Monthly Archives: July 2013

Who do You Believe: Equity Analysts or the Market?

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.

Microsoft – EBV+5 Becomes a Brick Wall!

You are wondering whether our Economic Book Value or EBV lines work?  It’s my job to highlight different ways they do work.  Hopefully over time you will come convinced, as I am, that these multi-colored parallel lines on our model price charts have relevancy in terms of your investment decisions.

Microsoft reported its fourth quarter late last week disappointing equity participants, sending the stock lower.

Here is our model price chart after the close on Friday, July 19, 2013.

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

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

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

Microsoft had a negative transit of EBV+5 back on October 26,2012

Back on October 28, 2012 I wrote a blog highlighting Microsoft’s negative transit of EBV+5.  This was a significant event because MSFT traded above this EBV line for over 26 straight years!

Quoting from my blog post:

My point here is that Microsoft, which has been a public company since 1986 and has traded above EBV+5 for 26 years looks to be breaking or transited down through EBV+5.  Too me this event is amazing and historic.  I’m not saying Microsoft is going to go away anytime soon.  I’m saying in our Model Price work, EBV+5 has important relevance and what it says about the company.  The monopoly or dominance for Microsoft is truly over in “the market’s eyes”.  And if I’m right, that this is truly a negative transit, than EBV+5 support becomes resistance.

So what has happen to MSFT since my blog post on October 28, 2012?

As you can observe from the most recent model price chart indeed, EBV+5 has become resistance for Microsoft.  I think it bears repeating MSFT isn’t going away anytime soon and Mr. Softie will make tons of money and pay out billions in dividends.  The distinction I’m making here is valuation.  The market is reducing Microsoft’s valuation, probably on a permanent basis, reflecting its reduction in market dominance or eroding monopoly status.

Conclusion

An historic event occurred back on October 28, 2012 in the history of valuation of Microsoft (see blog).  This blogger highlighted the negative transit of EBV+5 – the first negative transit of this company in 26 years or since MSFT has been a public company.  As I highlighted then and will probably will be the case going forward EBV+5 will be price resistance for the company for the foreseeable future.

Knowing this information traders/position traders can seek opportunities when MSFT trades at a discount to EBV+5 and take profits when EBV+5 is achieved.

Why Apple’s Stock Price is Floundering!

With Apple’s earnings out tonight I thought I would reblog my blog on March 21, 2013 for those who are interested in Model Price analysis on Apple.

Model Price

“Apple’s valuation is a riddle wrapped in a mystery inside an enigma.”  I have revised Winston Churchill’s famous quote on Russia to make a point on investors, both professional and do-it-yourself types, that seem perplexed on Apple’s current valuation.  We have all watched while Apple’s stock price has inexplicably eroded from just over $700 per share to its current value of $452.08.  Why? This to my mind is what is wrong with the current state of finance. There is no definitive source or service available to have any discussion about valuation.  There is currently no math that exists today, in published textbooks or accredited courses that answer the question of valuation properly to the common man or investor.

New math has to be created.  New tools should be invented. The current orthodoxly is broken.  Isn’t there a Harvard MBA anywhere that can tell anybody the valuation puzzle that investors crave? …

View original post 1,367 more words

Chart of the Day – For My Long-Term File.

I was going through the piles of equity research on my desk – most of it garbage by the way – and I unearthed this chart courtesy of Scotiabank.  This chart will certainly be placed in my ‘Long Term File’! (See blogs “US Energy Self-sufficiency – Big Game Changer for Investors” and “What other things are in my long-term file?”)

This chart sums up what has been going on in terms of mutual fund investment flows since the S&P 500 bottomed in and around March 9, 2009.  Amazing.

Source: Scotiabank

Source: Scotiabank

I do like secular (long-term) themes.  As bond mutual funds start to produce negative rates of return in 2013 we are seeing evidence of a reversal in investment flows from bond funds to the positive rates of return of US equity mutual funds as investors seek higher rates of return.  As you can see from this chart we are in the earliest of days in terms of a secular shift from bonds to equities.  As this shift gathers strength this flow of funds reversal will place a floor under the US equity markets for the foreseeable future.

