I’m on Market Call!

On Wednesday, September 17th, 2014, I will be on the show ‘Market Call’ on BNN (Canadian Business Show) 1:00 pm – 2:00 pm (eastern standard) with Mark Bunting.

 

Take this opportunity, open our Model Price Facebook application and follow along while I’m on the show answering viewer’s questions about individual stocks.

 

Would you say anything different based on your interpretation of Model Price Theory and chart? You can make your comments via Facebook.

 

Should be fun!

 

modelprice

September 2014 – S&P/TSX Composite Market Strategy Update

Since it’s September and everyone is back to work or school, and I haven’t reviewed the Canadian market for a while, let’s have a look at our model price charts.

First, let’s have a look at the long-term model price chart of the S&P/TSX Composite Index to get some context of where we are and more importantly where we are going – probably.

 

Long-term Model Price Chart

 

S&P/TSX Composite Index with monthly price bars and EBV Lines (colored lines)

S&P/TSX Composite Index with monthly price bars and EBV Lines (colored lines)

 

As you can observe the S&P/TSX Composite is in the zone between EBV+2 and EBV+3. It doesn’t take a brain surgeon to figure out that this index will probably reach EBV+3 over a period of time especially if the US market reaches EBV+4. Again timing is difficult for us but at least we have a roadmap.

And like my comments on the S&P 500, I believe the most likely scenario will be for this Canadian index to rise to EBV+3 (Red Line) and then crawl along EBV+3 when the S&P/TSX Index finally achieves this EBV level – see illustrated on model price chart above.

Zeroing in to our short-term model price chart reveals the following

 

S&P/TSX Composite Index with weekly price bars and EBV Lines (colored lines)

S&P/TSX Composite Index with weekly price bars and EBV Lines (colored lines)

 

As a reminder we aggregate all companies in the S&P/TSX Composite Index into one chart on a market capitalized basis (like the Index itself), so we can see where the market – S&P/TSX Composite Index – is trading relative to its EBV lines.

As you can observe the Canadian market, as defined by the S&P/TSX Composite, is in the middle of the zone bookmarked by EBV+2 and EBV+3. If the market rallied to EBV+3 (19,592) this would represent a gain of some 26%. If the market corrected back to EBV+2 (14189) investors would be suffering losses of almost 9%.

For people new to Model Price Theory [MPT] the index value or price can move within an EBV zone with no real consequence. However when a transit occurs – index value or price crosses one of our parallel lines – an EBV line, either positive or negative this gives Model Price users a signal that fundamentals are improving or deteriorating, respectively.

So the question of the day is, “What industry sectors need to rally in order for the S&P/TSX Composite to rally up to EBV+3?”

When one looks at the S&P/TSX Composite Index three industry sectors make up 84% of the total Canadian composite index value. Financials make up a large 34.4%, with Energy 26.2% and Utilities/Telecoms 23.4% making up the balance (of the total 84%). So let’s do a quick review of each sector to get a sense what these three sectors need to do for the S&P/TSX Composite Index to achieve EBV+3.

Financials

Canadian financial stocks have been buoyant for much of 2014 as you can see from our long-term model price chart on the S&P/TSX Financial Sector.

S&P/TSX Financial Sector Index with monthly price bars and EBV Lines (colored lines)

S&P/TSX Financial Sector Index with monthly price bars and EBV Lines (colored lines)

 

But as you can observe from the above chart the overall sector valuation was substantially higher, over EBV+2, in 2007. Even in 1998 the Canadian financial sector peaked in valuation over EBV+1.

So a reasonable person can conclude that valuations in this sector could go higher, at least history does show higher past valuations.

Energy

Canadian energy stocks have had a good 2014, even though the sector has become stalled in the last month. This is logical because one can observe from the below S&P/TSX Energy Sector Model Price chart that the sector of energy companies has rallied just under EBV+3 and encountering resistance.

 

S&P/TSX Energy Sector Index with monthly price bars and EBV Lines (colored lines)

S&P/TSX Energy Sector Index with monthly price bars and EBV Lines (colored lines)

 

Looking at past valuations one can observe the positive transit of EBV+3 back in 2004, with the sector rallying to an eye popping EBV+5! One can also observe a positive transit of EBV+3 back in 1996 and rallying mid-way between EBV zones 4 and 5.

Clearly the Canadian energy sector does have room to rally and probably has to rally past EBV+3 to take the S&P/TSX Composite Index to EBV+3.

Telecoms

S&P/TSX Telecom Sector Index with monthly price bars and EBV Lines (colored lines)

S&P/TSX Telecom Sector Index with monthly price bars and EBV Lines (colored lines)

 

Hmm…. No surprise here.

Looking at the S&P/TSX Telecom sector we are at valuation highs going back to 1995. Some may point to 1998 to 2000 to say this index was at EBV+5 and higher. I discount this because Nortel was part of BCE at the time – remember – skewing both the valuation of BCE and our EBV valuation.

The bottom line here is the telecom index won’t provide much help in the S&P/TSX Composite index reaching EBV+3

Utilities

Now this was a surprise to me.

I thought ‘interest sensitives’ would be at the highest equity valuation since interest rates are currently at historic lows. But as you see on our S&P/TSX Utilities sector model price chart there is some headroom for the Utilities sector to reach EBV+3, as it did back in 2007.

