Friday, May 30, 2014

Keys to Writing About Investing

Substitute 'damn' every time you're inclined to write 'very;' your editor will delete it and the writing will be just as it should be. - Mark Twain
Whether you're just starting out or are a seasoned vet, I can think of no better way to accelerate your development as an investor than to write down your ideas -- and then share them with the world.

Not only does this peer review process force you to gather and organize your thoughts, but the feedback you get (both positive and negative) from your readers can help you see things you didn't before. You'll find yourself reading more books and articles on investing than you would otherwise to generate new article ideas. With time, these lessons add up.

Over my career in the industry, I've been fortunate to do a bit of writing and editing and thought I'd share some of the tips I've picked up over the years.

1. Be forward-looking. This is particularly true when writing about a stock idea. Providing background is important, but the market's already processed that information. What do you think will happen over the next few years? That's what the reader wants to know.

2. Be debatable. Of the articles I've written, the ones I'm most disappointed with are the ones in which I didn't take a firm stand on an important point. Don't hedge -- just say what you think.

3. Don’t bury the lede. Put your important points and key takeaways at the beginning or your article or the reader could lose interest before getting to the good stuff.

4. Avoid block text. This is particularly true with online writing -- more than three long sentences in a paragraph and there are good odds that it won't be read. Use charts, tables, and bullet points to break up text.

5. Read and reflect. After reading a great article or book, reflect on why the author's style resonated with you and apply those lessons to your own writing style.

6. Make strategic use of bold formatting - especially in long posts. Even though every word you've written is pure Shakespeare, the odds are that the online reader is skimming your masterpiece. If your post or article is over 1,000 words, highlight key points in bold. Like exclamation marks, however, bold formatting loses its impact if used too frequently. 

(Howard Marks makes masterful use of bold formatting in his memos.)

7. Be conversational and avoid financial jargon and formal language where possible. Read Peter Lynch's One Up on Wall Street and Beating the Street for excellent examples of conversational writing about investing.

8. Tell a story. The articles that stick with me are the ones where the author related a personal story with the investing lesson. A dry explanation about valuation will go in one ear and out the other, but weaving it in with a story about forecasting will make it more memorable.

9. Respect your reader's time. Say what you need to say to get your point across, but no more. Be brief, be brilliant, be gone.

10. In case of writer’s block, write about something that pisses you off. This was a great tip I received early in my career. Not only does it work, but it helps drive passion, which comes across in your writing and will make the piece more interesting.

What tips do you have?

What I've been reading this week:

Stay patient, stay focused.


@toddwenning on Twitter

Wednesday, May 21, 2014

The Best Investor You've (Probably) Never Heard Of

Earlier this month, I came across a great interview with one of my favorite investors, Chuck Akre of Akre Focus (disclosure: I own shares of his fund) -- thanks to Kevin Holloway (@kevin_holloway on Twitter) for pointing it out.

I've followed Akre for a while and have long been a fan of his "Compounding Machine" approach, which I think works particularly well with small caps. What I like most about his investing philosophy is it's a well-defined, cohesive, and repeatable framework for making investing decisions. Few investing gurus lay out their process in such detail.

Source: Akre Focus Fund

You can watch the interview with WealthTrack below:

Here are a few of the key takeaways from the interview:

  • We want businesses that can reinvest their free cash flow back in the business to earn above average rates of return on capital. 
  • Average rates of return in the market are about 10%. We look for companies that can earn significantly more.
  • Dividends reduce a company's ability to compound.
  • We seek above average returns with below market risk. Key is to own businesses with more growth and higher ROIC opportunities, have higher quality balance sheets, and pay good prices for them. That will provide below market risk. (See: A Simple Equation for Investing Success)
  • Akre has held some portfolio stocks for decades
  • Great business, great people, great history of reinvestment = Compounding machine
  • Business models get better or worse, people's behavior will get better or worse, reinvesting opportunities get better or worse. You need to stay up on these changes. 
  • Hard to find companies with those three characteristics. 
  • Akre has owned Markel for over 20 years. The growth in book value was about 14% compounded over that period. BVPS growth will fluctuate with time, pricing cycles, interest rates, etc. We didn't sell during down times. We look at things at Markel differently than the sell-side. In 2013, growth in BVPS was over $70 per share and the stock price was in $620 range -- still less than 10x the real economic earnings in 2013. The change in BVPS is the real economic earnings. 
  • American businesses have single digit net margins on average. ROE, ROOC in low teens. We research companies with returns significantly greater than that. Then we get curious. 
  • We may not know precisely why the company has a moat, but that's okay. The company may not want to share its secret. 
  • American Tower -- more towers, more tenants per tower, more rent per tenant. Contracts have annual price escalators of 3-4%. The 3G>4G progression requires denser tower network. Growing outside the U.S. 
  • MasterCard & Visa -- much harder to determine why the companies earn such high ROICs. Generate enormous free cash flow and have almost too much cash on hand, which can reduce compounding opportunities. They get paid a percentage of the amount of currency -- inflation hedge. 
  • Workbench companies -- Start with a small investment while investigating whether or not to invest more. Colfax started out this way and is now a top holding.
  • In management, you want to know how they measure their own success in the business. Avoid those managers who are too focused on the stock price as a measuring stick of success.  
  • Ultimately, investing isn't about punching numbers. Quants are trading against prices in their models; we're investors in businesses. 
  • Not enough investors/fund managers are striving to think long-term. You attract the shareholders/following you deserve. 
  • Late 2008 and early 2009 felt terrible. The shareholders who knew what we were about have done wonderfully as a result of sticking with the program. We want to make sure shareholders know what we're about.
  • Markel will benefit from rising rates, better industry pricing, recent acquisition, more opportunistic balance sheet management, and Markel Ventures program that moves business away from insurance. 
That's a lot of information in a twenty minute interview. If you're interested in screening for "Compounding Machine" ideas, I'd start with the following criteria:
  • Market Cap >$100m, <$10b
  • ROE >15% (ideally, screen for average five year ROE >15%)
  • Payout ratio <30%
  • Book value per share growth >10% CAGR (5-10 year period)
  • P/E ratio <20x or free cash flow yield > 5%
What did you think about the interview? Let me know in the comments section below or on Twitter