US individual and institutional investors hate equities.  I get it!  Two crashes in eight years.  This investment flow chart proves people have given up on this asset class and perhaps vowed to never return.  History can be a guide in this instance.  As equity rates of return over the last three to five years start to look better market participants will follow (chase) returns as market valuations go ever higher, paradoxically exposing investors to more risk.  Sadly, nothing ever changes with human nature and financial markets.

A wise man told me early in my career the investing public, including institutional investors, invest in asset categories that have performed well over the last five years thinking the asset class will enjoy the same performance over the next 5.  Fixed income, and related asset classes such as REITs and utilities, has performed well over the last 5 years with investment dollars following performance, again as the above chart shows.  Can this performance and funds flow continue?  With a modest increase in interest rates in the US, negative rates of return are starting to appear in the monthly investment statements of individual investors for the first half of 2013.  What will be the result? Apathy or action.

As always will be fun to watch.

Loblaw’s Deal with Shoppers Confirms our Model Price Calculation

What are individual stocks worth in the public traded equity markets?

This question plagued me for sometime not only early in my financial career but when I started taking finance courses in university.  Would you believe the world of finance does know how to answer this basic question?  Sure there is the famous ‘Discounted Cash Flow’ calculation but having spent 5 minutes doing this calculation and the amount of guess work about time frames, normal business activity and interest rates (discount rate) makes, at least in my mind, the calculation dubious and imprecise.  The other well-known calculation of valuation can be ‘Enterprise Value’.  Again spend any time with this calculation, and its simplistic nature and I have always wondered whether there was a better way.

Unfortunately in today’s financial world, there seems to be no definitive or agreed upon technique – algorithm – about what a company is worth especially public companies. In other words, business valuation is more art than science.

Enter Model Price

After many years of hard work and R&D our algorithm – Model Price – was born in 2002.  I have been observing our model price calculation for over 10 years with amazing observations.  Four years ago we decided, conceptually, to release Model Price to the public on the Facebook platform.  A year and a half ago we released our Model Price App (Application) on Facebook.  This application allows the general public to view model price on our database of stocks – over 2,000 companies both Canadian and US listed – at their (and your) convenience.

Our algorithm – Model Price – is so robust that we can calculate model price or fair market value for all companies in our database no matter what kind of business or peculiarities a specific industry sector may inhibit, like finance.  In my opinion model price represents a major break through in security analysis and helps me considerably in the evaluation of individual public companies for investment.

Hopefully model price can help you as well!

However in order for you to use model price you have to be convinced that our calculation – algorithm – is relevant.

How do I do this?

Certainly one way is to evaluate M&A activity, where independent parties come together and make acquisitions on an arms length basis.  This transaction price would certainly be considered fair market value especially in the transparent world of company boards, investment bankers and various experts on both sides of the transaction.

Since the start of my blog, a year and a half ago, the M&A activity has been a little ‘light’ but a few deals confirmed model price as fair market value.  (I have highlighted these transactions in previous blogs confirming our model price calculation – see links at the bottom of this blog.)

Finally a Blockbuster Deal

On Monday morning, Loblaws announced the acquisition of Shoppers Drug Mart.  (Both Canadian Companies)  This is a major acquisition worth over $12 billion dollars.  The financial press priced the acquisition of Shoppers at $61.54 a share even though Loblaws was offering both cash and stock as consideration.

Here was last Friday’s model price chart for Shoppers Drug Mart (SC)

Shoppers Drug Mart with weekly price bars, EBV Lines (colored lines) and model price (dashed line)

Shoppers Drug Mart with weekly price bars, EBV Lines (colored lines) and model price (dashed line)

On Friday, before the merger was announced, we calculated the model price of Shoppers (SC) to be $60.54.  This represented a 25% upside from the close on Friday afternoon of SC at $48.40

After the fireworks of trading on Monday, July 15, 2013, the end of day model price chart appeared as follows:

Shoppers Drug Mart with weekly price bars, EBV Lines (colored lines) and model price (dashed line)

Shoppers Drug Mart with weekly price bars, EBV Lines (colored lines) and model price (dashed line)

Conclusion

Our simple dashed purple line, included on our model price charts, probably looks superficial to the sophisticated and complicated world of finance.  I prefer elegant!

