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The Sleuth Investor: My Takeaways From Touring Spartan Motors

Summary On December 16th, 2015, I had the opportunity of touring Spartan Motors’ headquarters. The tour was very enlightening and I learned a ton that I wouldn’t have learned sitting in front of a computer screen. Spartan Motors is a very real company with continual improvements in their operations. I recently read a book called The Sleuth Investor. The book was not your typical methodical investment book. No, the book was strictly how to develop a qualitative research style. In fact, I’ve never read an investment book like it before. Pretty much the basis of the book is about how the enterprising investor should not solely rely on SEC statements and press releases. Yes, these statements and PRs are valuable; however, if you want to become a better investor, getting more “exclusive” information can be very valuable. Source: Amazon The word exclusive is a word the author uses a lot in the book; however, by exclusive he does not mean insider information. To the author, exclusive information is getting information that is publicly available, but is not as easily accessible like an SEC filing or PR release. For example: Following the physical movement of a product. Observing company management talking to investment bankers in public. Going to production facilities, offices and other physical surroundings. To some, the methods in the book may seem very unorthodox and time consuming. In fact, I believe many readers will not practice the methods and strategies found in this book. For me on the other hand, I found the book to be very enlightening, and I have started to incorporate the methodologies found in this book, in my own research. As an example, on December 16th, 2015, I did my own sleuthing. Sleuthing in Action with Spartan Motors On December 16, 2015, I went on a company tour at Spartan Motors (NASDAQ: SPAR ). Before I go into detail on the experience that I had, let’s back up the story a bit. I became aware of SPAR from another Seeking Alpha user who messaged me one day, let’s call him User X. User X messaged me a month or so ago pretty much telling me that I should look into SPAR for a variety of reasons. It was a pretty detailed and compelling message and influenced me to look into SPAR. User X’s thesis on SPAR is summarized in the following bullet points. Simple operational-improvement turnaround situation. The product offerings are sound and competitive in nature but management has fallen behind recently. Margins have fallen yet the balance sheet remains strong. Things are changing more rapidly than the market perceives. New management was brought in and a multi-year operational improvement initiative was launched. Overall, the basis of the thesis is derived upon management-driven operational improvement without any consideration of revenue growth. After doing my own due diligence on SPAR using public information such as SEC filings and PR releases, I wrote up a research report. Investors who are not familiar with SPAR should read the report here . I came to similar conclusions as User X. Below is a summarized conclusion of my findings: The new CEO, Daryl Adams’s plan to bring the company back to a state of profitability is already taking effect. They closed down one plant to consolidate operations, took some much-needed restructuring charges, and made operations much more efficient, especially at the Brandon facility. Two out of three of SPAR’s business segments are already profitable. The work currently being done to their unprofitable division (Emergency Response Vehicles (ERV) has improved drastically from new pricing models, operating improvements, capacity expansion, consolidation of production, and developments in the front end process. Even though the company is unprofitable (currently break-even), the dividend is stable due to the strong balance sheet. The strong balance sheet makes this a unique turnaround situation. The new management team is strong and all of the new executives have experience in turnarounds. Management is also aligned with shareholders for all of the executives hold shares in the company. Adams (the CEO) has recently been buying up a decent amount of shares in the open market. Overall, I felt like the company was/is a low risk decent return. Back to my sleuthing. Since I have started to incorporate a qualitative research method mixed with my quantitative process, I have talked to a handful of management teams, IR guys, suppliers and other investors. To say the least, my network has grown and my research skills have improved. Because SPAR was such a unique turnaround situation, and that their headquarters was only an hour and forty minutes from where I lived, I decided to reach out to Adams to see if I could get a company visit. After writing up the original report on SPAR, I sent Adams a message on LinkedIn, in which I gave him my contact. A few days later, Greg Salchow, SPAR’s Group Treasurer sent me an email. Salchow’s response instead of Adams, to me was actually more of a bullish indicator and gave me more respect towards Adams as a whole. The reason why I was pleased that Salchow responded to me instead of Adams derives itself off of opportunity cost. Adams is a busy man. Turning a company around back into a steady state of profitability takes a ton of time and effort. In reality, I was not expecting a response from Adams due to the fact that he is most likely spending the majority of his time working on improving the company. Thus, an email from Salchow meant that Adams doesn’t have the time to talk about company improvements due to the fact that he is on the front line everyday trying to bring SPAR back to being a topnotch firm. The second reason that I was impressed with Salchow responding is because Adams still sees the benefit into giving investors visibility. Despite the fact that Adams is too busy to talk to investors (a good sign), he still sees value into the visibility of his company. Visibility is important for micro-cap companies and Salchow’s response indicates that Adams fully understands this. To make a long story short, I responded to Salchow and we set up a date for a company visit. The Visit Before I went on the company tour, I had