Category Archives: Industry Analysis

paying for brokerage research

August 14, 2017 By in investment advice, Investment firms, paying for investment advice, soft dollars, Uncategorized Tags: , , , , , Leave a comment

As part of an EU overhaul of the financial industry, the UK has recently concluded an inquiry into pricing practices for mutual fund and other products offered to individual investors.  Press commentary is that the good luck for an industry with a bewildering array of prices (much higher than in the US) and little link between cost and value is not having been referred to the law enforcement authorities for criminal prosecution.

One big issue has been “soft dollars,” that is, paying brokers higher than usual commissions in return for their research, or for trading machines, or even newspapers–items that customers generally believe (and rightly suppose, in my view) they are paying for through management fees.   …but no!

Asset managers have been proclaiming that this is a weighty and complex issue, that the don’t know how to proceed.  They’ve generally been gnashing their teeth.

To me, this is all somewhat comical.  For decades, firms that do business in the US have been following an SEC mandate to keep meticulous records of the amount of their soft dollar expenses and what is being paid for.   The general rule was that if you stayed in line with industry practice, meaning doing whatever Fidelity did, you’d be ok legally.  They know exactly what they’ve been doing.  Also, the EU inquiry (see the link above) has been going on for three years.

There are two real issues:

–there’s a lot of money at stake, and

–handling the potential outcry from customers when they realize they’ve been paying twice (management fee + soft dollars) for research expenses.

An example:

A mutual fund has $50 billion in assets.  It turns those assets over at the industry average of 50% per year.  That means $50 billion in buys and $50 billion in sells.

Let’s say: the average stock trades for $40; the soft-dollar markup is $.02 per share; and the markup is taken on 20% of all shares traded (maybe slightly high, but the math is easier).

So, the fund “service” includes giving up $10 million a year of customer money on brokerage commissions in order to get the management company free goods and services.  That’s even though they’re collecting something like $250 million in management fees from the same customers.

disclosure vs. restructuring

Internally, I think disclosure is the lesser of the two issues.  The more difficult one is that industry revenues are stagnant or falling and by far the largest expense of any investment manager is salaries.  So, whose pocket does the lost soft dollar revenue come out of?

Vanguard, this decade’s Fidelity

Just prior to the 2007 financial crisis, Fidelity decided to turn up the competitive heat on fund management rivals by declaring it was unilaterally going to stop using soft dollars.  This time around, it’s silent so far.

Last week, Vanguard made a similar announcement.

 

new CEO for Tiffany (TIF)

July 17, 2017 By in jewelry, Retail, Uncategorized Tags: , , , , Leave a comment

TIF has languished for a number of years, for several reasons:

–the waning of the important Japanese market

–the shift of Chinese jewelry buyers away from foreign firms and toward local creations

–the recession, which lowered spending on jewelry worldwide

–perhaps most important, a lack of success in providing new designs for regular customers.

The company’s greatest strength is its brand name.  It’s unique in being able simultaneously to appeal to ultra-wealthy customers spending $10,000+ a pop and to ordinary people looking for a $200 trinket to have wrapped in the iconic blue box.

Oddly, in the discussion of TIF’s merchandising as being “tired” that I’ve been reading, analysts and (especially) reporters have been referring to this ability to serve low-end customers while still retaining the aura of exclusiveness that attracts the wealthy as a weakness.  Hard to understand.

At the same time, what’s being missed is the hole that has long existed in the TIF merchandise lineup–items that appeal to customers wanting to spend $2,000-$10,000. This middle ground is dominated by firms like Bulgari, which coincidentally have little presence among TIF’s customers in either of its market segments.

That’s wha’s so intriguing about the appointment of Allessendro Bogliolo, a former Bulgari executive, as TIF’s new CEO–something no one’s mentioning.

my $260 price target for Tesla (TSLA)

July 11, 2017 By in Autos, Tesla, Uncategorized Tags: , , , , Leave a comment

A regular reader recently asked how I arrived at $260 as a price target for selling TSLA, which many of you will know I have been trading alongside my younger son for a while.

 

To some degree, I’ve regarded TSLA in the way I would look at any growth stock.  That is to say, I look for signs that the company can grow faster than the market expects and/or would sustain an above-average expansion pace for longer than the market believes.

I then try to use the company’s financial information, plus government, trade association and individual competitors’ data to project an income statement and flow of funds statement for several years into the future.

In TSLA’s case, reliable data are scanty.  In addition, the company’s own projections of its production capacity and sales have not been anything to hang your hat on.

 

Typically, and for a stock I would consider as a core part of my portfolio, I would try to make a projection that I believe to be reasonable, or perhaps mildly aggressive, and would reassess as/when the stock reaches the future target price that projection would lead me to.

In the case of TSLA, however, I did something different.  I decided to make an extremely optimistic projection, one I thought would leave the shares at least temporarily overvalued–and which would serve as a sell signal.

 

This is what I did:

–I decided to make my projection based on 2018 earnings, since I don’t think anyone has the faintest idea of what earnings for years farther in the future will be

–I took the TSLA production forecast, which has proved consistently too optimistic, of 500,000 cars during 2018 as a given

–I decided that most of these cars would be Model 3s, where the average selling price indicated in preorders is about $42,000, as another given.  To account for a small portion of more expensive models, I rounded the average selling price up to $50,000

–I examined other publicly traded auto companies worldwide.  The highest pre-tax margin I found (yes, although this is a dangerous shortcut, I did use margins) was Porsche, at 15%.  I assumed that TSLA would achieve that margin in 2018, even though I think the figure is substantially too high

–I assigned a financial reporting tax rate of 25%, which is probably too low.  That gave me net financial reporting profits of $2.8 billion, and earnings per share of $17.10

–I decided to apply a price earnings multiple of 15x to the earnings number, even though auto companies typically trade at single digit valuations.  I don’t think TSLA should trade at the 20x+ multiple that an IT stock would merit, so 15x seemed about right.  That gave me a valuation, based on 2018 earnings of $257–which I rounded up to $260.

