Sold George Risk (RSKIA)

by Geoff Gannon

Last week, I eliminated my entire position in George Risk (RSKIA).

This position was about 20% of my portfolio. It is now 0%.

My average sale price was $8.40 a share.

My average purchase price had been $4.66 a share (back in 2010).

I held the stock for about 6.5 years. So, the stock price compounded at about 9.5% a year while I held it.

George Risk also paid a dividend. The yield was rarely less than 4% a year. So, my total return in the stock was about 13% a year over my entire holding period.

My return in George Risk was not better than the return I could have gotten by simply holding the S&P 500 for the same 6.5 years.

However, the stock was cheaper than the S&P 500 when I bought it. I believe it remains cheaper than the S&P 500 today.

Right now, George Risk’s dividend yield is about 4.2%. And the stock has $6.36 a share in cash and investments versus a share price of $8.40 a share.

I didn’t sell George Risk because I no longer like the stock. Rather, I sold George Risk to make room in my portfolio for a totally new position.

I try to only buy one new stock a year. So, when I do finally buy this new position – it’ll be a big moment for me.

I’ll let you know once I’ve added the new position.

Talk to Geoff about George Risk (RSKIA)

Some Books and Websites That Have Been Taking Up My Time

by Geoff Gannon

I get a lot of questions from readers about what investing sites I use, what books I’m reading, etc.

So, here are two sites and four books I’ve been spending time with lately.




GuruFocus: Buffett/Munger Screener

I write articles for GuruFocus (click the “Articles” link at the top of the page to see all of them). So, it’s a conflict of interest to recommend premium membership to the site. What I will say is that if you are a premium member – I think the most useful part of the premium membership is the various predictable companies screens. There’s a Buffett/Munger screen, an undervalued predictable companies screen, and you can also just filter companies by predictability score (GuruFocus assigns companies 1-5 stars of predictability in 0.5 star increments). I think the best thing GuruFocus ever developed is the predictability score. And it’s a good use of your time to type in some ticker symbols and see which of those companies are high predictability, which are low, etc. Do I personally invest based on predictability? No. GuruFocus doesn’t rate BWX Technologies (BWXT) and it assigns predictability scores of 1 (the minimum) to both Frost (CFR) and George Risk (RSKIA). I have about 85% of my portfolio in those 3 companies. So, I have almost all my money in non-predictable companies according to GuruFocus. The predictability score isn’t perfect. But, for non-cyclical and non-financial stocks that have been public for 10 years or more – I think it’s a pretty good indicator. Use it like you would the Z-Score, F-Score, etc. It’s just a vital sign to check. Don’t just buy a stock because it’s predictable or eliminate it because it’s unpredictable according to GuruFocus’s automated formula.

I can’t vouch for the accuracy of the data on this site. But, that’s true for summary financial statements at all websites. Once I’m actually researching a stock, I do my own calculations using the company’s financial statements as shown in their past 10-Ks on EDGAR (the SEC website). What I like about is that it’s simple and clean. Most websites that show you historical financial data give you way too much to look at. When you’re just typing in a ticker you heard of for the first time – which is what I use these sites for mainly – what you need is a “Value Line” type summary of the last 10 years. It shouldn’t be something you need to scroll down to see. As sites age, they get more and more complicated showing more and more financial info. You don’t need more than what shows you. If you like what you see of a company at then you should go to EDGAR yourself and do the work. is for the first 5 minutes of research. The next hours should be done manually by you – not relying on secondary sources like, GuruFocus, Morningstar, etc. None of them are a substitute for EDGAR.




Deep Work: Rules for Success in a Distracted World

This is a great concept. It’s not a great book though. I recommend reading the book only because focus is probably the most important concept in all of investing. If you can focus the way the author of this book talks about – you can become an above average investor. If you can’t focus the way this author talks about – I’m not sure you can ever become an above average investor. In fact, I actually think you can’t. Focus is the foundational skill for an investor. You can teach most everything else. I’m not sure you can teach focus. But, this book tries to teach focus. So, I do recommend it. Value and Opportunity reviewed this book last year.

By the way, Value and Opportunity is a great blog. You should read it.


Tao of Charlie Munger

I just said “Deep Work” wasn’t a great book. That’s true. But, it’s not a bad book. This book is really, really not a good book. However, it has some great quotes from Charlie Munger in it. And, although I was disappointed by the book as I read it – I did find myself quoting the book quoting Munger in the weeks after I read it. So, the author did actually imprint some of Munger’s quotes on my psyche. I guess it’s worth $12 on Kindle for that. Don’t expect much out of this book though. Just think of it as a collection of quotes from Charlie Munger.


The Founder’s Mentality

This is a Chris Zook book. You might know that I’ve read all of Zook’s books. They’re basically about profitable growth. How can a business grow for a long time in a way that compounds wealth for the business’s owners at an above average rate? I’m sure that’s not how Zook would phrase it exactly. But, that’s how I approach his books. This is a good book. It’s probably my least favorite Zook book so far. But, I do recommend it to all value investors. This kind of book is very useful for buy and hold investors. For example, I was just talking to someone about Howden Joinery and I mentioned that in about 6 years the company will have fully saturated the U.K. with its namesake concept (the concept is a chain of depots for local, small builders who are renovating kitchens). The founder/CEO is also about 61 now. So, I told this person I was talking to that while I thought Howden would likely return something like 12% a year as a stock – I was only interested in viewing the stock as a 6-year commitment. In 6 years, the founder would be about retirement age and the company would be producing a lot of free cash flow it could no longer put back into its core concept (Howden depots) in its core country (the U.K.). So, I just felt that it’s possible the company’s phase of value creating growth would be over at that point. I think it’ll continue to be a durable business. But, most companies start to stray once their original concept is mature and once they move on to the second generation, third generation, etc. of management. When I invest in a growth company, I want it to be run by the founder and to still have room to roll out its core concept in its core country. I think Howden has about 6 more years of that period left in it. I’m not sure I would be able to so clearly explain my thinking on Howden if I hadn’t read this book and Zook’s other books. So, I recommend them all.


