PHIL TOWN

RULE ONE, GRAY, BLACK, WHITE AND CERTAINTY

Rule One demands of us the determination to eliminate gray; to never invest in a business that we don't fully know.  We keep it 'black and white'.  

By 'black and white' I mean we insist on clarity.  Unfortunately, Clarity is a subjective experience.  When I was teaching my kids to hunt, I taught them to make sure they could see and identify what they were going to shoot at.  They had to know it was a deer and not something else.  With a weapon that can kill there is no room for gray uncertainty.  You have to know.  But only they can see what they see and know what they know.  I can see its a deer but if, from where they are sitting, they don't see it clearly, they can't shoot.  

Rule One investing is like that.  I can eliminate all the businesses about which I am uncertain.  This may be a different list than yours.  Rule One demands certainty but that certainty is sure to be subjective.  

We try to make it as objective as possible:

Will the business will be around for decades in the future (Meaning)?

Will it continue to have a durable means of preventing competition (Moat)?

Is it run by honest, owner-oriented people (Management)?

Good objective questions to which I can only answer subjectively, yes or no or I don't know.

If I don't know about one of these then I can't invest.  

You solve for gray by educating yourself on the business until either you realize this business will remain gray to you or it becomes black or white.  Most businesses will be gray or black.  A few will be white.  Be patient and buy those when they are on sale and forget about the rest.  Even if I'm buying them.

Now go play.

JASON AND ABE ON TEVA: GENERIC PHARMA WITH A BIG MOS. MAYBE.

Jason Klein and Abe Silk got together on TEVA Pharmaceuticals, an Isreali generic drug company that has some great numbers and a big MOS.  Here's what they found so far:

 

Meaning:  

 

With headquarters in Israel, Teva Pharmaceutical is the world's largest generic pharmaceutical manufacturer, with operations in 60 countries. Teva operates 38 finished dosage sites, 15 research and development centers, and 21 active pharmaceutical ingredient manufacturing sites. The company also develops and sells branded pharmaceuticals, including Copaxone, one of the world's leading multiple sclerosis drugs, and Azilect, a treatment for Parkinson’s disease.  

 

[This section requires us to show we understand the industry – particularly how these businesses compete with each other.  What is it that, if you were going to start a new pharmaceutical company you’d need to know to be successful?  I’d say something like: Pharmaceutical companies compete with a pipeline of patentable drugs.  Since most broad market diseases have drug solutions, it is getting harder and harder to come up with new drugs.  Teva is making a claim on being the low-cost generic provider, off-setting the cost and risk of its proprietary pipeline.  The key to being successful in their business is ……??????] 

 

Moat: 

 

Teva is a Rule 1 stock by the numbers. A possible red flag is a noticeable downtrend in all five year numbers as compared to their ten year numbers, with the exception of ROIC. This downtrend should change in the near future, though, due to expiring pharmaceutical patents and rising demand from the aging worldwide population.

ROIC: 13% (10yr); 13% (5yr);

BVPS: 25.5% (10yr); 21.5% (5yr);

EPS: 29% (10yr); 22% (5yr)

Sales: 16.5% (10yr); 16% (5yr)

Cash Flow: 25% (10 yr); 20% (5yr)

These numbers point to a clear moat, which upon some investigation seems to stem mainly from economies of scale.  Teva is by far the biggest generics company on the planet, with more than twice as much revenue as the next biggest generics company.  Teva is also in constant legal action to protect its drugs, which serves as another sort of moat.

 

[Note:  Pretty good section.  Legal action is indeed a help with its price moat]. 

 

Management:  Since Teva is a foreign company, it’s very hard to get information on their executives’ compensation levels. I wasn’t able to find anything. This presents something of a red flag, though I don’t have a ton of experience investing in ADRs so this may be par for the course with foreign companies. Israel, however, is a highly developed first world country, so it’s not exactly as if this is an emerging market investment.

Dr. Philip Frost is the Chairman of the Board, and he got his BA from the University of Pennsylvania, and MD from the Albert Einstein College of Medicine. CEO Schlomo Yanai has a degree from Harvard Business School, and then spent 31 years as a 4-star general in the Israeli defense force.  This tells us that the man certainly knows how to lead.  CFO Eyal Desheh has a BA and MBA from the Hebrew University in Jerusalem, the top school in Israel. While these execs possess an impressive academic pedigree, in the larger scheme that doesn’t mean that much more than they were good students. Perhaps Phil can provide more information about evaluating management of foreign companies.

 

[NOTE:  This is always a tough section but more so for foreign companies, but if you google these guys there is a lot there including Wiki articles.] 

 

Margin of Safety:

The analysts’ 5-yr growth rate is 18.8%.  The 10-yr PE values range from 29 to 12, with the historical average PE being around 20.

