The Dental Industry – Part 1- Overview

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Why the dental sector?

I had several sector themes in the past and some of them are still in my portfolio (EV’s, breweries, funeral). My most well covered theme has been Electric Vehicles. It’s time to learn about a new niche segment of the market. Over the past year I have spent a lot of time looking in to many different Pharma/Biotech/Healthcare related companies. Unfortunately it has not yielded in anything I can confidently hold long term. I thought I had an investment case with Teva, which I spent a lot of time researching (Teva – The Perfect Storm in 2 parts) but at the later stages of my analysis I decided not to. The main reason why I in general have such a hard time pulling the trigger on a Health related investment, has been the research pipelines. These Phase I, II & III research pipelines often drives most of the value in these companies. I just feel I never have an edge, in understanding the probability, if a product is going to pass through these stages. In the search for something more understandable but still healthcare related, I ended up with dental care. Although still complex, I think this is a niche which is understandable and therefore for me – more investable.

Some segments and markets in the dental services industry has very attractive investment dynamics. First of all it’s generally very defensive, especially in countries where dental care is government sponsored or part of a health insurance. Second, is demographics and economics, the world is getting older and we also live longer combined with increasing wealth. Old people need dentures and implants, and reaching a certain level of wealth, you start to take care of your teeth in another way. These two factors create a significant long term tailwind for these products. Third, it is a very fragmented market, with custom made products. This creates a very low price transparency for the end customer, it will take a long time before end consumers have proper price comparison, for dental services. In many cases it’s also not needed, given government sponsorship or insurance covering the procedures.

This will be a multi part exploration in understanding the dental sector and the investable players in that space. If any of you readers happens to be a dentist or just have deep knowledge in the sector, please do help out over the coming posts to explain the dynamics of the industry.

The Big Picture

It is very hard to get a good global industry overview. First of all because of scarcity of data, secondly because different sources group different products and services in different ways. I have done my best to pull together a industry overview from a number of sources. Most of the industry data is from 2014-2015.

One can divide everything related to mouth health into two main segments, my focus will be on the first of these two:

  1. Dental Services – All products and services when you visit the dentist (teeth check-up, tooth filling, dental implants, cosmetic changes, xray, etc).
  2. Oral Care products  – All products and services outside the dental clinic (toothbrush, toothpaste, dental floss, mouthwash, etc). Although a large market, I will leave this segment for now, this series will focus on Dental Services.

Tooth decay (dental caries) is the most widespread chronic disease worldwide and constitutes a major global public health challenge. It is the most common childhood disease, but it affects people of all ages throughout their lifetime. Current data show that untreated decay of permanent teeth has a global prevalence of over 40 percent for all ages combined and is the most prevalent condition out of 291 diseases included in the Global Burden of Disease Study. Another very common disease is periodontitis, which means inflammation of the gums and supporting structure of the teeth. Periodontitis starts with gingivitis, where the first sign is bleeding from the gums. I think many of you have experienced early stages of this, when you are flossing your teeth and the gums start bleeding.

Dental_diseases_world_wide

We can also see that teeth is a question of economic background, as people get richer they eat more sugary food and get more tooth decay. But as income rises, more of those teeth gets fixed:

tooth_decay

Source: The challenge of oral disease

Dental Service market

The U.S. dental services is today a market of more than a 130bn USD. The European dental market is valued at above 80bn USD. The U.S. dental market is growing at an average growth rate of 5.8% per year since the 1990’s. The European Dental market is a more mixed picture, but on average it is growing at a slower pace of 1-2%. For the Asian region the data is much more scarce. Large countries like China and India has not come nearly as far as the highly developed countries, but growing at significantly higher pace (from low levels).

U.S. Dental Services expenditure

Us_dentalmarket_growth

Source: Harris Williams & Co

The below picture gives a feeling for when markets are saturated in terms of number of dentist per 1000 population. One can see a pattern of about 0.5-0.8 dentists in developed markets, whereas a country as China has significant growth ahead:

Numberofdentistpercountry

Dental Services explained

To explain the different parts of the industry I use this split from 2015 on the U.S. Dental Services:

US_Overview_Dental_Services

Source: Brocair Partners

This gives a brief explanation of these different sub segments of dental services

Restorative – Dental fillings, dental crowns, procedures treating damaged or decaying teeth or gums.

Preventive – Routine dental exams, cleanings, fluoride and sealant applications.

Diagnostic – Digital radiography and x-rays, etc.

Orthodontics – Treating improper bites and misaligned teeth.

Prosthodontics – Artificial teeth, partial or full dentures, bridges and implants. This also includes veneers, a thin layer placed over a tooth and other types of tooth restoration.

Oral surgery – reconstructive surgery, jaw alignment, dental extraction. This segment also include cosmetic surgery to the jaw.

Endodontic – Root canal procedures and other treatments related to the pulp of the tooth.

Other – Includes services to dental practices, distributors, software solutions, HR, marketing, financial planning etc.

Within all these areas the are a number of large to medium sized companies providing different products and solutions to the dental clinics. In coming posts I will dive into some of these segments and see what kind of investment opportunities we can find.

Highly Fragmented Market

Dental centers do not normally belong to large chains or a company group. The dental service industry is in fact highly fragmented, with smaller dental shops run by one or a few dentists. The top four dental service firms in the US account for less than 2% of domestic market share, and over 88% of the US dental service companies operate with less than three dentists, according to a IBISWorld Dentist report. The same situation is seen globally in most countries. Some exceptions are: China, where some 350 dental practices control over 50% of the market. This is due to most current centers are government run, in a similar way as hospitals. But as could be seen in the above picture, China is a very under-served market in terms of number of dentists overall. The growth currently seen in China is coming from smaller groups of private centers. In Europe the situation is also mostly of a fragmented market (with Finland perhaps being the exception):

KPMG_DentalChain_marketshare_Europe

Source: KPMG – The dental chain opportunity

This fragmentation seems to have been something the Private Equity firm have picked up on. Obviously there are synergies to be had by running a larger operation. So from a very fragmented market we have seen the early days of some consolidation. This article (Pan-European dentistry is here, but at what price?) though argues that some players have been overpaying.

This fragmentation in dental clinics has also meant that the bargain power has been sitting with the dental suppliers. These companies are huge in comparison to the small dental clinics and supply the clinics with all the products they need, to run a modern dental clinic. Given this fragmentation on the dental clinics side, most of the investable universe is with these companies supplying the dentist with their products.

Your mouth is expensive

A strong motivational factor for spending on dental care is of course just pure looks. To change the appearance by moving misaligned teeth, using veeners, or just a simple whitening. This is a fast growing segment in the market, where products like Invisalign has grown tremendously. These procedures though are like cosmetic surgery, a luxury product, which will cost you a lot. The Invisalign procedure will cost you anything between US$4000 – Us$8000.

Very few people in the world can afford to out-of-pocket front the full bill for dental care when more advanced procedures are needed. Replacing a lost tooth with a single implant will cost you between US$2000-$6000 depending on where you are in the world. Since dental issues, like a lost tooth seldom is an emergency, we end up with a lot of untreated cases. Because of the high prices, the dental market is to a large extent driven by the level of government support. Few countries has totally free dental care to the whole population though. A rich country like Australia for example seems to have a very lively debate on this, where even young people go with untreated tooth decay: The dental divide – and the decay of public dental services.

Countries like northern Europe which are famous for their welfare states, have free dental care for kids up to around 18 years of age. Even in these countries adults have to pay, although there is still usually some type of back-stop coverage from the state. For example in Sweden 50% is covered between 3000-15 000 SEK and 85% of the amount above 15 000 SEK is covered by the state. This kind of coverage is similar to expensive health insurances in other countries which include dental. For example the health insurance I myself have (global coverage), covers 80% of my dental bills. Even if this sharing of cost helps, people still need to pay out of pocket fairly significant amounts when doing a larger change, like implants or dentures.

So the growth of dental care is very much up to governments willingness to pick up the bill. The other factor is is increasing overall wealth, like in China, where a rising middle-class is deciding to start to pay themselves, either out-of-pocket, or through better health insurances. To reach a larger part of the population, price is obviously an important factor, if companies are able to lower prices, volume will follow.

End of Part 1

I hope this set the stage for a series of posts on dental related companies. Do you have any investment favorites in this market segment and why? Anything you would like to add in terms of important industry trends? Please leave a comment!

 

 

Superforecasters – And being perpetual Beta

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I like reading, both for pleasure and as a great way of educating myself. A nice combination is when the educational book is written in such a way that it feels like pure pleasure reading. Michael Lewis is an example of such a writer for me. His books become page-turners for me, I just can’t get enough. Slightly more heavy educational material, usually get’s a bit boring and dry. The book Thinking Fast and Slow by Daniel Kahneman was a typical love/hate relationship of the sort. The book material was extraordinary interesting, probably top 3 educational book I ever read. But written in such a way that halfway through the book I really struggled. The latest book I read, Superforecasting: The Art and Science of Prediction, is an easier read. It draws some of it’s material from Kahneman’s book and for an equity investor like me it was almost more intriguing and interesting.

