Posts filed under ‘Stocks’
The Cyclical Seasons of Growth and Value
Continually the airwaves rotate through the growth and value managers du jour, and like religious zealots each one explains their philosophy with such confidence that Jersey Shore’s “The Situation” would even call them cocky. The fact of the matter is that styles go in and out of favor like the seasons of the year. What’s more, the consistency of the seasons is erratic and the duration of the style outperformance can in many instances extend for years. A major driver behind the relative outperformance of styles links back to where we stand in the economic cycle. Since these phases can last for years, meticulous precision is not required.
Case in point, take the “Go-Go” 1990s. In the back half of the decade, while the “New Economy” of technology companies propelled GDP to new heights, growth stocks witnessed historic price appreciation and P/E (Price-Earnings) multiple expansion. As members of our growth team high-fived each other on a daily basis, the “Four Horsemen” consistently jumped 2-3% like clockwork. Simultaneously, human resources had to keep sharp objects away from our value team colleagues and make sure the windows were locked shut. As you can see from the chart, growth stocks trounced value stocks during that period.
Source: INGdelivers.com
Karma can be a bi*ch however, because as the technology bubble burst in 2000, the coiled underperforming value stocks sprang to significant outperformance in the first half of the 2000s. The value managers were more than happy to hand over the straightjackets to us growth managers.
Since these style cycles can persist for long periods of time, and we managers get compensated based on performance versus peers, there is a strong incentive to cheat or style drift towards the outperforming style (see also Hail Mary Investing).
The pain threshold is increasing for value managers as the economic expansion matures and growth stocks have handily outperformed value stocks over the last five years. When value managers start piling into Apple Inc. (AAPL), maybe the value cycle will be ready to kick into gear again.
Growth consistently outperforming value (Source: Russell Investments)
- Source: Dynamic Hedge – Is value on the comeback trail?
Arbitrary Style Buckets
Understanding the dynamics of style outperformance cycles is important, but understanding how the sausage is made at the micro level is essential too. One must appreciate that style categorizations are determined by arbitrary criteria by self-anointed “bucket deciders” (i.e., S&P, Barra, Russell Investments). Like ping pong balls, individual stocks will bounce around from one style bucket to the other based largely on share price volatility and financial metrics such as Price/Book, Price/Earnings, and EPS growth. Regrettably, these metrics can become temporarily distorted and lead to irrational trading patterns for benchmark hugging managers that become myopically focused on minor deviations from the herd.
Based on the stock bucket decision criteria, some questionable head-scratching stock categorizations may occur. For examples International Business Machines (IBM) is classified as a growth stock in the Russell 1000 Growth Index despite a cheap forward 11x P/E multiple, meager 3% revenue growth, and a 2% dividend. Phillip Morris Intl (PM) is also considered a growth stock even though its revenue growth has recently been even more sluggish at 2%, and has a mouth watering value-like dividend of 4.4%.
On the flip side, stocks like Microsoft Corp. (MSFT) are thrown in the value bucket, although the software king grew revenues +25% and earnings +55% in the recent quarter. Iconic value stock Berkshire Hathaway (BRKA/B) follows many growth stocks by not paying a dividend, and the Buffett controlled entity trades at a sky-high trailing P/E multiple of 20x, and ironically expanded sales and earnings by +21% and +28%, respectively.
All this talk of style seasons and bucket hopping only highlights the boring but crucial principle of diversification. It’s important to understand these cycles and categorizations, especially at extremes, but this does not get rid of the fact that an overly concentrated portfolio concentrated in an outperforming style is setting itself up for failure (see also Riding the Wave). We’ve reviewed cycle dynamics surrounding investment styles, but these varied securities come in all shapes and sizes – we will tackle the relative performance forces of small, mid, and large capitalization stocks during another season.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, AAPL and CSCO, but at the time of publishing SCM had no direct position in ORCL, EMC, IBM, PM, MSFT, BRKA/B, 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.
Corporate Shockers: You did *#$@% to Steve Jobs?
Source: 1funny.com
Steve Jobs recruited John Sculley to run Apple Computers (AAPL) in 1983 because the board wanted someone more experienced than a snot-nosed 28 year old founder barking orders at Apple employees. Sculley was a seasoned 15 year veteran executive from Pepsi Co. (PEP) whom was persuaded by Jobs to take over the company and join him in changing the world.
Things were all nifty until Sculley went all Brutus on Jobs and decided to fire him with board assistance in 1985 when it was believed that Jobs was poaching executives from Apple to join Jobs’s successor company, Next Computers.
The verdict may not completely be out on Sculley’s effectiveness on running Apple, but he deserves a PhD in the “Obvious Arts.” When asked if the coordinated decision (between Sculley and the Board) to fire Steve Jobs more than 25 years ago was correct, this is what Sculley had to say:
“In hindsight, I think they [board] made the wrong choice. They should have chosen Steve…we should have figured out a way to work with it [Job’s talent].”
Click Here for John Sculley Bloomberg Interview
Over his term at Apple, Sculley increased sales from $800 million to $8 billion. Good performance, but apparently not good enough, because Sculley was axed in 1993 and a window was opened for Jobs to return as Apple’s puppet-master four years later. The rest is history and AAPL stock went from about $10 per share when Sculley left all the way up to $316.65 today. Not too shabby.
In another shocker, after hiring Sculley and then getting fired by Sculley, Jobs said Sculley won’t talk to him. I can’t understand why a company founder would hold a grudge toward a hand-picked former employee who spearheaded a lynching against his boss? Well, I guess karma has a way of evening things out in the long run – redemption was found with Jobs’s climbing the Silicon Valley mountain to create the $300 billion consumer technology behemoth. I’m sure you don’t have to cry a river for John Sculley, but if he can’t control his own tears, he can always use his hundred dollar bills as tissue surrogates.
