Tag Archives: security analysis

March 2015 – Monthly S&P 500 Market Strategy Update

When the global central banks want asset values to go up…. They go up!

As I noted in my last blog, we have seen unprecedented central bank activity so far in 2015 resulting in – no surprise – higher asset (equity) values especially in the United States.

Can asset prices go up forever? Or better still can confidence in the men and women who control central bank activities go any higher when everyone in the investment community is already giving them a standing ovation?

Let’s have a look at our Model Price chart to look for clues on how far asset pricing can go.

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 now at the top of the zone bookmarked by EBV+3 and EBV+4. If the market rallied to EBV+4 (2175) this would represent a gain of some 2.7%. If the market corrected back to EBV+3 (1739) investors would be suffering losses of almost 18%.

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

 

Top of Zone EBV+4

 

I believe it’s fair to say we are finally at the top of the zone (EBV+4). Viewing the market this way, call it my first iteration; this is what I believe is the “top” in the U.S. market – valuation wise.

Long time readers of this blog have seen our long-term model price chart on the S&P 500 Index a few times previously but I include it below to illustrate that even if I view EBV+4 as the “top” of the S&P 500 Index in terms of valuation the market can crawl along just underneath our calculated EBV line for a number of years as the market index did from 2003 to 2007.

Long-term Model Price chart of the S&P 500.

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).

 

Sharp-eyed observers will notice that our EBV+4 line (black line between the ‘Red’ line and ‘Yellow’ EBV line) continues on after the last price bar as of March 2, 2015. We project out our estimation of our EBV line by calculating from a bottom up basis or company-by-company basis adding daily pro-rated mean estimates to each company’s net worth less stated dividends and calculate (forecast, if you will) what our EBV values will look like. We do this on a daily basis to incorporate all the latest changes in company fundamentals within each index.

Our calculation of EBV+4, for March of 2016, is 2378. From the March 2, 2015 close (2117) this suggests an implied rate of return of 12% just on the growth of book values (net of dividends, of course) in the S&P 500 Index. Add in a further 2% for dividends and an investor can guesstimate an implied upside for U.S. equities of 14% without any increase in valuation if things go swimmingly.

But one has to ask the most obvious of questions.

Could the S&P 500 have a positive transit of EBV+4?

This is the second iteration an investor has to consider. Again, as sharp-eyed readers can observe back in 1995, the S&P 500 Index was following along the same EBV+4, when it lifted-off and the index ran up to EBV+5 in 1997. As a matter of fact, as you can see from our long-term model price chart, the S&P 500 index almost made it to our calculated EBV+6, calculated back in the day!

The question has to be asked: Was the economic scenarios or environment different in the 1995-2000 period from the 2002-2007 period?

The answer is a resounding yes!

What was the difference?

The U.S. dollar!

Below is a long-term chart of the U.S. Dollar Index (DXY) from Bloomberg.

U.S. Dollar Index (DXY)

U.S. Dollar Index (DXY)

 

I have annotated on this chart the various Bull/Bear market cycles of the U.S. Dollar (DXY Index) coinciding with each U.S. President.

Hopefully, you can clearly see the difference between the two equity bull markets of 1995-2000 and 2002-2007 periods. The first, 1995-2000 equity bull market, occurred while the U.S. dollar was also in a bull period, while the second, 2002-2007 equity bull market occurred while the U.S. Dollar Index was going down or in a bear market.

I have been on record, certainly on BNN and other media outlets, that I believe the fundamentals are in place that we can see a value on the U.S. Dollar Index that would rival the Ronald Reagan Bull Market of the U.S. Dollar Index at over 160. (Maybe this is a little optimistic but certainly Clinton’s Bull Market rally to over 120 would certainly work in my analysis.)

When global money flows pour into the U.S. Dollar, as momentum is starting to pick up since December 2014, global investors will look for U.S. dollar dominated assets to park their cash. Yes, the U.S. Treasury market is an obvious choice but certainly some money flows will seek out the S&P 500 Index ETFs for diversification and maybe a little extra return…. not to mention a 2% dividend yield that rivals current 10-year U.S. Treasury yields.

Is the analysis too simple? Sometimes simple is best!

And yes, fundamentals do count… eventually over secular periods of time, however in my experience money flows usually trump fundamentals over the short-term.

What Am I Saying?

