ValueInvestor
February 28, 2022
INSIGHT
The Leading Authority on Value Investing
Owner Mentality
Many investors want to take a private-equity approach to public-market investing. Simon Denison-Smith and Jonathan Mills do so with particular credibility.
H
aving met as Bain & Co. consultants in 1990, Jonathan Mills and
Simon Denison-Smith went on to
successfully run non-investing businesses
before launching London-based Metropolis Capital in 2008. While sharing portfolio
and firm-building responsibilities has been a
long-term challenge for many, Denison-Smith
cites one simple strength of their partnership:
“You want diversity of thought, undoubtedly,
but you also need to have sufficient marrying
of minds so you can actually do something
together. We’ve always had that.”
Now managing $2.5 billion, the firm has
earned a net annualized 9.3%, vs. 6.7% for
MSCI’s All Country World Index. Casting a
global net, they see upside today in such areas
as car insurance, online brokerage, industrial
See page 2
equipment and tortillas.
INVESTOR INSIGHT
Metropolis Capital
Simon Denison-Smith (l), Jonathan Mills (r)
Investment Focus: Seek companies that
meet strict criteria for revenue and margin
sustainability while also trading at significant discounts to estimated intrinsic value.
Bob Robotti believes the anomalous nature of the last decade in equity markets has
been lost on most investors, who don't yet see that “the tide has already turned.”
Robert Robotti
Robotti & Co.
Investment Focus: Seeks often-cyclical
companies when the market’s view of the
evolution of the particular cycle at hand appears to differ markedly from his own.
February 28, 2022
FEATURES
Interview: Metropolis Capital
Turning a keen eye on potential
mispricing and finding it today in
Progressive, Hargreaves Lansdown,
Andritz and Gruma.
PAGE 2 »
Interview: Bob Robotti
Seeing opportunities others are
ignoring in old-economy companies
such as Westlake, Subsea 7, Interfor
and West Fraser Timber. PAGE 10 »
What’s Old is New
INVESTOR INSIGHT
Inside this Issue
H
e’s a dyed-in-the-wool value investor with a track record going back
42 years – his firm’s longest-lived
fund since 1980 has earned a net annualized
12.1%, vs. 10.6% for the Russell 2000 – but
Robotti & Co.’s Bob Robotti is still like a kid
in a candy store when talking about the investment opportunity he sees today. “For the
businesses we own the fundamentals are so
powerful and the misvaluations are so dramatic, how can that not be exciting?”
His core argument is that “old economy”
businesses in the U.S. and elsewhere have dramatically changed for the better in ways that
investors obsessed with the next new thing
are missing. That’s translating into outsized
potential upside, he believes, in such industries as chemicals, lumber, building products
See page 10
and energy services.
www.valueinvestorinsight.com
Uncovering Value: Lumen
We love ideas with secular tailwinds
and unique competitive advantages.
This isn’t one of those. PAGE 17 »
Uncovering Value: F45 Training
The case for a pandemic recovery
play returning to substantially better than just "normal." PAGE 18 »
Of Sound Mind
What does it mean to have the right
investing temperament and why is it
PAGE 19 »
so vitally important?
INVESTMENT HIGHLIGHTS
INVESTMENT SNAPSHOTS
PAGE
Andritz
5
F45 Training
18
Gruma
8
Hargreaves Lansdown
4
Interfor
13
Lumen Technologies
17
Progressive
6
Subsea 7
15
West Fraser Timber
14
Westlake
12
Other companies in this issue:
Adidas, Admiral Group, Builders FirstSource, Cavco, Halfords, Howden Joinery, Legacy Housing, Louisiana-Pacific,
Nobility Homes, Olin, Oracle, Qurate,
Skyline Champion
Value Investor Insight 1
I N V E S T O R I N S I G H T : Metropolis Capital
Investor Insight: Metropolis Capital
Simon Denison-Smith and Jonathan Mills of the U.K.'s Metropolis Capital describe the situations they find most conducive to market mispricing, why they gravitate to investing in larger companies, why their partnership has endured as
long as it has, and why they see unappreciated value today in Hargreaves Lansdown, Andritz, Progressive and Gruma.
Describe how and why you went from
buying and selling private businesses for
Metropolis Group to buying and selling
public equities for the renamed Metropolis Capital.
Jonathan Mills: Metropolis Group was
very much patterned after Warren Buffett’s
strategy in buying for Berkshire Hathaway
entire businesses with strong market positions and sustainable business models at
attractive prices. We made over 30 private
acquisitions over roughly a decade from
the beginning of the 2000s, almost all in
unsexy businesses that dominated their
industry niches and were meant to stand
very much on their own two legs.
What I enjoyed most about the acquisition process was the analysis piece,
which involved about 10% of the work.
After that you had to agree to terms, the
lawyers got involved to work up all the
paperwork, and then you had to actually
oversee the new business with all its employees, properties and systems. After doing 30 of these I concluded the operational
grind wasn’t really what I wanted to do, or
where I added the most value.
When Simon sold his business in 2006,
we started to lay the groundwork for applying our experience in private markets
to investing in public markets with very
much the same analytical mindset. Search
for businesses with strong franchises in
their particular markets which may have
fallen out of favor due to perceived shortterm problems or market risk. Make investment decisions based on the company’s ability to deliver consistent long-term
returns. Make conservative assumptions
and buy only when there’s a significant
margin of safety to our estimate of intrinsic value. That’s what Metropolis Capital
tries to do.
You’ve tended to gravitate to larger-cap
companies. Why?
February 28, 2022
Simon Denison-Smith: Much of it goes
back to our time as consultants at Bain,
where most of our work was focused on
how companies should define their market
opportunity and then execute in a way to
remain or become market leaders. We put
considerable emphasis on market leadership, which is closely tied to revenue and
ON LARGE CAPS:
We realized early on that we
seemed to have better success in companies where we
had more data to assess.
margin sustainability, higher returns on
capital and management quality. The best
businesses in the world with the best managers tend to be the largest as well, almost
by definition.
We also realized early on that we
seemed to have better success in companies where we had more data to assess. We
think we’re pretty good at distilling data
to arrive at the key elements that are going to drive a company’s long-term performance and value creation. It’s hard in general to have an analytical advantage, but
we’ve found our chances are better when
we have the type of independent data you
often have available with big companies.
With small companies, in many cases we
just think you’re too dependent on what
management tells you and on where they
direct you to find more information.
How do you define your geographic circle
of competence?
SDS: We’ll look anywhere, but there are
certain markets we struggle with at the
moment. We aren’t comfortable with the
variable interest entity (VIE) structure
www.valueinvestorinsight.com
for Chinese companies listed outside of
China, for instance. With a 20-stock portfolio, it’s too big a risk that a change in
government attitude toward what is essentially an illegal structure could wipe out
shareholder value. We just can’t have 5%
of our portfolio in a business that could
go to zero. We have had a similar attitude
toward stocks in Russia, thank goodness,
and Saudi Arabia as well.
JM: Most businesses we invest in are
global, so where they trade is neither here
nor there. Last year we did incremental research on Japan, not because we had a different perception about what’s going on in
Japan, but because we found a number of
high-quality companies based there that
seemed to be potentially undervalued. We
haven’t bought anything as a result of that
yet, but there are several Japanese companies today on our active watch list. We’re
also looking closely today in a number of
emerging markets – the opportunity set is
small given our governance and quality
thresholds, but valuations in many markets are worthy of a closer look.
How worthy of a closer look is your home
U.K. market?
JM: The big companies listed in London
are quite international but tend to be biased toward commodity businesses we
typically avoid. We do own a couple of
pure U.K. businesses. Howden Joinery
[London: HWDN] is a leading kitchenappliance and woodworking company
that is benefiting from the fact that people
are investing more in their homes through
the pandemic and, we think, beyond. Hargreaves Lansdown [London: HL], is the
leading direct-to-consumer investment
platform in the U.K., similar to Charles
Schwab in the U.S. Is it possible the valuations for it and Howden’s are a bit better right now because market sentiment
Value Investor Insight 2
I N V E S T O R I N S I G H T : Metropolis Capital
hasn’t been as favorable in the U.K. as in
the U.S.? Yes, but a normalization of that
is not going to be a primary driver of our
investment case.
Describe the instances of potential market
mispricing that tend to catch your eye.
JM: One would be quality companies in
industries with generally poor economics.
The auto insurance industry is a good example. As businesses, auto insurers don't
usually make much money, regularly incurring underwriting losses and trying to
make up for that with investment returns
that often don’t quite get there. There
aren’t many barriers to competitive entry
and customer stickiness is quite low.
While the nature of the industry can
discourage many investors from taking a
closer look, you can find unique companies that are able to stand out. One of our
longest-held positions is Admiral Group
[London: ADM], which we first invested
in ten years ago after seeing it for several
years take share in the U.K. auto-insurance
market. It was an early pioneer in selling
directly to the consumer via the Internet
and it has been run in an intelligent and
efficient way by the two founders, using
its cost advantage to gain share while also
making a very good underwriting return.
It’s essentially a U.K. version of Geico,
but it grew up with the Internet, whereas
Geico was around well before that and
transformed itself.
SDS: One interesting thing about this example is that people often think of customer attachment and stickiness as the
prime definition of business quality. In
fact, quite fast turnover of clients can be
ideal for the low-cost provider. In a market like auto insurance that overall doesn’t
grow that fast, a low-cost provider like
Admiral – or like Geico and Progressive
[PGR] in the U.S. – can reliably grow by
winning incremental customers on price.
As one of the founders of Admiral likes
to say, as a disciplined underwriter there
are also some clients you’re quite happy
to lose to your competitors. We’re not saying customer stickiness isn’t an important
February 28, 2022
measure of business quality, but fixating
on it in certain situations can cause you
to overlook these kinds of opportunities.
