What's Worked for Dirt
I could not have picked a worse strategy to employ over the last 5 years.
I make my living buying value stocks - really cheap businesses with stable earnings, little to no debt, and lots of cash.
A typical valuation might look like this:
While this strategy will never go out of style, its relative performance is weaker than it would otherwise be in a less frothy market.
But somehow, I’ve managed to do okay. This is largely due to working with a small account and getting ideas from smart friends.
No other style of investing ever made sense to me. I don’t know how a person pays 25x earnings for a business. The level of foresight one would need is so far beyond me. But 25x earnings looks cheap compared to a lot of businesses today.
Here’s a chart I get weekly from this guy named Jamin Ball at Altimeter. His newsletter is really cool and I learn a lot from it.
But goddamn - these numbers make me sick:
Forget earnings. We’re valuing businesses on revenue. And forget actual revenue, we’re talking expected revenue.
Now, I know these are great businesses. I know they’re growing fast.
And I know if you’ve owned them, you can stick a finger in my face and laugh. Palantir shareholders made 15 times their money over the last 3 years. I’ve never made 15x in a single stock.
I just don’t know how a person handicaps the future at these kinds of prices.
In my view, the U.S. stock market has been overvalued for several years. I think the mass adoption of index funds, a flood of liquidity during the covid crisis, increased output/disretionary income for the middle and upper middle classes, and general American prosperity pushed us to this level.
But I’ve been saying this for a while now and I still look like a fool.
Enough with the market prognostications, Dirt.
Here’s a few things that helped me over the years.
Only Buy Cheap Stocks
I’ve basically never moved from this strategy. I may have risked 1-2% of my portfolio on coin-flip type events with asymmetric payouts. I think I’ve been a net loser on those coin flip bets by the way.
The future is almost always more complex than it seems in the present.
I’m not very good at predicting the future. I just try to buy things with a long history of consistent profits in industries that haven’t changed. Think HVAC, niche manufacturing, low churn Saas, mission critical infrastructure, etc.
I almost always buy businesses with excess cash or substantial asset value that can be used to generate cash (apartment buildings, excess land).
And I almost never rely on asset value alone. We need a business that earns money. Not a land bank, or a cash box on its own.
A lot of times when I tell people about these companies, they yell “VALUE TRAP”.
But I’ve generally found these kinds of things outperform.
In April 2024, for instance, I discussed a company that was in the HVAC/metal forming industry. It was a net-net that had earned an operating profit for 20 consecutive years. Net cash represented ~70% of the market cap, and the business traded at ~2x EV/EBIT.
While the management hoarded cash, it was clear the business was mispriced if sold in a privately negotiated transaction. The stock is up ~90% since that point.
I’m intentionally not mentioning the name, as I don’t want to direct 20,000 eyeballs to the stock all at once.
But it’s that kind of stuff. People are like “this stock will never move”.
Then it does.
Buy cheap stocks. That is a theme you’ll see in every example discussed. It’s a prerequisite for any investment.
Regulatory Arbitrage
I’m not sure this is the perfect definition. But that’s what I’ve chosen to call it.
Changes in laws can have a significant impact on a business.
The covid environment created extreme outcomes in certain corners of the market as the federal government essentially flooded the streets with liquidity.
Back in 2022 for instance, I figured out that certain small banks in America were essentially gifted huge sums of cash.
The government was “investing” in these banks, but received only a fraction of the economic prosperity they created.
In one example, I found a consistently profitable bank valued at $20MM. It earned $4MM a year in profits and sold for ~40% of book value.
This was interesting on its own.
As I read the annual report, it became clear that the federal government was “gifting” this bank $100 million dollars.
This would be like buying a house for $500k. Then walking into the basement and finding an open safe with $2.5MM inside.
Here’s the full story: ECIP Bank Madness
A couple more regulatory arb examples.
My memory on this one is a bit fuzzy, but this story is directionally accurate.
During covid, the Canadian government had a program called Canadian Emergency Wage Subsidy (CEWS).
It was a grant, not a loan, that would help companies with impacted revenue.
If your revenue was down a certain percentage, you could apply for this grant money.
Anyway, there was this little newspaper stock in Canada called FP Newspapers. A smart friend had turned me onto it.
FP was systematically shrinking before covid. And I knew that roughly half its revenue came from advertising - which was sure to be destroyed.
So I found this CEWS calculator somewhere on the internet and made a rough guess at how much revenue would be down and what the subsidy might be to offset it. This was a win-win scenario. Either revenue was down and a big subsidy came through. Or revenue was somehow magically stable, and earnings would’ve hummed along at their normal pace.
The company had earned ~$5MM of FCF in 2019 and had a ~$5MM market cap.
Anyway, in the second quarter of 2020, they did $4.8MM of FCF.
The company earned its market cap in a single quarter!
I knew the numbers would likely be good, but I don’t remember thinking they would be that good.
Anyway, that was regulatory arbitrage.
One last regulatory arbitrage story.
I’m not going to name this one, because I’m actively involved in it. But I’ll give a brief overview.
I own shares in a company that is adjacent to the healthcare industry. By its nature, the industry is quite fragmented.
