The Poor Investor

Investigatory Value Investing

Message from Natcore’s CEO

Last post I wrote about Natcore Technology. The president wrote a message to shareholders on the website that I thought was important enough to share considering my previous post. Here it is below:

I think it was the 1970s when I first realized that it was no longer possible to buy a television set that was made in America.
As time went on, I began to notice other products that had suffered a similar fate: stereo equipment, digital cameras, and small appliances immediately come to mind. I’m sure you could add to the list.
And I realized this: Whoever owns the technology owns the industry.
We at Natcore are determined that the solar industry will not go the way of the transistor radio. For that reason, much of our time is spent in developing and protecting our solar technology. We are determined that the solar industry will be based on our home soil.
We’ll soon convene a series of meetings with our scientific brain trust, whom we believe are the greatest solar scientists in the world today. This distinguished cadre includes:
Dr. Dennis Flood, Natcore co-founder and Chief Technology Officer. A NASA veteran, with more than 30 years’ experience in developing solar cell and array technology for both space and terrestrial applications.
Dr. Andy Barron, Natcore co-founder. The Charles W. Duncan, Jr.-Welch Chair of Chemistry and Professor of Materials Science at Rice University, as well as a visiting Professor at the University of Wales.
Dr. David Levy, Natcore Director of Research & Technology. A Chemical Engineering PhD, with a minor in Electrical Engineering, from MIT, then 20 years as a research scientist at Eastman Kodak.
Dr. Daniele Margadonna, Chairman, Natcore advisory board. Chief Technology Officer of MX Group SpA in Villasanta, Italy. An international expert in the solar photovoltaic industry with extensive experience in the planning and construction of turnkey photovoltaic plants.
Dr. David Carlson, Natcore advisory board. Until his recent retirement, the chief scientist of BP Solar, for whom he managed future technology programs and the intellectual property system. He invented the amorphous silicon solar cell at RCA Laboratories
Our multitalented technicians—Ted Zubil, Rich Topel and Wendy Ahearn– will participate, too. They’re an impressive bunch: they have 26 patents among them.
The meetings will be held at our Research and Development Center in Rochester, NY. Their purpose can be expressed in these questions: What are the strengths of our technology? What are the weaknesses? How can we maximize the strengths and fix the weaknesses? How can we most quickly move our technology from the lab to the production line?
Incidentally, we’ve finally consolidated all of our R&D work in Rochester. So there will be no more need for routine travel to university labs in Ohio, Arizona, and Texas. (Just to let you know how much money this will save us, we’re paying for Dr. Margadonna’s flight from Italy with airline miles accumulated from our past travel.)
In my next President’s message, I’ll report on the results of these meetings.
Sincerely,
Chuck Provini, President, CEO & Director


Disclosure: Long NXT.V

The Paradox of Penny Stock Investing

A lot of investors keep a portion of their portfolios for speculating in the stock market, often referred to as “fun money” by many.  This percentage generally ranges from 1-5% of an investor’s portfolio.  This is the portion of a portfolio that you’d use to bet on stocks that usually have more potential than actual substance; this often times means betting on penny stocks or stocks trading on the OTC market or pink sheets.  Keeping a portion of your portfolio dedicated to this endeavor is like having a release valve for your portfolio.  Many investors may find it to be quite cathartic.  It should be noted, however, that this is not for everyone.  You still have to remain extremely disciplined and, in a sense, compartmentalize the speculative portion of your portfolio to some extent.

Now, you’re not going to read about how to invest speculatively in “The Intelligent Investor” or “One Up on Wall Street,” two of my favorite books, as you might recall from this post.  However, this does not mean that speculative investing shouldn’t be part of your portfolio and shouldn’t be taken just as seriously as your overall investing philosophy.  A sound philosophy should be developed for the “fun money” portion as well.  The goal, just as with the larger portion of the portfolio, should be to minimize risk.  Just because you are speculating with this small part of your portfolio doesn’t mean you want to lose the money any more than you normally would.

There are many types of ways to speculate in the stock market but generally I tend to think of this as focusing on stocks at the low range of the micro cap world, or penny stocks (those interested in options trading, commodities, currency speculation, and other activities such as these should look elsewhere).  These are companies usually trading for a market cap less than $100 million.  Although these stocks should be analyzed just like other stocks in your portfolio there are several particular areas you really need to go over using a fine-toothed comb:

  • Legitimacy
  • Management
  • Growth

The first portion is business legitimacy.  This means that you should be scouring the SEC (or other) filings of the company and looking for any red flags.  It means that you should be evaluating the company as if you were going to start working there the next day.  If you wouldn’t work there, you wouldn’t want to buy the company, surely.  This means you should be asking questions like:

  • Has this company been around for at least 3 years?
  • Does the product/technology/business make sense?
  • Does the company keep issuing shares only to line executives’ pockets and dilute existing shareholders?
  • Is there an inordinate amount of outstanding shares?
  • How is the company financing itself?
  • Does the company carry too much debt?
  • Do insiders own a large portion of the company?
  • How does the company treat its employees?
  • Is the company hiring a lot of new employees?
  • Does the company have reputable partners or do business with those of high repute?
  • Does the company provide sufficient information/transparency to its shareholders?
  • Are the small shareholders valued?

