2018: A Year In Review

myperformance

My Portfolio

This has not been a good year for my portfolio. I am below where I started, and I am down 16.4% for the year.

This is the second year in a row in which I have underperformed the S&P 500. This is certainly disheartening. The last two years for me have made a strong case for shutting up and putting money in an index fund, but I’m not ready to give up just yet. More on this later.

Buys

This quarter, I purchased a number of new positions. You can read the write-ups below.

Most of these companies are statistically cheap on the basis of earnings, cash flows, enterprise multiples, and sales. All have a strong financial position with low debt/equity ratios, good Z-scores, good Piotroski F-Scores. From a quantitative perspective, they’re all in the right neighborhood.

One position, Amtech, was purchased for the asset value. Amtech is selling below net current asset value and near cash. This is high quality for a net-net, considering that the company actually has earnings and positive cash flow. Most net-net’s tend to be terrifying perpetual money losers.

For the stocks I purchased for earnings, a common concern for them is that their underlying businesses are at a “cyclical peak”. I don’t believe we are going to have a recession in the next year, which is why I am comfortable purchasing them. I’ll explain more on my views of the macro landscape later in this post.

Sells

Below is a list of all of my sells this year:

2018sells

Previously, I tried to hold stocks for at least a year before selling them unless the stock was up significantly.

I loosened that rule up this year to give myself an escape hatch if the fundamentals deteriorate. For me, the biggest red flag is an actual loss at the top of the income statement. This helped me get out of two value traps early: Big Five Sporting Goods and Francesca’s Holding. I managed to exit Big Five with an 8.27% gain, which is incredible considering that the stock is down 62% for the year. Getting out of Francesca’s early was another great move, as it is down 87% for the year.

I try not to get married to positions. I think it’s important to keep an eye on the fundamentals of the companies I own. If the fundamental change, I should revisit my opinion.

International Indexing

This year, I also abandoned my “international indexing” strategy, which I pursued because of the poor opportunity set in the US combined with my poor skills in researching individual foreign companies.

The debacle in Turkey exposed this as a bad idea for me.

In order to stick with a position, I need to understand it. I don’t know anything about the situation in Turkey other than the market was cheap. That’s not a good thesis that will give me enough confidence to hold through a horrific drawdown.

I decided in the fall that this account should focus on my original mission when I set aside this money and started this blog. I set out originally when I launched this blog to hold individual positions in companies that I’ve researched. That’s what I am sticking with.

Misery Loves Company

This has been a difficult year for systematic value investing. As they say, misery loves company. Value investing has had a terrible year and my portfolio is not an outlier. Here are some examples:

  • The Russell 2000 value index is down 15.3%.
  • The Vanguard small-cap value ETF (VBR) is down 14.8%.
  • QVAL, the quantitative value ETF from Alpha Architect, is down 19.69%.
  • Validea’s 20-stock Ben Graham screen is down 15%. The 10-stock various is down 23%.
  • AAII hasn’t updated it yet, but as of November 30th the value screens did not have a good year. I suspect that when they update for December, the results will be a lot worse. As of 11/30, the Ben Graham “enterprising investor” screen (probably the closest proxy to what I’m doing) was down 15.5%. Their low price-to-free cash flow screen was down 12.5%. The high F-score screen was down 17%. Notably, the magic formula held up nicely this year. They show that screen with a gain of 7%.

The current situation could go many different ways, as is always the case in markets.

Traditionally, value stocks sell off before the rest of the market before a major calamity. They tend to be canaries in the coal mine. This was certainly the case in 2007. This is because value stocks are cyclically sensitive and, at the end of the expansion, they are the most vulnerable to a decline. This is also why they tend to rip in the early years of expansion, like 2003 and 2009. Everyone thought they were utterly doomed, but the world doesn’t end the way everyone was expecting. Stocks that had the biggest clouds hanging over them tend to perform exceptionally well once the weather improves.

The critical question, then, is: are we at the end of the economic expansion? Are we at the end of this cycle of economic development, or is the recent market sell-off one of Mr. Market’s typical bouts of insanity?

For possible answers, I turn to history.

Mr. Market’s meaningless temper tantrums

The market is replete with the corrections of the 10-30% magnitude that don’t reflect any reality in the real economy.

The most famous example of this is the crash of 1987, which had hardly any impact on the real economy. Mr. Market went into euphoric overdrive in the first half of 1987 (probably cocaine-fueled), with the market rising 22% from January 1st through the August peak. It then suffered a 33.7% peak to trough decline from August 1987 through December.

People are obsessed with another 1987 style crash happening again. Whenever the market has a nice run, Twitter is replete with comparisons of the chart to a stock chart of 1987.

I find this amusing. We should be so lucky. The 1987 crash had zero impact on the real economy and turned out to be an incredible buying opportunity. During the crash, Buffett’s friends (people like Bill Ruane and Walter Schloss) were at their annual conclave in Williamsburg, Virginia. They saw the panic for what it was and went to the phones to buy stocks.

