Pendrell Corp (PCO)

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Key Statistics

Market Capitalization = $170.34 million

Cash & Equivalents = $187.22 million

Current Assets = $208.63 million

Total Liabilities = $8.5 million

Net Current Asset Value = $200.13 million

Z-Score = 2.19

Summary

Pendrell owns a portfolio of patents. They acquired most of their patents through acquisitions. In 2013, they purchased a number of patents (mostly dealing with memory storage) from Nokia. They have another group of patents purchased from ContentGuard, which prevent electronic content from being pirated. They also own patents related to digital cinema and wireless technology.

Pendrell makes most of their money through licensing the patents that they own, selling their portfolio of patents and through litigation to combat patent violations.

This is a business model which leads to wildly divergent operating results. In 2015, for instance, the company posted an operating loss of $121 million, while in 2016 the company had an operating income of $15.22 million.

Sentiment

I would classify sentiment against Pendrell as extreme hatred. Since 2006, the stock has lost 89% of its value. The current market capitalization is not only below net current asset value, it is below net cash value. If Pendrell simply took its cash on hand and paid all of its debts, it would pay for the company’s market capitalization. The market thinks that Pendrell is worth more dead than alive.

My Take

I placed 2% of my portfolio in Pendrell yesterday. Pendrell is a classic Ben Graham net-net or what Buffett would call a “cigar butt”. The nice thing about Pendrell is that nearly all of the net current asset value (NCAV) is pure cash, meaning that in a liquidation very little of the net current asset value would be lost. In contrast, many NCAV situations have most of the value tied up in inventory, which usually can only be liquidated at fire-sale prices. The true value of Pendrell’s stock is likely much higher, as the net current asset value assigns very little value to Pendrell’s portfolio of patents.

Obviously, bargains like this don’t come along without a reason. The reason for Pendrell’s undervaluation is its history of operational losses. Over the last 4 years, the company lost $3.32 per share.

I bought the stock purely for the balance sheet value. That’s why my “key statistics” section is different from those of companies I purchase for revenues & earnings. Pendrell could be liquidated, its portfolio of patents could be sold, and this could result in a positive outcome for shareholders. If the company isn’t liquidated, the slightest glimmer of hope could send the stock soaring. A major patent sale or a favorable outcome to ongoing litigation are possible events that could turn the stock around. Meanwhile, the NCAV value provides a floor for losses.

The main challenge with a net-net is simple: determining if the company will stay alive and not squander its net current asset value. I see little evidence of cash burn with Pendrell, as its cash on hand has remained consistent in the range of $138-$174 million over the last few years. Cash & equivalents are actually higher than they were a year ago: $187 million today vs. $176.31 million a year ago. The net current asset value should remain intact. Additionally, Pendrell has an Altman Z Score of 2.19, placing it outside of the zone of financial distress which would indicate that a bankruptcy is imminent.

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.

 

 

Cooper Tire & Rubber (CTB)

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Cooper Tire & Rubber (CTB)

Key Statistics

Enterprise Value = $1.900 billion

Operating Income = $330 million

EV/Operating Income = 5.7x

Price/Revenue = .62x

Debt/Equity = 28%

Earnings Yield = 11%

Debt/EBITDA = .7x

The Company

Cooper Tire and Rubber’s business is extremely complicated: they make tires. Their main competitors are Goodyear and Bridgestone. They manufacture and sell tires throughout the world. They operate in a highly competitive market with a commoditized product. Their business model is also impacted by the secular trend of the decline in domestic car driving (increasing use of things like ride sharing and Uber). The company could also be impacted by political headwinds. The Trump administration’s protectionist stance could impact tires that the company produces overseas and sell in the United States. At the same time, Trump’s desire to repeal the Affordable Care Act could help the company. It’s a mixed bag and it isn’t a particularly exciting business.

Sentiment

Year to date the stock is down 12.61% and it trades at an earnings yield of 11%. It is an unexciting company is a competitive, commoditized business and hasn’t participated in the bull run for stocks in the last year. The market doesn’t hate it, but it is indifferent to it.

My take

Despite the business pressures, the stock is cheap and the company is aggressively returning capital to shareholders.  In the last five years, the number of common shares has been reduced by 18%. The balance sheet is clean with a low debt/equity and low debt/EBITDA. The clean balance sheet combined with the attractive valuation means that shares will continuously be repurchased at an attractive valuation.

