Archive for May, 2008
Here is a link (opens PDF) to a 9 page analysis I did of American Express (AXP). Warning: it is a bit dry. I was going to present American Express at Value Investing Congress in Pasadena, but the stock ran up and exhausted a good portion of margin of safety.
Amex is one of the best, most transparent (you can actually analyze it) financial companies I’d want to own in today’s environment. We’ll probably get an opportunity to load up on it in the future, albeit at a lower price.
I ended up presenting my very contrarian case on Joseph A. Bank, 93% of float is short. Here is a link to the full presentation, JOSB starts on slide 31.
May 30th, 2008
Rich Karlgaard, the publisher of Forbes magazine, mentioned my book in his article:
- The new Benjamin Graham is Vitaliy N. Katsenelson. I highly recommend Katsenelson’s book, Active Value Investing: Making Money in Range-Bound Markets (Wiley, 2007). I like to think the old Ben Graham would have recommended it, too.
May 24th, 2008
I was interviewed by Kiplinger about Jos. A. Bank (JOSB), my favorite retail stock I presented (download PDF of my presentation) at Value Investing Congress in Pasadena. This is probably the most contrarian stock I ever owned – 93% of the float is short.
May 24th, 2008
By Vitaliy Katsenelson, CFA
The NY Times came up with a very interesting way to look at consumer spending. In the long run, consumer spending is a function of consumer income. Though since early 2000 it did not appear to be the case as consumers financed their spending by borrowing against their future income. If you believe that consumer spending is likely to stagnate but the cost of food, healthcare and energy is likely to increase (it did in 2007), then something has got to give.
In other words the income pie is not growing; some slices are expanding at the expense of “X.” And that is the question that this NY Times diagram may help to answer: at the expense of what?
Several categories come to mind right away: new car sales - yes we will be driving older cars (maybe we should look to used car or auto parts stores). We’ll be eating out less which will likely impact the full service restaurants by a large degree. Fast food may get hurt by this trend as well but at the same time, some may chose to downgrade to fast food from full service restaurants. In regards to travel, the vacation homes and hotels are likely to be another casualty.
May 13th, 2008
By Vitaliy Katsenelson, CFA
This article in Forbes about aircraft leasing companies names some publicly traded stocks that appear cheap: Genesis Lease (GLS), AerCap (AER), and Aircastle (AYR). But that cheapness may be a bit deceiving.
Plane leasing looks like a great business. Despite U.S. and global economies facing a slowdown and oil prices making all time highs, demand for planes is still very strong.
However, the more I think about it, the more I realize that this business cannot escape the fate that mirrors its customers - the airlines. I could be wrong, but this business doesn’t really have a sustainable competitive advantage. It’s basically just an arbitrage business: a lessor needs to be able to borrow at a low rate than airlines and lease planes to an airlines at a rate greater or equal to what they could borrow. Airlines get to keep planes off the balance sheet, show high return on capital, but may try to renege on the lease when times get tough (many did that after 9/11).
I think this is where things get dicey. A global slowdown and a recession will do what it does every time: send airlines in a place so frequently visited by them - bankruptcy. They’ll renege on the leases and leasing companies will get their planes back. But unless they decided to start flying those planes themselves, demand will not be there. Planes will make their usual pilgrimage to the desert.
May 13th, 2008
By Vitaliy Katsenelson, CFA
My firm sold Lloyds TSB Group (LYG) a couple of weeks ago. I still think it’s one of the best run banks in the world, but its exposure to loans underwritten by other banks made us pause and rethink our thesis.
LYG has a securitization conduit called Cancara. It uses the conduit to securitize some of the loans it generates. There’s no problem there. LYG has proven to be very conservative in its underwriting and that’s why it sports a very rare AAA rating by S&P.
However, about two thirds of the $25 billion Cancara conduit are loans that have been generated by other banks. For a fee, LYG allowed other banks to fold their loans into Cancara and LYG basically insured those loans by its own balance sheet. Call me paranoid, but other banks have little incentive to care about the quality of the loans. Now, LYG is on the hook, not them.
