Tag Archives: investing

Should Apple Investors Time The Market?

Summary You’re not always dumber, or unluckier, than every other investor. Neither am I nor any other group, manager, or fund. The irregularity of market prices makes it a near certainty that we all get fooled from time to time. Remember, someone else is on the opposite side of each trade. Odds of making profitable investments, along with their rate of gains, net of losses, is what counts. One target is above market averages. Another is above your goals; that’s success. Look at Apple as an example, over the past 5 years. Can it be timed? Does it need to be? Only your goals may answer that question. Let’s be real careful about measuring results. That means preventing the cherry-picking of favorable time periods to start and end with. If we look at every day as a start, and every day as an end, that problem is largely resolved. Largely, but not entirely. The holding-period that may be involved needs to be considered, as well. And the measurement units and manner of calculation matter. When it comes to combining gains and losses in one or more holding periods, you probably are aware (hopefully not from direct experience) that a 50% gain after a 50% loss does not return an investment to its starting point. That is why geometric mean averaging must be used to resolve the computational problem properly, rather than simple arithmetic summation and averaging. The holding period problem is resolved by calculating Compound Annual Growth Rates (CAGR). What the CAGR does is to find the average growth in each unit of the holding period, and then restate those holding period “grains” into a standard 1-year whole “loaf” of performance. Because each unit grain is represented by 1+the unit’s change, those pieces can be properly reassembled into a geometric mean. The CAGR of a 3-year, 4-month, and 5-day holding period (for example) measured by its beginning and ending points, will produce the same result as a series of those 3 years, 4 months, and 5 days of single day changes geometrically compounded day by day. Then when each are annualized by taking the 1/(number of days) root of that compounding, and raising it to its 365th power, minus 1, they will show the same CAGR. So if we took the CAGRs of 13-week periods (just for example) starting daily for 9 months, we should have a near-perfect measure of the annual rate of change for the data being examined during that year. Our Example of Apple We have a computer program tool that does exactly that kind of measuring. It was written originally over 40 years ago, back when the same kinds of measurements of stock performance were also needed. Figure 1 shows the result of it being applied to the last 5 years of stock price data for Apple (NASDAQ: AAPL ). Figure 1 (click to enlarge) It uses the daily closing prices of AAPL from 11/3/10 to 11/4/15, all 1261 of them to perform CAGR price-change measurements in progressively longer holding periods of from one week (5 market days) to 16 weeks of 80 market days, indicated by the yellow column footers. The average CAGRs during the whole 5 years are shown in the blue row marked at left by the RWD:RSK cryptic ratio title of 1 : 1. It contains all 1256 starting days possible to compute the 5-day holding periods averaged in the first data column, of 22 (%). Each column in that row contains 5 fewer days of CAGRs of 5-day longer holding periods than the column to its left, out to 1176 (count not shown) examples of 80-day long periods. It is a fair conclusion to reach that AAPL stock’s average annual rate of growth during the past 5 years has been 21% ~ 22%. Our last bullet-point question in the introduction to this article above may have its answer in this blue row of Figure 1 data. If the investor’s personal objective of investing in AAPL is to outperform the market, timing the purchase and sale of AAPL stock seems not to be necessary. On the other hand, if the investor’s goal is to compete successfully with the most productive equity investment managers, a 22% rate of gain might be inadequate. If so, the other question of “Can AAPL be timed?” may be worth exploring. What evidence exists of successful AAPL timing? That evidence exists in the upper rows of Figure 1. They contain the CAGRs of those days following forecasts that are implied by the hedging actions of the market-making (“MM”) community. Actions as they sought to protect their own firm capital that was necessary to be put at risk temporarily while helping big-dollar fund-clients adjust their portfolio holdings of AAPL. Those implied forecasts contained price ranges believed possible to be encountered during the time following the volume (block) trade