Tag Archives: earnings-center

China’s A Shares: My Biggest Bet In 67 Years Of Investing

I’m divesting myself of 50% of my U.S. holdings (stocks and bonds) and gently investing it all in China A shares (ASHR) in anticipation of an October 2015 upsurge. I anticipate billions of dollars flowing into China A shares in response to the IMF’s expected decision to make the Reminbi (Yuan) an official reserve currency in October. The operative words are “anticipate” and “expect”. This is NOT a slam-dunk; it’s a high-risk guesstimate. A year ago the IMF came within a whisker of approving the Reminbi to join the basket of official settlement currencies for worldwide debt settlement, bank retention, bond issuance, and credibility. In October of this year, I expect the organization to approve. Already major banks are issuing bonds and settling debts in Reminbi in anticipation. Major indexes and investment funds will pore billions into the China A shares market once the Yuan becomes internationally and easily and credibly convertible. This will occur for two reasons: first, because investors want exposure to the Reminbi in the foreign exchange market; and second, because China is liberalizing its rules to permit foreign investors to own these A shares, i.e. shares denominated in Reminibi. Asia, China, small-cap and development funds have been waiting years for this opportunity to buy the shares of Chinese companies in the currency of the country. And the funds that will be used to make all these new Reminbi investments in China will in large part come out of U.S. dollar investments, just as mine are. Meanwhile, the A share market itself has become particularly enticing of late. The off-putting “bubble” so bemoaned by the talking heads and the financial press has burst, with China’s indexes falling more than 10% since the start of June. That’s officially a correction. Last Friday the Shanghai Composite ended down 6.4% for a single week, with the Shenzhen close behind with a drop of 6%. This week there appears to be a stop to the falling knife: it appears to me the point to gently begin to buy A shares. As a consequence, I expect the China A share market to stabilize between now and October, at which point I anticipate the Reminbi (the Yuan) to rise significantly against the U.S. Dollar, and the A shares market to make real headway. But, as I pointed out, all of this is predicated upon “anticipate”, “expect”….and, I would add, “hope”. Follow my line of thinking at your own risk! But I must say I’ve never bet half the farm before on a single position in my 67 years of investing. I plan to hold this position until January, when I will begin transitioning back into the U.S. market, retaking the same positions I now hold (hopefully in larger measure) as I expect a strong 2016 for the U.S and U.S. stocks. I shall avoid U.S. bonds altogether, as a slough of despond. I doubt that I will hold any of my A shares beyond the October of 2016. Divesting myself of 50% of my U.S. liquid assets is a rash move, clearly not for the faint of heart. At the age of 75 I’m bored with the micromanagement of incrementalist investing. To me, this move looks like a one-time shot at an interesting risk with a limited downside. I simply do not foresee the implosion of the Chinese economy coming about in the next 18 months. After all, we trained their economists! But to say that this trade is not for the faint of heart is inadequate. Don’t put a dime into it that you are not willing — and comfortable — to lose. It’s just that straight forward. And just that much fun. Disclosure: I am/we are long ASHR. (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. Additional disclosure: I am unable to activate the SEEKING ALPHA template to accept ASHR as a ticker.

