Portfolio Earnings Reports and Macro Musings

A slew of earnings reports have come in. I will summarize them in 60 seconds.

McRae Industries reported earnings that were flat compared to last year. But looking at last year's fantastic results, this is an accomplishment. If the company can show that last year was not an anomaly, then we have a new normal for this company. If so, I feel the company should trade around $40 instead of $30 now.

Wellpoint reported decent earnings. But the market pays more attention to the company's guidance because it is so committed to Obamacare. The company raised its 2014 earnings guidance from $8.20 to $8.50 per share. The new CEO Joe Swedish seemed to have aimed low with this guidance earlier and he is carefully managing the expectation upwards.

Wellpoint is spending considerable money to upgrade its IT systems for Obamacare. The company has already spent $550M. This leads me to believe that the company will have an advantage over other smaller competitors who do not have the scale to do such large upgrades. Wellpoint's success will be tied to Obamacare and the first year Obamacare enrollment numbers do not look so bad. People can slice it or dice it in many ways, but I think the Obamacare enrollment is as good as one could have expected a year ago. The bottom line is, people who don't have healthcare will buy it at a reasonable price.

I think the mainstream is starting to agree with me on this one. Barron's just published a bullish piece on Wellpoint. But I think when the mainstream starts to tout a company, watch out! The stock probably hasn't got much more room to run, and it is time to be contrarian on the stock. I definitely wouldn't add to my position, the only thing I will do in the future is selling.

Petsmart reported mixed first quarter results and they also lowered the year-end guidance. Same store sales this year will be flat compared to a year ago. The stock has tumbled 20% off its peak of a year ago. Today it trades at 14 times forward earnings. But here again, Barron has a positive piece on the company recently, which help the stock recover a bit. I wouldn't buy any more but I also don't want to sell because I dislike the capital gains tax.

In other news, Seaboard Corp completed their tender and announced that it was not fully subscribed. Therefore the buyback price will be $2950, which is the maximum price. I tendered about 15% of my shares.

And ITIC is down more than 20% since I started buying 5 months ago! And I don't really have an explanation for it. I have looked over the company a bit further to see if there is something about it that I missed in my initial analysis. I cannot find anything. Overall the housing market is stable and near-term should improve. The job market is improving which will do wonders for the housing market. Interest rates are up a bit but still near 12 month lows. So, in the absence of red flags, I have added to my position on the way down.

The US has seen inflation pick up to 2.1% yoy in May. Inflation directly affects interest rates and I'll be watching both closely. I own ITIC and four other insurance stocks. Insurance companies have large bond portfolios which would take writedowns if interest rates rise. But everything considered, inflation is a heck of a lot better than deflation.

Why I Bought European Reliance

ATH:EUPIC
Price	€ 1.390
Market Cap	€ 38.22 M ($ 52 M USD)
P/E TTM	3.9 x
Div yield	0 %
P/BV	0.63
ROE	16.3 %

My next stop in my virtual world travels takes me to Greece. My macro impression is that Greece is on the road to recovery. I primarily invest in small and micro caps now, and I saw some interesting ideas for Greek small caps here and here. I applied my screener to stocks in Greece and found a few but one really stuck out: European Reliance General Insurance SA (ATH:EUPIC).

EUPIC offers insurance and pensions and mutual funds to individuals in Greece. The company insurance offerings include life, health, fire and car. Its underwriting operations are outstanding. And it trades significantly less than book. I am sure the main reason it trades so low is because it is in Greece. The world knows that Greece had a very difficult 2011 and 2012. In fact, the country has been in recession for 5 years, and it is far from over. The country still has 25% unemployment. But from what I gather, the country has turned the corner and is on the way to recovery. One can see this from how the bond markets are pricing Greek 10 year government bonds. See chart below from the WSJ.

I invested in EUPIC partly because the company had a stellar earnings record through the last four years. The company did suffer losses in its investment portfolio in 2011, but the company's outstanding underwriting results made up for it. Prior to four years ago, the company's underwriting was decent but not as good as it is now. The company also took a € 15M writedown in its equity in 2008, when the financial crisis hit. Before that the company was trading above book and it hasn't traded close to book since then. See the following table. All numbers except dividends are in millions.

	Income	Equity	Investment income	Dividend/shr	Shares
Q1 2014		60.4	0.9		27.5
2013	9.5	57.5	0.8	0.000	27.5
2012	9.0	50.0	0.9	0.100	27.5
2011	2.7	39.5	(7.0)	0.050	27.5
2010	1.3	37.9	1.5	0.040	27.5
2009	3.1	37.7	3.4	0.040	27.5
2008	(0.0)	30.2	4.2	0.040	27.5
2007	2.5	44.5	1.6	0.073	19.2
2006	3.2	25.5	1.9	0.000	19.2
2005	1.8	20.0	0.8	0.000	19.4
2004	1.7	21.6	0.5	0.000	18.3

The company's balance sheet is like most life insurance companies. The company has investment assets, mostly bonds and some equities. The company's liabilities are just the company's underwriting obligations. The company states that 75% of the company's bonds are in the US and "core European countries". I take this to mean countries like UK, France, Germany, Netherlands and not Greece.

EUPIC was established in 1977. The current CEO has been CEO or Chairman since its founding. Some of its founders are still directors. This shows a commitment and stability in the organization. I have found company statements going back to 2001, beyond that I have nothing. In 2007, the Greek bank Piraeus bought a 30% stake in the company. In exchange the bank gave the company the fire insurance business from its mortgage sales.

My impression (or hope) is that the company's insurance profile after the Piraeus investment has made the company much more profitable. But the financial crisis followed by the Greek bond crisis has overshadowed the company's solid underwriting performance. So when the sentiment turns and drives equities upwards, this company should once again trade for book.

The company's auditor is PKF Euroauditing SA going back to 2001. I have never heard of the auditor but their website seems to indicate it is a stable and big European company.

The one thing that worries me about the company me is that it has inexplicably chosen not to pay a dividend for the 2013 fiscal year. I cannot really think of a good reason for this.

---

Note**: investing in Greek microcaps is a risky business. I have tediously gathered the data in this article from filings written in Greek. But I am sure I have made mistakes. If you are considering investing in this please read the disclaimer on the right.

My Current Reading List

Money Myth an interesting article about a poor immigrant's thoughts after fulfilling the American dream.

Anatomy of the Bear by Russel Napier. Interesting history published in 2009. The author goes on to say we are in a going to be in a recession from 2000 to around 2014. I think that is pretty prescient.

Confidence Game by Christine Richard: I devour any investment book with behind the scenes stories about Wall Street. This one is about Bill Ackman's fight with MBIA.

Tap Dancing to Work, by Carol J. Loomis. One more book on Buffett which adds more insight to the best investor of our time.

Investing in the Unknown and Unknowable. This article adds a lot to my thinking about probability theory and the real investment world. It is on the same topic that I discussed here.


Poor Charlie's Almanack, Edited by Peter D. Kaufman. This is a well-known book which addresses the issues of the above, based on speeches and quotes of Charlie Munger.

An anonymous writer accuses Chaoda of rampant corporate fraud. This company interests me now that I have invested in a Hong Kong stock.

An anonymous writer accuses Huabao International of being a huge pump and dump.

I also am playing around with a cool new tool that can reveal the differences in the text of different 10Qs and 10Ks of a company.

