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Stocks Are Like Hamburgers: Be Bullish When Prices Go Down

Companies that buy back shares favor declines. So do bargain-hunters like Warren Buffett. Sellers should prefer price increases. The recent stock market decline was certainly disheartening for many investors, such as those needing to sell positions in order to fund retirement living expenses. Others, especially those building up a portfolio, or companies buying back shares, and with an eye out for the long term, reacted more gleefully. Why is it bad for some, and good for others, when the market goes south occasionally? Part of the answer can be gleaned from a 1997 letter written by Berkshire Hathaway ( BRK.A , BRK.B ) Chairman Warren Buffett: But now for the final exam: If you expect to be a net saver during the next five years, should you hope for a higher or lower stock market during that period? Many investors get this one wrong. Even though they are going to be net buyers of stocks for many years to come, they are elated when stock prices rise and depressed when they fall. In effect, they rejoice because prices have increased for the ‘hamburgers’ they will soon be buying. This reaction makes no sense. Only those who will be sellers of equities in the near future should be happy at seeing stocks rise. Prospective purchasers should much prefer sinking prices. Buffett roots for stocks to fall when he, or the company, is buying. The Oracle of Omaha owns a $12B chunk of International Business Machines (NYSE: IBM ), a company with a long history of buying back its own stock, which among other things makes the remaining shares more valuable. And occasionally he will add to his own holdings when he feels the time is right. Recently Berkshire increased its position in Phillips 66 (NYSE: PSX ). IBM is blue The Armonk, N.Y.-based IBM reduced its share count by 10% over the last two years, and by a fifth over the past half decade. However, by its own admission Big Blue is in a funk and has been unable to grow revenue and net income over the past few years. The company has been able to boost EPS only through the use of buybacks and other financial moves. The stock has dropped by 20% over the last two years. Management, led by CEO Virginia Rometty, is trying to right the ship and reinvent itself like it did after getting out of the PC business years ago. Today it is making bets in the fast growing cloud computing industry and with Big Data technology. IBM created a separate division for its Watson supercomputer and the Jeopardy! game show champion has found applications in the healthcare industry. In another potential lucrative move the company recently hooked-up with Apple, Inc. (NASDAQ: AAPL ) in a deal in which IBM will sell Apple products to its corporate clients. An investment in IBM could pay off for patient shareholders, like Buffett, willing to hold on for a long period of time. Indirectly, Berkshire investors can also expect a nice return. No oil shock here Not all of the players in the oil patch are in trouble. One niche, the refinery industry, has not been affected as much as the upstream and midstream segments of the business. And as the U.S. economy continues to improve demand for gasoline, diesel, and other refined fuels will probably increase and provide an opportunity for growth going forward. Phillips 66 is positioned well to benefit from the trends. Berkshire took advantage of a slight drop in Phillips 66 stock over the past year and increased its position to about $5B, including two purchases totaling about 3M shares over the past 10 days. After the recent, albeit small, pullback and with a price to book of 2.0, shares are reasonably priced at about 12x forward earnings estimates. A yield of 2.6% and payout ratio less than 30% might be attractive to investors needing a bit of extra income. Other financials, such as a debt to equity ratio of 39%, indicate that things are going well at Phillips. All things considered this might be a good entry point for any investor, not just Buffett. Conclusion Stocks are like hamburgers. Whether it is a company like International Business Machines wanting to reduce share count or an investor like Warren Buffett on the prowl for solid companies like Phillips 66 buying makes more sense at lower prices. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) 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.

