#WeeklyInvestorReader | wk. 4

Note to readers: #WeeklyInvestorReader contains a few of the articles I read during the week. Visit my Twitter @HurriCap for any other articles that may not have been included. 

You can look it up – Seth Godin, January 21, 2017 | Of course, for millions of years, people couldn’t look it up. They couldn’t read and they hadn’t invented writing yet, so there was nothing to look up.

The end of active investing? – Financial Times, January 20, 2017 | Technology and low returns have delivered a killer blow to a once-dominant industry.

Buy. Squeeze. Repeat. – Fortune, January , 2017 | The Brazilian investors who control Kraft Heinz are applying their proven formula to construct a new global food colossus. What will they buy next?

Valuation and investment analysis – Bronte Capital, January 3, 2017 | I just had a chat with someone who wondered why I did not have a valuation for everything in my portfolio – a buy and a sell price. My reaction: such (false) precision was silly and ultimately counter-productive.

When do you average down? – Bronte Capital, January 4, 2017 | A decent stock note is 15 pages on the business, one page on the management, one paragraph or even one sentence on valuation. Valuation might normally be a set of questions along the lines of “what do I need to believe” to get/not get my money back. But I would prefer a simple modification to this process. This is a modification we have not done well at Bronte (at least formally) and we should do better. And that is the question of averaging down.

My Interview with Edward Thorp, from Tim Melvin – Daily Speculations, January 19, 2017 | Edward Thorp is one of the most well known figures on Wall Street. Throughout his venerable career he’s spent time as a mathematics professor, hedge fund manager, blackjack player, and author. “The father of the wearable computer,” recently released his sixth book, “A Man for All Markets: From Las Vegas to Wall Street, How I Beat the Dealer and the Market.” Marketfy’s Tim Melvin recently caught up with the Wall Street legend to discuss his career and outlook on investing. Below is their conversation, slightly edited for length and clarity.

Big-Bank Executives Have Sold $100 Million in Shares Since Election – Wall Street Journal, January 24, 2017 | The sales, coming as financial stocks soared, are more than in that same period in any year over the past decade.

Tax Reform Top of Mind for Wide-Moat U.S. Industrial Firms – Morningstar, January 23, 2017 | While management teams enthusiastically highlighted corporate tax reform, capital mobility, and infrastructure spending as potential near-term earnings tailwinds, all stopped short of explicitly incorporating these favorable outcomes into 2017 expectations. We agree that it’s too early to include Trump’s America in the base-case assumptions that fuel our discounted cash flow analyses. However, if President Donald Trump’s target corporate tax rates and modest top-line growth materialize, our bull-case scenarios look realistic.

Does Dow 20,000 Mean Stocks Are Overvalued? – Morningstar, January 25, 2017 | With the Dow crossing the hurdle of 20,000 this morning, many investors are wondering if this is a sign that the bull market is nearing its end or if stocks have become significantly overvalued. In short, Morningstar’s stock analysts see stocks, as a whole, trading at only slightly above their fair value estimate and that there are some values out there, even among Dow components. However, this is not to say that a correction or even a bear market is not in the cards. Current market valuations don’t tell us very much about where stocks are going in the near term; the market can stay overvalued for a long time, could become deeply undervalued or could bounce along at current levels. This unpredictability is one the reasons that trying to time the market around major news events, index milestones. and broad valuations is exceedingly difficult.

Renowned value investor Francis Chou is willing to wait on a bargain – Canadian Business, January 26, 2017 | He’s regarded as one of the savviest value investors in the world. The market is overpriced right now, he says, but it will come down—it always does.

Inside Pandora’s Quest to Take on Spotify, Apple Music & Amazon – Billboard, January 19, 2017 | As the lights of the strip ­glimmer below, Pandora co-founder/CEO Tim Westergren stands before two dozen advertising executives in a 61st floor suite in the Cosmopolitan of Las Vegas. It’s the first day of 2017’s Consumer Electronics Show (CES), and he’s pitching Pandora’s new direction. “In my opinion, the other music subscription products out there are unsatisfying,” he says, referring to the on-demand streaming services the new Pandora Premium will begin competing with later in 2017. “They give you millions of songs, a search box and ‘good f—ing luck.'”

Cash Cows Of The Dow – Meb Faber, January 14, 2017 | Long time readers know that I have been a shareholder yield advocate on the blog for almost a decade.  (We used to call it net payout yield back then, and we define it as the combination of dividends and net buyacks.) People are slow to change of course, but my hopes are that eventually you all come around to a little common sense.  Sometimes books and white papers are too much, and all that is needed is a simple chart or table that will change people’s minds. Remember the old Dogs of the Dow strategy where you just invest in the 10 highest yielding Dow stocks each year?  This strategy was popularized by O’Higgins, and historically beat the market.  But as you all know, a shareholder yield approach does even better historically.

How Well Does Running Vanguard Pay? – Bloomberg Businessweek, January 19, 2017 | The index fund pioneer is an important shareholder voice on executive pay, but its own compensation practices are kept private.

In German

Mit diesen Problemen kämpft H&M – Stern, December 13, 2016 | H&M hat eine ganze Generation mit günstiger Mode versorgt. Doch das schwedische Modehaus hat Probleme, denn die jungen Kunden kaufen bei der Konkurrenz – oder gleich im Netz. H&M braucht dringend neue Ideen.

H&M fehlt das Konzept für neue Gegner – Wirtschafts Woche, November 16, 2016 | Die Krise bei H&M ist symptomatisch für die Branche: zu viele Filialen, zu wenig Umsatz, kein Konzept gegen neue Angreifer. Eine Änderung der Strategie der einstigen Vorzeigekette ist nicht in Sicht.

In Swedish

“För oss har pengarna inte varit problemet” – Di,24 januari 2017 | Den som investerade 10.000 kronor i investmentbolaget Latour vid starten 1985 har sett kapitalet växa till 8 miljoner kronor. Di har besökt vd Jan Svensson och familjen Douglas börsnoterade överavkastningsfabrik i ett industriområde i södra Göteborg.

