What a Difference a Year Makes…
Last year I highlighted Odyssey Re as the stock I liked best. A good management team, conservative investment portfolio, good insurance underwriting, great management, and of course a cheap price were the main factors in my analysis. Flash forward one year and the shares have risen about 10% (including dividends) in an 11 month stretch where virtually every single stock plummeted in value. It may be a surprise though to learn that I like Odyssey Re just as much now as I did then. The company is even cheaper now, and many of the business specific risks I highlighted have been reduced or eliminated. While there are many interesting relative values available, Odyssey is still unquestionably a good deal in my opinion.
A Recap and Update
For the 12 months ending Dec 31st 2008, roughly two thirds of Odyssey’s gross premiums came from Reinsurance, and the balance came from standard insurance. From a geographical perspective, the premium breakdown between geographies is: ~57% Americas, 26% EuroAsia, and 17% London. This is essentially the same as last year as the business mix has been reasonably consistent.
The balance sheet composition has changed a bit though (all data from the 10-k):
-- Total Equity of $2.82B (up slightly)
-- Total Assets of $9.72B
-- Total Unpaid losses and loss adjustment expenses of $5.25B (up ~$100m)
-- Total Investments and Cash of $7.89B (down slightly)
Investment account breakdown
-- $3.93B in fixed income securities (down $300m)
-- $1.70B in Stocks and Investments at Equity securities ($61.9M in Fairfax Asia) (up $550m)
-- $1.20B in Short term investments
-- $0.76B in Cash
-- $0.22 in ‘other’ (down $230m, mostly due to CDS sales)
While the overall portfolio size has been fairly stable, the composition has changed dramatically. A big increase in equities and a decrease in CDS and bond investments understate the real shift that has occurred. In addition to the reduction in CDS and bonds, Odyssey removed all their equity hedges in the 4th quarter of 2008 and swapped out a big chunk of their Treasury bond portfolio (yielding <3%)>5%) mostly insured by Berkshire Hathaway. Coming into 2007 and 2008 Odyssey’s portfolio was structured to protect against a one in 50 or 100 year storm. It did just that as their portfolio returned 10+% during last years’ absolute meltdown.
The recent portfolio actions taken by Odyssey’s investment team in the 4th quarter show that current pricing on many assets are now discounting a very dire economic scenario, so shifting more money into more ‘risk’ assets is appropriate at this time. I whole heartedly agree and I’m excited to see Odyssey put more money to work in quality stocks and higher yield bonds.
Valuation:
Using the same methodology as last time, I’ll summarize Odyssey’s value with the last financials
1) At the current quote of $40 and change, Odyssey Re trades at roughly a 15% discount to stated book.
2) The current investment portfolio of $7.89B comes to about $133/share… which if you assume a 6% return and 35% tax rate, would place normalized earnings at >$5.15/share. (This statement makes an inherent assumption that underwriting profits will just cover the debt costs which could be argued, but so could the 6% return figure)
3) Note that while YoY the investment portfolio has decreased slightly the share count shrunk dramatically (~15%) so the portfolio value/share increased 10%.
4) The debt to equity ratio is only 17% (up slightly), so the buybacks have not sacrificed the balance sheet in any meaningful way and Odyssey was also an active repurchase of preferred stock during Q4.
5) Average diluted EPS (GAAP) over the past 5 years has been >$5.00/share and while much of the recent homerun profit may be viewed as one time it has improved the equity base for future years of big(ger) profits.
6) Odyssey Re has a 26% stake in ‘Fairfax Asia’ on the balance sheet listed at $61.9M. Fairfax Asia is a private subsidiary that owns a 24% stake in ICICI Lombard, a large Indian insurance company. Last year, I placed a fair value on this ownership by Odyssey of over $200m but given the thrashing various global equities have taken I’d probably haircut that by 50% to be more conservative.
Again, the Risks…
Of utmost importance is the risk in this investment. Last time I highlighted a plethora of risks that face owners of Odyssey Re common stock. Below I’ll provide an update on the various items:
1) Soft insurance market: While the insurance market has show signs that prices are rationalizing in specialty lines as well as some reinsurance lines, overall the pricing is still less attractive than it was last year. Contract terms will likely start to harden before pricing materially improves, and overall this will lower Odyssey’s loss rates in lieu of pricing improvements. Net net it appears that the light may be at the end of the tunnel, but given the government actions around the world, and most notably actions taken with AIG, I think there is not much to be optimistic about here yet… time will tell. Insurance operating results will be weak in the near term.
2) Hurricanes / Earthquakes / Etc: Nothing has changed fundamentally about Odyssey’s core business. You don’t buy this one if you find that quarterly EPS volatility makes you queasy.
3) Lawsuits: As I followed up in July last year the baseless suits that were lurking around the Odyssey and Fairfax regarding tax avoidance were cleared up as the IRS closed the books on the years in question giving ORH a clean bill of health.
4) Lack of shareholder control: If anything, this ‘risk’ has worsened. As Odyssey Re has continued to buy back shares as an astronomical clip, the free float has decreased and Fairfax’s control has only increased (if that is possible). This continues to be a business you do not invest in unless you trust Fairfax completely. On a related note, a Canadian subsidiary (Northbridge) of Fairfax in a very similar situation to Odyssey Re was purchased for a premium of 35%+ of the stock price last year for a price to book of 1.3x. Fairfax (which stands for “Fair and Friendly Acquisitions”) has continued to treat its minority shareholders more than fairly in these dealing (as an example, Fairfax’s 1.3x book price for Northbridge was higher than not only the P&C Insurance sector on aggregate, but more than Fairfax’s own market value). I view the minority position of ORH as actually a potential catalyst if Fairfax chooses to take full control in a manner similar to Northbridge. A similar deal to the one for Northbridge would yield a 50% premium to the current price of $40/share.
5) CDS volatility: Since last year, the CDS position has been wound down quite substantially. While some investors may be turned off by the fact that ORH stock may no longer behave as a disaster insurance policy, there is no doubt that results will be perceived as much more transparent and less volatile by the market. This is probably marginally positive overall.
Summary:
So what you have here is still a solidly run insurance company, trading at a low (but admittedly not a crazy cheap) price of 80-85% of adjusted book and perhaps less than 8x earnings. They have repeated shown an adroit ability to side step big mistakes and do the basics well. Their book value compounding since early 2000’s has been near 20% annually while most supposed giants of the industry have nearly obliterated their franchise. Odyssey not only avoided, but profited from the follies of others in their sector. Now as losses and incompetence has been exposed, they are beginning to take risks on the investment side that favor those with cash ready for deployment. Additionally, they have the capacity waiting and ready for rational pricing in insurance policies. While I will concede that the current market environment certainly will present much ‘cheaper’ stocks for those willing to dig, I question how many will be as safe or as ‘easy’ as Odyssey.
