Monday, 27 January 2014

Back on the block (blog)

Last year I took an hiatus from blogging as most of it was spent working on the sell-side, which provided several regulatory restrictions and very little time to maintain a blog. Now having learned some of the technical skills required to understand and value a business, I hope to find a home at a value-minded shop where I can do what I love on a daily basis. While my search for a home on the buy-side continues, I will post any interesting investment ideas I come across. 

I've also started to manage money (pro-bono basis) for a couple of friends and a family member and this blog provides an ideal medium of communication with them as well. Since the funds are small and liquidity is not a concern at this point, I will try to update all buy/sell decisions in a timely manner - hopefully my "clients" can also gain some transparency into how their money is being invested.

Results and lessons:
Being based out of Canada and having no particular desire of investing in commodity based businesses, I will use the S&P 500 Index as my general benchmark. Last year was a great year for most equity indices and I'm obviously pleased by a year in which my holdings gained +40% while beating a fast rising market - however the year wasn't without its share of mistakes.

Key mistakes: 
  • Investing in a risk arbitrage situation (fancy word for buying a stock trading below its proposed acquisition price). Last summer I made a purchase of a stock offering 8-16% (tender offer had a range) in this situation despite reading warnings from several great investors on why these situations should be avoided - limited upside, much greater down-side, uncertain timing, and a lot of work for the usual 10-12% reward. I rationalized the purchase with the following: i) extremely cheap valuation - the stock was trading at under 5x EV/EBITDA at its takeout price; ii) stable/non-cyclical business - the company provides a niche equipment rental service to hospitals; and iii) well-aligned management - an activist investor stepped in the year before to replace the company's handsomely paid management team - in fact it was the activist investor acting as the company's Chairman that made the offer. Much to my dismay, two weeks after the initial offer the board rejected the bid citing "too low of a price". A couple of months go by and the stock now traded at 25% below my initial purchase. Since the underlying business did not change, and the valuation became much more attractive, I was happy to purchase shares on the way down while being cognoscente that shares could languish until the company decided to start returning cash or another buy-out offer comes by. Luckily, Mr. Market corrected the disparity between the company's price and value much sooner - shares closed the year at $2.14, with my initial purchase coming at $1.73 and average price of $1.49, I was able to walk away  from this lesson relatively and absolutely scot-free. 
  • Seeing a "special situation" through - last year I invested in my first spin-off - I provided a brief write-up on the situation in my Deans Foods post. This particular spin-off offered a bit of everything - a partial listing, spin-off of a high-growth business (WhiteWave), a residual leveraged-stub (remaining Dean Foods), cyclically depressed earnings, corporate restructuring (Dean Foods had also sold its Morningstar business and was aggressively paying down down), and  the promise of shareholder friendly capital allocation going forward - essentially, no matter what I did I should have made money. I realized a gain of 8% in just under 6 weeks - if I had held onto my position until the remaining spin-co shares were distributed, I would have made 28% in 9 weeks - however I was much more concerned about the "DF Stub" valuation and wasn't able to see the bigger picture transformation that was happening at the company. 
  • I'm not sure how to categorize this next mistake other than "once you find a compelling idea - invest in it", don't be an idiot and wait for your other positions to reach a selling price. Last fall I wrote a report for the annual value investing contest hosted by SumZero, with naturally my most appealing investment idea at the time. However, instead of taking a sizable position I waited for the opportunity to exit one of my other positions. The company received a go-private offer in the following weeks and shares ended the year 62% higher than my initial price write-up price.
Other errors include: a purchase of a competitive and deteriorating business, numerous omissions of decent businesses at great prices (debatable if errors), and my initial over-concentrated portfolio (2 positions). As you might imagine, still having a shirt on my back despite all these mistakes made me quite pleased with the 2013 results, and even more excited about future investments. 

Returns to date: I will continue to post my personal returns on a quarterly basis, other portfolios I manage will track these results extremely closely.

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