The news:

From Bloomberg

From Adweek

 

 

 

Here are two posts worth reading.

One is about the outperformance of "glamor" over "value" stocks these last few years. I've felt this. On a relative basis, the last couple years have been the hardest time ever for me to pick stocks. 

Value Badly Lagging Glamour

The other post is about Sanborn Map. It's a classic Buffett investment. And the post does a good job of breaking down the logical arguments that were probably running through Buffett's head.  

Some Thoughts on Sanborn Maps

 

A few people have emailed me asking for my thoughts about Armanino Foods of Distinction (AMNF). I don't have any right now. But Whopper Investments does:

I think Armanino is undervalued at today’s prices. It’s growing pretty fast and creating tons of value from that growth, so that value gap should (hopefully) grow over time. And, as an added kicker, there’s the potential for a merger at a huge premium, which would be easily supported by the synergy potential, and/or a big special dividend to lever the company up.

I lied. I do have one thought. At one point, Whopper says:

I tend to think that their frozen products fall more into the “commodity” segment than the “branded” segment, but their returns on capital actually suggest other wise. Pre-tax returns on capital are well over 50% and gross margins are in the 35% range. Those tend returns tend to indicate some form of brand strength or competitive advantage.

That's true. However, it is imperative that when you find empirical evidence of a competitive advantage you back it up with a rational explanation for that competitive advantage.

You always want to combine abstract reason with concrete evidence to prove something's practical existence.

If you fail to do this, you will end up taking the magic formula approach. Many companies earn excess returns. Some have durable moats. Others do not. It may work out on average to simply assume moats based on high returns on capital. In fact, the historical data Greenblatt used says that the approach did work in the past.

But you must never beg the question. You must never argue that this company has a moat because only a company with a moat could earn the returns this company is now earning.

Instead we must look for both a rational theory and empirical data that are reasonable when considered separately and agree when put together.

Articles

Is Quality as Good as Growth?

Where Does a Stock's Future Return Come From?

Should Buy and Hold Investors Worry about EV/EBITDA?

How Today's Debt Lowers Tomorrow's Returns

Why I'm Pessimistic about Stocks

A blog I read, valueprax, reviewed How to Read a Book. I had never read the book before. So I thought I would give it a try. It is – of course – mostly about reading books. And while investors read a lot (in fact, that’s most of what they do) it rarely comes in book form.

Still, a lot of what you’ll find in can help with reading 10-Ks, S-1s, investor presentations, earnings call transcripts, annual letters, newspaper articles, trade journals, etc.

I think this quote sums up the problem new investors have:

Most of us are addicted to non-active reading. The outstanding fault of the non-active or undemanding reader is his inattention to words, and his consequent failure to come to terms with the author.

SEC reports are not known for being communicative. But in most cases where someone emails me asking about a part of a 10-K they do not understand – the answer can be found in the same 10-K. You just have to read the footnotes, understand how the income statement and cash flow statement and balance sheet relate, and know whether the company is using GAAP or IFRS. With the internet, you don’t even need to know all the actual norms of GAAP and IFRS – since you can always just google “IFRS biological assets” if you’re confused.

This sounds like a lot to keep straight. But if you come to every 10-K armed with a pen, a pad of paper, a highlighter, and a calculator – it’s so much easier. When I see something out of the ordinary I just scrawl “Depreciating too fast?”, “Why did marketing expense double?”, “When was building bought?”, etc. right in the margin.

It is easy to miss the relevance of depreciation method, useful life, residual value, etc. in a depreciation footnote if you read it the way you would read a newspaper article, novel, etc. Most people read most things passively.

Read the 10-K actively.

A depreciation footnote takes on a whole new meaning when you are looking through the 10-K specifically making calculations based on questions you came up with yourself about depreciation. You now read it in the context that matters to you.

Here’s one other great piece of advice from . Just read the whole thing straight through first. It’s amazing how few people read a 10-K twice. If you’ve ever seen a movie straight through twice – within the same week or so – you’ll realize you missed a lot the first time through. Popular movies are not made to be dense or difficult to understand. But I don’t think there’s anyone who can see even a very superficial seeming movie twice in the same week and not find something in the rewatch they missed the first time through.

Why?

Context. The best context in which to analyze something is to already be familiar with it. The first time you see something you’re seeing it. The second time you see something you’re analyzing it.

If you feel like you’re not getting enough out of 10-Ks, try to read a 10-K a day. And try to read it twice. Read it once without worrying about whether you understand it. Then read it the second time with you pen and paper and highlighter and calculator.

You will always find something you missed the first time.

