Category Archives: Valuation Techniques

Ask the Right Questions



cfa-society-of-chicago-june-2015-final  Note pages 16 through 18 on Grainger and Fastenal.   GWW_VL Jul 2014  and Fast VL.   Since the prices are high and their gross margins are way above the competition, what can change that?  Ask the right questions.


Hallador Energy, Inc. (HNRG) Valuation Attempt


A Reader Writes:
John, Here’s my quick and dirty for Hallador:
Currently not screaming cheap.
Hallador has traded to .6 book before. Current 1.2x. Highest is 4.4 or 30.36 ($4.14-$30 2015 TBV)
ev/ebitda 3mth op. inc + depr = 22341000/.25 to annualize = 6.9

industry multiple (still using the same from CLD) is 8.91

for approx 58.65 – 61.8  TBV is 6.8. Current price is 8.42.

It is making money (not a pure coal company; has oil/gas assets). From VL, it has cash flow after capex, 10% cap of 6.5 for no growth value.
It’s not a bad coal company after buying sunrise coal. The negative thing is its coal is high sulphur whereas CLD has all <1% SO2 coal (some <.5%). China recently announced a ban on high sulphur content coal. Existing shipments from Australia and South Africa in China cannot be used.
It does not break down its international shipments, but gauging CLD exports, its not much. around 4.7mt total shipments.
The thing I need to look into is how the coal companies booked their profits. Using newcastle 2014 price? Currently it is 59.6.
Hallador has good average per ton cost.
2 main areas of coal in the US. East and West.
East is higher while West is lower (CLD is lower because of transportation cost). Hallador has a 11.9 margin per ton with avg cost/ton at 31.43 and price/ton 43.3 as its mine are in the Eastern zone.
As a comparison, ANR’s 2014 Eastern cost/ton is 61.66. And Western 11.5. CLD still lowest but they have only mines in the West.
There was a report earlier in the week about POSCO in talks with Peabody about asset sales or product sales. They may be talking to others. One of the miners in Mongolia announced sales contract to Seoul today. Mongolia coal has a low sulphur too; however, after the Oyu Tolgoi deal recently, top 20 stocks there had a momentum run, and are not cheap. Another market I will look at is Indonesia. The government there has announced plans to remove mining export ban that they blamed on excessive nationalism. Indonesian coal has poor BTU but low sulphur. Also, these things will take a long time to sort out. Maybe next year. Just some things to keep an eye on. There is a special situation SGX catalist stock I’m waiting to see. It has become the parent company of a mongolian miner (2.6x book so not cheap anymore after the run up) and intend to hold other Mongolian coal assets. Will write when I know more.
Looking forward to seeing your write up.
Thank you,

Valuing a Coal Company, Step 1: Will the Industry Survive?


Is the Coal Industry Dead?

The key point is to try to disprove your thesis. Seek out the negatives and the counter-arguments, then make a reasoned decision to invest, not invest, short, stand-aside and wait, or dig further.

Lots of bad news hitting the coal industry: China slow-down, EPA Rules, falling natural gas prices, falling met and steam coal prices, President Obama says he will put coal out of business (supposedly)

HARD TIMES for US-coal-producers/

Coal five year

met coal

Nat Gas

2015 is the reckoning for coal:

EPA Regulations Hit Economic Reality:

Will there be a coal industry over the next few decades in order to determine whether to use liquidation or going-concern value?

We seek to buy cyclical assets when there are NO REASONS to buy, the companies in the industry have depressed profits or large losses, and there seems to be no hope for the industry (Remember Airlines 9/11). However, we wish to avoid investing in Canal companies during the advent of the steam locomotive because then there is a permanent decline in asset value because long-term cash flows are driven by capacity constraints and customer demand changes.  Thus, we first try to answer this post’s question.

Let’s break down the energy producing statistics.

According to the Independent Statistics and Analysis Energy Information Administration, here’s how the nation’s electricity was generated in 2014:

  • ■ Coal: 38 percent
  • ■ Natural gas: 27 percent
  • ■ Nuclear: 19 percent
  • ■ Hydropower: 6 percent
  • ■ Other renewables: 7 percent, including
  •       — Biomass: 1.7 percent
  •       — Geothermal: 0.4 percent
  •       — Solar: 0.4 percent
  •       — Wind: 4.4 percent
  •       — Other gases: 1 percent

So let’s take the 38 percent of coal production out of the mix. Where’s the energy going to come from? It’s not. Therefore, we’re left with nothing but periods of darkness.


