The Q2 / H1 figures
from all global auto-companies have been released, and so as is the
norm, investment-auto-motives has been investigating the 'bottom-up'
intelligence gleaned from available figures relative to the
'top-down' context of regional macro trends. The former utilised in
the formulation of 'Coupled Ratios' analysis, which itself seeks to
graphically display the investment dynamics of the sector.
This to follow in a
successive web-log.
By providing a double
aspect view of Market Valuation, Profitability, Liquidity and Debt,
'Coupled Ratios' was and is an attempt to provide an improved ability
for investors, from privateer to institutional trustee, to rationally
contextualise and track the positions of the main automotive players,
both as individuals and as a group.
Thus 'Coupled Ratios'
was obviously devised so aid investment process intelligence, be it
only one part of the complete jigsaw to do so. It intentionally sits
as the simple 'country cousin' to the 'city slicker' that is
modern-day 'quant' analysis - complex mathematical equations driving
algorithmic high-speed trading.
Given that the future
of capitalism rests upon mass populations' improved appreciation and
trust of investment principles, there should, indeed must, be a
re-assessment of those far simpler methodologies; those derived from
history and understandable to even the most basically numerically
literate person – from a Manhattan penthouse to a Mumbai slum.
So that an ever
increasing number of people can participate in and so grow both the
global investment funding pot and its very structure. And though
financial hubs are indeed necessary, a notable move away from the
'ivory tower' syndrome which exists, which when inadvertently toppled
by complex financial instruments only serve to damage the finance
industry's reputation, the public purse from 'bail-outs' and the
future financial security of the average man and woman.
However, the creation
of 'Coupled Ratios' and the intent behind it are but nothing to the
learning and knowledge of the investment world's past-masters.
To this end, this
web-log and the next will relay in what is hopefully a concise manner
the advice of those luminaries.
The following text is
essentially an overtly simplified, very, very abridged version of the
book 'Money Masters of Out Time' as compiled by John Train, the
founder of a long established investment firm, author and
contributing writer to various financial newspapers, and first
published in 2000.
The persons covered in
the book are:
- T. Rowe Price
- Warren Buffet and
Charles Munger
- John Templeton
- Richard Rainwater
- Paul Cabot
- Philip Fisher
- Benjamin Graham
- Mark Lightbown
- John Neff
- Julian Robertson
- Jim Rogers
- George Soros
- Philip Carret
- Michael Steinhardt
- Ralph Wanger
- Robert Wilson
- Peter Lynch
It must be noted that
today's far more globalised, complex and inter-connected world can be
viewed as a different animal to the largely US centric world in which
many of these people operated as the best of broader group who for
the most part rode were able to ride portions of the American 20th
century economic boom. However, such experiences should have valuable
insights for those seeking to best ride global and intra-regional
economic development today and into the future
[NB all quotations are
paraphrases]
Thomas Rowe Price (1893
– 1983) -
“Stick with the best
companies in the highest growth industries”
“Be suspect of Wall
Street valuation models”
[this typically
referring to the much vaunted DCF (discounted cash-flow method) which
itself can be malleable to suit over-optimistic data inputs on sales
etc to suit prevailing management desires. This was the undoing of
the UK domestic motor industry in the 1970s, 1980s and 1990s]
“Many complex
mathematical approaches create the illusion of certainty, nothing
could be farther from the truth”
[the CDO sparked
financial crisis obviously attests to this]
“In the post 1974
bubble world I sought-out 3 categories of investment criteria:
1. growth stocks of the
future (early point in their life-cycle)
2. value stocks of
established companies (at good prices though matured)
3.'mixed grille'
companies (at basement bargain prices).
Warren Buffet (1930 -
), Charles Munger (1924 - ) -
“the investor should
have six basic characteristics”:
A. animated by
controlled greed, and fascinated by the investment process, yet don't
be hurried by greed...if too interested in money it will (both
metaphorically and literally) 'kill you', if not interested enough
you won't go to the office. Above all enjoy the process.