Readers have to consider that conditions are in place that a positive transit of EBV+4 is indeed possible and if money flows get out of hand or momentum is too strong EBV+5 could indeed be possible.

The risk here is that the investment community is way too bearish and conditions are in place that the U.S. equity markets have another EBV zone to go, in terms of valuation, to the upside.

Model Price Theory has the timing problem solved!

You hear and read this all the time on various websites, especially on bearish or perm-a-bear forecasts. Yes, the world is coming to an end because of all these very logical reasons however they can’t tell you ‘When’ this will happen.

O.K. you will face financial ruin…. but we can’t tell you when.

Model Price Theory [MPT] to the rescue!

How does MPT solve the timing issue you ask? Easy, wait for any negative transit of one of our EBV lines. Will this negative transit occur at EBV+4, EBV+5 or EBV+3? I haven’t a clue…but I will know it when I see it.

Doesn’t this solve the timing problem?

I believe so. So on a negative transit, any negative transit – which I will probably blog about – somewhere out there in the future, we will turn cautious on U.S. equities.

Again, my critics may scream “too simplistic.”

I don’t know about you but I do like “simple.”

Conclusion

The S&P 500 Index is now at the top of our EBV zone between EBV+3 and EBV+4. I have speculated or hypothesized on two iterations where the S&P 500 Index either crawls along just under EBV+4 until fundamentals or money flows start to turn negative – that could be years down the road – or the S&P 500 Index has a positive transit of EBV+4 and may have enough momentum to carry the index all the way to EBV+5.

Do I know for certain which scenario will occur? No, I don’t.

But I am certain any negative transit will give me the opportunity to adjust my asset allocation to a more cautious stance if and when this aforementioned negative transit has indeed occurred. And I will be ready for the widely believed financial calamity everyone seems to be forecasting.

 

 

P.S. I would be remiss not in acknowledging the anniversary of the bottom on the S&P 500 Index six years ago – on March 9, 2009 to be exact – at an index level of 666.

Not to be overly overt but I have included a screen shot of the front page of our Acker Finley website giving the performance relative to our benchmark (S&P 500 Total Return Index in CDN$) of our Acker Finley US Value 50 Fund priced in CDN dollars. Yes, we are up over 350% from March 3, 2009 to present, after all fund expenses.

Acker Finley Select US Value 50 Fund performance over the last six years. March 3, 2009 - March 4, 2015

Acker Finley Select US Value 50 Fund performance over the last six years. March 3, 2009 – March 4, 2015

 

I will never forget this bottom for as long as I live and it hardly seems possible that this event occurred six years ago – feels like yesterday.

A substantial part of this return occurred because we were fully invested at the market bottom on March 9, 2009.

For those interested, I blogged what I did differently in the market crash of 2008 that I didn’t do in my previous experienced market crashes of 1987 and 2000 on the fifth anniversary of the market bottom obviously one year ago. Of all my blogs this one remains one of the most popular.

“10 Things I Did Differently in the Crash of 2008; That I Didn’t Do in 1987 and 2000.”

 

November 2014, Monthly S&P 500 Market Strategy Update

Looking at what the US market did for the month of October, I reminded of what I would call a “Crazy Ivan”.

Yes, this is reference to the infamous movie, “The Hunt For Red October” where we were introduced to Russian submarine captains making aggressive maneuvers, turns, on a random basis to see if a US submarine was shadowing the aforementioned Russian sub.

Have a look at our model price chart below and see if you don’t agree.

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 (2199) this would represent a gain of some 9%. If the market corrected back to EBV+3 (1759) 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, respectfully.

IS THERE ANY MEANING TO OCTOBER’S MARKET ACTION?

As I have said previously, any and all index moves within ‘the zone’ – between EBV Levels – is without consequence. What we try to do is measure risk levels intra-zone. In other words when the index level or stock price recedes to the lower EBV Line then investors are taking lower risk than if the index level or stock price closes in at the top or upper EBV Line. This should make some sense.

Transits are another matter. Any transit, index level or stock price piercing an EBV Level, is giving model price users information that the fundamentals are changing depending on the transit. If there is a positive transit, the index level or stock price increases through the upper EBV level, this signifies a positive change in fundamentals is occurring. The opposite is true if negative transits occur.

