Category Archives: growth vs value

stocks were “unusually highly correlated” last year–meaning? implications?

January 21, 2014 By in Constructing a Portfolio, from growth to value: the life cycle, Portfolio management, Shaping a portfolio for 2014, stock market, Strategy Tags: , , , , , , , 1 Comment

A number of brokers have pointed out in their yearend reviews of the US stock market that stocks were unusually highly correlated with one another last year.  What does this mean?

Think of a stock as an abstract thing, as a bundle of different economic attributes or characteristics that you get when you buy it.  Some of these attributes–like that you get an ownership interest in a corporation that aims to make continually growing profits–are common to all stocks.  Others–that the underlying company you own an equity interest in makes yoga pants, mines gold, or sells online advertising, and grows faster/slower than most–are specific to that stock.

The “highly correlated” observation means that, much more than usual, what counted in 2013 was the fact the thing you own is a stock; its individual characteristics didn’t make much difference.  Check out my Keeping Score for December 2013 to see how closely aligned the performance of various industry groups was last year.

Note how clustered together the various sectors are around the S&P.  In simple terms, an investor got +30% just for owning the S&P 500.  He got an extra 8 percentage points for selecting Healthcare, and he lost 7 if he picked Energy.  But neither decision meant anything close to as much as just being in stocks.

Yes, there were two truly poisonous sectors, Telecom and Utilities, which just barely made it into the plus column for 2013.  These two sectors together make up only about 5% of the S&P, however.  So from a statistician’s point of view, they’re irrelevant.  That’s cold comfort for someone who bet the farm on either sector last year, although I think you’ve got to admit that being absent from 95% of the market is an extremely risky thing to do.

Tomorrow:  why is the 2013 outcome is strange.

Apple (AAPL) today

January 16, 2014 By in from growth to value: the life cycle, growth vs value, Recent Market Action, Stock ideas, Technology, Wireless Tags: , , , , Leave a comment

the stock vs. the company

the company

As a company, Apple has in most respects followed the typical pattern for businesses of high-flying growth stocks.

The company stabilized itself as a computer maker, after a brief flirtation with bankruptcy, with the return of Steve Jobs as CEO.  It took a chance on making the iPod, which a geeky DJ apparently brought to it.  That produced a series of big profit increases that lasted several years and doubled this size of the company.  Just as the iPod wave was cresting, Apple reinvented itself again, as the iPhone company.  Another huge profit surge followed, which crested as the global market for expensive smartphones matured.

Yes, Apple has reinvented itself again as the iPad company, but each blockbuster must be progressively larger to move the profit needle for a firm whose income has grown exponentially over the past decade.  The iPad doesn’t have enough oomph to do so.  Heartless as it may seem, Apple has gone ex-growth.

Look at IBM, or Oracle, or Cisco, or Wal-Mart  …or, on a smaller scale, the Cheesecake Factory or Chicos or PF Chang.  Same pattern.

the stock

What has been strange about Apple has been the behavior of its stock.  Typically, as a company’s earnings begin to accelerate, the price-earnings multiple begins to expand as well.  So the positive effect of the earnings growth is magnified.  When (or just before) earnings growth beings to disappoint, as it sooner or later will the PE begins to contract.–and the stock plunges.  Timing this shift is the key issue for growth investors.

Not so much with AAPL.  Its PE peaked in 2008, four years prior to the peak in earnings (which were, by the way, almost 8x the 2008 level).  The multiple contraction has been pretty continuous, moving from 30x ( and 1.8x the market multiple) in 2008 to 12.3x (and a .7x relative multiple) for 2013.

an investment thesis

Growth investors, who are searching for the next AAPL, have abandoned ship andgone elsewhere, leaving the field to their value counterparts.

For value investors, I think the key question revolves around the PE.  When growth stocks fall from grace, the multiple typically contracts severely–and over a long period of time.  The decline ends in an overreaction on the downside.

Looking at AAPL,nine months of stock price pain (late 2012 – mid-2013) would be unusually short period of time.  But, then, the AAPL multiple has already been contracting for five years.

