New Investment: Ternium S.A.

In my last post I mentioned that I  intend to recommend stocks in one industry as it is cheap. I'd like to retract that. I was talking about the oil industry but I have found a few other stocks I think are interesting to look into. So I will  give an oil stock or two in the coming days, but for now let us go into one of my favourite industries, actually my favourite, Steel & Iron.

I always loved mining, a simple business that anybody could understand. Just find a mine with some precious metals in it, acquire it which is the majority of the cost and then you pay people to excavate which is a lot cheaper than you think (relative to revenues). But this industry does not lend itself easily to financial statement analysis. Typically every few years they have a bad year, and with no explanation. Free cash flow is always very low and still means nothing. Though I have never been able to verify it, my theory has been that they spend a lot of capital expenditures on acquiring more mines or doing research on them. Either way, I have found over time these businesses are worth       8-10x earnings.

The stock I am recommending is Terniu SA (TX). When we look at the balance sheet, we don't exactly see a fortress balance sheet, but a solid one nonetheless. Current assets are only slightly below twice the current liabilities and total assets is only slightly below total liabilities. So highly unlikely to go bankrupt anytime soon.

Next comes the income statement. Margins in TX was about 6%-7% in 2013 and 2011. Bad years happen and in 2012 it was only 2%. Cost of Goods Sold was a bit higher that year relative to price. From what I've seen, even good companies in this industry periodically have a bad year, but we shouldn't let it affect us. After all the balance sheet has remained solid through this. So income statement seems solid.

Now the cash flow statement. As you may notice capital expenditures are very close to operating cash flow giving it a free cash flow of approximately 0. I have never fully understood why but for mining capital expenditures tend to equal operating cash flow quite often and it has never been a worrisome figure. If it was deep in the red I would be worried about if there is any real money in this business but as this business has paid dividends for years and remained so well capitalized I tend not to worry too much.

As the business is right now at 5x earnings and the analysts expect it to continue for the next year or so I recommend this stock as a buy with a selling price of approximately $30.

You may also be wondering why I like this industry so much when so little can be evaluated. I find that it is easier and faster because cash flow statement just needs to be glanced over to make sure free cash flow is not too far negative, balance sheet was always an easy calculation and the income statement shows your profits. Doesn't mean I can't be wrong, just that it is simpler to put the odds in your favour in this industry.

Updates and Companies to Consider Selling

Let us open with some bad news. I said I would not buy Microsoft because it is too confusing what will happen. In the ended they almost doubled in price in 2 years. Again, I do not have a crystal ball to see the future with. When it's too cloudy I go to a different opportunity. So for not recommending I do apologize but only someone who understands technology really well would have been able to see this coming. I'm not that good at it.

I also recommended to sell Blackberry because their phones were not that great, and I couldn't see the value in the business. I still don't and in the last year and a half the stock has gone nowhere. The new phones some people like but I am not that impressed. Sales are low, and quite frankly their specs still have not caught up to the other large companies. So no I do not have faith in BBRY at this time and thank god I was justified last month as well.

My first two posts shows that I gave advice that made no money. Idiotic, isn't it? So I would say bad things about myself except that I did give some advice that made money. So let's look into that.

Tim Hortons was a stock I recommended about 2 years ago. It was bought out for approximately 50% more than when I recommended it in cash and stock. Considering you had held it for approximately 2 years you got a rate of return of approximately 20% compounded. I was hoping to get that for the next 10 years, but Burger King saw the value and scooped it up at a price I believe will be considered a bargain in the next decade. So good for them. I recommend selling the stock in the new company as it seems a bit overpriced and there are bargains now.

Now we come to Hewlett Packard. This is the company you made the majority of your money in if you only followed my advice. This stock is up a whopping 150% in the last 2 years. Unbelievable right? I recommend a sale only because I think there are better stocks to buy now. Nothing against the company, If you want to hold on to the stock, hold on to the stock, but I am going in a different direction and would recommend a sale.

