Don't Lose Money!

I am a big margin of safety investor. I focus on the downside and let the upside take care of itself. My three rules of investing are:

  1. Don’t lose money

  2. Don’t lose money

  3. Don’t lose money

I have been a student of Graham and Dodd principals since I first started investing and haven’t looked back. It just made perfect sense to me. Buy the securities that have so much assets on their balance sheet, relative to their market value, and you will do ok.

The principals on margin of safety have served me well. Margin of safety serves as a guiding light when navigating the global markets. A starting point with a light to the end of the tunnel.

As a margin of safety investor I focus on these primary methods to find winning stocks:

  • Identify the most hated and unloved industries: I love investing in industries that have gotten absolutely sandbagged by the market. Multi-decade low type stocks. Industries that Wall Street can’t or won’t touch. Industries that haven’t seen growth or capital infusion in years. Those melting ice cube type companies. I love these kinds of industries as the market usually gets too negative about how much future free cash flows could be generated.

  • Force rank by cheapness: Once I identify an undervalued industry I will force rank the companies in this industry by how cheap they are. I love using metrics such as price to book, EV/EBITDA, P/E and other similar value ratios. I also like to look at what kind of property and equipment these companies hold on their balance sheet as these assets are a little more off the radar and hidden and sometimes can provide additional downside protection.

  • Find the best capitalized operator in this industry: When you are investing in the most hated and unloved industries you are typically dealing with leverage. To limit my downside from complete capital loss I typically will only invest in the best capitalized operator in these industries. I love companies with strong balance sheets that can make it through an extreme downturn. As a caveat, I will invest in extremely levered companies if I know the industry very well.

  • Run the full due diligence process: Readers can view my full due diligence process that I do before I invest in any company here.

This process of identifying companies has served me well. When an industry is really hated by Wall Street there can be dramatic selloffs. The selloffs can be so violent that sometimes these companies are priced like they have zero terminal value.

That is when I swoop in. I try to quickly identify the situation. Is there really something terminally wrong with the industry that is it being priced at zero? What else could go wrong to make the assets even cheaper? Could Wall Street be completely wrong?

I ask these questions because when assets are priced at effectively zero, not much good has to happen for the stock to re-rate. In fact, most of the time, all a company has to do is generate free cash flow for a couple of years, and you can make back your original investment.

The industries I am focusing on right now is the oil and gas industry, coal miners, fertilizers, traditional media, gold miners, oil tankers, and malls. I think all of these industries have very interesting setups and some of them are absolutely hated by Wall Street.

If you want to see my original research on specific companies in these industries consider subscribing to my research service below.

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Snippets

  • Surging Electricity Use, Higher Natural Gas Prices Give Coal A New Life: Coal use is starting to increase across the globe due to surging electricity demand. Higher natural gas prices have incentivized power distributors to use coal over natural gas due to the higher prices. Coal production in the U.S. is now expected to reach 617M short tons in 2021, the EIA says, nearly 3% higher than the month-ago forecast of 600M tons and a 6% above its outlook two months ago of 582M tons.

    My Take: I agree with this take. However I would rather put my money into metallurgical coal as I believe over 90% of thermal coal mines have a terminal value of zero. Met coal producers are trading at relatively the same multiples as thermal coal despite the rapid increase in hot rolled steel prices across the globe. I think this is occurring because investor clump all coal stocks together in the same basket despite significantly different business models. Find my top met coal idea here.

  • Are Treasury yields sniffing out a Fed mistake?: A prolonged drop in U.S. Treasury yields is catching bond and fixed income traders by surprise, as well as other investors in the broader financial markets. The 10-year U.S. Treasury yield dropped below 1.3% on Wednesday, and fell another 6 bps overnight to 1.26%, despite lingering concerns about rising inflation and a gradual removal of Fed stimulus. Treasury yields play an important role in the economy, affecting borrowing costs on everything from mortgages to corporate bonds.

    My Take: I think the main reason why treasuries have fallen is due to the Delta variant emerging across the world. If economies start shutting down again there will be further quantitative easing as additional money is dumped into the system. Overall, I expect inflation to no be transitory. The longer the Fed keeps buying back treasuries the more cheap dollars will be flooded into the market. The problem of inflation is only getting pushed farther into the future. Asset prices will move higher as the dollar falls.

  • Biden to Target Railroads, Ocean Shipping in Executive Order: The Biden administration will push regulators to confront consolidation and perceived anticompetitive pricing in the ocean shipping and railroad industries as part of a broad effort to blunt the power of big business to dominate industries. The administration, in a sweeping executive order expected this week, will ask the Federal Maritime Commission and the Surface Transportation Board to combat what it calls a pattern of consolidation and aggressive pricing that has made it onerously expensive for American companies to transport goods to market.

    My Take: When I read this article I thought I was reading a chapter straight out of Atlas Shrugged. Big government knows best. The transportation industry is almost perfectly competitive and the rates are determined by the market. Market rates are high right now due to pent-up demand from COVID-19 and everyone wanting to get goods now. My sense is that the government is using its power to try to lower rate prices in order to keep inflationary trends down. I suspect we will see more of these “regulations” in the future should inflation continue.

  • Rail disruptions to cut Teck’s 3Q coking coal sales: Canadian coking coal producer Teck Resources estimates that fire damage to rail lines that serve its coking coal mines will shed 300,000-500,000t from its third-quarter sales volumes.

    My Take: 300,000-500,000 tons isn’t a crazy amount of coal produced, but the Asia-Pacific market is already tight as it is. Coking coal prices continue to increase and as long as steel demand stays strong, I expect prices to continue to stay strong. Met coal producers should be making a significant amount of money in Q2 and Q3 if they are selling at the spot market.

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