Evaluating High Tech Companies

I have a fascination for small high technology companies.  It's largely the result of my past roots in managing research for many years in a variety of capacities: managing a long-established wildlife research station, administering a variety of research funding programs and, founding an energy research centre.

I've learned that research enterprises can only advance by taking risks but that the "bread and butter" of established research hauls the freight i.e. the research stream has well-established clients and is supported by a base of physical infrastructure, experienced staff, social networks, and institutional support.

I never forgot this.  However, to promote the possibility of venturing into new research areas, I let it be known that staff were free to spend 15 percent of their time doing anything they wanted ... and that I did not need to know what they were doing.  (I also realized that the more creative ones could easily "hide" their projects within existing budgets and played the financial side of things with a loose hand.)

I've put these lessons in play while evaluating high tech companies for investing purposes.  I look for a number of things:

• great management with "muddy boots" ... not fresh-washed MBA's whose life experience is limited to book learning
• a product/service which addresses a significant client need and provides a distinct advantage over competing products/services
• strong links to their "communities of interest"
• the ability to secure financing 
• a revenue stream (in the best scenario it's best to select companies which are able to bootstrap themselves using revenue flows)
• a business plan which "makes sense"

That is why I invested in Kelso Technologies and Titan Logix as a result of researching the theme of "railway tanker safety".  I will leave it to readers to visit the company web sites to see how the aforementioned characteristics are expressed. I am especially sanguine about the future prospects of Kelso Technologies.  It would appear that management is doing everything "right".

Here is one take on two companies in the biofuel sector: one that failed; and, one that succeeded. It is instructive and well worth considering when you go through the process of winnowing out potential investments in any field.
http://www.altenergystocks.com/archives/2014/03/as_kior_stumbles_aemetis_soars_what_made_the_difference.html?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+AlternativeEnergyStocks+%28AltEnergyStocks.com%29

I have a great respect for the editor and contributing editors of Alt Energy Stocks and subscribe to their offerings via an RSS feed.  I recommend it highly as it provides a great avenue of understanding for alternative energy, renewable energy and clean technology companies.  One of the best of breed.
http://www.altenergystocks.com

There is a risk in investing in small high tech companies:

• the "moat" for small enterprises is sometimes small as "innovation waves" of similar products/services tend to be synchronous, meaning that many other similar ideas may unseat a company's technological advantage in short order
• financing is always difficult to obtain
• the market base for a company's product/service is usually tiny and subject to fluctuation: it takes time to get known and establish a customer base
• there are always technical glitches to be ironed out in the product and its production and distribution
• key staff may move on to greener pastures 

This said, the hunt is fascinating and fun.  And sometimes, you knock one out of the park when the gods smile.  A case in point is Arotech Corp ARTX.  I looked at it using the above-noted metrics and established a position on March 18, 2014.  Imagine my surprise when it rocketed in value by almost 50 percent in very short order.  Why?  I Googled the company name and discovered that a very positive article in Seeking Alpha was likely the reason:

http://seekingalpha.com/article/2107833-arotech-corp-a-lithium-battery-stock-ready-to-quadruple-16-price-target

It illustrates the power of web sites such as Seeking Alpha.  Some websites (not Seeking Alpha) are shameless efforts on the part of "financial writers" who are out for hire.  I once fell victim to one and resolved NEVER to make the same mistake.  Some writers may or may not disclose their connection to companies which occupy their keyboard time.  Read this to learn more about the measures some people take - it's not pretty: 

http://finance.fortune.cnn.com/2014/03/20/seeking-alpha-dreamteam-news-sites/

Some Notes on Portfolio Strategy - Cove Street Capital

I read voraciously.  Here is a recent addition to my ports of call:
Cove Street Capital

The site is rich.  I recommend that you spend time in exploring the following offerings: strategy letter, thoughts, and recommended reading.  In contrast to many sites which offer large shoals of readings, the folks at Cove Street, focus on a few select fish of real value.

The most recent entry for the strategy letter has an excellent commentary on Prem Watsa.  I have invested in Fairfax Financial for three reasons:

• the quality of management: Watsa is a consummate investor of the first order
• Fairfax has an enviable track record over the long term, especially during "hard times"
• my sense is that the company will outperform other members of the fleet in the event of a market downturn and that by owning it, I will have some protection against downside risk 

FFH has been added to the Financial Log Book.  As usual, I will leave it up to readers to undertake their own financial due diligence.  