And yes, it’s much easier to read your 100th 10-K than your first 10-K. They are a genre. It’s a pretty dry genre. But it’s still a genre. And you’ll be pretty genre savvy by the time you reach your hundred and first 10-K.

 

I recently mentioned something in an email that I'm not sure I've said before on this blog. I always read the newest and oldest 10-K for a company when I start analyzing it. Reading the oldest 10-K gives you perspective.

This little habit will make you a better investor.

EDGAR has 10-Ks going back to the mid 1990s. So, you'll have the experience of reading a 2012 annual report and something like a 1996 annual report.

This always gives me added perspective on the business. And it gets my thinking about how the business has changed over time and how it will change in the future.

The man who turned around GEICO died:

John Byrne, Geico CEO Buffett Cited for ‘Brilliance,’ Dies at 80

I only own two American stocks. Both are micro caps. They are George Risk (RSKIA) and Ark Restaurants (ARKR). Both stocks came out with news recently.

Ken Risk, the CEO and majority (58%) owner of George Risk, died. His daughter, already the CFO, was made President and Chairman. His widow was also added to the board.  The company's record under Ken Risk was extraordinary. His death is a big negative for shareholders.

Ark Restaurants rejected a $22 a share buyout offer from Landry's. Then Landry's sent out a press release questioning the motives of Ark's board.

Here are the latest press releases in each story:

George Risk 8-K

Landry's Press Release

Market Folly links to an interview Mohnish Pabrai gave to The Motely Fool. In that interview, Pabrai mentions 3 places Charlie Munger said you should look for stocks. Munger said to look for stocks that:

1.    Great investors are buying

2.    Are reducing their share count

3.    Are being spun-off

For #1 you can read the Market Folly blog, go to GuruFocus, or subscribe to the Hedge Fund Wisdom Newsletter.

For #2 you can read Value Line, go to GuruFocus, or go to Morningstar.

And for #3 you can go someplace like StockSpinoffs.com.

I mentioned John Malone recently because I just watched an interview he did. Then I noticed Whopper Investments recommended Cable Cowboy which is a book about John Malone and TCI. And now, I see from Asif Suria’s “Insider Weekends” that on December 18th John Malone bought $56 million of Liberty Media (LMCA) stock.

One of my favorite blogs, Value and Opportunity, posted a list of 22 investments for 2013.

Whopper Investments has a post discussing what the sale of the New York Stock Exchange means for the Canadian closed end fund Urbana.

A lot of value bloggers have a problem with the management of Urbana. I don’t. But I do have a problem with the price of the portfolio that will be left after this merger. If you look at the stocks that make up the bulk of Urbana’s portfolio – which will be CBOE (CBOE) and some amount of Intercontinental Exchange (ICE) – these are pricey stocks.

Still, Urbana’s discount to net asset value was recently about 50%. It is a stock worth watching because the discount to NAV is often big and the portfolio is easy to understand. But the underlying assets are not something I’m interested in.

My favorite holding companies to invest in are situations where I like the underlying assets and think they are reasonably priced and then I get a discount to NAV. At Urbana, I think the discount to NAV is the only attraction.

But if you want to invest in securities exchanges, Urbana is the place to start.

Some readers emailed me about the fact that a company from my list of 15 Japanese net-nets I put out in a 2011 report is going private. The company is Noda Screen. It is up 124% in the last year. But only 32% since my “Buy Japan” post in March of 2011. Another company from the net-net list, Sanjo Machine Works, was taken private about a year ago.

For details on how Japanese net-nets performed from early 2011 through early 2012 see the post “How About Those Japanese Net-Nets” at Oddball Stocks.

Nate over at Oddball Stocks put up . This is a good list of obscure stocks from around the world. They are all worth looking into.

Mr. Market blog links to an excellent John Malone interview. It is definitely worth watching the whole thing. By the way, if you don’t know anything about John Malone the book is a good place to start.

Two people I know have brought up the same stock idea to me: QLogic (QLGC). Someone I email back and forth with brought it up as an example of a company that has been a constant buyer of its own shares. And now The Graham Disciple has written about QLogic. His focus is on the balance sheet.

Warren Buffett's Berkshire Hathaway (BRK.B) put out a press release announcing it bought back over $1.2 billion of its own stock. Berkshire also announced it will pay up to 120% of book value for its stock. Previously, Berkshire had been willing to pay 110% of book value.

Value and Opportunity has an excellent post on holding company discounts. The key point of the post is the division of holding companies into 3 types: value adding, value neutral, and value destroying.

Excellent point. I would take it a step further. The issue with the discount that should or shouldn’t be applied to holding companies is capital allocation. Capital allocation has a huge influence on long term returns in a stock.

