The World as 100 People

by JackHagley.

Here's a neat little infographic. Some things surprising, some not.

Read more ...

ITT Educational Services Investment Thesis (Ticker: ESI)

Description:

ITT Educational Services Inc. (ITT) provides technology-oriented post-secondary undergraduate and graduate degree programs in the United States. These are directly relevant to strong employment fields such as business, electronics, industrial design, telecommunications, and computer engineering/protection. It operates more than 140 ITT Technical Institutes in 39 different states.

In 2014, ITT entered into negotiations with College Portfolio Buyers LLC (CPB) to sell a number of its properties for approximately $119 million although this has not yet been finalized. ITT will continue to lease these properties to maintain the services it provides to its students but hopes to eventually phase out 7 identified underperforming campuses.

The Consumer Financial Protection Bureau (CFPB) has recently alleged that ITT engaged in illegal activities in offering high-interest rate loans through the PEAKs Trust to students that have shown to be likely to default. Combining this with a slump in earnings has led to the fall in its stock price.

Recently, ITT has begun to cut prices of current programs and offered over $170 million worth of scholarships in 2013. ITT has also reduced the net cost of its associate degree program to within a range of $20 000 to $25 000 which also covers many items such as books and course materials. This is something that traditional institutions don't offer. Approximately 70% of ITT's employable graduates obtained employment in 2013, using knowledge and skills taught in their program of study. The average annual salary reported by students entering one of ITT's programs increased from $17 000 prior to entering to $33 000 after graduating.

Catalyst(s):

Increasing enrollment trends among ITT's numerous information technology programs have been overshadowed by more rapid declines within its criminal justice programs. As ITT 'teaches out' these programs and begins focusing more on the business and IT sector, it is likely to see revenues return to historical levels.

The case the CFPB makes has been described as "flawed" and "unconstitutional" by not just ITT, but also Morgan Drexen, a company that delivers support services to American law firms which has also been targeted by the CFPB in recent years. They have both filed for a dismissal given the lack of power the CFPB has been proven to have with regards to enforcing credit regulations. Additionally, in 2013 ITT offered more than $170 million worth of scholarships, thus reducing the number of current students requiring financing to less than 0.1%, and severely hurting the CFPB's case against ITT. Additional revenues coming as the result of ITT's sale of assets to CPB will also offer a substantial buffer against any unfavorable settlements with the CFPB.

There is also a high option value associated with a stock that trades at less than 3.0x 2014 estimated EBITDA.

It is also my belief that the underlying programs (specifically IT) offered at the schools have increasing value in the marketplace given the strong trend towards the expansion of the technology sector. Additionally, ITT's new pricing strategy, though still nascent, appears to be generating enrollment growth.

A valuation range of $49 to $53 is derived by applying an EV/EBITDA multiple range of 5.5x to 6.0x to my 2015 estimate. These multiples are derived from the mean of the players within the vocational education industry and reflect risks associated with both ITT's new pricing strategy and those associated with potential asset impairments.

Read more ...

Consolidation of Notes from Investment Books

Over the last few years I have read a number of different books on the world of finance and investment. For each book that I have read I have taken detailed notes for myself to reference at a later date. In this post it will be my goal to consolidate their teachings with the hopes of converting the information into a relevant investment approach to today's markets.

Here is the list of books whose notes will be covered in this post:

• The Intelligent Investor
• Security Analysis
• Margin of Safety
• Common Stocks and Uncommon Profits
• The Little Book that Still Beats the Market

Looking for Investments

• Survey industries and companies that are currently unfavorable in the eyes of the financial community
• Be aware of sales and mergers and complete or partial acquisitions for investment opportunities
• Use the 'scuttlebutt' technique to find additional investment opportunities
• Look for companies that are invested in R&D to create new products that will lead to earnings growth

What is 'scuttlebutt'?

Scuttlebutt is a term used by Philip Fisher that refers to rumors and/or gossip that are used to find out additional information about a given company (or investment opportunity) in question that the general public may be unaware of. This consists of talking to all of the companies in a given industry about the strengths and weaknesses of its competitors. This also refers to talking to customers, suppliers, research scientists at universities, the government, and former employees as they relate to the target company. Fisher also states that any questions left unanswered after having completed the scuttlebutt technique should be directed towards the company executives.

