The Big Four

Here’s my post on the big four U.S. banks: JPMorgan Chase, Citigroup, Wells Fargo, and Bank of America. I go over third quarter results and what’s happen for the big banks.

Reposted from Seeking Alpha. The full article is available here.

Preview:


The Big Four

Summary

  • The big banks are hated. The negative sentiment creates an good entry point.
  • Once dividends and buyback restrictions are lifted, the space could attract more investors.
  • Q3 numbers suggest that banks are well-positioned to operate in an uncertain environment.
  • If the economy improves and the banks can release some of the reserve set aside.

This is a brief article on the four main big U.S. banks and its recent results. Earnings season has come and gone for America’s biggest banks. The results were better than expected but the sentiment is still negative. There’s no love for banks and to be fair they are hard to love. The combination of ultra-low rates, the pandemic, a recession, credit issues, the election, and regulations is not the cocktail that attracts investors. The Feds has also announced that it was extending restrictions on share repurchases and dividends for the largest banks—those with more than $100 billion in assets—for at least one more quarter. Buybacks historically accounted for roughly 70% of the banks’ capital return to shareholders.

The shares of Bank of America (BAC), JPMorgan Chase (JPM), Citigroup (C) and Wells Fargo (WFC) fell after earning release. 2020 hasn’t been a good year for bank investments. The KBW Bank index (BKX) is down 30% year-to-date. To summarize, earnings have surprised to the upside as robust trading activity helped offset lower net-income margins, and profits weren’t crimped by having to add billions to reserves to protect against bad loans. But the problem with banks is often what you don’t see. Trust is important. Insurance companies and banks are often considered black boxes. You don’t know with certainty if you can trust the balance sheet. Accounting and disclosures are opaque. Deutsche Bank (DB) trades at a paltry 0.3 times book value. Accounting can conceal more than it reveals about economic reality. Do bank’s financial statements provide a meaningful clue about its risks?

Banks are integral to how our system functions. Bank results are akin to taking the pulse of the economy. You get a diagnosis on how things are doing. Without getting deeply technical on how a bank functions, they are one of the organs that decide how much money circulates in the economy. When consumers pay down loans, that money gets recycled into new loans. A healthy bank system is core to a healthy economy. Look at Europe. The old continent desperately needs its banks to function better. Despite its flaws, I fundamentally believe the U.S. banking system is the best in the world. They are excellent at their primary function of allocating capital to the most promising opportunities which leads to an overall increase in the standard of living.

Continue reading “The Big Four”

Quality Shareholders

You heard of quality companies, but what about quality shareholders? I find the idea of “quality shareholders” very interesting. The topic is further explored by Professor Lawrence Cunningham. You can read more on the topic with the following paper: The Case for Empowering Quality Shareholders and Professor Cunningham has a book coming out this fall: Quality Shareholders: How the Best Managers Attract and Keep Them (Pre-order)

Here’s the preview from the book:

Anyone can buy stock in a public company, but not all shareholders are equally committed to a company’s long-term success. In an increasingly fragmented financial world, shareholders’ attitudes toward the companies in which they invest vary widely, from time horizon to conviction. Faced with indexers, short-term traders, and activists, it is more important than ever for businesses to ensure that their shareholders are dedicated to their missions. Today’s companies need “quality shareholders,” as Warren Buffett called those who “load up and stick around,” or buy large stakes and hold for long periods.

Who are the quality shareholders?

Quality shareholders can be defined by these characteristics:

  1. They are long-term shareholders. They believe in the vision and management. They stick around for a long time.
  2. They are concentrated owners. They own blocks of shares.
  3. They are studious shareholders with a focus on operations. They are not indexers or complacent.

Why have them?

Companies may benefit from a high density of such shareholders. They can be a source of lower cost of capital and are possibly available for consulting.

Also they can offset the balance between other shareholders. If you have an activist trying to rock the boat, the concentrated ownership of quality shareholders can be a source of stability

Or just think of what could happened if you didn’t have quality shareholders. If you shareholder base is composed of mostly indexers, traders or speculators, they might just bolt on you during the next market downturn. This will result in higher financing cost or possibly open the door for a takeover (maybe from a company with quality shareholders!)

