Category Archives: Anlage Philosophie

Quick check: KHD Humboldt Wedag (ISIN DE0006578008)

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Several readers already mentioned KHD Humboldt Wedag as a potential “special situation” investment, so it might make sense to quickly check it out.

KHD Humboldt Wedag

KHD is planning and constructing cement plants world wide. The company has a quite interesting past. It used to be part of the big “Deutz” Group of companies but was sold.

In the meantime, the company has been taken over and then spun off again in some sort of form. The mastermind behing those transactions is financier Michael J. Smith. This guy himself seems to be a very interesting investor himself as this Seekingalpha post shows.

There is a very good Thread on Wallstreet Online covering the history of the company for the last 7 years or so.

The business itself is highly cyclical. If I look at how cement companies themselves are struggeling to even earn a small profit because of a large over capacity in the indutry, I am not sure how many new cement plants will be actually built in the coming years. Sales dropped 50% from 2009 to 2011. One could describe this as “extremely late cyclical”.

KHD is since a long time a favourit among “net net “investors as they carry a large cash balance on their balance sheet. However, cashflows are extremely volatile.In 2011, operating cashflow was around -80 mn EUR.

Again in Q1 2012 the comapny showed shrinking sales and a large net cash outflow of around -20 mn EUR reulting in a loss for the first quarter, although the orderbook seems to have improved. I have however no idea how the orderbook actually transforms into sales and profits.

In early 2011, KHD executed a capital increase for around 20% of the company to bring on board a Chinese company. At least for me it was not clear why they did it. Officially they said to increase their “footprint” in China. if one looks at the order intake in 2011, this cooperation didn’t really show any results, at least not in the line for China.

Some weeks, Paul Desmarais, the guy behind the “Canandian Berkshire” Power Cooperation has revealed a 3% position. Another activist investor, Sterling Strategic Value is on board with 12%.

In the invitation to the annual shareholders meeting, Michael J Smith was proposed to enter the supervisory board as the boss. Although the first news seems to be interesting, the second part, MJS returning might not be the best news for the uninformed minority investor.

Just a few day’s ago, the annual shareholder’s meeting was postponed due to “technical reasons”, although some investoirs seem to have received a surprise dividend therafter.

For me, KHD at the moment is something I would not invest into due to the following reason:
– I have no idea about the goals of the parties involved (MJS, Chinese guys).
– the business is extremely cyclical and at the moment fully depending on Emerging markets
– I have no idea how much of the cash is really “free” and what is needed to finance new projects
– I would rather prefer to buy cheap cement companies, because they will proft earlier from a revival in cement sales
– I do not have any (good) experience with activist campaigns, I am not sure that I have the nerves for that

Overall, I do not think that I can gain any “edge” in this situation and it is clearly outside my core competencies. In such cases I will rather pass however it might be a good learning experience following the further “proceedings” from the outside.

For the record, some special situations which I try to avoid:

– merger arbitrage (to many pros)
– distressed debt (complex, dirty stuff going on)
– activist campaigns (insider)

A few thoughts on Free Cash Flow (and how easy it is to arbitrage this number)

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For many Value Investors, “Free Cashflow” has become the most important “mantra” in order to decide if a stock is attractive or not. Especially in the area of technology stocks (Dell, Microsoft, Cisco, HP), the stated large free cashflows are or were the the major arguments from some investors why the invested in those stocks.

A few examples:

Dell: In February, David Einhorn disclosed a stake in DELL (which however he just sold again…), Katsenelson is a big fan of Xerox because of its large free cash flow and of course many many value investors love Cisco and Microsoft.

Let us quickly look at how Free Cashflow is defined (from investopedia):

Definition of ‘Free Cash Flow – FCF’
A measure of financial performance calculated as operating cash flow minus capital expenditures. Free cash flow (FCF) represents the cash that a company is able to generate after laying out the money required to maintain or expand its asset base. Free cash flow is important because it allows a company to pursue opportunities that enhance shareholder value. Without cash, it’s tough to develop new products, make acquisitions, pay dividends and reduce debt. FCF is calculated as:

EBIT(1-Tax Rate) + Depreciation & Amortization – Change in Net Working Capital – Capital Expenditure

It is important to notice that “Capital expenditure” only includes “direct” expenditure, like actually buying machinery etc.

Investopedia adds a pretty important point:

It is important to note that negative free cash flow is not bad in itself. If free cash flow is negative, it could be a sign that a company is making large investments. If these investments earn a high return, the strategy has the potential to pay off in the long

I think this is a point, many market pundits tend to ignore, but more on that later.

An even more important point is not mentioned in this definition: Free Cashflow does not include cash outflows for M&A activity

So let’s look at a simple example for a model company:

Base case:

EUR
EBIT (1-tax rate) 10
Depr 5
Change WC -1
Capex -3
   
   
Free Cashflow 11
   
   
Financing cashflow 0
 
 
Total cashflow 11

So our company shows a free cashflow of 11 EUR in this period and a similar total cashflow.

Case 1: Old School – Buying a new machine at year end with a loan for 15 EUR (I use year end in order not to “disturb” depreciation etc.)

We get the following result:

EUR
EBIT (1-tax rate) 10
Depr 5
Change WC -1
Capex -3
Machinery -15
 
Free Cashflow -4
 
Loan 15
Financing cashflow 15
 
 
Total cashflow 11

Aarrrg, negative free cashflow many investors would say, negative free cashflow, stay away from this stock !!!!

