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Why I liquidated SPY

Recently I liquidated my holding in SPY realizing a decent return. Why did I choose do this? Well, my investment philosophy, which is closely aligned with Buffett’s (hopefully), is rooted in investing for value. Purchasing companies that are trading at a substantial discount to intrinsic value, book value, or earnings is central to this philosophy.  In my opinion, SPY has become overvalued and other opportunities warrant the capital originally allocated to it.  For example, Mazda Motor corp is trading at a discount to book value by nearly 30% and has a stellar balance sheet.  Another great opportunity is Intel, which is trading at 12x earnings and 3.2x book value compared to 23x earnings and 3.35x book value to SPY.   

You might be asking how do I reconcile my decision to liquidate my position in SPY while I continue to own equity in Alibaba and Tencent.  These holding do not represent value in the traditional sense, but their competitive “moat” makes up for these shortcomings.  Alibaba and Tencent dominate the Chinese domestic market, the second largest in the world.  While, both companies trade at a premium to earnings their competitive advantages compensate for this premium.  However, their shares are hovering close to a value that represents too large a premium and may have to be liquidated soon. 

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Fooled By Randomness

Success and Markets have an overarching connection: both are random. Fooled by Randomness does an excellent job conveying the randomness and luck involved in being successful.  Through brilliant story telling Nasim Taleb offers a powerful argument concerning the lucky success of traders.  Through his use of statistics, he systematically disregards speculators whom tout successful track-records.  By discrediting speculating and technical analysis Fooled by Randomness serves to legitimize value investing as a worthwhile investment strategy.  While the book delves, heavily into statistics it was designed with the lay person in mind.  With a snarky attitude, Fooled by Randomness offers a unique take on luck and is quintessential to a more thorough understanding of the markets.  I would highly recommend this book to anyone who regards technical analysis as a legitimate investment strategy. 

“Heroes are heroes because they are heroic in behavior, not because they won or lost.” 
― Nassim Nicholas Taleb, 
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Why Mazda Motor Corporation is a good investment

When buying a company as an investor you take a risk.  As a value investor, we try to mitigate these risks by understanding the underlying value of a company.  If a company were to liquidate, their value in liquidation would be determined by their net tangible assets or their net asset value. By understanding the net tangible asset value, we can determine what our margin of safety is.  If a company’s market capitalization is lower, then it’s net asset value it is trading at a discount.  If a company’s net tangible assets are double the market capitalization of the company that means for every dollar of equity you buy you get $1.5 in assets.  That represents a 50% return on capital.  Therefore, Mazda MZDAY: (%) represents an attractive investment at its current price. I will liquidate my position in this company after its market capitalization reaches its net asset value.  At a 50% discount on tangible assets, I would be hard pressed to find a more attractive use of my capital. 

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Speculator vs Investor

There are a lot of misconceptions about what an investor is and how you should “invest” in the stock market.  Investors… Real Investors focus on capital appreciation for minimal risk.  Investors attempt to maximize their income for the smallest amount of risk incurred.  However, the “investors” or speculators focus on trading pieces of paper back and forth called stocks.  While the speculator views stocks as pieces of paper the investor views stocks as a portion of a company, a value producing asset. 

When a person speculates, they focus solely on resale value, being able to sell the stock at a higher price. The speculator’s only opportunity lies in selling their asset at a higher price, but an Investor has several ways of realizing a profit. When a person invests in a stock they expect in one of three ways. 

1.From free cash flow generated by the underlying business, which eventually will be reflected in a higher share price or distributed as dividends 

2. From an increase in the multiple that investors are willing to pay for the underlying business as reflected in a higher share price 

3.By a narrowing of the gap between share price and underlying business value. 

Speculators take comfort in being with the consensus.  It is valuable, psychologically, to have someone agree with you.  Investors can take no solace in the consensus because they must have a perspective that differs from the masses to be successful.  When a sell-off begins speculators begin selling even more, fearing a further depreciation in price, and further drive down the cost of the asset.  Upon seeing the sell-off the Investor adds to his position instead of liquidating.   It is speculators that provide the opportunity for investors.   