SEB is Trading Near Tender Price

Seaboard Corp's tender offer is due in a week. And the stock is approaching the maximum tender price. The price today reached $2920. The maximum tender price is $2950. Volume at this price has been more than daily average. So, when I try to guess the intentions of the buyers and sellers, I can only deduce one thing. The market does not think that the stock is worth the tender price, and the company will not be able to buy Seaboard stock with all the allocated $100M.

Several news items are affecting the Seaboard stock recently. Seaboard announced quarterly earnings of $40.55 per share compared to $47.98 a year ago. Revenue was also down slightly versus a year ago. However, operating income actually rose compared to a year ago. The operating income rose but net income fell because the company benefited from a one-time tax benefit last year. This means that last year was the anomaly and this year is the norm. The company now trades at 18 times TTM earnings.

Pork prices have jumped by more than 30% recently. I am not exactly sure why, but there has been some kind of pig virus spreading about.

The other news is that Pilgrims and Tyson Foods are in a bidding war for Hillshire Brands. Hillshire Brands in turn is trying to buyout Pinnacle Foods. It looks like food company valuations are going up amidst consolidation. In 2013, Smithfield Foods was purchased by Shuanghui. Nonetheless, Seaboard's return on equity is 7.8%. The company does not appear undervalued unless one believes that it is a takeover target. Seaboard trades at a EV/EBITDA of 10, while Pinnacle and Hillshire trade at 13.

Seaboard is my third largest position and I must consider taxes carefully if I want to close the position. I wrote about taxes in another another post but it doesn't really guide me on whether to sell. Today I have another way to think about taxes.

Suppose my Seaboard investment has gone up 100% over a long period. Also suppose the tax rate is 25%. If I sell it, the capital gain is $50 for every $100 that I should pocket. But the government takes a $12.50 tax on that, which leaves me with $87.50.  Suppose further that Seaboard returns 10% a year in the future. So, by the rule of 72, it doubles about every 7 years. Then that $12.50 which would be in Seaboard if I did not sell, would give me $12.50 in gains in 7 years.

So the fundmental question is: can I get a further $12.50 in gains in 7 years on my $87.50 if I sell Seaboard and buy something else? When put in this way, tax considerations become much more straightforward.

So I think soon I will sell or tender at least some of my Seaboard shares.

Why I Bought New Century Holdings HK

HK:0234
Price	HK$ 0.154
Market Cap	HK$ 888.58 M ($ 114 M USD)
P/E TTM	5.7 x
Div yield	5.8 %
P/BV	0.63
Price/Netnet	1.13
ROE	11.0 %

I am currently armchair travelling through Hong Kong. My first words are: WOW! It is bargains galore!

Hong Kong gets a bad rap from me because of its proximity to China. I would not invest in China because I have heard of too many cases of fraud. In addition China's economy depends too much on government-driven construction. I feel China has to be in a real estate bubble now.

I first looked at Hong Kong after hearing about the Third Avenue Funds' investments in Hong Kong real estate companies. Some Hong Kong real estate companies are incredibly cheap; for example, Wheelock is selling for half of book. However, I backed off after looking at the Third Avenue holdings. The companies often have too much real estate in China, and they almost always are family majority owned.

Recently, I looked closely at small caps and they are much better, in part because they are too small for the smart money. The small caps have even better balance sheets and are less exposed to the real estate market. My first find is New Century Holdings Hong Kong (HK:0234).

New Century's ticker goes back at least 18 years. That is the extent of the online information at HKNews. However, 13 years ago it was called Multi-Asia International Holdings. And it was a money-loser basket case. It tried to do a number of ventures, from film processing to manufacturing to real estate. But that doesn't matter now. What matters is the net operating losses (NOL) that it had in the books in 2001. I believe the potential tax savings from the NOL is the reason that the current management, the family of Mr. Huang Cheow Leng, took over the company as New Century Holdings. Initially, in 2001, the Huang family owned 52% of the company. Today the family owns 65%.

In the last 12 years the family has built quite a company. The family has turned the company into a hotel and cruise ship and gaming enterprise. The family owns not only New Century but a number of other businesses, one of which sold New Century two cruise ships. These two cruise ships were the primary business of the company early on. In 2013, the company operates four segments and their operating incomes were in millions HK$:

• cruise ship - 50.2
• hotel operations - (0.1)
• property investments - 53.3
• securities trading - 116.5.

The following table shows the company's growth. The equity growth has been more than 20% CAGR! And though the drawback to equity growth is dilution, the growth makes up for the dilution, as the table shows. The significant share growth came in 2003, 2004 and 2008. In 2003, it was a rights issue, so the company got equity capital. In 2004 it was related to a convertible loan from the Huang family for the cruise ships. And in 2008, it was for a further share issue to third parties. So the company has been busy raising and putting capital to work. Today, the company has plenty of excess capital. This is despite a generous 6% dividend.

	Basic Shares	Diluted Shares	Dividends HK$	Equity HK$	Huang Family Interest
2002	1896.8	1896.8	0	97	0.52
2003	3325.6	3325.6	0	175
2004	3326	3378	0	232
2005	3355.2	3864.4	25.4	397	0.56
2006	3841.1	4571.9	39.3	610
2007	4655.6	4881.8	48.2	741
2008	5595.6	5645	0	1095
2009	5765.2	5765.2	20.2	985
2010	5765.2	5765.2	34.6	1143
2011	5765.6	5765.6	52	1323
2012	5767	5767	52	1316
2013	5767	5767	52	1406	0.65

The company's only long term debt is a loan equal to about 10% of the equity to the Huang family. But this loan is interest free and has no due date. On the asset side of the balance sheet, about a third is in investment properties, a third is in securities on the Hong Kong stock exchange, and a little less than a third is in cash. So the balance sheet is highly liquid. And what isn't liquid is mostly properties in Hong Kong, Singapore and Indonesia. They do not own properties in China as far as I can see.

I feel like buying this stock is like buying a Hong Kong stockmarket ETF, with a decent debt-free moneymaking cruise ship and property investment business thrown in for free.

Overall, the New Century seems to be relatively transparent. The company regularly file notices regarding operations and ownership. And the company values its assets and its depreciation reasonably. So, the family ownership does not appear detrimental to the minority shareholders. Still, as a minority shareholder, I will be vigilant. Mr. Huang has three children and one niece as executives directors of the company. They are compensated from $100k to $250k USD. They all also have a generous options package, which currently is underwater.

As a final note, I must remind the reader that New Century is a little-known smallcap stock with very concentrated control in an emerging market. I have done my best to decipher their filings, but I am sure my data has some errors here and there. So, if anyone wants to invest in this company, he should do his own research! And he should also read the disclaimer on the right.

My Plans for the SEB and Sterihealth Offers

Seaboard Corp is offering to repurchase $100 M USD in common stock through a dutch auction. The offer gives shareholders the opportunity to tender their shares at a price between $2500 and $2950. The company will pick the lowest price that allows it to buy $100 M worth of shares. Anyone who tenders at or below the chosen price will be selling their shares at the chosen price. The stock was at  $2350 before the announcment. The news caused the stock to pop, and it is now at $2615

This means the market thinks the chosen price will be above $2615. No one will tender his shares below $2615 because when he can sell it today. On the other hand, buyers are hoping to buy below the chosen price, and then tender. Those buyers must expect a large enough premium for their risk exposure. Say it is $100. Then, the market expects the chosen price to be $2715.  Considering their mediocre results last few quarters, I will tender some shares at $2700, $2800 and $2900.

