Tuesday, July 26, 2016

Record Valuation Spreads!

It's been a while, I know.  I was browsing around the net as usual and came across something that was at the back of my mind for a while now and it was graphically illustrated convincingly so I thought it would be a great excuse to break radio silence here.  Which, by the way, is not intentional.  I never made a decision to scale back posting or anything like that. I will try to get more active again because I do often have a lot to say about a lot of things.

Anyway, as usual, a digression (or two), even though I haven't even mentioned the main topic.

It's a little late to be talking about this, but this is what I was thinking throughout this 'panic'.  Of course, like everyone else, I was terrified when the vote came.  I never really put much thought to it either way, but when I saw the markets going nuts, I was terrified.  

But then I thought about it for a second. OK, so the Brits want out.  Fine.  Capex and business might slow down for a while as there is uncertainty that wasn't there before; can we build a plant in Britain or not?  Do we have to move to continental Europe?  Will banks have to move or not?

Two things came to mind when thinking about this.  First of all, if you look at all the major tops, markets rarely make a top on some specific news like this.  This just felt like fiscal cliff and other mini-panics we've seen in the recent past. 

I couldn't imagine, that 20 years from now, that we would be sitting here and looking at a long term S&P 500 chart and go, "see here? That's the high of 2016.  Things were OK until Brexit and that was it.  It was all over...". 

No matter how hard I tried to imagine that, I couldn't. 

Second of all, yes there is short term uncertainty, just like the fiscal cliff, end of QE, 9/11 or whatever.  But if you look out over five or ten years, how much economic impact is Brexit going to have?  People are still going to eat, travel, buy cars and whatnot. Sure, things may be time-shifted due to uncertainty. Maybe someone holds off on expanding capacity in England until things are more clear.  Maybe things will shift geographically.  Maybe Nissan closes a factory in England and opens one in Germany instead.

Over time, things will be made and consumed.  In five years, I don't know if you'd be able to tell by looking at most company income statements and balance sheets what happened. 

And if that is the case, who cares?  The market will understandably go down as people take risk off due to short-term uncertainty, but that doesn't have anything to do with intrinsic value of great businesses five years out.

Also, as is often the case with these things, the situation is dynamic.  If you analyze the situation statically, then Brexit can be disastrous in many ways.  But it is a dynamic situation. We have to remember that the Europeans need the Brits too.  They can't just say, OK, fine.  Leave.  And no trade.  So people will have to work to minimize the damage.  Companies are not static, linear organizations.  They change and adapt to the situation (well, at least the good ones will). 

And not to mention the tendency in some situations for an over-reaction; for example, central banks/governments may, out of fear, overcompensate for the potential negative economic pressure.  And who knows, that might actually end up being bullish. 

So, after thinking about all of that, I chose to ignore Brexit, even though people I respect were saying that this is serious and is a big deal that will cause a huge crisis.  You know, it's still early so it might.  Who knows.  But this is not the sort of thing I think I have an edge in predicting. 

Alternative/Market Neutral Funds
Here's the other thing I've been thinking about again recently.  As you know, it's been a peeve of mine for years; mutual funds that try to tactically time the markets and make money in 'all' markets.  I guess there are some that can do it well over time, but most don't. 

I guess what is surprising to me is that some fund managers allocate short market positions as if it were an asset class.  For example, you have funds that think the market is overvalued so they are short the market. OK, for macro hedge funds that makes sense as they are active traders and manage their risk.  If they are wrong, they get out and try again later. 

But when you apply this sort of thing with an asset allocation mindset, then you end up short for years and have terrible performance. 

OK, that's fine.  But here's the part I don't get.  If stocks are overvalued, say, at 20x P/E, I can see how some may reduce their exposure, go to cash or bonds or whatever. 

But if you go short, just because expected returns are low, then your expected return on that short position is still negative, even though it's a small negative.  If you think expected returns for stocks is a low 2-4%/year going out, why on earth would you short the S&P 500 for an expected loss of 2-4%/year? 

That makes no sense to me.

Anyway, it's just another thing that has been baffling me recently.   Again, this doesn't apply to the macro hedge funds as they are active traders.  They don't go short and just sit on it for years (well, some actually do that but still manage their risk well enough to make money). 

Valuation Spreads
OK, so to get to the original topic of what this post is about.  I really enjoy the research by Pzena Investment Management.  I keep referring to them but I don't own any funds they manage, nor do I own the stock. And I don't know anyone that works there either, just to be clear as it might seem like I'm promoting them.  

Anyway, check these charts out.  They are sort of mind-blowing.  And for value investors, very exciting to see. 

Make sure to read the whole report here:  Pzena 2Q commentary 

The charts below are the valuation of the bottom quintile stocks compared to the average (or equal-weighted composite valuation).  The higher the figure, the cheaper the cheapest stocks are compared to the average.  Figure 5 shows the same but compares the cheapest stocks to the most expensive. 

You will see that the spread is at historically high levels.  That's kind of amazing.  This is very, very interesting considering the big boom now in 'passive' strategies.  Does this look like an environment where you would want to invest passively? 

OK, so up to here you might say, so what?  That's great for long/short equity funds. But what about long-only value guys?  Well, Pzena has already thought of that, and here is how the bottom quintile (cheap) has performed three and five years after the spread widens.


Alpha may not be too encouraging if you are a big bear.  10% alpha could still be a 20% loss if the market is down 30%. 

How to Play It? 
Of course, the obvious way to play it is to stick with cheap stocks.  That is always a great idea, but it seems like it's a really, really great idea now. 

But, there is another interesting idea here.  Most of you have probably already thought of this. 

You know that one of my favorite authors and fund managers has a company running mutual funds.  Yes, Joel Greenblatt. I'm so predictable. 

