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So yeah…quite the bloody year, eh?!

I hope you & yours have kept safe & well during this #COVIDcrisis – even if you’re not exactly sheltering-in-place anymore, I presume you’re still a conscientious mask-wearer (as needed) in public? All else being equal, it’s disappointing the weather (apparently) isn’t a sure-fire virus-killer – remember when we all assumed, at worst, the summer would offer a welcome & effective respite? You know, meeting people, I used to joke investing was simply the ‘job’ I invented to keep me off the mean streets…I never imagined it would literally turn out like this!?

Anyway, let’s survey the carnage…

As usual, my H1-2020 Benchmark Return is a simple average of the four main indices which best represent the majority of my portfolio:

A (13.2)% benchmark loss is grim…though apologies to my puzzled American readers, who are wondering what carnage? [Apparently 100% of US investors now practice 0% global diversification!?]. If you didn’t know better – i.e. had avoided the media’s water-boarding over the last six months – you’d surely think a (4.0)% loss in the S&P was nothing more than some random market oscillation. Nothing to see here…

But in reality, lots of (US) investors now lean into technology stocks…and the Nasdaq didn’t disappoint, delivering a spectacular COVID-driven +12.1% gain! [C’mon, I tweeted ‘Nasdaq 10,000’ enough in the last year!] Of course, there’s a flip-side, with travel & hospitality being the most obvious sectors to experience devastating (& sustained) share price declines. We see a far more realistic ex-technology US performance in the Russell 2000, which recorded a (13.6)% loss in H1.

Not all that different from a savage (16.2)% decline in the European indices – the Bloomberg Euro 500 delivered a (13.7)% loss, with the ISEQ chalking up a (16.8)% loss. And no real surprise, the FTSE 100 racked up an (18.2)% loss – dare we ask if this reflects a more American approach to COVID?! Which seems to be corroborated by a (21.8)% loss in the domestic FTSE 250, though (bizarrely) the AIM All-Share managed to deliver a mere (7.8)% loss…shades of end-of-the-world speculation there?

[Alas, not enough to save the brave AIM-busters of #UKFinTwit – who consistently bested the worst index ever!? – they’ve been eerily quiet since re their H1 performance. Well, except for the Games Workshop (GAW:LN) faithful…we salute you!]

All in all, despite the coronavirus, it’s been more of the same – i.e. the S&P’s continued technology-driven out-performance vs. Europe (& the rest of the world). Perversely so, when it always seemed pretty inevitable – and alas, so it’s proved – that the US would produce the most bizarre/populist/screwed-up COVID response! [Forget second wave…America’s still trapped in the hold-down of a self-inflicted & apparently never-ending first wave]. But thanks to both technology stocks & the unprecedented juice the Fed & Congress have applied to the market (& even the economy!) – decades later, the US still remains the world’s default fiscal/monetary engine! – the S&P reversed most of its savage March decline & out-performed Euro indices (poor relations in terms of technology representation) by over 12% in H1.

[In particular, this technology gap totally shredded classic value…it’s horrific to see investors suffer crippling 20% & even 30% losses year-to-date.]

So…what have we learned?

Well, the first big lesson – which holds just as true today – is that nobody is an epidemiologist, unless they’re an actual friggin’ epidemiologist! Or as I’ve put it before:

Nobody knows anything…

In many ways, the coronavirus is a red herring here. The real virus in the markets has always been the doomsayers. The scum who lurk in the shadows, like decrepit stopped clocks…the self-appointed & ever-confident experts on social media (& #FinMedia, if they’re a little more polished), who always see another market crash looming ’round the next corner. Of course, you only have to look at long-term equity returns (vs. other asset classes) to know how consistently WRONG these criminal fools are…but time & again, it’s newbie & nervous investors they scare the hell outta the market, eviscerating their confidence & savings/retirement plans.

[As Peter Lynch said: ‘Far more money has been lost by investors trying to anticipate corrections, than lost in the corrections themselves’.]

But to give COVID its due, its arrival & the subsequent market decline also scared far more experienced investors outta the market. Unfortunately, the personal element of risk added a whole new dimension to the false prophets’ warnings. These exploding rocket scientists seize upon some alarming variable (like R-zero) that satisfies whatever agenda/failing they’re most obsessed with…and then extrapolate it to some ludicrous extremity.

