CNBC: Residential Housing Ready to Awaken?
There are some signs single-family housing is rebounding, as the above article suggest, but there are still mixed signals.
Buffett said back in November that residential construction was still essentially in not just a recession but a depression.
So some caution seems wise at this time when it comes to housing related stocks.
Yet, attempting to optimally time stock purchases is one of those great ideas in theory only.
As always, for me it's the quality of the business franchise and, considering long-term effects, the margin of safety that determines when to buy. It's never the macro environment.
So with near term or even medium term expectations should probably be tempered for stocks in the housing related sector. To me, it doesn't make much sense trying to guess when things will finally improve.
I sure can't figure that kind of thing out.
The big question, of course, is which stock or stocks in or related to the sector is best to own long-term. My solution has been to own the housing and construction related businesses that displayed the greatest resilience throughout the crisis. Unfortunately, the two I like, Lowe's (LOW) and Mohawk Industries (MHK) are selling well above the maximum price I'd be willing to pay.*
Both stocks were below that max price only a couple months ago (each stock has rallied some 30% plus from those recent lows). Of course, with markets as volatile as they have been, it's certainly possible I'll get a chance to add some more shares.
As always, I like to accumulate enough shares of something when the discount to value is very substantial and obvious.
The macro environment will develop, in fits and starts, at its own unpredictable pace.
There's always the chance, after making a purchase, that the stock price goes even lower (possibly even for an extended period). Knowing this, if shares of a very good business are attractively priced, my preference is to still establish a meaningful position. I just leave room in the portfolio to accumulate more if what seems cheap gets even cheaper.**
If the value of something goes down, it's a problem. If the price goes down, it's not.
"There's no reason we should become fearful if a stock goes down. If a stock goes down 50%, I'd look forward to it. In fact, I would offer you a significant sum of money if you could give me the opportunity for all of my stocks to go down 50% over the next month." - Warren Buffett, 2008 Berkshire Hathaway shareholder meeting
Buffett advice: Buy smart...and low
In the near or medium term, the stock price of a good business that continues to go down and down is an advantage not a problem.
What matters, in the long run, is if the expected growth in intrinsic valuation has been judged reasonably well, and a proper discount considering the specific risks has been paid.
The ability to judge value is crucial but, otherwise, the accumulation process is more about conviction, patience, and discipline than IQ.
Figuring out how market price compares to value isn't easy but, with some work, doable. Getting the timing right, isn't.
At least not on a consistent basis.
When the skies clear the discounts are usually long gone.
Adam
Established long positions in LOW and MHK at much lower than recent market prices.
Related posts:
A Housing Stock Not Reliant on a Big Recovery
Lowe's and Home Depot
Lowe's Shareholder-Friendly Buyback Plan
* As noted in Stocks To Watch
** Seeing a stock go down in price temporarily might be annoying (permanent capital loss because of misjudged value is another story, of course), but if the investor doesn't sell nothing is lost. Consider the opposite, that the stock an investor likes unexpectedly rallies before a meaningful position is built? Owning just a few shares when many shares were wanted is far more annoying. Those missed gains on the stock or stocks an investor feels the most strongly about have a very real impact on a portfolio in the long-run. For most investors, there are only so many stocks that come along where the conviction level is substantial. When it occurs substantial amounts should be accumulated.
---
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
Monday, December 12, 2011
Thursday, December 8, 2011
Profitless Prosperity
The future for Research in Motion (RIMM) seems, at least for now, less bright by the day but as this Barron's article points out, they're certainly not the only business struggling to profit in areas with a dynamic future.
The article makes the case that competing these days for some companies is leading to "profitless prosperity" and cites some examples.
The High Cost of Buying the Future
Slow-growth technology stocks remain relatively and, in some cases, absolutely cheap while faster growing, yet unproven technology franchises sell at huge speculative premiums. What the article calls "growth at any price".
"...Investors are still willing to pay for what I call GAAP, or growth at any price. They're dumping companies that aren't growing and paying up for those that are. But at some point, the high price of the future will bring diminishing investment returns, and investors will start growing impatient.
And when that happens, look out below."
Neither "growth at any price" nor "profitless prosperity" sound like a brilliant way to invest to me. I'll skip the ride and, instead, stick to buying the proven high quality businesses.
Paying a high multiple of earnings can work out occasionally*, but consider how quickly the earning outlook has changed for something like Netflix. With the profitability picture changing that rapidly, it's very tough to know what Netflix is or will be worth.
Before putting capital at risk, I'd need more certainty or, at least, what's an obvious and substantial discount to likely value.
Now I could reasonably argue, contrary to norms, that the relative economic certainty provided by a proven business like Coca-Cola (KO) actually deserves a higher earnings multiple than many of the more exciting fast growing yet unproven businesses.
(Though I'd certainly prefer if market participants don't draw that same conclusion about Coca-Cola for quite some time...a couple more decades would be nice!)
Some may dismiss this way of thinking but, before doing so, just think about it a bit.
It's not quite as crazy as it may initially sound.
The Barron's article makes the point that Amazon's (AMZN) Kindle Fire has a cost per unit of $202 but is being sold for $199.
Amazon's decision to sell the device for less than it costs to make was covered in this previous post. So, for now, it is a money-losing proposition unless the company can make up the money on sales of e-books, music, videos, etc. They just might but that's pure speculation at this point.
In contrast, according to the article, Apple (AAPL) should make roughly a 50% profit on the 19 million iPad tablets it may sell this quarter.
While Amazon's stock certainly seems expensive, the situation is, to me, very different from Netflix and even more so from RIM. In fact, Amazon seems to be building quite a franchise. It's willingness to patiently create its business over the long haul is, in many ways, very impressive.
Yet, that doesn't mean shareholders will do well on a risk-adjusted basis in the long run. I'm guessing they will not, even if Amazon succeeds as a business, but who knows (of course trading it may work just fine).
Amazon is expected to earn less than $ 1 billion next year (though the estimates are all over the map). So at that earnings run rate if there were no growth Amazon would earn, in total, by 2041 or so (30 years @ ~$ 1 billion/year) the roughly $ 30 billion Apple will earn this year alone.
Apple's enterprise value is only ~3x that of Amazon's enterprise value.
So investors are paying plenty for Amazon's promise. The company has quite the earnings mountain to climb to even justify its current valuation never mind actually making an acceptable risk-adjusted return for investors.
(By eventually creating a business with intrinsic per share value well above the current share price. Obviously, no investor puts capital at risk for the privilege of eventually just getting their money back.)
In contrast, investors these days are paying less than ten dollars for every dollar of Apple earnings. To produce a nice return for investors, the company has to grow little, if at all, at that kind of valuation.
Of course, using the current earnings run rate isn't really fair because Amazon will eventually grow those earnings substantially over that time, right?
Well, that might be true. All I know is it had better be true considering the valuation.
I mean, it's not like Apple exactly has unattractive prospects at this point.
So we have two businesses, each with unique risks and strengths and lots of promise. Yet, with one stock, investors are willing to pay 100 dollars for every dollar of current earnings while the other stock gets one tenth that valuation multiple.
Growth at any price, indeed.
Most of Amazon's valuation is based upon the promise of what it may do someday. Apple's valuation, assuming its current business is reasonably durable**, in contrast seems completely backed up by what it already is doing.
Apple is certainly not a favorite of mine as a long-term investment but the contrast with Amazon's valuation is really rather amazing.
As I've explained previously here and on other occasions, there's just no technology business that I'm comfortable with as a long-term investment.
Adam
Established long positions in KO and AAPL at much lower than recent market prices
Related posts:
Netflix: Buys High, Sells Low
Amazon Sells Kindle Fire Below Cost
Technology Stocks
* Give or take, when the speculative premium that's implicit in a high multiple stock disappears, only what's of more explicit value, if anything, will be there to support the stock price. Yet, if no speculative premium is paid in the first place, one doesn't have to worry about whether that premium will be sustainable.
**As far as I'm concerned, durability is never a given with any technology business. I'll never be as comfortable with most technology businesses as some others. In my view, just about all tech businesses fail this test: "What happens to cash flows long-term if they stopped innovating?" Try that test on Wrigley or Coca-Cola. Also, the potential for a disruptive technology shift is often around the corner so tech businesses will never be my favorite and always have a shorter leash.
---
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
The article makes the case that competing these days for some companies is leading to "profitless prosperity" and cites some examples.
The High Cost of Buying the Future
Slow-growth technology stocks remain relatively and, in some cases, absolutely cheap while faster growing, yet unproven technology franchises sell at huge speculative premiums. What the article calls "growth at any price".
"...Investors are still willing to pay for what I call GAAP, or growth at any price. They're dumping companies that aren't growing and paying up for those that are. But at some point, the high price of the future will bring diminishing investment returns, and investors will start growing impatient.
And when that happens, look out below."
Neither "growth at any price" nor "profitless prosperity" sound like a brilliant way to invest to me. I'll skip the ride and, instead, stick to buying the proven high quality businesses.
Paying a high multiple of earnings can work out occasionally*, but consider how quickly the earning outlook has changed for something like Netflix. With the profitability picture changing that rapidly, it's very tough to know what Netflix is or will be worth.
Before putting capital at risk, I'd need more certainty or, at least, what's an obvious and substantial discount to likely value.
Now I could reasonably argue, contrary to norms, that the relative economic certainty provided by a proven business like Coca-Cola (KO) actually deserves a higher earnings multiple than many of the more exciting fast growing yet unproven businesses.
(Though I'd certainly prefer if market participants don't draw that same conclusion about Coca-Cola for quite some time...a couple more decades would be nice!)
Some may dismiss this way of thinking but, before doing so, just think about it a bit.
It's not quite as crazy as it may initially sound.
The Barron's article makes the point that Amazon's (AMZN) Kindle Fire has a cost per unit of $202 but is being sold for $199.
Amazon's decision to sell the device for less than it costs to make was covered in this previous post. So, for now, it is a money-losing proposition unless the company can make up the money on sales of e-books, music, videos, etc. They just might but that's pure speculation at this point.
In contrast, according to the article, Apple (AAPL) should make roughly a 50% profit on the 19 million iPad tablets it may sell this quarter.
While Amazon's stock certainly seems expensive, the situation is, to me, very different from Netflix and even more so from RIM. In fact, Amazon seems to be building quite a franchise. It's willingness to patiently create its business over the long haul is, in many ways, very impressive.
Yet, that doesn't mean shareholders will do well on a risk-adjusted basis in the long run. I'm guessing they will not, even if Amazon succeeds as a business, but who knows (of course trading it may work just fine).
Amazon is expected to earn less than $ 1 billion next year (though the estimates are all over the map). So at that earnings run rate if there were no growth Amazon would earn, in total, by 2041 or so (30 years @ ~$ 1 billion/year) the roughly $ 30 billion Apple will earn this year alone.
Apple's enterprise value is only ~3x that of Amazon's enterprise value.
So investors are paying plenty for Amazon's promise. The company has quite the earnings mountain to climb to even justify its current valuation never mind actually making an acceptable risk-adjusted return for investors.
