Value Investing – Page 73

Additional Tickers for the Reshaping

Posted on 5 July 20086 July 2008 by David Merkel

Readers have suggested some additional tickers for me.? Here they are:

GE, MSFT, BMY, BA, ANAT, KCLI, and DE

Beyond that, there was my country screen — cheap names in Taiwan and Korea that trade in the US?

WF SHG LPL KEP KB IMOS AUO

Then for the industry screen.? Here’s the most recent list of cheap industries; I used the ones labeled “Dig Through”:

Remember, this can be used in momentum mode (red) or value mode (green).? I’m using it in value mode, and it gave me a flood of tickers — remember, in this screen, Price-to-book times Price-to-next year’s earnings must be less than 10.? That’s usually a pretty strict criterion, but this time it turned out 121 tickers:

ABD ABG ACE ACGL AEG AEL AFG AGII AIG AMCP ASI AWH AWI AXA AZ BBI BBW BC BKI BWINA BWINB BWS BZ CAB CHB CINF CMRG CNA CNO CONN CPHL CRH DSITY EBF EIHI FFG FMR FNF GBE GIII GLRE GNW GT HALL HMN HSTX IHC INDM ING INT IP IPCR KGFHY KPPC LFG LGGNY LIZ LNY M MERC MGAM MHLD MIG MIGP MRH MRT MSSR MTE MW MYSZY NP NSANY NSIT NYM OB OSK OXM PAG PCCC PEUGY PL PMACA PNX PSS PTP PTRY RCL RE RNR ROCK RSC RT RUSHA RUSHB RUTH SAH SEAB SEOAY SIGI SMLC SSCC SSI SUR SWCEY SWM THG TI TRH TUES TWGP UFCS UFS UNM UPMKY USMO UTR VOXX VR WHR XL ZFSVY

Well, the quantitative ranking method will have its work cut out when I build the main spreadsheet — it will take some effort to scrub the accounting data, and come to some buy decisions, but that’s my next task.

Replacement Candidates for the Portfolio — From AA to ZZ

Posted on 3 July 2008 by David Merkel

Here is my initial list of replacement candidates for the third quarter 2008 portfolio reshaping:

AA??? ACMR??? ACS??? ACXM??? ADP??? AEM??? AEO??? AET??? AFFM??? AHL??? AIB??? AINV??? ALL??? AME??? AN??? APA??? ARP??? ATWO??? AVID??? AVZA??? AXS??? AYR??? BAGL??? BCPC??? BDK??? BGC??? BHI??? BJS??? BKS??? BLL??? BP??? BRO??? BRS??? BSET??? CAM??? CBI??? CBK??? CCK??? CCRT??? CDNS??? CFI??? CKH??? CMI??? COG??? COLM??? COMS??? CPB??? CRDN??? CROX??? CSCO??? CSL??? CTB??? DD??? DELL??? DFG??? DLM??? DRYS??? DUK??? DVN??? EGLE??? ENH??? EP??? ETP??? FAST??? FCX??? FDRY??? FITB??? FLEX??? FLXS??? FRPT??? FRZ??? FSR??? FTEK??? FTO??? GFF??? GHM??? GIL??? GMT??? GNK??? HAIN??? HAL??? HAR??? HAST??? HCC??? HCN??? HCP??? HELE??? HK??? HLYS??? HNT??? HNZ??? HOC??? HON??? HRS??? HRZ??? HTH??? INFS??? IPSU??? IR??? IRE??? ISCA??? ISYS??? IVN??? JCI??? JNX??? JOSB??? KCI??? KEY??? KMX??? KOF??? LMC??? LPX??? LRCX??? LSTR??? LZB??? MAN??? MAS??? MCRL??? MGIC??? MHK??? MHP??? MI??? MKSI??? MOT??? MPS??? MPWR??? MWA/A??? MXGL??? MYE??? NBR??? NBTY??? NFX??? NG??? NM??? NRG??? NSHA??? NTGR??? NVS??? NWLIA??? OC??? OCR??? ODP??? OIS??? OKE??? OMAB??? ONNN??? ORI??? OSK??? OXY??? PAYX??? PBI??? PBY??? PCZ??? PHX??? PKD??? PKI??? PPC??? PPG??? PRE??? PRU??? PTEN??? PVA??? PWR??? PXP??? PZZA??? RCII??? RDC??? RDK??? ROP??? RS??? RTN??? SAFM??? SCX??? SENEB??? SFY??? SGIC??? SGY??? SI??? SII??? SJM??? SKM??? SKX??? SLB??? SLGN??? SNDK??? SNG??? SNX??? SNY??? SPSS??? STZ??? SVR??? SVU??? SWN??? TECUA??? TEX??? THOR??? TLK??? TMS??? TPX??? TRMA??? TRN??? TRV??? TSC??? TSO??? TTC??? TXT??? UNF??? UNT??? URI??? USU??? VE??? VLGEA??? VLTR??? VZ??? WAG??? WDC??? WFT??? WGOV??? WNC??? WRB??? WTI??? WTIU??? WTM??? WY??? XEL??? Y??? ZNT??? ZZ

