Increased Nokia position

I have been trimming down our Nokia position during this year and after Q1 result wrote that
"the stock hasn't gone anywhere in last 5 years."

Well,
Now it has, but not to the direction investors would like to see:

Nokia Corporation share price in New York (USD) last 5 years.

Chart courtesy of StockCharts.com

Stock price is now below 5 year lows (in dollars) and to me it looked like a good opportunity to once again increase the position.

After Q1 I wrote:
"My key worry relates to very weak gross margin (GM) in the core business outside of patent/licensing business."

Networks unit GM was better than Q1, but still weak below 30% (and 5% lower than a year before).

Nokia Software GM improved 5% year on year and operating margin more than doubled so that's in a good track.

Nokia Technologies delivers - as always - stellar GM (97,8%) and OP (82,1%).

So, despite the very negative reaction in stock market, it's fair to say the business - especially Nokia Software unit - is going to the right direction.

I think the stock price movement was mostly due to Nokia lowering the expectation for the years 2019-2020 and beyond. Also, halting of quarterly paid dividend - even if just for Q3 and Q4 as announced - is an alarming signal.

All in all, Nokia management moved the ball one year forward stating "We expect that we will be able to progressively mitigate these issues over the course of next year.".

2020 was supposed to be a really good year, but now the payday has been moved forward and it doesn't look so sweet as it used to.

Nevertheless, the potential is there. It is not all bad.

The company just needs to get all the ducks properly in the row - especially in the Mobile Networks side of the house, which is the key to success in 5G.

Once again, I bet our money on Nokia board of directors and management making the right calls. The investors are now in need of clear positive signals.

At these levels there is already some safety of margin given e.g. some sum-of-parts analysis that I have seen (everyone can make their own estimate on the value of e.g. patent portfolio, Nokia Software and so forth). However, I would not be surprised if the fall in stock price would continue still.


Disclosure: We are long Nokia and do not consider to sell or buy in next 48 hours.

Portfolio update

We continue almost fully invested in stocks (~99%).

Our new sector allocation for stocks look like this (please click the picture to enlarge):

The main theme is "technology and related services" as nearly 50% of the portfolio is now allocated to companies providing high tech products and/or services (software and/or hardware) or supplying components to such companies (e.g. semiconductor manufacturers).

In terms of place of incorporation, more than 60% are based our home country (Finland, Europe) and the rest are based in USA. Majority of the corporations operate and sell globally.

Sold Berkshire Hathaway and trimmed down Nokia

I have made many changes in our portfolio.

Selling all shares in Berkshire Hathaway (NYSE: BRK.B) is the most significant move this year. The position grew to be our largest position from entry at $126,75 in January 2016 to exit at $200,34.

Majority of the proceeds were converted to euro and deployed to grow our existing positions at Nasdaq Helsinki. The remaining dollars were used to open positions in Dell Technologies (NYSE: DELL) and CVS Health Corporation (NYSE: CVS).

Our position in Nokia Corporation (Nasdaq Helsinki: NOKIA) has been trimmed down significantly (over 50% sold). Our average entry cost - before trimming - was 3,13 euros with majority of the shares now sold having been acquired below that. Thus, a significant profit taken also from there. The proceeds were re-deployed to our other positions at Nasdaq Helsinki.

The main rationale behind the actions is to balance the portfolio and move money to the positions that seem to be much more promising over long term (5-10 year) than those that were sold.

We have now 25 stocks in portfolio and out of those 17 from Nasdaq Helsinki. Top 3 positions are dominated now by U.S names:

1. Western Digital
2. Apple
3. Micron

Cost control

The expense ratio of an Exchange Traded Fund (ETF) measures how much of the assets are used for administrative and other operating expenses. Expense ratios have come down significantly over the years as the funds have grown and have thus become more efficient (same fees etc. divided by larger amount of assets under management).

ETF expense ratios vary typically between 0,1-0,8% and the lowest ratios are to be found among very popular passive index funds such as SPDR S&P 500 ETF Trust (NYSEARCA: SPY).

Compared to actively managed mutual funds ETFs have very low yearly fees. However, it's easy to fall into trap of thinking that expense ratios below 1% are small enough not to matter that much.

To illustrate why even expense ratios in the ballpark of 0,2-0,6% are significant over the very long term, I calculated two examples for investment of 10.000 euros over 40 years.

In the first scenario (above) I assumed that yearly gain is 5%. The difference between no yearly cost (expense ratio 0%) and 0,6% year cost is 14.422 EUR.

To get a more drama, I calculated a second scenario (below) where yearly gain is 10%. There the difference between no yearly cost (expense ratio 0%) and 0,6% year cost is staggering 88.935 EUR.

