Weekly Stock Revisits Start Monday with Weight Watchers (WTW)

by Geoff Gannon

I'm going to be doing something new here. I don't normally discuss specific stocks much (mostly because I haven't bought a stock in about 2 years).

However, starting Monday, I will revisit each of the 27 stocks I picked from 2013-2016 for the newsletter I was then writing.

I'll start Monday with a blog post on Weight Watchers (WTW) since that was a stock I picked 3-4 years ago at $32 a share. It fell to $4 a share. And then closed today at $41 a share.

I'm not sure it's the most instructive case study. But, it's definitely the wildest ride to write about.

As I mentioned in an earlier post, I personally bought WTW shares at $37.68 and sold the shares at $19.40 for a realized loss of 49%.

To prepare you for my Weight Watchers re-visit here are two articles others wrote that were inspired in some way by my case for Weight Watchers:

Weight Watchers Provided A Valuable Lesson In Stock Watching (January 9th, 2017)

A Closer Look at Weight Watchers (WTW) (August 21st, 2013)

You can also read my own reasons for why I bought Weight Watchers:

What Led to the Weight Watchers (WTW) Purchase? (August 3rd, 2013)

The Two Things Every Stock Picker Needs to Learn: Independence and Arrogance

by Geoff Gannon

Check Out Geoff’s Members Only Site: Focused Compounding

I get a lot of emails from people asking how to become a better investor. They usually have very specific ideas about what would help them improve. For example, they think they need to get better at reading 10-Ks and that would fix their problem. Or they think they need to get better at deciding which stock to research in the first place. The truth is that most of the people I’ve talked with and tried to help improve as investors suffer from the same mental block.

They think there is a right way and a wrong way to analyze a stock. They have – whether they realize it or not, and I think usually they do not – a kind of moralistic view of how investing ought to be done. They believe that if you do what you’re supposed to do, work hard, etc. you will get a good outcome. Investing doesn’t work like that. Stock analysis doesn’t work like that. It really doesn’t matter whether you are a very hard working, diligent researcher of stocks or a lazy but brilliant one. There are no points for effort. Nor is there any degree of difficulty modifiers. Often, the best ideas are easy to come up with. They don’t take much time to research. They are 99% inspiration and 1% perspiration type ideas.

So, what do you need to be a good stock analyst? What is the key to hunting for and finding the right ideas to bet big on?

You need a different, better way of seeing the stock than most investors do. I’ve talked about the importance of “framing” an investment problem before. In my discussions with readers, I’ve realized they really underestimate the importance of this. Yes, I read the footnotes to financial statements, and I take notes on the 10-K, and I put together Excel spreadsheets. But there’s really nothing in any investment thesis that’s going to flip the correct answer of whether to buy a certain stock from a “no” to a “yes” or vice versa depending on whether the P/E is 14 or 18, the projected future growth rate is 4% or 6%, the Net Debt / EBITDA ratio is 1.5 or 2.5. If something as small as that can change your decision to invest – this stock probably isn’t worth your time.

The investment ideas really worth having are all “framing” problems. You have to find a stock where the way you frame the entire problem of analysis and appraisal is different from the way other people frame that same problem.

Let’s start with two examples from my own portfolio. Right now, I have 40% of my portfolio in Frost (CFR) and 25% of my portfolio BWX Technologies (BWXT). No other stock accounts for more than 6% of my portfolio. So, these are really the only two stocks that matter in my portfolio. In both cases, I framed the problem of appraising those stocks differently than most investors probably did.

Let’s start with the smaller position: BWX Technologies. I bought BWX Technologies when it was Babcock & Wilcox. That company had been separated from a larger public company – McDermott International – about 5 years before and Babcock itself was expected to break-up a second time into two units: BWX Technologies and B&W Enterprises. B&W Enterprises was a highly cyclical engineering company tied especially to maintenance on coal power plants in the U.S. and new build revenue on other types of power plants around the world that also used big steam boilers. That is what united the two parts of Babcock. Both BWX Technologies and B&W Enterprises had long experience engineering steam boilers for use in industrial power plants, power plants owned by electric utilities, and the onboard nuclear power plants that power U.S. Navy submarines and aircraft carriers. I was not interested in owning B&W Enterprises. I was interested in BWX Technologies. That company’s profits came from its work providing nuclear reactors and other critical components to 3 U.S. Navy projects: 1) aircraft carriers, 2) nuclear ballistic missile subs, and 3) attack subs. It also made some profits from other nuclear work for other parts of the U.S. government. For example, it down blended weapons grade uranium from the level of enrichment that the U.S. military used in its nuclear weapons program to a level that would allow civilian uses. And it also provided material to the U.S. nuclear weapons program. There were some other businesses like maintaining nuclear power plants in Canada (where nuclear reactors were built to a different design than the rest of the world). I thought nuclear was a mature technology with a limited number of companies that had experience in it, with certain national rivalries and security concerns that often kept foreign competition low, and – most importantly – I thought it was an area most companies weren’t interested in entering. In Warren Buffett’s terms: I thought BWX Technologies had a wide moat. In GuruFocus terms, I thought it was inherently a “5-star” type predictable company. None of this showed up in the headline financial data though. BWX Technologies had been part of a much larger company and then part of a combined company with a unit that did work on coal power plants. Also, there was a unit called mPower that was basically a skunkworks type project for an experimental modular nuclear reactor (a nuclear reactor so small you could deliver it by train anywhere there was a rail line and run it for years without needing to refuel).

Basically, the way I framed the problem was that I was looking at a crown jewel type business that should trade at 20 to 30 times earnings in normal times. And yet, when you tried to take the entire combined company – B&W Enterprises, mPower, and BWX Technologies – together and value it, you saw the market was putting a P/E of 10 to 20 times normal earnings on the stock.

There really were not big differences in any sort of math here between what I saw and what anyone else saw. I had perhaps slightly more aggressive targets for the unit that became BWX Technologies over the next 5 years than others might have (but I was basing that on BWXT’s announced backlog, the U.S. Navy’s announced long-term plan for its capital ship needs, etc.). There was nothing very math-y about any of my calculations. There were a couple key differences to how I saw the stock. One, was deciding that mPower had a value of zero – not a negative value as some investors might have put on it if they lumped in its EBIT loss each year with the EBIT profit of the established businesses and then slapped a multiple on the corporate EBIT as a whole. Two, was deciding that BWX Technologies was really as blue as a blue chip stock could get and should trade at a P/E of 25 or whatever companies like Coca-Cola, Colgate, etc. deserve – because its future seemed as certain and as profitable to me as those kinds of companies. And then the last part was that I decided to buy the stock right then – when it still consisted of mPower, B&W Enterprises, and BWX Technologies all together and hadn’t technically announced for sure that it was definitely going to split up on such and such a date. So, my way of framing the problem was to say that BWX Technologies was a wide moat, predictable company worth 25 times earnings and you could buy it now if you’d just put up with some waiting time and uncertainty about when mPower would be shut down and when the spin-off would take place. In retrospect, you could have done fine in BWX Technologies by making a different decision than me on that last one. You could have waited till BWX Technologies was trading cleanly on its own. You couldn’t – however – have made as much money if you waited a full year or so for BWX Technologies to report a full year on its own, give long-term EPS growth guidance, etc. So, to me, BWX Technologies is an investment that is all about how you “frame” the problem. I didn’t see anything other investors didn’t. I just saw the stock differently. I saw it as this blue chip unit hidden in a hodgepodge of 3 different business units that were muddying the reported results.

