Archive for the 'growth vs value' Category

two more years of emergency-low interest rates!

Published January 31, 2012 Current Market Thoughts , from growth to value: the life cycle , growth vs value , Recent Market Action , Shaping a portfolio for 2012 , Strategy Leave a Comment
Tags: , , , , , , , , , ,

the January 25th Fed meeting

Last week’s meeting of the Federal Reserve’s Open Market Committee had two important results:

1.  Chairman Ben Bernanke said the Fed funds rate, which has been at effectively 0% for just over three years (since December 16, 2008–how time flies) will likely remain at or near the current low rate into 2014.

2.  The Fed gave more detail than ever before on its thinking about prospects for the US economy and the appropriate level for the Fed funds rate.

The Fed thinks:

–the long-term growth rate of the US economy is  +2.4%-2.5%  a year (vs. 3%+ a decade ago).  The agency is content, however, to allow growth at somewhat above that rate from now into 2014.

–the appropriate long-term level for the Fed funds rate is about 4.5%, which amounts to a 2.5% real rate of interest (“real” means after subtracting inflation from the nominal rate).  This contrasts with the current rate, which is a negative real rate of about 2.5%.

–although the process of normalizing interest rates will probably begin before the end of 2014, the Fed is unlikely to raise the funds rate above 1% until at least 2015.

–despite the immense monetary stimulation going on now, inflation will not be an issue.  It will remain at 2% or below.

–the “natural” rate of unemployment, that is, full employment, is 5.5% of the workforce (in theory, the 5.5% is friction in the system–like people in transit from one employment location to another, or who decide to take a short break between jobs…).

According to the Fed’s projections, the unemployment rate will remain above 8% until some time in 2013.  It probably won’t crack below 7% for at least the next three years.

implications

The forecast itself isn’t a shocker.  The Fed has been talking about slow but steady progress for the economy, with no inflation threat, for some time.  The real news is that the Fed expects the current situation to persist into 2105, a year longer than it had previously indicated.

1.  To my mind, the biggest implication of the Fed announcements is that it makes less sense than ever to be holding a lot of cash.  How much “a lot” is depends on your economic circumstances and risk preferences.  But the Fed is saying that a money market fund or bank deposit is going to yield nothing for the next two years and well under 1% for the year after that.  Yes, you have secure storage in a bank and substantial assurance you won’t make a loss, but that’s about it.

To find income in liquid assets–as opposed to illiquid ones like, say, rental real estate–you have to look to riskier investments, dividend-paying stocks or long-dated bonds.  That in itself is nothing new.  Savers have been reallocating in this direction for the past couple of years.  Last week’s Fed’s message, though, is that it’s much too early to reverse these positions.  If anything–and, again, depending on personal circumstances and preferences–investors should think about allocating more away from cash.

2.  When the process of normalizing interest rates is eventually underway, the yields on long-dated bonds and dividend paying stocks will be benchmarked–and judged–against cash yields of 4%+.  For stocks, a static dividend yield of 3% won’t look that attractive.  At some point, low payout ratios (meaning the percentage of earnings paid out in dividends) and the ability to increase cash generation will become key attributes.  Both are indicators of a company’s ability to raise dividends.

3.  It’s my experience that when the Fed begins to tighten, Wall Street always underestimates how much rates will rise.  Last week, the Fed told us that when the Fed funds rate goes up this time, its ultimate destination is 4.5%.

4.  Investors taking a top-down view, that is, looking for the strongest economies, will have to seek exposure outside the US–which will only look good vs. the EU and Japan.  The main issue is demographics–an aging population.  It’s probably worthwhile to try to figure out what characteristics of the latter two economies, both of which have older populations than the US, are due to social/cultural peculiarities and which are due to aging.  The second set of traits may well turn up in the US market as well.

5.  The mechanics of how growth stocks and value stocks work may change in a slower-growing economy.  It’s hard to know today how that will play out.  True growth stocks may be harder to come by.  Value investors who say they buy asset value of $1.00 at $.30 and sell it at $.70 may have to buy at $.20 and sell at $.60 if there’s less room for second- and third-tier companies to succeed.