Superforecasting: The Art and Science of Prediction

superforecasting_cover

In a 20 year very impressive study, Professor Philip Tetlock showed that even the average expert was only slightly better at predicting the future than “monkey’s throwing darts”. Tetlock’s latest projects has since shown that there are, however, some people with real demonstrable foresight. These are ordinary people, who are nonetheless able to predict the future with a 60% greater degree of accuracy than regular forecasters. They are superforecasters.

Reading this book is about understanding what things these regular people do, to make them such great forecasters. Surely one would like to pick up such skills! The examples are mostly related to forecasting politically related events, but I think almost all of it is applicable in the world of investing as well. There are many reviews online of the book, so I will not provide that. Mostly I urge you to read the book, it is really good. But there are so many great books to read, so for the ones that do not have the time here are some personal reflections:

Some of my personal takeaways from the book (interpreted into a financial context)

  • This book resonates with me on multiple levels, but what spoke to me the most, was Tetlock’s description of perpetual beta: “a computer program that is not intended to be released in a final version, but will instead be used, analyzed, and improved without end.” As you might guess, we are not talking about computer programs really, but rather an approach to life itself. I finished my Masters studies many years ago now, the first few years working in Finance was very intense and I really learned a lot. But later on, I realized I had started to fall back on old knowledge in many occasions. I was still learning new things, but at a much slower pace than at Uni (or the first year working). And I realized I didn’t like it. It’s somewhat hard to explain, I have this need to constantly keep learning and understanding new things. I’m just very curious about understanding things. From how people think, to how a certain company operates and how it all slots in together in the bigger picture and the world we live in. Since back then I have found multiple ways to keep developing and improving: proper financial studies with exams, reading books on topics I want to understand better, listening to podcasts, reading blogs, following great people on Twitter and vloggers on YouTube. The world is today filled with so great, easily accessible ways to keep learning! The latest way of improving is my very own blog, where I can structure some of all that information I take in and do something useful out of it. One of the main points of the book and how to be a superforecaster, is to constantly keep learning and improving. Or in Tetlock’s words in the about superforecaster Bill Flack: “I can’t imagine a better description of the “try, fail, analyze, adjust, try again” cycle—and of the grit to keep at it and keep improving. Bill Flack is perpetual beta.”. Just like Bill I’m trying to very humbly be perpetual beta as well.
  • Another important concept of becoming a great forecaster is to actually measure how you are doing. Tetlock takes the example of medicine. In the old days, there was no actual follow-up on if what doctors did actually worked or not. It was just assumed by their reputation and knowledge that they knew what they were doing. This illusions of knowledge and accepting the doctors view was a terrible way to actually improve medicine. It was only when we started of putting medicine to test, through randomized controlled trials, that medicine science really took off. In the same way for investing, one should not forget to evaluate free from bias, what did one forecast and how did it actually turn out. Which leads to the next point
  • Be specific and clear in your forecasting. The financial field is full of people going on TV everyday, voicing their views and forecasts of the future. It is very seldom any TV-program goes back and reviews over the past 3 years, of all the people we brought here multiple times, who got in right and who was wrong? Except the problem that its not evaluated at all, next time you hear one of these people on TV, listen to what they really say. They use vague words, which basically never makes them entirely wrong (or right). To actually be able to evaluate yourself, you have to force yourself to make actual precise forecast, use percentages! And try to use as detailed percentages as possible! Example: Right now, weighting all factors available to me, there is 78% probability that the S&P 500 is lower at year end than it is today, that we can follow up upon! And if I do a hundred forecasts like that, we can start to see if I’m a superforecaster or a dart throwing monkey. Which leads me to me final main takeaway of the book:
  • Forecasting should be evaluated in two dimensions, calibration and resolution. To cite the book: “When we combine calibration and resolution, we get a scoring system that fully captures our sense of what good forecasters should do. Someone who says there is a 70% chance of X should do fairly well if X happens. But someone who says there is a 90% chance of X should do better. And someone bold enough to correctly predict X with 100% confidence gets top marks. But hubris must be punished. The forecaster who says X is a slam dunk should take a big hit if X does not happen. How big a hit is debatable, but it’s reasonable to think of it in betting terms. If I say it is 80% likely that the Yankees will beat the Dodgers, and I am willing to put a bet on it, I am offering you 4 to 1 odds. If you take my bet, and put $100 on it, you will pay me $100 if the Yankees win and I will pay you $400 if the Yankees lose. But if I say the probability of a Yankees victory is 90%, I’ve upped the odds to 9 to 1. If I say a win is 95% likely, I’ve put the odds at 19 to 1. That’s extreme. If you agree to bet $100, I will owe you $1,900 if the Yankees lose. Our scoring system for forecasting should capture that pain. The math behind this system was developed by Glenn W. Brier in 1950, hence results are called Brier scores. In effect, Brier scores measure the distance between what you forecast and what actually happened. So Brier scores are like golf scores: lower is better. Perfection is 0. A hedged fifty-fifty call, or random guessing in the aggregate, will produce a Brier score of 0.5. A forecast that is wrong to the greatest possible extent—saying there is a 100% chance that something will happen and it doesn’t, every time—scores a disastrous 2.0.” And the book then goes on describing that a Brier score needs to be set into a contex: “Let’s suppose we discover that you have a Brier score of 0.2. That’s far from godlike omniscience (0) but a lot better than chimp-like guessing (0.5), so it falls in the range of what one might expect from, say, a human being. But we can say much more than that. What a Brier score means depends on what’s being forecast. For instance, it’s quite easy to imagine circumstances where a Brier score of 0.2 would be disappointing. Consider the weather in Phoenix, Arizona. Each June, it gets very hot and sunny. A forecaster who followed a mindless rule like, “always assign 100% to hot and sunny” could get a Brier score close to 0, leaving 0.2 in the dust. Here, the right test of skill would be whether a forecaster can do better than mindlessly predicting no change. This is an underappreciated point. For example, after the 2012 presidential election, Nate Silver, Princeton’s Sam Wang, and other poll aggregators were hailed for correctly predicting all fifty state outcomes, but almost no one noted that a crude, across-the-board prediction of “no change”—if a state went Democratic or Republican in 2008, it will do the same in 2012—would have scored forty-eight out of fifty, which suggests that the many excited exclamations of “He called all fifty states!” we heard at the time were a tad overwrought. Fortunately, poll aggregators are pros: they know that improving predictions tends to be a game of inches. Another key benchmark is other forecasters. Who can beat everyone else? Who can beat the consensus forecast? How do they pull it off? Answering these questions requires comparing Brier scores, which, in turn, requires a level playing field. Forecasting the weather in Phoenix is just plain easier than forecasting the weather in Springfield, Missouri, where weather is notoriously variable, so comparing the Brier scores of a Phoenix meteorologist with those of a Springfield meteorologist would be unfair. A 0.2 Brier score in Springfield could be a sign that you are a world-class meteorologist. It’s a simple point, with a big implication: dredging up old forecasts from newspapers will seldom yield apples-to-apples comparisons because, outside of tournaments, real-world forecasters seldom predict exactly the same developments over exactly the same time period.”
  • This long explanation in a Financial context is such a nice way touching upon my very first post on the blog, where I tried to argue that it’s important to know what your benchmark is: Know your benchmark. Because if you do not know your benchmark, how can you then even start to test how well your investment strategy is doing?

How good was my forecast in Tonly Electronics?

I just published my analysis of Tonly a week ago. I ended the post saying that soon the Q3 Sales figures will be out, well now they are out. In the spirit of forecasting, let’s look how well I forecasted the newly released Sales figures for Q3 in my three scenarios:

tonly_q32018_sales

So far it seems I’m very far from being a superforecaster, when non of my three investment scenarios managed to capture the total Sales of Tonly would come in for Q3. Sales came in higher than my Bull scenario! Given the great results on a revenue basis and that the stock has traded down another 10%, I decided to allocate all the cash I had left, into Tonly (which was about another 2% of my portfolio) as of Friday. These Sales results doesn’t mean it’s a home run, something could still have happened to the margins, that we have to wait until next year to know. One could also notice that the segment I thought would drive future growth, with smartspeakers, did not actually even live up to my Base case of 550 million HKD. So although New Audio Products delivered extremely strong, it was still not a perfect report. One should not make too big of a deal of a quarter either, but very nice to see the execution of this company and I can’t believe that the market did not take notice of this at all and actually traded the stock down during the day (it ended flat, where I took my position at 5 HKD per share).

Forecasting is hard

To book brought up how hard it is to forecast something, and the further out in time you go, the harder it gets. The message more or less was, forecasts further than 5-6 years out is more or less meaningless, at least from trying to have an edge in guessing outcomes. I leave this post with a letter which was mentioned in the book, as a way of proving this point. The letter was written in April 2001 by Linton Wells, who at the time was principal staff assistant to President George W. Bush’s secretary and deputy secretary of defense.

