Saturday, September 29, 2007

new look

any thoughts? Hopefully you have noticed the new look -- I like it better but if you have any thoughts please let me know.

I have changed the ads too -- there used to be 2 adsense buttons but now I have added 2 referrals areas -- these appear to get higher quality ads which is nice. let me know if the advertising becomes too much and I'll cut it back. its on the side so I am hoping its not so bad.

feedback would be great -- since its now almost 3:40am -- probably hitting bed soon.

update on stocks not bought

Over the last couple of months I researched many many stocks and commented on most of them here in the blog -- I even wrote up long descriptions of why I liked the stocks and probably made it sound like I was either buying or about to be buying them. Instead, most of the time, I would just move on to the next story and not buy anything -- until I got to FLIR. Which I have bought a small position in and am hoping to buy more at more attractive prices.

One of the first stocks I reviewed was Ecolab (ECL) -- it was in the low $40s and selling at a discounted valuation vs. its history. fundamentals seemed fine so this looked like a good time to get in -- no real catalyst that could get the stock moving soon but often its hard to spot them ahead of time -- hard enough to pick a winner let alone picking the timing of it.

Sure enough ECL is now $47 -- new all time highs and up from a recent low around $41. Not bad for a few weeks work. Not uncommon either for me to have a strong return in a stock I have chosen not to buy. that's one reason I mention them all -- perhaps the story will sound interesting to you and after your own due diligence, you might decide its more attractive then I give the stock credit for and choose to buy in. great for you. I can't own them all. I am very happy with FLIR but it would be nice to own some ECL too -- now it dawns on me that maybe ECL would have been a better choice than GGG given all the icky news about housing but oh well.

Interesting that ADBE -- another stock I have mentioned but did not buy -- had great earnings yet the stock has been flat to down since I mentioned it -- hmmm.... as the chartists say its not the news that matters but the market's reaction (it seems the market expected good results).

IHS had great earnings and the stock popped from the low $50's to the $57 range. Not bad. again, I am very happy with FLIR.

Ralph Wanger Lunch

I had the privilege this week of having lunch with Ralph Wanger (former manager of the Acorn fund and member Morningstar investor hall of fame) ... well it was me, Ralph and 100 other close friends! You can see Ralph's influence on my portfolio in several stocks -- UEPS, NVT, ILMN, FLIR as well as some not so obvious choices like GOOG.

Ralph was a small cap manager because he thought small caps had the best growth opportunities (true) and were the least followed or least efficiently understood by wall street -- meaning you had the best chance to outperform benchmarks, while investing in small caps. He used a strategy often called GARP -- growth at a reasonable price although in the end he would rather focus on value then growth -- value reduced risk and increased returns.

He has written a book called a Zebra in Lion Country, which I would highly recommend to anyone interested in investing in stocks -- especially small caps. Ralph is unusual in the investing world because he is so funny -- while I didn't learn too much new at the lunch that wasn't in his book or other things I have read about him, it was well worth it because of how funny he was.

He is also humble -- at lunch I asked him the question what steps he took to try to avoid large declines in small cap growth stocks (a common problem because when a company misses their stock often declines 30% or more in a single day due to the lower liquidity and higher company risk within small cap stocks) and his response included the comment that of all the analysts and portfolio managers at his firm, he had recommended the highest number of stocks with big declines -- something he could get away with because it was his firm and because his winners were more important.

He explained how small cap stocks is a winners game -- slugging percentage matters. Your home runs offset your strike outs. He mentioned IGT -- slot machine maker as a stock his fund made 100 times its money in. wow -- that is a home run I would like to hit!. Best I have done is MSFT or about 14X my money. (if I had not been stupid in 1999 and sold my shares of BEN, I would have a 25X gain on my first shares and a 10X gain on my average cost but alas I sold.....)

Ralph uses secular themes to manage his fund -- he said turnover costs for a small cap fund are so high due to the price impact when you try to buy and sell small cap stocks. He would try to keep turnover around 20% -- equates to a 5 year holding period on average -- to minimize trading costs. No one can predict a company's earnings a few quarters out let alone 5 years! So he uses themes as a way of identifying stocks that he can be comfortable owning for 5 years and still be reasonably confident they will have good earnings growth over that time.

One of his themes he mentioned at lunch that was really interesting was to avoid technology companies themselves but instead target users or beneficiaries of technology such as IGT.

IGT buys microprocessors from some tech company for $40 -- that semi company makes $10+ in gross profits on that chip sale. IGT takes the chip and adds other stuff to create a $2000 cost slot machine, which they sell to a casino for $8000 or about $6000 in gross profits -- great business. But the casino buys the slot machine, puts it on the floor and makes $300 per day from gamblers who are bad at mathematics. That means the casino has a 3 month payback on that slot machine -- that's why there are so many casino operators on the Forbes 400.

One other interesting comment he made during lunch was how does he spend his time between existing holdings and new ideas. He said they have a database of stocks covering all the small cap stocks they could buy. For each stock they have an estimated future return potential based on a growth estimate and the valuation. He argued to look at the outliers -- the stocks that looked the most attractive were most likely using estimates that were too optimistic while the stocks that looked the least attractive were likely using estimates that were too pessimistic. Everything in the middle was probably fine -- if you owned them, then leave them alone because they are doing ok. If you didn't own a stock in the middle, it was probably fairly priced so not the best opportunity. That's a great idea although its not one that I have used I think it would be a great way to help with your time.

He didn't really answer the question of what themes he is playing now other than to say energy looks good -- thanks for that tip! not unexpected given that many managers like to keep their cards close to their vest -- why give away good investment ideas for free? one of his firms top holdings? number 12 is FLIR.

