Dear John: I have a friend who wants to know what to do with his money. I know Charlie Munger suggests investing in cheap index funds for a “no-nothing” investor. But aren’t there problems with indexes? What do you think?
Well, especially now when most bonds (especially government bonds) seem high risk for no-or-low return, the first question would be what should that person allocate towards equities.
I am working on my answer, but thought YOU have advice for this reader.
all provide a case for equity investing. However, when you hear that historically the stock market has returned 8.6% or 9% for the past 200 years, it is a little like saying the average height of the person in this room is five foot five inches tall. The room has a pro basketball player standing tall at 7.5 feet and a dwarf in the corner at 3.5 feet–the average is 5.5 feet. People are still seared by this experience in 2007-2009.
www.cafehayek.com… is from David Hume’s 1742 essay “Of Public Credit,” (here from page 350 of the 1985 Liberty Fund collection of Hume’s essays, edited by the late Eugene Miller,Essays: Moral, Political, and Literary) (original emphasis):
[O]ur modern expedient, which has become very general, is to mortgage the public revenues, and to trust that posterity will pay off the incumbrances contracted by their ancestors: And they, having before their eyes, so good an example of their wise fathers, have the same prudent reliance on their posterity; who, at last, from necessity more than choice, are obliged to place the same confidence in a new posterity.
Moods and Markets (Socionomics)
Of course, mood and emotion have an influence on people’s actions. I view socionomics/psychology as a supplement to but not a substitute for understanding Austrian Business Cycle Theory. In the interests of openness and inquiry I am posting on socionomics. Some may view it as star-gazing. YOU decide.
Socinomics is the study of how changes in social mood motivate and affect social actions and our behavior, not just in the financial markets but also in politics and popular culture. Socioeconomics, on the other hand, looks at how changing economic conditions and social conditions relate. The two fields have different views of cause and effect.
Mood is defined as our underlying confidence which is all about the future and how certain we are, not only about what we believe is ahead but whether our own immediate choice of action—our decisions–will be successful.
The reality, however, is that the future is in no way correlated to our level of confidence. The future is going to be what it is going to be whether we are confient about it or not.
For example, in June 2011, Wells Fargo exited the reverse mortgage business (www.wellsfargo.com/press/2011/20110616_Mortgage) by stating that “The decision was made based on today’s unpredictable home values.” The press release implies that when Wells Fargo entered the reverse mortgage business in 1990, the company thought that home values were predictable. The reality is that home values were just as predictable or unpredictable in 2011 as they were in 1990. When we are confident (good mood) we tend to believe that we can predict accurately and when we are not confident, we view the world as more unpredictable. Read more below:
Books: One of the greatest investors of all times was John Templeton who said to buy at the point of “maximum pessimism.” I have been looking for books that explain how to do this, or at least make an attempt.
Moods and Markets: A New Way to Invest in Good Times and in Bad (Minyanville Media) [Hardcover] Peter Atwater (Author)
The book, “Mood Matters,” makes the radical assertion that all social events ranging from fashions in music and art to the rise and fall of civilizations are biased by the attitudes a society holds toward the future. When the “social mood” is positive and people look forward to the future, events of an entirely different character tend to occur than when society is pessimistic. The message of the book – that the mood of a society dictates what will happen rather than the reverse – is counterintuitive at first sight, but supported by many quite surprising and convincing examples.
Mood Matters: From Rising Skirt Lengths to the Collapse of World Powers [Hardcover] byJohn L. Casti (Author)
Hempton: Short-seller Went Long Herbalife Fri 04 Jan 13. The following transcript has not been checked for accuracy.
CNBC: Activist Robert Chatman battling Bill Ackman on Herbalife (see next article in this post). Herbalife’s Chairman says Ackman will lose his fight against Herbalife. But he have not the only one who thinks they will lose. Watching this battle, in his own words, says it is like watching hedge fund porn. Herb, thanks for joining us today.
