Author Archives: Michael Lipka

About Michael Lipka

I worked in the hedge fund tax world for about 10 years and ran a few different web startups on the side and full time for a little while. My passion is the financial markets. I want to use this blog to share my research and methodologies with my kids (my son is 3 and my daughter is 1) and family.

Some New Ideas – July 2015

This year continues to be a bit of a struggle for me mentally because I know how much we have risen over the past 6 years, so I’ve been looking to take gains when I get them.  Unfortunately, it has left me pretty skittish and at times unable to properly assess risk / reward like I did in the past because I feel like I’ve had one foot out of the door waiting for the inevitable drop to come.  I’m assuming a lot of people are in the same boat that I’m in because stocks seem to be flip flopping all over the place all year, with very little price memory from one day to the next.

Anyway, figured I’d talk about a few new opportunities I’ve found: some that I’ll hopefully hold for longer than a few days / weeks.

Regional Financials:

There is a big move by the larger regional banks to take out smaller banks as the smaller banks are struggling to generate significant profits in light of increased governmental regulation.  I don’t think this trend will end, so I’ve been looking to get exposure to small regional banks that are trading at under 0.90x Book.   Back in 2006-7, banks were trading at around 2x Book, by comparison.  I don’t expect a return to those valuations anytime soon, but I have seen a lot of small banks getting bought out for around 1.2 to 1.3x book recently.

With all of these I’m trying to avoid exposure to energy markets (i.e., banks whose customer base is primarily energy related) as oil is down 55% and doesn’t look to be rebounding any time soon.

I bought some $KTHN, a tiny bank up in Maine, at $11.50.  With a market cap of $39 Million, they’re trading at about 0.65x Book Value (ie Net Equity), which is a pretty steep discount to most publicly traded banks.  It’s also trading at about 9.3x annualized EPS from last quarter and earnings grew about 30% last quarter.  The average microcap regional bank is trading around 14-15x EPS.  Below is a snap shot of its most recent earnings report:

Screen Shot 2015-07-30 at 12.20.20 PM

Another bank I bought is $FSFG.  It’s a little more expensive than $KTHN relative to book and EPS at 0.7 p/b and 11 p/e, respectively.  FSFG is based out of Indiana.

Investing in India

I feel like I have a pretty good knowledge of how important it is to become the leader in any particular internet space, having run a few internet sites over the past 15 years.  So I am always on the lookout for companies in the Internet space.  It is very hard for the 2nd/3rd tier players to acquire traffic to take over the leader.  Organic traffic from search engines is extremely valuable and having a leadership position becomes more and more difficult to overcome over time.  Once a leader is established in a particular internet space (i.e shopping, search engines, travel, etc), that leader starts exhibiting strong network effects that reinforce the value of that site to its visitors.

As the market has gone higher over the past 6 years, it has become harder and harder to find growth that isn’t already priced at extreme levels in the internet space.  I have had a lot of success over the years investing in internet related companies, with MySpace back in 2005 (the precursor to $FB), $BIDU in 2006, $Z in 2012 and a handful of others.  While growth in internet penetration is slowing down globally and valuations are pretty high in the majority of the biggest players like $GOOGL $AMZN $FB $BABA $BIDU etc, there are still opportunities in some international markets where internet penetration is still low.  Particularly, India comes to mind.

Mary Meeker recently highlighted India in her latest State of the Internet 2015 report, and Jeff Gundlach was recently interviewed on CNBC where he talked at length about India.  Here is a portion of his comments:

“Yeah. I’m really quite bullish long-term on India. In fact, I’m like a 10 on a scale of 1 to 10 bullish on Indian equities for the next generation.

What happens next month, I have no idea. Year to date, it’s been pretty sleepy, although last year they killed it. And the reason is basically a demographic reason.

One of the reasons China had such an incredible economic performance over the last generation is they had a couple hundred million people entering the labor force, and they also made some reforms and they took some of the glue out of the gears in the economy.

Well, India is in that same position. There will be a couple hundred million people entering the labor force in India and they have plenty of room for improvement when it comes to the legal system, the cronyism and all this. When I mention Indian equity market, people bring out these negatives. And I say, well, that means there’s room for improvement.