This is by no means an exhaustive list.  But questions along these lines should be asked and the answers you get to them should make you feel comfortable.  If you don’t find an answer you like, find out why and see if it makes sense.  If you find too many red flags in this portion of the process, don’t even move on to next examination step, just move on to the next company.

The next portion is management.  Many times with small companies it’s good to see management that has been around since the company’s inception.  It’s not necessarily a red flag if they haven’t, or the green light if they have, but as a general rule of thumb this should be the case.  Lots of times, with small companies, you can actually call the management and ask questions that concern you.  When speaking to the management try to get a sense of whether or not these are people you can trust.  You should ask yourself several questions after speaking to management:

  • Are they open to honest inquiry?
  • Do they evade or avoid certain questions?
  • Do the answers they give make sense?
  • Do the answers correlate with what you’ve read about the company?
  • Does what they say actually pan out? (wait a bit and see if what is said comes to fruition)

Other factors to consider when looking into the management of such companies are:

  • Have they invested their time, money, blood, sweat, and tears into the company?
  • Do they own a lot of the stock so that they eat their own cooking?
  • What are their credentials?
  • Are they accountable to anyone?
  • What is the track record of management, especially the CEO?
  • Is there sufficient diversity on the management team and BOD?

Again, this is not an exhaustive list, but gets you thinking along the lines you need to be thinking when looking into more speculative companies.  Act like you are a detective looking for any signs or hints of fraud and steer clear when things start to smell funny.

In the back of your head, you should have already considered the growth prospects of the company in question or it wouldn’t have even be worth looking into in the first place.  However, it should be noted that many micro cap or penny stock companies might look like good growth opportunities but the growth could actually be very limited.  For instance, the company could be in an extremely high growth market such as biotech or pharmaceuticals, but markets such as these mean that competition is going to make it very difficult for the company to actually succeed.  This means that the growth prospects should be tremendous (if you’re going to speculate, don’t speculate with a company that’s going to hit a home-run,  instead, think multiple grand slams).  Some aspects of growth you might want to look into are:

  • What are the odds of market penetration?
  • Are the competitive advantages big enough and sustainable?
  • Does the company have multiple patents? How solid are the patents?
  • Are there large partners aiding the company’s growth/penetration?
  • Does the company operate in a niche market within the growing market?
  • How does the company plan on funding growth?
  • Does the company have an expansion plan in place so that it can grow successfully?
  • If growth/market penetration has been proven already, how likely is it to continue?

Once again, this is not an exhaustive list, but how you should be thinking about the growth of the company.  Also, you should be comfortable with the answers to these questions and any other questions you decide are pertinent.  Above all, don’t make excuses for the company!  If you get answers that don’t jive with you, move on.

Last but not least, try to attend at least one shareholder meeting of the company.  This will give you a chance to get up-close and personal with management as well as bounce questions off of other shareholders.

A good example of an interesting speculation from my portfolio is Natcore Technology, a solar company headquartered in New Jersey.  While I won’t go into laborious detail about the company and how it fits the criteria mentioned above, I will mention some highlights.   The company was founded in 2009 when it bought out a company of the same name— thus clearing my 3-year hurdle.  The company trades on the TSX Venture exchange, a very well-regulated exchange, in Canada and the company reports regularly.  The company is headed by Chuck Provini, a former US Marine and graduate from the US Naval Academy.  He has at least 19 military decorations, was a captain in the Vietnam War, and has lived his whole life in the United States.  The rest of his bio can be found here.  The CEO has been very forthright with shareholders and encourages shareholders to call him if they have any questions.  He even issues regular statements via the Natcore website.  And, although he is surrounded by several other individuals with pretty extended resumes, the one that stands out the most is Dennis Flood.  Dennis Flood is the CTO of the company and has worked in the solar industry for over 30 years.  He worked at NASA where he developed photovoltaic power systems for space and planetary missions.  A more extensive bio is seen below:

“He received two Special Act or Service Awards from NASA for his pioneering work on advanced solar cells for space applications and for research that established the feasibility of powering a human outpost on the surface of Mars with solar energy.

Flood also served as chair of the IEEE Electron Device Society’s (EDS) photovoltaic device technical committee for seven years and as a member of the IEEE EDS education committee. He also participated in the EDS’s Distinguished Lecturer Series, a position he held for more than a decade.
He is a member of the international advisory committees of the European, the U.S, the Japan/Asia and the World Photovoltaic Conference organizing committees.

He is an inventor or co-inventor on several patents or patent applications in photovoltaics and nanotechnology and has over 100 peer-reviewed publications and presentations in solar energy, electron devices and materials science.”

Source: PV-Tech.org

Natcore has several patents.  It has also been granted a license to use the Department of Energy’s black silicon technology.  This allows more light to be absorbed so that solar cells are more efficient.  However, the patent which holds the most promise is the company’s Liquid Phase Deposition technology.  You can read more about this technology and the benefits here, but in a nutshell, this technology allows the company to manufacture solar cells at a much lower cost than they are currently being manufactured.  Combine that with the company’s latest selective emitter technology and the cost is further reduced.

The CEO explains the company’s technology here.

