Why Book Value Doesn't Matter, How to Find Cheaper Peers of Expensive U.S. Stocks, and How to Form a Fast Opinion about a New Stock

by Geoff Gannon


Listen to the Audio: Episode #81 of the Focused Compounding Podcast

Geoff:                   Hey, this is Geoff Gannon, and you're listening to the Focused Compounding podcast. This is the podcast where Andrew and I talk general investing concepts. If you want to know more about specific stocks I like, go to focusedcompounding.com where you can read stock ideas written up by me and other members. Membership costs $60 a month, but if you use the promo code PODCAST, it'll be $50 a month for you. Andrew and I also manage accounts for investors, to learn more about our managed accounts, email Andrew at info@focusedcompounding.com, or text or call Andrew at 469-207-5844, that's 469-207-5844. And now here's Andrew with your regularly scheduled podcast.

Andrew:              All right, we are back. How is everybody doing? Hope you are doing well. My name is Andrew Kuhn, Focused Compounding Podcast. Mr. Geoff Gannon, how's it going over there?

Geoff:                   It's going very well Andrew, how's it going with you?

Andrew:              It is going great. Hope it's going great for everybody else. I want to thank everybody for tuning in, and if you've given us a rating and review, that makes us happy and we definitely thank you for that. If you want to give us a rating review, feel free to go to the podcast app on your ... where you're listening to this, I mean we're on iTunes and the Podbean, and give us a rating and review. That definitely helps spread the word, and Geoff and I would be greatly appreciative of that.

Andrew:              So today we're going to be talking about ... So we always talk about, if they want to join your memo list to go to the website and type in their email. And if you're a member you get a premium memo, which is obviously a paid memo, which-

Geoff:                   Right a watch list.

Andrew:              Yeah, a watch list that you update every single week of stocks that you're currently researching, and you start a batting order from there. But there's a free part of the site where you do an investing topic and I think it'd be a good idea to sort of just chat about it, use an episode, because maybe not a lot of people know about it. There's a lot more people listen to our podcast than are subscribed to the email list, so that could be a good way-

Geoff:                   And it's free.

Andrew:              And it's for free, yeah.

Geoff:                   So, and we know a lot of people aren't going to sign up for a paid thing, but you can get this free thing, that you listen to a free podcast, you can get a free email each week, a written thing. It's one page.

Andrew:              Yeah it's always one page. So, a couple of weeks ago, and we'll go over a couple of different ones, and maybe we could just chat about them, a couple of weeks ago, you sent out a memo, what are super investors good for?

Geoff:                   Right. And I think we got a question from that on Twitter that we also talked about in our episode too.

Andrew:              Yeah, like cloning it-

Geoff:                   Because of that memo. Yeah.

Andrew:              Yeah, because cloning investors and what not. So, what are super investors good for?

Geoff:                   I think they're good for getting ideas from them. And so when we're talking about super investors, we're talking about things like Guru Focus and places like that where you can go and see all the stocks that they own, their portfolios. And I get a lot of questions about things from people's portfolios, from their 13Fs and things like that. I get a lot of emails saying, "Well, look at this in their holdings, what do you think about this," stuff like that. And I think we talked a little bit about how maybe the biggest position that they have isn't the best, because that might be the one that's gone up the most in value. So often the thing that they bought the most of when they bought is good, and more like looking at it at the price that they bought at, and seeing if you can buy it at a similar price to what they originally bought. Not that you can follow them in at a later higher price, obviously.

Geoff:                   So they're good for getting ideas for stocks. I also think they're good for getting ideas for industries. Sometimes picking a peer of a stock that they pick, as long as it's a smaller one because they tend to be bigger investors, and want to buy bigger stocks than you might be able to. But if you suddenly see that they're buying railroads, and that Buffett is buying railroads, and that he loves railroads, or airlines when he did that, that can tip you off on those are things that you should really study up on. There's something about it there.

Andrew:              Yeah, and Guy Spier and actually Mohnish Pabrai, I think they both kind of do that whenever they find a big company someone is interested in, they'll look overseas to see if they can find a pretty comparable company, because there may be cheaper than for example United States, or if it's a smaller company maybe more mispriced than a bigger company, but they just take like a good comparable to it. But that's just a good starting place.

Geoff:                   Yeah, I'll do that right now and say that Buffett did a private deal to buy Van Tuyl an auto dealership company in the U.S. We had a write up on the website about car dealerships in the U.K., and I talked about one of them in the U.K., but I think that would be a great example. If you're listening to this and you saw that Buffett bought car dealerships and you're looking at them in the U.S., there are actually a lot of them that are cheaper in the U.K., and it would be a good idea to at least compare them. There might be reasons why you like them better in the U.S., but you're going to pay more to buy them in the U.S., so definitely look in the U.K.

