Category: General investing

Management Intangibles I Look For

~ Travis Wiedower

Even though talking to CEOs is helpful, I don’t think it’s required in order to get an idea of how shareholder friendly they are. Last year I added a section to my investment checklist called “Management intangibles” where I go through a number of things that give hints as to what type of CEO I’m looking at. I like asking myself these questions because the answers to all of them are public information and/or fact-based. When talking to a highly charismatic CEO who is a natural salesman, it’s easy for the halo effect to take over and to think higher of them than I should. The halo effect is when we take one attribute of someone (this CEO is knowledgeable and talks with confidence) and assign them other unrelated positive attributes because of it (this CEO is shareholder friendly and a good capital allocator). It’s a human bias that we’re all guilty of (most commonly with attractive women) so it’s a good idea to try and counteract it.

I think combining these list items with my impressions from talking to the CEO leads me to a less biased opinion that’s more rooted in facts. So below is a list of all the things I go through in my intangibles checklist. None of these are deal killers and virtually all CEOs have the “wrong” answer on a few of them, but looking at them as a whole can give a decent picture as to what the CEO is like.
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Peer Group Valuation Is (Mostly) Useless

~ Travis Wiedower ~ 8 Comments

A company’s value is its future free cash flow discounted back to the present. I doubt any readers will argue with me there. And when you break it down, the two things that determine future cash flow are return on invested capital (ROIC) and growth. So if ROIC and growth are the two determinates of future value, then to have a fair peer analysis the included companies should have similar returns on capital and growth prospects. If two companies have different ROICs or growth prospects then it’s not an apples-to-apples comparison.

Having similar growth potential also insinuates the two companies are in the same stage of their life cycle, meaning they’re similar sizes. So including mature businesses in a peer valuation for a small-cap company is meaningless. When a company is selling for less than its peers, it’s almost always because it has lower returns on capital or its growth prospects are not as good as its competitors. There are a few other factors that play into this as well.
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Don’t Let Numbers Deceive You

~ Travis Wiedower ~ 2 Comments

One of the reasons the recent presidential election was such a surprise was that all the major polls showed Hillary holding a sizable lead right up until election night. There are many theories on why the polls were wrong, but two ideas struck a chord with me.

First, what people say they believe can be very different than what they actually believe. If someone is asked a question (who are you going to vote for?) and they’re embarrassed by their truthful answer, they might lie (answer with another candidate) or downplay it and say undecided. In theory, lying in polls will balance out with a large enough sample, but I don’t think that was the case in this election (Trump supporters were less likely to admit who they were voting for). Second, surveys done online or by telephone will always be skewed in some way. I doubt the group of people who are willing to sit on the phone for 5-10 minutes to answer a survey is a random sample of the entire population.

Those two theories about the failure of the presidential polling prompted me to review my notes from a book I read a couple years ago called How to Lie with Statistics. Whether given to us by management teams or discovered through research, investors are always looking at numbers. I think it’s a good idea to remind myself every once in a while how easy it is to be deceptive with numbers.
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Shut Up About Creating Shareholder Value

~ Travis Wiedower ~ 4 Comments

You know that feeling you get when a crappy salesman is trying too hard to sell you something? That stereotypical used car salesman? Ugh, I can’t stand it. That’s how I feel when a CEO goes on and on about creating shareholder value. I was recently reading through some Bob Evans Farms (BOBE) conference call transcripts and I wanted to throw up.

When talking about strategic alternatives the company is considering, the CEO Saed Mohseni said “All options of Bob Evans are under consideration by our board of directors. And I believe that ultimately the board will make a decision that is in the best interest of our shareholders and create value for our shareholders.” Next, an analyst asked about a timeline for the strategic alternatives and his answer nauseated me: “I think the best timeline is when we feel that truly enhances shareholder’s value.” My bullshit-meter could not have gone off any louder—what the fuck does that even mean? He obviously wanted to avoid the question, but it’s like he thinks that as long as he throws “shareholder value” into the answer that shareholders will be happy. The ironic thing is that he owns very few shares (all of which were gifted to him) so I highly doubt he cares about shareholder value as much as he talks about it. And if shareholder value is such a huge focus of his, he should probably be gobbling up shares in the open market in preparation for all the value he’s about to create.
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How Effective are Boards of Directors?

~ Travis Wiedower

Directors are supposed to represent shareholder interest. Isn’t it ironic then that new directors are usually a) handpicked by the CEO and b) not shareholders? How can a director represent shareholder interest when they haven’t been a shareholder? The situation is even worse when a hired CEO who has little share ownership himself is picking directors.

