With The Avid Hog relaunching as Singular Diligence, I thought now would be a good time to revisit a post I wrote when Quan and I first started this newsletter. What follows is a re-post of “(All) My Thoughts on The Avid Hog” which appeared on October 5th, 2013 on this blog.
But first let me explain why The Avid Hog has become Singular Diligence and what it means.
Reasons for the Relaunch
There is no change in content between The Avid Hog and Singular Diligence. The two newsletters are exactly the same and Quan and I prepare issues of Singular Diligence exactly the same way we prepared issues of The Avid Hog.
There are 5 differences:
The addition of Toby Carlisle of Greenbackd as our publisher
A new website at SingularDiligence.com
The interface at Marketfy
The name change from The Avid Hog (which Quan and I picked out based on Jim Collins’s use of the “hedgehog principle” in “Good to Great”) to Singular Diligence should make it clearer what the newsletter is about. It’s 12,000 words about one stock. The one stock is the singular part. The 12,000 words is the diligence part.
The look is just a change in the design from a landscape format newsletter that separated its 9 sections into individual pages presented like the interior pages of a daily newspaper to a more traditional electronic newsletter format.
Toby Carlisle is our new publisher. He writes the blog Greenbackd. He is also the co-author of Quantitative Value and the author of Deep Value. The blog and both of his books are good. And as a value investor he’s a good fit with the existing team made up of me and Quan.
The website at SingularDiligence.com is professionally designed and looks it. I designed the website for The Avid Hog. And it definitely looked it.
The interface at Marketfy will allow Toby to put up content more frequently. Marketfy is better equipped to process payments and handle customer service than we were.
Those are the only differences. Everything else is the same. And Singular Diligence is certainly the spiritual successor to The Avid Hog.
So, to learn the spirit in which Quan and I created The Avid Hog let’s go back to October 2013 and my post: “(All) My Thoughts On The Avid Hog”…
(All) My Thoughts On The Avid Hog
This post is going to be all about the new newsletter Quan and I just started. So, if a paid newsletter isn’t something you’re looking for right now – this post is going to be pretty boring for you.
It’s also going to be pretty long. I have a lot to say about The Avid Hog. I know most readers of the blog aren’t interested in ever paying $100 a month for any product. So, I don’t want to clog up the blog with a lot of little posts about the newsletter. Here’s one big one. If you’re not interested, skip it. Regularly scheduled (non-promotional) content will resume next week.
Quan and I have been working on The Avid Hog for over a year. I’m here in the United States (in Texas). Quan is back in Vietnam. He went to school in the U.S. And we started work on The Avid Hog in person while he was still living over here just after his graduation.
Quan moved back to Vietnam. But that did not end preparations for The Avid Hog. Today, we do everything by email, Skype, etc. The only difficulty is the time difference. It’s exactly 12 hours. It’s midnight in Hanoi when it’s noon in Dallas and vice versa. This make picking Skype times interesting.
The Avid Hog is an unusual newsletter for a few reasons. The biggest reason is that it’s a product of two people. All the decisions about what stocks we start research on, what stocks make the cut and get a full investigation, and what stock makes it into the next issue – these are all decisions we make together.
It’s easier than you might think. Quan and I don’t disagree on a lot about stocks. This is both a plus and a minus. The plus is that it makes it easier to produce The Avid Hog. The minus is that anything I badly misjudge is something Quan’s likely to misjudge too. We are not very good at catching each other’s mistakes. We are too similar in our thinking about stocks for that.
What is our thinking about stocks?
Officially, the label would be “value investor”. But that’s a rather wide tent. And we tend to be pretty far over on the quality side of things. If we’re going to compromise on quality or price, it’s always going to be price. I think we both tend to agree with Ben Graham. The biggest danger for investors isn’t usually paying too high a price for a high quality business. It’s paying too high a price for a second rate business.
The model business we like would be something like See’s Candies. Read Warren Buffett’s 2007 letter. There’s a section in it called “Businesses – The Great, The Good, and The Gruesome”. See’s is given as the example of a great business.
If you read that section carefully, you’ll understand what I mean when I say See’s is the kind of business Quan and I like. Buffett mentions that See’s uses very little net tangible assets – this is a big focus for Quan and me – and that it has a huge share of industry profits. He also mentions that unit volume – pounds of chocolate sold – rarely increases. And that there has been at least as much exiting from this industry as entering it. Basically, it’s a settled industry.
You might think that a fast growing business would attract us. Historically, that has not been the case. I doubt it will be the case very often in the future. There are several reasons for this.
One, fast growing industries are by definition less settled. For an industry to grow unit volume, it generally has to be growing the number of customers. Customer growth is always disruptive because the easiest way for a new entrant to gain ground is with new customers.
There are businesses that experience some constant unit growth without much customer growth. Obvious examples are businesses where you are charging your customers based on the amount of work you are doing for them. An ad agency can grow its top line without adding net new clients if those clients increase spending every year on average. FICO (FICO) can grow sales without adding customers – which is good, because just about everyone who could be a client of FICO’s already is – if their frequency of using a FICO score increases. The company in our September issue also fits this model. They aren’t going to grow their customer list. They will do a little more for the same customers each year. And they will charge a little more for everything they do. But that’s about it.
Those tend to be the businesses we like, because we are often focused on the idea of a “profit pool”. I’ve mentioned Chris Zook’s books on the blog before. I recommend all of them. They touch on a subject that is the key to long-term investing. How does a business gain a large share of an industry’s total profits? How does it keep that share year after year?
You aren’t going to find Apple (AAPL) in The Avid Hog. I suppose I can’t swear to that. But I pretty much can. Even if Quan liked the stock – even if it was a lot cheaper – I’d still veto the idea. The reason has to do with these ideas of market leadership and “profit pool”.
If you pick a moment in time and a product category – any product category – in consumer electronics, you can come up with a leaderboard of companies. You can choose the top 3 companies, top 5, top 10. Whatever you want. Often, if the industry involves worldwide competition – not a whole lot of companies beyond the top 3 will be making money.
But let’s put aside profits. Let’s just look at market share. Take any consumer electronic device (radio, microwave, TV, watch, game console, cell phone, etc.). Look at the leaderboard. Then fast forward 5 years, 10 years, 15 years. Check it again. How many names stayed the same? How many changed? How many are in totally different countries?
That’s not the kind of business we want to invest in. I recently did a podcast about Addressograph as of 1966. Everything looked pretty good. The stock traded at about 20 times earnings. Over the previous 10 years, it had traded at 20 to 40 times earnings on average. In about 15 years, it was bankrupt. That’s a tough business to buy and hold.
Most of Addressograph’s big competitors – including Xerox (XRX), IBM (IBM), and Kodak – had their own problems later on. Many exited those businesses. New companies – often foreign – gained a lot of share. And prices came down a lot.
