Posts filed under ‘Stocks’
Over the last 18 months, stock prices have been flat as a pancake. Absent a few brief China and recessionary scares, the Dow Jones Industrial Average index has spent most of 2015 and 2016 trading between the relatively tight levels of 17,000 – 18,000. Record corporate profits and faster growth than other developed and developing markets have created a tug-of-war with countervailing factors. A strong dollar, reversal in monetary policy, geopolitical turmoil, and volatile commodity markets have produced a neutralizing struggle among corporate executives with deep financial pockets and short arms. In this environment, share buybacks, stable profit margins, and growing dividends have taken precedence over accelerated capital investments and expensive new-hires.
With flat stock prices and interest rates at unprecedented low levels, it’s during times like these that stock investors really appreciate the appetizing flavor of stable, growing dividends. To this day, I still find it almost impossible to fathom how investors are burning money by irrationally speculating in $7 trillion in negative interest rate bonds (see Retire at Age 90).
Historically there are very few periods in which stock dividend yields have exceeded bond yields (2.1% S&P yield vs. 1.8% 10-Year Treasury yield). As I showed in my Dividend Floodgates article, for roughly 50 years (1960 – 2010), the yield on the 10-Year Treasury Notes have exceeded the dividend yield on stocks (S&P 500) – that longstanding trend does not hold today.
In the face of the competitive stock market, several trends are contributing to the upward trajectory in dividend payments (see chart below).
#1.) Corporate profits (ex-Energy) are growing and at/near record levels. Earnings are critical in providing fertile ground for dividend growth.
#2.) Demographics, plain and simple. As 76 million Baby Boomers transition into retirement, their income needs escalate. These shareholders whine and complain to corporate executives to share the spoils and increase dividends.
#3.) Low interest rates and disinflation are shrinking the available pool of income generating assets. As I pointed out above, when trillions of dollars are getting thrown into negative yielding investments, many investors are flocking to alternative income-generating assets…like dividend paying stocks.
The Power of Dividends (Case Studies)
Most people don’t realize it, but over the last 100 years, dividends have accounted for approximately 40% of stocks’ total return as measured by the S&P 500. In other words, using history as a guide, if you initially invested in a stock XYZ at $100 that appreciated in value to $160 (+60%) 10 years later, that stock on average would have supplied an incremental $40 in dividends (40%) over that period, creating a total return of 100%.
Rather than using a hypothetical example, here are a few stock specific illustrations that highlight the amazing power of compounding dividend growth rates. Here are two “Dividend Aristocrats” (stocks that have increased dividends for at least 25 consecutive years):
- PepsiCo Inc (PEP): PepsiCo has increased its dividend for an astonishing 44 consecutive years. Today, the dividend yield is 2.9% based on the current share price. But had you purchased the stock in June 1972 for $1.60 per share (split-adjusted), you would currently be earning a +188% dividend yield ($3.01 dividend / $1.60 purchase price), which doesn’t even account for the +6,460% increase in the share price ($104.96 per share today from $1.60 in 1972). Over that 44 year period, the split-adjusted dividend has increased from about $0.02 per share to an annualized $3.01 dividend per share today, which equates to a mind-blowing +16,153% increase. On top of the $103 price appreciation, assuming a conservative 5% dividend reinvestment rate, my estimates show investors would have received more than $60 in reinvested dividends, making the total return that much more gargantuan.
- Emerson Electric Co (EMR): Emerson Electric too has had an even more incredible streak of dividend increases, which has now extended for 59 consecutive years. Emerson currently yields a respectable 3.6% rate, but if you purchased the stock in June 1972 for $3.73 per share (split-adjusted), you would currently be earning a +51% dividend yield ($1.92 dividend / $3.73 purchase price), which doesn’t even consider the +1,423% increase in the share price ($53.31 per share today from $3.73 in 1972).
There is never a shortage of FUD (Fear, Uncertainty, and Doubt), which has kept stock prices flat as a pancake over the last couple of years, but market leading franchise companies with stable/increasing dividends do not disappear during challenging times. Record profits (ex-energy), demographics, and a scarcity of income-generating investment alternatives are all contributing factors to the increased appetite for dividends. If you want to sweeten those flat pancakes, do yourself a favor and pour some quality dividend syrup over your investment portfolio.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs) and PEP, but at the time of publishing had no direct position in EMR or any other security referenced in this article. 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.
Over my 25 year investment career, I’ve made quite a few technology investments and visited dozens of Silicon Valley companies. I heard bits and pieces about the story of the Traitorous 8, but I never fully comprehended the technology revolution they started. Out of intellectual curiosity, I decided to delve a little deeper into the topic.
At the heart of this topic is a small device about the size of a fingernail. This object has several different names and can be quite confusing. The official name is an integrated circuit or IC, but usually it’s referred to as a chip, microchip, or semiconductor. These chips have become ubiquitous, scattered invisibly throughout our daily lives in our cars, computers, TVs, cell phones, appliances, and remote controls (an average household is home to about 1,000 of these semiconductors). Despite most people taking the microchip for granted, this diminutive piece of silicon created from our beach’s sand have contributed the largest burst of wealth creation in human history.
Before gaining a true understanding into the birth of Silicon Valley, we have to better understand the historical context in which the global technology capital was created – this takes us back to the early twentieth century when the vacuum tube was invented in 1904. Before Al Gore invented the Internet, we needed computers, and before we had personal computers, we needed integrated circuits, and before we had integrated circuits we had vacuum tubes (see chart below). Vacuum tubes were the electronic circuitry components required to make telephones, radios and televisions work in the early 1900s.
