This is a very rough draft of my 2Q/1H09 letter:
“Dasan” portfolio.
We had a good first half. It wasn’t easy, though. Just as we find that sometimes our biggest gains come from the stocks we least expect to drive performance; some months surprise us with their gains. This was one of those time periods.
Performance numbers:
| | 2009 | | | | | |
| | Jan | Feb | Mar | Apr | May | Jun |
| | | | | | | |
| Dasan% | -4.7% | -7.2% | 12.6% | 24.3% | 9.0% | -1.3% |
| SPX % | -4.1% | -15.2% | 8.5% | 9.4% | 5.3% | -0.5% |
| | | | | | | |
| DasanYTD% | -4.7% | -11.6% | -0.4% | 23.7% | 34.9% | 33.1% |
| SPX YTD% | -4.1% | -18.6% | -11.7% | -3.4% | 1.8% | 1.3% |
| | | | | | | |
I do not expect to do this well in the second half of the year. In fact I will probably give back some of the gains. Why not go to cash and wait out the rest of the year? Because that would be a sure way to miss out on potential gains. The stock market doesn’t care about annual returns or high water marks. It does not follow a set season, like the tides. So like a fisherman, when the fish are biting, we will stay out in our boat, even if it gets dark.
This was one of the hardest investment periods I have seen in my 15 years of professional investing. January and February were debilitating, awful battles against legions of doomsayers and panic. If you look carefully at Smith Barney’s excellent report on mutual fund flows, you will see that record amounts of investors cashed out of funds in January and February, which pushed the market to unnatural lows.
Contrarian thinking doesn’t make money. Independent thinking does. Even Apple, with $28 cash per share, was pushed down to $85 per share, which valued the company at about 8.7 times earnings when you adjust for subscription-based accounting of iPhone sales. 8.7 times earnings for a company that will still grow 6% in the worst recession in our lifetimes. The orcs were definitely winning the battle for Rohan!
The gaming sector also got crushed, as all the market observers declared the major casinos all likely to go bankrupt, even though the operators had yet to pull the many levers available to them. Due to good work, done months in advance on Las Vegas Sands, we were able to buy shares for the ridiculous price of $2.25 in March. Our analysis indicated that the company was worth $10 if it could navigate it’s covenants successfully. It had many ways to do that – it could sell property, it could do a stock offering (which even if dilutive would have made the stock double) or negotiate covenants. When it went up to $10 we sold 2/3 of our position. We still think LVS is worth $20 in two years if they get the
The major contributor to performance this year was staying in “Triple A Tech” through this storm. By Triple A Tech I mean AAPL, ADBE, AMZN. Three companies with rock-solid defenses and enormous moats. I was told by many that “shorting AMZN is a no-brainer – the consumer is dead.” My thought was the world’s most efficient e-tailer becomes even more valuable as high costs and collapsing sales put their competition out of business. Now that brick and mortar companies are cutting back lines of business and product selection, we can see the value that “long-tail” retailing will have.
Now that the Nasdaq is up 16% for the year after being down low double digits during the panic, here is how much Triple A Technology has gone up year-to-date:
Apple +66%, Adobe +32% and Amazon +62%.
Independent thinking wins out again. Not contrarian thinking – simply buying the stock that was down the most in the Dow didn’t work – nor did avoiding AMZN because it had a high multiple. (General Motors would have been the contrarian play – and it effectively went to zero)
Mistakes I made and what we can learn from them.
ANF- made 17% but should have stayed with ARO which went up 90% during the same period. I was too early on the high-end side, but still think it will be the best trade.
Good: sold NTDOY after a nice long run- at the peak I had tripled the money, but sold at about 2.5x, so I could have made more on this one. Metrics on consoles sales and video games have weakened drastically. Video games are recession resistant, but I believe they are finally being affected by the recession. The current generation of consoles is looking dated and the only way for them to grow now is with add-on products like Wii fit, which has not had that much success in the
General motors “preferred”: paid 4.988 per share, with 10% chance of getting $25. Didn’t get it. I thought downside was about $2.50 with securities worth about $5.00 in chapter 11. The mistake was not selling when it jumped to about $8 right after I bought it. In Chap 11 now, trading hands off-market at about $2.80 now, will probably get about $5.00 when it’s done. This is why I don’t really like these types of speculations.
Macro situation.
Right now our assessment of the macro situation is the market is entering a new bull market phase or at least in a fairly durable bear market rally. The economy will form a “V” recovery and improve. We are seeing signs of that. However, I’m still afraid of the administration’s power grab and so I’m staying with bigger, better capitalized companies. I want companies that don’t need government money and aren’t on the government’s “bad list.” That describes tech stocks perfectly. I also think things are still shaky so to use a golf analogy I’m using a 5 wood, not a 1-iron. I want to have a little more margin for error than usual. I also think missing this rally was and will be devastating for investors because by the time everything looks great, the stocks will have much of that priced in already. But of course, I could be wrong.
Criteria for investing.
We are biased toward holding on to things instead of selling, or trying to outguess everyone that’s trying to outguess each other. We may have just seen a “generational low” on the stock market. Since we still like what we own, we think we’ll hold our winners for a while.