Global Shocks: An Investment Guide for Turbulent Markets

Now, this is actually a great book. Though I’m not sure it’s a great topic. And it’s a topic I’d recommend most value investors avoid. Full disclosure, a member of my extended family knows the author of this book. So, I actually heard about the book before it came out. It’s not a topic I would have found searching through Amazon. The topic is basically financial crises. However, it’s really focused on financial crises through the lens of monetary policy meaning especially foreign exchange and asset bubbles. It’s very useful for value investors to hunt in countries that have been devastated by these sorts of crises. It’s also useful to avoid countries that may be in bubbles. I would recommend this book with a caveat. Most value investors I talk to are already way too worried about things like the overall price of the stock market, whether a country is in an asset bubble, foreign exchange rate levels, etc. I started investing as a teenager in the late 1990s. So, I went through years like 1999-2001 and 2007-2009. Even when the stock market is overvalued, you can find stuff to do. The market is clearly overvalued now. And yet I hope to add a new stock to my portfolio later this year. I think it’s good to understand these things. But, I also think it’s good to be practical about it. If you’re a value investor and a stock picker – you should be capable of both believing that a market is overvalued and also believing that it isn’t pointless to keep reading 10-Ks, looking through spin-offs, etc. day after day. Hope is having something to do. And there’s always something for a stock picker to do. So, I recommend the book. But, I also recommend staying focused on individual stocks rather than macro-concerns. If you know you’re the kind of person who tends to get overwhelmed – don’t read this book. For everyone else, it’s an interesting read. Some people think it’s dry. I don’t. It helps if you’re interested in financial history. There’s a lot of (recent) financial history in this book.

Ask Geoff a question.







When Picking Stocks: Can Snap Decisions Ever Be Good Decisions?

by Geoff Gannon

"...if you’re an experienced investor, you’re going to be instantly attracted to the best ideas you have within the first hour of hearing about them. That’s just how it happens. Good ideas are simple. They’re obvious. You know them when you see them. It happens really fast. That doesn’t sound prudent and full of the kind of due diligence we’re told we’re supposed to practice, but it’s the truth. A great investment is usually something you fall in love with the day you first find it."

The Difference Between “Moat” and “Durability”

by Geoff Gannon

Someone emailed me this question:

"Am I correct in assuming that when you discuss durability, you are referring to the ongoing need or want for an industry’s products or services, whereas when you discuss moat, you are referring to the competitive positioning of an individual company within its industry?"

Yes. Exactly. Durability is about the product and the product economics of the industry. Moat is the ability of the specific company to sell more of the product and have better product economics than competitors.

In Michael Porter's approach: moat limits rivalry between firms.

And durability is about the relationship between the customers and the firm we are looking at.

So, Corticeira Amorim (Amorim Cork) in Portugal may have low durability and a wide moat at the same time, because it has advantages in the production and especially the distribution of cork compared to other firms. However, there are substitutes for cork including synthetic products and screw tops. Societal shifts in the acceptance of these ways of enclosing a wine bottle would mean that Amorim might not have very good durability.

On the other hand, a company like McCormick (MKC) has perfect durability. McCormick sells a variety of spices. Spices have been part of the food that even households that aren't very rich have used for well over 2,000 years and they have been used all over the world. It isn't anything cultural that determines the desire for spices. The spices used may change a little but people all over the world will always want to add spices to their meals. Whether McCormick will always be a leader in spices is a different question. But, 2,000 years from today people will be spicing the food they eat. I'm not a hundred percent sure people will be corking wine even just 20 years from now.

Sanderson Farms (SAFM) is another good example of the distinction between durability and moat. The durability of chicken is excellent. There are only a handful of domesticated animals that have been as selectively bred and extensively used as meat - mainly cattle and pigs - throughout human history. The product economics of processing chicken are also fine, you can earn a decent ROE doing it. I also think chicken should continue to be a cheaper protein than other alternatives. So, while I can't guarantee humans will be eating chicken in 2,000 years - I'm sure they'll be eating about as much or more chicken in 20 years. And I wouldn't be surprised if people are still eating more chicken than almost any other meat even 50, 100, or 200 years from now. So, I think the durability of SAFM's product and the business model - the things the firm actually does day-to-day - are both durable in terms of providing value for customers. The question is rivalry between firms. Fifteen years from today, someone will be doing what Sanderson is doing. But, how much profit will the firms that process chicken actually make? That's why I compare it to airlines. Airlines will be around in 20 years. It's not hard to guess how many passengers will be flying in 2037 within the United States. It may, however, be hard to know how much the major carriers will make in profit per passenger.

From a discounted cash flow perspective, it isn't very important what earnings will be far into the future. If you are buying a tradeable, liquid asset like a stock and you are expecting a fairly high return on your money (I try to stay in cash till I find something I expect to compound at 10% a year) you don't really need to worry about 50 or 100 years. I'd say that the clarity with which you can see the next 5-15 years is what matters. A lot of investors and analysts are looking out at years 1-4. But, if you can find situations where the durability 5-15 years out and the moat 5-15 years out looks good - you'll do fine. So, from an intrinsic value perspective - I'd say that both McCormick and Sanderson have high enough durability (in spices and chicken) that risks to durability don't need to factor into your investment analysis at all. I would say that Amorim Cork has enough risks to durability that you should factor those risks to the durability of cork as a product and the cork industry in general into your calculation of the price you’d be willing to pay for Amorim stock.

Here are some examples of how I'd classify durability.


ZERO RISK TO DURABILITY (nothing about the product is going to change in the next 15 years)

* Sanderson Farms (SAFM) - Chicken

* McCormick (MKC) - Spices

* Omnicom (OMC) – Advertising


SOME RISK TO DURABILITY (something about the product may change in the next 5-15 years)

* Progressive (PGR) - Car insurance

* Corticeira Amorim - Wine corks

* Village Supermarket (VLGEA) - Offline groceries


BIG RISK TO DURABILITY (something about the product may change in the next 5 years)

* Fossil (FOSL) - Watches

* Teradata (TDC) - Data warehouses

* Wal-Mart (WMT) - Offline general retail


What I said above doesn't deal with moat. For example, I would put Costco (COST) in the "low durability" category and yet also in the "wide moat" category. Costco has a strong competitive position. However, offline retail has serious risks to durability within even just the next 5 years. On the other hand, there are plenty of commodity type products (like steel) that have high durability as a product and yet no moat at all for many of the individual firms.

I think you can keep this fairly simple.

Durability: Will customers still value this product as much in 5 years, 15 years?

Moat: Will the company’s competitive position versus its rivals be as strong in 5 years, 15 years?

If you aren’t sure about either of these statements over the next 5 years, don’t buy the stock.

