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Seeking The Asian See’s Candies

Buffett’s Investment In See’s Candies See’s Candies, a manufacturer and distributor of candy, in particular, boxed chocolates, was cited by Warren Buffett in his response to the first question asked at this year’s Berkshire Hathaway (NYSE: BRK.A ) annual meeting. Buffett said that “The ideal business is one that takes no capital, and yet grows. And there are a few businesses like that, and we own some.” See’s is one of them.” Buffett purchased See’s Candies in January 1972 for $25 million, equivalent to 10 times and 6.2 times its after-tax earnings of $2.5 million and pre-tax earnings of $4.2 million respectively. See’s Candies’ Wide Moat At Berkshire Hathaway’s 1997 annual meeting, Charlie Munger made reference to the purchase of See’s Candies as “the first time we paid for quality,” according to Robert G. Hagstrom’s book “The Warren Buffett Way.” In Berkshire Hathaway’s 2007 letter, Buffett called See’s Candies the “prototype of a dream business.” See’s Candies’ wide moat is derived from several factors, including an enduring brand, strong pricing power, low capital intensity and local dominance. A 71-year old lady named Mary See started See’s Candies as a small candy shop in Los Angeles in 1921. In the domain of enduring consumer brands, where histories are measured in decades, instead of years, See’s Candies benefits from significant customer loyalty driven by habitual purchases and affiliation with the brand. The best illustration of See’s Candies’ brand power comes from none other than Buffett himself: When you were a 16-year-old, you took a box of candy on your first date with a girl and gave it either to her parents or to her. In California the girls slap you when you bring Russell Stover, and kiss you when you bring See’s. See’s Candies’ pricing power is validated by the fact that its pre-tax earnings per pound of chocolate sold grew by a 8.3% CAGR from 25 cents in 1972 to $2 in 1998, which were largely attributed to annual price increases which can be as much as 5% . It had the power to raise prices due to its brand equity and customer price sensitivity. While See’s Candies derived tremendous profit from the sale of boxed chocolate, the money spent on a small-ticket item like chocolates was only a small proportion of household expenditure (and were occasion-driven purchases), and buying more modestly-priced chocolate generated limited cost savings. According to Berkshire Hathaway’s 2007 shareholder letter, See’s Candies was a capital-efficient business which generated a 60% pre-tax return on invested capital at the time of Buffett’s purchase, helped by the fact that sales were transacted in cash (receivable days close to zero) and the production and distribution cycle was short (low inventory days). Regarding local dominance, it was noted in Buffett’s letters that See’s “obtains the bulk of its revenues from only a few states,” “our candy is preferred by an enormous margin to that of any competitor, and “most lovers of chocolate prefer it to candy costing two or three times as much” in the company’s primary marketing area on the West Coast. On the demand side, it is impossible to be everything to everyone given local tastes and heritage; See’s Candies clearly cemented its reputation in California and on the West Coast. See’s also benefited from local economies of scale by dominating the few states and benefiting from fixed cost leverage for logistics and advertising. In a nutshell, See’s Candies enjoyed the widest moat possibly by combining high customer captivity with scale economies. Asia’s See’s Candies Thailand-listed Taokaenoi Food & Marketing, a manufacturer of seaweed snacks, is potentially Asia’s See’s Candies and a wide moat investment candidate at the right price. Taokaenoi was founded by Mr. Itthipat “Tob” Peeradechapan in 2004 (he was 23 years old then), who is currently in his early-thirties. Mr. Itthipat had an entrepreneurial bent since his high school days, when he made money selling virtual weapons for cash on the online role-playing game EverQuest, according to a December 2015 Wall Street Journal article titled “Thai Fried Seaweed King Is on a Roll.” Tao Kae Noi was started as a roasted-chestnut stall business, before he discovered the huge demand and potential for seaweed snacks. Seaweed snacks can be perceived as the Asian equivalent of potato chip and snacks in the West. The brand Tao Kae Noi is synonymous with seaweed snacks in Thailand and many parts of Asia. Taokaenoi passes the local dominance test, boasting a 61.5% market share of Thailand’s 2.5 billion baht packaged seaweed snack market in 2015, according to AC Nielsen research. In other words, Taokaenoi has more than three times the market share of its closest competing brand Masita (17.5% market share) owned by Singha Corporation. The Company’s