So a clever company might do one of the 2 following things:

Case 2: Classic FCF arbitrage: Operating leasing

In this case the company enters into an “Operating lease” contract at year end. The machine gets delivered as in a direct contract, but if the contract is structured correctly, neither capex nor loan show up in the balance sheet in that year (only the lease payments in subsequent periods)

EUR
EBIT (1-tax rate) 10
Depr 5
Change WC -1
Capex -3
Machinery 0
   
Free Cashflow 11
   
Loan 0
Financing cashflow 0
   
   
Total cashflow 11
 
Off balance sheet  
– machinery 15
– operating leasing liability -15

On a reported free cash flow basis, without adjustment, going forward, the company will look quite asset and capital efficient. However, this kind of FCF “arbitrage” will end under IFRS when operating leases will become “on balance”.

Case 3: M&A transaction

Now consider the following: For some unknown reason, one competitor is currently selling a subsidiary which only owns the brand new machine we wanted to buy and nothing else. The competitor is selling the company for the same price as the machine. Again we finance this through a loan.

The simplified CF statement looks the following:

EUR
EBIT (1-tax rate) 10
Depr 5
Change WC -1
Capex -3
Machinery 0
   
Free Cashflow 11
   
Acquisition -15
Loan 15
Financing cashflow 15
   
   
Total cashflow 11
   
Off balance sheet  
– machinery 0
– operating leasing liability 0

So “Heureka”, we have the machine on balance without impacting the Free cashflow and everyone is happy.

To be honest, this example is somehow unrealistic, but on the other hand this is exactly what is happening with many technology firms at the moment. Those companies show high free cashflow because they don’t spend a lot on investments but acquire new technologies vie M&A transactions.

If they would build this on their own, the cost would run negatively through free cashflow in contrast to the M&A expense.

There is a good post at Seeking Alpha which shows free cashflows over the last 5 years for 6 tech companies (RIMM, MSFT,DELL, NOK, AAPL, HPQ) without and including acquisitions.

For companies with a clearly declining core business like DELL and NOK, those M&A cash outs definitley have to be treated as mainenance Capex, but to be on the safe side, M&A for tech companies and pharmaceuticals should always be included in free cashflow.

This is exactly the reason why Jim Chanos has identified Hewlett Packard as the ulitmate Value Trap despite a trailing 25% FCF yield at current prices. HPQ acquisitions are not “growth investments” but “maintenance Capex” to counter their declining core business or to say it differently: The current reported “free cashflows” are more like liquidation cash flows.

Summary:

– Free cash flow can be a good indicator for the value of a company
– however one should be aware that there are many ways to “arbitrage” free cash flow
– I have only shown a few of them relating to investments but many others exist
– one should be especailly carefull to use FCF for companies which do a lot of acquisitions or use Operating leases extensively
– calculating free cash flow after acquisitions and changes in operating leases is a crude but good way to identify “problematic” companies
– some companies might be very good investments despite negative Free Cash Flows because they have good investment opportunities and finacne “conservatively”
– it will be interesting to see with what the financial industry will come up if Operating leases will come “on balance”. I have seen already attempts to structure leases as payables…..

Red flags for investments: “Transformational” acquisitions – Example Walgreen

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Walgreen is one of the few large US stocks which looks good on my “Boss” Screen, with a consistently high ROE and low volatility. So I put it on my “priority” research to do list.

However,last week I dropped them from the list because of this.

Pessina had already hinted that his preferred exit would be via another merger rather than a fresh stock exchange listing: “If you do an IPO, you create financial value,” he said. “If you do a transformational deal, you create financial value and industrial value.”

Firstly, it is interesting that the seller makes this quote. Clearly, for him it was transformational as he transforms himself financially into a billionaire.

Secondly, if we look at some big “transformational deals in the past, we see that many of them fail.Some well known examples:

Daimler Chrysler
AOL Time Warner
RBS ABN Amro (Fortis, Santander, my all time favourite. everyone involved got screwed in the end))
Allianz Dresdner
Travelers Citicorp
Kraft cadbury
Vodafone Mannesmann

The list is endless. I actually don’t remember large “transformational” deals which actually worked well.

This aspect has not been unnoticed. A famous study by Bain showed that around 70% of large mergers fail:

Bain & Company M&A team leaders David Harding and Sam Rovit challenge the most common deal presumptions in Mastering the Merger: Four Critical Decisions That Make or Break the Deal (Harvard Business School Press, November, 2004) and found that while 70% of large deals fail to create meaningful shareholder value, 80% of the Fortune 100 companies have relied on mergers and acquisitions to fuel their growth over the past two decades.

The reasons are stunningly simple:

Bain examined over 50 case studies, analyzed 15 years of M&A data and surveyed 250 CEOs and senior executives about real-world successes and failures. They found that the top three reasons deals derailed were:

1. Ignored potential integration challenges (67%)

2. Over-estimated synergies (66%)

3. Had problems integrating management teams and/or retaining key managers (61%)

If we look at this article, Walgreen seem to rely heavily on point 2:

The deal will lead to cost and revenue benefits across both companies of $100 million to $150 million in the first year and $1 billion by the end of 2016, according to the statement.

Back to the Bain study. They identified a few critical success factors:

— Frequent acquirers outperform the pack – the more deals a company made, the more value it delivered to shareholders; the “frequent acquirers” outperformed the “never-evers” by a factor of two

— Frequent acquirers buy in good times and bad – frequent acquirers that bought constantly through both tough economic environments and boom times outperformed those that bought primarily in growth periods by a factor of 2.3; they also outperformed the “recession buyers” by a factor of 1.4

— Most successful dealmakers start small then ramp up – firms that focused on small deals on average outperformed those that made big bets by a factor of almost 6

In my opnion, Walgreen is unfortunately a very infrequent acquirer, to my knowledge it is the first acquisition outside the US and they only made one other acquisition in the US in the past few years. It rather looks like a desperate move to counter shrinking business in the US, which is never a good motivation to do a deal.

