How I try to put Value investing principals into a Growth Investing market.
All the following views and opinions are mine. At times I will be using Aurora and Aphria NON BIASEDLY as those are the two I follow most closely. All of these metrics can be found in various books and writings (google), I have put my own spin on them and thus far it is working out. Although frustrating at times.
I was asked today about an opinion on How I perceive Value plays in Emerging Industries. My response is this, and it starts with, I don't Know
This is the first time I've tried. But this is whats working for me so far.
Its fairly obvious Cannabis investing is a high growth industry. Ive seen some claims that the growth is over, and operations like Canopy, Aurora and Aphria, Hydropothecary and others can not 10X from today's values. I disagree with that
. There's a very large unknown market out there globally, And if the companies play their cards right, They will be able to outright own facilities and distribution in other countries.
The other countries want proven business history, compliance in current jurisdictions, and in-country jobs for their own citizens. Our Canadian companies CAN provide that. In my line of work, We send Management to Australia, Poland, Germany and next year I'm hearing New Zealand to oversee projects. OUR
Canadian management to Oversee THEIR
countries workers. Eventually, our Canadian people come home, but the Asset in that country is still Canadian owned, and employing their workers from the bottom up. That's not new. And its not isolated to my industry by any stretch. Does Coca-Cola not receive revenues from Australia sales? Does General Motors not own factories in Europe?
Lets look at the Characteristics actual Analysts use to compare companies in a space (Peer Comparison). We'll start with Growth Investing
. You can get as deep into this as you want, there is plenty of free and paid content out there. I would suggest researching the analysts and their past pics before committing to following them. And I would highly suggest researching any “outfits” and their past pics, before following their advice.
Great growth stocks have 6 main characteristics to look for. Mass Market Potential.
You want a company that will have a large customer base. Something largely untouched or serviced privately until now. Market Dominance
A growth company needs to be able to handle the mass market, empty shelves don't produce revenue. This also crosses into my last post on Future Capacity vs Time Lines. Accelerated Earnings Growth
A company with stagnant or reversing revenues is not growing. We want Accelerated
Net earnings (even if negative) should be growing faster than OPEX. This can be offset via a large expense such as an acquisition (MedReleaf) or Expansion (Extraction Center of Excellence) This is somewhat where EBITDA can help, as it backs out these one time expenses and shows the Core Operations of the company. Essentially, Earnings should be growing faster than Operations Expenses. Triple Digit Revenue Growth
YoY gross revenue should be growing 100% plus! YoY measures are better in this metric, as Hiccups (Wind Storms) and set backs (Construction Delays) can affect a company's QoQ revenues, retard their projections and momentarily inflate expenses. High Profit Margins
We're talking about economies of scale here after all. Even with Negative EBITDA, Negative NET earnings, or Negative EPS (All of which should be trending towards positive every Q preferably) a Low profit margin now, is a low profit margin later As a general rule
There are always exceptions. Perhaps the Margin will improve given the completion of an Asset, Perhaps the Margins will improve given an Acquisition. These are all factors you need to apply to your analysis. Whats coming down the pipes, When is it coming, And how will it affect the current status quo of Company X.
And the Last, and arguably most important one. Management
If you don't trust the management, Don't invest. I might have a different Idea of whats trustworthy than you. Perhaps I don't like the relations, and you see a different angle. That's OK. As one analyst I watched recently has put it, Our discrepancies in Value create Buyers and Sellers
. I'll add, Our differences are what Drive the market, and if that ever changes, The market will die. If we all valued everything the same, and we all held the same values for management, assets, and futures how would we ever sell for a profit or buy at a discount.
Now, How do I apply this to a peer set?
- Mass Market. Cannabis, Enough said. If you're here, you're company ticks this box.
