Contra The Heard: Building for the Long Run
Over the past few years, the portfolio managers and analysts here at Contra the Heard have had their hands full researching, reviewing, and placing our respective bets. Although we could complain, it’s true that we also enjoy the work as it speaks to the opportunities at hand. Needless to say, during the peak of the Dot com Bubble and in the years before the Sub Prime Mortgage Crisis, we were not busy researching and instead spent time twiddling our thumbs, making paper cranes, and thinking about the market’s substantial rise.
Today the S&P 500 is trading in the same range as it was in the first half of 1999. In Canada, the S&P/TSX has barely moved since mid 2006, and is not that much higher than it was during the peak of the Tech Boom in late 2000. True, there have been dividends along the way, but for the most part this decade has been a washout. In all likelihood, the ramifications associated with the Subprime Mortgage Crisis will continue to reverberate through the global economy for the foreseeable future. The situation in Europe today exemplifies this point well. However, the turmoil in turn means that the foreseeable future is also an ideal time to place long term bets on out-of-favour positions.
This is not to say that investing in this market will be an easy task. Hanging in there will require a controlled, contrary temperament, which means a high mental resolve for when the ride gets bumpy, as well as an indifference to the roar of (or occasional scream from) the crowd. Although we have made and will continue to make our share of mistakes, as contrarians our investment philosophy has undeniably served us well over time. We purchase companies that have the financial strength to weather long storms – low debt loads, high interest coverage, low relative valuations, and a sustainable dividend payout (if applicable) are important. Furthermore, we only consider companies that have been listed for at least ten years. One reason for this is that we like to see companies that have been able to pull through and recover from past downturns. Surviving the chaos, however, is only half the battle – thriving during the recovery is the rest. With that in mind, we like companies that could make attractive acquisitions and have historically traded at much higher levels – normally at a minimum of 100 per cent above what we pay. In addition, we look for organizations with good historic valuations, margins, and rates of return, and we like for them to provide necessary products or services and have solid management teams.
What have we been buying recently?
The biggest company within our President’s Portfolio is General Electric. Prospective investors must understand that this company is complex, with a black box of a financial division and many moving parts that are not easy to evaluate. That said, this global giant got slammed during the depths of the Subprime Mortgage Crisis, and is still undervalued. The behemoth’s revenues and net income are growing, its dividend payout is regaining some of its former lustre, and its industrial backlog is bulging. Benj bought in 2010, would consider buying now if he hadn’t already done so, and plans to hold for many years to come.
Deswell Industries, on the other hand, is a company with a more modest market cap. This Chinese manufacturer is facing rising raw material costs and wage increases. The cash balance, however, is nearly that of the market cap itself, the debt is nonexistent, and, having operated through thick and thin since the 1990s, the company is no stranger to adversity. To boot, it has a huge distribution and improving gross margins. Though they have decreased their distribution in the latest quarter, they made a quarterly profit for the first time in over a year. The worst may now have passed.
Finally, we have fallen in love with many small regional and community banks. Although the banking industry is littered with landmines and time bombs, it is also full of well-run, properly capitalized, and undervalued companies. Bank of Commerce Holdings in northern California is one such operation. The company consistently turned a profit during the recession and rarely turns in an ugly operational cash flow. Like Deswell and GE, it too has a pretty dividend, good rates of return, impressive capital appreciation prospects, and a long operating history.
At Contra the Heard we try not to make macro predictions and prefer to stick to our company by company analysis, which yields us beautiful companies such as the ones mentioned above. Even though we’re not “macro guys,” we can’t help drawing similarities between the events of last decade and those of decades gone by. History does not repeat itself, but it does echo. Over the last century the Dow has experienced periods of brutal decline and long stagnation, but has also had episodes of steady progress and astonishing growth. In this game, the market’s returns do anything but move in straight or predictable lines, and the moral of the story is that yesterday’s performance and today’s climate are poor metrics for tomorrow’s returns. With that in mind, long-term investors would do well to pick carefully, wait, and then wait some more.
Benj Gallander is co-editor and president of the Contra the Heard Investment Letter and Philip MacKellar works as an equity analyst. Contra has a 10-year annualized return of 19.6 per cent. www.contratheheard.com