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April 2014



Chipotle's Long-Term Prospects

April 24, 2014 – Comments (0) | RELATED TICKERS: CMG

Sorry for the lack of posts lately. Today is my final day of classes at Berea College, with finals week coming up next week. I'm doing my best to enjoy these final college experiences and, you know, maybe complete a few assignments in the meantime... 

Still, here is a recent article I wrote after Chipotle's latest earnings report. I probably won't be very active the next week or so, but I imagine you'll be seeing more of me after May 4. :-) 

Chipotle Mexican Grill's Long-Term Prospects Remain Strong

Last Thursday, Chipotle Mexican Grill (CMG) reported results for the first quarter of 2014. The market ended up pushing shares down 5.94% to $519.61, possibly due to fears that the company's planned price increases may deter customers. For long-term investors, however, the company's prospects are as bright as ever. 

Chipotle can handle price increases

Chipotle saw sales increase 24.4% year over year to $904.2 million in the first quarter, but net income only increased 8.5% to $83.07. Margins were pressured by rising commodity prices -- particularly with beef, avocados, and cheese -- and pushed management to announce Chipotle's first system-wide price increase across the U.S. since 2011. Management anticipates these price increases to be rolled out by the third quarter of this year. 

While investors should keep a close watch on how these price increases impact customer visits and overall sales, I think it is unlikely that low single-to-mid digit percentage increase in prices will significantly impact customers. As a conscious capitalism business focused on its Food With Integrity mission, Chipotle has built a loyal (and growing) customer base. 

This quarter, for instance, comparable restaurant sales increased an astounding 13.4%, and average restaurant sales hit a record of $2.23 million per restaurant. Chipotle offers an experience that few (if any) national restaurant chains have been able to match, and the numbers prove it.

"Ultimately," as founder and co-CEO Steve Ells explains, "it's our belief that the more people know about their food and how it was raised and where it comes from, the more likely they will be to eat at Chipotle." Given Chipotle's financial performance, it is hard to argue with that statement. 

Focus on the cash flow 

Shortsighted investors are focusing on the short-term impact that rising commodity prices are having on Chipotle's bottom line. Many investors, however, are missing a key statistic that demonstrates just how impressive Chipotle's business is: free cash flow

In the first quarter, Chipotle's free cash flow production increased 49.34% to $132.55 million. This cash flow performance allows Chipotle to open more than 40 new restaurants each quarter without adding any debt to the balance sheet. In fact, Chipotle now carries $411.59 million of cash with no debt. 

Long-term investors should focus on Chipotle's free cash flow performance going forward. Few restaurants, let alone businesses, come close to achieving the continued excellence of cash flow production demonstrated by Chipotle. In terms of cash flow production, Chipotle is as strong as it's ever been, and patient long-term investors should take notice. 

ShopHouse and Pizzeria Locale concepts off to a good start

We didn't learn much more about Pizzeria Locale or ShopHouse in this quarter's press release or conference call. However, Steve Ells did disclose that the volumes of Pizzeria Locale and ShopHouse are "behaving similarly in general to how we saw Chipotle going into early markets back when Chipotle was kind of unknown".

When it comes to Pizzeria Locale and ShopHouse, Ells explains they are "seeing patterns that are very similar to what we saw with Chipotle in the early days, and we find that to be very encouraging." Considering that Pizzeria Locale and ShopHouse are already opening new locations at a faster pace than Chipotle in its early days, long-term investors have reason to be optimistic that these new concepts can complement Chipotle's growth in the coming years and decades.

Foolish final thoughts

The market presently values Chipotle at $16.15 billion with a P/E ratio of 48.74. While this doesn't appear to be a bargain, I think this is a valuation that Chipotle can justify and grow into. Within the past several years, I made the foolish (small f) decision to sell shares of Chipotle based solely on price movements. Big mistake. Chipotle's long-term prospects are as bright as ever and will likely command a premium valuation for quite some time. 