Where do you find them?

It’s tough to be a publicly traded company. Eyes are on your every three months. If you don’t hit guidance your stock takes a hit. That’s not a way to run a company.

Today’s shareholders demographic is indexers heavy. They buy the index. They don’t care about the particulars of the business. They focus on the market returns. They don’t bring much to the table.

So where do you find these high quality angels?

Well it’s like anything in life. Do you have what it takes to attract them? Do you deserve them?

  • What corporate actions are you taking to attract them?
  • What message to you communicate?
  • Are you clear, consistent, and rational?

High quality companies choose their shareholders. By that I don’t mean they actually directly pick who will be their shareholders. What I mean is that they put the conditions in place to attract quality shareholders. Of course a publicly traded company is not going to have 100% quality shareholders. But they might bring a balance to the other groups.

I’m reminded by the old saying “birds of a feather flock together”. You attract what you deserve. It’s the same in life. Your partner in life, your circle of friends. How often do you see a smoker hanging out with a group of fit people? Not often. But if it happens you can tell it doesn’t fit. It’s the same when it comes to shareholders.

One idea is to end quarterly guidance and focus on the long-term plan of the business. And execute accordingly. Remember quality shareholders are not passive. It doesn’t mean you are a free pass. If you say you will deliver Italian food and you show up with fast food, they are not going to sit there quietly.

I’m reminded of a Phil Fisher analogy (author of the famous book Common Stocks and Uncommon Profits). Phil Fisher once compared companies to restaurants. Over time through a combination of policies and decisions, they self-select for a certain clientele. Are you serving fast food or 5-star dining? Two different crowd.

Here’s a couple Warren Buffett quotes from a presentation Professor Cunningham did on the topic. A link to the recording is here.

The Intelligent Investing Podcast – Brookfield Asset Management & Cultural Activism

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The Intelligent Investing Podcast – Eric Schleien

I had the pleasure to be back on the The Intelligent Investing Podcast with Eric Schleien.  Full show notes below.  If you are listening in a car or simply taking a walk, try these links:

After many weeks of back and forth, we finally got this episode done and it’s a big one. We mainly talked about the Brookfield Asset Management 2019 Investor Day that they held in New-York. We both attended the event as first timers and we share our take ways from the meeting. We also branched off and talked about cultural activism, Facebook/Instagram, Sears and malls, investing in India and China..and we could have talk a lot more. If you are interested, the whole event has been recorded is available with presentations here.

Brookfield (BAM) is a very interesting company. Only of few companies can do what they do. It has been one of my most successful investment and my bullish stance on it has been reinforced. Their business is only going to get bigger and more profitable over time. I’ve written and talked about BAM in the past if you are looking for a primer. If I ever get to it I plan on writing an article with my about the Investor Day. For now we have the podcast.

Show notes, links and summary by Eric: Continue reading “The Intelligent Investing Podcast – Brookfield Asset Management & Cultural Activism”

Keeping Your Dividend Edge

Keeping Your Dividend Edge
Available here.

Before I get to the book I want to share a little story. Something positive actually happened on Twitter. It turns out that Twitter doesn’t have to be carnage pit filled with trolls. There’s a nice guy on it and his name is Todd Wenning (@ToddWenning).

A while back I read Harriman’s New Book of Investing Rules. The book is 500 pages of wisdom by some great investors.  There are some well-known names and less familiar names like Todd. The investors profiled range in style and strategies. One of the articles in the book was written by Todd Wenning (@ToddWenning). I really enjoyed Todd’s piece and I reached out to him on Twitter to let him know. 

ToddWenning Book Twitter

Todd was a man of his tweet. I did received his book, Keeping Your Dividend Edge, and I was more than happy to read it. See, something positive came out of Twitter.

I like Todd’s philosophy on investing and dividends. His thinking really resonated with me. Invest like you are buying a business. Study the business, study the fundamentals, figure out the competitive advantage, and can you make a reasonable assumption that the company will be able to maintain its success for a decade or more to come. Focus on the long-term and get paid in growing dividends and capital appreciation.

