We’ve had questions about this ad pitch from John Del Vecchio over the past few days, and our accounts received a few copies of the ad directly from various sources as well in the past week or so… so I thought we’d look into these “hidden stocks” for you today.
But I also looked back in our email archives, and it turns out that we actually started seeing this email back in February — so although they’re still sending it now, unchanged, and presumably it still represents stocks that Del Vecchio likes, it is not “hot and fresh” today and I’m guessing the clues will be a little bit dated. In this context that may be an OK thing, I guess we’ll find out — despite the “screaming buy!” language, everything in Del Vecchio’s pitch indicates that these are chosen for their multi-year potential.
I’ve not written about Del Vecchio or his Hidden Profits very often, but we did post a teaser solution from that newsletter last fall — back then, he was using similar “hidden in plain sight” language to describe his favorite stock as a “genesis code” idea, and it turned out to be a pitch for Overstock.com (OSTK), which has lost about 60% of its value since then. I don’t know if Hidden Profits still recommends that one, or if they use stop losses or other “risk mitigation” tools.
Today, the tease that got my attention was for his special report, “Ten Times Your Money from the Billionaire Leaving Buffett in the Dust” … though he leads into that with a long spiel about the merits of his “FAST System” for sifting through stocks and winnowing out those who have “good” earnings and don’t try to hide ugliness or otherwise perk up his forensic-accountant ears.
Which means a lot of what he’s doing is probably screening stocks that meet various criteria, and then filtering those results to find the companies he finds most appealing. As with lots of newsletters that don’t have much of a track record (I think this letter is less than a year old, but not sure), most of his claims of brilliance are based not on stock picks he has made, but on older stocks he thinks he would have found that did well.
Del Vecchio says he found these great performers like AutoZone and The Gap by applying his “FAST” criteria and his multi-point screening to historical markets, thereby proving that this system works… but with all such cases, of course, you don’t know whether the chicken or the egg came first. The way you find the criteria that “work” is by either searching for stocks that did well and identifying the quantitative triggers that stand out, or testing different quantitative methodologies and seeing which ones identify the best-performing stocks from the time period you’re searching… either way, the only purpose for searching and screening is to identify stocks that did well or to test a theory on which indicators accompany a strong-performer. So of course any “system” that you have settled on, using reported data and some quantitative screening criteria, is going to “find” you the best stocks. Otherwise you wouldn’t have settled on it.
Sadly, if there is a quantitative indicator or collection of indicators that identify stocks that will consistently outperform, and those stocks can be identified in some mechanical way through screening or searching for specific trends or data points… you can kiss it away in about ten minutes.
That’s an exaggeration, but quantitative systems are still all the rage on Wall Street, thanks partly to Jim Simon’s massive math-driven success. If there is computer-readable data that exists, and in which patterns can be read, thousands of computers are doing exactly that right now, with the goal of identifying a trading or investing edge. You might use screening to identify companies that you think are worth more research, but don’t imagine that any newsletter is going to consistently beat the market with an automated system of data-driven recommendations — there’s so much volume in quantitative trading systems now, and so much competition to identify “edge” for the quants, that any edge they can find pretty quickly gets competed away. If you can find a stock using screening that shows potential to outperform like similar stocks have done historically, a half-dozen quants with supercomputer already found it and traded it and the price no longer reflects that “edge.”
But probably that “system” is an exaggeration of the way Del Vecchio finds stocks. I suspect he finds appealing ideas in lots of ways and uses what he says is his expertise, in forensic accounting, to identify those that have “cleaner” income statements and prospects. I think he was around as a short-seller before this newsletter, and maybe he still does that, but this is kind of like the opposite of that forensic “short” research — finding ugly or misleading accounting (or even fraud) is a nice way to identify short candidates, so, the argument goes, perhaps finding unusually smiley-face accounting is a way to identify good investments.
