Commonwealth Tries to Beat the Market

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16

They’re not all created equal. The IBA one was a mortal fucking lock, I considered using the maximum leverage I had available to me (and probably should have done it). It was literally a bet against a natural disaster/act of God. In hindsight, bird flu ripping through their farms was for sure the vast majority of the risk there. Wish I’d bet more on that one.

ATVI was the riskiest, but I also feel like I ran pretty bad on that one and am still likely to prevail in the end. X was a good example of like a really good spot to get myself into, things falling apart on it, and still managing to get out without taking an L. And the downside risk there was pretty capped (20-25% drop).

ATVI was an exception, that was pure merger arb, but the other merger arb spots I’ve ended up in were because I bought the company as a value investment, understood the company reasonably well, and then when the merger happened I knew what a steal the buyers were getting.

17

Well the first thing is, I don’t have the right connections.

If I did, the hundred million dollar question would be how big could the AUM get before the strategy stopped working? One of the investments I posted this week has a $34M market cap. If I didn’t set a limit order, I would have moved the price of the stock putting a few thousand dollars into it. On the other hand, if I was running several hundred million in the right structure, I could have tried to buy the whole company or a big chunk of it and instead of waiting on someone else to do the things the business needs to do to unlock the value, I could have made them happen. Of course, buying 51% or 100% of a company isn’t as simple as setting a limit order and clicking buy.

The other thing is, running other people’s money, you really don’t get the benefit of the doubt for very long. Have one unlucky year to start and it’s probably a wrap. I think my strategy will beat the market over a big sample size. But over any 2-3 year stretch there’s going to be significant luck involved.

18

My strategy is laughably simple to get the list of possible investments down to 5 to 20 stocks each quarter. But then there’s a healthy dose of having a good bullshit detector and recognizing growth catalysts and opportunities, or recognizing spots where the market has priced in an event as a ~certainty when it’s just a probability.

A lot of it is also just tedious work that people don’t like to do. I mean, I always think of the scene in Big Short where the guy is like how do you know this and Burry is like, “I read them,” and the guy is like, “Nobody reads them!”

I read them.

19

Sold HVT $31.55. Bought WSM $142.60. Bought WIRE $165.20.

HVT returned nicely for me, WSM is a better business at a similar discount. Sector could get beaten down here and I’ll gladly buy more WSM and could easily see myself holding it for a decade or more.

WIRE is a copper wire manufacturer trading at ~1.5 tan book. Benefitted a ton from inflation and so the market is pricing their earnings cratering. I think they come down somewhat, but long-term I love this business too. Benefits a ton from a shift to EVs and renewables, and there is a projected copper supply shortfall as demand skyrockets over the next 10 years or so. Similar to WSM this could get rocky short term, but it’s another business I’ll gladly buy more of in that case and hold onto for a while.

20

+22.66% 9/1/22 to 9/5/23

S&P did 14.68% plus whatever the dividend yield was, ~1.5%. So 16.18% or something like that.

21

Demand goes up, supply can’t pace, the gap means higher sale prices. They’re better than their competitors at vertical integration and sourcing (including specifically recycling copper), run a more efficient operation, and thus are less impacted by rising input costs. So a gap in supply/demand should increase their spreads.

Plus, even if their spreads stay the same and they can’t grow their profit margin, it’s coming from a bigger topline number in that scenario.

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22

Order just filled on BSET at $15.22. Mediocre furniture business at a price to cheap to pass on. Wouldn’t be surprised at all if they’re a takeover target again in the future. They passed on a $21 offer last year. Solid dividend yield while waiting for a catalyst to come.

So basically took a position in a good but not great furniture business in HVT, which was no longer quite as good on the value screens, and turned it into a mediocre but cheap furniture business with a better margin of safety, and a growth business that’s a mix of furniture/furnishings in WSM that has more upside.

23

Yeah I mean I think there are some big inefficiencies in the market, in particular on micro caps and in particular on microcaps that are boring to think about. The stock in question is a $134M market cap furniture company. I don’t think large funds are looking at them very hard.

I also think the entire sector is beaten down, and rightfully so, but one pattern I have seen in the last 18 months (and that’s a small sample so we’ll see if it holds) is that in a lot of cases sectors get beaten down too evenly. So what happens is the companies with really strong tangible book value get beaten down just as much as the ones who are highly levered with weak balance sheets or ones with reasonable balance sheets and better growth or more resiliency in a recession.

