Wednesday, March 20, 2013

A Macro View - Part 2, Decay

To recap the last post, the economy is lack-luster, and it doesn't have a lot of upside potential.  There is too much debt and most innovation is just "bling", full of flash and dazzle and signifying nothing.

So the economy languishes, but the markets are on fire.  Interest rates are held low using both traditional and non-traditional means.  The Australian economist Steve Keen holds that the stock market is a debt-fueled bubble and he illustrates this by comparing the relationship between margin levels and stock market levels.  Highly correlated and both highly high.

It appears as though the stimulus money has gone into the market, rather than the economy.

Bernacke is going to hold tight to QE.  I don't blame him, it is his job to try and fend off disaster and make the economy grow, but I think he is fighting against the tide.

QE may have unintended consequences - the depreciation or potential devaluation of the US dollar, perhaps a currency war and the damage this will cause to international trade.  Throw the EU/Cyprus thing into the mix (the tax levy on savings balances) and confidence is further undermined.

I think this desperate desire to make things grow is at the root cause.  In nature, pruning and sometimes even controlled burns are helpful to the cycle.  But the point is, it is a cycle, of growth and decay, growth and decay. 

In my opinion, we want to transcend this natural process and just grow, grow, grow.  Did you know that never happens?  From a microscopic to a universal scale, we ride a sine wave that oscillates us, up and down, forever and ever, amen.

I don't know why this needs to be a problem.  Embrace it, we can't change it anyway.  Look for opportunity in the decay phase.

That will be the topic of the next post.

Wednesday, March 13, 2013

A Macro-View, Part 1 - Growth

A couple of weeks ago I went to cash by selling all of my equity positions (I didn't have anything else).  It was partially reactionary - there was a lot of bullish sentiment and it was partially based on the research that I had done in order to produce those three infographics. 

Once out of the market, I could be more objective and think about what was going on and what was likely to happen.  Every morning for the past two or three weeks, I've been mocking up different macro-economic scenarios, looking at interest rates, money supply, inflation, exchange rates etc.  Frequently, I just get over-whelmed.  There are so many moving parts, so many possibilities.  I think, maybe I should just sit this one out.  But it's too interesting.

Of particular interest to me is quantitative easing.  Let me go over some of the questions that arise from this subject:
  • Why didn't low interest rates stimulate the economy (making some governments turn to QE)?
  • What are the effects, intended and not, of QE?

The first question is the focus of this blog.  My theory, based on the infographic work, is that low interest rates didn't work because, at least for the time being, our economies have grown all they are capable of growing.  Innovation is the main driver of growth because innovation can make us more productive.  More productivity, more growth.

There are some remarkable technological developments happening without a doubt, and they'll continue to happen, but they aren't going to move the needle on productivity the way, say, indoor plumbing did, or the electric light, or the car.  Let me illustrate graphically:

The invention of the telephone made huge productivity gains.  The cellphone made gains, but not as much as the telephone did.  And smartphones add comparatively little.  This is the law of diminishing returns in action, applied to technological development.

<As an aside, in my opinion, I think it is possible to get negative gains from technology in certain cases, smartphones being a good example.  The reason stems from distraction, the illusion of multi-tasking usefulness, and blurred boundaries between work and recreation.>

So perhaps we've hit a bit of a plateau for a while in our ability to grow our economy.  There are other reasons why this might be the case SUCH AS AN AWFUL LOT OF DEBT, and for more information I direct you to Robert J. Gordon's work on the subject.

However, we've been growing consistently for a number of generations, we've come to expect it.  I think governments are not prepared to face a non-growth environment and will attempt to grow by any means possible.  One of those means is what we have now - quantitative easing.

My next posting will discuss the impacts of this policy.

Sunday, March 3, 2013

The Final Infographic of the Series - Graphing and Understanding Growth of the S&P500


Over the month of February, I was hard at work producing a series of three financial infographics, inspired by the work of Dr. Albert Bartlett on compound growth.  I think his message is important and I recommend watching videos of his lectures.  It would be an investment of only an hour and 15 minutes of your time.

Although the first infographics came together quite quickly, I really struggled with the third.  I didn't know what to do.  I wasn't interested in the old saw of compound growth and how it grows your investments.  Who hasn't heard that?  I wanted these infographics to be useful and I didn't think recycling old information was useful.

Long story short, I started mucking around with S&P500 data.  There were a few dead ends, but eventually I calculated the average growth rate of the S&P and the doubling time that corresponded with that rate.  I graphed it and then graphed the actual value of the S&P at each of the doubling times.

