When Value Buying Can Bite You in the Ass

Ten years ago, I was given the option to buy shares in an IPO for a small company called Google. You may have heard of it.  I looked at the financials and thought, "Jeez, this thing is overpriced." So I ignored it.  The IPO price for early buyers was $60, I believe.  It currently sits at $1200 per share.  1900% increase.  Drats. So here is one of the rare examples of when value buying ends up having you lose out in the long term.  First off, I think Google is worth around $650 a share right now.  I know I know.  That's almost 50% lower than it sells for today...but it does sell for a premium. But in 2004, Google had $3Billion in sales and last year it had $60Billion in sales.  So clearly they are a growth machine.  They have done a great job meeting expectations and leading the industry in ads and it prints money.  Who would have guessed that back then?  Not many, I would presume. So do I beat myself up over this?  Yes and no.  Of course I wish I had done this, so I am upset about that, but if I had invested in Google back in 2004 based on what I saw, then I would have lost TONS more money on other IPOs now and in the future hoping for the same result and would have probably given back all of the Google gains over time. Having a plan and sticking to it...assess your work over years and years and many investments, not the short term and a few investments.  Warren Buffett and Ben Graham and all of the investing greats didn't beat the market each year...in fact, when years were good for the stock market, they tended to lag.  But they stick to their system and when times are bad, they tend to fair pretty well....
Read more

Updated CIO Index

Getting close to some playoff action here.  We are about 20 games out and teams are starting to roll. So of course, we must do an update on the best players in the CIO Index from overall standpoint and from a cost standpoint. Here are the top 10, with minimums of $5MM salaries, 45 games played, and 400 shots taken so far this season. Overall Screen Shot 2014-03-10 at 10.49.41 PM                 Salary Efficiency Screen Shot 2014-03-10 at 10.46.11 PM...
Read more

Short Term News Doesn’t Mean Long Term Value

When discussing the current stock market valuation, so many people tell me that since current earnings are putting the market at 15 times earnings, I am off my rocker for thinking it's overpriced.  What people always forget is that the current profit margin as a % of GDP is at 11%, which is almost double the historical average.  Of course, everyone wants to extrapolate that out, but when looking at profit margin levels in the last 10 years, this 11% rate is even an anomaly. So I ask this question: Back in 2008, the earnings on the S&P 500 got as low as $13 per share, I believe.  If you extrapolate out a 15X earnings on that, historically, it said the S&P 500 should have been at 195. Instead it bottomed at 666 or so.  So was the 666 level really worth 3.5 times more than the market should have been selling at? Of course not, and no one who I ask that question to says it was. Their response is some variation of "Well, that was an extreme one time situation."  Why can't the same extreme one time situation occur on the upside too!?!?! Every other Friday, I teach a class at my old high school where I teach investments.  One of the analogies I always make is that if you were always a C student but suddenly, you got an A on a test because the teacher let you use an open book, are you going to apply to colleges and say you are a straight A, 4.0, student?  Of course not! If you are a solid 4.0 student and all of a sudden you forgot, from some fluke occurrence, that you had a test today, and upon taking it, you earned an F, is your high school going to kick you out for poor grades?!?! Of course not.  Yes yes, one test may be too short of an example, so make it 1 quarter of grades...1 semester...1 year.  Whatever.  The bottom line is that if your fundamental study habits haven't changed, why would your outlook change drastically? There are good years and bad years in everything in life.  This is why we can't extrapolate one good year to infinity and beyond and we can't extrapolate one bad year to infinity and beyond. You have to look at fundamentals of why things are the way they are. If there is a shift in some sort of supply or demand, then I can understand that. But that's not the case here. In fact, the thing driving profits is low interest because of massive Fed spending.  We can all agree that that will not occur in perpetuity.  Well, we don't know that for sure, but every time it does happen, it leads to bad economic outcomes which would then, in turn, drive stocks down. Please don't think short sided when things are GOOD or BAD....
Read more