JM: Another area of potential mispricing
we look for is quality growth companies
where our assessment of future growth
is different to the market. These types of
opportunities tend to be more common
when the market overall falls sharply, as
it did following the impact of Covid in
March, April and May of 2020. Fairly
ON ORACLE:
It's the type of idea that
comes along when growth investors switch out of a stock
as growth decelerates.
suddenly the future outlooks for companies like Adidas [Frankfurt: ADS] and Visa
[V] were significantly marked down below
what we could reasonably expect to be the
case. In calm markets these types of companies can be quite highly valued, but in
a market downdraft they can come into
range for us.
SDS: To add on to that in the case of Adidas, it was a company that had been on
our radar because of its leadership with
Nike as a global sports brand. We typically favor market leaders – Nike in this
case – but in industries where there is a
significant gap between the two leading
players and the rest of the pack, we’re
willing to look at the industry’s #2. The
competitive dynamics often give rise to a
stable duopoly, and that stability increases
the confidence we can attach to modeling
the future cash flows of the #2 player. It's
quite striking how remarkably similar the
two companies’ growth rates and relative
market shares have been over a very long
period of time.
Both companies benefit from the same
underlying growth drivers, which include
the decades-long trend towards sports/
athletic footwear and apparel, a rebalancwww.valueinvestorinsight.com
ing of the under-representation of female
customers, and the growth of the middle
class in emerging markets. They benefit from similar competitive advantages,
through highly respected brands and scale
in marketing, supported by sponsorship of
the world’s leading sports stars and teams.
They’re also both executing a multi-year
strategy to shift a greater proportion of
their revenue, at higher margin, to their
own websites and stores.
We’ve owned Nike when a short period of relative underperformance gave us a
buying opportunity in it, and we had that
same opportunity in Adidas in March of
2020. We initiated the position after the
share price had fallen more than 45%
from its peak in January of 2020 and the
P/E ratio had fallen to 17x, very much at
the bottom end of its range over the prior
ten years.
Would a company like Oracle [ORCL],
which you also own, fall in the category
of an idea with underappreciated growth
potential?
SDS: It’s related, but we’d actually more
specifically categorize it as an opportunity
that comes along because growth investors
are switching out of the stock as growth
decelerates. The best example of that was
when we bought Microsoft in 2010 at a
single-digit multiple after it went from
being loved by growth investors to being
hated by growth investors following the
dot-com crash.
Oracle doesn’t energize the market
in the same way as a Salesforce.com or
Workday, which are considered exciting
new cloud companies with lofty valuations. But we believe Oracle is carving out
a dominant position in cloud ERP (Enterprise Resource Planning) applications, and
that the market will increasingly notice
this as it makes further material contributions to the company’s top-line growth.
Of even greater interest is the potential
of Oracle’s cloud-based Autonomous Database offering, which not only leverages
the infrastructure cost advantages of being
hosted on the Internet, but also substantially reduces the labor cost of managing
Value Investor Insight 3
I N V E S T O R I N S I G H T : Metropolis Capital
the database. Larry Ellison believes that
Oracle can turn a $15 billion run-rate
database-maintenance business into a $45
billion cloud-subscription business. If they
can achieve even half that, it would be materially accretive to our current valuation.
[Note: Oracle shares at around $76.50 are
nearly 30% below their 52-week high.]
Given your focus on business quality, do
you ever try to take advantage of industry
cyclicality?
SDS: Quality companies can certainly operate in sectors that are out of favor and
we try to take advantage of that. Here
we’re again focused on market leaders,
with genuine scale and margin advantages. When demand falls in a down cycle
and there’s an excess of supply, prices are
set by the marginal-cost provider. In that
scenario the market leader tends to continue to generate cash and often comes
out of that trough stronger because it can
reinvest in things like R&D or targeted acquisitions. Those can enhance product and
market advantages with both short-term
benefit as the cycle turns and with longterm benefit over time.
A really good example that we don’t
own today but has been in the portfolio in
the past is Deere & Co. [DE], the agricultural-equipment manufacturer. I won’t say
we always do a great job in timing where
we are in the cycle – which argues in these
cases for not going all in with your initial
position and leaving some dry powder to
buy more – but in a company like this if
you can reasonably model the normalized
earnings power and can be patient enough
to wait for a recovery, the upside can be
very substantial.
Describe in more detail your investment
case for U.K. online brokerage Hargreaves
Lansdown.
JM: This is the largest direct-to-consumer investment platform in the U.K., with
about £140 billion in assets under management, 2.5x larger than its next competitor. Scale is important to fund necessary
investments in technology and marketing,
February 28, 2022
and because Hargreaves Lansdown has
the strongest brand in the U.K. it gets a
better return on its marketing spend. All
that results in extremely high margins and
has led to the company increasing its market share, which has grown from 38% to
43% over the past five years.
The underlying market here has a very
good tailwind from people increasingly
managing their own money rather than
using more-expensive independent financial advisors and/or having company or
government pension schemes to rely on.
Hargreaves’ AUM has increased by 14%
per year over the past five years.
SDS: We started looking at the company's
stock back in 2020, but it wasn’t until late
summer last year that the share price had
de-rated sufficiently enough for us to be
interested. Part of a longer term drag on
the share price was the high-profile collapse of investment funds managed by
Neil Woodford, one of the U.K.’s bestknown money managers, which had been
fairly heavily promoted by Hargreaves
Lansdown to its customers. The market
also became worried, overly so in our
opinion, that the company was going to
have to lower its fees to meet the levels of
lower-priced competitors.
INVESTMENT SNAPSHOT
Valuation Metrics
Hargreaves Lansdown
(London: HL)
(@2/25/22):
Business: U.K.-based online platform offering
primarily do-it-yourself investors a wide range
of savings and investment options, accounts,
research services and financial advice.
P/E (TTM)
Forward P/E (Est.)
Share Information
(@12/31/21 or latest filing):
(@2/25/22, Exchange Rate: $1 = £0.75):
Price
52-Week Range
Dividend Yield
Market Cap
£11.31
£10.10 – £17.78
3.4%
£5.36 billion
Financials (TTM):
Revenue
Operating Profit Margin
Net Profit Margin
£622.6 million
53.0%
42.8%
HL
20.1
20.2
S&P 500
23.8
19.5
Largest Institutional Owners
Company
% Owned
Lindsell Train
14.0%
Baillie Gifford
5.0%
BlackRock
3.5%
Vanguard Group
1.9%
Liontrust Investment Partners
1.9%
Short Interest (as of 2/15/22):
Shares Short/Float
n/a
HL PRICE HISTORY
25
25
20
20
15
15
10
2020
2021
2022
10
THE BOTTOM LINE
The market appears overly concerned that the company will have to reduce its fees to
meet the levels of lower-priced competitors, says Jonathan Mills, neglecting the extent
to which it continues to take market share in a secularly expanding market. The shares
are even more attractive, he says, after a recent fall in price related to quarterly earnings.
Sources: Company reports, other publicly available information
www.valueinvestorinsight.com
Value Investor Insight 4
I N V E S T O R I N S I G H T : Metropolis Capital
One big difference in the U.K. market
versus in America is that you’re not allowed to get paid for order flow like Robinhood and others are in the U.S. Hargreaves Lansdown is typically paid on a
percentage of assets under management,
and that fee is roughly 10 basis points
higher than its lowest-price competitors.
We did quite a lot of research into this
and concluded not only that the quality of
the service and information provided by
Hargreaves Lansdown justified the higher
fee, but also that even the low-price competitors weren't counting on taking share
from it. If you look at the 93% customer
retention rate and growing market share,
there’s no evidence the company’s fee level
is an issue.
panding market. This to us today is an
unbelieved-growth type of idea that may
take time to play out, but we still very
much believe it will.
Why are you high on the prospects for industrial-equipment manufacturer Andritz
[Vienna: ANDR]?
SDS: The company builds and outfits very
large-scale projects primarily serving the
pulp and paper and hydroelectric-power
markets. In pulp and paper it’s one of
only two players in the world – Finland’s
Valmet is the other – that can build new
INVESTMENT SNAPSHOT
Valuation Metrics
Andritz
We haven’t talked yet about valuation.
How generally do you arrive at what you
think a stock is worth?
SDS: Our valuation work is primarily discounted-cash-flow based, using the
same discount rate that we’ve used since
2008. That’s the long-term real return of
the S&P 500, which after inflation is just
over 6.5%. We model specifically what we
expect to happen over multiple years, but
relatively quickly assume for most businesses no more than GDP-type growth.
Our discipline is to buy at no less than a
30% discount to our estimate of intrinsic
value. From earning our discount rate and
from at least some closing of the discount
gap, our long-term real return target is at
least 10%.
After a big hit just last week on a disappointing earnings report, Hargreaves'
shares are now sharply off their pre-pandemic level. How are you looking at valuation at today’s £11.30 price?
SDS: We originally bought the shares at a
price above the current level and haven’t
materially adjusted our intrinsic-value estimate, so the stock has gotten more attractive to us as the price has come down.
We think there’s a solid growth story here
long-term as online brokers like Hargreaves continue to take share in an exFebruary 28, 2022
plants that have price tags of $500 million
or more. In power generation, Andritz has
20% of the market for new hydroelectric
plants overall, and 40% of the market for
pumped-storage hydro plants. These are
plants that typically use variable, renewable energy sources in part to pump water
uphill, which then keeps the plant going
when the sun isn’t shining or the wind
isn’t blowing – it's essentially a huge water battery.
We see a number of positive drivers for
the company. In pulp and paper, increases
in packaging demand related to e-commerce are now more than offsetting print
(Vienna: ANDR)
(@2/25/22):
Business: Builds and outfits large-scale engineering and construction projects primarily
serving end customers in the global pulp-andpaper and hydroelectric-power markets.
P/E (TTM)
Forward P/E (Est.)