So despite the low valuation of Walgreen, this acquisition is definitely a “red flag” for any investor, as the chance for a positive outcome seems to be very low. However it looks like a great deal for KKR and Mr. Pessina. If you think about this, KKR and Pessina bought at boom prices in 2007 and seem to at least double their money after 5 years.

An additional remark on international expansion from retailers:Two of the best retailing companies of the world, Walmart and Tesco found out the hard way how difficult it is to transform local cometitive advantages into international markets. Walmart for instance failed in Germany, Tesco is still struggling in the US. As Bruce Greenwald said in “competition demystified”: All competitive advantages are local.

Summary:

Based on historical numbers, Walgreen would look like an interesting “Boss” investment. However the large acquisition completely changes the picture. As outlined above, the success rates of such “transformational” acquisitions are 30% or lower. And historical numbers do not not ho
ave a lot of predictive power in such situations.

So without any special insider knowledge, one should generally stay away from such stocks which in my case would also be the advise for Walgreen.

Sure it can work out, but the odds are strongly against a positive outcome.

Position sizing and cash quota

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Especially among active Value investors, there is a big debate about diversification or concentration of portfolio investments. Within the comments we were debating this already quite intensively, I also commented on Stephan’s blog why I think 30% of the portfolio in three Greek stocks is too much.

I would divide the the argument into two camps:

1. The “Buffet / Munger camp”: If you have a good idea, you should invest as much as possible into those 3-5 ideas. Reader Setla provided as proof Berkie’s balance sheet from 1995, where the top 5 investments made almost 100%.

2. The “others”, like Graham, Walter Schloss, Klarman, FPA, Tweedy etc. which usally construct portfolios with 20-50 stocks, in the case of Graham and Schloss sometimes even more.

My view on this is the following: There is no right or wrong, position sizing depends on many factors. Some of the more important ones are:

A. Type of stock

It makes a big difference in my opinion if you prefer “bufffet” style shares like Nestle, Coca Cola, Gillete etc. or small caps like SIAS, Installux, Poujoulat or Hornbach.

Nestle and Coca Cola for instance are global companies active in almost every part of the world and in different segments. If one country or even a continent doesn’t perform you still have the other 4 continents. So they are stocks which are already diversified theselves.

If I look at my portfolio, my small cap stocks are not divdersified at all on a stand alone basis. SIAS for instance only runs Northern Italian motorways or Poujoulat is highly dependent on French wod pellet heating. So those stocks are not diversified at all but have very specific risks.

The same applies for Graham/Schloss type of Net-Nets or other “deep value” stocks where on an individual basis a lot could go wrong, but within a diversified portfolio you could expect significant outperformance.

It would be therefore financial suicide to invest only into 3 or 5 of those small cap stocks as very singular events can wipe out significant amounts of the portfolio.

B) Control position

Many investors who try to invest like Warren Buffet, forget one important thing: Buffet is always in some kind of control position.

Either he is actually a direct control investor (GEICO, Iscar etc.) or he is the largest investor in a public company. You can imagine, if Warren Buffet calls Coca Cola, he will not be put into the endless phone loop but transferred directly to the CEO.

So if he has tied up a lot of money in one stock, he can influence the company to a certain degree if he doesn’t like what they are doing. And make now mistake, Warren seems to be a nice guy on the outside, but he can get quite nasty if things don’t go his way.

Other examples for less diversified control investors are for instance private equity funds which usually invest into 5-10 control investments per fund but with full control over management.

As a private investor, one is definitely no control investors. I personally do not trust ANY company management enough to put a very large amount of my hard earned money into it.

C) Personal risk tolerance

One thing: Not every investor has the same risk tolerance or risk preference. Making money in the stock market long term means that you have to be able to stay in the game.

If you are very young and run a small portfolio (say a couple of monthly salaries), you can always get back into the game by saving part of your salaries and start over again. A pensioner who relies on his portfolio to generate a large anount of his income does not have this “luxury”.

For someone too rich to bother (Warren, Charlie ?) the same applies as for the young guy. He/She can take more risk.

For me personally, the approach of investing a max of 5% of the portfolio has worked quite well in the past. I also found it helpful to start with a “half” position of 2.5% first and then increase if things go fundamentally the right way. I have no problem, letting the position grow due to performance up to 10%, by then I will decide if I take some money of the table.

Cash Quota

There are as many opinions on cash as there are investors. Interestingly Warren Buffet of course is famous for holding always cash to be prepared for crisis investments, as well as very clever investors like Seth Klarman or FPA (Bob Rodriguez) which hold large amounts of cash if they think the market is generally overvalued.

For me, a “general” target cash quota of 10% has worked quite qell in the past. Due to my investment style ( inc. Special situations ect.) I normally have continuous cashflows into the portfolio. On the other hand I have usually some stocks in my watchlist in which I want to invest at a certain price without having to sell one of my other position.

So effectively, my cash quota is “oscillating” around 5-15% depending on specific events and valuations.

I think a certain cash quota is necessary to remain flexible. Howevr one should avoid increasing or reducing cash based on one’s market expecation. At least in my experience I am not able to add value consistently through this kind of “tactical” asset allocation.

Summary:

I think both, for position sizing and cash quota, there is no “one fits all” strategy. In my opinion, many value investors make the mistake trying to apply the principles of one very succesful “guru” to any situation. It might also be difficult to copy any “Guru” because the “Guru” might have a very different kind of risk tolerance and risk capacity than the ordinary investor.