Early in my career I was having lunch with Howard Marks. I was sitting there and I said, you know what, Howard, I don’t understand why anybody ever buys a AAA-rated corporate bond because they can only go one way, right. They can only go down.

And so markets that have problems generally have some sort of discount built in to them.

So I believe that if you are going to — I was speaking and a guy came up to me, he was like 24 years old, what should I buy and not touch it, I have a 50-year horizon. I said I would buy the Indian stock market.”

India has seen a significant ramp in GDP growth recently due to new leadership coming in that is pro business, internet penetration rates rising substantially (yet still at only 19% of total population), excellent demographics (More than 50% of its population is below the age of 25 and more than 65% is below the age of 35), and low oil (India imports about 80% of its supply).  So lots of positives working for India in the longer term.  Here is a look at recent growth in GDP in India:

Screen Shot 2015-07-30 at 1.33.15 PM

Inflation had been pretty aggressive the past few years but that has fallen quite a bit as their currency has stabilized and oil prices have gone down, and as a result GDP is now rising about 8% annually, the fastest in the world amongst countries with a GDP above $1 Trillion.

Per a report from KPMG, 905 million Indians live in rural areas and only 6.7 percent, or 61 million, currently use the Internet on a regular basis.  The urban areas have seen pretty high internet usage rates, but the majority of internet users are on 2G networks with very slow connections (think AOL dialup in the mid 1990s in the US).  At the end of 2014, there were 82 million 3G subscribers in India, but that number is expected to almost triple to 284 million by the end of 2017.  If you put this into context, only 6% of its population is using 3G.  Compare this to a nearly 50% penetration rate of 3G or 4G users in China.

Below is a great chart from Mary Meeker’s report highlighting the inflection point that India is at with regards to internet penetration, comparing where it is now with where China was in 2008 and where the US was in 1996.  She makes the point that now is the time to be looking for those catalyst companies in India being shaped by this inflection point, much like Tencent ($TCEHY) and Alibaba ($BABA) in China and $AMZN $EBAY and $YHOO in the US at their respective inflection points.

Mery-Meeker_India_State_of_the_Internet-YourStory-2-1024x768

Anyway, you get the point: India is growing fast, its middle class is growing rapidly, internet penetration rates are exploding and yet it still has a ton of room to grow.  Great long term tailwinds for investors in India.  With this in mind, I took a look at the companies that are most likely to benefit from growing trends in India.  My strategy is to avoid 2nd tier companies like $REDF because of how difficult it is to compete against market leaders, and to focus on areas that would see direct benefit from a rapidly growing middle class with extra disposable income and that would benefit directly from increasing mobile usage.  The obvious play in my mind is Makemytrip ($MMYT), the Expedia ($EXPE) of India.

Makemytrip

$MMYT came public in 2011 and has seen dismal performance for its stock.  They IPO’d at $22 and ran up to $42 within the first few months.  The stock is currently trading at $15.59, down 19% today on a weak Fiscal 2016 Q1 earnings report.  The report was pretty ugly…marginal top line revenue growth below forecast, with an earnings miss and a below estimate guidance for the year.  Not exactly what you would expect when you see internet usage and growth in domestic flights exploding.

I think the headline #’s mask what is really going on, though.  The problem they’re dealing with is three-fold:

(1) There’s a mad scramble right now to gain market share as new competitors are coming into the market, at the expense of revenues and earnings.

(2) Currency fluctuations are impacting net revenues.

(3) Net transaction values have been decreasing on flights as airlines have been engaged in pricing wars to acquire customers, which reduces total revenues to MMYT.

Here is a look at the ugly headline #’s:

Screen Shot 2015-07-30 at 2.42.24 PM

Revenue less service costs (ie the margin they make on each transaction) only grew 7.5% (made up of 10.8% growth in air travel and 2.8% growth in hotels and packages).  Not exactly explosive growth.  But if you drill down a little more to the actual transactions occurring on their network (i.e., Makemytrip.com and on their mobile app), growth looks much better and more in line with growth in internet usage and domestic travel:

Screen Shot 2015-07-30 at 2.44.14 PM

The number of transactions for airline tickets grew 45.6% and for hotels and packages the number of transactions grew 27.6% when excluding a transaction they made last year.  And if you drill the latter figure down to just hotels (I’ll explain later) then you will see 78.1% growth year on year.

