Monthly Archives: March 2012

ModelPriceGuy will be on Vacation for a Week.

Yes, tomorrow ModelPriceGuy will be focusing on the dimples of a golf ball as opposed to pixels on the screen.

Tonight, of course, we are set up for the earnings release of Research in Motion (RIMM).  We will input their year-end balance sheet (if they give one) into our system so you can have a look at the most up-to-date graph on Facebook with tonight’s computer run.  If there is anything significant in the release or the call we will rip off a quick post.  We will be looking anyway, so no big deal.  As a reminder, this was our last blog post on RIM and what we are looking for in terms of information from the company (here).

We will return rested and looking forward to the start of 1st quarter earnings parade, which will start the second week of April.

Apple as an Example of What is wrong with our Global Economy

In Saturday’s Wall Street Journal we couldn’t help but notice Holman Jenkins column where he wrote this about Apple.

“Apple …. [and] its abnormal profits are not likely to last, which brings us to this week’s decision to pay a dividend and buy back its stock.  The efficient markets hypothesis may be a poor old thing, but it’s all we’ve got.  In buying its own shares at the market price, Apple is merely exchanging one asset for another of equal value.  In paying a dividend it is merely shifting cash from one shareholder pocket to another.

 There’s only one good reason, then, for the stock to have lurched upward on the announcement, as it did:  Shareholders will be getting their hands on some of the company’s cash before management can squander it.  This week’s announcement, moreover, was but a teensy down payment on the discipline that will be needed.  Even after allocating $45 billion to dividends and buybacks over the next three years, Apple’s cash hoard is likely to grow – to as much $200 billion from today’s $100 billion according to Sanford C. Bernstein analyst Toni Sacconaghi.”

The Lex Column, in the Financial Times, Monday, March 26, 2012.

“… the news that Apple would begin paying a $2.65 per share quarterly dividend and authorise [sic] a $10 billion share buyback programme [sic].  To be sure, payouts give signals and little old ladies love receiving regular cheques [sic] in the mail.  But Apple’s worth does not change a single cent because Tim Cook chose to pay out Steve Job’s hard-earned cash.”

Reading such comments in arguably the best financial newspapers in the world make our blood pressure explode.  We are often asked, why we are doing this blog?  Simple. We can’t take it anymore!  So here are our financial concepts.  This is our voice.  Even Mr. Jenkins concedes the efficient markets hypothesis (EMH) is a load of crap, which we agree with, however he does say the EMH is all they got.  Hopefully 2008 was a teachable moment in financial history.  We need new financial theories, need a different approach.  Trillions of dollars are locked away in global corporations today.  According to our leading global newspapers, if these funds were returned to their shareholders nothing would happen.  Really?  Is this so?  Does it pass the common sense test?

“I’m getting that headache again!”

If corporations paid out this latent capital, this will lift the model price calculation in all companies taking such action.  Two things would happen, first an enormous amount of capital would be injected into the world, saving governments from stimulating excess demand by accumulating more deficits.  Second, the market would reward corporations in increased market value; assets would increase, recognizing more efficient use of capital on their balance sheets.    How do we know this?

We can pretend Apple is symptomatic of the world today.  Yes, we applaud Apple’s announcement of dividends and buybacks, however let’s look what they will be doing on our Solvency Curve.  Even with their meager give back to shareholders they will be even more solvent three years from now, if nothing is done between now and then.  See our blog “Apple Computer – A Special Dividend of $75 Billion would Reward Shareholders, Management and the Economy.”

See our formula for the calculation of the Solvency Ratio in the “Key Concepts” tab.

In much of the world today, global businesses are sliding down this same curve as Apple.  Yes, their cash piles are building however their market prices are sliding (relative to their potential), with the lack of optimal values for solvency.

We are optimists, and we can say “we will all get there eventually” in terms of a growing, functioning global economy but we have to admit it’s painful to watch the process unfold.  Also, reading comments in the newspapers, like the above, make us crazy because high placed opinions such as these will further encourage managements to hoard cash yielding more sub par growth and further government spending.

JPM, GS, SLF, and MFC – Update on “Coming Out of the Blue” Stocks

Throughout the last few months we highlighted four financial stocks, two US and two Canadian, that we observed breaking up through EBV-3.  We pejoratively call this “Coming out of the Blue”.  Let’s review our model price charts for each company and make some observations.

