Category Archives: growth vs value

selling: different styles

August 10, 2015 By in bond market, Current Market Thoughts, from growth to value: the life cycle, growth vs value, securities markets, stock market Tags: , , , , , , Leave a comment

I’ve been thinking some more about what I wrote last week about selling in Disney(DIS) stock.  The thrust of my reaction to the sharp decline was, and still is, mild bemusement that selling only emerged as the company reported weak results from ESPN.  It’s not that disappointing earnings should not generate selling.  It’s that the handwriting had been on the wall about ESPN–and in vividly hued bold print–for some time before DIS’s 2Q15 earnings report.

Why no stock weakness earlier?  This would have been my strong expectation. I’m not talking about the results somehow being leaked to outsiders by the company.  Rather, I’d have thought that the market would have put two and two together and acted weeks or months ago on publicly available information about the cable industry–like Nielson reporting of subscriber losses at ESPN.

My conclusion was that the sharp fall in DIS shares on its earnings report might be evidence that Wall Street just didn’t know there were problems at ESPN, despite what I consider clear signals of trouble being visible for a considerable time.

I still think it is generally true that the stock market is becoming less efficient–and more like I perceive the bond market to have been throughout my time as an investor.

I’m no longer sure that DIS is evidence for my thesis, though.  Here’s why:

The key to successful investing in growth stocks is being able to sell them at the right time, meaning exiting as the firm is going ex-growth and before the rest of the world realizes this.

To me, the key signal is the breakdown of the conceptual “elevator speech” explanation of what gives the company in question its extraordinary growth potential.  In my experience, if we’re waiting for the first disappointing earnings report, we’re almost always hanging on too long.

The presupposition here is that the potential upside from my exit point is (far) less than the downside from being a holder of the stock when the disappointing earnings are released.  This assumes, of course, that I can recognize the point at which all the possible future good news–and maybe more than that–is already factored into the stock price.

My approach didn’t work so well for me in the case of DIS, where I failed to anticipate the fabulous success the company has had in its non-Marvel, non-Pixar movie business.

There is a second approach to growth stocks.  It argues that a well-managed company normally has more earnings growth tricks up its sleeve than any outsider is able to understand.  Therefore, it’s always too risky to sell when the conceptual story begins to unravel.  Better to wait for actual proof to come in through bad earnings.  Yes, one might lose 10% by selling after the bad report.  But that’s better than exiting at 40% below the stock’s peak.

In fact, I took this second approach myself, early in my investing career.

The difference in my thinking from last week and now:  my first thought was that information is not circulating on Wall Street as fast as it used to; my second thought is that investors may have the same information as always but they’re just using it differently.

Practical implications?  …they may be substantial.  My conclusion is still to look for more evidence.  My tendency is going to be to hang onto growth stocks for a bit longer than I might otherwise, though, figuring that others are going to do the same thing.   So the cost of waiting to find out if there’s another growth spurt left in a maturing company may be lower than it has been in the past. And I may no longer be committing the cardinal investment sin of underestimating the information the other guy has.

big day for Amazon (AMZN)–why?

July 24, 2015 By in Amazon, cloud services, Current Market Thoughts, Industry Analysis, internet, operating leverage, Recent Market Action, software, Stock ideas, Technology Tags: , , , , , , Leave a comment

AMZN reported 2Q15 results after the close last night.  They were very good.

Sales were up 20% year-on-year; expenses rose by 17%, three percentage points less.  As a result, the company reported an operating profit of $464 million vs. a loss in the second period of 2014.

More than that, AMZN’s cloud services division, AWS, had revenue growth of 81% yoy and a quintupling of segment profits (basically operating profits less stock option expense) to $391 million.  AWS, broken out as a separate segment for the first time after 1Q15, remained a bit more than a third of the AMZN total.

 

AMZN posted an overall profit of $.19 a share for the quarter, vs. analysts’ expectations of a loss of $.13 a share and a deficit of $.27 per share in the year-ago quarter.

On the announcement, the stock immediately rose by 15% in aftermarket trading.

AMZN opened up by 20% this morning, before drifting down steadily during the day to close +9.8% in a market that was down just more than 1%.

 

Why the strong advance?

I have no good explanation, although I do have some ideas.

1. The obvious factor that changed overnight was the earnings announcement.

It contained a significant positive earnings surprise, one that makes it more likely that the company will earn, say, $1- a share in the current year. It makes the analyst consensus of $2.78 a share for 2016 more believable.   On the other hand, the stock was trading at $482 before the earnings report, or 173x the 2016 consensus.  Looking at the stock price another way, let’s say that at maturity for its businesses (whenever that may be), AMZN shares will be trading at 20x earnings.  To sustain the pre-earnings report price, that would imply a burst of rapid growth that shoots earnings up to around $24 a share.  That would be something like a doubling of earnings each year for the next five or six.

That’s already baked in the cake.  A buyer of the stock at this level must believe that $24 a share in eventual earnings is way too low.