 

In my opinion both the BVPS growth rate (25.5%) and the analysts’ rate are far too high.  We  don’t want to be that optimistic. Being conservative, but still factoring growth from drugs going off patents, I chose a growth rate of 13.5% and a future PE of 24 (reflecting anticipated growth from sales + patent expirations), we get a Sticker Price of $70, so our Margin of Safety price is $35. TEVA is currently selling at 37.5, and has a 2.5% dividend, which has been and ought to continue to grow quickly along with earnings.

If our growth rate is reasonably accurate, it would give us a payback time of 7 years.  As a matter of fact, even if Teva grows at “only” 10% annually, its Payback Time is still 7 years.  This clearly is another way of representing Teva’s solid MOS.

 

[Note: This is well argued.]

 

Story  

 

Teva certainly has a few significant tailwinds at its back.  With $31.9 billion of drugs losing patent protection in 2012 alone, Teva stands to be one of the big winners as the 800 pound gorilla in the generic space.  The next few years after 2012 are also set to be big patent cliff years, with blockbuster drugs (including Lipitor and Lexapro) set to go generic.

Another tailwind is the aging of America.  As the baby boomers enter their later years, they are certain to consume more prescription medications.  This should prove to be a strong, lasting trend that benefits Teva out to the later years of this decade, if not beyond.

One final part of the story in Teva’s favor is its geographic expansion.  Teva has been expanding its footprint aggressively into parts of the world where generic penetration is low, with an emphasis on Latin America and Japan.  This certainly opens up the door for significant growth.  

 

Red Flags

 

A red flag for Teva is that it is losing patent protection on its biggest branded drug, Copaxone, the current market leading drug for multiple sclerosis.  Although management pledges to more than make up for this loss with an extremely robust pipeline (along with a new MS drug that is currently in testing), it still must be taken into account that Copaxone makes up for a very significant percentage of Teva’s revenues.  

 

[Do they break out how much of revenues and earnings are Copaxone in their SEC filing?  If not, can you find an estimate from elsewhere?  Here’s where I spend the $$ for a good analyst report because if Copaxone is a large part of revenues we have to figure out where the company will be after it goes generic.  Have to.]

 

Another red flag is that the pharmaceutical industry is an arena for aggressive legal action between its major players.  Although Teva is well-diversified (and becoming much more so through acquisitions), there is still a looming threat that a judge might rule against it in some major case.

 

[So it’s a red flag.  Is it a real problem?  If so, is it a deal killer?]

 

ADDITIONAL COMMENTS FROM PHIL

You can see from the Tools that the Big Four growth rates are, in fact, sliding a bit but Abe and Jason accounted for the slide in their growth projection.  They raised the issue of Return on Capital and you can see why.  The numbers are barely acceptable.  Still, its predictability we look for at a price.  If we can buy this well and we like the story, we can live with these numbers.  Debt, which they didn't comment on, is low.

However when we dig deeper into the numbers there is a problem.  Here's the detail from the Tools:

Notice the sudden jumps in EPS?  The problem is that the latest EPS numbers are not steady.  They jump.  Jumping makes things a bit unpredictable.  More than a bit.  This can create real opportunities for us since a bad quarter will cause the Big Guys to bail and the price to crater.  That said, if we start the MOS valuation analysis with an outsized EPS, we can end up with an excessive amount of growth.  Still, even if we do start high, Abe and Jason are using a much lower EPS than warranted by even these numbers.  Let's just note the issue and ask about it. 

NOW to where the rubber meets the road, The Valuation Tool:

 This tool does an analysis of analysts (is that english?) projections for TEVA and it comes up with a 10.4% growth rate, not the 18% that our guys found and lower than their 13.5%.  If we go for the lower number, we'll be using a lower PE, too - 20.8.  And that gives us a Sticker Price of $48 with a $24 MOS and a $37 price.  There is a bit of an MOS but the all-important 8-year Payback Time is at $45.  That means that even at the lower growth rate and PE, this company still gets a margin of safety because as Abe and Jason said, at the lower growth rate of 10% we still get a 7 year Payback and that's awesome.

 

I like this company.  I'm not ready to roll yet, but I like it so far.  It might be a better way to go than Merck.  I'll let you know if I buy any.

 

Thanks Jason and Abe,

 

Now go play.

RULE ONE AND THE DIVERSIFCATION MYTH

Will asked "Is there anything wrong with adding a certain level of diversification? Maybe split up your capital across 3-5 different companies in different industries? Isn't diversification considered the only free lunch? I am not talking about a basket of 20 stocks. But doesn't some diversification make sense? I just think that you can do everything right and still have an unforeseen event sink your battle ship. Like a natural disaster that wipes out your company. Or a misinformed short selling attack out of nowhere that may be totally false but can wipe out half your investment."

 

The short answer is that diversification in general is overrated but 3-5 businesses is hardly diversification by the standards of the financial services industry.  If you are managing someone else's money and are not a genius and do not want to be criticized by their accountant, you'll spread their money across cash, bonds, real estate, commodities and stocks and call yourself a pro.  And you'll also have about a snowball's chance of producing a significant return on invested capital.  

