Tag: valueinvesting

Growth vs. Value stocks… Why not both?

I’ll admit it. When someone asks me what type of investor I am, I always say value investor. But is that accurate? What really is the difference between growth vs. value stocks?

On one hand, traditional value investors would describe themselves as ones who buy statistically cheap stocks. The companies they buy may be down and out, but there is still a solid business supported by earnings / cash flows that you can nab for cheap. If sentiment improves or results come in better than feared, that’s all gravy.

On the flip side, I think growth investors are often relegated to universe of momentum investors. They are viewed as ones searching quickly growing companies and often ignore what the earnings of the business are.

But is this description correct or warranted? When considering growth vs. value stocks, I think people forget that growth is coming at some value.  That is why I view growth and value investors as one in the same.

Value investors are searching for companies that they think can be a low hurdle that investors are ascribing to the business. Growth investors are searching for assets that they think will beat a high hurdle.

In fact, I’ve come to learn over the years that growth can pay for a lot of sins. As Charlie Munger once said,

“Over the long term, it’s hard for a stock to earn a much better return than the business which underlies it earns. If the business earns 6% on capital over 40 years and you hold it for that 40 years, you’re not going to make much different than a 6% return – even if you originally buy it at a huge discount. Conversely, if a business earns 18% on capital over 20 or 30 years, even if you pay an expensive-looking price, you’ll end up with a fine result.”

 

Example of Growth & Value

Facebook’s recent decline in which it lost more than any other company in a single day is an example of this. At the end of the day, yes. Facebook has had some privacy issues among other things, but it is still a solid platform. They also own Instagram (which I spend way too much time on) and Whatsapp. Indeed, even after the disappointing earnings call that led to the drop, analysts still expect sales to grow 25% over 2018’s level and 21% in 2020. EBITDA is expected to grow at a 20% CAGR as well (slower than sales due to the company’s margin comments).

Growth vs. Value stocks? This seems like both.


Let’s examine what can happen when you buy an asset that is growing at this level. Note, this is not Facebook’s results, but an example of how growth can pay for “high-multiple” transgressions. Facebook currently has ~60% EBITDA margins, so allow me to use something more along the lines of Google and Apple at high 30s range (which is still incredible, though capex will also be high).

Let’s say you buy a business similar to this for 20x EBITDA (for context, FB trades for 14.3x est. EBITDA for this year).

Hypothetic buy

Again, these are all made-up numbers, but lets assume strong growth rates for the next few years that starts to level off over time. The business maintains high incremental margins (but offset by capex reinvested in the business). I assume little debt needed as these businesses such as Google, Apple, and Facebook don’t actually consume much cash (which is why their cash balances balloon).

Hypothetic buy 2

As you can see, the end result is still extremely attractive. I cut the multiple to 8x EBITDA which is well below where it started at 20x. The important factor still, as I have written before, is that the business has a competitive moat so that it can reach these targets. If they can, tech companies in particular are attractive since a company like Facebook or Google have tremendous platforms and additional customers or users cost next to nothing for them to serve.

On the flip side, if you’re buying a fashion retailer (something that is subject to fads), or a technology that is good today but could be disrupted tomorrow, then this is less attractive because it could be here and grow well in year 1, but destroyed in year 2 (perhaps a Snapchat IPOing vs. Instagram stories…).


Frankly, I’m tired of people saying they are a value investor when in fact they are just buying low P/E stocks and hoping it re-rates higher. I think it takes more than that, such as analyzing how the company will compound (re: grow) earnings.  

Cheap building products stock trading with at near 12% FCF yield

I’ve written previously about competitive advantages, moats, and investing in high quality businesses. That’s the ideal scenario. But sometimes, the valuation can be so attractive that the investment case is still strong.

I posit that Atkore International (ticker: ATKR) is now too cheap to ignore. Management seems focused on this as well, having repurchased a large portion of stock (26.5% of shares outstanding) from the former Sponsor owner, CD&R.

Atkore is a leading manufacturer of electrical raceway products and tubes that are used in a variety of construction applications.  The Electrical Raceway segment (65% of sales) is a leader in products that isolate, deploy, and protect electric circuitry as it moves through a building. The products include armored cable & fittings, steel and PVC conduit, and flexible conduit and cable trays. The Mechanical Products & Solutions segment (the balance of sales) manufactures in-line galvanized tube, metal framing and fittings, and other mechanical products used in non-residential construction.

I think it helps to see what these products include, as shown below.

ATKR Products

Atkore generates roughly 85% of its sales from markets where it is the No. 1 or No. 2 player. Products are distributed through national electrical distributors such as WESCO, Rexel, and Graybar, independent electrical distributors, industrial distributors including Grainger and Fastenal, and big box retail including Home Depot, Lowe’s, and Menards.

When you look at these products, its really hard for me to see how “secret sauce” is involved with manufacturing these products. However, you would probably be surprised to learn the company has 15% EBITDA margins and capex has averaged <1.5% of sales for the past 5 years. That brings me to one of the metrics I tend to follow and that is unlevered FCF conversion. And by that I mean, (EBITDA-Capex)/EBITDA as a percent. The reason why I like to look at this is to move beyond some business that might have lower EBITDA margins (like distributors with 3-7% margins), but convert a lot of that EBITDA into FCF. Typically FCF conversion greater than 80-85%+ is a really solid business. ATKR averages 90%.