I do not want to give explicit advice, but most investors should NOT try to construct 3 or 5 stock portfolios without cash reserves as the probability of NOT SURVIVING the next crisis is quite high, no matter how “safe” the stocks look like.

Digging deeper: Short interest and stock performance

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In my last post about potential short candidates, I said:

Personally, I would hesitate to short anything above a 15%-20% percentage of SI/Free float although I have no “hard knowledge” to support this.

In the comments, Winter correctly pointed out that one could also argue the other way around, the higher the short interest, the higher the possibility that the stock will drop.

Interestingly, for many trades, stocks with high short interests seem to be attractive long opportunities as pages like this show.

To quote them:

Stocks with high short interest are often very volatile and are well known for making explosive upside moves (known as a short squeeze). Stock traders will often flock to such stocks for no reason other than the fact that they have a high short interest and the price can potentially move up very quickly as traders with open short positions move to cover.

Googling around a littel bit I found the following interesting paper called Short Interest and Stock Returns

The introduction starts of supporting Winter comment:

It is now widely accepted that stocks with high short interest ratios underperform the market. This is a very recent bit of conventional wisdom, based largely on the evidence in Asquith and Meulbroek’s (1995) unpublished working paper for New York Stock Exchange (NYSE) and American Stock Exchange (Amex) stocks, and Desai, Ramesh, Thiagarajan, and Balachandran’s (2002) article for Nasdaq stocks. Both Asquith and Meulbroek and Desai et al report negative and significant abnormal returns for firms with short interest ratios of 2.5% or more, where the short interest ratio is defined as the ratio of short interest to shares outstanding. Both papers also report large secular increases in short interest ratios, and skewed cross-sectional distributions, with most stocks having short interest ratios of less than 0.5%, and very few firms having a ratio exceeding 10%. Prior to these papers, the conventional wisdom was that large short positions presaged positive future returns, caused by the flow demand from short sellers covering their positions

The paper is worth a read. In general, the authors confirm that stocks with high short ratios seem to underperform:

Consistent with other studies, we find that the higher the short interest ratio, the lower is the subsequent performance. That is, firms with short interest ratios of 10% or more underperform those of 5% or 2.5%.

Their research shows that the effect is not so significant as previously thought and that it only works for equal weighted portfolios, not for market cap weighted portfolios.

They paper also gives a good overview of ohter papers on this topic, it seems to be that this area is not as well researched as others.

Their results can be summarized with this quote:

We find that the underperformance of high short interest firms is fairly brief, and only rapid portfolio turnover allows us to realize this underperformance. We also examine whether high short interest is based only on valuation concerns and find that convertible bond arbitrage is a major reason for high short interest as well. Finally, we show that the performance of high short interest NYSE-Amex stocks is more severe and consistent than for their Nasdaq 24 counterparts over the period July 1988-2002, and that small cap firms make up a large portion of the firms that are highly shorted.

Howver they question if a such a strategy can be effectively implemented especially as the overall universe of high short interest stocks is relatively small.

One aspect is missing in the paper in my opnbion : As far as I could see they did not explicitly incorporate volatility of returns. So the outperformance could be just the effect of a much higher volatility of those shares.

However as a first summary, I will have to rethink my gut feeling to stay away from stocks with high short interest.

It might make also sense for short idea generation to use those short interest tables, especially AMEX/ NYSE stocks.

Currently the NYSE page from the link mentioned above shows the following top 20 NYSE stocks with high short interest:

TEA Teavana Holdings, Inc. NYSE 60.04% 8.81M 38.31M Retail (Grocery)
HGG hhgregg, Inc. NYSE 54.35% 17.26M 37.24M Retail (Technology)
BPI Bridgepoint Education Inc NYSE 53.93% 17.23M 52.21M Schools
BKS Barnes & Noble Inc NYSE 49.68% 38.38M 60.20M Retail (Specialty Non-Apparel)
GME GameStop Corp. NYSE 49.46% 131.18M 133.98M Retail (Technology)
KBH KB Home NYSE 47.06% 65.44M 77.10M Construction Services
SVU SUPERVALU INC. NYSE 41.95% 210.68M 212.26M Retail (Grocery)
ESI ITT Educational Services, Inc. NYSE 39.67% 24.44M 24.75M Schools
OSG Overseas Shipholding Group Inc NYSE 38.20% 23.27M 30.45M Water Transportation
MCP Molycorp, Inc. NYSE 37.87% 56.05M 96.40M Metal Mining
RSH RadioShack Corporation NYSE 36.41% 98.46M 99.43M Retail (Technology)
CRR CARBO Ceramics Inc. NYSE 35.98% 19.73M 23.09M Oil Well Services & Equipment
USNA USANA Health Sciences, Inc. NYSE 35.81% 6.17M 14.99M Personal & Household Products
ONE Higher One Holdings, Inc NYSE 34.55% 32.64M 56.81M Schools
SAM Boston Beer Company, Inc., The NYSE 34.14% 8.40M 8.79M Beverages (Alcoholic)
AM American Greetings Corporation NYSE 33.79% 34.51M 35.54M Printing & Publishing
GDP Goodrich Petroleum Corp NYSE 33.26% 26.03M 36.37M Oil & Gas Operations
URI United Rentals, Inc. NYSE 31.78% 63.05M 63.77M Rental & Leasing
CJES C&J Energy Services Inc NYSE 31.63% 39.07M 51.89M Oil Well Services & Equipment
FIO Fusion-IO, Inc. NYSE 31.15% 49.59M 90.12M Computer Hardware

Some of those stocks even show up regulary on value blogs. So another application of such lists could be to even more scrutinize “value stocks” with high short interest as they might be potential value traps.