Naturally, the markets do not produce steady returns and there are ups and downs over the years. Thus, the calculations above are completely theoretical and made to illustrate the effect of yearly cost in simple scenarios.

Takeaway for buy and hold investors:

In the long run, it's not the profits alone that matter - also cost of holding matters a great deal!

The good news is that the investor can fully control his/her yearly fees by selecting ETFs smartly or investing directly into stocks.

Winner take all - until..

Some of the Internet giants - also known as the "FAANG" companies based on their initials - start to be so big due to the winner-take-all effects that they may face antitrust lawsuit.

From what I understand two of the companies in particular are nearing this stage: Amazon and Google. Both are very dominant and vertically integrated (i.e. they develop most of their infrastructure by themselves). Apple is also vertically integrated, but in my view, they don't have the same kind of dominance in their respective markets than Google and Amazon do.

American Telephone & Telegraph Company (AT&T) is an interesting precedent because it was vertical integration - not it's domination in itself - that motivated Federal Communications Commission to sue AT&T. They suspected that the AT&T was using monopoly profits from its Western Electric subsidiary to subsidize the costs of its network, which was contrary to U.S. antitrust law. The case was filed by the United States Department of Justice in 1974. [source]

Vintage Telephone Equipment at Museum of Communications 

by Marcin Wichary [CC BY 2.0]

Initially, The plaintiff in the court complaint asked the court to order AT&T to divest ownership of Western Electric. AT&T didn't want to do this. Instead, they proposed to give up ownership of the local operating companies, which was what eventually took place in 1984. [source]

Over ten years later - in 1996 - AT&T divested also the equipment arm as Lucent. The end result is that no operator today has significant own development in the telecommunications equipment. There has been significant consolidation in both operator and equipment provider space (e.g. in latter space what used to be separate Alcatel, Lucent and Siemens Communications are now part of Nokia Corporation.

The same kind of development may have to take place in the Internet economy to prevent some corporations become too dominant for the market to function efficiently. Separating technology development from the "operator" function is one way. I'm not too deep into FAANG family so will not speculate on details. What is clear though is that monopoly (and near monopoly) is a bad thing in free market economy and authorities will step in when some company becomes too dominant. Winner really can't literally take all.

Disclosure: Long Nokia and Apple.

Thoughts on Technology stocks

Over third of our portfolio is invested into technology stocks. But what is considered a "Technology company" ?

It seems "Technology" in this context has come to mean computer, computer networking and electronics related technology and services:

• Digital electronics (includes computers and components thereof)
• Software
• Services making use of computers and networking (e.g. on-demand video over Internet, e-commerce etc.)

Intel core i7-970 pin side

Image: Rainer Knäpper, Free Art License

"Tech" companies are often spending a lot on research and development (R&D) activity and many of them end up having sizable patent portfolio over time that protects their core innovations. 

I know R&D very well having spent more than 20 years in the front lines of technology development. It can be described as endless running competition. Even if you would have the advantage of being first in some space, you need to continue as others - perhaps companies 10 times your size - will be looking to enter the competition.

Netscape was first to release modern browser and it was at the time superior to anything before it. They were undisputed market leader in the mid 1990s with over 90% market share. Yet, by 2006 they had just 1% market share as Microsoft and many others invested heavily in their own browsers.

People typically see only the winners and forget the losers. For every "tech" that have made it big time there are tens of losers. And even those that make it "big" may not last for a very long time. This makes investing in "tech" very tricky. 

I have seen many first releases of a product and can say that in many that release will need considerable patching later on. Perhaps even second major release to really get it solid. The thing with R&D activity is that the more you have released the more you have to maintain. The maintenance part may - depending on the nature of the business - tie significant amount of R&D engineers. In the worst case, you need to also customize the releases for a given customer increasing the parallel software branches still.

Over time it is also easy to get locked in to a particular platform. Nokia's former mobile phone business is a famous example of this. They were so heavily locked to Symbian that they just could not pivot fast enough and were overrun by iOS from Apple and Android from Google. Apple didn't invent smart phone. They observed the market and available technology and eventually came up with far better design with iPhone that anyone before them - by a wide margin. They also came up with "Apps" and made the ecosystem fly.

Especially big tech companies have this kind of option that Microsoft used with browsers and Apple with smart phone. They can observe and learn from existing players while making their first release. If you are big (and skilled) enough, you can catch up pretty fast.

Therefore, small technology companies have to grow big fast or they risk being overrun. Many times the big will buy the promising small companies before they make it big. There are, of course, famous exceptions to this rule. The problem is that they are so visible and so good stories that people forget the "tech graveyard". The ones that didn't made it.