In my opinion the world of security analysis and investing becomes a much more interesting place when participants begin to realize and have confidence in what the true fair market value of a public company really is.  Maybe investing becomes much more ‘rational’, at least for those who use Model Price and may have a significant impact on your net worth.

I have seen model price work for over 10 years.  I know this simplistic purple line ‘delivers’ the goods in terms of fair market value.  I also realize I need to prove to you that our calculation of model price is relevant.  Well the Loblaw’s acquisition of Shoppers Drug Market at our predetermined calculated model price gives our users a piece of evidence that our elegant purple line is worthy of consideration.

Links to other transactions conforming model price.

Warnaco (WRC) Acquisition Confirms Model Price Calculation

Another Data Point for Model Price – Flint Energy (FES)

Does Model Price Work? The Defense calls Gennum (GND.CA)

Other links to blogs about Model Price you may find interesting.

Model Price – Conversations About Model Price. (Part 1)

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

I’m on Market Call!

Surprise, Surprise

As a fill-in, I will be on the show Market Call, today Monday, July 15, 2013, on the BNN network (Canadian Business Show) from 1:00 – 2:00 pm (eastern standard).

Are You Watching CNBC? Nobody Else Is!

Back in the early 1990’s having a television tuned to CNBC was a necessity if you were working in “the business”.  The information flow from Ron Insana, Neil Cavuto and a very young Maria Bartiromo with Sue Herera was riveting and made the viewer au courant on all things financial.  Pre-Internet this business news channel was a blessing and a marvel.  The who’s who of the financial industry was interviewed and moved markets with their opinions.

I gave up my television set and CNBC after the 2000 Internet market crash.  The world had changed.  The Internet, though still in its infancy, found financial information flow easy to disseminate and on demand.  Why wait for the cheesy infomercial when the information was available at your fingertips.  Then along came video, yes it buffered more times than it played but I was patient because the information I was getting was worth it.  Today, video – such as YouTube – is amazing simple, on demand with little to no buffering.  (Do the kids today know what buffering is?  Probably not!)

From time to time I wonder whether anybody else is watching CNBC?  Well from Zero Hedge I got my answer.  Here is the Nielson Media chart on the viewership of CNBC over the last 10 years or so.  The numbers on the side of the chart are industry jargon but it doesn’t take a brain surgeon to figure out viewership is hitting an all time low.

Voila_Capture29

To me this is bullish.  Why?  The financial industry – especially the money management business – in my mind had gotten way to popular for its own good.  This used to be a cottage industry.  Money managers were nobodies back in the day not rock stars.  Speaking for myself it would be great if we could back to the good old days.  Less publicity, less of a spotlight on this industry would be a good thing in my opinion.

With the stock market delivering two market crashes, 2000 and 2008, in less than 10 years I get the sense the general public have given up on equities.  They are migrating back to the GIC world with which they originally came.  Going back to the 1830’s over each decade the 2000’s was the worst decade on record for stocks on the New York Stock Exchange giving a negative return of 0.5%.  Even the 1930’s had a better return!

Maybe the boomers have had enough and have taken their money and eyeballs somewhere else.  Leaving the playing field for those who understand valuation and the cyclicality of market cycles.  Maybe, just maybe television financial news is the thing of the past and will be lost in the unlimited channel universe of the future.

July 2013 – Monthly S&P 500 Market Strategy Update

Uncertainly seems all around us.  The financial media is full of angst!  For the last six months, the first half of 2013, we have seen tremendous swings in global asset prices (mostly down), leaving investors seemingly bewildered of future asset prices and their direction.

Meanwhile here at Model Price, life and the financial markets are unfolding according to plan.  The math of model price is leading the way in our world of certainty and clear headedness.

Let me spend the time piecing together the blog posts that I have written over the last year that gave readers and investors a roadmap to where we are today.

I started back on July 17, 2012 laying out my thesis and what I was looking for in terms of the US economy turning the corner economically by introducing readers to our ‘Solvency Curve’ of the US economy.

What is going on with the world of finance, and how do you fix it!

October 11, 2012 just before the US presidential election I first made reference to the ‘Fiscal Cliff’ and make my case the US should go over the ‘Fiscal Cliff’.