Historien om en bank som nästan gick omkull – Aktiefokus, 26 januari 2017 | Denna historia börjar 2002 med en bank. Det skulle egentligen kunna vara vilken bank som helst men det är en verklig nordisk bank som jag har valt för att illustrera några poänger för hur grov lönsamhet snabbt kan vända till att banken behöver räddas genom tillförsel av nytt eget kapital.

H&M- Sveriges största value trap? – Fundamentalanalysbloggen, 25 januari 2017 | Den som köpte H&M på toppen för två år sedan har idag bara 65 % kvar av sina pengar. Detta beror inte på något missförstånd på marknaden pga negativa skriverier, utan på verkligheten. En verklighet som borde ha sänkt aktien än mer vore det inte för att marknaden, inte minst när det gäller en gammal nationalklenod, är sen att agera när det börjar gå dåligt. Det känns också som om ingen riktigt vill skriva ner H&M i Sverige. Man får inte låta sig luras att tro att en fallande aktiekurs tyder på “rea på aktien”. Det beror oftast på att företaget har problem och i H&M:s fall väljer man istället för att lösa problemen att måla över rötan med expansion. Med andra ord mer av det gamla, det jättelika butiksnätet, som idag är ett problem. Lite som att kurera bakfylla med Bloody Mary.

H&M i marknaden – Lundaluppen, 22 januari 2017 | Sedan H&M släppte sina försäljningssiffror för december har dödsrunorna duggat tätt och att H&M är en besvikelse på aktiemarknaden de senaste åren är ett faktum. Jag tänkte titta lite mer på bolagets strategi, dess position i branschen och på klädmarknaden som helhet. Det är en marknad i förändring där den stora förflyttningen just nu går från fysisk butik till onlineförsäljning. Utöver denna mångåriga trend finns den vanliga utmaningen i modebranschen med skiftande moden och ständiga heta nykomlingar. I vissa fall förstärker dessa trender också varandra, men mer om det senare. I detta inlägg vill jag titta på bolaget H&M, inte så mycket på aktien H&M.

H&M: Stuck Between a Rock and a Hard Place?

All amounts in SEK. 

The story of H&M goes back to 1947 when Erling Persson – father to Stefan Persson (Chariman of the Board) and grandfather of current CEO Karl-Johan Persson – opened the first store. Since then, H&M has grown and expanded its business internationally. At the end of its latest full fiscal year in 2015 it operated a total of 3,924 stores in 61 different markets around the globe with total sales of 181 billion (fiscal year 2015). As of 31 August 2016 the group had 4,135 of which 176 were franchise stores.

The Persson family is the dominant major shareholder and controls 69.7% of voting rights and 37.7% of total shares outstanding (see table below). H&M is more of a publicly listed family company. This could be one of the reasons explaining H&M’s poor quality when it comes to financial reporting and the disclosures presented in the annual report.

This text focuses on H&M’s annual report for fiscal year 2015 (1 December 2014 to 30 November 2015).

hm_majorshareholder
Source: H&M Annual Report 2015

Expansion has been nothing but extraordinary with each year offering new store openings and growing total revenues. Focusing on revenues, H&M has delivered some pretty solid growth. But, the further down the profit and loss statement we go, the worse it gets. Profitability has not kept up with the growth in sales, putting pressure on profit margins.

During the last nine years, that is 2007 to 2015, H&M grew its revenues at a compounded annual growth rate (CAGR) of 8.7%, from 78,346 million in 2007 to 181,861 million in 2015. Gross profit and operating income during the same period grew at a CAGR of 8.0% and 3.9%, respectively. The lower CAGR in gross profit and operating income put pressure on profit margins, with gross profit margin going from 61.1% in 2007 to 57.0% in 2015, and operating margin from 23.5% to 14.9%.

The last decade has offered a solid mix of challenges for H&M; a financial crisis, currency movements, weather and fashion trends as well as growing competition from e-commerce and online retailers. The problem is not in the revenue growth itself, it is that profitability has significantly declined.

For most businesses growth comes at a cost. To maintain and grow its store count – from 1,522 in 2007 to 3,924 stores in 2015 – H&M spent a total of 56 billion in tangible capital expenditures. Then we also know most businesses have costs for growth SG&A and increasing working capital needs that comes with a certain amount of growth. H&M also spent an increasing amount of cash on its online sales business, either expensed directly through the income statement or capitalized on the balance sheet. Other operating expenses have increased from 8.9% of sales in 2007 to 10.8% in 2015. Intangible capital expenditures amounted to 5 billion, of which 4 billion was spent in 2012-2015.

The high level of investments together with declining profitability have resulted in a lower amount of cash, with cash and cash equivalents steadily declining from 20.9 billion in 2007 to 13.0 billion in 2015 (8.7 billion per Q3 2016). H&M is no longer able to found its yearly dividend from free cash flow, and the dividend has been maintained at about the same level in the latest five year period thanks to cash in the bank from prior years. Of course this could be solved to some extent by H&M if they decided to stop or reduce its growth capital expenditures (and other growth expenditures) or manage to increase profit margins and cash flows. The unpleasant part in this equation is that lowering capital expenditures would most likely result in a lower future growth rate (fewer store openings each year, even if compensated in the best case to some extent by rising online sales), or no future growth at all and in a worst case scenario with declining future total revenues.

hm_10y_financials
Source: Morningstar

Average return on equity (excluding cash and cash equivalents) has averaged 88% in 2007-2015, from a high of 134% in 2007 to a low of 52% in 2015. Returns are still great, but it’s also obvious that what we’ve got here is a negative trend in the underlying profitability. The main question for investors today is what H&M’s future profitability will look like? With the retail industry, and especially the fast-fashion sector being one of heavy competition it’s not entirely obvious what the future has to offer. Historically, H&M has made its long-term shareholders very wealthy. The question going forward isn’t about whether H&M has been great or not in the past – we all know it has. The question is what future performance H&M will be able to offer? And the last 5, 7 and 10 year periods may all have made a reasonable answer to this make-or-break question a little gloomier. But, it may still be as great as its always been, or? Since we don’t know in which areas H&M deploys all its growth expenditures and the mix between the “old H&M” and the new growth initiatives and brand building that has been ongoing for some time.

