bizzXceleration: Performance, Value and Profit

Once more into the breech dear friends and shorted be he who ignores to much stuff. Terrible poetry but perfectly in line with the realities of this morning, the week, the month and the last several. My perfect example is this headline from CNBC,Housing Recovery Is Looking a Lot Shakier These Days, which my friend Bill over at CalcRisk responded ROFLOL! Why - because he's been analyzing this for something like nine months. But as the stimulus fades it would appear the underlying weakness in Housing, which ain't all that underlying, is becoming visible enough to the commentariat and analtocracy to notice. The problem is that it's only one among several major data sets which have been visible for months, equally widely ignored, from which the lessons everybody should have learned haven't been because they were never taken, and which are increasingly likely to bite everybody in the arse tout suite'. Others include the Fed beginning to end QE and their purchase of MBS(the source of 80% of the housing demand), a surge in delinquencies in housing and credit cards, a previously mentioned cliff-dive in bank credit, a good GDP number entirely based on Inventory effects and the outlook for fiscal stimulus to start fading long before we reach self-sustaining takeoff velocity (the real point in Bernanke's recent testimony that was almost completely ignored). We ignore all those at our mutual peril but ignore them everybody is. Another blogging buddy (Prieur du Pleiss) was kind enough to call attention to Montier: Was it all just a bad dream? Or, ten lessons not learnt from which we take the following two quote:

"At its simplest, value investing tells us to buy when assets are cheap and to avoid purchasing expensive assets. This simple statement seems so self-evident that it is hardly worth saying. Yet repeatedly I’ve come across investors willing to undergo mental contortions to avoid the valuation reality."

"In his book on value investing, Marty Whitman says, “Graham and Dodd view macrofactors … as crucial to the analysis of a corporate security. Value investors, however, believe that such macrofactors are irrelevant.” If this is the case, then I am very happy to say that I am a Graham and Dodd investor. Ignoring the top-down can be extraordinarily expensive. The credit bust has been a perfect example of why understanding the top-down can benefit and inform the bottom-up. "

The chart is taken from that same white paper which is well worth your time along with a discussion of Shiller's CAPE without the cycle (What is the Cyclically Adjusted S&P500 P/E Ratio ? ), which finds that stocks have been tremendously over-valued for a long-time. Which is, as are the other points, entirely consistent with things we've been saying for years. The basic points we want to focus on is that you need to understand the macro-environment AND business performance, along with the notion that at current valuation levels the chances of a decent return for the next ten years are nil. The critical questions are what do you do about that?

Continue reading "Walkin the Talk: Lessons Lost, Value Creation - HD as Example" »

Posted by dblwyo at 02:54 PM | Permalink | Comments (0) | TrackBacks (0)

A few interesting things happened in this last week that define the things we want to address here. In an exchange with a friend on business performance in the new normal, despite several months of back and forth, most of what we'd been saying about the next decade hadn't really sunk home but we finally managed to get the other shoe to drop. His reaction was somewhere between Wow and OMG! What that exchange makes clear to us is that, in line with our expectations, most businesses haven't a clue as to what's coming at them. So those issues (defining the New Normal benchmark and assessing business preparation and performance outlook) define our endpoints. At the same time we had an amazing, in many senses State of the Union and Davos 2010 kicked off. This environment has moved from Chaos to Turbulence and is still very Fragile - and will remain both Turbulent and Fragile for the decade as deep structural adjustments in the global economy, governance (corporate and public) and geo-politics that will radically alter the deep foundations we've taken for granted for the last three decades are changed in response to the crisis and governance and performance failures. Those changes are a central theme of this year's conference.