And yes, I know, the Gotham Funds have not been doing so great performance-wise.  But if you see the above charts, it's easy to see why:  expensive stocks have been getting more expensive and cheap stocks are getting cheaper. 

Now, I am not a big fan of mean-reversion when looking at the market.  I do believe in mean-reversion to a point.  But that has lead people astray for decades.  For example, people waiting for mean-reversion of P/E ratios in the stock market have been waiting for 20, 30 years. Dividend yields too, for even longer. People waiting for interest rates to mean-revert have been waiting for decades too. 

But some things do mean-revert much more reliably. I would say volatility is one of those things. Volatility can't and won't stay above 20-30% for any length of time. 

Another, I think, are the above valuation spreads.

If you think those charts will keep going up like that, then invest in momentum funds and chase the hottest funds and you'll be fine (if those charts keep going up exponentially like that). 

But if you think things will mean-revert, then piling into value stocks seems like a great idea. 

If you want to be market neutral and 'safe', then the Gotham long/short funds are probably perfect; it may be the best time, ever, to invest in the Gotham long/shorts. 

Gotham's long/short funds mechanically (with human overlay, I hope) short the dearest and buy the cheapest stocks.  True, they are not using P/B ratios, so investing in a Gotham long/short fund would not be the same as trading those charts above.  But I would imagine they would be correlated.

Gotham Funds
So, returns so far at Gotham haven't been so great.  Not so bad either, but not so exciting. The charts above sort of indicate why that was so, so far... 

...but things may be starting to look better...

Forgot to post this more updated table when I initially posted this.  Year-to-date looking much more interesting.  These returns can really take off on any big mean-reversion of valuation spreads...

So, if you think the above charts will keep going up, and more and more money will keep going into passive strategies, then ignore all of this, maybe. 

But, if you think that the above chart rubber bands will snap the other way, eventually, and that active managers will start to outperform passive strategies etc., then maybe think about investing in some good value managers, long/short equity funds etc

Here is their webiste:  Gotham website

I think today, this is one of the most contrarian bets you can make! 

Oh, and I don't know anyone at Gotham either... 

Friday, April 8, 2016

JPM Annual Report 2015

It's been a while since I last posted.  The only explanation, I suppose, is inertia.  When you post a lot, you post a lot.  When you don't post for a while, then you stop posting.  It's true I started getting busy in September last year (kid/family stuff, mostly, so good stuff).  And then you just get used to not posting etc.

Anyway, some of my favorite annual reports are out, so I thought I'd use that as an excuse to break the silence and try to get back into posting more regularly.

The JPM report, as usual, is really well written.  I see a lot of people have a lot to say about it and I guess that's good, that it gets attention and gets people talking about the various issues.

I noticed Cramer saying that Dimon is whining too much and that he should admit and talk about all the things that JPM has done wrong and not just criticize regulations/policy.  To be fair, Dimon has talked a lot about what JPM and the industry has done wrong over the years, often in real time.  He has been doing that for years, so it's not like he hasn't taken responsibility for a lot of what's coming at the industry these days.

But I do agree that a lot of this stuff (anti-corporate, anti-big-bank rhetoric) seems to be going overboard.  As usual, people tend to expend a lot of energy fighting the last battle (and missing what's coming next!).

Anyway, enough of that.  Let's take a look at some cool charts.

Dimon's letter is full of great charts.  I wish more annual reports were like this. But then again, if you don't have a great historic track record, you wouldn't want charts like these in the first few pages of your report.

For many years since the crisis, people kept saying that JPM is putting up fake profits by reversing loss reserves and that when that runs out their earnings will tank.  Or that spread compression will continue so their earnings will tank on that.  Or that increasing capital requirements will hit their earnings. Well, they've been saying these things for years but JPM made record profits again in 2016.

And tangible book value per share has been rising every year since 2004.  Since the 2007 peak, TBPS has increased 10.3%/year.   That's pretty astounding.  This includes the great recession/ financial crisis, and the Whale 'disaster'.

TBPS has outperformed the S&P 500 since Dimon became CEO of Bank One, and since the Bank One/ JP Morgan merger.

Total return of the stock hasn't been as great, though.  But a CEO can't really control the stock price.

Dimon regrets that the stock price, while outperforming the industry, has only kept pace with the S&P 500 index.

Just for fun, and since Dimon and most of us are Buffett fans, I'll compare these figures with Berkshire Hathaway (BRK).  This may not be totally fair as I will compare tangible BPS growth of JPM with the BPS of BRK.  BRK does have a lot of goodwill on the balance sheet so it will make a difference.  So keep that in mind.  Still, BRK's BPS growth is a decent benchmark for performance of a great CEO.

First, let's just look at the BPS changes:

                          JPM            BRK
2000-2015        +12.5%        +9.2%
2004-2015        +13.7%        +9.8%
2007-2015        +10.3%        +9.0%
1 year                +7.9%          +6.4%
5 year                +9.8%          +10.3%
10 year              +7.9%          +10.1%

The figures for JPM are from the tables/charts above.  The 1, 5 and 10 year figures exclude dividends as I just looked at the TBPS chart.  JPM figures start during the year for 2000 and 2004 whereas for BRK, I just used the closest year-end figure (so as to minimize my work-load).

The bold figure is the higher one.  You will see that JPM has outperformed BRK in just about every time frame, even from the 2007 high.  That's really crazy when you think about it  (The five and ten year exclude dividends so is understated).

In 2007, right in front of the worst financial crisis since the great depression, if you knew exactly how bad it was going to get, you would never guess that JPM will outpeform BRK over the next eight years.  JPM had trillions and trillions of derivatives exposure, billions of mortgages, investment banking business exposure etc.  And BRK was a rock solid winner in bad times with the greatest capital allocator of all time etc.