Despite the competitive nature of the business, the company consistently generates stable free cash flow. This will give it the cash necessary to sustain the share buybacks.  Return on equity and assets is low, but this isn’t a bad thing because no one in corporate America is saying: “Hey guys, let’s enter the tire business!”

Additionally, I think the sentiment about the secular decline of driving is overblown.  While the growth rate has flattened since the Great Recession, the number of miles driven by Americans is not in decline. The total miles driven by Americans recently hit an all-time high of 3,193,010 in 2017. That’s a lot of driving and a lot of tires getting worn out and in need of replacement.

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.

Foot Locker (FL) Summary

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Foot Locker (FL)

Key Statistics

Enterprise Value = $4.587 billion

Operating Income = $836 million

EV/Operating Income = 5.48x

Earnings Yield = 10%

Price/Revenue = .69x

Debt/Equity = .05%

Debt/EBITDA = .126x

The Company

Foot Locker is known to everyone that has ever been in a mall. They are a physical retailer and operate primarily in malls selling sneakers. They also sell footwear directly to customers.

Sentiment

Market sentiment against the stock is extremely negative. Year to date the stock is down 42.42%. This is even after a monstrous 28% gain on November 17th after delivering an earnings surprise. The extreme sentiment against the stock is due to the fact that it is a retailer and most of its locations are in malls. The sharp change in sentiment has been rapid. As recently as May 2017, the stock was hitting all-time highs.

My take

The sentiment against mall retail has been extreme and the popular perception is that Amazon is going to dominate everything. Overall, I think this is overblown. 90% of all retail sales still occur in a store. E-sales have been increasing at a steady pace of about 1% a year since the year 2000. The trend hasn’t changed. This means that in 10 years, 80% of all retail sales will still occur in a store. The popular sentiment has driven retail stocks down to depths not seen since the Great Recession and the ridiculous multiples given to Amazon shows that the market sentiment is now at extreme levels.

Not only will people continue to shop in stores for the customer experience, they will continue to shop in apparel stores like Foot Locker because they want to try the apparel on.  Sneakers from different manufacturers aren’t consistent and most people want to try the shoe on in the store.

The company consistently produces ample free cash flow each year and they have been using the proceeds to grow the business and return capital to shareholders. Common shares have declined by 9% in the last five years as the company consistently repurchases shares. Additionally, the dividend yield is 3.04%. The company’s balance sheet is also extremely strong, with extremely low debt levels.

Foot Locker also possesses an important strategic relationship with Nike, which remains the leader in sneaker brands. This is a situation where bad sentiment has caused investors to throw the baby out with the bathwater.

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.

Gamestop (GME) Summary

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Key Statistics

Enterprise Value: $2.206 Billion

Operating Income: $522.80 Million

EV/Op Income = 4.22x

Earnings Yield = 20%

Debt/Equity = 35%

Price/Revenue = .25x

Debt/EBITDA: 1.19x

The Company

Gamestop is a video game retailer. They sell video games and the hardware associated with it. They’re the largest retailer of pre-owned video game products in the world and carry a broad selection of all generations of video game consoles. They have a variety of loyalty programs in an attempt to connect with and keep customers.

Sentiment

With the growth of online gaming and video games increasingly delivered in digital form, sentiment against Gamestop is extremely negative. The perception is that due to Gamestop’s reliance on pre-owned video games and sales of new video games being delivered digitally, it is a diminishing market that is in a state of decline. Year to date the stock is down 35% and the current price of $16.31 is close to its 52-week low of $15.85.

My take

Despite the challenges, Gamestop has continued to deliver strong operating results. While top-line revenues have declined, the company has been able to improve gross profits. They have also been using their revenues from their dying (but highly profitable) business to return capital to shareholders in the form of a large dividend yield and stock buyback. The new video game console (the Nintendo Switch) should help deliver better results this holiday season.

With a P/E of 4.91, the sentiment is extremely negative against Gamestop. This is due to the fears that physical retail of gaming is a business that is destined for death. The low valuation is also due to a double whammy of hatred: they have physical retail stores and they have lots of locations in malls.