Books on the Coal Industry and Coal’s History

Big Coal

Long dismissed as a relic of a bygone era, coal is back — with a vengence. Coal is one of the nation’s biggest and most influential industries — Big Coal provides more than half the electricity consumed by Americans today (2006) — and its dominance is growing, driven by rising oil prices and calls for energy independence. Is coal the solution to America’s energy problems?

On close examination, the glowing promise of coal quickly turns to ash. Coal mining remains a deadly and environmentally destructive industry. Nearly forty percent of the carbon dioxide released into the atmosphere each year comes from coal-fired power plants. In the last two decades, air pollution from coal plants has killed more than half a million Americans. In this eye-opening call to action, Goodell explains the costs and consequences of America’s addiction to coal and discusses how we can kick the habit.

Coal WarsThe Moral Case for fossil fuels

We need fossil fuels

Current policies to supplant fossil fuels with inferior energy sources need to incorporate a deeper understanding of the transformative role of energy in human society lest they jettison the wellsprings of mankind’s greatest advance.

The thesis of this paper is that fossil fuels, as a necessary condition of the Industrial Revolution, made modern living standards possible and vastly improved living conditions across the world. Humanity’s use of fossil fuels has released whole populations from abject poverty. Throughout human history, elites, of course, have enjoyed comfortable wealth. No more than 200 years ago, however, the lives of the bulk of humanity were “poor, nasty, brutish and short,” in the words memorably used by Thomas Hobbes.

This paper aims to articulate and explain some startling, but rarely acknowledged, facts about the role of energy in human history. Energy is so intimately connected to life itself that it is almost equivalent to physical life. Virtually everything needed to sustain the life of a human individual—food, heat, clothing, shelter—depends upon access to and conversion of energy. Modern, prosperous nations now access a seemingly limitless supply of energy. This cornucopia, however, is a very recent advance in mankind’s history. Fossil fuels, methodically harnessed for the first time in the English Industrial Revolution, beginning in the 18th century and taking off in the 19th century, have been a necessary condition of prosperous societies and of fundamental improvements in human well-being.

Adequate treatment of this topic is a daunting task for anyone. The unprecedented stakes in today’s contentious energy policy debates about carbon, however, make it a morally necessary topic. As a former final decision-maker in a large environmental regulatory agency, I urge current officials and concerned citizens to reflect on energy policies within a broad but fundamental context: human history and the physics of material lives.

My research was initially inspired by a comprehensively researched monograph by Indur Goklany titled “Humanity Unbound.” His paper took me to a dozen books and twice as many academic papers. With gratitude, I acknowledge the books listed below as the most enlightening, persuasive guides on the topic. And I highly recommend them for more thorough analysis than allowed by the confines of this paper. May those policymakers entrusted with the authority to make binding decisions about energy consider these books as “a look before an unreflective leap” that could unravel mankind’s greatest achievement—
the potential enjoyment of long, comfortable, healthy lives without the gnawing hunger of subsistence poverty.

moral case for FF Epstein


Yes, fossil fuels have fueled our progress through the industrial revolution into the information age. But we have over-used them and fouled our nest. We could and can shift rapidly to renewables, but big oil greed obstructs us.  (Really?) As Pope Francis says, we have made the earth into “an immense pile of filth.” Own it.

The first big flaw that tragically happens to be the binding of the entire book (and in the title) is his thesis that fossil fuels is what causes human flourishing. No. INDUSTRIALIZATION is the underlying mechanism hat has created the exponential increase in human progress. Fossil fuels was just the first way of converting potential energy to mechanical energy. And it was a good one, but we need to move on to a more advance potential energy source. Luckily exponential growth in renewables and other advanced technologies has just started to gain heavy heavy steam.

By Donald Prothero on February 8, 2015

As an actual Ph.D. geoscientist who HAS WORKED for oil companies, written textbooks in geology of oil, and also done actual published research in climate change in peer-reviewed journals, I can say this work is pure garbage. Epstein cherry-picks climate data he doesn’t understand (as the review by Kathy Moyd pointed out), denies the conclusions of an entire scientific community who are NOT paid to shill for industry, and denies the obvious evidence of climate change going on worldwide. Then he distorts the benefits of fossil fuels and neglects or underplays the problems. The biggest problem of all is that (as all of us who are in the industry know so well), we’re past the peak of Hubbert’s curve and oil isn’t going to be cheap for the uses he brags about much longer.    (CSInvesting: Whether fact-based, true or untrue, all this critic asserts is not backed up with evidence–an assertion is not an argument.)  Appeal to authority argument–I’m in the industry and brilliant, you’re an idiot, so listen up!

