Above is a chart of the Barrons Gold Mining Index, the oldest mining index available.
Above are chart analogs of past bear markets in gold-mining stocks. Rather than using charts to PREDICT the next “Head and Shoulders Bottom” or the next ROUNDING BOTTOM (How about I show you MY bottom?) what can charts tell you about this PARTICULAR industry? How is that information useful? Or is it?
Notice the difference with these charts of housing and banks.
What might account for the difference in the chart patterns? What do the charts tell you about the mining industry? IF–god forbid–you did wish to invest in precious metals miners, how might you adapt your strategy? What explains (mostly) the shape of the above charts? It is perfectly rational to avoid the industry but what do the charts tell you about the structure of the industry? Whip out your competitive analysis books or http://mskousen.com/economics-books/the-structure-of-production/ and post your thoughts.
After reading the report and using your knowledge of how capital cycles work, what would you say to your boss about using the information in that report for investing? IF you wanted to make an outstanding investment, then how might the report help you? The video below might give you a hint. Remember that the JP Morgan report goes to thousands of portfolio managers and analysts, so how can YOU use the information to have an edge? Or can you? Comments needed in order to keep your hedge fnd job.
This time, the Fiat Chrysler CEO went a step further than usual by declaring that the latest plan for the company is essentially a one-way bet on cheap gas. Production of compact cars will end to free up production capacity for high-margin, low-mileage Jeeps and RAM trucks.
This, combined with Fiat’s more or less complete lack of a fuel economy or electrification strategy beyond buying emissions credits from other manufacturers “foolish” enough to produce electric and hybrid “compliance cars,” is quickly making Marchionne, if not an industry joke, then certainly yesterday’s man.
At least, that is what people are saying. I have an alternate hypothesis. The Auto Industry Is Not Heading to a Good Place (The author, in my opinion, has the correct thesis. Ride sharing, Uber, Tesla, more complex electronics mean less demand and more investment to run in place).
Fiat vs. Ford above
Fiat (FCAU) has done slightly better than GM and much better than Ford (F). However, the auto industry is in a bad place that will worsen.
The context is frightening. Global fuel economy and emissions regulations are becoming so strict that it is possible to meet them only with partial or full electrification of the automobile. And the existing automobile production system, based primarily on stamping sheet metal and amortizing heartbreaking development costs and capital expenditures over millions of units, is incredibly capital inefficient.
What’s more, the industry’s move towards electric vehicles represents a significant challenge to the traditional strategic landscape an automaker faces. An electric vehicle has drastically fewer moving parts than an internal combustion vehicle and is, by design, far more modular, meaning that barriers to new entrants are significantly lower.
Electric vehicles are also far more uniform in their driving dynamics, because there is little scope for refining an electric motor with one moving part. Swathes of engineering and marketing investments become irrelevant. And both ride-sharing enterprises and developments in automation seem increasingly likely to grow beyond niche markets into something properly disruptive to the car ownership business model.
Marchionne Knows This
Last year, Marchionne presented a uniquely critical slide deck about the way the auto industry destroys capital. His argument was that, unless the industry consolidates and stops duplicating engineering costs (e.g., every car manufacturer has its own separately developed but fundamentally identical 2.0L 4-cylinder petrol engine), then the market will eventually force its hand, having gotten sick of miserly returns on billions in investments.
The industry response to this slide deck was more or less complete agreement, with the caveat that competitors would not have to outlast the market so much as merely outlast Fiat Chrysler. Marchionne then pursued an odd and ultimately unsuccessful merger with GM’s Mary Barra, who confidently rejected Fiat Chrysler’s plan, noting, “We are merging with ourselves.” (This presumably referred to GM’s decades-long quest to bring rationality to its stable of brands.)
GM is not only merging with itself, it is also “disrupting” itself — as evidenced by their recently announced Chevy Bolt long-range, affordable electric car. The company claimed the Bolt was designed to be the perfect car for ride-sharing apps. Just before launching the Bolt, GM announced a $500 million investment into Lyft, the main competitor to Uber.