This last part is hard to emphasize enough. I’ll be doing an information post soon to prepare you guys for the next Blind Stock Valuation Podcast. As part of that post, I’ll be including the retail price of watches a mystery company sold in 1966. I’ll also be giving you the inflation adjusted prices for those watches. In other words, what those 1966 watch prices would be in 2013 dollars.
Whatever you think watch prices were in 1966 – they were higher. Of the four brands this company made their middle of the road brand – the big seller – retailed for an inflation adjusted price of about $380. The fully electronic watches – remember, this was the 1960s – sold for $800 to $17,000 in today’s money.
Unless you are assured of future domination of a growing industry, you generally don’t want the real price of your product to fall by 80% or so. Quan and I have looked at a couple deflationary businesses we liked. In both cases, the company we looked at had the highest market share, the lowest costs, and was around since basically the time the industry started. So far, neither company – they’re Western Union (WU) and Carnival (CCL) – is slated to appear in The Avid Hog. In the case of Western Union, the durability of the business – not their moat relative to competitors – is an open question. Basically, the internet is opening up a lot of different possibilities for how Western Union’s niche could be ruined by more general payment solutions. Some of the things that are really necessary and really hard to do right now (mostly on the receive side in countries emigrants leave) may be easier hurdles to clear in the future. Maybe not. We’ll see. But the situation is less clear than it was a few years ago.
Carnival can’t control the price of oil. It’s a big input cost for them. If oil prices drop and stay down, Carnival will turn out well as an investment. If they don’t, it’s very possible the stock won’t do well at all. And, of course, oil prices could rise. It’s a lot less certain than the investment we want to make. So, for now, it’s not near the top of the list of Avid Hog candidates.
These two companies – and their uncertain futures – illustrate what The Avid Hog is all about. And it’s important potential subscribers know this. The Avid Hog isn’t exactly a newsletter with stock analysis. It’s really a business analysis newsletter. Those businesses happen to be publicly traded. And we happen to appraise the equity value – not just the enterprise value – at which the business would be attractive. But it’s a really unusual newsletter. We aren’t looking for reasons for the stock to go up over the next few months or few years. We’re looking for a business we think is one you’d want to hold. And we’re looking for an acceptable price to buy it at.
This is where the oddity of the partnership between Quan and me is most evident. I said we were value investors. That’s true. But I doubt many of the stocks you hear value investors talk about this year are going to make it into The Avid Hog.
For one thing, we really do adhere to Ben Graham’s Mr. Market metaphor. The stock we picked for the September issue wasn’t far from its all-time highs. I said before I think it was within about 10% to 15% or so of its all-time highest price. We’re fine with that. We thought it was a bargain regardless of where it had been priced in the past.
The question we ask is whether we’d buy the whole business for the enterprise value at which it’s being offered. That’s another point subscribers need to be warned about. I’m a little more dogmatic on this one than Quan is. But we both take it pretty seriously.
We appraise the business. We compare the value of the business – as we appraised it – to the value of the company’s entire capital structure. We know these are intended to be buy and hold investments. So we don’t assume we know what the capital structure will be when you sell the stock.
As a rule, we want subscribers to enter any stock we pick knowing – absolutely for sure – that they aren’t going to sell for 3 years. We are very serious about this point. The kind of (business) analysis we do isn’t something that can be expected to pay off in a matter of months or even a matter of a couple years.
If you think about what we are doing – analyzing the durability of a company’s cash flows, counting up those pre-tax cash flows, and then comparing them to the cost of buying all of a company’s debt and equity – it’s not that different from how a private equity buyer would look at a stock. They wouldn’t expect a return in less than 3 years. They might expect it to take quite a bit longer than that. So do we.
That’s a little unusual for a newsletter. But I don’t think it should be that unusual to the folks reading this blog. The idea that you can pick the right business to buy, pick the right price to pay, and pick the right time to make your profit – we’re not sure you can do more than 2 out of 3 there.
A lot of our time preparing The Avid Hog for launch over this last year (actually a little more than a year now) was spent on “the checklist”.
Checklists are very popular with value investors these days. So, I’m a little wary of the term. I’ll use it here as a name for a list of key ideas we always want to discuss. By key I definitely mean no more than 10. Right now, there are 7 sections we consider important enough to include in every issue:
4. Capital Allocation
This is hardly a novel list. Everybody has read Warren Buffett. Everybody knows you look for a good business with a durable product and a wide moat. Those are our top 3 concerns. They are probably the top 3 concerns of many value investors.
We diverge a little with many value investors – though probably not Buffett – in putting “Capital Allocation” at number 4. This list is in order of importance. Basically, failing a section near the top will kill an idea faster than failing a section near the bottom. There is one exception: “Misjudgment”. It’s at the bottom not because it’s unimportant – it’s the most important topic. It’s at the bottom because we can’t know what we don’t know until we know what we know. So, it’s always the last question we answer.
Capital allocation is ranked ahead of value and growth. I would guess almost every other value investor would put value ahead of capital allocation. And quite a few would put growth ahead of capital allocation.
We obviously think capital allocation is more important than most investors do. It can be a difficult area to judge, because we have to use past behavior and present day comments to predict future actions. The human element is particularly large in capital allocation. So, it tends to be viewed as a squishier subject.
Over time, I’ve learned that capital allocation is a lot more important than I thought it was. And I started investing believing capital allocation was a lot more important than most investors think it is. I’ve become more extreme in my views on capital allocation. This colors our candidates for The Avid Hog a bit. It tends to eliminate tech companies. Even when we can judge their future business prospects – we can rarely predict which businesses they will choose to be in. It is one thing to analyze Google (GOOG) as a search engine. It’s another thing entirely to analyze Google as a company. The reason for that is capital allocation. It’s not enough to know how much cash a company will produce. We also need to know what value that cash will have when it is put to another use. At some companies, those uses are fairly limited and we can guess that a dollar of retained owner earnings will add at least a dollar of market value to the stock over time. At other companies, we can’t do that.
Capital allocation is especially important in buy and hold investing. If you are right about a company’s quality, the durability of its cash flows, and how it will allocate its capital – you don’t really need to be right about anything else. That’s usually enough to tell a good buy and hold investment from a bad one. It may not be enough to find the very best investment – value often plays a bigger role in determining your annual returns (especially how quickly you’ll make your money). But getting quality, durability, and capital allocation right will often be enough to know you’ll earn an adequate return.
What is an adequate return?
This is a critical question for any subscriber to The Avid Hog. Our newsletter costs $100 a month. That’s $1,200 a year. So, there’s no point in subscribing unless you can make more than $1,200 a year based on the content of that newsletter.