Once the Saudis stop flooding the market with cheap oil to drive out the competition, it will pick up again to the levels of demand that anyone in the oil futures business knows so well, and we’ll be unable to use it for cheap plastics, fertilizers, pesticides, and all the other stuff that we wasted nearly all the planet’s oil heritage on. The moral case is clearly that we need to wean ourselves OFF of using up the last remaining oil so quickly before it reaches its true levels of scarcity, and it’s irresponsible to encourage people to use it up faster.
As all of my co-workers in the oil industry (and the students I trained who are now high in the business as well) know, oil is getting scarcer and scarcer, and the last thing we need to do is use it up faster and crash the global economy. Most of my colleagues in oil also agree that climate change is a serious problem–even though the bosses at ExxonMobil and Koch are bankrolling the climate denial lobby. Before you believe garbage by an industry hack with no actual training in the field, listen to those of us INSIDE the industry and INSIDE the climate science community. Our future is at stake when we make bad decisions based on crummy books like this!   (CSInvesting: I am an expert, therefore all my assertions are correct.   What’s to argue?  What better way to move to renewable energy than to let the free market decide to price oil at $1,000 a barrel–therefore making nuclear or hydro power more economic).

Environmentalists are evil: George Reisman-

Here’s David M. Graber, in his prominently featured Los Angeles Times book review of Bill McKibben’s The End of Nature: “McKibben is a biocentrist, and so am I (See video of debate below). We are not interested in the utility of a particular species or free-flowing river, or ecosystem, to mankind. They have intrinsic value, more value—to me—than another human body, or a billion of them.… It is cosmically unlikely that the developed world will choose to end its orgy of fossil-energy consumption, and the Third World its suicidal consumption of landscape. Until such time as Homo sapiens should decide to rejoin nature, some of us can only hope for the right virus to come along.”

And here’s Prince Philip of England (who for sixteen years was president of the World Wildlife Fund): “In the event that I am reincarnated, I would like to return as a deadly virus, in order to contribute something to solve overpopulation.” (A lengthy compilation of such statements, and worse, by prominent environmentalists can be found at Frightening Quotes from Environmentalists.)

There is no negative reaction from the environmental movement because what such statements express is nothing other than the actual philosophy of the movement. This is what the movement believes in. It’s what it agrees with. It’s what it desires. Environmentalists are no more prepared to attack the advocacy of mass destruction and death than Austrian economists are prepared to attack the advocacy of laissez-faire capitalism and economic progress. Mass destruction and death is the goal of environmentalists, just as laissez-faire capitalism and economic progress is the goal of Austrian economists.

And this is why I call environmentalism evil. It’s evil to the core. In the environmental movement, contemplating the mass death of people in general is no more shocking than it was in the Communist and Nazi movements to contemplate the mass death of capitalists or Jews in particular. All three are philosophies of death. The only difference is that environmentalism aims at death on a much larger scale.

Despite still being far from possessing full power in any country, the environmentalists are already responsible for approximately 96 million deaths from malaria across the world. These deaths are the result of the environmentalist-led ban on the use of DDT, which could easily have prevented them and, before its ban, was on the verge of wiping out malaria. The environmentalists brought about the ban because they deemed the survival of a species of vultures, to whom DDT was apparently poisonous, more important than the lives of millions of human beings.

The deaths that have already been caused by environmentalism approximate the combined number of deaths caused by the Nazis and Communists.

If and when the environmentalists take full power, and begin imposing and then progressively increasing the severity of such things as carbon taxes and carbon caps, in order to reach their goal of reducing carbon dioxide emissions by 90 percent, the number of deaths that will result will rise into the billions, which is in accord with the movement’s openly professed agenda of large-scale depopulation. (The policy will have little or no effect on global mean temperatures, the reduction of which is the rationalization for its adoption, but it will have a great effect on the size of human population.)

It is not at all accidental that environmentalism is evil and that its leading spokesmen hold or sanction ideas that are indistinguishable from those of sociopaths. Its evil springs from a fundamental philosophical doctrine that lies at the very core and deepest foundations of the movement, a doctrine that directly implies the movement’s destructiveness and hatred of the human race. This is the doctrine of the alleged intrinsic value of nature, i.e., that nature is valuable in and of itself, apart from all connection to human life and well being. This doctrine is accepted by the movement without any internal challenge, and, indeed, is the very basis of environmentalism’s existence.

