Investment Strategy Statement: J Mintzmyer

by: J Mintzmyer
Summary

I am outlining my investment approach for personal investments and reviewing our work at Value Investor's Edge.

This report will review our general security review and selection process along with thoughts on deep value and counter-cyclical approaches.

Brief comments on valuations, cash flows, and efficient capital allocation.

Quick review notes on the shipping sector and why I love it!

Investment Strategy Introduction

I've enjoyed sharing investment ideas and research on Seeking Alpha for 8 years and a public 'strategy review' is likely long overdue. First, a huge "thank you" to the community here on the platform. I've learned a tremendous amount from our interactions via over 300 public reports and over 14,000 comments, often in vigorous discussion/debate.

It's humbling that over ten thousand members have chosen to 'follow' my research, especially since I often focus in some far-flung areas, notably our primary expertise in global shipping. I've learned a lot from our interactions and I've certainly made a fair degree of mistakes. You've kept me honest, but also allowed for room to grow and improve. I dedicate this first official 'strategy review' to the community here at Seeking Alpha and I hope this is a good conversation starter.

I'll mention "we" or "our" a lot in discussion across this website and in the report to follow. The 'royal we' is terribly annoying, I understand. In this case, there's no mouse in my pocket! I'm discussing views from our team at Value Investor's Edge or various positions or strategy from that service. I am fortunate to work with exceptional analysts on our exclusive platform including James Catlin and Michael Boyd along with hundreds of other members and affiliates. We often share guest reports as well and I owe a special shout-out to Darren McCammon for his recent work. If you're not following these 3 gentlemen... you're wrong...or at least just missing out on great coverage!

Investment Focus: US Markets And Smaller Caps

I focus almost exclusively on the US equity markets, but do not explicitly discriminate on market capitalization. However, through my approximately 15 years of market experience including 8 years of writing coverage here, I've learned that if the market cap is over $10B, there's very little chance to outperform the giants. Whether or not we wish to believe in the efficient market hypothesis, there are simply thousands of absolutely brilliant people engaged in trades with names like Apple (AAPL), Tesla (TSLA), Google (GOOG) (NASDAQ:GOOGL), etc.

There are certainly some far less sophisticated investors involved in these names as well, but it's like the poker analogy about finding the fish at the table. When we work down into the sub-$1B range, there is often a dearth of research and stocks tend to trade on extremely superficial things like dividend yield and trailing earnings. In hotter markets, we are often swimming in short opportunities and in colder markets, there are lots of deep value skews with incredible risk/reward setups. Mistakes and poor judgement still can hurt, but a batting average of 60-70% can be incredibly lucrative.

I'm known as a shipping expert, but I'm not exclusively focused here. The sector happens to trade extremely inefficient from time-to-time and we've developed an edge over the years, especially due to shorting high-fliers and picking up deep values when everyone else hates them. I have a passion for the sector, but I've been negative on many segments at different times when the supply/demand balance calls for it.

I only publish public reports when I consider myself to be an expert on the name, so although almost all of my reports have been on shipping, we also do a lot of work with MLPs and other energy names. I go invest where the opportunities present themselves and right now there are incredible bargains across many parts of the energy sector and industrials as well as shipping.

Why Shipping!?

That's a valid question. In the majority of sub-sectors, there is very little barrier to entry, low pricing power, no major economies of scale, ego-focused management, weak corporate governance, heavy overbuilding, and rapidly fluctuating macro headwinds.

It's a terrible sector to 'invest' in. Buffett would shun it! In fact, the broad industry returns over the past 5 years have been abysmal with the lone ETF (SEA) down nearly 60% versus a gain of over 50% from the S&P 500.

Source: SEA vs. S&P 500, 5-year chart, Yahoo Finance

It has been a brutal run for the markets both due to all the challenges I listed above and also due to a decade-long hangover resulting from a monster bubble popping back in 2008. Unlike most industries which quickly rationalized and recovered, ship orders can take several years to deliver. Orderbooks across the segments were at record-highs back in 2007-2008 and as rates collapsed, deliveries got stretched out even further.

