Finding Investment Ideas, Brighthouse Financial; Dignity Plc; In Addition To Favouring Breadth Over Depth
January 26, 2018
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I am ofttimes asked how I source my ideas - specially operating every bit a one-man band running a global equity fund. I currently remove hold roughly 150 stocks inwards my portfolio across to a greater extent than than a dozen countries, as well as typically generate virtually 4-5 novel ideas a month. This calendar month has been specially productive - I remove hold unearthed 10 ideas, or nearly 1 every 2 calendar days, as well as if I go inwards a focused manner, I am sometimes able to become at a charge per unit of measurement of 1 a twenty-four hours (so much for global markets beingness devoid of value opportunities).
Many are confused virtually how I deal to practise this. How, it is asked, tin give the axe yous maintain runway of 150 stocks? My reply is that I don't - those are just the ones I like. I truly maintain runway of thousands as well as thousands of stocks.
How practise I practise it? Simple - I attempt to aspect at novel stocks, all the time - typically 5-10 novel stocks a day, seven days a calendar week (when I am non traveling or otherwise distracted), patch also 'checking in' on several dozen stocks I already follow each day. And I encompass so much basis yesteryear honing straight inwards on the things that truly matter, as well as ignoring all irrelevant, extraneous detail.
I am a large believer inwards Peter Lynch's dictum (Peter Lynch was the greatest portfolio managing director of the yesteryear few generations inwards my view) that he who turns over the most rocks wins, as well as I endeavour to plough over every bit many rocks every bit I can, every bit fast every bit I can, as well as believe that inwards markets, the returns to breadth overstep the returns to depth when researching stocks. A few examples - ane successful, ane unsuccessful - inwards the yesteryear few days may serve to highlight the procedure somewhat.
Although it is of import to ever last looking at stocks, yous tin give the axe as well as should prioritise your search inwards areas of markets where yous are most probable to detect opportunities. Certain regions as well as industries are relatively inexpensive at whatsoever given indicate of time, as well as others are relatively expensive. This is based, to a large degree, on where these economies, industries, as well as markets are at inwards their respective economic, industry, as well as investor sentiment cycles, which wax as well as wane over fourth dimension similar the seasons. It is of import to remove hold this contextual agreement firmly inwards house earlier yous proceed.
I prioritise looking at regions, industries, as well as marketplace seat segments that are out of favour or are going through downturns, because that is where inexpensive stocks are most probable to last found. In recent times, that has included recession-addled emerging markets such every bit Russian Federation as well as Brazil (as good every bit peripheral Europe as well as Greece); regions amongst prevalent pessimism virtually the economical outlook or risks (such every bit China/HK as well as Japan), as well as neglected industries people are pessimistic virtually including autos, coal as well as other commodities (until recently), fossil oil as well as fossil oil services, B&M retail, traditional media, as well as banks as well as other financials. Of late, some value has begun to emerge inwards the UK, every bit well, every bit Brexit anxieties remove hold begun to weigh on both valuations as well as earnings.
In addition, at that spot are many other predictors of stocks beingness inexpensive as well as potentially prospective. Spin-offs remove hold traditionally done good every bit a group. Companies buying dorsum a lot of stock and/or amongst management buying shares ofttimes practise well. Companies where at that spot is a important grade of insider ownership, or which are theater unit of measurement run, mostly outperform. Companies inwards dull industries, or areas where at that spot are considered to last weak growth opportunities and/or a bad narrative inwards house virtually the outlook are worth looking at (as these opportunities are difficult for the fiscal manufacture to 'sell' to clients); as well as depression expectations and/or widespread dubiety are also really bullish indicators.
Consequently, whatsoever companies exhibiting whatsoever of these attributes, or plumbing equipment into whatsoever of the other areas of markets where value is probable to last found, motility straight to the top of my list, as well as are where I focus my energies. This instantly narrows the land of potential opportunities downwards to a manageable number of prospective hunting grounds. And ane way to remove hold stocks come upwards onto yous listing is to aspect at what other investors yous abide by as well as who remove hold similar investment philosophies are doing as well as investing in. If they flag a stock that fits into ane of the clusters of chance outlined above, as well as so it is ofttimes worth a look.
Brighthouse Financial
One such instance is David Einhorn, who late published his 4Q17 investor letter. I disagree amongst Einhorn on many things, as well as his performance inwards recent years has been poor, but he has constitute much to a greater extent than success amongst the long side of his bulk than his brusk side, as well as some of his longs remove hold been good selected as well as remove hold performed well. I ain both Aercap as well as General Motors - both of which are inwards his top v holdings.
In his recent quarterly, he noted that he had taken a top-5 seat inwards Brighthouse Financial (BHF US) - provider of fixed as well as variable annuity products, every bit good every bit life insurance. His short-form investment thesis was outlined every bit such:
"We initiated a large long seat inwards Brighthouse Financial (BHF) at an average of $57.92. BHF was spun out of MetLife as well as was formerly most of MetLife's U.S. Retail business, selling annuities as well as life insurance. BHF appears to last a traditional spin-off - an underperforming as well as unloved role of a larger, to a greater extent than successful company. The tone of the spin-off route demo was noticeably downbeat, amongst management advancing a concern computer program that does non audio specially exciting for shareholders. Notably, despite really conservative capitalization as well as high risk-based upper-case missive of the alphabet levels, the base of operations expectation calls for no upper-case missive of the alphabet homecoming until 2020. The resultant is a valuation of just 56% of bulk value as well as 6.4x 2018 EPS estimates.
"There are many stocks today that don't appear to remove hold whatsoever cushion built inwards for a behave market. We are brusk quite a few of them, but on BHF, analysts are Light Amplification by Stimulated Emission of Radiation focused on the downside from a behave market. That seems every bit good pessimistic. The converse of the downside of adverse upper-case missive of the alphabet markets is the upside to favourable markets. The flow-through from favourable upper-case missive of the alphabet markets, mayhap combined amongst better-than-forecasted execution typical of spin-offs of this type, should yield an powerfulness to homecoming upper-case missive of the alphabet much sooner than expected. With the shares trading at roughly a 40-50% discount to similar companies amongst normal upper-case missive of the alphabet homecoming policies, at that spot is plenty of upside to the shares every bit the marketplace seat begins to discount normalization. Management is good incentivized if the shares appreciate. BHF ended the yr at $58.64".