Check out Mr. Watsa's March 2014 letter to shareholders.
Watsa letter to shareholders

Here's a very compelling entry in the recommended reading section of the Cove Street Capital site:
http://covestreetcapital.com/Blog/wp-content/uploads/2012/10/Small-Slam-Article.pdf

Charles Ellis contends that it's best to focus and limit one's holdings to a select few.  Why?  It's one of the best strategies to deal with the element of risk.  Read the article to learn more.  A great read.

In order to access Cove Street Capital's quarterly newsletters, click twice on the "Mutual Funds" title on the site's navigation bar.  I really like management's openness in discussing both its successes and failures.  The commentary is concise, and direct and well worth pondering.

I learned about Cove Street Capital as a result of subscribing to a weekly e-mail from the Stingy Investor which is written by Norman Rothery.  I've followed him for many years and for a good reason: he has a fine mind and consistently offers a wealth of ideas which can knock you out of the rut of routine thinking.  Visit him here: http://www.ndir.com

Silver Wheaton - commentary

The glittering performance of precious metals holdings since the beginning of the year has been gratifying ... and whoo hoo ... Silver Wheaton is now paying a dividend:

The first quarterly cash dividend of US$0.07 will be paid to holders of record of Silver Wheaton common shares as of the close of business on April 4, 2014, and will be distributed on or about April 15, 2014. Under the Company's dividend policy, the quarterly dividend per common share will be equal to 20% of the average cash generated by operating activities in the previous four quarters divided by the Company's outstanding common shares at the time the dividend is approved, all rounded to the nearest cent.
Dividend Announcement

All is not sweetness and light. http://www.theglobeandmail.com/report-on-business/industry-news/energy-and-resources/silver-wheaton-profit-falls-47-per-cent-on-lower-metal-prices/article17601162/ 

However, take a look at the company's financials, the size of its treasure fleet and the volume of booty aboard those ships ... arrgh matey, it's enough to attract even the most timid of pirates. In an earlier edition of The Financial Passage Maker, I noted the characteristics of mining enterprises which would be quick off the mark in the event of rising metals prices – SLW has most of 'em.

And .... in contrast to many of its peers, SLW is blessed with the combination of a business model and astute management which enables it to stay afloat nicely in good weather and bad. For those reasons, it is one of my core holdings.
For those of you who want to learn more about the dude in the photo, read this: http://en.wikipedia.org/wiki/Mel_Fisher ... some chicken farmer!

Postscript:

I hopped about SLW just after the company was formed. The ride has been interesting as precious metals prices have fluctuated significantly since that time. I've taken profits from time to time and may now add to my positions if precious metals prices decline significantly. 

As an investor, I am heartened by management's decision to initiate a dividend stream. While there is a high degree of speculation association with bets of this type, SLW is morphing into a company with some of the traditional attributes associated with a company one might consider as a more traditional investment. 

While SLW will need to make more deals to maintain flows of mine production, there is more competition. It's one of the desirable features of our economic system; namely, that success breeds competition.

To my mind, management has been wise: one cannot simply cannot build and expand forever. Otherwise, you risk the downfalls of hubris viz. the trajectories of Barrick Gold and many of its peers. They managed to accomplish an amazing feat of alchemy by turning gold into a biological by-product of digestion.

Better to wait for the “fat pitch” when conditions improve for purchasing production streams. In the meantime, investors get to share in revenues. Nice to see a company which has the interests of its shareholders in mind. Yup ... steady as she goes.

How to Become a Millionaire - and the Most Important Part

I subscribe to many RSS feeds - 102 of 'em at last count - everything to regional newspapers to the offerings of think tanks.

A recent entry from Inve$ment Moat$ got me thinking.  It is entitled, 8 Redditors tells us how they amassed more than 1 million in Networth.
http://www.investmentmoats.com/wealth-building-2/8-redditors-tells-us-how-they-amass-more-than-1-million-in-networth/
(I like reading Kyith Ng's blog and recommend it highly.  He has an agile mind.)

If you Goggle "how to become a millionaire" you will be deluged with a plethora of articles - everything from advertisements from shills to more prosaic pieces which document pathways followed by "just folks".

In the following discussion, I will focus on people who started with no savings and who managed to become millionaires on the basis of their own initiative.

A few common themes emerge:

Disciplined Saving

A trait shared by almost everyone (with the exception of a few entrepreneurs who "lucked out" with the next-best-thing) is the ability to accumulate a sizeable nest egg through the adoption of three habits:

• living below their means
• having a savings target
• exercising discipline

It is interesting to note that most self-made millionaires have life partners who share these traits.  

