Wednesday, May 31, 2006

Test Your VC Skills

I know I have been a bit remiss on posting lately. I have been working on a big project that wraps up this week, and it has been cutting into my blogging time, but I do have lots of material. I just need the time to organize it.

In the meantime, check out and test your investing skills. So far, they have had six case studies, and five "solutions".

What I really like about these scenarios is the radar chart and funding curve that The Venture Alliance use. TVA's radar chart looks at 12 key dimensions of an investment and shows in one picture the relative importance of a dimension to success and relative performance of a potential investment against that standard.

I like it so much, I am using a similar system as the basis of an entire business development methodology at my job. My GM thinks I'm a genius. I am looking to use a similar method to complement discounted cash flow modelling as part of my investment analysis.

So how's you do?

Saturday, May 27, 2006

New Link - Real Estate

I regularly read other financial blogs and make a point of selecting those I find most interesting as links here.

In pursuing my goal of investing strategically for income, I recognize that real estate investing is in my future. Advetures in Moneymaking is a blog by a real estate investor about real estate investing. His posts are straight forward, written in plain English and insightful.

I recommend the site.

Sunday, May 21, 2006

Technical Analysis

One of the investing discussion boards in which I participate, the paper assets group of NYC Cashflow , has been having a spirited discussion of exit strategies for stocks, particularly TRLG, which I have already written about, and which is one of my major holdings.

As a matter of strategy, I focus almost exclusively on the fundamentals of an invesment, but I have found that this sometimes leaves me in an investment too long, when a tactical exit would preserve my gains, and give me an opportunity to reenter later at a lower price-point (not buy and hold, in other words).

Judging this, however, is difficult. Charting, or technical analysis, attempts to decipher appropriate entry and exit points based on price movements, and what they suggest about supply and demand of a security.

Ed Patisso from NYC Cashflow shared this link, and it appears to be a very good resource.

Friday, May 19, 2006


A few of you have asked me to make it possible to subscribe to the site, so that you can get email feeds, or syndication. So, I have added Feedburner subscription options in the sidebar.

You can subscribe and receive the feed as part of your Feedburner account, or simply get an email delivered to your email address. If you want to get it at more than one address, sign up each address separately.

CL - Colgate-Palmolive

How to play the falling dollar? Everyone from Warren Buffett to Joe Kernan thinks that the dollar is headed lower against othe currencies. Treasury Secretary John Snow wants "currency flexibility" by which he means a weaker dollar - as a matter of government policy. They cite many reasons to justify their position: trade deficits, a slowing economy, easy money, and a negative savings rate. In seeming confirmation of their view, the dollar has definately taken lumps lately.

I will leave the economics of the dollar to another post, but suffice it to say, I believe that easy money from the Fed has very probably devalued the dollar, so further weakness would not be surprsing.

What to do? How do I protect myself from the ravages of a weaker dollar and lower purchasing power? Buy foreign currencies? Purchase commodities? Foreign equities?

While I do invest in international equity through my 401(k) I do not generally pick international stocks myself, even though I speak two languages, and many international stock reports are available in English. I don't invest directly, because the reporting and accounting rules for foreign companies are different than those in the US, and I have no expertise in those systems. I may consider studying them in the future, but I would probably choose to invest in other US assets before investing directly in foreign stocks. The only exceptions are those companies that also list their shares on US exchanges (ADRs), and therefore make filings with the SEC.

Similarly, I realize that the commodities and currency markets are outside of my expertise. So, what do I do? Invest in US equities with lots of overseas exposure!

Here's the thing - a weaker dollar is far from a certainty, only a possibility. As an investor, I want to be prepared whatever happens, and by investing in good US businesses with extensive foreign sales, I am. If the dollar strengthens, I make money, if the dollar falls, I make lots of money.

For the same reason, I like consumer staples. Here, the international operations help again - if the global economy continues booming, or even simply keeps growing, rising incomes in Asia mean growing sales, while, if the economy stalls, well, Westerners will keep buying basic necessities. Either way, I make money.

All I need is the right company, and in Colgate-Palmolive I found it. In my mind, this is about the most perfect business anywhere. Not only does it offer upside potential with downside protection, it also demostrates the following characteristics.