It's been a rough place to play. But I've been heavily focused here since 2013 and with the exception of an exceedingly brutal run in late 2018, it has been a handsomely profitable venture. This is due to the violently cyclical nature of the stocks and the tendency for valuations to run to absurd levels in both directions. For example in current markets, shipping stocks are at all-time record lows in terms of valuations, lower than even the depths of 2008-2009 and considerably lower than 2015-2016 lows. A few years ago, a basket of names traded at extreme valuations and made fantastic short opportunities.

Furthermore, information is more asymmetric in these sectors. Those who read broker reports, pour over hundreds of presentations each season, and pay subscription fees for industry data have a massive edge over those who rely on Google searches and online message boards.

Our Process: Selecting Investments

I follow around 150 names in the broad market and am 'generally familiar' with over 500. The difference between 'following' meaning that I review quarterly earnings, try to read most filings, read published coverage whereas generally familiar would mean I understand the business model and have a very broad view of 'fair valuations,' but I don't track them frequently.

If something in the 2nd bucket runs ballistic, I'll take a look and perhaps deploy capital. Recent examples would be NN Inc. (NNBR) and AerCap (AER) where I'd generally followed for a while and only recently (late-2018) jumped in. Since our research service at Value Investor's Edge heavily covers shipping, I follow all of the US-listed names and am 'generally familiar' with almost all of the foreign-listed firms as well.

When I 'take a look,' my first review is on cash flows, specifically "free cash flow," with a look towards the capital structure as well. How stable or predictable are cash flows? How strong is the liquidity? Are there any near-term debt maturities? It might be a shocker, but classic metrics like 'earnings' and 'book value' are often totally worthless (even more so if using bad screeners). Instead I look to sustainable free cash flow (or normalized free cash flow in a cyclical) and I look to net asset value ("NAV") with stress testing for cycles.

If the firm is attractive enough to pass the first test, then it's time to do a deeper review of the relevant macro environment and management quality. What I've learned in the past 15 years is that there are lots of great operators in management, perhaps 50% or more; however, there are very few great capital allocators, well under 10%. Management teams tend to want to expand their business, treating it like a personal fiefdom, regardless of the attractiveness of current or near-future markets.

A truly savvy capital allocator will push out hefty dividends if cash flows are strong and new investments are expensive. Likewise if stock values are cheap and investment options aren't plentiful, a good allocator will plow funds into repurchases. This type of management is few and far between. The savviest allocators in weak industries will destroy poor allocators in good industries. Shipping has been cursed with boatloads of terrible allocators and the combination of a decade of industry headwinds has driven huge losses.

If the valuations are good, the macro makes sense, and the management team is strong, then it might be time to deploy capital. The critical question then becomes whether this is a "trade," or an "investment?"

On the long side, I'm usually about 75-80% investments and about 20-25% trades. On the short side, it's usually closer to a 50/50 split. Let's take a quick diversion to discuss key differences here.

Trades Vs. Investments

There are lots of definitions, including time-based, but broadly speaking a "trade" is something I'm buying because I expect it to get 'hotter' and I'm just looking to flip it onto a higher bidder down the road. I have little interest in staying with the name long term and if price action reversed suddenly, I'd be uncomfortable with holding the name. There's sort of a negative connotation with trading sometimes, but it's absolutely necessary for a functioning market.

An "investment" is something I'm willing to hold for several years due to a strong belief in the underlying business. Unless there is a massive blow to the thesis or a major black swan event, if the price gets cheaper, I'd want to buy more. If the price runs up strong, I'd likely trim back a bit all-else-equal.

Unfortunately, there are far too many cases of "Trade-vestments," where a person has no interest in the underlying firm but perhaps reads a report and convinces themselves that it's a good idea to buy. Either there's a shallow agreement with the thesis or the plan is simply to flip it out next week/month. If the price slides backwards, a smart trader would bail, but too often a failed trade magically transforms into an "investment."

Another related and interesting note is that although the vast majority of people identify as "long-term focused investors," in reality, most are not. People will love a name at $30 and think it's going to $50. Then if the stock is at $20, the goal is now simply to "get back out" at $30. If the same stock went to $10-$15 (again barring massive changes to a thesis, in which case the only right move is to sell), buyers will often be totally gone.

Humans are naturally wired to be absolutely abysmal investors. We love hot markets and hate weak ones. Everyone raved about their 2nd or 3rd house in 2007, but how many people were out there scooping up dirt-cheap property in Phoenix or Las Vegas in 2010-2011? It's the same in the stock market, but on steroids. People maybe check their house quote every few months versus stocks that can rally or crash in minutes.

