Good Investing means learning How to Wait

Good Investing means learning How to Wait

Patience is a highly sought virtue. To be patient is to wait, to be able to mentally insert a wedge between a linked stimulus and response and so place a stop on repetitive, habitual, often destructive behavior. Patience gives you a moment to access, step back from the brink, and bring yourself back into balance.

The idea is that we restrain our will to stop an impulsive or destructive action (often based on short term relief from tension or instant gratification) and in doing so, turn our energy in a constructive or creative direction – to use our will in a directly beneficial way. Patience, then, is the mental reflection of the restraint of will.

Dr. Gerald Epstein


The stock market is really a vehicle to help you master yourself. The money you make or lose is just a way of keeping score. The market can be insidious in taking advantage of your character weaknesses. But at the end of the day it is just reflecting back what's going on inside of you. And because of this it can help you master yourself as you learn about your own behavior under the fire of having your money at risk while being in the market.

Remember the first time you bought the stock of a listed company. It seemed surreal. There you were putting your money at risk in the stock market while facing an unknowable future. The 'uncertainty' of the future of the act tempts one to execute their idea immediately and in so doing relieve themselves of the tension of the moment. Afterwards the investor will use 'confirmation bias' to justify his action so as to make himself more comfortable with the idea of living with his decision.

There is no rush to buy a stock. The volatility of the stock market will offer the long term investor many opportunities to invest carefully. Rather than purchase a large position at once, there are advantages to building up a position over time. How you enter a stock position has a lot to do with how you exit the position. The practice of patiently building a position in a stock teaches the investor to be disciplined in holding the stock.

Incubate your stock ideas. When you think you have found an interesting investment opportunity. Sit on it awhile. Read about the company and its management team. Over time new insights will present themselves. It's human nature to jump in and relieve yourself of the uncertainty of the moment (will I or won't I). Let the investment idea develop on its own and allow it to enlighten you over time. You will find you were wise in waiting and when you do finally pull the trigger it will be a more sure handed response to the market environment.

The Current Market Environment and the Unknowable Future

The Current Market Environment and the Unknowable Future

Since the market put in its bottom in the winter of 2016, the markets have performed quite well. But as market upswings mature, segments of the market get overheated and excess optimism usually results. Several trends have emerged in the last 18 months…A lot of money has gone into big-cap growth stocks (the fang stocks). And there has been a ground swell towards passive investing via ETF’s. Big institutions need to have investing vehicles that can absorb all their buying. Big cap growth stocks and passive ETF’s fill the bill. The only problem with that is, once market prices go the other way, they all try to leave by the same door at once causing prices to plummet. Another thing that has occurred is a bottoming and rebound of the commodity sector. The difference is there is a scarcity of supply in the commodity arena, so it should be better able to absorb a lot of buying.

I evaluate the current market environment by tracking the momentum of breadth (advancing volume-declining volume) of the NYSE. Momentum (rate of change) is a leading market indicator and can give information about a market before prices actually turn. The market indexes are little more than a proxy for what all the index huggers (institutions) are doing. Index hugging is primarily caused by career risk in the investment industry. In other words…’we can all go down together but I can’t let them go up without me.’

Now as big as these institutions are; there are still other entities above them in the food chain of influence, money and power. Call them the ‘lords of the playing field’. They are I suppose that one percent or maybe even that one half of a percent that work and control the levers of the truly big money. I like to think that by tracking the momentum of the breadth of the market I can trace their steps and adjust my risk profile accordingly.

According to the breadth of the NYSE, the lords of the playing field have been slowly siphoning their money out of the market. Now I know we all face an unknowable future where more things can happen than will happen, so the only thing left to do is try to manage your risk and be aware of the potential dangers that are currently in this overheated but weakening market.

Has the Capital Cycle turned for Commodities?

Has the Capital Cycle turned for Commodities?

The commodity cycle showed early signs of bottoming in Feb 2016. Sentiment was about as low as you could get and they seemed thoroughly washed-out, suddenly they experienced a very strong up thrust move (impulse move up), leading the entire stock market back up. Check the point and figure chart for copper (copper is a good industrial metal to track for the economically sensitive sectors of the market)…

http://stockcharts.com/freecharts/gallery.html?COPX

Commodities then had a spectacular rally (Canadian market surged) which resulted in an overbought market condition. A counter trend correction then ensued as commodities sold off the sudden excess of money that flowed into it. This correction seems to have run its course in June of this year as momentum started to improve. Check the attached daily chart for the copper complex.