I find it hard to believe that a $.32  per share earnings surprise during one quarter–when expectations were already sky-high=-would be enough to add 20%, or even 10%, to AMZN’s perceived market value.

2.  A second hypothesis…

What if investors are beginning to separate AMZN into two parts, AWS and everything else, and are doing a sum-of-the-parts evaluation.  To me, this sounds a little more plausible.  What would the numbers look like?

Let’s say that in 2016 AWS will comprise half of AMZN’s earnings and AMZN Retail the remainder.  To make the figures easier, let’s say each half earns $1.50 a share next year.

Let’s assume AMZN retail can grow in earnings at 20% a year for a long time, and that we’d be willing to pay 50x current results–a big number for a retail stock–for that future profit stream.  If so, AMZN Retail is worth $75.  To reach a sum-of-the-parts value of $482, AWS must therefore be worth about $400, or close to 270x its 2016 eps.  Ok, while I personally wouldn’t be willing to pay that much for AWS, I can see how someone else might.  However, I still don’t understand why confirmation that a holder at 270x earnings isn’t insane would cause the multiple to expand.  (Also, before I’d be comfortable valuing AWS as a separate company, I’d want to know more about how AMZN apportions revenues and costs among segments to ensure the published numbers don’t flatter AWS.  I’d also think long and hard about the possible effect of stock options.)

3.  The explanation for AMZN’s rocket ship ride that I’m leaning toward, however, is more technical.  Two factors may be involved.  At what Google Finance reports as 21+ million shares, today’s trading volume in AMZN was 7x normal.  The sharp opening spike suggests to me that algorithmic trading computers were at work reacting to the earnings report, not humans.  Humans, I think (?!?), would have a better sense of valuation.  I also suspect that the report and immediate upward move triggered a lot of short covering.

I’m partial to #3 because I think the whole reaction is a little  crazy.

Why is any of this important?  AMZN is a high-profile, large-cap stock with almost two decades of operating history.  There’s got to be a way to make money from the possibility that something like AMZN’s big move will occur with other similar names.

 

 

exiting a growth stock

June 30, 2015 By in from growth to value: the life cycle, growth vs value Tags: , , , 1 Comment

To paraphrase/summarize my last few posts, the key to value stock investing is to buy when things couldn’t be worse.  For growth stock investing it’s to leave the party when things couldn’t seem better.

Generally speaking, the key to making a successful exit from a growth stock is to always keep in mind the qualitative “elevator speech” whose essence is that it contains what you think gives the firm a special edge.  When that story begins to erode–maybe new competition emerges, or the target market the firm is exploiting gives signs of being saturated, or tastes change–it’s time to edge toward the door.  The important thing to remember is that this erosion occurs long before earnings growth begins to slow.

The first disappointing earnings report is typically followed by continuing bad news, so it’s not to late to get out then.  But that first bad report is typically a long way from the top for the stock.  The leading indicators are what really count.  They differ from stock to stock.

Take Wal-Mart as an example.  Its main business was opening superstores in small towns.  Government statistics could have told us how many such towns there are in the US.  That data allow us to figure out how many years of growth the company has before it’s forced to do something different.

Deviations from the norm are another indicator. Starting a second brand suggests #1 may be getting a bit long in the tooth.  Opening outlets in notoriously difficult markets like Los Angeles or New York might also be a signal.

A PE that’s too high for the firm to ever grow into is a third signal that things can’t get much better for the stock.

 

One caveat, something that makes the situation trickier:  most growth companies are unable to reinvent themselves when their initial good idea runs out.  The best of the best, however, are able to do so.  Some of them can do this multiple times.

Apple, for example, has had several lives.  It was initially the story of a near bankrupt company coming back from the brink (led, ironically by the man who put the enterprise on the road to the precipice in the first place, Steve Jobs).  Then it was the iPod company.  Then it was the iPhone company.   Most recently, it’s the firm Tim Cook saved from the craziness of having a phone that’s too small and a tablet that’s too big.

These situations are rare, however.  And there’s always time to change your mind after reducing a position or eliminating it entirely.  So the possibility that stock X might be another AAPL isn’t enough, io my mind, not to exit once the qualitative story begins to break down.

two aspects of securities analysis: quantitative and qualitative

June 29, 2015 By in activist investing, book value, from growth to value: the life cycle, growth vs value, mean reversion, stock market Tags: , , , , , 1 Comment

quantitative analysis

The quantitative aspect is easier to describe.  It, however, is much more complex and detailed and may take months to complete.  As a professional, I always thought part of the art of portfolio management was in deciding how much of this I had to do before I bought a stock, how much I could obtain from brokerage house securities analysts, and how much I could leave to fill in after I established a position.

The quantitive plan consists in a projection of future company performance–revenues, operating profits, interest, depreciation, general expenses, taxes…–for each line of business and for the company as a whole, over the next several years.  Creating spreadsheets this detailed is an ideal that’s striven for but seldom reached in practice.  That’s because companies rarely disclose this much information in their SEC filings.