As always, we know what’s been but not what will be. H&M is currently trading at 234 per share, a level first reached in 2010. In the middle of 2013 the market changed its view of H&M and the share price went from 230, reaching an all-time high of 368.50 in 2015. Since then the share price is down about 36%.

It’s been almost a decade of declining profit margins and profitability. With a great annual report at hand we would be able to search for potential answers and understand in a good enough way what goes into this negative trend in profitability. But I’m afraid we don’t have one, since H&M seems to be following more of a “non-disclosure” policy than the other way around– sad but true, at least for outside passive investors. Let’s take a look at a few different areas in the 2015 annual report to see what’s missing.

hm_shareprice
Source: Avanza.se

Quality of Financial Reporting

Reading H&M’s annual report for fiscal year 2015 provides some great insights into the business. Although there are a few things that an outside passive investor would probably very much like to know, about which H&M says nil.

When reading an annual report and thinking about a specific business, ask yourself; What financial and non-financial metrics would I want if I was the one running the business? A few things you probably would like to know about are:

  • Sales per region, per country, at the store level, as well as sales per square meter – for each major brand in the portfolio.
  • The profitability of the business – that is, profit margins and invested capital turnover, together making up the return on invested capital – and any changes occurring and the reasons explaining any significant changes in underlying trends – again for each major brand in the portfolio.
  • Tangible and intangible capital expenditures – both maintenance and growth – split between the major brands in the portfolio.
  • Revenue growth – probably on a quarterly basis, but at least year-over-year – per region, per country, and at the store level – and again you’d want to know this for each major brand.

Does management tell you the business facts that they themselves would want to know if their positions were reversed? Let’s find out, but as a primer – you might become a little concerned about the state of things if you keep on reading.

Same Store Sales Growth. H&M no longer discloses monthly same store sales data. That’s fine with me if we talk about monthly data, but I would very much like to know what same store sales, at least year-over-year, look like. Especially in a case like H&M were growth in new stores could mask the performance in the current and old store count. Too bad, H&M does not provide this data to outside investors. Of course the relative value of this metric declines as online sales makes up a greater part of total sales. But, since H&M does not break out its online sales, should outside passive minority investors interpret this as a fact that online sales makes up a non-material part of total sales? Because if online sales made up a material and significant part of total sales, shouldn’t this information be disclosed in the annual report?

Same store sales growth is a relevant metric as long as there are physical retail stores making up a material portion of total revenues. And with the current strategy of maintaining a high growth rate and expanding the total number of retail stores, it seems unreasonable to expect this to change for some time. Thus, same store sales data is a metric of interest to investors and should therefore be disclosed, at least on a yearly basis in the annual report.

Total square meters. What are the total square meters of all of H&M’s retail stores? Management knows, you don’t since this is a non-financial metric that is not disclosed. A highly relevant metric, one could argue, for a retailer to make it possible to track revenue, profit, and invested capital per square meter for its physical retail stores. This metric should also be disclosed (at least in the annual report).

Operating Segments. Below is note 3 Segment Reporting from the 2015 annual report. There is only one issue with this note; the way it is structured and presented. It doesn’t provide anything of real value to someone trying to understand, analyze and assess the underlying business fundamentals. Maybe that’s what management want? To make it as hard as possible for others to get a glimpse of how different regions are performing. I don’t know. All I know is that this disclosure from H&M about their operating segments is of no value to me when evaluating and valuing H&M as a going concern. Right now a great part of the total operating profit belongs to Group Functions which makes it a little less useful when it comes to analyzing and assessing the development for each operating segment.

One has to assume that this segment information is in line with the requirements in IFRS 8, but one also has to assume that management does not want to provide any real value to readers. If they had wanted to do so they would have designed it in a different way.

H&M should provide information about the different geographical segments (at a proper level), different brands and their sales and profit margins and invested capital. Regarding online sales, this should also be separated and reported on a stand-alone basis. More about this below.

segmentreporting
Source: H&M Annual Report 2015

Share of Online Sales. How much of total revenues is generated from H&M’s online business? No one knows, except for management. You could look around and try to make an educated guess, and that might be good enough, but a disclosure about revenue from online sales is nowhere to be found in the annual report.

One could elaborate on the question regarding at what level of online sales in relation to total sales that would require H&M to disclose this key metric. If H&M’s online business accounts for as much as 10-12% of the total 2015 sales revenue, that is around 21 billion to 25 billion (Source: Bernstein via just-style), one could argue that this is material information to investors, and therefore should be disclosed in the annual report.

It will be interesting to follow how this develops and whether we’ll see any online sales figures in the upcoming annual report for fiscal year 2016.

Profitability of Online Sales. As much as we want to know how much sales the online business generates, we also would like to know any profitability of such sales. But, there’s no information about this in the annual report. I guess we could all agree on the importance of online sales for fashion retailers from now on. The question is what profitability looks like in this area? An educated guess is that it might not be the high-margin, high-profitability business that we’ve gotten used to in the past where most of the sales was generated via H&M’s physical retail stores.

E-commerce is no cash cow for fast-fashion retailers, whose thin profit margins from high volume sales are slashed by free shipping and returns. As the retail market as a whole is moving online, however, H&M—which was late to the game—is finally making the necessary investments to compete. “The penetration rate of online sales for apparel is just going to increase over the next five years, so if you don’t have an e-commerce website, your customers are likely to go elsewhere,” said Grant. (Source: Forbes)

Sales and profitability of different store brands. H&M discloses total revenues (hey, that’s great – ain’t it?), revenue per country and also revenue per region (in their segment reporting). What’s missing is a breakdown of revenue between the different brands, and also the split in revenue between physical retail stores and online sales. Further, no information is provided about operating income and invested capital for each brand.

hm_brands
Source: H&M 2015 Annual Report

CEO comments. The CEO comments is a great chance for a CEO to talk directly to all the shareholders and outside passive minority investors. Many CEO’s are either not good enough to express themselves and their business strategy in writing, or they just don’t want to make an effort great enough to do so in a proper way (at least seen from the perspective of an outside passive investor). CEO comments when it comes to H&M might be good, but I still think it could be improved a lot from here since much of the information provided doesn’t really offer any great insights into the business more than on a consolidated level.