After eight years of monetary stimulus there is plenty of money on the sidelines ready to be put to work. It seems to be going into the economic sensitive sectors of the market (commodity related stocks and economic-sensitive sectors like technology, energy-related stocks, mining stocks and industrials).

The resource based Canadian market is showing clues that it is getting stronger. Canada experienced sharp increases in its five year bond (75 basis points in June and July). Its ten year bond was up 64 basis points over the same period. On top of that the Bank of Canada raised its key lending rate by 25 basis points for the first time in six years. And the Canadian dollar ran up and touched 80 dollars U.S...

Given these signals from the bond market, my feeling is the Canadian stock market has a good chance of outperforming its U.S counterpart in the ensuing months.

Stock Idea…Danaher Corp

Stock Idea…Danaher Corp

Symbol : DHR

Exchange: NYSE

Market Cap : 56.4 Billion

Revenue : 17.4 Billion
Three Year Revenue Growth : -2.6 %
Investment Type : Big Cap Value (Dividend Grower)

Price/Earnings : 26.1

Forward P/E : 18.8

Price/Book : 2.3

Price/Sales : 3.3

Price/Cash Flow : 18.9

Yield 0.65 %

Price : 81.20
Investment Stem : Akre Capital Management

Danaher Corp designs, manufactures and markets professional, medical, industrial and commercial products and services. It markets its products under the brand of Beckman Coulter, Aperio, Dexis, Chemtreat and others.

Danaher Corporation (Danaher) designs, manufactures and markets professional, medical, industrial and commercial products and services. The Company operates through four segments: Life Sciences, which offers a range of research tools that scientists use to study the basic building blocks of life, including genes, proteins, metabolites and cells, in order to understand the causes of disease, identify new therapies and test new drugs and vaccines; Diagnostics; which offers analytical instruments, reagents, consumables, software and services; Dental, which provides products that are used to diagnose, treat and prevent disease and ailments of the teeth, gums and supporting bone, and Environmental & Applied Solutions, which consists of various lines of business, including water quality and product identification. As of December 31, 2016, Danaher's research and development, manufacturing, sales, distribution, service and administrative facilities were located in over 60 countries.

Back in July of 2016 Danaher Corp spun off a separate business now named Fortive (NYSE: FTV). The spin-off made Danaher a predominately healthcare-care focused business, instead of a conglomerate with significant interests in industrial markets. The company operates in four segments: Life Sciences, Diagnostics, Dental, and Environmental & Applied Solutions. Life Sciences is the largest contributor to revenue at 32% or $5.36 billion. This segment has been a focus for management over the past 2 years, and revenue has grown 62% in 2016.

The main driver of this growth is from the acquisition of Pall in August of 2015 for $13.6 billion. The Pall acquisition brought an innovative industry leader in air and water filter technology. Management has employed growth through acquisition, but has come at a cost by adding significant leverage of $8.1 billion in debt.

The Life Science segment provides products and services that support pharmaceuticals, aerospace, and semiconductor industries. Under the segment the company operates multiple businesses from leading provider in microscopes and scientific medical instruments, to high-tech filtration, separation, and purification applications. Higher sales volumes and cost restructuring savings grew organic revenue and expanded operating income.

The Diagnostics segment supplies products and services for biomedical testing, point-of-care testing, pathology optimization, and blooding testing. All of these products help serve laboratories and hospitals diagnose and treat diseases. Demand in the U.S. was soft in 2016, but was more than offset by high growth markets like China. Diagnostics revenue increased 4.5% in 2016 on a 2.5% organic increase.

Dental develops and manufactures dental chairs, x-ray machines, laboratory equipment, and dental implants; basically a wide range of products that help treat teeth and gum disease along with helping people with their smile. Operating margins expanded 150 basis points on top of 2.5% organic growth in 2016, offset by .5% currency.

The Environmental & Applied Solutions business provides a wide range of analytical instruments, software and related consumables, disinfection systems, and industrial water treatment solutions. Revenue increase nicely at 3% organic growth, half was offset though by -1.5% foreign currency headwind. The operating profit margin profile of this segment is much different than the other three segments at 23%, 800 basis higher.

