William Smead's  Instablog

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Dear Fellow Investors:

I've seen West Virginia's Men's Basketball team play four times in the last two weeks. The first time was live at the Big East Tournament and the last three in the NCAA Tourney on TV. Close observance of them has helped us at Smead Capital Management to be even more excited about our investment discipline.

West Virginia has quality players. These players are molded into a team by a hard driving coach, Bob Huggins. But what got them to the final four is that they run their offense. They not only run it, but they actually set the screens that are required. I have been a rabid basketball fan for over forty years and can't remember better picks being set. They are wearing out the other teams physically and getting much easier shots in the process.

To us at SCM, this speaks to the fundamentals of successful investing. Buy quality common stocks and do it inside your circle of competency. Let the businesses operate for years, executing the kind of business plans which can be built on for decades. Do it in businesses which sell products and services again and again and again.

Setting a good screen is 90 per cent effort and 10 per cent talent. Finding a coach and players willing to do it is unusual, but could be done by anyone truly committed.

Think of companies we own like Starbucks, Disney, McDonalds and Walgreens. They provide products and services in the same clean and consistent way all over the US and around the world. They wear out the competition through branding, balance sheet strength and scale in the same way the Mountaineers have done through well-placed screens and consistent defense in this tournament. We at SCM like those kind of fundamentals on our side.

Best Wishes,

William Smead

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. Some 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 with in the past twelve month period is available upon request.

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Dear Fellow Investors:

"Hoarders" is a popular TV show currently. It tells the story of people who buy and collect things and virtually never throw anything away. As we look out to the rest of 2010, some of the lessons from the show could help us as investors over the coming years.

Like most addictions or idolatrous behaviors in a person's life, hoarding starts out with the best of intentioned purchases. None of the original items, be they knick knacks, clothing or even collectibles are in and of themselves harmful. Unfortunately, hoarders don't stop there. They continue to buy new things and never throw anything out.

In the US investment markets there has been some major hoarding going on the last five years. First, between 2004 and 2008, US investors hoarded Oil, Basic Materials and Heavy Industrial company’s common stock and international mutual fund shares to participate in the popularity of the emerging stock markets like Brazil, Russia, India and China (the BRIC trade).

Second, US households and corporations hoarded Treasury Bills and Money Market Funds during the market meltdown between October of 2007 and March of 2009. In a recent Barron’s' article, money manager William Priest points out that the ratio of cash to total assets surged to 35-year highs for both non-financial corporations and households. Since March of 2009, they have been hoarding bond Mutual Funds, despite the stock market marching upward. Various reports from Lipper and Morningstar have reported net inflows into bond funds at $350-400 billion, while US stock funds and ETFs saw net liquidations.

On the TV show, extreme problem hoarders end up with a great deal of useless trash in their house. The piles of junk collect dust and have no value to future buyers. It would be one thing to hoard works of art from Picasso or Chihuly, but the folks on the show buy and keep things that nobody else ends up wanting.

At Smead Capital Management, we watch what the crowd is hoarding and try to avoid those popular areas. Bond funds and most investments tied to the BRIC trade appear as over-crowded as the dust covered rooms in the TV show. Simultaneously, the lousy results of the last ten years have caused investors to avoid the kind of Hall of Fame companies we like. In our opinion, these works of art can make us wealthy by buying and hoarding their shares for ten years or longer until the building gets overcrowded. We have formed museums (portfolios) to collect what we believe are "works of art". We do this under the assumption that the companies that meet our Eight Criteria will successfully execute their business purpose and plans. In so doing, they grow their earnings and free cash flow. Ultimately, the hoarders of cyclical businesses, commodities, emerging markets, money market funds, T-bills and bond funds may someday have to look at what they hoarded and reevaluate what creates long-term wealth. This could cause a transition away from formerly useful investments into the kinds of “Hall of Fame” companies we like.

If interest rates in the US rise for many years and/or China’s economic growth slows down, we believe you should watch for a giant yard sale in bond mutual funds and the BRIC trade. Hoard quality when it is out-of-favor and avoid holding Hall of Fame companies only when maniacal pricing threatens to turn future returns into junk.

Best Wishes,

William Smead

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. Some 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 with in the past twelve month period is available upon request.

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Dear Fellow Investors:

For a long-term multi-year bull market to exist in stocks in the US, a number of things need to fall into place. Since we at Smead Capital Management enjoy owning high quality large cap US equities for long holding periods and seek to find “Hall of Fame Companies”, we would like to see a long bull run play out over the next 3-5 years. We thought it would be helpful to line up the current “ducks” to see if the markets have done what they need to do for this bull market to last for a long time

Duck No. 1—Negative Sentiment

When this market sneezes, investors get a cold. A recent 7.5% pullback in the S&P 500 Index caused individual investor sentiment and professional investor sentiment to plunge. Mark Hulbert covered this in a column called “A mid-winter night’s gloom” in which he showed that short-term professional market timer’s had reduced their equity exposure in a short time by 45%. Both the Investor’s Intelligence and American Association of Individual Investor’s (AAII) surveys saw the number of bulls plummet and the number of bears or people looking for a correction soar.

Duck No. 2—Insider’s Positive

The recent pullback in the market saw a big drop off in insider selling (Officers and Directors and Substantial Stockholders of public companies). When the Insider’s are big sellers of dips, beware.

Duck No. 3—Favorable Supply and Demand for Shares

Every week another major acquisition announcement is made. Most are all cash (Terra Industries $4.1 billion) or mostly cash purchases (Berkshire Hathaway’s buy of Burlington Northern). When shares of stock are bought out for cash, the supply of shares outstanding decline. Major stock buyback announcements have been fairly constant (Merck and Amgen in our stable are recent examples) and are being executed, wiping out more supply. In more normal times this supply elimination would be offset by Initial Public Offerings (IPO’s) and Secondary Common Stock offerings. Ask any investment banker, IPO issuance is almost non-existent.

Duck No. 4—Massive Cash on the Sidelines

US households ($7 Trillion), Banks ($1.2 Trillion) And Non-Financial Corporations ($1.8 Trillion ) are holding record levels of cash on their balance sheets. When confidence comes back a significant piece of this amount will either participate in business growth or stock purchases.

Duck No. 5—Negative “Nabobs” have Credibility

Any two-bit economist or market strategist who foresaw the sub-prime meltdown is treated like a god/guru and like they have a crystal ball. They all say the same thing about the US economy in one way or another. The US has seen its best days and we are in for a long deleveraging phase. In their mind commodities and emerging markets are a better place to invest than the best companies in the world domiciled in the USA.

Duck No. 6—The Public Can’t See the Ducks

We believe US household investors and many institutional investors are looking in the rearview mirror at the horrid decline of October 2007-March 2009 and can’t see the ducks lined up. Remember, US households were net liquidators of US common stock last year.

We are very excited to own the companies which fit our eight criteria and look to enjoy the ride as we believe investors will slowly recognize that the “ducks are lined up”.

Best Wishes,

William Smead

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. Some 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 with in the past twelve month period is available upon request.