Friday, September 28, 2007

300 bps

300 basis points of outperformance in 2007!!!!!

Pretty cool but its not nearly as much as it should be -- 3 stocks -- some of my biggest positions -- UEPS, TSRA and DFR are down for the year -- some double digits and some as much as 40%. That is creating a huge drag on the secular value investor's portfolio!

But today's thought is that the last time the portfolio had reached that level of outperformance was during July right near the peak of the market....hmmm.......

Tuesday, September 25, 2007


Factset reported EPS this morning and the numbers looked pretty good. They beat by a few pennies and maintained guidance for Q1 of fy2008 but the key for me was free cash flow. FY 2007 had EPS of 2.14 but FCF of about 2.28 -- about 5%+ MORE than EPS. It is rare for companies to have higher free cash flow than earnings. Wish I had some spare cash when the stock hit $52 -- that was a steal now that it hit $66 today.

Many worries about turmoil in money managers but FDS just kept right on going. They got 30% of revenues from overseas clients -- that is pretty cool.

Given the subscription nature of the business it is highly unlikely any issues with blowing up hedge funds or private equity or investment banking, etc. would show up so quickly. The subscription number they gave of over $500 mill suggests no issues yet. Factset is still fairly small compared to other service providers like bloomberg which has about 8X as many users as Factset. The stock is not cheap but it is one incredible business -- consistent sequential growth, high free cash flow, high margins, high return on capital, etc.

I'm up about 30%+ in the year or so that I have owned the stock. not bad -- here's hoping the next year is just as good.

FLIR and CME update

So far this week I have bought more FLIR and more CME -- just small increments to take advantage of the pull backs. In FLIR's case, its STILL less than 1% of my portfolio so we are talking baby steps here.

My largest positions are 10% -- those are reserved for Asia and AB (money management) -- next are a few in the 3-4% range including UEPS, TSRA, CME, LH etc. I would like to get FLIR closer to 3-4% but its going to be hard -- it means selling shares in my existng holdings. Microsoft will only provide 1-1.5% of that so I would still need another 1% or so from somewhere else. Not sure where yet -- maybe take gains in a stock that worked like UEPS or TSRA or LH or MDT if it gets above $60.

Anyway, more CME because its a monopoly with strong growth and potential for rising estimates and the stock has been flat for awhile. I am thinking $20 for 2008 in terms of earnings is possible, which gives you a 27X kind of PE at today's 540-550 price. For a 60+% margin business with tons of free cash flow, no real capital requirements and lots of potential growth this is a bargain.

Monday, September 24, 2007


Just wondering why this stock hasn't moved over the last month or two -- volumes are up big time yet the stock is not moving? either this is a great opportunity or I'm missing something. Hmmmmm... probably a combination of both.

volumes are up but customers get volume discounts so the rate per contract will be dropping.

Could it be that the merger is dilutive and that the big volumes are masking its real impact?

or is it merely that the stock is flat most of the time with a step function jump when they report earnings?

Ah Ha! did some more reading and thinking and I believe I have the answer -- less interest income.

the BMO Capital markets analyst abbreviated model that I have shows revenues (proforma for the deal) up 15% Q/Q and operating income up 25% Q/Q but EPS up only 8%. At first I figured it was due to the 50% jump in shares but then I looked at Q2 numbers and realized that adding CBOT's income would result in about a 50% increase in CME group's income so that wasn't it.

Then I remembered CME paid a dividend (to CBOT shareholders) of close to $500 mill as part of the deal and even though the share buyback auction was very under subscribed, they still spent hundreds of millions buying back stock. So last quarter they had between the two of them close to $25 mill in interest and other non-operating income or about 8% of the total.

If you take away that income, then unless volume surges like it has, EPS would have declined sequentially. So the volume surge has helped to keep estimates where they were -- flat estimates = flat stock. have to think about whether it makes sense then to add to the stock. Its still possible that analysts are underestimating the numbers -- they do produce lots of cash flow so the hit to income may not be as bad as some are assuming.

interesting huh?

Thursday, September 20, 2007


interesting question in the comment to my recent post on the Fed. The impact on the dollar... and inflation. Hmmmm.... Its not an easy question to answer. As you will see be prepared for quite the ramble. Obviously the knee jerk reaction is to assume the dollar will continue to fall in value and it very well might (you will notice I am far less certain in my currency pronouncements vs. stock comments given the abysmal track record of currecy predictors, excluding Mr. Soros of course).

Other hands....

I read a story this week that said the Canadian dollar had reached levels not seen since 1976 vs. the dollar -- and was very close to trading at parity. Seems like the dollar has fallen quite a bit already -- our economy and our inflation are SO MUCH better now than in 1976 that its not worth arguing over (I should clarify that I am thinking of the 70's in general and not that one specific year which could have been a very good one). Maybe we will fall some more but no market moves in a straight line all the time.

I am not one that subscribes to the Buffett view of the world that we have been outliving our means and that our trade deficit is evil and the only answer is a collapse in the dollar. First, the amounts involved are relatively trivial -- a few percent of GDP on an annual basis, which is a negligible percent of our total asset values. Are they big numbers vs. annual trading volumes in our markets? probably but currency volumes are pretty darn big -- check out CME's numbers (their comments on OTC currency markets not those that trade on globex). Second, I don't believe any numbers published by any government -- there is no way anyone could reliably keep up with all the trading that occurs around the world and the very lengthy route most goods take to their final destination. Big currency moves occur when countries do things that are unsustainble -- I'm not convinced that we are in that situation now.