Sterihealth's largest shareholder Dan Daniels recently offered to take the company private at $1.75. The vote is on June. Today it is trading at $1.73. This means that the market believes the transaction will happen. If the transaction happens, the shareholders will get their payment on June 26. This means that today's buyers expect to make a $0.02 gain within a little over a month. I am selling my shares today at $1.73 and I will forgo the $0.02 because I believe I can return greater than that by investing the capital.

The above is my understanding of two transactions. It may have errors or omissions. Please read the disclaimer on the right.

Tachibana Eletech and Fujimak Results Fail to Satisfy Investors

TSE:8159
Price	¥ 1161.00
Market Cap	¥ 25078.12 M ($ 246 M USD)
P/E TTM	6.5 x
Div yield	2.0 %
P/BV	0.57
Price/Netnet	0.65
ROE	8.8 %

Tachibana Eletech (TSE:8159) and Fujimak (TSE:5965) both reported 2013 results and both stocks tanked by 10% in the last month.

Tachibana's revenue was ¥141.9 B versus ¥123.8 B the previous year. The company earned ¥3.8 B versus ¥2.8 B the previous year. In addition, the company increased its dividend to ¥23 from ¥20 a year ago. The stock dropped mostly because the company's 2014 revenue and income guidance was ¥146 B and ¥3.5 B, respectively. And the company intends to give a ¥22 dividend. The market may be disappointed by the guidance, but I don't think that justifies such a low stock price.

In view of the disappointing stock price, I find myself doubting my thesis on this company. Tachibana Eletech is a wholesaler of factory automation and related products. Such a business requires a large large balance sheet. So, now I think being a netnet in this line of business isn't as attractive as in some other lines of business. This is something I am learning to appreciate. Nonetheless, when I bought I had such a margin of safety that I am still sitting on a USD gain today.

TSE:5965
Price	¥ 719.00
Market Cap	¥ 4712.04 M ($ 46 M USD)
P/E TTM	4.1 x
Div yield	2.8 %
P/BV	0.40
ROE	9.6 %
LT Debt/Equity	0.33

Fujimak had a similar story. Their 2013 results were great. Revenue was ¥36,276 M versus ¥32,713 M the previous year. Income was ¥1146 M versus ¥1246 M the previous year. See numbers in the box; the company's numbers relative to market cap are tremendous.

However, the stock tanked because management expects a -44% income drop in their 2014 guidance! But then again I have noticed that these standard projections are always quite conservative. And both companies have expressed worry about the consumption tax increase that comes into effect in April. But as usual, I think the market is discounting the macro issues too much. I wouldn't be surprised if the worries of slowdown don't pan out and these two companies do better than expected in 2014.

ITIC Q1 Earnings Fall

ITIC
Price (May 7)	$ 66.00
Market Cap	$ 134 M
P/E TTM	10.9 x
Div yield	1.6 %
P/BV	1.04
ROE	9.6 %

Investors Title Insurance Company (ITIC) recently reported Q1 2014 results. Revenue was $28.5 M versus $26.8 M the previous year. The company earned $1.0 M versus $3.4 M the previous year. To me, the results were decent overall. The company's revenues fell by a million yoy in the previous quarter and this quarter made up for it. So revenue was flat the last six months versus a year ago. The quarterly decrease in income was solely due to an almost $3 M increase in reserves expense. These things happen, but it doesn't materially affect the soundness of the results. The paid-out claims are a tiny fraction of premiums. What matters is the revenue and SG&A. So I am encouraged that the company can still generate flat revenues with the low interest rates causing less refinancing activity.

Installux and KCLI Report Good Earnings

KCLI
Price	$ 42.00
Market Cap	$ 460.66 M
P/E TTM	15.4 x
Div yield	2.6 %
P/BV	0.62
ROE	4 %

Installux (STAL) recently reported preliminary year end results for 2013. Revenue was € 108.4 M versus € 113.2 M the previous year. The company earned € 8.1 M versus € 6.7 M the previous year. Revenue decreased 4.3% due to a struggling French economy. But remarkably, earnings were up 20.8% due to much improved margins. The company has not published the full annual report so I don't have the balance sheet numbers. But at this rate the company probably trades slightly above book and at 9 times earnings. The stock is up more than 50% since I bought it a year ago.

Kansas City Life Insurance (KCLI) reported Q1 2014 results. Revenue was $70.6 M versus $78.8 M the previous year quarter. The company earned $5.5 M versus $5.2 M the previous year quarter. The earnings increase was primarily due to realized gains. The company earned $0.50 per share.

Most interestingly, however, is that the company increased equity by $20 M due to unrealized gain and earnings. That is four times the reported earnings! I do wonder how they did this. I read in their 10K that every percentage rise in interest rates causes a $150M drop in equity and vice versa. Their equity is about $750M.

I mentioned KCLI because I just bought back some stock after closing my position a few months ago. I initially bought a year ago at $37, and then sold recently at $48 and now re-bought at $43. So, I have shown that a trader can buy low, sell high, and buy low again. And I can do this indefinitely with KCLI.

Ok, ok, I couldn't resist a tongue in cheek reference to short-term trading.

My Current Reading List

Exposure by Michael Woodford. About the whistleblower Olympus president who exposed how how the company covered up its investment losses. I think it gives great insight into Japanese corporate culture and problems.

The Shipping Man by Matthew McCleery. It's a funny fiction about a hedge fund manager who gets swallowed up by the shipping world.

Quality of Earnings by Thornton L. O'glove. Studying financial reports is by far the biggest task for an investor like me. This books points out some common and important gotchas to watch out for.

A good article that says you have to dare to run away from the herd to get superior returns.

A refreshing view of China's unusual economy; i.e. things aren't as bad as some would have you believe.

How the Economy Works by Ray Dalio. It is a neat explanation of the deflationary world that we live in. It may be a bit too simplistic but it  certainly helps my understanding.

The Greatest Predictor of Future Stock Market Returns. A very well thought out article, and I am still absorbing it.

Why I Bought Putprop

Price	ZAR $ 7.00
Market Cap	ZAR $ 201.60 M ($ 19 M USD)
P/E TTM *	7.7 x
Div yield	5.1 %
P/TBV	0.59
ROE	7.7 %

While searching the world for cheap stocks, I typically choose a country and then do my research and run a screener looking for anything that strikes my interest. Last week, I decided to look at South Africa, which is a country I have never previously paid attention to.

South Africa a country with 50 million people. Its unemployment rate is high at about 25%. It has a 5.8% inflation rate, and it has about $50 bil USD in gold and foreign exchange reserves. In the last several years the South African Rand (ZAR) has dropped by a third. Today 1 ZAR is worth $0.095 USD. I guess this was in part due to the general decline of emerging markets all over the world. Interestingly, South Africa ranks quite high in corporate governance. Its corporate governance is higher than Singapore, Hong Kong and Germany.

So I looked at South Africa stocks and I was lucky enough to find a cheap smallcap that suits my style. The company is Putprop. Putprop is in the real estate rental business. It is not a REIT as far as I can see. I like the company because it has little debt, is very profitable, and sells for less than book.

So far it is all great news. But as with every great stock story, there usually are some skeletons there also lying in the closet.

