|
In 2008 I had a return of -33.4% compared to -38.5% for the S&P500 index. The prices of stocks declined regardless of their financial status. It has been an incredible year! The 2008 year was arguably the worst year in
the history of the stock market since the 1930s, but one of the best years for
stock prices! 2008 was marked by a
number of U.S. bank failures, a run on Freddy Mac and Fanny Mae, the bankruptcy
of Lehman Brothers and destruction of investment banks and In March of 2008, Warren Buffett declared in “USA Today”
that the Despite the doom and gloom in the media surrounding the stock market, Mr. Buffett was uncharacteristically busy in 2008 purchasing preferred stock of Goldman Sachs and General Electric, facilitating the purchase of Wrigley by Mars, becoming the biggest shareholder of Kraft, boosted his already huge stake in Wells Fargo, Burlington Santa Fe, snapped up 3% of Swiss Re, made a personal bet against hedge funds (with proceeds going to charity), and gambled that the 4 stock market indices will be higher in 2019 than they are now. Meanwhile, his company, Berkshire Hathaway fell to 1.0x book value or $80,000 per class A share – an almost 50% drop from its high of $150,000. What an incredible year! I added to my positions in K-Swiss (KSWS), The Buckle (BKE), and Fossil (FOSL). The earnings yields on the aforementioned stocks range from 9% to 15% and all of them have no long-term debt. The only catch with these investments is that I need to hold them for a number of years to reap my reward. I am in no hurry. "If you have more than 120 or 130 I.Q. points, you can afford
to give the rest away. You don't need extraordinary intelligence to succeed as
an investor." - Warren Buffett CREDIT DEFAULT SWAPS This year, credit default swaps (CDS) were often reported
alongside stories of the destruction of the A derivative is a financial contract whose values are “derived” from the value of something else (i.e. underlying). A credit derivative is a derivative whose value derives from the credit risk on an underlying bond, loan or other financial asset. A CDS is a credit derivative contract between two counterparties. The buyer of the CDS makes periodic payments (premium leg) to the seller, and in return receives a payoff (protection or default leg) if an underlying financial instrument defaults. Before you assume that this is similar to insurance, keep in mind that the buyer of a CDS does not need to own the underlying security and does not even have to suffer a loss from the default event. CDS are used for hedging, speculation and arbitrage. CDS are the most widely traded credit derivative product. It has been reported that the amount on outstanding CDSs to be over $42 trillion. The primary criticisms against CDS revolve around the lack of appropriate regulation considering the size of the market and that, since all contracts are negotiated privately, there is a lack of transparency. The problem between CDS buyers and sellers were not necessarily with the contract itself but what other CDS arrangements that both the buyer and seller were also involved with. Your company may be owed a net payout of $100M of protection, but if your counterparty to this agreement is unable to settle their other contracts, they will go bankrupt before you see your money. Paraphrasing a quote from Warren Buffett, it isn’t important who you’re sleeping with as much as whom your partner has been sleeping with. "Unless derivatives contracts are collateralized or guaranteed, their ultimate value also depends on the creditworthiness of the counterparties to them. In the meantime, though, before a contract is settled, the counterparties record profits and losses—often huge in amount—in their current earnings statements without so much as a penny changing hands. The range of derivatives contracts is limited only by the imagination of man (or sometimes, so it seems, madmen)." -
Warren Buffett, 2002 Annual Letter to Shareholders The 2008 financial crisis began in earnest as counterparty defaults increased. Specifically Lehman Brothers and AIG were involved in a large number of CDS counterparty agreements and the size and unregulated nature of the market created massive domino-effect of systemic risk. BIG COMPANIES SMALL
RETURNS Investing in ultra-large companies is a bad idea for individual investors. To hope that a $100B company will grow earnings at double digits over the course of the next decade (and beyond) is foolish. Unless an investor is looking for a stable flow of dividends, investing in large companies is a waste of time. Investing in large companies is one of the primary reasons that mutual funds (and mutual fund investors) fare so poorly over the long haul. The combination of paying high fees to buy ultra-large, slow growing businesses ensures poor performance. Peter Lynch noticed in his book, “One Up On Wall Street” that a 10-bagger (i.e. a stock that increases 10-fold) can change a poorly performing portfolio into a spectacular success. The odds that a $100B company will increase 10-fold are non-existent. Smaller companies (i.e. < $1B market capitalization) not only offer superior returns, but their price fluctuates far more dramatically which provides greater opportunities to invest at an attractive price. The best way to ensure satisfactory returns is to invest in “tiny” companies with pristine balance sheets and proven growth. So why do investors buy large company stock? One reason is likely to be social imperative. Nobody wants to be seen to stray from their peers or even worse, to be seen losing money while investing alone. When you lose money in Microsoft, your friends ask, “What’s wrong with Microsoft?” When you lose money on The Buckle, your friends ask, “What’s wrong with you?” THE HIGH PRICE OF
