How Do Superinvestors Find The Next 100-Bagger

Johnny HopkinsChristopher Mayer Comments

One of my favorite investing books is 100 Baggers: Stocks That Return 100-1 And How To Find Them, written by Christopher Mayer. It’s also one of the top two books on the bookshelf of Mohnish Pabrai. The other book is 1,000 Dollars and an Idea: Entrepreneur to Billionaire, by Sam Wyly.

The book is about 100-baggers – stocks that return $100 for every $1 invested. The inspiration for the book came by way of another book he’d read called, 100 to 1 in the Stock Market by Thomas Phelps.

One of my favorite parts of the book is in Chapter 10: Kelly’s Heroes: Big Bet, in which Mayer writes about the idea of making big bets on your best investment ideas. He provides some great examples from some of our best known Superinvestors – Klarman, Watsa, Ackman and Berkowitz. Here’s an excerpt from the book:

I can’t be involved in 50 or 75 things. That’s a Noah’s Ark way of investing—you end up with a zoo that way. I like to put meaningful amounts of money in a few things. — Warren Buffett

Thomas Phelps wrote, “Be not tempted to shoot at anything small,” the idea being you want to focus your capital on stocks with the potential to return 100x. You don’t want to own a zoo of stocks and ensure a mediocre result.

In this chapter, we explore the idea of concentration in your portfolio. In Zurich, at the ValueX conference, Matt Peterson of Peterson Capital Management presented the idea of the Kelly criterion. This can get mathematical and wonky, but the basic idea is simple: bet big on your best ideas.

It all began with a man named John L. Kelly Jr. (1923–1965).

Kelly was a Texan, a pilot for the navy in WWII and a PhD in physics. He worked at the storied Bell Labs, where he whipped up what became known as the Kelly criterion in 1956. The story is wonderfully told in William Poundstone’s Fortune’s Formula.

Kelly sought an answer to a question. Let us say a gambler has a tipoff as to how a race will likely go. It is not 100 percent reliable, but it does give him an edge. Assuming he can bet at the same odds as everyone else, how much of his bankroll should he bet? Kelly’s answer reduces to this, the risk taker’s version of E = mc2:

f = edge/odds

F is the percentage of your bankroll you bet. Say you can bet on Big Brown at 5–1 odds at the Kentucky Derby, meaning, if you bet $1, you would stand to win $5 if Big Brown wins. (Plus, you’d get your $1 back.) Odds = 5.

What about your edge? Your inside tip says Big Brown has a one-in-three chance of winning. That means a $1 bet gives you a one-third chance of ending up with $6 ($5 plus your initial $1 bet). On average, such $1 bets are worth $2—for a net profit of $1. Your edge is your profit divided by the size of your wager, in this case, $1. Edge = 1.

Plug it all into the formula, and Kelly says you should bet 20 percent of your bankroll on Big Brown. If you don’t get the math, don’t worry about it. The aim of the formula is to find the optimal amount to bet. And the rough answer is this: when you have a good thing, you bet big.

As you might imagine, this is useful for investors because they too face a question: how much do I put in any one stock? Kelly’s formula gives you an objective way to think about it. But it has quirks. For one thing, the formula is greedy. “It perpetually takes risks in order to achieve ever-higher peaks of wealth,” as Poundstone writes. It is for making the most the fastest, but that goal is not for everyone.

Yet it is also conservative in that it prevents ruin. It has, as one professor put it, an “automatically built-in . . . airtight survival motive.” Even so, it produces large swings in your bankroll. As you can see from our Big Brown example, if you lost—and you would have—you lost 20 percent of your bankroll. This has led some to try to smooth the ride a bit by taking a “half-Kelly.” In other words, if the formula says you put 20 percent of your account in one stock, you put half that amount, or 10 percent.

I favor the half-Kelly because it cuts the volatility drastically without sacrificing much return. Poundstone says a 10 percent return using full Kellys turns into 7.5 percent with half-Kellys. But note this: “The full-Kelly bettor stands a one-third chance of halving her bankroll before she doubles it. The half-Kelly better [sic] has only a one-ninth chance of losing half her money before doubling it.”

The formula has more ins and outs than I care to tackle here. It set off lots of catfights among academics that raged for decades. (See Poundstone’s book for a good look at the debates. Also, Michael Mauboussin has a summary discussion in a 2006 paper titled “Size Matters.” You can find it free online.)

For me, the big obstacle is that in the stock market, you can’t know your odds or your edge with any certainty. You must guess. Nonetheless, the idea is alluring. Ed Thorp used it in his hedge fund, Princeton/Newport. Started in 1974, it averaged 19 percent returns for nearly 30 years without a down year. How much of that is due to Kelly’s formula and how much to Thorp’s own genius is hard to say.

Thorp’s example is not a lonely one. Many great investors seem to intuitively use Kelly’s formula. Which brings us back to Matt’s presentation. He had a fascinating slide, which I reproduce here. (This data was current as of the end of 2014 and relies on public filings. This is not an accurate way to get a read on a portfolio because of certain limitations. For example, investors don’t have to disclose foreign-listed stocks and other positions. But it gives you a rough idea of a manager’s concentration in disclosed stocks.)

You’ll see a number of standout investors and how they bet big on their best ideas. These portfolios look a lot like what Kelly’s formula would demand.

Now, I doubt any of them is actually going through the trouble of plugging numbers in the edge/odds formula I showed you before. But it is like an analogy I heard once about Minnesota Fats and physics. Fats didn’t use math formulas from physics when he lined up a pool shot. But the principles of physics were at work nonetheless. It’s just that Minnesota Fats had internalized them through experience.

We might say the same thing for these super investors. The principles of using edge and odds are part of what they do. Matt’s slide showed this in a striking way. To maximize your returns, you’re better off following these examples.

To flip it around, look at what unsuccessful investors do. The typical mutual fund holds about 100 stocks. None matters very much (or for very long). And most funds are poor mimics of the market.

As Buffett says up top, reject the Noah’s Ark way of investing. It seems many great investors do. And it is what I try to do in my own portfolio: Keep the list of names relatively short. And focus on the best ideas. When you hit that 100-bagger, you want it to matter.

TSR Inc Trading Below NCAV and TBV, FCF/EV Yield 25%, – Small & Micro Cap Stock Screener

Johnny HopkinsStocks Comments

One of the cheapest stocks in our Small & Micro Cap Stock Screener is TSR Inc (NASDAQ:TSRI).

TSR, Inc. (TSR) is engaged in providing contract computer programming services to its customers. The Company provides its customers with technical computer personnel. It provides its customers with technical computer personnel to supplement their in-house information technology (IT) capabilities. The Company offers staffing capabilities in the areas of mainframe and mid-range computer operations, personal computers and client-server support, Internet and e-commerce operations, voice and data communications (including local and wide area networks), and help desk support. It provides services on day-to-day operations, special projects and on short-term or long-term basis. It also offers various services to other companies in various sectors, such as insurance, pharmaceutical and biotechnology, publishing and new media, financial services and project utilities. It provides contract computer programming services in the New York metropolitan area, New England and the Mid-Atlantic region.

A quick look at TSR’s share price history over the past twelve months shows that the price is up 32%, but here’s why the company still remains undervalued.

The following data is from the company’s latest financial statements, dated February 2017.

The company’s latest balance sheet shows that TSR has $6 Million in total cash and cash equivalents consisting of $5 Million in cash and $1 Million in short-term investments. Further down the balance sheet we can see that the company has zero debt. Therefore, TSR has a net cash position of $6 Million (cash minus debt).

If we consider that TSR currently has a market cap of $10 Million, when we subtract the cash totaling $6 Million that equates to an Enterprise Value of $4 Million.

If we move over to the company’s latest income statements we can see that TSR had $1 Million in trailing twelve month operating earnings which means that the company is currently trading on an Acquirer’s Multiple of 4, or 4 times operating earnings. That places TSR squarely in undervalued territory.

The Acquirer’s Multiple is defined as:

Enterprise Value/Operating Earnings*

*We make adjustments to operating earnings by constructing an operating earnings figure from the top of the income statement down, where EBIT and EBITDA are constructed from the bottom up. Calculating operating earnings from the top down standardizes the metric, making a comparison across companies, industries and sectors possible, and, by excluding special items–income that a company does not expect to recur in future years–ensures that these earnings are related only to operations.

It’s also important to note that if we take a look at the company’s latest cash flow statements we can see that TSR generated trailing twelve month operating cash flow of $1 Million and had $0 Million in Capex. That equates to $1 Million in trailing twelve month free cash flow, or a FCF/EV Yield of 25%.

TSR’s free cash flow of $1 Million (ttm) has been consistent for the past couple of years and the company’s current revenues of $61 Million (ttm) are inline with the all time highs recorded in FY2016 but what seems to get overlooked is that TSR currently has $13.43 Million in total current assets and $3.89 Million in total liabilities. If we subtract the total liabilities ($3.89 Million) from the total current assets ($13.43 Million) that equates to $9.54 Million in net current assets. And, if we divide the net current assets by the total number of outstanding shares (1.96 Million) that equates to $4.87 per share. When we consider that the company’s current share price is $4.85, that means TSR is currently trading at a discount to its net current asset value.

Lastly, TSR reported total equity of $9.638 Million for the quarter ending February 2017, if we divide the total equity by the number of outstanding shares (1.96 Million) we get a tangible book value per share of $4.92, and with the company’s current share price at $4.85, that means TSR is also trading at a discount to its tangible book value.