 

2001-Quadrennial-Defense-Review

 

 

Tonly Electronics – Another Hong Kong value investing case

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Before we start this analysis I just want to point out a few things. I spent a lot of effort to reduce my exposure towards China about 1.5 year ago. And here I am, pitching another Hong Kong listed company. I’m aware of this, but I just can’t give up on a investment just because it’s listed in Hong Kong. The actual China exposure in terms of sales is actually rather modest. That being said, I will be careful to increase my exposure further and I have worked hard trying to find investments elsewhere. Right now Hong Kong is one of few equity markets that has seen a major sell-off and valuations are in some cases, like this, too good to pass on. My next point is on liquidity. This is again a fairly illiquid stock, buying or selling large blocks in this company will affect the stock price. As always do your own due diligence and don’t consider my posts investment advice. The last thing before we go ahead, I made a mistake regarding my stated position size in UR-Energy, it was supposed to be 3% not 2%. It was just an unfortunate typo in my previous post.

Tonly Investment case summary

Tonly_graph

+ Low valuation (P/E ~7) growth company, 0.7bn Cash with a MCAP of 1.48bn HKD.

+ Dividend yield based on previous payout, north of 6%.

+ TCL main shareholder and incentive structure for staff in place (high stock/option ownership with management).

+ Track record of quickly shifting business into new products, high R&D spend.

+ Headphones and smart speakers growing rapidly on back of large respectable customers like Harman, JBL, Google, Alibaba etc.

– US/China Trade War is a worry and will most likely create real impact.

– As many Chinese OEM/ODM factories the reliance on a few companies is high, the largest customer (Harman) in 2017 stood for 42.8% of sales. Harman was acquired by Samsung in 2017, this puts some uncertainty towards the future relationship with Tonly.

– Products shifting quickly, no guarantee today’s successful sales will last more than a few years.

– Low margins showing low moat and high competition.

– Although aligned management is a big positive, options programs have lately been too generous in my view.

History

Tonly Electronics is a OEM/ODM manufacturer of home electronics. ODM (Original Design Manufacturer) is one step higher in the value chain, than pure assembly (OEM). This means that the company design and manufacture products which are later branded by another company for sale. Previously the products were mostly DVD/Bluray players, but that has changed over the last few years. Today the company mostly generates its revenue in the field of acoustics – speakers, soundbars, ear & headphones and smart audio devices.  This transition is something we will look a little closer at, it is also a part of the reason why I decided to invest in Tonly.

I have followed this company since it was introduced on the Hong Kong stock exchange. Back in 2013 I owned a Chinese LCD TV producer called TCL Multimedia (recently renamed to TCL Electronics). They decided to spin-off a smaller segment of their operations, which they named Tonly Electronics. Tonly produced DVD/BlueRay players, digital TV-boxes, speakers and soundbars. At the time I scratched my head somewhat what do with this holding. It so happened that all the ETFs/funds that held a position in TCL, just dumped their holdings as soon Tonly started trading. Probably because it was too small for their funds. This put significant pressure on the stock, which led me to my first case of bargain hunting among Hong Kong’s small caps. I liked what I saw an invested at cheap levels a few months after the spin-off. At first this went great, the company paid out a nice dividend, stock price recovered and then some. But then in 2015 things started to turn south. With rise of Netflix and other streaming services, DVD/BluRay player sales just fell of the cliff. Although audio products kept growing steadily, 2015 ended with decreasing revenue and 2016 sales were down further. Although the company still managed to stay profitable, the stock market did not like what it was seeing. The stock lost some -50% from its 2015 highs, into 2016. Around the time I started this blog in 2016 I locked in some profits, but kept a small position (hence I did not take it up as a GSP holding).

Tonly Video Products revenue contraction 2014-2016 (in million HKD)

Tonly_2014-2016 sales

During earlier parts of 2017 I gave up on this holding, believing it was a lost cause, and allocated my money elsewhere. That was a mistake, I should have followed the company more closely and understood what could be seen already in 2016 figures. Something was cooking in the Audio Products segment. By second half 2017 revenue just exploded in the Audio Products segment.

Tonly half year sales 2014-2017 – Audio Products revenue growth (in million HKD)

Tonly_2014-2017 salesh1h2

And this is where the investment case starts. Tonly was facing major headwinds, nobody was interested in DVD & BluRay players anymore and this was the largest revenue driver of the company. Management redirected its around 500 engineers to increase its R&D efforts in audio products. Management built new relationships with Audio product brands. Within just a few years time, the company manages to grow that business so that total revenue sets new all time highs in 2017 second half. The old revenue driver “video products” is now almost non existent. Be it that the company caught some tailwinds within the audio space, but to me this is a proper turn-around. It shows quality of management as well a testament to the research team to be able to develop new products. If I could just have spotted that in the second half figures for 2016, but alas I did not.

What does Tonly look like today and why is the stock price plummeting lately? Let’s find out.. Read More

GlobalStockPicking 2.0 – Major Portfolio Changes

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Before I start this post, I just have to comment on the last months terrible portfolio performance. After being comfortably ahead of the MSCI World benchmark, I’m now behind by almost 5% on the year. The portfolio is down nearly -8% in 1.5 month. Some of it, is company specific stuff, like the gaming halt in China (NetEase). Some of it is just general Emerging Markets and China sell-off, versus how strong USA (which I’m heavily underweight) is in comparison. A picture says more than a 1000 words:

MSCI World_USA outperf

Now over to something more fun than my under-performance, which I’m not too worried about, its bound to happen, especially when you have such large regional tilts.

GlobalStockPicking 2.0

In a recent post I laid out my new and hopefully improved portfolio construction/allocation. I summarize my new portfolio construction in the following three buckets:

GSP_3buckets_20180917

Long Term

The idea is to keep the main focus on the long-term portfolio. This bucket contains about 15 stocks and carries the majority weight (65-90%) of my total portfolio . Given a 5+ year holding period, this implies that I should not change more than 3 holdings in a year. I did not put that as a strict requirement, because sometimes more action is needed. But the Target Holding Period defined above is really there to imply that this should be a low turn-over portfolio of great long term holdings.

Opportunistic

I have been following stocks and the market so long now, that I see stocks that are miss-priced for one or another reason. When I see the risk/reward as favorable, I now have the flexibility to take part on a more short term basis. The analysis on my side here could be anything from very deep to more shallow.

Speculative

I’m not sure if this the gambling genes in me that likes this so much, but I just love speculative stocks. I added this investment bucket for two reasons:

1. I spend quite a lot of time researching and reading about these kind of stocks. I think I sometimes actually have an information advantage (that is yet to be proven).

2. Because its fun. Investing is mostly serious business, but it should also be fun and exciting.

Portfolio Changes – Selling 3 holdings

It will take some time to have a portfolio that is fully in line with the above buckets. I think for example the Opportunistic cases I present today are not the strongest ideas ever. Nevertheless I think they are good enough to enter my new and shiny three bucket investing strategy. Below I will go through what has to leave the portfolio. At a later stage there still might be 1-2 long term holdings that needs to be evaluated if I’m really comfortable holding long-term.

Kopparbergs – Sell Full Holding – 5% investment return

Since I bought into Kopparbergs I spent quite a lot of time, Peter Lynch style, looking at cider products in stores around the world. Walking around daily life, like in a supermarket is just full of investment opportunities don’t you think? In fact this is in general something I draw quite a lot of inspiration from. The more important step in that process is both figuring out what you think of the product compare to its competition and more importantly, how other people feel about it. In the case of Kopparbergs, I think that competition has stepped up significantly and consumers are now having choices similar to Kopparbergs. Kopparbergs more or less created a new cider segment, with very sweet cider. From what I see in stores, although less sweet, for example Carlsbergs Sommersby cider is extremely popular. My case was that Kopparbergs cider had a good chance of being a hit in the US, I now changed my mind about that and see it as less likely. Kopparbergs product offering is not strong enough to really stand out in this competition. Another important factor is that selling these products is as much about distribution and network as in having an awesome product. For all the above reasons I decided that the likelihood of Kopparberg continuing a strong growth journey in cider sales, is low.

Original Kopparbergs investment case

ISS – Sell Full Holding – 15% investment loss

A behemoth in property services, mainly related to cleaning with almost ½ million staff is an impressive entity. My investment thesis was a turn-around in free cash flow after paying down debt and after that a significant dividend increase. That didn’t really play out as planned and the stock market has also been as disappointed as I. Selling this holding is for totally different reasons though and that for me is too low growth opportunities. This is a steady (potentially) high dividend paying company. Although high dividend stocks have many nice characteristics, it’s not really what I look for in a long-term investments. There has to be both growth and dividends. Mature businesses which are just fighting with operational efficiencies is not what I believe will generate alpha long term. It might do so in a bear market, given the stability and quality of the company, but I’m not going to hold ISS as a timing play on a bear market.

