Tag Archives: united-states

Stock Market Control

Summary History shows there is a one in three chance that stocks will drop each year regardless of whatever happened the prior year. We think there are certain things we can’t control in the stock market. We try to control what we own, how cheap it is, how often we make changes to our portfolio and quality from the companies we own. We saw the chart below in a recent Marketwatch.com column from Mark Hulbert. It shows the likelihood of the stock market going up or down in the next year, based on how it did the prior year: This got us thinking about what you can and can’t control in the U.S. stock market. After all, the reason that stocks outperform other liquid asset classes over long stretches of time is the uncertainty and variability of returns. Here is a short list of things, which can’t be controlled in the U.S. stock market: 1. Stock market results The chart shows that there is a one in three chance that stocks will drop each year regardless of whatever happened the prior year. We don’t think investors should buy or own common stocks if they feel emotionally ill-equipped to withstand a losing year. 2. Stock Market Volatility Even in good years, stocks can swing wildly from week to week and month to month. The average year sees a peak to trough decline of 10%, and we have seen a 20% or greater decline about once every five years on average. Twice in the last 16 years, we saw the S&P 500 Index decline by more than 30%. Granted, that is an unusual occurrence, since there have been only five such declines since 1940. We remember telling common stock investors near the bottom of the stock market in March of 2009 that it would likely take about four years to get their portfolio value back to where it was before the decline in 2008-09. Those courageous and patient investors have been well rewarded by the bull market since then. An owner of common stocks should expect gyrations as part of the price of admission and use holding periods, which allow for recovery and success. The wise investor seeks to use wide, sharp and emotional price swings in their favor. 3. Stock Market Unpredictability I am approaching my 36th year participating in the U.S. stock market and can say that nobody has proven any consistent ability to predict price moves in the indexes. I’ve read the prognostications of Joe Granville, Stan Weinstein, Marty Zweig, Comstock Partners, Robert Prechter, George Gilder, Nouriel Roubini, Meredith Whitney and numerous other very smart people in my career. The one thing they have in common is they attracted a large following after being very right on a major stock market prediction. However, doing so consistently is a bit like trying to find the pot of gold at the end of the rainbow. We recently read the musings of a highly respected asset allocation firm about their seven-year predictions of asset class returns. Their prediction for the U.S. stock market is extremely negative, which would scare a normal observer and could very well end up being valid. However, we have been reading their predictions for the last ten years and have seen their consistent pessimism for U.S. stocks. We also remember their optimism about emerging markets and commodities. Surely, these predictions from the last five years must have cost someone who followed their advice some serious money. 4. Relative Performance A study of the best stock picking disciplines of the last 60 years (Buffett, Neff, Templeton, Lynch and Carret) showed that they underperformed the S&P 500 Index 35% of the calendar years during their long and illustrious track records. We expect to be subject to those statistics at best and have very little control over which years we get beat by the index. Our goal is to beat the stock market over ten and twenty-year time periods and we believe those results would be unattainable if you try and smooth that truth. Things We Seek to Control We’re not about being glum or dour. We certainly believe there are things that investors can control. We’ve outlined three key tenets to consider when investing in common stocks. 1. Valuation Matters Dearly You can control which stocks you own, and you are free to emphasize stocks, which are cheap in relation to profits, free cash flow, dividends or book value. Studies show that results are improved over both short and long term holdings periods by constantly reemphasizing cheaper common stocks. This requires a contrarian nature, because when these common stocks are cheap their warts show easily. Therefore, you need to be lonely and courageous. 2. Activity Eats into Returns A wise financial advisor told us in early 2012 that a stock portfolio is like a bar of soap: the more you rub it, the smaller it gets. A 2013 study in the Financial Analysts Journal showed that the average turnover among U.S. large-cap equity funds has been 62% and it costs the average equity mutual fund in the database 0.81% (81 basis points) per year in returns. We seek to own securities for an average of over seven years and attempt to save significantly on trading costs by doing so. If you can control yourself and be very patient, we think you can improve long-term results. 3. Quality Adds Alpha and Promotes Patience Studies have shown that qualitative characteristics like a strong balance sheet, consistently high profitability and low earnings variability add to returns over long time periods. These qualities give owners more ability to stay put in bad stock market environments and/or when a company temporarily stumbles. Riding through thick and thin can be controlled and is augmented if there is no threat of one of your companies going out of business. Again, if you can control yourself, you can use long-durations to let quality help you overcome the forces you can’t control. Conclusion We make no effort to have any control over stock market results, volatility, unpredictability and relative performance. We haven’t got any special ability to know what stocks will do next year or how we will fare on a relative basis. What we do try to control is what we own, how cheap it is, how often we make changes to our portfolio (we subscribe to “lethargy bordering on sloth” – Warren Buffett) and what kind of quality we demand from the companies we buy and own. We do this based on our eight criteria for stock selection. In practicing our discipline, we seek high quality companies, purchased at bargain prices and have a desire to hold them for long time periods. In other words, we try to control ourselves, our portfolio and apply long-durational and favorable probabilities. The information contained in this missive represents SCM’s opinions, and should not be construed as personalized or individualized investment advice. Past performance is no guarantee of future results. Bill Smead, CIO and CEO, wrote this article. It should not be assumed that investing in any securities mentioned above will or will not be profitable. A list of all recommendations made by Smead Capital Management within the past twelve-month period is available upon request.

