An alternative way to invest in SPACs

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This is not a post about buying the hottest SPAC at 13 and hoping it will reach 20 as others will want a piece of a new / disruptive / trendy / idea.

It’s an approach to put cash at work in assets with attractive risk-reward characteristics.

I’m talking about pre-deal SPACs trading below 10 and backed by sponsors with strong track records (in business and investments).

The case is simple. Downside risk is limited because you can redeem shares at 10 when the deal is announced. Upside potential exists in case the market liked the proposed deal.

A few examples:

Pegasus Europe. Looking for opportunities in fintech. Backed by Jean Pierre Mustier, Diego De Giorgi, Bernard Arnault.

2MX Organic. Looking for targets with a dedicated focus on sustainability. Backed by Xavier Niel, Moez-Alexandre Zouari, Matthieu Pigasse.

CC Neuberger Berman Holdings II. Backed by Chinh E. Chu, Neuberger Berman.

Some resources:

Prof. Damodaran provides a skeptical view on SPACs here. The video version is here

A sober look at SPACs on the Harvard Law School Forum on Corporate Governance.

A good Barron’s article about the opportunity here.

Value Investing From Graham to Buffett and Beyond (2nd edition)

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The first edition of this book was written in 1999, after a few years of underperformance of the value style. It became a big success as an authoritative source for value investors but according to its main author Bruce Greenwald “it was not a good book” (see here, here and here).

The second edition, revised and updated, came out after renewed massive underperformance of the value style, with the aim to correct the shortcomings of the first edition.

So what is so different in this edition?

Let’s first summarize 2 basic ideas that never change:

– Searching for overlooked opportunities that are out of fashion and not overpaying for glamour stocks.

– Approaching valuation with deep analysis rather than just applying a multiple.

The improved element, which is at the heart of the current debate around value investing (see for instance Howards Marks’ recent memo), is how to analyze growth. Greenwald dedicates 3 chapters to respectively Growth, Good Businesses, and The Valuation of Franchise Stocks. Building on his book Competition Demystified, he extensively describes the characteristics of a moat, including economies of scale and customer captivity

The other distinctiveness of the book’s approach is to adapt the valuation toolkit to the business at hand. Asset value and earnings power value are the first two components of a complete valuation description. For “good” companies or “franchise” businesses, where growth creates value, Greenwald proposes an original valuation approach to calculate returns (see Chapter 8 and its appendix). The approach is extensively illustrated with 2 detailed examples: WD-40 and Intel.

The back end of the book includes profiles of accomplished investors: obviously Warren Buffett but also Walter and Edwin Schloss, Mario Gabelli, Seth Klarman, Michael Price, Tom Russo and a few others. Video presentations are available here.

In summary, this book is a reference for (value) investors. It’s not a casual beach read but a profound contribution to the practice of investing. Given the density of the content, in particular the valuation of growth stocks, it’s a book that should be read multiple times.

Warren Buffett’s 2020 annual letter

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After a rough week in the bond markets, with the 10-year US Treasury closing at 1.4% (dear yield hunters, are you excited?), this is the time of the year where Warren Buffett shares his investment wisdom in his annual letter. For my notes from previous years, see 2015, 2016, 2017, 2018, 2019.

As always, my best recommendation – read the letter.

Below are the excerpts I found most insightful.

On investors and speculators

At Berkshire, we have been serving hamburgers and Coke for 56 years. We cherish the clientele this fare has attracted.

The tens of millions of other investors and speculators in the United States and elsewhere have a wide variety of equity choices to fit their tastes. They will find CEOs and market gurus with enticing ideas. If they want price targets, managed earnings and “stories,” they will not lack suitors. “Technicians” will confidently instruct them as to what some wiggles on a chart portend for a stock’s next move. The calls for action will never stop.

Many of those investors, I should add, will do quite well. After all, ownership of stocks is very much a “positive-sum” game. Indeed, a patient and level-headed monkey, who constructs a portfolio by throwing 50 darts at a board listing all of the S&P 500, will – over time – enjoy dividends and capital gains, just as long as it never gets tempted to make changes in its original “selections.”