Andrew:              Have you ever bought a stock because a guru or super investor has purchased a stock?

Geoff:                   That's a very good question.

Andrew:              Like what if you see okay that they own it at 50 and now it's like 40 or 30? Because you just talked about maybe the biggest stock has gone up the most, but what about in other situations where it's not like that? Like do you think it's a good way to filter and look for ideas?

Geoff:                   Yes. I have looked for ideas. I can immediately think of some ideas I took. I put an idea that they had right onto a watch list that I was looking at. So Buffett personally bought, and eventually his company would give a loan to Seritage, but he personally bought Seritage and when he did I looked at it. So Seritage was a spinoff from Sears.

Andrew:              Because you don't really hear about him purchasing in his personal account too much at all.

Geoff:                   Right, but he did. He's bought REITs and things like that in his personal account. He bought J.P. Morgan in his personal account long before he bought it for Berkshire which is many years later. So it's usually something that he thinks doesn't conflict with other stuff, and mostly I noticed that he'd done it years and years ago with REITs. He seemed to be buying REITs, and Seritage fits into that sort of category. So that was one that I saw.

Geoff:                   There was one with Allen Mecham where he'd bought a business that I looked at that business, but then I also looked harder and actually wrote up some companies in the same industry, but not that business.

Andrew:              What company was that?

Geoff:                   It was DNOW, is the ticker.

Andrew:              A spin off

Geoff:                   Yeah, so it's distribution. It's a spin off.

Andrew:              An oil company?

Geoff:                   Yeah.

Andrew:              Cool. And then so like for example getting back to it, if the stock is lower do you think that's a good place for people to-

Geoff:                   Yeah.

Andrew:              I mean Mohnish Pabrai always talks about that, how he's like a one man shop, but he utilizes all these filing that of these hedge funds that have a team of analysts and he just kind of sifts through them.

Geoff:                   Yeah, and that's a great way of doing it.

Andrew:              Do you think though, I mean in the question Q&A podcast that we did though how sometimes confirmation buys can become a thing. You kind of have to obviously probably guard against that.

Geoff:                   Yeah, I mean I think I have that issue. I'm going to have it less than most people I talk to. A lot of people seem to be really interested in it, and if it goes badly or something they sort of blame the investor who they found the idea from, you know?

Andrew:              Yeah, sure.

Geoff:                   I don't I guess put a lot of faith in other investors that way. Even if something like ... Just because Buffett was selling some stock doesn't mean that I wouldn't consider buying that stock.

Andrew:              And you've got to remember too sometimes people sell stuff because just portfolio constraints, or like redemptions. Or it could be nothing to do with the actual business, or because they may not disregard that business, or not like it, but they just found something else that they kind of like more.

Geoff:                   And there are things that, I can think of things that Buffett bought, liked, held for a while, sold, and they did fine since he sold them. I'm thinking right away of General Dynamics in the 1990s, he made money on and stuff, but if he'd held it through today he would have done well. He would have done well if he'd of held onto Disney and not gotten rid of his Disney stock when Capital Cities and Disney merged and things like that. Or the Disney stock-

Andrew:              Or if you follow him with IBM, the other way around right?

Geoff:                   Yeah, but I think it's always an interesting thing, especially someone like Buffett is a really good example, but there are others who don't own a huge number of stocks and so they focus particularly on one industry or something like that at a moment, and that can really tip you off to it. But also, you can get ideas from bloggers and things like that. I've probably got as many ideas from bloggers as I had from super investors. I had read some people talking about Japan before I invested in net-nets in Japan. And in some cases I think some people wrote about it and stuff and I ended up putting more of my money into it than they ever did, but they gave me the idea for it basically of that country at that time, to really look into and some sort of hints of what was available.

Andrew:              And if you do become a member there is a list of past memos on the website.

Geoff:                   Of past memos, yeah.

Andrew:              So if you do want to read those, and like I said, it's just one page. You know a lot of people like, I tweet it out every single week, and if you do sign up for free, it'll be in your email box.

Andrew:              So the next one you talked about is value matters, but book value doesn't

Geoff:                   Yeah, that's true.

Andrew:              And this was before or after we talked about Warren Buffett's shareholder letter, which is I'm sure where this idea came from for this memo.

Geoff:                   Yeah, probably yeah.

Andrew:              So thoughts on it? Value matters, but book value doesn't.

