The webinar was recorded October 22, 2020
You can find the slides here.
Chris Preston [00:00:05] Hello and welcome to today’s Cabot Wealth webinar, Turnaround Investing + Two Stocks to Buy Now. I’m your host, Chris Preston, Chief Analyst of the Cabot Wealth Daily Advisory and managing editor here at Cabot Wealth Network. With me today is Bruce Kaser, Chief Analyst of Cabot Undervalued Stocks Advisor and our newest adddition in the Cabot Turnaround Letter. Today Bruce is here to talk about the concept of turnaround investing or contrarian investing, how it’s worked so well for him over the years, how to employ the strategy now and what two turnaround stocks he likes today. This is an interactive webinar, which means we’ll be fielding your questions after Bruce wraps up his presentation. So if you have a question, feel free to ask it at any time. We’ll try to get to as many of them as we can. Once Bruce wraps up and you can just send your questions in the question box of your control panel, just keep in mind that we cannot offer advice in regards to your own personal investing situation or portfolio. First, let me introduce Bruce. Bruce Kaser has more than 25 years of value investing experience in managing institutional portfolios, mutual funds and private client accounts. The two successful investment platform turnarounds co-founded an investment management firm and was principal of a three billion dollar employee owned investment management company. Previously, he led the event-driven small and mid-cap strategy for Ironwood Investment Bank Management and was Senior Portfolio Manager with RBC Global Asset Management, where he co-managed the one billion dollar value/core equity platform for over a decade. He earned his MBA degree in Finance International Business from the University of Chicago and earned a Bachelor of Science in Finance with honors from Miami University of Ohio. Bruce joined the Cabot team this July and is already captaining the two value investing advisories I mentioned earlier. Bottom line, Bruce knows what he’s talking about when it comes to value investing and turnaround investing, in particular. So I’ll let him do just that. Bruce, take it away.
Bruce Kaser [00:02:09] Great. Thanks, Chris, and welcome, everybody, to our call here. I thought we’d spend maybe 35, 40 minutes going over the Turnaround Letter, some of our philosophy and approach and going through some names and then leaving the rest open for questions. So, yeah, I guess just in terms of what we do, the Turnaround Letter is a newsletter as - excuse me, I’m trying to get my slide deck to work here. There we go. It’s a newsletter that delivers your profitable contrarian investment ideas. It is backed, as Chris mentioned, by rigorous institutional quality research. I’ve done this for a long time at mutual fund and private client levels, and I’ve seen how the sausage is made at the institutional world and bring that, to, to this product. The letter’s been around for a long time, about 30 years. It was founded by George Putnam. Yes, that George Putnam of the Putnam Investment Family. And so it’s gained a lot of respect over the years from professional and private investors and has a pretty good track record. We track this over time through the Hulbert ratings website. We think they do a pretty good job of tracking the data and we like that transparency. In terms of what we do, we really look at investing as a craft. This is not a machine where you just crank through formulas and algorithms and put out ideas. We look at it as really as a craft research to the market or just those few stocks that fit our specific criteria. And we recommend only those stocks that we have high conviction in, then we closely monitor those recommended stocks throughout the entire investing cycle from buy to sell. So we we focus really on a very specific niche. And that niche is contrarian investing. And within contrarian investing, we focus on turnarounds and in many ways they’re very, very similar. So I think our philosophy here, if we were to boil it down to one sentence, it’s one that I think Warren Buffett of Berkshire Hathaway captured really, really well when he said price is what you pay, value is what you get. And I think it’s pretty commonly thought that price and value are the same. You know, hey, Procter and Gamble is priced at whatever per share. That’s the value and the price. They’re the same. But we found over the years, I’ve found over the years that the market is often, but not always so good at pricing stocks correctly or efficiently, and that that goes in both directions. Prices are set in a market run and occupied by people. People have emotions, money’s, incentives, a lot of different reasons to push stories around. And maybe there’s a narrative that pushes the story one way or the other, trends all that. So price and value can get disconnected. And that’s what we look for. We look to exploit the difference when the difference between price and value becomes pretty favorable. In terms of the market right now, I thought we just kind of touch quickly on kind of the market environment and stocks in general right now are pretty highly priced. Investors are paying a high - high price, as we say here, looking out at the 2021 or 2022, 2022 might be a post recovery kind of economy. The top five tech stocks, which everybody knows these, it’s Apple, Microsoft, Amazon, Google and Facebook. These are trading at 30 times 2022 earnings. That’s a pretty high price. Certainly, fundamentals are pretty good for these companies. That’s a pretty high price compared to the average stock in the S&P 500 or the overall S&P 500, which is about 19 times. So clearly something is going on with these better stocks. And this doesn’t really include, to much extent at all, the growing and speculative trends for biotech, electric vehicle stocks, SPACs which are special purpose acquisition companies. We’ve seen a lot of those coming out. I think those are now coming out in record volumes, which is really an amazing trend. Lot a new IPOs, cloud companies, digital economy and all these other ones that have no earnings? So the market is is really looking to play for a speculative gain on a lot of stocks and, you know, paying a high price to do that. And so as we watch these very popular stocks become crowded, we can see what happens with their performance. This is on a year to date basis. Top five tech stocks are up on average. Forty five percent. I just listed a couple of other ones here that are more emblematic of their their entire group. The next gen Internet ETF. This is a lot of cloud computing companies and a lot of digital companies. That’s a double that ETF is about a double this year so far. Tesla. Everybody knows about Tesla. Very strong stock. But that might be a proxy in many ways for all of the other electric vehicle stocks which have no earnings. Maybe they