CASE STUDY: Obsidian Energy (OBELF)


November 14, 2021

Many oil and gas companies appear remarkably cheap if oil prices stay at $70 to $80. Not only is it likely that oil prices will stay at $70 to $80, but it’s quite possible that oil prices will approach $90 or $100 (or even more).

Even at $60 oil, Obsidian Energy is undervalued. But if oil prices are much higher than that, then Obsidian Energy–like some other oil companies–will likely be a wonderful investment.

 

OIL PRICES

Over the past 6 to 7 years, oil producers and oil-producing countries have significantly cut their capital spending due to lower oil prices. As a result, many oil producers do not have much capacity to produce more oil. Similarly, even OPEC+ appears to have much less spare capacity than it did in the past.

Check out this piece by Josh Young of Bison Interests, “OPEC+ Spare Capacity is Insufficient Amid Global Energy Crisis.” Link: https://bisoninterests.com/content/f/opec-spare-capacity-is-insufficient-amid-global-energy-crisis

In recent years, shale oil companies have been able to boost production relatively quickly. However, under pressure from investors, shale oil companies are now much more focused on generating free cash flow. So they have yet to invest much in order to increase their production.

Thus, oil supply constrained.

Even more importantly, oil demand is very strong.

This is because massive monetary and fiscal stimuli have caused households to be flush with cash. This has greatly increased demand for most goods and commodities.

See this recent note from Bridgewater Associates, “It’s Mostly a Demand Shock, Not a Supply Shock, and It’s Everywhere”: https://www.bridgewater.com/its-mostly-a-demand-shock-not-a-supply-shock-and-its-everywhere

Bridgewater argues that the supply of everything is at all-time highs. But demand across most areas is much stronger than supply. Due to the large amount of money the Federal Reserve has been printing, coupled with large fiscal stimulus, a massive amount of cash has been transferred to households. Consumer spending has created demand that cannot be met by the increased supply.

Bridgewater concludes that demand is outstripping supply by a wide enough margin that high inflation will probably be mostly sustained, especially because extremely easy government policy continues to encourage further demand rather than limiting it.

Finally, even if car manufacturers started making only all-electric vehicles today, oil demand would keep rising for many years, as Daniel Yergin points out in The New Map.

Oil demand is likely to increase for at least 10 to 20 years before a peak is reached. The peak itself could last for another 10 to 20 years.

I am, of course, in favor of the transition to a post-fossil fuel economy. But the global economy needs a lot of oil in order to make that transition over the next several decades.

The oil and gas industry will exist in close to its current form 10 or 20 years from now, as Jeremy Grantham has noted. (As well, most oil companies do not have more than 15-20 years of reserves.) The fact that some investors are no longer investing in oil and gas companies means that oil and gas stocks now have even higher expected returns.

In sum, oil supply is quite constrained, while oil demand is very strong. This situation is likely to persist for some time, which means oil prices could easily be $70 to $80, or even higher. Also, oil stocks historically have done very well in inflationary environments. Due to massive monetary and fiscal stimuli, the gap between demand and supply is likely to persist in many areas, which means high inflation may last for some time.

 

OBSIDIAN ENERGY

Obsidian Energy (OBELF) appears very cheap because of the recent increases in oil prices. Here are the multiples:

    • EV/EBITDA = 1.53
    • P/E = 1.04
    • P/NAV = 0.29
    • P/CF = 1.97
    • P/S = 0.98

(We use P/NAV instead of P/B. The NAV assumes $70 WTI.)

The Piotroski F_Score is 6, which is OK.

The market cap is $289.5 million. The company has $4 million in cash and $406.5 million in debt. TL/TA is 48%, which is OK. The company plans to continuing paying down its debt, which it can easily due if oil prices remain relatively high.

Insider ownership is 7%. That is worth a bit more than $20 million. Insiders can make $40 million or much more if oil prices are $70 or higher and if the company continues to execute.

We calculate NAV based on 2P reserves (proved plus probable).

    • Low case: If the oil price averages $50 WTI, then NAV per share is $4.55, which is 21% higher than today’s $3.74.
    • Mid case: If the oil price averages $70 WTI, then NAV per share is $12.71, which is 240% higher than today’s $3.74.
    • High case: If the oil price averages $90 WTI, then NAV per share is $20.87, which is over 455% higher than today’s $3.74.

In March 2019, the company appointed Michael Faust as CEO. (The previous CEO had done a poor job on costs, on where to invest, and on others areas.)

Faust significantly cut costs and improved efficiency. Faust also focused capex on the right wells. Overall, he did a great job. After making these operational improvements, Faust stepped down. But he is still on the board of directors and is deeply involved.

The interim CEO is Steve Loukas, who works at a hedge fund with a large stake in Obsidian Energy. Loukas is doing an excellent job so far.

 

BOOLE MICROCAP FUND

An equal weighted group of micro caps generally far outperforms an equal weighted (or cap-weighted) group of larger stocks over time. See the historical chart here: https://boolefund.com/best-performers-microcap-stocks/

This outperformance increases significantly by focusing on cheap micro caps. Performance can be further boosted by isolating cheap microcap companies that show improving fundamentals. We rank microcap stocks based on these and similar criteria.

There are roughly 10-20 positions in the portfolio. The size of each position is determined by its rank. Typically the largest position is 15-20% (at cost), while the average position is 8-10% (at cost). Positions are held for 3 to 5 years unless a stock approachesintrinsic value sooner or an error has been discovered.

The mission of the Boole Fund is to outperform the S&P 500 Index by at least 5% per year (net of fees) over 5-year periods. We also aim to outpace the Russell Microcap Index by at least 2% per year (net). The Boole Fund has low fees.

 

 

 

Disclosures: Past performance is not a guarantee or a reliable indicator of future results. All investments contain risk and may lose value. This material is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Boole Capital, LLC.

CASE STUDY: Genco Shipping (GNK)


November 7, 2021

I first wrote up the idea of GNK in June 2020 here: https://boolefund.com/genco-shipping-gnk/

At the time, the stock at $6.94 a share was very cheap based on our five measures of cheapness:

    • EV/EBITDA = 4.60
    • P/E = 6.52
    • P/B = 0.34
    • P/CF = 2.07
    • P/S = 0.70

Now the stock is up to $15.81. There has been a huge increase in dry bulk shipping rates.

Dry bulk shipping rates are highly volatile. But the supply of dry bulk ships is at a historic low. Very few new vessels will come into the market over the next couple of years. If someone wanted to order a new dry bulk ship, they would have to wait until early 2024 to get it. There are far fewer shipyards than has been the case historically, and most of those shipyards already have orders, much of which is for container ships rather than dry bulk vessels.

Global GDP is expected to be 4% to 5%, which when coupled with the historically low supply, will probably lead to higher dry bulk shipping rates going forward.

Also, the company has a barbell approach to fleet composition: The minor bulk fleet provides stable cash flows, while the Capesize vessels provide meaningful upside and operating leverage if rates continue to move higher.

The market cap is $662.8 million. EV is $915.1 million. Normalized estimates: Revenue $620 million, EBITDA is $320 million, net income is $250 million, and cash flow of $360 million.

Here are the multiples based on normalized estimates:

    • EV/EBITDA = 2.86
    • P/E = 2.65
    • P/B = 0.53
    • P/CF = 1.84
    • P/S = 1.07

(P/B is based on P/NAV. Vessel values have increased due to the increase in shipping rates.)

Because of the large increase in rates and the expectation that rates will remain volatile but high, GNK looks cheaper now than it was in June 2020.

Insiders own about 7.4% of the shares outstanding, which is worth about $49 million (at today’s stock price of $15.81). Insiders will obviously do well if they successfully lead the company forward.

Genco Shipping has a Piotroski F_Score of 6, which is OK.

Debt is fairly low at $296.8 million. TL/TA is 29%, which is good. Also, the company is targeting total debt of zero.

Intrinsic value scenarios:

    • Low case: GNK is probably worth at least 50% of NAV. NAV/share is $29.72. 50% of that is $14.36, which is 9% lower than today’s $15.81.
    • Mid case: Dry bulk rates are likely to stay relatively high, due to limited supply. Also, the company will soon have no debt and plans a substantial dividend. In this context, GNK is probably worth at least 140% of NAV. That works out to $41.61, which is over 160% higher than today’s $15.81.
    • High case: If dry bulk rates continue to move higher over the next few years, GNK could be worth a P/E = 10. That works out to $59.62, which is over 275% higher than today’s $15.81.

 

BOOLE MICROCAP FUND

An equal weighted group of micro caps generally far outperforms an equal weighted (or cap-weighted) group of larger stocks over time. See the historical chart here: https://boolefund.com/best-performers-microcap-stocks/

This outperformance increases significantly by focusing on cheap micro caps. Performance can be further boosted by isolating cheap microcap companies that show improving fundamentals. We rank microcap stocks based on these and similar criteria.

There are roughly 10-20 positions in the portfolio. The size of each position is determined by its rank. Typically the largest position is 15-20% (at cost), while the average position is 8-10% (at cost). Positions are held for 3 to 5 years unless a stock approachesintrinsic value sooner or an error has been discovered.

The mission of the Boole Fund is to outperform the S&P 500 Index by at least 5% per year (net of fees) over 5-year periods. We also aim to outpace the Russell Microcap Index by at least 2% per year (net). The Boole Fund has low fees.

 

 

 

Disclosures: Past performance is not a guarantee or a reliable indicator of future results. All investments contain risk and may lose value. This material is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Boole Capital, LLC.

CASE STUDY: Ranger Energy Services (RNGR)


October 31, 2021

I first wrote up the idea of RNGR in January 2020 here: https://boolefund.com/ranger-energy-services-rngr/

At the time, the stock at $6.83 a share was very cheap based on our five measures of cheapness:

    • EV/EBITDA = 2.96
    • P/E = 17.51
    • P/B = 0.53
    • P/CF = 2.20
    • P/S = 0.31

Since then, Ranger has made a series of acquisitions at low multiples. Here are the estimates for 2022 figures: EBITDA of $125 million, earnings of $45 million, cash flow of $120 million, and sales of $500 million.