We’re not promising anything. Nobody does that. But we’re not even aiming that high. I don’t think it’s realistic to assume any newsletter that serves up 12 ideas a year – that’s a lot more than either Quan or I invest in each year – can do much more than about 10% a year.
We try to limit our picks to stocks that should return at least 10% a year if bought and held. The second part is key. Maybe you can make more money flipping them in a year. But, some will obviously decline in price over just one year. So, that’s not a good way to judge the value The Avid Hog can provide to subscribers.
The only way to judge that is to look at a holding period of at least 3 years. Do we think we can pick ideas that will return 11% a year over 3 years?
That sounds like a good goal to me. Don’t subscribe to The Avid Hog if you’re looking for more than that. I’m sure you can do better than 11% a year by focusing on the very best of the 12 ideas. That’s what I always do when investing my own money. And that’s what I’d recommend to the folks who can stomach a more concentrated portfolio.
But a list of 12 stocks is pretty diversified. And it’s not easy to do much better than 11% a year if you’re not concentrating. I don’t think anyone should expect better than 11% a year from any newsletter – and certainly not from The Avid Hog.
So, who is the newsletter for then? Is it for institutional investors or individual investors?
There’s no price difference. It’s $100 a month regardless of what you use it for. We know the majority of our subscribers – right now – are either current or former employees of investment firms. Of course, that doesn’t mean they plan to use The Avid Hog professionally. They have personal portfolios. Again, we don’t ask what subscribers do with the information we provide.
The price tag is a bit of a hurdle for individual investors. But I think the content is a bigger hurdle. The Avid Hog runs about 12,000 words. The first issue had 21 years of financial data in it. Not a lot of folks without some sort of analyst background are going to be interested in spending that much time with that much information about one company.
It’s not a breezy read. And it is extremely focused on just one company. So, it’s meant for a limited audience of equally focused investors. You have to like spending half an hour to an hour focused entirely on one company. If you read every line of The Avid Hog – and I certainly hope you do – you’ll probably need to spend 25 to 50 minutes with the issue. That’s at a normal reading speed. Some people read a little faster or slower than that. Most don’t. So the issue isn’t even something you can consume in less than the time it takes to watch a TV show. If you’re a fast reader, it’ll go by in about the time it takes to watch a sitcom. If you’re a slow reader, it’ll run about as long as an hour long drama. There are also charts and graphs, a bit of arithmetic here and there, etc. We hope you’ll linger with the issue longer than the absolute minimum time it takes to read the issue. But even that is on the long side for a lot of people. A lot of newsletters probably read faster than The Avid Hog. And, of course, most of them cover more stocks. So, you’re committing to a lot of time focused on one stock when you sit down with The Avid Hog.
This is really the whole point of the newsletter. Quan and I – when investing our own money – naturally do this. We focus for weeks at a time on one stock. It’s how we work. And it’s always been how we worked. I don’t know another method of analysis that works as well as really investigating a stock over a couple weeks.
The Avid Hog is really the product of a month of two people looking at one stock. This is something we always did. But it’s not something we saw a lot of people selling. There may be a good reason for that. Maybe the market for newsletters is a market for shorter, more varied reports. Since we’re focus investors – we wouldn’t be able to write those.
The basic idea of The Avid Hog is to provide you with the info we use when making an investment decision. We don’t do a perfect job of that. There was a ton of information we had on the company in our September issue that didn’t make it into the final issue. But, we didn’t get a lot of people asking for more information than we provided. A few suggested a little less would have sufficed.
Over time, I hope this is something we get better at. As an investor, you have a relationship with a business – a familiarity – that goes far beyond anything you can easily convey to a reader. This is a constant problem. It’s the one we are trying to overcome. But it’s still a very tough problem to solve. You can bet that we have a higher degree of confidence in any stock we pick than our readers will after reading an issue.
It shouldn’t be that way. We should be able to communicate our thoughts and analysis in such a clear way that everything we learned about a company can be as convincing – as great an aid to understanding – as when we finally digested it in our own heads. It never works out that way. Something is always lost in translation. And I’m afraid that conviction is a hard thing to express when your reasons for it are simple but also based on an accumulation of evidence from a lot of different sources that you’ve gather up over a month or so.
So, we’re still not perfect at getting across to readers everything we know. But that’s the point of The Avid Hog. We take a month to gather up everything we think is relevant. And then we present it to you. If you don’t have enough information to make an investment decision after reading the issue – then we’ve clearly failed.
One of my biggest concerns is how people will use The Avid Hog. Let’s look at a quick example of the math needed to make a subscription work.
If The Avid Hog can improve your results by 3% a year and you have a $50,000 portfolio – it works. Once the numbers are less favorable than that (we can’t improve your results by at least 3% a year, or your portfolio is less than $50,000) the math just doesn’t add up. It’s not worth the subscription price unless you can get a 3% annual increase and/or you have a portfolio of $50,000 or more.
That’s because a subscription is $1,200 a year. And 3% of $50,000 is $1,500. You can do the math on what kind of advantage The Avid Hog would need to provide your portfolio to make it worth subscribing. At $25,000, you’d need a 6% annual lift from our picks. That’s tough. Too tough in my opinion. So, I’d say folks with a portfolio of $25,000 simply can’t pay the $100 a month needed to become a subscriber. It’s not worth it for them.
On a $100,000 portfolio, just a 1.5% advantage would make the subscription pay for itself. I don’t think there are many people with a portfolio of $100,000 or more who wouldn’t come out ahead subscribing to The Avid Hog. But I’m biased. I think – if you act on our picks – you can make 1.5% more a year.
There is one other area that should be a big benefit. In fact, for some folks, this secondary benefit should more than pay for a year’s subscription to The Avid Hog.
It’s taxes. I’ll just talk about the U.S. here because I know the tax rules. Some people reading this have short-term capital gains in many years. This is very tax inefficient. At times, it can’t be avoided. I had a company bought out a few years ago. Most of my purchases were made within one year of the consummation of that buyout. So, I couldn’t avoid a short-term capital gain.
That’s not an awful position to be in. Only having short-term capital gains in the event of a buyout usually means you at least still end up with a high annual return after-taxes.
As a general rule, American investors need to avoid any short-term capital gains. I can’t think of many situations where you could actually demonstrate the benefit of selling before one year of purchase convincingly enough to make me recommend a sale within one year.
And yet, some people do it. Some people – even some value investors – end up with short-term capital gains.
The minimum intended time frame for any Avid Hog pick is always 3 years. We never want to see a subscriber sell before 3 years are up. They will. We know they will. And we know there’s nothing we can do about it. But, we also know there is at least a strong tax incentive for them to keep a winner for more than one year.
There’s, unfortunately, an incentive to sell a loser within one year as well. We don’t think the incentive there is strong enough to offset the likelihood that selling a pick – at a loss – within just one year is a really, really bad idea.