come out through a special purpose acquisition. Companies get a tremendous increase in price in these stocks. Hard to see what the value might be, but price has gone up. Zoom, everybody knows Zoom or actually I think a lot of people use Zoom every day, very strong returns there. And a number of these other ones are emblematic of some of the strong growth - strong returns in some of these very popular stocks. But we see that’s really a two tier market, stocks where investors are enthusiastic about the - about the companies and about their prospects. And where maybe they’re they’re not so enthusiastic and the not so enthusiastic group would be really the S&P 500 on a total return basis. It’s up not even eight percent this year. And the Dow Jones Industrial Average, which might be sort of the epitome of stocks where people are not so enthusiastic about, it’s not even up one percent. And so what’s interesting we’re seeing is a two tier market, kind of like the old economy, new economy of the late 1990s, where the narrative sounded really convincing long term growth prospects and potentials huge. The pandemic has accelerated the value creation process for a lot of these companies. It just sounds like a fantastic trend. But investors, I think, are extrapolating all this fantastic growth long into the future and these stocks are becoming quite expensive. And what we’re saying is that expectations are so high, which show up in valuations that that very strong extrapolated growth in many cases has to be there or companies will start missing estimates and those stocks are going to come back down to the ground. So similar to the late 1990s, a lot of excitement, but very one sided. And if you remember back in the 2001 through 2005, 2006 period is a very strong period of time for sort of value and maybe boring companies. And the tech companies did not do well at all. We’re seeing some of the financials and energy stocks selling at unusual discounts. And certainly the fundamentals may not be fantastic, but with lot of these stocks, we just don’t need to see much go right. Maybe just a little less goes wrong. So we see a lot a lot of possibility for good out of favor stocks to come back and favor maybe. I guess the best way to say it is it’s a great time to be a value and contrarian investor in this market. This slide here just has what value are they getting? Get a lot of people paying high prices for these stocks. It’s hard to see what the value is in many, many cases.
Bruce Kaser [00:09:59] So let’s go in a little bit of our our strategy and how we approach contrarian investing. So we look at stocks that have three specific traits, stocks that are out of favor. Stocks that have real value and stocks or companies that are undergoing significant positive change. Let’s look at some of those a little bit more in detail. So out of favor stocks. This is really the opposite of momentum investing. That’s really on the opposite end. Momentum investing is stocks going up we’re excited. We often look at stocks that are very weak, in some cases at or near, near term or long term lows. These stocks, lack mainstream appeal. But in some ways, that’s their key attraction, is that they’re they’re so disliked that it doesn’t take much for them to come back into favor. The other thing that’s interesting about these out of favor stocks is that they tend to have a low correlation with the market. They won’t necessarily move with the market over their lifecycle. And so if the markets get choppy, these contrarian names probably can do OK. If we pick them right. What about real value? So our focus is on companies that have real value. And this would be, you know, real companies that make real products usually have real earnings. They have real balance sheets and they’re meaningfully undervalued especially versus their potential. We’re not big into trick plays or companies that have sort of bizarre one off products and 17 different things need to go right. We really look for companies, if you see our list, you probably recognize half the companies or more. And the others would be pretty obvious once once you dig into them a little bit. We want to find real companies and then undergoing significant positive change, this is really the most important aspect in some ways to contrarian investing. And that is we want companies that have a compelling reason for the fundamentals to recover. Weak companies could theoretically struggle indefinitely. We just don’t want to be a part of those. We want a company that can get better and improve. And what this gives us, the combination of these three traits is rising earnings plus a higher multiple should be the key ingredients for outsized share price appreciation.
Bruce Kaser [00:12:22] And let’s go to the next slide and dig into a little bit more about why this works. I listed a lot of different reasons here. There might be more, but I think the key reasons would be that most investors aren’t comfortable. Certainly clients, consultants get nervous when they see these names in their portfolios. Professional investors and certainly Wall Street analysts, they’re just not going to go out on a limb until a stock becomes more respectable. But in many ways, this is just a truism of human nature. And a lot of the times we want to exploit that. And many times I recommend or describe some of these stocks to my friends and they’ll go, are you kidding me? That stock is awful. And to me, that’s kind of saying, well, now I want to look at it because it might be something there. A couple of the traits I wanted to highlight the fourth one. Very different from value investing. Value investing is often seen as the opposite of momentum investing. But the way we look at value investing is it’s stocks that are cheap but can get better. It’s not just buying low valued stocks that have a p/e of five or six. That’s just not enough. A lot of people will say, gee, all the financials and energy stocks are out of favor. They must be good values. Well, sometimes they are and sometimes they’re not. A lot of investors might say, well, value investing is just out of favor and it’s been out of favor for a long time. We certainly share the value investing mindset. But it’s very different from a lot of things you hear in the media about value investing as it grew. Two other traits. One is the holding period. Most investors will hold a stock for three months, six months, maybe a year. Anything beyond that tends to be out beyond most people’s horizons. So we look out beyond most people’s horizons to see value where they do not. And I think the other thing, too, in an era where quantitative investing, machine investing, A.I. and all this other stuff is becoming so important and algorithms, algorithms can’t figure out turnaround investing. They just don’t have the tools. It’s more subjective. And so that makes the area a little more inefficient.
