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Smead Capital Management is a registered investment advisor headquartered in Seattle, WA; founded in 2007. The company was formed to allow investors to benefit from long-term ownership of common stocks meeting the firm’s eight proprietary investment criteria. The firm manages a US Large Cap... More
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  • Who Is Your Daddy And What Does He Do?

    In the 1990 movie Kindergarten Cop, Arnold Schwarzenegger portrayed a police officer who goes undercover as John Kimble, a kindergarten teacher in Astoria, OR. Early in the movie, Mr. Kimble tells his class they are going to play a game called "Who is your daddy and what does he do?" After a myriad of answers, one of the children asks him if his ensuing headache is a tumor. Kimble replies "It's not a tumor." We at Smead Capital Management believe this was not only one of the more comical moments of Kindergarten Cop, but also a great question to ponder in today's investment environment.

    Our firm has been trying to help the investment community understand a misperception that has come under our purview. Most people believe the risk of a stock comes from the market it trades in; most people call this market risk or beta. The problem is that stocks like Microsoft, GE and Boeing don't just trade on the US exchanges like the NYSE and the NASDAQ, but also EuroNext, the London Stock Exchange, the Hong Kong Exchange and Deutsche Bourse. Less important than where a business trades is where they take their company risk or put another way, their operating risk. This is where their cash flows come from. To us at Smead Capital Management, the value of a business is the present value of those future cash flows.

    To illuminate our point, during a recent trip to London we came across a feature article in the Financial Times titled "P&G gambles on A.G. delivering the goods." The article highlighted the return of A.G. Lafley to the helm of Proctor & Gamble. What caught our eye was the graphic to the left that was printed with the article. The numbers entailed in it get to the heart of our concern for quite a few US large cap companies that we believe will be problematic for index investors and can, in turn, create lots of alpha for stock pickers and asset allocators that take heed.

    The graphic shows seven large consumer staples companies that have worldwide brands and the percentage of revenues that come from the emerging markets. Colgate-Palmolive derives 50% of its revenues from the emerging markets, followed by Proctor & Gamble with 40% of its revenues coming from emerging markets. It is our opinion that the last 10 years were a fairly poor economic period in the history of the US. We believe that in order for companies to report robust growth, they had to seek out growth away from US shores. This greatly benefited these companies, in our opinion, but that is in the rear-view mirror.

    What we believe has been inherently lost on investors is that these are not what we would consider "US Equity Risk." Yes, they are US-Listed stocks, but more than half of their business risk is coming from abroad. It may be more appropriate to call companies like Colgate-Palmolive and Proctor & Gamble "Foreign Equity Risk" or "Emerging Market Equity Risk". No one in the US went without toilet paper, tooth brushes or ketchup in the last five years. What leverage do these businesses have in the comeback of the US economy?

    This missive is not to pick on these individual companies, but to show why this has become an index problem. Bespoke Investment Group presented the chart below on their blog on April 19, 2013. The chart shows the S&P 500 Sectors with one-year performance on the Y-Axis and the percentage of revenues in the US for those sectors on the X-axis. You can quickly see what our problem is today with certain sectors in the market.

    We believe the best investment opportunity in the world is domestically-oriented (US) companies. We want the leverage from US consumers and accelerating household formation. This will come from the largest age group in America, the 86 million people in the 18-37 age group. Consumer discretionary and financial stocks have a very high portion of their revenues in the United States. We see them benefitting greatly from the comeback in the US. Technology, materials, industrials and consumer staples have a higher percentage of their revenues coming from beyond our shores.

    We own companies like Nordstrom (JWN), Bank of America (BAC) and Gannett (GCI), whose revenues are heavily weighted to the US comeback. The most non-US equity risk we are taking is in companies like Merck (MRK), Pfizer (PFE) and Walgreens (WAG) due to their operations in Europe. We like this risk, because of the need for healthcare. More importantly, these companies have very little revenue in the emerging markets, especially compared to companies like Colgate-Palmolive, Proctor & Gamble or the Technology sector broadly-speaking. We believe investors should be asking "Who is your daddy and what does he do?" Where do your companies take their risk and where will their business expansion come from? We are making the case to advisors, family offices and institutions that these companies with low levels of operating risk in the US could be a "tumor" in their investment portfolios. We can almost hear these investors with their Austrian accent brimming with confidence saying, "It's not a tumor."

