With the current pullback, I thought it'd be good to review the recent positions discussed:
VOYA's financials continue to improve. while not a home-run quarter, a positive GAAP result and improving operating ROE points to the normalization of business. The fee-based retirement services that VOYA provides are actually more stable (and marginally sticky given regulations, etc.). Compared to AIG, which is essentially a highly levered fixed income fund with relatively stable funding (due to ~100% combined ratio), VOYA should trade at a higher book/earnings multiple. I'm long both because both are cheap - but VOYA is more so relative to the underlying business. I have kept the same positions in each as a month ago.
The counterpoint to this is that GAAP financials still look weak on a TTM basis - underlying economics should show up more in subsequent quarters for the above thesis to be valid.
IBTX's growth makes it more expensive. A friend recently emailed about IBTX's most recent acquisition (BOH Holdings) at 2.5 tangible book - not cheap given that other regional banks range from 1-2.5x tangible book and large caps often at ~1x (e.g. BAC). Management was fair in paying with IBTX's own stock at 2.5x tangible. I, like many investors, remain wary with acquisitive managements because they often overpay for subpar assets. Size alone is not usually not a durable competitive advantage, especially when you are a community bank competing with WFC. Any advantage would be local, given relationships in the area and regional differentiators.
More generally, the portfolio has grown in size considerable due to more opportunities, and I have unfortunately ended up on margin (net long >100%). As a result, days like today can become problematic as I have little dry powder to buy. Nonetheless, nearly all of my positions have near-term catalysts and/or are compelling at current prices. The mental stops I have in place per position are still wide enough that the portfolio can swing even while not being stopped out. Given a choice, however, I have ordered current positions in order of conviction to sell (VOYA/IBTX are near the top, so won't be sold unless a severe disruption occurs). I don't anticipate current weakness to last past the Fed meeting next week.
Wednesday, December 11, 2013
Rage against the EBITDA
EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) is often used by sophisticated investors to price companies. A sample valuation statement can be "XYZ company is trading at 5x mid-cycle EBITDA and presents a compelling opportunity." 5 times means its enterprise value (equity + net debt) divided by EBITDA is 5 (a 20% yield).
The traditional explanation is that EBITDA is a proxy for cash flow that is capitalization (debt) agnostic and allows for a less noisy picture of the earnings power. In more practical terms, a buyer of a company often changes the capital structure (by paying off/adding additional debt). The current debt structure is merely the financial decision by management and often has little to do with the underlying business.
The cynical explanation is that EBITDA, by ignoring capital expenditures, is often a misleading metric. Combined with metrics such as "adjusted EBITDA," these metrics are often used to justify high prices for transactions. 10mm EBITDA is really 5 mm if there is 5mm of maintenance capex expected.
More specifically:
1) Interest and Taxes are paid by the company and do not belong to shareholders. Sure, companies may choose a capital structure with less debt and pay less in interest. But that by definition means companies have less cash to deploy to make money. More fundamentally, companies profit from what is, not what could be. If a company is under/over-levered, is that not just a reflection of the company's management and should be evaluated? Other than in LBO situations, debt is part of what one buys. Such buyout perspectives should not be the main source of valuation, unless you are selling to a LBO sponsor!
2) Depreciation and Amortization (D&A from capital expenditures/goodwill from acquisitions) is actually a benefit to company financials. It allows the smoothing out of large expenses to buy equipment, etc. when the benefits of the expense is over the long term. Backing out D&A should also mean a car company doesn't need a factory to make cars. Now, if there is a one-time capital expenditure that will not repeat for many years (longer than the depreciation period), then maybe it is work considering. The workaround of EBITDA minus average (maintenance) capex is in fact D&A anyways. A similar analogy applies to amortization of goodwill.
Bottom line, using EBITDA can easily lead to overestimation of earnings power, which conveniently allows higher selling prices! EBITDA used and adjusted correctly usually results in roughly the same as averaging 10-year GAAP financials in most cases. As a result, I have little faith in EBITDA..
The traditional explanation is that EBITDA is a proxy for cash flow that is capitalization (debt) agnostic and allows for a less noisy picture of the earnings power. In more practical terms, a buyer of a company often changes the capital structure (by paying off/adding additional debt). The current debt structure is merely the financial decision by management and often has little to do with the underlying business.
The cynical explanation is that EBITDA, by ignoring capital expenditures, is often a misleading metric. Combined with metrics such as "adjusted EBITDA," these metrics are often used to justify high prices for transactions. 10mm EBITDA is really 5 mm if there is 5mm of maintenance capex expected.
More specifically:
1) Interest and Taxes are paid by the company and do not belong to shareholders. Sure, companies may choose a capital structure with less debt and pay less in interest. But that by definition means companies have less cash to deploy to make money. More fundamentally, companies profit from what is, not what could be. If a company is under/over-levered, is that not just a reflection of the company's management and should be evaluated? Other than in LBO situations, debt is part of what one buys. Such buyout perspectives should not be the main source of valuation, unless you are selling to a LBO sponsor!
2) Depreciation and Amortization (D&A from capital expenditures/goodwill from acquisitions) is actually a benefit to company financials. It allows the smoothing out of large expenses to buy equipment, etc. when the benefits of the expense is over the long term. Backing out D&A should also mean a car company doesn't need a factory to make cars. Now, if there is a one-time capital expenditure that will not repeat for many years (longer than the depreciation period), then maybe it is work considering. The workaround of EBITDA minus average (maintenance) capex is in fact D&A anyways. A similar analogy applies to amortization of goodwill.
Bottom line, using EBITDA can easily lead to overestimation of earnings power, which conveniently allows higher selling prices! EBITDA used and adjusted correctly usually results in roughly the same as averaging 10-year GAAP financials in most cases. As a result, I have little faith in EBITDA..
Saturday, November 23, 2013
Fannie/Freddie Preferreds - An Introduction
The Federal National Mortgage ("Fannie Mae") and Federal Home Loan Mortgage Corporation ("Freddie Mac") are government-sponsored enterprises which were created to provide liquidity to the mortgage market in the United States. They do this, in large part, by buying pools of mortgages from lenders, securitizing them, and selling/guaranteeing the resulting mortgage securities. While there are endless wrinkles to this description, these entities fed the growing demand for house ownership over past few decades and ate themselves nearly to oblivion during the crash.
After being left for dead in 2008 as they ("F&F") went into conservatorship, both have returned to profitability, to say the least:
(Source: Fairholme Funds)
The US Treasury has invested a total of 189.5$ billion in the GSEs to keep them afloat in exchange for 1) government control through warrants for 79.9% of equity and 2) senior preferred shares. By Q1 2014E all of that investment is projected to be repaid. In particular, 2013 Q3's payment was $30.4+8.6 billion and brings repayments within striking distance of the investment. To clarify, these repayments are the redirection of net income to the government- the majority equity holder.
As a result, both the equity and preferred have surged.
However, where exactly do the junior issues actually stand? The original investment simply diluted the equity and added another layer of debt, but a 2012 amendment siphons off any profits back to the treasury and prevents any nearly any equity ("net worth") from building up. Right now, there is no income/ownership which feeds to preferreds/non-govt common equity, even though the underlying business has dramatically improved and private investors still own 20.1%. In essence, the government has monetized its warrants without having to exercise and has crowded out the remaining owners.
This does open the door for private investors (Fairholme, Perry, etc.) to provide a more definite exit. There have been at least 2 proposals for the junior issues to get paid:
First, there is the legal approach to overturn the 2012 amendment by arguing it violates the Economic and Housing Recovery Act of 2008. Without that amendment, F&F can build up equity based on the billions it is making.
Second, Fairholme has proposed a broad recapitalization and split off of F&F operating entities ( 2nd version) using $50B+ of private capital.
Each approach requires the leaders to put significant time/resources to navigate both the political and legal hurdles necessary to change. This opportunity exists because of the haphazard manner of the F&F bailout, and its resolution requires those in charge to desire private sector involvement on generous terms.
As a miniscule fund, I cannot hope to influence such events. I could however, benefit partially from these efforts by buying at a slightly higher price. The downside is $0 for both common and preferred. Obama/Congress can choose to retain the status quo indefinitely and send all profits back to the treasury. Politically, this may be the easiest as it can produce profits while not angering either aisle. That would make the investment a total loss.
What if the private catalysts above succeed? Preferred could get paid off at par and common trades again freely. If the common is not liquidated, the treasury could get paid handsomely for its warrants in addition to making back all the money it invested (i.e. having its cake and eating it too).
The upside here is that investors can benefit in the strengthening business, as mentioned above.
Specifically, increases in guarantee rates, stronger underwriting standards, a recovering housing market and growth in market share (10k) have not only made the GSEs more powerful, but also more profitable than ever before. The specific merits of this business can be explore much more in detail, but the overall conclusion is that the Fannie & Freddie (F&F) are back, possibly better than ever.
The question is - what does this mean for private investors?
Disclosure: long FNMAS (Fannie Mae preferred S series).
After being left for dead in 2008 as they ("F&F") went into conservatorship, both have returned to profitability, to say the least:
(Source: Fairholme Funds)
The US Treasury has invested a total of 189.5$ billion in the GSEs to keep them afloat in exchange for 1) government control through warrants for 79.9% of equity and 2) senior preferred shares. By Q1 2014E all of that investment is projected to be repaid. In particular, 2013 Q3's payment was $30.4+8.6 billion and brings repayments within striking distance of the investment. To clarify, these repayments are the redirection of net income to the government- the majority equity holder.
As a result, both the equity and preferred have surged.
However, where exactly do the junior issues actually stand? The original investment simply diluted the equity and added another layer of debt, but a 2012 amendment siphons off any profits back to the treasury and prevents any nearly any equity ("net worth") from building up. Right now, there is no income/ownership which feeds to preferreds/non-govt common equity, even though the underlying business has dramatically improved and private investors still own 20.1%. In essence, the government has monetized its warrants without having to exercise and has crowded out the remaining owners.