Bruce Kaser [00:14:37] So let’s go a little bit more into the two components, contrarian investing - it focuses on unpopular stocks. The stocks typically have something wrong with them. There’s no doubt something might be wrong with these stocks. And we’ve listed several of these here. Maybe revenues, margins. Maybe you’ve had the acquisition that didn’t work out. Maybe they’ve been tainted by a bankruptcy. A lot of other reasons that make a narrative simply awful on these stocks. I think one time somebody said to me, well, if a story doesn’t sound good, I’m not going to touch it. And I think sometimes the analysis starts and stops with, Doesn’t that company do this? Oh, I don’t want to touch it. So we go beyond the very start and stop analysis of one sentence. And so I want to find the stocks that are out of favor and and focus on those. One thing I think we touched on earlier, investors tend to extrapolate trends. They extrapolate the good. We’ve seen that in these momentum driven stocks. Now let’s extrapolate the bad. A lot of times, markets and investors assume that a temporary problem is permanent. So this gives us sort of our universe to start with.
Bruce Kaser [00:15:54] But the next step, though, a weak stock is only really half the strategy. Some stocks will recover if they have the right catalyst and we’ve listed some of the catalysts here, these catalysts need to be big enough and powerful enough to really reverse a company’s fortunes. The most powerful one we look at is new management. If you subscribe and you see our our list of stocks, it might be half or more have new management. And this is really a powerful because if a company is not doing well, it’s probably because the old management just did not know how to solve the problem. I was in a meeting once with a company and they described something that I’ve remembered for a long time. They said they’ve never run into a problem that doesn’t wear shoes. And so that told me is that most of the problems with companies is a management problem. And when you think about it, too, companies are really just collections of people and assets. And if somebody comes in to run the business better, they set new priorities, bring in new energy and new motivations that can very much change the nature of the company’s direction. We’ll just touch on some of these other ones, that credible shareholder exerting pressure? That’s really a one way of saying an activist. Some activists are good. Some are bad. We find a handful are pretty good to follow. We won’t buy by any stretch everything they recommend because they don’t always fit our criteria. But some are better. They have a right philosophy. They tend to be quieter. We don’t like loud activists. We want to see an analyst or an activist who’s fundamentally focused. Here’s what a company can do to fix their business. Not so much financial engineering. And so we look at the activists for sure. That can be a real important catalyst for change. Spinoffs can be very good, both the spun off company and the returning company or the residual company. A lot of reasons why these can work. Companies in imminent cyclical upturn. And what we look for there is a reasonable possibility of a cyclical upturn. But importantly, from the company’s perspective, we want to make sure they have a cost minded management and they have a healthy balance sheet. And these two things buy them a lot of time. If they can muddle through at the bottom of the cycle with a good balance sheet and maybe break even cash flow, they can last a long time. And we’ve got the ability for that company to eventually survive and endure and then make it to the other the other end. Temporary legal issues. Sometimes these can scare investors off. Sometimes they scare us off, too. A company called First Energy had a lot of regulatory problems and their stock was hit pretty hard recently. We’re not really going to touch that. We just can’t get our hands around it in terms of what the problem is, how deep it is. We just won’t touch all of these. Some are very interesting. We will look at them. So that’s another possible source of Catalyst’s. Fresh start emerging from bankruptcy. Sometimes these can be really interesting, we’ve not seen many companies come out of bankruptcy, it’s been a very unusual cycle for the past decade. But these can be really powerful if they’re done right. We want to see a company that has a clean balance sheet. The operational problems have been resolved and that they have a new leadership. One thing we will almost never do is buy the stock of a company when it is in bankruptcy. Typically, those stocks go to zero. So we just don’t want to be involved until they come out of bankruptcy.
Bruce Kaser [00:19:18] Typically, there’ll be 30 to 50 Catalyst’s every month. We actually track these. We’ll talk about our Catalyst report a little bit later. But tracking these catalysts can be a real, real good source of ideas. So where we see the opportunities, really intersection of these two out of favor stocks. Yet those with catalysts. There aren’t many. But sometimes it can be really powerful. And those are the ones we focus on. I think one thing I want to touch on here is that we’re not macro driven. We’re certainly macro aware, we’re aware of the economic environment, we’re aware of prices and commodities and politics and Fed policy and all this other stuff. But we’re not driven by that. We don’t rely on proprietary information or guessing where the market’s headed or daily news flow. We just cannot predict the future. We’re not really in the predicting business. We really want to just focus on making sure the company executes the strategy well. We buy it at a good valuation.