This no doubt surprised competitors who have been making efforts to disabuse markets and investors of the notion that they would become mere providers of hardware to ride-sharing companies like Uber or autonomous car suppliers like Google. Dieter Zetsche, CEO of Daimler, remarked “We do not plan to become the Foxconn of Apple.”
Manufacturers Are Going to Have to Invest
In fact, the bosses of Daimler, BMW, and Audi went looking behind the couch for some spare change to buy joint ownership of Nokia’s (remember them?) mapping service HERE, and did so primarily to stop their rival bidder – Uber – from buying it. High-resolution maps are crucial to autonomous cars; Uber’s CEO has said that, if Tesla can make good on their promise of a long-range, autonomous electric car, he would buy “all” of them.
The Germans are thus investing billions into electric vehicles made out of carbon fiber that pilot themselves using super-high resolution maps, all the while fighting back against Apple and Google’s requests for access to their cars’ infotainment systems. Their global leadership of the auto industry will have to be pried from their cold, dead hands.
Meanwhile, all the difficult bits of the Chevy Bolt (“custom-built” for Lyft, remember) are built in large part by Korea’s LG. One wonders why Lyft (or Uber) would not simply buy the next model directly from LG? I guess even if there is no Foxconn for cars yet, there may be soon. Remember, electric cars are far more modular than internal combustion cars.
Marchionne Says “No Thanks”
Or, if not him, then certainly the Agnelli family. A sort of Italian royalty who control Fiat Chrysler (and Marchionne) via their ownership of the Exor holding company, the Agnellis have been showing signs that they are tiring of the endless drama surrounding Fiat and the auto industry in general. They bought a stake in The Economist in 2015 in a move towards media, but the recent de-conglomeration of Fiat has been noticeable in other ways.
First, in 2013, Fiat’s industrial division was de-merged and combined with CNH Global (maker of tractors under the Case IH and New Holland brands) into a separate company, CNH Industrial. Most recently, Ferrari, the jewel in the Fiat Chrysler stable of brands, was floated in New York.
Speaking of Ferrari, Marchionne took advantage of a recent dip in the fortunes of Ferrari’s eponymous Formula 1 team to unceremoniously eject Luca di Montezemolo as president and chairman of Ferrari and replace him with . . . himself. It should be noted that di Montezemolo was appointed by Gianni Agnelli himself after the death of the founder, Enzo Ferrari, and is a bona fide business superstar in Italy. Marchionne has been playing an increasingly active part in the politics of Formula 1 recently, something that will no doubt continue to make for a less stressful (but still stimulating) retirement when Marchionne puts on his famous blue sweater for the last time in 2018.
But for now, Marchionne has seen the future. Large subcontractors will produce partially or fully autonomous electric vehicles, with the sole differences between them being brand value and design. The car makers that survive may well simply produce cars for Google (Ford recently signed an agreement along these lines), Apple, or Uber. Some, like BMW or Mercedes-Benz, may survive because of their brand and design qualities. Fiat Chrysler does not have this.
Marchionne doesn’t care about expensive gas or electric vehicles because his plan is simple:
Sell the profitable Jeep/RAM brands to another conglomerate that does not compete in these segments (for example, Hyundai KIA).
Sell the unprofitable Fiat to anyone who will take it. Perhaps synergies in the lucrative European light commercial vehicle segment will attract another European maker, such as PSA Peugeot Citroën, whose CEO, Carlos Tavares, has ambitions that were thwarted at his previous employer, Renault.
Sell Alfa Romeo and Maserati to someone who could use a strong brand. Perhaps Volkswagen will finally get hold of its prized Italian trophy if they can sort out their global legal woes.
Retire to play with his giant Formula 1 Scalextric set. Marchionne has been mocked for his firms’ strategy, which has been attributed to hubris. But perhaps he is the one seeing clearest of all.
Is the best way to deal with disruption simply to step out of the way?
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Tit-for-Tat Competitive Analysis
Question: Who wins when–in a perfectly competitive market–competitors fight each other? Prize awarded for best answer.
May 8, 2017This Time is Not Different, Because This Time is Always Different John P. Hussman, Ph.D.
