1Q 2018	2Q 2018	3Q 2018	YTD
Rockvue Capital	6.70%	0.40%	2.66%	9.76%
S&P 500	-1.22%	2.93%	7.20%	8.91%
Russel 2000	-2.05%	7.43%	3.26%	8.64%
RC vs. S&P	8.25%	-2.53%	-4.54%	0.85%
RC vs. Russel	9.08%	-7.03%	-0.60%	1.12%

“To Improve is to change, so to be perfect is to have changed often.” – Winston Churchill

Third quarter of 2018 is in the books, and it was another productive one for the Fund. Rockvue Capital returned 2.66% for 3Q 2018, trailing the S&P return of 7.20% and trailing the Russel 2000 return of 3.26%. Per the chart above, you can see that YTD Rockvue Capital is beating the chosen indexes by close to 1%. Remember, three quarters is a foolishly short time-frame to judge an investment strategy or philosophy. The farther time frame you use, the clearer the picture. I fully expect to be judged by my five-year track record. During this letter, I want to touch on three topics that I believe will give great insight into my philosophy and give the readers of this letter a deeper level into my thinking (as well as sprinkle in a review of the portfolio). These topics are: Crowd Psychology, Dumpster Diving, and When To Sell. 

Repositioning The Portfolio

In previous quarters, I liked to sprinkle in a few “macro” trades here and there. Trades such as commodity plays or country specific indices where I wasn’t necessarily trying to buy great businesses at great prices, but rather I was exploiting what I thought to be a positively asymmetric risk/reward opportunity. While most of these plays weren’t losers (in fact, most of them were decent winners), it was capital deployed that could have been invested in those great businesses trading at great prices. As I’ve grown as a value investor, I’ve recognized that 99% of my portfolio should be (as best I can) filled with great businesses at great prices, special situations, and asset plays. The remaining 1% of my time and capital might still be used for those commodity plays and the like, but minimal capital will be used.

With that being said, I spent this quarter repositioning the portfolio to reflect my inner transition and dedication to a pure value investing style. I cut the following positions: Long US Oil, Short Gold, and Long USD. Each of these plays ended up being winners for the Fund, with my Long USD position adding nearly 80bps to the Fund’s performance. These trades gave me capital to deploy into other businesses that I’ve been following, which we will get to later.

In summary, I want to go back to the quote at the top of the letter. To improve is to change. I’ve changed a great deal over these last three quarters as an investor. Each quarter I’ve learned more, developed new ideas, and refined what it means to me to be a value investor. Although I model my style after the likes of Ben Graham, Warren Buffett, and Michael Burry, I still need to be unique to what works for me. I feel extremely confident in my strategy and in my philosophy; I sleep well at night because of it. Let’s dive into the losers!

Knowing When To Sell

Knowing when to sell is much harder than knowing when to buy. When you buy a position, you’re using a margin of safety, you think there’s a value discrepancy, and you’re using time to your advantage to watch the market realize that difference. With selling, it’s different. You’re giving up a business you once thought was great (and still might be great!), you’re doing away with hours, days, or even weeks of hardcore research into the fundamentals, just to toss it aside. Hindsight bias is also brutal in the selling game. If you sell and shortly thereafter the price of your stock skyrockets, you’re left with FOMO, kicking yourself for not staying in the game, getting out too soon. Neurologically speaking, painful / hurtful events impact us twice as hard as positive events. In a sense, your brain tells you, “who cares about the last time you sold and the stock tanked right after, look at how much money you left on the table on this trade!”. To be successful as a value investor, you need to know when this side of your brain is talking, and you need to learn how to control it. I’m going to give two examples on selling: one for a loss, and one for a gain.