Qualitative Factors of a Favorable Investment

Value

• Good management should place just as much importance on the day-to-day operations of the business as it does on the long-term goals
• Does the company have an above average sales organization?
• What is the company doing to maintain or improve profit margins?
• Does the company have outstanding labor and personnel relations? (companies that still have no union likely have great labor relations but unionization does not necessarily imply poor labor relations)
• Does the company have outstanding executive relations? (executives and board demonstrate confidence in leader)
• Are there other aspects of the business that pertain specifically to its industry which will give the investor important clues as to how outstanding the company may be in relation to its competitors? (ie. if retailer, does it have good control over lease contracts?)
• In the foreseeable future, will the growth of the company require equity financing that will dilute the existing shareholders' benefit? (usually occurs when there isn't adequate stability for debt financing)
• Does the management talk freely to investors about its affairs when things are going well but 'clam up' when troubles occur?
• Does the company have a management of unquestionable integrity? (sense of moral responsibility to its shareholders)

Growth

• Does the company have products or services with sufficient market potential to make possible a sizable increase in sales for at least several years into the future?
• Does the management have a determination to continue to develop products or processes that will still further increase total sales potentials when the growth potentials of currently attractive product lines have largely been exploited?
• How effective are the company's R&D efforts in relation to its size? (R&D as % of sales; $R&D/share; compare to industry)
• Does the company have depth to its management?
• Does the company have a short- or long-term outlook in regards to profits? (want companies that focus on a long-term, consistent profits)

Look for possibilities of an enhancement of earnings power that can stem from:

• General industry improvements
• Changes in the company's operating policies (with or without management changes)
• More efficient operating methods (cost cutting, etc.)
• New product offerings
• Abandonment of unprofitable product lines or services
• Effective R&D that has led to earnings growth in the past

Quantitative Factors of a Favorable Investment

Value

• Does the company have a worthwhile profit margin? (want this to be as high as possible but compare with industry; not necessarily bad if profit margin is decreasing if being spent on R&D)
• How good are the company's cost analysis and accounting controls?
• Paying no dividend isn't bad unless the company in question is stockpiling an excess amount of cash in order to maintain a feeling of security
• When doing a valuation, come up with a range of values as opposed to a single figure and then buy stocks that are trading at a discount to this range and the same thing when deciding when to sell (compare to the maximum value of the range)
• Company with the lower P/E (higher earnings yield) but higher return on capital is almost always better
• A high ROC is key because it allows businesses to make a greater profit with the same assets that can then be reinvested into the same assets that are already known to produce a high ROC

Figures to check:

• Profit margin
• Book value per share
• Price to book ratio (ideally < 1:1)
• Earnings per share*
• Price to earnings ratio (ideally < 30)
• Liquidation value per share (as a % of current assets)
• Does the stock pay dividends?
• How many years has the stock paid dividends for?
• Current ratio
• Quick ratio
• Interest coverage
• Debt to equity ratio
• Growth estimates**
• Return on capital (ROC)***

*Note on earnings per share:

In order to be as conservative as possible when calculating EPS, use a 5 year weighted average of the diluted EPS. The weights should be calculated using the sum of the years' digits method. For example, if diluted EPS over the last five years was 1.33, 2.02, 1.62, 1, 3.5 we would take the sum of the years digits over 5 years to find out the respective weightings for each year and then apply this to each EPS figure. To illustrate:

EPS over 5 years so: (5 + 4 + 3 + 2 + 1) = 15

Year 1 (most recent year): 5/15 = 33%

Year 2: 4/15 = 27%

Year 3: 3/15 = 20%

Year 4: 2/15 = 13%

Year 5: 1/15 = 7%

(3.5 * 33%) + (1 * 27%) + (1.62 * 20%) + (2.02 * 13%) + (1.33 * 7%) = 2.1 EPS

**Note on growth estimates:

Growth estimates should be based on taking the growth in EPS (based on the above calculation) over the same 5 year period and then taking the average to find the EPS growth per year. Subject this to some percentage margin of safety (50% to 90%) depending on your confidence in your estimates and use this as the projected growth in EPS. I would recommend capping growth at around 20%.

***Note on return on capital:

Oftentimes the common return on assets (ROA) figure is too broad to carry any real value to it. What we are really interested in finding out is if the tangible capital is producing a good return. For this reason, ROC should be calculated as follows:

ROC = EBIT/(Net Working Capital + Net Fixed Assets)

where,

Net working capital = Current Assets - Current Liabilities

Net fixed assets = Total Fixed Assets - Total Depreciation

When to Buy

Fisher's most ideal time to buy is right around when the company in question is starting the first commercial production of the new product that is expected to lead to earnings growth. This is because unique costs in getting the new plant/process up and running and selling leftovers of the old product will show a decrease in earnings, thus lowering the stock price. Market participants will thing the new product is a flop just before sales start to show an increase which is why it's a good time to buy in.

When to Sell

• Sell whenever a mistake has been made in regards to the original investment thesis and the factual background that originally made the company appealing no longer exists
• Sell when changes resulting from the passage of time no longer qualifies the investment with regards to the above points about what makes a good investment
• Sell when funds are not available and better investment alternative arise over the current holdings

"If the job has been correctly done when a common stock is purchased, the time to sell is -- almost never." - Philip Fisher

Warren Buffett's Criteria for a Wonderful Business

• They have a good return on capital without too much debt
• They are understandable
• They see their profits translating into cash flow
• They have strong franchises and have freedom to price
• They don't take a genius to run
• Their earnings are predictable
• The management is owner-oriented

Read more ...

