Category: One time buyer

June Issue Of Hidden Value Stocks

NOTE: Existing members can skip to the bottom to find the full 20-page issue.

We asked a ton of ValueWalk readers what their #1 goal was for improving their value investing.

Can you guess what they said?

No, it wasn’t more coverage of Apple or Tesla, those are already well covered by the likes of CNBC, sell side firms and blogs.

Nor was it more coverage of risky leveraged trades, ETNs.

They wanted good small-cap investment ideas that are vetted and have liquidity, but not well covered by Wall Street, Bloomberg, CNBC, sell-side analysts, blogs or even closed sites like SumZero or Value Investing Club.

This answer makes sense: we all want to collect more winners in our portfolio.

But after following investments of ultra-famous investors (Buffett, Dalio, Icahn), reading diligently through 10-Qs at night, and even combing through article after article on obscure forums and blogs, it can be hard to find qualified “special situation” ideas that aren’t already widely known.

So, to meet this key need of our readers, ValueWalk launched the Hidden Value Stock newsletter.

The Hidden Value Stock newsletter is a 20+ page deep dive report that gives you detailed analysis behind specific small and mid cap stocks that two under-the-radar value investing hedge funds like, as well as interviews with the fund managers about their investing process.

The latest issue of Hidden Value Stocks is out this week and if you want to sign up to receive an issue.

Below is a teaser copy of the new issue. If you would like to get the full issue and access to the entire site subscribe with one of the options below.

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June 2017 teaser

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The Small-Cap Investing Handbook Part One: Introduction

This is the first part of what will be a ten part series on small-cap investing.

Throughout this series, I’m going to take a look at both the benefits, and drawbacks of investing in small caps, considering all of the evidence available to us today for both sides of the debate.

When completed we are planning to turn the series into an e-book, which we hope will be a comprehensive guide to investing in small caps.

The series is a collaboration between ValueWalk and ValueWalk’s new small cap investing magazine Hidden Value Stocks.

Hidden Value Stocks is a quarterly publication which profiles two top-notch small-cap focused hedge funds in each issue. Within each issue, the managers discuss their investing process as well as to small-cap ideas each. To find out more, head over to www.hiddenvaluestocks.com.

 

small-cap investing
small-cap investing

The Small-Cap Investing Handbook Part One: Introduction

Small-capp stocks have a reputation that’s not necessarily good but at the same time, it is not necessarily bad. The majority of the world’s most renowned investors started their early careers by investing in small caps.

The reason why is because the likelihood of the market mispricing securities in the small-cap arena is much higher than with blue chips. Blue-chip stocks tend to be well covered by Wall Street analysts and owned by the largest funds. Small caps, on the other hand, are generally overlooked by Wall Street as it’s not lucrative enough to produce coverage on smaller names.

As a result, some small caps fly completely under the radar of most investors, and it’s here where the largest mispricings exist.

Small-cap investing – Building wealth

Warren Buffett is perhaps the most famous example (barring his tutor Benjamin Graham) of an investor who has used small caps to make a name for himself. In his early days, Warren Buffett made millions for his investors by investing in such names as Dempster Mill and Sanborn Map. Both of these examples were trading at a deep discount to net asset value when Buffett became involved because Wall Street had no idea of how much they were worth. Warren Buffett took the time to do the legwork and was richly rewarded as a result.

Peter Lynch is another investor who made a name for himself in the small-cap arena. Lynch is considered to be one of the greatest money managers of all time and he achieved this accolade by finding small-cap companies that weren’t yet on institutional investors’ radar.

Lynch firmly believed that individual investors had inherent advantages over large institutions because the large firms either wouldn’t or couldn’t invest in smaller cap companies that have yet to receive big attention from analysts or mutual funds.

Still, while Buffett and Lynch have made names for themselves by investing in small caps, investors should be under no illusion that small-cap investing is easy.

It is considered (although as you will see later not entirely factually correct) that because small caps can produce high returns than the market, investing in small caps comes with greater risk. Even though the evidence does not support this statement 100%, it is an important observation.

Unloved small caps can outperform because they fall under the radar of larger investors and research houses. However, because these small caps are not well researched, it is vital that you conduct your own rigorous due diligence. It’s here where most investors trip up.