[They’re the offspring of the 19th century experts who confidently predicted London streets would end up buried under 9 feet of horse-shit by the 1940s!]

This might work in Excel, but falls at the first fence in the real world. A reflexive world where all variables respond/interact/adapt accordingly. The most important variable being humans…and our wonderful adaptive behaviour & relentless ability to discover new (technological) solutions to problems. Hence, if the virus doesn’t adapt – i.e. naturally slow down, stabilize & stop spreading – we inevitably adapt! Of course, this didn’t stop the ‘I’m not an epidemiologist, BUT…’ experts – the people who lectured/trolled/blocked you for daring to question/let alone ridicule their insane ‘conservatively, 1.0-2.5 million deaths’ projections (just for the US!?). Sounds crazy now – most of those clowns have deleted their tweets since – but this fear-mongering was responsible for much of the social/market hysteria we were all feeling back in March. Next time ’round, try remember their names/handles & all their doom-mongering…’cos you know they’ll soon be back for more.

Fortunately, I didn’t panic…and I back that up with actions, not just words. [Always watch what they do, not what they say!] Or specifically, lack of action – I was NOT selling – as per this blog (& Twitter), where I’ve tracked my (disclosed) portfolio buys/sells & performance for nigh on a decade now! And while I’m not an epidemiologist, I do know the best thing to do in almost every market circumstance is…nothing! [This presupposes you already own a high quality portfolio]. Looking back, I laid out my COVID stall as far back as Jan…and it’s consistent with everything I tweeted since, plus my perspective today:

‘…everybody & their mother is now obsessing over the #coronavirus. Personally, I think Ebola’s far more terrifying – but hey, who remembers the 2014 Ebola ‘outbreak’ now? Maybe, just maybe, there’s a lesson to be learned there…need I say more?! So stand firm, don’t panic, and just make sure you’re holding great stocks…and if the market does reverse, try & swap/buy into even better high quality growth stocks!’

And if you also stood pat with your portfolio, avoiding survivors’ guilt is another lesson to learn. Lord, even when we ignore the doom merchants, the siren call of market timing is so strong. I can’t help but look back & wonder why the hell I didn’t tactically bail out in Jan/Feb, despite believing it would all work out in the end!? But that’s the madness of hindsight, market timing’s inevitably a fantasy where we only remember the rare occasion when we really shoulda…and never all the times we shouldnae! In reality, the S&P rallied for most of February – and even bounced +10% (vs. its Feb-28th low) in the opening days of March – the market offered plenty of initial reassurance that COVID wasn’t a real problem for the West.

[As the grim joke goes…the market only actually started selling off when white people started dying! And Wall Street traders were literally stuck in the worst coronavirus hot-spot on the planet – New York City – don’t under-estimate how much this human proximity effect exaggerated the March crash.]

We also chastise ourselves if we couldn’t put money to work, as the talking heads always recommend. What a missed opportunity…but that’s foolish too: If you know market timing is fool’s gold, believe equities are the best long-term investment, and insist on keeping buckets of cash lying ’round idle…well, those are obviously incompatible beliefs & invariably it makes financial sense to be as fully invested as possible. Accordingly, in market setbacks, we should mostly be content with the opportunity to upgrade our portfolio – i.e. ‘swap…into even better high quality growth stocks!’.

Personally, I even feel guilty I didn’t pen some pound-the-table #BTFD post in March, as I did a couple of times before in shaky markets. But I stuck with my buy quality mantra on Twitter – ‘cos in the eye of #pandemic storm, the unprecedented level of fear & greed is inescapably something we’re all forced to deal with alone. But there’s still a potentially rocky road ahead, so these tips & tricks are definitely worth considering/adopting to ward off that fear & greed. And remember, at the time, nothing’s ever clear-cut in the markets:

So, Just Average Is Best…

Which brings me back to my portfolio – but as a reminder, here’s my H1-2020 Benchmark Return again:

And now here’s my Wexboy H1-2020 Portfolio Performance, in terms of individual winners & losers:

[All gains based on average stake size & end-H1 2020 vs. end-2019 share prices. All dividends & FX gains/losses are excluded.]