I believe the discrepancy between the headline #’s and these transaction figures is due to MMYT’s decision to gain market share at all costs…ie. getting as many hotels as possible on their network so they can increase the # of offerings to their customers, even if it means charging lower fees to the hotel.  This is the exact same game that $AMZN has played for the past 20 years as they gain market share at the expense of profits.

I’m not sure if this decision is a reaction to competitors trying to negotiate lower rates with hotels or if MMYT is proactively trying to squeeze out competitors.  Given MMYT management’s recent comments, my guess is its more of the latter:

“As we begin the new fiscal 2016, we believe we are on the cusp of a second wave of internet penetration driven by unprecedented smartphone penetration which is helping drive online booking behavior in the strategic India standalone hotels segment. We were able to leverage our investments on the mobile channel and in the hotels segment to drive 78% transaction growth in India standalone online hotels fueled by over 200% growth on transactions coming from mobile channel during this quarter” said Deep Kalra, Group Chairman and Group CEO. “This makes us believe that it’s the right time for us to single mindedly focus on accelerating transaction growth in the Hotels and Packages business to grow our market share in this strategic segment with a view of consolidating long term market leadership in the OTA space.”

Unfortunately, MMYT hasn’t released data on the standalone hotel transactions until this past quarter, so I can’t see the trends in those numbers.  The growth in hotels and packages transactions has been decelerating in recent quarters as shown below:

Screen Shot 2015-07-30 at 3.02.08 PM

Growth in the H&P segment has gone from 106% > 70.9% > 46.6% > 32.2% > 27.6% over the past 5 quarters.  Still very solid #’s but the trend is slowing down.  To get a sense of what’s going on, management’s disclosure that hotel transaction growth this quarter was 78% implied that customers are booking less packages.  On their Q1 2016 call, management made some comments about seeing customers’ preferences to only book hotels versus packages recently, which has resulted in lower gross bookings and thus lower revenues per transaction:

“However, the deceleration in hotel packages and international online hotels reduced overall hotel packages transaction growth.  Increasing customer preference to buy standalone airline tickets and hotels has resulted in average transaction value decreasing by 13.5% and gross bookings remain almost unchanged on a year on year basis.”

Conversely, airline transactions growth has been accelerating, from 16.1% > 45.6% over the past 5 quarters.  The net revenue coming from this segment was up 10.8%.  The discrepancy between the 45% transaction growth and 11% revenue growth was caused by currency fluctuations and lower average transaction values as airlines are engaging in price wars to gain customers.

With about $150 Million in net cash (cash and term deposits), the balance sheet is pretty strong.

Airline Traffic in India

Growth in domestic travel in India has been a major catalyst for growth in air ticketing transactions as they are directly correlated.  MMYT air ticketing transaction growth has been roughly doubling the domestic travel growth for the past 3 years:
2013: Indian domestic travel growth: +4.45%, MMYT transaction growth +9.3%
2014: Indian domestic travel growth: +9.24%, MMYT transaction growth +15.24%
Q1 2015: Indian domestic travel growth: +20.9%, MMYT transaction growth +39.8%

Q2 2015: Indian domestic travel growth: 18.5%, MMYT transaction growth 45.6%

With transaction growth nearly double the growth of domestic travel growth in India, MMYT is expanding its already 40% market share of online travel (latter figure disclosed by MMYT last quarter):

Screen Shot 2015-07-30 at 3.37.30 PM

To get a sense for what kind of growth the travel market might have in store in India, its best to look at China and the US as guides.  In the US, the average person flies roughly 1 time every 5 months.  In China, the average person flies roughly 1 time every 3.5 years.  In India, the average person flies 1 time every 20 years.  In order to get to the current averages in China, India would see its travel market grow 6-fold and to get to current averages in the US, it would see its travel market growth 48-fold.

Conclusion

This reminds me a lot of Ctrip.com (CTRP), the leading online travel agent in China.  In 2005, $CTRP had a market cap of about $600 Million.  10 years later CTRP revenues are up 20-fold from $65 Million to $1.3 Billion while domestic flights in China are up from 70-80 million to over 400 million annually.  CTRP’s stock is up 1300%.