What makes Jobs’s decline and subsequent triumph even more unbelievable are the hugs and kisses Steve Jobs owes Microsoft founder and billionaire Bill Gates. If not for a $150 million lifeline offered by Gates to Steve Jobs in August 1997, while Apple was on its financial deathbed, we may not have ever experienced the iPod, iPhone, iPad, or future overhyped consumer gadget (OK, I admit it, I have succumbed to the hype myself). I’m guessing if Bill were given another chance, he would have passed on that Apple investment and we would be stuck paying for $4,000 computers and $1,000 Microsoft Office upgrades.
As a result of these corporate shockers, several lessons can be learned. Number one: If you are hired by a company founder, be careful about firing that boss if put in that position – you could potentially be jeopardizing the creation of hundreds of billions of dollars in future value. Number two: If you are unable to successfully negotiate lesson number one, then just find someone to lend you $150 million. History has taught us lessons based on past events ranging from Prohibition to Watergate, and from Nazi Germany to Tiger Woods’s indiscretions. John Sculley also learned lessons from Apple’s corporate shockers, and so can you.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds and AAPL, but at the time of publishing SCM had no direct position in PEP, MSFT, 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.
From Merger Wedding to eHarmony
Source: Photobucket
“Keep your eyes wide open before marriage, and half-shut afterwards.”
– Benjamin Franklin
Stocks share a lot of the same dynamics with dating and marriage. Some may choose to play the field through partnerships and joint ventures, while others may choose to remain independent as eternal bachelors/bachelorettes. Others, however, are willing to take the plunge. Unfortunately some marriages don’t last. But if things don’t work out, there is no need to worry because eHarmony.com (or resident investment bank) will always be there to help find your next perfect match.
Unlucky in Love
An example of a bloody divorce is the mega-merger between AOL Inc. and Time Warner (TWX) in 2000. The relationship was so destructive that investors witnessed AOL’s peak value of $222 billion in December 1999 (Fortune) plummet to around $3 billion today…ooooph!
Compared to some relationships, AOL lasted much longer. In fact Yahoo! Inc. (YHOO) didn’t even get to celebrate a honeymoon with Microsoft Corp. (MSFT) in February 2008 when the behemoth software company offered a +62% premium ($31 per share) for the gigantic portal. Microsoft’s $45 billion cash and stock offer was ruled unworthy by Yahoo’s board, so the company decided to leave Microsoft at the altar. Even after considering Yahoo’s latest price spike on acquisition rumors, Microsoft’s original bid is still almost double Yahoo’s current stock price of $16 per share.
Merger Scuttlebutt
As I discussed in my earlier mergers and acquisitions article (M&A) conditions are ripening with large corporate cash piles, a continued economic recovery, improved capital markets availability, and cheap credit costs (at least for those that qualify). With the clouds slowly lifting in the M&A world, suitors are shaking the trees for more potential opportunities.
While some acquirers may have altruistic intentions in combining companies, some marriages are done for pure gold-digging purposes. Private equity firms Blackstone Group (BX) and Silver Lake are rumored to be circling the Yahoo wagons and courting AOL as a potential partner in a joint bid. Whatever the expectations, if private equity plays a role in a Yahoo bid, the internet company should not become disillusioned with romantic warm and fuzzies – private equity firms like to get straight down to dirty business. Yahoo owns a 35% stake in Yahoo Japan and a 43% interest in leading Chinese e-commerce company, Alibaba Group. If a joint private equity bid were ever to win, I believe there would be a strong impetus to realize shareholder value by carving up these non-operating stakes. Consolidating overhead and streamlining expenses would likely be a top priority as well.
The Perfect Marriage
A “perfect marriage” could almost be called an oxymoron because like any relationship, there is significant work required by both parties. The divorce rate is estimated at around 40-50% in North America (Europe around the same), however mergers even fail at a higher 70% rate, according to Bain and Company study. I would argue successfully integrating larger deals are even more difficult, hampering the success rate even further. Merging two poorly managed companies purely for cost purposes is probably not the best way to go. Crashing two garbage trucks together is not going to create a Ferrari. I wouldn’t go as far as to say Yahoo and AOL are garbage trucks, but they face numerous, substantial challenges. Maybe these two companies are more akin to Mazdas transforming into a Toyota Camry (TM).
From my perspective, if companies really are dead set on engaging in acquisitions, then I urge management teams to focus on smaller digestible deals. Specifically, concentrate on those deals with experienced senior management teams who understand and respect the unique culture of the acquirer. Mergers also often fail due to excessive optimism and overly optimistic assumptions. This is an area in which Warren Buffett excels. Rarely do you observe the Oracle of Omaha overpaying for an acquisition, but rather he patiently waits for his fat pitch, and when it floats over the plate, Buffett is quick to throw out a lowball offer that will dramatically increase the probabilities of long-term merger success (think Geico, Sees Candy, Burlington Northern, etc.).
In the end, a joint relationship may not be forged between Yahoo, AOL and private equity firms, but if talks disintegrate, no need to worry – alternative partnerships can be explored on eHarmony.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in YHOO, MSFT, TWX, BX, BRKA, TM, Alibaba, 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.
Microsoft Makes Dividend Splash
Source: ActingLikeAnimals.com
I’ve talked about growing profits and cash piles for a while now (read more), but at some point investors and board members get restless and demand action (Steve Jobs has not yet). The most recent blue-chip company to make a splash, when it comes to capital management, is Microsoft Corp. (MSFT), which just announced a significant +23% increase in its dividend in conjunction with $4.75 billion in debt offerings. These capital structure changes still leave plenty of room for additional share repurchases and acquisitions.
