Readers Discuss charlie479

No victor believes in chance. – Friedrich Wilhelm Nietzsche

Thanks to contributions from two readers, Chai and “TC”, who analyzed charlie479–the author of these case studies:http://wp.me/p1PgpH-cghttp://wp.me/p1PgpH-dc and http://wp.me/p1PgpH-cT we can learn what they gained from the cases.

Please excuse the light editing. Chai says,

Three key distinct lessons stand out. First, the key to long-term wealth creation is to invest in compounders i.e., stocks that can grow profitably and preferably with high pricing power and operating leverage and hold on as long as possible. Time would do the compounding magic. While investing in short-term oriented special situations may give you a return uplift you will still face capital reinvestment risk to find another good investment for redeployment of capital.

Secondly, great performance results come from investing in compounders at a valuation as low as possible. Compounders are rare but not cheap, true compounders are even rarer. This means you have to be willing to look at ugly situations (e.g., European stocks now?) or try to identify and recognize the sources of competitive advantage of the companies before anyone else (sometimes maybe even before the management themselves recognize the potential).

Thirdly, it’s crucial to always go to primary sources: 10k, Merger Proxy etc. and not to rely on secondary sources media to gain true informational advantage.

Questions

Separately while I am still trying to catch up on the material on Value Vault and your site, a few questions while reading this interview came out are:

(1) How concentrated should a portfolio be i.e., how should you size your portfolio? I know ultimately it would have to be dependent on your risk appetite / temperament (and perhaps if you are a fund manager, your investors expectation) etc. but would be keen to learn your perspective on this. If you use a 5-stock or 10 stocks approach, how do you rank various investment opportunities to take into consideration of non-quantitative consideration such as business quality aside from pure risk-reward /upside-downside ratio?

My reply: Prof. Greenblatt uses the example of the man who inherits $1 million and he has to invest it within 50 miles of where he lives. He wouldn’t put $1,000 in 1,000 businesses. He would walk around looking to put $100,000 to $200,000 in 5 to 10 businesses–the best businesses at the lowest prices he could find. If you can find great businesses at attractive prices then 6 to 8 positions diversify out 83% to 88% of the market specific risk. If you have only 6 positions then each position is 16.67% of your portfolio. If you get the following results over two years:

$16.67

$0.00

$16.67

$5.00

$16.67

$8.00

$16.67

$25.00

$16.67

$34.00

$16.67

$66.68

$100.02

$138.68

$136.89

cagr 17%

Most could not stomach the volatility in each stock but overall the portfolio does well. You really have to be unlucky/bad to get a goose egg or lose more than 50%, but your winners are what drive the returns.  Buying these compounders that can redeploy capital at high rates is nirvana, but exceedingly difficult and rare to do.

All investing involves context. But you have to choose a philosophy and method that fits you.  And you also must know the nuances with the approach. Charlie479 is buying companies that can compound their capital by both being very profitable and by redeploying their capital at high rates. Since these are difficult to find and buy he owns few of them and holds them to allow the compounding to work.  For example, I believe Morningstar (Morn) is one example, but the price is too high for my understanding. But I do want to invest as much as possible in these—even no more than 4 or 5 if they have all the signs of a good investment.

But if I was buying net/nets then I might own 5 to 10 companies in a sector—playing a numbers game. If I am buying stable franchises I might by 20 to 25 names because I have no edge other than price.  Also, I have to be quick to sell if the price closes my estimate of intrinsic value because then my return is only the return on equity over time. I am taking a long record of stability as my benchmark rather than my edge in understanding of how long the company can maintain its competitive advantage. I assume the company will hold onto it while I am an owner (the odds favor the strong) but I will be wrong occasionally, of course, as franchises (Nokia, Newspapers, radio) get breached or destroyed.

(2) The issue of price vs. business risk. What should one do when share price drops by 25%, 50% of 75%? What if you re-examine the investment thesis and the business risk seems to stay intact, do you double up your stake – given it’s a better bargain now? Do you sell out- perhaps partially as prudent measure just in case your analysis is wrong? Or to stay put?