Herb Greenberg: What makes him so interesting in this case is that he is mostly known as a short seller and he is buying the stock even though he agrees with Ackman. He joins us now live in our studios. John Hempton of www.bronte.com, “How are you.”
Hempton: I’m pretty well.
Greenberg: I got to ask a quick question here. yeah. You’re a short seller and you are — you are long this stock. How does that work? Why would you do that? I’m pretty familiar with scum bags. Multilevel marketing schemes are scum bags. There are a million people in their chain and Bill Ackman says Herbalife is ripping them off. Tobacco companies kill twice as many people a year as Herbalife has in its network. Those companies kill 400,000 people in America. Hugely profitable. They are scum bags but return cash to shareholders for decades. If you have shorted them, you’ve been run over.
Herbalife, five years ago, had about 140 million shares, it now has 108 million shares. It buys back stock regularly; pays a fairly hefty dividend. They are a scum bags, but they are a stock market scum bag.
Greenberg: You have to be careful with what you say here. The question is, will the Federal Trade Commission (“FTC”) go after the company? One reason you don’t believe that Ackman will be right is because you don’t believe the FTC will do that.
Hempton: You say something obviously is wrong and you think the government will rescue you. all Herbalife needs to do is find somebody who was fat and is less fat because of Herbalife and somewhere in the 2.5 million distributors there will be a few of those. Wheel them out in front of them (FTC regulators), and you are know, what Bill Ackman’s case now is that the government’s going to go and help the billionaire hedge fund manager.
Greenberg: I know another hedge fund manager here john, and he is very politically connected, very short the stock, and he believes that the heat will get turned up on this industry very quickly here. And he believes that one of the things they will be looking at is the industry itself targeting lower-income people. So what is to say that even though the FTC didn’t do this before, they don’t come back and do it now?
Hempton: I believe the same thing about the tobacco companies 20 years ago. the FTC has known about multilevel marketing schemes for decades. If this (Herbalife’s scam/cash flows) lasts three years, Ackman is wrong. If it lasts a decade, Ackman is so wrong, it’s just silly. Now this thing really has cash flow. A thesis that says, I got to wait for government is a bad thesis. I don’t know how many really dodgy companies I’ve reported to the FTC and what do they do? Sometimes they fine them. The vast bulk of the time they don’t.
CNBC: “Herb (Greenberg), I’m wondering where we go from here. I know we are looking forward to Herbalife’s rebuttal and Ackman is preparing his rebuttal to that rebuttal. What is the next chapter in the story?
Greenberg: Does this does become the equivalent of the for profit education industry where they go after it and where the industry, people said, they will never go after that industry. The government went after that and in this case you end up with a very hard reset of the business models of these companies.
Hempton: And for profit education industry case the victim is at least in part the government. the government giving stupid loans. a relatively easy way of the government reducing their fiscal drain.
Greenberg: John (Hempton), if in it case the victim is lower-income population, a lot of lower-income population and the Obama Administration could be very interested in that, wouldn’t that potentially have an impact?
Hempton: When did the government care about lower-income people in that way? Lower-income people are largely the victims of tobacco companies too. You look at tobacco, it is completely inversely correlated to wealth and income. Rich people don’t smoke. Poor people smoke. People in most jurisdictions just raise taxes from that.
Greenberg: Okay, we will see who is correct on this one. John, thank you very much for coming along.
Herbalife: Why I Made It a 35% Position after the Bill Ackman Bear Raid
This is a guest post prepared by Robert Chapman. Chapman is the founder of Chapman Capital LLC, which is a Los Angeles based investment company specializing in takeovers and turnarounds. In 2000, Chapman Capital was an activist versus Herbalife following the death of Herbalife’s founder Mark Hughes. This is an amazing article. It’s well-researched and easy to understand. If you’re remotely curious about the future of Herbalife after Ackman’s attack, the mechanics of short selling and the potential value of Herbalife’s stock, this is a MUST read. If you find this article informative, hit the +1 or Like buttons above. Sincerely, +Kevin Thompson
…REGUATORY SUMMARY: FTC has been there, done that.
