continuing apparel retailing woes

I haven’t been watching publicly traded apparel retailers carefully for years.  For me, the issues/problems in picking winners in this area have been legion.  There’s the generational shift in spending power from Baby Boomers to Millennials, the move from bricks-and-mortar to online, the lingering effects of recession on spending power and spending habits.  And then, of course, there’s the normal movement of retailers in and out of fashion.

I’m not saying that retail isn’t worth following.  I just find it too hard to find solid ground to build an investment thesis on.  Maybe the pace of change is too rapid for me.  Maybe I don’t have a good enough feel for how Millennials regard apparel–or whether retiring Boomers are using their accumulated inventories of fashion clothing rather than adding to them.

Having said that, I’m still surprised–shocked, actually–at how the current quarter for apparel retailers is playing out.  It seems like every day a new retailer is reporting quarterly earnings that fall below management guidance, usually the latest in a string of sub-par quarters.  That itself isn’t so unusual.

But the stocks react by plummeting.

You’d think that the market would have caught on that Retailland is facing structural headwinds.  Or at least, that the retail area that made the careers of so many active managers over the past twenty or thirty years doesn’t exist any more.


Is it robot traders?  Is it an effect of continuing buying by index funds?  I don’t know.  But the continuing inability of investors to factor into stock prices the continuing slump of apparel retailers is certainly odd.

the Sears “going concern” warning

the auditor’s opinion

On my first day of OJT in equity securities analysis, the instructor asked our class what the most important page of a company’s annual report/10k filing is.  The correct answer, which escaped most of us, is:  the one that contains the auditor’s assessment of the accuracy of the financials and the state of health of the company.  The auditor’s report is usually brief and formulaic.  Longer = trouble.

Anything less than a clean bill of health is a matter grave concern.  The worst situation is one in which the auditor expresses doubt about the firm’s ability to remain a going concern.

a new financial accounting rule

In today’s world, that class would be a little different.  Yes, the auditor’s opinion is the single most important thing.  But new, post-recession financial accounting rules that go into effect with the 2016 reporting year require the company itself to point out any risks it sees to its ability to remain in business.

the Sears case

That’s what Sears did when it issued its 2016 financials in late March.  What’s odd about this trailblazing instance is that while the firm raised the question, its auditors issued an “unqualified” (meaning clean-bill-of-health) opinion.

what’s going on?

Suppliers to retail study their customers’ operations very carefully, with a particular eye on creditworthiness.  That’s because trade creditors fall at the absolute back of the line for repayment in the case of a customer bankruptcy.  They don’t get unsold merchandise back; the money from their sale will likely go to interests higher up on the repayment food chain–like employee salaries/pensions and secured creditors.  So their receivable claims are pretty much toast.

Because of this, at the slightest whiff of trouble, and to limit the damage a bankruptcy might cause them, suppliers begin to shrink the amount and assortment of merchandise, and the terms of payment for them, that they offer to a troubled customer.   My reading of the Sears CEO’s recent blog post is that this process has already started there.

It may also be, assuming I’m correct, that the effects are not yet visible in the working capital data from 2016 that an auditor might look at.  Hence the unqualified statement.  But we’re at the very earliest stage with the new accounting rules, so nothing is 100% clear.

breaking a contract?

Sears has complained in the same blog post about the behavior of one supplier, Hong Kong-based One World, which supplies Craftsman-branded power tools to Sears through its Techtronic subsidiary.  Techtronic apparently wants to unilaterally tear up its contract  with Sears and stop sending any merchandise.

Obviously, Sears can’t allow this to happen.  It’s not only the importance of the Craftsman line.  If One World is successful, other suppliers who may have been more sympathetic to Sears will doubtless expect similar treatment.

Developments here are well worth monitoring, not only for Sears, but as a template for how new rules will affect other retailers.




buying an individual tech stock

This is just a brief overview:

–Buying any stock involves both a qualitative and a quantitative element.  That is:  What does the company do that makes this a good stock to own? and How do the numbers–the PE ratio, asset value, dividend yield and earnings growth–stack up?

–For value stocks, the numbers are more important; for growth stocks, the story is the key.  That’s because the primary element in success for value investors is how carefully they buy (because the ceiling for a given stock is relatively clearly defined).  For growth investors, it’s selling before/as the drivers of extra-fast earnings expansion run out of steam.

–Most tech stocks fall in the growth category.  My advocacy for Intel a few years ago was one of the rare occasions where a tech story is about under valued assets.

–In most cases, tech companies own key intellectual property–software, patents, industrial knowhow–that is in great demand, and which competitors don’t have and can’t seem to create substitutes for.  As long as that remains true, the company’s stock typically does well.  As I just mentioned, a crucial element in success with tech (or any other growth sector) is to exit before/as the growth story begins to unwind.  One yardstick is that this typically happens five years or so after the super-growth starts.  Yes, the best growth companies, like Apple or Microsoft or Amazon, have an ability reinvent themselves and thereby extend their period of strong earnings success.  But this isn’t the norm.

