business line analysis and sum-of-the-parts

This is mostly a reply to reader Alex’s comment on a post from early 2017 about Disney (DIS).

The most common, and in my opinion, most reliable method securities analysts use to project future earnings for multi-business companies is doing a separate analysis for each business line.  This effort is aided by an SEC requirement that such publicly traded companies disclose operating revenues and profits for each line of business it is in.

In the case of DIS, it’s involved in:  broadcast, including ESPN; movie production and distribution; theme parks and resorts; and sales of merchandise related to the other business lines.

There is plenty of comparative data–from trade associations, government bodies and the financials of publicly traded single-business firms–to help with the analysis.  And every company has, in theory at least, an investor relations department that answers questions put to it by investors. ( My experience since retiring as a money manager for institutional clients is that many backward-thinking well-established companies–DIS and Intel come to mind–can be distinctly unhelpful to their most important supporters, you and me.  (To be fair, I haven’t spoken with DIS’s IR people for several years, so they may be better now.))

Analysis consists in projecting revenues/ profits for each business line and using the results as the key to constructing a series of whole-company income statements–one each for this year, next year and the year after that.

The trickiest part is to decide how to value this earnings stream.  The ability to do this well either comes with experience or from having worked for a professional investor who’s willing to teach.

 

More tomorrow, or in a day or two if I don’t get my film editing homework done today.

 

 

 

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.

 

The kinks of financial journalism

This is the tile of a 2014 paper by Prof. Diego Garcia of the University of North Carolina, in which heanalyzes the relationship between recent behavior of the stock market and subsequent reporting in financial newspapers.

Conventional wisdom holds that reporters’ articles mirror and perhaps intensify the tone of the recent past.  That is to say, they are unduly bearish when the stock market has been making losses, and similarly unduly bullish when it has been making gains.

Prof. Garcia, studying Wall Street as reflected in the Wall Street Journal and the New York Times from 1920 to 2005, draws a different conclusion.  He writes:

“…the asymmetry of journalists’ writing is pervasive: it has barely changed from the 1920s to the 1990s, and virtually all authors exhibit the same pattern, emphasizing negative returns, ignoring large positive market moves.”

Why should financial reporting have a negative bias?

The first thing that comes to my mind is television and radio weather people, who have a strong tendency to predict more precipitation than the US Weather Service, the government body from which they derive their data, says will happen.  How so?  Media weather people know that talking about looming bad weather has more entertainment value than a more benign forecast.  Also, viewers/listeners feel relieved if the forecast is for rain and the day is sunny instead.  They only get angry if the forecast is for fair weather and it ends up pouring.  Therefore, media weather people have every business/career reason to shade their forecasts heavily toward more precipitation rather than less.

John Authers, a reporter from the Financial Times from whom I learned about Prof. Garcia’s paper, gives more or less the same rationale for the similar phenomenon with newspapers.

my thoughts

–if the default position of a newspaper writer is to write a negative story, then we probably get no investment information from it.  On the other hand, if the story is positive, it’s unusual enough that we should look into the company or industry being reported on as a possible investment idea.

–Mr. Authers illustrates the risks to a journalist of making a positive recommendation.   Better, he says, to recommend not buying Amazon and watch it double than to run the risk of a loss.  Suppose the positive recommendation turn out to be Enron?

Of course, anyone in his right mind who read the Enron financials would have stayed as far away from that company as possible (yes, a couple of less-skilled colleagues at my last firm were, incomprehensibly to me, quite eager to buy the stock just before it imploded–and, yes, I did buy a stock certificate before it was delisted at $.80 or so as a souvenir–but that’s another story).  Reporters are trained journalists, however, not securities analysts.  They typically don’t have the economics, accounting or finance background to do analysis (although Mr. Authers does have an MBA from Columbia).  Nor do they have the time.  So the risk they run by saying something positive about a company is enormously high.

–An aside:  oddly enough, one of the first steps in training a growth stock analyst is to question this common sense attitude that avoiding all possibility of loss is the highest virtue.  For growth investors, finding a stock that can triple is.

–this study is only of US newspapers.  In my experience, reporters for the Financial Times are much more highly skilled than their US paper counterparts.