As for TSR’s current valuation, the company is currently trading on a P/E of 24.3, a FCF/EV Yield of 25%, and an Acquirer’s Multiple of 4, or 4 times operating earnings. TSR has is also trading at a discount to both its tangible boom value and its net current asset value. All of which indicates that the company remains squarely in undervalued territory.

About The Small & Micro Cap Stock Screener (CAGR 22%)

Over a full sixteen-and-a-half year period from January 2, 1999 to July 26, 2016., the Small & Micro Cap stock screener generated a total return of 3,284 percent, or a compound growth rate (CAGR) of 22.0 percent per year. This compared favorably with the Russell 3000 TR, which returned a cumulative total of 265 percent, or 5.7 percent compound.

Henry Singleton – (“The Best Capital Deployment Record In American Business” – Warren Buffett)

Johnny HopkinsHenry Singleton, Warren Buffett Comments

One of my favorite investing books is The Outsiders: Eight Unconventional CEOs and Their Radically Rational Blueprint for Success, by William N. Thorndike. In fact it’s also the top choice on Warren Buffett’s reading list. The book provides stories on eight of the most successful CEOs in history who were great capital allocators.

One of my favorite chapters is on Teledyne CEO Henry Singleton, who Buffett said had the best operating and capital deployment record in American business. While the whole chapter is a must read I pulled out the following excerpt on Singleton:

One of the most important decisions any CEO makes is how he spends his time—specifically, how much time he spends in three essential areas: management of operations, capital allocation, and investor relations. Henry Singleton’s approach to time management was, not surprisingly, very different from peers like Tex Thornton and Harold Geneen and very similar to his fellow outsider CEOs.

As he told Financial World magazine in 1978, “I don’t reserve any day-to-day responsibilities for myself, so I don’t get into any particular rut. I do not define my job in any rigid terms but in terms of having the freedom to do whatever seems to be in the best interests of the company at any time.” Singleton eschewed detailed strategic plans, preferring instead to retain flexibility and keep options open. As he once explained at a Teledyne annual meeting, “I know a lot of people have very strong and definite plans that they’ve worked out on all kinds of things, but we’re subject to a tremendous number of outside influences and the vast majority of them cannot be predicted. So my idea is to stay flexible.”

In a rare interview with a BusinessWeek reporter, he explained himself more simply: “My only plan is to keep coming to work. . . . I like to steer the boat each day rather than plan ahead way into the future.” Unlike conglomerate peers such as Thornton or Geneen or Gulf & Western’s colorful Charles Bluhdorn, Singleton did not court Wall Street analysts or the business press. In fact, he believed investor relations was an inefficient use of time, and simply refused to provide quarterly earnings guidance or appear at industry conferences. This was highly unconventional behavior at a time when his more accommodating peers were often on the cover of the top business magazines.

Even in a book filled with CEOs who were aggressive in buying back stock, Singleton is in a league of his own. Given his voracious appetite for Teledyne’s shares and the overall high levels of repurchases among the outsider CEOs, it’s worth looking a little more closely at Singleton’s approach to buybacks, which differed significantly from that of most CEOs today.

Fundamentally, there are two basic approaches to buying back stock. In the most common contemporary approach, a company authorizes an amount of capital (usually a relatively small percentage of the excess cash on its balance sheet) for the repurchase of shares and then gradually over a period of quarters (or sometimes years) buys in stock on the open market. This approach is careful, conservative, and, not coincidentally, unlikely to have any meaningful impact on long-term share values. Let’s call this cautious, methodical approach the “straw.”

The other approach, the one favored by the CEOs in this book and pioneered by Singleton, is quite a bit bolder. This approach features less frequent and much larger repurchases timed to coincide with low stock prices—typically made within very short periods of time, often via tender offers, and occasionally funded with debt. Singleton, who employed this approach no fewer than eight times, disdained the “straw,” preferring instead a “suction hose.” Singleton’s 1980 share buyback provides an excellent example of his capital allocation acumen. In May of that year, with Teledyne’s P/E multiple near an all-time low, Singleton initiated the company’s largest tender yet, which was oversubscribed by threefold. Singleton decided to buy all the tendered shares (over 20 percent of shares outstanding), and given the company’s strong free cash flow and a recent drop in interest rates, financed the entire repurchase with fixed-rate debt.

After the repurchase, interest rates rose sharply, and the price of the newly issued bonds fell. Singleton did not believe interest rates were likely to continue to rise, so he initiated a buyback of the bonds. He retired the bonds, however, with cash from the company’s pension fund, which was not taxed on investment gains.

As a result of this complex series of transactions, Teledyne successfully financed a large stock repurchase with inexpensive debt, the pension fund realized sizable tax-free gains on its bond purchase when interest rates subsequently fell, and, oh yes . . . the stock appreciated enormously (a ten-year compound return of over 40 percent).

Singleton’s fierce independence of mind remained a prominent trait until the end of his life. In 1997, two years before his death from brain cancer at age eighty-two, he sat down with Leon Cooperman, a longtime Teledyne investor. At the time, a number of Fortune 500 companies had recently announced large share repurchases. When Cooperman asked him about them, Singleton responded presciently, “If everyone’s doing them, there must be something wrong with them.”

Buffett and Singleton: Separated at Birth?

Many of the distinctive tenets of Warren Buffett’s unique approach to managing Berkshire Hathaway were first employed by Singleton at Teledyne. In fact, Singleton can be seen as a sort of proto-Buffett, and there are uncanny similarities between these two virtuoso CEOs, as the following list demonstrates.

• The CEO as investor. Both Buffett and Singleton designed organizations that allowed them to focus on capital allocation, not operations. Both viewed themselves primarily as investors, not managers.

• Decentralized operations, centralized investment decisions. Both ran highly decentralized organizations with very few employees at corporate and few, if any, intervening layers between operating companies and top management. Both made all major capital allocation decisions for their companies.

• Investment philosophy. Both Buffett and Singleton focused their investments in industries they knew well, and were comfortable with concentrated portfolios of public securities.

• Approach to investor relations. Neither offered quarterly guidance to analysts or attended conferences. Both provided informative annual reports with detailed business unit information.

• Dividends. Teledyne, alone among conglomerates, didn’t pay a dividend for its first twenty-six years. Berkshire has never paid a dividend.

• Stock splits. Teledyne was the highest-priced issue on the NYSE for much of the 1970s and 1980s. Buffett has never split Berkshire’s A shares (which now trade at over $120,000 a share).

• Significant CEO ownership. Both Singleton and Buffett had significant ownership stakes in their companies (13 percent for Singleton and 30-plus percent for Buffet). They thought like owners because they were owners.

• Insurance subsidiaries. Both Singleton and Buffett recognized the potential to invest insurance company “float” to create shareholder value, and for both companies, insurance was the largest and most important business.

• The restaurant analogy. Phil Fisher, a famous investor, once compared companies to restaurants—over time through a combination of policies and decisions (analogous to cuisine, prices, and ambiance), they self-select for a certain clientele. By this standard, both Buffett and Singleton intentionally ran highly unusual restaurants that over time attracted like-minded, long-term-oriented customer/shareholders.

Howard Marks – A Defensive Mindset Provides Above-Average Results With Below-Average Volatility

Johnny HopkinsHoward Marks Comments

One of my favorite investing books is The Most Important Thing: Uncommon Sense for the Thoughtful Investor, by Howard Marks. The book includes passages from Marks’ memos to illustrate his investment philosophy. In Chapter 17 Marks provides a very simple example of the importance of developing a defensive mindset as an investor. This mindset means you can keep up in good times and outperform in bad times, resulting in above-average results over full cycles with below-average volatility.

Here’s an excerpt from that book:

There are a lot of things I like about investing, and most of them are true of sports as well.

• It’s competitive— some succeed and some fail, and the distinction is clear.
• It’s quantitative— you can see the results in black and white.
• It’s a meritocracy— in the long term, the better returns go to the superior investors.
• It’s team oriented— an effective group can accomplish more than one person.
• It’s satisfying and enjoyable— but much more so when you win.

These positives can make investing a very rewarding activity in which to engage. But as in sports, there are also negatives.

• There can be a premium on aggressiveness, which doesn’t serve well in the long run.
• Unlucky bounces can be frustrating.
• Short-term success can lead to widespread recognition without enough attention being paid to the likely durability and consistency of the record.

Overall, I think investing and sports are quite similar, and so are the decisions they call for. Think about an American football game. The offense has the ball. They have four tries to make ten yards. If they don’t, the referee blows the whistle. The clock stops. Off the field goes the offense and on comes the defense, whose job it is to stop the other team from advancing the ball.

Is football a good metaphor for your view of investing? Well, I’ll tell you, it isn’t for mine. In investing there’s no one there to blow the whistle; you rarely know when to switch from offense to defense; and there aren’t any time- outs during which to do it.

No, I think investing is more like the “football” that’s played outside the United States— soccer. In soccer, the same eleven players are on the field for essentially the whole game. There isn’t an offensive squad and a defensive squad. The same people have to play both ways . . . have to be able to deal with all eventualities.

Collectively, those eleven players must have the potential to score goals and stop the opposition from scoring more. A soccer coach has to decide whether to field a team that emphasizes offense (in order to score a lot of goals and somehow hold the other team to fewer) or defense (hoping to shut out the other team and find the net once) or one that’s evenly balanced. Because coaches know they won’t have many opportunities to switch between offensive and defensive personnel during the game, they have to come up with a winning lineup and pretty much stick with it.