Here are the multiples based on the 2022 estimates:

    • EV/EBITDA = 1.75
    • P/E = 4.45
    • P/B = 0.44
    • P/CF = 1.48
    • P/S = 0.36

The company named Stuart Bodden as the new CEO effective September 1, 2021. (Bill Austin, Chairman of the Board of Directors, was interim CEO. ) Bodden has 20+ years of experience in various executive roles in the oil and gas industry. Bodden was a Partner at McKinsey & Company, leading projects in the oilfield services and upstream oil and gas sectors. Bodden received his Bachelor of Science degree from Brown University and his Master of Business Administration from The University of Texas, Austin.

Insiders own 19% of the shares outstanding, which is worth about $34 million (at today’s stock price of $9.95). Insiders can make a lot of money if they successfully lead the company forward.

Ranger Energy Services has a Piotroski F_Score of 3. This is low because the company has recently made a series of acquisitions. As the company moves through 2022, its F_Score will rise.

Debt is low at $49 million. TL/TA is 30%, which is good. Also, the company is targeting debt of zero.

The oil price (WTI) is $83.57. If oil prices stay around this level, Ranger Energy Services will comfortably hit its targets for 2022.

For a good take on how tight oil supplies are currently, check out this piece by Josh Young of Bison Interests, “OPEC+ Spare Capacity is Insufficient Amid Global Energy Crisis.” Link: https://bisoninterests.com/content/f/opec-spare-capacity-is-insufficient-amid-global-energy-crisis

More importantly, demand is very strongly increasing, which will continue. See this recent note from Bridgewater Associates, “It’s Mostly a Demand Shock, Not a Supply Shock, and It’s Everywhere:https://www.bridgewater.com/its-mostly-a-demand-shock-not-a-supply-shock-and-its-everywhere

Bridgewater argues that the supply of everything is at all-time highs. But demand across most areas is much stronger than supply. Demand is being driven by the MP3, which is a combination of monetary and fiscal policy. Due to the large amount of money the Federal Reserve has been printing, coupled with large fiscal stimulus, a massive amount of cash has been transferred to households. Consumer spending has created demand that cannot be met by the increased supply.

Bridgewater concludes that demand is outstripping supply by a wide enough margin that high inflation will probably be mostly sustained, especially because extremely easy government policy continues to encourage further demand rather than limiting it.

Finally, even if car manufacturers started making only all-electric vehicles today, oil demand would keep rising for many years, as Daniel Yergin points out in The New Map.

Intrinsic value scenarios:

    • Low case: RNGR is probably worth at least 50% of book value. That is $11.30, which is over 10% higher than today’s $9.95.
    • Mid case: The P/E = 4.45 relative to 2022 earnings. But the P/E should be at least 15. This implies over 335% upside from today’s $9.95, or an intrinsic value of at least $43.50 per share.
    • High case: Oil prices could exceed $100 (WTI). In that case, RNGR could be worth $70 per share. That is 600% higher than today’s $9.95.

 

BOOLE MICROCAP FUND

An equal weighted group of micro caps generally far outperforms an equal weighted (or cap-weighted) group of larger stocks over time. See the historical chart here: https://boolefund.com/best-performers-microcap-stocks/

This outperformance increases significantly by focusing on cheap micro caps. Performance can be further boosted by isolating cheap microcap companies that show improving fundamentals. We rank microcap stocks based on these and similar criteria.

There are roughly 10-20 positions in the portfolio. The size of each position is determined by its rank. Typically the largest position is 15-20% (at cost), while the average position is 8-10% (at cost). Positions are held for 3 to 5 years unless a stock approachesintrinsic value sooner or an error has been discovered.

The mission of the Boole Fund is to outperform the S&P 500 Index by at least 5% per year (net of fees) over 5-year periods. We also aim to outpace the Russell Microcap Index by at least 2% per year (net). The Boole Fund has low fees.

 

 

 

Disclosures: Past performance is not a guarantee or a reliable indicator of future results. All investments contain risk and may lose value. This material is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Boole Capital, LLC.

CASE STUDY: Karora Resources (KRRGF)


October 24, 2021

Although the stock price has moved up from $2.62 to $3.50, our investment in Karora Resources (KRRGF) is still quite undervalued under most scenarios.

I first wrote up the idea of KRRGF in December 2020 here: https://boolefund.com/karora-resources-inc-krrgf/

At the time, the stock at $2.62 a share was cheap based on our five measures of cheapness:

    • EV/EBITDA = 4.50
    • P/E = 13.04
    • P/NAV = 0.29
    • P/CF = 5.95
    • P/S = 2.12

The mid case scenario for intrinsic value was that KRRGF was probably worth $9.08 based on NAV.

How much is KRRGF worth today?

    • EV/EBITDA = 1.74
    • P/E = 4
    • P/NAV = 0.20
    • P/CF = 2.50
    • P/S = 1.23
  • These figures are based on 2024 production of roughly 200k ounces of gold per year. The gold price is assumed to be $1,750. (Note that Karora’s operations are in Western Australia, so there is very little political risk.)

Karora Resources is exceptionally well-managed, led by CEO Paul Andre Huet and head of Australian operations Graeme Sloan. The Karora team–despite numerous external headwinds–has met or exceeded every target it has set since its acquisition of HGO Mill in mid-2019.

Also, management owns 2% of the shares outstanding, which is worth $10 million (at today’s stock price of $3.50). That $10 million could become $30 or $40 million (or more) if Karora keeps executing.

Karora Resources has a Piotroski F_Score of 7, which is good.

Net debt is low: Cash is $82.2 million. Debt is $30.8 million. TL/TA is 40%, which is good.

Very importantly, Karora’s growth is internally funded by existing cash and cash flow. Karora is not relying on debt for growth.

Furthermore, the company is increasing its production steadily each year until it reaches 200k gold ounces per year in 2024.

Finally, Karora has massive exploration potential.

Intrinsic value scenarios:

    • Low case: Gold prices could fall. Also, there could be a market correction or a recession during which the stock could temporarily fall by 50% or more (from today’s $3.50 to $1.75).
    • Mid case: The P/E = 4 relative to 2024 production, assuming the gold price stays around $1,750 per ounce. But the P/E should be at least 16 for a mid-tier, multi-asset gold producer in a top tier jurisdiction (Western Australia). This implies 300% upside from today’s $3.50, or an intrinsic value of $14 per share. This does not factor in the continued lowering of AISC (which could reach $935/oz or lower). Keep in mind that the company has met or exceeded all targets thus far and that its growth will be internally funded from existing cash and cash flow, and not debt. Also, Karora has huge exploration potential.
    • High case: Gold prices could be much higher in an inflationary scenario. Fair value could easily be $21 per share, 500% above today’s $3.50.

 

BOOLE MICROCAP FUND

An equal weighted group of micro caps generally far outperforms an equal weighted (or cap-weighted) group of larger stocks over time. See the historical chart here: https://boolefund.com/best-performers-microcap-stocks/

This outperformance increases significantly by focusing on cheap micro caps. Performance can be further boosted by isolating cheap microcap companies that show improving fundamentals. We rank microcap stocks based on these and similar criteria.

There are roughly 10-20 positions in the portfolio. The size of each position is determined by its rank. Typically the largest position is 15-20% (at cost), while the average position is 8-10% (at cost). Positions are held for 3 to 5 years unless a stock approachesintrinsic value sooner or an error has been discovered.

The mission of the Boole Fund is to outperform the S&P 500 Index by at least 5% per year (net of fees) over 5-year periods. We also aim to outpace the Russell Microcap Index by at least 2% per year (net). The Boole Fund has low fees.

 

 

 

Disclosures: Past performance is not a guarantee or a reliable indicator of future results. All investments contain risk and may lose value. This material is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Boole Capital, LLC.

CASE STUDY: Tidewater, Inc. (TDW)


October 17, 2021

Our investment in Tidewater, Inc. (TDW) has been one of our best ideas thus far.

I first wrote up the idea of TDW in May 2020 here: https://boolefund.com/tidewater-tdw/

At the time, the stock at $5.12 a share was extremely cheap based on our five measures of cheapness:

    • EV/EBITDA = 3.85
    • P/E = 2.95
    • P/B = 0.21
    • P/CF = 2.06
    • P/S = 0.43

Since then, TDW stock is up to $12.49.

How much is TDW worth today?

On a normalized basis: revenue is approximately $600 million; cash flow is $300 million; EBITDA is $260 million; earnings are $120 million. (The market cap is $531.1 million. Enterprise value (EV) is $555.9 million.) NAV per share is about $40.

    • EV/EBITDA = 2.14
    • P/E = 4.43
    • P/B = 0.31
    • P/CF = 1.77
    • P/S = 0.89
  • (I used P/NAV instead of P/B because P/NAV is more accurate.) TDW is still very cheap assuming that the industry experiences some normalization–i.e., reversion to the mean.

The oil price (WTI) is $82.17. If oil prices stay around this level, Tidewater will achieve normalized revenues and earnings. But the oil price could move quite a bit higher, in which case Tidewater could approach peak earnings within a couple of years.

For an interesting take on how tight oil supplies are currently, check out this piece by Josh Young of Bison Interests, “OPEC+ Spare Capacity is Insufficient Amid Global Energy Crisis.” Link: https://bisoninterests.com/content/f/opec-spare-capacity-is-insufficient-amid-global-energy-crisis

Intrinsic value scenarios:

    • Low case: The current book value per share is $18.51. TDW could be worth 50% of book value. That’s $9.25, which is 25% lower than today’s $12.49.
    • Mid case: TDW is probably worth the current NAV of $40 per share. That is 220% higher than today’s $12.49.
    • High case: TDW could be worth 150% of the current NAV ($40 per share). That is $60 per share, which is 380% higher than today’s $12.49. (NAV itself could be revised upward significantly in a recovery scenario.)

The Piotroski F_Score is 4, which is not very good. But this is a cyclical company whose trailing revenues, cash flows, and earnings are far below normal. As the industry recovers, TDW’s F_Score will also recover.

Insider ownership is 2.6%, which is low. But that’s still about $14 million. So insiders have an incentive to maximize the value of the company over time.

Note: Robert Robotti, through his investment management firm, owns a stake in TDW. Robotti has a long history of successfully investing in energy companies. Also, Robotti is on the board of directors of Tidewater.

Debt is low. Net debt is zero. TL/TA is 33%. This is excellent. One of Tidewater’s advantages is that it has much lower debt than most if its competitors.

 

BOOLE MICROCAP FUND

An equal weighted group of micro caps generally far outperforms an equal weighted (or cap-weighted) group of larger stocks over time. See the historical chart here: https://boolefund.com/best-performers-microcap-stocks/

This outperformance increases significantly by focusing on cheap micro caps. Performance can be further boosted by isolating cheap microcap companies that show improving fundamentals. We rank microcap stocks based on these and similar criteria.