(By eventually creating a business with intrinsic per share value well above the current share price. Obviously, no investor puts capital at risk for the privilege of eventually just getting their money back.)
In contrast, investors these days are paying less than ten dollars for every dollar of Apple earnings. To produce a nice return for investors, the company has to grow little, if at all, at that kind of valuation.
Of course, using the current earnings run rate isn't really fair because Amazon will eventually grow those earnings substantially over that time, right?
Well, that might be true. All I know is it had better be true considering the valuation.
I mean, it's not like Apple exactly has unattractive prospects at this point.
So we have two businesses, each with unique risks and strengths and lots of promise. Yet, with one stock, investors are willing to pay 100 dollars for every dollar of current earnings while the other stock gets one tenth that valuation multiple.
Growth at any price, indeed.
Most of Amazon's valuation is based upon the promise of what it may do someday. Apple's valuation, assuming its current business is reasonably durable**, in contrast seems completely backed up by what it already is doing.
Apple is certainly not a favorite of mine as a long-term investment but the contrast with Amazon's valuation is really rather amazing.
As I've explained previously here and on other occasions, there's just no technology business that I'm comfortable with as a long-term investment.
Adam
Established long positions in KO and AAPL at much lower than recent market prices
Related posts:
Netflix: Buys High, Sells Low
Amazon Sells Kindle Fire Below Cost
Technology Stocks
* Give or take, when the speculative premium that's implicit in a high multiple stock disappears, only what's of more explicit value, if anything, will be there to support the stock price. Yet, if no speculative premium is paid in the first place, one doesn't have to worry about whether that premium will be sustainable.
**As far as I'm concerned, durability is never a given with any technology business. I'll never be as comfortable with most technology businesses as some others. In my view, just about all tech businesses fail this test: "What happens to cash flows long-term if they stopped innovating?" Try that test on Wrigley or Coca-Cola. Also, the potential for a disruptive technology shift is often around the corner so tech businesses will never be my favorite and always have a shorter leash.
---
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
Wednesday, December 7, 2011
Consumer Staples: Long-term Performance, Part II
Jeremy Grantham has called quality stocks the "one free lunch" over the long run.
While the definition of quality is necessarily subjective, the Consumer Staples SPDR (XLP) ETF is made up of a whole bunch of high quality businesses. It's a convenient low frictional cost way to gain exposure to them if they're generally priced right.
Top 5 Holding of XLP
Procter & Gamble (PG)
Philip Morris International (PM)
Wal-Mart (WMT)
Coca-Cola (KO)
Kraft (KFT)
Yet, since not all consumer staples businesses are created equal, I'd rather own what I consider the best individual stocks within the sector.*
This recent prior post and CNBC article provide some more background on the long-term track record of many consumer staples stocks.
Jim O'Shaughnessy did a sector analysis of the stock market over a four decade period. Here's a couple of his findings:
- Not only did consumer staples do the best among 10 sectors, the highest performing stocks in the consumer staples sector had the highest buybacks plus dividend yield (shareholder yield).
- Those with the highest shareholder yield had an average annual return of 17.8%. So they have worked very well as an "offense" over the long run, despite their reputation, and produced above market returns.
(As I've said: Over the shorter run -- less than five years or so -- anything can happen as far as relative performance goes, of course.)
Consistent with their reputation, they can provide better downside protection than most other stocks. Yet, the evidence is there that, over the long haul, many consumer staples businesses are, in fact, not just "defensive" in nature even if they're frequently described and thought of that way.
Characterizing them as "defensive" underestimates their long-term "offensive" potential.
Now, consumer staples stocks often do underperform during bull markets so their reputation is understandable. Naturally, some investors and especially traders, attempt to time when they want to own these kind of stocks based upon the perceived risks that exists in the market environment.
(i.e. In a bull market, own fewer consumer staples. In a bear or, at least, uncertain market, own more.)
An approach that, at a minimum, certainly adds frictional costs and the chance to make costly mistakes. To me, it is one of those great sounding ideas until you have to put it into practice. Like choosing the fate of Sisyphus when a perfectly attractive alternative exists: To buy shares of quality businesses at a discount and allow compounding to work for them over time.
Sisyphus had to eternally roll an immense boulder up hill but it wasn't choice, it was punishment. Some seem willing to take the more Sisyphean investing approach by choice.
If, over the long haul, shares of a business or sector (via an ETF) bought at reasonable valuation** can produce higher returns than the market, why add the chance to make costly mistakes trying to time it?
Doing this creates unnecessary execution risks. Understandably, most will heavily weigh the chance of temporary (or worse, permanent) loss more so than the possibility of missing a gain. Loss aversion is a powerful psychological force. Yet, by definition, additional buying and selling brings a chance to make another error into the equation.
Errors of omission comes to mind.
Missing the chance to own something one doesn't understand well, something outside their circle of competence, is not a problem.
That's not a mistake. It's best to only invest in attractively priced things one understands well.
On the other hand, missing the chance to own what one understands that also stacks up favorably against investing alternatives is costly. Sell shares because of concerns about short-term price action, with the intent to buy it back at a lower price, opens up the possibility of making an error of omission. What if it rallies? How do you get back in to the position?
Since consumer staples stocks also generally perform better on the downside during rough markets (their "defensive" characteristics) this jumping in and out of positions based upon perceive market risk makes even less sense.
Of course, this only works if we are talking about a good business that is soundly financed. If business quality was misjudged sell it as soon as possible.
An error of commission.
The fact that many consumer staples businesses have done very well in the past is, of course, no guarantee when it comes to the future. Yet, the evidence more than just suggests businesses with well-known, trusted, small-ticket consumer brands (fast-moving consumer goods: FMCG) that also have broad-based distribution capabilities tend to do very well over the long run.
(Branded shampoo, beverages, beer, spirits, tobacco, chocolate, and gum among other things.)
Great brands and strong distribution, in combination, often produces a sustainable advantage, pricing power, and attractive core business economics.
Are the best days behind these kinds of businesses? Is it too late? Well, maybe, but consider this:
Some think if an investment idea is well-known and seems obvious it can't be really good. In 1938, Fortune Magazine concluded "Several times every year, a weighty and serious investor looks long and with profound respect at Coca-Cola's record, but comes regretfully to the conclusion that he is looking too late." Since that time, Coca-Cola has grown significantly both domestically and around the world. It was not too late in 1938, and we believe it is far from that today. - From the 1Q 2010 Yacktman Quarterly Letter
To me, the probability that a business like Coca-Cola will perform just fine, even if not quite as well, over a longer future time horizon is not low. Of course, in the short and medium term, just about anything can happen to share prices. Expect it. Yet, over the longer haul as the "voting machines" gives way to the "weighing machine", share prices will at least roughly track increases to per share intrinsic business value. Well, that value is ultimately driven by business performance. Much as it was not too late in 1938, it seems unlikely that it is too late now. Many, if not all the forces, that created these long-term results remain in place.
These are mostly durable high quality businesses that produce high return on capital, at relatively lower risk, especially if bought at the right price.***
As always, what's sensible to buy at a plain discount doesn't make sense at some materially higher valuation no matter how good the business may be.
They have a good probability of continuing to possess competitive advantages but, as always, keep an eye on how the economic moat may be changing over time along with capital allocation decision-making by management.
One question I like to ask is the following: If a business stopped innovating for five years what would happen to its financial performance? Most consumer staples businesses would miss some opportunities and lose some market share yet still continue making a nice living.
Not so for most tech stocks. Imagine Apple (AAPL), as good as the company is, not innovating for five years.
Now I suspect one of the reasons why more professional investors do not make full use of, what Jeremy Grantham calls "the one free lunch", is this:
"Smart people aren't exempt from professional disasters from overconfidence. Often, they just run aground in the more difficult voyages they choose, relying on their self-appraisals that they have superior talents and methods." - Charlie Munger in a speech to the Foundation Financial Officers Group
Some seem to think that when a wise but more straightforward approach comes along there must be more to it:
"...our model is too simple. Most people believe you can't be an expert if it's too simple." - Charlie Munger at the 2007 Wesco Meeting
Sidekick has sage advice of his own
In any case, all too many investors have a difficult time keeping up with the S&P 500.
Yet, many consumer staples stocks have a great long-term record of doing just that over the long haul. That may not be true going forward, but their risk-adjusted merits are not insignificant.
Little to no trading required.
Adam
Long common stocks mentioned
Related posts:
Consumer Staples: Long-term Performance - Dec 2011
Grantham: What to Buy? - Aug 2011
Defensive Stocks Revisited - Mar 2011
KO and JNJ: Defensive Stocks? - Jan 2011
Altria Outperforms...Again - Oct 2010
Grantham on Quality Stocks Revisited - Jul 2010
Friends & Romans - May 2010
Grantham on Quality Stocks - Nov 2009
Best Performing Mutual Funds - 20 Years - May 2009
Staples vs Cyclicals - Apr 2009
Best and Worst Performing DJIA Stock - Apr 2009
Defensive Stocks? - Apr 2009
* Three of the six stocks in the Six Stock Portfolio are consumer staples and I also have many in my Stocks to Watch. They are not in these portfolios for "defensive" reasons. They're just quality durable businesses that over the long-haul produce high return on capital, at relatively low risk, especially if bought at the right price. Margin of safety still always matters no matter how good a business might seem to be.
** Though certainly not expensive, the one problem at this time, unlike not too long ago, is that far fewer shares of consumer staples businesses are selling at a discount these days. So some patience in building a long-term position seems warranted.
*** With any investment, no matter how seemingly attractive, margin of safety is all-important. It protects against the unforeseen real, even if fixable, business problems. Still, it's worth considering this: "If the business earns 6% on capital over 40 years and you hold it for that 40 years, you're not going to make much different than a 6% return - even if you originally buy it at a huge discount. Conversely, if a business earns 18% on capital over 20 or 30 years, even if you pay an expensive looking price, you'll end up with a fine result." - Charlie Munger at USC Business School in 1994
---
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and are never a recommendation to buy or sell anything.
While the definition of quality is necessarily subjective, the Consumer Staples SPDR (XLP) ETF is made up of a whole bunch of high quality businesses. It's a convenient low frictional cost way to gain exposure to them if they're generally priced right.
Top 5 Holding of XLP
Procter & Gamble (PG)
Philip Morris International (PM)
Wal-Mart (WMT)
Coca-Cola (KO)
Kraft (KFT)
Yet, since not all consumer staples businesses are created equal, I'd rather own what I consider the best individual stocks within the sector.*
This recent prior post and CNBC article provide some more background on the long-term track record of many consumer staples stocks.
Jim O'Shaughnessy did a sector analysis of the stock market over a four decade period. Here's a couple of his findings:
- Not only did consumer staples do the best among 10 sectors, the highest performing stocks in the consumer staples sector had the highest buybacks plus dividend yield (shareholder yield).
- Those with the highest shareholder yield had an average annual return of 17.8%. So they have worked very well as an "offense" over the long run, despite their reputation, and produced above market returns.