Buying a solid insurance company with a world class investment arm for a 15% discount to book has tended over time to be a rewarding proposition and I believe that will be the result in this instance as well.
Ben Hacker
Disclosure: Ben Hacker and clients of Remick Capital, LLC owned shares of Odyssey Re and Fairfax Financial at the time of this writing.
Saturday, April 4, 2009
Wednesday, July 30, 2008
Odyssey Re: The Truth Shall Set You Free
In my last post I highlighted the reasons why I own Odyssey Re, and also some of the risks in the investment.
Of the 5 risks I highlighted, one was relating to a dispute about some tax transactions in the past wrt to the Fairfax Financial parent company:
"Lawsuits: Fairfax made some transactions in Odyssey stock several years back to be able to consolidate ORH onto its balance sheet for tax purposes. I personally believe that when Fairfax management says that the IRS had approved of this transaction, then the discussion is over. But company critics and a few short sellers certainly have a different view. This may be a grey cloud that hangs over the company for a while until it blows over and is resolved."
An announcement tonight by Fairfax has put the issue to rest (finally). Unsurprisingly, Fairfax and Odyssey management did not break any rules, and adhered to the tax code. The IRS has completed the review of those tax years and has closed the books.
"No changes were made to the above-mentioned consolidated 2003 and 2004 tax returns with respect to that purchase of shares and issuance of exchangeable debentures or the inclusion of Odyssey Re..."
The fact that only days ago Fairfax critics were putting out harassing and misleading PR announcements stating that Fairfax and Odyssey should come clean about the tax issue is just that much funnier.
Since my post in May, Odyssey shares have appreciated slightly while the market has tanked. I believe this announcement only further clears the air about ORH and FFH as solid investment candidates with great management.
Fairfax fought the good fight on this issue. When it was first raised they said that the issue was reviewed by the tax authorities and was signed off. They then were silent as their many critics bantered about the issue ad nauseum. While some may have preferred Fairfax and Odyssey be more vocal in their defense, to me the critics were so out of line with so little actual facts behind their argument that I'm glad they were never ackknowledged and given legitimacy.
Fairfax and Odyssey are now at a point in their businesses where they can let the results speak for themselves... and that is just what they are doing.
Ben
Long ORH and FFH
Of the 5 risks I highlighted, one was relating to a dispute about some tax transactions in the past wrt to the Fairfax Financial parent company:
"Lawsuits: Fairfax made some transactions in Odyssey stock several years back to be able to consolidate ORH onto its balance sheet for tax purposes. I personally believe that when Fairfax management says that the IRS had approved of this transaction, then the discussion is over. But company critics and a few short sellers certainly have a different view. This may be a grey cloud that hangs over the company for a while until it blows over and is resolved."
An announcement tonight by Fairfax has put the issue to rest (finally). Unsurprisingly, Fairfax and Odyssey management did not break any rules, and adhered to the tax code. The IRS has completed the review of those tax years and has closed the books.
"No changes were made to the above-mentioned consolidated 2003 and 2004 tax returns with respect to that purchase of shares and issuance of exchangeable debentures or the inclusion of Odyssey Re..."
The fact that only days ago Fairfax critics were putting out harassing and misleading PR announcements stating that Fairfax and Odyssey should come clean about the tax issue is just that much funnier.
Since my post in May, Odyssey shares have appreciated slightly while the market has tanked. I believe this announcement only further clears the air about ORH and FFH as solid investment candidates with great management.
Fairfax fought the good fight on this issue. When it was first raised they said that the issue was reviewed by the tax authorities and was signed off. They then were silent as their many critics bantered about the issue ad nauseum. While some may have preferred Fairfax and Odyssey be more vocal in their defense, to me the critics were so out of line with so little actual facts behind their argument that I'm glad they were never ackknowledged and given legitimacy.
Fairfax and Odyssey are now at a point in their businesses where they can let the results speak for themselves... and that is just what they are doing.
Ben
Long ORH and FFH
Saturday, May 24, 2008
The Stock I Like Best: Odyssey Re Holdings (NYSE: ORH)
Don't look away, it's a financial:
The insurance industry isn’t exactly viewed as a panacea for the investment woes inflicted on many of us over the past several months. While not as lowly as banking or retail, the insurance industry has certinaly seen its share of pain recently. The most notable problems are due to very soft pricing industry wide, and write downs of all sorts of products from Asset Backed bonds, CDS contracts, and other acronym-filled toxic waste that need no introductions in this format. Both of these problems are well captured by mighty AIG’s most recent results and consequent $20B recapitalization plan.
So what goes down, must come up, is that the thesis here?:
Odyssey Re is an insurance company. For the 12 months ending Dec 31st, roughly two thirds of Odyssey’s gross premiums came from Reinsurance, and the balance came from standard insurance. From a geographical perspective, the premium breakdown between geographies is: ~60% Americas, 25% EuroAsia, and 15% London.
As of the latest 10-Q, the balance sheet looked like this (also see transcript link):
Total Equity of $2.81B
Total Assets of $9.80B
Total Unpaid losses and loss adjustment expenses of $5.14B (we’ll use this to approximate insurance ‘float’)
Total Investments and Cash of $8.11B
Odyssey Re’s investment portfolio is run by Hamblin Watsa (HWIC) which is a Fairfax Financial (NYSE: FFH) subsidiary. HWIC has a >20yr history of providing dominate absolute returns on both stock and bond investments. Over the past 15 years, equities run by HWIC have returned >15% net of hedges and bonds have exceeded >9%. Odyssey Re, by virtue of being a public subsidiary of Fairfax (>60% owned) has access to the HWIC team for the low price of 0.2-0.3% (depending on performance).
The proof is in the pudding:
I highlighted above the Fairfax Financial connection that Odyssey Re has. In 2001, Fairfax was hurting for cash and was forced to spin out ORH in an IPO to raise funds for the holding company. Odyssey Re has been public ever since. The managers of ORH are distinct from the Fairfax parent, but the companies are indeed closely linked. The question is; do the managers have skill? Since the IPO year end (2001), until the most recent quarter Odyssey Re has compounded book value by >17% annually. Amazingly, this was done without taking gigantic risks and maintaining a very cautious investment portfolio. It was also during a time when there were multiple devastating hurricanes/floods in the US and several natural disasters around the world.