- Market Dominance. Its not about whats in the vault now, Its what will they produce next year, and what distribution ability to they have. 2019 I feel will be a big fake out year. There are limited products, Limited quantities, and Limited store fronts thus far. 2019 I think will be more volatile than the last 3 years. At the end of 2020, Company A has 10KG/s monthly, Company B has 9KG's Company C has 14Kg's. All different than current production. Rank them. 1 thru 5
- Accelerated Earnings. I think with the exception of a few unlicensed or recently licensed LP's, Every one I've looked at ticks this box. So to get a market value, you compare to their peers. How does Company A's earnings growth compare to B, C and D. Now you can rank. 1 thru 5
- Triple Digit Revenue Growth. Self explaining. Year over Year, should be over 100%. Again, compare to peers. If all peers are under 100%, then that's what you get. I'm pretty sure every company here with sales however is above that (or will be next year). Ill let you judge your own portfolio. Rank, 1 thru 5
- Profit Margins. Low margins now = Low margins later. With some notable exceptions but that's part of the risk. Can the company deliver on their promises, on time, and on budget. If they promised 70% margin after such and such date, why did it not happen (or did it). If its a construction delay, Why. If the project was completed, and margins only hit 50%, why. Ramp up to production? Unforeseen expense? All these answers should be easily attainable in the MD&A or Financials. TRANSPARENCY MATTERS.
- Management. Look, We can all point at every CEO or COO here and find some demons. So ill leave you with this. Henry Ford almost ran his company into the ground, twice! For not listening to his investors, Board members or even his own Son. Stubbornness nearly killed Ford Motors. And look, Ford is still around. No thanks to the founder, But that's another story for another Sub. Walt Disney fought harder than most for his dreams. Refusing to sellout, even while his friends, co-workers and peers begged him to. Who just bought the star-wars franchise? And there’s Steve Jobs. Thanks to Ashton Kutcher we have a good idea how that panned out. Sometimes the Board is wrong. Sometimes the CEO is not a good fit for CEO, but is needed for the company to succeed. This is observational, bias, and history dependent. We will all have different views. What matters to me is Ability to navigate in the global sector. Rank, 1 thru 5
The object here is to find the company with the lowest number. Add up your ranks, and you'll get your order based on this. Ok, Thats a very basic Growth Investment Characteristic guide.
So how do I add Value characteristics to this? First lets define Value Investing. It is the art of finding a company being mistreated, or ignored in the market place. Value investing requires patience, diligence, and above all, future ROI. You need to determine WHY the company is being blackballed. Bad Management? Recent miss on financials? Unforeseen however detrimental incident? Lack of PR? It Doesn't matter. What matters is recovery potential and past/ongoing execution. Is this a one time event or does the company/management have a history of missing targets? Deadlines Matter, Promises matter, Excuses are shit spewed in hopes of forgiveness, Reasons are provided before an event happens or before the public finds out through other means. I’ll even go so far as to breakdown Deals, How much was paid and what was Gained. Company A paying $50 for something Company B built for $15, there could be an issue there. Company B might have been a better sniper, OR, maybe they've missed something Company A saw in the acquisition. Be MORE CRITICAL of your OWN holdings than you are of OTHERS. YOUR holdings affect YOUR future. MINE do not.
There are 7 criteria for Basic Value Investing. Benjamin Graham Style.
The first one we will ignore, as it requires heavy analyst coverage in a mature market. Ratings. Benjamin Graham recommended using Standard&Poor’s rating system and required companies to have an S&P Earnings and Dividend Rating of B or better
Obviously we wont get that with our companies. The dividend is to compensate you for your paitience while you wait for the market to self correct, or realize the value you've found in the company. If your equity value isn't appreciating, at the very least you can collect a dividend while you wait.
Most of our companies don't have any traditional Debt, Some do have credit facilities. Of all the ones I've calculated, All score less than 1.10. So I replaced this metric with Future capacity Vs Time to Sales. If company A says 8,400Kg Monthly by February, and company B says 20,000Kg by June, Company A may see a better reporting period than Company B. BUT Company B might not even have the cash on hand to make it to their Sales timeline. The valuation could already have those sales Baked In. That's why we Value against Peers. How does the market currently value the company. Is there room for appreciation.This is very tricky to do in this environment and is yet to be proven. Remember, Lying to yourself is lying to your portfolio. Stocks don't love you, So don't love them back.
