Following on from my last post, I’ve been keeping quiet, but busy… My short term objective of raising cash was achieved, in spades – while I continued to trim a couple of minor/legacy positions, I was pleasantly surprised by two corporate events in quick succession:
i) Alternative Asset Opportunities (TLI:LN) announced a sale of its portfolio (see here & here). Granted, the board announced preliminary discussions in June, but after the drip feed of bad news & near-incompetence in the last few years, I had little faith they’d manage a sale…let alone a good sale! [Despite TLI’s NAV discounting a constant cycle of LE re-evaluations & a 12% IRR]. But in the end, they actually sold the policies at an average 6% NAV premium.
With most of the consideration now in escrow & a successful EGM approval, the company will shortly propose a wind-up to yield an estimated GBP 54.4p per share capital return (reflecting a 1.2191 GBP/USD rate) for shareholders. Counting 4p of distributions, that’s actually a 50%+ return vs. my original write-up almost 4 years ago…not too shabby an outcome, notwithstanding the upside I initially anticipated (& well ahead of the naysayers’ dire predictions!). Since the shares still trade at a discount, I’m in no rush to sell here, and I’m unconcerned about further FX volatility as I already consider TLI part of my dollar ‘bucket’.
ii) A takeover offer was also announced for another of my holdings. In fact, it had actually evolved into my largest position (yes, ahead of Zamano..!), as a result of continued/incremental purchases & sustained price appreciation – it was my best-performing stock YTD – in the end, the offer was just icing on the cake! Unfortunately, I could never quite catch up with it, in terms of nailing down an investment write-up – yep, apologies, it was an undisclosed holding – and it contributes nada to my portfolio performance here on the blog.
But hey, who’s complaining..?! 😉
On assessing the specific circumstances of the deal, I subsequently sold out of my entire position (actually at a premium to the offer).
Totting up all of the above, my total cash allocation (inc. TLI as quasi-cash) recently maxed out at approx. 25% of my entire portfolio – since then, I couldn’t resist pulling the trigger on a new starter position. [How often do you encounter a company consistently growing revenue at a 21% CAGR for a decade & a half, trading on a sub-15 P/E, and sporting zero ifs & buts?!] Which is probably a good start…as the second part of my near term game plan, i.e. Sep/Oct market volatility, is showing little sign of playing out here (um, never say never!?). In the end, Yellen genuflected to the White House & the September Fed meeting passed without incident, the November meeting’s an obvious non-event, and Trump may finally have pressed the self-destruct button once too often.
But on the other hand, Yellen is probably dying to reassert her
cojones independence in December…and coupled with fresh mutterings globally of a gradual/part reversal of QE, who knows when market turmoil strikes again? Last week’s sterling flash crash can be partly blamed on an illiquid time zone, but it’s still a stark reminder how fragile markets are becoming, as banks (& in turn, hedge funds) have been forced to radically scale back their trading capacity & risk appetite. As usual, the next market crisis will almost inevitably be caused by the regulators & their response to the last crisis…
Once again, overall, I can’t help but conclude Average In, Average Out seems like the most compelling strategy available – and since I intend adding to some existing undisclosed holdings, as well as some new potential buys, hopefully this heralds a rash of new write-ups in due course. And in that vein, let’s take a look at what I call my High-Low Strategy, which now provides increasingly important guidance in my stock selection & portfolio. Let’s approach it from two distinct (but related) perspectives – first:
If we understand what drives the world’s uber-consumer – of course, I mean the American consumer, who famously underwrites 70% of the economy – we better understand the risks & opportunities consumer-focused companies face globally. After all, where the American consumer leads, the rest of the world will inevitably follow…
At one time, everybody knew their place – while some focused exclusively on the rich, or even the poor, most companies preferred the middle class. Fortunately, damn near everybody in America believes they’re middle class…so unlike many countries even today, it really is the largest possible consumer demographic. And for decades, department stores, big box stores, and gargantuan shopping malls stuffed with said department & big box stores, were immensely successful venues for this middle-class spending – and investors profited accordingly. Today, alas, this world’s been turned upside-down…of course, the internet’s to blame! True, but if we examine today’s middle-class consumer, this dislocation might actually have been inevitable, regardless of the internet.
In reality, today’s consumer was molded decades ago. You know them as Baby Boomers, but originally they were Hippies who became Yippies, who became the Me Generation, who then became Yuppies in the 80s as they finally settled down to work. And while the labels changed, their now infamous narcissism didn’t… Not surprisingly, they heralded a triumphant return of the luxury industry (after the lost decades of the 60s/70s) with fistfuls of credit cards – production-line gold-plated luxury was finally on sale to the masses. This orgy of self-entitlement was compounded by the arrival of the internet & the ‘Real World’ in the 90s, ultimately paving the way for a brave new world of social media & reality TV, where celebrity was debased & narcissism celebrated. The high-end champagne lifestyle was no longer limited to the wealthy & famous – such inequality wouldn’t be tolerated any more, with every red-blooded American consumer entitled to shove their face in the pie too, and nothing was going to damn well stop them!