All rights reserved and actively enforced. Reprint Policy
“History repeats – the argument for abandoning prevailing valuation methods regularly emerges late in a bull market, and typically survives until about the second down-leg (or sufficiently hard first leg) of a bear. Such arguments have included the ‘investment company’ and ‘stock scarcity’ arguments in the late 20’s, the ‘technology’ and ‘conglomerate’ arguments in the late 60’s, the nifty-fifty ‘good stocks always go up’ argument in the early 70’s, the ‘globalization’ and ‘leveraged buyout’ arguments in 1987 (and curiously, again today), and the ‘tech revolution’ and ‘knowledge-based economy’ arguments in the late 1990’s. Speculative investors regularly create ‘new era’ arguments and valuation metrics to justify their speculation.”
– John P. Hussman, Ph.D., New Economy or Unfinished Cycle?, June 18, 2007. The S&P 500 would peak just 2% higher in October of that year, followed by a collapse of more than -55%.
“Old ways of valuing stocks are outdated. A technological revolution has created opportunities for continued low inflation, expanding profits and rising productivity. Thanks to these factors, the United States may be able to enjoy an extended period of expanding stock prices. Jumping out now would leave you poorer than you might become if you have some faith.”
– Los Angeles Times, May 11, 1999. While it’s tempting to counter that the S&P 500 would rise by more than 12% to its peak 10 months later, it’s easily forgotten that the entire gain was wiped out in the 3 weeks that followed, moving on to a 50% loss for the S&P 500 and an 83% loss for the tech-heavy Nasdaq 100..
“Stock prices returned to record levels yesterday, building on the rally that began in late trading on Wednesday… ‘It’s all real buying’ [said the head of index futures at Shearson Lehman Brothers], ‘The excitement here is unbelievable. It’s steaming.’ The continuing surge in American stock prices has produced a spate of theories. [The] chief economist of Kemper Financial Services Inc. in Chicago argued in a report that, contrary to common opinion, American equities may not be significantly overpriced. For one thing, [he] said, ‘The market may be discounting a far-larger rise in future corporate earnings than most investors realize is possible, [and foreign investment] may be altering the traditional valuation parameters used to determine share-price multiples.’ He added, ‘It is quite possible that we have entered a new era for share price evaluation.’”
– The New York Times, August 21, 1987 (the S&P advanced by less than 1% over the next 3 sessions, and then crashed)
“The failure of the general market to decline during the past year despite its obvious vulnerability, as well as the emergence of new investment characteristics, has caused investors to believe that the U.S. has entered a new investment era to which the old guidelines no longer apply. Many have now come to believe that market risk is no longer a realistic consideration, while the risk of being underinvested or in cash and missing opportunities exceeds any other.”
– Barron’s Magazine, February 3, 1969. The bear market that had already quietly started in late-1968 would take stocks down by more than one-third over the next 18 months, and the S&P 500 Index would stand below its 1968 peak even 14 years later.
“The ‘new-era’ doctrine – that ‘good’ stocks (or ‘blue chips’) were sound investments regardless of how high the price paid for them — was at bottom only a means for rationalizing under the title of ‘investment’ the well-nigh universal capitulation to the gambling fever.”
– Benjamin Graham & David Dodd, Security Analysis, 1934, following the 1929-1932 collapse
“The recent collapse is the climax, but not the end, of an exceptionally long, extensive and violent period of inflation in security prices and national, even world-wide, speculative fever. This is the longest period of practically uninterrupted rise in security prices in our history… The psychological illusion upon which it is based, though not essentially new, has been stronger and more widespread than has ever been the case in this country in the past. This illusion is summed up in the phrase ‘the new era.’ The phrase itself is not new. Every period of speculation rediscovers it.”
– Business Week, November 1929. The market collapse would ultimately exceed -80%.
This time is not different, because this time is always different.
Throwing in the towel
When a boxer is taking a beating, to avoid further punishment, a towel is sometimes thrown from the corner as a token of defeat. Yet even after the towel is thrown, a judicious referee has the right to toss the towel back into the corner and allow the fight to continue.