I will have to expand what I look for later, in my Part 2 of the “Art of Screening”

Original ISS investment case

Radisson Hotel Group – Sell Full Holding – 39% investment return

I’m usually pretty tough on myself and my investments failures. That’s because I’m not here to brag, but to become a better investor. But now I will do a bit of bragging. Damn it feels good when you are spot on in an investment idea. I painted out a investment scenario whereby HNA would be forced to sell it’s position in Rezidor (now renamed to Radisson). On top of that I had listened to a 3.5 hour investor presentation on how the hotel group was going to structure it’s turn-around. So it was a double whammy turn-around + bid case. As it happened the market started to believe the turn-around, especially when it already started to show in the latest results. Then came the bid by a Chinese hotel company: HNA sells Radisson Holdings to Jin Jiang-led consortium.

Unfortunately this bid did not give as much of a stock price bump as I had hoped. There is still some un-clarity around how much Jin Jiang will need to offer the minority holders, but they might low ball investors and keep the stock listed. There still might be more upside here, but my investment case has played out and I’m happy stepping off here, overall a great investment which returned 39% in less than 6 months.

Original Radisson/Rezidor investment case

New Holdings – Adding 5 holdings

I will at end of trading today add 5 new holdings to the portfolio, and after selling the 3 above holdings, this is what my new 3 bucket portfolio will look like:

GSP_3buckets_Holdings_20180917

Short comments on new holdings

Obviously this will need to be expanded over multiple posts, but here is the quick and dirty on these 5 new holdings:

Amer Sports – Opportunistic – 4% position

Since my previous investment in Xtep, I have both researched and followed the Chinese sportswear and sport shoe producers in China. I invested in the one (Xtep) that was trading cheap on all kinds of metrics. If I had taken a more long-term approach, perhaps I should have considered the local champion Anta instead. Anta which is a 13bn USD MCAP company recently showed a tentative interest in bidding for Amer Sports, a Finnish holding company for a long list of attractive brands/assets. The tentative offer was at 40 EUR per share and the stock quickly after repriced from 29 EUR to 36 EUR, but has after that come down to 34 EUR. If one wants to play mathematics on that, one can say the market is pricing about a 50% probability of this bid actually going through.

My investment case is two fold:

  1. I liked Amer Sports already before this bid and had already done a quick due diligence on the stock. Even if the bid falls through, I’m not in panic mode holding this stock, it could convert to the long-term time bucket if I did a deeper due diligence and like what I see even more than I already do. There has already been other speculations that Amer might spin-off parts of its business to unlock value.
  2. The market is way too skeptical on the bidder in this case. I take this as typical “China fear”. This investment, so makes sense for Anta. If and when it goes through I will be very compelled to add Anta to my long-term holding bucket, I think they would do great things with Amers portfolio of companies. We have Winter Olympics coming up in Beijing 2022 and Amer holds several “winter” assets. Anta has the network in China to actually being able to grow these brands in this tricky market, in the past Anta has bought the China rights to the at the time quite poor brand Fila in 2009. They have totally re-positioned the brand in China over these years, growing it into a real success, from 200 to over 1000 stores in the country. I put the probability of Anta being serious with this bid at 90-95% and I take the probability of a successful takeover somewhat lower (85%), since there is some overhang with for example USA wanting to meddle in this, given that many of the brands under Amer are tightly related to USA.

My own expectation is that this should be priced at 85%*40 + 15%*29 = 38.35 EUR, giving about 12.5% upside on current market price of 34.1 EUR.

JD.com – Opportunistic – 4% position

In this pretty brutal China sell-off I have been scratching my head if and when I should poke my hand in trying to catch any of these “falling knives”. I somewhat randomly felt that now would be a good time to catch one of the stocks I have been looking at for quite some time. JD.com is the case of a quickly growing e-commerce company with tremendous revenue growth. The company plows all of the cash back into investments in its own business and other businesses. For example it’s a co-investor in Yonghui Superstores, which my largest holding Dairy Farm owns 19.99% of. For a primer on JD.com I kindly refer to Travis Wiedower who presents the case in his investor letter: JD.com in Letter, EGREGIOUSLY CHEAP blog.

What has taken this fall into another gear, is what happened recently to the CEO of the company: Richard Liu of JD.com Was Arrested on a Rape Allegation, Police Say

A pretty disastrous allegation having hanging over you, I will refrain from speculating in the probabilities of this being true. The main point here is that at this stage the company is bigger than Richard. Yes, Richard built this company and yes this will have a negative effect on JD’s perception among the Chinese. What did Richard do in the US when he got arrested? He was actually studying at Carlson School of Management to complete the American residency of a US-China business administration doctorate programme. Having time for these types of studies shows that other people are running the company by now. There is some issues with the governance structure if Richard would be imprisoned, but we very far from that right now, he is not even charged yet. Richard has built a fantastic business in China, in many ways better than Alibaba’s model. My best guess is that these allegations will die out and JD.com will on a 1-2 year time horizon trade significantly higher. When/if this allegation overhang is removed, this might move into my long term time bucket.

Irisity – Speculative – 2% position

The company listed in 2013 under the name Mindmancer. The idea was to provide smart camera surveillance systems to construction sites, schools and such. The whole package of software imagine recognition, cameras and installation was provided by Mindmancer. They had some success and have installed this in numerous places over these last ~5 years. The problem was that the business model didn’t scale and it was hard to keep the company profitable. There was also management issues, where one of the founders, a very young an enthusiastic guy was the CEO. He probably had the heart in the right place, but was to inexperienced to run and grow this company. The largest shareholders which is connected to the University in Sweden where the company started, decided to appoint a new CEO, change the name of the company to Irisity and do a rights issue (24 MSEK at 7.8 SEK per share) to strengthen the balance sheet. After that the new CEOs strategy has been to go for scalable sales model, just selling the software they develop. The software is proven in all the live conditions where it has been installed already. They are going for so called Software as a Service (SaaS) model. Somewhat surprisingly this quite quickly has got a lot of interest from market participants, both G4S and several of the worlds largest camera producers.

A somewhat sloppy google translate of one of their press releases recently (Irisity press releases):

“Irisity AB (publ) signs license agreement with Hangzhou Hikvision Digital Technology Co. Ltd.

Hikvision is the world’s largest supplier of innovative video surveillance products and solutions. With 20,000 employees, including nearly 10,000 in R & D, the development of intelligent cameras leads. Hikvision is listed on the Shenzhen Stock Exchange with a valuation of USD 46 billion. The company shows a strong YoY 32% growth, with sales of USD 6.6 billion (2017). In collaboration with Hikvision, Irisity now evaluates embedded integration of IRIS ™ AI software in Hikvision’s camera platform.

–        Hikvision is a wish party to Irisity, we already have our AI with several of their IP cameras, but are also looking forward to creating a Linux embedded solution right in the camera. This is the future, since very few cameras will be delivered without built-in AI! Comments Victor Hagelbäck, CTO on Irisity.”

What is not mentioned in the press release is that Hikvision produces almost 100 million cameras per year, so the potential is gigantic if these companies really like the Irisity software.

So to summarize, the company has a proven product in the Nordic markets. They are currently trying to convince huge players, that its software algorithms are good enough. In a best case they would want to pay Irisity to embedd them in their products. Right now this license agreement is not worth any money, its just shows that Irisity has got to actually showcase their products and on some level for example Hikvision (several other big companies are doing the same) is evaluating their product. I find Irisity (valued at about 35m USD) at a very attractive risk reward right now, even if the probability is very low to see large orders. This is truly speculative, one of these lottery tickets, but with much better odds than playing the lottery.

Scorpio Tankers – Speculative – 2% position

This is a fairly simple case, market analysts seems to think that Day Rates should normalize. They have not done so, so far. Equity markets have given up and stock is tanking (ha ha). Taking the long term view on day rates, its seems plausible that they would increase from these levels. I’m a firm believer in mean reversion. Scorpio has a attractive fleet of new vessels, as long as day rates recovers somewhat, they are highly cash generative. Let’s see if that happens or not.

Scorpio_day_rates

UR-Energy – Speculative – 2% Position

Canadian listed Uranium miner, that I actually owned already back in 2006-2007. At the time, it was the only junior Uranium prospecting company, that actually came out on the other side of the bull and following bear Uranium market. They are now a small scale Uranium producer, with a large portion of their production hedged at higher levels. I will have to write another time about Uranium, but its a very special market and a strong case can be made for long term increases of as its called yellow cake. I’m choosing UR-Energy as my Uranium proxy, because they have excellent management, a very crucial detail in the mining industry, which is full of crooks and cheaters.

Please comment what you think of my new holdings and I will try to follow up with more details in later posts!

 

The Art of Screening – Part 1

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This will be an exploration in how to set up stock screenings, if you have a lot of experience of playing around with this, please do comment and help me out.

A stock screening could have many purposes, most screens are not related to finding the “hidden gems”. The screening could be used to list companies with certain characteristics, for example all Bank stocks in Asia. This post will not be about these type of screens. It will be about screening for stocks you otherwise would struggle to find and stocks that hopefully few others have looked at. Later post will explore other angles of screening, for example dive deeper into what stock characteristics I’m looking for. The beauty of being a Global investor is that you work with the widest possible set of publicly traded companies. I think would be a waste if you as a Global investor did not take advantage of having access to all markets. This should be exploited to the largest extend possible. According to Bloomberg there are 61 000 listed companies in the world. Just like my catch-line of this blog, surely among the 61 000 companies there is bull market somewhere? But with 61 000 companies it is like finding a needle in a haystack, the question is, how do we find the needle?