Taken all together the economic outlook, the implications for investment and asset performance and business governance define the touchpoints of our highly selected readings section after the break, including several critical vidclips from Davos as some from the FT on emerging markets. There's nothing there that we're putting up just for fun. But the central questions are what will the New Normal look like and how are businesses prepared for it? And how will public authorities deal with restoring a fragile world economy. To set the stage you might want to listen to this brief round table from McKinsey. But we'll let a much wiser man define the situation in words we hope you recognize and take to heart:

"The dogmas of the quiet past, are inadequate to the stormy present. The occasion is piled high with difficulty, and we must rise with the occasion. As our case is new, so we must think anew, and act anew. We must disenthrall our selves, and then we shall save our country. Fellow-citizens, we cannot escape history. We of this Congress and this administration, will be remembered in spite of ourselves. No personal significance, or insignificance, can spare one or another of us. The fiery trial through which we pass, will light us down, in honor or dishonor, to the latest generation."

Annual Message to Congress (1 December 1862) – A. Lincoln

Continue reading "Chaos, Turbulence, Fragilities: Defining the New Normal, Blueprinting Business Performance" »

Posted by dblwyo at 02:58 PM | Permalink | Comments (0) | TrackBacks (0)

The Markets have been tanking most of this week and have given up most of mini-bubble beyond 1100, which if you recall was our upper resistance limit in previous posts. It's doing so because a bunch of things have come together, though semi-predictably there's a chorus of voices blaming the President's announcements of a major reform to restructure the Finance Industry and change what it's allowed to do and how it functions. Given the poor quality of earnings since last March, recent reports showing how weak the core businesses are and Industry behavior over the year with regard to reform that announcement was, at best, a trigger that crystallized an already saturated solution. What really saturated things and put them on the cusp point of teetering over an edge was a slew of disappointing earnings, an improved grasp on the real economic outlook and China's major changes in policy. ALL of which we've been discussing for months.

Rather than reviewing all that it's collected in the readings but we're going to use it as our fulcrum to focus on the salvo across the bow fired on reform, and ask you to start with investing eight minutes in listening the President's announcement. This is not just political theater, though there's some of that, it's to the point, substantive, grounded and a sensible reaction to being stone-walled by the industry for one year (bear in mind the Administration reached out to the Industry within days of taking office and has been trying to reach out for months).

Continue reading "Comes 'round, Goes 'round: Hastening Forward Slowly to Finance Reform" »

Posted by dblwyo at 10:15 AM | Permalink | Comments (0) | TrackBacks (0)

Hopefully the last post was useful - in case you didn't know it we had several objectives and key points. The first thing was that we directly challenged the intellectual foundations that lies behind 95% of the investment management principles people have been recommending for three decades (the EMH), which includes much of the misused Wall St. math, much of the theory behind index funds (to a limited extent) and definitely Buy-N-Hold. We hope you took away the fundamental lesson that BnH is so much quackery. At the same time that "indictment" was also not support for much of the arm-waving that passes for "active" investment advice - it's still hard to beat the market and it takes some work and, especially some thought. What we did was lay down the foundations for two Principles and Two Guidelines.

Principle #1 - you need to actively managed your investments.

Principle #2 - you need to invest in those assets where you clearly understand the performance factors.

Guideline #1 - invest in those assets where you are pretty sure that the margin of value over price gives you a margin of safety and a good probability of a decent return.

Guideline #2 - you're going to have to spend some time working at this. Buy and forget will kill you. There's a tradeoff between the amount of risk, the amount of work. NB: we actually did a lot of the work for you by providing a strategic assessment of the Economy, Markets and Business Performance. And by updating and discussing our Four Factor Model.

So the next question is, what do we mean by active and how do you go about? Well you can start by listening to the most recent WealthTrack interview on the outlook for one thing. (WT is one of three goto information sources we're going to suggest you need to monitor frequently).

Continue reading "Active Allocation, Active Investing: Investing Guidelines for Lost Decade #2" »

Posted by dblwyo at 05:46 PM | Permalink | Comments (0) | TrackBacks (0)

Not to rush everybody along but after the big overview and the detailed dissection of the turbulent markets the natural question is what now? That breaks down into two parts - framing the question and getting down to specifics. On the "teach someone to fish" theory we believe starting with the framework means reactions and decisions will be informed and, most importantly, adjustable. So that's where we're going to start. Specifically with thinking about the design, concepts and constructs for Investment Strategy. Along the way we're going to take a big pass at EMH (Efficient-markets Hypothesis), suggest where it does or doesn't work and propose some alternatives. EMH, otherwise known or translated as the Buy-N-Hold strategy in practice but usually implemented by buy-forget-regret, has a few minor "weaknesses" that got a lot of folks into trouble who didn't check the fine print. Of course it made a lot of money for those who took advantage of the first set of suckers, oops, investors and those who did read the find print.