There are roughly 10-20 positions in the portfolio. The size of each position is determined by its rank. Typically the largest position is 15-20% (at cost), while the average position is 8-10% (at cost). Positions are held for 3 to 5 years unless a stock approachesintrinsic value sooner or an error has been discovered.

The mission of the Boole Fund is to outperform the S&P 500 Index by at least 5% per year (net of fees) over 5-year periods. We also aim to outpace the Russell Microcap Index by at least 2% per year (net). The Boole Fund has low fees.

 

 

 

Disclosures: Past performance is not a guarantee or a reliable indicator of future results. All investments contain risk and may lose value. This material is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Boole Capital, LLC.

CASE STUDY: Global Ship Lease (GSL)


October 10, 2021

Our investment in Global Ship Lease (GSL) has been one of our best ideas thus far.

Shipping is a terrible business. It is asset-intensive, with low returns on capital. There are short-lived booms and sustained busts. Also, the booms are impossible to predict with any precision. However, if you can be roughly right about when the next boom will start, you can do well investing in shipping.

I first wrote up the idea of GSL in June 2020 here: https://boolefund.com/global-ship-lease-gsl/

At the time, the stock at $4.62 a share was extremely cheap based on our five measures of cheapness:

    • EV/EBITDA = 5.28
    • P/E = 1.93
    • P/B = 0.20
    • P/CF = 0.81
    • P/S = 0.29

These figures made Global Ship Lease one of the top ten cheapest companies out of over two thousand that we ranked.

We bought GSL stock in June 2020 at $4.57. Today the stock is at $21.48. The position is up 370% so far, which makes it our best-performing idea.

But there still appears to be substantial upside for GSL.

Shipping rates now are at record highs. They could stay this way for 6 to 12 months and maybe longer. That’s because demand is strong, while supply is quite constrained.

Demand

Demand is strong and likely to remain strong because global GDP is strong.

Moreover, 70% of global containerized trade volume is in non-mainline routes–and these routes are growing faster than mainline routes. As well, these routes are served by mid-sized and smaller containerships. This is where GSL focuses.

Supply

The supply of container ships is constrained. There are not many new ships coming into the market in the next couple of years. It takes two to three years for shipyards to make a new ship, and there are only 120 shipyards (compared to 300 in 2008).

Furthermore, the supply of mid-sized and smaller containerships is even more constrained that the supply of larger ships. There are very few orders of mid-sized and smaller containerships coming into the market in the next couple of years.

What is the intrinsic value of GSL today?

EBITDA based on 10-year average rates is about $350 million. Normalized net income is ~$150 million. Normalized cash flow is ~$160 million. Based on normalized figures:

    • EV/EBITDA = 4.23
    • P/E = 5.33
    • P/B = 0.46
    • P/CF = 5.00
    • P/S = 1.33

NOTE: I use P/NAV instead of P/B. A conservative estimate of NAV is approximately $47 per share. A more realistic estimate of NAV is around $62 per share. See this analysis by J. Mintzmyer on Seeking Alpha: https://tinyurl.com/39jx5fey

George Youroukos, Executive Chairman of the Board, recently acquired approximately $10 million of GSL’s stock. Youroukos clearly believes GSL’s stock is cheap. This brings Youroukos’ total position to 6.4% of GSL’s outstanding shares, worth over $50 million.

Here is GSL’s Q2 2021 earnings presentation: https://www.globalshiplease.com/static-files/a226750c-bb27-45e2-8017-a0183e07ad26

Intrinsic value scenarios:

    • Low case: Global Ship Lease may be worth 50% of NAV. (A conservative estimate of NAV is about $47 per share.) That works out to $23.50 a share, which is over 9% higher than today’s $21.48.
    • Mid case: Global Ship Lease is likely worth at least NAV of $47 per share. That’s about 120% higher than today’s $21.48.
    • High case: NAV may be closer to $62, which is over 180% higher than today’s $21.48.

So far in 2021, GSL has increased its fleet by 53%. It paid prices in the range of 3.6 to 4.0 times EBITDA. These deals are immediately accretive because most of then already have charters attached. GSL will have most of its fleet contracted by the end of the year.

The Piotroski F_Score for Global Ship Lease is 6, which is OK.

Bottom Line

GSL is one of our best-performing stocks, up over 370% since we bought it in June of 2020. The Boole Microcap Fund continues to hold most of the position because GSL is still undervalued compared to NAV. If GSL hits NAV of $47, it will be up over 925% since we bought it. That said, NAV may be closer to $62, which is over 1,255% higher than where we bought it.

 

BOOLE MICROCAP FUND

An equal weighted group of micro caps generally far outperforms an equal weighted (or cap-weighted) group of larger stocks over time. See the historical chart here: https://boolefund.com/best-performers-microcap-stocks/

This outperformance increases significantly by focusing on cheap micro caps. Performance can be further boosted by isolating cheap microcap companies that show improving fundamentals. We rank microcap stocks based on these and similar criteria.

There are roughly 10-20 positions in the portfolio. The size of each position is determined by its rank. Typically the largest position is 15-20% (at cost), while the average position is 8-10% (at cost). Positions are held for 3 to 5 years unless a stock approachesintrinsic value sooner or an error has been discovered.

The mission of the Boole Fund is to outperform the S&P 500 Index by at least 5% per year (net of fees) over 5-year periods. We also aim to outpace the Russell Microcap Index by at least 2% per year (net). The Boole Fund has low fees.

 

 

 

Disclosures: Past performance is not a guarantee or a reliable indicator of future results. All investments contain risk and may lose value. This material is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Boole Capital, LLC.

CASE STUDY: TravelCenters of America (TA)


October 3, 2021

Our investment in TravelCenters of America (TA) has been one of our best ideas thus far.

I first wrote up the idea of TA in May 2020 here: https://boolefund.com/travelcenters-america-ta/

At the time, the stock at $9.29 a share was extremely cheap based on our five measures of cheapness:

    • EV/EBITDA = 2.55
    • P/E = 2.90
    • P/B = 0.14
    • P/CF = 1.40
    • P/S = 0.01

These figures made TravelCenters of America one of the top ten cheapest companies out of over two thousand that we ranked.

However, just because a stock is quantitatively cheap does not mean that it’s a good investment. In fact, before launching the Boole Microcap Fund on 6/9/20, I had bought TA at quantitatively cheap prices. But the company was being chronically mismanaged and so the stock was deservedly cheap. I ended up selling at a loss. But this experience is what prepared me to buy TA for the Boole Microcap Fund.

Studies have shown that if you systematically buy quantitatively cheap stocks, then your portfolio will beat the market over time. This is called deep value investing, which is what the Boole Microcap Fund does. See this classic paper: http://scholar.harvard.edu/files/shleifer/files/contrarianinvestment.pdf

However, if you’re doing deep value investing, roughly 57% of your quantitatively cheap stocks will underperform the market. It’s only because the other 43% increase a great deal that the overall deep value portfolio beats the market over time.

But there are ways to decrease the number of cheap but underperforming stocks in your deep value portfolio. This will boost your long-term performance.

One example is the Piotroski F_Score, which the Boole Microcap Fund uses. A high F_Score indicates improving fundamentals. See: https://boolefund.com/piotroski-f-score/

Another thing that can greatly improve your odds is if new management with a track record of success is brought in to turn around an underperforming company. This is what happened with TravelCenters of America.

Turnaround specialist Jon Pertchik was named CEO of TravelCenters of America in December 2019. Pertchik has a track record of significantly improving the performance of underperforming companies.

With Pertchik in charge, it now seemed probable that TravelCenters of America would be worth at least book value of $66.54 per share, which was 615% higher than its May 2020 price of $9.29.

Furthermore, the company could be worth close to $100 a share if Pertchik’s turnaround efforts exceeded expectations.

We bought TA stock in July 2020 at $13.04. Today the stock is at $53.14. The position is up over 300% so far. We sold some along the way, but have kept most of it because Jon Pertchik has set very aggressive goals and is meeting or exceeding those goals.

Normalized EBTIDA is approximately $300 million (trailing EBITDA is $190 million). Normalized earnings are about $200 million. Normalized cash flow is close to $300 million. The current market cap is $657 million while current enterprise value (EV) is $599 million. That means that:

    • EV/EBITDA = 2.0
    • P/E = 3.29
    • P/B = 1.17
    • P/CF = 0.29
    • P/S = 0.14
  • TA stock is still cheap.

But how cheap is it? What is TA’s intrinsic value?

Intrinsic value scenarios:

    • Low case: The current book value per share is $45.63. That is about 14% lower than today’s $53.14.
    • Mid case: Normalized EBITDA is about $300 million. A conservative EV/EBITDA is 5.0. That puts EV (enterprise value) at $1,500 million. The market cap would be $1,558 million, which works out to $106.86 per share. That’s over 100% higher than today’s $53.14.
    • High case: Normalized EBITDA could reach $350 million. At an EV/EBITDA of 6.0, the EV would be $2,100 million. The market cap would be $2,158 million, which works out to $148.01 per share. That’s over 175% higher than today’s $53.14.

Insider ownership is 15%, which is pretty good.

The Piotroski F_Score is 5, which is mediocre. But the company is improving fast and is investing heavily to create the best customer experience.

 

BOTTOM LINE

Since the Boole Microcap Fund bought TA stock at $13.04, the stock is up over 300%.

Today, thanks to the great performance of the new CEO Jon Pertchik and everyone at TA, the stock still appears cheap. $106.86 a share is 100% higher than today’s $53.14.

Also, $106.86 is about 720% higher than $13.04.

 

BOOLE MICROCAP FUND

An equal weighted group of micro caps generally far outperforms an equal weighted (or cap-weighted) group of larger stocks over time. See the historical chart here: https://boolefund.com/best-performers-microcap-stocks/

This outperformance increases significantly by focusing on cheap micro caps. Performance can be further boosted by isolating cheap microcap companies that show improving fundamentals. We rank microcap stocks based on these and similar criteria.

There are roughly 10-20 positions in the portfolio. The size of each position is determined by its rank. Typically the largest position is 15-20% (at cost), while the average position is 8-10% (at cost). Positions are held for 3 to 5 years unless a stock approachesintrinsic value sooner or an error has been discovered.

