On Markets & Investing

My Shopping List (2 May 2022)

Companies logos collage
It is remarkable how investors’ psychology changes during market corrections. Until recently, when markets were strong, many investors focused on the next 5-10 years justifying high multiples by strong long-term growth prospects and low-interest rates. Now, as stocks decline, the investment horizon is collapsing. The following phrase describes market psychology well:

“I like the stock, but I think they will have terrible results next quarter. I will look at it after their earnings release.”

Stan Druckenmiller put it well:

“It doesn’t make any sense, but when security goes up, every bone in your body wants to buy more of it. And when it goes down, you’re fighting and making yourself not sell it. It’s just the nature of the beast.“

His first boss used to say:

"The higher they [stocks] go, the cheaper they look.”

Jason Zweig also wrote about the difference between knowing something in theory and applying this knowledge in practice, during a period of emotional stress:

“If I ask you in a questionnaire whether you are afraid of snakes, you might say no. If I throw a live snake in your lap and then ask if you’re afraid of snakes, you’ll probably say yes—if you ever talk to me again.”

I think the best activity during market corrections is refining your Shopping List to potentially take advantage of better prices. There is zero value in trying to predict when markets may bottom out.

In this post, I share some interesting names in terms of business quality and price that I may buy during this correction. Some of them are still not cheap enough and I would wait for lower prices. Other stocks may look cheap but I want to have a better conviction in their business models or the quality of management teams.

I have put the stocks into six categories:

  1. Merger Arbitrage (Special Situations)
  2. Small caps (possibly offering the best growth potential but also very risky)
  3. Quality brands
  4. Stalwarts (quality businesses with slow growth but attractive valuation)
  5. Tech stars
  6. Holding companies (family-run companies, great long-term compounders)

This is not a complete list of course.

Please feel free to share your ideas via email or Direct Message on Twitter. I would greatly appreciate your feedback.

1. Merger Arbitrage

Activision Blizzard (ATVI)

Microsoft offered to buy out ATVI for $95 on 18 January 2022. The stock closed at $75.6 on Friday (29 April 2022), which offers a 25.7% upside to Microsoft’s offer price. Berkshire has acquired a 9.9% interest in ATVI. Buffett said that he found the opportunity attractive - Microsoft has the cash to pay for ATVI, and the risk is regulatory approval of the deal.

2. Small-Caps

SDI Group (SDI.L)

Key data: Price - £1.57, Mkt Cap - £162mn, EV - £161mn, stock down -20% YTD, -30% from all time high.

The company produces equipment for digital imaging, sensing and control used in life sciences, healthcare, astronomy, precision optics etc.
The stock trades at about 5% FCF yield, 20x PE. The company has increased revenue by c. 40% CAGR (2016-2021), generating 64% gross margin, 19% operating margin and 15% net income margin.

The company is a serial acquirer focused on small-sized bolt-on deals.

Victoria PLC (VCP.L)

Key data: Price - £6.4, Mkt Cap - £747mn, EV - $1.2bn, stock down - 47% YTD, -48% from all-time high

A serial acquirer in the flooring space (carpets, tiles, underlay, etc.) that has increased its revenue by 28% since 2012.

38% of shares are owned by the Chairman, Geoff Wilding, and a Board Member, Zachary Sternberg, co-founder of private equity The Spruce House Partnership.

InPractice has a good discussion with sector insiders on Victoria PLC and its strategy.

Boston Omaha Company (BOC)

Key data: Price - $29.5, Mkt Cap - $698mn, EV - $658mn, stock down - 19% YTD, -50% from all-time high (although it was overvalued in the past so this -50% drop is not very meaningful). 10x EV/EBIT, 5% FCF yield, 34% gross margin, 12% operating margin. 