A final word on European stocks: Unfortunately, the disclosure of short interest in Europe is close to non-existent. Also, as the Volkswagen example showed, “cornering” is still an issue with European stocks. So in any case one should be extra carefull with single stock shorts.

Performence review April 2012 & comments

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April 2012 was a relatively good month for the Portfolio. Against a Benchmark Performance in April of -2.6%, the portfolio showed a gain of +1.2%. YTD, the portfolio is now up 12.6%% against 11.9% of the Benchmark.

Performance overview:

Bench Portfolio Perf BM Perf. Portf. Portf-BM
2010 6394 100      
2011 5509.87 95.95 -13.8% -4.1% 9.8%
           
Jan 12 5972.48 99.27 8.4% 3.5% -4.9%
Feb 12 6275.00 105.90 5.1% 6.7% 1.6%
Mrz 12 6329.66 107.22 0.9% 1.2% 0.4%
Apr 12 6168.20 108.02 -2.6% 0.8% -3.8%
 
YTD 12 6168.20 108.02 11.9% 12.6% 0.6%
 
Since inception 6168.20 108.02 -3.5% 8.0% 11.6%

The outperformance in April was mostly triggered by the jump in the share price of AIRE KGaA, which went up from around 11 EUR to 17 EUR at month end. Luckily, I only sold a very small amount after the 10% tender offer from the company itself (~1000 stocks) before the AIG offer of EUR 17 was announced on Monday April 30th.

The relatively weak performance of my Italian positions (EMAK, Buzzi, Piquadro, SIAS) was partly off set by the gain in the FTSE MIB short position.

Other notable outperformers in April were WMF and AS Creation.

Portfolio Changes April:

Nestle: fully sold
Piquadro: 0.5% added at around 1.43 EUR (50% hedged with FTSE MIB short)
AIRE KGAA As discussed above, I sold 1.060 stocks at 13.52 EUR (25% of trading volume) before the announcement on Friday April 30th with a gain of 54.50%. On Friday April 30th, the volume was so high, that I sold 22.952 stocks (position down to 5%) at 17 EUR with a gain of 94.26%, almost a double.
Installux: Beginning on April 30th, the first 55 shares were bought. This will be a long way to establish a position…

Portfolio composition April 30th

Name Weight Perf. Incl. Div
Hornbach Baumarkt 5.1% 4.92%
Fortum OYJ 4.4% -14.56%
AS Creation Tapeten 4.0% -4.02%
BUZZI UNICEM SPA-RSP 5.1% -12.75%
EVN 2.8% -13.72%
Walmart 3.9% 18.75%
WMF VZ 4.2% 44.32%
Tonnellerie Frere Paris 4.9% 7.07%
Vetropack 4.6% -2.99%
Total Produce 5.0% 15.98%
OMV AG 2.2% -14.99%
Piquadro 1.6% 8.78%
SIAS 2.4% -6.40%
Installux 0.1% 0.00%
     
Drägerwerk Genüsse D 8.9% 44.61%
IVG Wandler 2.2% 7.70%
WESTLB 6.9% 5.6% 35.25%
DEPFA LT2 2015 3.1% 29.04%
AIRE 4.8% 96.72%
HT1 Funding 4.7% 5.92%
EMAK SPA 4.8% 0.96%
DJE Real Estate 4.2% -3.18%
Praktiker 2016 2.5% 0.75%
     
     
Short: Kabel Deutschland -2.2% -23.07%
Short: Green Mountain -1.6% 14.30%
Short Ishares FTSE MIB -2.4% 3.74%
Terminverkauf CHF EUR 0.2% 4.43%
     
Tagesgeldkonto 2% 14.9% 0.00%
     
Summe 100.0%  
     
Value 50.1%  
Opportunity 40.8%  
Short -6.0%  
Cash 14.9%

Outlook & Strategy:

As a contrarian investor at heart, current times are quite exciting. There are a lot of industries and entire countries (PIIGS, utilities, financials) which trade at very cheap valuations. Of course there are a lot of macro risks on the horizon. As a value oriented contrarian investor one should howver focus on the long run. The “This time is different” argument should also be applied on the positive side, meaning that the world will not end, people will still need bank accounts, electricity or want to travel in the future.

So the focus should be less on guessing and interpreting daily Central Bank actions or election outcomes but on analyzing cheap companies with lasting business models, no matter where they are located.

Greed and fear are the two worst investment advisors available. Because of this, one should not fear investing in currently depressed businesses if they are deemed to be lasting, on the other hand one should try to avoid chasing expensive past “winners” like consumer stocks, flats in Munich etc.

However this is often easier said than done, especially if one takes the daily news “tsunami” too serious. My personal technique is to read a historical finance book from time to time in order to get the “right perspective” and that current problems are nothing new. At the moment I am reading “Lombard Street” from Walter Bagehot, I hope I can post a rview soon.

Macro post: Does having an own currency solve all problems ? (HUF, GBP, ARS)

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If one observes the current debate at the moment, there are is a lot of criticism for the Euro as a concept in general.

Many so called experts basically say the following:

If [Ireland/Spain/Greece/Italy/Portugal] would have their own currency, all problems could be easily solved just by a little devaluation and everyone would be happy again.

As the “poster child” for this example, many pundits than refer to the Icelandic example and how well Iceland is doing these days.

Star economist Steven Keen for example is promoting a similar approach in this Interview in Ireland, where even his Irish host seems to have a problem in understanding how this really should work.