Debt Offering – Are You Sure?
Huh? What in the heck is Microsoft doing borrowing money? I mean, does a company with $44 billion in cash and investments, generating a whopping additional $22 billion in free cash flow in fiscal 2010 (ended in June), really need access to additional capital? The short answer is “NO.” But a company like Microsoft borrowing $4.75 billion is like Donald Trump borrowing $50 on his credit card. Well wait, “The Donald” has actually had some hair and Chapter 11 problems, so the more appropriate analogy would be Bill Gates borrowing $20 on his credit card. Not only is it a rounding error, but it’s a good financial management practice for corporations to take advantage of the debt tax shield (read definition).
What makes Microsoft’s debt issuance that much more incredible is the astonishingly low rates the company is paying investors on the debt. According to Dealogic, Microsoft set a record low for yield paid on corporate unsecured debt. For the separate maturities ranging from 2013 to 2040, Microsoft paid a stunningly low 25-83 basis point spread over Treasuries. I don’t want to get into government credit worthiness today, but who knows, maybe Microsoft will pay lower debt rates than the U.S. Treasury, in the not too distant future?!
Regardless of the array of capital structure management strategies used by other companies, Microsoft is not alone in dealing with its cash hoarding problems. Cisco Systems Inc. (CSCO), another blue-chip cash printing press, just announced the initiation of a 1-2% dividend to be paid by the end of their fiscal year ending in July 2011 (read more about dividend cash “un-hoarding”).
But Who Cares?
Who cares about Microsoft’s wimpy 2.62% yield anyway? Well, for one, I sure care! A 10-year Treasury Note is yielding a measly, static 2.55%. If Microsoft continued on the same dividend path growth over the next five years as it did over the last five years, investors could potentially be talking about a 5.2% yield on our initial investment, and this excludes any potential stock price appreciation. With only roughly a 25% payout ratio on Microsoft’s fiscal 2010 free cash flow, the company has a lot of freedom to hike future dividends, even if earnings don’t grow. Microsoft has also enhanced shareholder value by putting its money where its mouth is by purchasing over $30 billion of company stock over the last three years.
Nice trend in dividend growth.
The extreme case of dividend growth is Wal-Mart Stores (WMT), which if purchased in 1972 would provide a +2,300% yield on the original investment, excluding any benefit from the massive price appreciation ($.05 split-adjusted per share to $53.65). Microsoft is no young chick like Wal-Mart 40 years ago, but you get the gist (read Dividend Sapling to Fruit Tree).
So while strategists and economists fret about the possibilities of a “double dip” recession, in the interim there have been 179 companies in the S&P 500 index that have hiked dividends in 2010 (versus only 3 companies that have cut). Microsoft has been no slouch either, growing revenues by +22% and EPS (Earnings Per Share) by +50% in their most recent fiscal fourth quarter. Although Microsoft’s stock is down -20% for 2010, the capital management and dividend splash recently announced by Microsoft (and other companies) should eventually capture the eye of investors currently earning squat on overpriced bonds and almost worthless Certificates of Deposit.
Read complete Microsoft dividend story
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, CSCO, nd WMT, but at the time of publishing SCM had no direct position in MSFT, 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.
Questioning the Death of Buy & Hold Investing
In the midst of the so-called “Lost Decade,” pundits continue to talk about the death of “buy and hold” (B&H) investing. I guess it probably makes sense to define B&H first before discussing it, but like most amorphous financial concepts, there is no clear cut definition. According to some strict B&H interpreters, B&H means buy and hold forever (i.e., buy today and carry to your grave). For other more forgiving Wall Street lexicon analysts, B&H could mean a multi-year timeframe. However, with the advent of high frequency trading (HFT) and supercomputers, the speed of trading has only accelerated further to milliseconds, microseconds, and even nanoseconds. Pretty soon B&H will be considered buying a stock and holding it for a day! Average mutual fund turnover (holding periods) has already declined from about 6 years in the 1950s to about 11 months in the 2000s according to John Bogle.
Technology and the lower costs associated with trading advancements is obviously a key driver to shortened investment horizons, but even after these developments, professionals success in beating the market is less clear. Passive gurus Burton Malkiel and John Bogle have consistently asserted that 75% or more of professional money managers underperform benchmarks and passive investment vehicles (e.g., index funds and exchange traded funds).
This is not the first time that B&H has been held for dead. For example, BusinessWeek ran an article in August 1979 entitled The Death of Equities (see Magazine Cover article), which aimed to eradicate any stock market believers off the face of the planet. Sure enough, just a few years later, the market went on to advance on one of the greatest, if not the greatest, multi-decade bull market run in history. People repudiated themselves from B&H back then, and while B&H was in vogue during the 1980s and 1990s it is back to becoming the whipping boy today.
Excuse Me, But What About Bonds?
With all this talk about the demise of B&H and the rise of the HFT machines, I can’t help but wonder why B&H is dead in equities but alive and screaming in the bond market? Am I not mistaken, but has this not been the largest (or darn near largest) thirty year bull market in bonds? The Federal Funds Rate has gone from 20% in 1981 to 0% thirty years later. Not a bad period to buy and hold, but I’m going to go out on a limb and say the Fed Funds won’t go from 0% to a negative -20% over the next thirty years.