Quite a melange, huh?? Well, my quantitative techniques will winnow the list down.? At this phase in the cycle, I am likely to lower my weights that I apply to future earnings.? Profit margins are declining in many places.

The second quarter was good for me on a relative basis, though being away from home, I suspect I am off a tiny amount in the first half, and that I was a little ahead of the S&P 500 in June.? The first two days of the quarter have not been kind, either.? Well, the quarter is young, and we have a lot of the year remaining.? The market is short-term oversold by my oscillator.? When I have opportunities I add a little here and there.

Over the long weekend, I should post the results of my industry and country screens.? I might begin my quarterly reshaping while on the road.? Pretty amazing what one can do with a PC, the Internet, and Bloomberg out in the middle of nowhere.

I try to ignore short term market moves, and just focus on what I have done well with in stock-picking.? Usually that ends up working well for me, though one can never tellwhat the future will hold.? No stock-picking method is perfect.? I try to make mine a little better by structuring my process highly, making fewer decisions, and making the structure of my decisions easier.? I don’t have to choose the best stocks, just a few stocks that will do better than the stocks that I am selling.? Keep repeating that formula, and the results can be quite good.

If you have other replacement candidate ideas, please feel free to pass them on to me and the rest of the readers.? I usually throw them into the mix, and sometimes I buy one of them.

We Need Economic Stimulus, And We Need It Now!

Posted on 1 July 2008 by David Merkel

It is a wondrous thing to be the global reserve currency.? We can run government deficits of any size that we want, and the rest of the world gets to fund us by buying our debt.? Thus, when I look at calls for still greater stimulus (through Government spending and borrowing) from men like Bill Gross, Larry Summers, and Bob Shiller, I just groan.? When does the rest of the world say “Enough!”, particularly the Persian Gulf States and other oil exporters who don’t have as much of an economic reason to support the US Dollar, because they don’t have to promote exports to the rest of the world.? But, perhaps for political reasons, they keep buying US debts.

This will not end well; the only questions are when, and how severe?? On this issue, I’m not sure it matters who the next president is, because the US no longer independently controls its own destiny.? (Great question for the debates: “Sir, what will you do as President to strengthen the Dolllar’s position as the global reserve currency?”? I would expect the intelligent equivalent of a stutter.)? The main barrier is that there is no good replacement for the Dollar as the global reserve currency.? The Euro could still fail; large-scale monetary unions need to be political unions for them to succeed in the long run.? The rest of the currencies are too small, or their banking systems insufficiently liberalized.

But, maybe the world could live without a single reserve currency.? Currencies could compete against each other, and gold, and other commodities.? This is an age of computers; I’m not sure why there would have to be one standard of value, particularly, when the standard of value varies so much.

I’m still away on vacation, so I may not post a lot until I am back on July 8th.? I did do a trade today; I bought some Smithfield Foods (rebalancing buy).? I suspect they will export a lot more as time goes on, and perhaps one their new major owners agrees.? After all, China’s staple meat is pork, and Smithfield is a high-quality provider.? This is just another way that I consider global demand, rather than local demand.

Bringing this piece full circle, perhaps China found a better way to recycle dollars; at least this investment brings home the bacon.

