Launching Best Of Breed: Invest In The Highest Of Quality

Includes: CBL, FB, SKT, SPG, WPG
by: Julian Lin

The cheapest stocks may have the most potential upside, but best of breed has the most probable upside.

Best of Breed is a community of investors who seek to minimize the uncontrollable variables to maximize the potential total returns.

Become a Best of Breed investor today.

Editors' Note: This article is meant to introduce Julian Lin's Marketplace service, Best of Breed.

Deep Value investing isn’t what it used to be. 21st century technological advances have made true value opportunities far and fewer in between, and I have found that nowadays more often than not something “unexpected” and out of our control always seems to occur to ruin the deep value investment thesis. I am sick of seeing so many retail investors get burned by such randomness. Investing doesn’t have to have so many unknowns with such unpredictable returns. Allow me to now introduce an alternative and in my opinion superior way of investing.

Best of Breed: We Buy Best Of Breed

Today I am launching my new marketplace service, Best of Breed. At Best of Breed, we buy best of breed stocks at discounted prices, which may differ from the traditional and more popular method of investing in the absolute cheapest stocks. I started Best of Breed with the aim of covering undervalued best of breed securities and sharing my ideas with a community of like-minded investors. This service targets long term investors who like knowing every position they hold very closely and further do not chase “cheap” stocks just because they are cheap. At Best of Breed we stick with quality over quantity because we believe that when all is said and done, best of breed will be the only ones left standing.

The Case For Best Of Breed

The typical value investor might search for stocks with deeply discounted valuations as measured by P/E or P/B ratios. While these investors believe that low prices can alone compensate for the risk, I however have a different opinion.

If you look at the following graph from late 2017 of three operators in the same sector, which stock would you want to buy?

(Yahoo Finance)

In late 2017 I released a public report covering the mall REIT sector. At the time, CBL Properties (CBL) and Washington Prime Group (WPG) were fan favorites on this site due to their apparently “covered” double digit dividend yields which at the time were in excess of 14%. I recommended avoiding these two names and instead buying the best of breed operator in the space, Simon Property Group (SPG), which yielded “only” 4.5% at the time. I explained that retail investors seemed to be misevaluating the dividend coverage on CBL and WPG, specifically by overlooking the fact that their re-development projects were a necessity for survival and thus should be incorporated in factoring their dividend safety. WPG and CBL offered potentially much higher reward than SPG but the probability of them succeeding was so low that I instead found SPG and its relatively lower potential returns to be the better buy. Since then, CBL has cut their dividend several times and WPG has also reported rapidly deteriorating financial metrics. SPG on the other hand has raised their dividend 10.8% since then. The outperformance in their share prices has been remarkable:

(Yahoo Finance)

This showed a very important reality: while the more beaten-up stock may provide greater potential upside, the probability of realizing such upside is much smaller than that of the best of breed peer.

With the “deep value” stocks you are almost guaranteed uncertainties and risks such as:

  • Management may not be aligned with shareholders and thus may not act in shareholders’ interests in a timely matter, or at all. This is especially seen when management teams refuse to repurchase their own stock in spite of their clearly deeply undervalued stock, and instead pursue value-destructive endeavors.

  • The headwinds facing their underlying industry or their individual company may be more vicious than anticipated - in my opinion it is an impossible and arguably unnecessary task to determine when industry headwinds will subside.

  • Their balance sheet may be over-leveraged and the “earnings” making the stock look so cheap might actually need to be redirected towards paying down debt. Is it really called earnings in this case?

With best of breed names, you get a very different investment proposition:

  • Best of breed companies in our coverage universe have conservative balance sheets which decrease their cost of capital and allow them to take advantage of market volatility.

  • Best of breed management teams have a long track record of excellent capital allocation, and thus have both the experience and motivation to take advantage of persisting discounts in their stock price.