That’s my view of investing. Few people (if any) have the ability to switch tactics to match market conditions on a timely basis. So investors should commit to an approach— hopefully one that will serve them through a variety of scenarios. They can be aggressive, hoping they’ll make a lot on the winners and not give it back on the losers. They can emphasize defense, hoping to keep up in good times and excel by losing less than others in bad times. Or they can balance offense and defense, largely giving up on tactical timing but aiming to win through superior security selection in both up and down markets.

Oaktree’s preference for defense is clear. In good times, we feel it’s okay if we just keep up with the indices (and in the best of times we may even lag a bit). But even average investors make a lot of money in good times, and I doubt many managers get fired for being average in up markets. Oaktree portfolios are set up to outperform in bad times, and that’s when we think outperformance is essential. Clearly, if we can keep up in good times and outperform in bad times, we’ll have above-average results over full cycles with below-average volatility, and our clients will enjoy outperformance when others are suffering.

What’s more important to you: scoring points or keeping your opponent from doing so? In investing, will you go for winners or try to avoid losers? (Or, perhaps more appropriately, how will you balance the two?). Great danger lies in acting without having considered these questions. And, by the way, there’s no right choice between offense and defense. Lots of possible routes can bring you to success, and your decision should be a function of your personality and leanings, the extent of your belief in your ability, and the peculiarities of the markets you work in and the clients you work for.

What is offense in investing, and what is defense? Offense is easy to define. It’s the adoption of aggressive tactics and elevated risk in the pursuit of above-average gains. But what’s defense? Rather than doing the right thing, the defensive investor’s main emphasis is on not doing the wrong thing.

Is there a difference between doing the right thing and avoiding doing the wrong thing? On the surface, they sound quite alike. But when you look deeper, there’s a big difference between the mind-set needed for one and the mind-set needed for the other, and a big difference in the tactics to which the two lead.

While defense may sound like little more than trying to avoid bad outcomes, it’s not as negative or nonaspirational as that. Defense actually can be seen as an attempt at higher returns, but more through the avoidance of minuses than through the inclusion of pluses, and more through consistent but perhaps moderate progress than through occasional flashes of brilliance.

This Week’s Best Investing Reads – Curated Links

Johnny HopkinsValue Investing News Comments

Here’s a list of this week’s best investing reads:

Blogs

Why Simple Beats Complex (A Wealth of Common Sense)

Investing Successfully is Really Hard (Above The Market)

Tactical Asset Allocation: Does the Day of the Month Matter? (Alpha Architect)

Emerging Market Equities: Unloved and Under-Owned (CFA Institute Enterprising Investor)

The Reasonable Formation of Unreasonable Things (Collaborative Fund)

Active Listening (Farnam Street)

A (Long) Chat with Peter L. Bernstein (Jason Zweig)

Fairholme Capital Management Jun 29, 2017 Conference Call (Dataroma)

Episode #60: William Bernstein, “The More Comfortable You Are Buying Something, in General, the Worse the Investment It’s Going to Be” (Meb Faber Research)

User/Subscriber Economics: Value Dynamics (Musings on Markets)

This Is What A Bubble Looks Like: Japan 1989 Edition (The Fat Pitch)

Yes, Bitcoin Is A Bubble And It’s About To Burst (The Felder Report)

This is Your Nightmare Scenario (The Irrelevant Investor)

Top 15 Books on Every Investment Professionals Reading List (Old School Value)

Undervalued Alliance Holdings, FCF/EV Yield 27%, Shareholder Yield 9% – All Investable Stock Screener

Johnny HopkinsStocks Comments

One of the cheapest stocks in our All Investable Stock Screener is Alliance Holdings GP LP (NASDAQ:AHGP).

Alliance Holdings GP LP (Alliance) is a limited partnership formed in November 2005 to own and control Alliance Resource Management GP, LLC, the managing general partner of Alliance Resource Partners, L.P. (ARLP), a publicly traded limited partnership engaged in the production and marketing of coal to major U.S. utilities and industrial users.

A quick look at Alliance’s share price history over the past twelve months shows that the price is up 10%, but here’s why the company is remains undervalued.

The following data is from the company’s latest financial statements, dated March 2017.

The company’s latest balance sheet shows that Alliance has $92 Million in total cash and cash equivalents. Further down the balance sheet we can see that the company has $178 Million in short-term debt and capital leases, and long-term debt and lease obligations of $447 Million. Therefore, Alliance has a net debt position of $533 Million (debt minus cash).

If we consider that Alliance currently has a market cap of $1.535 Billion, when we add the net debt totaling $533 Million plus the minority interests of $546 Million that equates to an Enterprise Value of $2.614 Billion.

If we move over to the company’s latest income statements we can see that Alliance had $412 Million in trailing twelve month operating earnings which means that the company is currently trading on an Acquirer’s Multiple of 6.34, or 6.34 times operating earnings. That places Alliance squarely in undervalued territory.

The Acquirer’s Multiple is defined as:

Enterprise Value/Operating Earnings*

*We make adjustments to operating earnings by constructing an operating earnings figure from the top of the income statement down, where EBIT and EBITDA are constructed from the bottom up. Calculating operating earnings from the top down standardizes the metric, making a comparison across companies, industries and sectors possible, and, by excluding special items–income that a company does not expect to recur in future years–ensures that these earnings are related only to operations.

It’s also important to note that if we take a look at the company’s latest cash flow statements we can see that Alliance generated trailing twelve month operating cash flow of $797 Million and had $90 Million in Capex. That equates to $707 Million in trailing twelve month free cash flow, or a FCF/EV Yield of 27%. So while the company appears to have a lot of debt when compared to its cash when you consider that Alliance has $707 Million (ttm) in FCF the total amount of debt, $533 Million becomes much less significant.

In terms of its financial strength, all financial strength indicators show that Alliance remains financially sound with a Piotroski F-Score of 8, an Altman Z-Score of 2.10, and a Beneish M-Score of -3.58.

Regarding its growth prospects, while some analysts may argue that Alliance’s current revenue of $1.979 Billion (ttm) and net profit of $210 Million (ttm) is well off the 2014 revenues of $2.300 Billion and net profit of $284 Million I would argue that Alliance is in a much better position for growth when you compare its current free cash flow of $707 Million (ttm) to the $427 Million in 2014.

Moreover, Alliance’s current operating cash flow of $797 Million (ttm) is an historical high while capex of $90 Million (ttm) is an historical low. Additionally, Alliance’s current book value per share of $10.10 has been higher in one other year, 2012 when it was $11.82 but we shouldn’t forget that in that same year the company posted a net loss of $135 Million and its free cash flow was just $87 Million compared to the $707 Million (ttm) that we see today. Alliance has become much more operationally efficient with gross margins around 40% (ttm) and operating margins around 20% (ttm) but most importantly it’s the company’s ability to generate free cash flow going forward thanks to the significant reductions in capex.

Something else that seems to get overlooked regarding Alliance is its annualized return on equity (ROE) for the most recent quarter. The company had $582 Million in equity for the quarter ending December 2016 and $604 Million for the quarter ending March 2017. If we add those two numbers together ($1.186 Billion) and divide by two we get $593 Million. If we consider that Alliance has $210 Million (ttm) in net income that equates to an annualized return on equity (ROE) for the most recent quarter of 35%. At the same time the company has reduced its long-term debt and capital lease obligations by 10% and has not issued any new shares. And, the company pays a nice dividend yield of 9%.

As for Alliance’s current valuation, the company is currently trading on a P/E of 7.3 compared to its 5Y average of 12.4*, a P/B of 2.6 compared to its 5Y average of 4.9*, a P/S of 0.8 compared to its 5Y average of 1.3*, a FCF/EV Yield of 27%, and an Acquirer’s Multiple of 6.34, or 6.34 times operating earnings. Plus, a dividend yield of 9%. All of which indicates that Alliance sits squarely in undervalued territory.

*Source: Morningstar

About The All Investable U.S. Stock Screener (CAGR 25.9%)

Over a full sixteen-and-one-half year period from January 2, 1999 to July 26, 2016., the All Investable stock screener generated a total return of 5,705 percent, or a compound growth rate (CAGR) of 25.9 percent per year. This compared favorably with the Russell 3000 TR, which returned a cumulative total of 265 percent, or 5.7 percent compound.

Alexander Roepers – Look For Companies With Predictable, Sustainable Franchises That Have Hit A Speed Bump

Johnny HopkinsAlexander Roepers Comments

One of the investors we watch closely here at The Acquirer’s Multiple is Alexander Roepers, the founder of Atlantic Investment Management.

The firm’s investing methodology is differentiated by its: (1) well-defined universe of quality publicly-traded industrial / consumer companies; (2) concentration of capital and research on its highest conviction investments; (3) private equity-like due diligence; (4) constructive engagement with managements and boards to enhance and accelerate shareholder value; (5) strict adherence to its buy/sell cash flow focused valuation discipline; and (6) maintenance of liquidity to allow for opportunistic trading around core positions.

One of the best Roepers interviews was one he did with Value Investor Insight in 2007 in which he discusses his investing strategy and the types of businesses he targets. Here’s an excerpt from that interview:

Since you started out in the business you’ve focused on quite a narrow investment universe. Why?

Alexander Roepers: I realized early on from watching people like Warren Buffett and some of the early private equity players that if I was going to stand out, I needed to concentrate on my highest-conviction ideas, in a well defined set of companies that I knew very well. As a result, I limit my universe inside and outside the U.S. in a variety of ways. I want liquidity, so I don’t look at anything below $1 billion in market cap. I want to have direct contact with management and to be a top-ten shareholder in my core holdings, so anything above a $20 billion market cap is out.