Sell When Your Thesis Changes

I sold LIVE Ventures (LIVE) in mid August for an 85bps loss after the company failed to disclose that it was under subpoena from the SEC in its most recent quarterly report. I reached out to the CEO via StockTwits and he (Jon Isaac) explained to me that the company, “wasn’t required to disclose that information via the 10-Q”. That response right there sent huge red flags in my head, and I wanted out as soon as possible. I want to be clear though, the reason I exited wasn’t because the company was subpoenaed, it was because management knowingly withheld that information from their quarterly earnings call. They left shareholders on their own to dig for it in the last few pages of their 10-Q.

When I invest in businesses, I am investing in management’s ability to enhance the value of the business over time. Given the smaller size of some of my investments, the importance of trusting in management is paramount to the company’s overall success. Knowing that management would withhold critical information such as ongoing subpoena from their shareholders, I knew it was a management team I could no longer trust. I value transparency, even if it means ugly news. Remember, the goal is to own great businesses with incentivized management teams that are both doing the right thing and maximizing shareholder value. I need that to sleep well at night.

I sold my stake in LIVE the next trading day for around $10 and change. Fast forward to today (10/02) and the company is trading around $8 and falling fast. I don’t say this to gloat about how I got the timing right on this one. I sold because my overall thesis changed. I could no longer trust the management team. The company could’ve skyrocketed back into the $12 – $14 range and I still would’ve been okay with my decision. It’s a process, value investing. If you are dedicated to the process you will be rewarded. I will never be comfortable investing capital in businesses with shady management teams, never.

Sell When You Can Buy Something Else That’s Better

The second example of one of my sells in 2Q 2018 was Vaalco Energy, Inc (EGY). EGY turned out to be a great investment, generating a little over 1% total gain for the Fund. Share prices rose over 150% from where I originally bought six months ago, giving the position an average monthly return of 25%. EGY was an asset play on oil prices. The company had zero debt, a super clean balance sheet, and oil prices locked in at $74 per barrel for their sales. Knowing this, I initiated my position and held on for the ride. However, with asset plays, there will always be an exit, and it won’t always be because the business has changed. Commodity plays, like oil, are cyclical in nature. Timing matters. I knew the shelf life of this investment wasn’t going to be one, two, or three years. Because of this, I knew that the time would come where I could sell it for a profit, and take the proceeds to plow into another great business at a great price.

Sometimes you sell because you simply found something that has a better risk/reward ratio, or the business is better, or the prices are so cheap you’d be stupid not to buy. That decision is made easier if your current investment is a) already given you high profits, and b) is a cyclical commodity play. For those reasons I decided to sell, but you can see how it is starkly different from the first reason I gave. But remember, there’s always opportunity cost that goes into effect once you sell. In the case of the Fund, if I am selling an investment because I think there’s better options, I better have high conviction in that idea. My portfolio is only around 10 – 12 positions. Because of this, potential investments have a high barrier to entry to clear through before becoming part of the Fund.

Other Notable Sells (Post-Mortem)

I exited out of three investments (all for losses): Carriage Services, Advanced Energy Industries, and Hostess Brands. All three of these businesses remain on my radar, and I hope to revisit them at better prices. Looking back on all three of these investments I found a single determinant into why they ended up being losers: lack of patience. I simply didn’t wait for my price. Instead, I became so enthusiastic about the business that I failed to stay patient enough to wait for Mr. Market to give me an opportunity. I tried to force it.

Carriage Services (CSV), for example, is a great business with an excellent management team. I didn’t wait long enough to see if Mr. Market was going to give me a better price. I bought in on the highs, something I try to never do, and I paid the price. I took the loss. Through this, I learned a valuable lesson: always wait for your price. Patience is my greatest asset, I need to utilize it more. There’s a quote that says, “There are no such things as bad assets only bad prices.” I couldn’t agree more.

