And so, after weeks of bluster around the budget / debt ceiling impasse, something did finally give. No political comments here, but we seem to be right back where we started, with just a little breathing room. Nevertheless, with the possibility of an imminent U.S. default off the table, risk markets reacted favorably, and Credit was among them – the index was tighter by 4-5 basis points. This doesn’t seem fair, in some ways. Equities at least traded lower during the uncertainty, before rebounding to new highs. But cash credit spreads have been tightening all along. Lack of supply, continued strong demand – it feels like a very technical market to me right now, but spreads just keep grinding in. Continue reading
Monthly Archives: October 2013
Computer Literate
During this time of year in the Upper Midwest one can say if you don’t like the weather—wait a day. With the jet stream bouncing above and below us in rapid order like so many Vikings passes, our weather can go from frustrating to fine in the short-term often before we can react to it. It reminds us of the market.
The question we have is that with the rise of computerized trading and artificial intelligence, are we mere humans getting beat in short-term investing? Despite The Rise of the Machines, these devices do have to be programmed by some lowly carbon-based life form somewhere. But the software can be programmed without the personal biases of humans and can take into consideration several different investment styles modeled after some of the best investors in those styles. Continue reading
Nothing to be done
It was another week of waiting for Washington, and there was little movement in time to help credit markets along. It’s not that spreads were especially weak – a few basis points wider until Thursday, and the street seemed happy to engage in any activity that came along. In other words, odd lots traded well. But the new issue calendar was extremely quiet for the second week in a row, and secondary markets seemed to slow to a crawl. Thursday was a little better – word of a potential compromise late in the day helped to push spreads tighter, the rally pretty much in line with equities. But by that time, most new issuers had gone home for the week, ready to take off for a long holiday weekend. Yes, equity friends, the bond markets are closed on Monday in recognition of Columbus Day.
So here’s the recap. There was about $12 billion in Investment Grade supply for the week, with large deals from Sinopec (a Chinese oil refiner), Centrica PLC (the parent company of British Gas), Codelco (copper mining), and our U.S. domestic entry for the week, Berkshire Hathaway. The dominance of foreign issuers was notable – we will assume it is due to earnings season and not because U.S. issuers are busy searching for a more stable political climate to call home.
We are expecting another $10-15 billion in supply next week, but the banks are a bit of a wild card. As we start to move through earnings, we might see some of them hit the market, pushing that supply number higher. A lot will be contingent on progress in Washington – which is starting to feel like waiting for Godot.
Smart Growth
I participated in a panel for the Minnesota Chapter of the National Association of Corporate Directors a Wednesday mornings a few weeks back. The audience was composed of private business owners, attorneys and accountants. Although the panel’s focus was on smart growth for private businesses, the topic is certainly relevant to any business. To keep the focus on private companies I did some research and found that private businesses, particularly family owned businesses, tend to be overcapitalized (i.e. use significantly more equity than debt), often are understaffed, and tend to focus more on the top line than the bottom line. All three of these traits impact growth in significant ways. Finite capital is a problem for any firm but a private company relying on equity is even more challenged. This “equity” is all internally generated and forces firms to make tough choices on how to fund growth. Understaffed businesses will find that their human capital resources are stretched too thin to be able to manage any growth in the business, and will likely not even have the time to adequately evaluate any ideas that could generate growth opportunities. And the final point, the over-reliance on top line growth, is in my mind the most problematic of all. If the mindset is to meet revenue growth projections the decision makers are likely to chase revenue with little analysis of the impact on profitability. This not only causes tension with finite capital but it can also quickly destroy value. To that point I ended my presentation with the following example that showed how conserving capital can add value. Continue reading
It’s That Time of Year Again!
Now that we are entering October, we Upper Midwesterners have to look forward to a dreary period of time when days are darker, our skin starts to shiver and our hearts beat faster to move our chilled blood. I am speaking, of course, of Earnings Season.
After listening to countless conference calls, several detailed phone discussions and reading/writing many reports we need to figure out what we think these securities are worth. But what method does one use for valuation? Price to Earnings is the most popular and can be used across sectors, but can be managed via accounting methods and is not useful for early stage/pre-earnings companies. Price to Sales combats some of those problems and can be the least susceptible to accounting noise, but can overlook poor cost oversight. Enterprise Value to EBITDA works well because it can reflect the cash generation characteristics of a company and is comparable across capital structures but can be difficult to utilize across industries. Price to Book can be the go to valuation for pre-earnings companies but can be difficult to use due to differences in accounting assumptions. We have other valuation tools as well, discounted cash flow, PEG ratios and many others.
Naturally, we use each of these valuation methods on a daily basis and some may work better than others for certain sectors and certain situations—and we all need to use a combination to get a more qualified valuation picture. But usually we have our favorites and one that we typically put more weight on than others—especially during the screening process. Do you have a valuation method that you go to more often than others? What do you think?