vendredi 4 octobre 2019

Respect the market

In the beginning, I thought that it was easy to find great stocks: just find something with a good ROE and a low PE and bingo, you're a great investor.  

But that's not how it works. A stock with a low PE is usually (90% of the time) cheap for some good reason. It may not be obvious at first sight and you may be tempted to buy the stock, but you should be careful. Take some time to think about it before buying it. I think that I'm giving a good advice here.

Lately, I've realized that I now respect the market a lot. The valuation given to stocks is usually correct, if we exclude the hype stocks like Shopify and Canopy Growth or some really depressed stocks that had some bad quarters in a row.

Let's take a look at two examples that explain, in my opinion, why we should most of the time respect the valuation of the market. Obviously, there's a bias there, because these are two stocks I know. But fuck, I'm doing what I can.

First example: Linamar (a cheap stock)

Share price october 2013: 34,50$
EPS 2013: 3,52$
PE 2013: 15
ROE 2013: 19
Net profit margin 2013: 9%

Share price october 2018: 61$ (currently 38$)
EPS 2018: 8,94$
PE 2018: 5
ROE 2018: 17
Net profit margin 2018: 10%

Second example: Intuit (an expensive stock)

Share price october 2013: 67$
EPS 2013: 2,83$
PE 2013: 28
ROE 2013: 27
Net profit margin 2013: 23%

Share price october 2018: 211$ (currently 263$)
EPS 2018: 4,64$
PE 2018: 41
ROE 2018: 65
Net profit margin 2018: 25%


Both are good businesses in my opinion. We can't say that Linamar (auto components) is a bad stock. It's well managed, growth has been very good so far. But it's cyclical and related to the state of the economy. However, the current PE (5) is very low and I'd be tempted, even if I respect the valuation of the market, to say that it's undervalued right now. 

Intuit (tax softwares) is a great company. But I'd say that it's overvalued right now. There was a massive expansion of the PE over the last 5 years (50% higher).
However, there was a massive compression of Linamar's PE (66% drop) over the same period.

It's very strange to see that Linamar's PE has compressed that much with such EPS growth while the PE of Intuit increased a lot with a good growth, but not as spectacular as Linamar.

I don't really understand what has happened here with both stocks. But the market told us to be careful with Linamar 5 years ago and told us we could expect something good from Intuit 5 years ago (on a PE basis). That's exactly what happened.

That's sorcellery.

6 commentaires:

  1. I do not understand the market as my poor performance vividly demonstrates. Dear Penetrator, what are your predictions about what Mr Market is telling us NOW about LNR? If it is trading at 5x PE, does it imply LNR will go bankrupt? What about the implications of PE for pot or energy stocks?

    The increased volatility and multi-year losses in many of my smaller cap holdings are not making me very happy or confident in the market, its foresight, or its efficiency. My portfolio is 7% in cash/GIC and even with low interest rates it has underlying 5+% earnings yield. Most of my holdings have fairly large insider ownership and some continue to buy despite of multi-year lows.

    LNR is 4% of my portfolio with over 33% loss. I have bought it last year and again this winter. I naughtily hope there will be some horrific tax loss selling at the end of December and I will be able to scoop up some extra shares at a discount price in my TFSA in early January. Right now, I do not have any cash since all money is locked in short term GICs.

  2. Currently, LNR is trading at lesser valuation than in 2009 according to several trailing ratios and only little bit more than 2x of the amount it paid for MacDon acquisition just last year. Sure, it is involved in production of combustion engine related parts which are hated by the market, but nearly half of its EBIDTA is actually from non-automobile OEM (Skyjack platforms and MacDon combine blades which should fetch double PE multiples of car parts manufacturers). LNR should also be currently buying back a tiny amount of shares below book and hopefully continuing to rapidly repay its debt. According to the most recent press release it is also taking away business from competitors who might go bankrupt because of the unexpectedly bad GM strike. From the long-term perspective, these all sound as positives: higher per share ownership of the business and more opportunities and financial capacity for future growth.

    For comparison, CSU is about 10% of my portfolio but I paid quite a bit less to buy my CSU shares, although one or two years earlier than LNR (I was scared to buy a full position in CSU at around 600+ since I thought it was super expensive and am still scared to buy more now or sell since I have still not reached my long-term target position - in the long term I would like to at least 5x my tiny portfolio). At the moment, CSU has earnings yield of about 1.79% while LNR has an earnings yield of about 23.31% at market price (according to google finance). My book cost yield for CSU is about 5.77% while about 15.51% for LNR.

    I do not understand the valuation very well, but if each of the companies were worth a million dollars and I could buy them out as a yield-hungry greedy owner, owning LNR would let me milk out of the company over 19k a month while owning CSU would pay me only less than 1.5k a month. That is a difference of being a millionaire and living in a basement sublet eating ramen noodles versus a downtown penthouse eating out at steakhouses and sushi bars. Even though CSU might be able to grow 2-3x faster than LNR, that is still a big difference and it would take CSU quite a while to catch up while I would get closer and closer to death from the eventual MSG overdose and basement mold. If we assume a 15% growth for LNR and 40% growth for CSU, the CSU earnings yield would exceed LNR only after 14 years in which time the cumulative tangible earnings would be almost 2x from LNR than that from CSU.