Buffett used the crash to buy one of his most famous investments: his large allocation to Coca-Cola, which would set Berkshire’s returns into overdrive in the 1990s.

The people who are trying to predict the next crash of 1987 are missing the point. You can’t predict things like the crash of 1987. The trick is to identify the opportunities created by these events by buying new opportunities with a prudently calculated margin of safety.

Even indexers were fine in the crash of 1987 as long as they didn’t succumb to panic selling. Amid all of the “carnage” of 1987, the S&P 500 returned 5.25% that year. In 1988, the index returned 16.61%. In 1989, it returned 31.69%. It was a non-event, but market commentators are still obsessed with it.

Who suffered from the 1987 decline? Speculators. People who were leveraged. People who bought financial derivatives and exotic financial products. People who bought concentrated positions in speculative names. People who bought concentrated positions on margin. In other words: they’re the same people that always lose money over the long run and people who deserve to lose money over the long run.

Investors, in contrast to speculators, made out just fine in 1987. In modern parlance, these are the kind of people who thought they could predict volatility and went long in XIV. Alternatively, these are the kind of people who thought they could predict the price movement of cryptocurrency – i.e., a financial product best suited for anonymously buying heroin. Because blockchain is going to alter Western Civilization or something. Speculators always lose, and they’re always surprised when they lose. It’s so strange to me how people keep flocking to speculation like blood-sucking mosquitoes to a bug zapper.

What are some other instances of market downturns that didn’t reflect or predict anything in the real economy? In 1961-62 the market suffered a 28% drawdown. In the summer of 1998, the S&P suffered a 19% drawdown. ’83-’84 – 14% drawdown. 2011 – 19.4%. 1967 – 22%. 1975 – 14%. You get the idea. These things happen all the time.

Here is a young Warren Buffett talking about the 1962 hiccup. It sounds pretty familiar.

 

 

What particularly amuses me is how people are always trying to develop explanations for why these things happened. The 1987 crash is the most studied crash of all time with extensive media coverage. There still isn’t any consensus on what caused it. Some blame “portfolio insurance”. Others blame the Plaza Accords. Others still contend that the 1980s stock boom was a speculative bubble and the bubble never ended. They think the Fed has just been bailing out markets for 30 years and all of the gains since 1987 have been illusory.

Trying to predict and explain these things is a fool’s errand, unless you think you’re the next Taleb or Paul Tudor Jones (you’re not). I usually laugh at the commentators with impressive credentials and expensive suits who go on cable and explain why this stuff happened. Well, sir, if you look at the 200-day moving average, put this over the 50 day moving average, and if you look at the uptick in volume, and compare this to steel prices, and then take a look at these Bollinger Bands, and then look at the M2 supply’s impact on bond outflows, and compare this to the put/call ratio . . . blah, blah, blah

They might as well be astrologers. They might as well be ripping apart chicken guts and trying to predict tomorrow’s lottery numbers. Of course, this really shouldn’t be a surprise coming from the Wall Street elite. This stuff isn’t above them. They’re not all rational. These are people who buy healing crystals, after all.

The people who try to predict Mr. Market’s moods are like dutiful scientists following around someone at a bar after 15 tequila shots and trying to explain all of their behavior, trying to develop some rhyme or reason to it. “Hmmmm, very interesting, she is projectile vomiting after singing Sweet Caroline. Perhaps there is a correlation between vomit and Neil Diamond.”

I suppose much of it has to do with the rise of the efficient markets theory. If markets are efficient and they reflect all available information, then Mr. Market’s temper tantrums must actually mean something.

From their perspective, it can’t be my simple explanation: people are crazy and stuff happens. It can’t be that Ben Graham got it right in the 1930s and that much of financial theory since then has been a big waste of time.

Mr. Market gets it right (sort of)

Occasionally, Mr. Market gets it right and the carnage is tied to real turmoil in the real economy that will cause a real impact on the fundamentals.

Sort of, anyway. Even when Mr. Market gets it right, he overreacts. Mr. Market usually believes every bad recession is the end of Western civilization and the market suffers a 50% drawdown that would not be justified if markets were truly efficient. This is evidenced by the fact that the market normally snaps back by 50-100% in a year or two after the bloodbath.

The ’73-’74 drawdown is one example of an authentic event. The S&P 500 suffered a peak-to-trough decline of 48%. Oil drove the economic funk. With US oil production peaking in the 1970s, the US economy became more reliant on oil imported from OPEC nations. When OPEC colluded to restrict supply in response to US support for Israel, oil skyrocketed. This caused a severe and brutal recession in the United States.

The 2008 event was tied to real economic activity, as we’re all aware of and I don’t need to repeat. Banks were failing and it felt like the system was falling apart.

How about 2000? Many cite the 2000-02 market as one long bear market. I divide it up into stages. The initial fall in 2000 was simply Mr. Market throwing a temper tantrum. There was no catalyst. In 2000, people suddenly realized that it was crazy to pay 100x earnings for Cisco, even though it was a great company. They realized it was insane to pay 10x sales for IPOs of dot com companies that didn’t make any money. It was simply a mood wearing off.