The two lines moved in sync for the first 50 years (1950 to 2000), but after 2000, the S&P500 couldn't sustain parabolic growth.  Wow, unlimited growth not sustainable.    In hindsight it seems so obvious, as that is what the esteemed Dr. Bartlett says, but I was very excited to see it.

Next step, more research.  Cutting another lengthy tale short, I came across the work of Dr. Robert J. Gordon from Northwestern University.  He published a working paper called, "The End of Growth?  Faltering Innovation Confronts the Six Headwinds".  A worth-while read.

I used Dr. Gordon's work to help explain the results of the doubling time graph.

I hope you enjoy the infographic.  Please send me a message with any comments or questions you have.  I'd love to hear from you.

In closing, the whole process got me thinking like stink about where the focus of my next investment analysis should be.  It's going to be a macro-view leveraging our financial analysis software and it'll be the topic of my next blog.

Tuesday, February 5, 2013

Financial Infographic - Using Compound Growth to Grow Wealth

The second in our three part infographic series developed to help investors understand the underlying concepts behind financial and investment analysis.  These same basic concepts and equations have been used by Verdasis to develop unique financial analysis software to more effectively manage complex personal or institutional investment portfolios using data readily available from financial statements, the market as well as beta and macro-economic data.  Our software enables investors to run their own ratios, regressions and equations or to simply use financial analysis models to obtain immediate results.

The infographic identifies two key equations of wealth, the balance sheet equation of Assets – Liabilities = Equity, which we call the wealth equation and the wealth growth equation, which calculates equity growth over time. The latter equation is equal to the sum of the weighted averages of asset growth and liability growth. According to the infographic, both equations impact wealth and individuals can alter their wealth profile by understanding and adjusting the constituent parts. Improving either equation will deliver positive results, but enhancing both will greatly increase compound growth.

personal financial implications of growth infographic

Let us know how you manage wealth and calculate compound growth.

Tuesday, January 29, 2013

Financial Infographic - Understanding Financial Growth Concepts

The first of three highly informative infographics we have developed to help investors better understand the core concepts behind financial and investment analysis. These concepts have likewise been used as the basis for our own financial analysis software, which in turn has been designed to help take the guesswork out of financial decision-making by applying analytical principals. In this first graphic we look at the concepts of compound and exponential growth, which are applied and used to described virtually every important item we measure today.

Monday, January 28, 2013

Analyzing US Bank Stocks..or Not

I decided not to look at the appears as though the sector is kind of expensive.

I feel I got a bit ahead of myself; I like to look at things from a top-down perspective and I've been too keen to get right into the financial analysis part.

I want to look at all of the sectors first and find one that is out of favour.  I was hoping to get to that this weekend, but some other things took precedence.  As it appears now, I should be able to start that next week, February 4th.

Wednesday, January 23, 2013

Theoretical Price on the Bank Stocks

I did the Ohlson Calculation on the 19 bank stocks.  We're interested in two things:

1) Does the sector on the whole look undervalued? and
2) Which stocks are trading at a discount?

Here is the graph of the premiums and discounts:

Obviously WBK is an aberration - but we aren't interested in the premium ones, we're interested in the discount ones.  Of the five stocks trading at a discount, one of them, MS, isn't showing a correct Ohlson calculation because it had a loss and a weird dividend payout ratio.

So there are four out of 19 stocks at a theoretical discount.  There are some non-US domiciled stocks - four Canadian, one UK and one Swiss that make up the next highest premiums after WBK.  So if we took those five plus WBK and MS, there are four out of 11 trading at a discount, still under half.  I wouldn't consider the sector undervalued.

Given the sector is moderately expensive, I am lukewarm about going further.  I am however, curious about one in particular.   For the record, the stocks that are trading at a discount are C, BAC, COF and IBN.

I'm going to sleep on it and decide tomorrow.  It would be nice to find a really unfashionable sector with a lot of upside potential.

Monday, January 21, 2013

Banking Sector Financial Analysis

The next financial analysis will focus on the U.S. banking sector.    I was wondering what to focus on next and I decided on banks because of this article.

It says that Warren Buffett is bullish and banks are cheap.  Well, we'll see for ourselves.

This financial analysis will go a lot faster than the last one, as I don't need go into the mechanics of each step.  I also thought I'd cut to the chase by taking a look at the theoretical prices using ohlson's clean surplus theory right out of the gate.

However, the first step is to build the portfolio of U.S. bank stocks in Verdasis financial analysis software.