–Learning to be a stock investor is sort of like learning to play baseball.  There’s no substitute for actually playing the game.  The best way I know to learn about a stock is to buy a very small position and see what happens.  Don’t just sit idle, though.  Read everything on the company website, and the websites of competitors.  Read the last annual report and 10k.  Listen to (or read the transcripts of) the firm’s earnings conference calls.  Find and monitor (at least the headlines) financial newspapers and relevant blogs.  Try to form expectations about what future earnings might be and check this against what actually happens.  Then figure out where/how you went wrong and adjust.  Watch how the market reacts to news.  At first you may be terrible.  I certainly was.  But if you’re honest with yourself in your postmortems, you’ll probably make considerable progress quickly.

–Sooner or later–preferably sooner, learn to interpret a balance sheet and income statement.  A local community college course would probably be good, but you can get the basics of financial accounting (definitely don’t worry about double entry bookkeeping) from a book over a weekend.  Remember, here too there’s no substitute for the experience of trying to work out from a given company’s actuals what future income statements, balance sheets and flow-of-funds statements will look like.


investing in tech (ii)

other tech characteristics

–unlike areas like, say, fossil fuels, tech will likely continue to experience strong growth for a long period of time

–tech is also an area where the US has a comparative advantage, due to the presence of  strong tech-oriented universities, the large size of the existing tech community and the easy availability of capital to finance new tech ventures

a French scholar as tech banker

Early in my career, I had an acquaintance who had spent her life to that point studying for a PhD in French literature, intending to teach at a university somewhere.  She should have studied at least some economics in addition, because, like me, she finished here degree just as the Baby Boom finished college and universities stopped hiring new faculty.  I’d become an equity securities analyst; she’d become a banker to tech companies.  Initially, she was worried that her lack of a science background would be a severe negative.  She found, however–as I did–that electrical engineering was far less important than being able to figure out whether there was any demand for the stuff a given tech company made, at what price, and whether there was any competition.

I think this is still true today–meaning that most people can be successful tech investors, provided they’re willing to put in time and effort.  While a technical background (or access to a friend or relative who has one) is a plus, common sense and a little supply/demand economics is much more crucial.

active or passive/individual stock or fund

The simplest, and lowest risk, way for any of us to increase the tech component of our equity exposure is to replace an S&P 500 index fund/ETF with a tech sector index fund/ETF .

There are also subsector funds/ETFs that allow a narrower focus on, to name a few popular subsectors, internet or cypersecurity or semiconductor stocks.  There are even a few actively managed tech ETFs, although it’s not clear that these outperform passive vehicles.

The largest rewards, and the greatest risks, come with buying individual stocks.  My approach to holding an individual tech stock is pretty much the same as for holding any other type of individual stock.

More tomorrow.


investing in tech

A reader asked me to write about how I approach investing in tech stocks, an area I like and one which I think I’ve acquired some competence in over the years.

IT as a component of the S&P 500

Let’s start with the structure of the S&P 500, which, as of yesterday’s market close, looked like this:

Information Technology          22.5% of the index

Financials          14.1%

Healthcare          14.0%

Consumer discretionary          12.5%

Industrials          10.2%

Staples          9.3%

Energy          6.3%

Utilities          3.2%

Real estate          2.9%

Materials          2.9%

Telecom          2.3%.

Source:  Standard and Poors

Yes, the numbers add up to 100.2% but that’s just rounding and doesn’t affect analysis.


An obvious conclusion from this list is that when we buy an S&P index fund, almost a quarter of what we get is already tech.

A second observation is that 22.5% is a big number.  But if we look back to the end of 2009, when the current bull market was in its earliest stage, IT represented 19.8% of the index.  In other words, by far the largest determinant of IT sector performance in the bull market has been the upward movement of stocks in general.  (For what it’s worth, by far the largest losing sector has been Energy, which comprised 11.6% of the S&P 500 back then.)

Still, there have been spectacular winners, both individual stocks and subsectors, in IT.  So taking the time and effort to study IT stocks can pay big dividends.

placing IT in a business cycle context

Let’s group stocks by the sensitivity of their profits to the ups and downs of the business cycle, starting with the most aggressive (meaning most sensitive) and ending with the most defensive.  This is my list:

most aggressive




Industrials  (this would be #3, except US industrials make mostly consumer            products)

less aggressive 

Consumer discretionary

Real Estate (this would be #4, except that a lot of the publicly traded vehicles are income-                            oriented REITs)





more defensive



I’m sure that the lists others would come up with would rank the sectors differently.  Try it yourself and see.

What I make of my list is that IT will likely outperform anything lower on the list during an economic upturn and underperform during a downturn.

Two reasons:

–most consumer IT purchases, like a new smartphone or a new PC/tablet, are discretionary and can easily be postponed when times are tough, and

–for many modern corporations, capital spending means software.  And, in my experience, no matter how they say they maintain steady investment in their business, companies rarely outspend their cash flow.  When bad times lessen cash flow, companies–despite their promises–cut capex (i.e., software) spending.  Consumers, on the other hand, are much less draconian in their cutbacks, at least in the US.