Portfolio Risk And Strategy

I strive to maximize my overall risk/reward balance in speculative investments. By speculative, I am referring to pretty much anything that isn't a blue-chip or index. I personally keep about 60-70% of assets in stable things like real estate, indices, and some blue chips. More recently (starting in 2017 into 2018) I've been much heavier in cash.

Risk/reward is measured differently by all investors, but I generally view "Beta" as a worthless measure of risk for investments (but it can be definitely relevant for trade positioning). Beta, by definition, is a volatility metric related to trailing moves against the broad market. It has nothing to do with actual investment risk in terms of company solvency, market prospects, etc.

I attempt to determine an "expected value" or EV based upon a weighted average of bearish risks, baseline models, and bullish potentials. The best risk/reward comes from names where pretty much everything can go wrong and the long-term losses are minimum. If a decent amount of stuff goes right, we make good money. If everything goes right, we make a killing.

The perfect risk/reward setup comes from a name where my thesis could turn out to be absolutely busted and stupid-looking in a few years, but we didn't lose any money. Ideally we look smarter on average, but with good risk-reward set-ups even nailing just one-third to one-half of our ideas can be (and certainly has been) extremely lucrative in the long-run.

Capital Product Partners Case Study

One such example of good risk/reward would be Capital Product Partners (CPLP). This was a name that I was very bullish on in 2016, with the following simplified thesis listed below. I bought heavily in the mid-$2s up towards $3 when my major public report was released ($3.00, 18 Jul 2016)

  • Tanker rates improving - WRONG (mediocre to terrible for 2.5 yrs)
  • Major refinancing on the cusp - WRONG (refinancing was weak)
  • Big dividend potential - WRONG (weaker rates & poor re-fi = flat divs)

Pretty much everything worked against us on CPLP and most public readers generally hate the stock right now. From mid-$2s in May, we're still up nearly 25%. From the public report at $3.00, the total return is 3%.

That's a bad return indeed, but for virtually everything in the thesis to work against us and come out with no lost capital? Those are the set-ups I like. The chart below shows how peers, Scorpio (STNG), Ardmore (ASC), and Navios Maritime Acquisition (NNA) performed over the same period (May 2016 to now). Adjusted for distributions, CPLP is up over 20% versus losses of 40-60% for the other trio even with their payouts included.

Source: CPLP vs. STNG, ASC, NNA, May16-Mar19, Yahoo Finance

Ironically, CPLP is one of the best risk/reward investments in the shipping space today, but it is incredibly hated right now due to the aforementioned disappointment in previous thesis (recent case here Dec 18 and here Feb 19).

I try limit speculative allocations to about 30-35% of my assets and I aim for huge risk/reward skews. Stuff like buying Golar LNG Partners (GMLP) in Dec 15-Jan 16 for $8.00 and seeing it at $21 a year later. Or loading up on Scorpio Bulkers (SALT) at $2.98 and debt (SLTB) at $9.10 and seeing it hit $10.00 and $24.00 within a year. There are dozens of examples (and cases where I've been totally wrong), if we want to share more 'war stories' in the comments section.

Return Objectives

I aim to make as much as possible in speculative investments when right while losing as little as possible when I'm wrong.

How do I quantify this? Total speculative portfolio return over time.

What do I compare this to? The "market" which is broadly the S&P 500, but I also track the Russell 2000 to get a closer small cap comparable. I have to beat the S&P 500 over time to make it worth my while. Since I'm a shipping guy I should benchmark myself to the SEA ETF, but that's an absolute joke of a comp (reference 5-year chart above). If the SEA ever runs positive, it'll be interesting to see how much money we make!

How are we doing? It depends at which time-frame. Over the past 5 years, I'm very happy and if we were tracking performance in January 2018 or even June 2018, I would have been thrilled. Many of my positions got absolutely crushed in late 2018, specifically in November and December. 2018 was the first big year where I considerably underperformed the market in speculatives. Thankfully I was about 30% spec (I always aim for 25-35% here) and pushing 60% cash in October, but the losses were still pretty huge.

