The one number all investors must know... How to get a major leg up over most investors... We do the work that others aren't willing to do... Investing should be boring... A hint about our newest Extreme Value recommendation...
'I wouldn't buy it, because I'm focused on volumes'...
That's what a former beer-company executive turned hedge-fund manager told me (Dan Ferris) and a couple other investors as we sipped cocktails at the end of a three-day investor meeting I attend each year in the mountains of Colorado.
I interpreted his comment to mean that years of experience in the beer business taught him that you can't invest in a brewing company without knowing the amount of beer it sells. Another investor in the conversation was thinking about buying shares of Molson Coors Brewing (TAP). The former exec said he couldn't buy it, because a brewer with declining volumes is a nonstarter for a guy with his knowledge and experience.
Earlier that evening, a veteran real estate investor discussed the merits of preferred stocks of various mall real estate investment trusts (REITs). The preferreds are higher in the capital structure, so they'll keep paying dividends... even if the company cuts its common stock dividend.
As he started his talk, he said, "The most important metric in malls is sales per square foot." High and/or increasing sales per square foot is good. Low or declining is lousy. Invest accordingly.
I'm not saying you only need to know a single number to invest in beer companies, malls, or any other business...
But I've learned something important over the last two decades: Every business has a key metric that investors must understand. Without knowing a business' key metric, you might as well take your money to Vegas and gamble it away.
Talk to a publisher or software maker who sells subscriptions. They're obsessed with marketing, advertising, and other related costs associated with gaining subscribers.
Talk to a banker. He's obsessed with net interest margin, the spread between the interest costs the bank pays and the interest it earns from loans and securities.
Talk to a gold miner. He's obsessed with the all-in capital costs and operating expense of mining an ounce of gold.
Microprocessor makers like Intel (INTC) tend to watch the average selling price ("ASP") of their chips. They make most of their money on high ASPs for their latest and most advanced chips, versus the lower ASPs they get for their older chips.
Knowing ASPs is essential, but it's only part of the job. Years ago, when I gave a presentation on Intel in New York, someone forwarded a 104-page research report that was bearish on Intel because it said ASPs would soon fall. I read the report and didn't change my presentation (partly because 104 pages about ASPs was overkill – a waste of time).
By now, you're probably nodding your head and thinking of the most important metric in your own business...
That's what I hope you're doing, anyway. Now, take that hard-won wisdom and apply it to the stocks you buy. If you do that, your portfolio will likely get a dramatic upgrade... And you'll spend a lot less time worrying about it.
Understanding key metrics reduces risk... and with it, some of the excess worry too many investors seem to indulge about their equity portfolios.
Most key metrics are either costs or profits. But sometimes, they're neither. Social media platform Twitter (TWTR) has been consistently unprofitable, yet the company and its shareholders remain focused on the number of monthly active users ("MAU"), with more than twice as many mentions of MAU in its annual and quarterly U.S. Security and Exchange Commission filings than daily active users ("DAU").
Twitter's highly profitable peer Facebook (FB) obsesses about the same number. (At more than 2 billion MAU, Facebook is more popular than communism, Islam, and Catholicism.)
You'll find this 'key metric' phenomenon all over the business and financial worlds...
For example, anybody who listens to quarterly conference calls knows that most Wall Street analysts focus more on gross margin than most other financial metrics. Gross margin is the percentage of gross profits left over after you pay the cost of the goods or services you've sold. After gross margin, deducting other layers of expense leaves you with operating, pretax, and net-profit margins.
Relatively small changes to gross margin can lead to big changes in other margins, including the cash-profit margin left over for cash dividends and share repurchases (cash in investors' pockets). In other words, for many analysts on Wall Street, gross margin is a key metric, if not the key metric.
Sometimes, knowing the key metric can help you strategize about larger developments in the overall economy...
For example, my longtime Extreme Value subscribers are familiar with Automatic Data Processing (ADP), the largest payroll processor in the U.S., responsible for delivering roughly one-sixth of the country's paychecks.
I recommended the stock in October 2008, in the depths of the financial crisis, because I knew it was a wonderful long-term investment trading at a dirt-cheap price. I continue to recommend holding the stock, which has returned more than 380% (including dividends and spinoffs) since then.
ADP hangs on to your pay for a night or two, earning interest on the funds before delivering them to your bank account. Last year, ADP held overnight $1.8 trillion (with a "t") in employee payroll funds for its employer clients. That $1.8 trillion is "float," just like an insurance company. Float is money you receive from customers that you'll pay back to them some time in the future. For ADP, it's just a day or two. Float is the key metric for ADP (referred to as "funds held for clients" in company filings).
I continue to recommend my readers hold on to their ADP shares because small rises in interest rates can generate tens of millions of dollars, or perhaps $100 million or more of additional cash profit from the interest on float... without a single additional penny of expense or investment. It's like an insurance company, without the risk of underwriting losses. Who's afraid of rising interest rates? Not ADP shareholders who read Extreme Value!
Of course, getting the most important number wrong can be devastating to investors, too...
Remember during the dot-com era, when everyone talked about "eyeballs" – slang for website traffic? The metric was frequently used to justify exorbitant valuations for businesses with no profits (and occasionally, no revenue). Many dot-com companies disappeared from existence, demonstrating there are more important numbers than eyeballs.
