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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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  • The Internet Is Brutally Efficient And Totally Agnostic

    On my way home from work recently my progress was impinged by a group of protesters headed up 4th Avenue in downtown Seattle to the headquarters of the Gates Foundation. Bill and Melinda Gates are spending millions trying to figure out how to make the U.S. education system more efficient and successful. Some of their recommendations are thought to damage efforts by the most powerful teachers' unions to protect the interests of teachers. The Gates Foundation wants to bring efficiency and seems to understand that they need to be agnostic in their approach.

    At Smead Capital Management, we believe investors in common stocks are like this group of teachers protesting the Gates Foundation. Just as some teachers balk at the Gates Foundation's recommendations, many investors balk at the brutally efficient and agnostic approach the Internet fosters in everything from retailing, technology, communication and labor. We contend that investors' should remove their emotion when thinking of the Internet.

    The Internet allows for new and great inventions every year that drive down prices for consumers. In effect, it is massively deflationary. The trick for business owners is being in toll-bridge businesses which require low levels of ongoing innovation, but can defend or (to our glee) raise their prices. Therefore, these toll-bridge business owners don't need to march on the Gates Foundation headquarters.

    Amazon (NASDAQ:AMZN), eBay (NASDAQ:EBAY) and others have brought efficiency to online commerce and a great deal of competition to brick and mortar retailing. As the 86 million echo-boomers age during the next 15 years, we see them driving online commerce to 15 percent of total commerce, up from the current 6.2 percent level. PayPal appears to be a big winner in an environment where secure, online payments could flourish. It will become more and more important for retailers to compete against online commerce by being effective online themselves and by providing significant value to what we call an addicted-customer base. We own eBay , Nordstrom (NYSE:JWN) and Cabela's (NYSE:CAB) under this premise. If you don't have a cult of fans, you don't have a toll bridge. Competing on price alone could kill many retail businesses-just ask former employees of companies like Sears and K-Mart.

    The pass-through nature of the Internet is putting a great deal of pressure on designers and manufacturers of technological equipment. The commoditization of personal computers, cell phones and tablet devices appears to us to be another "Battle Royal." For those who weren't addicted to local professional wrestling, a "Battle Royal" was a situation where 12 wrestlers were put into the ring and threw each other over the ropes until one was left standing. Only the winner made money. It was quite entertaining for the fans, but a terrible business model for wrestlers. From our vantage point, technology manufacturing, automobile manufacturing and oil/gas production appear to be in a similar battle-royal situation. To avoid them, we prefer to own a company like Accenture (NYSE:ACN), which is technology agnostic and is not threatened by the Internet. Accenture helps bring the brutal efficiency of the Internet to the largest organizations in the world to give them better systems and processes.

    We compare the Internet's efficiency to playing golf on a very good, but difficult course. When you play a tough course, the flaws in your golf game get exposed. Everyone is aware that the Internet is very democratic and well-written thoughts generally travel fast and gain great traction. The negative side of this is that massive amounts of relatively unworthy writing and business promotion can easily dilute the attention of readers. It seems then that content is king. To that end, we own Comcast (NASDAQ:CMCSK), Disney (NYSE:DIS) and Gannett (NYSE:GCI) because they have proven they can provide well-written and well-created content. Any company that can gain multimillion person audiences with their content can be a toll bridge to advertisers in the agnostic environment.

    Lastly, the Internet presents its brutal efficiency and agnosticism in the U.S. labor market. If I were a young man or woman, I would ask the following question: is the brutal efficiency of the Internet going to be my friend or my enemy? Can I compete better by fighting in the very competitive labor battle by being a participant in unleashing the Internet, along with millions of other super-smart software engineers? Or would I be better off to get out of the way of the Internet, learn trades and form businesses which meet economic needs on the ground. People need to eat, be clothed, be sheltered and have the physical aspects of their life be regularly maintained. We own NVR (NYSE:NVR) in the home-building space, Pfizer (NYSE:PFE) in the pharmaceutical industry and JP Morgan (NYSE:JPM) in banking. These are examples of businesses which are primarily helped by the brutal efficiency of the Internet and employ laborers who are not threatened by a "Battle Royal."

    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. Bill Smead, CIO and CEO, wrote this article. 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: The author is long EBAY, JWN, CAB, ACN, DIS, GCI, CMCSK, NVR, JPM, PFE. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.

    Jul 11 1:49 AM | Link | Comment!
  • 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 (NYSE:JWN), Bank of America (NYSE:BAC) and Gannett (NYSE:GCI), whose revenues are heavily weighted to the US comeback. The most non-US equity risk we are taking is in companies like Merck (NYSE:MRK), Pfizer (NYSE:PFE) and Walgreens (NYSE: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.

    Demographics

    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.

    Psychology

    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 (aaii.com), 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!
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