For Q1 2023, my stock picking portfolio was up 7.9%. The Q1 starting balance was $75,407.31, and finished the quarter at $84,519.57. Contributions to the portfolio during the quarter amounted to $5,092.
Portfolio Composition
The current allocation of the portfolio is shown in the chart below. Currently, the portfolio consists of 19 stocks. The top five largest positions are British American Tobacco, Emerson Electric, Omnicom Group, Alico, and Bank OZK Preferred.
Current Holdings
My portfolio generally consists of two types of stocks. The first is quality companies that I believe are facing a negative setback in which the market has over-reacted to. I will typically perform more due diligence on these companies, and size the position around 10% of the portfolio at purchase.
The other stocks I hold could be trading at a low valuation multiple, be a net-net, special situation, etc. I usually do less due diligence on these companies, and hold them for shorter periods of time. Accordingly, I take a basket approach where each individual stock makes up 2-5% of the portfolio.
Currently, British American Tobacco (BTI) is one of my largest stock holdings, a stock that I have owned since 2021. BTI is the largest tobacco company by sales, selling traditional tobacco products but also innovating in smokeless nicotine products. Tobacco stocks have been out of favor the past couple of years, with lackluster share prices. This depressed share price, and BTIs 7.5% dividend yield begs the question as to whether the company is currently trading below intrinsic value. In this post I will do a rough valuation of British American Tobacco in order to see if the stock is a bargain.
The first place I am going to start with valuing BTI is approximating their normalized operating earnings. Over the past 5 years, British American Tobacco has produced around $12B in operating earnings. This is slightly less than the 2022 figure of $12.6B, so I will use the more conservative figure of $12B.
BTI usually pays around a 25% tax rate. Applying this rate to the estimated operating earnings produces an after tax earnings of $9B.
Next, I capitalize the estimated after tax earnings to produce an enterprise value. Typically I estimate a cost of capital based on historical P/E ratios, and also factor in the size and quality of the business. In recent years, BTI has been trading at a fairly low multiple. Prior to the large acquisition they made in 2017, British American Tobacco was regularly trading over 25 times earnings. Currently the company has an $80B market cap, which makes it a large cap. The high margins and large amount of cash produced by the company suggests some quality. On the flip side, tobacco companies are in favor with investors, which could produce higher cost of capital. For this analysis, I will use a discount rate of 6.7%. Capitalizing the $9B in after-tax earnings using this rate produces an enterprise value of $134B.
In order to convert the enterprise value into an equity valuation, the long term debt is subtracted from the EV, and the cash balance is added back. BTI has about $46.5B in debt, and about $4.1B in cash. This produces an estimated fair value market capitalization of $91.6B.
Dividing the fair value market cap by the 2,267M shares outstanding, we arrive at a fair value stock price around $40. The current market price is around $35, indicating that BTI may be slightly undervalued. One thing that is in British American Tobacco’s favor is that they have historically paid out most of their cash flow out as dividends. Currently the stock has quite a large dividend yield, over 7.5%. Perhaps if investors bid up the stock to produce a more normal dividend yield, the stock would be worth more than my $40 estimate.
In this Capital Allocation Snapshot I am looking at Investors Title Company, a small insurer with a market cap around $300M. Investors Title (ITIC) provides title insurance for real estate transactions. I am interested in this business because it is a niche insurer, and it seems to be a quality microcap stock. As with any company that I am interested in, I seek to understand their capital allocation. In this post I will look at Investors Title cash flow statement to get a high-level overview of how they allocate their capital.
Cash Flow Summary
The first thing I like to do is look at 5 years of cash flow data to get an idea of where Investors Title is spending their money. The first line item is cash from operations. This figure decreased a bit from 2018 to 2019, bottoming around $21M. Over the next two years, the operating cash flow dramatically increased, peaking at $52M in 2021. Subsequently, 2022 showed ITIC producing less cash flow, but still more than 2020. Since Investors Title is dependent on the housing market, it makes sense that cash flows peaked in 2021 when there was a boom in house sales, then the housing market cooled off in 2022 with interest rates ticking up.
Next is ITICs cash from investing. Four of the last five years showed spending of cash on investments. Investors Title had the highest year of investment spending in 2022 with almost $29M going towards investments.
ITIC has only had outflows of cash for financing items during the last five years. Cash from financing was the highest during 2020-21, peaking at $37.5M, then largely falling off last year.
Finally, Investors Title has a wide range in the net change of cash. The reduction in the cash balances in 2018 and 2022 were pretty modest, with 2020 showing a fairly large decrease of $12M. Investors Title had a large gain in cash during 2021, a decent gain in 2019. Overall, ITICs cash balance has increased over the five year period.
Cash from Investing
Looking deeper into Investors Title cash from investing, we see that capital expenditure nearly tripled from 2018 to 2022. Compared to ITICs operating cash flow, the capex spend does not indicate that the company is capital intensive, which makes sense as an insurer. It would be interesting to investigate why ITIC has increased capital expenditures so much recently.
The next line item is Investors Title change in investments. ITIC has a securities portfolio that includes short term investments, bonds, and equities. Each year portions of this portfolio get sold and new investments get bought. Modest net proceeds from selling securities occurred in 2019 and 2021. Investors Title deployed a sizable portion of their cash into investments during 2020 and 2022. Compared to the operating cash flow, 2020 saw 33% of cash going into investments while 2022 saw this figure increase to 50%. Further analysis should be done to see what kinds of gains or losses ITIC is generated from their securities portfolio.
