Correspondence with a friend on Investing

"I really enjoyed your analysis of SAFM vs PPC on your Amvona site. I felt the article was very well organized and was a strony fundamental security analysis,which presented SAFM as the smartest pick of the sector. From a Macro-economic perspective I would also agree with your premise that chicken is the most economical protein in a down economy and a steadily improved financial environment followed closely by overseas markets should see consumers returning for protein demand. However, with 9.8% unemployment and a general priority for many to 'save' or reduce consumer debt, chicken is not a 'necessity' or pure consumer staple. Here's an article that supports your premise, but reveals the patience you may need for it to resolve.  

http://www.extension.iastate.edu/agdm/articles/others/HenAug09.html

[Gregory M. Lemelson]thank you for the kind comments on the blog – Tyson isn't in much better shape than PPC – but didn't want to review three companies – but they are the top three. Interesting thoughts on chicken not being a "necessity" – ...have to give further thought to that. ...read the link you sent... SAFM mentions in their annual report a contraction in sales to the restaurant sector (no surprise there), and has the agdm site mentions – but see that being offset by consumption at home and exports (particularly Russia). In a way, one of the best things for the poultry industry would be if the economy further slowed, as commodity prices would decline, importantly corn, and people may have increased demand for their product – these two factors would converge to increase profits. Patience is no problem, typically the plan is to own companies for at least a year, if not much longer...

My experience with the Ag sector is very limited, only a single trip to my college roommates farm in Nebraska, where his family grew corn and raised beef. His father traded commodities futures, in which he told me that the commodity business usually is better left to those who actually grow or raise the crops they buy and sell.

[Gregory M. Lemelson] very well put.

I followed his advice and have chosen to follow other sectors in which I have a deeper understanding. I know you also bring technicals into your analysis, and unless SAFM is an ultra-long range position, I don't see a reversal or support level that would motivate me to pull the trigger anytime soon. Also, I'm not sure I want to be in a business with a profit margin of only 5%. Let's be sure to re-visit this one.

[Gregory M. Lemelson] totally agree. Yes, SAFM is intended to be long range, as hoped / expected of all positions (doesn't mean won't change mind if new data is presented, or if the price becomes ridiculously high, or would rather own something else, and need the cash). Very good point on the Margin – and I agree about owning companies with low profit margins – it needs to be carefully considered - but you might find that all food processors operate on very low margins (relative to say tech. companies), as do grocery stores, convenience stores, etc. etc. So in the food processing business, the net margin (in this case 5.73% ttm) is actually very high on a relative basis (2.8 x higher than PPC and about 13.25 x higher than TSN) – and just generally very high for the industry. Since they don't have to compete against the likes of GOOG – than it's the relative margin which is more important in my mind – but also it's the reason to focus on the efficient management of equity, and not only to look at the net margin (...agree it's hard to get excited about that margin), but more importantly how much of that is being sent to and kept on the balance sheet in retained earnings. It might also be noteworthy that the net income figure has increased for the last 4+ quarters. After I sent the email yesterday the price of the stock rose 4.5% (closed up 3.75%), I think it is very likely to rise much more in the next 12 months – there is no shame in any investment that can produce over 15% in a year– if the entry point was ~$39 – than the investor would be half way there (15 pt return) in about a week (so the investor has 51 more weeks to make the next 7 points – and benefit from long term capital gains tax instead of short term - talk about sleeping well at night ;o) - but it's more likely the stock will return far more than 15 pts. – perhaps twice that. Admission – great apprehension with anything even vaguely related to farming – it's highly unpredictable, and often victim to such things as climate, and radical speculation...

If correctly understand the meaning of "technicals"– then unfortunately, can't add much commentary – I'm not smart enough to understand the "technicals", "the charts", "resistance", "Beta" or other ways of speculating in a security that is common in the market place in terms of predicting the future. Perhaps because of my ignorance, those "technicals", (in the popular definition of the word), are to investing, as "reading bird entrails" is to proper religion.

I don't want to sit back and just be a taker of information so I'll offer my latest long position- CREE. A look at finviz (which I forget to mention I've been fondly using for years) will show 'Greg Lemelson' style fundamentals, and a technically good entry point. They report earnings tomorrow, and I think they'll push a good forecast. I'm simply long stock, but may consider a six month out call spread if the company is sold off after a good report. I'm also interested to see what will happen with AAPL (core position) at the open tomorrow. It continually amazes me the emotions that the market ties to this stock. I long ago stopped trying to 'trade' around a position and simply will hold it Buffet style until either Steve Jobs morts or the earth starts spinning the opposite direction. Finally, I do think the market is getting a bit long in tooth and am itching to hedge my long positions with front month SPY puts.

[Gregory M. Lemelson] have to admit that CREE looks good (looked at it about six months ago). ...marveling at why investments in the further development of LED lighting didn't come to prominence sooner (60 yrs. Since inception) – ironically, it was an ag company (MON) that first mass produced them.... ;o). My general thoughts are it's a very cool industry – maybe too cool – everyone will be watching (that's why their trading at 300% of tangible assets, despite a recent and precipitous decline). Like any tech. company, and indeed if you look at the history of LED,

a) market leaders change constantly,

b) there is always a need for large investment in R & D which may or may not pay off for investors (R & D is never an efficient use of capital - and often the true innovators are not the one who enjoy the most commercial success – [see also the Wright Brothers and Jerome Lemelson – Jerry and Jerome collected only pennies on the dollars for patent infringements – and it took a huge war to get even that]

c) disruptive technologies are always on the horizon – very few tech. companies have truly long life spans and produce consistently high returns even over say a short horizon of just ten years (notable exceptions are companies such as MS and IBM, etc.) – finding the next MS or IBM in the early stage is almost as tough as finding the next winning lottery ticket.

Personally wouldn't buy CREE for the following reasons:

a) It's like paying 300k for a house that cost 100k in materials and land to build – even if housing prices increase 10% per annum it would take a long time to pay for the premium (that includes two major entries for intangibles – the real price is much higher if you strip those out) – that premium is the same as WMT by the way, the largest and most efficient retailer in the world – that's a lot of optimism for otherwise relatively young and new issue.

b) While their profit margin is high, their return on owners equity (what matters to the owner most – if ROI matters), is very low (less than half that of SAFM). CREE is going through a mighty effort to generate 6 bln. In revenue, but there sending a mighty small potatoes to their owners (less than 2.5%) available to the common. SAFM on the other hand is turning over 10% to their owners, and an additional 1.7% in the form of a dividend, which is constantly rising... so ~12% in reality and rising. CREE like so many tech. companies doesn't pay a dividend. In sum SAFM is returning 480% more to the owners than CREE (does it matter if the net is 5%?)– and CREE's competitors look pretty fierce, unlike those of SAFM.   SAFM has an F-22, there competitors are flying Korean war era Mig's – not the case for CREE.

At any rate, CREE will probably go on to become the next Microsoft, and I'll live to lament everything I just wrote... ;o) willing to accept it now if it happens...

With regards to AAPL just a couple thoughts:

a) Don't care what anyone says, Jobs is irreplaceable and his health is declining

b) Rates of return slow with size – and AAPL is already the second largest concern in the world

c) Unless you have to put a lot of capital to work – mega-size companies don't make too much sense.

Are you a Canon or Nikon guy?

[Gregory M. Lemelson] Canon – but both companies and products are amazing – I hope one day Canon's stock goes on sale... ;o)"