Note: This page is for posts closely related to current investment decisions.

Buying cheap Brazilian equities

16 Jul 2015 by Jim Fickett.

Inflated markets never last forever, even with central bank support, and bargains are once again beginning to appear. At least platinum, coal, and some global equities are cheap. This post is about Brazilian stocks.

There is ample bad news out of Brazil. Corruption has caught up with current leadership. A drought is hitting hydroelectric plants and residents of the largest cities. The cost of the many apparent freebies handed out by Lula, the previous president, have begun to significantly impact the federal budget. The two biggest props under the previous expansion – the global commodity boom and a huge expansion of domestic consumer credit – have both gone bust. And so sentiment is very poor as, for the short term, it should be.

However there is little reason to think Brazil will not recover from this downturn, as it has recovered from others. There are two possible caveats to that statement. The first is inflation, currently running at 9%, and still rising. Brazil had a bout of hyperinflation in the 1980s and 90s. If that were to return all bets would be off on the value of any equities. That is a real risk, but the government seems realistic about trimming the budget and keeping interest rates high, even though it is causing a recession. Second, Brazil has abysmal infrastructure. Recent data confirm that the summary on this topic that I wrote in 2012 (Brazil infrastructure) still provides a reasonably accurate picture. On the one hand, I don't believe sustained high growth will be possible unless the country finds a way to tackle this problem. On the other hand, businesses have always found a way to function despite the terrible roads and ports, and will continue to do so.

All in all, I think it is not clear to what extent the country will experience extraordinary growth again, but it would be surprising if the economic cycle were not to bring at least a normal recovery in due time.

Research Affiliates reports that CAPE for the MSCI Brazil index is currently at 9.2, compared to an historical median value of 16.3. The EPS record only goes back to 1994, so the CAPE record only goes back to 2004. Still, 9.2 is low enough, on an absolute scale, to provide a reasonable margin of safety. The nominal dollar price of EWZ, the iShares MSCI capped ETF, is approximately at a 10-year low. This is partly due to the behavior of the Brazilian domestic market (cf. the performance of DBBR, a dollar-hedged fund), and partly due to the fact that the dollar is approximately at a 10-year high against the real. Thus both the economic cycle and the long-term cyclicality of exchange rates are in favor of a current buy.

There are a number of ETFs focusing on Brazilian stocks but only one two, EWZ and DBBR, follow the broad market. I prefer NOT to hedge the exchange risk; I will put 2% of the portfolio in EWZ tomorrow.

Buying Tweedy Browne Global Value Fund

28 Nov 2014 by Jim Fickett.

This week I put 2% of the portfolio into the Tweedy Browne Global Value Fund (TBGVX).

My first goal in making this purchase is to have greater exposure to European stocks because, while American stocks are, in general, quite overvalued, European stocks are not. The table below gives the top 6 country allocations in the fund, with recent CAPE (Shiller Cyclically Adjusted Price Earnings) information from Research Affiliates (many thanks to Rich Toscano of Pacific Capital Associates for pointing out the Research Affiliates site to me):

Country UK Switzerland France United States Netherlands Germany
Allocation 14.5% 13.7% 11.7% 9.5% 7.8% 7.0%
Historic Median CAPE 14.7 19.3 19.3 15.9 17.8
Current CAPE 12.5 22.6 14.3 26.3 16.4

Research Affiliates does not cover the Netherlands. Older data indicates a severely undervalued market (see Belgium, France, Germany and the Netherlands have attractive CAPE; at that time CAPE was about 10 compared to a long-term average of about 16). The market has risen about 50% since then, but is probably still close to fair value (see also this page). The picture for CAPE is not perfect. TBGVX is holding stocks from one very overvalued market (the US) and one slightly overvalued market (Switzerland). The main CAPE point is that the fund is concentrated on countries where stocks are reasonably valued.

My second goal in buying TBGVX is to have more help from others in locating good companies. Bonds, still widely considered the safe alternative, are in fact very risky. I want quite a large fraction of my portfolio in stocks. Stocks are, of course, quite volatile, and the stock market as a whole can lose money for many years. But value stocks almost always make money within, say, five years. So a value portfolio is not too dangerous even for an older investor. I want to move more money into stocks, but do not have time to research individually a large number of companies, especially foreign companies, where it is more difficult to track down the necessary information.

Tweedy Browne are value investors, and are fully informed on value measures, different styles, and the history of the field. They do not say exactly what their methodology is, but their mode of operation is fairly clear from looking at their research papers (see the recent post A helpful summary on value strategies from Tweedy, Browne), their quarterly commentary, prospectus, and annual report on their website, and a video of a recent talk by the senior managing director, William H Browne. My take is that they do not find enough bargains using simple measures like price-to-book, but make every effort to understand the true intrinsic value of future income streams, and to buy stock in companies that (1) have conservative capital structures and (2) are bargain priced relative to intrinsic value. I'm sure I would disagree with some of their decisions; in fact they own one stock I sold as fully valued – J&J – but I think they probably do find solid value on the whole.

