.9 percent stake in the merged entity for 38.74 billion rupees ($592 million) in cash, on completion of the transaction.
The latest transaction is expected to be completed in 2018, according to the statement. It’s the biggest deal to emerge after billionaire Mukesh Ambani’s Reliance Jio Infocomm Ltd. stormed into the market last year by offering free calls and data, pressuring other carriers to consolidate.
Last month, Bharti agreed to acquire Telenor ASA’s Indian business. The Norwegian state-controlled carrier said at the time that prospects for the industry didn’t warrant further investments.
Birla units, including Aditya Birla Nuvo Ltd., own 42 percent of Idea, according to the company’s website. Malaysian carrier Axiata Group Bhdhas a 20 percent stake. Vodafone India Ltd. is a wholly owned unit of Vodafone.
In the quarter ended Dec. 31, Idea reported its first loss for the group in about a decade. Idea reduced its voice calling rates by 11 percent and mobile data rates by 15 percent from the previous quarter. Free calls and data offered by Reliance Jio also reduced data consumers on its network.

AC makers betting on consumers’ shift to inverter models


In line with the global trends, air-conditioner makers are betting big on the Indian market beginning its shift towards inverter air-conditioners from regular or the fixed speed ACs.
With the new energy efficiency ISEER rating set to kick-in from next year, which will make energy efficiency parameters even more stringent, most players are working on making their inverter AC product portfolio more robust this summer season.
One of the leading players, LG India has completely shifted to making inverter split-ACs and stopped manufacturing regular split ACs.
For some of the other key players such as Daikin India, inverter ACs contributes nearly 25-30 per cent of their sales in this segment currently.
Kanwal Jeet Jawa, CEO and MD, Daikin India, said: “The Indian market is definitely at an inflection stage for inverter ACs. The share of inverter ACs is expected to grow significantly in the next three to four years.”
Factors such as government regulations and energy-saving benefits has led global markets to rapidly shift towards inverter ACs. Inverter ACs contributed about 63 per cent to the global sales in 2016.
In mature markets such as Japan, Australia and the US, the share of inverter ACs is much higher. Kamal Nandi, Business Head & EVP, Godrej Appliances, said: “We believe the share of inverter ACs is expected to grow to about 15 per cent this year from about 8-10 per cent currently. Next year, we will be seeing an even bigger shift and inverter ACs could contribute as much as 25-30 per cent.”
In a bid to push the consumers to shift towards inverter ACs, companies are also working towards reducing the price gap between entry-level inverter ACs and 5-star regular ACs.
However, other industry players believe this may not be sustainable in the long-term and the real reduction in prices is expected to come in only once the volumes for inverter ACs pick up. Overall, the Indian AC sales are expected to grow by about 15-20 per cent this year.
Kapil Agarwal, Vice-President, Marketing at Whirlpool India, added that while the industry is pushing inverter ACs in the market it all depends on consumer preferences.
“With low penetration levels for ACs in the country, the industry has been seeing good growth rates since the past two years. The growth of the market depends on affordability of products, besides sustainable growth strategies. A bigger shift towards inverter ACs is expected to be seen next year,” he added.

