Friday, September 28, 2012

Verizon Vs. Vodafone--Go With the Brits

Verizon has been a widely popular income stock in the U.S.  Until its rise this summer, the stock's dividend yield was more than 5%, at a time when cash yields almost nothing and bond yields have been near record lows.

Its Verizon Wireless business is an effective duopoly with AT & T in the U.S. wireless communications business.  However, closer examination reveals a stock with little appeal, particularly compared to Vodafone of the U.K., which owns half of Verizon Wireless.

After rising 23% over the past year, Verizon shares now have a dividend yield of 4.5%.  But the dividend payout ratio (as a percent of earnings per share) is an extraordinarily high 80%.  (I generally avoid income stocks with dividend payout ratios above 50-55%, unless earnings are temporarily depressed or earnings growth is expected to accelerate.)  In addition, the valuation of Verizon is quite poor.  Verizon trades at 18 times estimated 2012 earnings per share, a substantial premium to the market despite having profit declines in two of the past three years.

Verizon's balance sheet also is quite poor.  When adding the company's $32 billion of unfunded pension obligations to its outstanding debt, its debt/equity ratio is 200%.  But Verizon also has $103 billion of "goodwill" and other intangible assets on its balance sheet.  When subtracting this amount from its shareholders equity (or net worth), the company's tangible book value per share is minus $23 (half of the share price).  On the plus side, the cash generation from its businesses is quite good, and the free cash flow yield after capital spending and paying a sizable dividend is 7% (quite high relative to other stocks currently).

Vodafone, the owner of the other half of Verizon Wireless, seems a superior investment to Verizon.  Its dividend yield is 5.2% with a dividend payout ratio of 57%. That dividend could be supplemented by another special dividend paid later this year or early next year if Verizon Wireless pays another dividend to its owners, Verizon and Vodafone.  

Vodafone's valuation is quite good, at only 11 times estimated 2012 earnings per share.  Expectations for the stock are low, with earnings expected to be flat for the next two years because of the company's European exposure.  Unlike Verizon, Vodafone's pension is effectively fully funded.  Its debt ratio is only 34% of shareholders' equity, and after subtracting intangible assets, it has a positive tangible book value per share.  The company generates less free cash flow than Verizon, but Vodafone's CEO intends to sell assets, increase the dividend, and repurchase shares on the open market to help the stock, which has been a laggard.

At a time when a surge in stock prices over the summer has left few remaining good values, Vodafone is an exceptional value--and it is one of the best dividend-paying stocks in the world.

Steve Lehman

VOD:  $28.40
VZ:  $45.40

Nike--Another Earnings Decline for Corporate America

There has been a disturbing trend of declines in corporate profits among leading American companies.  Intel, Norfolk-Southern, 3M, and FedEx are recent examples among varied industry sectors.  Yesterday, Nike, a leading consumer products company that has been one of America's esteemed growth stocks, reported that profits declined 12% in its recent quarter.

Profit margins at American corporations have been near record highs in recent years, and they have provided valuation support to stock prices.  But with stocks generally up sharply this year (the S & P 500's total return is 16%), I think the risks to equity holders have risen significantly.  High levels of investor sentiment (a contrary indicator), the potential for significant earnings disappointments, and troubles in Europe and China that are likely to persist or worsen lead me to reiterate my advice to pare stock holdings and build cash reserves for better opportunities to come.

Steve Lehman

S & P 500:  1438

Wednesday, September 26, 2012


Even the best investors make mistakes.  Some make the same mistakes repeatedly, as a result of behavioral biases.  That is the premise of Behavioral Finance, which identifies common, repeated behaviors that impede sound investment decision making.  While we can strive to identify which behavioral missteps each of us is prone to, it often is too much to ask of us humans to overcome those tendencies.  Instead, the best approach in overcoming these flaws is to use disciplined valuation approaches, such as stock prices as multiples of book value, revenues, or trailing earnings.

Being human myself, I keep making mistakes despite more than 25 years as a professional investor.  I tend toward "confirmatory bias," which is to seek information that confirms my existing view instead of seeking opposing views that might expose flaws in my reasoning.  The one that continues to bedevil me is my reluctance to admit a mistake and sell a losing position.  A Wall Street adage is to "cut your losses (promptly) and let your profits run."  Too often, I do the reverse, citing a different adage (by a former colleague), "You never go broke taking a profit."

