Monthly Archives: August 2017

conglomerates

August 10, 2017 By in conglomerates, Uncategorized Tags: 2 Comments

Conglomerates

…are collections of businesses, often with little operational connection with one another, linked together by common ownership.  Outside the US, the controlling entity typically exercises its influence by taking large minority interests in the subsidiary firms;  in the US it’s more common that the controlling entity owns its subsidiaries entirely.

The former structure allows greater reach; the latter makes it easier to dividend cash from one arm to another without incurring tax.

the conglomerate era

Looking back, it’s often strange to see investment suppositions that, to us, are patently crazy but which investors of another era held as gospel.

In particular, there was a conglomerate “era” in the US during the 1960s.  This was a time when Wall Street thought that there is such a thing as “pure” management, which could be applied by expert practitioners to all kinds of businesses, no matter what they were.   So, a management expert could run, say, a movie studio without knowing anything about entertainment, or head a department store chain without knowing anything about fashion or real estate or retailing, or a lead computer chip company without knowing anything about coding or chip fabrication or materials science.

What were these “pure” management skills?  Allocation capital was one.  Your guess is as least as good as mine about any others.

During that period–a decade before I entered the stock market, so I’ve only read about it–conglomerates traded at a premium to the sum of their parts.

Maybe 1950s-style conglomerates made some sense.  I don’t know.  But their executives soon worked out that they could use debt to make acquisitions that would give a (temporary) boost to ep that would get their firm a higher earnings multiple.  So companies like Gulf and Western, ITT, National Student Marketing and Textron turned themselves into M&A machines.  As long as investors believed in the supposed alchemy of management, the worst low-PE dross a conglomerate held its nose and acquired, the greater the gain from multiple expansion when those earnings came under the conglomerate umbrella.

This all ended in tears in the late 1960s, through a combination of higher interest rates, the dead weight of senseless acquisitions,and the inability of conglomerate managers to improve businesses they owned but didn’t know the first thing about, that caused the conglomerates to crater.

today’s view

Today’s view is that conglomerates should trade at a discount to the sum of their parts.  It has its roots–not in the companies per se–but in the idea that investors want to fashion portfolios for themselves, not buy pre-assembled packages.  Off-the-rack conglomerates should be worth less than bespoke portfolios.

One of my favorite examples of this belief (which I think is basically correct) comes from one of the old opium trading companies in Hong Kong, Swire Pacific.  At one time, Swires was a property development company + an airline.  The first component is income-oriented and buttressed by a steady stream of rental payments.  The other is a highly economically-sensitive industrial.

Income-oriented investors, the argument goes, must be compensated through a lower overall PE for having to hold the airline component of Swires they don’t really want.  Similarly, more adventurous investors have to be compensated for being stuck with an income vehicle they don’t want.

Therefore, the parts separated should be worth more than the two together.

In fact, when Swires announced it would seek a separate listing for Cathay Pacific, the stock rose by 40%.

 

Tomorrow, Disney as a conglomerate.

 

 

 

 

selling: average cost or specific shares?

August 9, 2017 By in ordinary income vs. capital gains, securities markets, Securities regulation, taxes, Uncategorized Tags: , , , , Leave a comment

I’ve had a Fidelity brokerage account for a long time.  I’ve been relatively happy, with only two complaints:

–The first is a “just me” concern.  The Hong Kong stocks I own are always mispriced, except during Hong Kong trading hours.  Other than when that market is live, prices are typically two days old.

I’ve discussed this numerous times with Fidelity representatives (who probably think:  “Oh, him again!”);  I’ve also mentioned this in many surveys I’ve filled out over the years.  Apparently, it isn’t important enough to fix.  Every once in a while a Fidelity trader will advise me to trade these shares on the OTC market in the US, where they will be priced in my account, if accurate quotes are so important.  I don’t see the advantage for me, since my experience is that in times of stress US volumes for stocks like these evaporates.   In such circumstances, my observation is that prices can easily be 5% -10% less favorable in the US than in Hong Kong.  They’re also cheaper to trade in Hong Kong, too, but that’s a lesser issue.

 

–The second is more serious.  For some years, brokers have been required to report gains an losses from trading in taxable accounts to the IRS.  Determining selling price is straightforward.  The default option Fidelity uses for the cost of the shares sold, however, is the average price paid for all the shares in the position.