Geoff:                   Yeah, this is one that I've talked ... like I consider myself a value investor in a lot of things we talk about here are value investing related, but a lot of times when academics talk about value investing they're talking about price to book. That's actually how a lot of indexes and things like that are formed of like of in style boxes and things like that, that you see for judging what a fund is, like if it's a value fund or something, is in part based on high the price to book is of the things that they own. Now it so happens that somethings that we own in the managed accounts have low price to book, but many don't, and some of the one that don't have low price to book I actually think are very cheap versus their appraisal value. And so I gave some examples in there.

Geoff:                   I gave an example of land that has been on the books for 100 years. Well you can buy it at a 50% discount to what it's worth, and yet still be paying three, four times book value. So is it not a value stock because it's three or four times book value? Or is it a value stock because it's half the price people are buying the acres next to it for? So value means paying less than what it's actually worth, then your appraisal of it, whereas book value is an accounting thing, which sometimes gives you an idea of what it's worth, but sometimes has nothing to do with that.

Andrew:              I mean back in the day it was probably more prevalent because of the types of companies that were around, right?

Geoff:                   Yeah. And it is still a very good way of valuing things like cash, current assets like receivables, things like that. Anything that was put into the business very recently. So if something goes public, raises a bunch of cash and puts it on the balance sheet, well the book value's going to be 100% accurate in that case, but it's going to become less accurate as they buy land to build a factory on it, or then they start producing things on it, and then 10 years later well a lot times that won't be worth what it says in the books. I can think of cases where companies that shut down a factory had to pay to have equipment moved away. They didn't get paid for it, because it was so not valuable at that time. Whereas in other cases you can have inventory and things that are worth quite a lot. There are cases of companies involved in like certain precious metals and things like that, but also diamonds, diamond inventory. I can think of things where there was steel inventory where it was probably worth actually more than the company was carrying on the books for it. Whereas most companies the inventory's worth quite a lot less if they can't sell it in their normal sort of way of doing it.

Andrew:              Why do you think Buffett spent so much time talking about that in his letter?

Geoff:                   Well because he's going to buy back stock I think. And because I think that-

Andrew:              It's not as important as-

Geoff:                   He's going to buy it back above book value.

Andrew:              Okay.

Geoff:                   So I think that's the biggest reason. So if you buy back ... There's actually, I talked about with someone, there's a pretty good article about all the companies that exist today that have negative book value. And I've actually invested in companies with negative book value, which would seem to be the ultimate not a value stock, but I for instance had a pretty big part of my portfolio in a company IMS Health, the public company IMS Health today is a little bit different than this one, but this one was back in very early 2009, and it had negative book value at that time, and that's because it produced a lot of free cash flow which it used to buy back its own stock. And it had borrowed some money and it used that money to buy back stock, but it used to buy back stock way above book value. And so, when you do that you reduce your book value as you buy back. If you pay above book value and you buy back stock then you'll reduce your book value over time, and if you do the reverse and you buy it back under book value it'll grow.

Geoff:                   But it was a very good company and it probably had a free cash flow yield over 10% and it grew a little bit each year as basically just a data base of information and things like that. And it would be a bargain at probably twice the price they paid, it would be worth in terms of like if you were adjusting the fair value of the company. They were buying back the stock at about half of what it was really worth in terms of its cash flows and things like that. And yet, they were causing the company to have negative book value when that happens.

Geoff:                   I think Buffett when he bought into Gillette, Gillette momentarily had negative book value. It took on some debt and ended up with negative book value. But you know Gillette isn't based on the factories that it has and things like that. It's based on the brand name and things like that which have no presence on the books.

Andrew:              Yeah, which is kind of a lot like the companies we see today. I mean they are just not-

Geoff:                   Yeah, if they’re built internally. Yeah, so if you have something like Apple which grew all of this brand and technology and stuff internally, yes. Now if someone goes and buys another company then they put on the books all these intangibles and that's different. But yeah, anything that's created brand names yourself through your advertising you've already expensed that. You expense that advertising each and every year.

Andrew:              Sure. Cool. Next one. Expanding your circle of confidence into other countries, and this is one I think is interesting because on the watch list that you send out, you do have a spot for I think overseas don't you? Overseas companies?

Geoff:                   Yeah, there's three parts. There's domestic, there's foreign companies, and then there's companies I'm going to revisit that I've already mentioned before.

Andrew:              Are you making a market call when you're going to other countries?

Geoff:                   Yeah, so no, I mean I'm looking at other countries, but in part that is true that it means I'm having trouble finding things in the U.S. I've said before in the letter to clients, that in the managed accounts, that ideally I would love to be 50% U.S., 50% the rest of the world. That's still a pretty big focus in the U.S. It's half of the portfolio. The U.S. isn't half of the world's economy. But I know more about things in the U.S. and stuff like that. But, it's something that I have not gotten anywhere near to, and would like to get closer to having 50% in other countries.

