Monthly Round Up: April
Earnings season, David Einhorn on value investing, Buffett on 1970's small banks
Enterprising Investor 1 Year Anniversary đ
Earlier in April marked the anniversary of my first Substack post. I wanted to thank everyone for reading my work, which motivates me to continue publish my thoughts so that hopefully we all learn something.
Portfolio News and Updates
The advertising giant Omnicom (OMC) had a solid quarter with 4% organic growth in revenue and increased operating margins to 13.2% from 10.1%. Earnings per share grew to $1.59 compared to $1.11 last year. Additionally OMC repurchased 2.2% of its shares in Q1.
Verizon (VZ) total revenue up only 0.2%, while wireless service revenue up 3.3%. In the wireless services, Verizon increased prices earlier in the year but revenue was offset by lackluster device sales. EPS declined a bit to $1.09 compare to $1.17, although free cash flow increased due to less capex spend. Wireless companies add customers, but also lose some customers during a period, Verizon mentioned this was the best quarter since 2018 in minimizing customer losses. After the earnings release, VZ stock sold off but the financials seem to be doing fine and the management are maintaining their guidance.
Capital One (COF) revenue slightly down from prior quarter, but up a little over 5% YoY. Net income increased from $706M last quarter to $1.3B this quarter. Both loans and deposits grew about 1% over the quarter. Charge off rates increased a bit, but the trend appears to be slowing and CEO Richard Fairbank attributed some of the increase to delayed tax refunds.
During the quarter I did not buy any new companies, but did add to some existing holdings. I added 100 shares of Alico, 150 shares of British American Tobacco, and 100 shares of Hurco Companies.
David Einhorn on the State of Value Investing
Recently, hedge fund manager and value investor David Einhorn gave an interview where he discussed how the rules to the value investing game have changed. He starts of explaining how when he started his fund back in the 1990âs, there were plenty of funds that focused on finding undervalued stocks. However, passive investing has become dominant, replacing the actively managed funds. Einhorn says the passive index funds buy solely on price instead of considering value. As actively managed value funds are displaced by passive, they face redemptions from investors, forcing them to sell their value stocks.
The result of this is that in the past, a stock trading at 10x earnings that produces a surprise growth in earnings may trade up to a PE of 13x. This scenario does not play out now, because nobody is paying attention to the financials of the company, so it never re-rates to the higher valuation. Einhorn further explains that the market is so apathetic to some of these stocks, that they no longer trade at 10x earnings, but trade at 4-5x. This is where he is pivoting his strategy. Instead of buying stocks hoping for them to re-rate to a high multiple, Einhorn is buying companies at 5x earnings with clean balance sheets and can return a lot of cash to shareholders. If the company buys back its own shares in mass, it can drive the price up without relying on the market to appreciate the business.
At a high level I like Einhornâs new strategy and I may try to adopt it. My one hesitation however is that in my experience, these stocks trading at 5x earnings are commodity-type companies. These companies have had a large run up in revenue and earnings over the past couple of years, so they have low multiples because they have abnormally high earnings. My fear is that these companies are highly cyclical and you are buying at peak earnings, meaning the company is not actually undervalued.
Buffett and 1970âs Banks
Recently I stumbled upon some letters Warren Buffett wrote to some small bank managers back in the 1970âs. Buffett is an expert on banks, so I took some notes from these letters to see how he was thinking about these stocks early in his career. The first letter was from 1972 complimenting the manager of PNC bank on repurchasing 400k shares since the bank was undervalued.
Buffett also complimented the CEO of Detroit Bank and Trust Company for repurchasing shares in 1973. He then went on to say that this bank buying its shares is like a good bank with the following attributes: $5M in âsolidâ book value, loan loss reserve of $600k, long record of high returns on capital, deposits of $60M, trust department with income of $300k. I thought it was interesting to see Buffett lay out what he thinks a good small bank is.
Finally, Buffett sent a pretty long letter to Citizens State Bank of Mount Morris in 1973. He said the bank should prioritize absence of loan losses, tight control of operating cost, growth of deposits, in that order. Next, the letter warned of hidden loan portfolio concentration, where Buffett gave an example of Omaha banks getting caught up in a fraud scheme. Low operating costs was a consistent theme in these letters, and Buffett compared Mount Morris to the Berkshire owned bank Rockford National. Rockford had operating costs as a percentage of demand deposits (which is a measure Iâve never seen before) of 2.71%, Mount Morrisâ costs came in at 4.4%. Later Buffett told the manager to feel no pressure to increase loans, only loan to trusted accounts at market rates of interest.
In summary, the common themes in these letters was to reduce costs, focus on loan quality, buy back undervalued shares, be judicious about making loans in an rising rate environment.
Congratulations on 1 Year Anniversary đ