YTD19 has been pretty good, but shipping names are still lagging the market fairly hard (case for shipping: 27 Dec 18 and 22 Jan 19). I shared our top public ideas for 2019 on 28 December and both baskets are lagging the Russell 2000 as I'm writing this. Again my goal is to maximize returns versus accepted risk, but I track performance against the S&P 500 so I'm not 'thrilled' about the past 2 months and the past 6 months have been cumulatively very tough.

Situational Profile

I've been following the markets and researching stocks at varying levels for around 15 years and have been a 'serious investor' for about 5-6 years. I have a primary 'day job' that has nothing to do with investments. I absolutely love my job and will do it as long as I can. Diversity keeps me sane and I work with wonderful people on a daily basis in both worlds.

I have been extremely fortunate to have the chance to work with an amazing team of researchers, associates, and members as part of our research service at Value Investor's Edge. We've grown substantially since launching in May 2015 and our work is recognized across the industry.

Investing and trading profits fluctuate. On November 1st of last year, 2018 was still a fairly profitable year. On 31 December, it was deeply red.

How large are portfolios in our group? According to our latest member survey, the breakdown is below, with the lion's share at $250K-$5M of portfolio holdings. I also consult with a few very large funds and offices (9-10 figure range), but those are not included here and clearly smaller on sample size.

Source: Value Investor's Edge, Member Survey (SurveyMonkey Chart)

Related Strategy Questions

Some related frequently asked questions involve liquidity constraints, time horizons, and tax considerations.

I typically prefer firms with at least $200M in capitalization, healthy turnover and plentiful listed options in case I'd like to hedge, short, or add a kicker. If I'm opening a position and it moves the market noticeably, that's not great. I'm happy with my portfolio, but it's hardly massive compared to some, so if my purchase is moving the market, the name is way too thin.

It was more difficult to build up a nice position in Navios Maritime Acquisition, which was one of my favorite trade ideas for early-2019 than it was to build a position in DHT Holdings (NYSE:DHT) as one recent example.

My time horizon depends upon the thesis and whether or not it is a trade or an investment position. For example with Golar LNG (GLNG), I'd be happy to hold for 2-3 years or longer and I think we could reach $100 from here. With an aforementioned name like NNA or a total trade-piece like DryShips (DRYS), it's a weeks or months-type holding.

I prefer to pay long-term capital gains, but I won't hold a huge winner 3-6 months for 'tax reasons' if I think the price is flimsy. I prefer to do most of my trading in tax advantaged accounts, but as I'm sure most readers can relate, the bigger the accounts and contributions, the less proportion we have that is tax-advantaged...

With income names, I prefer to hold bonds in tax-free accounts and K-1s and preferred equities in taxable accounts. I'm not a 'tax expert' though so I'm just sharing general approaches.

Lessons Learned

This review has already turned lengthy and I could spend 50 pages discussing lessons learned across the past 10-15 years. Generally, these lessons boil down to the more confident I am about a certain position, the higher the chance my expected value calculation is off or I am missing a blind spot. I regularly look for research which runs contrary to our views.

Another major lesson involves timing. If I think it will happen in 3-6 months, it's almost certainly a year or more. If something is a 1-year story, it's probably at least 2 years or more. Over the past couple of years, I've built these 'expanded' time frames into more of my trades and reports. If I go back to reports written in 2016 for example, I was clearly more enthusiastic and some might say "naive" about the time it takes to turnaround balance sheets and especially to shift investor perceptions.

A key lesson for all value investors, and a subject of a recent investor panel, is "cheap can always get cheaper." There's no such thing as a floor in any sort of value investment. If you want to invest in something you think is cheap at $20 and the thought of $10 makes you sick, then it's best to move along to calmer waters mate! Deep value investing probably isn't your cup of tea.

Finally, know thyself and your positions and know the thesis and its weak points. Are you a true investor (few actually are) or are you a trader? Being a trader is fantastic by the way, not a negative word at all, just don't get caught with the "trade-vestment" nightmare! If the thesis changes too much or outright 'cracks,' then sell and take the loss, and we'll get 'em next time.

Discussion/Debate

I look forward to a strong discourse below and I certainly hope this article can serve as a good conversation starter. As this report began: Thank you for the opportunity to share and debate ideas for the past 8 years, here's to the next 8 and beyond!

Disclosure: I am/we are long CPLP, NNBR, AER, STNG, NNA, GMLP, SALT, GLNG. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.