Tag Archives: value investing

reversion to the mean

October 30, 2013 By in book value, distressed assets, from growth to value: the life cycle, growth vs value, mean reversion, two flavors of value Tags: , , , , , , , Leave a comment

Mean version has two senses:

1.  The first is important for traders, less so for investors.  It’s that if we construct a trend line or moving average for a stock from past prices, the stock will tend to trade in a reasonably well-defined band or channel around the trend.  In theory at least, one can make money by buying when the stock is at the lower edge of the band and selling when it’s at the higher edge.

2.  The second is a cardinal tenet for value investors.  It’s that over long periods of time stocks in general tend to rise and fall in line with overall earnings performance, which is, in turn, a function of the ebb and flow of nominal GDP.  Some stocks may have episodes where they perform far better than that.  Others may have extended periods when they fall far short of this mark, which in the US probably averages around +8% per year.  The value investor’s argument is that both classes, serial outperformers and serial underperformers alike, will inevitably see their fortunes reverse and their stocks revert to the long-term mean performance.

For high-fliers, this means they’ll, sooner or later, crash and burn.  For the stock market’s junk pile, on the other hand, its denizens will have periods when they’ll rise like the phoenix.  The latter are what value investors look for.

old school value investing

For some value investors, this is it.  This is all they do.  They run screens that find the cheapest stocks based on price/cash flow, price/earnings or price/assets–or some combination of the three.  And then they buy them.

I knew one who systematically went through books of charts looking for stocks that had experienced catastrophic drops (not a good strategy–once they figured out what he was doing, brokers began to send this guy charts with the price axis stretched out and the time axis compressed, so that every stock they touted looked like a train wreck.  Last I heard–I was hired to clean up the unholy mess he created–he was selling real estate in the Philippines).

Every investor is in some sense a contrarian.  At the very least, we all believe that the stock we are buying has more up left in it than the seller does, and the stock we are selling has less.  We also know the cardinal rule is to “buy low and sell high.”  Nevertheless, I think the simple strategy I just outlined, which is at the heart of the value investing practiced a generation ago, no longer works.

Why am I writing about this today?  

I was listening to Bloomberg radio in my car yesterday,when Dave Wilson repeated the observation of a market strategist that the divergence between the strong relative performance of the sector ETF for Consumer Discretionary and the weak outcome for Staples was as great as it was just before the Internet bubble popped in 2000.  What followed was a fierce reversion to the mean by both sectors.

The implication was that this factoid is significant.  As usual for Bloomberg, what or why was not forthcoming.

More tomorrow.

 

 

how cheap is MSFT? …very

July 26, 2012 By in Constructing a Portfolio, Current Market Thoughts, Industry Analysis, internet, Stock ideas, Technology Tags: , , , , , , Leave a comment

MSFT…

When I was writing about AAPL yesterday and wanted to make the point that the stock is cheap, I looked around at other, much weaker, tech-related firms to see their valuations.  I wanted to illustrate that AAPL shares are not only cheap in an absolute sense but are also inexpensive relative to other tech firms with weaker managements and/or inferior business models.  I settled on CSCO as a good example of both latter characteristics.  There were lots of others, too.

…is a very cheap stock

While I was searching, I took a quick look at MSFT.  I knew it has been the darling of value investors for some time.  But I was stunned by how cheap it is–much cheaper than AAPL.

I do have some history with MSFT.  I’ve been a user of its products beginning with the 30 lb+ Compaq “portables” of the early 1980s.  I bought the stock in my portfolios for the first time in late 1990.  I held it continuously for almost a decade, before selling it in late 1999 at around double the current quote.  Yes, I have subsequently held the stock for short periods after that, at the urging of a former CIO, but without much conviction–and without much success.

details

But this is what I saw yesterday:

1.  As of June 30, 2012, MSFT had cash of $63 billion.  Against that, the company had $11 billion in debt.  So net cash is $52 billion.  8.4 billion shares are outstanding, meaning net cash amounts to $6.20 per share.

2.  During the June 2012 fiscal year, MSFT generated $31.6 billion in cash flow, or $3.75 a share.  It spent $2.3 billion of that on capital equipment and about $10 billion more on dividends and stock buybacks.

3.  Consensus Wall Street estimates are for about a 10% increase in cash generation over the coming year.

some arithmetic

The share price of MSFT as I’m writing this is about $29.  Subtract out $6.25 in cash, leaving $22.75.  Dividing by $3.75 indicates that MSFT is trading at about 6x cash flow in fiscal 2012 and 5.5x expected cash flow for the coming 12 months.  That’s an extremely low number, especially for a firm like MSFT which has negligible capital spending needs.

Why so cheap?

What is this valuation saying about the company?

Three possibilities:

–much of MSFT’s cash pile, and a good portion of its profits, are accumulating overseas, free of US corporate tax.  Returning that money to the US, where it could be used for dividends, would require that MSFT pay Uncle Sam.  To some degree, that lessens the value of MSFT’s cash flow.  But any global company is in the same boat.  And, although I think it’s an issue, Wall Street doesn’t seem to mind at all.

–top management has been, well, bad, for at least a decade.  These are the same folks who wanted to pay $40 billion+ for YHOO a few years ago (they probably thank Jerry Yang every day for refusing to sell).  They just took a $6 billion+ charge for impairment of goodwill–acknowledging that the company overpaid substantially when it bought aQuantive five years ago.

On the other hand, MSFT has the dominant PC operating system.  And neither AAPL nor GOOG, nor Linux have been able to make much headway against the Office productivity suite.  So they have arguably been adequate stewards of the MSFT legacy of the last century.

In addition, poor management is often a plus for value investors eyeing a stock.  They imagine how much better things could be if competent hands were at the tiller.

–Is change of control possible?  It’s hard to say.  My impression is that MSFT has always been run for by long-time friends of Mr. Gates, whom he knows personally and trusts.  He seems extremely loyal to managers he has appointed, without much regard to their objective performance.  As the past decade+ has shown, change from within doesn’t appear to be a good bet.

Forced change from the outside?  Together, the founder and Steve Ballmer, the CEO, own 10% of MSFT.  The Bill and Melissa Gates Foundation may own more.

History shows that individual shareholders are immensely supportive of incumbent management, no matter how bad its performance may have been.  A proxy fight involving a company this large would be expensive. Its outcome would be hard to predict.  Are individual investors going to  support a movement that will effectively unseat Mr. Gates?  I’m not sure.

I think the belief that corporate change is unlikely is the main barrier to a better valuation for MSFT.  Wall Street believes–with ample justification, I think–that a dollar of cash flow in the hands of MSFT management is worth substantially less than one hundred cents.  And the market believes there’s no easy way to change the situation.  That’s certainly what I hear the stock price saying.