WhatsApp – How Facebook isn’t spending as much as you think

I really dislike the idea of writing a blog post on WhatsApp because it has, by far, been the biggest news of the last week, I think.  WhatsApp has VERY SMALL revenue but they can charge their users $1 per year after the first year of free use, so with the 450MM users they have now, that's $450MM per year in revenue. Big woop. But of the $16Billion initial acquisition price, $12Billion of that was being done with Facebook stock.  So what you may ask?  Well, it matters big time and it tells me that even Facebook execs think their stock is overvalued. Think about it...if you feel your stock is undervalued, you will never ever give that stock away to make acquisitions.  You would use cash because you feel like your stock will eventually go much higher.  On the flip side, if you think your stock is OVERVALUED, you will want to buy as much as you can with that stock because you feel the stock will go down in price, so you really aren't paying as much. To break it down further.  Let's say, in a wonderful world, God came down and told you that your stock is going to be worth $20 per share in 1 week because everyone will realize how great your company is...But it is currently selling for $10 per share...would you EVER buy $10 worth of stuff with that $10 share?  No! God just told it was worth $20 per share in a week, so you wouldn't be paying $10, you would be paying $20 since the share will be $20 in one week (yes, there are time value considerations here, but let's not overcomplicate it). Again, on the flip side, let's say your stock is selling for $50 per share, but God said "Next week, your shares will be selling at $20."  So anyone selling you anything for $50, you will try like hell to get them to take your shares because, really, you are only spending $20 in next week's dollars to buy that stuff. I hope it makes sense because it is a very telling sign when people are making acquisitions with shares.  It shows either a lack of liquidity or concern over stock price, or both. So let's say that Facebook, who is selling at over 100 times earnings, is actually worth 1/3rd of its current stock price after you account for growth in revenue and earnings.  Revenue and earnings increase nicely over the next year or two and they are able to justify the high valuation and sell at a reasonable multiple.  If the shares were to drop to the $20 mark, which could very well happen, their $12Billion in stock that they gave up is actually only $4Billion.  Add to that the $4Billion in cash and you have a total acquisition of $8Billion instead of $16Billion.  Not a bad way to make acquisitions when everyone is so high on your stock.  The company acquired believes they are getting shares in an awesome company that is high flying, while the CFO of Facebook knows that they are just giving away overpriced stock to fund expansion....
Read more

Yellen and the Stock Market

A heading today on CNN Money was "Can Yellen Push S&P 500 to Record High?"  WTF?!?!?! It is NOT the Fed chair's job to even worry about that.  I am getting a bit annoyed with the expectation of the Fed Chair to keep rates low in order to keep stocks elevated.  At some point in the future, rates will have to go higher and then, by the assumption that stocks will go down because of that, stocks will have to decrease. So let's just get it over and done with! Unless, of course, the low rates are needed to keep the economy humming along and inflation higher. Remember, the low rates will be needed to drive inflation higher so that all of this debt that we have can be buried in higher GDP growth due to higher inflation. Let Yellen do her job which is to worry about inflation (stable prices), full employment, and long term interest rates.  Everything else will take care of itself.  The economy, if it needs to, will go through its problems and fix themselves, as they have done over the past few hundred years.  The stock market will go through bull and bear cycles, as it has for the last 145 years of history that I have at my fingertips.  It's ok for bad times to occur....
Read more

Deja Vu all over again…all over again

Facebook buys WhatsApp yesterday for $19Billion...Banks are back to lower down payment loans on houses and interest only again. Can everyone PLEASE see what is becoming so obvious?!?! That's all I have to say....
Read more

CIO Index Update – February 13 2014

Going into the All-Star Weekend, I wanted to update the CIO Index.  I am going to concentrate this one with one specific aspect:  $10MM+ Salary guys who have played in at least 30 games The top guys are a bit surprising, but it is what it is. Notice where my good friend and motivator of this index, Carmelo, stands...27th out of 41.  Hmmm.     Screen Shot 2014-02-13 at 6.42.52 PM          ...
Read more