Bruce Kaser [00:20:17] Let’s go into the in depth here in terms of our research process for us. We have really three levers that we focus on. In many ways, all stocks are driven by one or more. These every philosophy focuses on something different. Perhaps a momentum investor just focuses maybe exclusively on relative strength. We focus on the first two fundamentals and the valuation. And with the fundamentals. That’s really the business itself. Every business, whether it’s public or private, has fundamentals. This is what we focus on. The first is one of the most important. The relevance or stability of the business. We want to make sure that customers are buying the products and services that the company sells. Then it has a reasonable chance of continuing to be in business for the foreseeable future and is able to do that at pretty good margins. And that’s really the foundation of success for a turnaround. We tend to avoid companies that are in sharp secular decline unless the management has a really credible plan to create significant value for the shareholders that acknowledges that secular decline. Those are pretty rare, but we do entertain those if we see a good pathway. In general, we want to see more margin traits or I’m sorry, the wider margins compared to thinner margins. We want to see some sort of edge or mode, something that maybe differentiates the company. It’s not just a pure commodity company for the most part. The balance sheet and free cash flow, this really gives the company time. Every turnaround is on a clock and the longer that clock or the slower the clock runs, the the better the chance for the turnaround. If a company is highly leveraged and generating negative cash flow, that clock is going to run down very, very quickly. We want the opposite, if possible, then management, we touched on this earlier. We look for managements that are awake. They’re motivated properly for shareholders, and they have the capabilities of solving the company’s problems and that they have the right priorities in terms of the people and the capital.
Bruce Kaser [00:22:28] The second is valuation. This gets back to the price does not equal value all the time. This is how the stock is priced or valued. We want to see something that’s meaningfully undervalued. And this is a bit more of an art than a science. We’d like to minimize the legitimate chances of downside. We know there’s downside to all these names, but we try to minimize that by buying these stocks when they’re meaningfully undervalued. We put a note on here about not just statistically cheap. And I think this differentiates our strategy from sort of the generic strategy, a generic value strategy would say, well, these stocks are between five and 10 times earnings. So they’re value stocks. That’s not necessarily true. Those can be value traps, stocks that are cheap statistically, but because their earnings keep going down, there’s not really a lot of value there at all. So we want to buy companies that have - that’re undervalued based on the fundamentals as we see them, not just on the on the numbers. We’ll touch on dividend and price targets a little bit later. But basically, dividends are helpful but not necessary. And then price targets. We set a price target for all of our stocks and we’ll touch on that a little bit more.
Bruce Kaser [00:23:41] Then a third is relative strength. This is only dealing with the stock price movements. We tend not to put a lot of a lot of weight on this, but we find it very helpful to know why a stock has done what it’s done. We want to look back in time as long as necessary to understand the story and the narrative around the stock. One example is we we started looking at the shoe company Crocs. They make the foam shoes that a really comfortable. That company, we recommended it in 2016. But to better understand the story, we look back at the pre IPO and how the company was founded. The company did its IPO in 2006 and that was at twenty one dollars a share stock, ran to seventy two dollars a share by the next year. We want to understand what was going on there. And then by 2008, 2009, the stock had dropped to less than a dollar. But we wanted certain understand that it’s a key part of the story that everything that happened between then and when we recommended it in 2016, it took a lot of research to understand this story. But once we can, we’re convinced that this turnaround is under way for a lot of the reasons that fit our criteria. The fundamentals and valuation recommended it add about a little over eight dollars a share. Sold it over twenty dollars a share. Not much. A couple years after that. So it just kind of illustrates that we don’t rely on the stock price. But it it helps us understand the story that’s behind the behind the stock.
Bruce Kaser [00:25:16] This is a very busy slide, we’re going to just touch on it. You can download the slides later and look at it, but this is really a summary of how our process works. We do a lot of fundamental research. We’ll look at a lot of regulatory filings, conference calls. We will do field research if if that’s warranted. And then we’ll look through the numbers and some of the qualitative aspects of management, the board. And again, you can look at this later. But it just gives you a sense of the fundamental research that we do to try to understand the story. So the key components of our approach, I think these are really important mindsets to to think about. One is to get a holding period is from months to two to three years. Sometimes stocks work really well. We’ll sell them when they hit our target. But generally, it takes two to three years. And so it’s important to think like an owner. We think as if we’re buying the entire company, not just a share, but the whole thing. And then we think about what if we can’t sell for two to three years? That’s the change, is how we view the stock. Now, owners and we think about that. Another is we want to ignore the noise. This is so important. Stocks move around for a million different reasons and they may move in one week, two week, one month trend all in the wrong direction and then come back for no reason either. We want to ignore all that noise. And in many cases, the only real fundamental information we get is on a quarterly report where the company gives us all their updates. So it’s so important to ignore the noise in the day to day and week to week movements of the stock. Just hang in there with the with the fundamentals and then the price targets.
Bruce Kaser [00:26:58] So let’s talk about a little bit of price targets we do find is really helpful. It’s based on the post turnaround scenario. If the turnaround is successful, what were the fundamentals look like? And then how do we evaluate based on that? We want this to be pretty realistic. This also helps us monitor the company’s progress and it helps us anchor our resolve and the stock price goes down. I think the biggest departure of our strategy from what growth investors might be familiar with is is is not to sell when the stock goes down. It’s being comfortable with the stock. It goes down 10, 20 percent or more on the way to hopefully a much higher price. That can be really hard. So having a price target where we anchor our expectations allows us to hang on when things get a little bit sloppy. And it also helps us, takes the emotions out of out of trading. So when do we sell? We sell when a stock hits our price target or it approaches it when the fundamentals deteriorate in a way that the value is just permanently impaired. We were wrong, frankly, is a better way to say that. But we’re not going to sell just because a stock price has gone down.