I subscribe to the Milton Friedman school of rates -- floating is best. Why? which makes more sense to change the price of currency exchange or keep that one stable and change every other price in the US or Europe or wherever to reflect the changing values of the currency? one price or millions and millions of prices? Yet smart folks like the WSJ editorial staff like stable exchange rates (well so do I, but the world is dynamic so which do you change -- one price or billions of prices?). The WSJ would have the US change monetary or fiscal policies to keep the dollar flat because this way businesses can plan for the future better including making investment decisions.

While we have this deficit thing and our rates are different from other countries interest rates we have also had faster economic growth than the rest of the developed world -- where do you want to invest? where the growth is. The housing and credit issues are likely to slow our economy over the next year so that argues for a lower dollar too unless our economy still beats the others (Germany, France, UK, Japan, etc), which is quite likely.

All that said -- longer term why do you think I have about 1/4 of my assets in Asian equity funds? because over time they are very very very very likely to gain market share vs. the US in terms of GDP and the market cap of their stocks. Would not be surprised to see Asian currencies gain vs. the US as that process plays out too.

Now on to inflation -- I don't think we will see a big surge in inflation but a continuing uptick is very likely -- if we see the Congress actually following through with higher tax rates then we can look forward to the very real possibility of stagflation. Yuck. nothing works except maybe energy and other commodities. T Rowe Price saw this coming in the early 70's -- he knew that growth stocks valuations were ridiculous (similar to 2000) and that based on underinvestment to curb supply and growing economies helping demand -- he foresaw the new era in which commodities and other hard assets would dominate -- perfect timing as he introduced the T Rowe Price New Era fund.

Besides energy -- look for companies with strong brand names that are able to raise prices without seeing drop in demand. consumer staples are key. I am hopeful new cycles like FLIR will also be OK.

My energy exposure is wimpy -- the Vanguard energy fund for broad exposure has done reasonably well; ERF has done OK -- pays a good yield but canadian tax laws took a bite out last year; EPD and MMP are not price sensitive but more volume related -- not a very good play on energy per se but still they have been outperformers given their growth and high yield. Services/equipment stocks are the non-wimpy play.

History suggests the Fed is almost never one and done -- more rate cuts coming and the impact on liquidity should drive inflation - falling dollar adds to that. Still, there are ways to improve productivity through capital investments and if labor is an issue -- China and India are adding millions to cities each year -- they need jobs. IF Fed is one and done that could change quite a lot of thinking -- that maybe he isn't following in the footsteps of Burns (70's fed chief).

great question - thanks for the comment. will do some more thinking on it.

Wednesday, September 19, 2007

FLIR -- a quick 6%

Never have enough of a stock that goes up 6% in less than a week! oh well. I would be kicking myself right now if I didn't have at least some exposure -- in this case I think I have made $150 so far -- Yippie!!! (sarcasm!) anyway, they got an order from overseas gov for their high end system. This keeps the gov mo going and it also opens up international gov as another growth area. Plus they are in an area where the fed's cuts will help demand.

Some more thoughts on the potential -- Garmin has about 25% of the world wide market for portable navigation devices and is expected to produce total revenues around $3 bill this year. The price of their PNDs ranges from $300 to $1000.

FLIR has 40% share of the commercial/dual use market for infrared tech and they are expected to have $750 mill in revenues and the price of their systems ranges from $2k (tech core for BMWs) to $1 mill (gov system for military use).

I wonder how big FLIR can be when the price of their product gets to $300 -- will they be able to hold on to their 40% share between now and then? I don't think a $300 infrared camera or thermography instrument would engender the same excited purchase behavior that today's PNDs are for Garmin but I have to believe someone would think up some cool applications at those much lower price points for infrared to drive much higher volumes than the current several thousand units FLIR sells.

Over time they will be much bigger -- question is are there valleys in the middle. In some ways I hope so because I would like to buy more.

fed cuts 50bps

wow -- not only does the fed cut 50bps but the market takes off. Just because you get the first part right doesn't mean you would get the second part (market reaction) right too.

I think this should increase the odds that DFR survives and if that happens the stock should over time make its way back to the mid teens -- unless their book value has dropped (as I had speculated about a few weeks ago) due to any price declines in their mortgages. We shall know when they report Q3 results.

Key to the fed cut is NOT to focus on the financials that might get a little better but rather to focus on the strong areas that are about to get ridiculous. I spent some of the weekend reading about oil services like SLB (schlumberger) -- a stock that was up like 5% today. I wouldn't have bought except for on a pullback but it bugs me that I sold the OIH at 126 last summer. In a moment of panic about volatility I sold my shares and never bought back in even after it was clear the bottom had been reached. I could have easily bought back in around 155-160 during the last month but was focused elsewhere.

Given the strength of those stocks (slb is up a lot more than the oih), its hard to even think about buying them here. I thought about going into a whole description of Cramer and how to use him but not tonight. He is the reason I bought the OIH in the first place -- his bullish call has been great except for last summer where he got nervous about the oih and told everyone to sell saying it was going below 100. I think the low was around $116 or so and then it was straight up to the 180s. ugh!!!!

You have to be really bullish on the cycle to buy here but there are reasons to be bullish -- its just too hard to get the oil out of the ground in the places where it is (unfriendly). The energy industry underspent on cap ex for 20 years after the last boom busted in the early 1980's. Every exec in that industry has made it to the top because they didn't buy in to boom times -- they made it to the top because they knew how to cut costs and do consolidating mergers, etc. Now an upcycle comes along and no one has really believed in it yet. Obviously people believe in it more now than in 2003 when I was buying my vanguard energy fund shares. Yet most investors and companies have been expecting the cycle to end at any time.