Tech History & the Vacuum Tube
The vacuum tube was invented in 1904 by an English physicist named John Ambrose Fleming. Like semiconductors, the main function of a Vacuum tube is to control the flow of electric current. More specifically, a vacuum tube controls the current transferred between cathode and anode to make a circuit. Vacuum tubes were used for amazing applications, but in modern society this technology has been largely replaced by semiconductors, primarily because of cost, scalability and reliability factors.
The first all-electronic digital computer title is usually awarded to the ENIAC computer, which stood for Electronic Numerical Integrator and Calculator. ENIAC was built at the University of Pennsylvania between 1943 and 1945 by two professors, John Mauchly and J. Presper Eckert. World War II, the Soviet Union Cold War, and the space race kicked off by the Sputnik launch all pushed the vacuum tube technology to its limits. To give you an idea of how costly and inefficient vacuum tubes were relative to today’s microchips consider some of the ENIAC statistics. ENIAC filled a 20 x 40 foot room; weighed 30 tons; used more than 18,000 vacuum tubes; and only operated 50% of the time because operators were continuously replacing burned out vacuum tubes. In fact, the ENIAC vacuum tubes generated so much heat, the temperature in the computer room often reached 120 degrees.
Shockley – The Godfather of the Transistor
Something had to change to improve vacuum tube technology, and it did…thanks in large part to a physicist named William Shockley, the so-called “Godfather of the Transistor.” Shockley received his Bachelor of Science degree from Caltech in 1932 and earned his Ph.D. degree from MIT in 1936. After graduation, Shockley left the famous Bell Labs research center, which was a research division of AT&T at the time (now owned by Nokia). As part of Shockley’s work at Bell Labs in the late 1940s, he contributed to the invention of the transistor with experimentalist Walter Brattain and quantum theorist John Bardeen. Fundamentally, the transistor is a switch, which over time has shrunk down to the size of a virus. The transistor is what ultimately replaced the vacuum tubes because it is smaller, more efficient, more reliable, more durable, and cheaper than vacuum tubes. Transistors switch and amplify the flow of electronic signals to create digital ones and zeros that instruct electronic applications. Without the benefits of shrinking transistors, today’s computer servers would be three stories high.
How small have transistors become? Take the iPhone 6 for example – it uses the A8 chip, which is made up of a whopping two billion transistors. To accomplish this feat, engineers are now creating transistors at the atomic level. Large semiconductor manufacturers like Intel Corp (INTC) are now developing transistors at the 10 nanometer level. To put this scale into perspective, consider a sheet of paper is approximately 100,000 nanometers thick. So in order to create a 10 nanometer sheet of paper, one would have to slice a single sheet 10,000 times thinner to reach 10 nanometers…mind-boggling.
Building atomic sized transistor technology is very cool, but also very expensive. Only a handful of semiconductor manufacturers have enough capital to build these new state-of-the art facilities. Case in point is Intel’s D1X fabrication facility in Hillsboro, Oregon, which is estimated to have cost $6 billion. Like seeing the pyramids – it’s difficult to understand the enormity of the structure without visiting it, which I was fortunate to do in 2014. It’s very ironic that in order to build these microscopic transistors and integrated circuits, multi-billion dollar manufacturing facilities the size of 38 football fields (~2.2 million square feet) are required. Another example of a next-generation manufacturing facility is Taiwan Semiconductor’s – Fab 15 (TSM), which was estimated to cost $9.3 billion.
These mega-transistor manufacturing facilities would not have been possible without Shockley’s contributions. Having helped invent the transistor largely replace the dominant computing technology of the last half century (i.e., vacuum tube), Shockley mustered up the courage to leave Bell Labs and start his own company, but he needed some cash to make it happen. He contacted Arnold Beckman, CEO of Beckman Coulter and his old professor at Caltech. Over a boat ride in Newport Beach, California, Shockley asked Beckman for $1 million to start his own lab. Silicon Valley potentially could have started in Southern California, but Shockley explained his aging mother lived in Palo Alto and convinced Beckman to start Shockley Semiconductor Laboratory in Mountain View, California during 1956.
After Shockley Semiconductor began operations, everything appeared to be going according to plan. Shortly after opening shop and recruiting the best and brightest engineers across the country, Shockley and his former Bell Labs colleagues Walter Brattain and John Bardeen were notified they all had won the Nobel Prize in physics (see photo below).
After the Nobel Prize celebrations, everything went downhill quickly. Shockley was known as a brilliant engineer but a horrific manager. He put his employees through a battery of tests including psychological tests, intelligence tests, and even lie detector tests. Shockley also posted employee salaries publicly and recorded phone calls. He was a paranoid individual who believed his workers were stealing trade secrets and sabotaging projects, so therefore he wouldn’t share findings with his research staff. Adding insult to injury, Shockley was a racist, who believed blacks were genetically inferior with subpar IQs, so they shouldn’t have kids.
Here is a video link summarizing William Shockley’s leadership:
The Traitorous 8 Surface
In 1957, the year after Shockley Semiconductor Labs started up, the division reached 30 employees. Eight of the employees, Sheldon Roberts, Eugene Kleiner, Victor Grinich, Jay Last, Julius Blank, Jean Hoerni, Robert Noyce, and Gordon Moore finally said, enough-is-enough and decided mutiny was their best option.