    The dividend payout ratio for CSU is actually quite a bit higher than that of LNR also. This means less capital being compounded in the long run in the CSU --> in LNR only about 5-10% earnings is paid out in dividends which can be reinvested at below book while around 20-50% is paid out by CSU and could be only reinvested at something like 37x book value (and only if you are super wealthy to be able to own enough shares to have enough dividends to DRIP the $1,300+ per share). I am still trying to understand investing and company models, but generally speaking, I would ideally like to own a company trading at high book value multiple which pays no dividend and can redeploy all capital internally at high returns (in CSU's case, a cash dividend would be equal to 37x less theoretical gains than if the money was reinvested and not distributed, also ignoring the additional losses due to earlier recognition of tax by the shareholder). Dividends seem to destroy long term value (even though there is quite a robust filter whereby only good companies pay persistent dividend).

    Would any of you be interested in LNR in the nearby future or do you think averaging down on LNR is catching another falling knife on my part?

    1. I don't know LNR well but why is the dividend only 1.25% when the PE is so low?
      With regards to ATD, I think, there is a difference even if electrification of cars takes place very fast. Take an extreme example that starting from now on no more ICE cars will be made, there will still be plenty of existing gas cars that require gas, it would impact ATD's biz alot less than LNR?
      However, I don't think people are really worried about ICE being taken over by electric fast. I think generally, auto parts have not been doing well as people are afraid of "peak car" - that the global car production has reached a peak. Also, car sales have fallen off a cliff in China, the largest car market in the world.

  3. The UAW identified that the electrification of vehicles is it's largest threat as it takes something like 40% less manpower to build an electric car. Fewer parts, no transmissions, combustion engines, etc. All parts that Linamar makes. Furthermore the electronic components in an electric car are probably better suited to be made in economies such as China, Japan, Korea who have the skill and technology base. Hard to make a long term case on Linamar unless they figure out how to address this. They used to sell electronic lawn mowers and had a brushless motor technology, perhaps there is value in this?

  4. Dear TwoTime,
    Thank you for your insights. Do you have a link to the UAW report? I would like to read more about their projections.

    Automation in general should be a bigger threat to UAW jobs than shift from ICE to BEV. We might see "lights out" factories in our life time. At the same time, more flexible automated factories might encourage companies to repatriate manufacturing base from Asia to countries with better rule of law and cheaper energy... but most of the jobs will be lost forever... not to Chinese but to robots. Union strikes will only accelerate this process.

    I am curious, whether you have similar negative outlook on ATD? I do not know whether reselling tobacco and gasoline is more resilient to the switch from ICE to BEV than manufacturing metal parts. I was willing to overlook the negatives for LNR because of its valuation but I am not sure the big trends will be any kinder to ATD than to LNR. LNR is also projecting to have the same content in BEV as in 2017 in ICE within five years or less and should have the Hungarian e-axle factory up an running soon.

    Have a wonderful day!

  5. Dear all,

    Tonight, I was thinking about Mr. Market, LNR, CSU, my portfolio and remembered Jason Del Vicario's post about his "spice" factor from his comment from June 2019.

    I really did not want to work on my homework, so I have instead tried to see what would a simplified dummy version of the ratio be in today's market.

    Briefly, he has stated that the "spice" factor should be EBIDTA^2/assets/EV*100, where the EBIDTA should be adjusted for e.g. for stock compensation etc. My numbers are from yahoo (most recent quarter TTM) and I did not make any adjustments or check for typos. I looked only at about 70 TSX companies in my spreadsheet and could not calculate the numbers for financials since EBITDA, EV etc. are a bit problematic due to their deposit business model.

    The strange thing is that most of the companies I consider inferior or uninvestable ranked near the top:
    BHC 3.82*
    LNR 3.17*
    CGO 3.15
    CMG 2.70*
    GC 2.30
    CPH 2.37*
    MG 2.28
    CNQ 2.20
    DOO 2.14
    SU 2.08

    Good companies scored not so great. For e.g.:
    BAM 0.32*
    CSU 0.34*
    BYD 0.50
    MTY 0.58*
    OTEX 0.61
    ATD 0.93
    GIB 1.08*
    DOL 1.20*
    CCL 1.23*
    CNR 1.39*

    //* I currently hold.

    Generally we would like to own companies which score over 1 (ie their profitability % [EBITDA/assets] is more than their price [EV/EBITDA]). Jason has mentioned that an undervalued company should rank over 2.

    I have to get back to my homework so I do not have time to compare this to ROE/PE or other ranking measures (like NOPAT instead of EBIDTA) or to try to see historical trends. I am curious about what might be a better measure so that I can run a ranking later in the new year. I normally try to rank companies based on historical average trends and not their most recent profitability, taxes etc should be considered since they are not an optional business expense, and I also think that per share growth trends are important (for e.g. several years ago I got stuck in CMG trap since it is stagnant and has no room, new verticals, etc. to expand)... I will have think about this when I have more time.
    Have a nice evening!