Side note: Cisco was the first stock I ever bought. I sold it after I read “The Intelligent Investor” and realized it was crazy to own it.

In 2001, however, the deflation in the stock market along with 9/11 began to have a real impact on the economy, which triggered the more serious sell off of 2002 and early 2003.

What is this thing – a meaningless temper tantrum or something real?

The key question is whether or not the recent decline is merely Mr. Market panicking or if he is predicting real damage in the US economy.

To answer that, we should ask what distinguishes speculative panics from real events.

The most significant difference between a real event and speculative BS is that there is no consensus explanation for speculative panics. There are plenty of scapegoats for the crash of 1987, the “flash crash” of 2011, but no consistent broadly accepted explanation. In contrast, there is no doubt what caused the market declines of 1981-82, 1973-74, 1990, 2008.

Is there any consensus on what caused the recent collapse? Not really. Speculation abounds: the market is concerned about trade wars, the Fed hiking interest rates, hedge funds are “de-risking.” There isn’t any consensus. There isn’t a clear bogeyman. That leads me to believe that the market is not accurately predicting any carnage in the real economy within the upcoming year.

I also doubt we’re entering a recession for the following reasons:

1) The yield curve hasn’t inverted. While some rates briefly inverted this year, there is a lot of noise in the shorter end of the curve (under 5 years). The inversion that accurately predicts recessions, the 2 year versus 10 year, has not inverted. It’s also worth noting that the inversion usually happens a year or two before the recession begins in earnest. The fact that it hasn’t happened at all leads me to believe that rates are not yet high enough to push the economy into a recession.

yieldcurve

2) There has been no discernible change in the unemployment trend. October 2018 marked an all-time low in the unemployment rate. The unemployment rate usually begins to tick upward before the onset of a recession. The unemployment rate started to rise in the first half of 2007, months before the beginning of a bear market or the start of the recession in December 2007. The unemployment rate also began to rise in the fall of 2000, the summer of 1990, and the fall of 1981. I would expect the unemployment rate to begin tipping upward if a recession was imminent.

unemployment

broader unemployment

3) Household leverage is healthy. Think about what causes a recession. Typically, it is driven by monetary policy. In a boom, interest rates are cut and households accumulate debt, which drives the expansion. In the later stages of a boom, the Fed increases interest rates. The higher debt burden plus the higher interest rates restrict the cash flow of households. As they cut back to deal with the stress on cash flows, this pushes the economy into a recession. Currently, household debt payments as a percentage of disposable income are near all-time lows, despite the recent increases in interest rates.

leverage

4) There isn’t any sign of a slip in broad economic indicators. In fact, most of them are at all-time highs. Here are a couple: truck tonnage and industrial production.

trucktonnage

industrialproduction

The Opportunity For Value Investors

In the last couple of years, I have been concerned about rich equity valuations. I invested anyway in the best bargains I could find. I invest for the market that exists, not the one that I wish for. I wish every year could offer up 2009-style bargains. I also wish pizza, cookies, and ice cream didn’t cause me to gain weight. Unfortunately, my wishes are not reality.

With that said, the recent sell-off has helped the situation. It’s not 2009 cheap, but it’s a much better situation than it has been in a long time. The Shiller P/E is down to 27.69, which is hardly cheap but is better than it has been in a few years. The latest data isn’t available, but I’m sure that the average investor allocation to equities has also declined, which is also good news for future returns.

The drawdown has produced an ample number of cheap stocks, which is great news for value investors. The high number of cheap stocks is unprecedented for a healthy economy.

In December of 2016, there were only 47 stocks in the Russell 3,000 with an EV/EBIT multiple under 5. In December 2017, the count was down to 40. There are now 90 of these stocks, which is historically very high. Such a high number of cheap stocks bodes well for value. In past years when there have been more than 80 of these, as a group, these cheap stocks have delivered an average annual return of 32%.

The year 2000, in particular, was an incredible year for the relative performance of this group. This group of stocks with an EV/EBIT multiple below 5 delivered a 28.35% return compared to a loss of 9.1% in the S&P 500. This was extraordinary out-performance. The good times made the careers of a number of value investors who were new to the game and weren’t already tarnished by the under-performance of value in the ’90s, like David Einhorn.

Everyone knows that value has under-performed for a decade and this is similar to the late 1990s. The thinking goes that this under-performance will lead to another period like the 2000s when value stocks crushed expensive stocks. For the last few years, I wanted to believe that this situation was bound to mean revert soon. The main factor that made me doubt this reversion to the mean was the low number of cheap stocks that were available.

What made value roar in the early 2000s? The ’90s bubble led to a plethora of bargains in the small-cap value universe. The depth of these bargains led to an incredible performance in the early 2000s. Looking at the dearth of cheap names in 2016-2018, my concern was that even though value had under-performed recently, I didn’t see the quantity of bargains that I knew existed circa 2000.

The recent sell-off has changed that dynamic. There were 101 stocks with an EV/EBIT multiple under 5 back in 2000. Now, there are 90. A week ago, there were 108.