Can Airlines Funds Take Off On Profit Outlook, Low Fuel Cost?

The Airline sector is witnessing improving trends right now, and the momentum is much needed to ensure profits for investors in this space. While much of the encouragement comes from fundamentals within the airline space, another key catalyst for the sector’s growth is the slumping oil price. Airline stocks will likely continue their bull run into 2016 as recently reinforced by the encouraging outlook provided by the International Air Transport Association (IATA). Separately, weakness in oil prices, which has lasted for well over a year now, is nothing short of a godsend for the airline space. Airline profits depend largely on fuel prices, which form nearly 30% of operating expenses and are also the major variable component in the industry. Operating expenses of airline companies have gone down considerably as fuel accounts for one of the major input costs for air carriers. Thus, it is time to focus on funds that have investments in the airline space. Please note that there is hardly any fund that focuses solely on airline stocks. However, the sector attracts heavy investments from many mutual funds that focus on the transportation sector. The funds we discuss may not carry a favorable Zacks Mutual Fund Rank at the moment, but an improving trend in the airline space demands attention on them. Airliners Fly High as Crude Hits Ground Stocks in the airline space soared following the Dec 4 decision by the Organization of the Petroleum Exporting Countries (OPEC) – the international cartel of oil producers – to not curb output of crude. A blip came thereafter as Southwest Airlines (NYSE: LUV ) revealed a disappointing outlook with respect to its operating revenue per available seat miles (RASM) for the fourth quarter of 2015. Nonetheless, the low oil price environment makes airline stocks attractive. The drop in oil prices has reduced airline companies’ operating expenses significantly, thereby boosting the bottom line. OPEC’s decision not to curb output despite the slump in prices means that the oversupply will continue to haunt the energy space. This implies good times ahead for airline carriers. Weak oil prices have resulted in tremendous savings and improved bottom lines for carriers in the past quarters. The massive savings have certainly supported the financial health of carriers and prompted them to launch share buyback programs, hike dividend payments and significantly reduce their debt levels. Buoyed by their sound financial health, several carriers intend to invest heavily in upgrading overall facilities for better customer satisfaction. This is likely to result in greater travel demand, improved goodwill and eventually, a higher top line. Although it is true that most carriers struggled to post meaningful revenue growth in the third quarter of 2015 courtesy of a strong US dollar, their bottom lines benefited owing to low fuel costs. IATA’s Outlook Buoys Airliners Further The International Air Transport Association now expects profits in the aviation industry to touch $36.3 billion in 2016 with a net profit margin of 5.1%. IATA also projects profits of around $33 billion in 2015 with net profit margin of 4.6%, marking an improvement from the previous guidance of $29.3 billion, which was released in June 2015. Christmas holidays and summer vacations will contribute to traffic. IATA projects 6.7% and 6.9% growth in air traffic in 2015 and 2016, respectively, with load factor or percentage of seats filled by passengers pegged at 80.7%. IATA also believes that 3.8 billion passengers will travel in 2016. Moreover, increased fleet restructuring programs, retiring older and less efficient aircraft and new aircraft orders are anticipated to enhance the performance level of the company by trimming fuel and operating costs, and rendering a comfortable flying experience. Moreover, most carriers are focused on augmenting ancillary revenues by launching value-added services at affordable rates. Funds In Need of a Turnaround Although there is no airline-specific mutual fund category, the space represents a substantial portion of the transportation sector. Mutual funds from the transportation sector with significant focus on airliners are the ones to watch out for. Not all of them may be carrying a favorable rank right now, but the positives are much needed to turn the tide for them. Fidelity Select Transportation (MUTF: FSRFX ) seeks growth of capital. FSRFX invests the majority of its assets in common stocks of firms mostly involved in providing transportation services or ones that design, manufacture and sell transportation equipment. FSRFX is the only fund that carries a Zacks Mutual Fund Rank #2 (Buy). FSRFX has not been able to stay in the green in recent times, as its year to date and 1-year returns are -16.7% and -13.7%, respectively. The 3- and 5-year annualized returns are, however, respectively 