Tag: Value Investing

Real Estate Investing Framework

[This is an edited version of a talk I recently gave at a MOI Global event.]

I’d like to summarize some of the lessons I learned from helping to run a buy and hold real estate portfolio:

Lesson 1: Find a framework

Before my involvement, I had no prior experience in the real estate industry.  So I needed a framework.

As you might know, my main investing model is value investing. So I chose value investing as my framework. I stopped viewing it like an isolated real estate operation, and started to view it like a regular investment.

Lesson 2: The need for a simple valuation heuristic

My second problem was, that I needed a simple valuation method.

I discovered a very simple one: the rent multiple. Basically, it’s comparable to a Price-to-Sales (P/S) ratio. You take the price of a property, and divide it by the yearly rent revenue.
 
After that, I needed a heuristic of what is expensive and what is cheap. In the current market condition you often see multiples of 25, and even 30 or more. This is quite expensive. In more calmer market conditions you see multiples of 20 or less. A multiple of 15 is reasonably cheap and a multiple below 10 might be described as deep value.

There are two ways to calculate this multiple. First, you can calculate it based on the most recent effective numbers, or secondly, you might use what might be called an intrinsic value multiple, where you take the realistic gross rent you expect, once you take control and implement the obvious quick wins. Of course, it’s more conservative to use effective numbers vs. the projections. Personally, I like to use both, and also like to apply a margin of safety.

After that, I needed to decide on what I consider fair value. In the end, I’ve decided to use a multiple of 20 as a proxy for fair value. The reason why I don’t mark-to-market is that it’s a buy and hold portfolio, so the owners are not interested in market gyrations. This gives the framework a certain stability, and takes the speculation out of the equation.

Lesson 3: You need comparable metrics

My next problem was, that I needed useful metrics to aid our decision-making.

It turns out that the real estate industry uses quite fuzzy metrics. You hear terms like gross yield, net yield, or return on investment. People that use those metrics often seem to exclude very key elements, such as financing costs, taxes, or the fair value of the employed equity. My best guess is that the purpose of these fuzzy metrics is to help the sellers (and their agents) inflate their numbers and make them look better than they are. This is supported by my impression that there seem to be enough real estate investors that keep using those fuzzy metrics, and don’t make the effort to find better ones.

Okay, so what was the job to be done? My main goal for finding a metric was to compare the real estate performace with the performance of a public stock portfolio.
 
I ultimately decided to use the after-tax return on equity. I want to stress after-tax, as a lot of people in the real estate industry seem to keep using pre-tax numbers.

To calculate the after-tax return on equity, I first calculate the after tax free cash flow. Again, without adjustments, and without exclusions of key elements. 

On the equity side, I use my fair value proxy. A lot of real estate investors use their cost basis, because this boosts their returns. This doesn’t make sense to me, because I want to take into account the opportunity cost of the employed equity. That’s why I use my fair value multiple of 20.

So now, this allows me to compare apples with apples and have a useful framework for capital allocation decisions, especially between real estate opportunities and public stocks.

Lesson 4: What are the performance drivers of buy and hold properties?

The next question I had, was to identify the main performance drivers of buy and hold properties. Basically a simple checklist to help me evaluate new opportunities.

I see three main drivers of performance:

First driver: Untapped growth potential: the best buy and hold property is one with untapped growth potential, first in terms of development potential (e.g. turning unproductive spaces into new units) and second, untapped rent potential (meaning: that the current rent is below comparable market rent that you could charge).

Second driver: A reasonable purchase multiple: in the best case scenario, you want to purchase a property with a low multiple, which results in an instant capital gain when you mark it up to fair value.

Third driver: Leverage: the more debt you have, the less equity you have to employ, which of course boosts your after-tax return on equity. With debt, you also have a yield from paying back the principle. This builds up equity. But over time, this reduces your returns, so you might need to re-finance periodically to keep equity low. Personally, I’m not a huge fan of leverage. But if you operate with a large enough margin of safety, leverage makes sense and boosts your returns.

What’s important to note is that I don’t view price increases as a driver. For a lot of real estate investors, this is their main goal and their main performance driver. In contrast, my main goal is to grow the underlying fundamentals. When rent increases by 10%, the value increases by 10%, because I keep the valuation multiple constant. That means that I only consider value increases when there is a corresponding rent increase. If a value increase is not based on fundamentals, I view it as speculation and don’t consider it.

This change in attitude helps focus our energies on increasing the underlying value, and not on being distracted by the fluctuations of the market.