Full disclosure: long SFD

Last Post Before I Leave Again

Posted on 28 June 200822 June 2017 by David Merkel

What did I do last week while the market was being whacked? I bought some Reinsurance Group of America, Shoe Carnival, YRC Worldwide, SABESP, and Universal American. I reduced cash in the portfolio from 11% to 8%. It may have hurt me in the short run, but should be good in the long run.

I have modest concerns about the current profitability of Smithfield Foods, but no concern about their long-term profitability. They have an intelligent management team. I may buy some more soon.

Now, as to my comments yesterday regarding quantitative risk measures: yes, I am highly skeptical. Economics is not Physics. The relationships are not stable enough for the quantitative statistics to be valuable. I go back to what Buffett said, “I’d rather have a noisy 15% than a stable 12%.” If you have a long time horizon, why do you care about standard deviation or beta? If you have a short time horizon, why are you investing in risk assets?

Risk is not short-term variation, unless your time horizon is short. Consider my article on longevity risk.? All good risk management considers when the money will be needed. Risk is unique for each person, and can’t be summarized through a “one size fits all” statistic. What are the odds of not meeting the goals of the investor? How severe will the shortfall be? That is risk.

Personally, I am annoyed at the consultant community. They employ statistics that have little relation to future performance in an effort to earn fees. They get away with it because clients don’t get investing. They buy the concept of randomness, and ignore the managers with good processes that have been hit by bad short-run performance.

Eventually value investing wins. Do value investors calculate the Modern Portfolio Theory [MPT] statistics before investing? Of course not. They know that their job is to find undervalued businesses. They don’t care about market trends.

As you consider investments, ignore MPT. It is better (if you have a long horizon) to focus on overall investment processes, with a review of the names in the portfolio over time, to get a feel for the methods of the manager.

Full disclosure: Long SBS SCVL RGA YRCW UAM SFD

Recent Portfolio Moves

Posted on 21 June 2008 by David Merkel

Selling 70% of my National Atlantic stake freed up cash, and I deployed half of that today in a variety of rebalancing trades.? Today I bought some Jones Apparel, Valero Energy, Hartford Financial Services, and OfficeMax.? I sold some RGA to buy some MetLife, in order to get cheaper RGA.

Today’s actions brought cash in the portfolio from 14% to 11%.? It’s a good time to be adding to positions in a modest way.? If the market declines further, I will continue to slowly reduce cash and add to positions.? One nice thing about the rebalancing discipline is that I don’t time the market, but it often seems like the rebalancing discipline forces buying low and selling high, in ways that most investors would not want to emulate, because I am constantly leaning against the wind.

Starting on Monday, I’m going to be on the road until July 8th.? My ability to blog and follow the markets will possibly be impaired, because I will be busy the first week with the annual meeting (Synod) of my denomination, and the next week, with my parents’ 50th wedding anniversary.? I will be in rural Western Pennsylvania and Northern Wisconsin, respectively.? The first is a lot of work; the second, a lot of fun.? In both cases, Internet access may be spotty.

I’ll leave a few standing orders out to take advantage of further declines in the market, especially if the NAHC deal fails on Monday.? Beyond that, I will start in on the next portfolio reshaping when I return.? For those that want an early preview, here are my current industry ranks.? It’s been a good year so far, but who can tell, the market can spin on a dime, and once again find a new way to make fools out of us all.

Full disclosure: long NAHC JNY VLO HIG OMX MET RGA

Inflation and Stocks

Posted on 19 June 200819 June 2008 by David Merkel

I read this article today, and it made me want to write on the topic.? This is a concept that I learned early in my investment career.? It is worth understanding, so that you can do better in investing.? Inflation is negative for stocks, but it is a small negative — for every 1% that the inflation rate goes up, stocks decline 2% on average.

That’s not very big.? So why do stock investors panic over inflation?? They panic because the Fed might respond to inflation, and raise real (inflation-adjusted) interest rates enough to quell inflation.? Rises in real interest rates are far more negative to the market — a 1% rise in real rates hurts the equity market by 10%.? Why such a big impact?