OK, let's look at the stock price.

                          JPM            BRK
2000-2015      +10.2%          +8.2%
2004-2015        +7.6%          +7.6%
2007-2015        +7.8%          +4.3%
1 year               +8.4%          +1.4%
5 year              +12.1%       +10.4%
10 year              +7.9%          +8.3%

By stock price, JPM outperforms in just about every time frame too.  This one doesn't have the tangible BPS versus BPS problem, so is 'pure' in that sense.   Not bad at all.

Best in Class Across the Board
And it's not like JPM is doing well in one area versus another.  It seems like they perform consistently in all areas, which is reassuring.

Break Up the Big Banks?
Dimon spends some time talking about the big bank issue.  You may not agree with everything he says (I do, though... surprised?), but he raises many valid points.  The thing that annoys me about this argument is that the biggest problems (well, OK, Citi was a problem) were Lehman, Bear Stearns, Merrill Lynch and Morgan Stanley.  Oh, and AIG, which wasn't even a bank or investment bank.

JPM, WFC and even BAC did fine throughout the crisis.  Well, BAC got into trouble for what it did during the crisis, but I think they were fine going into it.

Anyway, here are some interesting charts in Dimon's letter that shows that our big banks aren't even that big, relatively speaking, compared to other countries.

Call me stubborn (or stupid), but I still think Glass-Steagall is not an issue, really.  I know many veterans on Wall Street (even the ones that wanted it repealed) believe that Glass-Steagall should be reinstated and that investment banks and commercial banks should be separated.

This has never made any sense to me.   If you are a financial services company and have a client that needs to raise funds, why should there have to be two separate entities depending on if you want to borrow money from you (as a bank) or sell bonds to your clients (as an investment banker)?

I remember reading about the old days when institutions were highly regulated, based on things like if you are making long term loans or short term loans, interest rates were regulated etc.  In fact, the S&L industry was very highly regulated and they blew up spectacularly.  I don't think any one S&L was big enough to threaten the financial system, but they all seemed to blow up at once.  Too big to fail? Or too many to fail?

The Solution
Buffett probably has the best answer to all of this; clawbacks and make sure that the CEO ends up in the poorhouse if their bank fails.  The fact that the CEOs that blew up their firms during the financial crisis are playing golf at exclusive clubs and are living rich is really annoying even to me (the big financial industry groupie/cheerleader).   OK, this has nothing to do with Dimon's letter.

Increasing capital requirements drastically may not matter as many banks that blew up early in the last century had very high capital ratios.  Turning banks into utilities, as Dimon says, makes no sense either.  Utilities are monopolies, first of all.  Banks are not.

Utilities have their own problems, and they've had their own blowups.

Interest Rates
In the letter, Dimon says he is not worried about negative interest rates.  He is in fact much more worried about interest rates going up faster than they expect.   And in the Goldman Sachs letter, Blankfein/Cohn say, "We don't see how a world of zero or negative interest rates could possibly be the 'new normal'".  

To which I say, "but what if it is!!??!". 

That would be my big fear for financial stocks.  We have all been watching the impossible happen, first in Japan, and now in Europe.  Yes, we are better here for sure.  But how much better?  Can we really avoid this 'new normal' if it continues in Japan/Europe etc.?  Are we strong enough to resist such a strong force?  Even the strongest swimmers will drown if weighed down by an anchor heavy enough...  I don't know.

Anyway, the letter is a great and educational read so go read it!

By the way, there is a shareholder proposal in the proxy.  But before that, let's take a look at some charts from it.

So Dimon's pay is performance based, and we are getting a great deal.

Anyway, here is the proposal:

Proposal 7Appoint a stockholder value committee — address whether divestiture of non-core banking business segments would enhance shareholder value

Bartlett Naylor, 215 Pennsylvania Avenue, S.E., Washington, D.C. 20003, the holder of shares of our common stock with a market value in excess of $2,000, has advised us that he intends to introduce the following resolution: 
Resolved, that stockholders of JPMorgan Chase & Co. urge that:
The Board of Directors should appoint a committee (the ‘Stockholder Value Committee’) composed exclusively of independent directors to address whether the divestiture of all non-core banking business segments would enhance shareholder value.
The Stockholder Value Committee should publicly report on its analysis to stockholders no later than 300 days after the 2016 Annual Meeting of Stockholders, although confidential information may be withheld.
In carrying out its evaluation, the Stockholder Value Committee should avail itself at reasonable cost of such independent legal, investment banking and other third party advisers as the Stockholder Value Committee determines is necessary or appropriate in its sole discretion.

And here's the supporting info: 

The financial crisis that began in 2008 revealed that some banks were “too big to fail.”  This is the moral hazard that invites managers to take extraordinary risks with an understanding that taxpayers will rescue the firm, as failure would cause widespread financial chaos. That 2008 rescue may have served JP Morgan’s creditors, but shareholders suffered. JP Morgan stock fell from $49.63 on Oct 1, 2008, to $15.93, on March 6, 2009.  
Risk-taking at major banks can be especially lethal following the elimination of certain activity restrictions (known in the vernacular as “Glass-Steagall”) on how a bank can deploy FDIC-insured deposits. Congress began to address some of these problems with the 2010 Dodd-Frank Act. But an analysis by Goldman Sachs argues that implementation of this law means JP Morgan would be worth more in parts. 
The crisis and subsequent events have also demonstrated that JP Morgan may be “too big to manage.” Mismanagement of deposits by a half-dozen London-based traders (known as the “London Whale”) sent JP Morgan stock down 24 percent. Further, shareholders have paid more than $30 billion in fines because bank managers failed to prevent misconduct in a variety of operations. 
We therefore recommend that the board act to explore options to split the firm into two or more companies, with one performing basic business and consumer lending with FDIC-guaranteed deposit liabilities, and the other businesses focused on investment banking such as underwriting, trading and market-making.  Divestiture would also give investors more choice and control about investment risks.
You can go read JPM's response to this, which is good.  But what I was thinking as I read this was:

