AMM Dividend Letter Issue 33 ~ Halo, Horns, & Hilton

Download this issue as a PDF

How would you rate this quote?

“You have to be confident as you face the world each day, but you can’t be too cocky. Anyone who thinks he’s going to win them all is going to wind up a huge loser.”

Pretty good, right? It’s no Lincoln.

“Better to remain silent and be thought a fool than to speak and remove all doubt.”

Or Kennedy.

“Ask not what your country can do for you but what you can do for your country.”

What if we told you the first quote came from the 45th President of the United States, Donald Trump. How would you rate the quote now?

Did your rating change for the better? For the worse? If it changed one way or the other, then you have likely fallen for the Halo and Horn effect.


When you like some aspect of a person you tend to like all other aspects of that person and overate their abilities. Even if you’ve never witnessed these attributes.

You meet Jane at a cocktail party. Jane is personable and easy to talk to. You enjoyed your brief time with Jane. Then later on someone running a charity asks you how generous Jane is and how likely Jane will donate to their charity. You will most likely rate Jane as very generous and very likely to donate to the charity.¹

But how do you know this?

You know nothing about Jane’s generosity. You only really know that Jane was friendly and personable. You overrated Jane’s level of generosity because you liked her.


The opposite is the horn effect. You tend to underweight someone’s abilities and dislike all other aspects of a person based on one trait.

A perfect example comes from the book Good Advice from Bad People: Selected Wisdom from Murderers, Stock Swindlers, and Lance Armstrong.

“The day you take complete responsibility for yourself, the day you stop making any excuse, that’s the day you start to the top.” — O.J. Simpson

We immediately discount what these people said because of the person who said them.

Tom Brady is an all-time great NFL quarterback. No quarterback has won more Super Bowls than Tom Brady. Go ask a die-hard New York Jets fan what they think about Tom Brady. You’ll likely hear how overrated Tom Brady is. That he isn’t that good and he benefits from the Patriots’ “system”. And you’ll most definitely hear, “He’s a cheater!”

Now, what do you think the comments from Jets fans would be if Tom Brady were on the Jets?

Tom Brady’s only transgression against the Jets is that he plays for a hated rival.

Halo, Horns, Politics, & Your Portfolio

The halo and horn effect happens a lot in politics.

If you like a President’s politics and party affiliation you tend to like the way they dress, how they speak, and how they carry themselves in public. If you don’t like their politics you tend to dislike everything about the President.

Your political affiliation also has an unintended consequence on your portfolio.

From the paper Political Climate, Optimism, and Investment Decision.

In our main empirical analysis, using the Gallup data, we show that Democrats (Republicans) become more optimistic about the stock market and the overall economy when Democrats (Republicans) come to power and there is a decline in optimism when the opposite party comes to power.

Investors tend to increase their exposure to risky, more volatile, assets, when their political party is in power and decrease their exposure when the opposite party is in power. This has the effect of increasing the investors’ returns over time, but not for the reason they think. The casual investor will attribute the performance to their political leader. In reality, increasing their risk exposure simply increases their odds of having higher returns in their portfolio, regardless of which political party is in power.

It’s not just the average investor that falls prey to the Halo and Horn effect. It can happen to us all.

Whitney Tilson runs a small hedge fund but he is a tireless self-promoter and has made a name for himself. You may have seen him on 60 Minutes during their Lumber Liquidators segment. Mr. Tilson spent considerable effort campaigning for Hillary Clinton and spilling a large amount of digital ink deriding “Con Man Don”. After Donald Trump won the election Whitney Tilson sold more of his equity positions into the market rally.

By Wednesday morning, as stocks made a big comeback rally after a near-800-point plunge late Tuesday night in pre-market futures trading on the prospects of a Trump victory, Tilson was busy unloading shares into the rally.

“I was at 60 percent cash coming into today, and I’m selling stocks today,” he told the New York Times.

Mr. Tilson may have let his political affiliation determine his market perception. In Mr. Tilson’s defense, a couple months later he realized he acted on emotion and added equities back to his portfolio.

