Q1 2019 Update


I had a good quarter. I gained 15.74%, which compares to the S&P 500’s total return of 13.5%.

For the last few years, I’ve done a major rebalance in December and then usually did absolutely nothing in the first quarter. This year, the market move and company specific events compelled me to sell some positions, and with the cash I established some new ones.


Gamestop – After two years of waiting in Gamestop for the company to be bought out,  Gamestop announced they were going to stop trying to sell to a private equity firm, dashing all of my hopes. The major source of Gamestop’s cash flow is the re-selling of old video games and system platforms. This is a dying business as more video game consumers will download games directly and purchase platforms online. With that said, I think the business will be around longer than the market thinks. This is why about 4 years of Gamestop’s business could pay for the entire company. While the business is  in decline, this cashflow has value if Gamestop plays it correctly. My hope was that an acquirer would see this value, because Gamestop itself seems to be blowing the dwindling cash on dividends.

Looking back at this debacle, I likely should have sold this after the first accounting loss a year ago and admitted defeat. I also foolishly doubled down on the position in 2017. This is usually a bad idea. I lost 52% on the stock.

Sanderson Farms – I sold Sanderson Farms after an operating loss. At the moment, this looks like a mistake. The stock is now up to $130/share from my sale price of $115/share. Sanderson is a great company, but I try to sell when my positions approach a rich valuation, even if I like the business. A higher valuation plus a top line loss compelled me to sell. I made 16.6% on the position. I will likely return if the stock becomes cheap again.

ProPetro – I made 45.33% on this position in a very short time. I purchased this in December, and I thought the uptick was absurd, so I sold. Since then, it has gone higher.

Gap – Gap announced on March 1st that they were going to split the company up into a “good company” (Old Navy) and a “bad company” (all of the mall retailers). The stock soared on the news very quickly in one day. This made no sense to me, as current shareholders still own the same thing. I thought the increase didn’t make any sense, so I sold for a 19.76% gain. This looks like it was a good trade, as I sold at the top after the surge and the stock has steadily declined since then.

Thor – Thor reported terrible results and I sold the stock because of the deteriorating fundamentals. I sold the stock for a loss of 38.27%.

Aaron’s – Aaron’s reached a 52-week high in March, and the valuation increased significantly, so I sold the stock for a 29% gain.


With all of the unexpected cash from my sells, I purchased some brand new positions. The new positions are listed below with links to my rationales.

  1. Louisana Pacific
  2. Hollyfrontier
  3. Winnebago
  4. Urban Outfitters
  5. Express

I also expanded my position in Nucor.

The Value Opportunity

In the fall of last year, Mr. Market’s temper tantrum created a high number of bargain stocks, which is historically an excellent sign for value stocks. More bargains typically result in higher returns.

In December, the number of cheap stocks in the Russell 3,000 peaked at 108 stocks. My definition of cheap is an EV/EBIT multiple under 5.

The below chart, which I put together back in 2017, breaks down the number of cheap stocks in the market and the subsequent return they delivered over the next calendar year.

Generally speaking, a higher quantity of cheap stocks tends to result in higher returns for this group. It means that the “cheap” stocks are unusually cheap, giving them a long runway to expand their multiples and substantially increase in price.


2000 and 2001 stand out as years of substantial outperformance for value. The indexes suffered declines as the tech bubble deflated, but value performed exceptionally well. This is because the cheapest stocks were cheap on an absolute basis after being overlooked during the mania of the late ’90s and their multiples expanded despite the carnage in the broader market.

I noticed that the situation at the end of 2018 was similar to 2000, a year which delivered epic outperformance for value investors. There were over 100 cheap stocks in the US market and, as the yield curve had not yet inverted, it didn’t seem likely that we were going to have a recession.

The market delivered on this faster than I imagined. December was a time when investors needed to strike while the iron was hot, as the opportunity came and quickly dissipated. As a group, the number of cheap stocks went from 108 on Christmas Eve to 67 today.

The record for this cohort has been mixed. In February, the group was up nearly 20% for the year. That gain has since dissipated to a 10% year to date return, now underperforming the index.  We’ll see how this shakes out as the year continues.


