Category Archives: growth vs value

ARK Investment Management and its ETFs

October 13, 2014 By in Autos, cloud services, ETFs Vs. Mutual Funds, growth vs value, Industry Analysis, internet, Investment firms, robots, semiconductor manufacturing, software, Technology, Wireless Tags: , , , , , , , , Leave a comment

ARK

I was listening to Bloomberg Radio (again!?!) earlier this month and heard an interview of Cathie Wood, the CEO/CIO of recently formed ARK Investment Management.  I don’t know Ms. Wood, although we both worked at Jennison Associates, a growth-oriented equity manager with a very strong record, during different time periods.  Just before ARK, she had been CIO of Global Thematic Strategies for twelve years at value investor AllianceBernstein.  (As a portfolio manager I was a big fan of Bernstein’s equity research but I’m not familiar with her Bernstein output.)  She’s been  endorsed by Arthur Laffer of Laffer Curve fame, who sits on her board.

ARK is all about finding and benefiting from “disruptive innovation that will change the world.”

Ms. Wood was promoting two actively managed ETFs that ARK launched at the beginning of the month, one focused on industrial innovation (ARKQ) and another the internet (ARKW).  Two more are in the works, one for genomics (ARKG) and the last (ARKK) an umbrella innovation portfolio which will apparently hold what it considers the best of the other three portfolios.

What really caught my ear in the interview was Ms. Wood’s discussion of the domestic automobile market (summary research available on the ARK website).  Most cars lie around doing nothing during the day.  What happens if either ride-sharing services like Uber or the Google self-driven car, which make more constant use of autos, catch on as substitutes?  According to Ms. Wood, until these innovations reach 2.5% of total miles driven (based on the idea that on a per mile basis ride-sharing costs half what owning a car does), there’s little effect.  But at 5% penetration, the bottom falls out of the new car market.  New car sales get cut in half!

Who knows whether this is correct or whether it will happen or not   …but I find this a very interesting idea.

about the ETFs

The top holdings of ARKW are:  athenahealth, Apple, Facebook, Salesforce.com and Twitter.  These comprise just under 25% of the portfolio.

For ARKQ, the top five are:  Google, Autodesk, Tesla, Monsanto and Fanuc.  They make up just over 24% of the portfolio.

Both will likely be high β portfolios.  Both have performed roughly in line with the NASDAQ Composite since their debut.

The perennial question about thematic investors (I consider myself one) is whether the high-level concepts are backed up by meticulous company by company financial research.  This is essential.  In addition, it’s important, to me anyway, that the holdings be arranged so that they’re not all dependent on a single theme–the continuing success of the Apple ecosystem, for instance.

I’m not familiar with Ms. Wood’s work, so I can’t say one way or another (Fanuc and ABB strike me as kind of weird holding for ARKQ, though).  But I think her research is worth reading and her ETFs worth at least monitoring.  For us as investors, the ultimate question will be whether Ms. Wood can outperform an appropriate index.  The NASDAQ Composite would be my initial choice.

 

 

 

 

 

failing toll roads in the US-why?

September 25, 2014 By in distressed assets, project accounting, Transport Tags: , , , Leave a comment

I’m convinced that studying the behavior of Millennials –and in particular how it differs from previous generations’–will ultimately produce a treasure trove of equity investment ideas.

So my ears perked up when I began noticing recent reports of continuing failure of toll road investment projects that had been in vogue ten years or so.  Many were packaged by Australian investment bank Macquarie and/or Spain’s Ferrovial.

Chapter 11 filings have been attributed in the media to a sharp slowdown in total miles driven by Americans since 2007 (“…largest decline since World War II,” said one article).  Millennials’ aversion to autos and the suburbs are the supposed causes.

A quick check shows that’s not exactly right.

The Federal Highway Administration’s monthly Traffic Volumes Trends indicates that total miles driven by Americans has fallen from the peak of 3.03 trillion miles in 2007.  But the present level is still 2.98 trillion, a seven-year decline that totals only 1.65%.  Yes, this is a change from the pretty steady rise of just over 1% annually during the prior couple of decades.  But it’s hard to image that worst-case planning didn’t allow for a flattening out of traffic volume.

Two other characteristics of these deals stand out to my, admittedly cursory, glance, as being much more important:

–they’re very highly financially leveraged, and

–they contained a ton of derivative protection against rising interest rates–which backfired horribly, adding significantly to the already-high debt burden.

