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Equity Life Cycle: The Moneyball Approach
Building a portfolio of stocks is a little like assembling a baseball team. However, unlike a team of real baseball players, constructing a portfolio of stocks can mix low-priced single-A farm players with blue chip Hall of Fame players from the Majors. Billy Beane, the General Manager for the Oakland Athletics, was chronicled in Michael Lewis’ book, Moneyball. Beane creates an amazing proprietary system of building teams more cost-efficiently than his deep-pocketed counterparts by statistically identifying undervalued players with higher on-base and slugging percentages. According to Beane, traditional baseball scouts were overpaying for less relevant factors, such as speed (stolen bases) and hitting (batting percentage).
In the stock world, before you can scout your team, you must first determine where in the life cycle the company lies. If Beane were to name this quality, perhaps he would call it Time-to-Maturity (TTM). Some companies operate in small, mature bitterly competitive industries (e.g. shoe laces), while others may operate in large growing markets (e.g. Google [GOOG] in online advertising and algorithmic search). Some companies because of negative regulation or heightened competition have a very short life cycle from early growth to maturity. Other companies with competitive advantages and untapped growth markets can have very long life spans before reaching maturity (think of a younger Coca Cola [KO] or Starbucks [SBUX]). Like Beane talks about in his book, many young, promising, immature baseball players flame out with short TTMs, nonetheless many scouts overpay for the cache´ such players offer.
Unfortunately, many investors do not even contemplate the TTM of their stock. Buying juvenile stocks (i.e., private companies like Twitter & Facebook – see article) or elderly stocks in and of itself is not a bad thing, but before you price a security it’s advantageous to know what type of discount or premium is deserved. Obviously, I’m looking for undervalued stocks across all age spectrums, however finding an undervalued, undiscovered late-teen just beginning on its long runway of growth combines the best of all worlds. Finding what Peter Lynch calls the “multi-baggers” is easier said than done, like searching for a needle in a haystack, but the rewards can be handsome.
What creates long runways of growth – the equivalent of winning dynasties in baseball? Well, there are several contributors leading to longer TTMs, including economies of scale, large industries, barriers to entry, competitive advantages, growing industries, superior and experienced management teams, to name a few factors. But like anything, even the great growth companies, including Microsoft (MSFT), turn from teenagers to mature adults. As famed businessman Thomas Brittingham said, “A good horse can’t go on winning races forever, and a good stock eventually passes its peak, too.”
There are many aspects to creating a winning team. If Billy Beane were to draw up factors for a baseball team, I’m confident TTM would be near the top of his list. What you pay for the length of the growth cycle is obviously imperative, but since I’m a strong believer in the tenet that “price follows earnings,” it only makes sense that above average sustainable earnings growth should eventually lead to superior price appreciation. As Bob Smith, successful manager from T. Rowe Price states, “The important thing is not what you pay for the stock, so much as being right on the company.” So if you want to recruit a portfolio of winning stocks, like Billy Beane picks successful baseball players, then include the equity life cycle maturity as a factor in your selection process.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management nor its client accounts have no direct position in MSFT, SBUX, KO, Facebook, or Twitter shares at the time this article was originally posted. Some Sidoxia Capital Management accounts do have a long position in GOOG shares. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
3 comments October 15, 2009
Green Loses to Greenback
We are currently in a political environment that sees no gray, but rather only sharp contrasts in black and white. As it turns out, these three colors are not the winners or losers – the winner is the almighty “greenback” and the loser is the “green” movement. The so-called environmentally friendly Obama administration recently approved the Alberta Clipper project – a 1,000 mile pipeline being built by Endbridge Energy that is designed to carry 800,000 barrels of fuel from Canada to the U.S.
As our reliance on what New York Times journalist Tom Friedman calls the “petro dictators” has not gone away, the recent decision seems very rational in securing supplies from friendlier neighbors. However, environmental constituents like the Sierra Club feel differently:
“At a time when concern is growing about the national security threat posted by global warming, it doesn’t make sense to open our gates to one of the dirtiest fuels on earth.”