The company’s technology is breakthrough, to say the least.  It could completely change the solar industry.  If you research the company some more you’ll see a myriad of great accomplishments.  So, you might be wondering, with so many “great things” going on, why is this company speculative?   Well, the company has yet to generate any revenue.  It is still working on commercializing the technology and proving the cost benefits of the technology.  The company has reached several milestones and has been making forward progress but it has nothing to sell as of yet.  Although it is working on what it calls the “AR-BOX” as its first commercialization effort, it is not ready for commercialization yet.  So questions remain.  Will the company prove that its product is commercially viable?  When will it be ready?  Will the company produce significant enough revenue with large enough margins if/when the product is ready?  Will the market adopt the product even if the company does prove it?  Several more questions like this remain.  That’s why this is speculative.  There is nothing to go off of except for future hopes and dreams of revenue.  Although the company has been marching towards that territory, there is nothing to sink your teeth into as an investor to figure out what the margin of safety is here.  This is why a small percentage of my portfolio is dedicated to this type of investing.

At the end of the day, many investors should avoid speculating.  It can be tempting to get carried away and not keep the speculative portion of the portfolio below 1-5% and sell when the speculate portion rises well above this point (assuming you adopt the 1-5% strategy).  Investors often ride a speculative investment up just to ride it back down again.  There is often times more discipline involved in speculation than there is with regular investing and many investors have enough trouble maintaining discipline with their regular strategies.  So, this is only for the bold, disciplined, and cautious investor.  It almost sounds like a paradox, being disciplined to be speculative, but it’s impossible to be successful at speculation without the discipline.  Otherwise, your “fun money” will be “dumb money,” which defeats the whole purpose of allocating a portion of your portfolio to speculation in the first place.  You might as well just cash out 1-5% of your portfolio a year and burn the money if you aren’t going to follow a disciplined approach.

Disclosure: Long NXT.V

Pawn Stars, Shark Tank, and Investing

Two of my favorite television shows are Pawn Stars, on the History Channel, and Shark Tank, on ABC.  These shows entertain, and most importantly, inform viewers.  A lot can be learned from both of these shows.  A lot can also be learned from the characters on these shows.  Rick Harrison, part owner of the pawn shop with his father and son, is one such character;  Kevin O’Leary, from Shark Tank, is another.

Rick Harrison started in the pawning business at age 13.  He co-founded the Gold & Silver Pawn Shop in 1988 with his dad, Richard Harrison, at age 23.   When Rick was 8 he had his first grand mal epileptic seizure and was bed-ridden for most of his childhood.  This proved to be fortuitous as he developed his love for reading during this time.  He read lots and lots of books.  One book series he particularly enjoyed was The Great Brain by John D. Fitzgerald, about a boy who always had new schemes to make money.  No need to explain the irony here.  His love of reading became the foundation of his life as he found his love of curiosity and knowledge.  He finds television boring, also ironic in that his show is one of the top hits, and finds reading to be the most exciting way to pass time.  Described in his own words, from his book, License to Pawn, he says “…much of the enjoyment I’ve gained from life has stemmed from a book — either researching some arcane item or reading to learn how to do something practical with my hands.”

So what can we, as investors, learn from Rick Harrison?

  • His love of knowledge and reading is extremely beneficial.  For him, knowledge of an item is key to buying it for the right price.  He also discovers items at antique stores and other pawn shops because of his knowledge.  It is no different in investing.  You must love reading and knowledge.  This includes reading “arcane” material as often times lesser known information can give you a leg up on other investors.  It can also help you find rare opportunities like Rick.  Many of the most successful investors are avid readers.  Warren Buffett admits to loving to read annual reports.  His partner, Charlie Munger, put it best when he said, “In my whole life, I have known no wise people (over a broad subject matter area) who didn’t read all the time – none, zero. You’d be amazed at how much Warren reads – at how much I read. My children laugh at me. They think I’m a book with a couple of legs sticking out.”
  • He knows how to say no.  Rick always turns down items if the price isn’t right and he can’t make a solid return on his investment, even if he loves something.  In investing, you have to learn to pass on many opportunities.  A company many be attractive but the price may not be right.  Other times, the company isn’t right.  Sometimes, you may really like the company or its products but the management is running it into the ground.  These are just a few of the many reasons to pass on a potential company or stock.  No matter how much you like some investment, or some aspect of any investment, you have to learn to say no.  As Peter Lynch says, in Beating the Street, “Never fall in love with a stock; always have an open mind.”
  • If the price is right, he sometimes takes a perceived gamble.  If Rick sees an item that he thinks could be worth $100 to $2500 bucks, sometimes he’ll buy it for $500 dollars because the potential return is so high it’s worth the risk.  Now, why do I call it a perceived gamble?  It all comes down to expected value.  Rick might have an 80% of losing $400 here and a 20% of making $2000.  His expected value is $80.  On average, if he makes bets where the expected value is positive he comes out ahead.  So, it’s not really a gamble.  He’s also not betting the house here, he’s only risking $500, not $1,000,000.  He’s not going to risk his store on something that might be fake.  As such, sometimes you might decide to go after a stock that’s a long shot but has a positive expected value according to your calculations.  So, putting 1-5% of your portfolio in it might be worth it.  The problem with this is that the math will never be 100% accurate in investing.  This is why I say sometimes.  You do it when you’re more certain about the odds — something that won’t happen very often, if ever.  You cannot build a portfolio, or a business for that matter, going after long shots.  A good analogy is found in baseball.  It’s best to swing at the pitches right down the middle and hit base hits with near 75% certainty than swing for home runs, out of the strike zone, with 5% certainty of hitting one.  You can score a lot more points with the base hits.
  •  He always pays a lot less for something than it’s worth.  If he believes an item is worth $2000 or an expert tells him he can get $2000-5000 for an item, he never pays $2000 for it.  He’ll usually pay something like $1500 for the item to make sure he can profit off of it.  In investing, this is called margin of safety.  You don’t buy stocks to make 1% off of them.  You factor in a larger margin of safety than that, perhaps 20% or so, in case you make a mistake.  Why?  Because you, and Rick Harrison, never know what someone will actually pay for something, be it a stock or a piece of antique furniture.  The stock could actually be worth $1.10, you pay $1.05 for it, but the market might never price it at $1.10.  Just like the item Rick bought might be worth $2000, but he might only be able to get $1800 in the market.  
  • Always factors in the amount of time it will take him to sell something.  When Rick buys an item, like a book, that might take a lot longer to sell than, say, a signed Beatles album, he factors that in to what he’ll pay for it.  It also takes up room in his store for a longer period of time.  Just like if you buy a stock that might take 3-5 years to appreciate in value versus one that might take only 6 months to 1 year to appreciate the same amount, you would want to pay a lot less for the former to factor in opportunity cost, inflation, and the time value of money.