And forever, margins have been low, because my business is paid by an insurance company for its product/service. The insurance companies are the dog, and my company is the tail.
So my company would limp by, earning a sustainable, but not great profit.
Then about 3 years ago a law was passed.
This law basically said, “Hey insurance company, no more ripping off Dirt’s business with lowball payouts.”
I’m not going to get into exactly why this law was passed but suffice it to say, this was in the interest of patients. So it’s quite unlikely to be changed. In helping patients, insurance companies were forced to pony up, and my little business benefited as a byproduct.
Anyway, the stock on this thing hasn’t moved in two years. It’s an asset rich business with a growing pile of net cash.
When you pull it all apart, you’ll see that today’s shareholder in this mystery company is buying a vastly different business than what existed 4 years ago.
Today’s buyer is getting a fast growing, margin expanding business at ~1x EBITDA.
And it’s all because of one tiny change in the law.
Regulatory arbitrage has been good to me.
Sniffing Out the Truth
That’s the easiest way I can describe this next section.
Basically, just keep chasing and hounding and birddogging until you get the answer.
Here’s another one where I won’t name the stock, but I’ll give you the story. It’s unfolded over the last 18 months.
Let’s call the company “XYZ”.
XYZ is a holding company. They’ve got interests in a half dozen industries. All segments are profitable. It’s a nice little business.
I’m obscuring the numbers, but here’s how the valuation looked when I got involved.
XYZ stock sold for $3, it had $4/share of net cash and was earning $1 of profit.
So it was a negative EV stock selling for less than net cash.
This on its own is incredibly compelling.
As I dug into the business, there was an oddity on the cash flow statement. There was a cash outflow in the financing section, but I couldn’t tell who the money was going to.
A friend and I chased after XYZ management for about 3 weeks before finally nailing them down. In effect, a couple private equity firms had owned this company before it went public. They had owned their interest in the business for ~20 years.
For the PE fund, the rest of their investments inside that particular vintage had been realized. They were just left with this one cast off business.
XYZ’s management approached the PE funds to buy out stakes in these old vintages which owned nothing but XYZ stock. They made lowball offers, which were accepted because this was found money for the PE fund’s LPs. The investment was almost certainly immaterial by now, and a few extra bucks would be nice to have.
So, in effect, XYZ was buying an entity that owned nothing but XYZ stock.
This was a buyback.
Once I realized what was actually going on, I became even more excited.
Over a 3 year period, XYZ has managed to buy in ~45% of its stock. Largely through this mechanism I described.
Of course, anyone who even bothered to read the numbers was unlikely to figure out what exactly was going on.
I’m a CPA (though not much of one), and I struggled for a few weeks to chase down management and put the pieces of this accounting puzzle together.
Then I went to the annual meeting of XYZ company. Other than management, the only folks there were myself and two friends. We got a chance to talk deeply with management and understand their approach.
These were sharp, shrewd guys running a super cash generative business.
The stock is up 3x over the last 18 months, but I’m still buying.
Anyway, the moral of that story is to keep chasing the lead. Go find some business that 99% of investors have never heard of and beat the piss out of the facts until you know more than 95% of the shareholders.
It’s simple, but not easy.
Hidden Segments
This is the last topic I’ll cover.
I’ve had success in owning businesses with “hidden segments”.
Sometimes a business will operate in multiple segments. Maybe two out of three segments are decent and the final one is a complete juggernaut.
These can be great deals because the business doesn’t pop up on a screener.
What’s more, the growth of the hidden segment can be obfuscated.
My favorite example is in a company called Azeus (shoutout to my friend Nick Peters).
In the summer of 2021 I was able to buy shares in this rapidly growing enterprise Saas business for 3x EV/FCF.
Sales were growing ~70% a year at the time I bought it.
It was all because the Saas segment was smaller than the old line business.
Final Thoughts
There is one core tenet underlying each of these strategies - hard work.
Buffett gave the best answer to how a small investor can get ahead at the 2024 annual meeting:
You’ve got to look at every stock. Turn every rock. Flip every page.
Nobody is going to do it for you.
This is probably not a statement I should make, seeing as how I make a few bucks from writing - but I don’t care.
You’ve got to do the work.
Whatever limited success I’ve had in investing has come from turning every page.
It’s the best way to get ahead.
DISCLAIMER: THIS IS NOT INVESTMENT ADVICE. I MAY OWN SECURITIES MENTIONED IN THIS ARTICLE. THIS IS NOT A RECOMENDATION TO BUY THIS STOCK OR ANY OTHER STOCK. I MAY BUY OR SELL ANY SECURITY AT ANY TIME. I MAY NOT TELL YOU IF AND WHEN I BUY OR SELL. THESE STOCKS ARE ILLIQUID AND YOU SHOULD UNDERSTAND THE IMPLICATIONS OF THAT IF YOU BUY THEM. THIS IS NOT TAX, LEGAL OR FINANCIAL ADVICE. I AM NOT YOUR FIDUCIARY. THIS IS THE INTERNET AND YOU’RE LISTENING TO A GUY NAMED DIRT.