I think that the yield curve is the best indicator of the likelihood of a recession. I covered the use of the yield curve as a recession predictor in this post: the Dark Art of recession prediction.

Why does the yield curve “work” as a recession indicator? Simply put, the Federal Reserve is the dominant factor in the business cycle. The Federal Reserve is the cause of and cure to nearly every recession. Expansions in the US end when the Fed is too tight. A yield curve inversion is a sign that the fed is too tight.

The 3-month and 10-year treasury yield inverted a few weeks ago. The 2 year and 10 year haven’t inverted yet, but have flattened. The 10 and the 30 is another good indicator, as pointed out in this post by Scott Grannis.

There is typically a lag between a yield curve inversion and the onset of a recession of a year or two. There is a similar lag between Fed cuts and the beginning of a new economic expansion. The yield curve inverted in 2005-06 and the impact of that relatively tight monetary policy wasn’t felt until 2008-09. The Fed began aggressively cutting rates in 2007, but this didn’t start to have a positive effect on the economy until late 2009.

Ray Dalio famously says an economy is a machine. I think it’s more likely an organism, responding slowly and organically to policy changes.

The slow way that the economy responds to these changes is difficult to navigate for investors. We are like blindfolded people trying to navigate our way through a funhouse. It’s particularly confusing because the year or two after a yield curve inversion is often one of the best parts of the business cycle. The economy is red hot, and everything seems wonderful. Think about the mood in 1989, 1999, or 2006. The party was about to end, but it was also at its most roaring. All of these years were after a yield curve inversion, and it was difficult for investors to look at the robust economy and imagine how it could fall apart.

Ensemble Capital had a great tweet summarizing how strong the environment is at the end of the cycle.


It’s almost as if the market tries to lure investors in before it slaughters them.

Another great indicator of where we are in the cycle is trending in the unemployment rate, as pointed out in this post. Right now, the unemployment rate hasn’t yet changed its trend, but it looks like it is flattening. It is already below the lows experienced in 2000. How much lower can it go?

uetrendA yield curve inversion is like a yellow light. A shift in the unemployment rate is a big red light telling you that a recession is imminent and we might already be in one.

I still think the yield curve is a valuable tool for forecasting recessions. One of the reasons it is such a useful tool is because so many people doubt it every time it happens. I remember being a teenager watching CNBC in the late ’90s and listening to pundits say that the yield curve didn’t matter. A popular narrative at the time was that the US budget surplus was distorting rates. There was similar talk in 2006. A popular narrative at that time was that the “global savings glut” (emerging markets had high savings rates and they were pouring money into treasuries) was distorting the bond market, and the yield curve didn’t mean anything.

No one wants a recession except for maybe the perma-bear crowd. Listening to a recession prediction is like telling someone that they’re going to get into a car accident tomorrow or that their significant other is going to cheat on them. It’s a horrible prediction, and our minds will try very hard to find reasons not to believe it.

The narrative this time is that rates are too low for the yield curve to matter. The Fed can’t trigger a recession when the Fed funds rate is only 2.5%. I don’t accept this explanation, either. I think rates are only “low” in the context of our experiences in the ’80s and ’90s, when rates were abnormally high.

I like to boil things down to their essential components, and I don’t think anything explains the relationship between the quantity of money and inflation better than the classical equation, MV = PQ, the equation of exchange that Milton Friedman had on his license plate. The equation simply states that the quantity of money and the velocity of money are the key determinants of inflation.

The instinct of most people was that the Fed’s dramatic expansion of the money supply would result in a massive inflation problem. This never happened. Inflation hasn’t even gone above 3% throughout this entire expansion.

It seemed logical that an explosion of the Fed’s balance sheet and the quantity of money would result in massive inflation. The reason this didn’t happen is that the velocity of money remained stuck at an absurdly low level after the carnage of the financial crisis.

This decline in the velocity of money could have happened for a few reasons. It could be demographic reasons, such as declining birth rates and an expanding elderly population. This is a popular explanation for what happened in Japan, who didn’t experience inflation after an explosion in their own monetary base and ultra-low interest rates. The US has more favorable demographics than Japan, so I’m not sure if this holds up. Another possibility is that the crisis was so severe that it psychologically scarred households and firms and depressed the overall velocity of money.