Right now, India is on pace for about 75 to 80 million domestic flights, up from about 25 million in 2006, and growing about 20% annually right now.  I believe MMYT is going through the same thing CTRP went through in 2012.  In 2012, CTRP’s stock was down from $50 to $12 – 13 on fears of competition impacting revenues and earnings.  At its low the stock traded at around 3.5 – 4x Trailing Twelve Months Revenues.  CTRP shifted its focus to maintaining / gaining market share and while operating income dropped from $203 Million in 2011 to -$27M in the past 12 months, the stock has soared from $13 to $70+.

Similar to CTRP, MMYT has shifted its focus away from net income toward maintaining / gaining market share.  Management guided 50% to 55% transaction growth in hotels and packages and air ticketing transaction growth has been running near 40% recently.  I believe within 12 to 18 months we should see a much higher price for MMYT.

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Are Biotechs In A Bubble?

About:IBB Includes:AMGN, BIIB, CELG, GILD

Summary

  • IShares excludes companies with negative earnings in P/E.
  • TTM adjusted P/E is approximate 104.
  • Majority of earnings growth came from only top 32% of holdings.

The Biotech sector has been on a similar epic bull run as the late 90’s tech sector. Below are the returns for the iShares Nasdaq Biotechnology Index (NASDAQ:IBB), the biotech ETF, over the past several years:
Screen Shot 2015-07-02 at 1.07.28 PM

Total returns were 421.06% from the close of 12/31/08 to 7/2/15 and 523.73% from the lows on 3/9/09.

By comparison, the only period I can find that is close in terms of total returns and time is the 1995-2000 Nasdaq bull market, which generated returns of 441.21% over that time period. That bubble occurred over a shorter time period than the recent biotech bull run (5 years vs 6.5 years for Biotechs) so the resulting negative performance after the Nasdaq bubble popped was most likely more severe than what we should most likely see with biotechs after they peak. The late 90’s tech run resulted in an 85% drop over a few years. I don’t see the same happening with biotechs, but valuations in the biotech space are similar to the valuations seen in the Nasdaq bubble right around its peak, as I will show below.

Returns for the Nasdaq during that time period are listed below (I included the subsequent 3 years after the peak of that bubble as well):

Screen Shot 2015-07-02 at 3.20.42 PM

According to iShares, the trailing P/E of IBB is 31.10, which is high but not necessarily unheard of. However, iShares has a small almost hidden disclaimer that states that the P/E excludes those companies with negative earnings from its calculation. Considering the fact that roughly 60% of the holdings of IBB lose money, it’s safe to assume the P/E isn’t 31.10. The only way to calculate the P/E is by going through the financials of each component of IBB and weighting them according to the pro rata share that they make up in IBB. I went through this tedious task below for the top 33 holdings, which account for 82% of the weighting of IBB.

I randomly chose to look at 33 of them primarily because I didn’t have time to go through all of them. However, my suspicion is that the majority of the companies making up the remaining 18% of the index are losing money and would result in a higher p/e than the one I calculate below (indeed a quick glance at the next 12 holdings shows 9 companies losing significant money – over $300 Million net losses).

Can the REAL Biotech P/E please stand up?
General consensus is that holding IBB instead of individual stocks will shield you from overall risk with biotechs because the bigger ones like Gilead (NASDAQ:GILD), Biogen (NASDAQ:BIIB), Celgene (NASDAQ:CELG), and Amgen (NASDAQ:AMGN) are cheaper and bring down the valuation of the entire ETF. While this is true to a certain extent, investors need to keep in mind that they only make up about 30% of the ETF and a closer look at the valuations of each of the components of IBB yields an extremely expensive ETF.

As I mentioned above, an important thing to note with IBB is that iShares excludes companies with negative earnings from the calculation of the p/e for the ETF. This is especially noteworthy considering 17 of the top 33 holdings that I analyzed, which account for 82% of the holdings in IBB, are losing money. By weighting, 28% of the top 82% of the holdings of IBB loses money. See the note below from iShares’ website regarding negative earnings:

Screen Shot 2015-07-02 at 1.21.19 PM

To get to the real p/e, I’ve gone through the exercise of calculating the trailing twelve months (NYSE:TTM) earnings for each of the top 33 holdings of IBB, which again account for 82% of the holdings.

