scorpioncapital

Well if a stock trades at 10x earnings and has an above average growth rate, if you strip out inflation and the growth itself, the only thing that remains is investors' placing a higher multiple on the same earning stream - say 20x... And vice versa when growth slows or goes negative (if the ratio is currently high from a previous period of high growth). Thus expectations about growth by the investing community, not particularly quantifiable in a scientific way, is what causes growth in share prices outside of the two variables you mentioned. About the only thing you can usually say is that higher than normal growth commands a higher multiple than normal growth, if you knew what the central expectation was and if that expectation was itself correct based on inflation expectations. That word again, expectations. It's why markets can be so precarious. It's not a cold hard fact. I think it also explains why managements that actively try to unlock value in a pragmatic way are valued highly because outside of this, you really have very little control.

Check out Paths to Wealth through Common Stocks by Phillip Fischer, the *only* reason stocks go up is sentiment, not cash in the bank, not the 'truth'. There is some vague connection with inflation and growth in earnings but it could be anything. It could track this imaginary line below, at, or above forever or it might not for some mysterious and quarky reason. To some degree, the unpleasant truth is that stocks are a mass delusion but it's not something you have to worry about too much at the extremes. Now if you control the income stream, you really don't care, take your dividends and hope to negotiate a mutual sale at some future date (fingers crossed that the other party sees the logic of the valuation).

According to this, the Charter change is a reclassification of shares due to the merger with Time Warner Cable - http://brooklyninvestor.blogspot.ca/2016/08/13f-fun.html?utm_source=twitterfeed&utm_medium=twitter

Maybe LGND...it seems to have more upside than downside but I highlight the request for *speculative* ideas.

Fascinating discussion. I definitely feel there is some mispricing especially of cash rich companies. I am intrigued by this quote, "But suppose that both companies have made it clear that neither is going to be returning capital to shareholders. The business that reinvests its cash into low returning investments is going to be more valuable than the company that just sits on it. I think there are a fair amount of companies that are punished valuation wise because it's clear that management has no plans to run the correct capital structure." This is exactly what I see happening! And it really feels like a who is swimming naked problem. That is, right now, you can't tell. Inefficiencies are being papered over. The incorrect capital structure company that is holding a ton of cash is being valued less than the reckless "investor" but only because we are in a liquidity drug zone kind of world. I wonder truly if the wrong structure is ultimately the prudent one because you want to be where things are going not where they are now and pay dearly later for what seems just too easy. Almost feels like companies are chasing projects and returns just like investors are chasing stock prices up and up. One company I follow earns 7.5% return on equity and another earns 20% ROE but the former is valued higher than the latter because they did an acquisition (with about a 5% IRR) , has higher absolute FCF/share due to the merger, and holds no cash (they used debt to finance it). The question then becomes, given the crazy environment we are in - do you hold cash which you can only reinvest a portion at 20% or do you "plunge in" and buy everything in sight for 7% return just because rates are zero. Come to think of it, this is the private investor's problem too, not just a corporate problem :) I'm going to be stubborn here and go with the cash hoarder and the superior return business just because it seems more forward thinking. I'll take the company that invests $100m and turns it into a $2 billion asset than the one that invests $2 billion asset to earn $100m. Meanwhile I'll watch the market give the low return business the higher valuation temporarily.

Ok, let's take it to the extreme. Why must any company be efficient? For example, why should a company care to be very careful to make good investments to get good returns? I think Buffett gave an example. Let's throw 1 trillion at the problem. Suppose I could just get that money. And put it in the bank and earn 1%, I can say I made $10 billion in profit this year! If there is no penalty for throwing money at anything and earning "something" (even if not much) what can we make of this? The reason I ask is that I look at two companies in the same industry (or even different industries) where the inefficient one trades at a higher share price than the more efficient one because it decided to "merge and buy growth in earnings per share" or just threw a ton of money/debt at the problem.

Say a company has IRR of 20% and another has IRR of 10%. I.e. they earn a certain amount on the amount they invest. Let's say both companies grow at 10% and the initial yield (P/E ratio) is 5%. After 5 years your return is 5% plus the incremental addition of 10% each year. That's sort of "your IRR" as an outside investor buying at a given share price. But how is IRR, the internal efficiency of the company related to this external return and growth rate to you. My intuition says the 20% IRR company is getting better returns on their investment. If they invest $1 and earn $1000 the returns are astronomical. So is the contradiction here that the premise - 'both companies are growing at 10%' is false? Must higher IRR translate into higher growth rate?