Because five or six unique holdings make up 60-70% of each of my portfolios, I also exclude companies with idiosyncratic risk profiles that I consider unacceptable in such a concentrated portfolio. That means I exclude high-tech and biotech companies with technological obsolescence risk, tobacco or pharmaceutical companies with big product-liability risks, utilities and other regulated companies where the government can change the rules of the game, and companies that lack sufficient transparency, like banks, brokerages and insurance companies.

Then we boil it down further into potential “core” longs and “other” longs. Core longs are those in which we can own 2-7% of the company and have a close, constructive relationship with management. Overall, the potential universe of core holdings has around 170 companies in the U.S. and about 180 outside the U.S. These are the stocks that drive our performance – we’ve made our record by finding our share of big winners among these core longs while avoiding almost any losers. Our most-concentrated U.S. fund, which holds only five or six stocks, has had only one losing investment since we started it more than 14 years ago.

Describe the types of companies that do make the cut.

AR: They’re typically industrial products and services companies, like defense suppliers, packaging firms and diversified industrials. We favor companies with transparent businesses that we can understand fairly quickly and those that have large and recurring maintenance, repair and overhaul revenues from an installed base, such as elevator companies or aerospace-parts firms.

We require strong balance sheets and a long record of profitability, so we’re not usually investing in classic turnarounds. The stocks are cheap because they’ve hit a speed bump of some kind – from a messed-up factory changeover, an unusual competitive pricing issue or maybe some kind of commodity pricing pressure – but we think we can understand the problems and anticipate that the issues are solvable or going away.

We also put a lot of emphasis on the sustainability and predictability of the business. Our companies tend to be in industries that have consolidated, with only two, three or four leading players. For example, we’ve owned Ball Corporation [BLL], the packaging company, as a core long four times over the past 14 years. Ball’s customers require a global scale that only a very few companies can have and, if a competitor doesn’t have it, it’s likely to go away. We can’t take that type of risk in a concentrated portfolio.

How do you generate specific ideas?

AR: With a narrowly defined universe, the ideas typically just fall in our lap. We have what we call a signal system, which tracks hundreds of companies against valuation metrics and historical trading levels. Our primary input is to make sure we have all the right companies in the system and then set the triggers for each company at which we think it deserves a closer look. So if a Constellation Brands [STZ], for example, falls 10% in a day as it did last month, we’ll put someone on it right away. I’ve got an analyst reviewing the company as we speak.

I sit down three or four times a week with all of our analysts and go through the system and make to-do lists. It’s my favorite and most productive time and it’s a disciplined way to ensure we don’t miss things.

I’ll give you a good example of one of our typical investments, in Sonoco Products [SON]. Sonoco is a 108-year-old company in South Carolina that makes industrial and consumer packaging, such as composite-paper cans for Pringles or flexible packaging for Gillette shavers or Oreo cookies. I had watched the company for 10 years and the fabric of the business is just what we look for: it has never lost money, has paid quarterly dividends since 1925, has 250 facilities around the world and has no major technological obsolescence risk.

The problem was that it was never cheap enough, until about four years ago when they had problems in some of their more cyclical businesses and had pension fund losses that hit earnings. The stock fell by a third, the dividend yield got to 4% and we started buying around $20. It may be a boring business, but they were well-positioned, continued to execute very well and the temporary problems got better.

On top of that, with some fairly strong urging on our part, they started last year buying back shares in
volume with excess cash flow. As the share price recently started hitting all time highs, we sold almost all of our position. [Note: Sonoco shares currently trade around $37.]

On what valuation metrics do you focus?

AR: We want to see at least a 10% freecash-flow yield and a 6x or less multiple of enterprise value to next year’s earnings before interest, taxes, depreciation and amortization [EBITDA]. For enterprise value we use the current market value plus the estimated net debt 12 months out. Most of the companies in our universe generally live within a range of 6x to 8x EBITDA. The idea is to identify companies having some earnings or other trouble that leave them trading at the low end of the valuation range.

If our analysis is right that the difficulties are temporary, we get two boosts: from earnings recovering and from the market reacting to the earnings recovering and moving the multiple to the higher end of the range. We believe that dynamic gives all our core positions a very high probability of at least a 50% return within two years. At the end of the day we’re trying to buy companies as if we were buying a $10 million office building across the street.

We do our homework on the tenants and the leases in place and make sure it’s financed in a way that produces a 10% free-cash-flow yield. The idea is to increase equity by paying down debt with the free cash flow and also to benefit from the asset appreciating over time. With stocks, if you focus on companies with around 10% free cash flow yields and highly predictable, sustainable franchises, you protect your downside and set yourself up for nice capital appreciation.

What kind of a sell discipline do you typically follow?

AR: We try to keep it fairly rigid. When a holding hits some combination of 8x EBITDA, 12x EBIT or 15x forward earnings, we’re going to start selling. That means the shares are in the top end of their valuation range and we can’t expect enough further upside. When Sonoco hit a 15x forward P/E there was just no further reason for us to be in the stock.

Same with Black & Decker [BDK], which we also recently sold after a good run. Not only did the valuation get relatively high, but we became increasingly concerned about the company’s exposure to a housing market that is likely to be troublesome for some time.

Central to your strategy is to have position sizes that ensure an active dialogue with management. Why?

AR: Being an activist has taken on a bit of a negative connotation in the past few years, but we absolutely want to be constructively-engaged shareholders. We have 10-15% of our capital in each of our core companies, so I just think it’s imperative that we make our views, particularly with respect to capital allocation, clear. For the most part, management appreciates the faith we’re placing in their business and in them to get the stock out of the valuation hole it’s in.

And when they don’t appreciate it?

AR: When management is unresponsive, we work to change that. We’ve had a successful investment in Schindler, the elevator company based in Switzerland. But when I first called to arrange a meeting with Mr. Schindler after becoming the third-largest shareholder, I was told that he doesn’t meet with shareholders. I suggested that Mr. Schindler could instead arrange a meeting with his bankers about taking the company private, so he could maintain that attitude. We eventually met for 2 1/2 hours and now have a good relationship.

I don’t like proxy battles, I just want to make money and maintain my liquidity. The moment you force yourself on a board, you become illiquid. We do get frustrated from time to time, as a result of management inaction or when we don’t think it’s acting in shareholders’ interest. With Dole Food, for example, it appeared to us that the chairman in 2002 was taking actions that held back the share price and then he subsequently tried to buy the company for a paltry premium.

We were the second-largest shareholder and called him on it publicly and he eventually had to pay substantially more. That’s a rare scuffle; we generally try to operate more behind the scenes.

More than half your assets are invested outside the U.S. Do you do anything differently when investing internationally?

AR: Not at all. We define our universe in the same way in each major developed market. In doing that, of course, some markets offer more opportunity than others. In Taiwan, after excluding tech and banks, there’s little left for us to invest in. There are only five to ten companies each for us in markets like South Korea and Hong Kong. The real opportunities for us are in Japan, the U.K. and continental European countries like Germany, Holland, France, Sweden, Norway and Switzerland.

Japan is particularly interesting right now. It’s a bit of a two-headed dragon, with both quite overvalued and quite undervalued stocks in our universe. You’ve got interesting companies like Dai Nippon Printing trading at extremely low multiples, while other companies in our universe trade at 12-15x EV/EBITDA multiples. While corporate governance is improving in the developed countries, Japan is probably still the furthest behind. Some of the best opportunities today, though, are in companies that have a long way to go in improving corporate governance.

You mentioned your family used to be in the printing business. Tell us why you like printing giant R.R. Donnelley [RRD].

AR: Prior to actually owning it, I had long considered Donnelley to be an ideal LBO candidate. It was run out of large, pompously designed mahogany-paneled offices in Chicago and was just ripe for someone to come in and take out a ton of overhead. This is a very competitive, nickel-and-dime business and the last thing a printer should do is show its employees and customers that it’s making a lot of money.

In late 2003, R.R. Donnelley merged with Moore Wallace, a restructured business-forms and outsourcing company, and that’s when we first started buying the stock. Both companies had been top candidates for us and we saw a huge opportunity for new management to cut costs and find other operating synergies. The CEO of Moore Wallace, Mark Angelson, became CEO of the combined company.

While early estimates were for around $100 million in cost savings, they achieved $300 million in the first year and-a-half and now are closing in on annual savings of $500 million from the deal. The company now doesn’t really have a peer, given the breadth of services it offers. They are the 800-lb. gorilla in most of the areas they operate in.

Is being the 800-lb. gorilla in the printing business that attractive?

AR: The traditional printing business keeps plugging along. Donnelley currently prints about half of the best selling books, Yellow Pages directories and magazines produced in the U.S. While you might assume all of these are threatened by the Internet, print volumes have remained quite stable. Yellow Pages directories are still a venue for local advertisers that they can’t do without. While some magazines fold, others get launched.

Given the volume and quality requirements of big customers, printing is becoming a more concentrated business and being the biggest is a clear advantage. The catalog business continues to grow for them, for example, partly because it’s hard for some of the larger cataloguers to get their work done anywhere else. Small printers find it harder and harder to compete for national accounts. There are only three major printers that can do the big jobs – Quad/Graphics, which is privately held, and Quebecor, which has had a lot of problems, are the other two – but we believe Donnelley is much better managed and more competitive.

To give you an example of how scale matters: Donnelley claims that 20% of the volume going through the U.S. postal system is either printed or handled by them. In Chicago we visited a gigantic distribution facility, from which magazines and catalogs are sorted by zip code and then shipped closer to their ultimate destination before being entered into the mail stream. Donnelley can do that much more quickly and efficiently than if the items were dropped into the postal system near the printing plant.