This leads me to believe that we are entering a situation very similar to 2000. Just like 2000, the economy is fundamentally healthy and not in a recession. A recession would negatively impact all stocks, not merely the pricey growth-oriented names. Meanwhile, there are a massive number of bargains to choose from.

Despite my under-performance in the last two years, I am now more optimistic than ever.

I think we will see substantial out-performance for value and I think my portfolio of diversified value names should perform well. Value stocks are no longer merely cheap on a relative basis; they are cheap on an absolute basis as well.

Moreover, the sentiment that the value factor is played out and over-farmed is more widely accepted than ever before. You even see this in the behavior of so-called “value” investors. Value investors in recent years have thrown away the old metrics and adopted a “can’t beat ’em, join ’em” philosophy. “Value” guys are out there pitching Facebook, Amazon, and the like. Usually, the pitch involves wildly overoptimistic metrics plugged into a DCF model along with talk of “moats”. Excellent value investors like David Einhorn are treated like out of touch dinosaurs.

Everything feels right to me. The time for value is now, and I am wildly excited for the upcoming year in a way that I wasn’t previously.

Random & Personal

  • I read a number of good books this year. Chief among these is Margin of Safety by Seth Klarman. I wrote a blog post about it here. Saudi America was another great read, which I wrote about here. Here are a few other standouts I read this year:
    • Seinfeldia. If you are a Seinfeld and Curb Your Enthusiasm fan like myself, this book is a must read. It’s all about the birth of Seinfeld and the history of the show, with an inside scoop on all of the details of production.
    • Keeping at It. This was Paul Volcker’s autobiography. It was an amazing read about my favorite Fed chairman. You’ll come away with a sense of how hard economic policy is. Everything Paul Volcker did now seems so clear, but at the time it was extraordinarily hard and uncertain.
    • Brat Pack America: A Love Letter to ’80s Teen Movies. I grew up on a steady diet of movies from my favorite decade, the 1980s. This was an in depth homage to all of them. The author clearly has a deep love of the decade and the movies and music it produced. It shines through in this book. He ties each movie into larger cultural trends which were happening at the moment. He also interviews many of the creators of these movies and visits the real life locations in which they happened. Highly recommended.
  • This was a challenging year for me professionally. I’ve worked in back office banking operations for 11 years. I’ve moved up within banking operations on a pretty standard track: I started as a temp, I was hired full time to an analyst position, then a senior analyst position, then I was promoted to be the supervisor of a small team. Last December, I was promoted to a VP-level manager position overseeing 25 staff members on 4 different teams. It was a tough transition for me and I struggled to adapt to the high level of responsibility.
  • Managing the stress of the new job was hard for me. Every day brings a new crisis, a new emergency, a new demand, a new threat to deal with. Every five minutes my inbox blows up with a new problem. It’s particularly rough when faced with the constant challenge from upper management to reduce staff and increase efficiency, especially when clients and upper management are also constantly demanding better results with less resources.
  • Managing people is hard. You can’t come down too hard: you’ll hurt morale. You can’t be too easy on everyone: they will take advantage of it. Everyone has unique problems: people going through medical issues, people having trouble with their spouses, people dealing with challenging situations with their children and care for their children. I have a moral obligation to accommodate these personal issues, but management doesn’t want me to be too accommodating. Audit and controls are also a major focus and source of conflict. Like everything else, there is nuance to this. We need to have stronger controls, but we can’t tighten the controls so much that the client suffers. Meanwhile, a failure in controls results in intense backlash and threats to my employment. There are no easy solutions to every problem. Every decision I make seems to have some unforeseen consequence that I didn’t anticipate.
  • With all of this said about my job, I think I delivered and performed well in a challenging environment. I haven’t gotten my review yet, so I’ll have to wait and see if my boss agrees. I also get paid pretty well to deal with all of this, so I shouldn’t complain too much! I also tend to think too much instead of stopping and smelling the roses. There are people out there who have it a lot worse.
  • With that said, as this blog expands it audience and I interact with so many great people in the financial world on Twitter, I yearn to get out of the back office and do something different with my life professionally. I yearn to do something more rewarding than ensuring other people’s trades in weird financial products are processed more efficiently. Doing something different would also enable me to stop being anonymous on this blog and on Twitter. I have no idea what this change could be, but I’m yearning for a change. I have no idea what or when. Hopefully I’ll figure this out.
  • This was also a tough year for me personally, as I alluded to in this blog post. This was tough to handle on top of all of the professional stress. I am now 10 years sober and I’m very proud I didn’t give in and fall back into the arms of my old nemesis, booze. I think I need to make my mental health more of a priority in the upcoming year to prevent me from relapsing.
  • I found myself watching Star Trek III a lot this year. It is such an underrated movie in the wake of Star Trek II. This is the ending and it should be heart warming to every nerd out there.

 

 

PLEASE NOTE: The information provided on this site is not financial advice and it is for informational and discussion purposes only. Do your own homework. Full disclosure: my current holdings.  Read the full disclaimer.

