Category Archives: Freezing Assets Shout Out

Living on the Edge, Part 1

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Snow and us have a mixed past. We loved it growing up, but our liking for it soured when we moved back here from grad school in the South—just in time for the 1991 Halloween blizzard. Lucky us. Overall we like winter, but the first storm irritates us because it is shock to our system. What else irritates us? Near the top of our list is when people ask us “do you have an edge on the stock?” when discussing a new idea.

We dislike that question since people in the investment community usually talk to the same analysts, read the same regulatory filings, go to the same conferences and often know each other in the financial community by name at least locally—how does one get an informational edge when there is that much intimacy with the companies we follow, especially with mid and large cap stocks? We think a better question is how does your investment thesis different than conventional wisdom and why?

Having said that, we think that the “edge” question is an occupational hazard we must live with daily. Therefore over the course of the next couple of weeks we’ll explore the topic if can one get an edge from both a large cap and small cap perspective and if is it relevant. What do you think? Can one get an edge on a particular stock/security?

But These Go to Eleven (or Twenty Times), and Over What Time Frame?

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When we were in high school we were in a band called Felix Flux and the Flemtones. We had it all: the looks, the clothes and the attitude—however that talent thing got in the way getting our star on the wall of First Avenue. What we lacked in talent we compensated for in volume. The Flemtones were loud enough to drown out a fleet of garbage trucks, and we provided about the same audio enjoyment. Luckily our time horizon for the band was short-term fun, in the long-run we would have starved.

The stock market volume as measured by both a return and market multiple basis has been increasing as well this past year. Thankfully we are not writing about if the market is correctly valued at this point in time. Rather, we are wondering what is the investment time horizon the market is implying with current multiples. Theoretically speaking one can back into that number at a certain spot in time via various methodologies, e.g. Black/Scholes, but we do not think that tells the whole story. After all investing is putting a value on future cash flows—therefore adequately predicting the length of time of future cash flows will be discounted by the market is as important as accurately predicting such flows in our opinion. Our question therefore is what is the market’s implied time horizon in the future?

Of course, the correct answer is “it depends” as the market is nothing but an amalgamation of millions of individual investment decisions. But as we remind ourselves every day, we are not always trading with humans. With a good percentage of the market’s volume is done by computerized and algorithmic trading, one can make the argument that the market’s time horizon has been and may continue to shrink. Additionally many institutional investment firms are judged not on a multi-year or even yearly basis—oftentimes it is quarterly. Sometimes in our more cynical moments we think that the market time horizon is the amount of time between Fed announcements. Finally, anecdotally speaking, the past several earnings seasons we often observed certain stocks going up on “beaten” earnings estimates that had been lowered relentlessly throughout the preceding quarter, which also may point to a shortened investment time horizon.

Having said that, there are occasions when we hear market prognosticators say that a stock is “good for the long term investor” we often think that translates to “this is a catalyst-free stock, but it’s cheap.” While we jest, we do believe there is some positive truth to that statement. Time after time it seems that good old-fashioned Graham and Dodd investing wins out in the long run. Mean reversion is a powerful force and buying inexpensive assets at historically lower valuations usually is a great strategy.

What do you think? Is the market time horizon shortening or is the market still driven by long-term fundamentals and investment techniques?

Lutefisk Buyback

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The holidays are rapidly approaching. Unfortunately for us in the Upper Midwest, holidays often equal lutefisk. Lutefisk in our view has to be the worst holiday food tradition in the region, even worse than receiving a fruit cake. At least fruit cake can be re-gifted, often for years at a time—kind of like a culinary chain letter.  When it comes to lutefisk, we would rather perform open heart surgery on ourselves than eat this alleged food. Some hearty souls claim to like lutefisk. In fact several years ago there were lutefisk microwave entrees. For most of us, the less lutefisk—the better.

On the opposite end of the scale, there are stock buybacks. The more we get, the happier most investors are. Usually for growth-oriented stocks we are not fans of stock buybacks. While we think it can be an effective way to return cash to shareholders in a tax-efficient manner, the timing and the amount of the buyback can dramatically impact the return on the company’s (and ultimately the  shareholders’) investment. For instance, most share buybacks undertook during the 2006-8 timeframe likely did not deliver a good, if any, return for shareholders. Additionally, while a share buyback can grab headlines, oftentimes stock options and grants can dilute or even undermine the earnings per share impact of a buyback.