JP Morgan (JPM)

JP Morgan with weekly price bars, EBV Lines (colored lines) and model price (dashed line)

For those interested, a daily updated chart of JPM subsequent to this post will be maintained on Facebook, here.

This is what we said on March 9, 2012 (here) when JPM transited above EBV-3.

“A trader/investor should always keep an eye on transits up through EBV-3.  We call this “Coming out of the blue” as the title of this piece suggests.  Why?  Subsequent to an upward transit of EBV-3, stocks tend to have powerful moves, price wise, that can take a stock from EBV-3 to at least EBV, or EBV+2.  Sometimes investors, if patient, can ride their winners all the way to EBV+5.”

“We look for “break out/pull backs”, for higher probability trades.  This occurs when a stock transits above EBV-3, then pulls back under, then breaks above again over a period of weeks/months.  To us this means the market is undecided in terms of the price action which zone the stock belongs.  When the market does decide to stay above EBV-3, could be along side of news and/or corporate action, the price action is very positive.”

On March 13, 2012 JP Morgan passed the Fed’s stress test.  Once JPM passed the test, they boosted their dividend by 20% and announced a $15 billion dollar stock buyback.  This does qualify as news and/or corporate action stated above.

What Happens Now to JPM?

As we stated above  “Subsequent to an upward transit of EBV-3, stocks tend to have powerful moves, price wise, that can take a stock from EBV-3 to at least EBV, or EBV+2.”  On the positive side, the issue is not that JPM will go to EBV, but how long will it take to get there.  On the negative side, if there were a correction, support would be EBV-3, which would present a good buying opportunity for those missing the first transit through.

Goldman Sachs (GS)

Goldman Sachs with weekly price bars, EBV Lines (colored lines) and model price (dashed line)

For those interested, a daily updated chart of GS subsequent to this post will be maintained on Facebook, here.

We wrote about Goldman Sachs (GS) on February 5, 2012 (here) when GS broke above EBV-3.  Goldman spent about six weeks trading in and around EBV-3 before the March 13th announcement on the Fed’s stress test results.  Since March 13, GS has lifted nicely off of EBV-3.

What Happens Now to GS?

Identical to the JPM scenario we outlined above.  On the positive side, the issue is not that GS will go to EBV, but how long will it take to get there.  Again, on the negative side EBV-3, $116.71, is support and if GS were to correct to this level this would be an excellent entry point for those who missed GS the first time.

Sun Life Financial (SLF)

Sun Life Financial with weekly price bars, EBV Lines (colored lines) and model price (dashed line)

For those interested, a daily updated chart of SLF subsequent to this post will be maintained on Facebook, here.

We wrote about Sun Life (SLF) back on February 28, 2012, here.  SLF reported under IFRS reporting, Canadian rules, which has been much anticipated by market participants.  The market waited at EBV-3 until the year-end financials were released.  Once released, the market and buyers were buoyed thinking the worst was over for SLF in terms of write-downs or any other accounting surprises.  Also, with positive market reaction to the Fed’s stress test results on US bank owned holding companies helped SLF in the last couple of weeks or so.

What Happens Now to SLF?

You guessed it!  Even though SLF has almost reached EBV-2, any correction to EBV-3 would be a good opportunity for investors.

Manulife Financial (MFC)

Manulife Financial with weekly price bars, EBV Lines (colored lines) and model price (dashed line)

For those interested, a daily updated chart of MFC subsequent to this post will be maintained on Facebook, here.

Yes, we know this is getting boring.  MFC occurred quickly, transiting above EBV-3, with resulting gains.  We wrote about MFC on March 15, 2012, here.  Financials tend to move together and MFC is no exception.

What Happens Now to MFC?

You guessed again!

Closing Comments

If you notice in all of the charts posted, model price is below our target price.  So you may ask, why didn’t we use model price as our target price?  Financials are different than standard operating business in many ways.  This post is getting too long to go into all the differences however suffice to say this is a balance sheet story not an earnings story.  Asset quality is increasing and this is what the market is reflecting to investors.

Also we could have written up other US financials, Capital One Financial and Bank of NY Mellon come to mind.  As we have said in a previous post, “if it rains, it pours”.  We had many names, in the financial space, transited at the same time and their charts look similar to the ones we highlighted. We will keep an eye on Citi (C) and Bank of America (BAC), these two have yet to transit.  Positive transits in these two will be a big event in terms of asset quality for all financials and the US market as a whole.