From this thesis, as well as a quick scan of the company's website as well as presentation, it could last instantly discerned that at that spot was a lot to similar here, as well as that it ticked many of the boxes I outlined above. The fellowship was a spin-off - check. It was inexpensive (0.56x bulk as well as a high unmarried digit PE) - check. It was inwards an opaque insurance sector amongst complexity - banking company check (complexity is ofttimes discounted every bit investors cannot last bothered doing the work). It was inwards an out of favour (though starting to come upwards dorsum into favour) fiscal sector - check. Management were incentivised to improve performance - check. There were no prospects for upper-case missive of the alphabet returns until 2020 - a argue for investors to ignore the stock at nowadays as well as banking company check inwards afterwards - banking company check (markets favour immediate gratification - at that spot was an chance hither to remove hold a longer term view as well as hold back for a re-rating coming into 2019/20 ahead of increased upper-case missive of the alphabet returns). I was intrigued. These indicia all pushed BHF towards the top of the listing of novel stocks I ought to aspect at.
The commencement thing I did was become to their website as well as download their latest investor presentation, which was virtually 50 slides inwards length. Initially, things were looking promising, until I happened upon slide 24 of the deck. After reading this, I knew the stock was going to last a pass:
Here nosotros remove hold the primal number staring us inwards the face. BHF is a long-tailed insurance company, as well as the key number for long-tailed insurance companies is this: how practise yous value their liabilities?
The number for banks as well as other lenders is the character of their assets - predominately loans as well as other bonds/financial instruments. Banks become broke when their assets plough out to last worth a lot less than they thought because their counterparties can't pay them dorsum (or where they remove hold a liquidity crisis they cannot resolve).
The number for (long tailed) insurance companies is different, as well as instead centres on the value of their liabilities. The property side of insurance companies' remainder sail soundless has risk, but it is unremarkably relatively low, every bit they mostly invest their assets relatively conservatively (typically mostly inwards high grade corporate as well as authorities bonds). However, their liabilities are dependent to much to a greater extent than uncertainty, ofttimes involving the utilisation of numerous discount charge per unit of measurement as well as other assumptions.
Insurance companies write policies which entail hereafter liabilities to policyholders, as well as have premiums which air current upwards every bit assets on the remainder sail which are used to fund those liabilities over time. Hopefully, the spread betwixt what the fellowship earns on those assets vs. their obligations nether these insurance contracts (net of costs) is large plenty for them to brand a decent profit. Importantly, dissimilar for non-financial companies, insurance fellowship reported earnings - similar many other financials - depend on the utilisation of assumptions virtually the valuation of those liabilities, the accuracy of which nosotros may non detect out virtually for years if non decades. Consequently, the assumptions beingness used demand to last scrutinised. Otherwise the earnings beingness reported are meaningless, as well as tin give the axe last wiped out yesteryear major 'reserve strengthening' write offs many years downwards the track.
Here inwards this slide nosotros remove hold evidence that the assumptions beingness used yesteryear the fellowship may non last sufficiently conservative. For their key variable annuity block of concern (variable annuities grant policyholders differing levels of payouts depending on the performance of markets, but typically amongst some minimum payout guaranties), they are assuming a long term homecoming on equities of 8.5%, as well as 6.5% inwards total including 3.5% on high-grade debt instruments (primarily authorities bonds). That seems much every bit good aggressive. Based on the electrical flow bird of U.S. of America equity pricing, 8.5% pa long term returns are most unlikely - markets are priced to homecoming virtually 5%, at best. And long term authorities bond yields are soundless sitting below 3% as well as are arguably just every bit probable to autumn over fourth dimension every bit rise.
If ane were to shift to to a greater extent than realistically conservative assumptions, every bit is shown inwards their slide, the NPV of their VA bulk would turn down precipitously, as well as to a grade roughly approximating the grade to which the company's bulk value currently exceeds its marketplace seat capitalisation. The company's insistence on maintaining a larger upper-case missive of the alphabet buffer inwards a higher house regulatorily mandated levels is also, arguably, a tacit acknowledgement that they believe their assumptions to last aggressive. Adjusting the value of their liabilities to the utilisation of to a greater extent than conservative assumptions wipes away the apparent undervaluation of the stock.
Has Einhorn non thought of this? The same Einhorn that wrote an entire bulk Fooling some people all of the fourth dimension about Allied Financial (a bulk I remove hold read as well as recommend)? Einhorn noted inwards his short-form thesis that markets were inwards an enthusiastic mood at the 2nd as well as were rising rapidly, as well as yet investors were non willing to allow BHF to assume hereafter marketplace seat equity returns were good. There is truly no inconsistency here. Investors are buying upwards markets at the 2nd amongst positive medium term homecoming expectations, but most investors concur that at electrical flow marketplace seat valuations, aggregate long term marketplace seat returns volition last good below historical levels.
The other number is that the value of an annuity fellowship centers on its powerfulness to effectively borrow long term coin at below-market rates, as well as and so invest those funds inwards higher-returning assets. That is what gives the concern model value. The work for annuity companies is that nosotros are currently living inwards a populace amongst really depression involvement rates, which significantly reduces the value of this powerfulness (just similar how depression rates negatively impact the value of deposit franchises held yesteryear companies such every bit Wells Fargo - transactional accounts typically yield niggling interest, as well as so these funds are worth a lot inwards a high involvement charge per unit of measurement surroundings where the funds tin give the axe last lent out at high involvement rates; inwards a depression charge per unit of measurement surroundings where the funds cannot, the value of these deposits significantly declines).