The "savings" trait was common to all levels of employment income and it continued long after individuals had attained millionaire status. 

Importantly, the "savings" trait started early.  Adherents, therefore, had the wind of "compounding interest" at their backs.  

In our case, we made a decision to live off one salary and bank the other.  It was not difficult and we had a very high quality of life.  We used the library for our reading, spent a lot of time with friends in cooking meals, managed to take trips to Europe every two years etc.  Also, we were able to distinguish "needs" from "wants" - something we still do to this day.  I follow an approach that I adopted during my childhood, a time when our family had little money.  Whenever I wanted to buy something over and above meeting the necessities of basic life, I would defer the purchase for a month or two.  It was amazing how the "wants" evaporated over time.  And if I finally made a decision to buy, I would wait until I could find a bargain.   We now have a more flexible approach to buying new things but we can afford to since we live well within our means.  

Investing in Learning

Virtually everyone applied themselves to learning.  There are two dimensions to this:

• investing in one's self
• learning how to invest

Many people upgraded their skills, either through addition formal education or by consciously searching out new employment to enhance their skill sets and broaden their networks.  Increases in income were used to augment savings.  

Virtually everyone learned to invest.  The pathways varied greatly: some invested in real estate; others invested in market indices and stocks; others invested in their businesses.  The common denominator is that everyone learned how to make their savings work for them and worked to enhance their skills over many years.  

Speaking personally, years ago, I was job threatened as a result of a massive downsizing in government.  As a response to this insecurity, I decided to amass a nest egg to sustain the family for several years until I reskilled and started a business of my own.  I spent two hours a night (between 2:00 and 4:00 AM) in learning and returned to my "day job" in the daylight hours.  I hated it at first, but over time, found that the journey was intellectually challenging and fulfilling.  After eight years of sustained effort, the annual increase from our investments started to exceed my salary. The sense of freedom was immeasurable.  

Having a Plan

Everyone had a "plan" i.e. a set of goals/targets to direct their efforts.  "Plans" ranged from generalized visions to more formalized goals, objectives and tactics. The bottom line is that everyone had a conceptual framework to ground their outlook and focus their behaviour.  They also had the discipline execute their plans. 

Most monitored their "progress" diligently and learned from their mistakes. Most had the capacity to accept setbacks and the tenacity to continue through hard times.  While it was unsaid, I think that most shared the traits of self confidence and an optimistic outlook on life. 

The Most Important Part

Having money is a means to an end.  My bet is that most self-made millionaires look at their net worth much in the same way as they look at a thermometer.  

The measure of one's wealth is not to be conflated the measure of one's worth as a person.  

It's all about how you feel about yourself and the conduct of your life: your relationships with friends, family and the broader community; your ability to see beyond yourself and empathize with the world around you, be it the sounds of the street to philosophical writings of the ancients - there is just so much to embrace.  

The value of money as an enabler is highly over-rated. It is the outcome of a behaviour not the road to "salvation".  

Most self-made millionaires would do largely the same things regardless of the size of their stash in the sense that their primary satisfactions are the result of their conduct: their time with children, the joys of a walk in the woods, the intellectual stimulation of encountering a new idea ... 

So ... it's now almost spring time.  As I was writing this article in the early morning hours, I heard the scampering of feet on the rooftop.  I paused and looked out.  In the beam of the flashlight gleamed two shiny eyes - a young raccoon.  He moved a few inches closer to the window to get a better look at me - a well urbanized creature with no fear.  Now that I've completed this note, I'll have to check the street.  It's garbage day and the green bin is out on the curb - a target for plundering.  Guess I'll have to revert to the summer habit of keeping that container in the shed before putting it out for morning collection.  Ah ... the joys of urban wildlife ... and I wouldn't have it any other way. 

When to Purchase Airline Tickets and the Joys of Agro-Tourism

Have you ever wondered about the best time to buy tickets in order to get the best price?  Here is one view:

Number crunchers from CheapAir.com, an airfare booking site, monitored 4,191,533 trips last year to find a solution. They looked at fare fluctuations from 320 days to one day in advance of departure to determine how far ahead of time travellers should book plane tickets. All in all, the folks at CheapAir.com analyzed the booking data from roughly 1.3 billion airfares.