Bruce Kaser [00:28:08] Turnaround does involve risk to be a turnaround investor, It’s important to have the capacity to tolerate risks, both financial and emotional. Some investors are great with that. Others, maybe not. So it’s very important to have the right capacity to tolerate the risk. Turnarounds don’t always work. Sometimes the losses can be high. Diversification is absolutely critical. Diversification means a couple different things. One is diversified by sector, of course. You don’t want all financials or tech or energy or whatever. You want to spread it around the market. By Catalyst type. You don’t want necessarily all new CEOs. By turnaround stage. You want to be able to buy some early and mid stage, maybe some late stage turnarounds. So something’s probably working if all your stocks go down at once, that could be a little unnerving. The idea here is to diversify, to get shaken out of to not get shaken out of your position. We’ve listed some of the common turnaround mistakes, so well kind of pass those by for now. But again, you can download the charts and and the slides here and kind of look through those.
Bruce Kaser [00:29:17] So let’s go through a couple of our stocks. First one that we currently have a recommendation on, the stock has moved up a little bit since we first recommended it. But it’s GCP Applied Technologies. So GCP Applied Technologies is a global construction company. Construction materials company. They have two segments. One is a business that does additive for concrete and cement that help improve the performance of concrete and cement. It’s not a bad business. It’s a little more than half the revenues. Then the other one is a specialty materials business. They produce waterproofing membranes and roofing underlayments and other materials that help keep a building free from water damage. These are very, very nichey products. And they were initially part of W.R Grace when when that company was working to spin off part of the business. And these two companies were these two segments are kind of smashed together and spun off in 2016. And the stock did really well right out of the gate. Investors were excited about the growth prospects. It was undervalued at the time and also really for the prospects of a breakup where somebody might buy one or both of these parts of the business. And there’s a period where I think it’s - I’m not sure, if you can see my arrow here. But two thirds the way over, you can see a big jump in the stock price. And that’s when the company sold one of their divisions for a little over a billion dollars. The stock went up 25 percent. Investors were pretty excited about that. But since then, the stock has been on a downward slide, almost cut in half. And at one point is below the IPO price. Company had a lot of problems with missing expectations. They were poorly managed. The revenue growth just did not happen. Expenses got bloated. The management created a stream of restructuring plans that never really seem to do anything other, maybe other than perhaps extending their tenure. And so it really just got the reputation as a busted spin off and really just not not of much interest to really anybody. So we were actually pretty intrigued by the stock in in early 2019, an activist investor that we have a lot of respect for Starboard Value put in, acquired some of the stock and put in some plans to try to make changes. But it wasn’t appealing enough to us. The stock wasn’t cheap enough. So we just kind of watched it for a while. But earlier this year, Starboard mounted a very, very aggressive campaign, and they ended up replacing almost tje entire board of directors and they brought in a new CEO this past October 1st, about two or three weeks ago, who is very capable. So we think the company now is much better run. It has a good board of directors backing it up and they have a credible plan for improving the margins, using the cash better for generating some revenue growth and making this a much more viable business. There’s another interesting aspect to this where Standard Industries, they’re listed as somebody else on shareholder listings if you see them. But the company behind it is Standard Industries they are a manufacturing firm and part of their business is in this membranes business, very similar to what GCP has. They hold a 17 percent stake. We think they’re pulling some strings and they might actually acquire that business. So we think there’s a lot of good things going on with with GCP. In terms of some of the basics. The revenues are fairly stable. They’re very relevant. They’re tied to the national and global construction business. These are products that are necessary and they hold a number one, number two market share and in their core products. So a relevant, stable revenue base to generate free cash flow, almost no debt, net of cash. So very under levered balance sheet with tons of financial flexibility. We think the stock is pretty undervalued. Our subscribers got in about seventeen dollars and ninety six cents. Stock is now about twenty two. Twenty three. We think it’s still a decent amount of upside here in GCP Applied Technology. So we think that’s an interesting stock and it is on our recommended list.
