Merry Xmas

Another year is just about gone.

As usual, there were many headline events over the year. The cumulative effect of these events on the trajectory of the good businesses that we hold will be virtually nil in the coming 5 to 10 years. On a portfolio level, I have had my share of good decisions and bad decisions, and fortunately, at this stage, the impact of my good decisions appear to outweigh the impact of the bad ones. There is always room for improvement, and I will be taking some time off during the Xmas and New Year to examine ways to minimise my unforced errors.

With a few trading days to go, we received an early Xmas gift from our indomitable UOS with an encouraging profit guidance for the full year. It is worthwhile noting that this guidance came in the face of a 10% slide in the MYR/AUD currency cross-rates. May we have many many more bountiful years with the Kongs.

The folks at DTL continue to kick goals. At the current trajectory rate of the business, I doubt many of the employees at DTL will get a decent break over Xmas. Many thanks from a happy and grateful shareholder.

Once again, another big thank you to Alf Mouffaridge of Servcorp, not the least for presenting another entertaining Annual Report. My message to you this year is that there is no shame in imitation. Many great business successes are based on imitation of best methods invented by others.

Finally, to Indy Singh of Fiducian. You have built a might fine business. Stick to what you believe, and do exactly what you say. The rest will follow.

To all readers, thank you for your patronage. I wish you a Merry Xmas and a Happy New Year!

Yours One-Legged

Xero: Update

Last year in August 2015, I published a review on Xero.

Today, Xero published its half yearly, so I thought it will be interesting to update our figures. The following table summarises the salient metrics:

	2014	2015	2016HY	2016F
Revenue	143m	207m	137m	300m
COGS	30%	24%	25%
R & D	50%	48%	42%
General	20%	15%	14%
Marketing	75%	72%	62%
Total	175%	159%	143%

The figures are certainly headed in the right direction. Pleasingly cash burn has reduced to $13.4m in the last half, with $137m left in the bank, implying a steady runrate of 5 years. 

EDIT: 7 November 2016, cash burn is actually $45.8m. $13.4m is cash burn from operations, with the balance classified as investing cash outflow. However, the company's presentation materials emphasised $13.4m rather than real cash burn of $45.8m. Instead of a steady runrate of 5 years stated above based on $13.4m, the runrate is actually only 1.5 years.  This is the problem with promotional companies, and I should have been much more careful in scrutinising the figures.

The current market cap is roughly NZ$2.3 billion. Share price is up roughly 10% since my August review, and given growth rates of 50% in actual financial performance, has resulted in a narrowing of the gap between valuation and earnings expectation. However, in my view, the share price is still incorporating very optimistic assumptions of growth and eventual margins. In fairness, the probability of these optimistic assumptions eventuating have increased since last year.

Giverny Capital Annual Letter 2015

A bit late this year, here is another letter from the good folks at Giverny. I post these letters because I operate on a near identical investment philosophy with the notable exceptions being:

1. my writing skills are far inferior;
2. my investment record is much shorter.

Giverny Capital Annual Letter 2015.

Notable quote from the letter:

"Significant and educational conclusions can be drawn from a 20-year period. Since 1996, our companies have increased their intrinsic value by 1102%, or close to a twelvefold increase. Meanwhile, the value of their stocks has increased 1141% (net of estimated currency effects). On an annualized basis, our 9 companies increased their intrinsic value by 13.2% and our stock portfolio returned 13.4% per year. The similarity between those two numbers is not a coincidence. (my emphasis)"

Yours One Legged

Current Reading

I have just started reading this book.

This book profiles 8 CEOs and then attempts to draw some form of generalisations as to their common features. The objective is to be able to spot these features in CEOs that could possibly achieve outstanding results in the future.

At this stage, whilst being an interesting read, I am also wary of ideas that attempt to extrapolate general ideas from a small preselected sample size. In a nutshell, my argument is that we do not know of countless other CEOs, possibly with similar traits, who has actually failed and lost shareholders' money.

It is also interesting to note that the whole thing could be simplified by viewing CEOs filtering via Jack Welch's criteria of integrity, passion and 4Es, set out in his book, Winning.

I will continue reading, and post any further insights.

Readers may be interested in my Library listing here.

Yours One Legged

Dogs versus Darlings 2.5 years later

Keeping track of my amusing exercise started in March 2014.

Since then, one of the Dogs has been taken over for a gain of 61.54%. Not to be outdone, one of the Darlings was also taken over for a gain of 22.27%.