The disgruntled group ended up contacting a 30-year-old, snot-nosed, Harvard MBA graduate named Arthur Rock, the individual who eventually coined the phrase “venture capitalist.” In 1957, Rock was a New York banker working at Hayden Stone & Co. Rock believed the group of eight engineers (six of which had Ph.Ds) deserved attention, given their experience working with a Nobel Prize winner. The Traitorous 8 simply wanted to find an employer that would hire them as a group, but Rock advised them to start their own company – a novel idea during the 1950s.
After making a list and calling about 40 blue chip companies from the Wall Street Journal for funding, Rock almost gave up until they received a lead to contact Sherman Fairchild. Fairchild was a wealthy entrepreneur and playboy who hung out at the El Morocco in New York with Howard Hughes. Rock convinced Fairchild, the CEO of Fairchild Camera & Instrument, to invest $1.5 million into a Traitorous 8 startup.
The rest is history. The Traitorous 8 set up shop as Fairchild Semiconductor (FCS) in Mountain View, about twelve blocks from Shockley’s operations. Over the next 10 years, Fairchild Semiconductor grew from twelve employees to twelve thousand employees, and raked in some $130 million in annual revenues. Of the original Traitorous 8, two have become historical figures – Robert “Bob” Noyce and Gordon Moore. All good things come to an end, and Noyce and Moore increasingly got frustrated with Fairchild’s mismanagement of the semiconductor division.
After Fairchild passed over Noyce for a CEO promotion in 1968, Noyce told Moore, “I’m going to leave, are you interested?” Moore agreed, so he and Noyce contacted Arthur Rock again for his assistance. Rock quickly helped them raise $2.5 million, and Intel Corporation (short for “Integrated Electronics”) was born. Three years later in 1971, Intel launched its IPO at $23.50 per share ($.02 split-adjusted). An investment of $10,000 back then would be worth about $12,000,000 today –about a +120,000% return.
Here’s a video summarizing the creation of Intel:
Thomas Edison of Silicon Valley
Nowadays, Noyce is hailed by many as the “Thomas Edison of Silicon Valley.” Noyce received his Ph.D. from MIT and is most known for his invention of the integrated circuit. During the late 1950s, other engineers also worked on the IC, including Jack Kilby at Texas Instruments, but Noyce received the first patent in 1961. Unlike Kilby, who created his IC from germanium, Noyce created his IC from silicon, the semiconductor of choice still today. After a decade of litigation, Noyce and Kilby settled their differences and decided to cross-license their patents. Unfortunately, the Nobel Foundation doesn’t issue Nobel Prizes posthumously, so when the Nobel Prize was issued for the invention of the integrated circuit in the year 2000 (10 years after Noyce’s death), only Kilby was recognized. To Kilby’s credit, he acknowledged the contributions of Noyce and others in his Nobel speech with a story of a rabbit and beaver looking up at the Hoover Dam, “No, I didn’t build it myself. But it’s based on an idea of mine!”
Moore’s Law Established
Arguably, Moore was just as influential as Noyce, but due to his quiet leadership style, Moore is often overlooked. Moore was a year younger than Noyce and earned his chemistry degree from Berkeley and Ph.D. from Caltech. Unlike Noyce, who grew up in the Midwest (Iowa), Moore was raised near Palo Alto, which made recruiting Moore by William Shockley quite easy. Moore’s largest contribution is considered to “Moore’s Law,” which generally states the number of transistors (i.e., a chip’s computing power) will double every 1-2 years. During the 1980s, Noyce described the implications of Moore’s Law by comparing Moore’s Law to the airline industry. If the airline industry progressed at the trajectory of the semiconductor industry over the last 20 years, then the 767 airplane would cost $500 and travel around the world in 20 minutes on five gallons of gas. Regrettably, not many industries advance at the pace of semiconductors.
Moore came up with “Moore’s Law” when her wrote a seminal article for Electronics magazine in 1965 and in the article he properly predicted that the number of transistors that could be squeezed onto a microchip (around 60 at the time) would increase 1,000-fold to 60,000 transistors by 1975. It would take decades for his projections to come true, but Moore very presciently predicted the explosion of home computers, cell phones (which he called “portable communications equipment”), electronic wrist-watches, digital cars, and a host of other electronic devices and applications. A half century later, Moore’s Law holds true, but the pace of transistor growth admittedly is slowing. The physics behind semiconductor manufacturing is running into serious limitations of quantum mechanics, cost, and heat. Microchips are becoming so dense and fast that the internal components in many cases are melting the chips in research labs.
Here is a video link summarizing Moore’s Law:
While Moore’s Law is approaching diminishing returns, the costs of microchips keep declining, power keeps increasing, and efficiency keeps improving. Despite the slowing in Moore’s Law, as you can see below, the adoption of transistors via microchips is not plateauing. According to Intel, we are now consuming an estimated sextillion transistors!
Politics, economics, terrorism, and social issues may dominate the daily headlines, but behind the scenes there are daily miracles occurring due to technology advancements. Driving much of that innovation is the microchip, and without the Traitorous 8, the world would look a lot different and there would be no Silicon Valley as we know it today. Had Robert Noyce and Gordon Moore miserably resigned themselves to remain at Shockley Semiconductor, perhaps mankind would not have achieved the giant strides in global standards of living (see chart below). Thankfully, their contributions live on today and ensure a bright future for our kids, grandchildren, and the world at large.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs) and in INTC (non-discretionary), TXN (non-discretionary), T (non-discretionary), but at the time of publishing had no direct position in TSM, NOK, FCS, or any other security referenced in this article. 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.
This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (January 4, 2016). Subscribe on the right side of the page for the complete text.