I will divide the challenge of finding the needles in the haystack into two parts:

  1. Where should one look? Meaning what should be filtered away from categorizing metrics. Examples being: Country, Company Size, Industry
  2. What type of metrics? Meaning what company specific criteria are on average delivering out-performance? Examples being: Price to Book, P/E, Growth, Piotroski F-Score, Momentum

What universe?

Obviously in practice as a private investor you do not have access to every single market in the world. Few professional investors do either. So in practice, in my case the Global Universe of stocks is listed on one of these countries exchanges: Australia, Austria, Belgium, Canada, China (Shanghai & Shenzhen), Czech Republic, Denmark, England, Finland, Germany, Greece,  Hong Kong, Hungary, Indonesia, Ireland, Italy, Japan, Malaysia, Netherlands, Norway, Philippines, Poland, Portugal, Singapore, South Africa, South Korea, Spain, Sweden, Switzerland, Taiwan, Thailand, Turkey and USA.

What is the competition?

To understand where we should look to find the hidden gems, we first need to understand the current investment landscape and competition. I’m a firm believer that markets are fairly efficient. One should respect the huge amount of clever highly educated people spending all their efforts trying to find the best investment cases, all with the goal to outperform markets. Lately a lot of money has gone into passive investments but there is still a lot of money sitting with fundamental active managers.

Not only passive investments drive return today, we also need to compete with machines. In the last 10-15 years the competition from computer algorithms have increased significantly. In the beginning it was only hedge funds, like AQR, Renaissance Capital and a few other that were using statistical analysis to find stocks characteristics that on average outperformed the market. They applied much of their strategies in a market neutral or at least hedge manner. Meaning going long the stocks they thought had the right characteristics and short the ones that had the opposite. Today this market has exploded, Smart Beta, Factor/Style investing has gone mainstream and huge amounts of money is invested in it. Also fundamental fund managers use these screens to come up with stock picking ideas and evaluate their fundamental portfolios from a factor/style perspective. When I started this blog my ambition has always been to apply similar screens, but on parts of stock universe which institutional investors can not reach.

On top of that, with internet, cheaper brokerage fees and everyone having all the information in the world at their fingertips, private individuals have entered the space of stock picking in a way never seen before. Just look at the amount investment blogs out there, with young and old trying to dig up new investment cases.

To summarize – Three categories of investors:

  1. Professional investors, most of the money sitting with long only mutual funds, but also hedge funds and family offices has large pools of money to deploy. Through company visits, and deep analysis they find the miss-priced stocks according to a multitude of investment styles and approaches.
  2. Smart Beta / Factor / Risk Premia / Statistical Investing, it has many names, but all of them is based on the idea of sifting through large amounts data, finding patterns in that data that indicates as high probability as possible of out-performance. The styles here are also developing, but having worked in this field, the strategies tend to be more similar. The sophistication is rather related to the type of Quant strategy, the simplest being large smart beta ETFs and Funds and the most sophisticated are still firms like AQR and Renaissance Capital.
  3. Individual investors – everything from total beginners, to very professional individuals, investing mostly their own money. Here many have no idea of what they are doing, but there is also wisdom in crowds and on average they might be right, that’s all that matters. There is also a large group of clever hobby investors or finance professionals who invest their own money.

Where to look

My main thesis is to look where few are looking. Do not look for stocks in the same pool as where one or all three above listed categories of investors are looking. The probability to find something “unique” is pretty low, but at least concentrate your efforts where the above three categories is looking less.

Sabre Capital (John Huber) wrote an excellent piece on this, well worth a read: What is your investing edge?. As is argued, many investors believe that if you just look for small caps you have an edge. You have then solved the problem of competing with the “big fish” in category 1-2 above. That is probably true, but one then forgets the “small fish” in category 1-2, as well as the whole category 3. Meaning just buying small-caps is simplifying it a bit too much. Actually as we all know many private individuals love investing in small caps, penny stocks etc. This is appealing to anyone with some gambling genes in them, the thrill of fast gains is exciting even for the most professional investor. Just like the option market has a volatility smile, meaning investors are willing to pay more for call options with a high return potential. I believe small and micro caps in bull markets could actually on average be overvalued, due to this effect, people love buying a lottery ticket. Again, in bull markets this might be an area to avoid.

Avoiding Category 1 & 2

Professional investors come in all shapes and sizes, but to manage money in today’s world comes with certain levels of costs. If your AUM (Assets Under Management) is too small, those costs become unreasonably large compared to your potential income. Without doing a big deep-dive into this, this is my thinking in a few sentences. I would argue that firms with less than 200-300 million USD in a fund, does not really bear itself long-term. There is definitely a lot of funds smaller than that. But they either do not have the resources to actually do all that research that we are afraid of competing with, or they belong to a larger fund group, where they have some small funds but total AUM is higher. Such a firm usually will focus its research on larger companies, for its larger funds.

What are the smallest companies these funds can then reasonably invest in? Again we want to avoid the stock pickers, small funds that run a 200 stock portfolio, would not worry me. The amount of research spent per company, by a small fund with 200 holdings, will be more like an index fund than actually doing deep research. Let’s say 30 holdings for a small stock picking fund of 250 million AUM. That gives us 8.3 million USD invested per holding. What would such a fund managers requirement on liquidity be for buying position in the 8 million range? Well I don’t think they would be comfortable holding anything more than 10 daily turnovers. Actually if the fund is registered under UCITS or such, this would not be allowed for a daily traded fund, but some funds are not daily, like hedge funds. So let’s stick with the generous assumption to begin with. This means that stocks with daily turnover below about 800 000 USD would be a no-go.

If we look at Quant funds, I would say their requirements on liquidity is much much higher. Having worked on building such quant strategies, in a long/short context, for Europe we would not go outside the Stoxx 600 companies, so anything below that, would be under the radar for our factor strategies. Some other funds do go lower, but not much much lower, meaning there is still a huge chunk of the market where factor strategies is not applied. Again this something we then instead could explore to copy their ideas, but in a stock universe they can not touch.

Avoiding Category 3

So my first idea of avoiding the three types of investor above would be something like this: Avoid category 1-2 by looking at small enough companies so most of the competition is gone. Avoid category 3 by looking at markets where individuals are not participating to a large extend in direct ownership of shares. This idea led me to a fairly lengthy search trying to finding out, what markets have low direct ownership of shares from the local population. The data is somewhat sketchy on this and some of the data is unfortunately old, but I managed from several research papers collect together a fairly good overview of direct ownership:

Country stock market participation rates

The source of this data is 3 different studies: “Participation Matters: Stock Market Participation and the Valuation of National Equity Markets – Journal of Financial and Quantitative Analysis”, “Stock market participation and household characteristics in Europe” and “The Effect of House Price on Stock Market Participation in China: Evidence from the CHFS Micro-Data – Emerging Markets Finance and Trade”.

For the few markets that has data both from 2000 and 2007, one can see stock participation in most developed economies has increased significantly (Sweden, Denmark) over the year. In general if we would have data for 2018, participation it probably higher in most markets. Better data would be great, but if the pattern stays the same the above is still useful.  We can definitely conclude that less people are participating as direct owners of companies in Italy, compared to Sweden. My thesis here is that on average one would have more success looking at smaller companies in Italy, than in Sweden.

From my list on markets that I’m able to trade, data on participation rates are missing in some cases. But a good guess is that also these markets have low participation rates, just because they are not very developed. So adding those back in and making a somewhat arbitrary cut, I come up with these markets as good hunting grounds:

Low participation countries

How many companies are we then left with?

Applying the above Country Filter: 61 000 –> 12 700 companies

Now let’s also define a liquidity filter. Unfortunately my screening does not support a turnover screening, instead I have translated it into a rough estimate in terms of MCAP. After some sample checks a Market Cap below 500 MUSD combined with a free float above 30%, is more or less in line with a daily turnover under 800 000 USD. Another filter I throw in putting floor on MCAP at 15 MUSD. I’m not interested in investing in too small companies.

MCAP < 500 MUSD: 12 700 –> 9400 companies

MCAP >15 MUSD: 9400 –> 7700 companies

Free Float > 30%:  7700 –> 5774 companies

So by trying to look in the right place, where other people are not looking, we are down to 5774 companies. This is how they are distributed country-wise

Hunting Grounds Stocks

Hunting Grounds established – Time for factors

So if these 5774 stocks is our new hunting grounds, what do we do next? It is still too many stocks to read up on, now its time to apply different metrics. These metrics should be something you believe in that your companies should have to be great investments. One such metric is the Piotroski F Score (More about Piotroski).