My bigger position is in Frost. This is an extreme example of kind of crunching the numbers exactly the same as other investors do – but just choosing to focus on different numbers. I think Frost is – in normal times – one of the most value creating banks in the country. Let me explain. Frost has some of the lowest “all-in” funding costs per dollar of deposits. Banks pay two types of costs for their deposits. They pay interest. And then they pay everything else – branch costs, the cost of providing you with a nice website, moving your money around at no extra cost, etc. However, banks also charge fees. Frost doesn’t charge much in fees. It charges very little relative to what it provides. But, for some – especially big – banks fees are a huge offset to services. So, the way I look at banks is simply to add up what I think normal interest expense is and normal NET non-interest expense (cost of services less revenue from fees) and then divide that number by the bank’s deposits. If you do this, you get an “all-in” cost of funding which might be 2%, 4%, 6%, etc. Right now, if it’s 6% – that bank’s not worth anything. Banks make loans which aren’t better investments than government bonds, mortgage backed bonds, corporate bonds, etc. So, the way I “frame” the problem of valuing a bank – money is a commodity. Loanable funds are the same as investable funds. I don’t care if you are a life insurer that is buying long-term corporate bonds, a bank that is making loans to small businesses, or a sovereign wealth fund that is buying U.S. Treasuries. The asset side of your balance sheet is basically the same. I’m not going to be interested in an investment because of what the financial firm owns. I’m only interested in what it “owes”. I am interested in an insurer for its float. I am interested in a bank for its deposits.

Many banks use some liabilities other than customer deposits. These tend to be expensive. Frost’s balance sheet is pretty close to fully funded by shareholder’s equity (a little bit) and customer checking and savings accounts (a big bit). I don’t want them to use a lot of shareholder’s equity – that’s “my” money that they’ve had to retain. What I want them to use is a lot of low-cost, stable deposits. That is their “float”. If Frost can invest in 4.5% bonds the same as everyone else but it can fund deposits at an “all-in” cost of 2.5%, then it can make a 2% pre-tax profit on this “float”. And then I think Frost is a bank with a higher than average retention rate. Although I can’t definitively prove it, there’s evidence that Frost’s retention rate is the equal of any other bank in the U.S. A bank with a higher retention rate will grow deposits faster than a bank with an industry average retention rate. And then Frost is in Texas. Texas will grow its economy – and its banking deposits – faster than the rest of the country. So, the way I “frame” Frost is that I see a bank with low cost float that is going to grow that float faster than other banks (including banks with much higher cost float). I may or may not be right about that. However, I’m definitely different in doing that. I value Frost purely on deposits per share and the growth rate in deposits per share. So, if Frost had $200 a share in deposits and was growing deposits at 6% a year, I’d use a multiplier (it’s always actually a fraction less than 1) to multiply the deposits per share by to get a valuation figure. So, I might say that Frost is – if growing deposits by 6% a year – worth somewhere between 0.25 and 0.35 times deposits.

I don’t care what the P/E is today. I don’t care what the price to tangible book value is. I also don’t care what the “efficiency ratio” is (this is costs as a percent of revenue) because I always think in terms of costs relative to deposits never costs relative to revenue. And I don’t think about net interest margin. Float will appear to be less valuable in low interest rate environments and will appear to be more valuable in high interest rate environments. However, bank customers rarely switch banks or pull their deposits – so a dollar you add to your “float” in a low interest rate environment will eventually be an extra dollar you have in the next high interest rate environment.

I bought Frost a couple years ago. Before buying it, I analyzed and appraised it. When I valued Frost this way, I got an appraisal that was something like 2-3 times the then current stock price. Frost was then trading at 0.16 times its deposits while I valued the stock at 0.37 times deposits.

This is what I mean by an investment not being about seeing something others don’t and instead being about seeing the entire stock analysis problem differently. If I had framed Frost as something to be valued on the basis of the current P/E, P/B, etc. I would have seen the P/B was high and the P/E was a fairly normal 14 or so. Frost was – at the time I bought it – about the most normal looking stock you could find in terms of P/E, dividend yield, and EPS growth rate. It looked like a boring and correctly valued stock.

I looked at it differently. I valued the stock for the low cost “float” provided by its deposits. I didn’t look at the reported EPS growth rate from 2008-2014. Instead, I looked at the deposit growth rate from 2008-2014. And I didn’t look at what that float would provide in interest income when the Fed Funds Rate was 0% (as it was when I started looking at Frost). Instead, I looked at the interest income Frost would take in when the Fed Funds Rate was 3%.

What I am outlining here may seem like a boring rehash of the investment cases for two stocks I already own and which you can no longer buy at anywhere near the prices I paid for my shares. But, the process I am laying out here is one of the most important parts of successful investing. There is an intellectual pillar to good investing and there is an emotional pillar to good investing. The intellectual pillar is seeing things differently than others see the stock. The emotional pillar is holding on to your shares while others continue to see the stock the way you think is wrong.

There isn’t much I can do to help anyone with the emotional pillar of good investing. But, the answer to mastering the intellectual pillar is easy. You need to be more arrogant and independent. You need to be independent minded enough to be willing to frame the problem of appraising a stock in a way that is completely different from the approach everyone else is taking. And then you need to be arrogant enough to recognize that sometimes – far less than half the time, but yes, sometimes – your view is so clearly correct and yet so clearly at odds with the standard valuation approach, that you need to act on it.

I know it’s scary to think that way. Suggesting that most value investors I’ve come across lack both the independence and the arrogance to carry out a good, contrarian analysis and pounce seems like dangerous advice. But that’s what stock picking is. If you want to use “standard” approaches with the Ben Graham stamp of approval or something like that – you can. I think that’s a great approach. But, it’s a basket approach. You don’t need to spend a lot of time “picking” specific stocks along the traditional value metrics of price-to-book, EV/EBITDA, etc. If all banks are cheap enough – buy a basket of 5 of them, don’t try to select one over another. But, if you want to invest a lot of time in picking one stock over another – the only sensible approach is to up your level of intellectual independence and arrogance to the levels you see in someone like Warren Buffett.

If you’re going to pick specific stocks, you have to trust your analytical abilities enough to allow you to create a model of a stock that differs from the standard model. Every stock pick is an act of arrogance. If you don’t think you’re capable of seeing a stock more clearly than the market – get out of the game.

In 99 cases out of 100, I’m not capable of seeing a stock more clearly than the market. But, when I do act – it’s usually because I have the intellectual independence and, yes, arrogance to believe I’m framing the investment problem more clearly than the market is.

Check Out Geoff’s Members Only Site: Focused Compounding

Focused Compounding Now Includes One-on-One Sessions with Geoff

by Geoff Gannon

Focused Compounding

A membership at Focused Compounding comes with an unlimited number of private one-on-one texting sessions (conducted via Skype) with Focused Compounding co-founder Geoff Gannon.


The only restrictions are:

  • Each session runs only from 9 a.m. to 11 a.m. (U.S. Central Time).
  • Sessions are only scheduled for Monday-Friday.
  • You can’t book a session for a day the calendar shows as “ALREADY BOOKED”.


During your session, you can discuss any investing topic with Geoff. You pick the topic. It can be a specific stock you are thinking of buying or selling. It can be a general investing question. It can be asking Geoff a laundry list of questions you’ve come up with.

Everything is on the table.

The agenda is yours to set for those two hours and the conversation can cover absolutely anything related to investing.