I’m not saying traders don’t profit but on the aggregate, they will not because it is a fool’s game, but an investor if their analysis correct will always profit.  It is because they buy into the fundamentals not a piece of paper.  While it may be difficult to become an investor it is almost certainly worth the reward. 

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Building Your Portfolio

When building your portfolio, you must answer one question: What are your goals? 

This is a difficult question to answer but a good investor wants to maximize their returns for some level of risk. This is called CAPM or Capital Asset Pricing model.  CAPM is a model used to determine a theoretically appropriate required rate of return of an asset, to make decisions about adding assets to a well-diversified portfolio.  We will utilize this model for setting guidelines regarding different investment strategies. 

Low Risk Defensive Portfolio: 

This type of portfolio is for a person who wants to realize minimal returns for almost no risk.   If we are focused on conservative asset allocation than we need to look as low risk assets.  Bonds tend to be an asset class with significantly lower risk than stocks but also have significantly lower returns.  However, bonds are not created equal which requires us to look at some asset subclasses which we can add to our defensive portfolio.   

U.S. Treasuries: Issued by the United States Department of the Treasury, these types of bonds are generally considered to be the least risky. 

Municipal bonds: Debt issued by states, cities or other local government entities are commonly known as munis. These debt instruments help finance municipal activities and projects. 

Corporate bonds: Corporate bonds typically have maturities of one year or longer. Corporate debt with maturities under a year is known as commercial paper. Bonds issued by companies with high credit ratings are referred to as investment grade or high grade, rated BBB and higher. 

This is CAPM applied to various assets.  As we can see we should focus on Government Bonds and Investment-grade Corporate debt.  In addition, another very defensive position to hold is cash.   Now that we know we should focus our asset allocation on government securities and investment grade bonds we can set guidelines for our defensive portfolio.  If we want a relatively defensive portfolio, we can have 60% of our assets in Treasury Bills another 30% in investment grade bonds and 10% cash.  Regardless of the exact percentages focusing your assets in these asset classes will make a much more defensive portfolio than a portfolio with a high exposure to the stock market. 

High Risk High Return Portfolio: 

If you are at the beginning of your career and have very little in savings this is the strategy you would want to follow.  If we look back to our chart, we see small-size equity offerings as a risky yet fruitful investment.  In addition, equities located in emerging markets tend to be very risky and offer large returns.  For this portfolio we want to focus on asset classes that are very volatile and have a high beta.  These assets offer the most upside yet is inherently risky.   A baseline for this portfolio could be 20% large cap equities, 40% small cap equities, and 24% emerging market etf’s.  We can change the degree of risk for the equity heavy portfolio by allocating more assets towards large cap equities to reduce risk or increase the capital allocation towards emerging markets to make our portfolio more volatile. 

Income Investor Portfolio: 

This type of portfolio is great in retirement.  If you need cash and do not want to liquidate your holdings dividends are a great way to subsidize your income.  This type of portfolio is relatively risky because equity prices are subject to lots of change.  This portfolio is heavily focused on large cap equities that pay dividends.  In order to reduce the risk of decreasing asset prices long-term options offers insurance from this risk.   


Portfolio building is difficult and dependent of your goals.  Once you understand what you want to achieve it is easy to balance your portfolio in a way that is right for you.  CAPM is a great tool to use once you understand your goals.  However, the best way to reduce any risk is through extensive research.  The best advice I can offer on portfolio building is to thoroughly research the assets before you aquire them. 

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The 2019 recession: Why it’s here.

The 2019 recession: Why it’s  coming.

Two years out is when I’m worried about,” said Dalio. “It’ll be more of a dollar crisis than a debt crisis, and I think it’ll be more of a political and social crisis. 

-Ray Dalio September 2018


Two-thirds of business economists in the U.S. expect a recession to begin by 2020 with another ten percent see the next contraction starting in 2019 according to the National Association for Business Economics.  The economists cited trade policies and rising interest rates.  New macroeconomic developments suggest we are headed this way.  Recently Apple announced a rare guidance cut to its earnings citing the slowdown in China’s Economy.  It also cited that the “strong US dollar [created] foreign exchange headwinds.”  The curve yield for the 3-5-year treasury bond inverted; the first time since the 08-09 financial crisis.  In addition, recent developments such as the prolonged government shutdown have adversely affected the border economy.  These developments will cause an economic retraction soon. 