We can’t tell subscribers how long to hold their stocks. I mean, we can – and we do. We say 3 years at an absolute minimum. And we’ll keep saying that.
But the truth is that the value of our picks is in how you use them. If you have a portfolio of $50,000 or more and you really do devote it to just picks from The Avid Hog and you really do hold each stock for at least 3 years – I’m confident you’ll get more than $1,200 a year out of our newsletter. Honestly, I’m not very confident subscribers will do all those things I just said. I’m not sure the implementation will always be ideal in practice. But you know yourself. And you know if it would be in your case.
So, in theory, the tax savings from moving to a 100% buy and hold approach should be enough to justify a subscription to The Avid Hog for those who have fairly large portfolios and some short-term capital gains. Again, you can do the math on your own portfolio. But moving $7,000 a year from short-term capital gains to long-term capital gains would more than pay for a subscription for investors in the top three U.S. tax brackets.
Of course, you don’t need to subscribe to The Avid Hog to turn short-term capital gains into long-term capital gains. You just need to commit to a buy and hold approach. You can do that on your own. Or you can do it with The Avid Hog.
We hope that subscribers will get some additional lift – some extra value each year – from moving more of their capital gains into the long-term variety. Even if there was no tax advantage in doing so, we’d always want to have subscribers holding for the long-term.
The other benefits of The Avid Hog are less tangible.
The first is simplification. We want to simplify and focus the investing lives of our subscribers. We want to encourage them to turn off CNBC and Bloomberg, put down the Wall Street Journal and The Financial Times – and focus on one business at a time. We’re only asking for about an hour of their time once a month. But we hope that will be focused time.
That’s the word we like best when talking about The Avid Hog: focus. We certainly focus on a specific checklist, on a single stock, etc. We go into greater depth instead of giving you a lot of breadth. That is all fairly obvious in the issues. If you haven’t sampled an issue yet, you can email Subscriber Services and ask for one. There will be an email address at the bottom of this post.
Quan and I don’t want that to be the only focus though. We don’t want The Avid Hog to be only about the two of us focusing on a stock. What we really want is for The Avid Hog to be an oasis of focus in your investment life. We know that anyone who subscribes to The Avid Hog has a less simplified investment life than they’d like. They certainly have a less focused investment life than is ideal for achieving the best long-term returns.
We would like to create a product that – once a month – gives readers the opportunity to forget there are other stocks out there. To forget there is a market. And just to focus on a single business and a single price. It’s a handpicked business and price. So we think it’s an attractive one. But, even if you don’t agree, we hope that hour or so you spend with us each month will be – minute for minute – the best time of your investing month. We hope more than anything that it will be the most focused. It will come closest to the Mr. Market ideal of seeing a quote and using it to serve you rather than guide you.
We know a lot of the folks who will subscribe to The Avid Hog will not be living exactly the investment life they aspire too. They are value investors. And their life situation – often their job at an investment firm – will put certain demands on them that lead them further from the ideals described by Buffett and Graham than they would like.
More than anything, we know they feel overwhelmed. We know they feel like they consume a lot of noise. And don’t get to spend enough time on the stuff that really matters.
We hope paying $100 for an issue will be incentive enough for them to block out a time that they can spend with just one stock.
This is how Quan and I spend virtually all our time. It’s how many great investors spend their time. And it’s really how individual investors should be spending their time too.
But the world isn’t designed to accommodate that kind of focus. Almost every form of financial media is going to bombard you with a lot more breadth than depth.
We’re trying to flip that around for about an hour a month for our subscribers. That’s the thing Quan and I are most interested in doing for subscribers. We’d like to create an environment where they can focus. We’d like to make them feel we’ve simplified their investment life.
Of course, that’s not something we can do alone. Like the matters of returns and taxes – focus isn’t something we can guarantee for subscribers. It’s something they have to work as hard receiving as we do on giving. So it’s an uncertain benefit of The Avid Hog. But it’s the one I’m most hopeful we can provide. It’s the one I think is actually most valuable. If we can provide our subscribers with an hour of intense focus each month, I think we’ll have provided good value for the $100 a month price we charge.
I don’t know how many subscribers will focus on the issue the way we hope. It’s one thing to invest $100 of your money. It’s another to invest an hour of your total focus. For many people, the latter is actually the harder one to give.
Speaking of focus, the focus of The Avid Hog on above average businesses should provide an added benefit for subscribers. It should give them a list of companies they can revisit in later years – even if they don’t buy the stock today.
We don’t sell individual issues of The Avid Hog. All subscriptions are billed monthly at $100. So, from that perspective, it’s like every issue is sold separately. But we don’t like to think of it that way. We like to think of The Avid Hog as being as much about the process as the product.
In a year, we’ll publish 12 issues. As I mentioned, each issue is about 12,000 words. So, you can do the math and see you’re basically reading a book or two a year with The Avid Hog.
We like to think of The Avid Hog more like that. We like to imagine that you are getting 12 chapters you can use later even if you don’t put them to use now. Quan and I certainly won’t put our money into 12 stocks a year. We tend to be more of the “one idea a year is plenty” type investors. A lot of subscribers will want to diversify more. But plenty will still decide to pass on some of our picks.
We hope that doesn’t mean they pass on the businesses. Knowledge of a good business has a certain permanence to it. Or at least it has a longer shelf life than a lot of what you know about investing.
The Avid Hog doesn’t revisit past picks. But we hope subscribers will. We hope that when an above average business we profiled earlier plunges in price, some of our subscribers will be ready to jump in. We hope you’ll be able to build up a personal database of above average businesses. We’ll discuss them at the rate of 12 a year. That should provide a pretty good shopping list in the next market downturn.
That brings me to the market. And to a point I haven’t stressed enough yet. The Avid Hog is not meant to outperform the market. We hope we’ll do that. We expect to do that. But we don’t aim to do that. Quan and I don’t try to beat the market. We just try to find the best above average business trading at a below average price this month. And repeat that every month.
We believe that process will – over time – beat the market. But, we also believe it will underperform in great years for the market. It’ll outperform in some very bad years. But neither will be the result of our actually trying to beat the market in the bad years or holding back in some way in the good years.
The process will always be the same. The relative results will vary because the S&P 500’s returns will vary. And because the opportunities the market serves up will vary.
We don’t target relative results. We think we can – long-term – get good relative results without worrying about them. That has always been my personal experience. But a lot of newsletters – and some investors – do focus on relative results. So it’s important that anyone thinking about subscribing to The Avid Hog knows that we do not – and we never will – target relative results.
What do we target?
My number one focus is always the margin of safety. If there’s no margin of safety, you can’t buy the stock. How big is the right margin of safety?