    The information contained in this missive represents SCM's opinions, and should not be construed as personalized or individualized investment advice. Past performance is no guarantee of future results. It should not be assumed that investing in any securities mentioned above will or will not be profitable. A list of all recommendations made by Smead Capital Management within the past twelve month period is available upon request.

    Disclosure: I am long JWN, BAC, GCI, MRK, PFE, WAG.

    Additional disclosure: I am long disclosed stocks through owenership of the Smead Value Fund

    Jun 11 2:38 PM | Link | Comment!
  • The Who: Talking About A Bargain In US Large Cap

    As we approach the end of 2012, those of us at Smead Capital Management are struck by how helpful the band, The Who, could be to those who are interested in relative performance. Their comments on demographics, psychology and relative value are as beneficial to the contrarian investor today as they were 40 years ago when their songs were first popularized.


    People try to put us d-down (Talkin' 'bout my generation)
    Just because we get around (Talkin' 'bout my generation)
    Things they do look awful c-c-cold (Talkin' 'bout my generation)
    I hope I die before I get old (Talkin' 'bout my generation)

    There are 85 million Americans in the echo-boomer category. Thanks to the temporary implosion of the housing market, deepest recession since the 1930's and very high unemployment levels, this is a group which has been historically slow to get married, have kids and buy houses. By being stuck in what some call "extended adolescence", these boomer kids have been easy to "put d-down". Hollywood understands what goes on in culture and has provided us with movies and television shows about twenty-something's living with friends or at home, engaging in sexual exploits and participating in bachelor and bachelorette parties, where they "get around". When it comes to being a positive force in our economy, things looked "awful c-cold" for this group and some have thought that the economy would "die before they get old".

    However, there is good news. The Wall Street Journal reported on November 6th, 2012 that household formation jumped in the year ended September 30th of 2012.

    Americans are setting up house at the fastest rate in more than six years, an indication that recession anxiety, which prompted adult children to move in with their parents and single people to postpone marriage, is starting to ease.

    The nation added 1.15 million households in the 12 months that ended in September, according to the most recent Census Bureau data. That is a significant rise from the past four years when an average of 650,000 households were formed annually. While what economists call "household formation" is running a little lower than the average 1.25 million added annually during the boom years, the latest data nevertheless represent an important shift.


    I'll tip my hat to the new constitution
    Take a bow for the new revolution
    Smile and grin at the change all around me
    Pick up my guitar and play
    Just like yesterday
    And I'll get on my knees and pray
    We don't get fooled again
    Don't get fooled again

    Very smart people have told us since the beginning of 2009 that everything has changed. They tell us that our economy won't make a "normal" comeback from the deep recession. They've sought to convince us that the only reason that the US equity market has rebounded is manipulation by the Fed. They "take a bow for the new revolution" in commodity markets and call it "a permanently higher plateau" in Malthusian dialect. They "smile and grin at the change all around me" and tell us that the only way to succeed is play the emerging market's production of new middle class people. THEY TRIED TO FOOL US! If you are under-invested in US large cap and US equity in general, we believe you have been "fooled" by those experts and have been paying a serious performance price for it. "DON'T GET FOOLED AGAIN".

    We have believed and invested under the premise that the anemic recovery has been a function of historically high commodity prices, depression-level housing starts and the slow employment transition to the "new revolution" where the virtual/online economy meet up with the "real" economy. We assumed that very low housing activity and auto buying would translate to outsized gains for those that sell everything else. We have been positive about the stock market, because it has a history of treating you well in the years following other deep recessions and massive liquidations like we saw from 2007-2009. Lastly, we believed that asset allocators have prolonged the anemic recovery by bidding up commodities for diversification purposes and economic experts have done a great job of scaring our largest population group (echo-boomers).

