Tuesday, August 25, 2015

The Charles Schwab Corporation (SCHW)

So, it looks like Lou Simpson added a bunch of Charles Schwab (SCHW) to his portfolio, making it the top holding as of the end of June; he increased his position almost 50%.

I am not stalking Simpson in particular, but I just happened to notice this and SCHW is a name that I am sort of familiar with and have been a fan of for a long time.  Putting those two together, I figured it's worth a post.  We all know who Lou Simpson is, but in case you don't, here is a look at his past performance during his time at Berkshire Hathaway with some quotes by Buffett about him:  Brookfield Asset Management post

I'm not going to go into too much detail about the business as I think most of us are familiar with SCHW; a discount broker that grew into a more full service financial company.

Quick Comment on Markets
I have no idea what's going on in the markets, and have no idea what will happen going forward.  But I had a conversation with someone very concerned.  My answer was that if it's going to be a major problem if the market keeps going down, you simply own too much stocks.  But this is something you have to think about all the time, not when the market is down 1000 points. That is the worst time to think about what to do (unless you want to buy!).  Why do people think about this only when the market is down?  The market goes down and the first instinct always seems to be, "Should I sell?!".

If a declining market is a problem for you, don't own stocks.  Or only own enough so that this sort of volatility won't be a problem.

As for what will happen going forward, I still stick to my view that the market is not that overvalued given the interest rate environment, and we have plenty of cushion even if long term rates rise. They can go to 6% and we'd still be in a zone of reasonableness in terms of valuation.

As for China, yes, the U.S. market is tanking on news out of China, but I still think the world need not go down with China.  I don't worry too much in that respect.

Oh, and by the way, for those interested in stock screens of the Superinvestors' stockholdings (as defined and tracked by Dataroma) I have updated the screens Friday and last night.  I automated the process completely so I just need to type a single line in the command line for the spreadsheets to be updated (I initially had it set up to update an Excel spreadsheet which I cut and paste later to a Google spreadsheet since it was a hassle to directly update a Google sheet from a program; I got over that hump...) so I can update it every time the market has big moves.

See the spreadsheets here:
     Superinvestor Stock Rankings
     Superinvestor Stock Ranking (Small list)

I do intend to add spreadsheets that show year-to-date winners and losers of those stocks too.  Stay tuned for that. (My recent hobby is programming so I did all of this for fun and thought it would make a nice addition to the blog so just put it there...)

Anyway, end of digression and back to SCHW:

Solid Management
I've always been impressed with the customer service and the conservative nature of the management there.  There are some things that I don't like, like their dependence on trading frequency; the more people trade, the more money they make.  The more margin loans people use, the more money they make etc...

But there seems to be a lot of integrity there.  There isn't much I can say other than that I've been following and reading about SCHW for years, and they tend to be very conservative and client focused.  I've never had a bad experience, and never read anything I didn't like about them.

One thing, though, is that a lot of this is due to my faith in and respect for Charles Schwab, the founder.  He is 77 years old now.  Who knows what will happen post-Schwab?   The business itself doesn't depend on his talents on a day-to-day basis so there is a good chance that they can continue to do well as long as they keep their culture.

The only reason I've never owned the stock is that it has always been a growth stock.  The P/E has always been far above 20x.  And there has been growth to support that, except in the past few years.  But we'll get to that in a second.

When an investor you highly respect makes it the top holding in his portfolio, even larger than Berkshire Hathaway, a company he knows better than anyone in the business (as an investor,  former employee and Buffett friend), you have to pay attention.

Interest Rate Normalization Bet
So let's get to the gist of the idea here.  In short, this is an interest rate normalization play.  This doesn't sound right because investors like Lou Simpson don't make macro plays or 'bets'.  But in another sense, value investors make  "earnings normalization" bets all the time.  When a company is going through hard times, we look at what the business can earn in a more normalized environment.  We slap a multiple on it and then buy the stock if it is meaningfully lower than that.

In that sense, this is sort of the same thing so not really a macro play.  Macro plays are often time-dependent.  People make bets about this or that, and when it doesn't happen within a year or two, they are in trouble.  But in the value investing world, playing for normalization is not as time-dependent.  We often don't know when something will happen, but only need to be confident that it will some day.  And if the underlying business can continue to grow and pay dividends in the meantime, that's great.  This is not the same as making a macro bet, like shorting bonds or whatever.

Clip from 2014 Annual Report
SCHW has been talking about this for a few years now, but I never really paid too much attention to it as I was in the camp that the U.S. interest rate environment might follow Japan's.   Well, yes, I do own JPM and they too are a great interest normalization bet, but JPM was trading very cheaply while earning 15% return on tangible equity even with rates very low.  SCHW is not really trading cheap in that sense.

But anyway, here is a clip from the 2014 annual report that is the key to this whole idea:

SCHW earned $0.95/share in EPS in 2014.   The stock is trading at around $30 for a P/E above 30x.  2015 estimates is $1.05/share (Yahoo finance) so that makes it 29x P/E.  Expensive.

