My Favorite Industry

Investors,

The market fascinates me. Thousands of smart individuals competing. Value investors. Venture Capitalists. Day Traders. Quant guys. Short seller. You name it. An entire ecosystem of brilliant individuals all trying make intelligent decisions.

These market participants, no matter how different their investment strategy, are all after one single thing. They are trying to accumulate more public information than their competitors. Because in this game the one with the most information takes the cake home at the end of the day.

Accumulating public information takes a significant amount of time. You have to read annual reports and proxies. Build elaborate financial models and listen to countless earning calls. Update your models when new information is available. Talk to management teams. Tour facilities. Then use all of the available information you can accumulate to make an allocation decision.

Given the time consuming nature of accumulating information and aggregating it into a potential allocation, I believe the best ways to generate alpha over the long-term is the become a student of a single sector.

This is my playbook as a student of the market:

  • Identify a sector that is deeply misunderstood and undervalued

  • Figure out if that sector will continue to produce cash flows for years to come (90% of the time this is a yes)

  • Find the least levered player in the sector that will most likely survive the downturn and not be burdened by debt risk

  • Learn all you can on this company: read annual reports, build a working financial model, go through at least three years of earning calls, read old investor presentations, talk to the management team, tour facilities, channel checks with customers, etc.

  • After all of the above you should have a pretty good understanding of the risk and rewards of a potential investment. If you want to move forward with an allocation do all of the prior with their competitors (some of this can be skipped like touring facilities if you know you will never touch one of the stocks).

Doing all of the above work takes a significant amount of time and effort. I have literally spent months building working financial models and taking elaborate notes on one single sector. But all of that work pays off. Because once you have all of the models built, you only have to do maintenance due diligence in the future.

This is when all of your hard work starts to pay off. By this time you should have a pretty good working model of the entire industry. You have spent months if not years following these companies. You know how revenues are made. You know which companies you can trust. And you directionally know where free cash flows will go.

Since the business cycle is not a continuum roller coaster only going up, when the eventual downturn occurs, you can use your past knowledge to confidently invest when others are selling.

One industry I would consider myself a student of the market on is the traditional media space. It was one of the first sectors I started to cover as a young analyst. I found a company trading below the implied liquidation value of their assets and went all in.

I spent months figuring out what their assets were worth. Who the major players in the industry were. How cash flows were generated. Who to trust and who to not. I flew all over the country meeting management teams and seeing the business in action. After completing my original due diligence, I have made four major investments in the space. Two of these investments I hold now.

We are now into the third quarter earnings season and my thousands of hours of due diligence is beginning to pay off again. Since I have working financial models on almost every company in this industry, when anyone reports I can be up to speed in minutes. Figure out what is going on and if I am going to make money this quarter. I don’t have to spend 80 hours slamming out a financial model from scratch. I made those models back in 2015 and now just need to do some maintenance due diligence.

One of these companies that I have been following for years reported today. They generated decent results with the stock going up 4% or so. I highlighted this stock a few times to Alpha Letter Pro subscribers. The stock still hasn’t recovered from its pandemic lows and is trading at a 15-20% free cash flow yield with a solid dividend.

Another company in the same industry that I own has not reported yet, but their competitor recently did. Their competitor absolutely killed it and they are one of the worst operators in the industry. I’m expecting when my company reports they will blow it out of the water.

I provided updates on these two stocks below for all of the Alpha Letter Pro subscribers.

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