With Chipotle we have a proven values-driven management team with an unprecedented ability to generate cash flow. Should the market continue to discount the strength of Chipotle's business and push shares downward, I will strongly consider adding to my existing position. Patient long-term investors shouldn't go anywhere, because Chipotle's growth is far from over.

David K  [more]



Thoughts on Under Armour

April 19, 2014 – Comments (2) | RELATED TICKERS: UAA , NKE

Under Armour (UA) is a company I have been closely watching as a potential addition to the Pencils IRA Project portfolio. Under Armour has been an incredible investment over the past several years, increasing 960% in value since 2009. I added the company to my watchlist last month:

Under Armour is guided by founder, chairman, and CEO Kevin Plank, who founded the company in 1996. Under Armour produces a wide of apparel products and sportswear, most notably for athletes. Speaking from personal experience, I have noticed that much of the sportswear worn by Berea College's athletes is in fact made by Under Armour. There is little doubt that this is a well-respected brand growing in popularity. 

Under Armour has seen sales expand at an average pace of 21.68% annually since 2010. This pace actually accelerated last year, with sales increasing 27.09% in 2013 to $2.33 billion. Since 2010 Under Armour's earnings have increased at an average annual rate of 24.08% to $162.33 million in 2013.

I hesitate to open a position in Under Armour at this point largely because of the valuation. The stock trades at a P/E of 70.75 and a P/S of 4.88, with a market cap of $11.23 billion. (This compares to Nike's P/E of 25.27, P/S of 2.37, and market cap of $65.01 million.) Under Armour will have to maintain significant growth rates to lead to market-beating returns over the next 3-5 years. Over the past year Under Armour has traded in a P/E range of approximately 50-80, and the P/E tended to stay in the range of 40-60 in the two years prior to 2013. So, there are a good deal of expectations priced into the stock today. 

If the company is able to grow earnings at 25% annually for the next five years and trades at a P/E of 45 in 2019, here is what we are looking at in terms of investment returns: 

.75*(1.25^5)*45 = $103.00 

This is just under a double in five years from today's price of $53.06. Still, these are ambitious growth projections. Management is projecting operating income to grow 23%-24% in 2014, so I am not so sure we can confidently expect net income to grow at an average pace of 25% annually for the next five years. (Keep in mind that earnings grew 24% annually over the past five years. As the company grows larger, it will be increasingly challenging to continue growing earnings at this pace.) 

Another concern I have is the fact that Under Armour's cash flow production has been irregular over the past four years. The company produced -$115.86 million of free cash flow in 2013, pushing the company to issue stock and debt to finance a significant increase in capital expenditures (as well as a 39.89% decrease in operating cash flow production). There may be reasons why the company's cash flow production has been up and down over the past several years, but it isn't exactly something for which I am willing to pay a significant premium. 

As I've shown with SolarCity, I don't necessarily mind investing in a business who is still producing negative free cash flow, provided a) there is a great leadership team focused on long-term growth, b) the company is continually improving cash flow production over time (growing operating cash flow faster than capital expenditures), c) there are clear prospects for continued growth. 

In Under Armour's case, I think Kevin Plank is a great leader heading up an innovative business. However, I don't see the growth prospects or sound cash flow performance to back up such a lofty valuation in the present day. If the P/E drifted closer to 40 (or a price of $30 given the current EPS of $0.75), I would seriously consider opening a position in Under Armour. 

I am trying to build more discipline in my investing decisions, and part of this process is recognizing that bargains aren't readily available in today's market. I think there are still some great long-term investment opportunities available today, but I am not sure Under Armour should be at the top of the list. I am watching the company closely and want to do additional research, but these are my thoughts at this point. 

What do you think about Under Armour? 

David K  [more]



Utilizing Glassdoor as an Investment Analysis Tool

April 17, 2014 – Comments (2) | RELATED TICKERS: COST , LNKD.DL

 I wanted to delve deeper into why I see Glassdoor as such a valuable and increasingly important tool for Foolish long-term investors. This article, I hope, gives a clear explanation of why I am attempting to integrate Glassdoor into my various company analyses. 