Their record is good. They have done better than the closest benchmark, the MSCI EAFE, over the long haul, and have averaged 9.7% annual return over the last 20 years.

Some other points. First, on the plus side:

  • The managing directors and other employees have substantial amounts invested alongside you.
  • Tweedy Browne manages five funds; they invest their own money most heavily in the global value fund.
  • Average 12-month turnover is only 4.1%, so you are not losing a lot of money to transaction costs.
  • The total expense ratio is 1.38%.

On the negative side, they seemingly did not fully recognize the nature of the developing crisis in 2006 and 2007. Near the top they owned ABN Amro, AIG, MBIA, and Freddi Mac, all companies with severe credit problems. The last two they did sell before the crash. My impression is that they kept to their standard approach and, though they recognized the overall inflation of easy credit, they did not try to go deeply into the developing problems with credit default swaps and securitized debt. If that is right, it is both a strength and a weakness. A weakness because one may miss an important danger sign; a strength because it is good to keep your investing approach as simple as possible. My own conclusion is that I will reserve judgement on this point, watch the overall trends in the market, occasionally review TBGVX holdings in light of those trends, and possibly sell at times of excessive exuberance. Since they are careful not to buy companies with too much debt, and I expect the next crisis to be centered around a corporate credit crisis, I'm not too worried about the possibility that they will lose more than temporary value in the next bear market.

On the whole I think TBGVX is competently managed, with goals quite close to mine, and I am happy to turn over a small (for now) part of the job to them.

Berkshire Hathaway update

17 Nov 2014 by Jim Fickett.

My stake in Berkshire Hathaway (BRK) is up 82% since I bought in 2011. Is it time to sell?

On the side of selling,

  • Some fraction of the increase in shareholder equity, and stock price, is simply due to the Fed inflating all asset prices (though it is very hard to guess, without access to the books of all the subsidiaries, what the precise fraction might be)
  • The ratio of price/book, which was very low – about 1.08 – in 2011, is now substantially higher, at 1.45 (current price to end-Q3 book value)
  • There will come a time when the Fed can no longer paper over corporate debt problems, the stock market will fall, and BRK with it

Nevertheless, I will hold. Although I think it is quite likely that at some point in the next few years the price will be lower, I also think that getting the timing right is difficult and, because BRK will continue to grow the real value of the underlying businesses, one can do just fine by staying in the game.

BRK has grown book value by an average of 19.7% per year since 1965, and one has never had to wait more than five years for a dip to be rectified and a new high set. Even for the five year periods including the 2008 crash, 5-year growth, annualized, has been at least 7%.

For the patient investor, book value is as good a measure as any for long-term health of an investment. But if you need your money, the stock price matters. Since 1980, the beginning of the price record on public sites, it is also true that the longest one has ever had to wait for an old peak to be exceeded is 5 years. And the current price-to-book ratio, while higher than recent values, is also not excessive in view of the historical record.

If one is planning to hold BRK for the long run, as I am, one must also keep the succession issue in view. Neither Warren Buffett nor Charlie Munger will live forever. When they are gone the allocation of capital will suffer. The Economist recently painted painted a picture of what post-Buffett governance might look like:

The most obvious flaw in the succession plan, apart from the firm’s inability to clone Mr Buffett, is the one name that has been announced. The chairman will be his eldest son, Howard, a board-member of more than 20 years’ standing, a farmer, photographer and, thanks to the $1 billion foundation given to him by his father, philanthropist. Even accepting that his duties will be centred on preserving the culture and ethics of the firm, not on decisions that benefit from business experience, it seems a curious appointment for a fierce critic of the hereditary principle such as Mr Buffett senior to have made.

The board Mr Buffett junior is likely to inherit will be largely made up of friends of his father and of Mr Munger. At present, it works better than one might expect, but as Mr Munger says, “[Warren] knows what they’re going to say, and everybody knows that what he says is going to govern.” Under new leadership, the dynamics of a board made up of owners could easily turn nasty if times get tough. The most influential director is likely to be Bill Gates, the philanthropist and co-founder of Microsoft; he has strong opinions and does not suffer fools gladly.

At the very least, the new chief executive will have to win the trust of the post-Buffett board, and it may be a long time before he can be confident that what he says will go. It would be surprising if this did not result in a slower, more bureaucratic decision-making process than that of Mr Buffett, who says he has thought through and approved a multi-billion-dollar investment while taking a bath.

