Tag Archives: government

Buffett Explains Bubbles

Back when the financial crisis was in full blown collapse mode, the government stepped in to shore up the problem areas and infused a huge amount of reassurance in the financial system. It was like a giant hug for the markets, for the people, and anyone else that needed one, that said, “things will be okay.” Then the government did what all governments do best. Congress formed a committee to investigate why it happened. They needed a villain. So the FCIC, Financial Crisis Inquiry Committee, was created to find who or what was to blame. In the end, we all know what happened. The banks took the heat while a lot of the co-conspirators walked away clean. In reality, it was a fairly solid team effort between lenders, borrowers, Congress, rating agencies, regulators, Fannie Mae ( OTCQB:FNMA ), Freddie Mac ( OTCQB:FMCC ), mortgage brokers, real estate speculators, derivatives, media, etc. that led to the largest bubble and crisis in history. This past weekend, the FCIC made available some transcripts and notes from that investigation. One of those transcripts was a two-hour interview with Warren Buffett. I won’t cover the entire interview though it was an interesting read (at least I thought so). Buffett offered an enlightening take on bubbles, which I thought I’d share. It didn’t cause it, but there were a vast number of things that contributed to it. The basic cause, you know, embedded in psychology – partly in psychology and party in reality in a growing and finally pervasive belief that house prices couldn’t go down and everyone succumbed – virtually everybody succumbed to that. But that’s – the only way you get a bubble is when basically a very high percentage of the population buys into the same originally sound premise and – it’s quite interesting how that develops – originally sound that becomes distorted as time passes and people forget the original sound premise and start focusing solely on the price action. So every – the media, investor, the mortgage bankers, the American public, me, my neighbor, rating agencies, Congress, you name it, people overwhelmingly came to believe that house prices could not fall significantly. And since it was the biggest asset class in the country and it was the easiest class to borrow against, it created probably the biggest bubble in our history. … I think every aspect of society contributed to it virtually, but they fell prey to the same delusion that existed throughout the country eventually and it meant that the models that they had were no good. They didn’t contemplate – but neither did the models in the minds of 300 million Americans contemplate – what was going to happen. … Well, there’s a very interesting aspect of this, which will take a minute or two to explain, but what my former boss, Ben Graham, made an observation, 50 or so years ago to me that it really stuck in my mind and now I’ve seen evidence of it. He said, “You can get in a whole lot more trouble in investing with a sound premise than with a false premise.” … It’s a totally sound premise that houses will become worth more over time because the dollar becomes worth less. It isn’t because – you know, construction costs go up. So it isn’t because houses are so wonderful, it’s because the dollar becomes worth less, and that a house that was bought 40 years ago is worth more today than it was then. And since 66 or 67 percent of the people want to own their own home and because you can borrow money on it and you’re dreaming of buying a home, if you really believe that houses are going to go up in value, you buy one as soon as you can. And that’s a very sound premise. It’s related, of course, though, to houses selling at something like replacement price and not far outstripping inflation. So this sound premise that it’s a good idea to buy a house this year because it’s probably going to cost more next year and you’re going to want a home, and the fact that you can finance it gets distorted over time if housing prices are going up 10 percent a year and inflation is a couple percent a year. Soon the price action – or at some point the price action takes over, and you want to buy three houses and five houses and you want to buy it with nothing down and you want to agree to payments that you can’t make and all of that sort of thing, because it doesn’t make any difference: It’s going to be worth more next year. … And the price action becomes so important to people that it takes over the – it takes over their minds, and because housing was the largest single asset, around $22 trillion or something like that…Such a huge asset. So understandable to the public – they might not understand stocks, they might not understand tulip bulbs, but they understood houses and they wanted to buy one anyway and the financing, and you could leverage up to the sky, it created a bubble like we’ve never seen. … It wasn’t like somebody was thinking, “This is going to end in a paralysis of the American economy.” You know, they just – they started believing what other people believed. It’s very tough to fight that. Of course, a similar sound premise was behind the ’29 bubble and internet boom. Buffett explained both cases started with a sound premise – stocks outperform bonds over time and the internet will change our lives – which was a solid argument for owning stocks. But at some point, the sound premise became “you should own stocks because prices are going up,” then momentum and FOMO (Fear Of Missing Out) kicked in. Eventually, people gradually wake up to the reality that it’s not true and the bubble pops. Source: Buffett FCIC Interview Transcript

