Eidelman Virant News

3Q 2019 Quarterly Letter – Frequently Asked Questions (FAQ)

16th of October 2019

Dear Clients and Friends,

In this letter, I’m going to answer the most common questions we are getting, including our thoughts on a potential U.S. recession, impeachment inquiry, trade wars, Trump’s effect on the market, the upcoming 2020 U.S. Presidential election, and marijuana stocks.  While we evaluate the ramification of these issues on our portfolios, the best course of action to grow wealth over time is to invest in a diversified portfolio of outstanding investment opportunities.  Our client portfolios are concentrated in companies with great management teams, profitable advantaged businesses, low-debt balance sheets, motivated employees, and trading at valuations that offer significant appreciation potential.   

Before jumping into the questions, I wanted to outline why we’ve re-initiated an investment in online shopping retailer Stitch Fix (SFIX).  While delivering 29% sales growth, 18% customer growth, and a 9% increase in revenue per customer over the past year, SFIX shares have declined significantly as concerns surrounding cost of acquiring customers and new competition from Amazon spooked investors.  We think their core offering remains robust and are particularly excited about a new “direct-buy” functionality where customers can go online, browse 30-40 personally selected items, and buy directly. 

SFIX recorded $1.5 billion in sales in 2019 and forecasts close to $2B in 2020.  Its current earnings power is masked by its large investments in data science, new categories, and marketing.  Given SFIX’s superior business model, culture, and growth, we estimate 1) sales growing 20% compounded over the next few years, 2) after-tax margins reaching 8%, consistent with apparel industry leaders like TJ Maxx & Ross Stores and 3) the stock maintaining a premium earnings multiple reflecting its leadership (25x+ EPS).  In such a scenario, SFIX shares would be worth roughly $50 per share in three years (EPS of $2.14 x 25x EPS), a potential 35% compounded annualized return from current levels. 

On the next page, I’ll dive into the most common questions we’ve been getting from clients.  If you have any further questions, please don’t hesitate to give us a call.

                                                                                                            Sincerely,

                                                                                                            Tom Eidelman, CFA

Managing Director

Frequently Asked Questions

Question #1: “What’s your view related to potential concerns about an economic downturn and impact to the markets?  I do believe something will happen although timing is clearly a big question.  What can we do to protect ourselves as much as possible?”

We are cautiously optimistic regarding the stock market and believe we’ve positioned the portfolio for success under many market scenarios.  We’ve moved towards some higher quality, well-managed, great culture, large companies like Google (GOOG) Southwest airlines (LUV), and Amazon (AMZN), that we think will continue to grow and possibly improve their positions in a downturn.  Conversely, we sold off some of the smaller economically sensitive companies that weren’t performing and could be knocked down further if the economy falters.  We also continue to avoid many of the high-flying, overvalued faddish sectors along with acquisitive companies which are most vulnerable to a downturn. 

The economy could also surprise us on the upside and our investments are poised to benefit.  Given their attractive valuations, our investments, such as our bank holdings, could rise significantly from their historically low valuation levels.  Given the limited downside and healthy upside, we feel confident about the portfolio from a risk/reward perspective.    

Question #2: “I have a large amount of cash outside my investment account, but I’m not comfortable putting it in the market right now.  Is that ok?” 

Conventional investment advice recommends not trying to “time the market.”  There are studies that show that by being out of the market on just the 10 best trading days over the past 15 years, investors would have earned just a 3% compounded annual return versus 8% for buy and hold investors.  Being out of the market can subject market timers to the risk of missing the upside.  For this reason, as well as many others, we don’t try to time the market, nor do we recommend clients attempt to do so.  Our goal is to remain close to fully invested for our accounts under normal circumstances. 

While we don’t typically recommend keeping cash on the sidelines, each client’s risk tolerance, time horizon, and ability to opportunistically react to the market is different.  In many cases, keeping some extra cash on the sidelines to help a client sleep better at night or wait for a personal investment opportunity may make sense.  We would be happy to discuss this with any client at any time to help make the best decision possible.

Client Question #3: “Trump is destroying our country.  His policies have to whack the stock market at some point, right?”

