Everybody gather 'round now
Let your body feel the heat.
Don't you worry if you can't dance
Let the music move your feet.
--Miami Sound Machine
One nice thing about a blog is that you can record real time experiences and feelings so that, in the future, you can go back to old posts and remember what certain environments felt like. Otherwise, once removed from the context, it's easy to lose that feel.
Getting back in touch with past experiences comes in handy during market extremes. If you're able to recall what it felt like during past market tops and bottoms, then it might help you make better decisions during periods that are often wrought with emotion of greed and fear.
We may be experiencing one of those extremes currently. While I have big picture concerns that lead me to believe that stock indices will be signficantly lower over the next few years, in the near term, fear seems to be growing mighty palpable. As Toddo offered earlier this am, it feels like a 'bid wanted' situation in the financials.
Not to say things couldn't get more extreme. Indeed, chances of an outright crash have increased substatially (although, by definition, dislocations are always a low probability event).
But I'm smelling a rally. If we get one, then I'll be looking to lighten up my risk profile--even on longer term holdings.
position in select financials
Tuesday, July 15, 2008
Wednesday, July 9, 2008
Early Bird Special
Take a load off Fannie
Take a load for free
Take a load off Fannie
And you can put the load right on me
--The Band
The problems now surfacing in Fannie Mae (FNM), and her cousin Freddie Mac (FRE), were 'easy' to spot many years back. However, shorts who immediately acted on that perception may not have lasted to collect their reward when, years later, Fannie finally came unglued.
Count me among them. Short FNM since 2003, I was worn down by the market's ebb and flow while waiting for 'the big one'--that period when the collective market 'saw' Fannie's fundamental problems. Classically, I capitulated last summer--just before the financials blew.
There's little room for 'woulda, coulda, shoulda' in financial decision-making. Still, it's hard not to look at the 75% decline in Fannie over the past 12 months and marvel at the market's ability to dissolve an individual's commitment to an investment thesis at precisely the wrong time.
no positions
Take a load for free
Take a load off Fannie
And you can put the load right on me
--The Band
The problems now surfacing in Fannie Mae (FNM), and her cousin Freddie Mac (FRE), were 'easy' to spot many years back. However, shorts who immediately acted on that perception may not have lasted to collect their reward when, years later, Fannie finally came unglued.
Count me among them. Short FNM since 2003, I was worn down by the market's ebb and flow while waiting for 'the big one'--that period when the collective market 'saw' Fannie's fundamental problems. Classically, I capitulated last summer--just before the financials blew.
There's little room for 'woulda, coulda, shoulda' in financial decision-making. Still, it's hard not to look at the 75% decline in Fannie over the past 12 months and marvel at the market's ability to dissolve an individual's commitment to an investment thesis at precisely the wrong time.no positions
Friday, July 4, 2008
Value Quest
Why can't they just say, 'Go to this place and here is the treasure; spend it wisely?'
--Riley Poole (National Treasure)
Recently some have opined that General Motors (GM) is a buy here because of its low market capitalization. Market capitalization, or 'market cap', is found by multiplying the number of shares outstanding in a stock (a.k.a. 'the float') by the share price.
market capitalization = number of shares outstanding * stock price
With a float of about 556 million shares and a share price of $10.17 (July 3rd close), GM's market cap is approximately $5.8 billion. As a component of the Dow Jones Industrial Average, GM's market cap is significantly lower than the other 29 stocks that comprise index. Next lowest are Alcoa (AA) at about $27 billion, and DuPont (DD) and Home Depot (HD) at about $38 billion.
Market cap is often viewed as a measure of overall company value. And, in the eyes of some, GM's low market cap reflects a company that is inexpensive and worthy of investment (or at least a trade).
As a measure of overall corporation value, however, market capitalization is incomplete since it does not directly account for a company's debt and cash positions. In the event of a buyout, the buyer would have to assume the company's debts while pocketing its cash.
A better reflection of takeover value is enterprise value. Enterprise value equals the company's market cap plus its debt (which could include minority positions and preferred stock) minus its cash.
enterprise value = market capitalization + debt - cash
GM's March 2008 balance sheet indicates total debt of about $44 billion and cash of about $22 billion which implies an enterprise value of about $28 billion. As such, GM's enterprise value is more than 4 times its market capitalization--due to the large amount of debt to be assumed by any would-be acquirer.
