Mid-Year Letter 2018

2018/07/06

To my partners,

The first half of the year has been volatile for the stock market, the S&P 500 advanced from 2,673.61 to 2,718.3, a rise of 44.76 points or 1.67%. Including dividends, the index returned 2.65%. Although this gain was nothing to be excited about, most large funds trailed this benchmark according to an article by Bloomberg (You can read it here). Managers blame their failures on things such as the feds policies, trade wars and many other excuses.

One promise I make to you my partner: if our partnership underperforms the general market – and it will happen, rest assured! – the only person who should take the blame is the general partner: Me. It will be because of my securities selections and nothing else.

Although, a six-month period is too short to form a conclusion about a manager’s ability, a three to 5-year time frame should be a good test of his aptitude. Unfortunately, many managers are in the business of making money for themselves and not their clients.

In late 2007, Warren Buffett took a $1 million wager that the S&P 500 index, would beat many hedge funds. A fund of fund called Protégé Partners took the bet. They selected five investment experts who, in turn, employed several hundred other investment experts, each managing his or her own hedge fund (talk about layers of fees!). The timing of this “bet” plays in the advantage of the hedge funds as it was the beginning of this extensive bull market. However, a decade later the results are eye opening:

 

Year 2008-2017 Fund of Fund A Fund of Fund B Fund of Fund C
Compounded Annual Return
2.00%
3.60%
6.50%
Year 2008-2017 Fund of Fund D Fund of Fund E S&P 500
Compounded Annual Return
0.30%
2.40%
8.50%

*Fund names kept secret as to not be embarrassed!

In his annual report, Buffett said “Though markets are generally rational, they occasionally do crazy things. Seizing the opportunities then offered does not require great intelligence, a degree in economics or a familiarity with Wall Street jargon such as alpha and beta. What investors then need instead is an ability to both disregard mob fears or enthusiasms and to focus on a few simple fundamentals.”

This is an advantage we have at LEMBIRIK GROUP®, we follow a bottom-up approach to investing, we never comment on interest rates or any macro-economic factors. We spend our time solely looking for undervalued securities. During February, we were lucky to find such security: Fossil Group, Inc.

The company is an American fashion designer and a manufacturer. They also make licensed accessories for brands such as Michael Kors, Diesel, Kate Spade New York, Burberry and many others. The sentiment around it was negative: revenue was dropping, a charge to earnings resulting in a loss to income and to top it off, the CFO resigned. The company was in a turnaround situation and was not popular at that time.

We built our position at an average price of $8.54 per common share. Ignoring the noise and concentrating on the balance sheet, was very rewarding because underneath the surface the company was selling for 55% of working capital (current assets minus current liabilities).

The company was also generating substantial cash flow, combining that with the fact that over 40% of market cap is cash offer a great margin of safety.

This investment illustrates the fallacy that value investing is about low P/E ratios. While it’s true that a low multiple indicates that a stock is cheap, it doesn’t tell the whole story (You may read our article about value investing here). Since FOSL forwarded earnings (a favorite Wall Street figure) were low because of the charge, the forwarded P/E was 160! Again, value investing is about the margin of safety and not low multiples. It’s true that while being conservative with this approach, we pass on some good companies (selling with no margin of safety) that reward shareholders substantially over time, but we rather protect our capital first to achieve a good return than strive to make a quick buck and lose it all.

With a current stock price of $26.47, our investment in FOSL tripled in 4 months (210% return), we are not planning to sell anytime soon. We believe that the company (and our investment) has much room to grow.

Now thanks to FOSL, LEMBIRIK GROUP® year to date gross performance is 15.6%.

Please feel free to contact me if you have any questions or concerns. Our annual letter will be sent in January 2019 unless a major development occurs. Meanwhile, your quarterly statements were sent this week.

 

Yours truly,

 

Sid-El Mehdi Lembirik

Managing Partner,

Lembirik Group Investments

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