EMH in Practice: Markets vs. the Economy

This paired composite look at YoY changes in the SPX vs. GDP. Notice a couple of things very carefully. First off the cyclic patterns mirror the GDP almost exactly. Next, the almost part comes when some piece of irrationality gets carried away. If EMH worked none of that would be true. BtW, hopefully you remember all the long-run GDP vs. Profits vs. SPX charts we keep throwing up. None of the standard shibboleths or mythologies of investing are supported by those charts. Though on some timescales in some instances the notion that the markets anticipate the economy has some merit (that weaselly enough for you?). The trick is to know what works, why and to judge how the factors are playing out.

We've got two timeframes going here so you can see how long and how well it works and then so you can actually see enough detail (1980 on) to see what's actually going on. HINT: if the EMH was entirely accurate in a pure form markets wouldn't gyrate but would look at l.t. discounted cash flow and real earnings and converge on a steady-state having nothing to do with economic cycles; adjusting only for major changes in structural factors because those changes the driving forces. Known cyclical patterns shouldn't be surprises, but of course they are since real analysts don't actually analyze reality, just what they want to look at. The difference between a known pattern and a widely ignored one, btw, should be arbitraged away by the markets if the EMH was true. Which is how Warren plays the game.

Continue reading "Investing in Turbulence: EMH, Irrational Markets & Pragmatic Decisions" »

Posted by dblwyo at 12:29 PM | Permalink | Comments (0) | TrackBacks (0)

Let's focus on some of the implications and repercussions of the prior set of posts and pull them together to understand why things are headed into the "facility" with regard to business performance and earnings outlooks. Why in other words we talk about and mean smackdown, unfortunately with two very badly ill-matched opponents. In this corner earnings, which look like your kindergarten teacher, and in the other corner it's "The Rock" ! The readings excerpts after the break go into some specifics from the stimulus package outlook/realities to market and earnings performance to some specific on representative industries and/or geographies.

Market's Lost Decade

But let's begin with a look back at past performance of the market over the last decade (courtesy of Lloyd Norris and the NYT [if you want to see some of previous arm-wavings try Value Analysis & Valuation]). This almost explains itself but what it shows is market returns for the previous ten years for each year, and this year's for the last decade is -5.1% !!! Abysmal and the worst ever, so far. But if you believe our unending litany of Cassandra warnings this is likely to go on longer than the terrible '70s ! So start factoring that into your thinking. (And skim the readings - btw if you click on the highlighted titles they are URL's in disguises and you can read the whole thing in case you missed that notice).

Smacked in the Kisser: Market vs Economy

 We've taken multiple shots at looking at market trends and the relatioinship between the market and the economy but the common meme that markets lead and that there's some disconnects appears to be deeply embedded in analysts DNA, beyond hope of eradication even with genetic surgery. The composite chart shows the YoY changes in GDP vs the Sp500 on top and W+E vs the SP500 on the bottom. The logic is GDP => Profits => Earnings, part of the genetic denial barrier, while W+E => GDP, hence the strong and obvious correlations. So if there's any remaining doubt the if the Economy keeps heading into the crapper earnings will follow right along now would be the time to go onto some other reading.