The Ackman Tell. Many poker games are won and lost upon that infamous turning point when a player properly reads his opponent’s “tell.” To wit, I am confident that during an interview with CNBC’s Andrew Ross Sorkin on “D-Day” (12/20/2012), Bill Ackman slipped his “tell”, confirming my suspicion that he already realized the FTC wasn’t going to make his day by shutting down HLF. I strongly recommend all HLF traders/investors read the transcript of this interview, as Sorkin does a masterful job of fighting the media urge to genuflect before Ackman’s drawn down zipper, otherwise known as “The Whitney Tilson”.
Interview with Michael Mauboussin: Untangling Skill and Luck in Business, Sports, and Investing (From www.simoleonsense.com)
Today we’re going to talk about the role of skill and luck in generating success.
Michael Mauboussin’s Background
Michael Mauboussin, is the Chief Investment Strategist at Legg Mason Capital Management. Michael is also an adjunct at Columbia Business School and Chairman of the Board of Trustees at The Santa Fe Institute.
Book Synopsis
What role, exactly, do skill and luck play in our successes and failures? Some games, like roulette and the lottery, are pure luck. Others, like chess, exist at the other end of the spectrum, relying almost wholly on players’ skill. In his provocative new book, Michael Mauboussin untangles the intricate strands of skill and luck, defines them, and provides useful frameworks for analyzing their relative contributions. He offers concrete suggestions for how to put these insights to work to your advantage in business and other dimensions of life.
CSinvesting Editor: Just remember that those that know, don’t tell; and those that don’t know, have the floor to themselves. Some might call Mr. Mauboussin, “an entertainer.”
The first scam that I have come across that tugs at the heartstrings. My spam box receives about 25 a day. I wonder what the scammer’s conversion rate is…………
Hello,
Apology for invading your privacy. I came across your email address in my email book today as my spirit leads. I have been praying and fasting for direction to meet someone i can trust with my life endeavors for humanitarian purpose. I’m Kate Johnson, 70-yrs old from England affected with cancer of the breast. My condition has deteriorated to the 5th stage. My surgical specialist informed me recently that i would not be able to survive my next surgery is a matter of 50/50 Operation. That might just be trust as my medical Report explained more in details. Right now, am left with no hope as a childless widow.
Considering my condition now, I have been touched by the lord to donate from what I have inherited from my late husband to less privilege through someone i can trust with my heart as my spirit lead me for good work to humanity rather than allow my heartless relatives to use my husband’s hard earned funds inappropriately. Right now, am on sick bed at cancer center in Liverpool, England for treatment. Am writing you this letter purposely because i need to know if you can be trusted to handle a humanitarian project for me. I am willing to donate a huge Amount to the poor through a Godly minded and honest person since is very impossible for me to even get up from sick bed. Can you help me?
Please send full contact details so you can receive my donation.
Kindly get back to me as soon as possible for further details on what to next, waiting for your urgent responds.
You can never hear this lesson enough–beware of experts. In the end, no one knows the future. In fact, market gurus or experts have a greater than even chance of being wrong than a coin toss. Skip those odds and save yourself a lot of time.
Jon Stewart Puts CNBC on Trial. Cramer is roasted.
For a more detailed video of CNBC’s expert predictions (11 minutes) with more of Jon Stewarts’ savage commentary: http://youtu.be/N3LCZ3wTDoQ
Stewart is really going after CNBC’s promotional stock hyping while masquerading as a knowledgeable news source. Jim Cramer is part of the market ecology just like his famous predecessor, Gerald M. Loeb, the author of The Battle for Stock Market Survival (1935). Loeb, whom Forbes once tagged “the most quoted man on Wall Street,” became synonymous with the Hutton brokerage firm in the 1950s–and, not coincidentally, a flamboyant method of trading that generated brokerage commissions. Meanwhile, his visibility in the press was, as it often is, mistaken for respectability.
