Category Archives: Investments

posts on investment candidates

Amateurinvestor beats S&P in 2017

In 2017, Amateurinvestor portfolio soundly beat the S & P 10, 5 3 and 1 year returns, as shown in the table below.

Fund/index Expense ratio (%) 10y (%) 5y (%) 3y (%) 1 (%)
Amateur Investor   17.9 21.4 21.5 35.6
S & P Index   6.9 13.2 9.65 20.16

 

Holdings of each stock at 2017 year end are as follows:

ADBE: 7.7%

CNI: 5.1%

MSFT: 46.1%

SBUX: 12.6%

V: 27%

Performance of my stocks for 10, 5 3 and 1 year in the market, end of 2017, shown in the table below.

    ARR %    
stock 1y 3y 5y 10y
ADBE  74.97 35.77 36.8 15.8
CNI  25.7 8.38 14 14.67
MSFT 40.5 24.7 27.7 10.48
SBUX 7.97 14.6 17.6 21.04
V 46 21 na na

Note Starbucks (SBUX) has slowed its growth as it failed to meet earnings targets predicted by management, although earnings were still adequate for the present, just not fulfilling the past sunny promises. This is a common growth stock story and this is why we pay more attention to past achievement rather than rosy predictions.  It is also why we buy cautiously at high valuations.

Microsoft (MSFT) was range bound from late 2000 until late 2013. In that decade MSFT proceeded to dominate one historical stage of its market, consumer and business server software, with revenue increasing from $23B in 2000  to 77.8B in 2013. However under the non-engineer  Ballmer, MSFT did not reliably expand its dominance to newly emerging markets such as mobile and search.  In late 2013 under new CEO engineer Nadella, MSFT has accelerated its growth into the public/hybrid cloud on which business will depend in the future, returned to its historical focus of making its software available as a standard on all platforms.  The stock has accelerated, with the realization that even with the investment required to establish public cloud infrastructure, margins will remain high, and that the historical dominance in business server software will translate into a preferred competitive position in the hybrid/public cloud  for the business market.

VISA (V) has been a pioneer company with the  steadily strengthening competitive advantage of its global Visanet for multiple decades. It came out of the gate running as a public company March 2008, and has steadily grown into an expanding addressable market, while actively establishing standards which enable the  digital payments market.

Canadian National Railroad (CNI) stock price and to some extent revenue was affected by the fall in oil prices in 2015, but this did not materially affect the strength of its business.  meanwhile, its ports are expanding container volume capacity.

Adobe Inc. (ADBE) has continued to dominate the graphic arts digital content business and become a dominant force in digital marketing of this content.  Its partnership with MSFT gives it a stronger global reach.

It is satisfying to find that an Amateur can achieve these definitely satisfactory returns. Young or old new investors can do likewise, provided they do the adequate reading and think critically. Investment can be fascinating in what it teaches you about human nature in history and today, and what you need to learn about  prospective companies or those you buy.  The investor’s assets work and grow for him or her.

 

 

 

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Portfolio Performance for 2016: underperformed, but businesses doing well

Performance of my portfolio for 2016 was only 7.4%, underperforming S&P which made 9.54%. 

On 12-31-16 the relative proportions of holdings were

 

MSFT 49.9%

V 22.7%

SBUX 15.2%

CNI 5.59%

ADBE 4.98%

Cash 1.43%

 

No stock trades were made this year.

Beginning with Q2 2016 dividends were credited to cash instead of reinvested, to build a reserve for future purchase of stocks when they should reach an attractive low price. 

The performance of my stocks in the market was as follows:

 

MSFT    +14.65%

V           +1.36%

SBUX     -6.1%

CNI        +22.67%

ADBE    +9.59%

 

Possible causes of the relatively low performance are as follows. 

In the market volatility in September 2015 and January 2016, the S&P fell 10% from its peak of 2126 on July 17 2015 to 1921 on September 4, 2015, before climbing again to a peak of 2099 in November 6, then falling 12% to 1864 on February 12, 2016.  Unfortunately, I had no cash ready to invest in order to take advantage of the attractive low prices which appeared during the dip.  That is one reason that my performance was lower than it should be.  To address this, as mentioned above I began setting aside dividends to build a cash balance to fund acquisitions at attractive prices, whenever these should appear.