This does open the door for private investors (Fairholme, Perry, etc.) to provide a more definite exit. There have been at least 2 proposals for the junior issues to get paid:
First, there is the legal approach to overturn the 2012 amendment by arguing it violates the Economic and Housing Recovery Act of 2008. Without that amendment, F&F can build up equity based on the billions it is making.
Second, Fairholme has proposed a broad recapitalization and split off of F&F operating entities ( 2nd version) using $50B+ of private capital.
Each approach requires the leaders to put significant time/resources to navigate both the political and legal hurdles necessary to change. This opportunity exists because of the haphazard manner of the F&F bailout, and its resolution requires those in charge to desire private sector involvement on generous terms.
As a miniscule fund, I cannot hope to influence such events. I could however, benefit partially from these efforts by buying at a slightly higher price. The downside is $0 for both common and preferred. Obama/Congress can choose to retain the status quo indefinitely and send all profits back to the treasury. Politically, this may be the easiest as it can produce profits while not angering either aisle. That would make the investment a total loss.
What if the private catalysts above succeed? Preferred could get paid off at par and common trades again freely. If the common is not liquidated, the treasury could get paid handsomely for its warrants in addition to making back all the money it invested (i.e. having its cake and eating it too).
The upside here is that investors can benefit in the strengthening business, as mentioned above.
Specifically, increases in guarantee rates, stronger underwriting standards, a recovering housing market and growth in market share (10k) have not only made the GSEs more powerful, but also more profitable than ever before. The specific merits of this business can be explore much more in detail, but the overall conclusion is that the Fannie & Freddie (F&F) are back, possibly better than ever.
The question is - what does this mean for private investors?
Disclosure: long FNMAS (Fannie Mae preferred S series).
Wednesday, November 13, 2013
On Bitcoin, Gold and Monetary Policy, Part 2
2) Misconception: Gold is a great alternative to the US dollar as well because it is not manipulated and is a hard asset. Gold prices are indeed not at the whim of the Federal Reserve, but can be influenced by non-stable factors as well -after all, isn't the gold supply determined by how much gold is mined? Buffett noted that all the gold in the world could fit inside a baseball infield (when melted down to pure gold, etc.). If one miner such as Barrick Gold finds a large deposit that would add 5%, 10% to the supply (exaggeration), is that addition to the money supply warranted?
This actually happened in the 16th century Spain, where gold from the New World led to inflation. Yes, gold - like any other currency - can lead to inflation. The point is this - the usefulness of gold as a currency is of stability, not because you can see/touch it.
3) Misconception: US dollar and most other currencies are fiat, not based off anything tangible and are therefore prone to manipulation, excessive printing by governments/politicians, and ultimately lead to fiscal/monetary instability.
The history of government printing can be bleak to review. Liaquat Ahamed's
---
The upside to this is that it continues to demonstrate that the market is far from efficient. More specifically, the level of ignorant vitriol directed at the Fed, the US dollar and economy means that the vanilla long equity trade remains viable. I hope to not be ensnared by my own ignorance, however, and will continually reevaluate the above.
From The Big Short/Tolstoy:
This actually happened in the 16th century Spain, where gold from the New World led to inflation. Yes, gold - like any other currency - can lead to inflation. The point is this - the usefulness of gold as a currency is of stability, not because you can see/touch it.
3) Misconception: US dollar and most other currencies are fiat, not based off anything tangible and are therefore prone to manipulation, excessive printing by governments/politicians, and ultimately lead to fiscal/monetary instability.
The history of government printing can be bleak to review. Liaquat Ahamed's
---
The upside to this is that it continues to demonstrate that the market is far from efficient. More specifically, the level of ignorant vitriol directed at the Fed, the US dollar and economy means that the vanilla long equity trade remains viable. I hope to not be ensnared by my own ignorance, however, and will continually reevaluate the above.
From The Big Short/Tolstoy:
"The most difficult subjects can be explained to the slow-witted man if he has not formed any idea of them already; but the simplest thing cannot be made clear to the most intelligent man if he is firmly persuaded that he knows already, without a shadow of a doubt,what is laid before him." —Leo Tolstoy,1897 [ix]"
Friday, November 8, 2013
On Bitcoin, Gold and Monetary Policy
This negative article on bitcoin indirectly brought together a few disparate thoughts for me. The article's position/bias is clear - the digital currency, which has grown significantly vs. the dollar is a speculatively bubble:
(source)
What is even more interesting, however, is the set of comments which mostly defend bitcoin. These online comments, to me, show exactly the misconceptions which drives bitcoin, gold and many arguments about US monetary policy. Let us begin!
1) Misconception: Bitcoin is a valid and perhaps best currency because it is not manipulated, transparent and free from government control. It is true that there is no government control and transactions are automatically tracked. What about manipulation? There may be no group trying to set a price, but the alternative is a currency that changes by 100%+ in a year. Is that what currencies are? A reminder: typical characteristics of a currency include 1) medium of exchange 2) unit of account and 3) store of value. The first two could arguable, but the store of value? While the currency has been gaining versus G10 currencies, its volatility could easily swing the other way by double digit % points.
Finally - no manipulation or adjustment also means no flexibility. There is a set formula that grows the supply until a specified limit in the future. Why that limit? If there are 100 dollars in circulation for 100 people now, and still 100 dollars for 500 people later, what will happen? Deflation. <- this, incidentally, makes a consistent price rise nearly rational, as deflation is literally designed into the system. As a result, speculation will override traditional usage (why sell goods via bitcoin when bitcoin will rise in value the next day?) Assuming more goods are sold/bought using bitcoin system, bitcoin value will rise - the result is what we see today, where most bitcoin usage is actually speculation vs. use in commerce.
This reflexive (ref: Soros) rally is self-reinforcing and may indeed reach new heights for sometime. However, bitcoin's ultimate usefulness is supposed to be its use as legitimate currency, which in my opinion will ironically be a smaller and smaller part of bitcoin usage as the currency rises. So, bitcoin gains in value are self-reinforcing in the short run but ultimately self-defeating in the long run (perhaps an apt definition of a bubble). If bitcoin mania continues and commercial usage lowers, there may very well come a point when the crowd discovers that they hold more money than there are goods possibly to buy it with.
... to be continued
What is even more interesting, however, is the set of comments which mostly defend bitcoin. These online comments, to me, show exactly the misconceptions which drives bitcoin, gold and many arguments about US monetary policy. Let us begin!
1) Misconception: Bitcoin is a valid and perhaps best currency because it is not manipulated, transparent and free from government control. It is true that there is no government control and transactions are automatically tracked. What about manipulation? There may be no group trying to set a price, but the alternative is a currency that changes by 100%+ in a year. Is that what currencies are? A reminder: typical characteristics of a currency include 1) medium of exchange 2) unit of account and 3) store of value. The first two could arguable, but the store of value? While the currency has been gaining versus G10 currencies, its volatility could easily swing the other way by double digit % points.
Finally - no manipulation or adjustment also means no flexibility. There is a set formula that grows the supply until a specified limit in the future. Why that limit? If there are 100 dollars in circulation for 100 people now, and still 100 dollars for 500 people later, what will happen? Deflation. <- this, incidentally, makes a consistent price rise nearly rational, as deflation is literally designed into the system. As a result, speculation will override traditional usage (why sell goods via bitcoin when bitcoin will rise in value the next day?) Assuming more goods are sold/bought using bitcoin system, bitcoin value will rise - the result is what we see today, where most bitcoin usage is actually speculation vs. use in commerce.
This reflexive (ref: Soros) rally is self-reinforcing and may indeed reach new heights for sometime. However, bitcoin's ultimate usefulness is supposed to be its use as legitimate currency, which in my opinion will ironically be a smaller and smaller part of bitcoin usage as the currency rises. So, bitcoin gains in value are self-reinforcing in the short run but ultimately self-defeating in the long run (perhaps an apt definition of a bubble). If bitcoin mania continues and commercial usage lowers, there may very well come a point when the crowd discovers that they hold more money than there are goods possibly to buy it with.
... to be continued
Wednesday, November 6, 2013
IBTX - An Investment in Texas
Independent Bank Group, Inc. (NASDAQ:IBTX) is a recently ipo'd regional bank with branches in the Austin and Dallas-Fort Worth areas of Texas. This is not cheap company on a past basis, trading at ~2x book and nearly 20 times ttm earnings. It is instead a growing, incentive-aligned financial company in an economically vibrant area at a fair price.
Consistent, profitably insider provides the catalyst. Many investors consider insider buying to be a strong signal to buy. Unlike selling, buyers typically have one goal in mind - to make money. By its very nature, it has potential to be a durable signal, as if future gains are already priced in there would not be a reason to buy.
There are some important caveats, however. Weak shares, especially in deteriorating companies (such as Dell in the last few years) often see insider buying as officers attempt to boost confidence. In Dell's case, a billionaire's token buys are far more likely a way to boost confidence and push up shares (versus just participating in the gains of the business).
The opposite has been the case here - a recent ipo (where by definition the company is selling) combined with buying as the shares move up and remain near 52 week highs. Among the numerous insider buyers (no sellers) is William E Fair, who has been at IBTX for 9 years, and Brian Hobart, the Chief Lending Officer who has spent 9+ years at IBTX as well.
It is reasonable to say that incentives are aligned at IBTX. But what about the underlying business?
Decent, though levered, operating metrics show an aggressive but efficient operation. I've typically approached financial institutions with a negative-bias- too many seem to be essentially put sellers of liquidity (lending long, borrowing short) and ultimately have weak returns on capital (that is, preleverage).
For a bank, IBTX has a decent financial showing, posting 1%+ roa for the last 3-4 years. The lack of data previous to 2010 is price of buying a new company, and is definitely worth investigating. It is fairly aggressive, levering equity to assets 9-10 times equity. That is a bit high in general, but compared to other regionals (HBAN) and even the top 4 (WFC/BAC), it is on the side. It does not quite have the same moat-like characteristics of WFC, but is a bit better than the rest.
Going forward though, what distinguishes IBTX for HBAN and the rest of the TARP-exiting regionals and indeed the huge money-center banks?