-Carl Pope (Executive Director of the Sierra Club)
As far as I’m concerned, we still import about 2/3 of our oil and until alternative energies become more cost effective, we have little choice but to explore a multitude of strategic supply agreements. Canada is a neighbor and ally, therefore the U.S. should not walk away from any similar future agreement that will bring a stable and reliable source of supply. The scarcity of the critical resource and other commodities is evident by strategic deals and acquisitions being made by China and its government (See previous Investing Caffeine article, “The China Vacuum, Sucking Up Assets”).
As economic hungry emerging markets seek expansionary policies, I expect to see even more of these international types of deals.
The oil-sands region in the Athabasca region (about the size of Florida) of Alberta holds great promise. If you believe famous oil investor/speculator T. Boone Pickens and other pundits, the oil-sands region holds the equivalent amount of reserves as world supply leader Saudi Arabia – about 250 billion barrels.
I concur with recent comments Financial Times article that says the Endbridge Energy deal meets a number of U.S. strategic interests, including:
“Increasing the diversity of oil supplies for the U.S., amid political tension in many major oil-producing regions; shortening the transportation path for crude oil supplies; and increasing crude oil supplies from a major non-Organization of Petroleum Exporting Countries producer.”
I am not a believer in damaging our environment for the pure sake of profits, however in this competitive global economy I think we need to seek an aggressive dual-source supply of energy (alternative energy AND traditional petroleum/coal products). The fact of the matter is that we have been pursuing solar, wind, nuclear, and other alternative energy resources for decades with very limited success. More financial resources and subsidies must be thrown at these alternative resource possibilities, while we simultaneously seek strategic supplies like this Canadian oil-sands deal.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management and its clients have direct investment exposure in companies investing in Canadian oil-sand projects (SU) at the time the article was published. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
Add comment September 2, 2009
UFC 100 Lesnar-Mir: Pro Fighting or Cockfighting?
Brock Lesnar vs. Frank Mir
“Mayhem” may be the best word to describe UFC 100 – the mixed martial arts (MMA) event held in Las Vegas on July 11th was attended by 11,000 wound up fans. Regardless of the controversy related to the brutality of the sport – John McCain at one point called it “human cockfighting” – people are opening their wallets up in droves to watch these roided beasts bludgeon each other for $44.95 on Pay-Per-View.
In the Heavyweight class Brock “The Next Big Thing” Lesnar, a 6’3” – 265 pound monster destroyed his lesser foe Frank Mir in two rounds. For his winning demolition, Lesnar is estimated to rake in more than $2 million for his two round mauling. Despite Mir’s earlier victory over Lesnar, he earned a shockingly low $45,000 for the main event. With over $5 million collected from the gates in Las Vegas, an estimated 1.5 million Pay-Per-View watchers, and key advertisers like Bud Light and Harley Davidson, UFC executives had a little loose change to pay the stable of barbarian fighters.
After walloping Mir and flipping two prominently displayed birds (i.e., middle fingers) to the Las Vegas fans, Lesnar also KO’d UFC sponsor Bud Light by saying he was thirsty for a Coors. Lesnar held a grudge because he was not compensated for his victory by Bud Light. As the old saying goes, “There is no such thing as bad publicity.” Well, we’ll have to wait and see what impact Lesnar’s shenanigans will have on future UFC sponsorships.
Debate still lingers on whether MMA will go mainstream, and based on the force of this juggernaut, I would have to say the Magic 8-ball says the “Possibilities are strong.” Not only has 60 Minutes done a story on UFC here in the states, but the popularity of the sport is spreading rapidly globally. Evidence includes the beaming of the live fights to 75 countries and the large 20-member Japanese media group that travelled to Nevada to follow UFC star Yoshihiro Akiyama.
Whether you agree with the raw violence of the sport or not, there is no denying the momentum of this express train. UFC has come a long way in a relatively short period of time. UFC President Dana White and business partners purchased UFC in 2001 for $2 million – CNBC estimates the value of the company at $1 billion today. The IPO markets have been pretty stingy of late, but with a few more successful events like UFC 100, don’t be surprised to see Dana White offering shares via a road show through your local financial center. If Lesnar gets a cut of the shares, he might even celebrate the IPO with a swig of Bud Light.