 

S&P/TSX Utilities Sector Index with monthly price bars and EBV Lines (colored lines)

S&P/TSX Utilities Sector Index with monthly price bars and EBV Lines (colored lines)

 

You can also see back in 1998 this sector almost reached EBV+3.

Conclusion

Can the S&P/TSX Composite Index reach EBV+3?

Sure, there seems to be headroom, for valuation increases based on past years valuation highs, in the sectors that make up 84% of the Composite index that I have illustrated.

Can the S&P/TSX Composite Index reach this important valuation level, EBV+3, without the help of U.S. equity markets? No, of course not. But as the most watched S&P 500 Index pushes up to EBV+4 the less globally watched Canadian composite index will probably get pulled higher as well. This makes sense and jives with financial history.

Am I saying this is a slam-dunk that equity markets, on both sides of the North American border, will trade substantially higher in the near future and without risk? Of course not! But viewing valuation through the prism of our model price charts not only at the composite level but also at the individual sector level can give an investor an invaluable insight and a roadmap on a probable future valuation levels that equity markets can achieve based on the past valuation highs (and lows).

September 2014 – Monthly S&P 500 Market Strategy Update

There are no ‘Cheerleaders!’

If you want to put your finger on ‘what’s wrong’ with this market it’s that no one wants to cheerlead this thing. In the run up to the market crashes of 1987, 2000 and 2007 equities were the only game in town with the investment public along with institutional investors shaking pom-poms with excitement. Everyone back then, and I do mean everyone was invested with both feet with the financial press leading the charge.

Comparatively today as the S&P 500 Index hits all-time highs, on a daily basis, nobody seems to care. (See CNBC’s latest ratings courtesy of ZeroHedge here) Better still who or what group of people or institutions can be seen as leading the charge to invest in equities. Giving everybody the all-clear signal that it’s OK to be invested.

In the past bull markets we had Abby Joseph Cohen, George Soros and even Alan Greenspan for goodness sake! Industry leaders publicly announcing bullish price targets and trumpeting America’s inherit abilities and strength. Who and where are these people today? Anybody?

Or is having no ‘Cheerleaders’ the single biggest positive for the US equity market going forward?

Confusing…. maybe?

And the institutions and retail investors who I talk to everyday – who are invested – seem to have the confidence only to have one foot in this market. It seems to me that for any reason if something were to happen – from a myriad of Global hot issues – or if a correction were to start tomorrow seemingly everyone would hit the sell button immediately.

Talk about ‘knife edged’ investing!

However look at our model price chart for the S&P 500 – below. It looks tranquil and upward sloping. Remember our index price bars show weekly movement of the S&P 500 and what does it indicate? Index price gains with no intra weekly price volatility.

In other words a perfect market to ‘Cheerlead’!

S&P 500 Index with weekly price bars and EBV Lines (colored lines).

S&P 500 Index with weekly price bars and EBV Lines (colored lines).

 

As a reminder we aggregate all companies in the S&P 500 Index into one chart on a market capitalized basis (like the S&P 500 Index itself), so we can see where the market – S&P 500 – is trading relative to its EBV lines.

As you can observe the US market, as defined by the S&P 500, is still in the middle of the zone bookmarked by EBV+3 and EBV+4. If the market rallied to EBV+4 (2190) this would represent a gain of some 9%. If the market corrected back to EBV+3 (1751) investors would be suffering losses of almost 13%.

For people new to Model Price Theory [MPT] the index value or price can move within an EBV zone with no real consequence. However when a transit occurs – index value or price crosses one of our parallel lines – an EBV line, either positive or negative this gives Model Price users a signal that fundamentals are improving or deteriorating, respectively.

Two Ways of Making Gains in the Market

Model Price charts can help investors differentiate between the two ways of making gains in the equity market. As the index price value increases and moves up in the zone between EBV levels, the valuation of the overall market is increasing. In other words the market, collective buyers and sellers at the margin are willing to pay more in price terms for the earnings generated by the companies included in the index or in this case the S&P 500. As the S&P 500 Index crawls to EBV+4 investors are benefiting from an ever-increasing valuation.

The second way of making gains is the growth of the book values of the companies included in the index. Companies over time usually increase their book value as excess earnings are accumulated on their balance sheet. We capture this growth by calculation of our EBV lines. If you observe upward sloping EBV Lines the collective companies in the S&P 500 Index are increasing their book value or net worth over time. Over long periods of time companies usually increase their book value after dividends are paid and stock buybacks are deducted from capital of about 4 or 5 percent compounded.

Why do I mention this?

Over the last soon to be six years, from the market bottom of March 9, 2009, investors have been benefiting from both increased valuation – from EBV+1 to over EBV+3 – and growth in book value of the underlying companies in the index. The past returns have been phenomenal to say the least…in the mid-twenty percent range compounded.

This however cannot last!

If you assume the S&P 500 Index goes to EBV+4 and stays there for a prolonged period – my most likely assumption like the period between 2002 to July 2007 (See long-term model price chart below) – the ever- increasing valuation portion of investors return will stop. Future stock returns will have to rely on the growth of the collective book value or the growth of our EBV Lines. So for instance, say the S&P 500 Index goes to the top of the zone or EBV+4 (2190). We calculate the value of EBV+4 in September 2015 to be 2420. This implies a return of 10.5% for the Index over the year. Which is good, don’t get me wrong, but not as good as the past 5 and a half years.