    Relative Value

    I'd gladly lose me to find you
    I'd gladly give up all I had
    To find you I'd suffer anything and be glad

    I'd pay any price just to get you
    I'd work all my life and I will
    To win you I'd stand naked, stoned and stabbed

    I'd call that a bargain
    The best I ever had
    The best I ever had

    What did you need to do four years ago and what do we believe you need to do now? Four years ago you needed to bet that we would survive and rebound. Now you need to "gladly lose" your ownership of the popular investments of the last ten years (gold, oil, commodities, emerging markets). We think you should "gladly give up all you had" in short duration investments designed to protect yourself from the next Armageddon. You need to not "pay any price just to get" commodities and you need to embrace an optimistic future based on the idea that this population group will get married, have kids and buy houses! Here is how the Wall Street Journal writer, Robbie Whelan, explained the future:

    Rising household formation, which is tied to employment growth, means more students are finding jobs when they leave college, more adult children are leaving their parents' homes and more couples feel confident enough about the future to tie the knot. It could also mean that immigration is picking up.

    "During the recession, a lot of those major life events like marriage, children and migration were put on hold," said Kenneth Johnson, a senior demographer at the University of New Hampshire's Carsey Institute. "It may be that there are couples who are thinking about living together, and they're thinking, 'The jobs picture is getting better. It's time to make the next step.' "

    We believe "to win" you need to risk "standing naked" and having "stones" thrown at you. In our view, you need to believe that long duration common stock investing, while lonely, is best practiced right after major economic cleansings. You need to look at last week's American Association of Individual Investor poll (, where nearly 49% of individuals were bearish as compared to less than 29% bullish on stocks. You do this when all the negative economic expert nabobs attempt to cause this to "be a bargain" which on a relative basis could be "the best I've ever had"!

    The information contained in this missive represents SCM's opinions, and should not be construed as personalized or individualized investment advice. Past performance is no guarantee of future results. It should not be assumed that investing in any securities mentioned above will or will not be profitable. A list of all recommendations made by Smead Capital Management within the past twelve month period is available upon request.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

    Nov 22 9:12 PM | Link | Comment!
  • Math, History And Psychology

    In my 32 years in the investment business, success in common stock investing seems to come down to math, history and psychology. At Smead Capital Management (SCM), we have built our investment discipline and our eight proprietary criteria around these academic subjects. With the stock markets gyrating wildly the last few weeks, we thought it would be helpful to see where we are today in each of these disciplines. We will start with our view on the math section.


    We believe the math of common stock investing is pretty simple. Without leverage, you can only lose your original investment. Your gains can be unlimited over the longest term (long duration). Most of the benefit (90%) of diversification is reached by owning a twelve-to-eighteen stock portfolio. Valuation matters dearly to portfolio results. Stocks purchased at depressed prices (as a group) outperform those which are more expensive over both shorter (1 year) and longer-run time periods.

    Turnover creates expense and is the enemy of performance. Long-term common stock performance fits on a bell curve. In a portfolio of well-selected common stocks, most of the long-term gains are going to come from 20% of the portfolio. This is only true if the most successful shares are held to a fault. Every stock which goes up ten-fold, must have first doubled, tripled and quadrupled. The only good reason to sell shares in a successful common stock of high quality is if it gets what we call "maniacal" pricing or if it no longer meets our eight proprietary criteria. Maniacal pricing to us means a PE ratio more than two times the average of the prior ten years.

    One hundred percent of the stocks that go to zero fell by 20%, 40% and 60% before ultimately losing 100% of their value. Poor stock price performance among our portfolio holdings requires us to refocus on the fundamentals to preserve capital. Other than maniacal pricing, worrying about price performance of fundamentally strong businesses is damaging to performance and success.

    Our observation over 32 years is that no one can consistently predict either the stock market or the US economy. Therefore, breaking any of the mathematical disciplines mentioned above, based on stock market or economic predictions, has the potential to ruin the benefit of common stock investing. Paying someone to make directional stock market or economic predictions automatically reduces portfolio results by its cost. Stocks, as measured by Ibbotson and Associates, have outperformed the other major liquid asset classes over long stretches of time (30-50 years). However, to get this added return you must accept some extreme variability of returns.