(As I've said: Over the shorter run -- less than five years or so -- anything can happen as far as relative performance goes, of course.)
Consistent with their reputation, they can provide better downside protection than most other stocks. Yet, the evidence is there that, over the long haul, many consumer staples businesses are, in fact, not just "defensive" in nature even if they're frequently described and thought of that way.
Characterizing them as "defensive" underestimates their long-term "offensive" potential.
Now, consumer staples stocks often do underperform during bull markets so their reputation is understandable. Naturally, some investors and especially traders, attempt to time when they want to own these kind of stocks based upon the perceived risks that exists in the market environment.
(i.e. In a bull market, own fewer consumer staples. In a bear or, at least, uncertain market, own more.)
An approach that, at a minimum, certainly adds frictional costs and the chance to make costly mistakes. To me, it is one of those great sounding ideas until you have to put it into practice. Like choosing the fate of Sisyphus when a perfectly attractive alternative exists: To buy shares of quality businesses at a discount and allow compounding to work for them over time.
Sisyphus had to eternally roll an immense boulder up hill but it wasn't choice, it was punishment. Some seem willing to take the more Sisyphean investing approach by choice.
If, over the long haul, shares of a business or sector (via an ETF) bought at reasonable valuation** can produce higher returns than the market, why add the chance to make costly mistakes trying to time it?
Doing this creates unnecessary execution risks. Understandably, most will heavily weigh the chance of temporary (or worse, permanent) loss more so than the possibility of missing a gain. Loss aversion is a powerful psychological force. Yet, by definition, additional buying and selling brings a chance to make another error into the equation.
Errors of omission comes to mind.
Missing the chance to own something one doesn't understand well, something outside their circle of competence, is not a problem.
That's not a mistake. It's best to only invest in attractively priced things one understands well.
On the other hand, missing the chance to own what one understands that also stacks up favorably against investing alternatives is costly. Sell shares because of concerns about short-term price action, with the intent to buy it back at a lower price, opens up the possibility of making an error of omission. What if it rallies? How do you get back in to the position?
Since consumer staples stocks also generally perform better on the downside during rough markets (their "defensive" characteristics) this jumping in and out of positions based upon perceive market risk makes even less sense.
Of course, this only works if we are talking about a good business that is soundly financed. If business quality was misjudged sell it as soon as possible.
An error of commission.
The fact that many consumer staples businesses have done very well in the past is, of course, no guarantee when it comes to the future. Yet, the evidence more than just suggests businesses with well-known, trusted, small-ticket consumer brands (fast-moving consumer goods: FMCG) that also have broad-based distribution capabilities tend to do very well over the long run.
(Branded shampoo, beverages, beer, spirits, tobacco, chocolate, and gum among other things.)
Great brands and strong distribution, in combination, often produces a sustainable advantage, pricing power, and attractive core business economics.
Are the best days behind these kinds of businesses? Is it too late? Well, maybe, but consider this:
Some think if an investment idea is well-known and seems obvious it can't be really good. In 1938, Fortune Magazine concluded "Several times every year, a weighty and serious investor looks long and with profound respect at Coca-Cola's record, but comes regretfully to the conclusion that he is looking too late." Since that time, Coca-Cola has grown significantly both domestically and around the world. It was not too late in 1938, and we believe it is far from that today. - From the 1Q 2010 Yacktman Quarterly Letter
To me, the probability that a business like Coca-Cola will perform just fine, even if not quite as well, over a longer future time horizon is not low. Of course, in the short and medium term, just about anything can happen to share prices. Expect it. Yet, over the longer haul as the "voting machines" gives way to the "weighing machine", share prices will at least roughly track increases to per share intrinsic business value. Well, that value is ultimately driven by business performance. Much as it was not too late in 1938, it seems unlikely that it is too late now. Many, if not all the forces, that created these long-term results remain in place.
These are mostly durable high quality businesses that produce high return on capital, at relatively lower risk, especially if bought at the right price.***
As always, what's sensible to buy at a plain discount doesn't make sense at some materially higher valuation no matter how good the business may be.
They have a good probability of continuing to possess competitive advantages but, as always, keep an eye on how the economic moat may be changing over time along with capital allocation decision-making by management.
One question I like to ask is the following: If a business stopped innovating for five years what would happen to its financial performance? Most consumer staples businesses would miss some opportunities and lose some market share yet still continue making a nice living.
Not so for most tech stocks. Imagine Apple (AAPL), as good as the company is, not innovating for five years.
Now I suspect one of the reasons why more professional investors do not make full use of, what Jeremy Grantham calls "the one free lunch", is this:
"Smart people aren't exempt from professional disasters from overconfidence. Often, they just run aground in the more difficult voyages they choose, relying on their self-appraisals that they have superior talents and methods." - Charlie Munger in a speech to the Foundation Financial Officers Group
Some seem to think that when a wise but more straightforward approach comes along there must be more to it:
"...our model is too simple. Most people believe you can't be an expert if it's too simple." - Charlie Munger at the 2007 Wesco Meeting
Sidekick has sage advice of his own
In any case, all too many investors have a difficult time keeping up with the S&P 500.
Yet, many consumer staples stocks have a great long-term record of doing just that over the long haul. That may not be true going forward, but their risk-adjusted merits are not insignificant.
Little to no trading required.
Adam
Long common stocks mentioned
Related posts:
Consumer Staples: Long-term Performance - Dec 2011
Grantham: What to Buy? - Aug 2011
Defensive Stocks Revisited - Mar 2011
KO and JNJ: Defensive Stocks? - Jan 2011
Altria Outperforms...Again - Oct 2010
Grantham on Quality Stocks Revisited - Jul 2010
Friends & Romans - May 2010
Grantham on Quality Stocks - Nov 2009
Best Performing Mutual Funds - 20 Years - May 2009
Staples vs Cyclicals - Apr 2009
Best and Worst Performing DJIA Stock - Apr 2009
Defensive Stocks? - Apr 2009
* Three of the six stocks in the Six Stock Portfolio are consumer staples and I also have many in my Stocks to Watch. They are not in these portfolios for "defensive" reasons. They're just quality durable businesses that over the long-haul produce high return on capital, at relatively low risk, especially if bought at the right price. Margin of safety still always matters no matter how good a business might seem to be.
** Though certainly not expensive, the one problem at this time, unlike not too long ago, is that far fewer shares of consumer staples businesses are selling at a discount these days. So some patience in building a long-term position seems warranted.
*** With any investment, no matter how seemingly attractive, margin of safety is all-important. It protects against the unforeseen real, even if fixable, business problems. Still, it's worth considering this: "If the business earns 6% on capital over 40 years and you hold it for that 40 years, you're not going to make much different than a 6% return - even if you originally buy it at a huge discount. Conversely, if a business earns 18% on capital over 20 or 30 years, even if you pay an expensive looking price, you'll end up with a fine result." - Charlie Munger at USC Business School in 1994
---
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and are never a recommendation to buy or sell anything.
Tuesday, December 6, 2011
Stop the Brain Drain
In 1950, roughly 3% of U.S. GDP came from the financial sector.
These days it is well over 8%.
An astonishing number of college graduates, some of the best and brightest with many from science and engineering, now end up on Wall Street.
Here's just one example according to this New York Times article:
In 2007, 29 percent of M.I.T. grads went to Wall Street rather than Silicon Valley, at far higher wages, a disparity that continued even after the financial crisis.
Below are more excerpts from articles that describe the "brain drain" problem and what some are doing about it.
Stanford Daily: Stop the Wall Street Recruitment
As the financial industry's profits have increasingly come from complex financial products...its demand has steadily grown for graduates with technical degrees. In 2006, the securities and commodity exchange sector employed a larger portion of scientists and engineers than semiconductor manufacturing, pharmaceuticals and telecommunications.
The result has been a major reallocation of top talent into financial sector jobs, many of which are "socially useless," as the chairman of the United Kingdom's Financial Services Authority put it.
Some students are taking on the matter themselves.
Los Angeles Times: Getting brilliant Students to seek jobs beyond Wall Street
"The best minds of my generation are using their brainpower in ways that will not make society's problems better, and could make them worse," said Andrew Lohse, a senior at Dartmouth.
Lohse and students at Yale, Harvard and Stanford have recently written articles in their campus papers calling attention to the issue. And a new national campaign called Stop the Brain Drain is gathering signatures from students online and pushing for a change in recruiting practices on campus.
An op-ed on why the system nearly collapsed.
New York Times: Wall Street Smarts
The reason:
"Smart guys had started going to Wall Street."
"Did you ever hear the word 'derivatives'? Do you think our guys could have invented, say, credit default swaps? Give me a break! They couldn't have done the math."
"When the smart guys started this business of securitizing things that didn't even exist in the first place, who was running the firms they worked for? Our guys! The lower third of the class! Guys who didn't have the foggiest notion of what a credit default swap was. All our guys knew was that they were getting disgustingly rich, and they had gotten to like that. All of that easy money had eaten away at their sense of enoughness."
It shouldn't be surprising why people go to Wall Street. The reason is straightforward enough. Incentives. How many students with substantial college debt would not find a $ 7,839/month internship ($ 94,000 annualized) tempting? The talent drain won't stop until the incentives have materially changed.
Finally, the Kaufmann Foundation has been studying the impact of this science and engineering talent drain on entrepreneurship.
Kauffman Foundation: Financialization and Its Entrepreneurial Consequences
...to pretend that we can have widespread entrepreneurial capitalism in the absence of a significant and active financial services sector—is to be fanciful. At the same time, however, financial services and entrepreneurial ventures compete in the economy for many of the same employees. Given that the social returns from entrepreneurial efforts generally are higher...this can be a source of allocative inefficiency in the economy, one with potentially material consequences.
Most frictional costs are explicit and measurable. I write about the importance of developing an approach to investing that reduces frictional costs. In the narrow context of producing successful long run investor returns it is a crucial factor.
Newton's 4th Law.
Yet, in a broader context, the more important frictional cost to society may be, though much harder to measure, all this "allocative inefficiency".
Adam
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and are never a recommendation to buy or sell anything.
These days it is well over 8%.
An astonishing number of college graduates, some of the best and brightest with many from science and engineering, now end up on Wall Street.
Here's just one example according to this New York Times article:
In 2007, 29 percent of M.I.T. grads went to Wall Street rather than Silicon Valley, at far higher wages, a disparity that continued even after the financial crisis.
Below are more excerpts from articles that describe the "brain drain" problem and what some are doing about it.
Stanford Daily: Stop the Wall Street Recruitment
As the financial industry's profits have increasingly come from complex financial products...its demand has steadily grown for graduates with technical degrees. In 2006, the securities and commodity exchange sector employed a larger portion of scientists and engineers than semiconductor manufacturing, pharmaceuticals and telecommunications.
The result has been a major reallocation of top talent into financial sector jobs, many of which are "socially useless," as the chairman of the United Kingdom's Financial Services Authority put it.
