Category Archives: growth vs value

News Corp’s proposed split-up

June 27, 2012 By in growth vs value, Industry Analysis, Portfolio management, Publishing, Recent Market Action, Stock ideas Tags: , , , , , , , , , Leave a comment

the NWS split

Monday evening the Wall Street Journal  reported that News Corp (NWS) will be considering splitting the company in two at its next board meeting.  The movie and television units would be placed in one publicly traded company, and the newspaper and publishing divisions in another.   Presumably both new companies would retain the current dual share structure, which ensures effective control by the Murdoch family.  Given that NWS owns the WSJ, the report should be considered highly reliable.

not a new idea

Dividing a conglomerate into smaller, more focused pieces isn’t a novel idea.   But it’s one that has so far been opposed for NWS by family patriarch, Rupert Murdoch.  Maybe he worries that doing so would dilute the extraordinary political influence NWS has been able to wield in the countries where it has operations.

why now?

The rationale for considering a separation now is doubtless the negative political and regulatory fallout from the cellphone-hacking scandal that has engulfed NWS’s newspapers in the UK.  The affair has foiled the company’s plans to acquire complete ownership of BSkyB.  It might also ultimately result in NWS being forced to divest its current controlling interest in the satellite broadcaster.

Demonstrating that its BSkyB equity is held in a corporation completely separate from the Murdoch newspaper operations may be a pivotal consideration in staving off this outcome.  True, the regulators may regard the move as simply a ruse, especially if the successor companies have basically identical boards of directors.  But NWS’ allies in the British government must either think the move has a reasonable chance of success, or that without it the negative outcome for NWS is a foregone conclusion.

the move makes stock market sense

Reorganizing a conglomerate into a number of smaller companies may not always make economic sense.  This is especially true for a firm run in effect as a privately-held firm.  There may be complex borrowing and tax planning arrangements that need to be unwound, for example.  There may be jointly-owned computer control systems that need to be separated.  And what happens, say, to any book deals with Harper Collins that personalities on Fox News may have?

here’s why

But it almost always makes stock market sense, for several related reasons:

1.  In the case of NWS, the publishing/newspaper arm makes very little of NWS’ operating profit.  On the plus side, then, it’s almost inconsequential.  But bitter experience has taught every portfolio manager that when such “inconsequential” businesses lapse into loss, they can punch a huge hole in the bottom of the boat.  That’s one reason for the PE multiple discount at which virtually all conglomerates trade.

2.  Professional equity portfolio managers like to build their own portfolios.  I may decide I want to overweight the media industry, for instance.  Within media, I want to overweight film and TV, and severely underweight newspapers.  This is harder to do with NWS than with “pure” film and TV companies.  Another reason for the conglomerate discount.

3.  Professionally managed equity portfolios are increasingly “style”-oriented, displaying either growth or value attributes.  This is partly a function of the psychological makeup and training of the managers, partly a marketing constraint forced on them by the pension consultants who recommend them to institutional customers.  Film/TV is arguably a growth industry.  Newspaper/publishing is clearly a value one.  So some managers may want one part, some the other.  But none want the entire bundle.  Conglomerate discount again.

In theory, then, and almost always in practice, the sum of the values of the two post-split pieces will be noticeably higher than the two were together.  That’s the reason the announcement has sparked a rally in the stock.

Often, it happens that operations in each of the pieces become sharper and capital allocation becomes more efficient when they are run by experts in their fields rather than generalists.  It’s unclear whether these favorable developments will also occur, given that the Murdoch family will be fully in control of both sides.  But they may.  And this isn’t the main reason the stock is going up, in any event.

calculating fair value

How to get a fair value for the decoupled pieces?  Compare each with its peers.  I’m not a NWS fan (although I’ve watched the company grow from its Australian roots since the mid-1980s), so I’m not going to do the work.  But it’s a pretty straightforward task, however.  Value Line, which you can probably find in the local library, should give you all the relevant metrics.

why is it so hard to stay ahead of a rising market?

April 3, 2012 By in Absolute vs. relative performance, Constructing a Portfolio, developing competence as an investor, Getting financial advice, growth vs value, Portfolio management Tags: , , , , , , Leave a comment

staying ahead of a rising market is difficult

That’s the cliché, anyway.  And, for what it may be worth, my experience is it’s true.  It’s much harder to stay ahead of a rising market than a falling one.

but why?

