#1 Interview with Financial Engineering
This is a 2 part series with Alan from financial-engineering.com
This is the first interview on the MODERN INVESTING NEWSLETTER ! And there couldn’t be a better 1st guest then Alan Gałecki from the Blog Financial Engineering (here). His Twitter (X) account (here) is perfect to learn about interesting stocks and to get in contact with him.
Both Alan and I have polish roots. But apart from this, we have similar investing styles with the goal of not only making money, but beating the market.
THIS IS A 2 PART SERIES. IF YOU WANT TO FIND THE INTERVIEW AND MY ANSWERS, HEAD OVER TO PART 2 (here) !
OLIVER: Great to having you on Alan, before we start I have to say that this is the first interview on my blog and that I have been looking forward to this conversation for a long time. Could you quickly introduce yourself to my audience ?
ALAN: Thanks, Oliver, for having me as a guest. My name is Alan and I have been active "in the markets" since around 2011. After different professional jobs in auditing, as an equity analyst and fund advisor, I started my own blog financial-engineering.net in August 2022 to be able to share my thoughts and ideas with like-minded stock pickers who like treasure hunting. The goal is to even beat the market (benchmarks: S&P 500 and iShares MSCI World ETF) which even 90% of professional, highly-paid fund managers do not accomplish. As of now, my ideas are ahead of the pack. I update frequently on this.
OLIVER: We will get to the current situation regarding the markets, interest rates, etc, soon. But firstly: How did you start investing in stocks? What was your motivation and has anybody in your family invested in stocks before you?
ALAN: My family never had a tradition of investing in stocks, because it was and still is by some seen as a casino or not recognized that there is such a thing at all. Personally, while being a student, I started to get interested in stocks, because I did not want to rely on the public pension system, but instead take my destiny into my own hands by investing and building my own retirement fund. The final spark that ignited my journey was a colleague and friend until today who bought shares during lectures. By education, I am an industrial engineer. However, the world of finance sucked me in. Hence, also the name of my blog.
OLIVER: Please, name one or two investors that have inspired you.
ALAN: The very first who comes to my mind is Peter Lynch. After I read "One up on Wall Street", my view on stocks and markets changed completely. I understood that there are real businesses behind every share and that what counts is the positive development of the underlying business in the long-term. Add to that that valuations and market fluctuations are as normal as brushing teeth every day, and your mindset is set properly.
Another important piece is the second book by Edward Chancellor which is a collection of investor letters from Marathon Asset Management. This shaped my understanding of cycles, especially investing in commodities based on supply and demand imbalances.
OLIVER: What has been your biggest mistakes in investing ? I ask this question, because learning from mistakes is much more powerful, then learning from books, videos, etc.
ALAN: There are three groups of mistakes I made:
- Listening to pretend experts in my early years, especially economists, TV experts and gold-bugs who themselves have never invested or managed any money. I was a victim of their propaganda, because I thought their plausible-sounding arguments would make sense. While they are frankly in part right about their analyses of certain structural problems, they are not good for idea generation for investments, especially stocks. Ironically, the only thing you get from them, if at all, is to buy stocks of gold or silver miners – stocks that almost always dramatically underperform even the spot price development of the metals.
- Being lured in by low PE ratios, the more so if the broader markets have higher valuations and you think you have suddenly found a bargain. In most cases you haven’t. Chances are higher it is a value trap due to underlying issues with the business.
- Underestimating debt, which was even easier to do in times of quasi-nonexistent interest rates. Now, you can see that stocks of many heavily indebted companies are suffering dramatically. When I then see people writing or talking about "great buying opportunities due to low PE ratios", we are back at the previous point.
I recently read a nice statement: "PE is for TV". And I fully agree. It is a simplification by media people to connect with retail investors, because they often know this figure. However, this simplification is also misleading, as the PE ratio does not tell you anything about growth prospects and also not about debt. Stocks of companies with shrinking businesses and much debt will almost always have low PE ratios – are they a great buy? I doubt so, at least in most cases.
OLIVER: Interesting. I can tell several stories about the points you just made. So moving over to my next question, that actually fits the question above very well. What’s your greatest weakness still that you’d like to improve?
ALAN: Funnily, the same as yours. I am also inclined to overthink things, although I got better at making quicker decisions and by listening more to my gut feeling in addition to my head.
Also, I like round numbers, so that I often place limits at round numbers which frustrates me when the set limit is missed by a smidgen.
OLIVER: Your goal is to beat the market (S&P 500) over the long run. So what’s the strategy you follow to achieve this goal ? And please don’t use the word value investor (laughs).
ALAN: Basically, I am driven by fundamentals. My concept spins around adaptive multi-bagger investing, which means I am looking for stocks with the potential to multiply and dramatically outperform the market.