Model Price – Conversations About Model Price. (Part 2)

Yes, our curious and insistent friend, dropped by to have a more in-depth conversation on model price.  A summary of the conversation went like this.  (See Part 1 here)

Yes, I'm here to learn some finance.

Friend – I think I get what you are doing with model price.  You’re giving me, on a daily basis, a calculation of what the fair market value is on any and every company in your Facebook database.  You have also pointed out situations in your blog (herehere and here) where transactions were announced that have confirmed your calculation of model price.  So my question is, do you have the same degree in confidence in all stated model price calculations in your database or does it vary?

ModelPriceGuy – It varies.  The critical factor is the variance in earnings estimates.  For every reasonable large cap company there are a number of analysts who follow every detail of what the company does, including giving earnings estimates of what the company will earn not only for the next quarter but also for the next year.  For those who don’t know, this is a very competitive field, and the most accurate analyst will be noticed by way of remuneration and industry awards.  To us there is a lot of information when you look at analysts’ estimates as a group.  An important piece of information is the high, low, mean estimate range.  (Also, we look at the number of analysts making the estimates.  This is not a problem for US companies.  Unfortunately in Canada, there maybe only 1 or 2 analysts, which is better than nothing however a consideration when evaluating model price.)

Friend – OK, let’s stop here.  Where do you get this information?

ModelPriceGuy – You can go to finance.yahoo.com.  This is just one site, there are many others including Bloomberg and Thomson Reuters.  But let’s keep to finance.yahoo.com.  So place a quote of a stock in the appropriate box, say Yahoo (YHOO), and hit go.  You will notice a left hand column, and as you look down this column you will see “Analyst Coverage” and below that you will see “Analyst Estimates”.  Click on this and a lot of information will be displayed on what analysts’ are doing as a group.

Friend – Wait, this seems complicated.  I thought you said I would be free of numbers.

ModelPriceGuy – You certainly don’t have to do this background work, we take care in downloading this information everyday.  Can you image downloading this data and daily changes to this data on over 2000 securities.  This is one of the reasons we have a daily computer run.  Our daily computer run incorporates the latest in earnings estimates, and other variables, which can change for every one of our listed companies.

Friend – I’m no math whiz but that must be millions of calculations a day.

ModelPriceGuy – Absolutely!  We tried to calculate how many calculations we did on a daily basis but we gave up!

Friend – You were saying, an important piece of information is the high, low, mean estimate range.

ModelPriceGuy – Well, important when considering the confidence a user may place on model price.  When considering the high, low, mean earnings estimate a user can consider the variance of all three numbers.  The tighter these estimates are, the higher confidence level on the calculation of model price.  If the high and the low estimates are wide we say there is a lot of variance.  Our confidence level in model price wouldn’t be as high as in the tighter earnings estimate situation.  We call this coefficient of variation.

Friend – Stop, this is getting too complicated.

ModelPriceGuy – Sorry, the bottom line is, most of the 2000 companies in our database have a high coefficient of variation and our model price calculation is accurate using the mean estimate commercial services publish on a daily basis.  Where model price isn’t as accurate is with highly cyclical companies especially small cap companies or companies with only 1 analyst’s estimate.  (If this 1 analyst is correct, then our model price is correct, however there is safety in numbers!)

Friend – So if I could paraphrase, there is a lot of information in this simplistic purple line and obviously the amount of variables it takes to calculate this line on a daily basis is numerous.  However, I think what your saying is large cap companies have an advantage in your system because with more analysts following the company the better reliability of the inputs to your algorithm the better the output, in terms of model price.

Wow! This purple model price line looks so simplistic but it's doing so much work for me.

ModelPriceGuy – Yes, that is absolutely correct.

Friend – That’s enough for now.  Let me go away and think about our conversation in terms of how I invest my portfolio.

Apple – Model Price Update – Resistance is $600 (Update)

In our blog on February 15, 2012 we noted that AAPL was running and the next area of resistance would be EBV+6, which we calculated to be $600. We reproduced the chart we inserted in our blog for your reference.

Apple with weekly price bars, EBV Lines (colored lines) and model price (dashed line)

Also, AAPL announced, with great fanfare, a quarterly dividend and a stock repurchase program, which we speculated would happen. We applaud this corporate action, however tepid, considering the resources (cash on hand) they have on their balance sheet.

Now that Apple is Trading at $600, what now?

Here is our Model Price Chart (calculated as of last night).

Apple with weekly price bars, EBV Lines (colored lines) and model price (dashed line)

For those interested, a daily updated chart of AAPL subsequent to this post will be maintained on Facebook, here.

