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Owen Bernard
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  • Observational Notes On Knowles Corp.

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    By Owen I.L. Bernard II
    Edited by Alexander H. Yazdani
    Description

    Knowles Corp. is a market leader with a degrading market share. Knowles Corp represents a lucrative holding to date; market price ~ $19. There is a growth story within the micro electro-mechanical systems tech space especially this global market leader in micro acoustics with 60% of the market share. The market is uncertain of whether this type of growth story is one shared by the historical competitive performance of the automobile and airline industry, creative destruction. With significant market share, the company generates stable operating cash flow and produced strong growth in terms of unit volume and top-line revenue among their operating segments. The company has high returns on capital, which not reflected in most institutional screens due to conservative GAAP SG&A reporting by the company; marginal returns on capital are similarly as high against the company's reinvested earnings. Valuation in terms of discounted cash flow, the company is trading at 40%-50% of its worth. A conservative 12x multiple on unlevered 2015 eps, I estimate a worth of at least $40. Given the valuation guidance, the market price should double over the next two years as shipment issues are resolved and market share normalizes.

    The market is overvaluing the risk of new entrants potentially resulting in lost market share decreasing KN's hold from 80% in 2009 to currently 60% due to temporary shipment issues to a top-tier client. This along with the "risk-on" perspective by market participants and the fear of a macro bubble touted by pundits.

    Tags: KN, AACAY
    Mar 13 1:53 AM | Link | Comment!
  • Book Review: You're Welcome Planet Earth: The Most Powerful Trading System Ever Publicly Revealed

    How would another life form view our financial market system? In his book, "You're Welcome Planet Earth: The Most Powerful Trading System Ever Publicly Revealed," author Harry Long puts you front seat of his intergalactic space travel in order to answer this question. He peers inside the mind of this rational Spoc-like unearthly being and debunks the mystery of contextual thinking in the investment space.

    I found myself wildly impressed with the book and the strategy laid out. If anyone has read Edward O. Thorpe's "Beat the Market: A Scientific Stock Market System" you immediately see similarities between the strategies. The strategy is not as obvious as you might think until you sit down and dig into this book. Harry was kind enough to have a conversation and discuss his recent book.

    A Conversation with the Harry Long, author of You're Welcome Planet Earth: The Most Powerful Trading System Ever Publicly Revealed

    O.B.: What got you started?

    H.L.: As a teenager in 1998, my father allowed me to make trades in his brokerage account. In effect, the deal was that he was loaning me money at an exorbitant interest rate, so if I lost money, or didn't make steady profits, I would have to repay him a large sum (for a teenager!). He effectively let me learn by telling his broker in advance to accept my orders and in essence extended me margin, rather than equity seed capital.

    Dad was actually quite shrewd. I think he expected that I would lose it all and have to get a serious summer job. It ended up being a great learning experience and a very funny story to tell at parties. I ended up doing so well, that when I sold the positions and had quite a princely profit after repaying him with interest, he ended up telling me, "You can't have the money, that is waaay too much for a teenager to have!" And I wasn't upset at all, because that was his way of telling me that he was incredibly proud and that I had succeeded beyond his wildest expectations.

    And my father was right, too. I love that story. And I never did get a Summer job in 1998.

    O.B.: What is the story behind the title?

    H.L.: The joke behind the title is that I really wrote the book from the perspective of an advanced life form from another planet who created a cool systematic trading strategy and is sharing it with some lucky human. It's really tongue in cheek, but I will be highly disappointed if readers don't conclude that it's the simplest and best strategy ever shared in the public domain. As you can see, the alien does not suffer from humility.

    O.B.: Who are some investors who have directly and indirectly influenced you?

    H.L.: Paul Tudor Jones was incredibly generous with his insights when I was just starting out in the business, as was Edwin Schloss. They have two totally different perspectives on markets, but they were both very kind to a young kid who was long theory and short experience. I think that long/short mix is the starting point for most young investors' mental portfolios.

    O.B.: In terms of portfolio allocation, how have you looked at this question in terms of the Kelly Capital Growth Criterion?