Bruce Kaser [00:33:48] The second one is Dupont. Dupont is a.. Is a massive company. How can a company as big as Dupont be undervalued? Well, there’s a lot of stories that are going around on a lot of narratives here that maybe are complicated, that make - that made Dupont and still does make Dupont a pretty interesting story. As everybody knows they’re a global specialty chemical company. They’re not in the commodity business. They do specialty chemicals which have higher margins and less competition. They are huge. Twenty two billion in revenues. The company underwent a pretty complicated merger and demerger in the past few years. And I think investors are still trying to figure out for a long time what what’s really going on here. They merged with Dupont. I’m sorry they merged with Dow in 2017. That created a just a giant mess, as you saw, of a company. A lot of divisions. And they were going to split these off. That was all kind of described at the top, but nobody really knew how this thing would turn out. And it took almost two years for them to sort through these businesses. What it is they put the like businesses together and then spun those off and ended up with three companies. One is Dow, the new Dow. One is Dupont, which we have here. And the one is Corteva, which is a agriculture business. And all that occurred last year. And this chart here is really just a two sorry, a one year chart, maybe one and a half years. And so investors were not clear what was going on. Complicated merger split up. The pandemic certainly pushed the stock price down a lot as worries came in about the overall global economy. Then there’s some potentially large liabilities from toxic chemicals. The chemicals. The chemistry is is pretty complicated, certainly beyond me. But the issue really is that when they spun off Chemours in 2015, which is a performance chemical business. Chemours, they indemnified Dupont and Corteva against liabilities from these toxic chemicals. But as it turns out, Chemours said, well, that’s not really a fair deal. We want you to come back and pay for those. So they’re suing Dupont. Dupont, theoretically is on the hook for some of these. We think that that’s a pretty ring-fenced risk. It may endure for many years, but I think a price tag of about four billion dollars, maximum cost has been placed on this. Much of that’s probably been reserved. And it wouldn’t all hit it wanted would hit over several years. So we feel fairly comfortable that even if Dupont did have liability, it would not be very large and it would be spread over a number of years. So we feel pretty comfortable that that risk has been ring fenced. So our view on Dupont, a high quality company. They have very good brands and patented products which have higher margins because they are specialized, they’re diversified across a number of industries. The biggest industry is really automotive industry. I think it’s about 15 percent of revenues. But they’re well-positioned for electric vehicles where they have actually a higher content than gas powered vehicles. They have chemicals and products which will do well in the 5G transition. A lot of other industries, they generate pretty healthy cash, operating profit margins. Twenty six percent, that’s - that’s a pretty good number. They’re doing an innovative deal with International Flavors and Fragrances that’ll be completed probably early next year. That’ll bring in a seven billion dollar or so cash inflow to Dupont to help them pay down their debt. So we think that’s a pretty intriguing deal that they struck with IFF. It’ll be a little bit of a joint venture kind of transaction. They may make future divestitures. We really like the CEO. Ed Breen is exceptionally capable and he initially was the architect of the combination and three way split up of Dow Dupont. We think he knows this company intimately and is very aware of how to improve the company and the margins. And he’s making good progress in doing that. He’s also brought in a CFO that he’s worked with for years who is very good at what she does. Generates considerable cash flow. It’s a cash flow generator that gives it a lot of operating flexibility, buys time for all these improvements to occur. Company has a little bit of debt on the balance sheet, but it certainly has a lot of cash. They’ll be getting more once the IFF deal is completed. And we think the stock is undervalued. We think it’s worth probably about 70 dollars a share. Right now, the stock is at about fifty nine. The stock was about forty five when we recommended it. So a little bit of a gain already, but still some upside to it. And we think it’s pretty intriguing stock. So those are our two ideas.
Bruce Kaser [00:38:48] And I think we want to kind of summarize here with what are the keys to a successful turnaround investing. First block, the patience to wait. Focus on the end game. Wait, wait, wait. These things can take a while to cook. And so it’s important to wait for the turnaround to happen and ignore so much of the noise that happens. The second is know the valuation. We spend a lot of time on valuation, know why the price target is set and know why it’s valued the way it is today. Be very picky. There’s a lot of intriguing turnarounds. Some are false. Pick the half percent. That will have a pretty good chance. Then know the management management drives a story in many cases. So know who the leaders are, the company and know, know what’s going on and then diversify. Diversify is really important. And then I just touch on this really quickly. What can subscribers expect when they sign up for the Turnaround Letter? So what would you get if you were to sign up for the Turnaround Letter? The first two come out every month. Our monthly letter with twelve. Well, one every month. Twelve per year of high conviction investment ideas. And then each issue, we’ll also talk about a theme or an industry that has a lot of undervalued contrarian stocks with some pretty good appeal. We might have maybe two per issue in terms of themes, and then we’d have five, six, seven stocks in each one. So in addition to the feature name will have other names that are worth looking into, though not quite as high conviction as our featured name, the ones that have pretty intriguing starter potential. Every week we do a podcast. This will update you on all the names that have news or relevant information in the week. Also include updates on earnings that may happen and any of the commentary that we think value investors might find interesting across the market. We’ll, also, this is earnings season. So right now we’re busy following earnings. We report on summarized earnings with our comments on every recommended stock every quarter. And then if there’s updates, like right now, we seem to be having a lot of stocks that are getting close to their price targets. So any time a stock is, it’s a target. We want to sell it. We’ll send out a note that day. So we’re pretty pretty fast when when things are timely. We want to get that to you. Well, we’ll send that out the day it matters. The monthly Catalyst report - we’ll just touch on this. This is a fascinating report - it’s proprietary. We’ve never seen anything like this on the street. This lists all stocks that have fresh catalysts. Earlier, we talked about Catalyst stocks, maybe 30 to 50 every month. We list all those that we can find and then we’ll highlight some that look like they are the most promising. And often these stocks will become a featured name. So we think this is a pretty a pretty interesting report. Again, haven’t seen anything like it on the street. Right now, we’ve got twenty six hundred names in the database. So we think that’s something that is kind of interesting. We send out an update every month. One thing I think it’s important, too. I’m an investor. I’m a former professional investor. I back every idea that I recommend. All the feature ideas with my own money. And I invest in all these stocks. So if it works, it works. I’m profiting with you. And if for some reason the stock doesn’t work, well, I’m eating my own cooking as well. So I feel any pain that you might feel. I’m into these stocks and in meaningful, meaningful size. And then the direct e-mail access to me, direct access to a customer service team - they’re fantastic. So if you have questions, they will get back to you pretty quickly. And and help you out. So we’d like to support our customers with any any questions they have. Then a closing thought. This is by Ben Graham, he’s kind of the father of value investing from a long time ago. In the short run, the market is a voting machine, but in the long run, it’s a weighing machine. We very much see that, it’s a popularity contest day to day, week to week. But over time, it’s companies have to support their own weight. Chris, do I turn it over to you now or you? This is a.. OK, perfect.