I recently read Dear Chairman, which is a great book about corporate governance (or lack thereof) on public company boards. One of the examples from the book was Steve Jobs inviting someone to join Apple’s board. But after that person mentioned some of his ideas to improve corporate governance, Jobs rescinded the offer. He wanted directors who were yes-men, not ones who wanted to change things. This happens all the time and it shouldn’t be a surprise. Humans are selfish and we look out for ourselves first (and that’s how it should be, our self-preservation instinct is a good thing). A CEO wants to keep his cushy position making way too much money every year—why would he want to shake up the group of people that “oversee” him? It makes perfect sense when you think about it from a psychology standpoint.
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Investing in Canadian Marijuana

~ Travis Wiedower ~ 5 Comments

Want to invest in an industry set to grow 20x over the next 5-10 years? You and me both. Canada first allowed medical marijuana sales in 2014 and they’re already planning to legalize recreational use by 2019. With current marijuana sales of $200 million and the mature market size estimated at over $5 billion, there is a very long runway for growth. Predicting how a new industry will evolve is not easy, especially one that is inherently a commodity. There are quite a few public marijuana companies in Canada, but this is more of a high level blog post about the industry as a whole, not a specific buy or sell recommendation for any of those companies.

Background

In 2001, Canada implemented the Marijuana Medical Access Regulations (MMAR), which allowed patients to produce marijuana themselves, designate someone else to do it for them, or purchase it directly from Health Canada. Two-thirds chose to grow it themselves. Enrollment was 39,000 when Canada replaced the MMAR with the Marijuana Medical Purpose Regulations (MMPR) in 2013. Under the MMPR, patients receive a prescription from a doctor and then purchase the marijuana direct from a licensed producer. As of June, there were 32 licensed producers of medical marijuana—22 are fully authorized, four are owned by Canopy Growth, and three are owned by Mettrum. Thus, I believe there are around 15 separate companies that are fully authorized to produce and sell medical marijuana in Canada (with this number expected to grow as more companies are licensed).
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Going Through 1,500 OTC Stocks

~ Travis Wiedower ~ 5 Comments

Throughout 2016 I’ve been going through a list of over-the-counter stocks I screened for at the beginning of the year. I started with an Excel spreadsheet of all OTC stocks listed in America (9,855) and then narrowed it down via the following criteria:

  1. Only these exchanges: OTCQX, OTCQB, Pink Current (only wanted companies that were up-to-date with their filings)
  2. Companies based in first world countries
  3. Removed banks, biotech, pharma, minerals, and oil and gas
  4. Removed stocks selling for less than $0.05 and companies larger than $500M market cap

This left me with a list of 1,437 stocks that had a total market cap of just $80.6 billion. This is the third time I’ve gone through a similar list of OTC stocks. The first time was 2011 and the second was 2014. Not surprisingly, the 2016 trip through the list has been by far the least fruitful. The first time I went through in 2011 I found quite a few profitable net-nets, and even in 2014 I found a couple. While I didn’t uncover any interesting cigar butt-type investments this year, I did discover a few high quality companies.
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WACCs are Wack

~ Travis Wiedower ~ 11 Comments

The weighted average cost of capital (WACC) measures what it costs a company to acquire funding. Internally, it’s the hurdle rate a CEO should be using to decide on what projects to allocate money to. If it costs a company 8% per year to acquire their debt and equity, they shouldn’t be green lighting projects that return 5% per year. That’s lighting money on fire. Externally, we as investors can compare a company’s return on invested capital (ROIC) to its WACC to evaluate the quality of the company and the CEO’s capital allocation skills.

A CEO’s goal is to invest capital at a higher rate of return than what that capital costs the company to acquire. If he or she is able to do this, the value of the company will grow. If he or she invests in projects at low returns, the company’s value will shrink. Similarly, as an investor, my goal is to invest my own capital at a rate of return that surpasses what I can easily achieve elsewhere (such as a broad market index fund). My hurdle rate for investing capital is different than that CEO’s. Yet, the traditional discounted cash flow method suggests I use the company’s cost of capital as my own hurdle rate. This doesn’t make sense to me.
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My Love-Hate Relationship with DCFs

~ Travis Wiedower ~ 5 Comments

One of the biggest changes in my investing process over the past year has been my increasing usage of discounted cash flow (DCF) models. I used to rarely use them and now I build DCF models for every company I’m serious about. I want to start by reviewing the major things that a lot of investors (including myself) don’t like about DCFs and how I’ve gotten over these concerns.
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Human Biases Make Investing Hard

~ Travis Wiedower ~ 2 Comments

I recently read Thinking, Fast and Slow for the first time, one of the go-to books on human biases. If you’re unfamiliar, there are many things the human brain does that are both automatic and unconscious. You can’t look at “2+2=” and not have “4” pop to the forefront of your thoughts—it’s automatic. Most of these unconscious processes are there for our own good thanks to generations of evolution, but sometimes these innate biases can get in our way. Being aware of these biases is the first step to being able to recognize and overcome them. Thinking, Fast and Slow dives into many biases that affect us, but I want to talk about the ones that relate most to investing.
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