 

If are managing your own money and want to be and stay rich, I’d recommend doing what the best investors in the world do - focus your portfolio on businesses you understand that you know you are buying cheap and let the diversification happen naturally.   

 

It is worse to be in things you don't understand than to be un-diversified in industries you do understand.  If you're doing your work well, you shouldn't have an industry-wide permanent bad surprise.  [NOTE:  This assertion does not extend to the tech industries.  It is in the nature of tech to have massively disruptive technology appear as if out of nowhere.  Beware tech for that reason.  It also does not extend to fraud.  If your CEO is lying to you, you are screwed.  That's why the third M is Management - honest, passionate, owner-oriented management.]  

 

The number of stocks I own, and thus my diversification, such as it is, will ebb and flow as I find great businesses to buy.  Sometimes I have ten stocks. Sometimes none.  I buy real estate like I buy businesses.  Same Rule One rules.  And commodities like Gold?  I hedge by trading like I showed you in my first book, Rule #1.

 

The amount you're investing matters, too.  With $1000 you can buy one stock.  Trading friction will eat up your return otherwise.  With $100,000 you can do 5 to 10 if you can stay on top of that many.  Lou Simpson ran Geico's $2 billion fund until last year.  He had an average of 8 stocks.

 

For Rule One investors, diversification is a by-product of finding companies to buy.  Company A is cheap, I buy it, it goes up and its not cheap any more and I'm done buying but I still have money to invest.  I find Company B.  It goes up and its not cheap any more and I'm done buying but I still have more money to invest ....  And so it goes.

 

I’d argue that diversification is not at all a free lunch.  I think it costs quite a lot in time and education to be able to successfully buy businesses in many industries and across asset groups.  I think it’s a better, safer investment strategy to buy one right thing over and over again than many wrong things once.

 

Novice investors who are concerned about losing money on their first investment should not invest more than they can afford to lose.  Or, even better, not invest at all.  Just paper trade until their confidence goes up to a point where they sleep well at night knowing the bought a great company.  

 

Getting to a place where you are comfortable takes time.  If you are investing a million dollars that you can't afford to lose, you might take a few years to get to where you are comfortable with that responsibility.  Until then, either sit in cash or diversify by buying market wide ETFs like SPY or trade carefully and gradually add great businesses that you know you understand.

 

Now go play.

 

ABE ROCKS A WALGREENS PAYBACK TIME AND DIVIDEND PLAY

Let me introduce another member of the Rule One investor community - Abe Silk.  Here is his Rule One analysis of an old standby great company, Walgreens (WAG).  I've re-arranged a few paragraphs to fit my 4M model, added some comments and put additional comments at the end:

MEANING:  

Walgreen Company, founded in Chicago in 1901, is the largest drugstore chain in the United States, and provides access to consumer goods and services and pharmacy, health and wellness services in through its retail drugstores, Walgreens Health Services division and Walgreens Health and Wellness division. Walgreens Health Services offers pharmacy patients and prescription drug and medical plans through Walgreens Mail Service Inc., Walgreens Home Care Inc., Walgreens Specialty Pharmacy LLC and SeniorMed LLC (a pharmacy provider to long-term care facilities). Walgreens Health and Wellness division includes Take Care Health Systems.  Walgreens has a pretty clear meaning: It’s one of two ubiquitous drugstores in the country that is trusted by tens of millions of people each year. With seniors living longer and baby boomers reaching retirement age, there’s sure to be a strong demand for prescription drugs and pharmaceutical items for years to come.  Walgreens has 7,733 drugstores as of June 30, 2011, and operates 8,210 locations in total across all 50 states, the District of Columbia and Puerto Rico. In 2010, pharmacy contributed 65% of sales (3rd party, 95.3% of Rx); and other general merchandise, were 35%. Stores average $8.9 million in annual sales. The company has about 244,000 employees.   

[NOTE: How about telling us what a company has to do to compete in this industry?  That's the real point of Meaning - proving we know enough about the key issues of making a successful business in this industry.  This gets shorted way too much in our analysis.]

Moat:  Walgreens certainly faces stiff competition. In addition to major competitor CVS, there are also smaller pharmacies like Rite Aid and Duane Reade. Supermarkets and big box stores such as Target and Wal-Mart offer pharmacies as well, and mail-order pharmacies have become increasingly prevalent.  Still, Walgreens has locations nearly everywhere, and convenience is a huge advantage in the retail pharmacy market. It also has a strong brand and a loyal customer base.  

WAG is absolutely a Rule 1 stock by the numbers. Its Big 5 are beautiful and remarkably consistent. 

ROIC: 16% (10yr); 15.2% (5yr);

BVPS: 15% (10yr); 12.5% (5yr);

EPS: 13% (10yr); 10% (5yr)

Sales: 13.5% (10yr); 12.5% (5yr)

Cash Flow: 14% (10 yr); 12.5% (5yr)

 [NOTE: Starting with the numbers is a good way to determine that a moat might exist.  Good numbers mean there must be some kind of moat. Its important to see whether there is a decline in the numbers as you go from long term to short term.  In this case there is a definite decline in evidence.  We need to not only see it, but to understand what we're seeing and then ask the pertinent question: Is this a company with permanently slowing growth?]

