by William Smead, Smead Capital Management
As famed market strategist Richard Bernstein has pointed out, investors should pattern common stock selection after the investment style of the Mafia. What causes the Mafia to get such good returns? How do they spot opportunities? Why should we as investors in publicly-traded common stocks emulate their behavior near the end of 2017?
First, the Mafia invests in areas where no one else is willing to invest. Usually, in their case, it is because the business is illegal. Second, the Mafia demands very favorable terms and seeks high cash-on-cash returns. Many times, they are the only ones willing to provide capital. Third, the Mafia tends to let the investments come to them. Think of Sollozzo coming to the Godfather in the first movie in the series. He asked for an investment of $1 million and political protection for dealing drugs in the New York area. He offered 30% of the ongoing profits to Don Corleone.
John Maynard Keynes said the same thing to investors in publicly-traded common stocks: âInvesting is the only sphere of life where victory, security and success go only to the minority and never to the majority.â As we approach the end of 2017, a group of powerful technology companies have gained a historically and inordinate share of overall index returns. Simultaneously, the success of these tech giants has made certain industries nearly un-investable. In the eighth year of a bull market in stocks, these un-investable companies are getting blasted by tax-loss selling and treated like what they do is illegal. Retailers, old media and pharmacy/drug distribution are good examples.
Out of this comes extremely favorable terms for long-duration common stock buyers. At Smead Capital Management, we invest in companies which fit our eight criteria for common stock selection and like the Mafia, are extremely attracted when offered unusually favorable terms. We want to buy companies with long histories of success that gush free cash flow, have defendable moats and are very profitable amid being attacked by todayâs most popular disrupters.
The confluence of challenging times and the tax-loss selling season makes todayâs circumstances more attractive than normal years. Value investors have been thrown under the bus in the recent growth buyerâs nirvana market and we believe many of them have lost their mojo. Some days when we are buying shares, we feel incredibly lonely. Therefore, we believe the numerous opportunities being laid in our lap sport historically superior relative value.
In retailing, Target (TGT) is being left for dead. They are currently very profitable and produce massive free cash flow. Their dividend rate well exceeds 4% which we believe will compensate us through a three-year rejuvenation process for the stores. Their brand has power and their moat will grow as Millennial households with two kids explode in number. Target is an oasis to moms with toddlers.
In old media, we like Tegna (TGNA), the largest owner of CBS and NBC affiliate TV stations in the U.S. These network-affiliated stations have a wonderful moat. Nobody else creates professionally produced local news programming and it is one of the most popular items linked on Facebook. They are very profitable and pay an above-average dividend. At nine-times earnings in a non-election, non-Olympics year, Tegna looks cheap.
Among pharmacies, Walgreens (WBA) looks very attractive compared to the other large company shares; the best it has looked since they divorced Express Scripts (ESRX) and lost millions of customers five years ago. It is priced at 13 times after-tax profits because Amazon (AMZN) is threatening to get into the pharmacy business. With Walgreens 10,000 drug stores and 30% ownership of AmerisourceBergen (ABC), Amazon would show they are serious about the pharmacy business if they used their pricy common shares to buy Walgreens. Forgive us for thinking like the Mafia, because in this maniacal tech environment, it might make too much sense.
In conclusion, retailers, old media and pharmacy businesses have been âsleeping with the fishesâ after being left for dead in the stock market. They are offering terms to us which almost look illegal compared to todayâs popular securities. Lastly, their businesses look as recession proof and cash generating as gambling and prostitution looked to the Mafia in decades gone by. We just might give these beaten down gems âan offer they canât refuse.â
Warm Regards,
William Smead
The information contained in this missive represents Smead Capital Managementâs opinions, and should not be construed as personalized or individualized investment advice and are subject to change. Past performance is no guarantee of future results. Bill Smead, CIO and CEO, wrote this article. It should not be assumed that investing in any securities mentioned above will or will not be profitable. Portfolio composition is subject to change at any time and references to specific securities, industries and sectors in this letter are not recommendations to purchase or sell any particular security. Current and future portfolio holdings are subject to risk. In preparing this document, SCM has relied upon and assumed, without independent verification, the accuracy and completeness of all information available from public sources. A list of all recommendations made by Smead Capital Management within the past twelve-month period is available upon request.
Š 2017 Smead Capital Management, Inc. All rights reserved.