The short of it is this: research demonstrates that happier employees are more productive, employees feel more engaged in a values-based/purpose-driven culture, and happy and engaged employees result in lower employee turnover and longer-serving employees. Glassdoor is a great tool to begin gaining a better understanding of how successfully (or not) companies are serving their employees. 

In our quest to find great long-term investments, Glassdoor is a tool that ought to be consulted before investing in a business. I wouldn't be surprised if the companies with the top CEO and workplace ratings on Glassdoor have been solid market outperformers over the past several years. Maybe that's a project for another day... 

What a Good Glassdoor Rating Can Tell You About the Health of a Business -- a website that allows employees to anonymously review their place of current or former employment -- is a tool commonly used by prospective job seekers. The insights Glassdoor offers into company cultures and leadership, however, are equally valuable for investors. Here are three reasons long-term investors should be paying close attention to company reviews on Glassdoor. 

1. Happier employees are more productive 

This may seem like common sense, but research really does back up this simple concept. A team of economists at the Warwick Business School conducted a study attempting to identify a link between an individual's happiness levels and productivity. "Happier workers, our research found, were 12% more productive," the researchers concluded. "Unhappier workers were 10% less productive." The report also suggested that "economists and other social scientists may need to pay more attention to emotional well-being as a causal force."

What causes employees to be happy? This is the question proactive businesses are attempting to answer. Glassdoor's marketplace of employee reviews helps employees reveal the positives and negatives of their respective workplaces. Investors should carefully review this employee feedback, which provides critical insights into the company cultures in which we may invest our hard-earned dollars. 

2. Values engage employees

In its 2012 Global Workforce Study, Towers Watson surveyed more than 32,000 employees in 29 countries and found that only 35% of employees feel "highly engaged" with their respective place of work. 43% consider themselves "detached" or "disengaged" in the workplace. Tom Gardner, co-founder and CEO of The Motley Fool, and Morgan Housel put this into visual terms: 

"Imagine a 10-person bicycle. This means that three people are pedaling, five are pretending to pedal, and two are jamming the brakes." Such is the state of the corporate world today. Glassdoor, however, gives us a glimpse into the company cultures that are bucking the trend and proactively developing workplaces that cultivate, engage, and retain top talent.

LinkedIn CEO Jeff Weiner -- ranked by employees as the best CEO in 2014 among companies with more than 1,000 employees -- explains that LinkedIn's success "starts with investing heavily in our culture and values and not just talking about it but walking the walk." Whether it be Weiner's bi-monthly company meetings with employees, free yoga classes for employees, or encouraging employees to pitch and develop new ideas, the company's employee rating of 4.5/5 on Glassdoor shows there is much other businesses can learn from LinkedIn's dynamic employee culture.

LinkedIn has also turned in stellar financial results, with total sales increasing an average of 58.4% annually since 2010. Since going public in 2011, the stock has increased more than 100%, handily beating the S&P 500's performance of 39% over the same period. 

3. Employee retention 

As you may be able to guess by now, the level of employee happiness and engagement in the workplace plays a major role in a company's ability (or lack thereof) to retain employees. In a 2012 survey from the American Psychological Association, employees most commonly cited reasons such as work-life fit and enjoying their work tasks as the top reasons to stay with their current employer. "For employees who said they plan to stay with their current employers for more than two years," the survey noted, "the biggest drivers of expected tenure were enjoying the work, having a job that fits well with other life demands, and feeling connected to the organization."

Entrepreneur and author Nilofer Merchant puts this concept in other terms: "Money motivates neither the best people nor the best in people. Purpose does." When it comes to retaining employees, purpose trumps monetary benefits. 

