Monday, May 29, 2017

Recent Exits: NBIX, VIPS, SLM

Thoughts on three recent exits/position reductions. I would consider buying back at lower prices.

Neurocrine Bioscience (NBIX)

Ingrezza failed its phase 2 trial for Tourette’s syndrome; and the stock dropped from $53.5 to now $46.2.

I came away with a small profit and actually bigger confidence. The results were not good, but the decision procedure was sound – it gave me a shot at high upside while preserving capital. Had the trial results came out good this could have easily been up 30% with long term upside of 100%.

Going into the phase 2 results, NBIX was 8-9% of my total net worth with average cost of ~$47.4. I was sitting on a 13% gain. That gave me the cushion to sit through the event, knowing that a failure would probably result in a small hit to principal. The idea was to be aggressive with profits but conservative with capital. After the bad news came out I quickly cut NBIX down to a immaterial position with average exit price of more than $48, retaining a small profit for the entire trade.

Buying well is truly half the battle. That requires knowing a situation well, anticipating the scenarios, and going big when opportunities present themselves.

The episode also illustrated one of the advantages of individual investors. I highly doubt an institution could have went from 0% position to a 9% position and then down to < 1% position as quickly as I did - and come out unscathed.

The stock is now undervalued, but with no clear catalyst. If NBIX gets to low 40’s I’d strongly consider loading up again.

Vipshop (VIPS)
I exited the position before the company’s latest earnings. I had been accumulating JD and Alibaba and prefer their competitive positions.

Originally I saw Vipshop as a niche strategy (discount retailer), but the more I look at JD and Alibaba, the more I wonder if that’s even a valid category. For example, Vipshop sells excess inventory for brands – a lot of which are typically available after China’s November 11th “singles day”. Now, obviously Alibaba is the king of Single’s Day – so why can’t Alibaba just run some discount/flash sales to get rid of those exact same items, which is already listed on Tmall/Taobao?

The other thing I wonder about is the integration of warehouse and inventory systems. Let's say some apparels were listed on and was already in JD’s warehouse. Why not just let JD run its own flash sales? Why bother with moving inventory from JD’s warehouse to Vipshop’s warehouses?

As e-commerce matures and inventories get more integrated into JD or Alibaba affiliates warehouses, whoever list the items originally will also be the best candidate to get rid of that same (now excess) inventory. So is the “online discount retailer” even valid as a separate model?

Another thing that bothers me about Vipshop is its build out in last mile delivery. It seems to me they are aping JD, but with less resources. Logistics in China is becoming a crowded space, and a capital intensive one. Alibaba’s Cainiao allies are mostly publicly listed now, so they will be able to access capital and pour money into logistics. It’s not clear to me how Vipshop has a competitive advantage there.

This is another one where I bought so cheaply that I booked a nice gain. The stock actually looks like it has bottomed, but I'm in no hurry to get back in.

Sallie Mae (SLM)

I cut this down after the stock started dropping. As much as I like the growth prospects, I never felt comfortable with the political risk. SLM would have been a huge beneficiary of Trump's tax cut but it doesn't look like it will happen anytime soon.

Everyday, major news outlets report on America’s "student loan crisis". Read through the comment sections and I get the sense that people think if they can sue the hell out of Sallie Mae, cause it to go bankrupt, then they don’t have to pay back their loans.

Borrowers (a big and growing portion of society nowadays) have incentives to hurt Sallie Mae. That means politicians have great incentives to hurt Sallie Mae. That’s a dangerous place to be for shareholders.

Saturday, May 13, 2017

Common Quotes and (Maybe Not so Common) Thoughts on Investing

1. Investment vs Speculation - the classical definition

An investment operation is one which, upon thorough analysis, promises safety of principal and a satisfactory return. Operations not meeting these requirements are speculative.” - Ben Graham, from “Security Analysis”

By this definition “investments” are exceedingly rare in today’s equity market. Good companies don’t trade at <17x earnings. Great companies could be 30x-50x earnings. Justifying those prices often require extrapolating growth out for 5-10 years, then assuming 1) margins and earnings don’t get destroyed by a recession during the forecast period, and 2) multiples don’t decline due to higher risk-free rates (as if there’s such a thing).

Thus, at today’s prices, much of “investing” (certainly much of growth oriented investing) contains implicit macro bets on the direction of economy and interest rates. A high percentage of these same investors would consider questions of interest rates and macroeconomics to be rank speculation. By that logic then, one can only conclude these "investors" are really "speculators".

Given the majority of "investing" today is really speculation, Graham's distinction kind of loses its meaning and usefulness. Perhaps it's time to redefine the two. Personally, I think of investment versus speculation as follows:
  • Investment = I'm betting on real world fundamentals playing out as I figured. 
  • Speculation = I'm betting on shifting expectations. It doesn’t matter how things actually play out, as long as people think it will go well, they will buy the stock and push prices up.

