Analysis

The Apple Watch Is More Than a Cool Gadget

in Analysis

“You know how difficult it is to explain to a nonparent the joy of having kids? The Apple Watch is the same thing. It’s hard to explain how great it is to someone who has never worn one.” The other day I found myself using this line to explain why I love the Apple Watch. And just as those words came out of my mouth, I realized how I had just cheapened my kids, comparing them to a gadget. So, Jonah, Hannah and Mia Sarah — my apologies. The Apple Watch, as well as many other Apple products, doesn’t make a lot of sense in theory, but in practice it does (I am borrowing from Yogi Berra here). I’ve been wearing an Apple Watch for two and a half weeks, and I have to tell you, this is not a watch; it’s an iPhone extender. If the Apple Watch was called an Apple Band instead, our perceptions and expectation of this product would be very different. When Apple reinvents a category of products, our initial analysis is stuck in the old paradigm. I remember in 2007, when Apple came out with the iPhone, that commentators were arguing that no one would want to...

The Conn’s Paradox, or the Synergy of Awful

in Analysis

One plus one equals three: That is a business school definition of synergy. Two companies join forces, and the quality and profitability of the combined entity improves more than the arithmetical sum of the parts. On the other hand, when you combine two awful businesses you get the inverse synergy: Negative one plus negative one equals negative three. I expected to see inverse synergy at Conn’s when we started analyzing it; after all, the company consists of two pretty awful businesses — a retailer of electronics, furniture and appliances and a subprime lender. However, we discovered the opposite phenomenon and are now proud to reveal Conn’s paradox: the (positive) synergy of awful. Conn’s brick-and-mortar retail business — especially in electronics — has very few competitive advantages. The company sells commodities and is therefore fighting for its life against competitors that are much larger and have greater buying power (think Wal-Mart and Best Buy), often have more-efficient distribution systems ( Amazon) and therefore have structural cost advantages. The subprime lending business is not any better: Just a few years ago, that industry was the culprit that almost bombed the U.S. into a depression. Conn’s paradox is that the severe unattractiveness of each business in...

Buying Warren Buffett, Richard Branson and Steve Jobs at a Discount

in Analysis

What would you get if you crossed Warren Buffett, Richard Branson and Steve Jobs? Answer: Masayoshi Son, the Korean-Japanese, University of California, Berkeley–educated founder of one of Japan’s most successful companies, SoftBank Corp. Just like Buffett, Son is a tremendous capital allocator with a very impressive record: Over the past nine and a half years, SoftBank’s investments have had a 45 percent annualized rate of return. A big chunk of this success can be attributed to one stock: Chinese e-commerce giant Alibaba, a $100 million investment SoftBank made in 2001 that is worth about $80 billion today. Though you may put Alibaba in the (positive) black swan column, Son’s success as an investor goes well beyond it — the list of his investments that have brought multibagger returns is very long. Today, at the tender age of 57, he is the richest man in Japan, and SoftBank, which he started in 1981 and owns 19 percent of, has a market capitalization of $72 billion. Son, like Apple co-founder Jobs, is blessed with clairvoyance. He saw the Internet as an amazing, transformative force well before that fact became common knowledge. In 1995 he invested in a then-tiny company, Yahoo!, earning six times his...

Bad News at Tesco Could Be Good News for Investors

in Analysis

Sir John Templeton, father of international investing, coined the term "points of maximum pessimism" — you want to buy when the news flow is horrible, because the bad news is likely to be more than priced into the stock. This is where I feel Tesco is today, and this is why my firm recently added to our position in the U.K.-based retailer. Although Tesco’s business is doing worse today than it was even six months ago, things are not as bad as you’d infer from the stock price or from reading the financial press. Almost every single piece of news coming from Tesco over the past few months could be put in one of two buckets: bad or horrible. Its same-store sales were down a few percentage points; it reduced its earnings guidance for 2014, fired its CEO and decreased its dividend. And to put a cherry on this sagging cake, Tesco found a £250 million ($400 million) accounting error in its earnings forecast. The cumulative effect of this news has sent the company’s shares to an 11-year low. Tesco went from being one of the most successful and respected retailers in the world — its previous CEO was knighted —...