Skill or luck?:
In the last few years, while other insurers and banks were fumbling around and selling default insurance on various bonds and businesses to make a tiny extra return, Odyssey Re was quietly buying a portfolio of CDS on companies like Countrywide, Washington Mutual, and other perceived ‘strong’ financial institutions. From 2005 to the beginning of 2007 this was a losing strategy for Odyssey as the risks in these institutions were not seen or perceived by anyone. However, as we all know, 2007 ended with quite a bang for financials and 2008 has been a wild ride (mostly down) so far. Consequently, the CDS wager that Odyssey had been losing money on for a few years has paid itself back several times over in the last 12 months which has helped to grow equity per share by 40%.
Interestingly enough, while the insurance industry is expected to write down upwards of $200B in Asset Backed and related paper (which would rival the largest insurance disasters in history in dollar terms) Odyssey will write down approximately $0.00. At the same time through their CDS investments, they will profit from the pain of others. And in the end, Odyssey will be flush with cash right when their competitors are hurting the most; an envious place to be. This positioning is beginning to show its strength as Odyssey has made some joint investments recently in distressed debt; most notably their $100M investment in Abitibi-Bowater 8% convertible bonds. As the recession begins to unfold, there should be more interesting things that HWIC decides to buy.
That's great, but is it cheap?:
Above, I tried to capture some softer points about why Odyssey Re is a good company, and a brief industry macro view, but value investors know “Price is what you pay, value is what you get.” So is this a value?
So is this risk free?:
As with all investments, there are risks here to be aware of.
Summary:
So what you have here is a solidly run insurance company, trading at a low (but admittedly not crazy cheap) price. They have made steps in the past and successfully avoided the problems others have stepped into (namely real estate and financial woes). On top of that, they not only avoided but profited from the follies of others in their sector. Now as losses begin to pile up, you have a company that is well positioned; flush with cash, buying back its stock as fast as possible, trading for less than a reasonable estimate of book value, that will probably grow book by >15% annually over the next 10 years. It is certainly a company that is at least worth a look in my opinion.
The insurance industry isn’t exactly viewed as a panacea for the investment woes inflicted on many of us over the past several months. While not as lowly as banking or retail, the insurance industry has certinaly seen its share of pain recently. The most notable problems are due to very soft pricing industry wide, and write downs of all sorts of products from Asset Backed bonds, CDS contracts, and other acronym-filled toxic waste that need no introductions in this format. Both of these problems are well captured by mighty AIG’s most recent results and consequent $20B recapitalization plan.
So what goes down, must come up, is that the thesis here?:
Not quite. For one, Odyssey stock isn’t really down. It’s survived the downturn fairly well in fact and depending on your measurement dates, the stock has actually been up. No the thesis for Odyssey, is based on something much more intuitive in my mind:
- It’s cheap
- It has great management that avoids doing dumb things
That’s pretty much the thesis. I could stop, but some elaboration may be in order.
Business overview:Odyssey Re is an insurance company. For the 12 months ending Dec 31st, roughly two thirds of Odyssey’s gross premiums came from Reinsurance, and the balance came from standard insurance. From a geographical perspective, the premium breakdown between geographies is: ~60% Americas, 25% EuroAsia, and 15% London.
As of the latest 10-Q, the balance sheet looked like this (also see transcript link):
Total Equity of $2.81B
Total Assets of $9.80B
Total Unpaid losses and loss adjustment expenses of $5.14B (we’ll use this to approximate insurance ‘float’)
Total Investments and Cash of $8.11B
*Investment account breakdown
- $4.26B in fixed income securities
- $1.05B in Stocks and Investments at Equity securities ($61.9M in Fairfax Asia)
- $1.30B in Short term investments
- $1.05B in Cash
- $0.45 in ‘other’ ($0.24B of Credit Default Swaps)
The fixed income securities are >92% in AAA rated issues (and before you ask…); there are no ABS bonds, no CDOs, and only $180M worth of Municipals. For the equity investments, of the investments that are publically traded equities, the company has a ~100% hedge via shorts and a total return swap on the S&P500. So you ‘could’ describe this portfolio as conservative if you wanted to make an understatement.
Odyssey Re’s investment portfolio is run by Hamblin Watsa (HWIC) which is a Fairfax Financial (NYSE: FFH) subsidiary. HWIC has a >20yr history of providing dominate absolute returns on both stock and bond investments. Over the past 15 years, equities run by HWIC have returned >15% net of hedges and bonds have exceeded >9%. Odyssey Re, by virtue of being a public subsidiary of Fairfax (>60% owned) has access to the HWIC team for the low price of 0.2-0.3% (depending on performance).
The proof is in the pudding:
I highlighted above the Fairfax Financial connection that Odyssey Re has. In 2001, Fairfax was hurting for cash and was forced to spin out ORH in an IPO to raise funds for the holding company. Odyssey Re has been public ever since. The managers of ORH are distinct from the Fairfax parent, but the companies are indeed closely linked. The question is; do the managers have skill? Since the IPO year end (2001), until the most recent quarter Odyssey Re has compounded book value by >17% annually. Amazingly, this was done without taking gigantic risks and maintaining a very cautious investment portfolio. It was also during a time when there were multiple devastating hurricanes/floods in the US and several natural disasters around the world.
Skill or luck?:
In the last few years, while other insurers and banks were fumbling around and selling default insurance on various bonds and businesses to make a tiny extra return, Odyssey Re was quietly buying a portfolio of CDS on companies like Countrywide, Washington Mutual, and other perceived ‘strong’ financial institutions. From 2005 to the beginning of 2007 this was a losing strategy for Odyssey as the risks in these institutions were not seen or perceived by anyone. However, as we all know, 2007 ended with quite a bang for financials and 2008 has been a wild ride (mostly down) so far. Consequently, the CDS wager that Odyssey had been losing money on for a few years has paid itself back several times over in the last 12 months which has helped to grow equity per share by 40%.
Interestingly enough, while the insurance industry is expected to write down upwards of $200B in Asset Backed and related paper (which would rival the largest insurance disasters in history in dollar terms) Odyssey will write down approximately $0.00. At the same time through their CDS investments, they will profit from the pain of others. And in the end, Odyssey will be flush with cash right when their competitors are hurting the most; an envious place to be. This positioning is beginning to show its strength as Odyssey has made some joint investments recently in distressed debt; most notably their $100M investment in Abitibi-Bowater 8% convertible bonds. As the recession begins to unfold, there should be more interesting things that HWIC decides to buy.
That's great, but is it cheap?:
Above, I tried to capture some softer points about why Odyssey Re is a good company, and a brief industry macro view, but value investors know “Price is what you pay, value is what you get.” So is this a value?
- At the current quote of $37 and change, Odyssey Re trades at roughly a 10% discount to stated book.
- You can sleep well at night knowing that in the next earnings report you won’t find out that company put all their ‘cash’ in a CPDO/ABS toxic waste money market fund that is locked up and devalued by 10%. There are no skeletons in this closet.
