Hope you are enjoying the summer. A big welcome to our new investors. My goal is to preserve and grow your wealth. My investment process is repeatable and scalable.
General Thoughts On World Markets:
The Stock Market (the “Market”) has enjoyed one of the longest runs of positive gains in history. This has caused many investors to flock to popular stocks, often chasing companies that have negative net income, high leverage, and generally money losing enterprises. Many investors chase dreams and hopes that these companies will eventually turn a profit. Some of the popular companies are profitable but priced for perfection.
Margin debt has risen to much higher levels. Leveraged investments such as leveraged ETFs have higher risk for those who are exposed when there is a downturn. They will be hit the hardest when a down turn comes.
What caused this extended bull market? Starting with the recession and subsequent years, the U.S. Federal Reserve took the lead with lowering interest rates to historic lows and a historic purchasing of debt with its quantitative easing policy. Central banks in other countries followed suit. This period has made money cheap with low interest rates. These factors contribute to asset inflation.
If interest rates continue to stay low then current asset prices are still undervalued. However, if rates start reverting back to a historical average, then prices are highly valued.
Interest rates are like gravity to asset prices. We have operated in a low gravity environment similar to an astronaut making a jump on the moon. Sooner or later the astronaut has to come back to Earth and face the gravity he normally lives in.
Passive funds have also pushed up prices with their indiscriminate buying of all stocks in their respective indices. Many stocks have become overpriced relative to their intrinsic value. These passive funds are creating market valuations that will benefit patient active investors.
What is peculiar about the current bull market is that most major markets around the world have also enjoyed extended runs and there is relatively low volatility. The current productivity revolution continues with robotics and software algorithms. New methods to access previously hard to drill oil and natural gas along with the rise of hybrid/electric vehicles have pushed those prices far lower. Crop yields and animal herd efficiencies have created more supply. Underemployment and skill set mismatches have caused labor prices to trail historic increases. These forces have created a period of low inflation.
However, interest rates, volatility, and inflation may not stay low forever. At some point, the Central Banks cannot and will not hold on to the immense amounts of debt they purchased during the recession and subsequent years. When the Fed keeps raising rates and it starts selling off some of these notes, it will cause a head wind for stocks and other asset classes. The first phase of selling will occur in the coming months.
My value approach has outperformed the market and most other funds in a time when many are chasing growth and throwing caution to the wind.
I still find good bargains for quality companies in this current environment. However, I am cautious heading into this fall and I have positioned our partnership to be ready to take advantage of terrific opportunities that arise. I suspect there will be significant opportunity in the near future and we will be ready to strike and strike hard when the opportunities arise. It is a good time to invest in Talguard.
While we have performed well, I am more excited when outperforming the Markets during down turns. This is where my strategy of buying #1s with demonstrated cash flow and margin of safety will help us survive the one year that no one else does.
Why My Value Approach Works To Safeguard And Grow Your Assets In The Long Run:
The Wall Street Journal recently reported that many analysts are questioning the viability of value investing given the recent run up in the Markets. I disagree. It reminds me of the crowd following mindset of “this time it’s different”. Cash flow and value has proven to generate outsized returns for the long run. It is not what you make in the short run that counts, it is whether you can keep your gains in the long run that matters.
Value investing is the approach of finding great companies at reasonable to greatly discounted prices. This approach works because if you invest in the right companies at the right prices you have the opportunity to generate outsized long term returns. You reduce short term capital gains taxes and you can go to sleep at night knowing your stocks will survive during downturns, especially during financial panics. You can ride out the storm.
My goal is to preserve wealth and then to grow it. Preserving wealth is often the greatest concerns for wealthy individuals, families, and institutions. There is an ancient Chinese saying that wealth does not last past three generations. I want to help preserve and grow assets for the long run.
As you can see with the partnership’s outsized returns, value investing does not mean low returns during boom times. My strategy really shines in preserving wealth when during market downturns. So how do I do this?
I am an asset allocator and I treat myself as an owner of each company I invest in. I seek to find the best companies that have durable advantages and allocate according to their valuation and strength of business. I focus on market leaders that generate long term cash flow and treat shareholders well.
