Why I Avoid Commodities

I’ve been biased against commodity producers and for the most part have stuck to my bias. They have great growth and returns on capital in a cyclical upswing, but they
tend to peak before you expect. They are capital-intensive and lack pricing power. They are prone to competition, overcapacity, and overleverage. Plus cost overruns is frequent and so does funding uncertainty.

Occasionally, I’ve been seduced by a commodities story that appears to be either so
cheap or so unique that it can’t lose. For a while, it doesn’t. Inevitably, though, demand and pricing fall apart quicker than you expect and a stock price drop of 50% or more leaves me wondering I have ever strayed from our discipline to avoid commodity stocks.

I got really lucky twice. Once with Cliff Natural Resources and Tronox. I got in Cliff at $19 and got out at $25. Then iron ore prices collapsed and so did Cliff. It went down to a $3 a one point. With Tronox, I actually wrote a piece in Seeking Alpha recommending the buy. It turned out to be my worst recommendation on Seeking Alpha. My thesis was grounded on the fact that the demand for titanium dioxide
would rise and the glut of TiO2 would disappear. I loss confidence in my thesis and I got out between $21 and $26. Then Tronox collapsed to a few dollars. Since Tronox has rebounded to $14 and Cliff is at $6. The rollercoaster stock price action points out how little control commodity producers (and their shareholders) often have over their destinies.

This does not mean I am good at investing in commodity stocks and I should avoid them. I got out because I was a chicken, not because I knew that commodity prices would collapse. I was just lucky and my analysis was weak.

Long-Term Capital Management’s Pamphlet

Source: LTCM

If you like financial history, this piece of marketing is too good not to share. Thanks to François Denault, a value investor from Montreal, for the find. Here’s the pamphlet of Long-Term Capital Management (LTCM)’s marketing pamphlet. The stock photos are absolutely ridiculous. I can’t imagine anybody working there looking like that. If there’s a museum of ridiculous financial artifacts, this should be up there.

For the younger readers of this blog, Long-Term Capital Management (LTCM) almost brought down the financial system in 1998. LTCM was founded in 1994 by John W. Meriwether, the former vice-chairman and head of bond trading at Salomon Brothers. Again with the financial history, what happened at Salomon Brothers wasn’t pretty either. You may remember Meriwether from such books as Michael Lewis’ Liar’s Poker, in which Lewis painted his old boss as a high-stakes gambler (read it if you haven’t). Anyway, John Meriwether, the investment wizard (gambler/speculator), assembles the “dream team” of Wall-Street, which included two economists with a Nobel prize and the Vice-Chairman of the Federal Reserve. The best of Wall-Street under one roof.

Source: LTCM

Initially successful at first, LTCM used a highly leveraged strategy that backfired following the 1997 Asian financial crisis and 1998 Russian financial crisis requiring financial intervention by the Federal Reserve. By 1998 LTCM had amassed about $125 billion in debts against $4.7 billion in assets, and the notional value of its derivative positions had ballooned to well more than $1 trillion. On the eve of the bailout, LTCM’s leverage ratio had ballooned to 50-to-1, but investor flight further reduced the firm’s capital base before the bailout could calm the herd. The Federal Reserve of New-York organized a $3.6 billion bailout because LTCM’s failure could cause a chain reaction in numerous markets, causing catastrophic losses throughout the financial system. This was similar to what we saw in 2008 on a larger scale.

Source: Wikipedia and JayHenry
Source: LTCM

 

Interview: Investing With A Margin Of Safety

I was honored when the Editors of Seeking Alpha asked me if I would like to be interviewed for their PRO Weekly Digest. PRO is Seeking Alpha’s research platform for serious investors looking to get better ideas. The interview was far ranging and discussed such topics as: business valuation and the CBV, my investment approach, past mistakes, and a review of old and new stock ideas.

To read the interview at its original source, please click here.

It’s also up on the blog, here.

Below is a copy of the interview:

PRO Weekly Digest: Investing With A Margin Of Safety With Brian Langis

Summary

  • Being a Chartered Business Valuator, why having a high IQ is not enough and how to find underfollowed foreign companies are topics discussed, and he makes the bullish case for ECN Capital.

Welcome to the latest issue of the PRO Weekly Digest. Every Saturday for Seeking Alpha PRO subscribers and Sunday for all other Seeking Alpha users, we publish highlights from our PRO coverage as well as feature interviews and other notable goings-on with SA PRO. Comment below or email us at pro-editors@seekingalpha.com to let us know what you think. Find past editions here.