A lot more could be said about the show, and Rick, as it relates to investing, but suffice it to say the show is full of tidbits and useful information that can work to your advantage as an investor.

Likewise, Shark Tank is also a great show for an individual investor to watch.   While I won’t go much into the show and how it relates to investing, as a lot of this is self-explanatory for anyone who watches it, it may, or may not, surprise you to know that Kevin O’Leary, known as “Mr. Wonderful” on the show, also runs his own mutual fund.

Besides being a television personality, Kevin O’Leary is a Canadian entrepreneur and investor.  He started a software company called Softkey with $10,000 from his mother and grew the company to ~$3.8 billion when it was purchased by Mattel (at that time it was known as The Learning Company).  He also had several other successes that you can read all about in his book.

O’Leary Funds was started in 2008 when Kevin O’Learly was looking for someone to manage his money but couldn’t find the right person.   The company was co-founded by Connor O’Brien.  The company’s philosophy is simple, to “provide investors with value and yield.”  It does that through three core principles, “income, capital appreciation, and capital preservation,” according to the company’s website.   The company also describes its funds as being long-term oriented and disciplined.

So what is Kevin O’Leary’s investing philosophy/approach?

  • He never buys a stock that doesn’t pay a dividend.  This is something his mother taught him long ago and he firmly believes in it.
  • He buys companies that are growing free-cash flow and calls earnings “mumbo-jumbo,” saying, “you can’t lie about cash.”
  • Believes commodities aren’t attractive but the service providers are, saying, “I’d rather own the pipeline than the oil that flows through it.”  He believes if you own commodities you are speculating, not investing as commodities don’t produce a yield.
  • Thinks diversification is the only “free lunch” in investing and that you should not dedicate more than 5% of your portfolio to one investment.  He also owns multiple currencies as a way of diversifying.
  • Uses gold as a “buffer,” or “stabilizer,” and leaves it at 5% of his portfolio.  Gold, to him, is not an investment, merely a hedge that he sells when it becomes more than 5% of his portfolio and buys when it becomes less than 5%.
  • Likes to invest in countries where GDP is growing at >3%.  Some examples he gives are Brazil, India, and China.
  • Believes China will overtake US global economic leader and invests accordingly.
  • 5% of his net worth goes to venture deals.
  • Believes people should invest 20% of your earnings the day you start working for the rest of your life.
  • Believes people should always “spend the interest, never the principal.”

Here is an example from his “Global Equity Yield Fund” of what he is buying:

While a lot can be learned from these two individuals about investing specifics, the most important lesson lies between the lines.  What makes Rick Harrison and Kevin O’Learly so successful at what they do is their passion and discipline.  They believe in what they do and they hardly ever deviate from their rules.  The times they do, you can watch with your own eyes the lessons they learn and exactly how they get burnt by not being disciplined.  You can even hear in their own words why they don’t do this or that because they have learned from their mistakes.  Above all, they’re nice and honest guys (despite the fact that Kevin is seen as cold-blooded on the show).  So turn off Mad Money with Jim Cramer, because it will only drive you mad as you watch all your money fly out the window, and turn on Pawn Stars and Shark Tank and actually learn how to be a successful investor.

Apple’s Stock and the Voting Machine

Peter Lynch put it quite simply by saying, “Buy what you know.”  Now, I’d be remiss if I didn’t mention that there was a study showing this often does not work.  Here, however, it does.

