the FINRA Guide to Understanding Analysts’ Recommendations

Yesterday someone sent me a link to Understanding Securities Analyst Recommendations, written by the Financial Industry Regulatory Authority (FINRA), the brokerage industry trade organization.

The short article is surprisingly candid and contains important information, although couched in very abstract language.

The highlights (paraphrased by me):

–brokerage house analysts, and the brokerage houses themselves, are subject to enormous potential conflicts of interest when it come s to saying what they think the future performance of a given stock may be.  For instance, –a company may select a brokerage house for lucrative investment banking business based on how favorably the firm rates its stock

–conversely, it may refuse to give corporate information to analysts who rate the stock unfavorably.  The company may “forget” to return phone calls, avoid appearing at conferences sponsored by the analyst, refuse to appear with the analyst at public or private investor meetings, or not acknowledge requests for information from institutional investors that are directed through the offending analyst.  The company may even more overtly try to get the analyst fired.

–very large money management companies may build up gigantic positions in the stock of a given company.  Powerful portfolio managers may have large stakes riding on the stock’s performance–and the positions may well be too big to sell quickly, in any event.  So they may pressure brokers and their analysts to maintain a favorable opinion on the stock.  Their threat–to withhold trading commissions from a firm that downgrades the stock.  Same thing about firing the analyst, too.

–as a result, the terms brokers use to rate stocks may not be self-evident.  “Buy,” for example. may not be a particularly good rating.  “Strong Buy” or “Conviction Buy” may be what we’d ordinarily understand as”buy.”  “Buy” may be closer to “Eh” or “Hold.”  Of course, analysts may also have one official opinion in writing and another that it expresses verbally to clients.

Two other worthwhile points the article makes:

–some analysts may not be highly skilled, so their recommendation may not be worth much.  Rookies may not have enough experience, for instance, and they may be more susceptible to outside pressure than others.  Analysts may not know a spreadsheet from a hole in the ground but have the ear of management.  (Oddly, old-fashioned managements continue to give information to favored analysts that they deny to shareholders.)

–the fact that a portfolio manager owns a stocks, even if it’s a large position and if his analyst appears on TV saying positive things about it, the manager may hold the stock for completely different reasons (more on this tomorrow). Anyway, the FINRA page is well worth reading.

2Q14 results for Wynn Resorts (WYNN) and Wynn Macau (HK: 1128)

it’s been same old, same old for the big casino operators…

I haven’t written about WYNN and its subsidiary Wynn Macau (1128) for a while.  That’s mostly because I perceive the company to be in a holding pattern.  It has two casino operations:  Las Vegas and Macau, the latter through 72%-owned Wynn Resorts.

–In Las Vegas, all the major casino resort operators, WYNN included, upped their operating leverage by opening big new casino and hotel capacity in 2007-08, just as the recession was unfolding.  Demand dropped through the floor.    Profits disappeared faster.  Results since have been consistently weak as the casinos wait for demand to pick up and/or for weaker entries to close up shop.

–In the Macau market, which is now many times the size of Las Vegas, 1128 has been capacity constrained for some time.  Its next expansion, the Wynn Palace, isn’t slated to open until early 2016.

…until now

Las Vegas

For WYNN, the near-term story is Las Vegas.  And the change is for the better.  Room revenues in 2Q14 were up by 7.3% year-on-year in the quarter.  Average room rates rose to $283, up from $268 in 2Q13.  Occupancy increased from 88.4% from 86.9%.  To my mind, the room rate rise is a particularly important indicator of increasing demand.

In addition, the amount bet at WYNN’s Las Vegas tables was up by almost 15%, year-on-year.  The company’s win percentage was an unusually high 27.4%. vs.  the company’s expected range of 21% – 24%.  In all likelihood, the “extra” win from this quarter will be offset by sub-par “luck” in coming periods.  But, again, the more interesting number is the sharp jump in table games betting.

Slot machines were flat.

Management said on the earnings conference call that the 2Q strength was continuing into 3Q.