This is apparently the easiest thing for Fidelity to deliver.  But it’s not always the best for the client.  And the layout of the Fidelity online trade ticket doesn’t really highlight this important issue.  Unless you click on the expanded ticket link at the bottom of the form, you won’t be able to specify the tax lots that will be sold.

What is this about?

Two considerations:

–gains from stocks held for a year or less are taxed as ordinary income;  gains on stocks held longer than that are taxed at the (lower) long-term gains rate (more information from Turbotax).  So all other things being equal, it’s better to recognize a long-term gain than a short-term one.

–I generally try to sell my highest-cost shares first.  This results in recognizing the largest loss or smallest gain.  A net loss can have a tax value (see the Turbotax link above); subject to the holding period rules, the smallest gain should also mean the smallest income tax payment.

An example:

Suppose I hold 100 shares of JPM that I’ve bought at $50 and another 100 at $80.  Both lots are short-term.

I decide to sell 100 shares and net $9000 for them.

If at the time of sale I specify the shares with the $80 cost, my taxable gain is $1000.

If I specify the $50 shares, my gain is $4000. (I would probably only do this if I expected to offset this gain with a loss from other stock sales or from losses carried forward from prior years.)

If I let the Fidelity computer do the work, my capital gain is $2500.

 

If I’m in the 25% tax bracket, my income tax on the sale will be $250, $625 or $1000–depending on how I handle my cost basis.

 

Yes, I’ll likely sell the remainder of the position eventually, so I’m only postponing tax by choosing the highest cost shares.  Even so, in the meantime I have more money to put back to work today if I minimize current taxes.

 

 

 

“Value Loses Shine in Torrid Growth Era”: WSJ

August 8, 2017 By in Uncategorized Leave a comment

 

That’s the title of an article I read in yesterday’s print edition of the Wall Street Journal.

I perked up immediately.  This is the kind of headline professional investors dream of.  The only better one would have been “Death of Stocks.”  Such dramatic headlines typically come only after a certain trend (here, growth investing) has had a years-long favorable run.  Newspaper acknowledgement of the validity–and likely continuance–of the trend very often heralds its imminent reversal.

The analogous time implicitly invoked by the word “Era” is of the late 1999s, when a several-year string of underperformance by value led to massive withdrawals from value-oriented mutual funds and the cashiering of their managers.  Many of the latter group, out of necessity, formed hedge funds–which prospered fabulously as the great value market of the early 2000s unfolded soon after.

What’s disappointing about this case is that the article which accompanies it, there’s very little support for the thesis proclaimed in the headline.  In fact, the headline has been changed to the less jazzy “Hot-Stock Rally Tests the Patience of a Choosy Lot:  Value Investors.”

Still, the facts are interesting:

–from 2012 through 2014, growth stocks and value stocks, as measured by their Russell 1000 style indices, performed in lockstep

–from 2015 through the election in 2016, growth outpaced value.  But the performance gap closed almost completely after the Trump victory

–so far in 2017, the Russell 1000 Growth has risen by almost 17%, while the 1000 Value is up by just under 5%.  So the 1000 Growth “era” has really only been going on for about seven months.

…so, a tempest in a teapot.

Also worthy of note:

–State Street Global Advisors got themselves quoted as declaring, in defiance of the numbers, in my view, that the past ten years have been the worst period for value investing “since the late 1940s.”  I have no idea what counted as growth back then and the Russell indices certainly weren’t around, so I’m not 100% sure how to assess the claim.  Can that period have been worse for value than 1995 – 1999, when the 1000 Value gained 133% while the 1000 Growth soared by 312%, a performance gap of 179 percentage points in five years?

–if the WSJ chart contained in the article is correct, the relative performance of value and growth portfolio managers has been substantially different from the action of their benchmarks–implying that growth investors are less growthy, and value investors less valuish, than their names imply.

My bottom line:  searching for a stable point about which to anchor my portfolio tactics, I was hoping to find a leverage point in journalists’ sentiment.  But this seems like a false alarm to me.

