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In several recent articles I have indicated that when it comes to investing, as with many other aspects of life, it is important to set objectives and a goal and to have a strategy by which to achieve them. Hope is not an investment strategy I have ever recommended.
The subject matter for this post came to me yesterday afternoon when I was asked for my opinion about Canada Goose Holdings Inc. (GOOS.TO) as a potential investment. The individual indicated this company's products are gaining popularity in China and the thought is sales in China will increase significantly. This individual, however, did not review the company's financial statements, risk, or valuation. Of greater concern to me is the inquiry comes from someone with no prior experience of investing in individual equities.
Very shortly after receiving this inquiry, I received in the mail a few copies of the 2020 Berkshire Hathaway Inc. (BRK-a and BRK-b) Annual Report.
In my April 2021 FFJ Portfolio Holdings Review, I disclose that BRK-b is my 16th largest holding.
Let's have a very brief look at both companies.
A Worrisome Investment
I do not dispute Canada Goose Holdings Inc. (GOOS.TO) could reward shareholders. This is, however, a speculative investment. Anybody investing in this company should be aware of the elevated level of risk.
After a very quick review of the Q3 2021 and FYE 2020 results, I conclude this is not an appropriate investment for an equity investor with no prior investment experience in individual equities.
These are my top concerns.
Act In The Best Interests Of Stockholders
We regularly hear of management acting in ways that are not in the best interests of stockholders.
My immediate concern is the stock options which are very likely extended to senior employees and Directors.
The table on page 190 of 251 in the FY2020 Form 20-F summarizes information about stock options outstanding and exercisable as at March 29, 2020. Just under 800,000 options are outstanding with strike prices under $10! Some people will make out like bandits. I can not say the same for the average shareholder.
NOTE: The SEC Form 20-F is an annual report filing for non-U.S. and non-Canadian companies that have securities trading in the U.S. The purpose of the SEC Form 20-F is to help standardize the reporting requirements of foreign-based companies.
Risk
In September 2020, Moody's initiated coverage of this company and assigned a B1 long-term debt rating. In the same month, S&P Global issued coverage and assigned a B+ long-term debt rating.
Both ratings are identical and are the top tier of the Highly Speculative category. These ratings are 4 notches below the weakest investment-grade credit rating!
Such a rating defines an obligor as being MORE VULNERABLE than the obligors rated 'BB'. The obligor, however, currently has the capacity to meet its financial commitments. Adverse business, financial, or economic conditions will likely impair the obligor's capacity or willingness to meet its financial commitments.
Keep in mind these are debt ratings. Debt holders rank in priority to equity holders. In essence, equity investors in this company are truly speculating.
Valuation
The Q3 2021 results show that GOOS.TO generated diluted EPS of $0.61 versus $1.34 in the first 3 quarters of the prior fiscal year. Clearly, the pandemic has negatively impacted this company's business. In fact, in the February 4, 2021 Q3 Press Release, management indicates:
'Given ongoing COVID-19 disruptions and uncertainties, the Company is not providing an outlook for fiscal 2021. As of the date of this release, 7 of 28 Canada Goose retail stores, representing 25% of the network, are closed.'
Interestingly, guidance from 10 brokers calls for a mean adjusted diluted EPS of $0.62 and a low/high range of $0.51 - $0.77. I don't know how brokers can provide 2021 guidance considering management can not even provide guidance. Furthermore, FY2022 guidance from 11 brokers is a mean adjusted diluted EPS of $1.56 and a low/high range of $1.30 - $1.71.
Shares closed at $49.70 on April 20. If the company manages to have an outstanding Q4 and generates $1 in FY2021 diluted EPS, we arrive at a 49.7 diluted PE!
In the Q3 2020 Earnings Release, we see adjusted diluted EPS exceeded diluted EPS for the first 3 quarters of FY2020 and FY2021 by $0.16/share and $0.11/share.
Let's give GOOS.TO the benefit of the doubt that FY2022 diluted EPS will only be $0.11/share less than adjusted guidance from the brokers. Subtract $0.11/share from the $1.56 adjusted diluted EPS guidance and we get $1.45 FY2022 diluted EPS. With shares trading at $49.70, we have a PE above 34 based on FY2022 earnings expectations.
In my opinion, GOOS.TO is grossly overvalued.
A Peace Of Mind Investment
My strategy as a long-term investor is to invest in reasonably valued high-quality companies which have a very good probability of generating a total return above the rate of inflation.
I readily accept some investors view my investment strategy as boring. I do not, however, seek thrills with our family's investment holdings.