  • A simple, understandable, profitable business, with a wide moat. This is a business that manufactures and distributes a host of household, personal care, and pet care products. The business has strong and rising margins (over 50%, excluding the temporary effects of their restructuring program). These products and margins are protected by the strong moat of their brands, including the eponymous Colgate and Palmolive brands, Irish Spring, Ajax, Softsoap, and Science Diet. People are remarkably loyal to brands. My girlfriend swears by Colgate Total, and the price differential that you would have to offer her to switch is huge. I'm not sure you could get her to switch if you gave your brand away.
  • Honest, effective, shareholder-friendly management. What do these numbers mean to you? 591, 585, 578, 567, 551, 536, 534, 527, 516? They are the number of common shares outstanding from 1997 to 2005. The company has just committed to repurchase 30 million more shares over the next two years. What about these numbers? 0.53, 0.55, 0.59, 0.63, 0.675, 0.72, 0.90, 0.96, 1.11? That is the cash dividend per share over the same period. Management takes every excess dollar and returns it to shareholders. It keeps equity compensation to a minimum, and has consistently reduced the amount of convertible preference stock. As far as honestey is concerned, the company regularly gets top billing from Institutional Shareholder Services, for the independence of the board. Finally, in the best measure of management effectiveness, return on equity is over 100% (because of all the capital regularly returned to shareholders), and return on assets is in the double digits. Management does not uses shareholder's money to fund its pet projects, only the profitable ones.
  • Good growth potential. Household products may not seem like a growth category, but on a worldwide basis, they are. As incomes rise, people chose to invest in more preventive medicine (good dentistry being one of the most important indicators of health, since it influences diet and other health issues), invest in larger homes (that require more cleaning) with modern appliances and the like. The company's ability to continue to grow revenue at a high single digit basis, or better, is likely.
  • A good price. When I purchased the stock in October of 2004, the stock was near a 52-week low, and trading at about 20x trailing earnings that were hampered by older factories with higher costs (due to lower efficiency). Still, the stock was attractive, the dividend yield had risen to 2.5%, earnings were clearly at a nadir, and opportunities to improve margins abounded. Shortly thereafter, in fact, the company announced a new restructuring program (first in 10 years), and, after a charge in the 4th quarter, began a process of modernization of facilities. That program is in its second year (it is a four year program), and so far, results have been exemplary. Still, the stock has experienced both increased earnings and multiple expansion, and at 24x earnings, no longer looks cheap.
In short, I own shares in a well run company, with good growth prospects, excellent management, and good downside protection. Revenue is likely to grow 6-8% per year, margins should expand, pushing overall earnings to 7=10% per year, and share repurchases should increase EPS at 8-12% per year, with dividends increasing at a comparable rate.

Downside risk is small, the stock rallied in the middle of last week's commodity and market meltdown (lower commodity prices mean lower costs and better margins) though the higher multiple invites more price volatility.

Still, the question remains, does it fit in my portfolio at $60+? My goal is to grow at 20% per year, and while the stock has achieved this over the last 19 months, I don't expect it be able to maintain this rate going forward. On the other hand, it helps to prevent losses (guaranteeing a positive portfolio return, and from my first post, recall that losses kill compounded returns).

Your thoughts?

Tuesday, May 16, 2006

TRLG - I still have True Religion

In my last post, I suggested that small cap stocks are reaching the end of their run. As an asset class, I continue to believe this, but, obviously, there are exceptions, and True Religion (TRLG)is one such stock. Now, today was NOT a good day for owners of TRLG, but it represents an opportunity for anyone looking for a fast money investment with great fundamentals.

I was first introduced to this stock through Gualberto and NYC Cashflow. When I first heard about it, I ignored it, because (I said to myself) I do not purchase fashion stocks. I remember what happened to Donna Karen a few years ago, huge runup after the IPO, and then, squat.

But eventually, I was encouraged to take a look at the stock, and the numbers were simply eye-popping. At the time (Nov 2005) the company was earning 108% on shareholders equity. The most important measure of any company's performace, ROE tells you how efficiently a company is using the shareholders capital. Most companies with high ROE (above 20-25%) have undertaken major stock repurchases (like another holding CL, Colgate-Palmolive), and have therefore returned most of shareholders money to them. Companies with high ROE sometiemes have high leverage (like the financials), and you have to be careful about this, but they are also the best companies - they can take on the leverage because their cash flows are both regular and predictable. Because they are earning big bucks on every dollar invested, they are very often companies that need very little capital investment to increase revenues and profits, and can instead return their cash to shareholders . They are also usually mature businesses: "cows" in the parlance of the Boston Consulting Group.

