Wednesday, September 9, 2009

Goodbye, And What I've Learned

Sorry to say so, but I've decided to wrap this blog up. As it turns out, I've bitten off more than I can chew with this approach; that's why it was turning into little more than a daily round-up. Also, I have to admit to being a writer at heart. Perhaps I veered out of my own circle of competence.

I have, however, learned a lot by watching low P/E, high-yield stocks. Just below, I've got the most important lessons I've learned:

1. The Low P/E strategy is counterintuitive. That's what makes it work, but it only works if done statistically. Picking and choosing, I've found, doesn't work all that well because the counterintuitiveness makes for an added barrier. More than patience, the categorical approach is needed.

2. Because the strategy is counterintuitive, active trading while using it induces specific perils. I'm sure you've already encountered the well-tested advice that it's better to stay pat than trade, but there's a specific performance-drainer that kicks in with low P/E stocks. Because their rising is usually counterintuitive, I've found, they seem to go up too fast. Consequently, active trading often means throwing a lot of the gains away.

More generally, I found that active trading also wrecks diversification. Also: it might be tempting to see the stock market as something of a casino, and to stop trading when your hot hand seems to have vanished. The trouble is, the stock market isn't a casino. Taking this approach leads to opportunity losses.

3. Low P/E stocks that suffer huge one-day plummets often, though not always, bounce back. If there's nothing wrong with the company itself, taking advantage of a big one-day drop often works out.

4. Buying low P/E companies with above-average long-term returns on their equities seems to add performance. I haven't been at this a long time, but investing - categorically - in stocks with long-term return on shareholders' equities has resulted in a mock fund with the highest positive alpha of all the ones I tried. To be specific, "long-term return on equity" is measured in this way: ([sum of net incomes over ten years] / (sum of shareholders' equities over ten years)]. If there are fewer than ten years' worth of financials available, then use what's available but cut out any stock with fewer than five years' worth.

4a. The above strategy does have vulnerabilities. The high-ROE approach would have blown a hole in the investor's portfolio in 2008 due to the bank stocks getting in. (Remember: this approach uses long-term ROE, not short-term.) It also malfunctions in the case of cyclical stocks when in the middle of a cyclical downturn. However, given the counterintuitiveness of the low P/E strategy, I have to urge caution when excluding some companies. My own experience suggests quite plainly that the stocks that shoot up are often a surprise. The best approach to selecting is to make an entire list based upon the low P/E, high-dividend, high-long-term ROE criteria and examine each of them individually. If any individual company has something wrong with it, strike it off individually. Categorical strike-offs should not be done except for cyclicals - and only if you're sure the downcycle will continue for some time. Ironically, the best approach that works is the one Ben Graham recommended for bond selection - with the exception that the only companies to be struck off are those with "clear and present dangers." It's often unclear as to what's junky and what isn't in this part of the stock universe, so confining the exclusion to explicit trouble-criteria is best.

5. Remember to reposition any low P/E portfolio once per year. This turnover rate is enough to keep it roughly current, while also providing enough time for the winners to run.

6. Except for prophylactic research, it's best to work the low P/E strategy mechanically. Once again, the counterintutive performace of many low P/E stocks is the reason why.


I hope these rules give enough basics to use the low P/E, high-dividend strategy successfully. The works of David Dreman go into more details, and supply copious evidence that shows the strategy works. I'd like to thank everyone who's checked in here, regulars as well as occasionals, and I'd also like to point out where I'm going to be in the blogosphere now. I've set up a new blog that's a real veer-off from this one; it's called The Gold Bubble. I hope the title is self-explanatory.

Note: I've read the blogs in the blogroll regularly. There's lots of talent therein; I suggest you give them a try.

Ameren Issuing More Stock, Price Drops

Once again, a non-financial company has issued plans for a secondary offering to the detriment of its stock price. Ameren, an electric utility holding company whose main operating subsidiaries are based in Illinois, has announced it will issue another 19 million shares. (With over-allottment rights of 2.85 million, the issance could be as high as 21.85 million.) Since the company plans to use the proceeds to up its investments in its subsidiaries, there's no reason to assume that the offering won't be dilutive. The best face for this offering would be an increase in regulatory capital leading to higher rates being allowed under the regulations.

Ameren's total shares outstanding as of June 30th was 214.2 million. Adding 21.85 million makes for an increase of slightly more than 10% of total shares outstanding. The money is earmarked to be spent, so there's no offset for the dilution factor except for the increase in earnings permitted by the increases in regulatory capital.

Left unspecified were the specific uses to which the funds will be put. Ameren stock dropped when cap-and-trade legislation was churining along, which leads me to suspect that the proceeds will be used to cut down the company's coal consumption by building natural gas generators.