2. You are NOT the owner

“You are not buying a stock, you are buying part ownership in a business” – Warren Buffett (not sure, really every value investor)

Ok, I get the point, but let’s face it - most of us are not REALLY owners in the business. Understand this is key to avoid getting ripped off by unscrupulous management and insiders. 

To me, ownership means I have access and control. If I own a coffee shop, I would be able to access the shop’s profit and loss data any given day. I would have the power to fire under-performing workers, change the marketing and advertising strategy when it’s not working…etc. 

I own GOOGL stock. But If I call up Google today, I’d be lucky if investor relations call me back in a week, let alone have access to management. I certainly don’t get to tell Sundar Pichai what to do. I’m not really an owner of Google.

When Warren Buffett buys a stock, he’s an owner. He has great access, and has at least some influence on the board. He can influence the companies’ capital allocation decisions and extract cash flows if he needs to.

I think a lot of Buffett’s ability to bet big with conviction comes from having access and control. It also explains why entrepreneurs and business owners are willing to risk their life savings on one idea – essentially take leveraged, super-concentrated bets, while most investment manager consider a 15% position a big position.

3. Bet you didn’t know Ben Graham said this!

"It would be extremely unwise - and hypocritical - for anybody to buy a list of common stocks and say that he was interested only in his dividend return and cared nothing at all about price changes…the problem is not whether price changes should be disregarded - because clearly they should not be - but rather in what way can the investor and the security analyst deal intelligently with price changes which take place." - Ben Graham, from Current Problems in Security Analysis

In recent years the so called "dividend growth investing" crowd blindly chased yield without regard to valuation. They would pull up some old Benjamin Graham quote about ignoring "Mr. Market", and babble on about "long term investing" to justify their pavlovian "buy the dip" strategy.

Yet Benjamin Graham himself would say stock prices clearly matter. After all, if you make 3% dividend and risk 10% on principal, what's so good with that?

This is all the more so if you’re not really an owner like Buffett, but rather an OPMI: outside passive minority investor.

Now, what are prices dependent on? Why, supply and demand, of course. That’s a function of 1) people’s ability to buy (liquidity on their hands), and 2) willingness to buy (based on their assessment of company’s future outlook and “intrinsic value”, versus their alternatives).

This leads me to the next point.

4. What is it worth? And to whom?

“Value investing is figuring out what something is worth and paying a lot less for it.” – Joel Greenblatt

This quote is helpful to the extent it points out “value investing” is not just low P/E, low EV/FCF, or some other valuation metric. Warren Buffet would agree: there's no "value" versus "growth" investing. You're always looking for value.

What’s not helpful though, are the discussions that typical follow. Typically, these discussions of “what something is worth” automatically jump to some sort of discounted cash flow analysis, complete with disclaimers on how estimating “intrinsic value” is more of an art than science.

I think there’s a lot of talk about “intrinsic value” and not enough about “intrinsic value to whom?” The latter question matters. A control investor looking to extract synergy sees a different set of cash flows versus a mutual fund investor. The Bank of Japan, which has been gobbling up local equities, sees a different set of “values” from what Warren Buffett sees.

An example of the “intrinsic value to whom?” question is Canadian real estates. Consider a very logical housing investor. He might value a house by projecting out rental income minus various expenses, capitalize that cash flow stream with some desired yield. He then arrives at an "intrinsic value" that's way lower than the market price, and declares the housing market a bubble.

A rich guy from China, however, may be willing to pay a multiple of the market price. Why? because he's not just buying a house. He’s buying fresh air, safe food, quality education for his kids…etc. Heck, even just freedom of using gmail without getting censored by the government. A few millions for a crappy Canadian house is a bargain for that guy. 

The "value to whom" question matters. Knowing who's the buyer and the seller matters.

5. Compounders? or just justification to buy high?

“Given the three ingredients of a) optimistic assumptions as to the rate of earnings growth, b) a sufficiently long projection of this growth into the future, and c) the miraculous workings of compound interest - and the security analyst is supplied with a new kind of philosopher's stone which can produce or justify any desired valuation for a really good stock” - Ben Graham, from The New Speculation in Common Stocks

Nowadays, a typical “compounder” thesis goes something like this. This company is run by management with great integrity. The company has such and such competitive advantage: low cost structure, differentiated business model, this and that. The company is awesome. This company trades at some expensive looking valuation. But hey, if you project revenue out 5 years at 30% growth rate, put some 30x terminal EV/EBIT on it (all justified by qualitative discussion of competitive advantage), then we can get to 15% IRR.

Is this really margin of safety? Or are we just stretching ourselves to justify buying a good company? 

I have no problem against paying up for compounders. In fact I have lots of these: GOOGL, BABA, JD, EW...etc. But I'm under no illusion of what will happen to these stock when investors decide they will only look 3 years ahead instead of 7 years ahead.