19.2% and 11.8%. Annual expense ratio of 0.81% is lower than the category average of 1.14%. FSRFX carries no sales load. Among the top 10 holdings, FSRFX holds airline companies such as Southwest Airlines, American Airlines Group Inc (NASDAQ: AAL ) and Delta Air Lines Inc. (NYSE: DAL ). Rydex Transportation Fund Investor (MUTF: RYPIX ) invests a large chunk of its assets in domestically traded companies from the transportation sector and in other securities including futures contracts and options. RYPIX may allocate a notable portion of its assets in companies having market capitalization within the range of small to medium size. RYPIX may also invest in ADRs in order to gain exposure to non-US companies and may also invest in US government securities. RYPIX currently carries a Zacks Mutual Fund Rank #4 (Sell). The year to date and 1-year losses of RYPIX are 12.4% and 8.6%, respectively. The 3- and 5-year annualized gains are 19.4% and 11%, respectively. Annual expense ratio of 1.35% is higher than the category average of 1.14%. RYPIX carries no sales load. Among the top 10 holdings, RYPIX holds airline companies such as Delta Air Lines, Southwest Airlines and American Airlines Group. Fidelity Select Air Transportation Portfolio (MUTF: FSAIX ) seeks long-term capital growth. FSAIX invests the major portion of its assets in companies primarily engaged in providing air transport services all over the world. FSAIX focuses on acquiring common stocks of companies depending on factors such as financial strength and economic condition. FSAIX currently carries a Zacks Mutual Fund Rank #4 (Sell). The year to date and 1-year losses of FSAIX are 6.5% and 3.2%, respectively. The 3- and 5-year annualized gains are 23.1% and 15%, respectively. Annual expense ratio of 0.83% is lower than the category average of 1.14%. FSAIX carries no sales load. Among the top 10 holdings, FSAIX has airline companies such as Southwest Airlines, American Airlines Group, Delta Air Lines and Spirit AeroSystems Holdings (NYSE: SPR ), which is one of the largest independent suppliers of commercial airplane assemblies and components. Original Post

Follow Free Cash Flow Not EPS

Summary Momentum in earnings is a simple and effective investment idea. A company’s profitability can be described by EPS and FCFPS. Momentum in FCFPS lets investors select stocks with higher potential return than momentum in EPS. Momentum in earnings is a fairly popular criterion for selecting companies that could potentially be a good investment. The idea behind this is very simple, but also quite sound. Steadily increasing profits over a long period of time indicate that this trend is likely to continue in the future. Moreover, if profits grow at a consistent pace, it is also safe to also assume that the company will be doing well in the future. When investors talk about momentum in earnings, they are usually referring to EPS momentum – that is, companies that have a steadily increasing EPS over a long period of time. But another indicator that investors should pay attention to is Free Cash Flow per Share (FCFPS). The thing is that Free Cash Flow is seen by many investors as a metric that reflects real company profits more accurately than Net Income. This, first and foremost, is due to the difference in the way CAPEX is factored into these two indicators. We will try to figure out which momentum in which factor EPS or FCFPS lets investors select companies with the highest potential return. In order to do this, we are going to look at two portfolios. One will be based on EPS and the other on FCFPS. We are going to look at 1,500 largest US companies traded on the US stock exchange from 01/01/2008 until the present. We are going to look at EPS and FCFPS growth over the past twenty quarters (five years). The indicators are TTM. This way, we are going to get YoY EPS and FCFPS growth for every quarter. For the first portfolio, we want to select companies with stable EPS growth. Thus, we are going to select companies that post EPS growth at least 17 times over the past 20 quarters. We will accept that a company can post EPS losses no more than three times, since profit is an indicator that can be affected by temporary negative factors, which will not necessarily be reflected in future earnings growth dynamics. For the second portfolio, we are interested in companies with stable FCFPS growth. We are going to select companies that have posted FCFPS growth for at least 14 out of the past 20 quarters. The reasoning behind this is similar to the EPS-based portfolios, but the requirements are less strict because Free Cash Flow is by nature a lot more volatile than Net Income – it is directly affected by CAPEX and Working Capital changes, which are smoothed in Net Income. We are not interested in companies that posted drops in EPS and FCFPS over the given time period. In spite of the strict criteria outlined above, this is