PHIL TOWN

Phil Town on Meaning - Reap What You Sow

I got this letter a couple days ago from Mark that I want to share with everyone. He has a question about one of the 4M's from Rule #1 - Meaning.

Hi Phil Town.  My name is Mark and I've been doing my best to learn as much as possible about Rule #1.  One of your big tenets is Meaning.  What does the company mean to me?  I'm not entirely sure I'm all the way on board with this idea as my main goal is making money, and even an "Evil Empire" like Exxon or their ilk can make a guy a boat load of cash.
 
But I read one of your blog posts about how Karma can come back and haunt you.  Have you ever read the book "The Secret" by Rhonda Byrne?  If you have, do you agree with the idea about laws of attraction?  Could this be why "Meaning" means so much in your investing model?  If I see stocks that are doing well and have the right kind of numbers, do I say no to them just because I may have a moral qualm about them?  Will the universe punish me for being greedy? :)
 
Anyway, I want to thank you for any time you can give me regarding this, and I hope that between your book, the blog and my own research I can get a better understanding of how to find these great companies.

Here's what I told Mark:

The Third M

The four M’s, Meaning, Moat, Management and Margin of Safety, are the key to finding wonderful businesses on sale.  The third M – Management – is the hardest to evaluate.  There are no tools to objectively decode the passion, honesty and owner-orientation of the CEO of a business.  You have to do the homework.  And you have to know what you’re looking for.

A good friend of mine, Steve Farber, and I worked together many years ago consulting to executives about becoming better leaders.  Steve just wrote a really great book and I want you to read it.  Its title says it all: Greater Than Yourself. 

That’s what I want my CEO to think and feel about the business I own.  I want him to sublimate himself to the task of making my business successful and a positive contributor to life on earth on all levels – certainly for me, the owner, but also for the people he’s leader, the suppliers, the customers and the environment. 

Steve is a great writer.   His first book, The Radical Leap, was named one of the best 100 business books of all time.   I read Greater Than Yourself in an evening.  It will help you spot a great CEO.  Even better, it will help you be a better leader yourself.

Now go Play.

Phil Town

Payback Time

The day after I told Manny (Kiplingers) to get in, the market shot up 500 points. Nice call on the market if I do say so myself.  And pure luck.  I was thinking it would continue down for a while.  But businesses are cheap and that’s what we really care about.  And now it's time to figure out what to buy.   You guys asked me about Apple, (AAPL), Altria (MO),  Verizon (VZ), AT&T (T), Microsoft (MSFT) & ConocoPhillips (COP).  I’ll dig in on these, but only after you tell me what they are worth and why.

As always, I want you to do the homework.  You sent me two opinions of value for AAPL – Charpe197 thinks $286 is retail.  Lynn suggests the right retail value is $151.  Since I didn’t see their work, I can’t say for sure why the difference in value, but I thought I’d add another layer of information for those of you who are looking to buy some businesses right now.

The 4M Valuation Process Still Applies, Even in this Market

A few days ago, Nathan asked the following question -- which is echoed in a lot of emails I've received from RULE #1 investors:

Phil, I'm struggling with putting a value on a company right now b/c of how much the P/E and the growth rate we use affects the results. Should we stick to your standard way: using either the historical P/E or double the lowest growth rate (b/w historical and analyst projections), whichever is lower? That method is providing pretty high P/E ratios and, therefore, nice and high sticker prices for some companies. Should we slash the P/E ratio used in the calculation given the current market environment? If so, any rule as to how much?

I also wonder about the growth number that we use in the calculation. What should we do when analysts are predicting negative growth in 2009 for Rule #1 companies? Should we still consider it? If so, what number should we use for growth?

Thanks for all your help.

Here is my answer:

Nathan,

Let's go over the process of valuation:

1. Meaning:  You've got to know the business.

In a sketchy economic environment like the one we're in, it's even more important. 

Is HANS a Buy Now?

HANS (Hansen's Natural sodas) has great numbers.  But it's not enough to have great numbers.  Remember the 4Ms? 

The numbers tell us there must be a moat, but "Is it going to last?" is a question that is only answered by the first M -- the Meaning of the business.  Do you know this business?  If you do, you should be able to handle this question well:  Is HANS going to definitely be here and still growing in 20 years?  That is the key question.

Time to Back up the Truck on ACF?

You pay a hefty premium for a cheery consensus.  And you get a hefty discount for a gloomy one.  We’re a long way from a depression-era stock market, or even a recession-era market (like 1973, 1983), but in one industry we’re tapping along at the bottom and that’s where you want to be looking for a great business that is on sale.

Here’s an example for you to consider: Americredit Corporation (ACF).