Let’s first get a technical, or maybe a definitional, point out of the way.

The world consists of growth investors and value investors–both, by the way, claiming to be in the minority (because that’s cooler than being run-of-the-mill).  Value investors stress defense.  They’re more risk averse.  As a result, they typically make their outperformance during the part of a market cycle when stocks are going down.  Of course, they’d like to outperform an uptrending market.  But because they put defense first, deep down they know they should be satisfied (even ecstatic) to keep pace in a rising market.  Their approach to the stock market, their longer term strategy, is to protect against possible downside.  So they know that not falling too far behind is the best they can realistically hope for. Let’s not count them.

So our question really is:  why is so hard for growth investors, whose strategy calls for them to make their outperformance in an up market, to do so?

I think a lot is due to the fact that a rising market attracts substantial amounts of new money to stocks.  Not only that, but the new money doesn’t come in all at once; it arrives at different times.  depending on timing, new money can create demand for many stocks, not necessarily those best positioned to benefit from the bull run.

For example:

— (Almost) every professional investor is taught from day one not to “chase” stocks that have already risen a lot before he starts to look at them.  Instead, he’s told, look for stocks that may not be quite as good but which haven’t moved yet.

Someone late to the smartphone party might not buy Apple or ARM Holdings.  He might buy Qualcomm instead.  Money arriving later still might gravitate toward a contract manufacturer like Hon Hai, or to Intel, or maybe even Verizon or Sprint, on the idea that smartphones or tablets will add oomph to those businesses.

These latter stocks may not necessarily be the purest plays or the greatest companies, but buyers will tell themselves (sometimes rightly, other times wrongly) that the risk/reward tradeoff is better for them than for the more expensive “pure play” stock like AAPL or ARMH.

Put another way, when the leading lights of an industry make a major move upward, they tend to drag a lot of the lesser lights along with them–at least to some degree, from time to time and with a lag.  It’s very hard psychologically–and arguably not the best idea financially–for someone who has identified a trend early and holds all the major players to rotate away from them and dip down into second-line stocks to play these ripples.  But during a period while others are playing catch-up by bidding up the minor stocks, the holder of industry leaders will underperform.

–There’s also a more general arbitrage in an up market–in any market, really, but more so when stocks are moving up.  It’s not only among relative valuations of participants in an industry which is on Wall Street’s center stage, but between that industry and other sectors/ industries/stocks.

Let’s say that tech stocks have gone up 40% in the past six months, while healthcare names have lost 5% of their value.  At some point, even tech investors will start to say that healthcare stocks look relatively cheap.  As this perception spreads, the market will direct its new money flows to healthcare.  Investors may even begin to rebalance–selling some of their tech stocks, and using the funds to buy healthcare, until a better relationship in valuation is restored.  While this is going on, anyone overweight tech and underweight healthcare will probably underperform.

should you want to outperform all the time?

If there were no tradeoffs, the answer would be easy.  But there are.

–All of us have different goals and objectives.  Younger investors, for instance, will probably want maximum growth of capital.  Older investors may want preservation of income, instead.  The former objective is consistent with trying to shoot the lights out in a bull market.  For the latter, that strategy is too risky.

-Not everyone has the temperament to be good at investing.  That’s just the way it is.  Someone who falls below the market return year in and year out should realize that for him active management is an expensive hobby.  Index funds would be a better wealth-building alternative.

–We also have different knowledge bases, aptitudes and interests.  That may make us better at defense than offense, or better at value investing than growth.  As in just about everything else, we should play to our strengths, not our weaknesses.

–Contrary to the wishes of the marketing departments of investment firms, no investor–not even the best professional–outperforms 100% of the time.  The other team eventually gets a turn at bat.  If you can outperform for two or three years out of five, and if your overall results match or exceed the market return for the half-decade, that’s more than enough.  That would put you deep in the top half of all professionals.

I don’t think this last is a crazy expectation for a non-professional.  Investing is a craft skill, like, say, baseball or shoe repair.  It can be learned.  Knowing a few things better than the market does will likely bring better than average long-term returns, even with occasional bouts of underperformance.

two more years of emergency-low interest rates!