Reply: All answers rely on context. Are you right or wrong? If you are wrong then you go down with the ship. What specific areas do you have to understand to know that you are wrong?  Certain businesses are much riskier operationally then others (selling steel vs. soap). If the assets are solid and the company has no debt and the reason the price is dropping is due to mismanagement (earnings power value below asset value) and you know a strong activist value fund taking a large position, then perhaps you can double up. But, again, what are your choices? Perhaps while this is happening there are even better opportunities elsewhere? Or the tax loss is a good asset to have against an equivalent gain in another new position.   There are so many variables, a precise answer is impossible.

Charlie Munger would tell you, “The importance of knowing what you know and don’t know. There is a lot of wisdom in this remark from Eitan Wertheimer: “I had a big lesson from Warren: the use of the word discipline…We learned very quickly that our most important asset is our limitations… the second thing we understand is that when we respect our limitations we don’t suffer from them anymore.”

(3) Cash portion of portfolio. What shall be the cash % a portfolio should have? I see that both charlie479 and Seth Klarman routinely set aside 25 – 30% cash. I would have thought instead of letting the cash sitting idle, it could be better deployed by upsizing into existing positions given these positions are well researched?

Cash allows them future optionality. Also, they allow for being wrong. You never know.  Cash can build up because you sell one position or part of it and you can’t redeploy the capital at the prior discount to intrinsic value thus you wait until an opportunity arises and you don’t do anything stupid with cash burning a hole in your pocket.

I will ask Confucius, Buffett and Dwight Schrute (the Office) to help with your question.

In no particular order of wisdom:

Dwight Schrute– The secret to investing is not being an idiot (15 second video) http://www.youtube.com/watch?v=yVqhxMEf1jc&feature=related

Confuscius: “The superior man, when resting in safety, does not forget that danger may come. When in a state of security he does not forget the possibility of ruin. When all is orderly, he does not forget that disorder may come. Thus, his person is not endangered, and his States and all their clans are preserved.”

As Buffett said (about absence of the need to invest all the time): “You only have to do a few things right in your life as long as you don’t do too many things wrong.” Also, Seneca said, “The mind must be given relaxation; it will arise better and keener after resting.”

I wish I could give you easy rules to follow, but investing is an art more than a science and the biggest part of your investing success is YOU. Spend time thinking about your inherent flaws as well as the next 10-K.

“TC” comments on the charlie479 interview

Prior to even being interested in the stock market, charlie479 developed two excellent traits for successful investing – he was confident in his ability to solve problems, and he questioned conventional wisdom.

Charlie learned early on that investing in high quality, undervalued equities and allowing them to compound over many years was far superior (both in terms of excess return and the required effort) to the analysis and investing he was doing in his day job).

Charlie resonated with Buffet’s twenty punches philosophy. He realized (separately) that finding high quality companies at low valuations did not occur often, and portfolio concentration allowed him to take full advantage of his best ideas while acting a filter on those that did not make the cut. Buffet’s quote was reassuring to him, that yes, taking a 25% position in your best idea does not make you crazy, it makes you intelligent!

Charlie focuses much of his effort on the qualitative side of his analysis – knowing the industry well and a deep dive on the competitive advantages and their sustainability at the company level. I get the impression he would first identify a high quality company by its quantitative factors – high ROIC relative to peers, high margins, etc. but would then thoroughly explore the qualitative causes of this advantage. A critical component of his best ideas was that they could reinvest their cash flows and earn similar high levels of return on large amounts of capital – i.e., a long and wide runway.

What I learned:

It is nice to see someone investing successfully with a model of extreme concentration. Buffet and Greenblatt preach it, but Charlie proves once again it can be done.

In my opinion, the best part of a concentrated portfolio is that, with fewer investment decisions, I can devote more time to finding more ideas, or doing non-investment related things. A common complaint I hear from fellow investors is they don’t have enough time to find good ideas. Portfolio concentration fixes this problem.

I love his analogy of investors jumping from fire to fire, trying to determine if the stock is worthy of investment, while he seems to do his preparation well ahead of making a buying decision. This sounds like what people do who are following the 52-week low list. Right out of Buffet’s playbook, he follows many high quality companies on a regular basis and reads 10-ks consistently – two of his investment examples showed this (7-10 years of following I believe). I can picture him thumbing through a 10-k asking himself “is the competitive advantage still present? Does the company still have a long runway for reinvestment?”

