Saturday, March 28, 2015

Has Long-Term Investing Become Too Popular?

Long-term investing has gotten so popular it's easier to admit you're a crack addict than to admit you're a short-term investor. - Peter Lynch in 2000
Having publicly written about investing since 2006, it's been interesting to observe changing investor opinion on long-term investing.

In the years following the financial crisis, for example, I would routinely receive reader comments and emails saying that long-term investing was flawed. And to be fair, they had numbers on their side, as ten-year trailing returns for the S&P 500 were unimpressive. As late as 2010, investors in the S&P 500 were looking back at a "lost decade" with negative ten-year total returns.

It was easy to see why investor patience was in short supply. Even though the starting point of that ten-year period was the beginning of the end for the tech bubble, ten years is still a long time to wait for positive returns.

What a difference a few years of steady market gains makes. Since starting this blog three years ago and writing about the benefits of long-term investing, I have yet to receive any pushback on whether or not long-term investing works.

Indeed, a recent Gallup poll (h/t Ben Carlson at A Wealth of Common Sense) shows that the majority of investors today say they'll do nothing in the face of market volatility and nearly half said they'd put more money into stocks in the event of a sell off.



Of course, what investors say they'll do and what they'll actually do are two different things. (Everyone is a long-term investor when the market's going up, but we find out who really means it when the market falls.) However, the level of fear in the market seems to be rather low at the moment and that's not a great thing if you're looking to invest more into the market.

Does this mean you should do a 180 and become a daytrader? Absolutely not, but it does mean you should tighten rather than loosen your criteria for making a new investment. As one of Buffett's more famous sayings goes, "The less prudence with which other conduct their affairs, the greater prudence with which we should conduct our own affairs."

Related posts:
Stay patient, stay focused.

Best,

Todd


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Wednesday, March 25, 2015

Weekly Reading List - 3/25/2015

What I've been reading - March 25, 2015
Stay patient, stay focused.

Best,

Todd
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Sunday, March 15, 2015

5 Signs of a Good Annual Report

Annual report season is upon us, which presents an opportunity to better understand our current portfolio holdings and watchlist ideas, as well as management's strategy and outlook.

Here are five signs of a good annual report -- that is, one that is helpful, informative, and could signal that a smart management team is at the helm.

1. They aren't afraid to admit mistakes: If the company had a bad year, was management forthcoming about what went wrong or did they sweep it under the rug? Assuming it's something they can control, do they have a clear strategy for not repeating the mistake? Frank discussions of mistakes also help shareholders gain insight into management's decision-making process. This year's Berkshire Hathaway annual report features a number of discussions about mistakes the company has made over the years.

2. They spend time talking about capital allocation: One of the things that William Thorndike stressed in The Outsiders was that capital allocation is a CEO's most important job, yet it's remarkable how few annual reports provide details on the company's capital allocation strategy. How do they prioritize uses of free cash flow? Does the company have a clear and appropriate buyback and dividend policy? U.K.-based retailer, Next, does a particularly good job outlining its capital allocation philosophy in its annual report, as does U.S. based textile firm, Culp.

3. They focus on returns on capital and economic profit: A recent study by IRRCi found that 75% of companies in the S&P 1500 don't use any balance sheet/capital efficiency metrics like ROIC, ROE, or EVA in determining long-term management incentives. This opens the door to management pursuing growth-for-growth's-sake and destroying shareholder value; therefore, I see it as a positive sign when a management team is held accountable for the cost of the capital that its using to grow the business over the long-term. It's an even better sign when ROIC is ingrained in the corporate culture. Good examples of annual reports that discuss ROIC and economic profit metrics are Constellation Software and Sun Hydraulics.

4. They communicate plainly. In my experience, too many companies assume readers of their annual reports have intimate knowledge of key industry phrases and metrics or they make the business sound more complicated than it really is. I like to see companies that take the time to explain their business in everyday language that can be understood by all stakeholders and readers. Admiral Group's annual report is a good example of this. 