January 31, 2012 By in Current Market Thoughts, from growth to value: the life cycle, growth vs value, Recent Market Action, Shaping a portfolio for 2012, Strategy Tags: , , , , , , , , , , Leave a comment

the January 25th Fed meeting

Last week’s meeting of the Federal Reserve’s Open Market Committee had two important results:

1.  Chairman Ben Bernanke said the Fed funds rate, which has been at effectively 0% for just over three years (since December 16, 2008–how time flies) will likely remain at or near the current low rate into 2014.

2.  The Fed gave more detail than ever before on its thinking about prospects for the US economy and the appropriate level for the Fed funds rate.

The Fed thinks:

–the long-term growth rate of the US economy is  +2.4%-2.5%  a year (vs. 3%+ a decade ago).  The agency is content, however, to allow growth at somewhat above that rate from now into 2014.

–the appropriate long-term level for the Fed funds rate is about 4.5%, which amounts to a 2.5% real rate of interest (“real” means after subtracting inflation from the nominal rate).  This contrasts with the current rate, which is a negative real rate of about 2.5%.

–although the process of normalizing interest rates will probably begin before the end of 2014, the Fed is unlikely to raise the funds rate above 1% until at least 2015.

–despite the immense monetary stimulation going on now, inflation will not be an issue.  It will remain at 2% or below.

–the “natural” rate of unemployment, that is, full employment, is 5.5% of the workforce (in theory, the 5.5% is friction in the system–like people in transit from one employment location to another, or who decide to take a short break between jobs…).

According to the Fed’s projections, the unemployment rate will remain above 8% until some time in 2013.  It probably won’t crack below 7% for at least the next three years.

implications

The forecast itself isn’t a shocker.  The Fed has been talking about slow but steady progress for the economy, with no inflation threat, for some time.  The real news is that the Fed expects the current situation to persist into 2105, a year longer than it had previously indicated.

1.  To my mind, the biggest implication of the Fed announcements is that it makes less sense than ever to be holding a lot of cash.  How much “a lot” is depends on your economic circumstances and risk preferences.  But the Fed is saying that a money market fund or bank deposit is going to yield nothing for the next two years and well under 1% for the year after that.  Yes, you have secure storage in a bank and substantial assurance you won’t make a loss, but that’s about it.

To find income in liquid assets–as opposed to illiquid ones like, say, rental real estate–you have to look to riskier investments, dividend-paying stocks or long-dated bonds.  That in itself is nothing new.  Savers have been reallocating in this direction for the past couple of years.  Last week’s Fed’s message, though, is that it’s much too early to reverse these positions.  If anything–and, again, depending on personal circumstances and preferences–investors should think about allocating more away from cash.

2.  When the process of normalizing interest rates is eventually underway, the yields on long-dated bonds and dividend paying stocks will be benchmarked–and judged–against cash yields of 4%+.  For stocks, a static dividend yield of 3% won’t look that attractive.  At some point, low payout ratios (meaning the percentage of earnings paid out in dividends) and the ability to increase cash generation will become key attributes.  Both are indicators of a company’s ability to raise dividends.

3.  It’s my experience that when the Fed begins to tighten, Wall Street always underestimates how much rates will rise.  Last week, the Fed told us that when the Fed funds rate goes up this time, its ultimate destination is 4.5%.

4.  Investors taking a top-down view, that is, looking for the strongest economies, will have to seek exposure outside the US–which will only look good vs. the EU and Japan.  The main issue is demographics–an aging population.  It’s probably worthwhile to try to figure out what characteristics of the latter two economies, both of which have older populations than the US, are due to social/cultural peculiarities and which are due to aging.  The second set of traits may well turn up in the US market as well.

5.  The mechanics of how growth stocks and value stocks work may change in a slower-growing economy.  It’s hard to know today how that will play out.  True growth stocks may be harder to come by.  Value investors who say they buy asset value of $1.00 at $.30 and sell it at $.70 may have to buy at $.20 and sell at $.60 if there’s less room for second- and third-tier companies to succeed.

I think it’s way too soon to be worrying about anything other than #1.  The rest are thoughts to be filed away for next year, maybe.

sizing the coming fiscal contraction in the US–effect on equities?