 

As we can clearly see from a TSLA chart, the stock blew through my $260 target in March-April as if it weren’t there.  It peaked, for now, at least, at $386–leaving an embarrassingly large gap between me and it.

 

Where did I go wrong?

The obvious place is in the PE multiple.  The prevailing market view would seem to be that 2019 earnings will be, say, $25/share, and that it’s safe to be factoring anticipated earnings for two years from now into today’s stock price.  Another way of saying the same thing, one which I think must be TSLA bulls’ belief, is that TSLA is this decade’s Amazon (AMZN)

That may well be correct.  Personally, I’m uncomfortable making the bet, though.  One thing experience does tell me, however, is that, barring a total corporate collapse, the stock is highly unlikely to get back to the $180 – $200 range that has marked the lows over the past couple of years.

a bad day for Tesla (TSLA) shares

July 6, 2017 By in Tesla, Uncategorized Tags: , , , 1 Comment

First, let’s put yesterday’s negative price action for TSLA–down by 7%+–in context.  Prior to yesterday, the stock had risen by 75%+ since the opening bell in January.  So a down day–or even a down few weeks–shouldn’t come as a shock.

What happened yesterday:

–TSLA reported 2Q17 results.  Profits were hurt by another production foulup–a shortage of batteries this time–that prevented the company from churning out cars at a higher rate.  The good news is that the problem was solved intra-quarter and shouldn’t affect results for the second half

–TSLA also said it intends to be churning out 20,000 Model 3s a month by the end of the year and 500,000 in total during 2018

–two negative analyst reports were released, arguing that TSLA is substantially overvalued.  Reasons:  plateauing demand for older models, increasing competition from other auto companies and TSLA’s less-than-perfect production experience.  Goldman Sachs says it now thinks the stock is worth $180 a share (down from $190 previously)

–Volvo announced it intends to become a exclusively a hybrid/electric car company in 2019; Baidu announced it will give its autonomous-driving car technology away for free in return for usage data.  Takers include a bunch of other Chinese carmakers + Ford and Daimler

my take

–I sold my last shares of TSLA at $260, based on the idea that this is the highest price I can reasonably conceive of TSLA trading at during 2018, assuming the company does indeed make and sell 500,000 cars.  I guess that’s my bottom line

–the negative reports are good news in the limited sense that they imply the authors’ firms see no possibility of future investment banking business from TSLA.  Maybe their negative analyst stance in the past has already ruled them out.  But emphatically underlining the fact suggests to me they think TSLA needs no further funding to carry out its production plans

–the possible turn to significant profits being earned in 2018 is a mixed blessing.  On the one hand, say, $5 a share in earnings for the company, with the promise of more to come in 2019 is better than the current situation.  On the other, the emergence of earnings–and of a more easily predictable future–means an end to the “dream” of unparalleled riches that many early-stage-company investors routinely harbor with any of their stocks.  For a certain percentage of “dream” stocks, the minute the earnings begin to arrive marks the peak in the stock price.  A minerals exploration company that owns a single orebody peaking the day the mine opens is the stock example.  Euro Disneyland is another.

UK investigation of the investment management industry

July 5, 2017 By in investment advice, Investment firms, paying for investment advice, Uncategorized Tags: , , Leave a comment

The UK Financial Conduct Authority is wrapping up a two year investigation of the money management industry in this important global financial center.

Despite heavy industry lobbying which has squelched similar inquiries in the US, the FCA’s just-released preliminary report is an indictment of many traditional industry practices.  Excessive fees, lack of disclosure and conflicts of interest among asset managers and pension consultants are recurring themes.  The Financial Times, which seems to me to be in the best position to know, thinks that the “good” news for the industry is that the FCA has not recommended a government investigation of its practices for potential breach of UK law.

Although the investigation began before Brexit became a reality, it occurs to me that the FCA’s conclusions are being shaped by the idea that UK investment services no longer need simply meet the (very) low bar of being better than what’s available in the rest of the EU.  Without a built-in clientele, services must also be good in an absolute sense.  A regulatory regime that gives investors a fair shake is a sine qua non–as well as miles better than what is generally the case elsewhere, including in the US, the current market leader.

The FCA investigation has two implications I can see for US-based money management:

–increased disclosure of fees/performance in the UK will increase pressure for similar disclosure in the US.  One particular bone of contention is the use of “soft dollars” or “research commissions,” meaning a management company pays a broker, say, 2x the going rate for a portion of its trading.   In return it receives goods/services that the manager would otherwise have to pay for from management fees.  The kinds of stuff a manager can receive is already regulated in the US, but disclosure of the amount of money in extra commissions ultimately being paid by clients is not.  The FCA will require such disclosure in the UK.  My sense is that the amounts will be surprisingly large.

–during the years prior to the financial meltdown, US banks opened London branches to process transactions–often involving US buyers and US sellers of US products–that were allowed in the UK but illegal domestically (think:  sub-prime mortgage derivatives).  This was a result of the UK’s decision to build up its financial services industry using a “regulation lite” approach to governance.

In the absence of any changes to US laws, why wouldn’t large US institutional investors demand that their investment managers similarly conduct business out of London.  In this case, however, it would be to obtain lower fees, greater transparency and better legal recourse in the case of disputes.

Yes, this sounds a little crazy, but the legacy investment management industry–both managers and consultants–are so powerful that I think favorable change for investors is unlikely to happen otherwise.