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Cox & Kings – Q3 Update

COX released unaudited Q3 numbers yesterday.  We won’t know some of the key metrics, segment info, and outlook until the company’s quarterly call and investor presentation, but the numbers should give us an idea of directional performance.

Q3 and Q4 are slow quarters for COX.  The Indian holiday season typically runs from March-June and the rest of the world runs from June-September.  Nevertheless, performance was quite strong in Q3.  Most notably, the company managed expenses well in the context of a growing operation.

I’ll be able to provide more color in a few days.

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Portfolio Update

I’ve updated the portfolio page to show the full transaction history and entry / exit prices.  Note, my explicit goals are not to beat a benchmark index or generate positive returns on a quarterly or even annual basis.  My goals are (i) to buy high quality businesses at a good or reasonable price, (ii) limit risk (I define risk as the probability of a permanent loss of purchasing power), and (iii) patiently wait if I can’t find anything interesting which fits within my circle of understanding.  I believe this strategy, over time, will produce superior results.

After doing more work, I sold out of a small position in SolarCity.  I remembered one of Buffett’s quotes (full quote is in the quote repository) which states in so many words – if you are struggling to make things clear in your head, you probably don’t understand the business.  I went through my checklist and couldn’t provide logical answers for many items.

A few key areas I can’t grasp include (i) competitive threat from utilities and banks, (ii) long term cost advantage versus Asian suppliers, (iii) future policy implications including net metering policy, (iv) accounting, (v) the impact of rising interest rates / tough financing markets, and (vi) long term capital needs to build out manufacturing capacity and investments in marketing.  I also think back to all the lessons I’ve learned from reading business history.  In most instances, a new technology provides a wonderful outcome for humanity, but lays waste to many industry participants. The automobile was an incredible invention, yet hundreds of car companies have failed over the years.  The commercial aircraft was also revolutionary, but most airlines have gone out of business.  Solar is a game changing technology which is driving us toward a carbon neutral future, but the markets are simply too large.  You’d rather own a small company dominating a slow growing niche than a large one playing in a trillion dollar market.

The only time to invest is when something feels like an absolute no-brainer.  If you are handicapping too many items, you should stop and look at something else.

Fairfax India Holdings

Most individuals don’t have the time or desire to sift through annual reports, earnings call transcripts, and industry trade publications to find the next great investment idea.  They’d rather turn their money over to professionals or invest in index funds.  In most instances, I suggest passive investors invest in a handful of broad market index funds through a systematic investment program (Wealthfront, Betterment, and Future Advisor are great online platforms which automate the process).  One way to beat the market over time is to increase exposure to the market during severe (20%+) corrections.  History shows that the nominal value of the market has never failed to recapture prior peak levels.  Having the proper temperament over a long period of time can produce superior returns.

For those investors seeking a bit more alpha, there are a handful of good funds to invest in.  I’m not a thematic investor by any means, but having lived in India for 2 years, I am optimistic about the country’s long term prospects.  A young working population, vibrant democracy (exhibited by last year’s election), a once in 50 years leader, a culture focused on education (particularly science and engineering), a high savings rate, rising consumption, and continued adoption of free market policies could result in a golden era for the Indian economy over the coming decade.

North American investors don’t have any easy way of trading Indian stocks.  They must either be an Indian citizen with an overseas account or go through an expensive broker.

Now, there’s an opportunity to invest in India alongside one of the great investors of our time.  Prem Watsa, proprietor of Canada’s Fairfax Financial, recently launched Fairfax India Holdings, a publicly traded SPAC which will invest in Indian companies, public and private.  Fairfax will own 30% of the vehicle with a 10 year lockup.  Moreover, the fees are quite reasonable for such a vehicle – a 1.5% management fee and 20% performance fee after a 5% hurdle rate.  I particularly appreciate the 5% hurdle rate because it guarantees investors a 5% return before Fairfax is paid, similar to the Buffett partnerships.  A high watermark also applies.

I’m attaching the investor presentation and long form prospectus.  The sections on India are particularly insightful.

I worked with TD Ameritrade to get the ticker symbol added to their system.  The subordinated voting shares trade on the Toronto Stock Exchange under ticker: FIH.U.  The CUSIP number is 303897102.  If you can’t purchase shares online, you should be able to call in and have a broker execute the trade.

As a disclaimer, investors should read the prospectus and understand the risks before investing in this vehicle.

Reinvestment Risk

I’m continuing to explore a few ideas in greater depth, mostly in the energy sector, but haven’t reached conviction on any one idea in particular.  Great opportunities are generally very hard to come by.  There are greater than 50,000 publicly traded companies worldwide.  Most people can probably follow only 30-50 companies while maintaining a high standard of quality.  Therefore, it’s critical to (i) focus on your areas of competence and slowly expand the circle over time, (ii) develop strong filters so ideas can be quickly weeded out, and (iii) bet large sums of money when a superior opportunity is identified.

As mentioned previously, I’ll continue to write on topics which I’m thinking about.  One common perception which I’ve been pondering is that rising interest rates will harm bond portfolios.  The consensus opinion is that interest rates will rise, perhaps dramatically, over the coming years.  It’s interesting to note that this has been the consensus view over the past four years, a time period when interest rates have fallen substantially.  It follows that rising interest rates will harm most assets, particularly bonds.

When thinking of a long term bond, say a 30 year bond, a majority of return does not come from coupon payments.  It comes from reinvestment of the coupons (the interest on the interest).  Therefore, in a low rate environment, a 10% coupon bond will generate a lower yield to maturity than the 10% stated rate since the coupons will likely be reinvested at a rate lower than 10%.  Stated another way, when a bond is purchased at a stated yield to maturity, the implied reinvestment rate in the calculation is the quoted yield to maturity.  However, it doesn’t have to be.  In an environment where treasuries are 3%, it’s not reasonable to assume that all coupons can be reinvested at a 10% rate.  For this reason, the yield to maturity calculation is somewhat illusory.

Most bond investors and insurance company portfolio managers are terrified of rising rates.  Yes, when rates rise, quoted bond prices will fall.  However, if a long term bond is held to maturity, the overall return on the bond will increase in a rising rate environment.

Oil Crash

It’s during moments of mass market liquidation, when asset holders would rather sell than wait for rationality to resume, that buying opportunities surface.  The recent crash in oil prices has sent the whole energy sector into freefall.  Much of the energy complex is tied to oil prices, but certain high quality businesses such as Western Refining and SolarCity could do well long term irrespective of oil prices.

As mentioned previously, I’ve formed a preliminary hypothesis that SCTY is poised to be a large winner in the exponentially growing solar energy sector.  The market value of the company is currently quoted at ~$5bn, implying lofty expectations for future growth.  There certainly isn’t a large margin of safety in the price, but there appears to be a margin of safety in the company’s business model.  However, it may prove to be too difficult a business to reach conviction on as some elements of the analysis may always be a black box – accounting, regulatory environment (subsidies, net metering policy), and competition from utilities and banks.

I’m continuing to do work on SCTY and some other names in the energy sector to see if an investment opportunity exists.