Y H & C Investments July 2024 Update
Your actions speak...
(Return figures in this section come from the June 28, 2024, edition of the Wall St. Journal. Y H & C Investments may have positions in companies mentioned in this newsletter. 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)
Y H & C Investments: Contrast Between What I Don’t Want Versus What I Do!
A little more than six months ago, there was a live interview at an investment conference with one of the most famous investors of our generation, let’s call him Bobby Bigshot. Mr. Bigshot is a multi-billionaire who helped break the British pound many years ago in a famous currency short. Mr. Bigshot was asked about the most high-profile stock in the market and mentioned that when he went back and did research about the internet bubble, the leaders could often have multi-year runs of great performance. He indicated this company was his biggest position at the time. A few months ago, with not nearly as much publicity, Mr. Bigshot disclosed he sold all of this position after it had another big run-up. He subsequently redeployed the capital into small cap holdings. Why do I mention this event?
One of the biggest challenges in the equity markets investors must manage is the question of whether management teams or other large holders of a company stock are acting the way they publicly speak. Investors constantly hear leadership teams or investment celebrities talk about their faith in a company to create long term shareholder value. Who can forget the legendary television performance of a high-profile Silicon Valley superstar touting their SPAC holdings as long-term positions, only to sell them two weeks later? These SPACs subsequently lost over 90% of their value. I have no interest in deploying capital with anyone that remotely acts in this manner.
Instead, I pay very close attention to what corporate executives do in the capital markets. When they file form 4’s, I read the filing. Are they buying or selling? How much do they own? What percent of this is being sold or bought? Are these options or restricted stock? In nearly all cases, from my perspective, it is not a significant piece of information. However, if your CEO or CFO or corporate VP is telling a story about building long term shareholder value, and yet at every turn they are dumping tens of thousands of shares, well, clearly, these actions are inconsistent with what they are saying. Even worse is when a stock has performed poorly for quite a while, and the executives are selling stock every chance they get. It is important to realize that if a company has performed very well, let’s call it double or triple or more in five or ten years, it’s probably justified for an executive to ring the cash register. For me, this issue is one of the biggest hurdles investors face when investing in individual stocks. Let’s turn to what I believe is important with respect to insider owners and stock transactions.
The people who are crucial are the largest holders, usually the CEO and CFO. I want the CEO, CFO, and executive team to own a significant amount of stock. It is important their holdings are not an excess of option grants. I want the executive teams to own at least 10% of the stock, and typically with our smaller companies they own 20-60% of the equity. It also is preferred to see a consistent pattern of buying by executives. I am not talking about token purchases of anything less than a thousand shares. When the stock of a company isn’t doing well, the largest holders bear the brunt of the pain. If I own half a percent to two percent of the outstanding equity, and the CEO owns 10-20%, how the stock performs is far more significant financially to the larger owner. The investment term this refers to is skin in the game. Once the company executes and the stock has a massive run, you have a different situation. Still, I want the leadership to keep their eye on building shareholder value with a focus on growing the competitive advantages of the business. Just because a stock has gone from a market value of fifty or a hundred million to two or three hundred million does not mean victory should be declared. Companies which have good stock performance should be looking to constantly build on it. Executives who continue to buy and hold the stock reinforce shareholder faith in the longer-term opportunity of the business. The opposite is true as well. As Ralph Waldo Emerson said, “Your actions speak so loud, I can't hear what you say.”
Events and Happenings In June: Travel, Global Events, Macroeconomics, and Turnarounds (Return figures in this section come from the June 28, 2024, edition of the Wall St. Journal. Y H & C Investments may have positions in companies mentioned in this newsletter. 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)
Many investors are not aware the currency market is the largest market in the world by trading volume. Travel is affected by currency fluctuations as one must be able to pay for things wherever one goes. I have long been fascinated with the currency market, and current investors know we have exposure in this massive area. Travel and currency have seasonal fluctuations, so the time of the year determines the amount of volume which takes place. Over the last month, the heaviest part of the summer travel season started and continues for the next few months. Regardless of what happens with exchange rates, I want our investors to benefit from it.