3 Things I Think I Think – Financial Crisis Edition

Here are some things I think I am thinking about: Warren Buffett on the financial crisis, investing with a sound premise & silly Congressional ideas. 1 – What Caused the Financial Crisis according to Warren Buffett? The National Archives released documents related to the Financial Crisis late last week. Among them were some interviews with Warren Buffett on the crisis. I noticed that, aside from being nerdy white guys, the only thing I might have in common with Buffett is that we both believe the cause of the financial crisis was, well, just about everybody: I think the primary cause was an almost universal belief, among everybody ‑ and I don’t ascribe particular blame to any part of it – whether it’s Congress, media, regulators, homeowners, mortgage bankers, Wall Street ‑ everybody ‑ that houses prices would go up. ” I’ve described this several times over the last 7 years and every time I do it, I seem to catch a bunch of flak from people with a political bone to pick. And every time I see someone trying to place sole blame on “the government” or “Wall Street” or “house flippers” or whoever, I am reminded of how common fallacies of composition are in the financial world. We don’t see things in totality. We see what we want to see inside of the big picture so we can confirm what we already believe. This just leads to a lot of narrow-minded thinking that causes more arguments than objective analysis. 2 – Investing with a False Premise. One comment I disagreed with (at least partly) was Buffett quoting Ben Graham on investing with a false premise: ” You can get in a whole lot more trouble in investing with a sound premise than with a false premise .” I don’t know about that. If you’ve read my paper on the monetary system or portfolio construction , you’ve probably noticed that this is the primary thing I am trying to avoid when analyzing the economy – false premises. There are so many myths and misconceptions about money that you can get into a lot of trouble buying into these ideas. Whether it’s flawed concepts like the money multiplier, crowding out, being a permabull/bear, dividend investing for safe income, “beat the market” or whatever. Starting with a sound premise is an intelligent way to improve the odds that you’ll succeed going forward. Of course, you have to maintain some rationality within this context. Extremists get killed in the financial markets because they tend to go all in on what they believe. Believing that house prices never go down was obviously irrational (and I had that argument with a lot of people back in 2005/6), but the fact that asset prices usually go up is not an unsound premise from which to start because the economy usually expands and people tend to become more productive over time. So, in this example, being a rational optimist always beats being a perma pessimist AND a perma optimist. 3 – Let’s talk about that silly balanced budget idea. One myth that just never dies is this idea that the US government is going bankrupt and needs to tighten its belt so we avoid impending crisis. I’ve spent an inordinate amount of time debunking this myth over the last decade, but I wanted to congratulate a group of economists for fighting back against a truly stupid idea – a federal balanced budget amendment. Mark Thoma linked to this letter yesterday highlighting the dangers of a balanced budget amendment. I’ll just point out two facts: First, one of the most powerful economic policies we have in place is what’s called automatic stabilizers. This is the tendency for the budget deficit/surplus to expand and contract naturally to offset economic conditions. So, during a recession, government deficits rise because spending naturally increases due to things like unemployment benefits while tax receipts decline. This leads to more income to the private sector and a flow of net financial assets that helps offset the decline. And the exact opposite happens during booms thereby cushioning against the risk of booms. If we had a balanced budget amendment in place, the economy would likely be a lot more volatile because these stabilizers would be gone. Second, the federal government plays an important role in ensuring that our states don’t turn into Greece. As I’ve explained before , since the states have balanced budget amendments, they are constrained by a true solvency constraint. The states, like Greece, have real limits on how much debt they can issue. But since the US states run trade surpluses/deficits against one another with no foreign exchange rebalancing then the poor states are always exporting more dollars than they’re importing. They can borrow to offset this, but there’s a Congressionally mandated limit to this borrowing. So, where does the income come from that helps avoid inevitable insolvency and occasional financial crisis? You guessed it – it comes from the federal government who takes more from the rich states and redistributes it to the poor states. It sounds like socialism, but it’s actually saving capitalism from itself. And it works beautifully in the case of a single currency system by helping us avoid the debacle of a situation that is Europe….