Share Information
(@12/31/21 or latest filing):
(@2/25/22, Exchange Rate: $1 = €0.89):
Price
52-Week Range
Dividend Yield
Market Cap
€40.98
€37.04 – €50.95
2.4%
€4.07 billion
Financials (TTM):
Revenue
Operating Profit Margin
Net Profit Margin
€6.41 billion
5.4%
4.4%
ANDR
14.4
10.8
S&P 500
23.8
19.5
Largest Institutional Owners
Company
% Owned
Vanguard Group
1.9%
Norges Bank Inv Mgmt
1.7%
Erste Asset Mgmt
1.7%
Schroder Inv Mgmt
1.4%
Polaris Capital
1.2%
Short Interest (as of 2/15/22):
Shares Short/Float
n/a
ANDR PRICE HISTORY
60
60
50
50
40
40
30
30
20
2020
2021
2022
20
THE BOTTOM LINE
The dynamics in the pulp and paper, hydroelectricity and auto-manufacturing-equipment
industries that the company serves are more positive than the market appreciates, says
Simon Denison-Smith. He considers the current 9% normalized free-cash-flow yield on
the stock "very attractive for a business with entrenched positions in growing markets."
Sources: Company reports, other publicly available information
www.valueinvestorinsight.com
Value Investor Insight 5
I N V E S T O R I N S I G H T : Metropolis Capital
demand declines, to the point that the
overall global market is growing again.
With respect to new plants, an ongoing
shift of production from North America
to South America is resulting in incremental new-plant demand as older plants in
the north are shut down. Attesting to Andritz’s relative competitive position, it has
won something like 70% of the new-plant
orders in South America over the past 15
years. It's also a positive that with all of
these plants there’s a significant ongoing
stream of long-term consumables and services revenues attached.
The hydroelectric business has been
quite flat, but we also think its growth
trajectory is starting to improve, driven
by increased climate-change-related demand, especially in the pumped-hydro end
of the market where the company has a
stronger position. There’s also likely to be
incremental demand for new plants as aging industry infrastructure is, by necessity,
replaced.
Another area that’s interesting and
more of a turnaround story is the company’s business providing metal-flattening
equipment to the automotive industry.
Andritz has historically had an excellent
position at the high end of the market,
particularly with the German manufacturers, but has struggled somewhat against
lower-cost competition from China in the
low end. That business is showing signs of
improvement as the company’s technology
edge provides a good growth opportunity,
particularly in applications for electric-vehicle production. EVs tend to have higher
metal content per vehicle for things like
battery casings.
How cheap do you consider the shares at
today’s price of just under €41?
SDS: We added the position last June so
didn’t catch the lowest valuation, but the
stock now trades at around our purchase
price and at what we consider a normalized free cash flow yield of more than 9%.
That to us is very attractive for a business with entrenched positions in growing
markets and a conservative, very competent management team.
February 28, 2022
JM: I would just add a word here on management. We like managers who are owners, or who behave like owners, and believe that is very much the case here with
Wolfgang Leitner, who has been the company’s CEO since 1994. He’s kind of the
prototype of what we look for: low ego,
very modest, very thoughtful and taking
a long-term approach. He’s not looking to
empire build, but expand on the company’s existing strengths. We’ll partner with
the brash Chairman or CEO as well – I
mentioned we own a stake in Oracle – but
we tend to prefer understated rather than
overstated when it comes to leadership.
You spoke earlier about your positive experience with auto-insurer Admiral Group
in the U.K. Explain your current interest
in U.S.-based Progressive as well.
JM: It means something when Warren
Buffett and Ajit Jain single out a company
as a worthy competitor, which was actually the impetus here for our starting to
look more closely into Progressive. It is a
strong #2 to Berkshire Hathaway’s Geico
in direct-to-consumer auto insurance in
the U.S., where both of them have been
relentlessly gaining market share. Each
had maybe 4% of the market in 2000 and
INVESTMENT SNAPSHOT
Valuation Metrics
Progressive
(NYSE: PGR)
(@2/25/22):
Business: U.S.-based insurer specializing in
automobile and home insurance lines sold in
roughly equal measure directly to consumers
as well as through third-party agents.
P/E (TTM)
Forward P/E (Est.)
Share Information (@2/25/22):
(@12/31/21 or latest filing):
Price
52-Week Range
Dividend Yield
Market Cap
107.24
85.50 – 111.85
0.4%
$62.67 billion
Financials (TTM):
Revenue
Operating Profit Margin
Net Profit Margin
$47.68 billion
9.3%
7.0%
PGR
15.5
21.0
S&P 500
23.8
19.5
Largest Institutional Owners
Company
% Owned
Vanguard Group
7.7%
BlackRock4.9%
Wellington Mgmt
4.8%
State Street
4.6%
J.P. Morgan Inv Mgmt
3.3%
Short Interest (as of 2/15/22):
Shares Short/Float
1.2%
PGR PRICE HISTORY
120
120
100
100
80
80
60
2020
2021
2022
60
THE BOTTOM LINE
Jonathan Mills says it means something when Warren Buffett and Ajit Jain single out the
company as a worthy competitor, which they've done at Berkshire Hathaway's annual
meeting. He sees attractive upside in owning the stock of a competitively advantaged
business growing at 10% per year when it trades at a sharp discount to the broad market.
Sources: Company reports, other publicly available information
www.valueinvestorinsight.com
Value Investor Insight 6
I N V E S T O R I N S I G H T : Metropolis Capital
now they each have closer to 15%. Geico
has somewhat lower operating costs, but
Progressive has a cost advantage over the
rest of the industry and has also proved to
be particularly adept at pricing, resulting
in combined ratios consistently at 96% or
below, much better than industry averages. At a certain price you have to be willing
to hand a customer to your competitors
and let them lose money on them. Progressive is very disciplined in that regard.
The company sells through agents as
well – at similar profitability to its directto-consumer business – but in the direct
business scale matters a lot and it and Geico outspend competitors dramatically on
marketing and technology. Customers in
the U.S. don’t turn over as quickly as they
do in the U.K., and Progressive’s retention
has been improving now that it also offers
homeowners insurance. People who buy a
bundle are more locked in and less likely
to switch providers regularly.
I’d also say a word here about company
culture. Progressive was founded in 1937
and the founder’s son, Peter Lewis, was
CEO from 1965 to 2000 and remained
Chairman until he died in 2013. The
company since 2000 has had two nonfamily CEO’s – Tricia Griffith took over
in 2016 – and we don’t see any decline in
what we still consider an owner-occupied
culture. The management and employees
have been and remain very well aligned
with outside shareholders, with bonuses
intelligently based on targets for growth
and profitability. It’s also interesting that
this is the only company we are aware of
that reports an abbreviated profit-and-loss
statement, along with operational metrics,
on a monthly basis. That suggests to us a
transparent and confident organization.
You often examine the bear case in detail
for any potential holding. What does that
uncover here?
JM: There are two main bear cases to consider. Some investors are nervous about
Progressive’s terminal value as autonomous cars eventually impinge on the need
for insurance. The question is about timing and what this means for value. As we
February 28, 2022
model out the ultimate inevitability of a
transition to autonomous cars, we think
that results in the company’s revenues
peaking sometime in the mid-2030s. In
estimating intrinsic value the significant
share of that value comes from the next
10 to 15 years, when we don’t consider the
bite from autonomous to be that material.
The second main bear case is that Progressive’s combined ratio has been unsustainably low. That’s been particularly sa-
ON AUTO INSURANCE:
We often look for potential
mispricing in quality companies in industries with generally poor economics.
lient in recent months as there has been
an increased frequency of accidents combined with higher claims costs, not least
from a spike in used-car prices. This has
pressured underwriting margins across the
industry and at Progressive. Our expectation is that the company will adjust pricing appropriately and that pricing overall
will harden to reflect any change in underlying economics. This should support a
reversion in underwriting profitability just
as it has many times in past cycles.
The shares are up more than 50% from
pandemic lows. How attractive are they at
today’s price of $107.25?
JM: When we first invested, the P/E was
13-14x so it has rerated somewhat, but
the trailing multiple today is only about
15.5x. We are happy to be invested in a
competitively advantaged business growing at circa 10% per annum when – even
adjusting somewhat for higher-than-normal profits during the pandemic – it trades
close to the long-term average multiple of
the S&P 500 and at a sharp discount to
where the broader market is today.
It’s not something we build massively
into our models, but Progressive would
benefit from increasing interest rates. They
www.valueinvestorinsight.com
invest their float quite conservatively and
that would translate into increased investment income if rates ticked up.
You mentioned earlier an increasing interest in emerging markets. What’s behind
your interest in recent portfolio addition
Gruma [Mexico City: GRUMAB]?
JM: The company is based in Mexico but
makes over 60% of its operating profit in
the U.S., where it sells a wide variety of tortillas, tortilla chips, taco shells, flatbreads,
sauces and dips under brand names including Mission, Guerrero and Calidad. In
core product categories the Mission brand
is by far the U.S. market leader. In Mexico,
which accounts for close to 25% of profits, the business is primarily focused on
corn flour, where Gruma controls threequarters of the market.
The story here is relatively simple. The
company remains family owned and operated – the CEO is the founder’s son and
the González family controls just under
50% of the equity. They have proven to
be very good long-term stewards of the
business, focusing appropriately we think
on profitability while also investing in new
product and market development. The
U.S. has been an excellent market for the
company, with continuing tailwinds from
a growing Latino community and from
health-conscious consumers seeking out
what are perceived to be more healthful
snacks and meal items. Europe is also an
attractive growth opportunity.
Why would a company like this be mispriced by the market?
JM: As was the case with a number of sellers of packaged foods, the business did
very well in the early stages of the pandemic. Our opportunity to buy came in
May of last year when the share price fell
out of concern over rising corn prices, obviously a key input cost for Gruma. When
we looked at history, higher corn prices
initially caused some pain, but the company had traditionally been able to pass
on the higher prices relatively quickly. It
turned out that they were able to do so
Value Investor Insight 7
I N V E S T O R I N S I G H T : Metropolis Capital
INVESTMENT SNAPSHOT
Valuation Metrics
Gruma
(Mexico City: GRUMAB)
(@2/25/22):
Business: Production and sale of corn flour
and a variety of tortilla-based consumer
products; leading brands in top U.S. market
include Mission, Guerrero and Calidad.
P/E (TTM)
Forward P/E (Est.)