Marketing and other operating expenses. H&M does not disclose its marketing expense and not any expenses related to IT. By putting together the different expense categories (rental, payroll etc.) disclosed in H&M’s annual report we can calculate how much of total operating expenses that is made up of other expenses – see table below.

Total operating expenses to sales increased from 76.5% in 2007 to 85.1% in 2015, mostly explained by higher COGS to sales (+2.3 pp), depreciation to sales (+1.1 pp), and other expenses to sales (+3.3 pp). Rental, labor, and amortization was almost unchanged. Other expenses made up 12.7% of total operating expenses in 2015 compared to 11.7% in 2007. It would be interesting to know what makes up these other operating expenses and how they have changed in composition during 2007-2015.

hm_opex
Calculations by Hurricane Capital. Source data from H&M.

Earnings Call Transcripts. This is not an issue that is specific to H&M, neither to the annual report itself. I bring this up just because I think all listed Swedish companies should be required to provide transcripts of earnings calls in their investor relations section. Fortunately, there are external parts providing transcripts. See here for some H&M earnings call transcripts provided via Seeking Alpha.

Nine-Month Report 2016

A quick look at the most recent nine months shows an increase in net sales of 5.6%, compared to an increase in total store of 12.5%. H&M opened 264 (206) stores and closed 53 (42) stores, i.e. a net increase of 211 (164) new stores. The group had 4,135 (3,675) stores as of 31 August 2016, of which 176 were franchise stores.

Revenue growth slowed significantly in the first nine months in 2016 compared to the same period in the prior year. The negative trend in both gross and operating profit continued to put pressure on margins and profitability. Earnings per share declined in Q3 2016 (-9.3%) as well as for the nine months 2016 (-17.2%).

Inventory increased with 23.9% year-over-year to 31.231 million at the end of Q3 2016. Total capital expenditures amounted to -9.288 million (tangible capital expenditures of -8.087 million and intangible capital expenditures of -1.201 million).

Also, H&M raised 3.724 million in short-term loans in the first nine months 2016. Without this short-term loan H&M’s cash and cash equivalents would have been 4.956 million instead of 8.680 million at the end of Q3 2016, compared to 10.963 million in Q3 2015.

hm_q3_2016
Source: H&M Nine-Month Report 2016

Final words and valuation

To wrap this up, H&M is a good business and I have liked it earlier on and might come to do so again in the future depending on how it all plays out. What I don’t like is to invest in a business I think is a good one – especially when the historical track record has been great (which could have a significant impact on the quality of your own judgement) – just to realize later on that it wasn’t such a good business as I originally thought (and by then running the risk of a permanent loss of capital).

hm_valuation
Calculation by Hurricane Capital. Source data from Börsdata.se.

Currently H&M is trading at a P/E (TTM) of 21.2 and EV/EBIT (TTM) of 16.1, in line with its 10-year average. If H&M is able to maintain or even turn around the negative trend in earnings and keep growing the business, the current share price probably would be considered a great entry point for investors in hindsight, most likely somewhat of a bargain. If this is not the case, that is, profitability will decline even further along with slowing revenue growth, the current share price is at a high level and you should look elsewhere for ways to invest your hard-earned money.

Personally, the last decade and the negative trend in profitability coupled with increased importance of having a presence in the online sales field and the tough competition in the retail business makes H&M a too uncertain investment case for me, at least at the current price level. There are many other great businesses out there with more favorable characteristics and less uncertainty. Let’s go try find some of these instead.

If you want to make your own assessment of the quality of H&M’s financial disclosures, click here to read H&M’s annual report for fiscal year 2015.

Disclosure: I have no position in the stock mentioned, and no plans to initiate any position within the next 24 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. This article is informational and is in my own personal opinion, and should not be considered investment advice. Always do your own due diligence and contact a financial professional before executing any trades or investments.

Q&A: Financial Analysis and Valuation Books

Someone who reads the blog emailed me this question:

Hi HurricaneCap!

I’ve been following your Twitter handle and blog for quite some time now, and have to say, it’s an amazing repository of knowledge. Thanks for that!

I was wondering if you could help me out a bit with regards to book recos for financial analysis and valuation specifically. There are ample quality books on the psychology behind investing, biographies of great businessmen and investors, but when it comes to financial analysis and valuation, I can’t seem to find a good starting point. Could you lead me to that?

I look forward to hearing from you soon!

Many thanks,

XYZ

Thanks for writing. Good question there. I have a few books I can recommend and I have put together a list containing a few of the books that I think could be of great help to you.

If you want to read one book, read the first one in the list below. If you want to read two, take the first to, etc. You get it. Or, just pick one book that you find interesting. I’m not saying you should, or even need to, read all of the books included in the list. I don’t recommend books that I haven’t read myself. So yes, I have read all of them myself. Some of the books more than once, but that’s not the important part here. Remember, it’s not a competition where the person who reads the most books wins in the end. Reading the first one, and being able to use the framework presented in that book will take you far. If you go on and read all of the books you will also see that a lot of things are the same. Still, a few things differ and reading different books is also a great way to reflect upon the ideas presented in each book, and also about what differentiates one book from another. It’s also a great way for yourself to collect different parts from different books that you find to be of greatest use and by doing so putting together your own toolkit, your own framework for business analysis and valuation.

  1. Financial Statement Analysis and Security Valuation, 5th Edition, by Stephen Penman
  2. Competition Demystified: A Radically Simplified Approach to Business Strategy, by Greenwald and Kahn
  3. Valuation: Measuring and Managing the Value of Companies, 6th Edition, by Koller, Goedhart, and Wessels
  4. Financial Shenanigans: How to Detect Accounting Gimmicks & Fraud in Financial Reports, 3rd Edition, by Howard Schilit
  5. Quality of Earnings by Thornton L. O’Glove
  6. Accounting for Value by Stephen Penman
  7. Business Analysis & Valuation: Text and Cases (IFRS edition), 3rd Edition, by Palepu, Healy, and Peek
  8. The Interpretation of Financial Statements by Benjamin Graham
  9. What’s Behind the Numbers?: A Guide to Exposing Financial Chicanery and Avoiding Huge Losses in Your Portfolio by Del Vecchio and Jacobs
  10. From Graham to Buffett and Beyond by Greenwald, Kahn, Sonkin and van Biema

Remember, this is my list. I’m sure there are lots of other great books out there, you just have to find them. If you do, feel free to share your insights.