But not just holding company stocks. All stocks. A company that buys back stock when it’s cheap deserves to trade at a premium to other stocks. A company that issues stock when it’s cheap deserves to trade at a discount.

I recently looked at a list of good, cheap U.K. businesses. I passed on most of them. Not because they were too expensive. Most were cheaper than similar quality U.S. companies. I passed on the U.K. companies because they tended to issue shares over the last 10 years.

Some of these U.K. share issuers traded around enterprise values of 6 times EBITDA for much of the last decade. Interest rates were not high during the last 10 years. Issuing stock at 6 times EBITDA is criminal. I don’t care what you were acquiring. You can’t make money doing it by issuing such cheap currency.

Capital allocation at non-holding companies is critical. And often overlooked. Because it’s complicated. Take Western Union (WU). Western Union made several acquisitions over the last few years. They overpaid.

That’s the bad news. The good news is that Western Union never stopped buying back its stock. And when they needed money – they borrowed. They didn’t issue stock.

Let’s take a look at CEC Entertainment (CEC). This is Chuck E. Cheese. The stock has returned 8% a year over the last 15 years – versus 4% for the S&P 500. That’s impressive for 2 reasons. For most of the last 15 years, Chuck E. Cheese’s operations have been getting worse – not better. Margins have dropped virtually every year for the last decade. And the stock is cheap right now. EV/EBITDA is about 5. It’s hard for any stock that cheap to show good past returns – an incredibly low end point is incredibly hard to overcome.

I doubt anyone is applauding CEC’s board. But they should be. It would’ve been very easy to deliver returns of zero percent a year over the last 15 years.

Operating income peaked 8 years ago. Earnings per share kept rising for the next 7 years. Shares outstanding decreased 57% over the last 10 years. Those are Teledyne like number.

Some might argue the return on those buybacks has been poor. And they would have been better off paying out dividends. Maybe. But let’s consider another alternative – the one most companies actually take. CEC could’ve invested that cash – not in buybacks or dividends – but in expanding the business.

Investors make an arbitrary distinction between operating companies and holding companies. They blame CEC for bad operations. And don’t applaud them for good capital allocation. The truth is that your return in a stock is the product of both those factors – how operations are managed and how capital is allocated.

There should be a discount applied to many conglomerates, holding companies, etc. But it has nothing to do with their structure. I apply a discount to most large tech companies based on the dumb acquisitions they will make in the future.

Should you apply a discount to Google (GOOG) the corporation that you wouldn’t apply to Google the search engine?

I think so. I’d be willing to pay more for outright ownership of the search engine if I could allocate the free cash flow it generates. The rest of the company is likely to be value destructive.

Finally, I would caution every long term investor about assuming standard discounts for holding companies, conglomerates, etc. Historically, there is no such thing. It’s a matter of taste.

A half century ago, there was a conglomerate premium. In the early part of the 20th century, some insurance companies traded at discounts to book value simply because they were valued on the dividends they paid. If you didn’t pay big dividends and you were a bank, insurer, etc. – it didn’t matter how much book value you had – Wall Street marked you down. Financials were supposed to be priced on yield.

This leads to a related issue. And it’s a big one for modern investors. Can we drop “dividend yield” from our lexicon.

When most companies didn’t use buybacks the idea of a dividend yield had some validity. When companies followed unorthodox capital allocation policies – it was a poor measure. But for companies following the accepted payout policies, it made sense.

Does dividend yield make any sense today? Some companies pay dividends. Some companies buy back stock. Some companies do both.

Why is it that when I type in a ticker symbol I’m immediately shown the dividend yield? And there’s no mention of stock buybacks?

Because of tradition. That’s the only reason. It’s become customary to show the P/E ratio and dividend yield for a stock. Neither measure is as important as its prominence on stock websites suggests. But tradition says it belongs there.

I want investors to think for themselves when it comes to things like holding companies. A standard discount is just a tradition. In the 1960s, conglomerates traded at a premium, stocks paid dividends, and men wore hats.

Those were historical facts. Not immutable laws.

One of my favorite blogs, Oddball Stocks, just announced a new website. The site is called Unlistedstocks.net  It’s a database of unlisted stocks. Subscriptions are $300 a year. If you become a contributor, the price drops to $75 a year. A contributor is someone who contributes data to the website.

Here is a list of companies in the database.  

Someone emailed me with a link to a blog I hadn’t read before. It’s called The Graham Disciple. And so far it has posts on Xerox, Dolby, Rheinmetall, and Bijou Brigitte. Each post starts with a quote from Ben Graham.

I just finished reading . This was recommended to me by the blogger who writes Neat Value. It was a good recommendation. The book is short. And simple. And all about moats.

I’m now reading . This one’s even better. Every buy and hold investor should read it.