Paying A Premium For Water

Summary Aqua America provides an essential business that churns out profits year after year. In 2005, investors were willing to pay an extraordinary premium for the company. This article details what occurred as a result of this valuation, along with some takeaways that can be gleaned. Roughly, 3 million people living in Pennsylvania, Ohio, North Carolina, Illinois, Texas, New Jersey, Indiana and Virginia likely know Aqua America (NYSE: WTR ) as their water utility. Income investors probably recognize the company by its dividend program: having paid consecutive quarterly dividends for 70 years and increased this payout for 24 years. Of course, to generate these payments you need a solid underlying business to fuel the payout growth. To this point, the company has been quite consistent – increasing earnings per share in nine of the last 10 years – and earning reasonable returns on shareholder capital. Of course, this is more or less to be expected. When you sell a good everyone desires and deems essential, it follows that even with regulation, you stand to make a profit. Comparing the major components of Aqua America over the years can better illuminate this strong history along with how investors have valued the company. Business performance is one thing, but investment results can be altogether different. Revenue By the end of 2005, Aqua America was generating nearly $500 million in revenue. Nine years later, that amount had grown to $780 million, or a compound annual growth rate of about 5.1% per annum. This represents reasonable, albeit not astounding growth. Earnings Based on the $500 million in revenue during 2005, the company earned about $91 million for a net profit margin of roughly 18%. By 2014, this margin had climbed to over 27%, resulting in total earnings of nearly $214 million. On an average compound basis, this represents 9.9% yearly growth. This is a bit more impressive. Naturally, the repeatability might be a bit more difficult – you can’t grow margins forever – but it nonetheless provided a nice boost during this time frame. Earnings Per Share If the number of shares outstanding remains the same over the period, total company earnings growth will be equal to earnings per share growth. Yet this situation rarely holds. Many dividend growth companies routinely retire shares over the years. Utilities tend to issue shares due to the capital-intensive nature of the business. At the end of 2005, Aqua America had about 161 million shares outstanding. By the end of 2014, this number had climbed to 179 million, or an increase of 1.1% per year. As a result, earnings per share did not grow as fast as total earnings, coming in at 8.6% per annum. Share Price This is where things get interesting (or cautious depending on your viewpoint) in reviewing the company’s history. At the end of 2005, shares of Aqua America were trading hands around $22. This represents a trailing earnings multiple of about 38. Now surely, Aqua America is a solid company with a proven track record and the ability to meaningfully grow both its business and payouts over time. Yet paying nearly 40 times for a water utility doesn’t appear especially compelling. Indeed, by the end of 2014, the share price had only climbed to $26.70, representing an earnings multiple of about 22. This is the type of thing that you have to watch out for. First, you want to find a solid business, but the next step is to determine whether or not the price paid is roughly fair. In this instance, investors saw the share price greatly underperform the business due to the initial valuation paid. Earnings per share grew by 8.6% per year, yet the share price only grew by 2.3% annually. Total Return Note that while the P/E compression was quite imposing – going from 38 to 22 – it wasn’t the difference between positive and negative. Over longer time periods, investors still would have seen positive (albeit greatly trailing) returns. Over this period, an investor would have collected about $4.30 in dividends, or roughly 20% of your beginning investment. This is a bit more impressive than it seems, it’s just that the starting price paid distorts the benefit of a solid and increasing dividend. Overall, investors would have seen annual returns of about 4% per year. Here’s a summary of the above progression: WTR Revenue Growth 5.1% Start Profit Margin 18.4% End Profit Margin 27.4% Earnings Growth 9.9% Yearly Share Count 1.1% EPS Growth 8.6% Start P/E 38 End P/E 22 Share Price Growth 2.3% % Of Divs Collected 20% Start Payout % 56% End Payout % 53% Dividend Growth 7.8% Total Returns 4.0% As noted, revenue growth was reasonable, while earnings growth was quite solid. (Although these growth rates are partially attributable to a robust acquisition strategy.) The company routinely issued shares, resulting in EPS growth of about 8.6% per year. The first few parts appear relatively normal. In knowing that a company grew earnings per share by 8% to 9% annually, you might suspect that the investment performance was strong as well. Yet this wasn’t the case. Instead, due to a high relative starting multiple, P/E compression gobbled up a lot of the potential. Business performance and investment performance were two drastically different things due to the value others were willing to pay. It’s not that the business wasn’t solid or that you didn’t keep enjoying a higher and higher dividend payment – both situations held. The cause of the disconnection was the willingness and a lack thereof in others of paying a large premium for a water utility. From this history, we can learn two important lessons. First, the price you pay is naturally important – no different than in the grocery store or at the gas pump. If you’re looking for your investment to track business results, you need the beginning and end multiple to be about the same. It’s hard to make a prudent expectation that a company with single-digit growth ought to routinely trade at 30 or 40 times earnings. This focus on value is important. You don’t have to be perfect, but it helps to be aware. From 2002 to 2014, Aqua America grew earnings by about 8.9% per year – quite similar to the 2005 through 2014 period. The difference was the relative valuation at the time. At the end of 2002, shares were trading around 23 times earnings. As a result, investors saw the share price increase by about 8.6% annually during this period – far greater than the period covered above. The price you pay has a lasting impact on performance. Most of the time it more or less works out, but occasionally investment performance will greatly lead or trail business performance due to investor sentiment. The second thing to take away is that the above example wasn’t the difference between positive and negative results. If you pay 38 times earnings for a company today and next year it’s trading at 22 times earnings, it’d be a reasonable bet that you’re carrying a paper “loss.” Yet over the long term, this doesn’t have to hold. Eventually a strong, profitable business will make up for “overpaying.” Granted you’re still going to trail business results, but you would nonetheless end up with positive performance results; thus the focus on wonderful businesses. Ideally, you’re looking for reasonable valuations throughout, but you can take solace in the fact that owning a collection of strong businesses can help alleviate some of your missteps along the way. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) 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.

