Hempton on Valuation Analysis
Posted by Eddy Elfenbein on January 3rd, 2017 at 12:32 pm

Here’s a very good post by John Hempton on valuation analysis. Here’s a key bit:

This is a general quality of investment analysis. Proper valuations are far more art than science. DCF valuations – especially of something growing near or above the discount rate are famously sensitive to assumptions. The right comparison is to the Hubble Telescope: move direction a fraction of a degree and you wind up in another galaxy.

—

By contrast there are some things for which a proper valuation should be done and can be done.

If you own a regulated utility what you really own is a regulated series of cash flows with regulatory risk around them.

An accurate valuation is part-and-parcel of the analysis – because it delineates what you own.

—

The battle here is to work out what the salient details are. Sometimes they are whether young people will continue drinking Red Bull. Sometimes they are working out a technological change.

In rare cases they are working out valuation.

Mostly valuation is simply about bounding a margin of safety. And most of that involves understanding the business anyway.

This is a reason why I tell investors not to rely on stock screeners. The big winners in your portfolio won’t be stocks that go from a 13 P/E to a 17 P/E. Rather they’ll be ones that increase their “E” by 10 fold.

“Risks Remain in this Market”
Posted by Eddy Elfenbein on January 3rd, 2017 at 12:27 pm

One of the staples of the financial media is telling us that “risks remain in this market.” There are several different ways of spinning this. You can get a key quote from some muckety muck. See “Summers Says Markets Underestimating Risks of Trump Presidency.”

My problem with these stories is that they sound as if they’re saying something sober and judicious when they’re really saying very little. Of course, there are risks in every market.

Risk involves two components: the chance that something will happen and the fallout from what does happen. Last year was a perfect example of risky things happening but not having the expected impact. Brexit and Donald Trump were expected to lose at the polls. In both cases, a win was expected to bring disaster to follow. Both happened and markets took them in stride.

People tend to view the market as a running back darting downfield, avoiding tackles and sprinting toward the end zone. That’s a fun but flawed metaphor. Instead, the market synthesizes events. It’s more like a giant scale that’s constantly weighing new information. There are always risks, but the question is, how important (i.e., heavy) are they?

The Cyclicals are Out Front
Posted by Eddy Elfenbein on January 3rd, 2017 at 11:46 am

The stock market is starting 2017 on the right foot. The S&P 500 has been as high as 2,263.88 this morning. However, the underlying currents of the market are quite different. Cyclical stocks like Materials and Energy are doing very well, while defensive sectors like Healthcare and Income are pretty flat. (As I write this, the Energy Sector has made an abrupt U-turn and has given back much of its gains.)

This morning, the ISM Manufacturing Index came in at a healthy 54.7. Wall Street had been expecting 53.8. The ISM has been trending higher over the past few months. Tomorrow we’ll get the minutes from the Fed’s last meeting which is the one where they raised interest rates. Then on Friday is the December jobs report.

Morning News: January 3, 2017
Posted by Eddy Elfenbein on January 3rd, 2017 at 7:28 am

Finland’s Basic Income Experiment Starts – Really, It’s Testing The Laffer Curve For Poor People

Pound Drop Boosts U.K. Manufacturing, Pushes Up Factories’ Costs

Analysts Can’t Seem to Agree on Whether China’s New Yuan Basket Will Be More or Less Volatile

Solar Could Beat Coal to Become the Cheapest Power on Earth

OPEC Dismisses American Shale Oil

Paris Eyes Luring 20,000 Bankers From London Amid Brexit Rupture

With Trump, an Economic Feast With Surprises on the Menu

Jain Finds His Second Act as Ex-Deutsche Bank Chief Joins Cantor

Euronext Offers to Buy Unit of London Stock Exchange for $536 Million

Growing a Different Apple

Indonesia Penalizes JPMorgan for `Underweight’ Call

Twitter’s China Boss Kathy Chen Quits After Eight Months

Another Madoff Legacy: Ways for Investors to Keep Ponzi Profits

Josh Brown: Our Obligation

Howard Lindzon: Information Overload or Filter Failure

Be sure to follow me on Twitter.