If Charlie is able to find these type of companies at low prices, it means the market does not always see the true competitive advantages underlying a company – even if you can know their presence from a quantitative standpoint. Having an absolute understanding of a company’s competitive advantages is an edge over the market, and the confidence to load up when the price is right.

I hope you found my report satisfactory!

My reply: Yes, excellent insights and thanks for sharing your thoughts. You noticed charlie’s inquisitive, skeptical mind and his disciplined habit to read original documents like 10-ks not broker reports.  Also, this investor thinks deeply about what creates and sustains an excellent business. Well done.

I  will post a few more case studies of charlie479 as good examples of an investment thesis.

5 responses to “Readers Discuss charlie479

  1. Do you know who is Charlie479?

  2. What does Charlie do full time? Wouldn’t it be tough to raise capital if you tell investors that there may be years at a time without an investment?

    How many positions does he maintain, because his VIC ideas aren’t many.

    • Go into the Value Vault and see interview with Charlie for your answer. His focus is on returns not asset gathering. Also, in investing, activity does not equal results otherwise day traders would be on the Forbes Richest list.

  3. NOKIA: June 15 2012–Technology is Brutal When the Moat is Lost:

    Nokia to Cut 10,000 Jobs and Close 3 Facilities
    By KEVIN J. O`BRIEN
    Published: June 14, 2012

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    BERLIN — Nokia said Thursday it would slash 10,000 jobs, or 19 percent of its work force, by the end of 2013 as part of an emergency overhaul that includes closing research centers and a factory in Germany, Canada and Finland, and the departures of three senior executives.

    The company also warned investors that its loss was likely to be greater in the second quarter, which ends June 30, than it was in the first, and that the negative effects of its transition to a Windows-based smartphone business would continue into the third quarter.

    Nokia, based in Espoo, Finland, posted a loss of €929 million, or $1.2 billion, in the first quarter as sales plummeted 29 percent. Once the undisputed global leader in the mobile phone business, Nokia has been outcompeted by Apple, as well as by Samsung and other makers of handsets running Google’s Android operating system.

    In February 2011, Nokia and Microsoft announced an alliance to produce a line of smartphones called Lumia running the Windows operating system.

    Since then, the Finnish company has seen its sales fall and profit evaporate as consumers and operators have avoided, or demanded discounts on, smartphones running Nokia’s in-house Symbian operating system, which the company is phasing out. Although Lumia devices have won critical praise, sales have not been strong enough to offset declines in its main business.

    “These planned reductions are a difficult consequence of the intended actions we believe we must take to ensure Nokia’s long-term competitive strength,” said Stephen Elop, the Nokia chief executive and a former Microsoft executive. “We do not make plans that may impact our employees lightly, and as a company we will work tirelessly to ensure that those at risk are offered the support, options and advice necessary to find new opportunities.”

    The company said the job reductions, and the shutdowns of research and development centers in Ulm, Germany, and Burnaby, Canada, and a handset factory in Salo, Finland, would save €1.6 billion by the end of next year.

    As part of its streamlining, Nokia announced the sale of its luxury handset business, Vertu, to EQT VI, a European private equity firm, for an undisclosed price. The company also said it had purchased Scalado, a maker of smartphone imaging technology that is based in Lund, Sweden. It did not say what it paid for Scalado. Further, Nokia said it would “closely assess the future of certain noncore assets.”

    In a conference call with journalists, Mr. Elop suggested that Nokia Siemens Networks, the company’s 50-50 network equipment venture with Germany’s Siemens, which lost a combined €986 million in 2010 and 2011, could be one of the businesses in the focus of its future review. Mr. Elop declined to describe Nokia Siemens as a noncore asset but said the network gear maker’s restructuring, now in its second year, was designed to make it more attractive for potential investors.

    “What we have said is that Nokia Siemens is going through its own restructuring and we are pleased with the efforts so far,” Mr. Elop said. All the restructuring is being done to make it “a more independent entity in future,” he added. “As that proceeds, we will make a determination to see what the future holds.”

