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Tag Archives: investment performance
What is a “correction,” exactly? Is one going on now?
corrections
A correction is the signature countertrend movement of a bull market.
It’s normally short–lasting two or three weeks. It’s also shallow, although psychologically it may not seem like it at the time. Typically, the decline will be more than 3% but fall considerably short of 10%.
trigger vs. cause
I think it’s important to distinguish between the trigger for a correction and its cause.
The cause, which is always valuation, is usually easier to see.
Stock markets are ultimately driven by the economic performance of the companies whose stocks are publicly traded. Bull markets occur during periods when corporate profits are not only expanding now but are also expected by investors to continue to do so for an extended period. During times like this, investors can easily become overenthusiastic and bid stock prices up to levels that are too high too soon, given consensus expectations for profit growth. In fact, they tend to do so repeatedly.
Actual earnings expansion may eventually show–and it often does, in bull markets–that the consensus is too conservative. But the market rarely stands still for an extended periods of time. It either goes up, or it goes down (don’t ask me why, that’s just the way it is). So if the justification for the price you’re paying in February for a stock will only come through an earnings report that will be made in October or in the following January, your stock probably isn’t going to sit there and wait. If there’s no way it can go up for now, you can be very sure it’s going to start to go down.
Put a slightly different way, if the consensus thinks that S&P 500 earnings will be at best $100 for 2011 and that investors will be paying 14x for those profits, the consensus target for the S&P–until the market begins to factor in 2012 earnings–is 1400. At 1350, this implies only about 3% upside for the market for, say, the next six months. That isn’t enough financial incentive to choose stocks over some other, less risky investment, in my opinion.
It isn’t that the market thinks bad things will happen in the economy. It’s a question of the odds of making a satisfactory return. Sooner or later, this fact dawns on investors. They slow down their buying to a trickle.
This is the position we were in a week ago.
What must–and always does–happen in this situation is that the market has to decline enough to restore favorable odds. Last year the magic number for “favorable” seemed to me to be more than 10% but less than 15%. My guess is that this year the number is lower,because investors are more confident, maybe 10% or so.
The trigger for a correction can be anything. Many times it comes out of the blue. You should also note that the trigger doesn’t necessarily have to make any sense. In 2010, for example, INTC reported the first of a series of stunningly good profit results early in the year. The consensus concluded (incorrectly, as it turns out) that this was the high point for tech earnings in the current business cycle. So the entire market, which had been a bit frothy, sold off.
This year the trigger is unrest in the Middle East. My guess is that if equity markets had been 10% lower, stocks would have shrugged off events in Libya.
where are we now?
Proceeding in logical order, the first question to answer is whether we are still in a bull market or whether what we are seeing now is not a correction, but evidence of a reversal of the markets from bull to bear.
True, market tops are notoriously difficult to recognize–more so for always-bullish growth stock investors like me. But we’ve just begun to see economic recovery take hold in developed markets. Corporate profits seem to me to be very likely to continue to expand. Valuations aren’t crazy high. Interest rate hikes are a long way away. Therefore, I interpret what we’re in now as a correction. (Also, as it turns out, I’ve been writing that one is due for some time.)
Applying the rules of thumb I outlined above, stocks in the S&P 500 should be weak for another 5-10 trading days and bottom somewhere around 1250.
On the other hand, there seems to have been a mini-panic in New York trading around midday last Thursday that may have taken a lot of the negative sentiment out of the market. From intraday high the previous Friday to intraday low on Thursday, the S&P fell around 4%, which would just barely qualify for the depth of a decline.
I think trading in the next few days will be interesting to watch. Last week’s decline really wasn’t deep enough or long enough to qualify as a correction, no matter what happened on Thursday. So there should be more weakness to come, unless underlying sentiment is super-bullish.
what to do in a correction
As I’ve mentioned a number of times in other posts, stocks that have gone up a lot usually suffer the worst in a correction. “Clunker” stocks (and everyone holds one or two), on the other hand, don’t decline much because they’ve never gone up. The most useful thing to do when the market is declining is not to hide under the bed, but to upgrade your holdings. Sell the clunkers at relatively attractive prices and buy healthier stocks at a discount. You should make gains from doing this. At the very least, you’ll have gotten rid of securities that would have continued to subtract from performance.
I found myself doing this on Thursday. That’s pretty early in a correction to be acting. I’ll be interested to see how this works out.