Big discrepancies between market cap and enterprise value are common, which shouldn't be too surprising given the degree of corporate leverage these days. As a further example, consider the other 'General' in the Dow 30, General Electric (GE). GE's market cap currently stands at nearly $270 billion. However, due to the company's half a trillion dollar debt load, GE's enterprise value balloons to about $800 billion.
When trying to get a picture of the overall value that the market is assigning to a company, enterprise value often adds perspective not offered by market capitalization alone.
position in GE
--Riley Poole (National Treasure)
Recently some have opined that General Motors (GM) is a buy here because of its low market capitalization. Market capitalization, or 'market cap', is found by multiplying the number of shares outstanding in a stock (a.k.a. 'the float') by the share price.
market capitalization = number of shares outstanding * stock price
With a float of about 556 million shares and a share price of $10.17 (July 3rd close), GM's market cap is approximately $5.8 billion. As a component of the Dow Jones Industrial Average, GM's market cap is significantly lower than the other 29 stocks that comprise index. Next lowest are Alcoa (AA) at about $27 billion, and DuPont (DD) and Home Depot (HD) at about $38 billion.
Market cap is often viewed as a measure of overall company value. And, in the eyes of some, GM's low market cap reflects a company that is inexpensive and worthy of investment (or at least a trade).
As a measure of overall corporation value, however, market capitalization is incomplete since it does not directly account for a company's debt and cash positions. In the event of a buyout, the buyer would have to assume the company's debts while pocketing its cash.
A better reflection of takeover value is enterprise value. Enterprise value equals the company's market cap plus its debt (which could include minority positions and preferred stock) minus its cash.
enterprise value = market capitalization + debt - cash
GM's March 2008 balance sheet indicates total debt of about $44 billion and cash of about $22 billion which implies an enterprise value of about $28 billion. As such, GM's enterprise value is more than 4 times its market capitalization--due to the large amount of debt to be assumed by any would-be acquirer.
Big discrepancies between market cap and enterprise value are common, which shouldn't be too surprising given the degree of corporate leverage these days. As a further example, consider the other 'General' in the Dow 30, General Electric (GE). GE's market cap currently stands at nearly $270 billion. However, due to the company's half a trillion dollar debt load, GE's enterprise value balloons to about $800 billion.
When trying to get a picture of the overall value that the market is assigning to a company, enterprise value often adds perspective not offered by market capitalization alone.
position in GE
Tuesday, July 1, 2008
Battery Park
"You know, I know this steak doesn't exist. I know that when I put it in my mouth, the Matrix is telling my brain that it is juicy and delicious. After nine years, you know what I realize? Ignorance is bliss."
--Cypher (The Matrix)
We know that humans are subject to herd behavior and social influence. However, humans possess self-awareness. Self-awareness allows us to recognize context, and select our response (e.g., comply with the herd or go our own way). It is perhaps the most fundamental way in which we differ from the rest of the animal kingdom.
Self-awareness facilitates freedom of choice.
Cypher exemplifies those who prefer to cede their freedom for a State of Dependence. The comfort and satisfaction offered by this state is, like Cypher's steak, an illusion. In reality, we surrender our persona and become, well, part of a battery park. And folks go willingly.
Perhaps the greatest barrier to liberty is not the desire of some to rule, but rather the desire of many to be ruled.
--Cypher (The Matrix)
We know that humans are subject to herd behavior and social influence. However, humans possess self-awareness. Self-awareness allows us to recognize context, and select our response (e.g., comply with the herd or go our own way). It is perhaps the most fundamental way in which we differ from the rest of the animal kingdom.
Self-awareness facilitates freedom of choice.
Cypher exemplifies those who prefer to cede their freedom for a State of Dependence. The comfort and satisfaction offered by this state is, like Cypher's steak, an illusion. In reality, we surrender our persona and become, well, part of a battery park. And folks go willingly.
Perhaps the greatest barrier to liberty is not the desire of some to rule, but rather the desire of many to be ruled.
Saturday, June 28, 2008
Who's the Boss?
The highway's jammed with broken heroes on a last chance power drive
Everybody's out on the run tonight but there's no place left to hide
--Bruce Springsteen
A popular view (and one promoted by many politicians) is that, in a free market system, power is held by the producers. Through this lens, capitalists are seen as antagonists and in need of government intervention and control.
Such perspective is misguided. In a truly free market, power is held by the buyers (Mises, 1949; Rothbard, 1962). Buyers decide what to purchase, and their purchasing decisions provide critical feedback to producers on what constitutes value. Through free exchange, customers steer economic activity towards innovation and efficiency (Schumpeter, 1942).