I think it’s way too soon to be worrying about anything other than #1.  The rest are thoughts to be filed away for next year, maybe.

sizing the coming fiscal contraction in the US–effect on equities?

Published August 2, 2011 Capital-intensive firms , Current Market Thoughts , economics , growth vs value , Portfolio management , Recent Market Action , Shaping a portfolio for 2011 , Stock ideas , Strategy Leave a Comment
Tags: , , , , , , , , , ,

raising the debt ceiling

As I’m writing this, the House has already passed a bill that authorizes an increase in the permitted level of Federal government borrowing–one that’s big enough to get the country through the 2012 election; the Senate appears very likely to do the same at noon.  Mr. Obama will presumably sign the legislation into law before the end of the day.  That, in turn, will allow the Treasury to borrow enough to pay all of the $300+ billion in bills that come due this month, not just the $175 billion or so that the government’s income will cover.

addressing the budget deficit

The bill’s provisions (no, I haven’t read the legislation itself, just press accounts) appear to be guided by the usual congressional principle of deflecting blame from the legislators themselves.  It calls for $900 billion in immediate spending reductions.  A bipartisan panel, soon to be appointed, will find $1.5 trillion more over the coming months that Congress will vote on before yearend.  Congress will have no ability to change any of the panel’s recommendations, but must simply say yes or no.  If this second bill doesn’t pass, a pre-determined set of budget cuts, heavily weighted toward the military (which, after all, is the largest item in the budget at 25% of outlays) and entitlement spending (not far behind) will go into effect.

In addition to raising the debt ceiling, today’s bill marks the first step toward addressing two important macroeconomic problems:

–the reemergence of spending in excess of government receipts by Washington after several years of restraint during the second Clinton administration, and

–the resulting sharp rise in the amount of federal debt outstanding.

sizing the issue

GDP in the US is around $15 trillion.  The federal government is currently taking in about $2.5 trillion a year and spending $4 trillion.  See my post last week for a list of the major categories of government spending.

Outstanding federal debt is $14.3 trillion (the debt ceiling).  Of that, about $9 trillion is in public hands; the rest is held by government trusts, predominantly Social Security.

The annual budget deficit is currently about $1.5 trillion.  To cover today’s spending levels, government receipts would have to rise by 60%.   Government spending would have to drop by about a third to be funded by income.

The excess government spending over income is equal to 10% of GDP.

Two conclusions:

–the problem is too big to fix all at once,

–the problem is too big to “grow” out of.  If we assume that tax receipts increase by 5% annually, it would take almost a decade for government income to rise to the current spending level.  Government debt would be about $7 billion higher at that point than it is today.

effect on the economy

The federal budget deficit represents a very large stimulus to the economy, one that in effect shifts economic growth from the future to the present.  Shrinking the deficit means reversing this process. Eventually–and probably sooner than later–we end up with a healthier country.  But while the process is going on, the removal of stimulus will make economic growth lower than it would otherwise be.  …a loss of .5% a year?  Given that the long-term growth rate of the economy is maybe 2.5%, that’s a sizable chunk.

investment implications

Interest rates in the US are likely to stay low for much longer than most people (including me) thought a year or two ago.

This suggests that the appeal of fixed income instruments, especially short-term ones, as yield vehicles will remain limited.  By default, stocks become more attractive.

The recipe for stock market success in the US won’t change much:

–growth stocks over value

–foreign, especially Asian, exposure over domestic

–domestic consumer over domestic capital-intensive

–upscale consumer over the broad market.

from growth to value: a life cycle progression

Published May 4, 2011 from growth to value: the life cycle , growth vs value , Industry Analysis , Stock ideas , Technology Leave a Comment
Tags: , , , , , , , , , ,

going ex-growth

What happens when a growth stock goes ex-growth.  Nothing good.

Owners of a stock like this face two issues:

–the share is doubtless trading at a very high relative price-earnings multiple, based on Wall Street expectations that its superior track record of profit expansion will continue.  Not only that, growth stocks often experience a kind of buying frenzy at the peak of their popularity that pushes the multiple way above the level the stock would deserve, even if investor expectations could be met.

