The Rational Cloning: Weekly Ideas #50
Credit Bubble Stocks Thursday Night Links, The Compounding Capital Review on Share Buybacks as a Capital Allocation Tool, Tweets That Make You Go… Hmm 🤔
Welcome to the 50th edition of the Rational Cloning Newsletter (Weekly Ideas Series).
Helping you discover the best ideas of others.
Happy cloning.
Weekly Investment Ideas
(1) Credit Bubble Stocks- Thursday Night Links (SEPTEMBER 1, 2022)
Our Canadian oil majors are trading for less than five times earnings because, supposedly, there is going to be an electric vehicle transition that brings us battery electric vehicles powered by "renewable" (wind and solar) energy. Well if that is true, we are going to need vast quantities of steel, copper, concrete, and other basic materials. Yet when we look, we find that the investors who espouse this transition have not invested in the production of any of those materials, and shares of those companies are going begging at very low valuations. Professional investors seem to have lost the ability to translate a worldview into a portfolio if it involves natural resources. [CBS]
We are really interested in finding royalties and tollbooth businesses that we can hold through a significant coming inflation. An operation under the influence of greater or less mischances is something that we may be forced to sell because of poor capital allocation by or other disagreements with management. That would expose us to loss or to paying taxes on partly illusory (nominal) capital gains.
We should do better over time with investments that have lower volatility of operating profits and the highest percentage of revenue returned to shareholders, provided that we buy them at attractive prices. Remember our discussion of hydrocarbon royalties and pipelines? Profits that fluctuate into the red are signs of weak business models and poor competitive position. Royalty trusts never lose money, by definition. Pipelines basically never lose money. The cigarette companies may have to take a non-cash writeoff of a stupid acquisition, but their operations are always profitable. Public sector employees (university professors with tenure, as an example) do very well for themselves, when you consider that they are paid public sector wages and are selected for a lack of interest in wealth creation. This may be because of the lack of volatility in their earnings - they are never unemployed. This is a theme worth exploring further - slow, boring consistency as a path to long-term survival. [CBS]
If you look around the world, you will notice tons of countries with fiat currencies are running high inflation rates. Meanwhile, deflationary collapses are rare. Can you imagine the central banks of Brazil, Argentina, or Ghana tightening enough to cause a deflationary collapse? It has never happened, because the path of least resistance is inflation. Betting on inflation is the cynical bet. But we have to be cynical enough to realize that the central bank doesn't want us hoarding real assets and is going to try to trick us with jawboning talk. People will believe the talk and there will be violent selloffs. This is why we like "first class" inflation protected assets and not leveraged junk. [CBS]
Substacks That Make You Go… Hmm 🤔
Share repurchase is one of the least understood uses of capital in the corporate world, yet it accounts for a massive use of capital every year. Investors often build investment theses around large share repurchases while not fully grasping what a share repurchase actually does and when it should be implemented, and corporate mangers destroy tens of billions of dollars of value via share repurchase, sometimes with the encouragement of investors. Obvious recent examples of value destruction via share repurchase over the past few years are John Malone-controlled entities like Liberty Global LBTYA 0.00%↑ and Qurate Retail Group QRTEA 0.00%↑ , notwithstanding Malone’s brilliant long-term track record and obvious understanding of share repurchase.
On the other hand, some business managers have created immense value through intelligent buybacks, rewarding patient shareholders. Perhaps the most famous example is Teledyne TDY 0.00%↑ under Henry Singleton, who at one point bought back over 90% of the company’s shares when the valuation was completely disconnected from reality.
So what is a share repurchase, also known as a stock buyback? Really, all it represents is a company choosing to use its capital (internally generated free cash flow and/or capital raised from borrowing money) to buy shares from existing shareholders and permanently retire those shares.
Buybacks should only be pursued with excess cash flow for growing businesses after thoroughly evaluating other uses of capital—namely, reinvestment in the business and acquisitions. And even then, it is critical that buybacks be done for below intrinsic value. If this sounds like a high bar, it is, as should be the case when shepherding precious firm capital.
Tweets That Make You Go… Hmm 🤔