According to the results of the study, the best time to book a domestic flight is 54 days (or seven and a half weeks) in advance. For international flights, CheapAir.com generally advises travellers to buy earlier rather than later, but prime booking dates vary by destination. 

http://www.smartertravel.com/blogs/today-in-travel/why-you-should-book-your-flight-exactly-54-days-in-advance.html?id=17812107&source=44525

A great deal has been written on the topic.  If you are like me, you simply do not have the time to monitor airline web sites to get specials which pop up from time to time.  I subscribe to a few sites which send out periodic notices about deals. Here are a few: 

CheapAir http://www.cheapair.com

airfarewatchdog http://www.airfarewatchdog.com

While it's nice to find a cheap fare, I find generally, that greater savings can be achieved by focussing more time on getting cheaper accommodation and rental cars.  I've written about this a length in previous editions of The Financial Passage Maker.  

Affinity cards are useful, especially if you book in advance over the internet.  If you book in at the hotel desk at the time of arrival, rates are generally higher ... unless you have a good story which catches the interest of the desk clerk.  If you are not particularly picky about getting accommodation in a specific hotel, web sites such as Priceline are useful.  Many of our friends have used them and have been satisfied. 

http://www.priceline.com

This said, when it comes to selecting rural accommodation, I have found that agro-tourism sites provide some wonderful leads.  In fact, most of our most memorable stays have been on farms.  In one instance, when visiting Spain north of Girona we stayed on a farm for a few days while exploring the world of Dali, a surrealist artist.  We learned that the owners' daughter had intentions to visit North America, and indicated that we would be pleased to have her stay with us for a while.  The owners were so touched that they said we could stay free at their place any time in the future. Two years later, we took them up on their offer.   Maria is a renowned chef and offers regional items that you simply cannot get anywhere else.  http://www.elmolidesiurana.com/en/main.html

Agro-tourism sites are generally organized on a country-by-country or on a regional basis.  For example, if you are interested in visiting Tuscany, why stay in town when you can be immersed in the wonders of a stunning landscape? Look no farther than here: http://www.agriturismo.net

We learned early to stay at farms as they provide a respite from the "sameness" which pervades much of the urban landscape these days.  You also get to savour the "flavour" of a region - both through the eyes and the end of your fork. Further, your money goes directly into the hands of farmers who are seeking to diversify their operations in difficult times.  As an added advantage, listed farms are inspected and many agro-tourism sites include reviews from visitors.  

And in certain places such as Scotland, farms are often the "best bets" for accommodation in many of the more remoter areas ... and certainly on the islands.  

Things to Consider When Investing in Mining Enterprises

In previous editions I've written about the mining cycle.  Here I delve into some of the strategic considerations management must consider and why investors must also heed them when placing their bets on mining ventures.

A short paper by Ian Runge serves a good entry point for this discussion.

Every industry, including mining, has to face uncertainty prior to the investment decision; it is the nature of the uncertainty that sets mining apart. A tourism investment, like a mining development, for example, might be subject to the vagaries of the weather, but no amount of study beforehand will necessarily resolve the uncertainty ....

What sets mining investments apart from most other investments is that the economics of resolving the uncertainty are both significant, and endogenous to the investment process. Except in rare circumstances, it is not possible to optimize a mine plan in advance.

The problem lies in obtaining reliable input data

http://www.ceecthefuture.org/wp-content/uploads/2013/02/dr-ian-runge-mining-economics-as-presented-at-discover-mongolia-20121.pdf?dl=1

Once again, Richard Schodde, one of my favourite analysts (and mentioned in earlier editions of The Financial Passage Maker), puts it all into perspective. Here are the salient points of his most recent presentation:

• Only 45% of all discoveries made since 1950 have turned into mines. In terms of contained metal the convestion rates is 57%.
  
• In practice, due to time delays, the final conversion rates will be approximately 15% percentage points higher.
  
• Bigger discoveries have better conversion rates.
  
• For those deposits which were developed, there was an average delay of 12.4 years between discovery and mine start-up. The delay is getting longer over time.
  
• Country risk is important. Projects in low risk countries are 30-40 % quicker to develop.
  
• The business cycle is important. It may require several cycles (and decades) to be developed. In terms of creating value, it is important that you catch the first wave!
  
• Project conversion rates and the time delay between discovery and production are both set to deteriorate over the next decade.
  
• To help offset this, companies will have to improve their risk management practices.
  