The Halo and Horns effect is another mental heuristic we use to make quick decisions. It is a form of pattern recognition that often produces irrational and heavily biased decisions.

It is hard for us to tell when we are making an irrational decision based on simple heuristics like the Halo and Horn effect. There is no easy way to counteract this effect. We always advise slowing down your decision making steps and reviewing your process. When truly in doubt, it never hurts to enlist a trusted friend or confidant to play devil’s advocate.

Dividend Stock in Focus

Hilton (HLT): $65.49*
*price as of the close May 24, 2017

We build our dividend growth portfolio on three categories.

  • Dividend Stalwarts: Companies that have paid and grown their dividend over several decades
  • New Dividend Payers: Companies that recently initiated a dividend and can grow their dividend at above average rates for many years.
  • Special Situations: Companies that pay a dividend and are undergoing a corporate restructuring.

Hilton Inc. has been around for a long time. The company started in 1919 when Conrad Hilton bought the Mobley Hotel in Cisco, Texas. In the last few years, Hilton has undergone several ownership changes, corporate restructurings, and Paris’ new DJ career. This is why we classify Hilton as a new dividend payer.

In the fall of 2007 Hilton went private through a leveraged buyout by Blackstone. Then in December 2013 Blackstone took Hilton public again as Hilton Worldwide Holdings (HLT).

In January of 2017 Hilton underwent another corporate restructuring. Hilton Worldwide split into 3 different companies.

  • Hilton Grand Vacations (HGV) is now focused on Hilton’s timeshare business.
  • Park Hotels and Resorts (PK) is a REIT that owns the hotels and other properties.
  • Hilton Inc (HLT) retained the franchise and hotel management business.

It was after the three-way spin-off that we took interest in Hilton Inc. (HLT). As we’ll discuss further below, Hilton is now operating as an asset light business. We expect Hilton’s profit margins to increase and, more importantly, its return on invested capital (ROIC).

Did we mention that Paris Hilton is now a DJ?

Dividend History:

Hilton Worldwide Holdings started paying a dividend of $0.14364 per share a year ago. Post spin-off, the new Hilton Inc. continued to pay the dividend and slightly increased it to $0.15 per share.

We’ll further discuss Hilton’s capital return plans below.

Catalysts for Dividend Growth and Price Appreciation:

Asset Light Management & Franchise Model

By jettisoning the timeshares, hotels, and other properties Hilton became an asset light business. Less assets mean less capital needed to maintain and grow the business. Margins and return on invested capital (ROIC) should both increase. This leads to excess capital available to return to shareholders.

Increasing ROIC

Building hotels requires a lot of capital. Managing hotels and licensing your brand does not. Reducing its capital needs will drive Hilton’s return on capital higher. Increasing returns on invested capital is a key driver to building shareholder value.

Pre-spinoff Hilton’s ROIC reached a high of 9%

Marriott International (MAR) has undergone a similar transformation. In 1992 it spun-off the hotels they owned in to a Real Estate Investment Trust (REIT). 19 years later Marriott International spun-off its time share business, Marriott Vacations Worldwide (VAC). Marriott International retained the franchise and management contract business. Return on invested capital for Marriott International improved greatly since then*.

*The drop in Marriott’s ROIC was due to the completed merger with Starwood Hotels in 2016. Click image to enlarge.

We expect a similar improvement in ROIC for Hilton as they are now in a similar position as Marriott International was in 2011.

Increasing Market Share

The new Hilton generates revenue in two ways. The first is through management contracts with the following set-up:

  • a base fee, which is a percentage of each hotel’s gross revenue
  • Outside of the U.S., fees are often more dependent on hotel profitability measures
  • One-time upfront fees upon execution of certain management contracts
  • A monthly fee based on a percentage of the total gross room revenue that covers the costs of advertising and marketing programs; internet technology and reservation systems expenses; and quality assurance program costs.

The second way Hilton generates revenue is through Franchise agreements.