Feature interview

Brian Langis, a long-time Seeking Alpha contributor, manages a private investment company and is a Chartered Business Valuator (CBV). He employs a contrarian/value strategy with notable calls including Moleskine, NTELOS (NASDAQ:NTLS) and Dollarama (OTC:DLMAF). We emailed with Brian about the extra work (and reward) of international investing, the first place he looks when researching a company and how losing money can be the best education.

Seeking Alpha: Can you discuss your work as a Chartered Business Valuator (CBV), the designation itself and how this expertise applies to your personal investing?

Brian Langis: I was always interested in business and how the world functions. I like history, psychology, economics, science and so on. These interests led me to investing. And in investing, it’s all about figuring out the intrinsic value of an asset and its relation to price. So I had to learn how to value different businesses and assets. I like Warren Buffett’s style of valuation. That’s played into the idea of completing the CBV.

As you mentioned I’m a CBV and a lot of readers are probably unfamiliar with this three letter designation. The CBV designation is the premier credential for professional business valuators in Canada. There’s a national body (the CICBV), a code of ethics and professional standards to follow. It’s been around since the 1970s, when the capital gain tax was introduced in Canada. As a CBV, I have the knowledge to quantify the value of a business or assets. I’m trained to put a value not only on business tangibles, but also the intangibles such as intellectual property and key patents, which is taking more and more space on the balance sheet. With publicly traded equities, it’s much easier to determine the value of a company, but in the private-equity sector it’s more complicated. I worked in the investment business, but most CBVs find themselves working in corporate finance, taxation, valuation for financial reporting, or litigation. Also a CBV is very practical if you are involved in M&A.

Everybody can learn business valuation, but for me having credibility is important. It can take 3-4 years of studying on top of a four-year degree to get it done. The CBV is very specialized and very useful. The CBV is more about learning valuation procedures than finance theory. If you want to get very deep into equity valuation, the CBV is a good designation. If people are interested in completing the CBV, having some background in accounting would definitely make life easier. Some work experience would also help.

In Canada the CBV is well respected. However the CBV lacks recognition outside of Canada. Unlike the CFA, the CBV is not well known outside of Canada. The business valuation practice is fragmented by countries. The U.S., U.K., and Australia each have their own designation, governing body and practice standards vary widely. But there’s currently a process to harmonize and to implement universally accepted standards for the valuation of assets across the world.

SA: To follow up, which valuation methodologies do you find most/least useful or is the usefulness determined by the type of asset you are valuing?

BL: Unfortunately, there’s no “best” method of valuing a business. There’s no secret formula. There’s no one-size-fits-all investment strategy that I can give you. Trying to come up with a satisfactory formula that would identify undervalued shares in the stock market with a reasonable degree of safety and consistency will lead you down a series of blind alleys. Knowing what an asset is worth and what determines that value is more an art than science. It’s not supposed to be easy. If it was easy everybody would be rich doing it, right? I made and lost money buying companies trading at 6x P/E and 25x P/E. It turns out that stocks trading at 6x P/E can go down to 4x P/E. Continue reading “Interview: Investing With A Margin Of Safety”

2016 Baupost Group Annual Letter Part 2

My publication of the 2016 Baupost Group Annual Letter was taken down. I wasn’t supposed to published it, as clearly stated at the bottom of every page in the letter. I felt a little guilty publishing it. At the same time I felt like I was doing the right thing. Let me explain.

In the letter, Seth Klarman, the legendary value investor running Baupost, stated that the letter is addressed to the limited partners only (his investors). However, after reading the letter, which is available all over the Internet, it’s clear that he wrote it for a larger audience. It’s obvious by the content of the letter that he expected non-investors and the media to study and analyze every line. He wanted people to read it. A good portion of the letter is on Trump.  Klarman warn us about a Trump presidency. He knew his thoughts would end up in the New-York Times and Wall-Street Journal. You don’t write that kind of stuff without expecting it to go public. His shareholder letters are not like reading a personal email he sent to somebody. Publishing something like that would clearly be in violation of privacy and other rights.

I also think he didn’t make his letter public on purpose. Seth Klarman obviously understands basic psychology; as soon you can’t have something you create a desire for it. If he didn’t understand that he wouldn’t be the legend he is at investing. Since “you are not supposed” to read his letter, now you want to read it. Just like his book, Margin of Safety, one of the most sought after value investing book, was never reprinted and now sells for over $1,500 a copy (Imagine the price crash if a reprint is ordered). He knew that his letter was going to be leaked.  His letter are up there with Warren Buffett’s annual letters. Imagine if Buffett didn’t make his shareholder letters public, it would become of the most pirated document ever.