Overall, the Dogs portfolio is down -9.5%. The Darlings portfolio, unfortunately, with -15%, has done worse.

But wait, there is more. After accounting for dividends fully grossed up, the Dogs portfolio is flat whereas the Darlings are still down -4%.

The one obvious lesson from this exercise to date is that overpaying for shares could yield results comparable or worse than buying shares in a lousy industry facing severe headwinds.

Valuation matters. Nothing grows to the sky forever.

Yours One Legged

My learning continues with this excellent transcript of Q & A with Robert Bruce.

Summary of wisdom tidbits:

"The idea is to invest when the market price is below the cost of production."

"We value investors want to get the future cheap, preferably free."

Enjoy and Prosper,
Yours One-Legged

Transcript of Jim Chanos interview

Here is a transcript of an interview with Jim Chanos.

I learned heck of a lot from reading this. I hope you do too.


Enjoy and Prosper,
Yours One-Legged

Transcript of Charlie Munger's 2016 Daily Journal Annual Meeting

Transcript of Charlie Munger's comments at the 2016 Daily Journal Annual Meeting.

Notable extracts:

1. They had a monopoly where every year they kept raising prices and every year people had to pay for it. A wonderful business.

2. There's an endless market for software in these public agencies, and it is a market that is sure to keep flourishing and needing more and better software.

3. It is agony to do business with a whole bunch of public bodies, so a lot of companies in software don't come near it, because they prefer the easy money.

4. Good investment opportunities are scarce, so one must act decisively when presented with one.

5. A fair amount of patience is required, followed by pretty aggressive conduct.

6. Electric forklifts= example of a very big idea.

7. Opportunity cost matters= if you have a rich uncle who will sell you his business for 10% of what it is worth, you don't want to think about some other investment.

8. We don't want any lousy businesses anymore.

9. We spend a lot of time thinking.

10. A constant search for wisdom and a constant search for the right temperamental reaction to opportunities, these will never be obsolete.

11. The nature of ordinary results is that they are ordinary.

12. The first time we bought Wells Fargo, we bought heavily, because we had an informational advantage, based on general thinking and collecting data. (Wells Fargo's lending officers are more conservative and operate better due to their backgrounds in the garment district.)

13. One should not invest in banking unless one has deep insight, especially on management shrewdness.

14. Synthesis is reality, but the reward systems of the world pays for extreme specialisation.

15. Being rationales mean avoiding awful things like anger, resentment, jealousy, envy, self-pity.

16. Good behaviour makes your life easier- you dont have to remember all your lies.

17. The big busts hurt us more than the big booms help us.

18. I don't think the auto industry will be a terribly easy place to invest in.

19. A lot of people think that if an axe murder happens in a free market, it has to be all right because free markets are always right.

20. People will cheerfully tolerate differences of outcome if they seemed deserved. Differences in outcome that seem to be undeserved tend to disrupt democracy. Inequality is a natural outcome of a successful civilisation that is improving for everybody.

21. Munger's Rule= large amount of money makes people behave badly.

22. I don’t think fundamental value investing will ever be irrelevant because of course if you’re going to succeed in investment you have to buy things for less than they’re worth instead of more than they’re worth. You have to be smarter than the market. That will never go out of style. That is like arithmetic. It’s going to always be with us.

23. Generally, I avoid circumstances which automatically causes reasonable fear.

Enjoy and Prosper,
Yours One-Legged

Debunking the Growth Mantra and Getting Real

Roughly two years ago, I ran the following screening exercise on the ASX:

29 April 2014	>20%	>15%	10 to 15	5 to 10	0 to 5	Negative
10 years average Sales/Share growth	65	92	62	64	93	1633
10 years average EPS growth	47	86	57	304	100	1405
10 years average Book Value/share growth	81	128	69	122	112	1513
10 years average DPS growth	22	34	36	41	44	1797
10 years average Operating cashflow/share growth	83	116	50	300	114	1373
ALL	2	5				1156

Total population=2100 companies

Intersecting analysis:

Only 2 companies filled all 5 criteria above 20% per annum: MND, WOR on the back of the super resources boom.

5 companies filled all 5 criteria above 15% per annum: JBH, WOR, RCR, CTL, MND. 0.2%

13 companies achieved both sales and EPS growth above 20% pa for 10 years. 0.6%

28 companies achieved both sales and EPS growth above 15% pa for 10 years. 1.3%

68 companies achieved both sales and EPS growth above 10% pa for 10 years. 3.2%

145 companies achieved both sales and EPS growth above 5% pa for 10 years. 7%

220 companies achieved both sales and EPS growth above 0% pa for 10 years. 10%

(Notice the number roughly doubles as we go down the ranking. These sort of data series follows the power law. Don't ask- no one knows why as yet.)