There are two types of losses on a stock.  When a stock declines from the purchase price, it could be the result of negative news from the company that might be at odds with the original reason for buying the stock.  In this case, then it probably makes sense to take the loss.  The other type is for no company-specific reason, other than perhaps an overall market decline.  In this case, if the stock was at an attractive price in the first place, I'd be inclined to add at a lower price--or at least hold.

When speculating on an instrument or a commodity (or even a stock), however, there isn't the valuation support to justify holding a losing position.  In that case, the challenge is to get a sense of whether it is a temporary decline or the beginning of something longer and more substantial.  

A number of investors use "stop-loss" orders to sell out of losing positions at preset prices, in order to limit losses to a specified percentage.  (Abrupt price declines might skip over the stop-loss price and result in an even larger loss, however.)

I have had a longstanding bias against using stop-loss orders.  , If I like the price I paid and the stock price drops, I'm inclined to buy more as long as the valuation is better and the fundamental case is the same.  But after a sizable recent loss on a speculative instrument, I have reconsidered using stop loss orders and now recommend them in that type of situation.  I'm not ready to advocate their use in long-only investments in stocks that are based on solid financial conditions, good business prospects, and favorable valuation.

Successful investing requires continual efforts at improvements in market knowledge, as well as in trading or investing techniques.  I'm still learning.

Steve Lehman

Tuesday, September 25, 2012

Gannett--Follow the Insiders

Gannett (GCI) has been an intriguing investment over the past year.  As the publisher of USA Today, the company has faced challenging conditions from the declining newspaper business, which has forced many newspapers to curtail operations or even shut down.

Gannett, however, has other assets (such as television stations) that have considerable value.  As an indication of management's confidence in the company's prospects, earlier this year the company more than doubled its dividend.  A few months ago, the stock was attractively valued at about six times earnings and a free cash flow yield of about 12%, even after paying a large dividend.

The stock has surged lately.  It had been rising steadily this summer, presumably because its tv stations would benefit from massive political advertising this year.  In addition, Warren Buffett revealed that he had increased his company's investment in the newspaper business.  Any Buffett investment still seems to have spillover effects on other companies in the same industry.

But with Gannett's stock up 33% in about a month, I think holders of the stock should follow the actions of company insiders, who have sold meaningful personal stakes in the company.

Steve Lehman

GCI:  $18.45

Monday, September 24, 2012

Is the U.S. Stock Market Expensive or Cheap?

The most important determinant of long-term returns from the stock market indisputably has been valuation.  When entering the stock market at times of cheap valuations, subsequent long-term returns have been the highest.  And vice versa.  But valuation is useless in the short-term, as momentum tends to drive stock prices higher than one would think even after they have become historically overvalued.  And prices have fallen lower over short periods despite historic undervaluations.  But over time, valuations have reverted to their long-term norms, or means.

But it's not as simple as that.  Valuation is not always straightforward.  Valuations compared to various historic periods can appear quite different, depending on which time period is being measured.  

And the basis of valuation can make a difference.  On a book value or price/sales basis, historic valuation comparisons seem straightforward and quite reliable.  On these measures, stock prices today are historically high.

Valuations based on earnings measures, however, are more challenging.  Most professional investors use forecasted operating earnings.  This is a dubious practice, as the practice overstates earnings and understates p/e ratios.  A better approach is to take actual earnings that are based on Generally Accepted Accounting Principles (GAAP earnings) and to use earnings over the prior ten years, not a forecast for the next twelve months.

There are two primary ways of using 10-year GAAP earnings, both of which are intended to remove the effect of the business cycle on valuations.  The first is to use cyclically-adjusted, or "normalized" earnings, which are essentially the long-term trend of earnings.  On this basis, the current p/e on the S & P 500 is 20 times.  Using market history back to the 1920's, this is comparable to valuations at historic market peaks, before the 1987 crash and in the 1960's, before  a 16-year period of basically no gain in stock prices.

But going back only to 1990, 20x times is comparatively low, with only early 2009 at 12x significantly cheaper than today.  Confusing, isn't it?

The other major way of using 10-year earnings is to use average earnings and to deflate them for the level of inflation.  On this basis going back to the late 1800's, the current 10-year inflation-adjusted p/e (also known as the "Shiller p/e" after economist Robert Shiller)  is 21x.  This is near historic peaks of 23x, with market troughs typically near 8x.

Using these alternative p/e measures, today's stock market is historically quite high.  So new investments from today's starting point would likely have poor returns on a valuation basis.

