Wednesday, 30 January 2013

A Value Investing World Interview With Tim McElvaine

In an October, 2012 interview, Tim McElvaine discusses his approach to investing in Japan.  Since the country’s famous bubble and bust, few investors have been tempted to commit capital there.  Macroeconomic challenges that include a radically high level of debt-to-GDP and the chronic threat of deflation have been enough to scare most stock pickers away.  The simple fact that few other North American (or European) investors are interested in the Japanese market, however, may open up opportunities.  It is not impossible, after all, for individual companies to thrive despite economic troubles in their home nation.

The interview offers ground-level insights into the obstacles in Japan that include long-standing corporate governance issues, entrenched management that ignore the best interests of shareholders, poor capital allocation, questionable stewardship of the capital structure, and a range of cultural differences.  

The blog is christened North American Value Investing for these very reasons.  This is not to romanticize US and Canadian markets, which have suffered from many of the same troubles.  However, the problems are not as entrenched in North America, and cultural discrepancies only affect people unfamiliar with foreign customs.  However, brave investors may find opportunities in Japan despite all of the drawbacks.

Here is a Profile of  Tim McElvaine


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Monday, 28 January 2013

Profile - Tim McElvaine

In the 11-year period from 1997 to 2007, Victoria, B.C.-based investor Tim McElvaine returned 21% per year before fees (16% net to investors), compared to 11% for the S&P/TSX index.  Moreover, he didn't suffer a single down year, while the index fell three times.  This impressive result was achieved despite holding large amounts of cash: in fact, on average he was only 82% invested over the period.  In theory, had he been fully invested, McElvaine's gross returns would have exceeded 25% per annum.

But - and with a cutoff year of 2007 you knew there was a "But" coming - in 2008 his fund fell by almost half.  McElvaine was hardly alone in this, of course; unlike many investors, however, he has yet to rebound sharply since the end of the Great Recession.  Indeed, even after a net return in 2012 of 18.3%, McElvaine remains about 30% off his former peak.  In absolute dollars, his fund has shrunk even more dramatically, forcing him to lay off most of his already small group of staff.  Will Tim McElvaine return to his past stellar performance, or was he permanently diminished by the recent turmoil?

An 11-year run of substantial outperformance is likely long enough to rule out pure fluke.  However, in order to determine with confidence if his pre-2008 success was a streak of long-lasting good luck, or the product of skill and experience, it's necessary to look beyond just the numbers and assess the "How" and "Why" of his performance.  

McElvaine's philosophical influences include John Templeton, Ben Graham and Warren Buffett.  Peter Cundill, though, was not only an intellectual influence, he hired the young and persistent McElvaine, and mentored him first-hand.  One of the qualities that Cundill instilled in McElvaine was patience.  This helps explain why McElvaine has steadfastly - and correctly, in this writer's opinion - held on to Glacier Media.  For many years Glacier has been his largest position, but the stock has underperformed lately, and is partly responsible for his restrained post-2008 performance (in fairness, he originally paid around $0.70 for GVC, so the fact that it hasn't done anything for him lately doesn't mean it hasn't done anything for him at all).  In addition, Cundill's interest in Japan wore off on McElvaine.  Most notable North American investors must think the fallen country's nickname is Land of the Setting Sun, if they think of it at all, but McElvaine had 17% of his portfolio committed to Japan at the end of 2011.

In the manner of Graham and Buffett, McElvaine has a disciplined, multi-faceted approach to estimating a company's value, and is sure to only buy at a discount, leaving him a "margin of safety."  His own personal twist is that he likes to buy when sellers are so determined to unload their position that they "don't care about price" (p.36).  Arguably, buyers of Glacier Media have been purchasing from sellers that blindly lump the company together with the newspaper industry in general, without regard for its genuine differences.  Other cases where sellers want out regardless of price may include a stock that has been delisted from an index or distressed securities that funds are not permitted to hold.