- Total Debt to Current Asset ratios of less than 1.10.
This can be applied to our companies. For instance, Last reporting period I had Aphria at 6.26, trending down due to their Liabilities growing (Their Assets were also grown, However Liabilities are growing faster). I had Aurora at 2.91, Also trending down for the same reasons. Both these companies have growing Liabilities. Both these companies have growing Assets. On its own, its a shit metric, When used in conjunction with other means, It can provide Value to your thesis.
- Current Ratio (current assets divided by current liabilities) to find companies with ratios over 1.50.
Well this wont be viable in our current market. So I look for EPS Trend lines. If overall trend is towards the positive, minus maybe one Q (always find out WHY it was bad, Reason or Excuse),
- Find companies with positive earnings per share growth during the past five years with no earnings deficits
This is Share price divided by Earnings per Share. All these companies are trading at Insane Multiples. And their Share prices fluctuate wildly. So I range it. Basically, I Shoot it in the dark some-wheres around where the SP has been hanging. In fact, On my spread sheets, I can plug the current price in and it will automatically calculate based on the last EPS. I also follow the EPS Fully Diluted, looking for......TRENDS!
- Invest in companies with price to earnings per share (P/E) ratios of 9.0 or less
Last reporting period, Aphria posted $0.08 in their Fins, I came to $0.07 and currently as of today's close and and YR eng EPS, I have Aphria at a multiple 58.2, but I rounded down the third decimal point. Aurora posted $0.02 where I came out with $0.01, and Todays close with last Q's EPS I have them at a multiple of 342. Again I round down. (I'm always skeptical) 1 to 1 in this current market, EPS isnt a great metric for comparison however P/E is an ongowing metric in ANY industry. Most Napkin math is PE of 15 to 25 ;) .
All the companies are in different stages of growth using different strategy and deploying capital, and resources in different ways with different share counts. What I look for is Trend. Is the EPS trending Up? Down? Sporadic? Why. If Revenue is growing faster than OPEX and SBC, than EPS should reflect that. This is Net Income divided by Share Count. I prefer to use Fully Diluted, because I like to keep an eye on Share Based Compensation. In all my spreads I keep a running Talley on SBC, as it vests, as it is exercised or cancelled, and as it is given out. If SBC is outpacing Revenue, it can hide among other improving OPEX figures. This is why I focus on Trends and “Common Financials” (That is comparing EVERY expense as a % of revenue).
P/E ratios (the previous point) can be misleading. Looking at the most recent Price divided by the Book value per share can shine light on other misleading metrics. Companies with a share price lower than their Book Value is a simple value play. Now, In this current market, That's few and far betweenn if any, Any of you can calculate this. A simple google search will get started. Do it for any company in your portfolio. This metric on its own as any of them, doesn't tell the full story.
- price to book value (P/BV) ratios less than 1.20.
I'm Plagiarizing Cabot Wealth here. Invest in companies that are currently paying dividends. Investing in undervalued companies requires waiting for other investors to discover the bargains you have already found. Sometimes your wait period will be long and tedious, but if the company pays a decent dividend, you can sit back and collect dividends while you wait patiently for your stock to go from undervalued to overvalued.
Unfortunately, non of my cannabis holdings pay dividends.
Its not easy, It takes time. But investing is a Job. Part time, Full Time, Some of the Time. You get out what you put in. You will get lucky, You will get beat. But you CAN improve your chances for success. Be honest with yourself. If your after Quick Gains, You'll be after different companies than Me and most likely look for different metrics.
I look forward to civilized discussion, lets all make money together.
Edited for a calculation error. When building your own spread sheets, try to catch these things before posting to a public forum.