Longs to consider:
MMM
DHR
WAB
UNH
JNJ
WU
Shorts:
NVR
RIMM
GS
Of the longs, many are industrials with the exporting/infrastructure theme intact. They are cheap enough that even if the overseas demand slowing scenario occurs, for the long-term [say 5-10 years] they should do quite well. WAB leverages Buffet's railroad theme, but at a global level; it competes in a duopoly, so perhaps there is more of a moat in a single railroad, but we would trade it gladly for the global leverage/lower reliance on US trade flows. UNH is a health insurer that is incredibly cheap - even if you don't see huge growth, its priced to not grow at all.
WU is just amazing - the only thing we can complain about is its price. Add on dips below $20.
The longs are all overpriced relative to our outlook for housing (ie it will suck for at least another 2-3 years, it is priced for a Q3 recovery), investment banking (longer decline in finance business in our view vs a 2-3 quarter decline priced in) and of course the correlation between housing/finance/domestic US consumer and the number of blackberries sold.
Even solid companies are restricting who they give balckberries to, and everyone is trimming their middle and back offices along with reducing front offices significantly. Look at it another way - at the peak there was about $1 trillion in excess mortage production - loans that never should have been made. The finance industry collected about 2 points on each par amount originated - so about $20 billion. That $20 billion paid for a lot of things - all the extra people the loan originators, bond insurers, rating agencies, dealers, and ABS funds hired to specialize in non-agency RMBS, CDOs, and so on; also all their blackberries. Even at $250k per person, that is 80,000 people.
Then think about all the personal services these people (living mostly in NY/CA urban areas) employed....they probably had a much higher multiplier effect than the average person.
So while $20 billion is only 0.2% of GDP, the multiplier means it could mean as much as a percent gone forever (or at least until the next bubble comes along). For the economy as a whole, it is significant but not huge. For certain sectors, it is HUGE.
Additional notes on GS: pay attention to their level 3 assets. Last quarter the increase in value in these assets was a huge percent of their net income. They are priced as the ultimate beneficiary of the crisis - the Ibank that will pick up what all the losers lose, at a hefty premium to book value compared to the rest, with the traders that never lose a bet or make a large mistake.
Guess what the trader that made and won the big bets shoritng ABX there did recently?
He left and went to start his own fund...
Friday, April 25, 2008
Reflections on Earnings Season
Some brief observations
(1)As the season progressed, analysts revised their estimates down so that most companies could still beat the estimate by a penny or two. In a class where the professor dumbs down the test so 75% of the class can bet a B+, only Cs and As have any value.
(2)GE, Starbucks, and a host of others showed that our thesis about exposure to the US consumer is correct. However, subsequent discussion/writings about the events show that in general people expect the consumer to bounce back rather more quickly than we do.
(3)exporters, particularly with food or infrastructure exposure, did well. The big question is whether that will continue through the year or creeping uncertainty, conservatism and caution will dampen growth for a few quarters there as well.
Our expectations is that the US consumer is experiencing a secular, not a cyclical, change. Just as the past 15 years saw a gradual decline in savings and growth in indebtedness, the next 10 will show a return to sanity. Some of this will be wisdom learned from harsh experience, and some will be in the form of methadone treatment applied to addicts. In some cases more like shutting the junkies up in a cell till their bodies stop shaking [ie foreclosure/bankrupcy, car repo, no more unsecured credit cards].
(1)As the season progressed, analysts revised their estimates down so that most companies could still beat the estimate by a penny or two. In a class where the professor dumbs down the test so 75% of the class can bet a B+, only Cs and As have any value.
(2)GE, Starbucks, and a host of others showed that our thesis about exposure to the US consumer is correct. However, subsequent discussion/writings about the events show that in general people expect the consumer to bounce back rather more quickly than we do.
(3)exporters, particularly with food or infrastructure exposure, did well. The big question is whether that will continue through the year or creeping uncertainty, conservatism and caution will dampen growth for a few quarters there as well.