Todd’s book is about dividend investing. It’s a short read with approximately 120 pages. There’s nothing wrong with a small read. It’s actually refreshing. The book doesn’t waste your time. It’s delivers on content. It goes straight to the point. It’s concise and clear. Just the plain blue cover signals no b.s., no hype.

You will become a better investor if you read this book and actually apply it’s principles. You will. Todd didn’t reinvent the wheel here. Dividend investing has been a staple strategy. But what Todd did is to remind us of the art of dividend investing.

I feel that dividend investing is a lost art. Or investing for income in general. Most income investors are doing it wrong. It’s like health. Everybody wants to be fit and healthy but they are doing it wrong by buying into trends and taking short-cuts. I feel it’s the same with income/dividend investing. People are approaching it the wrong way.

Investors are turned off by blue chips dividend payers because of the low ~2% yield so they chase high-yield stocks. We live in a world where investors are buying bonds for capital gains. The world has turned upside down. The most probable cause is the 10-year plus of ultra low interest rates is distorting financial markets. It’s been a tough stretch for savers in need of yield. Another cause is buybacks as the preferred way to return money to investors.

You can’t just invest for the dividend. If you don’t do your homework it could led to trouble. Dividends should be part of a grander strategy. A good strategy should include dividends as a part of total performance. It’s a key component of long-term share price movements. You can’t guarantee a dividend because a company doesn’t have to pay one, but with the right analysis you can have pretty good idea if they will pay one and raise it over time. If you aim for let’s say a conservative 6% to 7% annual return (S&P Index has returned 10%+ in the last ten years). With a 3% yield you have accomplished half your returns. One aspect of dividends I like is that it’s a tangible returns. It’s a real return. It’s real cash that you receive. And I like cash because it allows me to allocate more capital.

Dividend investing is about patience. Focus on the long-term. Focus on the business. Focus on the fundamentals. Focus on the cash flow because that’s where dividends are from. Dividends need to come from cash produced by the company (not accounting earnings).

Dividends are not a magic pill. A company can’t guarantee a dividend because unlike a bond, there’s no obligation to pay. Dividends can be cut. We have seen blue chips like GE, Pfizer, and more recently Vodafone slash their dividends. A company might take on too much debt and get in trouble. The share price of the company you invested in can languish, or worse disappear. Taxes could be an issue if not handle properly. Todd’s book has a whole chapter on avoiding dividend cuts. Usually the main reason is the lack of sustainable free cash flow.  If a company can’t covert a dividend with free cash flow, they need to fund the payouts with cash on hand, debt, or asset sales. Expect trouble if that happens.

The holy-grail of dividend investing success is the compounding effect. The combination of the increased in value of your stock (capital gain), dividends, and growing dividends reinvested that creates bigger dividends, that gets reinvested can turn your investment into a snowball what creates wealth.

In case it wasn’t clear by now Todd makes the case for smart dividend investing. In case you need to read it again, if you want success in the stock market you need a long-term patient approach. Dividends helps you focus on the business. It helps you focus on the fundamentals of the business. It helps you forget about the daily gyrations of the stock market. I have no clue what the stock market is going to do, so it would be more profitable to forget it and concentrate on trying to find the right stock to buy. Dividends also help you take hit. If you have an investment that is down 15% (because it happens) and the business is sound, you have your dividends coming in and an opportunity to buy the business 15% cheaper.

Long-term thinking, patience, and persistence are qualities which should pertain to investors. Dividends delivers on these fronts. Keeping Your Dividend Edge deserved a place on your investing book shelf.

Enjoy!

Brian

The Intelligent Investing Podcast – Berkshire Hathaway 2018 Letter

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*Update: I fixed the link to the podcast.

I reviewed the Berkshire Hathaway (BRK)’s 2018 letter and listened to CNBC interview that followed. I also share my comments on The Intelligent Investing Podcast with Eric Schleien from Granite State Capital Management.  I’m currently writing a post on the topic which will be available soon.