Although I’m not a value investor (read: although I’m no good at making these judgments), my sense is that the AAPL PE is too low.  I don’t feel an overpowering urge to buy the stock.  But 10% earnings growth + one point of multiple expansion this year doesn’t sound so bad, either.

 

 

 

can activists pay their nominees to target company boards? should they?

December 30, 2013 By in activist invstors, from growth to value: the life cycle, growth vs value, two flavors of value Tags: , , 1 Comment

Today’s Financial Times points out that 33 major American publicly traded companies have changed their bylaws to forbid board members from taking incentive payments keyed to the firm’s performance from third parties.

What is this all about?

In a sense, this is an aspect of the question of who really owns a company.  In theory, the owners are the shareholders and the company is run for their benefit.  As a matter of practice, most often the top management of the firm is in control.  It is usually happy with the status quo, and doesn’t typically stint on corporate jets, country club memberships and the like for themselves.

That’s where the board of directors comes in.  The board is elected by the shareholders to run the company.  It does so by appointing professional management to actually do the job, while it supervises, sets compensation and approves major decisions.  Control the board and you control the company.

A time-tested way for activist investors (a term which covers a whole raft of characters, from greenmailers and corporate raiders to more respectable operators who simply want to replace incompetent management) to influence the running of a company is through its board.  Activists often wage proxy battles to get their own nominees elected to the board by shareholder vote.  What better way, activists argue, to motivate such nominees to press for improved corporate performance than to pay them bonuses for achieving it?

The idea of activist investors compensating compliant directors potentially strengthens the activists’ hands in the three-way battle for company influence among:  management (which is virtually always backed 100% by individual shareholders, regardless of performance), institutional investors (who want strong stock performance but who suspect activists) and the activists themselves.

Personally, I think suspicion of activists is often warranted.  After all, look at what Bill Ackman did to JCP.  He erased a third of that firm’s revenues and all of its profits, and then sold his stock quickly–with board approval–at much more favorable prices than ordinary shareholders were able to achieve.  Thanks a lot.

So far, activists haven’t had much success with their pay-for-performance strategy, mainly because the incentivized nominees have lost in their board elections. But managements apparently see this tactic as enough of a threat to be quietly closing the door to it.

To me, the most interesting question is why activists feel the need to motivate their hand-picked board nominees with sizable amounts of cash.  From their rhetoric, it appears the answer is that their successful nominees quickly get used to receiving  hundreds of thousands of dollars for attending a few meetings a year, plus free use of the company’s jet fleet, free lunch   …and find the prospect of living the good life up much less appealing than they did when they were standing outside with their noses pressed up against the glass.

the inventory problem: holding costs vs. stockout risks

December 4, 2013 By in Inventory Cycle, inventory days, operating leverage, the inventory problem: stockout vs. carrying costs, working capital Tags: , , , , 1 Comment

The domestic auto industry reported November vehicle sales yesterday.  The numbers were very good.  But most of the (negative) media attention centered on the elevated level of inventories–about three months worth of sales–on dealer lots. Yes, that may eventually be a worry, but I don’t think it’s the right way to look at the current situation.

The auto news also gives me the occasion to write about the balancing act every manufacturer and retailer faces in deciding how much inventory to have.

the simplified story

There’s an often convoluted dance between supplier and distributor/end user about return policy, payment terms, co-op advertising…in negotiating over how much of a product to buy and at what price.  Nevertheless, the decision about how much inventory to hold ultimately comes down to weighing two opposing risks:

—stockout costs.  This is when your brilliant national advertising campaign, your sterling reputation for high quality and service–or sometimes just random factors–prompt a potential customer to either go online or enter a physical store with the intention of buying an item.

You’re out of stock.  You try to interest him in a substitute, or promise to have the item tomorrow.  He says thanks, leaves and buys the item somewhere else.

You’ve lost a sale.  And the person you’ve disappointed is at least marginally less likely to have you first on his list next time he’s shopping.

That’s stockout costs.

—inventory holding costs are much more straightforwardly quantifiable.

There are three main factors:

-financing costs, which in today’s world are negligible;

-liquidity risk of having your capital tied up in inventory rather than in cash during the time it tales you to make a sale; and

-the possibility that the items either become obsolete, go out of style, or–like fresh food–exceed their shelf life before they can be sold.  Then your asset has become a wirtedown.

complications

(In the stock market, there are always complications.)