I read some reports about day rates for certain drillers flattening out -- no longer rising -- sign that supply is catching up with demand. The amazing thing about the energy industry now is the decline rates -- in US natural gas, the industry is experiencing 30% decline rates on new wells which means you have to find 30% more natural gas each year to maintain production levels. Amazingly the industry has been doing this enough to create a falling gas price (at least some point this year not necessarily this week).

So while oil is going to new highs not sure that everything energy related is. Merrill posited that SLB had exceptional earnings last quarter and the rest of the industry was mixed.

I will keep watch and perhaps add to my energy holdings during the next time everyone assumes the cycle is about to end.

Monday, September 17, 2007


What will the fed do this week? probably lower rates. What should the Fed do? harder to say. Great editorial in the Journal this weekend talking about the Fed repeating the mistakes of the 1970's (being more worried about growth than inflation). Are they right? Is the Fed more worried about recession than inflation? probably -- take a look at the price of gold -- its almost at new highs. History time:

1970's we had about 4 recessions from 1969 to 1982 or about 1 every 3 years with the last one in 1982 being the worst since the depression. Stagflation was the term to describe the 1970's because we had periods where the economy was not growing or barely growing and yet inflation was reaching high single to low double digits? That wasn't possible according to the Keynesian view of the world (uh.... maybe Keynes has always been wrong about pretty much everything!) but it was basically caused by a combination of an ineffective and incompetent Fed as well as too high taxes and too many regulations.

Volcker comes in and tries to eliminate inflation and doesn't let up even though the economy gets crushed. He finally relents and then Reagan cuts taxes and continues to deregulate the economy (Carter actually started it by eliminating the Civil Aeronautics Board that set airline prices) and the combination eliminates the inflation and gets the economy growing -- this unleashes the last 25 year boom.

Greenspan takes over a few months prior to the Crash of 87. His response to the crash? add liquidity. Next tax reform hurts real estate investing plus partial dereg and the collapse of the junk bond market threaten savings and loans -- much much worse than today's issues in terms of the banking system. Combine this with tax increases a la Bush as well as higher rates from the G-man and you get a recession. What is Greenspan's response? cut fed funds to 3% -- lower than it had been in quite a while. In 1994, he raises and almost causes the next recession but he relents in late 94 when the GOP wins the congress and Mexico blows up. Strong economy until Asian issue starts in 97 and then the Russian default and LTCM in 1998 -- what does G-man do? cuts rates 3 times in the fall. Nasdaq explodes higher. He raises rates in 2000 then comes tech collapse. Response? cut rates to 1% to avoid deflation and keeps them there for 1 year and then raises them very slowly. Response? huge debt boom in real estate -- and LBO's.

Just to recap -- in early 90's real estate was ugly -- especially commercial real estate. Fed funds cuts dont' really help real estate but they do start up a boom in technology spending helped by the advent of windows, networking and other technologies. By 2001, tech has collapsed after a huge boom but by now real estate hasn't done much in 10 years so all the new liquidity goes there -- not to mention into commodities like energy (thanks to oil's 20 years in the wilderness of no cap ex spending causing supply to finally reach shortages once China's growth kicks in). Several years later the real estate boom collapses but by now technology has finally moved back into shortages. Meanwhile China continues to keep the commodity boom going.

So it sure appears that the fed's mismangement under Greenspan has caused the economy to alternate booms/busts between technology and real estate. Right now we appear to be starting another tech boom. Fed cuts won't save mortgages but will help Tech. Will we have a recession? don't know but for the next 6 months the answer is no. As liquidity is used to push out a recession -- a normal cleansing process -- there is a theory that the imbalances aren't allowed to clear and that they just keep building until one day the economy will suffer the worst recession since the depression again. Its possible but I like to think of the last 25 years as not too many general overall recessions but a lot of rolling industry recessions/cycles. So maybe all those excesses do clear its just a few industries at a time.

have a good week

Well I bought some (FLIR)

Yep, on Friday I sold my first shares of Illumina after its big gain and used the proceeds from that NVT sale a week or so ago to start a position in FLIR -- probably no more than 25% of the ultimate position size. Why did I buy some FLIR?

1. I kept the position size small because the current price isn't the best entry point for the stock.

2. I bought the stock because:

a. its a great secular story that is only dependent on falling costs/prices. Its true that there are technology stories with much better growth rates ( - CRM for one) but they also come with much higher valuations and often with much lower margins. FLIR is already quite profitable and is only 25X earnings -- I say only because with a history of high teens revenue growth, Flir is in a rare group indeed. Not too many businesses have that kind of organic revenue growth.

b. in the last recession (2000-2002) they grew revenues during that period despite the economic weakness because with FLIR it ALL depends on new defense contract wins as well as new commercial product cycles. Thermography started one last year and I am hoping its good for another few quarters. Meanwhile, the commerical vision systems business is just beginning new product cycles based on falling prices. They are adding distribution and partnerships to increase sales in this area just like they did with thermography a few years ago.

c. if it pulls back, I will buy more -- do not think any slowdown will last long because their new product cycles seem short. Key is their ability to continue to produce step function cost/price drops that encourage new applications and new customers.

d. momentum is strong -- what happens if the pullback comes after the stock has doubled? that's why I buy some now -- would really be upset if I missed a double in a stock I identified as having a great secular story.

e. expect margins to widen some more based on continued operating leverage in the commercial vision area where margins are quite low compared to the corporate average. stocks do well on increasing margins.

that's all I can think of tonight.

Friday, September 14, 2007


UEPS reported earnings at the end of August and they appeared in line but I read a report from Thomas Weisel today that talked about how revenues would have missed if not for higher than expected software sales -- i.e. lower quality since the company has some control over when those revenues are booked. Transaction revenues -- i.e. payments for card usage came in lower than expected due to start up delays with a new set of 300k welfare beneficiaries UEPS was awarded by the south african government as well as some civil servant strike -- one time temporary factors that should be past.