I suspect that’s a reasonable thing to do for long-term investors, though finding better corporate actors and less-misleading accounting is not necessarily going to give you any short term advantage — the market goes through long periods of not caring at all about how misleading accounting can be.
His back-testing apparently goes back to 2000, and he says that his FAST stocks go up 2/3 of the time….
“Over 18 years of backtested data, FAST stocks have gone up an average of 66% of the time.
“That’s two out of every three stocks!
“And even when you factor in the ones that did go down, the results are still market beating.
“That’s because FAST stocks, hidden as they may be, ALL meet a very specific set of criteria…”
For that you really have to know more to judge whether this is a remarkable claim or not — and you especially need to know for how long those stocks were held in his backtesting. Identifying stocks that go up 2/3 of the time is not remarkable if you’re holding for at least three months, and it’s not market-beating — picking stocks at random means they’ll go up 2/3 of the time over a three month period. That doesn’t mean they “beat the market” over that time period, just that they go up — notice that he says they went up, not that they went up more than other stocks… though he does seem to claim that the stocks that went down “still beat the market.”
So take that with a little grain of salt.
But anyway, back to the ad:
“Today, I’ll reveal the next wave of “hidden” opportunities with three of my favorite FAST stocks.
“My extensive backtest shows that FAST would have pinpointed stocks like AutoZone, Wyndham, and Gap… and several more I’ll tell you about in a moment.
“All poised to multiply as much as tenfold in the years ahead.
“And you may kick yourself that it took you this long to find them.”
Then we get an extraordinary claim:
“It’s no surprise then to think that if you can just eliminate the AVERAGE stocks and the WORST stocks from your portfolio, it should be EASY to beat the market.
“And if you can handpick the top 10% of all stocks consistently, which is exactly what FAST stocks are…
“Year in and year out…
“Then you’ll be in a position to beat the market by a massive 15-to-1 margin.”
Uh, no you won’t.
If you want some context for that, “beat the market by a 15-to-1 margin” would mean, as I parse those words, that your returns are 15X higher than the S&P 500… so over the past five years, a portfolio of these “top 10%” stocks, he’s saying, would have returned 945% instead of the 63% that the S&P returned.
Which is not at all realistic. If Del Vecchio could actually generate consistent 1,000% returns over five year periods for a full portfolio, he’d be a god. He might be able to cherry pick a few stocks like that from a particular time period that also show up in his backtesting screens — there’s probably a screen that can identify stocks that have consistently posted 200% annual gains, or thereabouts, you can make a backtesting screen that finds pretty much whatever you want… but such a screen is so dramatically outside the realm of “normal” returns and is going to identify such a tiny slice of past companies that it is almost certainly just identifying anomalies that happen to describe some past performers but are not going to be enough for you to select future performers.
So no, you’re not going to beat the market 15-to-1. You’re not even going to beat the market 2-to-1 over long periods of time, not unless you’re truly exceptional and lucky. You might do it with a few stock picks, or during a short period of time when your ideas do exceptionally well or you’re riding a momentum trend (like if you’ve been “all-in” on pot stocks for some key periods in recent years, for example), but that’s not the same thing.
But what we’re really looking for are the actual stocks he’s been teasing, right?
“I’ll even tell you about three FAST stocks I’ve selected from a pool of over 50 stocks that currently meet my strict requirements….
“I perform a 26-point inspection on every company I look at… to determine whether or not it meets the criteria necessary to become a FAST stock….
… every quarter I push hundreds of stocks through FAST…
“And the stocks that ace my 26-point inspection aren’t just honest…
“They’re the absolute best in the market at any given time based on my inspection.”
He also notes FAST stocks also offer “the shareholder trifecta”….
“See, the massive total gains from companies like AutoZone, Gap, Wyndham, TJ Maxx, and Moody’s haven’t just come from the stock prices going up…
“They’ve also come from what I call the shareholder trifecta:
- FAST stocks pay a safe, consistent, and increasing dividend
- FAST stocks reinvest in themselves by strategically buying back shares, helping to boost share prices for investors
- FAST stocks reduce risk and survive economic downturns by paying down high-interest debt
“The shareholder trifecta is an outstanding indicator of a well-run company and a potential high-flying stock…”
OK, hard to argue about any of those.