Clean Energy Fuel – The Turnaround Has Begun

Summary CLNE has shot up 17% in a week after announcing new refueling agreements and the construction of CNG stations for a number of transit agencies. Despite the drop in oil prices, natural gas is still cheaper than diesel to operate truck fleets, which is why CLNE’s gallons delivered has increased and it is improving capacity. CLNE could see a turnaround in natural gas pricing as LNG exports from the U.S. gather steam, and this will have a positive impact on its financial performance. Clean Energy Fuels (NASDAQ: CLNE ) is in turnaround mode. Over the past week, shares of the natural gas fueling company have appreciated over 17%. A key catalyst behind this jump is Clean Energy’s announcement that it will be constructing of compressed natural gas (CNG) stations for Arlington Transit (NYSE: ART ) in Arlington County, Virginia, along with a number of other transit agencies and new contracts. In addition, Clean Energy has won more contracts in the transit segment, as I will discuss later in the article. This spike has come as a relief for investors, as Clean Energy has struggled so far this year due to weak natural gas prices. In fact, in the second quarter reported earlier this month, Clean Energy had missed Wall Street’s estimates on both earnings and revenue as its revenue dropped 11.5% year-over-year and losses widened. But, will Clean Energy be able to sustain this newly-found momentum going forward? Let’s find out. Advantage of natural gas over diesel is a catalyst The decline in natural gas prices over the past year has created pressure on Clean Energy’s financial performance. In addition, the drop in oil prices has reduced incentives for fleet owners to switch to natural gas. As a result, Clean Energy’s top and bottom lines have taken a hit. However, we should not forget that natural gas is still a cheaper alternative than diesel. This is shown in the following chart: (click to enlarge) Source: Clean Energy This is the reason why Clean Energy is encouraged to continue building its fueling network in the U.S. despite the drop in natural gas prices, as it is still cheaper than diesel. As such, in the last two quarters, Clean Energy’s NG Advantage unit has reported 10 million gallons of volume growth. Encouraged by end market demand, the company has elected to expand its station in Milton, Vermont, to add 30% more contracted capacity. In fact, this is the second significant upgrade of that station in the past year to meet increasing demand for contracted volumes. In addition, the company has signed a number of new contracts that will allow it to sustain volume growth. For instance, Clean Energy has entered into a bulk fuel sales agreement with PG&E, under which it will supply 1.5 million gallons of LNG. In light of such agreements, Clean Energy has opened 15 truck-friendly stations in 11 states in the first half of the year. Going forward, it will open another 10 stations by the end of this year, extending its network to a total of 208 truck-friendly stations across 31 states. This clearly indicates the confidence that Clean Energy has in its business, as the company believes that the price advantage of natural gas over diesel will act as a tailwind in the long run. Moreover, according to CEO Andrew Littlefair, “Despite lower oil prices, Clean Energy continues to add fueling partnerships across all our transportation markets. No matter if they are with a school district, municipality or trucking company, managers of large fleets are looking for a cleaner fuel that reliably costs less and does not have volatile price swings. Natural gas continues to meet their needs.” Improving natural gas market dynamics could be a tailwind Going forward, Clean Energy Fuels could also benefit from an expected improvement in natural gas prices. A key role in the resurgence of natural gas prices in the U.S. will be driven by LNG exports to areas such as Europe. Recently, Cheniere Energy (NYSEMKT: LNG ) announced its plan of supplying LNG to central and southeastern Europe by bringing a floating regasification tunnel to Croatia. Now, Europe is a key market for LNG exports as the EIA believes that imports of LNG into the continent will double in the next five years. This will act as a catalyst for natural gas prices in the U.S. due to a drop in inventory levels. Additionally, the initiation of LNG exports from the U.S. on a big scale will help producers benefit from higher prices abroad , as “gas sells at for $7 in Europe, and over $10 in North-East Asia, four times more expensive.” Hence, as the oversupply of natural gas in the U.S. comes down and demand increases due to switching from coal to gas-fired power plants, prices will improve. In fact, over the long run, the EIA sees natural gas prices rising at an impressive clip as shown below: (click to enlarge) Conclusion Hence, the probability that Clean Energy Fuels will be able to sustain its momentum in the long run appears to be strong. Natural gas enjoys an advantage over diesel in terms of cost and emissions, which is why Clean Energy is seeing an increase in demand for the fuel. As such, investors should consider staying invested in Clean Energy Fuels as it can continue delivering upside in the long run. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) 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.