That results in cost and time savings for customers that no one in the business has the scale to match, which is an excellent competitive advantage as well as barrier to entry. The growth area of the company is document business process outsourcing, which now accounts for 15% of revenues and operating profit. They do things like help American Express and Barclays with new-customer sign-ups, including managing call centers in India as well as the printing of forms and follow-up materials. They’ll print, assemble and send all the brochures, luggage tags and marketing materials for companies like Carnival Cruise Lines. They’ll produce customized customer statements for companies like Prudential, Charles Schwab, Fidelity and others. In general, this business is growing faster than printing, is less cyclical and has higher margins.

How cheap are the shares, trading at a recent $36.10?

AR: Earnings per share have doubled since 2003, to $2.55 last year. With cost savings on recent acquisitions, the ongoing rationalization of the manufacturing and distribution infrastructure, debt reduction and share buybacks, we think EPS could be as much as $3.40 in 2008. On an EV/EBITDA basis, the shares trade at only a 6x multiple and have a 2.7% dividend yield. For a company that has solid growth potential in a wide variety of leading businesses, sharp management, good cash flow and a strong balance sheet, we think an 8x multiple would be far more reasonable. By 2008, that would give you a potential share price of around $58.

What activist role have you played here?

AR: A year ago we proposed a $1 billion share buyback as part of our filing a 13D after our stake rose above 5%. The math was really quite compelling with the share price in the $30-35 range. Borrowing $1 billion to buy back shares would cost less than $40 million in interest after tax, but the company would save $35-38 million in dividends. So for a few million dollars, remaining shareholders would benefit when the share price reflected a 10% increase in earnings per share. The company approved a buyback plan, but didn’t implement it despite a continued weak share price.

Last August there were a variety of rumors that Donnelley was in talks to do a leveraged buyout. Our concern was that any deal would get done at a level that would relinquish a lot of the embedded upside in the company to the financial buyers, while public shareholders were sitting there with a mediocre return.

We went back with a public recommendation of a $3 billion buyback. I subsequently told the CEO I wasn’t obsessed with a share buyback and that I’d much rather he find accretive acquisition opportunities. But absent that, I wanted to make sure a share buyback was clearly considered as an alternative versus some sort of going-private transaction. Since then, the company has announced close to $2 billion in earnings-accretive acquisitions, giving it additional operating and financial leverage.

Do any market environments tend to give you trouble?

AR: I’d say that when investors focus particular attention on a given sector – like technology stocks in the late 1990s or energy and commodity stocks more recently – we’re unlikely to outperform. Multiples get compressed in our universe in those times, so it’s tough for us to beat an index increasingly weighted by the hot sector. We’ve held our own over the past three years, but it hasn’t been easy having no energy/commodity producers and quite a few energy/commodity consumers in our portfolio.

What’s your biggest single worry about the market today?

AR: In our view, the world economy looks pretty healthy. But I do believe there’s reason to worry about systemic risk that could be triggered rather easily by one type of geopolitical event or another. I think there is an unknown but possibly very large amount of leverage in the system. If there is a dislocation, we’d very much prefer to be invested as we are – without leverage, in profitable companies with strong balance sheets and attractive end markets.

Tobias Carlisle In The News – Canadian Acquirer’s Multiple – The Globe And Mail

Johnny HopkinsTobias Carlisle Comments

Following the recent micro-cap conference in Toronto our very own Tobias Carlisle was interviewed by Norman Rothery at The Globe and Mail regarding our Canada All TSX Stock Screener. The article is titled, How a money manager is producing phenomenal results using ‘the Acquirer’s Multiple’.

Here’s an excerpt from that article:

Tobias Carlisle recently spoke about value investing at a microcap conference in Toronto. Fans will know the money manager as the author of a series of books on the discipline. The accessible Deep Value: Why Activist Investors and Other Contrarians Battle for Control of Losing Corporations is suitable for a wide audience of interested investors and represents a personal favourite.

Mr. Carlisle loves to look for bargains using what he calls “the Acquirer’s Multiple.” You can think of the multiple as a more complicated variant of the familiar price-to-earnings ratio. But instead of price, he uses a firm’s enterprise value – in simple terms, the market value of its equity plus net debt – and instead of earnings, he uses operating income after depreciation. (The ratio is a close cousin of the enterprise-value to earnings-before-interest-and-taxes ratio.)

In preparation for his trip to Toronto, Mr. Carlisle looked at how an investor would have fared by buying the 30 stocks with the lowest Acquirer’s Multiples each year from the all-TSX universe, which contains the largest 95 per cent of stocks on the TSX by market capitalization (not including financials and utilities).

The results were pretty phenomenal. The portfolio of 30 low-multiple stocks sported a compound annual growth rate of 19.1 per cent from the start of 1999 through to June 16, 2017. By way of comparison the S&P/TSX composite total return index climbed by just 4.7 per cent annually over the same period.

You can see the stunning ascent of the Canadian Acquirer’s Multiple portfolio in the accompanying chart, which shows the growth, for every dollar invested, over the whole period.

But it wasn’t all roses. The method hit a few potholes along the way. As one might expect, the portfolio suffered its worst drawdown from July, 2007, to March, 2009, when it plummeted 63 per cent. The market index fared a little better over the same period but it still fell 50 per cent.

Selecting stocks with low Acquirer’s Multiples from within the largest 25 per cent of stocks on the TSX generated gains of 11.7 per cent annually from 1999 through to June 16, 2017. Picking low-multiple stocks from the largest half of stocks provided returns of 16.8 per cent annually. Low-multiple stocks in the smallest half of the market (currently those with market caps of less than about $300-million) provided returns of 23.8 per cent annually.

But, before you rush to invest all of your money in small low-multiple stocks, Mr Carlisle warns that the 23.8-per cent annual gains they generated on paper are probably not achievable in practice because of liquidity constraints and relatively wide bid-ask spreads in the small-cap space. Nonetheless, the value effect tends to be stronger when it comes to smaller stocks.

Mr. Carlisle was willing to reveal the names of three of his favourite small-cap companies from his Canadian Acquirer’s Multiple portfolio.

He likes Vancouver-based Alio Gold (ALO) which mines for the yellow metal in Mexico and was formerly known as Timmins Gold. The stock trades at about three times earnings and has a market capitalization near $230-million, after accounting for its recent capital raising efforts.

He is keen on Pacific Insight Electronics (PIH). The auto parts supplier based in Nelson, B.C., trades for less than 10 times earnings and has a market capitalization just shy of $70-million.

The smallest of his recommendations is Caldwell Partners International (CWL). The Toronto-based executive search firm provides a hefty dividend yield of almost 8 per cent. But it has a tiny market capitalization of $21-million and its stock trades near $1 a share.

Care should be taken when trading any small stock and, despite having good prospects, these three are no exceptions. If you’re looking to buy a broader basket of bargains, you should check out Mr. Carlisle’s approach and invest some time to read Deep Value.

Norman Rothery is the value investor for Globe Investor’s Strategy Lab.

Undervalued Hawaiian Holdings, ROE 32%, FCF/EV Yield 10% – All Investable Stock Screener

Johnny HopkinsStocks Comments

One of the cheapest stocks in our All Investable Stock Screener is Hawaiian Holdings Inc (NASDAQ:HA).

Hawaiian Holdings Inc. (Hawaiian) is a holding company. The company is engaged in the scheduled air transportation of passengers and cargo amongst the Hawaiian Islands (the Neighbor Island routes), between the Hawaiian Islands and certain cities in the United States (the North America routes), and between the Hawaiian Islands and the South Pacific, Australia, New Zealand and Asia (the International routes), collectively referred to as its Scheduled Operations. It offers non-stop service to Hawai’i from United States gateway cities.

A quick look at Hawaiian’s share price history over the past twelve months shows that the price is up 13%, but here’s why the company is currently undervalued and still has more room from growth.

The following data is from the company’s latest financial statements, dated March 2017.

The company’s latest balance sheet shows that Hawaiian has $740 Million in total cash consisting of cash and cash equivalents of $467 Million and $274 Million in short term investments. Further down the balance sheet we can see that the company has $58 Million in short-term capital leases and long-term debt and lease obligations of $477 Million. Therefore, Hawaiian has a net cash position of $206 Million (cash minus debt).

If we consider that Hawaiian currently has a market cap of $2.526 Billion, when we subtract the net cash totaling $206 Million that equates to an Enterprise Value of $2.320 Billion.

If we move over to the company’s latest income statements we can see that Hawaiian had $494 Million in trailing twelve month operating earnings which means that the company is currently trading on an Acquirer’s Multiple of 4.69, or 4.69 times operating earnings. That places Hawaiian squarely in undervalued territory.

The Acquirer’s Multiple is defined as:

Enterprise Value/Operating Earnings*

*We make adjustments to operating earnings by constructing an operating earnings figure from the top of the income statement down, where EBIT and EBITDA are constructed from the bottom up. Calculating operating earnings from the top down standardizes the metric, making a comparison across companies, industries and sectors possible, and, by excluding special items–income that a company does not expect to recur in future years–ensures that these earnings are related only to operations.

In addition to Hawaiian’s strong balance sheet it’s also important to note that if we take a look at the company’s latest cash flow statements we can see that Hawaiian generated trailing twelve month operating cash flow of $428 Million and had $202 Million in Capex. That equates to $226 Million in trailing twelve month free cash flow, or a FCF/EV Yield of 10%. Further highlighting that Hawaiian remains currently undervalued.