My conclusion, reached after virtually 20 minutes or so of work, was that this stock was probably a pass. The stock was optically inexpensive but probable for valid reasons - the assumptions underpinning the valuation of their liabilities looked aggressive, as well as after adjusting them, the discount to bulk value would disappear. And given the depression charge per unit of measurement surroundings inwards which nosotros are living, which has reduced the value of annuity businesses, coupled amongst the company's recently-weakened distribution position, 1x marked-down bulk (marked downwards to to a greater extent than realistic liability assumptions) appeared total (although yesteryear no agency expensive). I had turned over a promising stone, but it had non yielded anything.
I powerfulness last wrong. I powerfulness remove hold missed something. And fifty-fifty if I remove hold non missed anything, the stock powerfulness rally dorsum to 1x bulk regardless. I don't care. I'm looking for no brainers, as well as BHF didn't hand my commencement cut, which is designed to save fourth dimension resources for to a greater extent than promising opportunities. I volition maintain the stock on my watchlist as well as banking company check inwards in ane lawsuit to a greater extent than from fourth dimension to time, or revisit my view if the province of affairs is explained to me meliorate as well as allows me to view the stock inwards a different low-cal (or if the stock cost drops a lot), but for the moment, it's onto the side yesteryear side one.
Dignity plc
After finishing my go on BHF, I was scrolling through a watchlist of several M securities I follow a distich of days agone when I noticed something odd - ASX-listed funeral services provider Invocare (IVC AU) was trading downwards 5%, inwards a broader marketplace seat that was rising. Something was going on.
A quick search revealed no announcements from the company, so I did a tidings search, as well as after poking around for a while, discovered the reason: Market-leading LSE-listed funeral services provider Dignity plc had downgraded its earnings outlook as well as was trading downwards virtually 50%.
I remove hold followed Invocare for a patch as well as am familiar amongst their business. It is a expert concern - profitable, stable, as well as predictable - as well as has yielded shareholders really expert returns over time. However, amongst the stock trading at 25-30x earnings, it is good exterior the 'strike zone' - specially because inwards recent years they remove hold started to lose marketplace seat portion to cheaper, low-end providers (as good every bit providers of to a greater extent than new-age funeral services), as well as because the marketplace seat has reacted complacently to that threat, failing to ascribe whatsoever discount to the stock to reverberate these adverse evolution whatsoever.
Invocare was trading downwards because although Dignity operates inwards a different marketplace seat on the other side of the globe, Dignity is a similar concern to Invocare facing similar issues, as well as it had just issued a surprisingly-severe turn a profit alarm (to holders accustomed to steady, profitable growth), noting that they had taken a strategic determination to cutting the prices of its 'simple' funeral service offering inwards club to stalk marketplace seat portion losses. Investors paying attending to Dignity had correctly surmised that at that spot was a growing adventure Invocare could good imminently follow a similar path amongst a similarly barbarous portion cost correction. Although IVC had weakened 5%, it was soundless really expensive, as well as hence at that spot was for certain no chance to last had amongst Invocare on the long side whatsoever fourth dimension presently - if anything the inquiry suggested Invocare was a expert short.
However, this Pb me to remove hold a closer aspect at Dignity, as well as I liked what I saw. The stock really much looked to last inwards the 'strike zone' of the types of stocks I similar to own. My inquiry procedure took virtually an hour. I looked at their long term fiscal runway tape as well as trading history on Bloomberg, as well as saw that - much similar Invocare - the fellowship had been a highly profitable as well as steadily growing concern over to a greater extent than than a decade, as well as a stock that typically traded at 20x earnings or to a greater extent than - closed to Invocare. I as well as so went to their website as well as read their most recent earnings results (1H17, which remained strong); their recent downgrade announcement; as well as and so transcript of their conference telephone outcry upwards explaining the downgrade. I also leafed through their 2016 annual study quickly.
The next speedily became clear: their 2017 results, presently to last announced, were probable to last at tape levels, much similar Invocare. In addition, much similar Invocare, they had already been alarm for 12-18 months of rising depression destination contest as well as minor marketplace seat portion pressures, which the marketplace seat had until late ignored. However, dissimilar Invocare, they had decided to remove hold a strategic determination to defend their long term marketplace seat portion seat yesteryear cutting prices at the depression end. This would wound close term results, but was, inwards management's opinion, the right long term strategic decision. They offered no specific guidance on the impact, noting alone that they expected 2018 earnings to last 'materially below marketplace seat expectations', leaving opened upwards a broad attain of potential hereafter outcomes (likely reflecting the fact that management themselves don't yet know just what the impact volition aspect like).
Funeral services contain virtually 65% of their earnings. 35% comes from crematorium services as well as pre-funded funeral services. That 35% appears probable to stay unaffected. Furthermore, of their 65% earnings coming from funeral services, alone 8% of their bulk comes from 'simple' low-end funerals where they remove hold at nowadays cutting prices yesteryear virtually 25%. The other 92% remove hold non seen cost cuts. A mix shift is likely, as well as they noted that they expected 20% of bulk to come upwards from uncomplicated services this year, as well as this is a relatively fixed cost business, so revenue declines volition hurt. But they may also succeed inwards picking upwards some novel bulk every bit they win dorsum some previously ceded marketplace seat share. Overall, it would seem that a bulk of their concern is in all likelihood going to last relatively unaffected yesteryear this decision, but the marketplace seat has withal instantly assumed the worst.
The stock is at nowadays trading at 7.5x 2017 earnings - good downwards from highs of some 25x (the stock is at nowadays 65% off its highs). The marketplace seat previously preferred to pay 20-25x for the illusion of steady low-risk high unmarried digit earnings growth, fifty-fifty when incremental marketplace seat portion pressures were beingness flagged. However, at the acquaint juncture, fifty-fifty if earnings autumn 30-50% this yr (and I retrieve 30% is much to a greater extent than probable than 50%, if non less), the stock volition at nowadays last on 10-15x earnings on an earnings base of operations that is at nowadays significantly to a greater extent than sustainable as well as which may assist inwards winning dorsum lost marketplace seat share.