This is quite a controversial company. It is either a small Berkshire Hathaway or a potential disappointment. The company was founded by two young investors, one of whom (Alex Rozek) is a relative of Warren Buffett (he is the grandson of Buffett’s sister). The company publishes very thoughtful letters referring to the same principles that Buffett speaks about. The difference is that management also has stakes in various underlying assets. The company has had several equity raises since 2015, and it is generally harder to analyse the company due to its corporate structure.

The two co-CEOs collectively own 29% of BOC’s shares (and 49.5% of voting rights). 

Management states that:

“Boston Omaha’s focused objective is growing intrinsic value per share at an attractive rate while seeking to maintain an uncompromising financial position.”

The company operates four businesses: a Billboard company, Insurance, Broadband and Investments. It has also about $152mn of cash and practically no debt.

My concerns:

  1. co-CEOs seem to have interests in other businesses, and unlike Buffett, they don’t keep 90% of their net worth in one company (BOC)
  2. The company pays high professional fees ($7mn in 2021 vs revenue of $57mn and total assets of $807mn)
  3. Operating loss of $23.8mn and $4.99mn in 2021 and 2020, respectively
  4. Regular new share issue

Smith-Midland Corporation (SMID)

Key data: Price - $16.9, Mkt Cap - $88mn, EV - $76mn, stock down - 64% YTD, -66% from all-time high

A family-run business founded in the 1960s. Key products include Highway barriers, SlenderWall Cladding, Noise absorbing walls and other construction products.

Trades at 12x PE, although earnings need to be adjusted for one-offs.

The business has partially pivoted to rentals which improved economics (relative to the sale of manufactured products).

There are natural barriers to entry as concrete parts are heavy and are not economical to transport long-distance; local manufacturers are mini-monopolies. SMID is a leader in a few South-East locations in the US.

3. Quality brands

Stanley Black and Decker (SWK)

Key data: Price - $120, Mkt Cap - $19.6bn, EV - $29.8bn, stock down - 35% YTD, -45% from all-time high; PE - 12x, Div yield - 2.6%

Featured in Lessons from the Titans book by Scott Davis (Chapter 10) as an example of a successful turnaround strategy and acquisitions.

146 years of consecutive payment of dividends (longer than Coca Cola).

CEO Jim Loree has been with the company since 1999, starting as the CFO.
CFO, Donald Allan, has been with the company also since 1999, joining as Director of Financial Planning and later working as Controller.

33% gross margin, 14% operating margin, 7% organic growth (3-year average).

Adidas (ADS.DE)

Key data: Price - €194, Mkt Cap - €36.7bn, EV - $29.8bn, stock down - 35% YTD, -45% from all-time high; PE - 19x, Div yield - 2.6%

7% owned by a family holding, GBL.

Strong management headed by CEO Kasper Roersted, who has become known for a very strong performance as CEO of Henkel (the stock quadrupled during his 8-year tenure).

The company has a buyback programme of €5.5bn until 2025. Overall, Adidas plans to return €9-10.5bn to shareholders by 2025.

The company targets 8-10% annual sales growth (2021-25) while expanding operating margins to 12-14%.

Up to 10% of sales are essentially investments into growth which could be treated as Capex and reported in the Cashflow statement, which would boost profits and reduce valuation multiple.

Abercrombie & Fitch (ANF)

Key data: Price - $34.6, Mkt Cap - $1.7bn, EV - $2.1bn, stock flat YTD, down -29% from all-time high; PE - 6.5x (2021A)

Share count is down 22% during the 2017-21 period.

The company has one of the highest gross margins and net margins in the sector among its peers.

It was featured in the Three Rules book as a case study on successful growth strategy.

TJ Maxx (TJX)

Key data: Price - $61.3, Mkt Cap - $72bn, EV - $66bn, stock down -19.3% YTD, -21% from all-time high; PE - 21.8, FCF yield - 3%

I have been a customer for a few years now (in the UK) and see a lot of value compared to traditional retailers. You get better quality clothes and lower prices. The company has developed a unique business model of buying inventory from big brands at a huge discount and selling it fast in its stores, holding minimum inventory. Each time I visit one of TK Maxx stores in the UK, I almost always see lines of shoppers with a few items waiting in front of a cashier. I don’t see it at traditional retailers that often.  