The deals also appear to have suffered from wildly overoptimistic projections of future road usage, although these were likely less linked to project survival and more to the possibility of above-average gains.

In any event, my main point is that this is not a story of differing Millennial behavior.  It’s all about bad project design and mistaken derivatives overlays.

 

 

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when to analyze sales rather than earnings

September 11, 2014 By in growth vs value Tags: , , , 1 Comment

I was listening to Bloomberg News on the radio the other day, when a stock market reporter began a segment of an afternoon show by mentioning a a study he’d received of US stock market valuation based on price to sales rather than PE.

“Why sales and not earnings?” asked the show host.

The reporter had no clue. (An aside: it’s not clear to me whether this host asks probing questions of this particular reporter despite the fact he never can answer them or because he can’t.  I also sometimes wonder how aware each party is of the dynamics of their interaction–showing I must have too much time on my hands.)

Anyway, I decided to write about using sales as an analytic tool.

First, I should be clear that I’m not normally a fan of price to sales.  That’s probably because I’m a growth stock investor and am most often seeking out situations where profits are going to expand faster than sales..

To answer the host’s question as best I can:

Some companies are highly cyclical, like American autos or semiconductor equipment makers.  In bad times, they still have sales but may be posting losses.  Yet nobody pays you to take the shares off their hands; the stock trade at a price greater than zero.  In other words, at market bottoms they trade on something (i.e., sales or assets) other than earnings.  Similarly, as the economy recovers and the profits of deep cyclicals begin to explode to the upside, the PE multiple they sport progressively contracts.  In many cases, profits continue to surge but the stock price stops going up–because investors are anticipating the next dip of the cyclical roller coaster.  Again, they’e not trading on earnings.

So, at market bottoms the losses from cyclicals reduce overall index earnings, making the market look more expensive than it arguably should be.  At market tops, the stingy multiples that investors apply to peak earnings can make the market look misleadingly cheap.

Both distortions are eliminated, or at lest mitigated, by using price/sales.

Also, one might maintain that price/sales allows a better comparison between past decades, when a large portion of the market consisted of deep cyclicals, and the present, when the cyclical content is much smaller.

More tomorrow.

the Market Basket saga: taking Arthur S’s position

August 29, 2014 By in activist investing, activist invstors, book value, family owned companies, mergers and acquisitions, supermarkets Tags: , , , , Leave a comment

Market Basket is a privately held New England discount grocery chain controlled by two third-generation branches of the founding family.  One branch, owning 50.5% of MB, is led by Arthur S. and has no role–other than being on the board of directors–in the day-to-day running of the firm.  The other is led by the largest single shareholder, Arthur T.

MB recently deposed Arthur T. as CEO and replaced him with two non-family members.  Warehouse and delivery workers struck when they heard the news (with the encouragement of Arthur T., some have suggested), preventing the 71 stores from restocking and effectively hamstringing the firm.  Recently, the Arthur S. branch has agreed to sell its shares of MB to Arthur T. for $1.5 billion.

Throughout this highly public dispute, Arthur T. has been portrayed as a benevolent retail genius, creating an immensely successful business with fanatically devoted employees and extremely loyal customers.  Arthur S., on the other hand, has been seen as a money-grubbing child of privilege who wants to fund his yacht and string of polo ponies by pillaging the workers’ retirement plans.

A lot of this may be true, for all I know.  And the issues rocking MB are all pretty routine third-generation family owned company stuff (see my earlier post on MB).  But in the feel-good story line being taken by the media, one fact is being overlooked.  From what little has been in the press about MB’s profits, it doesn’t appear to be a particularly well-run company.  Arthur S. is probably right that Arthur T. isn’t a good manager.

the case for Arthur S.

Let’s say I’m a member of the Arthur S family and I hold 5% of MB’s outstanding stock.  I receive a yearly dividend of $5 million.  My genetic good fortune is significantly better even than winning the Megamillions jackpot.  So in one sense I should have no complaints.

On the other hand, my share of the assets of MB is worth about $175 million.  Therefore, my annual return on that asset value is 2.9%.  That’s about half the return on assets that Kroger achieves.  It’s also just over a third of what Wal-Mart generates, but I’m confident MB doesn’t aspire to be WMT.