I am not a trained economist, only a “humble” value investor, but out of my actual experience, I try to reconcile the “Euro is evil” thesis with reality. I find it interesting that there are at least 3 countries with their own currency, where thiscurrency does not solve any problems. Let’s look at them seperately:

Argentina

Argentinia is the well documented poster child of what can go wrong with its own currency. Despite a commodity led export boom, devaluation of 80% and more they still didn’t really manage to turn the ship around. Many observers attribute this to widespread mismanagament and corruption, but at least in the case of Greece one could expect the exact same outcome. However without any chance from additional exports and natural resources.

As far as I know, banks were not the problem in Argentina, but the lack of trust in leadership and rampaging inflation following the devaluation despite price controls etc.

Hungary

Also an interesting case. Hungary was on “convergence path” with the Euro. The following devaluation brought many Hungarians on the brink of bankruptcy, because everyone had financed everything in EUR or CHF anyway, so devaluation actually backfired big time.

Since then a nationalstic Government tries to achieve some sort of “Silent Nationalization” through special taxes on foreign owned companies (see Magyar Telekom, which i owned but sold due to this risk).

As most of the foreign currency loans were granted by bank subsidiaries of Italian, German and Austrian banks, the Hungarian Government did not have to stabilize banks in a significant way.

United Kingdom

The Uk did the full program: Quantitative easing (several times), deficit spending (a lot), devaluation and achieved some significant inflation. Nevertheless, the UK is already in a double dip recession .

So also in the UK, the own currency including the full instrument case doesn’t seem to be the silver bullet, at least in a time frame of 3-4 years time.

So what can a value investor learn from this ?

In my opinion there are a few take aways:

– exiting the Euro and having one’s own currency is not the silver bullet for countries like Portugal, Spain, Ireland, Italy and even Greece. It only really helps if you can export much more than you import, otherwise you just end up with high inflation

– politicians are not completely stupid. They will be aware of this.

– current discussions about a Euro break up, especially from the notorious US based perma bears should be weighed against the actual experiences in those 3 countries

– investments in the PIIGS countries are risky, but a currency break up might not be realistic, even in the case of Greece

– within any analysis, one should focus on structural changes, where the impact is only seen at a later stage

– one should never forget: Real (positive) change only happens in the time of crisis.

Trying to understand momentum from a value perspective

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Momentum is one the concepts I really have some difficulties with. As a traditional value investor, one would basically ignore market movements and invest purely based on intrinsic value.

However if one looks at different reasearch papers, “momentum” seems to be an important indicator. For instance Tim du Toits latest research, momentum combined with value metrics created some astonishing results for the 1999-2011 period.

Also for example this article shows based on a back test that pure momentum trading strategies can produce theoretically 10 % p.a. outperformance.

Interestingly, the mentioned AQR US momentum fund isn’t really outperforming the indeces in real life. Bloomberg shows an underperformance of this momnetaum fund against all major US indices since inception in mid 2009.

Definition & application of momentum for grwoth stocks

I have been looking around a little bit, but there seem to be different definitions for “momentum”.

The more simple approaches seem to look at a trailing time period (1M, 6M, 1Y) and define momentum either as the best performance within a certain group of stocks (i.e. low P/B) or in general relative performance agains an index.

I have found this site where they give the following advice for “momentum growth stocks”:

One of the things to spot momentum stocks is the relative strength of the stock compared to the overall market over a specific timeframe. Most momentum investors seek at a stock which has outperformed at least 90% of all stocks over the past 12 months. When major indices declines, a great momentum stock exhibit strength by holding or even exceeding their highs. When the major indices rally, momentum stocks typically lead the rally and make new highs outpacing the market.

Potential momentum stocks should show in their balance sheet that they are growing at an accelerated rate.

Another factor is the Earnings per Share growth. At least a 15% year-over-year earnings per share growth is needed to qualify a momentum stock. Stocks with accelerating rates of EPS growth over previous quarters are also considered.

In addition, a positive forecast by at least some analysts regarding the Company’s earnings in necessary for identifying momentum stocks. Further, momentum investors also looks at whether the reported earnings exceeded the analysts forecasts compared to the last quarter.

A company can’t grow its earnings faster than its Return on Equity, which is the Company’s net income divided by the number of shares held by investors, without raising cash by borrowing or selling more shares. Many companies raise cash by issuing stock or borrowing, but both alternatives reduce earnings-per-share growth. For momentum investors, a potential stock should show an ROE of 17% or better.

This simple strategy at the moment is quite succesfull. If we look at two typical “MoMo” stocks Chipotle and LuluLemon we can see this in action. The “fundamental requirements” are clearly in place like this table shows:

EPS Growth   ROE  
  Chipotle Lululemon Chipotle Lululemon
2007 67% 292% 14% 41%
2008 11% 30% 13% 29%
2009 61% 34% 19% 30%
2010 42% 109% 24% 39%
2011 19% 49% 23% 37%

As one could expect, analysts go wild for both stocks and as for any respectable US comapny, earnings are ALWAYS above (carefully guided) expectations and of copurse both shares are in the top 10% performers.

And both stocks are still in their “parabolic” phase:

However, as my two “MoMo” short positions, Netflix and Green Mountain showed, once “Momentum” dissapears, those stocks can loose 50-80% of their value in the matter of a few days or weeks:

“Fundamentally”, momentum is usually explained the following way:

The capital market is not really efficient, so positive and negative information does not transform directly into securitiy prices but this takes some time.

However, in my opnion, there is also a “psychological” component for momentum:

Many investors prefer to see an immeadiate positive feedback on an investment decision. Even for myself, I tend to look more closely to daily or even intraday price movements when I just have bought a stock. With a “positive” momentum stock, there is a very high probability that the stock continuos to climb and you see direct positive feedback (and feel like an investing genius),

With a declining stock, on a short time horizon it is very likely to see a loss directly after buying the stock (and feel like an idiot for not waiting longer).