Investors are at nowadays applying a lower multiple to a lower-risk, rebased earnings stream, which makes no rational sense. They are doing this because of the way investors' psychology plant - the risks feel higher at nowadays fifty-fifty though they are not, as well as because investors systematically excessively discount dubiety (worse than beingness told earnings are going to autumn this year, is not beingness told yesteryear how much, which maximises the sense of fearfulness as well as disorientation).
A realistic scenario powerfulness last earnings dropping 30%, putting the stock at 10x, but as well as so the fellowship says marketplace seat portion has stabilised as well as earnings are expected to resume growth inwards 2019. With investors at nowadays aware of where the bottom of earnings is, as well as a to a greater extent than promising outlook for 2019 off a lower base, the stock could good rally 50-100% dorsum to 15-20x 2018 earnings. Not at all impossible.
On the downside, expectations are at nowadays already low, as well as the adventure of marketplace seat portion losses as well as margin declines forepart as well as centre of investor expectations. Investors already aspect earnings to driblet a lot, so if earnings turn down yesteryear to a greater extent than than I aspect - tell 50-60% as well as never recover, that scenario is at nowadays already inwards the price. The fellowship does remove hold some debt, but it is good structured, beingness long term, depression involvement rate, fixed charge per unit of measurement debt, as well as so should last comfortably able to last accommodated.
The psychology of investors is, incidentally, just why Joel Greenblatt's quant approach of buying depression PE businesses relative to their ROEs on past earnings (not forecast earnings) plant so well. Dignity falls into this category now. It plant because if investors misappraise the extent to which earnings are probable to decline, at that spot is range for a important portion cost rebound, but if they are right as well as earnings practise driblet precipitously as well as permanently, that is already inwards the portion price, as well as so farther portion cost downside is ofttimes limited. This is the really Definition of a high return, depression adventure investment, inwards my view.
I bought some at 960-980p after virtually 1hr of inquiry (about a 30-40bp position). I powerfulness last wrong. I powerfulness remove hold missed something. But I don't care. Because when I invest I am focused on probabilities non outcomes. Based on my nearly two-decades experience investing as well as attempting to empathize investor psychology, I strongly believe that stocks similar Dignity right at nowadays offering attractive risk/reward potential, as well as yesteryear diversifying, I am also able to diversify away private safety adventure as well as focus on exploiting systematic marketplace seat mispricings.
Reflections
In less than 2 hours, I was able to detect ane purchase idea, as well as dismiss some other superficially promising chance that didn't behave scrutiny. I practise this all day, twenty-four hours after twenty-four hours after day. That is how yous brand coin inwards markets - through difficult go as well as a disciplined process.
Furthermore, ane of the key takeaways from the inwards a higher house is that when researching stocks, the returns on breadth overstep the returns on depth (coupled amongst an powerfulness to brand fast as well as relatively accurate judgements). In other words, yous are much meliorate off, inwards my opinion, spending your fourth dimension looking at lots as well as lots as well as lots of stocks as well as trying to unearth the most obvious opportunities, than investing tremendous amounts of fourth dimension learning all the irrelevant details virtually private issues.
This is because most stocks, most of the time, are non inwards the 'strike zone', as well as no amount of detailed inquiry volition of a abrupt become far so. If a stock does non instantly strike yous every bit cheap, it is in all likelihood non inexpensive plenty as well as yous should divert your inquiry resources elsewhere as well as banking company check inwards in ane lawsuit to a greater extent than later. Furthermore, non alone volition detailed inquiry on private issues deprive yous of opportunities to aspect at other stocks, but it volition also brand yous experience every bit though yous demand some sort of 'reward' for the amount of fourth dimension yous remove hold committed to your inquiry process, as well as so tempt yous to purchase some lest all that travail become to waste. That is a sunk cost psychological bias that is best avoided.
In addition, the to a greater extent than conventional depth over breadth inquiry procedure also ofttimes leads to excessive portfolio concentration - a frequent work these days. This occurs because a detailed-oriented procedure does non leave of absence plenty fourth dimension to aspect at plenty stocks, so relatively few expert ideas are uncovered. That as well as so requires either a selection to 'diworsify' the portfolio, or excessively concentrate.
My widely diversified portfolio grants me important flexibility. I am non excessively exposed to the outcome of whatsoever private stock (with some exceptions - I remove hold a handful of large, conviction positions), so tin give the axe focus on procedure as well as full general probabilities, rather than feeling the demand to predict specific outcomes. In addition, I remove hold the capacity to last extremely patient amongst private positions, as well as remove hold important flexibility to average downwards if given the opportunity. Dignity powerfulness last a peachy investment at electrical flow levels, but it powerfulness halve in ane lawsuit to a greater extent than for all I know. I volition remove hold the capacity to increment my seat yesteryear many multiples of my initial entry size, if such an outstanding chance were to acquaint itself. Conventionally concentrated portfolios surrender that flexibility (indeed, the best opportunities I detect are ofttimes inwards stocks other value investors cannot purchase to a greater extent than of because they already bought total positions at much higher levels as well as practise non remove hold the capacity to adventure to a greater extent than upper-case missive of the alphabet on the position).
Many people stay bemused at how I am making 50% a yr amongst a 'diversified' 150 stock portfolio. Conventional wisdom says that ought non last possible. The inwards a higher house explains how. You merely practise non demand to know all the extraneous details. You demand to know what is important, as well as alone what is important. As I blogged virtually inwards existent fourth dimension final year, I bought Michael Kors after less than an lx minutes of research, as well as remove hold since made 80% on that seat (I soundless ain it). All the of import information could last gleaned inwards less than an hour. Everything else was irrelevant, as well as ignoring irrelevant information is every bit of import every bit paying attending to what truly counts.
This works, of course, provided yous are an experienced investor that understands the ins as well as outs of many industries; how to value stocks; as well as how marketplace seat psychology as well as cycles go at a really deep level. Blink investing requires a important amount of accumulated effort, experience, as well as knowledge, such that relatively accurate judgments tin give the axe last rendered on a large number of situations really speedily (Buffett claims to last able to shape a judgment on most stocks as well as businesses he looks at inwards less than 10 minutes). I could non remove hold invested this speedily inwards these names, for instance, if I didn't already empathize insurance companies, or had non previously researched Invocare. But when those prerequisites are inwards place, it plant amazingly well.
