Money flow trumps fundamentals! The only way markets can deal with excessive money flows from investors is excessive valuation.
Fundamentals are different than money flows. Money flows occur in the equity markets irrespective of fundamentals and by the way this phenomena occurs all the time. Sometimes excessive money flows can last for years at a time giving investors and analysts’ comfort that excessive valuation of a specific equity must be approximate to the real fundament value of the company. Unfortunately this is NOT the case.
Let me be more specific.
Look at Emera Inc. – a Canadian Power Utility. (Believe me I could have chosen any number of utility companies, in US or Canada, as a subject for this blog. Have a look at the new 52-week low list of your local business daily newspaper or website. Pick any utility on this list and look it up on our Facebook application and do your own analysis.)
Model Price Chart – Super Long-term Chart
Emera Inc. with monthly price line, EBV Lines (colored lines) and model price (dashed line)
I pulled this long-term model price chart from our database that goes back to 1995. As you can observe Emera would hit valuation highs in and around EBV+2 from 1995 to mid 2010. Any dips from EBV+2, especially to EBV+1 became buying opportunities for investors/traders.
Model Price Chart – Long-term Chart from Facebook Database (monthly price bars)
Emera Inc. with monthly price bars, EBV Lines (colored lines) and model price (dashed line)
For those interested, a daily updated chart of EMA subsequent to this post will be maintained on Facebook, here.
As you can observe starting in mid 2010 Emera exploded in valuation up to EBV+3. Why? Yield hungry investors piled into high yielding stocks without regard to valuation. And why not? Investors had a choice between less than 1% on government bonds and GIC’s versus 4 and 5% yields on utility stocks like Emera.
“Getting Paid to Wait” Nonsense
So I guess the question is how can excessive money flows occur without any change in the fundamentals of the company in question. We just witnessed over the last 3 years global equity investors, especially Canadian investors – including institutions, directed their investment capital into high yielding and long considered safe securities like utility shares and other industry sectors such as real estate investment trusts (REITs). Financial history is littered with investment fads that start and are maintained by superficial analysis or common colloquialisms that do not hold up under careful or analytical analysis. My personal favorite colloquialism is the nonsensical “Getting Paid to Wait” slogan. Yield hungry investors took the saying to heart by placing a major portion of their invested capital in securities that paid a substantial yield – relative to safe government bands and GICs – and didn’t much care whether the yield was earned through income of the company or the company returned some or all the yield with investors’ own capital (a blog topic for another time). Early investors were richly rewarded as excessive money flows increased equity valuation to a point never seen as you can see from our model price chart with my Emera example.
Model Price calculations can keep investors on track
I have blogged many times before we are delivering two pieces of information, through our algorithms, to help investors evaluate large capitalized securities. The first calculation is model price or our calculation of fair market value of the company. As you can see from our model price charts above the excessive valuation increase from EBV+2 to EBV+3 was NOT collaborated by an equivalent increase in our model price calculation.
The second piece of information, in terms of our EBV lines, helps investors by illustrating, when the last time if ever Emera achieved the valuation of EBV+3 going back some 18 years. As you can clearly see Emera has never traded at this lofty valuation going back to 1995. (As an aside I have data going back to 1980 and still Emera has never traded at EBV+3)
“Yield is not Valuation”
To counteract one colloquialism I tried to make up another for the financial press and audiences familiar with my appearances on television. I came up with “Yield is NOT valuation”. Since valuation calculations like ours are not well known I’m sure audiences where mystified about my message or what I was trying to say. Fair enough. However investors where happy, initially, investing in a utility company yielding over 4.5% and trading over EBV+3 irrespective of the past history of Emera’s valuation parameters or our calculation of fair market value or model price.
Sometimes it takes a while!
Unfortunately excessive money flows from investors can last for quite sometime. New people looking at our calculation of model price could and would probably assume that our calculation is misguided or wrong, especially in circumstances where over valuation occurs over a lengthy period of time. Markets change. Investors’ perceptions change. Money flows abate. Excessive valuations are corrected, sometimes overnight.
The excess valuation in Emera and similar utility stocks in both Canada and the United States is finally coming to an end as money flows from investors get diverted to other areas of the market. Initial investors back in 2009 have performed well with Emera and other utility stocks and valuations increased to unprecedented levels. Investors late to the party, mid 2013, are already experiencing negative rates of return even though they are “getting paid to wait” – waiting for what is another matter.
Time will obviously bail out investors in quality equities including utility shares that have been purchased at excessive valuation levels. Investors who are curious about fair market values of individual equities and excessive valuation in terms of our EBV lines can check their portfolios against our database to spot areas or companies they are holding for possible overvaluation concern. The lesson here is twofold. Don’t let simple colloquialisms separate you from your hard earn capital and knowing valuation will give you a leg up in terms making a rate of return on your portfolio without being confused by a company’s dividend yield.