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Valuation Always Matters – Especially For This Cheapskate

Summary I am a cheapskate – I like a good bargain on quality merchandise. The same principle should apply to investing – why pay premium prices if we don’t need to? It is helpful to keep an eye on the value of something – since the price we pay is completely our choice, we know we got a good deal. This article provides two midcap examples where valuation mattered: those who ignored the price-to- value relationship were probably disappointed. As someone always looking for a bargain, I offer an example of a company possibly on the sale rack right now. I will confess: I am a cheapskate. There are many of us out there. For whatever reason, we like to get the best deal possible when we buy something. Name-brand clothing? Wait for a sale (“Can you believe it – $95 bluejeans for $56!”) Toothpaste and toiletries? Stock up during the in-store sales. Quality electronics? Wait patiently for holiday sales. Estate auctions are prime hunting grounds for us cheapskates. Imagine you are at a poorly-attended auction and a name-brand, 8-seat, mint-condition oak dining room table set has no buyers above $8.75 (this really happened). Even if we are not the buyer, we know that is probably a great deal. What makes it a “great deal” to us cheapskates? We know the value of something. Then we compare the price to that value. One of the subtle nuances of value investing is to apply that same mentality and behavior to our investment choices. This is often easier said than done, because investing can seem to turn things upside down: rather than wanting lower prices, we like it when prices go up. And we may not be confident in our ability to value a company. In my view, we would become better investors if we continually explore and understand this whole price-to valuation relationship. Why? Mr. Buffett, as usual, says it well: “The critical investment factor is determining the intrinsic value of a business and paying a fair or bargain price.” Objective The point of this article is to suggest that we can and should apply our same frugal mentality to our investing decisions. And this discussion assumes that historical facts on any company could serve as one piece of our investing decision-making. To support that view, two midcap companies will be offered as examples where valuation mattered over time–those who bought well above normal valuations were disappointed, and those who acted when the price fell below valuation were rewarded. Lastly I will offer an example of a company likely on the discount rack at current levels. Valuation Matters, Example 1: CEB, Inc. $2.5 billion company CEB Inc., provides ”best practices” research and analysis, focusing on corporate strategy, operations, and human resources issues. With a long-term, normal PE around 37, it is never really cheap by absolute standards. But a closer look at the company’s own history gives us a good guide toward periods where the price seemed overvalued or undervalued. Have a look at the graph below, courtesy of my F.A.S.T. Graphs subscription. Please note the orange line represents a valuation tied to the earnings per share growth rate. And also note that the blue line represents the company’s own PE over time. The black line is the market price line. You’ll see the period from 2006 to 2009 highlighted first. Note that investors who bought when the PE was well above the company’s own norms were in for sharp disappointment until the bottom in 2009. From a price to valuation perspective, in 2006 as CEB was running well above its own historical norms. In addition, a year-by-year review of high and low PE’s the company actually experienced would suggest that shares were not on sale around that time. If viewing investment decisions from a frugal, “cheapskate” perspective, the period of overvaluation would not have been enticing to bargain hunters. (click to enlarge) Historical Graph – Copyright 2015, F.A.S.T. Graphs – All Rights Reserved The picture in 2009-2010 following the Great Recession was a different story. In that period CEB was offered at a discount to its normalized valuation. Thrifty buyers paying attention to valuation may likely have recognized this period as an opportunity to buy as part of a “storewide sale” in the stock-market. Investors at that time have probably been satisfied with the purchase. (click to enlarge) Historical Graph – Copyright 2015, F.A.S.T. Graphs – All Rights Reserved Valuation Matters, Example 2: Brown & Brown, Inc. (NYSE: BRO ) $4.5B company Brown & Brown, Inc. ( BRO ) offers another example where the price to valuation situation mattered to investors. Brown & Brown operates an insurance brokerage firm that markets property/casualty products and services to commercial,professional, and individual customers. F.A.S.T. Graphs again offers a useful picture. Note in this example the orange line represents a possible valuation based on an earnings multiple of 15X, the blue line is the company normalized PE ratio over time, and the black line is the market price. Please take a look at the period beginning in 2006. In that period, we bargain-hunters would notice that the PE ratio was well above norms for this company. Those who bought near those peak levels had to watch the decline during the Great Recession and thereafter and didn’t experience a bottom until 4 years later. While in this case even those who bought in 2004 or so would have been impacted, an eye on excessive valuations may have limited the damage to those buyers. (click to enlarge) Historical Graph – Copyright 2015, F.A.S.T. Graphs – All Rights Reserved Fast forward to 2011 when it again appeared BRO was being offered at discount levels. The PE had sold off to well below historical norms and yet earnings forecasts for this quality company were intact. Those willing to wait for sale prices have probably been satisfied with the returns since that time. (click to enlarge) A Company Possibly On Sale: Bed, Bath & Beyond (NASDAQ: BBBY ) The previous two examples were offered as examples where a look at relative valuation to price may have been helpful. But those were looks at history. Looking forward and applying the cheapskate mentality, it is possible that BBBY is on the discount rack right now. At around $57 BBBY is near its 52-week lows and has been sold off to a point where it merits close review. First, Let’s Make Sure BBBY is Quality Merchandise The idea is to buy quality merchandise on sale, not the low-quality stuff. In my view, BBBY qualifies as a quality company based on, among other factors, its historical growth in per share book value, earnings, and revenue. This F.A.S.T. Graphs snapshot captures the trend graphically: (click to enlarge) Historical Graph – Copyright 2015, F.A.S.T. Graphs – All Rights Reserved Why Are Shares On Sale? BBBY sales have been a bit slower than desired, and the retail environment has been challenging. That and the entire retail sector has seen selling lately. The company itself, however, is taking steps to increase sales and has authorized a share buyback program which is favorable. Here’s Where Valuation Matters Again a F.A.S.T. Graphs summary is a useful tool. My read is that BBBY has done a very effective job of growing earnings and valuation over time (orange line). Recall the blue line represents a normal PE and the black line is price. Over a 20-year time frame the normal PE for this company is 23.6X. And note there have been times (2002-2004) when the company is actually priced at a premium and not as attractive to us frugal types. But the situation today is different: the current PE is around 12X earnings. At these levels, with solid fundamentals and earnings expected to grow, this appears to be a case where the price is now attractive. This is visible when viewing the relationship between the price I pay (which I can control) and the valuation – which includes lots of external forces I cannot control. Interestingly, as a side note, I suspect the recent range-bound price action means there is uncertainty in the market. As a patient investor, that’s no worry as long as I am confident in the quality of the merchandise: I realize I sometimes need to wait for the value to be recognized later. (click to enlarge) Historical Graph – Copyright 2015, F.A.S.T. Graphs – All Rights Reserved Recap I have noticed that it is fairly easy being a cheapskate for day-to-day life purchases: waiting for a good sale or refusing to purchase something at unreasonable prices comes fairly easily when it comes consumer goods or even larger purchases like cars and homes. It seems easier to recognize value. But often that mentality gets turned upside down when investing. The focus is price – and we always want that price to go up. The point of this article was to suggest that we can and should apply our same frugal mentality to our investing decisions. To support that view, two midcap companies were offered as examples where valuation mattered over time–those who bought well above normal valuations were disappointed, and those who acted when the price fell below valuation were rewarded. Lastly I tried to outline why and how BBBY may be a company likely on the discount rack at current levels. To a cheapskate like me, that is music to my ears. As always, thank you very much for reading. All of this is in my opinion only and intended solely to add to the investing conversation so that we all benefit.

