Investing: Narrative and Analytics, Art and Science


January 19, 2017 | By Alex Gavrish, Etalon Investment Research; author of "Story Investing"



Embrace uncertainty

In my recently published book Story Investing I discuss how to be creative in the investment research process and come up with great investment ideas. One of the highlights of the approach is the proposal to develop both a historical perspective as well as future narrative for the company and its share price.


Limitations of analytics

Strictly analytical approach to investment management does not provide us tools for dealing with uncertainty. The closed and fixed form of analytics leaves no place for imagination. And without imagination, we are just not capable of fathoming uncertainty, fathoming the future. Famous investors say that investing is half art and half science. Many succeed with the science part. The analytical effort is exactly this science they talk about. But what about the art part? What exactly they mean by art?


Investing is half science, half art

I think that one of the "art" aspects of investing is exactly this ability to work with uncertainty. The analytical approach just cannot help us with this. It does not allow one to become an artist. One of the reasons being that analytical approach, by nature, does not lend itself to multiple perspectives and meanings. But the artistic does. Roland Barthes, French literary theorist and philosopher, proposed an idea that meaning should be actively created by the reader of a text. He considered that apart from strictly sequential elements of the timeline that reader follows, stories can have many meanings. He thought that ideal text is one which is not restrictive in meaning and is open to a variety of independent interpretations. He defined such text as "writerly" - text, in which the reader is active in the creative process, compared to a "readerly" text which is restricted to reading. Whatever the depth of research and analysis investor reaches, there is always some uncertainty, some risk and unknowns that remain.


Narrative mode of thinking

Jerome Bruner explains that narrative mode of thinking leads to conclusions not about certain absolute truths, but about varying perspectives that can be constructed to make experience comprehensible. He believes that a great writer's gift to a reader is to make him a better writer. It is not a coincidence that most of successful investors are also good writers. Of course, one should not be carried away into fantasy with this storytelling: the story should be combined with analytical thinking and should be supported by fundamental valuation.


L Brands Inc: a classic value investment story

Shares of L Brands Inc declined by about 39% from their December 2015 high. Despite ongoing weakness in retail sector overall, we believe L Brands Inc is an exceptionally high quality company. We therefore think that large hedge funds or activist investors will not miss the opportunity to allocate capital at these price levels and it is a matter of time before media news articles will highlight this. We believe that significant decline in share price provides a classic value investment opportunity for long-term, value-oriented investors.


Company profile

L Brands Inc is a specialty retailer of women's intimate and other apparel, beauty and personal care products and accessories. Company sells its merchandise through company-owned specialty retail stores in the United States, Canada, United Kingdom and Greater China (China and Hong Kong), and through its websites and other channels. Company's other international operations are primarily through franchise, license and wholesale partners. L Brands Inc currently operates the following retail brands: Victoria's Secret, PINK, Bath & Body Works, La Senza, and Henri Bendel.


Valuation narrative

Based on a recent share price, L Brands Inc had market capitalization of $17,277 million, net debt of $5,070 million and an enterprise value of $22,347 million. In the 2015 fiscal year, company generated $2,607 million in EBITDA. Based on 2015 BITDA, the company is currently valued at an EV/EBITDA multiple of x8.57. Free cash flow was also attractive: over the past three years it averaged $1,017 million, which provides a free cash flow yield of 5.9% based on current market price. Company pays a regular quarterly dividend of $0.60 per share, which at current market price represents an annual dividend yield of 4%. Over past three years, company returned to shareholders a total amount of $2,841 million through share buybacks and dividends, which is close to approximately $3,051 million of free cash flow generated over this period. This indicates that the company is highly shareholder-friendly.


Conclusion

L Brands Inc's shares declined during 2015-2016 from a high of $99.47 in December of 2015 to current $60.42 per share, a decline of about 39%. Conservative valuation, meaningful dividend yield of almost 4%, attractive free cash flow yield of 5.9%, and growth potential provide an excellent entry point for long-term, value oriented investors.