In addition to the extreme market/sector volatility driven by global geopolitical events and macroeconomic headlines, this month was also post-Dec quarter earnings season. Overall, our portfolio acted very well despite the continued (and worsening) uncertainty. Our average post-earnings return was +0.9% (+1.9% on a weighted average basis) and the weekly post-earnings return was similar at +0.6% (+1.3% weighted average). The relative performance vs the benchmark was similar at +0.7% (+1.7% weighted average) and +0.2% (+1.1% weighted average) respectively. However, we ended the month with a slight underperformance vs the benchmark due to our second largest name that was hit with a sell-side ratings downgrade at the end of the month. This one event caused the stock to fall nearly -6% and cost us -0.80% of performance this month.
 
Normally, I would have ignored such downgrades since most sell-side analyst ratings are short-term driven anyway. But I thought I’d highlight this case as the reason is even less fundamental than other typical rating changes. The sell-side analyst who had downgraded did so due to a change in internal research rules that requires each sector analyst to have a larger proportion of “sell” recommendations for every “buy” recommendation, presumably in order to cater to hedge funds. Because he had upgraded another name among his coverage, he was forced to downgrade something, and his estimated earnings growth was lower with our company. I understand he even apologized to the company after the downgrade, explaining why these new rules required him to lower his recommendation. However, this example also highlights an odd fundamental side effect which was somewhat thought-provoking and shows why forward earnings multiples are a bad way to value a business.
 
The company in question is [...]

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Still, the market only uses past data to make predictions and market consensus is looking for a decline in both sales and earnings in 2026. Given the not-so-subtle optimism of our company’s guidance for 2025, many analysts raised their 2025 forecasts while maintaining 2026 forecasts, thus accentuating the YoY decline in 2026 vs 2025. The irony is that the analyst who downgraded their rating actually raised 2025 estimates to Street high levels but simultaneously shifted their valuation period to 2026, thus lowering their target price since EPS is expected to be lower in 2026 vs 2025. In other words, despite the fact that the company will see a huge increase in operating cash flow this year ([...]), the value of that cash is essentially being written off in full by using a multiple on 2026 EPS. To be fair, our own DCF valuation methodology has a similar side effect because we generally discount excess cash on the balance sheet (anywhere from 0%~100%, averaging 50%, depending on whether management is a value creator through accretive acquisitions and high payouts, or they are a value destroyer through bad acquisitions or cash hoarders). Given the fact that our company generally pays out 50~60% of earnings via dividends and buybacks, roughly 40~50% of future estimated cash flows are then instantly discounted as soon as that cash is realized. However, using multiples from earnings in 2026 wipes out all of the cash flow generated from 2025. Using this logic, if demand [...] is even stronger as the quarters progress over 2025, one would presume that earnings will fall further next year assuming a pull-in of future demand, thus causing EPS and perhaps even expected multiples to decline even further in 2026. In other words, the better they do this year, the multiple-based “fair value” would theoretically fall further.
 
Not only does this logic feel warped, but it also assumes that the efforts that the company is implementing to flatten the cycle will be ineffective. I have known this company for 20 years now, meeting the exact same senior officer since 2005. In fact, we were recently reminiscing how [since I first met them, revenue has increased 3x and profits 5x]. During these 20 years, there was GFC (when earnings fell -87%), the earthquake, [...], COVID, and a few technical recessions thrown in for good measure. And yet, excluding the pandemic, annual EPS had risen less than double-digits only 3 times (and declined only once) despite disinflation throughout those 20 years. Having known them for so long, I understand how the business operates and how management thinks. And one thing I am absolutely certain of is that they will not (willingly) make the same mistake twice. Besides, there are other potential structural changes such as [...], rising sales per client, increased automation of their own sales and services, and the fact that they pay well above market wages, helping to attract the best sales force whose revenue and profit per head has continually exceeded all-time highs every year. While I wouldn’t say the stock is “cheap” ([...]), I see fair value at least +45% despite conservatively assuming that EPS grows only single digits from 2028 and beyond. The difference between the 15 sell-side analysts and I is that I believe in their forward execution whereas the market believes in only the past.
 
This type of analysis shows why, even among well-covered stocks, there is ample opportunity to generate high returns.
 
Masaki Gotoh
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“Don’t pray to God to solve your problems. Pray to that part of God within you. Have the guts – to fight for yourself. God wants brave souls. He wants winners! Not quitters. If you can’t win, at least try to win. God loves tryers.” – Reverend Frank Scott, played by Gene Hackman in The Poseidon Adventure.

 

I’ve probably mentioned Gene Hackman several times in my monthlies that I’ve been writing for over 10 years. If someone were to ask me, “Who is your favorite actor?”, I’d probably say a different name each time, but I’m certain that if I had the option to name the top 5, Gene Hackman would be one of them.
 
My very first movie I saw him in was The Poseidon Adventure released in 1972, the year I was born. They made quite a few disaster movies in the ‘70s like the Airport series, Meteor (which starred a post-James Bond Sean Connery), The Andromeda Strain based on the book by a great fiction writer Michael Crichton, and, of course, The Towering Inferno with a star-studded cast led by Paul Newman and Steve McQueen and whose producer was the same as Poseidon. They are often compared but, for me, the Poseidon Adventure wins out, largely due to Gene Hackman’s performance. According to IMDb (the Internet Movie Database, a site that I’ve been using well before the World Wide Web became a thing, going all the way back to when it was still a Usenet group), Gene Hackman was credited in 78 movies from 1964 to 2004 (as well as 21 television programs from 1961 to 1972). Going through the list, I realized that I had watched over 30 of them including famous movies like French Connection, Mississippi Burning, Unforgiven, 3 movies based on John Grisham novels, and, of course, his iconic performances as Lex Luthor in 3 Superman movies. But they also include several movies that I suspect most people hadn’t heard of but featured equally riveting performances in a variety of movie genres such as Scarecrow, The Conversation, Crimson Tide, Enemy of the State, The Quick and the Dead, Behind Enemy Lines, Get Shorty, Class Action, Uncommon Valor, and Bat-21. In each of them, he played characters, both villains and heroes (and often times anti-heroes), with memorably vivid personalities; rather, he made them very memorable, whether he played the lead, a supporting role, or just a minor part. In fact, I think he often outshined the lead role when he took supporting roles. It was this intensity, regardless of the character, that I believe sets him apart from other actors.
 
Like the favorite actor question, I couldn’t easily say which movie that Gene Hackman starred in was my favorite. But if I absolutely had to choose, it would probably be Mississippi Burning, where he starred with Willem Defoe, playing an FBI agent investigating the disappearance of civil rights workers against a hostile, Ku Klux Klan centered town in the south before the Civil Rights Act of 1964 was enacted. I rewatched it very recently and had learned only now that, while it was a work of fiction, it was based on actual events that occurred in 1964. If you hadn’t seen it, I would strongly suggest it. The movie received four Golden Globe Award nominations and seven Academy Awards nominations, losing to Rain Man for Best Picture and Best Actor in a Leading Role. He lost to Dustin Hoffman for the Best Actor award, a close friend of Gene Hackman, both of whom were apparently voted “the least likely to succeed” among their classmates at the Pasadena Playhouse.
 
Like I often do for my monthlies, I wanted to use one of his memorable movie quotes, like that above from the Poseidon Adventure, to tie into how I think about investing or life in general. But that would be an injustice to such an acclaimed Hollywood star. Besides, the implied hook is hardly subtle. Rather, I think the best way to honor him is to mention him here and hope that some of you may remember him and perhaps watch one of his remarkable performances again.
 
I thank him for the many happy moments he gave me. May he rest in peace.​

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