ProPetro Holding Corp (PUMP)

pump

Key Statistics

Enterprise Value = $1.024 billion

Operating Income = $233.82 million

EV/Operating Income = 4.38x

Earnings Yield = 13%

Price/Revenue = .63x

Debt/Equity = 17%

The Company

ProPetro is a Midland, Texas-based oilfield services company. The company’s focus is providing equipment and services to support the fracking industry with a concentration in the Permian Basin.

The Permian Basin is an ocean of oil, currently producing 2 million barrels of oil a day. PUMP owns and operates a fleet of mobile hydraulic fracturing units. Other companies pay ProPetro for the use of these units, along with the supporting crew which operates the equipment. They provide equipment, personnel, and services to meet the needs of their clients that work in the Permian Basin. They have strong relationships with their clients and are local to the Permian basin, giving them a substantial advantage in this region due to the relationships that they have in place.

This is a company whose fortunes are directly tied to the performance of fracking in the United States, which is directly linked to oil prices.

wti

Oil has been hammered recently, which led to a decline in the stock price.

PUMP has been punished further in the recent market sell-off, pushing it below its 2017 IPO price of $14.50. This is a small company in a rocky industry and has been, in my opinion, oversold because it is perceived as a risky small cap in a risky industry.

My Take

I am optimistic about the fracking industry, primarily due to the fact that it defied all expectations and survived the misery of the 2015-16 oil price crash. This was a crash that was engineered by Saudis who increased oil production to cripple the fracking industry in the United States. Fracking is only profitable at high oil prices, and the Saudis hoped to cripple the industry by boosting production and lowering the price. They did not succeed despite their best efforts and fracking, while damaged over the crash, survived the crash.

With that said, there is a lot to dislike about the industry. The oil crash of 2015-16 led to a string of bankruptcies among the highly indebted companies in the space. There is also criticism that the industry is too capital intensive and can’t produce sufficient free cash flow to be viable for the long run. The only thing supporting the industry, critics say, is a flood of cheap money from yield-hungry investors and greedy Wall Street banks determined to earn fees while they hold their nose over the stench of crappy deals. Adding more support to the “ick” factor is the environmental criticism of the industry.

Add up all of this and what do you get? An industry ripe for mispricing because of the revulsion is creates. I think ProPetro has been punished unnecessarily by this sentiment.

The speculative nature of this trade is that I am betting that oil prices are close to a cyclical low. The Saudis seem strongly incentivized to increase the price of oil, and they are already taking action to make this happen. They want to take Aramco public in the near future. To get the best possible offering price, they need to maximize the price of oil. This is going to benefit fracking, to the long-term detriment of Saudi Arabia but it will support their short-term interest to maximize the price of oil so they can get the most money out of their IPO.

ProPetro is uniquely positioned as one of the key players in the Permian Basin, which is a hub of fracking activity in the United States. They will benefit immensely by an increase in oil prices.

Even if I am wrong and oil heads lower, ProPetro held up nicely during the 2015-16 crash. They were able to eke out positive operating income in 2015 of $8.78 million and lost only $37.38 million in operating income in 2016. Once oil prices bounced back slightly in 2017, ProPetro came back to life and generated an operating income of $63 million. This suggests to me that even if my thesis is wrong, ProPetro should survive a downturn in the fracking industry and minimize my losses. Furthermore, I purchased the stock at such a significant discount to intrinsic value (4.38x Operating Income, a 13% earnings yield, and only 5 times cash flow), that the stock price should hold up in a downturn.

If my thesis is correct and the Saudis engineer a hike in oil prices to support their IPO, fracking in the United States ought to boom and ProPetro’s multiple ought to improve significantly.

PLEASE NOTE: The information provided on this site is not financial advice and it is for informational and discussion purposes only. Do your own homework. Full disclosure: my current holdings.  Read the full disclaimer.

Nucor (NUE)

nucor

Key Statistics

Enterprise Value = $19.038 billion

Operating Income = $2.726 billion

EV/Operating Income = 6.98x

Earnings Yield = 13%

Price/Revenue = .68x

Debt/Equity = 44%

The Company

Nucor exclusively produces steel via minimills. Minimills take in scrap steel, vehicles, or equipment and melt them down in a furnace. Nucor uses electric arc furnaces, which heat the raw materials up to temperatures of over 5,000 degrees Fahrenheit to melt the metal down. The melted down steel is then re-purposed and sold. Nucor is the largest operator of steel minimills in the United States.

The cheap valuation is a result of the recent market sell-off combined with Nucor’s strong earnings in the last couple of years. The market seems to be indicating its belief that we are headed for a recession and steel demand is near a cyclical peak.

My Take

Nucor’s business prospects are driven by demand for steel and steel products. With strong US and global growth, Nucor has benefitted. A bet on Nucor is a bet that the economy will continue to grow and will not enter a recession. As I’ve stated previously on the blog, I do not believe that the US will enter a downturn in the next year.