The same concept applies to people buying and selling ETFs for sectors, which forces the ETF to buy/sell everything in the sector indiscriminately.

The overall bet against the sector can be good, but it can also create opportunities in small and micro caps.

Whether these theories hold over 3, 5, 10 years, we’ll see. But so far, it’s working out quite nicely.

I dunno, was META really worth $378 a share in Sept 2021, $187 a share in March of 2022, $91 a share in November of 2022, and $300 a share now? Did the fundamental value of the business actually change that wildly in two years?

META certainly doesn’t lack collective eyeballs, but those swings indicate to me that there was a market for finding them undervalued.

Large companies are probably never going to be my bread and butter, let me be clear. But if the market can miss that badly on META, it sure as hell can miss that badly on 10-20 small and micro caps out of the thousands of companies that are publicly traded.

(Hopefully none of that came off as rude or combative, I enjoy your posts and I enjoy debating this stuff.)

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24

I’d just add that a lot of people running a lot of money on Wall Street have really perverse personal financial incentives relative to their fiduciary responsibilities and… yeah, personal incentives rule the day.

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25

Bought MBUU this morning at $48.39, again may be a rough six months but love it moving forward long term. Really well run business with a solid balance sheet and a tremendous track record of earnings growth and return on capital.

26

In the case of BSET, I don’t think the dividend itself is an upside catalyst for the share price. Basically I think the business is worth somewhere in the $20 to $25 range, but I think a lot of that is based on the tangible book value - which could set them up to be acquired. It also just provides a margin of safety.

I also don’t think they’re going to do anything accretive with extra cash on their books. So I’m hoping to buy it at $15 and sell it at say $22.50, or see it be acquired in that range. In the mean time the best thing that can happen with their earnings IMO is to return the capital. Since I think it’s irrationally cheap, I don’t think the dividend is going to cause the stock price to move as much as it should in theory. Like if it were properly priced (imo) at $20-25 then I would expect the stock to drop by the dividend amount when it goes ex-div, but I think there’s often more price support when stocks are trading at/around their book value because of the types of people who buy them at those prices.

Yeah I mean I agree that public perception can play a role and lead to some inefficiency. I agree it’s often just stocks being overvalued, which tends not to create opportunities for a value investor who doesn’t want to go short (and I don’t). However, eventually the numbers and the math matter, so if a lot of the large caps are overvalued like that, it means the index funds are overvalued in a broad sense, which means you should in theory be able to beat them.

I think they were probably overvalued at $375 at that time, undervalued at $100, and are approaching a fair value now. I think the negative hype around some of the metaverse stuff overlooked a lot of that more important metaverse/ai that fell under those huge capex numbers. Like Horizon Worlds was hilariously bad (but who knows where it is in 5 years), but they were doing some cool/valuable stuff for business application and with input devices.

I also think everyone was so focused on the metaverse that they kind of ignored the fact that the company could drop most of that capex, focus back in on the core business, and print $15 EPS numbers again with reasonable (but not crazy) growth potential, which would probably warrant a $300 valuation in and of itself.

But it’s also possible that I underestimated Zuck’s hubris on that particular point. I tend to agree with him on the metaverse/ai spend, but the only way we’ll ever find out if my read on his willingness to drop it is if they fail.

Also they made some horrible HORRIBLE decisions on buybacks at exorbitant prices when they would have been better off initiating a dividend or sitting on the cash. How many shares did they buy at $300-375 a year before it was trading at $100-150? A lot of blown capital, which is part of the reason I didn’t want to consider buying it at those prices.

27

The ATVI deal closed.

In at $81.075 on 2/17/22, out for $95 on 10/13/23. Collected $0.47 and $0.99 in dividends. Total return $96.46, or 18.98%.

VOO $407.49 on 2/17/22, $396.42 close on 10/13/23, $10.50 in dividends. Total return -0.14%.

Not sure if I posted when I sold the last of my position in X, but it was at $30.88 on 9/15/23. Unlucky timing on news of new bidders coming right after I exited, but still a sizable win.

About 63% of my position was at $21.28 from 2/1/22, 15% at $25.38 5/10/22, and 22% at $19.99 on 6/17/22. Total return including dividends was 44.56%, and that doesn’t count the portion I exited from in March 2022.