That’s up to you. Valuing a stock is as much art as science. Exact appraisals vary a bit. On the last page of each issue of The Avid Hog, we print an exact (dollar and cents) appraisal of the company’s shares. We actually write “Company Name (Ticker Symbol): $46.36 a share” or whatever. We’re that precise.
That can be misleading if you don’t see the appraisal in the context of the other stuff on that page.
So, the last page of each issue is called the “appraisal” page. It has a calculation of “owner earnings”. It has an appraisal of the value of each share (using a multiple of owner earnings). And it has a margin of safety measurement. It also presents some data and how the current stock price – and our appraised price – compare to the market prices of some public peers.
I want to focus on the owner earnings calculation, the appraisal, and the margin of safety.
You probably know the term “owner earnings”. If you don’t, you can read the appendix to Warren Buffett’s 1986 letter to shareholders. We use the basic approach he does. We basically want to count pre-tax cash flow. We use pre-tax numbers because we always value a business independent of its capital structure. Only after we’ve settled on a “business value” do we compare that value to the debt and equity of the company. This is pretty typical stuff for a lot of value investors. Like I said, we’re a bit more dogmatic – at least I am, I won’t speak for Quan here – about using capitalization independent (unleveraged) numbers and about using cash flow rather than reported earnings.
It’s very important to mention how unconventional we are here. You should never pick up The Avid Hog expecting to be told about a company’s EPS. We don’t do earnings per share. We don’t talk about earnings per share. I don’t mean we discuss it as one of many things. I mean we literally don’t spend a second on EPS. Whether a company will or won’t be able to report earnings doesn’t mean anything to us as long as the company will be able to harvest that cash flow.
This attitude pervades everything in The Avid Hog. So it’s important that you know ahead of time that reported earnings will never, ever be discussed. I know EPS is a relevant number in a lot of the financial media. It is irrelevant for us. And we never discuss it. Likewise, we tend to discuss prices in relation to enterprise value rather than market cap. We do move on to valuing the equity after comparing the company’s debt to its business value. But we really don’t do P/E ratios at all.
For some subscribers, it’s a bit of an adjustment to only think in terms of enterprise value and owner earnings rather than EPS and P/E ratios. But it’s the only approach that makes sense to us. And Quan and I don’t do anything halfway. We don’t compromise on this point. In a lot of issues, you’re literally going to get 12,000 words without a single mention of EPS. I know that’s unconventional. A lot of The Avid Hog is unconventional in this sort of ways. We present the stuff we think matters. We don’t present information that is customary but ultimately irrelevant.
So we do our little owner earnings calculation. We present it item by item. So, you’ll see items adjusting for non-cash charges, for pension expense, for restructuring, for cash received but not reported (yet) as revenue, and so on. We do it as a reconciliation of reported operating income to owner earnings. Think of it like a statement of cash flows. It’s the same basic idea.
Sometimes there’s very little to reconcile. Right now, it looks like the stock in the October issue has similar owner earnings to reported operating income. Not a lot of big changes.
If you read the September issue, you know the company in that issue has owner earnings that are a lot higher than reported operating income. Again, we don’t care even a little bit about reported operating income. You can see the reconciliation yourself. And you may be inclined to trust reported operating income more than our estimate of owner earnings.
Personally, I think you’d be very, very wrong to do that. But the information is there for you. You can quibble with us line by line. We put every item right there on the page. So, if we count something as earnings that you wouldn’t – go ahead and make your own adjustment.
Everyone’s appraisal of a company’s intrinsic value differs a little. Even Quan and I – who’ve been looking at the same facts and talking about the stock for a month or so – come up with slightly different intrinsic values for the same stock. For the September issue, I think my intrinsic value estimate would be a bit higher than Quan’s. That won’t be true for the October issue. Where we have significantly different methods, we show you both. Generally, we go with the most conservative method that we still consider reasonable. We don’t use unreasonably conservative appraisals. The conservatism should come through insisting on a margin of safety – not through making an unreasonably low appraisal of the stock. But, when in doubt, we err on the side of conservatism. The price printed in the September issue is lower than the appraisal I would put on a share of that stock. If you offered to buy the stock from me at that price, I would turn you down. Logically, if I would reject your offer at that price, that means I’d appraise the stock higher. So, the appraisal in the September issue is lower than what I would have come up with privately. But it’s a number I’m comfortable having out their publicly. That’s what I mean when I say we err on the side of conservatism. We aren’t going to print an appraisal I think makes no sense. But we will print an appraisal that’s on the low side of what I think makes sense. The same goes for Quan. In the case of the September issue, I would’ve been the one arguing for a higher appraisal. In future months, I’m sure our positions will be reversed.
We’re not the Supreme Court. We don’t print dissenting opinions. The figure you see is always a consensus agreed upon by the both of us.
As I said earlier, The Avid Hog is as much about the process as the product. That’s why Quan and I spent a year perfecting the process.
Our process for the appraisal page has been standardized by now. It will be the same in each issue. We calculate owner earnings. Then we come up with a fair multiple of owner earnings. We apply the multiply. We then compare Owner Earnings x Fair Multiple = Business Value to the enterprise value of the company. The excess of business value over the company’s debt is used to calculate the equity value. And, of course, the equity value divided by fully diluted shares is how we get our appraisal price per share. We then measure the margin of safety.
The margin of safety confuses some people. It’s easy to understand if you look at the calculation we show. Basically, the margin of safety is always the percentage amount by which the business could be less valuable than we think. It is not a measure of the difference in stock price between our appraisal price and the market price. That would only occur in instances where the company had neither debt nor cash. In that case, an appraisal value of $70 a share and a market price of $50 a share would result in a 29% margin of safety ($70 - $50 = $20; $20 / $70 = 29%). That’s not normally how margin of safety works, because the company is less safe to the extent it has debt.
Let’s take our October issue – not yet released – as an example. It’s not finalized yet, but I can give you a pretty good idea of what the margin of safety on the stock is by our estimates. The stock trades for about 60% of our appraisal value. So, if it’s a $30 stock, we think it’s worth $50. That’s pretty simple. But the company has debt. So, in theory, the upside on the stock would be about 67% ($50 - $30 = $20; $20 / $30 = 67%). Quan and I don’t calculate the upside. So, that’s not a number you would ever see. It’s a number that reflects leverage. And leverage is only on your side if we are right in our estimate of that $50 (or whatever) appraisal.
The number we actually show you is very different. It’s how much the business value of the stock could decline and still be greater than all of the company’s debt and the price you paid for the stock. Imagine an example where a company has a $30 stock price, $10 of net debt per share, and a $50 business value per share appraisal from us. In that case, the margin of safety is only 20% ($50 - $40 = $10; $10 / $50 = 20%). And that’s the only number you would see. We would never mention the stock has a 20% margin of safety and a 67% upside. We would just talk about the 20% margin of safety.