As I wrote in Capitalism, “The idea of nature’s intrinsic value inexorably implies a desire to destroy man and his works because it implies a perception of man as the systematic destroyer of the good, and thus as the systematic doer of evil. Just as man perceives coyotes, wolves, and rattlesnakes as evil because they regularly destroy the cattle and sheep he values as sources of food and clothing, so on the premise of nature’s intrinsic value, the environmentalists view man as evil, because, in the pursuit of his well-being, man systematically destroys the wildlife, jungles, and rock formations that the environmentalists hold to be intrinsically valuable. Indeed, from the perspective of such alleged intrinsic values of nature, the degree of man’s alleged destructiveness and evil is directly in proportion to his loyalty to his essential nature. Man is the rational being. It is his application of his reason in the form of science, technology, and an industrial civilization that enables him to act on nature on the enormous scale on which he now does. Thus, it is his possession and use of reason—manifested in his technology and industry—for which he is hated.”

Thus these are the reasons that I think it is necessary for people never to describe themselves as environmentalists, that to do is comparable to describing oneself as a Communist or Nazi. Doing so marks one as a hater and enemy of the human race.

Climate Change Caused by Man? List_of_scientists_opposing_the_mainstream_scientific_assessment_of_global_warming

For and Against Fossil Fuels

Valuing a Coal Company: How Do We Start?


From a reader: Hi John,

Thank you for the library access to VL. Responses about Value-Line from the group have been underwhelming. Got zero replies for discussion about coal or other topics. Most people just ask for certain industries (REIT, Insurance, Chemicals), so I tried to make it interesting by asking for a “quick and dirty” valuation in return for VLs, but I did not get the promised short write ups. So I have stopped uploading to the group for now.

John Chew: Sorry to hear that, but, on the other hand, most folks are too busy and distracted to do the hard work–therein lies our opportunity.

I’m trying to value Cloud Energy and am not sure how to go about it. Its proven and probable reserves are 1.1billion tons. With an average margin of $3.2 since 2010 (selling price per ton – average cost per ton), this works out to 1.1×3 or 3.3 total value of coal. But the variation low is about 2.24. Cloud makes money and is able to service debt. It is also trying to cut cost. The coal value works out to 3.3/61mil sh outstanding or about 40-$51/sh.  The highest it has traded is half this value. I understand the problems with coal now (cheap oil, natural gas, environment, competition from other suppliers), but would like to know what it is worth.

I’ve looked on your blog for examples for asset type companies, but you have not posted some like RGLD, FNV, SLV etc. The case studies on CRR and other nuggets like determining the per unit value and spread (for gold) were helpful. Could I get your write up for coal and gold?

John Chew: Ask what would you need to know to own a coal company outright? If this was one of your lifetime investments what would you look for?

If I wanted to buy a coal company outright, I would want a productive asset. How much coal is it selling, price, what it costs them to dig it out of the ground and get to market, and how much it has left, whether it is sustaining itself and has costs under control.

CLD operates ok and management is doing what it can to cut costs to weather the industry downturn.

EV/EBITDA is 4.54, almost half 8.9 industry EV/EBITDA multiple. This works out to about 38.25-40.5.

Tangible Book Value is around 17.2.  Price is significantly below. I’m surprised it went so much below tangible book.

John Chew: So why is the market pricing CLD at $4.50? (June 17th 2015). What is the market implying by the current price?

There is even cash flow and decreasing capex, So 2.4-.31 with no growth and 10% return req is about $20.

Margin between cost to mine of 10-10.19 and sell price of 13 is 2.81. Taking off tax considerations, leaves 1.9 approx. With no growth, I would pay 19. It’s 4.5 now.

Its per ton cost is 10.2 and 2015 sell price is estimated 12+ to 13. The 3.5 mines it owns are productive. Thermal coal is 44/ton but using their 10.2 sale price is more relevant. Sales to Asia seems to be the demand driver.

Vulture funds also seem to be waiting for some industry consolidation (which has not materialized yet) before buying.

Thank you. Appreciate your help.

John Chew: You ask the right questions.  If we buy a coal company we have to know how much (in total on a sustaining basis) does it take to find, mine and replenish reserves. What influences the customer’s decision to buy?  What does the demand and supply of coal look like in the past, present and what might influence the future?

Let’s start by:

1. getting an overview of the coal market

Search out all the negatives on coal like: Obama’s War on Coal


To survive in an industry consolidation/shakeout, you must find the lowest cost producers on the cost curve:

Despite the hysteria of pension fund divestitures, cheap natural gas, global warming, what is actually going on?

