Y H & C Investments February 2025 Update
"The quality remains long after the price is forgotten." Sir Henry Royce
Y H & C Investments- Asset Quality Is a Crucial Consideration of Investing
(Return figures come from the January 31, 2024, edition of the Wall St. Journal. Y H & C Investments may have positions in companies mentioned in this newsletter. Nothing in the newsletter should be taken as an offer to buy or sell individual securities. It is the responsibility of each investor to research the investments mentioned so they can decide on the appropriateness and suitability of the investments consistent with their risk tolerance, risk constraints, and return objectives)
Consider the following pairs:
Rolex vs Timex Four Seasons vs Days Inn Chipotle vs Taco Bell Peter Luger vs Olive Garden Shake Shack vs McDonald’s Macy’s vs Sears
In each of the examples, one is clearly a superior product and experience compared to the other. Customers pay more money for a high-quality offering rather than an inferior one. Just as customers are willing to pay up for a superior experience, so do investors. The difference being investors pay for assets, and their management. The asset can be a financial asset, like a stock or bond. It may be a piece of property like real estate or land. It might be a collectible, like a baseball card, a comic book, a ticket, or a piece of porcelain. Last, it can be a currency, like the Dollar, the Pound, the Yen, the Euro, etc. Notice I did not include cryptocurrency, including meme coins. Crypto related ‘assets’ have the distinct feature of offering buyers none of the benefits of the other categories. Let’s use the most recent high profile crypto offerings as examples- Fartcoin, Trump coin and Melania coin.
If you buy a financial asset like a stock, as an owner you can benefit from the organic growth of the company and its ability to reinvest profits for future expansion. You will also be rewarded if another company decides it wants to buy your company. You may similarly benefit if your company decides to merge with a competitor. Your company has the ability to raise capital by offering stock, issuing debt, or related instruments attached to the stock or bond. As a prominent example, consider the company Microsoft. Over the last decade, it bought LinkedIn and Activision. It issued debt to finance the LinkedIn purchase. It used its own cash to buy Activision. Now, let’s consider the prior examples of Fart coin, Trump coin, and Melania coin. Do they generate cash from a product or service offered to customers? No. Can they grow their operations? No. Can they issue debt? No. Can they issue more meme coin? Yes, but by doing so existing owners own less of the coin. Can they merge with another coin, consider Fartcoin merging with Trump coin, lets call it Trumpfart. Uh, no. I could see Trump coin with Melania coin, but they did ‘merge’ in real life to procreate Barron. Oh, yes, let’s call that Barron coin. Could this happen? Yes. In all seriousness, crypto related assets offer no possibility of a structured transaction to benefit its owner. So, why do I bring this up?
Asset quality matters. Many believe asset quality is related to liquidity of the asset, which means one’s ability to sell it quickly. I agree that is important, but my own opinion is profitability takes greater priority. The ability to maintain profits over time without diluting existing owners is at the top of my criteria. Another aspect of asset quality is management behavior. If you own something where the majority owners consistently undermine minority owners, well, you wind up with poor returns. The best managers create wealth for all investors, not just themselves or their selected management team. As an investor, you are trying to grow your wealth over time at returns which exceed inflation. Historically, the most wealth comes from owning a profitable company’s stock which can grow from x, to 3x, to 5x, to 10x, to 20x, and beyond. It is the ability to reinvest profitably or use profits to buy competitors and their profits which is crucial to the desired outcome. Crypto related meme coins offer none of these important features. If you are into speculating, yes, then it is a domain where you will have plenty of opportunity to trade and make or lose money. The current environment is one where many people are speculating on assets with dubious quality. Thanks, but I prefer assets which have proven their potential benefit.
Spanning the Globe: Tariffs, Taxes, Interest Rates and Inflation Are All Part of the Cocktail-
As the United States has different political leadership, a complete reversal of its approach in nearly every policy aspect is beginning to affect other countries. The threat of increased use of tariffs is making global countries reconsider their trading situation with the United States. Of course, each country has their own dynamics to consider and from a financial point of view, interest rates are always front and center.
On that front, there are quite a few variations across the globe. As examples, in the UK, EU, and Canada, interest rate policy is headed down, mostly because of economic weakness (what is new?). In Japan, rates are now headed higher because of inflation concerns, albeit the current rate is still very low (again, nothing new). In Brazil and Mexico, interest rates are 14% and 10% respectively, so inflation is a ‘huge’ issue. Argentina comes in at 32%, but that is a big improvement over the last year. Clearly, we have a wide range of interest rates. With President Trump adopting a US first approach, each trading partner has to consider how to deal with someone who is intent on using trade and tariffs to enhance US economic performance. Most prominent are Canada, Mexico, and China. President Trump slapped 25% taxes on anything exported from the first two countries, and 10% from the last one. Oil from Canada will be taxed at 10%. One could argue that given the dominance US companies have in the investment world, a focus on tariffs could make things worse, not better for the US.