It's a pretty simple business.  They lend you the money to buy your car, particularly if GMAC isn’t interested because your credit kind of sucks.  You put a pile down and Americredit puts up the rest.  They do about 400,000 a month.  You pay, everything is good.  You don’t pay, they come get your car and resell it.  Simple business.

Garmin's Moat: Garmin vs. TomTom

In response to my last post about Garmin, Dave H had two concerns about its moat:

I used to love Garmin, However I'm concerned about the moat for 2 reasons.

1. They don't own the software (recent battle with Tom Tom)

2. All cell phones will soon have GPS. Leaving only the Auto/Aviation/Marine business at low margin negotiated prices with those manufacturers.

How do you see the moat?

Thanks.

Here's what I think:

Dave H,

Well, this is where really knowing this marketplace is the key. And I'm going to confess that I'm no expert. Still, here's my view if only to give you some things to dig in on:

1. The lawsuits are about TomTom swiping Garmin software. Both sued each other. It's a stand off. And seriously, have you seen TomTom compared to Garmin? If Garmin swiped it from them, how'd they make it so much better? This should tell you that TomTom swiped it from Garmin since the rule is that if you steal, you steal from the best. This law was set when Microsoft swiped Apple's GUI and it remains in effect.

Garmin: Much Ado About Nothing Much

Garmin keeps being such a good example that I think I’ll drag it out once more for you guys to look at. 

Right now it's selling for $54 on a long plunge down from $125.  Gotta love that stuff if you like to trade the good ones.  This year, if you use a 30 day MA, you would have bought in April for a couple of weeks (0% ROI), June and held until October (90% ROI), Oct-Nov for a small loss, Dec for a small loss and, unless you really like to buck trends an industry group sell off, you’d be done right up to now.

Overall you’d be well above 80% for the year trading this one.  Not bad for a stock that sold 12 months ago for  $53 and is selling today for $54.

And here’s the best part.

Whole Foods: Just Can't Get it Back

I wrote last year that the change in growth rate announced by management changed the valuation big time.  It basically cut it in half.  And it isn’t getting any better. 

Right now if we use 14% as the growth rate with a 28 PE, WFMI is worth about $30.  It just bounced off of $30 (which makes me think John Mackey is using about the same number and stepping in as a buyer with WFMI equity every time the stock gets to its real value). 

It's now at $33.  The problem is, we want to be a buyer when we can get the price at least 20% off of retail, and preferably 50% off.  That puts WFMI at $15 to $24 for us to get in.

Don’t hold your breath.  The company is a big time believer in its own future and will be stepping in to buy before it gets down there.  Its been a long time since I’ve owned any.  Just can’t quite seem to get it back.

# # #

Posting here has been light because I'm at work on important projects related to Rule #1. More soon.

Now go play.

Rule #1 Looks at Forbes View of America's Best Big Companies

In keeping with some sort of theme here at the beginning of 2008, I took a look at Forbes Best 400 Businesses list with a focus on the ‘honor roll’ list of the 29 best.

Usually when you read about the best picks for next year, what you don’t see is something about the value of the business.  In fairness, Forbes isn’t telling us that these businesses are on sale.  Just that they are really good businesses and have performed well in the past.  Still, since we are paying for something when we buy a stock, doesn’t it seem odd that you almost never read a discussion of what the stock is worth?

This may be a throwback to a very influential old school theory of valuation that was taught in almost all business schools for thirty years… right up until recently… and it is still defended by some real old school econ profs. 

The theory is that in a large marketplace where all the information is known about the things that are on sale, the price of the things being sold is what they are worth.  The reasoning goes that since everyone knows everything, there is no reason that anyone would pay too much or take too little.  In this perfect marketplace, price equals value. 

The marketplace that was held up as the ideal market for this theory is the stock market, and the proof that it is correct is that the professionals who manage mutual funds almost never beat the market returns over any long period of time.  The logic is that since the pros can’t beat the market, the market must be pricing things perfectly. 

Good argument if it wasn’t for one small thing: the pros ARE the market. 

They control so much stock in any given investment that the price of the stock goes down when they sell and goes up when they buy.  Also, almost all fund managers own hundreds of stocks at any one time.  If you own hundreds of stocks, you are the market.

This theory is further discomforted by the fact that individual investors like Warren Buffett, Eddie Lampert, Bill Ruane, Bill Nygren and many more like them do beat the market, and not by just a little. They slaughter the market.  $10,000 invested in the market in 1969 is now worth $134,000.  The same $10,000 with Buffett in 1969 and held to today would be now be worth $44 Million. 

That difference demands that we learn what Buffett knows.  And what Buffett knows is that when you buy a wonderful business at a great price, you are certain to make money.  This is the essence of Rule #1 style investing.

So let’s take a look Rule #1 style at what look like the best businesses in America for 2008, according to Forbes.