Primary energy consumption continues to grow and will be dominated by fossil fuels and nuclear power for many years, but renewables continue to post the highest growth rates by far. In 2014, renewables comprised 2% of primary energy consumption, with hydropower adding another 7%. Nuclear power accounted for 4% of the world’s primary energy consumption, while oil continues to be the world’s leading primary energy source at 33% of overall consumption. Coal is responsible for another 30%, while natural gas makes up 24% of the world’s primary energy consumption. See statistics:


Also, review the past annual reports and presentations of:

Arch coal, Peabody, Consol Energy, Cloud Peak Energy.

Thoughts on valuation of mining companies:


Also, an EXCELLENT annual report on the operations of Hallador Energy:


HNRG_VL 2013



The Gloves Are Off in Mining

We probably need to look at a history of met. coal prices (Newcastle) for the past 20 years and various Thermal Coal prices and compare how companies did.

We want companies that will survive/thrive in this chaos.   Right now the coal market is suffering a cascading amount of bad news: pension fund divestitures, low natural gas prices, China not importing as much, unknown environmental laws, impending bankruptcies, and falling stock prices.

Ask who is on the other side of the trades?

By next week, let’s lay out the financials and operating metrics of both Hallador Energy (HNRG) and Cloud Peak Energy (CLD).   Are we at the trough of the cycle and how long would it take for a peak in the cycle based on history?

If you use EV/EBITDA don’t forget to also deduce maintenance capex or the capex needed to sustain operations.  Since coal is a bulky/low cost product, the cost of shipping to the customer may be a major part of the final cost to the customer, so where are the mines located in relation to the customer?

What are our companies worth in various scenarios: Bad Cast, Base case, Good case?  

What is the cure for low prices of coal?  What signs to look for?


Cost/Ton is the Appropriate Measure to Compare Coal Companies

The Wheel of Fortune: Mean Reversion (Part 1)


Last post on Chapter 4 in Quantitative Value . Let’s get back to our course on Deep Value.

Let’s go back to DEEP VALUE, Chapter 5: A Clockwork Market: Mean reversion and the Wheel of Fortune.

As a value investor you are doing either:

  1. Buying a franchise, where barriers to entry allow for profitable growth, before mean reversion sets in or
  2. Buying assets where the normalized earnings’ power of those assets is below norm (Asset value = Earnings Power Value) and earnings’ power will mean revert to normal.

Therefore the concept of Regression to the Mean is powerful.  By putting the words, “Many shall be restored that now are fallend and many shall fall that now are in honor” on the facing page of Security Analysis, Graham gave the most prominent position in his seminal text to the idea that Fortuna’s wheel turns too for securities, lowering those that have risen and lifting those that have fallen.  The line, from Horace’s Ars Poetica, echoes the phrase spoken by the wise men of legend who boiled down the history of mortal affairs into the four words, “This too will pass.”  This is regression toward the mean. (p. 79).

The more extreme the initial price movement, the greater will be the subsequent adjustment in the opposite direction. There tends to be a price trend before reversal. The reasons are manifold, but the most obvious is that the trials aren’t independent—our own trading decisions are affected by the buying or selling preceding our trade.

Keynes discussed this phenomenon here: or John Maynard Keynes and his life as an investor, Keynes as an investor

Two economists known for research into both market behavior and individual decision-making, Werner De Bondt and Richard Thaler, theorized that it is this overreaction to meaningless price movements that creates the conditions for mean reversion. Note page 800 in the link Does Stock Market Overreact—  the loser and winner portfolios.  Losers win out.

In a second study, Further Evidence of Inv Overreaction Thaler, Thaler and De Bondt revisited the research from a new perspective.  They hypothesized that the mean reversion they obserbed in stock prices in the first study might have been caused by investors focusing too much on the short-term. this fixation on the recent past and failure to look beyond the immediate future would cause investors to miscalculate future earnings by failing to account for mean reversion.  If earnings were also mean reversing, then extreme stock price increases and decreases might, paradoxically, be predictive of mean-reversion not just in stock prices, but in earnings too.  A stock price that has fallen a great deal becomes a good candidate for subsequent earnings growth, a vice versa for a stock price that has gone up a lot.  As you can see from the two research reports that the undervalued portfolio delivered better earnings and price performance.

The above research stand the conventional wisdom on its head and show compelling evidence for mean reversion in stocks in a variety of forms.

Buffett Discusses Mean Reversion in the Stock Market

Buffett_on_1999_Stock_Market_-_Fortune_Article & 2008 Market Call and a MUST READ: A Study of Market History through Graham Babson Buffett and Others

In the 1964 to 1981 period, Buffett wrote, U.S. GNP almost quintuples, rising 373 percent. The market, by contrast, went nowhere.