Another reason was that SBUX and VISA had suboptimal years in performance, although not as businesses.  SBUX missed revenue expectations for the first threequarters of 2016, then beat in Q4.  It beat earnings in Q1, met in-line in Q2 and 3, and barely beat in Q4.  The stock price more of less followed these results.

During 2016 Starbucks began developing its strategy of “premiumization” of the Starbucks experience, with the Roastery flagships stores and the Reserve category of Starbucks stores.  The various initiatives to expand the Channel Development segment continued.  The Full year 2016 revenue rose 11% and non-GAAP EPS 17% yoy, so hardly a poor showing.  The trailing PE is currently about 30, which is approximately average for recent 10 years. The continued evolution of SBUX to strengthen its competitive advantage and adapt to new markets is intact.

VISA acquired VISA Europe on June 21, 2016, for €12.2 billion ($13.9 billion) and €5.3 billion ($6.1 billion) in preferred stock, convertible to VISA Class A stock, with an additional €1.0 billion, plus 4% compound annual interest, to be paid on June 21, 2019.  To pay for this, VISA in December 2015 issued $16 billion of senior notes with maturities ranging between two and 30 years. The acquisition was expected to be dilutive to earnings in 2016 in the low single digit range. 

Stock dilution is being offset as the $16B debt issuance is being used partly to increase stock buy backs.  The acquisition should be accretive in low single digits in 2017 excluding integration costs, and accretive in high single digit range by 2020.  The increased earnings are partly from increased efficiency:  increased scale, cost cutting efficiencies realized by integration of the businesses, and benefits related to Visa Europe’s transition from a member-owned association to a for-profit enterprise. VISA Inc. will be positioned to take on the estimated 37%, or USD $3.3 trillion, of personal cash and check spending in Europe. Europe has been an early adopter of mobile payments using NFC, expected to grow.  Visa Inc. has aggressively launched new mobile payment partnerships, platforms and products that will enable faster growth and adoption of mobile payments in Europe. This includes new tokenization services, support for digital wallets and wearables, strategic investments in other enabling technologies, ecommerce (such as VISA Checkout) and P2P payment capabilities, as well as the opening of several global innovation centers. 

VISA will be able to present a seamless experience and global capabilities to its European and international clients.  Hence the evolution of VISA Inc. to strengthen its competitive advantage as digital payments global market leader, and adapt to serve evolving markets, is intact.

 

VISA Q1 2017 Earnings, harvesting market growth, ploughing and sowing for the future

2-4-2017.  VISA Q1 2017 (2-2-2017) earnings call was led by Alfred Kelly Jr., who became CEO, replacing Charlie Scharf on 12-1-2016.  Al Kelly graduated from Catholic, Christian Brothers affiliated Iona College, in Westchester, NY, with undergraduate and MBA degrees. He worked in the Reagan White House as manager of information systems (using DOS, or Windows 2.0?) from 1985 to 1987, then held a range of important roles at American Express for the next 23 years.  He has been on the VISA Board of Directors since 2014 and therefore played a role in approving the current strategy. 

In the earnings call, Kelly noted that VISA strategy will remain as is, in a seamless transition with the previous CEO. He noted VISA has a talented leadership team; strong relationships with issuers clients, acquirer clients and merchant clients. It is important to learn about and address their business needs while reducing friction in and enabling digital payments. VISA is in an industry with strong growth. In developing markets, middle classes and governments are demanding payment digitization. In developed markets, ecommerce and mobile payments are displacing checks and cash. VISA is a leader in payments technology and constantly supports innovation in ecommerce and novel forms of payment digitization.

I will address the overall strategy of VISA, which describes how VISA fills a key criterion of an Eternal Company investment: the ability to extend its competitive advance into evolving new markets, in a separate post.