The stock is still not cheap enough for me; I would prefer to buy it closer to 15x (c. 30% cheaper vs spot price).

Starbucks (SBUX)

Key data: Price - $175, Mkt Cap - $86bn, EV - $bn, stock down - 35% YTD, -40% from all-time high; PE - 20x, Div yield - 2.6%

The company could potentially be an interesting turnaround case with its legendary CEO, Howard Schultz, re-joining the company for the third time. The main issue has been weakening experience as Starbucks has focused too much on drive-through and efficiency. This focus on speed has caused much frustration among employees. The company would likely see higher costs in the short term as management increases compensation for store personnel and probably spends more on rebranding and store upgrades. Longer-term, the business will likely deliver more value for customers, translating into adequate shareholder returns.

NVR Inc. (NVR)

Key data: Price - $4,376, Mkt Cap - $14.7bn, EV - $16.2bn, stock down -24% YTD, -27% from all-time high

NVR is a leading US homebuilder known for exceptional capital allocation (including timely share repurchases) and an innovative business model which minimises the use of own capital and improves business returns (20-30% ROE). The company does not buy land upfront (unlike other developers) but instead negotiates options. This helps it to reduce risks during the downturn.

With rising rates and cost of living, there are reasons to expect some slowdown in demand for new homes. However, long term prospects for the US housing market look very solid.

It was highlighted in a few podcasts, case studies and can be seen in many value investors’ portfolios.

I want to understand better the impact of the cycle and a potential downside to earnings if house prices decline.

4. Stalwarts

Bank of America (BAC)

Key data: Price - $35.7, Mkt Cap - $288bn, stock down - 23% YTD, -29% from all-time high 

10x PE, 11% shareholder yield (based on 2021 distributions), Buffett is the biggest shareholder (12.5%), and BAC is Buffett’s biggest position in US banks.

HP Inc (HPQ)

Key data: Price - $36.6, Mkt Cap - $38.6bn, EV - $41.8bn, stock down -2.8% YTD, -12% from all-time high

While HPQ is in a competitive hardware sector, it has leading market positions in the US printing segment with a growing share of recurring revenue. The business has good margins and cashflows.

I need to understand how much recent results have been boosted by work-from-home demand and the share of profits that are less cyclical and relatively safe from competition.

HPQ returned $7.2bn to shareholders last year (buyback + dividends) - 19% of the current market cap.

3M Company (MMM)

Key data: Price - $144, Mkt Cap - $82, EV - $bn, stock down -19% YTD, -45% from all-time high; dividend yield - 4.1%

One of the oldest industrial companies in the US, founded in 1902, has always focused on innovation. Currently sells 60,000 products used in homes, businesses, schools and hospitals. One-third of its sales come from products invented within the past five years.

Has been generating strong operating margins (21%) but slow top-line growth (1.7% in the past ten years). Its dividend has grown by 6.9% annually since 1992. Dividends increased in 2008/9 and 2020. Current dividend payout ratio - 59%. Dividends cannot grow much faster than sales in the long run.

5. Tech stars at a discount

Google (GOOG)

Key data: Price - $116, Mkt Cap - $1.45tn, EV - $1.32tn, stock down - 20% YTD, -23% from the all-time high

23% revenue growth (5-year average) trading at 5.3% FCF yield, 3% net buyback yield. Profits / Cashflow partially underreported due to investments in new ventures (dilution from share compensation partially offsets it).

Amazon (AMZN)

Key data: Price - $115, Mkt Cap - $1.15tn, EV - $1.12tn, stock down - 19% YTD, -38% from the all-time high

Plan to look at it if it falls 20-30% more (slowing growth, declining margins, huge size - not a fast grower anymore, although high-quality, innovative with a strong moat).