As an “intrinsic value” investor one should not care about the short term direction of stock prices, but never the less it still takes a lot of conviction to buy into a falling or underperforming stock.

The big question for me would be: Can momentum add value to an investment process based on intrinsic value ?

Intuitively I would say that extremely negative momentum could be a warning sign for a “value trap”. On the other hand, I can also see the argument for stocks where after a long decline some fundamental changes are occuring.

One of the stocks I have been tracking for a long time is Sto AG. Sto in the 90ties was one of the typical construction related stocks. After the reunification, prices of construction and construction related stocks exploded. However in the mid 90ties the boom went bust and construction stocks suffered. In the 2000s, then Sto could participate in the boom for energy saving, multiplying its earnings sevral times.

I did a very crude check on Sto with regard to relative performance: I compared annual returns with the dax since 1992 ( I diddn’t get earlier numbers). The result is quite surprising:

P/E EPS Last price 12m change DAX 12m Change Delta
1992 11.9 1.51 17.985      
1993 20.7 1.47 30.523 69.7% 46.7% 23.0%
1994 13.2 2.58 33.901 11.1% -7.1% 18.1%
1995 12.8 2.51 32.098 -5.3% 7.3% -12.6%
1996 18.0 1.83 32.915 2.5% 27.8% -25.2%
1997 14.1 2.12 29.927 -9.1% 47.1% -56.2%
1998 16.8 1.11 18.618 -37.8% 17.7% -55.5%
1999 12.0 1.69 20.32 9.1% 39.1% -30.0%
2000 13.2 1.39 18.342 -9.7% -7.5% -2.2%
2001 13.1 1.17 15.285 -16.7% -19.8% 3.1%
2002 7.6 1.27 9.71 -36.5% -43.9% 7.5%
2003 15.0 0.96 14.386 48.2% 37.1% 11.1%
2004 10.3 1.46 14.97 4.1% 7.3% -3.3%
2005 8.3 2.41 20.05 33.9% 27.1% 6.9%
2006 3.9 7.35 28.591 42.6% 22.0% 20.6%
2007 6.7 7.29 48.855 70.9% 22.3% 48.6%
2008 5.3 8.05 42.794 -12.4% -40.4% 28.0%
2009 7.1 8.60 61.057 42.7% 23.8% 18.8%
2010 10.3 8.98 92.17 51.0% 16.1% 34.9%

One can clearly see that once “negative momentum” occured in 1995, four subsequent years with strong underperformance followed. Sto shareholders basically missed the whole 90ties boom.

Then again the same happened in 2006: Once Sto really started to outperform, 4 more years of outperformance followed.

Another example: KSB

When we look at the same type of crude analysis, we see a less clear picture at KSB:

P/E EPS Last price 12m change DAX 12m Change Delta
1992 10.2 19.32 196.847      
1993 40.1 5.74 230.081 16.9% 46.7% -29.8%
1994 41.8 4.59 191.734 -16.7% -7.1% -9.6%
1995 #N/A N/A -18.82 121.687 -36.5% 7.3% -43.8%
1996 #N/A N/A -5.71 123.733 1.7% 27.8% -26.1%
1997 18.2 11.35 206.562 66.9% 47.1% 19.8%
1998 9.5 17.82 169.238 -18.1% 17.7% -35.8%
1999 18.9 5.92 112 -33.8% 39.1% -72.9%
2000 14.2 5.8354 82.98 -25.9% -7.5% -18.4%
2001 15.0 5.32 80 -3.6% -19.8% 16.2%
2002 8.4 8.65 73.09 -8.6% -43.9% 35.3%
2003 19.4 7 136 86.1% 37.1% 49.0%
2004 27.1 4.67 126.5 -7.0% 7.3% -14.3%
2005 25.9 5.85 151.43 19.7% 27.1% -7.4%
2006 13.4 27.99 375 147.6% 22.0% 125.7%
2007 10.3 43.86 450.06 20.0% 22.3% -2.3%
2008 5.1 70.17 360 -20.0% -40.4% 20.4%
2009 6.7 61.32 409 13.6% 23.8% -10.2%
2010 14.0 44.09 618 51.1% 16.1% 35.0%
2011 11.0623 40.95 453 -26.7% -14.7% -12.0%

For the first 4 years, momentum would have worked but in 1997, momentum would have failed us. However in the subsequent years momentum might have worked OK, although one would have missed the big jump in 2006.

Let’s finally look at one of the “true hidden champions”, Fuchs Petrolub which I regret deeply not to have bought in the past:

P/E EPS Last price 12m change DAX 12m Change Delta
1992 23.0 0.10 2.414      
1993 27.3 0.13 3.46 43.3% 46.7% -3.4%
1994 23.3 0.17 3.848 11.2% -7.1% 18.3%
1995 34.2 0.08 2.869 -25.4% 7.3% -32.8%
1996 21.6 0.14 3.123 8.9% 27.8% -18.9%
1997 13.0 0.27 3.544 13.5% 47.1% -33.6%
1998 44.6 0.07 2.92 -17.6% 17.7% -35.3%
1999 9.2 0.22 2.03 -30.5% 39.1% -69.6%
2000 8.4 0.234 1.964 -3.3% -7.5% 4.3%
2001 19.9 0.1089 2.162 10.1% -19.8% 29.9%
2002 7.3 0.3207 2.327 7.6% -43.9% 51.6%
2003 11.6 0.4152 4.816 107.0% 37.1% 69.9%
2004 17.4 0.4919 8.564 77.8% 7.3% 70.5%
2005 11.3 0.9394 10.57 23.4% 27.1% -3.6%
2006 13.8 1.2413 17.163 62.4% 22.0% 40.4%
2007 13.5 1.5517 20.983 22.3% 22.3% 0.0%
2008 8.7 1.4867 12.943 -38.3% -40.4% 2.1%
2009 11.9 1.70 20.217 56.2% 23.8% 32.4%
2010 13.7 2.39 32.9 62.7% 16.1% 46.7%
2011 11.7637 2.56 30.115 -8.5% -14.7% 6.2%

Again we can see here longer stretches of under- and outperformance which clearly seem to imply some kind of momentum, persisting at least for some 4-5 years in this example.