Membership also includes:

  • General investing articles by Geoff
  • Specific stock write-ups by Geoff
  • A variety of articles by Andrew Kuhn
  • An idea exchange where members post their own stock write-ups. Ideas on the board already include detailed write-ups on: Merkur Bank, Kroger, Protector Forsikring, Wells Fargo, and Under Armour.
  • And a collection of 27 past stock reports written by Geoff between 2013-2016.

A Focused Compounding membership is $60 a month.

Focused Compounding

Guesses About My Next Purchase

by Geoff Gannon

In an earlier post, I mentioned I MIGHT be buying a new 20% position this week. Here is what you guys guessed that position would be:

Blog readers emailed me guessing I would buy one of four stocks this week: Howden Joinery, Omnicom, Hunter Douglas, or MSC Industrial.

Blog readers emailed me guessing I would buy one of four stocks this week: Howden Joinery, Omnicom, Hunter Douglas, or MSC Industrial.

The stock I am considering is not among those four.

Richard Beddard's Share Sleuth portfolio, however, did buy Howden Joinery. Read the post explaining why here.

Focused Compounding: Member Stock-Writeups

by Geoff Gannon

Focused Compounding

Merkur Bank

“Merkur Bank (MBK) is a small regional bank located in Munich, Germany…MBK’s stock offers a good opportunity to partner with an owner-operator whose financial wealth is being tied to the bank’s future performance. This should provide outside investors with the comfort that Mr. Lingel will not take on any undue risks. MBK is a well-run bank that does business quite differently than most of its competitors; it focuses on a few attractive markets that it understands well and values long-term partnerships with its clients. At the current price, investors can expect a satisfactory return on their investment without paying for any potential growth in the coming years.”



“Founded in 1883, Kroger is now one of the largest retailers in the world, with more than $115 billion in revenue in 2016, serving more than 8.5 million customers every day. As of January 28, 2017, Kroger operated, either directly or through its subsidiaries, 2,796 supermarkets under a variety of local banner names…it’s hard to get comfortable about Kroger’s ability to grow its EPS by 8% a year without more aggressive assumptions such as meaningful increase in leverage.”


Protector Forsikring

“Protector is quite a new player in the Scandinavian insurance market. The company was established in 2004, and listed on the Norwegian stock exchange in 2007... This is a far riskier investment than for example Progressive, Gjensidige or any other stable insurance operator. But at the same time, it is cheap relative to their historical performance and the potential growth rate it may achieve over the next 5 years. For a more diversified portfolio, this might be an interesting bet. However, for a very concentrated portfolio, this investment may be a pass.”


Wells Fargo

“In general, Wells Fargo makes money in two ways.  Firstly, it earns a spread on its interest-earning assets by borrowing at low rates and lending at higher ones.  Secondly, Wells Fargo collects fees for the products and services it offers (non-interest income).  Non-interest income only partially offsets the company’s non-interest expenses; thus, it is only accretive to earnings if it outpaces costs…I believe Wells Fargo securities represent a safe investment.  U.S. banks are very durable businesses with high customer / deposit retention.  Most American consumers and businesses use their bank accounts for transactions and are generally indifferent to interest payments on the money they use month-to-month.  Banks could change for the worse, but changing for the better is much more likely. Traffic to branches is declining, which should lead to branch closures and cost reductions.  Wells Fargo has a strong competitive advantage built on a strong branch network, huge base of low cost deposits, conservative lending practices, and an ability to increase non-interest income by cross-selling its products.”


Under Armour – One Member’s Take

“Athletic apparel manufacturers typically develop, market, and distribute their own branded apparel, footwear, and accessories for men, women, and youth.  Products are usually sold worldwide and worn by athletes, as well as by consumers of active lifestyles…the athletic apparel industry is an attractive industry for investors to shop in.  After a track record of impressive and consistent sales growth, Under Armour has stumbled in its last 2 quarters, causing a mass sell-off of its shares that have driven the price down by around 50% over the last year.  I believe that most of the causes of recent poor performance are either temporary or cyclical in nature; however, the brand’s dropping popularity with fickle teenagers could be problematic if it endures.  If the brand’s strength is intact and sustainable, Under Armour shares should perform well by offering returns ranging from 9% to 15% over the next decade or more if the brand endures, but if the brand fades, investors should expect a loss of 40% on their investment.”


Under Armour – Another Member’s Take

“Under Armour (UA) was founded in 1995 by Kevin Plank, then special teams captain of the football team from University of Maryland. Frustrated by the increase in weight traditional cotton T-shirts incur after heavy sweating, Plank set out to develop T-shirts using better materials…While UA is not a traditional value investment. Given the business quality and reasonable growth assumptions, buying its stock now may still get you market beating results if you buy and hold for 20 years. But if you want a wider margin of safety, you should closely monitor the stock price. Let’s say the stock price drops another 20% or so, it may still trade at a seemingly high P/E of 40x. Yet, that would be a good entry point already, with an expected return closer to 9% to 10% over the next 20 years.”

Focused Compounding

Talk to Geoff about Focused Compounding

I MIGHT Buy a New 20% Position This Week

by Geoff Gannon

It's very possible I will purchase a new 20% position this week (29% of my portfolio is in cash and 6% is in a stock I'd happily eliminate).

If I do buy the stock, I'll announce it on the paid site (Focused Compounding) first and then mention the stock's name here a week or two later.

Anyone who wants to guess what the stock is can email me at gannononinvesting@gmail.com

There are no prizes for a correct guess. But, it might be a fun exercise.

All Supermarket Moats are Local

by Geoff Gannon

Following Amazon’s acquisition of Whole Foods and the big drop in supermarket stocks – especially Kroger (KR) – I’ve decided to do a series of re-posts of my analysis of the U.S. supermarket industry.

Today’s re-post is a roughly 1,300 word excerpt from the Village Supermarket (VLGEA) stock report Quan and I wrote back in 2014. This section focuses on how the moat around a supermarket is always local.

Read the Full Report on Village Supermarket (VLGEA)

In the Grocery Industry: All Moats are Local

The market for groceries is local. Kroger’s superstores – about 61,000 square feet vs. 58,000 square feet at a Village run Shop-Rite – target customers in a 2 to 2.5 mile radius. An academic study of Wal-Mart’s impact on grocery stores, found the opening of a new Wal-Mart is only noticeable in the financial results of supermarkets located within 2 miles of the new Wal-Mart. This suggests that the opening of a supermarket even as close as 3 miles from an incumbent’s circle of convenience does not count as local market entry.

In the United States, there is one supermarket for every 8,772 people. This number has been fairly stable for the last 20 years. However, store churn is significant. Each year, around 1,656 new supermarkets are opened in the United States. Another 1,323 supermarkets are closed. This is 4.4% of the total store count. That suggests a lifespan per store of just under 23 years. In reality, the risk of store closure is highest at new stores or newly acquired stores. Mature locations with stable ownership rarely close. So, the churn is partially caused by companies seeking growth. Where barriers to new store growth are highest – like in Northern New Jersey – store closings tend to be lowest. Village’s CFO, Kevin Begley, described the obstacles to Village’s growth back in 2002: “…real estate in New Jersey is so costly and difficult to develop. New Jersey is not an easy area to enter. This situation also makes it challenging for us to find new sites. It’s been very difficult for us, and for our competitors, to find viable locations where there is enough land especially in northern Jersey and where towns will approve a new retail center. With the Garwood store…we signed a contract to develop that piece of property in 1992; it just opened last September (2001). So it can be a long time frame from when you identify a potentially excellent site and when you’re able to develop it. Finding viable sites is certainly a challenge that we face, as do our competitors.”