Lie-ins and TIGRS and Bears: Earnings Prognutifications

Yes, most of the funny wordings are deliberate to make our point, which is that analysts have been too wildly optimistic for years, missed '08 badly and, in continued mis-placed optimism, are likely to miss '09 as badly or worse. The chart at right borrows multiple sets of data, the two charts on the left source from a Mauldin newsletter while the tables on the right are the running S&P operating earnings estimates from S&P's web site at various times (NOTE: Mauldin and S&P are reporting different numbers so you can't directly compare them. Never-the-less....). On the left notice where '08 started and ended up - the only small ray of light is that reported ended up higher, but that may just be the different (apples vs potatoes) data types. Now look at '09, which shows the same appalling drop, and also shows '08 > '09 ! Yet S&P is reporting that the analysts are estimating a significant rise in '09 ! Which is completely contraditory to Mauldin's message and all our analysis. Oh what surprises lurk in the self-decieving minds of men, or in this case business executives, since almost all analysts merely collect, filter and pass on what they're being told. Not what their independent and informed analysis would show. Even with all that S&P is reporting an estimate PE of ~12 to go with that EPS of $68.88. Hmmm....well 12 X $68.88 = 827. Which means that at best the market will be flat in '09. Would that it might be so. On the other hand 12 X $42.26 = 507...ouch, ouch, really ouch. And in line with all our earlier guestimating about L.T. market trends and outlooks.

A real key here is that phrase "business executives tell"....as we've pointed out (Let the Triage Begin: Business Performance vs "Stupid Is",Survivor: Search for the Next "Blue Chips" (UPDATE)) most executives are dealing with a completely unexpected tsunami they didn't anticipate (ignored) and were caught flat-footed and very ill-prepared. Worse, based on the McKinsey and Booz surveys we reported on, they aren't responding well at all, and in fact seem to be shell-shocked and frozen in place. In the readings you'll find excerpts talking about the US and Chinese auto industries, the Mining industry, Retail and the Japanese eletronic manufacturers. To put the shoe on the other foot there are a couple of retail counter-examples where two of the best retailers in the world are being aggressive and taking advantage of the windows of opportunity here.

Bottom line ? There's a huge pile of equine excretory output in train car loads headed for the rotary impellers and it's going to get splatterred all over us all. And NOBODY is prepared or preparing.

Continue reading "Economy vs Earnings Cage Match: Outlook, Business Performance & Realities ???" »

Posted by dblwyo at 09:28 PM | Permalink | Comments (1) | TrackBacks (0)

There's a couple of things going on that caused us to dig into long-term market performance, using the SP500 as a proxy. The big one, which'll we'll dig into shortly, is it's earnings seasons and we anticipate a large dose of cold water in the face as reality meets the analysts. A different and surprising tack is how does the current market compare to long-term performance trends. Oddly we were led to that by all the hoorah about Citi's performance where Weill has been claiming sanctity because he generated such wonderful performance. That turns out to be even more ill-founded than future earnings outlooks. But in the process we stumbled across some perspectives we thought worth sharing. So we're going to start with a short-term lookat the SP500 but follow up with some very long-term ones back to 1950.

If you'll take a gander at the busy little chart at right (we apologize for the business if it's too excessive but wanted in this case to take advantage of some tools). In prior posts we talked about the steps and stumbles as the market gradually worked its' way down the staircase of the credit crisis and associated realities. If you look at the base chart you'll notice, among all the information, that the 50-day MA was still pulling away from the 200-day but has recently flattened. Driven largely by (our alternate title) April Fools where UBS doubled its' writedowns another ~ $19B but raised capital ! Sheesh. We don't want to spend immense time here but notice the flags and pennants. As we mentioned we saw three forming. The last two got busted to the downside but 4/1 saw the upside "surprise" all the bottom-callers were looking for. Which seems to be coming under pressure. Whether the rally holds will depend on how views on earnings evolve. But let's shift gears a LOT and look at real market performance over the long-term.

Below you'll find charts dissecting long-term market performance and returns in four different ways going back to 1950 and some, we think, very surprising conclusions. Our bottomline is that the era of highest performance was the '50s and early '60s. And that performance was driven by huge increases in economic performance which are unlikely to come again. But take a look for yourselves. 