So now, finally, can we get to the “ten times your money” clues and the talk about the billionaire who’s leaving Warren Buffett in the dust? Yes, indeedy…
“I set aside time every year to read Warren Buffett’s annual letter to Berkshire Hathaway shareholders…
“I track SEC filings to see what the activist investors and hedge fund managers are buying…
“And I closely follow the moves of a trader that I consider to be as good, if not better than, Warren Buffett….
“According to Barron’s, from 2004 to 2016 this billionaire investor beat Buffett by nearly 2-to-1, with an annualized return of 13% compared to just 7.5% for Buffett.”
And Del Vecchio says that he “had to follow” one of this billionaire’s recent investments. Oooooh, which one?
Those numbers come not from this billionaire’s total results, it turns out, but from the performance you would have gotten if you bought one of his vehicles in 2004 and held on through a dizzying array of splits and spinoffs.
So which vehicle? That’s the group that was born as Liberty Media, which has done extraordinarily well (and, yes, was covered in Barron’s as a “Buffett-beater” in 2016).
So yes, this is John Malone, the telecom tycoon who is known for creating shareholder value and a near-obsessive focus on avoiding taxes and, at least around these parts, for creating massive webs of interrelationships and inter-ownership that make the analysis of any of his companies as much a leap of faith as a rational investment (unless, of course, you’re ready and able to sit down with the filings and sift through data for weeks).
If you’re going to make a leap of faith, though, you could certainly do worse than John Malone — he “eats his own cooking,” as they say, and he has eaten well for decades. There are a lot of investors who follow Malone and buy into many of his investments, or who just bought Liberty Media 15 or 20 years ago and held onto all the spins and splits. Probably his biggest fan is Mario Gabelli, whose Gabelli Funds has gone so far as to launch an ETF (actively managed) that tracks the Malone companies — buying, as far as I can tell, pretty much all of the spinoffs and tracking stocks that have been created out of Liberty Media, along with other stocks in which Malone and the Liberty family of companies have invested. He’s even got an awesome flowchart of all the companies in the “world of Malone”.
Incidentally, Malone’s doing fine and not missing any meals, and we’ll concede that he’s brilliant, but that doesn’t mean the stocks of his companies beat the market consistently. The Gabelli Media Mogul NextShares fund (MOGLC) that tracks his brilliant and confusing world seems like a clever and cool idea, even if the expense ratio is a bit high, but it has trailed the S&P 500 pretty badly since inception, roughly a 9% return vs. 35% for the broader market.
But back on track… which of the stocks Malone’s interested in or invested in is being teased here?
“When I recently ran my FAST system on the market, one particular stock caught my attention.
“It’s a classic ‘hidden in plain sight’ stock that most investors have never considered…
“And I’m convinced it could be one of your biggest wins ever.”
So what is this? It’s related to sports somehow…
“Today, there’s a new sport attracts more than 400 million global viewers in more than 150 countries through 115 broadcasting partners, totaling 41,945 hours of coverage.
“And yet for all those eyeballs, this league isn’t raking in the advertising dollars… yet.
“It currently brings in an average of $1.80 per viewer, compared to $11.17 for the NFL. That’s a huge difference and one I expect to narrow in the coming years due to some shrewd business moves by my new favorite billionaire investor.
“Now, you can’t buy stock in the NFL…
“But you can buy stock in the world’s #3 most-watched sport.”
He also shows a chart along with this one, which indicates that it was a “buy here” stock in mid-2017 around $25, was up 12.4% in a couple months, and as of 2018 was around $40 and he was “predicting a 7X increase over the next 3 to 5 years.” So perhaps the content for this ad was put together even before we started seeing it in February.