I think you can analyze the numbers like this. Say the 30 year bond is 2.5%. And say you think this is unusually low and it will go to 5%. And say you want your stock investment to yield 2x the bond yield or around 11-12x P/E max. Two ways to find this: The Value Stock Way: Just find a stock with a P/E of <= 11-12 and you get that immediately. Any growth is gravy. The Growth Way: You find a stock with a P/E of 20 but that has a growth rate of 20%. Your first year you get 5%, year 2 - 6%, ..year 5 - 9.6%. So you've reached your target based on your purchase price but it took 5 years. That's sort of the link between growth and value, the growth of the expanding coupon which is your initial yield. Buffett has done a few of these plays described in the book by Mary Buffett , Buffetology. Some things you can see from this...if growth rate is too low, you won't reach that yield fast enough to offset the difference between the bond yield and the equity yield if you pay a high P/E. In essence you can say the margin of safety is not there or you overpaid, you have to wait a long time. Today, it's scary what is happening with very low bond yields and P/Es of growth stocks in the 1-2% range. Often lower than the 30 year! Especially high flyer tech stocks. These stocks better have phenomenal growth for quite a few years to come. Of course it seems this era of very slow rate increases (possibly to change?) gives companies the luxury to grow. I would say two big risks are large bond interest rises faster than expected or an operational misstep that causes you to not get the growth you desperately need. If you pay a moderate price, you will be less stressed out. Buying 3% yielding stocks growing at 30% per year seems like you will have your eyes glued to each earnings report and start feeling like a trader to make sure that growth doesn't drop off.

TwoCitiesCapital, you've hit on the gist of the nature of value investing! Not sure if it's a separate category but these days there is a class of profit-less companies growing revenues fast valued at price to revenue. This is mind-boggling to me even as a growth-value investor, mostly because of the present-day faith in the materializing of future profits. Yet you can't deny that some very successful companies do grow an intangible franchise-network value without much in the way of earnings but do build a valuable asset over time. However if they get the business model wrong, or it changes while they are "growing" and the promise changes (sort of like the government might have to change pension promises due to massive liabilities and slow growth), I imagine these quickly become neither growth nor value when that realization occurs.

A guess: As inflation picks up, Walmart has a large employee base and reduced pricing power. This is the kind of thing stock nightmares are made of. Rising costs and pricing pressure. Buffett wrote the article How Inflation Swindles the Equity Investor. I think the key takeaway is that if you are to invest in stocks in these sort of periods the business must have pricing power and ability to contain costs. All other stocks will not be good inflation hedges. I always see this thing about stocks as great during inflation. The sentiment should read that a *specific subset* of stocks can do well, all others can do very poorly.

I thought this was pretty entertaining and useful - http://www.fooledbyrandomness.com/rationality.pdf (draft from his new book)

He also says in that book that the investing public is incorrigible, they will buy anything at any price. He seems a mild fellow so not sure if he was being a little annoyed, however, this sheep-like public which makes 10x their money in a few months because there is 'risk-on' or there is a cyclical boom in some sector can make up for a lifetime of bargains. Some get out and keep their profits, others lose it on the way down. Many traders buy puts to protect their gains. How many tech companies do you know over the last little while that make either no money or very little money and trade at valuations that you know expectations will hit a wall at some point for most of them. Yet, these things can last quite a while. You can imagine the lure - make a lifetime of value investing gains in 1-2 year instead of profiting only when you're old.

Thanks, I agree with you and that article. I like this article by James Altucher who says do not buy a house, it's a waste of money (but he's a bit of a radical): http://www.jamesaltucher.com/2015/10/own-house/

What's dead is patience & temperament more than value investing, hopefully there will be sufficient losses by those who don't manage risk to ensure patience comes about by the apathy produced when you don't want to open your computer to look at your net worth balance anymore :)

If inflation is 20% and paper money will halve in value in 3.4 years, why wouldn't your house stay the same or even double in price? If it collapsed it would be a real bargain. To sell a house at 1/2 price when paper money is dropping like a stone will definitely be painful for some who are forced to default, but there may be a cushion there. Even in the States defaults were high but I think it didn't even reach 20%.

So we have that Graham formula of <1.5x BV and <15x earnings. Well, the earnings part is still quite valid, but the BV criteria not so much. Why? I wonder if in the old days companies either: a) retained earnings out of a deep conservatism due to the Great Depression causing BVs to be inflated. Today such companies might buyback stock or return to shareholders. If they didn't they'd meet the criteria. b) companies were more capital intensive due to the industrial/manufacturing stage in human evolution and less globalization. Today, many companies are in the 'cloud' and so the average P/BV is going to creep up as more money is made with less physical investment. So if you keep the P/E criteria as a reasonable price for growth, it does still look very similar. Of course quality of earnings and qualitative factors are another thing to look at, but you can't really put a number on them.