Applying Piotroski F Score > 8

5774 –> 111 companies

Here are all the 111 companies

Piotroski Screen_20180902

Summary

Now we got the universe down to something manageable. From this stage on, its time to go back to the regular due diligence process. This list above contains 111 new companies for me. The screening has helped me with:

  1. Pick out a universe of stocks where few others are looking.
  2. Use a quantitative metric like Piotroski F-Score to within the this universe pick out stocks with good characteristics.

The idea of this is that this selection should on average out-perform the market. For this to be true, one has to believe that these are stocks less covered by the market and that Piotroski F-Score actually works as an indicator for alpha generation. If you start a fund investing according to my steps above, basically you then have a Piotroski Quant Fund. This fund is probably picking stocks where no other Quant-funds are looking. I hope such a Quant fund would outperform the market, and we could back-test this model (if I just had the time). But even if it does not, my idea is to apply my own due intelligence on top of this, to pick the best companies from the above 111. So for me it matters if the above 111 stocks generates alpha, but its not the end of the world if they do not. As long as the stocks I pick from the 111, generate alpha.

Another way which I played with earlier to find certain investments, has been identifying sub-sectors with future great prospects. For example I believe certain type of beverage and brewery companies have a very attractive business profile. Instead of using countries to define the universe, one could combine sub-sectors with metrics to find the for example few undervalued Beverage companies.

This was one example of a screening process. One could endlessly modify how one picks out the first the universe, and then the metrics. A will write more on this topics in a follow-up post, creating especially more metrics. The trick is to figure out what your investment style is, express that in metrics, and the screening will do the rest. Well maybe not the rest, you still need to decide what on the shortlist you want to invest in.

Happy to take any input on what you think would be successful screening methods, preferably backed up by some good reasoning!

Thoughts on the market and portfolio construction

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The last month I have not written much here on the blog. However the inactivity does not mirror what I have been up to. I spent a lot of time lately, screening for stock picking ideas, reading, listening to inspiring podcast and most of all thinking and contemplating.

My screening which will be covered in a separate post has made me realize that I need to significantly improve the way I look for new potential investments. The power of screening increases significantly when you have the luxury (like I do) of looking for stocks all over the world in all market cap sizes. The reading I have done lately has in part been inspired by trying to understand more what metrics I’m looking for in companies that I want to invest in over the long term. Hopefully the steps which I’m about to take over the coming months will be crucial to take my portfolio and investment process to the next level. Slowly but surely the aim is to move towards a more structured and professional investment approach.

My thinking and contemplation has mainly been around two things: 1. What markets are up to currently, if and how I need to adjust my approach. 2. How my portfolio construction should be structured to maximize my changes of success. That’s what I thought I write about today.

Markets and the Trade War

Let’s start with the current market environment. Anyone not living under a rock for the last six months has been flooded in the news about Trump, China and the Trade War. But return wise for most global stock portfolio this has so far had minor impact. US stock markets are at all time highs, Europe is doing pretty well (except Turkey). So far only one major stock market has really fallen significantly and that is China/Hong Kong. Although I made a point of reducing my exposure towards China already back in May 2017 (Rotate away from China). I still keep a large overweight compared to MSCI World in Chinese related stocks. Either that they are listed in Hong Kong, or that they actually are materially exposed to the Chinese economy. Below is the total return of both benchmarks since I made my post about rotating away from China.

WorldvsHangSEng201808

The trade war puts a stock picker in a bit of a conundrum. Most Macro events should be ignored by a stock picker, but the Trade War actually becomes a company specific event as well. In my view it can not and should not be ignored. The effects of the tariffs are so big that a producer in China could be totally out-competed by a producer in another country, as soon as the tariffs comes into place. One could say that the Trade War is bigger than just China and USA, that’s probably true and Trump might for example still have a beef with the Japanese car producers and the imbalances created there in trade. But for now I have just focused on US/China conflict and how that has affected my portfolio.

I have not looked at the stock market in this light before, but I tend to group companies like this since the Trade War started. Especially for stocks listed in Hong Kong.

  1. Companies which mainly sell products and/or services to Chinese consumers. Here the main risks are more subtle, how will the Chinese economy fare if the Trade War intensifies? For the first time ever since I started visiting Mainland China, the people I talk to are afraid of the Trade War effects on the Chinese economy. I just have to point out how rare this is. I discussed everything from ghost cities, rampant borrowing, spiraling property market etc, nothing has really moved the belief among the Chinese I talked to, the only way was up. This is the first time I hear the Chinese people themselves admitting that this could end badly. One should not underestimate the effects such a psychological shift has on an economy which has been a one way street for so long. This makes me worried about my large China exposure.
  2. Companies producing products in China and mainly selling products to the USA/World, but products currently not on the list of tariff goods. Here the risk is more obvious and probably the area where one should be most careful. The stock market has probably not fully discounted that the companies products will fall under future tariffs. An excellent investment thesis could be destroyed by the stroke of a pen from Mr Trump.
  3. Companies producing products in China and mainly selling products to the USA/World, products already on the list of US tariff goods. These companies have probably already seen most of its initial stock price fall already. There might be opportunities here if the company somehow can navigate through this mess, perhaps relocating production or other measures.
  4. The rest – Companies with little or no direct exposure to the Trade War. Here we should more be looking at indirect effects. A lot of companies producing products in other countries are reliant on parts from China, which might be under new tariffs. This could quickly alter margins and shift advantages to producers in other countries which has non-Chinese suppliers of their parts. The problem here is it requires very very deep due diligence to understand these dynamics, if the management is not upfront about it.

Looking at my holdings grouped into the above categories:

  1. NetEase, Fu Shou Yuan, Essity (mainly its holding in Vinda), Dairy Farm (mainly its holding in Yonghui Superstores), Nagacorp (Chinese going to Cambodia to gamble), Coslight
  2. Dream International (although majority of production is now in Vietnam).
  3. I don’t hold any company with significant portion of their goods under current US/China tariffs.
  4. Since I have very few US based holdings I don’t see any major effects here for my portfolio.

So the conclusion for my current portfolio is that I have to be mindful of the general economic strength of the Chinese consumer. If they stop spending, my portfolio would be hurt significantly with so much direct exposure to Chinese consumers. So should I reduce my exposure? If this really pulls down China into a recession and all the unraveling of leverage that would mean, then yes, I really should reduce my exposure. My this is threading dangerous grounds, because now we are not talking about company specific effects anymore, this is Macro. As we concluded many times before as a stock picker we should be wary to try to time too much macro. The truth is I haven’t really made up my mind yet. Let’s look at the other side of the coin too, opportunities.

Opportunities?

Such serious fall in one stock market also gives rise to opportunities. The same reasons why I had such an overweight towards China when I started the blog was partly due to the relatively low valuations compared to other markets. When the Hang Seng now is falling when other markets are rising, this puts me in a tough spot again. Hong Kong stocks looks cheap, but I already have a significant exposure, if I find something very interesting, do I dare to add more China exposure? I think my conclusion so far is, very selectively and with a larger margin of safety than before. I have one investment idea (again in a fairly illiquid company unfortunately), if it falls a bit further, it might enter the portfolio during the autumn. Please give your comments on what do you think of my portfolio taking larger tilts towards China in such sensitive times?

My new portfolio construction

I written quite a lot about the importance for me to find investments that I’m comfortable holding long term. I think this will always be main foundation of my portfolio, lower turnover and a long-term approach to investing. Although a few of my holdings to do not fully meet all my investment criteria (which I by the way will define more clearly later), in general I hold a portfolio now which I’m more comfortable with holding for the long term. I realized now, that reaching this is actually a very nice feeling in many ways. Mostly because I can relax more in terms of following up on my holdings. Instead spend that time on rather finding new good investments and taking my time to do so. Before there was always a stress to find something new to invest in, since many of my investments were short term and I knew I needed to replace them with new ideas rather quickly. This brings me to my next point.

I actually miss not being able to invest in what I would call a swing trade. A large part of my investing “career” I dedicated to following the markets very closely. I’m a contrarian investor at heart and I almost love catching knives (until I cut myself badly on them and need to lick the wounds for a while). Many of my investments in the past were at infliction points in stocks and actually I think I’m rather good at it! So this focus on long-term has taken away some of my possibilities for short term swings when I see an opportunity. Supposedly I could just do these trades outside of the GSP portfolio, but that’s not really what this blog is about. This is my journey to become a better investor and if I think I’m good at something, it should be evaluated properly under the scrutiny of the blog.

Another type of investment which I since the beginning have left outside of the blog is smaller positions in (usually loss making) companies with a return profile somewhat more like a out of the money call option. There is tremendous upside if things go right, but in most cases it turns into a dud and depending on sentiment money will be lost. This is also something I have been decently successful in outside the GSP portfolio. Again the exact same reasoning, if these strategies should be evaluated properly I should include it into the GSP. So with no further ado, I present to you my new future portfolio construction:

The new Global Stock Picking Portfolio

80% Long Term Holding – My current portfolio of long term holdings, target holding period 5+ years, maximum 15 holdings, range of allocation allowed 65%-90%.

10% Opportunistic Holdings – Holding period maximum 2 years, maximum 2 holdings at any one time, range of allocation allowed 0%-20%.