The evidence is that valuation, rather than economic growth, determines investment returns at the market and country level. Research suggests that chasing growth economies is akin to chasing overvalued stocks, and generates disappointing results. See

The growth illusion

Alas, this is not the case. Work done by Elroy Dimson, Paul Marsh and Mike Staunton at the London Business School established this back in 2005. Over the 17 countries they studied, going back to 1900, there was actually a negative correlation between investment returns and growth in GDP per capita, the best measure of how rich people are getting.  In a second test, they took the five-year growth rates of the economies and divided them into quintiles. The quintle of countries with the highest growth rate over the previous five years, produced average returns over the following year of 6%; those in the slowest-growing quintile produced returns of 12%. In a third test, they looked at the countries and found no statistical link between one year’s GDP growth rate and the next year’s investment returns.

Why might this be? One likely explanation is that growth countries are like growth stocks; their potential is recognised and the price of their equities is bid up to stratospheric levels. The second is that a stockmarket does not precisely represent a country’s economy – it excludes unquoted companies and includes the foreign subsidiaries of domestic businesses. The third factor may be that growth is siphoned off by insiders – executives and the like – at the expense of shareholders.

Paul Marson, the chief investment officer of Lombard Odier, has extended this research to emerging markets. He found no correlation between GDP growth and stockmarket returns in developing countries over the period 1976-2005. A classic example is China; average nominal GDP growth since 1993 has been 15.6%, the compound stockmarket return over the same period has been minus 3.3%. In stodgy old Britain, nominal GDP growth has averaged just 4.9%, but investment returns have been 6.1% per annum, more than nine percentage points ahead of booming China.

What does work? Over the long run (but not the short), it is valuation; the higher the starting price-earnings ratio when you buy a market, the lower the return over the next 10 years. That is why buying shares back in 1999 and 2000 has provided to be such a bad deal.

High Growth Depresses Future Stock Returns

Why does high growth seem to depress stock market returns and low growth seem to generate high stock market returns?  The market ALREADY recognizes the high growth nation’s potential, and bids the price of its equities too high. Market participants become overly optimistic during periods of high growth, driving up the prices of stocks and lowering long term returns, and become too pessimistic during busts, selling down stocks and creating e conditions for high long-term returns.  More research on that here:

  1. Jay_Ritter_paper_14_August Economic Growth and Stock Returns
  2. value-vs-glamour-a-global-phenomenon
  3. Blinded by Growth

I will finish this chapter in the next post. If you do not have DEEP VALUE or Quantitative Value, then join the deep value group found here: and I will send.

If you only understand one concept besides Margin of Safety in investing then let it be Reversion to the Mean.

Lesson on Franchises in Cyclical Markets




Money Managers Are Price Chasers

Markets can do ANYTHING in the short-term, so the following is not a prediction that miners will rise in price. However, what comes first–the price rising or the buying? :) Miners chop around in a trading range as money managers flee the sector and now sit with record low allocations to this sector. * How good are money managers (on the whole) picking the right sector to invest in?  I leave it to you to find that out.

Wedgewood Partners: Franchises in Cyclical Market and a Lesson on Diversification

wedgewood partners fourth quarter 2014 client letter Look at pages 12-20 where David Rolfe, the manager, discusses NOV, SLB and CLB–high-quality companies in the cyclical oil sector.

  1. clb_vl
  2. slb_vl
  3. nov_vl

He points out diversification may mean the sources of profitability can be different among companies within a particular sector.  (Refer to Competition Demystified by Bruce Greenwald for a course on this distinction). Note the high revenue conversion to free cash flow (page-14) for those companies compared to other companies in the oil services sector.

Now move on to wedgewood partners first quarter 2015 client letter crude realities.  Note on page 13 how he looks at the oil services market–the structural attribute to focus on is drilling intensity.  Interesting…. Look at pages 18 and 19 for a further discussion on NOV and CLB.

To learn, you might download those company’s recent annual reports and try to figure out their revenue to free cash flow conversion.  Look at what the companies use for maintenance capex.  Note how Core Labs is a free cash flow gusher (Charlie Munger would smile on this).  Core Labs is a different business than SLB and NOV, but is grouped in the same industry/index.  When sellers of ETF sell, they don’t distinguish among companies and therein lies opportunity for us. Yeah!

I do the opposite of this:

**Merrill Lynch Fund Managers Survey May 4, 2015

Today’s chart of the day focuses on sentiment in the basic materials sector. Regular readers of the blog already know that I have been closely following Merrill Lynch’s Fund Manager Survey for years now. This months survey was conducted in a period between 2nd to 9th April 2015 with a total of 177 panellists, with $494 billion of assets under management. The survey should be used as a very good contrarian indicator.