But notice the above; due to low interest rates, they waved $751 million in money market fund management fees.  Since they are incurring the expenses to manage the funds, getting that back should go right back into pretax profits.  Using a 40% tax rate and 1.3 billion shares outstanding, that amounts to $0.35/share in EPS.  Adding that to the $0.95 EPS in 2014, that would get us a normalized EPS of $1.30/share bringing the P/E down to around 23x.

Now look at the net interest margin (NIM).  NIM was 1.64% in 2014, but as recently as 2008, it was 3.84%.  Back then, returns on cash averaged around 2.5%.   If NIM went back to 3.84%, that would be a 2.2% increase in NIM.  With $140 billion in earning assets on the balance sheet (as of year-end 2014; as of the end of June, there was more than $150 billion), that would add $3.1 billion to revenues.  This should also fall straight down to pretax profits.  If that is the case, and assuming a 40% tax rate and 1.3 billion shares, it would add $1.42/share to EPS.

Adding $1.42 to $1.30 gets us to a normalized EPS of $2.72/share.    At $30/share, SCHW would be trading at a normalized P/E ratio of 11x.  Now, that is really, really cheap for SCHW.   Using a 3.00% NIM, you get 13.6x P/E.

The question, of course, is if interest rates will normalize.  The 'when' is not so important here, I don't think, because the underlying business is growing nicely so if normalization takes place later than people think, it will just have a bigger impact on EPS by then.

I thought about making this post last week, before the market got messy.  So maybe interest rate normalization is not at the top of investors' minds right now.  Maybe the scenario is pushed back a little.  But if you can wait, and you think rates will eventually normalize to some extent, this is certainly an interesting idea.

And keep in mind, the average yield on cash in 2008 when NIM was 3.84% was around 2.5% so we're not talking about short rates needing to go back up to 5-6% or anything like that at all.

More Detail on Rate Normalization
This is a slide from their summer business review presentation.  They take a closer look at how interest rates will impact revenues.

SCHW is a Growth Stock
Looking at recent trends, SCHW doesn't look like a growth stock.  It had EPS of $0.92 back in 2007 and only earned $0.95 in 2014.  But that is largely due to the above interest rate and fund fee waivers.

If you look over the ten years through 2014, EPS at SCHW actually grew around +14%/year, and going back twenty years to 1994, EPS grew +13.5%/year.   And it is still growing.  And keep in mind that these growth rates are with an unnaturally depressed endpoint (sub-normal NIM in 2014).

If we use a normalized EPS figure (assume NIM was 3.84% in 2014), then the growth rates would have been +26%/year over ten years and +20%/year over twenty years.  That's kind of insane.

Look at the slide below and you will see that the business is growing since the 2007 peak despite an unchanged EPS.

Client assets are up nicely even compared to the 2007 high.

Here is one of the drivers of SCHW's growth over the past few years. This trend seems to be continuing so there is plenty of runway for growth.

This is a nice chart that shows a trend that I believe will continue:

SCHW sort of feels like the organic food companies while the wirehouses are like the old, traditional food companies.

So, this is kind of an interesting idea.  There are a lot of interest rate normalization plays (like, all financials?).  But this one is a little different in that it has a lot of growth potential, unlike, say, the larger banks.  Plus, I have always liked the company, the management (well, at least the Chairman Charles Schwab) etc.  Recent events make interest rate normalization seem less likely to happen soon, but if you believe that it will eventually happen, then this is an interesting idea with a lot of potential.   Paying a normalized 11x P/E (or 14x P/E using a 3.00% NIM) for a high growth business with plenty of room to grow seems pretty interesting.

Friday, August 7, 2015

Mondelez International (MDLZ)

Bill Ackman apparently took a humongous position in MDLZ.   The stock price popped up 5%-7% at first but went back to unchanged as the market tanked.  And today, the stock is actually down a little.
I guess it popped up on comments that Kraft-Heinz/3G would be interested in making a bid for MDLZ, and then gave up the gains when people realized that 3G might be a little too busy integrating Kraft-Heinz at the moment to be making such a big bid so soon.  Also, the trailing twelve month P/E ratio of 33.5x (according to Yahoo Finance) looks a little expensive. 

MDLZ earned an adjusted EPS of $1.75 in 2014 and is guiding double-digit growth.  So let's say they grow EPS 10% for a 2015 EPS of $1.93.   With the stock around $46/share, that's 24x current year EPS.  Not really so cheap. 

When Heinz/3G bought Kraft, they said there would be $1.5 billion in synergies.  Kraft had $18.2 billion in sales in 2014, so that's 8.2% of sales in synergies.  But since Heinz cut so much in costs, much of that is probably expected cost cuts at Kraft.  8% of sales would be in line with other 3G situations. I looked at that here: Kraft-Heinz

When 3G/BRK bought Heinz, they boosted operating margins by 7% within a year, and in that case it was an outright purchase and not merger so there weren't any 'synergies' but just pure cost cuts.   Operating margins went from 14.4% to 21.5% in a year (check out Heinz Update: Who's Next?).

The post-synergy Kraft-Heinz operating margin is over 25%.

Back to MDLZ
So, looking at it this way and going back to MDLZ, if you think 3G (or someone else) can do something similar again, the purchase price including synergies would look quite a bit different.

Adjusted operating margins are up to 14% at MDLZ.  This is around the level of operating margins of HNZ before 3G took over.

