Do you own Boyd Group Income Fund (BYD.UN)? It’s one of the best performing stocks on the S&P/TSX over the past decade. Boyd’s market cap grew from $25 million to $1.8 billion, and today, it is the largest operator of collision repair centres in North America.
Well, someone you’ve probably never heard of – Ryan Irvine, Founder of KeyStone Financial – recommended Boyd “in November 2008 at $2.30/share and today it trades in the $95.00 range (it has paid over $3.00/share in dividends) and returned over 4,250%”. That’s a 40+ bagger! ($1 investment turns into $40+). Peter Lynch would certainly be proud. No doubt – Boyd is an exceptional capital compounder stock. (Btw email me and I’ll send you a free copy of my new book, Capital Compounders, which includes stocks similar to Boyd Group Income Fund).
That’s why I’m featuring Ryan Irvine in this issue of my newsletter. He’s going to explain “the anatomy of great stock selection”; how he selects capital compounders, walking-through his profitable analysis of Boyd Group Income Fund. Ryan’s based in Vancouver, and has been running KeyStone Financial since 2000. KeyStone is an independent stock market research advisor firm. It’s similar to Peter Hodson’s 5i Research. For the past 17-years, KeyStone has specialized in uncovering, before the broader market, under-followed small-to-mid-sized companies based on the GARP (growth at a reasonable price) approach. KeyStone’s Small Cap Strategy has achieved a whopping 37.2% average annual return since inception.
Consider this issue on Ryan Irvine a “lost” chapter from my book, Market Masters. However, the following three sections below that comprise this issue – “My Investing Journey”, “Small Cap Investing Methodology” and “The Anatomy of Great Stock Selection – Boyd Group Income Fund”, were all written by Ryan who I met in Toronto earlier this year. We found many overlaps in our investing philosophy so I asked him if he’d be interested in sharing his stock-picking principles with all of you. This issue is going to be a longer read than usual but I think you’ll enjoy what Ryan has to say. And if you have any questions for Ryan – email him directly; email@example.com. Cheers, Robin.
By Ryan Irvine, Founder, KeyStone Financial, August, 2017 –
My Investing Journey
The journey to create KeyStone Financial and KeyStocks.com started back in high school in a stock picking contest put on by one of my math teachers.
I found the idea of capital markets exciting and while there was plenty of information to be found on the TD’s, Royal Banks, and at the time Nortel’s of the world, what intrigued me were the underdogs, untold stories, or the stocks trading at under $10 or even in the pennies (my price range at the time) that could be the next great company. The ones that could provide the returns that could easily win that contest.
The problem, there was very little information on these types of companies.
With some digging, what you could find were what I later discovered (after they lightened my wallet) were glorified sell side reports written by brokerages that were paid by the companies they were covering through financing fees or worse, puff pieces authored essentially by paid shills for the companies. Most of these were mining exploration companies. The TSX and TSX-Venture are laden with these black holes where capital that should be put to productive use, goes to die. I learned this the hard way and it is one of the primary reasons KeyStone has little coverage in the resource segment in Canada – it is beat to death in this country and most investors are already overexposed. As far as the junior exploration segment, we would not touch it with the proverbial ten-foot pole.
On I went to university (Simon Fraser) to get grounding in financial and security or stock analysis specifically. The education has served me well, but the philosophy taught academia at the time and still today in most institutions surrounds the efficient market hypothesis (EMH). EMH theory basically states it is impossible to “beat the market” because stock market efficiency causes existing share prices to always incorporate and reflect all relevant information.
Many academics blindly take the theory hold, where in my reality I disagree with it strongly. I recall a 4th year class where our professor was lecturing about how to construct the perfect portfolio to mirror the market. I put up my hand and asked why we would not try to pick stocks that actually beat the market? The professor immediately replied that this was impossible and told me to re-read the chapter on EMH. I put my hand back-up and asked him how he would explain Warren Buffett’s multi-decade track record of outperformance that is considered impossible according to EMH. He replied, “Who is Warren Buffett”. I later realized this was one of the issues with having a math teacher teach a finance course. Sure, he could teach us how to crunch the numbers, but he was not an investor and would not help me beat the market.
