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"If there was just one screen I could run, it would be to have a list of the most predictable companies with the strongest competitive positions that were trading at the lowest price-to-sales ratios in their history."

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I’ve mentioned Howden Joinery in the past.

It’s a U.K. stock I have considered buying. I don’t own it now. But, I might someday.

Gurpreet Narang (@Gurpreetnarang2) wrote a report on the company and sent it to me. He let me share it on the blog. So, here is Gurpreet Narang’s write up on Howden Joinery.

Howden Joinery Write Up (PDF).

"...when I say you should have a rule that you always hold a stock for a full five years, I know that isn’t going to translate into you never selling a stock within five years. But, I also know that if you don’t have any sort of rule at all, you’re going to sell much sooner than you think you will."

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In this video, I answer twenty questions related to net-nets.

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"...know your own style. Be honest about it. Then find those investors you admire most. The true investing masters out there, not just the guys with good records, but the guys you personally have admiration for. The guys you want to learn from. Then study up on all the ways they are different from you. Look for those places where their beliefs challenge your beliefs. Then start trying to ape their style."

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"The growth of the industry’s deposits isn’t very useful to you. Three things matter more. One, the growth in deposits at the bank you’re looking at. Two, the growth in deposits per branch at the bank you’re looking at. And, most importantly, the growth in deposits per share of stock at the bank you are interested in."

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"Variation in the operating margin is really a measure of profit wobble. In a capitalist economy, some firms tend to act as shock absorbers – they take a hit – and other firms tend to pass the shock on to customers, suppliers and employees without themselves showing much sign of the shock rippling through their industry, the economy, etc."

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"I guess you could say I have a checklist that reads: durability, moat, quality, capital allocation, value, growth, misjudgment, and future. I also always compare the company I'm interested in to publicly traded peers. And, most importantly, I look at historical financials going as many years into the past as possible. I'd say I'm usually working from about 20 to 25 years of past financial data. That data is the bedrock of my process. It's the only quantitative part. Everything else I do is qualitative."

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Today, I sold my entire positions in Weight Watchers (WTW) and B&W Enterprises (BW).

My Weight Watchers position was eliminated at an average sale price of $19.40 a share.

My B&W Enterprises position was eliminated at an average sale price of $10.22 a share.

My Weight Watchers position had an average cost of $37.68 a share. So, I realized a loss of 49% on Weight Watchers.

My B&W Enterprises position had an average cost of $15.48 a share. So, I realized a loss of 34% on B&W Enterprises.

Note: I got my shares of B&W Enterprises as part of the Babcock & Wilcox spin-off. I bought that stock ahead of the spin-off. I still retain my shares in BWX Technologies (BWXT). My BWXT position is about 10 times the size (in market value) of the BW position I just eliminated.

My portfolio is now:

Frost (CFR)

BWX Technologies (BWXT)

George Risk (RSKIA)

Natoco (a Japanese stock)

and

Cash

In rough terms, Frost is about 40% of my portfolio, BWX Technologies is about 25%, and George Risk is about 20%. Natoco is less than 5%. The rest is cash.

So, about two-thirds of the portfolio is just Frost and BWX Technologies and more than six out of every seven dollars is in just three stocks.

Why did I sell WTW and BW?

Weight Watchers, B&W Enterprises, and Natoco combined were now only about 10% of my portfolio. I had no intention of buying more of these stocks. I like individual positions to be about 20% of my portfolio. So, both Weight Watchers and B&W Enterprises had become distractions I wanted to eliminate at some point.

Also, this portfolio is taxable. Three stocks account for 85% of the value of my portfolio and those three stocks are anywhere from 80% to 150% higher than where I bought them. I hope to buy a new stock sometime this year. To make room for that stock, I'll have to trim some positions with large capital gains.

Today's sales provide me with capital losses.

As a side note, you may have noticed WTW stock was up over 30% today and B&W Enterprises was down over 30% today. My Weight Watchers position was several times the size of my B&W Enterprises position, so today's rise in WTW's stock price may have had some influence on my decision to sell right now. However, I could have opted to eliminate just WTW and keep BW - and I didn't. So, I'd still say the sale is mostly not due to short-term price movements.

I really just wanted to:

1. Eliminate positions that were less than 10% of my account

2. Realize capital losses

3. Raise cash for a future stock purchase

Talk to Geoff about his Sales of Weight Watchers (WTW) and B&W Enterprises (BW)

"As an industry becomes less competitive and more cooperative, the stocks in the industry deserve higher multiples. Conversely, as an industry becomes more competitive and less cooperative, the stocks in the industry deserve lower multiples."

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Someone emailed me this question:

"Am I correct in assuming that when you discuss durability, you are referring to the ongoing need or want for an industry’s products or services, whereas when you discuss moat, you are referring to the competitive positioning of an individual company within its industry?"