So as you can see from the above model price chart the US market as represented by the S&P 500 Index sold off in the first two and a half weeks of October, only to rebound to new highs in the second half of the month. This ‘high jinx’ in market action was certainly noteworthy however since all this action took place intra-zone no fundamental economic conclusions can be interpreted via Model Price Theory [MPT].

CONCLUSION

The market was certainly more volatile in the month of October than we have seen in awhile. However according to Model Price Theory [MPT] this volatility is par for the course because all the market action took place intra-zone – between EBV+3 and EBV+4.

Until evidence to the contrary, a negative transit of EBV+3, the bull market in US equities is still intact. So the US market did a “Crazy Ivan”, making some investors nervous and of course giving the permabears something to talk about in the financial press. But fundamentally and according to Model Price nothing has changed by October’s market action.

Apple Inc. – China Mobile (or Legal insider trading made easy!)

This deal happened seven weeks ago.

In the past week Apple and China Mobile struck a deal publicly announcing to make the iPhone available to the telecom’s 740 million subscribers.  This announced partnership has been a long time coming, with rumors of a possible China Mobile iPhone offering dating back years.

With China Mobile’s unique TD-LTE network rollout coming in mid-December equity analysts are well on their way of ratcheting up Apple’s earnings estimates expectations for the coming quarters.

How did Apple’s shares preform last week, the week of this publicly announced blockbuster of a deal?  Apple shares were lower on week.

Huh?

How could this make any sense?  This is what people hate about the stock market.  This seemingly illogical price movement in relation to a bullish publicly announced material business transaction.  Of course there is the well-worn Wall Street cliché ‘Buy on rumor, sell on news’ crap.  But as far as I can see this deal, as I said earlier, was rumored for years and just fell out of the blue.

Or did it?

Back on October 27th I wrote a blog, “Apple Inc. – Breaking Out of EBV+5!” highlighting Apple’s positive transit of EBV+5.  Here is the model price chart at that time.

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

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

I professed in another blog; a previous blog (August 19th) that I thought it was unlikely that Apple would ever have a positive transit of EBV+5 in the future.  I was wrong and Apple did have a positive transit of EBV+5.

So I wrote this in my October 27th blog post:

For those who have reading this blog for a while know that EBV+5 is a significant EBV level and that any positive transit would have importance.  My first response was to check whether earnings were about to be released.  I quickly found out that Apple’s earnings would be released on Monday (October 28th), probably after the close.  Wow, could this be a coincidence.  Will the Apple earnings blow away what the street is expecting?  Will there be corporate action, such as a special dividend, that will make shareholders and the market happy?  My guess is as good as yours.

But I don’t have to over think this move.  I can be just a part of it.  Yes, I took a position in Apple.  That was the easiest thing to do.  Go with the flow.  I have seen this occur so often over the last 10 or so years it is of little surprise.  See people always know corporate events before they are publicly disseminated and they act according for their own interests.  Isn’t this insider trading, you ask?  Maybe!  I know I’m not trading on any inside information.  Model price is telling you something is up and I’m just going with the flow.

And I conclude

Who knows what will happen?  But as I have said before, the likely hood of Apple having a positive transit of EBV+5 was a low probability event.  That low probability event occurred just before Apple’s year-end financial results are about to be released.  Call me crazy but Model Price is telling everyone who will listen there will be good news coming! 

After the market close on October 28th Apple’s year-end earnings were released.

Apple’s Earnings were released with little fanfare.  Yes, they were good and met analysis expectations but there were no blockbuster announcements.  However look at the trading in Apple’s shares subsequent to their earnings release.  Apple’s shares still traded above EBV+5 (see chart below) albeit with little volatility.

Model Price chart of Apple

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

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

The week before last  – the week of November 25th – Apple’s shares spiked with no apparent news. (See arrow on chart above.) Obviously news of the China Mobile deal started to leak in the public domain.  Finally culminating in the publicly announced deal last week.  Insiders and others probably used this opportunity to dump Apple’s shares for a quick profit after holding over sized positions awaiting the publicly announced news giving short-term downward selling pressure on the shares.

What can I say?  Fortunately (or unfortunately depending on your point of view) I see this all the time.  This is what gives the stock market a bad name or leaves a bad taste in peoples’ months.  Insiders profiting on non-public news while outsiders are stuck holding the bag when things go wrong.  Model Price Theory (MPT) can go a long way to level the playing field and help investors profit from potential non-public news.

