Category Archives: Vocabulary

3Q16 earnings for Intel (INTC): implications

October 19, 2016 By in earnings conference calls, strong earnings, Uncategorized Tags: , , , Leave a comment

Last night after the close, INTC reported 3Q16 earnings results.

The number were good.  INTC’s growth businesses grew; its legacy arms showed unusual pep.  The latter development had been flagged by INTC during the quarter when the company announced wholesale customers were increasing their chip inventories. Nevertheless, earnings per share of $.80 exceeded the average of 29 Wall Street analysts by $.07–and surpassed even the highest street estimate by a penny.

Despite this, the stock fell by about 3% as soon as the earnings release was made public.  Traders clipped another 2% off the share price on the earnings conference call.  During trading today, the stock initially fell almost another 2%, before rallying a bit to close just below its worst aftermarket level.

There was some bad news in the report.  It will cost INTC more than anticipated to rid itself of McAfee.  It also looks like chip customers are no longer so eager to build inventory.  Instead, thus far in the fourth quarter they seem to be subtracting some of the extra they added during 3Q.   The result of this is that INTC thinks 4Q–usually the strongest period of the year seasonally–will only be flat with the robust performance of 3Q16.

 

I find the selling to be unusually harsh (be aware:  I own INTC shares).  After all, if INTC had earned the $.73/share the market had expected, a forecast of $.76 wouldn’t look all that bad.  That outcome, which appears to be the company’s current guidance, would also be better than the analyst consensus had been predicting for 4Q last week.

I’m not trying to argue that the stock should have gone up on this report.  I just don’t see enough bad–or, better said, enough unforeseeably bad–news to warrant a selloff of this magnitude in a gently rising market.

I attribute the aftermarket selloff to some combination of computer trading and thin volumes.  What surprises me is that there were no significant buyers once regular trading–overseen, presumably, by senior human investors–began.

Because of this, I think that trading in INTC over the next days is well worth watching to see if/when buyers reenter the market.  We may be able to draw conclusions that reach wider than INTC itself.

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.

 

 

 

 

 

 

 

the Lucky Country, the Dutch/Detroit disease and the Middle East

April 27, 2016 By in "Dutch disease", oil and natural gas, Uncategorized Tags: , , , , , , , , Leave a comment

lucky countries

where is Wikipedia when you need it?

The original “Lucky Country” was Argentina.  As I googled the term before writing this post, however, I found no trace of a link between the name and the South American agricultural giant.

Still, I began my international investing career in the mid-1980s with an Australian portfolio.  In that Cro-Magnon time the Argentina/Australia comparison was common.

The idea for both nations was that they were endowed with abundant natural resources, but that this was a curse, not a blessing.  That good luck spawned its opposite–excessive reliance on food/mineral production, insularity, dysfunctional government and resultant economic misery.  In contrast, resource-poor places like Japan or Korea were blossoming as economic powerhouses.

the Dutch/Detroit disease

I stuck in the Detroit part.  For me the Michigan analogy is much more current and powerful.

The Dutch “disease” was the discovery of gigantic offshore oil deposits.  They required a lot of labor to develop–mostly strong backs and a willingness to spend long periods of time on floating oil development platforms. 

The jobs required a lot of people, however, and paid maybe 3x normal wages.  Combine that with a small national population and the result was soaring wages and, therefore, a mass migration of non-oil industries to other countries.  When oil prices peaked in December 1980 and began a swoon that would reduce them by about 3/4, the oil business collapsed.  Government finances fell apart and unemployment skyrocketed as laid-off oil workers couldn’t find new domestic jobs.

The “disease,” then, is small area and reliance on a single industry.

Detroit is the American equivalent, with automobiles instead of oil.  The domestic auto industry grew fat and lazy in the 1970s-80s behind protective barriers erected against imports.  It paid high wages that drove most other businesses out of the area.  Heavy reliance on the “Big Three” car makers, corrupt government and the arrival of foreign auto manufacturers in lower-cost areas in the US eventually combined to drive the city into bankruptcy.

the Middle East

Economically, the typical oil producing country is Detroit in the desert.

Two twists on the all-eggs-in-one-basket theme:

— very young populations, meaning an imminent threat of significant youth unemployment; and

–a reluctance to allow women into the workforce.