LT3000
*The inwards a higher house analysis is furnished for informational/entertainment purposes only, as well as is non to last construed every bit investment advice. The writer provides no warranty whatsoever every bit to the accuracy of the contents of the post, as well as reserves all rights to merchandise inwards whatsoever securities mentioned inwards whatsoever article at whatsoever time.
Many are confused virtually how I deal to practise this. How, it is asked, tin give the axe yous maintain runway of 150 stocks? My reply is that I don't - those are just the ones I like. I truly maintain runway of thousands as well as thousands of stocks.
How practise I practise it? Simple - I attempt to aspect at novel stocks, all the time - typically 5-10 novel stocks a day, seven days a calendar week (when I am non traveling or otherwise distracted), patch also 'checking in' on several dozen stocks I already follow each day. And I encompass so much basis yesteryear honing straight inwards on the things that truly matter, as well as ignoring all irrelevant, extraneous detail.
I am a large believer inwards Peter Lynch's dictum (Peter Lynch was the greatest portfolio managing director of the yesteryear few generations inwards my view) that he who turns over the most rocks wins, as well as I endeavour to plough over every bit many rocks every bit I can, every bit fast every bit I can, as well as believe that inwards markets, the returns to breadth overstep the returns to depth when researching stocks. A few examples - ane successful, ane unsuccessful - inwards the yesteryear few days may serve to highlight the procedure somewhat.
Although it is of import to ever last looking at stocks, yous tin give the axe as well as should prioritise your search inwards areas of markets where yous are most probable to detect opportunities. Certain regions as well as industries are relatively inexpensive at whatsoever given indicate of time, as well as others are relatively expensive. This is based, to a large degree, on where these economies, industries, as well as markets are at inwards their respective economic, industry, as well as investor sentiment cycles, which wax as well as wane over fourth dimension similar the seasons. It is of import to remove hold this contextual agreement firmly inwards house earlier yous proceed.
I prioritise looking at regions, industries, as well as marketplace seat segments that are out of favour or are going through downturns, because that is where inexpensive stocks are most probable to last found. In recent times, that has included recession-addled emerging markets such every bit Russian Federation as well as Brazil (as good every bit peripheral Europe as well as Greece); regions amongst prevalent pessimism virtually the economical outlook or risks (such every bit China/HK as well as Japan), as well as neglected industries people are pessimistic virtually including autos, coal as well as other commodities (until recently), fossil oil as well as fossil oil services, B&M retail, traditional media, as well as banks as well as other financials. Of late, some value has begun to emerge inwards the UK, every bit well, every bit Brexit anxieties remove hold begun to weigh on both valuations as well as earnings.
In addition, at that spot are many other predictors of stocks beingness inexpensive as well as potentially prospective. Spin-offs remove hold traditionally done good every bit a group. Companies buying dorsum a lot of stock and/or amongst management buying shares ofttimes practise well. Companies where at that spot is a important grade of insider ownership, or which are theater unit of measurement run, mostly outperform. Companies inwards dull industries, or areas where at that spot are considered to last weak growth opportunities and/or a bad narrative inwards house virtually the outlook are worth looking at (as these opportunities are difficult for the fiscal manufacture to 'sell' to clients); as well as depression expectations and/or widespread dubiety are also really bullish indicators.
Consequently, whatsoever companies exhibiting whatsoever of these attributes, or plumbing equipment into whatsoever of the other areas of markets where value is probable to last found, motility straight to the top of my list, as well as are where I focus my energies. This instantly narrows the land of potential opportunities downwards to a manageable number of prospective hunting grounds. And ane way to remove hold stocks come upwards onto yous listing is to aspect at what other investors yous abide by as well as who remove hold similar investment philosophies are doing as well as investing in. If they flag a stock that fits into ane of the clusters of chance outlined above, as well as so it is ofttimes worth a look.
Brighthouse Financial
One such instance is David Einhorn, who late published his 4Q17 investor letter. I disagree amongst Einhorn on many things, as well as his performance inwards recent years has been poor, but he has constitute much to a greater extent than success amongst the long side of his bulk than his brusk side, as well as some of his longs remove hold been good selected as well as remove hold performed well. I ain both Aercap as well as General Motors - both of which are inwards his top v holdings.
In his recent quarterly, he noted that he had taken a top-5 seat inwards Brighthouse Financial (BHF US) - provider of fixed as well as variable annuity products, every bit good every bit life insurance. His short-form investment thesis was outlined every bit such:
"We initiated a large long seat inwards Brighthouse Financial (BHF) at an average of $57.92. BHF was spun out of MetLife as well as was formerly most of MetLife's U.S. Retail business, selling annuities as well as life insurance. BHF appears to last a traditional spin-off - an underperforming as well as unloved role of a larger, to a greater extent than successful company. The tone of the spin-off route demo was noticeably downbeat, amongst management advancing a concern computer program that does non audio specially exciting for shareholders. Notably, despite really conservative capitalization as well as high risk-based upper-case missive of the alphabet levels, the base of operations expectation calls for no upper-case missive of the alphabet homecoming until 2020. The resultant is a valuation of just 56% of bulk value as well as 6.4x 2018 EPS estimates.
"There are many stocks today that don't appear to remove hold whatsoever cushion built inwards for a behave market. We are brusk quite a few of them, but on BHF, analysts are Light Amplification by Stimulated Emission of Radiation focused on the downside from a behave market. That seems every bit good pessimistic. The converse of the downside of adverse upper-case missive of the alphabet markets is the upside to favourable markets. The flow-through from favourable upper-case missive of the alphabet markets, mayhap combined amongst better-than-forecasted execution typical of spin-offs of this type, should yield an powerfulness to homecoming upper-case missive of the alphabet much sooner than expected. With the shares trading at roughly a 40-50% discount to similar companies amongst normal upper-case missive of the alphabet homecoming policies, at that spot is plenty of upside to the shares every bit the marketplace seat begins to discount normalization. Management is good incentivized if the shares appreciate. BHF ended the yr at $58.64".