I would urge all readers to access the full text of Mr. Schodde's presentation: Key issues affecting the time delay between discovery and development – is it getting harder and longer? (comment: typical Aussie humour here) http://www.minexconsulting.com/publications/Schodde%20presentation%20to%20PDAC%20March%202014.pdf

The following paper was written for company management but it is equally relevant for investors. It addresses the many factors that management must consider in its strategic and tactical planning. Ik recommend it highly. It is interesting to note that the characteristics of the ore body are not mentioned directly in the paper. I will retain this paper and use it to develop a checklist when I read company reports in order to determine whether or not they are investment worthy.  Here are the top 10 issues:

• counting costs
• managing demand uncertainty
• capital project deceleration
• preparing for the M&A storm
• governments eye the mining prize
• combatting corruption
• climbing the social ladder
• plugging the talent gap
• playing it safe
• at the IT edge

Tracking the Trends 2013 – the top 10 issues mining companies may face in the coming year
http://www.deloitte.com/assets/Dcom-Canada/Local%20Assets/Documents/EandR/Mining/ca_en_energy_Tracking_the_trends_2013_112812.pdf#page=6

So ... what to make of make of this when it comes to investing in precious metals mining enterprises? Buy and hold is not a good strategy given the boom and bust nature of the industry. I have learned to heed the mining business cycle and not to invest too early in the early stages. I have learned, that once the cycle starts on the upswing (something I sense by monitoring mining journals), it makes sense to invest in existing operations which can be ramped up quickly. Later, when the financiers get more confident with the prospects of the industry, it's time to invest in junior companies with excellent properties and above all, great management.

Are we “there” yet. No. I'll bide my time with precious metals miners.
This is definitely not the case with oil and gas enterprises where (with the exception of tar sands) development costs are much lower and where discovery-to-production timelines in brownfield patches are much shorter than in the hardrock mining sector. 

At present, the demand for energy remains high and investors are mindful yet of the spector of “peak oil”. It is one area where junior companies can grow quickly if helmed by capable and experienced management – people with reputations that financiers could bank on. Even though financing has been a major problem in recent years, I have the sense that things are changing. For that reason, I remain interested in expanding my holdings in oil and gas ... but only modestly as I already hold a number of assets in that sector.

Analysts' Reports - It's a Matter of Understanding Context

Analysts' reports can be useful but it is important to take into consideration the writers' motives. Chris Umiastowski, a contributor to the Globe and Mail, has some interesting observations. He notes that reports can be useful in presenting investment theses and sources of data as leads for further research on the part of DIY investors. He also notes:

So, should you bother to read analyst reports or think about the details of these reports as written about in the financial media? Yes and no. I think you should completely throw away any target price and recommendation information, and toss out any discussion that doesn’t pertain to the long-term performance of the business. Leave that to the pros who chase this kind of unimportant information. Spend your time looking at the more interesting discussions that actually matter to the long-term performance of a business.

http://www.theglobeandmail.com/globe-investor/investment-ideas/strategy-lab/growth-investing/what-to-read-and-what-to-ignore-in-analyst-reports/article16353898/

... price targets are often met with skepticism. Some investors see them mainly as marketing tools for brokerages that want to drum up interest in a stock. Indeed, research has shown that price targets tell you little about where a company’s share price is actually heading.

http://www.theglobeandmail.com/globe-investor/investor-education/the-hit-and-miss-world-of-price-targets/article15093603/

Sometimes, when investigating an investment theme, I will review analysts' reports in an effort to learn more about the theme and potential targets for the Gun Port. I also visit discussion sites such as Stockhouse in order to take the pulse of the investment community. (You can find discussion sites by using the term, “stock discussion boards” in Google.) While there is a lot of drivel, you can sometimes unearth some real gems: thoughtful commentary from people well versed in the industry, useful tidbits from people who may surface details about company management and practices which investor relations staff would prefer to be well hidden, and so on.   

The bottom line: Learn all you can about a company before committing yourself to a financial relationship.  Here are some sources of company-specific information I consider as part of the dating process:

• company documents: annual reports, news releases, investor presentations
• summaries of company information as found on sites such as Yahoo Finance
• discussion boards
• trade publications
• Google searches of company managers and directors
• details re personnel e.g. Glassdoor, job advertisements
• analysts' reports (note that I generally read them, if at all, in the latter part of my investigations as a check to see if I missed anything)

In my opinion, analysts are at heart, sophisticated but generally overworked shills.  They follow boilerplate templates and are limited in what they can say by institutional constraints and the conventions of their trade.  This said, there is some value in what they might have to say, as noted so well by Mr. Umiastowski.