  • Franchisees pay franchise fees which consist of initial application and initiation fees for new hotels entering the system and monthly royalty fees, generally calculated as a percentage of room revenues
  • Franchisees also pay a monthly program fee based on a percentage of the total gross room revenue that covers the cost of advertising and marketing programs; internet, technology and reservation system expenses; and quality assurance program costs.

Both revenue streams are driven by total rooms available, the average daily rate, and the occupancy rate. Adding more rooms while maintaining the average daily rate and occupancy rate will increase Hilton’s revenues.

Currently, Hilton has a 4.8% global market share of hotel rooms. Of the hotel rooms under construction Hilton has a 21.5% market share. Hilton’s overall room count is growing and its global market share is increasing.

From Company Presentation March 1, 2017. Click image to enlarge.

Large Capital Return to Shareholders

An asset light business does not need a lot of capital reinvestment to grow the business. This is a very attractive feature for investors because the company returns excess capital to shareholders through dividend increases and share buybacks.

Hilton Capital Return
From Company Presentation March 1, 2017. Click image to enlarge.

Right after the three-way spin-off transaction, Hilton Inc. announced its first buyback program. Hilton will buy $1 billion worth of shares. At Hilton’s current price, this about 5% of shares outstanding.

Pre-Mortem (Potential Risks to our Thesis):


Travel, both for leisure and business, tends to follow the business cycle. One of the first costs to get reduced during a recession is travel costs. Individuals will take fewer and/or less expensive trips. Companies will look to scale back how many people in their organization will travel and how much they will spend on business travel.

By spinning off its real estate holdings and focusing on franchise fees and the management contract. Hilton has removed some of the cyclicality of its earnings. The restructuring smooths its revenues out over the full business cycle but a portion of Hilton’s revenues is based on the gross dollar volume from each room. Less travelers leads to less gross dollar volume spent and less revenue for Hilton.

The current bull market is in its 8th year along with the current economic expansion. Any upcoming downturn will affect our recent investment in Hilton but a recession will affect all of our positions. If the company is a high-quality business that generates high returns on capital over a full business cycle, then we would likely seek to add to the position during any prolonged downturn.


AirBnb is a platform from which homeowners can rent out a room or a whole house to travelers. The concern and/or the current hype is that AirBnB will disrupt hotel businesses in the same way that Uber and Lyft are disrupting the Taxi business.

There is a big difference between platforms like Uber and Lyft versus AirBnb. The car share platforms are competing against a business, Taxis, with high prices and terrible customer service. The hotel industry, especially companies like Marriott and Hilton, already offer great service and at various price points.

Cities that are tourist destinations make a good portion of their tax revenue from hotels. For example, San Diego’s third largest driver of tax revenue is its Transient Occupancy Tax (TOT). The TOT accounts for 6% of San Diego’s tax revenue.

Taxis have their lobbying groups trying to get cities to push back against Uber and Lyft with limited success. But as soon as you mess with a city’s revenue source then the cities start pushing back. Cities are now passing legislation to limit short-term rentals like AirBnb. Cities and states are also passing laws that AirBnb has to collect taxes on the short term rentals offered on their platform. This is driving up the cost of short-term rentals and making them more in line with the cost of hotel rooms.

Short-term rental owners are trying to maximize their profits too and are pricing their rentals at rates only slightly below average hotel room rates.

AirBnb’s success is from group travelers looking to stay together and with very cost conscious travelers that are willing to stay in someone’s extra bedroom. Business travel is a large part of Hilton’s business and currently AirBnb does not target business travelers. If or when AirBnb does we’ll have to assess the effect on Hilton’s business.

Travel Bans

Hilton’s business is heavily tilted towards travel within and to the U.S. Before the spin-off transaction, the U.S. business represented over 75% of Hilton’s rooms and 60% of Revenue from Owned or leased hotels according to the 2016 10-K.

Hilton U.S. Hotel Rooms
Click image to enlarge.

And 70% of Hilton’s EBITDA comes from its U.S. business.

Click image to enlarge.

If travel to the U.S. became less attractive and more restrictive then Hilton’s earnings will likely suffer.