[NB: Since I reported no subsequent buys/sells year-to-date, average stake sizes are effectively unchanged from year-end 2019 portfolio allocations.]

And ranked by size of individual portfolio holdings:

And again, merging the two together – in terms of individual portfolio return:

In the end, my H1-2020 Portfolio Performance turned out to be a (3.2)% loss – not flat, but damn close! And it’s still gratifying to out-perform my benchmark return by +10.0% in such a turbulent market.

With such a potentially volatile cryptocurrency micro-cap, there’s an obvious limit to the KR1 plc (KR1:PZ) stake I’m comfortable holding, but this was a beautiful H1 outcome: It again provided valuable portfolio diversification – as I’ve flagged up before – and a +47% gain to boot! And yeah, literally in the last few days – along with gold, silver & a weaker dollar – it really does look like BTC, ETH & the rest of the crypto-universe just might finally be ready for another monster-rally here!?

Alphabet (GOOGL:US) was the only other real winner in the pack – no surprise there – though in reality it’s a FANG laggard, with Facebook, Apple & Netflix being more obvious bets for investors as users shelter-in-place. But what’s good for cloud/internet/social media/e-commerce stocks is equally good for Alphabet – it’s embedded just as deeply in the daily lives of those same users. I mean, what other company in the world can boast nine different products with a billion plus users each?! I’m confident Alphabet can continue to churn out the relentless 20%+ growth it’s famous for, while its sum-of-the-parts value continues to (positively) diverge vs. a more earnings based valuation. [Just imagine what YouTube or Waymo are potentially worth in today’s market as stand-alone/listed spin-offs?!). Alphabet is still my largest holding, so even a +6% gain resulted in a decent H1 portfolio return.

However, these gains were basically offset by Applegreen (APGN:ID) & Saga Furs (SAGCV:FH) – the COVID losers. Applegreen fared much better than many of its retail/travel/hospitality peers – whose business literally evaporated – as its sites remained open as essential services. It was impacted by traffic & commuting volumes, but fuel’s now its lowest margin/gross profit contributor, and its convenience stores (& food/beverage offerings, as permitted) proved a welcome & in-demand alternative for customers (vs. supermarkets, restaurants & takeaways). Applegreen continues to service its Welcome Break debt, while it re-establishes its underlying revenue run-rate…and post-COVID, I expect investors will better appreciate how well its on-the-go fuel/convenience/food & beverage offerings are positioned vs. an otherwise embattled retail sector. As for Saga Furs, it’s nailed to the deep-value mast: It’s still a unique auction-house business, but one where sales prices have been under-mined by the Chinese fur industry…and since Saga’s part of the wholesale luxury/fashion supply chain, buyers can afford to miss an auction or two & rely on inventory ’til the retail outlook’s a little bit clearer. An (eventual..?) acquisition by Kopenhagen Fur still seems like a potential end-game here, but meanwhile the company’s finally being forced to rationalize & right-size its workforce.

Which left the more value-focused stocks to essentially deliver a final net (3.2)% loss – I certainly can’t complain! A steadily increasing Asia allocation across my portfolio also helped – in terms of timing,  plus the fact most of Asia locked-down far more quickly & effectively than the West, and/or simply evaded any serious COVID outbreak. [Well, duhhh, masks & social unity?!] And in my (undisclosed) portfolio, internet/mobile/e-commerce* stocks & other high quality growth stocks – and July gains – have made a significant contribution to my overall year-to-date portfolio results.

[*And yeah, there were/are still some value-priced e-commerce stocks out there…even some  that don’t actually incinerate cash!]

And it’s not a focus on the blog – which remains equity-focused – but I’ve also been betting on a weaker dollar, despite its tendency to exacerbate portfolio volatility. [Dollar strength/weakness is generally inversely correlated with risk-off/risk-on appetite in the markets]. More emerging & frontier market exposure would also escalate this Texas hedge…a tough proposition after years of under-performance, but nicely satisfied by my growing Asia allocation. And while we’re at it, real assets are fair game too: For me, cryptocurrency belongs in this bucket – not everyone’s cup of tea, but a 3-5% portfolio allocation now makes sense in any portfolio – and I’m finally keen on increasing my property exposure (perhaps significantly), but only via unique (primarily UK-listed) sub-sectors, companies & management, since the typical property team’s invariably all about the beta & almost never about the alpha!