I also think it’s possible that demand for steel can increase from current levels. With the Democrats seizing control of Congress and Donald Trump’s attitude towards deficits and spending, I think it’s possible that a big infrastructure bill could pass through Congress. This would be excellent for steel demand and could help boost earnings and sales from already strong levels. Infrastructure spending is probably the only area that Congressional Democrats and Donald Trump can find common ground.

Nucor has been expanding in recent years, pursuing a strategy aimed at growing its business. Recently on November 29th, they acquired a Mexican precision castings company called Corporacion POK, S.A. de C.V. In 2016, they acquired Independence Tube Corporation for $430 million. In 2014, they bought Gallatin Steel for $779 million in cash. The acquisition is in addition to Nucor’s investment in its existing capacity. They spent $230 million on a cold mill in their Arkansas facility, allowing it to manufacture more advanced low alloy steel products. They are also building new minimills in the United States, including a $250 million facility in Missouri. All of these efforts, I believe, will strengthen Nucor’s competitive position within their industry.

Nucor is financially healthy. They currently have a perfect F-Score of 9. The debt/equity ratio of 44% and the current ratio of 2.77x indicates that debt is at healthy levels. This is particularly impressive considering that they have been expanding and acquiring new businesses over the last few years. The Z-Score of 4.23 implies a very low risk of bankruptcy in the upcoming year.

Nucor’s valuations look favorable compared to its own history and its industry. The P/E of 7.9 compares to an industry average of 12.18. An increase to this level would be a 54% increase from current levels. Nucor’s average P/E over the last 5 years is 25.28. On a price/revenue basis, Nucor currently trades at 68% of revenue, compared to an industry average of 159%. On an EV/EBIT basis, Nucor trades at a multiple of 7x, compared to a 5-year average of 15.

PLEASE NOTE: The information provided on this site is not financial advice and it is for informational and discussion purposes only. Do your own homework. Full disclosure: my current holdings.  Read the full disclaimer.

Gap (GPS)

mall

Key Statistics

Enterprise Value = $9.397 billion

Operating Income = $1.386 billion

EV/Operating Income = 6.77x

Earnings Yield = 10%

Price/Revenue = .56x

Debt/Equity = 36%

The Company

Gap is a retailer. Have you been to the mall in the last 20 years? Have you seen its commercials trying to convince you to buy khakis? I’m fairly certain you’re familiar with them. (Personally, I buy most of clothes at K-Mart, Wal Mart, and Costco, but whatever.)

The company is not simply the Gap stores in malls. They also own Banana Republic and Old Navy. Banana Republic is pricier than both Old Navy and Gap. Old Navy is the discount apparel retailer that is currently driving the company’s growth. Old Navy has continued growing while the other two segments have been in decline. Old Navy grew sales by 6% in 2017 while both Gap and Bananan Republic experienced sales decline as customers shy away from the mall.

Gap was beat up by the retail carnage a few years ago. From 2014 through its 2016 low, Gap went from around $40/share to a low of $17 in mid-2016. From there, as Mr. Market woke up and realized that most apparel transactions still happen in a store, the stock recovered to $35 in January 2018.

From the heights of $35/share, the stock has been punished again over the last year after some choppy quarters, but the news has hardly been devastating. The stock has also been punished by concerns over a trade war that isn’t yet showing up in the actual results.

My Take

Yes, I’m diving back into this category again – retailers punished by the sentiment that Amazon is eating brick and mortar retail. I keep ignoring the warnings. Like Z’Ha’Dum, the advice is: if you go there, you will die. I keep going there anyway.

Anyway, I think I made a few good picks in the retail sector (American Eagle, Dillard’s, Foot Locker, Dick’s), but this area has largely been a wasteland for my portfolio. Fortunately, I exited the dumpster fires like Francesca’s and Big Five after they posted operating losses. I even got out of Big Five for a slight profit! This is shocking considering the stock is down 68% year to date. In retrospect, the best way to play a beaten up sector is to own more of them in smaller chunks. I made “big” bets on a small handful of dirt cheap ones, but I probably should have been more diversified among a broad number of stocks in the group.

The trade is now played out. Retail recovered as a sector, even though I didn’t always have the right picks. Even after that after the run up, Gap looks to me like one of the best of the bunch and the multiple has been compressed due to some slight underperformance in business results along with trade war jitters.

Gap hasn’t posted a loss at any point in the last decade. Even in the depths of the Great Recession, it still earned $1.34/share. It has also maintained profitability throughout the last few years of intense competition with online brands. They also began a restructuring effort in 2016, which is working. They closed 75 stores internationally that were not performing and realized a $275 million cost savings. I find this encouraging, especially compared to my experience in Francesca’s, which continued to open new stores even while the existing stores were posting terrible results. Gap has a strong shareholder orientation in this regard.

Gap is very well run with a high degree of financial quality. The F-Score is a perfect 9 out of 9. The Altman Z-Score is currently 4.73, implying an extremely low risk of bankruptcy. The debt to equity ratio of 36% compares favorably to industry averages, which currently averages 68%. The company also has a high degree of yield. Last year, they bought back 2% of the existing share count and the current dividend yield is 3.94%.

