June 18, 2008 | Posted by Vitaliy Katsenelson

Two Interviews: BetterInvesting and Vinny Catalano

I have not written anything for awhile. It seems that I am researching ten stocks at once which often pushes me into indecision paralysis. High conviction ideas are hard to come by, though we recently found a few which I’ll write about soon.

We are stress testing our portfolios for two additional risks which makes stock selection even more difficult: 1) extremely strong balance sheets – today’s recession, which is a consumer driven one, may last longer than the ones in the past. Thus as I mentioned before access to capital markets may turn into a privilege not a birthright. I want to own companies that don’t have a burden of debt and preferably suffer from a burden of cash. 2) normalizing profit margins, which in most cases today results in lower earnings and higher valuations (in my presentation I use Paccar (PCAR) as an example of an industrial “stuff” stock that may not be as cheap as it appears to be, see slide 35).

Here are two interviews I gave:

BetterInvesting Magazine interview where I discuss the Absolute P/E framework. I developed that framework originally to answer a question so often asked by my students – “what is the right P/E for a stock”. Later I adapted that framework in our research process. I discuss that framework in the book in great detail, but I’ll say the same thing say in the book:

“My goal in this discussion is to provide the qualitative framework and illustrate its possible use with quantitative examples. Using the so-called precision of math, I am trying to illustrate the process of analysis, not a secret formula that will answer investors’ prayers (sorry). The quality of any model is as good as the inputs that go into the model, and this one is no different.

Second is audio interview with Vinny Catalano, (here is a link) where I discuss range-bound markets and profit margins. I met Vinny when he moderated a CFA Society of Colorado forecast dinner in January. I was very impressed with his interviewer/moderator skills.

Short URL: http://ContrarianEdge.com/?p=282

Fernando

Congrats for the book, I enjoyed very much. you wrote “in my presentation I use Paccar (PCAR) see slide 35″. where do I download this presentation??
Vitaliy

Fernando,

I added a link. Take a look.
John

I have recently read your book “Active Value Investing”. I found your Q-V-G framework comprehensive and informative, and the Absolute P/E Model useful and far easier to compute than DCF.

But there are a couple issues puzzling me that I hope you can shed some light on.

First is the linear relationship between dividend yield and P/E. Say, currently bond yield is 10%, and company A with average risk has zero growth but consistent dividend yield same as bond yield, 10%. Based on your model, the fair P/E is 8 + 10 = 18 times. But that doesn’t look right. Why would I want to pay 18 times earning for the 10% yield when I can get the same return risk-free? What have I missed?

Secondly, it is the interpretation of the (risk-unadjusted) margin of safety = initial required rate of return – dividend yield – earning growth.

Say, my initial required rate of return is 30% and a company grows at 30% and offers zero dividend. Based on your model, my required margin of safety is 0%. It is because the expected growth is covering it. That doesn’t sound right. I would imagine the opposite is true: high the growth is, more risk one expects and more margin of safety one needs. What looks concerning is the margin of safety contains the same risk element (i.e. growth) it tries to compensate for. As an analogy, it’s like a bank underwrites mortgage insurances for its own mortgages on its own book. The risk is not hedged but just moved from left pocket to right pocket. What do I miss?

I am looking forward to your reply.
Alex

In your interview, you said that investors value yield more than earnings growth; is that conclusion derived from market analysis, client feedback, or other?

Also, are you skeptical about AMEX’s emphasis on small business accounts? In their talking points, the growth of the small business portfolio seems to correlate with increasing concentration in housing bubble locations.

Great website, and congratulations on the JOSB analysis.
Vitaliy

John,

If you bond yields 10%, as I mention in the book, you’d have to adjust the zero growth P/E down, a lot.

Alex,

My observation about yield is based is from my experience.

On AMEX, I have no doubts that their defaults in the short run will be exceed expectations of many.
http://thehackensack.blogspot.com/ DaveinHackensack

Vitaliy,

If you are interested in taking a look, on my site, I compared and contrasted your thesis that we are in a secular range-bound market in stocks with Jim Rogers’s thesis that we are in a secular bear market* for stocks coinciding with a secular bull market in commodities:: Jim Rogers versus Vitaliy Katsenelson, Part I.

*Rogers seems to have a similar opinion to yours on the state of U.S. stocks, despite this slight difference in terminology.
John

HI Vitaliy,

Thanks for you reply. II need to go back to re-read the book.

How about my 2nd question regarding margin of safety. I think you missed it.

Thanks.
Vitaliy

Hi John,

Yes, I guess I did miss the second question.

First of all, as you’ll see from my book, growth rate P/E doesn’t have linear relationship as your example would suggest. I suggest after certain level of growth, in the book I used 16%, to reduce P/E points further i.e. from 0.65 to 0.5 for 1% of growth. Finally, In calculation of margin of safety we make two adjustments: for business and financial risks.

I hope I answered your question.

Best,

Vitaliy

Two Interviews: BetterInvesting and Vinny Catalano

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