Geoff:                   I think the thing is, especially right now, but this has been happening a lot during the time that I've been investing, stocks in the U.S. have been more expensive than stocks in some other countries, and so there's the opportunity to look in other countries and to maybe find comparable merchandise at a lower price. You know, and that's what you're always trying to do. You're always trying to find the one peer in an industry or something that looks cheaper than all the others. So yeah, I know that recently I mentioned an elevator company in Japan is on that watch list, and it's much cheaper than elevator companies in other parts of the world. There's car dealers in the U.K. on that list, and they're much cheaper than car dealers in the U.S., and those are just generally industries that are pretty good. I think it's not a bad asset to own stock in an elevator company for the long term. It's not a bad asset to own stock in a car dealer for the long term. It's not like these are steel companies or something. It's not that I'm picking particular industries for the short term. These are assets that will be desirable for the long term.

Geoff:                   We just had a write up on the website about a company involved in public relations, which is basically related to advertising type of stuff, same sort of industry, in Japan and that kind of firm in the U.S. can sometimes be a lot more expensive, a public relations company in the U.S. So it's just historically those have been good industries. If you look the returns you get in things like advertising, marketing type companies, car dealers, elevator companies, all those things tend to have good returns as industries in all sorts of different countries. And so if you're finding them really expensive in your home country, why not look at other countries to see if there might be a cheaper example there.

Andrew:              What type of companies does Buffett own in other countries?

Geoff:                   Well one of the big ones is ISCAR, which makes like sort of cutting tools, things like that. So yeah-

Andrew:              He's predominantly in the United States though.

Geoff:                   Yeah.

Andrew:              For sure.

Geoff:                   He has at times owned some stock in other parts of the world. Let's see they owned ... They had an investment in POSCO at one time, which is a South Korean steel company. That was an unusual investment for them. Diageo. When he had bought it at least its biggest brand would have been an Irish beer. So there are some investments that he's made in other parts of the world, not very big. I'm excluding insurers, he's made some pretty big investments in insurers that are pretty global, but yeah.

Andrew:              What country is it that he said he bought an accounting book for that country?

Geoff:                   Korea.

Andrew:              It was Korea. Okay, that's who I thought it was.

Geoff:                   Yeah, he bought like 20 Korean companies.

Andrew:              That was just more of a like a-

Geoff:                   Like net-net type things. And he pointed them out, like he bought-

Andrew:              Reminds me of Japan, the net-nets.

Geoff:                   Yeah, they were very cheap in Korean. It was after the Asian crisis there that they had, the financial crisis, so.

Andrew:              He did this in his personal account?

Geoff:                   Yeah.

Andrew:              He said it brought him back to the early days.

Geoff:                   Yeah, and he looked at some things and he had some concerns that he didn't understand. If he didn't understand the accounting or wouldn't know if they were frauds or things like that so he wanted to diversify over like I think he said 20 or something things. Yeah, but some of the examples he gave were things selling at like one times earnings and stuff. Korean as a country tends to be pretty cheap compared to some of the others. So yeah, that's a good example. Japan, I think everyone should look at Japan. I think that the small companies there and those sorts of things, and we'll have posts I think each month now we're going to have a, in fact I know, each month now we're going to have a Japanese stock right now.

Andrew:              Is that for free?

Geoff:                   Yeah. That will be available for free. Well if you're on the memo list you'll see it. So we should point that out. If you're on the memo list, what happens if we send you the memo and at the top of the memo I put a link to whatever content you have access to that week so that people know there's new stuff to read, because otherwise, you wouldn't know. And I forget if it was last week or the week before when you were hearing this was about a Japanese stock and it was the first of what we'll have monthly up there. Which is something I've wanted to add to the site for a while. To have more coverage of those sorts of things and I think Japan is a good example there. But, it was a high quality company. I'd like to add more of those sorts of things because it does seem like people writing about Japan only write about like net-nets. You know that seems to be the thing, yeah.

Andrew:              Okay, next one. How to prejudge a stock?

Geoff:                   Okay, so that is a question I get a lot from people is like, "Do you really just sit down and read all about, like read the entire 10K without having any sort of knowing where the price is and knowing the sort of past financials and things like that?" The biggest things about prejudging a stock would be the industry. So know what industry it's in and if you've looked at things like it before. That's the most helpful thing. It's really hard to analyze a stock that has no connection to any stocks that you've researched in the past. So like when we were just talking about the countries' thing, it's really good to analyze and elevator company in Japan if you've analyzed one that's European or U.S. in the past. Or car dealers in the U.S., that makes them so easy to analyze them in the U.K. So those are really easy that way. And that's what I do a lot of.

