My investing mistakes and lessons that I’ve learned

This is a list of the most important things that I’ve discovered.  Sometimes I have learned these things the hard way.

Pretium update: Graham Farquharson speaks out

Those interested in Pretium should definitely check out this Financial Post article on the company.  In the article, Graham Farquharson (president of Strathcona) comments on what’s happening and criticizes Pretium’s management.

MTY Food Group (MTY.TO): Fast food, faster growth

MTY Food Group is a collection of fast food franchises.  A large part of its growth has come from buying second-rate and third-rate food franchises.  MTY is a very good operator as purchased concepts have generally become much more profitable and have grown into much larger franchises since being bought.  The company’s CEO and founder, Stanley Ma, has been referred to as “the king of the food courts”.

Return on equity: around 22.75%.  (The company has virtually no debt.)
Growth in book value from 1996 to 2012:  21.5%/year.
Growth in share price from 2003 to today:  Over 100X.  (Yes, over one hundred times!)

*Disclosure:  Long 1 share as a tracking position.

Pretium: Strathcona says that there is no gold

See Pretium’s press release for yourself.  The stock is currently down around 26%.  Here’s one juicy tidbit from the press release:

Strathcona withdrew from the Program on October 8, 2013 before any results from the processing of the bulk sample were available. In withdrawing from the Program, Strathcona advised Pretivm that “…there are no valid gold mineral resources for the VOK Zone, and without mineral resources there can be no mineral reserves, and without mineral reserves there can be no basis for a Feasibility Study.” They also advised that “…statements included in all recent press releases [by Pretivm] about probable mineral reserves and future gold production [from the Valley of the Kings zone] over a 22-year mine life are erroneous and misleading.”

Strathcona is saying that there is no gold (“no valid gold mineral resources”).

Chesapeake (CHK): Is this really a long?

Chesapeake is an oil & gas stock that has been owned by many notable value investors (Mason Hawkins, Lou Simpson) and has often been written up as a long on VIC more than once.  In my cynical opinion, Chesapeake is an example of a stock where supposedly sophisticated investors have been continually fooled by management.  Since its IPO in 1983, Chesapeake has done a very poor job at value creation and generating GAAP earnings.  However, book value per share has gone up dramatically since Chesapeake has been continually selling shares at higher and higher prices.

Perhaps shareholders will realize that they aren’t going to make money and should stop buying stock through secondary offerings (and convertible debt).  However, I don’t think that Chesapeake is a compelling short as the company is not the worst company in the E&P space.

Shorting VIC (ValueInvestorsClub.com), PRXI, PVG

Occasionally, I find myself shorting long ideas that are written up on VIC (ValueInvestorsClub.com).  VIC is an exclusive website where a mix of professional money managers and non-Wall Streeters post investment ideas.  Non-members like myself can sign up for a guest account and see ideas with a 45-day delay.

Here are situations where I have taken the opposite side of their trades.

China Ming Yang (MY) – Another Chinese stock to short

China Ming Yang is a Chinese company listed on the New York Stock Exchange.  Many similar companies have turned out to be frauds or have been taken over by private equity.  I’m not aware of a single fraudster being jailed, though investigators for short sellers have been thrown in jail.  The incentives seem to be perverse and in favour of committing fraud.  So far, the danger in shorting Chinese stocks has been:

1. Private equity takeovers.  Some companies heavily targeted by short sellers (e.g. Muddy Waters) have been taken over by US private equity, causing large losses for the shorts.  e.g. HRBN, FMCN, etc.
2. Liquidity.  In the past, some of these stocks have gone up several times before going to 0.
3. Borrow costs.  As Chinese reverse mergers have been recognized as an area with extreme levels of fraud, short sellers have piled on.
4. Short squeezes.  e.g. CMEDY
5. (If you own put options.)  The stock may be delisted and you may not be able to exercise the puts unless you buy stock on a secondary market.

While I am not going to spent the time going through China Ming Yang’s entire 20-F filing, I believe that it is a compelling short due to the sheer ridiculousness of its related party transactions.

Shares short:  1.01M  (0.8% of shares outstanding, 1.47% of float)
Borrow cost:  Low single digits

Quality businesses on my radar

I’m interested in emulating Warren Buffett in finding “first-class businesses with first-class management”.  These are generally businesses with one or both of:

1. A unique competitive advantage.
2. Excellent management.

Here are businesses on my watch list.

Visa: A wonderful business with a strong moat

Visa is basically a technology company in the payments processing industry.  Network effects and economies of scale contribute to the duopoly enjoyed by Visa and Mastercard.  Both companies should grow earnings as they are toll bridges on the secular trend towards electronic payments.

Unfortunately, the valuation remains a little high so this is not one of my best ideas.

Adjusted TTM P/E: 23.47 (source: Yahoo Finance / Capital IQ)
Forecasted earnings growth: “Mid to high teens” (source: Q3 investor presentation)

*Disclosure:  Long Visa.

Pretium Resources (PVG) – Massive red flags

Strathcona has was hired to oversee Pretium’s bulk sample program.  The purpose of these programs is to get a better idea of the amount of gold contained in a deposit since the gold distribution may be erratic and drilling samples very little of a deposit.

Strathcona has inexplicably resigned from the project.  This is a massive red flag for me.  In my opinion, Strathcona has a very good reputation as Graham Farquharson’s work is famous for uncovering the Bre-X fraud.  He has also continued to attack John Felderhof over his involvement in the fraud.  (Felderhof remains a free man, his children are reported to be millionaires, and has never been convicted.  I agree with Farquharson’s assessment.)  His company strikes me as having high integrity.  I was surprised that Strathcona would work with Pretium in the first place since Pretium’s quality control checks were consistent with fraud (see my previous post).  It wouldn’t make sense for Pretium to hire Strathcona if fraud was occurring because Strathcona’s engineers are smart and have integrity.  Now I’m less confused and strongly believe that the red flags are too big to ignore.

Here is Pretium’s press release:

Strathcona Mineral Services Ltd. (“Strathcona”), which had been engaged as the independent Qualified Person to oversee and report on the 10,000-tonne bulk sample for the Program, has resigned from the Project.