Add comment July 14, 2009
Are Two Stimulus Packages Really Enough?
Plenty of talk of a 2nd stimulus adrenaline shot.
Am I the only one getting nauseated with all this debate regarding another potential stimulus package? Laura Tyson (Obama advisor), James Galbraith (collegiate professor), Paul Krugman (economist), and Warren Buffett, among other pundits, have recently suggested that the current multi-hundred billion plan doesn’t pack enough punch. I think I’m going to jump in front of all these experts and start screaming for a 3rd stimulus package. Why stop at two when we can just print some more money.
Isn’t the gargantuan $11 trillion in debt and massive projected $1.8 trillion budget deficit large enough? Call me crazy, but if we currently have only spent 10% of the current $787 billion package, then shouldn’t we focus on spending the other $700 billion first before we plan a 2nd stimulus and choke our children and grandchildren with $100s of billions in additional debt. Judging by the slow implementation of stimulus disbursements and spending, I guess we still need to buy all the shovels at The Home Depot before all the “shovel-ready” projects commence.
Click Here for Bloomberg Interview with James Galbraith
Here’s another thought – perhaps we can cut wasteful inefficient spending that has grown out of control and invest those dollars into innovative research and education. Investing into the brainpower of our country will create jobs now and even higher paying ones in the future. Of course cutting spending (and jobs) doesn’t get you more votes and lobbyists are quick to remind our elected officials of this fact. We live in a society that desires instant gratification, but before lurching into a panicked state let’s collectively take a deep breath and realize this economic mess took us a while to get into and therefore will take a while to get out.
Rather than spending more in additional stimulus, possibly the current spending programs can be more efficiently prioritized. Not all spending is created equally, and therefore temporarily stuffing our houses with more cars, TVs, and clothing probably is not going to sustainably grow our economy in a country dealing with harsh realities. For example, globalization, energy dependence, and escalating healthcare costs are just a few issues that our nation needs to address.
If none of these ideas seem to gain traction, then you can join me at the trough in a push for a 3rd economic stimulus.
Wade W. Slome, CFA, CFP® www.Sidoxia.com
DISCLOSURE: Sidoxia Capital Management and client accounts do not have direct positions in BRKA/B or HD at the time the article was published. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
Add comment July 13, 2009
Banking Pigs Back at the Trough
Sooey! With some of the TARP (Troubled Asset Relief Program) government loans paid back, it appears that the malnourished pigs of the banking sector are hungry again and back at the trough for loftier pay packages. A recent Wall Street Journal article pointed out Goldman Sachs is on track to pay its employees $20 billion in 2009, almost double the compensation of 2008, and forking out even a higher average ($700,000 per employee) than 2007.
Beyond gluttonous appetites, these banking execs are attempting to make pigs fly as well. Like a magician using the art of illusion to move an object from one shell to the next, or divert attention with smoke and mirrors, these large Wall Street banks are shuffling around their compensation plans. A recent Bloomberg article noted that Citigroup Inc. is moving to raise base salaries by as much as 50% to help counterbalance reductions in annual bonuses. Citigroup is particularly in hot water because the U.S. bank received $45 billion in government fund assistance. According to the Wall Street Journal, similar trends are bubbling up at Zurich-based UBS, where executives raised banker base pay by 50%. Bank of America also said in March 2009 it may boost salaries as a percentage of total compensation. The banks are hoping that reducing bonuses tied to risky behavior, while raising salaries, will appease the regulators.
The governments “pay czar,” Kenneth Feinberg, may have something to say about these inflating compensation trends. The WSJ points out:
Feinberg will have the authority to regulate compensation for 175 executives at seven companies, including Citigroup, that received “exceptional” government help.