–growth investors lose interest, leaving value investors as the only possible buyers.  But, as we saw yesterday, value investors are attracted only to issues that have been all beaten up and tossed onto Wall Street’s scrap heap.  Like famous relief pitcher Sparky Lyle, former growth stocks must go “from Cy Young to sayonara” –or from living in the penthouse to sleeping in a doorway in the alley–before they attract much investor support.

This process of price earnings multiple “compression” or “derating” normally takes a very long time.  I don’t understand why.  Maybe it’s confirmation bias–that people see only what they want to see.  In any event, it happens.  The first half of the 1970s, before I entered the market, were characterized by the rise of a small number of stocks, like Xerox, Polaroid or (my favorite) National Lead, that were believed to be able to grow at high rates forever.  They were called “one decision” stocks–no need to sell ever.  Many of these issues traded at 90x-100x earnings in an overall market that was selling at around 12x.

In the case of the “Nifty Fifty”, it took from 1975 to 1984 for the excesses to be wrung out of the majority of these stocks.  Of course, we need only to look at the aftermath of the Internet bubble of a decade ago to see the same process play out again, although this time it “only” took 2 1/2 years.

INTC and MSFT–APPL, too

…which brings us to the topic of INTC and MSFT, two titans of the personal computer era, and how to evaluate them today.  I’m tossing in AAPL, as well, although that firm was doomed by a series of strategic missteps by a younger Steve Jobs, to remain a bit player in the PC world.

the performance record

All three stocks hit a peak in early 2000.  From April of that year to now, their stock performance is as follows:

S&P 500          +.5%

MSFT          -41.8%

INTC          -66.2%

AAPL          +963%

From the market bottom in early 2003:

S&P 500          +55.9%

MSFT          +23.8%

INTC          +36.6%

AAPL          +2007%

From the market bottom in March 2009:

S&P 500          +98.5%

MSFT          +68.9%

INTC          87.2%  (including a 15% rise in the past couple of weeks)

AAPL          +308%.

valuations:  2000 vs. now

At the top in 2000, the S&P 500 traded at 27x earnings of $56.18; now it is trading at 13x earnings of $100.  eps growth, 2000-2011 = 78%.

At the top in 2000, INTC traded at 36x earnings of 1.53;  now it is trading at 9x earnings of $2.50.  eps growth = 63%.

At the top in 2000, MSFT traded at 68x earnings of $.85;  now it is trading at 10x earnings of $2.50.  eps growth = 194%.

At the top in 2000, AAPL traded at 30x earnings of $.85; now it is trading at 14x earnings of $25.  eps growth = 28x.

Looking at MSFT and INTC shares:

MSFT:  the obvious factor is that the stock’s relative PE has been crushed.  During much of the 1990s, the company was growing earnings at a 50% annual clip.  During the past decade, it has barely managed to get into double digits.  That’s better than the overall US economy and the S&P did over the same period, but still represents a sharp departure from the past.  One might also argue that MSFT’s numbers are flattered by the recent launches of Windows 7 and Office 2010, which together have added about $1 a share to eps.  What comes next?

INTC:  it took INTC until 2010 to surpass its earnings peak of 2000.  Yes, the PE has been flattened and the company trades at at about 2/3 of the market multiple, but earnings growth has been sub-par until recently.  The big change for INTC, to my mind, is new management that is focused on building what customers want rather than on what its engineers can create.

which to buy?

Here’s where ideology comes in.

On a PE basis, INTC is a little cheaper.

But, to my mind, MSFT has a far superior operating model.  Relative earnings growth vs. INTC over any time period shows this.  MSFT has had a stranglehold on the personal computer operating system and productivity program businesses for over two decades.  There are few signs of this changing, since so many corporate IT systems are built on MSFT products.  Unlike INTC, MSFT has little need for capital.  And, again to my mind, because AAPL’s Office-like products are so bad, MSFT faces less competition in this arena than INTC does vs. AMD.