As an investor I tend to favor fairly valued established technology companies with long history, excellent brand and products, big enough footprint in their core markets, sizable patent portfolio and large R&D and sales departments. These are all things that are not easily replicated. For semiconductor stocks, you can add extremely expensive production lines requiring tens of years of know-how to build and operate.

It is hard to find "ten baggers" with this profile. However, it is possible to find companies that will see their market value grow many fold over time. That's good enough for me combined as it often comes with limited downside risk compared to whatever is currently "hot" in tech sector.

A look at the co-investment arrangement for Nokia GLT

The group leadership team of Nokia Corporation (NYSE: NOK / Nasdaq Helsinki: NOKIA) owned about 4,8 million shares in Nokia at the end of 2018. They also have a very lucrative co-investment arrangement, which allows them to invest their own money in Nokia shares and receive two performance shares under the 2018 long-term incentive plan for every share they purchase. The plan vests on 1.1.2021.

I call this lucrative because purchasing and holding on to those shares will expose them to minimal risk of losses. Let's assume the plan vests at 100% i.e. they get two additional shares for every share they have purchased with their own money. That would mean they will make profit even if Nokia would trade at 2 euros (2+2*2 euros). For example, Rajeev Suri purchased the shares related to this plan with average price of 5,25 euros.

Therefore, I wanted to find out that how many shares out of the 2,4 million GLT members own fall into this category (of minimal risk).

Let's start from the CEO Rajeev Suri. He owns  2 473 450 shares out of which 575 309 shares via the co-investment plan. That's excellent news: Vast majority of his stake carries same risk than the rest of the shareholders in Nokia do. What's more: he purchased the maximum amount he was allowed to in the co-investment plan.

The rest of the GLT owned less than 2,4 million shares in the end of 2018 out of which a bit more than a million is explained by the co-investment arrangement. Maria Varsellona, President of Nokia Technologies and Chief Legal Officer, sold recently 128 000 shares so the ratio of "normal shares" to "shares under co-investment agreement" is about 1,3 to 1. Not bad, but not as good ratio as ratio that the CEO has: about 4,3 to 1.

All in all, I would say that the GLT, and especially the CEO, is well aligned with the interest of the rest of the stock holders and takes sufficiently risk also with their own money.


Disclosure: Long Nokia at the time of writing.

Sold Fortum

I have been trimming down our position in Fortum (Nasdaq Helsinki: FORTUM) during the last 12 months as in my view there has not been much upside potential left for quite some time now compared to the situation 2-3 years ago when the stock was trading at a lot lower level and offered nice asymmetric risk/reward potential then.

Today I decided to sell the position completely. The final trigger was news that the next Finnish cabinet will very likely be formed around the political left including the Greens of Finland and the Centre Party.

In my view this combination is the worst combination possible from the view point of Fortum, where Finnish state is majority owner with over 50% stake. To boot, the cabinet would be backed by the most anti-nuclear parties there is in Finland. While I do not think any of the parties will propose ramping down the existing plants, getting them replaced eventually would likely require another kind of cabinet setup.

In terms of plants in Fortum's portfolio, the likely political "hot potato" will be the vast number of coal plants owned by Uniper where Fortum now has a big stake. The bombardment to "shut down" has already started from the finnish environmental groups (even though the plants are not even in Finland!).

Overall the political ambition level towards changing the energy mix is a bit too high, which may manifest in hasty decisions which may have unwanted consequences in the energy market.

However, Most of all it's just the socialist agenda that is in my opinion the big problem. The cabinet will not be shareholder friendly (of any company - listed or not). On top of that, there is a history of cabinet officials meddling with Fortum at least indirectly (via meddling with the board and other governance structures).

My all time favourite meddling was related to Fortum options. The politicians failed to oppose very lucrative option deal at the time when it caused the dilutation (when options were issued) to share holders. It was only when the the options were sold at huge profits that the scheme became a massive political problem.

The funny thing is that once dilutation had taken place, it was actually good for the state that the options had value. Most of the money from the options came back to government because of the ~60% tax rate for very high income individuals.

Nokia has not gone anywhere in 5 years

Latest Q1 result of Nokia Corporation (NYSE: NOK) was a huge disapointment and this was reflected yesterday in the stock price first in Helsinki stock exchange and later in New York. 

Nokia is one of our largest positions and I follow it closely. After the upward surges of stock price related to selling mobile phones unit to Microsoft and Alcatel-Lucent acquisition the stock hasn't gone anywhere in last 5 years.

Nokia stock price in last 5 years (NYSE) in U.S dollars

Chart courtesy of StockCharts.com

My key worry relates to very weak gross margin (GM) in the core business outside of patent/licencing business.