Posted on by Remo Uherek

Investing Lessons from Running a Startup

[This is an edited version of a talk I recently gave at a MOI Global event.]

I’d like to share some of the lessons I learned from being a startup founder, and how these can be applied to investing:

Lesson 1: I’m a better investor because I was a founder

As Warren Buffett famously said: „I’m a better investor because I’m a businessman. And I am a better businessman because I am an investor.“

This rings very true to me, and I can confirm it based on my own experiences.

I was in the middle of my startup, back in late 2008, when I discovered Warren Buffett and Benjamin Graham. My main takeaway for my business was that I realized how bad our gross margins were. At the time, our gross margin was around 30%, and we were burning money. Then, when applying this insight over a period of 3 years, we were able to double the gross margin to 60%, which helped us to achieve break-even and ultimately lead to selling our business. Without those gross margin improvements, it would have been much more difficult.

Lesson 2: “Creative accounting”

The second lesson is what I call „creative accounting“.

We were sending our investors monthly updates. But, brained-washed by the venture capital industry, and suffering from our own insecurities, we believed that everything that didn’t go „up and to the right“, was hurting our story. So we made a conscious effort to keep the story going, by applying what we called „creative accounting“.

We took advantage of the grey areas, and applied somewhat loose and not very consistent accounting practices. We played with the capitalization of certain expenses, to move them off the profit and loss statement. We recognized revenues in different ways, sometimes at the start of a project, sometimes in the middle, and sometimes at the end of a project.

In good months, we rolled over revenues to the next month, to have a head-start and create a cushion. In bad months, we scrambled to recognize everything we could, to avoid reporting bad news.

So based on these experiences, I’ve learned to become more skeptical of accounting statements, because there is always room for “creativity”: adjusted numbers, not expensing stock options, playing with accruals, playing with revenue recognition, and similar tactics.

Lesson 3: Seek owner-operated businesses

The next thing I learned is what it means to be an owner-operator.

I’ve been a founder of my own startups, but I’ve also managed startups that other people have founded. A founder is an owner-operator. He holds a large stake, and the whole responsibility lies on his shoulders. There is „skin in the game“ and a sense of „ownership“. It’s a different quality than managing someone else’s company.

When the company is mostly you, you cannot escape. You have to „go forward or go under“.  We had very tough periods in our startup. On multiple occasions, I was very close to giving up. But I didn’t, because I was an owner-operator. As a manager, you can quit much more easily. It’s a different situation.

That’s why in my investing today, I gravitate towards owner-operators. I’ve been one, and I understand them much better than hired managers. 

Lesson 4: Strong sales organization

Number 4 on Phil Fishers 15 point checklist is: “Does the company have an above average sales organization?“

I had to learn this the hard way. For the first two years, I was the only sales person in our company. It wasn’t working well. I had no prior sales experience, and I wasn’t enjoying the job. I realized that we need to build a sales team.

So I took a deep dive: I read sales books, went to sales seminars and hired our first sales manager. We ended up hiring 4 sales managers in one year, and quadrupled our revenues.

So today, I have a much better sense for what Fisher means by „above average sales organization“.

Lesson 5: Strong marketing & lead generation

A sales organization cannot be effective without a strong lead generation. If all you do is cold sales, you likely won’t get very far. You need qualified prospects and hot leads. 

Here we had an advantage. Because it was one of the areas we were above average.

Our core product was sponsored postings on blogs, what today is called influencer marketing. To not be misleading, we required every blogger to label their sponsored posts. And not only label them with something like „This is an ad“. Instead, we branded the label with our company name, and most importantly, included a link to our website. So each campaign for our clients, be it NIKE or RedBull or Disney, turned out to be a free campaign for ourselves. It was a marketing flywheel. And it was our #1 lead generation source.

So, in order to assess the sales capabilities, you need to be able to understand the whole marketing & sales funnel.

Lesson 6: The Flywheel Effect

Ever since reading Good to Great by Jim Collins, I keep thinking about flywheels.

I’ve learned that great companies have a strong, self-perpetuating and ever-increasing engines. Our viral marketing tactic was a one example. Network effects are another example.

So my lesson is: look for strong flywheels.

Lesson 7: Innovator’s Dilemma

The Innovator’s Dilemma describes why established companies have great difficulties to cannibalize and re-invent themselves, and why startups can be so disruptive.

It was one of the favorite business books of Steve Jobs, and he was a master of solving the dilemma. 

In times of ever faster technological change, it’s important to keep this concept in mind, and seek companies that have demonstrated that they have the courage and stamina to solve this dilemma.