Emerging Markets:  


After Apple’s earnings revisions many analysts believe other companies will report lower earnings, attributable to a slow in emerging markets.  China reported the lowest GDP growth since 1990 with annual growth rate of 6.6%.  China is also lowering its growth projections for 2019 aiming for a 6% growth rate.  This growth rate will prove exceptionally hard to meet because of the trade tensions between the United States and China.  The slowdown in emerging markets isn’t only affecting China.  The Chinese market will also continue to face downward pressures because of the prolonged trade war.  Xi Jinping will probably diffuse the situation by promising to buy more American made goods to reduce the trade deficits without conceding any long-term reforms.  In Turkey economic growth slowed to 5.2% growth year-over-year slightly less than its expected 5.3% growth rate.  This growth is significantly slower to last year’s growth rate of 7.4% An emerging markets forex strategist said, “The Turkish economy is widely expected to lose even more momentum in the coming quarters as a result of significant lira depreciation,” 


Interest Rate Hikes: 


The United States corporate debt load is quite significant sitting at $9 trillion dollars.  Increasing interest rates will put downward pressure on earnings and cost companies more to service their debt.  Jerome Powell, the chairmen of the board, has stated recently that the fed has no “planned interest hikes.”  His statements coupled with the good jobs report are the reason for the surge in equity prices.  Jerome Powell also sees no reason for the economy to enter a contractionary period in the near future.  However, he has said that the Fed is prepared to raise interest rates to meet the 2% inflation rate. 



There are two main political points worth discussing both stemming from the current administration in the United States: trade: The trade wars with China and the government shutdown.  If the trade wars with China become prolonged it will have a severe determinantal impact on global growth.  However, these trade wars are largely ineffective China’s trade surplus with the U.S. hit a record high $323.32 billion a 17% increase YoY.  Thus, if Trump’s aggressive trade policies are ineffective perhaps a rethinking of his approach without  

The second point worth discussing the government shutdown actual economic impact is marginal to the psychological impact it has on equities.  Economists estimate that each week the government remains shut down it costs the economy $1 billion to $2 billion dollars a week.  These numbers are mere rounding errors in an economy that produces $20 trillion dollars in goods and services a year.  However, a protracted government shutdown has never persisted.  The data regarding a protracted government shutdown does not exist.  Thus, it is difficult to predict how a protracted government shutdown will impact the American economy. 

Image result for pennies


There are dissenting voices on the timeline of the next recession, but it is inevitable that the economic contraction occurs.  While certain over politicized factors like the government shutdown may not have a macroeconomic effect, it may affect people’s perception of the U.S. economy pushing asset prices lower.  However, economists are not worried of an economic contraction but rather a slowdown of the expansion the world has witnessed.  In addition, Jerome Powell has stated that the Fed policy towards tightening rates is very flexible.  These factors along with a slowdown in emerging markets suggest a recession is within the next two years. 

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Wendy Needs International Markets

  • Wendy’s opportunity lies in the International markets 
  • Wendy’s Capital Allocation Program dooms the future of Wendy’s performance 
  • The domestic market is Competitive, and Wendy will cede market share to smaller more versatile companies 


Wendy’s is the sixth largest QSR business in the United States with systemwide sales exceeding nine billion dollars and global systemwide sales of more than ten billion dollars.  Wendy’s International Franchised stores made only a sliver of these sales with 477 million dollars.  In addition, by 2020 the international franchised restaurant industry is expected to be worth $5 trillion. 


While there are certainly challenges to overcome in the domestic markets the opportunity international markets provide the company will outweigh the loss of any market share in the domestic arena.  