In good times, companies want to hold more inventory (because they see stockout as a greater risk than holding costs); in bad times sentiment reverses and everyone wants to hold as little as possible.

If prices are rising, procurement managers see the chance to make windfall profits and order more than they need; if prices are falling–as is chronically the case in industries like consumer electronics–inventories are kept trimmed to the bone (except in really good times, when everyone throws caution to the winds).

In industries with low fixed, high variable costs, manufacturers see no percentage in upping production volumes.  In industries like autos, with high fixed costs and therefore tons of potential operating leverage, there’s a tremendous incentive to make extra units once a firm reaches breakeven.

The competitive structure of an industry doesn’t change the nature of inventory risk, but it can change who it is who’s assuming them.  This may not always be obvious from even a detailed study of the working capital sections of the balance sheet.  If a manufacturer were to have a policy of unlimited returns (that would be crazy, but let’s just suppose), then it–not anyone farther down the distribution chain–would ultimately be responsible for any unsold goods.

 

More tomorrow.

 

 

 

 

 

pining for inflation to return

November 15, 2013 By in Constructing a Portfolio, Current Market Thoughts, Dividend Discount Model, growth vs value, inflation vs deflation Tags: , , , , , , , , Leave a comment

background

Every macroeconomics student quickly learns the lesson of the Great Depression–that deflation (an environment where prices in general are falling) is the gravest ill that can befall a country.  Why?   …for companies, deflation means continuously declining revenues.  At some point, the firm can no longer meet its payroll.  Eventually, it can no longer service, much less repay, any borrowings it may have.  As the 1930s showed, deflation breeds widespread unemployment and corporate bankruptcies.

Second place on the list of bad things that can happen goes to runaway inflation (accelerating rises in prices in general), a malady common in emerging economies–and one the US experienced in the 1970s.  The issue here is that no one knows what interest rates in the future will be–only that they’ll be crazy high.  So no one, neither individuals nor companies, invests in long-term projects–because they can’t figure out whether they’re money-makers or not.  Instead, everyone starts to shun financial assets in favor of buying and hoarding tangibles like gold or real estate, sometimes in a completely loony way, on the idea that they will rise at lest in line with the soaring price level.

When the US began to fight its incipient runaway inflation under Paul Volcker in the early 1980s, the question arose among  academic economists as to what was the “right” level of inflation.  The consensus answer:  2%.  Not so close to zero as to say “deflation,” but low enough not to suggest “runaway.”

So 2% inflation became the holy grail of US, and global, monetary policy.  It took the US twenty years to hit this target.

the present

Over the past several months, I’ve been reading and nearing comments from lots of different sources that suggest that 2% may be the wrong answer.   Not the academic world, of course.  Two reasons:

1.  The Fed has been perplexed at its inability to keep inflation at 2%. The number seems to want to gravitate toward zero, instead.  This raises the specter of deflation, the sure-fire investment killer.  So this tendency is bad.

2.  For small businesses, which have been the biggest engine of economic growth in the US in recent decades, a 2% rise in prices + at best 2% real growth = a 4% increase in annual revenues.  The first objective for most family-owned firms is to make sure that this year’s profits won’t fall short of last year’s.  That’s because any shortfall is money out of their pockets, not simply a theoretical loss.  Apparently, +4% in revenues isn’t far enough away from zero to create enthusiasm for taking the risk of investing to expand the business.  Therefore, no capital projects, no new hires.

significance?

Two reasons are most often cited for the current slow growth in the US:  hangover from the Great Recession and dysfunction in Washington that prevents growth-promoting fiscal policy from being enacted.

I think a consensus is beginning to form that there may be a third culprit–an inflation target that has been set too low and which has inadvertently mired us in a kind of Bermuda Triangle monetary situation that  the Fed can’t extract us from by itself.

This implies fiscal policy may be the only cure for sub-par growth.  Therefore, ineptitude in Washington, even if that has been the norm forever, is no loner as tolerable as it has been in the past.

If this is so, growth stocks will continue to outperform value names in a slow-growth economy–unless/until fiscal policy gives a helping hand.