The mission of the Boole Fund is to outperform the S&P 500 Index by at least 5% per year (net of fees) over 5-year periods. We also aim to outpace the Russell Microcap Index by at least 2% per year (net). The Boole Fund has low fees.

 

 

 

Disclosures: Past performance is not a guarantee or a reliable indicator of future results. All investments contain risk and may lose value. This material is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Boole Capital, LLC.

Tips from a Legendary Growth Investor


September 26, 2021

Philip A. Fisher is a legendary growth investor. He is the author of Common Stocks and Uncommon Profits (Wiley, 1996; originally published by Harper & Brothers, 1958). Growth only creates value when the return on invested capital (ROIC) is higher than the cost of capital. Fisher focuses on value-creating growth.

Warren Buffett – partly through the influences of both Charlie Munger and Phil Fisher – went from buying statistically cheap stocks to buying stocks where the business could maintain a high ROIC for many years. Buffett also learned from Fisher the value of scuttlebutt research – interviewing competitors, suppliers, customers, industry experts, and others who might have special insight into the company or industry. Finally, Buffett learned from Fisher that you should concentrate the investment portfolio on your best ideas. Buffett once remarked:

I’m 15% Fisher and 85% Benjamin Graham.

Typically, Buffett only buys a stock (or an entire company) when he feels certain about the future earnings. This means the business in question must have a sustainable competitive advantage in order to keep theROIC above the cost of capital. Buffett then looks at the current price and determines if it’s at a discount relative to future earnings power. Because Buffett is still trying to buy at a discount to intrinsic value (in terms of future earnings power), he’s 85% Graham.

  • That’s not to say Buffett does a precise calculation. Only that there must be an obvious discount present. At the 1996 Berkshire Hathaway annual meeting, Munger said: “Warren talks about these discounted cash flows… I’ve never seen him do one.” Buffett replied: “That’s true. If [the value of the company] doesn’t just scream at you, it’s too close.” (Janet Lowe, page 145, Warren Buffett Speaks (Wiley, 2007))

Phil Fisher doesn’t think about buying at a discount to future earnings power. He just knows that if a company can maintain a relatively high ROIC for many years into the future, then all else equal, earnings will march higher over the years and the stock will follow. So Fisher simply looks for these rare companies that can maintain a high ROIC many years into the future. Fisher doesn’t try to calculate whether the current price is at a discount to some specific level of future earnings.

 

THE FIFTEEN POINTS

Fisher highlights fifteen points that an investor should investigate in order to determine if a prospective investment is worthwhile. A worthwhile investment can, over a few years, increase several hundred percent, or it can increase proportionately more over a longer period of time.

Point 1. Does the company have products or services with sufficient market potential to make possible a sizable increase in sales for at least several years?

Fisher writes that sales growth is often uneven on an annual basis. So the important question is whether the company can grow over several years. Ideally, a company should be able to grow for decades. This generally only happens when management is highly capable.

Point 2. Does the management have a determination to continue to develop products or processes that will still further increase total sales potentials when the growth potentials of currently attractive product lines have largely been exploited?

To grow beyond the next few years, ongoing scientific research and development engineering are required. Usually such research is most effective when it is clearly related to new products bearing some similarity to existing products. The main point is that management has to be farsighted enough to develop new products that, if successful, will produce growth many years from today.

Point 3. How effective are the company’s research and development efforts in relation to its size?

Some well-run companies get twice (or more) the ultimate gains for each research dollar than other companies. A good company has technically skilled engineers and scientists, but also leaders who can coordinate the research efforts of people with diverse backgrounds.

Moreover, company leaders have to integrate research, production, and sales. Otherwise, costs may not be minimized or products may not sell as well as they could. Non-optimal products are usually vulnerable to more efficient competition.

Point 4. Does the company have an above-average sales organization?

Fisher writes:

It is the making of a sale that is the most basic single activity of any business. Without sales, survival is impossible. It is the making of repeat sales to satisfied customers that is the first benchmark of success. Yet, strange as it seems, the relative efficiency of a company’s sales, advertising, and distributive organizations receives far less attention from most investors, even the careful ones, than do production, research, finance, or other major subdivisions of corporate activity. (page 31)

In some successful companies, a large chunk of a salesperson’s time – often over the course of many years – is devoted to training.

Point 5. Does the company have a worthwhile profit margin?

Marginal companies typically increase their earnings more during good periods, but they also experience more rapid declines during bad periods. The best long-term investments usually have the best profit margins and the best ROICin the industry. Marginal companies are very rarely good long-term investments.

Point 6. What is the company doing to maintain or improve profit margins?

Fisher observes:

Some companies achieve great success by maintaining capital-improvement or product-engineering departments. The sole function of such departments is to design new equipment that will reduce costs and thus offset or partially offset the rising trend of wages. Many companies are constantly reviewing procedures and methods to see where economies can be brought about. (page 37)

Point 7. Does the company have outstanding labor and personnel relations?

A company that has above-average profits and that pays above-average wages is likely to have good labor relations. Furthermore, management should treat employees well in other ways. Ideally, employees will feel that they are a crucial part of the business mission.

Point 8. Does the company have outstanding executive relations?

Executives should feel that promotions are based solely on merit. Some degree of friction is natural, but such friction should be kept to a minimum in order to ensure that executives work together.

Point 9. Does the company have depth to its management?

Fisher explains:

…companies worthy of investment interest are those that will continue to grow. Sooner or later a company will reach a size where it just will not be able to take advantage of further opportunities unless it starts developing some executive talent in some depth. (page 41)

Fisher also points out that executives must be given real authority in order forthem to develop. As well, top executives should be open to suggestions from developing executives.

Point 10. How good are the company’s cost analysis and accounting controls?

No company is going to continue to have outstanding success for a long period of time if it cannot break down its over-all costs with sufficient accuracy and detail to show the cost of each small step in its operation. Only in this way will a management know what most needs its attention. Only in this way can management judge whether it is properly solving each problem that does need its attention. (page 42)

Point 11. Are there other aspects of the business, somewhat peculiar to the industry involved, which will give the investor important clues as to how outstanding the company may be in relation to its competition?

Typically it is leadership in engineering or in business processes – rather in than patents – that allows a company to maintain its competitive position.

Point 12. Does the company have a short-range or long-range outlook in regard to profits?

One company will constantly make the sharpest possible deals with suppliers. Another will at times pay above contract price to a vendor who has had unexpected expense in making delivery, because it wants to be sure of having a dependable source of needed raw materials or high quality components available when the market has turned and supplies may be desperately needed. The difference in treatment of customers is equally noticeable. The company that will go to special trouble and expense to take care of the needs of a regular customer caught in an unexpected jam may show lower profits on the particular transaction, but far greater profits over the years. (page 46)

Point 13. In the foreseeable future will the growth of the company require sufficient equity financing so that the larger number of shares then outstanding will largely cancel the existing stockholders’ benefit from this anticipated growth?

If the company is well-run and profitable, then a reasonable amount of equity financing need not deter you as an investor. A stock offering creates cash for the company. If the ROIC on this cash is high enough, and the price at which the stock offering is made is not too low, then future earnings per share will not suffer.

Point 14. Does the management talk freely to investors about its affairs when things are going well but ‘clam up’ when troubles and disappointments occur?

Even the best-run companies will encounter unexpected difficulties at times. Also, companies that will grow their earnings far into the future will constantly be pursuing technical research projects, some of which won’t work:

By the law of averages, some of these are bound to be costly failures. Others will have unexpected delays and heartbreaking expenses during the early period of plant shake-down. For months on end, such extra and unbudgeted costs will spoil the most carefully laid profit forecasts for the business as a whole. Such disappointments are an inevitable part of even the most successful business. If met forthrightly and with good judgment, they are merely one of the costs of eventual success. They are frequently a sign of strength rather than weakness in a company. (page 48)

It’s crucial when failures or setbacks do occur that management is candidin reporting the bad news.

Point 15. Does the company have a management of unquestionable integrity?

There are countless ways management could enrich itself at the expense of shareholders. This includes issuing stock options far beyond what is reasonable and fair.

Managers with high integrity always keep the interests of outside shareholders ahead of their own interests. Good managers tend to produce positive surprises, while bad managers tend to produce negative surprises. Over a long period of time, it’s simply not worth investing when you can’t trust management.

 

WHAT TO BUY

Fisher argues that a superbly managed growth company will generally see its stock increase hundreds of percent each decade. By contrast, a stock that is merely statistically undervalued by 50 percent will generally only double.

You should invest part of your portfolio in larger, more conservative growth companies, and the rest in smaller growth companies. How much to invest in each category depends on your circumstances and temperament. If you can leave the investment alone for a long time and you don’t mind shorter term volatility, then it makes sense to invest more in smaller growth companies.

 

WHEN TO BUY

Fisher writes that forecasting business trends is not far enough along to be dependable for investing purposes. This is still true. I wrote last week about why you shouldn’t try market timing: https://boolefund.com/shouldnt-try-market-timing/

Yet, says Fisher, often when a new full-scale plant is about to begin production, there will be a buying opportunity. First, it takes many weeks at least to get the plant running. And if it’s a revolutionary process, it can take far longer than even the most pessimistic engineer estimates.

Even after the new plant is operating, generally there are difficulties and unexpected expenses. Often word spreads that the new plant is in trouble, which causes some investors to sell the stock. A few months later, the company might report a drop in net income due to the unexpected expenses. Fisher:

Word passes all through the financial community that the management has blundered.

At this point the stock might well prove a sensational buy. Once the extra sales effort has produced enough volume to make the first production scale plant pay, normal sales effort is frequently enough to continue the upward movement of the sales curve for many years. Since the same techniques are used, the placing in operation of a second, third, fourth, and fifth plant can nearly always be done without the delays and special expenses that occurred during the prolonged shake-down period of the first plant. By the time plant Number Five is running at capacity, the company has grown so big and prosperous that the whole cycle can be repeated on another brand new product without the same drain on earnings percentage-wise or the same downward effect on the price of the company’s shares. The investor has acquired at the right time an investment which can grow for him for many years. (page 65)

Fisher reiterates that it’s possible to learn how an individual company will perform. But it’s not possible to forecast the stock market with any useful degree of consistency. There are too many variables, including the business cycle, interest rates, government policy, and technological innovation.