Continue reading "Long-term Market Performance: It Sure Ain't What You Thought !" »

Posted by dblwyo at 12:38 PM | Permalink | Comments (0) | TrackBacks (0)

A constant them here is having to dig into the actual structural nature of an investment, particularly business. On that topic we've put up some posts on approaches, valuations, and Warren Buffett's thinking (btw - if you haven't follow that post to the YouTube videos we repeat it's well worth your time). The question we haven't addressed as yet is how. Which we propose to make a bit of a start on here. Below the line you'll find a listing of web resources that we've found useful. Now these aren't the resources of course that somebody in the business has access to - in fact we rather hope they have much better and deeper ones. Nonetheless there's more and more information sufficient for you get into investment and business analysis. Along with the links we'll also wrap a short explanation of the stepwise process.

As part of the approach let's repeat our fundamental mantra: Economy, Industry, Company. In other words understand how the overall Economy (& therefore Markets are headed), then understand how particular industries will play in this context. And finally how particular companies will play. Now Warren is found of saying he pays no attention to big picture, macro stuff which is all well and good, especially when you've got his resources and timeframe. But the mantra is not just top-down, as it might appear. One could as readily start on the other end by finding interesting companies, however you do it, and then understanding their bigger picture context. So the mantra works both topdown and bottom-up. 

So below the line please find our suggested links, resources and (implicit) approach to business analysis. We hope you find it useful and productive. 

Continue reading "Earnings, Valuations & Business Analysis (II): Resources and Approaches" »

Posted by dblwyo at 01:19 PM | Permalink | Comments (0) | TrackBacks (0)

At the end of the lost post we laid down a, perhaps the, challenge for these interesting times:

"As this sorting goes on the real winners will be the firms and industries who have an effective business model or who re-invent one. Finding them will be the interesting challenge. "

So how does one go about sorting things out. Well there's our interesting little mantra of economy - industry - firm but we thought, beyond that, we'd appeal to the words of the Master. Mr. Warren Buffett himself. Now there's several ways to do that from reading any of the several books that've come out, to reading Warren's annual stockholders letters. Which are btw online at the Berkshire web site and entirely worth your time. And he's made several invaluable and wisdom filled visits to the Charlie Rose program. Two other interesting sources are another of our favorite blog sites and the AAII. 

• NotMakingThatUp (Jeff Matthews): this is the last of a ten part series on Jeff's attendence at the annual BRK meeting. Also if you'll search Jeff's site there are several other interesting posts that are well worth your time and attention:Pilgrimage, Part X: On The Cheap
• Another is this introduction to the AAII's Buffett Screen

 We strongly suggest follow-up on those but fortunately modern technology has given us an even better starting point. Back around 1998 Warren made a major appearance at the founding of the Graham-Buffett school of Security Analysis, the speech/Q&A was recorded and now it's posted on YouTube as a 10-part vidclip set. Each of the parts is well worth watching, pondering, taking notes and re-watching. In fact as part of our prep work, obviously in addition to reading the previously mentioned materials, we watched the set twice. Being slow it took us a while to catch on to the "take notes" part as well as the little gems and insights that we've heard no where else.

Continue reading "Masterclass: Buffett on Investing and Business Analysis" »

Posted by dblwyo at 02:51 PM | Permalink | Comments (0) | TrackBacks (0)

In the prior post we looked at the Grahm-Dodd PE valuation formula, built some useful tables and talked a bit about applying the approach to both company and market performance assessment. It seems like it might be a good idea to test it a little bit so let's walk thru SP500 quarterly earnings, PE's and compare the latter to what might be calculated using average earnings growth rates and AAA-rates. This will turn out to be a little rough and approximate but nonetheless be useful - at least in thinking about trends in valuations. Let's start with the following chart that looks at earnings from Q11990 to Q42006 and compares actual PE ratios to calculated ones.

 Here the dark blue is SP500 quarterly earnings on the left axis while reported PE and the 3Mo Moving Averge of GD calculated PEs (MAGDPE) are on the right. Not suprisingly the latter is volatile but the polynomial trend is revealing. Notice the converence of the two PEs in the mid-90s, their wide divergence in the late 90s and now the new convergence. Also notice that the GDPE is quite a bit more conservative than market-based PEs. A final, very interesting thing to note is the recent continued decline in market PEs over the last several years with the exception of the very last quarter. I think we'll find that this is a fair estimate on the long-term growth prospects of the economy as well as that of the market, profits and earnings.