Following is a summary of Q1 2017 financial results.  Rev and EPS exceeded expectations as accelerating business more than offset exchange rate shifts.  GAAP Q1 rev up 25%, EPS 7%. Adjusting for the non cash gain in Q1 2016 from writing off the VISA Europe put, adjusted EPS up 23%.  Payment volume growth increased 1-2 % in most geo regions. Cross border payment growth accelerated 2% from 10-12% globally excluding VISA Europe. Including VISA Europe impact, they accelerated 10%.  Process transaction growth accelerated 15 from 12-13% driven by India and US.

Did not issue 2$ Billion in debt as panned to finance VISA Europe acquisition as well as other costs. VISA has 8$ Billion offshore, will await Trump plan for corporate tax reform which may well allow cash efficient cash repatriation. Until then, used commercial paper issuance to fund stock buyback and operating cash needs.

The only region with reduction in growth was Latin America, due to Brazil. 

The integration of VISA Europe is proceeding and will continue throughout 2017. Europe represents meaningful growth opportunities, with large opportunities to displace cash.  Plan to advance digital payments by rolling out tokenization, VISA Checkout, and supporting digital wallets.   VISA continued to focus on local market priorities alongside client engagement. The vast majority of VISA payments volume in Europe remain under contract and is therefore protected in the short term.

The deliberate process of consultation of VISA Europe staff was completed later than expected. New hiring, investment to integrate technology with that of the international VISA system are adding expenses as planned.   As cost reductions are realized and Europe clients access global VISA capabilities,  earnings will accrete and value will be realized for shareholders, as planned since the takeover was announced.  Equity dilution related to the purchase is being offset by accelerated share buybacks. 

In India, Aggressive demonetization measures pushed by the government resulted in doubled transaction volumes but little revenue growth. Responsive to request by the Indian Government, VISA charged no fees for processing through 12-31-2016.  VISA regards this as an opportunity to expand the network and acceptance internationally, focusing on building customer awareness and merchant acceptance 

Kelly articulated “So.. when you consider the economics of the investment we will make in India, plus conservative pricing, it will not drive much profit this year. But this is a great year to make sure we do everything we can in one of the two largest population countries in the world to get as good a position as we can to help us over the next decade. “

I would like to make two observations on this lovely sentence.

1. It prioritizes strengthening the company competitive advance for the long term over short  term profits

2. the nature of the VISA business supports long term investments such as the one mentioned because of its competitive advantage.  The VISA services introduced into the developing India market will still be indispensable in 10 y.  As long as VISA continues to support successful innovations in payments, while nurturing and strengthening its network security and reach, it will undoubtedly maintain its relevance and dominance in the market. 

 

 

 

Essential Criteria of an Amateur Investor investment.

edited 4-4-2016
1.  Sustainable Competitive advantage defending or growing market share in its specific market.  This is the sine qua non of our investment choices and the foundation of our approach to investment.  The company with a competitive advantage is rare.  It is marked by the ability to increasingly attain returns on investment above its cost of capital, and above those of its competitors.  A competitive advantage might be made durable by low cost/high volume leadership among competitors; barrier to market entry of competitors; product differentiation/switching costs to customers.  The company with a sustainable competitive advantage sells an indispensable product.

2. No competitive advantage truly lasts for ever. Hence, a related critical facet of the competitive advantage feature is that management consistently anticipates or reacts to changes in the market or competitive landscape by finding profitable ways of extending the company’s competitive advantage into new markets that are tangibly related to its current markets. That is, the company adapts and evolves to perpetuate its competitive advantage by extending it into the evolving new markets.

3.  Evidence of devotion to shareholders by its capital allocation, manifested in the following ways
stock buybacks to reduce share count
avoiding excessive dilutive stock compensation
obtaining good returns on investments in acquisitions
aligning reward and performance of management and employees to reward shareholders and long term company performance
allowing shareholders to have voting power commensurate with their stock ownership.

4  Common stock of publically traded company based in U.S. or other relatively transparent legal environment with respect for property rights, at least 10 years old.

5. The investment worthy activities of the business are demonstrated in the record of its past and present achievements, not in the hoped for future.

6.  quantitative evidence of ability to obtain returns on investment above cost of capital, such as low debt level, growing free cash flow, high free cash/revenue, high gross margin, high ROE and ROI.