Hostess Brands (TWNK) ended up being bad timing on my part as I bought very close to the company’s earnings report. This is always a gamble because right after earnings is the most binary time for a company: they either skyrocket or fall significantly, there’s rarely an in-between. During their earnings call the company disclosed that they lost a significant amount of shelf space with one of their biggest customers, Walmart. This sent shares tumbling upwards of 20% over the next few trading days, and prices still haven’t found a bottom. TWNK ended up being a 1% loss for the Fund, but at this point, I hope share prices keep falling. TWNK is still a tremendous brand with competitive advantages, I simply paid the wrong price and failed to recognize the timing of my purchase. Please realize that I am not saying I try to predict tops and bottoms in stocks, nobody can do that consistently (I will do that maybe 0.50% of the time). What I am saying is that it matters what price you pay. Even if the business has great growth prospects and competitive advantages, it matters the price you pay.

A Word On The Winners (& New Position)

The Fund had a number of positions positively impact the portfolio, and I’ll touch on a few here. Finjan Holdings (FNJN) increased nearly 30% during the quarter off the back of a fantastic earnings report, topping revenues, cash flow, and cash on hand. The company is extremely well positioned to deploy capital in a shareholder-friendly way while maintaining zero debt on the balance sheet. FNJN remains a patent-troll and generates its revenues from court case decisions, which come in lumpy fashion. On top of that, the company sells Virtual Private Network (VPN) products such as web hosting and VPN applications for Android and iPhone. FNJN has high barriers to entry given its significant patent profile, and with the importance of cybersecurity on the rise, the company is suited well to continue to profit off those patents.

Park City Group, Inc (PCYG) was also a large contributor to the Fund’s positive performance, returning close to 20% for the quarter. PCYG came out with excellent earnings report for 4Q 2018. Revenues were up 22%, net income rose 44%, added 12 new Supplier Hubs, and recorded its largest compliance contract in its history. With each new supplier and distributor deal, the company expands its network effect, giving more value to its ReposiTrak software. Take Patrick Spear’s quote on ReposiTrak’s Marketplace software that he uses at the GMDC (Global Market Development Center) (emphasis mine):

“As a retail-owned association, fueled by a strategic partnership with ReposiTrak, it is our mission to amplify and create a seamless, year-round connection for buyers to suppliers and their products. Buyers can search the GMDC MarketPlace anytime and discover new products, line extensions and catch up on the latest trends. We see the MarketPlace becoming an indispensable tool for our members to expand assortments to meet the evolving tastes of consumers.”

PCYG is well positioned for 2019. Management expects continued double-digit top-line revenue growth with even higher growth rates in net income and free cash flow. Food safety & compliance as well as supply chain management is a growing industry with many tailwinds in place. I am optimistic about PCYG’s continued success.

The last winner I’ll touch on is Discovery Communications (DISCA). Since purchasing my stake in DISCA share prices have risen upwards of 20%. The big news for the quarter was the company’s deal with Hulu, giving Hulu rights to broadcast Discovery shows on their platform. This was a big step in DISCA’s plan to adapt to the changing streaming environment of television and video. By signing that deal with Hulu, DISCA enabled its content to be viewed by an additional 22.3 million Hulu subscribers. That should bode well for their advertising revenues. The deal signaled to me that management is doing what it should, and for that, I remain confident.

New Investment Highlight

One new investment I want to highlight is Estre Ambiental (ESTR). I wrote a very lengthly post on ESTR in the blog, but I want to take the time to flesh out the reasons for the investment because it gives you the reader a deeper look into where I seek value. ESTR is a Brazilian Waste Management company formed via a SPAC offering with Boulevard Acquisition Corp. Estre is the largest waste management company in Brazil. It sports tremendous barriers to entry, numerous competitive advantages, and it’s in an industry that won’t ever go away and is resistance to recessions.

The company also has its fair share of problems. Before current management came in, the ESTR dealt with criminal investigations for bribes and saddled itself up with debt (to the point of 4.3x leverage). However, with new management in place, the company is letting go of its criminally investigated past and transitioning into the future. CEO Sergio Pedreiro is the former CFO of Coty, Inc. the United States perfume company that generates roughly $8B in sales annually. Before that, Pedreiro served as CEO of a leading Latin America railroad company, as well as serving on the board of Advanced Disposal, Inc, a US waste management company that sported annual revenues of $1.4B during his time. Pedreiroo reduced corporate headcount by 30%, slashing capital expenditures where there was extra fat. This is important in an industry like waste management due to it’s already higher than normal fixed costs of operating. Cutting wherever one can in a business like waste management can have significantly positive impacts on incremental margin expansion.

