The Island of Misfit Toys
In a perfect world you should be able to explain your investment strategy in one sentence.
My strategy is best explained by a children’s story. In my old age, I have become Rudolph the Red Nosed reindeer. On this foggy night, it has become my job to go to Island of Misfit Toys and deliver the unusual toys to children that want them. I know that every child wants a Jack in the Box, but all I have are Charlie’s in the Box. They might have a strange name, but they will make the children happy.
Am I a madman that built an investment strategy based on a children’s story? Not quite, there is a method to my madness.
My investment strategy comes from constantly looking at stocks selling in the bottom quintile of Price/Book and also stocks selling near their 5-year lows. These are very unpopular stocks. They are “Charlie’s in the Box”.
I can to this day, point to the spot on floor where I was standing at the University of Virginia (I was grading CFA exams) where I was handed an early draft of the famous Fama/French study. Until that time, value investing was only expressed as being a low Price/Earnings ratio strategy. I hated that idea. I knew I did not want to invest in Ford (a typical cyclical) when when their earnings were peaking. Fama/French conclusively proved that the true measure of “out of favor” stocks was Price/Book.
Price/Book is not perfect. Large stock buybacks, big restructuring charges, spin-offs, and other accounting issues, can make Price/Book distorted, so I add stocks I find on the new low list. Here I relied upon the Nobel Prize winning work behavioral economist Richard Thaler.
In the 1990’s I helped design the investment strategy for a $1 billion advisor in the Southwest. The advisor became the favorite small cap value manager for a large brokerage “wrap” program. When the top consultant, Evaluation Associates, looked at our portfolio he said “I have never seen a portfolio like that”, I said “thank you, that is the greatest complement, you could possibly give me”.
Below are my misfit toys:
The “cool” kids want stocks with predictable earnings. I want the opposite, so I start with the agricultural cyclicals. Corteva - CTVA and Nutrien - NTR - are both great companies, but when farm income is down, nobody cares.
Few things are as unpredictable as refining margins so I own HF Sinclair - DINO. No business is smellier, and more cyclical, than meat rendering, so I own Darling - DAR.
The cattle cycle in putting pressure on Tyson’s - TSN margins, and Treehouse - THS has been restructuring for 10 years.
With a little work, you can always find a restaurant stock and a hotel/casino stock that is out of favor, like Red Rock Resorts - RRR and Jack in the Box - JACK (it really is the best restaurant stock, I did not just choose it for its name)
There was a boom in biotech/biophama in 2019-21, and now many of those stocks are unpopular so I own Revvity - RVTY and Royalty Pharma - RPRX. This is classic example of when low Price/Book investing does not work.
Government spending and money printing is out of control so you should own at least one gold stock. Royal Gold - RGLD gives you exposure to 40+ developing gold plays. If a recession comes, we will need pawn shops, First Cash Financial - FCFS
High dividend yields can also be an indication of being out of favor so I own, Kinder-Morgan - KMI and Rayonier - RYN
Oil service stocks are near their lows, so I chose Halliburton - HAL, the little guys have shaky balance sheets.
Titan International - TWI - is a classic small cap, low Price/Book, stock that Wall Street ignores
In a world where the popular big streamers lose billions, Nexstar - NXST profitably operates over 200 old fashioned local TV stations
It is hard to find industrial stocks not near their highs, but I have found a few like Middleby - MIDD and Chart Industries - GTLS.
I have 5% of the portfolio, one stock, Brunswick - BC - tied to consumer discretionary spending.
You know what they said about old Rudolph,
“they used to laugh and call him names, they never let poor Rudolph play in and reindeer games”
I do not expect this portfolio to be popular with most investors.
The Island of Misfit Toys Portfolio:
Corteva - top market share in seeds and pesticides
Nutrien - big market share in potash, nitrogen and phosphate fertilizer
HF Sinclair - well located oil refineries
Darling - unwanted animal parts turned in food and fuel
Tyson - dominant supplier of chicken, beef, and pork
Treehouse Foods - the world is moving to generics
Red Rock Resorts - locals casinos are a stable business
Jack in the Box - burger/taco restaurants with good franchisees
Royal Gold - a hedge against the madness, 40+ royalties
First Cash Financial - pawn shops are America’s best financial institution
Kinder Morgan - pipelines are the key to generating electricity
Rayonier - great timber assets, with a real estate kicker
Halliburton - surviving in tough oil service environment
Revvity - surviving in a tough lab equipment environment
Royalty Pharma - 70% market share of large pharma royalties
Titan International - decent market share is tires for tractors
Chart Industries - building out hydrogen, LNG, and SMR’s
Middleby - dominant restaurant equipment maker
Brunswick - dominant in fishing boats, and large boats
Nexstar - large, profitable, network of 200 local TV stations