And in the end, I fortunately had the opportunity to actually focus on buying a couple of new stocks in H1…via a combination of some residual portfolio cash, a nice (undisclosed) realization & a judicious trimming of some (undisclosed) holdings that held up well. In March, I managed to invest almost 10% of my overall portfolio in: i) the perfect play on the (emerging) Asian middle-class, one boasting strong market share, reputation & plenty of white-space opportunity in multiple markets (& no governance issues), and ii) an investment specifically focused on an owner-operator (that I also think of as an insider-outsider) who’s delivered close to 20% pa intrinsic value growth over the last 15 years. I certainly hope/look forward to writing about these holdings in due course!

Otherwise, I have no additional portfolio re-allocation plans, despite the COVID crisis…which looks nowhere close to being over yet, thanks (mostly) to the US & its comrade-in-harms, Brazil. The logistics of arriving at a (widely available) vaccine are also challenging. But that still leaves us with little we can assume: Humans are really bad at evaluating/ranking the genuine risks we face…we obsess over the most recent/newsworthy risk(s), but equally we’re also extraordinarily good at normalizing & adapting to fatal risks like cancer, heart disease, car accidents, diabetes, influenza & pneumonia, etc. in our daily lives. The other tragedy today is the creeping realization that pre-existing & potential mortality risks could likely be significantly/sustainably reduced for a fraction of the trillions in damage this COVID crisis & response will inflict. That’s doubly true of America, which chose to both destroy its economy AND wilfully fail to properly observe & enforce masks, social distancing & sheltering-in-place.

And recency bias also convinces us the world’s changed irrevocably, despite countless counter-examples from history. A few months in, it seems premature to assume we’re working from home forever now & the cities empty out accordingly. This #NewNormal narrative’s courtesy of your typical young single journo – who has little skin in the game, or appreciation of the actual pros & cons involved, let alone any conception of the corporate & cultural inertia that would still need to be overcome. Just because something’s possible doesn’t necessarily mean it’s actually probable. Working from home feels a bit like a long-distance relationship, it works great in theory…but almost never in practice! [And don’t we have just 12 years left to save the earth?! Isn’t it critical we embrace high-density urban residential even more aggressively now (like nuclear energy, eco-warriors still don’t appreciate this obvious green choice)]. I’m focusing instead on pre-existing trends that COVID can re-inforce/accelerate – e-commerce, food delivery, the grudging transition (finally) to online grocery shopping, streaming, the death of cinemas & cable/network TV, etc. So yeah, there’s some (temporary) froth involved, but many technology stocks are seeing a genuine secular step-change in their businesses here & have re-priced accordingly.

But again, we should also be humble enough to admit:

Nobody knows anything...

And as terrifying as that may sound, the truth will set you free. Because in the end, does it really matter? The ultimate lesson we’ve learned in the last six months is the same lesson we’ve learned over the last dozen or so years…not to mention a few decades previously as well. As I asked last July:

‘Do you really think we came this far…after decades of deficits, trillions in money-printing, and tens of trillions in sovereign debt…to suddenly decide one day to get fiscal religion, turn off the money spigots, and embrace the agony of full-blown cold turkey?!

Yeah, of course not…’

Today, it’s hard to imagine I even had to make/justify that argument. And even if you disagreed, this year it’s inescapable…we’ve crossed some final Rubicon here & there’s no turning back. ‘Cos, you know…

We live in a world where essentially unlimited deficits & debt no longer matter. A world of zero/negative interest rates & sovereign debt monetization. A world where perhaps the media finally understands America & China are caught in a Thucydides’ Trap (& Russia’s irrelevant). A world in which the lessons of history are ignored…or simply canceled. [And the 1970s never happened]. A world that’s apparently ending in just 12 more years. A world in which it will become ever more difficult to deny the masses & the moral/economic imperative of more & more spending. [So much for ‘A billion here, a billion there, and pretty soon you’re talking real money!’] A world in which Modern Monetary Theory, or its bastard offspring, is inevitably legitimized & embraced. A world of brand new free lunches. A world that enjoys & endures an unprecedented global digital & technological revolution. A world that will re-label welfare as universal basic income, when even the middle-class fears potential long-term unemployment. And more prosaically, a world where stock P/Es are arguably still cheap, when the greatest mega-cap of them all trades on a 188 P/E…yeah, the US government, which now issues 10 year USTs at 0.53%! As Buffett noted:

‘Everything is a function of interest rates. Interest rates are like gravity.’