- The current investment portfolio of $8.11B comes to about $120/share… which if you assume a 6% return and 35% tax rate, would place normalized earnings at >$4.50/share assuming that the insurance side of the business makes enough underwriting profit to pay interest on the company's small debt load.
- Recently, the management (who have been shown to be shrewd allocators of capital) has been repurchasing shares at a fast clip in the $35’s and $36’s. In the first quarter, the company repurchased 3% of the outstanding shares, and just since March 31st to the quarterly call, the company repurchased 1.1 million shares.
- The debt to capital ratio is only 15%, so the buybacks are not sacrificing the balance sheet in any meaningful way.
- Average diluted EPS (GAAP) over the past 5 years has been >$4.00/share (this includes the Rita/Katrina disaster years).
- Odyssey Re has a 26% stake in ‘Fairfax Asia’ on the balance sheet listed at $61M. Fairfax Asia is a private subsidiary that owns a 24% stake in ICICI Lombard, a large Indian insurance company. Pricing of the ICICI parent company IPO last year would imply a valuation of the 24% stake in Lombard at >$800M, which would put Odyssey Re’s stake at a value of >$200M (likely more as Lombard is growing like a weed), so this would increase book value by 5% if accounted at market prices.
So what I think you have here is an interesting company. It’s a very conservative organization that’s well capitalized, they don't reach for yield, and they are heavily hedged against a recession and general economic weakness. On top of that, the stock is trading for likely <80-85%> of book value.
So is this risk free?:
As with all investments, there are risks here to be aware of.
- Soft insurance market: Odyssey Re, Warren Buffett, and other insurance veterans are noting that a soft market is well under way in all areas of insurance. As Odyssey Re has a total return philosophy to insurance, they don’t write business for market share, and they are letting their premiums scale back where pricing is unacceptable. This will continue to have a negative effect on the stock as revenues decline; until it doesn’t anymore. Insurance companies’ earnings are cyclical, and no one knows when the next hard pricing market will come; but it will.
- Hurricanes / Earthquakes / Etc: Odyssey has “Re” in its name. Reinsurers generally have the most volatile earnings in the insurance sector (in exchange for the average highest ROE). Odyssey is no exception. As disasters strike Odyssey will lose money. This isn’t the kind of company you try to predict the next 5 quarters’ earnings with any particular accuracy; it’s not likely possible given the vagaries of Mother Nature.
- Lawsuits: Fairfax made some transactions in Odyssey stock several years back to be able to consolidate ORH onto its balance sheet for tax purposes. I personally believe that when Fairfax management says that the IRS had approved of this transaction, then the discussion is over. But company critics and a few short sellers certainly have a different view. This may be a grey cloud that hangs over the company for a while until it blows over and is resolved.
- Lack of shareholder control: Odyssey has about 68M shares outstanding as of now. Fairfax controls 42.4M of those shares (or >62%). Now, I’d argue that Fairfax has been a fair steward of capital for both private and public subsidiaries. For example, whenever Fairfax makes a sweet investment deal, Odyssey gets cut in on a piece of the action as well (the Abitibi Bowater convertibles are case in point), but lack of any control by public shareholders will likely keep a stigma on the stock until people begin to fully trust management at Odyssey and Fairfax.
- CDS volatility: While Odyssey has made a lot of money on their CDS positions in the past 12 months, these investments continue to be very volatile. Tens of millions of dollars can appear or disappear each day on these positions and the future value is highly uncertain. Odyssey Re and HWIC have proven adept so far at managing investments and a portion of the thesis in Odyssey Re is certainly a continued belief in HWIC investing prowess.
Summary:
So what you have here is a solidly run insurance company, trading at a low (but admittedly not crazy cheap) price. They have made steps in the past and successfully avoided the problems others have stepped into (namely real estate and financial woes). On top of that, they not only avoided but profited from the follies of others in their sector. Now as losses begin to pile up, you have a company that is well positioned; flush with cash, buying back its stock as fast as possible, trading for less than a reasonable estimate of book value, that will probably grow book by >15% annually over the next 10 years. It is certainly a company that is at least worth a look in my opinion.
Disclaimer: At the time of this writing Ben Hacker and his clients had positions in ORH and FFH but no other investments discussed in this article.
Tuesday, January 8, 2008
US Fixed Income: (In)Efficient Market?
I certainly wouldn't consider myself an 'income' investor per se; I'm an equity or cash guy in most circumstances. However, I do own insurance companies that have large bond portfolios, and the general market does take some cues from the fixed income markets so in my opinion it is always good to pay attention to what is going on in the general credit markets.
Recent market action in the MBS, ABS, CDO, and SIV markets have received much coverage for good reason. The TED spread (difference between LIBOR and Fed Funds) is even getting some mainstream attention these days for its historically large deviation from the mean. However, just recently I was doing some (very frustrating) research on the bond insurers and I stumbled upon something absolutely bizarre to my eyes. (Click here for the Bloomberg interest rate summary)
It turns out that the current rates for 30yr AAA (insured) rated Municipal Revenue Bonds are ~4.50%. (Note that these Muni bonds are federally tax exempt for US taxpayers.)
At the same time, you can see that 30yr US Treasury Bonds have a YTM of <4.3%.
Now I have to admit that I am most certainly not a municipal bond market expert or even watcher (usually), but when Muni's yield more on a nominal basis than their maturity matched UST, I just can't help but thinking there is an inefficiency or pair trade that is waiting to be exploited.
At 4.5%, the taxable equivalent municipal yield (for a 35% marginal payer) is 6.9%.
While there is certainly some finite amount of extra default risk that you take on when purchasing a AAA insured Muni vs. a US Agency Bond, I believe is is immaterial. Over the last 30 years, there have been zero AAA rate muni bond defaults (even AA and A have been zero). The bigger risk here, and in my opinion this is what the market is freaking out about, is that there is a tremendous amount of liquidity risk with Munis. And as we all know right now, the market is valuing liquidity above all else. In fact, in the limited data I've been able to dig up, it appears that it has not been unprecedented to see Muni yields surpass treasuries in times of stress.... although historically the mean ratio is ~0.9 (Muni/UST); which would make sense given that the marginal pricing for Munis is probably set by tax paying investors. (In fact, I would have guessed that the ratio would be even lower...)
As an investor (or speculator) attempting to profit from this, it seems to be pretty straight forward: You can go long any number of leveraged or unlevered Muni-Bond CEFs and simultaneously short an equivalent of UST (maturity matched) bonds or funds.