Better Looking Corpse
There’s no denying the fact that equities have been a lousy place to be for the last ten years, and I have no clue what stocks will do for the next twelve months, but what I do know is that stocks offer a completely different value proposition today. At the beginning of the 2000, the market P/E (Price Earnings) valued earnings at a 29x multiple with the 10-year Treasury Note trading with a yield of about 6%. Today, the market trades at 13.5 x’s 2010 earnings estimates (12x’s 2011) and the 10-Year is trading at a level less than half the 2000 rate (2.75% today). Maybe stocks go nowhere for a while, but it’s difficult to dispute now that equities are at least much more attractive (less ugly) than the prices ten years ago. If B&H is dead, at least the corpse is looking a little better now.
As is usually the case, most generalizations are too simplistic in making a point. So in fully reviewing B&H, perhaps it’s not a bad idea of clarifying the two core beliefs underpinning the diehard buy and holders:
1) Buying and holding stocks is only wise if you are buying and holding good stocks.
2) Buying and holding stocks is not wise if you are buying and holding bad stocks.
Even in the face of a disastrous market environment, here are a few stocks that have met B&H rule #1:
Maybe buy and hold is not dead after all? Certainly there have been plenty of stinking losing stocks to offset these winners. Regardless of the environment, if proper homework is completed, there is plenty of room to profitably resurrect stocks that are left for a buy and hold death by the so-called pundits.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds and AAPL, AMZN, ARMH, and NFLX, but at the time of publishing SCM had no direct position in GGP, APKT, KRO, AKAM, FFIV, OPEN, RVBD, BIDU, PCLN, CRM, FLS, GMCR, HANS, BYI, SWN (*2,901% is correct %), CTSH, CMI, ISRG, ESRX, 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.
Winner’s Curse: HP’s Storage Prize
Congratulations HP (HPQ)…you are the proud winner of 3Par Inc. (PAR), a relatively small enterprise storage hardware and software company, for the bargain price of 125x’s 2011 earnings! Never mind that you were late to the game in your winning $2.4 billion bid against Dell Inc. (DELL), or that you paid more than triple the price ($33 per share) that 3Par was trading just 21 days ago (< $10 per share). At least you have a storage trophy you can show all your friends and you don’t have to carry around all those heavy bills anymore.
Winner’s Curse
In bidding wars and auctions, the victor of the price battle runs the risk of earning the “Winner’s Curse.” The curse falls upon those that bid a price that exceeds an auctioned asset’s intrinsic value. How can this occur? Well for one reason, the bidder may not have complete information regarding the value of the asset. Secondly, there can be emotional factors, or ego, that play a role in the decision and price paid. Lastly, unique factors, such as strategic benefits or synergies may exist that allow one bidder to offer a higher price than other auction participants. For example, consider an exploration and production company (XYZ Drilling Co.) that is bidding for drilling lease rights in Prudhoe Bay, Alaska. If XYZ Drilling Co. has unique existing drilling operations in the same area as the auctioned assets, XYZ Drilling Co. may be in a better position of making a profitable bid relative to its peers.
HP vs. Dell – A Deeper Look
Let’s take a deeper dive into the HP bid of 3Par. While HP generates a lot of cash by selling printers, cartridges, and computers, the company doesn’t exactly have a bullet-proof balance sheet. Unlike let’s say Apple Inc. (AAPL), which has about $46 billion in cash on its balance sheet with no debt (see Steve Jobs: Gluttonous Hog), HP actually carries more debt than cash (about $20 billion in debt and $15 billion in cash). What’s more, HP has little tangible equity, once $42 billion in goodwill and intangible assets are subtracted from the total asset value of the company – leaving HP with an astronomically high ratio of 275x’s price to tangible book value. For most companies operating with a positive net cash position, making acquisitions accretive is not that difficult in this current environment – when cash is decaying away with a paltry 1% return. Unfortunately for HP, their accretive hurdle is higher than a cash-rich company. Their weighted average cost of capital is ratcheted significantly higher due to a net debt position (not net cash).
Here is the viewpoint on the deal from Ashok Kumar, senior technology analyst at Rodman & Renshaw LLC:
“It’s in excess of $3 million per employee. To put it in perspective, today 3Par has about 5 percent [market share] of the very high-end market and for these premiums to pay out, [HP] would have to expand their market share to about 25 percent or about $1.5 billion, which is 5x the projected growth rate. And all of that would come at the expense of incumbents [like] IBM, EMC, Hitachi.”
On the Bright Side
Although the price paid by Hewlett-Packard for 3Par is ridiculously too high, this deal alone is not going to break HP’s piggybank. HP is currently raking in about $8 billion in cash flow per year, so absent aggressive share buybacks or other large acquisitions, HP should be able to pay off the cost of the deal in a few quarters. Secondarily, HP does gain some synergies by integrating 3Par’s blocklevel data storage expertise into HP’s existing portfolio of other storage technologies ( i.e., StoreOnce and IBRIX). Thirdly, HP gains some strategic defensive benefits by keeping 3Par out of Dell’s hands, a potentially formidable competitor in the storage space, given the intensive overlap in customer bases between HP & Dell. Lastly, HP will no doubt be able to introduce and cross-sell 3Par products into Hewlett’s vastly larger customer distribution channels and reap the resulting rewards.
All in all, the 3Par acquisition by HP makes perfect strategic sense, however the price paid will turn out to be a much better deal for 3Par shareholders, rather than HP shareholders. HP ultimately shelled out a hefty price tag to become the victorious party in the 3Par bidding war, but rather than increasing shareholder value, HP ended up achieving the “Winner’s Curse.”
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds and AAPL, but at the time of publishing SCM had no direct position in HPQ, PAR, DELL, IBM, EMC, Hitachi, 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.