Remember our EBV lines are fundamentals and transits of any kind are very important signals.  Obviously people knew about this coming China Mobile deal and acted in their own economic interests sending an important signal to model price users that something big was in the works.  I took a trading position in Apple, as I said in my blog on October 27th because of this positive transit and yes, I profited from the China Mobile news, happily.

Just another profitable day in the life of a model price user.

May 2013 – Monthly S&P 500 Market Strategy Update

Talk about a market rally!  (US equity market that is!)  Since mid November 2012 the market, as measured by the S&P 500, has rallied almost 18% to May 1, 2013.

As I have been noting in my “Monthly Strategy Update” blogs, I have been foolishly calling for a correction as my most likely scenario.  Well, so much for this most likely of my guesses. (see blog)

Let’s first review our model price chart of the S&P 500 Index.  First our short-term model price chart (weekly price bars).

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

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

For perspective I have included our long-term model price chart (monthly price bars).

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

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

Remember 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.

S&P 500 Positive Transit of EBV+3

As you can see in the above model price chart the S&P 500 had a positive transit of EBV+3.  This is AMAZING and we should stop and ponder its implications.  Our EBV levels are about valuation.  Collectively in a capitalized weighted index known as the S&P 500 equity prices are increasing in terms of valuation – equity asset prices are increasing.  Whether this is occurring because of corporate profits, good government policy or market participants searching for yield does it really matter?  Some market professionals think there are negative reasons for this unexplained (according to them) market rise but I would like to point out these persons exist in every market cycle and receive considerable ink from the financial press.

As I have stated in previous blogs this is the first time the S&P 500 Index has had a positive transit of EBV+3 since mid 1992.  Our long term chart unfortunately doesn’t go back this far, and you have to take my word for it, but you can see from our model price chart how the market increased from 1995 to 2000 subsequent to the positive transit of EBV+3 in mid 1992.  Am I saying this will occur again?  What I am saying is you have to think of this possibility – the possibility of a long-term secular bull market in US equities.  Is there anyone else saying this?  No one I know!

Risk and Reward

Markets and individual stocks are about risk and reward.  Obviously good investors want to minimize risk, wherever possible, and maximize reward.  This is what our EBV lines are all about.  Making purchases close to support or our EBV line minimizes possible downside risk in that if there were a down transit of this same EBV line this would be an excellent sell point for your position or investment.  In other words market prices don’t have to fall very far to let you know the position should be sold thereby not placing a significant portion of your capital at risk.

What am I saying?

The risk and reward of the US equity market has changed.  With the S&P 500 Index trading above EBV+3 the risk is minimal and the reward is EBV+4 or 1980 in the above S&P 500 model price chart.  That’s an upside of a further 25%.

Even if the market trades along EBV+3, this implies a return of 10.5% plus dividends.  (How did I get 10.5%? EBV+3 one year from May 1, 2013 is 1749.  We get this number by inputting all the balance sheets of the underlying companies in the S&P 500 Index, add estimated annual earnings on a bottom up basis less projected dividends for the year and calculate EBV+3 one year hence.)

Traffic Light turns Green!

Back in a blog post last August (here) I started to use a traffic light analogy in terms highlighting and/or quantifying the risk level for investors/traders.  In my initial assessment I thought the traffic light should be yellow to signify caution.  Why?  The S&P 500 Index traded under EBV+3 signifying limited upside (to EBV+3) and a big downside to EBV+2.  Now, with the positive transit of EBV+3, the downside risk is EBV+3 and the upside is EBV+4, some 25% higher.  I do have to emphasize these general market calls which I blog about are secular (long term) in nature and will last until the market moves significantly higher changing the risk and reward characteristics which I have highlighted above.

What if the S&P 500 has a down transit of EBV+3?

The S&P 500 potentially could negatively transit below EBV+3 for a period of weeks maybe a few months, in what I call a “break out pull back”.  A “break out pull back” formation is common in model price work and very bullish when there is a “re break out” or a positive transit of EBV+3 for a second time.  Traders can be quick to make profits from such an event, but long-term investors should ignore such market gyrations and hold quality equities for the long-term.