In Extreme Value, for example, we noticed that apparel retailer Duluth Holdings (DLTH) wasn't reporting same-store sales ("SSS"). Same-store sales is a key retail metric that compares the sales of stores that have been open for more than one year. Sales tend to skew higher the first year.
Comparing SSS tells you how the business is performing after the store's novelty has worn off. Duluth used to put a single line of same-store sales commentary in its quarterly reports, always reporting a favorable trend. Then one quarter, it toned down its comment. The next quarter, it stopped commenting altogether... raising our suspicions.
In Extreme Value, we've used our understanding of key metrics to find incredible deals with huge upside and limited downside...
A few months ago, we recommended a pair of dry-bulk shipping companies. We spent plenty of time thinking about time charter equivalents ("TCE"), the daily sales figure most important to owners of ships that move commodities like iron ore, coal, grains, metals, and chemicals across the world's oceans.
We found two companies with low debt burdens that traded at huge discounts to their value, based on the rising TCEs they were charging. We realized we had found a couple of stocks that could return 200%-500% over the next few years, with less risk than all of their competitors (most of which are horribly overloaded with debt).
Earlier this year, I found the single greatest equity opportunity I've ever found in my 20 years playing this game...
I noticed that the most important number in that industry had risen dramatically – even through a brutal four-year industry-wide downturn.
That's a rare and highly robust business... one that gushes free cash flow, pays a 4% dividend yield, and has no debt. It's currently just pennies above my maximum buy price, which we're considering raising right now, due to an unusual and likely one-time situation that should play out over the next year.
All in all, I'm comfortable saying that this stock has limited downside risk and upside potential of as much as 20 times your money over the next 10 years or so.
In Extreme Value (and other Stansberry Research publications), we do the work other investors can't or won't do for themselves...
Ask yourself how many of the key metrics I've mentioned were squarely on your radar... something you look at before you look at anything else about a business.
Most folks answering honestly will realize they don't know the key metrics for the stocks they own. These people have a huge (and potentially embarrassing) hole in their investing skill set... one we're laser-focused on plugging for you.
Learning to track key metrics isn't easy, either. You'd better know someone who's already pretty good at it. In fact, you may have noticed something else about these important numbers: Except for gross margin and net-interest margin, none of the key metrics I've discussed appear in a pristine, easy-to-use form on a company's quarterly financial statements. An accountant would probably say something like, "Most of these key metrics Dan is talking about aren't compliant with GAAP accounting rules."
He's right. They're not. But generally accepted accounting principles ("GAAP") aren't enough if you don't want to lose the money you invest (and make a whole lot). You must know key metrics, too. So, either the company must report them separately from its GAAP financials, or investors must learn to calculate them using the financials and other data the company reports. It's like I tell my readers now and then: Analysis begins with the published financials – it doesn't end there.
If you want to make more money and take less risk in the stock market, you'd better be more informed than the average investor. I promise you, the average Joe doesn't have a clue what the key metrics are of the businesses he's invested in. That's just crazy.
If you buy a stock but don't know the key metric and other important data – some of which don't appear in quarterly reports at all – you're gambling with your portfolio.
I've been at Stansberry Research longer than anyone besides Porter. I've been working with just one analyst – the intrepid Mike Barrett – for most of the last decade. Between the two of us, we have around 50 years' experience (and lots of gray hair). Learning key business metrics is an important lesson that has been ingrained into our psyches over multiple decades. Passing it on to you is one of the most important roles we play in the lives of our subscribers.
If the topic of key metrics is boring to you, it's a sign we're right on track...
Investing is best when it's as boring as watching paint dry.
And for those who won't take the time to learn the key metrics of the businesses in their equity portfolios, we're grateful. The more ignorant they remain about key metrics, the more of an advantage we'll have in the stock market, and the better our readers will fare when they take our advice.
In Extreme Value, understanding key metrics is one of the main tools that helps us find crazy good deals in the public equity markets, which other investors clearly don't understand at all. For example, in the July issue, out next Friday, we're recommending a company everybody thinks is in health care, but which is really a luxury-goods provider.
It has gotten cheaper lately because folks aren't focused on the key metrics. (In this case, there's more than one key metric.) They're thinking about a now-meaningless news headline from 2016, which no longer has anything to do with the business.
Next Friday, July 13, Extreme Value readers will learn the name of this stock, which we think will be a solid, dividend-paying double for investors over the next couple years.
Learn key metrics before your investments give you a painful lesson in them. Or not. Your call.
(Extreme Value isn't for everyone. But if you're a serious long-term investor who wants to learn about key metrics and other important investing tools that can keep your money safely compounding for years, Extreme Value might be right for you. Learn more about a subscription right here.)
New 52-week highs (as of 7/6/18): First Majestic Silver (AG), Facebook (FB), Fidelity Medical Equipment Fund (FSMEX), Sysco (SYY), and Wheaton Precious Metals (WPM).
If you're a business owner, let us know what your key metric is. Drop us a quick note at feedback@stansberryresearch.com. We'd love to hear from you.
Regards,
Dan Ferris
Vancouver, Washington
July 9, 2018