Monthly Archives: July 2014

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 ‘picks up’ 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 geniuses. 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 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 of 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.”