Long-term model price chart of the S&P 500 Index

S&P 500 Index with monthly price bars and EBV Lines (colored lines).

S&P 500 Index with monthly price bars and EBV Lines (colored lines).

 

Am I adjusting everyone’s expectations… Yup!

Could there be other possibilities? Yes, countless including a market correction back to EBV+3, which is always a risk.

Conclusion

The great thing about Model Price Theory [MPT] are the ‘What if’ scenarios investors can see in a graphical format that makes mathematical sense. And from these ‘What if’ scenarios investors can position their portfolios to reflect market risk and reward.

US market gains over the last 5 years have been great. However, mathematically speaking, the US markets are running “out of headroom” and lower market returns are inevitable as ever increasing valuation is unlikely to continue.

This is not the end of the world. This is just a comment on the general index itself. For those who trade individual stocks – stock pickers – this future period of time, if my most likely scenario pans out, can represent a great opportunity to significantly outperform if you or your clients are comparing yourself to the S&P 500 Index as we did using MPT during 2002 to July 2007 period.

Yes, always a bright side when using Model Price Theory [MPT].

As always see what happens.

Badger Daylighting – Catching Lighting in a Bottle

Yes, it has a funny name but big gains were made from investing in this company over the last year and a half.

We are a society that hunts for and admires winners. And when a stock climbs in a parabolic fashion we have no problem recognizing what a winner looks like.

We live in an information culture and there’s so much information that you have to feel inadequate at least some of the time. Badger, I have to admit, came from left field for me. I never heard of the company until mid way through 2013. Cable television shows, financial media – both print and the Internet – are all pushing to get your attention and making sure you and everybody else know who the winners are.

And I love looking for and actively seek out big stock winners like Badger. They attract what I call “heat” or “buzz”. Like a moth attracted to a night light investors/traders want to know everything there is to know about a winning stock – the management, the product and growth prospects in this very slow national economy. And of course the word brilliant is used a lot. One will hear the business press use the words ‘brilliant management’, ‘the best product ever to hit the market’, and of course ‘unlimited growth potential’.

But valuation is a two edged sword. The higher the stock rises the more the company has to do to maintain everyone’s expectations. And in the end an impossible task to fulfill or a self-fulfilling prophecy.

From my experience investors can’t resist such temptations. We all want to belong. We want to be part of the action. In our capitalist society you can belong by purchasing the winning company’s shares with our hard earned cash. And if you don’t have enough money the investment industry will lend it to you – happily. Leverage? Yes sir…step right up!

And of course a surging stock price confirms what you already know. It’s seems circular and self-reinforcing.

And once we’re an owner you are part of the story. You’re smart because you’re part of a group of people who are smart. The business press and a surging stock price confirm this to yourself and others you have told at the proverbial Saturday night cocktail party where your closest friends or relatives are impressed by your business acumen.

You’re a winner by default because you’re an owner.

And I could go on. You put the stock in your iPhone portfolio tracker. You become mesmerized by the flicking stock price, tick by tick. You see every research report, listen to the quarterly conference call, and check ‘StockTwits’ once an hour to see every tweet.

And lastly, you start personalizing your gains. Think of a bigger house, family vacation or that new sports car you always wanted.

And your stock starts to go down!

But when do you sell?

Yikes, nobody wants to talk about selling because selling is hard. Like leaving the poker table with your pockets full. It never happens.

And when the stock starts to go down, you can’t sell. You know the story too well. You spent how many hours doing what you consider research. You know everything there is to know about the stock, about the industry and management but the stock continues to slide and the losses continue to escalate. (You calculate your losses from the 52-week high NOT from your purchase price because you could have sold at the high, couldn’t you? That money was yours to take but you didn’t, did you?)

And of course, the dreaded realization “When this stock price recovers and I can get my money back I will sell the position.”

I digress.

Badger Daylighting has had one hell of a ride. Let’s take a look at the long-term model price chart of BAD.

Badger Daylighting with monthly price bars, EBV Lines (colored lines) and model price ( purple dashed line)

Badger Daylighting with monthly price bars, EBV Lines (colored lines) and model price ( purple dashed line)

 

Observables from the above chart

 

  1. Interesting to note that Badger bottomed at EBV+2 back at the market lows in March 2009. Over the last 5 years the stock has risen from EBV+2 to over EBV+7. Giving both investors and management one hell of a ride and tremendous gains.

 

  1. Badger tried and failed to positively transit from EBV+4 at points ‘A’ and ‘B’ annotated on the model price chart above. Note that are calculation of model price supported such a transit.

 

  1. Finally at the end of 2012, Badger had a positive transit of EBV+4 and according to MPT [Model Price Theory] a buy signal.

 

  1. As Badger stock price rockets upward there are multiple positive transits after the first positive transit noted in observation number 3. The stock transited through EBVs 5,6 and 7 giving investors holding the stock confidence of future gains and good entry points for traders/investors who wanted to initiate a position in the company.

 

  1. Our calculation of model price, or our definition of fair market value, is supporting the upward movement in the stock price up to a point – it begins to flatten out at EBV+6.