They also faced some margin pressure due to the lower revenues and start up costs -- I expect this will be a common theme because they have so many new projects starting up this has to hit margins in the near term but once the infrastructure in Nigeria is built (or wage payment in SA, or all the other countries they are entering) and the revenues start to flow in, margins will expand dramatically. They won a share in a smart card contract in Nigeria for 65 mill cards -- vs. the 4 mill they have now. They are working out the details with the other party that won and the government but this should be a big deal.

Welfare contract is now an October event they hope -- with elections in December if they don't get a decision by late October, there is a good chance they won't get an answer for another year. The delay would suck. Given that this is 75% of revenues, resolution is a key issue for the stock.

Owned this a year now and have nothing to show for it -- still tons of promise but the multiple keeps dropping. I doubt the stock will be flat for another year -- there should be some visibility on various growth engines over the next year to get the stock moving:

1. welfare contract resolution
2. wage payment -- how quick is the ramp in customers; how profitable per card is the new service?
3. Nigeria -- how quick is the ramp in customers and how profitable per card will they be?
4. Ghana's new mobile bank project -- using the virtual credit card payments (linking master card/visa with UEPS in a way that allows secure payments over the cellular net or Internet.

I don't have the best track record of predicting what will be my biggest future winner, but I still believe this is it -- more upside here than any of my other stocks (with possible exception of my biotech GNVC). The numbers tell the story -- 4 mill customers now and 3 billion people in world without bank account. if they can get even 1% share that's 7X current number of cards.


I first heard about Flir Systems several years ago but at the time I wasn't interested in a defense play. I re-read about it last year but the person making the case for it started out with the company has missed estimates for 4 quarters in a row but we still like it. That's not a ringing endorsement. I re-read about it over the last several weeks but the story still didn't resonate with me -- I still thought of it as a defense play. Then I read a comment about it in an issue of Forbes from a year ago (their 200 best small caps) and everything changed -- I finally got it!

My goal is to find can't miss situations -- companies that have such strong secular trends that they almost have to increase in value over time. Think about my recent purchases that have worked out wonderfully -- NVT and ILMN. Both times I bought in at a time when most investors were questioning the future of the two companies. Yet they both are beneficiaries of powerful secular trends: GPS/location based services and DNA analysis (genotyping and sequencing to be precise). Able to buy without having to pay for the great secular growth because no one believed in it. A year ago last summer, Flir Systems was also a great opportunity -- 18X next 12 months estimates ($25) and a beneficiary of strong secular growth trends.

Now the stock is $50 and sells for 25X next 12 months estimates and no one questions their growth prospects anymore. Yet I am still thinking about buying a small position in the stock -- why? Because the growth trends and profitability levels are that good. I would buy more on a pullback.

FLIR sells infrared equipment -- both thermography (temperature) and vision systems -- night vision. 46% of sales are to governments, 37% is in thermography and the rest is commercial vision systems. Within dual use (military and commercial) and commercial markets FLIR's market share is 40% vs. only 5% in dedicated military markets. Their main competitors are defense companies like LLL -- who are used to low volume high priced equipment -- i.e. military orders not commercial business. Flir has 3X the market share of their nearest competitor in the commerical/dual use market -- that means Flir has scale advantages that are huge in terms of costs and distribution.

The key to the growth story is that the cost to manufacture infrared cameras is dropping quickly -- and with that the prices customers pay. As the price drops more applications or uses make economic sense and more customers become interested.

What are the uses of infrared cameras? Thermography is about detecting small changes in temperature so its ideal for preventive maintenance, home inspection and process control applications to name a few. Vision systems are basically night vision equipment, which can be used for search and rescue, transportation (see more clearly while driving, flying or shipping/boating) and security.

Think about GPS systems several years ago -- they were expensive; used mostly by the government and were primarily about determining location. Years later they are cheap, used mostly by individuals for not only determining where they are but also for navigation -- how to get somewhere. Right now the cheapest infrared camera is about $7000 but in a few years it will be under $1000 and volumes will soar. Now Flir's volumes are measured in thousands but in a few years they could be measured in hundreds of thousands or even millions. Costs are dropping on a predictable curve -- similar to Moore's Law in semiconductors.

According to Bear Stearns, the company has had 18% CAGR for organic revenues since 1995. That's so much better than any of the companies I have been looking at recently. I expect the rapid growth to continue as volumes jump thanks to the lower costs/prices.

Flir sells integrated solutions as well as technology cores -- meaning BMW has bought a night vision solution for their 7 series cars from a firm called Autoliv, which gets its infrared technology from Flir. Integrated solutions means they design the product for a particular use including features and specs that matter to customers that need a particular application. This is how markets get started -- through application specific products -- over time more generic products may work better for lots of uses. One other key aspect to Flir is their ability to partner (Autoliv for cars, others for security cameras) and to add distributors to get the products to customers -- its a key barrier to entry.

So just to spell it out again in a slightly different way.... I see this as a technology that many many people would like to have at the right price point for various industrial, commercial and personal uses. With costs dropping, the company can lower prices and maintain margins while reaching those prices at which more customers think its worth it to buy. It then becomes a matter of time and execution -- can they continue to lower costs and introduce compelling new products to take advantage of the lower costs/prices? This is a much easier problem to solve then trying to find sources of growth.

That's the intro -- I have written about several companies lately -- all wannabes for inclusion in the portfolio -- this one is now at the top of the list. pray for a pullback so that I can buy in at a lower risk point. I'll keep you posted.....