Management:  Gregory Wasson is WAG’s President, CEO, and Director, who joined the company as in intern in 1980. In 2010 he earned a base salary of $1.06 million, and took home just over $8 million in total. Alan McNally is director of the board and made grand total of just under $1.5 million. Wade Miquelon is the CFO and Executive VP, and he made $3.5 million. None of these totals are out of line with a company of Walgreen’s size (~$28.7 billion market cap), and a Google search netted no negatives about these executives.

[NOTE: I agree that management income is important as a way to judge their purpose.  I wonder this: are employees being squeezed for every nickel at WAG while their leaders enjoy princely retainers regardless what the industry standard is?  Isn't leadership about setting an example, taking the moral high ground?  I'm just saying....]

Margin of Safety:

The analysts’ 5-yr growth rate is 12.6%.  The 10-yr PE values range from 46.4 to 13.9, with the historical average PE being 26.

Using the more conservative growth rate of 12.6%— the analysts’ rather than the BVPS— and a future PE of 25, we get a Sticker Price of $59.50, so our Margin of Safety price is $29.75. Walgreens is currently selling for $32.22, and has been in something of a free fall over the past 6 months due to problems with its deal with Express Scripts (ESRX). It seems as if this may be a prime buying opportunity—I’ve seen similar sentiments on Seeking Alpha and elsewhere.

It should also be noted that the stock has a 2.5% dividend, but to be honest, I’m not really sure how to use that in my valuation. A healthy dividend is certainly not a bad thing, though, and the dividend was raised just last month.

Possible Red flags:

Walgreens has been around for 110 years, and it won’t be going anywhere for awhile. Still, there are a couple of red flags. Competition is an issue, though Walgreens is so large that it should be able to compete with anyone on price due to economies of scale. Also concerning is uncertainty around healthcare reform, though the demand for prescription medicine is practically certain to rise in the near-to-medium term future, so this concern is mitigated considerably as well.

[NOTE:  I really like it that Abe put this section in.  We should include it from now on - a section that tells us what can go wrong with the STORY.  I want to see a new section called STORY.  We have to have a STORY about the company.  What makes this good to buy (or short) at this time.] 

ADDITIONAL COMMENTS:

Thanks for the thoughtful and rational argument in favor of a WAG buy, Abe.  Let’s talk about the projected growth rate of 12.6%.  While it is a lower number than the historical BVPS, its lower than the 5 year EPS growth rate of 10%.  Here’s another view of the numbers from my Toolset (coming next week, so they tell me):

 Notice how these great 'green' numbers turn 'yellow' at the 3-year point?  This slide down is continuing with mixed results in the 1-year numbers.  Analysts are hanging a big number up there for a company that is this large with this much of a slide.  I'd be more conservative here and project something like 10% with a 20 PE. 

What I’d ask you to do, Abe, is to try to tell me where the growth is going to come from that will double the earnings of this business in the next 6 years (which is what a 12.5% growth rate will do).  Once we know that we can feel a whole lot more secure that the analysts aren’t sucking up to Walgreens management so they can get an investment banking deal.  Unfortunately it’s the nature of the industry so we have to account for it particularly when it’s a big company that may have hit the limits of growth. 

Here's the Toolset Valuation tool analysis of WAG:

Note that the Sticker Price is $38 with a $19 MOS using my estimate of future long-term sustainable growth.  That would make it a bit pricy at today's price of $33.  However, notice that the Tools show a 7 year Payback Time price is $31.  That's a wonderful payback time and a great price for a really good company.  That makes this quite buyable at $32.

Regarding the dividend: This might be the secret formula for this business.  If WAG is slowing its growth and its stock price is suffering accordingly as the Big Guys bail (since there may be anemic growth in the near term) WAG management may decide the best place for the free cash flow is back in the pockets of the owners of the company – the stock investors.  Let’s take a look at how fast they are increasing the size of their dividend.

Notice that the dividend has 2.5 doubles in 10 years.  That's a double every 4 years and produces about an 18% growth rate for dividends.  

The dividend is growing from increasing free cash as well as buy backs.  Note the number of shares of stock is going down meaning there is more cash per share for dividend payouts:

Watch what this does to our Basis (the amount we have in the stock at any point in time):

Start with current dividend of $0.75 and grow it at 18% per year.  That's a double every four years, right? So in 4 years the dividend is at $1.50, in 8 years its at $3 and in ten it grows to about $4.50.  You can add up this growth on an excel spreadsheet and see what it does to the Basis - what we still have in the stock after cash flows reduce our original investment:

33% per year cash on remaining cash return in ten years is huge.  I love the concept of reducing basis. That's why I really like the looks of WAG.  