Despite all the ink that was spilled about him (and Cramer, today), there is no real contribution there of enduring value. Separate what is fundamental and new, or for that matter fundamental and old, from the kind of superficial sales-driven froth that Loeb and his PR machine have delivered. Loeb was the personification of the saying that” you can’t believe everything you read.” (Source: 100 Minds That Made The Market by Ken Fisher).
More proof that Chimps could pick stocks better (at least 50% randomly choosing stocks that will do better or worse) than “experts.”
Louis Rukeyser Shelves Elves Missed Market Trends Tinkering didn’t improve index’s track record for calling market’s direction.(MUTUAL FUNDS)
Investor’s Business Daily
November 01, 2001 Byline: KEN HOOVER
Louis Rukeyser, host of the popular “Wall Street Week” TV show, has quietly shelved his Elves Index, which was made up of his panel of experts’ stock market forecasts.
On Sept. 14, in the aftermath of the World Trade Center attack, he told his audience he was going to “give our elves a rest for a while.” He hasn’t mentioned them in weeks. And he declined to be interviewed on the subject.
He’s doing viewers a big favor. The index had a terrible track record. The elves said buy when they should have said sell, and vice-versa.
They were giddy with optimism as stocks crumbled the past two years. Maybe their darkest hour came in 1999 when an elf was indicted by a federal grand jury.
There’s a lesson here for investors. Pay no attention to experts, even if they are handpicked by the venerated Rukeyser. Sure, his show has helped PBS viewers gain an understanding of the arcane world of the stock market for three decades. But all investors need to learn to separate fact from opinion. And be especially leery if there’s a consensus about the market’s direction from Wall Street’s best minds. Chances are the market will go in the opposite direction.
“As far as I’m concerned, the experts are nothing more than the herd,” said Don Hayes, a money manager who closely follows market psychology. “Most people get their current market opinion from current market news. And news looks backward. The market is always looking forward six to 12 months.”
Rukeyser’s index worked like this: Each of 10 panelists voted on the Dow’s direction. A bullish vote counted +1. A bearish vote was -1. Zero was neutral. A +5 reading was supposed to be a buy signal. A -5 was a sell signal.
This system went against decades of research about market psychology. Several widely watched and reliable market indicators are built around the principle that markets are likely to do the opposite of consensus opinion.
After The Fact
The elves index started in 1989. It was reading +3 on July 27, 1990. That was a market top. It read -4 on Oct. 12, 1990. That was a market bottom. It gave its lowest reading ever, -6, on April 1, 1994.
That was after a nasty correction. The problem was the correction was almost over. The elves stood at -5 on Nov. 25, 1994, just as a powerful advance was about to begin.
The index was working just like any other contrarian sentiment indicator. Some market strategists started watching it that way.
The elves never gave another negative reading after May 1995. Rukeyser tinkered with the elves’ makeup, adding bullish votes. In May 1996, he purged five elves, replacing them with new blood.
That moved the index from +1 to +6, just in time for a correction that made some elves nervous. It fell back to +3.
On July 31, 1998, just as the market was starting to sink into a quick but painful bear market, the elves were a chipper +6. A 21% Dow plunge moved them down only to +3.
Rukeyser gave the elves another bullish boost just as the bubble was about to burst. In November 1999, he expelled long-time bear Gail Dudack. She was replaced with pension-fund manager Alan Bond.
Bond voted with the bulls, pushing the index to an all-time high of +7. A few weeks later it reached +8. If Dudack had stayed, she would have finally been right a four months later.
Bond was on the panel only five weeks. He was indicted on charges of taking $6 million in kickbacks. Last August while awaiting trial, he was arrested on new fraud charges. Trials are pending.
Nurock’s Record
As the market peaked in March 2000, the elves were bullish at +7. For 11 weeks during the worst bear market in a generation, the elves gave readings of +9. Late last year, Rukeyser started a parallel index for the Nasdaq. Its readings differed little from that of the Dow.