  • Well, the stock price declined a lot, but JPM didn't lose money in any single quarter throughout the crisis!  Look at the charts in the letter to shareholders.  There is not even a blip where the financial crisis occured (in terms of TBPS). 
  • My old-fashioned thinking is that Glass-Steagall's elimination can't be the cause of the crisis because the biggest problems occurred at independent investment banks.  In fact, GS, MS and others wanted to become attached to banks to enhance stability; this is exactly the model at JPM, and that is why JPM was so stable throughout the crisis.  Citibank had problems, but that's a whole other story,  I think. 
  • The London Whale trade made the JPM stock price go down, but it was pretty inconseqential, relatively speaking (loss versus shareholders' equity etc.).  Ironically, in hindsight, it's basically a tempest in a teapot...  
  • JPM paid $30 billion in fines, but other firms paid a lot of fines too.  GS, MS and others paid fines too because "managers failed to prevent misconduct in a variety of operations".  
Anyway, as it says in the proxy, JPM has described at their investor days in the past few years why the integrated model makes sense. 

OK, so that wasn't so hard (to make a blog post after three months!). 

Thursday, December 17, 2015


Seriously, I am not stalking Lou Simpson at all (or at least any more than any other 'great' investor).  But this sort of jumped out at me.  It's sort of old news as the 13-F's came out in November.

Sometimes, some investors just buy or own stuff that just resonates with me, like that time Nehal Chopra of Ratan Capital was on CNBC talking about Post Holdings and Charter Communcations.  I owned (and still own) both of them.  Apparently, Chopra dumped POST when it tanked but bought back recently.  I rode it all the way down without selling anything and am nicely in-the-money on it now.

At the time, I had no idea who Chopra was.

This is sometimes why I post about certain investors.  If they do something that interests me, I will make a post about it.  And if it happens three times in a row, well, so be it.  Surely, other investors have made more interesting buys recently.  This is just what jumps out at me.  By the way, I don't own BAM, SCHW or AME.

Anyway, AMETEK (AME) has been mentioned here in the past (by readers) as an outsider-CEO-type company; growing through acquisitions etc.  Maybe you can call it a DHR-like company.  I guess "outsider-CEO-like company" might not sound so great now after VRX, but whatever.

And by the way, I know it's been a while since I posted.  I never make a post and then say, OK, I'm going to take a break for a month or two from blogging.  It's just that time passes and then it's like, wow, I haven't posted in more than a month!  Well, all sorts of things happen, some travelling, obsession with other things etc.  But my main thing is still investing; it's just that sometimes time flies without me having made a post even when some ideas pop up (and I never bother to make the post for one reason or another).

Simpson Buys Big
So check this out.  Simpson had no AME shares earlier this year (and never showed up in any 13-F for SQ Advisors recently).

Number of shares of AME in SQ Advisors' 13-F:

3/31/2015:   0
6/31/2015:  1.8 million
9/31/2015:  8.1 million

So that's kind of huge.   The 13-F as of September-end showed $3.0 billion in U.S. stocks, and more than 14% of the portfolio in AME (this excludes cash and other assets that are not U.S. listed stocks).

Lou Simpson Portfolio

My last couple of posts related to Simpson were about BAM and SCHW, and AME is even bigger than those.  It's also interesting that Simpson added to VRX in September, but this was before the real crash in the stock.  I wonder what he did after that. It is interesting how Munger can really despise this company and Simpson can like it enough to make it such a large holding (he has owned it since (at least) 2011 and actually owns more shares now than in 2011; 2 million shares as of September 2015 versus 1.2 million back in 2011).

AME has been run by Frank Hermance (now aged 66 or so) since 1999.  He became President and CEO in September 1999 and Chairman and CEO in January 2001.   AME aims to double the size and profitability of the company every five years.  1/2 to 2/3 of their growth is to come from acquisitions.

From their 10-K, this is what they do:
Products and Services     AMETEK’s products are marketed and sold worldwide through two operating groups: Electronic Instruments (“EIG”) and Electromechanical (“EMG”). Electronic Instruments is a leader in the design and manufacture of advanced instruments for the process, aerospace, power and industrial markets. Electromechanical is a differentiated supplier of electrical interconnects, precision motion control solutions, specialty metals, thermal management systems, and floor care and specialty motors. Its end markets include aerospace and defense, medical, factory automation, mass transit, petrochemical and other industrial markets.

Competitive Strengths 
Management believes AMETEK has significant competitive advantages that help strengthen and sustain its market positions. Those advantages include: 
Significant Market Share.    AMETEK maintains significant market shares in a number of targeted niche markets through its ability to produce and deliver high-quality products at competitive prices. EIG has significant market positions in niche segments of the process, aerospace, power and industrial instrument markets. EMG holds significant positions in niche segments of the aerospace and defense, precision motion control, factory automation, robotics, medical and mass transit markets. 
Technological and Development Capabilities.    AMETEK believes it has certain technological advantages over its competitors that allow it to maintain its leading market positions. Historically, it has demonstrated an ability to develop innovative new products that anticipate customer needs and to bring them to market successfully. It has consistently added to its investment in research, development and engineering and improved its new product development efforts with the adoption of Design for Six Sigma and Value Analysis/Value Engineering methodologies. These have improved the pace and quality of product innovation and resulted in the introduction of a steady stream of new products across all of AMETEK’s lines of business. 
Efficient and Low-Cost Manufacturing Operations.    Through its Operational Excellence initiatives, AMETEK has established a lean manufacturing platform for its businesses. In its effort to achieve best-cost manufacturing, AMETEK has relocated manufacturing and expanded plants in Brazil, China, the Czech Republic, Malaysia, Mexico, and Serbia. These plants offer proximity to customers and provide opportunities for increasing international sales. Acquisitions also have allowed AMETEK to reduce costs and achieve operating synergies by consolidating operations, product lines and distribution channels, benefitting both of AMETEK’s operating groups. 
Experienced Management Team.    Another component of AMETEK’s success is the strength of its management team and that team’s commitment to improving Company performance. AMETEK senior management has extensive industry experience and an average of approximately 23 years of AMETEK service. The management team is focused on achieving results, building stockholder value and continually growing AMETEK. Individual performance is tied to financial results through Company-established stock ownership guidelines and equity incentive programs.