  • Finally, best of breed names have long histories of strong financial execution - investing in their stocks only requires that they continue to do what they have been doing.

I believe that strong underlying financials is another form of “margin of safety” - when combined with a cheap valuation we can get a more complete margin of safety.

Another notable example: last year I turned bullish on Facebook (FB) after a series of ongoing scandals sent the stock cratering from all time highs. Despite the negative headlines, FB continued to report rapidly growing revenues, high operating margins, and a surprising amount of share repurchases. I viewed FB to be a best of breed business with secular tailwinds selling for around 20 times earnings - providing the complete margin of safety allowing for stock price outperformance. This was not a popular opinion as analyst downgrades kept piling on and short pieces were released almost every week. I remained bullish on shares all the way to the bottom, and shares have shown their best of breed colors ever since, returning over 50% from its lows last year.

At Best of Breed we scour the market for best of breed opportunities like that of FB in 2018.

Avoiding The Value Traps: Wall Street Isn’t Stupid

Time and time again I see retail investors buying falling stocks of companies at 52 week lows. They view these stocks as “deep value bargains” but more often than not they are simply stocks dumped by the “smart money.

Case in point: in late 2017 I presented the short thesis for Tanger Factory Outlets (SKT), a stock which at the time was (and is still) very popular among readers on this site, in spite of poor stock price performance and an abnormally high short interest ranging from 20% to 30%. Many of the bulls on this site asserted that SKT would continue to perform strongly as a dividend growth stock due to the fact that they didn’t cut their dividend in 2008, something even industry giant SPG had to do. I showed that their tenant sales psf were alarmingly low and made their tenant profile more resemble that of low quality mall REIT peers CBL and WPG than SPG. I also predicted in follow up articles that their leasing spreads would not only remain pressured but also go negative as they lose pricing power with tenants. This was a contrarian view among retail investors but clearly was being priced in by Wall Street.

SKT proceeded to report negative leasing spreads for the full year 2018 and has guided for declining funds from operations (‘FFO’) for 2019, and its stock has performed poorly ever since.

In spite of the low valuations I continue to remain bearish on SKT and will provide continued in depth coverage of stocks like SKT at Best of Breed. There are two important guidelines of strong portfolio performance: in addition to finding best of breed opportunities you need to also avoid the value traps, even if it seems like all the “experts” are buying it.

Why You Should Join Best of Breed

If you join us at Best of Breed, you will gain access to the following:

  • Access to our real-time portfolio tracker of best of breed top picks in the market.

  • Access to our real-time Best of Breed Universe which tracks valuations of best of breed names in our coverage universe.

  • In depth reports of best of breed core holdings including analysis of their financial results, balance sheet, and more.

  • Wall Street Isn’t Stupid reports: Buying something just because it’s at 52 week lows doesn’t make one a contrarian. Time and time again retail investors are buying stocks thrown away by the “smart money” without considering the real reasons why they have fallen. My Wall Street Isn’t Stupid reports analyze popular “falling knives” with a critical eye so that our members don’t get caught buying value traps.

About Julian Lin

I have been a contributor on Seeking Alpha since 2017. Today, I am the founder of Best of Breed, a service seeking best of breed investment opportunities with the highest probability of success. I cover best of breed names in tech stocks, REITs, and any other sector offering value. I started Best of Breed to create a community of investors who are passionate about finding high quality businesses at great prices. I am ranked in the top 1% of all bloggers on Tipranks, using the same strategies utilized in Best of Breed:

Join Us Today For A Best Of Breed Discount

If you are ready to gain access to all of the above, this is the time to do it. For the first 500 subscribers only, I am offering a 20% discount for a mere $40 per month. Annual subscribers get a further 33% discount on top of that for a mere $320 per year. I have priced the service so cheaply in order to build a large community of best of breed investors. Start your risk-free, 2 week trial and Become a Best of Breed Investor today!

Disclosure: I am/we are long FB, SPG. 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.