Yes. Exactly. Durability is about the product and the product economics of the industry. Moat is the ability of the specific company to sell more of the product and have better product economics than competitors.

In Michael Porter's approach: moat limits rivalry between firms.

And durability is about the relationship between the customers and the firm we are looking at.

So, Corticeira Amorim (Amorim Cork) in Portugal may have low durability and a wide moat at the same time, because it has advantages in the production and especially the distribution of cork compared to other firms. However, there are substitutes for cork including synthetic products and screw tops. Societal shifts in the acceptance of these ways of enclosing a wine bottle would mean that Amorim might not have very good durability.

On the other hand, a company like McCormick (MKC) has perfect durability. McCormick sells a variety of spices. Spices have been part of the food that even households that aren't very rich have used for well over 2,000 years and they have been used all over the world. It isn't anything cultural that determines the desire for spices. The spices used may change a little but people all over the world will always want to add spices to their meals. Whether McCormick will always be a leader in spices is a different question. But, 2,000 years from today people will be spicing the food they eat. I'm not a hundred percent sure people will be corking wine even just 20 years from now.

Sanderson Farms (SAFM) is another good example of the distinction between durability and moat. The durability of chicken is excellent. There are only a handful of domesticated animals that have been as selectively bred and extensively used as meat - mainly cattle and pigs - throughout human history. The product economics of processing chicken are also fine, you can earn a decent ROE doing it. I also think chicken should continue to be a cheaper protein than other alternatives. So, while I can't guarantee humans will be eating chicken in 2,000 years - I'm sure they'll be eating about as much or more chicken in 20 years. And I wouldn't be surprised if people are still eating more chicken than almost any other meat even 50, 100, or 200 years from now. So, I think the durability of SAFM's product and the business model - the things the firm actually does day-to-day - are both durable in terms of providing value for customers. The question is rivalry between firms. Fifteen years from today, someone will be doing what Sanderson is doing. But, how much profit will the firms that process chicken actually make? That's why I compare it to airlines. Airlines will be around in 20 years. It's not hard to guess how many passengers will be flying in 2037 within the United States. It may, however, be hard to know how much the major carriers will make in profit per passenger.

From a discounted cash flow perspective, it isn't very important what earnings will be far into the future. If you are buying a tradeable, liquid asset like a stock and you are expecting a fairly high return on your money (I try to stay in cash till I find something I expect to compound at 10% a year) you don't really need to worry about 50 or 100 years. I'd say that the clarity with which you can see the next 5-15 years is what matters. A lot of investors and analysts are looking out at years 1-4. But, if you can find situations where the durability 5-15 years out and the moat 5-15 years out looks good - you'll do fine. So, from an intrinsic value perspective - I'd say that both McCormick and Sanderson have high enough durability (in spices and chicken) that risks to durability don't need to factor into your investment analysis at all. I would say that Amorim Cork has enough risks to durability that you should factor those risks to the durability of cork as a product and the cork industry in general into your calculation of the price you’d be willing to pay for Amorim stock.

Here are some examples of how I'd classify durability.

ZERO RISK TO DURABILITY (nothing about the product is going to change in the next 15 years)

* Sanderson Farms (SAFM) - Chicken

* McCormick (MKC) - Spices

* Omnicom (OMC) – Advertising

SOME RISK TO DURABILITY (something about the product may change in the next 5-15 years)

* Progressive (PGR) - Car insurance

* Corticeira Amorim - Wine corks

* Village Supermarket (VLGEA) - Offline groceries

BIG RISK TO DURABILITY (something about the product may change in the next 5 years)

* Fossil (FOSL) - Watches

* Teradata (TDC) - Data warehouses

* Wal-Mart (WMT) - Offline general retail

What I said above doesn't deal with moat. For example, I would put Costco (COST) in the "low durability" category and yet also in the "wide moat" category. Costco has a strong competitive position. However, offline retail has serious risks to durability within even just the next 5 years. On the other hand, there are plenty of commodity type products (like steel) that have high durability as a product and yet no moat at all for many of the individual firms.

I think you can keep this fairly simple.

Durability: Will customers still value this product as much in 5 years, 15 years?

Moat: Will the company’s competitive position versus its rivals be as strong in 5 years, 15 years?

If you aren’t sure about either of these statements over the next 5 years, don’t buy the stock.

If you aren’t sure about either of these statements over the next 5-15 years, you need to seriously consider whether this is the kind of business you want to own and how cheaply you need the stock to be selling for.

If are sure about both of these statements over the next 15 years, you’re fine. To buy Apple (AAPL), you need to be sure of the durability of smartphones generally and the Apple iPhone specifically through 2032. Beyond that, it’s okay if you don’t know what the future will be. But, if you have any uncertainty about the durability of smartphones or the moat around the iPhone between now and 2022 – you really can’t buy the stock. Risks to moat or durability that could manifest themselves within the next 5 years are what cause losses in a stock.