I’ve just updated Current Market Tactics
This is the first of two updates of Current Market Tactics (the second will come on Sunday). If you’re on the blog, you can also click the tab at the top of the page.
Skandia Life: we’ve made money on private equity
Who says insurance companies don’t have a good sense of humor?
the Skandia Life study
The Financial Times reported today that Skandia Life has done a proprietary study that “proves” its investments in private equity have made money for the company, even from purchases made during the wildest days of the middle of the last decade–when loans were flowing like water and everything not nailed down was being bid for at very high prices.
Despite this, Skandia concludes that its private equity investments earned it “between six and 14 per cent per year” better than publicly traded equities (which would likely have lost some money during the period). The print newspaper article said the margin of outperformance was “between 0.8 and 1.5 per cent,” a set of figures that the FT apparently subsequently changed. I don’t know which is correct. (I’ve looked for the study on the internet but have been unable to find it. So all I have to go on is the FT newspaper and website.)
the study’s assumptions
To get the Skandia results, you have to make a number of (heroic) assumptions. They include:
1. that the private equity people who sold Skandia its deals worked for free. That is, they collect no fees and have no carried interest.
2. that estimates of the current values of the companies bought, which are made by the private equity firms doing the buying, are fair and accurate. There was apparently a “third party” check on the figures, presumably by the investment banks who were paid by the private equity firms to line up and help finance the deals.
3. that the highly leveraged acquisitions of poorly-performing companies are no riskier than buying, say, a stock index ETF, so no adjustment to returns for”extra” risk needs to be made.
are they believable???
How likely are any of these suppositions? In New York they say…”If you believe this, I have a bridge you might be interested in buying.”
The icing on this comedic cake is the answer to the question, “What financial professional could possibly have approved this study and endorsed its dubious results?” …why, the guy in charge of giving Skandia Life’s money to private equity, that’s who.
In the thrust and parry of bureaucratic infighting in large companies, I can see why someone might call for a justification for making private equity investments at the top of the market to be made. And I can see how a study like the FT writes about might have been the response. What I don’t understand is why the authors would want it made public in any form.
On the other hand, maybe they didn’t.
Activision’s 4Q10: a reprise of 4Q09
the results
Activision reported fourth quarter and full year 2010 results after the market closed in New York on Wednesday. On a non-GAAP (Generally Accepted Accounting Principles) basis, the firm earned $.53 a share–in line with Wall Street analysts’ expectations–vs. $51 in the year ago quarter. For the full year, GAAP earnings per share were $.34 vs $.09 in 2009. On a non-GAAP basis, eps were $.79 vs. $.69.
On a GAAP basis, however, ATVI reported an operating loss in the vicinity of $400 million for the closing three months of the year–the second time in a row they’ve accomplished this “feat.”
The company issued initial (non-GAAP) guidance for 2011 of $.70 per share in earnings, or about an 11% year on year decline (more on this below), which was lower than analysts’ preliminary guesses of a flat earnings year. (Some are also saying that ATVI is guiding to earnings of $.07 a share for the March quarter, which would be below analysts’ estimates of $.10. I don’t think that’s right, though, since the $.07 includes $.02-$.-3 of restructuring charges. In other words, ATVI guidance is for earnings of $.10 per share for March.)
ATVI also announced that its board of directors had authorized a 10% increase in the dividend to $.165 per share and a $1.5 billion share buyback.
The shares were down about 7% in the aftermarket. As I’m writing this, in the early afternoon of February 10th, ATVI shares are down about 10% on very heavy volume.
the details
1. Bobby Kotick has developed feet of clay. The CEO of ATVI has had a well-deserved reputation for quickly focusing his firm on new trends and deftly cutting his exposure to the old without taking big losses. No more. For the second year in a row, ATVI is taking a gigantic writeoff related to the Activision side of the business.
Elements of the writeoff are scattered around in different accounting categories, however, including some costs that will only be recognized in 2011, so I find it difficult to figure out exactly how big the current damage is. $400 million + is the best I can do. Unlike last year, when management blithely ignored the loss completely in the conference call, there were at least a few passing references to it Wednesday night.
What’s happening? ATVI’s financials suggest that, ex Call of Duty, the Activision side of the house continues to be deeply in loss. That got the former Activision-side top brass fired a year or so ago. After posting a large deficit ex CoD again in 2010, new management has decided to:
–stop making new versions of Guitar Hero and concentrate on digital downloads to the title’s waning fan base,
–shut down True Crime,
–not launch a new Tony Hawk game this year (no more, ever?).