If we drill down a bit to more recent dates some of these trends in valuation are a little more clear.

 Here we can see earnings growing steadily until the last quarter but market PEs showing a relatively steady decline. Based on the logic of the G-D framework that would mean that the market as a whole view long-term growth prospects for earnings, and therefore the economy, as not very good. In fact given how well profits and earnings have done over the last several years the relatively flat markets of '04, '05 and mid-06 can really only be explained by lowered earnings growth expectations. Conversely the sudden drop in oil prices as well as the 'apparent' containment of inflation expectations - so that interest rates will stay relatively low - may have led to the Q3/Q4 surge in the markets. Ironically however Q4 saw one of the more serious downturns in earnings.

The question now becomes how do we expects the economy to do and what impact will that have on profits, earnings and expecations ? And of course, not to forget where we started, how do we apply these sorts of questions to corporate performance analysis ?

Prior Posts:

Value, PE and Mr. Benjamin 

Posted by dblwyo at 01:57 PM | Permalink | Comments (0) | TrackBacks (0)

The great, as in superlative, grandfather and progenitor of stock market analysis and valuation is Mr. Benjamin Grahm. While other anlaysts have evolved different methods and techniques Mr. Benjamin's emphasis on understanding stock value as a function of performance and outlook will always be with us. As well as notions of letting Mr. Market do his thing while concentrating on value but under-standing what the margin of safety is; i.e. what's something really worth as a going concern, do we know where we can get it for a much lower price than it's worth, how far could it fall in market gyrations and, best yet, do we know where can sell it to realize a major gain. Those are indeed interesting questions.

Earlier commentators and correspondents pointed to the assessment of Bob Nardelli's performance at Home Depot and asked whether or not the rapid deterioration in PE ratios didn't reflect better alternatives. Exactly. But the question is bigger and more important than that. It also helps us gain some insight in looking at the overall market. In fact it's been a suprise to me that over longer timeframes PE ratios are so revealing of long-term performance trends for companies, though quarterly there's a lot of noise and confusion. Mr. Benjamin's work (as adapted by the AAII) suggested a simple formula for first-pass valuations based on longer-term performance, company outlook and market/economic conditions:

PE = (8.5 + 2XG) X 4.4/Yield.

Here G is earnings growth and yield is AAA-rated corporate bond rates. 

The following table shows expected 5-year annula growth rates (columns) verses AAA-rated corporate yields (rows).

The preceeding table works out the formula for a wide range of earnings growth rates and for interest rates. It's an interesting exercise to go back to, say, the heights of the Internet/Telecom boom and see whether or not using the Grahm-Dodd PE formula lent us any insight. At the beginning of 2000 Cisco's PE was 200 while EPS had grown from about 1.20 to 1.80 or so (judging from some hard to read charts) while interest rates were around 7%. So (8.5 + 2*30%) X 4.4/7 is 43 or so. Still an incredibly respectable number but a long way from 200, or 100 or even 50.

The real point here is not that the G-D PE formulat is precise but that it is accurate in the sense of providing a test of reasonableness and under-lying value. Especially when one keeps applying it over time because the trends, patterns and turning points might be even more interesting than the number at any particular given point.

By and large we're quite a ways beyond the days, until they come again of course, of 20% interest rates, 50% earnings growth in multi-$B companies and 200 PE's. So the following table looks a little more closely at details more immediately useful. 

Now there's plenty of room here for informed judgement as well. If you think that rates are going to change direction or that corporate performance is going to surprise, up or down, from the broad run of expectations then using this chart will help you do a quick scan of what it might be worth.

In the earlier entry on Home Depot it was this valuation philosophy we were essentially pointing at - and arguing that, over time, the market was arriving at. At least as the longer-term consequences for HD performance became clearer. We'll be re-visiting HD in future posts to re-test this but from the last couple of week's headlines and earnings reports it does indeed look as if the chickens came home. 

Posted by dblwyo at 12:28 PM | Permalink | Comments (0) | TrackBacks (0)