Commentary

Imagine you’re choosing between investing in two start-up businesses.  Both will start with $10mm and invest in projects expected to generate a 15% return.  The only difference between these two companies is that one will invest in tangible factories and the other will invest in intangible R&D.  So far, you would be correct if you said these companies should be valued equivalently.  But would you be able to tell that these companies are equivalent by looking at their financial statements?  Let’s look at the first 5 years of two startups, starting with the factory builder…

Airlines have been, and will likely continue to be, a notoriously bad investment.  The industry is capital intensive, massively fragmented with hundreds of global players, heavily regulated, and unionized… with no real way for carriers to differentiate their services.  Bankruptcy courts keep carriers alive in a zombie like state allowing them to continually erode margins while regulators block mergers.  And on top of that, the industry attracts new entrants every few years despite low expectations for return.  There is absolutely no reason to expect any player in this industry to generate above average returns on invested capital. But within the industry, there are a number of players that have been able to consistently generate a reasonable return on invested capital, and at the right stock price, that’s all investors need.  In particular, regional airlines and airplane/engine lessors have generally been able to secure long-term contracts guaranteeing rates of return in the range of 3%, which when leveraged 4-5x yields a 12-15% return on equity.  At the moment, there are a number of players in both industries trading at unusual valuations.  In this report, we focus on the regional airline industry.  In the future we will also take a look at equipment lessors…

Every quarter, Fannie Mae and Freddie Mac release a chart depicting the cumulative default rates by origination year.  This chart is usually hidden in the middle of the presentation, but it provides a tremendous amount of information about what's happening in the US housing market.  Below is the cumulative default rate chart from Freddie Mac at year end 2009…

In a report from the Milken Institute, the US was ranked 5^th out of 122 countries for providing an economic environment favorable to accessing global capital.  At a time when we're considering how best to regulate our banking and financial institutions, it might be interesting to take a closer look at these numbers to get a sense for how the US compares to other countries.  Living in New York, it's easy to believe Manhattan is the financial center of the universe.  But if that's the case, why did the Milken Institute determine that US entrepreneurs have less access to capital than their counterparts in Canada, Hong Kong, the UK and Singapore?  Why did L'Occitane, a major French cosmetics company, recently announce their IPO in Hong Kong instead of the US? For a brief overview of how the index is compiled, the process is fairly straightforward.  There are seven components to the index each with a number of variables.  For each variable, a country is scored and ranked into a decile, the average of which comprises the score for each component.  Each component is then weighted (25% for macroeconomics, 25% for the institutional environment, and 10% for each of an additional five categories) and averaged to determine the final score…

With the S&P up 75% from its March 9, 2009 market bottom, it's smart to take a step back from individual stock valuations to look at the market as a whole.  A good way to do that is with Robert Shiller's S&P 500 P/E data, which he used to predict the internet bubble of 2000 (weeks before it popped) in his book Irrational Exuberance.  His excel spreadsheet is regularly updated at http://www.econ.yale.edu/~shiller/data/ie_data.xls. His methodology is simple.  He compares the current price of the S&P 500 to the average index earnings per share of the composite companies over the past ten years.  The resulting product is a chart of how the P/E ratio has fluctuated since 1880…

In this post, we're going to profile The Cash Store Financial Services Inc., which trades as CSF on the Toronto Stock Exchange. Accounts managed by Kerrisdale currently hold CSF, and we may buy or sell shares at any time. We will not disclose our sale if and when we sell, and we will not necessarily disclose that we have changed our thesis if we discover something faulty with our analysis at a later date. Our PDF materials for CSF can be downloaded here. All figures in this email are in Canadian Dollars. Financials have not been updated for 3-31-10 figures released late last week. Although we own CSF, the main purpose of this post is to provide background information for our monthly investment writeup AUC. AUC is essentially a startup version of CSF in a new country where the payday lending market is a fraction of the size of Canada's. AUC management are former Canadian executives from CSF, and the business strategy is to simply export the successful Canadian business model to Australia. Understanding CSF's historical growth in Canada is integral to envisioning how AUC could grow in Australia…

In this post, we profile the payday lending industry. We discuss how payday lenders make money and the regulatory landscapes that have evolved in Canada, the United States and Australia. This discussion is meant to be read in conjunction with our posts on CSF and AUC. Payday Lending Payday loans are small-value short-term, unsecured personal loans to borrowers requiring short-term funds until their next payday. Neither assets nor credit ratings are taken into account when determining a borrower's creditworthiness. The borrower must have a job, a bank account, picture identification, a permanent address, and several references. A recent bank statement, pay stub, and proof of address (such as a current utility bill) are required as verification. Normally, upwards of 33-50% of the person's paycheck is loaned for up to 15 days. The borrower writes a post-dated check for the repayment of the loan. The lender / broker will charge a fee, or several fees, for making the loan, as well as interest that the loan will accrue. Annualized interest rates can exceed 500%, but because much of that “interest rate” comes in the form of a $20 or so fee for each $100 borrowed (keep in mind that these are typically 2-week loans), many borrowers don't view that they're paying 500% interest rates on their loans…

We’ve split up our blog into an “Investment Ideas” Blog and a “Commentary” Blog. Previously, we’ve published our blog postings in the form of a long, in-depth investment idea on an approximately monthly basis.

We’re going to continue doing that, under the Investment Ideas section of our website. In addition, we’re going to gradually a ramp up a “Commentary” blog, whereby we provide general commentary on investing, industry trends, interesting investment situations, unusual corporate transactions, etc. Our Commentary blog will often not be related to any underlying investments, and will act as more of a free-form forum by which we can share research and insights that are not related to specific investments that we have made…