If you aren’t sure about either of these statements over the next 5-15 years, you need to seriously consider whether this is the kind of business you want to own and how cheaply you need the stock to be selling for.

If are sure about both of these statements over the next 15 years, you’re fine. To buy Apple (AAPL), you need to be sure of the durability of smartphones generally and the Apple iPhone specifically through 2032. Beyond that, it’s okay if you don’t know what the future will be. But, if you have any uncertainty about the durability of smartphones or the moat around the iPhone between now and 2022 – you really can’t buy the stock. Risks to moat or durability that could manifest themselves within the next 5 years are what cause losses in a stock.

Ask Geoff a question.

Sold Weight Watchers (WTW) and B&W Enterprises (BW)

by Geoff Gannon

Today, I sold my entire positions in Weight Watchers (WTW) and B&W Enterprises (BW).

My Weight Watchers position was eliminated at an average sale price of $19.40 a share.

My B&W Enterprises position was eliminated at an average sale price of $10.22 a share.

My Weight Watchers position had an average cost of $37.68 a share. So, I realized a loss of 49% on Weight Watchers.

My B&W Enterprises position had an average cost of $15.48 a share. So, I realized a loss of 34% on B&W Enterprises.

Note: I got my shares of B&W Enterprises as part of the Babcock & Wilcox spin-off. I bought that stock ahead of the spin-off. I still retain my shares in BWX Technologies (BWXT). My BWXT position is about 10 times the size (in market value) of the BW position I just eliminated.

My portfolio is now:

Frost (CFR)

BWX Technologies (BWXT)

George Risk (RSKIA)

Natoco (a Japanese stock)



In rough terms, Frost is about 40% of my portfolio, BWX Technologies is about 25%, and George Risk is about 20%. Natoco is less than 5%. The rest is cash.

So, about two-thirds of the portfolio is just Frost and BWX Technologies and more than six out of every seven dollars is in just three stocks.

Why did I sell WTW and BW?

Weight Watchers, B&W Enterprises, and Natoco combined were now only about 10% of my portfolio. I had no intention of buying more of these stocks. I like individual positions to be about 20% of my portfolio. So, both Weight Watchers and B&W Enterprises had become distractions I wanted to eliminate at some point.

Also, this portfolio is taxable. Three stocks account for 85% of the value of my portfolio and those three stocks are anywhere from 80% to 150% higher than where I bought them. I hope to buy a new stock sometime this year. To make room for that stock, I'll have to trim some positions with large capital gains.

Today's sales provide me with capital losses.

As a side note, you may have noticed WTW stock was up over 30% today and B&W Enterprises was down over 30% today. My Weight Watchers position was several times the size of my B&W Enterprises position, so today's rise in WTW's stock price may have had some influence on my decision to sell right now. However, I could have opted to eliminate just WTW and keep BW - and I didn't. So, I'd still say the sale is mostly not due to short-term price movements.

I really just wanted to:

1. Eliminate positions that were less than 10% of my account

2. Realize capital losses

3. Raise cash for a future stock purchase

Talk to Geoff about his Sales of Weight Watchers (WTW) and B&W Enterprises (BW)

How I Research Stocks

by Geoff Gannon

"I guess you could say I have a checklist that reads: durability, moat, quality, capital allocation, value, growth, misjudgment, and future. I also always compare the company I'm interested in to publicly traded peers. And, most importantly, I look at historical financials going as many years into the past as possible. I'd say I'm usually working from about 20 to 25 years of past financial data. That data is the bedrock of my process. It's the only quantitative part. Everything else I do is qualitative."

How to Tell Which Company Will Survive an Industry Downturn

by Geoff Gannon

"Variation in the operating margin is really a measure of profit wobble. In a capitalist economy, some firms tend to act as shock absorbers – they take a hit – and other firms tend to pass the shock on to customers, suppliers and employees without themselves showing much sign of the shock rippling through their industry, the economy, etc."

How to Steal Another Investor's Style

by Geoff Gannon

"...know your own style. Be honest about it. Then find those investors you admire most. The true investing masters out there, not just the guys with good records, but the guys you personally have admiration for. The guys you want to learn from. Then study up on all the ways they are different from you. Look for those places where their beliefs challenge your beliefs. Then start trying to ape their style."

Read the text version of this episode.

Get your question answered on the podcast.

Analyzing Stocks With a Partner

by Geoff Gannon

(To have your question answered on the blog, email Geoff.)

Someone who reads the blog emailed me this question:

“Buffett has Munger, and you have Quan. It seems like in this industry, a collaboration of minds can be a potent formula for long-term success if approached correctly. That said, how would you recommend investors/ aspiring portfolio managers to find a suitable partner who not only is able to shine light on your blind spots, but who can also be of one mind and culture?”


It's a huge help to have someone to talk stocks with. But, I’m not sure it’s a help in quite the way people think it is. I think people believe that Buffett is less likely to make a big mistake if he has Munger to talk to, that I’m less likely to make a big mistake if I have Quan to talk to, and so on. I’m not sure that’s true. I know from my experience working with Quan that our thinking was more similar than subscribers thought. For example, one question I got a lot was who picked which stock. And that’s a hard question for me to answer. Some of that might be the exact process we used. I can describe that process a bit here.


When I was writing the newsletter with Quan, we had a stock discussion via instant messaging on Skype. We did this every week. The session lasted anywhere from maybe 2 hours at the very shortest to maybe 8 hours at the very longest. A normal session was 4-5 hours. So, we were talking for let’s say 4 hours a week about stocks. We weren’t talking about stocks we had already decided on. Instead we were just throwing out ideas for stocks we could put on a “watch list” of sorts. We called it our candidates pipeline. It was really a top ten list. So, instead of saying “yes” or “no” to a stock – what we did is rank that stock. We always had the stock Quan was currently writing notes on, the stock I was currently writing an issue on, and then 10 other stocks. In almost every case, once I started writing an issue – that issue did end up going to print. In most (but not all) cases, whenever Quan started writing notes on a stock – that stock eventually became an issue. But, there were probably 3 to 5 times that he started writing notes on a stock and yet we didn’t publish an issue on that stock. This was rare. Most stocks we thought about but eliminated were eliminated in the “top ten” stage.