Sunday, March 19, 2017

I Passed on Berkshire Hathaway at $97 Per Share‎: Rod Maciver


In 1982, working as a 26-year-old money manager, I passed on Berkshire Hathaway, which was trading at $97, because I thought it was too expensive. The price represented a 50 percent price to earnings and price to book premium to the broad market. Had I made a different decision – at the time I was sitting on a large cash position from a successful real estate investment – I would now be smoking $10 cigars and hanging out with swell chicks. I’ll wait, I thought, until it hits $60. I’m still waiting. On Friday BRK.A closed at $217,000.
Although I was familiar with Warren Buffett’s investment record – he was widely regarded as one of the best investors of his generation, and I carefully read the Berkshire Hathaway annual report each year – he had not attained the prominence he now has. I mentioned this to Ian, and he suggested I might write about what I learned from passing on Berkshire Hathaway, and the years I worked as an investment analyst on Wall Street.
By way of background, I did not finish high school. I left home at the age of fifteen and hitchhiked up into Canada’s subarctic and worked fighting forest fires and then as a forest tower lookout. The loneliness was too much for me, so at the age of eighteen I became a real estate salesman. In my early twenties I sold hotels and nursing homes, and then met with some success as a real estate investor. I became fascinated by the stock market, and a full time investor in my mid-twenties. Within a couple of years I was managing money, specializing in mismanaged, undervalued companies. They ran the gamut from companies whose stock had declined significantly, had new management, heavy insider buying, to the bonds of bankrupt or distressed companies, to companies with substantial real estate holdings, low insider ownership and minimal or no profitability. I was fairly successful at this in Toronto, acquired some major clients in New York City and in my late twenties moved to the US and started an investment research firm serving institutional money managers and corporate acquirers. I did that for five years, made some money and retired to the Adirondack woods.
Overall, I was successful but my performance was extremely volatile including two years in a row down over 40 percent. Most of my investments lost money or broke even; the few winners were up so much that overall my portfolio averaged a thirty percent return. Among my clients were some of the most successful corporate acquirers of the day – Sam Zell, Richard Rainwater, Leucadia, Jay Jordan, and some of the most successful money managers of the day, Chuck Royce, Leon Levy, Michael Price, Seth Klarman, Fidelity’s Alan Leifer, Ernie Kiehne of Legg Mason (Bill Miller was Ernie’s assistant at the time), George Soros — about 100 money mangers paid my firm $20,000 a year in soft dollars for my “contrarian research.” They followed my work because I studied, in an in-depth way, companies not otherwise followed by analysts.
Much of what I learned I learned from watching extremely successful investors make and lose money. And from losing my own money.
What did I learn?
Lesson 1: The role of financial markets is to take money away from mediocre and underperforming companies and put it in stable, growing, high return on capital companies. Money has an almost metaphysical attraction to places where it is put to careful, good use. You can fight that trend, and invest in companies, for instance that are deeply undervalued and mismanaged – and some people are successful investing in the dregs – but very few over the long term. To use a whitewater kayaking analogy, freshwater seeks salt water, and you can fight that if you want, but paddling upstream eventually is likely to become highly problematic.
The approach that’s worked best in my experience is investing in high return on capital, low debt, growing companies that have the ability to reinvest earnings in the business and generate high returns on those reinvested earnings. The power of compound interest is so profound (mind-boggling really) that over time, returns in investments in those companies are enormous. The trick is finding companies that are compound interest machines. I remember Leon Levy, founder of Odyssey Partners, once telling me that John Paul Getty became the wealthiest man in the world by achieving a 17%percent compound rate of return, on average, over his career.
As in the case of Berkshire Hathaway, trying to invest in those companies based on an analysis of value is more likely to result in opportunities missed than it is make money. An approach that is much more likely to be successful – investing in high quality companies after a market decline of thirty percent, and retaining the liquidity to build positions in those companies after a fifty percent decline in the broad market averages. That takes extraordinary patience, which is a matter of personality.
Lesson 2: I’ve worked for two extremely successful investors who were experts in cyclical, commodity-dependent, capital intensive industries – real estate and mining – and learned that almost all of the real money made in those areas is made only by extremely patient investors who invest once every ten or twenty years, liquidate their holdings once a decade and spend long, long periods of time in cash.
One of those investors, Pat Sheridan, an owner of mines all over the world, once said to me that the classic business mistake was to be fully invested at the top of the market. The objective, he said, was to be liquid at the bottom because business cycles are primarily caused by the creation and destruction of debt. Those are functions of greed and fear, in other words of emotions. He built inventory (by buying mines) during times of low demand, and sold them during times of high demand, including one for $10 million in 2011. Managing cash is crucial to his strategy, he told me.
When oil or real estate prices increase, money flows in to take advantage of what appears to be above-average returns. Overcapacity results, prices decline, debt can’t be serviced and gets converted into equity or otherwise written off, capacity declines and within a few years commodity prices begin to recover. Then the whole cycle starts over again. The swings are unpredictable in terms of duration, but successful investors in those areas look for opportunities after a major (20 percent or more) capacity reduction in an industry, when the debt of the bottom thirty percent of companies in terms of quality of management and assets no longer exists and the debt of mediocre companies (the next ten or twenty percent of companies) trades at pennies on the dollar.
