I was interviewed by Seeking Alpha Pro. I think it’s only available to PRO subscribers but I’m not too sure. Maybe you can read some of it or get limited free access. I know some people without PRO were able to read.
Here’s a preview. There are 9 questions total, the first two are below. Full interview.
SA Interview: Investing With A Margin Of Safety With Brian Langis
Summary
- Brian Langis is an investor and a Chartered Business Valuator (CBV). He manages Cape May Capital, a private investment company, and specializes in business valuation.
- How to build a margin of safety, key questions to answer in the research process and how to identify catalysts are topics discussed.
- Brian Langis shares a long thesis on Spectrum Brands, Lumen Technologies, Stella-Jones, Haleon, Activision-Blizzard and Primaris Real Estate Investment Trust.
Feature interview
Brian Langis is an investor and a Chartered Business Valuator (“CBV”). He manages Cape May Capital, a private investment company, and specializes in business valuation. He has been publishing articles on Seeking Alpha for almost ten years. You can learn more about Brian at brianlangis.com and on Twitter @absolut_brian. We discussed best practices for a SOTP valuation analysis, the opportunity in stocks that “fell off the orbit” and an under the radar company that should benefit from a key demographic trend.
Seeking Alpha: Walk us through your investment decision making process. What area of the market do you focus on and what strategies do you employ?
Brian Langis: When I look at a new business for the first time, I go straight to the balance sheet. I do a quick read of the balance sheet. By just reading the balance sheet you can learn a lot about a business without actually knowing anything about it. I can tell if it has enough money to pay the bills for the next 12 months. It’s akin to doing a blood test on a stranger. You can learn a lot about a person’s health without ever talking to them.
A quick read of the balance sheet tells me right away if it’s a company that’s worth spending more time on. It tells me how much cash, assets and debt is behind the business. The retained earning line is a number that reflects what happened in the past. You get a feel if this business can stand on its own or not. If the balance sheet doesn’t feel right, I don’t waste time.
The reason I look at the balance sheet first is because I have scars from some of my early days of investing as a teen when I got in trouble with penny stocks. I had no clue what a balance sheet was and that was an expensive lesson. So balance sheet first. It accomplishes two things: 1) It’s time well spent. For 5 minutes it prevents me from wasting my time and 2) It potentially keeps me out of trouble.
Then I look at the statement of cash flow. I like to see how the cash flow moves around. I want to see if it’s generating free cash flow. I want to see if it’s growing and sustainable. I want to see what they do with their FCF. I reject most companies that cannot show enough cash income to care for growth and expansion, capital returns, without resort to continual new financing (there are few exceptions). The statement of cash flow gives you a good idea of their capital allocation strategy.
And then I look at the income statement. I try to answer simple questions like 1) Is it growing? 2) How are the margins? 3) Is it profitable?
Then you piece all of it together. I want to be able to see the cash flow flowing through the business. All I am doing is getting a “feel” for the business. If it feels good, it might warrant that I spend more time on it. If not, or it’s too complicated, I move on.
There’s some classic value investing to my approach. I’m buying a business. That’s the mindset. It’s important that I understand the business. It’s important I understand how it makes money and what it does with it. I try to visualize the cash from the sale, to the expenses, and to the bottom line. If I can’t, I move on.
There’s a test that I need to pass. I try to answer key questions like 1) Would I like to own the whole business? 2) How would I feel about holding it for a really long time, like 10 years? 3) How much would I pay for the whole business? The purpose of the test is to get me in the right mindset when I analyze the business. This forces me to focus on the fundamental drivers of the business and think long-term. It helps you avoid costly errors.
As for the rest of the process,
- I want companies that are profitable, FCF generators with decent return on capital.
- I want great management. It’s a point I used to overlook. For the past couple years it has taken more importance in the process. Business is about people. If it’s not about the people, then what is it about? I’m looking for a business that is run with honest talented managers that think and act like owners. That’s very important.
- I’m looking for capital allocation discipline. What are the reinvestment opportunities? A great business takes money in, invests it, and turns it into more money.
- Valuation. Can I get the business at a fair price? I want a business that is trading at a significant discount to its intrinsic value. At the end of the day, I’m counting cash and I need to make a decision on how much to pay for it.
When it comes to opportunities, I don’t discriminate. I’m not restricted by sector or asset class. I’ve a pretty wide hunting ground. An opportunity is an opportunity, why would I care if it’s bonds, stocks, or real estate? The only restrictions are things outside my circle of competence. All you want is getting more than you paid for. You are looking for the mismatch between price and value. You often find it where nobody is looking. And if nobody is looking it’s because it’s generally hated. And if it’s hated it might present opportunities for bargains.
SA: How do you identify catalysts, and more importantly, how do you tell if they are priced in already or not? What is the difference between a hard and soft catalyst, and which one is better and why?
Brian Langis: Value investors like me like to focus on fundamentals, come up with a value, and say “look I’m getting all that other stuff for free.” And you know what happens? It stays that way forever. Because the perceived value is trapped.
A catalyst is anything that can lead to a drastic change in a stock’s current price trend. It could be good or bad (i.e. buyout, bankruptcy). You are looking for an event or action. Identifying an asset that’s undervalued or not recognized by the market probably won’t lead to much. The market will discount it until action is taken to unlock that value. Otherwise it will most likely stay trapped. Basically you try to take advantage of companies undergoing change.
As for the question “how do you tell if the catalysts are priced in?”, the catalyst investing practice is mostly geared towards undervalued situations.
If a stock is trading on a high multiple basis, it’s hard to tell if any potential catalyst is already priced in. You can assume it is. Let’s say you identify a catalyst that you think the market has ignored, what’s the upside if the stock is overvalued? Unless it’s a massive catalyst, the upside is likely to be marginal. In situations where valuation is overstretched, it is safer to avoid.
As for companies that are perceived to be undervalued, I work with what the market gives me. I reverse engineer the stock price. I try to answer the question “What is the market saying?” The price is the collective view of the market. I might use a reverse DCF. A traditional DCF forecast cash flows to determine value. A reverse DCF starts with the end, the stock price, and works backward. You try to estimate the level of expected performance embedded in the current stock price. For a company with many different assets and businesses, a Sum-of-The-Parts (“SOTP”) approach can help. You are looking for mismatches, a gap between price and value.
Not all catalysts are equal. I don’t know if there’s a preset definition of a hard and soft catalyst (I didn’t find any). Below is my own spin on the meaning:
Soft catalysts are more internal. It could be a change of management, a new strategy, a new product, cost cutting, better execution, hidden or misvalued assets, unique intangibles, key people, tax losses. It could be real estate or excess land just sitting there. For example MSG Entertainment has unused air rights/development rights that could be unlocked. Or a company that’s net cash and it’s just sitting in the bank account doing nothing. That will be discounted by the market. Soft catalysts can have a wider range of outcomes and may be more nuanced in nature.
Hard catalyst is more of an external event. It could be a company getting sold, carved out, a spin-off, an asset sale. It’s very specific. I don’t know if hard catalysts are better, but they are easier to value. A hard catalyst has a more defined outcome and timeline (i.e.merger, spinoff). We know what is getting sold, for how much, and we have a timeline. So they are easier to work with.
For the rest of the interview click here.
Brian Langis 