B. have patience with
holdings that are taken
C. think
independently...no committees...”if you don't know enough to make
your own decisions, get out of decision-making”
D. self-confidence and
self-security should come from knowledge, without being rash or
head-strong
E. recognise and accept
when you don't know something
F. be
flexible as to the types of businesses bought, but never pay more
than the business is worth now, or its worth in due course.
“sometimes
though the bell rings and you can almost hear the cash register”
“the
bigger fool in the 'bigger fool theory' – accepting a bad buy and
seeking to sell it on – is usually the original buyer and not the
intended victim.
Also...
“be a
genius of sorts” (in whatever sphere) [presumably to confirm
intellectual capability]
“possess a
high degree if intellectual honesty”
“avoid any
significant distraction”
“recognise
that only a few businesses are truly exceptional”, their
characteristics are:
1. good
return on capital without accounting gimmicks of lots of leverage
2. they are
understandable, and what motivates all stakeholders from stockholders
to management to staff and to suppliers
3. they see their
profits in cash
4. they have strong
franchises (ie branding) and so have pricing power
5. they don't take a
genius to run
6. earnings are
predictable
7. not natural targets
of regulation
8. low inventories and
high turnover
9. owner-orientated
management
10. high rate of return
on inventories and plant (ie high utilization)
“the best business is
a royalty on the growth of others, requiring little capital
itself”..this essentially meaning that it directly benefits from
the growth of others with little in-house expenditure.
“bad business
include”:
1. retail (ironic given
that aspects of Berkshire Hathaway's growth included the former),
2. bet the company
situations (eg aircraft makers),
3. farm-related
enterprises (given long inventory cycle of the crop year, possibility
of crop failure, and upfront farmer's costs),
4. dependence upon
research and development (seeing R and D costs as a problem not a
strength).
5. debt-burdened
companies
6. 'chain letter'
businesses (geometric growth requiring ever more cash)
7. dishonest management
8. long-term service
contracts
Buffet previously
espoused that one should “avoid smokestack American industries
requiring continuous massive investment, many of them are in trouble
because of strong competition, over-regulation, rising labour costs
etc”..”the symptom is that to stay in business requires more
money than can be be retained out of reported earnings after paying
reasonable dividends on the new stock and interest on the new bonds
that they constantly issue”.
[NB this was of course
long the case for GM and Chrysler of old prior to Chapter 11
bankruptcy, and indeed a 're-mortgaged' Ford, and still arguably is
in the long term inside the US even with recent complete 'write-down'
re-births. Hence far far greater reliance upon EM regions able to
replay the early 20th century American industrial model in
the 21st century; the new headwinds being EM political and
socio-economic demands of those countries].
“understand at least
basic accounting principles, the bedrock of investment
analysis...without it the investor cannot understand the discipline,
let alone find where the truth lies...understand changes to
accounting methods (eg meaning if a switch from LIFO vs FIFO) etc.
“be aware the dangers
of management stock options, which is detrimental to the external
stock-holder's income, the manager then gains from the upside but not
exposed to any (possibly self-induced) downside in the businesses
fortunes”
Buffet's co-operator
Charlie Munger similarly sets out 8 principles:
1. specialisation often
produces very good business economics
2. advantages of scale
are important
[NB these the
corner-stones to Germany's global-reach Mittelstand businesses]
3. technology business
improvements must serve the shareholder before customer
4. investors should
figure where they have an edge and stay there
5. 'bet big' when the
the right moment comes, otherwise never
6. a significant
discount means more upside and a greater margin for safety.
7. buy quality even if
its costs more
8. low turnover reduced
taxes and increases returns
John Templeton (1912 -
2008)
The ten principles:
A. portfolio
diversification across various sectors
B. search many markets
for companies selling at a fraction of their true value
C. be sector specific
and country specific
D. hold flexible
viewpoint(s), see past the .surface'.
E. understand the
negative importance of 'expropriations'.