I'm going to look at:
Goldman Sachs
State Street
JP Morgan
First Republic
Toronto-Dominion Bank (USA)
Westpac Banking Corporation
PNC Financial Services
Morgan Stanley
Royal Bank (USA)
Bank of America
Capital One
Credit Suisse Group
Royal Bank of Scotland
Bank of Montreal (USA)
LLoyd's Banking Group
Bank of Nova Scotia (USA)

The market cap of these companies is over $20 Billion, with the exception of First Republic (~$5B).

On Wednesday we'll look at theoretical price.

Thanks for reading.

Monday, January 14, 2013

Sum of the Value Indicators and Sum of Quality of Earnings Indicators

We need to sum the Value Indicators.  I did it in Excel as I was having trouble today making a spreadsheet in Google Docs that pulled information from several spreadsheets.

I also re-did the quality of earnings one as it was getting out of date.

As I mentioned in the last post, STO and cautiously PZE look good.

When I put all three pieces together, I don't like anything.  CVX looks great from an indicator perspective, but it is over-valued according to the theoretical price.

STO is good in the value indicators, but its quality of earnings is poor, which gives me a lower level of confidence for the financials themselves.

PZE isn't a candidate for me because I can't get to the bottom of the discrepancy in the financials AND the website is in Spanish, so I would have trouble doing further research on their management.

So, for me, right now, there is no investment candidate in U.S. Integrated Oil & Gas.  The good news, however, is that we've gone through all of the indicators in minute detail, which is kind of tedious, and from here on it we can look at things much faster using financial analysis software.

I'm also playing with another indicator, which might be useful.

Anyway, I'll be writing again shortly.  Thanks, Jen

Monday, January 7, 2013

Review of Theoretical Price in the Oil and Gas Sector

We are interested in securities trading at a discount relative to the theoretical price generated by Ohlson's Clean Surplus Theory.  You'll notice that most of them are trading at a premium.  This could mean that the entire sector is over-valued, in which case it would be imprudent to make a purchase at all.  We'll look more carefully at that in a later post.

As I mentioned previously, you have to use a bit of common sense when you interpret the results using financial analysis software.

Let's look at PSTR (Post Rock Energy Corporation) for example.  You can see it is trading at a 100% discount to the theoretical price.  Does that make sense?

The future theoretical book value grows rapidly because of its very high return on equity rate.  You'll notice that the ROE is significantly higher than every other security; at 256%, it seems rather fishy.  It is high in part because preferred shares reduce the denominator but there is no preferred dividends reducing the net income in the numerator.  Most preferred shares are cumulative, so I researched the financial statements at source.  They are cumulative and have been declared and paid.  Therefore, the numerator is incorrect.  Upon further research, I realize the denominator is incorrect as well. When preferred shares are subtracted from shareholders equity, the value is negative.  Therefore we do not have a meaningful ROE; without which we cannot calculate the clean surplus.

So the very high, uncharacteristic ROE alerted us to a problem.  If we had just jumped on this security as being undervalued without evaluating whether it makes sense, we would have made an error.

There are three other securities trading at an apparent discount: PZE, STO, and VOC.

PZE has a reasonable cost of equity, a reasonable ROE.  However, I noticed that Net Income After Tax was positive, but the EPS was negative.  I investigated the financials in Google and noted that NI after tax was positive, but NI was negative.  Normally that would be the result of a low persistence item like an accounting change or discontinued operations or an extraordinary result, but the financials in google were non-illuminating.  I tried to pull it up on the company's website but it is an Argentinian company and the website was in Spanish.  I was able to find the quarterly results but not the annual ones.  I also tried the SEC and but I had no luck.

Just for fun, I added another column for net income on the data sheet and recalculated ROE using that number.  ROE becomes -8% and the discount becomes a premium (75%).

It's my opinion that Net Income After Tax is the right line item to use in this calculation because we want to get close to the true, actual operating results.  We want to remove superfluous transactions or events that won't repeat.  (Just as an aside, frequently it is just the transactions that have a negative effect on the income statement that are pulled out to go below the Net Income After Tax number.  This is unfortunate as it hints toward earnings manipulation and ultimately degrades the capital system.)  I feel a little uneasy about PZE because I can't get to the bottom of the discrepency   So, I'm going to be cautious.

After reviewing STO, nothing jumped out at me as being cause for concern.

I did notice that VOC is a very small company - it's market cap is only $243 Million and that I don't have a beta for it.  Therefore the clean surplus calculation is incorrect...we have to take VOC off the list.

So we have as candidates STO, and cautiously PZE.

Next post we'll start putting all the financial analyses together.

Thanks for reading.