 

  1. Our calculation of model price may stop at EBV+6 but Badger’s stock price continues higher as momentum traders’ pile in hoping for more and fast gains.

 

Transitioning to our short-term Model Price Chart below

Badger Daylighting with weekly price bars, EBV Lines (colored lines) and model price (purple dashed line)

Badger Daylighting with weekly price bars, EBV Lines (colored lines) and model price (purple dashed line)

 

Observables

 

  1. As you can observe Badger had a positive transit of EBV+7 in the first week of April 2014. And after spending 6 weeks above EBV+7 the stock had a negative transit in the middle of May. This is the first negative transit for Badger since 2008-09 and according to MPT [Model Price Theory] a sell signal.

 

  1. Badger tried and failed to rally back and over EBV+7 in June. This is a classic retest where investors/traders think Badger is cheap on a pull back only to find the stock goes lower in the future.

 

  1. The second sell signal for Badger comes this past week with another negative transit of EBV+6. And obviously Badger starts trading lower than our calculated model price. This, at least, is one positive but usually in these broken momentum stock stories substantial value has to be created in order for new money flows to come in and buy the name.

 

Conclusion

How many times have I seen stocks like Badger over my career? Hundreds of times would probably understate my experience.

But through the prism of Model Price Theory [MPT] you can be resistant to such stock moves. Oh sure, you can trade/play/invest in these stocks, as I have over the years. But you know these situations will probably end badly for most people. Yes, you get a feeling of schadenfreude because the happiness everyone feels with today’s winners will be just as painful for many people down the road as the stock turns lower.

Am I predicting disaster for Badger?

No!

I’m just following and observing a negative transit – actually 2 negative transits but who’s counting! Like when the tides recede one can’t tell what is going on by looking at the shoreline close up. One needs a broader perspective and hopefully a fixed marker to gauge what is happening to the water level for clarity.

Our EBV levels give you this fundamental certainty and from my experience the best sell signals in finance.

I’m on Market Call!

On Friday, August 15th, 2014, I will be on Market Call on BNN (Canadian Business Show) 1:00 pm – 2:00 pm (eastern standard) with Mark Bunting.

 

Take this opportunity, open our Model Price Facebook application and follow along while I’m on the show answering viewer’s questions about individual stocks.

 

Would you say anything different based on your interpretation of Model Price Theory and chart? You can make your comments via Facebook.

 

Should be fun!

August 2014 – Monthly S&P 500 Market Strategy Update

Ukraine seems to be getting worse with pro-Russian rebels downing Malaysia Airlines flight MH17 over Eastern Ukraine. Israel decides to send in troops to Gaza after rockets have been fired from Gaza into Israeli broader settlements. The meanest and the most feared terrorist group in the world today, ISIS, seems to be accumulating and consolidating land and power in central Iraq prompting President Obama to send military observers back into Iraq.

Yes, it was a busy July for world affairs (and US Secretary of State) but the U.S. equities markets barely noticed.

But then Argentina defaulted on their sovereign debt during the last week of July sending the U.S. markets for a much-publicized down day, erasing the annual accumulated gains for the Dow Jones Industrials and shaved half the yearly gains in the S&P 500.

At least the U.S. financial markets noticed something!

As usual let’s have a look at the model price chart of the S&P 500 Index.

 

S&P 500 Index with weekly price bars and EBV Lines (colored lines)

S&P 500 Index with weekly price bars and EBV Lines (colored lines)

 

As a reminder we aggregate all companies in the S&P 500 Index into one chart on a market capitalized basis (like the S&P 500 Index itself), so we can see where the market – S&P 500 – is trading relative to its EBV lines.

As you can observe the US market, as defined by the S&P 500, is still in the middle of the zone bookmarked by EBV+3 and EBV+4. If the market rallied to EBV+4 (2176) this would represent a gain of some 12%. If the market corrected back to EBV+3 (1740) investors would be suffering losses of 10%.

For people new to Model Price Theory [MPT] the index value or price can move within an EBV zone with no real consequence. However when a transit occurs – index value or price crosses one of our parallel lines – of an EBV line, either positive or negative this gives Model Price users a signal that fundamentals are improving or deteriorating, respectfully.

Can the S&P 500 move down to EBV+3?

Absolutely!

Would it mean anything?

Nope!

Can the S&P500 make new annual highs?

Absolutely!

Yup, the higher the S&P 500 Index value or price is from our calculated EBV+3 (red line) the more risk, and conversely less reward, investors are taking on their U.S. investments.

The world can be a complicated place. The global news media along with the Internet use a loudspeaker on any and all news. The din can be deafening and disorientating. But our model price charts have a calming affect if often used. It sooths me and puts everything in perspective.

Have I found anything in the financial information world to do the same thing?

Nope!

But I’ve only got 30 years in the investment and finance business; maybe I haven’t found it yet?

Enbridge Inc. – What Asset Bubbles Look Like!


So you have some cash to invest.

 

Ten year Government of Canada bonds currently yield 2.12%.

 

Today the dividend yield of Enbridge is 2.54% without considering tax advantages of a taxable individual taxpayer.

 

Plus look at the rates of return on Enbridge Inc. over the last 5 years. Enbridge is up 180% over the last 5 years not including dividends. Chuck in the dividends earned and assume Treasury bill returns on your dividend cash and you increase the return to some 210%. That’s 25% compounded over the last 5 years.