The way to preserve and grow wealth for the long run is to buy quality at reasonable prices. I seek to invest in quality companies that are number #1’s in their niches that have durable competitive advantages. I desire a margin of safety to ensure we sleep comfortable at night and that we will weather downturns when fear grips the Market. I like companies that generate lots of cash flow and then utilize that cash flow in a shareholder friendly manner. Downturns will come. It is those who survive those storms that will see the massive fruits of a future boom when the sun shines again.
It is a great time to be alive. The advancement of human ingenuity is advancing at a quickening pace. In our lifetime, we will see the discovery of more than twin for our home world. The advancement of the medical field will prolong our lives much longer on average than any previous generations in human history. There is a good chance we will detect some form of extraterrestrial life in our lifetime.
We will live older while retaining our health. Longevity has profound implications for investments. Eventually, technologies such as organ regeneration, implants, and next generation medicine will make its way onto the field.
So where does that leave us for our investments?
It is great news for Talguard investors. We will have many more years to compound returns. The power of reinvested capital compounded over many years is geometric. We will compound with many more years than any investors in previous generations.
Past Investment Examples:
I have learned a great deal from investors and other people throughout history. I have learned from the best through the power of reading. I read as much as I can every day. It is targeted reading that gives me the base knowledge about companies and industries that gives rise to my investments.
I seek to invest in #1 companies, I want dominant companies that will crush their competition. In the midst of the Great Recession and Financial Crisis, I invested in a leading financial services company starting in 2010. This Company is the ultimate toll booth company and had three separate decade-long catalysts that the market was missing. This investment generated a compound return of over 20% a year.
I never invest in companies hoping they will be bought out. If you invest correctly, buy outs are a natural course. Since all my companies are #1 market leaders in their niches they have attractive business traits that can attract acquirers. They also often have very little debt which makes them attractive to private equity firms and business competitors because they can borrow against the assets for the buy outs.
We owned shares of Precision Cast Parts before it was bought out by Warren Buffett and Berkshire Hathaway. Three other investments have also been bought out. Each investment was made after the Market pushed their stock prices down due to short term concerns. These investments performed well and coincidentally were bought out making us a nice bonus profit. I much rather have owned them for longer periods. Alas, most shareholders voted for selling out.
As mentioned, I never invest in companies hoping or predicting they will be bought out. That is not the way I work. I think long term for my investments. If they happened to be bought out then we move on with the proceeds to seek new candidates for investments.
Next I discuss some industries of interest below.
Financial Services:
I really enjoy reading about this sector. It houses a number of terrific companies with business models I find attractive. Payment Services has been one of my fortes and it has rewarded us with investments that have generated market beating results. Payment Services also has a lot going on from both ends of the tech spectrum. On the lower tech side, payment wire service companies have experimented with new fin tech services. On the higher tech side, you have loosely regulated new crypto currencies making headlines. I avoid these so called high flying crypto currencies. They are by nature highly speculative. I seek cash flow and durable competitive advantages. Crypto currencies provide neither.
Interest rates will go up at some point. In some areas they already are going up. Just ask any current home buyer who needs a loan. We do not know how fast and to what degree. A recession can reverse this course but rates will most likely not go down by the same degree similar to the past two economic downturns. Why is that?
It is because there is not as much room for the Central Banks to lower rates the next time around. Interest rates are at historic lows and near zero. As rates go up, the interest rate spread will benefit financial services companies and commercial banks in particular. With banks they are in the unique business of gathering assets and lending those same assets out to generate their profits. A lot can go wrong if they make too many bad loans. My investment approach of seeking quality companies is extra helpful when investing in this sector.
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| Will Amazon take over online retail? |
Retail:
There has been a lot of news about retail with many stocks in different subsectors getting punished. The investment world and many in the public at this time believe Amazon will take over all aspects of retail. Amazon is certainly a formidable competitor. I predicted 10 years ago that Amazon would one day over take Walmart in market cap, amidst the recession. It is now more than Walmart’s market valuation.
However, I make a case that Amazon will not take over the retail world. I define take over as owning more than 50% of all retail. The reasons are both structural and demographical. History shows that no retailer has been able to capture anywhere near a majority of American retail sales.