Again, I welcome you to the Floating World…for years now, governments, central banks & markets have stuck to my long-standing macro investment thesis. [Its one great failing to date was…not investing more aggressively!] Let me reassure you, I haven’t lost my mind – of course this ultimately ends in tears, but never under-estimate how long governments & central banks can gamble our future away. It’s easy when you get to print your gambling chips and fix the table! But this is still an opportunity to focus on high quality growth stocks:

‘…(esp. those boasting wide economic moats), for both defensive & offensive reasons. Defensive, because I’m still hugely concerned by the underlying fiscal & economic strength of the developed world…so I need companies that can boast a robust business and/or secular growth even in a fragile economic environment. And offensive, because (more cynically) I believe putting the QE genie back in the bottle may prove a near-impossible task…ultra-low (even negative) interest rates & unprecedented monetary stimulus could still unleash a completely unprecedented equity bubble.’

And that’s still the big question/proposition for all investors to consider:

‘We’re over a decade now into what’s surely the most unprecedented fiscal & monetary experiment in the history of mankind…is it so crazy to ask/wonder whether this ultimately leads to the most unprecedented investment bubble in history too?’

So what’s your answer..?

For me, the COVID crisis (& response) just serves to reinforce my thesis. And I’m even more cognizant of the value of portfolio diversification – e.g. I’ve invested more & more in Asia, even though America’s almighty COVID FUBAR has perversely ended up helping it out-perform the world yet again. And I can’t help marveling how investors’ often random good & bad luck – in terms of their stock/sector/market choices – can dictate such radically different YTD returns. More rigorous portfolio allocation seems like the only logical solution – both defensive & offensive – which I study regularly in terms of portfolio geography, currency, sector, investment themes, market caps, liquidity, etc. And I’ve often revisited the topic here. But the real focus of my portfolio allocation has changed over the last few years – I’m sure regular readers noticed it in my evolving stock picks – and it goes to the heart of what defines a high quality growth stock.

I homed in on this in January: I see a bifurcation…with investors buying either high revenue growth stocks (the Netflix/Tesla/etc. stocks of the world), OR slow revenue growth/high quality stocks (the FMCG stocks of the world), at nearly any price. But for me, there’s an uncanny valley between the two, where there’s still value to be found:

‘…companies that are high quality but present that little bit more of a risk, that grow consistently but opt for profits rather than super-charged revenue growth, the 10-15% to 20-25% revenue & profit machines which (in relative terms) seem to bizarrely miss out on the kind attentions of so many growth investors today.’

And this doesn’t necessarily mean the obvious mega-cap stocks we all know…it’s actually the outsiders, the owner-operators, and the founder/family-controlled companies. And what characterizes them isn’t always market cap size, or name-brand recognition. It’s companies that can boast consistent long-term investment & profitable revenue growth, a focus on strong free cash flow conversion, an emphasis on organic-led growth vs. acquisitions, low(er) employee turnover and a genuine corporate & service culture…and more importantly, a prudent balance sheet. And most critically of all, insiders have real skin in the game – i.e. a substantial stake in the business. When the health of your portfolio determines your family’s present & future, this is precisely what you focus on most in the businesses you own…and what helps you sleep soundly at night.

And so, I humbly submit two new portfolio allocations for your consideration. Think about how you might feel – today, or back in March, or in any kind of bad market – owning this portfolio instead? Well, this is my (total) portfolio allocation – from earlier this year – just as we were heading into the COVID crisis! First up, let’s consider balance sheet strength:

[All info. derived from latest pre-COVID results ( i.e. up to end-Feb, but mostly end-Dec results. Net Cash & Investments inc. balance sheet marketable equity/debt securities, unless it’s an actual investment company/trust.]