Hope it helps.

 

#WeeklyInvestorReader | wk. 2-3

Note to readers: #WeeklyInvestorReader contains a few of the articles I read during the week. Visit my Twitter @HurriCap for any other articles that may not have been included. 

To survive in an increasingly unpredictable world, we need to train our brains to embrace uncertainty – Quartz, January 9, 2017 | We don’t like experts to express uncertainty. Imagine a politician running for president who promises “I’ll try to make good decisions most of the time. Our policies will probably improve the economy.” Would you vote for them? Probably not. We also want doctors devoid of any doubt over treatments and scientists with perfect foresight about climate change variables. That’s because we believe that leaders and authorities are supposed to know and tell us exactly what’s going to happen, thereby absorbing our uncertainty. But life is rife with risks. Misperceiving and underestimating these risks can lead to vital mistakes. Therefore, to make well-informed decisions, we need to become comfortable with uncertainty.

Inside Sears’ death spiral: How a billionaire who was ‘the next Warren Buffet’ drove an iconic American brand to the brink of bankruptcy – Business Insider, January 8, 2017 | Lampert, a former Wall Street prodigy, took control of Sears more than a decade ago and became its CEO in 2013. But he’s rarely seen in the office, typically visiting about once a year for the shareholder meeting and projecting into videoconference rooms at Sears’ Hoffman Estates, Illinois headquarters the rest of the time, according to interviews with employees. He prefers to stay on Indian Creek Island off the coast of Miami, behind a desk dressed up with the Sears logo. The island has been dubbed the “billionaire bunker,” partly because of a private police force that protects the island’s 86 residents.

Lessons from the Strategy Crisis at Netflix – strategy+business, September 6, 2016 | Netflix would seem to be on a roll. The world’s largest online entertainment distribution business has seen its streaming revenues grow from US$1.2 billion in 2007 to $6.8 billion today.

How to Analyze a Company – Science of Hitting, January 10, 2017 | A fellow GuruFocus reader recently sent me an email with the following question: “Which books would you recommend if I want to start investing in individual companies?”

Poker Is the Latest Game to Fold Against Artificial Intelligence – Technology Review, January 11, 2017 | Two research groups have developed poker-playing AI programs that show how computers can out-hustle the best humans.

SoundCloud Vows Growth In 2017, But Time Is Running Out – Fast Company, January 6, 2017 | At a crossroads, the company is desperate to turn its massive music platform into a real business.

Why I don’t use watch lists – Oddball Stocks, January, 2017 | I remember as a kid sitting in a chair near our kitchen with my grandfather two chairs away.  I was leafing through a toy catalog.  The catalog’s pages were worn and I knew the items and their prices by heart.  Suddenly my grandfather looked at me and said “What are you doing?  Looking at all the things you can’t buy but wish you could?”  I was stung by the criticism, but he was right.  I had almost no ability to purchase any of the items.  I was just envying items I couldn’t have.  As I reflected on this story recently it reminded me of why I don’t keep a stock watch list or research stocks that I wish I can buy someday.

No More Moats in Self-Storage Stocks – Morningstar, January 13, 2017 | After taking a deeper dive into the self-storage industry, focusing on how the efficient scale moat source applies to competitive dynamics, we have downgraded  Public Storage’s (PSA) economic moat rating to none from narrow. Peer  Extra Space Storage (EXR) already has a no-moat rating. The main reasons for Public Storage’s rating change were (1) moaty qualities related to intangible assets were identified in only 25% of the portfolio, while switching costs were determined to be too small to retain tenants; (2) new supply can easily challenge the company’s presence in less densely populated areas; and (3) occupancy is decreasing as competition pressures market share. Our fair value estimates stand at $229 per share for Public Storage and $85 per share for Extra Space.

Three ‘Uninvestable’ Industries for 2017 – Scott Fearon, January 13, 2017 | Today, three industries (and others I have yet to identify) are facing severe disruptions.

How to Read a 10-K Annual Report Efficiently – Rational Walk, January 8, 2017 | Effective techniques for reading books have been well documented for years but the same isn’t really true for S.E.C. filings.  S.E.C. filings are legal documents that a company is required to file on a periodic basis and the consequences for making mistakes can be significant.  Depending on the nature of the company, risks and disclaimers of a legal nature can vary in length.  Nearly all companies include information that is, in some regards, repetitive or unenlightening due to the need for legal cover.  While all information in a filing should be read prior to making an actual investment decision, trying to read filings sequentially on a page-by-page basis when just getting to know a company is not the best approach.

Importance of Knowing Your Investment Boundaries (Sears Mini-Case Study) – Base Hit Investing, January 12, 2017 | A week ago I read an article in Business Insider that referenced a Q&A from 2005 where Buffett was talking to a group of students from the University of Kansas and he was asked about the chances of success of the Sears/Kmart merger (which had just recently occurred at that time).

Lifelong learning is becoming an economic imperative – The Economist, January 14, 2017 | Technological change demands stronger and more continuous connections between education and employment, says Andrew Palmer. The faint outlines of such a system are now emerging.

Amazon is Eating the Retail World – Ben Carlson, January 18, 2017 | Amazon is the first place I look to price check just about anything I buy these days.

Amazon Stock’s Exceptional Price History Meets Value Investing – The Conservative Income Investor, January 14, 2017 | Revenues have grown from $10 billion to $134 billion in the past twelve years. The market cap has increased from $10 billion to something approaching $400 billion. And yet, Amazon’s profits are below $3 billion. That is 133x earnings for one of the ten largest corporations in the United States. History shows you tend to get into trouble when you pay much more than 25x earnings for even an excellent, fast-growing company.

How streaming saved the music industry – Financial Times, January 16, 2017 | Spotify and Apple are making money for the big labels but technology is likely to change the equation again.

Economics is messy – Seth Godin, January 17, 2017 | We still teach a lot of myths in the intro to economics course, myths that spill over to conventional wisdom.