Why did I think I was doing the right thing? In his letter he share his thoughts on the current state of the market and investment philosophy. You can learn a lot and will make you a better investor. Again, that’s something Klarman intended to accomplished since he is one of the most successful and influential investor.

As mentioned his letter got taken down on this blog. But somehow, the New-York Times among others, published large section of the letter in numerous posts and it’s legal. I guess they know the legal tricks to get around the “ban”. From what I understand, if I copy and paste sections of the letter, it’s fine, but if I publish the document (the source), it’s wrong. Not sure how that makes it legal. So don’t take my legal advice. Anyway, people who want to read his letter will find it and read it.

Baupost Group has a reputation for being extremely private. I like that and I respect that. But it’s also strategic. Klarman has long kept a low public profile. But when he comes out in the media, it creates an impact. People listen because it’s a rare event.

What Investors Really Want

We want high returns from our investments, but we want much more. We want to nurture hope for riches and banish fear of poverty. We want to be number 1 and beat the market. We want to feel pride when our investments bring gains and avoid regret that comes with losses. We want the status and esteem of hedge funds, the warm glow and virtue of socially responsible funds, and the patriotism of investing in our own country. We want good advice from financial advisors, magazines, and the Internet. We want financial markets to be fair but search for an edge that would let us win, sometimes fair and at other times not. We want to leave a legacy for our children when we are gone. And we want to leave nothing for the tax man. The sum of our wants and behaviors make financial markets go up or down as we herd together or go our separate ways, sometimes inflating bubbles and other times popping them.

Source: What Investors Really Want by Meir Statman and Ben Carlson from awealthofcommonsense.com

Baupost Group 2016 Annual Letter

**February 24, 2017 Update Here.


Here’s a copy of Seth Klarman’s 2016 annual letter. As always, very insightful, a must read if you want to become a better investor. The letter also provides his take on Trump.

Baupost 2016 Annual Letter

Bonus:

Seth Klarman Baupost Group Letters 1995-2001

 

Some content on this page was disabled on February 13, 2017 as a result of a DMCA takedown notice from The Baupost Group, L.L.C.. You can learn more about the DMCA here:

https://en.support.wordpress.com/copyright-and-the-dmca/

Becoming Warren Buffett

This is the HBO documentary on Warren Buffett’s life. You don’t need to be a fan of Buffett or investmenting in general to enjoy this. There’s a lot you can learn from this documentary. Below are copies of the documentary on Youtube. I don’t know how long it will be there since it’s most likely an illegal feed. Below the video I have attached some notes from the doc provided by Market Folly.

Link #1:

Link #2:

Market Folly notes:

– He was always fascinated by numbers and it talks about how at an early age he discovered the power of compound interest. He concluded, “It’s a pretty simple concept, but over time it accomplishes extraordinary things.”

– He goes to McDonald’s everyday for breakfast on the way to work and has three options based on how much change his wife has given him for the day. Yup, one of the biggest owners of American Express (AXP) pays for breakfast in cash.

– He framed newspapers from various financial crises and hung them on the wall as a reminder that “anything can happen in this world.”

– As a young student, all his teachers owned AT&T at the time and he shorted the stock and showed the teachers proof to kind of spite them.

– Buffett learned two rules of investing from Benjamin Graham: Rule 1: Never lose money. Rule 2: Never forget rule number one.

– Doesn’t hang his diploma from undergrad or graduate school, but instead the certificate from the Dale Carnegie course of public speaking, which he says changed his life since he was so scared of it.

– Charlie Munger said Buffett made a lot of money early on buying thinly traded securities that were incredibly cheap statistically (“cigar butt” investing).

– Started his first partnership with $105,100 – $100 from himself and the rest from investors.

– Buffett says, “The trick in investing is to just sit there and watch pitch after pitch go by and wait for the one in your sweet spot. There’s a temptation for people to act far too frequently in stocks simply because they’re so liquid. Over the years, you develop a lot of filters. I do know what I call my circle of competence. I stay within that circle. Defining what your game is, where you’re going to have an edge is enormously important.”

– He later adds, “If you’re emotional about investment you’re not going to do well.”