The Presidency impacts individual companies much less than people realize.  Conversely, the power of free markets, innovation, and productivity are much more powerful.  The stock market is an amalgamation of thousands of individual companies each trying to deliver value to customers and returns to shareholders.  While tax rates, trade rules, and regulation may change the rules of the game that businesses must follow, the stock market will correlate to how successful each of these companies are over the long term.  Most companies can thrive no matter what political party is in power.     

Question #4: “What are the market implications of a Trump impeachment?” 

Given the Republican controlled Senate, the betting websites have the odds of the Senate convicting and removing Trump from office at 20%.  Because of Trump’s unpredictability and tough trade stances, especially regarding China, it is also possible that Trump’s removal from office may not be seen as a negative market event.  Combining these two facts with our answer to question #1, impeachment prospects are not a material factor in our current investment evaluation.

Question #5: “How would an Elizabeth Warren Presidency impact the markets?  How should we think about the upcoming presidential elections?”

While the political party of the White House hasn’t proven significant to stock markets overall, individual sectors and companies may prove more fruitful than others depending on the presidency.  President Trump has been an advocate of domestic manufacturing, defense spending, deregulation, while being critical of global supply chains and trade with other countries. 

Recently, Elizabeth Warren’s chances of winning the Democrat nomination have risen dramatically.  Given Senator Warren’s comments regarding a ban on new fossil fuel leases on public lands and fracking, breaking up Amazon, Facebook, and Google, and calling for the end of the private healthcare industry, some of these respective companies have lagged.  She is also thought to be equally tough on China. 

While her comments may cause some concern, she still characterizes herself as a capitalist, and major reforms would need to be approved by congress.  There are also other sectors that may benefit including clean energy and infrastructure sectors.  While there is still much to learn about her economic policies, we feel confident that companies will continue to innovate and grow under a Warren presidency, driving stock prices up over time.    

Question #6: “Now that Missouri has passed a medical marijuana law, maybe we should look into marijuana growers & producers. There is a definite trend of acceptance now.  Are there investment opportunities to take advantage of the legalization of marijuana?” 

While excitement and growth in Cannabis is rampant due to legalization, it’s important to remember that cannabis is a commodity like corn and soybeans.  As more growers and retailers open for business, prices are falling and margins shrinking.  There is also the risk of big tobacco entering the space along with regulatory concerns that will cloud the space.  

Consumers of cannabis products will surely be happy, but we think the business prospects don’t look promising for many fledgling cannabis companies.  While there have been a couple of successful cannabis stocks and trading opportunities, as a group, they have vastly underperformed.  The largest cannabis ETF (ETFMG Alternative Harvest Ticker: MJ) with $750m in assets has declined 24% since its founding in 2015 and declined 50% in the last 12 months.  While we will continue to monitor the sector, we think most cannabis stocks are best avoided at this time. 

2Q 2019 Quarterly Letter – New Buy Ideas

12th of July, 2019

Dear Clients and Friends,

            The S&P 500 Index recorded a 4.5% gain in the second quarter.  Such strength is attributed to the Federal Reserve shifting their tone from “gradual tightening” to “patient” regarding interest rates.  In other words, investors went from fearing rising rates to excited about lower rates.  Low interest rates make stocks more valuable because they 1) entice investors into equities due to their relative attractiveness versus lower-yielding fixed income options, 2) reduce interest payments on company debt thus increasing corporate profits, and 3) increase the valuations of all companies by lowering their cost of capital. 

            We remain cautiously optimistic for the stock market.  On the plus side, the U.S. economy is enjoying modest growth, inflation and interest rates remain low, stock market momentum is robust, investor sentiment is neutral, and valuations in many areas are reasonable.  While the median P/E ratio for the overall market is slightly overvalued at 24x earnings, approximately 22% above its 40-year average of 20x, there is value in certain sectors and companies.  For example, banks and airlines trade at nearly half the market valuation at 12x and 11x respectively.  Conversely, there has been $37B of initial public offerings (IPOs) of companies sporting lofty valuations with more expected later this year.  So far, IPO volume is 30% above last year’s level. 

