Drystone Communications


October 17, 2013

The goal of Drystone Concentrated Investments research is an informed estimate of intrinsic, a.k.a. fair, value for each candidate, an approximation of what a company might be worth to an all-in strategic or private equity acquirer.  Of the many metrics, free cashflow (FCF) ÷ enterprise value (EV) ranks as most important to me. FCF is cash generated by business operations minus the capital improvements/maintenance necessary to keep a company running and EV is the market value of a company’s stock plus its long-term liabilities minus cash on hand.

FCF÷EV, while a powerful tool, offers only a measure of a stock’s current value or cashflow yield, though, not a prediction of future intrinsic value. To estimate a company’s intrinsic value, you have to estimate its future growth. That’s why popular labels “growth” versus “value” investing present an artificial distinction – the two do not exist independently of one another. You cannot really assess value without a growth assumption, and chasing assumed growth without the rudder of a value (buy) discipline is similarly ill-advised. If asked to shoehorn Drystone’s stock purchases into a “style” box, therefore, I opt for the awkward-sounding “GARP, growth at a reasonable price.” Preferably a price better than reasonable, ideally downright cheap. And a growth rate, modest or no, in which I feel some confidence.

July 17, 2013

To calculate their fair value estimates for a stock, investors have to make projections of a company’s expected future performance, e.g., revenue growth, profit margins, management competence, etc.   Risk is directly correlated with those expectations – higher expectations result in higher risk.  It’s not to say that every investment that has done well will fail to sustain its gains and inevitably plummet back to earth.  Reversions to mean do not afflict every single performer; indeed the best investments are those which can sustain superior performance over many years.

If you think of risk as potential energy, i.e., a potential drop in price, though, it becomes clear how following any investment up a mountain of expectations increases that potential energy.  Risk is not the actual kinetic act of price decline, it is the potential.  A stock whose valuation has climbed steeply, and which has to continue meeting high expectations, by definition bears more of that potential. It may continue to be a great performer, but it’s also now riskier.  Likewise, a cheaper stock in which investors place less faith, while by no means a guaranteed turnaround winner, at least bears less “expectations risk.”  Above all, investors should guard against tacitly relaxing their valuation standards and artificially boosting their projections for growth, etc. just to chase a winner.  If a stock’s price reflects unrealistic or unsustainable expectations, beware.

April 19, 2013

In each client’s Statement of Investment Objectives I list minimum-to-maximum ranges for various asset classes (equities, bonds, etc.) as percentages of a total portfolio, and in the case of equities I add a specific neutral or mid-point percentage target. The ranges are narrow enough to be meaningful safeguards but wide enough to allow flexibility, e.g., to seize opportunities or let healthy winners run or alternatively to retreat from asset classes when their risk v. reward appears unattractive or too uncertain. Likewise, the neutral mid-points for equities serve as a rudder or benchmark to prompt occasional rebalancing, not as an arbitrary tether warranting reflexive adherence (and frequent capital gains realization).

January 17, 2013

After two robust years and given the mixed macro backdrop, I want to guard against excessive bullishness or over-extrapolating recent market resilience. I am, however, still confident that the S&P 500 can average at least +4% price change per year over the next 5-10 years, and I of course hope and strive for Drystone Concentrated Investments to continue adding a healthy percentage on top of that S&P benchmark over time. I also remain very confident that the aggregate total return on stocks will outperform the total return on bonds.

Drystone LLC investment portfolio manager