 

WHEN TO SELL

For an investor, mistakes are inevitable. Generally speaking, a careful investor may be right as much as 70% of the time. But that means being wrong 30% of the time. The important thing is to learn to identify mistakes as quickly as possible. This is not easy, as Fisher explains:

…there is a complicating factor that makes the handling of investment mistakes more difficult. This is the ego in each of us. None of us likes to admit to himself that he has been wrong. If we have made a mistake in buying a stock but can sell the stock at a small profit, we have somehow lost any sense of having been foolish. On the other hand, if we sell at a small loss we are quite unhappy about the whole matter. This reaction, while completely natural and normal, is probably one of the most dangerous in which we can indulge ourselves in the entire investment process. More money has probably been lost by investors holding a stock they really did not want until they could ‘at least come out even’ than from any other single reason. If to these actual losses are added the profits that might have been made through the proper reinvestment of these funds if such reinvestment had been made when the mistake was first realized, the cost of self-indulgence becomes truly tremendous.

Furthermore this dislike of taking a loss, even a small loss, is just as illogical as it is natural. If the real object of common stock investment is the making of a gain of a great many hundreds of per cent over a period of years, the difference between, say, a 20 per cent loss or a 5 per cent profit becomes a comparatively insignificant matter…

While losses should never cause strong self-disgust or emotional upset, neither should they be passed over lightly. They should always be reviewed with care so that a lesson is learned from each of them. If the particular elements which caused a misjudgment on a common stock purchase are thoroughly understood, it is unlikely that another poor purchase will be made through misjudging the same investment factors. (page 78)

The second reason for selling is if the company no longer qualifies with respect to the fifteen points. Usually this is either because there has been a deterioration of management or because the company no longer has the same growth prospects.

Deterioration of management, writes Fisher, is sometimes due to complacency, but it usually is because new top executives are not as good as their predecessors.

A third reason for selling is that a much better investment opportunity has been found. Attractive investments are extremely hard to find, observes Fisher. When you do find one, it’s often worth switching (including paying capital gains taxes) if the new opportunity appears to have much more upside than some current investment.

Once you have found a good company, you should rarely sell. Even if you knew a bear market was about to occur – which can very rarely, if ever, be known – if your stock will probably reach a new high in the next bull market, then trying to sell and then re-buy is risky and time-consuming.

You can’t know how far a specific stock will decline – if at all – and thus you won’t know when to buy the stock back. Also, the stock may not necessarily decline at the same rate, or even at the same time, as the general market. In other words, if your stock is likely to increase at least 400% eventually, say from a price of $20 a share to $100+ a share, then it’s risky and time-consuming to try to sell at $20 and buy it back at $16 or $12. Many investors who try to do this end up not buying the stock back below where they sold it. Fisher sums it up:

That which really matters is not to disturb a position that is going to be worth a great deal more later. (page 83)

This is even more true when you factor in capital gains taxes.

Some argue that if a stock has increased a great deal, you should sell it. This makes no sense, says Fisher. If the stock is a long-term winner of the sort you’re looking for, then by definition it’s going to increase significantlyand frequently be hitting new all-time highs. Fisher concludes:

If the job has been correctly done when a common stock is purchased, the time to sell it is–almost never. (page 85)

 

THE HULLABALOO ABOUT DIVIDENDS

If you’ve found an excellently managed growth company – a company that can maintain a relatively high ROIC, including on reinvested earnings – then you should prefer low dividends or no dividends.Fisher:

Actually dividend considerations should be given the least, not the most, weight by those desiring to select outstanding stocks. Perhaps the most peculiar aspect of this much-discussed subject of dividends is that those giving them the least consideration usually end up getting the best dividend return. Worthy of repetition here is that over a span of five to ten years, the best dividend results will come not from the high-yield stocks but from those with the relatively low yield. So profitable are the results of the ventures opened up by exceptional managements that while they still continue the policy of paying out a low proportion of current earnings, the actual number of dollars paid out progressively exceed what could have been obtained from high-yield shares. Why shouldn’t this natural and logical trend continue in the future? (pages 94-95)

At the extreme, for an outstanding company that will grow for decades, it may be best if the company paid no dividends at all. If you bought Berkshire Hathaway at the beginning of 1965 and held it through the end of 2015, you would have gotten 20.8% annual returns versus 9.7% for the S&P 500 (including dividends). Your cumulative return for holding Berkshire stock would come to 1,598,284% versus 11,335% for the S&P 500 (including dividends). Berkshire has never paid a dividend because Buffett and Munger have always been able to find better uses for the cash over the years.

 

FIVE DON’TS FOR INVESTORS

Don’t buy into promotional companies.

All too often, young promotional companies are dominated by one or two individuals who have great talent for certain phases of business procedure but are lacking in other equally essential talents. They may be superb salesmen but lack other types of business ability. More often they are inventors or production men, totally unaware that even the best products need skillful marketing as well as manufacture. The investor is seldom in a position to convince such individuals of the skills missing in themselves or their young organizations. Usually he is even less in a position to point out to such individuals where such talents may be found. (page 97)

Don’t ignore a good stock just because it is traded ‘over the counter.’

The key point here is just to be sure you are investing in the right company.

Don’t buy a stock just because you like the ‘tone’ of its annual report.

Often annual reports are either overly optimistic or they fail to disclose material information needed by the investor. Very often you need to look beyond the annual report in order to find all important information.

Don’t assume that the high price at which a stock may be selling in relation to earnings is necessarily an indication that further growth in those earnings has largely been already discounted in the price.

If a company can grow profitably in the future like it has in the past, then even with a high P/E, the stock may still be a good buy. Fisher:

This is why some of the stocks that at first glance appear highest priced may, upon analysis, be the biggest bargains. (page 105)

Don’t quibble over eighths and quarters.

If you’ve found a well-managed growth company whose stock is likely to increase at least several hundreds of percent in the future, then obviously it would be a big mistake to miss it just because the price is slightly higher than what you want.

 

FIVE MORE DON’TS FOR INVESTORS

Don’t overstress diversification.

Investors have been so oversold on diversification that fear of having too many eggs in one basket has caused them to put far too little into companies they thoroughly know and far too much in others about which they know nothing at all. It never seems to occur to them… that buying a company without having sufficient knowledge of it may be even more dangerous than having inadequate diversification. (pages 108-109)

When Buffett was managing the Buffett Partnerships (1957 to 1970), in the mid 1960’s he put 40% of the portfolio in American Express when the stock fell due to the salad oil scandal. Buffett and Munger have always believed in concentrating on their best ideas. Buffett:

We believe that a policy of portfolio concentration may well decrease risk if it raises, as it should, both the intensity with which an investor thinks about a business and the comfort-level he must feel with its economic characteristics before buying into it.

Buffett again in a 1998 lecture at the University of Florida:

If you can identify six wonderful businesses, that is all the diversification you need. And you will make a lot of money. And I can guarantee that going into the seventh one instead of putting more money into your first one is [going to] be a terrible mistake. Very few people have gotten rich on their seventh best idea. So I would say for anyone working with normal capital who really knows the businesses they have gone into, six is plenty, and I [would] probably have half of [it in] what I like best.

Link: http://intelligentinvestorclub.com/downloads/Warren-Buffett-Florida-Speech.pdf

Fisher summarizes:

In the field of common stocks, a little bit of a great many can never be more than a poor substitute for a few of the outstanding. (page 118)

Don’t be afraid of buying on a war scare.

Fisher explains:

Through the entire twentieth century, with a single exception, every time major war has broken out anywhere in the world or whenever American forces have become involved in any fighting whatever, the American stock market has always plunged sharply downward. This one exception was the outbreak of World War II in September 1939. At that time, after an abortive rally on thoughts of fat war contracts to a neutral nation, the market soon was following the typical downward course, a course which some months later resembled panic as news of German victories began piling up. Nevertheless, at the conclusion of all actual fighting – regardless of whether it was World War I, World War II, or Korea – most stocks were selling at levels vastly higher than prevailed before there was any thought of war at all. (page 118)

Whether stocks end up higher due to inflationary government policies, or whether stocks actually are worth more, depends on circumstances, writes Fisher. Yet either way, buying stocks after the initial war scare has been the right move.

Don’t forget your Gilbert and Sullivan.

Some investors look at the highest and lowest price at which a stock has traded in each of the past five years. This is illogical and dangerous, writes Fisher, because what really matters is how the company – and stock – will perform for many years into the future. A good growth stock will increase at least several hundred percent from its current price as a result of the company’s future economic performance. Past stock prices are largely irrelevant.

Don’t fail to consider time as well as price in buying a true growth stock.

Occasionally if you’ve followed a company for some time, you may notice that certain ventures have consistently been followed by stock price increases. Although it won’t always work, you could use this information as a guide to when to buy the stock.

Don’t follow the crowd.

Psychology can cause a stock to be priced almost anywhere in the short term, as the value investor Howard Marks has noted. Fisher:

These great shifts in the way the financial community appraises the same set of facts at different times are by no means confined to stocks as a whole. Particular industries and individual companies within those industries constantly change in financial favor, due as often to altered ways of looking at the same facts as to actual background occurrences themselves. (page 131)

 

HOW TOGO ABOUT FINDING A GROWTH STOCK

It’s difficult to find good investment ideas. In your search, you may accidentally exclude a few of the best ideas, while spending a great deal of time on many stocks that won’t turn out to be good ideas.

Note: Fisher is talking about growth stocks. If you’re a value investor, then a quantitative investment strategy can work well over time.

One way to find good investment ideas is to see what top investors are doing.

Fisher offers some details about how he approaches potential investment ideas. In the first stage, he does not seek to talk with anyone in management. He does not go over old annual reports. Fisher:

I will, however, glance over the balance sheet to determine the general nature of the capitalization and financial position. If there is an SEC prospectus I will read with care those parts covering breakdown of total sales by product lines, competition, degree of officer or other major ownership of common stock (this can also usually be obtained from the proxy statement) and all earning statement figures throwing light on depreciation (and depletion, if any), profit margins, extent of research activity, and abnormal or non-recurring costs in prior years’ operations.

Now I am ready really to go to work. I will use the ‘scuttlebutt’ method I have already described just as much as I possibly can… I will try to see (or reach by telephone) every key customer, supplier, competitor, ex-employee, or scientist in a related field that I know or whom I can approach through mutual friends. However, suppose I still do not know enough people or do not have a friend of a friend who knows enough of the people who can supply me with the required background? What do I do then?