Before Rukeyser had the elves, he had Robert Nurock, who cobbled together 10 technical indicators into a composite that actually had a decent record, according to a study by technical analyst Arthur Merrill.
From 1974 to the end of 1986, the index correctly forecast the Dow’s direction 26 months in advance 79.5% of the time. That’s according to Merrill’s study, which was reported in the book “The Encyclopedia of Technical Market Indicators,” by Robert Colby and Thomas Meyers.
Nurock and Rukeyser parted company after the 1987 crash.
In The Intelligent Investor, Benjamin Graham sums up his investment philosophy by saying that an intelligent investor must be “businesslike” in approach. Investing in shares in a company is just like owning a share in a business enterprise and the investment must be approached as if one were buying a business, or a partnership in one.
There are four guiding principles for Graham:
1. Know the business
The investor needs to become knowledgeable about the business or businesses carried on by the company in which they propose to invest – what it sells, how it operates, what is the competitive environment, what are the threats and opportunities, the strengths and weaknesses.
An investor who bought a fruit shop, or a shoe factory, without investigating these things, and knowing them, would be foolish. The same applies to share investment. An investor who does not understand the business should not be investing in it.
2. Know who runs the business
An investor who cannot operate the business for himself or herself, needs a manager. This is the position of the average share investor, who owns a share of an enterprise that is run by others.
The owner of a business in this position would want a manager who will manage the business competently, efficiently and honestly. The share investor should not be satisfied with less. Unless the investor believes, through sound research, that the company is managed efficiently, competently and honestly, in the best interests of the shareholders, the investment should not be made.
3. Invest for profits
An investor would not normally buy a business that did not, on proper research, appear to have reasonable expectations of producing good profits over time. Share investors should take the same approach and buy, as Graham says, “not on optimism, but on arithmetic”.
4. Have confidence
Graham encourages investors to properly research their investments and, if they believe their investment judgment to be sound, to act on it. He cautions investors in this position against listening to others.
“You are neither right nor wrong because the crowd disagrees with you. You are right [or wrong] because your data and reasoning are right [or wrong].”
You can feel the fear, anger, and despair (visit the Yahoo Finance Board for JCP to get a feel for what small investors think), because you own the company. Whom do you blame, what can you do? The only way to stop the price from going down is to turn off your screen. 🙂
To gain a more realistic view of J.C. Penney’s prospects, however, here is the Deutsche Bank analyst Charles Grom: “Trends at J.C. Penney are obviously getting worse, not better, and we are becoming more and more convinced that sales in 2013 will also decline, which could lead to a going-concern problem next year.” (CS Editor: OK, if that were the case would the management and Board of Directors take a different course? Slow spending, sell off assets, etc. OR is the analyst just linearly extrapolating to come up with his thesis?)
The company’s stock has fallen nearly 50 percent since the beginning of the year. Even its online sales, through jcp.com, fell 37.3 percent last quarter from a year ago. Yet Mr. Johnson, a well-regarded and charismatic retailer who worked at Target before his meteoric rise at Apple, appears to be trying to mimic Steve Jobs and create what Mr. Jobs’s biographer, Walter Isaacson, called a “reality distortion field.” An opinion not a fact.
Andrew Burton/ReutersRon Johnson, chief executive of J.C. Penney, says the store renovation plan is a success. Mr. Johnson has spent the last several months trying to persuade investors that his transformation of J.C. Penney was the equivalent of Mr. Jobs’s efforts to turn around Apple a decade ago.
“You know, I watched this movie before. When I joined Apple in 2000, Apple was a company dwindling. Everyone said to me, ‘What are you doing there?’ ” Mr. Johnson told investors in September. “Apple wept through 2002 and I think sales were down 38 percent as we dreamed about becoming a digital device company. But Apple invested during that downturn. That’s when Apple built, started to build its chain of stores. That’s when Apple transitioned to Intel. That’s when Apple started its app division. That’s when Apple imagined and built the first iPod.”