Lesson 8: Certain things don’t show up in the accounting statements

I’ve learned that certain things don’t show up in accounting statements.
Hiring procedures, HR practices, company culture, early R&D experimentation all don’t show up at all, or only much later. 

As a startup, we had a strong company culture. It was a matter of necessity. We couldn’t afford to pay market salaries, and the job required every team member to put their heart & soul into the company.

Startups not for everybody, but if done right, they create a strong culture and a high level of productivity. If a company can preserve this startup ethos, it can be a huge asset. 

So the lesson is: don’t forget the soft factors.

Lesson 9: All eggs in one basket / Take something off the table

As a founder, especially a young founder who has no meaningful assets outside his company, you are not only concentrated, you are hyper-concentrated. All your eggs are in one basket, and as this would‘t be enough, the odds are stacked against you. 8 out of 10 startups fail.

It’s not a healthy situation, because you are over-exposed. That’s why it can be good to take a portion, say 10 or 20 percent of your stake, off the table, if you have the opportunity, to reduce the psychological pressure. Not right away of course, but maybe after 2 or 3 years, depending on how your startup develops.

So while insider buying is usually a good sign, insider selling doesn’t need to be bad. It could be prudent from a personal capital allocation perspective, and also a risk-taking perspective. If essentially your whole net-worth is tied up in your company, it might be hard to take the necessary risks to maximize long-term potential. So you need to understand the motive of insider selling before drawing conclusions too fast.

Lesson 10: Be a Learning Machine

Books have been super important for me. Whenever I faced a problem, I ordered the best books on a the topic, and tried to apply the best practices. That’s how I learned how to organize myself, how to build a sales team, how to build a positive company culture, and much more.


Posted on by Remo Uherek

“Margin of Safety” as a Principle of Life

In my last post I talked about the key principles of value investing.

The one principle I keep using almost daily is the “Margin of Safety” principle. It’s such a powerful concept that I try to apply it almost everywhere in my life, especially to time management.

When I have an appointment, I give myself a margin of 10 to 30 minutes. Often, I take an earlier train. When going to the airport, I usually have 1-2 hours of extra margin.

When nothing goes wrong, this margin gives me more time to walk around and listening to audio. And when things go wrong, I (usually) still make it on time.

Phrases like “How much margin of safety do I need?” or “My margin of safety is shrinking” have become regular phrases of my self-talk.

I also apply it to clothing (always carrying an extra layer) or power (always having a powerbank with me).

That is what I like about universal principles like these. You can apply them not only in investing, but also in life.


Posted on by Remo Uherek

The Key Principles of Value Investing

The style of investing that speaks most to me is value investing, as practiced by Warren Buffett and Benjamin Graham. I’m often asked: “What is value investing exactly?”

Here is my understanding of the core principles:

Have more purchasing power in the future
The goal of all investing is laying out money today, so that you can enjoy more purchasing power in the future. The principle is: Instead of eating the seeds, plant them, so one day, you will have plenty more to enjoy.

Investing vs. Speculation
The goal is to be an “investor” and not a “speculator”. Here is the definition by Benjamin Graham: “An investment operation is one which, upon thorough analysis promises safety of principle and an adequate return. Operations not meeting these requirements are speculative.” (The Intelligent Investor)

A stock is a partial ownership of a business
A stock is not just an abstract ticker symbol with a constantly moving price. It is a partial ownership of a business. So no matter whether you are buying 0.000001%, 10% or 100% of a business, the decision process should be quite similar. You have to know what the whole business is worth, so that you can determine what each share of the business is worth.

Mr. Market is here to serve you, not to guide you
Treat the market as your manic-depressive business partner called “Mr. Market“. He is emotional, euphoric, moody, and often irrational. Every day, he quotes you a new price for his shares. You can reject him every day, and the next day he always comes back with a new price. You can never know what price he will offer next and you don’t know why he offers you the price that he does. Your job is to simply listen to him every day, and only buy if when he offers you a low price. As opposed to “market timing”, this is “market pricing”. You simply recognize a good deal when you hear one, but can never know when it happens.

A great song about Mr. Market

Margin of safety
Always have a margin of safety, as a buffer for errors and unforeseen situations. The principle is simple: If you are building a bridge that is supposed to support 20 tons of weight, you don’t build it for 21 tons. You build it for 40 tons, to have plenty of margin. The same is true for value investors: they try to be very conservative in their calculations. They don’t buy a stock because they think it’s 6% undervalued. They demand 50%.