In Macau, the individual pluses and minuses for 1128 may be a little different, but the near-term profit profile–flattish–remains the same.

Overall market growth in Macau has slowed as an economic lull in China and Beijing’s anti-corruption campaign have tempered VIP’s  enthusiasm for high-stakes gambling.  This has been offset by a sharp jump in visits by the mass affluent, who–unlike their high-roller counterparts–are more concerned with being entertained than at winning a lot at baccarat.  They also want to eat, shop and go to shows.  So from the casinos’ point of view, they’re great customers.

While it waits for the new capacity the Wynn Palace will bring, 1128 is refurbishing its existing hotel and casino spaces.  It’s also raising salaries considerably, both to reinforce its reputation for superior service and to retain staff.  While these actions may make profits a bit weaker than they would be otherwise, it makes sense to use the current lull to set the stage for stronger growth in a year or two.

my take

WYNN has a market cap of $22 billion.  Its stake in 1128 is worth $16 billion, meaning that Wall Street is valuing the Wynn name, Las Vegas operations, royalties from Macau and the potential of future casino development in, say, Japan, at $6 billion.  That’s roughly 25x earnings.

WYNN shares yield 2.3%, 1128 about double that.

Last year, I sold the 1128 I had held since just after the IPO, partly because my casino holdings had become too large a part of my portfolio, partly in anticipation of the current fallow time.  I’m beginning to think about buying it back.  But I’d prefer to do so in the mid- to high-HK$20s.  Rightly or wrongly, I think I have time before the market begins to discount the opening of the Wynn Palace–with a presumed strong profit upsurge–in 2016.

I bought a lot of the WYNN I hold during the market collapse in early 2009.  I may be influenced by the tax I’d pay if I sold (I hope not, because this is virtually always a bad way to think), but I’m content to collect the dividend while I wait for Las Vegas to recover and the Wynn Palace to open.  To me it sounds as if the first may already be happening, which would be good news for WYNN shares.

What would I do if I owned nothing in this sector?

The least risky thing to do would be to buy a small amount of either WYNN or LVS and try to add on weakness.  LVS has the better near-term profit profile; WYNN has the better management, in my view.  Their valuations are similar, although their business models are a bit different.  LVS runs convention hotels; WYNN focuses on the high-roller niche.  (I own both.)

The most attractive firm I see at the moment is Galaxy Entertainment.  It’s a Macau-only operator and trades either in Hong Kong, or on the pink sheets–so it’s riskier than the other two.









Amazon’s no-show profits

Amazon’s 2Q14 results

When Amazon (AMZN) reported 2Q14 results last Thursday, not only did the company post a bigger operating loss than anticipated but it said that the 3Q14 red ink would dwarf the 2Q14 actuals.

The news came as a surprise  …and not one that Wall Street took favorably.  The stock dropped 11% in Friday trading.

At the same time, the news media were filled with red-faced portfolio managers and analysts complaining that Jeff Bezos should be more sensitive to their need for more robust profits, which–allegedly–would make the stock go up.

To me, this is a case of being careful what you wish for.

Let’s do some back of the envelope calculations to see why…

is AMZN’s valuation reasonable?

The analyst consensus is that AMZN will earn around $2 a share in 2015.  That’s a forward PE of 160x.  How could anyone pay that price to own a share of any company?  For someone who holds AMZN, he must be thinking something like this:

–the company consists of a US business that makes a considerable profit and a foreign one that is flirting with breakeven.  If we assume that foreign operations can equal the US in size and profits at some point, then that $2 a share will sooner or later become $4 a share at some point.  On this basis, the multiple is “only” 80x.

–the company spends a lot of money on computer software.  In a very real sense, this is capital spending.  That is to say, as is the case with any capital asset, the expenditure on software should arguably be registered on the balance sheet and written off bit by bit against revenue over the lifetime of the programs.  Because of past accounting abuses, however, programming costs are recognized as expenses immediately, even though the programs may last a long time.  This depresses current income.

