Dear partner,
At Chess Capital, we invest in companies, not “the stock market.” However, this does not mean that it is illogical to compare our results to those of asset managers or the market in general.
We have received some questions from concerned partners regarding our fund’s underperformance compared to other portfolios. We understand that it doesn’t help much when we say we are certainly not doing poorly compared to similar funds with the same investment style. After all, what is the value of an investment style that does not yield returns?
From our previous quarterly letters, you are aware of our concerns about the current market situation. We agree on this as well: the results run counter to our logical reasoning.
And yes, we too are frustrated and absolutely not satisfied with the fund’s performance. Most of our liquid assets are in the fund, and as you know, we only earn something if we exceed a minimum threshold.
Still, we are talking about outstanding results.
What if Chess Capital was a company?
Suppose Chess Capital were not a fund but an ordinary company. Would we then measure our performance based on the stock price? Yes, many investors do, but we do not. We are entrepreneurs investing in companies, and we see ourselves as a company.
Let’s take a look at the company Chess Capital. From December 31, 2020, until today, earnings per share have grown annually by 50,7%. Yes, you read that correctly: more than fifty percent per year.
Why from December 31, 2020, and not from the start date in early June 2020? Because, of course, we started with 100% in cash, and cash does not generate profits. The portfolio still needed to be built up. Moreover, the profits in 2020 were negatively impacted by COVID-19. Therefore, if we were to compare profits from an earlier date to the current ones, the growth would be even greater (and that would not be a fair comparison). By December 31, 2020, almost two-thirds of our funds were invested.
Let’s also consider the period starting from December 31, 2021, when we can truly speak of the post-ramp-up phase. Over the three years that followed, we saw an average earnings growth of 22.1% per share per year. Over the past two years, that average is 37%.
Manipulated profits? Both EBIT and EBITDA followed the same growth patterns, and the book value increased significantly.
A technical note before we review the overviews:
- The calculations run until October 2, 2024. This means that 2024 is not yet a complete year.
- The figures we have available for 2024 are the LTM (last twelve months) figures, usually from July 1, 2023, to June 30, 2024. These comments apply to both the fund and the companies mentioned.
An overview of the CAGR (the Compounded Annual Growth Rate) of our fund:
EPS = Earning per share
BPS = Bookvalue per share
Yes, you see that correctly: these are indeed outstanding results, which you would expect from a tech company, not from a fund that mainly invests in simple and “boring” companies.
Let’s compare this with a number of companies, starting from what has so far been the highest price for our fund: December 31, 2021.
If we look at the growth figures of the Magnificent 7 and our Belgian pride, Lotus Bakeries, our ‘company’ Chess Capital would rank third in earnings growth, fifth in book value growth, third in EBIT, and second in EBITDA.
Our results match those of the Magnificent 7 and Lotus Bakeries.
It is doubly frustrating that all our hard (and good) work is not being rewarded—neither through better results for all of us, nor through compensation for Joël and me.
But let it be absolutely clear that this frustration is not the same as concern: we are not concerned about our portfolio and the underlying companies.
Then what’s going wrong?
Yet, our fund does not come close to matching the price evolution of these companies. Where is it going wrong?
Investors are willing to pay less and less for our companies, even though we bought them at already low prices. These lower valuations are reflected in the share price of our fund.
This is the evolution of what was paid for our portfolio in the market:
You can see the evolution from investors willing to pay 1.94 times the book value at the end of 2020 to 0.91 times today. It is even worse in terms of earnings figures. The price-to-earnings ratio on December 31, 2020, was of course somewhat skewed by COVID-19, and at that time there was still a lot of cash that yielded nothing, so it’s better to track the earnings figures from 2021 onwards.
However, for book value, €1 in cash is also €1 in book value, so tracking it from 2020 is appropriate.
If you invest in the fund today, you are buying below book value. As we’ve seen, this isn’t due to a lack of earnings growth. Our companies are indeed growing their profits.
If you invest in the fund today, you are buying at a price-to-earnings ratio of 8.3—again, for growing companies.
Furthermore, if you invest in the fund today, you are buying companies with a debt ratio of just 34% (transparently calculated for the underlying companies, as the fund itself does not use leverage), meaning we also face less-than-average risk in that regard.