Buy one dollar for 50 cents
To summarize, and to quote Warren Buffett: “All investing is value investing.” In fact, Warren Buffett or Charlie Munger don’t even call themselves value investors. They simply master these principles. The goal is to find something worth one dollar and buy it for 50 cents. And even if your assessment was wrong and it turns out to be worth only 50 cents, you at least didn’t lose any money, thanks to your wide margin of safety.

Results
By applying these principles, Warren Buffett has grown his net worth from $10,000 when he was 19 years old to more than $80 billion today, compounding at an average rate of more than 20 percent per year for more than 60 years straight.

If you’ve invested $1,000 into Warren Buffett’s publicly traded holding company Berkshire Hathaway in 1965, you would currently have $4.3 million.

So these principles are not just theory, they are achieving wonderful results.


Posted on by Remo Uherek

How to Attend Warren Buffett’s Berkshire Hathaway Shareholders Meeting: Guide for First-Time Visitors

It took me 11 years after becoming a Warren Buffett enthusiast to finally attend my first Berkshire Hathaway Annual Meeting in Omaha, Nebraska. Here are my notes and my guide for first-time attenders.


Key Learnings from 2019 Meeting

Write down your thesis
Before you buy a stock, write down: “I’m buying this company for [insert market cap, e.g. $500 billion], because…” If you can’t answer this question, don’t buy the company. Remember: A stock is not a piece of paper, it’s a part ownership of a business.

Broad vs. narrow circle of competence
You need to find what you can understand. There is much more competition today than when Buffett started. It’s always a good strategy to specialize. Read as much you can. Figure out what you are good at. You need an edge. Be smart in spots and try to stay around those spots. Having one edge is enough.

Environmental, social and governance (ESG)
Don’t spend time creating ESG committees and writing long reports. Simply do the right thing. Example: Berkshire Hathaway’s utility is on a path to soon produce 100% renewable energy in Iowa.

The Future Performance of Berkshire Hathaway
“Berkshire Hathaway won’t be the biggest compounder by a long shot. But it will and continue to be a very safe way to make decent returns for a long time.” — Warren Buffett

Keep trying things
“If you keep doing enough things, some of them will work out.” — Warren Buffett

Figure out what works
“Figure out what works, and go do it.” — Charlie Munger


How to attend / Guide for First-Timers

This guide by The Investors Podcast (TIP) is a great starting point. But there are a lot of additional details to figure out. Here is my guide for first-timers:

When to plan the trip?
Next years meeting will take place on May 2, 2020. It’s advisable to plan the trip as soon as possible, optimally as early as October or November. I planned my trip in January and it was already quite difficult to find reasonably priced hotels (I was still lucky though, see below).

Credentials / Tickets
You don’t need to be a shareholder to get tickets, and there aren’t any further controls once you have tickets. The easiest way is to order them on eBay directly from Berkshire Hathaway (brka_b is their user name) and send them to your hotel address. If you are a shareholder, then simply print out a recent broker statement, bring a matching ID/passport and pick them up at the CHI Health Center on Friday before the meeting at the “Will Call”. You can pick up as many as 4 credentials, so not all of your friends need to stand in line.

Accommodation / Hotels
I highly recommend staying in Council Bluffs, right across the river in Iowa. I booked in January and was lucky to find a decent hotel for just $55 per night. It only takes 10 minutes to go Downtown and the traffic was always very smooth, because you take the freeway most of the way. If you are on a low budget or like to stay with locals, you might also consider Couchsurfing. If budget is not an issue, then you might stay near the Old Market area, so you have everything in walking distance.

Rental Car / Parking
A rental car is highly recommended, and only costs around $30 per day. The alternative is using Uber/Lyft, but this can get quite expensive if you want to see many things. I never had parking problems, even in Downtown. Mostly you have parking meters which cost $1.25 per hour (payable with credit card or cash). I downloaded the “ParkOmaha App” which made the process even easier. (If you don’t mind walking 10-15 minutes, you can park for free on the bridge next to the Durham Museum. That’s what I did most days. But don’t tell others ;)

Join a WhatsApp / Telegram group
One of the best things I did was to join WhatsApp / Telegram groups. That way I always knew what’s going on and was never alone. We ended up being a group of 4-5 people that did most things together. One group I found on the TIP Forum, and the other through Guy Spier’s mailing list. I’m pretty sure there are others as well.

The TIP WhatsApp group photo!

How to prepare for the meeting
If you want to stand in line very early, I recommend to buy a $10 camping chair from Walmart. I did and it was a very good investment. Some Chinese people also brought blankets to lie on the ground, but I’d say this is optional. Other than that no special preparations needed.