Analysis of ModernGraham.com Track Record

For those that don't know, I consider myself to be 70% a value investor and 30% growth. With that being said, I closely follow the stock recommendations from a number of different sources that follow a similar investment philosophy to myself. One of the major sources I follow is ModernGraham.com.

ModernGraham prides itself on following the teachings of Benjamin Graham, the author of Security Analysis and the father of value investing, while taking important cues from Warren Buffett as well. Given that by today's standards it would be very difficult to find any company that passes Graham's original criteria, ModernGraham has made important adjustments to the criteria to make it applicable to today's markets. I believe these adjustments are justified but would like to see the kind of track record they have generated using the new framework.

In this sense, for my next project I have gone through the archives of ModernGraham and reviewed all of the companies that have passed their defensive investor and enterprising investor criteria from May 2008 to Feb. 2010. I would've continued all the way up to Nov. 26th 2012 but the owner of the site went on hiatus between 2010 and 2013 to focus on other things (which isn't a bad thing). Although the site started back in 2006 they changed their valuation method on Nov. 26th 2007 so I will consider only those stocks that pass the tests under this new method. All of these choices can be found within their 'Valuation' or their 'Added and Updated Valuations' posts. The returns are then calculated based on each stock being held for exactly one year from the date the post was made and then sold.

Note: Only stocks that are explicitly stated to be a good buy for either the defensive or enterprising investor while also being undervalued according to ModernGraham's valuation method are included in these calculations. Those that were considered as good choices for the Defensive investor are also assumed to be good choices for the Enterprising investor. In other words, every investment that is a good choice for the Defensive investor also has to be a good choice for the Enterprising investor but not all 'enterprising investments' make good 'defensive investments'. Additionally, if a particular stock is recommended twice through an update, it is only calculated as being repurchased if the second recommendation comes more than a year after the first given that all returns are calculated based on holding the recommended stock for one year. Finally, I used the adjusted closing price on the day of the recommendation. The adjustment implying that any splits or dividends are being accounted for. If the post was made on a weekend, the next available trading day was used.

So without further ado:

