Questions From Philip Carret
By Paul Lamont
May 22, 2015
Lessons From Top Investors
We continue to systematically study the perspectives of investors with the best long term track records. Some are listed in the chart below. In addition to displaying their record of out-performance over the S&P500, the chart also includes the number of years the out-performance was maintained.
As you can see from the chart above, Philip Carret has one of the longest (and best) investment records of all time. His six keys questions in analyzing a company (from A Money Mind at Ninety. 1991.) are paraphrased below;
1. Does the company have a long record (10 years) of earnings with an almost unbroken record of rising earnings?
2. How has the company financed growth? (borrowing money, stock issuance or reinvesting cash flows)
3. Does the company have low debt?
4. Is the company a leader, preferably THE leader in its field?
5. Does the company have entrenched corporate management?
6. Is there a broad and liquid market for company shares?
In addition, he mentions in The Art of Speculation (published in 1930); “Consider yield the least important factor in analyzing any stock.” He goes on to describe two types of these attractive but low yielding companies; “dividend paying companies of high grade, representing ownership in strong companies with good future prospects, ordinarily selling on a low yield basis” and “non-dividend-paying stocks of companies which are making definite progress in strength and earning power and are headed toward dividend rank.” The two other types (which Mr. Carret finds unattractive) are: “low-grade dividend paying stocks, affording high yields because their dividends are in doubt and future outlook uncertain” and “non-dividend paying stocks of companies showing no evidence of growth in strength and earning power.”
‘The Real Thing; What the World Wants Today’ = Income without Volatility
One word of caution though is currently warranted for investors searching through the high grade/low yield companies. Investors have been chasing fixed income yield. Because of absurdly low rates, some income investors have shifted money into consumer non-cyclical stocks. But valuations still matter.
In the recent finale of Mad Men, Advertising executive Don Draper appears to create the iconic 1971 Coca Cola Hilltop commercial (link to YouTube). Coke is still a great business but with its trailing multiple approaching ten year highs (25x+), investors moving in from bond land should hope that only the Hilltop Ad is being replayed and not the subsequent stock performance (see below).
High Yield Corporate Bonds
We have been concerned about riskier bonds at such low yields for some time now. A further discussion of their unattractiveness can be found here and here. Not only are returns low by historical standards, fundamentals worsened as prices increased. For instance, median leverage for investment grade corporate is the highest ever. Citigroup notes that corporations brought on the extra debt to pay dividends and not to make investments in growing business. Corporations have been known to issue shares to retire debt. Investors buying shares for the debt fueled dividends could find their interests diluted.
“Because investing evokes emotion, advisors need to help their clients maintain a long-term perspective and a disciplined approach – the amount of potential value an advisor can add here is large…Advisors, as behavioral coaches, can act as emotional circuit breakers by circumventing clients’ tendencies to chase returns or run for cover in emotionally charged markets. In the process, advisors may save their clients from significant wealth destruction and also add percentage points- rather than basis points - of value. A single client intervention, such as we just described could more than offset years of advisory fees.” – Vanguard Research.
Low European Rates Bullish for Gold
According to the most recent Annaly Capital Management report, “Approximately 52% of global government debt is yielding 0% or less.” Due to the negative interest rates, Spanish bank Bankinter is paying mortgage holders’ principal. Bank depositors are allowing bankers to give their money to homeowners to help pay the mortgage. In this low interest rate environment, Europeans are finding an alternative: gold. In the first quarter, German gold purchases were up 20% with France, Switzerland and Austria up double digits.
BHP Spin-off Update
BHP has spun off South32 to its shareholders. Recall that South32 is an Australian-listed global aluminum and metals mining company which includes the Cannington Mine, the largest (and lowest cost) silver mine in the world.
As we quoted Joel Greenblatt in The Golden Trigger; “The spin-off process itself is a fundamentally inefficient system of distributing stock to the wrong people. Generally, the new spin-off stock isn’t sold; it’s given to the shareholders who, for the most part, were investing in the parent company’s business. Therefore, once the spin-off’s shares are distributed to the parent company’s shareholders, they are typically sold immediately without regard to price or fundamental value.” Also “many funds can only own shares of companies in the Standard and Poor’s 500 index, and that index includes only the country’s largest companies. If an S&P500 company spins off a division, you can be pretty sure that right out of the box that division will be the subject of a huge amount of indiscriminate selling. Does this practice seem foolish? Yes. Understandable? Sort of. Is it an opportunity for you to pick up some low priced shares? Definitively.”
As MarketWatch recently reported in ‘BHP spin-off could prove hard to value’; “Near term, trading in South32 may be volatile because it will be ineligible for inclusion in key U.K. stock market indexes as it isn't incorporated in that country. U.K. funds that track such indexes will have to sell shares they receive in the firm when it splits from BHP. Barclays estimates roughly 40% of U.K. holders will be forced to divest.”
As Greenblatt says; “Insider participation is one of the key areas to look for when picking and choosing between spin-offs – for me, the most important area.” Joel then goes on to describe a successful spin-off in 1993 of Marriott International. To paraphrase, the CFO of the parent company became the new CEO of the spin-off with a large allotment of shares to ensure the new company did well.
Which is why in January, we relayed; “BHP Chief Financial Officer Graham Kerr is the new CEO of the spin-off. Compensation details (dependent on the initial spin-off share price?) to follow in March.” According to the South32 Australian Listing document, we now find out that 71% of Mr. Kerr’s compensation will be dependent on the share price.
Acquire, if Possible
We continue to seek out value. Analyzing different mining companies has been fascinating work. But we are not caught up in ‘the romance of buried treasure’ as Philip Carret would say. We will acquire companies that will offer attractive rates of return over a multiyear period. Large portions of the account will remain in Treasury Bills and precious metals, until overall conditions become more favorable.
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