It’s been too long

I don’t know where to start.

I guess with Peter’s death. To me Peter was one of the greatest living Irishmen. His warmth, generosity, kindness, fire and brilliant humour made life better.

I used to keep this picture of Peter with my son on my desk. The photo reminded me to live in the moment, to enjoy the moment, to love the moment.

Peter died from cancer this week.

I’ll write more soon.

Investing Myths and Disjunction Fallacy

Here are the results from a twitter poll I ran yesterday.

gain loss quiz

It was a small sample size. Only 30 people. I assume most were financially literate.

I wonder what people thought when they saw the results, after answering the poll. Did they feel more or less sure of their answer? Did they feel validated or perhaps confident in their contrary position?

It seems most people believe that a 50 percent loss takes a 100 percent to make it whole again. That a 90 percent loss takes a massive 900 percent to offset it.

That my friends is bullshit. It is one of the most widely perpetuated myths in investing.

Investing is a parallel pursuit. A 50 percent loss in one investment is offset by a 50 percent gain in another investment of the same size. A 90% loss is made whole by a 90% gain.

the real gain loss picture

Yes if you loose 80% of your total portfolio you’ll need to make 400% to get back to scratch. While that concept is important, I consider focusing on outcomes for individual investments more crucial. I’ve always liked the saying, look after your pennies and the pounds will look after themselves.

There is no need to be terrified of losses. The upside is infinite the maximum downside is only 100 percent (ignoring leverage). I don’t wish to encourage you to be a bag holder and take big losses. My aim is simply to make you wonder why almost everyone is hell bent on convincing you that deepening losses require exponentially higher returns to offset.

Now for anyone thinking, but you didn’t say an investment I thought you were talking about a portfolio, let’s talk about disjunction fallacy.

In short disjunction fallacy is thinking that a member is more likely to be part of a subset rather than a member of the set which contains the subset. In the above poll, both 50% and 100% are subsets of it depends.

This is similar to the better known Linda effect or conjunction fallacy, when people guess that the odds of two events co-occurring is greater than either one occurring alone.

The return required to make you whole depends on whether you’re considering a portfolio or an investment and the position size of each investment.

Is your mobile phone glued to your hand?

“Never invest in any idea you can’t illustrate with a crayon.” Peter Lynch

Mobile Embrace (ASX:MBE) is a fast growing, mobile marketing company.

Passionate founders, hugely scalable, high margins and massive tailwinds.

Crayons are so yesterday! Here’s my Mobile Embrace illustration.

Mobile Embrace business

 

If you want to read more go read the annual and half year reports.

Or be influenced by Marcus Hamilton at Taylor Collison.

MBE looks cheap for a fast-growing, mobile-focused company with a strong track record of delivering organic and acquisitive growth. Accordingly, we reiterate our Outperform recommendation and $0.45/sh price target.

Long Mobile Embrace. My target is $1 within 2 to 5 years, reassessing as it goes.

Regulatory and technology risks.

Dismantle your binary thinking

Most of us are programmed from birth to think in binary terms.

Right and wrong, good vs evil, heaven and hell, cops and robbers, snake and ladders, to name but a few.

Binary thinking keeps things simple at the expense of reality.

Break the binary chains restraining your mind

Look at Investing from a New Angle

We do not live in a binary world. We live in a multivariate world.

The core of investing is assessing probabilities. If you think in binary terms you’re closing your mind to the raft of possible outcomes.

This is a quick rant, inspired by the following example of binary thinking resulting in a logical fallacy.

When 50-60% of your revenue is “highly likely” to reoccur, then by definition 40-50% of your revenue is “highly unlikely” to reoccur.

That sentence is at the end of this great write-up on billing software company Gentrack. [Update: author was being humourous, it was a play on words.]

If 50-60 percent of revenue is highly likely to reoccur then all you know is that 40-50 percent is not highly likely to reoccur. 20 percent may be likely to reoccur.

Open your mind to a world of possibilities.

How to tell if management will reward shareholders

The extravagance of any corporate office is directly proportional to management’s reluctance to reward the shareholders.  Peter Lynch

Director’s and management’s salary packages are inversely proportional to their willingness to reward shareholders.

Those wasting shareholder money on remuneration consultants don’t deserve your trust. Hiring remuneration consultants is managements way of telling you they want more of your money than they deserve. It indicates management are profligate and will waste your money on non-profitable activities, such as those consultants.