The other day I walked into an Apple store to check out the iPad mini.  It was like walking into a swarm of bees in a beehive.  People were everywhere.  Everyone I know loves Apple’s products and owns at least 1 apple device.  Those I know who don’t own an Apple device plan on buying one in the near future.  I’ve used other products, talked to others who use other products, and everyone admits these devices aren’t as good as Apple devices, this includes: phones, computers, MP3 players, portable tablets, etc.  Apple products are vastly superior in every category, there’s really no debate.  The only reason you wouldn’t buy an Apple product is because you were interested in saving money, with plans to purchase one in the future when the price goes down.

As for the current state of Apple’s stock, Peter Lynch has something else to say about that:

“When even the analysts are bored, it’s time to start buying.”

There’s no question that analysts are bored with Apple, but, really, who cares?  Apple’s stock is a no-brainer at $431.72 as I type right now, March 10, 2013.  The company has $137b in cash.  With that amount of cash Apple could buy Ford and Honda and almost have enough money left over to buy Tata Motors at the companies’ current market valuations.  This is an insane amount of cash for one company.  If Apple has any problem, it’s having too much cash, not the worst problem a company could have.  Personally, I think Apple should follow in the footsteps of IBM and buy a massive amount of its own shares.  Its current share buyback program only allots $10b for this endeavor.  With $137b in cash, that is chump change.

Apple, according to a recent press release, plans on returning a lot of that cash to its shareholders:

“Apple’s management team and Board of Directors have been in active discussions about returning additional cash to shareholders. As part of our review, we will thoroughly evaluate Greenlight Capital’s current proposal to issue some form of preferred stock. We welcome Greenlight’s views and the views of all of our shareholders.”

Cash considerations aside, Apple trades at a current P/E of 9.79.  This is well below the 5-yr. average P/E of 15.6.  Furthermore, Apple’s P/E has never been so far removed from the S&P 500’s P/E as it is now, trading at ~40% below the S&P 500’s (~43% below the Nasdaq’s), with Apple’s average P/E being 64% above the S&P 500’s since 2003.

If the P/E is any indication of investors’ expectation, they don’t seem to believe that Apple will grow much faster than ~10% per year.  However, over the last 5 years Apple has increased earnings by an average of 63% per year.  If Apple continues growing at even half that rate, you’d be looking at EPS of ~$174 by 2017.  This would equate to a share price of $1703.46 at the current P/E.  Now, I must reiterate, this is the half-growth scenario.  Staying at the average current growth rate would mean a share price of $4973.32.  Now, my hypothesis is that we land somewhere towards the lower end near $1703, taking into consideration that the market discounts the future and that the company is not going to realistically grow into being 20% of our economy— but this would still amount to almost a 4-fold gain in under 4 years.  Furthermore, either way growth pans out, you’re looking at what could be over a trillion dollar company sometime in the 2014-2015 range.

With growth and P/E considerations in mind, read these quotes by famous P/E investor John Neff:

“Low p/e multiples usually languished 40 percent to 60 percent below prevailing market multiples.”

“Low p/e companies growing faster than 7 percent a year tipped us off to underappreciated signs of life, particularly accompanied by an attention getting dividend yield.”

As shown earlier, the p/e multiple does languish more than 40% below prevailing market multiples.  Also, Apple is growing much faster than 7 percent with a pretty astonishing dividend, for what I still deem a “growth company,” of 2.46%.

Peter Lynch would love this stock, especially when looking at the P/E in terms of the growth.  While Yahoo gives a PEG of 0.5, Peter Lynch looks at it a slightly different way.  He takes the long-term growth rate, which I estimate on the low side to be 30% (Yahoo’s estimate is 20%), adds the dividend yield, 2.46%, and divides by the P/E ratio, 9.79.  This gives 3.3 for my estimate vs. 2.3 for Yahoo’s.  In One Up on Wall Street Lynch describes the interpretation of these values as the following:

 “Less than a 1 is poor, and 1.5 is okay, but what you’re really looking for is a 2 or better.”

He goes on to give an example of a stock that scores a “3” and deems it “fabulous.”  If we say that the number will most likely fall somewhere between these two estimates, 2.3-3.3, we’re looking at a stock Peter Lynch would undoubtedly rate as a “strong buy.”

Now, there are concerns that Apple’s moat may be drying up as companies like Google continue to steal market share.  However, in this analysis a margin of safety was added by considering Apple’s stock in light of growth drying up 50%, which isn’t likely to happen.  You have the new Macbook Air coming out, iPad 5, iPad mini 2, iPhone 5s, iMac, Mac mini, just to name a few.  And according to CEO Tim Cook, new products in new categories are on the horizon.  Some anticipate the iWatch as one.  The bottom line: it doesn’t matter what is on the horizon.  Apple could make a car and people would buy it just because it is an Apple product.  Even if Apple didn’t come out with any new products, looking at the company from a zero growth perspective, seen here (provided by Old School Value) for those interested in more advanced valuation methods, Apple’s stock has significant downside protection.

As was said by many great value investors, “Protect the downside and the upside will take care of itself.”

Let’s forget the growth concern altogether. A huge aspect not talked about very often is the strong IP position Apple has, illuminated below, from this article:

“…Apple is falling back on its IP portfolio to protect its market position. Generating revenue by suing other companies is not the ultimate goal of Apple’s recent lawsuits. Rather, each case that Apple wins confirms the validity and enforceability of its patents to its competitors. Apple can then license its patented technologies and designs and charge Google and other competitors for using them, piggybacking on their competitors’ success.