Interestingly, the dollar strengthened again after Mr. Trump announced the taxes on Canada, Mexico, and China. From my standpoint, and I am a broken record on this, the biggest risk for all investors across the globe is dollar weakness. 36 trillion in debt and 2 trillion in annual deficits is not a recipe for continued dollar strength. The new Treasury Secretary Scott Bessent knows this and recognizes the problem. Whether or not the Trump Administration can get deficits moving down from 6.3% of GDP to 3%, which is what Bessent is targeting, is going to be the key question.
It is this large issue which the capital markets are focusing, and it starts with the bond market. The current ten-year treasury rate is 4.6%, but we need some more context. Last month, the Federal Reserve lowered the Fed funds rate for the second consecutive time. It is a short-term rate which gets a great deal of attention because much borrowing is related to it. While this rate went lower, the investment world sold ten-year bonds, so the rate on this instrument moved higher (bond prices move inversely to their yield/rate). Given the lack of fiscal discipline by the US government over the last twenty years, investors do not believe the yield on the debt is commensurate with the risk. I would also observe the Fed decided last week to make no interest rate decision as the language Mr. Powell used was, “We are in no hurry to cut rates again.” I would note he did not say raise rates, either. Many believe the 10-yr treasury yield will head higher than 5% over the next year and could end up at 6% or more. A higher yield puts bonds in a more competitive position versus stocks, and that my friends, is the question all investors are currently faced with. With inflation sitting at 2.5-3.0% annualized, bond investors currently make a real return of 1.5-2.5%. Congrats. I’ll take my chances with stocks.
Y H & C Investments in January- A Nice Rebound, and More on Asset Quality
One of the interesting things about markets is there are obvious historical patterns. There is no hard and fast rule, but you see the same things happen repeatedly. One of them is called the January effect, which refers to a rebound of beaten down issues from the end of the prior year. Some of this took place during the month, though for many shareholders, maybe not as much as hoped for. With respect to the overall market, some broadening out of investor capital occurred, and a prime focus is on the AI story and the biggest stocks in the S&P 500. The most dramatic example is the effect of the Chinese AI model Deepseek on Nvidia and other semiconductor stocks. When money flows out of one area, or a few large names, the capital has to be absorbed in other segments. The critical AI question for companies gets back to return on capital and what kinds of returns will be generated from those expenditures? It is the same concern for any company, but when valuations are in the trillions and expenditures are in the hundreds of billions, well, there is quite a bit riding on these returns.
As for my little neck of the woods, early in the month one position was named stock of the year by a high-profile investment podcaster. I hope they are right! Banks are showing strong gains as the largest money center banks reported big profits and are optimistic about many areas of their business. It appears merger and acquisitions, the IPO market, debt and equity underwriting, wealth management, and consumer spending for credit cards and potentially housing are all benefiting from a change in outlook across the entire business spectrum. Confidence matters for business owners, and many feel much more optimistic with the current political leadership. Our real estate holdings will report next week and later in February. On the small company front, quite a few companies benefited from the January effect, and one entity reported numbers which were pretty much in line with what was expected.
As a follow up, a massive pharmacy retailer reported earnings which were a little better than predicted. There was some slight improvement in the equity but more needs to be done as far as closing stores, higher reimbursement from pharmacy benefit managers, a more efficient supply chain, and sharper focus on white label merchandise. All will benefit margins, which is where the company has plenty of room for expansion. The company eliminated its dividend yesterday, and investors did not like the move, but if it helps conserve cash while the company improves operationally, it may wind up being the appropriate tactic.
One of the important areas to remember with investing is you have to be comfortable with what you own. At the top of this list are the people who lead these enterprises. Management quality shows up over time as operational results, smart capital allocation, and decisive decision making when opportunity arises all combine to benefit shareholders. If any of these areas are lacking, returns suffer. Not every company is going to be a huge winner every year. You need one or two big wins every decade to make a massive difference to your portfolio. Most of the time, you are monitoring developments and waiting, and waiting, and waiting, and waiting. Then you wait some more. It is called patience. And then, well, use your imagination. Thank you for reading the monthly update. Please reach out to me at information@y-hc.com if you have any questions or thoughts about the update, investing, or life in general!
Y H & C Investments may have positions in companies mentioned in this newsletter. Nothing in the newsletter should be taken as an offer to buy or sell individual securities. It is the responsibility of each investor to research the investments mentioned so they can decide on the appropriateness and suitability of the investments consistent with their risk tolerance, risk constraints, and return objectives)