gross margin, a proxy for pricing power, increased by 610 basis points from 29.3% in 2011 to 35.4% in 2015. I estimate Taokaenoi’s 2015 return on invested capital to be approximately 80% in 2015, comparable with See’s Candies’ 60% pre-tax return on invested capital at the time of Buffett’s investment. Taokaenoi’s inventory days are decent at slightly over a month. Taokaenoi has set an ambitious target of becoming the top Asian seaweed snack brand with annual revenues of 5 billion baht by 2018 and transforming into a global (Taokaenoi derived 52% of its 2015 sales outside of its home market Thailand via export to 34 countries) seaweed snack powerhouse with yearly sales of 10 billion baht by 2024. This implies three-year and nine-year revenue CAGRs of 12.6% and 12.4% respectively compared with Taokaenoi’s 2015 sales of 3.5 billion baht. Taokaenoi was first highlighted to my premium research service subscribers on December 5, 2015 in a subscribers-only article listing five Asian hidden champions. Since Taokaenoi’s listing and trading debut in December 2015, its share price has surged by over 70%. Please refer to my article “Hidden Champions As A Source Of Wide Moat Investment Opportunities” for more information on hidden champions. As a bonus for my subscribers of my premium research service , they will get access to a profile of another Asia-listed hidden champion/See’s Candies in the food business and a list of five “new” Asian hidden champions. Asia/U.S. Deep-Value Wide-Moat Stocks Premium Research Subscribers to my Asia/U.S. Deep-Value Wide-Moat Stocks exclusive research service get full access to the list of deep-value & wide moat investment candidates and value traps, including “Magic Formula” stocks, wide moat compounders, hidden champions, high quality businesses, net-nets, net cash stocks, low P/B stocks and sum-of-the-parts discounts. The potential investment candidates I profiled for my subscribers in May 2015 include: (1) a U.S.-listed market leader in a niche consumer lifestyle space which is trading at 0.80 times P/NCAV and 0.70 times P/B, but remains debt-free and profitable; (2) a U.S.-listed Net Operating Losses-rich deep value play valued by the market at 2.6 times EV/EBITDA net of the present value of its NOLs; (3) an Asian-listed manufacturer of wireless communication products which is the market leader in its home market and the first to export such products to the U.S.; it is a net-net trading at 0.75 times P/NCAV with net cash equivalent to its market capitalization; (4) a U.S.-listed Magic Formula stock trading at 3 times trailing EV/EBIT and Acquirer’s Multiple, sporting a 10% dividend yield net of withholding tax; (5) a U.S.-listed Munger Cannibal trading at 7 times trailing EV/EBIT and Acquirer’s Multiple; (6) an Asian-listed company which is a global leader in a certain medical device niche trading at 3.5 times trailing EV/EBIT and 3.5 times Acquirer’s Multiple, versus a trailing ROIC of 27%. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Using Economic Indicators To Time The Market

If you pay attention to the financial market news, you may have noticed a lot of attention being focused on the slowing US/Global economy and the implications it has for financial markets. Just do a search on ‘slowing global PMI’ and watch the hours waste away. Basically, the US/Global economy is slowing which means recession is right around the corner, which means financial markets will tank. That seems to be the predominant bear case now, or one of the many. There is some merit to this argument. The worst market downturns occur during recessions. The trick is that you need to know that before the recessions actually happen. In this post, I’ll point you to some research in this area, then focus on just one indicator that does a decent job of forecasting recessions and how it can potentially be used as a market timing indicator on its own. To try and predict recessions, there are all kinds of metric and techniques used (ECRI, Conference board indicators, etc.). You can spend many many hours looking at all of these and their histories. Believe me. Me and an investor friend have spent tons of hours looking at and studying these. And the history of indicators predicting recessions is mixed to say the least. But I won’t bore you with that here. Instead, if you’re interested, you should read this by Philosophical Economics (which I’ll call PhiloEcon) and some of the linked posts in that piece. There is some incredible work and insight in the post (pretty much anything he/she writes is worth your time). Turns out that historically, the change in the trend in unemployment rate has been a pretty good indicator of recessions. It has also been decent at signaling when the economy has come out of a recession. Below is the key chart. Not bad. When the unemployment rate crosses above the 12-month moving average to the