Gap’s current valuations compare favorably to the industry and its history. Gap’s current P/E of 10.29 compares to an industry average of 14.32. A P/E of 14-15 seems reasonable to me for a steadily performing and financially healthy retailer. On a price/sales basis, Gap’s current ratio of 56% compares to a 5-year average of 83%. On an EV/EBIT basis, Gap’s current level of 6.77x compares to its 5-year average of 7.68. The forward P/E is 9, implying analysts don’t expect any kind of operational loss in the upcoming year.

PLEASE NOTE: The information provided on this site is not financial advice and it is for informational and discussion purposes only. Do your own homework. Full disclosure: my current holdings.  Read the full disclaimer.

First American Financial (FAF)

house

Key Statistics

Enterprise Value = $3.245 billion

Operating Income = $689 million

EV/Operating Income = 4.7x

Earnings Yield = 12%

Price/Revenue = .84x

Debt/Equity = 22%

The Company

First American Financial is a California based insurance company. Their focus is title insurance, from which roughly 92% of their revenue is derived. Title insurance is simply insurance which protects against losses if a title is deficient.

FAF is paid when mortgage transactions closed. With the real estate market in the United States steadily growing over the last decade, the company has benefited from real estate activity. Since 2013, earnings are up 119%.

The title business improves due to volume and the premium paid for title insurance is derivative of the home’s value. Therefore, FAF benefits from a rising real estate environment. The stock has been punished over the last year due to concerns that this real estate expansion is slowing down.

FAF also maintains an investment portfolio, which is mostly concentrated in fixed income instruments. Currently, they have $4.7 billion in fixed income instruments and $467 million in equity. For this reason, the pressure experienced by the markets in recent months has weighed upon the price. From 2016 to 2017, the investment portfolio increased in size by 157%. If we entered a serious downturn, it is unlikely that that this would persist.

Side note: In the summer of 2001, I had a job working for a title insurance company. My task was simply to spend all day calling title abstractors across the country. I would order title reports from the counties in which the properties were purchased, they would fax it to me, and it was my job to regularly follow up with them. I had a lot of fun doing it! I’m sure the operation is more sophisticated these days, but back then obtaining the reports from the local abstractors was like pulling teeth.

My Take

I owned this back in 2017 and made a 50% profit on it. It is one of my few successes over the last couple of years. I bought it around a P/E of 12. When I sold it, the multiple was around 20, and I made a 50% profit, so I got out. The stock is way down from those lofty levels, and it is now at a P/E of 8.

From a relative valuation standpoint, FAF looks like it is at an attractive level. The P/E of 8 compares to a 5-year average for the stock of 15. The average for the industry is also 15. On a price/revenue basis, the stock currently trades at 84% of revenue compared to an industry average of 125%.

With an F-Score of 6 and a low debt/equity ratio of 22%, the company exhibits a high degree of financial quality. Indeed, FAF is a well run company and this has buoyed its ability to consistently grow over the last decade. Additionally, while title abstracts and insurances looks like an area ripe for disruption, to truly streamline this industry would require many local governments throughout the country to upgrade their technology and systems used to track title information. I don’t think this will happen any time soon.

I expect that FAF will continue to perform well and I don’t think there will be a recession in the next year as many pundits are predicting right now. With that said, even in the midst of the 2008 real estate meltdown, FAF only lost 81 cents per share and quickly recovered to profitability in 2009. I would be shocked if the US entered a real estate meltdown of that magnitude. By all indications, the quality of mortgage loans has improved and household mortgage debt looks sustainable when compared to the disposable income of households.

PLEASE NOTE: The information provided on this site is not financial advice and it is for informational and discussion purposes only. Do your own homework. Full disclosure: my current holdings.  Read the full disclaimer.

Amtech Systems (ASYS)

winter

Key Statistics

Market Capitalization = $66.96 million

Cash & Equivalents = $62.50 million

Current Assets = $124.29 million

Total Liabilities = $56.32 million

Net Current Asset Value = $67.97 million

Z-Score = 2.45

The Company

Amtech operates three segments in three industries: (1) Semiconductors, representing 45% of revenue, (2) Solar cells, representing 47% of revenue, and (3) Polishing of newly sliced silicon wafers, representing 8% of revenue. They supply components and materials used in the manufacture of semiconductors and solar panels.

While the company has produced profits and cash flows for the last couple of years, the market believes semiconductor and solar revenues hit a cyclical peak this year and that the company is doomed to return to its loss-making years. In 2014, 2015, and 2016 Amtech generated net income losses of $13.09 million, $12.94 million, and $7.91 million respectively.

You see this same sentiment in mega caps like Micron, another one of my holdings. For a micro-cap stock like this, this sentiment is producing brutal price declines – i.e., a company selling for less than the cash it has in the bank. Amtech is down 55% year to date.