Whatever the explanation, it looks like monetary velocity is stuck at a low level, meaning that rates can stay “low” with little impact on inflation.


Money velocity: extraordinarily low


Inflation: can barely crack 3% even with unemployment near all-time lows

Rates look low when we compare them to recent experiences in the ’80s and ’90s, when we were working off the Great Inflation of the 1970s and when money velocity was high. I believe that with an inflation rate below 3% and money velocity stuck at a low level, a 2.5% fed funds rate can be high enough to push the economy into a recession even though it appears to be absurdly low based on our experiences in recent decades.

What do I do about it?

The phrase “late cycle” has become a punchline. People have been saying “late cycle” for the last 7 years. With that said, the yield curve seems to indicate that at this point we really are in the late cycle. This is 1998, 1989, 2005. Trouble is probably on the horizon.

In my little world, I am merely trying to determine what I should do about it.

Option #1 – Do nothing and stay fully invested. This is what Peter Lynch and Warren Buffett would recommend. They ignore the macro environment and focus on the businesses in the portfolio. This would also be the advice of many quants, who all advise that timing the market is nearly impossible. I’m sympathetic to this point of view, but I find it hard to accept. I analyze individual businesses, but none of them exist in a vacuum. Their fates are wholly determined by the macro environment, so I find it hard to accept the idea that I should just ignore it completely. It also doesn’t jive with what Munger and Buffett actually do. Berkshire carries massive cash balances. Munger kept Daily Journal mostly out of the market in the mid-2000s, moving aggressively once the global financial crisis dished out a tremendous opportunity set.

Option #2 – Get out of stocks completely. Should I get out of stocks completely? It is extremely difficult to time an economic cycle correctly and it is even harder to time a factor like value. There are unusual moments such as the early 2000s when value investing performed well even though the economy was in a recession. Missing a time like that would be terrible for my returns.

Much of the evidence indicates that the cycles are so difficult to time and the performances are so lumpy that it’s best to just stay fully invested.

My sense is that this cycle is more like the late ’60s and early ’70s than it is like anything like the ’90s or 2000s. The ’70s was a period of time where value was crushed with the overall market in the ’73-’74 drawdown. The darlings of that era, the Nifty Fifty, weren’t anything like the late ’90s absurdity. They were quality companies at crazy valuations.

How did value hold up during this period? Below is a comparison of S&P 500 returns to those of Walter Schloss along with the low P/E low debt/equity strategy that Ben Graham pursued and was backtested by Wes Gray’s Alpha Architect team.


Schloss was known for holding a lot of cash when he couldn’t find bargains, which is likely why he avoided a lot of the horror in the ’73-’74 drawdown. The fully invested Ben Graham quant strategy fared worse.

I would like to avoid the next drawdown and have a lot of cash to take advantage of the opportunities that will emerge in the aftermath of the decline.

The classical value investing approach is to not time the market but only invest in the bargains, like Schloss did. At the end of the expansion, there will be fewer bargains, and you’ll end up accurately timing the market without really trying.

This approach is easier said than done. If you took a classical asset value approach, Schloss would have had to wind up the partnership in the late ’60s when the net-net’s disappeared in the United States. Instead, he shifted his focus to stocks selling below book value. If he waited for the net-net’s to return, he would have missed out on some of his best years for returns. Not only could you wait for a few years, but you could also end up waiting for an investing lifetime.  For this reason, I think it would be foolish to “get out” of the market entirely.

At the same time, I don’t want to suffer horrific drawdowns and have no cash to take advantage of the opportunities that will inevitably result from a significant drawdown.

Option #3 – Short the market. I don’t short anything. I am proud to say that I have never shorted a stock in my life. After following markets for the last twenty years, I have developed a deep appreciation for how insane markets can be. Tech stocks were overvalued in 1998. They still doubled in 1999. Enron was engaged in fraudulent behavior going all the way back to the 1980s. It didn’t melt down until 2001.