upside, a recession is likely coming, when it crosses below the 12-month moving average, the economy is out of the recession. Can this be used to time the stock market? And does it work better than other market timing indicator such as the popular 200-day simple moving average of prices? Basically, yes. You can read through the post and see how using the unemployment rate improves returns and risk over buy and hold and a trend following system. As usual, I wanted to run some numbers myself. Let’s take a look at that. I first wanted to see how the unemployment rate indicator (UI from now on) performed on its own versus buy and hold and other trend indicators, specifically the 200-day SMA and 12-month absolute returns. I also wanted to use real investable products, including fees. I looked at returns going back to the beginning of 1999 through April 26, 2016, for the S&P 500 ETF (NYSEARCA: SPY ), which fortunately started in 1993. This time period encompasses two of the biggest market downturns in history. I compared buy and holding the SPY versus using the 200-day SMA, 12-month total return, and the UI to exit and enter the market. When the timing systems are out of the market they are not invested, i.e. 0% cash return. Below are the results. Very impressive. This simple indicator delivered returns 3.4% per year greater than buy and hold and more than doubled risk-adjusted returns. It also beat both other timing systems by a long shot. In addition, the simple UI system produced fewer false positives and traded a lot less. Definitely worthy of consideration. You can probably see where I’ll be going next with this. In some following posts, I’ll look at adding a risk-free asset to the mix during times of risk-off, combining the UI with other indicators (which is what PhiloEcon has done in the GTT system), and adding some global risk assets to the mix. To give you a preview, they are all better than what I’ve shown here. Finally, before I end this post, what is the unemployment indicator saying right now. Does it support the bear case I noted in the opening paragraph. No, it doesn’t. The current unemployment rate is 5.0% where the 12-month moving average stands at 5.2%. If the unemployment rate increases by 0.1% each of the next two months (April and May – remember the reported unemployment rate is for the previous month), then the rate would cross above the 12-month moving average. We won’t find out until the May unemployment rate is reported at the beginning of June. And we’ll know this week what the April rate is. This seems unlikely but you never know. The FOMC’s own projections don’t support a change but they are notoriously poor forecasters. Others think that more realistically the end of the year would be the time frame we could possibly see a trigger. But there is no need to forecast to use the UI system. For now, if you were using this system it would be risk on still. In summary, historically, the change of trend in the unemployment rate has been a good signal to time the market. Better than the two most popular trend indicators around.

Finding Quality

So how can investors beat the market? Click to enlarge Photo: Jason DeFillippo. Source: Morguefile There are lots of answers to that question. One approach is to find a stable of well-managed companies and stick with those. It’s harder than you think. For one thing, good management is hard to find. A great CEO can inspire people to deliver results that even they don’t think they can do; to envision markets that don’t exist right now; and to avoid professional and personal potholes that erode trust and poison the culture. These are hard to do, and they’re even harder when you’re a CEO with fiduciary responsibilities. The only person you can talk to about all your problems is your Priest or your dog. There are some extraordinary leaders out there, a lot of mediocre ones, and a few really bad apples. It’s hard, from a distance, to identify who the superior managers are, to separate the wheat from the chaff. At Charter, we look at corporate financial performance as well as manager compensation. When they treat the company as if it’s their personal piggy bank, that’s a bad sign. One investor has noted that the extravagance of a corporate office is inversely proportional management’s commitment to shareholders. Warren Buffett bought a stake in an insurance company when he saw that they had linoleum floors in their headquarters. “They’re cheaper to clean,” the CEO told him. Great leaders can make potato chips or dumping trash exciting for those who work for them. Owning stocks based on management competence and financial performance is a solid, fundamental approach to adding value. It doesn’t require a lot of trading. And management isn’t as volatile as the market. There are plenty of ways to add value. Finding a manager that you can grow with is a good way to do this.