Tuesday, September 11, 2007

Skimming the cream

Why is Google such a good business? Because they skim the cream in terms of Internet revenues. Microsoft was one of the first to do this when they decided early on to just sell software. At that time there was no independent software industry -- computing was fully integrated so you bought everything you needed from one company -- most of the time that was IBM.

Microsoft realized that the true value add was in the software so why not just concentrate on that part. That's the cream -- by focusing on just operating systems, large scale applications as well as some programming tools, Microsoft was able to generate very high operating margins -- as in nearly 50% at their peak a few years ago.

Google is similar -- they generate most of their revenues from online search advertising which is the highest value added part of online revenues because most of the time when you are searching you are looking for something -- often something that someone else sells. How powerful is that information -- to know when someone is looking to buy something a high percentage of the time? That is incredibly valuable info and that is why some companies pay huge key word prices -- because what looks huge is actually a much smaller customer acquisition cost than other methods (offline advertising, promotions, store displays, etc).

I was reminded of this concept of skimming the cream when looking at a company called Landstar. They offer trucking services without the trucks -- non-asset based services is the term. They use independent truckers and serve as a middleman between them and those with goods to be shipped. They earn low margins but they don't have much in the way of assets so they can earn a high return on assets and a good return on equity. They also produce good cash flow too. In fact their cash flow is so good that they have bought back over 40% of the stock in the last 10 years -- a slow motion LBO I guess. Their costs are all variable just like revenues so margins are pretty consistent but revenues fluctuate with the economy -- now is not the best time to be almost all US based revenues in a heavily economically cyclical business like trucking. Still its a neat business and one to keep an eye on -- I think CH Robinson (CHRW) is similar.

In a way skimming the cream is also what Amphenol (APH) does -- completely focused on the higher margin parts in the business. I listened to a webcast of a recent presentation they made and learned a couple of insights. They divided up their markets into 2 parts -- the top 10 competitors of which they are number 3 and the next 1000 competitors. The top 10 have a bit more than 50% of the market, which leaves the rest of the market spread amongst 1000 others. They should have some advantages over the bottom 1000 including scale, customer relationships, broad product line etc. I still don't know for sure how much of the market is 20% margin but I now believe it is bigger than I first thought. Their scale (size) and focus on costs means they could be earning 20% margins on revenues that some of those 1000 competitors are only earning 10% on.

They are focused on organic revenue growth of 2X the industry and profit growth of 2X revenues -- if they could maintain that pace the stock is a bargain.

Monday, September 10, 2007


The elevator speech on ADBE -- hey its 2:12 am right now so this the best I can do (still have to take out the garbage and recycling before bedtime too!)

Reasons to like ADBE:

1. Almost all web development involving video related effects is done in Adobe Flash. Quite a lot of other development on the web is done using other Adobe technologies. This makes them an indirect play on the growth in the web. Its not the best play -- that is a direct one where revenues directly move with usage. An indirect play benefits over time because the more websites there are the more people are needed to program them and make them look pretty and use all the latest technologies like ADBE's.

2. PDF -- its 25% of revenues and has grown very consistently in its history as ADBE has continually found ways to increase usage and productivity. Think forms like the irs website. In my own case we use it at work to pull together presentations from various packages -- rather than put everything into powerpoint we take information from excel, word, access and powerpoint and put it all together in Acrobat (PDF). Its just easier to do it that way.

3. CS3 -- their latest product launch means an upgrade cycle is at hand. That should drive results to be greater than estimates -- rising estimates is the best way to get this stock going.

4. Stock has been relatively flat since late September of 2006 -- stuck in a high 30's to low 40's range. Now we are at the high end of that range but still relatively flat yet EPS are growing.

5. Free Cash Flow is higher than earnings consistently -- I think they are selling for 21X 2008 free cash flow but they might be closer to 25X when looking at earnings estimates. As a software company there are very little needs for cap ex -- they have almost $4 per share in cash on the balance sheet.

6. Management knows how to build a software franchise and keep it fresh by continually adding innovative functionality in ways that build the size of their potential markets. slow and steady but adobe keeps growing. Their profitability is pretty solid too. Before purchasing the stock, I will have to get comfortable that I can envision them not as a $25 bill market cap but rather a $50-100 bill market cap stock over the next several years. Are Adobe's markets big enough to support $5-10 bill in sales at current margin levels?

stay tuned to see if this one gets added to the portfolio. They have a lot going for them but on the other hand if the US economy declines, Adobe will be hurt -- about 50% of sales are US based.


Before we get to more on Adobe, I thought I would take a moment to go over my latest thoughts on DFR. Merrill published a report last week cutting numbers slightly but still expecting them to have earnings and dividends that would drive a 20%+ dividend yield at current prices. I was surprised they were as optimistic as they were. I will be pleasantly surprised if their Q3 results are as good as Merrill thinks.

I wonder what everyone's thoughts would be if DFR was able to still do the deal for DCM but used all stock instead of the current terms of cash and stock. If they kept to the original terms but cancelled the cash portion, then the deal would be for just $80 mill -- probably too much of a drop from the original value of $290 million. But if they could increase the number of shares and get the deal done for $125-150 mill, that would be interesting. By paying stock, they wouldn't have to worry about the liquidity impact of borrowing money for the deal. It would make sense that DCM's value has dropped a lot -- no new CDO's will be issued for quite some time -- so maybe a drop of 50-60% in value makes sense -- well to a DFR shareholder (I'm not so sure those terms would excite a DCM shareholder. Under the current terms the deal likely won't happen -- too difficult to get bank financing.

