I'm here
Robert
Saturday, December 13, 2008
Sunday, January 27, 2008
Are stocks cheap?
Definition: S&P 500. A group of stocks that frequently appears in “stocks are cheap” discussions. http://en.wikipedia.org/wiki/S%26P_500.
If you are a casual observer of the financial markets, you will from time to time, see discussions that “stocks are cheap”. I will not hide my bias. Right now I think that stocks are expensive. With that admission out of the way, I want to review what goes into that “stocks are cheap” discussion.
Whenever people talk about stocks being cheap, that means that they are talking about the price/earnings (PE) ratio. This is the price of the stock divided by its earnings. So, if a stock with a price of $100 had earnings of $5, then the PE is 20. Now the first place that the the discussion gets fuzzy is that the earnings can either be trailing earnings or forward earnings. Trailing earnings are good because they reflect actual performance. Forward earnings are less good, because they reflect predicted performance. Most folks who declare that “stocks are cheap” use forward or predicted earnings. Right now, the consensus forward earnings forecast is that they will be better even though the economy is slowing. So, if the consensus forward PE of the S&P 500 is 14 and the average of the last 10 years is 15, then “stocks are cheap”.
The other issue in the “stocks are cheap” discussion is that the PE is a per share number. So, even if earnings are declining, the PE can be increased if the company buys back stock. Since investors (see Debt bubble Part 1) have a lot of money to lend, many companies have borrowed money to buy back stock. So, when deciding whether stocks are cheap, the quality of the earnings are an important considerations. As you might expect, the “stocks are cheap” analysts are great fans of the practice of borrowing money to buy back shares. BTW, this is called reducing the float. Per share earnings are also important to the compensation of many corporate executives. This also increases the tendency to borrow money to buy back shares.
There is another dimension to the quality of earnings. This gets a little convoluted. Going back the the S&P 500, it turns out that banks and other financial institutions and oil companies are a large part of that index. These companies tend to have lower than average PE ratios, so they drag down the overall index. Their PE ratios are lower because folks are skeptical about the quality of the forward or predicted earnings. In the case of the financial institutions, this skepticism has proven to be well founded as many have taken huge write downs and reported reduced earnings or losses. These write downs are, of course, related to the dynamics of the imploding debt bubble. They reflect the reality that the quality of the reported earnings were not as good as originally reported. Since these write downs are one off events, the forward earnings forecasts do not include provisions for future write downs. This effectively inflates the forward PE. The “stocks are cheap” tend to believe that “all of the bad news is out”. I put that in quotes because “all of the bad news is out” is a very common phrase used by analysts; especially analysts who believe that “stocks are cheap”.
One of the other things that drives me crazy is that many of the “stocks are cheap” analysts are also fans of certain high PE stocks. They tend to like companies like Amazon (AMZN) with a PE of 90, Research in Motion – the Blackberry folks (RIMM) with a PE of 49. Google (GOOG) with a PE of 44, Chipolte Mexican Grill (CMG) with a PE of 67. The list goes on. These are called momentum (or MOMO) stocks and their lofty PE multiples are justified for a variety of reasons. DO NOT BUY THESE STOCKS. Unless, of course, you are a very active stock trader and can get in and out very quickly (which means that you are likely not a reader of this blog post). If your financial advisor recommends that you buy any of these high PE stocks as a long term holding, then you should find a new financial advisor.
So what is somebody who has money in the stock market to do? If you have time to do more research, then these folks publish a lot of good information and have a couple of mutual funds. http://www.hussmanfunds.com/index.html. I have not purchased these because I am aggressively invested in the stocks are not cheap thesis. When I get to a point where I stop obsessing about what is happening in the financial markets and want my life back, I expect to put a lot of money in these funds.
If you are a casual observer of the financial markets, you will from time to time, see discussions that “stocks are cheap”. I will not hide my bias. Right now I think that stocks are expensive. With that admission out of the way, I want to review what goes into that “stocks are cheap” discussion.
Whenever people talk about stocks being cheap, that means that they are talking about the price/earnings (PE) ratio. This is the price of the stock divided by its earnings. So, if a stock with a price of $100 had earnings of $5, then the PE is 20. Now the first place that the the discussion gets fuzzy is that the earnings can either be trailing earnings or forward earnings. Trailing earnings are good because they reflect actual performance. Forward earnings are less good, because they reflect predicted performance. Most folks who declare that “stocks are cheap” use forward or predicted earnings. Right now, the consensus forward earnings forecast is that they will be better even though the economy is slowing. So, if the consensus forward PE of the S&P 500 is 14 and the average of the last 10 years is 15, then “stocks are cheap”.