The dreaded metrics from Morningstar…

http://quote.morningstar.ca/Quicktakes/stock/keyratios.aspx?t=DHR&region=USA&culture=en-CA&ops=clear

The company’s website…

http://www.danaher.com/

Article from seeking alpha…

https://seekingalpha.com/article/4080723-one-year-later-post-spin-danaher-corporation

Danaher business lines provide a diverse revenue base that doesn't compete in many commoditized markets. With less commoditized products comes less competition, but innovation and meeting customers needs is crucial in keeping their moat.

High switching costs allow Danaher to benefit from supplier power. Supplier power is the leverage the supplier has over its customers mostly on pricing. With Danaher large equipment install base within the Life Science and Diagnostics segments, allows additional sales to funnel through to consumables. Danaher is a specialized supplier because of the innovative products and services the company provides to its customer base.

Danaher isn't an industry leader of any of the markets it operates in, but has strategically acquired many companies over the past two decades that have provided high returns on invested capital. With these acquisitions, the company has benefited from economies of scale through selling, inventory, and distribution efficiencies.

The company is emerging from a transformative period. On July 5, 2016, Danaher split into two companies, the ongoing Danaher and the new Fortive (NYSE: FTV). Fortive is an industrial growth company comprised of Danaher's former Professional Instrumentation and Industrial Technologies businesses. Danaher is now more focused on medical technology. Danaher is a quality big cap dividend grower run by share holder friendly management. A good way to play global growth in the medical technology sector of the world economy.

In lieu of the recent weakness in the market breadth of the NYSE, it might be a good idea to hold off buying the stock until the November/December time period.

Stock Idea…Tecsys Inc

Stock Idea…Tecsys Inc

Symbol : TCS

Exchange: TSX

Market Cap : 172.0 Million

Revenue : 68.0 Million
Three Year Revenue Growth : 13.7 %
Investment Type : Small Cap Emerging Growth

Price/Earnings : 27.3

Forward P/E : 21.3

Price/Book : 5.7

Price/Sales : 2.4

Price/Cash Flow : 16.8

Price : 13.15
Investment Stem : Mawer New Canada Fund 
                                Cheap Small Caps Screen

Tecsys Inc is engaged in the development, marketing and sale of enterprise-wide supply chain management software for distribution, warehousing, and transportation logistics. It also provides related consulting, education and support services.

Tecsys Inc is a Canada-based company engaged in the development, marketing and sale of enterprise-wide supply chain management software for distribution, warehousing, transportation logistics and point-of-use. The Company also provides related consulting, education and support services. Its Supply Chain Platform with Visual Content is a technology for optimizing warehouse management operations. It offers various services, such as project management, customer support, training and technical services. The Company also offers Supply Chain Modeling And Reference Tools (SMART), which is a supply chain knowledge product. In addition, the Company offers business consulting services, including warehousing and inventory management, transportation and logistics, procurement planning, business intelligence, accounting and finance, and business process re-engineering. The Company provides hosting solutions. The Company caters to healthcare systems and high-volume distributors of discrete goods.

Tecsys Inc. is a provider of innovative supply chain management software solutions to streamline operations, reduce costs and improve customer service for distribution businesses. Its solutions touch warehouse management, distribution, transport management and purchasing & planning.

Tecsys' business has two major business lines: Complex Distribution and Health Care.

The Complex Distribution segment involves organizations that use a complex network of warehouses, distribution channels and multiple products and formats. Management has estimated this total market was worth $3B in 2014 and is increasing at a CAGR of 10% until 2019 based on Gartner estimates.

The dreaded metrics from Morningstar…

http://quote.morningstar.ca/Quicktakes/stock/keyratios.aspx?t=TCS&region=CAN&culture=en-CA&ops=clear

The company’s website…

http://www.tecsys.com/

Cash flow positive (and that's free cash flow) with no debt. Pay a dividend as well, that's rare for a company this size. Cash return of a sparkling 5.6 per cent. The Canadian 10 year bond is just over 2 per cent I think. A substantial premium. The stock seems to be a comer.