Unfortunately Nearmap Limited (ASX:NEA) have gone one step further and are wasting even more money. Nearmap are holding a special general meeting for shareholders to approve two option grants valued at over $200,000 each. The two directors are new and are on already on $70,000 annual packages.

The two directors, Ian Morris and Peter James, don’t even have any of their own skin in the game. Neither has invested one cent in Nearmap.

The cost of these options grants includes:

  • the time/opportunity cost the directors should have spent improving the fortunes of the company instead of figuring out how to enrich each other
  • the cost of the remuneration consultant
  • the costs of the general meeting, including documentation, director’s and management’s time, cost of venue and associated costs
  • the value of the options $434,000

The directors and management of Nearmap should concentrate on improving the business and spend less time wasting valuable shareholder funds and enriching themselves.

MMC Contrarian Share Buy Back - Vote No

How low can WorleyParsons go?

A little under two years ago I met the then CFO of WorleyParsons Limited (ASX:WOR) over drinks at my daughter’s new school. The next day I looked at WOR for the very first time. The shares were then trading at around $16, down 70 percent from the all time of $54.19 and down 30 percent over the last year.

On trailing financials WOR looked interesting, but with an uncertain future and stacks of mining and energy services falling hard I decided to wait.

and wait

and wait some more.

While biding my time a neighbour mentioned buying WorleyParsons. As I recall that was around $10 and despite the near on 40 percent fall since I first looked at WOR the deterioration in the sector appeared to be accelerating.  I held my tongue, as nobody appreciates contrary views to their purchases.

WorleyParsons 2016 top pick for the brave

Credit Suisse have now listed WorleyParsons as one of its top six 2016 stocks picks for the brave. With a projected return of 150 percent.

Buyers beware! That projected return should be taken with a grain, nay a big bag of salt. Back in September 2013 Credit Suisse upgraded WorleyParsons to outperform and increased the target price to $26.60. Credit Suisee said WorleyParsons’ 14-times price-to-earnings ratio and 5 percent dividend yield were compelling.

Someone should have schooled that analyst in the danger of driving forward while looking in the rare view mirror.

 

WOR falling knife

Today WOR trades at $3.35! Has this falling knife bottomed? Is a 94 percent fall from its all time high far enough?

I’m sure I don’t know the answer. However, despite legal action to the contrary management appear to be doing a decent job of navigating difficult times. What I do know is market conditions will one day improve and a leaner WorleyParsons will deliver a 150 percent return and more. It has the balance sheet and cash flow to survive.

After two years of watching and waiting I’m finally confident enough to say WorleyParsons deserves a place on your watchlist.

More importantly, don’t try to catch falling knives! 

Are you concentrating hard enough?

I sure am!

The top two shares account for 78 percent of our concentrated share fund. The top three 92 percent.

So yes, we’re concentrated!

Two great investing principles

The five shares in the portfolio reflect two simple investing principles.

Two rules from two great investors, Peter Lynch and Warren Buffett.

Water your flowers and pull out the weeds, and only own a handful of companies.

I learnt both rules from Peter Lynch. Though it was Warren Buffett who popularised the concentrated approach with his catchy 20 ticket punch card analogy and his ‘You don’t have to swing at everything — you can wait for your pitch’ phrase.

Lynch was more mater-of-fact.

‘The smallest investor can follow the Rule of Five and limit the portfolio to five issues. If just one of those is a 10-bagger and the other four combined go nowhere, you’ve still tripled your money.’

I illustrated that point in this post highlighting how the view of ‘the greater the loss the ever greater the gain required to make you whole again’, was wrong. For example instead of requiring a 400 percent gain to make up for an 80 percent loss as contended, due to the parallel nature of investing an 80 percent loss is balanced by an 80 percent gain.

The two largest positions are a result of watering of the flowers. Adding on the way up and then simply holding on. Though the second largest has now been trimmed three times. A potential fourth haircut inspired this post.

There are only five companies in the portfolio as the weeds have been pulled.

The third largest portfolio position deserves some water. It’s management are frugal and appear focused on safely growing and rewarding shareholders.

The smallest two positions are speculative long shots. They’ll only receive water if their odds of success shorten.

Please keep in mind there are many right paths. We hold close to 20 companies in our super fund. Plus our concentrated fund has and likely will hold more companies.

3 Ways a Stock Should Pay You

Do you get a lot of useless mass emails? I know I do.

You know the type of emails I’m talking about. They have a catchy headline and a thin veneer of information, but really they’re simply advertising. Mutton dressed up as lamb.