Business Strategy 
AMETEK is committed to achieving earnings growth through the successful implementation of a Corporate Growth Plan. The goal of that plan is double-digit annual percentage growth in earnings per share over the business cycle and a superior return on total capital. In addition, other financial initiatives have or may be undertaken, including public and private debt or equity issuance, bank debt refinancing, local financing in certain foreign countries and share repurchases. 
AMETEK’s Corporate Growth Plan consists of four key strategies: 
Operational Excellence.    Operational Excellence is AMETEK’s cornerstone strategy for improving profit margins and strengthening its competitive position across its businesses. Operational Excellence focuses on cost reductions, improvements in operating efficiencies and sustainable practices. It emphasizes team building and a participative management culture. AMETEK’s Operational Excellence strategies include lean manufacturing, global sourcing, Design for Six Sigma and Value Engineering/Value Analysis. Each plays an important role in improving efficiency, enhancing the pace and quality of innovation and cost reduction. Operational Excellence initiatives have yielded lower operating and administrative costs, shortened manufacturing cycle times, higher cash flow from operations and increased customer satisfaction. It also has played a key role in achieving synergies from newly acquired companies. 
Strategic Acquisitions.    Acquisitions are a key to achieving the goals of AMETEK’s Corporate Growth Plan. Since the beginning of 2010 through December 31, 2014, AMETEK has completed 26 acquisitions with annualized sales totaling approximately $1.4 billion, including five acquisitions in 2014 (see “Recent Acquisitions”). AMETEK targets companies that offer the right strategic, technical and cultural fit. It seeks to acquire businesses in adjacent markets with complementary products and technologies. It also looks for businesses that provide attractive growth opportunities, often in new and emerging markets. Through these and prior acquisitions, AMETEK’s management team has developed considerable skill in identifying, acquiring and integrating new businesses. As it has executed its acquisition strategy, AMETEK’s mix of businesses has shifted toward those that are more highly differentiated and, therefore, offer better opportunities for growth and profitability. 
Global & Market Expansion.    AMETEK has experienced dramatic growth outside the United States, reflecting an expanding international customer base and the attractive growth potential of its businesses in overseas markets. Its largest presence outside the United States is in Europe, where it has operations in the United Kingdom, Germany, France, Denmark, Italy, the Czech Republic, Serbia, Romania, Austria, Switzerland and the Netherlands. While Europe remains its largest overseas market, AMETEK has pursued growth opportunities worldwide, especially in key emerging markets. It has grown sales in Latin America and Asia by building, acquiring and expanding manufacturing facilities in Reynosa, Mexico; Sao Paulo, Brazil; Shanghai, China; and Penang, Malaysia. AMETEK also has expanded its sales and service capabilities in China and enhanced its sales presence and engineering capabilities in India. Elsewhere in Asia and in the Middle East, it has expanded sales, service and technical support. Recently acquired businesses have further added to AMETEK’s international presence. In recent years, AMETEK has acquired businesses with plants in Germany, Switzerland, the United Kingdom, Serbia and China as well as acquired domestically located businesses that derive a substantial portion of their revenues from global markets. 
New Products.    New products are essential to AMETEK’s long-term growth. As a result, AMETEK has maintained a consistent investment in new product development and engineering. In 2014, AMETEK added to its highly differentiated product portfolio with a range of new products across each of its businesses. 

And from the annual report, a snapshot:

It looks pretty impressive. Nice growth, and new highs after the 2008/2009 recession pretty quickly.  I dug up some figures going back to 1999 when Hermance became CEO to see how he has done, and it is pretty impressive:

Financial Summary of AME since 1999

Net sales grew 10%/year since 1999 while operating income grew around 15%/year, and EPS around 16%/year.

As with DHR, free cash flow has been higher than net income throughout the period by around 1.2x.

The interesting thing about AME is that these figures are not "adjusted" or anything like that.  Unlike, say, VLX, AME's EPS is plain EPS.

As of the third quarter, guidance for the full year 2015 was $2.55/share, up 5% over 2014.  With the stock at around $54/share, it's trading at a P/E of around 21x.

AME does seem to be facing some macro headwinds.  Oil and gas hasn't been too much of an issue as they don't have that much exposure to upstream, but slowing growth in Asia and emerging markets are holding back their growth this year and probably into next year.  So there is some risk there.

The stock is certainly not for cheapskates at 21x P/E, but they do have good free cash flow conversion and growth potential.  Their operating margins are higher than say, DHR or CFX too (with similar business models).   AME isn't leveraged at all, either, with long term debt of $1.6 billion against 2014 EBITDA of $1 billion.  With the junk bond market tanking and rates going up, this may be a good thing.

There are plenty of 20+ P/E stocks with very little growth prospects (and the whole market at close to 22x P/E), maybe this is not a bad idea.  Historically, AME has traded at around 20x P/E.