In terms of its financial strength, the company currently holds approximately 30% of its current market cap in cash. Other financial strength indicators show that Hawaiian remains financially sound with a Piotroski F-Score of 7, an Altman Z-Score of 2.37, and a Beneish M-Score of -2.47.

Regarding its growth prospects, Hawaiian’s current revenue of $2.514 Billion (ttm) is an historical high and its net income of $221 Million (ttm) is just 6% off the 2016 historical high of $235 Million (ttm). To illustrate the company’s recent growth it’s important to remember that Hawaiian had just double digit net profits of $53 Million, $52 Million, and $69 Million in 2012, 2013, and 2014.

What also seems to get overlooked is Hawaiian’s annualized return on equity (ROE) for the most recent quarter. The company had $680 Million in equity for the quarter ending December 2016 and $706 Million for the quarter ending March 2017. If we add those two numbers together ($1.386 Billion) and divide by two we get $693 Million. If we consider that Hawaiian has $221 Million in net income (ttm) that equates to an annualized return on equity (ROE) for the most recent quarter of 32% while at the same time it reduced its long-term debt and capital lease obligations by $20 Million and did not issue any new shares.

Moreover, since 2012 Hawaiian has grown its net income from $53 Million to $221 Million (ttm). At the same time the company has quadrupled its EPS from $1.01 to $4.09 (ttm) and its book value per share from $5.22 to $13.16 (ttm) while improving its gross and operating margins from 48% and 7% respectively to 65% and 15% respectively for the trailing twelve months.

As for Hawaiian’s current valuation, the company is currently trading on a P/E of 11.5 compared to its 5Y average of 15.4*, a P/S of 1, a FCF/EV Yield of 10%, and an Acquirer’s Multiple of 4.69, or 4.69 times operating earnings. All of which indicates that Hawaiian sits squarely in undervalued territory.

*Source: Morningstar

About The All Investable U.S. Stock Screener (CAGR 25.9%)

Over a full sixteen-and-one-half year period from January 2, 1999 to July 26, 2016., the All Investable U.S. stock screener generated a total return of 5,705 percent, or a compound growth rate (CAGR) of 25.9 percent per year. This compared favorably with the Russell 3000 TR, which returned a cumulative total of 265 percent, or 5.7 percent compound.

Walter Schloss Would Roll In His Grave If He Could Read This Latest Research From Stanford

Johnny HopkinsWalter J. Schloss Comments

Walter Schloss is on Warren Buffett’s list of Super-investors. He’s a man who rarely spoke to management and analysts. So, I’m fairly certain he would roll in his grave he if could read this latest research from Stanford University regarding analyst coverage and how it’s a good prediction of how well a company will perform. Their research shows:

Companies with abnormally big analyst followings at any given moment almost consistently outperformed companies with unusually small followings. It wasn’t simply that the increased buzz drove up their stock prices. The companies with unusually heavy coverage actually reported better operating results as well.

Here’s an excerpt from that research:

It’s an old chestnut: Watch what they do, not what they say.

Now a startling new study from Stanford finds that the adage may well provide valuable clues to what stock analysts really think about the companies they recommend. And those clues can lead to higher returns.

Stock analysts have a well-deserved reputation for erring on the side of bubbly optimism. They issue far more “buy” recommendations than “holds” or “sells.” They can also be trend-chasers, talking up companies that already generate a lot of buzz because of their size, glamour, or recent earnings “momentum.”

But analysts aren’t simply lemmings, says Charles M.C. Lee, professor of finance at Stanford Graduate School of Business.

Leaving aside what the analysts actually say, it turns out that unusually high or low amounts of analyst coverage of a company are surprisingly good predictors of how a company will perform in the months that follow.

That finding is the result of a new study by Lee and Eric C. So, a former Stanford graduate student who now teaches at the Massachusetts Institute of Technology. The study looked at the interplay between analyst coverage and company performance over a 33-year period from 1982 through 2014.

The results were striking.

Companies with abnormally big analyst followings at any given moment almost consistently outperformed companies with unusually small followings. It wasn’t simply that the increased buzz drove up their stock prices. The companies with unusually heavy coverage actually reported better operating results as well.

Specifically, the researchers report, companies in the top 10% for “abnormally” (see below for the definition of abnormal) high analyst coverage generated returns that were on average .08% higher per month — about 10% a year — than firms in the bottom decile for abnormal coverage. That’s a significant edge.


Analyzing the “Abnormal”

What does “abnormal’’ analyst coverage mean?

“If you look at the raw number of analysts who cover a company, you won’t find any pattern at all,” professor Charles Lee says. That’s because certain companies inevitably attract more analysts, typically because those companies are big, generate heavy trading volumes, or have earnings “momentum.”

These are what Lee calls the “mechanical” factors that account for normal or expected amounts of coverage. The researchers calculated the normal amount of coverage for a company based on what’s typical for companies of comparable size, trading volume, and momentum.

An abnormal amount of analyst attention is the amount that is significantly above or below what’s normal. Most often, abnormally high coverage is a predictor of good returns. But the coverage can also be abnormally low, a sign that the company is heading into trouble and may be ripe for selling short.

Overall, the researchers found, an unusually high level of analyst coverage at any particular moment is a good predictor of improved operating results in the two or three months that follow.


Drilling deeper into companies’ operating performance, Lee and So found that companies with unusually high analyst coverage were also more likely to report subsequent improvements in net income, gross margins, cash positions, and the overall strength of their balance sheets.

When the researchers tested a hypothetical value-weighted investment portfolio based on analyst coverage, that portfolio generated better returns than a random mix of stocks in 24 out of the 33 years.

Why should the number of analysts affect future returns?

Lee argues that, collectively, analysts make an important cost-benefit decision when they decide to cover or not cover a company. The decision is how to allocate their time and attention, and their economic incentive is to focus on the companies that offer the most upside potential. The “normal’’ companies are often mandatory and predictable: the big players and the up-and-comers in a particular industry. On top of those, however, are the “abnormal” ones that may have hidden strengths or represent unusual bargains.

Lee and So theorized that unusually intense analyst coverage — regardless of what the analysts were saying — was an important signal about where they wanted to place their own bets.

“We decided to look at what analysts do, not what they say,” Lee explains. “We don’t know what they do with their private wealth, but we can see what they’re doing with their own human capital. Their attention is a scarce commodity, which they have to allocate judiciously. So what they pay attention to is a clue to what they actually believe.”

Lee and So also found that analysts flock to companies that seem to be underpriced because of temporary dislocations in the market.

When investors pull large sums of money out of a major mutual fund, for example, that fund will often be forced to sell large volumes of shares at whatever prices it can get. This “flow-induced trading” temporarily depresses a stock’s price, but it also represents a buying opportunity because the stocks should quickly rebound to reflect underlying values.

Sure enough, Lee and So found that analysts apparently recognized the bargain and flocked to stocks affected by forced selling from mutual funds.

“We actually spent a fair bit of the paper asking whether analysts knew some good fundamental news that the market hadn’t figured out, or whether the fundamentals were fine but the price had gone the wrong way,” Lee says. “It turns out to be both.”

You can read the original here.

Undervalued Micro-Cap Natural Alternatives, FCF/EV Yield 15%, Zero Debt – Small & Micro Cap Stock Screener

Johnny HopkinsStocks Comments

One of the cheapest stocks in our Small & Micro Cap Stock Screener is Natural Alternatives International Inc (NASDAQ:NAII).

Natural Alternatives International Inc (NAII). is a formulator, manufacturer and marketer of nutritional supplements. The company operates through three segments: private-label contract manufacturing, patent and trademark licensing, and branded products.

A quick look at NAII’s share price history over the past twelve months shows that the price is down 7%, but here’s why the company is currently undervalued.

The following data is from the company’s latest financial statements, dated March 2017.

As usual I like to start with the balance sheet. The latest balance sheet shows that NAII has $23 Million in cash and cash equivalents. Further down the balance sheet we can see that the company has zero debt. Therefore, NAII has a net cash and cash equivalents position of $23 Million (cash minus debt).

If we consider that NAII currently has a market cap of $70 Million, when we subtract the net cash and cash equivalents totaling $23 Million we get an Enterprise Value of $47 Million.

If we move over to the company’s latest income statements we can see that NAII had $12 Million in trailing twelve month operating earnings which means that the company is currently trading on an Acquirer’s Multiple of 3.88, or 3.88 times operating earnings. That places NAII squarely in undervalued territory.

The Acquirer’s Multiple is defined as:

Enterprise Value/Operating Earnings*

*We make adjustments to operating earnings by constructing an operating earnings figure from the top of the income statement down, where EBIT and EBITDA are constructed from the bottom up. Calculating operating earnings from the top down standardizes the metric, making a comparison across companies, industries and sectors possible, and, by excluding special items–income that a company does not expect to recur in future years–ensures that these earnings are related only to operations.

In addition to NAII’s very strong balance sheet it’s also important to note that if we take a look at the company’s latest cash flow statements we can see that NAII generated trailing twelve month operating cash flow of $15 Million and had $8 Million (ttm) in Capex. That equates to $7 Million in trailing twelve month free cash flow, or a FCF/EV Yield of 15%. Further highlighting that NAII remains undervalued.

NAII has maintained solid growth over the past five years.  NAII’s trailing twelve month revenues of $125 Million are at historical highs. The company has also significantly improved its net profits in the past five years from $4 Million in 2012 to $9 Million (ttm) while maintaining gross margins around 22% and operating margins around 10%. Since 2012 NAII has also improved its EPS from $0.59 cents to $1.38 (ttm) and its book value per share from $5.66 to $8.63 (ttm).