An example of one simple way to approach this would be the following pair trade:
1) Long MLN (a new National Muni Bond ETF from Van Eck - Fact Sheet)
Duration is 10yr, Maturity is 25yr, 90+% A rated or better, Weighted Average Yield - 4.7%
2) Short TLT (iShares 20+ Gov Bond fund - Fact Sheet)
Duration is 14yr, Maturity is 25yr, 100% Agency, Weighted Average Yield - 4.35%
A Tax paying investor would capture the spread (net of fees and factoring in expense ratios) between the two funds. The cost to pay the TLT interest would be tax deductible and the interest received on the MLN position would be federally tax free.
In addition assuming the spread narrows, there could be a good chance to pick up some capital gains here.
Overall, this smacks a bit of the Long Term Capital Management strategy of picking up nickles in front of the liquidity bulldozer, but the intellectual in me thinks that it would probably be a good trade for a small position of the portfolio, assuming you can keep fees in check and ignore any mark-to-market losses for several months at least.
I have no plans to deploy this trade at this time, but that may change in the future.
Ben
Disclosures - None
Recent market action in the MBS, ABS, CDO, and SIV markets have received much coverage for good reason. The TED spread (difference between LIBOR and Fed Funds) is even getting some mainstream attention these days for its historically large deviation from the mean. However, just recently I was doing some (very frustrating) research on the bond insurers and I stumbled upon something absolutely bizarre to my eyes. (Click here for the Bloomberg interest rate summary)
It turns out that the current rates for 30yr AAA (insured) rated Municipal Revenue Bonds are ~4.50%. (Note that these Muni bonds are federally tax exempt for US taxpayers.)
At the same time, you can see that 30yr US Treasury Bonds have a YTM of <4.3%.
Now I have to admit that I am most certainly not a municipal bond market expert or even watcher (usually), but when Muni's yield more on a nominal basis than their maturity matched UST, I just can't help but thinking there is an inefficiency or pair trade that is waiting to be exploited.
At 4.5%, the taxable equivalent municipal yield (for a 35% marginal payer) is 6.9%.
While there is certainly some finite amount of extra default risk that you take on when purchasing a AAA insured Muni vs. a US Agency Bond, I believe is is immaterial. Over the last 30 years, there have been zero AAA rate muni bond defaults (even AA and A have been zero). The bigger risk here, and in my opinion this is what the market is freaking out about, is that there is a tremendous amount of liquidity risk with Munis. And as we all know right now, the market is valuing liquidity above all else. In fact, in the limited data I've been able to dig up, it appears that it has not been unprecedented to see Muni yields surpass treasuries in times of stress.... although historically the mean ratio is ~0.9 (Muni/UST); which would make sense given that the marginal pricing for Munis is probably set by tax paying investors. (In fact, I would have guessed that the ratio would be even lower...)
As an investor (or speculator) attempting to profit from this, it seems to be pretty straight forward: You can go long any number of leveraged or unlevered Muni-Bond CEFs and simultaneously short an equivalent of UST (maturity matched) bonds or funds.
An example of one simple way to approach this would be the following pair trade:
1) Long MLN (a new National Muni Bond ETF from Van Eck - Fact Sheet)
Duration is 10yr, Maturity is 25yr, 90+% A rated or better, Weighted Average Yield - 4.7%
2) Short TLT (iShares 20+ Gov Bond fund - Fact Sheet)
Duration is 14yr, Maturity is 25yr, 100% Agency, Weighted Average Yield - 4.35%
A Tax paying investor would capture the spread (net of fees and factoring in expense ratios) between the two funds. The cost to pay the TLT interest would be tax deductible and the interest received on the MLN position would be federally tax free.
In addition assuming the spread narrows, there could be a good chance to pick up some capital gains here.
Overall, this smacks a bit of the Long Term Capital Management strategy of picking up nickles in front of the liquidity bulldozer, but the intellectual in me thinks that it would probably be a good trade for a small position of the portfolio, assuming you can keep fees in check and ignore any mark-to-market losses for several months at least.
I have no plans to deploy this trade at this time, but that may change in the future.
Ben
Disclosures - None
Wednesday, December 26, 2007
Japan is Looking Interesting...
Some (rare) macro investment thinking I've been doing lately has lead me to Japan. From my post early this week I highlighted how Japan is certainly below average when looking at the world markets from a profitability perspective. I will be the first to concede that low profitability may be a non-intuitive place to unearth investment ideas, but in the case of Japan, there may be something interesting lurking underneath the ugly numbers.
Japan has a couple of issues which I believe have really compressed corporate profitability:
1) Historically high valuations - Japan in some ways is still recovering from the massive excesses of the late 80's when the market took complete leave of its senses and bid anything Japanese up to stratospheric levels that would make a .com speculator in 1999 blush. After more than 15 years of property market declines and a >75% routing of the Nikkei, I believe expectations in Japan are about as close to zero as you can get.
2) Broken Regulation - The financial sector in Japan has been operating under a rather buerocratic leadership for some time. With the initial proposal recently by the Japanese Financial Services Agency to derugulate the stock exchanges and to loosen some rules on investment funds, there may be a change in the wind for the economy. Add to that the fact that the Japanese Post is also going to be privatised via a staged IPO process over the next few years and you have a few quiet rumblings that may be the beginning of a trend.
Some interesting statistics about the Japanese market (from S&P):
Net Margin - 4.26% (lowest of any country/market)
Price / Sales - 0.79x (second lowest of any country/market)
Price / Book - 1.68x (third lowest of any country/market)
Return on Equity - 8.69% (third lowest of any country/market)
Based on the above, the argument can be made that the tough, low interest rate enviroment in Japan right now is (rightly) causing the pain. The contrarian in me thinks that the outcome of Japanese economic purgatory continueing for 10 more years is already baked in here. It is reinforced for me when I looked at the Emerging Market statistics and they basically look like the above stats for Japan; just multiplied by 2 or 3x. It wasn't so long ago that Emerging Markets were in purgatory themselves... it is amazing how fast things can change when margins improve quickly (like they have for EM over the last 7 years).
All said, I think that Japan at this time offers several compelling investment traits:
1) Rock bottom expectations
2) Very attractive revenue/book valuations
3) Earnings well below any reasonable trend or mean for a country
4) Positive and changing regulatory environoment
5) Large pent up demand for Japanese citizens savings (both from the Japan Post deregulation as well as the low interest rates in Japan)
Any combination of the above could be a strong catalyst for Japanese shares.
Ok, so let's assume we've made the leap to invest in Japan, the immediate question becomes "what vehicle to use?" Well, given the proliferation of CEF/ETFs these days, we have quite a few options:
1) iShares MSCI Japan Index (EWJ)
2) iShares S&P/TOPIX 150 (ITF)
Both of these two are essentially cap-weighed straight Japanese index funds. The ITF is only the top 150 shares in terms of size, while the EWJ ETF holds nearly 400 stocks.