Globally, the biggest stories are the election results in Mexico and India, the upcoming contests in England and France, and let’s not forget the first debate between the two presidential candidates here in the US (if that is what we want to call them, but I can think of more appropriate descriptions). Interestingly, investors were not encouraged by what took place in Mexico and India. In the UK and France, it appears British voters detest the conservative party while France is moving further in the populist direction. The results will impact future economic policy as it appears the UK will enact more stringent tax rates while the France could have a far more confrontational approach towards European unity. With respect to global central banks, the ECB, Bank of England, and Bank of Canada are all beginning to cut interest rates. The posture is either inflation is settling down (ECB and UK) or the economy is very weak and needs help (Canada). In Japan, the Yen remains very weak as the Bank of Japan contemplates raising interest rates and decided to reduce the rate of bond buying. Fed head Jerome Powell maintains he is on hold, but I believe he would just love to start reducing rates. Hmmm, don’t we have an election in November?
I want to bring up a couple of turnaround investments as they provide an interesting look at the challenge of investing, especially with individual stocks. Both are large companies in industries which are quite stable, retail pharmacy and pet food supplies and services. Both stocks have been crushed, trading at multi-year lows. Both have big businesses in terms of revenues. Both reside in a part of the value chain, meaning their margin profile, which is currently very poor. It means these industries are relegated to the leftovers, the remains after most of the profit is accounted for. Why would any investor want to own these situations? The answer is in the price, or as investors prefer it described, the risk reward of the situation. I invest in these situations knowing they take a long time to play out. If you expect it to take a year, it probably will take two or three. That said, one of the companies reported last week and with management just mentioning they are starting to see a little improvement, the stock has recovered nicely. The other company reported a poor quarter and are considering closing 25% of their store base. These are not big positions but in these kinds of situations, when there is improvement, and especially if it is over a prolonged period, the return possibilities are well worth the risk. I’ll make sure to follow up and keep you posted.
Y H & C In June: Industry & Holdings Update, Applying CE Learnings for CFA, and plans for July
(Return figures in this section come from the June 28, 2024, edition of the Wall St. Journal. Y H & C Investments may have positions in companies mentioned in this newsletter. 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)
The most significant market event affecting the portfolio during June was a merger between two community banks based in the northern section of California. In combination and once completed, the entity will have over three billion dollars of assets and a strong position in two of the most populous counties of the north central coast of California. Relatedly, the community banking area is a segment which has plenty of consolidation possibilities because there are 4,411 such entities in the United States. Will there be 4,411 community banks three years from now? Not a hard question to answer.
As part of the requirements to maintain a CFA credential, there are annual continuing education duties a member must fulfill. It is my sixteenth year of meeting these learning obligations, and I always try to pick information which is useful. A valuable piece was a video about the benefits of using artificial intelligence when evaluating markets. It broke down the components of returns from stocks. You may find it interesting that 70 percent of a return from a stock comes from the industry, while 30 percent is unique to the company. Capital flows are dynamic, so the pattern of money piling in to areas which are considered desirable happens repeatedly. It then moves on based on how participants see the market evolving. The most prominent example is the recent popularity of the semiconductor manufacturing sector. The leading companies in this area have seen their equities soar, as have some not so leading entities. Those of us long familiar with the market know the semiconductor industry is notoriously cyclical. The money chasing what company will become the standard for artificial intelligence is highly speculative, but that it is why it is called hot money.
The other interesting piece was by a money manager in India who has long had excellent returns. The noteworthy point was the concentration in winners which has taken place in India, like what is now transpiring in the US market. My observation is that when there is a high concentration of assets in a few large names, it speaks to the large level of perceived fear from participants. With governments more involved in markets than ever, unpredictability in geopolitical events, politics, policy, and regulation which remains not well thought out, investors say, “forget this, let’s just own the best stuff that has done well.” We know the only constant is change, and as time evolves, investors usually adapt and there is a high probability the concentration of assets will spread out. When this takes place I cannot tell you. A famous quote from Bernard Baruch is quite applicable, “Information cannot serve as an effective substitute for thinking.”
Finally, during the end of June and the first few weeks of July I am traveling with my family. Of course, I am always attentive to clients and our holdings, so I’ll still be in contact! I very much appreciate your interest and if you have any questions or comments, please say hello at information@y-hc.com. Thanks for your continued support!