A recent travel ban by President Trump is having a spillover effect on potential travel from other countries.

President Donald Trump’s immigration stance has begun to discourage foreign visits to major U.S. cities, threatening to cost billions of dollars and thousands of jobs.

New York, the nation’s most visited city by people overseas, predicts such trips will drop more than 2 percent this year to 12.4 million, the first decline after eight consecutive annual increases. Los Angeles and Miami may also experience decreases.

According to Adam Sacks president of Tourism Economics, Foreigners spent $250 billion in the U.S. last year. If travel drops by 4.3 million visitors as expected by Mr. Sacks then the U.S. travel industry may lose $7.4 billion in revenue.

It is still too early to assess the actual effects of the proposed travel bans (as of this writing the bans are tied up in federal courts). However, given the importance of US hotel traffic to Hilton’s business model, we must include this in our Pre-mortem assessment of risks.


We used an economic profit model to value Hilton Inc. since a main part of our investment thesis is a rising return on invested capital. An economic profit model is driven by Returns on Invested Capital, Invested Capital and the Cost of Capital.

Economic Profit = Invested Capital * (Return on Invested Capital – Weighted Average Cost of Capital)

First, we estimate Hilton’s capital need for the next 10 years. Then we use Hilton’s current capital structure (debt and equity) to derive their Weighted Average Cost of Capital. From here we use our base case estimate of return on invested capital (30%) for Hilton over the next 10 years and calculate each year’s expected economic profit. Finally, we discount back each year’s economic profit and sum it to arrive at a present day value.

We then do a couple balance sheet adjustments, add cash and remove debt, to arrive at a per share equity value.

Using our economic profit model we estimate Hilton’s fair value per share to be $70. This is our base case. If Hilton can increase its ROIC further then Hilton will be worth even more.

All previous letters are archived here.

¹Example from Thinking, Fast and Slow by Daniel Kahneman


Snapchat and the Substitution Heuristic

We have a cognitive quirk.

We have a bunch but let’s focus on one.

When faced with a hard or complex problem instead of answering it we swap it for an easier question to answer. We believe we have answered the hard question when in fact we answered a totally different question.

Substitution Heuristic

This is the Substitution Heuristic.

These are few examples from Daniel Kahneman’s book Thinking, Fast and Slow.

Target question: How much would you contribute to save an endangered species?

Heuristic Questions: How much emotion do I feel when I think of dying dolphins?

Target Question: This woman is running for the primary. How far will she go in politics?

Heuristic Question: Does this woman look like a political winner?


A more timely and real world example.

Is Snap Inc. (SNAP), aka Snapchat, a good investment?

A simple but complex question.

Snapchat recently IPO’d and like a lot of new publically traded companies it is not profitable yet. In lieu of earnings and cash flow, you need to figure out Snapchat’s path to profitability and how likely Snap is to achieve this goal.

Snapchat is a social network. You’ll need to track its daily and/or monthly active users. Is it growing or slowing? What is the demographics of its users? Is it popular with the young and tech-savvy or is this group moving on to something else?

Then there is competition. How does Snapchat fit in a world with Facebook, twitter, and other emerging companies?

Finally, you have to figure out an appropriate price to pay for Snapchat’s potential versus the risk.

I told you it’s a hard question.

The Easier Question

It is far far easier to swap these questions with do I use Snapchat? Do my friends use it? Do we like it?

That’s what a lot of millennials did when thinking about investing in Snapchat on the day of its IPO.

Trading activity on Robinhood, an online brokerage platform, jumped by half on Thursday as Snap began trading, with 43% of users active that day buying shares, according to the company.

Robinhood’s demographic already skews to the younger side, with a median user age of 29, the company said. But the median age among Snap buyers on Thursday was even younger, at 26. (That happens to be the same age as Snap co-founder–and newly minted billionaire–Evan Spiegel.)

Rebecca Shoenthal, a 22-year-old journalism student at the University of North Carolina at Chapel Hill, was among them. She said she bought four shares of Snap for about $24 each. She put in an order for them on Wednesday night, stipulating that she would pay as much as $40 per share.