American States Water: Temporary Factors & Analyst Downgrade Lead To Buying Opportunity

This week, American States Water (NYSE: AWR ) popped up on my radar as an oversold dividend growth stock with a long history of dividend increases. Shares of AWR have fallen nearly 17% since February 24th when the company released earnings that beat on the top and bottom line. The results were better than expected, however, earnings were down year/year and to add to that, the stock was downgraded by Ladenburg Thalmann from neutral to sell on February 26th and the stock fell over 9% just that day and has continued its downward trajectory ever since. I believe the sell-off in AWR is extremely overdone and the reasons why AWR earnings were down year/year are easily explainable and show that they are temporary in nature. Those items include billings, drought and government projects. Billings In the earnings press release for the 4th quarter, the company noted that results for its water business were down because of ” a delay in recognizing $1.4 million of Water Revenue Adjustment Mechanism (WRAM) revenue.” AWR was delayed in recognizing because of water conservation measures taken by the state of California. Simply put the drought had a negative impact on AWR because it was not able to recognize $1.4 million in revenues during the year, however, they will make up for it in 2016 as the statement from the earnings release shows. ” The impact of state-mandated water-conservation targets on customer usage, GSWC recorded large WRAM balances during 2015. Under current CPUC amortization guidelines, surcharges ranging from 12 – 36 months will be implemented in 2016 to recover the recorded WRAM balances, as well as the $1.4 million not recorded.” Drought Last year California had a very bad drought where as noted about there were mandatory water conservation measures put into place, which affected the results for AWR. This year is looking much better in terms of rainfall and snowfall for California. Rainfall data from the California/Nevada River Forecast Center, which is part of NOAA, showed that of the 49 California locations that monitor rainfall, 33 [67%] had increased rainfall totals from October 2015-March 2016 compared to October 2014-March 2015. In addition, as the following comparison of snowfall totals from the California Department of Water Resources shows, 2016 snowfall totals are massively ahead of where they were last year. The left side of the chart shows that snowfall, as a percentage of normal for this time of year in 2015 was 10%, 13% and 13% in the three regions. This year however, the snowfall totals are significantly better with those same regions posting 102%, 95%, and 79% of normal. With the significant increase in rainfall and snowfall totals 2016 should be a much better year for AWR because there should not be the water shortage like there was in 2015. Click to enlarge [Images from California Department of Water Resources ] Government Projects In the earnings press release for AWR, it was noted that its American States Utility Services subsidiary, which focuses on utility projects for military bases had lower earnings year/year because of a large project that was completed at the end of 2014 and AWR did not have a similar large project completed during the fourth quarter of 2015. This is the most appealing aspect of AWR because they currently operate & maintain water and wastewater systems at nine military bases throughout the United States under 50 year contracts. These long-term contracts give the business current growth as well as long-term stability because of the duration of the contracts. As was noted in an investor presentation in December, “Numerous military bases still to be privatized; active bids are currently in process. Significant water and wastewater contracts to be awarded over the next 5 years.” With its existing portfolio of military bases and the potential for more bases to be served over the coming years, AWR is set up for continued stable growth going forward. Dividend Growth History & Potential AWR has a long history of dividend increases [61 years], with the company classified as a “Dividend King”, that means they have increased their dividend for a minimum of 50 years in a row. With the ability to consistently increase its dividend through any market environment AWR can be a place investors look to for dividend safety in times where there are adverse market conditions. Click to enlarge [AWR December Investor Presentation ] Dividend Growth Potential As you can see in the table below, AWR has a weighted dividend growth rate of 7.15% and I expect the dividend to continue growing