August 2, 2011 By in Capital-intensive firms, Current Market Thoughts, economics, growth vs value, Portfolio management, Recent Market Action, Shaping a portfolio for 2011, Stock ideas, Strategy Tags: , , , , , , , , , , Leave a comment

raising the debt ceiling

As I’m writing this, the House has already passed a bill that authorizes an increase in the permitted level of Federal government borrowing–one that’s big enough to get the country through the 2012 election; the Senate appears very likely to do the same at noon.  Mr. Obama will presumably sign the legislation into law before the end of the day.  That, in turn, will allow the Treasury to borrow enough to pay all of the $300+ billion in bills that come due this month, not just the $175 billion or so that the government’s income will cover.

addressing the budget deficit

The bill’s provisions (no, I haven’t read the legislation itself, just press accounts) appear to be guided by the usual congressional principle of deflecting blame from the legislators themselves.  It calls for $900 billion in immediate spending reductions.  A bipartisan panel, soon to be appointed, will find $1.5 trillion more over the coming months that Congress will vote on before yearend.  Congress will have no ability to change any of the panel’s recommendations, but must simply say yes or no.  If this second bill doesn’t pass, a pre-determined set of budget cuts, heavily weighted toward the military (which, after all, is the largest item in the budget at 25% of outlays) and entitlement spending (not far behind) will go into effect.

In addition to raising the debt ceiling, today’s bill marks the first step toward addressing two important macroeconomic problems:

–the reemergence of spending in excess of government receipts by Washington after several years of restraint during the second Clinton administration, and

–the resulting sharp rise in the amount of federal debt outstanding.

sizing the issue

GDP in the US is around $15 trillion.  The federal government is currently taking in about $2.5 trillion a year and spending $4 trillion.  See my post last week for a list of the major categories of government spending.

Outstanding federal debt is $14.3 trillion (the debt ceiling).  Of that, about $9 trillion is in public hands; the rest is held by government trusts, predominantly Social Security.

The annual budget deficit is currently about $1.5 trillion.  To cover today’s spending levels, government receipts would have to rise by 60%.   Government spending would have to drop by about a third to be funded by income.

The excess government spending over income is equal to 10% of GDP.

Two conclusions:

–the problem is too big to fix all at once,

–the problem is too big to “grow” out of.  If we assume that tax receipts increase by 5% annually, it would take almost a decade for government income to rise to the current spending level.  Government debt would be about $7 billion higher at that point than it is today.

effect on the economy

The federal budget deficit represents a very large stimulus to the economy, one that in effect shifts economic growth from the future to the present.  Shrinking the deficit means reversing this process. Eventually–and probably sooner than later–we end up with a healthier country.  But while the process is going on, the removal of stimulus will make economic growth lower than it would otherwise be.  …a loss of .5% a year?  Given that the long-term growth rate of the economy is maybe 2.5%, that’s a sizable chunk.

investment implications

Interest rates in the US are likely to stay low for much longer than most people (including me) thought a year or two ago.

This suggests that the appeal of fixed income instruments, especially short-term ones, as yield vehicles will remain limited.  By default, stocks become more attractive.

The recipe for stock market success in the US won’t change much:

–growth stocks over value

–foreign, especially Asian, exposure over domestic

–domestic consumer over domestic capital-intensive

–upscale consumer over the broad market.

from growth to value: a life cycle progression

May 4, 2011 By in from growth to value: the life cycle, growth vs value, Industry Analysis, Stock ideas, Technology Tags: , , , , , , , , , , Leave a comment

going ex-growth

What happens when a growth stock goes ex-growth.  Nothing good.

Owners of a stock like this face two issues:

–the share is doubtless trading at a very high relative price-earnings multiple, based on Wall Street expectations that its superior track record of profit expansion will continue.  Not only that, growth stocks often experience a kind of buying frenzy at the peak of their popularity that pushes the multiple way above the level the stock would deserve, even if investor expectations could be met.

–growth investors lose interest, leaving value investors as the only possible buyers.  But, as we saw yesterday, value investors are attracted only to issues that have been all beaten up and tossed onto Wall Street’s scrap heap.  Like famous relief pitcher Sparky Lyle, former growth stocks must go “from Cy Young to sayonara” –or from living in the penthouse to sleeping in a doorway in the alley–before they attract much investor support.

This process of price earnings multiple “compression” or “derating” normally takes a very long time.  I don’t understand why.  Maybe it’s confirmation bias–that people see only what they want to see.  In any event, it happens.  The first half of the 1970s, before I entered the market, were characterized by the rise of a small number of stocks, like Xerox, Polaroid or (my favorite) National Lead, that were believed to be able to grow at high rates forever.  They were called “one decision” stocks–no need to sell ever.  Many of these issues traded at 90x-100x earnings in an overall market that was selling at around 12x.