Gamestop is fighting the decline by adopting a subscription-based video game rental service for $60/month. Gamers can borrow as many games as they want from the physical store. They’re also using the cash flow from their declining (but highly profitable) used games business to return capital to shareholders. Gamestop is returning capital to shareholders in the form of dividends and buybacks. Common shares have declined by 2.59% in the last year and the dividend yield is currently 9.32%. Gamestop’s low debt/equity and low debt/EBITDA give it the balance sheet strength to pursue a turnaround strategy and continue the large return of capital to shareholders in the form of dividends and buybacks.

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.

Winter is Coming: The December Rebalance

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The December Rebalance

December is for the holidays. Warm fires, quality time with family, generosity, cookies, gift giving and . . . Rebalancing my portfolio and buying hated assets!

Why do I want to rebalance in December?

  1. Give cheap stocks a chance – I want to give my investments at least a year to work out.
  2. Time is not on my side – I buy stocks of the “deep value” variety. These are companies that are in trouble. I believe if there is not a problem with a stock, then there can’t really be any value. I think that cheap stocks without any hair on them are about as rare as unicorns. These are not Warren Buffett value stocks that are long-term compounders with a moat and high returns on capital that I can stay invested in for decades. I’m not “picking winners,” I’m buying mispriced stocks and selling when they reach their intrinsic value. As a result, time is not on my side. As Warren Buffett says, time is the friend of the good business and the enemy of the bad business. I have to continuously move into and out of cheap stocks as their valuations change.
  3. Momentum – Once a cheap stock gathers some momentum, I want to ride it as long as it lasts. Quarterly rebalancing can cut off momentum as soon as the situation gets fun. Quarterly rebalancing also increases transaction costs, which I’m trying to minimize as they’re already high.
  4. The December Effect – I am shamelessly taking advantage of what academics call the January effect. Academics notice that stocks tend to do very well in January. They assert that this is due to investors selling their losers in December for tax purposes and then piling back in come January. I prefer to call it the “December Effect” because it is a time of the year that momentum takes over. Cheap stocks get cheaper and hot stocks get more expensive. This creates opportunities for value investors. There is the tax loss effect, but there is more to it than that. In one of Peter Lynch’s books (I don’t have it handy, but I believe it’s in One Up on Wall Street), he explained that December is a time of year that portfolio managers do significant clean up going into year end. A professional portfolio manager doesn’t want to go to his boss, consultants and investors with a bunch of “garbage” in his portfolio (i.e., the kind of stocks that I like to buy). They want to buy cool stuff that will get their superiors and investors excited — i.e., whatever has gone up this year (FANG, Tesla, maybe a dash of cryptocurrency for dramatic effect). This tends to make value stocks even cheaper in December, creating a great opportunity to buy them.
  5. Will this just get arbed away? – The December/January effect will probably get arbitraged away eventually. Then again, it was identified in the 1980s, and it still works to this day. Even if it stops working, I still need to rebalance annually, and I might as well pick the time of the year that has been historically most advantageous to do that. December it is.

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Die Hard: The Finest Christmas Movie

The Candidates

With the bull market now raging for nearly a decade, the number of cheap stocks is rapidly decreasing.  Most of the value in this market is concentrated in retail.  While I am okay with taking a huge (i.e., 30-40%) position in one industry that is struggling and hated, I am not going to invest 60-80% of my portfolio in it.  That is far too much for my taste.  If I were to buy all the statistically cheap stocks out there, most of my portfolio would be in the retail sector.

To prevent this, I moved 20% of my portfolio into international indexes at attractive valuations.  The purpose of this was to diminish my concentration in retail stocks and reduce my exposure to a heated US market.  If the US market falls next year and increases the value opportunity, I’ll sell these indexes and buy more US companies at attractive valuations in a diversified group of industries.

Here are the candidates I am considering:

Current positions I will likely keep and expand:

Cooper Tire & Rubber (CTB)

Gamestop (GME)

Foot Locker (FL)

New Retail Positions:

Big 5 Sporting Goods Company (BGFV)

Francesca’s Holding Corp (FRAN)

Hibbett Sports (HIBB)

Dick’s Sporting Goods (DKS)

Chico’s (CHS)

Gap (GPS)

New Insurance Positions:

Genworth Financial (GNW)

American Equity Investment (AEL)

New Assorted Positions:

Interdigital (IDCC) – Tech

United Therapeutics (UTHR) – Biotech

Tredegar (TG) – Chemicals

Reliance Steel & Aluminum (RS) – Materials

Pendrell Corp (PCO) – Sub-liquidation value and net cash

Tennis Shoes

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I am considering more concentration into 10-15 stocks instead of 20.