Some students are taking on the matter themselves.
Los Angeles Times: Getting brilliant Students to seek jobs beyond Wall Street
"The best minds of my generation are using their brainpower in ways that will not make society's problems better, and could make them worse," said Andrew Lohse, a senior at Dartmouth.
Lohse and students at Yale, Harvard and Stanford have recently written articles in their campus papers calling attention to the issue. And a new national campaign called Stop the Brain Drain is gathering signatures from students online and pushing for a change in recruiting practices on campus.
An op-ed on why the system nearly collapsed.
New York Times: Wall Street Smarts
The reason:
"Smart guys had started going to Wall Street."
"Did you ever hear the word 'derivatives'? Do you think our guys could have invented, say, credit default swaps? Give me a break! They couldn't have done the math."
"When the smart guys started this business of securitizing things that didn't even exist in the first place, who was running the firms they worked for? Our guys! The lower third of the class! Guys who didn't have the foggiest notion of what a credit default swap was. All our guys knew was that they were getting disgustingly rich, and they had gotten to like that. All of that easy money had eaten away at their sense of enoughness."
It shouldn't be surprising why people go to Wall Street. The reason is straightforward enough. Incentives. How many students with substantial college debt would not find a $ 7,839/month internship ($ 94,000 annualized) tempting? The talent drain won't stop until the incentives have materially changed.
Finally, the Kaufmann Foundation has been studying the impact of this science and engineering talent drain on entrepreneurship.
Kauffman Foundation: Financialization and Its Entrepreneurial Consequences
...to pretend that we can have widespread entrepreneurial capitalism in the absence of a significant and active financial services sector—is to be fanciful. At the same time, however, financial services and entrepreneurial ventures compete in the economy for many of the same employees. Given that the social returns from entrepreneurial efforts generally are higher...this can be a source of allocative inefficiency in the economy, one with potentially material consequences.
Most frictional costs are explicit and measurable. I write about the importance of developing an approach to investing that reduces frictional costs. In the narrow context of producing successful long run investor returns it is a crucial factor.
Newton's 4th Law.
Yet, in a broader context, the more important frictional cost to society may be, though much harder to measure, all this "allocative inefficiency".
Adam
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and are never a recommendation to buy or sell anything.
Monday, December 5, 2011
Beware the Corporate Buyback
This Barron's article points out buybacks are at the highest level since late 2007. As the article says:
Many companies effectively are taking themselves private.
Now, given that buybacks have a more than somewhat bewildering history of being executed when stocks aren't necessarily cheap, this activity would seem to be not, in itself, of particular interest.
Unfortunately, there's plenty of evidence poorly judged buybacks.
A recent example of this is that buybacks peaked in 2007 when stocks were hitting highs. From this article:
Stock buybacks: Buy high and sell low
From 2004 to 2008 companies flush with cash and confidence spent $1.8 trillion on their own soaring shares. When the market collapsed, what did they do? Rather than take advantage of discount share prices, as wise investors are supposed to do, they stopped buying.
What seems to make the more recent ramp up in buybacks more interesting is how different the current valuation environment is. For most of the past decade, buybacks made little sense for many companies because stocks were often fully priced (fully priced and then some in more than a few instances even when the market was bottoming in 2002-03).
So prices of marketable securities were frequently near or well above intrinsic value. Buybacks only work effectively when a substantial discount to intrinsic value exists.
A discount to value that should be a plain to see (not a mere five or even fifteen percentage points).
These days, more than a few stocks seem to be selling at comfortable discounts to value (even if the market is well above the more recent 2009 bottom).
Clearly in the short-run prices can go much lower based upon macro factors, but at least there's some buoyancy provided by the fundamentals.
In contrast consider that in 2003, after stocks had fallen roughly 50%, Warren Buffett wrote the following:
We are neither enthusiastic nor negative about the portfolio we hold. We own pieces of excellent businesses – all of which had good gains in intrinsic value last year – but their current prices reflect their excellence. The unpleasant corollary to this conclusion is that I made a big mistake in not selling several of our larger holdings during The Great Bubble. If these stocks are fully priced now, you may wonder what I was thinking four years ago when their intrinsic value was lower and their prices far higher. So do I. - From the 2003 Berkshire Hathaway (BRKa) Shareholder Letter
What seems unique about 2003, as far as stock market bottoms go, is that quite a few stocks bottomed when they were still fully priced to very expensive. What Buffett wrote back then is in fairly stark contrast to what he seems to be thinking now and, these days, it's more than just words. His 3rd quarter buying spree represents one of Berkshire's most active periods in terms of buying stocks in a very long time.
Buffett Invests Over $ 20 Billion in 3Q 2011
Stocks that weren't cheap, for the most part, at the bottom in 2003 went on to rally again over the next several years. The expensive becoming even more expensive. So, naturally, buybacks during that time were not particularly enriching to long-term owners.
Using buyback activity, by itself, as evidence of cheapness for an individual stock or stocks in general doesn't really work*. Instead, investors have to judge whether something is cheap or not by comparing market prices to their own conservative estimate of value. There's no way around that fact.
Still, if valuations in general seem plainly attractive then seeing that the buyback activity being stepped up can't be a bad thing. This is true even if, in a disappointing number of instances, it turns out to be mere coincidence that buybacks are occurring when valuations are low.
Adam
Long position in BRKb
* Though management with a proven track record when it comes to making capital allocation decisions that is buying back stock at some scale would, at least, be noteworthy.
---
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
Many companies effectively are taking themselves private.
Now, given that buybacks have a more than somewhat bewildering history of being executed when stocks aren't necessarily cheap, this activity would seem to be not, in itself, of particular interest.
Unfortunately, there's plenty of evidence poorly judged buybacks.
A recent example of this is that buybacks peaked in 2007 when stocks were hitting highs. From this article:
Stock buybacks: Buy high and sell low
From 2004 to 2008 companies flush with cash and confidence spent $1.8 trillion on their own soaring shares. When the market collapsed, what did they do? Rather than take advantage of discount share prices, as wise investors are supposed to do, they stopped buying.
What seems to make the more recent ramp up in buybacks more interesting is how different the current valuation environment is. For most of the past decade, buybacks made little sense for many companies because stocks were often fully priced (fully priced and then some in more than a few instances even when the market was bottoming in 2002-03).
So prices of marketable securities were frequently near or well above intrinsic value. Buybacks only work effectively when a substantial discount to intrinsic value exists.
A discount to value that should be a plain to see (not a mere five or even fifteen percentage points).
These days, more than a few stocks seem to be selling at comfortable discounts to value (even if the market is well above the more recent 2009 bottom).
Clearly in the short-run prices can go much lower based upon macro factors, but at least there's some buoyancy provided by the fundamentals.
In contrast consider that in 2003, after stocks had fallen roughly 50%, Warren Buffett wrote the following:
We are neither enthusiastic nor negative about the portfolio we hold. We own pieces of excellent businesses – all of which had good gains in intrinsic value last year – but their current prices reflect their excellence. The unpleasant corollary to this conclusion is that I made a big mistake in not selling several of our larger holdings during The Great Bubble. If these stocks are fully priced now, you may wonder what I was thinking four years ago when their intrinsic value was lower and their prices far higher. So do I. - From the 2003 Berkshire Hathaway (BRKa) Shareholder Letter
What seems unique about 2003, as far as stock market bottoms go, is that quite a few stocks bottomed when they were still fully priced to very expensive. What Buffett wrote back then is in fairly stark contrast to what he seems to be thinking now and, these days, it's more than just words. His 3rd quarter buying spree represents one of Berkshire's most active periods in terms of buying stocks in a very long time.
Buffett Invests Over $ 20 Billion in 3Q 2011
Stocks that weren't cheap, for the most part, at the bottom in 2003 went on to rally again over the next several years. The expensive becoming even more expensive. So, naturally, buybacks during that time were not particularly enriching to long-term owners.
Using buyback activity, by itself, as evidence of cheapness for an individual stock or stocks in general doesn't really work*. Instead, investors have to judge whether something is cheap or not by comparing market prices to their own conservative estimate of value. There's no way around that fact.
Still, if valuations in general seem plainly attractive then seeing that the buyback activity being stepped up can't be a bad thing. This is true even if, in a disappointing number of instances, it turns out to be mere coincidence that buybacks are occurring when valuations are low.
Adam
Long position in BRKb
* Though management with a proven track record when it comes to making capital allocation decisions that is buying back stock at some scale would, at least, be noteworthy.
---
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
Friday, December 2, 2011
Rear-View Mirror Investing
"People are habitually guided by the rear-view mirror and, for the most part, by the vistas immediately behind them." - Warren Buffett in Fortune, December 2001
From this article in AAII Journal on the "Nifty Fifty":
"The Nifty Fifty were a group of premier growth stocks...that became institutional darlings in the early 1970s."
The article then added...
"The Nifty Fifty were often called one-decision stocks: buy and never sell. Because their prospects were so bright, many analysts claimed that the only direction they could go was up."
Ugh. Many of these were good businesses but price matters. Here's what to keep in mind you hear an extreme valuation being justified:
"...many investors did not seem to find 50, 80 or even 100 times earnings at all an unreasonable price to pay for the world's preeminent growth companies."
Forbes magazine later said this...
"What held the Nifty Fifty up? The same thing that held up tulip-bulb prices in long-ago Holland—popular delusions and the madness of crowds. The delusion was that these companies were so good it didn't matter what you paid for them..."
Forbes then pointed out the problem wasn't with the companies. Instead, the problem was...
"...the temporary insanity of institutional money managers—proving again that stupidity well-packaged can sound like wisdom. It was so easy to forget that probably no sizable company could possibly be worth over 50 times normal earnings."
These days, quite a few high quality large cap stocks are selling at price to earnings (P/E) in the mid-teens and even much lower that that. Of course, the P/E multiple can shrink further but it's not as if, at some point, the opposite can't also happen. The growth in intrinsic value and the expansion/contraction of P/E ratios frequently have little to do with one another.
At a time when the macro world seems to have only darkening skies ahead, many won't be considering that a high probability. If or when large caps will get expensive again* isn't knowable but, while it seems improbable now, at some point down the road they just may.
The multiple of earnings that investors are willing to pay tend to expand when the skies seem clear and predictably often contract when less so.
In the 2001 Fortune article, Buffett compares the 1920s to the 1940s and explains the "monumental hangover" the public was still suffering 20 years later:
"The country was then intrinsically far more valuable than it had been 20 years before; dividend yields were more than double the yield on bonds; and yet stock prices were at less than half their 1929 peak...But rather than seeing what was in plain sight in the late 1940s, investors were transfixed by the frightening market of the early 1930s..."
Buffett then said don't assume it's just the small investor who invests in the rear-view. He uses the early 1970s as an example:
"...this was Nifty Fifty time--pension managers, feeling great about the market, put more than 90% of their net cash flow into stocks, a record commitment at the time. And then, in a couple of years, the roof fell in and stocks got way cheaper. So what did the pension fund managers do? They quit buying because stocks got cheaper!" - Warren Buffett in Fortune, December 2001
When a good business is bought at a nice discount to value, there's little need for the macro world to improve or for P/E multiples to expand to make investor returns satisfactory.