The 25 Best Personal Finance Books To Read This Year

Both Warren Buffett and Peter Lynch are known for their researching ability. Buffett is known for his love of figures and continual study of company earnings reports, while Lynch was known for his hectic travel schedule to visit company managements when he was running the Fidelity Magellan Fund from 1977 to 1990.

Yes, small caps can outperform the market, but unfortunately, these premium returns don’t come easy.

Can small caps outperform?

The first study that seemed to suggest small caps can outperform appeared in 1980. Titled “The Relationship Between Return And Market Value Of Common Stocks” the study found that smaller firms have higher risk-adjusted returns, on average, than larger enterprises and this ‘size effect’ has been in existence for at least 40 years.

To arrive at this result, the relatively simplistic study broke companies down into market capitalization deciles and found that companies in the lowest decile and the higher returns, after adjusting for conventional risk. Figures showed that the average excess return from holding very small firms long and very large firm short is, on average, 1.52% per month or 19.8% on an annualized basis.

By replicating the above study and extending the sample period through to the end of 2014, Aswath Damodaran professor of corporate finance and valuation at the Stern School of Business at New York University found that this small-cap performance anomaly has continued with companies falling into the lowest decile during the period 1926 to 2014 earning 4.33% more than the market after adjusting for risk.

The 1980 small-cap study has been used again and again as the basis for other academic studies on the topic and by actively managed small-cap funds in marketing materials. But today, there’s a growing debate over whether or not the small-cap premium actually continues to exist or if it has been arbitraged away by those seeking to profit from this market anomaly.

March Issue Of Hidden Value Stocks

NOTE: Existing members can skip to the bottom to find the full 40 page issue.

We asked a ton of ValueWalk readers what their #1 goal was for improving their value investing.

Can you guess what they said?

No, it wasn’t more coverage of Apple or Tesla, those are already well covered by the likes of CNBC, sell side firms and blogs.

Nor was it more coverage of risky leveraged trades, ETNs.

They wanted good small-cap investment ideas that are vetted and have liquidity, but not well covered by Wall Street, Bloomberg, CNBC, sell-side analysts, blogs or even closed sites like SumZero or Value Investing Club.

This answer makes sense: we all want to collect more winners in our portfolio.

But after following investments of ultra-famous investors (Buffett, Dalio, Icahn), reading diligently through 10-Qs at night, and even combing through article after article on obscure forums and blogs, it can be hard to find qualified “special situation” ideas that aren’t already widely known.

So, to meet this key need of our readers, ValueWalk launched the Hidden Value Stock newsletter.

The Hidden Value Stock newsletter is a 30+ page deep dive report that gives you detailed analysis behind specific small and mid cap stocks that two under-the-radar value investing hedge funds like, as well as interviews with the fund managers about their investing process.

The latest issue of Hidden Value Stocks is out this week and if you want to sign up to receive an issue.

Below is an excerpt from our interview with Steven Kiel of Arquitos Capital Partners. At the bottom of this page, there’s a teaser copy of the new issue.

Interview With Steven Kiel Of Arquitos Capital Partners

Arquitos was founded with a goal of emulating the success of Warren Buffett’s early partnerships. Even your mission statement is lifted directly from the Buffett Partnerships. A lot of people have tried to replicate Buffett’s success in the past and failed. What made you think you could succeed?

Buffett has been an inspiration to a generation of investors, myself included. Investors should learn from him, but ultimately you have to apply your own personality to the way you approach research and the construction of the portfolio. You should try to emulate the process, but in a way that fits you.

The goal for any investor should be to compound funds at a better than average rate with less exposure to long term loss of capital. How do you improve on that statement? It’s kind of like the Declaration of Independence. The ideals stand the test of time. If you were starting a new country, just copy the first 273 words of the Declaration of Independence as the foundation of your country. That’s how I felt about the mission statement.

As far as what made me think I could succeed, it’s a constant process of proving it. Just like a baseball player, you’re only as good as your last year.

Do you have three special investment buckets similar to those of Buffett?

I break the portfolio into several segments but in a different way from the Buffett Partnership approach. We have core holdings that I would like to own as long as the company has internal reinvestment opportunities and as long as they effectively allocate capital. I also have a portion of the portfolio focused on arbitrage or special situations such as mergers, spin-offs, or other short term opportunities. I also keep on a more general market hedge.