O.K., Mr. Johnson, but that was Apple. And J.C. Penney is not Apple — and let’s be honest, it can never be Apple. The company doesn’t make its own magical, revolutionary products that bring tears of joy to its customers. It is a low-end department store that Mr. Johnson is hoping to turn into a slightly higher-end department store that sells clothing made mostly by other manufacturers.
Still, Mr. Johnson has sought to remake the company quickly, perhaps too quickly, by eliminating promotions and discounts, moving the stores more upscale, rebranding the company as JCP and putting in place a “fair and square” pricing model. (J.C. Penney is, however, putting on a special sale for the holidays.) Granted, JCP is no Apple, but what did Ron Johnson accomplish at Target–probably a better comparison.
Yet the renovations are hardly finished — or in some cases even started. Only 11 percent of its stores’ floor space has been remodeled with his successful specialty-store-within-a-store concept, in which he has opened up outposts for brands like Levi’s, Izod, Liz Claiborne and the Original Arizona Jean Company.
J.C. Penney may have been dying a slow death before Mr. Johnson’s arrival — some rivals used call it “death by coupon,” given the retailer’s penchant for discounts — but the company’s decline has only accelerated.
But the lessons, and successes, of the rollout of Apple stores are proving that they do not apply to Penney. While the customer experience at Apple is in a class by itself, and Mr. Johnson should rightly receive credit for that, the success of the stores was in large part a function of stunning products with a fan base that would stand outside stores for days in the rain to get their hands on them without any chance of a discount. Do you think there are customers who will ever stand outside J.C. Penney overnight for the next Liz Claiborne sweater? (J.C. Penney bought the Liz Claiborne brand last year.)
“Ron Johnson’s remake of JCP has assumed the consumer — the only one who matters — is the one who shops at Target or Macy’s or Nordstrom’s. Instead of pivoting on and strengthening the historic JCP brand (What brand?), Johnson’s decided to recreate the Target and Apple wheel, a move akin to Toyota suddenly deciding it’s Porsche. In short, a ridiculous and condescending move,” Margaret Bogenrief, a partner at ACM Partners, a boutique crisis management and distressed investing firm, recently wrote.
There is something romantic about watching Mr. Johnson try to remake a dying classic icon (So why did Sorkin call JCP a brand in the prior paragraph). At some gut level, you have to root for him. He’s making a bold bet. Transitions are inherently painful. And everyone loves a great comeback story.
Here’s the good news: In the stores that have been transformed, J.C. Penney is making $269 in sales a square foot, versus $134 in sales a square foot in the older stores. So the model itself is working. And Mr. Johnson has the support of the company’s largest shareholder, Pershing Square’s Bill Ackman, who personally recruited Mr. Johnson. If Mr. Johnson were starting with a blank slate, it might be a great business.
Mr. Ackman declined to comment. J.C. Penney did not make Mr. Johnson available.
Now here’s the bad news. Mr. Johnson still has to convert nearly 90 percent of his square feet of shopping space. That will very likely take $1 billion and as long as three years. If the sales decline that occurred last quarter accelerates, the company could run out of money. It now has about a half-billion in cash and access to a credit line for as much as $1.5 billion.
Of course, it remains possible that Mr. Johnson, who people close to him say is a realist, could always decide that the transformation is not working and change course to return to the old model of J.C. Penney and save all that money remodeling. But that would be a huge setback.
The question Mr. Johnson may be asking himself now is: What would Steve do?
A version of this article appeared in print on 11/13/2012, on page B1 of the NewYork edition with the headline: A Dose Of Realism For the Chief Of J.C. Penney.
So What is JCP worth? Forget the price today, what is the value of JCP? Since this is NOT a franchise, then this would be an asset type of investment. What is the real estate worth for JCP? I would start there and review with a critical mind my valuation of the company. Oh, and forget blaming anyone for the price being below your purchase price, perhaps or perhaps not, today is your luckiest day.
