bizzXceleration: Performance, Value and Profit

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)

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)

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)

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)

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)