For decades, Jeremy Grantham, a value investor whom I respect tremendously, has championed the idea, recognized by legendary value investors like Ben Graham, that current profits are a poor measure of long-term cash flows, and that it is essential to adjust earnings-based valuation measures for the position of profit margins relative to their norms. In Grantham’s words, “Profit margins are probably the most mean-reverting series in finance, and if profit margins do not mean-revert, then something has gone badly wrong with capitalism.”
He learned this lesson early on, during the collapse that followed the go-go years of the late-1960’s. Grantham once described his epiphany: “I got wiped out personally in 1968, which was the last really crazy, silly stock market before the Internet era… I became a great reader of history books. I was shocked and horrified to discover that I had just learned a lesson that was freely available all the way back to the South Sea Bubble.”
In recent weeks, Grantham has essentially thrown in the towel, suggesting “this time is decently different”:
“Stock prices are held up by abnormal profit margins, which in turn are produced mainly by lower real rates, the benefits of which are not competed away because of increased monopoly power… In conclusion, there are two important things to carry in your mind: First, the market now and in the past acts as if it believes the current higher levels of profitability are permanent; and second, a regular bear market of 15% to 20% can always occur for any one of many reasons. What I am interested in here is quite different: a more or less permanent move back to, or at least close to, the pre-1997 trends of profitability, interest rates, and pricing. And for that it seems likely that we will have a longer wait than any value manager would like (including me).”
I’ve received a flurry of requests for my views on Grantham’s shift.
My simple response is to very respectfully toss Grantham’s towel back into the corner.
First, Grantham argues that much of the benefit to margins is driven by lower real interest rates. The problem here is two-fold. One is that the relationship between real interest rates and corporate profit margins is extremely tenuous in market cycles across history. Second, the fact is that debt of U.S. corporations as a ratio to revenues is more than double its historical median, leaving total interest costs, relative to corporate revenues, no lower than the post-war norm.
The last three months of 1999 were just about the sickest thing I’d ever seen. It was an orgy, but I simply couldn’t bring myself to buy a stock that was up $10m, hoping it would go up $15, even though it was overvalued by $100. But by choosing to sit out most of the ramp, determined to wait for the inevitable implosion, I was the Greatest Fool of All, as those around me made mind-numbing profits as, day after day. YHOO, AMZN and CGMI would gap $10 a day, immune to gravity as the Nazz, aka NASDAQ, ripped right past 3000 and didn’t even blink rocketing past 4,000. At the end of the year, the Nazz was up 83 percent, a far cry from the 5 to 7 percent stocks had returned historically. People were too busy celebrating and shouting “It’s different this time.” to realize such an adjustment was unsustainable. It is like a guy who averages five home runs a year suddenly hitting fifty. Something is not right in Mudville. —Confessions of a Wall Street Insider: A Cautionary Tale of Rats, Feds, And Banksters by Michael Kimelman
Expanding your circle of competence-Platforms and Networks
Note what Prof. Greenwald says about Amazon and Apple. If Apple is JUST a product company then I would agree, but what if Apple has network effects with its music and iPods for example?
The twenty-minute time limit was to force you to concentrate on the key issue: Does this company have economies of scale? Because of it doesn’t, then growth will NOT help profitability. In fact, growth with losses financed by debt can be financially lethal.
Our 10-K reading skills and our analysis of competitive advantage. Despite how CRITICAL it is for an investor/management to determine and distinguish competitive advantages, structural advantages are often confused with outcomes or efficiency.
Competitive advantage refers to something specific–a structural barrier that prevents competitors from simply replicating the results of a successful business. It should not be surprising that the terms competitive advantage and barriers to entry are interchangeable.
Without barriers to entry, a business cannot long enjoy an advantage over competitors that will quickly do the obvious—enter. This process of new entry will hurt not only relative performance but also absolute performance, as competition for customers dampens revenues, and competition for resources raised costs.
FIRST MOVER ADVANTAGE
First, it is NOT a competitive advantage. But here is an example of having a first mover advantage. You and I are in a duel. We walk ten paces away from each other then turn and shoot the other. After three paces, you turn around and shoot me in the back–now THAT is a first mover advantage.
Scale not size matters
It is industry structure determines which categories are most likely to manifest themselves and in what form.