Did you enjoy your New Year’s festivities? If you were like me and ate excessively and drank too much egg nog, you may have decided along the line to take a nap. It’s not a bad idea to recharge those batteries before implementing those New Year’s resolutions and jumping on the treadmill. That’s exactly what happened in the financial markets this year. After six consecutive years of positive returns in the Dow Jones Industrial Average (2009 – 2014), stock markets took a snooze in 2015, as measured by the S&P 500 and Dow, which were each down -0.7% and -2.2%, respectively. And bonds didn’t fare any better, evidenced by the -1.9% decline in the Aggregate Bond ETF (AGG), over the same time period. Given the deep-seated fears about the Federal Reserve potentially catapulting interest rates higher in 2015, investors effectively took a big yawn by barely nudging the 10-year Treasury Note yield higher by +0.1% from 2.2% to 2.3%.
Even though 2015 ended up being a quiet year overall, there were plenty of sweet dreams mixed in with scary nightmares during the year-long nap:
INVESTMENT SWEET DREAMS
Diamonds in the Rough: While 2015 stock prices were generally flat to down around the globe (Vanguard Total Word -4.2%), there was some sunshine and rainbows gleaming for a number of segments in the market. For example, handsome gains were achieved in the NASDAQ index (+5.7%); Biotech Index – BTK (+10.9%); Consumer Discretionary ETF – XLY (+8.3%); Health Care ETF – VHT (+5.8%); Information Technology ETF – VGT (+4.6%); along with numerous other investment areas.
Fuel Fantasy Driven by Low Gas Prices: Gas prices averaged $2.01 per gallon nationally in December (see chart below), marking the lowest prices seen since 2009. Each penny in lower gas prices roughly equates to $1 billion in savings, which has strengthened consumers’ balance sheets and contributed to the multi-year economic expansion. Although these savings have partially gone to pay down personal debt, these gas reserves have also provided a financial tailwind for record auto sales (estimated 17.5million in 2015) and a slow but steady recovery in the housing market. The outlook for “lower-for-longer” oil prices is further supported by an expanding oil glut from new, upcoming Iranian supplies. Due to the lifting of economic sanctions related to the global nuclear deal, Iran is expected to deliver crude oil to an already over-supplied world energy market during the first quarter of 2016. Additionally, the removal of the 40-year ban on U.S. oil exports -could provide a near-term ceiling on energy prices as well.
Counting Cash Cows
Catching some shut-eye after reading frightening 2015 headlines on the China slowdown, $96 billion Greek bailout/elections, and Paris/San Bernardino terrorist attacks forced some nervous investors to count sheep to fall asleep. However, long-term investors understand that underpinning this long-lived bull market are record revenues, profits, and cash flows. The record $4.7 trillion dollars in 2015 estimated mergers along with approximately $1 trillion in dividends and share buybacks (see chart below) is strong confirmation that investors should be concentrating on counting more cash cows than sheep, if they want to sleep comfortably.
Creepy Commodities: Putting aside the -30% collapse in WTI crude oil prices last year, commodity investors overall were exhausted in 2015. The -24% decline in the CRB Commodity Index and the -11% weakening in the Gold Index (GLD) was further proof that a strong U.S. dollar, coupled with stagnant global growth, caused investors a lot of tossing and turning. While bad for commodity exporting countries, the collapse in commodity prices will ultimately keep a lid on inflation and eventually become stimulative for those consumers suffering from lower standards of living.
Dollar Dread: The +25% spike in the value of the U.S. dollar over the last 18 months has made life tough for multinational companies. If your business received approximately 35-40% of their profits overseas and suddenly your goods cost 25% more than international competitors, you might grind your teeth in your sleep too. Monetary policies around the globe, including the European Union, will have an impact on the direction of future foreign exchange rates, but after a spike in the value of the dollar in early 2015, there are signs this scary move may now be stabilizing. Although multinationals are getting squeezed, now is the time for consumers to load up on cheap imports and take that bargain foreign vacation they have long been waiting for.
January has been a challenging month the last couple years, and inevitably there will be additional unknown turbulence ahead – the opening day of 2016 not being an exception (i.e., China slowdown concerns and Mideast tensions). However, given near record-low interest rates, record corporate profits, and accommodative central bank policies, the 2015 nap taken by global stock markets should supply the necessary energy to provide a lift to financial markets in the year ahead.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions VHT, AGG, and in certain exchange traded funds (ETFs), but at the time of publishing had no direct position VT, BTK, XLY, VGT, GLD, or in any other security referenced in this article. 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.
This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (December 1, 2015). Subscribe on the right side of the page for the complete text.
It’s that time of year again when an estimated 135 million bargain shoppers set aside personal dignity and topple innocent children in the name of Black Friday holiday weekend, doorbuster discounts. Whether you are buying a new big screen television at Amazon for half-off or a new low-cost index fund, everyone appreciates a good value or bargain, which amplifies the importance of the price you pay. Even though consumers are estimated to have spent $83 billion over the post-turkey-coma, holiday weekend, this spending splurge only represents a fraction of the total 2015 holiday shopping season frenzy. When all is said and done, the average person is projected to dole out $805 for the full holiday shopping season (see chart below) – just slightly higher than the $802 spent over the same period last year.
While consumers have displayed guarded optimism in their spending plans, Americans have demonstrated the same cautiousness in their investing behavior, as evidenced by the muted 2015 stock market gains. More specifically, for the month of November, stock prices increased by +0.32% for the Dow Jones Industrial Average (17,720) and +0.05% for the S&P 500 index (2,080). For the first 11 months of the year, the stock market results do not look much different. The Dow has barely slipped by -0.58% and the S&P 500 has inched up by +1.01%.
