Wednesday, 30 September 2015

Ongoing work on 52 week lows

I've added a link to the blog which should take anyone interested to the googledocs spreadsheet in which I am currently tracking new 52 week lows on a daily basis.

I basically log new 52 week lows into a googledocs template as a starting point for additional research.

None of the stocks logged into this spreadsheet should be construed (or confused) as buy/sell recommendations.  These are preliminary observations only on candidates for further research.

What am I looking for?

  • High pre-tax cap rate (in excess of 15%).  I measure pre-tax cap rate as EBIT / EV
  • Preferably, excess cash.  I measure excess cash by taking the difference between mkt cap and EV.  
  • Very preferably, micro-caps (i.e., caps < $200M).

I don't automatically add anything making a new 52 week low to the spreadsheet.  I do a quick analysis of free cash flow, margins, leverage, and valuation.

Happy huntimg.  Hope the list helps anyone interested in their search for ideas.

Transcanada and Margin of Safety

I’ve been reading Seth Klarman’s book Margin of Safety.  His bio is here.

I'm about 1/2 way through the book. If anyone's interested in reading it, it can be found via easy google search.  I'm not going to post a link. 

If my understanding of Klarman’s approach is correct, balance sheet first.  p/l second.  Dividend yield = irrelevant.  Dividend yield is like a shiny dangling carrot to equity just before the titanic hits the iceberg.

As my thought process has evolved, I’ve begun thinking only in terms of margin of safety. 

I looked at transcanada.  I’m attaching a very simple analysis of TRP’s ratios over time (all amounts taken from gurufocus, and all in USD’s)

Interest expense-704-635-614-684-714-777-795-1,016-823-966-754-969-986-926-991-1,028
Int coverage1.642.
Current debt55355157000001,0052,1842,2553,0272,7323,2012,6463,6983,907
Total debt8,0877,4417,1617,7888,6609,10210,42815,20216,32519,30921,69221,03322,40624,22024,61425,306
Effective interest8.71%8.53%8.57%8.78%8.24%8.54%7.62%6.68%5.04%5.00%3.48%4.61%4.40%3.82%4.03%4.06%
Less: capx-534-312-384-298-391-649-1,363-1,647-2,540-5,139-4,996-3,197-2,621-4,193-3,078-3,132
Free cash flow5963378471,1531,0059884361,184-239-2,302-1,938683986-740459272
Less: dividends-352-327-350-447-511-504-535-545-582-786-748-1,120-1,430-1,430-1,402-1,391
Sensitivity at:5%6%7%8%
Interest expense-1,265-1,518-1,771-2,024
Int coverage2.632.191.881.64
Less: dividends-1,391-1,391-1,391-1,391

A few things jump out:

  • Interest coverage appears to have improved since 2000.  It’s gone from 1.64x to 3.24x.  A first level thinker would be happy about this.  He/she would feel comfortable that the interest coverage improvement suggests an improvement in safety to equity.  A higher level thinker would look at the effective interest expense (Interest expense / debt) over the last 15 years.  It’s come down from almost 9% to 4%.  I would hazard a guess that this is indicative of decreasing cost of borrowing in the market due to injection of liquidity since 2009.  A higher level thinker would sensitivity test the impact of higher cost of funds on the debt at cost of funds between 5% and 8%.
  • Free cash flow is terrible.  This is a function of capx.  Since 2000 (15 years), FCF has totalled $3.7B, vs. CF from operations of $38B.  This business hardly generates any free cash flow due to constant reinvestment in capx.  The whole business model is predicated on building capx.  While it may look great at cost of funds  = 4%, equity needs to ignore 4% and worry about 8% cost of funds and the impact on future capx funding.
  • Free cash flow less dividends is a black hole.  They continue to pay dividends by issuing more shares.  Share count has increased from 475m to 709m since 2000.  It’s basically doubled.  In 2015, they will have to make up about $1.1B of dividend deficiency by either borrowing or issuing more shares.
  • I have attempted to sensitivity test higher cost of funds, and I’ve roughly calculated that interest coverage gets back to 1.64x at 8%, and free cash flow less dividends jumps to -$1.8B from $1.1B.

My thoughts?  There is no margin of safety in equity.  Better to buy the debt at $.50 on the $1 (or less), at least you’ll be covered by the pipeline assets if they go bankrupt.

TRP has a number of different bond issues, you can see them at morningstar here

The majority of the maturities seem to be spread out between 2034 and (gulp) 2067.  They've floated $2B of 4.625% and 6.2% bonds maturing between 2034 and 2037.  Let's call the average coupon 5.4%.  They've floated another $2.025B of 4.6%, 5% and 7.25% bonds maturing between 2038 and 2045. Let's call average coupon 5.6%. They've locked long term cost of funding in at between 5.4% and 5.6%.  The equity yields 5% currently.  Adding the two together, I get an approximate discount rate of at least 10% (if I were equity, I'd want more than just a 5% yield in order to compensate me for the leverage and riskiness of the cash flows).  Let's choose 12%.

I'm going to value the dividend as a perpetuity.  I'm assuming equity holds this for the dividend only. 

Div of $1.60 / .12 = $13.33 vs. $31.02

Just my two cents and I’m probably over-simplifying.

Tuesday, 29 September 2015

Liquidity (and What Will You Do if You Wake Up and There is No Bid)

This will be a quick post on Liquidity and Howard Marks (again).