Share Information
(@12/31/21 or latest filing):
(@2/25/22, Exchange Rate: $1 = 20.35 pesos):
Price
52-Week Range
Dividend Yield
Market Cap
MXN 282.96
MXN 204.97 – MXN 283.80
1.8%
MXN 107.11 billion
Financials (TTM):
Revenue
Operating Profit Margin
Net Profit Margin
MXN 94.25 billion
12.0%
6.5%
GRUMAB
18.1
n/a
S&P 500
23.8
19.5
Largest Institutional Owners
Company
% Owned
Southeastern Asset Mgmt
3.3%
Norges Bank Inv Mgmt
3.0%
Artisan Partners
2.8%
Massachusetts Fin Serv
2.1%
Handelsbanken Fonder
1.8%
Short Interest (as of 2/15/22):
Shares Short/Float
n/a
GRUMAB PRICE HISTORY
300
300
250
250
200
200
150
2020
2021
2022
150
THE BOTTOM LINE
The company isn't being recognized as a consumer-products leader with genuine growth
potential from strong secular demand for its products and from geographic expansion,
says Jonathan Mills. The stock today, he says, is "particularly inexpensive relative to
many bigger, beloved consumer stocks that ... without inflation, are barely growing at all."
Sources: Company reports, other publicly available information
even more quickly this time and the shares
have recovered quite well.
How are you looking at upside from today’s price of 283 pesos?
JM: The stock is up enough that it doesn’t
currently meet our 30% discount-to-value hurdle to buy, but it isn’t expensive at
18x trailing earnings and is still materially
below our estimate of intrinsic value. It’s
particularly inexpensive relative to many
bigger, beloved consumer stocks that trade
on much higher multiples but that, without inflation, are barely growing at all.
February 28, 2022
This is still a consumer name with genuine growth potential that you don’t see in
something like P&G or Unilever.
Can you generalize at all about where
you’ve historically made mistakes?
JM: One area where we’ve had issues is
when management simply changes its
strategy in what we consider a fundamentally negative way. We’ve spoken with you
in the past about Halfords [VII, July 29,
2016], which is most recognized in the
U.K. as a bicycle and car-parts retailer,
but it also has an auto-repair business that
www.valueinvestorinsight.com
it had diversified into in 2010. While we
were quite positive on the retail business,
we thought the auto-repair business was
terrible, that it would never improve, and
that the company should offload it.
We made that case to Halfords’ new
chairman in 2019 and thought he listened
with a sympathetic ear, but three months
later they announced they were going to
radically increase their investments in the
auto-center business and reduce their focus
on bikes. We exited as the stock continued
to go down prior to Covid, and despite it
doing fairly well during the pandemic –
because of the bike business, by the way –
the share price today is still below where it
was five years ago. We think the long-term
prospects for the auto-repair business are
likely to be a drag on the stock for as long
as they have it.
This is the type of mistake you can’t
necessarily avoid, but we’re very sensitive
to identifying in our due diligence potential strategic initiatives that would derail
our investment outlook. With Hargreaves
Lansdown, for example, we think it would
be a mistake for the company to reduce
prices to match lower-cost competitors.
There’s no guarantee they won’t do that,
but in order to invest we had to be very
comfortable that it wasn’t on management’s agenda and we continue to discuss
this point with them.
SDS: Another idea we’ve spoken about
with you in the past is Regus, the sharedoffice-space provider that now goes under the name of IWG. It’s a holding we
pulled the plug on when we saw the wave
of money flooding into the business globally, most prominently from WeWork, but
also from others. However ill-considered
we thought that capital inflow was, we
rightly, as it turned out, saw the negative
impact that it was going to have on Regus’s pricing and rental volumes.
Our sensitivity to that came from an
earlier investment mistake in the longtime dominant grocer in the U.K., Tesco.
We did not fully recognize the impact on
its business from the growth of discounters, led by the German retailers Aldi and
Lidl. That experience has made us more
Value Investor Insight 8
I N V E S T O R I N S I G H T : Metropolis Capital
attuned and ready to move if we see excess capital coming into a market that we
haven’t anticipated. That can change the
industry economics very quickly.
JM: We’re not ready to call it a mistake
yet, but one holding we worry about today is Qurate [QRTEA], the parent company of the teleshopping channels QVC
and HSN. The stock was down significantly at the onset of the pandemic, seemingly pricing in the destruction of the
business well beyond what we considered
likely. The business actually prospered as
the pandemic wore on, but the company
reported a disappointing fourth quarter of
last year and the stock is off 60% from its
52-week high, trading on something like a
2x trailing P/E. It is something we’re looking at very closely.
SDS: You could say there’s a theme to this
particular discussion. Each of the three
companies we just talked about are retailers. When it goes well it can go very well,
but retail is a difficult space to invest in.
He's more glass half empty
and I'm more glass half full
when we look at opportunities. That's a healthy dynamic.
folio. We have a “no blame” culture and
we want people to admit and learn from
mistakes. If we didn’t have a meeting of
the minds on those sorts of things it would
be very difficult.
On the research and decision-making
side of things, Jonathan is probably more
glass half empty and I’m more glass half
full when we look at opportunities. That’s
not always the case, but it’s generally a
healthy dynamic to have. We also will
never make an investment if we both don’t
agree, and if either of us wants out of a
position, we’re out. That builds a conservatism into our process that we think has
served us very well.
While working in larger companies, we
both hated the negative impacts of office politics and have tried through the
people we hire and the culture we model
to avoid all that. Everyone is incentivized
through an equity program, not linked to
the performance of their specific ideas or
how many stocks they get into the port-
JM: This is a job you can never perfect.
Technology changes. Competitive environments change. Market sentiments change.
There are always new and fascinating
things to learn. That’s all very challenging,
but it’s difficult for either of us to imagine
a more interesting way to make a living.
There’s a shared passion there which is not
dissipating. VII
It’s not that common in this business to
see a partnership like yours last long-term.
Any secrets to share on that front?
SDS: Fundamentally, Jonathan and I share
very similar values and want to build an
organization that reflects those values.
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February 28, 2022
www.valueinvestorinsight.com
Value Investor Insight 9
I N V E S T O R I N S I G H T : Robert Robotti
Investor Insight: Robert Robotti
Robert Robotti of Robotti & Co. explains why he believes the fundamental strength of many old-economy businesses
has structurally improved, why the recovery in the U.S. housing market still has a long way to run, where he's finding
head-shakingly low valuations, and why he sees particular upside in Westlake, Subsea 7, Interfor and West Fraser Timber.
You’ve been speaking about the “revenge
of the old economy” as a central theme reflected in your investment portfolio. There
may be a lot to unpack there, but describe
what’s behind that.
Robert Robotti: Interest rates have dominated the financial landscape for years as
governments everywhere have consistently
driven down rates and flooded the world’s
economies with liquidity in an effort to
trickle up into improved economic activity. You can debate how successful that’s
been – I’d argue it’s been an abject failure with severe unintended consequences
– but the result has been artificially depressed interest rates that everyone seems
to have come to believe are now normal.
The actual novelty of that really has been
lost on investors.
One important impact has been a frantic search for yield by investors, squeezing
them into longer-duration assets such as
the large-cap stocks of companies that
could grow in a chronically low-growth
environment. They’ve been sucking in
huge amounts of capital and the valuations more than reflect that. Higher investment returns attract even more capital and
the up cycle rinses and repeats.
So over now a long period, capital
has shifted to the new economy led by
the FAANG stocks and away from what
is considered the old. What we’ve seen
then in a number of businesses that produce, distribute or service physical goods
– think building materials, chemicals,
steel, some areas in energy – is a dramatic
restructuring of industries where capital
investment has been relatively scarce. The
core of our “revenge of the old economy”
thesis is that in a number of these industries the competitive environments have
structurally changed after years and years
of downsizing, consolidating and underinvestment. These industries still produce vitally important products, but now will do
February 28, 2022
so in a less cyclical and more disciplined
way. We think that changes the game for
the companies in these markets, making
the record earnings many are realizing today more sustainable and capable of further growth.
But if you look at the valuation multiples at which their stocks trade, no one
seems to believe. We own a number of
companies that trade at single-digit P/E
ON THE "OLD ECONOMY":
In a number of these industries the competitive environments after years of change
have structurally improved.
multiples. It makes sense for a company
to trade at 5x earnings because we all
know it’s a crummy, cyclical commodity
business and earnings are just going to go
down again like they always have, right?
We’re saying in many cases that’s not right,
that in an industry now with only two or
three major players operating near capacity, where adding capacity is more difficult
and where capital is being more rationally
managed, pricing power isn’t going to go
away easily. That’s a fundamentally different scenario than the one that has existed
for a long time.
People act like this type of thing just
doesn’t happen, but it does and has many
times in the past. One obvious example
would be the rail-transportation industry
in the U.S., which was a classically horrible, capital-destroying business when I
got out of college. Today, the remaining
railroad competitors operate in monopoly
and duopoly markets and offer low-cost,
energy-efficient transportation services
with strong economics. That’s not going
back to the way it was.
www.valueinvestorinsight.com
Walk through some more recent representative examples of industries you believe
have fundamentally changed.
RR: Let’s look at the history of buildingproducts distribution in the U.S. Not so
long ago there were mom-and-pop local
lumberyards spread across the country
that sold lumber and other related products to two primary customers, new home
builders and repair-and-remodel consumers. The consumer side consolidated first,
with the mom-and-pop distributors being replaced by Home Depot and Lowe’s,
which now dominate the industry and
maintain huge barriers to entry.
Accelerated by the severity and length
of the cyclical downcycle in homebuilding after the financial crisis, you’ve seen
the same dynamic playing out for the segment of the industry that distributes building materials to professional builders and
contractors. We’ve long held a position in
Builders FirstSource [BLDR], which after
its merger in 2020 with BMC Stock Holdings solidified its position as the leading
U.S. supplier of building products, prefabricated components and value-added
services to the residential construction,
repair and remodeling markets. With that
merger, it meant that four of the industry’s
top five competitors as recently as 2015
were now one company.