Most people will say this is a terrible idea. Graham recommended 20-30 stocks. That’s also what Greenblatt recommends in The Little Book that Beats the Market. The academics also seem to agree that 20-30 is the ideal portfolio size.

I recently read Concentrated Investinga series of excellent stories about famous investors (Buffett, John Maynard Keynes, Lou Simpson, Charlie Munger) who ran very concentrated portfolios. One funny story from the book involves a conversation with Arthur Ross, who explained the secret to his success as “tennis shoes.” This was a misinterpretation: he actually said “ten issues.” He owned only ten stocks at any given time. Most of the investors featured in the book had great success with this kind of concentration.

Joel Greenblatt was also successful with concentrated investing in the 1980s and 1990s when he maintained a portfolio with as few as 8 names.

Concentration is a great tool to increase returns. Alternatively, it should also increase losses and drawdowns. It increases the volatility of the portfolio. Of course, as a value investor, I don’t consider volatility to be a risk.

In fact, looking at my dismal performance over the last year, I think a lot of it had to do with the fact that I filled my portfolio with additional stocks for the sole reason of hitting a 20-stock goal. The general underperformance of value hurt my performance, but I think that diluting my best ideas also played a big role.

Here is a comparison of my high confidence ideas vs. my low confidence ones:

 

10 highest confidence ideas:

Kelly Services (KELYA) Up 25.35% YTD

Gamestop (GME) Down 35.43% YTD

United Insurance Holdings (UIHC) Up 3.5%

Cato Corp (CATO) Down 45.64%

First American Financial (FAF) Up 48.68%

Sanderson Farms (SAFM) Up 72.27%

Cooper Tire & Rubber (CTB) Down 1.5%

MSG Networks (MSGN) Down 19.53%

Greenbrier (GBX) Up 13.12%

American Eagle (AEO) Down 1.58%

Net Result = 5.92% Gain

 

10 Lowest Confidence Ideas:

TopBuild (BLD) Up 79.78%

IDT (IDT) Down 27.78%

Manning and Napier (MN) Down 49.01%

Dillard’s (DDS) Down 11.34%

NHTC (NHTC) Down 25.71%

Steelcase (SCS) Down 19.27%

Supreme Industries (STS) Up 31.38% (bought out)

Federated National Holding (FNHC) Down 26.97%

IESC (IESC) Up 35.35%

Valero (VLO) Up 21.31%

Net Result = .77% Gain

 

Even with the big assists in my “low confidence” portfolio from TopBuild and Supreme Industries, my best 10 ideas outperformed my worst. This is even with some highly prominent duds in my top 10 stocks, with CATO being the biggest. For this reason, I think it might make sense to concentrate on my top 10 ideas.

My primary concern with a portfolio isn’t volatility, it’s maximum drawdowns. I did a bit of backtesting and research to determine the kind of maximum drawdowns I could expect from a concentrated portfolio.

I performed a backtest on the lowest EV/EBIT names. A portfolio of 10 stocks had a max drawdown of 62.48%. A portfolio of 20 only lowered it slightly to 62.04%. More stocks didn’t bring much to the party.

I also took a look at Validea’s value investment screen.  Their 10-stock screen has delivered a 12.6% rate of return since 2003 with a 2008 drawdown of 27.2%. The 20-stock variation achieved a 9.2% rate of return with a 2008 drawdown of 31.5%. In other words, the portfolio with more stocks decreased returns and increased drawdowns.

The results are similar for their price to sales screen. The 20 stock screen delivered a return of 8.9% with a 2008 drawdown of 39.4%. The 10 stock variation returned 9.8% with a 25.1% drawdown in 2008. Same result: more stocks increased the bear market drawdown and lowered overall returns.

Stockopedia has a handy chart showing the number of stocks and volatility versus the index. Once you get up to 10 stocks, most of the volatility is meaningfully reduced. To get the major benefits of diversification after owning 10 stocks, you have to get up to 50 stocks. At that point – why are you even bothering owning individual stocks? You might as well buy a fund or ETF with a style that you agree with.