Let's say they can get this up to 22%.  MDLZ had $33.4 billion in revenues in the last 12 months.  22% of that is $7.35 billion in operating earnings.  Interest expense is $750 million (company guidance for 2015).  That's pretax profit of $6.6 billion.  Using a 22% tax rate (company guidance for 2015 is for low 20s) gets us a net profit of $5.1 billion.  1.6 billion shares outstanding gets us an EPS of $3.20.

With the stock at around $46/share, MDLZ is trading at 14.4x P/E (post-3G-like-cost-cuts).

If they can get operating margins up to 25%, then the above math would get us to $3.70 in EPS, and MDLZ would be trading at 12.4x post synergy P/E.  (25% operating margin might be a stretch, though, but I just used it because that's the post-synergy operating margin of Kraft-Heinz.)

Now, that's pretty cheap.

(The above figures don't make any adjustments for the coffee business (which now goes through equity earnings and not revenues, operating earnings etc.); it shouldn't make a huge difference to this rough analysis.)

The interesting thing here is that only 20% or so of sales (and slightly more in segment profits) is in North America.  40% of sales is in Europe.  And they have a lot of exposure to the emerging economies.  This is good and bad, of course, depending on what's going on in the world.  But it seems like the U.S. is a step or two ahead of everyone in terms of the economic cycle.  Emerging markets have been in a down-cycle for a while now, and these things eventually turn.

It is possible that if Europe and other economies are behind the U.S. in the economic cycle, that they might turn which would be very good for a company like MDLZ.

MDLZ is a much growthier name than other food companies, like, say, Kellogg, Campbell's etc.

Still, it is highly unlikely that 3G will come out with a bid very soon.   That doesn't mean MDLZ can't do pretty well on it's own for a while.  Some stability in Europe and emerging markets, continued cost-cutting etc. can make MDLZ a decent stock to own until someone is ready to really take costs out of this thing, at which point if sales are higher, MDLZ could be even more interesting to 3G or someone else who can do something similar.

At it's current price, someone like 3G would be able to 'create' an investment with some real growth potential at 12-14x P/E.


Saturday, July 18, 2015

China Crash -> U.S. Crash?! and Great Book

A lot of people are talking about how bad China is.  It's worse than the U.S. 2007, it's worse than Greece, it's worse than this or that.  It seems like the big China bubble is blowing up.  But so what, right?  Who cares what happens over there.  Yes, the prices got crazy, but as long as you don't own that stuff, it really shouldn't matter.

Or should it?  China owns a lot of U.S. treasuries, and if things get really bad over there, it can cause problems around the world.  Well, we've been seeing the impact of China on the commodities markets over the past few years.  That's certainly a big deal.

So I've been thinking about that, and this is a movie I've seen before.  The same exact thing seems to be happening as when the Japanese market topped out in December 1989.  Now, that was a bubble.  I'm not saying China isn't or wasn't a bubble.  It sure seems like some stocks got pretty expensive over there.  But it is a little confusing because the Hong Kong listed H-shares are trading at below 9x P/E or something like that.

But anyway, yeah, Japan was quite a bubble.  That one goes into the history books along with 1929, 1999, South Sea Bubble etc...   And the Chinese one may too.

Back then, people were worried about Japan taking over the world.  They were buying up trophy properties in the U.S.  By the way, did any of those investments work out?   And do the Japanese still own those properties?  Did they actually make money on them?  Or was it just a big transfer of wealth (from the Japanese buyers to the American sellers)?

When the bubble popped, there was a tremendous amount of fear.  The Japanese were buying U.S. treasuries in such huge amounts that the fear was that U.S. interest rates will spike once Japanese buying evaporates.

As you see, this is sort of very similar to the situation currently with China.  Whenever people say that if Japan (and now China) stops buying U.S. paper, we are in big trouble, I scratch my head because they will only stop buying U.S. paper when we stop shipping all our money over there (we import stuff from them, they take the dollars, come back and buy treasuries).  I always thought that the day they stop buying our treasuries will be when they don't have the dollars flowing in.  And in that case, the dollars will come from somewhere else.  In the 80's, Japan funded the U.S. deficits.  In the 00's and 10's, China did.   Maybe we will start funding them internally (excess bank liquidity etc.).   Who knows.

Anyway, I remember how resilient the U.S. (and the rest of the world) was to the Japanese bubble collapse.  Check this out.  Here is the chart of the Nikkei 225 index (blue) and the S&P 500 (red) index, both indexed to 0% at the end of 1989.

Nikkei Index versus S&P 500 Index 
(December 1989 - October 1995: change in index, excl dividends)

The Nikkei started to collapse immediately in 1990, but the U.S. market was fine.  For the record, the S&P 500 index was trading at 15.2x P/E (ttm) and the 10-year treasury rate was 7.8% at the end of 1989.  That's an earnings yield of 6.6% versus the 7.8% interest rate.

As you can see, the S&P 500 was fine despite the total collapse in the Nikkei.  The little bear market in the second half of 1990, as you recall, was when oil prices hit $40/barrel due to Sadam Hussein's invasion of Kuwait.  We all remember that, and the Baker press conference which began with "Regrettably..." or some such thing that began the war; the comment, "the skies of Baghdad have been illuminated" etc. (those events came way after the low).