For those of you who want to know my track record. I only made 3 recommendations in the last 2 years. One of them was an error that I recommended a sale at a 10% loss. The second stock gained 50% and the third one gained 150%. I rounded down the returns because I don't know what price would have been reasonable for people to get into the stock. If that is the case then on average each stock returned 63%. So your average return if you put equal amounts in those 3 stocks on an annual basis is 27%. You can call me lucky if you want, but I was hoping for better returns actually.

The problem you have now if you follow my advice is that all your money is in cash, so what do I invest in? Interestingly enough, if you pay attention to everyday things there is an entire industry that looks to be cheap and I am considering diversifying into that industry. You can call it risky, I do not agree because this industry cannot easily be replaced. See you all soon.

Why so Few Updates and Updates on THI and HPQ

I know you all thought I was done with this site. Nothing could be further from the truth. The thing is, when there is nothing to do, nothing to invest in, what can I write on? This is an important lesson in investments, when there is nothing to be done, do nothing. You can screw up some fantastic investments simply by doing something for the sake of it. So if I have not said anything, it is because there is nothing to buy. Don't worry, typically a period of nothing to buy is followed by a large number of companies becoming undervalued. Be patient. There is one stock I own, but I don't want to recommend as it seems self serving, though I do believe it is still undervalued.

Nothing has really changed at THI, I think it is a growth stock that will grow for a few more years at least. This is a really patient play, and as I am not patient you see my former point of not having enough undervalued companies. Still not a lot of stores in America, and don't know for sure if it can unseat Dunkin' Donuts, but I like their chances, and there are other countries to expand to. Recently they announced they will open another 500 stores in Canada. Why not? It's been unbelievably profitable here. Let us see where this takes us. So hold the stock. I don't really have a price target but if it ever gets to 40 times earnings, it is probably a sell, though again, take everything into account.

HPQ is interesting. I cannot say why but my assumption is that the earnings power of HPQ is $3.60 per share per year. As a result with a multiple of 10, I would sell it at $36. Hold onto it for now, as really there is nothing else to buy. $30 is what it's at now, but I really cannot find cheap companies to replace it with. The business is running along smoothly with nothing new to report and I expect it to for a while.

Update on Hewlett-Packard and Tim Hortons

As you know, last year I recommended Hewlett-Packard (HPQ) and Tim Hortons (THI). I decided to do an update on these stocks. I'd like to point out, that HPQ has beaten the market while THI has just kept pace. This may make people think that the picks were correct, but that is not what we should look for to see if they were correct. For that, we should go to the facts about the companies and how they are operating.

Let us begin with HPQ. Last year their profits were negative due to $20 billion in non-recurring expenses. If we ignore these expenses they made about $7 billion to $8 billion. $11 billion was for a write down of a terrible acquisition called Autonomy. A lot of people believed they were paying 1999 dot com boom valuations for it. It seems they were right as $11 billion is close to what they paid for it. So they essentially wrote down the entire investment. Then there were charges for layoffs and other restructurings. These seem to be non-recurring so we can reasonable expect HPQ to make $7-$8 billion per year in the long run. That puts the valuation of the company between $70 billion to $80 billion if we assume a P/E ratio of 10 which is typical. As the current valuation is approximately $50 billion you are looking at about a 50% upside and if they can grow earnings it can do better. I am a huge fan of Whitman as she built up the Ebay empire so I think for now HPQ should still be a buy, but of course it is not as undervalued as before. Another reason HPQ is good right now is that there really are not a lot of companies that are undervalued. So I would still recommend it.

Now we must discuss THI. Excellent company that I believe can grow to compete with Starbucks (SBUX). SBUX has profits of $1.3 billion so THI can become that big. As a result I see at least 5 years of growth left at 15-20 percent per year. The company is phenomenal but the profits have been stagnating this last year. The last 4 quarters combined have basically left profits around the same level as the profits of the previous year. Part of that may be the $25 million in non-recurring charges in the last 4 quarters. I would still say to be careful, but I believe THI has another 5 years to go and so would still classify this as a growth stock and give it a buy.

