In this edition of the Alpha Letter, we cover:
My due diligence process for finding winning stocks
What industries I am bullish on
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My Due Diligence Process
I love investing in hated industries. It is what I have always done. Find the most unloved industry and do a deep dive into the fundamentals of its business model. Find the best companies in the hated industry and if/when I get comfortable I will bet heavy. This is my process:
Identify an industry that everyone hates
Make a list of the companies in this industry
Force rank these companies by their balance sheets — I will typically start researching the companies with the best balance sheets
Build a financial model(s) for the company I think is the best to survive
Read through multiple years of financials and earnings transcripts (transcripts are in my opinion the best way to forecast future free cash flows)
Speak with the management team(s), industry experts and do channel checks
Build financial models for the competitors and repeat all of the above steps
Invest heavily if I get comfortable
Depending on how complex the industry/companies are in the sector this process can take upwards of 1-2 months. By the end of the due diligence process I should be one of the top analysts on that one given company in this sector.
I should note, I typically try to focus on the smallest companies in these given sectors due to the lack of competition from other professional investors. When you are investing in sub-$100 million market capitalization there is very little competition from Harvard MBA analysts who have been trained for years. Your competition is typically a retail investor who invests spare change on the side with a full-time job outside of investing.
Earlier in 2021 I was primarily focused on the retail industry. The retail industry has been one of the most hated industries for a long-time. If you asked anyone on Wall Street why they avoided retail they would say something like, “well Amazon risk.”
Utter bullsh*t. It was the most typical statement from a lazy analyst who didn’t want to or has never tried to understand how a physical retail store generates cash flow. But that was where the opportunity lied. No one was touching retail stores due to the “Amazon risk” and when COVID-19 came around the last remaining value guys dumped these stocks off a cliff.
My thought process for the retail industry was pretty simple by the time 2021 came around.
Any retailer who have survived this far isn’t going to go bankrupt
Costs were dramatically slashed at corporate and the store level giving potential for massive operating leverage should store sales return (think post Great Recession era — the same thing happened here)
There was less competition due to bankruptcies so if sales did return the ones left standing would take a larger share of the pie
There were multiple companies trading at a fraction of their 2019 price levels giving investors significant upside should their thesis work
It was a slam dunk for me. Everything that I laid out in the bullet points worked and continues to work. I wrote up three different retailers in March and April that are now up over 100% each (or more).
There isn’t many opportunities left in retail (besides this one that I wrote up in June —only up 6% so far with another 50% upside to go potentially) so I have begun to look in other industries for more hated ideas.
What Industries I Am Looking At
Here is a list of industries I am currently focused on. This is not exhaustive as I am always curious to learn how other businesses make money. But this is where 90% of my time is spent at the current moment.
Energy Industry: I really like coal companies here. Thermal and metallurgical coal. Coal is probably one of the most hated industries around due to the impact it has on the environment and the consistent bankruptcies the industry has faced. But there are multiple tailwinds that should allow both the thermal and metallurgical industry to thrive over the next few years. I have identified one company that I think will do very well over the next 12 months. I also plan to write up another idea this coming week so keep an eye out. I am also looking at a couple of energy service names to the traditional oil and gas industry that should do well as oil is now over $70/bbl.
Agriculture/Fertilizers: Not really a hated industry but there is a good opportunity I have identified that could be a multi-bagger. Rising corn prices combined with a drought have pushed fertilizer prices sky high. The company I have identified (see write-up here) is trading around $60/unit. The last time fertilizer prices were this high (back in 2012) this company was trading for $320/unit with 60% less capacity than it has today. This is a super cyclical commodity cycle we are in and I think it continues.
Traditional Media: The traditional media space looks pretty interesting right now. Newspapers, radio and television. Wall Street hates this space due to new competitors in the tech industry (think Netflix, Spotify, Google, etc.). A lot of these companies are trading like they don’t have a terminal value and some are trading under cash value. Junk Bond Investor recently wrote up two media companies that I am long (find them here and here).
Private Prisons: This is probably the most hated industry out there. The two public companies The Geo Group ($GEO) and CoreCivic ($CXW) are highly levered, contentious and trading at multi-decade lows. GEO and CXW recently bounced up from their lows on a short squeeze. If they get hammered again it could be worth a deeper look.
Gold Miners: I own physical gold given the reckless spending and debt levels governments across the globe have been doing. I penned an article title “I have been accumulating gold” that details my approach to physical ownership. To get operating leverage I have been doing some research into a few different junior gold miners. So far I have only taken a position in one. Gran Colombia Gold Corp. ($TPRFF) seems pretty interesting given the assets and value metrics. I will be spending some time on this one.
Dry Bulk and Oil Tankers: Two different industries but similar opportunities. Dry bulk carriers are making a lot of money right now as there is a significant amount of demand from iron ore and lack of new build ship. Ship rates have skyrocketed and everything is flowing to the bottom line. Oil tankers are still in the hole but should experience demand as the price of oil is rebounding and individuals are beginning to travel again. I also like how oil tankers are trading like no one wants them.
Malls: There are some class A mall owners that still haven’t recovered due to COVID. This is another hated sector that Wall Street pretty much avoids due to the “Amazon Risk” I talked about a few bullet points up. I am not as familiar with the business model here as I haven’t done a deep dive but this is a space I plan to look at in the coming weeks. The The Macerich Company ($MAC) has had a great run but is still trading way below its pre-COVID highs. This is a name I would like to know well.
What industries/companies are you bullish on? Drop them in the comment section below.
The Week Ahead
I will be dropping a research report this coming week on a special situation commodity idea for subscribers. I think in the short-term this stock will re-rate 10-15% higher with potential to go up >50% in the mid to long-term due to the current commodity tailwinds. Be sure to keep a look out for this idea. Get instant access to this stock idea along with all of my prior research for only $10/month.
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Sounds like a sophisticated and solid approach! Love that you build financial models, speak to stakeholders and do the same for competitoers. In case you don't already do so, speaking to customers to further evaluate product/service quality might be quite beneficial (depending on the sector/company of course).
Haven't read one of your specific DDs yet, but I'm very keen on how detailed you describe your findings (which financial metrics are important and why, conditions for thesis to become invalid, to whom you've spoken and maybe a summarised transcript, etc.).
I wonder what your thoughts are on these two:
https://youtu.be/L-ahF-f5oYM (brilliant guy)
https://youtu.be/tOs9DTQXOKg (very interesting for growth companies)