In 2022, ITIC acquired a subsidiary for $5M, but I can’t find any details from press releases or their latest 10k. Since Investors Title is nearly a $300M company, the acquisition is very small. From the five year data, it is clear that ITIC is not much of an acquirer of businesses.
The figures in the other category is quite small so they do not impact ITICs cash from investing too much.
Cash from Financing
The last, and sometimes most important section, of the cash flow statement with regards to capital allocation is the cash from financing. Investors Title has barely spent any cash repurchasing stock, these figures probably offset stock based compensation.
The meat of ITICs cash from financing is the dividends. The dividends paid vary from year to year, and I have observed that ITIC often pays special dividends at the end of the year. The largest dividend payout was $37.5M in 2021, followed by nearly $32M in 2020. Last year saw $9M being paid, far lower than any other year over the past five years. From 2018 to 2020, ITIC nearly paid out all operating cash flow as dividends. The boon year in 2021 saw the company return the peak amount of cash to shareholders, but it was “only” 72% of operating cash flow. The paltry dividend payout in 2022 can be compared to the large use of cash towards investments that year.
One thing missing from Investors Title cash from financing is the use issuance or payment of debt. This means the company does not need debt to maintain or grow the business, which is a plus.
Conclusion
Investors Title capital allocation appears to be pretty straightforward. The two main areas where ITIC is allocating their capital is the change of investments, and the dividend. The cash flows to and from the securities book may be due to bonds maturing, so it is possible that large purchases of securities is not really an active capital allocation decision. As for the dividend, ITIC typically pays out a large portion of operating cash flow as dividends. This large dividend payout indicates that Investors Title does not need to retain earnings to grow the business, therefore they can return the cash to shareholders.
Charter Communications provides cable TV and broadband internet services. The company’s stock price peaked in 2021, and has slid down around 50% since then. I am aware that Charter does a lot of stock buybacks, so I thought they may have an interesting capital allocation policy. With that, let’s jump in to get a high level overview of Charter’s capital allocation.
Cash Flow Summary
In these capital allocation snapshots, I like to look at 5 years of cash flow data to get an idea of where the company is spending their money. Looking at Charter’s cash from operations, we see a steady increase from 2018 to 2021, then a moderation in 2022. I am not super familiar with the cable industry, but I believe they benefit in a strong housing market because people shop around for cable when they move. Therefore as the housing market cooled in 2022 from higher interest rates, it seems reasonable that operating cash flows would decrease.
CHTRs cash from investing is fairly consistent, ranging between $7-10B. These outlays of cash for investing takes up a large portion of the company’s cash from operations. Cash from financing varies more, with Charter spending less cash in 2018-19, and ramping up spend over the past 3 years. Even though the cash from operations was a bit higher in 2022 than 2022, the cash from financing is quite a bit lower.
The figures in Charter’s net change in cash basically cancel each other out, meaning Charter’s cash balance has not changed much over the last 5 years.
Cash from Investing
Charter’s main line item on the cash from investing is capital expenditures. This figure has hovered between $7-9B over the last 5 years. These capex figures range between 50% and 75% of operating cash flow. With such a high percentage of cash from operations going towards capex, CHTR seems to be a capital intensive business. This seems to make sense, it probably costs a lot of money to maintain and expand cable and fiber networks. A deeper analysis would try to figure out what portion of the capex is for maintenance vs growth.
The rest of the cash from investing line items are pretty negligible. I tried to skim Charter’s 10K to see what “other” consisted of, but I did not see where they break it out.
Cash from Financing
Charter’s cash from financing shows debt being added to the books each year over the last 5 years. The largest increase in debt was in 2021. Currently, CHTRs long term debt stands at 96B, so 2021s increase was nearly 10% of their current debt level.
Looking at Charter’s 2022 D/E ratio shows a figure of 10.5, and their D/EBITDA is at 4.6. The debt-to-equity is very high, but probably makes some sense because CHTR is reducing equity with buybacks. The D/EBITDA is high, but not unusual for a that seemingly has strong cash flows. As a reference, 2018 D/E was 1.9 and D/EBITDA was 4.5, so the former has largely increased while the latter has stayed flat.
The next major line item on Charter’s cash from financing are the stock buybacks. The company has ramped up buybacks from 2018. The peak in buybacks was in 2021, with a pullback in 2022. In order to put these buybacks in perspective, the company currently has a market capitalization around $60B (although it was about twice as high in the peak of 2021). These are large percentages of the company’s equity that is being repurchased. From 2020-22, the buybacks were over 80% of the cash from operations, and was over 100% in 2021.
The amount of cash Charter paid for dividends is tiny. I do not think CHTR pays a common dividend, so these dividend payments are probably to some preferred stock.
Conclusion
Charter’s cash flows are pretty straight forward since only a few line items make up the bulk of where the cash is going. The company spends a large amount on its cable/fiber infrastructure. This high capex could be beneficial if it is for growth projects that provide an attractive return on investment, or this capex could be a negative if it is mostly used for maintenance. More research would need to be done. Charter also has been adding quite a bit of debt over the last 5 years. Since the large capex and share buybacks surpass the amount CHTR receives from its operations, the debt is being used to fill the shortfall. The strategy of issuing debt to repurchase shares can be powerful when interest rates are low like they have been. It will be interesting to see if Charter can maintain this strategy if interest rates stay below the levels seen over the past decade.
Southwest Airlines has recently been caught up in a software debacle that canceled thousands of flights during the holiday season. The stock price has been quite beat up even before the bad press, with the stock peaking around $64 in 2021, then sliding down to a low of $30 during the worst of the market downturn in 2022. Since I like finding stocks that have been beat up from bad news, I decided to do a quick earnings power valuation of Southwest.