Our expectations is that the US consumer is experiencing a secular, not a cyclical, change. Just as the past 15 years saw a gradual decline in savings and growth in indebtedness, the next 10 will show a return to sanity. Some of this will be wisdom learned from harsh experience, and some will be in the form of methadone treatment applied to addicts. In some cases more like shutting the junkies up in a cell till their bodies stop shaking [ie foreclosure/bankrupcy, car repo, no more unsecured credit cards].
Tuesday, April 8, 2008
The Whites of Their Eyes
In an old British era novel the colonel instructs his minions "Do not pull your triggers until you see the whites of their eyes!". Apparently this equity market believes likewise. The whites of their eyes being negative earnings surprises. It has completely lost its ability to predict, anticipate, discount.
Even a quarter or two ahead. Before digressing philosophically into why we might have entered such a period, let us consider some examples:
Alcoa: In this case, not only did the market try to wait until the whites of its eyes are showing, but it tried to deny that the enemy should be shot. Clearly the trends of increasing energy and labor costs are going to continue; meanwhile demand from automobiles in the number 1 consumer of aluminum (everyone - subscribe to the economist and get a copy of their annual statistical handbook!) is about to drop significantly, along with a number of manufacturing operations. You really have to buy the 2 quarters and we're done with this recession scenario to not discount some risk of multiple quarters of earnings drops at this company.
Likewise for copper/other industrial metals as well as oil (again - stats - the US is the number 1 consumer of oil BY A LONG SHOT). Each of the producers uses energy, so while they face decreases in demand, they continue to face high energy and labor costs (labor, after all, has to eat, and look at grain and meat prices, which should be last to drop). Higher energy prices ought to continue until both industrial demand and consumer demand slacken a bit further.
AMD: well, the market fully saw the whites of their eyes there.
Exceptions: Is there no connection between financial sector employment in the US and the number of Blackberries sold? Again, for this market it is not enough to see the outline of the enemy rushing at your with bayonets drawn. No rifles with telescopic mounts that can down the enemy at 1000 yards here - we need them to be 50 yards away, or if we are near-sighted, perhaps about 5 feet away. And then their bayonet, with the momentum of the body, may actually pierce the near-sighted shooter.
now the philosophy: almost everyone is now A.D.D. In the good old days only the elites engaged in speculation or investment. Computers did not act to speed up the velocity of noise and mayhem. The masses READ as much as they watched TV. There were fewer devices such as CNBC to propagate mass hysteria (only trading room rumors and phones!). Still, there was a fair amount of gossip and hysteria. But the markets ability to discount a quarter or two ahead seemed to largely be intact.
Now we have people with 5 minute attention spans WHEN they've remembered their rytalin.
Every Joe is now an investor, what with the internet, CNBC, etc. Just as admitting every idiot into a college has vastly increased the value of graduate degrees relative to college degrees (or those of elite institutions relative to MacColleges), so does the admittance of every idiot into trading make the market as a whole considerably more near-sighted. In fact, it is not just the retail investor, but every idiot with a HEDGE fund who can plot a chart on Bloomberg is creating massive amounts of momentum to every short-term trade idea. Partly it is because of the investor focus on short-term results (a quarterly drawdown will start making investors flee even if the fundamental trade idea is sound), and partly it is due to the preponderance of adrenaline junkies to serious investors in the business.
Consequence: trading driven technicals (such as everyone trying to exit a crowded trade at the same time) can, in the short-run, dominate fundamentals even when the fundamentals become known.
What does this mean to serious, thinking, long-term investors? (1)increase in potential opportunities (2)increase in patience required (3)stay away from leverage!
Even a quarter or two ahead. Before digressing philosophically into why we might have entered such a period, let us consider some examples:
Alcoa: In this case, not only did the market try to wait until the whites of its eyes are showing, but it tried to deny that the enemy should be shot. Clearly the trends of increasing energy and labor costs are going to continue; meanwhile demand from automobiles in the number 1 consumer of aluminum (everyone - subscribe to the economist and get a copy of their annual statistical handbook!) is about to drop significantly, along with a number of manufacturing operations. You really have to buy the 2 quarters and we're done with this recession scenario to not discount some risk of multiple quarters of earnings drops at this company.