Arquitos returned 54.9% for its investors during 2016, a tremendous result. What would you attribute this return to?

Well, we definitely had a great year. I would not expect that our run over the first five years of the fund is sustainable, but I’ll certainly keep trying. It’s important to remember that you can only control the inputs, not the outputs. Because our portfolio is fairly concentrated (12-20 stocks) good results will come when the largest holdings do well. The results haven’t historically been connected to the general markets. The timing is just luck and can’t be controlled, but the goal is to be consistent on the process. This may sound trite, but our biggest holdings went up the most, Intrawest Resorts, MMA Capital, Berkshire LEAPs, and Bank of America warrants. There is still value in all of them, though I exited the Berkshire LEAPs.

Your best-performing stock last year was Intrawest Resorts Holdings. Can you give a brief description of what happened here and how you stumbled across to opportunity?

That one is a good example of the importance of being flexible. Intrawest was cheap on the merits, but what caused me to make it our largest holding in the beginning of 2016 was their tender offer. They had sold their time share business and bought back about 12% of their outstanding shares. Fortress owns 60% of the company and did not sell any shares despite having a need to exit the investment. Clearly, Fortress thought that shares were trading too cheaply and it seemed to me that they had a plan to realize the value. Their plan seems to have come to fruition and recently Intrawest announced that they were putting themselves up for sale. Shares have passed $20, up from the $9.00 tender offer price a year ago.

On that note, what do you look for when you’re assessing a potential investment, what makes you say, “yes we want that” or “no we don’t”?

There are patterns. The Intrawest example is a good one because the situation was similar to previous investments I’ve made and witnessed where there was a large tender offer and the controlling shareholder does not participate. Seeing that definitely makes my ears perk up. On the negative side, there are a lot of things that make me want to stay away. The biggest ones are ethics issues. There are too many opportunities out there to get hung up with a company that has a poor culture.

So a company’s management plays a significant role in your decisions?

It plays a big role, especially with regards to incentives. My favorite investments are ones where the management is effectively allocating capital. The best companies are the ones that have high returns on equity and continue to find internal reinvestment opportunities. Those are the ones you can own for a long time. Sometimes the managers are inherently good capital allocators. Other times they are responding to incentives that cause them to focus on returns on invested capital and cash generation.  

Do you get involved with managements at all in an activist way?

I’d prefer not to. The frustration of dealing with negative things just kills too many brain cells. As a passive investor if management is doing something I don’t like, it’s just better to move on. Chances are they’ll continue to frustrate you. The one time I didn’t follow that path led to me taking over Sitestar (OTCQB:SYTE) with two other partners, Jeff Moore and Jeremy Gold, and led to a lot of work to clean the company up. I wouldn’t want to go through that experience again though we have a lot of interesting opportunities within Sitestar. Once was enough for me. I have supported other activists on occasion and am happy to ride their coattails.

Let’s move on to another of your winning positions last year, which was Berkshire Hathaway. You own the stock through long dated options. Can you explain the logic behind this trade?

Berkshire traded below 1.3 times book value at the beginning of 2016 and even lower if you considered what they were likely to report the next quarter. Of course, Buffett has said that he will buy back shares under 1.2 times book value. Given that situation, the easiest thing to do is either buy shares directly or buy long dated call options at the 1.2 times book strike price. I bought the call options. I don’t typically buy options, but you had to believe that at some point in the next two years either the multiple would be higher than what I bought the options at or book value would have grown or both. It turns out both happened and we made a really nice return. The risk/reward profile was better for the long dated options than the stock. It was a pretty simple thesis. It really required willpower more than anything else.

Do you do any shorting and if so do you have any short positions on at the moment?

I don’t have any short position though I keep a small hedge on. I just haven’t had luck with specific company shorts. It doesn’t seem suited to my approach.

Sure. Moving back to your investment strategy, reading through your letters to investors, you seem to focus on a company’s Net Operating Losses (NOLs) more than any other metric when analyzing its future potential. Why do you prefer to use NOLs to evaluate a company, rather than more traditional valuation methods?

That may be a trade that goes away if corporate tax rates are lowered. Tax reform would bring other opportunities such as partnerships converting to C corps, so I’m keeping an eye on any changes that occur….

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March 2017 teaser

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