Ameren stock was down 0.70% in regular trading, and down a further 3.12% in after-hours trading. The latter drop may not be reflected in its performance once regular trading starts again.

GE Leaps Up On Upgrade

Thanks to an upgrade of the company, from J.P. Morgan, the shares of General Electric rose 4.54%. The analyst, Stephen Tusa, now rates GE as "Overweight" because the worst seems to be over for the company; even if GE ends up raising money through a secondary offering, said Mr. Tusa, it would be good for the stock because it would dispel undercapitalization doubts.

Mr. Tusa could very well be right, but note the "even bad news is good news" thrust. Call me a worry wart, but that kind of reasoning makes me jumpy even if the troubled banks have shown the same effect over the last several months. Mr. Tusa's price target of $17 will likely be met from the latest close of $14.50, but I believe the path will be fairly jagged. I've been burned myself by "all clear ahead" bullishness.

Tuesday, September 8, 2009

Daily Wrapup For September 8th

Post-long weekend, the three major averages did quite well; so far, the widely-anticipated September Effect has yet to make its appearance except for a few down days. After opening with gains averaging about 0.5%, the averages carved out a trading range; at no point were any of them down on the day. The Dow closed up 0.59%, the S&P finished up 0.88% and the NASDAQ gained 0.94%. Light sweet crude for October delivery ended above $70 per barrel again, closing at $71.10/bbl for a gain of $3.08. Gold got top-story play today because the metal broached $1000/oz, even though it failed to hold on to most its gains in regular trading. Spot gold ended the regular session at $996.70, but moved back above $1000 later.

The lowest-quintile cut-off continued to rise today, from Friday's 11.75 to today's 11.88. The yield cut-off, being the S&P dividend yield, dropped two basis points to 2.58%. After ETFs and stocks with less then 500M market cap were discarded, along with ones yielding more than 10%, the Low P/E Bin was left with one hundred and four stocks for a gain of three from yesterday. Here are the changes in the Bin, as dash-listed below:

- AstraZeneca plc
- New York Community Bancorp, Inc.
- NiSource Inc.
- Northeast Utilities System
- SCANA Corporation
- The McGraw-Hill Companies, Inc.

- Compass Minerals International, Inc.
- General Dynamics Corporation
- Telecom Italia SpA

Three of today's six Arrivals are new: they all got in because their P/Es fell below the lowest-quintile cut-off. New York Community Bancorp, the holding company for New York Community Bank and New York Commercial Bank, is one of not many companies with a payout ratio of more than 100%: its P/E is 11.85 and its yield is 9.51%, for a dividend that has neither been raised nor cut in the last five years. Northeastern Utilities is a holding company for four utilities in the Northeastern United States: three electric, one gas. Its stock was virtually unchanged, but the Bin P/E cut-off rose above its own. McGraw-Hill got into the Bin becaue its stock plummeted 7.22% today, continuing a drop that started last Thursday. Its ratings division is facing potential lawsuits, and Warren Buffett is lowering Berkshire Hathaway's stake in the company.

The three other Arrivals have been in the Bin before. AstraZeneca, the U.K.-based major pharmaceutical company, got back in because its dividend yield ticked above the yield cut-off. Natural gas utility NiSource returned because its P/E fell below the lowest-quintile cut-off. The same cause was behind the return of electric utility SCANA.

All of the three Departures got out of the Bin because of gains in their stocks. Both Compass Minerals, a miner and seller of salt and sulfate of potassium products, and General Dynamics, a defense company, got out because their yields sunk below the yield cut-off. Compass stock gained 0.86%, and General Dynamics stock put in a much higher gain of 4.02%. The final Departure, Telecom Italia, saw its stock gain 3.15%. That leap was enough to push its P/E above the lowest-quintile cut-off.

Gains in both the stock market and metals added a real boost to the stock of metal and coal miner BHP Billiton plc. Recently, Billiton was sagging as an uptrend turned into a trading range. Today's 4.45% gain pushed it up to the top of its range from near the bottom. The company has a diversified product range - "alumina and aluminum, copper, energy (thermal) coal, iron ore, nickel, manganese, metallurgical coal, oil and gas and uranium, as well as gold, zinc, lead, silver and diamonds" - so it has benefitted from recent uptrends in those commodities. There was no company-specific news to account for its leap.

That's all for today's Wrapup. Thanks for reading, and welcome back to another post-summer season.

Monday, September 7, 2009

Now that the long weekend is here...

...I'd like to leave you with a trivia question. Being behind the curve as I am, I watched the Will Smith movie The Pursuit of Happyness for the first time last weekend. I spotted one anachronism in the movie, set in 1981, on first sight.