Looking at Southwest’s top line from 2019-2022 shows figures of $22.4B, $9B, $15.8B, and 23.8B respectively. Obviously revenue was impacted during 2020 due to Covid, and still did not fully recover in 2021. Removing these outlier years, we can estimate Southwest’s go forward revenue at $23B.
Southwest’s operating margins vary, especially during outlier years 2020 and 2021. A reasonable estimate of operating margins seems to be 15%. Applying this margin to the estimated revenue produces an approximate operating earnings of $3.45B.
The income tax rate the LUV pays also varies quite a bit. For this analysis I will use a 25% tax rate. This tax rate turns our operating earnings into $2.6B of after tax earnings.
Next, I capitalize the estimated after tax earnings to produce an enterprise value. First I look at Southwest’s historical P/E ratio, which ranges between 10-16, with a few outlier years. While Southwest is known to be a quality airline, the airline industry is not known for having the qualities of a high quality business. Therefore I think Southwest should have a discount rate a tad higher than quality large cap companies. For my analysis I will use a 7% discount rate, which produces a $37B enterprise value.
In order to convert the enterprise value into an equity valuation, the long term debt is subtracted from the EV, and the cash balance is added back. LUV has about $9.5B in debt, and about $10.5B in cash. This produces an estimated fair value market capitalization of $38B.
Dividing the fair value market cap by the 593M shares outstanding, we arrive at a fair value stock price of $64. As I mentioned earlier, Southwest currently trades for around $37. This appears to be quite the discount to fair value. Just for some context, LUV traded above $60 a share pre-pandemic and for a brief time in 2021.
It appears the recent scandal has made Southwest’s shares look pretty attractive. One problem with this valuation is that it is potentially based on cyclical peak earnings. If a recession happens in 2023, Southwest’s revenue may take a beating. However, travel seems to be on a secular uptrend, so perhaps LUV would bounce back quickly. Either way, I think the company is worth doing a deeper dive on.
In this post, I want to take a look at Alico, a small orange grove that has an interesting approach to capital allocation. Alico currently has about a $205M market capitalization. The company owns orange groves, and also ranch land in central Florida. In order to get a high level overview of Alico’s capital allocation, I am going to focus on their cash flow statement to see where the cash is coming and going.
Cash Flow Summary
Starting at the top of Alico’s cash flow statement is their cash from operations. This figure varies quite wildly. The cash flows from 2018 and 2021 are probably normal, with 2019 seemingly abnormally high, and 2020 and 2022 below average. Looking deeper, it appears Alico had a large increase in revenue from 2018 to 2019, which explains the high operating cash flow in the data shown (and 2019 revenue was similar to 2017 FWIW). The reason for the lower cash flow in 2022 was due to frost and a hurricane damaging Alico’s orange crop. Ideally the cash from operations would be a bit more smooth.
Alico’s cash spent on investments also varies quite a bit. As we will see later, ALCO has been selling off some of their land which causes the big swings in cash from investing.
Cash outflows for financing were slightly more steady than the previous cash flow categories. Alico spent the most in financing in 2019 at $52.29M. The two years of 2018 and 2020 had about the spend on financing, while 2021 and 2022 were close in figures.
With the big swings in Alico’s cash flows, it shouldn’t be a surprise that their net change in cash also varied over the past several years. Last year, ALCO practically broke even. The company had the largest boost in cash in 2018 with $28.86M, and drew down their cash balance the most in 2021 at $18.8M.
Cash from Investing
After seeing Alico’s use of cash at a high level, we can now dive deeper to see why their cash flows vary so much and get a glimpse of how they are allocating capital. Alico’s capital allocation spend has been slowly growing over the past years, except it declined a bit in 2022. If we take an average of ALCOs 5 year cash from operations, about $18M, and compare it to their average capex, we see that most of the operating cash flow is going into capex. This high proportion of capex to operating cash flows would seem to indicate the company is capital intensive.
Alico’s acquisition of business, or in this case acquisition of orange groves, was fairly small the last several years. However, the company did do a large acquisition in 2021 amounting to about a full year’s worth of operating cash flow.
Despite Alico making some purchases of orange groves, they have been quite the seller of property. About ⅔ of ALCOs land is the orange groves, but they do own quite a bit of ranch land. It seems the ranch land is primarily what the company is selling. Alico’s selling of the land is an interesting capital allocation decision, which is what caught my eye with the company. While 2019 was a lull, the company has been selling around $35M a year of property. This is about twice as much as their average operating cash flow.
As we can see, the swings in Alico’s cash from financing is mostly due to their sale of varying amounts of land and the large acquisition in 2021. Next we can look to the cash for financing to see how Alico is using the proceeds of these property sales.
Cash from Financing
Now to look at Alico’s use of cash for financing. Alico has been consistently paying down debt over the past 5 years, peaking in 2021 with about $25M. I believe the land that Alico is selling is encumbered with debt, so they are using the proceeds to pay off the principal.
Currently Alico’s D/E ratio is about 0.42, which suggests the company is not very leveraged. Looking at ACLOs D/EBITDA, the figure is about 3.2, which is slightly high. However the company’s 2022 EBITDA was affected by the frost and hurricane.
As for share buybacks, Alico has not done much except for 2019. The buyback in 2019 is more than the company’s 5 year average operating cash flow. It would be interesting to look at Alico’s valuation during 2019 to see if this large repurchase was actually beneficial to shareholders.
