Professional Documents
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Lisa Rapuano Finding Your Way Along The Many Paths of Value
Lisa Rapuano Finding Your Way Along The Many Paths of Value
www.ValueInvestingCongress.com
Aint only three things to gambling. Knowin the 60-40 end of a proposition, money management, and knowin yourself - Puggy Pearson (HT Bill Miller)
All approaches to value investing attempt to buy $1.00 for $0.50 We watch other investors ownership positions and reasoning Very few managers outperform over long periods of time A common trait of long term successful investors is commitment to personal process Important to consider:
Just because some very smart investor owns it, doesnt mean you should Know yourself
Evaluate, research and invest in securities that are mispriced by the market
Market prices diverge from long-term business values when short-term issues drive investor fear Exploit the psychology and behavior that create pricing anomalies Use depth of research and long-term, strategic thinking to identify areas where the market is over-weighting unlikely adverse outcomes
Compounders
Great businesses at great prices due to short term problems Misunderstood: great businesses priced as average businesses Never significantly undervalued, but lower risk
Contrarian Investments
Out-of-favor, unloved, troubled, really cheap companies Behavioral finance influenced approach
Good companies
High return on capital Solid balance sheet Enduring competitive advantage Lower than average business volatility Opportunity to reinvest cash flow in the business at high returns
Good managements
Uses ROI to make business decisions History of proper capital allocation Repeatable business processes which reinforce competitive advantage
Less frequently mispriced everyone knows the good ones Sources of undervaluation
Certainty of continued growth is high, but underappreciated Competitive advantage period is longer
Cautions
Great businesses are rare Distinguish between businesses in sweet spot and those with longevity Investments in growth can destroy value EVERYTHING is subject to technological change Selectivity is critical
Temperament Requirements
Patience Ability to withstand periodic worry cycles of sentiment and press coverage Ability to withstand long periods of no new information Long bouts of mediocre performance Often better in down markets than up markets
Out-of favor stocks, clear potential for loss, price no longer reflects potential for improvement or hidden assets Higher expected returns
But a wider range of possible outcomes Drivers of return or loss are not market-, industry- or economy-specific, but rather company-specific or turnaround/execution related
Less correlated with market indices Human behavior is always searching for clarity and certainty: attractive contrarian investments are available in almost any market Best candidates often have
Formerly good business model, formerly high valuation Signs of capitulation: shareholder turnover, disgust, management credibility in question No visibility; no catalyst Operating leverage magnifies upside scenarios Specious secular or competitive decline arguments
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Temperament Requirements Patience for the right entry price Patience with the turnaround Weirdness Ability to handle criticism Ability to stand alone Comfortable with extreme volatility Resourcefulness Humility
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Changing capital allocation Changing management incentives Changing strategy Changing governance
Limited restrictions on shareholder rights Consolidated shareholder base with limited exposure to passive funds Other contrarian investors on shareholder list Stable (enough) underlying business to withstand transition period Management or Board open to discussion
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Temperament Requirements Patience Intensity requires consistent pressure and engagement Ability to withstand intense criticism changing conventional management thinking is an arduous process. (Think the B-wordBad Guy) Requires financial analysis that exceeds financial statement analysis
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If you can time it correctly, you should, (but you cant) Compounders always seem lower risk, until youre wrong about one
From 2004-2007 Contrarians worked best Portfolio diversity manages risk and creates upside
For example, currently compounders massively outperforming contrarians because of falling interest rates, low risk tolerance and large cap market bias
Higher range of outcomes in contrarian investments means more upside if you do it right Lower absolute undervaluation in compounders makes mistakes difficult to make up for
Compounders more market correlated Contrarian Investments value-drivers are more company specific
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Two Ideas
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Time from premium receipts to claims payouts creates float, which is invested in financial assets Markel makes underwriting profits, so has enough cash from premiums to pay claims Therefore, all income from investments (value) accrues to shareholders AND future underwriting profits add to shareholders capital base Excess capital is reinvested in insurance (when favorable), or equities and ventures for higher returns
MKL vs. Industry Combined Ratios Markel cash income vs. net claims paid:
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Must visit Markel to understand its culture (and read the proxy) Sticks to niche insurance segments, never prices for share Reserves cautiously, and allocates capital sensibly All united by single shared goal: Entire management teams bonuses are paid on 5-year trailing book value CAGR. Book Value CAGR < 11% = no bonus CAGR since 1995
Book Value: 15.8%
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Best in class property casualty (P&C) insurer outperforms peers and the stock market with MUCH lower volatility (Beta = 0.6) Yet stock follows the run-off value (book adjusted for timing and reserve redundancies) So all future underwriting profits, investment and ventures growth is free Dont expect the market to understand, given belief that you cant value an insurer with a DCF
MKL Stock: $593 (1.25x book) Run-Off: $596 Plus Future UW Profit: $125 Conservative Value: $721 (+22%) Net Investments per Share: $992 Plus Future UW Profit: $125 $1,117 per share (1.9x book)
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Market values Markel like all P&Cs, on book value, so stock will grow roughly with book value Acquisition of Alterra increased net investments per share to $992. Plus current insurance cycle creating capital inflows (profits) from underwriting lots of new capital to invest in equities and ventures Ventures and equities rarely sold, so MKL is a tax-deferred savings account Oh and its a PMs dream:
Beta:
0.6
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Established merchant with a see-it-before-you-buy-it assortment Five unique concepts Significant valuation discrepancy with home-goods peers Stable profitability and cash flow enabling reinvestment in mobile, e-commerce Thoughtful, well-timed share repurchase creates a significant cash yield Price strategy and nature of goods allows time for omni-channel transformation PWV of $105 implying 54% return from here
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BBBY is down 15% year-to-date only Pier One has performed worse BBBY trades at a 15% to 25% discount to home related retail peers depending on ones preferred valuation metric
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BBBY has consistently produced higher profit margins and returns on equity versus peers If the stock were to simply trade in line with HD, a company producing a similar average return on equity, BBBY would be a $90 stock ULFCF has remained just under $1 billion for the past five years and the management team has committed to continuous share repurchase
Last year EBITDA Margin 13.8% 10.7% 13.8% 13.7% -2.7% 9.9% 16.8% 5-yr Avg ROE 22.8% 12.3% 16.7% 13.3% N/A 16.3% 21.1%
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40 new stores a year across five concepts Remaining share repurchase authorization $2.5 billion, expires 2015 To complete the program, which we believe is the goal, share repurchase should meaningfully accelerate The depressed stock price provides an opportunity for management to increase value through share repurchase, which they have been apt to do in the past
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Thank You!
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