Morning News: January 2, 2017
Posted by Eddy Elfenbein on January 2nd, 2017 at 6:08 am

German Factory growth Reaches Close to Three-Year High in December

French Employees Can Legally Ignore Work Emails Outside of Office Hours

Mexicans Are Outraged Over a Big Hike in Gas Prices on Jan. 1

India’s Demonetization And Interest Rates – Now SBI Cuts By 0.9%

China’s New Rules on Yuan Transfers Are Not Capital Controls

The Most Popular Investor Picks for Emerging Markets in 2017

What U.S. Tech Giants Face in Europe in 2017

Google Makes So Much Money, It Never Had to Worry About Financial Discipline—Until Now

Apple partner Wistron Seeks to Expand India Smartphone Parts Plant

Hyundai, Kia Forecast Sales to Rebound on Capacity, Models

Samsung, Hyndai Motor See Growing Uncertainties in 2017

Tesla: Buying The Experiment

Deutsche Bank Flew and Fell. Some Paid a High Price.

Jeff Miller: Santa Rally Trumped?

Josh Brown: In 2016 I Learned That…

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The 2017 Buy List
Posted by Eddy Elfenbein on December 31st, 2016 at 6:33 pm

Here are the 25 stocks for the 2017 Buy List. It’s locked and sealed and I can’t make any changes for 12 months.

For tracking purposes, I assume the Buy List is a $1 million portfolio that’s equally divided among 25 stocks. Below are all 25 positions with the amount of shares for each and the closing price for 2016. Whenever I discuss how the Buy List is doing, the list below is what I’m referring to.

The ten new stocks are Axalta Coating Systems, Cinemark, Continental Building Products, Danaher, Ingredion, Intercontinental Exchange, Moody’s, RPM International, Sherwin-Williams and JM Smucker.

The five deletions are Bed Bath & Beyond, Biogen, Ford, Stericycle and Wells Fargo.

The 25 stocks range from a market cap of $483 billion for Microsoft to $924 million for Continental Building Products. The average market cap is $38 billion, but that’s heavily distorted by Microsoft. Take out MSFT and the average market cap is just under $20 billion. Fourteen of the 25 stocks fall between $4 billion and $20 billion in market value.

Eighteen of the 25 stocks pay dividends. Currently, the Buy List has a yield of 1.48%.

Only AFLAC and Fiserv have been on the Buy List all 12 years. This is Stryker’s 10th year. Danaher is returning to the Buy List after a seven-year absence.

Here’s a brief look at the ten new stocks.

Axalta Coating Systems (AXTA) is a Philadelphia-based coatings company. The stock had its IPO two years ago. It was previously owned by The Carlyle Group.

Cinemark Holdings (CNK) runs a chain of movie theaters in the United States, Taiwan and South America.

Continental Building Products (CBPX) is a “leading manufacturer of gypsum wallboard, joint compound and complementary finishing products.”

Danaher (DHR) is a diversified manufacturer. The stock has been an amazing long-term winner.

Ingredion (INGR) calls itself “a global ingredient-solutions company.” They turn plants into ingredients for food.

Intercontinental Exchange (ICE) runs several exchanges, including the New York Stock Exchange.

Moody’s (MCO) is a credit-rating agency. They also own Moody’s Analytics.

RPM International (RPM) makes building materials and adhesives. The company has increased its dividend for 43 consecutive years.

Sherwin-Williams (SHW) is mostly known for its line of paint. The company recently bought Valspar for $9 billion.

JM Smucker (SJM) makes a lot more than jelly. The company makes a broad line of food products. Of course, with a name like Smucker’s, it has to be good.

The 2016 Buy List
Posted by Eddy Elfenbein on December 31st, 2016 at 1:35 pm

The 2016 trading year is on the books! For 2016, the S&P 500 gained 9.54%, while our Buy List gained 0.99%. Although we did make a profit, we trailed the broader market. This was only the second time in the last decade in which we lost to the market.

Including dividends, the S&P 500 gained 11.96% this year, while our Buy List gained 2.17%.