Part 1 of Graham’s Chapter 39 Newer Methods for Valuing Growth Stocks (Security Analysis 4th Ed.: http://wp.me/p2OaYY-1qQ
Also, what Graham said prior to this chapter on growth-stock investing:Growth in 2nd Edition
We will have another valuation case study next post to break-up this fusty theory. Read on.
Part 2: Valuation of DJIA in 1961 by this method.
In a 1961 article, Molodovsky selected 5 percent as the most plausible growth rate for DJIA in 1961- 1970. This would result in a ten-year increase of 63 percent, raise earnings from a 1960 “normal” of say, $35 to $57, and produce a 1970 expected price of 765, with a 1960 discounted value of 365. To this must be added 70 percent of the expected ten-year dividends aggregating about $300—or $210 net. The 1960 valuation of DJIA, calculated by this method, works out at some $575. (Molodovsky advanced it to $590 for 1961.)
Similarity with Calculation of Bond Yields
The student should recognize that the mathematical process employed above is identical with that used to determine the price of a bond corresponding to a given yield, and hence the yield indicated by a given price. The value, or proper price, of a bond is calculated by discounting each coupon payment and also the ultimate principal payment to their present worth, at a discount rate of required return equal to the designated yield. In growth-stock valuation the assumed market price in the target year corresponds to the repayment of the bond at par at maturity.
Mathematical Assumptions Made by Others
While the calculations used in the DJIA example may be viewed as fairly representative of the general method, a rather wide diversity must be noted in the specific assumptions , or “parameters,” used by various writers. The original tables of Clendenin and Van Cleave carry the growth-period calculations out as far as 60 years. The periods actually assumed in calculations by financial writers have included 5 years (Bing) , 10 years (Molodovsky and Buckley), 12 to 13 years (Bohmfalk), 20 years (Palmer and Burrell), and up to 30 years (Kennedy) . The discount rate has also varied widely –from 5 percent (Burrell) to 9 percent (Bohmfalk).
The Selection of Future Growth Rates
Most growth-stock valuers will use a uniform period for projecting future growth and a uniform discount or required-return rate, regardless of what issues they are considering (Bohmfalk, exceptionally divides his growth stocks into three quality classes, and varies the growth period between 12 and 13 years, and the discount rate between 8 and 9 percent, according to class.) But the expected rate of growth will of course vary from company to company. It is equally true that the rate assumed for a given company will vary from analyst to analyst.
It would appear that the growth rate for any company could be established objectively if it were based entirely on past performance for an accepted period. But all financial writers insist, entirely properly, that the past growth rate should be taken only as one factor in analyzing a company and cannot be followed mechanically in setting the growth rate for the future. Perhaps we should point out, as a cautionary observation, that even the past rate of growth appears to be calculated in different ways by different analysts.
Multiplier Applied to “Normal Earnings”
The methods discussed produce a multiplier for a dollar of present earnings. It is applied not necessarily to the actual current or recent earnings, but to a figure presumed to be “normal”—i.e., to the current earnings as they would appear on a smoothed-out earning curve. Thus the DJIA multipliers in 1960 and 1961 were generally applied to “trend-line” earnings which exceeded the actual figures for those years—assumed to be “subnormal.”
Dividends vs. Earnings in the Formulas. A Simplification
The “modern” methods of growth—stock valuations represent a considerable departure from the basic concept of J.B. Williams that the present value of a common stock is the sum of the present worths of all future dividends to be expected from it. True, there is now typically a ten-to-twenty – year dividend calculation, which forms part of the final value. But as the expected growth rate increased from company to company, the anticipated payout tends also to decrease, and the dividend component loses in importance against the target year’s earnings.
Possible variations in the expected payout will not have a great effect on the final multiplier. Consequently the calculation process may be simplified by assuming a uniform payout for all companies of 60 percent in the next ten years. If T is the tenth-year figure attained by $1 of present earnings growing at any assumed rate, the value of the ten-year dividends works out at about 2.1 + 2.1 T. The present value of the tenth-year market price works out at 48 percent of 13.5T, or about 6.5T. ? Hence the total value of $1 of present earnings –or the final multiplier for the shares—would equal 8.6T + 2.1.
