Thursday, August 5, 2010

American Express and the Downgrade/Upgrade Cycle

When any good franchise goes through a period like the past three years, the intrinsic value does not necessarily change very much even though short-term earnings may be impaired. Back in April of 2009, when American Express (AXP) was selling at $ 15/share, I said that my best estimate of AXP's intrinsic value was between $ 55-65/share within 3 years. Beyond that time frame, like any great business I expected AXP to steadily increase its intrinsic value. Today, AXP is selling at ~$ 43/share so that price to intrinsic value gap has closed substantially*.

Still a great business but no longer a bargain.

While the financial crisis did delay some of AXP's increase in intrinsic value, its value did not move around nearly as much as the helter skelter stock prices or Wall Street analyst upgrades, downgrades, and new price targets would make you think. Just one example among many:

January 27th, 2009: Citi reiterates a 'Sell' rating on AmEx, lowers price target from $19 to $14. Link
March 12th, 2009: Citi maintains a 'Sell' rating on AmEx, lowers price target from $14 to $9. Link

April 7th, 2009: Citi upgrades AmEx from 'Sell' to 'Hold'. Increases price target from $9 to $16. Link
April 24th, 2009: Citi
maintains a 'Hold' on AmEx, raises price target from $16 to $22. Link
August 6th, 2009: Citi upgrades AmEx from 'Hold' to 'Buy'. Price target to $36. Citi also added AmEx to its Top Picks Live list. Link
April 13th, 2010: Citi reiterates a 'Buy' on AmEx, price target raised from $48 to $51. Link

April 23rd, 2010: Citi maintains a 'Buy' on AmEx, raises price target from $51 to $55. Link

Let's see.

Sell the stock when at $ 15.56-16.83/share. That was the market price range on January 27th, 2009 when AXP was downgraded to 'sell' with a $ 14 price target.

Sell the stock again when at $ 11.09-13.38/share. That was the market price range on March 12th, 2009 when AXP was downgraded to 'sell' with a $ 9 price target.

AXP was then upgraded to a 'hold' on two occasions with raised price targets in April 2009 (I guess this is for investors who ignored the recent 'sell' recommendations.)

In August 2009, when the shares were  $ 30.92-32.24/share, AXP was upgraded to 'buy' with a price target of $ 36 (four times higher than the one set in March 2009). By the following April 13th of 2010, on a day AXP was selling in the $ 44.33-45.06/share range, it remained a 'buy' but the target was raised to $ 51.

Finally, with the stock selling at $ 47.66-49.19/share on April 23, 2010, AXP was still rated a 'buy' with a new $ 55 price target.

In a nutshell:
- Sell shares at  roughly $ 15-16/share
- Sell more shares at roughly $ 11-13/share
- Hold what's not been sold
- Start buying again at many times higher prices

At the very least, seems just a little bit impractical. The 'sell' rating in January 2009 to the last 'buy' rating in April 2010 covered a time frame of roughly 15 months.

In that roughly 15 month stretch, somehow the value of one business went from ~ $ 22 billion (using the initial lowered from price target of $19/share on January 27th, 2009) down to a little over $ 10 billion (using the price target of $ 9/share on March 12th, 2009) then up to ~ $ 66 billion (using the price target of $ 55/share on April 23rd, 2010).**

Huh?

Sorry, but the intrinsic value of a business like American Express just does not change that much in such a short time frame.

Now, I realize these upgrades/downgrades are likely for market participants with a shorter time horizon but, practically speaking, it makes sense to step back a bit. A little less focus on potential near-term price action and more emphasis on long-term values goes a long way for those investing with a long time horizon in mind.

Trading is about price action. Investing is about what the underlying asset is going to produce over a long time frame.

When it comes to getting satisfactory or better LONG-TERM investing results, estimating what a business is intrinsically worth per share (and the rate that value is likely to increase over time) matters.

Buying shares at a nice discount to that conservative estimate of value also matters.

How the shares might temporarily trade in the near-term or even longer also matters but the reasons may be less intuitive.
(It's a good thing if a stock that's been bought below per share intrinsic value drops further since it allows for more shares to be accumulated cheap. Even for those shareholders who don't want to own more shares it's a good thing. A cheap stock allows each dollar spent on share repurchases to go further. The longer the cheap stock persists, the more it boosts long-term returns. Obviously, no one complains about a stock that rallies right after they buy it. Yet that's actually not the best outcome for those interested in long-term effects.)

To me, it is better to use energy judging whether an understandable business (understandable is, of course, necessarily very much down to individual investors strengths and limits) has durable, attractive economics and, if it does, what the shares are likely to be worth over the longer run. Hardly an easy thing to judge with any precision (more a range of values) but, with some work, occasionally doable.

In my view, investing is mostly about whether the price provides sufficient margin of safety and an attractive long-term return considering the specific risks (and in relation to investing alternatives).

Generally speaking, investing requires discipline, patience, and an even temperament. It's not just judging what something is intrinsically worth based upon what's quantifiable then buying shares at a discount. That's important but insufficient. A bunch of subjective and qualitative judgments have to also be made since much of what counts is not quantifiable.

Yet, none of this is exactly rocket science.  With all of this in mind, I'm just saying that trying to guess the near term price action of a stock, then somehow successfully trading around it, seems like an extremely poor use of energy.

Adam

Long position in AXP

* AXP remains a core holding in the Six  Stock Portfolio and is on my Stocks to Watch list.
** ~ $ 22 billion based upon the initial lowered from price target of $19/share*1.155 billion shares outstanding (based upon the latest 8-K at that time); ~ $ 10 billion using the price target of $ 9/share*1.155 billion shares; ~ $ 66 billion at the price target of $ 55/share* 1.191 shares (share count was slightly higher by April of 2010 based upon the latest 8-K at the time).
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