Tag Archives: cash

Find Businesses That Control Their Destinies

By Frank Caruso, James T. Tierney, Jr. In a volatile world, it often feels like companies are subject to forces beyond their control. Finding companies that can steer their own course is a good way to capture resilient growth through changing market conditions. Not all companies are equally vulnerable to unpredictable market forces. Some exercise a much greater degree of control over their fate by virtue of having fundamentally sounder businesses based on stronger people, better products, superior operating execution and more responsible financial behavior. Searching for companies that command their destinies is one of several ways that active investors can capture excess returns over long time horizons. Balance Sheets Matter Balance sheet health – and low earnings volatility – is a great indicator of resilience. Investors should always scrutinize a company’s balance sheet, but in times of stress, this is even more important. Companies with less debt to service will pay less of a penalty in their financing costs when interest rates rise. Low debt ratios also are good indicators of a company’s flexibility to execute its strategy without relying on banks or credit markets. And businesses that can generate the cash they need to fund and invest in their operations are less beholden to the demands of externally sourced capital, and less vulnerable to a potential tightening of credit markets. Solid balance sheets and sustainable sources of growth are a winning combination. Companies with both are much better equipped to reward shareholders by increasing their dividends or buying back shares – even in tough market conditions. Companies in the top quintile of share repurchases – especially those with attractive valuations – have outperformed the market historically ( Display ). Click to enlarge Focus on Pricing Power Pricing power is another indicator of a company’s ability to deliver sustainable growth. With China and emerging markets slowing down, and with anemic recoveries in countries from the US to Europe, it’s difficult to find sources of new demand. And with inflation stuck at very low levels, it’s not easy for companies to raise prices. So companies that demonstrate pricing power in their industries are better positioned to improve their earnings than are their competitors that lack it. We think there are three keys to pricing power: innovation, competition and cost and inflation dynamics. Innovative products and services are capable of commanding higher prices even in a tough economy and amid low inflation. For example, Apple (NASDAQ: AAPL ) commands premium prices for its smartphones because of its innovative features and an ecosystem that allows all the company’s devices to work together seamlessly. A highly competitive environment makes it much more difficult for companies to raise prices. And in a low-inflation world, cost dynamics are crucial. Given this reality, we believe that companies with strong market positions and relatively fixed cost businesses are better placed to increase revenues while leveraging costs. For example, Visa (NYSE: V ) and MasterCard (NYSE: MA ) are the two largest global card networks. As such, they have had the ability to modestly increase prices over time while competitors have seen price erosion. And the nature of their networks means that additional transactions or volumes are highly profitable from an incremental margin perspective. Understanding these dynamics can help underpin an investing plan for an unpredictable world. Investors in passive equity portfolios may be more exposed to capricious market forces because they will hold many benchmark stocks that are more vulnerable to instability. In contrast, in our view, active equity managers can target companies with clear advantages in confronting erratic headwinds – and controlling their destinies – which can lead to resilient long-term returns. The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams. Frank Caruso, CFA, Chief Investment Officer – US Growth Equities James T. Tierney, Jr., Chief Investment Officer – Concentrated US Growth

GDX: Gold’s Resurgence Can Keep Rising

By Brenton Garen and Tom Lydon An obvious though still impressive beneficiary of gold’s resurgence this year is the gold mining industry and its corresponding exchange traded funds. That includes the Market Vectors Gold Miners ETF (NYSEArca: GDX ) , the largest and most heavily traded gold miners ETF. GDX is up 50% year-to-date. Not only is that good for one of the best performances among non-leveraged ETFs, it also puts GDX up nearly three times as much as ETFs that hold physical gold. That does not mean GDX and rival gold miners ETFs are perfect investments, not when the industry still faces headwinds. Strategists point out that costs keep rising, which has narrowed profit margins among gold miners. Recent mine closures have not improved margins. Current mining operations are also facing deteriorating ore grades. The recent decline in energy prices and depreciating currencies where local miners operate have also had minimal beneficial impact on cash costs. Gold is seeing greater support from safe-haven demand after currency devaluations across Asia added to investment demand for a better store of value than paper currencies or stocks and bonds. Gold assets look more attractive in a low interest rate environment as the precious metal is more competitive against assets that pay low interest, like bonds. Additionally, if the Fed holds off on further rate hikes, it would suggests the economy is not as strong, which would also help gold attract safe-haven demand. “I believe this could be due to the fact that the cash cost of mining the yellow metal has not only been constantly below the gold price, but also falling. For miners, any increase in the price of gold can push the income as well as profit margins even higher,” according to a Seeking Alpha analysis of GDX. Supporting miners and GDX is the dollar, which has quickly weakened. The greenback is being weighed down on speculation that ongoing uncertainty may force the Federal Reserve to refrain from hiking interest rates in the near future. Consequently, a weaker USD makes alternative assets like metals more attractive . Market Vectors Gold Miners ETF Click to enlarge Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