Three approaches, I’ve observed, work best over time: investing in the low cost producer with a durable cost advantage, investing in premium assets such as well-located real estate, and buying debt at pennies on the dollar after an industry wide collapse. All three strategies are most successful after a severe market decline when emotionally it is difficult to do.
The approach that almost always results in disaster – investing in cyclical stocks based on P/E ratios. Cyclical stocks are cheapest when, industry-wide, companies are losing money or have very low earnings, and most risky when they have low P/E and high price-to-book ratios.
Lesson 3: Most successful investors share some common personality characteristics.
They have superior analytical skills in at least one important area of investing. This results from an obsession with investing. They are students of the art. Ian, your commentary on this subject has helped me really focus on what I think I do better than most other investors. In your case Ian, I think that you have an important long term advantage in being willing to, and knowing how to, build relationships with management based on mutual trust and respect. In my case it is an ability to identify superior companies based on financial statement trends. I think. I hope. Only time will tell.
My skill evolved out of the realization that I could have avoided 90 percent of my disasters by spending a couple of hours with a company’s quarterly balance sheets and income statements. Instead, I would routinely fly thousands of miles, interview management, interview former executives and directors, especially those bearing grudges, visit company real estate and local appraisers, interview competitors, suppliers, and customers. I even, on occasion, would sit in a bar outside company factories and have a beer (or two) with workers coming off shifts. I studied accounting at night, read Ben Graham’s classic Security Analysis (twice) and spent twenty years running a business with customers, distributors, suppliers, employees and, as part of that, prepared financial statements once a month. I learned what fluctuations in twenty criteria including inventory, accounts payable and receivables and gross profit margin indicate about a company’s competitive position and prospects. That makes me uniquely qualified, I think, to analyze companies based on their financial statements. We’ll see.
Investing can be looked at as an emotional competition – your emotions and ability to control them versus the emotions of those you buy or sell securities from and to. A primary function of investment strategy is to counteract emotional impulses and thus survive (and take advantage of) adverse market developments. Investment performance is mostly determined by patience, risk management, a willingness to study, and what you do when things go differently than you anticipated. Those factors are personality driven.
In addition to having a clear concept of what their competitive advantage is over others, successful investors, I’ve learned, incorporate into their investment strategy clear concepts of acceptable risk, what constitutes an acceptable level of inactivity and length of holding period after funds are committed. And successful investors stick to their strategy. That strategy – for instance sitting on cash, sitting on losing positions, sitting on winning positions — must be based on self-knowledge. If the strategy is out of sync with the personality, it won’t work, no matter how well it has worked for others.
There are successful short and long term investors, but rarely are there successful investors who do both. A long-term investor must be a patient person. A short term trader who thrives on, perhaps needs, constant activity is likely to be an impatient person.
Regardless of short or long term investor/trader, risk management is crucial to survival and success. Once again, this is a personality issue. A successful investor’s strategy will anticipate adverse market developments – will assume that sooner or later they will be wrong and will lose money. Cash position versus invested capital is perhaps the single most important area of risk management, although acceptable debt levels (both in one’s own financial structure, and the companies in one’s portfolio) is also important. Does an investor have a cash management plan that fits with the other key elements of his or her investment strategy? Successful investors, in my experience, think their cash position through very, very carefully and they pursue a strategy that mitigates risk in what is otherwise a very risky field of endeavor – investing. Depending on the stage of the market cycle, very high or very low cash positions have a major impact on portfolio returns. And on investment survival.
Does and investor buy on strength or buy on weakness? Fluctuations in security prices are often determined by factors other than the underlying fundamentals of the companies involved. A stock can decline due to a major investor needing to raise cash, emotion, faulty analysis, and macro economic factors that do not affect the particular company in question. Is an investor a victim of those factors or a beneficiary? Does an investor know more about a particular company than the market? If yes, buying on weakness augments an investor’s returns. If not, returns are diminished by buying on weakness. Does an investor have the ability to admit when he or she is wrong and take action? Does an investor have the courage to buy during irrational price declines, when economic collapse is widely anticipated and discussed in the news media? Those factors impact long term returns, and they too are personality driven.
Ian, I find your belief that quality companies with market caps of under $30 million are more or less immune to general market declines because they have low institutional ownership very intriguing. Regardless, I strongly suspect that investing in quality companies that used to have market caps of over $100 million, and high institutional ownership, but now have market caps of under $30 million and no institutional ownership because the market is down 50%percent, is a lower risk variant on your strategy.
Whatever one’s position on that subject, an investment strategy needs to anticipate significant market declines, as well as declines in the securities in one’s portfolio, since declines have been a part of markets ever since markets were first created. Humans are emotional, therefore markets are emotional, debt results, markets collapse, and humans become more emotional. And master investors invest.
Or something like that.