AMZN also writes off startup expenses for new ventures right away. This is a conservative approach, but it also depresses current income.

To pluck a figure out of the air, if AMZN were less conservative and if it could treat software costs as capital items, $4 would be $8–and the future PE multiple is a “mere” 40x.  That’s too rich for my blood, but it’s not absolutely crazy, provided AMZN continues to grow.

what will likely happen if/when AMZN’s profits start to surge

What would it mean if AMZN began to show large amounts of current income?

The most likely scenario–and the one pms and analysts are calling for–would be that the company is no longer incurring software creation expense and  hefty startup costs for new ventures.

…in other words, it would imply that AMZN had run out of growth opportunities!  Surging profits imply AMZN is going ex-growth.

In my experience, there are few things worse, in stock market terms, than holding a growth stock that has suddenly gone ex growth.

In my judgment, a +30% increase in earnings by AMZN would be accompanied by a gigantic price earnings multiple contraction.  A halving of the PE would be my best guess.  If that’s anywhere near correct, the end result would be a loss of a third of AMZN’s market value.

As I said above, be careful what you wish for.  It also strikes me that the Wall Street complainers have no clue about the kind of stock they’re dealing with.



economist Edmund Phelps on inequality

Last Friday, Edmund Phelps ,Nobel Laureate in economics and professor at Columbia, wrote an op-ed column in the Financial Times that addresses the topic of the day since the publication of Thomas Piketty’s Capital in the Twenty-first Century–namely, inequality.

Professor Piketty’s argument (see my earlier post on Piketty) is as follows:

–empirical evidence shows (although the FT has subsequently written a front-page article alleging serious errors in Piketty’s data) that over the past fifty years the percentage of total wealth in developed countries that’s in the hands of the super-rich has increased

–this is a straightforward result of capitalism at work,

–it’s unfair, and

–the best (only?) way to fix the problem is to tax the wealthy heavily and redistribute the proceeds to the rest of us.

Professor Phelps, who got his Nobel Prize for his work on entrepreneurship, begs to differ.  His points:

–strong increases in productivity, e=leading to robust economic growth, have been a hallmark of capitalism since its inception

–the innovative spirit of entrepreneurs has waned since WWII, causing the low-growth environment we’re in now–and the consequent concentration of economic gains in the hands of the wealthy.  It’s harder today to become wealthy.

–this is not the result of capitalism, but of corporatism.  As Phelps puts it, in the name of solidarity, security and stability, “Politicians have introduced regulation that has stifled competition; patronized interest groups through pork-barrel contracts; and lent direction to the economy through industrial policy.  In the process, they have impeded those who would innovate, or reduced their incentive to try.”

–in addition, in an attempt to secure their own personal fortunes, corporate CEOs have become obsessed with short-term results, eschewing innovation in favor of immediate stock price rises.  The obsession with wealth for its own sake is a sickness, which is doing grave damage to overall growth prospects.

In Phelps” view, egalitarians like Piketty have fundamentally misassessed the malady affecting mature western economies.  More than that, their policies are actually causing what’s wrong.  Raising tax rates on the income of entrepreneurs who are lucky enough to become very wealthy won’t restore dynamism to the US or EU economies.  Quite the opposite.  And increased dynamism is what the west needs to restore lost productivity growth.

my take

Personally, I’m skeptical of analyses that boil down to following a single principle, whether it be “leave entrepreneurs alone” or “redistribute the wealth.”

I also think that in order to survive in French academics you have to end up with the kind of conclusion Piketty does–that France is the high point of modern economies and that it can only be improved by having more of the same.  I also don’t have a great deal of faith that the extra taxes would end up being put to productive use.  And the exodus of entrepreneurs from France since the Hollande administration took office gives a hint of what effect higher taxes will actually have.

So, although I think there are serious issues with hereditary wealth and I don’t think nineteenth-century capitalism is the way to go, I’m with Phelps on this one.



Kindle Unlimited: publishers as collateral damage?

At one time there was only the Kindle.