Alico has been consistently paying a dividend, dramatically ramping up the payout in 2021 and 2022. These increased payouts are probably due to the land sales. I think selling land and returning some of the proceeds is an interesting capital allocation strategy. If Alico can maintain selling land and paying large dividends, then the stock could be worth some consideration.
In 2019, the company had an $11M charge for “payment on termination of sugarcane agreement”. I am not sure what that is, but it seems like a one time charge.
Conclusion
Alico is a small company with pretty inconsistent operating results. However, their strategy of selling off ranch land and returning some of the cash to shareholders is an interesting capital allocation move. It is also interesting that Alico made a decently large acquisition of orange groves in 2021. Going beyond this snapshot, I would look further back in Alico’s financials to get a better understanding of their operating cash flows. Also I would try to estimate a sustainable dividend payout in case the company had to put a pause on selling land.
For Q4 2022, the multi-asset portfolio was up 8.3%, yet down 10.8% over the full year. The Q4 starting balance was $160,358.87, and finished the quarter at $181,597.13. Contributions to the portfolio during the quarter amounted to 7,083.
As for the portfolio of individual stocks, the Q4 starting balance was $77,297.12, with an ending balance of $86,299.07. Over the quarter, there were no additions of cash into this portfolio. Performance for the stock-only portfolio was up 11.7% for Q4, and down 4.5% for the year.
Two stocks were purchased this quarter: Advanced Emission Solutions (ADES), and EMCORE (EMKR). The Sprott Physical Gold Trust (PHYS) was also added to the precious metals section of the portfolio. Several deep value stocks were sold this quarter: MI Homes (MHO), Boise Cascade (BCC), Seneca Foods (SENEA), Gray Television (GTN), and Koppers Holdings (KOP). The rolling over of tail hedge put options continued.
The current allocation of the portfolio is shown in the chart below. Currently, the portfolio consists of discretionary value stocks, oil tankers, deep value, 401k stocks, precious metals, and cash. It can be seen that 80.9% of the portfolio is in stocks, while 19.1% is in cash and safe haven assets.
Year in Review
This year has been the most difficult year to invest in since I started buying individual stocks in 2017. The year was not so bad because of the portfolio returns, I expect some down years worse than my performance this year. Instead, the year was frustrating because inflation was elevated, so I felt like I urgently needed to put cash to work, yet I was not finding many bargain priced stocks. Sure, the major stock indices and bonds were down quite a bit this year, and speculative junk crashed, but many quality stocks were unphased. This contrasts to March 2020, where the panic was creating a once in a blue moon buying opportunity.
Another point of frustration was the slow downward grind of the market. The SPY put options I buy as my tail hedging strategy do well during market panic, which by proxy is associated with a high level in the VIX volatility index. Since there was little panic in 2021, the VIX did not reach high levels. While the tail hedging paid off mightily in 2020, it was a drag on performance throughout 2022. Despite money burned through tail hedging, I still find the strategy appealing to provide some anit-fragility to the portfolio.
Returning to the topic of bargain priced stocks, even though I did not feel like there were many undervalued stocks worth purchasing, there were many stocks that appeared cheap. During the year, there were plenty of stocks trading at earnings multiples below 10, even several large companies trading below 5x earnings. The problem is that I am not too confident these stocks are actually cheap. The vast majority of the low earnings multiple stocks were cyclical/commodity based companies in industries such as mining, steel, fertilizer, basic chemicals, poultry, homebuilding, paper products, etc. These commodity stocks have had huge run up in earnings due to inflation and supply/demand being out of whack due to COVID. Looking at years prior to COVID, these companies had much lower earnings, and often had unprofitable years. To add a cherry on top, many of the commodity companies were trading at all time high stock prices during 2022.
It is possible that we are in a period of sustained inflation and a long term commodity bull market. However, I feel like this is more of a macroeconomic call than a story of undervalued businesses. Inflation could persist for years, or we have a recession this year that would crush all these cyclical commodity stocks. I have no idea, so I do not want to load up my portfolio with these types of companies (that being said, I do own a chemical company and some other cyclical companies, so I’m not completely missing the party).
To me, value investing is about finding companies where the stock price is beat up due factors such as the industry being out of favor, the business missed short term expectations but has solid future earning prospects, or perhaps some kind of scandal that will not dramatically affect the business. At a high level, valuing businesses usually takes the form of estimating the value of the assets, or a reasonable future earnings power. I think it is more prudent to look at a normalized 5 year earnings figure when determining value, than to give weight to current earnings that are several times higher than average. We shall see if my prudence works out or if I will regret not loading up on cyclical commodity businesses during 2023.
Discretionary Summary
Discretionary value is the label I’m giving to the positions that are fairly large (~5% of the portfolio) I believe are undervalued and may have the following characteristics: quality business, competitive advantage, misunderstood by the market, or a good company in a heavily sold off industry. The current discretionary value stocks I own consist of Capital One Financial (COF), Emerson Electric (EMR), Simon Property Group (SPG), British American Tobacco (BTI), Qurate Retail (QRTEA), and Warner Bros Discovery (WBD). The table below shows the cost basis, current value, and gains/losses for these positions.