    Nokia said 3,700 of the planned 10,000 job to be cut would take place in Finland. The handset factory in Salo to be closed is Nokia’s largest in the country, and about 850 employees will be affected there by the reductions. Nokia plans to keep a research center in Salo open.

    Pete Cunningham, an analyst at Canalys, a research firm in Reading, England, said the cuts by Nokia were not surprising given the intense competition from Apple, the global leader in smartphones, and Samsung, the South Korean rival that overtook Nokia this year as the world’s largest bulk maker of cellphones.

    “It is an unfortunate but necessary action to streamline the business to ensure that it has the best chance of competing,” Mr. Cunningham said. “Apple and Samsung are really turning the thumbscrews on the rest of the market. Nokia is having to work very hard to make its Lumia handsets attractive due to the lack of traction that Windows Phone has in the market today.”

    Shares of Nokia were down 9.4 percent Thursday in Helsinki trading.

    Nokia employed 53,553 workers in its handset business at the end of March. The company also had 68,595 employees in Nokia Siemens.

    The Nokia executive responsible for Nokia’s bulk handset business, Mary T. McDowell is one of three senior level executives who will be leaving the company at the end of this month, Nokia said. Jerri DeVard, the chief marketing officer, and Niklas Savander, the executive vice president of markets, will also leave.

    Ms. McDowell, an American and a former Hewlett-Packard executive, had been with Nokia since 2004. Ms. DeVard, an American who had worked in marketing at Verizon, Citigroup and Revlon, had joined Nokia in January 2011. Mr. Savander, a Finn, had served in a variety of senior roles since joining Nokia in 1997.

    Nokia promoted three Finnish citizens and two Americans as replacements. Juha Putkiranta was named executive vice president of operations; Timo Toikkanen was appointed executive vice president of mobile phones; Chris Weber, an American, was named executive vice president of sales and marketing; Tuula Rytila was appointed as senior vice president of marketing and chief marketing officer; and Susan Sheehan, an American and former Microsoft executive, was named senior vice president of communications.

    Ilkka Rauvola, an analyst at Danske Bank in Helsinki, said that while the profit warning might hurt shares in the short term, Nokia appeared to be addressing its core challenges for the long term. “It looks to me that management is taking action and doing what they need to do,” Mr. Rauvola said.

    Mr. Elop, the Nokia chief, said the cost savings and job cuts were intended to return Nokia to profitability “as soon as possible.” He said Nokia, which reported net cash reserves of €4.9 billion at the end of March, had “ample” resources to weather the transition.

    But Francisco Jeronimo, an analyst with International Data in London, said Nokia was running out of time to return to profitability and prove the success of its strategy to align its business with Microsoft, the world’s largest maker of software.

    “They have been announcing job cuts almost every quarter,” Mr. Jeronimo said. In the year through March, Nokia had cut 11,169 jobs, or 17 percent of its work force. “They need to tell the market when they plan to return to profitability, or else they will become a takeover target themselves by the end of this year.”

    Mr. Jeronimo said Microsoft would be the most likely suitor for Nokia, whose share price has fallen by 75 percent since the company announced its Windows strategy last year.

    “The integration of software and hardware is key to Apple’s success and the reason why Google has bought Motorola’s handset business,” Mr. Jeronimo said. “Microsoft would benefit most from the acquisition.”

    Both companies have declined to comment on market rumors about a pending takeover. In the conference call, Mr. Elop described Nokia’s relationship with Microsoft as fruitful and close, saying that both companies expected a boost from the upcoming introduction of the Windows 8 operating system, which will have enhanced mobile features and allow for the integration of services across smartphones, tablet computers and other computing devices.

    A major question is whether Nokia on its own can bridge the transition to a Windows-based future.

    Nokia told investors that it expected its second-quarter operating loss in its devices and services segment, its main business, to be greater than the 3 percent of sales recorded in the first quarter. The company had previously said the second-quarter loss could be equal or more than the loss in the first quarter.

    “With these planned actions, we believe our devices and services business has a clear path to profitability,” said Timo Ihamuotila, the Nokia chief financial officer, said. “Nokia intends to maintain its strong financial position while proceeding aggressively with actions aimed at creating shareholder value.”

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