    H.L.: I appreciate the theoretical elegance of the Kelly Criterion, but make no mistake, at my age if I have a drawdown on greater than 10%, I am taking massive corrective action. Heck, if I drawdown 7%, I had better move my feet. I do not subscribe to the pain theory of investing. The notion that one has to bear massive amounts of pain to enjoy a decent return is stupid, lazy, unethical, wrong-headed, statistically incorrect, and insipid. Did I mention that my life goal was to enter diplomatic corps?

    O.B.: Tell me about Contrarian Industries, LLC.

    H.L.: Our main business is managing proprietary capital, but private equity firms increasingly approach us to use our technology to find companies to acquire. Increasingly, they approach us to establish liquid trading operations. I think it has evolved that way, because most hedge funds already have a research department and traders think of our technology as a threat to their jobs.

    Private equity firms that wish to establish trading operations, in contrast, want to leverage technology to avoid hiring an army of new people and the associated expenses. And it goes without saying that they have no pre-existing traders who feel that our technology is a threat to their jobs, so systematic methods are much easier for them to accept culturally. With each new insider trading debacle, they are increasingly attracted to systematic methods which avoid the incentives discretionary traders have to break laws in search of profit.

    And they also realize that systematic investment strategies allow them to establish a trading operation which has very low fixed costs in relation to those of running discretionary trading desks. They love to have multiple systems which give them even greater diversification than teams of traders, but without the emotional, financial, and legal risks of having to hire and fire real living, breathing humans. If a system isn't working as expected, one simply turns it off and shuts it down. Humans who lose money, by contrast, often use emotional manipulation to over-ride well established risk management protocols.

    O.B.: What books do you recommend?

    H.L.: When Things Start to Think by Neil Gershenfeld is excellent.

    O.B.: Do you hold any opinions/concerns of the U.S. markets?

    H.L.: I try not to hold any opinions about macro market direction, since we are fully systematic, but I do hold significant concerns periodically about market structures, regulatory regimes, and public policy. The financial survival of the United States should be firmly based upon reigning in the excesses of fractional reserve banking and upon strengthening laws requiring derivatives of all kinds to be traded and centrally cleared on bone fide futures exchanges.

    O.B: In regard to your strategy, how much importance does the no-arbitrage principle have in approach?

    H.L.: I think Economic "Laws" should best be termed Economic "tendencies". The No-Arbitrage Principle, and its closely related cousin, the Law of One Price, are strong tendencies in markets. Going back to market structure, deviations from these Economic tendencies (inefficiencies) have a strength and duration directly related to the market structures which cause those deviations.

    So when one finds a massive inefficiency, which my book empirically proves that we have, the massive inefficiency's size and persistence is directly related to the size and persistence of the market "mis"-structure which causes it.

    O.B.: Thank you Harry for your time.

    Tags: ETF Analysis
    Aug 04 1:47 PM | Link | Comment!
  • Always Yield To Individual Opportunities

    In Howard Marks most recent Chairman memo, he remarks intensively about his disdain for investment generalizations. He certainly is not wrong in his thinking because some of the biggest hazards (e.g. Long-Term Capital Management and the usual concepts behind most quant funds) come from generalizations.

    There's little I hate more than investment generaliztions. For years, for example, self-styled authorities on the high yield bond market would say "bond defaults typically tae place 2-3 years after issuance." That always set my teeth on edge.

    As he explains his viewpoints, the equity risk premium, brought up by FierceFinance that sparked the memo, gets the full brunt of what he believes is wrong with how the equity risk premium is used. It may seem petty to harp on the article's present-tense use of the term, as written in the corresponding online article in Pensions & Investments:

    The long-term equity risk premium is typically between 4.5% and 5%.

    How does one sentence gain such attention to spark a nine page assault?

    The memo is a great read to gain better perspective in thinking about markets going forward. He brings a far more appropriate line of thinking in assessing markets by using earnings yield or the inverse property of the infamous price to earnings ratio, P/E.

    I have tried to use it in a similar fashion when assessing Lender Process Services Inc., LPS, when it seemed to be destined for failure and written off by most. Howard Mark's memo has been a good reminder of what perspectives to hold when valuations, broadly speaking, gradually become richer with the passage of time.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

    Mar 23 9:47 PM | Link | Comment!
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