Category Archives: Basic Concepts

warts becoming visible (i)

April 7, 2020 By in Accounting, factoring receivables, reverse factoring aka supply chain finance, Uncategorized, working capital Tags: , , , Leave a comment

receivables vs. payables

I’ve always been a fan of analyzing working capital, which shows the flow of cash in the inventory cycle, from the bank account to raw materials to finished goods to sales and getting paid.

There are lots of standard ratios, but my favorite has always been receivables vs. payables.  Taken in its simplest form this shows how eager people are to obtain the company’s goods (small receivables, which means little financing provided by the company) vs. how eager suppliers are to have the company as a customer (large receivables, which means easy payment terms).

Whenever markets go south, some limitation or other–or some abuse–of financial reporting rules invariably comes to the fore.   This time, for me at least, the culprit is payables.

factoring

I’ve known for a long time about factoring receivables, meaning the company sells them to a third party, getting them off the balance sheet.  Whatever the motivations of management, factoring makes the demand from customers and the company’s need for cash look better.

Until the financial crisis of 2008, financial accounting standards did not require that this activity be disclosed to shareholders.  Since then, as I read the FASB rules, big changes in the level of factoring, up or down, must be disclosed   …but nothing else.

reverse factoring

Something I’m just learning about during the current downturn is reverse factoring aka supply chain finance.  It’s the cousin of factoring, but on the liabilities side of the balance sheet.

This one’s a little more complicated, but there’s a bad case where a company arranges for a bank credit line.  A supplier essentially takes his payable to the bank for payment, creating a loan balance for the arranging company.  But this debt either doesn’t appear, or doesn’t appear in an easily understandable way, in the company financial statements.

This esoteric financing ploy only came to the market’s attention in the bankruptcy of Carillon in the UK in early 2018.   But the recent call by the big four accounting firms for the SEC to clarify what disclosure of reverse factoring must be made suggests that
Carillon is not an isolated case.

My sense is that this is not an issue for most companies but that highly financially leveraged firms may be in considerably worse shape than the reported financials show.  This presents a problem for anyone wanting to speculate on a turnaround in world economies or world stock markets.  The most aggressive strategy would be to bet on the companies that have been pummeled on fears they won’t survive the pandemic-related downturn.  To my mind, however, these are precisely the firms where risk of large “hidden” debt is the greatest.

 

 

 

my take on Disney (DIS)

March 19, 2020 By in securities analysis, Uncategorized Tags: , , , , , , Leave a comment

Post the Fox Studios acquisition, DIS remains in three businesses:  broadcasting, theme parks and movies.  December 2019 quarterly operating income from the three (ex direct to consumer) was roughly $5 billion.  Of that, just under half came from theme parks, a third came from broadcasting and the rest from movies.

All three business lines have their warts:

–ESPN, the largest part of broadcasting, has long since lost its allure as a growth vehicle; ABC is breakeven-ish; I think there’s some scope for boosting results from Fox.  Pencil in slow/no growth

–theme parks are (were?) booming, but they’re a highly business cycle sensitive business.  We’ll see that, I think, in March- and June-quarter results.  so even though it’s Disney we should apply a discount multiple to these earnings

–movies are traditionally a low multiple business because of the irregularity of new releases and their typical hit-and-miss nature.  DIS has been exceptionally good for a long time under Bob Iger (it was pretty awful before him), but this is still inherently a low multiple enterprise.

 

This is the main reason the stock spent years bouncing around the $110 level with flattish $10 billion, $6 a share, in earnings.  In the era of human analysts, it wasn’t just the earnings that held the company back.  It was also knowledge of the slow demise of ESPN, the (in hindsight too conservative) sense that theme parks were nearing a cyclical peak, and the idea that the company’s incredible movie hot streak might come to an end.

Then there’s the streaming business, where–to pluck a number out of the air, DIS is spending 10% of its operating income to develop.

 

A couple of months ago no price seemed too high for Wall Street to pay for Disney+, with the stock peaking at $153.    If we say $25 of the rise was due to streaming, at the top the market was valuing Disney+ at $40 billion+, or roughly a quarter of the value of Netflix.

The stock has fallen by about 40% since.

Now, hang onto your hat:

If we assume that the implied value of Disney+ has fallen in tandem with NFLX, it’s now valued at $32 billion.  This gives a residual value for the rest of DIS of about $140 billion.

That would imply a multiple of 13x current earnings–or, alternatively, an assumed 20% decline in profits.  The decline would likely be mostly (I’m assuming entirely) in the parks and movie divisions, implying that area’s income would fall by somewhere around 30%.

So–in this way of looking at things, we are assuming substantial success for Disney+ and a decline in the most cyclical businesses of roughly half what the market is assuming for companies like Marriott.  It would be cheaper to create a “synthetic” DIS out of NFLX + MAR shares, although what would be missing would be the Disney brand.

My conclusion:  Mickey and Minnie aren’t screaming “Buy me.”

 

 

 

 

dealing with market volatility

March 6, 2020 By in correction vs. bear market, Current Market Thoughts, major changes in market direction, market bottoms, market tops, stock market, Strategy, Uncategorized Tags: , , , , , Leave a comment

Beginning rant:  finance academics equate volatility with risk.  This has some intuitive plausibility.  Volatility is also easy to measure and you don’t have to know much about actual financial markets.  Using volatility as the principal measure of risk leads to odd conclusions, however.