Below is a list of the top 33 companies and their weightings. Again, I could have gone through the exercise of calculating earnings for all of the holdings but I figured with these 33 companies I would capture the lion’s share of the ETF’s holdings. Note that the prices below are as of the close on 6/22/15.

Screen Shot 2015-07-02 at 1.29.44 PM

I went through the financials for each of these 33 companies and highlighted in gray and boxed those quarters that were either negatively or positively impacted by one time charges and I adjusted those earnings by removing those one-time items to get a better reflection of actual earnings. See each of the holdings and the last 4 quarters of earnings below:

Screen Shot 2015-07-02 at 1.53.52 PM

To calculate a weight adjusted price to earnings ratio for the entire ETF, I then assumed I purchased 1,000 shares of IBB to illustrate how many shares I would get of each holding. This is helpful in visualizing earnings per share for the entire ETF.

Since I only looked at the top 33 holdings which make up 82.3% of the holdings of the ETF, the total shares I would get is 822.5 shares. This is what I used as a denominator in calculating p/e.

I then used the price to earnings ratio of each holding (arrived at by dividing the above TTM earnings by the total shares outstanding of each company) and then I multiplied each p/e by the # of shares of each holding I get with my hypothetical purchase of 1,000 shares to arrive at earnings for each holding.

The last step to calculate the p/e for the entire index is to add up the earnings for each of the 33 holdings and divide that number by the 822.5 shares above. This calculation yields a TTM p/e of 97.84. See my calculations below:

Screen Shot 2015-07-02 at 2.16.51 PM

Accounting for More One Time Items
In addition to iShares not including companies with negative earnings and many quarters having one time items that benefited earnings, I also noticed that the tax rate at 3 of the top 4 holdings were abnormally low: GILD had a tax rate of 17%, CELG had a tax rate of 13%, and AMGN had a tax rate of 8%. The only company sporting an abnormally high tax rate was REGN, which had a tax rate of 59%. In order to arrive at a normalized p/e I assumed a tax rate of 27% for each of these 4 holdings. The net impact was a reduction in earnings from the $3,113.46 shown above to $2,916.66. The net effect is the p/e rises from the 97.84 above to 104.44 using the closing price on 7/2/15 of $370.35.

What’s worse is a quick glance at the remaining holdings of IBB making up 18% of the ETF shows a majority of money losing companies, which would ultimately drive the p/e higher. As I mentioned above, the next 12 holdings had a combined net loss of over $300 Million last year. After including the remaining holdings the P/E would be closer to 110.

So how does this stack up with the P/E of Nasdaq stocks during the late 1990’s bull market?

P/E During Nasdaq Bubble
The best chart I could find with TTM earnings for the Nasdaq during the 90’s/2000 bubble is below:

citi-nasdaq-bubble

The TTM P/E for the Nasdaq crossed above 110 in February 2000, about a month before the top. The biotech index currently sports an adjusted p/e of around 110.

What about Earnings Growth?

The bull argument is that earnings are growing rapidly. However, a closer look reveals that 87% of the earnings growth last year for the 33 companies that I analyzed came from the top 4 holdings, which only accounted for 32% of the weighting of the fund. A better way to illustrate this is if earnings of those top 4 holdings jump by 100% they will only increase earnings for the entire fund by 32%. The remaining holdings barely increased earnings year on year and those top 4 holdings are expecting a significant slowdown in earnings growth going forward, making it hard to justify a P/E of ~110.

When I look at the forward analyst estimates from Yahoo, I calculate a P/E close to 70 using non-GAAP numbers, which is extremely high by historical standards and given a history of drug failures and choppy earnings growth within the biotech space over longer periods of time.

Summary
Valuations in biotechs as represented by the IBB ETF are on par with the peak valuations in tech stocks in 2000. Returns in this space since the 2009 bottom are also similar to the late 1990’s tech bull market. In my exercise above, I did not include the remaining 18% of the holdings of IBB, which most likely would increase the adjusted TTM p/e above the 104.4 I calculated. As I mentioned, a quick glance at the next 12 holdings shows 9 of 12 losing money, with the combined net loss of $317 Million for all 12. Realistically, the TTM p/e is most likely around 110 after including the rest of the holdings.