What is going on with the world of finance, and how do you fix it! (Update 2)

As tension mounted between the President and Congress on the ‘Fiscal Cliff’ deadline of December 31, I blogged on December 30:

Fall Over the Fiscal Cliff, Please!

And they did!!

On February 24, 2013 I observed a phenomena that I don’t think I have ever saw before using model price charts for the last 15 years or so.  Three major gold stocks, each having a negative transit in the same week!  So as usual I had to write the blog:

$76 Billion Reasons to Sell Gold Stocks!

In March with the passing of the “Budget Sequestration” and the positive signals given by model price with a potential positive transit of EBV+3 led me to write:

S&P 500 – Why the US Stock Market is going up (Part 1)

S&P 500 – Why the US Stock Market is going up (Part 2)

In April I wrote one of my personal favorite blogs that discussed “Paper Money versus Physical Stuff”.  This blog had nothing to do with model price math but talks of one of favorite secular indicators.

In May of this year, using a traffic light analogy I developed last year in my monthly strategy blogs on the S&P 500, I switched the color from yellow (caution) to green.  The color green designating a positive secular call on US equities as an asset class prognosticating that rates of return should be good over an extended period of time (a 3 to 5 year time frame).

See my blog; May 2013 – Monthly S&P 500 Market Strategy Update

Summary of Investment Returns for 2013, so far

Trends in rates of return of different global asset classes where trending lower at a slow pace throughout the first five months of 2013 except for US equities and excluding Japan.  Interest rates were creeping up, bond prices going down, marginally.  Gold shares and bullion were trading materially lower from my February 24 blog however no sign of panic selling.

Then June 19th happened.

On June 19th, Mr. Bernanke stated the obvious, saying that ‘QE forever’ will be “tapered” as the US economy increases in strength.  Asset prices and investment fund flows accentuated the trends already under way that I highlighted above before Mr. Bernanke made his “tapered” comments.  In the last two weeks of June US Treasuries, especially the thirty-year long bonds have declined in price showing negative returns for the first half of 2013, down almost 9%.  The selling of gold shares and bullion reached panic levels as the price slide of this asset class accelerated.  (I guess the gold bulls thought Mr. Bernanke was going to print money forever!)  Emerging markets, the primary beneficiaries of the outflow of money from the United States over the last five years, suffered large negative returns as reversals of money flowing back to the United States, again occurring primarily in the last two weeks of June.

From my reading of the business press everyone seems a bit confused here.

Really!

Model Price Chart

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

S&P 500 Index with weekly price bars with 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.

After hitting a high on May 22, 2013 of 1687 the S&P 500 took the next six weeks to trade back to EBV+3 or 1588.  (1588 was the EBV+3 level for the month of June.)  S&P 500 market pullbacks to support, like this, can and will occur anytime.  The red line or EBV+3 is support for the market going forward.  As I have noted in the model price chart above, EBV+3 is 1604 for the month of July.

What the US Equity market is saying?

The equity market tipped its hand back in March with a positive transit of EBV+3 and I highlighted this fact in my May blog.  This positive transit signaled the US equity market was comfortable rewarding a higher valuation to US equities because of the US economy is getting stronger (more solvent) and more supportive of equity valuations.

Of course, the pessimists are in full swing.  “The business press is so negative”, one client says.  One reads US equities are in ‘bubble territory’ says another.  The US economy is so weak screams the talking head on CNBC.  “What about the debt levels?” inquires another client and …the list goes on!

THIS IS NOT WHAT THE US EQUITY MARKETS ARE SAYING!

It’s time to be optimistic.  The model price math is leading the way.  Economic life evolves.  Economic life changes.  The 2008 financial crash was about solvency.  Over the last 5 years economic policy was used to get the US economy, through its economic actors, back to a solvent condition.  In the last stage of this economic healing, the only remaining and most important insolvent economic actor left was the US federal government.  Going into 2013 with the ‘Fiscal Cliff’ and the ‘Budget Sequestration’ high jinx, leading some to call Washington dysfunctional, actually solved the ‘solvency’ problem of the US federal government.  This is a big secular change in the investment landscape – doesn’t anyone recognize this?

Maybe not.

So what global asset class had the most muted response to Mr. Bernanke comments on ‘tapering’ – you guessed it, US equities – which lazily traded back to EBV+3 and still up by a healthy margin in 2013.