Ask Geoff a question.

"...always avoid bad, immature industries. If you have to invest in a bad industry, at least make sure it is a mature industry. The easiest way to go broke is to invest in a business that is growing quickly and unprofitably."

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"...if you’re an experienced investor, you’re going to be instantly attracted to the best ideas you have within the first hour of hearing about them. That’s just how it happens. Good ideas are simple. They’re obvious. You know them when you see them. It happens really fast. That doesn’t sound prudent and full of the kind of due diligence we’re told we’re supposed to practice, but it’s the truth. A great investment is usually something you fall in love with the day you first find it."

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I get a lot of questions from readers about what investing sites I use, what books I’m reading, etc.

So, here are two sites and four books I’ve been spending time with lately.

Websites

GuruFocus: Buffett/Munger Screener

I write articles for GuruFocus (click the “Articles” link at the top of the page to see all of them). So, it’s a conflict of interest to recommend premium membership to the site. What I will say is that if you are a premium member – I think the most useful part of the premium membership is the various predictable companies screens. There’s a Buffett/Munger screen, an undervalued predictable companies screen, and you can also just filter companies by predictability score (GuruFocus assigns companies 1-5 stars of predictability in 0.5 star increments). I think the best thing GuruFocus ever developed is the predictability score. And it’s a good use of your time to type in some ticker symbols and see which of those companies are high predictability, which are low, etc. Do I personally invest based on predictability? No. GuruFocus doesn’t rate BWX Technologies (BWXT) and it assigns predictability scores of 1 (the minimum) to both Frost (CFR) and George Risk (RSKIA). I have about 85% of my portfolio in those 3 companies. So, I have almost all my money in non-predictable companies according to GuruFocus. The predictability score isn’t perfect. But, for non-cyclical and non-financial stocks that have been public for 10 years or more – I think it’s a pretty good indicator. Use it like you would the Z-Score, F-Score, etc. It’s just a vital sign to check. Don’t just buy a stock because it’s predictable or eliminate it because it’s unpredictable according to GuruFocus’s automated formula.

Quickfs.net

I can’t vouch for the accuracy of the data on this site. But, that’s true for summary financial statements at all websites. Once I’m actually researching a stock, I do my own calculations using the company’s financial statements as shown in their past 10-Ks on EDGAR (the SEC website). What I like about Quickfs.net is that it’s simple and clean. Most websites that show you historical financial data give you way too much to look at. When you’re just typing in a ticker you heard of for the first time – which is what I use these sites for mainly – what you need is a “Value Line” type summary of the last 10 years. It shouldn’t be something you need to scroll down to see. As sites age, they get more and more complicated showing more and more financial info. You don’t need more than what Quickfs.net shows you. If you like what you see of a company at Quickfs.net then you should go to EDGAR yourself and do the work. Quickfs.net is for the first 5 minutes of research. The next hours should be done manually by you – not relying on secondary sources like Quickfs.net, GuruFocus, Morningstar, etc. None of them are a substitute for EDGAR.

Books

Deep Work: Rules for Success in a Distracted World

This is a great concept. It’s not a great book though. I recommend reading the book only because focus is probably the most important concept in all of investing. If you can focus the way the author of this book talks about – you can become an above average investor. If you can’t focus the way this author talks about – I’m not sure you can ever become an above average investor. In fact, I actually think you can’t. Focus is the foundational skill for an investor. You can teach most everything else. I’m not sure you can teach focus. But, this book tries to teach focus. So, I do recommend it. Value and Opportunity reviewed this book last year.

By the way, Value and Opportunity is a great blog. You should read it.

Tao of Charlie Munger

I just said “Deep Work” wasn’t a great book. That’s true. But, it’s not a bad book. This book is really, really not a good book. However, it has some great quotes from Charlie Munger in it. And, although I was disappointed by the book as I read it – I did find myself quoting the book quoting Munger in the weeks after I read it. So, the author did actually imprint some of Munger’s quotes on my psyche. I guess it’s worth $12 on Kindle for that. Don’t expect much out of this book though. Just think of it as a collection of quotes from Charlie Munger.