Our reasoning on this goes back to Ben Graham. But it’s also consistent with what we want The Avid Hog to be. What we’re trying to do is come up with above average businesses at below average prices. We’re trying to do that regardless of how the market performs. So, our focus is not on the upside over the next couple years. Our focus is on getting subscribers in the best possible business to buy and hold and ensuring that there is a margin of safety that protects them from a permanent loss of principal. As long as the purchase price is justified, they will end up in a better than average business. That’s the part that should lead to good long-term returns. Our value calculation is really all about ensuring the presence of a margin of safety. This is the protection you get when you buy the stock. The quality of the company – and the durability of its cash flows and the moat around its business – is what ensures adequate returns over time.
This means we discuss value a bit less than most value investors do. We certainly discuss the upside implied by our valuation a lot less. We don’t make a big deal of paying $45 for a $70 stock. We make a big deal about getting in the right business at a suitable discount to what we think the entire business is worth.
For ease of illustration, I used per share values here. We tend to focus on the value of the entire business right up till the last step – where we divide by the diluted share count. So, we talk about a business being worth $5 billion and having an enterprise value of $3 billion rather than being worth $50 a share and trading for $30 a share. The per share intrinsic value is really only discussed once.
Like I said, different people will come up with different intrinsic values for the same stock. Quan and I discuss ours on the appraisal page. But we also provide the data subscribers need to make their own judgments. This starts on the datasheet. When you first open The Avid Hog – after seeing a cover page, it’s just a teaser drawing that hints at the business we’ll be discussing – you find a datasheet. The datasheet presents the numbers Quan and I care most about.
These are historical financials. The September issue went back pretty far. It had a total of 21 years of financial data. The company we chose has already reported its fiscal year 2013 results. And we had data for the company going back to 1993. Quan and I don’t have a target for how many years of financial data we give you. We simply print everything we use. Generally, we use everything we can get our hands on. In the current issue of The Avid Hog, that happens to be 21 years of data. Next month’s issue will have a lot less. Probably fewer than 15 years of data. The company hasn’t been public for that long. In any case, we’re confident we’ll be providing you with more historical financial data on the company than you’ve ever seen. It’s also probably more data than you can find on that company anywhere other than EDGAR. And EDGAR doesn’t put it into nice rows and columns for you. You have to go back and read the 1993 report for yourself.
What kinds of information do Quan and I care about? What’s in the datasheet?
Again, we’re unconventional in our approach. There is no mention of per share numbers. You won’t see anything about earnings per share, book value per share, etc. It looks a lot like a Value Line page. But that’s just the first impression. The actual numbers presented are quite different.
We focus on sales, gross profits, EBITDA, and EBIT. Balance sheet data is all about the numbers needed to calculate net tangible assets – which we do for you – so that’s receivables, inventory, PP&E, accounts payable, and accrued expenses. There’s also the issue of deferred revenue at some companies. We present the liability side together. It’s usually more important to look at receivables and inventories separately than to look at accounts payable and accrued expenses separately. So we break out the current assets by line. We don’t break out the current liabilities.
Quan and I care a lot about returns on capital. We especially care about returns on net tangible assets. So we provide all the info you need to make that calculation. That means we do margins (Gross Profit/Sales, EBIT/Sales, and EBITDA/Sales) as well as “turns”. We show you the turnover in the business’s receivables, inventory, PP&E, and – most importantly – its NTA. When you put the two numbers together – margins and turns – you get returns. We don’t just calculate EBIT returns. We also do gross returns and EBITDA returns. At some companies, EBITDA returns are quite important. Gross returns are rarely important in the short-term. But as mentioned in some journal articles, they are actually a good proxy for how profitable a business is. Basically, if a company’s gross returns are too low today, they’re likely to always have a problem earning a good return on capital. This is less true of things like EBIT/NTA. That’s a number that some companies can improve a lot by scaling up. But scaling up usually isn’t going to help enough if your Gross Profit/NTA is really low.
The first couple companies we’ll be profiling for you in The Avid Hog have essentially infinite returns on tangible assets. They don’t really use tangible assets. This makes the return figures less important. The turnover numbers are also less important. The margin data may be useful. Regardless of how useful the number is for the particular company, we always include it.
These calculations are done for every year where we can do them. In our September issue, I think we had full calculations of all lines for at least 19 years. Returns on capital can’t be calculated for the first year in a series because you don’t know what the average amount of capital was in a business until you have two balance sheets – a starting and ending one – to work from. We can – and do – obviously calculate margins for all years. So, the September issue had 21 years of gross margins, 21 years of EBITDA margins, and 21 years of operating margins.
Free cash flow data is not shown explicitly in the datasheet. But you can think of the datasheet as really being all about free cash flow. We calculate year-over-year growth numbers for all items. So, you can see – for example – that the company we chose in the September issue increased EBITDA by about 9% a year on average while NTA increased only 6% a year on average. I’m using median as the average here. We present minimum, maximum, median, mean and some variation numbers. If you use only one number – I’d use median. But it’s up to you. Anyway, you can see from the 3% a year difference in a cash flow number compared to NTA that the company will tend to always have higher free cash flow than reported income. This is because the amount of additional cash coming in is always exceeding the amount of growth in net assets. You can see this at a website like GuruFocus or Morningstar for the last 10 years (or whatever) by looking at free cash flow. But you can also see it in our 21 years (or whatever) of data that includes growth rates in NTA versus growth rates in sales, gross profits, EBITDA, and EBIT.
The biggest departures for our datasheet relative to what others like to show you is our focus on gross figures and our focus on net tangible assets. These aren’t the two most important numbers in the datasheet. But they are the two most important numbers you’ll see highlighted in The Avid Hog that you won’t have heard much about when studying the same stock using someone else’s data. This is just a matter of presentation. Everyone provides enough info for you to do these calculations yourself.
I suppose the biggest difference between our datasheet and the data you’ll get elsewhere is how far it goes back. I’m sure a lot of subscribers will doubt the importance of seeing 1990s era data in 2013. What importance could a company’s results in the 1990s have on its future in the 2010s?
It’s a logical sounding complaint. But it’s not supported by the facts. The length of time a company has been consistently profitable is a surprisingly good indicator of what future results will be. In fact, if you asked me for just one criterion to screen on it would be the number of consecutive years of profits. Most investors err badly by assuming that a company that has a couple losses in the last 10 to 15 years is fine because it’s made money now for 6 straight years or whatever. Making money for 20 straight years tells you a lot more than making money for 6 straight years.
There are economic cycles and industry cycles. Some can be short. But some can be long. The longest – something construction related like housing, shipbuilding, etc. – probably run in the 15 to 20 year length rather than the 5 to 10 year length. I’ve never felt that 5 to 10 years of data was sufficient to make a decision about a stock. I would hate to have to decide much of anything on less than 15 years of data. I do think it’s relevant that Apple today has nothing to do with Apple 15 years ago. And I think a company’s long-term financial results show you that.