Apple’s Moat Just Got a Lot Wider

in Analysis

I have to admit I was not able to get anything done on Tuesday when Apple released its new iPhone, Apple Pay and Apple Watch — absolutely nothing. Like millions of others, I was glued to my iPad watching Tim Cook do a two-hour Apple infomercial. (And unlike any other infomercial, I watched it twice.) The interest must have been greater than even Apple expected, as its website simply could not handle the traffic and kept crashing. A lot of viewers must have been sleep-deprived Chinese; it was 1:00 am in China, and Cook’s keynote was simultaneously dubbed in Mandarin. Apple’s emphasis on China makes a lot of sense, of course: The country is Apple’s biggest growth driver, with 4G just being rolled out there. The release of the new iPhones was important for Apple in the short run — it desperately needed to introduce larger phones to battle Android handsets. Both the 4.7- and 5.5-inch phones looked terrific. However, the fact that Apple introduced two sizes may have an interesting consequence: Consumers will need to hold the actual phones to figure out which one fits them best. Online orders will likely be lower than usual, while traffic to Apple Stores...

Behind the Red Door: Finding Value in an Overpriced Market

in Analysis

I am about to write a quarterly letter to clients, telling them that despite all the giddiness in the stock market, we are in Value Investor Second Hell. This is not the first hell; that one is reserved for value traps — stocks that look cheap based on past earnings but whose earnings are about to disappear, whereupon the stocks will permanently decline. The second hell is when you cannot find value. I recently read a study that said the difference in valuation between the cheapest stocks (the lowest 10 percent of the market) and the rest of the market is the smallest it has been in more than 20 years. Of course, the market overall is very pricey; finding undervalued stocks in this environment has become increasingly difficult. To adapt, you need to understand that there are two types of value stocks. The first are statistically cheap — their cheapness stares you in the face. This breed is quickly becoming scarce; even Hewlett-Packard Co. and Xerox Corp. are now found in growth investors’ portfolios. But before I talk about the second type of value stocks, let me tell you how my wife and I bought our house. It was 2005. The housing market in Denver, just...

How I Bought the Internet — and You Can Too

in Analysis

A few months ago my firm bought the Internet. Let me explain: When people think about the Internet, they imagine an enormous, decentralized (key word), spiderweblike network of millions of servers and hundreds of millions of business and personal computers, all loosely connected to one another. That image makes a lot of sense; after all, the Internet was created by the Defense Advanced Research Projects Agency (Darpa) to make sure the military forces and other branches of the government could communicate in case of nuclear war. This was my image of the Internet too — but then I read Tubes: A Journey to the Center of the Internet by Andrew Blum, and this naive notion was completely shattered. Blum, a journalist who used to write about architecture, went on a quest to discover what the Internet is after a squirrel chewed through a cable at his home and severed his connection. To his surprise (and to mine as well), he found that the Internet is a lot more intimate than the common conception; it is really a network of networks located in a few dozen buildings globally that hold most of those decentralized servers. In Tubes, Blum goes on about a company that owns...

Qualcomm’s Competitive Advantages Are Too Numerous to Ignore

in Analysis

Asphyxiation is a condition in which the body doesn’t receive enough oxygen. A common side effect of asphyxiation is death. Before then, of course, there are hallucinations; we start seeing things that don’t exist. When the market is making new highs, valuations are high, and you get altitude sickness. It is typical to suffer from value asphyxiation: imagining value when it is not there. Mistakes in this environment predominantly come from the commission (not the omission) of buy decisions. That is why, before you commit your capital, you have to double-check your lucidity and think thrice. And that is why, when we stumbled on Qualcomm, we could not believe what we saw. The San Diego–based chipmaker should double its earnings over the next four years. It has an impenetrable moat, great management, a cash-laden balance sheet, infinite incremental return on capital — and it is cheap, trading at a low-teens multiple. These things are not supposed to happen to a company with a market cap of more than $100 billion that is followed by several dozen analysts — unless the Street is concerned that the company is on its way to becoming obsolete — and especially not while the market is making...

The Blessing of a Declining Stock Price

in Analysis

After I told my father what I am about to tell you, he called me a charlatan. He said, “You basically tell people that it is okay to lose money on their stocks.” It’s a bit more nuanced than that, but, yes, here is my message to you: When you buy the right company — one that generates enormous cash flow and is run by good capital allocators — a decline in the stock price could be a blessing, not a curse. Okay, now it’s your turn to call me a charlatan. But before you do, let me share with you two examples: one that has already played out and one that is still very actionable. In May 2012 I made the case for Redwood City, California, gamemaker Electronic Arts. My firm’s original premise in buying EA was that it looked expensive statistically, but statistics did not capture the company’s true earnings power. EA is transitioning from selling packaged games to digital ones. Digital games come with much higher profit margins; thus, even with little revenue growth, EA’s margins should go up. And they have. In fact EA’s fundamental story worked as we expected. During the third quarter of 2013, we sold Electronic Arts...

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"Vitaliy Katsenelson is the new Benjamin Graham."
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