After 20 years on Wall Street, the most common two mistakes I’ve seen are #1: selling too soon – “booking a profit” and #2: buying what everyone else is buying. Much of the regret I have is investments I didn’t make big enough that I knew were right, or selling stocks too early that kept on going. Seth Klarman says the opposite – he says he sells early but is fine with it. I admire his mental strength, because I round trip stocks more often than I sell early.
On holding stocks, I find it’s so hard to get the story right on a stock that everyone else on the street is missing and it’s fairly rare to find a big mispricing that when I’m aboard a good position I don’t want to pitch it too soon. It’s like getting a pair of dress shoes that fit and are comfortable – I’ll re-sole them 10 times before buying a new one. New shoes always look and feel good in the store, but after a month don’t usually measure up to the old ones.
We buy companies that are either out of favor, or have a great business with competitive advantage. We don’t usually buy financials as they lie like hell in their accounting. We like companies that have 10ks that we can read.
We do have a couple of companies that if people knew we owned them, they’d be quick to point out how stupid we are. Here’s an example: ANF: Abercrombie and Fitch. The street hates this company because sales are plummeting of their expensive clothing. The company says they will not dilute the brand by mass discounting, and will cut OPEX instead. I believe their goods are aspirational and as soon as the economy gets better, sales will boom and the multiple will go from the 14x it is today to 20x+. Their international store openings are the key to this “out of favor growth story.”
Competitive advantage.
In tech, it’s tough for competitive advantage to last, so the best companies morph and adapt. For example, Apple has morphed from PC maker to Smartphone maker. My simple thesis: the iPhone is a platform, not a hardware product, and vastly more profitable than GAAP accounting profits indicate because they are using subscription accounting. On actual earnings power and free cash flow basis the company is cheap versus its growth rate. With a minuscule 1% share or less of the worldwide handset market, they have a lot of room to grow. Contrast AAPL to INTC, MSFT, or CSCO, three big techs that are more like General Motors than tech companies. These companies have spent more money acquiring other companies and on marketing than they have on innovation.
Commodity businesses.
Some people are clever enough to make money investing in commodity businesses, picking the right spot in the cycles. I don’t like investing in businesses that are commodity-like in nature. SNDK and WDC may be exceptions to this rule now. The reason I’m involved with SNDK is I think NAND, especially 3D and MLC technology is not commoditized yet – as evidenced by the Samsung-SNDK licensing deal. Clearly, Samsung was not able to make the newest NAND chips with their own IP. Sandisk is coming out with newer and faster flash products on a weekly basis. Also, we think the street is missing the massive amounts of NAND demand due to smartphones and MP3 players. In the case of WDC, we are playing the cycle a bit. Our WDC investment is more of a “record low inventory” play. Coupled with record-low valuations and only 3 rational players left, I’m allowing myself to buy WDC. The key thing to watch in these situations are if competition becomes dysfunctional – the early tell is price cutting.
Buyout targets.
I love buying companies that are buyout targets. I’ve had a lot of luck with my companies getting bought out over the years. In fact, I bet about 1 in 20 of my positions get bought out. I made a ton on the Harrahs buyout. Sometimes I don’t even need to get bought out to make money, because the stock goes up in advance. I’m involved with YHOO, CTXS, and RVBD now as potential buyouts. However I have to love the business or management too- buyout rumors are not the reason I buy. I buy companies that are a natural fit with someone else and that someone else needs to have a lot of appetite for buyouts. Usually it’s smart to sell when the deal happens, because buyouts actually have a terrible track record.
I see the second half of the year unfolding in a few possible scenarios:
- Positive economic data continues to arrive, and Gandalf helps the Fellowship of the Ring beat back the Orcs. All metrics get better except perhaps Unemployment, which is a lagging indicator. Massive stimulus and monetary expansion starts to take hold and the wheels of commerce which have already started slowly grinding forward begin take on speed. Stocks go up in anticipation, and we get multiple expansion ahead of actual improving numbers. Our companies are lean, with record low levels of OPEX and record amounts of cash. As the market improves, Hedge Funds and investors quickly put cash back into the markets, out of “performance envy”. Remember, many Hedge Funds in 2009 will be facing the difficult decision of whether to close down since they’ll still be under their high water marks. In this scenario, our good quality stocks will be bid up, but probably not as much as the higher beta lower quality stocks. Even the terrible financials will probably go up in this setting, but I doubt we will buy them. (70% chance)
- The economy muddles along, the banks stay pretty sick, and talk of a “double dip” becomes in vogue. The banks are zombies anyway, but with the government will keep them afloat. There will be calls for another stimulus package, and the stock market will re-test lows or at least give up half of its recent gains. This is the scenario that I am most afraid of. I find solace in the fact that this is the viewpoint most in vogue on the street right now, so I think it’s unlikely to happen. This scenario will be tough on us in our current investment posture. However, our stocks are still loaded with cash with durable business models so they should survive. In this scenario, we will probably lighten up our exposure to stocks a bit, but will look to be opportunistic buyers when we have signs the market has turned. (20% chance)
- “Long Tail” scenarios: the dollar is lost as reserve currency and the
It’s going to be an interesting second half of 2009. I’m guessing quite a few funds will decide in the 4th quarter that “managing money for free” is not worth it. If they haven’t gotten above their high-water marks (I doubt most will) they will be tempted to shut down and restart in a different incarnation. Even if they only manage 20% of what they were managing before, it’s still worth it to them because 20% of something is better than 100% of nothing.
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1 comments:
Nice work!
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