It would appear that Apple’s business model is evolving into two modes. First, use a closed model to develop innovative technologies for sophisticated user markets; patent the utilities and designs that the company engineers. Second, license those utilities and designs to businesses that wish to use them. So long as Apple continues to be the first of its competitors to patent new technologies, combining both modes would create serious revenue for Apple and help it maintain its leadership position.”

So… to reiterate the absolute absurdness of this price and to lighten things up a bit, watch this video of Bill Maher and his guests talking about Apple:

And although this video is older, I still find it extremely relevant to this post:

As Ben Graham famously said, “In the short term, the stock market behaves like a voting machine, but in the long term it acts like a weighing machine.”  Long-term shareholders that buy Apple at this price can take advantage of this phenomenon.

Disclosure: Long AAPL

Housekeeping

All my “ranting” about Dell has been moved over to Twitter as I believe that is a better forum for those types of conversations.  Although I still disagree with the price offer, I believe that the valuation is being properly looked into at this point.  I have since sold my stake in the company, which may be premature depending on how everything pans out, but I believe there are other opportunities which offer more certainty at this juncture.  In the future, any comments that are aimed at individual companies that do not help to illuminate a particular point or idea will be directed to Twitter as I believe that is a more appropriate venue.

The Investing Book You Haven’t Read

As a do-it-yourself investor, I love to read investing books. However, there are only a few books that have really had great educational value, the rest were merely entertainment.

Here are the books which have helped me the most:

  1. One Up on Wall Street, by Peter Lynch
  2. The Intelligent Investor, by Benjamin Graham
  3. Poor Charlie’s Almanack, by Charles Munger
  4. Common Stocks and Uncommon Profits, by Phil Fisher
  5. What Works on Wall Street, by James O’Shaughnessy
  6. See below.

Most of these books you’ve probably heard of or read yourself. If you haven’t read them, I suggest you do if you plan on investing on your own. However, there’s one more book (6) that also goes on this list that most people haven’t read. This book, in my opinion, is essential to the go-it-alone investor. The book is called “100 to 1 in the Stock Market,” by Thomas Phelps. The only problem is the book is out of print and hard to find. Your best bet is borrowing it from your local library.

Thomas Phelps offers some good advice as to what to look for when trying to find a 100- to-1 investment:

  1. Inventions that enable us to do things we have always wanted to do but could never do before. 
  2. New methods or new equipment that helps people do commonplace things easier, faster or at less cost than ever before.
  3. Processes or equipment to improve or maintain the quality of a service while reducing or eliminating the labor required.
  4. New and cheaper sources of energy.
  5. New methods of doing essential jobs with less or no ecological damage.
  6. Improved methods or equipment for recycling the materials used by civilized man instead of making mountains of waste and oceans of sewage.
  7. New methods for delivering the morning newspaper without carriers or waste.
  8. New methods or equipment for transporting people and goods on land without wheels.

He even gives 365 examples of 100-to-1 stocks (from 1932-1971) which could have turned $10,000 into $1,000,000 if bought right and held tight.  Some of  the more familiar of these include:

  • J.C. Penney Co.
  • Deere & Co.
  • Abbott Laboratories
  • Dr. Pepper
  • Lockheed
  • Greyhound Corp.
  • Philip Morris
  • Merck & Co.
  • Goodyear Tire & Rubber
  • Motorola
  • International Business Machines
  • Johnson & Johnson

These stocks all gained at least 100x their original value and some obviously much more.

Let’s say you decided to invest using Mr. Phelps’ method using $10,000 (+any additional money for fees).  Furthermore, say you decide to devote a year to trying to uncover 25 stocks which you thought fit the bill as 100-to-1 type companies.  After this, you divide your money equally into the 25, buying $400 of each company, and hold them for 20 years.  If you only identified 3 out of 25 stocks that went 100-to-1, and say the rest went to zero, even factoring in that year you were looking for the stock, you would have a compound annual growth rate of 12.56%, and $120,000.

Here is the CAGR for identifying 1 out of 25 to 10 out of 25:

  1. 6.82%
  2. 10.41%
  3. 12.56%
  4. 14.11%
  5. 15.33%
  6. 16.34%
  7. 17.20%
  8. 17.94%
  9. 18.61%
  10. 19.20%

Even identifying 2 out of 25 is nothing to scoff at, which beats the average S&P 500 return, including dividends, by ~1%.  Not to mention, this method does not include the dividends you might gain from the companies you invest in.