For the solar business, in particular, the industry is subject to brutal pricing pressure and is likely not a “good” business going forward. Solar projects are being shelved due to the President’s trade war and inclinations against the solar industry.

Furthermore, the company is diluting the shareholders. They have issued shares in the last year and the share count is up 8.37%.

My Take

Amtech is operating in a brutally competitive industry that appears to have peaked, they are issuing shares, and the situation appears grim. Why am I buying this stock?

I bought this because of the absurd valuation. This currently trades below net current asset value and for roughly the cash that they have in the bank.

Usually, when a net-net is this cheap, there are usually catastrophic losses going on. There is typically an asset value, but the market believes that the asset value will quickly go away due to losses. The risk is usually that the company will piss away the cash and the company will go out of business. This is not the case here. With a Z-Score of 2.45, the risk of bankruptcy is minimal. The company is also producing cash flows and earnings, which is extremely unusual for something trading this cheap. In 2017, they made $9.13 million in net income. In 2018, they made $5.31 million. They also produced free cash flow for the last couple of years, generated $5.3 million of free cash flow in FY2018 and $10.53 million in 2017.

There is also a high degree of insider ownership, with insiders owning 15.63% of the company. This is a positive sign, as insiders have a strong incentive to keep the business afloat.

I have no idea if semiconductor and solar demand is at a cyclical peak. As a value investor, I am drawn to the industries where Mr. Market is fretting, stressing, and creating potential bargains. Amtech seems like a compelling bargain to me. Even if the business is at a cyclical peak, I don’t think it matters for a stock like this. Frankly, I would be attracted to this stock even if it were producing losses.

When a company sells for the cash in the bank, all it needs to do to perform well is to simply survive. The question I am trying to answer is: Will Amtech exist a year from now? Will they maintain the current asset value? With a high degree of insider ownership and steady cash flows, I think the answer to both questions is yes. When a net-net like this is generating profits and cash flows, it seems like a compelling opportunity.

PLEASE NOTE: The information provided on this site is not financial advice and it is for informational and discussion purposes only. Do your own homework. Full disclosure: my current holdings.  Read the full disclaimer.

Oshkosh Corp (OSK)

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Key Statistics

Enterprise Value = $4.996 billion

Operating Income = $639.4 million

EV/Operating Income = 7.8x

Earnings Yield = 10%

Price/Revenue = .6x

Debt/Equity = 33%

The Company

Oshkosh is a 101-year-old company that focuses on building specially designed trucks and military vehicles. The company headquarters is in Oshkosh, Wisconsin. They began in 1917 by creating the first all-wheel-drive truck, known as “Old Betsy.” Throughout the last century, they’ve expanded into making many other types of vehicles. They make off-road trucks, fire trucks, farm equipment, and vehicles for the US military.

The stock has gone down in the last year over jitters concerning tariffs and trade wars. Of principal concern is the impact that tariffs will have on many of the components and raw materials that they use to build vehicles. The stock is presently down 30% year to date over these worries.

My Take

While the stock has gone down in the last year over tariff worries, the actual business is performing well. Revenues were up 12.8% in 2018 from 2017. Operating income was up 32%. Oshkosh is also in excellent financial condition with an F-Score of 8 and a debt/equity ratio that is nearly half of the industry average.

Their close ties with the US government give the company an excellent competitive advantage. For many key vehicles, such as the Oshkosh Light Combat Tactical All-Terrain Vehicle, they are the sole supplier to the US military. The ties with the US military are also long-standing, and they have been selling vehicles to the US military for 90 years. Sales to the US government presently account for 20% of their revenue. The ties with the military also strengthen their reputation in the private sector as a reliable manufacturer of sturdy, quality vehicles.

A major risk to the business would be a decline in the US defense budget. Based on the biases of the current White House occupant, I don’t think that is a serious possibility. Another major risk would be a US recession. While the stock market is fretting over this, I am not very concerned about it, particularly over the next year. The market might also be correct and a trade war will adversely affect the company, but this is speculation that is not showing up in the actual performance of the business. At the moment, this doesn’t appear to be the case.

From a relative valuation standpoint, Oshkosh trades at valuation multiples that are attractive compared to its history and its industry. Oshkosh currently has a P/E of 10.15, compared to an industry average of 18.85 and a five year average of 17.10 for Oshkosh itself. An increase to these levels would be a 68% increase from current levels. Trading at 60% of revenue, this compares to an industry average of 119%. On an EV/EBIT basis, Oshkosh currently trades at 7.8x compared to a 5-year average of 11.44.

Overall, I think Oshkosh is an excellent company with a deep history of solid performance and a stable competitive position. The stock has gone through pain over macro concerns that are not showing up in the real operating performance of the company. At the current valuation, I think it is an attractive choice.

PLEASE NOTE: The information provided on this site is not financial advice and it is for informational and discussion purposes only. Do your own homework. Full disclosure: my current holdings.  Read the full disclaimer.

I am a value investor. My outlook is inspired by the ideas of Benjamin Graham. This site is a real time chronicle of my portfolio and an outlet to share my ideas. I hope you enjoy.