In reality, US real median income had already peaked in the 80s… Not that many acknowledged such an inconvenient statistic – the money illusion, the increasing prevalence of dual-income households (by necessity), the collapse in the savings rate, coupled with exploding personal debt, and (of course) the housing bubble, helped keep the party going for decades. Unfortunately, the government also fooled the middle class into becoming unquestioning consumers of education & healthcare at almost any price. Something clearly had to give, and the solution was there all along…courtesy of the actual poor:
So if you really really need that luxury handbag & that 5-star break, because it makes you a better person, radically economising on other parts of your life is the obvious way to pay for it…why else do you keep bumping into your neighbour in Aldi? But who wants to admit to such schizophrenic financial behaviour? Instead, we dress it up as personal empowerment…’cos we love ‘treasure hunting’ in TJ Maxx, digging up interesting knick-knacks in dollar/euro/pound/vintage stores, taking on eclectic reverse-recipe challenges in cheapo supermarkets, creating H&M outfit + two grand handbag fashion combos (‘cos it’s sassy), cycling to work ‘for exercise’ (and ‘liberating’ loo roll & office supplies from said work), etc. Of course, such sacrifice really deserves a reward, which justifies more high-end purchases, which demands more sacrifice…and yes, right there, it’s the hamster wheel of modern life.
Let’s face it, the classic middle class consumer is a pretty endangered species today – by choice & necessity, the majority have been transformed over the years & decades into dedicated high-end/low-end consumers…
[And don’t be fooled by the new crop, this schizophrenic & entitled consumer behaviour is also the birth-right of Millennials. To them, a $750 iPhone, an (ironic) vintage $5 t-shirt & a GoFundMe account is a perfectly sensible combo. Sure, maybe they’re into more ‘authentic’ experiences now, but that’s mostly just a function of being young & strapped for cash, you can bet the craving for shiny expensive stuff kicks in with a vengeance in due course].
And these consumers wouldn’t be caught dead indulging in something so naff, or such bad value, as middle class shopping! Except department stores, big box stores & shopping malls still haven’t twigged this, they’re still piled high with dreary mid-price/mid-range/middle-of-the-road products for the largest possible common denominator – it’s like everybody became the Gap! And that’s why they’re getting crushed relentlessly, year after year. ‘Cos who bothers to shop at the Gap anymore – you basically know exactly what to expect, what to order & how much it costs – what’s special about that, isn’t that why they invented the bloody internet anyway?! And if the internet can offer some disruptive service & pricing as part of the bargain, so much the better…
A lovely theory, perhaps – but does it really matter? I think it does. Regardless of the cause(s), I’m sure you’ll agree this consumer mindset is now pervasive, and both mirrored & celebrated in the media. But today we nervously survey a new & sclerotic low-growth world…where consumers will surely lose their last shreds of confidence, leaving the luxury industry (for example) facing a particularly bleak future of collapsing sales & profits? But my theory, plus the actual stats, would suggest today isn’t all that different from the underlying reality the consumer’s been living for decades now! And that high-end/low-end mentality is perfectly attuned to today’s narcissistic & entitled consumer…and what’s the alternative anyway, a global religious revival?! Er, surely not – in fact, if things do take a turn for the worse, I’ll bet consumers simply double down on this behaviour.
Like I say, always bet on human vanity & insecurity…
And globally, this bifurcation in demand still represents a huge opportunity for consumer-focused companies…if they can get it right. In Europe, real incomes continued to rise over the last 30 years, and people were slower to adopt a more rampant consumerism, so there’s still plenty of runway left. [Except for the British, who’ve now reached the end-game & are virtually indistinguishable from their US cousins, in terms of spending habits & personal balance sheets]. As for the rest of the world (obviously Asia leads the way), there’s a burgeoning middle class population out there that already numbers in the hundreds of millions & you know they’re just dying to leap-frog their way headlong into Western consumerism.
As an investor, the key here is to avoid your classic mid-range mid-price retailers & consumer-focused goods/services companies. The exception proves the rule, but this rule would generally have saved you a fortune & a plenty of heartache over the years – and that’s not gonna change, in fact I reckon the stakes will keep rising. Instead, investors should focus (almost) exclusively on both high-end & low-end companies – the former sell the dream (escaping reality), while the latter sell the best price/value (paying for said reality).
[Also, it’s probably wise to favour the producer/brand owner/service provider over the retailer (or restaurant chain) – I can’t think of a more brutal sector, and valuations are invariably priced either for perfection, or failure (& perhaps rightly so, if a bad operating strategy doesn’t kill a business, management’s capital allocation usually does…]
Western companies should continue to dominate the high-end – for them, the internet’s still more about brand-recognition & promotion (rather than distribution), and the biggest growth opportunity ahead may now be in emerging (& eventually, frontier) markets. For low-end companies, not everything sells well online, but the internet’s obviously still an incredible direct distribution opportunity for the lowest cost/best value companies to leverage. However, we’re already seeing local low cost champions starting to dominate many emerging & frontier markets – in due course, I suspect we’ll see some of these companies emerge as global challengers, so investors will need to cast their net much wider here.