This is the event, by the way, that lead to every trading room on Wall Street being equipped with televisions. During this first Iraq war, traders called their wives, told them to turn on CNN, put the phone by the TV and just leave it there.  Traders then took that 'feed' and piped it into the squawk box for all to hear (this was before you could watch TV on your computer.  Don't forget, this was the era of glowing, green screen Quotrons).

Anyway, other than that, the U.S. stock market did fine as Japan disintegrated.

We usually look at long term returns going backwards, like the five, ten, twenty year figures going backwards.

Let's look at this going forwards from December 1989 for the S&P 500 index (total return):

From December 1989:
5 years   (to 1994-end):   +8.7%/year
10 years (to 1999-end):   +18.2%/year
20 years (to 2009-end):   +8.2%/year
25 years (to 2014-end):   +9.6%/year

And just for fun, if you looked at the period from December 1989 through December 2008, which was the year-end low point of the financial crisis, the 19-year annualized return would have been +7.3%/year.

The ten year return from 1989 might be meaningless as that was the great bubble.  But if you look at the 19, 20 and 25 year returns, the U.S. stock market did fine despite the Japan crash.

I really don't know what will happen going forward, but I thought I'd take a look at this as it seems really analogous to what's going on now in China.  Of course there are a lot of things different than 1989, but it's one thing to think about when thinking about China.

Of course, this is not to say the we won't have a correction or a bear market.  I'm just looking at things, sometimes one at a time, like when I looked at interest rates versus the stock market.  There are many other factors that will impact the stock market.  And this is not to say that there won't be impact in certain places.  I think luxury goods makers took a hit when Japan collapsed.  There will be certain areas that will get hit if China falls apart (more than just the stock market).

But judging from this, it need not take down the whole world.

Great Book

And by the way, I recently finished this book by Lawrence Cunningham and really enjoyed it.  The only thought was that I wished it was a longer book.   This is the first time I read stuff that dug deeply into the histories of the operating companies.  Some of the stuff, we've read over the years from other sources, but there is a lot here that is new to me.

For those planning on holding Berkshire Hathaway post-Buffett, this book is a must read.

Check it out!

Friday, June 19, 2015

Brookfield Asset Management (BAM)

This name has been mentioned on this blog a few times in the comments section, but I never wrote about it.  It is well known in the value investing community and I said I'll make a post about it in the near future so here it is.

First of all, BAM is sort of an outsider/owner-proprietor business as it has been run for a long time by a single CEO, and the great track record is attributed to him.

Story Fits Too Much
The only thing that I am not so excited about in recent years is that the story sort of fits the environment a little but too much; pension funds and others need to increase returns to be able to make obligations, with interest rates low and stock market scary people need alternative investments.  With the perception of higher risk (or high cost, low return) of hedge funds and private equity funds, fear of future inflation due to global perpetual pump-priming (global PPP?), hard or real assets and real asset managers look really, really interesting.

Oftentimes, when everything is just too perfect, the investment doesn't pan out.  So that's what I've sort of been worried about.  Plus, honestly, I've never really been a big fan of commercial real estate.  There have been some great wealth created in real estate for sure, and it's a solid investment if you have good people investing.  But it's just never been something that excited me.  Don't tell Ackman I said that, though...

Lou Simpson's Concentrated Bet
What's really interesting is that Lou Simpson bumped up his bet on BAM this year.  Lou Simpson probably needs no introduction here, but just in case, he's a portfolio manager that managed GEICO's investments for many years with great results (I think beating Buffett).  He now runs SQ Advisors, after retiring from GEICO.

Just as a reminder, here is Simpson's investment performance at GEICO from BRK's 2004 annual report:

And then when he retired at the end of 2010, this is what Buffett wrote in the annual report:

Here is the history of Simpson's BAM holdings in the past year:

                    shares owned
6/30/2014:   3.8 million
9/30/2014:   4.0 million
12/31/2014: 4.5 million
3/31/2015:   6.8 million

This looks like the effect of a 3/2 split, but that didn't happen until May, so Simpson really bumped up his investment in BAM.

BAM now accounts for a whopping 12.5% of Simpson's portfolio, second only to his Valeant (VRX) position.  BAM is also bigger than his positions in BRK and WFC each of which constitute 11.5% of his portfolio. (It is interesting how Munger absolutely deplores VRX (he said it's worse than ITT in the 60's) while it's Simpson's top holding. This is why when people disagree with me, I don't care too much.  Even the best and the brightest don't agree on things.  Who am I to expect people to agree with me?!)

Anyway, this might have gotten some of your attention.   This also makes this post timely.

And by the way, this is Simpson's current portfolio (as of March 2015):

ORACLE CORPCOM91,2162,113,921SH
WELLS FARGO & CO NEWCOM334,0576,140,747SH

Back to BAM
Here is the long term performance for BAM from their 2014 annual report:

Pretty good, I think.

There was an investor day back in September, 2014, so let's take a look at some slides from that presentation.  (Check out their website for their annual reports, presentations etc: BAM Investor relations)

There was a 3/2 split in May of this year, so the above share price targets is actually $100 - 130, which corresponds to 12-15% annualized growth from the current price of around $36/share.