So what is it? Those are all references, sez the Mighty, Mighty Thinkolator, to Formula One Racing, a global auto racing circuit whose commercial rights are owned by the Liberty Formula One Group (FWONK, FWONA, FWONB).
The stats about Formula One in general are a little bit on the old side, it looks like they probably came from this NY Time article a couple years ago. Formula One has apparently seen some fluctuating attendance and television viewership, not unlike the faltering NASCAR circuit in the US, but it is also one of the world’s truly major global sports.
And like NASCAR, it has mostly been a global circuit of fast-moving billboards, the real financial lifeline for these hugely expensive cars and drivers are the team sponsors and advertisers… car companies that want to build their brand in the shadow of Mercedes and Ferrari, who have dominated the racing for years, or other advertisers who want to draw the attention of consumers or wealthy businesses. Germany, Italy and Brazil are their biggest markets in terms of television viewership, but they are also seeing rapid growth in China and they’ve had some very successful races that are boosting interest in the US, Singapore, China and elsewhere in the world.
Formula One in general is in a big transition phase right now — there’s a good FT article here about how F1 and the teams are “racing to rewrite revenue split” because the agreement they’ve worked under is expiring at the end of next year. Like many other sports leagues around the world, they’re trying to figure out how to level the playing field, limit the crazy spending, and, always, make things more exciting (Mercedes and Ferrari spend several times as much as most of the other teams, and win essentially all of the races).
I don’t know that Liberty Formula One will be hurt or helped by changes to the league’s governing agreements, it seems like the share the teams are getting is not changing a lot but it’s the split between the teams and the operating principles that will be changing… though, of course, any changes they make the change the appeal of the sport for either viewers or sponsors, for good or ill, has the potential to impact their earnings.
Right now, Formula One is not reporting a profit. Not shocking for a John Malone/Liberty company, since not making a profit means they don’t have to pay taxes… and, also like other Liberty companies, the goal is essentially to take a growing stream of capital and lever it up, so Formula One also carries a big chunk of long-term debt. Revenue has been growing gradually over the past few years, and analysts expect it to keep growing in the 5-10% neighborhood this year and for the next few.
I have no idea whether the new rules of engagement for the F1 teams will make the sport more exciting, I have friends who love to watch the races but I find it completely uninteresting — but obviously there’s a huge fan base and opinions differ (I can’t usually get anyone to watch the Tour de France with me, and that’s OK). I wouldn’t bet against anything in the John Malone stable, and “owning” what is effectively a whole sports league is indeed an exciting notion, but I don’t find this one particularly interesting.
And apparently there’s another Malone stock that Del Vecchio likes… clues:
“FAST STOCK #2:
“Your Next TRIPLE… Hidden At The Bottom Of The Ocean
“Right now, deep down near the floor of our oceans, a global network of undersea data cables help supply voice, data, and internet services to the rest of the world.
“And yet despite this massive undersea highway, a vast majority of the world still suffers from horrendously slow internet speeds and poor phone quality.
“That’s why my next FAST recommendation is a company focused on helping to bring better, faster technology services to the masses.”
Ah, that’s more in the Malone wheelhouse — his companies own a lot of “content” now, from Formula 1 to the Atlanta Braves to the Discovery Channel, but his genius started in cable companies and telecom… the wires, not the stuff that travels over them.
“This company has positioned itself to become the premier phone, television and broadband internet provider in Latin America and the Caribbean – everything from the U.S-Mexico border to the tip of South America.
“This region is one of the safer ones to invest in right now and the demand for data is immense…
“A study by networking giant Cisco estimates that the demand for mobile data traffic will explode as much as 6.5 times higher by 2021 in this region.
“In addition to that massive growth explosion, this firm has also been actively acquiring other companies in order to grow market share.
“It all adds up to a stock that I believe could easily make you five- to 10-times your money over the next several years.”