Of course, these are just projections and are going to be wrong in some sort of way, either too high or too low, but I think they are reasonable and point to WAG as being more than a little interesting right now.

Now go play.

 

MIKE THINKS GILDAN (GIL) DESERVES A RULE ONE EVAL

Mike has been kind enough to put his thoughts forward on Gildan (GIL).  This is a nice job of Rule One analysis.  I like it that he Red Flagged some issues for us.  In particular I like it that he nailed down the moat.  See if you see what it is (and my comments follow):

 

Hi Phil,

I have been unable to post to your blog for some reason, so I am e-mailing my blog post in hopes that you could review it and have it posted for the community to comment on my analysis.   I have been investigating a basic apparel company called Gildan (Ticker: GIL).  This appears to be a great company that is growing and taking market share…and at the current price, it might be a buy.  Here is my analysis:

Background:  According to its 2010 annual report:

“Gildan is a vertically-integrated marketer and manufacturer of quality branded basic apparel.  The Company is the leading supplier of activewear for the screenprint market in the U.S. and Canada.  It is also establishing a growing presence in Europe, Mexico and the Asia-Pacific region. The Company sells T-shirts, sport shirts and fleece in large quantities as undecorated “blanks”, which are subsequently decorated by screenprinters with designs and logos. Consumers ultimately purchase the Company’s products, with the Gildan label, in venues such as sports, entertainment and corporate events, and travel and tourism destinations.”

In my view, Gildan is a t-shirt company; however, in reality it is much more than that (see Gold Toe socks, underwear, and they are implementing a “strategy to become a major full-line supplier of basic family apparel in the U.S. mass-market retail channel.”).  Its core business is the U.S. screenprint market, and Gildan-branded products are now sold in over 5,000 retail outlets across North America.

Management:  Glenn Chamandy is the current CEO, one of the founders of the company, and one of the largest shareholders.  His base salary of $752,371 and was awarded a performance bonus of $1.5 million. Laurence G. Sellyn is the executive VP and CFO.  His cash compensation is $463,500.  Michael R. Hoffman is the current President and has been since 2004. His cash compensation was approximately $314,505.  Based on my Google searching, I could not find any negatives regarding the corporate officers or the company.

Meaning:  It must be the kid in me, but I personally love high quality t-shirts.  There is nothing worse than losing an old trusty t-shirt that you enjoy wearing (kind of like Golden Boy on Seinfeld!), especially after wearing dress shirts and ties all week!  Plus, understanding a t-shirt business has to be easier than say a Rimm (yeah, I bought it like a sucker because I was too focused on the view out the back window!)

Moat:  Hmmm.  This is one of the points on which I have struggled.  Gildan is a well-regarded brand in the industry that produces quality t-shirts, but not well known by consumers.  Heck, my friends wear Gildan products all of the time and have no idea.  Indeed, their name-brand recognition is not as great as some competitors such as Hanes and Fruit of the Loom.  Make no mistake though, Gildan is the dominate player in its markets and it seems poised to continue it growth.  Its U.S. wholesale distributor channel has generally been increasing (e.g., from 56.6% in 2009 to 64.1% in 2010; however, in 3Q of 2011 market share did slide to 61.1%). 

Some of its competitors include Hanesbrands Inc., Berkshire Hathaway Inc. through its subsidiaries Fruit of the Loom, Inc. and Russell Corporation, and smaller U.S.-based manufacturers, including Anvil Knitwear Inc., Alstyle Apparel, a division of Ennis Corp., and Delta Apparel Inc.  Many of these are well-known brands, so competition is surely stiff, but Gildan seems to have a greater share of the market.

Margin of Safety:

Gildan almost meets the requirement of having growth rates in excess of 10% for a 10 year period.  The one miss is in free cash flow, which stems largely from 2001.  (this number will not be factored into the equation once we get into 2012).

ROIC: 13.5% (10yr);

BVPS: 18.6% (10yr);

EPS: 206% (10 yr); 26% (5yr)

Sales: 12% (10yr)

Cash Flow: -52% (10 yr); 32% (5yr)

The analyst’s 5-yr growth rate is 20.62%.  The 10-yr PE values range from 12 to 28, with the historical average PE being 19.2%.

Using the more conservative 18.6% growth rate (i.e., BVPS %) as opposed to the analyst’s rate of 20.62%, and a PE of 19.2%, we get a Sticker Price of $53.05, so our Margin of Safety is $26.53.  Gildan is currently selling for $26.62, and has recently been trading between the $25-$27 range. (On a more conservative note, we could use the lower 2010 PE of 15.8 which lowers the sticker price to about $43, with a MOS of $21.  Hence, this company would be slightly too expensive to buy right now, but still very close to being a buy).