Note:  regular readers will know that I’ve been arguing for several years that the internet has deeply undermined the tenets of Graham and Dodd value investing.  Still, I think there will be times in equity investing where valuation will be the primary concern.  I think we’re in one of those now, although I have no firm idea on how, if I’m right, this will play itself out near-term trading.

when is a sale a sale?: the EFII case

August 7, 2017 By in Accounting, recognizing revenue, Uncategorized Tags: , , , , , , Leave a comment

On Thursday, Electronics for Imaging (EFII), a copier company I knew well twenty years ago, issued a press release which it filed as an 8-K with the SEC.  The release reads in part:

“Electronics For Imaging, Inc. (Nasdaq:EFII), a world leader in customer-focused digital printing innovation, is postponing the conference call at which it anticipated discussing second quarter 2017 preliminary results in order to enable the Company to complete an assessment of the timing of recognition of revenue. The assessment is related to certain transactions where a customer signed a sales contract for one or more large format printers and was invoiced, and the printer(s) were stored at a third party in-transit warehouse prior to delivery to the end user.

In addition, EFI is in the process of completing an assessment of the effectiveness of EFI’s current and historical disclosure controls and internal control over financial reporting. EFI expects to report a material weakness in internal control over financial reporting related to this matter. EFI also expects to report that EFI’s disclosure controls were not effective in prior periods.

The Company currently expects that the total aggregate revenue for the periods under review will not be materially different from the aggregate revenue that was previously reported for those periods, taking into account any revenue from the prior periods that may be moved into the current or upcoming periods.”

The stock lost 45% of its market value in Friday trading.

What’s this about?

While the situation is still pretty muddy, the basic issue is what counts as a sale–how an order for a company’s products ends up being counted as revenue in the company’s income statement.

In the case of large, expensive precision equipment (think: multi-million dollar semiconductor production machines), an order doesn’t become a sale until the unit is delivered to the plant and is installed and working to the satisfaction of the receiving company’s engineers.  This process can take weeks from the time the equipment leaves the factory.

For just about everything else, an item is considered sold the second it leaves the factory–whether in the mail or a UPS van, or in a truck owned by either party to the transaction–and a bill is sent.  Initiating delivery allows the sender to book the associated revenue on the income statement.  (Returns?  Companies typically reduce reported revenue by an estimate–based on their past experience–of likely returns.  The estimate is usually not disclosed.  Returns only become an issue if they’re much larger than the return provision.)

 

In the EFII case, in contrast, it sounds like items were shipped, a bill was sent and revenue was recorded on the income statement, even though no one had actually ordered the shipped merchandise.  The merchandise was then held in a third-party warehouse until an actual customer order came in–at which point the items were shipped.

 

Why do this?   …to make current earnings look better than they actually were.

What’s still unclear:

–who knew about this

–how long the practice was going on

–how large the phantom sales had grown

–how it was discovered.

 

The press release, which I’m regarding as having been carefully crafted by EFII’s lawyers, suggests to me that the revenue overstatements:

–have been going on for a long time (“controls were not effective in prior periods”), and

–the amounts involved may be large (“revenue from the prior periods…may be moved into…upcoming periods” (emphasis mine)).

Yes, the warehoused merchandise may eventually be sold (that’s my reading of the third press release paragraph above).  The biggest issue for investors is that the company may have been overstating its growth rate for some time through phantom “sales.”

 

 

Employment Situation, July 2017

August 4, 2017 By in employment, Employment Situation report, Uncategorized Tags: , , , , , Leave a comment

This morning the Bureau of Labor Statistics released the latest monthly installment of its Employment Situation report, a long-standing series that monitors the state of the labor market in the US.

The report, a compilation of data from a large number of employers around the country,  estimates that a total of +209,000 new jobs were created last month (I’ve corrected a typo from an earlier version of this post).  Revisions to the prior two months’ data added another +2,000 new positions to that.

The unemployment rate came in at an ultra-low 4.3% of the workforce.  This figure is in line with recent experience, but one which would traditionally be regarded as indicating full employment plus a lot (the idea being that there’s a certain level (4.5%?) of frictional unemployment, basically people quitting one job to take another but not having yet started).

 

In the past, reaching full employment has also made itself known by accelerating wage gains, as employers bid up the price of the additional workers they need and raise wages all around for existing employees to ward off job poaching from rivals.

In perhaps the most perplexing aspect of this recovery, however, there’s still no sign of wage acceleration.  Wages are rising by a tad more than inflation but the rate of growth has remained steady at about 2.5%/year for a long time.

Although the +220,000 figure is 20% higher than the consensus guess of Wall Street economists, the stock market is regarding the ES with a shrug of the shoulders.  Only a sharp uptick in wage growth will make an impact (probably negative, at least at first) on stocks and bonds from this point on.