DIVERSIFICATION Another oft promoted concept is diversification. Mutual funds and financial planners have pounded this concept into the mind of the public for years and in 2008, the downside risk that was supposedly avoided by rampant diversification was nowhere to be found. Businesses across every sector were decimated as prices all came down to earth. Diversification offers no protection from downside risk and virtually guarantees poor results. The great irony here is that my portfolio of half a dozen stocks has performed better than the wildly diversified market indexes in the last two stock market meltdowns. GOOD BYE BARR As an aside, I have been following generic drug maker Barr Laboratories for a long time and have always admired the financial strength of this company. However, the price never fell to a reasonable level. The business had all the earmarks of success that I look for, unfortunately Teva Pharmaceuticals were looking for the same thing and in the summer of 2008, came to an agreement to purchase Barr Laboratories for $7.46B. DISCUSSION
Our cash decreased as the markets fell and we allocated capital into K-Swiss, Fossil and The Buckle. Here is a brief look at the relative sizes of the companies in the portfolio:
The following are brief discussions surrounding the businesses in the portfolio. They are not discussed in any particular order. Fossil Fossil is a leading mid-priced watchmaker in the U.S. and the company generates most of its sales from watches. Brands include its Fossil and Relic watches, as well as licensed names Giorgio Armani, Michael Kors, adidas, Burberry, Marc Jacobs, and Donna Karan and private-label watches for Target and Wal-Mart. Fossil also distributes fashion accessories, such as leather goods, sunglasses, and apparel. Fossil sells through department stores and specialty shops in more than 90 countries and some 240 company-owned stores, as well as through its own catalog and Web site. Brothers and executives Tom and Kosta Kartsotis own about 32% of Fossil. In 2008 the price of Fossil stock declined 44% from $36 per share to $16 per share resulting in a doubling of its’ earnings yield to 13%. At the time of this writing, Fossil’s P/E stands at a little less than 8. Fossil’s revenue grew 16.8% in Q1, 15.2% in Q2, and 14.3% in Q3 of 2008 compared to the same period a year ago. Net income rose 20.7% in Q1, 71.3% in Q2, and 25.6% in Q3 in 2008 compared to the same period a year ago. Keep in mind that 2007 was a challenging year and comparisons to that year may be appear overly optimistic. These 3 quarters represents $1.1B in sales and over $91M in profit which will ensure that 2008 will be the most profitable year in Fossil’s history. Instead of blowing out Q4, Fossil has cut
their outlook from $0.95 per share in profit to $0.70 per share. The company cites the failing Inventory levels at the end of Q3 were $331.6M which is an increase of 24.6% over prior year and cash dropped from $193M to $125M. In 2008, Fossil entered into an agreement with Donna Karan to design and sell a line of jewelry for women and men under the DKNY brand. They also signed a new licensing agreement with Armani to continue creating watches under the Emporio Armani brand through 2013. K-Swiss K-Swiss sells athletic, training and children's shoes; apparel; and accessories. Shoppers keep coming back to the K-Swiss Classic, the white, all-weather, leather tennis shoe that was introduced in 1966 by its founders. K-Swiss products, marketed under its namesake and Royal Elastics brands, are made by independent suppliers in China and are sold in department and specialty retail stores. Steven Nichols is the CEO and owns about 93% of the company's voting shares. In 2008 the price of K-Swiss stock declined 32% from $16.7 per share to $11.3 per share due to poor profitability its earnings yield remains at 9%. The company has a market capitalization of $400M with $290M in cash. The company paid out a $2 per share dividend in December of 2008 which will take the amount of cash-on-hand to $220M. The company has no debt on its balance sheet. K-Swiss is going through tough times. Return on equity is an anemic 8.5% and in the trailing 12 months the company has produced a $32M in net profit. An investment in this company is an investment in a 2 -3 year turnaround otherwise known as a leap-of-faith. The company anticipates a “significant decline” in domestic and international revenue. In Q1 of 2008 revenue declined 16% to $102.9M although international sales were up slightly; this was obviously not enough to offset the 33.6% decline in domestic sales. Net profit came in at a little over $7M. In Q2 of 2008 K-Swiss reported profit of $26.4M due to a one-time $30M litigation settlement from Payless ShoeSource on total revenues of $85M. In Q3 2008 revenue was $95.8M compared to $107.2M a year ago, a decline of 10% creating a loss of $100,000 (or break-even per share) compared to $12.8 for Q3 2007. Backlog continues to point towards declining sales. Total backlog is down 29%, comprising a decrease of 35% domestically and a decrease of 25% internationally. Many analysts attribute the poor performance to the fact that over 60% of their sales comes from one shoe design – the “classic”. Oddly enough, when times were good, this attribute was hailed as the reason K-Swiss outperformed its peers (less design/inventory costs etc.). K-Swiss is heading for a loss of $0.10 to $0.35 per share in the fourth quarter. During the conference call management said that they are expecting a loss in 2009 that could burn through 20% of their cash. This would leave them with approximately $180M on their balance sheet. For the full year, K-Swiss will have