Much of the magic of BRK comes from the fact that, while all the subsidiaries run their own businesses without interference from the top, their free cash flow is pooled and allocated by Buffett to wherever he thinks it will best grow. It seems very likely that at some point this will degenerate to the CEOs of the individual businesses fighting to keep control of their own excess cash, and the board rather ineffectually making a few changes.

Yet even in that unhappy scenario, the holder of BRK will own an index fund containing a large number of solid, well-run companies. And the intrinsic value of the conglomerate will continue to exceed book value by a considerable amount. So, although I do think growth will slow at some point, I also think the current price is reasonable even on that assumption.

Platinum: The short-term price drop is an opportunity

8 Oct 2014 by Jim Fickett.

The supply of platinum is mostly from new mining, and the current price (about $1270/oz) is far below what it costs to mine the metal (about $1700/oz). The short-term price drop is driven by traders who do not look ahead, in reaction to poor economic news out of Europe. This will pass, and I have added to my position.

Mining cost

There is an in-depth analysis of mining costs, still applicable, in the Dec 2012 post Platinum mining costs are likely to drive the long-term price moderately higher. The main conclusion there was

For a significant fraction of platinum mines, market prices below $1500/oz fail to cover cash costs, and below $1700/oz fail to cover cash costs plus capex. The cost increases of recent years were not a temporary aberration. Therefore the current platinum price of about $1600, while not a screaming bargain, is on the low side

That statement must be qualified with a comment on exchange rates, since costs are mostly incurred in South African Rand and the international market in platinum is priced in dollars. Part of the reason the platinum price is currently low is that that the dollar is high.

The rand has decreased in value over the last few years; I am assuming that costs in rand have adjusted. The dollar has been up and down. Taking into account a ten-year history of the dollar's value against a trade-weighted basket of currencies, it is probably reasonable to replace that $1700/oz all-in cost with a range of $1600-$1800 and say that in the long run the platinum price will need to exceed $1600/oz.

Long-term supply and demand

One should also ask if there are any major trend changes in demand. Johnson-Matthey no longer make their market analysis freely available, unfortunately. However they do still provide freely both (1) their archived reports (full reports and summary tables), and (2) a high-level summary of recent supply and demand. Putting together several of these sources gives the following:

(The way recycling was counted changed in 2005. Before 2005 recycling only included the recycling of auto catalysts, while industrial recycling was netted out of demand. After 2005 both were included in the recycling number.)

I have lumped together the two main sources of demand that follow the business cycle, namely auto catalysts and industrial process catalysts, and have also lumped together the two main sources of demand that tend to react most strongly to the price, namely jewelry and investment. Clearly demand is somewhat volatile. Just as clearly, demand has stayed close to supply for a long time, and will probably continue to do so. In other words, the cost of mining will drive the market price.

Inventories could allow irrational prices to persist for some time

Markets can remain irrational for extended periods. Johnson Matthey predicts this year's deficit will be about 1.2 million ounces. According to a recent issue of the Citi Metals Weekly, above ground stocks of platinum total about 6 million ounces. So the market could remain in deficit for some time and still function. Nevertheless, as inventories fall, more people will notice the opportunity, and eventually the market will turn. Most analysts who are familiar with the platinum market expect a significantly higher price next year.

The long-term price history suggests there is a margin of safety

Looking at the price history over several decades (last analyzed in All precious metals are down, but only one is obviously cheap) shows that the current price of platinum is about 20% above its (inflation-adjusted) 40-year average. Since mining costs have risen, the price should be somewhat above the long-term average. This suggests that, given natural volatility in the market, there is some margin of safety in the current price, simply from the point of view of the price history.

Timing a purchase

The price has been dropping for several months. It could go lower still. But the current price is a real bargain already. I put another 2% of the portfolio in the exchange traded fund PPLT today.

Encana: Exchanging value for income

29 Sep 2014 by Jim Fickett.

Encana, in overcorrecting for previous mistakes, is destroying long-term value in order to increase short-term income. The good news is that investors do not understand what is happening so, if an exit is necessary, optimism driven by improvements in short-term income will probably provide a good exit point.

The strategic management of Encana has been unfortunate. On the one hand, they deserve credit for seeing the coming revolution in shale gas before others, and acquiring a substantial portfolio of land at excellent prices. On the other hand, since then, they have made two major moves that turned out to be mistakes, and are in the middle of a third move that is destroying value.

1) In 2009 they spun out all liquids-producing assets into Cenovus, becoming a pure-play natural gas company. (Here “liquids” includes oil and the lighter “natural gas liquids” - NGL - such as butane.) Only two years later the annual report strongly emphasizes trying to acquire and develop liquids-rich locations and ramp up liquids production (“we are adapting to the market reality by shifting our investment and operational excellence towards growing our oil and NGLs production … invested - about $515 million – in acquiring prospective oil and liquids-rich lands.”)