That consolidation has dramatically
changed the scale, scope and capabilities
of Builders FirstSource and means it can
offer differentiated benefits to both its
suppliers and end customers. Even before
the U.S. housing market started to turn – a
process we still believe has plenty of running room, by the way – its competitive
advantages had grown more identifiable
and clearer. At the same time, its earnings power and the sustainability of those
earnings have significantly improved in a
way that isn’t transitory. We’ve taken a lot
of profits in the stock over the years, but
Value Investor Insight 10
I N V E S T O R I N S I G H T : Robert Robotti
it’s still our largest position. [Note: Bob
Robotti first recommended Builders FirstSource in the August 31, 2011 issue of VII
at a price of just over $2. The stock closed
recently at nearly $73.]
Another good example of a fundamentally changed industry – also related to
housing – would be the manufacture of
oriented strand board (OSB), which is a
wood composite that can replace plywood
to build homes and is also used as the
wood framework in furniture.
The price of OSB struggled for over a
decade after the financial crisis as the housing recovery muddled along, so capital left
the industry, older mills were shuttered,
companies with weak balance sheets were
acquired by stronger competitors, and extremely limited incremental capacity was
built. The result is that North America
barely has enough OSB capacity to satisfy
housing demand today – and that's with 1
million single-family-home starts, which is
still below the 1.1 to 1.2 million level that
is the 50-year average in the U.S.
We would not argue that price volatility has left a business like this, but we believe the dramatic increases in the prices
for OSB over the past two years are the result of structural changes – decades in the
making – which should make them more
sustainable. Yes, there will still be pricing
volatility, but around a much higher average, with more time spent above that average price. That is benefiting a company like
West Fraser Timber [WFG], which bought
Norbord – the leading OSB producer in
North America and a long-time portfolio
holding of ours – in a deal that closed last
year. It’s a big reason we own LouisianaPacific [LPX], which is also converting
commodity-OSB production capacity to
capacity for its value-added OSB siding
business. Efforts like that improve the
industry supply/demand equation in general, and should specifically drive earnings
growth for Louisiana-Pacific.
L-P is actually an interesting and representative case in terms of valuation. The
company is growing and has net cash on
its balance sheet. It’s not spending capital
to increase its overall OSB plant capacity,
but has instead over the past five years
February 28, 2022
bought back 40% of its outstanding common shares with free cash flow. But the
stock trades at a trailing P/E of 5x. A 20%
earnings yield? How can that be in today's
interest-rate environment? People say
earnings are just going to go back down as
they always have. I'm saying it's a growth
company with a deep-value multiple.
I’ll give you one more general example,
this time in the chemical industry. The
chloralkaline process produces two com-
ON U.S. COMPETITIVENESS:
Certain U.S. businesses are
increasingly advantaged,
especially where energy is an
important input cost.
modities – caustic soda, which is used to
make detergents and has other important industrial applications, and chlorine, which is used to make intermediate
plastics and end products like PVC. The
chloralkaline market has consolidated to
three players who meet roughly 70% of
total demand. They now focus more on
profitability, producing to match market
demand rather than trying to steal volume
from competitors by cutting prices. That
has turned out to be a boon for the market leader in the space, Olin [OLN], which
bought the "commodity" chloralkaline
business that Dow Chemical wanted to
sell after merging with Du Pont. Westlake
Chemical [WLK], which we’ll talk about
in more detail later, benefits from this new
industry dynamic as well.
I should also mention another aspect of
the chloralkaline story that is applicable
to other markets as well. Some 80% of the
variable costs in the chloralkaline process
are energy costs, which are substantially
and sustainably lower for domestic producers due to North America’s plentiful
natural-gas supplies. This cost advantage
is particularly pronounced versus other
developed countries, notably coal-burning
China. This gives U.S. producers, already
benefitting from a more rational domestic
www.valueinvestorinsight.com
market, a competitive advantage to capture export business as well. In general,
North America's independence in natural
gas will be important as the world increasingly recognizes natural gas as a critical
bridge in the long-term energy transition
underway.
On the subject of global trade, does your
case for U.S. industrial companies rest on
less freely flowing international trade?
RR: China was able to perform its economic miracle because its businesses were
able to produce goods that consumers in
developed economies wanted, and they
were able to produce them at a much lower cost than anywhere else. As inexpensive
Chinese goods became pervasive around
the world, that had a dampening effect on
inflation almost everywhere.
There’s plenty of reason to believe that
dynamic is over. Chinese labor costs have
gone up significantly. As its economy has
grown, internal demand for everything
from basic materials to end manufactured
products is increasing. When the low-cost
producer suddenly starts to see its costs
of goods increase, its competitiveness is
likely to change. So my argument is based
more on economics than on trade disruptions, which may very well happen. I believe U.S. businesses in certain areas are
increasingly competitively advantaged on
a global scale, again, especially for industries where energy is the most important
input cost.
We’re assuming at least in the relatively
near term you also have a sanguine view
on the overall demand environment?
RR: There was already evidence of much
better supply/demand balance in a number of industries prior to the pandemic,
which translated into strong pricing power and high returns earned as the recovery
out of the pandemic began. That recovery
is still underway, and also don’t forget all
the fiscal stimulus still on the way for infrastructure, alternative energy and elsewhere. We think the demand environment
is still generally going to be positive in the
Value Investor Insight 11
I N V E S T O R I N S I G H T : Robert Robotti
near to medium term. Even if that turns
more quickly, we think through-the-cycle
profitability in the areas we’re invested in
will be much higher than historically experienced and currently expected.
Housing-related stocks have been prominent in your portfolio for some time. As
the story has gotten a bit more traction,
are you still as bullish as you were?
RR: We are at a different point, but we
don’t at all think the thesis has fully run
its course. In the 10 years post the financial crisis, an average of 640,000 homes
per year were built in the U.S. That’s the
fewest number of homes built in any decade since the numbers were first reported
in 1968. That’s as the population has increased, so estimates are that we’re still a
few million homes under-built.
There have been transitory factors that
have overcome the population demographics that would have suggested higher
demand: millennials postponing starting
a family, the student-debt burden, a trend
toward urbanization, and just the hangover from the housing-centered financial
crisis. We’d argue all that postponed demand rather than eliminated it, and the
onset of Covid accelerated the return to at
least historical levels of demand. Increasingly, the idea of having your own home,
your own backyard, having a study, being able to work from home – all those
things matter. Higher mortgage rates may
have an impact here and there, but we still
believe there’s a multi-year period of continued housing recovery ahead, driven by
demographics above all else.
We noticed a number of manufacturedhousing companies in your portfolio.
What’s the background there?
RR: This is an industry, like a lot of those
we’re talking about, that has consolidated and increased efficiencies, while also
delivering a higher-quality product that
addresses the significant issue of housing
affordability. Starter homes are cookiecutter, whether they’re built on site or
made in a factory, except that the one
February 28, 2022
done on site costs 30-40% more and takes
a lot longer to complete.
These companies – we own Cavco
Industries [CVCO], Skyline Champion
[SKY], Nobility Homes [NOBH] and
Legacy Housing [LEGH] – are now sold
out for at least six to nine months and we
think that dramatically increased building
costs today have made for a tipping point
in acceptance of manufactured-housing
alternatives in what has been an extremely
old-fashioned business.
These stocks, by the way, don’t trade
at the highly discounted valuations we're
seeing elsewhere. But given the industry’s
evolution and cost dynamics, we think
there's a long runway of sustainable earnings growth and that the stocks of the
manufactured-housing players are still
quite interesting.
You mentioned Westlake Chemical earlier,
which just changed its name to Westlake
Corp. Describe your broader investment
case for it.
RR: Westlake is a leading global manufacturer of chemicals, vinyls and polymers.
They’re a big player in polyethylene, the
most common plastic packaging in use to-
INVESTMENT SNAPSHOT
Valuation Metrics
Westlake Corp.
(NYSE: WLK)
(@2/25/22):
Business: Producer of chemicals, vinyls and
polymers as well as finished building products
such as siding, roofing and PVC pipe used in
residential and commercial construction.
P/E (TTM)
Forward P/E (Est.)
Share Information (@2/25/22):
(@12/31/21 or latest filing):
Price
52-Week Range
Dividend Yield
Market Cap
110.05
78.06 – 111.48
1.1%
$14.08 billion
Financials (TTM):
Revenue
Operating Profit Margin
Net Profit Margin
$11.78 billion
24.1%
17.1%
WLK
7.1
7.9
S&P 500
23.8
19.5
Largest Institutional Owners
Company
% Owned
Victory Capital Mgmt
3.2%
Vanguard Group
3.1%
Dimensional Fund Adv
1.8%
BlackRock1.0%
T. Rowe Price
1.0%
Short Interest (as of 2/15/22):
Shares Short/Float
4.4%
WLK PRICE HISTORY
120
120
100
100
80
80
60
60
40
40
20
2020
2021
2022
20
THE BOTTOM LINE
The company's traditional chemicals-based businesses have structurally improved and
its now-large building-products franchise is well positioned in a strong U.S. housing
market, says Bob Robotti. But the stock trades at a trailing P/E of 7x, which is less than
half what he would consider reasonable for a company with its earnings-growth potential.
Sources: Company reports, other publicly available information
www.valueinvestorinsight.com
Value Investor Insight 12
I N V E S T O R I N S I G H T : Robert Robotti
day. I highlighted their large chloralkaline
business, where they’re now one of the
three biggest industry players. In addition,
after buying a North American division of
Boral Ltd. last year and combining it with
existing operations that sell vinyl trim,
roofing and PVC products, more than
30% of the company’s revenues currently
come from building products. The name
change was meant to highlight the breadth
of its business today.
One primary distinguishing characteristic here is the Chao brothers, Albert
and James, who founded the company
with their father and have run it for the
past 25 years. They still control roughly
70% of the stock and have a tremendous
long-term record not only in generating
free cash flow but also in redeploying it
at high rates of return. They have consistently grown different businesses in step
form, and those businesses often interrelate, with base materials produced in one
used as feedstock into another. They’re really just like exceptional, disciplined value
investors, and they almost always have
cash on hand and plenty of debt capacity to take advantage of opportunities that
come along.