 

Your investment advisor recommends Enbridge as an investment, considering the alternative what choice do you have. Or you’re doing equity database screens looking for possible investments and Enbridge sticks out like a lighthouse on a foggy night.

 

The investment public and financial advisors alike have no defense when they look at these numbers. With Enbridge an investor ‘pick ups’ or receives an uptick in current yield and no one has lost any money in recent memory. What is there not to like?

 

Ah! Smart Money.

 

The Fly in the Ointment!

 

Unfortunately there is something wrong here. But nobody can figure it out because it’s complicated. And we all know when things get complicated the majority of the people are lost. Hell, the whole investment industry is lost by my account.

 

What’s wrong with Enbridge? It’s overvalued. It costs too much. And we all know what happens when you overpay for something… anything? You get burned. You lose some or all of your money that you’ve invested.

 

But being wrong, or not understating something because it’s complicated won’t lose you money immediately. Nope. Sometimes it takes time. When strong money flows are being invested in a stock or investment theme usually certain fundamentals are considered but not others.

 

Because we equate making money in the stock market with being smart. But the truth is being smart and making money in the market have little to do with each other.

 

Huh?

 

Let me put it this way. I have seen some truly bright people (few I admit) in the investment business that were unlucky and financially wiped out. Yes, their analysis was top drawer. They were totally logical and analytically correct and as I remember in one or two cases… eloquent. But the market did something unexpected. “How is this possible?” each one said to me rhetorically and in a couple of instances tearfully.

 

And I have seen a lot of financially unsophisticated individuals in the financial business and some ‘stupid as a post’ (more than I care to admit) that were lucky. Right time right investment. No analysis whatsoever. Truly throwing a dart at the proverbial dartboard. And you guessed it, they were heralded as true genius. If there was a cocktail party or a crowded bar they were the ones surrounded by the most people, five rows deep, hanging off their every word.

 

When I looked at the investment business critically when I first started in the business…luck, whether good or bad, plays a very important part in a persons’ success or failure. Please don’t tell a newly minted MBA or CFA this fact. I have and received more than my share of scorn.

 

The truth is if an investor or portfolio manager is consistent with his or her investment style over long periods of time they will have good and sometimes great investment returns. However there will be short periods of time when this same investor will endure subpar to nonexistent returns not because the investor is wrong or lost his marbles its just the market or better still a sector of the market (say gold or utility companies) that can perform in such a way to make the investor and portfolio manager look stupid or out of touch.

 

So forgetting luck, let’s grind some numbers and do some analysis.

 

Snap shot of Enbridge from our Model Price app.

Screen Shot of Enbridge Inc. from our Facebook Model Price app

Screen Shot of Enbridge Inc. from our Facebook Model Price app

 

 

The first observation one can make is that our calculation of model price has always been below the stock price of Enbridge over the last 6 years. And currently Enbridge is trading at a 40% premium above its calculated fair market value. This is what I mean by expensive. Someday Enbridge will be trading at or at a discount to our calculation of model price, we just don’t know when that will be.

 

The second observation I can make is from our EBV Lines. I have looked at our database that goes back to 1995 and at no time has Enbridge traded at EBV+5! Yes, that’s almost 4 times accounting book value that for a utility with limited growth prospects is exceedingly pricey (expensive).

 

But investors don’t care. The yield differential is compelling and everyone has made a ton of money riding the boom to lower and lower Canadian interest rates.

 

Do I feel bad for missing out?

 

Nope!

 

The great reckoning will come (I’m sure of it) and besides I’ve been making investment dollars elsewhere. Places that make sense. Where the market has been discounting assets while other assets are selling at premium prices.

 

Sometimes simplistic investment themes can work to an investor’s advantage. And work over long periods of time – say six years in Enbridge’s case. But investors relying on ‘TINA’ (There Is No Alternative) will get a shock one of these days and their luck will run out.

 

Investors doing the second iteration financial analysis, Model Price Theory [MPT] analysis will be joyful and ‘lucky’ not to be picking up yield at the expense of valuation.

 

Spend any time on the Internet looking at financial information and you’ll see the phrase ‘financial bubbles’ used often. And asset bubbles can and will form in the most unlikely places (i.e. tulip bulbs). Who would expect an asset bubble in a industry sector known for conservatism and coupon clipping? Fortunes of conservative investors taking huge valuation risk for little additional income will end badly, guaranteed, unfortunately the critical question is when.

 

And to predict when you have to be… lucky or not play at all. I choose the latter.

Intel (INTC) – Model Price Analysis

What we call “Old Tech” has been on a tear in 2014.

 

Has anybody noticed?

 

Case in point has been Intel Corp. that had a positive transit of EBV+4 last week when the company reported second quarter earnings. All in all (with dividends) Intel is up almost 40% for 2014 and with a positive transit of one of our EBV Lines indicating improving corporate fundamentals and potential share gains in the future.

 

An additional fundamental positive is our calculation of model price. As you can observe from the model price chart below our calculation of fair market value for Intel is $46.25. This implies another 35% gain potential for investors sometime in the future.