VOO 2/1/22 $414.34 (-1.42%)
VOO 5/10/22 $366.84 (+11.35%)
VOO 6/17/22 $334.24 (+22.21%)
VOO 9/15/23 $408.48

Solid win all around there.

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28

Sold all my remaining META at $334.82. Current VOO $411.84.

75% of current sale was bought 2/7/22 $225.525.
Result +48.46%

VOO 2/7/22 $411.16 → $411.84 + $10.503 in dividends = $422.343
Result +2.72%

25% of current sale was bought 11/7/22 $94.99
Result +252.48%

VOO 11/7/22 $349.14 → $411.84 + $6.228 in dividends = $418.068
Result +19.74%

(Had previously sold some from 11/7/22 on 4/26/23 at $228.14.)

META has moved outside value range, and I think there’s a lot of risk in 2024 which weighs pretty fairly (at best) against the upside at current prices. I’m not looking for fair (at best) pricing.

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29

Sold all my MHO.

In at $46.24 on 8/5/22. (VOO $379.98)
Out at $103.15 on 11/14/23. (VOO $411.76 + $7.70 dividends = $419.46)

MHO +123.07%
VOO +10.39%

Like the company, it’s just a bit too expensive relative to my value metrics now.

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30

Down to $1.53, bought it back to my normal allocation. Very bad quarter, one of their main customers lost a lot of business. It should recover cyclically with agriculture, and $1.53 is an attractive price relative to the upside here.

This is a reasonably good business at a cheap price, and there’s a freeroll upside on climate change for a product that significantly reduces water reservoir loss to evaporation. They’re currently making nothing on it, seems like a reasonable chance that takes off at some point and blows them up into a much bigger business.

31

Bought DHI at $127.73. Similar play. I like the company a little less long-term, but it’s a little better price on my value screener, and I think it’ll be steadier than MHO if there’s a housing crash in a high rate environment because they have less debt, a segment selling to rental companies, and more room to acquire distressed companies.

They’re obviously highly correlated but the thought here is to rotate between a handful of housing stocks and other correlated stocks based on their value metrics.

32

Bought SILC today for $15.40. They make network adapters, smart cards, and edge networking products. Israel-based, not directly impacted by the war. Locations near Haifa and Tel-Aviv. Also locations in the US and Europe.

Tangible book $22.73, NCAV $13.95. Something like $19.25 in cash and inventory, and they reaffirmed that their inventory is money-good inventory.

TTM P/E 6.04, but they’re going to lose a little or break even in 2024. Customers built up inventory the last year or two to mitigate supply chain risks and now they’re working through it and purchase orders are down. They expect a return to baseline and double digit growth in 2025.

No debt, good current ratio for the situation (almost 9), $67M in cash against a market cap around $103M.

18 straight years of profitability, 22 consecutive quarters of accurate guidance, so to basically get the business at negative value after cash and inventory is insane to me.

Baseline profitability is a very fluid definition I guess, but they seem to mean in the neighborhood of $1.50 to $2.00 eps. They’ve previously hit valuations as high as 28x earnings (ignoring the inflated ratios in 2020), so I think 15-25x is very reasonable, so $30-40 seems like a reasonable target using the middle of that range for the end of 2025, which means annualized returns in the ballpark of 50%. And they intend to continue buybacks through 2024.

If they manage to hit closer to $2.00 eps in 2025, restore their margins, and guide for double digit growth, it could get even better.

Also could easily see them being acquired in the next 12 months if they keep trading this low.

33

I’m still in FSI, don’t plan on selling it near current levels. I’ll post if/when I do sell it, though.

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34

Bought GGB yesterday at $4.28. Brazilian steelmaker but half their profits come from US operations. Trading below tangible book, for like 5x ttm earnings and < 10x future earnings. Low debt.

China is dumping steel in Brazil and globally so steelmakers are in a down cycle, that’s why it’s cheap. But tons of infrastructure spending in the US, and on a relative basis like 5 times more in Brazil. They should get through it just fine, quite possibly stay profitable, and the infrastructure spending should fuel higher steel demand for the next 3-5 years. Brazil may also increase tariffs on steel which I’m not banking on but if it happens, we could get a fast win here.

35

Just doubled my position in SILC since it’s back down to $15.70. I had been regretting not taking a bigger position initially.