How about companies able to grow EPS without corresponding growth in sales?

Of 93 companies with less than 5% pa average growth in sales, 38 companies (ie 40%) were able to grow EPS more than 5% pa average,  12 companies grew EPS by more than 10% pa, 9 companies grew by more than 15% pa, and only 3 companies by more than 20% pa.

Of 157 companies with less than 10% pa average growth in sales, 33 companies (21%) able to grow EPS more than 10% pa average,  18 companies grew EPS by more than 15% pa, 7 by more than 20% pa.

Of 219 companies with less than 15% pa average growth in sales, 30 companies (13.7%) able to grow EPS more than 15% pa average,  11 by more than 20% pa.

Higher growth rates in sales appear to reduce ability to increase margins.

204 companies trade above PE 20 as at 30 April 2014. PE 20 roughly implies a growth rate of at least 10% per annum for 10 years and 10x terminal.

The Siren Call of Growth

As of the time of writing in April 2014, I noted that FLN (Freelancer) is trading at a PE multiple of over 615, making it the most expensive stock on the ASX by the measure of price earnings multiple.  I will have to leave the dissection of the business prospects of FLN for another time.  My main objective is to briefly address the issue of “growth” and how it fits within our investing philosophy and framework.

1.       Less than 7% of companies on the ASX achieve compound annual growth in earnings per share of more than 10% per year over periods of 10 years or more. If you remove companies whose EPS figures are distorted by abnormal gains offsetting continual losses, or companies with no consistent earnings, the figure drops dramatically to less than 5%.

2.      However, close to 10% of companies on the ASX are priced for annual compound growth in earnings per share exceeding 10%.  This number does not include loss making companies, which makes up over 66% of the ASX. Clearly, there is presently a divergence between wishes (reflected in pricing) and reality (reflected in historical data).

3.       We need to keep in mind that this distribution is a normal functioning of the market, due to the mysterious workings of power laws.

4.       However, bearing in mind Rule Number 1, we are fearful of Siegling’s Paradox. Whilst sizzling growth rates are always used to justify lofty valuations, many forget that an initial gain of 50% or more is more than wiped out by subsequent losses of similar sizes. For example, you lose all your capital if you gain 100% in the first year, and losses 100% in the second year. You lose 25% of your capital if you gain 50% in the first year and losses 50% in the second year.  As evidenced by the Kelly criterion, bigger risk does not equate bigger gains if you have a scarcity of capital.

5.       Sustained growth is rare and difficult, it requires a confluence of factors- industry tailwinds driving revenue, costs being kept in control, competitors being kept at bay, management not making mistakes, no disruption by technology, no interference from government, no unforeseen events.

Edit: I need to insert a word of caution here on the common but nonsensical use of PEG ratios popularised by proponents of growth investing. The basic idea is to divide the PE ratio by the projected EPS growth to get the PEG ratio. Apparently, anything between 1 to 2 falls within the attractive range. A stock growing EPS at 20% per annum is justified by PE 20, since the PE falls rapidly. To take the logic even further, a stock growing EPS at 100% per annum is justified by PE 100, since 3 years of doubling will bring the PE back to a lowish 12.5. The problem is that the issue of risk is not addressed. A stock growing at more than 20% per annum (let alone 50% per annum) for an extended period of time is a rare beast, as the numbers I have shown above attest to. If I have two stocks, each with a PEG ratio of 1, the first stock at PE 20 projected to grow at 20%, and the second stock at PE 1 projected to grow at 1% per annum, the choice is an absolute no brainer. The absolute irony is that with the second stock, I am getting a 100% per annum yield, assuming all earnings are paid out.

Enjoy and Prosper

Yours One Legged 

Musings 15 March 2016

I came across a good book recently- Aurora by Kim Stanley Robinson. You can get a synopsis from various sources online including the link to Amazon. The author tends to get quite descriptive and it is a characteristic of this particular author that readers will have to come to terms with. The reason why I am always partial to this author is that he always presents big interesting thought stimulating ideas.  Aurora is a reminder that I should reread his previous books to refresh or gain new perspectives.

Before you read on further, just be aware that this blog post contains SPOILERS. To avoid ruining your enjoyment of the book, you should stop here and read the book first before reading on.

