Regarding… Vol 2 no 20 – Lessons Learnt

Dear Fellow Investors and Friends

Welcome! I do appreciate you taking the time to read this.

I’m Piet Viljoen, and today is Thursday, the 30th of May, the 151st day of the year. There are 215 days left until the end of the year. On this day in 1953, Sir Edmund Hilary (NZ) and Tenzing Norgay (Nepal) were the first to reach the summit of Mount Everest as part of a British Expedition.

This year, around 900 people are expected to attempt the summit. This all happens in a 2-week window period, weather dependent. Of course, this results in long queues, congestion, and a lot of litter, as you can see in these pics.

One of the quotes I saw describes Everesting as “a DMV line at altitude for wealthy people.”

The odds of dying while attempting a summit is close to 2% – which means around 18 people might die on Everest this year.

I don’t like those odds. I’ll stick to Everesting on a bicycle. Not as hard and much, much safer.

This week, I’m starting another “trilogy”, in which I’ll share the important lessons I’ve learned over almost a lifetime of investing. Next week, I’ll discuss the principles I apply in managing money due to these lessons. I’ll tie it all up a week later by examining the investment philosophy and process I use in managing the cockroach.

I have worked in the financial industry for almost 40 years – nearly two generations. No, I can’t believe it either. Managing money over such a long period – and, importantly, being measured – has helped me learn what drives good and bad outcomes.

Documenting these lessons and principles was invaluable. As I plan on managing money for at least another two decades and hopefully more, writing down these lessons – rubbing my nose in them, so to speak – will hopefully reduce the odds of having to learn them again. And again.

I will understand if you skip this section and move on to the highs and lows, etc. But for those interested, here goes!

1. Active money management is way too active. Maybe the most important paper in economics is about how people sometimes give themselves painful electric shocks just because that is an option, instead of just sitting still and doing nothing.The same holds in fund management. Initiating a trade makes you feel in control, even though your edge might be minimal or negative. It’s no accident the stock market looks like a slot machine in a casino: lots of flashing green and red lights with the noise of constant news flow – all encouraging you to Act! Now!The stock exchange and its clients, the stockbrokers, get paid when you trade, and they do very nicely. Their gains come out of your returns. Sitting on your hands is hard, but it is possibly the single most profitable action you can take.
2. Everything is cyclical. History doesn’t repeat, but it rhymes. Cycles are inescapable and are driven by intrinsic factors. Preparing for this cyclicality is better than assuming it can be prevented or avoided. Or even worse, applying the “this time it’s different” theory of money management.I have learnt how to deal with this: lean the other way when markets get carried away with a new, new thing. Easier said than done, especially if everyone else is also getting carried away.But it adds value over the long term.
3. Forecasting is impossible. In the Devil’s Dictionary, Jason Zweig defines forecasting as “The attempt to predict the unknowable by measuring the irrelevant, a task that, in one way or the other, employs most of Wall Street.”Most people on Wall Street earn lots of money. It follows that forecasting is a valuable activity even though financial markets are too complex and adaptive to be predicted accurately. Society places a high value on comfort. Forecasts provide just that, however false.You must decide what business you are in. Are you in the marketing business, selling comfort through forecasts? Or are you a fiduciary, accepting uncertainty and implementing strategies to deal with it?

   If you don’t know, you will find out the hard way.

4. Concentration vs. diversification. Running a highly concentrated portfolio is risky but can create tremendous wealth. Entrepreneurs who start a business have a portfolio of exactly one asset. Often, this is a highly profitable venture, but it can also easily fail. The same goes for funds that run concentrated investment portfolios. Investing in concentrated funds is a “get rich” strategy. Higher return, higher risk.On the other hand, a well-diversified portfolio almost certainly won’t make you rich, but it can protect your wealth. As Markowitz said, “Diversification is the only free lunch in finance”. He meant that diversification provides a certain level of return at a lower level of risk than alternatives. A diversified portfolio is a stay-rich strategy. Lower return, lower risk.Choose your strategy wisely.
5. Behavior drives outcome. Carl Richards wrote a book called “The Behavior Gap”. In it, he defined the behavior gap as the difference between the investment return of an asset, and the return an investor earns. The gap is created by wanting more of what gives you pleasure. And less of that which causes you pain. This behavior translates into buy high, sell low and repeat until broke. It’s not the investment doing poorly; it’s your behavior.Richards writes about how the gap is also caused by how much we focus on issues entirely out of our control, such as: Are markets up or down today? Who is Russia invading? What’s happening in the Middle East? When’s the Fed going to cut or raise rates? All these things are entirely outside of not only our control but our ability to forecast. (see above)What I’ve learned to do is to stop reading the news, force myself not to think about events outside of my control (which makes me a dull dinner companion) and focus on building portfolios that are robust to most possible futures.

