My investment philosophy is unsurprisingly similar to that of the Oracle of Omaha, Warren Buffett, owner of Berkshire Hathaway (BRK-A). Readers of this article are likely prepared for an unoriginal regurgitation of various 'value investing' tenets that have been recited at nausea. Oft-repeated quips by the Oracle, such as "Rule #1: Don't lose money. Rule #2: Don't forget Rule #1." and "I wait for meatballs when investing, only swinging when I see a great pitch" succinctly sum up my personal approach to investing. My prior investment pitches all share common characteristics such as:
1. Cheap-to-fair valuation
2. Strong economic advantages (moats)
3. Strong management
4. Business models that tend to generate consistent cash flows.
Results of stock recommendations (published articles and Instablogs):
(click to enlarge)
The table above is a summary of all pertinent information necessary to judge the merits and success of my past investment suggestions. The first thing I noticed when reviewing my results was that I did not suggest an investment that ended in a loss. This is something I was quite proud of, even if the strong rally of the broader market may have influenced this result. Normally, I'd prefer to ignore my results as compared to broader index returns except in the long-run (3-5 years minimum). I am a strong believer that absolute results are all that matter. Without elaborating, I feel that my savings pale in comparison to the total investing capital in the US, so I will not notice an increase in purchasing power if I lose 10% when the broader market loses 20%. I prefer to make money regardless of the results of the S&P 500, however I recognize the preferences of my readers and the name of this site (we are all supposedly 'seeking alpha' after all) so I have included the results of the S&P 500 ETF (NYSEARCA:SPY) for comparison.
The Worst Picks and What Went Wrong:
This group includes Molson Coors Brewing Company (NYSE:TAP), Cisco Systems, Inc (NASDAQ:CSCO), and UFP Technologies, Inc (NASDAQ:UFPT). I would like to highlight that TAP and CSCO were likely poor investments in hindsight with both lacking all 4 characteristics listed above. TAP lacks a meaningful economic advantage of the likes of Anheuser-Busch InBev SA/NV (NYSE:BUD). I had originally believed there was a greater brand loyalty for beer than what operating results have shown. Consumers of beer as a whole are slowly migrating towards craft/locally brewed beers and BUD has made a concerted marketing effort to gain a larger market share of the young male demographic. Although operating profits have improved since purchase, these headwinds are certainly effecting margins. Although others argue otherwise, I believe Cisco has a strong economic advantage (even with the most recent quarterly results) and relatively consistent cash flows, however management is vastly overpaid and billions of dollars in would be shareholder equity are used to prevent dilution of the shareholder through buybacks. Normally, I would generally be a supporter of share buybacks, but CSCO has made a habit of re-purchasing shares without consideration of valuation. I would sell both CSCO and TAP immediately, due both to valuation (each at ~20 P/E for what are average businesses) and the lack of all 4 characteristics I require (this is what makes each business "average" in my opinion). The last of the 'poor' performers is UFPT. The main cause of near market performance is a lack of substantial earnings growth since my article. However, I would not sell at this time as the company meets all of my 4 criteria for investment. The economic advantage is debatable but, I believe the extremely strong balance sheet and flexibility of the company's product mix which allows UFPT to have outsized margins as compared to peers and thus a relative economic advantage. None of these companies has the characteristics of a "homerun investment".