Putprop gets 85% of its rental business by renting bus terminals and garages to Putco. Putco is South Africa's largest bus service that serves many disadvantaged areas. I am not an expert on South Africa, but for me cheap buses conjures up images of an integral segregation tool. The poor black population can work in areas where whites run businesses. But after work, they are forced to leave on crowded, rundown and dangerous buses. And Putco has a long history going back to the heyday of Apartheid. At that time it was run by Albino Carleos. At some point Albino Carleo also created Putprop.

Today Putco is still a rundown bus service. But it has less ridership than during the Apartheid days. Taxis and better shuttle services have cut into Putco's business. Putco has also changed ownership. I believe it is now mostly owned by blacks. Albino Carleo is no longer the CEO. And it has delisted eleven years ago. But Putprop still remains in the family. It is run by Bruno Carleo which I presume is related to Albino Carleo's, possibly his son, although I cannot confirm that.

Putco is obviously important to Putprop's well-being. But I think Putco's image also depresses Putprop's stock price. And I think the image portrays a bleaker picture than the reality. Therefore, Putprop is my kind of contrarian stock. The Putprop management says it wants to diversify its customer base. But considering that Putco is 85% of revenue, either management isn't trying very hard or management is very conservative. Still, I would want the company to err on the side of being too conservative rather than rush into reckless expansion. I also think Putco ridership can improve, no matter how bad the buses, South Africans are desperate for jobs, when the jobs come they will put up with the buses.

Putprop is a company with only a $19M USD marketcap. However, the South African Rand is cheap compared to the USD. Therefore, Putprop can be considered a much bigger company than a company with similar marketcap in the US. The company has great earnings power. However, they account for it strangely. The company assesses the value of its properties annually, and counts the unrealized gains or losses in the income statement. I am not used to seeing gains treated this way. I always used to see it as part of comprehensive income, but not regular income. This treatment has greatly exaggerated their reported income. The stock is 4x their 2013 income! For my purposes, I backed out the unrealized gains, and the caption box shows their adjusted earning and numbers.

In addition to the great earnings, the company pays a high dividend. And the company can easily keep this up as it trades at half of book, with no long-term debt.

A final issue to consider is the value of the Rand. South Africa has a slight trade deficit but the country is not desperate for foreign cash. So the currency is not at risk of devaluation. However, the Rand has depreciated by about a third compared to just five years ago. The Rand is at almost the all time lows. Of course, the flip side is that the Rand is low and can only go up.

That is about all I know about this company now, if I find any more info I will update.

Why I Bought Hanover Foods

Price	$ 122.00
Market Cap	$ 91.5 M
P/E (2012)	6.7 x
Div yield	0.9 %
P/TBV	0.45
ROE	6.2 %
LT Debt/TBV	0.11

Recently, I bought shares in an obscure U.S. food company I had known for about a year. I first heard about it from Oddballstocks — one of the best investment blogs out there, by the way.  The company is Hanover Foods (OTC:HNFSA). The company is not really public so it doesn't have to file with SEC. I took a while to invest with the company because I couldn't get access to their financials. I also wasn't sure how I could get access to the financials once I became a shareholder.

Hanover Foods makes the food products shown above. I do not ever recall buying their products or even seeing it at the grocery store. But I am not a person that studies a companies products when I invest. I focus on financial statements to make investment decisions.

Hanover Foods was a pretty straightforward decision once I had access to the financials. The company like many of my smallcaps, is in a staid business, trades at less than ten times earnings, and less than tangible book value.

In addition, the company is "dark", which could be a plus as well as a minus. When a smallcap company is dark it is under the radar of most investors. This could mean I can build a position at a low price. But of course someone can argue that the company can stay that way indefinitely. But I have faith in the markets and all securities will reach their fair values sooner or later.

Given the great numbers for the company the reader may ask what is the catch, other than the fact that the company is an obscure smallcap. Some internet sources especially Oddballstocks have explained the ownership strife and analyzed the company here and here. The company was founded by Harry Warehime. His descendants are still in control of the company. His grandson John Warehime is the current CEO, and half the board seats are held by the Warehimes. However, the family members are bickering incessantly. And some of their dirty laundry is even documented in lawsuits. From what I can gather there are people who second hand knowledge of the family and for them it appears that issue is about control and not money. As a minority shareholder, I want to ensure that those in control do not cheat the minority, and that the family bickering does not destroy the company. Regarding the first point, the family does not seem to be united so they can't be working together to take away value from minority shareholders. And regarding the second point, this has been going on for decades and in that time the company has grown earnings and equity. For details, the reader can refer to Oddballstocks.

A final issue is the lack of transparency regarding the actual diluted shares out there. The company has various stock option and incentive plans. But from what I have read, it appears to be in the range of 700-800k. So I'll use the mid-point: 750k.

Overall, this company is pretty simple and straightforward and I trust others' research. However, because this company isn't that transparent, I don't have a huge position. But if the reader wants to invest in this stock, she should do her own research! Don't do what I did, which is to rely on information in blogs like this one.

Inflation Is Back in Japan

Japanese companies said in a recent survey that they expect inflation to be 1.5% in the coming year. If true that would be an end to 15 years of deflation that has dragged down the Japanese economy. Though this is lower than the BOJ's stated target of 2%, I think the BOJ target was really using the target as a device to increase people's inflation expectations. I doubt that the BOJ really thought the 2% target was achievable.

The Yen is now at 103.8 to the dollar, which is around a high for the last five years. With this depreciation, may companies will now be able to turn a profit after years of losses, and hence pay taxes. Short term, I think this is great news. My Japanese holdings which I first began to buy 13 months ago are up about 20% in USD, including dividends. It is a decent result but not spectacular considering the current raging US market. It looks like I need to think more long term. I confess I was hoping for a relatively quick profit. I feel my Japanese netnet investments deserve to gain 50%, at least, so I'll keep waiting.

To read about my three Japanese investments, look for them under labels, on the right.

Betting Against Headlines

We have reached just a momentous milestone. Yesterday was the deadline for Obamacare's individual mandate. As it stands, Obamacare enrollment met its 7 million original goal, despite a lot of heckling from its detractors. And possible more will be tallied in the coming weeks. However, it isn't clear to me what these numbers mean. It could consist of a lot people who lost their existing insurance plans and who turned to Obamacare. In any case, it looks like Obamacare is here to stay.

WLP, my largest holding, has invested more than any other MCO in Obamacare. WLP shares have broken over the $100 barrier recently. That is a 20% rise from just 2 months ago at least in part because Obamacare has turned out reasonably well at this critical juncture,

As I have said before. Obamacare is huge and unprecedented, so it is almost impossible to predict. And I don't try. I just took the bet for WLP and Obamacare because I felt the market was overreacting. Every little glitch or complaint seemed to be magnified by the media. If I was wrong I don't think I would lose much. But if I turned out right like it now appears, I could make some good money. This is an asymmetric bet.

Also, Obamacare became law because Obama shoved his plan down the Republican's throats — not a single Republican voted for it in Congress. He needs all the cooperation from the people and the MCOs. I don't think of insurance companies under Obamacare as a traditional regulated industry. Obamacare is asking the MCO's to take on the risks but the government will backstop the MCO losses. Each MCO can freely enter the market in whichever state it chooses. US healthcare cannot work well if the MCOs are hobbled by the government.