TRLG, however, is not a cash-cow in BCG terms; it is definately a star. As a new company, it has huge growth, which usually requires lots of capital investment, but at TRLG they generated $35 million in revenue in the first quarter, and had only $193 thousand in cap-ex, or 0.65% of revenue! Consider this carefully - at this rate, we would anticipate about $1 million in cap-ex for the year. In order to maintain 85% return-on-capital-employed, the company would have to increase net income by $850 thousand in 2007 (and that assumes no depreciation!), in fact, the company will have much stronger growth than this. Usually, increasing ROCE is extremely difficult, thus, if you wish to see earnings increase, you have to see the capital base increase with it. At TRLG ROCE is trending higher, but ROE will not increase, because cash and equivalents are piling up on the balance sheet. This, my friends, is a very good thing. How the company will use cash in the future is the next test of management. If they begin purchasing things, beware. If they discuss shareholder-friendly initiatives (dividends, which they have pretty much ruled out, and share buybacks) rejoice. In all likelihood, they will use that cash to grow the business, but as long as they do so carefully, I can be satisfied as a shareholder.

When it comes to leverage, to boost returns, unlike CL, TRLG has more cash and equivalents than liabilities! This DOES NOT include receivables or inventories!

Ok - so we know the balance sheet is awesome, what about the income statement? Well, revenues were up to $35 million in Q1 from $20 million in the year ago period, an increase of 77%. Margins INCREASED, from 50 to 52%, and according to management this is the outlook for 2006:

We have begun to demonstrate our leadership position to the market, both in the United States and overseas. The premium denim market remains highly competitive; however, we are beginning to increase our market share. Certain of our competitors have exited the higher end of the premium market and have announced lower prices and are targeting the low $100 range. In contrast, we have held our prices in the $170-$200+ range with no wholesale price erosion. Our brand continues to have strong broad-based appeal and has captured increased shelf space and square footage in major department and specialty stores.
We plan to continue selling denim and non-denim products under the label True Religion Brand Jeans. We plan to continue to broaden our product line during 2006 introducing a broader selection of skirts, t-shirts, knits and other sportswear, cotton twill pants for Summer. Later in the year, we will be showing a collection focusing on a down-filled parka and vests with corduroy-contrast yokes. We forecast 25% non-denim product sales for full year 2006 and achieved 22% for the three months ended March 31, 2006. For the full year 2006, we forecast that U.S. sales will account for approximately 60% of total sales, and international sales for approximately 40%, with our gross profit margin remaining in the 50-52% range. (Form 10Q, May 15,2006)

Management remains fixed on its strategy, and is gaining share of the premium market, which will help insulate it if there is something of a retail downturn (the premium end of the market usually holds up best, because high-end consumers have the deepest income streams).

Net margins did decline, due to higher Selling, General, and Administrative expense, but this is due in large part to staff increase to prepare for this year's growth (especially at the retail store).

Final question (though it is usually one of the first I ask) - what about equity compensation. If the company is supressing costs by handing over "non-cash" compensation in the form of stock and options, you have nothing (ask your friend who is wondering why his CSCO is stuck in the mud). Check out the footnotes in the the 10K. Fortunately, at TRLG, things are pretty reasonable. The company has ceased awarding options, since the mid of 2005. They are awarding restricted stock, but the 300 thousand shares awarded vest over the next three years. 1.5% dilution is a high price for a company with such numbers, but fair.

So, any downside risks? Absolutely. Fashion, obviously, is fickle. The death of premium denim is rumored regularly. If companies reversed the trend toward more casual attire, killing jeans Fridays and the like, the market for such denim could decline. But this is also a company that had just $100 million in revenue in 2005, it has room to run, and denim is not going away. Gualberto, ever the king of fundamental research, started chatting up a fabric saleswoman, and found out that denim is still moving, so the imminent demise of denim is perhaps not so imminent.