Economic opportunity. Bottom-line, a booming energy and now technology industry (1, 2) in TX will allow it to growth and reap better returns on capital than much of the country. Whereas many states are struggling with debt, Texas's conservative fiscal position combined with luck (oil & gas) will allow it to continue to grow.
Disclosure: long IBTX since the low 30s, but believe it is a good business to hold/buy in small size even at 38.
Consistent, profitably insider provides the catalyst. Many investors consider insider buying to be a strong signal to buy. Unlike selling, buyers typically have one goal in mind - to make money. By its very nature, it has potential to be a durable signal, as if future gains are already priced in there would not be a reason to buy.
There are some important caveats, however. Weak shares, especially in deteriorating companies (such as Dell in the last few years) often see insider buying as officers attempt to boost confidence. In Dell's case, a billionaire's token buys are far more likely a way to boost confidence and push up shares (versus just participating in the gains of the business).
The opposite has been the case here - a recent ipo (where by definition the company is selling) combined with buying as the shares move up and remain near 52 week highs. Among the numerous insider buyers (no sellers) is William E Fair, who has been at IBTX for 9 years, and Brian Hobart, the Chief Lending Officer who has spent 9+ years at IBTX as well.
It is reasonable to say that incentives are aligned at IBTX. But what about the underlying business?
Decent, though levered, operating metrics show an aggressive but efficient operation. I've typically approached financial institutions with a negative-bias- too many seem to be essentially put sellers of liquidity (lending long, borrowing short) and ultimately have weak returns on capital (that is, preleverage).
For a bank, IBTX has a decent financial showing, posting 1%+ roa for the last 3-4 years. The lack of data previous to 2010 is price of buying a new company, and is definitely worth investigating. It is fairly aggressive, levering equity to assets 9-10 times equity. That is a bit high in general, but compared to other regionals (HBAN) and even the top 4 (WFC/BAC), it is on the side. It does not quite have the same moat-like characteristics of WFC, but is a bit better than the rest.
Going forward though, what distinguishes IBTX for HBAN and the rest of the TARP-exiting regionals and indeed the huge money-center banks?
Economic opportunity. Bottom-line, a booming energy and now technology industry (1, 2) in TX will allow it to growth and reap better returns on capital than much of the country. Whereas many states are struggling with debt, Texas's conservative fiscal position combined with luck (oil & gas) will allow it to continue to grow.
Disclosure: long IBTX since the low 30s, but believe it is a good business to hold/buy in small size even at 38.
Thursday, October 31, 2013
Portfolio Management as Counterpoint
While my previous long bias remains, the recent market weakness after a strong October has finally given me pause. I had been insanely long (using significant margin) up until today because there were continual buy signals (technicals, insider buying) which lined up with the businesses and valuations I liked (durable competitive advantage/roe at less than 25 ttm earnings).
The business thesis for most of these investments remain, but my portfolio has simply gotten too large and often leads to a fundamental issue of my approach. A stock that falls is cheaper and often a better buy (value), but persistent weakness is often a signal of worse things to come (momentum). My bread and butter approach is to find businesses which I would like to buy as they get cheaper, but wait under the trend turns (or at least stabilizes) to prevent a Bill Miller-like 2008.
The corollary to the above then, is to not hesitate to cut positions when the trend turns or weakens, even if an investment has not reached what I believe to be fair value. This has happened now with HLSS, VOYA, AIG, (some of the largest positions) and have I reduced. I had recently added to HLSS on weakness because 1) the weakness was not panic-driven and 2) there was a nearby catalyst that could reverse the trend (earnings). The earnings driven pop has now weakened, so I have reduced the position to more manageable level, especially given the lower returns which I now believe is reasonable for HLSS.
As for specific numbers, I use a variation of the kelly criterion, described by another well-known blogger and money-manager.
*My approach remains value + trend-following, for the long-term. While minimizing activity is a goal, position-sizing and risk-management is necessary to ensure the portfolio can take advantage of long-term views.
The business thesis for most of these investments remain, but my portfolio has simply gotten too large and often leads to a fundamental issue of my approach. A stock that falls is cheaper and often a better buy (value), but persistent weakness is often a signal of worse things to come (momentum). My bread and butter approach is to find businesses which I would like to buy as they get cheaper, but wait under the trend turns (or at least stabilizes) to prevent a Bill Miller-like 2008.
The corollary to the above then, is to not hesitate to cut positions when the trend turns or weakens, even if an investment has not reached what I believe to be fair value. This has happened now with HLSS, VOYA, AIG, (some of the largest positions) and have I reduced. I had recently added to HLSS on weakness because 1) the weakness was not panic-driven and 2) there was a nearby catalyst that could reverse the trend (earnings). The earnings driven pop has now weakened, so I have reduced the position to more manageable level, especially given the lower returns which I now believe is reasonable for HLSS.
As for specific numbers, I use a variation of the kelly criterion, described by another well-known blogger and money-manager.
*My approach remains value + trend-following, for the long-term. While minimizing activity is a goal, position-sizing and risk-management is necessary to ensure the portfolio can take advantage of long-term views.
Monday, October 28, 2013
A broad market squeeze... upwards?
With the current relentless rally, I do wonder how this compares to the post-92 rally, when stocks would steadily reach new highs. Shorts (esp. valuation/tech) continue to get clobbered (save for pockets such as China tech in the last week), but of all the long positions I own (e.g. VOYA, AIG), I'm finding it hard to reduce because they all seem highly compelling as businesses and technically. I have reduced a percent here or there, but remain very long and have very few/often no shorts on.
Time will tell, but communities such as zerohedge do keep me more comfortable. If everyone has bought in, the rally is tough to sustain. If, however, there are many doomsday sales/shorts in the market...
Time will tell, but communities such as zerohedge do keep me more comfortable. If everyone has bought in, the rally is tough to sustain. If, however, there are many doomsday sales/shorts in the market...
Saturday, October 26, 2013
HLSS - A Follow Up
I've written about Home Loan Servicing Solutions, Ltd. since last year and added from 19$ all the way until $25. With the price at $23.90 as of today's close, I'm still in the money, but a bit from the highs.
Despite being different than a traditional mREIT, HLSS has fallen similarly from its highs. From fears about book value to lower dividends, HLSS has become a victim of the general shift away from (financially-driven) dividend stocks. An even more fundamental reason is that in a time of rising rates, the relative value of other fixed income-like investments are less (similar to duration risk for treasury bonds).
Bill Erbey (Chairman) did address this on the Q3 conference call, referring to the current valuation and weakness relative to equity market as a whole as due to 1) interest rate volatility and 2) an assumption of low-growth and relatively high valuation due to book (~1.4). The latter does seem the most interesting, as Erbey hints (but not does detail) that this assumption is not true. But where/how does growth come from?
There are plenty of articles about the market opportunity for mortgage servicing rights (MSRs) in general (see Nationstar's S-1 last year for one), but how does the selling reach HLSS? Ocwen can buy rights at about 3% of UPB or less and sub-sells a portion to HLSS. 3% is roughly 6 times the (max) 50 bps fee that Ocwen gets. MSRs are a wasting asset with principal (pre)payments, however, and 6 times is higher than the 4 or even 2 times paid for homeward. Granted, there are more details (quality of borrowers, delinquencies, etc.) which could make either one worth it or not, but the multiple is a bit worse than before. On the other hand, HLSS only needed to use 0.64% for ~0.20% annual revenue in cash to subservice the same asset from Ocwen by borrowing the rest. In other words, HLSS paid the full purchasing price that Ocwen paid, allowing Ocwen to gain revenue without paying for it (a nice business model). HLSS gains the ability to lever by keeping the less volatile part of the fee (variation is usually paid by Ocwen).
HLSS gets most of that cash from equity raises as 90% of net income is paid out as dividends, so that doesn't necessary increase (or even maintain) the dividend. What does? the 90-250% of net income that is cash available for reinvestment (from the Q3 investor presentation):
The non-cash amortization of the MSR portfolio (due to prepayments) means that HLSS has more cash to buy assets and the the dividends are only part of the story. It is true that the amortization means lower future revenue from the existing revenue, so it is up to HLSS to deploy that cash in an accretive manner.
The result? HLSS has an insurance like-free float available to invest in more MSRs - if prices remain low and there is more selling from banks such as Citi (banks currently 50% of $10 trillion market).
Based on the next $50B to be acquired (after 2 quarters and given that amortization decreases per the conference call, then 5% quarterly UPB increase after):
With a 7.66% yield, that means in one year, HLSS could be trading >$30. My previous write-up underestimated the sizes of the equity raises necessary, so this is closer to the mark.
*Disclosure: still long HLSS
Despite being different than a traditional mREIT, HLSS has fallen similarly from its highs. From fears about book value to lower dividends, HLSS has become a victim of the general shift away from (financially-driven) dividend stocks. An even more fundamental reason is that in a time of rising rates, the relative value of other fixed income-like investments are less (similar to duration risk for treasury bonds).
Bill Erbey (Chairman) did address this on the Q3 conference call, referring to the current valuation and weakness relative to equity market as a whole as due to 1) interest rate volatility and 2) an assumption of low-growth and relatively high valuation due to book (~1.4). The latter does seem the most interesting, as Erbey hints (but not does detail) that this assumption is not true. But where/how does growth come from?
There are plenty of articles about the market opportunity for mortgage servicing rights (MSRs) in general (see Nationstar's S-1 last year for one), but how does the selling reach HLSS? Ocwen can buy rights at about 3% of UPB or less and sub-sells a portion to HLSS. 3% is roughly 6 times the (max) 50 bps fee that Ocwen gets. MSRs are a wasting asset with principal (pre)payments, however, and 6 times is higher than the 4 or even 2 times paid for homeward. Granted, there are more details (quality of borrowers, delinquencies, etc.) which could make either one worth it or not, but the multiple is a bit worse than before. On the other hand, HLSS only needed to use 0.64% for ~0.20% annual revenue in cash to subservice the same asset from Ocwen by borrowing the rest. In other words, HLSS paid the full purchasing price that Ocwen paid, allowing Ocwen to gain revenue without paying for it (a nice business model). HLSS gains the ability to lever by keeping the less volatile part of the fee (variation is usually paid by Ocwen).