I presumably also know that good supermarket locations are extremely hard to find in New England and that those MB has established over prior generations are immensely valuable.  It’s conceivable that if MB were to conceptually divide itself into two parts, a property owning one and a supermarket operating one, and have the property arm charge market rents to the stores, MB would see that the supermarket operations lose money and are only kept afloat by subsidies from the property arm.  (This situation is more common than you’d think.  It was, for example, the rationale behind the hedge fund attack on J C Penney.  That fact that inept activists botched the retail turnaround doesn’t mean the underlying strategy was incorrect.)

Even back-of-the-envelope numbers suggest something is very wrong with the way MB is being run.  Personally, my guess is that the inefficiency has little to do with employee compensation or with merchandise pricing, although the former has apparently been the focus of the AS’s discontent.  I’d bet it’s in sourcing and in how shelf space is allocated.

At the same time, Arthur T is presumably blocking my every attempt at finding stuff out and is rebuffing board suggestions that he bring in help to analyze why his returns are so low.  If MB were a publicly traded company, I could sell my shares and reinvest in a higher-return business.  I’m probably not able to do this with MB.  Even if I were, the public intra-family feuding would suggest the stock wouldn’t fetch a high price.

I have two choices, then.  I can accept the status quo, or I can try to create a consensus for the family to sell the firm.  That latter is what Arthur S. chose to do.

“New World Order”: Foreign Affairs

June 30, 2014 By in book value, Capital-intensive firms, cloud services, Current Market Thoughts, economics, employment, growth vs value, Industrials, return on equity, return on equity vs. return on capital, robots, software, Stock ideas, Strategy, Technology Tags: , , , , , , 1 Comment

The July/August 2104 issue of Foreign Affairs contains an interesting conceptual economics article titled “New World Order.”  It’s written by three professors–Erik Brynjolfsson (MIT) , Andrew McAfee (MIT) and Michael Spence (NYU)–and outlines what the authors believe are the major long-term trends influencing global employment and economic growth.  I’m not sure I agree 100%, but I think it’s a reasonable roadmap to start with.

Here’s what the article says:

the past

Globalization has allowed companies to exploit wide wage differentials between countries by moving production from high-cost labor markets close to consumers to low labor cost areas in the developing world.  Former manufacturing workers in high-cost areas enter the service sector to seek employment, depressing wages there.

This period is now ending, as relative wage differentials have narrowed.

now

Relative labor costs are at the point where manufacturing plant location is determined by other factors.  These include:  transportation cost, turnaround time for new orders and required finished goods inventory.  This implies that manufacturing can be located closer to the end uses it serves.  However, globally higher labor costs also imply that new factories will be much more highly mechanized than before.  Robots replace humans.

As a result, wage growth will remain unusually subdued.

the future 

Although returns to capital have avoided the erosion that has befallen labor over the past generation, this situation won’t last.  Long-lived physical capital is being replaced by software (note:  the majority of investment spending done by US companies is already on software).

Software doesn’t have either the total cost or the permanence of capital invested in physical things.  Software can be moved, it can be duplicated at virtually zero extra expense.  To the extent that software replaces physical capital as a competitive differentiator, it makes the latter obsolete.  It, in turn, can be made obsolete by the innovative activity of a small number of clever coders.

Therefore, the authors conclude, returns on invested capital (especially physical capital) are already beginning to enter secular decline.

Where will future high returns be found?

…in the innovative activity of talented, well-educated entrepreneurs.

education

This brings us to a major problem the US faces.  It’s the relative slippage of the domestic education system vs. the rest of the world, and an increased emphasis on rote learning (No Child Left Behind?).

The trio dodge this politically charged issue–they do observe that there’s a direction relationship between the quality of a community’s schools and the affluence of its citizens–by asserting that online learning will come to the rescue.  A child stuck in a weak school system will, they think, be able to in a sense “home-school” himself to acquire the skills he needs to succeed in the future they envision.

my take

What I find most interesting is the presumed speed at which the authors seem to think transition will occur.

–Is it possible that we’ve reached the point where there’s no available low-cost labor left in the world?  If so, this is a dood news/bad news story for low-skill workers.  On the one hand, downward wage pressure will stop.  On the other, robotization is going to take place at warp speed, making it harder to find a job.

Relocation of factories will also have implications for transportation companies, warehousing and even the amount of raw materials tied up in company inventories.

–Does software begin to undermine hardware so quickly?  Certainly this the case with online retailing and strip malls.  But how much wider is this model applicable?

–If the key to future growth is young entrepreneurs, then the sooner we as investors reject the Baby Boom and embrace Millennials the better.  This, I think, is the safest way to benefit in the stock market if the New World Order thesis proves correct.