With the Boral acquisition, Westlake is
well positioned to take advantage of the
positive secular trends in the homebuilding and home repair and remodeling markets. There are significant cost and supply
synergies in integrating the new business,
but the bigger appeal is the opportunity to
add a number of siding and window products with strong market shares to the company’s building-products offer. This takes
it a big step further in becoming more of
a products company, which tend to earn
higher valuations from the market than
the typical chemical firm.
If you go down the line of the company’s main businesses, the dynamic I spoke
of earlier where markets have consolidated and are now structurally much improved is very much in evidence. Westlake
is also a big beneficiary of low natural gas,
ethane and electricity prices in the U.S. In
markets where prices are set by the marginal producer, the cost advantage of having lower input costs than your competiFebruary 28, 2022
tors should have a highly positive impact
on profitability.
At a recent $110, how cheap do you consider Westlake’s shares?
We’re assuming our discussions earlier
about oriented strand board and about
housing are relevant to understanding
your interest in lumber company Interfor
[Toronto: IFP].
RR: I don’t think it’s very complicated.
The stock trades at a trailing P/E of 7x,
for a business that is very well run and
that we believe can compound earnings at
more than 10% annually. Just looking at
the fundamentals, this is a company that
could easily trade at 15x earnings. If earnings grow as we think they can, we’d expect the stock to re-rate pretty materially.
RR: Very much so. Interfor is a leading
lumber manufacturer that has actively
been acquiring and integrating competitors, three of which in 2021 alone. The first
was the acquisition of a sawmill in South
Carolina for nearly $60 million. The next,
for $375 million, was the purchase of four
U.S. sawmill operations from GeorgiaPacific. Then in November the company
INVESTMENT SNAPSHOT
Valuation Metrics
Interfor
(Toronto: IFP)
(@2/25/22):
Business: Canada-based manufacturer of
lumber products that is aggressively expanding its manufacturing footprint primarily in the
U.S. Southeast and Pacific Northwest.
P/E (TTM)
Forward P/E (Est.)
Share Information
(@12/31/21 or latest filing):
(@2/25/22, Exchange Rate: $1 = C$1.27):
Price
52-Week Range
Dividend Yield
Market Cap
C$38.90
C$22.75 – C$44.56
0.0%
C$2.37 billion
Financials (TTM):
Revenue
Operating Profit Margin
Net Profit Margin
C$3.29 billion
34.4%
24.9%
IFP
3.1
3.5
S&P 500
23.8
19.5
Largest Institutional Owners
Company
% Owned
Letko, Brosseau & Assoc
10.8%
Pictet Asset Mgmt
5.2%
Dimensional Fund Adv
3.9%
RBC Global
2.8%
IG Investment Mgmt
2.7%
Short Interest (as of 2/15/22):
Shares Short/Float
n/a
IFP PRICE HISTORY
50
50
40
40
30
30
20
20
10
10
0
2020
2021
2022
0
THE BOTTOM LINE
Supported by its increasingly strong market position and the continued vitality of the
U.S. housing market, Bob Robotti believes the company can earn in free cash flow over
the next four years its entire current market capitalization. "Given our understanding of
the company and its business," he says, "that valuation doesn't make much sense to us."
Sources: Company reports, other publicly available information
www.valueinvestorinsight.com
Value Investor Insight 13
I N V E S T O R I N S I G H T : Robert Robotti
increased its total lumber capacity by another 25% by buying EACOM Timber
for $490 million from private-equity firm
Kelso & Co.
In addition to M&A, over the past several years you’ve seen industry production
capacity move from British Columbia,
where the regulatory and natural environments – think beetle infestations – have
not been kind to the timber industry, to the
Southeastern U.S. The net result, however,
is that there’s been no addition to industry
capacity over that time, and we don’t expect much net capacity to be added from
here. When demand took off from housing in 2020, that helped fuel the dramatic
increases in lumber prices that made the
news. Even though prices have come back,
they have stayed much higher than they
were entering the pandemic.
Our basic case here is similar to others
we’ve discussed. The competitive environment has changed, becoming more consolidated and rational. That means that
the cycles shouldn’t be as pronounced as
before and that profitability for the bigger
players has been enhanced. Layer in a tailwind for housing and we think Interfor’s
prospects are much brighter than seems to
be priced into its stock.
What do you think is priced into the stock
at today’s C$39 share price?
RR: I don’t know exactly, but it’s clearly
not our expectation that the company
over the next three or four years can earn
in free cash flow the entire current market cap. If it takes four years, that’s a 25%
free-cash-flow yield. Given our understanding of the company and its business,
that type of valuation doesn’t make much
sense to us.
Is the story essentially the same for West
Fraser Timber, which you mentioned earlier as a big player in OSB?
RR: After its deal to buy Norbord closed
early last year, we continued to hold the
West Fraser shares we received for our
Norbord stake. I’m starting to sound like
a broken record: Industry changes over
February 28, 2022
the past two decades have altered the supply/demand equation in favor of lumber,
and particularly OSB, producers. That
advantage has legs, which will allow companies like West Fraser – whose business
is roughly 60% lumber and 40% OSB –
to generate significant free cash flow and
earn above average returns on capital.
The substantial OSB piece adds a different element than with Interfor, which is
a positive for the business. OSB continues
to take share from other building products and is finding new uses. We also think
OSB has considerable potential to grow
and take share in Europe, where West Fra-
ser – through the Norbord acquisition – is
well established.
With the shares now at $97.70, is there a
similar story here on valuation?
RR: The multiples are miniscule. The stock
trades at less than 4x trailing earnings. It’s
at 2x this year’s free cash flow and maybe
5x next year's. As with Interfor, we think
free cash flow pays for the entire current
market cap in the next three to four years.
In a world with 2% 10-year Treasuries
and a 20x forward P/E for the S&P 500,
that’s remarkable.
INVESTMENT SNAPSHOT
Valuation Metrics
West Fraser Timber
(NYSE: WFG)
(@2/25/22):
Business: Diversified producer of lumber,
plywood, oriented strand board, newsprint
and other wood products with over 60 facilities in the U.S., Canada, the U.K. and Europe.
P/E (TTM)
Forward P/E (Est.)
Share Information (@2/25/22):
(@12/31/21 or latest filing):
Price
52-Week Range
Dividend Yield
Market Cap
97.66
61.36 – 101.83
1.0%
$10.62 billion
Financials (TTM):
Revenue
Operating Profit Margin
Net Profit Margin
$10.52 billion
37.6%
28.0%
WFG
3.7
9.1
S&P 500
23.8
19.5
Largest Institutional Owners
Company
% Owned
Pictet Asset Mgmt
5.7%
Fidelity Mgmt & Research
4.4%
Bank of Montreal
3.5%
Vanguard Group
3.1%
Royal Bank of Canada
3.6%
Short Interest (as of 2/15/22):
Shares Short/Float
0.6%
WFG PRICE HISTORY
100
100
80
80
60
60
40
40
20
20
0
2020
2021
2022
0
THE BOTTOM LINE
Changing lumber-industry dynamics for the better and the company's strong position in
the expanding global market for oriented strand board would imply for it much brighter
future prospects than are built into its share price, says Bob Robotti. On next year's
estimated free cash flow, the stock today trades at a free-cash-flow yield of around 20%.
Sources: Company reports, other publicly available information
www.valueinvestorinsight.com
Value Investor Insight 14
I N V E S T O R I N S I G H T : Robert Robotti
What will they do with all that cash?
There may have been a time when a lot of
it would have made its way to expanding
production capacity. We don’t think those
days are coming back. Far more likely is
that the company will continue to buy
back a lot of stock and will probably pay
out special dividends from time to time.
We haven’t spoken about an energy company. Describe the upside you see in energy-services firm Subsea 7 [Oslo: SUBC].
RR: This is a business we’ve known for a
long time, a global leader in the engineer-
ing and installation of offshore oil and
gas development projects. The industry
is down to two real global players who
can deliver projects from soup to nuts:
TechnipFMC [FTI], and Subsea 7, often
partnered with Schlumberger through the
OneSubsea Alliance.
As the world shifts from hydrocarbons
to renewable energy, we’re in the camp
that argues this transition, by necessity,
will take a very long time and will require increased production – particularly
of natural gas – to bridge the old energy
regime to the new. We expect an important share of the new production to come
INVESTMENT SNAPSHOT
Valuation Metrics
Subsea 7
(Oslo: SUBC)
(@2/25/22):
Business: Engineers, constructs and services offshore platforms used in the exploration,
development and production of oil and gas as
well as in the production of wind energy.
P/E (TTM)
Forward P/E (Est.)
Share Information
(@12/31/21 or latest filing):
(@2/25/22, Exchange Rate: $1 = NOK 8.83):
Price
52-Week Range
Dividend Yield
Market Cap
NOK 60.78
NOK 58.04 – NOK 97.86
0.0%
NOK 18.09 billion
Financials (TTM):
Revenue
Operating Profit Margin
Net Profit Margin
$4.66 billion
6.9%
(-1.5%)
SUBC
n/a
17.0
S&P 500
23.8
19.5
Largest Institutional Owners
Company
% Owned
Folketrygdfondet 7.7%
BlackRock3.8%
Trinity Street Asset Mgmt
2.6%
DNB Asset Mgmt
2.5%
Eleva Capital
2.3%
Short Interest (as of 2/15/22):
Shares Short/Float
n/a
SUBC PRICE HISTORY
120
120
100
100
80
80
60
60
40
40
2020
2021
2022
THE BOTTOM LINE
Bob Robotti believes that due to industry consolidation and the company's ongoing newproduct and new-market development that its earnings power is 50% higher than it was
in the last real upcycle for oil and gas. Based on its recent U.S. ADR price of $6.95, the
stock today trades at only 2.3x his roughly $3 per share estimate of normalized earnings.