HLSS gets most of that cash from equity raises as 90% of net income is paid out as dividends, so that doesn't necessary increase (or even maintain) the dividend. What does? the 90-250% of net income that is cash available for reinvestment (from the Q3 investor presentation):
The non-cash amortization of the MSR portfolio (due to prepayments) means that HLSS has more cash to buy assets and the the dividends are only part of the story. It is true that the amortization means lower future revenue from the existing revenue, so it is up to HLSS to deploy that cash in an accretive manner.
The result? HLSS has an insurance like-free float available to invest in more MSRs - if prices remain low and there is more selling from banks such as Citi (banks currently 50% of $10 trillion market).
Based on the next $50B to be acquired (after 2 quarters and given that amortization decreases per the conference call, then 5% quarterly UPB increase after):
With a 7.66% yield, that means in one year, HLSS could be trading >$30. My previous write-up underestimated the sizes of the equity raises necessary, so this is closer to the mark.
*Disclosure: still long HLSS
Thursday, October 3, 2013
Macro as an opportunity - HLSS, IBTX
Many have lamented the dominance of macro-events in markets. From 2008's soul-crushing housing-driven swings in the market to 2011's euro-crisis dips, financial journalists and some money managers bring up the difficulty of investing when all stocks move up/down together. This, however, assumes that daily market moves are the main risk to investing, i.e. seeing the market drop 5% in a week is painful. This may indeed be true emotionally when most judge performance on a daily/monthly/quarterly basis.
What if we instead see the stock market as simply a marketplace for buying companies? Indeed, what if macro drawdowns are just Mr. Market instituting a fire-sale of all items? A heat-wave inside Target may make the dairy products go bad, but how about the clothes?
Few would believe that all companies are equally affected by the government shutdown, so given any (fear-driven) corrections in the market as a whole, I'd actually welcome them as opportunities to buy unjustly affected companies.
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Actions speak louder than words, though, so I am therefore taking this opportunity to buy more of HLSS, IBTX and UHAL, the first two of which I plan to write more of.
What if we instead see the stock market as simply a marketplace for buying companies? Indeed, what if macro drawdowns are just Mr. Market instituting a fire-sale of all items? A heat-wave inside Target may make the dairy products go bad, but how about the clothes?
Few would believe that all companies are equally affected by the government shutdown, so given any (fear-driven) corrections in the market as a whole, I'd actually welcome them as opportunities to buy unjustly affected companies.
--
Actions speak louder than words, though, so I am therefore taking this opportunity to buy more of HLSS, IBTX and UHAL, the first two of which I plan to write more of.
Sunday, September 29, 2013
The Fantastic Business that is China Commercial Credit Inc. (CCCR)?
I've been pretty negative on China's financial system. Bottom-line: a large shadow-banking system financing a fixed asset investment bubble. Pivot Capital's 2011 report is applicable here for reference. Now, imagine my surprise when a China-based micro-lender has an IPO this year!
China Commercial Credit, Inc. (CCCR) is a microcredit company which "provides direct loans and loan guarantee services to small-to-medium sized businesses (“SMEs”), farmers and individuals in the city of Wujiang, Jiangsu Province, China" (Prospectus). Its niche is to fill the gap between large, state-run banks and the underground lenders (subprime-like) which charge exorbitant fees.
My inherent negative bias notwithstanding, There is certainly an argument to be made for this business. In a country run by relationships ("guanxi"), there may very well be profitable lending opportunities outside the state. After all, subprime lending in the United States existed for decades before the 2007 crash and did provide necessary cash for consumers at relatively low rates. The difference here is that this is commercial lending vs. residential lending. Specifically, CCCR is based in Wujiang City, one of the most vibrant economic areas in China. Much of industry is manufacturing/industrial/technology related (Source). In other words, CCCR is lending to China's best microcosm of China's industrial revolution.
However, why is a Chinese company with only domestic (even local) operations raising money in the United States? The official reason:
Furthermore, Mr. Huichun Qin (CEO and Chairman of the Board) was the Vice President of the Wujiang branch of the PBOC (People's Bank of China), the central bank of China. Given that China itself prefers domestic companies to list locally, why aren't such credentials enough to push through a sale? Especially given CCCR's 7%+ return on assets (pg 39 of prospectus). This is a for bank, mind you. Not some high tech/asset-light company. Now, this is a microcredit lending and so there must be some inefficiencies to profit from. But 7%? Vs. 1-2% of a well-run bank such WFC or even regionals such SunTrust (STI) or even Ag Bank (HKG:1288).
Something different is happening here - loan losses have ballooned from less than 30,000 to 488,000 usd. CCCR does both lending as well as a guarantee business. The latter in particular is worth investigating more.
This is far from a complete picture, but from this I know that 1) more investigation is necessary and that 2) I remain negatively-biased on this company. I don't consider this a short candidate because of the small float/marketcap (<100mm). Nonetheless, it may be useful to follow this as the modern incarnation of China credit.
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More generally, I've been tied up with portfolio management issues recently (hence the lack of updates). However, there are still many things that are worth writing about recently and I will do so - notably regarding MSRs and Home Loan Servicing Solutions (a position I hold on the long side).
China Commercial Credit, Inc.
China Commercial Credit, Inc. (CCCR) is a microcredit company which "provides direct loans and loan guarantee services to small-to-medium sized businesses (“SMEs”), farmers and individuals in the city of Wujiang, Jiangsu Province, China" (Prospectus). Its niche is to fill the gap between large, state-run banks and the underground lenders (subprime-like) which charge exorbitant fees.
My inherent negative bias notwithstanding, There is certainly an argument to be made for this business. In a country run by relationships ("guanxi"), there may very well be profitable lending opportunities outside the state. After all, subprime lending in the United States existed for decades before the 2007 crash and did provide necessary cash for consumers at relatively low rates. The difference here is that this is commercial lending vs. residential lending. Specifically, CCCR is based in Wujiang City, one of the most vibrant economic areas in China. Much of industry is manufacturing/industrial/technology related (Source). In other words, CCCR is lending to China's best microcosm of China's industrial revolution.
However, why is a Chinese company with only domestic (even local) operations raising money in the United States? The official reason:
a public offering on the Chinese exchanges can be an uncertain and lengthy process for private Chinese companies, especially for microcredit companiesCCCR took advantage of the JOBS act to file as an "emerging growth" company and report less financial information and have a a longer time to fulfill SEC regulatory requirements. But wait - is the company really implying that is easier to go public in the USA vs. Shanghai - that it is more difficult for a Chinese company to list in China than in the USA? It passes all the requirements on the Shanghai exchange, both in terms of profitability and size (60mm usd in equity vs 30mm rmb required).
Furthermore, Mr. Huichun Qin (CEO and Chairman of the Board) was the Vice President of the Wujiang branch of the PBOC (People's Bank of China), the central bank of China. Given that China itself prefers domestic companies to list locally, why aren't such credentials enough to push through a sale? Especially given CCCR's 7%+ return on assets (pg 39 of prospectus). This is a for bank, mind you. Not some high tech/asset-light company. Now, this is a microcredit lending and so there must be some inefficiencies to profit from. But 7%? Vs. 1-2% of a well-run bank such WFC or even regionals such SunTrust (STI) or even Ag Bank (HKG:1288).
Something different is happening here - loan losses have ballooned from less than 30,000 to 488,000 usd. CCCR does both lending as well as a guarantee business. The latter in particular is worth investigating more.
This is far from a complete picture, but from this I know that 1) more investigation is necessary and that 2) I remain negatively-biased on this company. I don't consider this a short candidate because of the small float/marketcap (<100mm). Nonetheless, it may be useful to follow this as the modern incarnation of China credit.
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More generally, I've been tied up with portfolio management issues recently (hence the lack of updates). However, there are still many things that are worth writing about recently and I will do so - notably regarding MSRs and Home Loan Servicing Solutions (a position I hold on the long side).
Monday, September 2, 2013
Gold Shortage?
Given the new gold backwardation, bulls have returned back in force (1, 2, 3) to explain how this will push gold higher. But does backwardation correlate with flat price?
Compared with flat price (front month), there doesn't seem to be an easy correlation. The last breakout for gold prices in 2006 happened when there was no backwardation. More generally, a recent paper from the IMF shows that:
From articles such as this, one would think that the world was scrambling for gold. With aggregate Jewelery demand up 50%+ yoy, central banks continuing their buying and supply constrained (per the bulls' own argument), why did gld fall nearly 25% in Q2? If the entire world is buying and the price falls, what happens if supply/demand moderates?
It seems like rather than supply and demand, one should be focusing on price reactions to supply and demand. After, commodities (esp. gold) are often purely psychological instruments.
Disclosure: I am short GDX
"... we find that the forecast from the futures market is hard to beat. We find that the forecasting performance of futures does not depend on the slope of the futures curve"This means that all else being equal, 1) the current futures price is the best predictor of prices, and 2) the slope of the curve has little to do with futures prices. As a result, are the gold bulls falling into another example of confirmation bias? If supply is so constrained, why are prices not at all time highs?
From articles such as this, one would think that the world was scrambling for gold. With aggregate Jewelery demand up 50%+ yoy, central banks continuing their buying and supply constrained (per the bulls' own argument), why did gld fall nearly 25% in Q2? If the entire world is buying and the price falls, what happens if supply/demand moderates?
It seems like rather than supply and demand, one should be focusing on price reactions to supply and demand. After, commodities (esp. gold) are often purely psychological instruments.
Disclosure: I am short GDX
Monday, August 19, 2013
Digging into ING US (VOYA)
After taking a position in ING US (NYSE: VOYA) at about the $25/share level, I have been fortunate to participate in the rise to above $30. The original target was around the 40-50$, with stop around $20, the ipo price. The recent rise and earnings report make this a good time to reevaluate the thesis.
The firm posted an operating gain of $0.71/share, but on a net basis lost $0.56/share. Why? In a phrase, variable annuities (p134-135). Variable annuities took a (408.4) million capital (loss) related to hedging. How can such "hedging" turn a respectable gain into a loss that reduced book value?