In fact, a good deal of academia and financial education today still tells us you cannot. The system is actually set-up to produce applicants who are well suited to fill the well-oiled machine that is the North American financial system. This was not going to be my path. Once I recognised this, I decided I should pave my own path.
For a different line of thinking I turned to books such as The Intelligent Investor by Benjamin Graham and basically anything about or from Warren Buffett, perhaps the greatest equity investor of all time.
In 1993, the year I graduated high school, Warren Buffett gave an interview that would truly impact the way we conduct research at KeyStone today with a gentlemen by the name of Adam Smith. Alas, while Buffett has been around a long time, in economic circles this was a less famous Adam Smith. In the interview, he was asked if a younger Warren Buffett were coming into the investment field today, what areas would you tell him to point himself in?
“Well, if he were coming in and working with small sums of capital I’d tell him to do exactly what I did 40-odd years ago, which is to learn about every company in the United States that has publicly traded securities and that bank of knowledge will do him or her terrific good over time, Buffett Replied”.
The interviewer Smith chuckled, half surprised at this notion and replied, “But there’s 27,000 public companies (in the country).”
And with a wry smile Buffett replied, “Well, start with the A’s.”
Some years later I read the interview and the quote made a big impression on me. It has helped shape the way we conduct our “discover research” at KeyStone.
Today, you can use digital tools to screen stocks. Select whatever criteria you’d like. 25%+ revenue growth – cash flow positive – PE under 25 – market cap under $500 million and the screener will spit out a bunch of names. So why the heck would we put ourselves through all those annual reports? Because screeners are nowhere near perfect. For the average investors, they are a great start. But, they do not typically remove one-time items that obscure true earnings power, they cannot read an outlook, find you backlog numbers, or interview a management team among other things.
Only by actually looking at the financial statements of 1,000s of public companies can we be sure we are not missing something. Often the real opportunities appear outside of what a typical stock screener or data terminal will provide you.
Small Cap Investing Methodology
Core to our strategy is to start with businesses (small-cap stocks) that have achieved profitability – in most cases they have a history of growing profits. We look for revenue and operational cash flow growth and perhaps most importantly, a viable growth path or multiple paths ahead for the business. Specifically, in reference to small-cap growth stocks, we prefer strong balance sheets with great net cash positions or, at the very least, reasonably manageable debt levels. Businesses that have strong balance sheets can not only weather the inevitable downturns, but profit from them by scooping up assets on the cheap. They are then positioned to post extraordinary growth in boom times. We prefer to buy businesses at a bargain, but often (dependent largely on general market conditions) buy a great business for a reasonable or fair price.
A solid growth path, good profitability, strong balance sheet and reasonable valuations – essentially a variant on GARP or growth at a reasonable price is core to our research philosophy. While core, they are by no means exhaustive.
In fact, we also find a strong management team with skin in the game. Typically, a company that consistently generates strong cash flow and possesses the core criteria we look for above confirms a strong management team – they most often go hand in hand. But, in a perfect world, we also like to see a good management team with significant ownership stake in the business. While it cannot always be the case, we are looking at key management in an ideal small-cap owning between 5 and 40% of the business. If management’s share ownership position is a significant or meaningful percentage of their own personal wealth, their interests are aligned with shareholders and they are more likely to implement dividends, grow dividends, limit dilution, make only cash flow accretive acquisitions and general conduct themselves in a manner which creates shareholder wealth.
There is no substitute for experience as well. I believe an analyst who hasn’t gone through a severe downturn can never be as seasoned or successful long-term than one that has felt this type of pain.
Becoming a good investor is about more than just the numbers. In fact, almost any analyst can run the numbers and study investment theory. They can read about the effects of a true bear market, but it will not prepare them to experience it in action. There is nothing that can compare to owning a stock and watching it drop 50% in a matter of days. The decision then to sell, hold or buy when the market is irrational and you and your clients are feeling real pain is difficult without experience.
This broad experience in the face of adversity (and adversity faces even the best analysts and the best businesses) translates into how we treat a set-back in a stock in our recommendation universe.
We recently experienced this exact scenario in a stock we recommended in our U.S. Growth Stock research this past year.