Summary: Momentum is something which is is usually not connected to intrinsic value investing but with growth investing. However, some recent studies show that momentum also seems to be a factor in “value” stocks. A crude test with three examples from my long term “circle of comeptence” shows some anecdotical evidence for momentum in stock prices of “normal” companies and even “value companies”.

So this is definitely something to include in the investment process as additional aspect.

Edit: There is acutally a new Dilbert out referring to “momentum”:

Track record (attention: shameless self advertisement)

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When I looked through Tim du Toit’s Eurosharelab, I saw that Tim actually also shows his non-public track record since 2004.

For myself, I keep score of my track record since 2001 but I hesitate to publish this as it is not really possible to verify.

Then however I realised that I took part in the “Aktienbord Musterdepot” since 2007 with a kind of “best ideas” portfolio. In parallel, I discussed my strategy at my “home Board” Antizyklisch Investieren (only in German and you have to register).

Although the “Aktienboard” platform is not perfect (for example Dividends are not included), the performance relatively closely tracked my “real” performance. It is also an interesting way to look at how my old portfolios looked like and in what kind of stocks i was invested at that time.

2007

2007 Performance was 34.4% plus 2,94% in Dividends.

That compares pretty well against 22.9% for the Dax 22.3 for the MDAX and +6.9% for the DJ Stoxx.

If I look at the 2007 ending portfolio, the only stock I still hold is WMF Vz. At that point in time, I held mostly German special situation stocks as I was not able to find cheap stocks anymore.

2008

2008 Aktienboard performance ended with a loss -13.54 % before dividends of 2.70%, again quite good against -40.4 DAX, -46% MDAX and -45% DJ stoxx.

This was mostly due to avoiding any financial exposure and concentrating on low beta special situations like Biotest and other small caps which is basically still my main strategy.

2009

“>2009 Aktienboard performance was +45.86% plus an additional 3.56% in Dividends and the absolut best year “on the record”. Again quite good compared to Dax (23.9%), MDAX (26.7) and DJ Stoxx (21%).

On the one hand, I rode the recovery story in cheap large caps, but additionally I kind of “discovered” distressed and subordinated debt which offered amazing risk/return opportunities. Subordinated bonds were also the way to inevst in financials without getting diluted through all the capital increases.

2010

In the last “pre blog” year, the Aktienboard portfolio performed with 33.5% + 3.47% dividends (remark: I think the overview number is better than the detail page performance).

This was the only year where the “best ideas” performed better than my real portfolio by a margin of about 10%.

Benchmarks in 2010 were DAX 16.1%, MDAX 34.9% and DDow Jones Stoxx -5.35%. The 2010 portfolio contains already a significant part of the current portfolio, with AIRE, Buzzi, Hornbach, AS Craetion and EVN, 5 stocks are still relatively heavily weighted today.

Before getting to enthusiastic about this track record, one has to say that this investment style would not fully scale into a 10 mn portfolio I am trying to run virtually at the moment. Some trades, like in illiquid Depfa subordinates etc. were only possibel with double digit k EUR amounts or sometimes less.

In the last 5-6 years, I was also able to profit from the “secular” German recovery story which turbo charged German small caps plus the “once in a lifetime” opportunites in the subordinated bond area.

Going forward, it will be very difficult in my opinion to find such secular stories again. My biggest hope is that an eventual PIIGS revovery and maybe some French small caps offer comparable risk/return opportunities.

Spass mit dem Griechischen Schuldenschnitt – Bernd Niquet Edition

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Eigentlich soll man sich ja nicht über “Kollegen” lustig machen, aber hier kann man nicht anders.

“Erfolgsautor” Bernd Niquet feiert sich bei wallstreet:online selber:

Das Wichtigste ist jedoch: Für 1.000 Euro nominal alt besitzt man jetzt 315 Euro EFSF-Papiere zzgl. für den Betrag der aufgelaufenen Zinsen.

Wer also, wie ich vorgeschlagen habe, zu 30 gekauft hat, besitzt jetzt 31,5 (EFSF-Papiere allererster Bonität, die zu pari notieren) plus ein ganzes Sammelsurium aus kleinen Wundertüten und Schokoladentäfelchen, die einen süß, die anderen hingegen zartbitter.

Das ist kein Super-Profit, aber sehr ansehnlich. Und wer tatsächlich noch kurz vor Schluss zu 20 oder gar 16 gekauft hat, hat sein Geld jetzt bereits mehr als verdoppelt. Man sollte also nicht immer nur herumjammern.

FALSCH Herr Niquet. Wer Ihrem Tipp gefolgt ist besitzt jetzt 15% EFSF Anleihen dazu noch 31,5% “neue Anleihen” die ungefähr 6-7% vom alten NominalWert sind. Dazu noch der Warrant zu aktuell 0,8%, dann ist man bei 22% ohne Stückzinsen.

Macht also einen Verlust von -25% gegenüber Ihrem Empfehlungskurs. Mal schauen wie lange der Artikel stehen bleibt. Peinlich peinlich.

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