As I described in 2012 when WLP was low, every year or two some crisis appears in the headlines that takes some stock to attractive lows. That's when I try to be brave and buy. This year the headline victim is Russia. As we all know, Ukraine had some political turmoil that forced out a pro-Russian leader. Russia's Putin then used the situation as a pretext for annexing the Crimea, which before the crisis was a part of Ukraine, but which 60 years ago was part of Russia.

I then read that the crisis has caused the entire Russia stock market to trade at about 5 times earnings! So I decided, based on my best estimate of the geopolitical situations and Putin's intentions, to make a bet on Russia. I bought some ERUS, the iShares' Russian ETF. As it has so far turned out, the situation has calmed down and it appears Putin has no more territorial ambitions. It also appears that the West is going to let Russia get away with it. I hope that the Russian market will return to the highs of 2013. If that happens I can make a 40% profit. I don't expect this to happen overnight. I expect it to take a year or two if it happens.

McRae Reports Lackluster Q2, Sterihealth Gets Takeover Offer

Sterihealth at Buyout
Buyout Price	AU $ 1.75
Market Cap	AU $ 34.20 M ($ 31 M USD)
P/E TTM	8.9 x
Div yield	4.0 %
LT Debt/TBV	3.96
EV/EBITDA	5.35

McRea Industries reported Q2 revenue was up 3% but income was down 20% yoy. However Q1 was a great quarter. So H1 revenue was still up 14% and income was up 20% yoy. Profit margin was still a decent 8% in H1.

The company blamed the worse Q2 numbers primarily on 1) higher consumer sales in Q1 offsetting the Q2 consumer sales and 2) lower margins due to higher import shipping costs and consumers shifting away from premium boots, among other factors.

The stock went as high as $36 before the earnings report. Now it is $31 due to the lackluster Q2 results. I believe the Q2 numbers are more likely the norm than the exception. McRae has had a great recent run of improving sales and earnings. It's time for them to stop growing and maybe even fall back a bit. The boot business is not high tech. One reason I first bought the stock was the balance sheet. The company has no debt. With returns on equity around 15%, the company is simply growing book by 15%. The price to book ratio is currently at about 1.25. I am hoping the stock goes back to the $36 level before I contemplate selling.

In other news, the Steriheath board has accepted a $1.75 AU per share buyout offer from Dan Daniels. Dan Daniels currently owns almost 50% of the shares. After buying the stock three months ago at $1.30, I'll gladly take my money and run!

Know What You Don't Know

Over the past Christmas holidays I had some free time to pursue an intriguing project. I wanted to get some insight into the what is the best cash-stock allocation mix. In today's world of virtually zero interest yield we can think of this as the classic bond-stock allocation problem. The traditionally accepted to invest is through diversification of between stocks and bonds and also diversification within stocks. For example, Benjamen Graham devotes part of The Intelligent Investor to explain the percentage allocation of each under different circumstances. His advice is intuitive and conventional. When the market appears overvalued, allocate more to cash, up a maximum of 75%. And when the market is undervalued, put the money back in stocks. The 75% number is a bit extreme in my opinion, but I follow his advice otherwise.

As far as I have seen, though, everyone gives this advice in a heuristic manner. I want to change that. I want to find some mathematical confirmation that the conventional cash and stock mix yields a better result than just all stocks. To this end I will need to make some assumptions of the market behaviour. Under these assumptions I put in a mechanical cash-stock allocator algorithm and repeated simulate it. Each simulation is a possible realization of the stockmarket outcome over say 30 years, using my assumptions. My findings were quite surprising (to me). Try as I might, I could not beat a 100% stock strategy over the long run. So, I gave up. Though, I did not shake my belief that one must have ample cash at any time. Cash saved me in 2008-2009, and many a wise investor such as Buffett, employ this strategy. Then recently while thinking about it again, I think I answered this mystery.

Any probabilistic mathematical analysis requires some assumptions to create a model. I assumed that the stockmarket will return the same as it has for the last one or two hundred years, which is an average of about 10%. But the last two hundred years has been a resounding success for the markets. And no theory says it will continue. To assume a 7 or 10% return for the market is to put total faith in one possible scenario. We shouldn't put too much faith in the assumption because we really don't know! If we don't know what we don't know, bad things happen.

As one example consider one of the most elegant theoretical results in use in finance: the Black-Scholes formula for pricing options. It is a piece of mathematical elegance to price the option on an underlying stock assuming that stock behaves in a simplistic theoretical manner. Some blame Black-Scholes for the financial crises of 2008-2009. But I feel the problem is not the formula. The problem is with the investor who forces real world stocks to fit the Black-Scholes assumption. The Black-Scholes assumption is just one possible way of modeling stocks. This formula certainly does not factor in the human psychology that is part of every market transaction. When market participants overuse the Black-Scholes formula they can then change the behaviour stocks such that the assumption no longer holds. It is like the Truman Show. The Truman show only works if the participating is unaware of his world. If he is aware, then he will change his behaviour unpredictably.

So now back to the cash-stock mix. I realize we should always reserve some cash because we do not know the future of markets. Though I tend to think it will be somewhat like the past, the best approach given this uncertainty is to have a portion in stocks and also hedge the stocks with cash. The cash portion is like a call option on some stock at some cheap price in the future. The cost of this option is the opportunity cost. However I cannot quantify this opportunity cost because I don't know what the market will do. But I do know that the higher the market value, the less is my opportunity cost. And so I would allocate more to cash.

For me then, it is hedging for maximum benefit under all unforeseen scenarios. I know this is a bit contradictory, saying there is a optimal way to operate in a unknown world. But we have to admit we don't know something. That's a lot better than not knowing what we don't know. Investors who ignore this fact do so at their peril.

Seaboard Reports 2013 Results

SEB
Price	$ 2620
Market Cap	$ 3127.18 M
P/E TTM	15.2 x
Div yield	0.0 %
P/BV	1.26
ROE	8.3 %
LT Debt/Equity	0.13

Seaboard Corp (SEB) reported that Q4 was the best quarterly result in 2013, but for the year income was lower than 2012. Revenue for 2011 2012 and 2013 were 5746M 6189M and 6670M, respectively. Income for 2011 2012 and 2013 were 346M 282M and 205M, respectively This appears to indicate that margins are dropping. SEB has many businesses segments, all of which are cyclical commodities. So I wouldn't read too much into the drop.

The pork segment is Seaboard's largest at 1/4 of total sales. This segment made up 3/4 of the company's profit however. The marine segment turned in a loss, though it was profitable last year. Shipping is suffering from a glut of ships and rates don't appear to be improving much. Seaboard is committed to shipping however and it is investing in several new ships. I believe Seaboard wants to stay in shipping to be a vertically integrated food company.

Overall I feel the company's management has a very long term view. They allocate capital prudently with little debt. And this shows in their consistent revenue growth. The last year's numbers came in a bit lower than I would like but in my eye this is a company that is trading at 10 times forward earnings.

In other news from my portfolio, Sterihealth (ASX:STP) resported H1 earnings were $0.10 AUD, which is the same as a year ago. However, sales were up 9%. This indicates some margin pressure. Still the company trades at 6.5x earnings.