Given all the negative headlines and geopolitical concerns swirling around, how have stock prices managed to stay afloat? In the face of significant uncertainty, here are some of the calming factors that have supported the U.S. financial markets:
- Jobs Piling Up: The slowly-but-surely expanding economy has created about 13 million new jobs since late 2009 and the unemployment rate has been chopped in half (from a peak of 10% to 5%).
Source: Calafia Beach Pundit
- Housing Recovery: New and existing home sales are recovering and home prices are approaching previous record levels, as the Case-Shiller price indices indicate below.
Source: Calculated Risk Blog
- Strong Consumer: Cars are flying off the shelves at a record annualized pace of 18 million units – a level not seen since 2000. Lower oil and gasoline prices have freed up cash for consumers to pay down debt and load up on durable goods, like some fresh new wheels.
Source: Calculated Risk Blog
Despite a number of positive factors supporting stock prices near all-time record highs and providing plenty of attractive opportunities, there are plenty of risks to consider. If you watch the alarming nightly news stories on TV or read the scary newspaper headlines, you’re more likely to think it’s Halloween season rather than Christmas season.
At the center of the recent angst are the recent coordinated terrorist attacks that took place in Paris, killing some 130 people. With ISIS (Islamic State of Iraq and Syria) claiming responsibility for the horrific acts, political and military resources have been concentrated on the ISIS occupied territories of Syria and Iraq. Although I do not want to diminish the effects of the appalling and destructive attacks in Paris, the events should be placed in proper context. This is not the first or last large terrorist attack – terrorism is here to stay. As I show in the chart below, there have been more than 200 terrorist attacks that have killed more than 10 people since the 9/11 attacks. Much of the Western military power has turned a blind eye towards these post-9/11 attacks because many of them have taken place off of U.S. or Western country soil. With the recent downing of the Russian airliner (killing all 224 passengers), coupled with the Paris terror attacks, ISIS has gained the full military attention of the French, Americans, and Russians. As a result, political willpower is gaining momentum to heighten military involvement.
Investor anxiety isn’t solely focused outside our borders. The never ending saga of when the Federal Reserve will initiate its first Federal Funds interest rate target increase could finally be coming to an end. According to the CME futures market, there currently is a 78% probability of a 0.25% interest rate increase on December 16th. As I have said many times before, interest rates are currently near generational lows, and the widely communicated position of Federal Reserve Chairwoman Yellen (i.e., shallow slope of future interest rate hike trajectory) means much of the initial rate increase pain has likely been anticipated already by market participants. After all, a shift in your credit card interest rate from 19.00% to 19.25% or an adjustment to your mortgage rate from 3.90% to 4.15% is unlikely to have a major effect on consumer spending. In fact, the initial rate hike may be considered a vote of confidence by Yellen to the sustainability of the current economic expansion.
Shopping Without My Rose Colored Glasses
Regardless of the state of the economic environment, proper investing should be instituted through an unemotional decision-making process, just as going shopping should be an unemotional endeavor. Price and value should be the key criteria used when buying a specific investment or holiday gift. Unfortunately for many, emotions such as greed, fear, impatience, and instant gratification overwhelm objective measurements such as price and value.
As I have noted on many occasions, over the long-run, money unemotionally moves to where it is treated best. From a long-term perspective, that has meant more capital has migrated to democratic and capitalistic countries with a strong rule of law. Closed, autocratic societies operating under corrupt regimes have been the big economic losers.
With all of that set aside, the last six years have created tremendous investment opportunities due to the extreme investor risk aversion created by the financial crisis – hence the more than tripling in U.S. stock prices since March 2009.
When comparing the yield (i.e., profit earned on an investment) between stocks and bonds, as shown in the chart below, you can see that stock investors are being treated significantly better than bond investors (6.1% vs. 4.0%). Not only are bond investors receiving a lower yield than stock investors, but bond investors also have no hope of achieving higher payouts in the future. Stocks, on the other hand, earn the opportunity of a double positive whammy. Not only are stocks currently receiving a higher yield, but stockholders could achieve a significantly higher yield in the future. For example, if S&P 500 earnings can grow at their historic rate of about 7%, then the current stock earnings yield of 6.1% would about double to 12.0% over the next decade at current prices. The inflated price and relative attractiveness of stocks looks that much better if you compare the 6.1% earnings yield to the paltry 2.2% 10-Year Treasury yield.
This analysis doesn’t mean everyone should pile 100% of their portfolios into stocks, but it does show how expensively nervous investors are valuing bonds. Time horizon, risk tolerance, and diversification should always be pillars to a disciplined, systematic investment strategy, but as long as these disparities remain between the earnings yields on stocks and bonds, long-term investors should be able to shop for plenty of doorbuster discount bargain opportunities.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in AMZN and certain exchange traded funds (ETFs), but at the time of publishing had no direct position in any other security referenced in this article. 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.
Historically, when people speak about unicorns they are referring to those magical white horses with long horns sprouting from their foreheads. Today, in Silicon Valley and on Wall Street, “unicorns” refer to those private companies valued at more than $1 billion. The current list of unicorns is extensive, including household names like money-losing Uber ($51.0 billion valuation), Airbnb ($25.5 billion), SnapChat ($15.3 billion), and about 150 other money-losing companies with a combined valuation of approximately a half trillion dollars (see list here). Just like the mythical unicorns we imagine and read about in fairy tales, Silicon Valley unicorns are at risk of dying off and becoming a myth as well.