However, I am not talking about 50/50 binary outcomes of speculative biotech stocks, but fundamentally strong businesses that generate cash flows. Adaptive, because this applies often to cyclical stocks and sectors, where you will have to get out at some point in order not to take the elevator down later.
I built my portfolio around the following cornerstones:
- My best growth ideas with multi-bagger potential
- As there aren’t that many of them that fully convince me, the rest is spread across high-yield, but also high-quality dividend stocks which at the time for the most part are energy stocks
- Most of the time, I also have some 10–15% cash on hand, but I don’t have a target threshold
OLIVER: We have discussed this earlier, but just so that this is carved in stone. What are your investment goals ? Is it more about capital growth, or keeping wealth ?
ALAN: Clearly building my own retirement fund, hence, first and foremost capital growth.
OLIVER: Now what do you define as risk ?
ALAN: The opposite of the mainstream. Risk is not defined by the volatility of the price of an asset, but by the ignorance of the investor. I often say "know what you own and why".
OLIVER: This is my view as well. Why do you think do most people (80%) lose money in the stock market, although the market has returned 7-8% p.a. ?
ALAN: Emotions and following the herd. Buying high and selling low, fear and greed. Another point I rather realized only recently is many especially inexperienced investors or those who don’t bother about cycles and history, tend to simply project the past straight into the future. But a company that was successful in the last 30 years does not have to be [successful] over the next 30 years.
OLIVER: Let’s talk about the current environment. The S&P 500 currently has lost not around 10% since the highs in early August 2023 (we’re at late-October 2023), but sentiment is already like we were in a deep bear market. Volatility has also jumped by more than 50%. How are you positioned and how do you make sure not be directed by emotions?
ALAN: Here again, my motto is "know what you own and why“. If your mind is prepared to invest in real businesses, not in virtual lottery tickets, then you automatically become calmer. The more so, if your picks are less correlated to the broader markets. This can be special situations, company restructurings and obviously commodity producers with favorable supply and demand dynamics, where especially the supply-side is cracked.
OLIVER: If you read that this is a "generational buying opportunity“, in the context of slow growth and (relatively) highly valued stocks such as 3M or Verizon, what is the first thing that comes to your mind ?
ALAN: I often shake my head and even answer on some of these postings on Twitter (X), but I try to get over them quickly and invest my time at a higher return.
OLIVER: As I personally believe, that we will see a decade of higher interest rates (especially in the US), what do you think are the impacts of higher interest rates ?
ALAN: My conviction is twofold: first, many underestimate the impact on the cost of debt as well as on valuations, but also assume that rates will be lowered again soon. However, I am and I would advise anyone to prepare for an environment where this is not the case. Look for companies with low, manageable debt or even net cash, as the latter even generates extra income just by holding cash.
Another important point I want to make is that darling-stocks which recently declined by 20% like many "safe" consumer stocks, now are even more expensive, despite their lower share prices, than they were at low interest rates. Many do not understand this.
A quick example: With interest rates at say 2%, the reciprocal value is 50. This can be seen as the expected fair value multiple. With interest rates now marching towards 6%, this fair value drops to just 16x. Although consumer stocks had multiples more in the 30x area and not 50x, even this justifies a correction of close to 50% (from 30x to 16x) due to the changed interest rate environment, because stocks got more competition (bonds, brokerage accounts – so the theory). Those stocks would under these circumstances still be only fairly valued when down by 50% – not undervalued!
OLIVER: Since there is often the debate about portfolio construction, is your portfolio very diversified, or concentrated ?
ALAN: Clearly concentrated. We could debate what concentrated really means, but my rule of thumb is that my whole portfolio must fit on the full screen of my iPhone when I open the Interactive Brokers app. No scrolling.
The reason is, you can only outperform when you have big winners. By gearing towards ETFs which you do with more than 15 or 20 individual positions, you do not necessarily increase the diversification factor, but you decrease your potential for outperformance. If you have a stock that goes up 3x or even 5x, you don’t care about three stocks going down by 30% each (assuming your starting positions were similar). To the contrary, if you had a portfolio full of over-levered dividend stocks from sectors like consumer staples, telecom and utilities, you are now likely down disproportionately compared to the markets – so much on diversification.
OLIVER: While I have to agree with this, we should always keep in mind that Peter Lynch had more then 1400 position and still crushed the market. So with that out of the way, what are your 3 favorite stocks ? And why ?