To answer that, we start with the basics. What is a variable annuity? It's a hybrid product which, after an investment period by the buyer, pays an income stream that usually varies with the market. Basically, it attempts the best of both worlds by giving income but more so when the equity market rallies. Insurers such as VOYA can invest initial proceeds in equity (funds) to match this potential liability. They can then add a margin for profits/cushion against potential mismatches.
At the same time, many variable annuities have a minimum return guarantee. If the market falls significantly, insurers may often still be on the hook for income. How can the insurer handle this? Investing in fixed income can provide relatively stable residual income, but in the current environment they can probably not buy enough. My hypothesis - invest more in equity but hedge with put options (and other derivatives such as variance swaps). In fact, VOYA has over-hedged:
That is why VOYA posted gains last Q2 (when equities fell) vs. a loss now.
How does this reconcile with the results? Yes, the loss was not insignificant, but from the most recent 10-Q (page 107), we see that persistently low interest rates increase the hedging costs for such variable annuities. VOYA also states that it focuses on capital adequacy vs. GAAP volatility. Going forward, I'd like to see the swings diminish as the book runs off.
The firm posted an operating gain of $0.71/share, but on a net basis lost $0.56/share. Why? In a phrase, variable annuities (p134-135). Variable annuities took a (408.4) million capital (loss) related to hedging. How can such "hedging" turn a respectable gain into a loss that reduced book value?
To answer that, we start with the basics. What is a variable annuity? It's a hybrid product which, after an investment period by the buyer, pays an income stream that usually varies with the market. Basically, it attempts the best of both worlds by giving income but more so when the equity market rallies. Insurers such as VOYA can invest initial proceeds in equity (funds) to match this potential liability. They can then add a margin for profits/cushion against potential mismatches.
At the same time, many variable annuities have a minimum return guarantee. If the market falls significantly, insurers may often still be on the hook for income. How can the insurer handle this? Investing in fixed income can provide relatively stable residual income, but in the current environment they can probably not buy enough. My hypothesis - invest more in equity but hedge with put options (and other derivatives such as variance swaps). In fact, VOYA has over-hedged:
That is why VOYA posted gains last Q2 (when equities fell) vs. a loss now.
How does this reconcile with the results? Yes, the loss was not insignificant, but from the most recent 10-Q (page 107), we see that persistently low interest rates increase the hedging costs for such variable annuities. VOYA also states that it focuses on capital adequacy vs. GAAP volatility. Going forward, I'd like to see the swings diminish as the book runs off.
Monday, August 12, 2013
The next catalyst for GDX
I've been pretty negative on gold miners (GDX), both because of the perceived weak hands involved on the long side and the terrible capital allocation policies/rising breakeven costs of the miners. At the risk of falling into confirmation bias, the recent articles about renewed gold hedging could be the next catalyst for further gold weakness (this month's strength notwithstanding).
While the exact magnitude and effect of such selling may be difficult to predict, it is something that I believe will grow in intensity the longer gold stagnates and/or remains volatile. Taking the analogy of a new speculator who has taken multiple large illiquid long positions (and indeed higher forward buying), gold miners would rather not lock in mediocre profitability (or indeed loss) going forward. If the analogy holds, the components of GDX will hedge more if/as gold falls more as the pain grows, exacerbating the fall and creating that reflexivity that Soros speaks of.
To recap: miners have been slowly eliminating gold hedges as gold prices rise, perhaps exacerbating the rise itself.
(Source: http://www.gfms.co.uk/Market%20Commentary/SG-Hedge-Book/SG_GFMS_Global_Hedge_Book_Analysis_Q1_12.pdf.)
What if this tide turns? Given that marginal all in cash costs for the gold mining industry (which includes capex) is at roughly 1300/oz and growing, there is little room until losses. Cash costs ex capex (or variable cost, a la economics) at roughly 1100 is the level when firms theoretically stop production. But do they actually stop?
This is not to say that GDX will fall to new lows tomorrow - but there is a parallel here to prisoner's dilemma for gold miners. Given gold weakness over a year, the first ones to hedge above 1100-1300 will lock in okay results, but those who don't could see the effects of the first sellers...
*Note to be fair: the effect of such selling is a key point that I haven't been able to figure out: when the quarterly volume of gold traded is in the billions of oz., millions don't seem too bad. Relative to annual production (50-100mm oz), those same millions do look sizable.
Disclosure: no position now, but intend to short GDX later this year
While the exact magnitude and effect of such selling may be difficult to predict, it is something that I believe will grow in intensity the longer gold stagnates and/or remains volatile. Taking the analogy of a new speculator who has taken multiple large illiquid long positions (and indeed higher forward buying), gold miners would rather not lock in mediocre profitability (or indeed loss) going forward. If the analogy holds, the components of GDX will hedge more if/as gold falls more as the pain grows, exacerbating the fall and creating that reflexivity that Soros speaks of.
To recap: miners have been slowly eliminating gold hedges as gold prices rise, perhaps exacerbating the rise itself.
What if this tide turns? Given that marginal all in cash costs for the gold mining industry (which includes capex) is at roughly 1300/oz and growing, there is little room until losses. Cash costs ex capex (or variable cost, a la economics) at roughly 1100 is the level when firms theoretically stop production. But do they actually stop?
This is not to say that GDX will fall to new lows tomorrow - but there is a parallel here to prisoner's dilemma for gold miners. Given gold weakness over a year, the first ones to hedge above 1100-1300 will lock in okay results, but those who don't could see the effects of the first sellers...
*Note to be fair: the effect of such selling is a key point that I haven't been able to figure out: when the quarterly volume of gold traded is in the billions of oz., millions don't seem too bad. Relative to annual production (50-100mm oz), those same millions do look sizable.
Disclosure: no position now, but intend to short GDX later this year
Sunday, August 4, 2013
Are Emerging Markets Diversified?
GMO's most recent yearly forecasts seem like what most people think - negative on most bonds and most US equities, but most positive on emerging market equities (but interestingly, not their debt):
The traditional rationale for this is that emerging markets (Brazil, Russian India, China) are growing faster and will take a larger slice of the world economic pie going forward. More growth = more profits and more results for investors, right? It seems so obvious and straightforward, but how true is it?
First, emerging markets did outperform up to 2009:
However, looking at the composition of such indices, we see that up to 50%+ is essentially China (Taiwan, even Brazil because of commodity dependence):
As such, is emerging market investing essentially investing in China? Given the the relative short period (1-2 decades vs 1-2 centuries for the USA), are we assuming too much about emerging markets diversification?
The traditional rationale for this is that emerging markets (Brazil, Russian India, China) are growing faster and will take a larger slice of the world economic pie going forward. More growth = more profits and more results for investors, right? It seems so obvious and straightforward, but how true is it?
First, emerging markets did outperform up to 2009:
However, looking at the composition of such indices, we see that up to 50%+ is essentially China (Taiwan, even Brazil because of commodity dependence):
As such, is emerging market investing essentially investing in China? Given the the relative short period (1-2 decades vs 1-2 centuries for the USA), are we assuming too much about emerging markets diversification?
Sunday, July 28, 2013
How to pick a manager
Perhaps it is actually harder to pick a manager than to pick investments. The general statistics against active management are well-known. In 2012, for example, 63% of large cap mutual funds failed to match the market (even worse less for hedge funds).
As a result, the full choice set for selecting investments includes both asset class as well as manager, and the probability of choosing a good asset class And a good manager is less than a good asset class itself. Given that most investors usually time managers incorrectly, are there some nontraditional metrics which would work?
Tudor's infamous divorce heuristic notwithstanding , what about some more specific methods to pick a manager? How about through the lens of incentives. A manager should be incentivized for long term outperformance.
1) The manager should still be "hungry." If you are already a household name and have "made it" as a big time manager, you cannot have the same drive for performance as before. A key barrier could be $1B AUM, but the idea should be clear.
2) The manager should be focused primarily on investing. If he has a such a large staff that he spends most of the time either buying baseball teams or opening a huge new office which makes headlines.
3) The manager should not be on CNBC etc. enough to be a talking head. If the manager has enough time and/or interest to continually market himself, he/she is too focused on raising money. Raising money/awareness of his/her ideas does not really make performance better.
What other ones could work?
As a result, the full choice set for selecting investments includes both asset class as well as manager, and the probability of choosing a good asset class And a good manager is less than a good asset class itself. Given that most investors usually time managers incorrectly, are there some nontraditional metrics which would work?
Tudor's infamous divorce heuristic notwithstanding , what about some more specific methods to pick a manager? How about through the lens of incentives. A manager should be incentivized for long term outperformance.
1) The manager should still be "hungry." If you are already a household name and have "made it" as a big time manager, you cannot have the same drive for performance as before. A key barrier could be $1B AUM, but the idea should be clear.
2) The manager should be focused primarily on investing. If he has a such a large staff that he spends most of the time either buying baseball teams or opening a huge new office which makes headlines.
3) The manager should not be on CNBC etc. enough to be a talking head. If the manager has enough time and/or interest to continually market himself, he/she is too focused on raising money. Raising money/awareness of his/her ideas does not really make performance better.
What other ones could work?
Sunday, July 21, 2013
Lampert's Folly?
Edward Lampert's credentials are impeccable - Yale Skull & Bones, Goldman Sachs risk arbitrage under Robert Rubin (Secretary of the Treasury under Clinton), and of course the billion dollar hedge fund ESL Investments that he founded. Billionaire at 41, he even talked his way out of a kidnapping during negotiations to take over Kmart. Before 2007, his culminating merger of K-Mart and Sears was applauded by both the markets and many commentators.
Since then, however, SHLD has floundered. What happened?
While other retailers are recovering (ex-JCP), Sears can't even seem to be make money and more importantly, has been losing sales for the last five years.
A recent BusinessWeek article may hold some of the answers here. After reorganizing Sears into dozens of entities, each with CEO, board and profit/loss statement, the firm has devolved into bureaucratic infighting. With thousands of stores and over 200,000 employees, the firm has chosen to split itself internally into dozens of smaller entities (but not really). Sears has traded inefficient cooperation for efficient (if cutthroat) competition. A former executive describes Lampert's model has
Given this, is Sears's problem actually its Chairman, Lampert?