As strange as it may sound: such abnormal evolutions are normal in the stock market. This is also why we have always been able to achieve substantial returns in the past by taking advantage of this irrationality. We need these periods to sow so that we can reap later. However, the harvest has been delayed for a very long time now.
Some more shocking figures? The earnings per share of the S&P 500 (the 500 largest companies in the world’s strongest economy) have been stagnant for three years. From the end of 2021 at $198 per share to perhaps $205 to $210 by the end of Q3 (those figures are not yet available).
The book value of the S&P 500? It grew over three years from $1,008 to an estimated $1,130. That’s almost nothing.
Meanwhile, investors are willing to pay 15% more for the same dollar of earnings in the S&P 500. This stands in stark contrast to our portfolio, where investors are paying 50% less for each euro of profit compared to three years ago. The S&P 500 trades at a P/E of 27.9—more than three times what is paid for our selection.
If you then compare what investors are willing to pay for our companies with what they pay for the Magnificent 7, I’ll let you calculate for yourself what this would mean for your shares if they applied the same multiples to our company/fund.
Of course, we must be honest: the growth we achieved was mainly because we could acquire all those profits very cheaply. Now that we are almost fully invested, our profit growth is limited to:
- The growth of the underlying companies, and
- Replacing positions that have risen to or above fair value with new positions that are significantly undervalued.
To understand the growth realized by the underlying companies, without our capital allocation effects, we refer to the presentation given at the last two annual meetings.
Once a year, we take a snapshot of the portfolio and look at these companies over the past five years. Last year, the average annual growth over the previous five years of our underlying companies was 11.9%.
We’re not looking at this through rose-colored glasses either. The economy is slowing down, both in Europe and the United States, which will put pressure on earnings, especially for our cyclical companies.
That’s why the evolution of book value, both in terms of growth and multiple, is more enjoyable to observe. Profits can fluctuate significantly, but as long as profits are being made, book value will grow—some years faster than others.
The Fund
The third quarter was very volatile, not just for our fund. On Monday, August 5th, the media and market watchers announced a crash, but by Friday, it was already forgotten.
Our fund experienced a mixed quarter with a flat July, a weak August, and a recovery in September.
Again, I want to emphasize what was previously written: we have no control over how the markets react. We can only continue working on the growth of intrinsic value. According to our conservative approach, it is doing well. You know, that orange line.
Results T-Class
Results A-Class
Our five largest positions are:
The following positions had the most negative impact on the result since January 1st. 
The following positions had the most positieve impact on the result since January 1st.
Transactions
This quarter, there was more movement in our portfolio. We sold three holdings to free up funds for cheap stocks.
This was always one of the purposes of these holdings, although we certainly cannot complain about the profits we made with them. We made a 25.3% profit on Markel, 57.3% on Ackermans, and 128.31% on Berkshire.
Below is an overview of all positions closed to date:
These results include net dividends and are after transaction costs.
This quarter, we acquired four new companies. K+S is a potash and salt company from Germany. Due to increasingly strict environmental regulations in Germany, this company has fallen somewhat out of favor. Additionally, it is a cyclical company, with the market already anticipating significant declines. We bought it for 0.3 times its tangible book value.
Vicat and Manitou have a similar story. Vicat is a French cement company, and Manitou is a French specialist in all-terrain equipment such as forklifts and telehandlers. For these three companies, the situation is the same: because the market has a very pessimistic view of the future, they are trading at rock-bottom valuations.
While K+S trades at 0.3 times tangible book value, Vicat trades at 0.92 times, and Manitou at 0.74 times. Even under much worse conditions, these companies traded at a multiple twice as high.
Glatfelter and the “position in progress” fall into the category of “special situations,” such as net-nets, mergers, and spin-offs that the market has incorrectly valued. However, these are very small, less liquid, and volatile companies, meaning we can only take a small position. These are good for achieving short-term results, but within the entirety of the fund, they are not significant enough to discuss separately.
Company news top 10
We are consciously skipping this section this quarter. While we promote investing as investing in companies, this time we want to focus on our message from the first pages: the entirety of the fund.
Kind regards and thank you,
Sam & Joël