ATKR unlevered FCF

Now you can see that 2015 was not as high as the past 2 years. That is because ATKR undertook a significant portfolio restructuring, as summarized in the company’s slide below. The company divested low margin product and focused on higher margin product where it had strong market share and areas where it could raise price. Raising price is important part of the story here, as that extra price drops straight to the bottom line. EBITDA margins were less than 6% in 2011, moved to 15% by 2017 and their long-term goal is to reach 20% EBITDA margins.

ATKR Transformation

Now to valuation. ATKR trades at a significant discount to peers. Most building products companies right now are trading at 10-12x and a FCF yield of about 5%. As can be seen below, ATKR is trading well below that and will generate a significant amount of its market cap in FCF. This provides flexibility for the company to pay a dividend, acquire additional companies, buy back stock, or even down debt (which builds equity value).

ATKR FCF Walk

One quick comment about the projections – the top line growth expected in 2018 is mainly due to an acquisition and the moderation in 2019 is due to a divestiture. I do not expect much growth in 2020 just as we get to a more mature place in the cycle. Either way, the stock is too cheap to ignore.

Even using a 7% FCF yield, which foots to less than 9x EV/EBITDA, the stock has significant upside.

ATKR Price Target

Now, the risk here is really the non-residential cycle. It could quite possibly be near peak or slowing down, but I don’t think my assumptions are too aggressive.

Let me know what you think.

-DD

Recap from Berkshire Hathaway Annual Meeting

I was fortunate enough to attend the Berkshire Hathoway annual meeting and wanted to provide a recap to readers. I’ll try to skip much of the fluff questions that were asked.

IMG_2825

But to kick it off, I think its important to recap how Buffett started the meeting. He noted that he expects to receive many “macro” questions, such as what the fed will do with interest rates, risks from an unpredictable president, and the tariffs and to put these topics into context, he brought an actual, physical NY times newspaper from March 1942. The Phillipines had just been lost to Japan. The US had been bombed by Japan in the previous December. The outcome of World War II was far from certain.

Despite all this, 11 year old Warren Buffet decided to invest. And although he did not have this much money at the time, he noted if you bought $10,000 in the S&P500, it would be $51 million today. If you had bought productive US assets, they would have compounded at a fantastic rate of return.  At the same time, if you bought gold in fear and left it, it would be worth $400,000, higher than you invested but significantly less than the amount generated by stocks. Also, the yield on bonds at the time was 2.9% and there was encouragement by the government to “support the cause” and buy war bonds. Buffett & Munger did not partake much in this by simple math -> 2.9% minus taxes less 2% inflation leads to a minuscule return.

  • Succession planning:
    • Many questions related to succession planning, which makes sense given Mr. Munger and Mr. Buffett’s age (87 and 94 respectively). However, based on their responses, their ability  to work all day from ~7:30am to ~5:00pm all while eating peanut brittle and coca-cola, made me confident that Buffett and Charlie are in solid mental health at least.
    • “I’ve been semi-retired for decades”, Buffett’s response to succession planning. Ted Weschler and Todd Combs have assumed some investment responsibilities and Ajit Jain and Greg Abel now oversee Berkshire’s operating businesses.
    • However, Ted and Todd manage ~$25BN compared to Berkshire’s $100BN in cash as well as his current investment decisions. Bottom line: Buffett is still in charge
    • That being said, it should give some confidence that Buffett is relinquishing the reins responsibly.
  • Dark clouds on the horizon
    • Buffett was asked about Amex, given there are “dark clouds on the horizon” in payments. By this, he meant changes are happening in the industry and many technologies are trying to disrupt the industry.
    • However, he reiterated that the business is terrific, global payments are increasing, and Amex is a great brand. Over time, through share buybacks, Buffett will increase his stake.
    • In response to dark clouds, Buffett said something along the lines of, we used to buy outright declines (e.g. the textile business Berkshire is named after) so they are improving.
  • Dividends & Share buybacks
    • When asked to clarify why Buffett does not pay a special dividend or conduct buybacks, yet Buffett is favorable on Apple’s massive share buyback plan.
    • For starters, Buffett thinks Apple’s stock is cheap, and recently added 75MM shares to his portfolio. It then would make sense for Apple to buyback its stock if it also thinks it is cheap.
    • Second, it is unlike that Apple can find acquisitions in size “that they can make at remotely sensible price that really become additive to them.”
    • “The reason companies are buying their stocks is that they are smart enough to know it’s better for them than anything else,” Mr. Munger said.
    • Therefore it makes sense for them to acquire shares. Buffett on the other hand, has said he is open to share repurchases if he can’t find a way to deploy it (but he think he can).
  • Cryptocurrencies
    • Much has been said about what Buffett and Charlie said on crypto, but it bears repeating.
    • First, like gold, cryptocurrencies are non-productive assets and therefore depend on a “greater fool” to buy at a higher price than you bought it.
    • Charlie called this idiotic and immoral (given the greater fool piece). However, the BEST PIECE, was when he compared it to turds.
    • “To me, it’s just dementia. It’s like somebody else is trading turds and you decide you can’t be left out.”