Tag Archives: ideas

Connecticut Water Service – A Stable Business With A Twist

Summary The company is primarily a water utility business. While the utility business is highly profitable, the return on equity is capped at around 10%. The Services and Rentals could generate significant value in the future. Connecticut Water Service (NASDAQ: CTWS ) is a utility company that focuses on water distribution. As a water utility company, the company does not have to worry about commodity fluctuations, unlike a natural gas utility company . Unfortunately, the company was not able to escape the pessimism in the market. Despite on the way to post another year of growth, the stock barely budged in 2015, fluctuating around $36. In the chart above, we can see that over the long-term, the stock tracks the company’s top-line growth. This makes a lot of sense because the company primarily runs a regulated business, so margins will be fairly consistent from year to year. More recently, the company seems to have benefited from economy of scale, as the operating margin climbed along with the growth in revenue. For any other company, this track record would suggest an extremely well-run business with the potential to generate a lot of profit. Unfortunately for investors (and fortunately for citizens), the utility business is regulated for this exact reason. The company’s two main water subsidiaries in Connecticut and Maine have a rate cap (return on equity) of 9.75% and 9.5%, respectively As you can see, ROE has fluctuated around the 10%, reflecting this cap. What this means is that the maximum growth equity investors can expect from the company’s regulated business over the long-run is around 10%. Because the company provides a critical service, I have no doubt that the company will achieve this rate of return over the long term. Of course, the company can try to apply for rate increases, but I wouldn’t count them since there is no way to know in advance whether they will be approved. While most of the revenue comes from the regulated water utility business (~90%), the company does have some non-regulated operations. On the non-regulated side, the main segment is Services and Rentals. The segment’s operation is quite diverse, ranging from typical repairs to providing emergency drinking water. While small, the company is highly profitable. Year to date, the segment’s net profit margin was 24%. This is pretty much on par with the margin of the water business (25%)! However, it would seem that the management has trouble growing it. Quarter on quarter, revenue only increased by 5%. That being said, the segment could generate significant value if the management figures out a way to scale it. While I am not seeing any promises right now, it nevertheless has good option value, after all, the segment’s services do go hand in hand with the water business. Conclusion If you are satisfied with the rate of return (~10%) over the long-term, then I think Connecticut Water Service represents a good opportunity. Due to the nature of water utility (a critical service), the company should be able to reach the rate cap over the long-run. While the non-regulated side of the business is still small, I believe that once the management finds a way to convince more water business customers to use the company’s maintenance services, there could be significant upside. Overall, I believe that the company will continue to deliver stable profits from its water business, and the non-regulated activities are an added bonus for investors.