a few questions in mind that I would try to get answered. These questions are as follows. Were there attitude and motivation issues when Daryl took over that were hindering efficient production? Has there been acceptance or enthusiasm for management efforts over the transition to a more efficient manufacturing process? And, has there been an increased turnover associated with the changes being implemented? So on 12/18/15, I went on my first public company visit. The unique aspect of the visit was the fact that it was the employee Christmas party/lunch (will get to later). When I got to the facility, Salchow took me to his office so we could chat a little bit before the employee Christmas party/lunch. In our discussion I learned some valuable information. First, if you remember from my original write-up on SPAR, I stated that SPAR contributes around 50% of the UPS (NYSE: UPS ) and FedEx (NYSE: FDX ) builds. From reading the SEC filings, I could not figure out who controls the other half of that market. However, after my conversation with Salchow, I found out that Morgan Olson controls the other half of the market. Morgan Olson is a privately held company owned by J.B. Poindexter & Co . Learning this information was invaluable and I may be reaching out to Morgan Olson soon in order to continue my sleuthing process. My biggest takeaway from the conversation with Salchow was how management is focused on the pricing model. From reading the annual and quarterly reports, one can come to a conclusion that the pricing model is going through a change, in order to better the business as a whole. However, the annual and quarterly reports do not go into detail on what exactly was the issue beforehand and what the solution is to the problem. The following will discuss my takeaway from the pricing model then and now. Before Adams took over as the COO/CEO, it was normal for a customer in the ERV segment to want a custom design, with all sorts of bells and whistles, on pretty much every firetruck that they were ordering. In the past, SPAR provided each customer with what they wanted. There are a few problems that transpired from this. First, since each firetruck order was custom designed by the customer, the time it took to manufacture/build the firetruck increased, drastically. The longer it takes to build out an order, the higher the chance of margins getting squeezed. Remember, from 2012 until now, margins have been in the red. The second issue with customizable builds is that the laborers are more prone to make a mistake. Thus, if a firetruck is a custom build, it is most likely the laborer’s first time building this type of vehicle out. What this means is that the process is not systematic, it will take significantly more time, and if a mistake occurs (depending on how big), they may have to start completely over, thus continuing to eat into margins. To combat these difficulties with custom builds and to make the manufacturing process much more efficient, management has done a few key things. First, they now give customers an option to go with a pre-built out truck, which is much more inexpensive than a custom build and saves time on the manufacturing floor. Urban customers who order > 70 trucks have taken a liking to this method. Having a pre-built out model is a win-win situation for the customer and for SPAR. This benefits the customer due to the fact that the overall monetary cost will be much cheaper and they can have their firetrucks in a much faster time period. SPAR wins from this due to the fact that the manufacturing process is much more systematic (they have seen the time it takes to build out a truck drastically cut down). Not only is it systematic and takes much less time, but in the long run, it will be margin enhancing. Urban customers have responded more positively to a more systematic approach than have the rural customers. The reason is twofold. First, urban customers (like the City of Chicago) order a lot more trucks than rural customers. Secondly, urban customers, on average, go through trucks every five years or so, while rural customers can make a truck last 15-20 years. Thus, rural customers really don’t mind spending more money on a few builds to customize it, since they will get a much longer lifespan out of the trucks over the urban customers. The second way that SPAR has combated customized trucks is by an update to their pricing model. If a rural customer wants a customized truck with a lot of bells and whistles, SPAR will now charge the customer much more money in order to improve their margins. In my opinion, this is a much-needed change that has a ton of potential to turn the company back into a solid state of profitability. This truck was sitting outside of the customer service department. Inside the manufacturing plant there was a significant amount of these being built. After my chat with Salchow in his office, we went out to one of the plants to hear Adams speak in front of the ~700 employees. All employee eyes were on Adams and his speech was very well put together and professional. After the speech, I got to talk to Adams and the CFO Rick Sohm for a few minutes. It was very crowded and busy so I did not have too much time to ask Adams or Sohm any business related questions. However, I did get a sense of their personalities and feel like they are very candid and competent leaders. Salchow and I ended up eating lunch with some other employees and to me it seemed like the transition from old to new management went very well. The employees seemed to be very happy and well taken care of. Overall, there were not really any motivational or attitude issues on the manufacturing floor. From my understanding the issues were from a poor operating methodology mixed with the overstocking of inventory (especially at Brandon). After lunch, Salchow took me on a tour on how the firetrucks and other vehicles were built from start to finish. It was a very enlightening experience and really helped me understand the business model in a much easier fashion than by just reading SEC filings. What I found interesting is that the average order takes around four months to get completed. However, with the new systematic method being instilled upon orders, SPAR has already started to cut back on the time it