Shorting is speculation and can result in a permanent loss of capital. I don’t do it. Shorting is for masochists.

This isn’t to knock the shorts. They’re the smartest people in the market and often do the most in-depth diligence. This doesn’t make it a wise investing strategy. I feel the same way about marathon runners. They are hard working, dedicated, impressive people. They’re also masochists who pursue pain for the sake of pain. Just because they are awesome individuals doesn’t mean that it’s a good idea to go out and run a bunch of marathons.

I’m also not interested in hedging. The best hedge is to merely own less of whatever it is that you’re hedging.

I’m also averse to complicated investing strategies. Perhaps I read “When Genius Failed” too many times. Whenever I hear a complex investing approach touted by an investing egghead, it’s hard for me not to roll my eyes. My instincts scream at me to steer clear.

Option #4 – Gradually adjust my positioning.

This is what I will probably do.

Right now, the cheapest stocks in the market are cyclicals. I own a lot of them. These stocks will likely be annihilated in a drawdown. Winnebago is a glaring one. There aren’t a lot of people with enough confidence and disposable income to go out and buy a big, expensive, RV during a recession. Winnebago suffered an 80% drawdown during the financial crisis.

Additionally, the fact that a yield curve inversion usually takes a year or two to impact the “real” economy gives me time to adjust my positioning. As I sell positions (as they age, run up in price, or the fundamentals change), I will likely reduce my positioning in cyclicals.

I will probably hold onto my cheap insurance and more defensive picks. Oshkosh is a good example. With a significant chunk of their business originating from the federal government, it should hold up well in a large equity drawdown.

Fortunately, I own zero leveraged companies. I specifically stick to stocks with low debt/equity ratios at all times because I know they will hold up well in a drawdown and I have a healthy enough respect for the market to know that a bloodbath can happen at any time, regardless of what the yield curve and unemployment are doing. It’s also what Ben Graham recommended. I covered my logic for this approach in this post about the debt/equity ratio and how a lack of leverage provides protection during drawdowns. To summarize, sticking to companies with healthy balance sheets enhances long-term returns by reducing the extent of a drawdown during a market meltdown.


As I reduce my exposure to cyclicals, I will need to find a home for the cash. I don’t want this money sitting around earning nothing. I am considering buying more defensive stock picks and accumulating a position in long-term government bonds. As the Fed reduces interest rates to combat a recession, long-term bonds should perform well. Long-term bonds increased by over 20% in 2008, for instance. I will likely do this through an ETF vehicle like TLT.

At the same time, if I’m wrong, long-term bonds will go down but will still pay interest and won’t suffer huge drawdowns. I think this is a much safer choice than outright shorting the market.


I’m curious about your thoughts and input into how you are navigating the rapidly changing environment. What do you think the best approach is?


I love the latest season of Documentary Now. The below is an excellent parody of “Wild, Wild, Country.”



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.


Urban Outfitters (URBN)


Key Statistics

Enterprise Value = $2.488 billion

Operating Income = $381 million

EV/Operating Income = 6.53x

Price/Revenue = .81x

Earnings Yield = 9.2%

Debt/Equity = 0%

The Company

Urban Outfitters is a Philadelphia based global retail company. They opened their first store in Philadelphia around the University of Pennsylvania in 1970. Since those origins, it has grown into a massive global company with 613 locations. While they are a global company, about 87% of sales originate in the US.

They currently operate a few crucial divisions. Urban Outfitters itself includes 245 stores. Urban Outfitters is an apparel retailer targeting the 18-28 year old demographic. Anthropologie represents 226 stores and 41% of sales. Anthropologie targets women aged 28 to 48. They also operate a food & beverage business focused on pizza & casual dining bought through an acquisition.

Another segment is their Free People brand,  which sells clothes and accessories to women aged 25 5o 30. Their brands are also sold in department stores like Nordstrom and Macy’s.

Urban Outfitters is cheap because of their mall locations, their connection to department stores like Nordstrom and Macy’s, and pressure in recent years on the margins. Trade jitters and late 2018 recession worries also took the stock down late last year. It peaked at $48 in September 2018 and has plummeted down to $29.59. An increase to those levels would be a 62% increase from current levels.