Note I didn't talk too much about stuff that was previously covered. If anything had changed in a major way I would have. These 2 stocks remain a buy for now. Which reminds me, never think that just because a stock has gone up means it cannot go higher, and never think if a stock has gone down it cannot go lower. Bankruptcies prove the latter, and stocks of companies like General Electric prove the former. So just evaluate the business at that time and even if it has gone up a lot, if the price relative to value is low, buy it.

Blackberry Is a Sell

I know my previous article said to buy RIMM which changed its name to Blackberry. However, times change, and we must change our views accordingly. Also, I made some silly errors in my last post. So let us delve right into it.

Regarding the financial statements, Blackberry is as strong as ever. On the balance sheet the company has no debt and lots of cash. Income statement in the last few quarters has been all losses but modest losses. When a billion dollar enterprise  losses 10s of millions of dollars, it's a bad quarter but we have to look at why as the losses are not significant. Even if the free cash flow was positive (I didn't even look for it) I would ignore it because of net income being negative.

So why am I telling you to sell Blackberry at about a 10% loss? The first thing I say is if a company cannot be expected to make huge profits (at least double your money) don't buy it, and if you own it sell it. Admit your mistakes quickly. That way you can buy something else that will double your money. And in the long run a 10% loss is nothing, but losses should teach us something no matter how small the loss was. So that is the first thing you gotta think about. I think Blackberry at the moment offers very little profit.

Now why do I think that? First I do not like their new phones. By the way, I'm a huge fan of Blackberry. I should probably be institutionalized for it. The phones are awful. You have the Blackberry Z10 which is a 4.2 inch phone with a 1.7 GHz dual core processor and 2GB of RAM. Not a bad phone by itself but the Nexus 4 which comes unlocked and at a price of $300 to $350 is a 4.7 inch phone with a 1.5 GHz quad core processor and 2 GB of RAM. Blackberry Z10 price is at least $500. You may say the phone companies give you discounts, but they don't just give it for the Z10, they also give it for the Nexus 4. So they cannot really compete with it. Apps may be another issue, but being able to port Android apps may help. However, not enough for me to say I would want that phone.

They also came out with the Blackberry Q5 and Q10 phones. These are the most promising. The reason I say that is that the keyboards make them unique as most phones are full touch screens. However, this means the phone is large but the screen is small to the tune of only 3.1 inches. The screens are touch but what can you really do with 3.1 inches? The Q10 is a dual core with 1.5 GHz and 2 GB of RAM whereas the Q5 is 1.2 GHz dual core with 2 GHz of RAM. Not bad. The idea was good but the pricing was awful. The Q5 is $350 in Canada whereas the Q10 goes from $600-$700. Considering the Q5 is supposed to compete with the cheaper phones, why is it priced higher than the technically superior Nexus 4? In my opinion the pricing is what's killing Blackberry right now. These are not superior phones. These are mid tier phones and in the case of the Q5 a low tier phone and prices should be ruthlessly slashed. Another warning I want to give investors is regarding pricing of products. Peter Lynch once noted that the closer a product is to a finished product the faster the price declines. So an out of style dress which once retailed for $300 may not sell for $3 now. Whereas the material to make it such as cotton probably has not fluctuated a lot in price. So typically it is safer to invest in products that are further away from the consumers. Ironic considering all the stocks I have recommended have been very close to the finished product.

So we do not know what the next product will be for Blackberry. Hoping it will good enough to save the company is just pure speculation. And Benjamin Graham always knew that investing is better than the speculation. I apologize for the loss and sincerely hope I do not make too many of these. Next topic is a bit cheerier, HPQ. Remember I recommended it a while back? It's an interesting company and one I intend to discuss. So sell Blackberry, I'm sorry and we'll discuss HPQ next.