Both probably turn them into Detroit on steroids.

I have no idea how this all works out.  Dubai, which has no oil, is looking a lot smarter than it did six or seven years ago.  The recent Saudi announcements of a radical restructuring of its economy are just the curtain being raised on what may be a lengthy, twisty-plot drama, I think.

 

the Sequoia Fund (iii)

April 13, 2016 By in redemption in kind, Uncategorized Tags: , , , , , Leave a comment

tax factors

Mutual funds are corporations of a special type.  In return for agreeing to limit their activities to portfolio investing and to distribute basically all their net realized gains to shareholders, mutual funds are exempt from paying corporate tax on those profits.  Net here means after subtracting realized losses.  Realized means that the winning/losing stock has been sold and the gain/loss recorded in the fund’s accounts.

Typically, distribution of gains occurs once a year, in November or December.

In my experience, almost no one other than the fund manager thinks much about the profits and losses imbedded in a fund, whether realized or unrealized.  There are certain situations, though, where they can be important.

net losses

In my career, I’ve turned around a couple of global mutual funds where the single most valuable asset on the day I arrived was the funds’ realized tax losses.  They allowed me to trade the portfolio aggressively without shareholders incurring any tax liability.

net gains

Most funds today are in the opposite situation.  Given that the S&P 500 is at all-time highs, funds tend to have large accumulated unrealized gains.  Tax on these gains is only due when stocks in the portfolio are sold and profits distributed to shareholders.  Also–and this is important–the tax is the obligation of the person who receives the yearend distribution.  That’s not necessarily the same as the person who enjoyed the rise in net asset value of the fund.

sales and redemptions

The potential per share value of losses falls if the fund is having net sales (meaning the number of outstanding shares is increasing), and rises if it is having net redemptions.

The potential per share tax obligation of gains also falls if the fund is having net sales and rises if it is having net redemptions.

the Sequoia situation

If the Wall Street Journal is correct, Sequoia is experiencing substantial net redemptions.  If it has to sell stocks where it has large gains in order to meet these outflows, it could be setting the stage for shareholders who stay loyal to the brand to incur a large income tax liability this year.

What the firm appears to be doing to reduce this burden on remaining shareholders is to meet large (over $250,000) redemptions mostly by distributing shares of stock from the portfolio rather than by (selling them and distributing) cash.

While this may be unusual and inconvenient to redeeming shareholders, it does not hurt them, since their cost basis on in-kind distributions is not the fund’s.  Rather, it’s the closing price on the day they receive the stock.  At the same time, distributing stock protects shareholders who don’t redeem from getting a whopping income tax bill at yearend.

 

 

 

 

the Sequoia Fund (ii)

April 12, 2016 By in redemption in kind, Uncategorized Tags: , , , , , 2 Comments

large position sizes

At the end of June 2015, the Sequoia Fund had assets of $8.7 billion, of which 28.7% was in shares of Valeant Pharmaceuticals (VRX) and another 10.6% in Berkshire Hathaway.

How did these positions get so large?

a.  The portfolio managers chose to have nearly 40% of their fund in two names.  In fact, as VRX began to decline in the second half of last year, the managers bought more.

Don’t ask me why.  To my mind, following Bernard Baruch’s dictum to have all one’s eggs in one basket may have been ok for the renowned speculator way back when, but it makes no business or economic sense for mutual funds today.  According to the Wall Street Journal, two members of the board of directors of the fund resigned last year because they disagreed so strongly with the strategy.

b.  SEC diversification rules permit this.  The pertinent regulation has two parts:

  1.  The fund can’t make a purchase of a security if doing so would make its total holding in the security more than 5.0% of fund assets.  At the 5% threshold, the manager can allow the existing position to grow; he just can’t buy more.  Growth can come because the security is outperforming and/or because the total asset size is shrinking.
  2. 25% of the fund’s assets are exempt from rule 1.

The second provision is much less well-known than the first.  I’m not sure why the SEC wrote the rules the way it did (my guess would be lobbying from the fund management industry), but I can’t recall an instance where having a whopping position like Sequoia has with VRX didn’t end in tears.  And I can only recall two other cases, one involving a junk bond fund, another a Pacific Basin fund, where managers took such large bets with shareholder money.

More tomorrow.