Chris Preston [00:43:16] Yeah, thanks Bruce. I’ll give you a minute to catch your breath. Grab a sip of water. Yeah. I just want to tell people - you just filled people in on that last slide with a lot of detail about what they get when they sign up for your service. But, I just want to tell you, if you like, what you’ve heard from Bruce so far today and are interested in signing up for his Cabot Turnaround Letter? We do have a special half price offer reserved exclusively for listeners of today’s webinar and what you get in return for paying just 50 percent of the normal price are a lot of the things he just told you about monthly issues featuring new investing ideas and stock recommendations, weekly updates with special bulletins about market updates, news and trade alerts, weekly podcasts summarizing that week’s action, exclusive access to the Catalyst report, which Bruce just described, 24/7 online access to our exclusive subscriber website and analyst archives and direct private access to Bruce for answers to your investing questions. Sign up now and again, it’s for half the normal price. Just go to the website on your screen. That’s CabotWealth.com/webinarspecial. Now let’s get to your questions. Let’s see. I can kick things off with this one. “Bruce, what do you think of deep, deep value stack stocks in the cruise line, airline and movie theater industries? Are there any values to be had there?”
Bruce Kaser [00:44:52] Yeah. That’s a great question. I do get that from time to time because these stocks have been hit really hard with the pandemic. Right now, we’re avoiding these stocks. We think that there’s a couple of problems. One is the amount of debt that these companies have taken on to barely survive is gargantuan, I guess, a way to describe it. The markets are happy to provide cheap funding in terms of debt and they provide yield. Investors are happy with that. We’re not. So we find these companies have debt that is in many ways unserviceable now and maybe unserviceable forever. The revenues are unstable. They take a long time for them to come back. So we just don’t know when or if they’ll be able to generate any earnings. So these have two traits that give them a very short clock, high debt that they can’t service and there’s not a lot of earnings. So their clocks are really short. I think with AMC theaters, they’re almost sure to go go into bankruptcy because they could service their debt and fund their business when things are going great. But the margin is a little bit thin. Well, now that they’re showing almost no revenues but have even more debt, there’s probably no way that companies can survive. And same with the airlines. They’ll probably make it. Some airlines look pretty interesting, but most airlines have so much debt that they’re just going to be maybe zombies, I guess, as a way to describe it. So we’re not looking at these very closely now just because the debt levels are too high. Southwest certainly has some intriguing potential. We’re watching that one, but otherwise we’re not really focused on them because the fundamentals are weak and the debt is very high.
Chris Preston [00:46:47] All right, question from Ali. Ali asks, “How do you estimate price target? Is it broker predictions?”
Bruce Kaser [00:46:55] Yeah, it’s a really important question. So we do our all our own work. We will look at the current position of the company revenues, margins, balance sheet, cash flows, and then will project based on what we think the company can do in two or three years once the turnaround is completed. And those are the same metrics. What’s the revenue we think the company can generate? What are the profit margins? We typically use cash operating profits, which might be also labeled earnings before interest, appreciation, amortization or any for interest, taxes, depreciation and amortization or EBITDA. Again that’s kind of cash operating profits. So we’ll project out through the turnaround period what we think those metrics will be. We’ll think how much we’ll look at how much cash they can generate over the period of time and we’ll look at their capital structure. So we look at those metrics. In many ways, our price target is based on a multiple of EBITDA. So enterprise value to EBITDA is the metric we’ll use. And that’s all in-house. We do all that on our own. And so that’s generally how we do the price targets.
Chris Preston [00:48:10] OK, question from Sanjeev, I hope I’m pronouncing that right. “To what extent do you think Nokia is a turnaround stock? Does it fit your parameters?”
Bruce Kaser [00:48:21] Yeah, Nokia really is a very interesting company. They have a lot of ingredients that we look for. They have a decent revenue stream that is stable enough. They have upcoming 5G cycle, which, if nothing else, it should help boost their revenue growth. So we like the relevancy of that business. Certainly, if Huawei is shut out of the Western economies, that will bring the 5G equipment business into maybe a duopoly with Ericsson. Samsung is moving aggressively into the business. So at worst, it will be a three way game instead of four. So their business is relevant and probably in front of a pretty good trend here. You do have new management, which is refocusing the business, getting rid of a lot of the weak priorities and some bad operations that they had in terms of practices and priorities. Balance sheet is definitely getting better. Valuation is inexpensive. It’s a name that has a lot of potential. And I would say that definite qualifies as a tricky tunaround candidate.
Chris Preston [00:49:32] Good question. A question from Neil. Neil asks us - similar question to the earlier one about airlines and movie theaters. But, “Do big oil companies fall under turnaround stocks, in your opinion?”