Likewise for copper/other industrial metals as well as oil (again - stats - the US is the number 1 consumer of oil BY A LONG SHOT). Each of the producers uses energy, so while they face decreases in demand, they continue to face high energy and labor costs (labor, after all, has to eat, and look at grain and meat prices, which should be last to drop). Higher energy prices ought to continue until both industrial demand and consumer demand slacken a bit further.
AMD: well, the market fully saw the whites of their eyes there.
Exceptions: Is there no connection between financial sector employment in the US and the number of Blackberries sold? Again, for this market it is not enough to see the outline of the enemy rushing at your with bayonets drawn. No rifles with telescopic mounts that can down the enemy at 1000 yards here - we need them to be 50 yards away, or if we are near-sighted, perhaps about 5 feet away. And then their bayonet, with the momentum of the body, may actually pierce the near-sighted shooter.
now the philosophy: almost everyone is now A.D.D. In the good old days only the elites engaged in speculation or investment. Computers did not act to speed up the velocity of noise and mayhem. The masses READ as much as they watched TV. There were fewer devices such as CNBC to propagate mass hysteria (only trading room rumors and phones!). Still, there was a fair amount of gossip and hysteria. But the markets ability to discount a quarter or two ahead seemed to largely be intact.
Now we have people with 5 minute attention spans WHEN they've remembered their rytalin.
Every Joe is now an investor, what with the internet, CNBC, etc. Just as admitting every idiot into a college has vastly increased the value of graduate degrees relative to college degrees (or those of elite institutions relative to MacColleges), so does the admittance of every idiot into trading make the market as a whole considerably more near-sighted. In fact, it is not just the retail investor, but every idiot with a HEDGE fund who can plot a chart on Bloomberg is creating massive amounts of momentum to every short-term trade idea. Partly it is because of the investor focus on short-term results (a quarterly drawdown will start making investors flee even if the fundamental trade idea is sound), and partly it is due to the preponderance of adrenaline junkies to serious investors in the business.
Consequence: trading driven technicals (such as everyone trying to exit a crowded trade at the same time) can, in the short-run, dominate fundamentals even when the fundamentals become known.
What does this mean to serious, thinking, long-term investors? (1)increase in potential opportunities (2)increase in patience required (3)stay away from leverage!
Tuesday, April 1, 2008
Best Trade Idea - Best Long
JNJ. P/E of 15-16 depending on time period.
Getting very close to 50% of sales from outside the US.
Within the US, about as recession-proof as it gets.
Their annual report came out recently - check out the subsegments of their three main segments, which are consumer, pharma, and medical devices. This is the P&G of healthcare.
Check out the R&D spending, and the 75 years of sales growth.
Check out the list of brands.
Check out ROEs and margins.
Check out use of debt, debt types (short-vs long-term) and coverage ratios.
If you can tell us why this company should not be priced like a growth company, why it should not have at least the same P/E as a commodity company (whose moats are not protected by trademarks, patents and research), we would appreciate hearing from you.
Getting very close to 50% of sales from outside the US.
Within the US, about as recession-proof as it gets.
Their annual report came out recently - check out the subsegments of their three main segments, which are consumer, pharma, and medical devices. This is the P&G of healthcare.
Check out the R&D spending, and the 75 years of sales growth.
Check out the list of brands.
Check out ROEs and margins.
Check out use of debt, debt types (short-vs long-term) and coverage ratios.
If you can tell us why this company should not be priced like a growth company, why it should not have at least the same P/E as a commodity company (whose moats are not protected by trademarks, patents and research), we would appreciate hearing from you.
Best Trade Ideas - April 1 No Fooling Issue
It looks like time to short some home builders again. Check out NVR aka Ryan homes, which sells, for example, in the northern VA area. At just over $600 per share, it is now back to where it was in Q4 2004. But back then it had just earned $66 per share and was expected to grow earnings to $87 per share. Now it is expected to earn $23 per share this year with no visibility beyond what is in current backlog that anyone can rely on. This with the bulk of foreclosures yet to come, and very few foreclosures that have become REOs having been sold.