In addition to the margin of safety, McElvaine's investing approach is similar to Buffett's in several ways: like the Oracle of Omaha, McElvaine runs a concentrated portfolio, where single positions can constitute 10% or more of his portfolio; when a stock falls, he tends to add to his position, on the reasoning that the upside is higher and the margin of safety larger; when he assesses management and directors, he ensures that they behave in the shareholders' interest, not their own, and occasionally takes a seat on the board to make sure executives don't confuse the two; and he focuses on return on capital and cash flow.

Some of McElvaine's habits and values resemble Buffett's, as well.  In describing a typical day at the office, he cites a poster that reads, "Sometimes I sit and think, and sometimes I just sit," which would delight Buffett, who firmly believes that activity is the enemy of investors.  McElvaine, like the Berkshire Hathaway CEO, has the bulk of his family's money invested in his fund, as they both like to "eat their own cooking."  And McElvaine's letters to partners, while not appointment reading for most of the investing world, are unfailingly candid and humorous.

One important area where McElvaine strays from Buffett, however, is in his willingness to own "duds" (p.45).  As he explains, "What I ideally like is a mediocre business, so to speak, that each year will be worth a little bit more primarily because of cash flow" (p.47).  Buffett, on the other hand, refuses to invest in companies without a sustainable competitive advantage.

There's a good chance that McElvaine will return to form in the future.  His success in the past was not an accident, and he has wisely remained loyal to the key ideas that have served him, and many other excellent investors, so well.  To be sure, he has tweaked a few things, such as investing less money in small caps to provide more liquidity, and diversifying into a somewhat larger number of holdings.  To his credit, however, he hasn't abandoned a formula that is likely to work over time.  And a greater commitment to buying only companies with a wide and formidable "moat" would further increase the odds that Tim McElvaine returns to his past glory.

Sources: Thompson, Bob.  Stock Market Superstars: Secrets of Canada'sTop Stock Pickers. Toronto: Insomniac Press, 2008.

Publications that can be found on Tim McElvaine's website

Other Profiles include investor Tom Stanley, and New Yorker writer James Surowieki.

Disclaimer: The host of this blog shall not be held responsible or liable for, and indeed expressly disclaims any responsibility or liability for any losses, financial or otherwise, or damages of any nature whatsoever, that may result from or relate to the use of this blog. This disclaimer applies to all material that is posted or published anywhere on this blog.

Tuesday, 22 January 2013

On The Economist's Special Report on Reshoring

The Special Report in the January 19, 2013 issue of the Economist, focuses on the increasing trend of "reshoring," bringing back manufacturing and some services jobs that were once "offshored" to foreign countries.  There are several reasons for this. 

Wages in China and India have been rising 10-20% a year for decades, and, while still much cheaper than developed world rates, are doubling as quickly as every five years.  When the cost of overseas shipping is included, the difference between developed and developing world costs narrows further.  Though rarely noted in the media, more jobs are lost due to automation than from offshoring, and labor's component of overall costs has continued to fall.  Manpower urges companies not to offshore at all if labor consists of 15% or less of a product's overall cost.

Shipping often takes weeks, and global supply chains expose companies to political, currency, climate, intellectual property and many other risks.  Boeing, for example, suffered badly by outsourcing too much of its supply chain, and Samsung used the knowledge it gained manufacturing for clients and became a competitor, and a triumphant one.

Much of the motivation is simply to be close to end markets, where it's easier to respond quickly to the tastes and demands of local customers.  In addition, offshoring enrages many citizens who are also potential customers, and reshoring can make for good public relations. 

Interestingly, one justification for bringing production "home" is to increase innovation by having manufacturing and research and development (and, though the Economist failed to emphasize it, design, data analytics, marketing and customer service) housed in the same location, a move towards the "end-to-end" production that Steve Jobs advocated.  (Ironically, Apple has outsourced much of its manufacturing to Foxconn, with a number of high-profile consequences).  It's more difficult, on second thought, to draw a distinction between "core" functions, and superfluous ones.

Herd Behavior
And, to the Economist's credit, it points out that some of the frenzy for offshoring was caused by "herd" behavior in the first place. Very simply: some companies did it merely because other companies were doing it.  One quality that Warren Buffett looks for in managers is independence, to avoid lemming-like behavior.