On the other hand, MSFT appears rudderless.  It hasn’t had a new product success in at least a decade.  And I see no signs MSFT is wiling to adapt itself to a changing environment.

INTC, in contrast, faces serious competition from ARMH.  But INTC seems to me to understand the need to recast the way it operates and is changing itself as quickly as it can.

If I could choose one of the two to own 100% of myself, there’s no question I’d pick MSFT.   So it seems to me that if I were a “no catalyst” value investor, that’s the stock I’d choose.

But, as it turns out, I’m a catalyst-for-change kind of guy.   I own INTC and not MSFT.  Why?  It isn’t the lower PE.  It’s the catalyst that I see in the current INTC management and that I don’t detect with MSFT.

a footnote on AAPL

How does AAPL fit into this discussion?  In a sense, it doesn’t, because AAPL is clearly a growth stock.  Over the past two years, however, the AAPL PE has contracted from about 30 to the current 14.  In fact, if you subtract AAPL’s $50+ billion in cash from the market capitalization, AAPL is trading at a sub-market multiple of under 12.  The stock is being priced almost as if the company had already gone ex-growth, which it clearly has not.  I can’t recall ever having seen a true growth stock act this way.

the two (possibly three) flavors of value: with and without a catalyst for change

Published May 3, 2011 book value , cash flow/share vs. earnings/share , growth vs value , two flavors of value 1 Comment
Tags: , , , , , , , , , , ,

As you know if you’ve been reading this blog for a while, I’m a growth investor.  But I started out my career as a value investor and spent over half my working years in shops that had either a value orientation or a substantial value presence.  For an outsider, then, I think I have a reasonable grasp of what value investors think and do.  I’m also laying the groundwork in this post for writing tomorrow about the titans of the personal computer industry, AAPL, INTC and MSFT.

how all value investors operate

Value investors like to invest in companies whose stocks are trading at very low ratios of price to book value (shareholders’ equity), price to cash flow, price to earnings and/or price to assets.  Many times such companies have gotten to low valuations because their managements have made strategic missteps.  Sometimes, though, the environment in which they work is highly cyclical and the cycle has turned against them.  Or it may just be that the industry in which the company operates is boring and seldom catches investors’ eyes.

In their pursuit of very cheap companies, value investors hold to two ground-level beliefs, namely:

–you can’t fall off the floor, and

–everything reverts to the mean, sooner or later (but mostly sooner).

The first dictum suggests that if a company’s stock is already all beaten up, at some point it just won’t go any lower.  So if buyers can locate and act at around this level, they have limited downside risk.

The second idea is that the company will eventually overcome the mistakes it has made–either with present management, new leadership, or as a division of a larger company.  In any of these events, the stock will go up …or the business cycle will turn in the company’s favor …or investors may just spontaneously wake up one morning and find the company’s industry much more fascinating (maybe as the first market entrant is taken over).

In any of these cases, the severe negative market emotion that has driven the stock to extremely low levels will dissipate and the stock will return to a more normal valuation–that is, one more in line with its past trading and with what companies with similar financial characteristics in other industries sell at.

All value investors believe this.

What sets them apart from one another?

For one thing, different investors may use somewhat different metrics.  One may be deeply convinced that he should only pay attention to price/book.  Another may be equally committed to price/cash flow.  A third may want to have another company in the same industry that’s very well run, whose (higher) margins may give a strong clue as to how good things might one day get.

In the final analysis, however, I don’t think these differences mean all that much.  Where I see the big divide for value practitioners is between those who want to see some catalyst that will encourage/force favorable change in the firm being analyzed before they’ll buy it, and those who don’t.

no catalyst

I understand the argument that the “no catalyst needed” camp makes.  They say that when things start to go bad for a company, investors can (and usually do) have a violent negative reaction that far exceeds anything that the (deteriorating) fundamentals justify.  The stock gets battered in a way it never will again, once the sellers are able regain a bit of their self-control.  Therefore, by buying when the blood is flowing the thickest in the streets, you get by far the best prices. You’re more than compensated for the risk early buying entails.