takes to build out an order. This is a picture of how the firetrucks come in. What is interesting is that the majority of the body is aluminum not steel, which makes for a much lighter and inexpensive body. When we were done on the firetruck build tour, Salchow took me to the manufacturing plant where they put together Isuzu vehicles. In regards to Isuzu, SPAR gets sent the parts by Isuzu (pretty much in a box) then puts the vehicles together. With around fifty laborers in the plant, they can build out around thirty Isuzu vehicles in a day (this really goes to show how a systematic approach can be much more efficient over a custom build). Source: Vehicle Service Pro I did not snap any pictures of the Isuzu plant but these are the vehicles that they are building. SPAR started building these vehicles in April of 2011 and since then, they have built over 20,000. It is remarkable on how fast fifty workers can throw together these vehicles. Finally, the parking lot of the plant is filled with a ton of these completed vehicles. This gave me a sense that demand is strong. If you have ever read Adam Smith’s Wealth of the Nations, you can understand the efficiency of breaking down of large jobs into many tiny components. The Isuzu plant was the end of the tour and my sleuthing was done for the day. Conclusion You can learn a ton about public companies sitting in front of a computer all day and reading annual report after annual report. However, getting into the field and doing qualitative research is a huge eye opener. In the three hours that I was at the SPAR plant, I learned a ton that I could not have learned sitting in front of a computer screen. This was my first experience touring a public company and I plan on continuing sleuthing around in the future. Once you get a taste for how much you can learn in a short period of time sleuthing, it becomes a much-needed part of the research style of an equity analyst. Going forward, I plan on continuing to develop my research style into a heavily quantitative focus, mixed with qualitative sleuthing methodologies.

Low Risk, High Return, A Dream Come True: SPLV

Most active managers fail to beat their indices. Passive management is systematic and delivers expectations over the long term. Stock-picking is lucrative, but time consuming. SPLV facts make it attractive. When it comes to investing in equities in North America, the S&P 500 is one if not the most popular index used as a guideline and benchmark. There are various exchange-traded funds that replicate the composition and the return of the S&P 500. Best known ETFs in this space are: State Street SPDR, SPY iShares, IVV Vanguard, VOO This index has delivered an annualized return of approximately 7.48% (depending on month calculated) in the past ten years with an annualized standard deviation of approximately 15.05%. This performance is certainly not rock star, but is respectable and relatively consistent. On a longer time period (since 1928), the S&P 500 has averaged around 10% annualized. So what is the S&P 500? The S&P 500 is an index composed of 500 companies in the U.S., considered leaders in their respective industries. Companies in this index are mostly of large capitalization and together they represent around 80% of the economy. Therefore, this index is considered a representation of the U.S. market. Some companies in this index are Apple (NASDAQ: AAPL ), Johnson & Johnson (NYSE: JNJ ), and General Electric (NYSE: GE ) . Knowing this index represents the U.S. market and that it has performed relatively well, we ask ourselves if we can make a better index. Like all changes, there may be something to sacrifice. Second, what do we seek in an investment? It turns out two and only two things are priority. First, we want our investment to appreciate the most be in terms of capital appreciation, income (dividend or interest), or both. Second, we want our investment to be as less risky as possible. We measure risk as continuous change in value (standard deviation) and loss of permanent capital. How do we minimize risk? Our first action is to diversity; this way we eliminate diversifiable risk known as unsystematic risk (company going bankrupt or not meeting expectations). Second, we invest in strategy that has delivered expected returns over an expected holding time period. Meet the S&P 500 Low Volatility Index. This index is a stripped version of the S&P 500, by selecting 100 constituents with the lowest volatility over the trailing 12 months from the S&P 500 and rebalancing the index quarterly. What is so great about this index? The risk-adjusted returns are impressive. Here is a graph of the index performance: (click to enlarge) As can be seen, the returns in the graph demonstrate adequate upside and safer downside risk in comparison to the S&P 500. How about the performance and the standard deviation of the index? (click to enlarge) Source: SP Indices The return table shows that on all periods except 3 years, the Low Volatility Index performs better than the S&P 500. Also, the Low Volatility Index demonstrates that it has been less risky than the S&P 500 in the trailing 3, 5, and 10 year periods. Before you get excited, I have talked about this index and the returns and risk it has provided over the previous 10 years but the index is not an instrument to invest in. So where can you invest in a fund that replicates this index? PowerShares S&P 500 Low Volatility Portfolio (NYSEARCA: SPLV ). This ETF has over $5 billion in assets under management and charges a total expense ratio of 0.25%, making liquidity and fees manageable. In terms of performance, the ETF has delivered an annualized return of 13.33% since inception versus 12.59% for the S&P 500 Index. The funds top ten holdings currently are Plum Creek Timber (NYSE: PCL ), PepsiCo (NYSE: PEP ), Republic Services ‘A’ (NYSE: RSG ), Procter & Gamble (NYSE: PG ), Campbell Soup (NYSE: CPB ), Stericycle (NASDAQ: SRCL ), McCormick (NYSE: MKC ), Paychex (NASDAQ: PAYX ), Ace (NYSE: ACE ), and XL Group (NYSE: XL ). Source: PowerShares Currently, this ETF is the only investment option in this index (per my research). There are other low-volatility ETF’s out there, but their methodology differs. It is clear SPLV is an attractive position to be considered for any portfolio.