 

Model Price Chart that can be found on our Facebook app 'Model Price'

Model Price Chart that can be found on our Facebook app ‘Model Price’

 

Additional Model Price Analysis

 

I was curious about Intel. Maybe something is going on here that can make me a few dollars – more than I have already made from EBV+3. I seem to recall, from the daily white noise of the business press, Intel getting into the chip (semiconductor) business for mobile phones, albeit very late in the game, combined with the fact the company has a new CEO. CEO’s are very important to the long run (secular) gains of any public company. Ask an investor in Apple since Steve Jobs returned to Apple in 1996 or long term investors in General Electric when Jack Welsh was running the company back in 1980’s and 90’s. CEOs make a big difference in rates of returns on your investments and if you can identify one early enough, invest, sit back and relax and you can enjoy a great financial ride into retirement.

 

Good CEOs leave fingerprints. Financial fingerprints. Fingerprints you can identify and see concurrently on a quarterly earnings report. Yes, we can all spot a special CEO after the fact. After this CEO added tens (and hundreds) of billions of market capitalization to the company that she runs. That’s easy.

 

In the context of investing; history is nice, but it’s the future I want to know.

 

First, I have a quick look at our long-term model price chart of Intel going back to 2007 of the Model Price Facebook app.

 

Model Price Chart that can be found on our Facebook app 'Model Price'

Model Price Chart that can be found on our Facebook app ‘Model Price’

 

Hmm… you can observe that Intel’s stock price had a positive transit of EBV+4 on two other occasions before last week. The first positive transit occurred in 2010 and the other obviously at the beginning of 2012. Interestingly both times the stock price peaked in price at mid-year before not only falling in price but also negatively transited back down through the same EBV+4. Yikes! Check your calendar; yes, it’s mid-year 2014!

 

“OK, strike one!” I say to myself.

 

But I’m still intrigued.

 

So I call up my Model Price database. My first analysis is looking at the long-term history of earnings of Intel and what is going on concurrently with Theoretical Earnings (TE). Theoretical Earnings is a financial concept particular to MPT. (For a fuller discussion of TE see ‘Key Concepts’ above.)

 

image00114

 

A few observables from the above chart

 

1. Intel’s earnings over the last twenty years have been more cyclical than I remember them.

 

2. Intel’s earnings ‘crashed’ during the financial crises of 2008 however rebounded smartly to record highs in 2012.

 

3. Looks like something happened in 2013 that caused a dip in earnings. What happened? I haven’t a clue nor do I care to find out. But a year after this dip, Intel’s earnings consolidated around the $2 a share level and look like they are returning to record highs (maybe).

 

4. Theoretical Earnings (TE) have been on a steady increase since 1995 with a dip starting in 2011 and 2012. I’m guessing here but this is probably because of share buybacks on behalf of the company. (Again I do not care why the TE is falling just that a falling TE and increasing earnings is a positive for the valuation of the company.)

 

We can look at this above chart differently.

 

I like computing a ratio between the two data series displayed above and charting the series over long periods of time. What I’m getting at with this analysis is how profitable Intel is relative to its’ own calculation of benchmarked earnings or TE. Or if you prefer the earnings of Intel relative to the size of the company’s balance sheet – a balance sheet the company’s CEO can control.

 

image0039

 

You can observe back in 1997-98 Intel was earning 9 times its TE. And having peaked at this level this ratio has fallen to a low and stable level at 2 times, plus or minus, over the last 12 years.

 

What does this mean?

 

Relative to the size of the balance sheet Intel’s earnings are quite unimpressive, somewhat stable (ignoring 2008), and a country mile from the robust years of 1997-98.

 

“Strike two!”

 

Convexity

 

The next MPT variable I call up in our Model Price database is convexity. Again you can find a definition of convexity under our ‘Key Concepts’ tab or better still I go to great lengths to discuss and define convexity in my blog on Apple and its share split (here).

 

image0052

 

Want a simple way to think of convexity? The higher the convexity number computed by Model Price Theory (MPT), the higher the valuation of the company. To crunch this number takes a lot of computer power on our part but integral to understanding the valuation mysteries of the market.   Also our convexity variable is embedded in our model price algorithm and necessary for its calculation.

 

Looking at the history of our convexity calculation you can observe that back in 1996 Intel had a convexity variable of 9 and it has been falling steadily since this peak. Again this variable is CEO controlled in the way she structures the balance sheet of the company.

 

For interest and giggles sake, with a convexity reading of 9 and a ratio of 9 times earnings versus Theoretical Earnings (TE), Intel traded at a valuation level of EBV+8 in 2000. Looking at our Facebook App for Intel shows if Intel was trading at EBV+8 today the stock price would be over $170 a share from the current $34! (Yes, that’s only a difference in market capitalization of $675 billion dollars.)

 

Both mind boggling in terms of potential gains for investors and proof what the market can reward management for good financial decision-making.

 

Irrespective of the glory days, Intel’s convexity is hitting new lows as you can observe on the above chart.

 

 

You guessed it, “Strike Three!”

 

So what does all the financial analysis mean?

 

My initial excitement on this most recent positive transit is waning. Certainly if earnings were to spike to record highs Intel could very well capture the valuation space between our model price calculation and its current trading price. Still representing a 40% upside target.

 

Not bad, yes?

 

A quick google search tells me Brian Krzanich took the reins as CEO back in May 2013. What does MPT tells us about his tenure so far? He’s no Jack Welch according to Model Price Theory (MPT).

