Moody’s downgraded a story we’ve covered in previous posts to below-investment-grade ratings, aka “junk” or “high yield”. This is the second such rating agency to downgrade Teva to junk. That means the bonds now officially transition to the high yield markets, typically making bond yields more attractive. This is the next leg of our thesis playing out. Remember, we think there is long-term value in a large generic pharmaceutical company like Teva.
Microchip Security Flaws (Intel)
Intel has a been a stock we’ve kept an eye on recently, as it is a high-quality company with industry leading technologies and a high probability of remaining a key force in the tech industry for years to come. To boot, Intel pays a dividend, which seems ever rare in this new technology growth wave.
In early January, a researcher discovered a major security flaw to chip architecture called ‘x86’. There were many manufacturers impacted, but none more so than Intel. The flaw impacts computers dating back to the mid-90s and the fix, if there is one, could dramatically slow computers – a costly proposition. Intel and the tech sector fell in price on the news. Ballast perked up even more on the pull-back of Intel’s price, but investors quickly brushed off the news, and the price ran away from sensible levels. It didn’t help us that Intel released strong, estimate-beating earnings figures that sent the stock rallying an additional 10% higher.
TV Programming (Netflix)
Netflix stock has been invincible and continues to defy traditional valuation methods. With no (to little) earnings and a massive negative cash flow, the stock price continues to rise. Market capitalization for Netflix increased by $10bn as the price jumped from $225 to $250 after the company announced 2 million new subscribers, which was higher than expected. As one commentator put it, and we paraphrase: “that is $5,000 per subscriber, or that $5,000 would hit the top line after just 35 years at today’s subscription pricing”. Let that settle in. That represents revenue [not income] over 35 years’ time. Are investors valuing this company correctly?
Here are a couple additional thoughts regarding Netflix. Between 2010 and 2016, original TV shows have more than doubled. Netflix original content is fifth most popular on its own platform behind CW (owned by CBS & Time Warner), Fox, Disney, and CBS. On its own platform! Each of those named leaders is already working on building their own platform or partnering to do so.
Our final thought regarding Netflix is from David Einhorn, a respected manager of hedge fund Greenlight Capital. We thought he framed it succinctly when he wrote in a recent letter to investors:
“[Time Warner] and Netflix now have roughly the same enterprise value, despite [Time Warner] having a better library, an exciting content creation engine and substantial current profitability.”
Time Warner owns Warner Brothers, HBO, TNT, TBS, CNN, Cartoon Network, etc. and an exhaustive list of accompanying TV and Movie content.
Speaking of highly valued stocks defying traditional valuation methods, Tesla is now among the largest car manufacturers by market capitalization. However, they hold this ranking with no profit, with only a fraction of the vehicle production/sales, and with unproven ability to meet targets and scale production. We like a successful visionary and innovative company as much as the next person, but we offer caution against pricing for perfection. Are “investors” renting or owning this stock?
Last year was a bad loss-year for insurance and reinsurance companies. January 1st was a big day for the industry because much of the property catastrophe reinsurance business is (re)priced on that day each year. Pricing increases or decreases can give indication as to whether the insurance market is hardening (as with price increases) or softening (as with price decreases). Overall, the news delivered modest price increases, and so, we think the industry could be in for a status quo of a soft market. We continue to monitor.
GE, as it is commonly known, has been in downsize mode ever since its financial unit nearly collapsed the company during the financial crisis. The company has shed countless assets in effort to reduce risk and boost stock price performance that has been anemic going back to the days of Jack Welch. GE was considered a model company under Jack Welch and his six-sigma regime. (GE was practically considered a management university.) However, this may have been a facade given the long poor share price performance. A recent announcement highlights that management may have been good at window dressing too. GE announced its reinsurance unit would take a $15 billion reserve charge and require statutory capital contributions. GE will accomplish this by suspending GE Capital’s dividend to the parent company, allowing for contributions to the financial unit. This was disappointing, but not very surprising given the poor financial health of Genworth, the life insurer that the GE unit reinsures. GE’s share price has suffered from this and other announcements, and management has reduced the dividend to shareholders. Investors have been fleeing, but Ballast sees opportunity. After all, GE remains a leading industrial group, manufacturing aircraft engines, locomotives, power generation turbines, healthcare equipment, and oil & gas equipment & services. We continue to monitor GE.
Howard Marks on Market Risks
There is much to be said about investing and risks, especially given the recent years’ runup in asset values. Rather than presenting more of our thoughts here this month, we offer a few quotes from a recent memo to investors by Howard Marks, a respected investor and founder of Oaktree Capital. (Bold type as presented by the author).
[Re: today’s market prices] Most valuation parameters are either the richest ever (Buffett ratio of stock market capitalization to GDP, price-to-sales ratio, the VIX, bond yields, private equity transaction multiples, real estate capitalization ratios) or among the highest in history (p/e ratios, Shiller cycle-adjusted p/e ratio). In the past, levels like these were followed by downturns. Thus, a decision to invest today has to rely on the belief that “it’s different this time.”
It appears many investment decisions are being made today on the basis of relative return, the unacceptability of the returns on cash and Treasurys, the belief that the overpriced market may have further to go, and FOMO [“fear of missing out”]. That is, they’re not being based on absolute returns or the fairness of price relative to intrinsic value. Thus, as my colleague Julio Herrera said the other day, “valuation is a lost art; today it’s all about momentum.”
The potential catalysts for decline that we have to worry about most may be the unknown ones. And although I read recently that bull markets don’t die of old age or collapse of their own weight, I think sometimes they do (a dollar for anyone who can identify the catalyst for the collapse of the bull market and tech bubble in 2000 – it’s not easy)
For one thing, I’m convinced the easy money has been made. For example, the S&P 500 has roughly quadrupled, including income, from its low in 2009. It was certainly easier for the p/e ratio to go from the low teens in 2011-12 to 25 today than it would be for it to double again from here. Thus, the one thing we can say for sure is that the current prospects for making money in U.S. equities aren’t what they were half a dozen years ago. And if that’s the case, isn’t it appropriate to take less risk in equities than one took six years ago?