The 10 Cheapest Stocks in the Wide Moat Focus Index – Morningstar, January 19, 2017 | In December, the Morningstar Wide Moat Focus Index swapped out 11 stock positions.

Netflix Stock Still Has A Profit Problem – The Conservative Income Investor, January 19, 2017 | When you see the price of Netflix stock climb to $143 per share in after-hours trading, the $60 billion valuation for the streaming giant at first sounds reasonable. But the reality is more complicated than that. Netflix is distinguishable from firms like Pepsi, Colgate, or Johnson & Johnson because its fixed costs are enormous. It has to pay obscene-sounding licensing fees to have access to the content it streams to its consumers. And, the more appealing the content, the higher the fees.

Netflix Ends 2016 on High Note; Margin Improvement Expected to Be Steady, Not a Hockey Stick – Morningstar, January 19, 2017 | Netflix ended 2016 on a high note with stronger international subscriber growth (5.12 million net adds, versus guidance of 3.75 million) and U.S. growth (1.93 million net adds, versus guidance of 1.45 million). Despite the impressive fourth quarter and better-than-expected guidance for next quarter, the most important information from the conference call may have been management’s admission that the operating margin will improve modestly on a yearly basis, as opposed to a “hockey stick manner.” Our long-term model for the company still projects that the operating margin for the international segment will improve slowly but will remain well below that of the U.S. segment over the next five years. We retain our narrow moat rating and are modestly increasing our fair value estimate to $73 from $69 to account for the time value of money from rolling our model forward and an additional year of margin expansion for the international segment. With shares trading well above our new fair value estimate, we advise investors to steer clear of this very high uncertainty company.

“Leaked Documents From Startup Maple Show the Brutal Economics of Food Delivery” – Climateer Invest, January 8, 2017 | On average, the restaurant-in-an-app lost money on each meal in 2015.

A Century of Opinions: Companies with auditor tenure over 100 years – XXX, January 20, 2017 | There are 13 companies that have engaged the same auditor for at least a century. The Big Four auditors account for all of these engagements.

BOOK REVIEW: “THE ART OF THE DEAL” – DONALD J. TRUMP (WITH TONY SCHWARTZ) – Value and Opportunity, January 20, 2017 | As with stock analysis, I am a big fan of “Primary resources” and so I decided that I should at least read one book co-authored by “his Trumpness” himself. There are many Donald Trump books out there but the first one from 1987 is “the Art of the deal”. I thought that maybe the first one is also the most authentic one.

It’s Time to Shake Up the Legal Industry – Craig Shapiro, January 6, 2017 | Close your eyes and picture the dream industry waiting to be disrupted. What’s it look like? Probably: It’s massively important to the functioning of society but doesn’t work for most people. It’s dominated by old incumbents that enjoy huge profit margins. Those incumbents don’t have much, if any, consumer brand recognition. But this isn’t a dream. This is the law industry, and it desperately needs to be shaken up.

Retailing In America: Brick & Torture – Danielle DiMartino, January 18, 2017 | Outright bankruptcies, nonetheless, are not where the pain is most acute. That preserve is on reserve for a different kind of demise, an appreciably slower descent into irrelevance. At first, the disruptive power of E-Commerce appeared to apply only to things that could be read or viewed on a screen. More recently, though, any product that’s quantifiable at any level is fair game whether it be Jimmy Choo’s, a trip to Katmandu or Vintage Scooby Doo. Hence the frantic game of catch-up so many retailers are playing to raise their online visibility. The problem is catch-up can be costly. Just ask any retailer closing stores, one not-quite-lethal cut at a time, and they’ll set you straight.

Mohnish Pabrai’s Approach To Beating The Market – Forbes, January 16, 2017 | Since inception, Mohnish Pabrai has beat the stock market by triple digit returns. What was the key to his success?

Are H&M store sales cannibalising online growth? – Just-Style, May 16, 2016 | Swedish retailer Hennes & Mauritz (H&M) risks cannibalising store sales through the growth of its e-commerce business, analysts believe, adding that this could be detrimental to margins.

Cassandra’s Song – John P. Hussman, January 16, 2017 | While valuations are extremely informative about full-cycle returns and potential risks, returns over shorter segments of the market cycle are primarily driven by the inclination of investors toward risk-seeking or risk-aversion, which is best inferred from market action. The challenge in the recent half-cycle had to do with Fed-induced yield-seeking, which disrupted the historical tendency for deteriorating internals to accompany or quickly follow extreme “overvalued, overbought, overbullish” syndromes as they had in other cycles across history. In the face of zero interest rates, one had to wait for market internals to deteriorate explicitly before taking a hard-negative outlook.

Harnessing automation for a future that works – McKinsey Global Institute, January 17, 2017 | Automation is happening, and it will bring substantial benefits to businesses and economies worldwide, but it won’t arrive overnight. A new McKinsey Global Institute report finds realizing automation’s full potential requires people and technology to work hand in hand.

BlackRock Continues to Impress – Morningstar, January 20, 2017 | We continue to be impressed by  BlackRock’s (BLK) ability to generate solid organic growth, especially considering the size of its operations. With $5.148 trillion in total assets under management at the end of 2016, BlackRock is the largest asset manager in the world. Unlike many of its peers, BlackRock is generating organic growth in its operations with its iShares platform, which is the leading domestic and global provider of exchange-traded funds, riding a secular trend toward passively managed products that began more than two decades ago. We recently increased our fair value estimate to $410 per share from $385 to reflect changes in our assumptions about AUM, revenue, and profitability since our last update.

Think savvy business owners make savvy public investors? Not necessarily – The Globe & Mail, January 19, 2017 | Having talked to dozens of successful private business owners in this country over the years, I have found they generally display a few consistent cognitive characteristics when talking about the operation of their business. Yet, when they invest in the stock market, it is almost as if they have completely lost their senses. As owners they are rational, logical and business-like; as investors they are ruled by emotion and irrationality. So while they have succeeded as private owners, many have failed as public investors. My conclusion after being in the investment business for so long: Public and private owners are not just different; they are opposites. Armed with this foreknowledge, I believe there is opportunity. Let me explain further.