 

 

momentum investing

what it is

Momentum investing is a style, if one can call it that, of buying and selling securities based simply/solely on recent price momentum.  If a given stock is going up, buy some.  If it continues to rise, buy more.  If a stock begins to decline, sell it   …or, for very aggressive players, sell it short.  No fundamental data counts.

Day traders and very short-term-oriented algorithmic players are the main people who use this simple buy-if-they’re-going -up, sell-if-they’re-going-down rule.  In my career, I’m only aware of two “professional” investment groups who have practiced momentum investing as their main strategy:  Wood Mackenzie trading oil stocks in the early 1980s, Janus trading tech stocks in the late 1990s.  The former was an almost immediate disaster; the latter had a surprisingly long period of success before going down in spectacular flames.

recent use

The term has come into recent vogue in the financial press as a description of growth investing.

It isn’t one, although it may reflect the jaundiced view a few (narrow-minded, in my view) value investors have of their growth colleagues.

To be clear, growth investors try to make money by finding companies that are expanding faster than the consensus expects.  This is not momentum investing.  Nor is the style of value investing that requires that a company not only be bargain-basement cheap but that there be a catalyst (reflected in positive price momentum) for change before buying.

why write about this?

A few days ago, a regular reader, Small Ivy, characterized my speculative dabbling in Tesla as momentum investing.  Maybe so, maybe not.  More tomorrow.

 

Brexit vs. the Trump election

Trump and Brexit

Right before election day, Donald Trump predicted his victory by saying that it would be just like Brexit, only more so.

That turned out to be correct, in the sense that in both cases the pre-election polls were incorrect and that the result turned on the votes of older, disaffected, less-educated citizens who came out in large numbers in response to a call to roll back the clock to days of former glory.

post-Brexit

The immediate UK stock market response to the Brexit vote was to drop through the floor, with the multinational-laden large-cap FTSE 100 index faring far better than generally domestic-focused small caps.  The FTSE has rallied since, with the index now sitting about 6% higher than its level when the election results were announced.

That does not mean, however, that the Brexit vote turned out to be a plus for UK stock market participants.  By far the largest amount of damage to their wealth was done in the 15% drop vs. the dollar that the UK currency has experienced since June.

post-Election Day

Despite the voting similarity between UK and US, the currency and stock market outcomes have been very different.  In the week+ since the US presidential election,

–the dollar has risen by about 3% against both the euro and the yen since the election result became known

–the S&P 500 is up by a bit less than 2%, with small caps significantly better than that.  Potential beneficiaries of Trump policies–oil and gas, construction, banks, pharma, prisons–have all done much better than that.

Why the difference?

Brexit

Brexit was a simple, binding in-or-out vote on an economic issue (recent legal action seems to show it’s not so clear-cut as that, however).  Leaving, which is the action voters selected, has immediate, easily predictable, severely negative economic consequences.  Hence, the continuing slide in the currency.

Trump

The Trump vote, on the other hand,  was for a charismatic reality show star with unacceptable social views, very limited economic or policy knowledge/interests and a questionable record of business (other than show business) success.   Not good.

The US vote was for a person, however flawed, not necessarily for policies.  In addition, the  legislative logjam in Washington has potentially been broken, since Republicans will control both houses and the Oval Office.

The general economic tone Trump seems to be setting is for fiscal stimulation through tax reform and deficit spending on infrastructure.  Both would relieve the extraordinary burden that has been placed on the Fed (the only adult in the Washington room).  This will likely mean larger, and faster, interest rate hikes.  Hence the rise in the currency.

knock-on effects

Democrats seem to realize the folly of having a cultural program without an economic one; a substantial restructuring of that party may now be under way.  Bipartisan cooperation in Congress seems to once again be in the air, if for no other reason than to act as a check on Mr. Trump’s more economically questionable impulses.   Trump’s “basket of deplorables” social views may make Americans more vividly aware of the issues at stake, and what progress needs to be made   …and serve as a call to arms for activism, as well.

Another thought:  yesterday’s news showed the Trump brand name being removed from several apartment buildings on the West Side of Manhattan.  Based on feedback from tenants, the owner, who licenses the Trump name, concluded that retaining the buildings’ branding would result in lower rents/higher vacancies.  Given that Trump does not intend to have his business interests run by an independent third party while he is in office, the public would seem to me to have an unusually large ability to influence his presidential actions by its attitude toward Trump-branded products.  I’m not sure whether this is good or bad   …but “good” would be my guess.