The main proposition from the book is that interstellar travel and colonisation are extremely difficult, and quite likely much more difficult than what we would like to believe at present. For various reasons, ranging from physics to chemistry to biology to psychology to sociology, such an undertaking may well be impossible. If so, it presents a very neat answer to the Fermi Paradox.

In respect of the Fermi Paradox, the lesson to be learned here is applicable to life and to investing. The weak assumptive link in the Fermi Paradox is the assertion of interstellar travel as a given. In Aurora, the author demonstrates to us the effect of being realistic and critical in a chain of reasoning. Asking the question why, and demanding an answer is imperative. And then tackling the question with multidisciplinary methods. As usual and often the case, these methods lead to fresh valuable insights.

In investing, constant stress test of the hypothesis is vital in order to avoid mistakes and the permanent loss of capital. Logically, our job would be much easier if we concentrate on a simple hypothesis, rather than one consisting of many moving parts whose cause and effect are unclear. This is one reason why I cannot do macro investing.

Stress testing of investing hypothesis has recently gotten us out of REF, although the final verdict on our decision remains unknown. The same exercise also got us out of PRG just in time before its implosion, and helped us steer clear of disasters such as VET and SGH. The absence of rigorous stress testing accounted for some of our losses, one of such being NWH, Stress testing continues to make us wary of XRO and MSB, although I could certainly see a bright future if things work out. Also very much of importance, continual stress testing of investment hypothesis has given us the confidence to stay with our winners, allowing us to reap the benefits of compounding a winning position.  Finally, stress testing of one investment hypothesis has also led us to better insights, resulting in a development of a much better, and currently profitable, hypothesis.

Another lesson from Aurora is the futility of detailed planning when one is dealing with complex and chaotic systems, and the serious importance of adaptability. From ship components breaking down due to physical stresses, the effect on biological cells due to changes in gravity, to the recycling of vital elements in a closed ecosystem, the ship engineer's continuing lament about the lack of foresight of the ship builders reminds me starkly of the futility of financial forecasting of complex economic systems. If we cannot be certain of the future, the best that we can do, and should do, is to prepare ourselves for a range of outcomes. This is where Graham's concept of Margin of Safety becomes relevant. The importance of adaptability is also a reason why we tend to focus on organisations that maintain maximum flexibility via low costs, low debt and high gross margins. Just have a look at the taxi industry in NSW, and the performance of CAB, for a bleak illustration of the consequence of a stubborn lack of adaptability.

Aurora also reminds us of what it means to be humans, literally speaking, and if you are metaphysically inclined, spiritually. As usual, parallels can be drawn with the investing world. Just as the existence of humans and the existence of Earth are arguably intrinsically inseparable, we would be ill-advised to view businesses in isolation from their ecosystems. Valuation from empirical data cannot be relied exclusively and separated from the business environment. A short cautionary note against blind and complete reliance on common metrics such as PE and PB.

Finally, the second level question: so what? Aurora deals with this admirably. Just as Charlie Munger wants to know where he will die, so that he never goes there, if we are being realistic and aware of the difficulties involve in interstellar travel and colonisation, we should be focusing more efforts on the difficulties rather than on the easy solutions such as physics and propulsion. It is certainly relevant in terms of Elon Musk's long term plans to colonise Mars.

Aurora attempts to bring us awarenesss of the possibility that interstellar travel and colonisation may well be an impossible undertaking. It points out that perhaps our existence as humans is inextricably linked to the existence and wellbeing of planet Earth. If this is so, it would be prudent on all of us to rethink our relationship with, and treatment of, what may well be our only home.

Enjoy and Prosper,
Yours One-Legged

UOS another year on

Another year rolls along, and we get another balance sheet. Judge the progress for yourselves:

	2H15	1H15	2H14	1H14	2H13
Cash	$487m	$469m	$400m	$353m	$435m
Receivables	$196m	$179m	$169m	$171m	$158m
Inventories	$395m	$388m	$358m	$348m	$310m
Land held for property development	$123m	$84m	$84m	$26m	$22m
Property plant and equipment	$57m	$61m	$62m	$57	$28.2
Investment properties	$668m	$683m	$679m	$621m	$649m
Total of Asset Items above	$1926m	$1862m	$1752m	$1576m	$1602m
Total liabilities	$486m	$435m	$367m	$333m	$344m

Edit: 15 March 2016- Mr Tony Hansen of EGP has kindly pointed out that there was a 9.8% adverse swing on the AUD/MYR currency crossrates at the time of the UOS report, where the figures above have been taken from. The increase in NTA would have been eye-watering if you take out this currency swing.