As a rule of thumb, securities firms generally pay out approximately 50% of revenue in employee compensation. Bonuses have traditionally made up about two-thirds of bankers’ total compensation. Compensation consultant Alan Johnson in New York says salaries typically range from $80,000 to $300,000, with bonuses often adding millions of dollars. The article goes onto highlight the five biggest Wall Street firms awarded their employees a record $39 billion of bonuses in 2007. Sparking some of this heated debate stems from the eye-popping bonuses paid out to Merrill employees before the Bank of America merger. Merrill Lynch emptied $14.8 billion out of its wallet for pay and benefits last year before it was acquired by Bank of America – the New York Attorney General Andrew Cuomo is investigating $3.6 billion of the bonuses (tied mostly to payments made in December 2008).
To protect themselves, firms like Morgan Stanley and UBS have also added “clawback” provisions that allow portions of a worker’s bonus to be recouped under certain scenarios if the firms are harmed by an employee in the future. Perhaps this will create a disincentive for harmful behavior, but likely not enough to pacify the regulators
The pigs have regained their appetites and are eagerly awaiting for some more fixings at the trough. Time will tell if 2009 can produce squeals of swinish satisfaction or will regulators take the bankers to an unfortunate visit to the butchers?
Add comment July 6, 2009
Oil + Addiction = 50 Consecutive Day Price Hike in Gasoline
Gas Prices Rise for 50th Straight Day (CLICK HERE to read full article)
With 70% of our oil imported (much of it from countries with different human right beliefs), it is not very difficult to realize we are addicted to oil. Sure crude prices have declined dramatically from its peak of close to $150 per barrel to around $70 a barrel today, but nonetheless, gasoline prices have increased for 50 consecutive days (article above)! The amazing streak can be chalked up to the incredible rise in crude oil prices in recent months from the low $30s per barrel. This 50 day streak would even make Pete Rose proud in light of his 44 consecutive Major League Baseball League game hitting-streak achieved in 1978. Next up, Joe DiMaggio’s 56 game streak (we’re almost there!).
Time will tell if currently more cost prohibitive energy alternatives can be efficiently implemented. However, if current gasoline price trends continue skyrocketing, then the economics and probability of realization becomes much more compelling. At this rate you may even see my pending hydrogen-solar hybrid car passing you on the highway fast lane!
Add comment June 19, 2009
Chasing Profits – Can Fund Managers Beat the Game?
Achieving Long-Term Excess Returns is a Tough Race
How someone invests their money should fundamentally be based on their view of what’s the best way of playing the investment game. Before playing, the investor should answer the following key question: “Is the market efficient?” Efficient market followers believe active managers – professionals that periodically buy and sell with a profit motive – CANNOT consistently earn excess returns over longer periods of time, in part because market prices reflect all available information. If you fall into the efficiency camp, then you should dial 1-800-VANGUARD to simply buy some index funds. However, if you believe the market is inefficient, then invest in an exploitable strategy or hire an active investment manager you believe can outperform the market after fees and taxes.
For me personally, I fall somewhere in between both camps. I opportunistically invest my hedge fund in areas where I see superior return potential. However, in other areas of my investment practice (outside my main circle of expertise), I choose to side with the overwhelming body of evidence from academics that show passive/indexing slaughters about 75% of professionals.
Richard Roll, renowned economist and thought leader on the efficient market hypothesis, said this:
“I have personally tried to invest money, my client’s and my own, in every single anomaly and predictive result that academics have dreamed up. And I have yet to make a nickel on any of these supposed market inefficiencies. An inefficiency ought to be an exploitable opportunity. If there’s nothing investors can exploit in a systematic way, time in and time out, then it’s very hard to say that information is not being properly incorporated into stock prices. Real money investment strategies don’t produce the results that academic papers say they should.”
—(Wall Street Journal, 12/28/00)
The market gurus du jour blanket the media airwaves, but don’t hurt your back by hastily bowing. Having worked in the investment industry for a long time, you learn very quickly that many of the celebrated talking-heads on the TV today rotate quickly from the penthouse to the outhouse. Certainly, there are the well regarded professional money managers that survive the walk across the burning-coals and have performed great feats with their clients’ money over long periods of time. But even the legendary ones take their lumps and suffer droughts when their style or strategy falls out of favor.