This is one of my shorter podcast, it’s only 25 minutes long. You can listen here:

Connect with Eric Schleien:

Visit Eric Schleien’s PODCAST: http://intelligentinvesting.podbean.com

Visit Eric Schleien’s WEBSITE: https://www.EricSchleien.com

Visit Eric Schleien’s TWITTER: https://twitter.com/ericschleien

Visit The Intelligent Investing Podcast’s TWITTER: https://twitter.com/investingcast

Like The Intelligent Investing Podcast on FACEBOOK: https://www.facebook.com/theintelligentinvestingpodcast/

Follow Eric Schleien on FACEBOOK: https://www.facebook.com/eric.schleien

Visit Granite State Capital Management’s WEBSITE: https://www.GSCM.co

Follow Eric Schleien on INSTAGRAM: https://www.instagram.com/ericschleien/

Capital Allocation Presentation

Phil Ordway from Anabalic LLC has made a great presentation on capital allocation. In everyday parlance, capital allocation is “how you use cash”. Everything involves tradeoffs based on opportunity cost and how you evaluate these tradeoffs is essential.

For those who read the excellent book The Outsiders (read it if you did not), you will enjoy Phil’s presentation. The presentation goes a beyond effective capital allocation. It address three things companies need to do that everybody would agree on.

  1. Effective Capital Allocation
  2. “Good” shareholders
  3. Meaningful communications with stakeholders

Point #2, “good” shareholders, is interesting and definitely not talked about enough. I’m glad Phil brought it up and should be the subject of further studies. Just having the “right” shareholders can make a significant difference. Think of the effect of having Warren Buffett as a shareholder did for Graham Holdings (The Washington Post). Point #3, meaningful communications with stakeholders, is not done properly. Most companies have some kind of Investor Relation “IR” department but don’t communicate properly.

This presentation is for investors, board members, executives, and anybody that runs a company.

Here’s a bonus presentation from William Thorndike, author of The Outsiders”.

Podcast: Investing in Cuba

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Copyright Eric Schleien

I was back on the The Intelligent Investing Podcast with Eric Schleien of GSCM to discuss Cuba. In a previous post I talked about my recent trip to Cuba. While the post has more of a global approach to Cuba (politics, economy, reforms etc…), the podcast is more geared towards investing. Of course they are opportunities but it’s not easy to invest in Cuba and it would require a lot of work (even more if you American).

The podcast is a about 45 minutes long, perfect for the work commute. If you can’t stand my accent, or you prefer reading, Eric published a transcript on SA.

Other platforms:

Charlie Munger’s Commentary on the 1960s Buffett Partnerships Fee Structure

Charlie Munger used Monish Pabrai as an example because he’s one of the rare to used the original Buffett Partnerships free structure. Monish went 10 years without taking fees, just living off his capital. That’s tough. But this is the right way to do it. It’s extremely rare to see investment managers use that formula because it’s  simply too hard.

The formula is 0/6/25:

  • 0% Management fee
  • 6% Annual performance hurdle with high water mark. That means you need a minimum of 6% gain to start getting paid. The high water mark is the highest peak in value that the investment has reached. The manager cannot collect an incentive fee unless the fund’s value is above the high water mark and returns are above the hurdle rate.
  • 25% fee on gains over 6%

A good question is do you think that formula would incentive a manager to take higher risk just to get over the hurdle rate? Or does it align the interest of the shareholders with the manager? I think the answer depends on the manager.

Graham & Doddsville Fall 2018 Issue

Here’s the new Graham & Doddsville Fall 2018 Issue from the Columbia Business School. There are some great interviews in it with some good ideas to further study. Here’s the archives for the past newsletters.

And here’s the Fall 2018 issue:

Graham & Doddsville Fall 2018 Issue

Getting Into The Weeds

My latest article, Getting Into the Weeds, hit #1 on Seeking Alpha! It’s an extension of The Intelligent Investing Podcast I did with Eric Schleien (GSCM). Eric’s podcast is doing very well and about to break the top #100 in the investment space.  In the article I take the time to dig deeper into specific sector of the marijuana industry.  With the legalization in Canada coming tomorrow (October 17) it’s good to have a sense of the buzz surrounding the space.