Square at the Heart of the Problem
Following young technology start-ups with names like, Box, Dropbox, and Square can become quite confusing, but investors are becoming less confused about their desire for profits and fair valuations. The recent –33% discount in the planned pre-IPO offering price of Square shares to $11 – $13 ($4 billion) from the last private funding valuation of $15.46 ($6 billion) is signaling the deteriorating health of money-losing unicorns.
Adding insult to injury, money-losing Square provided recent private investors with a controversial “ratchet” clause, which essentially gives privileged investors additional shares, if the IPO (Initial Public Offering) price does not occur at a minimum set price. The net result is a fraction of advantaged investors receive a disproportionate percentage of the company’s value, while a majority of the other investors see their ownership value diluted. According to Forbes, approximately 30% of unicorns carry some contentious ratchet provisions, which may make IPO exits for these companies that much more difficult.
The recent Square news comes on the heels of other unicorns like Dropbox seeing its pre-IPO value being reduced by -24% from industry giant BlackRock Inc (BLK), an early Dropbox investor. According to the Wall Street Journal¸ bankers close to the company admitted achieving a pre-IPO valuation of $10 billion will be challenging. Subsequently, mutual fund behemoth Fidelity wrote down the value of social media, photo disappearing, mobile application company, Snapchat, by -25%.
Unfortunately, the problems for unicorn companies don’t stop after the IPO. Take for example, Fitbit Inc (FIT), the newly minted $6 billion IPO, which took place in June. Even though the wearable technology company may no longer be a unicorn, the -31% decline in its share price during the first half of November is evidence there are consequences to insiders dumping additional over-priced (or high-priced) shares on investors. Of the planned 17 million secondary share sale, the vast majority of the proceeds (14 million shares) are going to insiders who are taking the money and running, thereby leaving the company itself with a much smaller portion of the offering dollars.
Veteran investors have seen this movie before during the late 1990s tech bubble, and investors know that this type of movie ends very badly. As in any bubble, if you are able to participate early enough during the inflation process, it can be a spectacular ride before the bubble bursts. Unicorn companies can sell a dream for a while, but profitless prosperity cannot last forever. Eventually, profits and cash flows do become important for investors. And for some unicorn companies, the day of reckoning appears to have arrived now. It has been a fun, fairy tale ride for unicorn investors up until now, but with a half trillion dollars in unicorn investments beginning to die off, these early stage companies will need a steadier diet of profits to stay alive.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs), but at the time of publishing, SCM had no direct position in Uber, Airbnb, SnapChat, Box, Dropbox, Square, BLK, FIT and any other security referenced in this article. 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.
This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (November 2, 2015). Subscribe on the right side of the page for the complete text.
Have you finished licking the last of your Halloween chocolate-covered fingers and scheduled your next cavity-filled dental appointment? After a few challenging months, the normally spooky month of October produced an abundance of sweet treats rather than scary tricks for stock market investors. In fact, the S&P 500 index finished the month with a whopping +8.3% burst, making October the tastiest performing month since late 2010. This came in stark contrast to the indigestion experienced with the -8.7% decline over the previous two months.
What’s behind all these sweet gains? For starters, fears of a Chinese economic sugar-high ending in a crash have abated for now. With that said, “Little Red Riding Hood” is not out of the woods quite yet. Like a surprising goblin or ghost popping out to scare you at a Halloween haunted house, China could still rear its ugly head in the future due to its prominent stature as the second largest global economy. We have been forced to deal with similar on-again-off-again concerns associated with Greece.
The good news is the Chinese government and central bank are not sitting on their hands. In addition to interest rate cuts and corruption crackdowns, Chinese government officials have even recently halted its decades-long one-child policy. China’s new two-child policy is designed to spur flagging economic growth and also reverse the country’s aging demographic profile.
Also contributing to the stock market’s sugary October advances is an increasing comfort level with the Federal Reserve’s eventual interest rate increase. Just last week, the central bank released the statement from its October Federal Open Market Committee meetings stating it will determine whether it will be “appropriate” to increase interest rates at its next meetings, which take place on December 15th and 16th. Interest rate financial markets are now baking in a roughly 50% probability of a Fed interest rate hike next month. Initially, the October Fed statement was perceived negatively by investors due to fears that higher rates could potentially choke off economic growth. Within a 30 minute period after the announcement, stock prices reversed course and surged higher. Investors interpreted the Fed signal of a possible interest rate hike as an upbeat display of confidence in a strengthening economy.
As I have reiterated on numerous occasions (see also Fed Fatigue), a +0.25% increase in the Federal Funds rate from essentially a level of 0% is almost irrelevant in my eyes – just like adjusting the Jacuzzi temperature from 102 degrees down to 101 degrees is hardly noticeable. More practically speaking, an increase from 14.00% to 14.25% on a credit card interest rate will not deter consumers from spending, just like a 3.90% mortgage rising to 4.15% will not break the bank for homebuyers. On the other hand, if interest rates were to spike materially higher by 3.00% – 4.00% over a very short period of time, this move would have a much more disruptive impact, and would be cause for concern. Fortunately for equity investors, this scenario is rather unlikely in the short-run due to virtually no sign of inflation at either the consumer or worker level. Actually, if you read the Fed’s most recent statement, Fed Chairwoman Janet Yellen indicated the central bank intends to maintain interest rates below “normal” levels for “some time” even if the economy keeps chugging along at a healthy clip.