Drivers Of ROE In The Context Of Portfolio Management

Someone on the Corner of Berkshire and Fairfax message board recently posted this comment referencing Buffett’s well-known piece on inflation from 1977 . In the article, Buffett describes the variables that drive a company’s return on equity. There are only five ways that a company can improve returns: Increase turnover Cheaper leverage (reduce interest charges) More leverage (increase the amount of assets relative to a given level of equity) Lower income taxes Wider margins Notice three of the five drivers of ROE have to do with taxes and leverage. So the pretax returns (as opposed to capital structure variations) are really driven by just asset turnover and profit margins. Some executives at the DuPont Corporation (NYSE: DD ) also noticed these drivers in the 1920s when analyzing their company’s financial performance. They broadly categorized the drivers as turnover, margins, and leverage. For now, I want to leave leverage out of it and think about turnover and margins. Portfolio Turnover I wrote a post a while back discussing the misunderstood concept of turnover in the context of portfolio management. Specifically, the topic of realizing gains (and paying those dreaded taxes). Basically, the idea of short-term capital gains is taboo among many value investors. I think it’s very important to try and be as efficient as possible with taxes. However, I think that tax consideration is only one of the (not the only) factors to consider. We could take Buffett’s five inputs that increase or decrease a company’s ROE and apply them to the portfolio. Basically, as investors, we are running our portfolio just like a business . We have a certain level of equity in the portfolio, and we are trying to achieve a high return on that equity over time. The exact same factors that Buffett talks about above apply to our portfolio. Those five factors are the inputs that will increase or decrease our portfolio ROE (aka CAGR) over time. Notice that taxes is one of the (but not the only) factors. Turnover is also one of the (but not the only) factors. Michael Masters is not a value investor, but he runs a fund that has produced fabulous returns over the past 20 years or so (from what I’ve read, north of 40% annually). You can read about him in the book Stock Market Wizards by Jack Schwager . Now, I don’t understand his specific strategy, and I’m not suggesting it’s one that should be cloned, or copied, etc… I’m just focusing on the turnover concept here. Masters, according to the interview, runs a strategy focused on fundamental catalysts, and holds stocks an average of 2-4 weeks. When he was running a smaller amount of money, he was compounding at 80%+ per year. Of course, he was paying a lot of taxes. His investors – the ones in the highest tax bracket – might be “only” netting 40% or so after tax. But who would be upset with paying a lot of taxes if it means achieving a 40% return on the equity in your capital account? Obviously an extreme example, but the concept illustrates the point that just because you hold stocks for years and years and pay very low taxes doesn’t mean that your after tax ROE will be any better than an investor who pays a lot of tax and achieves a much higher pretax return. I think it’s very difficult to compound capital at 20% or more without some amount of turnover in the portfolio. This doesn’t mean I’m promoting higher levels of activity. I’m not. I think making fewer decisions is often better, and trying to do too many things is very often counterproductive. I’m just saying that the math suggests that some level of turnover is needed if your goal is to compound capital at north of 20% over time. This is one of the reasons I love bargains and deep value special situations in addition to the compounders. As I’ve said before, very few companies compound their equity and earnings at 20% or more over years and years. Those that do often are priced expensively in the market. But to achieve portfolio returns of 20% without paying taxes, you’d have to not only properly identify these companies in advance, but you’d have to have the foresight to invest your entire portfolio in them. How Did Buffett and Munger Achieve Their Results? It’s a difficult proposition to be able to seek out in advance the truly great compounders that will compound at 20%+ for a decade or more, and that’s why investors who focus on bargains and special situations often are the ones with the extreme performance numbers (like Buffett doing 50% annual returns in the 50s, Greenblatt doing 40% annual returns in the 80s and 90s, etc…). It’s unlikely to do 20% annual returns by buying and holding great businesses for a decade without selling. It’s basically impossible to do 30%+ without ever selling. Charlie Munger has promoted the idea of low turnover – and I think his reasoning (as usual) is very sound, but I think he was using the Washington Post as an example – and I think that might be (dare I say) somewhat biased in hindsight. But if you’re looking for decent after tax returns, he’s right. If you can find a company that compounds at 13% per year for 30 years, you’re going to achieve good after tax returns on your capital. But, I think finding the Washington Posts of the world are easier said than done in hindsight, especially when thinking about a 30-year time horizon. Another example I’ve discussed before is Disney (NYSE: DIS ). Buffett bought Disney for $0.31 per share and sold a year later for a 50% gain in the mid-60s. He laments that decision as a poor one, but in fact his equity has compounded at a faster rate than Disney’s stock over time, making his decision to sell out for $0.50 a good one. And that is an extreme example