that necessitated each capital risk exposure and its protection. A time necessary (up to a few months) to unwind the derivatives contracts involved in providing the hedge protections. The MM beliefs producing the price ranges of the forecasts are the products of well-informed depth research of publicly-known fundamental economic, competitive, and political surroundings, plus possible advantages of personal and professional contacts among industry and corporate sources. Plus appraisals of current market influences from other interested investors seen by “order flow” among the community of market-making professionals. The price range forecasts, split by the market quote at the time of the trade, provide an upside-to-downside price change potential balance of reward-to-risk proportions. That changes from day to day. The extent of its imbalance is indicated in the upper row RWD:RSK captions and the frequency of its presence, (or more extreme) is shown in the column headed #BUYS. Pure logic suggests that there should be no days where buyers might be found during periods where knowledgeable appraisals indicated larger downsides than upsides. But it does exist, perhaps due to less well-reasoned appraisals among the public than among the market pros. But during this 5-year period that has not happened. Instead, there have been 47 days that prompted professional analysis suggesting practically no downside price change prospect for a buyer of AAPL. Those 47 days were followed by periods of up to 80 days in which the subsequent price of AAPL stock rose at rates of as much as CAGRs of 70%. Another 18 days joined that 47 where AAPL price drawdowns from the forecast-day quotes were seen to be a trivial 1/50th as large as the upside prospect. Combined, those 65 days averaged CAGRs of as much as 60% or more. Should timing be tried? Now, is this enough of an incentive to attempt the timing of AAPL purchases? The excess returns above the blue-row average are +40% to +50% rates above the usual AAPL gains. And they have occurred in about 5% of the days – one out of every 20. With 21 market days a month, that’s almost one a month. But these are overall averages among the 65 days. How good are the odds of hitting a winner? Are there just a few big payoffs involved here? Figure 2 shows what percentage of the 65 produced gains. Figure 2 (click to enlarge) Say, not bad! With 7 out of every 8 instances a winner, that looks a lot better than the blue-row average of 2 out of 3. But how bad might that 8th experience be. Could it kill four of the others? Figure 3 addresses that question. Figure 3 (click to enlarge) Whoa! Lose nearly a quarter of my money? No way, Way. Easy does it. This table show the single worst case price drawdown – at any point in the holding period. Figure 2 tells what proportion of all the exposures have recovered from the drawdowns during their periods after the forecast, and those that have not may have recovered some, so their positions at this time of measurement may be a lot better than the worst possible. But you would have to struggle past that -24% worst case, if it recurred during your adventure, and simply being aware that it could happen, even once, no matter when, if that is scare enough, then the answer is no, you shouldn’t try to time AAPL buys. Still, be aware that drawdown (or worse, -30%) could have happened any time an AAPL buy might have been held as long as 65 market days (13 weeks, or 3 months). And you would have had to live through that. Maybe you did, like a lot of folks. At least 2/3rds of them, maybe 7 out of 10, are back in the win column. There’s a reason that AAPL is the biggest market cap in the game. Conclusion With good guidance many stocks can be effectively timed, in comparison with simply buying and holding them. Even good growers like AAPL. In fact few stocks have 5-year records of over +20% CAGRs. Those with slow growth, high dividend yields (4-6%) often have price ranges each year that are in the 50% to 100% low to high experience. One adequately-timed purchase and subsequent sale often can result in a year’s payoff that is double or even triple what the buy & hold year would produce. But it requires a mind-set that can accommodate the awareness and presence of temporary price risks. That is more than many investors can stand, and they are limited to single-to-low-double-digit returns from their investments. With adequate capital resources, that may be all they need, and so they are fortunate. The failure of market averages to show much of any growth over the past 15 years suggests that there are many passive market index investors not so fortunate, losing all that time, with little to show for it.