Since then, however, SHLD has floundered. What happened?
While other retailers are recovering (ex-JCP), Sears can't even seem to be make money and more importantly, has been losing sales for the last five years.
A recent BusinessWeek article may hold some of the answers here. After reorganizing Sears into dozens of entities, each with CEO, board and profit/loss statement, the firm has devolved into bureaucratic infighting. With thousands of stores and over 200,000 employees, the firm has chosen to split itself internally into dozens of smaller entities (but not really). Sears has traded inefficient cooperation for efficient (if cutthroat) competition. A former executive describes Lampert's model has
created a “warring tribes” culture. “If you were in a different business unit, we were in two competing companies,” he says. “Cooperation and collaboration aren’t there.”How did this happen? Lampert has interpreted free market economics and Ayn Rand's philosophy to make decentralization a key component of Sears. Lampert intends to have the invisible hand choose which business units succeed. However, a key non-free market part is Lampert. Because all units ultimately report to him and he disburses funds, this system is more like centralized planning. Units are vying for Lampert's attention, not trying to make SHLD. In fact, by artificially splitting apart Sear's business (which were formed roughly along market lines' of cooperation), he is disrupting the free-market economics that he seeks to follow.
Given this, is Sears's problem actually its Chairman, Lampert?
Monday, July 8, 2013
Conflict of Interest - Unfair but Necessary?
Misaligned incentives seem to be a common trait in selling financial products. After issuer-paid credit ratings and stock exchanges which cater to high frequency traders, even data releases are not immune to such practices. Thomson Reuters is now under investigation for releasing a well-known customer confidence survey two seconds earlier to select clients for a $6K/month fee. In terms of information fairness, they issue is clear - high frequency traders have a huge advantage other short term traders without such information. However, what is the alternative?
Like free email, the market does not support the conflict-free model for these industries. Few customers are willing to pay for basic email or credit ratings. The later is especially difficult to conceal at the high level because of the ease of free-riding (e.g. a AAA for a company only takes three characters to send and the issuer wants it to be as well known as possible). How else can such companies compete when everybody wants it but nobody is willing to pay by themselves? This is not a defense of such practices, but rather an investigation as to the why.
While we may want this:
It may be very hard to achieve "absolute" fairness without paying for it in some other way.
This brings up a larger question: are the most profitable operations, in finance and beyond, riddled with conflict of interest? Does "fair" mean unprofitable? As Hank Greenberg once said, "All I want in life is an unfair advantage."
Like free email, the market does not support the conflict-free model for these industries. Few customers are willing to pay for basic email or credit ratings. The later is especially difficult to conceal at the high level because of the ease of free-riding (e.g. a AAA for a company only takes three characters to send and the issuer wants it to be as well known as possible). How else can such companies compete when everybody wants it but nobody is willing to pay by themselves? This is not a defense of such practices, but rather an investigation as to the why.
While we may want this:
(Source: http://thinkbeta.com/blog/2012/01/25/thursday-president-obama-fairness/)
It may be very hard to achieve "absolute" fairness without paying for it in some other way.
This brings up a larger question: are the most profitable operations, in finance and beyond, riddled with conflict of interest? Does "fair" mean unprofitable? As Hank Greenberg once said, "All I want in life is an unfair advantage."
Monday, July 1, 2013
Single Family Rentals - Institutional Herding Continues?
I originally got interested in single-family rentals with the spinoffs of Silver Bay Realty (SBY) and Altisource Residential (RESI) in the last half year or so. These companies buy single-family homes with the intention of renting them out. Given that mortgage rates (<5%) are less than rental yields (>5%), it is typically cheaper to own than rent. On face, these companies provide a compelling statement - they effectively arbitrage low mortgage rates with the fed with tight credit standards for mortgages and have an implicit put in stabilizing housing prices.
But how much does this translate to company profits? Rental yields are usually < 10% to begin with pre-leverage (RESI presentation, slide 13) and mortgage/upkeep are ongoing while renters may leave and so profits depend on 1) maintaining a steady stream of renters while 2) keeping costs low.
The first might not be so easy, given that nationwide supply has increased by over a third since 2005 (the housing peak). Early players have amassed large holdings, leading to downward rental yield pressures even as new entrants, such as SBY/RESI, try to capitalize on the new trend. The result? Silver Bay Realty, one of the larger (new) public companies, is so far unprofitable with a 81% occupancy rate even on homes owned for 6 months. 81% might not sound so bad, but then why is SBY unprofitable?
This leads to the second point - just how much economies of scale does one get from managing thousands of houses? Does owning two lawns mean you only have to mow one of them? There may be the usual pricing power that comes with size, but such services to have to be applied to each individual house in different locations etc. If these costs are actually too high, how does one monetize/exit gracefully or at least protect downside? How about an IPO/spinoff?
So, given an industry that has low barriers to entry (only need plentiful capital), revenue that is not consistent, and costs that do scale with size, how well can we expect the institutional herd/interest in such companies to do?
Disclosure: no position in SBY/RESI
But how much does this translate to company profits? Rental yields are usually < 10% to begin with pre-leverage (RESI presentation, slide 13) and mortgage/upkeep are ongoing while renters may leave and so profits depend on 1) maintaining a steady stream of renters while 2) keeping costs low.
The first might not be so easy, given that nationwide supply has increased by over a third since 2005 (the housing peak). Early players have amassed large holdings, leading to downward rental yield pressures even as new entrants, such as SBY/RESI, try to capitalize on the new trend. The result? Silver Bay Realty, one of the larger (new) public companies, is so far unprofitable with a 81% occupancy rate even on homes owned for 6 months. 81% might not sound so bad, but then why is SBY unprofitable?
This leads to the second point - just how much economies of scale does one get from managing thousands of houses? Does owning two lawns mean you only have to mow one of them? There may be the usual pricing power that comes with size, but such services to have to be applied to each individual house in different locations etc. If these costs are actually too high, how does one monetize/exit gracefully or at least protect downside? How about an IPO/spinoff?
So, given an industry that has low barriers to entry (only need plentiful capital), revenue that is not consistent, and costs that do scale with size, how well can we expect the institutional herd/interest in such companies to do?
Disclosure: no position in SBY/RESI
Sunday, June 23, 2013
Shibor - Canary in the Coal Mine?
I'm surprised that the recent Shibor spike hasn't (Shibor is the Chinese version of LIBOR) sparked more concern. After staying at less than 4% for the last year, the 3-month rate has surged to above 5%. The overnight rate has spiked even further to 13%. To put things in perspective, 2011's top five banks by profits included four chinese banks. What is happening?
One major explanation being posited is that this is the just the next step in the Chinese government's attempt reduce credit expansion/leverage in the system. However, what if this is a different signal - that of a funding crisis? Such a crisis was prelude to the US-led recession of 2008.
On face, China's metrics are fine (gdp growth of over 7%, large fx reserves, small deficit), the soft landing scenario from rapid growth. However, how much of this growth was economical and indeed sustainable? The overall china argument has been debated ad nauseum centering on non-economical commercial real estate backed by a levered shadow banking system, but could this funding crisis be catalyst for the bears? After all, this is not just restricting lending, it is choking China' banking system.
More specifically the strongest point that is related to this is China's own "Ponzi Scheme" (central bank governor's works) fundamentals in its wealth management products and in others' opinions (see: Chanos) more generally the China's shadow banking system. These products essentially allow yet another layer of borrowing short to lend long. However, what happens when funding disappears (a la Lehman 2008) given the vast proliferation of these products?
As a result, what if the funding pop is not by choice? A large flood of liquidity would push the rmb lower, usually okay, but given Fed tapering could push the rmb lower than even what the government/economy wants? Furthermore, fear of this could unfortunately be self-fulfilling because a push to buy usd could lead to more conversion into usd (or non-rmb currencies) ahead of a banking/currency crisis.
One major explanation being posited is that this is the just the next step in the Chinese government's attempt reduce credit expansion/leverage in the system. However, what if this is a different signal - that of a funding crisis? Such a crisis was prelude to the US-led recession of 2008.
On face, China's metrics are fine (gdp growth of over 7%, large fx reserves, small deficit), the soft landing scenario from rapid growth. However, how much of this growth was economical and indeed sustainable? The overall china argument has been debated ad nauseum centering on non-economical commercial real estate backed by a levered shadow banking system, but could this funding crisis be catalyst for the bears? After all, this is not just restricting lending, it is choking China' banking system.
More specifically the strongest point that is related to this is China's own "Ponzi Scheme" (central bank governor's works) fundamentals in its wealth management products and in others' opinions (see: Chanos) more generally the China's shadow banking system. These products essentially allow yet another layer of borrowing short to lend long. However, what happens when funding disappears (a la Lehman 2008) given the vast proliferation of these products?
As a result, what if the funding pop is not by choice? A large flood of liquidity would push the rmb lower, usually okay, but given Fed tapering could push the rmb lower than even what the government/economy wants? Furthermore, fear of this could unfortunately be self-fulfilling because a push to buy usd could lead to more conversion into usd (or non-rmb currencies) ahead of a banking/currency crisis.
Monday, June 17, 2013
Pricing Power of the TI-83 Plus
For many of us in United States, the TI-83 Plus is the quintessential (pre-college) calculator. It was required for many classes (e.g. AP Calculus) and the $100+ price tag 10+ years ago did not do wonders for the wallet. Still, the multi-line interface, matrix operation capabilities and games such as snake made it a versatile instrument pre-iphone.
Yet, as an electronic system in a highly competitive field, why is the same TI-83 Plus still almost as pricey as a decade ago?? Keep in mind that with the same money, one can buy a 4th gen ipod touch with a Color screen, gigabytes of ram and streaming video+wifi and that the same smartphones a year from now are probably worth far less (try selling the older motorola razr's now). This extends beyond phones to vcrs (remember those?), stereos etc.
John Herrman from Buzzfeed gives us a reasonable explanation - captive customers:
This is a list of CollegeBoard-approved calculators for the AP exams (college-level high school courses) which includes the TI-83 Plus. The TI-83 Plus has remained on this list for at least a decade, requiring each new batch of customers/students to either buy from the year above (which may or may not happen depending on the older students' needs) or buy a new set of the same product.