   Then, I sit on my hands.

6. Taxes matter. A lot. Taxes represent a significant leakage from investment returns. Over time, they play a much more substantial role than fees, yet we tend to myopically focus on fees and forget the massive negative drain on returns that taxes represent. Importantly, taxes are a factor over which one has some control. So, it is worth spending time on minimising these leakages. Being less “active” is a step in the right direction, as is considering the tax implications of both the structure in which investments are held and the investments themselves.

In short, the lessons come down to spending time on things we can control, minimising transactional activity, being thoughtful about tax and our behavior, building robust portfolios and being contrarian when necessary – but not all the time.

These lessons also guide how I manage money today – but more on that over the next two weeks.

This one hurts. It’s a significant investment of Astoria, our Mauritian-domiciled investment company. Astoria owns around 8% of the business, acquired – in two separate transactions – at prices of $26 and $14 per share. Today, Leatt is trading at $7.

Since our first purchase, Leatt has halved and halved again. The business is currently loss-making. The industry in which it operates – moto and bicycle safety gear and apparel – has gone through a substantial up-and-down cycle post-Covid. This has resulted in massive supply chain challenges, with some of its customers going bankrupt. As a result, current revenue is well below normal levels.

The investment case is that revenue picks up once the supply chain issues have been sorted. If that happens, it will prove to be a steal, even at $27 per share. In the meantime, things are looking tough.

This is a wonderful business that faces two challenges. One is their revenue issue, which should be sorted out eventually. Their product is that good. The second is the malaise of the small-cap company, in which markets show no interest at all.

My take: I have no idea how long it will take to overcome these twin “threats”. However, Leatt has net cash on the balance sheet of $13.5mn vs. a market cap of $43mn. It is financially strong enough to ride out the current downtrend. Let’s see. Our money is firmly on management to execute through this. But there are no guarantees.

Apple was down by 67% in 1996-1998 and 71% in 2000 before becoming a 700 bagger. Who knows what the future holds for Leatt?

Anglos used to be a dominant force in the global mining industry. However, poor capital allocation – most notably by CEO Cynthia Carrol in the early part of the century – has resulted in them being left in the dust by their erstwhile peers. This table from Reuters shows how far Anglos has fallen behind BHP over the years:

And its share price has reflected this, even including the recent bid premium:

Now, Anglos has rejected a $47bn bid from BHP. In effect, BHP’s bid entailed Anglo divesting Amplats and Kumba first, and BHP then buying the rump. Anglos countered by saying, no, that’s too complicated. Instead, they proposed unbundling Amplats, as well as their Nickel and Diamond interests, and keeping Kumba.

From the outside, that looks equally complicated. One can only surmise that it was all about price.

My take: With the rejections of the bid and BHP’s unwillingness to pay up any further, the pressure will be on Anglo to perform. If not, BHP could come back in 6 months, or another bidder may emerge. In the meantime, I guess there will be some disappointed Anglo shareholders around, and the bid premium in the share price might disappear.

They published another set of blowout results last week, and the share price duly performed:

One can argue about the valuation, and you can argue about extrapolating current trends into the future. Still, the one thing you can’t argue about is that this is a wonderful business. Gross margins of 78% and operating margins of 67% tell the story.