Networks unit had really poor GM in Q1 (26,9%). We have many technology stocks (Intel, NVIDIA and Micron) that have better net margin than Nokia's GM even though they are lower in the food chain as component suppliers to equipment manufacturers.

The GM of Nokia's software unit isn't either in the level what you would expect for _software_ (40.3%). After R&D and SG&A expenses the Software unit is only near breakeven profitability whereas Networks is clearly a loss making unit. Even if you would take Networks' result and replaced minus sign to plus sign it still would not be a great result.

One other thing I do not understand with Nokia is that where are the synergy benefits from ALU deal? By now they should have come through all the way to the bottom line.

Nokia has spent so many years in restructuring that it would be about time to get out of that negative cycle. However, the result at hand is so weak that it screams to look at R&D and SG&A expenses harder than ever before.

5G in large scheme of things is just another large business cycle on top of GSM, 3G and 4G. In the long run, the company has to be in good shape to sustain the cyclicality of the business.

In terms of profitability, I would expect more like 10% net profit from base business PLUS profits from Technologies unit on top. It can be achieved in many other fields of business so why not here.

You can't endlessly make excuses that the profitability .... will follow ... some day.


Disclosure: We are long Nokia and do not consider to sell or buy in next 48 hours.

Portfolio spring cleaning

It was time to do spring cleaning for our portfolio.

I decided to get rid of all very small positions. Some of them were initially small extremely risky bets - I recall labeling in blog as "lottery tickets" - shrinking to fraction of what was invested. These included Leading Edge Material Corp (ex. Tasman Metals position) and Nautilus Minerals Inc. (which actually could not be sold since there has been trading halt since Feb 21, 2019 due to restructuring).

There was also a small stake of Wabtec Corp. that we got from General Electric in connection to GE Transportation merge to Wabtec. Nothing wrong with that company except didn't want to stick to a very small position so the call was between adding some more at current valuation or getting rid of that altogether.

Few small Finnish corporations were also dumped as bad calls from my part based on too much reliance for analyst estimates for the "fair price" of these companies. Luckily small positions to start with so no significant damage done.

Once can get rid of Nautilus Minerals Inc. we are down to 23 companies.

Portfolio overview

Our starting portfolio allocation for year 2019 is as follows:

• Stocks 98,5%
• Gold 1,4%
• Cash 0,1%

No bonds. We simply substitute bonds with quality dividend payers in our portfolio.

The big changes compared to year ago are:

• Emerging markets exposure ramped to zero (money shifted to U.S. market)
• Exposure to technology sector ramped up to 48% of entire portfolio.
• All investments are now directly made to individual stocks (compared to 19,4% via ETFs on 1.1.2018).

Geographical Allocation (stocks):

• Europe 58,1%
• North America 41,9%
• Emerging markets 0%

Actually, place of incorporation is pretty meaningless for most corporations we have invested in. Most operate and sell globally.


Sector Allocation is heavily tilted towards technology companies:

Sector Allocation (stocks)

Top 5 positions - in order of weight in portfolio:

1. Siili Solutions (Finland)
2. Berkshire Hathaway (USA)
3. Nokia (Finland)
4. Apple (USA)
5. UPM (Finland)

There are now 7 technology companies (semiconductor/product/services) among largest 10 positions. Out of these 4 are in semiconductor business. Thus, short term volatility to be expected ..

Portfolio performance 2009-2018

Happy New Year 2019!

It's once again time to check how our portfolio fared in the previous year against passive index investing.

The year 2018 was a roller coaster ride of ups and downs in the market. We ended deeper into red than ever before in the 10 years that I have kept record of our performance.

The bencmark investment* was down 6,1% and our portfolio dived 10,8%. 

Portfolio performance 2009-2017. 

Note: "Difference" column uses exact values as input rather than figures rounded to 1 decimal that are displayed.

Many of our largest positions did quite poorly compared to the broad market. Also, we jumped too early into General Electric and saw quite a slide there. Semiconductors - especially Western Digital Corporation (down 53%) - did their share of damage. My decision to take many small cap companies in Finland into portfolio also turned out at least badly timed. Nokia Corporation was pretty much the only one beating the market with clear margin (up 29%).

In terms of cumulative yearly gains, we are now 1,9% below the benchmark investment. In the larger scheme of things (cumulative gains net of taxes 134% so far) this is very small deviation. However, the long term goal is to outperform the benchmark I have set for our investments.

Cumulative gains of our portfolio (blue line) vs. benchmark investment (red line). 31.12.2008 = 100.

Going into 2019 we continue to be almost 100% invested into stocks. I will cover our current allocation in the next post.


*) The "benchmark investment" is an imaginary passive ETF that closely tracks the performance of MSCI all country world (ACWI) index in euros (more info here).