So, we’d have a list of ten stocks that we weren’t yet doing but that we planned – if nothing better came along – to work on next. Let’s make up a list here. Let’s pretend #1 is Howden Joinery, #2 is UMB Financial, #3 is Cheesecake Factory (CAKE), #4 is Kroger (KR), #5 is Transcat (TRNS), and #6 is ATN International (ATNI). It would go on like this for 10 stocks. A lot of times there were stocks on there that we didn’t really love – but we had this rule that we had to always keep 10 stocks on the board. This kept us from ever saying an idea just wasn’t good enough. We were trying to do an issue a month – so the answer was that if it’s better than every other idea we have right now, it should be the next issue. This way of working – by making our next best idea the hurdle – was very helpful. Each week, as we’d talk, we’d move stocks up or down. So, maybe I would say that I had been reading about Cheesecake (since it’s number 3 on our hypothetical list) and I decided that its future growth prospects in terms of the number of sites it could open is just not high enough to justify its P/E. It might be fairly valued. But, it’s unlikely to be undervalued. So, I wanted to move it down the list. Well, instead of just moving it down the list – I had to say where I wanted to move it and what I wanted to move up in its place. In other words, I’d have to explain to Quan why I thought Cheesecake was a less attractive stock than Kroger, Transcat, and ATN International. Otherwise, the stock would stay where it was.


I’m sure that if each of us had done separate newsletters, we would have ended up with a different set of stocks than Singular Diligence covered. But, it’s not like Quan and I disagreed much on which stocks to do. I think we tended to be furthest apart in the earliest stages of considering stocks. Early on, we weren’t going to do any financial stocks. But, independently, Quan and I had kept looking at Progressive (PGR). This was an obvious choice for the newsletter. GEICO and Progressive are similar. Over the years, they’ve become even more similar. Progressive has a very long history of excellent stock returns (something we always looked at). Some value investors own it. I think it had been consistently buying back stock and it may even have been within spitting distance of a 5-year low when Quan and I first talked about the stock. Things like a continuously declining share count (“cannibals” as Munger calls them) and a 5-year low (we don’t look at 52-week lows – but we are interested in when a company seems to have gotten better while its share price has gone nowhere) would have attracted us to the stock. So, either I brought Progressive up to Quan or Quan brought Progressive up to me. And the other one said he’d already looked at the stock. And neither of us was sure at first whether we’d do it. It’s not that we didn’t like Progressive. We just weren’t sure we ever wanted to do an insurer. We had done HomeServe (a U.K. stock). But, the actual insurance aspect of HomeServe – the risks it takes – is extremely minor when compared to something like Progressive. Progressive is a true financial stock. It is taking tremendous underwriting risk. In fact, you won’t find many insurers that write more in premiums (and expect to cover more in losses) relative to their shareholder’s equity than Progressive. If Progressive suddenly had a combined ratio of 110 for 2-3 years in a row – the company would be insolvent. On the other hand, if Progressive had low equity levels and then had 2-3 years of its usual – very good – underwriting profit, it could quickly re-build an insufficient capital level to an overcapitalized position. Progressive takes very little investment risk. But, it takes huge underwriting risk. Premiums are very high relative to equity. It can – if it misprices its policies – wipe out a good chunk of its shareholder’s equity in a single year.


So, Quan and I thought about Progressive a lot. Did we really want to break the seal on financial stocks? Once we did Progressive, other financial ideas might start appearing on our top 10 list. I mean, if we can do Progressive – why not Wells Fargo?


And that’s exactly what happened. We saw how much Progressive was hurting because of low interest rates. I described it as “flying on one engine” because Progressive usually made profits on both investments and underwriting. But, the stock’s current P/E only reflected the underwriting profit. It had way more float than it had ten years ago – yet it wasn’t earning more investment profit than it had 10 years ago. If that was true of Progressive – it was probably true of some banks too. There had to be banks that had twice as much in deposits today as they did before the financial crisis – and yet they weren’t earning a penny more in income than they had before the crisis. The stock I’m describing here is Frost (CFR). I had mentioned it to Quan several times. But, we weren’t doing financial stocks. It’s just not something we ever planned to do. And so, whenever I mentioned Frost – Quan wouldn’t say there was anything wrong with Frost. He just said we weren’t doing financials. But then we had done Progressive. So, now we were doing financials. So, it was time to look at banks.


Warren Buffett has said something like – I’m paraphrasing here: the best investments are the ones where the numbers almost tell you not to invest, because then you are so sure of the underlying business.


I don’t think he is talking about numbers specifically when he says that. I don’t think that statement is an argument against value investing. It’s an argument against prejudice. So, Warren Buffett is – at heart – a value investor. He is going to make the mistake of passing on a great business because it trades at too high a P/E ratio more often than he’s going to make the mistake of buying a great business at too high a price. Well, we each have our own biases. I certainly have that same value bias that Buffett has. I have missed out on some stocks I should have bought because they were trading at an above average P/E ratio, EV/EBITDA ratio, etc. They looked expensive by all the usual metrics. I also have a bias against financials stocks. So does Quan. So, it took a lot for us to move in that direction. We didn’t do it for just any insurance company – we did it for Progressive. And then when we moved into banks, we didn’t just pick any bank – we picked Frost (CFR). Progressive is a much better business than almost any other insurer. Frost is a much better business than almost any other bank.


It's interesting to talk about how we moved into doing banks at all. It took a lot of time. What happened was Quan had to do some research into the industry. He needed to gather information on a lot of banks and create some Excel sheets we couldn’t find ready made elsewhere. There were two reasons for this. One, we needed long-term data on the industry to prove that something like the 2008 financial crisis wasn’t more common than we thought. And, two, we needed many banks to draw from for potential picks. It was especially hard to come up with good banks. We thought we’d find a ton of them. If we’d been looking for banks that were cheap enough – value stocks – we might have found plenty. There are thousands of banks in the U.S. But, they aren’t equally attractive. Small banks don’t have the economies of scale of big banks. They tend to have higher expenses as a percent of their total earning assets. They also don’t have equally attractive deposit bases. I know the three banks I was most interested in from the start were: Frost (CFR), Bank of Hawaii (BOH), and Wells Fargo (WFC) because I was most comfortable with their deposit bases. We never did an issue on Wells. Quan looked at it for a very long time. I can’t think of another time where we talked so much about a stock we didn’t do. But, we did do issues on Frost and Bank of Hawaii.