This was my reasoning to sell the company I praised for a very long time. Again, there’s a good chance this may end up being nothing. We’ll monitor the performance of Cancara loans for awhile and may buy LYG back at some point in time.
May 13th, 2008
May 3rd 2008 - Financial Times
By Vitaliy Katsenelson, CFA
I love the price/earnings ratio, but like all investment tools, it is flawed. This is because it is only as good as the numbers that go into it. There is no debate about the “p” in the equation – price is quoted every second. But the “e”, though readily available, is only as good as the best estimates.
Many people describe the stock market as cheap. After all, at 18 times earnings, p/es are half of what they were eight years ago (those bubbly valuations are not coming back anytime soon) and only three points above their long-term average of 15. However, the “e” is temporarily inflated by all-time high (pre-tax) profit margins, which are at 11.5 per cent, or about 35 per cent higher than their multi-decade average of 8.5 per cent.
Historically, every time profit margins have become overextended, they have reverted towards the mean (that is, declined). This is because capitalism works. One company’s excess profits are another’s potential opportunity – increased competition puts pressure on profit margins. This time round is no different. If profit margins fell and stopped when they reached the average level – an aggressive assumption as historically they have overshot and gone lower – the market’s p/e would rise from 18 to 22.
The same logic applies to individual stocks. Most excess profit today is generated from three sectors: “stuff” (energy, materials and industrials); financials; and the “new” economy (telecommunications and technology). “Stuff” stocks are responsible for about half of the overall excesses in profits. Historically their sales and profits have moved in tandem with the US economy. However, as fast-growing, “stuff hungry” nations such as India and China became a larger part of the global economy, these stocks started moving less with their domestic economies and more with the global economy. A slowdown in the US alone may not be enough to derail their high profit margins, though it may trigger a gradual process of global slowdown. The global economy has to slow down before the margins of “stuff” stocks will decline.
These companies have a high proportion of fixed costs, meaning that their margins increase in good times (a concept known as operational leverage). But that leverage could now work in the opposite direction – lower sales and high fixed costs will push margins to the other extreme. Earnings will either decline or stop rising and cheap stocks won’t be cheap any longer. Timing the global economic cycle is impossible as it is driven by random variables. While it may appear that India and China operate by a different economic playbook, they do not. When growth, especially fast growth, takes place in countries where rule of law and free market practices are still developing, it breeds inefficiencies. Recession exposes underlying problems. The risk is China and India will slow down, fall into recession, and consume less “stuff”.
[Since recession may bring a political unrest in China and India, their respective governments will likely fight it using every bullet in the monetary and fiscal arsenal, but recession can be postponed but cannot be escaped. ] The second group, financial companies, are responsible for about 20 per cent of excess profits. Cheap money and loose lending practises fuelled the excesses, but rising loan defaults mean that margins are now compressing.
The last group, the “new” economy stocks are responsible for slightly less than 20 per cent of overall margin excesses. The technology and telecoms sectors have changed dramatically over the past two decades; higher-margin software and services now account for a much larger portion of sales. The “new” economy stocks should have higher margins than they had in the past, but by how much? I don’t know, but they likely will face a lower margin compression than “stuff” stocks and financials. We are in a “global cyclicality bubble” not unlike the bubble of the late 1990s or the housing bubble of the 2000s. Since cyclical companies have not seen the other, darker, side of the cycle for a while – many are granted historically high valuations on top of cyclically high earnings.
Don’t abandon the p/e ratio, but adjust the earnings for high margins. Take a close look at the profit margins of the stocks in your portfolio and ask yourself if today’s margins are sustainable. If you adjusted margins to the historical average, would the stock still look cheap? If you own a stock that belongs to the “stuff” or financial services groups, assume its high margins won’t last. The writer is director of research at Investment Management Associates and author of Active Value Investing.
May 10th, 2008
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