– Charlie Munger had a big impact on him by shifting him to look at wonderful companies at fair prices rather than fair companies at wonderful companies.

– Buffett said he spends 5-6 hours a day reading. He likes to just sit and think. When asked to describe what one word describes his success, he said ‘focus.’

– “The biggest thing in making money is time. You don’t have to be critically smart, you just have to be patient.”

– “Look for the job you’d take if you didn’t need a job.”

Uber Part Deux

Here’s the first part on Uber’s sale pitch.

I just can’t get over this quote from Morgan Stanley’s pitch of Uber shares to their clients when addressing the lack of financial info from Uber (There’s a 290 page prospectus of just verbiages and no financial data):“the development of insights and big ideas is valuable to the investment process, whereas obsession over incremental ‘information’ flow is not.” Nice quote right. Well Uber is still raising billion despite the lack of info. A chart like the one below is probably all some investors need to make an “informed” decision.

number-of-uber-rides
Source: Bloomberg

The bankers that refused to push the Uber stocks on their clients will probably not be doing the IPO. But at the same time, this is great risk management from their part. Let’s say Uber investors starts to lose a lot of money, they might have a legal case for suing the banks for pushing the stock on them. This is the kind of stuff that got bank in troubles over and over. Just look at the financial crisis mess with the subprime mortgage bonds.

I can’t believe they can sell that stuff. How much money can Uber be losing for not disclosing their financials? This is like Trump’s taxes. There’s stuff in there he doesn’t want us to see otherwise he would have disclosed it a long time ago. If Uber is making money, they would proudly show it. Now everybody know they are in the red. Losing money is not bad thing when you are starting up since people are investing on the potential of making money in the future. The real question is will Uber will ever be profitable? Can they show a path to investors that will see a positive return in the future? Uber has been around 6-7 years and it’s still classified as a $65 billion start-up. When do you lose the tag start-up?  This is what Uber is offering: the potential of making money in the future. But maybe they can’t show that therefore we will talk about our big dream. People love investing in these new concepts. Sometime it works, like Facebook, and sometimes its a flop like Twitter. Twitter has been around longer than Uber and still hasn’t figured out how to make money.

“the development of insights and big ideas is valuable to the investment process, whereas obsession over incremental ‘information’ flow is not.”

Let’s assume you need money for a house or a project. So you go to your bank asking for the money. The banker ask you for pay slip, your budget, assets and liabilities, you know the usual stuff that would ask somebody if they were asking you for money. But instead of providing the info, you tell him about that your insights and big ideas are valuable to getting money, whereas the banker’s obsession over incremental ‘information’ flow is not.” No way in hell you are getting a dollar. They might think you have been smoking too much. But somehow you can pull that stunt with the sale of Uber shares…

Good for Uber really. If they can raise that money without putting up any financial data, good for them. Heck there are a lot of suckers out there, might not be a great shareholder base to have but they are willing to throw money at you, why not take it.

Regarding Uber’s financials and future, there’s a great piece online by the nakedcapitalism you can read here.

Uber’s Pitch to Investors

Update: After publication I received a Tweet  suggesting an excellent article on Uber: Can Uber Ever Deliver? Part One – Understanding Uber’s Bleak Operating Economics posted Yves Smith. Hubert Horan did a thorough 6 part series on the company. The article includes financials from Uber.

A lot of people are asking how can I invest in Uber. They say things like “Uber is the next big thing, I can’t miss out on its IPO”…Every year we have a company that makes people dream. People want the next Microsoft. The fantasy of easy money makes people dream and they kind of lose their mind when it comes to rational investing.

Uber is what we call a “disruptor” business. Companies like Uber, Netflix, Spotify, Airbnb and Amazon among others are “disrupting” the world we know with the aim of making it better. Along the way it creates winners (usually the consumers) and losers (taxi drivers, cable companies, hotels etc…) Uber is simply an taxi app on your phone that let’s book a ride. Uber didn’t reinvent the wheel here. They simply made an under-served service, cabing, much better.

Uber is a company that I admire. I like taking it and I believe they are not going anywhere no matter how many angry cabs drivers block the streets. Technology is not something bad or good, just like steel is not bad or good. It’s just that our laws are not up to date for these new an upcoming companies. Companies like Uber take on the establishment and left the old guard gritting their teeth. Fast growing companies like Uber constantly need money. Uber is still a private company and we don’t have access to financials. Various media have reported that Uber is burning over $500 million a quarter. It could be an exaggeration but it’s reasonable to think they are burning through a lot of cash since they are constantly looking for money. Uber is not profitable and probably won’t be for a long time. A company like Uber is still allowed to exist because the capital market let it exist. If the tide turned, like it did with the dotcom boom in 2000, it could become a bust.