Sunday, October 4, 2015

Superinvestor Portfolio Winners and Losers

This is sort of just an administrative post:  I added to the 'pages' section a winners and losers sort of the Superinvestor portfolios.  This, I guess, is the companion to the Superinvestor screens.

It's just sorts the stocks in the portfolio by year-to-date returns.

I'm guessing with all of the volatility in the markets these days, this would make an interesting browse for some people.  

This is all just part of my recent hobby (coding), so I am doing this for fun; to see what it feels like to actually get some coding stuff into 'production', and see if I can make it as automated as possible so I don't have to do anything etc.

Superinvestor Portfolio Winners and Losers

Monday, September 28, 2015

12% Dividend Yield?! (Och-Ziff Capital Management Group (OZM))

The alternative management companies have been getting crushed in the recent correction.  A lot of these guys were trading 'cheap' to begin with so I was wondering if there was some opportunity here.  I've talked about some of these in the past, but other than OAK, have not invested in any of them.

That's mostly because I thought there was an alternative asset bubble and I wasn't that excited about prospective returns from some of these guys who have grown their assets so quickly in the past few years.  Every presentation you look at, you see these alternative managers growing AUM at a double digit clip.  And then you have to wonder, all of these guys at some point have to fish in a smaller and smaller pond (as their asset base gets bigger, they have to pursue bigger deals).  What will happen to returns when so many giants are chasing the same, small number of fish?

I sort of still feel this way, but Och-Ziff Capital Management (OZM) caught my attention because I've always liked their approach and mix of strategies.  I was sort of surprised to see that they are diversifying into real estate and credit.  OZM is not really completely market neutral, but they are known for hedged strategies in equities; risk arbitrage, convertible arbitrage, equity long/short etc.  So that is sort of the appeal at OZM; they are not bull market dependent, and they outperform in down markets.

Adding real estate and credit makes them less so, even though Och has said in a conference call that he doesn't think that is the case.  Well, for a while if you are doing only really special situation deals, that is probably true, but as you get bigger in the area, you can't not start to correlate to some extent with the real estate/credit markets.  Plus, I think OZM is concerned with correlation with the S&P 500 index. In that sense, yes, adding credit and real estate may not increase correlation to the index (except in bear markets/crashes when everything goes down!).

12% Dividend Yield?!
Anyway, what hit my radar is that OZM is now trading at around $8.60/share, and their dividends for the past twelve months is $1.03/share; that's a 12% dividend yield.  That certainly looks appealing in this market.

Since 2008, dividends average around $0.91/share, so OZM is trading at a 10.6% yield to average dividends since 2008.  Again, looks good.

Returns at OZM's Master fund wasn't that inspiring at 5.5% net last year.  I think investors expect (or used to) 10%.  I hope OZM still shoots for double digit returns.  In 2013 when the fund returned 13.9%, dividends were $1.79/share.   If OZM had a similar year again, that's a potential 21% dividend yield (but read on before getting too excited).   Anyway, if we normalize earnings for a 10% return we can figure out what normalized earnings would be going forward.

As of the end of June 2015, OZM had AUM of $48 billion.  Their management fees as a percentage of average assets (using the average of beginning of the year and end of year AUM) averaged around 1.6% since 2003.  But their growth in credit in real estate has caused that to come down some.  The average management fee in 2Q2015 was 1.42%.  So let's just use 1.4% for now.

Management fee with $48 billion in AUM gives us $672 million in revenues. 20% incentive fees on 10% return would give us $960 million in incentive fees and total revenues of $1.6 billion.   Economic income margins have averaged around 67% since 2003, but more like 61% since the IPO.  In good years, like 2013, the margin would be higher (67%) due to higher incentive fee income, and in so-so years like 2014, lower (60%).

So let's use 60% economic income margin to be conservative.  That gives us $960 million in economic income.  Using a 20% tax rate (average of last three years), that gets us to distributable income of around $770 million.  With 516 million shares outstanding (using average adjusted shares outstanding for 2Q15), that's $1.50/share in distributable income.  Since OZM tends to pay out most of their distributable income, that would be a 17% dividend yield on a normalized basis.

Pretty nice, and conservative too.

But Wait!!
So my first pass at looking at this was kind of exciting.  But then I realized it's not so simple.  I noticed that their cash bonuses tends to be around 20% of total revenues every year, and that sounded a bit low.  As most of us know, at these alternative asset managers, anything from 40-60% of incentive income is actually paid out to the fund managers.

OZM earned around $1 billion in incentive fees in 2013, but only paid $316 million in cash bonuses.  This includes bonuses for non-investment managers, so seems a little low for an alternative manager.

But look at what's not included in the economic income calculation:  in 2013, OZM granted 12,470,271 RSU's and 24,097,722 Group A Units at fair values of around $10.00 at the time of grant.   That's $366 million of pay to employees that doesn't hit the economic income line.  So the economic income margin is sort of bogus.

Total bonuses are more like $682 million, which comes to 42% of total revenues and 63% of incentive income. That makes more sense.

Total Share Count
Of course, we don't have to look at all that to realize this.  All you need to do is track the total shares outstanding over time to see what's going on.  I won't get into the details of the various share classes; I'll just focus on what OZM calls the adjusted class A shares.

These are the weighted average outstanding for the respective years:

            million shares
2008   400
2009   404
2010   410
2011   419
2012   455
2013   482
2014   509

Over the past six years, shares outstanding have grown 4%/year.   The above dividends per share already accounts for the growing number of shares outstanding so you don't have to deduct 4% from the 10% dividend yield.