generated revenues of $300M and earned a profit of $30M. Management has not masked these problems and has
laid those bare, ugly warts and all, for everybody to see. Only time will tell if Berkshire Hathaway owns a variety of companies, from insurance and building materials to apparel and furniture retailers. Insurance subsidiaries include National Indemnity, GEICO Corporation, and reinsurance giant General Re. The company also owns McLane Company, Dairy Queen, Clayton Homes, and MidAmerican Energy Holdings. In 2006 it bought press release distributor Business Wire, sportswear company Russell, and 80% of ISCAR Metalworking, an Israel-based maker of metal-cutting tools and the first foreign company in which Berkshire has a controlling stake. Buffett owns about a third of Berkshire Hathaway. In 2008 Berkshire Hathaway saw its share price whipsaw from $140,000 per class A share to $90,000 per class A share. For the second time in the last decade, the stock traded a hair above 1.0x book value. For more information about Berkshire Hathaway, I would recommend reading Warren Buffett’s annual letter to shareholders. The
Buckle With about 370 mostly mall-based stores in 38 states, The Buckle sells fashion-conscious 12- to 24-year-olds the clothes they've just got to have: mid- to higher-priced casual apparel (pants, tops, outerwear, shoes, and accessories), including brand names such as Dr. Martens, Fossil, Lucky, Polo, and Silver. Denim, which accounts for about 40% of sales, is popular with its customers. The Buckle operates under the names Buckle and The Buckle; it also has an online store. Born and raised in Nebraska, it has expanded into the South and West. Chairman Daniel Hirschfeld, the founder's son, owns more than 40% of The Buckle's shares. Somebody should tell The Buckle that the U.S. is in a recession. On The company has been growing top line and
bottom line numbers throughout the year.
There is nothing much to report here.
Some media quotes at the end of 2008 include: “Buckle October same-store
sales jump 14.5 percent”, “ …the teen apparel and accessories retail reported
that sales jumped 15% - marking a rare bright spot in what was an otherwise bleak
November for retailers”, “Comparable store net sales year-to-date for the
48-week period ended In short, top line revenue and profit climbed to an all-time high of $620M and $75.3M respectively. The company continues to employ no debt. The punch line to this joke is that the price of The Buckle shares dropped by half in 2008. Gertrude Boyle, the octogenarian chairwoman and star of Columbia Sportswear's popular "tough mother" and "tested tough" ads transformed her father's floundering sportswear firm into a top US skiwear seller and one of the world's biggest outerwear makers. The company popularized the three-in-one Bugaboo jacket (its shell and lining can each be worn separately or zipped together). Columbia also makes leather outerwear, sportswear, Sorel brand boots, and other rugged footwear, as well as accessories such as gloves and caps. The Boyles (Gertrude; son Tim, president and CEO; and daughter Sarah Bany) own more than 60% of Columbia Sportswear. Columbia Sportswear reported their Q1 results in April 2008. The company generated sales of $297.4M which was an increase of 3% compared to the year before. Net profit dropped, however, to $19.9M compared to $26M in Q1 2007. The increase in top line sales was attributed to outerwear, accessories and equipment offset by decreases in sportswear and footwear. Q2 came in 3% lower than a year earlier due
to tougher economic conditions.
Nevertheless Q3 shaped up to be similar to Q2. Sales dropped 4% year over year to $452.4M and profits dropped 2% to $58.3M. However, because of the company’s proactive move to trim inventories and accounts receivables the profit was 20% higher than expectations. These moves continue into Q4 and likely into 2009 as sales continue to decline. Before the year drew to a close, the
company cut approximately 4% of their The price of Columbia Stock has been unusually resilient during this economic downturn. The company is acting a quarter ahead of poor results, trimming inventories and accounts receivable. We expect the business to recover nicely when the economic climate turns. Closing The following is a summary of my sentiments towards each of the companies in the portfolio. It should not be interpreted as a market call or prediction on the direction of the North American economy.
Best regards, Jim Chuong |
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Chuong Letters |
| Quote of the moment |
|
"Much success can be attributed to inactivity. Most investors cannot resist the temptation to constantly buy and sell." "There's no reason we should become fearful if a stock goes down. If a stock goes down 50%, I'd look forward to it. In fact, I would offer you a significant sum of money if you could give me the opportunity for all of my stocks to go down 50% over the next month." "If you have more than 120 or 130 I.Q. points, you can afford to give the rest away. You don't need extraordinary intelligence to succeed as an investor." |
|
Jim Chuong In The Media |
||||||||||||||||||||||||||||||||||||||||
| ||||||||||||||||||||||||||||||||||||||||
Jim Chuong can be reached by emailing jimchuong@hotmail.com or calling 416-254-0159.
| w w w . t i c o n l i n e . c o m |