Then came the Kindle Fire and Amazon Prime.  Now there’s the Fire phone and Kindle Unlimited–all five programs (along with a bunch of smaller ones) launched by Amazon (AMZN) to bind customers ever closer to the shopping service and get them to buy more stuff through it.

For AMZN, it’s not that important that any of these be moneymakers straight out of the box.  That can always be straightened out later, when the customer has been transformed from a buyer of X who happens to use AMZN to an AMZN customer who happens to want to buy X.

Kindle Unlimited, the just introduced subscription service for e-books and audio-books, is a particularly interesting instance.  That’s because it may end up being the tipping point in AMZN’s favor in its long-running battle with the five big publishing houses for control of the English-language book reader.

Another intriguing aspect of Kindle Unlimited is that AMZN has more relevant information, I think, than any other party at the table–but it isn’t talking.  So analysts, both the Wall Street kind and the planners inside the publishing companies, have less than normal to work from as they create their castles in the air.

Here’s how I view the situation:

1.  For $9.99 a month–about $120 a year–Kindle Unlimited lets subscribers read as many e-books as they want, from a collection of over 600,000, as well as to listen to as many Audible audiobooks, from a list of “thousands.”

No titles from the big five publishing houses are included, although, for example, all the Harry Potter books are.

The rollout of KU suggests that the very public spat between AMZN and Hachette, the smallest of the big five, may have been aimed at persuading Hachette to take part.

2.  Most industries exhibit a “heavy half.”   The idea is that, say, 20% of the purchasers buy a huge amount, usually put at 80%, of the stuff.  For e-books, only AMZN knows what the exact proportions are.  My guess is that heavy users easily spend $50 a month ($100+?) on e-books.  For them, signing up for KU is a no-brainer.

3.  It seems to me that KU users will dig deeper into “free” content in the 600,000 titles instead of buying expensive bestsellers launched by the big five.  Presumably, AMZN has surveyed the heavy half, and maybe even run small tests to figure out what will likely happen.  Certainly AMZN must believe that KU will redirect a lot of e-book use away from the big five and toward AMZN self-published content, or content from smaller presses that may sign up.

4.  Until yesterday, I hadn’t looked at AMZN’s financials for years.  From my perusal, I’ve decided, for no particularly good reason, that AMZN makes $60 million in operating profit per quarter from e-books in the US.  The company could easily let that drop to zero, as sales of high-priced best sellers wane. However, AMZN seems to be indicating–who knows whether bluster or not–that it is willing to go deep into the red to get KU off the ground (remember, AMZN is generates about $5 billion in yearly cash flow, so it can afford to lose money on KU for a l-o-o-ng time).  Last night it guided to a possible operating loss of over $800 million for the coming quarter.

5.  The big five could be squeezed in a number of ways.  KU users switch away from them, constricting their cash flow.  Fewer pre-orders from KU users would mean new titles fall off the bestseller lists, hurting sales further.  Authors complain about diminished royalty payments and ponder self-publishing through AMZN themselves, where, for sales in the US, the author receives 70% of the sales price vs. 25% from the big five.

6.  AMZN has lots of customer information; the publishers probably have much less.  Therefore, this negative money cycle may end up being much larger than the big five anticipate.  One or more may break ranks.

It will be interesting to see how this plays out.



new money market fund regulations

Yesterday, the SEC announced new rules for US money market funds, which in the aggregate hold $2.6 trillion in investors’ money.  Of that amount, two-thirds is in funds catering to institutions and high net worth individuals; one-third is in funds serving the mass market.

Why the need for new rules?  

Two reasons:

–today’s aggregate money market assets are large enough to be a risk to the overall financial system if something goes badly wrong, and

–the funds are typically sold as being just like bank deposits, only with higher yields.  However, like most Wall Street claims that  “x is just like y, only better,” it’s not really true.  The differences only become important in times of market stress, when normally sane people do crazy things, and when “yes, but…” is a sign for panic to begin.  So there’s a chance that “badly wrong” can happen.