Now, all hail the mighty consumer, but in general we’re obviously really talking here about focusing exclusively on:
(Wide) Economic Moat Companies
#wellduhhh OK, now I say it, what I’m peddling here sounds like very old news!? But c’mon, there’s nothing new under the sun when it comes to investing. And yet we still end up making the same mistakes over & over again, and getting distracted by shiny new stocks & ideas. Of course we’d all like to see our portfolios stuffed with the moatiest of companies, all busy charging the highest prices, or killing it with the lowest costs. Ah but, if only it were that simple…
Intangible Assets: Superior technology & features, trusted brand & reputation, patents and/or regulatory approvals.
Switching Costs: Making it difficult for customers (in terms of time & money) to switch to competing products/services.
Cost Advantage: Driving down costs & leveraging economies of scale to offer better prices/value to customers.
Network Effects: Creating a strong network that becomes exponentially more valuable as more customers join it.
[Personally, I like all the Dorsey/Morningstar books here:
a) ‘The Five Rules for Successful Stock Investing’ (2004) – can’t recommend this enough, one of the very few books which offers investing valuation & metrics, economic moats, and a guided tour of the major market sectors (detailing unique dynamics/jargon, metrics & valuation approaches for each). Shame it’s become rather dated now, we probably won’t be seeing another edition…
b) ‘The Little Book That Builds Wealth’ (2008) – focuses specifically on moats.
c) ‘Why Moats Matter’ (2014) – newest primer on moats comes from Morningstar (ex-Dorsey).]
And to analyse a company’s economic moat, we:
i) Evaluate the company’s historical profitability.
ii) If it has solid returns on capital & consistent profitability, assess the sources of the company’s profits.
iii) Estimate how long the company can hope to fend off competitors (its competitive advantage period).
iv) Analyse the relevant industry’s competitive structure.
Of course, the usual temptation here is to rely primarily on quantitative analysis – let the numbers do the talking – focusing on the consistency & sustainability of strong free cash flow (as a % of net income), high net margins, high return on equity (though not dependent on excessive debt), and good return on assets (in excess of WACC). But while the numbers are clearly important – providing essential confirmation of an economic moat – they won’t necessarily warn you if you’re simply looking at a lucky streak…or a company that’s about to head off a cliff. In the end, comprehensive qualitative analysis (which can be challenging, I know…often, we only see what we really want to see) is far more critical in determining whether a company’s economic moat actually offers a sustained competitive advantage in the future.
Again, it’s all about focusing on the companies which have the economic moats to consistently charge higher prices, or offer low prices, than their competitors. The obvious problem is they’re generally priced accordingly – their additional valuation premium reflecting the (perceived) consistency & sustainability of future excess profits. And unless there’s bad news, it’s pretty rare to see the market under-value this premium…unless you uniquely perceive some key inflection point yet to come in terms of scale & untapped profitability. This is also complicated by an increasing prevalence of winner-takes-all network effects in what’s become a digital/software-driven world – to win the prize, and/or feed the ‘flywheel’ (lower prices means greater volume means lower prices…), many companies are willing to accept short/medium term reduced profitability, or even losses, as they seek to capture much larger future profits.
In terms of more well-known/larger companies, this means you need to be ready to take advantage of sudden (but apparently temporary) setbacks in results, news-flow & sentiment – i.e. GARP investing, with all the risks & opportunities that entails (as you valiantly strive to distinguish temporary from permanent). A broader but more challenging opportunity may lie with smaller companies – you’ll certainly find more entry & valuation opportunities, but it’s always a struggle to assess how sustainable their competitive advantage really is, or whether they even have one…they may simply have found a small & comfortable niche. But you can also find undiscovered gems, as smaller company management is
sometimes often appallingly bad at making their investment pitch. [Probably because most listed company CEOs never dealt with investors for the majority of their careers]. And yet VCs are besieged by startups touting they’re ‘the Uber of X’ or ‘the AirBnB of Y’…why can’t a few goddamn listed CEOs make all our lives just a little bit easier by telling us they’re actually ‘the Ryanair of A’ or ‘the Tiffany of B’?!
But if we really are facing into a far more uncertain low-growth environment, companies boasting high price or low cost moats are obviously best-equipped to thrive & deliver returns in a much harsher world. And looking at the elevated valuations of (far less compelling) income & defensive stocks today, it’s not difficult to argue companies who offer genuine long term secular growth (regardless of the economic environment), may actually deliver far superior risk/reward & upside potential from current levels. Which suggests this may be a investment thesis both defensive & offensive investors should consider. I’m not suggesting we all start playing the greater fool here…but I can still identify plenty of opportunities out there, some of which remain pretty cheap in absolute terms, while others aren’t so cheap at first glance but offer compelling long term compounding potential (particularly vs. what the market’s offering). As I’ve said before, the time’s ripe for a select group of companies to become a new/global Nifty Fifty – you can bet your bottom dollar a High-Low Strategy is one of the better ways of hunting ’em down!