Here's the question: What was the anachronism?

Here's the answer: When the class for the trainees starts, the teacher/supervisor (played by Dan Castellanetta) hands out copies of Security Analysis...the fifth edition of it. The fifth edition (the "heterodox" one, as it was the only one whose text was not filled with Ben Graham's own writings) was first published in 1988. The only version available in 1981 was the fourth, published in 1962.

New Article In Enter Stage Right

After an end-of-summer hiatus, Enter Stage Right is back on its weekly schedule. As usual, I'm part of the line-up; this week, I center upon the current ObamaCare quagmire as an example of political cynicism gone overboard. If you're here from ESR, welcome.

I have to confess to falling back into my old habits. This long weekend, I've been plowing through Pat Buchanan's revisionist work Hitler, Churchill and the Unnecessary War. Mr. Buchanan's criticism of Churchill in the first two-thirds of the book (which is all I've read so far) have basically gone in one of my ears and out of the other. The impression that I got of Churchill was a politician who was adept at shifting with both party and popular winds. Granted that it does make him inconsistent over time, but that's what a lot of politicians are like....


My overall impression was that Britain lost its Empire because its trick that always worked, no longer did so. The U.K.'s European diplomacy strategy, centered on Europe, bears a striking resemblance to H.L. Mencken's definition of the mission of journalists: to "confort the afflicted and afflict the comfortable." In Britain's case, it was "reward the co-operative and punish the bully." The aim was to keep Europe multipolar and divided. Given this mind-set, it's hard to see how the U.K. governments could have avoided their blunders in the 1930s. Any great power has to be the cat of Aesop's fable The Fox And The Cat; it has to rely upon a single trick that always works. The trouble comes when one of the hounds eventually figures out how to cut the tree down.

Hitler was that hound with respect to the U.K.'s balance-of-power tree. Now cut, it's a wreck. The EU is showing Europe's former great powers how to settle differences peacefully. The "bullies" have figured out how to be co-operative without the U.K.'s help. How to keep France and Germany, not to mention the other EU powers, at odds with each other when they're now bound by treaty?

In geopolitics, America is now the cat with the hegemony. Its trick that always works is the assumption that war is usually unpopular with the people of the warlike States, and that any regime that attacks America's allies (or America) is ipso facto unpopular with its subjects. Mr. Buchanan fears that the extension of NATO to Russia's doorstep is the same kind of folly that humbled the U.K. Although his point is a wise one, and is informed by sound strategic considerations, it seems to me to be too schematic. America is not the U.K.; they're different breeds of cat (so to speak.)

My own opinion is that America's Achilles heel - the hound that will cut down America's hegemony tree - is a a regime that is not a democratic republic, is militarily aggressive on the world stage, but neverthless has the knack of fighting wars that are popular amongst its subjects. One of the reasons why World War 1 dragged out for so long, and why the Versailles Treaty was so vindictive, was the Allies discerning that the German people seemed to like the war.

America may face its own WWI yet.

Saturday, September 5, 2009

The Buckle Picked Up By Reuters (And Now Motley Fool)

Maybe I'm lucky, or maybe it's coincidence, but a stock I provided a rudimentary analysis for has made it into a Reuters "Buy Or Sell" feature. The stock is The Buckle, Inc., and my analysis is here. The Reuters feature on it does add some detail missing from my own work, such as the fact that the company depends on price increases to keep its margins growing. This point was made by the bear-side analyst cited in the feature. That analyst, Adrienne Tennant of FBR Capital Markets, downgraded The Buckle to "udnerperform" right after its disappointing same-store sales results for July.

The bull-side analyst is Laura Champine, chief financial analyst at Cowen and Co. She pointed to the valuation, noting that its P/E is well below its peers. Each analyst's arguments can be found in the feature.

This is the second time I've lopped into a stock before the pros did. The first was Compass Minerals: after my own rudimentary jobbie, a J.P. Morgan analyst upgraded it on more thorough grounds. To be frank, I'm just glad of the coverage regardless of any influence I have. Time constraints, plus my own dearth of intellectual capital, means that any analysis I undertake will be little more than a poke-through of the financials. Having pros take notice of the same company gives me information I can't scarf out on my own.

So, thanks. Thanks to Reuters; thanks to Nivedita Bhattacharjee, the author of the feature; thanks to both analysts; thanks to J.P Morgan and the analyst for the Compass analysis; thanks to the reporter who wrote it up...

Update: The Motley Fool has published a bullish analysis on The Buckle by Alyce Lomax, which has gotten three supportive comments so far. On the other hand, this fellow went into a Buckle store and didn't like what he saw.

Disclosure: I'm holding both Compass and The Buckle in the actively-managed Marketocracy mock fund I run.