The Founder’s Mentality

This is a Chris Zook book. You might know that I’ve read all of Zook’s books. They’re basically about profitable growth. How can a business grow for a long time in a way that compounds wealth for the business’s owners at an above average rate? I’m sure that’s not how Zook would phrase it exactly. But, that’s how I approach his books. This is a good book. It’s probably my least favorite Zook book so far. But, I do recommend it to all value investors. This kind of book is very useful for buy and hold investors. For example, I was just talking to someone about Howden Joinery and I mentioned that in about 6 years the company will have fully saturated the U.K. with its namesake concept (the concept is a chain of depots for local, small builders who are renovating kitchens). The founder/CEO is also about 61 now. So, I told this person I was talking to that while I thought Howden would likely return something like 12% a year as a stock – I was only interested in viewing the stock as a 6-year commitment. In 6 years, the founder would be about retirement age and the company would be producing a lot of free cash flow it could no longer put back into its core concept (Howden depots) in its core country (the U.K.). So, I just felt that it’s possible the company’s phase of value creating growth would be over at that point. I think it’ll continue to be a durable business. But, most companies start to stray once their original concept is mature and once they move on to the second generation, third generation, etc. of management. When I invest in a growth company, I want it to be run by the founder and to still have room to roll out its core concept in its core country. I think Howden has about 6 more years of that period left in it. I’m not sure I would be able to so clearly explain my thinking on Howden if I hadn’t read this book and Zook’s other books. So, I recommend them all.

Global Shocks: An Investment Guide for Turbulent Markets

Now, this is actually a great book. Though I’m not sure it’s a great topic. And it’s a topic I’d recommend most value investors avoid. Full disclosure, a member of my extended family knows the author of this book. So, I actually heard about the book before it came out. It’s not a topic I would have found searching through Amazon. The topic is basically financial crises. However, it’s really focused on financial crises through the lens of monetary policy meaning especially foreign exchange and asset bubbles. It’s very useful for value investors to hunt in countries that have been devastated by these sorts of crises. It’s also useful to avoid countries that may be in bubbles. I would recommend this book with a caveat. Most value investors I talk to are already way too worried about things like the overall price of the stock market, whether a country is in an asset bubble, foreign exchange rate levels, etc. I started investing as a teenager in the late 1990s. So, I went through years like 1999-2001 and 2007-2009. Even when the stock market is overvalued, you can find stuff to do. The market is clearly overvalued now. And yet I hope to add a new stock to my portfolio later this year. I think it’s good to understand these things. But, I also think it’s good to be practical about it. If you’re a value investor and a stock picker – you should be capable of both believing that a market is overvalued and also believing that it isn’t pointless to keep reading 10-Ks, looking through spin-offs, etc. day after day. Hope is having something to do. And there’s always something for a stock picker to do. So, I recommend the book. But, I also recommend staying focused on individual stocks rather than macro-concerns. If you know you’re the kind of person who tends to get overwhelmed – don’t read this book. For everyone else, it’s an interesting read. Some people think it’s dry. I don’t. It helps if you’re interested in financial history. There’s a lot of (recent) financial history in this book.

Ask Geoff a question.

Last week, I eliminated my entire position in George Risk (RSKIA).

This position was about 20% of my portfolio. It is now 0%.

My average sale price was $8.40 a share.

My average purchase price had been $4.66 a share (back in 2010).

I held the stock for about 6.5 years. So, the stock price compounded at about 9.5% a year while I held it.

George Risk also paid a dividend. The yield was rarely less than 4% a year. So, my total return in the stock was about 13% a year over my entire holding period.

My return in George Risk was not better than the return I could have gotten by simply holding the S&P 500 for the same 6.5 years.

However, the stock was cheaper than the S&P 500 when I bought it. I believe it remains cheaper than the S&P 500 today.

Right now, George Risk’s dividend yield is about 4.2%. And the stock has $6.36 a share in cash and investments versus a share price of $8.40 a share.

I didn’t sell George Risk because I no longer like the stock. Rather, I sold George Risk to make room in my portfolio for a totally new position.

I try to only buy one new stock a year. So, when I do finally buy this new position – it’ll be a big moment for me.

I’ll let you know once I’ve added the new position.

Talk to Geoff about George Risk (RSKIA)

Recently I went out to a restaurant I like. Unfortunately, the restaurant went out of business. That reminded me how tough it is for small business to survive and led me to some thoughts on Singular Diligence.

It’s been 1.5 years since we launched The Avid Hog (the predecessor to Singular Diligence). Geoff and I actually worked on the newsletter for 3 years. Somehow we still survive, building up an archive of well over 1,000 pages of research and notes. Only passion and perseverance can lead us this far. And there are things I hate and love about the newsletter.

I simply hate the pressure. Geoff and I want to work together. He had the idea of writing a newsletter in early 2012. I never thought it’s possible. Warren Buffett says he’ll “settle for one good idea a year”. How can we come up with a good idea a month?

Make Priorities

We must make priorities. We give priority to downside protection over upside. So, clients won’t lose money if they act today. We also give priority to business quality over cheapness. Business quality doesn’t change fast so a qualitative research can be timeless. If clients read our research today, they’ll be ready to act quickly in the future. Clients will make the best return if they see the newsletter as a tool instead of as investment advice.