using probably one of the top 10 compounders of all time. Not every stock is a Disney, thus making the decision to sell at fair value after a big gain in a year or two much more likely to be the correct one. Back to Munger’s Washington Post example… I like to consider his audience. I don’t necessarily think he was saying this is the highest way to achieve attractive investment results. My guess is he was trying to convey the importance of long-term thinking and lower turnover. However, when Munger ran his partnership, he was trying to compound at very high rates, and for years did 30% annual returns. He didn’t do this by buying and socking away companies like the Washington Post. He may have had a few ideas like that, but he was a concentrated special situation investor who was willing to look at all kinds of mispriced ideas. Buffett/Munger of Old vs. New I think there is a disconnect between the Buffett/Munger of old, and the Buffett/Munger of today. Their strategies have obviously changed, and their thinking has evolved. But their best returns were in the early years when they could take advantage of the (often irrational) pricing that Mr. Market offered. They were partners with the often moody Mr. Market back then and they took advantage of his mood swings. When they came into the office and Mr. Market was downtrodden, they’d buy from him. And on the days when Mr. Market was excited and overly optimistic, they’d sell to him. Their bargain hunting days provided them and their investors with 20-30% annual returns. They made a lot of money. They paid a lot of taxes. As they compounded capital, they began to evolve. Buffett and Munger both have discussed this, but they both have said with smaller amounts of capital, they’d invest very differently. Buffett bought baskets of Korean stocks in his personal account in 2005 when some were trading at 2 times earnings with net cash on the balance sheet. He’s also done arbitrage situations, REIT conversions, and other things in his personal account that provided attractive, low-risk returns (and very high annualized CAGRs). By the way, this is not an indictment against compounders. As I’ve mentioned before, my investments tend to fall into one of two broad categories: compounders and special situations/bargains. I actually enjoy investing in compounders the most, since they do the work for you. But bargains are the ones that often get more glaringly mispriced for a variety of reasons (not the least of which is the fact that the compounders are great businesses – and everyone knows they are great). But I don’t have a dogmatic approach to investing, and I will look for value wherever I can find it. I’m not sure if this post really has a hard conclusion and maybe this is more of a ramble than anything else. I’m not sure how to sum it up, so I’ll just stop here. These are just observations I have had, and the COBF post on Buffett’s 1977 piece ( which is a great piece to read if you haven’t ) prompted some of these thoughts which I decided to write down and share. I think it’s important to understand the drivers of investment results (portfolio returns on equity) are the exact same factors that drive the ROE of a business. Feel free to add to the discussion if you’d like. Have a great week, and for the golf fans, enjoy the US Open.

Growth And Upside Potential Highlight American Electric Power’s Bullish Credentials Going Forward

Summary Company has encouraging fundamental outlook due to increased efforts on getting a broader regulated asset base. Continuous investments in regulated operations such as transmission business give it huge opportunity for future rate base growth. AEP’s on-track cost containment plan will better its future earnings growth prospects. I have a bullish stance on American Electric Power (NYSE: AEP ); the company’s focus on getting a broader, regulated asset base and its escalated growth investments in the transmission business will better its long-term growth trajectory. In addition, the resolution of the company’s previously filled rate cases with West Virginia and Kentucky by the end of this month will strengthen its future top-line and cash flows. Owing to the attractive outlook of AEP’s future cash flows, I believe its dividend payment will remain attractive for investors. Moreover, the company’s on-track cost savings plan, “Lean deployment”, will continue improving its bottom-line. Furthermore, my price target calculation suggests a potential upside of approximately 25% for AEP. AEP’s Strategic Growth Drivers Remain Intact In the recent past, increased focus on infrastructure development investment by utilities has been positively affecting the industry fundamentals and performance. For 1Q’15, the earnings growth of the U.S. Utility Industry was 8.4% , well above the S&P-500’s growth of only 2.4% year-on-year. As far as AEP is concerned, the company has made great strides in becoming a high-quality regulated utility, with improved execution and better management of its intelligent strategic growth efforts. One of the most important strategic growth drivers, increased focus on regulated asset base, has been helping its financials grow at a decent pace. In fact, AEP’s management has reiterated their intentions to sell the company’s unregulated business under its plan of growing its regulated utility business; the decision is on hold until state regulators make a final decision about the company’s proposal regarding state subsidized purchase power agreement that will help it maintain 3,100MW of coal-fired capacity. AEP has requested regulators make the final decision regarding this matter, at least by October ’15. The prevailing uncertainty around the acceptance of the PPA agreement and the