2) In 2010, as the natural gas price began a 3-year trend to new lows, they set a goal to “double [natural gas] production per share in five years (from 2009 base).” Two years later gas production was lower than in 2010. And currently they have an explicit goal of increasing liquids production and reducing gas production.

3) The great strength of Encana is a very rich stock of natural gas reserves and economic contingent resources but, in the current push to increase liquids production, Encana is selling natural gas land at fire-sale prices. For example, according to a news release dated 31 Mar 2014, “Encana Oil & Gas (USA) Inc., has reached an agreement with an affiliate of TPG Capital (TPG) to sell certain natural gas properties in the Jonah field located in Sublette County, Wyoming, for a purchase price of approximately US$1.8 billion. … Estimated year-end 2013 proved reserves for Jonah totaled approximately 1,493 billion cubic feet equivalent (Bcfe).” The Jonah reserves were thus priced at $1.20/Mcfe, probably less than they cost the company to acquire (Encana checkup).

At the same time that Encana is selling its gas resources when prices are at record lows, they are buying liquids-rich land after all the other gas producers made their similar moves, and hence are paying peak prices. For example, the FT wrote today, “Encana of Canada has become the latest company working in North America’s shale reserves to make a leap to reduce its reliance on gas, and increase its oil production, by agreeing a $7.1bn deal to buy US-listed Athlon Energy. The deal unveiled yesterday is worth $58.50 per share in cash – almost three times the price of $20 that Athlon floated at last year.”

I invested in Encana because I thought the gas in the ground was undervalued by the market, and I wanted to be a part-owner for the long term. Currently the company is disposing of a significant fraction of that gas for far less than its long-term value. So it is unclear whether my value proposition is intact. There is, unfortunately, insufficient information in current news reports to fully evaluate the effect of current actions on reserves and resources.

Fortunately, current commentary in the news is very positive about Encana's dispositions because (and with this I agree) the current strategy is likely to increase near-term income. Thus my strategy is (1) to wait for the 2014 annual report, in order to evaluate the overall effect of dispositions and acquisitions in 2014 on reserves and contingent resources and (2) if my long-term value investment thesis is no longer convincing, wait for a quarter with good news on income, and hopefully a pop in the share price, to sell.

Sold Best Buy

4 Sep 2013 by Jim Fickett.

I bought Best Buy at an average price of about $16/share (see Holding on to Best Buy), and sold this week at about $35/share. Greater-than-100% gain is a pretty good reward for simply ignoring widely repeated myths with no basis in fact.

It could be that the stock will rise significantly further. At today's closing price of $37 the market cap is $12.64 bn. One estimate of future sustainable free cash flow, based on a long-term average of (free cash flow)/revenue, is $1.07 bn, which gives a free cash flow yield of about 8% – still impressively high. But Best Buy is still a turnaround story – they built too many stores, let customer service lapse, and ignored the web. So although I think the stock is probably not a bad holding, the case is not as strong as it was, and I will happily take my profits.

Emerging market bonds are approximately at fair value

17 Jun 2013 by Jim Fickett.

I pointed out in a recent post that EM bonds, which have taken a significant hit recently, might present a buying opportunity (Possible opportunity in EM bonds). After looking at yields and inflation in a little more detail, I think the fund I mentioned, PIMCO's Emerging Local Bond Fund, PELAX, is probably near fair value.

The top three countries targeted by the fund are Mexico, Brazil, and South Africa. Together, holdings from these three cover about half the value of the fund. In each of these countries bond yields are now at a level to give a positive and reasonable real return. For example, in Mexico inflation seems to have been under control for a decade or more, has averaged around 4% over the last couple years and in June was running at 4.6%. The ten-year government bond yield has so far in June averaged about 5.3%.

In South Africa the situation is quite similar to that in Mexico – inflation averaging around 6% and the 10-year yield currently around 7%. In Brazil the situation is a little more complicated. Official inflation figures are fairly steady around 6%, but an increasing number of price controls and other government subterfuges suggest inflation is, in reality, getting worse (Brazil inflation). On the other hand the current 10-year government bond yield is at about 10%, which does somewhat compensate for the danger.

Assuming these three countries are fairly representative (which, for PELAX, is probably the case), that suggests EM bonds are currently approximately fairly valued. If I didn't already have nearly my full allocation, I would buy more today. But since I already own most of what I want to own, I will save that one last purchase for a time when the assets are undervalued. I suspect such a time will come when Japan gets into deeper trouble or people finally realize Draghi is not really in a position to do “whatever it takes” for Europe.

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