 

Looks like just another ‘care taker’ CEO, unfortunately. I was hoping for so much more.

 

So to be clear I like Intel, and still see the value gap between where the stock is trading and our calculation of model price closing giving further gains to shareholders – see enclosed model price chart from Facebook. As of today, as I write this blog, Intel is our largest position or weight in our Acker Finley Select US 50 Fund with an unrealized gain of 47%. It’s just I was hoping or potentially intrigued that Intel may have the ability to be a 5 or 10 ‘bagger’ (5 times our original investment) that I clearly did’t see because of our above MPT analysis and hence this blog post.

Who do You Believe: Equity Analysts or the Market? – Reblog


I have been on hiatus from my blogging.

I have been upgrading my skills. Learning to ‘touch type’ so the words flow more freely, more genuine. I’m up to thirty words a minute and probably at the most frustrating part of this learned skill. Wanting to let the words fly on the keyboard but stopping way short by my fat fingers.

But I’m working everyday.

Also we are entering second quarter earnings season of 2014. My feeling is the US equity market is in a ‘take no prisoners’ kind of mindset. If any disappointment both on top line revenues and bottom line earnings the market reaction will be swift and judgmental. In other words…down. Even though the stock risk will be high, in my estimation, I still believe the market – S&P 500 – crawls higher to EBV+4.

In the mean time I will post a re blog of a blog I posted a year ago delineating the difference between our model price calculation and our EBV Lines illustrated on our model price charts. New individuals are joining and commenting everyday on the Model Price Facebook App and I believe this blog clearly explains the two pieces of calculated information we give to our users.

The blogging will be starting up again, now that at least I’m somewhat proficient at the keyboard and leaving behind the two finger ‘pecking’.

 

 

People new to Model Price have to weigh fundamental information given to them in the form of our lines on our model price charts.  Remember our Model Price charts gives or calculates two pieces of information for users – the first is our purple line or model price and the second is our parallel lines known as EBV lines or Economic Book Value lines.  Each product deliverable, model price and EBV lines, is independent of the other.  Sometimes these two data sets can confirm each other or offer major divergences from each other. I use both pieces of data independently but often give higher importance to our calculated EBV lines.

This blog post will discuss each product, model price and EBV lines, to give you a better or a more full understanding of the similarities or differences between the two.

Model Price (Purple Line on our Model Price Charts)

Our objective in the calculation of model price is to calculate what we believe to be fair market value of the company.  The algorithm that calculates this number is long and complicated but the most relevant piece of data in the calculation of model price is analysts “mean” earnings estimates.  For convenience sake we use estimates from of a group of published analysts from services that can be found on any popular financial news website.  (Yahoo is a popular example)

Whether people realize this fact but analysts’ earnings estimates change all the time when taken as a group mean average.  Individual analysts can change their quarterly estimates by fractions having an impact on the group “mean” estimate. Also material changes can occur during a quarterly earnings release and conference call, for example, as analysts adjust earnings when new information maybe released by company management impacting future financial results. We capture these changes on a daily basis and calculate a new model price based on the most up-to-date financial information. We maintain a database of our calculated model price and obviously use this price series to maintain our model price charts.

Probably the most interesting aspect of our model price calculation is the forward calculation of model price for the next year (long term model price chart – right chart) to give our users some perspective of the future trend of model price based, of course, on analysts’ estimates of future earnings.  We take great care to grow the balance sheet in future periods so the earnings estimates are current with the relevant balance sheet.  Obviously we cannot anticipate future corporate actions like M&A activity or common stock sales however most large cap stocks have stable capital structures that any projections of model price can be very accurate using past history as a guide.

For those of you who don’t know the job of equity analyst of Wall or Bay Street is one of the most demanding jobs in the security business. A top analyst can receive millions in compensation from their investment bank if they are the most accurate in terms of a company’s quarterly earnings estimate.  The pressure to be right about their coverage not only about the company itself but also the industry can be intense.  As a general rule of thumb, the larger the company the more analysts cover the company yielding higher quality earnings estimate data and relevance for the purposes of our calculation of model price.

This is the good news.

See my blog “Loblaw’s Deal with Shoppers Confirms our Model Price Calculation” as an example of our model price confirming fair market value (FMV) of a company.

The bad news is that equity analysts can also be wrong!

When company and industry trends are placid and predictable equity analysts are usually 99% on the mark in forecast quarterly estimates.  This makes sense.  Unfortunately when the company or industry is in turmoil the vast majority of the analyst’s freeze or hold their changes in estimates until the company comes clean or more information is available to quantify potential changes, usually in a quarterly conference call, or clearer trends manifest itself  in the industry.  These are major transition points where the stock price and the fundamentals of the company start to diverge.

These divergences – between the perceived fundamentals and actual fundamentals – is, in my opinion, where investors are the most vulnerable.

Enter Economic Book Value (EBV Lines)

Our second product deliverable is our EBV lines.  These are parallel lines that run through our model price charts.  Some of the EBV lines are coloured (green, blue, red and yellow for example) and others are grey or black.  In constructing these EBV lines we start with our green line or EBV.  As we add lines above our green line on a constant basis and we number each line in sequence (i.e. EBV+1, EBV+2…EBV+10). For EBV lines below or calculated green line we label EBV-1, EBV-2, and our last one EBV-3.