What Happens in Vegas, Stays on Wall Street
What happens in Vegas, stays in Vegas, unless it’s a habit of betting, in which case that habit will follow you back to Wall Street. Just as there are a million ways to make or lose money by investing or speculating in the market, the same principles apply to sports betting as well. Anybody who has been to Las Vegas and gone to the sportsbook knows how incredibly and insanely accurate the oddsmakers are – I speak from immature experience having traveled there for a healthy number of investment conferences and vacations. The oddsmakers are so accurate; you could say they are almost “efficient” at what they do.
But like the market, in the sports world too, efficiency has a tendency to breakdown occasionally and form bubbles. This dynamic leaves both a huge threat of substantial losses and a potential for windfall gains. Where there are bubbles forming, you are bound to find a large number of excited individuals jumping on a bandwagon. Now, let’s take a look at how the worlds of Wall Street and wagers collide and see if any lessons can be learned.
Jumping on the Stock Bandwagon
band·wag·on [band-wag-uhn]: a party, cause, movement, etc., that by its mass appeal or strength readily attracts many followers.
Photo source: Freshpics.blogspot.com
Everybody loves a winner and no one more so than a fresh fan jumping on the bandwagon. Living in Southern California, the bandwagon is presently fully-loaded with proclaimed Los Angeles Laker fans and USC fans, although the Trojan wagon is currently undergoing repair. It’s easy to identify bandwagoners in sports – just find the face painter, guy with a rainbow afro, Boston native sporting a Kobe Bryant jersey, or the fanatic betting on the team favored by three touchdowns. In the game of stocks, identifying the fickle but passionate followers is a little more subtle. Bandwagon status is not measured by the extent of point spreads (predicted scoring differential between two opponents), but rather by level of P/E ratios (Price-Earnings ratio) or other valuation metric of choice.
While it is clear sports bandwagoners root for the “favorites,” in the realm of investing this translates into piling onto the “growth or momentum” stocks (see Momentum Investing article) – I hate generalizing terms but that’s what we bloggers do. Value investors, on the other hand, root for (buy) the “underdogs.”
To illustrate my point, let’s take a look at a few past bandwagon momentum stocks:
- JDS Uniphase Corp. (JDSU): In 2000 we saw these bandwagoners valuing investor favorites like JDS Uniphase at a whopping $99 billion – meaning investors were willingly paying over 100x’s revenues and 600 x’s trailing earnings to own the stock. At the time, JDSU was a “New Economy” stock that was going to revolutionize the proliferation of bandwidth around the globe with their proprietary optical laser components. For those of you keeping score at home, today JDSU’s stock is valued at approximately $2 billion ($9.97), or -98% less than the market value in March 2000 (split-adjusted peak share price of $1,227.38 per share). If it wasn’t for a 1-for-8 reverse stock split in 2006, then a share of JDSU would fetch you $1.25 today, or less than the amount needed to cover an out of network ATM penalty fee.
- Crocs Inc. (CROX): Crox is another one of my favorite bandwagon stocks, because this loud plastic eyesore footwear was clearly a fad that couldn’t sustain its growth once popularity waned, despite my wife being a bandwagon-ee. Like other fad product-related stocks, the company could no longer maintain its growth once they completed stuffing the channel and their customers cried uncle from choking on inventory. Making matters worse for CROX, knockoff versions were offered for a fraction of the cost at local grocery stores and mall kiosks. After about 20 months post its IPO (Initial Public Offering), the music stopped and within 13 months the stock cratered from a $75 per share peak to $0.79 in 2008. The stock never traded at the absurd dot-com levels, but the lofty 37x P/E in 2007 quickly turned negative after close to $200 million in losses were realized in 2008 and 2009. The stock has since rebounded to $12 and change, and maybe their new Crocs high-heel line of $99.00 shoes (see here) will propel the stock higher…cough, cough.
Point Spread, Point Spread, Point Spread
In sports betting the three most important factors in making a winning bet are point spread, point spread, and point spread. Unlike the March Madness college basketball pool in which you may have participated, in the real world the participant needs to do more than just pick the winning teams – the participant must determine by how much a team will win by. Let’s take a gander at a few actual examples.
- Florida Gators vs. Charleston Southern Buccaneers (9/5/09): Without knowing a lot about the powerhouse squad from South Carolina, 99% of respondents, when asked before the game who would win, would select Florida – a consistently dominant national-powerhouse program. The question gets a little trickier when asked the question: “Will the Florida Gators win by more than 63 points?” That’s exactly the point spread sports bettors faced when deciding whether or not to place the bet – somewhat analogous to the question whether JDSU was a prudent investment at 600x’s earnings? Needless to say, although the Buccs kept it close in the first half, and only trailed by 42-3 at halftime, the Gators still managed to squeak by with a 62-3 victory. Worth noting, the 59 point margin of victory resulted in a losing wager for anyone picking the Gators.
- USC Trojans vs. Stanford Cardinal (10/6/2007): Ranked as the presumptive #1 team of the country pre-season, and entering the game with a 35-0 home-game winning streak, USC was a whopping 41 point favorite over Stanford. On the flip side, the Cardinal came into the game fresh off of a 1-11 losing season the prior year, and in the previous year the Cardinal lost to the Trojans 42-0. Stanford ended up winning the 2007 match-up by a score of 24-23, not only pulling off one of the greatest upsets of all-time, but also spoiling USC’s chances of winning the national championship.
Read more about the greatest upsets of all-time.
Beyond the Point Spread
As you can surmise from our discussion, the same point spread standards apply to investing, but when discussing stocks the spread is measured by various valuation metrics based on earnings, cash flows, book value, EBITDA, sales, and other fundamental growth factors.
