Issue #19 - Gazelling, Value Investing, and Negative Operating Leverage

May 27, 2024

Read time: 3 minutes

Hey friends! As usual a quick thank you to all readers of the Journal.

If you enjoy, please forward to friends, family, and colleagues to subscribe.

PS. With an array of readers, my words may come off a too simple or too complex. I try to find a balance in the middle so everyone can get some value from it, but it's hard to thread that needle every week. If you ever have any questions or comments, or if I'm completely out to lunch, please let me know :) 


1. Personal Finance

In a word: balance. 

The key to being happy in your financial life is to balance yourself between saving and spending. 

Gazelle 100% - constantly spending = broke

Lion 100% - never spend a penny = probably a grinch

Somewhere in the middle or maybe 70% Lion and 30% Gazelle = just right

FYI - I Gazelled big time last weekend... spent $500 on a retro Nintendo 64 so I can play Mario Kart.

Because with all this saving and investing talk, why not splurge on something once in a while?

2. Stock Markets

I listened to a fabulous podcast with David Einhorn last week (listen on youtube or apple podcasts). 

David is 55 years old and one of the great investors of our time. Indeed, one of a handful of stock pickers that have ousted the S&P500. His fund Greenlight Capital has returned 12.8% since inception in 1996 and he has a net worth over $2 Billion. 

He speaks about the early days raising money for his fund as a nobody, finding early success in the 90s, and struggling during the mid 2010s with basically flat performance and unsatisfied investors. Yet, sticking to his strategy of doing high quality research, thinking of himself as an analyst first and a portfolio manager second, and looking where others aren't has led to outsized returns again. 

A few jumbled notes I took: 

  • Look for difference of opinion.
  • Passive world has taken over.
  • Value industry has been annihilated.
  • Their managers don't have the time to wait for a stock pick to prove its value while the FAANG stocks rip.
  • Investors redeem, which kill the flows and lowers the price of your value stocks.
  • Must be even more disciplined on price today vs 20 years ago. 
  • And you have to be patient.
  • Market is fundamentally broken. Machine money has no opinion of value. Just price.
  • David likes to buy stocks at 4x vs 10x. Stocks that have no debt, cash on the balance sheet, and are doing heavy buybacks etc. 
  • A bargain that remains a bargain is no bargain.
  • Wiltshire 5000 index - 30 to 60% of capital in 5 names.
  • There’s way less competition today.
  • So opportunity is better than it has ever been.
  • If you have an idea, find the best way to express that idea, directly.

As much as I emphasize passive ETF investing, I grew up fascinated with single stock investing.

I will therefore from time to time have some exposure to individual stocks, but the bulk of my assets will keep going toward low cost ETFs and direct real estate projects and bitcoin. 

If you are an aspiring stock picker, listen to David talk, read his quarterly and annual letters, too. It is a wealth of information. 


3. Real Estate 

It's no secret many Real Estate cap rates (defined as net operating income / price .... in other words, dividend yield) are lower than the cost of financing.

We see this particularly in multi family with cap rates around 4% - which is risky since rent controls in some areas limit the landlords ability to increase cash flow quickly.

Also for some grocery stores in highly sought after areas, i.e. lower mainland BC that sees these retail assets valued in the 4.75%-5.75% cap rate value range.

Meanwhile the cost of traditional 5 year debt is 6% or more. We call this negative operating leverage.

You must have cash in the bank in order to fill the gap. Which is a big bet. It relies mostly on asset appreciation to make a deal profitable. 

This partly why there have been so few real estate transactions - and a result, real price discovery - in the last 2 years since interest rates started marching upwards. 

It sure makes it hard for groups like us to acquire assets, since we won't entertain a negative operating leverage scenario. 

One solution, if rare, is finding properties that have attractive assumable financing. 

If an asset is being sold that has an assumable 2.5% mortgage on it for 3 or 4 more years, well then, the cash flow numbers start to look very attractive once again. And there is a net present value advantage, too. 

So next time you are reviewing an opportunity, ask if there is existing financing that might make your deal perform better. 


1 Quote

I guess it comes down to a simple choice, really. Get busy living, or get busy dying.

- Andy Dufresne, Shawshank Redemption


A Question

Should the Oxford Dictionary add the verb "to Gazelle"?

Among my Venezuelan in-laws - together we have created a new verb "Gazellear". 

Seems to be catching on lol ๐Ÿ˜Š



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Thank you

Eddie Gudewill, CFA


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