If you think my interest rate perspective is the equivalent of me whistling past the graveyard, history proves to be a pretty good guide of what normally happens after the Fed increases interest rates. Bolstering my argument is data observed over the last seven Federal Reserve interest rate hike cycles from 1983 – 2006 (see table below). As the statistics show, stock prices increased an impressive +20.9% on average over Fed interest rate “Tightening Cycles.” It is entirely conceivable that the announcement of a December interest rate hike could increase short-term volatility. We saw this rate hike fear phenomenon a few months ago, and also a few years ago in 2013 (see also Will Rising Rates Murder Market?) when Federal Reserve Chairman Ben Bernanke threatened an end to quantitative easing (a.k.a., “Taper Tantrum”), but eventually people figured out the world was not going to end and stock prices ultimately moved higher.
Besides increased comfort with Fed interest rate policies, another positive contributing factor to the financial market rebound was the latest Congressional approval of a two-year budget deal that prevents the government from defaulting on its debt. Not only does the deal suspend the $18.1 trillion debt limit through March 2017 (see chart below), but the legislation also lowers the chance of a government shutdown in December. Rather than creating a contentious battle for the fresh, incoming Speaker of the House (Paul Ryan), the approved budget deal will allow the new Speaker to start with a clean slate with which he can use to negotiate across a spectrum of political issues.
Source: Wall Street Journal
Remain Calm – Not Frightened
Humans, including all investors, are emotional beings, but the best investors separate fear from greed and are masters at making unemotional, objective decisions. Just as everything wasn’t a scary disaster when stocks declined during August and September, so too, the subsequent rise in October doesn’t mean everything is a bed of roses.
Every three months, thousands of companies share their financial report cards with investors, and so far with more than 65% of the S&P 500 companies reporting their results this period, corporate America is not making the honor roll. Collapsing commodity prices, including oil, along with the rapid appreciation in the value of the U.S. dollar (i.e., causing declines in relatively expensive U.S. exports), third quarter profit growth has declined -1%. If you exclude the energy sector from the equation, corporations are still not making the “Dean’s List,” however the report cards look a lot more respectable through this lens with profits rising +6% during the third quarter. A sluggish third quarter GDP (Gross Domestic Product) growth report of +1.5% is further evidence the economy has plenty of room to improve the country’s financial GPA.
Historically speaking, October has been a scary period, if you consider the 1929 and 1987 stock market crashes occurred during this Halloween month. Now that investors have survived this frightening period, we will see if the “Santa Claus Rally” will arrive early this season. Stock market treats have been sweet in recent weeks, but investors cannot lose sight of the long-term. With interest rates near generational lows, investors need to make sure they are efficiently investing their investment funds in a low-cost, tax-efficient, diversified manner, subject to personal time horizons and risk tolerances. Over the long-run, meeting these objectives will create a lot more treats than tricks.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs) , but at the time of publishing, SCM had no direct position in any other security referenced in this article. 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.
Those readers who have frequented my Investing Caffeine site are familiar with the numerous profiles on professional investors of both current and prior periods (See Profiles). Many of the individuals described have a tremendous track record of success, while others have a tremendous ability of making outrageous forecasts. I have covered both. Regardless, much can be learned from the successes and failures by mirroring the behavior of the greats – like modeling your golf swing after Tiger Woods (O.K., since Tiger is out of favor right now, let’s say Jordan Spieth). My investment swing borrows techniques and tips from many great investors, but Peter Lynch (ex-Fidelity fund manager), probably more than any icon, has had the most influence on my investing philosophy and career as any investor. His breadth of knowledge and versatility across styles has allowed him to compile a record that few, if any, could match – outside perhaps the great Warren Buffett.
Consider that Lynch’s Magellan fund averaged +29% per year from 1977 – 1990 (almost doubling the return of the S&P 500 index for that period). In 1977, the obscure Magellan Fund started with about $20 million, and by his retirement the fund grew to approximately $14 billion (700x’s larger). Cynics believed that Magellan was too big to adequately perform at $1, $2, $3, $5 and then $10 billion, but Lynch ultimately silenced the critics. Despite the fund’s gargantuan size, over the final five years of Lynch’s tenure, Magellan outperformed 99.5% of all other funds, according to Barron’s. How did Magellan investors fare in the period under Lynch’s watch? A $10,000 investment initiated when he took the helm would have grown to roughly $280,000 (+2,700%) by the day he retired. Not too shabby.
Lynch graduated from Boston College in 1965 and earned a Master of Business Administration from the Wharton School of the University of Pennsylvania in 1968. Like the previously mentioned Warren Buffett, Peter Lynch shared his knowledge with the investing masses through his writings, including his two seminal books One Up on Wall Street and Beating the Street. Subsequently, Lynch authored Learn to Earn, a book targeted at younger, novice investors. Regardless, the ideas and lessons from his writings, including contributing author to Worth magazine, are still transferable to investors across a broad spectrum of skill levels, even today.
The Lessons of Lynch
Although Lynch has left me with enough financially rich content to write a full-blown textbook, I will limit the meat of this article to lessons and quotations coming directly from the horse’s mouth. Here is a selective list of gems Lynch has shared with investors over the years:
Buy within Your Comfort Zone: Lynch simply urges investors to “Buy what you know.” In similar fashion to Warren Buffett, who stuck to investing in stocks within his “circle of competence,” Lynch focused on investments he understood or on industries he felt he had an edge over others. Perhaps if investors would have heeded this advice, the leveraged, toxic derivative debacle occurring over previous years could have been avoided.