All in all, the UK seems to be lost in dreams of the days when it ruled the oceans.  The US is less clear.  We may be in the early days of a renaissance.

 

3Q2016 earnings for Tesla (TSLA): still a “dream” stock

TSLA reported 3Q16 results yesterday after the New York close. The numbers were better than admittedly modest expectations:  the company sold a record number of cars: it had profits; cash flow was strongly positive–although flattered by better management of working capital and sale of pollution tax credits.  Still, a plus.  And the stock is up by about 4% in pre-market trading as I’m writing this.  (I should mention that other members of my family and I hold small positions in TSLA.)

The fact that a $30+ billion market cap company earned $22 million in a quarter would scarcely be considered good news under most circumstances.  Annualizing and rounding up to $100 million for a full year would imply a PE of 300x for the company’s stock!  However, TSLA is still to a considerable degree a “dream” or “concept” stock.

 

The prototypcial “dream” stock is a firm that starts up with the intention of prospecting for gold.  It makes what it thinks/says is a significant strike.  While the company creates the mine and associated processing facilities, speculation about the quality and extent of the orebody runs rampant.  After all, there’s no factual information to contradict any rumors that may float about.

Then the mine opens.  There are now facts available about ore quality and mining costs.  So there’s no more dream–only brass-tacks reality.  The stock typically peaks the day the mine opens.

TSLA’s case is an unusual one.  Auto production has been under way for some time.  Yet the stock hasn’t reverted to trading on actual results.  To some degree the dream has been dented–I find it hard to imagine TSLA could repeat today its 2014 convertible bond offering, whose conversion price was set at $350.  But Elon Musk has expanded and reset his aspirations for TSLA  often enough during its short life as a public company that at least some version of the dream remains alive.  Unless/until TSLA disappoints severely in its results, I’d think the stock will continue to trade without a strong connection to earnings for some time to come.

 

 

 

1Qfiscal17 earnings for Microsoft(MSFT)

MSFT reported a strong 1Q17 after the close last night.

Revenue was up +3% (non-GAAP) year on year.  Operating income was flat, on the same basis, and net up +6%.  EPS was up by +9%, at $.76, exceeding the high end of the expectations of the thirty-odd professional sell side analysts who follow the company.

Growth businesses, like the cloud or the Surface line of laptop/tablet hybrids, were up strongly.  Legacy businesses held their own.  Guidance is for a flattish 2Q17.

 

In many ways, the MSFT report is similar to the Intel (INTC) results from the night before.  Guidance for both companies appeared roughly the same, as well–more or less flat quarter on quarter performance, during a period that’s typically seasonally strong.

The reaction in the press and in the stock price for MSFT, however, was strongly positive.  The stock was up by 4%+ when the results were made public   …and by more than that after the conference call.  As I’m writing this on Friday afternoon, MSFT is holding onto almost all of its after-hours gain during a down day on Wall Street.

INTC, in contrast, fell at all three waypoints–announcement, conference call, next-day trading.

 

Part of the contrast in stock performance has to do with the differing nature of the two companies’ businesses, hardware vs. software.  Part is a function of the greater speed at which MSFT has been able to demonstrate that it is turning itself around.

 

On the other hand, I find it noteworthy that there should be a 10% relative performance difference in two days between the two behemoths who were once the constituents of the former Wintel alliance–and on bottom lines that, if we removed the company names, don’t look all that different.

The rest, of course, must represent two different sets of expectations.  I hold both stocks, which I’ve been studying for over a quarter century (and which I find a little scary).  My expectations aren’t that different.

I’m not simply grousing about being wrong aobut INTC.  I think of investing in the stock market as somewhat like playing a game whose rules each player has to figure out as play progresses.  I’ve often likened the difference between investing in, say, the UK or Japan vs. the US as like that between playing checkers or Sorry and playing chess.

I have a hunch that in reports like these we’re seeing evidence of a change in how the stock market game will be played in the US in the future.  If so, it will be important to catch on to the new state of things as soon as possible.