The impact is large, because when real interest rates are high, capital is scarce.? Go back to my “Fed Model” article which is very different from other “Fed Models.”? High corporate bond rates raise interest costs for corporations, reducing profits, and raising discount rates (cost of equity capital).

At present, real interst rates are negative — in nominal dollar terms, this is not a bad time to own stocks.? Think of the dividend discount model for a moment.? Inflation runs through earnings and the discount rate, so the effect is muted.? Real rates run through the discount rate only — poison.

Is there any hope in an era where inflation is rising, and where real rates may rise?? Value investing always offers some hope, but that’s not my main point here.? Inflation manifests itself differently in different eras.? Look for the areas that are in short supply.? They will be the areas where corporations will have pricing power.? Those areas will outperform the market, even if the market as a whole declines.? At present, I am looking at energy stocks, food stocks, and others.

Inflation is bad for the market, but don’t let that stand in the way of looking for what might offer relative profit in this environment.

Ten Notes on Residential Housing

Posted on 18 June 200818 June 2008 by David Merkel

I’m waiting for the day when I can write upbeat stuff about housing…? when I can buy homebuilder and mortgage stocks and crow about my gains.? I hope I live two more years. ;)? (Many thanks to Calculated Risk for their excellent coverage of residential housing.)

1) The first thing to note is that residential real estate values are still falling nationwide.? That affects Mortgage Equity Withdrawal [MEW] and derivatively, consumption.

2) Now, housing prices are likely to fall another 10-15%, which is what I have been saying for a while.? That will lead to more situations where there is negative equity, and more defaults, as they happen with negative equity and negative life events.

3) Foreclosures are making up a larger percentage of all sales, which is not a positive in the short run for prices.? In Sacramento, and some other places in California, foreclosures are the majority of sales.? As a result, it is no surprise that housing sales are at a low.? Foreclosures have risen rapidly across the country, not boding well for future sale prices.? Even in Florida, foreclosures are gumming up the market, and are getting reconciled slowly.

4) The GSEs are in a tough spot.? The government pushes them to make suboptimal loans that their shareholders don’t like.? I guess that’s a part of their deal.? As it is, the GSEs are playing a large role in many loans today.? Private capital doesn’t step up in an environment like this.

5) Labor mobility is limited when housing prices fall.? Pretty normal, if infrequent, in my opinion.? I faced this back in 1989; employers offered limited housing perks to new hires.? In three years, this will be gone.

6) Now, it should be no surprise for lending standards to tighten now.? We always shut the barn doors after the cows are in the fields.

7) Mortgage rates are rising, largely due to the reaction of the bond market to Fed chatter.

8 ) Prime ARMs will fuel the next wave of delinquencies.? If home values fall enough, any class of lending is vulnerable.

9) It should not surprise us that housing starts are low in an environment like this.? The bigger the boom, the bigger the bust.

10) I am not generally a Tom Brown fan.? He is too perma-bullish for my tastes.? He may have a correct technical point on subprime losses, but it may misrepresent losses for the financial sector as a whole.? Subprime is small.? Alt-A and Prime are much bigger, and losses are growing there.

National Atlantic Notes

Posted on 17 June 200817 June 2008 by David Merkel

The last several days have been interesting to me regarding National Atlantic. It started with a discussion with another person who worked for my former employer (no, not the same one as last time). It went something like this:

Friend: Did you see the filing by our old boss?

DM: Yes, but unless he files suit alleging fraud, it is unlikely to amount to much.

F: Good point. What do you think the odds are of the deal going through?

DM: The deal is more likely to go through than not, but if the deal does fail, the stock will fall to $4, and if the deal succeeds it will go to $6.25. The payoff is asymmetric. I think the odds are 65% that the deal goes through.

F: So why are you holding on if the odds are that poor relative to the rewards?

DM: Uh…

So, on Thursday of last week and yesterday, I sold away 70% of my position after voting “no” on the deal. My thoughts: it is quite possible that the deal will get voted down. Sure, it isn’t in the short term interest of stock holders to see the deal fail, but National Atlantic has so annoyed shareholders that many will vote against their short term interests because of the egregiousness of the deal.