Of course, in Las Vegas and on Wall Street not everyone follows traditional fundamental analysis. Some gamblers and speculators will transact solely based on less conventional methods, for example quantitative models, technical analysis and trend review (read Technical Analysis: Astrology or Lob Wedge). For example in sports, handicappers may only wager on teams with five-game winning streaks and winning home records. Whereas on Wall Street, speculators may only trade stocks with positive earnings surprises or “head-and-shoulder” patterns. Hot technicians come and go, but very few real investors survive the long haul without using fundamental analysis and valuation as key components of their winning strategies.
As I have argued, there are many ways to make (and lose) money on Wall Street or in Las Vegas, and consistently jumping on the bandwagon is a sure way to lose. For the successful minority whose performance has endured the test of time, a common thread connecting the two disciplines is the ability to determine and profit from a prudently calculated point spread/valuation. History teaches us that the same effective handicapping skills happening in Las Vegas are the same abilities needed to stay on Wall Street and win.
Wade W. Slome, CFA, CFP®
P.S. See how a pro handicapper conquered Las Vegas and placed sportsbooks on the run.
Plan. Invest. Prosper.
*DISCLOSURE: The undergraduate alma mater of Sidoxia Capital Management’s (SCM) President happens to be UCLA, so although I believe any reference to rival school USC is not provided with any malicious agenda, nonetheless there may exist an inherent conflict of interest. SCM and some of its clients own certain exchange traded funds, but at the time of publishing, SCM had no direct position in JDSU, CROX, 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.
BP: Sweet Opportunity or Sloppy Mess?
Photo source: 1Funny.com
Discussing the BP oil spill is not exactly cutting-edge, fresh news at this point. However, now that the 5 million barrel gaping gusher of black sludge has been plugged, many of the uncertain variables are beginning to come in focus. From mid-April this year, right before the disaster occurred, the equity value of BP’s stock peaked around $189 billion. The value of the company subsequently shed over $100 billion in value over the next two months, before rebounding to a level about -35% below the April highs today. BP is not out of the woods yet, even though the discussion has migrated from potential bankruptcy scenarios. The question now is whether purchasing BP stock currently is a sweet opportunity or just a sloppy mess that will drag value down for years to come?
Whitney Tilson, whom I profiled last year in Fat Lady Housing article, is the founder and Managing Partner of T2 Partners LLC who decided to tackle the tough BP questions. Tilson compiled his bullish thesis on BP at the 7th Annual Value Investor conference when BP’s share price was trading at $36.76. Why is Tilson so optimistic about BP’s stock price appreciation potential? He uses a few approaches, but his number one approach is a walk down catastrophe memory lane. If previous stock calamities resulted in opportunities due to investor overreaction, then certainly the same principal should apply to BP (or so Tilson believes). Here are some of the previous train wrecks Tilson highlighted in his presentation:
Pretty convincing evidence that the bark was bigger than the bite for these examples, but Tilson chose to save his best precedent illustration for last…Merck (MRK). In 2004, the pharmacy company came under assault after it was revealed the drug Vioxx increased the likelihood of patient heart attacks. What fanned the flames of panic were the allegations that Merck had known about these detrimental risks for years, but the company did not disclose this valuable knowledge. To make a long story short, the initial $50 billion liability estimate attributed to Merck actually came in closer to $5 billion and the stock rallied from a low of $26 in 2005 to $60 by the end of 2007. Tilson however, conveniently neglects to mention that the company’s stock shortly thereafter collapsed, before bottoming at $20 per share in early 2009 and settling in at a price around $35 today.
Regardless, Tilson’s points are well taken. Often these major catastrophes that sprawl across media headlines become overdone and offer an opportunity to those investors with thick skin and a stomach that can withstand severe heartburn.
Besides having history on his side, Tilson provided additional supportive bullet points to bolster his sanguine view on BP:
- BP is a Cash Cow: The average estimate of BP’s liability (approximately $30 billion) is less than the $34 billion in operating profits ($20 billion in net income) expected to be realized by BP in 2010.
- Financial Flexibility: BP has access to over $20 billion in access to cash and liquidity, not even counting the more than $100 billion in property, plant, & equipment (PP&E) on the balance sheet. Asset sales provide BP with even more flexibility.
- Small U.S. Footprint: BP’s Gulf of Mexico operations, home of the Macondo well disaster, represent only about 15% of BP’s total global oil production, so the inference is BP would do just fine without access to the Gulf.
All, in all, Tilson provides a perspective with logical arguments to support his case. The analysis, however, does not give a lot of weight to political consequences that can cause this situation to go from bad to worse. Specifically, some pundits are using a more negative legal precedent of the tobacco companies to explain the downside potential of this situation (see legal pay-out table).
The 1998 master tobacco settlement agreement with the tobacco industry resulted in a whopping $206 billion in pay-outs to be made by the tobacco manufactures over 25 years (Financial Times). This is significantly greater than the $20 billion escrow account that BP has verbally committed to funding (and BP has already funded the account with a $3 billion initial deposit). What’s more, the spill volume estimates are a moving target, and as a result, BP just raised its oil spill cleanup costs from $3.95 billion to $6.1 billion. These numbers can have a way of becoming their own monsters over time.
As you can see, Whitney Tilson makes some pretty compelling arguments for BP, but not many arguments can be made against his long-term performance at the T2 Accredited Fund, which is up +202% since 1999 through mid-2010 (versus +7% for the S&P 500 for the same time period). If you believe Tilson, BP may turn out to be a sweeter kiss than the sloppy mess we constantly hear about.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
*DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in BP, MRK, XOM, or any 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.