The Strong Performers and What Went Right:
There is an obvious overlap between the next 3 investments, they each share all 4 characteristics. Allied World Assurance Company Holdings, AG (NYSE:AWH) is my favorite insurer outside of Berkshire Hathaway with a reasonable chance to outperform Berkshire. AWH has a strong balance sheet and a history of increasing book value at a double digit rate. Fixed income products comprise a large majority of AWH's investment portfolio with outsized returns coming from investments purchased during the crisis at large discounts to intrinsic value. Although the increase in P/B has driven the majority of the returns for AWH, with a 10% - 15% annual ROE and a 1.8% yield, I would expect AWH to continue to provide double digit returns for an investor purchasing today. Google Inc (NASDAQ:GOOG) has been famously cited by Charlie Munger and Warren Buffett as having the largest moat they have ever seen. I recommended GOOG with a P/E of nearly 20, yet an investor taking my recommendation would still have realized annualized returns of ~32%. Consistent double-digit earnings growth and the market recognizing the seemingly insurmountable moat [leading to P/E expansion] have driven the strong returns. GOOG appears to be the Coca-Cola (NYSE:KO) of the 21st century, with search engine profits creating a growing profit floor and some interesting innovations that may become future catalysts to continued outsized profit growth. Without regard to valuation, I would agree with Munger and Buffett that GOOG is by far the company with the largest, alligator filled moat. Finally, a micro-cap with all 4 characteristics, Simulations Plus, Inc (NASDAQ:SLP) has potential to be a rare 10 bagger similar to Peter Lynch's investment process. Earnings have continued to grow in 2013 after 2012's slight pause and SLP's management has shown they are admirable capital allocators. Shortly before my article on SLP, they initiated a dividend that has since barely dented the strong cash balance or fortress balance sheet of this small tech company. SLP still generates FCF at ~5% yield against the current share price of $5.24 (as of 11/13/2013). Although no longer cheap, SLP still has the potential to be a 10 bagger today over the long-run.
The Best Performer and Can it Continue:
The best example to only invest when you are highly certain you have a great investment is Bofi Holding, Inc (NASDAQ:BOFI). The Bank of the Internet was selling below tangible book value, trading at a P/E of 7 - 8, and experiencing ROE of 15% - 20%. Since each of my recommendations (first article and second article), profits have increased substantially from $15.6mm ($1.87 eps) to $34.9mm ($2.89 eps) in FY13. Profits have grown rapidly due to substantial increases in customer deposits, a decrease in interest rates on deposits, very strong organic loan origination (BOFI is well known for strict underwriting standards), and extremely competent management. Management has increased capital to meet their goal of $3Bn in assets through a variety of methods, always with a focus on increasing shareholder value. Although equity raises seem like harmful dilution in hindsight, at the time of each secondary offering BOFI shares seemed overvalued or, at the least, fairly valued. Deposits have increased 30% in each of the last two years which allowed for asset growth to increase 30% in each of the last two years. However, non-performing assets (NPA) has decreased to 0.70% of the asset portfolio from 1.40% in 2011 when my articles were published. This decrease has been explained by management as a symptom of consistently stringent underwriting standards such as 20% minimum down payment instead of 10% industry standard. Their relationship with Costco has increased visibility with customers substantially. Currently overvalued in my opinion, I believe investors will continue to see high double-digit returns over the long-run with a purchase around $50 (if we ever see a 5-handle again).
Hopefully, I have beaten the proverbial horse dead with my repeated mentions of the 4 characteristics for a good investment. Although it may be boring or difficult to restrain from investing when all 4 characteristics are not present, I see no reason to swing prematurely in a game where balls and strikes are not called and every swing carries a consequence (such as permanent capital loss). My 38% annualized returns (beating the S&P 500 by ~25%!) will likely be difficult to duplicate, I believe investors reading this article are capable of not just seeking, but capturing alpha by being conservative and patient investors. However, if you ever want to take the thought out of investing it may be as simple as following my future investment advice.
Of course, it always looks better to look back at past results while the market is up 14% annually with the start date corresponding to a relative peak while 20%+ annualized market gains were possible depending on an investor's purchase price around that time. The market may not be as generous over the immediate short-run, I believe an investor will do best going long American companies. My real money portfolio has seen tremendous gains (beating these recommendations) over the past two years with low correlation to the market because I have stuck to buying only strong, growing companies that sell with low prices. I have purchased each company after a sharp decline due to market's overreaction to a non-event. Situations such as S&P being sued (for amount likely years down the line and for likely less than they have cash on hand), the "London Whale", Media companies selling for 10 P/E in a non-election year (presidential), and Berkshire Hathaway at book value at any time. My recommendation would be to make a list of strong companies with consistent and growing cash flows and check everyday for sharp declines. The 52-week lows for some of these companies should serve as a reminder of the types of returns awaiting a patient buyer.
Additional disclosure: I have held positions in each of these stocks at some point since the time of the original article. I currently do not hold any positions in the mentioned stocks due to trading restrictions and not necessarily due to my opinion of the merits of a current investment.