Tachibana Eletech (TSE:8159) recently announced the company will expand into Indonesia. But at the same time, Tachibana Eletech will sell ¥ 1 B (about $10 M USD) new and treasury shares! They say the purpose is for buying office buildings which would save on leases. What the heck?? What is that about?? This company has ¥ 13 B in investments, of which ¥ 8 B is marketable equities and ¥ 2 B is bonds. And yet they are issuing shares to raise a relatively small amount. Several possibilities come to my mind. Maybe it is patriotism; the company wants to keep its government bonds. Maybe management management feels the stock price is overvalued; but the company is very profitable. Maybe the company is allocating the shares to favoured shareholders. But I can't find a very plausible reason really. I am baffled. What do you think?

On the other hand, the company seems to be doing great. Sales are up, exports are up. The company just raised guidance for the year to ¥ 179 which means the company trades at 7.2x earnings. The company also raised the dividend payout for the year from ¥ 20 to ¥ 22.

ITIC Reports Decline in Q4

Price	$ 79.90
Market Cap	$ 163.00 M
P/E TTM	11.1 x
Div yield	0.4 %
P/BV	1.27
ROE	11.5 %

Investors Title Insurance Company (ITIC) reported year end earnings that were lower than expected due to disappointing Q4 results. Premium revenue dropped by about one million yoy, or 3% of total. This along with about another million drop in realized investment gains meant Q4 net income was $1.8 million versus $3.2 million a year earlier. Note, however, that a year ago interest rates were at record lows.

Still, for the entire year, revenue was up 12% yoy. Earnings was up 34% yoy. The stock has dropped a few percent since I bought it two months ago. It went down as much as 10%. I do not regret owning it. But of course I wish I had slowly accumulated to take advantage of the dips instead of buying it all at once.

The recent results show that ITIC had a good recent run due to the low interest rates. Banks require title insurance when purchasing and when refinancing. So title insurance companies get a cut of each mortgage transaction! Even though refinancing activity may slow due to rising rates, I feel housing is bound to pick up in the coming years. Single home sales are about one million below what I would consider normal for the current population.

ITIC is also a balance sheet play. ITIC's most important metric to me is the book value, and it increased 12% yoy.

IEHC Reports Disappointing Q3

Price	$ 4.50
Market Cap	$ 10.36 M
P/E TTM	7.7 x
Div yield	0.0 %
P/BV	1.05
ROE	13.8 %

IEH Corp stock tanked 20% on disappointing Q3 earnings. Ouch!

The stock has been up some 100% since I bought it because earnings have doubled yoy for the last few quarters. Well that trend did not continue. In fact Q3 earnings were down to $0.08 from $0.11 from a year earlier. Revenues were up 12%, less than the earlier two quarters. Gross margin was a few percentage lower. But Q3 SG&A was $143k higher than last year, due to increased travel expenses. These three factors resulted in the drop in income.

Looking back I of course wish I had sold the stock at its all time high of $6. Now, I'll just wait for next quarter to improve and hope this quarter was just a blip.

Riken Keiki Reports Great Q3 Earnings, Fujimak Not So Good

Riken Keiki
Price	¥ 874
Market Cap	¥ 20.29 B ($ 198 M USD)
P/E TTM	8.2 x
Div yield	1.9 %
P/BV	0.70
Price/Netnet	1.02
ROE	8.6 %

Riken Keiki (TSE:7734) reported earnings improved 40% for the first 9 months this year versus last year. The company makes gas detectors and related equipment for industrial use. Sales were up and cost of goods were down. This shows good management of operations.

The company's year-end earnings projection of ¥ 76 / shr did not change, but I think that is a bit conservative. Book value increased 5% over the last 9 months.

Fujimak (TSE:5965) reported disappointing earnings that caused the stock to drop 10%. Fujimak makes commercial grade kitchen equipment. The company reported earnings that came 30% lower than this point last year. I believe the report indicated that the fast food segment was a major contributor to the poor results. Overall, sales were up 10%. But high raw material costs offset the sales gains. Also, SG&A costs were significantly higher than last year. The comprehensive earnings was better at 10% lower. Like many other Japanese companies, Fujimak benefited from gains in its investment holdings in yen.

Fujimak
Price	¥ 800 B
Market Cap	¥ 5.24 B ($ 51 M USD)
P/E TTM	5.1 x
Div yield	2.0 %
P/BV	0.58
ROE	11.55 %

The company did not change its current year earnings projection of ¥ 130 which would give the company a 6.3x earnings multiple for the year. For now I am not panicking.

Tachibana Eletech Q3 Earnings up 39%

Tachibana Eletech (TSE:8159) reported 39% increase in earnings for the first 9 months versus a year ago. Sales were up 14%. Comprehensive income was up a whopping 155% on asset gains (mostly securities). Earnings reflect operations, but comprehensive income reflect the change in book value. The book value is up 11% in the last 9 months. I bought the company for the balance sheet and earnings. The last quarter shows both are firing on all cylinders.

Price	¥ 1265
Market Cap	¥ 26.4B ($259M USD)
P/E	7.3x
Div yield	1.2%
P/BV	0.59
Price/Netnet	0.64
ROE	8%

Operationally, the company showed the most sales gains in their Factory Automation division and their Semiconductor division. These are the two largest divisions of the company. Exports are at 18% of sales, and I hope they improve that number.

This stock could easily trade at ¥ 2000. I don't know what it would take to get there, other than hostile takeover or huge share buybacks, which I feel the company won't allow. I am a little frustrated, but then again I am patient and I am not a believer in catalysts. I don't try to predict events. But I also cannot ignore the market price of this company because I am not Japanese, so I don't intend to hold Yen forever. When this does reach what I believe is my intrinsic value, I will sell and repatriate the money.

Why the Japanese Debt Doesn't Affect the Yen

There is a pretty dreadful argument going around that the Japanese Yen will go to zero like Zimbabwe's currency recently. The reason is the crippling Japanese government debt. Right now that debt is running at over 200% of GDP. The argument can certainly get attention and makes great headlines. But the facts fly in the face of this, at least in the short term.

Japan has struggled with deflation — not inflation — for more than a decade. Deflation is a dreadful situation that governments try to avoid at all costs. An infamous example of deflation was the Great Depression. Also, the puny rates on Japanese bonds shows that the market doesn't remotely believe in a bond default.

Japan recently summoned the political will to take drastic measures against deflation. This is called Abenomics. But removing deflation is like pushing a huge boulder up a hill. If you let up for just a bit, the gains are undone. But the Yen detractors say pushing inflation is difficult only now. Wait till they get inflation going, then it is game over. Inflation will go on forever. See figure below.

The detractors even know where is the hump in the figure. It will be the point when annual tax revenues cannot pay for the annual interest. They say we aren't at that hump only because the Japanese government can finance this debt with unusually low interest rates. And this rate will rise. I will spare you the details of why interest rates will rise. But based on this theory, people like Kyle Bass have setup funds that bet against the Yen, Japanese bond rates and the Japanese economy as a whole.

But I am very skeptical of this argument because the reality does not match the theory, at least in the short term.  It reminds me of people who believe in the efficient market theory. EMT all makes sense because as information and capital is more readily available, stocks should be less volatile. But crash after crash in the last two decades simply flies in the face of this argument.

At the extreme, why is the tipping point when the interest rate equals the tax revenue? Even when that happens, in theory the Bank of Japan can still print more money to pay the interest. Yes, it's a giant Ponzi scheme, but governments can do that with their own currency.  Also, the bond purchasers are overwhelming Japanese, so this is an internal issue of Japanese owing Japanese. If the debt is a problem, it will show up when the Japanese cannot fulfill their obligations to their old and needy. That's a very gradual process.