If DFR's mortgage assets have not dropped in value, that would mean book value should still be in the $13 range assuming no new credit losses from the alternatives side. From that level they should be able to produce a dividend that is actually higher than the 42 cents they have paid so far. Reading the merrill note, I didn't get the feeling that they had talked to management and gotten some kind of scoop -- it was more just that analysts analysis of the situation. I am afraid he was too optimistic but I hope he is right!

With any luck maybe DFR will do a midquarter update like TMA is doing.

If they make it through the current liquidity crisis, then the stock's value will jump back to the mid teens. On the other hand, one of the reasons I so liked the story was the ability to play the growth in an alternative asset manager and their ability to rapidly raise the dividend to the $2.50 range. Now I doubt the deal goes through so that leg of the thesis is gone. They probably won't be raising the dividend to $2.50 any time soon so that leg of the thesis is questionable too. So why hold on if the thesis is not playing out? Because the loss has already hit the stock hard -- question is what new issue could bring it down further besides a liquidity one. At this point the only risk I see is the liquidity one. Even if you assume their future earnings power has been impaired, has it been hurt more than $8 a share? I doubt it. As long as they survive this is a low risk high gain play. Of course that risk they might not survive is real and is what keeps this from being a buy. but a hold -- why not?

Sunday, September 9, 2007

update -- DCI, APH, IEX, ADBE

Wow, I apologize -- didn't realize that the last post I made was last Tuesday -- I swear I wrote another piece since then but its not on the site so it doesn't count.

Been doing lots of reading -- more than I should have about various stocks -- mostly industrial types like Donaldson (DCI), IDEX (IEX) and Ametek (AME) as well as many others. I was looking for a consistent grower with good return on assets that had strong free cash flow as well as high international sales that also wasn't just an acquisition story. Didn't really find one yet. I would say I like the ECL story better than all of those others.

Donaldson (DCI) really looked good until I looked at the cash flow. Here are the numbers -- free cash flow (cash flow from operations minus cap ex) and net income.

2002 $107 mill (vs. net income of $86.9 mill)
2003 $99 mill (vs. net income of $95.3 mill)
2004 $70 mill (vs. net income of $106 mill)
2005 $87 mill (vs. net income of $110 mill)
2006 $79 mill (vs. net income of $132 mill)
2007 $40 mill (vs. net income of $150 mill)

The decline in free cash flow is both due to lower cash flow from operations (higher receivables and inventories) and increased cap ex. Notice the progression from more FCF than net income in 2002 to FCF of barely more than 25% of net income. This sure implies that earnings quality is poor and that the reported EPS are overstating the profitability of the company -- not that you would notice from the stock, which has done well. I would touch it myself -- it may work through this with no trouble or it could blow up hard with a huge earnings miss -- not worth the risk.

APH -- hugely successful over the last few years with much faster growth and much higher margins than its peers -- its all about management focus and execution. The management is focused on the higher margin products and on adding new product areas to drive growth. They are less than $2 bill in sales amongst a $40 bill industry -- very low market share. However they are earning 20%+ operating margins vs. others in the industry closer to 10% at most. That's great, I love managements that focus on profitability and not just growth. They also have great return on assets -- 12-14% so its not just margins but they also know how to manage assets too. What concerns me are 2 things -- 1. is the valuation/stock performance and 2. just how much of the industry is 20% margin business?

The stock has done really well over the last several years -- remember its the future that matters -- but you have to have confidence in the business and what it is likely to do to make sure you are not buying in at the top. I guess I just don't have that confidence, given the second point. There is $40 bill in industry revenues but how much of it is 20% operating margin business? To earn twice the industry average you have to find niche areas that have much less competition. Either these are technically very difficult or they are small volume customized deals or they are protected in some other way from price competition. So how much of the $40 bill is high margin? tough to say but it means their market share is higher than it first appears. Say the high margin part is 20% of the total -- that's $8 bill and that means they are at 25% market share rather than the 5% you first thought. I'm sure they have plenty of room to run for at least the next couple of years but at some point they are going to hit a wall and either have to accept lower margins or slower growth.

APH has some good secular growth parts -- electronicization of more products (i.e. increased electronics content in more products) has been going on uninterrupted for about 50 years. That should drive industry growth of high single digits. I will definitely keep a watch on this one but I'm nervous at these valuation levels.

I was reading something on real money last Friday and it got me thinking about ADBE again. I have watched this one from a distance for many years but never bought any or really understood its position. I spent some time over the weekend in between the Greek festival and my church's annual picnic reading up on ADBE -- its a great story but I'll save the details for the next note.....

Tuesday, September 4, 2007


I have been nervous about GGG due to its housing exposure but recently I had a thought -- I remembered that the company's worst performance was during Q1 when GDP growth was near 1%. Q2 saw a rebound in the company's results and a reacceleration in GDP growth back over 3%. Housing has remained weak but their overall results jumped in Q2 vs. Q1.

This suggests they are more exposed to GDP growth then to housing. Wow. If true, that makes them a bargain because I believe GDP growth is going to be Ok -- certainly a lot better than the growth of housing.

The other thing I noticed is that the current revenue estimates for GGG for the next 4-6 quarters are only assuming mid single digit growth -- the 5-7% kind of range. Seeing those numbers got me thinking about the different segments of their business. If you assume the industrials segment provides mid teens growth, then the US contractor business can shrink 20% or more and they will still hit the overall numbers. That's comforting to know that the estimates are THAT conservative. reassures me that they are going to hit the numbers.

GGG is selling for less than 16X 2008 EPS estimates. Not bad for a company with a mid 40's ROE, 30% ROA, 8-10% revenue growth, strong free cash flow, etc. its a keeper.