In terms of its financial strength, the company has a very strong balance sheet with zero debt and ability to generate loads of free cash flow. NAII holds 33% of its current market cap in cash. Other financial strength indicators show that NAII has a Piotroski F-Score of 8, an Altman Z-Score of 8.17, and a Beneish M-Score of -2.87, so the company is financially sound.

With regards its current valuation, NAII is currently trading on a P/E of 7.4 compared to its 5Y average of 16.4*, a P/B of 1.2, a P/S of 0.5, a FCF/EV Yield of 15%, and an Acquirer’s Multiple of 3.88, or 3.88 times operating earnings, all of which indicates that NAII sits squarely in undervalued territory.

*Source: Morningstar

Jozef Bystricky over at Seeking Alpha also wrote a great piece on NAII in March this year called A Micro Stock With Significant Upside Potential in which he said:

The shift in strategy has resulted in higher revenue

Company management has made a couple of changes in its business strategy recently, as a result of which sales have increased significantly. For instance, the company decided to stop selling branded products, sell licensing and patents on its own rather than through distributors and increase its customer base. These initiatives have borne fruit, and NAII’s revenue skyrocketed. Sales in the licensing segment have doubled since 2015 and increased further by 30% in 1H 2017. In the private-label segment, the management focus was on increasing the customer base, and this has also worked handsomely recently, as sales increased more than 30% last year.

The company has also reported sales for 1H 2017 (six months ended in December), and again reported double-digit growth in each of its reporting segments.

About The Small & Micro Cap U.S. Stock Screener (CAGR 22%)

Over a full sixteen-and-a-half year period from January 2, 1999 to July 26, 2016., the Small & Micro Cap U.S stock screener generated a total return of 3,284 percent, or a compound growth rate (CAGR) of 22.0 percent per year. This compared favorably with the Russell 3000 TR, which returned a cumulative total of 265 percent, or 5.7 percent compound.

Howard Marks – The Poor Man’s Guide To Market Assessment

Johnny HopkinsHoward Marks Comments

One of my favorite investing books is The Most Important Thing: Uncommon Sense for the Thoughtful Investor, by Howard Marks. The book includes passages from Marks’ memos to illustrate his investment philosophy. In Chapter 15 Marks provides a very simple example of how to identify the current state of any market using what he calls his  – Poor Man’s Guide To Market Assessment. Here’s an excerpt from that book:

THE POOR MAN’S GUIDE TO MARKET ASSESSMENT

Here’s a simple exercise that might help you take the temperature of future markets. I have listed a number of market characteristics. For each pair, check off the one you think is most descriptive of today. And if you find that most of your checkmarks are in the left – hand column, as I do, hold on to your wallet.

Undervalued Argan Inc, FCF/EV Yield 66%, ROE 26%, Zero Debt- All Investable Stock Screener

Johnny HopkinsStocks Comments

One of the cheapest stocks in our All Investable Stock Screener is Argan Inc (NYSE:AGX).

Argan, Inc. (Argan) is a holding company. The company conducts operations through its subsidiaries, Gemma Power Systems, LLC and affiliates (GPS), Atlantic Projects Company Limited (APC), Southern Maryland Cable, Inc. (SMC) and The Roberts Company (Roberts or TRC). The company’s segments include power industry services, industrial fabrication and field services, and telecommunications infrastructure services.

A quick look at Argan’s share price history over the past twelve months shows that the price is up 47%, but here’s why the company remains undervalued.

The following data is from the company’s latest financial statements, dated March 2017.

As always I like to start with the balance sheet. The latest balance sheet shows that Argan has $167 Million in cash and cash equivalents and $396 Million in short term investments which equates to $563 Million in cash and cash equivalents. Further down the balance sheet we can see that the company has zero debt. Therefore Argan has a net cash and cash equivalents position of $563 Million (cash minus debt).

Argan currently has a market cap of $943 Million, so if we subtract the net cash and cash equivalents totaling $563 Million we get an Enterprise Value of $380 Million.

While we’re still on the balance sheet, for the most recent quarter ending March 2017 Argan had net income of $79 Million (ttm). At the same time the company had total equity of $314 Million (ttm) compared to $292 Million for the previous quarter ending January 2017. That equates to an annualized return on equity (ROE) for the quarter ending March 2017 of 26%.

If we move over to the company’s latest income statements we can see that Argan had $124 Million in operating earnings over the trailing twelve months which means that the company is currently trading on an Acquirer’s Multiple of 3.06, or 3.06 times operating earnings. That places Argan squarely in undervalued territory.

The Acquirer’s Multiple is defined as:

Enterprise Value/Operating Earnings*

*We make adjustments to operating earnings by constructing an operating earnings figure from the top of the income statement down, where EBIT and EBITDA are constructed from the bottom up. Calculating operating earnings from the top down standardizes the metric, making a comparison across companies, industries and sectors possible, and, by excluding special items–income that a company does not expect to recur in future years–ensures that these earnings are related only to operations.

In addition to Argan’s very strong balance sheet it’s also important to note that if we take a look at the company’s latest cash flow statements we can see that Argan generated trailing twelve month operating cash flow of $256 Million and had just $4 Million (ttm) in Capex. That equates to $252 Million in trailing twelve month free cash flow, or a FCF/EV Yield of 66%. Further highlighting that Argan remains undervalued.

To provide some context on Argan’s current financial position here’s some historical comparisons.

  • Argan’s trailing twelve month revenue of $775 Million is the highest in the company’s history
  • Argan’s trailing twelve month net income of $79 Million is also the highest in the company’s history
  • Argan’s trailing twelve month EPS of $5 has grown 646% since 2012
  • Argan’s trailing twelve month Book Value per share of $20.25 has grown 173% since 2012
  • Argan’s trailing twelve month free cash flow of $252 Million has grown 227% since 2012

Argan is a on a solid growth path. The company has a very strong balance sheet with zero debt and ability to generate loads of free cash flow. Based on its latest trailing twelve revenues of $775 Million, Argan converts $0.32 cents of every dollar into free cash flow. The company remains financially strong, as of today Argan has a Piotroski F-Score of 6, an Altman Z-Score of 3.89, and a Beneish M-Score of -3.50.

In terms of Argan’s valuation. The company is currently trading on a P/E of 12.1, a P/S of 1.2, a FCF/EV Yield of 66%, an ROE of 26%, and an Acquirer’s Multiple of 3.06, or 3.06 times operating earnings, all of which places Argan squarely in undervalued territory. The company also provides a nice little dividend yield of 2%.

Disclosure: I am long Argan Inc.

About The All Investable U.S. Stock Screener (CAGR 25.9%)

Over a full sixteen-and-one-half year period from January 2, 1999 to July 26, 2016., the All Investable U.S. stock screener generated a total return of 5,705 percent, or a compound growth rate (CAGR) of 25.9 percent per year. This compared favorably with the Russell 3000 TR, which returned a cumulative total of 265 percent, or 5.7 percent compound.

Seth Klarman – Herd Mentality Creates Buying Opportunities For Contrarians – Margin of Safety

Johnny HopkinsSeth Klarman Comments

One of the investors we follow closely at The Acquirer’s Multiple is Seth Klarman. In his best selling book, Margin of Safety, Klarman provides some great insights into how herd mentality towards popular stocks creates buying opportunities for contrarian value investors. Here’s an excerpt from that book:

Value investing by its very nature is contrarian. Out-of-favor securities may be undervalued; popular securities almost never are. What the herd is buying is, by definition, in favor. Securities in favor have already been bid up in price on the basis of optimistic expectations and are unlikely to represent good value that has been overlooked.

If value is not likely to exist in what the herd is buying, where may it exist? In what they are selling, unaware of, or ignoring. When the herd is selling a security, the market price may fall well beyond reason. Ignored, obscure, or newly created securities may similarly be or become undervalued. Investors may find it difficult to act as contrarians for they can never be certain whether or when they will be proven correct.

Since they are acting against the crowd, contrarians are almost always initially wrong and likely for a time to suffer paper losses. By contrast, members of the herd are nearly always right for a period. Not only are contrarians initially wrong, they may be wrong more often and for longer periods than others because market trends can continue long past any limits warranted by underlying value.

Holding a contrary opinion is not always useful to investors, however. When widely held opinions have no influence on the issue at hand, nothing is gained by swimming against the tide. It is always the consensus that the sun will rise tomorrow, but this view does not influence the outcome. By contrast, when majority opinion does affect the outcome or the odds, contrary opinion can be put to use. When the herd rushes into home health-care stocks, bidding up prices and thereby lowering available returns, the majority has altered the risk/reward ratio, allowing contrarians to bet against the crowd with the odds skewed in their favor.

When investors in 1983 either ignored or panned the stock of Nabisco, causing it to trade at a discount to other food companies, the risk/reward ratio became more favorable, creating a buying opportunity for contrarians.