Heuristics Help But Can Cause Trouble

Heuristics are not bad. They help us get through the day.

We face a lot of decision throughout the day and we don’t have time to contemplate everyone. Heuristics help us make quick decisions freeing up time for more important things.

Also, the answers heuristics give us are good enough but they can lead us into trouble. Especially with investing.

Snap Inc.’s Earnings

Snap Inc. reported its first earnings as a public company yesterday and it wasn’t good.

  • Slowing user growth
  • Stock compensation expense greater than annual revenues
  • Large increases in operating expenses

Snap was down over 20% after the announcement and the stock is now down 26% since its IPO.
SNAP Chart

SNAP data by YCharts

Heuristics, Investing, & Trouble

Because they didn’t answer the hard questions before buying Snapchat these young investors are unsure what to do now. And instead of asking the hard questions now, they are selling their shares.

On Robinhood, an online brokerage platform with a younger clientele, sellers of Snap shares outnumber buyers among users under 30. Ahead of the earnings report, the ratio of those Snap buyers to sellers was 0.80, meaning 80 hypothetical buyers of the stock for every 100 sellers. In the week after the IPO, there had been 280 buyers for every 100 sellers. For those over 30, Snap’s buy-to-sell ratio is currently 1.2 times, down from 3.1 times the week of the IPO.

Rebecca the UNC student who was excited about Snpachat’s IPO is starting to realize the questions that need to be answered.

Rebecca Shoenthal, who is due to graduate from the University of North Carolina at Chapel Hill this weekend, told the Journal in March that she bought Snap shares after their public debut because she was excited about the company.

In a follow-up e-mail Wednesday, she said that, “Facebook is certainly making things hard for Snap, especially since they have essentially the same product with a much larger user base already established.”[emphasis added]


Does the sell off present a buying opportunity in Snapchat?

You’ll have to ask and answer the hard questions to determine that.

Splitting AbbVie to Unlock Value

AbbVie (ABBV) is a rare stock.

AbbVie’s yields almost 4%. Its current dividend yield is 3.87%. And unlike the other 4% yielders, it is not a slow growing utility, telecom, or cyclical car manufacturing business.

High dividend yield
Chart from Goldman Sachs. Click image to enlarge.

AbbVie is a growing biotech company with a promising drug pipeline with even more potential growth.

Why is a growth company trading with the yield of a utility company?

Because of Humira.

Humira starts losing patent exclusivity in a couple years.

Biologic vs Small Molecule Losing Its Patent

We’ve argued before that the loss of the Humira and other large biologics will be different than a small molecule drug losing its patent.

With a small molecule drug, like Claritin or Viagra, a generic version only has to prove that it is the same chemical formula and structure as the name brand drug. The generic drug does not have to undergo efficacy and safety tests. The name brand drug already underwent these trials and the two drugs are exactly the same.

Biologics are different.The entire process to produce the biologic is the drug. Small changes in the process can have large effects on the outcome. It is because of this that a generic biologic, a biosimilar, has to undergo efficacy and safety tests. This drives the cost of the biosimilar up. The cost savings of switching from a name brand biologic to a biosimilar is much less.

The entire process to produce the biologic is the drug. Small changes in the process can have large effects on the outcome. It is because of this that a generic biologic, a biosimilar, has to undergo efficacy and safety tests. This drives the cost of the biosimilar up. The cost savings of switching from a name brand biologic to a biosimilar are much less.

The real issue is potential Humira users using a biosimilar to start their treatment and finding it works. The likelihood of these patients switching to the higher costing Humira when their lower cost biosimilar works are minuscule.

Growth will slow but Humira will remain a cash cow from AbbVie.

And yet AbbVie is trading as if Humira will follow the same pattern as a small molecule going off patent and very little value is being given to AbbVie’s pipeline.

Goldman Sachs has a potential solution.

Splitting AbbVie into Two

Splitting the company into two. A Humira company and a pipeline company.