That is Liberty Latin America (LILA, LILAB or LILAK), a smaller rollup of Caribbean and South American telecom companies that has also been teased as a millionaire-maker by Jeff Yastine at Banyan Hill off and on since January. LILA is the ticker for the normal shares, with one vote each — LILAK shares have no vote, and LILAB are supervoting shares with 10 votes (very illiquid, John Malone owns most of them). Sometimes LILA trades at a bit of a discount to the non-voting LILAK shares, which is counterintuitive but happens probably just because there’s usually more liquidity in LILAK, so if I were buying as a long-term proposition I’d buy whichever of the three is cheapest.
LILA is going to grow through debt-fueled acquisition, we can expect — that’s the Malone model — and it’s going to try to build large businesses that can feed off of each other across Latin America, bringing broadband and eventually 5G mobile to new markets.
It’s hard to understand the web of Malone companies, but it’s also hard to complain about his peformance — not every one of the companies has done well, but shareholders who have followed him in general have very likely done well in most of the Liberty stocks. He is a big fan of using cheap money to lever up equity, giving himself and other shareholders a better return, and that might be a risk if money stops being cheap — but it’s not an immediate risk for Liberty Latin America, at least, their maturities begin to hit several years in the future and they pay only about 6% interest, with fixed rates.
Liberty Latin America seems to mostly be a play on Puerto Rico’s recovery at this point, levered by the value of their big subsea fiber-optic network in the caribbean that bolsters their mobile subscriptions, and by the continuing upgrading of customers to 4G service in PR, Costa Rica, Panama and elsewhere (as with much of the rest of the less-developed world, 4G still isn’t everywhere so we needn’t even dream of the potential of 5G just yet.. and 5G will be challenging for smaller telecoms like LILA because it will be so expensive to roll out).
They are facing the same cord-cutting and phone-cutting trends as we see in the US and elsewhere, and competition in mobile and other businesses, but their broadband business and business telecom services seem to be doing well and it may be that Liberty LatAm will have an easier time growing and doing acquisitions in Latin America than it did in Europe, where the competition is much stronger and more entrenched and the antitrust sentiment is robust.
So I have no idea how it will work out, of course, it does look interesting as Puerto Rico continues to recover… and betting against John Malone has usually been silly, even if you can’t quite understand his complex web of financial engineering. Maybe a few years of rising rates, if they ever come, will finally put a dent in his empire, which has all been built in an era of steadily declining interest rates that benefit the “borrow and go big” mentality, but making those kind of big-picture projections isn’t really going to do anyone any good. and LILA is still quite concentrated in a few major markets, mostly in the Caribbean, so there’s absolutely the risk that a weak economy (or another natural disaster) could hurt them, but it might be worth considering if you like the Malone strategy of rolling up controlling stakes in telecom companies.
The biggest news over the winter was that they called off their attempted takeover of parts of Millicom, which would have given them a much bigger business in South America to complement Liberty’s strength in the Caribbean… so although the balance sheet looks better than it would with a big acquisition, the growth also looks worse than some investors were probably expecting last year, even though they’ve made some smaller acquisitions (Cabletica in Costa Rica, UTS across a bunch of smaller caribbean islands). The stock did surge for a while in February and March, but after investors didn’t like the last quarterly earnings report it is now back in the $17.50 neighborhood, about where it was when Yastine was teasing the stock in January, and a little lower than it was when we got the first ads from Del Vecchio for this particular teaser in February.
You can see the investor presentation of their first quarter results here, and the transcript of the conference call here. The tone of it, to my ear, was “cautious optimism” — they are not going to grow quickly, they face competition in most of their larger markets that has kept their pricing in check (particularly Chile and Panama), and they still aren’t at full speed and full usage in the hurricane-hit parts of the caribbean, particularly Puerto Rico, though those are doing much better than a year ago.