Frankly, if I am not even close to getting much of the information I need, I will give up the investigation and go on to something else. To make big money on investments it is unnecessary to get some answer to every investment that might be considered. What is necessary is to get the right answer a large proportion of the very small number of times actual purchases are made. For this reason, if way too little background is forthcoming and the prospects for a great deal more is bleak, I believe the intelligent thing to do is to put the matter aside and go on to something else. (pages 140-141)

If you’ve finished ‘scuttlebutt’ research with regard to the fifteen points, then the next step is to approach management. Only ‘scuttlebutt’ can give you enough knowledge to approach management with intelligent questions.

Fisher writes that he may find one worthwhile stock out of every 250 stocks he considers as possibilities. He finds one good stock out of every 50 he looks at in some detail. And Fisher invests about one time of out every 2 or 2.5 company visits. By the time Fisher visits a company, he has already uncovered via ‘scuttlebutt’ nearly all the important information. If Fisher can confirm his investment thesis when he meets with management, as well as ease some of his concerns, then he is ready to make the investment.

 

TEMPERAMENT MORE IMPORTANT THAN IQ

Fisher concludes Common Stocks and Uncommon Profits by noting the importance of temperament:

One of the ablest investment men I have ever known told me many years ago that in the stock market a good nervous system is even more important than a good head. (page 148)

Or as Buffett put it:

Investing is not a game where the guy with the 160 IQ beats the guy with the 130 IQ… Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble in investing.

 

BOOLE MICROCAP FUND

An equal weighted group of micro caps generally far outperforms an equal weighted (or cap-weighted) group of larger stocks over time. See the historical chart here: https://boolefund.com/best-performers-microcap-stocks/

This outperformance increases significantly by focusing on cheap micro caps. Performance can be further boosted by isolating cheap microcap companies that show improving fundamentals. We rank microcap stocks based on these and similar criteria.

There are roughly 10-20 positions in the portfolio. The size of each position is determined by its rank. Typically the largest position is 15-20% (at cost), while the average position is 8-10% (at cost). Positions are held for 3 to 5 years unless a stock approachesintrinsic value sooner or an error has been discovered.

The mission of the Boole Fund is to outperform the S&P 500 Index by at least 5% per year (net of fees) over 5-year periods. We also aim to outpace the Russell Microcap Index by at least 2% per year (net). The Boole Fund has low fees.

 

If you are interested in finding out more, please e-mail me or leave a comment.

My e-mail: jb@boolefund.com

 

 

 

Disclosures: Past performance is not a guarantee or a reliable indicator of future results. All investments contain risk and may lose value. This material is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Boole Capital, LLC.

Emotions and Biases


September 19, 2021

Meir Statman, an expert in behavioral finance, has written a good book, What Investors Really Want (McGraw-Hill, 2011).

Here is my brief summary of the important points:

 

UTILITY AND EMOTIONS

Statman argues that investments bring utilitarian benefits, expressive benefits, and emotional benefits. The utilitarian benefits relate to being able to achieve financial goals, such as financial freedom or the ability to pay for the education of grandchildren.

Expressive benefits can convey to ourselves and others our values and tastes. For instance, an investor is, in effect, saying, ‘I’m smart and can pick winning investments.’ Emotional benefits relate to how the activity makes you feel. As Statman notes, Christopher Tsai said about his father Gerald Tsai, Jr. – a pioneer of the go-go funds in the 1960s: “He loved doing transactions. He loved the excitement of it.”

Statman tells the story of an engineer who learned that Statman is a professor of finance. The engineer asked where he could buy the Japanese yen. Statman asked him why, and the engineer said that the yen would zoom past the dollar based on macroeconomic fundamentals. Statman replied:

Buying and selling Japanese yen, American stocks, French bonds, and all other investments is not like playing tennis against a practice wall, where you can watch the ball hit the wall and place yourself at just the right spot to hit it back when it bounces. It is like playing tennis against an opponent you’ve never met before. Are you faster than your opponent? Will your opponent fool you by pretending to hit the ball to the left side, only to hit it to the right? (page ix)

Later, Statman continues:

I tried to dissuade my fellow dinner guest from trading Japanese yen but I have probably failed. Perhaps I failed to help my fellow dinner guest overcome his cognitive error, learn that trading should be framed as playing tennis against a possibly better player, and refrain from trading. Or I might have succeeded in helping my fellow guest overcome his cognitive error and yet failed to dissuade him from trading because he wanted the expressive and emotional benefits of the trading game, the fun of playing and the thrill of winning. (page xiii)

Statman explains that, in many fields of life, emotions are helpful in good decision-making. Yet when it comes to areas such as investing, emotions tend to be harmful.

There is often a tension between what we should do and what we want to do. And if we are stressed or fatigued, then it becomes even harder to do what we should do instead of what we want to do.

Moreover, our emotional reactions to changing stock prices generally mislead us. When stocks are going up, we typicallyfeel more confident and want to own more stocks. When stocks are going down, we tend to feel less confident and want to own fewer stocks. But this is exactly the opposite of what we should doif we want to maximize our long-term investment results.

 

WE WANT PROFITS HIGHER THAN RISKS

Beat-the-market investors have always been searching for investments with returns higher than risks. But such investments are much rarer than is commonly supposed. For every investor who beats the market, another must trail the market. And that is before fees and expenses. After fees and expenses, there are very few investors who beat the market over the course of several decades.

Statman mentions a study of stock traders. Those who traded the most trailed the index by more than 7 percent per year on average. Those who traded the least trailed the index by only one-quarter of 1 percent. Furthermore, a study of Swedish investors showed that heavy traders lose, on average, nearly 4 percent of their total financial wealth each year.

 

FRAMING

Framing means that people can react differently to a particular choice based on how it is presented. Framing is everywhere in the world of investments. Statman explains:

Some frames are quick and intuitive, but frames that come to mind quickly and intuitively are not always correct… The beat-the-market frame that comes to mind quickly and intuitively is that of tennis played against a practice wall, but the correct frame is tennis played against a possibly better player. Incorrect framing of the beat-the-market game is one cognitive error that fools us into believing that beating the market is easy. (page 18)

Statman has some advice for overcoming the framing error:

It is not difficult to overcome the framing error. All we need to do is install an app in our minds as we install apps on our iPhones. When we are ready to trade it would pipe in, asking, ‘Who is the idiot on the other side of the trade? Have you considered the likelihood that the idiot is you?’ (page 21)

The broader issue (discussed below) is that most of us, by nature, are overconfident in many areas of life, including investing. Overconfidence is the most widespread cognitive bias that we have. Using procedures such as a checklist can help reduce errors from overconfidence. Also, keeping a journal of every investment decision – what the hypothesis is, what the evidence is, and what ended up happening – can help you to improve over time, hopefully reducing cognitive errors such as overconfidence.

REPRESENTATIVENESS HEURISTIC

Heuristics are mental shortcuts that often work, but sometimes don’t. There is a good discussion of the representativeness heuristic on Wikipedia: https://en.wikipedia.org/wiki/Representativeness_heuristic

Daniel Kahneman and Amos Tversky defined representativeness as:

the degree to which [an event] (i) is similar in essential characteristics to its parent population, and (ii) reflects the salient features of the process by which it is generated.

When people rely on representativeness to make judgments, they are likely to judge wrongly because the fact that something is more representative does not actually make it more likely. The key issue is sample size versus base rate.

Many people mistakenly assume that a small sample – even as small as a single example – is representative of the relevant population. This mistake is called the law of small numbers.

If you have a small sample, you cannot take it as representative of the entire population. In other words, a small sample may differ significantly from the base rate. If you have a large enough sample, then by the law of large numbers, you can conclude that the large sample approximates the base rate (the entire population).

For instance, if you flip a coin ten times and get 8 heads, you cannot conclude that flipping the same coin thousands of times will yield approximately 80% heads. But if you flip a coin ten thousand times and get 5,003 heads, you can conclude that the base rate for heads is 50%.

If a mutual fund manager beats the market five years out of six, we conclude that it must be due to skill even though that is far too short a period for such a conclusion. By randomness alone, there will bemany mutual fund managers who beat the market five years out of six.

 

FINDING PATTERNS

Our brains are good at finding patterns. But when the data are highly random, our brains often find patterns that don’t really exist.

For example, there is no way to time the market. Yet many investors try to time the market, jumping in and out of stocks. Nearly everyone who tries market timing ends up trailing a simple index fund over time.

Part of the problem is that the brain only notices and remembers the handful of investors who were able to time the market successfully. What investors should examine is the base rate: Out of all investors who have tried market timing, how many have succeeded? A very tiny percentage.

WE HAVE EMOTIONS, SOME MISLEADING

When our sentiment is positive, we expect our investments to bring returns higher than risk. When our sentiment is negative, we expect our investments to bring returns lower than risk.

People expect the stocks of admired companies to do better than the stocks of spurned companies, but the opposite is true. That’s a key reason deep value investing works: on average, people are overly negative on out-of-favor or struggling companies, and people are overly positive on companies currently doing well.

People even expect higher returns if the name of a stock is easier to pronounce!

Finally, many investors think they can get rich from a new technological innovation. In the vast majority of the cases, this is not true. For every Ford, for every Microsoft, for every Google, for every Amazon, there are many companies in the same industry that failed.

THE ILLUSION OF CONTROL

A sense of control, like optimism, is generally beneficial, helping us to overcome challenges and feel happier. A sense of control is good in most areas of life, but – like overconfidence – it is generally harmful in areas that involve much randomness, such as investing.

Statman explains:

A sense of control gained through lucky charms or rituals can be useful. In a golfing experiment, some people were told they were receiving a lucky ball; others received the same ball and were told nothing. Everyone was instructed to take ten putts. Players who were told that their ball was lucky made 6.42 putts on average while those with the ordinary ball made only 4.75. People in another experiment were asked to bring a personal lucky charm to a memory test. Half of them kept the charm with them, but the charms of the other half were kept in another room. People who had the charms with them reported that they had greater confidence that they would do well on the test than the people whose charms were kept away, and people who had the charms with them indeed did better on the memory test.

The outcomes of golf and memory tasks are not random; they are tasks that can be improved by concentration and effort. A sense of control brought about by lucky charms or lucky balls can help improve performance if a sense of control brings real control. But no concentration or effort can improve performance when outcomes are random, not susceptible to control, as is often true in much of investing and trading. (page 50)

Statman describes one experiment involving traders who saw an index move up or down. The task was to raise the index as much as possible by the end of each of four rounds. Traders were also told that three keys on their keyboard have special effect.