Bureaucratic intervention distorts this mechanism. Perversely, government regulation and control often hands more power to producers. For instance, regulation commonly erects entry barriers that discourage prospective entrepreneurs with potentially compelling value propositions from entering industries, thus protecting the franchises of incumbent firms (Porter, 1980).
Moreover, regulation atrophies the decision-making process of buyers. For example, bank accounts backed by federal government insurance (e.g., FDIC) has blunted the critical assessment process necessary for customers to determine the health of financial institutions they patronize.
Reduced due diligence by buyers increases the error in purchasing decisions. Inevitably, society's scarce resources will be mis-allocated as producers respond to distorted signals emanating from buyers.
Quite paradoxically, by seeking government-sponsored intervention and control over producers, buyers cede power that was originally theirs in a free market system.
no positions
References
Mises, L. (1949). Human action. New Haven: Yale University Press.
Porter, M.E. (1980). Competitive strategy. New York: Free Press.
Rothbard, M.N. (1962). Man, economy, and state. Princeton, NJ: D. Van Nostrand Co.
Schumpeter, J.A. (1942). Capitalism, socialism, and democracy. New York: Harper & Bros.
Everybody's out on the run tonight but there's no place left to hide
--Bruce Springsteen
A popular view (and one promoted by many politicians) is that, in a free market system, power is held by the producers. Through this lens, capitalists are seen as antagonists and in need of government intervention and control.
Such perspective is misguided. In a truly free market, power is held by the buyers (Mises, 1949; Rothbard, 1962). Buyers decide what to purchase, and their purchasing decisions provide critical feedback to producers on what constitutes value. Through free exchange, customers steer economic activity towards innovation and efficiency (Schumpeter, 1942).
Bureaucratic intervention distorts this mechanism. Perversely, government regulation and control often hands more power to producers. For instance, regulation commonly erects entry barriers that discourage prospective entrepreneurs with potentially compelling value propositions from entering industries, thus protecting the franchises of incumbent firms (Porter, 1980).
Moreover, regulation atrophies the decision-making process of buyers. For example, bank accounts backed by federal government insurance (e.g., FDIC) has blunted the critical assessment process necessary for customers to determine the health of financial institutions they patronize.
Reduced due diligence by buyers increases the error in purchasing decisions. Inevitably, society's scarce resources will be mis-allocated as producers respond to distorted signals emanating from buyers.
Quite paradoxically, by seeking government-sponsored intervention and control over producers, buyers cede power that was originally theirs in a free market system.
no positions
References
Mises, L. (1949). Human action. New Haven: Yale University Press.
Porter, M.E. (1980). Competitive strategy. New York: Free Press.
Rothbard, M.N. (1962). Man, economy, and state. Princeton, NJ: D. Van Nostrand Co.
Schumpeter, J.A. (1942). Capitalism, socialism, and democracy. New York: Harper & Bros.
Thursday, June 26, 2008
Gimme Shelter
Ooh, see the fire is sweepin'
Our very street today
Burns like a red coal carpet
Mad bull lost its way
--Rolling Stones
Common wisdom is that businesses dislike government regulation. A plausible rival hypothesis is that industry participants welcome regulation. Viewed through a strategic lens, regulation raises barriers to entry, thus protecting the franchises of incumbents.
Although popular history teaches that trustbusting activity of the late 1800s - early 1900s helped reign in rampant monopolies in oil, railroads, banking, and other sectors, Rothbard (2002) offers compelling evidence that incumbent firms proactively sought regulation as a means to preserve franchises that were under attack by slews of upstarts.
As such, regulation serves to reduce competition.
References
Rothbard, M.N. (2002). A history of money and banking in the United States. Auburn, AL: Ludwig von Mises Institute.
Our very street today
Burns like a red coal carpet
Mad bull lost its way
--Rolling Stones
Common wisdom is that businesses dislike government regulation. A plausible rival hypothesis is that industry participants welcome regulation. Viewed through a strategic lens, regulation raises barriers to entry, thus protecting the franchises of incumbents.
Although popular history teaches that trustbusting activity of the late 1800s - early 1900s helped reign in rampant monopolies in oil, railroads, banking, and other sectors, Rothbard (2002) offers compelling evidence that incumbent firms proactively sought regulation as a means to preserve franchises that were under attack by slews of upstarts.
As such, regulation serves to reduce competition.