Company	Ticker	Date	Investor Type	Historical Price	Price after 1 year	Return
3M	MMM	5/5/2008	E	51.37	66.00	28.48%
Alcoa	AA	5/6/2008	E/D	34.46	9.94	(71.15%)
American Internatioal Group	AIG	5/8/2008	E/D	716.40	33.13	(95.38%)
Garmin	GRMN	5/24/2008	E	36.90	16.95	(54.07%)
American Eagle Outfitters	AEO	8/7/2008	E/D	10.24	12.32	20.31%
Olin	OLN	9/5/2008	E	18.63	13.98	(24.96%)
Gap	GPS	3/26/2009	E	11.78	21.55	82.94%
Wolverine World Wide	WWW	3/26/2009	E	7.39	13.97	89.04%
Dover	DOV	3/27/2009	E/D	20.13	35.65	77.10%
Genuine Parts Company	GPC	3/30/2009	E/D	25.03	37.45	49.62%
Goodrich Company*	GR	3/30/2009	E	37.79	71.54	89.31%
The Walt Disney Company	DIS	3/31/2009	E/D	16.99	33.04	94.47%
Microsoft	MSFT	3/31/2009	E	16.04	26.12	62.84%
Walmart	WMT	3/31/2009	E	45.89	50.04	9.04%
EV Energy Partners	EVEP	6/22/2009	E	12.13	25.20	107.75%
Hi Shear Technology	HSR	6/22/2009	E	N/A	N/A	N/A
Suburban Propane Partners	SPH	6/22/2009	E	27.67	34.97	26.38%
Teekay Tankers	TNK	6/22/2009	E	5.93	8.38	41.32%
B&G Foods	BGS	6/29/2009	E	6.74	9.35	38.72%
Burlington Northern Santa Fe	BNI	6/29/2009	E/D	N/A	N/A	N/A
Eaton	ETN	6/29/2009	E/D	19.72	29.46	49.39%
International Shipholding	ISH	6/29/2009	E	19.83	16.84	(15.08%)
Johnson & Johnson	JNJ	6/29/2009	E/D	48.55	52.17	7.46%
Nike	NKE	6/29/2009	E/D	24.13	32.32	33.94%
UnitedHealth Group	UNH	6/29/2009	E/D	23.68	27.12	14.53%
Union Pacific	UNP	6/29/2009	E/D	48.02	65.06	35.49%
Garmin	GRMN	6/29/2009	E/D	19.64	25.37	29.18%
MTS Systems	MTSC	6/29/2009	E/D	18.55	26.84	44.69%
National Presto Industries	NPK	6/29/2009	E/D	53.78	71.73	33.38%
Regal-Beloit	RBC	6/29/2009	E/D	37.83	53.34	41.00%
Norfolk Southern	NSC	7/6/2009	E/D	32.65	45.62	39.72%
Proctor & Gamble	PG	7/6/2009	E/D	44.59	52.28	17.25%
Aflac	AFL	7/13/2009	E/D	27.13	44.35	63.47%
Boeing Company	BA	7/13/2009	E/D	35.80	58.82	64.30%
Caterpillar	CAT	7/13/2009	E/D	28.12	61.03	117.03%
Chubb	CB	7/13/2009	E/D	36.60	48.16	31.58%
Cisco Systems	CSCO	7/13/2009	E	17.21	21.40	24.35%
E.I. du Pont de Nemours and Company	DD	7/13/2009	E	21.11	32.71	54.95%
Emerson Electric Company	EMR	7/13/2009	E/D	27.47	41.52	51.15%
McDonald's	MCD	7/13/2009	E	49.22	63.00	28.00%
3M Company	MMM	7/13/2009	E	53.64	76.09	41.85%
Paychex	PAYX	7/13/2009	E	20.15	22.27	10.52%
United Technologies	UTX	7/13/2009	E/D	45.71	61.73	35.05%
Pfizer	PFE	7/20/2009	E/D	12.62	12.51	(0.87%)
Exxon Mobil	XOM	7/20/2009	E/D	60.67	53.20	(12.31%)
Infosys Technologies	INFY	7/27/2009	E	39.38	56.98	44.69%
Philip Morris International	PM	9/7/2009	E	39.16	46.41	18.51%
Amgen	AMGN	9/14/2009	E	55.86	51.43	(7.93%)
Baxter International	BAX	9/14/2009	E/D	50.69	40.19	(20.71%)
Exelon	EXC	9/21/2009	E/D	40.32	35.17	(12.77%)
Olin	OLN	9/21/2009	E	14.91	17.81	19.45%
Heinz Company*	HNZ	9/28/2009	E	40.04	47.94	19.73%
Medtronic	MDT	9/28/2009	E/D	33.56	30.61	(8.79%)
National Oilwell Varco	NOV	9/28/2009	E	40.57	42.99	5.96%
Tidewater	TDW	9/28/2009	E/D	42.48	41.18	(3.06%)
American Electric Power Company	AEP	10/5/2009	E/D	24.59	30.65	24.64%
Baker Hughes	BHI	10/5/2009	E/D	39.49	42.03	6.43%
CVS Caremark	CVS	10/19/2009	E/D	35.58	28.92	(18.72%)
Nucor	NUE	10/19/2009	E/D	39.25	34.17	(12.94%)
EMC	EMC	10/26/2009	E	17.01	20.85	22.57%
Entergy	ETR	10/26/2009	E/D	62.60	61.65	(1.52%)
General Dynamics	GD	10/26/2009	E/D	58.39	58.15	(0.41%)
Halliburton Company	HAL	11/2/2009	E/D	27.87	30.29	8.68%
Monsanto	MON	11/9/2009	E	65.03	59.40	(8.66%)
Oracle	ORCL	11/9/2009	E	20.92	27.76	32.70%
Occidental Petroleum	OXY	11/9/2009	E/D	74.88	77.13	3.00%
Raytheon Company	RTN	11/16/2009	E	43.04	40.81	(5.18%)
Schlumberger NV	SLB	11/16/2009	E	63.66	69.57	9.28%
Texas Instruments	TXN	11/16/2009	E/D	23.42	28.12	20.07%
Xerox	XRX	11/23/2009	E	7.22	10.66	47.65%
Allegheny Technologies	ATI	11/30/2009	E/D	31.33	48.36	54.36%
Psychemedics	PMD	12/21/2009	E	4.48	7.17	60.04%
Automatic Data Processing	ADP	2/22/2010	E	36.81	44.89	21.95%

*Companies that no longer exist but existed at the time. These prices are do not account for splits or dividends.

Average Return for the Enterprising Investor: 24.38%

Average Return for the Defensive Investor: 20.73%

S&P500 Return over the same period: (6.54%)

Note: the share prices marked by N/A could not be found or adjusted and have been omitted.

It's safe to say that -- at least over this period -- the value-oriented methodology being followed by ModernGraham yields great results. Ideally, I would've liked to run the test over at least a period of 5 years but given the circumstances this is unrealistic. It would be even better if we could backtest the results over a period of 30 years using the same investment criteria to see how the investment process performs in a number of different environments. However, for now I'm happy with the results and am willing to place even more confidence in the value-oriented process being followed over at ModernGraham.

Read more ...