    In the view of SCM, most of the best mathematicians in the investment business spend their time trying to predict the direction of the stock market or the size of the GDP of the US economy. This over-crowded playing field should function like all other crowded playing fields have over the last 32 years. Use of macroeconomic forecasting should make for very low returns in the stock market and in asset allocation because too many people are "trying to squeeze blood out of a turnip". We believe individual security analyses is as unpopular as it just about ever gets and will have a much easier time than it normally would in providing additional return for those who use math to practice it.


    Next we will focus on history and the importance of that academic discipline to us as common stock portfolio managers here at Smead Capital Management (SCM).

    Edmund Burke said, "Those who don't know history are doomed to repeat it." We at SCM like to think in terms of taking advantage of what we know about history to make money owning good quality common stocks. Mark Twain said, "History doesn't repeat itself, but it does rhyme!" We believe these are the most important statements on how history should affect portfolio management decisions. In our opinion, you must know the history of the markets and you must trust the "rhymes" to be effective and successful.

    We will use some historical examples to back up Burke and Twain's argument. History shows that there have been regular bouts of financial euphoria. In his book, "A Short History of Financial Euphoria", John Kenneth Galbraith used the Tulip Mania of the 17th century and the "South Sea Bubble" of the 18th century to help people understand how dangerous excessive optimism is in business. The aftermath of these speculative episodes was drastic and debilitating losses. Here is how Galbraith described the lead up into the height of the euphoria:

    "The price of the object of speculation goes up. Securities, land, objects d'art, and other property, when bought today are worth more tomorrow. This increase and the prospect attract new buyers; the new buyers assure a further increase. Yet more are attracted; yet buy; the increase continues. The speculation building on itself provides its own momentum.

    This process, once it is recognized, is clearly evident, and especially so after the fact. So also, if more subjectively, are the basic attitudes of the participants. These take two forms. There are those who are persuaded that some new price-enhancing circumstance is in control, and they expect the market to stay up and go up, perhaps indefinitely. It is adjusting to a new situation, a new world of greatly, even infinitely increasing returns and resulting values. Then there are those, superficially more astute and generally fewer in number, who perceive or believe themselves to perceive the speculative mood of the moment. They are in to ride the upward wave; their particular genius, they are convinced, will allow them to get out before the speculation runs its course. They will get the maximum reward from the increase as it continues; they will be out before the eventual fall."

    History shows that these speculative episodes will happen and those who know history are to avoid participation in these episodes. It was tulips in the Netherlands, common stock in the South Seas, Western Railroads in the 1860's and 1870's, technology like cars, planes and radios in the 1920's, the internet in the late 1990's and residential real estate in 2005. We believe you must understand and know the history of these events and avoid participation in them once they get speculative!

    Folks have wondered why we believe that China's economy and their miraculous last thirty years of economic growth aren't sustainable. The answer is simple. CHINA HAS ALREADY QUALIFIED AS THE BENEFICIARY OF A SPECULATIVE EPISODE. THIS KIND OF UNINTERRUPTED ECONOMIC SUCCESS HAS ALWAYS ENDED BADLY IN ALL RECORDED ECONOMIC HISTORY! China has not had an economic contraction in thirty years. As Galbraith pointed out, China is in a new world of greatly, even infinitely increasing returns and resulting values. In China, it's all about GDP growth, because their internal stock market broke down four years ago and even that has not stopped the euphoria associated with China's future. The speculative episode just moved to houses from stocks in China.

    The most successful economy of all time, the US economy, grew 9% compounded from 1800 to 1900. However, there were 18 recessions, 3 depressions and 3 all-out panics. The economy was cleansed of its sins by regular economic contractions. As Warren Buffett says, "Only when the tide goes out do you discover who is swimming naked." In China, the tide has never been allowed to go out. Bad loans, fraud and poor investments have never been exposed and the masses have not been forced to learn and improve their economic behavior.

    This is why Twain's quote about history rhyming is so important. Every time that one of these episodes comes along, investors and professional portfolio managers focus on the difference in the current episode to the past ones. History repeats itself, but not identically! Therefore, the temptation is to focus on the difference and repeat the mistakes. This is true at both positive and negative extremes. A few examples might be helpful.

    We were in a deep recession with as high as 10.8% unemployment in 1981-82. Incredibly high interest rates crippled the economy and smokestack America. Budget deficits were high and the US national debt grew immensely. Stocks were out of favor and 1981-82 was a great time to buy many good quality common stocks.