Choose Candidates Better

In the early days, our focus was on improving the research process. We frequently ran into “crisis” when we don’t have the next stock to analyze. There were also times when I realized that a company isn’t good enough only after 2 or 3 weeks of research. I had to drop the stock. So, it’s a big risk to choose a wrong candidate.

We started building a process to maintain a candidate pipeline in September 2014. Geoff and I have a candidate meeting every week. We look at our watch list, screen, or other blogs to find ideas. We try to pick the best 2 or 3 stocks to discuss about in the meetings. We focus the discussion on risks and normal earnings. It’s important to have financial data for these early discussions. So, I type data from all 10-Ks of each stock into an excel template. This is a powerful process because we discuss about 100-150 stocks each year.

We maintain a list of top 10 candidates. The unbreakable rule is that a stock must be below 15 times EV/After-tax Normal Unlevered Earnings to appear in the list. The rule makes sure candidates trade at a below average price. This means we won’t pick stocks where we love business quality and prospect so much that we compromise on price. The rule makes our job difficult in today’s environment when people are talking about new low normal interest rates. Sometimes we have only 8-9 candidates in the top 10 list. But it helps push ourselves to actively search for new candidates.

To reduce the risk of choosing the wrong stock, we do a lot of basic research on top candidates. We do scuttlebutt in this stage. Some clients help us do scuttlebutt by talking to employees or learning about customers and products. Afterwards, we can contact the management if necessary. We also read Investor Day transcripts. My experience is that analysts tend to ask short-term oriented questions in quarterly earnings call. There’s not much useful information there. But there’s usually great information in Investor/Analyst Day conferences. So, instead of reading 1,000 pages of earnings call transcript, I read only 50 pages of Investor Day transcript in this stage.

Price Movement Is a Headache

Our weakness is long lead time. There are months from the time a stock enter the top 5 candidates to the time I start analyzing the stock. I do research for a month and send my notes to Geoff. Geoff does further research and writes the final report in another month. A stock can stay in our inventory for several months because we have some restrictions. For example, we try not to write about two obscure foreign stocks in two consecutive months because that upsets clients who prefer buying U.S. stocks. We can’t write about two micro-cap stocks in two consecutive months because clients may hate illiquidity.

We’re subject to price movement because of the long lead time. It’s heart-breaking to see the price moves so much that we’re unable to publish a report. Some examples are PetSmart or Greggs. Sometimes the stock price increases by 20% even before I finish my notes. I just talk to myself “no, I hate this job.”

One solution is to increase the speed we do research. I think we’ve increased our productivity by triple-digits since when we started. But we just reinvest productivity gains in further depth of research. Three years ago, it took me a month just to read and analyze all the information I can find about a stock. Today, I learn also about competitors, customers and suppliers.

Another reason that restrains our pace is procrastination. It’s always tempting to read some more instead of starting to write. So, I don’t think that we can analyze a stock in less than a month. And price movement remains our biggest risk.

That’s what I hate about Singular Diligence. People say that if you choose a job you love, you’ll never have to work a day in your life. But when you have to race against the deadline and struggle to make money, it’s not fun at all. Sometimes I just hate what I like to do.

The Best Way to Learn Is to Practice

But there are good reasons for loving this job. First, I think this is the best way to learn. I have a college friend who loves investing but doesn’t read investment books. He said that reading investment books doesn’t teach us how to make money because otherwise the authors wouldn’t share. I agree that we don’t become a better investor by reading books. But books prepare us to become a good investor. We get knowledge from books. And we start learning when we practice.

I always learn something new from each research. I can practice techniques that I learned from books. One example is we all learn that there’s a red flag when inventories grow faster than sales. I see that at Swatch (VTX:UHR). In 2014, sales grew 3% while inventories grew 10%. In 2013, sales grew 8% while inventories grew 23%. Is it a short sign? The answer isn’t that simple.

Tom Russo talked about working capital in a recent interview. He said that Wall Street analysts and some activist investors usually prefer lower working capital and higher cash flow. But long-term investors welcome more capital being reinvested in a great business.

I find that Swatch’s inventory turnover declined consistently from 3.1 in 1998 to 1.5 in 2014. There can be some fundamental changes. Swatch might have grown retail operations in this period. They might be investing in infrastructure in emerging markets. So, it’s useful to talk to management about this topic. It’s necessary to compare Swatch’s inventory turnover with Richemont’s during this period. The two companies are different so we should also compare finished inventory turnover.

So, the actual exercise is much more complicated than the technique we learn in a book.

Things that Books Can’t Teach

There are also things that books don’t teach us. Books about moats can’t help us analyze Majestic Wine (MJW: LN). They don’t have the purchasing power of supermarkets like Tesco. They can be killed by online competitors. But analyzing Majestic Wine’s business model and cost structure can tell a different story.

Similarly, I never read a good book that teaches us how to estimate normal earnings. That’s because each actual situation requires a specific approach.