I understand the argument, but temperamentally I could never just look at the price/book (or whatever other metric) screens and jump in.  What if the stock turned out to be GM, or Enron, or Global Crossing?  As a result, I’ve never tried to investigate whether the approach works.  Unfortunately, I have seen it fail, though.

catalyst required, please

The second camp of value investors are those who insist on being able to see some sign, or catalyst, that convinces them that change for the better is under way.  It may not have to be much.  The retirement of a CEO and the appointment of a more capable successor might be enough   …or an activist investor approaching another laggard in the same industry   …or indications that the business cycle is changing in the company’s favor.  Although I’m not that interested in a regular diet of value names, I’m much more comfortable with this second approach.  But that’s just me.

where does GARP stand?

There is a third style that stands on the border between growth and value.  It’s called Growth at a Reasonable Price, or GARP.  I’ve often had colleagues describe me as a GARP investor, mostly, I think, because I don’t see a compelling reason to live exclusively on the bleeding edge of growth (with emphasis on bleeding).  But I’m not a GARP investor in the way value players would understand it.

As growth, GARP means having a forward PE that’s equal to or lower than the forward growth rate.  As value, in contrast, being a GARP investor means that you determine a forward PE level, say, 15x, above which you refuse to make a purchase, no matter what you think the forward growth rate will likely be.

For example, I have no problem paying 22x earnings for a company that will grow earnings at a 28% annual rate for at least the next few years.  In fact, I’d consider myself lucky to have discovered the stock before the PE rose further. I’d also be happy to pay 40x for a company that could grow at a 50% rate.

A value-oriented GARP investor, in contrast, would have drawn a line in the sign in the sand, probably between 15x-20x–certainly no higher, and would refuse to buy either.

That’s it for today.  Tomorrow, let’s apply this to INTC and MSFT.


MSFT’s 3Q11: signs of Windows weakness

Published May 2, 2011 earnings conference calls , growth vs value , Industry Analysis , internet , Stock ideas , Technology , Video games Leave a Comment
Tags: , , , , , , , , , , , ,

the results

After the close of the market in New York on Thursday April 28th, MSFT reported its 3Q11 (MSFT’s fiscal year ends in June) results.  The company earned $.56 per share for the three months (+24% year on year), on revenue of $16.4 billion (+13%).  A non-recurring tax benefit raised the final per share tally by $.05, to $.61.  This compares with the Wall Street consensus estimate of $.56.

MSFT shares dropped by 3% in Friday trading, in a flat market for IT.  INTC, the second member of the “Wintel alliance,” whose shares tend to  trade more or less in line with those of MSFT, rose, in contrast, by 1.5%.

the details

picky points (symptoms of analyst’s disease)

–MSFT continues to show impressive control of operating expenses.  Despite this, operating income for the quarter was up by only 10.3% year on year.  That’s less than the rate of increase in revenue–not what you’d expect from a software company.

–The company spent $10.3 billion, or a tad less than 60% of net income, over the first nine months of fiscal 2011 buying back its own stock.  That’s far above the $2.2 billion in new issuance (presumably from exercise of employee stock options) over the same period.  Outstanding shares are down by about 4% year on year–meaning around 4% of the advance in per share income comes, not from an increase in the bottom line, but from shrinkage of the denominator used in the calculation.

more important things

MSFT has five divisions, two big ones, one medium-sized and two that you can safely ignore if you just want a general picture of where growth is likely to come from.  In size order, giving the percent of operating income each represented in fiscal 2011 to date, and year on year growth for 3Q11, the divisions are:

Business (meaning MS Office and related productivity tools)      43.5% of operating earnings, 24.5% year on year growth in 3Q

Windows (the PC operating system)          38.7% of operating earnings, 10% year on year decline

Server and Tools          20% of operating income, 11.7% year on year growth

Entertainment + Devices (X-Box, cellphones…)          5.4% of operating income, 50% year on year growth

Online Services          -7.6% of operating income (a loss of $1.8 billion), a 10.% increase in the year on year loss.

the numbers need a bit of tweaking

Windows 7  launched in late October 2009.  So year-ago sales were flattered by the rush to buy the new product (and ditch Vista).  Office 2010 debuted in June 2010.  Anyone who bought Office 2007 in the runup to launch of the new version got a free upgrade.  Revenue was booked when the upgrade was redeemed, not when the sale was made–meaning that revenues in the Business segment during the year-ago quarter were unusually weak.

