Wednesday, March 19, 2014

Giverny Capital Annual Letter 2013

I have been reading Giverny Capital's annual letters for a period of time.

I have nothing but admiration for the good folks at Giverny. Their investment philosophy and process closely echo mine, but they expressed themselves much better than me.

Reading Giverny's letters will give you a snapshot into my thinking processes involved in operating Castlereagh Equity.  Be kind and gentle, as the folks at Giverny has over 20 years of headstart over this one-legged  newbie.

Giverny Capital Annual Letter 2013

Wednesday, March 12, 2014

Song for the Day

Jackie Evancho- All I Ask of You

Enjoy and prosper.

Yours truly
One Legged

Tuesday, March 11, 2014

Dogs versus Darlings

On Wednesday 12 March 2014, I have set up a tracking portfolio populated by 4 market darlings and 4 market dogs.

The market darlings are OFX, REA, IPP and XRO.

The market dogs comprised of 4 mining services companies which shall remain anonymous at this time.

We will revisit this portfolio on a periodic basis. Hopefully some lessons and insights can be gained from this very simple exercise in real time.

Yours Truly

Thursday, March 6, 2014

Recent Thoughts in Brief

The more things change the more things remain the same.

I remember back in the late 90s where companies with no earnings burning through cash were trading at market valuations above companies which actually made profits and paid dividends. At one stage, was trading at twice the market value of Vision Systems. I shook my head in wonder, shrugged and moved on.

Nearly fifteen years later to the present, it appears that things have not really changed much. For example, XRO is now valued at $5 billion dollars, and yet the company is burning through cash like there is no tomorrow. The software contains nifty features, being operated in the cloud with crowd-sourcing features in its error systems. Read more about it here from Bronte Capital.  There are many rave reviews, and it has some serious investor backing. NZ and Australian fund managers are scrambling to get a slice of the action as they are now underweigh XRO which has become a significant part of the indices. Even the good old Motley Fool has chimed in to say that this stock has huge potential, making it the number one technology stock pick.

Then we have IPP, valued at $500m as the market superimposes and projects the trajectory of REA onto this relative minnow. The excitement is understandable if one sees REA currently valued at $6.8 billion, about close to a 50 fold increase over 10 years.  My problem is that REA needs to grow its free cashflow at annual compounding rates approaching 25% for ten years to justify its current price. The market cap of REA is about 34x operating cashflow. Mr Market appears not to be too concerned about this small little detail. Drink and be merry, for who cares what tomorrow brings?

I can cite many other examples, but I am too lazy to do so in this blog post.

On the other end of the scale, we see many companies sold down severely upon news or perception that earnings will not be flying to the sky, at least not within the next 12 months. The mining services sector is now the whipping boy of the ASX, much like what happened with financials, retail and media in the past few years. The malady is not restricted to the mining services sector. The fact that some of these businesses (especially mining services company) will likely survive and thrive in the future is not considered at all, let alone factored into any sort of valuations. Share prices are sent to the sin bin if there is no promise of earnings growth within the next 12 months, or if there is no compelling story.

Several examples suffice, with names withheld to protect the innocent. There is a company, whose business has significant tailwinds, who irritated Mr Market when it said there is too much business and the company needs to spend some money to ensure it has better processes and staff in place to handle the volumes. As they will be expensing all of these spending, short term profits will be affected, even though revenues will keep increasing. This name is now trading at less than 10x cashflow, with 30% of its market cap comprising of cash in hand. Even with the spending and payment of dividend, there is still free cashflow retained. There are two possible outcomes- the spending initiative pays off and free cashflow increases, all of which will continue to swell the bank account which is already swollen with cash. Or the spending initiative is not fruitful and management stops spending. As management already holds a big shareholding, the likely outcome is apparent.  Whilst I wait, I am receiving 3.4% of my entry price in dividends every year. Even if there is no growth, I will not be losing any money. If there is growth, I get it all for free.

Another company also suffered the same fate as the company described above. Mr Market assumed this company will die an inglorious death. Bear in mind that even though this company has cash comprising about 1/3 of its market cap, Mr Market will still sell this to you at less than 5x normalised cashflow.

There is another company with monopolistic assets. Mr Market is unhappy because He cannot see any growth and concerned because the company was impacted by adverse environmental and weather conditions which affected its earnings. This company is trading at 10x cashflow. It pays a 5% dividend even from its currently depressed state.

Another company which I am looking at incurred the displeasure of Mr Market last year when earnings stalled whilst it was integrating some acquisitions. Even though the last half yearly produced a sterling result, the company is still trading at less than 10x cashflow. It has no debt and has recurring revenues streams unlikely to be disrupted in the future.

From a broad perspective, it is not the case that investors are not focusing on risks.  They are. What is apparent is that investors are not factoring both risk and return together. Investors in the current climate either discount for risks severely without factoring in upside of possible returns, or they will pay a premium for potential returns without discounting for possible downside risks. Just have a look at any broker research reports.  You will likely find a nice table with earnings progressing up every year. This is a vivid illustration of linear thinking aka one track mind. Real life in business is much more messier than this. A Bayesian approach is the most appropriate, but I have seldom seen this applied in any brokerage reports, let alone snippets and articles in investment newsletter.

The Chinese are pretty big on the concept of yin and yang.  The basic lesson is one of maintaining a correct balance, which is where good judgment is called for.  Balancing risk and return is a basic requirement for any successful person in business. The same applies to investing.

Lastly, here is one simple tip: if you do not see a valuation anywhere in any report, tipsheet or article recommending a particular stock, keep your cursor away from the BUY button.

Yours truly,
One Legged

Sunday, March 2, 2014


Dear Readers,

For moments when you feel down and out, remember that human potential is boundless and limitless. It is true that angels do dwell amongst us.


Amira Willighagen- O Mio Babbino Caro

Jackie Evancho- Nessun Dorma

Sung Bong Choi- Nella Fantasia