Geoff:                   I mean I wrote about a company, and will write more about a company, Frontdoor, which was a spinoff in the last year, and a lot of that is because I had research a company called HomeServe which is U.K. based company, and so that's a big part of it is knowing the stocks that you've looked at in the past to be able to get some guess about the quality of the business, how the business works. I've talked a lot about like sort of Michael Porter approach to competition and things like that, about breaking down the competitive factors about relationships and bargaining power with customers and with employees and things like that. Actually that's a good example that recently is Buffett talking about how Kraft is not worth what it was before because them having less bargaining power with companies like Costco and Walmart. And that's a really good example of understanding those sorts of bargaining power. Usually you can make some guesses about bargaining power stuff right away just by knowing a little bit about the product and about the industry that it's in. So those are things that I used right away to do that.

Andrew:              And so when people reach out to you what do they sort of ask about other than, do you really spend so much time on it? Do they just say like, "How do you sift through it so quickly to move on to the next stock, or are you trying to disqualify it? Or what do you think?"

Geoff:                   Yeah, I think they're surprised by how much I just sit down and read the whole thing about the company. But, once I've made the decision to study this particular company, that is true. I just read the investor presentation, and the annual report, and for a lot of the stocks-

Andrew:              You can learn a lot about a business from their investor presentation. I would say it's a good place to start.

Geoff:                   Yeah, and for a lot of the stocks we're looking at which are for the manager accounts, we do overlooked stocks, a lot of times that is just reading an SEC filing or in some cases a dark company so they don't even have an SEC filing, but less likely to be investor presentations or things like that. But even then, you can find investor presentation in the same industry often.

Andrew:              Yeah, so that's a good place to start.

Geoff:                   I always say that to people that they should ... One thing people don't do, is like study three or four of the same kinds of companies at the exact same time which is really useful to do. So don't just try to figure out like you've never looked at a car dealer before, but you're going to try to value this one. Get a list of the five biggest public car dealers in the U.S.-

Andrew:              And compare them man. You learn so much from doing that too.

Geoff:                   Compare and contrast, that's really the key, yeah.

Andrew:              And even if you, talk about judging, if you just learn and you move on well you just learned so much about it which is only going to help you in the future.

Geoff:                   Yeah, so I think people try to too much to say one stock in isolation, instead of looking at the industry.

Andrew:              And you can very quickly, I mean from my experience, if you read about three or four of the competitors, you can tell which one's the best in my opinion.

Geoff:                   And you can see the differences in their strategy when they talk about that.

Andrew:              And then there's also things, you could take it forward, like for me it helps to propose questions like, "Why are these others companies spending so much on marketing, but this other company is not?" In relation to their revenue. Right? I mean cars.com that kind of

Geoff:                   Cars.com is a great example of that where we were like, "look at how much these other companies are spending on their marketing compared to their revenue and stuff," and that was a point of concern there is how much they would spend, and whether there was increased competition.

Andrew:              Cool. So if you do want to get access to all these, Geoff does send it out. Go to focusedcompounding.com and on the home page you will see a place to enter in your email and that will put you on our email list. We don't send you anything else other than a free memo, and you'll have that in your inbox every single week. It's just one page long like we talked about, and it's just always on an investing topic, and a lot of people really like it. So it's well received.

Geoff:                   Yeah, and that's free. You don't create user names, you don't do anything, you just give us your email.

Andrew:              And if you do want the premium memo, that comes if you're a premium member-

Geoff:                   Right, and that's when you create a user name and password, you get access to the whole site, the whole thing.

Andrew:              So if you do want to get access to those two reports, go to focusedcompounding.com, you can either enter in your email or if you become a member you get both.

Geoff:                   And if you become a member use the podcast promo code which I think we mention all the time on this podcast, but it's PODCAST and that'll save you $10 a month.

Andrew:              That will save you $10 per month. I want to thank everybody so much for tuning in with us. Have a great week. Make it a good one.

Geoff:                   Hey, this is Geoff Gannon and that was the Focused Compounding podcast. The podcast where Andrew and I talk general investing concepts. If you want to know more about specific stocks I like go to focusedcompounding.com where you can read stock ideas written up by me and other members. Membership costs $60 per month, but if you use the promo PODCAST it will be $50 a month for you. Andrew I also manage accounts for investors. To learn more about our managed accounts email Andrew at info@focusedcompounding.com or text or call Andrew at 469-207-5844, that's 469-207-5844. Thanks for listening.

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