For example: Portfolio A is either +/- 1% each week but is up by 8% each year; Portfolio B almost never changes and is up by 3% every twelve months.

Portfolio A will double in nine years; Portfolio B takes 24 years to double–by which time Portfolio A will be almost 4x the value of B.

People untrained in academic finance would opt for A.  Academics argue (with straight faces) that the results of A should be discounted because that portfolio fluctuates in value so much more than B.  Some of them might say that A is worse than B because of greater volatility, even though that would be cold comfort to an investor aiming to send a child to college or to retire (the two principal reasons for long-term savings).

more interesting stuff

–on the most basic level, if I’m saving to buy a car this year or for a vacation, that money should be in a bank account or money market fund, not in the stock market.  Same thing with next year’s tuition money

–the stock market is the intersection of the objective financial characteristics of publicly-traded companies with the hopes and fears of investors.  Most often, prices change because of human emotion rather than altered profit prospects.   What’s happening in markets now is unusual in two ways:  an external event, COVID-19, is causing unexpected and hard-to-predict declines in profit prospects for many publicly-traded companies; and the bizarrely incompetent response of the administration to the public health threat–little action + suppression of information (btw, vintage Trump, as we witnessed in Atlantic City)–is raising deep fears about the guy driving the bus we’re all on

–most professionals I’ve known try to avoid trading during down markets, realizing that what’s emotionally satisfying today will likely appear to be incredibly stupid in a few months.  For almost everyone, sticking with the plan is the right thing to do

–personally, I’ve found down markets to be excellent times for upgrading a portfolio.  That’s because clunkers that have badly lagged during an up phase tend to outperform when the market’s going down–this is a variation on “you can’t fall off the floor.”  Strong previous performers, on the other hand, tend to do relatively poorly (see my next point).  So it makes sense to switch.  Note:  this is much harder to do in practice than it seems.

–when all else fails, i.e., after the market has been going down for a while, even professionals revert to the charts–something no one wants to admit to.  Two things I look for:

support and resistance:  meaning prices at which lots of people have previously bought and sold.  Disney (DIS), for example, went sideways for a number of years at around $110 before spiking on news of its new streaming service.  Arguably people who sold DIS over that time would be willing to buy it back at around that level.  Strong previous performers have farther to fall to reach these levels

selling climax:  meaning a point where investors succumb to fear and dump out stocks without regard to price just to stop losing money.  Sometimes the same kind of thing happens when speculators on margin are unable to meet margin calls and are sold out.  In either case, the sign is a sharp drop on high volume.  I see a little bit of that going on today

 

more on Monday

 

Keeping Score for February 2020

March 3, 2020 By in Analyzing performance, Current Market Thoughts, Keeping Score, performance attribution, performance measurement, Recent Market Action, securities markets, Strategy, Uncategorized Tags: , , , , , , Leave a comment

I’ve just updated my Keeping Score page for February and year-to-date.  What a strange time!

margin calls

March 2, 2020 By in Current Market Thoughts, Margin, margin trading, Uncategorized Tags: , , , Leave a comment

When I looked at my Fidelity account this morning I saw two odd things:  a simplified interface, and a message sent to everyone with a margin account (my wife and my joint account with Fidelity is a margin account, although we don’t trade on margin).  The message was essentially a warning to be on the alert for potential margin calls.

I’ve never seen this before.  A caveat:  until I retired at the end of 2006 all the family money was in the mutual funds I was managing, in whatever vehicle my employer required.  Still, I didn’t see this in 2008-09.

Two conclusions:

–Fidelity is anticipating/seeing volume increases that are testing the limits of its software (probably mostly an issue of private-company-esque aversion to spending on software infrastructure)

–more interesting, aggregate equity in the accounts of its margin customers must be dangerously (for the customers) low.  Margin-driven selloffs are typically ugly–and very often mark a market bottom.  Here’s why:

margin trading

In its simplest form, a market participant establishes a margin portfolio by investing some of his own money and borrowing the rest from his broker.  He pays interest on the margin loan (Fidelity charges 5% – 9%+, depending on the amount) but all of the gains/losses from the stocks go to him.  The client does relinquish some control over the account to the broker.  In particular, the broker has the right to liquidate some/all of the portfolio, and use the proceeds to repay the loan, if the portfolio value minus the loan value falls below specified levels.

Before liquidating, the broker tells the client what is going to happen and gives him a short period of time to put enough new money (securities or cash) into the account to get the equity above the minimum amount.  This is a margin call.

If the client doesn’t meet the call, the broker begins to sell.  The broker has only one aim–not to get the best price for the client but to convert securities to cash as fast as possible.  Of course, potential buyers quickly figure out what’s going on and withdraw their bids.  Carnage ensues.

That’s what Fidelity was saying we’re on the cusp of this morning.

There are some very shrewd and successful margin traders.  Around the world, though, retail margin traders are regarded as the ultimate dumb money.  That’s why seeing forced selling from these portfolios is typically seen as a very positive sign for stocks.