(this being the impact
of constraints that destroy investment value, such as price controls)
F. be detached from
crowd psychology (typically enthusiasm vs desperation)
G. question business
management about competitor capabilities
H. use all
cost-efficient available intelligence sources
I. don't trust rules
and formulae
K. the four universal
criteria are:
- p/e ratio
- operating profits
margin
- liquidation value
- growth rate and
earnings consistency.
Richard Rainwater (1943
- ) -
A seemingly rarer type
of long-term investor, who would essentially scenario-plot the
expected future, imagine the 'shape' of what a 'perfect type' of
company would take and then seek out current companies which
approximated the notional ideal.
Having found a company
of that ilk, he would become an activist investor, working as
investor / consultant / merchant banker so as to re-mould the company
into his envisioned version.
Strategy elements:
“I'm interested in
large industries and companies that offer products the whole world
needs”...
A. target a major
industry in disrepute and ripe for change
B. Identify a
particularly attractive company or sector target within that
industry. This he refers to as the 'double-play', gaining at company
and sector structural levels.
...and “companies
which has a long-term sustainable advantage, or 'impregnable business
franchise'”
C. find a “world-class
player” to run the show, rather than personal hands-on management.
D. never enter an
investment alone, creation of a partnership with trusted colleagues
and specific industry experts
E. improve the
risk-reward ratio through financial engineering
[NB though in this
present new era, because of the leverage effect which snowballed the
financial crash, financial engineering has become problematic, though
the long low interest environment will no doubt unfortunately
regenerate this approach].
Paul Cabot (1898 -
1970s)
Long passed and an
elder statesmen of the investment community, this passage of the book
starts with his election to JP Morgan's board as a young man and
describes him as “the dean of institutional community in Boston for
many decades”, having run Harvard University's endowment fund for
17 years and at State Street Management.
Importantly he heavily
criticised the mutability of large educational endowment fund
trustees who could be convinced to change their typically
conservative stance by excessively exuberant influences in what
rightly appeared to him as the late phases of an economic and
business cycle.
His personal
investments included only 'good grade' municipal bonds where local
administrators has a sense of local responsibility.
Edicts:
“realism and
care”...”I've only got confidence in older men who have been
through depressions, recessions, wars and all the rest of it”.
Philip Fisher (1907 –
2004) -
Apparently a man of
simplistic behaviour who abhorred superfluous administration.
General perspectives:
- not a lot of 'good'
investments, just a few outstanding ones
- companies with
outstanding business management and technical leadership
- understood
manufacturing, avoided financials
- concentrate on growth
from intrinsic worth
- only sell for one or
more of three reasons:
a) you made an
appraisal mistake
b) the company ceases
to qualify under same appraisal method
c) if a better
opportunity elsewhere arises
- mature companies fine
if:
1. able to maintain low
cost production
2. constant cost-cutter
across the business
3. innovation culture
- do not throw away the
investor advantage of valuable knowledge gained about certain
companies in favour of comparable scant knowledge regards new
companies
- do not sell because
you think the stock is too highly priced, or because it has gone up a
lot.
- a truly great company
grows indefinitely
- act conservatively to
make capital grow in a practicable manner
- recognise mature
companies past their prime relative to their more dynamic younger
international competitors.
Fisher believed that
'outstanding companies' enjoyed two aspects;
A. characteristics of
the business
B. quality of
management
A. business
characteristics:
- growth from both
existing and new products
- high profit margin
- high return on
capital
- effective research
(management and technical)
- superior sales
organisation
- advantage of
comparative scale
- valid 'franchise'
(brand power)
B. management quality:
- high integrity
- conservative
accounting methods
- accessibility for
investors
- long range outlook
(at the expense of
quarterly earnings as required)
- excellent financial
controls
- multi-disciplinary
skills
- specialist knowledge
associated to specific industry
- good personnel
policies (staff and management)
- continuous programme
of cost cutting
Other issues recognised
were:
- exceptionally high
profit margins attract new competitors, often better to have a small
competitive edge plus a high turnover, so leaving little competitive
incentive.