Avg Price
Cost Basis
Current Value
Current Gain (Loss)
COF
63.25
3,478.75
5,112.80
46.97%
EMR
41.00
3,485.00
8,165.10
134.29%
SPG
74.50
3,427.00
5,404.08
57.69%
BTI
37.45
7,114.91
7,596.20
6.76%
QRTEA
7.60
5,700.00
1,222.00
-78.56%
WBD
24.50
4,957.00
2,085.60
-57.93%
Most of my discretionary value picks have been humming along this year without any major news. Emerson Electric did recently announce that they were selling a majority stake of their HVAC business to Blackstone. The deal values the HVAC unit at $14B and Emerson will initially receive $9.5B for their stake. The Emerson management stated they want to focus on the higher growth automation side of their business. Between this deal, and the recent AspenTech deal, Emerson is making some big capital allocation moves. I will have to spend some time reviewing my position in Emerson with these big changes happening at the company.
Qurate Retail has been my worst investing mistake so far, with the share price constantly grinding lower not long after I made my purchase. What drew me to the business was the qualitative aspect. Qurate is the holding company for QVC and HSN shopping channels, which are popular with older women. These channels provide entertainment in a way that e-commerce does not provide, with a demographic that may be more resilient to switching to online shopping. Additionally I was lured in by the siren call of Qurate’s large special dividend.
Not long after I bought Qurate, a fire destroyed one of their distribution centers. Supply chain issues also affected the company late 2021 and through 2022. For example, Qurate was unable to have the right product mix during the 2021 holiday season, lacking consumer electronics which typically drives sales during that season. Supply chain issues and management missteps seemed to have mucked up QVC’s “daily special value” segment that draws in customers.
Despite the issues within Qurate’s control, and beyond their control, I still held onto a stock that declined 80%. I should have focused more on the company’s financials and performed a more rigorous valuation of the company before my purchase. A big reason why QRTEA stock declined so much is the high debt load. A small decline in sales can crush a heavily indebted business. I typically shy away from companies with high debt unless they have a history of steady cash flow. So with Qurate, I learned a lesson that I already knew.
Warner Bros Discovery is also a sore spot in my portfolio. Originally I owned Discovery ahead of their merger with Warner Bros, which was spun out from AT&T. I believed Discovery was undervalued due to the uncertainty of the merger, and I thought the merger would provide an opportunity as a special situation. Discovery produces cheap, but popular content should pair well with the quality content from HBO and other parts of the Warner Bros library. Once the merger gets sorted out, I think WBD can be a top tier streaming service.
The problem is that the restructuring costs from the merger are high, content is expensive, and the merger occurred right during a slump in advertising revenue. WBD also has a lot of debt from the merger, but luckily it is at low interest rates and pretty distant maturities. While it is frustrating that the stock has not performed well so far, I think if they can reduce costs and put up a mediocre level of EBITDA in 2023, then the stock will be on solid ground to revert back to a market multiple.
Deep Value
Deep value is a sub-strategy I’m employing in my portfolio. This is a quantitative strategy that buys a basket of statistically cheap stocks. The metric I use is EV/EBIT, based on the wonderful book The Acquirers Multiple. Historically, this strategy has provided excellent returns, although it has not kept up with the S&P 500 the past few years. Additionally, I am making an effort to apply this strategy to microcap companies. Microcaps are classified as having a market capitalization between $50M-300M. These small companies are more volatile, but have the potential for attractive returns.
My position sizing is smaller than the discretionary side of my portfolio because I want to own a basket of about 20 stocks. Since this is a quantitative strategy, I do not spend much time analyzing these businesses. The main idea is that these companies are trading at very cheap valuations, and the winners will (hopefully) outnumber the losers.
The new additions to this part of the portfolio were EMCORE (EMKR), and Advanced Emission Systems (ADES).
Avg Price
Cost Basis
Current Value
Current Gain/Loss
EMKR
1.00
2,003.95
1,925.00
-3.94%
WSM
115.00
5,175.00
5,171.40
-0.07%
OMC
65.86
4,610.37
5,709.90
23.85%
BASFY
11.54
4,269.80
4,555.44
6.69%
SMTC
30.00
3,000.00
2,869.00
-4.37%
USNA
58.00
2,900.00
2,660.00
-8.28%
CHTR
360.00
3,600.00
3,391.00
-5.81%
FOSL
3.50
2,975.00
3,663.50
23.14%
ADES
2.75
3,025.00
2,673.00
-11.64%
INTC
30.00
3,000.00
2,643.00
-11.90%
SIX
20.00
3,000.00
3,487.50
16.25%
HXL
36.80
1,803.20
2,883.65
59.92%
Several companies were sold this quarter due to the one year rebalancing of the portfolio. Several of these stocks were sold for a loss, so hopefully the next batch of deep value stocks perform better.
Cost Basis
Sale Proceeds
Realized Gain/Loss
KOP
2,958.18
2,042.56
-31.0%
GTN
3,105.00
2,020.88
-34.9%
SENEA
3,000.00
3,048.52
1.6%
BCC
3,025.00
3,494.65
15.5%
MHO
2,520.00
1,720.32
-31.7%
Tanker Stocks
Oil tanker stocks performed pretty well this year. I will continue to hold them, but if they start to go against me again they will be sold off.
Avg Price
Cost Basis
Current Value
Current Gain/Loss
DHT
8.17
1,755.90
1,909.20
8.73%
TNK
23.86
1,765.88
2,279.94
29.11%
Dividends
During the quarter I received $378.35 total in dividends, which is broken down in the table below.
Ticker
Quarterly Dividend
BTI
120.75
DHT
8.60
EMR
44.20
COF
33.00
SPG
82.80
WSM
35.10
HXL
4.90
OMC
49.00
Total
378.35
401k and Precious Metals
My 401k is through my current employer and actively receives contributions. The 401k consists of a Blackrock Target Date Fund (which is no longer being funded), and the Oakmark Fund. The Oakmark Fund is a large cap value fund. Since I am actively contributing to my 401k, it will naturally have a growing influence on my portfolio.
