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The ongoing triumph of reason over emotion

By VW Staff. Originally published at ValueWalk.

Askeladden Capital Partners letter to investors for the second quarter ended June 30, 2017.

Dear Partners,Low Volatility Could Last Another 18 Months: Goldman

YTD, Askeladden Capital has returned approximately –3% net (negative three percent), compared to an approximately ~+5% (positive five percent) return for the benchmark S&P 1000 Total Return Index.  On a since-inception basis, our fee structure has cushioned recent underperformance, as unpaid performance allocations were un-accrued.

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As Asset Management Industry Grows A Search For New Revenue Streams

Askeladden Capital Partners

Portfolio Update: screaming… and then silence.

SETTING: TWO HAT-WEARING LLAMAS STAND ON A LIFEBOAT IN THE OCEAN, FAR FROM SHORE. “CARL,” A DANGEROUS SOCIOPATH WITH A LONG HISTORY OF VIOLENCE, HAS, PRIOR TO THE SCENE, SUNK AN ENTIRE CRUISE SHIP ALONG WITH ALL OF ITS PASSENGERS, EXCLUDING HIS FRIEND / TRAVEL COMPANION “PAUL” AND THE LOVELY ELDERLY COUPLE FROM 2B (WHO, IT IS IMPLIED, CARL GRUESOMELY MURDERED PRIOR TO SINKING THE SHIP). IN-SCENE, PAUL HAS BEEN INTERROGATING CARL REGARDING HIS HORRIFYING AND INEXCUSABLE BEHAVIOR.

So Value Investing Is Not Dead According To Goldman

PAUL: You are just terrible today.

CARL: Shhhh… do you hear that?  That’s the sound of forgiveness.

PAUL: That’s the sound of people drowning, Carl.

CARL: That! is what forgiveness sounds like.  Screaming… and then silence.

- “Llamas with Hats 2” by FilmCow / Jason Steele (2009)

What does that riveting exchange from my favorite absurdist comedy sketch, circa junior year of high school, have to do with value investing?  Well, not very much actually; I’m totally forcing the metaphor because a) that series has always made me laugh way more than it should given my moral standards[1], and b) I really like introducing section headings with quotes.  But, if you’ll indulge me, value investing (as measured by a mark-to-market track record) can often sound much the same: i.e. periods of screaming (excitement, whether good or bad)… and then silence.

Right now’s the silence; hopefully the screaming is to come (… in a good way, and now I’ll put this tenuous metaphor out of its misery.)  It would certainly be nice if I could earn a steady 7.3 bps per day, every day, ad infinitum, like sand in a never-ending hourglass[2]; unfortunately, that is pretty much the opposite of what I expect the future to look like, vol-wise.  I’ve cautioned against extrapolating past results into the future; indeed, setting aside the post-election rally, returns have been much choppier since last summer.  I’ll go into more detail below, but summarily, on the basis of fundamental results at underlying companies, our year has been good.  Yet, particularly on our two largest positions, the market has not (yet) rewarded us the way that I strongly believe it will.

To set the philosophical framework: continuing the sand-and-water theme, famous investor Donald Yacktman once used the metaphor of a beach ball forcibly held underwater to describe stocks where fundamental/intrinsic value was compounding, but the market wasn’t cooperating: the bigger the gap between the depth of the ball (the stock price) and the rising tide (the intrinsic value level, in this metaphor), the bigger the necessary eventual explosion upward.[3]  Of course, faster value realizations are better in the presence of a rich opportunity set (the equivalent of increasing inventory turns, in the context of an operating business).  That said, our typical three-year underwriting horizon should normally prove sufficient to deliver substantial holding-period IRR.

Mohnish Pabrai – How To Calculate Intrinsic Value

To give you color on the underlying drivers of YTD and future returns, let’s go through the portfolio one by one in order of current position size.  All standard legal caveats about forward-looking statements apply.

Franklin Covey (FC): this is the gift that keeps on giving, in the sense that the company keeps exceeding my expectations, and the market continues to be utterly confused, providing us with repeated opportunities to increase our stake at absurdly attractive CAGRs (napkin math: >25% on a 3-year basis and >20% on a 5-year basis).  Just two days ago, Franklin Covey reported a very interesting quarter wherein they reorganized their entire operational structure to take advantage of the runaway success of their new All Access Pass product offering, thereby adding ~10% to their current EBITDA on a go-forward basis, and improving their incremental margins on (substantial) future revenue growth by 300 – 400 bps.  Yet the market, and even several of our friends who should know better, chose to focus on irrelevant temporal numbers (penalizing the company for slightly lower fuel efficiency during a period in which they’re rebuilding the plane while keeping it smoothly flying at cruising altitude).  Although we’ve earned a modest return on this position YTD, the price-value gap remains extremely wide and this will either play out as a near-to-medium-term home run or a tax-efficient long-term mid-teens-plus compounder.  … or both.

The underlying reason why you’re averaging poor returns

Liquidity Services (LQDT): this is the test of patience.  On the one hand, there’s no indication that the company isn’t what I thought it was (i.e., the market leader in a very large industry that they are disrupting).  There are even green shoots insofar as their core (non-DoD) business has returned to solid organic growth without any benefit (yet) from meaningful platform investments over the past few years, and they are delivering reasonable growth numbers even with the DoD drag.  That said, they remain in investment mode, and the market wants to see these investments pay off on the PnL and cash flow statement.  I openly admit that I underestimated the time and expense that their transformation would take, although I don’t have any disagreements with management’s prioritization of getting it right over speed and near-term financials (there are echoes of FC, though the key difference is FC is generating a positive carry via strong cash flow).  However, even to the extent that I underwrite the real “bear case” here, I can’t come up with anything close to, let alone below, the current stock price – the decline year-to-date (which has meaningfully weighed on our returns, largely offsetting strong gains from some other positions) is wholly unjustified by results.  As one fellow shareholder (a deep value denizen) put it: if a deep value guy (him) and a much more quality-focused guy (me) can agree that a business is absurdly cheap… it’s probably really, really cheap.

Secret Small-Cap 1: I’m keeping this one really close to the vest because a) it’s small and illiquid, and b) I really want to add to this position over time.  Summarily, the company has many of the factors we look for – a seemingly defensible, nichey business with technology leadership and recurring revenues; strong management with a focus on both operational improvements and smart capital allocation; etc.  Results year to date haven’t been terribly exciting, but the stock price represents a reasonable valuation on current results and a meaningful discount to any sort of future success.  This is very much in the early stages of its lifecycle in our portfolio.

Secret Small-Cap 2: This one is less close to the vest, but still not one I want to shout about from the rooftops: it’s a nichey

The post The ongoing triumph of reason over emotion appeared first on ValueWalk.

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Click here to see some testimonials from our members!