Tuesday, November 20, 2012

10-K Checklist

1. What does the business do and how does the business make money 
2. What are the segments and which segment is the strongest?
3. How does the company grow:  Capital expenditures and acquisitions, or keep adding money to the savings account?
4. What is the MOAT that the business has that gives it an edge over its competitors.
5. 3 Cs:
(i) Customers:
(ii) Cost structure
(iii) Competitors: 
6. The selling process – How does the company sell its products? Directly to its customers or through some third party.
7. Pricing power: Does the company have pricing power.Can the company pass on the increase in raw material prices to consumers?
8. How much does the company spend on R&D?
9. How much leveraged is the business using? Operational and financial. 
10. What’s the impact of govt regulations in the business and what’s the risk involved here.
11. Is the business dependent on any government grants or subsidies?
12. Is it a Commodity business? If yes then what’s the volatility in the commodity prices.
13. Are there any long term contracts involved while selling the product ?
14. Is Operating Cash Flow tracking Operating Income?
15. What’s the risk involved with any quality issues? Recalls and warranties?
16. How easily are the products replaceable by other types of products? 
17. What’s the breakdown of business between international and USA operations and the impact of foreign currency on earnings?
18. Is the workforce of the company Unionized? 
19. Is the business dependent on any proprietary technology and are patents expiring soon?
20. Deferred taxes-DTA or DTP? If DTA, how sustainable?
21. Does the balance sheet have large amounts of goodwill and intangible assets.
22. Details of any legal issues company is facing.
23. Pension obligations.
24. Management stability and management type. Did they start within the company and how often has the senior leadership and the board structure changed for the company in the past five years.
25. Intricacies of the Financial statements and Footnotes-Separate analysis. 

Monday, November 5, 2012

An Amazingly Inspiring Friday With Arnold Van Den Berg

This past Friday I had the honor and privilege to meet Arnold Van Den Berg, a guru value investor who's been managing Century Management since 1974. He has handily beaten S&P and Dow Jones since the inception of Century Management based on sound investment principle set forth by Ben Graham.

I was very excited before the meeting. Even though we schedule for 11:00, I arrived at CM at 10:45. Arnold came out with his assistant Kara at exactly 11:00 and he gave me one of the warmest welcome that I have ever seen in my life. At 73 years old, with a sincere smile, he was exuding an incredible amount of energy and enthusiasm.

Immediately after a brief greeting, he showed me the way to the library of Century Management. The library is filled with thousands of books, broken down into 3 categories: Investing, Health and Personal Improvement. I instantly fell in love with this library. It would be amazing if I could work here and bath myself in these books, I thought to myself.

Then Arnold took me to CM's kitchen. It was the healthiest-smelling kitchen that I have ever been to. CM has a few employees working in the kitchen exclusively and their job is to prepare for healthy salads and healthy juice everyday. Everyone in CM seems to enjoy this green kitchen very much. Arnold had recommended the book "The China Study", which is about the dietary regime based on plant and whole foods. Seeing this kitchen, I realized that he is instilling this healthy concept throughout the company and everyone is benefited. Again, I thought to myself, it would be nice if I could work here and eat and drink healthy everyday. This is almost everything that I can dream of.

Coming back to the Library, Arnold started to teaching me his investment philosophy. He's done an extensive study of the stock market and he had developed a system using indicators like Value Line Median P/E, Moody's Baa and AAA rate, 10 year and 20 year Treasury rate, pay back % and the like to measure where in the value zone is the current market residing in. He has tracked the market for 38 years. I was amazed by his dedication and determination. Arnold told me that he has tried everything all his investment career and found out that those are the ones that work the best. He explained to me the Value Line Median P/E, the Baa corporate bond rate, the Value Line Appreciation potential, and the pay back % in details. He mentioned that the good thing about this system is that you've got a few other indicators checking against each other so when all the indicators are working in the same direction, you have a very good idea that the market is either overvalued or undervalued considerably.

One thing he did warn me about is to adjust the value line P/E accordingly when in recession. For example, if the U.S get into an recession and the earnings were 100 and the Value Line index price is 1,000, that gives us a P/E of 10. Is the market cheap, you bet. However, if the earnings go down further to 80, a price of 800 of the Value Line Index would have the same P/E as it has when it was 1,000. This is a very important point to remember and that explains the October 2008 and March 2009 market bottom (both times P/E was 10.2 but since at March 2009 earnings were lower, the market was also trading at a lower price as well). However, if we can glean some comfort over this 38 year study, that is the market only stay around 10 or below 10 times P/E 1.8% of the time. So if you buy the market at 10 times P/E, the odds are very much in your favor no matter what.

Then Arnold introduced me to his portfolio valuation techniques. Basically Century Management uses a variety of multiples including P/E, P/S, P/TB, P/B, P/FCF etc. Arnold and other portfolio managers will then come up with the worst case scenario or what they call the recession scenario as well as the upside potential based on reasonable expectations. The current price and buy point will then be established accordingly and a risk-reward ratio is established (bull case-current price/ current price-recession case) and if the odds are good compared to other opportunities (opportunity cost), they will buy the stock.

 Nothing fancy and nothing complicated, everything can be done even without a calculator. Simple but not simpler.

Then Arnold showed me around the whole company. He is exceptionally nice to everyone in the office and he treats everyone very well, even the interns. His office is "the future office". I saw Yoga Mats, trampolines, Japanese Tatami, a standing table, and a chair that's designed to help your back. He also has a lot of books, value line reports, industry reports, company annual reports lying around everywhere. Hanging on the wall are the pictures of his son, daughter, grandchildren, and his wife Eileen. He said doing Yoga is very beneficial because it helps your balance, it helps you stay focused, and it helps you to be more flexible. At age 73, he showed me some of his Yoga moves and it's hard to believe that he is a septuagenarian. He also showed me the pictures when he was the No.9 ranked national rope climber when he was young and how he discovered new techniques to outperform other rope climbers who are stronger and more muscular than he is. He said the way you held the rope and the way you climb played an important role and by changing the traditional method of rope climbing, he changed the game. What an inspiring story. He also taught me the idea of using your subconscious mind and visualize your goals and dreams. He gave me his own compilation on the best articles and sayings on subconscious mind. Again, I was honored by his generosity.

Going back to the library, I brought out the idea that I wanted to work for him, even for free. He mentioned that there is no immediate opening right now and he wanted to be fair to everybody. He said he could recommend me to other fund managers he knows or offer me a part time stock picking job. He also asked me to send him my current portfolio and stock recommendation and exchange ideas. I was very moved by his genuine will to help me. I told him I can wait until something opens up. If Warren Buffett can wait a few years to work for Ben Graham, I can do it too.

Then we talked about China, U.S Presidential Campaign, and how immigrants built 40% of the Fortune 500 companies. It was such a pleasure. After a while he showed me the gym where he has 2 shower rooms and a Yoga video course and various other equipment. One equipment I found particularly interesting is a machine that you use to hang upside down. It helps your blood circulate to your upper body since now your head is down and your feet are up.

At around 2:45, he said he needed to call his wife and told me he will have me come back to Austin again in the near future and have me meet everyone else that I didn't get to meet today. I will also get to spend the day and get to see the "whole system". In the end, he pulled out 3 books, maybe his favorite books and gave them to me and told me to read them and think about the content of those books.

When Arnold realized that my friend will not be picking me up until 45 minutes later, he offered to take a walk with me. We talked about everything from finding the purpose of life and finding what you like, to start visualizing my goals. I told myself I will do whatever I can to work for him. I noticed that I have subconsciously started visualizing myself working for CM in the near future. Make it happen!