This is only the beginning, however - teachers get used to these approved calculators (specifically) TI-83 Plus and learn to teach with them. Study guides, manuals etc. for calculus come directly with TI-83 Plus-specific instructions, further strengthening the stickiness of the the product. Given that the underlying topics (high-school/early college mathematics) do not change much, the product does not need to improve much.
As a result, for these certain products (especially the TI-83 Plus) there is an institutionally-mandated and sticky demand for these.
Unfortunately, it is harder to translate this into an investment because calculators as a whole is only 3% of revenues for the producer (page 6), Texas Instruments (TXN). Calculators revenues are lumped into an "other" segment that includes other products - but it is interesting to note that this other segment has the highest operating margin of the company:
Yet, as an electronic system in a highly competitive field, why is the same TI-83 Plus still almost as pricey as a decade ago?? Keep in mind that with the same money, one can buy a 4th gen ipod touch with a Color screen, gigabytes of ram and streaming video+wifi and that the same smartphones a year from now are probably worth far less (try selling the older motorola razr's now). This extends beyond phones to vcrs (remember those?), stereos etc.
John Herrman from Buzzfeed gives us a reasonable explanation - captive customers:
This is only the beginning, however - teachers get used to these approved calculators (specifically) TI-83 Plus and learn to teach with them. Study guides, manuals etc. for calculus come directly with TI-83 Plus-specific instructions, further strengthening the stickiness of the the product. Given that the underlying topics (high-school/early college mathematics) do not change much, the product does not need to improve much.
As a result, for these certain products (especially the TI-83 Plus) there is an institutionally-mandated and sticky demand for these.
Unfortunately, it is harder to translate this into an investment because calculators as a whole is only 3% of revenues for the producer (page 6), Texas Instruments (TXN). Calculators revenues are lumped into an "other" segment that includes other products - but it is interesting to note that this other segment has the highest operating margin of the company:
Sunday, June 9, 2013
When an Investment Goes Awry, Politely Ignore?
Paulson and Co. made an interesting decision last week:
This means that even the funds that are doing well, such as the credit funds (up 16.7% ytd) are often overwhelmed by the gold losses. Roughly 85% of Paulson's aum is in gold share classes so that the best fund's 16.7% is usually realized as -30.3 = 16.7%-47%. In other words, gold does matter greatly to the Paulson & Co. as a whole.
I do believe this is a unique situation and opportunity to learn (and possibly profit) as it is a purely marketing and psychological move meant to soothe investors' and consultants' fears. Like a many trader when a large position moves against him/her, the natural instinct is to ignore and hope it comes back. This phenomenon is well-known and is inherent to us as humans.
(source: http://sophlylaughing.blogspot.com/2012/03/home-cognitive-dissonance-kit.html)
In this case, it is Paulson & Co.'s unwillingness to truly consider a fundamental misunderstanding of gold. Indeed, the below statement shows the fallpack to general statements:
Disclosure: I am short GDX.
"At the request of clients and consultants, we will be reporting the performance of our Gold Funds separately to investors in those funds and interested parties," Paulson wrote to clients. The firm's gold investments "have received a disproportionate amount of attention over recent months"—as gold prices plummeted—"and have detracted attention from the performance and positive developments of our other funds."They key instigation is that despite being only 2% of the firms assets, the Gold Fund's -47% performance (not a typo) is getting all the attention. This would make sense, except that most of his fund is gold-denominated (e.g. gold-share classes).
This means that even the funds that are doing well, such as the credit funds (up 16.7% ytd) are often overwhelmed by the gold losses. Roughly 85% of Paulson's aum is in gold share classes so that the best fund's 16.7% is usually realized as -30.3 = 16.7%-47%. In other words, gold does matter greatly to the Paulson & Co. as a whole.
I do believe this is a unique situation and opportunity to learn (and possibly profit) as it is a purely marketing and psychological move meant to soothe investors' and consultants' fears. Like a many trader when a large position moves against him/her, the natural instinct is to ignore and hope it comes back. This phenomenon is well-known and is inherent to us as humans.
(source: http://sophlylaughing.blogspot.com/2012/03/home-cognitive-dissonance-kit.html)
In this case, it is Paulson & Co.'s unwillingness to truly consider a fundamental misunderstanding of gold. Indeed, the below statement shows the fallpack to general statements:
“Federal governments have been printing money at an unprecedented rate creating demand for gold as an alternative currency for individual and institutional savers and central banks alike,” John Reade, a partner and gold strategist at Paulson & Co., said yesterday in an e-mailed statement. “While gold can be volatile in the short term and is going through one of its periodic adjustments, we believe the long-term trend of increasing demand for gold in lieu of paper is intact.”As the the largest holder of GLD at 6.7%, it is not stretch to say that the first represents a large part of the gold bull arguments and crowd. What happens if the crowd realizes it can't take the pain?
Disclosure: I am short GDX.
Monday, June 3, 2013
Actively-Managed ETFs to Short Managers?
As one of the fastest growing segments of the already fast-growing ETF market, actively-managed ETFs could open up a whole new set of strategies - both betting on and against managers. ETFs- exchange-traded-funds- are already known as a more transparent, tax-efficient and liquid way to buy indices. They have these advantages as opposed to the commissions, spreads of trading which are now required to buy (full comparison). Increasingly, the costs are being outweighed by the benefits.
In my opinion, however, the key attribute that has led to ETFs' success is its liquidity/transparency. Like a shiny new machine in the casino, ETFs (such as DXJ) promised even faster trades and up to date pricing that make (or break) entire companies. With this in mind, will the next generation of active etfs allow for investors/speculators to hedge their managers?
The prototypical active etf is PIMCO's Total Return etf (BOND), which has done well:
(Source: http://seekingalpha.com/article/578491-pimco-total-return-etf-off-to-a-fast-start)
Notice that the etf (top-most line) is not just being compared to its benchmark (which it handily beat), but also PIMCO's own Total Return Fund. In a very real sense, Bill Gross has beaten himself. Similar to the cash-futures basis, could there be an etf-mutual fund basis?
Now let's take this a few steps further:
In my opinion, however, the key attribute that has led to ETFs' success is its liquidity/transparency. Like a shiny new machine in the casino, ETFs (such as DXJ) promised even faster trades and up to date pricing that make (or break) entire companies. With this in mind, will the next generation of active etfs allow for investors/speculators to hedge their managers?
The prototypical active etf is PIMCO's Total Return etf (BOND), which has done well:
(Source: http://seekingalpha.com/article/578491-pimco-total-return-etf-off-to-a-fast-start)
Notice that the etf (top-most line) is not just being compared to its benchmark (which it handily beat), but also PIMCO's own Total Return Fund. In a very real sense, Bill Gross has beaten himself. Similar to the cash-futures basis, could there be an etf-mutual fund basis?
Now let's take this a few steps further:
- Execution-hedging: If xyz investor has a large holding in a mutual fund that he wants to liquidate intraday (wanting, perhaps erroneously, to catch the top), he can short the etf until the close.
- Manager-hedging: xyz investor likes abc strategy and has invested in a top tier manager. There is another manager doing the same abc strategy but the investor believes this other manager will do significantly worse than the top tier. He/she can short the etf while still invested in the top tier manager
- "Basis" trading: If one believes that a particular manager's etf version is going to do worse or is mispriced relative to the mutual fund version, he/she can short the etf and buy the mutual fund. This is admittedly incomplete, as one cannot "short" a mutual fund easily.
Monday, May 27, 2013
Is Shiller P/E Worth It?
The Shiller P/E has been in the news lately (1, 2, 3) as various critics and proponents say say that the high level (~24 vs 17.5 average in the last century) is either indicative of danger or not applicable in this case. To review: the Shiller P/E is the 10 year inflation adjusted trailing P/E of the S&P 500. Also called the cyclically adjusted price-to-earnings ratio, the ratio is meant to smooth the volatile earnings of the business cycle and generate a genuine measure of value for the market.
After reading AQR's paper extolling the use of Shiller P/E (10 yr trailing P/E) while acknowledging its limitations, I am tempted to ask the question - Shiller P/E even worth it as a tool?
(Source: http://www.multpl.com/shiller-pe/)
There is little question that the indicator is elevated. Apart from the 90s technology craze and the 20s pre-Depression bubble the indicator has never been this high. But what does this actually mean for markets going forward? Before even questioning the assumptions behind Shiller P/E, what is its track record taken at face value? Again, AQR (and many others) have done some analysis:
As highlighted - we are in the 2nd to highest decile. This implies a measly 0.9% mean annual return going forward. But what about the volatility? The best 10yr return was 8.3% annually vs -4.4% worst. Not exactly compelling for a buy, but is it worth it to sell (short)? Selling now and being wrong means possibly missing/losing 8.3% annually for 10 yrs. Does that present an attractive risk reward?
On the other hand, buying at the lower two deciles is far more compelling. The worst case is a 4.8% return for the lowest return & 10.3% average. I'll take that all day.
Bottom line - I don't think Shiller P/E is useful for calling tops, even using the proponents' data. It is, however, possibly useful for bottoms. The market may correct severely tomorrow, but don't think that using this indicator one would have sold anywhere near the top.
After reading AQR's paper extolling the use of Shiller P/E (10 yr trailing P/E) while acknowledging its limitations, I am tempted to ask the question - Shiller P/E even worth it as a tool?
(Source: http://www.multpl.com/shiller-pe/)
There is little question that the indicator is elevated. Apart from the 90s technology craze and the 20s pre-Depression bubble the indicator has never been this high. But what does this actually mean for markets going forward? Before even questioning the assumptions behind Shiller P/E, what is its track record taken at face value? Again, AQR (and many others) have done some analysis:
As highlighted - we are in the 2nd to highest decile. This implies a measly 0.9% mean annual return going forward. But what about the volatility? The best 10yr return was 8.3% annually vs -4.4% worst. Not exactly compelling for a buy, but is it worth it to sell (short)? Selling now and being wrong means possibly missing/losing 8.3% annually for 10 yrs. Does that present an attractive risk reward?