10% Speculative Holdings – Holding period could be short or very long term. Minimum position size (at acquisition) 2%, Maximum position size (at acquisition) 3%, range of allocation allowed 0%-20%.

0% Cash – Maximum Cash position 15% – I reduce my max cash position from previously 25%.

The idea of the speculative trades is to be able to sustain larger losses on several speculative positions, but hopefully that one or more will make up for it, by its high returns. The speculative positions could be everything from a micro cap with a potential success product, or even a larger company, where earnings are yet to be proven (think Biotech etc). More on this later.

During the rest of the year I will restructure my portfolio and introduce especially new holdings in terms of the speculative positions. In due time I will evaluate the performance of the different “buckets”, but main focus will still be on total performance of the whole portfolio.

All comments on my changes are appreciated, since I feel they are not 100% set in stone yet.

 

 

Portfolio holdings – half year review

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Year to date the portfolio is up +3.5%, compared to MSCI World at +0.8%, both including dividends (so called total return). My portfolio has in the past generated it returns with significantly higher volatility than MSCI World. You can almost see it in the graph below how stable the upward trend was in MSCI World. Interestingly enough now this year, when markets have turned more volatile, my portfolio volatility is slightly lower than MSCI World, at 15.2% vs 15.8%. Downside volatility is what counts and I think this is one proof that I managed well to create a defensive portfolio, which has been one of my aims, many other aims were discussed in my previous post earlier today.

Total return of GSP portfolio vs Benchmark

Graph_20180629

Total return of holdings since investment

Holdings_20180629

Notable winners/losers during 2018

Some comments on the largest gainers and detractors during this year.

+ Swedish Match

The Swedish tobacco company has performed very strongly compared to its sector colleagues. Then again Swedish Match is a very different company selling smokeless tobacco products. For the interested reader this is a good primer on snus: New York Times on Snus. Except good results, one reasons for the strong share price performance is spelled ZYN. Which is a tobacco free nicotine pouch, which recently has become a big hit in the US. Swedish Match has recognized this and is spending 60 MUSD+ in increasing capacity over the coming to years of ZYN. Valuation short term is a bit stretched, if I had a larger position from the beginning, now would be the time to scale down the position somewhat, unfortunately I started of with a very small position. I’m willing to continue to hold 5% of my portfolio in this excellent company.

+ Fu Shou Yuan

One of my two funeral company investments, they truly went in opposite directions. In a very poor market environment this stock has been on a tear since I invested. The price momentum strength in this stock is almost a bit scary considering how weak the Chinese markets been lately. At these multiples/levels I have to say I’m close to scaling off a bit of this position. That will depend on if I find somewhere better to allocate my money. Here I also want to mention my fellow blogger who wrote an excellent analysis on the company: C for Compounding on Fu Shou Yuan.

+ Dream International

Another new investment that also just kept on its upward momentum. Since I did my analysis on the company I have understood a bit better what kind of plastic toys is driving this fast growth. The understanding came from a deeper analysis of newly US listed Funko. Basically a lot of the Funko’s toys called Pop! are collectible items. Just search for it on Youtube and you will find a lot of people like this guy: Funko Pop collector. The funniest one I found was a contract written up between husband and wife: Funko Pop contract – Limiting spending. This makes the picture a bit more clear how Funko in just a few years has become such a big player in the plastic toys industry. I see this as one of my strongest investment cases, therefor it also carries a large weight in the portfolio.

– Dignity

My second funeral stock has not done nearly as well the first one. I decided to double up in this stock after the fall of 50% in one day. That seemed like a very good move for some time. Actually I was close to making up the whole loss about a month ago, then the stock was hit again. This time it was due to UK’s CMA (Competition and Markets Authority) who launched a review of the countries funeral sector, to make sure “people are not getting a bad deal”. It seems after this most investors have given up hope on the stock. I haven’t really given up yet, since the reason for the rebound after me doubling up was that actual results came out much better than anticipated. We are still looking at a totally non-cyclical company, with a estimated P/E of about 11-12 and a dividend yield of 2.4%. As mention in previous posts, the worry is the debt load in case profit margins fall significantly further. I’m stubbornly keeping this one.

– LG Chem

After being one the portfolios true outperforms and a holding I had for a long time, LG Chem has given back much of that out-performance over the last few months. The stock is fairly volatile and living its own life, but the downturn is likely due to the oil price. This volatility from the Chemicals division is something I will have to live with, since I didn’t invest in more pure play like Samsung SDI. The reason why I’m owning the company is not due to the Chemicals division, but because the company is truly in the forefront of EV battery production. Now we are 1-2 years out for the start of really widespread EV sales from all the big car companies. My plan is to ride this whole wave and hopefully hold this company for another 10 years.

– Coslight

Similarly my idea with Coslight was that it could become a Chinese large player in the EV battery space. I’m less sure now than I was 3 years ago that actually will be the case. Not because Coslight is not going to try, but because the company does not really have the financial muscles to build up huge modern EV production plants. Like for example the newly listed CATL can do, or BYD for that matter. Coslight has proven itself as one of the largest producers of laptop batteries, so they have the know-how to make batteries cost efficiently, but I’m starting to feel less sure if that is enough. They sold of a portion of one of their factories to reduce debt and free up capital to invest further into EVs. Overall it was a good move for us that wanted the company to move towards EV battery production, but the market has not really received this news well. A tricky holding I followed for a long time, before I had a lot of conviction. I think the reasons why I’m not giving up on this company, is that they have truly hidden value within the firm. Strangely enough (due to the majority holders son) the other leg of the company is video/mobile games producer. The best case would be if they decided to list the games entity separately. The games developer might be valued at perhaps a third of whole Coslight’s value, given the multiples on games developers these days.

Summary

As you can see from my discussions above, some holdings I’m happy with, others more worrying. Given this, I still need to keep up the hunt for at least 2-3 new investments. I will also consider if I should increase the weights in some of my current holdings, to not keep cash levels too high. In general that has been a problem in the past and really big performance detractor, since I calculate 0% return on cash.

CashLevel_20180629

Reflections and how to improve

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Its been a few slow weeks for me with vacation, which is usually when I find time for reflections and lessons learned. My thoughts below are a continuation of this post 6 months ago: Portfolio changes larger reshuffle Part 1. I started out this blog and investment portfolio in March 2016. My portfolio at the time had a heavy tilt towards Hong Kong listed companies and holdings with exposure towards China. The big theme I had been researching for the past year, before starting the blog, was Electric Vehicles and this theme had a large presence in the portfolio as well. That was my starting point almost 2.5 years ago, since then I realized a lot of things on how I should build my portfolio and only three of the starting holdings are still around.

A picture says more than thousand words, so I will try a new format here showing the buy and sell timings of some of my holdings. The performance for all stocks is restated into USD, since my portfolio is in USD. As a reference the GlobalStockPicking portfolio performance is also shown, rebased to start at the same value as the stock price. The data series looks slightly choppy since the GSP portfolio returns are only calculated on weekly basis.

Step 1 – Rotate away from China

My main focus for quite a while has been to find new investment cases and at the same time becoming a better stock picker. The stock picking was needed, to find new type of investments when I decided to start reshaping my portfolio. As important is the portfolio management, side, what should I be looking for, and what kind of companies do I want to have in my portfolio? The starting point of that reshaping was to say, what I did not want to have too much of. In step 1 by decrease my portfolio country tilt, away from China (Rotate away from China). This was done in somewhat of a haste, since my bearish market view meant that I thought a stock market downturn was imminent. My views were based on that I thought the Chinese economy was (and still is) severely overheated, with all the stupid investments that goes along with such a overheating. In this haste to transform my portfolio, I tried to replace the Chinese holdings with less cyclical and defensive companies (like Huhtamäki and ISS). I have to confess here, these investments were made without going the full mile in due diligence. Of course I had done some sort of due diligence, but not really drilling into detailed valuations. More recently I understood that I bought some of these holdings at fairly stretched valuations. I just sold my Huhtamäki holding and I would say the next holding I’m closest to selling right now is ISS. Other non-cyclical defensive investments, like Swedish Match, has performed extremely well in the last year.

Lessons learned from this: Don’t overthink Macro, it still OK for me to make a Macro bet that something big is going to happen in the future. But starting to rush into new investments due to a Macro call of rotating away from China, is not OK anymore. It is very rare that there is such a rush to act, take the time to fully analyze what I’m buying before jumping in. I also have a tendency of finding some new investment and get very excited. It gets even worse when the stock is trending upwards and it feels like I’m missing out, classic FOMO. Investing in this way is not acceptable for me anymore, I have to do a proper deeper due diligence before anything goes into the portfolio. Although I have not formulated that here on the blog yet, this is something that has become a hard requirement in the last six months.

Huhta_20180629

SwedishMatch_20180629

China rotation – missed opportunities

My bearish China view obviously did not materialize at the time, rather Chinense stock markets continued to outperform for quite a while. Most of the holdings I sold, outperformed massively and only one, CRRC performed fairly poor. More recently though, Chinese stocks have turned bearish, with Trump trade wars having the most sever implications for China.