ALAN:
1. I like the uranium investment thesis. Not because demand is said to go up due to new reactors being built (which increases demand only by the next decade anyhow), but due to dramatic supply bottlenecks. Even under current circumstances, there is a supply gap of around a third compared to the demand of the current fleet of nuclear reactors. The USA and the EU alone have to replenish their uranium stocks. This will happen regardless of the state of the economy and even likely regardless of the price of uranium. Utilities will have to buy or the lights go out. They don’t care whether uranium costs 50 USD per pound or 200 USD. They don’t have any alternatives. Maybe they’ll cry for bailouts or so, but they will have to buy the stuff.
After 2011, the world shifted towards an end of nuclear energy. The price of uranium fell into the basement and many mines were put on care and maintenance. Now, the tide has shifted again. But you cannot switch mine production on and off as you like. Uranium has the highest energy density and it would likely be the most sane solution for base-load energy production. To not have the risks of individual miners, I decided to go the easy way by picking Yellow Cake (ISIN: JE00BF50RG45, Ticker: YCA), but you can also take the Sprott vehicle. However, Sprott is a gold-bug, hence I picked YCA.
2. Arch Resources (ISIN: US03940R1077, Ticker: ARCH) is an American low-cost producer of coal, mainly metallurgical, also called just "met“, which is needed for steel production and to a lesser extend also thermal coal which is used to produce electricity and heat. Coal is even more hated than oil so that the companies have to finance their operations by themselves as they do not get any money from banks due to ESG.
This has led not only to underinvestments (making companies like Arch ironically asset-light operations) and thus low supply, but also towards some of the greatest shareholder capital return programs I am aware of. Arch has net cash in the books, it pays an annualized dividend of c. 10% and buys back shares in a similar magnitude. In Q2 2023 alone, they repurchased 3% of their stock and paid a dividend of c. 3% – in just one quarter! Who needs Coca-Cola when you can have Arch ?
3. My list would not be complete without an oil stock. I have several, but the preferred share / ADRˋS of Petrobras (ISIN: BRPETRACNPR6, Ticker: PBR.A) is one of them. The case is mainly about the huge reserves and the dividend which should come in between 10–15% p.a. at current economics.
But there’s something else I wrote about in my report to my members. The share buyback does not deserve the attention it should. While buying back 3% of stock does not sound spectacular, if you look closely, they only buy back the preferred stock, not both classes. Why? My guess is to slowly get rid of the foreign investors who are the main holders of this class. Every president, no matter the party, has publicly railed against "dividendos" to foreigners on the back of the Brazilian population which is the main buyer of Petrobras’ oil.
The Brazilian government mainly holds the common stock. So effectively, by retiring the preferred stock, a higher percentage of the dividends remains in Brazil and especially in the coffers of the government. Plus, the preferred stock should outperform over time the common shares. And, the dividend will be spread over less stock in total. That’s my theory. I would not be surprised to see even an increase of the program, now that oil prices are above 80 USD again.
OLIVER: Petrobras is part of my portfolio too, since the valuation gap between them and other oil producers is simply to high. Since we are both active on Twitter (X), to which extend do you think, can social networks like Twitter (X) impact portfolio results and idea generation ?
ALAN: It certainly depends on the type of investor you are and on your experience. I think many retail investors see it as a team sports events where they are investing together in popular stocks. This I clearly not my approach. What I am personally doing and what I recommend to every serious investor is not to follow everybody that comes across you, but to de-follow even those who distract you from your main goals. Pick your small group of like-minded investors.
OLIVER: Absolutely, surrounding yourself with like minded people definitely helps to stay focused on the main goal. Please answer to the following words with just the first few words that come to your mind:
Fundamental analysis
Energy stocks
High dividend yields
ALAN:
Fundamental analysis – The concrete which holds your house (thesis)
Energy stocks – The new consumer staples (until the retail crowd jumps in)
High dividend yields – A sign of skepticism, pick not the traps, but the trophies
OLIVER: Can you tell as more about your work and why you started a blog ?
ALAN: My approach is to show that by keeping things simple, thinking critically and by allowing some gut feeling, one can beat the market. But you have to detach from the retail crowd and common narratives.
On my blog, I am opening my head so to speak:
- In my free newsletter (every Thursday) I am writing about things like stocks I don’t like (but with valuable lessons learnt), about stocks to put on the watchlist, mindset, strategies, common beliefs and also book summaries and like recently interviews (with you as my first guest).
- My paid members receive exclusively my best stock ideas via 12-page reports as well as frequent one-page updates.
OLIVER: Thanks for your time and until next time. Have a great day Alan.
Every serious stock picker is welcome to join Alanˋs blog. ETF and buy and hold likely won’t have fun, but stock pickers love my reports. That’s at least the feedback he got from his members. He is picking ideas you do not find anywhere else.
So, feel free to visit his page financial-engineering.net. Besides reading, you can also listen to his free Weeklies.
As a member, you get full access to all his published ideas, whether active or closed, plus are eligible for his coming next ideas.