In April of 2016 we recommended shares in Applied Optoelectronics Inc. (AAOI:NASDAQ) which makes high-speed transceivers and other components for fiber-optic networking equipment. The stock traded at $15.99 and boasted strong growth from a built out in the hyperscale data centers market by Amazon, Microsoft, and it was looking to add Facebook (now confirmed).
Two days later the company pre-announced a first quarter 2016 earnings warning for the upcoming quarter dropping the stock by around 30% and over the next couple weeks the stock touched the $8.00 range or 50% lower than our recommendation price.
The stock had limited coverage at the time and so the stock languished, but we maintained our rating at hold as we had done extensive research and expected quarterly volatility. The company had stated that it expected to make up for the shortfall in upcoming quarters. By the third quarter, the company had posted a positive earnings surprise and the stock had recovered to $18.00 range where we recommended buying more.
In fact, we have recommended buying the stock all the way to the $65 range this year as the company has now reported 4 consecutive record quarters, having more than made up for that quarterly miss. The stock now trades $100 up over 500% since our original recommendation and is ranked in the top 3 in terms of performance on the NASDAQ in 2017.
It would have been easy and natural to panic and sell the stock following the earnings warning, but we would like to think it is experience that helped us continue to hold and then buy in the face of adversity.
An analyst who is also an investor is a better analyst.
It is what makes Warren Buffett the greatest investor and stock picker. It is key to having the experience and steady hand to do as he famously advised, “Be fearful when others are greedy and greedy when others are fearful”.
As to our approach, we have more of a bottom-up style. We focus on the business, the fundamentals, the valuation, and look for a margin of safety via the value we achieve in a discount purchase, the balance sheet, lack of cyclicality or other unique elements. We read the filings, the presentations, listen to conference calls and related research. We prepare questions and talk to management. We also look at the competition if possible to see how they are performing and get a general idea of the sector.
The macro environment, particularly if there is a direct link to the prosperity of the business is not ignored, but we do not find it prudent or valuable to spend too much time on things that are out of our control. Our time is better spent focusing on learning about the business than trying to predict the direction of interest rates, the price of gold or where we are in the business cycle. Generally, we view one’s broader opinion or the broad consensus opinion on the economy to offer little value in our investment decisions.
I am fond of saying that even if you properly apply our methodology described above but buy just one stock, even if it is our table pounding buy of the year, then you are crazy.
On the flip side, you can rigorously apply our methodology and buy 50 stocks and I will tell you are wasting your time. Sounds like we are not sold on our own criteria. This could not be farther from the truth.
In fact, while we are very confident in the long-term success of our research, as part of a portfolio strategy it is incomplete.
For our clients, our strategy does not stop with our research. We advocate an approach we like to call Focused Diversification. The strategy runs counter to what most investors are told by big bank advisors who place them in multiple ETFs or mutual funds who stress diversification. In fact, we have seen many portfolios which hold up to 50 funds. A portfolio composed as such or which anything more than a couple well diversified funds is essentially going to leave an investor over diversified, over complicated, paying far too many fees and underperforming the index as a result over time.
For an investor that wants a passive strategy we would recommend investing in a couple of low cost, well diversified ETFs or index funds and calling it a day. This would be far easier to manage and you will incur less fees and either mirror or outperform the fund and ETF laden portfolio.
A portfolio consisting of anything greater than 20-25 individual stocks from an assortment of industry and with a global business reach will provide the average investor with all the diversification needed. In fact, there is little benefit of diversification past the range of investments. With most funds holding over 50 stocks, holding a basket of 10 or 20 funds is “diworsification”.
To beat the market, you cannot be the market.
The Anatomy of Great Stock Selection – Boyd Group Income Fund
One of our longest standing BUY recommendations in our portfolio, Boyd Group Income Fund (BYD.UN:TSX), can serve as an excellent example of the type of stock we love to uncover for our clients. It is the type of winner that allows an investor to make other mistakes (and we do) and still produce strong returns in a focused portfolio. We recommended Boyd in November, 2008 at $2.30 and today it trades in the $95.00 range (it has paid us over $3.00 in dividends) and returned over 4,250%.