U.S. Geothermal: A Messy Micro-Cap With No Catalyst In Sight

Summary HTM showed up on a screen for long ideas, but I find the stock unattractive: Slow growth, potential dilution, no dividend, and no EPS. My attempt to value the stock valuation relies on EV/EBITDA, and it’s a messy affair to reconcile the minority interests and company adjustments. The biggest risk to this short idea is that a strategic buyer might make a bid, since HTM is a pure play in geothermal. US Geothermal (NYSEMKT: HTM ) recently showed up on a micro-cap screen designed by Marc Gerstein, Director of Research at Portfolio123 . The screen uses a combination of value and momentum factors to identify attractive stocks while avoiding what Marc calls “dumpster fires.” As a side note, Marc and I started our careers three decades ago as stock analysts at Value Line. His stock screening process is not only sound, but it is far better than anything I could design. So the first step was to take a quick look to see if the screen had netted a fish or just an old tire. (Finding junk in the net is usually caused by bad data, and does not indicate a flaw in the screening process.) (click to enlarge) Minority Interests Dilute Earnings U.S. Geothermal , Inc. operates power plants in the Western U.S., and is a pure play on geothermal energy. Unfortunately, HTM only owns a 60% interest in its largest, most profitable plant: Neal Hot Springs in Oregon. Likewise, it has a 50% interest in the plant located at Raft River, Idaho. For a granular analysis of the plants at HTM, please see All Quiet on the Geothermal Front .The minority partners take a big cut of earnings, so potential investors should keep this in mind as they read HTM’s financial statements. Capital Constrained It is hard to see the firm growing significantly without raising capital or diluting current shareholders. This article on SA described it well: U.S. Geothermal Is an Open-Ended Story . I cannot add much to this well-written analysis, except to say that it the author used a value approach that makes sense to me and didn’t conflict with anything I discovered about the firm. The firm has a number of projects in the pipeline, but these take a long time to develop and do not always come to fruition. HTM gets government incentives to develop plants, including a $65-million loan at 2.6% interest from the Department of Energy. The reliance on tax breaks and government loans is both an opportunity and a risk that is inherent to renewable energy projects. Valuation I find HTM a hard stock to evaluate, since it has no dividends and GAAP EPS hover around $0.00 (that’s not a typo). So I had to resort to EBITDA (earnings before interest, taxes, and amortization). As of August 11, 2015 the company is guiding analysts to net income before taxes of $3 to $6 million–quite a wide range. This works out to adjusted EBITDA of $11 million, so the company maintains that stock is selling for about 6x EBITDA. (Source: Page 22 of company presentation here .) But this excludes net debt, as we shall see below. Total assets of U.S. Geothermal as of 6/30/15 were $231 million. Total debt was $97 million, and minority interests were $45 million. Throw in some short-term liabilities of $6 million and miscellaneous items, and total liabilities come to $145 million. Shareholder equity was $86 million, so I calculate enterprise value of $231 million. The company presentation uses data from December 31, 2014, so the enterprise value would be $233 million, rather than $231 million. (click to enlarge) Then the adjustments start. As shown above, U.S. Geothermal adjusts the year-end assets and liabilities to reflect minority interests to come up with the “USG portion” of each. This makes sense to me. The firm also adjusts asset values upward from $233 million reported at year-end 2014 to $375 million. I cannot vouch for this, since I have not followed the trail of breadcrumbs to confirm whether or not this contains reasonable assumptions. So I will I use unadjusted asset values of $233 million, rather than $375 million. Granted, it is possible that the company has bona fide reasons to make adjustments to its asset base up to $375 million. If I were shorting the stock, I’d look into this to make sure that there weren’t saleable assets that are undervalued. But the problem with this logic is that if the asset base really is this high, then the company’s return on assets is even lower than I calculate. In any case, adjusted for minority interests, U.S. Geothermal has debt of $71 million and equity of $171 million. This comes to an enterprise value of $242 million. Based on this, and on the firm’s projection of 2015 adjusted EBITDA of $11 million, U.S. Geothermal is not earning a particularly good return on assets: $11 million/$242 million amounts to a 4.5% return on total assets. The company may have a higher return on equity, which came to 15% according to year-end 2014 numbers as calculated by Reuters. But for a highly-leveraged utility, we need to look at returns on total assets, and it is not encouraging. 