In the end, reshoring likely won't happen in revolutionary numbers, but gains in manufacturing may offset most of the losses in services, and a significant drag on developed-world workers will be lifted.

Disclaimer: The host of this blog shall not be held responsible or liable for, and indeed expressly disclaims any responsibility or liability for any losses, financial or otherwise, or damages of any nature whatsoever, that may result from or relate to the use of this blog. This disclaimer applies to all material that is posted or published anywhere on this blog.

Sunday, 20 January 2013

The Trouble with Mining - Management or Structural Issues?

Rio Tinto boss Tom Albanese recently became the latest CEO of a major mining firm to be relieved of his duties.  His departure came in response to a $14 billion write-down that resulted from the 2007 purchase of Alcan, then a leading aluminum company.  He joined a growing list of departures that includes the top executives of Anglo American, Vale, Barrick Gold and Kinross Gold.  

Before 2008, the rising tide of the commodities "supercycle," propelled by infrastructure-heavy economic growth from the developing world, was enough to lift the earnings and share prices of many resource producers.  But as Warren Buffett has warned, when the tide goes out, you find out who's been swimming naked.  Today's unforgiving daylight reveals repeated cost overruns, rampant technical setbacks, and a pattern of overpaying for acquisitions.  Investors are left to wonder whether this is a management problem, which is solvable, or a more structural situation, which may not be?

Part of the blame lies squarely on management.  It's well known that around two-thirds of acquisitions fail, largely because acquirers routinely overpay.  The burden of proof, then, falls on senior executives and board members to demonstrate that their own prospective purchases are an exception to the general trend.  Even without the easy judgments of hindsight, the Alcan deal was always risky, given that aluminum is abundant and thus never in short supply.  Managers in the mining industry tend to be particularly poor at allocating capital: not only do they overpay for assets, they often have a soft addiction to issuing new equity, whatever the price; they rarely pay dividends; and they almost never take advantage of weak share prices to repurchase shares. Out-of-control costs and technical failures reflect mismanagement, as well.  Too often, managers have failed to halt development, even when added expenses push the rate of return to dismal levels, and executives have been unable to deliver on production or schedule-related promises.  

Still, many of the problems in the resource extraction industry are structural.  It is telling, in fact, that the names appearing on the casualty list above are managers from the strongest mining firms in the world.  As such, they have built-in advantages over competitors, including the resources to attract the best managers in the industry - in theory, at least - assets that are diversified both by geography and by mineral, and a lower cost of capital.  

Nonetheless there's a long and daunting list of enduring challenges in the mining industry: the difficulty of operating many mines reliably and profitably; unsteady demand; a lack of skilled technical labor, and shortages of general labor; ore grades in permanent decline; and a litany of political, regulatory, legal and environmental obstacles.  As if all that weren't enough, the largest problem is the "hole-in-the-ground" conundrum: every ounce, pound or tonne a producer sells leaves it one unit closer to being out of business.  These challenges surely contributed to many the mistakes and failures noted above.

This doesn't mean that there are no attractive mining investments.  The surest way to get an edge in a commodity business is to be a low-cost producer.  Most importantly, this means owning low-cost mines with long lives, as BHP Billiton does, for example.  As noted, size typically ensures large companies access to cheap capital, as well as a strong balance sheet that can withstand volatile commodity prices.  In addition, vast resources typically allow companies to better navigate the political, regulatory, legal and environmental challenges that exist in the global resource industry.  And a world-class management team is not only desirable, but flat-out necessary.

Potash Corp may be one of the few mining companies that’s worth investing in, despite the general difficulties of the industry.

Disclaimer: The host of this blog shall not be held responsible or liable for, and indeed expressly disclaims any responsibility or liability for any losses, financial or otherwise, or damages of any nature whatsoever, that may result from or relate to the use of this blog. This disclaimer applies to all material that is posted or published anywhere on this blog.

Calculated Risk

Investors searching for topical coverage of macroeconomic news ought to visit Calculated Risk, hosted by Bill McBride, a retired executive.  Fact-based and analytical, the blog covers most major economic data, with a focus on the US market.  Posts are timely, usually following official releases within a couple hours, often quicker.  The value-added comes in the form of placing data in its historical context, with the aid of simple long-term graphs.  In addition, many indicators are compared to other current data.  Though thorough, the posts are concise.