While the market may be temporarily rewarding such growth companies, history has not been kind to companies with large market valuations and little to no revenues and profitability.  In the two years following the dot.com boom ending December 1999, the tech-heavy Nasdaq index fell 58% while the Russell 2000 Value index gained 32%.  We will stick to fundamentally sound companies with proven and profitable business models, leading market positions, top management cultures, and low debt ratios, trading at attractive valuations.  We are optimistic that a portfolio of such companies gives us the best chance to minimize downside and maximize returns going forward. 

If you have any further questions, please give us a call.

                                                                                                                        Sincerely,

                                                                                                                        Tom Eidelman, CFA

Managing Director

New Purchases

Renewable Fuel Group – (REGI) – Price $16. 

REGI owns refineries that turn vegetable and cooking oil into biodiesel fuel.  Such activities benefit the environment by recycling waste products into fuel instead of going to landfills and reducing net carbon dioxode emissions by 78% compared to petroleum diesel gasoline.  Because of its environmental benefits and higher cost to produce, the U.S. government subsidizes biodiesel through mandated purchases for refineries and tax credits for producers.  While these biodiesel tax credits (BTCs) are supported on a bipartisan basis, the current political divide has delayed past tax credits and put future of the BTC into question.  Should the past two years credits be reinstated retroactively as we expect (which has been the case for the past 10 years), REGI would be owed a BTC of $237m or $6 per share.  Should congress cancel the BTC, we believe small, high-cost biodiesel producers would go out of business and REGIs large, low-cost competitive position would benefit over the longer term.  Should REGI receive the BTC by the end of 2019, we think shares should trade near its estimated tangible book value of $25 per share, a 56% premium to the current price. 

Southwest Airlines – (LUV) – Price $52. 

Southwest is the third largest airline in the U.S. with an outstanding corporate culture and attractive price.  Southwest was ranked #2 on Forbes list of Best employers for 2019.  In addition to never having a layoff and allowing employees and dependents to fly free whenever they want, Southwest pays 15% of the profits to employees.  Such dedication to their employees translates to the best customer service in the industry.  Southwest won the JD Power customer service award two years in a row and has net promotor score (NPS) of 62 vs industry at 44 and least customer complaints in the industry according to DOT (.36 per 100,000) 26 out of 28 years.  Lastly, Southwest has always had the lowest debt and highest profitability in the industry.   

We believe the recent controversies surrounding the grounding of Boeings 737 Max planes provided an attractive entry point into Southwest shares.  Despite the quality of the company as outlined above, Southwest shares trade at just 11x estimated earnings.  We think the valuation of such a high quality company should be at least equal to the industrial sector average of 15x earnings, offering a roughly 30% appreciation potential.  Southwest is also aggressively buying back 6% of their shares outstanding per year.   

1Q 2019 Quarterly Letter – Amazon is a “Value” Stock

11th of April, 2019

Dear Clients and Friends,

            The S&P 500 Index recorded a 13% gain in the first quarter, the best start to a year since 1998.  Many attributed the gains to the Federal Reserve pivoting from raising interest rates to stopping or potentially even lowering interest rates in the coming year.  We believe the magnitude of this year’s gain is mostly just a reversal of the pessimism surrounding the severe market decline experienced in Q4 of last year.  The good news is historically when the S&P 500 got off to a robust start of 10% or more in Q1 of a year, it rose the remaining nine months of the year 85% of the time by a median of 7% per year.  

While our portfolios experienced healthy gains in the first quarter, financial stocks lagged somewhat compared to the other sectors like technology and industrials.  Bank stocks remain attractive from a valuation perspective, but concerns about loan growth, competition for deposits, and a flat yield curve have acted as a headwind.  Weighing all the factors for banks going forward, we think the banks still offer superior potential risk-adjusted returns.  We are also buying banks with the best management teams, motivated corporate cultures, strong balance sheets, valuable locations, and are attractive acquisition targets.  Our top twenty largest bank holdings trade at an average valuation of 1.1x tangible book value and 11x estimated earnings, representing a roughly 25% discount from the industry average of similar sized banks.  Last year, there were 260 bank buyouts at an average takeout price of 1.75x tangible book value and 24x earnings, representing a 50% appreciation potential for our banks in the event of a buyout. 