Conclusion

For the month of April, 2013 the S&P 500 Index had a positive transit of EBV+3.  This is an historic occasion in our model price work and noteworthy.  The traffic light is “green” in that the risk and reward for long-term US equity investments is heavily skewed towards the reward side of the ledger.  In other words, the proverbial wind is at your back when choosing quality US large cap companies.  This could be the beginning of a secular run in US large capitalized equities that could last years.  And of course this positive transit doesn’t preclude some future hiccups in terms of monetary policy, and a million other macro considerations that have yet been imagined or forecasted but the market is speaking to you and it’s saying as of today and the foreseeable future all is well!

Netflix (NFLX) Reports 2nd Quarter Earnings – What Now?

For those readers new to my blog, I have written two major pieces on Netflix.  I have provided links to both pieces here.

Netflix – Three BIG questions (and answers) about Netflix

NFLX – Two Big Problems for the Bulls on NFLX!

Here is the new model price chart including 2nd quarter financials on NFLX

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

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

Here is what I said in my first blog on NFLX on January 30th, 2012

Just for fun we will make this prediction!

The more interesting question is what happens when NFLX transits downward through EBV+7.  If and when this happens we think NFLX will find a more comfortable home at EBV+5.  So when will this happen?  We don’t know. When we have done similar work in the past, sometimes the stock price and the math can take years to play out.  We are sure quarterly reporting of NFLX will be a nail-biter over the next year.  This will be interesting and we will be following.

For reference here was our model price chart on April 26, 2012.

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

What are we saying now?

Same thing!  NFLX should spend sometime at EBV+5.  This will be the true test for this (maybe former) growth stock.  As NFLX reported, they added 979,000 net subscribers in the second quarter, for a total of 30.1 million subscribers worldwide.  NFLX management also announced further international expansion plans, which management acknowledged is expensive and will hurt profitability, especially in the 4th quarter of this year.

Our model price calculation is based on NFLX earning $0.74 cents in 2012, and $2.13 in 2013.  Will be interesting to see how analysts’ revise their numbers in the coming days.  In other words watch our model price calculation in the next week – it should be interesting.

Will the market wait for NFLX?

This is the $64 million dollar question.  In other words, will the stock price of NFLX hang around EBV+5, while NFLX management sacrifices short-term profits for international market share and with increased competition?  My guess is the market will wait for a couple of quarters, at this level – EBV+5.  However, the market has to be happy at the subscription growth rate and NFLX must be winning over its’ rivals – no small task.  As I have said before, quarterly reporting for NFLX will be a nail-biter over the next year.  What if NFLX breaks EBV+5, you ask?  Next major level of support would be EBV+3.  This presents deadly combination for wounded investors, no upside and potential further downside in the coming quarters.

S&P/TSX 60 Index – Market Update on the Canadian Market

We have been getting requests from our Canadian readers to do a market update on the Canadian equity markets.  We can do this by looking at the S&P/TSX 60 Index.  Just like our S&P 500 model price chart, we aggregate all 60 companies into one chart, which can give investors a 40,000-foot view of what is transpiring in the Canadian markets as a whole.  I like looking at the S&P/TSX 60 Index because we are large cap managers, and there is enough diversity in terms of the number of companies in this index to get a feel for what is going on.

Here is the model price chart of the S&P/TSX 60 Index as of last nights close.

S&P/TSX 60 Index with weekly price bars, EBV Lines (colored lines).

 

As you can see the Canadian market topped out at EBV+2, concurrent with the S&P 500 index on the US markets.  As the S&P 500 corrected, the Canadian market corrected more severely.  This is not surprising since the current fears are with a slow down in world economic growth, this will directly impact economic sensitive companies which the index has an abundance.

That said Monday’s close of 645, the S&P/TSX index is only 3 percent away from EBV+1 or 626.  So in terms of percent upside/downside, as of last nights computer run, the S&P/TSX index has a possible upside potential of 15.5% and downside of 3%.  Not bad profit/loss potential.  This same situation occurred in the latter half of 2011, which resulted in a rally up to EBV+2.

Since investors and the financial press are extremely pessimistic these days, let’s consider full out disaster.  This occurred in 2008 where the S&P/TSX 60 index traded down to EBV or 513.  That’s 20 percent down from last night close.  Certainly possible but is it probable?  The good news for investors or readers of this blog the index would have to break EBV+1, which would be a very important signal increasing the probability of the S&P/TSX 60 trading at EBV.