Sources: Company reports, other publicly available information
February 28, 2022
www.valueinvestorinsight.com
from large offshore fields that have already been identified, but that now with
technology and process improvements
from companies like Subsea 7 are increasingly economic to develop. That’s not just
at today’s higher oil prices – although that
certainly helps – but in many cases at oil
prices as low as $40 per barrel. Development of LNG transportation and technology is also making natural gas in general
more economic to develop, as it’s now
more easily sold elsewhere.
As oil prices have increased, the pipeline
for Subsea 7’s traditional oil and gas business has grown nicely. We don’t see that
as a short-term phenomenon. We’re also
high on the company’s growing exposure
to alternative energy, which is a testament
to management’s nimbleness in pursuing
new markets. Close to 20% of the current
backlog is for the building and installation
of offshore wind platforms, mostly using
already existing equipment and taking advantage of in-house engineering expertise.
They’ve also through acquisition added a
variety of new wind-related capabilities,
including things like the installation of
ocean-bottom-affixed foundations, substation installation, turbine installation
and transport capability to move fabricated components from Far East shipyards.
As another example of new business in the
alternatives space, Subsea 7 recently won
a $150 million contract to capture CO2
from an onshore cement plant and sequester it off the coast of Norway.
The share price at a recent 60.75 Norwegian kroner – or $6.95 for the U.S. ADR
– is down more than 40% from its price
at the beginning of 2020. What upside do
you see from here?
RR: The relative performance of the
stock, particularly as oil prices have risen, has been horrible. Part of that may
be as simple as the time lag between the
company winning a contract and having
it start to generate revenue. New business has been picking up fairly recently,
so there hasn't been much to show for all
that yet. I would also mention that Subsea 7 over the past year has been winning
Value Investor Insight 15
I N V E S T O R I N S I G H T : Robert Robotti
less than its fair share of contracts. Some
might see that as a negative, but I’d argue
that shows they’re being smart about how
they're pricing. If we, and they, are right
about demand going forward, they’ll be
happy to have the capacity available at
what should be higher prices. Their discipline may be working against them in the
short term, but we don’t believe it will in
the long term. If you talk to management
about what things look like in 2024 and
2025, they’re quite upbeat.
We believe the company’s earnings
power has substantially improved from
what it was in the last real upcycle in
2013-2014, when without one-time events
it was earning over $2 per share. The industry has consolidated further. They’ve
expanded capabilities to capture more of
a project’s value. They’ve developed new
business lines. We think in the next few
years earnings power will approach $3
per share. That’s against a stock in the U.S.
that trades at less than $7. You don’t have
to be overly optimistic about the multiple
the business would deserve at that level of
earnings and the resulting return on capital to see pretty substantial upside in the
share price.
Energy-services stocks in general have
significantly trailed some of the substantial increases in commodity prices we've
ON THE OPPORTUNITY SET:
We're invested where it has
been lonely and uncomfortable, and where valuations
today are extremely modest.
seen. That makes sense if you’re convinced
commodity prices will just go back down.
As I hope I've made clear, I think the market is to a significant degree overestimating the likelihood of that happening.
If the underlying elements of your broader views here turn out to be wrong, why
might that be?
RR: We’ve spoken enough over the years
that you’ll know my timing in trying to
understand and respond to secular industry changes and the macroeconomic environment has not always been ideal. That’s
hurt our relative performance in recent
years, particularly given our exposure to
conventional oil and gas companies.
We’ll of course make mistakes, as all
investors do, in individual names for individual reasons, but if things generally
don’t play out the way we expect, I believe
it again will be a function more of timing
than our just being flat-out wrong. People
love to jump on the winning bandwagon,
but we’re very consciously invested where
it has been lonely and uncomfortable,
which is where valuations today remain
extremely modest. I think the tide has already turned in a number of these businesses, for fundamental economic reasons,
and it’s not coming back in again any time
soon. I hesitate to say it’s obvious and
people are just blindly ignoring it, but I
honestly believe it’s obvious and people
are just blindly ignoring it. VII
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Value Investor Insight 16
U N C O V E R I N G V A L U E : Lumen Technologies
Boring Can Be Beautiful
Investors in high-flying stocks are seeing first-hand today how what goes up can rather quickly go down. Here's a
decidedly low-flying stock that Jenny Harrington of Gilman Hill Asset Management expects to surprise on the upside.
Value investors are more at ease than
most in investing in boring, stagnant or
even declining businesses. Everyone loves
a great story with secular tailwinds and
unassailable competitive advantages, but
price matters, and sometimes even the
most uninteresting business can trade at
an interesting bargain price.
That’s more or less the case that Jenny
Harrington of Gilman Hill Asset Management makes today for Lumen Technologies. Lumen’s biggest business provides
telephone and broadband service to consumers and businesses mostly in the U.S.
Midwest and Southeast. It also is a leading
provider of enterprise data network and
transmission services – helping to make
up the proverbial “backbone” of the Internet – supported by a terrestrial and subsea
fiber infrastructure that before pending
divestitures spanned more than 450,000
route miles.
While the local telephone business is in
long-term decline and the enterprise-fiber
business is slow-growth and highly competitive, both generate significant revenues
and cash flow that provide real value, says
Harrington. In 2021, on $19.7 billion in
revenues, Lumen reported free cash flow
of $3.6 billion and net income of just over
$2 billion. “We’re not making the case
that these are great businesses with dynamic growth,” she says. “But they're cash
cows that would appear to be valued in
private markets at two to three times what
the public market is currently paying.”
Lumen itself is helping to establish representative private-market values, agreeing over the past six months to sell its Latin American fiber assets to private equity
firm Stonepeak for $2.7 billion, roughly
9x EV/EBITDA, and its landline assets in
20 U.S. states to Apollo Global for $7.5
billion, or 5.5x EV/EBITDA. Comparable
assets have been purchased in recent years
at even higher multiples by the infrastructure divisions of Macquarie Group, EQT
and Morgan Stanley. “These are not unsophisticated buyers,” says Harrington.
February 28, 2022
“That gives us more confidence that the
value of the assets is real and significant.”
To arrive at what she believes Lumen
is more reasonably worth, she ascribes a
10x EV/EBITDA multiple – again, below
where comparable assets have been trading hands – to the enterprise-fiber business, which files its own 10-Ks as it has
public debt. She values the rest of the business, using management’s post-divestiture
guidance, at the 5.5x EV/EBITDA Apollo
is paying for Lumen's Latin American assets. After adjusting for cash, debt and
taxes, she arrives at a fair value for Lumen’s shares of $24, a nearly 140% premium to today’s price.
While she waits for value to be recognized, she believes that even after a decline
in free cash flow due to asset sales that the
company is likely to maintain its $1-pershare annual dividend. At today’s share
price that translates into a dividend yield
of just under 10%. “I hesitated to bring
this up because it’s a pretty unglamorous
idea, but in our experience that doesn’t
mean it can’t be a good one,” she says. VII
INVESTMENT SNAPSHOT
Lumen Technologies
Valuation Metrics
(NYSE: LUMN)
(@2/25/22):
Business: Provides phone, data and network
telecommunications services to consumers,
small-businesses and large enterprises.
Share Information (@2/25/22):
Price
52-Week Range
Dividend Yield
Market Cap
10.09
9.31 – 15.45
9.9%
$10.33 billion
Financials (TTM):
Revenue
Operating Profit Margin
Net Profit Margin
$19.69 billion
21.8%
10.3%
P/E (TTM)
Forward P/E (Est.)
LUMN
5.3
n/a
S&P 500
23.8
19.5
Largest Institutional Owners
(@12/31/21 or latest filing):
Company
% Owned
Vanguard Group
10.7%
BlackRock
7.2%
Temasek Holdings
7.1%
Short Interest (as of 2/15/22):
Shares Short/Float
10.8%
LUMN PRICE HISTORY
20
20
15
15
10
10
5
2020
2021
2022
5
THE BOTTOM LINE
Its cash-cow businesses are hardly glamorous, says Jenny Harrington, but based on the
valuations sophisticated buyers are paying for comparable assets she believes the fair
value for the company's stock is around $24, a nearly 140% premium to today's price.
Sources: Company reports, other publicly available information
www.valueinvestorinsight.com
Value Investor Insight 17
U N C O V E R I N G V A L U E : F45 Training
Shaping Up
Butler Hall Capital's Brad Lundy has been finding opportunity in pandemic-hit industries that he expects to fully recover though they haven't yet. One representative example: the fitness-gym market and one newly public player in it.
Spending habits have gone through
pandemic-related upheaval in the past two
years, leading to many investment cases
today revolving around whether or not
consumer behavior returns to “normal.”
To what extent will we keep riding our
Pelotons? Will we continue to eat more at
home? Will we return to the office?
Wide dispersion of opinion over such
questions can, of course, create investment opportunity. That's what Brad
Lundy of Butler Hall Capital sees today
in F45 Training, a fitness-gym franchisor
that went public in July of last year at $16
per share. First established in Australia,
F45 has been signing on U.S. franchisees
at a rapid clip, but a combination of those
franchises taking time to open and lockdown restrictions remaining in place in
Australia resulted in the company badly
missing earnings expectations out of the
gate last fall. By the end of 2021 the stock
had fallen below $11.
The longer-term picture for F45 is far
more positive than its early returns would
indicate, says Lundy. The company specializes in High-Intensity Interval Training
(HIIT) workouts, a fast-paced mix of endurance and strength exercises that have
become increasingly popular for their
promise of high calorie burn in a short period of time. In addition, he says, the unit
economics for franchisees are compelling.
The F45 gym footprint is small – 1,600
square feet on average vs. 20,000 or so
for a Planet Fitness – resulting in opening costs of about $315,000, 15% of that
for a full-service gym. The typical location
breaks even with only 75 full-time members, and with a system-average 150 members the payback period is only 3.5 years.
Franchises sold from the end of 2019
through the end of 2021 grew 75%.
While the stock has recovered somewhat, it still trades below the IPO price
and Lundy believes it has plenty of room
to run. Given the broad closures of independent gyms during the pandemic, he believes F45 is uniquely positioned to cater
February 28, 2022
to the 10 million or so U.S. gym goers in
total who are or will be searching for a
new gym as the economy fully opens up.