New Jersey is 13.68 times more densely populated than the United States generally (1,205 people per square mile vs. 88). It is about 12 times more densely populated than the median state. This means New Jersey should have about 12 times more supermarkets per square mile to have the same foot traffic per store. The lack of available space makes this impossible. As a result, the number of people visiting a New Jersey supermarket is greater than the number of people visiting supermarkets in other states. The greater population density in New Jersey has several important influences on store economics.

One, it encourages the building of bigger stores. This sounds counter intuitive. If there are a lot of people in a small space and land is difficult to develop, it would be logical to enter the market with a small format store. That is true. However, incumbent stores have big advantages over new entrants. Incumbents have leases in key locations. Their stores are highly profitable. As a result, store owners in New Jersey will favor expanding each existing store to the maximum possible square footage whenever renovation is a possibility. This is what most Shop-Rite members have done. Village does not operate especially large Shop-Rites. However, 58,000 square feet is huge by national supermarket standards. Whenever Village has renovated a store, it has tried to increase square footage. Village has sometimes relocated stores to larger footprints. And Village’s most recent new stores have been huge. For example, Village recently built a 77,000 square foot replacement store in Morris Plains. This store is almost as large as the Wegman’s superstores (80,000 to 140,000 square feet) that tend to be the biggest supermarkets in New Jersey.

Two, New Jersey supermarkets turn the product on their shelves faster. This changes product economics for the store and the experience for the customer. A Shop-Rite turns its inventory phenomenally fast relative to the grocery section of a Wal-Mart. As a result, stale inventory and lack of help – the two largest complaints from grocery shoppers at Wal-Mart – are unusual in New Jersey supermarkets. More customers per square foot means higher sales velocity. It is not possible to stack more inventory per square foot. It is only possible to restock inventory faster. High inventory turnover can increase customer satisfaction by increasing the freshness of the product without requiring the store to buy different merchandise than a competitor with stale product on its shelves. More importantly for the stores, gross margins can be lower at a high traffic location and yet gross returns can be higher. In fact, this is exactly what happens at Village. Village’s gross margins are 10% lower than Kroger’s (27% vs. 30%) while gross profit divided by net tangible assets is 2.32 times higher (290% vs. 125%). A New Jersey Shop-Rite generates much higher returns on capital than any other traditional supermarket around the country. Again, this encourages reinvestment in existing stores. This further raises the barrier to local entry. A new store would need to find an open location where it could put a 60,000 square foot location to rival the breadth of selection and the low prices of the incumbent supermarkets. In most of the country, land is more widely available and the incumbent supermarkets are only around 35,000 square feet. Nationally, the average supermarket does $318,170 a week in sales. In New Jersey, the average Shop-Rite does $1 million a week. The initial investment required to enter a local grocery market in New Jersey is higher because the industry standard is higher and the costs of developing anything are higher. It is important to remember that the barrier is not simply the roughly 100% more expensive real estate in New Jersey versus the country generally. Nor is the barrier simply the lack of available space in New Jersey. The final hurdle to clear is the simple fact that supermarkets in New Jersey have evolved into much larger, lower margin beasts than the competition elsewhere.

Large stores support wide selection, low prices, fresh inventory, and high customer service. A comparison of inventory turns (Cost of Goods Sold / Average Inventory) helps illustrate this point. Village’s inventory turns are 26, The Fresh Market 21, Whole Foods 21, Fairway 20, Kroger 12, Safeway 11, and Weis Markets 9. It is easy to imagine a division between two groups: the supermarkets focused on freshness and the supermarkets focused on low cost. However, Village – a low cost generalist – has higher inventory turns than the group of “fresh” supermarkets (The Fresh Market, Whole Foods, and Fairway). Village turns its inventory twice as fast as traditional supermarkets like Kroger and Safeway. Kroger is an especially good comparison because its store size is the same as Village’s and its business strategy (big stores, wide selection, low prices, and generalist) is virtually identical. The difference between inventory turns at Village and Kroger is that almost all of Villages’ stores are in New Jersey while none of Kroger’s stores are in New Jersey. As a result of this higher inventory turnover, Village can charge customers 3 cents less per dollar of sales than Kroger and have double the return on capital (33% vs. 17%). The moat around Village is its portfolio of big, established stores in New Jersey that would take a lot of time, money, and risk to duplicate. If Kroger controlled these locations it would have at least as good returns on capital as Village. But the only way Kroger will ever control key New Jersey locations is through the acquisition of a New Jersey supermarket chain. The time, cost, and risk of introducing a new banner – the Kroger name is unknown in New Jersey – makes entry by any means other than acquisition extremely unlikely. The moat around Village is entirely local and historical. It runs big, mature stores under the well-known Shop-Rite name. Most importantly, it runs them in the best locations in America for supermarkets.

Read the Full Report on Village Supermarket (VLGEA)

Can Howdens Joinery Expand to the European Mainland?

by Geoff Gannon

Richard Beddard has added Howdens Joinery to his Share Sleuth portfolio. I mention this because I’ve written a little about Howdens Joinery in the past. And some of you know Howdens is the stock I like best that I don’t yet own.

This raises the question:

Why haven’t I bought Howdens yet?

There are two reasons:

1.       I try to buy stocks I’m confident I’d be willing to hold for more than 5 years if necessary

2.       I try to simply hold cash till I’m confident a stock will return at least 10% a year while I hold it

I believe Howdens may – in about five years from now – have fully covered the U.K. with about as many depots as it ever will have in that country. I’m not 100% sure this is true. I’ve seen companies raise their estimates of the size of their chain’s footprint that their home country can support. So, Howdens may have more years of depot growth ahead of it beyond 2022.

But, there will eventually be a limit to how many depots Howdens can build in the U.K. So, the next question is:

Can Howdens expand to other countries?

Richard Beddard writes:

“The other risk is Howdens might fill the UK with depots within my 10-year scenario, in which case it would need to find some other way to grow. Due to its entrepreneurial culture and decade long experimentation with European stores, I think it probably will be able to adapt its business model and establish profitable stores abroad.”

I don’t doubt Howdens’s entrepreneurial culture. But, at the risk of ethnocentrism here (I am an American writing about a British company), I am not 100% certain that Howdens’s entrepreneurial culture will – at the depot level – be easily exportable to non-English speaking countries. I’ve researched a few organizations in the past – notably Tandy Leather (TLF) and Car-Mart (CRMT) – where scuttlebutt taught me the importance of delegation and incentivization of the branch managers.

I believe Howdens’s model depends heavily on good management at the depot level.

As a rule, English speaking countries tend to be among the most “flexible” when it comes to labor in the sense employers can easily fire workers with little cost. And, as a rule, continental European countries tend to be among the least flexible when it comes to labor.

In its 2015 annual report, the company said:

“Managers hire their own staff locally and develop relationships with local builders. They do their own marketing to existing and potential customers. They adjust their pricing to suit local conditions. Managers manage their own stock. They work out where to put everything they can sell – old favourites and new introductions. Every day, they balance the needs of builders, end-users, staff and everyone in their local area who has an interest in the success of their depot...Managers are in charge of their own margin, and effectively of their own business. Both managers and staff are strongly incentivised on a share of their local profit less any stock loss, which results in a common aim to improve service, and consequently profit, with virtually no stock loss.”