The professional investing dynamics are no different than professional baseball. There are a relatively few hitters in the Major Leagues who can consistently achieve above a .300 batting average. In 2007, AssociatedContent.com did a study that showed there were only 12 active career .300 hitters in Major League Baseball. The same principle applies to investing – there is a narrow slice of managers that can consistently beat the market over longer periods of time.
There Are Only So Many .300 Hitters
Some statisticians point to the “law of large numbers” when describing long term investor success (a.k.a. “luck”) or ascribe the anomaly to statistical noise. Peter Lynch might have something to say about that. Peter Lynch managed the Fidelity Magellan Fund from 1977 – 1990, while he visited 200 companies per year and read about 700 company reports annually. Over that period Lynch averaged a 29% annual return for his investors vs. a 15% return for the S&P 500 index. Luck? How about Bill Miller from Legg Mason who outperformed the major industry benchmark for 15 consecutive years (1991-2005). Perhaps that too was good fortune? Or how about investor extraordinaire Warren Buffet who saw his stock price go from $33 per share in 1967 to $14,972 in 2007 – maybe that was just an accident too? An average schmuck off the street achieving Warren’s Buffett performance over a multi-decade period is equivalent to me batting .357 against Nolan Ryan and Randy Johnson…pure fantasy.
Academics also have difficulty with their efficiency arguments when it comes to explaining events like the “1987 Crash,” the technology bubble bursting in 2000, or the recent subprime derivative security meltdown. If all available information was already reflected in the market prices, then it would be unlikely the markets would experience such rapid and dramatic collapses.
What these bubbles show me is no matter how much academic research is conducted, the behavioral aspects of greed and fear will always create periods of inefficiency in the marketplace. These periods of inefficiency generate windows of profit opportunity that can be exploited by a subset of skillful managers. In the short-run, luck plays a great role; in the long-run sklill level determines ultimate performance. Benjamin Graham, summed it up best when he said, “In the short-term, the stock market is a voting machine; in the long-term a weighing machine.”
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management and client accounts do not have direct positions in LM or BRKA/B at the time the article was published.No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
1 comment June 8, 2009
Green Shoots or Spring Fever
Experts are debating whether the recent bounce experienced in the equity markets is a function of a fundamental turnaround in the economy, or is this more a function of wearing rose-colored glasses after extreme price declines. Irrespective of your view, the S&P 500 Index rose +9.4% in April; the Dow Jones Industrials +7.3%; and the NASDAQ Composite Index +12.4%. After wholesale panic began last September green shoots now appear to be budding through the ashes:
Healthier Than Anticipated Corporate Earnings: Company earnings reports are beating expectations. A +17% bounce in the KBW Bank Sector Index during April is one validating piece of evidence. “The earnings season in general has been better than expected, with 68% of the S&P 500 reporting upside surprises, and we’re three-quarters of the way done,” said Art Hogan, chief market strategist, Jefferies & Co.
Improving Consumer Spending: Despite significant job losses and weak economic activity, consumer spending, which accounts for about 2/3 of Gross Domestic Product (GDP), was up +1.5% in the first quarter of 2009.
Stabilization in Home Prices: Although housing prices continue to decline, existing home unit sales have stabilized over the last four to five months at around 4.5 million homes.
Merger Marriages On the Rise: Merger activity is perking up now that a market bottoming process appears to have commenced. Oracle/Sun Microsystems in technology; Merck/Schering Plough in healthcare; and Pulte Homes/Centex in homebuilding are just a few examples of recent merger marriages.
Capital-Raising on the Rise: Capital markets are functioning much better with bond spreads tightening and the cost of issuance declining for corporations. Beyond the hundreds of billions raised through new bond deals, we are seeing troubled areas like the REITS (Real Estate Investment Trusts) raising vital equity capital as well. Prologis (PLD), Chimera (CIM), Kimco (KIM), Vornado (VNO), AMB (AMB), and Simon Property Group (SPG) have raised over $4 billion in the last few months.
Add comment May 1, 2009