MSFT thinks the true rate of the Business segment revenue growth was 13%, not the 20% reported.  Conversely, it believes the decline in the PC market it saw in 3Q11 was 1%-3%, less than the 4.5% drop in sales it posted.

MSFT’s take on the PC market…

According to the company, netbook sales were down 40% year on year, business PCs were up 9% and consumer PCs were down 8%.  MSFT thinks that emerging markets represent “nearly half” of global PC shipments.

…vs. INTC’s

In simple terms, INTC (see my latest post on the company) is saying that the lion’s share of PC growth is coming in the emerging world, where consultants like Gartner or IDS, who are projecting lackluster growth in the PC market this year, have limited ability to collect data.  The two consultants are mistakenly extrapolating the present weakness in the US and Europe to include the developing world.  As a result their unit sales projections are too low.  INTC, which does over half its business in developing countries, says it has a much better look at demand through its warehouse and sales staffs–and business is better than the consultants think.

In a nutshell, MSFT sees the same picture the consultants do.

my thoughts

I don’t think netbooks are an important factor.  If they comprised 5% of the total PC market a year ago and that’s been cut in half, the resulting unit volume decline is 2.5%.  But they use low-cost Atom processors and Windows 7 Starter, which does little more than start the machine.  So they’re not a commensurate revenue loss.  Also,  to some degree buyers have switched to low-end laptops, which carry higher revenue and profits for both MSFT and INTC.

Macs are a factor, but not the key one, in my opinion.  Macs are growing much faster than the overall PC industry.  They use INTC chips but the AAPL operating system.  However, although Macs represent over 10% of the PCs sold in the US, they’re less than 4% of the world’s unit purchases.  Yes, they’ve been gaining half a point to a point of market share per year, but that probably means less than a 1% unit volume increase for INTC.

The MSFT management didn’t respond to an analyst’s question about piracy, which, in my experience, is rampant in the Pacific.  My guess is that non-branded “white box” computers with unauthorized copies of Windows software are a big part of the difference between MSFT’s experience and INTC’s.  There’s no way of knowing for sure, though, so MSFT’s judgment not to broach the topic is probably its best tack.

One other interesting MSFT management comment about INTC:  The MSFT CFO suggested that maybe the biggest reason for INTC’s good results was its ability to raise prices.  Although he didn’t say this, what seemed to me to be implied is that INTC can raise prices in a way MSFT can’t.  In other words, through constant innovation in chip size, speed, power consumption, INTC has a better value proposition for customers than MSFT does.  I think that’s right, but it’s funny to hear it from the lips of MSFT.

the stock

MSFT is guiding to a 4Q11 about in line with results from 3Q11.  This would bring full-year results to about $2.60 a share.  I think we’ve already seen the crest of the current product cycle with the launches of Windows 7 and Office 2010.  So fiscal 2012 will likely show eps growth at a much slower pace than the likely 24% gain this year.  Let’s pencil in 12%.

If so, the stock is trading at about 9X forward earnings, has net cash of around $4.50 a share, generates free cash flow and yields about 2.5%.  That looks cheap to me.  It’s hard to figure where the upside is going to come from, though.  Certainly, there are isolated interesting products, but I’m not sure there’s anything big or dramatic enough to move the needle for a giant like MSFT and engage investors’ imaginations. So value-oriented investors, the prime potential buyers of MSFT, may well worry that the stock will remain the “value trap” it has been for the last decade.




Next Page »

Enter your email address to subscribe to this blog and receive notifications of new posts by email.

Join 58 other followers

Categories

Subscribe to my RSS feed–Click on line 3

SiteMeter

practicalinvest

Follow

Get every new post delivered to your Inbox.

Join 58 other followers