We spoke to the heads of 2 different REO disposition outfits that work for some of the largest servicers in the past month. Both (men who have been in the business since the early 90s) said this was the scariest pipeline they had seen, with the traditionally bad markets (Ohio, Michigan) rapidly being supplemented with the new bad markets (CA,FL,NV,VA,AZ). They generally expect their pipelines of REO properties to grow for at least the next 12-18 months. Their inventories of existing properties are set to increase by between 3 and 4 times this year.
On the other hand, the people that take REOs off the market are: investors, move-up buyers and first-time buyers. Investors are not yet stepping forward because they would prefer to hold out for lower prices, so they can start out cash flow positive (ie with a renter occupying the property, which means mortgage payments need to fall below rental income). Move up buyers are generally stuck because it is exceedingly hard to get a loan with less than 10% down now, and very few people nowadays seem to be able to come up with this without selling their original property. So you have some very high FICO saver types in this category, but it is something like 1 in 4 move-up buyers.
Then, in the first-time buyer camp, you have only people who didn't get moved into this camp in the last 2-3 years when financing was super-easy to obtain. ie people who were simply too young to be first-time buyers, or those who were too cautious. Again, this is a small part of the 25-32 year-old traditional first-time buyer age group precisely because the housing bubble sucked in so many of these people prematurely already. Why would someone who is 25-32 be buying their first home now, when financing is so much harder to get, and you need more down, than 2-3 years ago unless you were 23 back then? Only if you were the rare value investor....
Our experience is that the proportion of value investors goes up significantly with age, and momentum investing is much more common with that age group. Bottom line, REO properties are going to hang around in most housing markets for the next 2 years. This means, even with a 10-20% premium for a new house, homebuilders are going to need to continue knocking their prices down. And volumes are going to have to hit some sort of bottom - look back to 1996-2000 for some guidance, then take 25% off that volume for the bottom.
We consider fair value for NVR to be in the $400-450 range and would be sellers over $550.
We will check back on this trade idea in 2 weeks.
We spoke to the heads of 2 different REO disposition outfits that work for some of the largest servicers in the past month. Both (men who have been in the business since the early 90s) said this was the scariest pipeline they had seen, with the traditionally bad markets (Ohio, Michigan) rapidly being supplemented with the new bad markets (CA,FL,NV,VA,AZ). They generally expect their pipelines of REO properties to grow for at least the next 12-18 months. Their inventories of existing properties are set to increase by between 3 and 4 times this year.
On the other hand, the people that take REOs off the market are: investors, move-up buyers and first-time buyers. Investors are not yet stepping forward because they would prefer to hold out for lower prices, so they can start out cash flow positive (ie with a renter occupying the property, which means mortgage payments need to fall below rental income). Move up buyers are generally stuck because it is exceedingly hard to get a loan with less than 10% down now, and very few people nowadays seem to be able to come up with this without selling their original property. So you have some very high FICO saver types in this category, but it is something like 1 in 4 move-up buyers.
Then, in the first-time buyer camp, you have only people who didn't get moved into this camp in the last 2-3 years when financing was super-easy to obtain. ie people who were simply too young to be first-time buyers, or those who were too cautious. Again, this is a small part of the 25-32 year-old traditional first-time buyer age group precisely because the housing bubble sucked in so many of these people prematurely already. Why would someone who is 25-32 be buying their first home now, when financing is so much harder to get, and you need more down, than 2-3 years ago unless you were 23 back then? Only if you were the rare value investor....
Our experience is that the proportion of value investors goes up significantly with age, and momentum investing is much more common with that age group. Bottom line, REO properties are going to hang around in most housing markets for the next 2 years. This means, even with a 10-20% premium for a new house, homebuilders are going to need to continue knocking their prices down. And volumes are going to have to hit some sort of bottom - look back to 1996-2000 for some guidance, then take 25% off that volume for the bottom.
We consider fair value for NVR to be in the $400-450 range and would be sellers over $550.
We will check back on this trade idea in 2 weeks.
Subscribe to:
Posts (Atom)