Fortnightly Review February 4, 2018

Fortnightly Review February 4, 2018


Interesting Articles


McKinsey wrote an article discussing their perspective on M&A in the Chemical industry. It includes an evolution of transaction multiples over the past few years. (link) The average deal multiple increased from 6.0 time EBITDA in 2012 to 10.0 times EBITDA in 2016.


McKinsey details the recent history of performance in the Chemical industry. (link) It mentioned superior performance came from industry concentration along with Chinese growth making it difficult for Chinese supply to keep up with demand. Since 2015, the industry underperformed due to fragmentation and slowing growth in China.


In my view, it is a commodity business with no barriers to entry where two things determine profitability operational efficiency and supply and demand. When China was growing rapidly supply could not keep up with demand allowing existing supply to earn abnormal returns. As soon as China started slowing and supply caught up with demand those abnormal returns were eliminated. Often abnormal returns lead to returns below the cost of capital as there is lead-time to bring new supply on stream. As demand slows new supply is still being built, therefore, supply can outstrip demand for some time as all the new supply is being finished. There are many variables but the lead-time for an oil refinery is estimated at 5-7 years.


McKinsey shares their perspective on how Chemicals companies can avoid the commodization trap. (link)


An older post by Tren Griffin at 25IQ on Buffett and Munger’s view of the discount rate (link) Credit Suisse wrote a report on modeling mean reversion in 2013. (link) The graphic below illustrates the average cash flow return on investment (CFROI).


The thought behind illustrating the graphic is the company must generate at least the average return in the industry therefore the discount rate should match the average CFROI of the industry. Other value investors use various rates.

  • In the Graham and Doddsville Fall 2014 issue (link), Wally Weitz uses a 12% discount rate.
  • Bares Capital mentioned in his interview with the Manuel of Ideas that he uses a 10% discount rate (link).
  • Akre Capital also mentioned in his interview in the value investing podcast that he uses a 10% discount rate (link) at that has been the historical return on investment of the US stock market.
  • Southeastern Asset Management uses a 9% discount rate (link).
  • Professor Bruce Greenwald of Columbia recommends a variable discount rate depending on the quality of the business; 7-8% for high quality businesses, 10-12% for average quality businesses, and 15% for low quality companies.
  • Bill Miller discounts at 6% due to low treasury yields.
  • Bill Nygren uses treasury yield + 450 basis points with a 300 basis point floor on the treasury yield.
  • Joel Greenblatt uses a 6% discount rate.


Using a historical returns on the US stock market the discount rate would be between 9-10%.


In Emerging Markets, stock markets have a much shorter history therefore a historical return approach may not be appropriate. An alternative approach would be to use a AAA bond yield as a hurdle rate. A long-term investment process should be focused on returns generated by the business rather than changes in valuation. If a normalized FCF yield plus a long-term FCF growth cannot beat a AAA corporate bond yield, it does not make sense to invest in an inherently riskier security.


Sophie Bakalar of the Collaborative Fund shares her thoughts on how to beat Amazon. (link)


REDEF wrote a great article on the potential evolution of Disney’s business model. (link)


Columbia Business School issued their latest Graham and Doddsville newsletter. (link)


Broyhill Asset Management’s last blog post is about certainty and uncertainty and the importance of understanding the limits of our knowledge. (link)


Saber Capital’s presentation for its Investing Talk at Google (link). I was unable to find any video related to the presentation. Included is an investment thesis for


@MineSafety10K created a repository for a number of investor letters. (link)


River Park’s Q4 letter includes a short thesis on CPG companies. (link)


Sage One Investments produces a thorough analysis of current valuations within the India. (link)


A well laid out bearish presentation on the US auto sector and Consumer Staples (link)


EM Growth is a historical premium to EM Value. (link)


Harding Loevner provides two examples of Japanese disruptors. (link)


A 4-minute video from McKinsey discussing The Power Curve of Economic Profit (link)


Bloomberg profiles the top performing Norwegian fund over the past five years and their investment thesis on Oil Services companies. (link)


Morgan Stanley’s 2017 primer on the Property & Casualty Insurance Industry (MS P&C Primer 2017)


Bloomberg highlights that there are less cheap stocks now than during the Dot Com Boom. (link)


Jana Vembunarayanan looks at Bajaj Finance. (link)


A GMT research report from 2014 investigates accounting fraud and red flags. (link)


An essay in American Affairs by Dan Rasmussen analyzes bad theories in modern finance. (link)


An article written by Graham Duncan explaining the investment game and the five different levels of the game (link)


Schroders’ 2017 Investment Study (June 2017 survey, link) The global average is a very high annual return of 10.2% over the next five years. Research Affiliates puts the All Country expected return (equity) at 2.4% per annum and Global Aggregate expected return (debt) at 0.5% per annum. (link)


AQR reviews the Shiller PE and expected returns. (link)


How Alibaba’s “new retail” disrupts JD’s World. Part 1 of 4 (link)


Interesting presentation by Hayden Capital on Incremental ROIC (link)



Recent Transactions


Keurig buys Dr Pepper Snapple. (link) The deal implies an EV/EBITDA multiple of 16.4 times.


Nestle backs away from Merck’s Consumer Health Unit (link).  Merck is seeking at least €4 billion or 20 times core earnings.

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