Just to be clear, I’m not an investor in the space. I’m also not recommending investing in the space. While on the sidelines, I know a lot of people making plenty of easy money on cannabis stock. We have seen Canopy Growth (WEED) go from $2 to $75 in a very short-time. Tilray, a company with just $20 million in first-half revenue, was briefly worth $30 billion. That’s more than Twitter, CBS, Harley-Davidson, Fitbit and American Airlines. At its height Tilray’s enterprise value surpassed 85x bullish estimates for its 2020-year sales and 340x that year’s estimated cash flows. Fast easy money is tempting and contagious. I’m happy for them but I believe the party is not going to last. We have seen this story repeat itself in the past.

To me the investor’s high on the marijuana sector is a red flag, and signaled that a sobering up may be imminent. The speculative craze is fueling a future crisis. This is the same story that repeats itself over and over. The tech bubble that ended in 2000, the pre-crisis U.S. housing craze, and the cryptocurrency bubble are some of the most recent examples of speculative manias. In each case, a defensible investment thesis – that technology will eventually dominate the economy, American housing prices could only move in one direction, and the blockchain was going to revolutionize everything – was extrapolated to a form of ridiculousness where no price was too much to pay for related investments.

There are some serious questions about just how profitable these companies can become under legalization. I think most investors do not understand what the space looks like, how competitive it is, what the margins look like. Distribution costs, advertising and sales taxes will further erode profit margins and cause price compression, possibly squeezing companies whose production costs are too high out of the market. Some of the companies that have gone public suffer from weak management, and investors need to be ready for a fall in marijuana prices because too many suppliers have entered the market. I see the valuations being attributed to places that have virtually no production, virtually no off-take agreements, which don’t operate in multiple countries and have a very limited R&D.

I’m not a market timer, I don’t have a crystal ball, and I don’t what’s going to happen. But I know that a company without profits can’t survive in the long-run. Right now these stocks are being valued like junior mining companies. They are valued in the “promised” of future riches. Eventually, once they start producing (legal sales in our case) they are valued based on their fundamentals (cost, margins, distributions, market, profits etc.). This is similar to a junior mining company transitioning from exploring to producing.

It’s a space that I suggest proper judgement.

Article: Getting Into The Weeds

Podcast: #36: Getting into the weeds on marijuana stocks (we aren’t so high on them) + Update on BAM & TSLA ItunesGoogle. First 23 minutes is a recap on Brookfield Asset Management and Tesla. Weed talk at the 23 minute mark.

Enjoy!

Brian


Getting Into The Weeds

By Brian Langis

  • Canada is legalizing marijuana for recreational use on October 17, 2018.
  • The changes that are underway closely mirror the process that alcohol went through after prohibition ended in the 1920s: liquor regained social acceptance and the product proliferated.
  • Investors need to figure out what something is worth and try to buy it for less. Investing in the marijuana industry is not different in that regard.
  • Most investors do not understand what the space looks like, how competitive it is, what the margins look like. There are questions about just how profitable these companies can become.
  • The long-term prospects for marijuana are very positive. The question is how much are you willing to pay for it?

The cannabis sector has been on a two-year high. Cannabis related stocks are trading at sky-high valuation. “The sky is the limit” as the saying goes. Since August, the segment has surged to a new level of hysteria on a wave of announcements. The sector got a boost when Constellation Brands (STZ), the brewer of Corona and Modelo, agreed to add $4 billion to its investment in Canada’s lead weed company Canopy Growth (CGCWEED). The hysteria got a new boost when Coca-Cola (KOconfirmed an interest in spiking sports drinks with cannabidiol (NYSE:CBD), the non-psychoactive ingredient of marijuana. And thanks to the DEA approving Tilray’s (TLRY) plan to import pot from Canada, a company with just $20 million in first-half revenue was briefly worth $30 billion. Continue reading “Getting Into The Weeds”