recent industry merchant divestitures make me believe that the company will either sell or spinoff its Ohio-based power generating subsidiary and the proceeds from the sale would be reinvested to support its growth-generating regulated transmission business. In fact, one of its former competitors, Dynegy, is interested in buying AEP’s unregulated assets. Since the transmission business is one of the most promising businesses of AEP, I believe reinvesting cash proceeds from the unregulated business sale in the transmission business will strengthen its long-term growth potentials. Moreover, the sale of Ohio plants (unregulated assets) will support its strategic move, which is away from de-regulated operations to regulated ones. In fact, the company has several multibillion-dollar projects in place for the next five-to-ten years, in order to grow its regulated asset base by improving the operational performance of its transmission business. Currently, AEP stands tall in the U.S. utility business with its major stake in several advanced transmission projects, and moving ahead, further increases in transmission project-related investments will improve its fundamentals. As part of its long-term growth plan, AEP has announced hefty investment of almost $4.8 billion in transmission projects from 2015 to 2017; I believe that these up-scaled investments in the transmission business will help the company’s rate base expand, which will increase its future cash flows and ROE. Moreover, increase in its earned returns will better AEP’s EPS growth. Furthermore, the company’s previously filed rate cases in West Virginia and Kentucky are expected to gain approval at the end of this month. AEP has requested a $227 million rate increase in West Virginia and a $70 million rate increase in Kentucky, which will allegedly go into effect on 1st July 2015. I believe that these recent rate hikes will portend well for raising the level of earned returns for the company and will add towards the certainty of its cash flow base success in the years ahead. On the bottom-line, AEP’s multi-year cost saving plan “Lean deployment” is working really well to get it a leaner cost base. Thus far, the company has completed the implementation of lean deployment at 13 distribution districts, whereas work at almost 19 more is still in process. Moreover, on the transmission business side, AEP has completed work on just one area and four more are scheduled for completion, this year. Given the fact that the implementation of lean deployment is keeping the company’s operational and management (O&M) expense down, I believe with the ongoing execution, cost efficiency gains from the lean deployment plan will keep on improving AEP’s earnings growth level. Safe & Sustainable Returns AEP’s strong growth prospects have been helping its cash flows grow and support its management’s dividend policy. With the increasingly healthy cash payments under its attractive dividend payment policy, the company has earned a strong five-year dividend growth rate of around 4.87%. Keeping track of its attractive dividend payment plan, AEP had recently announced another quarterly dividend payment of $0.53 , which translates into a dividend yield of 3.95% . Given the company’s strong strategic growth prospects and due to its management’s strong commitment towards paying healthy dividend payments, I believe AEP will have cash flows available to make and increase dividends in the years ahead. Guidance The company’s management has reaffirmed its guidance for 2015. AEP expects full year 2015 EPS to be in a range of $3.40-to-$3.60 . Also, it has maintained its stance about achieving long-term earnings growth in a range of 4%-to-6%. Thus far, the company has done pretty well in achieving allowed ROEs at its regulated subsidiaries; I believe its correct growth efforts and cost controls will help AEP achieve its anticipated 4%-to-6% growth rate in the years ahead. Risks The company’s future growth prospects will continue to face the risk of potential negative regulatory restrictions in its service territory. In addition, AEP’s inability to pull off well-timed, constructive regulatory rate base approvals by negotiating with FERC might pressurize its future growth prospects. Moreover, the company’s ongoing and planned development plans, if not properly executed, might burden its bottom-line with cost overruns. Furthermore, unfavorable temperature trends, environmental regulations and unforeseen negative economic changes are key risks hovering over its stock price performance. Price Target I reiterate my previously calculated price target of $69 for AEP, which was calculated using a dividend discounting method. In my price target calculations, I used cost of equity of 6% and nominal growth rate of 3%. Based on my price target, the stock offers potential price appreciation of 25%. Conclusion The company has an encouraging fundamental outlook due to its increased efforts on getting a broader regulated asset base. In fact, continuous investments in regulated operations such as the transmission business give it a huge opportunity for future rate base growth, which increases certainty about its future cash flows and earnings base. Moreover, the company’s on-track cost containment plan will better its future earnings growth prospects. As a matter of fact, the healthy future earnings growth will strengthen its cash flows, which will support its dividends. Furthermore, my price target calculations suggest a potential upside of approximately 25% for the stock. Analysts have also anticipated a healthy next five-years growth rate of 4.92% for AEP. Due to the aforementioned factors, I am bullish on AEP. 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.