I also have a decent allocation to precious metals that are used as a bond substitute, recession and inflation hedge. The table below shows the YTD performance for the precious metals and 401k, which includes the effects of contributions.
12/31/21
12/31/22
YTD Gain/Loss
YTD Cont.
Precious Metals
12,854.19
15,091.98
-0.1%
2,100.00
401k
60,578.76
70,943.77
-15.3%
20,466.14
Tail Hedging
This quarter I continued a tail hedging strategy that I have used in the past. The strategy involves buying 30% out of the money SPY put options that expire in a couple of months. Each month options are sold and a new set is bought. This quarter, the options have had a cost of $2,491 and proceeds of $1,116, resulting in a net cost of $1,375. For the full year, the hedging strategy cost $8,261 with proceeds of $3,159, resulting in a net cost of $5,102.
KLA Corp. (KLAC) is an American company that manufactures process control and yield management equipment for the semiconductor industry. It appears the large semiconductor equipment companies have high profit margins, great returns on capital, and barriers to entry. Currently, there seems to be a cyclical downturn in semiconductors in general, so many of the stocks are down quite a bit from their recent highs. Given this background, I want to do a rough valuation on KLA to see whether it is fairly valued or undervalued.
Since I believe KLA has a moat, I will use the growth return valuation method from Bruce Greenwald’s valuation book. With this valuation method, first a sustainable shareholder yield is estimated, then estimated growth rates are added to get expected return from buying the stock.
The first step is to figure out a reasonable steady state revenue. In 2022, KLAC did a record $9,212M in revenue. Since the semiconductor capital equipment industry can be cyclical, I will smooth out KLACs revenue by using a 5 year average. The 5 year average comes out to be $6,108M, which I’ll use for the preceding analysis.
After revenue comes operating margins. KLA has averaged 35% operating margins over the past 5 years. Using these margins, KLA should be able to produce $2,138M in operating earnings based on my estimated go-forward $6,108M revenue figure.
The next step is to get an after tax earnings figure. KLA typically pays an effective tax rate of around 17%. This tax rate applied to the $2,138M in operating earnings produces an after tax earnings of $1,774M.
Now that we have the estimated after tax earnings, we almost have a sustainable shareholder yield. KLAC has 152M shares outstanding, which produces an estimated EPS of $11.67. Looking at past shareholder returns, KLA tends to return most cash back to shareholders. I will estimate that KLAC can sustainably return 70% of their cash flow as dividends and stock buybacks. Applying the 70% to the $11.67 in EPS, we arrive at a distributable earnings of $8.17. With a current share price around $375, KLAC estimated shareholder yield is about 2.2%.
Once we have the estimated shareholder yield, Greenwald adds the estimated returns due to revenue/earnings growth to get the total expected yield of the stock. Revenue growth comes in two forms: organic and through reinvestment.
Thinking about the organic growth rate of the semiconductor equipment industry over the next 10 years, there are many tailwinds with increased semiconductor demand in automotive, cloud compute, Internet of Things, etc. Despite these tailwinds, the semiconductor industry is cyclical, so I want to be a bit conservative with a long term growth estimate. If GDP is usually around 3%, a long term revenue growth rate of 5-7% could be reasonable for the semiconductor equipment industry.
Reinvestment growth occurs when a company reinvests its leftover cash in things such as expanding production, performing research for new product lines, or performing major acquisitions. However if a company is returning a large portion of its cash back to shareholders, then the business is most likely in a mature state. Since KLAC is returning most of its profits back to shareholders, my view is that they are not reinvesting in their business at a large scale. Therefore I will only utilize the organic growth figure when estimating the return in KLAs stock.
Finally we have all the pieces to estimate the long-term returns of KLAC at its current stock price. The estimated shareholder return gives us 2.2%, then we add the growth return of 5-7% producing a total return of 7.2-9.2%. Given these ranges, KLAC seems fairly valued. However, if we re-compute the returns using their current 52 week low of $250 a share, the shareholder yield would be 3.3%, bumping the total return to 8.3-10.3%.
After doing this analysis, I think a decent return could be achieved from buying KLA at the current prices, however as a value investor I would prefer to see it get a bit cheaper. If the stock sells off back around $250 I may consider it. Another point is that my organic growth estimates are quite hand-wavy, so it could be possible that higher returns are realized if revenue growth surpasses my expectations.
Since Berkshire’s recent 13F showed an ownership of Taiwan Semiconductor, it made me want to dig deeper into the company. TSMC is one of the largest integrated circuit fabricators in the world, and one of the few that can mass produce the most cutting edge chips. In this post I will try to get a high level overview of TSMCs capital allocation by studying their use of cash.
Cash Flow Summary
The first place to look in order to get a high level understanding of TSMCs capital allocation is to look at their main uses of cash for the past several years. Cash from operations seemed stable from 2017-2019, but has been growing at a high rate the past few years. The cash from operations in the first 9 months of 2022 is already approximately equal to the 2021 value.
Looking at the operating cash flow numbers, and some of the other line items discussed later, it seems like TSMCs recent results can be split into two regimes: the 2017-2019 period, then the 2020-present that had much higher growth.
Cash spent on investments was initially about 50% of cash from operations, but lately it has grown to about 70%. Clearly investments have been ramping up.
