You can’t trust EBIT (AMZN/ASC)

The other day I was discussing with one of my colleagues the differences between tech valuations in the UK and in the US. There’s a good reason the real tech giants in the world are US companies, as far as I’m concerned, and you see a reflection of general investor sentiment in that respect when you look at the pricing of the stocks and the attitudes of management teams.

The simple fact is that US public equity investors seem to have more of a stomach for ongoing losses in exchange for top-line growth. Is this a good thing? Clearly, as a value investor, you wouldn’t expect me to say anything other than the usual spiel about racy tech stocks and their absurd valuations. One thing I do buy, though, is that the distinction between operating expenses (opex) and capital expenditures (capex) isn’t quite as solid as line as many investors seem to think.

Connect Group: Putting up a fight

I like Connect Group. I like Connect Group because it’s a solid, old-fashioned value investment; you’re buying it at 7.5x earnings (6.5x yesterday!), and you’re buying into what is basically a monopoly operating in a declining industry. Ok, technically they’re a duopoly, but the market is geographically split – so where they’re operate, they’re really the big dog. And being a monopoly in a declining industry is a pretty attractive place to be, since the lack of competition means you can derive great returns. Your competitors have left the market by force or by choice, and who’s going to spend the money competing with an incumbent in an industry on the way down?


Housebuilders in the UK

What place does a housebuilder have in your portfolio?

As a value guy, I’m not really sure. If I were to take a stab at valuing a housebuilder, it would comprise of two elements. It’s sort of like valuing insurance companies, really:

a) Value the land on their book. This sounds trivial – we have accounting book values for a reason – but the actual sums are more complicated than that. Housebuilders have portfolios which faced differing degrees of impairment during the crisis, and the companies which had the financial strength to restart big land-buying programs in the depths of 2009/2010 – while everyone else was battening down the hatches and staving off the baying banks – have a portfolio of land which allows for higher margin building today. They also have differing quantities of land, which are best modelled by comparing their land bank (in number of plots) versus their last-year completions. This is like valuing an insurance company’s in-force book; you’re essentially asking yourself how well-written their previous policies were, or how well bought their previous land was, and how benign the environment will be for that profitability over the next few years.Inline image 1

Tesco – Yes, again

A long-standing manager with a superb track record. An organisation at the top of its field, with vocal fans handsomely rewarded with continuing success. Then the wheels come off; the boss totters off into the blissful sunset, and his replacement at the reigns does nothing but disappoint. Probably no surprise – reversion to the mean, and all. Anyway,  the new guy doesn’t last long before a third manager comes along promising to turn the ship around, and only a few weeks into his leadership we’re reminded that we are still far from the glory days.

Yes, like you, I was pretty shocked when I woke up this morning to the news that Manchester United had lost last night to Leicester – and let in 5 goals in the process! There’s some rot at that organisation, I tell you.

It’s not as if they haven’t spent serious cash, either – though probably not in the right places. Investment probably could’ve been more optimised; they needed to stay on top of the game in their core areas, but instead overspent on ambition at the more exciting end of the spectrum. 

A note on Quality, part two

Earlier today, as I was pondering the quality of businesses - you will have noticed my style involves quite a lot of pondering and not too much doing, which may be a failing of mine – I stumbled came across a great article on a blog from 2011. I don’t know how I found it; sleepy little blogs come and go, after all, and lots of great ones languish in hidden corners of the internet… but this one made me smile.

It provided a better explanation of the value of high return companies than I could ever write and is a highly recommended read. Even more thought provoking, though, is the follow-up. Here, the author more or less runs through his take on the holy grail of investing; not just which companies generate super-normal returns on capital, which ‘any computer could do’, but why certain companies or industries generate consistently high returns. He uses airlines as an example of an industry which is basically structurally rigged to generate poor returns. See his intro, noting the following:

A note on quality

Clearly, now I work in the city (boo hiss), I spend even longer looking at shares than I ever had the opportunity to before. It drills some points home, because it’s given me longer to look at a whole bunch of stocks I never even considered before – ones that aren’t traditional value plays in my little niche, for instance, along with business models I never took the time to understand and geographies I never had the inclination to play around in.

If there’s one overarching message I take away from looking at loads of businesses, it’s this:

Really good companies – companies which return significantly above their cost of capital over the cycle – are incredible hard to find**. I don’t mean that on a valuation basis; I’m not necessarily trying to say that great companies are difficult to find because they’re usually too expensive, though that’s also true. I mean it on an absolute level – companies which have good return profiles, competitive advantages, competent management and are in a market which is, at least, not dying off –  are just very hard to find full stop.