My Take

There isn’t much to dislike about this company. If all you knew were that this was a mall retailer and then took a look at the stock chart, you’d assume this is just another retail trainwreck.

Look closer.

This is a company that has grown sales steadily and robustly by 103% since 2010. They earn a robust return on equity for a retail company, making 21.36%. They are in impeccable financial condition. They have zero long term debt and boast $5.88 in cash per share against a price of $29.59. They are a popular brand with a loyal, niche following. They are buying back shares to a tune of 2.96% per year. F-Score is a 7/9.

This is a fast growing, financially healthy company, boasting respectable returns on capital. That’s the reality. From Mr. Market’s perspective, all that Wall Street sees is “mall retailer,” and it’s priced like it’s roadkill. In fact, the current price is around 2011 levels, when they were earning 47% less and had sales that were 57% of what they are today. Despite all of the company’s growth and tremendous success over the last decade, the stock has been stuck in a trading range for that entire time period, ignored by the market because it’s lumped in with all of the other retail carnage.

URBN’s current P/E of 10.88 compares to a 5-year average of 19.66 and an industry average of 17.89. On an enterprise multiple basis, the current 6.53x multiple compares to a 5 year average of 10.28x. An increase to this level would be a 57% increase in the stock price. At a minimum, I think the stock could return to $45/share.

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.

Winnebago (WGO)


Key Statistics

Enterprise Value = $1.25 billion

Operating Income = $162 million

EV/Operating Income = 7.71x

Price/Revenue = .49x

Earnings Yield = 10.59%

Debt/Equity = 51%

The Company

Winnebago is an iconic, all-American brand. When you think of RV’s, you think of Winnebago. Winnebago is to RV’s what Harley-Davidson is to motorcycles. Winnebago manufactures two kinds of RV’s: towable (55.9% of sales) and motorhomes (42.7% of sales). Towables are RV’s that can be towed with a truck. Motorhomes do not need to be towed, and the RV itself can be driven. Within the motorhome segment, there is wide dispersion in price depending on what features the buyer wants. A new Winnebago motorhome can range in price anywhere from $80k to $250k.

Winnebago’s business has performed excellently throughout this economic expansion. Sales and earnings have steadily increased without a hiccup. Sales were $212 million in 2009 and have grown steadily every year to $2 billion in 2018. Earnings have gone from a loss of $2.71 in 2009 to a gain of $3.22 in 2018.

Despite the consistently improving results, sentiment against the stock in the last year has been negative. An increase to the 52-week high would be a 51% increase from current levels. The poor stock performance is occurring over trade jitters and concerns that the US might be at a cyclical peak and about to enter a recession.

This is a valid concern. Winnebago was annihilated in the last recession, with the stock falling over 80% from the 2007 peak to the 2009 low. The reasons behind this are obvious. Winnebagos are a massive, discretionary expense. Winnebagos are for fun. No one needs a Winnebago and recessions have a way of clarifying the difference between a want and a need. People are only going to buy them if they are doing well economically and feel good about their jobs. In a recession, sales for brand new Winnebago’s are going to fall dramatically.

My Take

I feel a bit dumb at the moment after purchasing this. After I bought this stock, Thor (another RV manufacturer) reported abysmal results and I sold the stock. Additionally, my entire thesis is that the US is not entering a recession. Friday’s lousy jobs report casts doubt on my hypothesis.

With that said, I am sticking with it. I still think that the US economic expansion is intact. I think that the bad jobs reports was only a temporary blip driven by the government shutdown. The two indicators I care the most about, the spreads between both the 2 and 10-year bonds and the spread between the 10-year and 30-year, don’t show signs that the Fed is too tight. Additionally, the Fed has been signaling that they are not going to allow the economy to fall into a recession. Like it or not, whether or not we go into a recession is mostly driven by one institution, and that’s the Federal Reserve. You can complain and shake your fists at this all you want, but that’s the world that we live in.