Again, Quan and I are on the wrong side of convention here. But I think we’re on the same side as Warren Buffett. When he buys a company, he likes to see as many past years of data as they have. But he doesn’t want to see any projections for the future. We like a clear past and a clear future. But only one of those things is verifiably clear. The past actually happened. The future is merely a projection. We think investors could all benefit from seeing a lot more past data than they do now. And we hope that including so much past data in The Avid Hog – and we’ll always include every bit we’ve got – will convince others of the usefulness of that approach.
Now the past data is more useful the more you know about the past. So, it helps to know what were good and bad years for the industry – not just the company. It helps to know what was going on in the economy. We can’t provide you with all of that. But we hope you’ll linger over the datasheet. In fact, we hope you’ll print out the datasheet, carry it around with you, do some exploring of the past yourself. We also think the datasheet makes our explanation of the company’s history clearer. We can’t – in prose – get into the kind of detail we’d like to see on a company’s past. But we can discuss a few qualitative aspects in words. And then we can present the rest to you in numbers on that one datasheet.
The datasheet is another area where I think The Avid Hog offers a lot. But you’re only going to get a lot out of it if you put a lot into it. You can flip through the datasheet in a couple seconds. Or you can spend a lot of time with it. There is a lot to think about in that datasheet. And I hope that it’s an area subscribers won’t just linger on – I hope it’s actually one they’ll ponder. And maybe even go back to the next day. Having that much data would always be the foundation of any investigation of a company for me personally. That is where you start. You start with the numbers. You start with the patterns in them. And then you move to trying to explain those patterns and see which are likely to prove durable.
The datasheet is something that I really wanted to include, because it’s something I always want to see in reports – and never do. Whether I am reading a blog post about a stock, a newsletter, or an analyst report – I’m always eager to see more data than I’m given. That’s why Quan and I are including all the data we can on that datasheet. That’s why we’re going much further into the past than most reports do.
This brings me to the question of why we’re doing this. Why did Quan and I create a newsletter? And why did we create this particular newsletter?
At a $100 a month price tag, the obvious motivation would seem to be money. But when you consider the amount of work that goes into the newsletter – and the small potential audience for a newsletter that focuses in this kind of depth on just one stock – money is less of a motivating factor than you might think. We’d like to get to the point where we have enough subscribers to justify the labor cost. We’re nowhere near that level now. And I’m not sure we’ll ever get to that level. There aren’t a lot of products like The Avid Hog. There are other monthly newsletters that charge $100 a month (a little more, a little less). Some bill annually. We bill monthly. But there’s really not a big difference on those points. There are plenty of other newsletters that come out with a similar frequency (monthly) and charge a similar price ($100 an issue).
The difference is in the product itself. If you’ve sampled The Avid Hog, you know this. It doesn’t look like other newsletters. It looks like a collection of articles on one company. It lacks the variety of other newsletters. We think it makes up for it in focus.
But we’re biased on that point. And this is the real reason Quan and I created The Avid Hog. It’s what we love to do. We would be doing all the research that makes The Avid Hog possible whether or not we were publishing it. We like to spend our time focused on a single stock for a full month. Business analysis is the kind of analysis we like best. Coming up with a list of 10 or 20 ideas doesn’t appeal to us in the same way that focusing on one or two ideas does. It never has. And it never will.
So The Avid Hog is really about trying to do what we like best while making enough money to support the process. As you can imagine, the external costs associated with producing one issue of The Avid Hog are minimal. The cost of a month of creating The Avid Hog is basically $300 in some fixed costs plus the time Quan and I put into it.
There are good and bad sides to this. The good side is that we have almost no costs other than our time investment. This means we can stick with The Avid Hog when it would be – like now – not remotely financially viable because the subscriber count is too low. Through our dedication to the product, we can keep it going for many months when any rational publisher would shut it down.
That gives us the chance to grow an audience and ensure the long-term survival of The Avid Hog.
The downside to not having a lot of costs other than our labor is obviously the price. We’d love to be able to charge a lot less. But you can only do that with a lot of subscribers. Other sites have a much bigger platform – more of a megaphone – from which to announce their product. They have bigger distribution capabilities than we do. And so they will always have a much larger group of subscribers for any product they put out. It will be better for the good products than the not so good products. But even a lousy product put out on a big online platform will sell more copies than the best product we could ever produce.
I can tell you now, the price of The Avid Hog will not drop. I just don’t see anything in what we know about the potential audience size that would allow that to happen. You can run the numbers yourself – after having read a sample – and guess what you think the commitment of labor is to something like that. It’s not a one person product. So, it requires a good deal of revenue to put out a product like that. It doesn’t for the first few months. But that’s only because Quan and I are committed to not getting paid for a long time.
So that’s the good side and the bad side of the cost situation. The good side is that we are committed to working for free on The Avid Hog. And the product doesn’t require much ongoing investment other than our time. So we can keep the thing running. The bad side is that because we are appealing to a very small audience – it’s a very niche product – we are never going to be able to lower our price per issue to a level we’d like to. We’ll never be price competitive with more general, more popular newsletters.
We didn’t design the product with financial considerations in mind. In fact, we didn’t design The Avid Hog with many marketing considerations in mind.
What we did is design the product we would want to read ourselves. And we created the product we love working on. It’s unclear whether there are enough likeminded people to support such a product. And, if there are, whether they read this blog. But it’s a passion project for me and Quan. And I know we will continue it at a loss for longer than most people would keep it going.
I should probably talk a little bit about that passion. Quan and I wanted to work together. And we wanted to work together on a product we could be proud of. I have had the experiences – no, I won’t be naming names – of working on some products I was not proud of. Generally, I think I did the best I could to make those products a lot better than they would have been. And I had to operate under that assumption. I had to believe that making a product better than it otherwise would’ve been was justification enough for the work.
It was not a fun experience for me. That isn’t because the products weren’t good. Nor is it because there wasn’t demand for the products. I think there was a lot more demand for the things I worked on that I wasn’t proud of than there will be on The Avid Hog (which I am proud of). But there was a serious mismatch of the content and the creator. Sometimes – if the content and the customer are matched up well – that can be financially rewarding. But it’s emotionally pretty tough for the creator of the content. I don’t think it leads to a good product. And it’s rarely sustainable. Because the creator will eventually quit regardless of financial rewards.
The Avid Hog is a good product. And it’s sustainable. At least it’s sustainable from a production side. We’ve worked hard to perfect production over the last year. As you can imagine – if you’ve read a sample – our first attempts at production (our pilot programs) failed to get an issue out in a month. Repeated iterations of the entire process were necessary to reduce the time it takes at every stage of production. Today, we’re very confident we can get an issue out each month. As we’ve already hit that target privately (we just haven’t published until now).