In truth, movements in the index were random and the three keys had no effect on outcomes. Any sense of control was illusory. Still, some traders believed that they had much control while others believed that they had little. It turned out that the traders with the highest sense of control displayed the lowest level of performance. (page 51)

COGNITIVE BIASES

Statman also discusses cognitive biases. He remarks that cognitive biases affect each one of us slightly differently. Some may fall prey to hindsight bias more often. Some have more trouble with availability. Others may be more overconfident, and so forth.

Before examining some cognitive biases, it’s worth briefly reviewing Daniel Kahneman’s definition of two different mental systems that we have:

System 1: Operates automatically and quickly; makes instinctual decisions based on heuristics.

System 2: Allocates attention (which has a limited budget) to the effortful mental activities that demand it, including complex computations involving logic, math, or statistics.

Kahneman writes – in Thinking, Fast and Slow – that System 1 and System 2 usually work quite well together:

The division of labor between System 1 and System 2 is highly efficient: it minimizes effort and optimizes performance. The arrangement works well most of the time because System 1 is generally very good at what it does: its models of familiar situations are accurate, its short-term predictions are usually accurate as well, and its initial reactions to challenges are swift and generally appropriate.

Yet in some circumstances – especially if a good judgment requires complex computations such as logic, math, or statistics – System 1 has cognitive biases, or systematic errors that it tends to make.

The systematic errors of System 1 happen predictably in areas such as investing or forecasting. These areas involve so much randomness that the intuitive statistics of System 1 lead predictably and consistently to errors.

AVAILABILITY BIAS

availability bias: we tend to overweight evidence that comes easily to mind.

Related to the availability bias arevividness biasandrecency bias. We typically overweight facts that are vivid (e.g., plane crashes or shark attacks). We also overweight facts that are recent (partly because they are more vivid).

Statman comments on the availability bias and on the near-miss effect:

Availability errors compound representativeness errors, misleading us further into the belief that beating the market is easy. Casinos exploit availability errors. Slot machines are quiet when players lose, but they jingle cascading coins when players win. We exaggerate the likelihood of winning because the loud voice of winning is available to our minds more readily than the quiet voice of losing… Scans of the brains of gamblers who experience near-misses show activation of a reward-related brain circuitry, suggesting that near-misses increase the transmission of dopamine. This makes gambling addiction similar to drug addiction. (page 29)

Statman pens the following about mutual fund marketing:

Mutual fund companies employ availability errors to persuade us to buy their funds. Morningstar, a company that rates mutual funds, assigns to each fund a number of stars that indicate its relative performance, one star for the bottom group, three stars for the average group, and five stars for the top group. Have you ever seen an advertisement for a fund with one or two stars? But we’ve all seen advertisements for four- and five-star funds. Availability errors lead us to judge the likelihood of finding winning funds by the proportion of four- and five-start funds available to our minds. (page 29-30)

CONFIRMATION BIAS

confirmation bias: we tend to search for, remember, and interpret information in a way that confirms our pre-existing beliefs or hypotheses.

Confirmation bias makes it quite difficult for many of us to improve upon or supplant our existing beliefs or hypotheses. This bias also tends to make most of us overconfident about our existing beliefs or hypotheses, since all we can see are supporting data.

It’s clear that System 1 (intuition) often errors when it comes to forming and testing hypotheses. First of all, System 1 always forms a coherent story (including causality), irrespective of whether there are truly any logical connections at all among various things in our experience. Furthermore, when System 1 is facing a hypothesis, it automatically looks for confirming evidence.

But even System 2 – the logical and mathematical system that we possess and can develop – by nature uses a positive test strategy:

A deliberate search for confirming evidence, known as positive test strategy, is also how System 2 tests a hypothesis. Contrary to the rules of philosophers of science, who advise testing hypotheses by trying to refute them, people (and scientists, quite often) seek data that are likely to be compatible with the beliefs they currently hold. (page 81, Thinking, Fast and Slow)

Thus, the habit of always looking for disconfirming evidence of our hypotheses – especially our best-loved hypotheses (Charlie Munger’s term) – is arguably the most important intellectual habit we could develop in the never-ending search for wisdom and knowledge.

Charles Darwin is a wonderful model in this regard. Darwin was far from being a genius in terms of IQ. Yet Darwin trained himself always to search for facts and evidence that would contradict his hypotheses. Charlie Munger explains in “The Psychology of Human Misjudgment” (see Poor Charlie’s Alamanack, expanded 3rd edition):

One of the most successful users of an antidote to first conclusion bias was Charles Darwin. He trained himself, early, to intensively consider any evidence tending to disconfirm any hypothesis of his, more so if he thought his hypothesis was a particularly good one…He provides a great example of psychological insight correctly used to advance some of the finest mental work ever done. (my emphasis)

As Statman states:

Confirmation errors contribute their share to the perception that winning the beat-the-market game is easy. We commit the confirmation error when we look for evidence that confirms our intuition, beliefs, claims, and hypotheses, but overlook evidence that disconfirms them… The remedy for confirmation errors is a structure that forces us to consider all the evidence, confirming and disconfirming alike, and guides us to tests that tell us whether our intuition, beliefs, claims, or hypotheses are confirmed by the evidence or disconfirmed by it.

One manifestation of confirmation errors is the tendency to trim disconfirming evidence from stories… The fact that a forecast of an imminent stock market crash was made years before its coming is unappetizing, so we tend to trim it off our stock market stories. (page 31)

 

HINDSIGHT BIAS

Hindsight bias: the tendency, after an event has occurred, to see the event as having been predictable, despite little or no objective basis for predicting the event prior to its occurrence.

This is a very powerful bias that we have. Because we view the past as much more predictable than it actually was, we also view the future as much more predictable than it actually is.

Hindsight bias is also called the knew-it-all-along effect or creeping determinism. (See:http://en.wikipedia.org/wiki/Hindsight_bias)

Kahneman writes abouthindsight biasas follows:

Your inability to reconstruct past beliefs will inevitably cause you to underestimate the extent to which you were surprised by past events. Baruch Fischhoff first demonstrated this ‘I-knew-it-all-along’ effect, orhindsight bias, when he was a student in Jerusalem. Together with Ruth Beyth (another of our students), Fischhoff conducted a survey before President Richard Nixon visited China and Russia in 1972. The respondents assigned probabilities to fifteen possible outcomes of Nixon’s diplomatic initiatives. Would Mao Zedong agree to meet with Nixon? Might the United States grant diplomatic recognition to China? After decades of enmity, could the United States and the Soviet Union agree on anything significant?

After Nixon’s return from his travels, Fischhoff and Beyth asked the same people to recall the probability that they had originally assigned to each of the fifteen possible outcomes. The results were clear. If an event had actually occurred, people exaggerated the probability that they had assigned to it earlier. If the possible event had not come to pass, the participants erroneously recalled that they had always considered it unlikely. Further experiments showed that people were driven to overstate the accuracy not only of their original predictions but also of those made by others. Similar results have been found for other events that gripped public attention, such as the O.J. Simpson murder trial and the impeachment of President Bill Clinton. The tendency to revise the history of one’s beliefs in light of what actually happened produces a robust cognitive illusion. (pages 202-3, my emphasis)

Concludes Kahneman:

The sense-making machinery of System 1 makes us see the world as more tidy, simple, predictable, and coherent that it really is. The illusion that one has understood the past feeds the further illusion that one can predict and control the future. These illusions are comforting. They reduce the anxiety we would experience if we allowed ourselves to fully acknowledge the uncertainties of existence. (page 204-5, my emphasis)

Statman elucidates:

So, if an introverted man marries a shy woman, it must be because, as we have known all along, ‘birds of a feather flock together’ and if he marries an outgoing woman, it must be because, as we have known all along, ‘opposites attract.’ Similarly, if stock prices decline after a prolonged rise, it must be, as we have known all along, that ‘trees don’t grow to the sky’ and if stock prices continue to rise, it must be, as we have equally known all along, that ‘the trend is your friend.’ Hindsight errors are a serious problem for all historians, including stock market historians. Once an event is part of history, there is a tendency to see the sequence that led to it as inevitable. In hindsight, poor choices with happy endings are described as brilliant choices, and unhappy endings of well-considered choices are attributed to horrendous choices. (page 33)

Statman later writes about Warren Buffett’s understanding of hindsight bias:

Warren Buffett understands well the distinction between hindsight and foresight and the temptation of hindsight. Roger Lowenstein mentioned in his biography of Buffett the events surrounding the increase in the Dow Jones Industrial Index beyond 1,000 in early 1966 and its subsequent decline by spring. Some of Buffett’s partners called to warn him that the market might decline further. Such calls, said Buffett, raised two questions:

If they knew in February that the Dow was going to 865 in May, why didn’t they let me in on it then; and

If they didn’t know what was going to happen during the ensuing three months back in February, how do they know in May?

Statman concludes: We will always be normal, never rational, but we can increase the ratio of smart normal behavior to stupid normal behavior by recognizing our cognitive errors and devising methods to overcome them.

One of the best ways to minimize errors from cognitive bias is to use a fully automated investment strategy. A low-cost broad market index fund will allow you to beat at least 90% of all investors over several decades. If you adopt a quantitative value approach, you can do even better.

OVERCONFIDENCE

Overconfidence is such as widespread cognitive bias among people that Kahneman devotes Part 3 of his book, Thinking, Fast and Slow, entirely to this topic. Kahneman says in his introduction:

The difficulties of statistical thinking contribute to the main theme of Part 3, which describes a puzzling limitation of our mind: our excessive confidence in what we believe we know, and our apparent inability to acknowledge the full extent of our ignorance and the uncertainty of the world we live in. We are prone to overestimate how much we understand about the world and to underestimate the role of chance in events. Overconfidence is fed by the illusory certainty of hindsight. My views on this topic have been influenced by Nassim Taleb, the author ofThe Black Swan. (pages 14-5)

As Statman describes:

Investors overestimate the future returns of their investments relative to the returns of the average investor. Investors even overestimate their past returns relative to the returns of the average investor. Members of the American Association of Individual Investors overestimated their own investment returns by an average of 3.4 percentage points relative to their actual returns, and they overestimated their own returns relative to those of the average investor by 5.1 percentage points. The unrealistic optimism we display in the investment arena is similar to the unrealistic optimism we display in other arenas. (page 45)

Statman also warns that stockbrokers and stock exchanges have good reasons to promote overconfidence because unrealistically optimistic investors trade far more often.