In the case of the “Nifty Fifty”, it took from 1975 to 1984 for the excesses to be wrung out of the majority of these stocks.  Of course, we need only to look at the aftermath of the Internet bubble of a decade ago to see the same process play out again, although this time it “only” took 2 1/2 years.

INTC and MSFT–APPL, too

…which brings us to the topic of INTC and MSFT, two titans of the personal computer era, and how to evaluate them today.  I’m tossing in AAPL, as well, although that firm was doomed by a series of strategic missteps by a younger Steve Jobs, to remain a bit player in the PC world.

the performance record

All three stocks hit a peak in early 2000.  From April of that year to now, their stock performance is as follows:

S&P 500          +.5%

MSFT          -41.8%

INTC          -66.2%

AAPL          +963%

From the market bottom in early 2003:

S&P 500          +55.9%

MSFT          +23.8%

INTC          +36.6%

AAPL          +2007%

From the market bottom in March 2009:

S&P 500          +98.5%

MSFT          +68.9%

INTC          87.2%  (including a 15% rise in the past couple of weeks)

AAPL          +308%.

valuations:  2000 vs. now

At the top in 2000, the S&P 500 traded at 27x earnings of $56.18; now it is trading at 13x earnings of $100.  eps growth, 2000-2011 = 78%.

At the top in 2000, INTC traded at 36x earnings of 1.53;  now it is trading at 9x earnings of $2.50.  eps growth = 63%.

At the top in 2000, MSFT traded at 68x earnings of $.85;  now it is trading at 10x earnings of $2.50.  eps growth = 194%.

At the top in 2000, AAPL traded at 30x earnings of $.85; now it is trading at 14x earnings of $25.  eps growth = 28x.

Looking at MSFT and INTC shares:

MSFT:  the obvious factor is that the stock’s relative PE has been crushed.  During much of the 1990s, the company was growing earnings at a 50% annual clip.  During the past decade, it has barely managed to get into double digits.  That’s better than the overall US economy and the S&P did over the same period, but still represents a sharp departure from the past.  One might also argue that MSFT’s numbers are flattered by the recent launches of Windows 7 and Office 2010, which together have added about $1 a share to eps.  What comes next?

INTC:  it took INTC until 2010 to surpass its earnings peak of 2000.  Yes, the PE has been flattened and the company trades at at about 2/3 of the market multiple, but earnings growth has been sub-par until recently.  The big change for INTC, to my mind, is new management that is focused on building what customers want rather than on what its engineers can create.

which to buy?

Here’s where ideology comes in.

On a PE basis, INTC is a little cheaper.

But, to my mind, MSFT has a far superior operating model.  Relative earnings growth vs. INTC over any time period shows this.  MSFT has had a stranglehold on the personal computer operating system and productivity program businesses for over two decades.  There are few signs of this changing, since so many corporate IT systems are built on MSFT products.  Unlike INTC, MSFT has little need for capital.  And, again to my mind, because AAPL’s Office-like products are so bad, MSFT faces less competition in this arena than INTC does vs. AMD.

On the other hand, MSFT appears rudderless.  It hasn’t had a new product success in at least a decade.  And I see no signs MSFT is wiling to adapt itself to a changing environment.

INTC, in contrast, faces serious competition from ARMH.  But INTC seems to me to understand the need to recast the way it operates and is changing itself as quickly as it can.

If I could choose one of the two to own 100% of myself, there’s no question I’d pick MSFT.   So it seems to me that if I were a “no catalyst” value investor, that’s the stock I’d choose.

But, as it turns out, I’m a catalyst-for-change kind of guy.   I own INTC and not MSFT.  Why?  It isn’t the lower PE.  It’s the catalyst that I see in the current INTC management and that I don’t detect with MSFT.

a footnote on AAPL

How does AAPL fit into this discussion?  In a sense, it doesn’t, because AAPL is clearly a growth stock.  Over the past two years, however, the AAPL PE has contracted from about 30 to the current 14.  In fact, if you subtract AAPL’s $50+ billion in cash from the market capitalization, AAPL is trading at a sub-market multiple of under 12.  The stock is being priced almost as if the company had already gone ex-growth, which it clearly has not.  I can’t recall ever having seen a true growth stock act this way.