We love buyouts, but we also love companies that can compound attractive returns over long periods of time.  In the vast majority of cases, these compounders had magnificent corporate cultures driving such outperformance.  Broadly, we define “great” corporate cultures as those that are the best places to work, have the most satisfied customers, and deliver superior long-term returns to shareholders.  While most Wall Street analysts focus primarily on financial success, we’ve found corporate culture is the engine that drives sustainable outperformance.         

            One of the biggest challenges we face when looking for new investment ideas is reconciling our expertise in the power of corporate culture with our strict value discipline.  While we have found some companies which neatly fit both criteria (particularly in the small banks I noted above), most companies with outstanding cultures aren’t cheap on traditional metrics.  These higher valuations previously dissuaded us from investing in some terrific opportunities. 

            “Value” has been and continues to be the bedrock of our investment philosophy.  It is in our DNA to be attracted to underappreciated companies where simple math points to attractive returns with low downside risk.  We often cite data supporting this approach such as from 1982 to 2018 the cheapest decile of stocks based on price/earnings (P/E) ratio have returned 11.4% per year versus just 6.8% for the most expensive decile.  We have benefited greatly from beaten down companies outperforming after tough times like banks in the great recession and avoiding Wall Street darlings getting knocked off their pedestals by competition like we saw with technology stocks in the dot.com bust.  However, the key factor we underestimated is the ability for top performing cultures to keep up their great performance versus reverting downward due to tough competition.  Google (GOOG) is a great example.         

Despite its legendary culture, delightful search technology, and tremendous growth potential, we thought Google stock was too high when it went public in 2004 at $85 per share. GOOG shares traded at 10x sales and 118x earnings, a valuation level about 5x higher than the average stock in the S&P 500 index at the time.  However, Google went on to increase in value 28 times and is attractively priced today.  How is that possible?  Powered by their world-class workforce, Googlers innovated in their core search engine, ad platform, YouTube, android operating system and more, capitalizing on the secular trend of global advertising transitioning online.  It turns out the company could have gone public at 1000x earnings and the stock still would have been a great value by outperforming the S&P 500 Index.  Google is no isolated incident. 

Stocks of the companies with the best corporate cultures have significantly outperformed the S&P 500 Index over time.  As a proxy for culture, an equal-weighted portfolio of Fortune magazine’s 100 Best Companies to Work For returned 10% annually from 1998 through the end of 2018 compared to just 7% for the S&P 500 Index.  Such ratios like P/E are short cuts which imply typical growth rates and competitive pressure.  Companies with outstanding cultures have far exceeded growth expectations and thus have been underestimated by such metrics.  Our investment analysis must evolve.  I believe our biggest opportunity to improve future investment performance is to incorporate our knowledge that companies with great management cultures can still be great values without having below market P/E ratios.  One current example is Amazon.com (AMZN). 

Amazon was rated #1 in Top Companies the US Wants to Work Now according to Linkedin, #1 for nine consecutive years in customer satisfaction for the retail industry including the highest score ever recorded, and delivered shareholder returns of 37% compounded for the past 10 years vs the S&P 500 of 13%.  Amazon is obsessed with customer service and their services are getting better every day.  The biggest obstacle to overcome investing in Amazon is and always has been the valuation.  Amazon shares currently trade at 68x next year’s estimated earnings.  On the next page, I’ll detail why we think Amazon’s position, strategy, and culture make shares undervalued and potentially worth $2,500 per share, a 40% premium to the current price.

I want to end by sharing the exciting news that Ben Weiss has joined the Eidelman Virant Capital team.  Ben will work as an analyst as well as portfolio manager for 8th & Jackson Partners, a concentrated value-oriented hedge fund he founded in 2014.  After working closely together, we agreed it would be mutually advantageous to work as one team to help all our investors generate superior investment returns.  Ben graduated from Vanderbilt University and Washington University Law School and worked as a corporate lawyer in St. Louis and as an equity analyst at ADW capital, a value NY-based hedge fund. Ben is also a guest contributor on the media industry to Hollywood trade publications like Variety and Hollywood Reporter.   We are thrilled to have him on board. 

If you have any further questions, please don’t hesitate to give me call.