In the global markets, Japan bond holders won't dump their bonds for other country's bonds. The world wants Japanese goods, so demand for Yen is healthy. And even if there is a small amount of flight from the Yen, Japan has $1.3 trillion USD in foreign exchange. Nobody thinks there will be a run on the Yen. For evidence of this, simply look at what happened last week. When the world became pessimistic about emerging markets, investors converted their capital to Yen, causing the Yen to appreciate. This is market reality!

I believe a prolonged Yen decline will be caused by structural problems of the Japanese economy. The very things that Abenomics is trying to fix. The Japanese, with the dwindling population, must fix their inefficient industries, such as agriculture. When and if that happens, I think they will recover from prolonged deflation and their malaise. In the meantime, the markets think the Yen is a safe haven that is only matched in size and safety by the Euro and USD.

My Current Reading List

Keys to Reading an Annual Report by George T. Friedlob and Ralph E. Welton. This is an excellent easy-to-ready guide which I will keep always as a reference for reading 10-K's.

Two very bullish investing gurus on weathtrack: Ed Hyman and Bill Miller. These two seem to me to be over-the-top bullish. And I am skeptical but also praying that they are right! You can view the two parts here and here.

Understanding Michael Porter by Joan Magretta. Michael Porter wrote the seminal book on the topic of business competitiveness called Competitive Strategy. He wrote that book more than 30 years ago, and it is very dry. That book and all of his works up to now are summarized in this book by Joan.

I found a treasure trove of data supplied by Aswath Damodaran of the Stern School of Business. It contains spreadsheets with individual company statistics for tens of thousands of companies all over the world. I intend to use this as the basis for making a global stock screener. And hopefully, I'll find some new neglected undervalued smallcaps.

Japan Hits Record Current Account Deficit

Just ten months ago, I opened a global trading account and began investing in Japanese stocks. I current own three Japanese small/microcaps: Tachibana Electech, Riken Keiki and Fujimak. If you want to read more about them, click on their respective labels on the right column.

I was luckily investing in the wake of multi-year lows for the Japanese stock market in 2012. Shinso Abe then began Abenomics. Abenomics' most drastic effect to me is the depreciation of the Yen. The Yen needs to depreciate to make Japanese companies profitable. But one year of Abenomics has brought a very bad downside. The Japanese current account hit an all time monthly low in November 2013. The following shows the monthly current account in units of ¥ 100M. The current account is the net outflow of a nation's currency versus the net inflow of foreign currencies. A positive number in the chart indicates a surplus — more outflows than inflows. Note the chart is very seasonal for reasons I don't yet fully understand.

The approximately ¥ 5 billion ($5 billion USD) outflow at the last point in the chart has gotten quite a bit of press lately. So, I gave it a closer look. I took five random months in the last five years and looked at the current account breakdown.

Units of 100M Yen

The huge swing between April and November of 2013 was due to 1) foreign profits repatriated to Japan and 2) a cheaper yen. And the difference between 2013 and 2010 was due to 1) cheaper yen and 2) nationwide nuclear power shutdown, which required oil imports to make up for the energy shortfall.

In any case, the Japanese foreign reserves stand at $1.3 trillion USD. So November results isn't even a rounding error. But, if this downtrend keeps up for a long long time, then the Japanese will have to make up for it somehow, maybe by restarting the nuclear plants, or by allowing more foreign investment. Otherwise, the yen could fall to a point of damaging the economy. But right now I am more relaxed after digging into the facts behind the headlines.

Why I Own ITIC

Lately, I have been busily searching the internet for my next smallcap. And the work paid off. The stock I found is Investor Title Insurance Company (ITIC:NASDAQ). And I first heard about it on this this twitter feed.

ITIC provides title insurance and associated transaction services in real estate transactions. I have always thought this is a lucrative industry. Any bank requires title insurance as a condition of a housing loan. It protects the buyer from defects in the title purchased. But there is rarely any issues as (almost) all deeds are recorded at the local city hall. And verifying the deed is a simple process in the computer ago. So, title insurance rarely pays out claims. Who wouldn't want get in on this industry.

ITIC is a smallcap company in an industry dominated by two giants, First American Financial and Fidelity National Financial. I summarize their key financial numbers below. Note they are based on the first 9 months of 2013 projected to the full year (which actually overestimates the PE).

As one can see, ITIC is more attractive than its two bigger peers because it has a lower earnings multiple, greater profit margin and a better balance sheet. ITIC has retained a lot of earnings. When I see that, I feel as if the person who sold me stock has given me the previous earnings, his earnings, to me for free! The two larger competitors don't have such a good balance sheet because they have a considerable amount of goodwill and intangibles.

Now a person new to this stock may be a bit gun-shy because it depends on the housing sector. Title companies have benefited from the recent increase in housing activity, no doubt. But housing sales have still some ways to go to return to pre-recession levels. After that however, there will be minimal growth for the industry as a whole. This is a classic no-growth value investment.

I also like the company's management. The company's is 42 years old yet is run still run by the original founder, J Allen Fine. His two son's are also executives with the company. This shows a good management continuity, dedication and track record, which is a key criteria for Warren Buffett. The Fine family owns 30% of the outstanding shares. They collectively earn less than $1 million in salary.

So, my investment thesis is simple. The company has a low PE for such a lucrative industry. The company has a great balance sheet, it is almost a netnet. And revenues are bound to go up in the near future.

WLP Sells Division

Wellpoint has announce that it will divest its eyeglass business in order to focus on its core business. The company said that this will cause an approximately $0.55 charge in the coming quarter.

So, Obamacare has begun and we have 2.1 million people enrolled. The initial goal is 7 million by the March deadline for enrolling without incurring a penalty. I think worse case is 4 million and if it is significantly above that I expect WLP will easily hit new highs.

So I'd like to, once again, summarize my thesis for WLP serving Obamacare.

1. Obamacare does not socialize or nationalize health care
2. The public, the politicians for Obamacare and the politicians against Obamacare are all either neutral or very sympathetic to insurance companies who are simply caught in the middle of this issue.
3. Obamacare is adding 7 million to the insured pool. Insurance companies like WLP know the risks and are voluntarily going in with their eyes wide open
4. I feel Obamacare is part of an overall consumer trend towards more "luxuries" as our standard of living rises.

In other news about my portfolio, I have closed my KCLI position. I feel Kansis City Life is a well-run company with minimal exposure to risky annuities. However, it has run up along with the rest of the stockmarket, and the price is now 75% of book. Still, if the market corrects and KCLI drops, I will certainly consider buying.

My Current Reading List

Starting today, I will regularly post links and reading material that I am reading. Hopefully you will find something interesting.

A series of posts by the late Doris Dungey. It is all about the insides of the mortgage industry. They were written before the 2008 crash, but still worthwhile to read today.

Another great interview on Wealthrack

Uprising by George Magnus: A very easy-to-read, thought provoking book on emerging markets.

100 Minds that Made the Market by Ken Fisher: A easy-to-read biographical history of US finance.

PetSmart Performing to Expectations

I have owned PetSmart for six years and it has tripled in that time. My earlier writeup was a year ago, so I think an update is in order.