Finding ways to retain employees is in the best interest of a business, considering employee turnover can become a major a drain on a company's financial bottom line and overall success. When a business loses an employee, it is losing the productivity, knowledge, and specialty of that individual. Dollars will have to be spent recruiting, interviewing, and training new employees. An organization's long-term viability should be called into question if its leadership does not recognize the importance (and financial sense) of attracting and retaining employee talent, particularly given today's growing workplace transparency thanks to services such as Glassdoor.

Costco Wholesale -- which enjoys a 3.8/5 rating on Glassdoor, while CEO Craig Jelinek is the #5-rated CEO in the country with a 95% employee approval rating -- serves as a prime example of the benefits of employee retention. Costco's average turnover in an employee's first year is 6% -- this number drops below 5% for employees who stay longer than one year -- compared to over 20% employee turnover for Wal-Mart. Over the past decade Costco has tripled for investors, crushing the S&P 500's returns by more than three times in the process. 

Foolish bottom line 

Glassdoor is still a fledgling service, but it already offers investors the opportunity to see what is really going on behind the scenes of our current and prospective investments. As Glassdoor grows beyond its current base of more than 3 million contributors and approximately 7 million unique monthly visitors, companies will be increasingly evaluated on their ability to please and retain top employee talent. Innovative company cultures will become the norm, not the exception. 

Over time, top talent will likely gravitate to (and remain with) companies that offer the most rewarding and values-driven environments for employees. These innovative company cultures will more likely than not -- based on the research reviewed above -- lead to more productive and longer-serving employees. These are exactly the company cultures that Foolish long-term investors should seek out. Thanks to services like Glassdoor, this has never been easier.

Thanks for reading! 

David K  [more]



Building a Portfolio for Long-Term Success

April 10, 2014 – Comments (0) | RELATED TICKERS: NFLX

As I get back into the flow of investing -- after a bit of an investing hiatus during most of my college years -- I find myself returning to questions that many new investors tend to ask. It is fair to say that I am still in the process of determining the best strategy for my own portfolio. 

I am still young enough where I can "experiment" with different strategies without losing sleep at night. For instance, I think the Pencils IRA Project will be a fun project to run for at least a year (maybe more depending on community interest and how the portfolio is performing), and then track over the next 5-10 years and beyond. I think identifying businesses with dynamic management, strong company cultures, and innovative product lines could be a sound market-beating strategy for the long haul. Time will tell based on how well this particular project does over the next several years. 

Most importantly, for me, is that the Pencils IRA Project gives me the opportunity to write my analyses and reasoning and track them over time. This is something that every investor should do -- regardless of their individual strategy -- in order to allow meaningful reflection and learning as we invest. 

Focusing on long-term potential of businesses has also helped me tune out short-term market noise. I remind myself that I am not investing in a business based on speculation from me (or others, for that matter) of where the stock will be in three months. I happened to start investing in 2005 and 2006, essentially the peak of the bull market before the market began to fade and the economy eventually entered the Great Recession. I got discouraged with my portfolio's performance atprecisely the time I should have been buying -- this is not a mistake I plan on repeating. 

My timing of entering the market may be similar this time around (you've been warned). I don't know where the market is going the next several months... nobody does. Looking back on the first investments I made nearly nine years ago, however, I see that the greatest investments in my portfolio stemmed from businesses with innovative product lines guided by dedicated and visionary leadership who had a focus on long-term performance: Chipotle, Netflix, Monster Energy, etc. This is why I am placing such an emphasis on these traits as I begin to get back into my investing flow. I truly want to focus on businesses that can flourish over the next ten years and beyond. It is critical to find leadership dedicated to (and capable of) sustaining long-term growth for all stakeholders. 

With all this said, below is an article I wrote expanding on some of these thoughts with regard to allocating funds within a portfolio and building a strong portfolio for long-term success. I hope these thoughts are helpful to some! 

Building a Portfolio for Long-Term Success

New investors often ask the question, "How much money should I allocate to each investment I make?" 

This is a great question! And the honest, realistic, and Foolish answer? It depends on the investor.