When Babcock & Wilcox (NYSE:BWC)’s government contracts are in serial production, they do the same thing every year. Costs are visible so past margin can be a good benchmark for future expectation. But we must be careful if they do a prototype project.

Swatch is run by a long-term oriented management. They’re willing to spend today to grow their portfolio of watch brands. Moreover, EBIT margin is cyclical but has a long-term upward trend. What should we do? Should we use current earnings or peak earnings? Should we estimate earnings using EBIT margin? If yes, how do we estimate the normal margin? A good answer requires us to understand why margin increased and have some expectation about future revenue.

Sometimes we have to delve into product economics to estimate normal earnings. America’s Car-Mart (NASDAG:CRMT) sells and finances used cars in small towns in South-Central states like Arkansas, Oklahoma, and Missouri. They don’t lend money but cars. The investment laid out isn’t in receivables on the balance sheet, but in the cars that they lend to customers. So, sales and EBIT margin are meaningless.

Encore Wire (NASDAG:WIRE) is another example. Encore Wire makes copper wire. The copper cost is almost 70% of revenue. So, the copper wire price mostly tracks the commodity copper price. Copper went from less than $1 per pound in 2003 to over $3 per pound today. So, it’s hard to estimate Encore Wire’s normal earnings by looking at sales and margin. The better approach is based on EBIT per copper pound of product.

Familiarity with One Company Can Help Analyze Another Company

I also love the chance to study a new industry each month. I can learn about nuclear components for one month and then move on to the most comfortable recliner in the world the next month. I can also develop new interests in wine or mechanical watches. That does help reduce the stress of racing against the deadline.

More importantly, familiarity with a company/industry can help analyze another. Studying the decline of the Omega watch brand in 1970s and 1980s can tell us to pay attention to the management when we analyze Ekornes (EKO:NO).

Familiarity with Coach or some other luxury brands can help us understand the distribution side of Swatch’s business. It also teaches us about the importance of scarcity in luxury.

Sometimes the connection is indirect. Reading about George Risk (RSKIA) shows the tendency of customers to re-order from the same supplier if they deliver on time. That can gives us some clue to the behaviors of contractors who buy copper wire from Encore Wire.

I see some similarity between Progressive (NYSE:PGR) and Encore Wire. About ½ of Progressive’s business is sold through the direct selling channel like Geico. Direct sellers have durable cost advantage because competitors are stuck with the agency channel.

Encore Wire is the second largest manufacture of electric wire in the US. They started in 1989. Today they have about 25% market share. They grew organically. They never made an acquisition. All earnings were reinvested into the manufacturing complex in McKinney, Texas. They have only one distribution center there. Their order fill rate is over 99.9%. They deliver to all customers within 7 days. They offer customization like selling 825 feet of copper wire instead of the 1,000-foot standard put-ups.

Encore Wire’s competitors tend to grow through acquisitions. They can have 3 or 5 plants and 10 distribution centers (DC). They ship from multiple plants to multiple DCs, and from multiple DCs to customers. So they have to handle shipping many times. Competitors’ shipping cost as % of sales can be 3% to 6% higher than Encore Wire.

Encore Wire also offers better service. Competitors are closer to customers. But there are 10,000 SKUs. They can’t hold full inventories in all 10 distribution centers. For an order, they can fill 50% from the nearest DC, 30% from a farther DC, and 20% from an even farther DC. They can take weeks to fill order. And it’s difficult for them to offer customized orders.

Encore Wire has the lowest cost in the industry but has the highest price because they offer great service. Meanwhile, competitors are stuck with their distribution model. They can’t close plants and concentrate on just one like Encore Wire.

Both Progressive and Encore Wire are the low cost players in their respective industries. They are both very cautious in pricing. They both do best when there’s cost inflation.

Another example is that understanding QLogic (NASDAG: QLGC) can help analyze Breeze-Eastern (NYSE:BZC). QLogic makes fiber channel adapter. Fiber channel adapter is a critical component in a storage-area network but is a tiny portion of the total cost. It takes a long time to go through OEM qualification and testing. QLogic has about 54% market share.

I see the same thing at Breeze-Eastern. They make rescue hoist. This is a mission critical component in a helicopter that pulls people up and down in search and rescue missions. The qualification process with a new airplane model is incredibly expensive and time-consuming. Breeze-Eastern has about 50-60% market share.

The Fountainhead

The last reason I love this job is simply I love value investing and I like to work with Geoff. I draw inspiration from Howard Roark in my favorite novel, The Fountainhead. Howard Roark is a visionary architect. He has his own philosophy. He works with his mentor Henry Cameron because they share the same philosophy. Their designs are unpopular and they make minimal amount of money. But they keep sticking to their philosophy because they believe there are some clients interested in their designs. Howard Roark gives me the courage to follow what I believe. And I’m happy to have a small group of like-minded clients reading Singular Diligence.