The other issue in the “stocks are cheap” discussion is that the PE is a per share number. So, even if earnings are declining, the PE can be increased if the company buys back stock. Since investors (see Debt bubble Part 1) have a lot of money to lend, many companies have borrowed money to buy back stock. So, when deciding whether stocks are cheap, the quality of the earnings are an important considerations. As you might expect, the “stocks are cheap” analysts are great fans of the practice of borrowing money to buy back shares. BTW, this is called reducing the float. Per share earnings are also important to the compensation of many corporate executives. This also increases the tendency to borrow money to buy back shares.
There is another dimension to the quality of earnings. This gets a little convoluted. Going back the the S&P 500, it turns out that banks and other financial institutions and oil companies are a large part of that index. These companies tend to have lower than average PE ratios, so they drag down the overall index. Their PE ratios are lower because folks are skeptical about the quality of the forward or predicted earnings. In the case of the financial institutions, this skepticism has proven to be well founded as many have taken huge write downs and reported reduced earnings or losses. These write downs are, of course, related to the dynamics of the imploding debt bubble. They reflect the reality that the quality of the reported earnings were not as good as originally reported. Since these write downs are one off events, the forward earnings forecasts do not include provisions for future write downs. This effectively inflates the forward PE. The “stocks are cheap” tend to believe that “all of the bad news is out”. I put that in quotes because “all of the bad news is out” is a very common phrase used by analysts; especially analysts who believe that “stocks are cheap”.
One of the other things that drives me crazy is that many of the “stocks are cheap” analysts are also fans of certain high PE stocks. They tend to like companies like Amazon (AMZN) with a PE of 90, Research in Motion – the Blackberry folks (RIMM) with a PE of 49. Google (GOOG) with a PE of 44, Chipolte Mexican Grill (CMG) with a PE of 67. The list goes on. These are called momentum (or MOMO) stocks and their lofty PE multiples are justified for a variety of reasons. DO NOT BUY THESE STOCKS. Unless, of course, you are a very active stock trader and can get in and out very quickly (which means that you are likely not a reader of this blog post). If your financial advisor recommends that you buy any of these high PE stocks as a long term holding, then you should find a new financial advisor.
So what is somebody who has money in the stock market to do? If you have time to do more research, then these folks publish a lot of good information and have a couple of mutual funds. http://www.hussmanfunds.com/index.html. I have not purchased these because I am aggressively invested in the stocks are not cheap thesis. When I get to a point where I stop obsessing about what is happening in the financial markets and want my life back, I expect to put a lot of money in these funds.
Debt bubble part 1
Cliffsnotes (I'm doing this to make sure that I have my head around the issues). Still lengthy:
Definitions:
-- Borrower: borrows money to buy stuff (could be citizen, could be a commercial venture).
-- Lender: loans money to borrowers.
-- Investor: Has money to loan to lenders or buy securitizations from lenders
-- Securitizations: some group of loans that is sold by lenders to investors.
When a lender makes a loan, the loan reduces the lender's ability to make another loan. If the lender can sell that loan to an investor, then it allows the lender to make another loan. Lenders like to do this because a large part of their profit comes from the fees that they charge to make a loan. It is not at all like the olden days when lenders would make their profits on the spread between the interest that they paid to their depositors and the interest rate that they charged on the loans.
For reasons that deserve their own Ciffsnotes, these securitizations became very popular with investors. This means that lenders were able to sell as many of them as they could create. We experienced a deterioration in quality of all types of loans, but especially loans that were made against residential real estate. Since the so-called sub-prime residential real estate borrower was the first to experience distress and start defaulting in large numbers, this unwinding debt bubble has been labeled a sub prime crisis. It is, in fact, a debt crisis. Poor quality loans were made against a wide variety of asset classes.
In order to understand why this is a large problem for us today requires an understanding of fractional reserve banking: http://en.wikipedia.org/wiki/Fractional_reserve_banking. In short, this means that because the lenders were able to sell their loans to the investors, they were able to “create” more money than would have been the case had they just held those loans on their balance sheets. This additional money creation supercharges the economy when the debt bubble is inflating but (gotta choose the right verb here) enhances the deceleration in the economy as the debt bubble deflates because money is being destroyed more rapidly then would have been the case had not so much money been created.
Now, just how dependent we are on supercharged debt/money creation and how bad will it be when the debt/money is being destroyed is a topic for vigorous discussion in a variety of forums. Your decision on this issue will have an important impact on how you decide to invest in the weeks, months and years to come.
Definitions:
-- Borrower: borrows money to buy stuff (could be citizen, could be a commercial venture).
-- Lender: loans money to borrowers.
-- Investor: Has money to loan to lenders or buy securitizations from lenders
-- Securitizations: some group of loans that is sold by lenders to investors.