References
Rothbard, M.N. (2002). A history of money and banking in the United States. Auburn, AL: Ludwig von Mises Institute.
Wednesday, June 25, 2008
The Elephant Dance
Why don't you tell me what's going on?
Why don't you tell me who's on the phone?
--Fleetwood Mac
Sometimes you have to actually own a stock before you realize just how tenuous a situation is. Late last week I bought a couple of bank stocks thinking that the selling was overdone. Stalwart names like Wells Fargo (WFC) were yielding 5%+ and regionals like Sun Trust (STI) were yielding 9% or so.
As soon as I bought them, however, I knew I couldn't hold them. I felt the structural risk right away. Even if the fat dividends are safe (a big if), bank stock prices could easily melt below the margin of error afforded by the rich yields.
So, this nervous long 'fed the ducks' (read: sold) into the oversold bank stock rally over the last couple of days.
What did I learn? Now is not the time for me to initiate long term positions in the financial sector. And since I'm not a trader, my best course of action is to do nothing when I perceive risk this high.
no positions
Why don't you tell me who's on the phone?
--Fleetwood Mac
Sometimes you have to actually own a stock before you realize just how tenuous a situation is. Late last week I bought a couple of bank stocks thinking that the selling was overdone. Stalwart names like Wells Fargo (WFC) were yielding 5%+ and regionals like Sun Trust (STI) were yielding 9% or so.
As soon as I bought them, however, I knew I couldn't hold them. I felt the structural risk right away. Even if the fat dividends are safe (a big if), bank stock prices could easily melt below the margin of error afforded by the rich yields.
So, this nervous long 'fed the ducks' (read: sold) into the oversold bank stock rally over the last couple of days.
What did I learn? Now is not the time for me to initiate long term positions in the financial sector. And since I'm not a trader, my best course of action is to do nothing when I perceive risk this high.
no positions
Wednesday, June 18, 2008
Crude Awakenings
Out where the river broke
The bloodwood and the desert oak
Holden wrecks and boiling diesels
Steam in forty five degrees
--Midnight Oil
A few rules of thumb when trying to make sense of the current crude oil supply/demand landscape (in millions of barrels per day).
World supply = 85
World demand = 87 (world demand currently outstrips supply by 2 MBPD)
US supply = 7 (US produces about 1/3 of what it consumes)
US demand = 21 (US consumes roughly 25% of world production)
China demand = 7.5 (about 1/3 of US demand but growing @ 3x US rate)
OPEC supply = 30 (about 35% of world supply)
At current production levels, the world consumes about 31 billion barrels/yr.
no positions
The bloodwood and the desert oak
Holden wrecks and boiling diesels
Steam in forty five degrees
--Midnight Oil
A few rules of thumb when trying to make sense of the current crude oil supply/demand landscape (in millions of barrels per day).
World supply = 85
World demand = 87 (world demand currently outstrips supply by 2 MBPD)
US supply = 7 (US produces about 1/3 of what it consumes)
US demand = 21 (US consumes roughly 25% of world production)
China demand = 7.5 (about 1/3 of US demand but growing @ 3x US rate)
OPEC supply = 30 (about 35% of world supply)
At current production levels, the world consumes about 31 billion barrels/yr.
no positions
Saturday, June 14, 2008
In a Box
I've been looking so long at these pictures of you That I almost believe that they're real Been living so long with these pictures of you That I almost believe that the pictures are all that I feel
--The Cure
The technical concept that I like to call 'box theory' was made 'famous' by stock market speculator Nicolas Darvas (1960). It proposes that, in a bull market, prices advance in cells or boxes that can be readily tracked.
We can apply box theory to the bullish gold move over the past 3-4 years. Four boxes have defined gold's move off the long base in 2005. Each box has ranged about $150.
Moreover, it appears that there have been two different types of boxes. An advancement box has been characterized by a rapid price rise thru the entire price range up into the next box higher. That advancement continues into a consolidation box, where prices spike up to the top of the box range, pull back, and then endure a period of consolidation before heading higher into the next advancement box.
Currently, we're in a consolidation box ranging from about $850 to $1000. In the previous consolidation box, we spent more than a year, well, consolidating. Will we need to do the same thing this time before (if) gold moves higher?
Let's see what happens.
position in gold
References
Darvas, N. (1960). How I made $2,000,000 in the stock market. New York: Carol Publishing Group.
--The Cure
The technical concept that I like to call 'box theory' was made 'famous' by stock market speculator Nicolas Darvas (1960). It proposes that, in a bull market, prices advance in cells or boxes that can be readily tracked.