Meaningful discounts to value are usually the most pronounced when the macro storm clouds seem to everywhere and getting worse.
Now, once a good business has been bought at a discount, it's certainly not a problem if the prices investors are willing to pay for a dollar of earnings happens to expand down the road.
Don't plan on it but consider that possible outcome a bonus if it happens.
The opposite, buying at the higher earnings multiples, doesn't work that way. You have to hope the high multiples remain high or sell and hope for attractive prices down the road. Being on the wrong end of a crunch in earnings multiples wouldn't be fun.
By comparison, buying when multiples are attractively low and learning to ride out the storms seems a much more doable game.
Inexpensive shares of blue chip businesses happen to be plentiful these days but it's probably not a good idea to assume they'll remain that way indefinitely.
Shares happen to be cheap for now and will be until they are not. Who knows if or when an era similar to the Nifty Fifty will return.
Adam
* Remarkably, and the AAII article reveals this, many of the Nifty Fifty did actually do very well over the long run despite the high P/E ratios. That doesn't mean it made sense on a risk-adjusted basis to pay up. The article has the luxury of looking at results after the fact. Investors don't have such a luxury. Since all investors have to invest going into an unknown and unknowable future, it's crucial to buy even the best businesses with a margin of safety.
---
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and are never a recommendation to buy or sell anything.
From this article in AAII Journal on the "Nifty Fifty":
"The Nifty Fifty were a group of premier growth stocks...that became institutional darlings in the early 1970s."
The article then added...
"The Nifty Fifty were often called one-decision stocks: buy and never sell. Because their prospects were so bright, many analysts claimed that the only direction they could go was up."
Ugh. Many of these were good businesses but price matters. Here's what to keep in mind you hear an extreme valuation being justified:
"...many investors did not seem to find 50, 80 or even 100 times earnings at all an unreasonable price to pay for the world's preeminent growth companies."
Forbes magazine later said this...
"What held the Nifty Fifty up? The same thing that held up tulip-bulb prices in long-ago Holland—popular delusions and the madness of crowds. The delusion was that these companies were so good it didn't matter what you paid for them..."
Forbes then pointed out the problem wasn't with the companies. Instead, the problem was...
"...the temporary insanity of institutional money managers—proving again that stupidity well-packaged can sound like wisdom. It was so easy to forget that probably no sizable company could possibly be worth over 50 times normal earnings."
These days, quite a few high quality large cap stocks are selling at price to earnings (P/E) in the mid-teens and even much lower that that. Of course, the P/E multiple can shrink further but it's not as if, at some point, the opposite can't also happen. The growth in intrinsic value and the expansion/contraction of P/E ratios frequently have little to do with one another.
At a time when the macro world seems to have only darkening skies ahead, many won't be considering that a high probability. If or when large caps will get expensive again* isn't knowable but, while it seems improbable now, at some point down the road they just may.
The multiple of earnings that investors are willing to pay tend to expand when the skies seem clear and predictably often contract when less so.
In the 2001 Fortune article, Buffett compares the 1920s to the 1940s and explains the "monumental hangover" the public was still suffering 20 years later:
"The country was then intrinsically far more valuable than it had been 20 years before; dividend yields were more than double the yield on bonds; and yet stock prices were at less than half their 1929 peak...But rather than seeing what was in plain sight in the late 1940s, investors were transfixed by the frightening market of the early 1930s..."
Buffett then said don't assume it's just the small investor who invests in the rear-view. He uses the early 1970s as an example:
"...this was Nifty Fifty time--pension managers, feeling great about the market, put more than 90% of their net cash flow into stocks, a record commitment at the time. And then, in a couple of years, the roof fell in and stocks got way cheaper. So what did the pension fund managers do? They quit buying because stocks got cheaper!" - Warren Buffett in Fortune, December 2001
When a good business is bought at a nice discount to value, there's little need for the macro world to improve or for P/E multiples to expand to make investor returns satisfactory.
Meaningful discounts to value are usually the most pronounced when the macro storm clouds seem to everywhere and getting worse.
Now, once a good business has been bought at a discount, it's certainly not a problem if the prices investors are willing to pay for a dollar of earnings happens to expand down the road.
Don't plan on it but consider that possible outcome a bonus if it happens.
The opposite, buying at the higher earnings multiples, doesn't work that way. You have to hope the high multiples remain high or sell and hope for attractive prices down the road. Being on the wrong end of a crunch in earnings multiples wouldn't be fun.
By comparison, buying when multiples are attractively low and learning to ride out the storms seems a much more doable game.
Inexpensive shares of blue chip businesses happen to be plentiful these days but it's probably not a good idea to assume they'll remain that way indefinitely.
Shares happen to be cheap for now and will be until they are not. Who knows if or when an era similar to the Nifty Fifty will return.
Adam
* Remarkably, and the AAII article reveals this, many of the Nifty Fifty did actually do very well over the long run despite the high P/E ratios. That doesn't mean it made sense on a risk-adjusted basis to pay up. The article has the luxury of looking at results after the fact. Investors don't have such a luxury. Since all investors have to invest going into an unknown and unknowable future, it's crucial to buy even the best businesses with a margin of safety.
---
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and are never a recommendation to buy or sell anything.
Thursday, December 1, 2011
Consumer Staples: Long-term Performance
Jim O'Shaughnessy of O'Shaughnessy Asset Management and author of "What Works on Wall Street" performed a sector analysis of the stock market over a four decade period. He appeared on CNBC recently and revealed the results of his analysis.
According to O'Shaughnessy, the highest return long-term sector has been consumer staples.
So the sector that has tended to outperform long-term is still frequently described as "defensive".
Many consumer staples stocks are not just "defensive" in nature, though they're frequently described and thought of that way. They can, consistent with their reputation, provide better downside protection than other stocks but, otherwise, calling them "defensive" is actually quite a mischaracterization when viewed over the long haul.
It underestimates their long-term "offensive" potential.
Defensive implies lower risk and lower returns. Well, when it comes to businesses like Coca-Cola (KO) that's half correct. Lower risk certainly, but historically Coke's shares have produced above market long-term returns and the company's future prospects aren't exactly dismal.
So consumer staples can be both offensive and defensive -- especially the highest quality ones -- but, like any stock, they still need to be bought at a nice discount to estimated per share intrinsic value.
The best are generally just quality durable businesses that produce high returns on capital at relatively low risk (again, especially if bought at the right price).
This CNBC article sums ups some of O'Shaughnessy's analysis.
Here's a couple of his findings:
- Not only did consumer staples do the best among 10 sectors, the highest performing stocks in the consumer staples sector had the highest buybacks plus dividend yield (shareholder yield).
- Those with the highest shareholder yield had an average annual return of 17.8%.
So they have worked very well as an "offense" long-term, despite their reputation, and produced above market returns.
Consistent with their reputation, they have also worked as a pretty good defense.
Higher returns...lower risk.
Over the shorter run -- less than five years or so -- anything can happen as far as price action and relative performance goes, of course (and some these days consider five years longer term no doubt). Even the best stocks in the consumer staples sector are just not likely to do particularly well in bull markets. In fact, anyone buying these stocks expecting them to outperform during a bull market is likely to be disappointed. That is, in part, how they have earned the reputation of being "defensive". Yet, this defensive reputation isn't quite correct when you look at their historic returns over long enough time horizons. So it's generally when they're looked at over longer time frames -- more than a full business cycle or two -- that the picture becomes more clear.
Though there's no way to know how they'll do going forward, it has generally been over the longer run when their merits become more obvious.
Here's a recent example.
At yesterday's close the S&P 500 was at 1246, down from its pre-financial crisis peak of 1565 hit back in 2007. A 20% drop (excluding dividends).
Now, imagine some unlucky person who happened to put all their money into the SPDR S&P 500 (SPY) on that day (it's generally not wise to commit dollars all at once like that).
So, assuming that person didn't sell, that person's portfolio would unfortunately now be down a little over 20%.
Naturally, that person would be similarly disappointed with portfolio results if, instead he or she happened buy each of the nine Select Sector SPDR ETFs* (Consumer Discretionary XLY, Consumer Staples XLP, Energy XLE, Financial XLF, Healthcare XLV, Industrials XLI, Materials XLB , Technology XLK, Utilities XLU) at their peak prices.
Eight of the nine sectors are, in fact, still below their pre-financial crisis peak. Some much more than others, of course.
The one exception is the consumer staples sector.
So somewhat amazingly, the unlucky individual who bought the Consumer Staples SPDR ETF (XLP) at its very highest pre-crisis price and held it throughout is not underwater and would have collected a very nice dividend**.
The returns from owning the XLP would be positive even if bought at the highest possible price when, nearly 4 years later, the S&P is still 20% below its peak levels. Even if not spectacular absolute performance it's exceptional relative performance.
Now, consider what the results could be with just some disciplined buying of the ETF as stocks were falling and falling during the crisis. Anyone who did that would have a relatively low cost basis and very nice returns these past few years.
Better yet, consider the results if someone was buying the best individual consumer staples stocks as they were getting cheaper and cheaper during that time.
Each sector, of course, went down dramatically during the worst days of the crisis. Most of the sectors were down more than 50% at some point. The best performer, once again, was consumer staples but it still was down for a brief period by a bit more than 30%.
Clearly pretty much nothing went unscathed as far as the price action goes. In the short to medium run, any sector will be vulnerable when stock prices are falling across the board.
Yet, in the long run, the best of the businesses that reside within the consumer staples sector are mostly consistent intrinsic value creators so, while prices can fall in the near term, over time it becomes like trying to hold a beach ball or basketball underwater as the tide rises.
The good news is, unlike the ocean, many of them have a tide that will be rising for a very long time.
Consumer staples have at times in the past few years been anywhere from extremely cheap to attractive.
While not necessarily expensive now, most consumer staples stocks are certainly no longer cheap.***
So there are some great stocks in this sector to own for the long haul but the price paid still matters. The bargains have all but disappeared. Even for very good businesses, what's sensible to buy at a discount to intrinsic value makes little sense at some materially higher valuation.
Finally, if the shares of higher quality businesses did not outperform over the long haul going forward (and they may not, of course), the sheer simplicity of the approach compared to alternatives needs to be considered.
So does the reduced likelihood of permanent capital loss and more narrow range of outcomes.
In fact, if these quality franchises produced merely market returns they'd still win in my book.
The reason is that, if bought well, the same return will have been arguably achieved at less risk of permanent capital loss.
In other words, temporary paper losses can happen with just about any stock.
Also, what these have done historically guarantees nothing going forward. Yet, considering risk and reward, these still seem like not a bad place to start.
Figuring out the likely future prospects -- and what to pay for those prospects -- still requires plenty of work.
The best of these high quality businesses tend to experience little change. They sell similar products year after year. They do it while maintaining, give or take, often rather attractive business economics.