Productive assets such as farms, real estate and, yes, business ownership produce wealth – lots of it. Most owners of such properties will be rewarded. All that’s required is the passage of time, an inner calm, ample diversification and a minimization of transactions and fees. Still, investors must never forget that their expenses are Wall Street’s income. And, unlike my monkey, Wall Streeters do not work for peanuts.

Never bet against America

Today, many people forge similar miracles throughout the world, creating a spread of prosperity that benefits all of humanity. In its brief 232 years of existence, however, there has been no incubator for unleashing human potential like America.

Despite some severe interruptions, our country’s economic progress has been breathtaking. Beyond that, we retain our constitutional aspiration of becoming “a more perfect union.” Progress on that front has been slow, uneven and often discouraging. We have, however, moved forward and will continue to do so.

Our unwavering conclusion: Never bet against America.

On the power of retained earnings

Retained earnings have propelled American business throughout our country’s history. What worked for Carnegie and Rockefeller has, over the years, worked its magic for millions of shareholders as well.

On capital-light businesses

The best results occur at companies that require minimal assets to conduct high-margin businesses – and offer goods or services that will expand their sales volume with only minor needs for additional capital. We, in fact, own a few of these exceptional businesses, but they are relatively small and, at best, grow slowly.

On bonds

Bonds are not the place to be these days. Can you believe that the income recently available from a 10-year U.S. Treasury bond – the yield was 0.93% at yearend – had fallen 94% from the 15.8% yield available in September 1981? In certain large and important countries, such as Germany and Japan, investors earn a negative return on trillions of dollars of sovereign debt. Fixed income investors worldwide – whether pension funds, insurance companies or retirees – face a bleak future.

* * *

And finally, a reminder of what it means to be a long term shareholder of a “cannibal”. Below are the number of American Express shares Berkshire holds and its ownership percentage of the company.

2014: 151,610,700   14.8%

2015: 151,610,700   15.6%

2016: 151,610,700   16.8%

2017: 151,610,700   17.6%

2018: 151,610,700   17.9%

2019: 151,610,700   18.7%

2020: 151,610,700   18.8%

The GameStop Short Squeeze: some resources

Below are some resources I find useful :

Prof. Damodaran offers insights.

Jim Bianco explains the situation in this Twitter thread.

John Authers talks about righteous anger, which is more dangerous than greed and fear.

Jason Zweig provides some historical perspective and thinks this latest upheaval will likely have a bigger impact on investors’ attention than on their portfolios.

Who really loses? Maybe, all of us.

Investing in the current market conditions

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I’ve collated below how some the best financial minds approach investing in the current markets.

FROM VALUE TO COMPOUNDERS

Howard Marks explains in his latest memo that Value and Growth should never have been viewed as mutually exclusive. In a world where so much innovation is happening at such a rapid space the natural skepticism of a value investor should be paired with a deep curiosity, openness to new ideas, and willingness to learn before forming a view.

Mohnish Pabrai, following Charlie Munger, is now in the camp of compounders with strong moats, long runways and strong management. He’s unwilling to sell these just because they’re a bit overvalued.

Rob Vinall has been very successful investing in compounders. He offers the following refinement to the concept of margin of safety so dear to value investors: “Applying margin of safety is no substitute for developing as accurate a picture of the future as possible. To the extent margin of safety is used as an excuse not to think about the future, it increases the chances of losses – the precise opposite of what it is intended to do.”

Terry Smith remains focused on companies with strong returns on invested capital and is unimpressed with market forecasters. He writes in his annual letter: “What are the similarities between a forecaster and a one-eyed javelin thrower? Answer: Neither is likely to be very accurate but they are typically good at keeping the attention of the audience.”

THE BEARS

Jeremy Grantham speak about a fully fledged epic bubble in this piece published on January 5th. Only the overlap of Value and Emerging finds grace in his eyes. He explains his views in this interview.

Seth Klarman compares investors to “frogs in boiling water”. Central bank policies and government stimulus have convinced investors that risk “has simply vanished”.

HARDCORE VALUE MANAGERS

They still exist, but it’s getting a bit lonely there.

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To conclude, let’s not forget that some things never change. As this great blogger puts it: “Try to find well run companies with solid balance sheets and good future prospects at a reasonable price. Let winners run, sell losers quickly if they perform much worse than I predicted. Avoid structurally impaired sectors/businesses. Try to learn as much as I can and stay away from market timing.”