2015 a year of realization, refocus, and anti-diversification

Amateurinvestor beat the market soundly in 2015. The 1 year return was 23.7%; 3 year: 22.1%; 5 year: 21.6% and 10 year: 15.3%. The S&P 1 year return in 2015 was -0.73%. As of 1-5-2016, S&P 3 year return was 11.2%, 5 year return: 9.58%, 10 year return: 4.70%. Therefore I have approximately doubled the S&P returns for 3, 5 and 10 years.

The relative proportions of my holdings are as follows:

MSFT 48.75%
CNI 4.6%
SBUX 19.7%
V 24.7%
ADBE 1.4%

The portfolio is rather focused, in fact the number of stocks dropped from 8 at the beginning of the year to only 5 stocks today. I would like to share some thoughts regarding my sale of 2 companies this year, Cerner (CERN) and Intuit (INTU). I sold these because I realized their purchase was a mistake.

I bought Cerner in October 2013 at $57.75. Cerner is the largest dedicated digital medical records software provider, has an impressive gross margin and a business with a high proportion of recurring revenue and switching costs. I bought it because it has an impressive record of growth for over 35 years. It provides a software platform is a critical part of its client’s business operations. It has staying power and seemed to have a durable competitive advantage. At the time I bought it, I owned just 6 stocks, which seemed to me to be very few, even for a focused portfolio. It seemed wise to diversify into a new strong company I had found. I had a few small doubts at time of purchase. At the time CERN had risen because of recent success in agreements to sell its software and services to major medical centers, particularly Intermountain Healthcare in Utah. I knew it was richly valued. In addition, it regular buys shares to compensate for share based compensation, but still manages to continually increase its share count, which casts doubt on its dedication to shareholder value. Unfortunately, events have shown that because of its high valuation, any miss in analysts’ earnings/revenue estimates are met with a drop in the stock price. There has been some loss of important customers to competitors recently which casts a little doubt on the invincibility of its moat. I decided to sell on August 10. At this point I was uncertain how well it would recover from the market instability of that time. Moreover, I was provoked by a quarterly revenue miss. Overvalued stocks with evidence of weakness in their franchise do not do well in market downturns. I sold at $65.40, at a modest gain, so the damage was limited. On Jan 6, 2016, CERN was at $57.9.

My error in this case was a failure to understand the Cerner business well enough either to a. be convinced that its earnings would continue to grow safely in spite of current overvaluation and related vulnerability to temporary downturns, or b. realize that it’s competitive advantage and dedication to shareholders were lacking and therefore not good enough to earn a place in my portfolio.

Underlying this mistake is a more fundamental and common error, that of impatience. I could have simply taken the necessary time to analyze the company before buying. Had I done so, CERN would have been available at a little less than $50 several months later in May 2014. In any case, the allocation at the time of purchase was approximately 0.8% of the portfolio, so the damage was bound to be limited. I cautiously limited my allocation because of my trepidation regarding valuation and other factors mentioned above. In fact, one might ask what was even the point of investing such a small amount in this company. To this I can only reply that I acted from intuition instead of analysis. The advantage of this is that it certainly limited the damage caused, while adding experience. The avoidance of serious mistakes is an important part of investing success.

Upon reflection, I note that I cautiously limited the size of my allocation, and also that I feel a needed a deeper understanding of the company, and that I could have been more patient. We will revisit these points later.

Intuit is an apparently attractive business, with a dominant share in small business accounting software, and market leading shares in retail DIY tax software and professional accountant tax software. As are Cerner, Microsoft (one of my favorite investments) Intuit was a survivor of the early 1980s boom in computing. As with Cerner, it seemed to be a judicious addition of a long lasting company with clear competitive advantages to my portfolio of so called eternal companies. I bought it in February 2015 at $91.00. It seemed somewhat overvalued but I attributed this to the well-established strength of its franchise. It has introduced Quickbooks Online, a cloud based version of its dominant Quickbooks small business accounting software. Other than Turbo tax, the market leading consumer tax software, the other anchor of its competitive advantage is (was) Quicken, software for home finance management.