And, although it is on a high 35 times P/E – that is only its 10-year average:

(this chart is from my colleagues at Merchant West Investments)

I have missed out on an incredible run by not owning this stock. But, as a value investor, I guess I can get away with it if I rationalise long and hard enough. But Cathie Wood, the chief charlatan of ARKK fame, can’t. She did own it in her ARKK funds at one point. The circle below shows where she sold:

My take: Nvidia is above my pay grade. But at least I’m honest about my lack of skill when it comes to growth stocks.

From the sublime to the ridiculous. From a large cap, global growth story, a must-have in any respectable portfolio, to a small cap, struggling South African industrial story. An aluminum fabricator. The stock in question? Hulamin. Which is making new highs:

New highs, of course, if you ignore the excitement around a cautionary in 2022, which pushed the share price to over R5,00. The cautionary was subsequently withdrawn, causing a decline back down to R2. It’s inching its way higher today, close to R4 per share.

To give you an idea of how cheap this stock is, here are some numbers:

EV to Sales: 0,2
P/E: 4,8
Price to Book: 0,3

My take: Like many SA Inc. stocks, this share is priced for continued decline. But this could be a multi-bagger if anything goes right for this company and its industry. Nvidia is a must-own for most portfolios. Conversely, I think too few portfolios have exposure to the sort of optionality embedded in stocks like Hulamin.

While we are on Nvidia, did you know what it takes to build a fab? A fab is where the chips Nvidia designs are made. Well, wonder no longer; this article has it in full detail.

The punchline: “A large fab will have hundreds of thousands of square feet of cleanroom, and the facility might be spread over hundreds of acres. Building it requires tens of thousands of tons of structural steel and hundreds of thousands of yards of concrete. Intel boasts that its fabs use twice the concrete as the Burj Khalifa and five times the metal used in the Eiffel Tower.”

My take: If you’re worried about the effect of a slowdown in Chinese infrastructure spending on the demand for commodities, this might alleviate some of that worry. This, and the demands for the commodities that the “green” economy necessitates. There are currently 73 fabs being constructed worldwide.

The theory is that a neglected, unwanted stock – a spin-off – is often priced for disaster, and the share price goes up when disaster doesn’t happen. Think Thungela, for instance.

Last month, we had a reverse spin-off on the JSE when Transaction Capital (TCP) spun off its jewel in the crown, We Buy Cars (WBC). Of course, WBC was only spun off once it had been sanitised for institutional consumption, and a part of it was sold to fund the rump of TCP.

This rump is still listed and can be seen as the spin-off, as it holds the unwanted, unattractive assets. Keith McLachlan published a good analysis of TCP on Moneyweb this week.

My take: A magician performs her tricks by misdirecting the audience, drawing their attention to the obvious while manipulating the actual target. Investment bankers do the same. They work hard to get the institutions to focus on bright, sparkly WBC, thereby affording the insiders a selling opportunity at a high price. Wide-awake investors would probably want to focus on what the investment bankers are not promoting. In this case, TCP.

By the way, you can follow Keith on X (@keithmclachlan) for a good analysis of SA small caps.

My take: Things are changing in the big tech world, and no one is discussing this issue.

My take: In this new world of AI, the company that implements this strategy the best will win. The problem is I don’t know which one this will be. And valuations provide no margin of safety, so I’m staying out.

My take: He sums up the headwinds faced by value investors in the USA since the GFC in 2008. However, he also points out that Value has been doing well outside the USA since the pandemic. Of course, this has been masked by the strong US$.

The money quote: “Even if the sun seems to have fallen on US value investors, the dawn has emerged internationally and, theory and evidence would suggest, the sun will rise again, perhaps sooner than expected, in the US as well.”

Here is a podcast with him being interviewed by Shane Parrish of Farnam Street.

The money quote: “I don’t think there are good rules. I think there are processes and habits and disciplines that you follow consistently over the years, and those will serve you well in times of need.”

My take: I agree. This applies not only to investing but also to life.

A new song or album by Nick Cave is always a wonderful thing. This song is called “Frogs”. And You can listen to it here:

That’s all for this week! Now, we are back to analysing the election results. The permutations of governance structures in the future are endless. We are all in for an exciting time.

But remember – it pays to be careful out there!

Piet Viljoen
RECM