Marks published a memo to Oaktree clients earlier this year on Liquidity.  The memo is here.

The memo was pretty timely in that it was published in March of this year as the market was humming along and the institutional / momentum imperative was to keep dumping money into biotech, on demand internet streaming, rechargeable cars, social media, and any number of ETFs meant to track the above (I won't name any individual company names).

Now, I know that none of the above themes should affect DGI's, heck, I've jumped around the DGI blogosphere enough to notice that for the most part, DGI's seem to have developed well structured plans to only buy certain types of dividend stocks: real companies, producing real goods and services which should be around producing the same or similar goods or services in the future, paying dividends out of real free cash flow, and which have a history of paying and raising dividends.

But the funny thing is, everything is related, even if we can't (or don't want to) see it.  If institutions are overweight garbage (let's use biotech for example) in their portfolios in order to generate alpha, and at the same time hold the same stocks that DGI's hold in market weight proportions, and if the market rolls, my guess is that everything gets sold in priority of liquidity in order to meet redemptions.  It's probably easier to sell a block of blue chip large cap Procter & Gamble with a market cap of $195B and a float of 2.7B shares, trading 10M shares per day, than it is to sell a block of Regeneron with a market cap of $47B and a float of 76M shares, trading 778K shares per day.

So for any investor out there looking to construct a portfolio over time, a series of hypothetical questions to consider in the context of liquidity:

What will you do if you woke up tomorrow and there was no bid?

Would you panic and sell everything?

Would you buy more of what you already owned?

Monday, 28 September 2015

Greenblatt Magic Formula Experiment, Sep 25, 2015 - Follow Up Comments

Quick follow up post to yesterday's post:

I was just thinking that in the context of Marks’ last letter to Oaktree shareholders (It’s Not Easy), that Greenblatt’s Little Book makes it all sound too easy, and we all know it’s not easy (sorry for the repetition).  

Greenblatt’s book makes it sound as if running a screen and throwing darts is a one way ticket to alpha.  Just run screen once a year, throw 20 or 30 darts, hold for a year, re-run screen next year, turn portfolio over, repeat.  By the 2nd or 3rd year, you will have your alpha.

So here are my thoughts:
  • The book was published in 2005
  • The follow up was published in 2007
  • If he was running his system for any period of time before 2005, it probably worked 
  • Once he published the book, lots and lots of smart people read it.  Over time, these smart people figured out a way to replicate the screens.  Greenblatt even hosts the screen results at, so anyone can just run the screen without their own research, and throw 20 darts with his published results
  • By virtue of convincing the market that his ranking system worked, lots and lots of people ended up running the system as we know that the institutional imperative is to generate alpha

When all this money started chasing the same stocks, they got bid, so really, what was left in the screen either had no real advantage as everyone owned the same stocks, or it was toxic waste.  As a result, any advantage has probably been arbitraged away over time

This doesn’t mean the screen isn’t a good starting point for additional research, but the additional research has to take the screen results and cut the results to shreds before throwing a single dart.

In any case, I'm absolutely curious to see how the results from Friday's screen perform over a 1 year holding period and I'll chime in every now and again to check up on my 20 darts.

Sunday, 27 September 2015

Greenblatt Magic Formula Experiment, Sep 25, 2015

I'm going to regress somewhat by doing a post on an attempt at building an auto-pilot portfolio courtesty of "The Little Book that Still Beats the Market"

I'll call this a real time experiment with imaginary money.

I've done a post on Joel Greenblatt before.  He was interviewed in Barrons last summer, see link here.

I'm going to follow Greenblatt's system to a tee on paper, which is basically the equivalent of throwing darts at 20 stocks with combined characteristics of highest return on capital and highest earnings yield relative to every other stock in Greenblatt's ranked universe.

I am in no way, shape or form, advocating that anyone throw darts with real money or copy this portfolio.  This is purely an educational exercise.  The system works as follows:

  • Run screen of 50 highest ranked Greenblatt universe stocks at
  • Buy top 20 of the 50 highest ranked stocks on day 1 of the year.  As we're now basically at Oct 1, 2015, I'll make Friday's close, Sep 25, 2015, my day 1 of the year.
  • Hold top 20 stocks for one year
  • On Sep 24, 2016, re-run the screen.  Turn the existing portfolio over and book the gains/losses, and buy the top 20 results from the new screen
A few comments regarding the results, which I've reproduced here:

  • I cheated by purposely ignoring a few of the stocks which I believed to be absolutely hopeless, such as ITT Education, Capella Education, Collectors Universe, and Lifevantage.  It will be interesting to see whether excluding these stocks ends up detracting from the paper performance of the portfolio
  • In their place, I simply selected the next lowest ranked stock 
Here's the portfolio on day one, assuming I bought everything at the close on September 25, 2015.  I will try and figure out how to make this portfolio accessible by seperate tab on the blog (I'm still learning how to use blogger).

Why am I doing this at all?

Curiosity mostly.  I currently have a number of personal accounts under my discretion, and it seems that the accounts I don't tinker with (the shareowner accounts), do better than the accounts I actively tinker with.  As I've developed an appreciation for Greenblatt, I figured I'd run his system on paper to see whether or not "The Little Book that Beats the Market System" actually  beats the market in real time.