We also did issues on Prosperity, BOK Financial, and Commerce (CBSH). We found those stocks as peers. Frost’s most natural peer in Texas is Prosperity. It’s the second largest bank in Texas. And then Frost’s closest peer in energy lending is BOK Financial. Commerce would have shown up as a peer of BOK Financial. And we were going to do an issue on UMB Financial. UMB is controlled by different descendants (I guess they’re cousins) of the founder of Commerce. So, members of the “Kemper” family control both Commerce and UMB. However, the lines of succession split off almost a century ago, so these people are not closely related even though the banks share the same founder and are both controlled by Kempers.


So, what can this tell you about working with an investing partner? Quan and I both had a bias against financial stocks. It may have taken us even longer than it would have if we were investing on our own to branch out into these stocks. Would I have written about Frost sooner if Quan hadn’t been so reluctant to do banks? Maybe. But, I certainly wouldn’t have done issues on Prosperity, BOK Financial, and Commerce without Quan. Those were much more his picks than mine. Without Quan, I might have eventually done issues on both Frost and Bank of Hawaii. I don’t know about Wells Fargo. Wells is a tricky idea to discuss. Quan and I both like the stock a lot. We thought – even at the time we were looking at the stock – that it was one of the cheapest banks we’d looked at on a normalized basis. And yet we didn’t do it. Quan was more insistent than me that we not do it. But, I’m not sure I’d do Wells if I’d been writing the newsletter on my own. I know I would have written about Frost first, Bank of Hawaii second, and Wells – if I ever decided to write about Wells – third. I was more comfortable with both Frost and BOH than Wells. Quan was more comfortable with all the banks we did than with Wells.


There are sometimes slight differences between Quan’s preferences and mine. For example, I told some subscribers who asked about it that Quan probably likes Prosperity (PB) a bit more than I do and I probably like Bank of Hawaii (BOH) a bit more than Quan does. But I like Prosperity fine. And Quan likes BOH fine. Maybe this reflects a difference that Quan is a little more comfortable with a long-term strategy of serial acquisitions and I’m a little more comfortable with a long-term strategy of continual stock buybacks. Prosperity is unusual in how many acquisitions it does. BOH is unusual in how much stock it buys back.


There’s a chance I would’ve done Wells if Quan wasn’t co-writing the newsletter. There’s a chance I would’ve done ATN International (ATNI) if Quan wasn’t co-writing the newsletter. I think ATNI is more likely than Wells. But, in most cases where we eliminated a stock – it was unanimous.


I’ll give just two examples. Two stocks we liked a lot – and thought were “good” bets in some sense – but eliminated from consideration were Western Union (WU) and Wells Fargo (WFC). However, we were pretty much in agreement that Wells was too difficult to understand and that we didn’t like the management at Western Union. If one person had each of these “hunches” alone – would they have ignored it? Maybe. So, maybe analyzing stocks in pairs helps build your confidence more than it helps you avoid your blind spots.



Ask Geoff a Question

How to Find the Most Persistently Profitable Companies

by Geoff Gannon

(To have your question answered on the blog, email Geoff.)

Someone who reads the blog emailed me this question:

GuruFocus provides data on predictability of a business. Do you like this metric? Do you use this metric in your analysis? It seems to me that the more predictable a company’s historic earnings, the easier it should be to calculate the intrinsic value of the company. Do you agree with this assessment? 
The problem with this for value investors is predictable businesses tend to not get nearly as mispriced (at least highly followed large cap stocks).”

I do use predictability in a general sense. I don’t want to talk about GuruFocus’s measure of predictability specifically – because GuruFocus publishes some of the stuff I write. So, I’m biased. If I say something good about a GuruFocus feature – you won’t believe me. And I wouldn’t want to say something bad because they’re kind enough to publish my writing. I’ll just say that “predictability” is a good measure to look at. And that is what the GuruFocus predictability rank is trying to do. So, it’s trying to do a good thing. And you’re not going to come to any harm by looking at it. And you might get something positive out of looking at GuruFocus’s predictability score for a company. So, yes, I like the metric of predictability.


Now, what do I use personally? I enter a company’s financial data into Excel myself. I’ll look at the data at places like GuruFocus. But, I want to go to the historical 10-Ks and pull the numbers out myself and adjust them as I see fit. This is to get comfortable with the numbers. There’s a difference between when you are relying on something a computer has done and when you are doing the data entry yourself. So, I set up an Excel sheet with 15 years or 20 years or 30 years of financial data. I prefer 30 years where 30 years of data exists. I also like to read the very oldest and very newest annual report from the company. Sometimes I read other specific past annual reports (like the 2008 financial crisis year) that were unusual for the company, the industry, or the country it operates in.


One thing I have Excel calculate is the variation in EBIT margin. So, if you have say 30 years of financial data for EBIT, and the EBIT margin is positive in every single year – you’ll be able to calculate both the standard deviation and the (arithmetic) mean in the series. Excel can give you other types of averages too. It does geometric and harmonic means which investors use rarely. But something like the harmonic mean is actually a useful measure for the very long-term return on capital, because as a rule – a company’s compounding in its intrinsic value will not be less than the long-term harmonic mean of its return on capital. It could – especially if it’s in a very cyclical industry – be much lower than the arithmetic mean. I bring this up because it’s sort of related to “predictability”. Investors don’t pay much attention – except to “recency” – to the order a company’s results come in. But, the order of results is important for things like compounding. It’s not important if the variation in ROC is close to the mean. Let’s say I’m looking at ROC and I have a 30-year series of ROC figures with – Minimum: 10%, Maximum: 20%, Median: 15%, Mean: 15%, Standard Deviation: 5%. That’s a very predictable company. The median and mean are the same. We can scale the standard deviation to the mean (5% / 15% = 0.33). Variation of 0.33 in ROC is low. Not many companies have such low variation in ROC.


I use the same calculations I just showed you for the company’s ROC history and apply it to the company’s EBIT margin history. I like to look at both return on sales (EBIT/Sales) and return on capital (EBIT/Net Tangible Assets). When you are buying into a company – you must remember that earnings aren’t actually that stable. As a rule, things like assets and sales are going to vary less than earnings. That’s as a rule. It’s not totally true. There are cases where a company has several good business units and one money-losing or breakeven business it’s just running as a legacy. In that case, it could dispose of a lot of assets and eliminate a lot of sales and yet not make much of a dent in earnings. But, if we’re talking about the core business – the good business – a change in assets or sales from year to year is going to be smaller than a change in earnings.