When to stand in line for the meeting
There are multiple entrances. Mohnish Pabrai recommends to go to the South Entrance, so I did that. We were there at 3.00am, which guaranteed us excellent seats. I think 3.30am would have been fine as well. Most people come after 4.00am and the line will get very long after that. I was sitting in my chair and was even able to take a few naps, as did several Chinese people next to me. In fact, most of the very early people at the South Entrance were Chinese.

Waiting in line with Mohnish Pabrai and thousands others.

How to get great seats
When you pass the security check at the South Entrance, take the stairs down one floor, then continue straight until you see the Lexus Club. Take any door to the left to enter the hall (the sectors are not separated, so you can move freely within the hall). If you feel lucky, you might go all the way down to the ground floor and try to get a front row seat. We didn’t do that. We chose Sectors 104 which offers a fantastic view.

The Floor Plan. The South Entrance is on the left side near sectors 211/212.

Want to see Warren Buffett up close?
After you have secured your seats around 7.15am, I recommend to go the the Exhibit Hall. Warren often takes a walk trough the hall before the meeting starts. The movie starts at 8.30am, so there is plenty of time to look for Warren. Don’t forget to go to the restroom before the event starts. The morning session is nonstop until noon.

Backpack / Security
CHI Center’s clear bag policy doesn’t apply to the Berkshire Hathaway meeting. You can bring a backpack. Full bottles are not allowed (empty ones are okay).

Events / Meetups
There are a lot of events and meetups, and the best way to stay up to date is to join a WhatsApp/Telegram group. I highly recommend doing the 5k on Sunday. It’s a very nice and quite short run. As we’re in the US I expected 5 miles, and was pleasantly surprised to see the finish line after just 5 km :) After that I went to Borsheims to play against ping pong champion Ariel Hsing, which was a lot of fun.

Restaurants
I really liked Jams in the Old Market. They have great salads. I also liked the Old Chicago pizza place in the Old Market. On weekdays they have great lunch deals.

Other fun things
The Hollywood Candy store was fun. That’s where Buffett and Gates made the Sweet Nostalgia video. You can easily spend one or two hours there. Don’t forget to have a strawberry milkshake!

Disclaimer: All the above information is based on my 2019 trip. Things might change in the future, so keep your eyes and ears open.

The closest selfie I got with Warren and Charlie.
My first meeting and I even made it into the Omaha World-Herald, thanks to my friend Marnix Troudes.

Other people’s experiences:


Posted on by Remo Uherek

6 Key Takeaways from Charlie Munger’s 2019 Daily Journal Annual Meeting

Charlie Munger, business partner of Warren Buffett, recently spoke at the 2019 Daily Journal Annual Meeting. You can watch the full recording here.

Here are my key takeaways:

#1: Fish where the fish are
For Charlie, that means China. High-quality companies in China are currently available for cheaper prices than similar companies in the USA.

#2: China
Charlie has outsourced his China investments to Li Lu. This is the only time he has ever given money to an external manager.

#3: Don’t be too active
As a value investor, you need to be okay with inactivity. Be a good picker and then hold for a very long time. For example, Charlie has held Berkshire Hathaway and Costco for many decades.

#4: No exit strategy
Charlie does not have an exit strategy or price target for his investments. He rarely sells.

#5: Have a “Too hard” bucket
Charlie has three categories when evaluating investing opportunities: Yes / No / Too hard. Especially the last category solves many problems. Charlie looks for the easy and obvious opportunities, and discards the rest.

#6: Charlie on Stoicism
He admires stoicism and has learned a lot from stoic thinkers. I didn’t expect anything else. In fact, I view Charlie and Warren as modern stoics!


Posted on by Remo Uherek

Deferred gratification

Recently I watched this Q&A with Charlie Munger. Pure wisdom, and two hours very well spent.

He talked about a key principle of (value) investing: Deferred gratification

We live in a world of instant gratification. It’s very hard to get rich if you eat your seeds, instead of planting them.

That’s what makes value investors rich. And that’s what transformed China into a rich country: they had a savings-rate of 50% and applied this principle masterfully.

Charlie also joked that people who have mastered this concept enjoy it so much, that they never harvest their fruit. They keep deferring until they die.

Personally, I’d rather die a rich deferrer than a poor pleasure-seeker. Even better, I’d prefer to die a poor deferrer. Having given away the fruit to people and causes who need them more than I do.


Posted on by Remo Uherek