This Week’s Best Investing Reads – Curated Links

Johnny HopkinsValue Investing News Comments

Here’s a list of this week’s best investing reads:

Blogs

Charlie Munger’s “The Psychology of Human Misjudgement” – Animated Version (Hurricane Capital)

Eugene Fama: Stick with Basic Factors (CFA Institute Enterprising Investor)

Finding Good Capital Allocators; The Problems with Using Sentiment (csinvesting)

The Best Way To Add Yield To Your Portfolio (Meb Faber Research)

Lessons Learned After Almost a Year (The Investor’s Field Guide)

Wise Words from Seth Klarman and Howard Marks (Old School Value)

Tom McClellan On Engineering Effective Stock Market Models (Jesse Felder Report)

6 Life Lessons from Warren Buffett, the World’s 3rd Richest Person (Vintage Value Investing)

Is the Bull Market Over? (The Wall Street Transcript)

What is a Stock Market Index? (Visual Capitalist)

Ray Dalio’s thoughts in 2017 (We Study Billionaires)

Patience Exemplified (A Wealth of Common Sense)

Value Investor Interview: Brent Beshore (Safal Niveshak)

Investing Successfully is Really Hard (Above The Market)

A few highlights from The Evidence-Based Investing Conference (West) (Alpha Architect)

A Puzzle For The Risk Manager (Bronte Capital)

What I Believe Most (Collaborative Fund)

Heartland Advisors Says Index Investors Are Open To Painful Losses When The Inevitable Correction Occurs

Johnny HopkinsValue Investing News Comments

One of the value investing firms we like to watch closely here at The Acquirer’s Multiple is Heartland Advisors run by Founder and CIO Bill Nasgovitz. In its most recent market commentary Heartland says, current market levels point to rampant group think where a single popular view spreads and no one stops to ask the hard questions. Here’s an excerpt from that commentary:

The lazy days of summer are just beginning, but for the markets, they’ve been going on for several years. Signs of indifference are widespread. For example, instead of rolling up their sleeves and doing the hard work of fundamental analysis, many investors have taken the path of least resistance and simply poured money into passive index funds and exchange traded funds (ETF). While these products may serve a role in an asset allocation strategy, we’d suggest current valuations leave them open to painful losses if, and when, an inevitable correction occurs.

Current low volatility for stocks, in our view, is another symptom of the lackadaisical route many are following. As shown below, the Chicago Board Options Exchange Volatility Index (VIX) has been shuffling along near historic lows for months. Levels like this often point to rampant group think where a single popular view spreads and no one stops to ask the hard questions—what happens when interest rates go up? Can big tech really grow fast enough to support current lofty valuations?

Too Quiet?

Heartland Advisors Value Investing VIX Index Chart

Source: Bloomberg L.P. and Heartland Advisors, Inc., 6/1/2012 to 6/30/2017
Chicago Board Options Exchange Market Volatility Index (VIX Index)
Past performance does not guarantee future results.


In the first half of 2017, the VIX dipped below 10 on seven occasions—as many occurrences as the previous 22 years combined!


Many management teams, recognizing an effortless way to boost earnings, have taken to borrowing on the cheap to fund stock buybacks. With fewer shares outstanding, earnings can go up without any actual improvement in margins and sales.  Thanks to an all-too-willing Federal Reserve Board that has flooded the economy with easy money, the low effort approach has been working—at least for now.

So what could bring an end to this current cycle? Here are a few things we are watching:

  • Anemic gross domestic product growth points to earnings pressure going forward.
  • Consumer debt levels that are at pre-financial crisis highs.
  • A softer dollar that could trigger higher inflation and raise costs for businesses.
  • The impact of elevated short-term interest rates, which could take a toll on highly leveraged companies.

These items could be a headwind for many companies but expensive growth names may be the ones with the most to lose. Based on current multiples, the market is pricing in growth for these businesses that outpaces even some of the most optimistic scenarios from analysts. That means the slightest earnings misstep could be magnified and result in significant pressure.

The future, in our view, is much brighter for reasonably valued companies. As growth/momentum begins to wilt under the weight of ever increasing expectations, value should once again attract investor attention. Additionally, many sensibly priced businesses are just beginning to see their earnings inflect and, therefore, will be building off a more manageable comparison base as opposed to trying to meet unrealistic projections. Put simply, we’d rather invest in businesses that have ample room to improve than those that have no room for error.

Here are a few more reasons for optimism:

  • Housing is robust.
  • Consumer confidence remains strong and small businesses are upbeat.
  • Merger and acquisition activity appears to be heating up among smaller companies.

The mixture of good and bad, points to the need for doing the hard work of evaluating opportunities. We agree with Coach Lombardi’s words and would add that in investing, not only does work come before success but a lack of it often leads to losses.

We thank you for your continued trust and confidence.

You can read the full commentary here.

Carl Icahn – How Did Icahn And Kingsley See Investment Opportunities When Others Couldn’t

Johnny HopkinsCarl Icahn Comments

One of the investors we follow closely here at The Acquirer’s Multiple is Carl Icahn, and one of the best pieces ever written on Icahn’s investing strategy comes from Tobias Carlisle’s book, Deep Value: Why Activist Investors and Other Contrarians Battle for Control of Losing Corporations. Carlisle illustrates how Icahn and Alfred Kingsley put together their audacious activist investing strategy. Here’s as excerpt from that book:

Over the fall of 1975, Carl Icahn and his right-hand man, Alfred Kingsley, hashed out a new investment strategy in the cramped offices of Icahn & Company. Located at 25 Broadway, a few steps away from the future site of the Charging Bull, the iconic 7,000-pound bronze sculpture erected by Arturo Di Modica following the 1987 stock market crash, Icahn & Company was then a small, but successful, discount option brokerage with a specialty in arbitrage.

Already moribund after a decade of stagflation, an oil crisis, and a failing U.S. economy, Wall Street was sent reeling from the knockout punch delivered by the 1974 stock market crash, the worst since the Great Depression. Out of the bear market punctuating the end of the Go-Go 1960s, the stock market had rallied to a new all-time high in early 1973.

From there it was brutally smashed down to a trough in October 1974 that was some 45 percent below the January 1973 peak. (The market would repeat this wrenching up and down cycle until November 1982, at which point it traded where it had in 1966, fully 16 years before.) Stocks that had become cheap in 1973 had proceeded to fall to dust in 1974. Bonds, ravaged by runaway inflation, were described by wags as “certificates of confiscation.” Investors were still shell shocked in 1975. Even if they could be persuaded that they were getting a bargain, most seemed unwilling to re-enter the market, believing that undervalued stocks could start dropping again at any moment. If they would take a call from their broker, they simply wanted “the hell out of the market.”

Although few could sense it, a quiet revolution was about to get under way. Icahn and Kingsley had seen what many others had missed—a decade of turmoil on the stock market had created a rare opportunity. After trading sideways for nine years, rampant inflation had yielded a swathe of undervalued stocks with assets carried on the books at a huge discount to their true worth. Recent experience had taught most investors that even deeply discounted stocks could continue falling with the market, but Icahn and Kingsley were uniquely positioned to see that they didn’t need to rely on the whim of the market to close the gap between price and intrinsic value.

Kingsley later recalled: We asked ourselves, “If we can be activists in an undervalued closed-end mutual fund, why can’t we be activists in a corporation with undervalued assets?”

As they had with the closed-end mutual funds, Icahn and Kingsley would seek to control the destiny of public companies. Their impact on America’s corporations would be profound.

ICAHN’S WALL STREET REFORMATION

Icahn’s progression from arbitrageur and liquidator of closed-end funds to full-blown corporate raider started in 1976 with a distillation of the strategy into an investment memorandum distributed to prospective investors:

It is our opinion that the elements in today’s economic environment have combined in a unique way to create large profit-making opportunities with relatively little risk. [T]he real or liquidating value of many American companies has increased markedly in the last few years; however, interestingly, this has not at all been reflected in the market value of their common stocks. Thus, we are faced with a unique set of circumstances that, if dealt with correctly can lead to large profits, as follows:

[T]he management of these asset-rich target companies generally own very little stock themselves and, therefore, usually have no interest in being acquired. They jealously guard their prerogatives by building ‘Chinese walls’ around their enterprises that hopefully will repel the invasion of domestic and foreign dollars. Although these ‘walls’ are penetrable, most domestic companies and almost all foreign companies are loath to launch an ‘unfriendly’ takeover attempt against a target company.

However, whenever a fight for control is initiated, it generally leads to windfall profits for shareholders. Often the target company, if seriously threatened, will seek another, more friendly enterprise, generally known as a ‘white knight’ to make a higher bid, thereby starting a bidding war. Another gambit occasionally used by the target company is to attempt to purchase the acquirers’ stock or, if all else fails, the target may offer to liquidate.

It is our contention that sizeable profits can be earned by taking large positions in ‘undervalued’ stocks and then attempting to control the destinies of the companies in question by:

a) trying to convince management to liquidate or sell the company to a ‘white knight’;

b) waging a proxy contest;

c) making a tender offer and/or;

d) selling back our position to the company.

The “Icahn Manifesto”—as Icahn’s biographer Mark Stevens coined it—was Icahn’s solution to the old corporate principal-agency dilemma identified by Adolf Berle and Gardiner Means in their seminal 1932 work, The Modern Corporation and Private Property.

The principal-agency problem speaks to the difficulty of one party (the principal) to motivate another (the agent) to put the interests of the principal ahead of the agent’s own interests. Berle and Means argued that the modern corporation shielded the agents (the boards of directors) from oversight by the principals (the shareholders) with the result that the directors tended to run the companies for their own ends, riding roughshod over the shareholders who were too small, dispersed, and ill-informed to fight back. According to Berle and Means:

It is traditional that a corporation should be run for the benefit of its owners, the stockholders, and that to them should go any profits which are distributed. We now know, however, that a controlling group may hold the power to divert profits into their own pockets.

There is no longer any certainty that a corporation will in fact be run primarily in the interests of the stockholders. The extensive separation of ownership and control, and the strengthening of the powers of control, raise a new situation calling for a decision whether social and legal pressure should be applied in an effort to insure corporate operation primarily in the interests of the owners or whether such pressure shall be applied in the interests of some other or wider group.