3) Japan Equity Fund, Inc. (JEQ)
This is a CEF that trades at a slight discount (7%) and has a reasonable expense ratio. However, historical performance has been poor. Perhaps more research would unearth some things here, but at first blush, I'm not interested.
4) Japan Smaller Capitalization Fund, Inc. (JOF)
This is another CEF but with no real discount and fairly high expenses. The portfolio seems actively chosen (not a closet indexer) and historical performance has been good. The high expenses here are a turnoff.
5) SPDR Russell/Nomura Prime Japan (JPP)
This is essentially the same as EWJ.
6) SPDR Russell/Nomura SmallCap Japan (JSC)
This is the small cap Japan ETF. It is market cap weighted and holds roughtly 400 companies.
7) PowerShares FTSE RAFI Japan (PJO)
This is a Japan based fundamentally weighted index based on the RAFI fundamental weighting. There has been a lot of hub-bub recently about fundamental weightings for indices (even though it's been around for 25 years...) and this fund may be a good play for those who view that fundamental weighted indices are the way to go.
8) WisdomTree JP High-Yielding Equity (DNL)
9) WisdomTree JP SmallCap Dividend (DFJ)
10) WisdomTree JP Total Dividend (DXJ)
On the topic of fundamental weights, the WisdomTree funds are similar to RAFI, but their only criteria is raw dividend amount. DNL focuses only on the highest yielding stocks in Japan and is very top heavy (50+% of assets in the top 10 holdings). DFJ is the small cap focused fund and DXJ is the pure overall Japan Dividend weighted fund (all capitalizations, all dividend payers).
My first instinct is to look to the smaller cap funds for Japan exposure as I think any economic improvement will be magnified in that segment of the market (due to the fact that small caps in Japan have lower overall margins than the big caps). Second, I want to own a fund that has lower valuation measure than the overall market by quite a bit.
For JSC I'm seeing that the Price / Book is roughtly 1.3x, and for DFJ I'm seeing it at ~1.15x. The DFJ index has a profit margin of roughly 2.5% shares trade at a price / sales of 0.40x. Both of these ETF shares are rather illiquid, but not to the point of being useless for most investors. The premium/discount on these ETFs is usually well within +/- 1.50%.
At these valuation levels, you have to assume that some component of it is due to the fact that perhaps the DFJ dividend weighting is selecting some non-optimal companies that are perhaps destorying value. Due to the governance issues in Japan, this is a real reason for concern. However, the thing I like about DFJ is that it only owns companies that pay dividends, which *should* eliminate a bit of the most unsavory corporate misdeads. Also, the wide diversification both by issue and by sector should also dampen any potential problem companies.
At this time I don't have a direct position any Japan ETF but I'm leaning toward possibly taking a small position in DFJ on any further weakness.
Cheers,
Ben Hacker
Japan has a couple of issues which I believe have really compressed corporate profitability:
1) Historically high valuations - Japan in some ways is still recovering from the massive excesses of the late 80's when the market took complete leave of its senses and bid anything Japanese up to stratospheric levels that would make a .com speculator in 1999 blush. After more than 15 years of property market declines and a >75% routing of the Nikkei, I believe expectations in Japan are about as close to zero as you can get.
2) Broken Regulation - The financial sector in Japan has been operating under a rather buerocratic leadership for some time. With the initial proposal recently by the Japanese Financial Services Agency to derugulate the stock exchanges and to loosen some rules on investment funds, there may be a change in the wind for the economy. Add to that the fact that the Japanese Post is also going to be privatised via a staged IPO process over the next few years and you have a few quiet rumblings that may be the beginning of a trend.
Some interesting statistics about the Japanese market (from S&P):
Net Margin - 4.26% (lowest of any country/market)
Price / Sales - 0.79x (second lowest of any country/market)
Price / Book - 1.68x (third lowest of any country/market)
Return on Equity - 8.69% (third lowest of any country/market)
Based on the above, the argument can be made that the tough, low interest rate enviroment in Japan right now is (rightly) causing the pain. The contrarian in me thinks that the outcome of Japanese economic purgatory continueing for 10 more years is already baked in here. It is reinforced for me when I looked at the Emerging Market statistics and they basically look like the above stats for Japan; just multiplied by 2 or 3x. It wasn't so long ago that Emerging Markets were in purgatory themselves... it is amazing how fast things can change when margins improve quickly (like they have for EM over the last 7 years).
All said, I think that Japan at this time offers several compelling investment traits:
1) Rock bottom expectations
2) Very attractive revenue/book valuations
3) Earnings well below any reasonable trend or mean for a country
4) Positive and changing regulatory environoment
5) Large pent up demand for Japanese citizens savings (both from the Japan Post deregulation as well as the low interest rates in Japan)
Any combination of the above could be a strong catalyst for Japanese shares.
Ok, so let's assume we've made the leap to invest in Japan, the immediate question becomes "what vehicle to use?" Well, given the proliferation of CEF/ETFs these days, we have quite a few options:
1) iShares MSCI Japan Index (EWJ)
2) iShares S&P/TOPIX 150 (ITF)
Both of these two are essentially cap-weighed straight Japanese index funds. The ITF is only the top 150 shares in terms of size, while the EWJ ETF holds nearly 400 stocks.
3) Japan Equity Fund, Inc. (JEQ)
This is a CEF that trades at a slight discount (7%) and has a reasonable expense ratio. However, historical performance has been poor. Perhaps more research would unearth some things here, but at first blush, I'm not interested.
4) Japan Smaller Capitalization Fund, Inc. (JOF)
This is another CEF but with no real discount and fairly high expenses. The portfolio seems actively chosen (not a closet indexer) and historical performance has been good. The high expenses here are a turnoff.
5) SPDR Russell/Nomura Prime Japan (JPP)
This is essentially the same as EWJ.
6) SPDR Russell/Nomura SmallCap Japan (JSC)
This is the small cap Japan ETF. It is market cap weighted and holds roughtly 400 companies.
7) PowerShares FTSE RAFI Japan (PJO)
This is a Japan based fundamentally weighted index based on the RAFI fundamental weighting. There has been a lot of hub-bub recently about fundamental weightings for indices (even though it's been around for 25 years...) and this fund may be a good play for those who view that fundamental weighted indices are the way to go.
8) WisdomTree JP High-Yielding Equity (DNL)
9) WisdomTree JP SmallCap Dividend (DFJ)
10) WisdomTree JP Total Dividend (DXJ)
On the topic of fundamental weights, the WisdomTree funds are similar to RAFI, but their only criteria is raw dividend amount. DNL focuses only on the highest yielding stocks in Japan and is very top heavy (50+% of assets in the top 10 holdings). DFJ is the small cap focused fund and DXJ is the pure overall Japan Dividend weighted fund (all capitalizations, all dividend payers).