Conclusion

What I love about this work, especially our EBV lines, is it’s based on structural equations derived from the balance sheets of public companies.  When we overlay market prices the feedback to investors and analysts’ is immediate.  What is our model price chart on the S&P/TSX 60 index telling investors about the Canadian large cap market?  The current risk reward is positive for the Canadian market, with a 3 percent downside and a 15% upside.

As I had stated in my blog on the S&P 500, if this US index falls to EBV+2, or another 15% then the probability of the S&P/TSX 60 falling to EBV will be high.  However, if this were to transpire I would consider, both US and Canadian indexes, an important market bottom.

Why do stocks go up and down?

As a teenager I was mystified how this happened.  The question of “why” never left my mind when looking at the stock tables in the newspaper.

Aren’t you curious why this happens?

I have put in my 10,000 hours.  I have seen it all.  I have studied track records of other managers.  I started reading Warren Buffet annual reports in 1984.  Warren who?  More importantly I gave up reading them in the mid 1990’s.  In the early 80’s I knew John Templeton’s track record off by heart.  Getting a Barron’s on a Saturday morning and digesting every page before the market opened on Monday morning.  I haven’t read a Barron’s in 15 years, maybe more!

I quit the accounting profession in 1985, to become a stockbroker.  In those days, I would ring up or go visit any manager of financial assets with a hot hand.  I would fetch coffee, lunch anything they needed just as long as I could sit silently in the corner and see what they did.  How they worked.  The system they used.  They were open and honest.  Those were the days.

I was on the trading floor, Sunday night, October 18, 1987, watching Jim Baker’s face and telling the world Germany would not lower their interest rates.  Two things happened, the crash of 1987 and television as a tool to deliver financial news.  I remember unplugging my television (CNBC) from my desk in early 2001.  If CNBC went off the air tomorrow I wouldn’t miss it at all.

When I saw the basic math for model price, just a kernel of what we have today – I saw the potential.  As the team built on these foundations I could start reconciling the movement of stock prices.  Stock prices were conforming to these valuations zones, now known to you as Economic Book Values (EBVs) or Economic Structural Values (ESVs).

We went into the bull market of 1998 – 2000 armed only with our EBVs.  What we were observing was something different.  There was a feedback mechanism-taking place that had to do with the structure of the balance sheet.  Curiosity. Hard work.  Convexity.  Model Price.

What is my dream?

I see it nightly.  There is a panel of experts.  CFAs’, stock analysts’, true experts in the field of equity securities analysis.  Sure, include a technical analyst for good measure. All gathered to opine on some equity security. Telling investors in their own way, they haven’t a clue what the security is worth and where the equity price is heading.

The panel is facing a six year old with an iPad.  The six year old calls up Facebook, starts up the Model Price application and drops in the symbol that is being discussed.  Presto, the child can recite what the stock is worth, model price, and with a blink of an eye can tell the audience, specifically, whether fundamentals are improving (equity price breaking up through EBVs) or declining (equity price breaking down through EBVs).  The six year old can give support and resistance price targets that work over time, much to the amazement of our esteemed panel of experts.

The financial industry, and finance itself needs a total rework in my estimation.  I have made this app, the graphical interface, as simple as possible.  Yes, the explanations maybe difficult to grasp but I have time and hopefully through this blog these concepts will become familiar to you.

I don’t care whether the financial professionals get it!  I care about the six year olds.  I care about the people finance has locked out.  Finance should be for everyone.  It’s time for democratization – finance’s Arab Spring!

Yes, I have been a registered securities broker for 26 years.  Started with the question, ‘Why do stocks go up and down?’ for close to 40 years.  I have not seen any security analysis anywhere that comes close to what I’m delivering here and Facebook.  No catch.  It’s the best I’ve found and developed with the help of others.  We are not going away.

Why do stocks go up and down?

EBV’s – Economic Book Values are the Foundations of Good Security Analysis.

In the last few blogs we touched at length on model price.  So let’s even it up with a discussion on EBV’s or Economic Book Values.

Most, if not all, financial quantitative models, that we have seen, are based on empirical relationships.  What do empirical relationships mean?  Referencing ‘empirical’ in our Merriam-Webster’s Dictionary says the following:

1.  Originating in or based on observation or experience.

2.  Relying on experience or observation alone often without due regard for system

and theory.