    Along came the meltdown of 2007-2009, with a deep recession which included 10% unemployment. Very few professional investors were buyers or holders of good quality common stocks back in late 2008 or early 2009. The 2009 market bottom was triggered by too much debt and the massive deleveraging which has occurred since then. Everyone told us not to buy because, "It's different this time." In 1981-82 it was the price of money which crippled the economy and in 2009 it was the huge principle balances which crippled it.

    Fortunately for us and unfortunately for those who couldn't sense the rhyme, 2009 was a great time to buy good quality US common stocks. Those who focused on the differences and ignored the rhyme missed the entire comeback the stock market has made since March of 2009. It grieves us to see the massive amount of capital which resides in doomsday-oriented mutual funds and ETFs, whose path to success would be our country's failure to make a full comeback in this deleveraging process. So far, the optimists have outperformed and the 1982 playbook proved to be effective.

    We believe the latest history to trust is the rhyme between the US economy and stock market in 1952 and today. In both cases, the US economy had high unemployment, huge government debt, massive recent stimulus, the Federal Reserve Board capping long-term interest rates, historically high profits as a percentage of GDP and what we believe are cheap large-cap stocks. Back then we funded the Marshall Plan to help Europe and Japan, as well as the GI Bill. Today, it is enormous unemployment compensation and deficit spending. Despite all those headwinds and a reversion to the mean in corporate profits as a percentage of GDP, the Dow Jones Industrial Average rose from 260 in 1952 to near 1000 in 1966. Those who ignored the headwinds created wealth and those who sat on the sidelines or hoped to make money from the misery of others ended up poorer. Will those circumstances play out differently this time? Or will this situation rhyme with 1952? At SCM, we are paid to trust the rhymes!

    Here is how Galbraith concluded his thesis on the history of euphoria:

    "At the risk of repetition-restatement of what one hopes is now evident-let the lessons be summarized. The circumstances that induce the recurrent lapses into financial dementia have not changed in any truly operative fashion since the Tulip Mania of 1636-37. Individuals and institutions are captured by the wondrous satisfaction from accruing wealth. The associated illusion of insight is protected, in turn by the oft-noted public impression that intelligence, one's own and that of others, marches in close step with the possession of money. Out of that belief, thus instilled, then comes action-the bidding up of values, whether in land, securities, or, as recently, art. The upward movement confirms the commitment to personal and group wisdom. And so on to the moment of mass disillusion and the crash. This last, it will now be sufficiently evident, never comes gently. It is always accompanied by a desperate and largely unsuccessful effort to get out."


    Over the years, we have heard Charlie Munger state that Psychology is the most underrated and underutilized of the major academic disciplines in business and investing. Andy Grove backed this up in a Fortune magazine interview by telling about the best business advice he had ever received. His City College of New York professor told him, "When everybody knows that something is so, it means nobody knows nothin'." At Smead Capital Management (SCM), we like to say that successful investing is the defeat of human nature. We will dig into the academic discipline of psychology and speak to using it to invest successfully.

    Why is psychology an underrated and under-utilized discipline in business? We believe there are four reasons. First, it is counter-intuitive. Psychology requires you to toss out logic and rationality. When there are either seemingly unsolvable economic or business problems, psychology demands at the extreme that you bet against the obvious. When a never ending stream of good news causes logical and rational experts to predict more of the same, you must "circle the wagons" (John Kenneth Galbraith-A Short History of Financial Euphoria). Currently, the US stock market suffers from what Randall Forsyth at Barron's calls "rational despair". It is an unhealthy pessimism in the same way that 'irrational exuberance" was a destructive optimism. These are psychological phenomena.

    Second, psychology never got the best scholars or professors. In the late 1970's, psychology was considered an easy class and a default major for those on rehab from economics or math or history or chemistry. Psychology has been considered somewhat of a "voodoo" discipline. It helps us explain things, but can it really solve anyone's problems. Psychology is the unwanted step-child of higher academics.