And, yes, they are still planning to use a little more debt to do more acquisitions, that’s still a key part of growth and “value creation” for any Malone company. My sense is that this has some real potential as a long-term investment if they can create some real synergies across their markets and expand more into South America (Chile is their only meaningful business outside Central America/Caribbean at the moment), but that they aren’t likely to become a sexy fast grower or big earner in the near future, particularly with the big debt load they already carry (mostly as a result of the huge C&W acquisition of that subsea caribbean cable network a few years ago). It’s all about building the business and continuing to leverage their growing size and their cross-market cost management to make these businesses more efficient over longer periods of time.
So… for the patient, maybe this is an appealing idea — and as long as we’re mentioning Berkshire Hathaway, Berkshire is also a substantial shareholder of LILA (they own about 5%), which is probably not a Buffett decision, that’s a small stake for Berkshire and is therefore an investment made by one of their other investment managers, but it’s another vote of confidence (in the Malone family of stocks in general, at least — if memory serves, Berkshire owned Liberty Global before the last wave of splits and spins so that’s probably where their LILA stake came from… Liberty Latin America was a tracking stock for a while before it was completely spun off as a separate company). Dodge & Cox was also a major shareholder, and that’s an active mutual fund shop that I really respect (and have some money invested with), but they scaled back their LILA position over the past couple quarters and are now fully out of the stock… so there are positives and negatives in the list of investors.
Since the earnings-spurred drop in the shares early this month there have also been two insider buys, with CEO Balan Nair and CFO Christopher Noyes both buying shares on May 14, at prices slightly above where it trades now — C-suite executives buying stock in the market at market prices is never a bad thing, though it doesn’t miraculously mean the stock is going straight back up. Bair, for, example, bought about $250,000 worth of stock on May 14, but he was also granted more than $6 million worth of stock in 2018 as part of his ~$13 million in compensation for the year, so context is important. Noyes’ purchase was more substantial in relative terms, but still comes in at less than 10% of his compensation for 2018. We are always told that “insiders only buy for one reason” and that it’s all about betting on the company because they are sure things are going well and that the stock will go up, but that’s no longer true — now that information travels so easily, and insider purchases are tracked by so many people, insiders buy both because they think the stock is going up and because they want to send a signal — they think their action will have an impact on other investors as a “vote of confidence” and support the share price.
But, of course, this is still really just a “will John Malone create magic again” story, so he’s the insider everyone watches. Enthusiasm is definitely a lot lower now than it was when Malone bought a big stake in LILA back when it was still a tracking stock in 2017 (the full split from Liberty Global happened in January 2018 — before that, Malone bought a big stake at ~$22 about two years ago). Malone still holds a substantial stake with about 25% voting control, he owns most of the supervoting shares (LILAB), and it would not be surprising if he’s still got the CEO on speed dial. I don’t know what will happen with the stock in the next few months, or whether they’ll be successful in finding a good acquisition candidate or otherwise get growth rolling again, but the company, at least, has some confidence that they will end the year strong as they continue adding subscribers across most of their markets and begin to become more efficient.
I’m still mulling this one over, I’m concerned about the lack of growth and the general deflationary tendencies in telecom, which is presumably due to competition and seems to be playing out with their average revenue per user dipping over the past couple quarters… but they are getting more subscribers and still expanding their networks, and the risk of their exposure to all these different currencies is mostly balanced by the fact that they’ve been able to borrow at good rates in those local currencies.
I’m inclined to think it’s interesting here as a possible platform for building a strong regional telecom player, but they’re still quite small and face a lot of competitive pressure outside of the smaller island markets. I don’t think there’s any reason to rush — it’s possible that they’re in the process of turning this into a real “earnings” story and a company that generates meaningful cash flow over the next few years and will be able to lever that up even more, Malone-style, and grow the base further… but the operational challenges are real, even beyond the Puerto Rico hurricane recovery, and the “John Malone Magic” is taking a lot longer to materialize than anyone would have predicted when the tracking stock started trading four years ago (at about twice this price). I don’t see signs of any real lusty enthusiasm that’s going to drive the stock out of reach quickly. Take your time, think it over, and let us know what you think with a comment below.