Equity CEFs: Enough Is Enough, Consider The Cohen & Steers Infrastructure Fund

Summary I realize this is a “have” market and you have to own what works but sometimes, the valuation of some CEFs become so absurd, you can’t ignore it. A number of CEFs are getting to this absurd level, including some REITs, but one fund I have owned a small position in for years I believe is especially attractive. You would be hard pressed to find an equity CEF that has had as good an NAV performance historically as the Cohen & Steers Infrastructure fund, despite a subpar year. I’m going to write this article rather quickly after yesterday’s market close since I wanted to get this out fresh today. The disgust in this market is becoming palpable as investors throw in the towel on what doesn’t work and are forced to buy what does, even at all-time highs. But there comes a point, like in the fall of 2008, when investors are flat-out wrong and making what I would consider to be emotional and short-sighted decisions. I believe we are at such an inflection point with a number of equity CEFs, but none more so than the Cohen & Steers Infrastructure fund (NYSE: UTF ) , $18.96 market price, $23.18 NAV, -18.2% discount, 8.4% current market yield . You read that right. UTF now trades at an unbelievable -18.2% discount with a market price well over $4 below its NAV. Think about this for a minute. UTF went public back in March of 2004 at a $19.10 NAV and a $20 market price (after a $0.90 sales credit per share). So after paying quarterly distributions averaging say, 6% to 7% annually, Cohen & Steers has still been able to grow UTF’s NAV from $19.10 to $23.18 today, even with some subpar years like 2015. You would be hard pressed to find any other equity CEF that has accomplished that. How strong has UTF been historically? Here is UTF’s Annual Performance figures taken from UTF’s Fact Sheet dated 9/30/2015. (click to enlarge) How many CEFs do you think have beaten the S&P 500 in both total return market price and NAV since their inception? Trust me, not many. And UTF has accomplished this as a global equity fund, including a portion of its portfolio in high yield corporate bonds and preferred securities. UTF also happens to be one of the largest CEFs at $2.8 billion in total assets so it is quite liquid. Here are UTF’s top 10 holdings as of 9/30/15. (click to enlarge) Now has UTF had a good past year? No, but I guess if you don’t own Facebook (NASDAQ: FB ) , Amazon (NASDAQ: AMZN ) , Alphabet (NASDAQ: GOOG ) (NASDAQ: GOOGL ) o r Netflix (NASDAQ: NFLX ) in your portfolio somewhere, you probably wouldn’t be having a good year either it seems. Year-to-date, UTF’s NAV is down -5.5%, but that’s hardly what I would call a disaster, especially considering what sectors UTF invests in. UTF is an infrastructure fund which means its owns mostly global stocks in the utility, communication tower, toll roads, rails and satellite sectors. Here is UTF’s sector and geographic breakdown. (click to enlarge) Obviously, UTF is invested in some areas that are under an immense amount of pressure this year, i.e. energy MLPs for example, but you’re also talking about a management team that has been in place since the fund’s inception and has weathered many storms. Barron’s also recently wrote a very positive article on two of UTF’s top positions shown above, Crown Castle International (NYSE: CCI ) and American Tower (NYSE: AMT ) , when it came out with this article on October 17th, How To Profit From The Real Estate Play In Wireless Stocks . If you can’t access the article since Barron’s is subscription based, here is a brief highlight from the article. The companies have slightly different identities. American Tower is the largest with the most international exposure, while Crown Castle has focused on U.S. urban areas. SBA is the smallest and fastest-growing. But the opportunity is the same. The stocks could each rise 20% or more in the coming 18 months, especially as investors shrug off near-term concerns and focus on the big picture. Also consider that UTF has been steadily raising its distributions over the years, most recently this past March from $0.37/share to $0.40/share and now offers an 8.4% current market yield, a healthy bonus over its very reasonable 6.9% NAV yield. Conclusion You almost have to go back to 2008 to find opportunities like this in my opinion. Now I have no crystal ball in regards to where interest rates go or if the utility, energy or “have not” sectors gets worse before they get better, but I do know that when emotions drive CEF market prices to these discount levels, your risk/reward improves dramatically if you just hold onto the fund and even