How sustainable is The Avid Hog from a demand perspective? This is the tougher question to answer. We are obviously far from the level of subscribers that would be needed to support the labor involved. You have two people – Quan and I – working on this full time. That’s a very high hurdle to clear in terms of revenue. And we’ll see if we’re ever able to clear it.
Subscribers won’t notice one way or the other. We will be burning through our savings to produce the newsletter for the next few months. And it may be for a lot longer than that.
Obviously, this is one of the reasons we only offer subscriptions that are monthly. We don’t want to – as many newsletters do – receive payments up to a year in advance when we expect The Avid Hog to be running at a loss throughout much of that subscription period. We prefer to collect payment when – or actually a little after – we put out the issue we need to deliver for people.
Our commitment to The Avid Hog is certain. Our passion for the product is certain. And – having now put out a finished issue – I can also say that our pride in the product is certain too.
It’s a good product. It may not be to everybody’s tastes. We can’t guarantee you will like it. But we can guarantee that if you like this sort of thing – if a 12,000 word report on a single stock sounds appealing – this one will satisfy you. It would satisfy me as a subscriber. And that’s always what we’ve been aiming at. We’ve tried to create the product we would want to read.
I listed some of the hoped for benefits of The Avid Hog. We’d like it to improve your returns. If we can help you make 3% more a year on a $50,000 portfolio we can justify our subscription price. If not, we can’t. We hope it will save you on taxes. Our American readers should only end up with long-term capital gains. There’s an advantage in that. But it will only materialize if their behavior causes it to materialize. We can promise the possibility of that benefit. We can’t promise you’ll capture the full value of the tax benefit – because we can’t ensure you won’t sell out of stocks we pick far quicker than you should or we would. We know it will provide you with a database – a sort of mental filing cabinet – of above average businesses that you now understand well and can return to in future years. That’s one benefit we can guarantee. We hope it will simplify your investing life. We think it will allow you to focus in a way you may never have before on a single, promising investment idea. We can’t guarantee that. But the $100 sunk cost makes us pretty optimistic you’ll spend time focused on something you paid that much for. So, focus is a benefit we feel pretty confident we can deliver. Finally, we think you’ll become a better business analyst over the months and months you spend reading The Avid Hog. There are other ways to improve those skills. But seeing us analyze real world examples and then questioning and critiquing our approach – making it your own through an analysis of our analysis – is as good a way of becoming a better business analyst as I can imagine. So, again, that’s a benefit we feel pretty sure of.
Our return expectations for The Avid Hog are modest compared to what other newsletters aim for. However, they are immodest compared to what I think most individual investors achieve. We ignore the market. We don’t target any relative outperformance. We hope to provide you with stocks you can buy and then make 10% a year holding. We have no clue what the stocks we pick will do over the next 2 months or even 2 years. But, if you come back to us with a stock we picked 3 years ago and see that it has not done 11% a year – we won’t be able to consider that a success regardless of what the market did. I should warn you: we will have failures. I am sure we will have failures. Nobody is in the business of promising certain returns – for obvious legal reasons – but even if we were, we wouldn’t feel certain about the results of any one stock we picked. It is too much to pick 12 stocks you are individually certain of each year. Quan and I can, however, pick the 12 stocks we are most convinced of. And we can provide a group of 12 stocks each year that we would be confident putting our own money in. Here, at least, we can speak relatively.
Quan and I would certainly feel more confident putting all our money in the 12 stocks we pick each year rather than the S&P 500. We are also confident that you will be better served by going with our 12 stocks than with those 500. That does not mean we think our 12 will always outperform those 500. It does mean we think you will be getting relatively better returns while taking relatively less risk for those returns in the group we pick. I am sure we will underperform in many years. I have always opted for a much more concentrated portfolio than 12 stocks. And I have underperformed in some years in my personal portfolio. Last year (2012), is a good example of that. I would expect The Avid Hog will fare no better in its picks than I have done investing my own money over the years. That means there will be underperformance. And that underperformance may get pretty bad in great years for the S&P 500.
Quan and I have a good process. So, I am not worried about our conviction in the ideas that make it into The Avid Hog. We have a brutal winnowing process. A very large number of initial ideas turns into a very small number of stocks we actually write about.
I am, however, always concerned with the conviction – the trust – our subscribers put in us. I think this is the hardest part in writing a newsletter. There is always a great fear that even if you provide all the information to get great results – your subscribers may not act on that information in a way that justifies your newsletter’s price tag. That is my fear. We may do a good enough job picking the stocks. But we may not do a good enough job “selling” our subscribers on the stocks.
We don’t present a balanced view in the issue. We like these stocks. We wouldn’t write about stocks we don’t think are above average businesses at below average prices. So, we’re not going to try to present the “bear” case in situations where we don’t agree with it. That would never accomplish anything more than setting up a straw man.
So we don’t go for fake balance. But we do try to present the information we think matters. There’s a section near the end of each issue – it’s right before the “Conclusion” – that we call “Misjudgment”. This is obviously a Charlie Munger inspired section. And in that section we tell you all the reasons we might be wrong.
I don’t mean we tell you the risks – the unknowables – that often appear in the front of a 10-K. We don’t tell you about terrorism, global warming, a repeat of the 2008 financial crisis, SARS, or any sort of extraordinary event that could render all analysis of the future meaningless. We just talk about our biases. We talk about how our interpretation of the business may be flawed because we may want to see something that isn’t there.
That is as far as we go with balance. To some extent, that section alone may undermine our ability to “sell” subscribers on a stock. To really communicate our conviction directly to them. I hope that turns out not to be the case. I hope that an honest discussion of the errors we may be making will increase rather than decrease people’s faith in our pick. Past experience tells me it doesn’t work that way. And it’s usually easiest to hide errors in judgment by eliding them rather than analyzing them.
But one of our mantras for The Avid Hog – you may notice we have accumulated quite a few in the year of preparation for the launch – is that we’re producing the report we’d want to read ourselves. For me, that report would include the biases of the people who created the report. I tend to prefer candor to precision. And while I can’t claim we’ve produced a balanced report – these are all “buy” recommendations – I can claim we’ve produced a candid one.
What you get when you open an issue of The Avid Hog is my thoughts and Quan’s thoughts about a specific stock. To the extent we have blind spots, The Avid Hog has blind spots. To the extent we err, The Avid Hog errs.
What I’m proud of is not our ability to eliminate the errors in our judgment – which we can never do – and keep them out of the report. What I’m proud of is our ability to communicate our judgment.
It is the judgment of two people who focused on one stock for a full month. I think it is worth $100 a month. I hope readers of this blog will too.