PetSmart is the the largest pet retail chain and it owns 40% of the US market. The pet industry is a $53 B industry. About 62% of household have pets and I estimate that Americans spend about $250 on each cat and dog annually. I think our pet owners can and should do better than that!  The pet industry has been growing at about twice the rate of GDP, and trend should continue. Although I don't believe we will have much more pets in homes, I do feel that as a wealthy society, we will gradually spend more than $250 on each pet annually. So even if PetSmart does not grow market share, which it has done successfully in the past, earnings should still outgrow the GDP. The following supports this point.

Revenue and Earnings (mil)

Div yield	1.2%
P/E	18x .
PTBV	6.8
Debt/Equity	0.41

Note that the chart shows the total earnings growth. Per share earnings growth is even greater due to regular share buybacks.

The downside to this stock is the relatively high earnings multiple. I generally stay away from anything with a multiple above 20. And PetSmart is close. But I am keeping it for two reasons. One is that I hope PetSmart will do what Coke did for Warren Buffett. Buffer bought Coke in the 80's and it has returned about 12% annually for 30yrs. He also bought Coke at a high multiple, but the company's moat was worth it. PetSmart doesn't have quite a moat, but it is the leader in a superb industry. The second reason I am keeping the stock is I want to avoid capital gains tax.


In other news, we have just ended a memorable year with the US markets up 30%. Who would have predicted that twelve months ago! But 2014 is another year and another chance for the pundits to redeem themselves. The following by Tren Griffin is the funniest though.

CNBC will continue to lose viewers by trying to make its programming similar to ESPN’s Sports Center, even though that approach is *exactly* what sends ordinary investors to their financial doom and *ensures* that ordinary investors will stop watching CNBC (i.e., the CNBC ratings death spiral will continue).

That does make me a bit sad. Now that is one less media outlet to goad suckers to take the other side of my trades *sigh*. Well, I hope Jim Cramer will find another network to hire him on after CNBC dies!

Arbitrage with Sterihealth and Stericycle

Recently, I was thinking new places to look for smallcap gems, and I decided to try Australia. There I found a candidate with a colorful past.

The company is Sterihealth (STP:ASX). It deals in hazardous medical waste disposal. The company was known in 1999 as Cutters Ridge Resources. I guess it's business in resources was a failure so the company's management decided to change the company name to Stericorp and try the medical waste business. However, it appears that the management initially didn't know the business.

The company initially tried waste disposal in Argentina, which failed. Then they bought a plant from Stericycle (SRCL:NASDAQ) in Canberra, Australia, but that was also written down to zero in 2004. Then in 2005, with new CEO Daniel Daniels, Stericorp sued Stericycle for breach of contract to try to recover some of the losses. They eventually won $18 M in that suit. I think the company has stablised with Daniels at the helm. Stericorp turned over a new leaf by changing its name to Sterihealth and it bought 100% interest in ADX, a company started by Daniels.

I think it is interesting to compare Sterihealth and its much bigger former partner Stericycle. The two are both in medical waste, but Sterihealth only operates in Australia while Stericycle is a global player. The following table shows their stats.

In my view medical waste is a profitable and growing industry. Companies in the industry should easily earn returns above their cost of capital. I think that is why Stericycle commands a 37x earnings multiple. But Sterihealth couldn't be more different, it trades at only 6.6x earnings! So, does this mean Sterihealth is a severely mispriced stock? The company history should give some clues.

The company has had a troubled history up to 2005. At that time, the stock reached less than $1 from a high of around $12, and for good reason. The company had accumulated losses of more than $30M! By 2006 they had turned a corner I feel with the new CEO and had raised $15M over three years to shore up the balance sheet. By 2007 Sterihealth got another $18M from settling with Stericycle. The following shows the company's earnings.

Sterihealth Earnings (Mil $ AUD)

Note, that the above results excludes the one-time $18M gain from the Stericycle settlement. So, one can see the company is in a good industry with consistently growing revenue. Therefore, I think the company deserves a higher multiple. Or, looking at it another way, the earnings multiple of Stericycle and Sterihealth should not be as dramatic as it is today. Stericycle must either fall or Sterihealth must go up, or both.


I am long Sterihealth.

McRae Q1 Earnings Up 55%

McRae Industries reports revenue up 27%, earnings up 55% yoy. See below. The company reported the diluted earnings per class A share as $1.33 for the quarter.

Last 5 Quarters (mils)

A significant contributor was the military segment; the company now produces boots for the Israeli military! The good news just doesn't stop.


For the last few years the company has been on a tear. See below.

But the company has said that western/lifestyle segment, which is the most discretionary, typically goes on a 3-4 year cycle, and we are on the 4th year of this cycle. So McRae investors must be wary. That said, I feel much of the world today has an overabundance of life's necessities, and consequently many are moving beyond necessity to luxury. Thus there will be more demand for goods such as pet products, alcohol, healthcare, recreational drugs such as marijuana, high-end watches and the western/lifestyle boots that McRae sells. I am trying to profit on all of the aforementioned areas - well, all except except marijuana.

In other news, I found this thought-provoking article on Shiller's CAPE. I wrote, and so have many others, that the CAPE is an excellent historical measure and that the CAPE indicates the market is overpriced now. However,  this article argues that this conclusion is incorrect because accounting rules have changed and therefore CAPE values are based on inconsistent rules over time. This article's argument has huge ramifications for me because I am reducing my equity exposure as the market continually hits new highs. But if I can be convinced that the market is not overvalued I will have to reverse course! I recommend this article to any serious investor.

Why I Own Insurance Stocks

Over my investing years, I have tried to make some general rules to hopefully help me avoid trouble. Currently, my general minimum critera are:

1. low PE
2. profitable over last several years
3. low debt requirement for operations, and
4. domiciled in a developed country

I have other requirements which are desirable but not necessary: I prefer small caps, and I have touched on it extensively in this blog.

When I initially invested and wrote about it last year, AIG fits the criteria except that it hasn't been profitable recently. But that was last year. In the year plus since, it has earned money consistently. In all, AIG has been profitable the last 9 consecutive quarters. I feel that companies that don't regularly need tons of capital expenditures are in general better investments. That's in general Warren Buffet's strategy up until recently when he bought Burlington Southern.

I bought AIG over a year ago when it was $30, and was trading at around 0.6x book. Since then it has run up to $50. A year after I bought AIG I tried to find a small cap company like it. I found Kansas City Life Insurance to be a small cap that also trades at 0.6x book; 0.6x is just about the lowest book I could find for insurance companies. KCLI has since run up 30%. The following table summarizes KCLI and AIG today

AIG does primarily Property and Casualty and Life Insurance and Annuities. KCLI only does Life Insurance and Annuities. AIG also owns ILFC, which is a aircraft leasing business. Just today, AIG announced it will divest ILFC to another company, AerCap. Although I don't think AIG will have any gains or losses from this transaction, I think it is yet another sign that AIG's dark days of five years ago are behind them.

My other insurance holding is Wellpoint; but then again WLP is not really an insurance company as much as a healthcare company. I have written many times about WLP as my bet on Obamacare. I have never really heard of any other investor taking my view. Until I saw a Forbes piece on Larry Robbins. Larry Robbins runs a hedge fund that is one of the best performers this year because he made a big contrarian bet on the healthcare sector. After following the hedge fund moves in the last year, it seems like to me the hedge funds are just being too conventional when their name implies that they should act contrarian.

My bottom line is, I am really liking insurance right now!