Table 39-1 gives the value of T and the consequent multipliers for various assumed growth rates.
These multipliers are a little low for the small growth rates, since they assume only a 60% payout. By this method the present value is calculated entirely from the current earnings and expected growth; the dividend disappears as a separately calculated factor. This anomaly may be accepted the more readily as one accepts also the rapidly decreasing importance of dividend payments in the growth-stock field.
To be continued……
GOLD.… A lot of people dumped their life savings into this Genneva Scheme. Quite a number of them are so pissed off with our (Malaysia) Central Bank that they’re planning to hold protests.
In the fall on 2008, in the wake of the greatest financial crisis in over three quarters of a century, the United States Congress approved and President Bush signed into law the Troubled Asset Relief Program. TARP allowed the US Treasury to invest $700 billion in “troubled assets”. Treasury Secretary Paulson used to program to inject equity into troubled banks.
In return for the much-needed equity infusion, the banks issued preferred stock to the US Treasury and supplemented them with warrants as an additional kicker. As warrants go, these TARP Warrants are highly unusual and heavily favor the investor (over the issuer).
Over the last few quarters, the US Treasury has been a seller of these warrants and many of them trade like stocks. In addition TARP-like warrants were issued by the likes of AIG and General Motors as part of their bailouts. It is clear from reading the fine print on the TARP warrants that the documents were prepared by treasury staff. The institutions were pretty much told where to sign.
Take the example of the GM Class B Warrants. Besides the US Government, GM creditors got some of these warrants in lieu of their claims in bankruptcy court. A single GM Class B Warrant gives one the right to acquire one share of GM stock at a price of $18.33 anytime until July 10, 2019. In addition, the exercise price gets adjusted downward if there are dividends or stock splits. The dividend adjustment is an unusual feature and very much pro-investor. These warrants were issued with a ten-year life which is also unusual.
GM stock (which Pabrai Funds owns) is presently changing hands at around $24.45/share. The Class B Warrants are also publicly traded and can be bought for about $9.40/warrant. The warrant is $6.12 in the money. If one has a view that GM is significantly undervalued, the warrant is likely to yield a higher return.
For example, if GM were to trade at $50, $75 or $100 in 2019, an investor in GM stock would end up with a gross return of 105%, 207% or 309%, respectively. An investor in the warrant would end up with a return of 137%, 503% and 770%, respectively. Once GM gets past $30, the warrant delivers a higher return. Of course, should GM languish below $29, holding the stock would be a better bet.
GM is not a franchise nor a good business—no competitive advantages, high capital intensity, variable demand, and intense competition. However, for those who seek cheap assets, you might study this.
GM has emerged from bankruptcy with $79 million less debt and about $47.2 billion of deferred tax assets before valuation allowances. The market is unhappy with GM’s exposure (18% of sales) to Europe and thus prices GM at 5 or 6 times the 2013 earnings estimate, and at 2 times EV to EBITDA. Last year GM reported sales of 150.3 billion, adjusted EBIT of $8.3 billion and $4.58 billion of diluted earnings per share of 1.8 billion fully diluted shares (conversion of the convertible preferred).
Grants (August 10, 2012, www.grantspub.com) estimates an enterprise value of $21.66 (try to figure this out by subtracting net operating losses, GM Financial, Chinese joint ventures, $28.6 billion in cash and the stake in Ally Financial. “Core” operating GM produces $12 billion in EBITDA so compare this to 3.5 times EV-to-EBITDA of Magna International and Delphi.
Those figures may be off, but these post bankruptcies may be interesting if priced for bad news. Be aware that his is a mediocre business with a much better balance sheet and a tax sheltered income stream. 2 times EV to EBITDA may seem cheap but GM has huge maintenance capex needs and low return on assets based on its past historical performance—pre-bankruptcy.