It seems reasonable to me that we should see a significant (ie 30-40% or more) correction in this space fairly soon just to get valuations back down to somewhat rational levels.

I also think it’s important to keep in mind the spillover effects a large drop in this sector might have on the overall market, not only from a pricing perspective, but also from a sentiment perspective. I’ve been reading quite a few articles recently from noteworthy investors like Byron Wein suggesting that biotechs are a safe haven. My takeaway from reading these articles is that there is a good deal of money hiding in this space as not too many people have taken the time to look closer at valuations of the entire space. Additionally, I think most people have forgotten the history of biotechs, which is one littered with drug failures. All of these factors could combine to add a lot of downward pressure when momentum starts waining.

Given how most market or sector meltdowns tend to occur around September/October, I have been on the lookout for a potential blowoff top in biotechs sometime this summer. I’m keeping open the possibility of this blowoff top having already occurred last week, which is why I started a short position in IBB on 7/2/15. I’m not sure what impact this will have on the overall market. My suspicion is we might see a 10 to 20% drop in overall market if we do get a 30-40% correction in biotechs. But whatever transpires, I have been and will continue to substantially reduce my holdings over the next month. I think it’s the prudent thing to do.

Biotech Blowoff + Solar Stocks

This year has been a tough year in general…certainly not one of those +170% years I got lucky enough to experience over the past 6 years. I’ve reserved myself to this possibility from the start of the year, trying my best to keep myself from taking too many risks. The downside to this is that if I’m wrong and we have a tremendous run from here, then I will be missing out on significant upside gains. But having been on such a good run, the goal now is to preserve as much of those gains as possible and still participate in the upside somehow.

Lately I’ve been eying up the potential for a substantial correction in biotech stocks in the fall, thinking that they might have one last run in them…a potential blowoff top coming in the late summer. First, its important to realize that nailing down the timing of blowoff tops is nearly impossible (and spending a significant amount of time watching the overall market is oftentimes just a waste of time…you’re usually better suited searching for cheap individual stocks). Just ask all of the people shorting the Nasdaq in the fall of 1999 (although I was still in college then I’ve read that there were plenty of skeptics then and the bull market just bulldozed over them) as it rallied almost 100% in the last 6 months of that epic bull market.

The Biotech sector has been on a similar epic bull run. Below are the returns for $IBB, an exchange traded fund (ETF) for the biotech index, over the past several years:

Screen Shot 2015-06-11 at 10.13.16 PM

As you can see, it has generated returns of 418.06% from the close of 12/31/08 to 6/11/15 and 523.73% from the lows on 3/9/09.

By comparison, the only bubble I can find that is close in terms of total returns is the 1995-1999 Nasdaq bubble, which generated returns of 441.21% over that time period. This bubble occurred over a shorter time period (5 years vs 6.5 years for Biotechs) so the resulting crash was most likely more severe than what we should inevitably see with biotechs – i.e., violent rallies often end in violent corrections. Returns for the Nasdaq during that time period are listed below (I included the subsequent 3 years to see what the bubble resulted in):

Screen Shot 2015-06-11 at 10.16.53 PM

In addition to this similarity, I’ve been casually watching the similarity in chart patterns of the current biotech bubble with the 1987 stock market, another stock market bubble. The early 1980’s bull market was an impressive bull market as well, with the S&P 500 seeing a roughly 240% rise from August 1982 lows to the peak in August 1987. Take a look at these chart similarities (the chart on the left only takes into account trading through mid May 2015 for the Biotech ETF (Symbol: $IBB). Biotechs has since risen from $355 to $368 over the past 3 weeks.). They actually line up fairly close, with biotechs currently on the verge of breaking out to new highs after a mini blowoff top in March, much like the S&P 500 did in June 1987 after a mini blowoff top in March of that year. See the charts below:
Screen Shot 2015-06-11 at 10.24.57 PM

Given how most market or sector meltdowns tend to occur around September/October, I’ll be on the lookout for a potential blowoff top in biotechs sometime in July or August, then a meager attempt to rally back to the highs, with a subsequent meaningful (20%+) drop in the biotech sector. If this does transform, I’ll be looking to buy BIS heading into July/August.