The book Good to great underlines some key aspects a great company needs to have.  Applying these concepts from the book to Wendy’s provides a few key indicators to look for.  One of the themes throughout the book was the idea that management must be superb.  The common thread linking great management is their continued involvement within the corporation and their loyalty towards their company.  These types of leaders are required to improve existing parts of the company or a new endeavor.  Abigail Pringle, the head of international development at Wendy’s, is a long-time company insider 

Ms. Pringle joined the Company in May 2002 and has served as our Chief Development Officer since December 2014. She served as our Senior Vice President of Restaurant Development and Growth Initiatives from July 2013 to December 2014, Senior Vice President of Strategic Initiatives and Planning from April 2012 to June 2013, Vice President of Strategic Initiatives and Planning from November 2008 to March 2012 and Director of Strategic Initiatives and Planning from May 2002 to November 2008. Prior to joining the Company, Ms. Pringle worked from August 1996 to May 2002 for Accenture plc, a global professional services company, where she served as a consultant in the areas of process re-engineering, systems implementations, organizational design, and change management. 


With a capable leader at the helm, other factors must be looked at to see how Wendy’s can compete in the international QSR business. Wendy’s management has been doing this recently expanding their international presence.  In Q3 of 2018, Wendy reported: “another impressive quarter of double-digit growth at 13%”.  The idea that management is focused solely on expanding Wendy’s operations brings us to another Good to Great concept.  The book Good to Great states every “great” company has had a strong strategic concept and focused solely on it called the “Hedgehog” concept.  


If management acknowledges this truth and works towards utilizing cash flows towards expanding in the international environment Wendy will recognize large growth.  For management to more effectively compete in the international marketplace more cash must be retained in the company.  If we recognize that Wendy must retain more cash to reinvest in its international operation to expand then its capital allocation program seems foolish at best.   


In a hypercompetitive domestic marketplace, the largely underinvested international markets offer Wendy’s new opportunities in redefining its position in the QSR industry.  While they contend with Restaurant Brands International (parent of Burger King) and McDonald’s with burgers Wendy has an opportunity to redefine this relationship.  By focusing on higher margin, healthier products Wendy can change the battlefield.  


With changing consumer trends, the continued perception of Mc Donald’s and Burger King as unhealthy allow Wendy’s to rebrand themselves more aggressively and dominate a larger portion of market share.  However, if Wendy does not adapt quickly enough substantial market share will be controlled by smaller enterprises such as Chic-fil-a. 


But if Wendy is not able to change the conditions on which this game is played the future looks bleak. It seems very unlikely Wendy will be able to do this with its capital allocation plan. This idea of giving excess cash back to investors goes against the hedgehog concept of focusing on international growth.  By not retaining its earnings and adapting to the hypercompetitive domestic market and ceding market share to smaller companies Wendy seems doomed to mediocre performance. 



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Berkshire Hathaway an Enduring Investment

Berkshire Hathaway an Enduring Investment

  • The economy is about to go into a recession and cash is king 
  • Berkshire Hathaway is well positioned with the companies it owns to power through a recession 
  • Warren Buffett has a 100 Billion to buy equities when the recession hits and its primary business will continue to perform even in an economic contraction.


The Federal Reserve has been tightening monetary policies and raising interest rates.  In addition to the Fed’s tightening policies, the 3-year and 5-year yield curves have inverted.  These changes come at a time when global economic growth has been slowing and after the longest economic expansion in history.  It is clear we are within two to three years of a major economic recession. As legendary hedge fund manager Ray Dalio said, “we are in the 7th inning of the current economic cycle.” Thus, with the looming recession, investors must look for securities that perform well in times of economic contractions. Berkshire Hathway is well positioned to not only survive but perform exceedingly well in the upcoming recession. 


Breakdown of Berkshire Hathway: 

There are two main components of Berkshire Hathaway.  The first is the investment side of Berkshire.  I define this side as the minority holdings in publicly traded companies and the income created from investing with the insurance float.  The second component of Berkshire is the fully owned subsidiaries.  I term this side of Berkshire “Physical Berkshire”.  Each component offers a path for Berkshire to succeed in the upcoming recession.  

Physical Berkshire: 

This component comprising of the wholly-owned subsidiaries is imperative to the success of the company and accounts for slightly more than 10 billion dollars about half of Berkshire’s net earnings (Earning not including Tax Cut).   