Is RIMM undervalued?

You must be curious as to what the valuation on RIMM is. After all I talked about it in my last post but I did not give you a valuation. So let me try to give you a valuation on RIMM and you'll see how I did what I did.

Let us begin with the usual. The financial statements. The balance sheet is outstanding. Long term debt is practically non-existent. Cash is at $2 billion which covers 2/3 of total debt. There is no bad debt on the balance sheet at all. The majority of the debt is accounts payable. So this company's balance sheet is given an A+.

Now the income statement. Although the last 3 full years have been profitable, we know that there have been losses in the last several quarters due to pathetic (yes I said it) phones. It would have been better if they were cheaper, but RIMM wouldn't even give that. Now the profit margins in those three full years were 16.4% (2010), 17.1% (2011), and 6.3%. As there have been losses in the last few quarters we have to give them a D. I know the grade may be low but also remember if they can significantly improve this back to 16% profit margins it would still be a buy.

Now we come to the cash flow statement. Here we notice that all three years the free cash flow has been positive, but in 2010 and 2011 FCF was lower than net income while in 2012 it was higher than net income. Interesting to note. What people fail to realize is that with the exception of quarter 4 2012 RIMM has had a positive FCF in every quarter including the last 2. Which is good but of course the amount has been going down. As it was not negative in the last 3 quarters we can give this a D+. Bad financial statements but if it has a legitimate plan to turn it around, we can expect a profitable year.

So how will it be turned around? First we have to ignore the buyout rumours. Thorsten Heins said he is not selling. Instead he wants to stake the company's future on the Blackberry 10. I think it's a good idea and quite frankly  Of course that depends on the specifications of the phone. Luckily they leaked out and we learned that they intend to release several Blackberry 10 very quickly one after the other. It's a good idea if the products are significantly better and fast. Let us see the specifications for the Blackberry 10 London first.

So what are the specs of the Blackberry London? And do I like it? That is what I'll try to answer here. The Blackberry London has a 4.2 inch screen. That's small compared to a lot of phones but still bigger than the Iphone 5. It has a dual core processor even though many phones nowadays have a quad core, however, if we compare it to the Iphone 5, Apple's latest flagship phone still has a dual core processor. It has an 8MP camera with a 2MP front facing camera. Now notice that this phone is not competitive with Samsung but is competitive with Iphone 5. Problem is, Iphone 5 came out months ago and this will come out in the next month and a half to 2 months. So the next Iphone should be better. That sounds like bad news, but luckily RIMM knows what they're doing this time and expects to release other phones within months. Now those should be able to compete with the next Iphone and maybe even the Samsung Galaxy S4. But don't take my word for it. Let's discuss them next.

So what is the best expected phone from the Blackberry 10 line? It is the Blackberry Aristo. Aristo is Greek for best. So when specifications of this phone leaked out, I realized it should be the best Blackberry 10 that comes out. When I looked at the specs I was actually impressed. The screen size is 4.65 inches. I hope they make that bigger as that is kind of small compared to Samsung S3 or especially the Note 2. However, it is huge compared to the Iphone 5 and will probably be huge compared to the next Iphone. As for the processor it is 1.5 GHz quad core. Not bad. Cameras are the same and to be fair, after 5MP I failed to see an improvement but they have an 8MP camera with a 2MP front facing camera. So these specs show that they can compete with Samsung Note 2, but by then the S4 will be out, so the only question is whether that is vastly improved from the Note 2. Hard to say but I would expect it to at least be better than the Aristo. As a result I see this as being better than the new Iphone and worse than Samsung. Also we haven't really talked about the lack of apps, but if Android can build up their app store as fast as they did, Blackberry should be able to follow suit.