Many people forget or may not know, there was an “Amazon” in the United States. A century ago a company called Sears rose to dominate the American retail landscape. Sears became much more than being the largest retailer by revenues. Sears started or acquired some of the largest companies in a variety of niches. It had one of the largest insurers in Allstate, one of the largest tool makers in Craftsman, one of the largest warranty businesses, and one of the largest appliance makers in Kenmore. You could purchase from Sears a vast variety of items including clothes, toys, groceries, motorcycles, and even houses from its catalog. Sears also came to own one of the largest portfolio of prime real estate in the country. In 1968, Sears employed over 350,000 people. Sears never reached anywhere close to 50% of American retail spending. Sears targeted middle income and affluent customers which is Amazon’s core target market.
A young upstart named Walmart took over the mantle of largest retailer from Sears due to its ultra low pricing big box store concept. Walmart’s focus on price and the lower income customer propelled it to nearly $500 billion in sales last year. Even then, Walmart represents less than 8% of American retail spending.
Since then Amazon has overshadowed Walmart on market valuation even though Walmart still has over three times the sales and ten times the profit. Even with these behemoths, other retailers have existed and thrived.
Amazon has created the convenience and incentive with its concepts such as Amazon Prime to entice repeat shoppers. However, it still has several fundamental hurdles to reach the size of Walmart or Sears during its heyday in sales. Amazon’s core customers are primarily affluent who can afford Prime membership and many of the products it sells. There is a reason Amazon purchased luxury grocery store Whole Foods and not a discount brand such as Dollar Tree.
Amazon is targeting a wide array of industries and geographies. It is spending billions in India and Singapore. Amazon is pushing into groceries with Whole Foods. It is also making a push into auto parts, clothing, jewelry, and other consumer goods. Amazon has been purchasing airplanes, trucks, and warehouses. This does not even include its cloud services which Microsoft is growing at a faster rate. Any company getting into too many fields and actively managing them creates a real risk.
This current dynamic has created investment opportunities in this space.
Retail is an exceptionally tough industry to invest in. There is often very little to no switching cost. Online retail’s rise has pushed this to a new extreme since another store is a click away.
Due to online retailing, luxury retailers are in trouble for the long run. Affluent customers do not get much benefit from shopping at a luxury retailer’s online brand versus any other brand. Affluent customers pay for time and service. Part of their allure were posh stores with exclusive selections that affluent clientele like to visit. Online retailing has changed this dynamic. Luxury retailers do not provide any time savings to online shoppers. If nothing else it often takes them longer to ship products. The exclusivity of selection is not there either.
I like to take the road less traveled as a true contrarian investor. I am also cautious when it comes to retail. The retailers I have invested in are few. They also tend to have some business to business, wholesale component, and their own branded product lines.
An example would be my investment in PetSmart. It grew into America’s largest pet and pet supply retailer with zero leverage. It had a management team that had integrity. PetSmart has unique qualities that are impossible to duplicate online. For example, it operates the largest chain of pet hotels in its stores. It also has heavy pet food and trained expertise that many pet owners enjoy in person. PetSmart has clean, standardized stores. 40% of its products are private labeled or exclusive partnerships such as their National Geographic aquarium tanks. PetSmart had steady cash flow and its financial decisions over time made sense. A private equity consortium bought out our shares.
Overall, no one company will take over the entire retail landscape. If nothing else, a company that gets into too many businesses creates added risk for itself and its shareholders especially if their expected revenue is priced into the stock.
Health Care:
The fact that the Republican Health Care Bill did not pass does not mean there will be no changes to the system now. For example, the FDA has recently stepped up approval of more generic drugs. We can expect other changes in the future. There are a few dynamics at play that will create ample opportunity for investment.
There are good opportunities in certain companies in this industry. As always, I focus on cash flow and valuation. I tend to avoid early stage companies in this sector that have little to no revenues. Of those that are investable to me, some are good investments for the next several years given their depressed valuations. Others are long term compounders when the price is right.