They have really diversified on many fronts; geographically, investment vehicles, asset classes etc.

And the fact that they are in so many areas serves as a big advantage for them:

This is a section from their first quarter 2015 report that talks about their culture and why they think they can continue to do well going forward.  By the way, critics complain about the lack of disclosure at BAM, but I find their reports to be very informative.  How many companies write their quarterly reports almost like annual reports?  (in fact, BAM's quarterly reports are better and more thoroughly written and more informative than most annual reports!):

Culture as a Competitive Advantage 
We are often asked whether Brookfield can continue to increase the amount of capital we have invested in global opportunities, on a profitable basis. The short answer is that we believe we can. 
While acknowledging the normal challenges, we believe we have three distinct competitive advantages which will help us accomplish our goals:
  • Team Approach – The first advantage is that over the years, we have invested significant capital and human resources to build out the backbone and support structure of our operations, creating a first-in-class global company. Operating decisions are a culmination of the views of approximately 40 members of the management partnership, our 18 senior managing partners, our 700 investment executives and our more than 28,000 employees. We try to mix entrepreneurship, institutional stewardship, best-in-class professionalism, global scale and localized expertise; all with a focus on generating long-term capital appreciation. Our team approach to our business, the pursuit of excellence and commitment to our colleagues and investment partners drives this success.  
  • Our Global Reach – Brookfield’s second advantage is the scale and global reach of our operations, enabling us to invest in and manage assets and opportunities across many investment products and jurisdictions, efficiently and effectively. The flexibility to opportunistically invest capital in this manner is rarely possible with smaller firms. We have built a global company operating today in the major cities of the world including London, New York, Sydney, São Paulo, Toronto, Shanghai, Dubai and Mumbai and many other locations. We are diversified: culturally, financially and geographically. As an investor in our company you acquire exposure to global economic and business diversification which few other investments offer.
  • A Distinct Culture – The third advantage and possibly our most important is our distinct corporate culture. We have written extensively over the years on our first two advantages, but seldom have we attempted to explain “how” we operate and “why” we believe our culture provides us with an important competitive advantage. 
While admittedly it is difficult to define culture precisely (the Oxford Dictionary defines it as “the attitudes and behaviour characteristic of a particular group”), ours is based on the following key principles. 
  • Principles of Business – Our core fundamental business principles are set out in our annual report and were formed by our early founders, and refined over the years. These principles include: building our business and all our relationships based on integrity, value investing in how we allocate and invest capital, fair-sharing in our relationships and measuring success based on total return on capital over the long term. We are required to report quarterly, but regardless of short-term reported results, our investment focus is always on creating long-term sustainable appreciation on invested capital. 
  • Personal Financial Commitment – We promote long-term ownership stability and orderly management succession and encourage our senior executives to devote most of their financial resources to investing in Brookfield. As a result, collectively our management partnership owns approximately 20% of Brookfield, which is consistent with our efforts to align our interests with investors and clients throughout the organization. 
  • Operating as a Partnership – We operate internally as a “true partnership” with long-term investment horizons. Our management partners are highly specialized, but all recognize that by working collaboratively together as a team, we can achieve far more than if we were structured on a more traditional basis. 
Our global platform enables us to finance and invest in a wide variety of opportunities, and few asset management firms offer as diverse a platform of specialized investment products. As we look forward to future decades, we believe that we are well positioned to build on our successes.  

Asset Management
One of the big drivers in the value of BAM is their asset management business.  They have high quality assets on the balance sheet, and at the same time they raise more funds from outside investors and earn management / incentive fees and carried interest and this is really growing.  This is the key to the BAM investment.

Importantly, they have performed very well so far:

One chart in the presentation is not so exciting.  They talk about the improving environment and then show this chart, but this is not so exciting for people who want to invest in a private equity manager; valuations are high now (so forward returns will be lower).  But then again, BAM is not doing conventional LBO's.

Their AUM continues to grow:

...and a big factor in this investment:

At the 2013 investor day, they said they plan to grow fee bearing assets at a 10%/year rate between 2013-2018.  Fee-related earnings was projected to grow +25%/year, target carried interest +18%/year and GP value (value of the asset management business) +20%/year from 2013-2018.

Their value of the asset management business (GP value) grew +28% last year.   With 983 million share outstanding at the end of March, 2015, this business is worth around $9.40/share.  This value is not reflected on the balance sheet, so adding this to the common equity per share of $19.70/share gets us to a full value of BAM of $29.10/share.   Common equity per share may be different from the LP value that BAM uses in presentations, but I used common equity per share as the LP value didn't seem to deduct some corporate things that I wasn't sure about.  Common equity per share, in that sense, might be a conservative look.

Big private equity firms seem to be trading these days at something closer to 10x earnings, so using that, BAM's GP value would be more like $6.00/share instead of $9.40/share.  Traditional asset managers used to typically trade at 20x P/E, but using 15x P/E would give a GP value of around $8.90/share.

These figures are pretax, though.  Many of the listed private equity funds do similar analysis with mostly pretax figures.  Since those are partnership units, taxes are paid by the LP unit-holders.  You can argue that the conventional asset managers who are valued at 15-20x earnings are valued on after-tax, net income, but the private equity folks will argue back that if those earnings are paid out to shareholders, shareholders would pay taxes on that too, so it is effectively pretax income if you compare it to owning LP units.   This is an interesting point.  If a corporation doesn't pay a lot of dividends, though, those reinvested earnings wouldn't be taxed at the personal shareholder level (until paid out later, or until capital gains are realized).

Anyway, BAM was trading between $34-38/share when Simpson added to his holdings in the first quarter.

BAM marks their assets to fair value in accordance with IFRS, and this value may differ from the publicly traded prices of the listed entities.  A reconciliation of this is shown in the quarterly report so you can make adjustments there.

Here it is:

Maybe BAM is worth a little bit more using market prices rather than IFRS fair value.

BAM expects to grow fee bearing capital 10%/year through 2019.

Using BAM's valuation, the asset management business could be worth more than $21/share by 2019.  At 10x earnings, it would be worth $13/share or so, and at 15x, $19.50/share.

If BAM does better than the base case, it can be worth a lot more. The above per share figures are before the split, so after the split, the above per share values would be $67, $77, $87, and $97, versus the current $36/share.

IFRS Fair Market Valuation
There was some criticism of BAM because they switched to fair market accounting saying that a lot of the gains in recent years have been due to BAM just marking their positions up.  Also, there was a time that some listed entities were trading below where it is marked on the balance sheet; critics said that these positions had to be marked down.

But this isn't really a big issue.  BAM, before going to fair market value, used to show what they thought everything was worth in their reports and many investors looked at them.  Yes, there is some management judgement involved here.  But traditional book value has problems too.

What's good about BAM is that they show you how they derive their fair market valuations.

Just to make sure they aren't marking things up with 2% cap rates, look at the assumptions used.  You can find this in their reports.

You really can't tell if these discount and cap rates are fair without really knowing the properties, but you can see that they aren't all that low given 2.5% bond yields.  These look pretty, 'normal'.

Real estate

Renewable Energy


Interest Rates
Pretty much everyone expects higher interest rates to come.  This will (if accompanied by a stronger economy) help banks and other financials, but it might hurt BAM.

I see BAM (the funds) as sort of more fixed income substitute than a substitute for equity.  People who have large fixed income portfolios tend to get into real estate, infrastructure, utility stocks and things like that; low volatility, steady-income-stream type investments.  I don't think people go, "gee, the stock market looks dear, I'm buying commercial real estate!".  It's more like, "gee, interest rates are too low... let's get into an infrastructure fund as stocks and hedge funds are too volatile for us...".

So in that sense, BAM is prone to a double-whammy.  Rising interest rates may push up cap rates (reducing values), and may slow the flow of funds into their funds (or even outflows).

This is true for stocks, too, to a certain extent, but I have shown in an earlier post that even if interest rates went back up to 6%, the stock market now wouldn't be out of line valuation-wise going back 30+ years.

I don't have that sort of confidence in this asset class.  Well, BAM is pretty diversified so it's not in any single asset class, but it is sort of the 'real asset' type stuff.

But even for real assets, as you can see from the above discount and cap rates that BAM uses, there is probably a big cushion against rising interest rates.

At the 2013 investor day, they showed a chart of cap rates against interest rates and showed that there is a substantial cushion between the two, just like I showed in stocks.

Check out this chart:

From 2013 investor day presentation

But that doesn't mean there won't be some upward pressure on cap rates when rates really start rising in a serious way.

The Good Part
On the other hand, Bruce Flatt has proven himself to be a very competent manager, and Lou Simpson seems to be buying into this in a big way (Murray Stahl has been a fan for a while too).  BAM is on the right side of all sorts of trends, whether it be capital moving to alternatives (CALPERS notwithstanding!), potential (or inevitable) inflation coming down the line due to Global PPP (so real assets == good), potential growth in emerging markets, pent up need for infrastructure invesments etc...

And this management seems to adjust to changing circumstances, so if you own BAM, you don't have to worry about this being a shoot-and-forget, static investment.  Even if your position in BAM doesn't change, you can be sure that BAM management will adjust to the ever-changing world; they are not inflexible, unadjusting automatons (like so many large companies seem to be)...

Wednesday, June 17, 2015

Quick Update on SuperPortfolios

In my previous post, I put a link to stock screens of Superinvestor stock holdings.  Initially, I just sloppily cut and paste out of a spreadsheet directly into the blogger and it was a mess.  So I redid it all and embedded spreadsheets instead.  It is now much easier to look through, and looks much better.

I also realize that a list of 1,000+ names is a bit much.  What are you going to do with it?  Well, all of the Dataroma Superinvestors are great investors, I think, so it's a good list to start with.

But at the same time, this is sort of a Buffett/value-leaning blog so I guess a lot of readers won't care for the more growthy names of the Tiger cubs, and maybe some of the holdings of the hedge fund types.

So I figured I would make a screen with a smaller universe.  Initially, I picked a bunch of the more traditional value guys and then my program crashed.  I don't know why it works well running the whole portfolio and crashes with a subset.

So to make it even simpler (and to debug), I just took the holdings of Berkshire Hathaway, Sequoia, Markel and SQ Advisors (Lou Simpson), and out came a nice list.

There are other worthy value managers, of course, in Dataroma.  I will eventually add the other value managers if I can get it to run without crashing.

But this short list was such a nice one that I decided to post it.  Take a look.

The original Superportfolio is the top link, and the one below, Small Portfolio, is the one that includes only stocks of the four managers named above.

SuperPortolio Stock Rankings
Small Portfolio

Looking at large, concentrated holdings and recent purchases is the best way to track managers and ideas, but sometimes manager favorites can be held for a long time and might get cheap even while they buy other stocks, so we might forget about them.  This sort of screening will make sure that we can see great ideas that might have gotten cheap.

These links are easily accessible by scrolling down on this blog and going to the "pages" section.

In Search of Value

So we have seen how the stock market is not really as bubbled up as it seems looking at it from 30,000 feet.  What are we to do, though?   What are we supposed to buy?  Where are we to look?

I mentioned that I would do a close-up look at the components of the S&P 500 index stocks like I did for the Dow 30 in my previous post.  I will do that.  I'll probably look at all of the major indices.

But a thought crossed my mind as I sat to figure out how to do the S&P 500 index.  It was a pain to go look for the 500 listed stock tickers, load it into a program and then run it without blowing anything up.  I know, I know, 500 stocks is nothing for computers these days.  You can tell I'm not really a computer person.

Screen Superinvestor Stocks!
I sorted/ranked Buffett's large stock holdings in my last post and it was an interesting thing to look at.  I never actually looked at it that way before and then a light bulb went off in my head.  What about doing that for all the great investors?  Go 'get' the holdings of all the great investors, scrape the financials on them and then rank/sort them.

A lot of us look at screens from time-to-time (or all the time for some), but I sort of get tired of screens because you get all the crappy stocks that you already know about and have no interest in show up all the time at the bottom of the barrel.

Many of us also spend a lot of time looking at the holdings of the investors we admire.

So by putting these two things together, we get a great screen; even the cheapest stocks are good enough, or there is something there, for a Superinvestor to own it.  So in that sense, the Superportfolio is pre-screened by the best investors.

And there is a great resource for this sort of thing.

Most of you readers know Dataroma.  It's a great website that tracks the holdings of what they call the Superinvestors.

I accumulated all the holdings of the Superinvestors listed there and was surprised to learn that collectively, they own more than 1,000 stocks (excluding duplicate holdings).

I took that Superportfolio and then did what I did yesterday; got the financial information and then ranked them according to various measures.

Here are the results of that:

Superinvestor Stock Rankings

I initially posted a crude version of this, just cutting and pasting off of a spreadsheet and it looked really awful, so I redid this and embedded an actual spreadsheet.  This is much easier to deal with and looks much better.

Anyway, this is sort of a different kind of post than I usually do, and I know it will be worthless to many who don't like long lists (what the heck am I supposed to do with that?!).  And others that love lists may enjoy it.

Either way, judging from the output from these screens, whatever we think about the stock market, I think there is a lot of work to be done.

Some Notes
Some names were left out.  Stocks with ticker symbols with a dash were left out as my program ran it with periods (BRK.B instead of BRK/B).  I can fix that for future runs, but there weren't that many names anyway so it's not a big deal and it wasn't worth redoing today. Also, if the data was missing, the name is not on the list.  For example, if a name didn't have an EV/EBITDA number (showed NA), it is not on the EV/EBITDA list.

Also, keep in mind that these are investments of the Superinvestors so these ranks may not mean as much.  Many Superinvestors look at and buy stuff based off of things that don't screen well (hidden assets, adjusted free cash, normalized earnings, understated earnings, events etc).

Tuesday, June 16, 2015

In Search of a Stock Market Bubble

So, (the sentence starts with "so" because this is a sort of ongoing discussion that's been going on here for years) I've been thinking about the overall market again.  Despite my telling people to ignore this and ignore that, I can't help it; sometimes I think about this stuff.  Well, it's OK to think about it as long as it doesn't lead to irrational decisions.

Anyway, as usual, there is a lot of talk of the market being insanely overvalued, median P/E's at post war records and all the usual.

I look at the charts and some are scary, but I still don't get the sense of a bubble.  I've seen the Japan bubble in 1989, the 2000 internet bubble and some others.  I see the Chinese bubble going on right now.  But I still don't really get the sense that the U.S. stock market is in a bubble.  Yes, there is a pocket of bubbliness, like in some parts of the tech sector (social networks, biotech etc.), but overall I just really don't see it.

Like Black Monday?
Also, there were comments to the effect that 2015 feels just like 1987 before Black Monday because interest rates spiked up right before the stock market crash.  Well, back then the stock market was at 20x P/E and bond yields spiked up to 10%.  So that was a Fed model yield gap of a whopping 5% (earnings yield of 5% versus bond yield of 10%).

Today, we are talking about interest rates spiking up to 2.5% with the P/E ratio under 20.  So in that sense, there is no stretched rubber band ready to snap based on interest rates.  And I showed in recent posts that the market is fine with interest rates spiking up to 6% (of course there will volatility based on that, though).

Nifty Fifty 1972
I made a post just like this one two or threes years ago when people were saying the market is overvalued.  I looked up the P/E ratios of the Nifty Fifty stocks in 1972 to see what a real bubble looks like.

Here is what you were dealing with if you were investing in blue chip stocks back in 1972:

What is really interesting to me here is that the S&P 500 index P/E ratio at the time was 19.2x.  But look at the nifty fifty P/E ratios.  To me, this is what a bubble looks like.  These 'ordinary' companies were trading at higher P/E's than high growth social network stocks or fast casual restaurant chain today!

So, while everyone focuses on the big scary charts of market P/E ratios and whatnot, let's just look under the hood and see what's actually going on.

To be totally neutral, I just picked the Dow 30 stocks.  They are large caps, representative of major U.S. companies.  Despite the horrible structure of the index (price-weighted), it does correlate pretty closely with the S&P 500 index.  I plan on looking at the S&P 500 index in the same way in the near future.

Dow Jones Industrial Average Component Valuations

I just scraped this data off of Yahoo Finance.   I ranked it from cheapest up based on forward P/Es.

It's sometimes a good idea, when trying to figure something out, to invert.  To get comfortable being long something, let's see what it would feel like to be short it instead (just because it's not a good short doesn't automatically make it a good long, though).

People say that the market is tremendously overvalued.  Is the market so overvalued that I would be comfortable with a massive short position?  I just imagine myself with a big short position to see how I would feel.  What do I need to make money?  What can go wrong?  Is there really a big margin of safety in terms of valuation; are things so overvalued that it's a no brainer to be short?  At this point, I would not be comfortable short at all.  Sure, earnings for everyone might be bloated due to QE-infinity and budget deficits.  There are other reasons to be bearish, but I just don't see it from a valuation point of view.  The market is certainly not cheap.  But it's not so expensive that it's a no-brainer short either.

It's true that many of the Nifty Fifty were the growth stocks of the day.  So shorting those back then may not have been any easier than shorting Facebook or Amazon today.  In that sense, this is not really apples to apples.  I'm comparing the Nifty Fifty of 1972 to the Dow 30 stocks now; not fair.

Here, by the way, is the list of Dow 30 stocks as of 1976 from the Dow Jones website (they didn't have 1972, but I assume it hasn't changed much):

But anyway, if you look slowly through the current Dow stocks, which ones are really overvalued?  I mean overvalued in a bubblistic sense?  I don't want to comment on each one, but most look pretty reasonable to me.  Most of the high P/E stocks (NKE, DIS, V, KO etc.) seem to be stocks that always had high P/Es, so don't feel like bloated P/Es based on a bubble.  Many others are just totally reasonable and some are really cheap (AXP, for example.  It has a close to 30% ROE, 12-15% long term EPS growth target, and it's trading at less than 14x P/E and less than 10x pretax earnings per share!).

Let's say you think the market should go down 50%.  I remember reading a comment by a hedge fund manager who said that he likes to buy stocks where if you doubled the price it would still be cheap and short stocks that if you cut the price in half, it would still be expensive.  That's quite a margin of safety built in!

If you look at the Dow stocks above, do I really think that the fair value of each of those is half the current P/E ratio?  I would say no to most of them.  OK, margins are bloated.  But just finger through the list slowly from the top to bottom.  Which ones are over-earning with bloated, bubbled up margins?  Honestly, I don't know.  Nothing jumps out at me as a candidate.  Readers here know that I am not a big long term fan of Apple as an investment, so I would argue that AAPL would be an example of possibly bloated, long-term unsustainable margins (and I know, I know, a lot of people don't agree with me on that and that's OK!).

But otherwise, it seems like a lot of them are actually under-earning.

Berkshire Stocks
As another 'sample', let's just look at BRK's portfolio, which in aggregate is down on the year so far.

Berkshire Hathaway Large Stockholdings Valuations

Here too, I come to a similar conclusion as the above (well, there are overlaps).  Nothing jumps out at me as needing a 'crash' or big bear market to correct.  I don't really see a stretched rubber band here either.  Most seem to be under-earning and I don't really see any unsustainably high margins.

Buffett Dogs Strategy?
So, looking at this, it's interesting to see that there are three stocks down a lot this year.  WMT, PG, and AXP are down -16%, -14% and -15% year-to-date respectively.  And as I said above, AXP has incredible margins and ROE and is trading under 14x P/E.  I know there are worries about competition; alternative payment systems (Munger said there is more competition now than before, but it's still a great business).  And the loss of Costco is certainly weighing on the stock.  This will cause earnings to be flat, but AXP expects EPS to start growing 12-15% again in 2017.

I've been saying this sort of thing since 2011 when I first started this blog; that the market is fine.  But sooner or later the bull market will end.  The market will tank and people will go back and read these posts and have a good laugh.  I know that will happen for sure.  But that's OK.

I'm not trying to predict anything, nor am I saying that we won't have another bear market again.  The market will go down for sure, 50% or more.  There is no doubt about that at all.  But I don't know when that will happen.

I am just looking at a bunch of facts to see what's actually going on.  Sometimes, it's hard to see what is happening just looking at big, macro charts; they can be misleading, like flying over a disaster zone in an airplane.  Sometimes you have to get on the ground and walk around to see for yourself.