ATVI will also be laying off 500 employees. This will leave the Activision part of ATVI with Call of Duty, the Bungie team that’s developing a new MMO, and some niche products like Cabelas hunting games, that make money.
2. Blizzard is doing fine–better than fine, actually.
–Non-GAAP operating income, at $850 million, was up 53% year on year.
–World of Warcraft has over 12 million subscribers globally. Blizzard’s new partner, NetEase, is making it easier to get permission from Beijing to introduce new WoW software to China.
–WoW: Cataclysm sold 4.7 million units during its launch month in December.
–Starcraft II has sold almost 4.5 million units, as well.
–Blizzard has also been talking about a new WoW-like game it is developing, code name: Titan.
3. Call of Duty is, too.
–Despite pre-launch worries that Call of Duty: Black Ops could never surpass the success of the 2009 entry in the game series, CoD: Modern Warfare 2, the number of players of Black Ops during its first three months is about 50% higher than for MW2.
–First-day downloads of the initial expansion pack for Black Ops (just launched) were 25% higher than for the comparable release for MW2.
4. ATVI will be announcing a mystery new gaming initiative at Toy Fair today.
5. New releases for 2011? Will there be any?
–There’ll certainly be one for Call of Duty. But ATVI is (sensibly) unwilling to project that it will meet the lofty sales standards of Black Ops. Other than that, the current-year cupboard may be pretty bare.
–There’s no word from Blizzard on (the now long-awaited) Diablo III. All we know is it’s not ready for beta testing yet. A 2011 launch has not been ruled out.
–Heart of the Swarm, the Zerg entry in the Starcraft II series, is certainly a 2012 event (if then).
–The Bungie MMO definitely won’t debut this year.
–On the bright side, there won’t be self-inflicted losses from Guitar Hero et al. But worries the new Blizzard launches could be pushed back into 2012 are the main reason for ATVI’s conservative earnings guidance.
why the big selloff in the stock?
1. Some investors may be throwing in the towel. ATVI has been a severe underperformer over the past two years. Another huge writeoff and prediction of a down earnings year in 2011–especially when most other firms, video game and otherwise are posting surprisingly good results–may have been more than many investors are able to take. Some professional investors who use mechanical rules for buying and selling, in an attempt to keep emotion out of their decisions, may also have been forced by them to divest.
2. Has Bobby Kotick lost the magic touch? I thought the Activision division problems had been fixed last year. It’s distressing to see that it has required another year of large losses to get management to smell the coffee. Odder still, ATVI has been much more aware than its rivals about the threat from casual and mobile games.
3. It’s also possible that ATVI’s juvenile attempt to divert investor attention from the writeoffs by not mentioning them is undermining investor confidence in management’s integrity and competence.
where to from here?
ATVI is a stock I’ve been consistently wrong about, so maybe you should skip this part and make up your own mind without my two cents.
First of all, the company has about $3 a share in cash on the balance sheet, and no debt. It is generating cash flow from operations, principally from Blizzard, of about $1.15 a share. That level of cash generation can probably continue indefinitely. True, there may not be a new mega-hit like Starcraft II in 2011, but there won’t be Guitar Hero, Tony Hawk or True Crime to pile up offsetting red ink. And MMOs, a field Blizzard leads, are the future for serious gamers.
Assume a current stock price of $11 and subtract the $3 in cash. The remaining $8 is equal to about 7x cash flow. If the current level of cash flow is sustainable–and I think it is–the stock is cheap. It’s the equivalent of a bond that yields 15%. If this were a different industry, or if ownership weren’t so concentrated in Vivendi’s hands, a takeover bid would be a good possibility. I don’t think that’s likely here, though.
The big question is whether there’s anything in ATVI’s future that could make it less cheap than it is today. A new Bungie MMO, a big increase in the number of WoW subscribers, new online moneymaking opportunities for Starcraft or Call of Duty are all possibilities that come to mind. Also, in time, and with more forthright communication, management may win back investor trust. In addition, at some time before the end of summer, focus will turn to 2012, which could be a year with two or three big new releases.
I can easily imagine circumstances–and again I have been as cold as ice with this stock–where ATVI is trading 20% higher than it is today six months from now. Like almost any value stock, however, the “what” is easier to figure out than the “when.”