When a lender makes a loan, the loan reduces the lender's ability to make another loan. If the lender can sell that loan to an investor, then it allows the lender to make another loan. Lenders like to do this because a large part of their profit comes from the fees that they charge to make a loan. It is not at all like the olden days when lenders would make their profits on the spread between the interest that they paid to their depositors and the interest rate that they charged on the loans.
For reasons that deserve their own Ciffsnotes, these securitizations became very popular with investors. This means that lenders were able to sell as many of them as they could create. We experienced a deterioration in quality of all types of loans, but especially loans that were made against residential real estate. Since the so-called sub-prime residential real estate borrower was the first to experience distress and start defaulting in large numbers, this unwinding debt bubble has been labeled a sub prime crisis. It is, in fact, a debt crisis. Poor quality loans were made against a wide variety of asset classes.
In order to understand why this is a large problem for us today requires an understanding of fractional reserve banking: http://en.wikipedia.org/wiki/Fractional_reserve_banking. In short, this means that because the lenders were able to sell their loans to the investors, they were able to “create” more money than would have been the case had they just held those loans on their balance sheets. This additional money creation supercharges the economy when the debt bubble is inflating but (gotta choose the right verb here) enhances the deceleration in the economy as the debt bubble deflates because money is being destroyed more rapidly then would have been the case had not so much money been created.
Now, just how dependent we are on supercharged debt/money creation and how bad will it be when the debt/money is being destroyed is a topic for vigorous discussion in a variety of forums. Your decision on this issue will have an important impact on how you decide to invest in the weeks, months and years to come.
Saturday, November 3, 2007
Bill Miller, we are watching
SAN FRANCISCO (MarketWatch) -- Bill Miller, the veteran Legg Mason mutual-fund manager whose remarkable 15-year streak of market-beating performance ended in 2006, says that battered brokerage, housing and consumer stocks are poised to become big winners. And he says he's trimming many of his fund's largest holdings in order to buy more of them.
This recommendation has created a bit of a commotion in certain circles because I and many others believe that there is much more downside to brokerage and housing stocks. Since Legg Mason already has very substantial positions in many of these stocks my question is whether he is really going to expand his position, or whether he wants to unload some of it. Rather than make idle accusations, we should let the facts speak for themselves. This story will take months to unwind, but this is what I have gathered from Yahoo finance so far. I've supplemented the Yahoo data with additional research when Legg Mason did not make the top 10 list of institutional holders. I will look forward to updating this chart when newer information is available.
This recommendation has created a bit of a commotion in certain circles because I and many others believe that there is much more downside to brokerage and housing stocks. Since Legg Mason already has very substantial positions in many of these stocks my question is whether he is really going to expand his position, or whether he wants to unload some of it. Rather than make idle accusations, we should let the facts speak for themselves. This story will take months to unwind, but this is what I have gathered from Yahoo finance so far. I've supplemented the Yahoo data with additional research when Legg Mason did not make the top 10 list of institutional holders. I will look forward to updating this chart when newer information is available.
| Ticker | Shares | % ownership | Report Date |
| CFC | 51,587,956 | 8.96 | 30-Jun-07 |
| KBH | 4,337,015 | 4.22 | 30-Jun-07 |
| LEN | 2,304,000 | 1.44 | 30-Jun-07 |
| TOL | 3,587,786 | 2.29 | 30-Jun-07 |
| RYK | 7,218,698 | 17.21 | 30-Jun-07 |
| PHM | 30,925,258 | 12.08 | 30-Jun-07 |
| DHI | nothing | found | 30-Jun-07 |
| BZH | 6,708,672 | 17.16 | 30-Jun-07 |
| HOV | nothing | found | 30-Jun-07 |
| CTX | 17,136,660 | 14.18 | 30-Jun-07 |
Monday, October 15, 2007
Financial Responsibility Petition
We continue to move from one mini-crisis to the next in the financial markets, so maybe this will all work out OK. One of my major concerns has been that reforms put in place in the 1930s to ensure the stability of the banking system have steadily eroded. The repeal of Glass-Steagal allowed traditional depository banks (which have direct access to Federal funds) to engage in much more risky financial wizardry. The recent collapse of mortgage lending standards and the resulting housing debacle is a good example of what happens when mega-banks operate without adult supervision.
Anyway, I was involved in helping to draft this on-line petition. I tried to get the author to tone down the rhetoric and eliminate the last two points. The petition is here. http://financialpetition.org/ .
If you take a look at it, please vote in the poll and let me know what you think.
More information about Glass-Steagal is here: http://en.wikipedia.org/wiki/Glass-Steagall_Act.
Anyway, I was involved in helping to draft this on-line petition. I tried to get the author to tone down the rhetoric and eliminate the last two points. The petition is here. http://financialpetition.org/ .
If you take a look at it, please vote in the poll and let me know what you think.
More information about Glass-Steagal is here: http://en.wikipedia.org/wiki/Glass-Steagall_Act.
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