Size doesn’t matter, but scale does. Scale is a relative concept, not an absolute one. The benefit it bestows are relative to peers within the relevant competitive set.
Look at WD 40_VL the company has a competitive advantage in PRODUCT SPACE. WD-40 is the ubiquitous oil/lubricant that people keep in their tool-box/shelf/or under the sink. They own 90% of the lubricant market. However, they also di-worsify their free cash flow into hand soap and motor-cycle products. Now the stock is over-priced in my opinion. If management could sell off its non-competitive products, and then become a tontine (use free-cash flow to buy in all shares)–investors would flourish.
Having 2% of a 10 billion dollar market or $100 million in sales is probably not as profitable as having sales of 40% of a 200 million dollar market or $80 million in sales.
Scale matters most when fixed costs matter most relative to the business’s overall cost structure. With large fixed costs, the operator serving the most customers will have a significant advantage due to its ability to spread those costs over more unit sales. If the costs of a business were entirely variable and increased proportionally as it grew, there would no advantage to scale.The extent of the advantage is determined by how relatively important fixed costs are how relatively large the business is compared to the next competitor. Second, much of what is thought of as traditional fixed costs in school management—admin, school relations and lobbying, and even curriculum development—has a significant variable component.
Curriculum requires local customization. The two primary sources of fixed-cost scale in education generally are content development on the one hand and sales and marketing on the other.
Reading the 10-K
We jump to page 27: Selected financial data and see rising sales financed by issuing shares and debt. Yet costs are not declining as a percentage of sales. Ebitda is declining per student. 1999 revenues of $133 million almost triple to $376 million in 2001 yet operating cash flows decline from negative $17.6 to negative $29.3.
Remember the little red school house? Edison Schools has to provide services in a regional area. If they can develop density (or clustering as management mentions on page 16 under competitive strengths) in particular regions, then perhaps this company needs more time to show progress? To determine their success in implementing a “clustering strategy, the next pages to peruse are pages 13-15 where you can see where Edison is operating schools. Take a large state like Colorado. Edison has two schools in Denver and three in Colorado Springs. Washington, DC, a huge metro area, only has eight schools and on and on. Management will not be able to leverage their admin, curriculum and development cost over such a widely dispersed area.
Imagine running a carting/garbage pick-up service where you have 5 customers in Eastern Connecticut, seven in New Jersey, 4 in Texas, you would go broke just driving to the different customers. You would lack customer density in your routes, so your costs would be too high.
PASS! Then if the analyst had more time, he/she could look at management. He or she would uncover the ugly history of Chris Whittle. No mention of that in the Credit Suisse analyst 50-page report.
Studying competitive advantages like economies of scale, customer captivity, network effects, low-cost producer will pay-off. Practice reading case studies of success and failure will help you hone your skills.
Prof. Greenwald on competitive advantage, the shift to services and why profit margins are so high and may remain so.
Most recent interview of Prof. Greenwald
You should think through Prof. Greenwald’s thoughts. Regarding investing, it is the art of the specific, so don’t let the the above macro talk affect your investing too much. I do agree that service companies develop competitive advantage through either product economices of scale or regional economies of scale.
There is an ongoing battle over Valeant’s (VRX) valuation and business model between short-sellers and investors. This opportunity allows us to improve our analysis skills and understanding of business models. Also, how will Sequoia, an owner of over 20% of Valeant’s equity, handle their portfolio?
My first question is whether Valeant is a franchise with durable competitive advantages or a roll-up of commodity products dressed-up in a fancy industry (Pharma)? We should use this case to learn how experienced analysts present their opposing views.
First: What’s not to like? Valeant has rapid growth with huge profit margins? Of course, the PERFECT investment is a company that has high returns on capital and can constantly redeploy its capital at the same high returns. The classic case would be the early (pre-2000) history of Wal-Mart (WMT) as the high returns generated from its stores could be redeployed into new stores on the borders of their regions which had economies of scale in administration, advertising, and management costs per unit of sales. WMT did not have, for example, advantages in gross margins, but net profit margins. See WMT_50 Year SRC Chart.