From this thesis, as well as a quick scan of the company's website as well as presentation, it could last instantly discerned that at that spot was a lot to similar here, as well as that it ticked many of the boxes I outlined above. The fellowship was a spin-off - check. It was inexpensive (0.56x bulk as well as a high unmarried digit PE) - check. It was inwards an opaque insurance sector amongst complexity - banking company check (complexity is ofttimes discounted every bit investors cannot last bothered doing the work). It was inwards an out of favour (though starting to come upwards dorsum into favour) fiscal sector - check. Management were incentivised to improve performance - check. There were no prospects for upper-case missive of the alphabet returns until 2020 - a argue for investors to ignore the stock at nowadays as well as banking company check inwards afterwards - banking company check (markets favour immediate gratification - at that spot was an chance hither to remove hold a longer term view as well as hold back for a re-rating coming into 2019/20 ahead of increased upper-case missive of the alphabet returns). I was intrigued. These indicia all pushed BHF towards the top of the listing of novel stocks I ought to aspect at.
The commencement thing I did was become to their website as well as download their latest investor presentation, which was virtually 50 slides inwards length. Initially, things were looking promising, until I happened upon slide 24 of the deck. After reading this, I knew the stock was going to last a pass:
The number for banks as well as other lenders is the character of their assets - predominately loans as well as other bonds/financial instruments. Banks become broke when their assets plough out to last worth a lot less than they thought because their counterparties can't pay them dorsum (or where they remove hold a liquidity crisis they cannot resolve).
The number for (long tailed) insurance companies is different, as well as instead centres on the value of their liabilities. The property side of insurance companies' remainder sail soundless has risk, but it is unremarkably relatively low, every bit they mostly invest their assets relatively conservatively (typically mostly inwards high grade corporate as well as authorities bonds). However, their liabilities are dependent to much to a greater extent than uncertainty, ofttimes involving the utilisation of numerous discount charge per unit of measurement as well as other assumptions.
Insurance companies write policies which entail hereafter liabilities to policyholders, as well as have premiums which air current upwards every bit assets on the remainder sail which are used to fund those liabilities over time. Hopefully, the spread betwixt what the fellowship earns on those assets vs. their obligations nether these insurance contracts (net of costs) is large plenty for them to brand a decent profit. Importantly, dissimilar for non-financial companies, insurance fellowship reported earnings - similar many other financials - depend on the utilisation of assumptions virtually the valuation of those liabilities, the accuracy of which nosotros may non detect out virtually for years if non decades. Consequently, the assumptions beingness used demand to last scrutinised. Otherwise the earnings beingness reported are meaningless, as well as tin give the axe last wiped out yesteryear major 'reserve strengthening' write offs many years downwards the track.
Here inwards this slide nosotros remove hold evidence that the assumptions beingness used yesteryear the fellowship may non last sufficiently conservative. For their key variable annuity block of concern (variable annuities grant policyholders differing levels of payouts depending on the performance of markets, but typically amongst some minimum payout guaranties), they are assuming a long term homecoming on equities of 8.5%, as well as 6.5% inwards total including 3.5% on high-grade debt instruments (primarily authorities bonds). That seems much every bit good aggressive. Based on the electrical flow bird of U.S. of America equity pricing, 8.5% pa long term returns are most unlikely - markets are priced to homecoming virtually 5%, at best. And long term authorities bond yields are soundless sitting below 3% as well as are arguably just every bit probable to autumn over fourth dimension every bit rise.
If ane were to shift to to a greater extent than realistically conservative assumptions, every bit is shown inwards their slide, the NPV of their VA bulk would turn down precipitously, as well as to a grade roughly approximating the grade to which the company's bulk value currently exceeds its marketplace seat capitalisation. The company's insistence on maintaining a larger upper-case missive of the alphabet buffer inwards a higher house regulatorily mandated levels is also, arguably, a tacit acknowledgement that they believe their assumptions to last aggressive. Adjusting the value of their liabilities to the utilisation of to a greater extent than conservative assumptions wipes away the apparent undervaluation of the stock.
Has Einhorn non thought of this? The same Einhorn that wrote an entire bulk Fooling some people all of the fourth dimension about Allied Financial (a bulk I remove hold read as well as recommend)? Einhorn noted inwards his short-form thesis that markets were inwards an enthusiastic mood at the 2nd as well as were rising rapidly, as well as yet investors were non willing to allow BHF to assume hereafter marketplace seat equity returns were good. There is truly no inconsistency here. Investors are buying upwards markets at the 2nd amongst positive medium term homecoming expectations, but most investors concur that at electrical flow marketplace seat valuations, aggregate long term marketplace seat returns volition last good below historical levels.
The other number is that the value of an annuity fellowship centers on its powerfulness to effectively borrow long term coin at below-market rates, as well as and so invest those funds inwards higher-returning assets. That is what gives the concern model value. The work for annuity companies is that nosotros are currently living inwards a populace amongst really depression involvement rates, which significantly reduces the value of this powerfulness (just similar how depression rates negatively impact the value of deposit franchises held yesteryear companies such every bit Wells Fargo - transactional accounts typically yield niggling interest, as well as so these funds are worth a lot inwards a high involvement charge per unit of measurement surroundings where the funds tin give the axe last lent out at high involvement rates; inwards a depression charge per unit of measurement surroundings where the funds cannot, the value of these deposits significantly declines).
My conclusion, reached after virtually 20 minutes or so of work, was that this stock was probably a pass. The stock was optically inexpensive but probable for valid reasons - the assumptions underpinning the valuation of their liabilities looked aggressive, as well as after adjusting them, the discount to bulk value would disappear. And given the depression charge per unit of measurement surroundings inwards which nosotros are living, which has reduced the value of annuity businesses, coupled amongst the company's recently-weakened distribution position, 1x marked-down bulk (marked downwards to to a greater extent than realistic liability assumptions) appeared total (although yesteryear no agency expensive). I had turned over a promising stone, but it had non yielded anything.