Debt’s always tempting, to fund new investment, an acquisition, a buyback…or even necessary, if you’re a hired gun whose options/restricted stock package critically depends on juicing your P&L and balance sheet. And banks are always ready with a taste. But once you’re hooked, it’s a habit that’s almost impossible to quit. It saps your strength, leaves you vulnerable & leads you down foolish paths. And as many of you have learned over the years – often painfully – no decent investment should require leverage to justify its existence, let alone deliver an attractive long-term return! And the same is true of my own investing (& business) experience…of all the growth stocks I’ve ever bought/still hope to buy, I’m hard-pressed to think of a single one where leverage was a key contributor to its long-term success. And that’s flattered by survivorship bias – we quickly forget the growth stories that were handicapped & bankrupted by debt.

Knowing this, I always home in on strong balance sheets. It’s never restricted my investment opportunities (or upside potential), and I’m rewarded for it…look at sector valuations, it’s very obvious investors systematically under-value cash (& free cash flow), and over-value debt (’til it’s too late & everything’s already going pear-shaped). Not to mention, the psychological reward – a strong balance sheet’s reassuring – I sleep easy at night knowing I don’t have to worry about inevitable business set-backs, or nasty & unexpected real world surprises.

Now, this doesn’t necessarily mean my stocks are invulnerable to market scares & reversals – when investors are panicked, they may sell everything (good & bad) at almost any price. We’ve all seen this kind of insanity. And it doesn’t mean they don’t have to re-set here & even suspend a dividend temporarily in this COVID crisis. But it DOES mean I don’t have to panic, or agonize about selling, or worry about a temporary mark-to-market, or fear management’s forced to dilute me with a huge placing, or worry about potential bankruptcy. And I DO know I own businesses that can maintain & ideally increase their operating capacity, expand market share at the expense of weaker competitors, potentially acquire said rivals at advantageous prices, and generally be the first to bounce back from set-backs, the market, the economy, COVID, anything else that’s thrown at them! Talk moats, economies of scale, network effects, etc, but the simple reality in business is that the strong generally get even stronger…and a strong balance sheet’s a lead that’s hard to beat with the right company & management.

72% of my portfolio’s allocated to companies with Net Cash & Investments on their balance sheet. As an investor, it makes sense to compare this metric vs. Current Market Cap (per the relevant reporting date). Breaking it down: a) 42% of my portfolio’s invested in companies with net cash/investments equating to (a weighted average) 10% of their market caps, and b) another 30% is invested in companies with net cash/investments equating to 29% of their market caps. [And yes, the outliers – two small (undisclosed) special situations boast an astonishing 98% & 167% of their balance sheets in net cash/investments – maybe that’s why the latter’s a 4-bagger YTD!].

Another 11% of the portfolio’s invested in balance sheet-focused companies (no banks, obviously!) with weighted average Net Debt to Equity a very manageable 21%. [Saga Furs is the outlier at 69%, noting this debt’s only drawn to fund interest-bearing receivables with a strong/consistent net collections history]. I prefer net debt to LTV/total asset ratios, but force myself to use net debt/equity – e.g. a 50% Net LTV ratio isn’t unusual for a residential property company, but notionally the same net debt/equity ratio is 100%! Maybe it’s me, but debt-equity always seems more alarming to me…a good trick to make me sit up & notice! And finally, 17% of the portfolio’s invested in operating companies with actual Net Debt/Adjusted EBITDA ratios – weighted average is fairly unalarming at 1.6 times – while Applegreen is the main outlier, on 3.7 times, resulting from the once-in-a-lifetime opportunity to acquire Welcome Break (where, notably, a substantial portion of the debt’s ring-fenced).

You’ll note a missing category: Cash Burners…and yes, that’s entirely intentional! I’m not totally opposed to cash burners, but it’s only a very rare category for me to consider – IF they’re creating significantly more value with each dollar spent, AND don’t face any obvious funding difficulties – frankly, those are judgements that often seem right (& easy to make), ’til they’re proved horribly wrong! Not to mention, such stocks attract blue sky investors who inflate valuation multiples to often ludicrous multiples.