Saturday, March 18, 2017

The Middle East’s once fast-expanding airlines are coming under pressure


LAST April, Etihad Airways, the flag-carrier of the emirate of Abu Dhabi, claimed that 2015 had been its fifth consecutive year in the black, with net profits of $103m. James Hogan, the firm’s chief executive, hailed the result as proof that Etihad is a “sustainably profitable airline”. Yet less than one year on, both Mr Hogan and his chief financial officer, James Rigney, have been eased out amid a “company-wide strategic review” to “improve cost efficiency, productivity and revenue”; reforms ill-befitting a healthy business. Just across the sand, Emirates, the flag-carrier of Dubai, has deferred orders for 12 double-decker Airbus A380s in response to a 75% drop in profits. Qatar Airways, the region’s other super-connector airline, has abandoned plans for a subsidiary in Saudi Arabia. After years of uninterrupted and speedy growth, the Gulf carriers are hitting turbulence.
Taken in isolation, falling profits and waning sales should be of no great concern to these industry goliaths. Low oil prices and jitters about terrorism may have sapped demand for business and leisure travel—particularly in their neighbourhood—but overall the global economy is holding up well. If Emirates, Etihad and Qatar Airways could survive and thrive during the 2007-08 financial crisis, they can surely shrug off whatever 2017 has to throw at them. Demand for their core product—competitively priced long-haul flights with a single stopover in the Gulf—should continue to grow in the long-term, fuelled by the public’s insatiable appetite for globetrotting and the innate geographical advantages of their home bases, which are a natural stopover on flights from Asia to Europe and beyond.

The carriers have not always helped themselves, however. During his time at the helm, Mr Hogan invested in seven struggling airlines, uniting them under the umbrella of the Etihad Aviation Group. One of those investments, India’s Jet Airways, is now delivering handsome profits. Two others, Air Serbia and Air Seychelles, have squeezed their way into the black. But those gains have been more than wiped out by continued heavy losses at two sorry adventures, Air Berlin and Alitalia. While Etihad’s annual report trumpeted the 5m passengers and $1.4bn revenue that its equity partners gifted it in 2015, the associated losses were brushed aside. The government of Abu Dhabi, the airline’s only shareholder, is belatedly winding down its exposure by leasing 38 of Air Berlin’s planes to Lufthansa, Germany’s flag-carrier. But even that deal comes with an unfortunate twist. Lufthansa is placing the jets at Eurowings, its new low-cost subsidiary, which was partly set up to compete with the Gulf carriers.
Etihad gambled on foreign investments because it needed to beef up its organic growth with non-organic feed. That has never been the case for the older, larger flag-carriers of Dubai and Qatar. Yet they too are suffering. Speaking at an industry conference in Berlin this month, Tim Clark, the president of Emirates, warned of a “gathering storm” for the sector. The problem goes beyond weak business demand and rising political instability. “At the back end of ’90s I did a paper on long-haul low-cost,” Sir Tim explained. "Everyone laughed at me. But what I predicted then has finally started to happen.” After decades of failed attempts, a new breed of airlines like Norwegian Air Shuttle and AirAsia X is managing to operate no-frills flights in the long-haul market. The sustainability of their models has not yet been proven, but with improved aircraft technology and low fuel prices they are undercutting legacy-carrier airfares. That is a worry for the Gulf super-connectors, which market their one-stop routings as the best alternative to pricey nonstop flights.
Indeed, that very cost advantage, though diminishing, is itself a cause for concern. The American majors—Delta Air Lines, American Airlines and United Airlines—spent two years lobbying Barack Obama’s administration to curb traffic rights for the Gulf states, accusing them of anti-competitive practices. They published evidence of $42bn of government subsidies and “unfair” advantages, ranging from direct equity injections to indirect infrastructure and tax benefits. That was not enough to sway a liberal-minded administration obsessed with friendly foreign relations and rapid globalisation. Donald Trump, however, has different priorities. After pledging to put “America First”, Mr Trump may be less forgiving of perceived misdemeanours. Similar scrutiny is growing on the other side of the Atlantic, where European lawmakers are working to impose duties on foreign airlines that exploit subsidies for commercial advantage. If enacted, their draft law will expose the Gulf carriers to the same kind of competition investigations that have forced several European flag-carriers to repay illegal state aid.
These headwinds will not stop Emirates and Qatar Airways from increasing capacity by about 7% this summer. (Etihad will cut its capacity by 1%.) Most mature airlines would be delighted with that speed. But for the Gulf carriers, which have expanded at a double-digit pace for more than a decade, it feels sluggish. With Mr Hogan departing this year, and Sir Tim hinting at his own exit, two of the main architects of the Gulf aviation boom could soon bow out. It will be up to their successors to avert the bust that typically follows years of breakneck growth.