The Average Joes Of The Dow

Summary We all know about the Dogs of the Dow. Last week I wrote about the Dow’s lowest-yielding stocks – the Gods of the Dow. The next step was to look at the middle-yielding stocks – the “Average Joes of the Dow.” See the results. In the past week I released an article, exclusively on SA, called ” The Gods of the Dow .” The main thrust of the article was to compare the performance of the 10 highest-yielding stocks of the Dow (the Dogs) against the 10 lowest-yielding stocks (what I called “the Gods”) over a decade. The Dogs won the contest by quite a margin. Here is a summary chart showing the performance of the investment strategies. The next logical step is to see how the middle 10 stocks of the Dow would perform. I call this cohort of stocks the “Average Joes of the Dow.” I am having a bit of fun running these tests, but I do believe these 3 groups – the Dogs, the Gods, and the Average Joes – act as rough proxies for value investment, growth investment and the middle ground in between. The Average Joes of the Dow Investment Strategy On December 31, buy the Dow’s 10 middle-yielding stocks. Hold these stocks for a year. Sell the 10 positions on December 31 the following year. Repeat the above process annually. Note: Stocks that are dropped from the Dow during the course of the year are still held until year-end — e.g., you would still hold AT&T through December 31, 2015, if you had purchased it December 31, 2014. Another note: The data for the test comes from the “Dogs of the Dow” website. I am not sure what would happen in the event or a merger or acquisition. A current example would be Pfizer: Allergan has proposed acquiring Pfizer in 2016. If you bought Pfizer on December 31, 2015, you would most likely sell the merged company or acquirer on December 31, 2016, but I am uncertain as to how such events were handled in this historic data set. The Dogs of the Dow Investment Strategy The same as above, but you buy the 10 highest-yielding stocks of the Dow year after year. The Questions What was the annual performance of each strategy on a total return basis? What was the overall performance of each strategy over a 10 year period? Some Sample Data The Dogs of the Dow on December 31, 2014 were: (NYSE: T ) AT&T 33.59 5.48% (NYSE: VZ ) Verizon 46.78 4.70% (NYSE: CVX ) Chevron 112.18 3.82% (NYSE: MCD ) McDonald’s 93.7 3.63% (NYSE: PFE ) Pfizer 31.15 3.60% (NYSE: GE ) General Electric 25.27 3.48% (NYSE: MRK ) Merck 56.79 3.17% (NYSE: CAT ) Caterpillar 91.53 3.06% (NYSE: XOM ) ExxonMobil 92.45 2.99% (NYSE: KO ) Coca-Cola 42.22 2.89% The Average Joes of the Dow on 31 December 2014 were: PG Procter & Gamble 91.09 2.82% IBM International Business Machines 160.44 2.74% CSCO Cisco Systems 27.82 2.73% JNJ Johnson & Johnson 104.57 2.68% MSFT Microsoft 46.45 2.67% JPM JPMorgan Chase 62.58 2.56% DD DuPont 73.94 2.54% INTC Intel 36.29 2.48% BA Boeing 129.98 2.25% WMT Wal-Mart 85.88 2.24% The Results The total returns each year of the Joes vs. the Dogs is shown in the chart below: 2005 2006 2007 2008 2009 Joes 7.65% 18% 16.60% -24.81% 26.65% Dogs -3.46% 25.80% 2.10% -36.56% 17.19% 2010 2011 2012 2013 2014 Joes 16.40% 9.25% 13.19% 33.77% 11.63% Dogs 21.43% 16.85% 8.95% 28.54% 6.45% Here’s a year-by-year comparison of the Joes Vs the Dogs in an easier-to-read graphic. The true outperformance is best explained by considering how well a $10k investment in each strategy on December 31, 2004, would have fared, as shown below: Over the 10-year period, the Joes strongly outperformed the Dogs. The Dogs strategy would have nearly double your money in 10 years, turning $10,000 into $19,320 — not bad. But the Joes strategy would have performed much better, turning $10,000 into $30,320! Conclusion First of all, I want to qualify the above analysis with the observation that it is only based on 10 years of data. As such, the Joes may have had a few exceptionally good years at the start of the decade which then exaggerates out-performance in the later years of the decade. Indeed looking at the Joes cohort from 31 December 2014, one would be concerned by some of the picks: P&G has lost 14% TR YTD IBM has lost 11% TR YTD Wal-Mart has lost 28% TR YTD But despite the above, the Average Joes has only lost 3% YTD on a total return basis. The Joes has included some good performers: MSFT has gained 20% TR YTD Boeing has gained 15.5% TR YTD JPMorgan Chase has gained 10% TR YTD The Dogs have had a better 2015 so far, with just a 1% loss. I have to say it is quite comforting to know that with such big individual losers in the Joes, that the overall loss is not too bad. I know in my own portfolio that I have had big losers this year, and it is quite easy to dwell on those underperformers. When I look at my total performance, it’s actually okay — it’s breaking even — and I need to focus on the big picture.