Talk to Quan about What He Hates and Likes about Singular Diligence

Check out Singular Diligence

I was interviewed by Eric Schleien for his Intelligent Investing Podcast.

We talked about Frost (CFR), BWX Technologies (BWXT), and Howden Joinery along with a lot of other stocks.

I also mention a new website I’m working on.

So, to hear me blabber on about stocks for a little over an hour – click here.

Listen to Geoff’s interview on the Intelligent Investing Podcast

Talk to Geoff about his interview

I’ve gotten a lot of questions regarding my sales of Weight Watchers (WTW) and George Risk (RSKIA).

Interestingly, literally no one emailed me about selling Babcock & Wilcox Enterprises (BW).  

I’ve picked out two questions as representatives of the larger group.

Question #1: George Risk

“Really interested in why you decided to suddenly sell RSKIA.

I mean it's still obviously undervalued. You could have sold it in the beginning of 2014 for a better price than $8.40. Stocks in general were obviously cheaper at that time than they are now.

So logically it means you've found a better opportunity now than you could find in 2014 relative to the current price of RSKIA. That just seems really surprising to me.

The only logical conclusions are that you either lost patience with RSKIA, now have a different view on the risk of the markets, or really did find something better than what you could in 2013/2014.

If it's the latter, I can't wait to hear what it is when you decide to post it...”

I sold George Risk, because I am planning to buy Howden Joinery.

I don’t like to take positions that are smaller than 20% of my portfolio. The total amount I had available in cash, Natoco, and Weight Watchers combined was less than 20% of my portfolio. So, I sold George Risk to make room for Howden Joinery.

I try to only sell one stock to make room for another. The reason I hadn’t sold George Risk before is that I hadn’t found a stock I liked better than George Risk. I’ve now decided I like Howden Joinery better than George Risk.

Yes, I could have and should have realized this a couple years ago. I’ve known about Howden for years. Howden shares were cheaper in the past than they are now. George Risk shares were more expensive in the past than they are now. I’d have been better off if I made the swap sooner. But, it took me a while to come to this decision. I don’t own Howden yet. But, I expect to buy it soon.

Question #2: Weight Watchers

“With regards to your long term stake in WTW, I am just curious about the WTW sale, since WTW has announced growing subscription numbers and has Oprah as a Board Member, so things look rosier than last year.”

Yes. Weight Watchers is doing better now than it was in the past. Oprah Winfrey is a great spokeswoman and a good board member for WTW.

I didn’t sell my shares in Weight Watchers because I like the stock less now than I did last year. I sold my shares of Weight Watchers because I looked at what percent of my portfolio the stock made up and then considered whether or not I’d like to buy more.

Here’s what I said in a previous post:

“Weight Watchers, B&W Enterprises, and Natoco combined were now only about 10% of my portfolio. I had no intention of buying more of these stocks. I like individual positions to be about 20% of my portfolio. So, both Weight Watchers and B&W Enterprises had become distractions I wanted to eliminate at some point.”

Honestly, once I come to the realization that I’m never going to buy enough of a stock to get it up to 20% of my portfolio – I start thinking about selling that stock. I still own Natoco. It’s only about 5% of my portfolio. And I plan to sell it at some point. When I do sell Natoco, it won’t be because I don’t like the stock. It’ll be because I don’t like the stock enough to bring it up to 20% of my portfolio.

That’s really just how I think. If I wouldn’t want a stock to be 20% of my portfolio – then why would I want it to be any percent of my portfolio?

From time to time, I do own stocks that are less than 20% of my portfolio. Natoco was bought as part of a roughly 25% to 50% of my portfolio basket of Japanese stocks. When I sold out of those Japanese net-nets, nobody was willing to take the price I was asking for some of my Natoco shares. So, I kept the leftover shares rather than compromise on price. Later on, I kept holding Natoco, because I didn’t have anything I wanted to buy more of at the moment. So, it was a choice between either doing nothing and staying in Natoco or doing something and adding 5% of my portfolio to my cash balance. My bias is usually toward: 1) Inaction and 2) Holding stocks instead of cash. So, I just stayed with Natoco.

Once I decided I was probably going to buy Howden Joinery, I started thinking about selling George Risk, Weight Watchers, Babcock & Wilcox Enterprises, and Natoco because these positions combined were about 30% of my portfolio. I knew I’d want to put at least 20% of my portfolio into a new stock idea like Howden.

And I knew I don’t like holding “distractions”. I consider any stock that makes up less than 10% of my portfolio to be a distraction. When I look at a distraction, I ask myself a simple question. Would I rather have 20% of my portfolio in this stock or 0% of my portfolio in this stock? And then, I either buy more to get the stock up to 20%. Or (much more likely) I eliminate the position entirely.