Sometimes Par is Good Enough to Win – Tin Cup

If you have ever seen the classic movie, Tin Cup, there is a scene in which Cheech is talking to Roy and he says “Sometimes par is good enough to win.”  Basically he is saying that you don’t need a birdie or eagle on every single hole in order to win.  And that makes sense doesn’t it? If you agree with that, then you’re going against all the people out there who are buying into this stock market and into this hot real estate market because the “other options” for investment are low yield bonds.  That is ridiculous though.  Yield is a concern but what should be of MORE concern is long term value.  Chasing yields will only result in problems when values finally revert and if you are standing there holding assets, which you will be, then you will get hurt at some point. I am not trying to be Debbie Downer here, I am just stating that keeping your capital preserved on short term treasuries yielding 0.15% per year may be good enough for now! Markets can turn on a dime and if that happens, are you going to be smart enough to get out and see that bigger losses are ahead?  If you say “yes” then you’re delusional.  It ain’t gonna happen. So again, look at values. Buy on value.  Then you never have to worry about yield.  Yield will take care of itself over the long haul.  If you just want yield, go buy a bunch of high risk debt and collect high yield there, but you don’t for a reason, right? So it’s not just about yield.  It’s about capital preservation…...
Read more

Is the Stock Market Overpriced? Why the Low Interest Rate Environment Causes People To Think Times are Great

So many people think the stock market is pretty close to fairly valued.  I've even heard some "experts" say that it is 8-10% below value, which is absurd and ridiculous and just wishful thinking by salesmen who think they are financial analysts.  Either way, John Hussman and other value investors keep pointing to the incredibly high profit margin % of US Companies as a reason why people believe stocks are fairly valued.  At 17 times earnings, it's not THAT far over value, but when you look deeper into the numbers and realize that profit margins are nearly double historical levels, you start to realize that that won't be sustainable and will eventually go back to the mean, which will cause lower profit per share and stock markets to fall. But what is causing such high profit margins?  Many people (I am one of them) that lower interest rates have caused profit to sky rocket because of the fact that long term debt is being refinanced at lower rates for longer periods of time to give companies the false feeling of higher profitability. Yes, profits ARE higher, but not for sustainable reasons. Not because revenues have doubled. Look at the chart below for the basis of my argument. I am looking at two time periods. The year ending 2007 and the year ending 2013.  One was before the financial collapse when interest rates were higher and the second is in the current environment (a mere 5 weeks ago) where rates are at all time historical lows.  A few things to keep in mind: 1.) This is based on S&P 500 only...Also, not all the companies that were in the S&P in 2007 were in it in 2013 and vice versa so I removed all of the discrepancies, took an average and multiplied by 500. 2.) I based the interest rate on the long term date on the 5 year treasury since companies take on debt of 30 days to 10 years, so I thought I would just pick the nice and juicy middle one. Data So as you can see above, at the peak of 2007, in October, the market cap of S&P 500 stocks was around $14.76 Trillion and at the end of 2013, the market cap had risen 18.22% from there.  Long Term Debt had increased 26.8%, and profit was up an astounding 36.66%! With that profit increase, it is VERY understandable to see a much higher stock market being justified.  But the data doesn't continue with good news. The 5 Year Treasury was down 74% to 1.14% yield while interest expense had COLLAPSED to $169Billion from $515Billion, which is a savings of 67.18%.  So when oyu add the profit and the interest together to see what profit would have been before interest, you see why I have concerns.  The profit is actually LOWER today than it was back in 2007 before interest.  LOWER! Yet the stock market is trading 18% higher than it was back in 2007. If interest rates normalized back to the 2007 rates, today's profit, after interest, would be $804 Billion in 2013 as opposed to $841 Billion in 2007. Does that not concern ANYONE here?  In addition, we have 27% MORE debt today than 6 years ago. Now, I am a BIG believer in riding the low rates as long as possible.  I am in the real estate business and you better believe I have refinanced all the properties I could to take advantage of the low rates, but at no time do I think these low rates are here to last.  I don't think they will be around in 10 years.  Could I be wrong? Of course! I was wrong in 2005 and 2006 when I thought THOSE rates were the lowest they'd ever be.  But why would 200 years of debt rates be wrong? We are at interest rate levels that the world has NEVER EVER seen.  Why would that continue?  It won't. From the chart above, when you look out 10 years and think about profit, we are going to have a great increase in overall interest expense at some point in the future.  That will cut right into profit because that isn't profit lost from decreased revenue.  That just comes off the top.  Ugh. Do you see my concern for current stock market valuations? Yes, the profit is high and fun, but it doesn't have a good foundation. It is relying on something that has nothing to do with the health of a company. In fact, quite the opposite.  Companies have almost 27% MORE debt but since interest is so low, their interest expense is VERY low.      ...
Read more