Valuation Dashboard: Financials – Update

Summary 4 key factors are reported across industries in the Financial sector. They give a valuation status of industries relative to their history. They give a reference for picking stocks in each industry. This is part of a monthly series of articles giving a valuation dashboard in sectors and industries. The idea is to follow up a certain number of fundamental factors for every sector, to compare them to historical averages. This article covers Financials. The choice of the fundamental ratios used in this study has been justified here and here . You can find in this article numbers that may be useful in a top-down approach. There is no analysis of individual stocks. You can refine your research reading articles by industry experts here . A link to a list of stocks to consider is provided in the conclusion. Methodology Four industry factors calculated by portfolio123 are extracted from the database: Price/Earnings (P/E), Price to sales (P/S), Price to free cash flow (P/FCF), Return on Equity (ROE). They are compared with their own historical averages “Avg”. The difference is measured in percentage for valuation ratios and in absolute for ROE, and named “D-xxx” if xxx is the factor’s name. For example, D-P/E = (AvgP/E – P/E)/AvgP/E. It can be interpreted as a percentage in under-pricing relative to a historical baseline: the higher, the better. It points to over-pricing when negative. ROE is already a percentage. A relative variation makes little sense. That’s why we take the simple difference: D-ROE = ROE – AvgROE. The industry factors are proprietary data from the platform. The calculation aims at eliminating extreme values and limiting the influence of the largest companies. These factors are not representative of capital-weighted indices. They are useful as reference values for picking stocks in an industry, not for ETF investors. Industry valuation table on 12/3/2015 The next table reports the 4 industry factors. For each factor, the next “Avg” column gives its average between January 1999 and October 2015, taken as an arbitrary reference of fair valuation. The next “D-xxx” column is the difference as explained above. So there are 3 columns for each ratio. P/E Avg D- P/E P/S Avg D- P/S P/FCF Avg D- P/FCF ROE Avg D-ROE Commercial Banks 15.85 15.24 -4.00% 3.02 2.06 -46.60% 18.45 13.44 -37.28% 8.79 8.89 -0.1 Thrifts & Mortgage Finance* 19.29 20.66 6.63% 2.92 2.03 -43.84% 21.57 14.75 -46.24% 6.08 5.02 1.06 Diversified Financial Services 23.8 17.85 -33.33% 4.41 2.94 -50.00% 18.4 16.13 -14.07% 4.78 6.38 -1.6 Consumer Finance* 10.62 13.15 19.24% 1.4 1.47 4.76% 7.11 8.22 13.50% 11.13 11.83 -0.7 Capital Markets* 16.22 18.07 10.24% 3.57 3.06 -16.67% 17.55 19.62 10.55% 8.2 7.89 0.31 Insurance 14.46 13.7 -5.55% 1.3 1.07 -21.50% 11.67 8.99 -29.81% 9.05 8.71 0.34 REITs** 34.38 35.42 2.94% 5.19 4.56 -13.82% 45.45 38.74 -17.32% 4.97 4.07 0.9 Real Estate Management** 35.72 31.19 -14.52% 3.44 3.06 -12.42% 22.08 25.55 13.58% 4.01 -1.33 5.34 * Averages since 2003 – ** Averages since 2006 Valuation The following charts give an idea of the current status of industries relative to their historical average. In all cases, the higher the better. Price/Earnings: Price/Sales: Price/Free Cash Flow: Quality (ROE) Relative Momentum The next chart compares the price action of the SPDR Select Sector ETF ( XLF ) with the SPDR S&P 500 Trust ETF (NYSEARCA: SPY ) (chart from freestockcharts.com). (click to enlarge) Conclusion The financial ETF has the same return as SPY in the last 3 months. On this period, the 5 best performing S&P 500 financial stocks are Blackrock Inc (NYSE: BLK ), Cincinnati Financial Corp (NASDAQ: CINF ), Equinix (NASDAQ: EQIX ), Plum Creek Timber Co (NYSE: PCL ) and Public Storage (NYSE: PSA ). CINF, PCL and PSA hit an all-time high this week. Some financial industries look overpriced, but all of them are above or close to their baseline in quality, with ROE in a [-1.6,+5.4] interval from the historical average. REITs have improved since last month in valuation and are stable in quality. Consumer Finance is the only industry with 3 valuation factors pointing to underpricing. For Capital Markets, 2 out of 3 are pointing to underpricing. Commercial Banks, Diversified Financial Services and Insurance are overpriced for the 3 valuation ratios. Diversified Financial Services look the less attractive industry, with all metrics in negative territory. However, there may be quality stocks at a reasonable price in any industry. To check them out, you can compare individual fundamental factors to the industry factors provided in the table. As an example, a list of stocks in Financials beating their industry factors is provided on this page . If you want to stay informed of my updates on this topic and other articles, click the “Follow” tab at the top of this article.