On the other hand, buying at the lower two deciles is far more compelling. The worst case is a 4.8% return for the lowest return & 10.3% average. I'll take that all day.
Bottom line - I don't think Shiller P/E is useful for calling tops, even using the proponents' data. It is, however, possibly useful for bottoms. The market may correct severely tomorrow, but don't think that using this indicator one would have sold anywhere near the top.
Monday, May 20, 2013
Contemplating ING US (VOYA)
Ran into ING US (VOYA) while hunting for cheap price to book investments. It has turned into a bit more interesting than just that metric and indeed may be an aig-style investment.
A background:
ING US is a financial services company that until recently was part of the Dutch company ING Groep NV. It, like many global financial services companies, went to the brink of catastrophe in 2008 and more specifically received a $13.5B tarp-like capital injection from the the Dutch State. Since then, ING has been selling assets to repay the bailout, most recently with the IPO of ING US (to be renamed VOYA Financial in 2014).
Key points of a long view here include: 1) forced selling by ING's parent 2) a stabilizing retirement, insurance & asset management business:
1) Forced selling - VOYA's own prospectus calls this ipo a divestment transaction meant to repay part of the remaining 2.2B EUR ( 10B - 7.8B from previous transactions) that VOYA still needs to repay. As such, it is clearly government-driven and not focused on economic value given back to the firm.
2) While it is one of the largest life insurers in the US, nearly half of VOYA's revenues actually come from the retirement division:
Revenues from that half the firm are fairly recurring and stable as a percentage of AUM. Provide plan administration, i.e. the boring/safe side of the business. Same goes for the asset/investment management side of the business. On the insurance side, there is exposure in the variable annuity product in that VOYA provides capital protection in an equity-like product. It is risk, but one that I continue to like because of my overall positive view on us equities (see previous blog posts).
Finally, there is the issue of the closed books (i.e. the "bad bank" that holds alt-a and other legacy assets from the financial crisis). Considering the great reversal of many of these former toxic instruments and the gains from last year, I do not think they are marked aggressively).
As such, is such a business trading @ ~0.5x book value in an industry usually => 1x book a compelling investment? This is not meant to be a full pitch, but rather a starting point for further thoughts.
P.S. Looks like I am not the only one looking into VOYA.
Thoughts?
Disclosure: I am long VOYA
A background:
ING US is a financial services company that until recently was part of the Dutch company ING Groep NV. It, like many global financial services companies, went to the brink of catastrophe in 2008 and more specifically received a $13.5B tarp-like capital injection from the the Dutch State. Since then, ING has been selling assets to repay the bailout, most recently with the IPO of ING US (to be renamed VOYA Financial in 2014).
Key points of a long view here include: 1) forced selling by ING's parent 2) a stabilizing retirement, insurance & asset management business:
1) Forced selling - VOYA's own prospectus calls this ipo a divestment transaction meant to repay part of the remaining 2.2B EUR ( 10B - 7.8B from previous transactions) that VOYA still needs to repay. As such, it is clearly government-driven and not focused on economic value given back to the firm.
2) While it is one of the largest life insurers in the US, nearly half of VOYA's revenues actually come from the retirement division:
Revenues from that half the firm are fairly recurring and stable as a percentage of AUM. Provide plan administration, i.e. the boring/safe side of the business. Same goes for the asset/investment management side of the business. On the insurance side, there is exposure in the variable annuity product in that VOYA provides capital protection in an equity-like product. It is risk, but one that I continue to like because of my overall positive view on us equities (see previous blog posts).
Finally, there is the issue of the closed books (i.e. the "bad bank" that holds alt-a and other legacy assets from the financial crisis). Considering the great reversal of many of these former toxic instruments and the gains from last year, I do not think they are marked aggressively).
As such, is such a business trading @ ~0.5x book value in an industry usually => 1x book a compelling investment? This is not meant to be a full pitch, but rather a starting point for further thoughts.
P.S. Looks like I am not the only one looking into VOYA.
Thoughts?
Disclosure: I am long VOYA
Sunday, May 12, 2013
Time to Buy Big Banks? (BAC/C/WFC/JPM)
Bank-bashing has become a national pastime in the last few years (1, 2, 3, 4). From unfair subsidies as too big to fail to unwieldy conglomerations that no one knows how to value, run or even understand, there is no shortage of criticisms for TBTF banks.
Early contrarian investors in 08 such as Bill Miller were trampled by the herd and in retrospect buying way too high. Paulson/BAC and Ackman/C have been similarly hurt trying to time to bottom and inevitably sells at the bottom:
Paulson in BAC 2011
Ackman with Citi in 2012:
So, what is different now that could make banks a buy? I actually won't go into the fundamental reasons because they are common place. At a high level, bac/c are trading at slightly less than 1x tangible book and all are trading ~10x or less "normalized" earnings.
I don't believe fundamentals can be an effective timing tool alone here, so let's look at market psychology. Are flows finally moving into financials?
As such, is now a good time to buy and hold for the next 3-5 yrs (until normalization?)
Early contrarian investors in 08 such as Bill Miller were trampled by the herd and in retrospect buying way too high. Paulson/BAC and Ackman/C have been similarly hurt trying to time to bottom and inevitably sells at the bottom:
Paulson in BAC 2011
Ackman with Citi in 2012:
So, what is different now that could make banks a buy? I actually won't go into the fundamental reasons because they are common place. At a high level, bac/c are trading at slightly less than 1x tangible book and all are trading ~10x or less "normalized" earnings.
I don't believe fundamentals can be an effective timing tool alone here, so let's look at market psychology. Are flows finally moving into financials?
As such, is now a good time to buy and hold for the next 3-5 yrs (until normalization?)
Sunday, April 28, 2013
Gold Miners - Value Traps In Waiting?
When searching for investment ideas, one thing that seems to work is the search for the weak hand. Relatively uninformed investors, or simply those who are making non-economic and indeed incorrect assumptions are often a good starting point to research the other side.
With that mind, the fact that the U.S. Mint has run out of small gold bullion coins to sell is particularly interesting. This is a mini gold craze which parallels the institutional interest but is unique because:
- The small denomination implies mostly retail interest, e.g. those who don't have that much money to begin with. They are therefore forced to buy the small denomination.
- The illiquid/indirect nature of the buying. One can buy GLD etf to get the same exposure with much higher liquidity. Given the world avoids anarchy (and even then), no one is forced to accept gold as payment and therefore is by definition fear-based buying.
Gold mining stocks follow from that same defensive logic - they are real businesses after all. They make sales based on gold prices and in addition provide operating leverage. If it costs them 500$/oz to mine the gold and the price is now $1000 but then moves to 1500, their income doubles. On the other hand, the gold price only moved 33%.
But is this leverage accurate? Consider this table from Barrick Gold's annual report (page 83)
Cash costs increased by roughly 43% (=584/409) over two years. What about gold itself?
Gold etf (physical) increased by roughly 20%, roughly half that amount.
In other words, the world's largest miner had negative operating leverage in one of the most consistent bull gold markets in the last 20 yrs.
As a result, gold miners may be trading at low fcf and earnings multiples, but may deserve such low multiples. They may therefore be a value trap. This is not even considering that most miners' do not have a consistently profitable business even in the last few years.
Disclosure: I am short GDX (etf of gold miners).
Monday, April 22, 2013
The Market as Rock, Paper, Scissors
I recently came across this old paper about a meeting between Ed Thorp and Warren Buffett in the late 1960s. Buffett had recently closed his famous partnership after the bull market in the past few years left few undervalued securities to buy. Afterwards, former clients asked him to evaluate a money manager: Ed Thorp.
Compound interest is the first (popular) discussion that's worth repeating:
Buffett then brings up the "three very strange dice." Labeled as A = A=(2, 2, 2, 2, 5, 6), B=(1, 1, 4, 4, 4, 4) and C=(3, 3, 3, 3, 3, 3), two people can play a game where each chooses a dice to roll. The person with the highest number then wins that round. Interestingly enough, through repeated games (and deduction) it can be shown that A > B, B > C, but C > A. They dice are intransitive. As a result, the 2nd person to pick a die should always win in the long term by # of wins if he/she recognizes this. Just like rock paper scissors, no pick is universally best.
In other words, in such a game and indeed the market a strategy's success is often very much dependent on the others being employed. I would argue that the very reason for value's outperformance in 02-03 post-dot-com crash is because of the focus on speculative technology stocks. Similarly, active investors want more short term speculators and index funds because they would provide the other side to profitable buys. On the other hand, if everyone is preaching value or quality businesses a la nifty-fifty, value investors may want to stay away.
This phenomenon is indeed well-known already, but the examples above and detailed in Ed Thorp's paper show just how pervasive and powerful this quality is.
Compound interest is the first (popular) discussion that's worth repeating:
if the Manhattan Indians had been able to invest the $24 for which they sold Manhattan in 1626 at, say a net return of 8%, their heirs could buy it back now (1968) with all the improvementsThis is just the beginning, however:
Buffett then brings up the "three very strange dice." Labeled as A = A=(2, 2, 2, 2, 5, 6), B=(1, 1, 4, 4, 4, 4) and C=(3, 3, 3, 3, 3, 3), two people can play a game where each chooses a dice to roll. The person with the highest number then wins that round. Interestingly enough, through repeated games (and deduction) it can be shown that A > B, B > C, but C > A. They dice are intransitive. As a result, the 2nd person to pick a die should always win in the long term by # of wins if he/she recognizes this. Just like rock paper scissors, no pick is universally best.
In other words, in such a game and indeed the market a strategy's success is often very much dependent on the others being employed. I would argue that the very reason for value's outperformance in 02-03 post-dot-com crash is because of the focus on speculative technology stocks. Similarly, active investors want more short term speculators and index funds because they would provide the other side to profitable buys. On the other hand, if everyone is preaching value or quality businesses a la nifty-fifty, value investors may want to stay away.
This phenomenon is indeed well-known already, but the examples above and detailed in Ed Thorp's paper show just how pervasive and powerful this quality is.
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