Quite frankly, I do not attempt to value Berkshire Hathaway. I just regularly check the credit ratings assigned by the major rating agencies. Secondly, I look at the bottom of the first page of the Letter to Shareholders (FY2020 Letter to Shareholders). When I see the extent to which Berkshire Hathaway has outperformed the S&P 500 with dividends included over several decades, I am satisfied this company is a sound investment for my family and me.
Act In The Best Interests Of Stockholders
Berkshire Hathaway is, in my opinion, the epitome of a company in which investment decisions are made in the best interests of shareholders.
In FY2020, the company reported $42.5B in diluted earnings or $17.78 in diluted EPS. Warren Buffett's Letters to Shareholders and in particular the 'The Family Jewels and How We Increase Your Share of These Gems' section of the FY2020 Letter to Shareholders, however, explains why relying on diluted EPS is not a practical way of looking at Berkshire Hathaway.
NOTE: Page 4 of 14 references page A-1 (page 143 of 148) of the 2020 10-K where we find the list of Berkshire’s subsidiaries that employ ~360,000 at FYE2020.
Risk
Moody's currently assigns an Aa2 long-term debt rating while S&P Global assigns an AA long-term debt rating. Both ratings are identical and are the mid-tier of the High-Grade category; only 1 notch separates Berkshire from the coveted AAA credit rating.
Such a rating defines an obligor as having a VERY STRONG capacity to meet its financial commitments. It differs from the highest-rated obligors only to a small degree.
The age of Warren Buffett (90) and Charlie Munger (97) is another risk we need to consider; I do not know if this is a factor the rating agencies take into consideration. These gentlemen will certainly not live in perpetuity and when one or both pass away, I fully expect Berkshire Hathaway's share prices (Class A and B shares) to take a hit. Should this occur, I anticipate I will acquire considerably more shares.
Just because these gentlemen pass away does not mean all the earnings of the wholly-owned companies within the Berkshire group will suffer. Furthermore, the company also holds substantial positions in publicly traded companies for which the passing of both gentlemen should have no bearing.
Plans are in place to address the inability of both men to no longer carry out their current duties and responsibilities. I do not, therefore, think investors need to be concerned about what will happen when Buffett and Munger pass away.
Valuation
Berkshire Hathaway's
- decentralized business model;
- high cash-generation capabilities;
- broad business diversification; and
- unmatched balance sheet strength
differentiates the company from so many other potential investments.
While the percentage return on equity and assets has often been in the single digits for most of this past decade we must remember:
- the sheer size of Berkshire Hathaway makes it extremely difficult to generate returns that are more easily achievable with much smaller companies;
- the ever-expanding cash balances generate very little return in a near-zero interest rate environment.
Returns should improve as management has become more focused on using cash to repurchase shares. In FY2020, ~$24.7B of Class A (~$5.4B) and Class B (~$19.3B) shares were repurchased. This eliminates ~5% of the total shares outstanding in the prior fiscal year.
Also, Berkshire Hathaway was a net seller of equities from its investment portfolio in FY2020. It did acquire higher dividend-yielding securities in the 2nd half of the year (eg. Verizon and Merck). We can expect substantial dividend income from these higher dividend-yielding investments.
Looking at the December 31, 2020 Balance Sheet, we see a little under ~$160B of cash and cash equivalents, short-term investments in US T-Bills, and fixed maturity securities. The valuations of the types of assets Berkshire Hathaway prefers to acquire continues to be too high so investors can well expect a portion of this dry powder to be used to fund acquisitions, stock (and bond) investments, and share repurchases. In addition to a higher level of dividend income relative to FY2020, the deployment of cash on the Balance Sheet to repurchase shares should boost shareholder returns.
A flyer is included with all 2020 Annual Reports mailed to shareholders. If you are interested in checking out some of the deals at the Berkshire-owned Nebraska Furniture Mart (NFM), register at www.nfm.com/berkshire to receive an email to shop between Wednesday, April 21 - Tuesday, May 4, 2021.
Hope Is Not An Investment Strategy - Final Thoughts
I tailor my strategy to achieve my investment objectives and goal and do not expect my strategy to appeal to all.
I share my thoughts on investing, however, because I want readers to succeed on their journey to financial freedom. Too many investors incur easily avoidable losses.
In hindsight, many investors with poorly performing investments readily admit no proper research was conducted before investing. The investment was made solely on hope. Regrettably, hope is not an investment strategy.
Stay safe. Stay focused.
I wish you much success on your journey to financial freedom!
Note: Please send any feedback, corrections, or questions to [email protected].
Disclosure: I am long BRK-b in the FFJ Portfolio and in accounts for which I do not disclose details.
Disclaimer: I do not know your circumstances and am not providing individualized advice or recommendations. You should not make any investment decision without conducting your research and due diligence.
I wrote this article myself and it expresses my own opinions. I do not receive compensation for it and have no business relationship with the company mentioned in this article.