Jobs: The Gluttonous Cash Hog
Really? Do you think Steve Jobs actually needs to hoard $42 billion in cash reserves on the company’s balance sheet, when they are already adding to the gargantuan mountain of money at a $12 billion clip per year. Let’s not forget, this gaudy amount of money is being added after all operating expenses and capital expenditures have been paid for.
Perhaps Steve is just a little worried about the economy, and wants a little extra loose change around for a rainy day? I’d buy that argument, but Mr. Jobs and the rest of the executives just witnessed the worst financial crisis in a generation, and the company still managed to generate about $9 billion in free cash flow in both fiscal 2008 and 2009.
If Apple was not creating cash flow like those cascading chocolate fountains I see at wedding receptions, then perhaps a cash safety blanket is needed for acquisitions? Here’s what Steve had to say about Apple’s cash levels in February:
Steve Jobs (Source: Photobucket)
“We know if we need to acquire something – a piece of the puzzle to make something big and bold – we can write a check for it and not borrow a lot of money and put our whole company at risk…The cash in the bank gives us tremendous security and flexibility.”
Let’s explore that idea a little further. First of all, what type of experience does Apple have in doing large acquisitions? Not a lot, and just to humor myself I ran a screen on a universe of more than 10,000 stocks and I came up with 111 companies with a value (market capitalization) greater than $40 billion. Unless Apple plans on buying companies like Coca Cola (KO), Chevron Corp. (CVX), Pfizer (PFE), or United Parcel Service (UPS), I think Apple can part ways with some of their billions. Certainly, there are a handful of theoretical targets in the areas of technology and content, but for certain, (a) any large deal would face intense regulatory scrutiny, and (b) if truly there were grand synergies from doing a massive deal, then most definitely they would be able to issue stock (if Jobs hates debt) to help fund the deal. It is pure nonsense and laughable to believe any “big and bold” acquisition would put the company “at risk.” The only thing at risk for doing a large deal would be Apple’s stock price.
The truth of the matter is returning cash to shareholders would be a fantastic self-disciplining tool, like putting mayonnaise on a brownie to prevent excess calorie consumption. Steve should give current or former CEOs of AOL, Time Warner, Mercedes Benz, Chrysler, Sprint, and Nextel a call to see how those large deals worked out for them. Apple could use an acquisition security blanket, but they do not need a circus tent of cash.
Times of Change
Although times have changed, some executives have not. Many tech companies, including Apple, have nostalgic memories of the go-go tech bubble days of the 1990s when growth at any price was the main mantra and no attention was paid to prudent capital allocation. With a stagnant stock market over the last twelve years, and interest rates sitting sluggishly at record lows (effectively 0% on the Federal Funds rate), investors are demanding prudent decision-making when it comes to capital allocation. Mr. Jobs, it is time to expand your narrow views and show the stewardship of sensibly managing the cash of your loyal investors.
Believe it or not, there are still a few of us actual “investors” that still exist. I’m talking about investors who do not just speculatively rent a stock for a day, week, or month, but rather those who invest for the long-term because they believe in the vision and execution capabilities of management and believe the company’s capital will be invested in their best interest.
I do not mean to single Mr. Jobs out, because he is not the only gluttonous, cash-hog offender among CEOs. In many respects, Apple has the good fortune of becoming a cash-hoarding poster child. The company does indeed deserve credit for becoming a $225 billion technology-consumer-media-retail juggernaut that has spread its tentacles brilliantly across numerous massive markets, whether its PCs, cell phones, music, television, movies, games, advertising etc.…you get the picture. But just because you are an exceptionally gifted visionary doesn’t give you the right to destroy value of hopelessly idle cash, which is begging for a better home than a 0.25% T-Bill.
Solutions – Taming the Cash Hog:
1) Divvy Up Dividends: With $42 billion in cash on the balance sheet and additional annual free cash generation on pace for $12 billion per year, there is no reason Steve Jobs and the board couldn’t declare a dividend that would yield 3% today. If that feels like too much, then how about shave off a pittance of $5 billion or so to pay out a sustainable dividend, which would yield a market-matching 2% dividend yield to investors. This scenario would accommodate Apple with at least a few decades of a cash cushion to cover ALL the company’s operating expenses and capital expenditures. This meagerly, ultra-conservative dividend policy can actually persist (or grow) longer than expected, if Apple can sustainably grow profits – a good possibility.
2) Share Buyback: This solution is much less desirable from my perspective compared to the dividend route, since many of the large share repurchasers tend to also issue lots of new shares to employees and executives, thereby neutering the benefits of the share repurchases.
3) Bank of Apple – (B of A): Why doesn’t Jobs just create a new entity, plop $40 billion of cash from Apple Inc. into the venture, and then open it up as Bank of Apple. At least that way, as an investor in the bank, I could make more profitable lending spreads at B of A relative to the 0.25% yield earned on the mega-billions deteriorating on Apple’s corporate balance sheet.
The downside of instituting these cash reducing solutions:
- The company doesn’t have as much cash as it would like to do large stupid acquisitions.
- The company loses a bunch of day-traders and short-term stock renters that don’t even know what a dividend is.
The upside to efficiently allocating capital through a 2% dividend is Steve (and the other investors) will receive a nice fat quarterly check. In the case of Jobs, he’ll collect a handsome $27 million or so to his measly $1 annual salary. In the process, the company will also gain long term shareholders that buy into the strategic vision of the company.