Net earnings                                                                                                 2017     2016      2015 

Insurance – underwriting …………………………………………………$(2,219) $ 1,370 $ 1,162 

Railroad …………………………………………………………………………………3,959     3,569    4,248  

Utilities and energy …………………………………………………………… 2,083      2,287   2,132  

Manufacturing, service and retailing ………………………………6,208      5,631   4,683 

Physical Berkshire, during times of high interest rates, benefits greatly from the cash it can borrow cheaply from the investment side.  This free flow of capital is great for capital-intensive activities like railroad and manufacturing.  As the Fed continues to increase interest rates, Berkshire will be more successful than the broader market.  While this company will be more competitive relative to its peers, it too will suffer during an economic contraction.  

The manufacturing, service and retailing portion of Berkshire Hathway will suffer significantly during a recession.  This portion of Berkshire accounts for about half of Physical Berkshires’ net income.  While the recession will hurt Berkshire in this area it will be more than made up for by its investment arm.  Physical Berkshire also includes its insurance underwriting segment.  The underwriting segment will begin to incur increasing losses due to climate change.  As major catastrophes begin to become more common the underwriting portion of Berkshire will see material adverse changes.  We have already begun to see this with the loss incurred from Hurricane Harvey in 2017.  However, the fully damaging effects of climate change will not need to be considered within the next decade.  Thus, in the near future, we can expect the net income from the underwriting segment to be positive. 

Each portion of Physical Berkshire save manufacturing, service, and retail are recession proof.  Insurance, energy, and railroad are all necessities in the face of an economic slowdown.  These industries will continue to produce large returns even in a recession something many other companies will struggle with.  This makes Berkshire Hathway a sound long-term investment especially with a recession on the way.  

Investment Berkshire: 

The investment portion of Berkshire contains Insurance – investment income, Finance, and Financial products, as well as investments.  These investments account for a significant portion of Berkshire Hathaway’s net earnings. 


Net earnings                                                                                         2017     2016     2015 

Insurance – investment income ………………………………………………..$ 3,917   $3,636   $3,725 

Finance and financial products …………………………………………………..1,335    1,427    1,378 

Investment and derivative gains/losses ……………………………………1,377    6,497    6,725 

Right now, Warren Buffets portfolio is split between equities and cash.  Cash currently accounts for 34% of Berkshire Hathaway’s portfolio. 




Having such a large cash position before entering the recession will position Berkshire strategically to succeed in the economic contraction.  This large position in cash is a testament of Warren Buffets belief the economy is headed into a recession.  In 2008, after Lehman’s Brother’s collapse, Buffett took advantage of the financial meltdown and profited handsomely.  If history is any predictor of the future, Berkshire will be well positioned again to succeed in the next recession. Thus, Warren Buffet is ensuring Berkshire Hathway’s success through this economic slowdown by having a large position of capital. 

 Having such a large cash position before entering the recession will position Berkshire strategically to succeed in the economic contraction.  This large position in cash is a testament of Warren Buffets belief the economy is headed into a recession.  In 2008, after Lehman’s Brother’s collapse, Buffett took advantage of the financial meltdown and profited handsomely.  If history is any predictor of the future, Berkshire will be well positioned again to succeed in the next recession. Thus, Warren Buffet is ensuring Berkshire Hathway’s success through this economic slowdown by having a large position of capital. 


Berkshire’s cheap capital allows for Berkshire to perform well even with increasing restrictions on credit.  Berkshire Hathway is also poised to utilize its capital to make strategic acquisitions to further its competitive edge in its physical segment.  These factors make Berkshire Hathway a solid long-term investment even in the face of an economic recession. 


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Made In America by Sam Walton


In my quest to understand the financial markets and receive valuable insights I turn to books.  Understanding the markets is very nuanced and complex but literature helps to bridge this gap and make the markets more accessible.  Thus, the books I recommend have helped me considerably in trying to grasp this complicated world.

In order to evaluate a company to be a viable value investor, we have to look holistically at a company.  Understanding the difference between successful companies and bankrupt ones requires an understanding of how they were created.  This link between company creation and success give corporate biographies incredible value.