My first instinct is to look to the smaller cap funds for Japan exposure as I think any economic improvement will be magnified in that segment of the market (due to the fact that small caps in Japan have lower overall margins than the big caps). Second, I want to own a fund that has lower valuation measure than the overall market by quite a bit.
For JSC I'm seeing that the Price / Book is roughtly 1.3x, and for DFJ I'm seeing it at ~1.15x. The DFJ index has a profit margin of roughly 2.5% shares trade at a price / sales of 0.40x. Both of these ETF shares are rather illiquid, but not to the point of being useless for most investors. The premium/discount on these ETFs is usually well within +/- 1.50%.
At these valuation levels, you have to assume that some component of it is due to the fact that perhaps the DFJ dividend weighting is selecting some non-optimal companies that are perhaps destorying value. Due to the governance issues in Japan, this is a real reason for concern. However, the thing I like about DFJ is that it only owns companies that pay dividends, which *should* eliminate a bit of the most unsavory corporate misdeads. Also, the wide diversification both by issue and by sector should also dampen any potential problem companies.
At this time I don't have a direct position any Japan ETF but I'm leaning toward possibly taking a small position in DFJ on any further weakness.
Cheers,
Ben Hacker
Tuesday, December 25, 2007
World Wide Margins: Just Outstanding, or Out of Whack?
A large focus for many professional and amateur investors alike is the determination of the appropriate level of valuation of the stock market. While often times you will hear some folks dismiss this topic as unecessary when hunting for superior individual stocks, I do believe that the discussion should merit at least a modest amount of focus.
Without a rough estimation of what the 'fair value' of a market may be, it (I believe) is speculation to dip too big of a toe into any individual equities that are encompassed by it. A prime example of where this may have gotten an investor into trouble was in 2000 in the US market. Investor enthusiasm for all technology issues distorted the valuation on many names to the point where the aggregate S&P500 was pushing up over 30x earnings. An investor specializing in large US equities, and technology names in particular would have done well to at least contemplate the underlying economic assumptions that a 30x multiple implies about a market.... and then immediately realize the lunacy that was taking place.
More importantly I think, are those investors/speculators who follow a so-called asset allocation investment model where decisions are more driven by overall valuations of an entire market as opposed to individual equities and bonds. These investors may be more keen to understand the level of valuation more, since individual valuations bear no weight on their decisions.
One of the rallying cries that have been made by myself and many other investors for the last few years has been that the aggregate profit margin level for the US stock market on a whole has been ominously high. Meaning simply that the portion of our economic output (GDP) that is flowing to capital (i.e., shareholders) is (too) high, and the portion going to labor is contracted. History has shown this is of significance because this margin level has been very consistently mean-reverting over the years, and the level has averaged to be ~6-7% over many economic cycles.
There are some interesting arguments as to why a rise above the mean may be sustained (it's different this time right?), but the two key ones that I think are relevant are:
1) The entry of additional labor markets from India and China (read: globalization) have shifted the balance of power toward capital for an extended (perhaps permanent) period of time
2) The US market cannot be taken in a vacuum as many high margin businesses with strong brands count toward the US figures but make much of their money abroad
The key conclusion for those who disagree with the above is that the current margin of the US (8.25%) is above trend, and is bound to mean revert. So the P/E of the market, is overstated by ((8.25-7.00)/8.25=) ~15%. Needless to say, if the net earnings of the S&P500 would drop tomorrow by 15%, the market would be lower than it is today.
While this line of reasoning has always resonated with me; it has always rung a bit hollow from the mouths of its vocal proponents because of an obvious omission. I have heard critics and pundits use the mean reverting profit margin argument probably over 100 times to argue that the US market is overvalued... but I've not seen a single article, blog, or speech by someone using the inverse reasoning to argue a bullish case for an asset class. As Charlie Munger says "Invert. Always invert."
It is often stated that the bearish case is easier to deliver because it makes one sound 'smart'. I fully agree that is the case, but I often believe that people are subconsciously effected by that truth. The reason in this case is simple. The reason margins get high is because everything is going right. Productivity is up, GDP is growing, unemployment is down. As a bear, you can always point to the profit margin and say "Be careful, the good times won't always be here..." Maybe some folks think you are an idiot, but you don't lose money by not buying... or better yet you can still be buying, but just voicing caution at the same. This is a prudent course of action.
On the flip side of the coin, you see Japan in its ultimate economic funk, with ~4% margins and you have a few things to wonder about:
a) Either one market has superior characteristics (regulation, ease of capital flow, strong human capital) AND those reasons provide a superior level of profitability at the expense of other companies from other countries.
OR
b) You believe that in the end, companies profit margins will revert to the mean as the global landscape for competition will push all returns to the mean.
So is the US strong because Japan is weak (simplistically speaking)? Or has the US just had a good run that can't last, and Japan has just had a bad run that can't last?
I personally believe that their may be a bit of truth in both, but I want to perform a little data reconstruction to see what the statistics show the market to believe. The following data set is from the S&P / Citigroup Global Indices (from 11/30/2007):
Immediately, you notice a few things:
1) The US isn't even in the 25th percentile in terms of profit margin.
2) The US is on par with the 'world' weighted profit margin (the implication is that the largest components of the index are toward the bottom, and the higher margin countries in this data set tend to be smallish)
3) Emerging Market profit margins are >11%!!!
4) Japan is dead last
5) Peru, Egypt, Hong Kong and Iceland are all up at 20% or above
The astonishing thing to me is that there continue to be people who not only claim that US equities are overvalued (they may be), but many times they are the same people who are advocating that you diversify out of the US and get foreign exposure without bringing up the same basic data point (net margin) with respect to foreign markets. Blind asset allocation won't help us!
I do believe that many educated folks do already understand this, and are acting on this knowledge already. Buffett for instance has made various overtures stating that the US markets are slightly to fairly overvalued... he has even offered up (in the past) his own valuation metric for the US market which is a price/sales ratio of 0.8x+ (and presumably rising based on his comments). By using a price/sales ratio Buffett is implying that there is a normalized profit level for the US market. On other occasions, Buffett has noted that he sees bargains in South Korea which is the second lowest country on the list in terms of margin level. Buffett has also actively made negative comments regarding Japan which implied that he took a long hard look at the companies there and just didn't find anything he liked.
Aside from Buffett though, there are many other who continually beat the 'mean-reverting margin' drum against US equities but don't seem to discuss the topic for any other markets. These pundits appear to have lost their way, or be parroting 3rd party research which they don't fully comprehend.
Of course there can be many explanations for *some* of the data points above (emerging markets tend to have much higher weight to metals / mining / energy companies which are currently generating substantial profits is just one explanation) but suffice to say that I don't ever see the data above shown much less explained. There just seems to be a lack of intellectual honesty about these things. Or perhaps they are just dumbing it down for their audience, i don't know.