The Value Of Transparency: Why Methodology Matters

Disagreement makes markets. Every time you buy a stock, someone on the other side has to be selling it. You’re making a bet that the stock is going to outperform in the future; the other person is betting that it will underperform. This point seems obvious, but it’s one that investors forget time and time again when they try to chase “sure things.” Many ignored this fact when they fell for Bernie Madoff’s Ponzi scheme . They forgot it when they chased high-flying stocks like Twitter (NYSE: TWTR ), LinkedIn (NYSE: LNKD ) or Valeant (NYSE: VRX ) (and many others ). Any investment that seems too good to be true probably is. Chuck Jaffe of MoneyLife and MarketWatch.com made an excellent point on this topic in his recent article, ” Here’s One Stock Market Tip You Really Want to Follow .” “On the MoneyLife show, money managers spend the bulk of their time discussing methodology and markets before moving to which stocks pass or fail their personal tests,” Jaffe writes. “In the end, however, what most people remember is the simple buy-sell-hold recommendation.” That’s a problem, Jaffe argues, because he often gets different money managers taking opposite opinions on the same stock. These are (presumably) sophisticated investors, with similar styles, who have taken a deep look at the same stocks and come to opposite conclusions. For every very smart investor that believes a security is undervalued, there’s usually another smart person with their own reasons to believe that it’s overvalued. Recently we faced off against another analyst over Valeant Pharmaceuticals. The other analyst put more emphasis on the company’s stated numbers, leading him to call it a good buy. We reiterated our position that VRX has questionable accounting and its business model destroys shareholder value. Investors couldn’t just look at the headline to make their decision; they had to dig into the logic and methodology of each argument to decide who they thought was right (given VRX’s 50% drop this week, we think that was us). Not only that, but on some occasions both sides could be right! A risk-averse analyst with a shorter time frame might see significant challenges for the company in the coming years and want to sell. A more opportunistic analyst with a longer horizon could see a cheap valuation and long-term growth opportunity. Neither one is wrong, they just have different criteria. Take A Look Underneath The Hood For this reason, investors always need to dig deeper than looking at a simple “buy” or “sell”. Sometimes, these ratings can be driven by factors that have nothing to do with markets or fundamentals . On other occasions, the argument might sound convincing but completely crumble when you examine some of the underlying assumptions. Even if the call looks accurate at the time, markets and the economy change constantly. For instance, let’s say an analyst rates a company a buy due to the fact that he or she believes it has pricing power, so you buy the stock. Now, if the company tries to raise prices and starts losing market share, you know that the underlying thesis does not hold up and you should sell right away. This is important, because analysts generally aren’t going to tell you when their calls go wrong. In addition, almost any call will be impacted by developments in other parts of the economy. It’s possible for analysts to be absolutely right on stock-specific issues but to miss on a more macro level. We have firsthand experience in this area. In 2012, we put Goodyear Tires (NASDAQ: GT ) in the Danger Zone . Given that the company had never earned an economic profit in any year we had data for (going back to 1998), had significant pension liabilities, and little history of growth, the call seemed eminently reasonable at the time. What we didn’t predict was the complete rout in commodities that would decrease the price of rubber by almost 80%. This price decline helped boost GT’s margins to record levels and gave it the cash flow it needed to make up the gap in its pension funding and justify a valuation significantly higher than we anticipated. We wrote back then that GT needed to grow after-tax profit ( NOPAT ) by 4% compounded annually for 10 years in order to justify its valuation of $10.16/share, a target we didn’t think was likely given that the company’s NOPAT had actually declined since 1998. Instead, the major decrease to one of its primary costs helped GT’s NOPAT grow by 18% compounded annually since our article. This major profit growth has allowed it to justify a valuation of ~$33/share today. Transparency Makes For More Informed Investors Why are we writing about a sell call we made that went over 200% in the opposite direction? Because it’s important for investors to remember that nobody has all the answers. We believe our methodology helps investors identify fundamentally undervalued and overvalued companies-and the data bears that out -but we still get calls wrong from time to time. That’s one of the primary reasons why we put such a big emphasis on transparency. It’s why we do things like: Give definitions and formulas for all the metrics we use Explain the adjustments we make to close accounting loopholes Show our calculations for the different factors that comprise our stock ratings Include links to our DCF models in all our long and short calls We want investors to understand our underlying methods and assumptions so they can analyze our findings, try to poke holes in our arguments, and make informed decisions about whether to follow our recommendations. Ultimately, our commitment to transparency comes from the confidence we have in our research. Our analysts digging through thousands of filings to create models that reflect the underlying economics of the thousands of stocks we cover, and we want people to be able to see the fruits of their labor. Compare this level of transparency with some of the other major providers of equity research out there: A lot of the work these analysts do can actually be valuable. Unfortunately, the lack of transparency makes it difficult for investors to analyze these research reports and form their own opinions. This leads to the situation Jaffe described where investors have learned to just pay attention to buy-sell-hold ratings rather than dig into methodology. We don’t want investors to just blindly buy our top-ranked stocks. Instead, we want to help them become more sophisticated by providing the data, tools, and frameworks they need to succeed. Disclosure: David Trainer and Sam McBride receive no compensation to write about any specific stock, sector, style, or theme. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.