Made in America, by Sam Walton gives invaluable insight into identifying qualities that make a company successful.  The book is not only humorous but a solid piece of financial literature.  Made in America will highlight qualities an adept investor should look for in evaluating a prospective company.  While the book centers around Walmart the lessons it shares transcend far beyond the realm of retail.

I highly recommend this book as a present or a quick read during the holidays.  If you read this book or have read it, please leave your comments below.




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Synchrony Financials Loan Loss Provision Analysis



  • Synchrony has close to a 6 – 6.8% of Total Loans Receivable as Provisions.
  • Industry Standard for Loan Loss provisions is 2 – 2.5% of Total Loans Receivable.
  • What does this mean to quality of assets listed on their balance sheet.


Synchrony financial (SYF) deals in the private credit line for business.  They have a very unique position in the health care sector compared to other banks. After buying Citi Corps portfolio of consumer credit debt in healthcare, Synchrony has become a dominant player in that arena.


While the company enjoys the “moat” of competitive advantages, analysts worry about asset quality especially after the last earning release in Q1.


Even with earnings beating the Streets expectations by close to 9%, the share price remained relatively unchanged. This primarily has to do with the quality of loans in Synchrony Financials portfolio. In the chart below, it is evident how the relative percentage of coverage for loan loss stacks up to its competitors.  

Two of the largest banks, Citi and Wells Fargo, have had decreasing percentages of loan loss provisions. In addition to lower percentages in subsequent years, they are also significantly lower than Synchrony Financial and Capital One.


Seeing how high the provisions are for these losses, warrants a special look at the quality of these loans. The graph below, from Synchrony’s 2017 annual report, shows the breakdown of the loans they have been amassing.


Seventy percent of all Loan receivables come from their Retail Credit line. It also demonstrates the significant amount of 20% from their payment solutions.


The annual report does not show what percentage of loan loss provisions are tied to each operating sector.  However, any increases in allowance for Payment Solutions through the fiscal year (2018) can be accounted for through the acquisition of the PayPal portfolio.  This is evident in the following quote from their 10-k, which says:


In addition, we also expect increases to our allowance for loan losses in the second half of 2018 to establish appropriate loan loss reserves for the PayPal transaction, which we expect to close in the third quarter of 2018.”


The acquisition of this debt explains the huge uptick in Loan Loss percentage between Q’4 of 2017 and Q’1 of 2018, which was given a larger allowance.  Even with the PayPal acquisition, there is no explanation for the 26% increase between 2016 – 2017.


In addition, the acquisition of PayPal debt portfolio can only explain an increase in Q’3 and Q’4 of this year.  So naturally any increase in the loan loss provisions between 2017 and 2018 Q’1 & 2 must be explained.


In examining the first earnings release this year, things get even uglier with provisions for loan loss increasing tremendously y/oy from  6.37% to 7.37%. Not only is the allowance for these delinquent debts increasing year-over-year, but it is expected to get worse as the quote below will demonstrate.


We also experience a seasonal increase in delinquency rates and delinquent loan receivables balances during the third and fourth quarters of each year.


This is due to the latter quarters including many holidays and is known to be a huge time for consumer spending.  But this means continued coverage of these through the allotment of capital.


With these huge increases of capital to cover these potential loses comes a great opportunity cost. Keeping this capital secure and away from investments means that it will be hard for management to put this capital to work.


Not only is this huge allowance for loss hindering future growth, it is also hindering current performance. At the end of fiscal year 2017, Synchrony Reported the following:


“Net earnings decreased 14.0% to $1,935 million for the year ended December 31, 2017, primarily driven by increases in provision for loan losses and other expenses.”


Although Synchrony enjoys being the largest private credit line in the world and has an unique position in the healthcare sector to provide credit, it is hindered by the allotment of capital to loan loss provisions. Synchrony is in a position to reap the benefits of its position in the healthcare industry to capture huge revenues by becoming the sole provider of consumer credit in that arena.  


While Synchrony is on a strong footing in its private credit line business, it has some major obstacles to overcome in the future which investors need to continually monitor.