Technology:
There are a few subsectors that are interesting in Technology. I am cautious in this space because many companies issue a lot of options to recruit and retain talent and because of the rapid rate of constant change. This has a dilutive effect on existing shareholders. More importantly, they often do not count these options as an expense. I disagree with this thought process. It is a grey area that the SEC allows. But to me, it creates a higher profit margin than reality. Think of it this way, if you have a pie and a piece of your pie is given away, would you not consider it as an expense to you? Another way to look at it is the following. If these companies did not pay these options, they would surely have to pay a lot more cash compensation which is clearly an expense. Options are a substitute for cash compensation but it is a form of compensation nevertheless. Therefore, it should be counted as an expense. This expense creates a true cash flow and earnings picture that is lower than stated.
I like companies that provide services, software, and cyber security. These services are often subscription based or has a toll booth like attribute which generates sticky and repeatable revenue. These companies often are embedded with their customers’ infrastructure which helps customer retention rates.
I avoid early stage technology companies. Rapid growth does not guarantee a happy ending for investors. I focus on companies that have proven cash flow that is hard to replicate. Another challenge with technology is that the rapid pace of change. It is only going to increase in the future. Many companies in this space do not possess the longevity that I desire. As Bill Gates once said, he could not tell you which out of 10,000 companies will be the next Microsoft. Think about that, one of the greatest minds in technologies has no idea who will become a large player in his industry. More importantly, how many industries do you know have over 10,000 competitors at any given time? That is why I seek proven cash flow companies here, just like I do for any investment.
Branded Manufacturers:
This space has many qualities I like in investments with branded products that have repeat purchase and desirable qualities. Although the food space has faced pressure as there is a stigma against big food processors, there are good potential investments when the price is right. I like non food companies in this space. These companies offer basic products that have are often simple and pure. These have low risk of consumer backlash. Many of the branded manufacturers I invest in have longevity and have an essential characteristic to their products.
A recent investment I made is in a company that produces a high quality line of products that has a great future ahead based on our extensive research. It possesses many of the qualities I like and is less susceptible to a downturn due to the nature of its products. It is also a company I know very well and understand.
Summary:
I am more sure than ever of America’s long term prospects. I also like the prospects for China and efficient economies in Europe such as Germany in the long run. There will be a real pull back in asset values at some point but that is all temporary. I will be ready to strike and strike hard just like I have in past down turns. I like to invest when others are fearful.
I view each investable dollar as a soldier standing patiently and silently on top of a mountain looking at the field. My soldiers comprise a patient army waiting for the right opportunity. When the opportunity comes, my army of investable dollars will attack.
At Talguard, we are dedicated to an old craft, and we run on old principles. I don’t follow fashions or fads. I concentrate on methods that I know to work, and in markets where we know we can apply them.
That makes us a safe option, but not an unthinking one. We continue to question, investigate, research and explore. But everything we have found up to now confirms our methods, even in the current market with its long run of success.
We know there are opportunities out there. We know we can find them.
I guard your assets and grow your assets as if they are my own.
I aim to be the best investor of my generation.
For existing investors, I guard and grow your wealth over the long run. Compounding returns over long periods of time is one of the most powerful forces in the Universe.
For new investors, contact me and learn about my dedicated long term investment process and how Talguard can help you preserve and grow your wealth.
Best,
Dan H. Chen
President
Talguard Investments LLC
Disclaimer Statement:
This document and information herein represents the views of Talguard Investments LLC and is not to be considered investment advice. The information herein should not be considered a recommendation to purchase or sell any particular security or financial instrument. There can be no assurance that any securities discussed herein will remain in the Talguard Value Fund LP. This document does not constitute an offer to sell or a solicitation to buy membership interests in the Talguard Value Fund LP. Past performance is not necessarily indicative of future results. All information provided herein is for informational purposes only.
Investment in the Fund will involve significant risks due to, among other things, the nature of the Fund’s Investments (as defined herein). Investment in the Fund is suitable only for sophisticated investors and requires the financial ability and willingness to accept the high risks in an investment in the Fund. No assurance can be given that the Fund’s investment objectives will be achieved or that investors will receive a return of their capital.
In making an investment decision, prospective investors must rely on their own examination of the Fund and the terms of this offering, including the merits and risks involved. Prospective investors should not construe the contents of this letter as legal, tax, investment or accounting advice. Prospective investors are urged to consult with their own advisors with respect to legal, tax, regulatory, financial and accounting consequences of their investment in the Fund.
©2017 Talguard Investments LLC, all rights reserved.