I powerfulness last wrong. I powerfulness remove hold missed something. And fifty-fifty if I remove hold non missed anything, the stock powerfulness rally dorsum to 1x bulk regardless. I don't care. I'm looking for no brainers, as well as BHF didn't hand my commencement cut, which is designed to save fourth dimension resources for to a greater extent than promising opportunities. I volition maintain the stock on my watchlist as well as banking company check inwards in ane lawsuit to a greater extent than from fourth dimension to time, or revisit my view if the province of affairs is explained to me meliorate as well as allows me to view the stock inwards a different low-cal (or if the stock cost drops a lot), but for the moment, it's onto the side yesteryear side one.
Dignity plc
After finishing my go on BHF, I was scrolling through a watchlist of several M securities I follow a distich of days agone when I noticed something odd - ASX-listed funeral services provider Invocare (IVC AU) was trading downwards 5%, inwards a broader marketplace seat that was rising. Something was going on.
A quick search revealed no announcements from the company, so I did a tidings search, as well as after poking around for a while, discovered the reason: Market-leading LSE-listed funeral services provider Dignity plc had downgraded its earnings outlook as well as was trading downwards virtually 50%.
I remove hold followed Invocare for a patch as well as am familiar amongst their business. It is a expert concern - profitable, stable, as well as predictable - as well as has yielded shareholders really expert returns over time. However, amongst the stock trading at 25-30x earnings, it is good exterior the 'strike zone' - specially because inwards recent years they remove hold started to lose marketplace seat portion to cheaper, low-end providers (as good every bit providers of to a greater extent than new-age funeral services), as well as because the marketplace seat has reacted complacently to that threat, failing to ascribe whatsoever discount to the stock to reverberate these adverse evolution whatsoever.
Invocare was trading downwards because although Dignity operates inwards a different marketplace seat on the other side of the globe, Dignity is a similar concern to Invocare facing similar issues, as well as it had just issued a surprisingly-severe turn a profit alarm (to holders accustomed to steady, profitable growth), noting that they had taken a strategic determination to cutting the prices of its 'simple' funeral service offering inwards club to stalk marketplace seat portion losses. Investors paying attending to Dignity had correctly surmised that at that spot was a growing adventure Invocare could good imminently follow a similar path amongst a similarly barbarous portion cost correction. Although IVC had weakened 5%, it was soundless really expensive, as well as hence at that spot was for certain no chance to last had amongst Invocare on the long side whatsoever fourth dimension presently - if anything the inquiry suggested Invocare was a expert short.
However, this Pb me to remove hold a closer aspect at Dignity, as well as I liked what I saw. The stock really much looked to last inwards the 'strike zone' of the types of stocks I similar to own. My inquiry procedure took virtually an hour. I looked at their long term fiscal runway tape as well as trading history on Bloomberg, as well as saw that - much similar Invocare - the fellowship had been a highly profitable as well as steadily growing concern over to a greater extent than than a decade, as well as a stock that typically traded at 20x earnings or to a greater extent than - closed to Invocare. I as well as so went to their website as well as read their most recent earnings results (1H17, which remained strong); their recent downgrade announcement; as well as and so transcript of their conference telephone outcry upwards explaining the downgrade. I also leafed through their 2016 annual study quickly.
The next speedily became clear: their 2017 results, presently to last announced, were probable to last at tape levels, much similar Invocare. In addition, much similar Invocare, they had already been alarm for 12-18 months of rising depression destination contest as well as minor marketplace seat portion pressures, which the marketplace seat had until late ignored. However, dissimilar Invocare, they had decided to remove hold a strategic determination to defend their long term marketplace seat portion seat yesteryear cutting prices at the depression end. This would wound close term results, but was, inwards management's opinion, the right long term strategic decision. They offered no specific guidance on the impact, noting alone that they expected 2018 earnings to last 'materially below marketplace seat expectations', leaving opened upwards a broad attain of potential hereafter outcomes (likely reflecting the fact that management themselves don't yet know just what the impact volition aspect like).
Funeral services contain virtually 65% of their earnings. 35% comes from crematorium services as well as pre-funded funeral services. That 35% appears probable to stay unaffected. Furthermore, of their 65% earnings coming from funeral services, alone 8% of their bulk comes from 'simple' low-end funerals where they remove hold at nowadays cutting prices yesteryear virtually 25%. The other 92% remove hold non seen cost cuts. A mix shift is likely, as well as they noted that they expected 20% of bulk to come upwards from uncomplicated services this year, as well as this is a relatively fixed cost business, so revenue declines volition hurt. But they may also succeed inwards picking upwards some novel bulk every bit they win dorsum some previously ceded marketplace seat share. Overall, it would seem that a bulk of their concern is in all likelihood going to last relatively unaffected yesteryear this decision, but the marketplace seat has withal instantly assumed the worst.
The stock is at nowadays trading at 7.5x 2017 earnings - good downwards from highs of some 25x (the stock is at nowadays 65% off its highs). The marketplace seat previously preferred to pay 20-25x for the illusion of steady low-risk high unmarried digit earnings growth, fifty-fifty when incremental marketplace seat portion pressures were beingness flagged. However, at the acquaint juncture, fifty-fifty if earnings autumn 30-50% this yr (and I retrieve 30% is much to a greater extent than probable than 50%, if non less), the stock volition at nowadays last on 10-15x earnings on an earnings base of operations that is at nowadays significantly to a greater extent than sustainable as well as which may assist inwards winning dorsum lost marketplace seat share.
Investors are at nowadays applying a lower multiple to a lower-risk, rebased earnings stream, which makes no rational sense. They are doing this because of the way investors' psychology plant - the risks feel higher at nowadays fifty-fifty though they are not, as well as because investors systematically excessively discount dubiety (worse than beingness told earnings are going to autumn this year, is not beingness told yesteryear how much, which maximises the sense of fearfulness as well as disorientation).
A realistic scenario powerfulness last earnings dropping 30%, putting the stock at 10x, but as well as so the fellowship says marketplace seat portion has stabilised as well as earnings are expected to resume growth inwards 2019. With investors at nowadays aware of where the bottom of earnings is, as well as a to a greater extent than promising outlook for 2019 off a lower base, the stock could good rally 50-100% dorsum to 15-20x 2018 earnings. Not at all impossible.