In case you were wondering I gave their strategy an A because the specs are competitive. Now, what can we expect in terms of profits. If these phones cannot be as good as the  next Iphone then I would expect low profits. Maybe $1 billion but that's a conservative estimate as these phones are better than everyone other than Samsung and Apple at that point. What I expect is for the next generation blackberries to be better than Iphones and weaker than Samsung's, so I expect it at $2 billion at that point. If that is the case valuation of RIMM is $40. At the current price I would recommend buying. If they can beat Samsung's specs, then the profits will be off the charts. So I would recommend a buy on RIMM with a price target at the moment of $40 but changing depending on sales when BB10 comes out.

Value Investing is NOT about being a Genius

This post is not about a stock valuation. This post is about what it takes to be a great value investor. Lots of people believe it requires a genius brain. That helps, but I still say if you're in the top 3% in the world in terms of brains, please just make the world a better place. You can make your fortune that way, and help the world. However, there is one other reason. Humans are hardwired to look for patterns even if none exist. Let me prove it to you. There is no pattern in the set of numbers I am going to give. 1,2,3,4. What is the next number? Did you guess 5? If you did, you're wrong! It's pi. Didn't guess that did you? You may argue that the set of numbers was increasing by 1, but remember what I said. There is no pattern. Even if one appears, it is by random chance. This is the problem faced with the top 3% of geniuses. You still have that bias where you think there's a pattern, except you're so smart you refuse to think you cannot find it, it's just nobody else has. So you keep looking, but in reality there is no pattern. You use your technical analysis to find a price, and then are wrong. You say it didn't follow the pattern, but again the reality is there is no pattern. This is why I say value investing should not be done by people that are in the top 3% or bottom 10% in terms of brainpower.

You may still succeed if you are in the top 3% but for that you need to learn how to control your emotions. This is a lot easier said than done. In fact when lots of people are telling you the opposite of what is true, you may want to consider changing your ideas because you think its wrong, but it isn't. Let me give you an example. When RIMM was at $120, I told a friend of mine it is overvalued. He laughed at me saying that it is worth whatever people are willing to pay for it. Most people at that time saw blackberries as the best device and said it's worth whatever price it's selling at. Remember, just because somebody is willing to pay a lot of money for a stock doesn't mean it's worth that much, however, you can sell it and make a nice tidy profit. In the end I was proven right, stunningly so. The stock crashed to $18 at which point I thought it was undervalued. People laughed at me. The same people who laughed at me when I said $120 was too much. Logic eludes them. After all it's still the exact same company and they think it's fairly priced at $120 and overvalued at $18. Now to be fair it fell further and now is around $13-$14. At this point people are starting to stay it may be undervalued after it doubled in the last month. I'm not saying they're right or wrong, I just find it interesting the way they're valuing it. When it had gone up a lot people said it was worth buying, after it went down a lot people said it should be sold, and now that it has doubled in a month people say it should be bought. This reminds me of something Peter Lynch wrote in One up on Wall Street. He said we always prepare for what has already happened. So if prices have gone up at a ridiculous rate, we think it will continue going up at that rate, even though we should know that is unlikely. This is because after prices go up a lot it has probably (though not certainly) hit it's fair value or more and will probably go down.

So what do we take away from this? First, we must ignore the market and make our own decisions. That is important. We have to analyze the companies ourselves and determine a fair price. Don't just take my analysis, if you disagree, all the better because you probably understand it better than I do. The RIMM thing shows the popular sentiment is not always right. So it is better to ignore it altogether. What you need to succeed in the market is to ignore everyone else and do it yourself. I know it helps if someone better than you analyzes it, but unless you understand his analysis don't follow him because he can change his mind, or even be wrong. Even Warren Buffett's been wrong. So the key is to analyze it yourself and ignore people unless you understand what they're saying and they're right according to you. Also notice that people buy when stock prices go up and sell when stock prices are going down. This is because they are emotional. You must not get emotional about stocks. That is key. As always if you disagree the comments section is below.