If this was to happen, I’m not sure what impact this will have on the overall market. My suspicion is we might see a 10 to 15% drop. But whatever transpires, I will be looking to substantially reduce my risk heading into next month. Having said that, I do really like one sector which I plan to write about more in the future: solar.  I haven’t yet taken positions in this space but I’m hoping to do so on a market pullback.

What Works in the Stock Market

This is going to be another ongoing post that I will add to…

What Has Worked in Investing

I came across a couple of articles on what has historically worked when it comes to investing in the stock market…which investment methods generated the highest returns.  It’s pretty well known that smaller companies (ie small capitalization (small cap) companies) tend to outperform larger companies.  That makes sense.  But here’s some concrete evidence from Tweedy, Browne to support this:

What Has Worked in Investing by Tweedy, Browne Company LLC
What Has Worked in Investing is an attempt to share with you our knowledge of historically successful investment characteristics and approaches. Included in this booklet are descriptions of over 50 studies, approximately half of which relate to non-U.S. stocks.  Our choice of studies has not been selective; we merely included most of the major studies we have seen through the years.”

Catching Fall Knives

Another article I came across is a study done by The Brandes Institute that looks at the 3-year returns from an investing strategy centered around catching falling knives.  Falling knives, in this case, are stocks that have dropped 60% or more from high to low.  This article looks at a few things: domestic (U.S.) vs international falling knives; falling knives by sector.

Falling Knives Around the World by The Brandes Institute

“In “Buying the Wrong Stock for the Right Reason”, we examined the performance of falling knives in the U.S. stock market from 1986 through 2002. While the falling knives we identified did post a relatively high bankruptcy rate over the three-year period following their initial drop, they also outperformed the S&P 500 by wide margins.”…

Inspiring Quotes from Business Leaders

Every once in a while I come across quotes from business leaders or provocative thinkers that inspire me to do more.  I figured I would start compiling a list of quotes I come across and stash it away on this blog so I can reference it in the future if I’m in need of some inspiration.

Last night I was reading a great article on Sergio Marchionne, the CEO of Fiat Chrysler ($FCAU), a stock I owned for a little while and one I’m still contemplating buying ahead of the upcoming Ferrari IPO.  Sergio is a tremendously hard worker, reportedly putting in 100 hour work weeks.  He’s also well educated and speaks fluent Italian and English.  He’s a chain smoker and coffee drinker whose work ethic and lifestyle will probably put him in a coffin early.  But the best part of him is his blunt honesty.  His background isn’t in the auto industry which allows him to think more outside of the box than others in the industry yet also puts him at odds with a lot of people.

The New York Times wrote an article about him recently and part of it quoted his philosophy on how he runs FCA:

“I’ve always had this incredible sense of urgency,” he said. “I’ve always had this desire not to let things fester and to really seize the moment, because it’s serendipity.”

He paused. “You create the conditions for it, and it just keeps producing outcomes or opportunities for you to pick,” he said. “And if you don’t pick them, then it’s your own damn fault.”

Awesome stuff.

Good Investing Resources

For future reference I wanted to make a list of good resources that I use. This list is a work in progress and most likely will change over time.

Finviz (http://www.finviz.com)

Best stock screening tool I’ve found.  Great for screening for all kinds of things.  I’m sure you can find hundreds of screens that are reliable. My favorite screens that I have found to produce reliable winners are as follows (I use other screens as well all of the time):

Screen 1: High Growth (25%+ Rev Growth, Profitable, USA Only) – Ideal candidates for longer term holds; you can also remove the profitable part of it to find fast growers that may be under followed because they aren’t profitable.  I only search for USA listed companies because they tend to trade more reliably and are less risky.
Click here for list as of 5/28/15.

Screen 2: Down 30% Past Year, Above 200 Day Moving Avg (DMA), USA Only – Ideal candidates for turnarounds.  Typically a stock will move before the fundamentals of the underlying business start to improve. By looking for stocks that have risen above a longer term moving average, this screen finds stocks that are both anticipating improving fundamentals and reversing longer term downtrends.
Click here for list as of 5/28/15.