Stay patient, stay focused.


@toddwenning on Twitter

Wednesday, May 7, 2014

What To Do When Your Stock Plunges

Invest long enough and one morning you'll open your browser to check your stocks only to find that one of them is down 20% or more in pre-market trading.

Fortunately, this sinking feeling doesn't happen often, but shareholders in a number of popular stocks including Whole Foods, Groupon, and AOL certainly had a rough morning today.

At Clear Eyes Investing, we talk a lot about ignoring short-term market fluctuations and staying focused on the long-term. When a stock plunges in a single day, however, you do need to pay attention as the market is making adjustments to its longer-term assumptions about the company.

As Philip Fisher wrote in Common Stocks & Uncommon Profits:
Every significant price move of any individual common stock in relation to stocks as a whole occurs because of a changed appraisal of that stock by the financial community.
In other words, something important happened. It's time to do some research.

Once the stock has plunged in price, there's no point in wishing you'd sold earlier. The deed is done, but you do need to figure out if you should buy, sell, or hold based on the current opportunity.

Having been through a few of these myself, here are five guidelines that have helped me evaluate a stock that's just plunged:

  1. Take a deep breath and collect the facts. Read the company's press release and read the conference call transcript (if there is one). What's the market worried about? How is it different from what you assume in your model and thesis? 
  2. Avoid reading media reports. The media (both traditional and social) will sensationalize the storyline. The last thing you need at this point is another helping of emotion in your decision-making process. Focus on the facts. 
  3. What's management doing? Are they being honest and forthright about the challenges or setback they face, or are they trying to smooth things over with corporate-speak? What are they doing with their own money? I see it as a very positive sign if management uses its own money to buy shares in the company after a sharp share price drop, but only if it's a material amount. Picking up 100 shares of a $50 stock doesn't imply strong conviction. If management announces a more aggressive buyback strategy, that's also good, but I'd much rather see them using their own money.
  4. Re-evaluate your thesis and model. If your thesis is now kaput, it might be a good time to consider selling. Things could get worse. If you think the market has overreacted to the news, however, and your thesis is still largely intact, consider buying more. 
  5. Make a calm decision. If your heart is racing before you place a buy or sell order, go for a walk, listen to some Mozart, play a video game -- whatever calms you down and helps you make a firm and informed decision.
What tips do you have?

Stay patient, stay focused.


@toddwenning on Twitter

Sunday, May 4, 2014

Let the Tool Do the Work

One of my summer jobs during college was to help build and repair pool filtration systems, which naturally required a good amount of sawing PVC pipes.

On my first day on the job, I put every ounce of strength I had into sawing a length of pipe and ended up making some bad cuts with uneven ends.

Thankfully my boss was a patient man. After watching me force each push and pull of the saw, he said to me, "You know why you made a bad cut? You didn't let the tool do the work. Take it nice and easy and let the tool do the work."

This advice popped into my mind after reading an article about increased trading activity among retail investors. After five-plus years of a fairly strong market, more investors seem to be willing new gains through speculation rather than waiting for them through investment.

They're not letting the tool -- that is, the business -- do the work.

Trying to time trades and generate returns through speculation might work in the short-run now and then, but it is a wholly inferior long-term strategy, particularly after taxes and transaction costs are considered.

Over the long-term, the vast majority of investment returns are driven by dividends and earnings growth, which result from business performance, not market speculation.

As Vanguard founder Jack Bogle wrote in Enough:
Investing is all about the long-term ownership of businesses. Business focuses on the gradual accumulation of intrinsic value, derived from the ability of our publicly owned corporations to produce the goods and services that our consumers and savers demand, to compete effectively, to thrive on entrepreneurship, and to capitalize on change.
Or as Buffett wrote in his 1996 letter to Berkshire shareholders:
Over time, the aggregate gains made by Berkshire shareholders must of necessity match the business gains of the company. 
As we discussed in this post, long-term investing success boils down to a simple formula:

Investment + good company + right price + patience

After you've done your research and bought a stock at what you consider to be a good-to-fair price, be patient and let the business do the work. The investment returns will follow. 

Good reads this week:

Quote of the week
The best thing a human being can do is to help another human being know more. - C. Munger
Stay patient, stay focused.


@toddwenning on Twitter