What Is A Good Balance Sheet?

Many of the readers of my blog are people who are trying to learn more about the financials and analysis of investing.  As a conservative investor both in stocks and in real estate, I like to know that I am secure with my investments.  One of the best ways, in stocks, is to look at a company balance sheet.  What I am about to describe is a very 500 foot view of what I look for in a balance sheet.  I can't explain ALL the things I look at and how I analyze things, like inventory, but to give you a start, this will be useful. Paying bills during tough times is one of the most important factors for me as an investor.  Companies that have the money to pay their bills are more likely to last because especially during tough times, cash on hand is king. And that's the key. CASH ON HAND.  A lot of people look at total assets and total liabilities but so much of the long term assets can be calculated and manipulated.  It's harder to do that with current assets, but not impossible. Look at the 2008 financial crisis.  Why did it happen?  The assets that banks said were worth $X were actually worth 40% of $X or something like that.  Think about how easy that is.  Think of your house.  What is your house worth?  If you had it on a balance sheet you would probably have it on there for what you paid for it if you bought it recently. If the market were to crash and no one required you to lower that value on your books, would you decrease that? Probably not. But anyway...so the thing I look at is Current Assets being able to pay off ALL TOTAL LIABILITIES. Sounds like a stretch? I thought so until I started to research how many companies are actually able to do that.  Benjamin Graham, in his famous book The Intelligent Investor, used this metric as one of the keys to finding safe companies. When I did a search of S&P 500 stocks to see which ones had met this stipulation, I was surprised to see that exactly 100 (20%) of them had.  They had enough on hand to pay ALL of their debts (short and long term) with ease.  Imagine if you were able to pay ALL your debt with the money in your account or the short term investments in your account.  That'd be nice huh? So let's look at the top 10. [caption id="attachment_1690" align="alignleft" width="400"]These are the highest S&P 500 ratio of Current Assets to Total Liabilities - Measures ability to quickly pay off all debts These are the highest S&P 500 ratio of Current Assets to Total Liabilities - Measures ability to quickly pay off all debts[/caption]             I am sure you can recognize quite a few names up there.  Now remember, this data above has NOTHING to do with a company's value and if it's worth the investment from a price of the stock standpoint.  PLEASE REREAD THAT STATEMENT.  The balance sheet items of the stocks above would be the same if they sold for 10 times more or 10% of what they are selling for now as a company.  So please remember that this is just a starting look to see what companies sit well from a financial health standpoint. As you can see above, the big names of Facebook, Google, and Michael Kors are companies that have done a good job for making sure they have more than enough money to pay off their debts and expand and keep business going if the economy or their business were to take a tank.  They also have a lot of cash to make acquisitions and grow their business into larger areas that can provide more security.  I've written about Google and Facebook in the past.  Both are great companies but unfortunately, from a price standpoint, people are willing to pay too much to own them. But when they do come down to a level I feel good about, I will most definitely be buying them, in large part, because they are not leveraging themselves to the tilt in order to grow.  They are managing their balance sheet wisely....
Read more