As an aside, NAHC is the sort of stock that if you are not careful, a large order can disrupt the market; I ended up using discretionary reserve orders routing through Arca [NYSE Archipelago], which allowed me to show 100 shares with much more behind that, and have discretion to lift bids within a penny of the stated offer. I was able to sell a lot without disturbing the market.

If the deal does get voted down, I will buy back in, at much lower prices. If it succeeds, I will take the small gain and move on.

Full disclosure: long NAHC

The Bottom for the Banks

Posted on 14 June 200815 June 2008 by David Merkel

There are many people calling for a bottom to banking stocks, and I must admit, it is a tempting place to play. I never thought Fifth Third would trade so low. Or Keycorp. Royal Bank of Scotland, sorry, I sold you early in 2008; yes, I thought you would fall. When does the excessive leverage finally eliminate the CEO?

Here’s the challenge for investors: on the one hand, you have declining earnings per share in the near term, from losses and capital raises. But when have equity prices fallen enough to discount the future losses?

I am being cautious here. I own no banks.

Here’s another way to think about it — after all of the bad debts are written off, and bad banks eliminated, what kind of earnings stream will be attractive?

I’ll use the homebuilders as an example here — at troughs, they sometimes trade for half of written-down book value, The question becomes the final side of the book value after the writedowns.

I would still be cautious here, but markets are discounting mechanisms — we are getting closer to a bottom in the banks; we are not there yet.

Book Review: The Wall Street Waltz

Posted on 13 June 200813 June 2008 by David Merkel

I’ve mentioned this before at RealMoney, but in early 2000, I was doing some serious thinking about investing. I decided to e-mail Ken Fisher a question that he had touched on in one of his Forbes pieces. That began an e-mail dialog that forced me to ask hard questions about how I did value investing. Personally, I was surprised how much time he was willing to waste on me, but I had read the three books that he had written up to that time, Super Stocks, 100 Minds that Made the Market, and The Wall Street Waltz. I had a good idea of how he approached investing.

He challenged me to throw away the CFA Syllabus and think independently — to focus on my own competitive advantage. That led me to analyze what had worked and failed in my prior efforts in value investing, and that led to what would become the Eight Rules. I did well in the prior era, but much better after my discussion with Ken Fisher.

One more note before I begin the book review. He told me that if something is known, it is not valuable for investing. I have modified that rule to be, “If something true is relied upon by many investors, it is not valuable for smart investors. If something false is relied upon by many investors, it is valuable for smart investors to bet against that.”

The Wall Street Waltz takes you on a graphic tour of economic and financial history. Using beautiful old charts created by multiple sources, he uses them to describe market action in the past, and what they might imply for the present. The original version, of which I have a copy, was written in 1987. The new edition updates Ken’s comments to 2007.

The charts provide a springboard for Fisher to explain a wide number of concepts:

Why preferred stocks are suboptimal investments. (Chart 31 — learned that first hand a a little kid as I saw my Litton convertible preferred crater.)
How economically linked Canada is to the US (Chart 15)
The value of P/E ratios for the market (Charts 1&2)
Why you shouldn’t panic over bad political/disaster news. (Chart 24)
How inflation is correlated internationally (Chart 49)
Gold preserves purchasing power in the long run, but that is about it. (Chart 57)
Stocks create value in the long run, despite short/intermediate-term fluctuations. (Chart 88)

I could go on. I chose those pages randomly. There is a wealth of knowledge here. I would like to close with a timely page that I targeted, Chart 64 — Unemployment and the 1 Percent Rule. The stock market tends to rally after the unemployment rate rises 1%, though the challenge is timing when to sell, and I don’t know what the rule should be for that. After the last unemployment report, the rate is more than 1% over the recent low. If correct, it is time to be a buyer, though what is true on average is not always true in specific.

Most investors don’t benefit from an understanding of economic history, which gives a broader skill set for analyzing current problems. This book is an aid in gaining understanding of economic history.

Full disclosure: If anyone enters Amazon through my site and buys something, I get a small commission. Your costs are not increased. This is my equivalent of the “tip jar” and so, if you like what I write, and need to buy through Amazon, please enter Amazon through links on my site.