Over the long haul, we’re still doing quite well. Over the last 11 years, the total compounded gain for the Buy List is 169.39%, compared with 126.63% for the S&P 500.

Our biggest winner this year was HEICO (HEI) which gained nearly 42%. Stryker (SYK) was a distant second with a 28.91% gain. Stericycle (SRCL) was our biggest loser with a loss of 36.12%. Next came Cerner (CERN) and Express Scripts (ESRX) which both lost just over 21%.

For people who care about such things, the “beta” of our Buy List in 2016 was 1.0164. The correlation of the daily changes of the Buy List to the changes of the S&P 500 was 92.6%.

The chart below details the Buy List’s performance. I’ve listed each stock, along with the number of shares and the starting and ending prices. For tracking purposes, I assume the Buy List is a $1 million portfolio that starts equally divided among the 20 stocks.

Note that Hormel Foods (HRL) split 2-for-1 on February 10.

Here’s how the Buy List performed throughout the year:

Here’s the data behind the dividend-adjusted returns. I’ve listed each stock’s beginning price, ending price and dividend-adjusted starting price. My source for dividend-adjusted prices is StockCharts.

Every Buy List Stock
Posted by Eddy Elfenbein on December 31st, 2016 at 11:04 am

Here are all 77 Buy List stocks and when they made the cut.

CWS Market Review – December 31, 2016
Posted by Eddy Elfenbein on December 31st, 2016 at 7:08 am

“Don’t you see what’s happening? Potter isn’t selling;
Potter’s buying! And why? Because we’re panicking and he’s not.”

The 2016 trading year has come to a close. For the year, the S&P 500 gained 9.5%, but a lot of that came late in the year. As late as November 4th, the index was up a measly 2% on the year.

This was a very unusual year for Wall Street—and the world. I would guess that if I had told the average professional investor the outcomes of the Brexit vote and the U.S. election beforehand, having that info probably would have harmed his or her portfolio. Here’s an amazing stat: 295 stocks in the S&P 500 beat the index this year.

Not only did the unexpected happen, but those unexpected events drew unexpected responses. In this week’s CWS Market Review, I’ll go through all the numbers on our Buy List’s performance. I’ll also list the details on the 2017 Buy List.

The Final Numbers for 2016

Now let’s get to the numbers. For 2016, the S&P 500 gained 9.54%, while our Buy List gained 0.99%. Although we did make a profit, we trailed the broader market. This was only the second time in the last decade in which we lost to the market.

Including dividends, the S&P 500 gained 11.96% this year, while our Buy List gained 2.17%.

Over the long haul, we’re still doing quite well. Over the last 11 years, the total compounded gain for the Buy List is 169.39%, compared with 126.63% for the S&P 500.

With the Buy List, I always try to be as transparent as possible. The table below details the Buy List’s performance for 2016. I’ve listed each stock, along with the number of shares and the starting and ending prices. For tracking purposes, I assume the Buy List is a $1 million portfolio that starts out equally divided among the 20 stocks.

Note that Hormel Foods (HRL) split 2-for-1 in February.

The 2017 Buy List

Now let’s turn our attention to the new Buy List. We’re expanding the Buy List to 25 names. Here again are the 25 stocks for 2017:

AFLAC (AFL)
Alliance Data Systems (ADS)
Axalta Coating Systems (AXTA)
Cerner (CERN)
Cinemark Holdings (CNK)
Continental Building Products (CBPX)
Cognizant Technology Solutions (CTSH)
CR Bard (BCR)
Danaher (DHR)
Express Scripts (ESRX)
Fiserv (FISV)
HEICO (HEI)
Hormel Foods (HRL)
Ingredion (INGR)
Intercontinental Exchange (ICE)
Microsoft (MSFT)
Moody’s (MCO)
Ross Stores (ROST)
RPM International (RPM)
Sherwin-Williams (SHW)
Signature Bank (SBNY)
JM Smucker (SJM)
Snap-on (SNA)
Stryker (SYK)
Wabtec (WAB)

Here’s the new $1 million portfolio, now divided equally among 25 stocks. Below are all 25 positions, with the number of shares for each and the closing price for 2016. Whenever I discuss how well the Buy List is doing, the list below is what I’m referring to. The Buy List is now locked and sealed, and I can’t make any changes for 12 months.