Companies that you admire and love doesn’t necessarily make it a great investment. I like Twitter, it doesn’t mean it’s a great investment. You still need to focus on the fundamentals. You still need to ask how you are going to make a return on that investment. Especially if the company is burning through cash. Interesting fun companies doesn’t necessary = I will be rich. A company like Uber can’t pay a dividend or buyback shares. So you are entirely hoping that the next valuation round will be higher (and you are diluting your ownership too). It’s the greater fool theory. Now I’m not saying Uber is a bad investment. We barely know anything about its finances. It might turn out to a great investment. I don’t know.

I suggest you read the article, Banks Passed Up Uber Share Sale on Lack of Data from Bloomberg. Credits to François Denault,  an excellent value investor in Montreal for the find.

The articles says that at least two investment banks passed on selling shares of Uber to their high-net worth clients — shares eventually sold by other banks in January — because the ride-share company wasn’t willing to provide financial details about its business. The 290-page Uber prospectus Morgan Stanley sent to prospective investors before the January stock sale didn’t include Uber’s net income or annual revenue. The New York-based bank addressed the lack of data in its prospectus, and love that part, by saying “the development of insights and big ideas is valuable to the investment process, whereas obsession over incremental ‘information’ flow is not.” I just love how you can spin so much b.s. and still get the money you need. Good for them. But there’s a lot of suckers out there. We live in a weird era. Reminds me of Trump with his “alternative facts” and “we disagree about the facts”.

Who is buying shares of a company without having any clues about the financials? A lot of folks apparently.  It’s a dream for Uber and a potential disastor for investors. Reminds me of the dot-com mania. Now that we have the Dow at 20,000 points, there’s seems to be a mini euphoria going on.

The Trustees’ Dilemma

John Train, one of the most respected financial author, his book, The Money Masters, published in 1980. Mr. Train shares a story of one woman, her family, and the difficulty of applying proper fiduciary management to her trust account. He ends the piece with a call for help from other professionals, as “it’s a problem that requires airing.

Retired baby boomers, more than ever, need financial advice. They retire at 65 and most of them have a life expectancy of 20 years plus. But the key is to make their money last as long as 30 years or more. I never bought into the theory as you get older you need more bonds. Bonds looks riskier than ever.  A portfolio full of “safe” bonds barely provide any income and the “safe” capital could be in for a shock in inflation and interest rates starts creeping up. Anyway that’s another story. The point is it’s hard to find a solid reliable financial advisor. They operate in a conflict of interest. Financial planners earn their living from selling products (commission) and from a % of managed assets. The majority of these “advisors” have lived in an isolated world of product distribution whose portfolio management skills revolved around a suitability standard. There are some good advisors out there and they are hard to find. You need to ask around, check their experience, qualifications, and find out how they work.  Talk to a few of them and you will see the difference. See if anybody can referred you somebody good. Is the person product centric or portfolio management focus?  Advisors have a fiduciary duty to the client. That means that the client’s interest comes first and should provide the highest standard of care. Make sure it’s respected. As the article suggest, another advice is to surround yourself with professionals. Make sure you get the input of a tax lawyer and an accountant on your situation. A financial advisor is not a tax expert. Here’s the article:


The Trustees’ Dilemma by John Train
Reposted from the July 9th, 1979 edition of Forbes Magazine

A widow was left a substantial amount of money by her husband when he died. The income went to her for life, with the capital to be divided among their three children after her death.

Her late husband had been a successful New York businessman, and the family had two large houses: one in Greenwich, Conn. and one on Cape Cod, where they went in summer. The children liked coming to the Greenwich place on the weekends and spending long periods on Cape Cod in summer, so she kept both. As a result, the widow found herself living at the limit of her resources.

At her annual meetings with her trustees, the problem was aired frankly. How could she maintain the houses and keep up roughly the same standard of living as before, with her husband’s considerable salary no longer available? Each year it was decided to sell some growth stocks with low yields and move into bonds or high-yielding equities to maintain the needed income, and hope that all would end well.

So the trust portfolio eventually became roughly half fixed-income securities and half high-dividend stocks, notably utilities and the like.
Continue reading “The Trustees’ Dilemma”