                                                                                                                        Sincerely,

                                                                                                                        Tom Eidelman, CFA

Managing Director

Amazon.com – (Ticker: AMZN) – Price $1,780, Target $2,500 (40% upside)

Amazon.com is the world’s largest online retailing company.  Amazon also owns Amazon Web Services (AWS), the largest cloud infrastructure company.  These are two of the largest and fastest growing industries in the world.  Driven by their world class corporate culture and management, we think these businesses will continue to wow customers, develop breakthrough products and services, and compound profits at an extraordinary rate.  The founder and CEO, Jeff Bezos, owns 16% of the company, perfectly aligning his financial interests with shareholders.  To evaluate the whole entity, the two businesses are best analyzed and valued separately. 

Amazon Retail (Amazon.com) – Value $1,500 per share – Amazon.com is an amazing shopping experience.  Customers can buy nearly any product 24 hours a day, 7 days a week, at the lowest price, hassle free, and shipped to their doorstep.  Amazon is obsessed with improving the customer experience and has been rewarded with a 49% market share of online retail sales. 

With online still representing just 14% of retail sales in the United States (excluding gas, restaurants, and autos), Amazon’s growth is expected to continue at 20% per year for the foreseeable future as a larger share of items are bought online.  Amazon further leverages its online platform by selling its own propriety products, advertising, and allowing other businesses to sell their products on its website.  In two years, the value of these combined profit streams could be $30B.  At 25x operating earnings, Amazon.com would be worth roughly $1,500 per share.      

Amazon Web Services (AWS) – Value: $1000 Per share – AWS is Amazon’s cloud computing business. As Amazon was building its own data centers to manage its growing computing needs, they recognized early that as the internet grew, other businesses would need access to infrastructure, data storage, security, and a host of other applications in the cloud. Thus, AWS was born. Amazon invested aggressively to meet this need, building data centers around the world, and hiring software engineers and programmers to develop advanced web-based applications. Today, AWS offers over 125 fully featured services for computing, storage, databases, networking, artificial intelligence, and a variety of other web-based services.  The breadth and quality of the AWS offering has led to capturing a 51% market share of this cloud infrastructure market.   

While AWS already earns $25B in sales and $7B in operating profit, they are in the first inning of cloud growth.  If Amazon can maintain their market position and margins into this forecasted opportunity, that would equate to $35B in profits in five years.  Applying a market multiple of 25x for this dominant recurring revenue platform, AWS could have a future value of $1,000 per share.         

Alexa – Value: TBD – Alexa is Amazon’s AI-enabled voice platform that allows customers to search, explore, and buy products with voice commands. With 10,000 employees and more than 100 million voice-enabled devices sold, Alexa is a disruptive and delightful technological platform which will reward Amazon with more consumer spending.

Conclusion

Amazon owns dominant businesses with outstanding growth, world-class management, and a culture of innovation and customer service.  We think shares are undervalued based on our analysis that this team improve their products, competitive position, and profitability beyond expectations.  Amazon is well known, but sometimes doing what is simple, and obvious, is most rewarding.  Amazon shares represent an opportunity to own part of one of the great companies in the world at an attractive price.   

Disclosures

This post is for informational purposes only and does not constitute a complete description of our investment advisory services. This post is in no way a recommendation of any security or a solicitation or offer to sell investment advisory services. This newsletter should not be construed as advice to buy or sell any particular security. This post is not definitive investment advice and should not be relied on as such. It does not take into account any investors’ particular investment objectives, tax status, or investment horizon. No recommendation or advice is being given as to whether any investment or strategy is suitable for a particular investor. Any forward-looking statements speak only as of the date they are made, and Eidelman Virant Capital assumes no duty to and does not undertake to update forward-looking statements. Certain investments mentioned in this post may not have been held by clients of, or recommended by, Eidelman Virant Capital.   Past performance is not indicative of future results. 