Investing for Growth

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This bookcompiles the writings of Terry Smith since he established Fundsmith in 2010.

Fundsmith is the quintessential quality growth investor. It invests for the long term in a small number of high quality, resilient, global growth companies that are good value. Or as Terry Smith puts it succinctly:

  • Buy good companies
  • Don’t overpay
  • Do nothing

The ‘buy good companies’ part deserves more explanation. Fundsmith exclusively invests in:

  • Businesses that can sustain a high return on operating capital employed (ROCE), typically well above 15%. Example: Visa.
  • Businesses whose advantages are difficult to replicate, what Warren Buffett calls a strong “moat”. Example: L’Oréal.
  • Businesses which do not require significant leverage to generate returns. Example: Microsoft. Banks are excluded from the portfolio.
  • Businesses with a high degree of certainty of growth from reinvestment of their cash flows at high
    rates of return. Favorite sectors includes consumer, tech and healthcare. No commodities-based businesses.
  • Businesses that are resilient to change, particularly technological innovation. Example: Unilever.

This disciplined approach has worked particularly well over the past decade.

The principles are simple and at the same time profound. The concepts are clearly explained using interesting analogies from day-to-day life including the world of sports (“To finish first you must first finish”).

Terry Smith’s wit transpires in his writings and speeches (see for example this video). I warmly recommend both.

The Joys of Compounding (by Warren Buffett)

From the Buffett Partnership Letters (18 January 1963):

I have it from unreliable sources that the cost of the voyage Isabella originally underwrote for Columbus was approximately $30,000. This has been considered at least a moderately successful utilization of venture capital. Without attempting to evaluate the psychic income derived from finding a new hemisphere, it must be pointed out that even had squatter’s rights prevailed, the whole deal was not exactly another IBM. Figured very roughly, the $30,000 invested at 4% compounded annually would have amounted to something like $2,000,000,000,000 (that’s $2 trillion for those of you who are not government statisticians) by 1962. Historical apologists for the Indians of Manhattan may find refuge in similar calculations. Such fanciful geometric progressions illustrate the value of either living a long time, or compounding your money at a decent rate. I have nothing particularly helpful to say on the former point.

The following table indicates the compounded value of $100,000 at 5%, 10% and 15% for 10, 20 and 30 years. It is always startling to see how relatively small differences in rates add up to very significant sums over a period of years. That is why, even though we are shooting for more, we feel that a few percentage points advantage over the Dow is a very worthwhile achievement. It can mean a lot of dollars over a decade or two.

5%10%15%
10 Years$162,889 $259,374$404,553
20 Years$265,328$672,748$1,636,640
30 Years$432,191$1,744,930$6,621,140

The Psychology of Money

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I you’re looking for wisdom on personal finance and life in general, this bookis for you! I like the title, I like the content, I like the author.

Morgan Housel provides what the subtitle says: timeless lessons on wealth, greed, and happiness.

In 20 short chapters, the author shares compelling stories of how people handle money. I’ve selected a few takeaways below.

  • No one is crazy (even if some stories sound insane). We all make decisions based on our own unique experiences that seem to make sense to us in a given moment.
  • Volatility is the price to pay to get equity market returns. It’s a fee, not a fine. The trick is convincing yourself that the admission fee is worth paying.
  • Few things matter more with money than understanding your own time horizon and not being persuaded by the actions and behaviours of people playing different games than you. This reminds my of a quote by John Pierpont Morgan: “Nothing so undermines your financial judgement as the sight of your neighbour getting rich”.
  • Save like a pessimist, invest like an optimist. Pessimism just sounds smarter and more plausible than optimism. Pessimism sounds like someone trying to help you. Optimism sounds like a sales pitch.
  • Successful investing consists of earning pretty good returns that you can stick with and which can be repeated for the longest period of time. That’s when compounding runs wild.

In the last chapter, “Confessions”, Morgan Housel describes how he invests his money. This chapter is reproduced as the first chapter in the book I reviewed recently – How I Invest My Money. So I’ve read it twice in a couple of weeks. It was a good use of my time.