In 2013, around 37 million shares were granted (RSU and Group A units) at a fair value of around $10.00.  Let's say they repurchased those shares at the grant-date fair value to keep shares outstanding flat for 2013.  This would have cost $370 million.   Distributable earnings in 2013 were around $900 million.  Instead of paying out dividends, if $370 million was used to repurchase shares, distributable earnings would go down to $530 million.  If we use the 455 million shares outstanding of 2012 (since this is the weighted average for the year, it would be higher for full year 2013 even if they granted no new shares), that would get us to distributable earnings per share of $1.16/share.

So, if OZM has another great year like 2013, that would give us an actual yield of 13.5% ($1.16/$8.60).  Not bad at all, but not the 20% we saw above.

2014 wasn't a great year in terms of returns (+5.5% net for the main fund), but not bad on an AUM growth basis.  One can argue a $1.07/share dividend in a so-so year on a $8.60/share stock price is not bad at all; a 12.4% yield.   Last year only 10 million RSU's were granted (and no Group A Units), so adjusting this would only reduce the possible dividend to $0.95/share or so, for a not so bad 11% yield.

Normalized @ 10% Return
Let's go back to my above example and normalize distributable earnings with a 10% return for OZM's funds.  Using AUM of $48 billion, management fee rate of 1.4%, 10% return on the funds and a 20% incentive fee rate, we got total revenues of $1.6 billion.  We then used an economic income margin of 60% for economic income of $960 million, and then a 20% tax rate to get to $770 million in distributable income.

But this figure excludes stock compensation expense.  I don't really care if it is included in earnings or not; if we want to assume shares outstanding to stay the same (share repurchase to offset dilution), this would reduce available cash to distribute to shareholders and that's what we sort of want to know.  Who cares what GAAP says, or what the amortization rate on expensing this stuff is.

I don't know the formula for paying out stock compensation, but one of the most consistent ratios is stock compensation expense (my definition, not OZM's) to total economic revenues.  Here, I use stock compensation expense as the total fair value of RSU's and Group A units granted (on grant date).

Looking at that versus total revenue (segment, or economic revenue):

               Fair value of grants / total revenue
2010       11.9%
2011       11.6%
2012       10.4%
2013       22.5%
2014       10.5%

It looks fairly consistent at between 10-12% except for 2013, which was a good year performance-wise.  Well, 2012 was good too.  I'm not sure why 2013 stands out.  There may be a good reason for this, but I couldn't find anything as I went through the conference calls and things like that.

Anyway, I will use 12% stock compensation in my normalized distributable earnings scenario.

So, we got up to $770 million in distributable income.  We know from the above that total revenues is $1.6 billion, so total value of equity grants would be $192 million.  Deduct that from our distributable income gives us real distributable income of $578 million.  With 516 million shares outstanding, that gives us $1.12 in distributable income per share.   That's still around a 13% yield; pretty nice, but not the big upside we thought earlier.

If, however, stock grants go up again, this would be much lower; if they granted stock worth 20% of total revenues, distributable income would drop to $0.87/share for a yield of around 10%.

Oddly enough (or not), there doesn't seem to be a huge difference implying that when OZM does really well, the upside is 'granted' away off the income statement.

Doing all of the above again with 65% economic income margin, we would get $1.24 in normalized distributable income for a 14.4% yield.  This could be lower if more stock was granted (here I only use 12% of revenues as the value of stocks granted).

I may be missing some things here and there. I know there are class D stocks, and to offset the above RSU/Group A Units, there are cancellations and forfeitures.   But it doesn't really change the big picture of what's going on here.

Also, I haven't modeled into the above the longer-term assets under management; some AUM are invested for three to five year terms and incentive fees are realized and booked as revenues at the end of the term.  As of the end of June 2015, there were $16.5 billion (34% of total AUM) of such assets with accrued incentive fees (but not booked as revenues) of $353 million.   I haven't modeled this in the above so actual margins may be higher than I suggest.  But if this has been going on for a while,  the incentive fees would actually be included in the historical figures as some funds may already have come to term (old funds come to term, revenues are recognized etc.); 6% and 17% of longer-term AUM will come to term in 3Q15 and second half of 2015 respectively.

In any case, all of this is very rough as it is tough to model.

OZM Fund Performance
Anyway, OZM is not a bad investment if you like this sort of thing (and I know many do not).  There are the usual concerns of size (can they keep performing as they get bigger?), diversification (Carlyle Group's blunders in hedge funds etc...), strategies getting crowded as alternative funds all seem to be growing their AUMs at rapid rates, perpetual-low-interest-rate-high-valuation-tight-spreads-low-return environment etc...

Anyway, let's look at some earlier performance figures.  OZM really did perform well until recently.
This is from their 2007 10-K and you can see how amazing OZM figures were:

  1 Year3 Years5 YearsStrategy
Net Annualized Return(1)
OZ Master Fund, Ltd.(2)
S&P 500 Index
Correlation of OZ Master Fund, Ltd. to S&P 500 Index(3)
Master Fund Standard Deviation (Annualized)
S&P 500 Index Standard Deviation (Annualized)
Sharpe Ratio(5)
Master Fund
S&P 500 Index

They outperformed the S&P 500 with low correlation to the market and with much lower volatility.

Here is the AUM growth chart from 2007:

And the most recent 10-k shows this:
Net Annualized Return through December 31, 2014
1 Year
3 Years
5 Years
Since OZ Master
Fund Inception
(January 1, 1998)
Since Och-Ziff
(April 1, 1994)
OZ Master Fund Composite(1) 
Och-Ziff Multi-Strategy Composite(2) 
S&P 500 Index(3) 
MSCI World Index(3) 
Volatility - Standard Deviation (Annualized)(4)
OZ Master Fund Composite(1) 
Och-Ziff Multi-Strategy Composite(2) 
S&P 500 Index(3) 
MSCI World Index(3) 
Sharpe Ratio(5)
OZ Master Fund Composite(1) 
Och-Ziff Multi-Strategy Composite(2) 
S&P 500 Index(3) 
MSCI World Index(3) 

Not so exciting anymore.  And the AUM chart looks like this:

Here's a table that shows yearly returns for OZM's fund going back to 1994.  You can see that a lot of the high returns were achieved in the early years.  Look at those returns from 1994-2000!  And when the market tanked after the internet bubble, they did pretty well preserving capital.