In August 2015, again at a time of market turmoil, Intuit management made some capital allocation decisions which shook my confidence in their competence, namely the decision to divest Demandforce and Quicken. Intuit had acquired Demnandforce, an email marketing company for small businesses, in 2012 for $423.5 million. Intuit thought to integrate it with Quickbooks. 3 Years later, CEO Smith explained the abrupt decision to divest this recent acquisition made for over 10% of its 2012 revenue at the related investor presentation. He matter of factly stated that Demandforce and QuickBase [another business divested at the same time) are great businesses, but they do not support the QuickBooks Online Ecosystem and both serve customers that are up-market from our core small business customers.” When asked by an analyst to address Intuit’s record of acquisitions, he stated “many of the larger ones have not gone well”. “…We have a mixed record in terms of bolt-on businesses, new businesses that may not plug-in directly with QuickBooks or tax businesses…” and promised that management had developed a “set of criteria that [future acquisitions] have to meet”. In other words, he was promising that 32 years after its founding in 1983, Intuit would begin to ensure acquisitions make sense for the company before purchase. Obviously these words are not those of a CEO of an eternal company. Quicken was one of its original businesses at the founding and was providing over 20% of revenue in FY 2014. I was surprised by the decision to divest this instead of adapting it and continuing growth.

The poorly planned capital allocation into Demandforce and the abrupt divestiture of Quicken gave me the impression that Intuit management may not be able to adapt successfully to future markets. I had bought in February 2015 at $91.02 and sold in September at 89.26. I found it difficult to pinpoint where I went wrong here. Intuit seemed to be a sound and strong business, providing necessary products which had market leading shares. Perhaps if I had read more of the past financial reports, I would have discovered other episodes of poor acquisitions. Perhaps I should have simply observed its progress over enough time to get a more detailed impression of how it functions. Prior to its purchase, I had considered Intuit to be a strong business with an economic moat which was akin to those I owned. I actually sold shares in Visa and Starbucks, both of which were highly valued by conventional measures such as cash return, to buy Intuit. As happened with Cerner, I felt I lacked deep enough understanding of the company and its management, without which I was vulnerable to nasty surprises.

In the case of both Cerner and Intuit, I felt surprised by adverse company events, and retrenched back to my long term holdings. Therefore, 2015 was a year of realization, that buying companies which seem to be good businesses, and even to have a durable competitive advantage, is not enough. they must be observed to dominate their markets for the foreseeable future, and be observed to demonstrate management competence and respect for shareholders over some time, until one is convinced.

But how is one to judge when the evidence is enough to justify buying and holding forever? Sometimes the clue to a solution to a life problem can be found in a careful reflection upon the experience, and asking the question, “how did it make you feel”. This is because the correction solution is only correct if it is the right one for yourself. In the case of investing, as Benjamin Graham stated, “the investor’s chief problem, and even his worst enemy, is likely to be himself” (Intelligent Investor). The investor will need to be comfortable holding his security in the face of inevitable market fluctuations. In this case, as previously noted, I reflected that I did not feel I had a profound enough understanding of the company to feel comfortable holding in the face of a market downturn. The solution then is to wait and continue to analyze the company until I feel I know it well enough to be able to commit, or not. There are also cases of companies which are actually worthy, but seem overpriced, in which case one would wait for a market downturn even after having come to understand the company sufficiently.

This process of coming to understand the company is not purely intellectual. For example, I doubt a simple analysis of financial statements prepare one for Intuit CEO Smith’s rather absurd explanation of his failed acquisition of Demandforce. I believe rather than one must experience the company as much as is possible via its communications, perhaps its products, and by communicating when possible with clients, customers, employees. One must build a relationship with the company, until one feels one can trust it. This is actually what the legendary investor Philip Fisher (author of the book Common Stocks and Uncommon Profits) termed “scuttlebutt”, the flow of information he held indispensable for analyzing a growth stock.