For the anatomy of this great stock selection we get into our time machine and set the mood of the market at the time. The year was 2008, the month was November and markets were in panic mode. The credit crisis and market meltdown were in full swing and investors were selling shares indiscriminately – like they were going out of style.
There was definitely blood in the streets, but the carnage was fresh and we had not likely reached full capitulation.
Despite the fact that prices had fallen precipitously and assets appeared on sale there was a lack of recommendations coming forward from Bay Street as analysts and investors were afraid to catch falling knives. From the value investor perspective, we were like kids in a candy store.
Great companies were on sale. And while it tested our stones (trust us it did), we started increasing the frequency and volume of our recommendations at this time. Over the next six-months we recommended in the range of 15 stocks. To give an idea of how rare this is, over the first 7-months of 2017 we have added only two stocks to our Canadian Growth Stock Focus BUY Portfolio.
For our first buy we were looking for a stock with recession resistant qualities. After all, we were in the midst of a potential great recession that was uncharted territory and destined to last for quite some time. We were looking for a simple business that would not easily go away and could potentially grow, even in tough times.
Enter the Boyd Group Income Fund (BYD.UN:TSX). The company was the largest operator of automotive collision repair service centres in Canada and was among the largest multi-site collision repair companies in North America. Recession or not, people tend to fix their vehicles as a means of getting from A to B is often essential in keeping gainful employment. Despite this, Boyd had basically zero following on Bay Street and the company’s total market cap was in the $25 million range. The company posted revenues in its last quarter alone of over $50 million.
Boyd had recently undergone a turnaround. In fact, since the start of 2007, the company had managed to cut its total debt outstanding in half, reinstate regular cash distributions, increase same store sales, and grow cash flow significantly. Organic growth was solid and the company had embarked on a U.S. acquisition plan that appeared to chart a path towards sustainable long-term growth. The management team owned a significant stake in the business, adding to the appeal.
Partly due to the crisis environment and partly due to its complete lack of analyst coverage (a perfect stock for us), the company was trading with very attractive valuations. The following is an excerpt from our 2008 Buy Report.
“Boyd’s PE multiple based on continued operations is currently south of 4, its price-to-sales is a paltry 0.14, and its EV/EBITDA is 3.32. Based on that, the company’s continued positive outlook, and the fact we like to get paid for holding a security in the current market, we will initiate coverage on Boyd with a BUY recommendation and adding the company to our FOCUS BUY list.”
Monthly distributions and dividends of $0.015 were reinstated commencing December 2007. Shareholder distributions increased to $0.01625 commencing April 2008, subsequently increased to $0.0175 commencing July 2008, increased to $0.01875 commencing October 2008, and finally increased to $0.02 commencing January 2009. At the time, this annualized distribution of $0.24 represented a very conservative annualized payout ratio estimated to be in the 25% range (many funds payout between 80-95%), a sustainable level that allowed for continued balance sheet improvement.
Over the next 9-plus years Boyd has delivered on its growth plans and then some. With each quarterly earnings beat, our comfort level with the management team and company grew. The stock has been recommended at ever increasing prices no less than 25 times in separate reports from KeyStone and it has maintained its position in our Focus BUY Portfolio. It is currently the longest standing buy recommendation.
Again, we recommended Boyd in November 2008 at $2.30 and today it trades at over $95.00 range (it has paid us over $3.00 in dividends) and returned over 4,250%.
Boyd’s market cap has risen from $25 million to $1.75 billion and the company has expanded from roughly 75 locations to 475 locations today. Despite the astonishing rate of growth, the company’s share count has only increased from 12 million to 18 million.
Despite being by far one of the best performing stocks on the entire TSX over the past decade, Reuters only tracks 12 analysts covering the stock. And this is a “surge” from between 0 to 3 analysts over the first 5-years we were recommending the stock.
The lack of coverage outlines the Street’s lack of interest in companies that are not serial share issuers – they just do not make them enough money. This lack of coverage has been a golden opportunity for our clients and produced one of our best recommendation of all time in a stock that is anything but sexy, but produces some of the sexiest returns one can imagine.
By Ryan Irvine, Founder, KeyStone Financial, August, 2017 –
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