Let’s talk about the danger of using the two ratios value investors mention most: P/E and P/B. Earnings are volatile. So, P/E isn’t a good measure. And then P/B is a net number. Book value – or tangible book value (you should always be using tangible numbers for equity and assets) – is net of the liability situation. So, it’s a heavily leveraged number. When a company has low liabilities, P/B could be a pretty stable and solid indicator because it’s basically like Price/Tangible Assets. But, in cases where the company has an “iceberg” type balance sheet where it has $100 a share in assets and $90 a share in liabilities and a stock price of $8 a share – yes, it’s selling for a price-to-book ratio of 0.8. But, an 11% decrease in assets would wipe out all of the company’s equity. You see the problem. If we look at things like sales and assets – those are much more stable.


I also do something else people think is really weird. I look at gross profit. Gross profitability is an important number for me. When I say gross profitability, I mean Gross Profits / Tangible Assets. So, it’s possible a supermarket – which tends to have a ton of operating leverage, it’s a high unit volume business – could have a 120% gross return on assets (Gross Profit/Total Assets = 1.2) and yet it only has a 20% pre-tax net return on assets (EBIT/Total Assets = 0.2). That can actually happen with a supermarket. So, why does gross profit matter? It has to do with things like scale, business organization, who is running the company at the top, how much are they getting paid. Things like that. For example, Village Supermarket (VLGEA) is a relatively small (by number of stores) Shop-Rite operator in New Jersey. It is run by members of the family that control the company’s stock. They are well compensated. It’s possible that there are years where the company makes say $30 million in EBIT and yet pays $5 million to top executives of a company with only about 30 stores. Now, if another New Jersey Shop-Rite operator (Wakefern co-op member) acquires Village, it’s not going to pay management $5 million a year to run 30 supermarkets. I’m not sure it’s even going to pay a combined $1 million to however many people you have running a 30-store operation. An acquirer already has general counsel, a CFO, a CEO, a COO, a board, etc. So, there’s $5 million right there that can be severely trimmed. And I don’t know how lean Village runs its head office, its IT, etc. I can better judge the stores. So, collecting data on the store level – and the gross profit level – is more useful. I’m not sure that high gross profitability is ever a “green flag”. But low gross profitability absolutely is a “red flag”. Companies talk about synergies all the time. They talk about plans to turn a business around and improve margins and so on. Sometimes these plans are realistic – sometimes they aren’t. But, I’ll tell you right now – they’re a lot more realistic if they plan to increase operating profit relative to gross profit. They are a lot less realistic if they think they are going to raise gross profit as a percent of total assets or total sales. If you have 10 firms in an industry with a combined $10 billion of assets and $2 billion of gross profit – that’s a bad industry. And it’s likely to be a bad industry even if you consolidate down to just 8 firms, 6 firms, or even 4 firms. The economics of that business have something severely wrong with them. The ratio of just 20 cents of gross profit for every 1 dollar of assets in service is simply unacceptable.


What does this have to do with predictability? It’s easy to predict an industry like that will have long-term problems it can’t fix. On the flip side, if you have a company with good gross profitability year after year for decades and yet net profitability is only now looking good – that’s something you might want to buy. The reason for this is that when we’re talking about predictability – we’re talking about persistency. How durable are sales, assets, gross profits, net income, book value, etc. Things like sales per share, assets per share, and gross profits per share are more persistent and more predictable from year to year. Now, some investors are going to say: so what? As an investor, you make money from free cash flow. Free cash flow is usually somewhat approximated by net income (it can be a very approximate relationship) and so the P/E ratio is telling you what kind of dividends and share buybacks a company can give you. That’s why a P/E ratio can tell you what kind of returns to expect in the future. I’d agree with that line of logic if you applied it to an entire nationwide market. If we’re talking the S&P 500. Then yes. First of all, the P/E ratio still doesn’t matter. But a normalized P/E – like the Shiller P/E does matter. But that’s because we know the quality of the S&P 500. It doesn’t get better or worse. It’s too generic a mix of businesses to be worth buying on anything but price.


A company can be worth buying for its predictability though. Some industries have more persistent profits than others. When I was writing my newsletter, Quan (my co-writer) and I gave every single stock we looked at an industry category code. So, we’d code an ad agency like Omnicom as “business services” and a fast food joint like Greggs as “restaurant” and a helicopter hoist maker like Breeze-Eastern as “capital goods”. You can find research on the relative persistency of profits in industries like business services, restaurants, and capital goods. Generally speaking, the lower your customer retention, the lower the purchase frequency, and the further you are from the end consumer – the worse the persistency of your profitability is. Now, this isn’t always true. Market structure matters too. Breeze-Eastern was a duopolist with a 50% or higher share of search and rescue helicopter hoists. It was serving an oligopoly (about 5-6 helicopter makers). As a rule, a duopoly that serves an oligopoly is going to have highly persistent profits compared to some other market structures. For example, the beverage can manufacturing business has persistent profits. In a given market, you generally have like 3 companies: Crown (CCK), Ball (BLL), and someone else serving a small number of customers (Coke, Pepsi, Coors, etc.). There’s probably a huge market for smaller plants serving smaller customers. But the biggest customers need someone who can do huge volumes at one plant. So, you have only a small number of customers who need huge volumes at a single plant and only a small number of competitors who are willing to produce huge volumes at a single plant for a single customer. So, you have persistency in that kind of business. I think BWX Technologies (BWXT) should have persistent profits. It’s the monopoly provider of all but one (Curtis-Wright makes the one) nuclear components for reactors in U.S. Navy submarines and aircraft carriers. It also has a monopoly position in uranium down blending and some other stuff related to the U.S. nuclear weapon program. I think it’s persistent because I don’t think the U.S. Navy will – within the next few decades at least – want to stop producing nuclear powered submarines or aircraft carriers and I don’t think they can possibly choose any other provider besides Babcock for what they need. So, Babcock has a monopoly position.