Exploring a company which seems promising, and might rise in value, while waiting to feel fully comfortable enough to commit before buying, is difficult for two reasons. First, it requires patience. Inevitable, one is afraid of missing a low price. Second, it is surprisingly difficult to be motivated to really experience a company, to form a relationship with it, unless you have an interest in it. This may lie behind the investing approach of the excellent hedge fund ValueAct Capital. The investment staff study a company until it seems to be a good bet, then buy a small share and continue to follow it until they know it well enough to feel they know how it makes money, and what to expect from it. They then deepen the relationship by buying a stake large enough to command a board seat, and continue becoming part of it. Perhaps by buying a small stake in a company, I can be motivated to follow it closely enough to understand it better. Seen in the light of these thoughts, perhaps my cautious forays into new additions to my portfolio may not be faulted too much, but in fact be considered a necessary step to taking the time to come to know a company. And by limiting the size of initial investment, I limited the damage caused by errors. But the benefit is that this might be a way to actually discover new gems. Such was indeed the case with Adobe, a small investment I made which was turned out to be a wonderful investment.

Finally, 2015 was a year of anti-diversification, the acceptance that there are truly few companies which have exhibited the qualities of an eternal company in a lasting way, and acceptance that there is no need to diversity just for its own sake. In 2015 I sold Visa and Starbucks, which I had owned for years, and which I knew where companies with very strong franchises, to buy a new company, INTU, which I was less familiar with. Having corrected this error, my portfolio was whittled down to 5 companies. This time, I feel happy with the small number.

But again, reflecting upon this retrenchment back into my small collection of investment gems, I find that the high degree of comfort I have with my existing portfolio, continually reinforces the reluctance to invest in new companies. As my understanding of and satisfaction with my exclusive set of existing investments grows, this sets a higher bar for new companies to meet. And this may actually be an anti-diversification mechanism by which focus investing reinforces its own success.

Philip Morris Intl., for the first time, an actually better product, and better for you!

Like everything else, competitive advantages are not everlasting. Even the strongest company must sooner or later defend its business against competition. Moreover in a changing economy presenting threats and opportunities, it must adapt by extending its market dominance into new markets or modifying its products and brand to meet new market needs. Philip Morris International Inc. is successfully taking on such a challenge, and is likely to gain market share as a result. Read more.

Sustainable competitive advantage drives the choice of investment. CNI: a toll bridge investment on steroids.

Competitive advantage does not mean a company earns high returns on capital just because the management is smart. It means that competitors are not able to match its returns on investment. There may be a barrier to market entry, or switching costs for customers are relatively high. The company with competitive advantage can sell its goods at prices well above its cost of sales, without fear that competitors will flood the market and attempt to undersell it. This is reflected in healthy gross margin that is sustained over an extended time, and steady or increasing returns on capital investment.

In the metaphorical toll bridge investment, customers must pay to use the company’s product in order to obtain something they demand. In the literal example of a toll bridge, customers must pay for access to the bridge to a destination. Assuming the demand to reach that destination is persistent enough to justify building the unique bridge, the shares of the company are bid up because of the durability of this demand. The problem with toll bridge investments is that unless demand to reach that destination continues to increase, the company shares will not continue to rise over time. Since the company management recognizes this, it will likely pay a dividend in order to keep investors, as long as earnings continue to support it. Assuming there is no alternative bridge, the company’s competitive position is hard to attack, and management does not have to be world class. Earnings do not rise any faster than economic growth at the bridge destination, the stock price will reflect this. In an attempt to increase earnings more quickly, Management may allocate some income to attempted expansion into other markets, but there it does not possess a competitive advantage and will do no better and possibly worse than competitors who are dominant in those different areas. An example of this is Hawaiian Electric (HE), a regulated electric utility that supplies virtually all power on the Hawaiian Islands. Its growth is limited to the growth of power demand on the Islands.

What if over time demand for reaching the destination not only increased with growth of the most stable economies in the world, but also with the growth of the most rapidly growing economies (thus growing at a rate exceeding the average growth of the world GDP)?

What if the company had exclusive use of 2 toll bridges, with different markets clamoring for access to them? What if the management in fact did not merely rely on the advantaged position afforded by their non-reproducible franchise, but was driven by a historic struggle for economic survival to run the most cost efficient toll bridge possible, therefore focusing its capital allocation on improving its transportation speed and the capacity of its bridges? What if management was systematically incentivized to grow return on invested capital, earnings, free cash flow, and expected to purchase ownership in the company?

What if the toll bridge investment was Canadian National Railway (CNI)?