But since 2000, OZM only returned around 6%/year, but that's still better than the 4%/year of the S&P 500 index (total return).  Since the 2007 peak (to look at 'through-cycle' performance), OZM returned around 6%/year versus the 7.3%/year for the S&P 500 index.

OZM fundS&P500
5 year avg7.68%15.46%
10 year avg7.64%7.68%
Since 199412.68%9.24%
Since 20005.97%3.86%
Since 20075.95%7.28%

Low Returns
It seems like they had great returns back in the old days when they had AUM under $10 billion,  They got their AUM over $10 billion in 2004, and since then their return has been around 7.6%/year.

Part of it is no doubt due to size; when you are bigger, you can't capitalize on the smaller opportunities.  There is no doubt about that regardless of what anybody says.   The bigger you get, the smaller the opportunity set.  If you find smaller ideas, you still have to find more of them.

Some of this is also due to the low interest rate environment post-crisis and the rush of investment capital into alternatives that serve to tighten spreads and lower returns.

I don't know how much of recent returns are due to each of these factors, so it's hard to tell how things will unfold going forward.

But I do like the strategy mix, at least of the main strategies (excluding credit/real estate).  Those strategies are typical of the pre-Dodd/Frank equity proprietary trading desks at the investment banks. They don't involve forecasting/guessing about the markets, economy or anything like that.  They are usually spread trades (risk arbitrage, convertible arbitrage etc...).

It's possible that there is so much capital chasing those deals that returns won't go back to what they were years ago.   But also, a lot of the spread compression is due to lower interest rates (if your carry costs go down, you can obviously pay a higher price in a risk arb trade, for example).

Low Returns in Context
Having said all that, we have to look at this in context.   10-year treasury yields are 2.2%, the earnings yield on the S&P 500 index is around 5%, and the expected return in stocks using Buffett's old metric is 6.2% or so (he has said more than once that expected returns in stocks is the dividend yield plus inflation plus real economic growth rate:  2.2% dividend yield + 2.0% real GDP growth + 2.0% inflation = 6.2% expected return for stocks).

6-8% returns for OZM funds in this environment is not bad at all.  Keep in mind their low beta on the downside; the stock market might have 5-6% prospective returns, bonds might yield 2.2%, but the stock market can have painful bear markets and if interest rates go up, losses in bonds can be pretty painful too.  OZM has shown that in down markets they outperform handily.

So one can ask, is it better to expect 6-8% returns from OZM funds with some downside protection, or should we go with 5-6% expected returns in the stock market with the inevitable, occasional 50% drawdowns?  Or should we invest in bonds for a 2.2% yield and a possible bloodbath when rates start to rise?  Or should we sit on 0% interest rates until the Fed really normalizes?

None of this is my opinion; just the possible thought process of an investor in OZM funds.

When you look at it like this, the low returns don't look so bad.  Also, there is the optionality to the upside. When markets return to a more chaotic environment (instead of the low volatility environment we've seen post-crisis), spreads may widen, opportunities increase and returns can improve.

In that sense, OZM funds don't look so bad at all.

Or you can take a look at OZM itself and shoot for 10% returns (but with the above-stated risks).

Well, I don't really have a conclusion here. It's certainly interesting and cheap.  OZM is a really great shop as far as I know, and I like the mix of their strategies.  But the two issues are the lower recent returns and the ongoing dilution that seems to really dampen the upside; if OZM has a great year, who knows how many RSU's and Group A units they will grant to their employees?

On the other hand, it looks like OZM yields 10%+ whether they do really well or have a so-so performance year like last year.

So would you be better off investing in OZM for that 10+% yield instead of the 6-7% return in the OZM funds?  Of course this would not be practical for large institutions, or investors who have a large portion of their net worth tied up in the funds.

Normalizing interest rates (which look more and more further out every day), like with so many other financials, will certainly help OZM as spreads will no doubt widen in the various strategies.

Other alternative managers are getting really cheap now too so I will be taking a look at those over the next few weeks.

Stephen Schwarzman of Blackstone (BX) has been frustrated with a cheap stock price for a long time now, and it's just getting cheaper.  BX is sort of the gold standard in private equity.  Schwarzman says that Wall Street doesn't get it, that BX is like LeBron James.  But what investors fear is that BX is like LeBron James, but that every time he scores, the ball gets a little bit bigger so each prospective point gets harder and harder.

There is no doubt that things are getting cheap in the sector.

If there is a credit event (Glencore bankruptcy?), though, financials can all get hit hard as nobody will really know who is holding the bag so one would have to be cautious.

Private equity needs a good credit market and good 'exit' market.  But of course, these things go through cycles and without bad times, they won't be able to put big amounts to work for high returns.  The fear is, I suppose, that these stocks get hit really hard in the down cycles.

I do think the good private equity firms will continue to do pretty well through the cycle.  It's how much stomach do you have to sit through the down cycles?  Anyway, maybe I'll look at some of that stuff later.

This is one aspect that interested me with OZM.  They are not private equity, so as long as they retain/increase AUM, they should do well.

I also understand that there is an investigation and that some pension funds are pulling out of hedge funds due to low returns.  These don't overly concern me.  Pension fund investing goes through cycles too.  There was a big boom in hedge fund investing after the crisis, and that is sort of unwinding.  Pension funds are rear-view mirror investors, so what they do doesn't concern me too much.  In fact, I don't mind at all going the other way.