The Manual of Ideas How to Find the Best Investment Ideas – John Mihaljevic

John Mihaljevic is the publisher of The Manual of Ideas, an acclaimed independent monthly research publication for investors and the author of The Manual of Ideas published by Wiley. He is also managing director of ValueConferences and co-host with Guy Spier of VALUEx Zurich/Klosters.

Introduction

  • Stock market is a beauty contest
  • Fictional contest: entrants choose prettiest face in order to win
  • Naïve: apply own sense of beauty
  • Considers majority opinion
  • Stock market is an ownership in the business. Price trends might be disconnected with the performance of the company. Eg if you notice a pattern in the price of a company historically, the pattern might not play out the same in the future

Mindset of Successful Investor:

  • Fallacy of focusing on the scale of our portfolio (incorrect though that my investments are so small that it has no impact on the company as a whole)
  • Instead focus on the scale of potential investments (distribute capital to activities with the highest ROC)
  • “Invest as an owner”

Stock Section Framework

  • Initial list of stocks via a screener (eg. quantitative, research, news)
  • Asset value analysis
    • Buy if trading below replacement cost
    • Buy if trading below liquidation value
  • Earnings power analysis
    • Return on capital
    • Earnings yield

Value-Oriented Idea Generation Approaches

Joel Greenblatt Magic Formula

  • Good businesses at good prices
  • High ROCE, high EBIT/EV
  • Earnings based approach

Observation on Magic Formula Approach

  1. Advise to buy good companies only when they’re cheap seems glib at first glance
  2. According to MF, the higher return on capital employed, the better the business
  3. Use of EBIT/EV and EBIT/CE eliminates the effect of leverage and taxes
  4. In theory, outperformance of MF methodology should prompt investors to flock to it, eliminating its attractiveness, in practice, mf is likely to keep outperforming
  5. Highly concentrated long-only MF portfolio could suffer debilitating volatility
  6. Mr. Market over values businesses whose return on capital derive from explosive but transitory trends or fads; Mr. Market often undervalues un-hyped quality businesses
  7. A key adjustment is to use forward-looking earnings data in the MF calculation
  8. If we run the MF screen on a database that includes both US and non-US listed companies, the greater number of candidates should enhance performance
  9. It might make sense to introduce a hurdle above which all companies are tied from the perspective of RCE – the cheapness factor then carries more weight
  10. High ROCE is almost meaningless without an ability to reinvest at high returns

Benjamin Graham Deep Value

  • Assets – Liabilities > market value
  • Buy something for more than what it’s worth liquidated
  • Look for market value < tangible book value
  • Asset based approach

Observation on Deep Value Approach

  1. Unabashedly starts with the price of the stock
  2. Studies show equities with high book to market ratio outperform
  3. Holy grail: companies with asset protection and high normalized return on capital
  4. Return of cash to shareholders can make a low return business a great investment
  5. Investors may overestimate liquidation value (dying businesses hide nasty surprises)
  6. Acceptance of discomfort can be rewarding in investing, as fearful equities frequently trade at exceptionally low valuations
  7. When we invest in asset rich, but low return busines, time may be working against us; as a result, catalysts become a relevant consideration
  8. Businesses at deep value prices are most likely to be creatively destroyed; unwise to allocate a large portion of investable capitals to any one deep value opportunity
  9. Suggest screening factors for Graham-style bargains; share repurchases, insider buying, and cash generated through working capital shrinkage
  10. Valuation based solely on readily ascertainable balance sheet value runs the risk that value erodes over time, negatively impacting future equity value

Carl Icahn Sum of the Parts

  • Monetizing non-core and/or excess assets
  • Look for companies with different parts, add it up, and check against the value of what it’s traded for today
  • Earnings and/or asset based

Observation on Sum of the Parts Approach

  1. Some companies best appraised by analyzing each business/asset separately and then adding up those components of value to arrive at an estimate of overall value (AMZN with cloud and retail businesses)
  2. A reason for occasional mispricing of companies with multiple sources of value may be unwillingness to value assets that differ materially from a company’s core assets
  3. Companies with distinct components of value often enjoy greater strategic flexibility
  4. Sometimes investor slice a companies into too many parts, creating an attractive investment thesis in theory but not in reality
  5. Sum of the parts idea are prone to becoming value traps absent strategic action
  6. It matters whether the offer is buy one get one free or buy 10 get 1 free
  7. Sum of the parts opportunities come in a few different flavors, each of which demand a slightly different approach to screening
  8. Usefulness of sum of the part analysis grows when the various business segments demand distinct approaches to valuation, making corporate-level data less relevant
  9. Investors may become patsies by failing to realize that hidden value is not hidden
  10. Focus on how the value in hidden assets will accrue to shareholders