Both the fundamentals (earnings) in terms of model price and the Economic Book Value (EBV) lines are growing quickly. For fun, let’s look at what model price and the EBV lines look like one year from now. We can model the balance sheet one year from today, obviously taking the announced dividends, into our calculations. What we can’t do is anticipate the share repurchase program and the amounts. This, obviously, is of the discretion of management. Any share repurchase would have a positive impact on model price and slow the growth of the EBV lines. However with the numbers management are suggesting the results wouldn’t be that material.

March 22, 2012 March 22, 2013 Differential
EBV+6 $619.23 $881.16 42.3%
Model Price $511.80 $586.80 14.65%

What we are saying with this table?

If AAPL follows along EBV+6, no change in valuation from today, AAPL will be up 42%. Model price seems to be growing slower, however a stock repurchase plan and higher earnings will help boost model price over time.

What do I do today?

AAPL is probably a little over bought just now, for new purchasers. Also AAPL is trading at a premium to its’ model price. What a “rational investor” would wish for is a substantial correction in the market. Buying AAPL at model price, or at a discount to model price, would be a positive. “Rational investors” are hoping Greece, China, the PIIGS, anything that would cause “irrational investors” to sell shares, even those of AAPL.

Please Mr. Market, go down so I can buy Apple at its model price.

The Financial Press and the “Rational Investor”

While waiting for the Oracle numbers after the close, we just happened to pick up the Financial Post dated March 20, 2012. (One of Canada financial newspapers, to our US readers.)  The reporter, Christine Dorry, strikes the title, “Why Apple is ‘Cheap’ at US$601 a share”.  Stating that Apple (AAPL) is trading at 16.9x earnings, cheaper than Philip Morris (PM) at 17.6x, Coca-Cola (KO) at 18.3x and McDonald’s (MCD) at 18.5x. Really!

Isn't the Financial Press suppose to help me?

What is the “Rational Investor” to think?  Simply dividing the price of the stock by last year’s earnings and you get what actually?   Well let’s use our Facebook database and have some fun!

AAPL PM KO MCD
Close 03/20/2012 $605.96 $86.54 $70.59 $97.65
Model Price $506.34 $24.08 $62.94 $82.09
Differential -16.44% -72.20% -10.83% -15.93%

(All data in the above table is as of March 20,2012, model price computer run)

Hum…. They all expansive, including Apple!

Christine goes on to quote, Mr. Ben Reitzes, an analyst at Barclays Equity Research in New York City, in a note to clients, “We believe Apple deserves a higher multiple vs. the group [which we will put in a table below] given our view that it is the best growth story in IT hardware over the long term”.

MSFT CSCO INTC ORCL IBM
Close 03/20/2012 $31.99 $20.57 $27.75 $30.10 $204.25
Model Price $41.83 $28.47 $39.71 $39.17 $155.94
Differential 30.77% 38.39% 43.10% 30.15% -23.65%

(All data in the above table is as of March 20, 2012, model price computer run)

What does the “rational investor” do?  When the “rational investor” knows what a stock is worth, versus what the stock costs investing should be a little easier.  Also, doing just the opposite of what the financial press (and some analysts) advises, priceless!

Grab me a newspaper, I want to look up some other stocks on the Facebook Model Price app.

Viterra – Another Transaction Verifying Model Price

Glencore just announced the acquisition of Viterra for CDN $16.25 per share.  On March 8, 2012, before talk of a transaction, VT closed at $10.98 and model price was $16.32.

Viterra with weekly price bars, EBV Lines (colored lines) and model price (dashed line)

Interesting sidebar since convexity of Viterra is 1.95, model price increased from $16.32 to $18.66 because of the price movement of the stock price subsequent to the announcement that suitors were interested in purchasing the company.  This is a small example how an increasing stock price helps the valuation of the enterprise as a whole.

BCE – Agreed to Acquire Astral Media “A” for $50 per share.

Before the market open this morning, BCE Inc., parent of Bell Canada, has agreed to acquire its largest content provider Astral Media for $3 billion Canadian Dollars.  Astral has both “A” non-voting and “B” voting shares outstanding.  BCE is buying “A” shares for $50 per share.

What was the model price for Astral Media (ACMA)?

Astral Media "A" with weekly price bars, EBV Lines (colored lines) and model price (dashed line)

Another piece of evidence showing the validity of model price being confirmed by independent arms length transactions.