PayPal (PYPL)

Key data: Price - $87.9, Mkt Cap - $102bn, EV - $100bn, stock down -55% YTD, -72% from all-time high; 22x PE

It was profiled by many quality investors in the past two years when the stock was at a much higher price. I generally like payment companies because they are very cash-rich and high margin businesses with high returns on capital. They should also outperform in inflationary periods (at least on sales/earnings level).

My concern is high competition and fast innovation in the sector. It does not feel that PayPal provides a unique service that other players cannot replace, and I can continue living normally if the business disappears tomorrow. Apple and Google are trying to offer consumers their own digital wallets in addition to payment providers like Visa and MasterCard, as well as traditional banks.

Wayfair (W)

Key data: Price - $77, Mkt Cap - $8bn, EV - $8.2bn, stock is down 61% YTD, -77% from all-time high

A successful online furniture retailer featured in many ‘smart’ podcasts and investor letters. I had a positive experience using Wayfair myself. The fact that Amazon tried but has not managed to succeed in selling furniture online is a good sign that suggests W has some unique edge. CEO Niraj Shah is a co-founder of the business.

InPractice had a few conversations with industry insiders discussing the sector and Wayfair.

FCF-positive with almost zero net debt.

Netflix (NFLX)

Key data: Price - $215, Mkt Cap - $99.2bn, EV -$108bn, stock down -64% YTD, -69% from all-time high (Oct 2021).

Issue: the company started to lose subscribers during 1Q22 (-0.2mn to ) and guided for -2mn more subscriber losses in 2Q22. Growth continued to slow down to 10% (14% constant currency). Another issue is rising competition with other companies providing on-demand video subscription services (e.g. Disney, Amazon Prime, Hulu, HBO).

Management expects 10% revenue growth in 2Q22. The operating margin in 2022 is expected at 19-20%, similar to 2021 (21%).

The long-term goal is to grow revenue at a double-digit rate and expand operating margin faster.

Valuation: not ‘dirt-cheap’, with 2021 EBIT of $6.2bn and less than $7bn in 2022. The company is on 15x EV/EBIT (’22E).

My take: I used to keep NFLX in a too-hard pile. My main issue has been the constant need for spending on new content and the short shelf-life of most video content (unlike music). I do not have a strong view on the sustainable long-term profits of the company (unit economics). The company has struggled to generate sustainable FCF ($1.9bn in 2020, a loss of -$0.2bn in 2021). 

I could take a fresh look at the company if its shares are c. 35% cheaper from here, below $150. This would imply close to 10x EV/EBIT valuation.

I think NFLX has a unique corporate culture. They managed to beat Blockbuster 20 years ago; they have an exceptional focus on the quality of service and customers. They have a great CEO who is also a founder and large shareholder.

FAANG stocks not included:

I have not included Facebook even though it is cheaper as social media seems to have weak moats. The speed with which TikTok penetrated the market shows that barriers to entry are not that high; the fast pace of innovation and changes would push FB to invest in new areas where success cannot be guaranteed.

I have also excluded Apple simply because it accounts for c. 20% of Berkshire’s market cap, and as a shareholder of Berkshire, I indirectly own Apple stock.

Microsoft seems to be delivering the strongest results among the Tech giants, supported by a timely and smart pivot to the cloud started by its under-appreciated CEO, Satya Nadella. At the same time, its stock is trading at one of the highest multiples, close to 30x PE.

6. Family holding companies

Investor AB (INVE-B.ST)

Key data: Price - SEK191, Mkt Cap - SEK605bn ($61.5bn), stock down -16% YTD, -18% from all-time high


Key data: Price - €66.8, Mkt Cap - €15.4bn, stock down -15% YTD, -22% from all-time high

I already own Exor (my second largest position after Berkshire), so it is very unlikely that I will buy more. However, it looks quite attractive at these levels, hence I added it to the list.

Groep Brussel Lambert (GBLB.BB)

Key data: Price - €90.6, Mkt Cap - €14.1bn, stock down -9% YTD, -14% from all-time high

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