That's their strength.
Innovation is a wonderful thing for the world but, as far as the investment process goes, picking winners while avoiding the losers is a good idea mostly on paper, less so in practice.
The idea that stocks in the consumer staples sector can be bought and sold at just the right time -- in other words, owning them when a defensive posture is warranted, selling them to buy something with more upside when not -- is another thing that looks good on paper but is just not easy to do in practice.
Adam
Long position in KO
Related posts:
Consumer Staples: Long-term Performance, Part II - Dec 2011 (follow-up)
Grantham: What to Buy? - Aug 2011
Defensive Stocks Revisited - Mar 2011
KO and JNJ: Defensive Stocks? - Jan 2011
Altria Outperforms...Again - Oct 2010
Grantham on Quality Stocks Revisited - Jul 2010
Friends & Romans - May 2010
Grantham on Quality Stocks - Nov 2009
Best Performing Mutual Funds - 20 Years - May 2009
Staples vs Cyclicals - Apr 2009
Best and Worst Performing DJIA Stock - Apr 2009
Defensive Stocks? - Apr 2009
* Select Sector SPDRs are ETFs that divide the S&P 500 into nine sectors.
** At roughly 2.7%, Consumer staples as a sector has higher dividends than the S&P 500 so, if you compare returns including dividends, the gap in performance only gets bigger.
*** With any investment, no matter how seemingly attractive, margin of safety is all-important. It protects against the unforeseen real, even if fixable, business problems. Still, it's worth considering this: "If the business earns 6% on capital over 40 years and you hold it for that 40 years, you're not going to make much different than a 6% return - even if you originally buy it at a huge discount. Conversely, if a business earns 18% on capital over 20 or 30 years, even if you pay an expensive looking price, you'll end up with a fine result." - Charlie Munger at USC Business School in 1994
---
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
According to O'Shaughnessy, the highest return long-term sector has been consumer staples.
So the sector that has tended to outperform long-term is still frequently described as "defensive".
Many consumer staples stocks are not just "defensive" in nature, though they're frequently described and thought of that way. They can, consistent with their reputation, provide better downside protection than other stocks but, otherwise, calling them "defensive" is actually quite a mischaracterization when viewed over the long haul.
It underestimates their long-term "offensive" potential.
Defensive implies lower risk and lower returns. Well, when it comes to businesses like Coca-Cola (KO) that's half correct. Lower risk certainly, but historically Coke's shares have produced above market long-term returns and the company's future prospects aren't exactly dismal.
So consumer staples can be both offensive and defensive -- especially the highest quality ones -- but, like any stock, they still need to be bought at a nice discount to estimated per share intrinsic value.
The best are generally just quality durable businesses that produce high returns on capital at relatively low risk (again, especially if bought at the right price).
This CNBC article sums ups some of O'Shaughnessy's analysis.
Here's a couple of his findings:
- Not only did consumer staples do the best among 10 sectors, the highest performing stocks in the consumer staples sector had the highest buybacks plus dividend yield (shareholder yield).
- Those with the highest shareholder yield had an average annual return of 17.8%.
So they have worked very well as an "offense" long-term, despite their reputation, and produced above market returns.
Consistent with their reputation, they have also worked as a pretty good defense.
Higher returns...lower risk.
Over the shorter run -- less than five years or so -- anything can happen as far as price action and relative performance goes, of course (and some these days consider five years longer term no doubt). Even the best stocks in the consumer staples sector are just not likely to do particularly well in bull markets. In fact, anyone buying these stocks expecting them to outperform during a bull market is likely to be disappointed. That is, in part, how they have earned the reputation of being "defensive". Yet, this defensive reputation isn't quite correct when you look at their historic returns over long enough time horizons. So it's generally when they're looked at over longer time frames -- more than a full business cycle or two -- that the picture becomes more clear.
Though there's no way to know how they'll do going forward, it has generally been over the longer run when their merits become more obvious.
Here's a recent example.
At yesterday's close the S&P 500 was at 1246, down from its pre-financial crisis peak of 1565 hit back in 2007. A 20% drop (excluding dividends).
Now, imagine some unlucky person who happened to put all their money into the SPDR S&P 500 (SPY) on that day (it's generally not wise to commit dollars all at once like that).
So, assuming that person didn't sell, that person's portfolio would unfortunately now be down a little over 20%.
Naturally, that person would be similarly disappointed with portfolio results if, instead he or she happened buy each of the nine Select Sector SPDR ETFs* (Consumer Discretionary XLY, Consumer Staples XLP, Energy XLE, Financial XLF, Healthcare XLV, Industrials XLI, Materials XLB , Technology XLK, Utilities XLU) at their peak prices.
Eight of the nine sectors are, in fact, still below their pre-financial crisis peak. Some much more than others, of course.
The one exception is the consumer staples sector.
So somewhat amazingly, the unlucky individual who bought the Consumer Staples SPDR ETF (XLP) at its very highest pre-crisis price and held it throughout is not underwater and would have collected a very nice dividend**.
The returns from owning the XLP would be positive even if bought at the highest possible price when, nearly 4 years later, the S&P is still 20% below its peak levels. Even if not spectacular absolute performance it's exceptional relative performance.
Now, consider what the results could be with just some disciplined buying of the ETF as stocks were falling and falling during the crisis. Anyone who did that would have a relatively low cost basis and very nice returns these past few years.
Better yet, consider the results if someone was buying the best individual consumer staples stocks as they were getting cheaper and cheaper during that time.
Each sector, of course, went down dramatically during the worst days of the crisis. Most of the sectors were down more than 50% at some point. The best performer, once again, was consumer staples but it still was down for a brief period by a bit more than 30%.
Clearly pretty much nothing went unscathed as far as the price action goes. In the short to medium run, any sector will be vulnerable when stock prices are falling across the board.
Yet, in the long run, the best of the businesses that reside within the consumer staples sector are mostly consistent intrinsic value creators so, while prices can fall in the near term, over time it becomes like trying to hold a beach ball or basketball underwater as the tide rises.
The good news is, unlike the ocean, many of them have a tide that will be rising for a very long time.
Consumer staples have at times in the past few years been anywhere from extremely cheap to attractive.
While not necessarily expensive now, most consumer staples stocks are certainly no longer cheap.***
So there are some great stocks in this sector to own for the long haul but the price paid still matters. The bargains have all but disappeared. Even for very good businesses, what's sensible to buy at a discount to intrinsic value makes little sense at some materially higher valuation.
Finally, if the shares of higher quality businesses did not outperform over the long haul going forward (and they may not, of course), the sheer simplicity of the approach compared to alternatives needs to be considered.
So does the reduced likelihood of permanent capital loss and more narrow range of outcomes.
In fact, if these quality franchises produced merely market returns they'd still win in my book.
The reason is that, if bought well, the same return will have been arguably achieved at less risk of permanent capital loss.
In other words, temporary paper losses can happen with just about any stock.
Also, what these have done historically guarantees nothing going forward. Yet, considering risk and reward, these still seem like not a bad place to start.
Figuring out the likely future prospects -- and what to pay for those prospects -- still requires plenty of work.
The best of these high quality businesses tend to experience little change. They sell similar products year after year. They do it while maintaining, give or take, often rather attractive business economics.
That's their strength.
Innovation is a wonderful thing for the world but, as far as the investment process goes, picking winners while avoiding the losers is a good idea mostly on paper, less so in practice.
The idea that stocks in the consumer staples sector can be bought and sold at just the right time -- in other words, owning them when a defensive posture is warranted, selling them to buy something with more upside when not -- is another thing that looks good on paper but is just not easy to do in practice.
Adam
Long position in KO
Related posts:
Consumer Staples: Long-term Performance, Part II - Dec 2011 (follow-up)
Grantham: What to Buy? - Aug 2011
Defensive Stocks Revisited - Mar 2011
KO and JNJ: Defensive Stocks? - Jan 2011
Altria Outperforms...Again - Oct 2010
Grantham on Quality Stocks Revisited - Jul 2010
Friends & Romans - May 2010
Grantham on Quality Stocks - Nov 2009
Best Performing Mutual Funds - 20 Years - May 2009
Staples vs Cyclicals - Apr 2009
Best and Worst Performing DJIA Stock - Apr 2009
Defensive Stocks? - Apr 2009
* Select Sector SPDRs are ETFs that divide the S&P 500 into nine sectors.
** At roughly 2.7%, Consumer staples as a sector has higher dividends than the S&P 500 so, if you compare returns including dividends, the gap in performance only gets bigger.
*** With any investment, no matter how seemingly attractive, margin of safety is all-important. It protects against the unforeseen real, even if fixable, business problems. Still, it's worth considering this: "If the business earns 6% on capital over 40 years and you hold it for that 40 years, you're not going to make much different than a 6% return - even if you originally buy it at a huge discount. Conversely, if a business earns 18% on capital over 20 or 30 years, even if you pay an expensive looking price, you'll end up with a fine result." - Charlie Munger at USC Business School in 1994
---
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
Wednesday, November 30, 2011
Buffett: Credit Default Swaps Potentially "Very Anti-Social" Instruments
In this CNBC interview, Warren Buffett is asked by Andrew Ross Sorkin if he believes credit default swaps should exist.
Well, Buffett points out that, for sound reasons, individuals can't insure someone else's house:
...because you do not have an insurable interest*, as they call it in the trade. Because once you insure my house against fire and you may decide that, you know, that maybe dropping a few matches around my lawn might be a good idea.
He added that with credit default swaps participants benefit if a place gets into difficulty:
...when a lot of people have an interest in a place getting in trouble, they may start putting out misleading statements...if you were short the stock of a bank, you might hire—and there wasn't any FDIC, you might go out and hire 100 movie extras to stand in front of that bank.
And...
...in effect, you would create your own reality. Now buying credit default swaps and talking about them and causing the price of credit default swaps to go up creates its own reality to some degree. So I think that they are potentially a very anti-social instrument.
This was Charlie Munger's take on credit default swaps when the worst of the financial crisis had begun to recede. As usual he's unequivocal. According to this Bloomberg article, Munger says he supports a complete ban so speculators can't profit from the failure of others.
From the article:
Berkshire's Munger Favors '100% Ban' on Credit Swaps
"If I were the governor of the world, I would eliminate it entirely -- 100 percent...That's the best solution. It isn't as though the economic world didn't function quite well without it, and it isn't as though what has happened has been so wonderfully desirable that we should logically want more of it."
Here's one of many reasons why I won't be holding my breath on something reasonably intelligent being done about credit default swaps (and, for that matter, some other forms of speculation) anytime soon. In this The Atlantic interview (also mentioned in this previous post), John Bogle paraphrases a quote by Upton Sinclair that pretty much sums it up:
"It's amazing how difficult it is for a man to understand something if he's paid a small fortune not to understand it."
So, with that in mind, better to have realistic expectations about whether the most logical financial system changes will happen.
Entrenched interests are "paid a small fortune not to understand" why the casino should be reigned in.