Howdens’s most recent annual report included this statement:

“We continue to investigate the opportunities for Howdens in Europe. At the end of 2016, we had twenty four depots outside the UK: twenty in France, two in Belgium, one in the Netherlands and one in Germany. We have been in mainland Europe for eleven years and continue to learn. We intend to thoroughly understand these markets before any decision is made to expand in them.”

The emphasis is mine. But, I think it’s reasonable to assume - from this statement and other little bits you can find in past annual reports - that the depot level economics are not as good in France as in the U.K.

Finally, the most recent annual report includes this passage:

“We give staff the opportunity to get substantial bonuses for exceptional performance. This has always been part of the Howdens business model and culture. Our people share in the profitability of their local site, as well as in the profitability of Howdens as a whole. In the words of some of our staff, the bonuses that they can achieve for exceptional performance in our peak trading period can be ‘life-changing’.”

As an American, I don’t know much about the differences between the U.K. and countries like France and Germany in regard to how low guaranteed pay can be and how big bonuses can be – nor how easy it is to fire people who don’t fit with your company’s “entrepreneurial” culture.

I’m not sure Howdens’s depot level culture can spread to other countries that easily. If I believed the model was easily repeatable in other countries – this might be my favorite stock of all (ahead of even the two I already own: BWX Technologies and Frost).

Instead, Howdens is on the bubble for me. I like the at least five year future I see in the U.K. And I can imagine the stock returning 10% a year for the next 5 years. I am less certain of the repeatability of growth beyond five years.

Does this mean I like Howdens less than Richard Beddard?

Actually, no.

His Share Sleuth portfolio has a “meaningful position” definition of about 3% to 4% of the portfolio. For my personal portfolio, a normal position would start at around 20% of the portfolio. If I was considering whether or not to put something like 3% or 4% or 5% of my portfolio into Howdens – I’d have already made the decision to buy. Because I’m considering putting 20% of my portfolio into Howdens, I still haven’t made a decision.

Read Richard Beddard's Post About Howdens Joinery

Talk to Geoff about Howdens Joinery

Do Supermarket Stocks Have Long-Term Staying Power?

by Geoff Gannon

Read the Free Report on Village Supermarket

Check Out Focused Compounding

Following Amazon’s acquisition of Whole Foods and the big drop in supermarket stocks – especially Kroger (KR) – I’ve decided to do a series of re-posts of my analysis of the U.S. supermarket industry.

Today’s re-post is a roughly 1,300 word excerpt from the Village Supermarket (VLGEA) stock report Quan and I wrote back in 2014. This section focuses on whether or not a supermarket can be a durable investment. The full 10,000+ word report on Village – along with 26 other reports of similar depth – are now available at my new site, Focused Compounding.

Some facts have changed since this report was written. For example, Amazon’s companywide sales figure is much, much higher than it was in 2013 (the last year for which we had data when we wrote this report).

And – more relevant to the grocery industry – Amazon Fresh has gone from a $300 a year add-on to Amazon Prime to a $15 a month add-on to Amazon Prime (so 40% cheaper).


Durability (From the 2014 Report on Village Supermarket)

High Volume Supermarkets are Durable Local Market Leaders

Demand for food is stable. Most grocers do not experience meaningful changes in real sales per square foot over time. Changes in real sales numbers almost always reflect changes in local market share. There will be online competition in the grocery business. However, in Village’s home market of New Jersey, direct to your door delivery of groceries has been available for 18 years. Peapod started offering online grocery shopping in 1996. The company was later bought by Royal Ahold. Royal Ahold owns Stop & Shop. Peapod has 4 locations in Somerset, Toms River, Wanaque, and Watchung. These locations offer grocery delivery in Village’s markets. They are direct competition and have been for years. Peapod does not require a $300 annual fee like Amazon Fresh. Instead, Peapod simply adds a delivery charge. Customers also tip the driver. Since the driver normally carries the bags into the customer’s home and puts them on the kitchen counter for the customer – the tip is usually a generous one.  Peapod charges $6.95 for orders over $100. The charge for orders under $100 is $9.95. The minimum order size is $60. Customers can also order online and then drive to one of the 4 Stop & Shops mentioned above (Peapod often uses the second floor of a building where the ground level is Stop & Shop’s retail store) and pick up their own order. Pick-up is free. However, a Peapod employee still collects the groceries and brings them to the customer’s car. So, a tip is still expected. Common tips are probably $5 to $10. So, the total cost of a Peapod home delivery order is probably anywhere from $12 to $20 higher than a trip to a Stop & Shop grocery store. Even a pick-up is probably $5 higher than a normal Stop & Shop visit – and the customer still has to drive to a store to make the pick-up.

Wakefern is a large co-op with similar scale to Stop & Shop nationally and more scale than Stop & Shop in New Jersey. Creating a retail website is easier now than it was in 1996. Therefore, it is no surprise that 87 of Shop-Rite’s 480 locations offer online shopping. In fact, online shopping is available from both Shop-Rite and Peapod in certain towns like Somerset.

This is important, because the average supermarket customer in the U.S. does not drive far to visit a location. Kroger uses a 2 to 2.5 mile radius to define its local market. Research on the opening of a new Wal-Mart found that supermarkets further than 3 miles from a new Wal-Mart saw no meaningful impact to their sales. This suggests that Wal-Mart Supercenter’s do not draw grocery customers from more than 3 miles away. So, a 2-3 mile radius is a reasonable definition of a supermarket’s local market. Convenience is the biggest hurdle for online grocery providers to clear. Amazon Fresh requires a $300 annual fee from its customers. Peapod requires a $60 minimum order.

The average grocery store visit results in a checkout of less than $60. At Shop-Rite, the average customer pays $52 at checkout. So, online grocery shopping tends to be more expensive and require larger orders than traditional brick and mortar supermarkets. Furthermore, online selection is usually inferior to the largest traditional supermarkets. For example, Peapod has a narrower selection of items on its website than it does at its retail stores – even though its online business is literally housed in actual supermarkets. This is a logistical problem caused by the difference between running a delivery business, an employee collected pick-up order, and a customer’s self-selected in store order.

Costs tend to be lowest and selection widest when a customer is forced to put their own items in their own cart by going through the store aisles themselves. Another problem with online ordering is the need for scheduling. Online grocery orders require the customer to be home at a specific time. The customer is usually given a window that can be as long as 2-3 hours during which they must be home to answer the door. Meanwhile, in store visits are always at the customer’s options. Traditional supermarkets are often open from roughly 10 a.m. to 8 p.m. seven days a week. Customers can drop into their local store at their convenience – including on the way home from work – and pick-up an order of any size. There is no scheduled time, no delivery fee, no tip, and no minimum order size. The selection is usually as wide as the company can provide.

For example, Village’s largest new store is 77,000 square feet. It includes plenty of fresh foods and prepared foods that are not sold online. So, online competition is not new to the New Jersey grocery market. And groceries are an especially tough business for online retailers to compete in.

One problem for online retailers is that all of their offline competitors have local scale. There is no such thing as a “Mom and Pop” grocery store in the U.S. Unlike hardware stores, pet stores, and book stores – the supermarket business is very locally consolidated. It would take an online retailer a long time to have scale locally. However, it would be possible for online retailers to develop bargaining power with suppliers. This is why Shop-Rite is run as a co-op.