over the next 5 years. To determine if that rate of dividend growth is sustainable over the next five years, I conducted an analysis to see if dividends paid as a percentage of net income was less than my self-imposed threshold of 80%. For my calculations, I used the dividend growth rate of 7.15% and I calculated the net income growth excluding discontinued operations over the last five years to be 9.49% and applied that growth for the next five years. The table below shows if AWR continues growing its dividend at its current pace that it will continue to be well below my 80% threshold. Based on my estimates, by 2020, AWR could be paying an annual dividend of $1.24/share or about $0.311/quarter, which is just about 39% above the current quarterly dividend. Estimated Dividend Div Growth Rate Weight Div Rt*Weight 5 Yr 12.28% 20.00% 2.46% 3 Yr 7.24% 30.00% 2.17% 1 Yr 5.05% 50.00% 2.52% Weighted Dividend Growth Rate 7.15% Current Quarterly Dividend 0.224 Shares Outstanding 37.6 Net Income Growth Last 5 years 9.49% Calendar Year Est. Div/Share Shares Divs $ Paid Proj. Net Income Proj. Div as % of Net Inc. 2016 est. 0.94 37.6 35.50 66.24 53.59% 2017 est. 1.01 37.6 38.03 72.53 52.44% 2018 est. 1.08 37.6 40.75 79.41 51.32% 2019 est. 1.16 37.6 43.67 86.94 50.23% 2020 est. 1.24 37.6 46.79 95.19 49.15% ` 2020 Div 1.244 2020 Quarterly 0.311 Current Quarterly 0.224 % Dividend Upside 38.89% Valuation To determine the upside opportunity for AWR, I conducted a discounted cash flow analysis (table below) and found that shares are undervalued at current levels. Because of the nature of its business and the variable nature of free cash flows due to changes in CAPEX, I used cash flows from operations, which are more stable and better reflect the value of cash flows for AWR. Cash flow data is from GuruFocus, long-term growth rate is from Zacks and to determine the discount rate & terminal growth rate, I used the following calculators. I found that shares of AWR are slightly undervalued by just under 10%. While, this may seem low, as I noted in the first section, AWR has potential to increase its cash flows if they were to win the contracts for the military bases that are up for bidding. Discount rate calculator Terminal Growth calculator TTM CF/Share: $2.53 Proj. Long-term growth rate: 3.85% Terminal growth rate: 0.11% Discount rate: 3.47% Fair Value Calculator Assumptions EPS grows for next 5 years. After that, growth levels off to the terminal rate for 15 years. AWR DCF Calculations CF/Share PV Year 1 1 2.63 $2.54 Year 2 2 2.73 $2.55 Year 3 3 2.83 $2.56 Year 4 4 2.94 $2.57 Year 5 5 3.06 $2.58 Year 6 6 3.06 $2.49 Year 7 7 3.06 $2.41 Year 8 8 3.07 $2.33 Year 9 9 3.07 $2.26 Year 10 10 3.07 $2.18 Year 11 11 3.08 $2.11 Year 12 12 3.08 $2.04 Year 13 13 3.08 $1.98 Year 14 14 3.09 $1.91 Year 15 15 3.09 $1.85 Year 16 16 3.09 $1.79 Year 17 17 3.10 $1.73 Year 18 18 3.10 $1.68 Year 19 19 3.10 $1.62 Year 20 20 3.11 $1.57 Fair Value $42.76 Current Price $38.92 Upside/Downside 9.87% Technical Outlook Looking at the technical chart, you can see that AWR has two significant levels of support just below where the stock is currently priced. The upward trending line of support [Red Line] has acted as support for the last four and half years and is currently just below where the stock is currently priced. In addition, if shares of AWR were to breach the upward trend line there is another level of support at $36 [Blue Line], which is another strong level of support. This is where shares failed to break above at the end of 2014 and after shares of AWR broke above the level in 2015, it acted as a strong level of support, making a double bottom during the middle of 2015. With both these levels of strong support nearby, I think shares of AWR are near a bottom. Click to enlarge [Chart from ThinkorSwim Platform] Closing Thoughts In closing, I believe American States Water is worth considering as an addition to dividend growth portfolios because they have increased their dividend each year for the last 61 years, which shows the strength of their business through any type of market. In addition, American States Water has a stable dividend payout ratio, which will allow them to continue increasing their dividend going forward. With the issues that caused the recent sell-off being temporary in nature, an improvement in billings and weather in 2016, along with the potential for increased revenues from new military base contracts, American States Water is poised for a strong rebound from current levels in my opinion. Disclaimer: See here . Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in AWR over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.