The best kind of persistence comes from high customer retention. I like the ad agency business, the auto insurance business (although I’m convinced driverless cars will obsolete this business over the next few decades), and banks because the customer retention rates for an ad agency can be 95%, for a bank they can be 90%, and for an insurer they can be 80%. If ad agencies, banks, and insurers didn’t retain the same clients – if they had to market aggressively to win new business, I’d have no interest in them. The lack of price competition to retain customers is what attracts me to this business. Now, there is very intense price competition in insurance – especially to win a new customer. In fact, auto insurers lose money on new customers at first because they spend so much on marketing. Once they have a customer though, retention rates are high. There are people who have been renewing with the same insurer for 25-50 years. Ad agencies are even better. There are tons of big brands that have been with the same creative agency for more than 25-50 years. A couple have been with the same agency for 100 years.


So, yes. I do look for predictable companies. I look at long-term variation (standard deviation / mean) in return on capital and EBIT margin. GuruFocus also has predictability rankings. You can use those too. Think a lot about how persistent profits tend to be in each kind of industry. Know that EBIT margins at a restaurant are a lot more predictable than EBIT margins at a capital goods company. And remember that things like assets and sales are more persistent than earnings. Gross profit is also more persistent than net profit. So, start by looking at long-term trends in sales, assets, and gross profit. For example, has asset growth been consistent? Or has it been accelerating in recent years? Try not to buy into a company that is growing its assets more rapidly than everything else. High asset growth right now is usually a bad sign for ROA in future years. Growing profits faster than assets in recent years is usually a better sign.


I’d focus on persistence on measures like ROC and margins rather than growth itself. Consistent growth is good. But, a 7% annual growth rate that is consistent and accompanied by a high ROE is all you need. You don’t need 12% annual growth. What you need is consistent growth accompanied by a high ROE.


Talk to Geoff about How to Find the Most Persistently Profitable Companies



How to Invest When You Only Have an Hour a Day to Do It

by Geoff Gannon

(To have your question answered on the blog, email Geoff.)

Someone who reads the blog emailed me this question:

If one was a widely-read value investor but only had 5-10hrs per week to spend on investing (due to employment / family constraints) and one had less than $1m, would you recommend a classic Graham net-net portfolio as the surest and best way to make market beating returns? If no, what other strategy (apart from indexing) would you recommend under these time constraints?"


I’m going to rephrase this question as “If one only had an hour a day to spend on investing”. You said 5 to 10 hours. I’m going to ask you to spend 5-7 hours a week on investing. But it must be an hour a day – every day – instead of five hours all at once. There’s a reason for this. I want you 100% focused when you are working on investing. You don’t have to spend a lot of time on investing. But you do need to be focused when you are doing it. Most people who invest are never fully focused for even an hour on a narrowly defined task. So, that is what I need from you. An hour a day of total focus. If you can’t do it every day – then don’t do it at all on weekends. Just spend an hour a day on Monday through Friday. But never skip a day. Okay. Let’s say you’re willing to make that commitment. Then what?


The approach for you to use is not a net-net approach. It’s a focused approach. A concentrated approach. You don’t have a lot of time. So, you need to spend that time focused on what matters most. Stock selection is what matters most. So, first I want you to give up the idea of selling stocks. Don’t worry about it. You’re only going to sell one stock to buy another stock. You’re not going to sell a stock because it is now too expensive, the situation has played out, etc. Okay. So, we’ve cut out about half the time investors spend thinking about stocks. You can now devote all the time you would have spent thinking about selling the stock you already own and instead double the time you will spend thinking of the next stock to buy. I also want to eliminate the idea of portfolio management – asset allocation, diversification, etc. – from your schedule. So, I’m going to ask you to commit to identically sized positions. By this I mean the positions will be the same size when you buy them. So, if you are comfortable being as concentrated as I am – then you’ll want to set 20% as your position size. You’ll own just 5 stocks. If you want to be more diversified – you can settle on owning 10 stocks at a time. That’s fine. But I don’t want you to have some 5% positions and some 20% positions. If you are going to own 10 stocks at a time – make every position a 10% position. If you want to be really, really diversified – you can own 20 stocks at one time. In that case, every time you buy a stock – you put 5% of your portfolio into the stock. There’s no point owning more than 20 stocks. It doesn’t do much to diversify any risks. And it does distract you from what matters most – deciding which stock to buy next. So, start out by making that decision now. Do you want to own 5 stocks, 10 stocks, or 20 stocks? Do you want to put 20% into each stock, 10% into each stock, or 5% into each stock? Make that decision now. And then that rule is set in stone for you. Never vary how much you put into a specific stock. This will keep you from being distracted by concerns about how much you like a stock – how much you “should” allocate to it. The answer is that you should allocate the same amount as you always do to every stock you like. Now, you can focus 100% on finding stocks to buy.


The next thing you need to do – if you only have an hour a day to spend on investing – is to commit to holding stocks for as long as possible. This is critical. I was talking to someone recently who considers himself a buy and hold investor. And yet he found that over the last year – when he was pretty happy with his portfolio – he still had portfolio turnover of about 30%. That means, on average, he was holding stocks for only about 3 years. And he probably had years – years where in January he liked the stocks in his portfolio less – where his turnover was more than 30%. Let’s think about the difference between owning stocks for an average of 2 years – as even many value investors do – and owning stocks for an average of 5 years. I want you to try to get closer to the 5-year holding period. Why?


The three choices I gave for diversification were a portfolio of 5 evenly weighted positions, 10 evenly weighted positions, or 20 evenly weighted positions. The ideal situation in terms of focused attention is a 5-stock portfolio and a 5-year holding period. That’s because this is a low maintenance portfolio. The “maintenance” level of idea replenishment is just one great idea per year. You have an hour a day to spend on investing. If you spend that every day – including weekends – that means you have 365 hours to spend picking just one stock. Coming up with one good idea for every 365 hours you spend looking for one sounds easy, right? Even if you don’t work on investing on the weekends – it’ll still be 260 hours of thought to come up with just one idea. Now, what if you own 10 stocks and hold them each for 5 years? Then your idea replenishment rate has to be 10 stocks / 5 years = 2 stocks a year. If you’re only spending 260 hours a year on investing – we’re down to 130 hours spent coming up with one idea. At 20 stocks / 5 year holding period it’s 4 stocks a year. And that’s only 65 hours of thinking per idea. Think of the worst-case scenario here: a portfolio of 20 stocks that you only hold on average for 2 years. Some investors do invest that way. How can they? You’re still committing to just 260 hours of focused thought on investing. But now your replenishment rate is 20 stocks divided by a 2-hour holding period equals 10 stocks. You’d need 10 new stock ideas this year. You only have 260 hours to spend thinking about investing this year. So, you’d have to come up with one great idea every 26 hours. That’s less than a work week (40 hours) of thought to come up with a great stock idea. Who can do that? You’re going to end up relying on other people’s judgment. Because you aren’t going to have enough time to form an opinion of your own.