Possible Red flags:

The main red flag that I saw was that Gildan is in a business that relies heavily on offering the best/lowest price.  The 2010 annual report states: “Competition is generally based upon price, with reliable quality and service also being critical requirements for success.”   I believe Phil has warned us to be wary of companies that compete on price to win customers.  Unlike the Ralph Laurens of the world that can charge and get top dollar, Gildan is much more limited in this regard (as is a Jos A. Bank – a company that I really like, but have never bought because they rely so heavily on sales and discounts such that they have trouble getting anyone to ever pay retail for their goods.  But that’s a post for another day because I do believe Jos A has a brand moat and is worth a closer look).

Part of Gildan’s profitability is tied to the cost of cotton, which recently has been very high – Gildan’s cost of cotton in the third quarter was approximately U.S. $1.25 per pound, compared to U.S. $0.64 per pound in the third quarter of fiscal 2010). However, the company reported “the impact of higher net selling prices on percentage gross margins offset the impact in the quarter of the higher cost of cotton.”  On the plus side, the company expects cotton cost during Q1 and Q2 of 2012 to be lower than in 2011, which will be good for the company’s margins and bottom line.

The current economic uncertainty has also caused the company to lower 4Q (2011) guidance slightly, but it has also announced a dividend to show its confidence in its future growth.

The company ended the recent 3Q with $252 million in debt because they recently acquired the Gold Toe brand.  This should not be a problem because Gildan was carrying no debt prior to the acquisition, and has sufficient cash from operating activities to pay down the debt (the company generated $95 million in the first 3 quarters of 2011).

So, is Gildan a Rule One buy?  Or am I making a mistake because this is too much of a commodity business with low margins that competes on price, such that Gildan should only be traded rather than stockpiled?  I would love to hear your thoughts.

-Mike

MY COMMENTS:

Looking at the Moat and Management numbers from my tools, its easy to see why Mike is attracted to this company.  These are really spectacular numbers that score 100% across the board.  Not many companies do that well.  So far, this is definitely Rule One material.

  

Sometimes the overall numbers get skewed by having a great last year.  We check for that by looking at the raw data, which in this case is fairly consistent with the past and moving up at about 16% per year:

I used a bit lower Growth Rate because it conforms more to what the Tools tell me.

Here's a view of the value using that 16% growth rate.  Note that I used a 25 PE because its the high average PE (that ranges as high as 39 - see below) and my assumption for the sake of setting the value is that we will sell this business in a good to great bull market hence the higher end of its historical PE:

The Payback Time at the Margin of Safety Price is 8 years and the MOS price is right at the current stock price.  In fact, the current price is where it was 5 years ago with some massive volatility in between. Clearly this stock suffers in a recession and hopefully that is what accounts for the low price to value that we're seeing.

Okay, so now what?  Let's dig in on that Moat question.  Is this a durable business model?  The fact that its a Price Moat is fine with me.  So is WalMart.  What I want to know is how they make this advantage durable.  I think they explain it pretty well in their quarterly report but I'd like to know more and that will take some digging.  Mike?  Come on back with as much on why they can beat out Berkshire's companies. And why this is the ONE company I should buy.

 

Now go play.

GREEN MOUNTAIN PRICE AVALANCHE BLASTS MY SHORTS TO THE TOP

We've been blogging about my short position in Green Mountain Coffee Roasters (GMRC).  The question: Now that the stock has dropped from $92 before Einhorn's presentation to $41 today, is it time to take cover the short position and then put on a short-term long position in anticipation of short covering driving up the price.  The short answer is 'Yes', 'No'.

 

I went short at $82 and covered the first part of the position at $57 and the rest of it this morning at $43.  It might go down much farther.  So what's it worth right now?  First, getting to a value of a business depends on finding that it is predicable long term.  Otherwise its a guess.  Predicting long term depends, most of the time, on seeing a highly consistent history of the Big Four numbers: Earnings, Book Value, Sales and Cash.  The reason all four are important is that accountants can get very clever with GAAP accounting to make some numbers better than they really are, but to do so they have to either lie (which requires a conspiracy of executives) or legally manipulate some numbers under GAAP rules.  Manipulation usually shows up as one of the Big Four numbers not on the same slope as the others.  GMCR is a good example of that.  This next image comes from my website (to be released this month).  Each of the Big Four numbers is a line.  All four should be roughly parallel and moving up together.  See if you see GMCR's issue:

Cash, right?  There is no growth in cash.  Einhorn saw that and asked, 'Why?" and his forensic accountants came back with an indication of fraud.  I don't have to know why the milk smells bad to stay away from it.  I just have to know it smells.  In this case, it smelled and Einhorn showed me why.  That became a good short.

 

Let's move on to question #2.  

 

Rule One rules my investing decisions.  Rule One asks this question: "If I do X, how will I Iose money?" In this case, a wave of short covering is certainly going on but its also possible that the Big Guys will now realize the momentum ride is over and sell off, giving the short covering all the room in the world to trade out.  (You have to buy stock to cover a short position.  With the Big Guys selling more than the little guys who are covering are buying, the price still goes down.) That is what's happening this morning.  

 

I covered no problem and the stock price is still going down.  