I don't think value investing was ever alive. Growth is a component of value, a very important one. A value stock in my definition is one that has growth which is mispriced. With tech/biotech stocks you often have growth that is overpriced. If you can get growth and something like trading at NAV (good luck, but possible in the odd case) you are in investing heaven.

What is the relationship between real estate purchase price and interest rates? I am having a debate with someone and I said that if rates are 20%, RE prices must be very low but they think inflation makes them very high. So this got me confused. Is inflation when rates are zero (like now) or when rates are 20%? There is also the matter of all cash buyer vs leveraged but most people use debt to buy property - or anything else that's very expensive.

- Seems to be a renters's paradise. Cap rates appear to be 1-2%? - But what of primary residence, like a work of art? Cap rate = debt servicing cost + maintenance. Sensitivity of rates to servicing costs based on avg incomes and % of total income. Anyone do the research on what 25 basis pt translates into as increase in % of disposable income? - Divergence of interest rate between Canada and other nations. Say US at 3% and Canada at 0%. Then not only could the bubble pop but there will be a double whammy of losses. The dollar will fall severely (maybe 2 for 1 even) and there will be an outflow of capital to higher rates elsewhere - a rush to the exit, crunching debt holders more so than paper loss on equity. - Stocks seem positively bargains compared to P/E 50-100 CA real estate. PE 50-100 implies growth rate of say 30-50% per year? Even if rates go to 5%, an "expensive" yield of 5% on a stock is still break-even but deeply underwater buying a house at 1-2% leveraged 5x-10x. - Only way this goes on is low rates forever but have to think global capital flows too. - CA real estate cannot deduct mortgage interest (not applicable to non-taxpaying non-residents) and there is no 30 year fixed rate loans - an additional burden on buyers, foreign or domestic. - Those who think money laundering and store of value in real estate is the cause of this should consider the illiquidity of the investment and the absolute fact that it is not a cash-equivalent. Most likely buyers want to live here in addition to other considerations. But they will not like losing the use of their equity for decades...

I found this quote from Buffett in 2012: "Farms, real estate, and many businesses such as Coca-Cola KO -0.05% , IBM IBM -0.46% , and our own See’s Candy meet that double-barreled test. Certain other companies — think of our regulated utilities, for example — fail it because inflation places heavy capital requirements on them. To earn more, their owners must invest more. Even so, these investments will remain superior to nonproductive or currency-based assets." http://fortune.com/2012/02/09/warren-buffett-why-stocks-beat-gold-and-bonds/ I think he's saying that these capital intensive industries are not the best, but they beat gold and cash and as has been pointed out can deploy lots of that depreciating cash. I'm trying to wrap my mind though around quality of businesses. Is he suggesting that large margins and pricing power involve things like low labour costs, royalty income streams, established relationships where you can raise prices without investing much. There are many products/services that don't have large capital requirements but you can't raise prices. Presumably you invest even there to brute force sell more or something. It's interesting to think about.

I guess bubble blowing is the only way that governments know how to help people recoup their losses from the previous disaster. Maybe at best they break even in the end, but you're a couple of decades older :)

So they'll sell and rent? or sell and migrate?

Replacement cost as in value of the franchise. Yes, owning the major utility in an entire group of States is hard to replicate. You're the only one. With railroad, you are one of very few. So one would accept lower return for the privilege of owning those cash-flows. But 5%? That's too low even if you had the only cash cow in town. One more question - Special niche or larger area? Maybe I make 20% on 1 million and you make 5% on 50 billion. Is it a case of parking large sums somewhere? Another question - a play on future inflation?

just some thoughts: -Was it equity or equity+ float? -Case of skate where the puck will be or where it's at? -Will the competitor's ROE go down while Berkshire's go up? -Replacement cost? I owned a stock with 5% ROE, it did NOT do well :)

This company has two main problems, so simple and yet I wouldn't trust a management that can't figure out something so basic... 1. Don't go for long shots and try to avoid pharma. 2. Don't invest in commodities. 3. Don't use excessive leverage. If they did just these 3 things, they could screw up a thousand times , they'd still be ahead of where they are now and I'd forgive any of their operational blunders. Like Buffett says, Mental Models are 80% of the battle :)