The blog pays careful attention to the US housing market, which closely correlates to the overall health of the American - and global - economy.  In fact, Calculated Risk was one of the few voices of alarm during the nearly decade-long housing bubble.  The crash may not have been so severe if more people had paid attention to historical rates of housing starts and household formation: for several years, housing starts were sharply higher than houses formed, and it should have been clear that eventually the hangover would match the party.  Although the blog covers other housing-related data, by highlighting those two simple numbers Calculated Risk was offering the public a great service, even if it went ignored.

Most of us were surprised by the intensity of the recent financial crisis; when the next one inevitably arrives, regular readers of Calculated Risk may not be caught entirely off-guard.

Another excellent resource on macroeconomics is the Rail Time Indicators report.

Disclaimer: The host of this blog shall not be held responsible or liable for, and indeed expressly disclaims any responsibility or liability for any losses, financial or otherwise, or damages of any nature whatsoever, that may result from or relate to the use of this blog. This disclaimer applies to all material that is posted or published anywhere on this blog.

Sunday, 13 January 2013

Book Review - Steve Jobs, by Walter Isaacson

Mere mortals dream of changing the world; Steve Jobs, however, hoped to "make a dent in the universe."  Partly because of an ambition that knew no earthly bounds, Jobs became one of the towering giants of the twentieth century and beyond - the focus of business case studies, tech newsletters, industry forums, and innumerable other venues.  It's telling that Walter Isaacson, the author of well-regarded biographies of Albert Einstein and Benjamin Franklin, considered Jobs a worthwhile subject.

By borrowing - or stealing - the concept of the graphical user interface from Xerox, then greatly improving on it, Jobs helped bring useful and intuitive computers to the masses.  Later the iPod changed how music is stored and consumed.  Apple sold an astounding 90 million iPhones - also known as "the Jesus phone" - over the first three and a half years of existence, collecting about half of all the profits for the global mobile phone industry.  The company later sold a mind-boggling 15 million iPads in the nine months after its release, among the most successful product launches in history.  Thanks to all these interwoven successes, Apple has recently become the most valuable company by market capitalization in history, and has had a social and cultural influence to match its financial glory.  

Not only did he play a central role in revolutionizing the computer industry, Jobs also upended a range of other businesses.  After he took command of Pixar, then fast approaching bankruptcy, it quickly became the gold standard in animation, creating hit after amazing hit, both critically and commercially.  Pixar was so spectacularly successful that even the vaunted Disney, long the standard bearer in animated movies, could no longer match the upstart studio, and bought it for the princely sum of $7.4 billion.  Moreover, Isaacson notes, the transaction had the feel of a reverse takeover, with the creative team at Pixar taking control of Disney's legendary animation studio.

More recently, he helped bring change to several sectors of the publishing industry.  The sheer reach of the iPhone and iPad together made the "app" business model viable.  Somewhat walled off from the worldwide web, applications have changed many business models in an online world, allowing magazine publishers, for example, to charge money for an exclusive readerly experience, and giving book publishers a further outlet for their literary wares.  In addition, Jobs  entered the old and difficult retail industry and achieved wild success.  By employing his famous eye for detail - only stone from a specific quarry near Florence, Italy is good enough for Apple stores, Jobs decreed - he created Apple stores, which broke a record for fastest march to $1 billion in sales, including Manhattan’s Fifth Avenue store, which grosses more than any other location in the world.

The Apple co-founder's unparalleled accomplishments came despite his many glaring defects.  Jobs, nearly everyone agrees, was petty, needlessly cruel, unreasonable, disloyal, unpredictable, and often flat-out weird.  Indeed, he often cried, and for long stretches of time, rarely bathed.  Name a character flaw, and Jobs probably suffered from it - and the people around him suffered because of it.  Yet even in the course of a foreshortened life, he achieved just what he set out to do.