According to the recent survey, global fund manager allocation towards global materials declined sharply in the month of April to net 27% underweight from net 16% underweight the previous month. As we can clearly see from todays chart of the day, sentiment is very depressed right now. Merrill Lynch states that the current allocation is 1.8 standard deviation below its long term average.

Furthermore, the overall commodity and natural resources theme is very much disliked by global money managers. Commodity allocation is unchanged for the third straight month and remains at net 20% underweight. That is 1.2 standard deviations below its long term average and even more interestingly, fund managers remain underweight commodities for the 28th month in the row.


Prof. Greenwald on Value Investing

OVERVIEW Value_Investing_Slides

Greenwald_2005_Inv_Process_Pres_Gabelli in London

Greenwald Overview of VI

A Value Investing Class in Three Minutes

Buying High

Next Week

I have been too busy to do another lesson but be ready next week! For those attending the Berkshire Hathaway Meeting in Omaha enjoy the experience. Flash your Deep-Value Group card for up to 95% discounts.


Don’t Spare the Rod: Critique of Investment Research Reports

Time WarnerA beginning analyst sent me a research report to discuss: Ensco PLC Write-Up

Now before I start, realize that when I was beginning, my idea of a research report was to mimic Cramer.  Buy because the “chart” looks good and I gotta feelin’.  One time my hedge fund boss said his time was worth $1,000 an hour so the six minutes he took to read my incoherent report meant that I OWED HIM, $100.  Well, we all have to start somewhere.  The point of this exercise is to learn.

Buffett’s punch   idea may apply. If you only had twenty investment ideas over a lifetime–one every two to three years–would this be it? Would you put all of your money and family’s money into the idea and why?

Or, you pretend that you have a 45-second ride in the elevator to the top of the Time Warner building with Carl Icahn while selling your idea.

Bill Miller once said that money managers had the attention span of knats. You had to summarize your thesis and then give three or four supporting reasons within thirty seconds.

My critique of Ensco PLC

Instead of four paragraphs to tell me what Ensco does, perhaps you can be more succinct while putting forth what is compelling about your investment thesis.

ESV (Ensco, PLC) is an owner/operator of offshore contract drilling rigs/services that is trading at X% under tangible book value.  This is a cyclical, asset-intensive business subject to swings in natural gas and oil prices. Over a fully cycle, the company earns normal returns on capital of XX?

The price: Enterprise Value

Returns: over several prior cycles?

Capital structure and terms of debt?

Bottom line: this is a non-franchise or asset-based investment that is currently and cyclically out of favor.  OK.   But if this is an asset based business what are the assets worth?  You would need to dig into tangible book–what is there?   What is the current and expected replacement value of their assets? Liquidation value?  Is their fleet of rigs unique? Who are their competitors?  Any hidden assets or potential assets like, say, NOLs or assets outside their core business for example?

What is their cash flow and owner earnings?   I would like to see enterprise value over EBITDA-MCX over the past decade to get an idea of how the market priced ESV over a cycle.

Who is management? What skin do they have in the game? Are they good operators and capital allocators? Insider buying?  Who owns this company?  I don’t have much to go on in the above report so I jump to my handy VL: ESV_VL.  Whoa!  I see debt has jumped about 35% from 2013. How does their capital structure compare to competitors?   It seems like there isn’t much free cash flow. Capex eats up most of the company’s cash flow.

Where is the margin of safety? Book value has been growing but during an up-cycle in drilling. What happens in a prolonged down-cycle?  What are the risks?   You mention a DCF? Where did that come from? Your assumptions?

I will let others in the Deep-Value group chime in, but for a first-ever research report I give a D- which isn’t bad. At least the writer has good instincts to look at an out-of-favor company, but the core analysis of the assets needs to be provided. Also the competitive landscape.  Obviously, it is a business without a competitive advantage due to the low and cyclical nature of the returns, so how does this business compare operationally, financially and value-wise to their main competitors? Who are their customers and how are they faring?

The only way to improve is to write, practice and look at other reports. Go to and sign up. Then look at the highest rated ideas and study those along side the 10-K of the company mentioned.

Study Other Examples of Research

Or The_Security_I_Like_Best_Buffett_1951  Warren Buffett on Geico. (you may have to paste into your browser) and as reference, Rockwell Automation Inc and ROK_VL from a Deep-Value member, Thomas Harris. We can critique this next if you wish.