In terms of Winnebago itself, I think that the long term secular trends favor this industry. As baby boomers retire, they are going to purchase more Winnebagos. RVs also have an appeal to the burgeoning population of people that want to live on the road. I also think that gas prices are going to be constrained due to the fracking industry in the United States. While I believe prices will probably rise slightly in the short term, the existence of the fracking industry prevents them from getting extraordinarily high as happened in 2007 and 2008.

There are many assumptions buried in my analysis so I will be observing this position carefully. With that said, I think investors are being paid for the uncertainty. The P/E of 9.44 compares to a 5-year average of 15. An increase back to these levels would be a 50% appreciation. They are also in excellent financial health. The Z-Score of 5.04 implies an extraordinarily low probability of bankruptcy. The F-Score is nearly a perfect of 8 out of 9. This is a cheap stock in a solid financial position and, as long as we avoid a recession in the near term, it should outperform the market. We shall see.


Fun movie: Sneakers, 1992. “I want a Winnebago.”

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.

Express (EXPR)


Key Statistics

Enterprise Value = $239.42 million

Operating Income = $57.54 million

EV/Operating Income = 4.16x

Price/Revenue = .16x

Earnings Yield = 10.64%

Debt/Equity = 10%

The Company

Express is a mall apparel retailer and is hated. It is down 81% from its all-time highs and down 63% from its 52-week high. It was hammered particularly hard during the November/December tantrum. Unlike most stocks, it didn’t recover from that. The CEO also stepped down in January.

Sales and earnings have been steadily declining for the last few years, which has led to an extremely negative reaction in the stock. Earnings have fallen from $1.38 in 2016 to $.25 in 2018.

Express’s target market is 20-30 year old men and women. Categories cover casual wear and work wear. It has established a niche in this area. They currently operate 635 stores, including 145 outlet stores. They design their own clothes, which also adds to their unique niche.

My Take

The expectations embedded in the price indicate that most investors expect this company to die. The question I try to answer when looking at situations is simple: will this company be a going concern in 5 years?

Looking at Express, I think this company will continue to exist in 5 years and will continue to be profitable. They are pursuing some initiatives to transform the current climate and sustain themselves while mall retail is decline. I think their niche focus on 20-somethings is critical here. When we think about the retail establishments that will survive, I believe that generic retail establishments that try to sell products to everyone are going to have a tougher time than retail establishments with a consistent, loyal niche. Retailers that have established themselves with a unique niche that inspires customer loyalty are likely to survive the shakeout. Express is doing this by laser focusing on young people and designing their own unique clothes.

Express is also taking steps to combat the decline of mall retail. They now offer ship-from-store, allowing their customers to order clothing directly from a nearby store and have it shipped to them. This entrenches its online brand and fights against declining mall traffic. Currently, online orders represent 24% of total sales for Express, and this is increasing.

As they expand their online presence, Express also shows a willingness to close underperforming stores when leases expire. This is a sharp contrast to the Francesca’s debacle I invested in over a year ago, a company which was opening new stores even as their existing chains struggled. Express, in contrast, closed stores and is moving them from malls to more traffic-friendly outlet locations. In 2017, they closed 45 mall locations and opened 24 outlet locations.

The financial position of Express also increases the odds that the turnaround strategy will eventually yield results. Currently, they have an extremely low debt to equity ratio of 10%. The F-Score of 8 also represents an extremely high degree of financial quality. The Z-Score is also 3.44, meaning that the company has an extremely low bankrtupcy risk. This strong financial position gives Express something critical: time. They have the time to weather the storm while other, less well-positioned retailers, are wiped out.

Investors are getting paid for the uncertainty. The P/E of 9.4 compares to an industry average of 17.10. In the last 5 years, the average P/E for Express has been 19. On a price/sales basis, the current ratio of .16 compares to an industry average of .5. On an enterprise multiple basis, the current value of 4.16x compares to a 5-year average of 6.9.

Overall, Express is a troubled retailer with an uncertain future. However, I think that investors are being paid for the uncertainty because the consensus expectation is that Express will not survive at all. Meanwhile, management is aggressively pursuing a turnaround strategy. If the plan actually works, Express should trade at a significantly higher multiple in the future. Trading at half of book value and around double cash value, I think this limits the risks on the downside.

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.