We can apply box theory to the bullish gold move over the past 3-4 years. Four boxes have defined gold's move off the long base in 2005. Each box has ranged about $150.
Moreover, it appears that there have been two different types of boxes. An advancement box has been characterized by a rapid price rise thru the entire price range up into the next box higher. That advancement continues into a consolidation box, where prices spike up to the top of the box range, pull back, and then endure a period of consolidation before heading higher into the next advancement box.
Currently, we're in a consolidation box ranging from about $850 to $1000. In the previous consolidation box, we spent more than a year, well, consolidating. Will we need to do the same thing this time before (if) gold moves higher?
Let's see what happens.
position in gold
References
Darvas, N. (1960). How I made $2,000,000 in the stock market. New York: Carol Publishing Group.
Sunday, June 8, 2008
Gushing Cash
With a little perseverance you can get things done
Without a blind adherence that has conquered some
--Corey Hart
In a previous missive we discussed the merits of free cash flow for valuing securities. To get a feel for this concept in motion, let's take a look at a company that has been generating mammoth free cash flow, Exxon Mobil (XOM). Recall that free cash flow (FCF) equals operating cash flow (OCF) minus capital expenditures (capex).
You can see that XOM's operating cash flow has increased by about 150% over the past few years. During this period, capital expenditures have increased less than 50%. As a result, free cash flow has increased nearly fourfold, reaching nearly $37 billion in 2007.
This is a remarkable level of FCF--even for enterprises in the 'sweet spot' energy space. Indeed, many favorite domestic 'go to' trading names in oil and gas production, such as Apache (APA), Devon Energy (DEV), and XTO Energy (XTO) have not been consistently FCF positive throughout this same period. While operating cash flows have increased significantly for these enterprises, capital expenditures have increased commensurately, leaving less FCF than one might expect given the favorable secular winds blowing at the backs of firms in this sector.
One of the first things that I do when examining an investment idea is to review historical FCF trends (similar to what we've done above). This exercise helps me get a toe hold on the economic value producing potential of an enterprise.
How can we use FCF info to estimate the 'fair value' of a stock? Stay tuned.
no positions
Without a blind adherence that has conquered some
--Corey Hart
In a previous missive we discussed the merits of free cash flow for valuing securities. To get a feel for this concept in motion, let's take a look at a company that has been generating mammoth free cash flow, Exxon Mobil (XOM). Recall that free cash flow (FCF) equals operating cash flow (OCF) minus capital expenditures (capex).
Annual XOM Free Cash Flow ($ Billions)
| Year | OCF | Capex | FCF |
| 2002 | 21.3 | 11.4 | 9.8 |
| 2003 | 28.5 | 12.9 | 15.6 |
| 2004 | 40.6 | 12.0 | 28.6 |
| 2005 | 48.1 | 13.8 | 34.3 |
| 2006 | 49.3 | 15.5 | 33.8 |
| 2007 | 52.0 | 15.4 | 36.6 |
You can see that XOM's operating cash flow has increased by about 150% over the past few years. During this period, capital expenditures have increased less than 50%. As a result, free cash flow has increased nearly fourfold, reaching nearly $37 billion in 2007.
This is a remarkable level of FCF--even for enterprises in the 'sweet spot' energy space. Indeed, many favorite domestic 'go to' trading names in oil and gas production, such as Apache (APA), Devon Energy (DEV), and XTO Energy (XTO) have not been consistently FCF positive throughout this same period. While operating cash flows have increased significantly for these enterprises, capital expenditures have increased commensurately, leaving less FCF than one might expect given the favorable secular winds blowing at the backs of firms in this sector.
One of the first things that I do when examining an investment idea is to review historical FCF trends (similar to what we've done above). This exercise helps me get a toe hold on the economic value producing potential of an enterprise.
How can we use FCF info to estimate the 'fair value' of a stock? Stay tuned.
no positions
Subscribe to:
Posts (Atom)
![[Most Recent Quotes from www.kitco.com]](https://lh3.googleusercontent.com/blogger_img_proxy/AEn0k_uYLyUC5l7hOE1N7ztCQE6tM3FmGNFPe8W5hp4QK44FPoXLR636Ou4mSw25WQw2Idi78mLQzNgK4EdVqWAfYUiErr04mzIQGKUm_Dm3-b3QeV-ZTbepoR3HdGA50VwIeYhOCg=s0-d)