This method, just like any other, is not fool-proof—and although I don’t know the odds, common sense tells me that they are heavily stacked against you in trying to find 100-to-1 type companies.  Keeping that in mind, I leave you with a parable Mr. Phelps shares with us in the beginning of his book:

“Ask and It Shall Be Given to You”

Five poor Arabs slept on the sand. A bright light woke them. Out of it came an angel.
“Each of you can have one wish,” the angel said.
“Praise be to Allah,” exulted the first Arab to catch his breath. “Give me a donkey.”
Instantly a donkey stood at his side.
“Fool,” thought the second Arab. “He should have asked for more.”
“Give me 10 donkeys,” the second Arab begged.
No sooner said than done. He had ten donkeys.
The third Arab had heard and seen how the first two had fared.
“To Allah all things are possible,” he said. “Give me a caravan with a hundred camels, a hundred donkeys, tents, rugs, food, wine, and servants.”
They came so fast that the third Arab was ashamed to be seen in his rags before such an entourage. But his shame did not last long. Deftly his servants dressed him in robes befitting his new status.
The fourth Arab was more than ready when his turn came.
“Make me a king,” he commanded.
So quickly did the crown appear on his head that he bruised his knuckles from scratching where an instant before there had been nothing but an itch. The palace gardens stretched out before him almost as far as the eye could see, and the palace turrets reached so high their pennants were lost in the desert haze.
Having seen his companions in misery ask too little, the fifth Arab resolved to make no such mistake.
“Make me Allah!” he ordered.
In a flash he found himself in sand, covered with leprous sores.

Recommendation Update

I am retracting my buy recommendation on Heska due to new information obtained about the company. All the posts below will now have Heska crossed out.

Bull Markets, Mega Caps, and College Campuses

Sir John Templeton famously said, “Bull-markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria.” As we know right now, we are still no where near the “euphoria” stage, even though the markets have had an impressive run, with the S&P 500 alone up 15% YTD.

I would like to share a video with you from Davis Advisors that I think is helpful during this time. This may not be new information, but I think it’s good to have a refresher every so often, think of it as mental flossing:

Davis Funds: Insights

Also, according to Ken Fisher’s research, this “phase” of a bull market is usually best for mega-cap stocks. To his point, I do see value in companies such as Apple, Berkshire Hathaway, Eli Lilly, Sanofi, Proctor & Gamble, and Kimberly-Clark, to name a few.

I would also like to reiterate my “buy” recommendation on Heska (pick removed due to new information: 01/03/2013), Dell, Nvidia, and Atrion. Dell has been particularly attractive as of late as it hit a new 52-week low which it has since bounced off of quite nicely. I hope you took advantage, as my readers, and picked up shares along with me.

I would also like to add one more recommendation: American Campus Communities. Ron Baron explains the moat:

“There are five million obsolete college campus housing units that need to be replaced and renovated. Colleges can’t afford to do this. That’s the growth opportunity. American Campus is the largest provider of such housing with nearly 70,000 units. It builds and owns housing on college campuses with 80 year land leases that prevent others from competing against them.”

Not to mention, the company has an 11% profit margin and a 3% dividend. Also, as housing comes back, this stock will rise with the tide. Revenue and operating cash flow have steadily increased over the past 10 years (10-year average for revenue: 25.35%) while operating margins have remained near 18-25% during this time. With a moat firmly in place, I see no reason for this not to continue.

What I would not be holding now: bonds, gold, cash.

Disclosure: Long DELL & NVDA

Higgs Boson, Markowitz, and Graham

From Roumell Asset Management’s quarterly report— I feel this exemplifies the philosophy I espouse on this website quite well.  

A “unified theory” has long been the Holy Grail in theoretical physics that could account for both subatomic and universal realities. It appears the field has made a giant leap forward with the recent discovery of the Higgs boson particle, commonly referred to as the “God particle.” Higgs boson accounts for the various strains of information, analyses, and data that physicists, working with different approaches, have gained over the years from their efforts to better understand our universe. While some physicists prefer to focus on big-picture questions like how time and space interact, others prefer to ask why some particles have mass, while others, such as light, do not. Different starting points, same goal: knowledge.

Although investing is certainly not a hard science, it too has long pursued its own unified theory. On the one hand, financial planners and advisers use asset allocation to construct portfolios with multiple asset classes in order to spread risk and reduce volatility. Harry M. Markowitz is known for his pioneering work on Modern Portfolio Theory. Markowitz’s Portfolio Selection, which he wrote in 1952 while a graduate student at the University of Chicago, serves as the framework for planners using asset allocation as the primary portfolio construction tool. Markowitz argued that a portfolio should be designed using uncorrelated asset classes to maximize returns with the greatest efficiency (reduced volatility).

The shortcomings of the asset allocation model include today’s high level of correlation among asset classes. In addition, performance is tied to overall market returns and leaves little opportunity to exploit market inefficiencies. Of course, many investors in this camp believe security prices reflect all known information and are thus always efficiently priced.

In contrast to the investment allocators are individual securities investors. For value investors like us, Benjamin Graham wrote the gospel with its emphasis on specific security characteristics, margin of safety, and the temperament to see the process to fruition. Graham elegantly stated in 1934, “The field of analytical work may be said to rest upon a two-fold assumption: first, that the market price is frequently out of line with the true value; and, second, that there is an inherent tendency for those disparities to correct themselves.” The mantra for security-specific investors is that market price diverges from intrinsic value often enough to add investment value, particularly in smaller overlooked and/or out-of-favor securities.