Do Your Homework: Building the conviction to ride through equity market volatility requires rigorous homework. Lynch adds, “A company does not tell you to buy it, there is always something to worry about. There are always respected investors that say you are wrong. You have to know the story better than they do, and have faith in what you know.”
Price Follows Earnings: Investing is often unnecessarily made complicated. Lynch fundamentally believes stock prices will follow the long-term trajectory of earnings growth. He makes the point that “People may bet on hourly wiggles of the market, but it’s the earnings that waggle the wiggle long term.” In a publicly attended group meeting, Michael Dell, CEO of Dell Inc. (DELL), asked Peter Lynch about the direction of Dell’s future stock price. Lynch’s answer: “If your earnings are higher in 5 years, your stock will be higher.” Maybe Dell’s price decline over the last five years can be attributed to its earnings decline over the same period? It’s no surprise that Hewlett-Packard’s dramatic stock price outperformance (relative to DELL) has something to do with the more than doubling of HP’s earnings over the same time frame.
Valuation & Price Declines: “People Concentrate too much on the P (Price), but the E (Earnings) really makes the difference.” In a nutshell, Lynch believes valuation metrics play an important role, but long-term earnings growth will have a larger impact on future stock price appreciation.
Two Key Stock Questions: 1) “Is the stock still attractively priced relative to earnings?” and 2) “What is happening in the company to make the earnings go up?” Improving fundamentals at an attractive price are key components to Lynch’s investing strategy.
Lynch on Buffett: Lynch was given an opportunity to write the foreword in Buffett’s biography, The Warren Buffett Way. Lynch did not believe in “pulling out flowers and watering the weeds,” or in other words, selling winners and buying losers. In highlighting this weed-flower concept, Lynch said this about Buffett: “He purchased over $1 billion of Coca-Cola in 1988 and 1989 after the stock had risen over fivefold the prior six years and over five-hundredfold the previous sixty years. He made four times his money in three years and plans to make a lot more the next five, ten, and twenty years with Coke.” Hammering home the idea that a few good stocks a decade can make an investment career, Lynch had this to say about Buffett: “Warren states that twelve investments decisions in his forty year career have made all the difference.”
You Don’t Need Perfect Batting Average: In order to significantly outperform the market, investors need not generate near perfect results. According to Lynch, “If you’re terrific in this business, you’re right six times out of 10 – I’ve had stocks go from $11 to 7 cents (American Intl Airways).” Here is one recipe Lynch shares with others on how to beat the market: “All you have to do really is find the best hundred stocks in the S&P 500 and find another few hundred outside the S&P 500 to beat the market.”
The Critical Element of Patience: With the explosion of information, expansion of the internet age, and the reduction of trading costs has come the itchy trading finger. This hasty investment principle runs contrary to Lynch’s core beliefs. Here’s what he had to say regarding the importance of a steady investment hand:
- “In my investing career, the best gains usually have come in the third or fourth year, not in the third or fourth week or the third or fourth month.”
- “Whatever method you use to pick stocks or stock mutual funds, your ultimate success or failure will depend on your ability to ignore the worries of the world long enough to allow your investments to succeed.”
- “Often, there is no correlation between the success of a company’s operations and the success of its stock over a few months or even a few years. In the long term, there is a 100% correlation between the success of a company and the success of its stock. It pays to be patient, and to own successful companies.”
- “The key to making money in stocks is not to get scared out of them.”
Bear Market Beliefs: “I’m always more depressed by an overpriced market in which many stocks are hitting new highs every day than by a beaten-down market in a recession,” says Lynch. The media responds in exactly the opposite manner – bear markets lead to an inundation of headlines driven by panic-based fear. Lynch shares a similar sentiment to Warren Buffett when it comes to the media holding a glass half full view in bear markets.
Market Worries: Is worrying about market concerns worth the stress? Not according to Lynch. His belief: “I’ve always said if you spend 13 minutes a year on economics, you’ve wasted 10 minutes.” Just this last March, Lynch used history to drive home his views: “We’ve had 11 recessions since World War II and we’ve had a perfect score — 11 recoveries. There are a lot of natural cushions in the economy now that weren’t there in the 1930s. They keep things from getting out of control. We have the Federal Deposit Insurance Corporation [which insures bank deposits]. We have social security. We have pensions. We have two-person, working families. We have unemployment payments. And we have a Federal Reserve with a brain.”
Thoughts on Cyclicals: Lynch divided his portfolio into several buckets, and cyclical stocks occupied one of the buckets. “Cyclicals are like blackjack: stay in the game too long and it’s bound to take all your profit,” Lynch emphasized.
Selling Discipline: The rationale behind Lynch’s selling discipline is straightforward – here are some of his thoughts on the subject:
- “When the fundamentals change, sell your mistakes.”
- “Write down why you own a stock and sell it if the reason isn’t true anymore.”
- “Sell a stock because the company’s fundamentals deteriorate, not because the sky is falling.”
Distilling the genius of an investing legend like Peter Lynch down to a single article is not only a grueling challenge, but it also cannot bring complete justice to the vast accomplishments of this incredible investment legend. Nonetheless, his record should be meticulously studied in hopes of adding jewels of investment knowledge to the repertoires of all investors. If delving into the head of this investing mastermind can provide access to even a fraction of his vast knowledge pool, then we can all benefit by adding a slice of this greatness to our investment portfolios.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, including KO, but at time of publishing had no direct positions in DELL, HPQ or any other security mentioned. 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.