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The Perils of Focusing on What Doesn't Matter
Or why you can safely throw most of an annual report into the trash
Most investing literature is altogether too wordy, and many so-called “analyst” reports are just thinly veiled dick measuring contests from a group of people who are way more interested in sounding smart than achieving results.
Now that’s an opening paragraph! One of my best.
Meanwhile, most retail investors are the exact opposite. They end up with some cash to invest and it literally burns a hole in their pocket. After a vigorous 15 minutes of scrolling Twitter (much of which is distraction from nudie pics), they stumble upon a thread from some smart-sounding guy listing the virtues of some SaaS stock. It checks off all their boxes — and someone with a large number of followers has clearly done some due diligence — so the next morning they hit the buy button.
I know this because I’ve literally had people tell me they’ve done this based on some of the stuff I published on Twitter, or FU, or wherever else had the misfortune of hosting my inane ramblings. I don’t mind so much when I have my capital tied up in something, since the misfortune of me losing money will always trump feeling bad when someone follows me into a stock. It’s not like I made the guy go out and buy something I tweeted about. And besides, I like to think I’m a pretty good securities analyst. Most of my picks don’t implode. Some end up making money even!
So when it comes to investment research, you end up with two sides that are probably equally extreme. The funny thing is the more experienced you get the quicker the process should become. I eliminate a lot of investments in minutes based on a quick look at the financials. A lot of these “stupid” retail investors who make decisions based on a Twitter thread or an article are anything but. They’re smart folks who have a nose for decent opportunities. They don’t need detailed analyst reports because they know already 90% of these are talking about things that will not matter in the long run. At. All.
That’s what this post will be about. The perils of basing an investing decision on something that didn’t matter.
The curious case of MEQ
Back in 2019 your author had his eye on Mainstreet Equity Corp (TSX:MEQ).
Many investors are unfamiliar with the company despite its excellent long-term results. Led by founder Bob Dhillon, Mainstreet has a simple strategy. It buys older apartments in clusters in cities like Calgary, Edmonton, Abbotsford, Saskatoon, Regina, and, most recently, Winnipeg. Apartments are then fixed up and refinanced, taking the equity out and using it to acquire more property.
As it stands today, Mainstreet owns more than 15,000 units in 17 different cites.
It’s a really smart strategy. By focusing on smaller buildings (without costly areas like elevators or parking garages) that are clustered close together, Mainstreet can create efficiencies on both the property management and repair/maintenance side. It also has an intimate knowledge of these neighborhoods, meaning it has a much better idea of what the assets are really worth. And even after 20 years and acquiring more than $2 billion worth of assets, there’s still plenty of growth potential.
Here’s the business model in one slide.
Dhillon and his team have rode this simple model to incredible results. The company has averaged a 19% CAGR in the number of suites owned since 1998. By the extensive use of debt and constantly pulling equity out of newly-renovated properties (and by also not paying a dividend), the company has been able to grow at this rate while keeping shares outstanding virtually the same. It’s a pretty impressive achievement.
It was cheap in 2019 when I first looked at it and the stock remains cheap now. Net asset value is around $132 per share today. Shares trade hands at $120. It’s not as cheap on a price-to-FFO perspective, with the stock trading at more than 23x 2021’s FFO of $5.08 per share. But 2022 should see nice improvements to the bottom line as MEQ is currently renovating about 8% of its total portfolio, properties that will start generating revenue next year.
If you like skin in the game, then you’ll love Mainstreet. As of March, 2021, Dhillon owned more than 4.3 million shares, or about 46% of the total shares outstanding. He’s still relatively young too (in his early 60s), meaning he could easily have another 20 year run in him.
Sounds pretty good, right? I liked all this in 2019 when I looked at the company originally. And the stock has increased from $40 to $120. The rest of this should be a victory lap.
But it isn’t. Because I never bought the stock. And in hindsight it was a pretty dumb reason, too.
Nelly dropped the ball
Here’s the paragraph that made me pause when originally researching Mainstreet:
(It’s the 2021 version but the 2019 version was essentially the same)
I never understood why everyone in the company thought that was okay. Is the CEO really the one doing all the work for acquisitions? Doesn’t he have more important things to do? And why wouldn’t the commissions go straight into the company’s coffers? A quarter million dollars per year works out to about $0.03 per share in annual FFO. Not much, but it’s something.
I focused on a quarter million in commissions and completely ignored the much bigger signal - that Dhillon owned nearly 50% of a company that, back then, had a market cap of more than $300 million. It’s close to $1.1 billion now, by the way.
It’s obvious that the commissions didn’t matter. The market saw the same info I did, shrugged, and proceeded to bid the stock much higher. And besides, maybe Mainstreet’s board saw the potential to reward the CEO by using money that came directly from sellers. Isn’t the whole point to continue to acquire property?
Let’s wrap it up, kids
I learned a valuable lesson from Mainstreet and dozens of other opportunities just like it. Investors focus on one or two main narratives. The rest doesn’t matter.
With Mainstreet, much of the stock’s success over the last couple years can be attributed to two things. Firstly, residential real estate did well as investor dollars flooded to safe havens as COVID ravaged certain parts of the market. And secondly, residential real estate is an excellent inflation hedge. These big trends were the thing that mattered. A few commissions paid to a CEO who is already doing a good job didn’t matter a lick. Yet I invalidated a whole investment thesis on them.
Investing is already hard. And identifying the thing or two that’s going to matter is easier said that done. But let’s not make it harder than it needs to be.
What I’m doing going forward is simple. I’ll still read a couple annual reports before putting capital into a company. But I put very little weighting on most of it. Rather, I’ll try to identify the major themes that will matter, write them down — preferably in this here Substack so y’all can see them too — and follow up years later to see if I’m right.