Mold your strategy around you 

In a working adult's IRA, the dollar amount allotted to each investment will likely be considerably higher than what I can allocate to investments in my individual portfolio as a student in college.

Even so, the meager $80 I invested in Netflix (NFLX) in 2006 is worth well over $1,000 today. Netflix ballooned from 5 million subscribers in 2006 to more than 44 million subscribers in 2013 and counting, expanding sales at an average rate of 23.5% annually between 2006 and 2013.

Netflix shareholders have benefited greatly from the visionary leadership of co-founder and CEO Reed Hastings, who from the very beginning recognized the need for Netflix to adapt to new mediums.

In his 2005 letter to shareholders, Hastings wrote, "The winners in downloading will be the companies that provide the best content and the best consumer experience, and that's what we do best." Less than a decade later, not only is Netflix an undisputed leader in streaming movies and TV programs, but the company is also producing its own original content. What a difference visionary leadership, an innovative product, and 10 years can make.

As you search for your own multibagger investments, keep in mind these (paraphrased) words of popular Motley Fool member Tom Engle (TMF1000): "If a company is the next big thing, a little position is all I need. If it isn't the next big thing, a little position is all a want."

Peter Lynch, investor extraordinaire and former manager of Fidelity's Magellan Fund, puts it this way: "All you need for a lifetime of successful investing is a few big winners, and the pluses from those will overwhelm the minuses from the stocks that don't work out."

In other words, individual investors don't have to bet big and commit all of their investing money to one or two investments. Building a diversified portfolio of quality businesses with great long-term prospects is the best way to achieve market-beating results over the long haul.

With this in mind, it is helpful to focus on percentage allocation, rather than the dollar amount invested in each stock. A rule of thumb used by some investors is to invest enough funds in each position so that commissions make up no more than 2% of your total investment. In other words: If your brokerage charges you $7 to buy shares of a stock, the minimum amount you would want to invest with each trade would be $350 (of which 2% is $7). This helps ensure that commissions do not eat up a significant portion of your investing dollars. 

Opportunities with diversification 

When a stock jumps in the short term, it can be easy to convince ourselves that we should have purchased more shares of that stock. But would you have felt comfortable holding a larger position if the stock had dropped 20%? Consider this when determining how much you want to invest in any given business.

We should be confident in all of our investments, but the benefit of diversification is that we can begin to look past the short-term volatility that will inevitably come about when investing in individual stocks. So consider expanding your portfolio beyond just a handful of stocks. We want to invest enough so that we benefit if a business succeeds over the long haul, but we also don't want to invest so much in one position that we hyper-analyze every little market movement and panic if the stock doesn't perform as anticipated.

Some investors opt to "buy in thirds," easing into individual stocks by purchasing their total position in increments of one-third over time. A potential downside to this strategy is the fact that the long-term trend for the market is to go up, in which case delaying investments into thirds over time can sometimes be counterproductive (or less rewarding than opening a full position from the get-go). On the other hand, going all-in with a full position right away can be difficult to stomach if the market or the individual stock should take a turn for the worse.

Foolish bottom line

It is important to manage your portfolio in such a way that leads you to focus more on the underlying businesses behind your stocks -- and the long-term prospects of those businesses -- rather than getting caught up in short-term market movements. Allocate your money in such a way that maximizes your confidence and comfort levels and minimizes uneasiness with your investments, allowing you to keep the bigger picture in mind. Volatility is all but guaranteed with individual stocks, but focusing on the business behind each stock can help investors avoid emotionally driven decisions based on short-term price swings.

The Pencils IRA Project -- a personal real-money portfolio -- is my attempt to build a portfolio of quality businesses with significant potential to generate market-beating results over the long term. The dollar amounts allocated to the individual positions in this Roth IRA portfolio are nothing huge, but the portfolio will prove to be lucrative over the long haul if only a few of the holdings prove to be big winners. With investing, starting small is better than not starting at all.

Thanks for reading! 

David K  [more]

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