As decided adherents of the security-specific, bottom-up value investment camp, Roumell Asset Management does not begin with a belief that we should own a little of everything. Rather, we begin by searching for value in the marketplace, wherever it may be. We firmly believe that obsessing about price paid has a far greater impact on securing respectable returns than gauging what John Maynard Keynes referred to as “the average opinion of the average opinion.” There are multitudes of analysts, commentators, and investors putting forth their opinions about the upcoming direction of gold bullion, U.S. Treasury bonds, and the stock market. We have nothing of substantive value to add to this conversation. It’s not what we do.

A subtle but highly important distinction in reviewing market efficiency literature is necessary, in our view. To paraphrase Warren Buffett, the difference between markets being mostly efficient and always efficient is the difference between night and day.  Interestingly, Berkshire Hathaway seeded additional capital to its two recently hired portfolio managers and gave them authority to manage the funds “exactly as they see fit.”

The reasonable question to ask then is how much should a portfolio be constructed with an emphasis on hitting all the major asset-class boxes (large cap growth, small cap value, emerging market stocks, corporate bonds, etc.) versus putting together a portfolio of security-specific-focused managers with the latitude to go anywhere in their search for value? In other words, rather than arguing about who’s “right” perhaps it’s more reasonable to simply ask: How much Markowitz and how much Graham does an investor want in his or her portfolio? An allocator only need believe that markets are inefficient enough to warrant some exposure to security-specific, bottom-up investors, be they growth or value oriented.

We do not seek to change any investor’s mind regarding investment philosophy. Rather, we want our investors to understand our investment philosophy. Our clients can trust that 100% of our own investment capital will remain invested in our portfolio options because determined research, a deep appreciation for value, a contrarian bent, and a steady temperament are what make the most sense to us.

Notes from The Poor Investor:

 It never hurts to reiterate your basic investment philosophy or tenet to see if your actions correlate with that philosophy/tenet.  If they are out of sync either: a) change your actions, or, b) change your philosophy.  However, as a word of caution, before you start investing heavily on your own you should have a philosophy that is sound (meaning it stands the common sense test), proven (is backed up by reliable data/facts), and unchanging (is time-tested and perfect enough that it does not have to be modified).  If you are constantly changing you investment philosophy and/or method of investing then you are setting yourself up for failure.

And with that I’ll leave you with a quote from James P. O’Shaughnessy:

“…we can see the simple truth that using simple, straightforward and time-tested investment strategies leads to the best overall results in virtually all market environments.”

What’s Next?

A lot has happened since I last wrote…  Mitt Romney chose Paul Ryan to be his running mate.  The European Union seems to have gotten its act together, financially speaking.  Facebook reached a new low and Amazon reached a new high.  Even the auto market has maintained most of its steam in the wake of the European Crisis.  In conjunction with this mostly good news, the stock market has also risen to new heights—following its usual trajectory during an election year.

So what does this mean for the future of the stock market?  Well, I will not pretend to know what will happen with the stock market overall, but there are still plenty of stocks out there that I think will provide favorable returns for those who buy individual stocks.  Some of these names will be familiar, some not.  Bargains come in all shapes and sizes (see Ken Fisher’s Debunkery for more on that).

In regards to the aforementioned “bargains,” let’s start with the more familiar.  At a price-to-sales ratio of 0.3 and a dividend of 3%, Dell is my favorite pick out of all the bottom-dwellers.  There is fear that Dell might be a “value trap” and this very well could be, although, I believe Black Friday and Christmas will serve as important catalysts.  As I type from my Alienware computer (Dell-owned), I remember bargain-hunting for it around the same time as the holidays were fast-approaching.  Also, there is a high margin of safety in that Dell is largely considered a value trap.  Value traps may trap buyers, but usually don’t go any lower.  In the end, the catalysts may prove false, but the stock should not depreciate much from this price.

The next in the “familiar” category, is Nvidia.  Now, this may not be familiar to all, but, computer geeks should be plenty familiar with this company.  Although Nvidia was snubbed by Amazon, its new chips are used in Google’s Nexus 7 and will be used in Microsoft’s new Surface tablet.  With around $5/share in cash, the company is effectively trading at  near 11x earnings, for a company that usually trades around 14x earnings.

In the “unfamiliar” category, the company I’d like to start with is Heska.  This company operates in the veterinary market, selling diagnostic equipment and other products to veterinary clinics.  This is a growing market and its growth is expected to continue well into the future.  The company trades with no debt, 16% of the share price is accounted for by cash, and it has a dividend of 4.60%.  As a smaller company, it is still speculative, and will require more due diligence than the more familiar companies.  However, there is more room for reward here if the company can successfully navigate the next few years.

Last, and also in the unfamiliar category, is Atrion Corporation.  This company has shown tremendous growth potential in a growing market— healthcare.  The company manufactures cardiovascular, fluid delivery, and ophthalmic devices.  It has also ranked highly over the years in Value Line’s “earnings persistence.”  The company has a small dividend (1%), positive cash per share, no debt, and boasts a profit margin of 20%.  Although the company has faced some headwinds as of late, it seems poised to perform well in the coming years.  This is another long-term growth story that will require proper due diligence.

In the face of what else is to come, be assured that there are still plenty of stocks out there whose performance will have nothing to do with what else is to come.  These are just a few of them that you might be interested in.  Feel free to mention some more that you think offer a better opportunity for potential price appreciation over the next few years.

Until next time…

The Poor Investor

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