BYD_20180629 CRRC_20180629 PingAn_20180629 ShanghaiFosun_20180629 YY_20180629

Another lesson learned here is to scale out of winning holdings, rather than cutting the whole position. Sure the stock could be more closely to fully valued, but momentum should not be neglected. Both in terms of stock price momentum, but usually the stock price increase is on the back of better fundamentals, where there is usually also some momentum, bringing the valuation downwards all else equal if you just hold on for a while. The way I sold out of YY (Further China reduce Sell YY), on a China Gov clampdown scare, rather than valuation, and how the stock afterwards continued to soar, that is hurtful to look back at.

Part 2 – Easier companies to understand with a longer term view

I stated a quite long term ago, a desire to have less portfolio turnover and take a longer term view on my holdings. The next step of the portfolio transformation was something I realized I had to do, to come closer to such a investment style. That was to remove holdings that is hard for me to fully understand. Meaning companies that I spent quite a lot of time understanding, but the nature of the business just makes it very difficult to fully penetrate. I had a discussion with value and opportunity blogger on this. His comment was that its no point in fooling oneself that you will ever fully understand any business. I agree with him, but the point for me is to understand the company to such a level, that even if a lot of factors around the company changes, I at least have a reasonable chance to grasp what does the changes mean. Hopefully I will also be able to understand if a stock price fall is warranted, or if its just market sentiment shifting. My experience is that when a stock just keeps rising, it doesn’t really matter how well you know the company, it feels great owning it anyway. The stock price increase just confirms how right you were buying it. Its when an investment falls significantly that your investment thesis is really tested, then at least I need that confidence that you understand the company well. I felt there were some holdings I would never reach that understanding of, at least not without a very serious continuous research effort. Companies that had to leave for these reasons were Criteo and Catena Media, one being one of my larger laggers and the other one of the largest gains.

Catena_20180629 Criteo_20180629

Part 3 – Long term yes, but to what cost?

The main reason why I want to be long term in my investments, is that I firmly and strongly believe that one of the last untapped pockets of easily available alpha out there, is to have a longer term investment horizon than the market in general. Given that we want to be long term investors, how do we merge that with an analysis of the current valuation of the company? Should I buy great companies that currently looks very expensive, because they will do great long term? I think there is more alpha in finding great companies, that also currently have some margin to safety. That means you both are looking at good returns just from the business growing, but also a one off multiple expansion, as the market also realizes that this is a great company. In the very very long term, that multiple expansion probably does not matter as much for total return, but when I say I’m long term, I do not mean 30 years, I mean that I have an investment horizon of 5-7 years. Finding such companies is the ideal case, usually it’s only possible to find these among small caps, which then usually comes with other problems. So it doesn’t mean I never buy companies that are trading at high multiples, it all comes down to what opportunities are available in the market as well. Inditex, Diageo and NetEase are all examples where I paid up an fairly high multiple, clearly there is little multiple expansion to hope for, rather I just think they are great businesses which will continue to do very well, again, long-term.

Part 4 – Stock picking efficiently

Stock picking/research is what I enjoy the most, but it is also a time consuming process. Before I present a new investment case for you, I have looked briefly at many different companies, done a lighter due diligence on 5-10 cases and one of these hopefully is interesting enough to add as a new holding in the portfolio, which is then presented to you. I do not spend my time doing full write-ups of companies I do not invest in, just because time is precious, and I don’t have enough of it, to “waste” my time doing nice write-ups of something that I’m not investing in. The only exception was Teva, and that was a stock I thought I would invest in, but during my deeper dive, I changed my mind. Another lesson learned, is that I need to become more time efficient in my stock screening/searching. Currently my screening process is very much random, reading about one company leads me to another company and so on. Another way has been a general investment idea around for example electric vehicles, this leads me to read up on 10-20 companies in and around that sector. In the past I have done certain screenings, for example I screened for all brewery companies world wide, which led me to investing in Olvi. I have also done some screens on Australian and New Zealand listed companies, where I still currently have a few stocks on my observation list. Since my investment universe is global I think I should utilize this more in the future and use screens/filters as a more efficient way of generating ideas and companies I would never otherwise find.

Summary

  • Having limited time and resources to find investment cases marries well with being a long term investor. Long term investing gives the opportunity to extract alpha where few others are looking. For me only certain types of companies can become truly long term investments. For example the company should be fairly easy to understand.
  • I should focus my search and research on long term type of investments and also try to come up with a screening processes which makes it quicker to find such companies.
  • No more rushing into new investments and never make hasty portfolio changes due to changing Macro, better to be late and do correct portfolio changes than rushing into new holdings.
  • When a company re-rates in the market and starts to look expensive, do not sell the full holding, rather scale back the position, my track record shows I’m often not just early to sell, but way too early. Something of a let your winners run, cut your losers short strategy, but with less emphasizes on cutting losers.

The effect of oil – selling Huhtamäki

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I think most people have noticed oil price increasing significantly over the last 12 months. I started to expand on this topic in my latest post about Dream International. I realized going through all those years of annual reports that the price of oil had a impact of the raw material cost for all the teddy-bears made. In the past years the collapse of oil has boosted profits for a large number of companies, on the raw material and energy side. But the part that probably is not discussed enough is the transportation cost and especially in countries where oil is not heavily taxed.

Transportation – USA

A friend of mine recently did an analysis of companies exposed to the increasing transportation costs in the US. After a longer discussion with my friend I was a bit baffled that I haven’t been able to see this more clearly myself. The labor costs increase and extreme labor shortage among truck-drivers in the US has been well covered. The second part of the equation is of course also the increasing oil price. But how this together changes the picture in terms of transportation, is something I at least have not reflected enough upon.

truck_rates_USA

In many cases its hard for companies to fully transfer the increased transportation cost to the end buyer, especially in the short term. There is also a forward market for both trucking rates and oil, which means that competitors might have hedged their costs further out. More importantly different companies most likely have hedged it differently, or not at all. So the company which has no or shorter tenor of its hedging will face increasing cost, with little to no possibility to transfer that cost on-wards.

Read also the following: Bloomberg – Rising cost on supply chain, USA Today: Trucker shortage

All this brings me back to my analysis I recently made on Huhtamäki.

Huhtamäki

In my recent analysis of Huhtamäki. I understood that valuation wise we needed to see a margin improvement. It seems feasible to believe that such improvement is possible, looking at competitors margin levels. But maybe its the other way around, everyone’s margins are actually coming down? Part of Huhtamäki’s products are flexibles, plastic based products, meaning dependent on price of oil. The other part is high volume paper based products like paper cups etc. A products which most likely is highly sensible to increased transportation costs. How Huhtamäki in the current environment with US being its largest market, could raise margins, is going to require some pretty magical management execution. So after contemplating this a bit more, I need to revise the probabilities for my bear/base/bull cases. The conclusion then is that this is a clear sell, in the short to medium term. Therefore as of today I sell my full holding in Huhtamäki.

Other companies affected

As noted in the linked articles a lot of companies are affected by this. In my own portfolio I see several companies that could see headwinds due to this: Dairy Farm (Asian retail), Olvi (Selling beer in northern Europe), Inditex (Clothes retailer, shipping much of its clothes by air), Essity (selling paper based products worldwide). Essity probably being the next company I need to take a closer look at, for example competitor Kimberly Clark has been in a downtrend for a year now. We have recently seen US retail giants like Kraft Heinz drop tremendously, there are many reasons for that drop, but partly it could also be related to transportation costs. One should not change the whole portfolio, just because oil price has increased, but it might affect share performance in the short/medium term significantly for many companies.

Dream International – a dream investment?

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Summary

Dream International is a Hong Kong listed plastic and plush stuffed toy manufacturer, with factories based in China and Vietnam. Most of the factories today are based out of Vietnam, which gives a cost advantage on China based producers. The company supplies toys to a limit number of larger companies, such as Disney, Oriental Land, Funko and Spin Master. The company has been growing revenue last 10 years with a CAGR of 12%. This has accelerated last 3 years to a CAGR of 21% for revenue and 38% for EBITDA. Although profits have been accelerating, the company is trading at a trailing P/E of about 6.8. Usually when something is trading so cheap, there is some catch, or is this the holy grail of Growth At a Reasonable Price (GARP)? I will try to give my views of what I have been able to find.

Dreamstockchart

+ Fast growing company trading below 7x P/E.

+ Exposure to segment of toys with high growth (Marvel superheros, Star Wars, Disney figures etc).

+ As one of the worlds largest plush stuffed toy producers, Dream has a long track record with large customers like Disney.

+ Recently expanded the customer relationships to plastic toy sales which has given explosive growth and earnings.

– Poor liquidity in the stock.

– Old (69 years) majority shareholder and CEO, unknown what his plans for the future are.

– Probable margin deterioration due to higher material costs (mostly related to oil price).

– Recently bought it’s office premises in Hong Kong for 200m HKD instead of continuing to rent.

Background / History

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