4Q 2018 Quarterly Letter – Market Correction = Opportunity

15th of January 2019

Dear Clients and Friends,

Former heavyweight boxing champion Mike Tyson famously said, “Everybody has a plan until they get punched in the mouth.”  In the fourth quarter, equities stunned investors with the S&P 500, Russell 2000, and NASDAQ indices falling 13.5%, 20.2%, and 17.5% respectively.  While we were aware that valuations and investor optimism were high, our plan was to mitigate this risk by concentrating in companies with top notch management teams, strong competitive positions, low debt, and attractive valuations.  While this strategy has historically performed exemplary in down markets, this time we took one on the chin.  There is a reason one of the most famous investment books is called “The Battle for Investment Survival.”  This last quarter was painful.  We intend on coming back stronger and are encouraged by the recovery so far this year.

With index funds representing over 50% of the U.S. equity universe, every stock is a constituent in dozens of exchanged traded funds (ETFs).  These ETFs swing around with sentiment and macroeconomic factors and the underlying stocks are whipped around by these price indiscriminate funds.  The result of this dynamic is that our investments may not be as insulated as they were in the past when broad market downturns led active managers to swoop in and buy companies with depressed valuations.  While this new paradigm could persist, and may add more short-term volatility to our portfolios, it provides increased long-term opportunity.  We will see more instances of “the baby being thrown out with the bath water” involving investors panic selling their passive funds which dumps all stocks indiscriminately.  On the last page, I will outline two new investments that we made which capitalize on such an opportunity.  

A key element of our success over time has come from investing in banks which dominate a local market, are conservatively managed, and trade at low price/earnings ratios.  In addition to providing excellent total investment returns, we’ve also found them to provide downside protection in volatile markets due to government oversight, simplicity, and inherent conservative nature.  This was not the case last year as the S&P Regional Bank Index declined 19% due to concerns over rising interest rates and a potential economic slowdown.  While share prices have been hit, the underlying earnings and fundamentals remain strong.  Citigroup CEO, Michael Corbit said it best when he recently told analysts, “We clearly see a disconnect between what we see in our business on an anecdotal basis and what the markets are saying.  Right now, we see the biggest risk in the global economy is one of talking ourselves into the next recession, as opposed to the underlying fundamentals taking us there.”  Across Eidelman Virant’s community bank holdings, we are seeing strong earnings and book value growth.  With the recent selloff, our top 16 community bank holdings trade at a median 1.15x tangible book value and 11x earnings, a 25% discount to similarly sized banks and a 35% discount to the Russell 2000 small cap index.  At these levels, it is cheaper for competitors to acquire these banks rather than open a new branch and compete with them.

                                                                                                                                Continued on next page ->

We have long been and continue to be believers in value investing.  Made famous by Warren Buffett, value investing is the practice of investing in companies with low valuation ratios like price/earnings (PE) as opposed to well-known growth stocks whose prospects are often already discounted in the form of very high prices.  Since 1979, investing in the 50% of stocks with the lowest PE multiples would have returned 11% vs 6% annually for the half with the highest PE ratios.  Value investing within small capitalization stocks has yielded even better results over time and historically provided downside protection.  In the six S&P 500 down years from 1979-2017, small cap value stocks outperformed large cap growth stocks by an average of 18% per year and only underperformed once.  Nevertheless, 2018 was another anomaly and saw small cap value stocks underperform large cap growth by 11%, only the second time in 40 years.  The good news is the last time this occurred in 1990, small cap value stock rebounded and outperformed large cap growth for the next three years by 15% per year. 

Below are some of our top holdings and their prices at the end of the 3rd and 4th quarters respectively versus our calculation for their intrinsic value.  You can see at the end of the third quarter, these holdings had an estimated 27% appreciation potential to our estimate of fair value.  While their share prices declined in the fourth quarter, we believe their intrinsic values remain the same and thus their appreciation potential has more than doubled to 56% based on their year-end values.  See table below.    

*Intrinsic Value was calculated using an average of 1) 2019 estimated tangible book value 2) An average of sell side analyst price targets, and 3) 10x estimated earnings.

Our community bank and other value holdings are priced to offer attractive potential returns while providing downside protection in the form of real asset value.  We also continue to invest in companies with great management cultures as defined by companies who treat employees well, wow customers, and target leading shareholder returns.  We are optimistic for 2019 and are already off to a solid start.  If you have any questions, please don’t hesitate to give me a call.