Let’s go back to the ideal. You spend an hour a day – including weekend. You only hold 5 stocks. And you hold each of them for 5 years on average. That’s 365 hours of thinking for just one great idea. This is what I want every value investor to reach for. Come as close to spending one focused hour a day on investing as you can. Come as close to keeping stocks for 5 years as you can. And come as close to owning just 5 stocks as you can. Most investors will fall short of each of these 3 goals. But these should be the goals you’re reaching for.


So, what kind of stocks should you spend this 365 hours a year looking for? And where can you find these ideas? You want great businesses that are having temporary problems. You want a list of companies you might one day own. Where can you come up with such a list? GuruFocus has a Buffett-Munger newsletter, it has a Buffett-Munger screen, and it shows 15 years of financial data for stocks. Look for the predictable ones. You can use ratings on this. But, look yourself at predictability as you would judge it – not just as a computer program would. Do you see a dependable history of EPS stability, EPS growth, margins, returns on capital, etc. I look at operating margin (EBIT) margin volatility. That’s always my favorite measure. In my experience, most companies – by which, I mean most managers who run the day-to-day business of each unit, location, etc. – don’t want to do less physical volume this year than last year and they don’t want to have a thinner profit margin. They like doing a little more physical volume – unit volume – than last year and they like making a little more profit per dollar of sales than they did last year. They are frightened by the idea of falling volume and falling margins. So, the competitive pressure in a lot of industries is toward protecting volume and protecting margin. When volume declines – a company may try to lower prices, increase marketing, etc. When margins decline – a company may try to cut overhead, look for synergies, cheapen the product, etc. We often don’t have good unit volume data. In fact, most public companies are too diversified across too many different product lines to have consistent reporting on unit sales and pricing per unit. Some commodity type businesses do have data on this. A miner, a steelmaker, an airline, a hotel, etc. has good data on this. But all companies have data on EBIT margin variation. So, that’s what I look at. EBIT margin is just pre-tax operating profit divided by sales. The level of the EBIT isn’t what’s important to me. In a business like software you could have an EBIT margin of 30%. In a business like groceries you could have an EBIT margin of 3%. What matters to me is how likely it is that the 30% margin for the software company is going to stay in the 20% to 40% (plus or minus one third of the average), and how likely the margin of the supermarket is to stay in the 2% to 4% range (plus or minus one third of the average). That’s really the same thing. So, stability in the EBIT margin has to be defined as variation scaled to the mean. For a company that has been profitable in each of the last 15 years – you could use 15-year average Standard Deviation / Mean. That’s a number I track in Excel. I prefer industries where EBIT margin variation (defined as the Standard Deviation in the 15-year EBIT margin divided by the 15-year mean EBIT margin) is low. And I like those companies in an industry who have the lowest EBIT margin variation. These are usually the least marginal players. They are leaders in their market niche. The weakest companies in an industry – especially those that compete primarily on price – often have wobbly EBIT margins compared to the leaders. It’s not a perfect measure. Scale can be a problem. Some companies have wobbly EBIT margins simply because they aren’t big enough to enjoy economies of scale. These companies may not be good investments yet – but they are good takeover targets for the bigger companies in the same industry. So, this isn’t a perfect measure. But some measure of predictability – whether it’s EBIT margin variation, or GuruFocus’s predictability measure, or your own eyeballing of the 15-year history, is a good place to start your search for ideas.


You can read blogs and articles. I recommend the GuruFocus articles written by “The Science of Hitting”:


And the blog “Base Hit Investing”:


There are also idea boards like “Value Investor’s Club”:


I don’t recommend Value Investors Club the same way I do the blogs and articles I mentioned above. A lot of that board is short-term oriented, interested in shorting, etc. And the quality of the ideas is very hit or miss. So, I’m not suggesting VIC on the basis of idea quality. Just quantity. It has a ton of different stocks that have been posted there over the years and those stock ideas come with plain English descriptions of the business and its possible competitive advantages. So, it’s a good place to peruse.


One caveat: if you’re going to read articles and blogs – don’t read them willy nilly. Block out your article and blog reading times. So, don’t read one article of mine at a time or one “The Science of Hitting” article or “Base Hit Investing” blog post. Instead, identify the articles you are interested in as you find them. But then print them out and put them aside till the end of the week. I want you to spend a full hour of total focus reading the blog posts, articles, etc. you thought you’d be interested in. Don’t just dip in for 15 minutes at a time reading blog posts, articles, newspapers, etc. as you come across them during the week. Put them away in a folder till you are ready to focus on them.


This is what I do. I have baskets that I fill with reading material during the week. Then I tell my Amazon Echo to set a timer for one hour and I read as much of the material as I can get through. I put the rest aside till later and do this again. I read with a pen in my hand and mark up the articles, posts, etc. I read with questions of my own. This ensures I’m 100% focused and 100% engaged with the material. Most people who read an article or blog post are neither fully focused on it nor fully engaged with it. They just read it passively for 10 or 15 minutes and then move on to the next unrelated task. They may have just been checking their email a minute before and will be checking their phone a minute after. Don’t do this. Create a “batch” of reading material you’re interested in. Set a timer for one hour. And then do nothing but read that material for that hour. An hour a day is plenty to spend on investing. But you have to spend it 100% focused.


For more information on how to do this kind of focused work you can read the book “Deep Work: Rules for Focused Success in a Distracted World” by Cal Newport. I’m recommending the subject. I’m not really recommending the book as a book. It’s not a great book. But it’s a great subject. And I’m sure you’ll get something out of reading the book if you haven’t already.


So, my five suggestions for someone who only has an hour a day to spend on investing are: 1) Read “Deep Work: Rules for Focused Success in a Distracted World” 2) Spend all your investing time focused entirely on selecting which stocks to buy 3) Read articles from authors like “The Science of Hitting” and blogs like “Base Hit Investing” – but only in hour long focused batches of reading material 4) Use tools like GuruFocus’s predictability ratings and 15-years of financial data to find the most predictable businesses and 5) Buy great businesses that are going through temporary problems.


Talk to Geoff about How to Invest When You Only Have an Hour a Day to Do It