add to your position on any added weakness. The Federal Reserve’s resolve to raise interest rates does not mean the end of anything and everything interest rate sensitive, though that seems to be the consensus of the markets right now, particularly in CEFs. But at some point, there will be a leveling of emotions and sanity will creep back into the market. UTF has been one of the best long term performers of all the CEFs I follow though it has historically traded at a wide discount. But that shouldn’t deter you from owning this fund as that is hardly an indication of its historic market price performance and in fact, some of the worst CEFs I follow trade at premium market prices despite having horrible market price performance. UTF’s -18.2% discount may be a valuation anomaly but it also presents an opportunity for investors to pick up one of the best windfall yield bonuses I have seen in years. In other words, the fund has only to cover a modest 6.9% NAV yield, which is a big reason why UTF has been so successful at growing its NAV over the years as a leveraged CEF, but because of the -18.2% discount, investor’s can receive a bonus 8.4% windfall market yield. Emotions are running high right now and investors, big and small, are jettisoning anything that hasn’t “worked” this year to chase what has. Though I have also been forced to adapt to this strategy, I also believe there are opportunities that can become either a “have” or “have not” as well. UTF has now become a “must have” opportunity.

Things Won’t Stay The Same

My kids keep growing up, and it continues to surprise me. One who was just learning to stay upright is now a constant chatterbox and a daredevil on her Strider bike. The other seems to have grown a foot this year, and has gone from quiet and reserved to confident ringleader of her friends. But the realization I’ve recently had is that it is so easy for us to assume the current state of affairs will perpetuate into the future. The little baby who was so happy to sit and play with a toy was suddenly gone, whether I was prepared for it or not. Someday soon, both of my girls will be in high school fighting over clothes and car keys. In the moment, that is hard to remember. Whether things are great and everyone in the house is sleeping and happy and playing nicely together or we’re up four times a night and separating a fight every twenty minutes, it is easy to believe that this is how things will always be. In behavioral finance, this effect is known as recency bias . It is our strong tendency to extrapolate recent events forward into the future. And investors do this all the time. I mean all the time . In March 2009, as the stock market was approaching generational lows, the most popular headlines and predictions were that the Dow Jones Industrial Average, having just passed below 7000, would continue to drop as low as 3000. And of course, the most famous example of recency bias is the book Dow 36,000: The New Strategy for Profiting From the Coming Rise in the Stock Market . Published near the height of the stock market in 1999, when the DJIA was just above 11,000, the book was wildly wrong. But it was a perfect example of how easy it is for us to see a pattern and project it into the future. We haven’t learned much since the 2008-2009 bear market or the late ’90s tech bubble. Oil prices seem to been in a near free fall for the past few years. So guess what is being predicted? More declines! Goldman Sachs suggested that oil prices could go to $20 a barrel in September. Of course, in 2008, Goldman Sachs also predicted that prices, then over $140 a barrel, would eventually surpass $200 a barrel. Making professional predictions is fairly easy – you take the recent changes and extrapolate them into the future. Tada! And of course, it isn’t just professionals making outlandish predictions that fall prey to recency issues. Individual investors are just as bad. Emerging markets have been dismal for the past several years. Returns have been negative so far in 2015, and emerging market stocks lost money in 3 of the last 4 calendar years. In May 2015, EM stocks started a nasty slide. By September, investors assuming that the recent past would continue indefinitely had had enough, and started pulling money out of these funds. Here’s what flows out of Vanguard’s Emerging Markets ETF looked like this year. Investors love to hear and talk about what is going on in the market “right now.” We love this idea because we assume that “right now” will continue into the future. But what is true today won’t necessarily be true tomorrow. The world is a changing place, and always has been. Don’t be fooled thinking anything else.