They're also paid to not understand why speculative activities should be kept more separate from the core banking utility function.
Sinclair would understand the forces at work here.
Adam
Related posts:
The Bond Market Rules
Sinking Seaworthy Ships
* Insurable interest is a fundamental principle in the insurance business that came about long ago for some very good reasons. From a historical perspective, it was the United Kingdom that provided leadership in this area. It had been learned the hard way from vast experience the lack of an insurable interest creates moral hazard. They sought to remove the ability to profit from another's loss and the misconduct associated with it. The principle hasn't served us too badly over the centuries. Human nature hasn't changed.
---
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
Well, Buffett points out that, for sound reasons, individuals can't insure someone else's house:
...because you do not have an insurable interest*, as they call it in the trade. Because once you insure my house against fire and you may decide that, you know, that maybe dropping a few matches around my lawn might be a good idea.
He added that with credit default swaps participants benefit if a place gets into difficulty:
...when a lot of people have an interest in a place getting in trouble, they may start putting out misleading statements...if you were short the stock of a bank, you might hire—and there wasn't any FDIC, you might go out and hire 100 movie extras to stand in front of that bank.
And...
...in effect, you would create your own reality. Now buying credit default swaps and talking about them and causing the price of credit default swaps to go up creates its own reality to some degree. So I think that they are potentially a very anti-social instrument.
This was Charlie Munger's take on credit default swaps when the worst of the financial crisis had begun to recede. As usual he's unequivocal. According to this Bloomberg article, Munger says he supports a complete ban so speculators can't profit from the failure of others.
From the article:
Berkshire's Munger Favors '100% Ban' on Credit Swaps
"If I were the governor of the world, I would eliminate it entirely -- 100 percent...That's the best solution. It isn't as though the economic world didn't function quite well without it, and it isn't as though what has happened has been so wonderfully desirable that we should logically want more of it."
Here's one of many reasons why I won't be holding my breath on something reasonably intelligent being done about credit default swaps (and, for that matter, some other forms of speculation) anytime soon. In this The Atlantic interview (also mentioned in this previous post), John Bogle paraphrases a quote by Upton Sinclair that pretty much sums it up:
"It's amazing how difficult it is for a man to understand something if he's paid a small fortune not to understand it."
So, with that in mind, better to have realistic expectations about whether the most logical financial system changes will happen.
Entrenched interests are "paid a small fortune not to understand" why the casino should be reigned in.
They're also paid to not understand why speculative activities should be kept more separate from the core banking utility function.
Sinclair would understand the forces at work here.
Adam
Related posts:
The Bond Market Rules
Sinking Seaworthy Ships
* Insurable interest is a fundamental principle in the insurance business that came about long ago for some very good reasons. From a historical perspective, it was the United Kingdom that provided leadership in this area. It had been learned the hard way from vast experience the lack of an insurable interest creates moral hazard. They sought to remove the ability to profit from another's loss and the misconduct associated with it. The principle hasn't served us too badly over the centuries. Human nature hasn't changed.
---
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
Tuesday, November 29, 2011
Facebook's IPO: $ 100 Billion Valuation?
This post from back in June looked at Facebook's potential valuation and compared it to some other large technology businesses.
Is Facebook Worth $ 100 Billion?
It now appears Facebook is getting closer to an IPO with a valuation at or, at least, near that $ 100 billion number. The IPO is expected to happen between April and June of 2012. This Wall Street Journal article points out the company wants to raise $ 10 billion. That would make it rather a large IPO by any standard.
The expected valuation?
$ 100 billion
Wall Street Journal: Facebook Targets Huge IPO
At $ 100 billion, Facebook will have nearly 4x the market valuation that Google (GOOG) had when it went public in 2004.
The Wall Street Journal article also says Facebook expects to have more than $ 4 billion in annual revenue once it goes public.
Previous post: Facebook's 1st Half Revenue Doubles
The SEC will require Facebook to make its financial information public once it has 500 shareholders. It's likely that will happen soon so it's a good bet we'll see more detailed financial information by April of next year.
If the Reuters article is correct, Facebook's annualized earnings should be $ 1 billion plus. Paying $ 100 billion for $ 1 billion plus of earning is obviously a very high multiple yet, considering the growth rate, who knows what the business is worth.
From this Bloomberg article:
"It's obviously a very steep valuation," said Schuster, whose firm invests in IPOs and oversees about $2.5 billion in assets. "They are realizing their window of opportunity, and they want to do it sooner rather than later."
On the surface, at least, Facebook's prospects are impressive. It looks to be potentially one heck of a potential franchise.
It may turn out to be a juggernaut for all I know. In time, it could even become clear why it's worth every penny of that $ 100 billion valuation. Yet, that doesn't necessarily make it a great stock to buy on a risk-adjusted basis.*
Investors don't put money at risk for the privilege of eventually getting their money back. It is about getting the best risk-adjusted return (preferably on something with a future prospects that are easily understood).
Price paid relative to value regulates risk. Higher uncertainty around valuation should logically require a greater discount, more of a margin of safety.
I think it is fair to say that starting at a $ 100 billion valuation takes away plenty of upside while offering quite a bit of downside if some dreams aren't realized.
With the information currently available and a relatively short track record, Facebook is obviously tough to value. We'll get more details and perspective on Facebook as the IPO approaches once the S-1 comes out.
It's worth noting that Apple (AAPL),who's not exactly growing slowly, has the earning capacity of roughly thirty Facebook's, yet an enterprise value (market cap - net cash and investments) that is less than 3x that $ 100 billion valuation.
Most companies when they go public do not start out as a large cap stock but it looks like Facebook's going to be an exception. I mean, quite a few rather solid, if less exciting, established business franchises could be bought for around $ 100 billion.
For example, the $ 100 billion could be used to buy all** shares of PepsiCo (PEP) and there'd still be a billion plus dollars remaining to start a nice venture fund.
Alternatively, that money could buy the three large U.S. railroads (CSX: CSX, Norfolk Southern: NSC, Union Pacific: UNP) not owned by Berkshire Hathaway (BRKa). After taking control of the railroads (and dealing with the inevitable anti-trust issues) that buyer would still have several billion dollars in the bank.
Easily enough pocket change to buy a full year's worth of production by Ferrari, Maserati, Aston Martin, and Lotus (hey, maybe even a Formula 1 team).
At least for me, those cars would be enough compensation for not being able to participate in the excitement of an IPO.
Besides, I'll take railroads over a social network. Even if the upside is more limited, in their current form the future prospects for railroads are easier to figure out and importantly, not too long ago, the price for some of them was right.
Adam
Related posts:
Facebook's 1st Half Revenue Doubles to $ 1.6 Billion
Is Facebook Worth $ 100 Billion?
Technology Stocks
* Near the expected valuation, the risk of negative returns is uncomfortably high if things go a bit less well than expected. Having said that, sustained high return on capital over 2 or 3 decades eventually does make an initially expensive looking investment make sense. In the very long run, results tend to be drawn like a magnet toward the return on capital earned by the business. I don't think I have any capacity to even roughly estimate Facebook's return on capital or its sustainability over such a long time horizon. Others may be able to.
** Of course, in the real world a premium to market value would need to be paid to buy all shares.
---
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
Is Facebook Worth $ 100 Billion?
It now appears Facebook is getting closer to an IPO with a valuation at or, at least, near that $ 100 billion number. The IPO is expected to happen between April and June of 2012. This Wall Street Journal article points out the company wants to raise $ 10 billion. That would make it rather a large IPO by any standard.
The expected valuation?
$ 100 billion
Wall Street Journal: Facebook Targets Huge IPO
At $ 100 billion, Facebook will have nearly 4x the market valuation that Google (GOOG) had when it went public in 2004.
The Wall Street Journal article also says Facebook expects to have more than $ 4 billion in annual revenue once it goes public.
$ 4 billion revenue already. Facebook may turn out to be a terrific business. Whether it's a good investment is less clear at this point. It certainly will be one of the more interesting IPOs in a while. It's supposed to be profitable already but, for now, we don't have much detail on the financials. That will soon change. This Reuters article from back in September said net income in the 1st half of 2011 was almost $ 500 million (according to an anonymous source).
Previous post: Facebook's 1st Half Revenue Doubles
The SEC will require Facebook to make its financial information public once it has 500 shareholders. It's likely that will happen soon so it's a good bet we'll see more detailed financial information by April of next year.
If the Reuters article is correct, Facebook's annualized earnings should be $ 1 billion plus. Paying $ 100 billion for $ 1 billion plus of earning is obviously a very high multiple yet, considering the growth rate, who knows what the business is worth.
From this Bloomberg article:
"It's obviously a very steep valuation," said Schuster, whose firm invests in IPOs and oversees about $2.5 billion in assets. "They are realizing their window of opportunity, and they want to do it sooner rather than later."
On the surface, at least, Facebook's prospects are impressive. It looks to be potentially one heck of a potential franchise.
It may turn out to be a juggernaut for all I know. In time, it could even become clear why it's worth every penny of that $ 100 billion valuation. Yet, that doesn't necessarily make it a great stock to buy on a risk-adjusted basis.*
Investors don't put money at risk for the privilege of eventually getting their money back. It is about getting the best risk-adjusted return (preferably on something with a future prospects that are easily understood).
Price paid relative to value regulates risk. Higher uncertainty around valuation should logically require a greater discount, more of a margin of safety.
I think it is fair to say that starting at a $ 100 billion valuation takes away plenty of upside while offering quite a bit of downside if some dreams aren't realized.
With the information currently available and a relatively short track record, Facebook is obviously tough to value. We'll get more details and perspective on Facebook as the IPO approaches once the S-1 comes out.
It's worth noting that Apple (AAPL),who's not exactly growing slowly, has the earning capacity of roughly thirty Facebook's, yet an enterprise value (market cap - net cash and investments) that is less than 3x that $ 100 billion valuation.
Most companies when they go public do not start out as a large cap stock but it looks like Facebook's going to be an exception. I mean, quite a few rather solid, if less exciting, established business franchises could be bought for around $ 100 billion.
For example, the $ 100 billion could be used to buy all** shares of PepsiCo (PEP) and there'd still be a billion plus dollars remaining to start a nice venture fund.
Alternatively, that money could buy the three large U.S. railroads (CSX: CSX, Norfolk Southern: NSC, Union Pacific: UNP) not owned by Berkshire Hathaway (BRKa). After taking control of the railroads (and dealing with the inevitable anti-trust issues) that buyer would still have several billion dollars in the bank.
Easily enough pocket change to buy a full year's worth of production by Ferrari, Maserati, Aston Martin, and Lotus (hey, maybe even a Formula 1 team).
At least for me, those cars would be enough compensation for not being able to participate in the excitement of an IPO.
Besides, I'll take railroads over a social network. Even if the upside is more limited, in their current form the future prospects for railroads are easier to figure out and importantly, not too long ago, the price for some of them was right.
Adam
Related posts:
Facebook's 1st Half Revenue Doubles to $ 1.6 Billion
Is Facebook Worth $ 100 Billion?