How was he able to do it?  This riddle is of interest not only to entrepreneurs, business and civic leaders, but to investors, too.  Some of his success, as always, had to do with luck.  For example, it’s not an accident that many tech firms were founded in Silicon Valley in the postwar decades, and Isaacson does an able job evoking the milieu in which Jobs came of age.  And he had enviable personal qualities to go along with the less desirable ones, including charm, a dramatic showman's streak that helped with the public aspect of his job, and a "reality distortion field" that helped him realize the seemingly impossible, even as it led to many mistakes and miscalculations.  However, as Isaacson illustrates in generous detail, the answer lies largely in that Jobs embraced the same kind of multi-disciplinary mode of thinking that super investor Charlie Munger advocates.  

Much of Jobs' success derived from his natural curiosity and wide-ranging self-education.  Indeed, when he grew tired of a standard, "by-the-book" degree at Reed College, he dropped out, but remained on campus and audited classes that interested him.  These included calligraphy, which he later credited for the "multiple typefaces" and "proportionally spaced fonts" featured on the Mac.  The "Less is More" Bauhaus movement informed the design of Apple products Isaacson and a number of Jobs' friends believe that Jobs became the embodiment of the convergence of hippie counter-culture and high technology.  His many other influences included a lifelong interest in Eastern spirituality, including Zen Buddhism and meditation; organic gardening; listening to, studying and playing music; reading literature and contemplating and writing poetry.
Isaacson argues convincingly that Jobs was a "magician genius," whose world-changing flashes of insight came more from intuition than from a rational mode of thinking.  As a young man, Jobs embarked on a pilgrimage to India, where he learned to value intuition as much as abstract and rational thought.  Unlike most analytical executives, Jobs paid no attention to market research, preferring instead to intuit what customers want, often even before they knew they wanted it. 

Thanks to his broad influences, Jobs was able to wear many hats at Apple.  He knew enough about engineering and electronics to understand the hardware, and had a sufficient grasp of programming to stay abreast of the software.  Jobs had a rare and special talent for marketing and branding.  Indeed, he personally oversaw all significant aspects of Apple's marketing efforts, getting involved in the nuts-and-bolts of billboards, magazine spreads, televisions commercials, and all other communications, almost unheard of for a CEO.  And he was particularly good at aesthetics and design, devoting much of his time and energy to ensuring a beautiful and elegant physical structure for all of Apple's products.  

It's possible that Jobs reached too liberally for ideas.  He went on strange diets, and insisted, all olfactory evidence to the contrary, that eating only fruits and vegetables meant it wasn't necessary to wear deodorant or bathe.  He christened one version of Apple computers the "Lisa," after his daughter.  And it’s debatable whether the use of recreational drugs and Freudian analysis are helpful in business or otherwise.  Perhaps fatally, when he was diagnosed with cancer, Jobs embraced a variety of unorthodox ideas, including unproven remedies found on the internet and consulting a psychic, and refused to undergo standard treatments for nine long months.  However, his famed "reality distortion field" bears much responsibility, too.  And, in fairness, it's impossible to be sure that a more orthodox medical approach would have vanquished his cancer.

Still, the magic he made came at the intersection of technology and the liberal arts.  If Apple and Pixar stay true to this ethos, they may well endure for many years to come.  When it was time for Pixar to move into a new building, Jobs designed it personally, ensuring that the central atrium would encourage inter-disciplinary collaboration from members of different departments.  He died before he was able to implement it, but Jobs spent many hours in the last years of his life attempting to do the same for Apple future headquarters.  He once explained the Xerox episode by proudly quoting Picasso: "Good artists copy, great artists steal" (98).  By applying a range of ideas from different disciplines, whether borrowed, copied or stolen, Jobs did more than create a masterpiece, he made a dent in the universe.

Source: Isaacson, Walter.  Steve Jobs.  New York: Simon & Schuster, 2011.

Disclaimer: The host of this blog shall not be held responsible or liable for, and indeed expressly disclaims any responsibility or liability for any losses, financial or otherwise, or damages of any nature whatsoever, that may result from or relate to the use of this blog. This disclaimer applies to all material that is posted or published anywhere on this blog.