Category Archives: growth vs value

Snap (SNAP) non-voting shares (iii)

February 27, 2017 By in return on equity, Uncategorized Tags: , , , , Leave a comment

forms of capital

Traditional financial theory separates a company’s long-term capital into two types:

–debt capital.  This is money the firm has borrowed, either through bank loans or company-issued bonds.  Creditors may have influence over company operations through restrictions spelled out in the loan documents, called covenants.  They generally specify measures to accelerate loan repayment that the company must take if it fails to meet stipulated profit or cash flow measures.  (An example:  the firm may be forced to devote all cash flow to loan repayment if profits decline sharply.  Money can’t be spent on things like capital improvements or dividends unless creditors give the ok.)

–equity capital.  Equity means ownership.  Common stock ownership is typically established by the means equity owners have to assert/protect their interests–usually the ability to vote on appointment of members of the firm’s board of directors.  The board, in turn, hires and evaluates management.

Some companies may also issue preferred stock.   Preferreds qualify for their name because they have some advantage, or preference, over common.  The typical preferences are: higher/more secured dividend payment; and/or priority over common equity in liquidation proceedings.  On the other hand, preferreds typically either have restricted/no voting rights.  In the US, preferreds, despite the equity in their name, typically trade as if they were a form of corporate debt.

SNAP non-voting shares

Where do the SNAP shares fit in this scheme?

They’re clearly not debt    …but are they equity?

They are certainly not traditional equity.  They have no ability to exercise any influence on company operations, and certainly no way to replace an underperforming board of directors.  On the other hand, they don’t appear to have any of the greater security of preferreds.  In fact, they seem to be a hybrid that combines the riskier features of both.

The closest I can come, in my past experience, to US non-voting shares like SNAP’s (or Google’s for that matter) are Korean preferreds and Italian certificates of participation.  In both cases, they traded well in up markets but underperformed very signficantly during market declines.

 

value investing and mergers/acquisitions

June 13, 2016 By in capital spending and the business cycle, Capital-intensive firms, capitalizing vs. expensing, mergers and acquisitions, return on equity vs. return on capital, Uncategorized Tags: , , , , Leave a comment

buy vs. build

When any company is figuring out how it should grow its existing businesses and potentially expand into other areas, it faces the classic “buy or build” problem.  That is to say, it has to decide whether it’s more profitable to use its money to create the new enterprise from the ground up, or whether it’s better to acquire a complementary firm that already has the intellectual property and market presence that our company covets.

There are pluses and minuses to either approach. Build-your-own takes more time.  The  buy-it route is faster, but invariably involves purchasing a firm that’s only available because it has been consigned to the stock market bargain basement because of perceived operational flaws.  Sometimes, acquirers learn to their sorrow that the target they have just bought is like a movie set, something that looks ok from the outside but is only a veneer.

when the urge is greatest

Companies feel the buy/build expansion urge the most keenly at times like today, when they are flush with cash after years of rising profits.

so why isn’t value doing better?

Many economists are explaining the apparent current lack of capital spending by companies by arguing that firms are opting in very large numbers to buy rather than to build.

The beneficiaries of such a universal impulse should be value investors, who specialize in holding slightly broken companies that are trading at large discounts to (what value investors hope is) their intrinsic value.  Growth investors, on the other hand, typically hold the strong-growing companies with high PE stocks who do the acquiring.

On the announcement of a bid, the target company typically goes up.  The bidder’s stock, on the other hand, usually goes down.  That’s partly because the bid is a surprise, partly because the target is perceived to be priced too high, partly simply because of arbitrage activity.

All this leads up to my point.

Over the past couple of years, growth investing has done very well.  Value has lagged badly.  How can this be if merger/acquisition activity continues to be large enough that it is making a significant dent in global capital spending?

 

 

earnings growth: velocity vs. acceleration

May 10, 2016 By in earnings surprise, growth vs value, strong earnings, Uncategorized Tags: , , , , , , 1 Comment

velocity vs. acceleration

For investors, earnings velocity is the rate of change of earnings.

Earnings acceleration is the rate of change of velocity.

Examples:

If a company is growing earnings per share at a steady +10% annual rate, it has earnings velocity of +10% and acceleration of 0.

To have earnings acceleration, the rate of earnings growth has to increase.  The growth rate pattern has to be something like:  +10%, +12%, +15%…

Both velocity and acceleration can be negative as well as positive.  If velocity is negative, earnings are shrinking.  If acceleration is negative, the rate of earnings growth is slowing down.  For growth investors, both are bad signs.

as applies to growth investing

Having any earnings per share growth is better than having none.  Having eps growth that’s fast, and faster than that of the average stock, is an important characteristic of attractive growth stocks.

Having eps acceleration is also important.  Its presence typically creates the largest price earnings multiple expansion.

Acceleration is a two-edged sword, however.  Securities analysts looks for signs of earnings growth deceleration as an early warning sign that a company’s period of superior growth–and therefore of its attraction to investors–is coming to an end.  So it’s often the case that the PE will begin to contract, even though absolute growth is high, because that growth is starting to decelerate.

why this can be important:  performance implications

This can create an odd situation between the performance of two stocks, A and B.

Annual growth of A’s earnings: +20%, +35%, +45%, +25%.

Growth of B’s earnings:  +10%, +12%, +15%, +18%.

In the first two years,  Stock A most likely has outperformed Stock B.  By year 4, B is most likely outperforming A, even though the rate of growth of A’s earnings is continually better than B’s.  That’s because A’s earnings are beginning to decelerate, while B’s are not.