Stubbornness has served Steve Jobs tremendously well in his career, and a successful CEO like Steve Jobs is not required to listen to my advice. However, I am hopeful that Mr. Jobs will see the hazards of choking on a rapidly growing $42 billion cash hoard and discover the benefits of slimming down a gluttonous cash hog.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
*DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds and AAPL, but at the time of publishing SCM had no direct positions in KO, CVX, PFE, UPS, AOL, Time Warner, Mercedes Benz, Chrysler, Sprint, Nextel, 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.
Dividends: From Sapling to Abundant Fruit Tree
Dividends are like fruit and an investment in stock is much like purchasing a sapling. When purchasing a stock (sapling) the goal is two-fold: 1) Buy a sapling (tree) that is expected to bear a lot of fruit; and 2) Pay a cheap or fair price. If the right saplings are purchased at the right prices, then investors can enjoy a steady diet of fruit that has the potential of producing more fruit each year. Fruit can come in the form of future profits, but as we will see, the sweetness of a profitable company also paying dividends can prove much more fruitful over the long-term.
Investing in growth equities at reasonable prices seems like a pretty intelligent strategy, but of late the vast majority of fresh investor capital has been piling into bonds. This is not a flawed plan for retirees (and certain wealthy individuals) and should be a staple in all investment portfolios, to a degree (some of my client portfolios contain more than 80%+ in fixed income-like securities), but for many investors this overly narrow bond focus can lead to suboptimal outcomes. Right now, I like to think of bonds like a reliable bag of dried fruit, selling for a costly price. However, unlike stocks, bonds do not have the potential of raising periodic payments like a sapling with strong growth prospects. “Double-dippers” who are expecting the economy to spiral into a tailspin, along with nervous snakebit equity investors, prefer the reliability of the bagged dry fruit (bonds)… no matter how high the price.
How Sweet is the Fruit? How Does a +2,300% Yield Sound?
Not only do equities offer the potential of capital appreciation, but they also present the prospect of dividend hikes in the future – important characteristics, especially in inflationary environments. Bonds, on the other hand, offer static fixed payments (no hope of interest rate hikes) with declining purchasing power during periods of escalating general prices.
Given the possibility of a “double-dip” recession, one would expect corporate executives to be guarding their cash with extreme stinginess. On the contrary, so far in 2010, companies have shown their confidence in the recovery by increasing or initiating dividends at a +55% higher clip versus the same period last year. Underpinning these announcements, beyond a belief in an economic recovery, are large piles of cash growing on the balance sheets of nonfinancial companies. According to Standard & Poor’s (S&P), cash hit a record $837 billion at the end of March, up from $665 billion last year.
The S&P 500 dividend yield at 2.06% may not sound overwhelmingly high, but with CDs and money markets paying next to nothing, the Federal Funds rate at effectively 0%, and the 10-Year Treasury Note yielding an uninspiring 3.11%, the S&P yield looks a little more respectable in that light.
If the stock market yield doesn’t enthuse you, how does a +2,300% yield sound to you? That’s roughly what a $.05 (split adjusted) purchase of Wal-Mart (WMT) stock in 1972 would be earning you today based on the current $1.21 dividend per share paid today. That return alone is mind-blowing, but this analysis doesn’t even account for the near 1,000-fold increase in the stock price over the similar timeframe. That’s what happens if you can find a company that increases its dividend for 37 consecutive years.
Procter & Gamble (PG) is another example. After PG increased its dividend for 54 consecutive years, from a split-adjusted $.01 per share in 1970 to a $1.93 payout today, original shareholders are earning an approximate 245% yield on their initial investment (excluding again the massive capital appreciation over 40 years). There’s a reason investment greats like Warren Buffett have invested in great dividend franchises like WMT, PG, KO, BUD, WFC, and AXP.
Bad Apples do Exist
Dividend payment is not guaranteed by any means, as evidenced by the dividend cuts by financial institutions during the 2008-2009 crisis (e.g., BAC, WFC, C) or the discontinuation of BP PLC’s (BP) dividend after the Gulf of Mexico oil spill disaster. Bonds are not immune either. Although bonds are perceived as “safe” investments, the interest and principal payment streams are not fully insured – just ask bondholders of bankrupt companies like Lehman Brothers, Visteon, Tribune, or the countless other companies that have defaulted on their debt promises.
This is where doing your homework by analyzing a company’s competitive positioning, financial wherewithal, and corporate management team can lead you to those companies that have a durable competitive advantage with a corporate culture of returning excess capital to shareholders (see Investing Caffeine’s “Education” section). Certainly finding a WMT and/or PG that will increase dividends consistently for decades is no easy chore, but there are dozens of budding possibilities that S&P has identified as “Dividend Aristocrats” – companies with a multi-year track record of increasing dividends. And although there is uncertainty revolving around dividend taxation going into 2011, I believe it is fair to assume dividend payment treatment will be more favorable than bond income.
Apple Allocation
Growth companies that reinvest profits into new value-expanding projects and/or hoard cash on the balance sheet may make sense conceptually, but dividend paying cultures instill a self-disciplining credo that can better ensure proper capital stewardship by corporate boards. All too often excess capital is treated as funny money, only to be flushed away by overpaying for some high-profile acquisition, or meaningless share buybacks that merely offset generous equity grants to employees.
So, when looking at new and existing investments, consider the importance of dividend payments and dividend growth potential. Investing in an attractively priced sapling with appealing growth prospects can lead to incredibly fruitful returns.
Read the Whole WSJ Article on Dividends
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
*DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds and WMT, but at the time of publishing SCM had no direct positions in BAC, WFC, C, BP, PG, KO, BUD, WFC, AXP, Lehman Brothers, Visteon, Tribune, 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.
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