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I am a private investor building a value focused portfolio. While I do not work directly in investing, I do have a financial background and hold the CFA designation. The goal of Margin of Safety Investing is to share my investing journey as I review and analyze investing opportunities using a... More
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  • Weekend reading with James Montier: margin of safety as central concept in investing.

    I recently came across an older publication from James Montier: An admission of Ignorance and found it very interesting and instructive.

     

    Throughout the article, Montier makes four key points:

     

    ·         “While ignorance is not bliss, it is a fact of life”, challenging the dominant model in the financial industry that everything can be known and forecasted out. I guess recent market conditions exemplify once more that this is clearly not the case. 

     

    ·         Since, in investing as well as in life in general, we can’t know or control everything, it makes sense to not try and forecast and us a margin of safety: “the margin of safety becomes central as a buffer against ignorance / error”

     

    ·         As a result value investing which implicitly (or sometime explicitly as on this blog) contains a margin of safety should over-perform…which it does handsomely, as you can see on the table in p4 of Montier’s article

     

    ·         Finally, if we accept our ignorance, then we must also recognize that market timing is essentially vain (which does not mean investors should always been fully invested).  As Montier says, it is probably to “build positions slowly over time […] each teim Mr. Market is kind enough to generate bargains I would deploy capital into them.

     

    All these points resonate very strongly and I hope I am able to integrate them properly in my value investing journey on Margin of Safety Investing.

     

    In the coming weeks I will be sharing more Montier’s article as he is one of my favority value investing writer – check back on the site!

     

    Many happy returns,
    Ben



    Disclosure: No positions
    Oct 23 1:29 PM | Link | Comment!
  • Raytheon (RTN) Review: I find GD more attractive

    Raytheon is one of the major US defense contractors (along with GD, NOC, LMT and BA) to the US government (85% of sales).  The company is in the idea pipeline as one of my legacy investments.

    Please refer to the Quick review explained post if you have questions on what I look for in this analysis.

     

    1- Business Performance Risk (=/-) and Intrinsic Returns (=)

    Metric

    Status

    FCF / Sales

    Last twelve months: 8.7%, in line with historical ranges between 3.5% (even negative in 2001) to 11.7%

    ROE

    LTM: 17%; RTN’s ROE was between 15% and 21% over the last 4 years, however in previous year it has been in the single digit, even negative a couple of years!

    ROA

    LTM: 7% - similar to ROE, ROA has been better over the last 4 years between 7% and 11% but was in the single digit and even negative before.

    Revenue Growth

    The long term growth trend of RTN has been between 2 and 4% with ups and down between +11% to -8% in 2006.  On a LTM basis the company has been slightly declining

    Cash distribution to shareholders

    RTN pays a 2.9% dividend yield on a payout of 30-35%

    The company is also buying back shares and has retired ~15% of its stock over the last 5 years.

    Overall RTN’s business performance has been ok over the last few years, albeit with a low growth and ROA. Compared to General Dynamics however, it seems that the company is more exposed to cyclicality and has lower returns and free cash flow generation.

    On the intrinsic returns front, the company is paying a 2.9% yield on 30% of earnings, could grow at 4-5% (re-using 30% of its earnings at a ROE of 15%) and using the remaining 40% of earnings to improve its cash position or buy back shares (3.5% at the current earnings yield of 9.3%).  This would lead to a 10-11% return, all in.

     

    2- Balance Sheet Risk (+)

    Metric

    Status

    LT Debt / Equity

    LTM: 0.24x

    Current Ratio

    1.36x, in line with past levels

    RTN’s balance sheet risk appears limited with a current ratio in line with past levels and industry norms.  The debt ratio is also conservative, especially taking into account the large portion of intangibles on the B/S.

     

    3- Valuation Risk (+)

    Metric

    Status

    Cash Return

    12.3%

    P/E

    10.7x

    RTN’s current valuation appears conservative, with a high cash return and a lower than industry and S&P 500’s P/E.  These compare to GD’s 9.4% cash yield and 10.1x P/E

     

    Conclusion

    RTN’s business seems to suffer from cyclicality more than GD which has generated more consistent returns and growth for its shareholders. In this context I would need a more attractive valuation for RTN to maybe invest vs. GD to provide for an additional margin of safety as I see RTN as lower quality. I will pass on RTN for now and swap the position for GD stock (while waiting to find time to do a GD Company analysis).  I will revisit in a year to evaluate how its returns and growth are doing.

     

    You can find other similar "Quick Reviews" as well as more in-depth "Company Analysis" on my blog, Margin of Safety Investing

    Many happy returns,

    Ben



    Disclosure: Long GD, sold RTN
    Tags: RTN, GD
    Oct 14 4:46 PM | Link | Comment!
  • General Dynamics (GD) quick review: Strong investment candidate

    General Dynamics currently trades at $61.3 and was added to my idea pipeline as it is a legacy stock which I currently own.

     

    1- Business Performance (+) and intrinsic returns (+)

    Metric

    Status

    FCF / Sales

    Last twelve month (NYSE:LTM): 7.7%, in line with GD’s historical performance between 6% and 9%

    ROE

    LTM: 20%, consistent with the company’s historical performance and average of 20.6 over the last 5 years

    ROA

    LTM: 8.1%, again in line with GD’s 5 and 10-year averages

    Revenue Growth

    The company has been slowing down a bit, with growth of ~7% to 9% in recent years vs. historical year over year growth rates of 13%+

    Cash distribution to shareholders

    GD’s dividend yield of 2.6% is in line with that of the S&P500, on a payout of about 25%.

    GD is an “irregular” buyer of shares, buying 5% of its shares back over the last 5 years with some years of net increases and large buybacks in 2008 (a smart move!).

    GD is a strong business with recent performance very much in line with historical averages. The company generates a reasonable amount of cash vs. its sales and has high ROE/ROA’s. The only ‘concern’ would be a slowing down of growth.

    In terms of returns, with a yield of 2.5% on a 25% payout ratio, the company could finance a 7-8% growth by using 40% of its earnings (@20% ROE) and use the remainder, 35% to buy back 3.5% of its shares based on the current earnings yield of 10.2%. This would give us an intrinsic return of up to 13% depending on GD’s ability to grow.

     

    2- Balance Sheet Risk (+)

    Metric

    Status

    LT Debt / Equity

    Currently at 0.25x and has been decreasing regularly from 0.6x in 2003

    Current Ratio

    1.3x in line with historical ranges between 1.1x and 1.3x

    Very limited debt and reasonable current ratio given pre-ordered nature of the business.  The Balance Sheet risk appears limited.

     

    3- Valuation Risk (+)

    Metric

    Status

    Cash Return

    9.6%

    P/E

    9.8x, below the S&P and the company’s 5 year average of 14x+

    GD’s valuation appears low both on a cash return, with the company being valued including debt at less than 10x FCF, and on a P/E basis.

     

    Conclusion

    GD appears to be a robust and stable business with little balance sheet risk and a relatively low valuation which may provide a good margin of safety to a new or existing investor. I will perform a Company analysis of GD.



    Disclosure: Long GD
    Tags: GD
    Sep 29 9:41 PM | Link | Comment!
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