3.  Capable of being verified or disproved by observation or experiment.

Whether you are reading a financial newspaper or an analyst’s report empirical relationships are everywhere in finance.  Our least favorite is regression analysis.  The “Financial Graveyard” is filled with many a career using linear regression and least squares regression as the murder weapon.  Financial relationships are sought, using regression analysis, money positioned to take advantage of this found relationship.  Sometimes money is made and if predictable, big money moves in and poof.  The relationship and the money are gone with everyone saying, “That shouldn’t have happened”.  Or our favorite, “the move in the market that bankrupted us was 23 standard deviations away from normal!”

What makes EBVs – Economic Book Value’s so different?

EBV’s are built on structural equations.  These equations do not change over time or across companies.  These equations are part of a theory of how economic activity is related to the structure of an entity and how the economic process creates value.

Human beings cannot visualize trends in a column of numbers.  We transpose these numbers into a graphical interface that viewers can easily see financial trends that can make an investor profits.  We also make use of logarithmic price scale so viewers of our charts can observe compounding that takes place in any company that is growing.

We have designed our own charts to include logarithmic price scale and include a spectrum of lines call EBVs or Economic Book Values.

How are EBV lines useful to you as an investor? 

1.  As a user, let’s first consider the EBV lines themselves, without price bars and model price.

What are the EBV lines doing long term, short term?  The reason we provide two charts is to give viewers prospective on the growth of the EBV lines.  You can actually see the compounding of the numbers, assuming the positive slope of our multi-colored lines.  If our EBV lines are flat, or trending down, tells the viewer that no growth has occurred or write-offs have occurred on the balance sheet.

Some questions we ask ourselves?  Can we see the growth in the EBV lines and how steep are these lines?  Steeper lines mean more compound growth.  How consistent is this growth?  Is growth accelerating or decelerating?  We believe this is a faster and easier way of viewing what is happening with the financials of a company then looking at the actual numbers from the balance sheet.

2.   EBV lines and overlay either a weekly or monthly price series.

Equity prices not only conform to EBV “zones” but also use EBV lines as support and resistance.  Therefore we use weekly, and monthly price bars because they reveal more information of the interaction between price and the EBV lines themselves. 

A company’s trading history usually confines’ itself to one or more “zones”.  We call the space between each line a “zone” for practical reasons.  Looking at our long term chart viewers can readily see which zone may seem comfortable for their given security.  An observer will note that even with the growth in the EBV lines, prices will conform to a zone sometimes for decades.  How and why does this happen?  The easiest way of explaining this phenomenon is to point out the EBV “constants” that define our EBV lines come from observable forces in nature.  Do known and observable forces in nature show up in the stock market? Absolutely.  We are confident over time and use of model price charts you will be amazed, just as we are, how equity prices interact with our EBV lines.

When stock prices transition from one zone to another important information is being transmitted.  Yes, we do occasionally say, “the market is speaking to you”.  A “transit” signals a change of fundamentals is occurring, either positive (break up) or negative (break down).  This can occur long before any signs and/or public announcement from the company itself.  We admit transits can be tricky to trade, sometimes there are multiple break ups/downs of an EBV line before the market makes up its’ mind before the actual transit.  This can be frustrating for a short-term trader, however when a transit does occur longer term traders can assess a very good predictor of the company’s investment performance long term.

3.  Lastly, considering EBV lines, overlaying weekly/monthly price series with model price.

As we have said previously, our model price calculation is our calculation of ‘What the company is worth’.  This can be of some help in determining which EBV zone the equity price should be trading.  Observing the long-term chart can give you guidance on any discount/premium that may exist between our model price history and the zone the security feels comfortable.  Also, any significant changes to model price, say change in earnings, can give advance notice on suspected transits in EBV zones in the future.

Conclusion

EBV lines and zones can give users considerable information with a blink of an eye.  We are delivering two very important and new concepts to our users, model price and EBV lines, where one is just as important as the other.  From blog to blog, we may emphasize one over the other however both are equally significant.

Also, we think it’s vital to point out the nature of our EBV lines.  They come directly from the balance sheet of each company and are based on structural equations that are NOT trended or use regression analysis in any way.  Yes, the same regression analysis, which has failed so many in the financial world.