Technology Stocks
* Near the expected valuation, the risk of negative returns is uncomfortably high if things go a bit less well than expected. Having said that, sustained high return on capital over 2 or 3 decades eventually does make an initially expensive looking investment make sense. In the very long run, results tend to be drawn like a magnet toward the return on capital earned by the business. I don't think I have any capacity to even roughly estimate Facebook's return on capital or its sustainability over such a long time horizon. Others may be able to.
** Of course, in the real world a premium to market value would need to be paid to buy all shares.
---
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
Friday, November 25, 2011
Buffett on Europe: Investing While Uncertain - Part II
"The world's always uncertain. The world was uncertain on December 6th, 1941, we just didn't know it. The world was uncertain on October 18th, 1987, you know, we just didn't know it. The world was uncertain on September 10th, 2001, we just didn't know it." - Warren Buffett on CNBC
In this earlier post, I highlighted some of Warren Buffett's thought on Europe from an interview on CNBC.
During the interview, Buffett said he sees Europe as having a fundamental flaw.
In a separate CNBC interview, he also said that the current system they have is not working and even has doubts about the euro survival.
His response to this very serious and developing situation in Europe has been fairly straightforward...to buy stocks aggressively.
Buffett explained some of his thinking when it comes to making investments in this kind of uncertain environment:
"...there's always uncertainty. Now the question is, what do you do with your money? And if you—the one thing is if you leave it in your pocket, it'll become worth less—not worthless—worth less over time. That's certain—that's almost certain. You can put it in bonds and then you can get a certain 2 percent for 10 years and that's almost certain to be less than the decline in the purchasing power."
He later added...
"It's very interesting to me, if you own a farm and somebody said, you know, Italy's got problems. Do you sell your farm tomorrow? If you own a good business locally in Omaha and somebody says Italy's got problems tomorrow, do you sell your—do you sell your business?"
and...
"...But for some reason, people think if they own wonderful businesses indirectly through stocks, they've got to make a decision every five minutes. So I do not think if Ben Bernanke comes up and whispers to me that he's going to do X, Y or Z tomorrow, I'm not going to change my view about what businesses I want to own."
Yes, Europe may not be a stable situation and it is not clear if the resolution will be orderly or not.
Yes, stocks will probably continue to go down if it goes badly over there.
Maybe, dramatically so.
Understandably, most do not want to watch something they just bought "cheap" get cheaper but, with stocks, that risk is always there and as Buffett points out above, it's not always the risks that are on the radar that cause the disruption.
Good businesses can withstand tough times and the best get stronger during the process even if price action gets really ugly. Many businesses during the last financial crisis made themselves stronger and intrinsically worth more. Share prices eventually follow.
The possibility or even likelihood that Europe will go very badly doesn't change whether part ownership of a good business makes sense when selling at the right discount to value. Margin of safety, as always, is key.
In the long run, it's generally the price paid relative to value, long-term compounding effects, low frictional costs, and the making of quality choices that dictates returns...not the macro stuff.
Later in the CNBC interview...
"I'm going to own these businesses five or 10 or 20 years from now and they'll be all kinds of good news and all kinds of bad news, but the good businesses, they do wonders for you over time."
None of this applies to money needed in the short or even medium run.
As the Europe situation develops, chances are shares in a good publicly traded business, even if bought with a margin of safety, will get cheaper for an extended period of time.
Yet, while near price action may head south, shares of a sound business (if judged correctly) is likely to be worth lots more in 10 or 20 years.
Why sell?
Besides, the lower prices just provide a chance to own more of the business at a discount.
As Buffett says, a farmer wouldn't sell productive farmland in Nebraska because Europe can't its act together. A true long-term shareowner will ignore the daily quotes and focus on things like: Can the business produce long-term high returns on capital? How substantial is the economic moat? Can it be built into something more robust over time? Is management honest and capable?
I think Buffett's belief that Europe may end up going very badly and the fact that he is buying so aggressively still baffles some. It shouldn't be surprising when considering how he has approached things over the years.
Shareowners need to worry about the quality of their business judgment not whether the stock market price will be up or down next week, month, or even year. I know this flies in the face of the many increasingly popular short-term trading strategies but the approach when applied well is a sound one.
In fact, maybe if more participants had a long-term value orientation, and fewer had a short-term technical/algorithmic orientation, maybe we'd have slightly less hyperactive markets.
Intrinsic value, doesn't fluctuate anything like the price action we see.
Those grounded first and foremost by value know it and their buy/sell behavior, if it made up a greater percent of volume, would likely be less about reacting to the next headline and gaming short-term price action. It certainly couldn't hurt though I realize markets will always have a tendency to be alternatively manic and depressed by nature.
The mood swings aren't going away.
Still, if participants with a long-term value bent were placing more of the votes in the short-term voting machine that is the stock market, it seems clear that the nature of price action as a whole would, to a meaningful degree, change. To me, it'd be a welcome culture change for capital markets that, considering entrenched interests, has just about zero chance of happening anytime soon.
The market still functions effectively as a weighing machine over the long haul but I think it is fair to say it need not be this hyperactive and dysfunctional in the short run.
There's plenty of room in the markets for speculation but the proportion matters. There are many capable long-term investors but having a disproportionate number of participants with little more than a passing interest in things like intrinsic value can't be a good thing.
For some, intrinsic value probably seems little more than a quaint concept as they proceed to read the tea leaves via some chart that supposedly has a head-and shoulders-double-wishbone-cup-with-handle or whatever formation.
The capital markets primary reason for existing to effectively allocate capital. To me, there's little doubt it would function better if more of its participants were grounded more by making judgments of long run value less by gaming price action. That kind of change may create less opportunities for individual investors to profit from extreme mispricing, but the system would become less prone to capital misallocation.
It would also likely behave in a more stable manner which can't hurt business and consumer confidence.
Adam
Related posts:
Buffett Doubts Euro Survival, Views European Stocks Favorably
Buffett on Europe: Investing While Uncertain
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This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
In this earlier post, I highlighted some of Warren Buffett's thought on Europe from an interview on CNBC.
During the interview, Buffett said he sees Europe as having a fundamental flaw.
In a separate CNBC interview, he also said that the current system they have is not working and even has doubts about the euro survival.
His response to this very serious and developing situation in Europe has been fairly straightforward...to buy stocks aggressively.
Buffett explained some of his thinking when it comes to making investments in this kind of uncertain environment:
"...there's always uncertainty. Now the question is, what do you do with your money? And if you—the one thing is if you leave it in your pocket, it'll become worth less—not worthless—worth less over time. That's certain—that's almost certain. You can put it in bonds and then you can get a certain 2 percent for 10 years and that's almost certain to be less than the decline in the purchasing power."
He later added...
"It's very interesting to me, if you own a farm and somebody said, you know, Italy's got problems. Do you sell your farm tomorrow? If you own a good business locally in Omaha and somebody says Italy's got problems tomorrow, do you sell your—do you sell your business?"
and...
"...But for some reason, people think if they own wonderful businesses indirectly through stocks, they've got to make a decision every five minutes. So I do not think if Ben Bernanke comes up and whispers to me that he's going to do X, Y or Z tomorrow, I'm not going to change my view about what businesses I want to own."
Yes, Europe may not be a stable situation and it is not clear if the resolution will be orderly or not.
Yes, stocks will probably continue to go down if it goes badly over there.
Maybe, dramatically so.
Understandably, most do not want to watch something they just bought "cheap" get cheaper but, with stocks, that risk is always there and as Buffett points out above, it's not always the risks that are on the radar that cause the disruption.
Good businesses can withstand tough times and the best get stronger during the process even if price action gets really ugly. Many businesses during the last financial crisis made themselves stronger and intrinsically worth more. Share prices eventually follow.
The possibility or even likelihood that Europe will go very badly doesn't change whether part ownership of a good business makes sense when selling at the right discount to value. Margin of safety, as always, is key.
In the long run, it's generally the price paid relative to value, long-term compounding effects, low frictional costs, and the making of quality choices that dictates returns...not the macro stuff.
Later in the CNBC interview...
"I'm going to own these businesses five or 10 or 20 years from now and they'll be all kinds of good news and all kinds of bad news, but the good businesses, they do wonders for you over time."
None of this applies to money needed in the short or even medium run.
As the Europe situation develops, chances are shares in a good publicly traded business, even if bought with a margin of safety, will get cheaper for an extended period of time.
Yet, while near price action may head south, shares of a sound business (if judged correctly) is likely to be worth lots more in 10 or 20 years.
Why sell?
Besides, the lower prices just provide a chance to own more of the business at a discount.
As Buffett says, a farmer wouldn't sell productive farmland in Nebraska because Europe can't its act together. A true long-term shareowner will ignore the daily quotes and focus on things like: Can the business produce long-term high returns on capital? How substantial is the economic moat? Can it be built into something more robust over time? Is management honest and capable?
I think Buffett's belief that Europe may end up going very badly and the fact that he is buying so aggressively still baffles some. It shouldn't be surprising when considering how he has approached things over the years.
Shareowners need to worry about the quality of their business judgment not whether the stock market price will be up or down next week, month, or even year. I know this flies in the face of the many increasingly popular short-term trading strategies but the approach when applied well is a sound one.
In fact, maybe if more participants had a long-term value orientation, and fewer had a short-term technical/algorithmic orientation, maybe we'd have slightly less hyperactive markets.
Intrinsic value, doesn't fluctuate anything like the price action we see.
Those grounded first and foremost by value know it and their buy/sell behavior, if it made up a greater percent of volume, would likely be less about reacting to the next headline and gaming short-term price action. It certainly couldn't hurt though I realize markets will always have a tendency to be alternatively manic and depressed by nature.
The mood swings aren't going away.
Still, if participants with a long-term value bent were placing more of the votes in the short-term voting machine that is the stock market, it seems clear that the nature of price action as a whole would, to a meaningful degree, change. To me, it'd be a welcome culture change for capital markets that, considering entrenched interests, has just about zero chance of happening anytime soon.
The market still functions effectively as a weighing machine over the long haul but I think it is fair to say it need not be this hyperactive and dysfunctional in the short run.
There's plenty of room in the markets for speculation but the proportion matters. There are many capable long-term investors but having a disproportionate number of participants with little more than a passing interest in things like intrinsic value can't be a good thing.
For some, intrinsic value probably seems little more than a quaint concept as they proceed to read the tea leaves via some chart that supposedly has a head-and shoulders-double-wishbone-cup-with-handle or whatever formation.
The capital markets primary reason for existing to effectively allocate capital. To me, there's little doubt it would function better if more of its participants were grounded more by making judgments of long run value less by gaming price action. That kind of change may create less opportunities for individual investors to profit from extreme mispricing, but the system would become less prone to capital misallocation.
It would also likely behave in a more stable manner which can't hurt business and consumer confidence.
Adam
Related posts:
Buffett Doubts Euro Survival, Views European Stocks Favorably
Buffett on Europe: Investing While Uncertain
---
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
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