 

I don't like to buy on speculation because when I ask that Rule One question of an 'investment' that is just a guess (but remember no real investment is a guess), the answer is 'I can lose simply by guessing wrong'.  You will not become rich by guessing.  

 

I shorted GMCR because its price was insane and Einhorn found potential fraud.  Einhorn was an obvious trigger but the facts had to be right and IMHO they were.  I'm now out.  Now the question becomes this: Is there a price that makes GMCR a Rule One buy?  The answer lies answering the first of two basic Rule One questions:

1.  Is it a wonderful business?

2.  Is it on sale?

 

I want to know 3 things to know if its a wonderful business, all of which go to the question of predictability. I call these the 3Ms. Here they are for GMCR:

 

Meaning: I understand the business and how the competitors compete.  The loss of patent protection is a red flag for GMCR.    

Moat: The GMCR secrets and brand Moats are being eroded in a market where brand isn't significant.  This becomes a commodity company and margins go away.  Big red flag.

Management: Management may have ethics issues. Big red flag.

 

Three red flags mean the business may not be predictable.  It may not be able to fend off competitors or its management may not tell us the truth.  Therefore, I can not predict with confidence what its earnings will be down the road.  Since the price I'm willing to pay today is based on tomorrow's predictable earnings, I can't know what the value of GMCR is today.  Therefore, the second question, 'is it on sale?' and the 4th M - Margin of Safety - are impossible to know with any degree of reliability.

 

Therefore, if I stick to the Rule One discipline, there is no price that makes GMCR a company I can own.

 

Remember this: To get rich investing in stocks and real estate you only have to know two things: "Is it a wonderful business? Is it on sale?"  If you don't get a 'yes' on the first one, you can't get a 'yes' on the second.  Do the 4Ms.  Avoid violating Rule One.  Get rich.

 

Now go play.

GARRETT DIGS DIRT ON THESTREETSWEEPER.COM RE BRLI

We have a number of readers interested in figuring out BRLI.  Essentially the question is whether they can sustain their amazing Moat and Management numbers, whether management is honest and whether its a long, short or a Strangle.  Garrett is a dedicated Rule One investor, a pilot for Southwest Airlines and is such a significant contributor its time to read what he has to say occasionally with Posts of his own.  

Enjoy!

Oh Sure Phil! Dump this one on my puny shoulders! :)

 

Well, again, my wife says, "BUY, BUY, BUY"...a little like Cramer...horns going off, whistles blowing...

 

As a Rule #1 investor, I have to do my homework and be patient. As Phil would say, “let the smoke clear” and find out what's really going on here.

I don't have all the answers yet. But I want to share with the community some interesting information.

 

One of the questions I had in my head today was, “Where is Part 2 of the BRLI article that was suppose to follow?”

 

And “Who exactly is profiting from this?”

 

Melissa Davis is the editor of www.TheStreetSweeper.Org and author of “Is Bio-Reference Labs as Healthy as it Seems?”

 

Could it be that Melissa is waiting to maximize her short and then post Part 2 when BRLI starts to recover? Just a hunch. TheStreetSweeper.Org is very clear that they intend to profit from their articles. Disclaimer cited here: http://www.thestreetsweeper.org/legaldisclaimer.html

 

So are they helping the little guy or just trying to pocket from sensationalism and exaggeration?

 

A little background on Melissa Davis may be helpful.

 

I read the article “Melissa Davis of Streetsweepr in Bed with Short Sellers and Convicted Felons” See: http://blog.redchip.com/index.php/stocks/melissa-davis-of-streetsweeper-in-bed-with-short-sellers-and-convicted-felons/#.TriCQfQUqso

 

This article speaks of her work “couched in innuendo, inflammatory language, misdirection, and logical fallacies. Her heavy reliance upon verbal gymnastics and sensationalism calls her motives into question. In our view, this is one “journalist” whose work just can’t be relied upon. “

This same company that came under her disparaging remarks fought back with a the above article and “attorneys have sent a cease and desist letter to Davis and The Street Sweeper for numerous false and defamatory statements concerning RedChip and its employees. “

 

And then some contributors at www.investimonials.com posted their own opinion of Ms. Davis and The Street Sweeper saying, “They have become as crooked as the company they are trying to expose”

 

Her bio definitely appears to be exaggerated regarding her “seven years as one of the top investigative reporters at TheStreet.com”

http://investimonials.com/websites/reviews-the-street-sweeper.aspx

Apparently, she was just writing articles at home.

 

How about folks at Motley Fool? Below is a blog post regarding Ms. Davis and her profiting from sensationalism, poor journalism, and fraud.

http://caps.fool.com/Blogs/the-credibility-battle-and-the/665380

There is an obvious pattern when researching “The Street Sweeper.”

In my opinion, Melissa Davis clearly is into tabloid journalism. She wraps her arms around Jim Cramer and then shorts a stock when he trashes it on his show.

 

Consider this from www.investorhub.com. “I find it interesting that Jim Cramer has his arm around Melissa in a photo on the TheStreetSweeper.org site and he slammed SWSH shortly after her article. How many shares did he short?”