 

 

 

 

 

 

 

why Apple (AAPL) is a growth stock anomoly

May 9, 2016 By in from growth to value: the life cycle, growth vs value, Uncategorized Tags: , , , , , 3 Comments

Although AAPL is one of the most important growth stocks of the past decade, its price action doesn’t fit my description of “typical” growth stock behavior.

Although AAPL’s earnings per share rose by 500% between 2009 and 2012, the price earnings ratio of AAPL, which experience says should have expanded a lot during this period, actually contracted.  More than that, it shrank during a period when the PE of the overall S&P 500 was expanding.  So, relatively speaking, its PE behavior was considerably worse than appears at first glance.

In addition, by 2013-14, there was, in my view, ample evidence that the best days for the iPhone would soon begin to be visible only in the rear view mirror.  Yet, after a slump in 2013, the shares recovered their upward momentum in 2014 and carried on their strong performance through most of 2015.  In other words, there wasn’t, as I read the stock price, the usual performance falloff in anticipation of the end to super-normal growth.

How did these things occur?

no PE expansion

On the first point, I don’t have a great answer.  As I wrote while this was happening (or, actually, not happening), I’d never seen this behavior elsewhere in 20+ years of buying growth stocks in the US and around the rest of the world (I was a value investor early in my career).

The only thing I can come up with is that AAPL changed from a very conservative method of accounting for its iPhone profits to a more aggressive one in late 2009.  The change added between 50% and 100% to near-term reported profits.

Professionals typically applaud companies whose accounting is conservative, and disapprove of those who sail closer to the wind.  In AAPL’s case the more flattering figures had been routinely included in notes to the financial statements, where anyone who cared could look at them. So although the move may have been calculated by AAPL management to give the stock a boost, the change didn’t provide any new positive information.  It only created the impression that AAPL was more concerned with flashy optics than operations.

(The issue was how to account for sales of iPhones by AT&T on two-year contracts where AAPL shared in the revenues AT&T collected over the contract life.  AAPL’s initial stance was to recognize the revenue over the two years.  The change was to credit everything up front, at the time of sale.)

no anticipation, no PE contraction

This is a lot easier.  The main factors:

The PE never went up in the way the multiple of growth stocks typically does.

As is the case with many successful growth stocks, AAPL started out with a retail investment base.  Then came hedge funds.  Traditional long only professionals bet against AAPL early on, in my view, and came to the party only after suffering considerable underperformance, either from not owning the name at all or from owning a less-than-market-weight position.  AAPL’s earnings growth was so powerful and so long-lasting that the safest position for skeptics became to establish, kicking and screaming, a market-weight position.  That allowed them to forget about AAPL and look for outperformance elsewhere.  In a sense, the stock’s upward momentum fed on itself.  But it also meant steady accumulation of the name.

In 2013 Carl Icahn convinced AAPL to begin using financial engineering–borrowing to fund large scale stock buybacks and dividend increases–to boost the stock price.  Maybe he didn’t put it quite that way, but between the end of the company’s fiscal 2012 and its fiscal 2015, AAPL shrank the number of its outstanding shares by 15%, despite issuance of new stock to employees.  That’s enough to change the psychology of buyers, as well as to relieve potential selling pressure and give a mild boost to eps.

Mr. Icahn has recently announced the sale of his AAPL holding.  Given that and recent negative earnings news, the stock has declined and the PE has contracted a bit.  However, the shares are now trading at about 2/3 the multiple of the typical US stock–mostly because the market PE has expanded while AAPL’s hasn’t.  All the damage has been in the relative PE, not the absolute.  At such a low relative PE today, I find it hard to argue that damage to the absolute PE multiple is in the cards.

Apple (AAPL) as a growth stock

May 6, 2016 By in from growth to value: the life cycle, growth vs value, Uncategorized Tags: , , , , , 1 Comment

Apple is among the most successful growth companies of the past ten years.  However, AAPL has had a most peculiar trajectory as a growth stock.  To my mind, it has barely followed any part of the typical growth stock pattern I outlined yesterday.

How so?

For one thing, the peak price earnings multiple and the peak stock price didn’t coincide from AAPL.  Yes, the company did switch to a much less conservative method of accounting for iPhone profits early in that product’s life, but I don’t mean that.  Even after the switch, the PE didn’t expand while the company was piling up quarter after quarter of spectacular, continually surprisingly strong, earnings performance .  The multiple contracted slightly instead.

For another, it was clear by, let’s say 2012, that the smartphone market was becoming saturated.  AAPL was also facing increasing competition from the Android operating system and from Samsung as a manufacturer of mobile devices.  So we had to think that pretty soon the iPhone profit dynamo would begin to lose momentum.

What about another reinvention?  The issue here has always been:

–Reinvention #1, the iPod, doubled the size of a small company.  Reinvention #2, the iPhone, more than doubled the size of a now-large company.  To repeat the same quantum leap, Reinvention #3 would have to be twice the size of the smartphone.  What would that product be?  Would such a product be possible?  (my answer: probably not)  Is such a product likely?  (not likely at all)

(AAPL has had two subsequent innovations, the iPad and the iWatch.  Neither has created anything like the response needed to be Reinvention #3)

In a nutshell, the elevator speech was starting to give a sell sign–based both on earnings momentum for the company as currently constituted and another possible reinvention.

 

Yet, the stock continued to go up, and to outperform the S&P, until about a year ago.

Why?

More on Monday.