Online retailers will continue to enter the grocery business. It is a huge market. The opportunity for growth is enormous. For example, the U.S. grocery business is probably about $600 billion a year while Amazon’s entire companywide sales are just $75 billion. Amazon could more than double its sales with just a 13% share of the nation’s grocery business. The size of the opportunity in groceries will continue to attract online and non-traditional competitors.

Non-traditional competitors are the biggest threat to Village. In the industry, “non-traditional” refers to both deep discount and high end (especially fresh and/or organic) grocery stores. In New Jersey, the high end is the area of greatest concern. The non-traditional supermarket with the store model best suited for entering New Jersey is The Fresh Market.

Local competitors that segment the market are a risk for existing supermarkets. The one-year customer retention rate in American supermarkets is probably around 70%. About 30% of customers may switch to a local competitor each year. In a Consumer Reports survey, the top reasons giving for switching were: “lower prices” and “better selection”. Shop-Rite generally has the lowest prices and widest selection in its local market. The only exception is in towns with a Wegman’s. Wegman’s has larger stores and wider selection than even the biggest Shop-Rites. As a result, Wegman’s is usually ranked #1 in customer satisfaction.

Supermarkets tend to be durable. However, there is a constant churn of locations at most companies – closing failed stores and relocating stores to better locations – that can be costly. Since a restructuring in the early 1990s, Village has not experienced any store failures. Nor has it relocated a store for any reason other than wanting to increase its size. Over the last 17 years, Village has spent just 1.7% of sales on cap-ex. Meanwhile, Kroger spent 2.7%, Safeway spent 3.0%, and Weis Markets spent 3.2%. Village’s low cap-ex advantage is entirely due to not closing stores. Because Village – as a Shop-Rite operator – has the highest sales per store of any supermarket, it also tends to be able to renew leases. Supermarkets are the “anchor” tenant at strip malls. In the last 17 years, there was only one example – in 2003 – of Village failing to sign a new lease. Village has the most durable portfolio of supermarkets of any publicly traded company. For example, in just the last 12 years, Kroger closed 21% of its starting store base. Village owns 4 stores (with 335,000 square feet of selling space) and leases 24 stores (with 1.3 million square feet of selling space). The initial term of a lease is usually 20-30 years. Many have multiple renewal options after those first 20-30 years.   

Read the Free Report on Village Supermarket

Check Out Focused Compounding

Supermarket Stocks Down: Start Your Industry Research with a Free Report on Village Supermarket (VLGEA)

by Geoff Gannon

Read the Free Report on Village Supermarket

Check Out Focused Compounding

Kroger (KR) is down 11% today. The stock’s P/E is now about 11.

Kroger is guiding for same store sales of flat to up just 1% this year. This guidance – combined with Amazon’s purchase of Whole Foods – is probably why the stock is down.

Supermarket stocks are a good area for value investors to research now.  One way to learn about the supermarket industry in the U.S. is to read the report Quan and I wrote on Village Supermarket (VLGEA) back in 2014.

That stock is now at roughly the same price – $25 a share – it was when we wrote about it.

A membership to my new site, Focused Compounding, gives you access to this report on Village Supermarket as well as 26 other stock reports just like it.

A membership to Focused Compounding costs $60 a month. If you enter the promo code “GANNON” at sign-up, you will save $10 a month forever.

Check Out Focused Compounding

Read the Full Report on Village Supermarket

The 3 Ways an Investor Can Compromise

by Geoff Gannon

GuruFocus: Pick the Winners First – Worry About Price Second

“There are 3 ways an investor can compromise:

1.    He can compromise by paying a higher price than he’d like to

2.    He can compromise by buying a lesser quality business than he’d like to

3.    He can compromise by not buying anything when he’d rather own something

You could use these 3 compromises as a test of what kind of investor you are.

A growth investor – like Phil Fisher – compromises by paying a higher price than he’d like. He won’t compromise on quality. So, he has to compromise on price. A value investor – like Ben Graham – compromises by purchasing a lower quality business than he’d like. He won’t compromise on price. So, he has to comprise on quality. Finally, a focus investor – like me – compromises by not owning any stock when he’d much rather be 100% invested.”

GuruFocus: Pick the Winners First – Worry About Price Second

I’ve Decided to Stop Deciding Which Stocks to Sell

by Geoff Gannon

Over the Last 17 Years: Have My Sell Decisions Really Added Anything?

“The stocks I pick don’t benefit much from well-timed sales. There’s usually little harm in holding on to them much, much longer than I do.

So, I’ve decided to hold the stocks I own indefinitely. When I find a really, really good stock idea – which might happen once a year – I will need to sell pieces of the stocks I already own to raise cash for that purpose. I’ll do that. So, if I’m fully invested and want to put 20% of my money into a new stock – I’ll have to sell 20% of each stock I now own. But, I’m not going to eliminate my entire position in a stock anymore. Those decisions to completely exit a specific stock haven’t added value for me. So, I’m not going to try to make them anymore.

From now on, I’m going to be a collector of stocks.”

Over the Last 17 Years: Have My Sell Decisions Really Added Anything?

Quan's Reflections on Writing the Newsletter

by Geoff Gannon


(Focused Compounding)

Many of you may remember Quan Hoang. He wrote some blog posts here. And he co-wrote a monthly stock newsletter called The Avid Hog (later renamed Singular Diligence) with me from 2013 to 2016. During those years, Quan was my investing partner. There wasn’t a single stock idea either of us considered without discussing it with the other person. Quan stopped writing about investing to pursue an MBA in the U.S. (he’s from Vietnam). And he’s now focused on studying artificial intelligence – specifically deep learning. Quan is the clearest thinker on investing I know. Here are his “reflections” on writing a newsletter with me for 3 years:

Reflections on the Newsletter

Like I said, he’s the clearest thinker on investing I know. So, it’s a good idea to read what he writes.


(Focused Compounding)

Get Geoff’s Take on a Stock You’re Interested In

by Geoff Gannon

(Focused Compounding)

Note: You have to be a member of the Focused Compounding community to take me up on this offer.

New Feature: Request for Research

Focused Compounding is adding a “Request for Research” feature to the site. Any member of the Focused Compounding community can now send Geoff a stock idea they’d like him to look at. Geoff will pick one stock from this idea pile each week. He will research the stock and do a full write. Geoff’s analysis will be viewable by the whole Focused Compounding community.

The stock you want to get Geoff’s thoughts on can be any size and traded anywhere in the world. There are no restrictions.

So, please send your best current stock idea to:


With the subject line:

Focused Compounding: Request for Research

Geoff will respond to all emails, even if time doesn’t permit him to do a full write-up of your idea.

(Focused Compounding)

The First 8 Things to Look at When Researching a Stock

by Geoff Gannon

(Focused Compounding)

The other day, someone I talk stocks with on Skype asked how I normally go about starting my initial research into a stock. What documents do I gather?

Here’s what I said:

“Basically, I start by finding the longest series of financial data I can (GuruFocus, Morningstar, whatever) and then look at that along with reading the newest 10-K and the oldest 10-K in detail. So, 10-year+ financial data summary, 20 year old 10-K (or whatever), this year's 10-K, and then the investor presentation if they have one, and the going public/spin-off documents if that's online. Also, I read the latest proxy statement and the latest 10-Q as needed for info on management, share ownership, the balance sheet etc.”

I also check the very long-term performance of the stock. So, I will chart the stock – at someplace like Google Finance – against the market over a period of 20, 30, or 40 years.