While investors wait for Growth-co to mature, we believe the company could unlock trapped value by separating business segments for reporting purposes (“Humira-co” and “Growth-Co”) and returning cash to shareholders. While Humira-co is a cash cow that is funding the pipeline, we believe its value (i.e., sustainable cash flows) is underappreciated, with heightened fear of Humira’s inevitable decline, the rate and magnitude of which are unclear. ABBV could unlock value by monetizing the asset and reward shareholders for owning the shares in the face of this uncertainty. We believe ABBV could return cash to shareholders through either a perpetual Humira dividend or share buyback, although we believe the former would be more attractive. We expect ABBV to have a strong balance sheet generating ~$60bn in cumulative cash flow (64% of current market cap) over the next 5 years that can more than support an additional dividend payout. With most of its cash overseas, tax repatriation makes this scenario even more possible. We think fears around Humira have overshadowed the new product story. For this reason, we think separating Growth co. for reporting purposes would reveal the segment’s potential for biotech top-line growth and margins. Driven by oncology, immunology, women’s health and other, Growth-co should see top line growth of 16% over the next 5 years from $9.8 bn (including legacy) to $20.5 bn.

AbbVie would remain whole. The company would create two new reporting structures.

I like the idea of a special dividend.

Chart courtesy of Goldman Sachs. Click image to enlarge.

The goal of the split is to act as aa catalyst to unlock and/or reveal AbbVie’s true worth. I’m all for that but when I’m ready to sell. I like AbbVie’s current low prices. I get to buy more at a cheap price.

Investing in Hilton, Did We Make a Mistake?

We own Hilton (HLT). We bought it for clients after it underwent its three-way spin-off into Hilton Grand Vacation (HGV), Park Hotels & Resorts (PK), and Hilton (HLT).

Did we make a mistake? Maybe, according to this video.

The video was uploaded on March 29, 2017, and uses financial data as of year end 2016. This is crucial.

First, I’ll give the guy credit. He is practicing his valuation skills and he is putting himself out there. I’m curious to see how he arrives at his data points: real earnings, the amount of capital the company earned, the percentage the company needs to earn, and the amount of capital needed to maintain the business. These would be helpful to know.

The important issue that the video doesn’t cover and what affects the valuation is on January 4, 2017, Hilton Worldwide completed its corporate restructuring.

New Hilton

The new Hilton is an asset-light business. It no longer owns hotels or builds them. Hilton solely focuses on management contracts and its franchise business. The new Hilton needs very little capital to maintain and grow its business. Returns on invested capital should increase. High returns on invested capital with very little need to reinvest that excess capital will lead to more capital returns to shareholders via buybacks and dividend increases.

High returns on invested capital with very little need to reinvest that excess capital leads to increased capital returns to shareholders via buybacks and dividend increases.

The perfect example is Marriott after it spun-off it’s timeshare business in 2011. After that spin-off, Marriott focused solely on hotel management contracts and its franchise business like Hilton now.

Below is Marriott’s return on invested capital, total shares outstanding, and dividend per share from right before the spin-off of its timeshare business until its buyout of Starwood.

MAR Return on Invested Capital (Annual) Chart

MAR Return on Invested Capital (Annual) data by YCharts

Hilton could and should follow the same pattern.

Hilton is the subject of our next dividend letter. Sign up now to get it.

Interview with Warren Buffett and the two Ts, Ted & Todd

Yahoo! Finance conducted an interview with Warren Buffett, Ted Weschler, and Todd Combs.

If you like to read all day and manage money, then Berkshire is the place to be. This is how Todd Comb’s describes his daily routine.

“I get in around 7 or 8, and I read until about 7 or 8 at night,” he says with a laugh. “And I go home, and see my family, and then I’ll read for another hour or two in bed at night. And you know, there might only be three to four phone calls the entire week. So there are very, very few interruptions. I have a great assistant who knows everything that I read, and she kinda provides everything, and there’s a back and forth between us where I’ll mark it up, and give it back to her. And we have a system for filing and so forth. But it’s literally just reading about 12 hours a day of everything I just mentioned.”