The bigger risk, in my mind is the opposite. If premium denim remains as hot as it is, potentially other companies with deeper pockets may try and enter the segment and buy shelf space at the stores that carry True Religion Jeans. TRLG is taking some steps to prevent this by diversifying to other product segments, including premium fleece and others. Management is trying to have 25% of its sales come from outside of the denim segment, and again, they seem poised to deliver, thru March 2006, 22% of revenue comes from other sources.

Growth to $400-$500 million in revenue in the next five years does not seem unreasonable. This is a compounded annual growth rate (of revenue) of 38%. Even if net income increases more slowly, and dilution takes EPS growth to 25%, the company's stock would triple in five years without any multiple expansion.

In short, this is one of the most incredible investments I have ever come across. It remains that today, and I will likely take this opportunity to increase my position. Many readers of this blog already have a position in this stock. I am interested to hear what you all are thinking.

My Investments - 401(k)

My investments fall generally into two categories, my 401(k), which is tactically allocated across various equity funds, and my personal portfolio, which is comprised of funds in my Roth IRA and my brokerage accounts. Since the funds in my 401(k) are not publicly traded funds (they are trusts of the Frank T. Russell Co that invest in multiple funds in their respective asset categories), I will not spend much time on them.

My current allocations are approximately

30% large cap value
25% large cap growth
20% small caps
20% international
5% cash

Since mid 2005, I have been allocating away from small caps, and toward large cap value stocks, and cash. This has produced decidedly inferior results to putting all of the money into small and international stocks, which have rallied strongly. However, I think that we are coming to the end of small cap dominance, because small caps are disproportionately dependent on bank financing bank financing usually comes with variable rates tied to the prime rate, which is increasing in lock step with the federal funds rate. Thus, credit is tightening faster for small cap companies than it is for large, diversifed companies that float debt directly through the capital markets (and which usually carries a fixed rate).

Most changes in leadership end badly for the former leaders, as people begin realizing that there are more attractive investments elsewhere. I am following the advice of Nathan Rothschild, who said that always sold to soon (but always when buyers were plentiful). Actually, smalls have rallied so dramatically that even though none of my new contributions go to purchasing small shares in this account, its percentage is remaining stable. I will probably look to take some more small cap money off the table, and potentially reallocate to international shares, which are likely to continue to perform well in their own right, and even better in US dollar terms.

Another mistake, in 2005, I also took some money off the table from international stocks, correctly anticipating a dollar rally, but failing to appreciate that international stocks would rally so strongly, that they would overcome even dollar strength.

I would very much appreciate thoughts on international investing, where I admit that I stick to funds, because reporting rules for non-US equity are different, and often use different accounting standards, so doing fundamental research is more difficult. What do you do?

Most of my discusssions on this blog will focus on my other investments, but I wanted to put these on the table, since in dollar terms, they still represent more than 50% of my net worth.

Saturday, May 13, 2006

Playboy Asset Management

Who makes the best asset managers? The people with the best assets, of course! Maybe that is why Amy Sue Cooper, a 23-year-old nursing student and 2005 Playboy Cybergirl of the Year, hast the distinction of beating all 9,771 Morningstar-related mutual funds in the US, according to Barrons (Review and Preview, May 1).

Along with nine other Playboy Playmates, she is competing the in Trading Markets/Playboy 2006 stock-picking contest. Through the end of April, she was up 47% year-to-date vs. Frontier Micro-Cap's (FEFPX) 33% return. Since then, her portfolio has further rocketed ahead to an eye-poping 64%!!

Just for the record, she's outperforming your humble writer over this period, as well. See Amy's picks and her reasons for them here. Her big pick is Pacific Ethanol (PEIX), which is up 288% since January 1, due to the government's continued support of ethanol subsidies. (She is studying at Nebraska, so I guess a Cornhusker should know).

Obviously, I posted this because of its entertainment value. But there is also a strategy lesson here. What her portfolio demonstrates is the power focus, a subject on which I have written before. Three of her five positions are down, but one tremendous pick lifts her performance far above the crowd. Mutual funds cannot concentrate their portfolios this way, by law they must hold a much larger number of securities, so even if they did spot a great opportunity like PEIX, it would be diluted, because it wouldn't be more than a small percentage of the portfolio.

The contest raises money for charity, but the best thing about it is that is proves that Playboy really is about the articles, after all.