- greedy managers are
likely to issue themselves new stock options when the company exists
valued 'under book' during lean business and economic periods, only
to grow, then achieve 'price to book' or over because of market
sentiment, without the management having fundamentally altered the
companies general shape or directly improved its natural health, yet
able to cash-in on their stock options. This seen as extracting
innate value from previous and recent external share-holders.
- management that
pursues short-term goals whilst talking 'long-term language', this
seen via short-term creative accounting, which “borrows from the
future to boost near term results”.
- viewed that
institutional investors soon recognised such traits and so
effectively 'capped' the innate long-term valuation of the company
concerned.
- the all too typical
over-optimism of annual reports...”the officers of a company seem
to view the report as a form of advertising”
Three stage company
analysis:
1. view all publicly
available material
2. use the
'scuttlebutt', that is industry forums (events to grapevine)
3. company visits
“A company best
serves its investors by management following a constant, predictable
dividend policy”
Yet
“Higher dividends
means lower corporate re-investment, and a lower long-term growth
build-up of value...which investment is all about”
Benjamin Graham (1894 -
1976)
Seen as the grand-daddy
of 20th century investment, influential through his 2
primary publications, his career greatly assisted when made a partner by the age of 25, and forming his own
investment pool in 1926.
However, as a
mathematics enthusiast and so a near purely numbers-driven
quantitative analyst, he was perhaps overly reliant upon just the
numbers and far less appreciative of the macro-trends.
“have the ability to
say no to apparent opportunities, many times over if necessary”
“diversification is
important, a singular investment might go wrong, but that effect
buoyed by a the range of others, a type of pro-active insurance”
“a holding may fail
to be an investment and thus mere speculation because the analysis,
the safety or return is lacking”
“the market pays no
attention to reality during periods of speculative enthusiasm”
“The fact that other
people agree or disagree with you makes you neither right nor wrong.
You will be right if your facts and reasoning are correct”
“seek-out 'bargain
issues', companies selling for less than their current net asset
value - “cigar butts”
“it always seemed
ridiculously simple to say that if one can acquire a diversified
group of common stocks at a price less than the applicable net
current assets alone – after deducting all prior claims, and
counting as zero the fixed and other assets – the results should be
quite satisfactory; they were so in our experience for over 30 years”
“sometimes the
patience needed is quite considerable”.
“yet in times of
gloom, as any practicising securities analyst knows, you always have
any opportunities”.
Six methods used by
Graham's fund:
- buying of stocks at
two-thirds or less of their net current assets
- buying companies in
liquidation (80% + hence of making 20% return annually)
- risk arbitrage:
playing both buy and sell sides of an acquisition
- “convertible
hedge”: buying a convertible bond or preferred stock whilst
simultaneously selling the common stock it converts into.
- buying control of a
company selling for less than its worth to force realisation of the
assets
- “hedged investing”:
buying long one security and short another to balance-out.
Noted by 1939 that
“hedged investing” was to precarious to continue.
Indeed, for the average
retail investor, only the first method is still periodically
available, since the others have become so professionalised.
Undervalued assets were
key, he didn't care what the company did or whether the management
were capable, simply the level of under-valuation, hence very happy
with liquidations.
By the 1970s his
theorems had become adopted as core techniques for all professional
and good amateur investors, so the competitive advantage seen to be
diminished.
He then proposed a much
simplified approach based on:
1. purchase of common
stock at less than working-capital value, or net current asset value,
giving no weight to plant and other fixed assets, and deducting in
full all liabilities from current assets.
2. purchase of common
stock at seven times reported earnings over previous 12 months
“at bottom it is a
technique by which true investors can exploit the recurrent excessive
optimism and excessive apprehension of the speculative public”
with in 1976, building
on previous standing:
A. purchase of common
stock at less than two-thirds of net current assets giving no weight
to fixed assets and deducting all liabilities in full, and thereafter
sold at 100% of net current assets
B. the company should
owe less than it is worth
C. the dividend should
be no less than two-thirds of AAA bond yield.