NVT, ECL, SIAL, etc.

Sold some more NVT today -- this is the 2nd time I have taken profits on NVT -- the total sold is about 1/3 of my original position. That still leaves me with some skin in the game but I have reduced my risk a bit after this stock's run -- it is one of the best performing stocks in the Russell 1000 index -- especially AFTER the market peaked. Still love the story or I would have sold all of it. You will find over time that I generally take profits in the stocks I shouldn't and let ride the ones that I should take profits -- oh well, if it were easy they could teach a computer to do it (Doh! sorry about that quant funds He! He! He!)

Did some more thinking about ECL -- those who have read me for a bit now should be familiar with the fact that I do lots of reading on stocks and usually don't do anything about it. Its all good for learning more about business but one doesn't want to churn the accounts either.

I took another look using Factset -- an amazing tool -- of the performance of ECL and Sigma Aldrich (SIAL) and realized that while ECL outperforms over the longer term, that is because SIAL had huge outperformance from the 1970's till 1992 and then sucked until 2000. If you include any time from 92 to 00 in your comparison, then ECL wins hands down. If you just look at either the 70's to 92 or 00 till now, then SIAL wins hands down. So what happened? my guess is sloppy management on SIAL's part that was fixed with a change in strategic direction in 2000. Still, even though SIAL has done well and has pretty good numbers, they haven't grown revenues as well as they wanted based on their 2001 annual report.

ECL isn't much better -- that stock actually underperformed the market from the 1970's till around 2000 -- since then they have done really well. Now there are years in the 90's when they outperformed but overall it's kind of an index like stock. Graco is similar but that company was transformed starting in the early 90's to become an incredibly profitable company. So when I see that they didn't really outperform the market for most years until the last 10, I don't mind because its a different company now then it was pre-outperformance. ECL doesn't look any different. Its still about cleaning solutions and whatever other products they try to shove down the same customers (leveraging their relationships to boost profits without increasing investment). I still might end up buying ECL but for now I am continuing to read -- in this case I'm on to DCI. I looked at this one last year but passed on it. Not sure why. I also passed on Neogen but that wasn't exactly bright either -- ouch, it was up again today!

Those reading from the yahoo board --- I haven't been able to post under my CA-man ID so I haven't posted. Either I have been blocked due to posting a link, or I am a victim of a bug or I need to start posting using another ID. anyway, question for goutah3006 (the guy with experience in semiconductor packaging from the TSRA board) -- I was wondering if you have the expertise or if you asked around about the quality of micro pilr, TSRA's new packaging technology? Is it as much of a leap forward as the company's comparison's suggest? This new technology is critical because it opens up big new markets as well as provides an incentive for existing customers to renew their licenses. just post here or on the yahoo board -- thanks!

Monday, September 3, 2007

start to the week

Back from the beach now and ready to start the week. Had a good day on Friday with nice gains in several stocks.

My plan is to trim some winners and potentially buy ECL this week. I had dinner with someone in the pest control business this weekend who also used to help manage a bar/restaurant. He was familiar with ecolab basically saying the core business of cleaning supplies is pretty good but its clear their other stuff like pest control is just an add on service -- as in "since we are already helping you with cleaning, why don't you sign up for our pest control service -- we can do it cheaper" but they are not specialists so if you have problems, ecolab is probably not going to be able to fix them. This all makes sense -- just like Google is best at search and Microsoft is best at Windows/Office; Ecolab is best at its original core business. That core is still growing and the other businesses add incremental cash flows with little incremental investment.

The risk is Patterson Dental -- they were a phenomenally successful company that sold equipment and other stuff to dentists for a long time. Fantastic record of consistent growth with most of it organic and some acquisitions helping. At some point they ran out of growth in their core business and the add on business' couldn't support the high multiple the stock had -- it declined sharply. Return on capital had declined because the other businesses were not as profitable. Patterson was stuck in a no win situation -- their core was a great business but they couldn't put new cpaital to work in the core and continue to earn high returns. That meant either giving the money back to shareholders or diluting the returns. they chose to dilute. I need to do some double checking on ECL to make sure this isn't occuring here but I don't think its an issue. International has been the problem because they are not growing as fast and they have lower margins. US continues to do well.

But one note of caution is why did their largest cleaning competitor in the US get out last year? Cleaning is a scale business (size matters) so that may explain it -- Ecolab definitely has scale. Perhaps the business is not as good as people think -- perhaps the competitor left because they knew the future stinks and so does ECL, they are just good at hiding it in these new businesses. I don't think that's true but some more digging couldn't hurt.

Last week I mentioned that Ecolab's international business should be much larger than its US business -- we have only 5% of the population and 25% of GDP so the rest of the world is 95% of the people and 75% of the GDP. True but labor conditions overseas are different -- they can throw bodies at cleaning problems without regard to cost because labor is practically free. Emerging markets also still cook at home mostly but rising incomes are increasing the amount of food eaten out. This is a long term trend -- increased consumer spending by Asians -- they won't just save money in the future.

Basically, when I look at a few good businesses in areas that I don't already own, I see most of them have done well recently but Ecolab has not. Praxair has done well; Sigma Aldrich has done well; etc. Ecolab beats them all longer term but over the last few years, Ecolab has not. Then its a matter of why? either the growth story is over -- which doesn't make sense so far given the record numbers they have put up. Or its due to something temporary like poor management in Europe. They have taken a lot of actions in europe to get growth and margins up -- I'm fairly confident this is a good chance to buy in when there are doubts about the growth story -- that's the time to do it because the price is good.

Secular drivers -- growth in travel (hotel cleaning, laundry), increase in eating out, focus on food safety; etc.