So, here’s a full list of my usual sources:

1.       Check long-term stock performance (what is the compound annual return in the stock over 20, 30, or 40 years?)

2.       Find the longest series of historical financial data possible (search for a Value Line sheet, a GuruFocus page, or go to Morningstar or QuickFS.net to see the long-term financial results)

3.       Read, highlight, and take notes on the latest 10-K (so 2016)

4.       Read, highlight, and take notes on the oldest 10-K (On EDGAR, this is usually around the year 1995)

5.       Read, highlight, and take notes on the company’s own investor presentation

6.       Read, highlight, and take notes on the IPO or spin-off documents (On EDGAR, this will be something like an S-1 or 424B1)

7.       Read, highlight, and take notes on the latest proxy statement (On EDGAR, this will be something like a DEF14A)

8.       Read, highlight, and take notes on the latest 10-Q.


Why Check the Long-Term Stock Performance?

This is something a lot of value investors wouldn’t think of. But, I find it very useful. Any time you are looking at a stock’s performance your choice of start date and end date are important. The good news is that your start date will be fairly arbitrary if you just look as far back as possible. So, if the stock has 27 years of history as a public company – and you look back 27 years – you probably aren’t picking a price near an unusual low point in the stock’s history. In fact, you’re probably picking the IPO price, which will rarely have seemed a “value” price at the time. The other good news is that – as a value investor – you’re probably attracted to stocks that seem cheap now. They trade at low or at least reasonable multiples of earnings, EBITDA, sales, tangible book value, etc. This means that any stock you are looking at as a possible purchase is unlikely to be benefiting right now from a particularly good choice of an end point.

Here’s an example.

If we go to Google Finance, we can see that Fossil (FOSL) has a stock price performance from 1994 through 2017 (so about 23 years) that’s a bit better than the S&P 500. You can use the data in Google Finance and combine that with a compound annual growth calculator to find the stock’s annual return was about 9% a year over the last 23 years. Does that mean Fossil created value over 23 years? Did it compound its intrinsic value faster than the average stock? That would be hard to tell if Fossil had started the period trading at a low price and now traded at a high price. However, the stock now trades at an EV/Sales ratio of 0.3. Historically, it traded around 1.5 times sales. It’s rare for a company in this kind of business to trade much below sales. So, if Fossil survives its current crisis and investors eventually warm to the stock’s future prospects – you’d expect the share price to jump at least 3 to 5 times. The stock’s $12 now. But, you’d expect it to be in the $35 to $60 range the moment investors felt sales had stopped plunging. That sounds like a big prediction to the upside – but this stock once traded at $120 a share. So, that’s still only a slight recovery of what Fossil’s market value had been.

Now, if Fossil stock was at a price 3-5 times higher than it is now, the 23 year return wouldn’t be 9% a year it’d be in the 14% a year to 17% a year range over more than 20 years. That’s a lot of value creation. In fact, if the end point had been the start of 2015 (when Fossil’s current problems hadn’t yet devastated its sales and earnings) instead of the middle of 2017, Fossil would have returned about 22% a year over more than 20 years.

So, the exact start point and end point you pick matters a lot when judging a stock’s past long-term compounding power. But, if you are looking at something that appears to be a value stock now and yet it still had returns of about 10% a year in its share price over 20, 30, 40 years or more – you’re fine. This is a business that didn’t destroy value over time. It compounded its intrinsic value as well or better than the stock market. If the stock’s future is as good as its past – and you’re buying it at a below average price – you’ll do well.

Those are two big ifs.

But, this check of the stock price performance compared with the more usual approach of looking at return on equity, return on capital, etc. over the past few decades will give you a good idea of what kind of quality business you’re dealing with. The stock performance check is especially important with conglomerates, cyclical companies, companies that issue and/or buyback a lot of stock, serial acquirers, and other corporations that are involved in a lot of financial engineering at the corporate level.

I strongly suggest checking the long-term stock performance when you’re looking at companies like: Baker Hughes (BHI) which is cyclical, Omnicom (OMC) which buys back its own stock, Textron (TXT) which is a conglomerate, and UniFirst (UNF) which acquires companies in the uniform industry.

Although it is easy to find the return on equity for these companies in any one year – it can be difficult to know what the return on investment of their various acquisitions, stock buybacks, etc. has been over a full cycle without using the long-term stock price performance as a guide.

It’s still not a perfect guide.

Remember, depending on exactly when in the last 2-3 years you checked Fossil’s stock price, you’d see long-term compound annual returns of anywhere from 9% to 22% in the stock. The important point is that you wouldn’t get a long-term compound annual return figure much below the S&P 500. So, you’d be able to assume Fossil had – historically – been an average or even an above average business. What you’re looking for here is any discrepancies where a company that seems to have an above average return on capital manages to always barely keep pace with – or even lag – the S&P 500 over the decades.


Why Use the Longest Series of Financial Data Possible?

The simplest reason here is that most investors don’t do this – so you should. There are figures that might be useful – like knowing what a company is expected to report in EPS next year, that have their usefulness diminished by the fact everyone else buying and selling the stock knows this figure. There are other numbers that might also be useful – which other investors aren’t looking at. You want to focus on figures that matter but are ignored by most people.

Let’s stick with the Fossil example. Knowing that Fossil’s pre-tax earnings dropped 22% in 1995, 18% in 2001, and 23% in 2005 might be useful when looking at the stock in 2015 because earnings had never declined from 2006-2014. So, at the end of 2014, a lot of investors might have only been looking at Fossil’s results from 2006-2014 (since that gives you the 5-10 years of history that many investors feel they needn’t look past). Investors may have also been looking at analyst estimates and the company’s guidance for the year ahead. I have nothing against you looking at near-term future projections. But, you should know, that probably 99% of investors are looking at projections for next year’s earnings while maybe 1% of investors are looking at historical data from further than 10 years in the past. That means the old historical data is more likely to give you an unorthodox insight into a company. And that’s what you need to be right when others are wrong.


Why Read the Most Recent 10-K?

As a serious value investor you know you’re supposed to do this. Everyone tells you you’re supposed to do this. You read the most recent 10-K to learn about the company as it exists today. I’m not going to waste words pushing this particular practice. If you aren’t reading 10-Ks, you should try it. They’re the most useful documents out there.


Why Read the Oldest 10-K?

Again, part of the reason for doing this is the same reason a lefty can have an advantage playing baseball. In absolute terms, it makes no difference if you’re left handed or right handed. Left handedness doesn’t make you a better baseball player. But, if 90% of the world is naturally right handed – being left handed makes you different. It makes you the opposite of what your opponent (the pitcher or the batter) normally faces. If trying to bat left handed makes you a worse hitter – there’s a point where you shouldn’t invest the effort in learning to do it. Likewise, if it’s a complete waste of your time to read the oldest 10-K, you shouldn’t read it. But, I don’t think it’s a waste of your time. And I know almost no one else does it. So, here’s something you can do that’s both useful and different.

Reading the oldest and newest 10-Ks one right after the other is a shortcut to understanding how the business developed and how the industry developed. You could work on studying the company’s entire history. But, that’s a huge investment of time for a stock you’re not sure you’re interested in yet. By reading the oldest annual report and the newest annual report, you get the quickest overview possible of the truly long-term history of the company. I think it’s sometimes useful. And I know it’s very rare for other investors to do this. So, if you’ve never read the oldest 10-K you can find on a company, try adding this to your regular routine.


Why Read the Company’s Own Investor Presentation?

This one is a bit more of a mixed bag.