Tomorrow, secular trends.




professional investment advice (ii)

Yesterday, I wrote about the problems a Wall Street Journal reporter had in discovering how much she paid in fees to the professionals she hired to invest her money.  The task, which we’d think should be a piece of cake, turned out to be very difficult.  Although the reporter didn’t identify the firm in question, the corporate philosophy seems to be the usual one for active managers of emphasizing service rather than fees.  This decision, which is hard to fault in itself, has been transmuted into two courses of action–bury fee information as deeply as possible, and keep the fees (1.4% of assets per year, in this case) very high, in the hope no one notices.

Oddly enough, this strategy has been relatively effective for decades.

It seems to me, though, that being aware of what one is paying for professional investment advice is only part of the assessment process.  A second important criterion is what the gains in investment performance are that come from having an investment adviser.  The relevant metric is how effective the adviser’s asset allocation and portfolio management efforts are in keeping the client at least even with the appropriate benchmark after subtracting fees.  

Andrea Fuller’s case would work out like this:

Let’s say her “moderate” asset allocation ends up being 60% stocks, 40% bonds.  If we take the returns of the S&P 500 and of some broad bond index as proxies, a rough benchmark return for her over a given period is easy to calculate.

In my view, a reasonable expectation would be that one’s portfolio should (at least) keep pace with the index after fees.  I say “reasonable” although knowing less than a quarter of active managers are able to consistently exceed my standard and over half consistently fall short.

In an ideal world, an active manager who is consistently unable to perform in line with the appropriate benchmark after fees has an easy fix–at least a partial one.  Lower fees to the point where the portfolio is at least close to the index.  Her firm’s high fee level and the teeth pulling needed to figure out what they are suggest this is the last thing on its mind.

Given that this is the case, the operative question for Andrea, and for anyone else, is how much the service the firm may be providing–like determining asset allocation or the availability of a knowledgeable account executive to answer questions or handholding during crises–is worth in terms of losses to an index fund strategy that one could easily implement on one’s own.

It also seems to me that if annual returns consistently fall more than 1% below a benchmark after fees it’s worth the time to shop around for a different investment management firm.


how much does professional investment advice cost?

the article

Yesterday’s Wall Street Journal has a curious article in its monthly “Investing in Funds & EFTs” section.  It’s by Stanford graduate Andrea Fuller, a reporter whose specialty is data analysis.  It’s about her trying to find out how much she pays for professional investment advice/management.

the outcome

As she describes it, her situation is a simple one.  She uses an investment firm that’s “one of the largest in the country,” no name though.  The bottom line for her is that she pays a yearly fee, deducted daily, of 1.40% of the assets under management, which consist entirely of ETFs and mutual funds.

The fees break out in the customary way into two parts–an overall fee, sometimes called a “wrap” fee for the service of determining an appropriate asset allocation and selecting funds/ETFs,  plus providing an interface to discuss investment issues.  In Ms. Fuller’s case, that amounts to 0.85% of the assets.  In addition, she pays an average of 0.55% per year for the portfolio construction and management of the mutual funds and ETFs she owns.

pulling teeth

What’s interesting about the story is that Ms. Fuller (1) didn’t know this information before she decided to write the story, and (2) assumed, as I would have, that the figure would be easily available with a phone call or email.  In Ms. Fuller’s case, that’s wrong.

(a longish, maybe pedantic…sorry) Note:  the article implies that all the products are “in-house,” that is, provided by a single investment firm which is also the client interface.  If so, finding out costs is straightforward–what Ms. Fuller pays in total and what she pays to the firm are the same.  If, however, the investment firm uses a third-party portfolio manager for any portfolio products, it typically demands a portion of the third party’s management fee in return for providing access to “its” client.  This means that the total fees paid consist of two parts:  the fees paid to the client-facing investment firm and amounts paid to third parties.  In my experience, investment firms are very reluctant to disclose what their fee-sharing arrangements are.  A Customer Service hotline or a plain-vanilla investment adviser would never have that information.  In that case, the answer to the fee question Ms. Fuller posed is not so simple.)

Tenaciously, Ms. Fuller made a series of phone call (and email?) attempts to get this basic information from her investment adviser.  On at least two occasions, she answer she got was wrong–and, surprise, surprise, understated fees.  Although she finally verbally received the figures I cited above, she was unable to get anything in writing.  Apparently, this basic data isn’t disclosed on the firm’s website, either.  At one point during her journey, she was told to consult Morningstar and figure the fees out herself.

My thoughts:


–By and large, investment firms are run by professional marketers, not professional investors.  Their emphasis is typically on cultivating a relationship that focuses on client service and peace of mind and which deemphasizes the nuts and bolts of fees and performance vs. an index or competitors’ offerings.

Still, I’ve never encountered a situation where fees haven’t been readily available and disclosed somewhere in the small print.  To me, Ms. Fuller’s firm seems to me to be either stunningly inept or to be deliberately choosing to make fee information virtually impossible to obtain.


More tomorrow.