 

Cary Spivak wrote, “Short on Ethics? Two Web sites that investigate business fraud are funded by short selling—placing market bets that the stock of companies they write about will go down. It’s an approach that makes journalism ethicist very uncomfortable.”

 

Apparently, Melissa is in plenty of bad company. There are several web sites masking themselves as investigative journalism whereby struggling journalist have discovered that by shorting a stock prior to their story, they can get rich quick. Barry Minkow has made his living doing this after his stint in prison. I read his book several years ago, called “Cleaning Up”. 

Melissa's web site partner is Hunter Adams.  “Hunter Adams, the brains behind The Street Sweeper (thestreetsweeper.org), helped launch the site last year, just eight years after federal prosecutors labeled him an associate of the Gambino crime family in New York. Adams, who was convicted for his role in a massive "pump and dump" scheme involving penny stocks, is still on federal probation for his crime. “

 

I find it rather hypocritical that Melissa cites BRLI as having ties to the Gambino family when she herself is working with Mr. Hunter who did prison time for his association with the Gambino's.

 

After reviewing several of Melissa's articles, they all follow the same pattern. Short a company, then use the internet, youtube, media, etc to profit by shorting it.

 

I think BRLI is oversold. I'm not interested in anything Melissa Davis and her cronies at The Street Sweeper are saying by profiting from tabloid journalism.

 

I'm going to watch "The Tools." Phil mentioned using an Option Strategy called a Strangle that could be effective. Even something as simple as a basic CALL option may be helpful if indeed BRLI is at the bottom.

I'm more inclined to listen to our BRLI Sales Rep's opinion of MANAGEMENT, my wife's belief in BRLI's MOAT and the MEANING it has to her, and my understanding of its MOS.

 

To Your Wealth!

Garrett

 

RULE ONE-ING BIO-REFERENCE LABS (BRLI) MOAT, VALUE AND TRADES

BioReference Laboratories (BRLI) has been capturing the attention of a number of Rule One investors here.  Its an interesting case study.  BRLI has been a successful company for a long time, growing in excess of 20% a year for 17 years.  Here are the Moat and Management numbers from my Toolbox (to be available this month).  With the notable exception of Operating Cash Flow growth per share, the numbers look very consistent and, therefore, more predictable.  

Here is a view of their value.  The average of the analysts estimates is 18.5%.  The bigger you get the harder it is to double sales and earnings every 4 years (which is what 18.5% requires).  While the larger industry may not be growing that fast, BRLI's pieces of the industry seem to have at least 10% growth built in.  If that is the case, reaching my long term growth number of 15% isn't so unreasonable.  Here's the Valuation chart:

The key numbers are on the bottom right - Valuation Result:  The Sticker is $37, MOS is $18 with an 8 year Payback Time and a Red Zone (Sell) Price of $44.  If they can handle 15% growth, this is a steal.

 

But that's the question, isn't it?  Can they sustain their growth or are they going to slow down?  Here's the negative thesis in yesterday's Street Sweeper article on SeekingAlpha.com.  

 

If we can't resolve the questins about management Mafia connections, systematic over-charging, systematic over-testing and missing cash flow but we still like the company anyway, one way to go is to trade it.  Here's the chart from Interactive Brokers:

The three Red Arrows running vertically on the right side of the chart show when each Tool said to get out.  All three were 'red' on Nov 1 when BRLI lost over 10% of its market cap.  Note that two days earlier the price bumped the Fibonacci Ceiling at $21 and ended the day down  That triggered the Stochastic to go 'red'.  The next day opened down and went down to the Fibonacci Floor and triggered the MACD to go 'red'.  If you were paying attention to these signals you would not have exited the trade but you would have prepared for an exit by putting in a stop loss below the Fib Floor at about a $1 below the close - about $19.25.  (The stock was trading in a dollar range regularly.)  You would have been stopped out at $19.25 as the third Tool, the Moving Average, was triggered.  (See my book, Rule #1, for how to set up these Tools properly.)  Note that the price drop tore right through two Fibonacci Floors, one at $20 and one at $19 and finally hung up at the $17.75 Fibonacci Floor where it opened and closed on Nov 2 and then opened and dropped today.  The next Floor down is at $16 and I note that the stock finished trading today at $16.86.  Also note that the last trip down to this price level the price stopped at $16.65.  That can be taken to mean BRLI is at or near the end of its plummet.  However, with Volume running at 3X normal, this might not be over.  Supporting that view is today's full candlestick with no wick at the bottom.  

 

The advantage to trading a company you like that is under attack is that you can follow the money in and out with lower risk than if you take a position but its only relatively less risky.  The disadvantage is that a stock this volatile can run up faster than the signals can react.  You can get whipsawed - buying just after the run up and holding through the drop, then selling just as it runs up again.  Still, using the Tools the way I indicated here would have saved some pain in this case.

 

Now go play.