There are aspects to reading this report that probably aren’t good for your understanding of the stock. One, everything in the presentation is well known by people buying and selling the stock. Two, this pitch is being made directly by the company’s management and aimed directly at people like you (potential investors).

So, it can be dangerously biased.

Those are the negatives. And they’re big negatives.

The positives are that, frankly, the investor presentation can give you the most background on a company and an industry in the shortest amount of time. If, for example, you have no idea how the frozen potato industry in the U.S. works, reading the Lamb Weston (LW) investor presentation is the quickest way to get an overview of the industry, the company’s rivals, and the company’s customers.

This is especially true for obscure industries – like frozen potatoes – where nobody writes books about the industry, none of the companies in the industry have ever had much cultural impact, and the companies just aren’t that well known by the public.

For example, you really need to read an investor presentation by Grainger (GWW), Fastenal (FAST), or MSC Industrial (MSM) to start your research into the MRO industry – because most people don’t know what the MRO industry is or how it works. It’s an invisible part of the economy.

If you don’t have much time to spend researching a stock before deciding whether or not to cross it off your list – I’d say skim at least 10 years of financial data (at someplace like GuruFocus) and read the investor presentation (on the company’s own website). That’ll take you a matter of minutes, not hours. And it’ll give you the background you need to look for the names of competitors, suppliers, and customers and to know what to look for in the 10-K. So, the investor presentation is often the best place to start your research into a company.


Why Read the IPO or Spin-Off Document?

This is often a very detailed report. It will have a lot of information on the industry. It is probably the single longest document on this list. Take your time. If you can work your way through a 10-K, you can work your way through an S-1, etc. Finding this document on EDGAR can sometimes be inconvenient because the company will often file a bare bones version initially and then keep amending it. Sometimes companies keep their original going public roadshow presentation on their website many years after actually going public. The same is true for spin-offs. For example, I own BWX Technologies (BWXT). Even though it is now 2017, that company keeps a 60 or so page presentation on its website that dates back to the 2015 analyst day which discussed the spin-off. Like a lot of IPO / spin-off presentations, that one takes a longer term view of the company. So, it has some discussion of how Babcock’s nuclear business evolved from the early 1990s through 2015. That’s the kind of historical information that is rarely discussed in quarterly earnings results. You’ll only find it in company presentations. Historical discussions that take a longer term view are especially common when a company goes public or is spun-off. So, an IPO or spin-off document is kind of the opposite of a quarterly earnings call transcript.


Why Read the Proxy Statement?

This will be the DEF14A on EDGAR. I read this just for background information on management, to understand how much control big shareholders have over the company, and to see how management is compensated.

So, I’m looking for: 1) Who the managers are 2) Who the owners are and 3) How the owners choose to compensate the managers. Incentives are part of what I’m looking for here.

For example, Grainger (GWW) has a passage in the latest DEF14A that reads:

“The 2016 Company Management Incentive Program (MIP) payout was calculated at 75% of target for all eligible employees as the Company fell short of the 2016 sales growth goal of 5.5% and the ROIC goal of 26.6%.”

So, we see that Grainger incentivizes management to hit two targets: 1) A sales growth goal and 2) A return on capital goal. The sales growth goal is modest. In a normal year, nominal GDP growth in the U.S. might be in the 4% to 6% range. So, a 5.5% sales growth target is close to a GDP type growth rate. And then the return on capital goal is aggressive. A 26.6% return on capital before taxes translates into about a 17% unleveraged return on equity. A business like Grainger can use some leverage. So, this return on capital target – if achieved – would tend to deliver a 20% or better after-tax return on equity for Grainger shareholders. There are more details about how incentive compensation is paid (in what form and when) as well as if it’s capped at some level. But, what I’ve discussed above is one of the most important parts of the proxy statement. Look for the metrics management is judged on for compensation purposes. And also look at what the specific target levels are for those metrics.

Finally, you also want to look at the ownership structure of the company. For example, the Under Armour (UA) proxy statement – this is the DEF14A – tells you that the CEO, Kevin Plank, is also the company’s founder. It tells you he has a 15% economic interest in the company and a 65% voting interest. It also tells you he’s 44 years old. Founders often make it to a retirement age of 65 or beyond. So, you this tells you that – since he has voting control of the company – Under Armour’s founder might lead the company for another 20 years or more. Minority shareholders have no say in the company, because the CEO has more than 50% of all votes. Also, we know the CEO owns about 15% of the company and UA has a market cap of around $8 billion. So, he has maybe $1.2 billion or so of his net worth in the company’s stock. His total compensation was usually in the $2 million to $4 million range over each of the last 3 years (that kind of information can be found in this same proxy). So, the performance of Under Armour stock is something like 300 times more important to Plank than his own pay. So, the proxy statement has told us: 1) This is a controlled company – your votes don’t matter 2) The company may have another 20 years to go in its founder led era and 3) The CEO’s overriding incentive is getting the best possible growth in the stock price over time.

A lot of people skip the proxy statement. But, the points I just made about Under Armour are huge. You could have another 20 years of the company being run by a founder who is something like 99% compensated as a permanent owner.

And that founder has voting control – so your votes don’t matter. Under Armour has 3 classes of stock. You can buy two of those classes. The two classes you can buy have identical economic rights but one comes with voting power and one comes with no votes. The shares with the “UAA” ticker cost $19.10 and have one vote each. The shares with the “UA” ticker cost $17.86 and have zero votes each. The proxy tells us your vote can’t matter in either case. So, you should buy “UA” shares not “UAA” shares and save yourself more than 6% of the purchase price. See, reading that proxy just made you 6% smarter. That’s why you should always read the proxy statement. You want to know: who the owners are, who the managers are, how everyone is compensated, and which class of stock is the better buy.


Why Read the 10-Q?

The more you know about accounting, the more you’ll get out of the 10-Q. The 10-Q is useful because it has the exact number of shares outstanding on the front of it (and, of course, this figure will be more recent than the 10-K in 3 out of 4 quarters of the year). You will want to study the balance sheet. And you’ll want to read the footnotes to the financial statements. A lot of the value in the 10-K and 10-Q comes from reading about how the company accounts for everything in the financial statements. What is amortization made up of? How quickly are they depreciating various assets? How long have they had certain assets – like land – on the books? Do they lease or own all their property? If you’re more of a Ben Graham type investor than Phil Fisher type investor – you’ll get more out of the 10-Q. Honestly, a long-term growth investor isn’t going to find anything in the last quarter to change his mind about a company. As far as sales and earnings go, it’s not necessary to check in more than once a year with the stocks you own. I’ll look at a 10-Q or even read an earnings call transcript or two if there’s been a big drop in the stock and I want to understand if the reaction from investors is appropriate given some change in the company. For example, Under Armour’s stock dropped a lot after an earnings report. The company’s sales growth has decelerated from more than 20% a year to closer to 10% a year (which is about what management is now guiding for in fiscal 2017). Recently, sales actually dropped about 1% in the U.S. So, you can read the 10-Q for Under Armour along with checking the 10-Qs of competitors like Nike (NKE) and key customers like Dick’s Sporting Goods (DKS) to try to understand exactly why sales and earnings disappointed investors, what the problem is, and whether or not it’s temporary. Other than that kind of analysis of a very recent event – the 10-Q is most useful for giving you an up to date balance sheet.

So, those are the first 8 things I look at when researching a stock. They aren’t necessarily the most important 8 things to look at. But, they are easy enough to find and important enough to give you a good foundation for understanding the business even if you never read anything else.

(Focused Compounding)