                                                                                                                                Sincerely,

                                                                                                                                Tom Eidelman, CFA

                                                                                                                                Managing Director

New Purchases:

First Trust MLP & Energy Income Fund (FEI) – Price $9.70 – The First Trust MLP and Energy Income Fund is a closed-end fund composed of Energy Infrastructure Master Limited Partnerships (MLPs).  Such companies own pipelines and make money from transporting and storing energy.  FEI has a dividend distribution rate of 10.9%.  As oil prices declined throughout the year, MLPs were unfairly pushed down with the overall energy sector despite the fact that low oil prices do not impact transmission profits.  In addition, this fund traded at a 10% discount to its net asset value due to temporary forced tax selling even though it traded at a premium throughout 2017 and 2018.  We think FEI could provide a total return up to 25% in the next twelve months due to a combination of its 11% dividend, recovery of its 10% discount to NAV, and underlying growth rate of 5%.     

Ring Energy (REI) – Price $5.08 – One example of a company we purchased after it had significantly declined due to tax selling is Ring Energy (REI).  Ring Energy is a small oil & gas exploration (E&P) company with key acreage in the Permian basin.  Despite having some of the best acreage, profitable production, and roughly no long-term debt, Ring Energy shares fell 63% from roughly $14 per share to $5 in late 2018 as oil prices fell.  Passive energy funds like the S&P Small Cap Energy ETF (of which Ring is a component) fell 43% with more than half of its constituents falling more than 30%.  With a $7.50 tangible book value and $.60 EPS estimate for 2019 earnings, we think REI shares are conservatively worth $8.00, a 60% premium to its year-end price.  As a confluence of selling hit REI due to hedge fund closures, tax loss selling, and window dressing, we capitalized on this opportunity to buy shares and are very optimistic for the investment in the near and long term.     

3Q 2018 Quarterly Letter – Quick Update

9th of October, 2018

Dear Clients & Friends,

                There have been some big changes recently here at Eidelman Virant Capital.  We moved offices and are now located in Suite 600 in the same 8000 Maryland building in the heart of Clayton, MO.  We are also pleased to introduce Abbi Marks as the newest member of our team.  Abbi will be replacing Amy Jadav, who is pursuing a career in early childhood education.  As Operations Manager, Abbi’s responsibilities include client service, reporting, accounting, and other back office operations. Prior to joining Eidelman Virant Capital, Abbi was a Compliance Analyst at Wells Fargo Advisors. Abbi received her B.A. in Sociology and Education from Hebrew University and her M.B.A. from the Ruppin Business Academy in Israel. 

                Now, on to the markets.  The S&P 500 Index appreciated 10.6% year-to-date through September.  Much of this increase has come from growth-oriented healthcare and technology companies, a scenario that has always been challenging for our value-oriented investment approach.  Other sectors, styles, and countries haven’t performed this year as well as exemplified by S&P 500 Financials -1.2%, Russell 2000 Value Index +7.1%, Barclay’s Aggregate Bond Index down -1.6%, and International MSCI ACWI -ex US index falling -2.7%.  Given our heavy weighting in community banks and bias towards reasonably valued companies, it has been difficult to keep up.  The good news is we think our portfolios are even more attractively positioned to outperform going forward.   

                There have been some recent positive developments on the trade front as President Trump reached a favorable trade deal with Canada and Mexico, called USCMA, formerly known as NAFTA.  This agreement reduces uncertainly and provides hope for future deals.  USCMA directly helps many of our specific investments such as our Canadian auto parts maker by mandating 75% of cars be made with high-wage North American labor and eliminating Canadian dairy quotas which could help our Wisconsin-based bank specializing in dairy farm lending. 

                We also continue to be optimistic about our community bank holdings which represent about a third of our equity portfolios.  Last month, David, Stan, and I attended the Raymond James bank conference, meeting face-to-face with more than forty management teams.  We walked away feeling even more confident of our portfolios which contain banks with dominant market share in growth markets, have outstanding management cultures, low levels of non-performing loans, trade at attractive valuation ratios and have a high likelihood of being bought out at a substantial premium to our cost. 

                Along with the banks, we are confident that our current investments have the right characteristics to perform well in the coming year and over the long-term.  Thank you for your continued business and feel free to contact us if you have any questions.          

Sincerely,

Tom Eidelman, CFA

Managing Director