Carl Icahn paid $500,000 for an investment bank to furnish a report on breaking up Time-Warner: lazard_twx (worth a look!) and Icahn was right about Time Warner

Analyzing Debt

Sell ABX

ABX Sombull along with Barrick Annual Report 2014 and Barrick 1 Q 2015

Stay with it………writing is hard and finding great ideas even harder.

Time-Out: Special Situation of a Capital Change (BB) GWW

Thin ICe

 I spilled spot remover on my dog. Now he’s gone. — Steven Wright

W. W. Grainger (GWW)

Someone asked what data tools do I use.  My brain and a Value-Line.

Try to look at the Value-Lines WITHOUT looking at the price of the stock. What would you pay for this entire business–not knowing what it did and the current price of the company?  Start with the numbers (excluding the stock price, at first) so to keep your prejudices at bay.   Maybe have a friend print out the Vale-Line and cut off the top of the page.

GWW_VL Jul 2014 and GWW_VL   Something should strike you about this business. What?  Asset or franchise?

A competitor: Fast VL

Grainger_ Capital Allocation-FINAL Whoa? An announcement of a capital structure change–so a type of special situation.  What does this mean?

Grainger_ 2015FactBook Time to dig deeper Grainger_2014_ARGrainger 14BALSTGrainger 14EARN

Ok, about what is this company worth and what type of return could I expect at today’s _____ price?

Not a recommendation! Do your own thinking because then you learn from your mistakes AND successes.

If you don’t know or are not sure; it is just too tough, difficult, or confusing, then you can always do this:


And when I see the sign that points one way
The lot we used to pass by every day

Just walk away, Renee
You won’t see me follow you back home
The empty sidewalks on my block are not the same
You’re not to blame

From deep inside the tears that I’m forced to cry
From deep inside the pain that I chose to hide

Just walk away, Renee
You won’t see me follow you back home
Now, as the rain beats down upon my weary eyes
For me, it cries

Just walk away, Renee
You won’t see me follow you back home
Now, as the rain beats down upon my weary eyes
For me, it cries

Your name and mine inside a heart upon a wall
Still finds a way to haunt me though they’re so small

Just walk away, Renee
You won’t see me follow you back home
The empty sidewalks on my block are not the same
You’re not to blame

Investment Checklists-Adapt Them for Yourself. GOODHAVEN


Someone sent me a postcard picture of the earth.
On the back it said, “Wish you were here.” — Steven Wright

Investment Checklists 

We left-off here Last Lesson on Gross Profitability and Magic Formula and in that post, the next focus would be on investment checklists.  We have been reading Chapter 2: A Blueprint to a Better Quantitative Value Strategy in Quantitative Value (I will email the Book to new students if they are in the Deep-Value Group at GOOGLE. Go here:!overview then type: DEEP-VALUE and ask to join.).

On pages 56 to 59 of this chapter the author discusses the case for a checklist. Atul Gawande in his book The Checklist Manifesto: How to Get Things Right argues for a broader implementation of checklists. The author believes that in many fields, the problem is not a lack of knowledge but in making sure we apply our knowledge consistently and correctly. 

The Quantitative Value Checklist

  1. Avoid Stocks that can cause a permanent loss of capital or avoid frauds and financial distress/bankruptcy.
  2. Find stocks with the cheapest quality.
  3. Find stocks with the cheapest prices.
  4. Find stocks with corroborative signals like insider buying, buyback announcements, etc.

Below are several books on checklists.

As students may know, I throw A LOT of information at you to force a choice on your part.   You have to focus on what material can be adapted to your needs. In the three books above, you will find many interesting ideas that may be helpful in learning how to build your own list.

The more experienced you are, then the shorter the checklist.  The point of a checklist is to be disciplined and not overlook the obvious while freeing up your mind for the big picture.   Yes, you check off if there is insider buying, but if insiders are absent, but the company has a strong franchise and the price is attractive, then those factors may be overwhelmingly positive.  You may ask, “Do I understand this business?” Then it may take weeks of industry reading to say yes or no.

Checklists are helpful, but only if you adapt them to your method.

Next, we will be reading Chapter 3, Eliminating Frauds in Quantitative Value. We are trying to improve our ability to build a margin of safety.


The Problem with Investor Time-frames

Note the dark line in the chart above representing the returns of the Goodhaven Fund. Two analysts/PMs split off from Fairholme and started in mid-2011. They had a big inflow in early 2014 and then some of their investors panicked as they vastly “underperformed the market.”  I don’t know if these managers are good or bad but making a decision on twelve to twenty-four months of data is absurd unless the managers completely changed their stripes (method of investing).  Therein lies opportunity for those with longer holding periods like five years or more.


Shareholder_Message_1114 (Some investors run for the door)