    Third, psychology kills the ability of intelligence to equate to successful investing. A PhD in Economics or Math and a librarian are likely to know math and history better than anyone you know. However, the math you need to be a successful investor is learned by the end of the seventh grade, in our opinion. If you are comfortable doing percentages and have the ability to understand crowd psychology, you can be a wealth creator in the US stock market. Over-educated people have a tendency to over think situations. Ben Graham said that as soon as the complex math gets thrown into the situation, you know that trouble is brewing. Here is how he said it in 1958:

    "Mathematics is ordinarily considered as producing precise, dependable results. But in the stock market, the more elaborate and obtuse the mathematics, the more uncertain and speculative the conclusions we draw there from. Whenever calculus is brought in, or higher algebra, you can take it as a warning signal that the operator is trying to substitute theory for experience."

    Just ask the folks at Long-Term Capital Management or analyze the investment returns of all the money being run today based on macroeconomic/mathematical genius in mutual funds, ETFs and hedge funds. Is the average institutional investor getting what they are paying for? Is there any chance the category is going to do well when it reaches down into the retail investment world? It is one of the psychological signs that we look for.

    Lastly, psychology is hard to measure. At SCM, we look at sentiment polls, insider buying, media coverage, asset allocation, anecdotal evidence and just about anything else which confirms that the crowd has moved to one side of a market. Reading the psychology is mostly learned by participating in the markets and through years of experience. The primary benefit of experience is having been in similar situations before. Professional golfers talk about dealing with the psychology of being the leader on Sunday in a pro golf tourney. Professional investors measure psychology in the same way. It is a gut feel and a learned discipline.

    Andy Grove's thought points out that psychology in business is most valuable at extremes. At SCM, we operate under the assumption that if 80% of the participants in a market are bullish or bearish, the exact opposite of their opinion is the right bet. A few examples would be helpful. Everyone knew by 1999 that the internet was "going to change our life" and that you must own companies which would benefit from that huge secular trend. They couldn't have been more wrong. The sentiment polls showed historically high levels of bullishness among individual and institutional investors. A Paine Webber/Gallup poll of their clients with less than five years experience showed that they expected 22.6% compounded returns over the next ten years. They got two 40% bear market declines and a lost decade in the stock market.

    A Bespoke website poll at the bottom of the stock market on March 9th of 2009 showed that 89% of those polled felt that the US stock market was headed lower and 59% felt that it would bottom at or below 5000 on the Dow. It was trading at 6480 at the time. One year ago, the Barron's "Big Money Poll" showed that 73% of those polled were bearish on US Treasury Bonds and only 5% were bullish. The tiny minority was the big winner over one year. At the risk of being repetitive, psychology is very useful at extremes.

    This same psychology is useful in the shares of individual common stocks. We have a rule at SCM. Whatever we own that gets questioned, objected to or made fun of by those we come in contact with, is likely to outperform in the following three years. In 2008, we got a regular diet of criticism for owning Starbucks (SBUX). Every day, someone would call us and say, "Nobody is going to want to pay $4 for a cup of coffee" or "those guys will never get their mojo back".

    We've received the most questions recently on Bank of America (BAC) and Gannett (GCI). Quite a contrast, since Warren Buffett seems to be buying up every community newspaper in the country and pumped $5 billion into Bank of America preferred stock with warrants to buy the common attached. We have been questioned for avoiding energy, basic material and heavy industrial shares in light of the secular crowd belief in the "global synchronized trade". China's secular trend smells, feels and acts like the internet bubble to us, so we have to sit it out.

    In summary, we at SCM believe that the academic disciplines of Math, History and Psychology are important to undergirding the investment discipline of those who seek to create wealth in common stock investing. All three in concert is our preference and don't forget to pay psychology its proper respect.

    The information contained in this missive represents SCM's opinions, and should not be construed as personalized or individualized investment advice. Past performance is no guarantee of future results. All of the securities identified and described in this missive are a sample of issuers being currently recommended for suitable clients as of the date stated in this missive and do not represent all of the securities purchased or recommended for our clients. It should not be assumed that investing in these securities was or will be profitable. A list of all recommendations made by Smead Capital Management within the past twelve month period is available upon request.

    Disclosure: I am long SBUX, BAC, GCI.

    Jul 20 1:22 PM | Link | Comment!
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