NB: If you find this portfolio of companies unusual – vs. the average mega-cap balance sheet, for example – please note it’s not some collection of small/micro-cap special situations! Admittedly, it’s a bar-bell portfolio, in terms of size – so the (weighted) average market cap’s ridiculously large – but a median $0.5 billion+ market cap confirms this kind of portfolio’s actually available to/can be assembled by most investors who put in the research.

And finally, insider ownership:

[Insider ownership inc. all stakes owned  by directors, founders, controlling families, investment managers (if relevant) & any other senior execs/employees share (if disclosed) – per the same pre-COVID reporting date as above.]

All investors face the dreaded principal-agent problem…you’re always a principal, and ideally you want to bet on/be aligned with a fellow owner, not an agent! But today, agents are mostly what you get in listed companies of any meaningful size – say, $100 million plus – and as companies & compensation gets larger, it’s more & more acceptable for management to be serial-sellers of stock as their incremental awards vest. [‘Course, you need to exclude frauds/promotions here, which automatically tend to have high insider ownership]. Don’t kid yourself, it makes a hell of a difference – with no real skin in the game, management’s never fully aligned with shareholders, and often operates on a very different set of metrics & incentives. When things are good, they’re incentivized to leverage the business, juice the P&L, buy back shares at any price & expand their empires via acquisition (again, at any price) – all strategies to inflate their compensation & trigger maximum incentive payouts, with little economic risk from potential future business/leverage risks. And when things turn bad, management’s main incentive is to keep their compensation packages…as long as the company doesn’t go bankrupt (even then, management can benefit!), so sales of former acquisitions & (suddenly) non-core subs, kitchen sink write-downs & massive equity dilution are all fair game.

All this changes with skin in the game – when the worth of your equity far exceeds annual compensation, management becomes a fellow shareholder, one who’s aligned & incentivized to determine & implement the best long-term investment & operating growth strategy. The quick & dirty approach is to identify aggregate insider ownership…but on a micro-level, it’s important to look at executives’ stakes in terms of annual comp. In my experience, management behaviour & incentives really starts changing when their equity stake exceeds 3 times annual compensation. Then, you’re looking at management you can genuinely trust – as fellow shareholders, decisions they make will generally affect them just like you. Whereas agents – in this COVID crisis – have a huge incentive to just batten down the hatches, fire employees & eliminate all investment, while a massive equity placing’s the tempting & apparently prudent option to consider. Applegreen is (hopefully) the perfect counter-example – COVID’s an operational & financial challenge for them near-term, esp. with the Welcome Break debt & integration process they’ve taken on. But the CEO & COO still own over 41%, almost a EUR 175 million stake between them…so I sleep soundly at night, because now they can’t! And I’ve little doubt equity dilution’s the last thing they want to consider…

Breaking things out: 16% of the portfolio’s invested in companies where insiders own less than 0.5% of the company…as I said, this is typical for the average listed company today, and reflects vested stock/options they’ve accumulated (but not yet sold). Another 11% is invested in companies where insiders own up to 5% – depending on market cap, this is potentially meaningful, so comparisons vs. annual comp. are essential. The bulk of my portfolio though – 56% in total – is invested in the sweet spot, i.e. insider ownership is somewhere between 5% to 40% of the company. [And the weighted average stake’s 19%]. Another 10% is invested in companies with 40-50% ownership – this kind of dominant stake presents risk for minorities, but can generally be evaluated in terms of prior management history. I’m comfortable with corporate governance & management strategy to date at both Applegreen & Record plc (in fact, Neil Record’s age & substantial stake would suggest a potential sale of Record in the medium term). The remaining 7% of the portfolio’s invested in companies where insiders own 50%+ (in two instances, it actually exceeds 75%). Again, this is a calculated bet, one that comes with greater risk – dominant control can mean potential abuses of total compensation/related-party deals & general corporate governance – main comfort here is that shareholder value in the main outlier will likely be realised via a highly visible (& therefore equitable) sale of the company.

And that’s it – during COVID, I’ve had the luxury of sitting home, with no worries re the financial strength of the companies I own, and leaving it to management to sweat over their equity stakes, worry about the day-to-day challenges right now, and ultimately plan for continued growth/success & taking advantage of any market share/acquisition opportunities this crisis may present.

Good luck in your portfolio too…any questions, don’t hesitate to ask, it’s good to talk in a crisis!

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