Cash outflows for financing grew modestly and peaked in 2019. Since then, cash from financing has deviated from its norm. As we’ll see later, this is due to TSMC issuing debt that counteracted their dividend payments.
Finally, 2017 and 2018 saw minimal changes in the net cash position of the company. The net change in cash was moderately negative in 2019 due to the increased investments. Since then, TSMC has been building cash from increased operating cash flow and debt issuance.
9 Months 2022
2021
2020
2019
2018
2017
Cash from Operations
38,374
40,200
29,280
20,520
18,670
19,670
Cash from Investing
(29,972)
(30,2300)
(18,000)
(15,310)
(10,220)
(11,300)
Cash from Financing
(4,454)
4,940
(3,150)
(8,990)
(7,970)
(7,250)
Net Change in Cash
7,889
14,630
7,290
(4,080)
794
407
Cash from Investing
The biggest component to TSMCs cash from financing is capital expenditures. Taiwan Semi has been expanding manufacturing capacity by building new fabs. Additionally, the company has to constantly upgrade machinery and existing fabs to handle each new generation of transistor sizes. Capex was consistent in 2017 and 2018, then showed a decent increase in 2019 and 2020. TSMC greatly increased capex spend in 2021, and looks to rival that spend in 2022. A deeper dive would be required to see if TSMC generates high returns from their investments in capital expenditures.
The other main line items in the cash from investing are the purchase and sale of investments. These two line items generally cancel each other out, as if TSMC is rolling over bonds or rebalancing their stock portfolio. However, so far in 2022, Taiwan Semi has purchased more investments than what they have disposed of.
9 Months 2022
2021
2020
2019
2018
2017
Capital Expenditures
(25,470)
(30,330)
(18,050)
(15,360)
(10,270)
(11,110)
Purchase of Investments
(5,900)
(9,367)
(9,509)
(8,622)
(3,230)
(3,500)
Sale of Investments
2,112
9,536
9,510
8,247
2,930
2,950
Cash from Investing
(28,972)
(30,230)
(18,000)
(15,310)
(10,220)
(11,300)
Cash from Financing
Now to look at Taiwan Semiconductor’s use of cash for financing. TSMC was paying off about $1B in debt in 2017 and 2018, then debt payments trickled in 2019. Debt issuance largely increased in 2021, coinciding with the large capex spend. The change in debt so far in 2022 shows a modest increase in debt.
TSMCs long term debt to equity ratio comes in at 0.3, and their D/EBIT is about 0.97. These debt ratios indicate that Taiwan Semi has pretty low amounts of debt, implying that they have not grossly misallocated capital in the past.
As for returning capital to shareholders, TSMC has done practically no share buybacks. Interestingly, they diluted investors a bit by issuing stock in 2021. It would be worth investigating if the proceeds were used fund investments, or something else like stock based compensation.
Instead of buying back stock, Taiwan Semi has been steadily paying dividends. The company has roughly paid dividends that amount to about 30% of operating cash flow. With this modest payout, it seems TSMC is caught between returning capital to shareholders, while also reinvesting in the business.In my opinion, if the company is growing at a high rate, and heavily reinvesting in the business with high incremental returns, they should minimize their dividend payments.
9 Months 2022
2021
2020
2019
2018
2017
Net Change in Debt
2,600
14,440
6,240
(124)
(1,120)
(1,030)
Issuance of Equity
0
341
0
0
0
0
Repurchase of Equity
(30)
(4)
0
(3)
(3)
(4)
Dividend Paid
(7,306)
(9,610)
(9,230)
(8,650)
(6,750)
(6,100)
Cash from Financing
(4,454)
4,940
(3,150)
(8,990)
(7,970)
(7,250)
Conclusion
The main takeaways from this quick analysis is that Taiwan Semiconductor has greatly increased cash from operations over the past few years, while also ramping up capital expenditures. I found it interesting that TSMC focuses solely on dividends to return cash to shareholders, instead of performing buybacks. Some next steps to dig deeper into TSMCs capital allocation is to get a better handle of what their capex spending goes towards, and to take a look at their R&D spend to see if that has been a driver for growth.
For Q3 2022, the multi-asset portfolio was down 5%, and down 18% YTD. The Q3 starting balance was $162,469.10, and finished the quarter at $160,358.87. Contributions to the portfolio during the quarter amounted to $6,546.
As I mentioned last quarter, I want to also report the returns of my stock picking portion of the portfolio. The Q3 starting balance was $72,164.80, with an ending balance of $77,297.12. For the return calculation, I add the proceeds from stock sales to an “internal cash” balance. Dividends received are also debited to this cash balance. Purchases of stocks are subtracted from the internal cash, unless the internal cash is depleted. This triggers a cash flow into the portfolio. Therefore the cash flow for Q3 was $10,604. Putting all of this together means the stock-only portfolio was down 6.7% for Q3, and is down 14.5% YTD.
September saw a flurry of new stock purchases: Intel (INTC), Charter Communications (CHTR), Six Flags Entertainment (SIX), Semtech Corp (SMTC), USANA Health Sciences (USNA), Fossil Group (FOSL). Stocks that were sold this quarter include Frontline (FRO), Scorpio Tankers (STNG), First Energy (FE), and Investors Title Company (ITIC). The rolling over of tail hedge put options continued.
The current allocation of the portfolio is shown in the chart below. Currently, the portfolio consists of discretionary value stocks, oil tankers, deep value, 401k stocks, precious metals, and cash. It can be seen that 87.3% of the portfolio is in stocks, while 12.7% is in cash and safe haven assets.