Selling points:
1. after the stock has
gone up 50%
2. if the dividend is
omitted
3. if earnings decline
that make current price is 50% over new target price
Interestingly Graham
stated that it is perhaps irrelevant if the investor knew nothing
about the company being selected, he had such faith in the numbers
[NB in the 2000 edition
John Train ends the synopsis of Graham by rightly stating that the
overly simplified 'all numbers approach' is overtly hypothetical, and
that a mix of 'deep numbers diving' (bottom-up) and
macro-appreciation (top-down) would return and has become the norm].
Mark Lightbown (1963 -
) -
By 2000 Lightbown had
earned a reputation as the EM investment manager, amongst those
operating in a 'classical style' of stock-picking, not just EM
mass-buying as seemed the case in the late 1990s after the Asian
Tiger Economies crash.
His interaction came
with recognition of the potential in South America, Chile
specifically given its richness in natural resources: copper, timber,
agriculture and fishing; after the Allende-Pinochet era.
- focus on 'true worth'
- derived from market
capitalization, including and excluding debt.
- compare results to
sector peers
- review against
self-calculated (not market set) valuation.
- if attractive, set a
price range for stock purchase
'True Worth':
- determine the FCF
(Free Cash Flow)
- preferred method is
to use operating profit plus depreciation and amortisation, then
subtract the amounts required in plant and equipment and additional
working capital to maintain the expected growth rate.
- this determines
whether the company will still spin-off cash to its owners, or if it
will instead demand fresh equity to support growth.
“the aim of every
business is to create economic goodwill”, ie to grow its innate
value.
- determine at which
stage or aspect of the business true added value arises
“ I seek management
able to grow the business on incremental invested capital”.
“management must have
'intellectual integrity' (ability) to appreciate the future”.
Macro and micro
viewpoints:
- EM countries must
have aligned President and Congress to support pro-capitalist reforms
- a country must see
beyond its natural resources base, to trade and 'people-soft'
activities
- indigenous population
must want to save and invest, so create a virtuous domestic cycle
- a large trade surplus
can be viewed as strong 'national savings'
- homogeneous
population with no of few ethnic rivalries, toward common goal.
- educated and
aspirational population
- good savings to
investment channels, esp for all new infrastructure
- a basic legal and
technical system to permit capital movement
- existence or arrival
of a stock exchange
- little / no
government intervention
- low and stable tax
rates
- deregulated labour
force
- structural
reformation is easier in a country of 'manageable size'
- extracting useful
information about a company from its competitors is problematic
- get to know the
owner-capitalist of the company, s/he has the same problems
- good companies
penetrate far corners of the country, so good distribution channels
- the substantive
reality of 'siphoned goods' into the hands of criminal groups
“don't wholly believe
local sources of information, even investment 'professionals'...to
get a feeling for how things really happen you should travel
extensively by public transport around the country that you are
interested in...sniffing around the countryside and provincial cities
is far more instructive than worrying about the latest opinion
polls...it helps you build a mental model of how different components
of the country interact...read local newspapers likewise”
Findings:
“the ultimate prize
in EM investing is to find a medium-sized company with a solid
position in its economy that is on the way to becoming a big company,
and eventually a regional or world-class company”
“critical to EM
regions is assessment of competitive forces, whether the true market
strength of a company is because of its own capabilities” (possibly
having acquired competitors) “or because a multi-national has not
arrived”
“be patient”
“if you buy a good
company that is a valid takeover candidate, you're sitting there when
a big multi-national makes an offer”.
To Follow -
A summary of John
Train's perspectives on:
- John Neff
- Julia Robertson
- Jim Rogers
- George Soros
- Philip Carret
- Michael Steinhardt
- Ralph Wanger
- Robert Wilson
- Peter Lynch