4.5% seems like a low return, which may explain why the firm cannot afford to pay a dividend. (click to enlarge) Above is page 24 of a company presentation, and it shows that the current stock price is 5.8x forward EBITDA of $11 million. This seems cheap. But it does not include the company’s portion of long-term debt, which is $71 million. Personally, I find that misleading. Would a Buyout Make Sense? As of November 4, 2015 the stock had a price of $0.58, giving the firm a market cap of $62 million. Any buyer of U.S. Geothermal would assume the company’s liabilities, and this includes its portion of long-term debt. If we assume that a buyer would pay at least 10% premium for the stock, we have equity of $68 million. Add $71 million of long-term debt, and the buyer would have to pay $139 million for the whole shebang; this is the Enterprise Value that would matter to a buyer. Using the company’s forward, adjusted EBITDA of $11 million for 2015, a takeover offer of $139 million would amount to an EBITDA/Enterprise Value multiple of 12.6x. Not cheap, but not expensive. Therefore, I do not see a buyout offer as a big catalyst for the stock. Nevertheless, given the company’s tiny capitalization and niche focus, the stock could eventually become a takeover target: A large utility might buy HTM for strategic reasons, and a private equity investor might add value by injecting capital, buying out minority interests, or breaking up the company and selling off assets. I have no reason to think that a buyer is waiting in the wings, but short sellers should keep this risk in mind. Short Interest According to Nasdaq , as of 10/15/2015 HTM has a short interest of 780,207 shares. With daily volume of 190,000 shares, it would take 4 days for the shorts to cover. There are 107 million shares issued and outstanding, and the float is about 105 million. The fully diluted shares are 126 million. I have to note that it is notoriously difficult to short micro-cap stocks, and the services of a good prime broker will be essential. (There are no active options for HTM.) As a side note, insider purchases of the stock show up on Yahoo as positive, but the executives receive significant grants and gifts. This stock compensation is not cheap, and it reflects the skills of the current executive team. A strategic buyer of U.S. Geothermal may decide that it can consolidate operations and save money by cutting executive pay. This is a minor consideration, but worth mentioning. Bottom Line HTM shares may be suitable for investors who like renewable energy. There is no dividend, so investors have to be very patient. And there is no guarantee that the project pipeline will pan out, so investors have to be risk tolerant. Given current valuation and the potential for dilution, I think the potential risk/reward is tilted toward the short side. Editor’s Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.

Sticking With Your Asset Allocation

By Seth J. Masters Careful analysis can help investors pre-experience the outcomes they’re likely to see with various allocation decisions. But an investment plan will work only if an investor has the emotional fortitude to stick with it. That’s easier said than done, particularly with a more aggressive portfolio, when market conditions are rough. Let’s look at the growth of $1 million in three portfolios from January 2005 through June 2015, assuming a withdrawal of $50,000 per year. In one case, the investor maintains a portfolio allocation with 80% in global stocks and 20% in municipal bonds. In the second, the investor stays in a much more conservative 30/70 portfolio. And in the third, the investor begins with 80/20, but panics after a 30% loss and switches out of stocks and into cash on November 1, 2008. He remains in cash through March 31, 2012, and returns to 80/20 thereafter. The Display below shows how each of these investors would have fared. With only 30% in stocks, the conservative investor wouldn’t have lost a great deal in the 2008 stock market slump, but neither would he have picked up much in the roaring bull market that followed. Altogether, after spending $50,000 a year, he would have ended up with $940,000 at midyear 2015 – not too bad considering his regular portfolio withdrawals. The steady 80/20 investor would have suffered a wrenching loss of 46% in the stock market slump, but she would have still wound up with the highest final portfolio value: $1,150,000, after spending outlays. The market timer who jumped into cash as the stock market was going south and returned to stocks somewhat late would have been left with only $670,000, far less than both the steady 30/70 investor and the steady 80/20 investor. Indeed, his portfolio’s ending value would have been more than 40% less than the ending value of the 80/20 investor who stuck with her allocation, although his worst drawdown was nearly as large. This illustrative case is – unfortunately – similar to what many investors actually did after 2008. Lots of investors who had flocked to global stocks in the years before the bubble burst stampeded out in 2009, 2010, and 2011, to the tune of $309 billion in outflows. It took until 2013 – by which time the global stock market had already rallied 55% – for fund flows to flip back into stocks. In market cycle after market cycle, most investors sell low and buy high. At Bernstein, we advised clients after the market slump to stick with their long-term strategic asset allocations, including their exposure to equities. One measure of the value of good investment advice, in our view, is the money saved by avoiding big mistakes. The value of that advice can be significant and quantifiable, as this example shows. Even so, there’s a deeper dimension to good investment advice that goes beyond such numbers. Planning carefully and thoroughly can create greater understanding of investment trade-offs, which leads to better life decisions. These benefits are hard to measure precisely, but nonetheless hugely valuable. The views expressed herein do not constitute research, investment advice, or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams.