Sunday, October 21, 2007

Forget the Lesson, Learn it Twice / Hussman

If you want to read what Hussman has to say about the Hindenburg omen click here

Die Kommentare von Hussman zum sog. Hindenburg Omen gibt es hier

Forget the Lesson, Learn it Twice
In addition to my overall concern about risks here, both to stocks and to the economy more generally, I think it's fascinating to watch how investors seem to partition certain stocks as if they are entirely “above the law” and impervious to any risk of overvaluation, “free entry” of competition, earnings dilution, margin erosion, or other factors. Investors took this view with dot-com and tech stocks in the late 1990's, with disastrous results (even for legitimate growth stocks like Cisco, which dropped from a bull market high of 82 to a bear market low of 8 with no intervening splits).

One way to identify these speculative darlings is to examine the extent to which investors focus on a growth story and blissfully ignore how a company treats them as shareholders. Speculative investors think of stocks as gambling stubs at the race track - they don't stop to think about the stream of cash flows that they can expect to actually receive as shareholders over the long-term.

Consider a possibly hypothetical company with $21 billion in tangible assets; two-thirds of which are IPO proceeds and about one-third of which are earnings that have been retained to-date. Now, if a company takes its IPO proceeds and invests them in cash and marketable securities, then as long as it doesn't generate net losses or other liabilities, the company must be worth at least the value of those assets, regardless of how much money was raised by issuing stock. Beyond that, however, any additional market value has to be backed up by an expectation that the company will actually deliver a stream of cash flows to shareholders over time.

What does “deliver” mean? Isn't it enough to report good earnings? Well, suppose that the 10-Q of this possibly hypothetical company notes that there are outstanding option grants to employees of 3.4 million shares at an average exercise price of $152, and another 11.5 million shares of outstanding option grants at an average exercise price of $244. If the current stock price is say, $645, you could whip out a calculator and confirm that the company has committed stock to employees worth $6.3 billion (the value in excess of the option strike prices), which is not much less than the total amount of earnings that have been retained to-date. That would be a lot like someone saying, “Hey man, I made a pizza for you,” eating it right before your eyes, and then saying “Hey man, I made two pizzas for you,” and eating those as well.

Often, companies use their retained earnings to “repurchase” stock, which is then handed over to employees as they exercise their stock options. What happens if the company doesn't repurchase stock? It simply dilutes the ownership claim of existing shareholders directly. The impact – a diversion of value from existing shareholders – is the same. For instance, suppose that the stock has a P/E of 50, and the company reports in its 8-K that “We currently anticipate that dilution related to all equity grants to employees will be at or below 2% this year.” A thinking investor might look at that and say, “Let's see. A P/E of 50 means that earnings represent 2% of the stock price, and the company is explicitly telling me that this is about the amount that will be given away in grants to employees.”

> I also recommend to read what Jeff Matthews has to say The Price of “Insanity” Doubles: Barron’s vs. Google

> Zu diesem Thema hat Jeff Matthews in The Price of “Insanity” Doubles: Barron’s vs. Google ebenfalls ein paar treffende Punkte zusammengefasst

If you actually observed that sort of thing, you would probably conclude that investors had not learned much from the experience of stocks with similar characteristics during the 2000-2002 market plunge. That collapse demonstrated that there is often a spectacular difference between the market price of a speculative stock at the height of its popularity, and the actual value of the cash flows that an investor in that stock will realize by owning that stock over time. There's no denying that there were stunning gains in many of the dot-coms before they came back to earth, but the round-trip was ultimately distressing.

Aw, then again, forget I even mentioned it. That dot-com thing was a once-in-a-lifetime event. The “possibly hypothetical” example above couldn't really exist in the real world. Investors have surely learned their lesson. Everybody knows that.

Speaking of distressing round trips – as of Friday, the Dow and S&P 500 closed Friday within a fraction of a percent of where they were minutes prior to the Fed's September 18th interest rate announcement. And just for the record, the Fed has still added zero liquidity to the banking system. The total amount lent by the Fed to the banking system through the discount window fell again last week to just $240 million. Total bank reserves fell in September, from $44.9 billion to $42.5 billion. The monetary base – the only monetary aggregate that the Fed directly controls, fell in September from $853.482 billion to $851.279 billion. At least $19 billion of temporary repos will come due on Thursday, so the Fed won't be “injecting liquidity” into the banking system when it predictably rolls these over.

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Blogger jmf said...

Peter Schiff

Prices are the Cart, Money Supply is the Horse

11:32 PM  
Blogger jmf said...

Apple Market Value Soars Past Dell's on Mac, IPod

Ten years ago this month, Dell Inc. founder Michael Dell said Steve Jobs should ```shut down'' Apple Inc. and return the money to shareholders.

Dell then had a market value of $4 billion to Apple's $700 million. Apple's valuation has since soared to $150 billion, more than double that of its personal-computer rival. Last month, Apple passed PC leader Hewlett-Packard Co. in market capitalization for the first time.


12:02 AM  
Blogger jmf said...

FT Deutschland


12:14 AM  
Anonymous Anonymous said...

Interesting stat about the market cap of HPQ vs AAPL, considering how much longer HPQ has been around, the strength of HPQ in both consumer and industrial products, and that HPQ has been very successful as well.

Personally, I do not own anything made by AAPL, have no plans to buy anything, and have rarely used any AAPL product (once at work I had a Mac on my desk, but I used my PC a LOT more), but I have owned an inkjet printer from HPQ, and have often used HPQ laser printers at work.


1:09 AM  
Blogger jmf said...

Moin Eh,

i think aapl and goog are great companies.

I find the value comparison with other companies fascinating.

Another example is Nintendo vs Sony. They made only a fraction of the revenue and the market cap is higher than the market cap from Sony

There is not much room for error ( as seen with Motorola). I have thought about a trade in shorting the high flyer's and going long the laggards.

But with the strenght of the RIMMs, AMZN, AAPL, GOOG (new nifty 50?) i´m glad that i havn´t done it.

But it is still on my radar

1:42 AM  
Blogger jmf said...

KKR and Goldman cut deal on Harman retreat

Harman hasn’t exactly come out a winner - whereas KKR and Goldman gave the company a $8bn valuation, the current market capitalisation is around $5.6bn. The $400m loan from the private equiteers is mostly going to be used to buy back stock - a pretty desperate attempt to placate angry shareholders if ever there was one.

4:02 AM  
Blogger jmf said...

Buyers Pounce on Deals as Homes Go on the Block

4:21 AM  
Blogger jmf said...

CDS report: A bleak Monday for credit

The cost of protection on the iTraxx Crossover index of mostly junk-rated debt, which acts as a barometer for investor risk appetite, was about 25 basis points higher at about 355.5bp, following a 14.5bp move wider on Friday and the subsequent roughly

4:41 AM  
Blogger jmf said...

Wasn’t the First, Won’t Be the Last / Jeff Matthews

5:16 AM  
Blogger Ben Bittrolff said...

For more about the Hindeburg Omen (an explanation including a chart) see:

9:32 AM  

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