Furthermore, U.S. based companies usually use cash domiciled in the U.S. for a buyback—all from the same pile of cash used to pay dividends, U.S. based pensions, U.S. employee health care costs and many other expenses. This can leave far less cash for growth-oriented activities especially here in America. These activities can include additional property, plant and equipment that can lower costs in the long run or increase productivity and/or capacity, additional investments in research in development, U.S. based acquisitions, new marketing channel development and sales force enhancements. The expected return of the buyback has to outstrip all of those other potential uses for cash in our view to be worth the risk and potential long-term growth opportunity costs.

Having said that, there are times when buybacks are worthwhile and we need to incorporate the potential for them into our investment analysis. For instance, for companies with a cyclical bent, there may not be any worthwhile investments for the company’s cash other than purchasing their own stock at that point in the cycle. Additionally we also know that if the buyback is timed properly, it can enhance shareholder returns. It is also nice to have the company conceivably buying stock on pullbacks, potentially supporting the stock. Finally at the end of the day, an investor should be concerned with generating an abnormally good return over the investor’s investment horizon. Buybacks certainly play a role in that regard. Therefore, when there is a buyback announcement one may have a percentage of float number in mind that would make us take notice of it being material to the stock’s shorter-term potential investment attractiveness.  Do you have such a number? What do you think?

Dazed and Confused

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This is going to date us, but we are Led Zeppelin fans. One benefit we here in Minnesota had over our pastoral neighbors to the east is that Zeppelin would not play in Wisconsin. Rumor had it that in 1969 Zeppelin did not sell out a show in Wisconsin and never wanted to play there again.

Channeling Zeppelin, we are “Dazed and Confused” about the industrial sector. Like most that follow the sector we monitor Institute of Supply Management (ISM) data on a regular basis. The data from ISM has been good lately—seemingly across the board. In our view Philadelphia Fed data echoes that sentiment. European and Chinese data are generally pointing toward expansion. Usually these data are a leading indicator of industrial health so that’s good news for the sector, right? Well, usually, but not so fast. Copper prices are also considered a leading indicator of industrial demand and prices are down notably since the beginning of this year. That’s not good for future industrial demand because money talks, right? Other data such as the National Federation of Small Business survey also shows conflicting trends in our opinion. Additionally U.S. and global GDP figures may indicate that we are just plodding along—no real change. Of course, there are some subsectors that are doing better than others—aerospace doing better than mining equipment, in our view. However, our question is where is the industrial sector going to perform as a whole over the next six to twelve months? What do you think?

Thinking Ahead

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One of the challenges of living in the Upper Midwest is that you have to prepare for the Holidays now before it gets too cold. As we say in our household, “Easter is the time of year when can take down the outside Christmas lights you put up after Halloween because the extension cords were frozen solid to the ground since Thanksgiving.” Therefore, we in the Tundra pride ourselves on thinking ahead. We were wondering if we need to think ahead about Affordable Care Act impacts, or if it is too early.

Many health care consumers are having their coverage dropped from their insurance provider (see link below). Much ink has been spilled discussing how that may impact health care companies. We also wonder if this will impact the broader economy, and if so when and do we need to prepare now as investors?

Our gut feel is that it will have less of an impact on the truly affluent in this country as many can pay out of pocket or find alternative sources of care worldwide. We also wonder if little will change with the less affluent. Yes many more will have affordable insurance, but we also do not know what the final deductible and co-payments might be until we get more data on the demographic characteristics of those that signed up. That leaves our large middle class. If premiums, deductibles and co-pays rise for a good percentage of middle-class Americans (e.g. those without existing conditions), what will that mean for disposable income? Will increasing health care costs crowd out consumer spending and will it impact other sectors?

Part of us says that it is too early to make any investment decision, especially since those who work for larger corporations will not feel the impact until 2015 since larger companies received a one year extension under the Affordable Care Act. But still a sizable subsector of the middle class could feel the impact by January, and others who are not affected now may see the impact higher costs have on their neighbors and act accordingly beforehand. What do you think?


 

 

Supporting links:

http://www.kaiserhealthnews.org/Stories/2013/October/21/cancellation-notices-health-insurance.aspx

http://www.bloomberg.com/news/2013-07-02/health-law-employer-mandate-said-to-be-delayed-to-2015.html