Investing Through Stories

Analyzing stories can lead to good, long-term investments. Entrepreneurs spin myths that teach employees values and lead to economic power. What happens when the founder dies? Here at Seeking Alpha we have a love of numbers. The best analysts here compare balance sheets, tease out EBITDA, or throw prices on charts in a continuing search for market advantage. But the best longer-term investments aren’t like that. The best places to put your money for five or 10 years are in entrepreneurs, and what entrepreneurs do is tell stories. Many numbers-oriented analysts don’t like to hear this. They listen to Jeff Bezos at Amazon.com (NASDAQ: AMZN ), or Elon Musk at Tesla (NASDAQ: TSLA ), and they say, this can’t be right. The numbers don’t add up. But the stories do. And when the stories make sense in the world, when they make sense of the world, when the entrepreneur can lead a team to scrupulously follow a true trend, the numbers will follow. This is how transformative change happens. Want an equation? Here’s one: M x V = P. Myths times values create power. Entrepreneurs create myths. The myths are meant to teach values, and create a corporate culture that can hold economic power. The myth is where the company came from, the values are what the company – by extension its employees – represent to the market. Through myths teaching values, corporations can have power even after the entrepreneur has left the scene if the story they tell remains true. I understand that analyzing companies through their stories is counter-intuitive to Seeking Alpha readers. It doesn’t yield short-term buy or sell recommendations. It doesn’t tell you how to trade assets against one another, or account for quarterly performance. But it can tell you where to invest. Stories can, of course, lead you astray. Many people bought the Enron story Ken Lay told. Many people bought the MCI story Bernie Ebbers told. Some investors even bought the stories that Martin Shrkreli told. Stories, and story-tellers, are compelling. As a journalist, I am in the business of analyzing stories. What I try to do is to match story against performance, against reality, and against the story itself. · Does the company’s performance indicate that the story needs to change, or are transitory effects in the market just putting it in the market’s shade? If it’s the former, sell. If it’s the latter, buy. · Does the story have any chance of becoming true? Does it match the longer-term trends within the market? Does the story describe things as they are, or more important as they will be? · Is the story being followed? Is the company on the path of the story, or has it lost its way? Does the story describe a world that no longer exists, like the story of James Cash Penney (NYSE: JCP ) does today? General Electric (NYSE: GE ) has stayed on the Dow Jones list since Charles Dow first created it in 1896 thanks to stories. Each CEO tells a story, transforms the company to match the story, and is then followed by a new leader with a different, transformative story of their own. The GE of Reginald Jones was not the GE of Jack Welch, and the GE of Jack Welch is not the GE of Jeff Immelt. The usefulness of a story can run out. The IBM (NYSE: IBM ) story, first told 100 years ago by Thomas Watson Sr., is about salesmen leading managers toward better ways of doing things. But technology changes so fast today that salesmen can’t lead this process. Thus IBM has lost its way. Every great entrepreneur is, first and foremost, a story teller. Warren Buffett (NYSE: BRK.A ) (NYSE: BRK.B ) tells the story of value investing. Larry Page (NASDAQ: GOOG ) ( NASDAQ: GOOGL ) tells the story of search. Intel (NASDAQ: INTC ) has followed Moore’s Law for over a half-century. My beat is technology, and what I’ve learned is that the dominant tech stories get under trends and drive them. Microsoft (NASDAQ: MSFT ), under Bill Gates, understood that if you control the operating system, you control everything above it. Apple (NASDAQ: AAPL ), under Steve Jobs, is about devices being central to the technology experience. Salesforce.com (NYSE: CRM ) is a story stock, about applications driving the cloud. Every story has a sell-by date. As the world changes, so stories must change, and a founder’s story will often die with the founder. This can set a company on auto-pilot, as in the case of Wal-Mart (NYSE: WMT ), unless new leaders find new ways to tell that story. A founder’s death, or retirement, thus becomes a crucial moment in corporate history. Can their story be re-interpreted? Will the company allow such a re-interpretation? Does that re-interpretation hold up? This is what Satya Nadella is trying to do with cloud at Microsoft. It’s what Tim Cook is trying to do at Apple. The point is my investment strategy is to measure stories, not numbers. Do they hold up? Do they make sense? Are these myths building values that have lasting economic power? I admit it’s not for everyone, but it works for me. And that’s my story.