BNN comments

Robert McWhirter
(A Top Pick July 21/16. Up 8.81%.) They make the lives of hospitals more efficient with some of their supply chain management work. A high recurring revenue. Earnings are expected to double by April 2018, going from $.24-$.51, giving you a 22X PE. They are free cash flow positive. ROE is very good at 24%. Feels this still has further upside.

Robert McWhirter
This is in the hospital supply chain management. It has roughly $120 million market cap. They have 2 new modules, one for in-house pharmacies in hospitals, as well as operating rooms. It keeps track of where all the stuff is. That has doubled the revenue potential per hospital. Their pipeline sales over the last year has increased by more than the factor of 3. Year-over-year sales were up 26%. Year-over-year earnings, free cash flow and EBITDA grew over 32%. Dividend yield of 1.21%.

 Colin Fisher
(A Top Pick March 16/16. Up 13.87%.) This is a great management team that has been around for a long time, and own quite a few of the shares. There was some weird selling pressure at the end of last year. He expects to see growth on a continuing basis.

Life Cycles of Companies...Mature Companies (Large Caps) Four

Life Cycles of Companies...Mature Companies (Large Caps) Four

Non-operating Assets

A significant chunk of a firm’s value comes from its non-operating assets (cash, marketable securities and holdings in other companies). While cash and marketable securities are by themselves neutral investments, earning a fair rate of return (a low one, but a fair one given the risk and liquidity of the investments), there are two scenarios where a large cash balance can be value destructive. The first is when cash is invested at below market rates. The second arises if investors are concerned that cash will be misused by management. Returning cash to stockholders in the form of dividends or stock buybacks will make stockholders better off. Then again if the management team has a history of efficiently allocating the companies capital (acquisitions) to enhance shareholder return , the stockholders will again benefit. So once again it depends on who is managing the company and their history of handling the firm's excess capital.

Firms with substantial cross holdings in diverse businesses may find these holdings being undervalued by the market (the conglomerate discount). Spinning off or divesting the cross holdings often exposes their true value benefiting both the parent company and its stockholders. 

Spinoffs or divestitures are a particularly interesting subject and I will have more to say about them in a separate blog post.

Life Cycles of Companies...Mature Companies (Large Caps) Three

Life Cycles of Companies...Mature Companies (Large Caps) Three

Financial Restructuring

Two aspects of financing affect the cost of capital, and through it the value that we derive for a firm. First, we will look at how changes in the mix of debt and equity used to fund operations affect the cost of capital. Second, we will look at how the choices of financing (in terms of seniority, maturity, currency, and other features) may affect the cost of funding and value.

The trade-off between debt and equity is simple. Interest expenses are tax deductible and cash flows to equity are not, making debt more attractive, relative to equity, as marginal tax rates rise. Debt can also operate as a disciplinary mechanism on managers in mature firms; managers are less likely to make bad investments if they have to make interest payments each period. Debt on the other hand has its own disadvantages. The first is 'expected bankruptcy cost', since as debt increases, so does the probability of bankruptcy. One direct cost of bankruptcy is incurring legal fees and court costs, which can be exorbitant and eat away at the value of a firm. But worse still is the effect of being perceived as being in financial trouble: Customers may stop buying your products, suppliers may demand cash for goods, and employees may abandon ship, creating a downward spiral for the firm that may destroy it. 

Another disadvantage of debt is 'agency cost', arising from different and competing interests of equity investors and lenders in a firm.  Equity investors see more upside from risky investments than lenders do. As lenders become aware of this conflict of interest, they protect themselves by either writing covenants into loan agreements or charging higher interest rates. This trade off forces management to consider both the costs and benefits of taking on more debt.

The optimal financing mix is one that minimizes a company's cost of capital. The amount of a company's sustainable cash flow will help determine the optimal equity/debt balance of a firm. The more stable and predictable a company's cash flow and the greater the magnitude of these cash flows - as a percentage of enterprise value - the higher the company's optimal debt ratio can be. And because the main advantage of debt is the tax benefit, the higher the tax rate, the higher the debt ratio should be as well.

The senior management of a firm has to consider the above capital requirements of its firm and try to find the right balance to enhance long-term shareholder value. This only underlies the importance of a company's free cash flows (ability of a company to self-fund) and its return on invested capital (ability to create value over time).

to be continued...


Resources

The Little Book of Valuation

Aswath Damodaran