I see a similar pattern with Alpha Architect’s backtest of the simple Ben Graham screen (low P/E, low debt/equity, which is very similar to my own strategy). In 2008, the 15 stock portfolio went down 27.78%, 20 stocks went down 29.38%, 25 stocks went down 30.88%. More stocks did nothing to reduce the severity of the drawdown. The results were similar for other big drawdowns in value stocks: 1990, 1998, 1974. All of the portfolios held up roughly the same in each drawdown, with the 15 stock variation usually holding up better.

Theoretically, a bigger portfolio should reduce returns, but also reduce the severity of drawdowns. That doesn’t seem to happen in practice.

A big portfolio does little more than reduce volatility while increasing drawdowns and lowering returns. It’s almost as if more stocks only provides the illusion of safety. The risk that I actually care about, lowering drawdowns, doesn’t seem to be impacted at all by the number of stocks held in a portfolio.

This is a point Greenblatt makes in his earlier book, You Can Be a Stock Market Genius. He points out that most of the benefits of diversification can be achieved by owning only 10 stocks. He makes the following point:

“Statistics say the chance of any year’s return [for the entire market] falling between -8% and +28% are about two out of three . . . these statistics hold for portfolios containing 50 to 500 different companies . . .What do statistics say you can expect, though, if your portfolio is limited to only five securities? The range of expected returns in any one year really must be immense . . . The answer is that there is an approximately two-out-of-three chance that your portfolio will fall in a range of -11 percent to +31 percent. The expected return of the portfolio still remains 10 percent. If there are eight stocks in your portfolio, the range narrows a little further, to -10 percent to +30 percent. Not a significant difference from owning 500 stocks.”

Joel further elaborates:

“The fact that this highly selective process may leave you with only a handful of positions that fit your strict criteria shouldn’t be a problem. The penalty you pay for having a focused portfolio – a slight increase in potential annual volatility – should be far outweighed by your increased long term returns.”

Style Considerations

A concentrated portfolio is unusual for a deep value investor. Graham owned lots of stocks. I believe he held over 100 net-nets at one point. Walter Schloss also owned a high number of stocks.

The investors who ran concentrated portfolios successfully (Buffett, Munger, Lou Simpson) were those who emphasized quality businesses and long-term positions. It’s one thing to put 10% of your portfolio into Coca-Cola. It’s entirely different to do it with a money-losing, terrifying net current asset value stock, for instance.

It’s highly unusual for a deep value investor to take such a focused approach. You’re dealing with businesses going through difficult times, and it can be somewhat frightening to some investors to have a concentrated, often volatile, position in these stocks.

In any case, if I do pursue more concentration, it would be a highly unusual move for someone with my outlook. If I do it, I’m going to have to make sure I do significantly more homework. I’m also going to have to make sure that I am diversified across different industries. I’m not going to buy 10 retail stocks, for instance (as tempting as that is right now).

Summary

  • My portfolio will be rebalanced every December. Annual rebalancing is my preference and December is the best time to do that due to tax loss selling and professionals “cleaning up” their portfolio for cosmetic reasons.
  • I noticed that my 10 best ideas outperformed my 10 worst.
  • Due to this, I’m considering concentrating my stock portfolio on only 10-15 stocks.
  • Looking at quant value screens, additional stocks only reduce volatility, but they don’t reduce max drawdowns which is what I actually care about.
  • Concentration is unusual for deep value investors.
  • If I do concentrate on 10 names, I need to make sure that they are diversified across different industries.

Disclaimers

To reiterate — I am not a professional. I am just a guy with a brokerage account and a blog. I’m taking risks that many smart people say I shouldn’t be taking.

This blog may go down in internet history as “crazy man proves that you should shut up and give your money to an index fund.”

It would break my heart if someone out there took my stock suggestions and lost money. So, please, do not emulate what I’m doing here. The purpose of this blog is to force me to record what I’m thinking (something that we often forget with the benefit of hindsight), to keep me honest (i.e., I hope you all send me scathing comments and emails if I do something whacky like buy Tesla stock or a cryptocurrency). Do your own homework, do your own analysis, get plenty of advice, and choose an investment approach that’s right for you.

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.

EIS and BLD

The momentum appears to be over in TopBuild (BLD) and the valuation is rich, so I sold today at $61.38. This secures a 61% gain from my purchase price of $37.91.

I also purchased 25 shares of an iShares Israeli ETF, EIS at $48.33.

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.