The 25 stocks range from a market cap of $483 billion for Microsoft to $924 million for Continental Building Products. The average market cap is $38 billion, but that’s heavily distorted by Microsoft. Take out MSFT, and the average market cap is just under $20 billion. Fourteen of the 25 stocks fall between $4 billion and $20 billion in market value.

Eighteen of the 25 stocks pay dividends. Currently, the Buy List has a yield of 1.48%.

Only AFLAC and Fiserv have been on the Buy List all 12 years. This is Stryker’s 10th year. Danaher is returning to the Buy List after a seven-year absence.

Our Ten New Members

Here’s a brief look at our ten new stocks, plus their starting Buy Below prices. I’ll have more to say on each stock in upcoming issues.

Axalta Coating Systems (AXTA) is a Philadelphia-based coatings company. The stock had its IPO two years ago. It was previously owned by The Carlyle Group. Buy Below $30 per share.

Cinemark Holdings (CNK) runs a chain of movie theaters in the United States, Taiwan and South America. Buy Below $42 per share.

Continental Building Products (CBPX) is a “leading manufacturer of gypsum wallboard, joint compound and complementary finishing products.” Buy below $26.

Danaher (DHR) is a diversified manufacturer. The stock has been an amazing long-term winner. Buy below $83 per share.

Ingredion (INGR) calls itself “a global ingredient-solutions company.” They turn plants into ingredients for food. Buy below $134.

Intercontinental Exchange (ICE) runs several exchanges, including the New York Stock Exchange. Buy below $61.

Moody’s (MCO) is a credit-rating agency. They also own Moody’s Analytics. Buy below $103.

RPM International (RPM) makes building materials and adhesives. The company has increased its dividend for 43 consecutive years. Buy below $58.

Sherwin-Williams (SHW) is mostly known for its line of paint. The company recently bought Valspar for $9 billion. Buy below $289.

JM Smucker (SJM) makes a lot more than jelly. The company makes a broad line of food products. Of course, with a name like Smucker’s, it has to be good. Buy below $136.

I’m also lifting the Buy Below on CR Bard (BCR) as $230 per share.

That’s all for now. The new trading year begins bright and early on Tuesday morning. We’ll get some of the key turn-of-the-month econ reports. ISM comes out on Tuesday. The ADP payroll report is on Thursday. Then the big jobs report comes out next Friday. Be sure to keep checking the blog for daily updates. I want to wish everyone a happy, healthy and profitable New Year. I’ll have more market analysis for you in the next issue of CWS Market Review!

– Eddy

About Those Forecasts for 2017
Posted by Eddy Elfenbein on December 30th, 2016 at 12:02 pm

The guys at Bespoke recently posted a chart looking at how well analysts have done in predicting the S&P 500. As you might guess, it’s not a great track record.

I was curious to see if there’s a method to the analysts’ madness, and indeed there is. Their forecasts for next year are largely dependent on what the market did this year. I was surprised to see how strong the relationship is.

The analysts are paid tons of money to tell us that the market is subject to…are you ready for this…simple mean reversion. Good years will be followed by bad years, and bad years by good years. The correlation works out to -0.627.

Here’s the scatterplot for the last 16 years.

The horizontal axis is the market’s return for this year. The vertical is the gain expected by Wall Street analysts. Note the fairly strong negative relationship. You’ll also notice the tight range of analysts’ forecasts compared with the real world. (Bear in mind that the horizontal axis is really four times wider than the vertical. I had to zoom in to make it more readable.)

The standard deviation in returns for the analysts is only 4%. It’s nearly 18% for reality.

I’ll simplify what the equation means. Assuming the market will return 10% next year, divide this year’s gain by six, and subtract it from 10%…and presto, you’re now a Wall Street analyst.

So what’s the real world explanatory of this year’s returns for next year? Here you go:

The R^2 is less than 1%.