Manulife Financial (MFC) – “Breaking Out of the Blue”

“When it rains, it pours” financials stocks on both sides of the border, Canada and the US, are “Breaking Out of the Blue”.  (In that, stock prices having positive transits above EBV-3).  During yesterday’s trading MFC traded above the EBV-3.  Manulife Financial (MFC) certainly hurt more in the 2008 financial crisis more than most.  This Canadian insurance company needs both increasing interest rates and rising equity markets to reverse the financial damage over the last 4 years.

Manulife Financial with weekly price bars, EBV Lines (colored lines) and model price (dashed line)

Certainly this week the financial markets have been kind to MFC in giving it want it wants.

Why should you care?

A trader/investor should always keep an eye on transits up through EBV-3.  We call this “Coming out of the blue”.  Why?  Subsequent to an upward transit of EBV-3, stocks tend to have powerful moves, price wise, that can take a stock from EBV-3 to at least EBV, or EBV+2.  Sometimes investors, if patient, can ride their winners all the way to EBV+5.

As we have noted in previous blogs we tend to look for “break out/pull backs”, for higher probability trades.  This occurs when a stock transits above EBV-3, then pulls back under, then breaks above again over a period of weeks/months.  To us this means the market is undecided in terms of the price action which zone the stock belongs.  When the market does decide to stay above EBV-3 (for a second or third time), which could coincide with news and/or corporate action, the price action is very positive.  In this situation MFC’s “break out/pull back” is not as clean as we would want it however, it still does qualify in our judgment.

Obviously, if the stock transits down through EBV-3, all bets are off!

Why are we always drawing our readers’ attention to situations that are “Coming out of the blue”? For over fifteen years we have seen this phenomena.  In our minds these are secular trades, trades lasting 3 to 5 years.  In other words, five years from now, an investor will look back to today and wish they had taken a position in anyone of these financials “breaking out of the blue”.  Not only we see this phenomenon all the time, we too kick ourselves for not playing these high probability trades.

Research In Motion (RIMM) – Target this Price on the Downside (Update 1)

On February 10, we produced a blog with the above title.  (See post here.)  In the blog we produced this chart targeting RIMM to reach EBV-3 or $13.

RIMM with weekly price bars, EBV Lines (colored lines) and model price (dashed line)

Since this blog post, one can see RIMM’s share price using EBV-3 for support.  Here is last night’s model price chart.

Research In Motion with weekly price bars, EBV Lines (colored lines) and model price (dashed line)

For those interested, a daily updated chart of RIMM subsequent to this post will be maintained on Facebook, here.

So what happens now?

RIMM will likely use EBV-3 for support until there is some pre-announcement on their 4th quarter, if any, or their scheduled release on March 29, 2012.  This will be what we are looking for.

1.  Obviously, the year-end balance sheet will be released, and we will update the model price chart to reflect this new information.

2.  Most analysts still have RIMM making money in the 4th quarter.  (Scotiabank for instance is looking for 85 cents for the quarter.)  Just as long RIMM is making money on an operational basis, until the release of QNX enabled smart phones, this we would view as positive.

3.  We will be looking for an update on when the new QNX OS smart phones will be released.  Current release date we believe is November 2012.  If this release date were pushed forward, this would be very positive for RIMM.  (Just as a delay, would be viewed negatively.)

Model Price Strategy

Currently, unless announced information from the company indicates otherwise, it’s hard to see RIMM trade below EBV-3.  Why?  It’s an operating business, making money, with no potential material write offs coming from the balance sheet.  (They already took an inventory write down in the third quarter.)  Solvency is not a concern short-term, as long as the company, keeps its’ expenses in line with their revenues.

We would love to see a 1-2-3 bottom in this situation.  We are NOT technical analysts however 1-2-3 bottoms and tops on a weekly, and monthly price chart are powerful signals for us.  RIMM definitely has the potential for this formation bottom.  Certainly if the share price exceeds point 2, or EBV-1, on the chart above, this would be very bullish signal.

What is interesting, in this situation, is the divergence between the analysts’ and the market.  With analysts’ consensus estimate of earnings giving us a computed model price of $42.30, bringing model price above EBV+2. Obviously with the market price at EBV-3 the market does not believe the analysts.  Who is right?  We guess we will find out in a couple of weeks.

Again, we are not making recommendations here to anyone.  Our point here is showing our readers how to use model price charts to strategize, to draw a battle plan, if you will, to profit in the equity markets.