Bruce Kaser [00:49:45] Yeah, it’s interesting. Some do, some maybe not. Companies like Occidental Petroleum, they have so much debt that we think they’re probably probably gone if oil prices don’t recover, they’re just so levered. Other companies like Exxon’s interesting in and from maybe not a good perspective. Maybe interesting from watching a train wreck slowly, they’ve taken the wrong strategy. They doubled down on production growth and capital spending. And now they’re having a reel all that in, their dividend is probably going to be cut. So Exxon really is just on the wrong side of the turnaround world right now. The stock needs to come down a lot and they need to make the business more cash flow sustainable. It is not right now. Some companies, Royal Dutch Shell, they are doing yeoman’s work of fixing their business, shrinking the capital, spending, shrinking the operating base. Interesting possibility there. It’s really tough for some of these companies because they’re really just in many ways a play on oil prices. But it could be interesting. It’s hard to say no to those. The upside may not be there, but the enduring value of a company like Chevron or Royal Dutch, they’re going to be there. So kind of a soft turnaround. I would say.
Chris Preston [00:51:17] OK, question from Sam. Sam asks, “So what is your minimum margin of safety?”
Bruce Kaser [00:51:25] Yeah, that’s that’s a question a lot of people ask, and it’s something that I think Ben Graham, Seth Klarman, a couple others have have used. What we look for are two things, what we want to see meaningful upside. And we want to see a fairly limited downside. Upside potential needs to be 50 percent or more. Fifty to one hundred is kind of what we shoot for. And so that gives us a bit of margin of safety there. We do assume that there is a turnaround in there. So if there’s no turnaround, we don’t want to see a stock deteriorate. I’m not going to use a specific number here, but we factor, in effect, a margin of safety and just in case we’re wrong. And part of that is built in the balance sheet and cash flow where if it doesn’t work, the company has some value fallback on.
Chris Preston [00:52:26] Here’s another interesting one. “Do you ever invest in a whole depressed sector? ie, automotives, the ETFs?”
Bruce Kaser [00:52:38] Interesting. We actually do not. We’re stock pickers and we find that even in an auto industry or an industry like autos, where there’s really only two domestic players that you could directly invest in in pure car companies, Ford, GM. Certainly Fiat Chrysler. But they’ve got a global business. There’s other car companies like Tesla. But they’re so different from Ford and GM that you couldn’t really put those in the same bucket. There’s a number of companies in Europe on their own, right, that have intriguing potential. But what we want to do is understand a specific company and specific stock, make sure that we have everything we’re looking for. We don’t just don’t get that with an ETF.
Chris Preston [00:53:28] OK, question from David. David asks, “Do some people use leaps, and I guess by some people it means you, use leap’s on a recommendation?”
Bruce Kaser [00:53:41] No, we use just common stocks.
Chris Preston [00:53:48] OK, short and swift. Let’s see.. “Value investing hasn’t worked in a long time. Why do you think it will work now?”
Bruce Kaser [00:53:57] Yeah. That’s a question we get a lot as well. There’s a real difference between value investing and contrarian investing. Value investing and contrarian investing overlap in the sense that we’re all looking for out of favor stocks. But where it departs is in the catalyst and the reasons why the stock might go up. Right now, energy stocks, financial stocks are all out of favor. They tend to be big in the value universe, as it were. Yes. As a group, they may or may not recover. They might. But we want to look for a specific company that has reason to recover and has the financial strength to to make it, so value investing, in some ways has had had it has had a tough road because the growth in technology sector has been so strong. So when people talk about value investing, that’s really a different program, a different game than we’re looking at. We’re we’re looking at specific stocks with reasons to go up, not just stocks that are that are cheap for whatever reason.
Chris Preston [00:55:14] I think we have time for one or two more. “How many turnaround stocks should I own?”
Bruce Kaser [00:55:22] Yes. So a lot of this depends on each individual’s preference and sort of risk tolerance. We generally suggest people own at least 10 turnaround stocks if if it has a meaningful part of their portfolio. And that gets back to the diversification. If you own one or two stocks. And they don’t work, it might maybe sour you to a whole group or maybe there’s too much risk. So by owning a group of the stocks, you can diversify and hang on through the entire turnaround period if it doesn’t immediately work for you. So we suggest if somebody dedicates a piece of their portfolio to these kind of stocks, 10 or so might be a good number. It certainly doesn’t preclude somebody who wants to take a starter position in one or two or three stocks and see how it goes. But somebody wants to do this with a big part of their portfolio, will want to diversify over or certainly more names.
Chris Preston [00:56:27] I think we’ll cut things off there. Good questions. Thanks to everyone, and thank you, Bruce. Any final words before I sign off?
Bruce Kaser [00:56:35] I think the one thing I’d wrap up with here is it’s a really good time to be looking at out of favor stocks because so many stocks are really expensive and that makes a lot of other stocks out of favor and and really good bargains. And I’ve done this for a long time. I’m actually probably more excited about these stocks than I’ve been in the past few years because, you know, the opportunity is there, the value is there. And there’s some pretty interesting fundamentals. And a lot of these names. So, I’m pretty excited. I hope you guys are excited as well. Please, feel free to send me or others an e-mail. And if you have any questions, we’d love to help you out and get you up for a subscription.
Chris Preston [00:57:19] Yeah, thanks. Thanks, everyone, for joining us today in these wild times. We’ll be back next month on November 19th with a webinar from Tyler London, Chief Analyst of our Cabot Small-Cap Confidential and Cabot Early Opportunities Advisories. They’ll be talking about small cap investing and how to spot early stage opportunities. Again, that’ll be Thursday, November 19th, at the same time as today, 2:00 Eastern. That does it for us, for Bruce Kaser and the entire Cabot Wealth Network team. I’m Chris Preston, and we’ll see you next time.