To go along with a newly invigorated management team, the Brazilian waste management industry has tailwinds for growth and is highly fragmented, presenting an opportunity for ESTR to roll-up most of the industry. Given ESTR’s size and scale of operations, it becomes much easier for them to roll-up than another firm with less capital and financial flexibility. Even during the last recession in Brazil ESTR was able to generate 4% CAGR revenue growth and 29% EBITDA margins. The company has reduced its leverage to 3x, generates consistent free cash flows, and is trading at 7x EV/EBIT.

I started buying shares around the $7 mark and prices have fallen ever since to where they currently stand around $6. The company reports earnings on October 4th, and I will be very interested to hear how their progress is going.

Dumpster Diving & Crowd Psychology

All Time Lows Are Great Starting Points

ESTR is a great case of how I find investment ideas. I dumpster dive. I look at the corners of the market that nobody likes going. This includes combing through a list of stocks hitting All Time Lows, SPAC offerings, spin-offs, and illiquid companies. I like looking into industries that are beaten down (think retail in summer of 2017 & oil / gas currently). I am not one to window-shop my portfolio, make it look good so people can see what cool names I have in my Fund. One might think, “But  if you’re looking at companies that are trading at all time lows, that must mean they have problems.” Exactly! My job is to see if those problems are permanent or temporary. If they are temporary, I have the potential for discovering something undervalued. If they are permanent (and most are), I move on and turn over another rock.

By searching through these areas of the market I give myself a competitive advantage over larger investors: restrictions. I have no restrictions as to what I invest in. Some investors, given their size, can only invest in companies with high enough market caps. Other investors, due to their ADV’s, can’t invest in foreign companies or spin-off companies. Any time I can find an asset that is being sold for reasons other than the fundamentals of the business, I get excited. One investor’s trash is another investor’s biggest winner. I’m a firm believer in that. Does it take more time? Yes, absolutely. But is it worth it? 100% yes. I will always be a dumpster diver, it’s in my nature. This brings me to the last topic I want to discuss: Crowd Psychology.

Fighting The Herd Mentality

I’ve always had a contrarian-like personality. Ask anyone that’s close to me and they will confirm my thesis. Because of this, I feel fine being the only one on the long side of a trade. I feel comfortable looking into a company that everyone else is throwing away and discarding as garbage. If I want to beat the market, I have to do something different from the market. It’s that simple. Following the herd is dangerous, but it’s evolutionarily what we are predisposed to do. Think about it for a second. When humans were hunter-gatherers, it paid to stay in groups. Leave your tribe to go hunting alone for the night and you’re asking for trouble. What if a lion visited you? What if you got lost? Following the herd equaled safety and preservation of life … No wonder the urge is so hard to fight! However, in investing, this herd mentality will erode any chance you have at outperformance. In order to generate outsized returns one has to be willing to un-hinge from the crowd, take a different point of view, and have high conviction in their contrarian holdings. By doing this, I give myself a chance to beat the market on an absolute basis over time.

To finish this point, I will leave you with the three investment ideas I am pondering right now for 4Q 2018. The three investment ideas include two spin-offs and one natural gas company that sells ceramic and sand proppants for drilling. Off the beaten path, dumpster divers, this is my home. Please feel free to reach out to me if you have any questions on specific investments, philosophies, or if you just want to chat about investing.

As we turn our eyes to the last quarter of the business year 2018, I want to stress that value investing is a marathon, not a sprint. Over a five-year period I fully expect to beat the market indices, and any short time frame (whether it be a quarter or a year) should be taken with a grain of salt as it fails to paint an accurate picture of the success of a value investing strategy.

DISCLAIMER