Steve Lehman

S & P 500:  1458

Sunday, September 23, 2012

Austerity in Europe--for Some

Millions of Europeans are suffering from wrenching declines in living standards.  The financial crisis of a few years ago was jolting and was followed by harsh austerity measures that have been imposed by governmental bodies, notably the European Central Bank.  

But the ECB apparently is better at telling others to tighten their spending than it is with its own.  The ECB is constructing a new headquarters in Frankfurt that is now estimated to cost $1.2 billion euros, or almost $1.6 billion dollars.  

It's apparently the same everywhere.  The political elites are well provided for and the economic and financial elites reap the gains from a system of privatized profits.  Meanwhile,  the rest struggle and bear the financial costs of socialized losses when crony capitalism goes awry.

Steve Lehman

Saturday, September 22, 2012

Gold--Risks Are Rising

I, along with many other observers, was caught unprepared for the recent surge in gold prices.  The 13% jump in the price of gold has been (not surprisingly) accompanied by a surge in optimism among most market participants and investment newsletter writers.  However, since the late 1990's, when newsletter writers have been highly optimistic about gold prices, the annualized price change of gold has been -46%.

There is one group of market participants--commercial buyers (the "smart money")--that is not optimistic.  Sentiment among commercial buyers has plummeted as the price of gold has surged.  Since the 1980's, when sentiment among this group has been low, the annualized price of gold has fallen 14%.

So despite missing the recent jump in the price of gold I definitely would not buy gold at current levels.

Steve Lehman

Gold:  $1,770

Friday, September 21, 2012

Decelerating--or Declining--Earnings

Many observers of the stock market intuitively think that strong economic periods--and high earnings growth--are the best environment for high returns in the stock market.  

Though it may be counterintuitive, the highest returns from equities actually have come when earnings estimates are subdued.  But the basis of contrary investing is that when sentiment is depressed, stocks are cheap, and expectations are low.  Under such conditions, stocks have had their highest subsequent returns.  For the S & P 500 Index overall, the highest annual returns have occurred when forecasted earnings growth for the upcoming twelve months have been less than 4%. 

The current forecast is for only 4.8% earnings growth as of 8/31, down from a high of 21% early in 2010.  And that number will likely be even lower as of 9/30.  Over the past two days, three prominent U.S. companies--FedEx, 3M, and Norfolk-Southern-- announced that their earnings this year will not meet the expectations of securities analysts.    

While this bad news/good news development would suggest favorable future returns from stock prices, other factors have convinced me that stock prices are more likely to decline than to rise from current price levels.

Steve Lehman

S & P 500:  1458

Thursday, September 20, 2012

Mea Culpa

I would never claim to be able to forecast precise tops or bottoms in the stock market.  I think instead that investing is largely a matter of probabilities, not certainties.  I also think that there have been reliable indicators that generally favor a higher or lower future trend of stock prices.  Or to put it another way, whether it is likely that stock prices will produce historically high or low intermediate- to long-term subsequent returns.

Short-term timing is another matter.  I consider it futile to try to time short-term moves in stock prices.  Instead, I use a variety of indicators to discern whether the odds are favorable or unfavorable for future returns from current starting prices.

Nearly two months ago, I urged a reduction in equity holdings after many stocks had risen 15-20% in only two months.  Since then, many stocks have risen another 10% or more, and the Standard & Poor's 500 Index has risen about 8%.

While it is quite frustrating to have missed out on this latest move higher, I reiterate my advice to pare equity holdings.  Sentiment measures remain historically high, which does not favor higher stock prices.  Volatility measures are now extraordinarily low, indicating widespread complacency among investors.  Things can change suddenly in financial markets, and about the only asset or instrument that hasn't risen sharply in price is volatility.  I'd raise cash by paring equities or else go long volatility instruments.

Steve Lehman

S & P 500:  1458

Tuesday, September 11, 2012

Caution on Gold

I turned cautious on gold about 10% ago.  It appeared that the price had broken down technically, despite the conceptual case for owning gold.  That was the wrong call over the short term, at least.

I realize that most observers expect central banks in major countries to continue to debase the currency as a way out from huge debts and sluggish economies.  But..

Now, sentiment measures have surged with the rebounding gold price.  Yet, commercial market participants (the "smart money") have become relative sellers.  The commercial participants have an excellent record in the gold market, so I'd heed their negative position.

I'd be cautious about gold here, and definitely would not buy now.

Steve Lehman