5. They provide helpful data points. Good annual reports should contain enough data points to help investors fully evaluate the company's performance. Obviously all companies are required to disclose financial statements, but I like to see more granular data offered at the segment and product level, too. Costco does a great job of this in its annual report. Companies that don't provide data beyond what's required makes you wonder why the data isn't being shared.

 What do you look for in companies' annual reports? Let me know in the comments section below or on Twitter @toddwenning.

Related posts
Please note: Going forward, links to articles I've been reading will be found in a separate post. 

Stay patient, stay focused.

 *I own shares of Admiral, Berkshire, Culp and Sun Hydraulics. A list of my equity holdings can always be found here. 

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Saturday, March 7, 2015

Lessons From Buffett's Tesco Mistake

As I read through the 2014 Berkshire Hathaway letter last weekend, one section stood out to me as being full of great investing lessons.

Here's the passage: 
Attentive readers will notice that Tesco, which last year appeared in the list of our largest common stock investments, is now absent. An attentive investor, I’m embarrassed to report, would have sold Tesco shares earlier. I made a big mistake with this investment by dawdling.
At the end of 2012 we owned 415 million shares of Tesco, then and now the leading food retailer in the U.K. and an important grocer in other countries as well. Our cost for this investment was $2.3 billion, and the market value was a similar amount. 
In 2013, I soured somewhat on the company’s then-management and sold 114 million shares, realizing a profit of $43 million. My leisurely pace in making sales would prove expensive. Charlie calls this sort of behavior “thumb-sucking.” (Considering what my delay cost us, he is being kind.) 
During 2014, Tesco’s problems worsened by the month. The company’s market share fell, its margins contracted and accounting problems surfaced. In the world of business, bad news often surfaces serially: You see a cockroach in your kitchen; as the days go by, you meet his relatives. 
While it was nice to hear Buffett's thoughts on his mistake with Tesco, I was surprised that he started the story at year-end 2012, as it's important to consider the full timeline of the investment.

Buffett started his position in 2006 and owned 3% of the company by the end of that year. At the time, Tesco was led by CEO Terry Leahy who, over a 14-year tenure, more than quadrupled the company's pre-tax profits and its store count. The company set its sights on international expansion in the U.S. and Asia and established a dominant share of the U.K. grocery market. Things were looking up for the business.

In June 2010, however, Leahy surprised the market by announcing his retirement. He was replaced by lifelong Tesco employee and head of international operations, Phil Clarke. 

Tesco struggled over the next eighteen months, as the U.S. operations floundered and U.K. discount grocers began chipping away at Tesco's market share on its home turf. And despite a profit warning after a bad 2011 Christmas trading season, Buffett increased his stake in Tesco to 5.2% in January 2012. Many observers, including yours truly, thought that this investment amounted to a vote of confidence in Tesco management and its business prospects. 

Around the same time, however, Neil Woodford, a well-known UK fund manager, announced he had sold his entire Tesco stake after owning shares for the better part of 20 years. He also laid out a compelling case for why Tesco had lost its way, wasn't practicing smart capital allocation, and was battling structural headwinds.

I point this out to illustrate that there were some well-founded and known concerns about Tesco's management and competitive advantages -- two core components of Buffett's investment philosophy -- in early 2012. I would be interested to know at what point between his increased investment in 2012 and when he began to "sour" on management in 2013 that Buffett began to rethink his Tesco thesis. 

Here are some of the key lessons I take from Buffett's Tesco mistake:
  • Every investor makes mistakes. Even Buffett. The key is to recognize them, correct them as quickly as possible, and learn from them. 
  • CEO changes matter. When a very successful CEO retires or leaves a company, it's time to reassess your investment thesis. Specifically, it's important to figure out the quality of the hand the new CEO has been dealt (i.e. how strong is the business?) and the skill with which the new CEO can play the hand (i.e. how strong is the CEO at capital allocation?) 
  • Doing nothing is doing something. It's important to be patient, of course, but even though you may not be buying or selling a stock, you're still making an active choice to hold. If you have concerns about key points in your thesis, doing nothing and hoping the problem goes away on its own isn't a good strategy.
What I've been reading this week:
Stay patient, stay focused.

Best,

Todd


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