What would be the source of Valeant’s high returns and competitive advantages?
Other investors (Charlie Munger, Citron) disagreed:
April 2, 2015 from www.fool.com
…..Recently, during a shareholders meeting for the Daily Journal Corporation, a newspaper where he serves as Chairman, Munger had this to say about Valeant Pharmaceuticals Intl Inc.(TSX:VRX)(NYSE:VRX): “Valeant is like ITT and Harold Geneen come back to life, only the guy is worse this time.”
What exactly does Munger mean by this?
A little history lesson
Who exactly was Harold Geneen? And what did he do at ITT that’s so infamous?
Geneen took over ITT Corp in 1959 when it was still mostly a telegraph and telephone company. After being blocked by the FCC in an attempt to buy the ABC television network in 1963, Geneen decided to diversify away from the company’s traditional business and completed more than 300 acquisitions during the decade in areas such as hotels, insurance, for-profit education, and the company that made Wonder Bread.
Geneen used cheap debt to finance these acquisitions, which later proved to be the company’s downfall. After Geneen’s retirement as CEO in 1977, subsequent CEOs spent much of the next two decades paying off the debt by selling most of Geneen’s acquisitions.
Is Valeant really comparable?
On the surface, Valeant looks like it could be pretty comparable to ITT. Since merging with Biovail in 2010, Valeant has made more than 30 different acquisitions, most of which were paid for with debt or by issuing shares.
Since the end of 2010, Valeant’s debt has skyrocketed from US$3.6 billion to US$15.3 billion. Shares outstanding have also gone up considerably from 196 million to 335 million. It’s obvious that Munger is onto something.
But on the other hand, I’m not sure Valeant is anywhere close to being as bad as ITT was. For one thing, all of the company’s acquisitions are at least in the same sector. ITT was buying up hotels and car dealerships, while Valeant is buying up pharmaceutical companies. Valeant’s efforts scale up a whole lot better than ITT’s ever did.
There’s also a bit of hypocrisy coming from Munger on this issue. Munger is actively involved in a company that does pretty much the same thing as ITT did back in the 1960s. Sure, Berkshire doesn’t use much debt or engage in hostile takeovers, but Berkshire and ITT have more in common than Munger is willing to admit. Both attempted to dominate the business world using a roll-up acquisition strategy; Buffett and Munger were just a little more patient with their plan.
But just because Munger exaggerates how bad Valeant’s acquisition spree has been doesn’t mean the stock is necessarily a buy at these levels. The company had earnings of just $2.67 per share in 2014, putting the stock at a P/E ratio of nearly 100 times. Yes, earnings are expected to grow substantially in 2015, but the outlook is simple. For the stock to continue performing, the company must continue to make acquisitions.
After making more than 30 acquisitions in just a few years, it’s hard to keep finding deals that will not only be big enough to make a difference, but will also prove to be good long-term buys. There’s so much pressure on management to keep buying that a serious misstep could be coming. If that happens, this hyped stock could head down in a hurry.
Although I don’t buy Munger’s alarmist concerns about Valeant, I agree with him on one thing. The stock just isn’t attractive at current levels.
Citron, a short-seller, attacks with a report: Valeant-Part-II-final-b. Valeant is another “Enron.” Use the search box on this blog and type in Enron and follow links to review that case. Enron never showed the profit margins that Valeant is currently showing. NEVER take another person’s statement on faith. Check it out for yourself.
Valeant today (October 26th, 2015) counters Citron and answers investors’ concerns with 10-26-15-Investor-presentation-Final4 Valeant and video presentation: http://ir.valeant.com/investor-relations/Presentations/default.aspxeep.
Ok, so what is Valeant worth? Can you make such an assessment? How do you think Mr. Market will weigh-in? If you owned a 20% stake in Valeant, how would you manage the position? What are the main issues to focus on?
This may be too difficult to analyze for many of us but we have or will have many documents and reports to provide insights. Remember that there are two sides to every narrative. Can we move closer to reality or the “truth”?
Note www.whalewisdom.com and type in VRX. What type of investor owns Valeant? Will momentum investors stick and stay?
Your comments welcome.
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