THERE’S A MASSIVE RESTAURANT INDUSTRY BUBBLE, AND IT’S ABOUT TO BURST – Thrillist, December 30, 2016 | Semmelhack is not the only restaurateur looking to duck and cover. The American restaurant business is a bubble, and that bubble is bursting.

Articles in Swedish

Catena Media en tillväxtmaskin – Swedbank, January 17, 2017 | Catena media är ett snabbväxande företag med globala tillväxtambitioner inom en ganska okänd, men betydelsefull nisch av spelsektorn. Swedbank anser att vinsten per aktie kan öka med 150 procent fram till 2019 och tar upp aktien till bevakning med rekommendationen Starkt Köp.

Larmet: Tiotusentals jobb på väg bort – Dagens Industri, 20 januari 2017 | Nästan 42.000 svenska butiksjobb riskerar att försvinna inom mindre än tio år. Den dystra profetian kommer från Svensk Handel, som också varnar för lägre lönsamhet och färre aktörer. ”Tre handelsföretag om dagen går i konkurs”, säger vd:n Karin Johansson.

Uppgifter: Analytiker tvingas ge positiva omdömen – Dagens Industri, 20 januari 2017 | En ny intressekonflikt inom finansbranschen har kommit i fokus i spåren av de krympande courtageintäkterna: att analytiker känner sig tvingade att ge positiva aktierekommendationer för få tillgång till bolagens högsta beslutsfattare, för egen eller för sina kunders del.

Axelssons i konkurs – Dagens Industri, 16 januari 2017 |Modevaruhuset Axelssons har gått i konkurs, rapporterar Katrineholms-Kuriren.

Arctic Securities sänker Fingerprint – Affärsvärlden, 10 januari 2017 | Fingerprint Cards besked till marknaden om sänkt intäktsprognos 2016 vid kapitalmarknadsdagen var nedslående, men risk föreligger för att även prognosen för 2017 kan behöva sänkas.

#WeeklyInvestorReader | wk. 1

Note to readers: #WeeklyInvestorReader contains a few of the articles I read during the week. Visit my Twitter @HurriCap for any other articles that may not have been included. 

The 5 Operating Principles Behind Berkshire Hathaway’s Uniquely Profitable Reinsurance Business – The Motley Fool, January 8, 2017 | In his 2015 letter, Warren Buffett warned Berkshire Hathaway shareholders that prospects for the reinsurance industry had dimmed. However, as this week’s $1.5 billion deal with The Hartford illustrates, five operating principles will enable Berkshire’s reinsurance activity to beat competitors and remain comfortably profitable.

Amazon 2004 Shareholder Letter – Jim Bezos, April 2005 | Jeff Bezos discusses the concept of free cash flow.

Sweden’s new business king takes the long-term view – Financial Times, January 5, 2017 | Fredrik Lundberg is seeking to move Industrivarden on from a business jet scandal.

Week in Review – Financial Times, January 6, 2017 | Christmas blues for retailers, Apple’s App boost, Airbnb, Alibaba and Moutai.

How Amazon innovates in ways that Google and Apple can’t – Vox, December 28, 2016 | In short, Amazon has shown a remarkable ability to succeed in a wide variety of different product categories. That’s a contrast to most other high-profile tech companies that are really good in one area — Google’s dominant online services or Apple’s extraordinarily profitable hardware — but struggle when the quest for growth pushes them outside their zone of core competency.

Hennes & Mauritz: Where Did My Operating Margin Go? – Larsson Group, September 16, 2016 | An investment analysis of H&M.

The TSC Streetside Chat: Robert Wilson – The Street, April 16, 2000 | Despite being wrong about the popularity of gambling in Atlantic City, Wilson made a mint. Today, he tells us how.

Alexa: Amazon’s Operating System – Stratechery, January 4, 2017 | The concept of an operating system is pretty straightforward: it is a piece of software that manages a computer, making said computer’s hardware resources accessible to software through a consistent set of interfaces.

Alphabet, Citigroup, and Other Secret Value Stocks – Barron’s, January 3, 2017 | The Oakmark fund’s Bill Nygren, who beat the market handily in 2016, shares some of his favorite picks.

Disney’s Not Just a Mickey Mouse Investment – Morningstar, January 4, 2017 | Disney’s economic moat is wide. Its media networks segment and collection of Disney-branded businesses have demonstrated strong pricing power in the past few years.

New Mauboussin Report: Looking for Easy Games – How Passive Investing Shapes Active Management

Looking for Easy Games – How Passive Investing Shapes Active Management

“As they say in poker, ‘If you’ve been in the game 30 minutes and you don’t know who the patsy is, you’re the patsy.’” –Warren E. Buffett

  • Investors are rapidly shifting their investment allocations from active to passive management. This trend has accelerated in recent years.
  • The investors leaving active managers are likely less informed than those who remain. This is equivalent to the weak players leaving the poker table. Since the winners need losers, this can make the market even more efficient, and hence less attractive, for those who remain.
  • Active management provides price discovery and liquidity, valuable social goods. However, the fees are higher for active managers than passive ones, identifying skill ahead of time is not easy, and there is a cost to assessing skill.
  • Passive management has lower costs and hence higher returns per dollar invested than active management does in the aggregate. But passive management introduces the possibility of market distortions.
  • Active managers have to constantly ask, “Who is on the other side?” The unrelenting objective is to find easy games, where differential skill pays off.

Click here to read the full report.

See here for a collection of links to other Mauboussin papers.

#WeeklyInvestorReader | wk. 52

Note to readers: #WeeklyInvestorReader contains a few of the articles I read during the week. Visit my Twitter @HurriCap for any other articles that may not have been included. 

How Can I Hurt You? – MicroCapClub, December 27, 2016 | If a competitor had unlimited resources, how quickly could they duplicate the company’s competitive advantage? This is a simple question that I ask myself and management when I try to measure the moat of a microcap company. Microcap companies are small companies and often times vulnerable to larger competitors with more resources. Paraphrased, even further, How Can I Hurt You?, is very powerful.

The Competitive Advantage of Disney – The Conservative Income Investor, December 27, 2016 | In 2012, Disney made an acquisition of LucasFilms for “only” $4 billion. Because the Star Wars franchise has now generated $2 billion in profit in the four years since making the acquisition, many casual commenters are observing that Disney got a steal of a deal.