still possible if a company’s EPS and FCFPS decreased so much during a particular quarter that it was unable to recover afterward. Moreover, in order to make sure that the growth trend is not over, one of our criteria is going to be that the current EPS and FCFPS values are the highest for the given period. A lot of companies will match the criteria we have outlined. We need to focus on those who have posted the most stable EPS and FCFPS growth. In order to measure stability, we can use the EPS Growth Sharpe Ratio and FCFPS Growth Sharpe Ratio – the higher these values are, the more stable growth in EPS and FCFPS is for a given company. EPS Growth Sharpe Ratio is calculated as the ratio of average EPS growth for a given period (20 quarters) and the standard deviation of this growth. The Sharpe Ratio for FCFPS is calculated in the same way. In order to make sure that our portfolio contains securities that are posting consistent growth, we are going to select the top 40 securities by EPS Growth Sharpe Ratio and FCFPS Growth Sharpe Ratio that have made it through the previous filters. The market usually recognizes and values companies that post stable EPS or FCFPS growth over a long period of time. This is why these companies can rarely be purchased at an attractive price in terms of Valuation. Since our goal entails not only selecting stocks according to EPS or FCFPS momentum, but also evaluating which indicator can bring in more profits, we need to select securities that are moderately priced relative to EPS and FCFPS respectively. In the first portfolio, we will leave only securities with a maximum P/E ratio value of 25. In the second portfolio, we will leave securities with a maximum P/FCFPS ratio value of 25. Thus, we are getting rid of securities that are obviously overvalued. We are looking at quarterly data, so it would make sense for us to rebalance our portfolios every quarter in order to have the most relevant selection of securities. The graph below shows the comparison between the two portfolios we have described. (click to enlarge) FCFPS Portfolio performs way better than EPS Portfolio. Only in 2011 EPS Portfolio had higher return than FCFPS Portfolio. This result confirms that momentum in FCFPS is more prominent driver of stock returns than momentum in EPS. We already mentioned the possible explanation to such a result. Free Cash Flow reflects cash that was generated by the company in the recent period, whereas Net Income doesn’t include present investments but include past investments as Depreciation and Amortization. Current list of stocks in FCFPS Portfolio is the following. Apple Inc. (NASDAQ: AAPL ), AutoZone (NYSE: AZO ), CB Richard Ellis Group (NYSE: CBG ), Deluxe Corporation (NYSE: DLX ), F5 Networks (NASDAQ: FFIV ), Jazz Pharmaceuticals (NASDAQ: JAZZ ), Jack Henry & Associates (NASDAQ: JKHY ), Kennametal Inc. (NYSE: KMT ), Mednax (NYSE: MD ), The Middley Corporation (NASDAQ: MIDD ), Mettler Toledo International Inc. (NYSE: MTD ), NeuStar (NYSE: NSR ), Priceline Group Inc. (NASDAQ: PCLN ), Red Hat Inc. (NYSE: RHT ), Roper Technologies (NYSE: ROP ), Sirius XM Holdings Inc. (NASDAQ: SIRI ), Scripps Networks Interactive (NYSE: SNI ), SolarWinds (NYSE: SWI ), Universal Health Services Inc. (NYSE: UHS ), USANA Health Sciences Inc. (NYSE: USNA ), United Therapeutics Corporation (NASDAQ: UTHR ). Current list of stocks in EPS Portfolio is the following. Ametek Inc. (NYSE: AME ), AutoNation Inc. (NYSE: AN ), AutoZone , Biogen Inc. (NASDAQ: BIIB ), The Walt Disney Company (NYSE: DIS ), Fastenal Company (NASDAQ: FAST ), Home Depot (NYSE: HD ), Henry Schein (NASDAQ: HSIC ), J. B. Hunt Transport Services (NASDAQ: JBHT ), LKQ Corporation (NASDAQ: LKQ ), Mednax , 3M Company (NYSE: MMM ), Mettler Toledo International Inc. , Old Dominion Freight Line (NASDAQ: ODFL ), Omnicom Group Inc. (NYSE: OMC ), Penske Automotive Group (NYSE: PAG ), Paychex (NASDAQ: PAYX ), Polaris Industries Inc. (NYSE: PII ), Portfolio Recovery Associates (NASDAQ: PRAA ), Robert Half International Inc. (NYSE: RHI ), Roper Technologies , Ross Stores (NASDAQ: ROST ), Signature Bank (NASDAQ: SBNY ), Snap-On Inc. (NYSE: SNA ), T. Rowe Price Group (NASDAQ: TROW ), Wabtec Corporate (NYSE: WAB ), Whole Foods Market (NASDAQ: WFM ). It is noteworthy that some stocks are present both in FCFPS and EPS Portfolios. These are AZO, MD, MTD and ROP. These companies had the most consistent growth both of EPS and FCFPS. Conclusion. Momentum in earnings is a simple and effective investment idea. Companies that posted profit increases in the past have good potential for growth in the future. A company’s profitability can be described by EPS and FCFPS. The test we conducted shows that the combination of a steadily growing FCFPS and moderate Valuation by P/FCFPS allows is to select securities with higher potential profitability than the combination of a steadily growing EPS and moderate Valuation by P/E.