SELF-ATTRIBUTION BIAS

self-attribution bias: we tend to attribute good outcomes to our own skill, while blaming bad outcomes on bad luck.

This ego-protective bias prevents us from recognizing and learning from our mistakes. This bias also contributes to overconfidence.

As with the other cognitive biases, often self-attribution bias makes us happier and stronger. But we have to learn to slow ourselves down and take extra care in areas – like investing – where overconfidence will hurt us.

 

INFORMATION AND OVERCONFIDENCE

InBehavioural Investing (Wiley, 2007), James Montier explains a study done by Paul Slovic (1973). Eight experienced bookmakers were shown a list of 88 variables found on a typical past performance chart on a horse. Each bookmaker was asked to rank the piece of information by importance.

Then the bookmakers were given data for 40 past races and asked to rank the top five horses in each race. Montier:

Each bookmaker was given the past data in increments of the 5, 10, 20, and 40 variables he had selected as most important. Hence each bookmaker predicted the outcome of each race four times – once for each of the information sets. For each prediction the bookmakers were asked to give a degree of confidence ranking in their forecast. (page 136)

Here are the results:

Accuracy was virtually unchanged, regardless of the number of pieces of information the bookmaker was given (5, 10, 20, then 40).

But confidence skyrocketedas the number of pieces of information increased (5, 10, 20, then 40).

This same result has been found in a variety of areas. As people get more information, the accuracy of their judgments or forecasts typically does not change at all, while their confidence in the accuracy of their judgments or forecasts tends to increase dramatically.

NARRATIVE FALLACY

InThe BlackSwan, Nassim Taleb writes the following about thenarrative fallacy:

The narrative fallacy addresses our limited ability to look at sequences of facts without weaving an explanation into them, or, equivalently, forcing a logical link, anarrow of relationship, upon them. Explanations bind facts together. They make them all the more easily remembered; they help themmake more sense. Where this propensity can go wrong is when it increases ourimpressionof understanding. (page 63-4)

The narrative fallacy is central to many of the biases and misjudgments mentioned by Daniel Kahneman and Charlie Munger. The human brain, whether using System 1 (intuition) or System 2 (logic), always looks for or creates logical coherence among random data.

Thanks to evolution, System 1 is usually right when it assumes causality. For example, there was movement in the grass, probably caused by a predator, so run. And even in the modern world, as long as cause-and-effect is straightforward and not statistical, System 1 is amazingly good at what it does: its models of familiar situations are accurate, its short-term predictions are usually accurate as well, and its initial reactions to challenges are swift and generally appropriate. (Kahneman)

Furthermore, System 2, by searching for underlying causes or coherence, has, through careful application of the scientific method over centuries, developed a highly useful set of scientific laws by which to explain and predict various phenomena.

The trouble comes when the data or phenomena in question are ‘highly random’ – or inherently unpredictable (based on current knowledge). In these areas, System 1 is often very wrong when it creates coherent stories or makes predictions. And even System 2 assumes necessary logical connections when there may not be any – at least, none that can be discovered for some time.

Note: The eighteenth century Scottish philosopher (and psychologist) David Hume was one of the first to clearly recognize the human brain’s insistence on always assuming necessary logical connections in any set of data or phenomena.

ANCHORING

anchoring effect: we tend to use any random number as a baseline for estimating an unknown quantity, despite the fact that the unknown quantity is totally unrelated to the random number.

Kahneman and Tversky did one experiment where they spun a wheel of fortune, but they had secretly programmed the wheel so that it would stop on 10 or 65. After the wheel stopped, participants were asked to estimate the percentage of African countries in the UN. Participants who saw “10” on the wheel guessed 25% on average, while participants who saw “65” on the wheel guessed 45% on average, ahuge difference.

Behavioral finance expert James Montier ran his own experiment on anchoring. People were asked to write down the last four digits of their phone number. Then they were asked whether the number of doctors in their capital city is higher or lower than the last four digits of their phone number. Results: Those whose last four digits were greater than 7000 on average reported 6762 doctors, while those with telephone numbers below 2000 arrived at an average 2270 doctors. (Behavioural Investing, page 120)

Those are just two experiments out of many. Theanchoring effectis “one of the most reliable and robust results of experimental psychology” (page 119, Kahneman). Furthermore, Montier observes that the anchoring effect is one reason why people cling to financial forecasts, despite the fact that most financial forecasts are either wrong, useless, or impossible to time.

When faced with the unknown, people will grasp onto almost anything. So it is little wonder that an investor will cling to forecasts, despite their uselessness. (Montier, page 120)

 

BOOLE MICROCAP FUND

An equal weighted group of micro caps generally far outperforms an equal weighted (or cap-weighted) group of larger stocks over time. See the historical chart here: https://boolefund.com/best-performers-microcap-stocks/

This outperformance increases significantly by focusing on cheap micro caps. Performance can be further boosted by isolating cheap microcap companies that show improving fundamentals. We rank microcap stocks based on these and similar criteria.

There are roughly 10-20 positions in the portfolio. The size of each position is determined by its rank. Typically the largest position is 15-20% (at cost), while the average position is 8-10% (at cost). Positions are held for 3 to 5 years unless a stock approachesintrinsic value sooner or an error has been discovered.

The mission of the Boole Fund is to outperform the S&P 500 Index by at least 5% per year (net of fees) over 5-year periods. We also aim to outpace the Russell Microcap Index by at least 2% per year (net). The Boole Fund has low fees.

 

If you are interested in finding out more, please e-mail me or leave a comment.

My e-mail: jb@boolefund.com

 

 

 

Disclosures: Past performance is not a guarantee or a reliable indicator of future results. All investments contain risk and may lose value. This material is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Boole Capital, LLC.

Our Process and Vision

September 12, 2021

If you’re investing small sums, you can earn the highest returns by focusing on microcap stocks. That’s why many top value investors started in micro caps. For instance, Warren Buffett concentrated on micro caps when he managed his partnership starting in 1957, which produced the highest returns of his career. And Buffett has repeatedly said that in today’s market, he could get 50% per year if he could invest in micro caps.

Look at this summary of the CRSP Decile-Based Size and Return Data from 1927 to 2020:

Decile Market Cap-Weighted Returns Equal Weighted Returns Number of Firms (year-end 2020) Mean Firm Size (in millions)
1 9.67% 9.47% 179 145,103
2 10.68% 10.63% 173 25,405
3 11.38% 11.17% 187 12,600
4 11.53% 11.29% 203 6,807
5 12.12% 12.03% 217 4,199
6 11.75% 11.60% 255 2,771
7 12.01% 11.99% 297 1,706
8 12.03% 12.33% 387 888
9 11.55% 12.51% 471 417
10 12.41% 17.27% 1,023 99
9+10 11.71% 15.77% 1,494 199

(CRSP is the Center for Research in Security Prices at the University of Chicago. You can find the data for various deciles here: http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html)

The smallest two deciles – 9+10 – comprise microcap stocks, which typically are stocks with market caps below $500 million. What stands out is the equal weighted returns of the 9th and 10th size deciles from 1927 to 2020:

Microcap equal weighted returns = 15.8% per year

Large-cap equal weighted returns = ~10% per year

In practice, the annual returns from microcap stocks will be 1-2% lower because of the difficulty (due to illiquidity) of entering and exiting positions. So we should say that an equal weighted microcap approach has returned 14% per year from 1927 to 2020, versus 10% per year for an equal weighted large-cap approach.

Still, if you can do 4% better per year than the S&P 500 Index (on average) – even with only a part of your total portfolio – that really adds up after a couple of decades.

  • Most professional investors ignore micro caps as too small for their portfolios. This causes many micro caps to get very cheap. And that’s why an equal weighted strategy – applied to micro caps – tends to work well.

 

VALUE SCREEN: +2-3%

By systematically implementing a value screen–e.g., low EV/EBITDA or low P/E–to a microcap strategy, you can add 2-3% per year.

 

GROWING EARNINGS AND IMPROVING FUNDAMENTALS: +2-3%

You can further boost performance by screening for growing earnings and improving fundamentals. One excellent way to do this is using the Piotroski F_Score, which works best for cheap micro caps. See: https://boolefund.com/joseph-piotroski-value-investing/

This screen should increase performance by at least 2-3% a year.

 

POSITIVE MOMENTUM AND OTHER FACTORS: +2-3%

Then our model screens for high shareholder yield, high insider ownership, insider buying, high ROE, low/no debt, and positive momentum.  This screen should further boost performance by at least 2-3% a year.

 

BOTTOM LINE

If you invest in microcap stocks, you can get about 14% a year. If you also use a simple screen for value, that adds at least 2-3% a year. If, in addition, you screen for growing earnings and improving fundamentals, that adds at least another 2-3% a year. Finally, screening for positive momentum and others factors boosts performance at least another 2-3% a year. So that takes you to 20-23% a year.  After fees, that comes to 15-18% a year, which compares quite well to the 10% a year you could get from an S&P 500 index fund.

What’s the difference between 15% a year and 10% a year? If you invest $50,000 at 10% a year for 30 years, you end up with $872,000, which is good. If you invest $50,000 at 15% a year for 30 years, you end up with $3.31 million, which is much better.

Please contact me if you would like to learn more.

    • My email: jb@boolefund.com.
    • My cell: 206.518.2519

 

BOOLE MICROCAP FUND

An equal weighted group of micro caps generally far outperforms an equal weighted (or cap-weighted) group of larger stocks over time.

This outperformance increases significantly by focusing on cheap micro caps. Performance can be further boosted by isolating cheap microcap companies with improving fundamentals and positive momentum. We rank microcap stocks based on these and similar criteria.

There are roughly 10-15 positions in the portfolio. The size of each position is determined by its rank. Typically the largest position is 15-20% (at cost), while the average position is 8-10% (at cost). Positions are held for 3 to 5 years unless a stock approaches intrinsic value sooner or an error has been discovered.

The mission of the Boole Fund is to outperform the S&P 500 Index by at least 5% per year (net of fees) over 5-year periods. We also aim to outpace the Russell Microcap Index by at least 2% per year (net). The Boole Fund has low fees.

 

If you are interested in finding out more, please e-mail me or leave a comment.

My e-mail: jb@boolefund.com

 

 

Disclosures: Past performance is not a guarantee or a reliable indicator of future results. All investments contain risk and may lose value. This material is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Boole Capital, LLC.