This is something I really do. With both Weight Watchers and Babcock & Wilcox Enterprises – which are two stocks that dropped 50% or more at one point to become small positions for me – I really did ask myself whether I wanted to more than “double down” on these positions. In both case, I decided I’d rather buy a completely new stock than take positions like these from less than 10% of my portfolio up to more like 20% of my portfolio.

So, I sold George Risk because I decided I liked Howden Joinery more than George Risk. And I sold Weight Watchers and Babcock & Wilcox Enterprises because – in both cases – I decided I’d rather have 0% of my portfolio in each of those stocks than 20% of my portfolio in each of those stocks.

I could have kept them at 10% or less. But, that always feels to me like a half measure that doesn’t make much sense. I never want to “water down” a future good idea I’ll have – like Howden – because I’m still holding some ideas I maybe half-like and half-don’t like so much anymore. I’d rather ask myself: do you really want to buy more of this stock to bring it up to 20% of your portfolio? No. Then why own it at all?

I know that’s an unorthodox approach. I’ll also admit that on a strictly rational single case basis, it’s an incorrect approach. It’s not rational to sell something just because you aren’t willing to make it 20% of your portfolio. However, I’m always trying to find the strategy that works best for me over the long-term. And I think a habit of focusing all my efforts on holding no more than 5 ideas is one that makes sense. If I’m going to implement that policy long-term, I need to constantly eliminate positions of less than 20% in the short-term.

Talk to Geoff About Why He Sold George Risk and Weight Watchers

“The fox knows many things, but the hedgehog knows one big thing.”

I’ve been writing about investing for 12 years now. And the most fun I ever had doing that was when I was co-writing The Avid Hog with Quan.  Although no new issues of that newsletter will ever be published, I’m happy to report I just worked out a deal with my partners on that newsletter that means all 27 past issues of the newsletter are now available at FocusedCompounding.com.

So What Was The Avid Hog?

For those who never read The Avid Hog (later renamed “Singular Diligence”), each issue is a single stock report. That report discusses a single stock in a series of 9 articles. These 9 articles – each over 1,300 words long – include separate sections on the 7 points that make up my personal buy and hold checklist:

1.      Durability

2.      Moat

3.      Quality

4.      Capital Allocation

5.      Value

6.      Growth

7.      And what the future five years out from today might look like

In addition to 12,000 words of written analysis, each issue of The Avid Hog included:

- Up to 20+ years of historical financial data

- An owner earnings calculation

- An intrinsic value appraisal

- And a margin of safety measurement

The goal of each issue was to provide subscribers with enough information – in the form of facts, quotes, and data – to make their own decision about the stock. Unlike many newsletters, the focus of The Avid Hog was business analysis. The intended minimum investment time frame was 3-5 years. The stocks profiled were the same stocks that Quan and I were considering for our personal accounts. That’s why you’ll see we did reports on Frost (CFR) and Babcock & Wilcox (pre-spinoff). Frost is now 40% of my portfolio. BWX Technologies (part of the Babcock & Wilcox break-up) is now 25% of my portfolio. So, two-thirds of my money is in ideas I wrote about in reports you can now read.

This free PDF of the Omnicom issue (a stock I like at today’s $83 price) is a good example of what a typical Avid Hog issue looks like.

Here’s a full list of the 27 newsletter issues now in the Focused Compounding library:

·  America’s Car-Mart

·  Ark Restaurants

·  Babcock and Wilcox

·  Bank of Hawaii

·  BOK Financial

·  Breeze Eastern

·  Commerce Bancshares

·  Ekornes

·  Fossil

·  Frost

·  Grainger

·  HomeServe

·  Hunter Douglas

·  John Wiley

·  LifeTime Fitness

·  Luxottica

·  Movado

·  MSC Industrial Direct

·  Omnicom

·  Progressive

·  Prosperity Bancshares

·  Swatch

·  Tandy Leather Factory

·  The Restaurant Group

·  Town Sports International

·  Village Supermarkets

·  Weight Watchers

So What Is Focused Compounding?

Focused Compounding is a new website I co-founded with Andrew Kuhn. Its mission is to “create a community of focused investors who compound their capital and wisdom together.”

Our site has:

·        Instructional videos (example)

·        A forum where members share their favorite stock ideas (there’s already an amazingly detailed Wells Fargo post up there now)

·        And “memos” – basically blog posts – from me and Andrew (example)

A membership to Focused Compounding costs $60 a month. However, you’ll save $10 a month for as long as you remain a member when you use the promo code “GANNON” at sign-up.

I hope you’ll become a member of Focused Compounding at the reduced rate of $50 a month (with the “GANNON” promo code) if only to work your way through all 27 newsletter issues in our library. 

Membership is billed monthly. You can cancel anytime.

Please give us a try.

Read the Omnicom Issue

Check Out Focused Compounding

Talk to Geoff