On the downside, expectations are at nowadays already low, as well as the adventure of marketplace seat portion losses as well as margin declines forepart as well as centre of investor expectations. Investors already aspect earnings to driblet a lot, so if earnings turn down yesteryear to a greater extent than than I aspect - tell 50-60% as well as never recover, that scenario is at nowadays already inwards the price. The fellowship does remove hold some debt, but it is good structured, beingness long term, depression involvement rate, fixed charge per unit of measurement debt, as well as so should last comfortably able to last accommodated.
The psychology of investors is, incidentally, just why Joel Greenblatt's quant approach of buying depression PE businesses relative to their ROEs on past earnings (not forecast earnings) plant so well. Dignity falls into this category now. It plant because if investors misappraise the extent to which earnings are probable to decline, at that spot is range for a important portion cost rebound, but if they are right as well as earnings practise driblet precipitously as well as permanently, that is already inwards the portion price, as well as so farther portion cost downside is ofttimes limited. This is the really Definition of a high return, depression adventure investment, inwards my view.
I bought some at 960-980p after virtually 1hr of inquiry (about a 30-40bp position). I powerfulness last wrong. I powerfulness remove hold missed something. But I don't care. Because when I invest I am focused on probabilities non outcomes. Based on my nearly two-decades experience investing as well as attempting to empathize investor psychology, I strongly believe that stocks similar Dignity right at nowadays offering attractive risk/reward potential, as well as yesteryear diversifying, I am also able to diversify away private safety adventure as well as focus on exploiting systematic marketplace seat mispricings.
Reflections
In less than 2 hours, I was able to detect ane purchase idea, as well as dismiss some other superficially promising chance that didn't behave scrutiny. I practise this all day, twenty-four hours after twenty-four hours after day. That is how yous brand coin inwards markets - through difficult go as well as a disciplined process.
Furthermore, ane of the key takeaways from the inwards a higher house is that when researching stocks, the returns on breadth overstep the returns on depth (coupled amongst an powerfulness to brand fast as well as relatively accurate judgements). In other words, yous are much meliorate off, inwards my opinion, spending your fourth dimension looking at lots as well as lots as well as lots of stocks as well as trying to unearth the most obvious opportunities, than investing tremendous amounts of fourth dimension learning all the irrelevant details virtually private issues.
This is because most stocks, most of the time, are non inwards the 'strike zone', as well as no amount of detailed inquiry volition of a abrupt become far so. If a stock does non instantly strike yous every bit cheap, it is in all likelihood non inexpensive plenty as well as yous should divert your inquiry resources elsewhere as well as banking company check inwards in ane lawsuit to a greater extent than later. Furthermore, non alone volition detailed inquiry on private issues deprive yous of opportunities to aspect at other stocks, but it volition also brand yous experience every bit though yous demand some sort of 'reward' for the amount of fourth dimension yous remove hold committed to your inquiry process, as well as so tempt yous to purchase some lest all that travail become to waste. That is a sunk cost psychological bias that is best avoided.
In addition, the to a greater extent than conventional depth over breadth inquiry procedure also ofttimes leads to excessive portfolio concentration - a frequent work these days. This occurs because a detailed-oriented procedure does non leave of absence plenty fourth dimension to aspect at plenty stocks, so relatively few expert ideas are uncovered. That as well as so requires either a selection to 'diworsify' the portfolio, or excessively concentrate.
My widely diversified portfolio grants me important flexibility. I am non excessively exposed to the outcome of whatsoever private stock (with some exceptions - I remove hold a handful of large, conviction positions), so tin give the axe focus on procedure as well as full general probabilities, rather than feeling the demand to predict specific outcomes. In addition, I remove hold the capacity to last extremely patient amongst private positions, as well as remove hold important flexibility to average downwards if given the opportunity. Dignity powerfulness last a peachy investment at electrical flow levels, but it powerfulness halve in ane lawsuit to a greater extent than for all I know. I volition remove hold the capacity to increment my seat yesteryear many multiples of my initial entry size, if such an outstanding chance were to acquaint itself. Conventionally concentrated portfolios surrender that flexibility (indeed, the best opportunities I detect are ofttimes inwards stocks other value investors cannot purchase to a greater extent than of because they already bought total positions at much higher levels as well as practise non remove hold the capacity to adventure to a greater extent than upper-case missive of the alphabet on the position).
Many people stay bemused at how I am making 50% a yr amongst a 'diversified' 150 stock portfolio. Conventional wisdom says that ought non last possible. The inwards a higher house explains how. You merely practise non demand to know all the extraneous details. You demand to know what is important, as well as alone what is important. As I blogged virtually inwards existent fourth dimension final year, I bought Michael Kors after less than an lx minutes of research, as well as remove hold since made 80% on that seat (I soundless ain it). All the of import information could last gleaned inwards less than an hour. Everything else was irrelevant, as well as ignoring irrelevant information is every bit of import every bit paying attending to what truly counts.
This works, of course, provided yous are an experienced investor that understands the ins as well as outs of many industries; how to value stocks; as well as how marketplace seat psychology as well as cycles go at a really deep level. Blink investing requires a important amount of accumulated effort, experience, as well as knowledge, such that relatively accurate judgments tin give the axe last rendered on a large number of situations really speedily (Buffett claims to last able to shape a judgment on most stocks as well as businesses he looks at inwards less than 10 minutes). I could non remove hold invested this speedily inwards these names, for instance, if I didn't already empathize insurance companies, or had non previously researched Invocare. But when those prerequisites are inwards place, it plant amazingly well.
LT3000
*The inwards a higher house analysis is furnished for informational/entertainment purposes only, as well as is non to last construed every bit investment advice. The writer provides no warranty whatsoever every bit to the accuracy of the contents of the post, as well as reserves all rights to merchandise inwards whatsoever securities mentioned inwards whatsoever article at whatsoever time.