As a first conservative pass, he assumes
franchise sales continue at their current
pace and total units sold reach some
4,000 by the end of 2022. At currentaverage membership levels per established
gym, that base would generate at cruising
altitude royalty fees and recurring equipment sales of roughly $75,000 per unit
to F45, yielding close to $290 million in
annual sales. Assuming 75% gross royalty
margins, 40% gross equipment margins,
$50 million in annual selling, general and
administrative costs, $3 million of maintenance capex and a tax rate in the low
20s, he arrives at a free cash flow estimate
of nearly $1.20 per share. Based on peer
multiples in fitness and elsewhere for franchise businesses, he would consider a 20x
multiple more than reasonable, resulting
in a $24 share price. “This assumes they
grow for another year and then stop,” he
says. “We like to build in that kind of conservatism and still see material upside.” VII
INVESTMENT SNAPSHOT
F45 Training
Valuation Metrics
(NYSE: FXLV)
(@2/25/22):
Business: Global franchised chain of fitness
centers, offering high-intensity interval, circuit
and functional training class workouts.
Share Information (@2/25/22):
Price
15.37
52-Week Range
Dividend Yield
Market Cap
9.38 – 17.75
0.0%
$1.39 billion
Financials (TTM):
Revenue
Operating Profit Margin
Net Profit Margin
$90.2 million
(-118.8%)
(-255.2%)
P/E (TTM)
Forward P/E (Est.)
FXLV
n/a
23.0
S&P 500
23.8
19.5
Largest Institutional Owners
(@12/31/21 or latest filing):
Company
% Owned
Kennedy Lewis Inv Mgmt
11.6%
Caledonia Investments
7.3%
L1 Capital
7.1%
Short Interest (as of 2/15/22):
Shares Short/Float
6.0%
FXLV PRICE HISTORY
20
20
15
15
10
10
5
2020
2021
2022
5
THE BOTTOM LINE
The company is positioned to prosper in a changed U.S. post-pandemic competitive environment for in-person fitness, says Brad Lundy. At 20x his estimate of annual free cash
flow, even assuming expansion stops at the end of 2022, its stock would trade at $24.
Sources: Company reports, other publicly available information
www.valueinvestorinsight.com
Value Investor Insight 18
OF SOUND MIND
An Enduring Advantage
Temperament as an investing edge has likely increased in relative importance over time, say Simon Denison-Smith
and Jonathan Mills. Here they explain what it means and why they consider it one of the few sources of alpha left.
Editor's Note: It’s common for successful investors to credit at
least part of their success to an ability to keep an even mental keel
through the emotional highs and lows that come from owning
common stocks. Warren Buffett speaks often of this, including in
his 2017 Berkshire Hathaway Chairman’s Letter when he quotes
these lines from Rudyard Kipling’s poem titled “If”: “If you can
keep your head when all about you are losing theirs . . . If you
can wait and not be tired by waiting . . . If you can think – and
not make thoughts your aim . . . If you can trust yourself when all
men doubt you . . . Yours is the Earth and everything that’s in it.”
Jonathan Mills and Simon Denison-Smith of Metropolis Capital
[see interview, p. 2] thoughtfully examined the role of temperament in investing in one of their own investor letters just over a
year ago. Starting with another quote from Buffett ("Investing is
not a game where the guy with the 160 IQ beats the guy with the
130 IQ – once you have ordinary intelligence, what you need is
the temperament to control the urges that get other people into
trouble in investing.”), they examined what it means to have the
right temperament for investing, why it matters so much, and how
they endeavor to turn it to their advantage. The portion of their
letter on temperament is reproduced here with their permission.
Warren Buffett’s insight that successful investing requires the
right temperament is profound and insufficiently appreciated.
What is temperament in the context of investing? It is difficult to
define precisely, but we'd point to certain features or behaviours:
• The ability to form balanced and independent judgement
amidst a cacophony of news, views and narratives.
• The ability to back those judgements with resolution when
there will be credible and articulate counter theses.
• Avoiding dogmatism or zealotry and being prepared to
change one’s mind in light of new information. Having a
philosophy but not holding onto it too tightly.
• Being prepared to delay short-term gratification (and have
the patience and fortitude to put up with short-term loss)
for a greater long-term gain.
• Battling and overcoming one’s psychological biases such as
FOMO (Fear Of Missing Out), sentimentality and pride.
It is possible that a temperament conducive to successful investing is partly heritable: you may either be born with it or not.
Some psychologists use the 5 Factor Personality Model in appraising people. The 5 factors, all shown to display some degree
February 28, 2022
of heritability, are: Openness, Conscientiousness, Extraversion,
Agreeableness and Neuroticism. It seems likely that at least 2
of these factors speak directly to temperament as relevant to investing. Those marked high for Conscientiousness are said to be
“competent, self-disciplined, thoughtful and goal-driven”. Those
marked low for Neuroticism are “Calm, even-tempered and secure”. Both of these sets of characteristics seem to describe desirable qualities in an investor.
Whilst temperament may be somewhat heritable, there are
ways to modify one’s natural temperament through rules and
procedures. These will generally improve an investment process.
Recognising our weaknesses, biases and imperfections, we institute rules at Metropolis Capital to ‘temper’ these. Some of these
rules include:
• Investing with a pre-defined margin of safety. We will only
initiate a position where we believe the market value is at
least a 30% discount to our assessment of intrinsic value.
• Adjusting our portfolio weightings according to pre-determined rules. To minimise costly and neurotic trading based
on slight changes in relative value, we have hurdles before
changes can be made. We also weight our positions based
on our assessment of quality, which is quantitively scored.
• Understanding the bear case. We will only invest when we
believe we understand the bear case and can either confidently dispute it with good evidence and reasoning, and/or
reflect it in our valuation.
Managers with the right temperament may have a fundamental and enduring advantage. Popularly cited sources of edge are
manifold. Some value access to proprietary information. High
frequency data such as mobility data, credit card spending data
or Google Trends have become increasingly popular as investment tools. Some investors who are focused primarily on shortterm results go to the lengths of procuring satellite data to deduce
how busy parking lots or manufacturing sites appear. Others rely
heavily on calls with market participants and former employees,
sourced through expert networks. Some will cite the size of their
research teams, or sector specialism. Our view is that there may
be value in all of these at times, but they may also have become
‘hygiene factors’ rather than sources of sustainable edge.
Counter-intuitively, temperament as an edge is likely to have
increased in relative importance over time. The investor who
sought proprietary information several decades ago was more
likely to have been richly rewarded than the equivalent contemporary investor for whom that information is now just par for the
course or not in the public domain and therefore illegal to act on.
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Value Investor Insight 19
OF SOUND MIND
Benjamin Graham made good money in the first half of the 20th
Century from putting in the work to manually detect ‘net nets’;
stocks trading for less than the value of their cash and working
capital. Net nets are very rare today partly because of the dissemination of information and computing power. Temperament
may be the only prevailing, or at least, primary source of alpha.
In order to fully appreciate this, we have looked back at the
last 16 years of the U.S. stock market. We show how neurotic
and volatile Mr. Market can be, as reflected by wild swings in
individual stock prices. In the analysis below we observe the year
high and year low of each company valued at greater than $2
billion in the U.S. stock market for the last 16 years and calculate
the percentage spread between these. We find that this spread is
significant, exists across different sizes of businesses, and there is
no evidence that it is dissipating over time. This is not evidence
against efficient markets per se – although it might be suggestive
of this – but reflects the opportunity for a disciplined, patient
investor of good temperament.
Chart A shows the average spread – defined as the percentage
difference between the calendar high and low share price – for all
U.S. stocks from 2005 to 2020. We show this for all businesses
and have segmented the data by market capitalisation. Over the
whole period, we find that the mean spread of all stocks is 79%
in a calendar year. This is lower for Mega Caps (greater than
$100 billion) at 57%, versus Large Caps ($20-100 billion) at
62% and Mid Caps ($2-20 billion) at 83%.
The level of volatility is notable and material, even for Mega
Caps. These are businesses typically followed by dozens of sell
side analysts and thousands of institutional investors, and yet the
market will typically change its mind to the extent of 57% in
just one calendar year. The market’s indecisiveness and neurosis
show no sign of abating. The spread is not diminishing over time.
This presents stock pickers with ongoing opportunities. There
are bouts of heightened volatility such as in 2008 and in 2020.
We extended our volatility analysis to look at a couple of additional variables. In chart B below we show what proportion of
stocks go up and what proportion go down in a calendar year.
Given the asymmetric bias towards growth, we find stocks will
end up on the year 70% of the time and down on the year 30%
of the time. Short sellers fish in a smaller pond. Clearly, the pro-
February 28, 2022
portion that go up will vary with market cycles such that this was
84% in 2019 but only 6% in 2008.
Additionally, in Chart C we show the proportion of stocks
that beat the market in a year. Over the 16-year time period, this
amounts to 46%. The reason this is not 50% is due to the asymmetry that stocks can go up more than stocks can go down. A
stock is capped at declining by 100%. In 2020, the proportion of
stocks beating the market was just 32% because there have been
outsized wins from a particular group of stocks such as Big Tech
and ‘stay at home’ stocks. As such, there is a curiosity that a randomly chosen portfolio of stocks will have more relative losers
than winners. Therefore, a randomly chosen portfolio of stocks
that is equal weighted will typically generate negative alpha.
Volatility is fundamental to our investment philosophy. The
fact that share prices trade with such a wide spread in any year
suggests that there should be times when the patient long-term
investor has the opportunity to buy into a position at a discount
to the company’s intrinsic value. Clearly, this is not the case for
every stock – many will move from being overvalued to very
overvalued – but there should be sufficient numbers for us to
find companies which provide both the quality characteristics we
require and a compelling margin of safety to form a portfolio of
15 to 25 companies which offer good long-term returns. VII
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Value Investor Insight 20
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February 28, 2022
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Value Investor Insight 21