I don't mean for this post to provide conclusions on which of these countries is a good place to invest. This list is only a starting point based on one piece of data, but it is instructive to always try to dig to the next level of data to understand what the masses are saying... and more importantly, what the masses are saying that is wrong.
Until next time,
Without a rough estimation of what the 'fair value' of a market may be, it (I believe) is speculation to dip too big of a toe into any individual equities that are encompassed by it. A prime example of where this may have gotten an investor into trouble was in 2000 in the US market. Investor enthusiasm for all technology issues distorted the valuation on many names to the point where the aggregate S&P500 was pushing up over 30x earnings. An investor specializing in large US equities, and technology names in particular would have done well to at least contemplate the underlying economic assumptions that a 30x multiple implies about a market.... and then immediately realize the lunacy that was taking place.
More importantly I think, are those investors/speculators who follow a so-called asset allocation investment model where decisions are more driven by overall valuations of an entire market as opposed to individual equities and bonds. These investors may be more keen to understand the level of valuation more, since individual valuations bear no weight on their decisions.
One of the rallying cries that have been made by myself and many other investors for the last few years has been that the aggregate profit margin level for the US stock market on a whole has been ominously high. Meaning simply that the portion of our economic output (GDP) that is flowing to capital (i.e., shareholders) is (too) high, and the portion going to labor is contracted. History has shown this is of significance because this margin level has been very consistently mean-reverting over the years, and the level has averaged to be ~6-7% over many economic cycles.
There are some interesting arguments as to why a rise above the mean may be sustained (it's different this time right?), but the two key ones that I think are relevant are:
1) The entry of additional labor markets from India and China (read: globalization) have shifted the balance of power toward capital for an extended (perhaps permanent) period of time
2) The US market cannot be taken in a vacuum as many high margin businesses with strong brands count toward the US figures but make much of their money abroad
The key conclusion for those who disagree with the above is that the current margin of the US (8.25%) is above trend, and is bound to mean revert. So the P/E of the market, is overstated by ((8.25-7.00)/8.25=) ~15%. Needless to say, if the net earnings of the S&P500 would drop tomorrow by 15%, the market would be lower than it is today.
While this line of reasoning has always resonated with me; it has always rung a bit hollow from the mouths of its vocal proponents because of an obvious omission. I have heard critics and pundits use the mean reverting profit margin argument probably over 100 times to argue that the US market is overvalued... but I've not seen a single article, blog, or speech by someone using the inverse reasoning to argue a bullish case for an asset class. As Charlie Munger says "Invert. Always invert."
It is often stated that the bearish case is easier to deliver because it makes one sound 'smart'. I fully agree that is the case, but I often believe that people are subconsciously effected by that truth. The reason in this case is simple. The reason margins get high is because everything is going right. Productivity is up, GDP is growing, unemployment is down. As a bear, you can always point to the profit margin and say "Be careful, the good times won't always be here..." Maybe some folks think you are an idiot, but you don't lose money by not buying... or better yet you can still be buying, but just voicing caution at the same. This is a prudent course of action.
On the flip side of the coin, you see Japan in its ultimate economic funk, with ~4% margins and you have a few things to wonder about:
a) Either one market has superior characteristics (regulation, ease of capital flow, strong human capital) AND those reasons provide a superior level of profitability at the expense of other companies from other countries.
OR
b) You believe that in the end, companies profit margins will revert to the mean as the global landscape for competition will push all returns to the mean.
So is the US strong because Japan is weak (simplistically speaking)? Or has the US just had a good run that can't last, and Japan has just had a bad run that can't last?
I personally believe that their may be a bit of truth in both, but I want to perform a little data reconstruction to see what the statistics show the market to believe. The following data set is from the S&P / Citigroup Global Indices (from 11/30/2007):
Immediately, you notice a few things:
1) The US isn't even in the 25th percentile in terms of profit margin.
2) The US is on par with the 'world' weighted profit margin (the implication is that the largest components of the index are toward the bottom, and the higher margin countries in this data set tend to be smallish)
3) Emerging Market profit margins are >11%!!!
4) Japan is dead last
5) Peru, Egypt, Hong Kong and Iceland are all up at 20% or above
The astonishing thing to me is that there continue to be people who not only claim that US equities are overvalued (they may be), but many times they are the same people who are advocating that you diversify out of the US and get foreign exposure without bringing up the same basic data point (net margin) with respect to foreign markets. Blind asset allocation won't help us!
I do believe that many educated folks do already understand this, and are acting on this knowledge already. Buffett for instance has made various overtures stating that the US markets are slightly to fairly overvalued... he has even offered up (in the past) his own valuation metric for the US market which is a price/sales ratio of 0.8x+ (and presumably rising based on his comments). By using a price/sales ratio Buffett is implying that there is a normalized profit level for the US market. On other occasions, Buffett has noted that he sees bargains in South Korea which is the second lowest country on the list in terms of margin level. Buffett has also actively made negative comments regarding Japan which implied that he took a long hard look at the companies there and just didn't find anything he liked.
Aside from Buffett though, there are many other who continually beat the 'mean-reverting margin' drum against US equities but don't seem to discuss the topic for any other markets. These pundits appear to have lost their way, or be parroting 3rd party research which they don't fully comprehend.
Of course there can be many explanations for *some* of the data points above (emerging markets tend to have much higher weight to metals / mining / energy companies which are currently generating substantial profits is just one explanation) but suffice to say that I don't ever see the data above shown much less explained. There just seems to be a lack of intellectual honesty about these things. Or perhaps they are just dumbing it down for their audience, i don't know.
I don't mean for this post to provide conclusions on which of these countries is a good place to invest. This list is only a starting point based on one piece of data, but it is instructive to always try to dig to the next level of data to understand what the masses are saying... and more importantly, what the masses are saying that is wrong.
Until next time,
Introduction
After some thought I decided it might be a good idea to start up a blog. My company site is fairly formal and I felt like it would be nice to have a place where I can jot down ideas that are seperate from the business and have a running record of my thoughts. This blog will be for fun to just throw ideas out there.
I don't imagine that this blog will be super-active in terms of posting, but my goal is to hit this blog with some of my thoughts at least once a week. I think there are some very interesting things happening the financial world these days, so there should be plenty of material for motivation!
With the above said, I think its time to get my nose back to the grind stone and dig up some interesting content and data.
I don't imagine that this blog will be super-active in terms of posting, but my goal is to hit this blog with some of my thoughts at least once a week. I think there are some very interesting things happening the financial world these days, so there should be plenty of material for motivation!
With the above said, I think its time to get my nose back to the grind stone and dig up some interesting content and data.
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