Alexa, What Should Investors Know About Amazon? – Morningstar, December 28, 2016 | On Dec. 27, Amazon noted that sales of its Alexa-enabled Echo devices increased more than 9 times over last year’s holiday sales, which could imply 4 million-5 million Alexa units sold to date, based on third-party estimates.

The Conjunction Fallacy Explains Why People Believe Fake News – Slate, December 19, 2016 | This fallacy warns that stories with more facts sound more believable, even though they’re actually less probable.

A Half-Dozen Ways to Look at the Unit Economics of a Business – Tren Griffin, December 31, 2016 | Amazon and Netflix are examples of the same value creation phenomenon as are many businesses that John Malone has created over the years. This post will try to help people understand why this is true.

Donald Trump’s market-moving tweets are a huge scandal waiting to happen – Los Angeles Times, December 23, 2016 | An undercurrent of amusement has been detectable in some of the news coverage of Donald Trump’s recent market-moving tweets, as though it serves big companies right to have a few billions stripped off their market values because the president-elect is holding them to account.

The Chevy Bolt Is the Ugly Car of the (Very Near) Future – Bloomberg, December 19, 2016 | With brilliant financial engineering, GM beats Tesla to the punch.

Surging Buybacks Say Stock Boom Isn’t Over – Wall Street Journal, December 26, 2016 | Stock repurchases have spiked in December on expectations of tax cuts, which could put more money in corporate coffers

Glenn Greenberg: the world’s greatest investors – MoneyWeek, December 23, 2016 | Glenn Greenberg was born in New York in 1947, the son of baseball player Hank Greenberg. After studying English at Yale and New York University, he set up Chieftain Capital Management with John Shapiro in 1984. In 2009 they split and he founded Brave Warrior Advisors, which manages nearly $3bn worth of assets.

HOW PHIL KNIGHT BUILT NIKE INTO A $100 BILLION GLOBAL EMPIRE – Maxim, September 29, 2016 | Find out Nike’s high-flying founder became the Sultan of Swoosh.

Are You Solving the Right Problems? – Harvard Business Review, September 29, 2016 | How good is your company at problem solving? Probably quite good, if your managers are like those at the companies I’ve studied. What they struggle with, it turns out, is not solving problems but figuring out what the problems are.

Biggest Billionaire Gainer Of 2016: Warren Buffett’s Fortune Surges More Than Anyone Else In America – Forbes, December 27, 2016 | Shares of Warren Buffett’s firm Berkshire Hathaway soared 20% in 2016, helping to boost Buffett’s personal fortune by $12.3 billion – more than any other billionaire in the United States. The Oracle of Omaha is now worth $74.2 billion, enough to make him the 2nd-richest person in the world (behind only Bill Gates, who is worth $84 billion), according to FORBES’ calculations.

Not Everyone Wants to Shop on Amazon – Wall Street Journal, December 29, 2016 | Roughly 22 million U.S. households didn’t use the retailer this year.

Make the Risk Premium Small Again – Antonio Fatas on the Global Economy, December 29, 2016 | In one my previous posts I looked at the stock market valuations in the US to conclude that they were in line with recent historical data. In fact the stock market looked cheap relative to most years since the mid 1980s. But that was before the US election! Since the election the stock market has gone up and interest rates have gone up as well. How do stock market valuations look like today?

Are mergers good or bad for the economy? – CBS Money Watch, December 29, 2016 | This year sure was a busy one for mergers and acquisitions. In October alone, nearly $490 billion of deals were announced, including AT&T’s (T) purchase of Time Warner (TWX) for $85.4 billion. While that massive telecom-media combination got plenty of headlines, most people pay little attention to mergers between firms, or the acquisition of one firm by another.

The key takeaway from Bill Gates and Warren Buffett’s all-time favorite book – CNBC, December 24, 2016 | “There’s an essential human factor in every business endeavor. It doesn’t matter if you have a perfect product, production plan and marketing pitch; you’ll still need the right people to lead and implement those plans.”

Five industries under threat from technology – Financial Times, December 26, 2016 | Travel agents, manufacturers, insurers, advisers and car repair garages face strain.

Don’t Get Trumped in 2017 – Pragmatic Capitalism, December 26, 2016 | Anyhow, the big trend this year was clear – 2017 will be all about Trump. And as we’ve seen in the media in recent weeks, Trump is perceived as very bullish for the stock market. In fact, a few people even admitted that they’d sold all their bonds and loaded the boat with stocks following the election.

Article in Swedish

Jan Jörnmark: Subventioner orsaken till dysfunktionell bomarknad – Dagens Industri, December 26, 2016 | DEBATT DEL ETT. Under mellandagarna kommer Jan Jörnmark att skriva om bostadspolitiken och dess problem. Ursprunget till dagens situation finns i hyresregleringen från 1942, som också innefattade en kontroll av priserna på bostadsrätter och statligt belånade villor, skriver han i den första delen.

Jan Jörnmark: Sverige har ingen bostadsbubbla – Dagens Industri, December 27, 2016 | DEBATT DEL TVÅ. I del två i serien om den svenska bostadsmarknaden behandlas utvecklingen i storstäderna. Allvarligast är att det som egentligen är en massiv förändring av relativa priser på olika bostäder har kommit att tolkas som en bubbla, skriver Jan Jörnmark.

Jan Jörnmark: Bygglagen uppmuntrar inte bostadsproduktion – Dagens Industri, December 28, 2016 | DEBATT DEL TRE. I den tredje delen i serien om bostadsmarknaden har turen kommit till lagarna som reglerar bostadsproduktion. Följden av dem blir en fortsatt stadsutspridning, med de negativa miljömässiga och mänskliga konsekvenser som det har, skriver Jan Jörnmark.

Jan Jörnmark: Nya lagar vägen framåt för bostadsmarknaden – Dagens Industri, December 29, 2016 | DEBATT DEL FYRA. Den avslutande delen i artikelserien om den svenska bostadsmarknaden handlar om framtiden. Först måste vi erkänna att ”bostadsbristen” är ett efterfrågeöverskott på en viss typ av mycket lågt prissatta centrala lägenheter, skriver Jan Jörnmark.