Among the deluge of email noise, Tom Jacobs stands tall. I asked his permission to reprint the following email, as both it and Tom deserve more attention. I’ve followed, liked and learnt from him for 15 years. I recommend you do too.

3 Ways a Stock Should Pay You

Many people incorrectly think there is magic to stock gains and losses because they consider only price. Rather, what matters is whether the business creates what’s called shareholder value. If it does, the stock price will eventually follow. Very simple.

You’d think creating shareholder value would be the goal of every company, right? Sell products and services, take in more money than you spend, and reinvest the excess cash to earn more than if it sits in the checking account. This creates value for owners, whether of a lemonade stand, coffee shop, or Apple, and someone would pay more to buy the business-through our shares.

Yet many businesses are in business to create value for management, not owner-shareholders. And even those who try to be shareholder friendly aren’t often good at it. There are very few truly good CEOs, or every company would make shareholders better off. How do we find good management?

 

The Five Choices

There are five places execs can spend cash beyond what’s needed to run the business: (1) property, plant, equipment, research and development; (2) mergers and acquisitions; (3) dividends; (4) buying back the company’s own undervalued stock; and (5) paying down higher interest debt.

The first two are growth investing. Here, companies build more manufacturing and distribution facilities, hire more software developers, buy other companies and grow empires! More often than not, these fail to create a more valuable company. These investments don’t earn a sufficient return, and roughly 85% of M&A activity fails to add shareholder value. Simply, most CEOs don’t spend shareholder cash well.

 

The Virtuous Cash Cycle

The other three choices help prevent management from blowing our money on skittles and beer. They provide shareholder yield. Paying down debt saves on interest payments, freeing up more cash. If the company’s shares are selling at a price that places a very low value on the company, buying its own stock is a good investment. And when the company buys back shares, our shares own more of the company, and earnings and cash flow per share rise, usually leading to stock gains.

Plus, if a company pays dividends, every share it buys back eliminates paying the dividend on that share forever. If the dividend yield is 4% a share, the company “earns” 4% a year forever just by not having spend it anymore. Even more cash is available to increase the dividends, buybacks, and debt paydowns. It’s a virtuous cycle.

Despite this simple thinking, most investors avoid companies that pay dividends and buy back stock, believing their best days are over. Quite the opposite. The best days for management moon-shot paydays may be gone, but the sweet paydays for shareholders have just begun.

Don’t worry about our vibrant entrepreneurial culture. Venture capitalists and institutional investors will always provide capital for companies with new ideas, products and services to enhance our lives. However, let’s leave it to them to speculate.

Instead, we will buy cheaply and get paid. It’s as simple as that.

 

Tom Jacobs is the co-author of What’s Behind the Numbers? A Guide to Exposing Financial Chicanery and Avoiding Huge Losses in Your Portfolio. He is an Investment Advisor for separately managed accounts at Dallas’s Echelon Investment Management and serves clients worldwide. You may reach him at tjacobs@echelonim.com.

Rene sure knows his acquisition sauce

My Net Fone Ltd (MNF.AX) CEO Rene Sugo sure knows his acquisition sauce.

The acquisition of Telecom New Zealand International voice business is another excellent bolt on for My Net Fone. The TNZI network that MNF are buying from Spark New Zealand Limited (SPK.AX) expands its reach.

$90-100 million of revenue and $3.5 million EBITDA before synergies. This deal will surely be less than 6 times EBITDA in the first year, maybe as low as 5. Anywhere in that range for a growing complementary business is good buying. This deal adds scale, global reach, a good brand and more. Two thumbs up!

Anyone want to talk about it? Or why Spark are selling?

Disclosure: Long MNF

 

Fusion Fund December Performance

With another year down it’s now only 4 billion years until the sun swallows the earth. Better hurry up and do all the things you’ve been wanting to!

I hope 2015 is a fantastic year for you and yours.

By now I’m sure you’ve seen all the Back to the Future II comparisons.  In case you missed it that 1989 movie was set in 2015 and featured flying cars, hover boards and self lacing Nike runners, along with some far out clothes. While people are working on flying cars and hoover boards, commercial availability is still decades away. The good news is Nike is planning on releasing self lacing shoes this year!

Fusion Fund Performance

Fusion Fund finished the year with a 7.9 percent gain, slightly ahead of the total return index’s 5.6 percent gain.

fusion-fund-performance-vs-all-ords-accum-2014-12 fusion-fund-performance-2014-12

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