Fortnightly Review January 21 2018

Fortnightly Review Jan 21 2018


Bruce Greenwald and Judy Kahn’s HBR article “All Strategy is Local” (link)  In my opinion, Bruce Greenwald and Judy Kahn’s book “Competition Demystified” is a must read for investors. (link) I am a big fan of all of Professor’s Greenwald’s work on strategy and value investing. Some of his lectures at Columbia University are on Youtube. (link) You can also see an outline of his investment process. (link) Professor Greenwald’s approach to investing is unique and any investor should gain some knowledge from his resources.


Research Affiliates updated their expected return expectations with year-end data. (link) Research Affiliates has two different 10-year expected return models. The first is based on current yield and growth expectations and the second uses mean valuation to determine an expected return. The yield and growth model expected annualized nominal return is 6.2% with a 5% chance of 0.3% annualized nominal return and a 5% chance of 12.1% annualized nominal return. The 25% to 75% range is 3.8% to 8.6% annualized nominal return. The valuation dependent model adds another 2.0% annualized expected return from mean reversion of valuations. In both models, inflation accounts for another 2.2% of annualized expected return.


I am a big believer in a hurdle rate for any investment as it creates discipline in times of elevated valuations. Given the need to outperform the benchmark to add value, an understanding of the expected returns of that benchmark is a good place to start. The top 5% expected annualized nominal return is 14.1%. Given the low probability of the 14.1% return, the 15% hurdle rate used in my process provides a sufficient margin of safety over benchmark returns. It could be argued that the 75% nominal expected return of 10.6% under the valuation dependent scenario should provide a sufficient buffer especially if you are buying businesses that are much better quality than the benchmark.


Going forward, I will continue to use a 15% hurdle rate for deep value scenarios. For higher quality companies, my hurdle rate for a full position will be 12.5% and 10.0% hurdle rate for a smaller position size.


Fred Wilson on why network effects are crucial to software companies. (link)


The Waiter’s Pad delves into Michael Mauboussin’s framework for better decision making. (link) Mr. Mauboussin and his team put out a Base Rate Book to help with decision making. (link)


Guggenheim outlines their ROIC curve framework and the benefits of focusing on ROIC as a key input into valuations. (link)


Ensemble Capital wrote a blog post on the biggest threats to each type of competitive advantage. (link)


The Financial Times investigated Chinese civil servants lending to municipalities. (link)


Indian Value and Contrarian Investor provides Prof. Bakshi’s thoughts on position sizing. (link) The blog post includes Warren Buffett’s Principle of Underwriting in his 2001 letter and how it relates to investing.


A short article by McKinsey illustrates how companies with organic growth generate better returns. (link)


Kinsale Compass Fund Owners’ Manual is a good overview of many key tenets of value investing. (link) H/T Terminal Value


Fiat Chrysler’s Marchionne gives his view of the future of the automobile industry. (link)


Acquirer’s Multiple talks about Charlie Munger’s thoughts on why a high conviction best ideas fund underperformed and the problem with deep dive research. (link) It was a anecdote from Monish Pabrai’s talk at Google titled “ Intensive Stock Research Can Be Injurious to Financial Health”. (link)


India banned PWC from performing audits in the country for two years after failing to identify the fraud at Satyam. (link)


Nike is using reverse auctions with its digital agencies, which could lead to fee pressure. (link)


The asks why the bear case on China has not worked out? (link)



Recent Transactions


KKR sold a minority stake in Valinge, a Swedish click-floor specialist, for roughly 14 times EBITDA. (link)


Founded in 1993, the Swedish company pioneered the concept of floating click floors, which can be installed without glue. It also profits from selling the rights to its patents to licensees, mainly in Europe and the US but it is also expanding in China.


The Kristiansen family, the Danish owners of Lego, was the buyer. The family buys minority stakes in companies in Northern Europe with strong growth. It expects to hold Valinge indefinitely at a lower returns than a typical private equity fund. Thomas Lau Schleicher, the chief investment officer at Kirkbi expects to own a company for 10 or 15 years but does not expect to generate the returns that you can generate in private through a business transformation over a very short period.


US-based Boardriders, the parent of Quiksilver, agreed to a takeover of Billabong, the Australian surfwear company. (link) Boardriders will purchase those it does not own at AUD1.00 a share, a 28 per cent premium to the closing price of AUD0.78 on November 30 when the deal was first disclosed. Billabong, which had net debt of AUD148 million on June 30 2017 leading to an enterprise value of AUD380 million. The company has negative EBITDA and operating profit on sales of AUD979 million in FY2017 and averaged sales of AUD1,049 million over the last five years placing the EV/Sales multiple just under 0.4 times.


Nestle sold its US Confectionary business to Ferrero for USD2.8 billion valuing the business at roughly 3.0 times sales. (link)



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