Once these EBV lines are constructed we add a simple open hi-lo-close price bar of the company’s publicly traded equity price.  We use a weekly price bar for our left hand chart – our definition of short-term view – and monthly price bars for our right hand chart.  It should be noted that these two pieces of data, EBV lines and public equity prices, interact independently of each other.  When the stock price of a company transits an EBV line, either positively or negatively, fundamental information is given to the observer of our model price chart.  A positive transit, stock price transits up through one of our EBV lines indicates fundamentals are improving for the stock in question and conversely if the stock price has a negative transit fundamentals are deteriorating.

Magically over time and experience users of model price will become convinced of the usefulness of our EBV lines. Equity prices of companies seem to use these EBV lines as support and resistance.  When transits do occur, both positive and negative, usually prognosticate major future company news that can have a major influence on the company’s future share price and direction.

See my blog “$76 Billion Reasons to Sell Gold Stocks.

These computed EBV lines can also give observers a quick reference point in terms of a company’s valuation.  When comparing a basket of equities together in indices or in the same industry an observer can quickly evaluate the valuation of the company in question.  For example, company ABC can trade above EBV+5 where as company XYZ may trade just over EBV+3 indicating a lower market valuation level for comparative purposes.  Our computed EBV lines can provide a quick reference and apples to apples comparison of individuals companies.

Back to the question, “Who do You Believe: Equity analysts or the Market?”

So you, the user of our Model Price App, get two pieces of financial information of a company that appears no where else on the internet and is not taught in any financial course at university – Model Price and EBV lines.

Users of Model Price App, a service that provides these calculations, have to weight these two pieces of information carefully.  Yes, knowing the fair market value of a company is indeed insightful when contemplating either a sale or a purchase of a particular company however analysts are the primary driver of this calculation and users should know their fallibility.  Where as our EBV lines are derived from the company’s balance sheet that in my opinion is more robust – a balance sheet has to balance after all  – and less likely manipulated by management, except in the case of fraud.

In a nutshell a lot of times, these two pieces of information – Model price and EBV lines – are confirming each other.

Here is a recent example of Yahoo having a positive transit of EBV+3 being confirmed by a positive and upward sloping model price calculation.

Yahoo Inc. with weekly price bars, EBV Lines (colored lines) and model price (dashed line)

Yahoo Inc. with weekly price bars, EBV Lines (colored lines) and model price (dashed line)

At major transition points, in equity markets in general and company dynamics in particular, I weight our EBV lines more heavily than our model price calculation. “The Market” is usually smarter at transition points than the equity analysts following the company on a group basis.

Barrick Gold back in February 21, 2013 having a negative transit even through our model price calculation is substantially above the current selling price is a good example of the divergance between model price and our EBV lines.

Barrick Gold Corp. with weekly price bars, EBV Lines (colored lines) and model price (dashed line)

Barrick Gold Corp. with weekly price bars, EBV Lines (colored lines) and model price (dashed line)

The weighting of the relevancy between model price and our EBV lines usually takes the user a short period of time and experience however in my opinion worth the time spent in terms of profitable investing.

July 2014 – Monthly S&P 500 Market Strategy Update

Ditto!

 

“Sorry what was that?” you say.

 

I opened last month – June 2014 – Monthly S&P 500 Market Strategy Update – with the opening, “What can one say about the US equity markets? No real volatility and hitting new highs everyday!”

 

What else can I say but the obvious…ditto!

 

As usual let’s have a look at the model price chart of the S&P 500 Index.

 

S&P 500 Index Model Price Chart

S&P 500 Index Model Price Chart

 

 

As a reminder we aggregate all companies in the S&P 500 Index into one chart on a market capitalized basis (like the S&P 500 Index itself), so we can see where the market – S&P 500 – is trading relative to its EBV lines.

 

As you can observe the US market, as defined by the S&P 500, is still in the middle of the zone bookmarked by EBV+3 and EBV+4. If the market rallied to EBV+4 (2162) this would represent a gain of some 9%. If the market corrected back to EBV+3 (1728) investors would be suffering losses of 13%.

 

This is the first time this year where the risks for the US equity investors outweigh the upside rewards since the positive transit of EBV+3 back in May of 2013.

 

Should US equity investors be alarmed? No. For me it’s just a reminder that risk is ever present and growing. I do look at my portfolio of stocks and ask, “Do I have too much?” And if I do I lighten up.

 

Of course it’s hard. Yes, I’m making tons of cash just holding my positions. But I have been in this game too long not to understand market risk. To me risk is being in a position of NOT buying more when the situation arises. Can you image having Apple (AAPL) pulling back to EBV+5 on a market pullback and NOT being in a position to buy more. That’s how I define risk. So I sell some Apple here. Make sense?

 

More than anything Model Price Theory (MPT) is about assessing risk/reward and investing a highly probable market or equity bottoms. Users of Model Price should always know where their individual equity positions are relative to their trading (EBV) zones including the overall market – S&P 500 Composite.

Since I began this blog quoting from the June market strategy blog, I will end it in the same way.

 

“So relax, take it easy because second quarter earnings are on the way and with September and October coming; these two months always seem to be eventful for one reason or another.

 

As always, see what happens.”