The differences?    …bank deposits are backed by government insurance that insulates depositors from investment mistakes a bank may make.  Also, the Fed stands ready to rush boatloads of cash to a bank if withdrawals exceed the money a bank happens to have on hand.  Money market funds have neither.

Yet many holders are unaware that it’s possible for a money market fund’s net asset value to fall below the customary $1.00 per share, or that a fund might be overwhelmed by redemptions and forced to sell assets at bargain-basement prices to meet them.

the fix

Fixing this potential vulnerability has two parts:

–giving the finds the ability to halt or postpone redemptions during financial emergencies, and

–requiring funds to have floating net asset values, not the simple $1.00 a share.  This would mean marking each security to market every day.  …which would likely require hiring a third-party to price securities that didn’t trade on a given day.

The first of these would avoid the government having to step in the case of a run on a fund.  The second should reinforce that money market funds aren’t bank deposits.

the new rules

Of source, the organizations that sell money market funds have been strongly opposed to anything that would ruin their “just like…, but better…” sales pitch.  Their lobbying has blocked action for years.

So it should be no surprise that yesterday’s SEC action was a compromise measure:

–all funds will be able to postpone redemptions in time of emergency, but

–only funds that cater to big-money investors will have to maintain a variable NAV.

Personally, I don’t understand why money market funds that serve ordinary investors should be exempt from having to calculate a true daily NAV.  You’d think that this is the group that most needs to understand that the (remote) possibility of loss is one of the tradeoffs for getting a higher yield.  Arguably, sophisticated investors already know.  But the financial lobby is incredibly powerful in Washington, and this may have been the price for getting anything at all done.



earnings calls: Apple (AAPL) vs. Microsoft (MSFT)

Last night after the market close, AAPL reported earnings per share that beat the consensus of Wall Street analysts–and the stock went down in the after-market.  MSFT, in contrast, reported results that fell short of analysts’ estimates–and the stock went up!

What’s going on?

AAPL gave next-quarter guidance that fell below Wall Street’s projection–but it always does this, so that’s not the reason.  MSFT’s income statement looks better after factoring out the large operating loss generated by Nokia, but I don’t think that’s the reason for the market’s positive response, either.  After all, if you wanted to (I didn’t), you could have gotten a reasonable guess at how much Nokia would subtract from the MSFT total from Nokia’s recent results as a stand-alone company.

I think the market’s response is much more a a conceptual response.

Tim Cook has made it clear that AAPL is a manufacturer of high-end mobile consumer technology.  There’s no “next big thing” on the horizon, however, with only a periodic refresh of the company’s smartphone line due any time soon.  If reports from suppliers are accurate, new offerings will include a phone with a large, Samsung Galaxy-matching screen size, and a(n even larger) tablet/phone.  For Jobs-ites, this departure from Steve’s view that phones should be small enough to operate with one hand may be earth-shaking.  But for the rest of the world, this is only catching up to what Samsung already has on the market.  So a ho-hum Wall Street response is appropriate.

For MSFT, on the other hand, the news is relatively better.  The company seems to have a focus for the first time in a long while.  The fact that Nokia is putting up operating losses at a near-$3 billion annual rate seems to me to justify the downsizing MSFT has recently announced.  The only surprise is that this wasn’t started sooner.

Leaving the X-Box content creation business is probably more symbolic than anything else, but it removes a potential distraction–especially given the continual mess the company has typically made of its game software development efforts.

One, admittedly small, figure what caught my eye was that MSFT has added another 1,000,000 individual/small business users to its Office 365 rolls during the June quarter.  I think this just shows the power of the cloud–easier administration, much lower cost-of-goods expense, and hugely better protection against counterfeiting.

For MSFT, then, the earnings were nice, but the fact that the company’s board is allowing significant changes is nicer.  True, the message may turn out only to be that the company will try harder not to shoot itself in the foot again, but even that’s an uptick.  Hence the positive market response.  Absence of missteps won’t be good enough for long, but it’s ok for now.