Screen 3: Down 20% in One Month, Profitable, Growing Revenues 10%+, USA Only – Ideal candidates for shorter term trades. These are typically stocks that are steadier stocks that got hit for short term misses on earnings that could bounce back. This one requires a faster trigger finger because if it is a temporary hit the stock most likely won’t stay down for long.
Click here for list as of 5/28/15.

You can obviously open up the list to non-USA listed companies.  I do this from time to time and probably should be more open to foreign listed companies.  I’ve found a few big winners overseas, including Baidu (BIDU) in September 2006, Nokia (NOK) in June 2012, Leju Holdings (LEJU) in 2014.

After going through these screens, I quickly flip through the financials to see how they’re doing. Below is a resource tool I use for looking at the 10 year financials of each company.

As a side note it might be a good indication of froth in the markets if you don’t find too many in Screen 2. I haven’t backtested this to be sure though.

Another useful tool I’ve found with Finviz is you can click on the tabs above the list of stocks in your screen for each of the following:

“Overview” – standard list of stocks in your screen

“Valuation” – shows the p/e, p/b, p/fcf and a variety of other stats for each stock in your screen

“Financial” – shows ROE, Dividend Yield, etc for each stock

“TA” – shows the chart of each stock

There are other tabs as well that you might find useful.

GuruFocus (http://www.gurufocus.com)

You can get access to the 10 year financials for free through Guru Focus. I pay for their screening service but you don’t need to do that. Here is a link to the 10 year financials for IACI, a company I hold as of May 28, 2015:

IACI 10 Year Financials: http://www.gurufocus.com/financials.php?symbol=iaci&Submit=Go

You can switch to the 10 year financials of other stocks by entering the ticker symbol in the box just below the chart at the top right.

Stockcharts (http://www.stockcharts.com)

You can get charts for the past 3 years through Stockcharts for free. If you want to go back further on your charts and be able to scroll back through date ranges in time then you will need to pay for their premium service.

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Accounting is the Language of Business

I figured for my first post I’d write about what you need to do before you start investing.  Before you do anything, you need to get up to speed with the basics of accounting.  It is the language of business and without any knowledge of it, you’ll be fighting an uphill battle when it comes to running a business or investing in businesses.  Like any other language, it takes time to learn it.

You don’t need to major in accounting or become a CPA, but you do need to learn the basics of accounting and how financial statements work.  Take an accounting class or two on the side, whether you go to college or not.  Local community colleges have courses that you can take or you can probably find something online.  I guarantee you that if you get comfortable in the language of business it will pay off later on down the road.

I usually try to ask myself if I’m truly comfortable with whatever it is that I’m invested in.  Some stocks I’m looking to trade shorter term and not taking big positions so this isn’t as crucial. But for my larger positions that I’m looking to hold for a longer time, its important for me to be comfortable with the position so I can sleep at night. If the market were to shut down right now or if trading were halted in a stock that I own before I could sell the stock, would I be comfortable owning it?  I need to know what it is that this business does, whether or not it has a strong balance sheet that can weather any storm, and whether or not operations are improving within it.  To answer these questions, you need to understand how to read statements of cash flow, balance sheets and income statements (ie Financial Statements).  These are the essentials of accounting.

I majored in accounting at Lehigh for three reasons:

(1) I started out in engineering and quickly realized I hated it.

(2) My family wasn’t well off so I needed to find a field that was reliable to work in.  Relying on my parents for financial support wasn’t an option.

(3) I wanted to be in business and knew that understanding accounting was essential to being successful in business.

I can’t really remember when I realized that accounting was the best way to learn the basics of business.  My parents weren’t into business or investing so most likely it came from reading books or articles about Warren Buffett.  It’s been 20 years since I started getting interested in investing in high school, but I still regularly seek out Warren Buffett’s advice on investing. The guy is just a fountain of awesome advice.

I was catching up on some recent articles about him which is how I came up with the title of this post.  He recently advised a teen cancer patient that “Accounting is the language of business and there’s nothing like getting it early and getting it into your system.  Getting comfortable in a foreign language takes a little experience, a little study, early on but it pays off big later on.”

It’s great advice for anyone at any age and you need to start getting that knowledge into your system as soon as you can.