During the quarter I received $401.28 total in dividends, which is broken down in the table below.
Ticker
Quarterly Dividend
FE
48.75
BTI
124.55
GTN
10.80
BCC
6.60
DHT
8.60
EMR
43.78
COF
33.00
SPG
80.5
WSM
35.10
KOP
4.70
HXL
4.90
Total
401.28
Discretionary Summary
Discretionary value is the label I’m giving to the positions that are fairly large (~5% of the portfolio) I believe are undervalued and may have the following characteristics: quality business, competitive advantage, misunderstood by the market, or a good company in a heavily sold off industry. The current discretionary value stocks I own consist of Capital One Financial (COF), Emerson Electric (EMR), Simon Property Group (SPG), British American Tobacco (BTI), Qurate Retail (QRTEA), and Warner Bros Discovery (WBD). The table below shows the cost basis, current value, and gains/losses for these positions.
Avg Price
Cost Basis
Current Value
Current Gain (Loss)
COF
63.25
3,478.75
5,069.35
45.72%
EMR
41.00
3,485.00
6,223.70
78.59%
SPG
74.50
3,427.00
4,128.50
20.47%
BTI
37.45
7,114.91
6,745.00
-5.20%
QRTEA
7.60
5,700.00
1,507.50
-73.55%
WBD
24.50
4,957.00
2,530.00
-48.96%
COF
63.25
3,478.75
5,069.35
45.72%
This quarter I sold my position in First Energy. The stock has reverted to fair value now that the company is moving past its bribery scandal. I considered holding FE for the long term for its dividends, however I changed my mind. The first factor is that the company is planning large amounts of capex over the next several years, and part of that is planned to be funded by equity issuance. As a long term stockholder, I do not like to see my position diluted by issuing new stock. Secondly, I believe that utilities can pass on higher costs to users, however it is a regulated process that may take a while or not keep up with inflation. If inflation persists, then the lack of pricing power would sour the benefits of owning the stock.
Cost Basis
Sale Proceeds
Realized Gain/Loss
FE
3,500.00
5,124.86
46.4%
Deep Value
Deep value is a sub-strategy I’m employing in my portfolio. This is a quantitative strategy that buys a basket of statistically cheap stocks. The metric I use is EV/EBIT, based on the wonderful book The Acquirers Multiple. Historically, this strategy has provided excellent returns, although it has not kept up with the S&P 500 the past few years. Additionally, I am making an effort to apply this strategy to microcap companies. Microcaps are classified as having a market capitalization between $50M-300M. These small companies are more volatile, but have the potential for attractive returns.
My position sizing is smaller than the discretionary side of my portfolio because I want to own a basket of about 20 stocks. Since this is a quantitative strategy, I do not spend much time analyzing these businesses. The main idea is that these companies are trading at very cheap valuations, and the winners will (hopefully) outnumber the losers.
The new additions to this part of the portfolio were Intel (INTC), Charter Communications (CHTR), Six Flags Entertainment (SIX), Semtech Corp (SMTC), USANA Health Sciences (USNA), and Fossil Group (FOSL).
Avg Price
Cost Basis
Current Value
Current Gain/Loss
BCC
55.00
3,025.00
3,270.30
8.11%
GTN
23.00
3,105.00
1,933.20
-37.74%
HXL
36.80
1,803.20
2,534.28
40.54%
KOP
31.47
2,958.18
1,953.32
-33.97%
MHO
60.00
2,520.00
1,521.66
-39.62%
SENEA
50.00
3,000.00
3,026.40
0.88%
SMTC
30.00
3,000.00
2,941.00
-1.97%
USNA
58.00
2,900.00
2,802.50
-3.36%
CHTR
360.00
3,600.00
3,033.50
-15.74%
FOSL
3.50
2,975.00
2,907.00
-2.29%
Investors Title Company was the only company sold this quarter.
Cost Basis
Sale Proceeds
Realized Gain/Loss
ITIC
1,974.48
1,986.56
0.6%
Tanker Stocks
The tankers are finally breaking even. I will continue to hold them, but if they start to go against me again they will be sold off.
Avg Price
Cost Basis
Current Value
Current Gain (Loss)
DHT
8.17
1,755.90
1,625.40
-7.43%
TNK
23.86
1,765.88
2,037.96
15.41%
After some progress in the share price, Scorpio and Frontline pulled back so I exited my position. In hindsight I sold too early since they have bounced back, oh well.
Cost Basis
Sale Proceeds
Realized Gain/Loss
FRO
1,738.29
1,351.21
-22.2%
STNG
1,742.67
1,992.34
14.3%
401k and Precious Metals
My 401k is through my current employer and actively receives contributions. The 401k consists of a Blackrock Target Date Fund (which is no longer being funded), and the Oakmark Fund. The Oakmark Fund is a large cap value fund. Since I am actively contributing to my 401k, it will naturally have a growing influence on my portfolio.
I also have a decent allocation to precious metals that are used as a bond substitute, recession and inflation hedge. The table below shows the YTD performance for the precious metals and 401k, which includes the effects of contributions.
12/31/21
09/30/22
YTD Gain/Loss
YTD Contributions
Precious Metals
12,854.19
11,173.10
-13.1%
0
401k
60,578.76
60,636.83
-22.9%
16,329.14
Tail Hedging
This quarter I continued a tail hedging strategy that I have used in the past. The strategy involves buying 30% out of the money SPY put options that expire in a couple of months. Each month options are sold and a new set is bought. This quarter, the options have had a cost of $1,719.05, with no gains.