Lengthy reports, called basic reports, issued by old-fashioned (i.e., “full service”) brokerage houses are the best example of what a quantitative analysis should look like.  Signing up for Merrill Edge discount brokerage will get you access to such reports.

The most important thing about them, in my view, is the analytical work, not necessarily the opinion.  I think the Merrill analyst covering Tesla, for instance, does extremely good work.  All the relevant issues and numbers are clearly laid out.  Last I read, he thought that fair value for the stock was around $75 a share.  Although he provides very valuable input, and he may ultimately be proven correct, I think he’s way too pessimistic about the stock.

qualitative analysis

This is the general concept behind an investment.  It’s extremely important–more important than the exact numbers, in my view–but it may be as short as an elevator speech.  In most cases, the shorter the better.

Examples, many of which are not current:

–Wal-Mart builds superstores on the outskirts of US cities with a population of 250,000 or less.  They offer better selection and lower prices than downtown merchants do, so they take huge market share everywhere they open.  There are a gazillion such towns left to exploit.

–J C Penney is trading at $25 a share. It owns or controls property that has a value, if rented to third parties, of $50 a share, plus a retail business that is making money.  The latte is worth more than zero as-is.  Let’s say $5 a share.  Taking control of JCP and breaking it up could double our money.

–Adobe is changing from a sales model for its software to a rental one.  This will eliminate counterfeiting, which is probably much more extensive than anyone now realizes.  We know from other industries that going from buy to rent probably doubles profits, even without considering eliminating theft. No one seems to believe this.   Therefore, ADBE’s profit growth over the next two or three years will be surprisingly good.

–Company X is a cement company.  It’s currently beaten down by an economic slowdown and is trading at 40% of book value.  At the next economic peak, it will likely be trading at 100% of book–which will be 20% higher than it is today.  Therefore, the stock should triple in price.

More tomorrow.

why selling is the most important for growth investors

June 26, 2015 By in from growth to value: the life cycle, growth vs value, mean reversion Tags: , , , , , , , , 1 Comment

Value investors make money by finding companies that are undervalued based on the state of their business today.  Their capabilities typically become undervalued because of bad management, a temporary misstep in judgment or a cyclical downturn.  Any of these factors will usually trigger an excessively negative emotional reaction by the market–creating the buying opportunity.

Growth investors like me, on the other hand, are dreamers.  We try to find companies that will likely be expanding their profits at a faster rate than the market expects, and for a longer time than the market expects.

Where the value investor asks “What can go wrong in the here and now from this point on?” and answers “Nothing that the market hasn’t already discounted three times over,” the growth investor asks “What can go right over the next few years that market is unwilling to pay for today?”

 

A generation ago, the classic growth stock was Wal-Mart (WMT), a company that built superstores on the outskirts of small towns with under 250,000 population and prospered by taking market share away from inefficient mom and pop local merchants.  It started in Arkansas and grew…and grew…and grew, for a long as there were new small towns to attack.

In this generation, we might think of Apple (AAPL) or Google (GOOG).  In the former case, it was the ability of a highly skilled management to resuscitate the brand and produce the iPod and then the iPhone that the market didn’t understand when the stock was at $25.  With GOOG, it’s the power of search that was vastly underestimated.

If a stock is going to reach, say, $100 a share–the growth investor’s dream–whether we pay $10 or $12 or $20 isn’t the crucial decision.   Getting on the train at some early stop is all that matters.

Selling at the appropriate point, however, is much more crucial.

How so?

what goes up…

Let’s say the market expects that a certain company is going to grow profits at 15% per year for at least the next several years.  The next quarterly earnings report comes in at +20% in profit growth; management says it thinks it can continue to grow at the higher rate.

Two positive things typically happen:

–the stock rises to adjust for the higher reported earnings, and

–the price earnings multiple expands, as the market begins to factor in the idea that the firm can grow more quickly than it thought.  In other words, the price rises more than simply the good earnings report would justify.

Let’s say that the quarter after that, earnings come in at +25%–and that management continues to make bullish comments about its future.

The same thing–two levels of upward price adjustment, higher earnings, higher multiple–happens again.

For a true growth stock, a WMT or an AAPL or a GOOG, this process of upward adjustment can go on for years.

At some point, though,

…must come down

…the stock market gets tired of being wrong on the downside.  It makes an emotional swing to the upside that can’t possibly be justified by the company’s fundamentals   …ever.

Typically, this is expressed as a sky-high price earnings multiple.

In addition, in my experience, the life span of a typical shooting star earnings grower is about five years.  After that, earnings growth begins to slow.  The crazy multiple expansion comes toward the tail end of the super growth period.

 

As the market senses that slower growth is in the offing, the process of upward adjustment goes into reverse.  The stock declines to reflect weaker than anticipated earnings, and the price earnings multiple begins to contract.

This is usually a very ugly process, with the stock declining much more than one might ordinarily expect.

 

The trick for a growth investor is to exit the stock, at least in large part if not totally, before this happens.

 

More on Monday.