Take one down, pass it around …
Here’s a 20-year look at the price of crude oil ($WTIC).
$100/barrel will be back before most people expect — perhaps in the 2018-2020 range. Unless somebody propagates a successful and sustained fusion reaction in their garage.
It is interesting that the slope of the long-term trend following the Great Recession resembles what we’re seeing for top-line growth from all companies, collectively.
LKQ (LKQ) provides replacement systems, components and parts needed to repair cars and light trucks, primarily in North America and Europe.
Think fender bender. That’s LKQ’s cue to spring into action.
LKQ buys wrecked cars at auction and distributes the reusable parts to collision repair shops. It also provides aftermarket parts services. Customers include repair facilities and insurance companies.
The industry is hugely fragmented. LKQ deploys an aggressive acquisition strategy.
It’s easy to see why this company captures the attention of many investors in our community. The up, straight and parallel images suggest a great deal of consistency in an industry that is fairly challenging and very competitive.
The Value Line low total return forecast is 14%.
Focusing on recent history and expectations for our 5-year time horizon, a sales growth forecast of 12% seems feasible. This could be vulnerable to an industry shift from repair to replace. We’ll probably take a closer look at the Retail Automotive industry — and its massive recent performance — and check that against some longer term history from trade/industry data to condition and build growth and profitability forecasts.
The projected net margin is more likely at 6% but Value Line is using 8.1% for their 3-5 year forecast. Shareholders hope that the Value Line analyst (Iason Dalavagas) is right.
A projected average P/E ratio of approximately 20x seems to be in order for this consistent performer that is still a medium-sized workhorse slogging away quite well in an extremely fragmented industry. But they’re becoming the 800-lb gorilla or at least they’re on the way to the jungle.
The Morningstar price-to-fair value (P/FV) ratio is 98% making them a little less optimistic. The S&P P/FV is 78%. The analyst consensus estimate (ACE) for 52-week total return is 33.9%. It’d be interesting to see how that would be impacted by any shift in industry repair/replace trends.
LKQ has a 40% debt-to-capital ratio and the effective interest rate is 6.39% (lowest quartile) so it’s not a leisurely walk through the junkyard. There are some junkyard dogs lurking that bite. Morningstar reduced the financial health to “B” and this will lower our financial strength composite to 72%. The overall quality ranking will still be 95 (Excellent).
Our projected annual return (PAR) is 15% based on 12.2% growth, 6.3% net margins and a projected P/E of 20×.
“There is little value in the single cow.” — Irish Proverb
“Any man who owns a cow can always find a woman to milk her.” — Irish Saying
Happy St. Patrick’s Day, Daniella!
After spending last weekend in Chicago with some Badgers, Spartans, Buckeyes and various other varmints, I was reminded that Chicago starts St. Patrick’s Day early with a parade on Saturday. The streets were packed with throngs of green-clad celebrants and we watched as the Chicago River was dyed green in compliance. I’m not sure I understand the difference between an Irish proverb and an Irish saying … or what is the meaning behind the bovine suggestions here. But given a choice, I think every portfolio needs more than one cow to avoid the adverse effects of cow tipping.
Chicago also honors a famous cow with a play every March, “When Irish Cows Are Smiling.” Set in March 1872, five months since the Great Chicago Fire, the MOO-morial service, held at the Diggum, Deepe & Dye Funeral Parlour, pays tribute to Mrs. O’Leary’s cow, Daniella Joy, the infamous firebug.
The average Value Line low total return forecast for the companies in this week’s update batch is 3.9% — slightly higher than the 3.7% for the Value Line 1700.
Materially Stronger: Gentex (GNTX), Synaptics (SYNA), Drew Industries (DW)
Materially Weaker: Avon Products (AVP), Windstream (WIN), Titan International (TWI), Cincinnati Bell (CBB)
Standard Coverage Initiated: Balchem (BCPC)
Discontinued:
Value Line Low Total Return (VLLTR) Forecast. The long-term low total return forecast for the 1700 companies featured in the Value Line Investment Survey is 3.7%, up slightly from 3.6% last week. For context, this indicator has ranged from low single digits (when stocks are generally overvalued) to approximately 20% when stocks are in the teeth of bear markets like 2008-2009.
Breaking News: Rite-Aid (RAD) actually has a financial strength rating (2%). While Value Line maintains its “C” (0%) rating on Rite-Aid, Morningstar checks in with a “C” … and the effective interest rate is still steep at 6.8% but it is better than it was!
“I would be a bum on the street corner with a tin cup if markets were efficient.” — Warren Buffett
This demonstration portfolio invests the maximum allowable 401(k) in stocks. Total assets reached $1,000,000 in 17 years. Tin Cup has outperformed the S&P 500 since inception (1995) and the annualized total return is now 18.6% vs. 9.9% for the S&P 500.
The total return for the trailing year for Tin Cup is 20.1% versus 13.9% for the Wilshire 5000 (VTSMX).
And not to “jinx” the free throw shooter during March Madness … but we can probably start thinking $2,000,000 count down fairly soon. The second million won’t take nearly as long as the first.
Tracking portfolio for Tin Cup: https://www.manifestinvesting.com/dashboards/public/tin-cup
The most “green lights” are on Chart Industries (GTLS) with a nod to Precision Castparts (PCP) a long-time community favorite.
We also note that — despite a solid 2014 (+26.6%) — Berkshire Hathaway (BRK-B) is still a pretty good idea. And a far, far better idea than reading what Berkshire Hathaway has bought and chasing those purchases. It’s a recipe for disaster … or at least erosion of several percentage points of total return.
March. “Madness … takes its toll.” — Riff Raff
The name “Hebron” traces back to a range of meanings from “colleague”, “unite” or “friend”. In the proper name Hebron, the original sense may have been alliance. Invest With Your Friends.
From 1908-1971, the Illinois boys high school basketball championship was a single tournament contested by nearly all high schools in Illinois. The Illinois High School Basketball Championship was the first tournament to be called ‘March Madness’. The term was first used about the Illinois tournament in 1939, decades before it was used about NCAA basketball tournament.
The movie Hoosiers was preceded by these real events from across the state line in Illinois. In 1952, the Hebron Green Giants (from a high school with a total enrollment of 98) defeated Quincy in a real David and Goliath story.
But that doesn’t stop us from fondly remembering the scene where Gene Hackman and his high school boys arrive at Butler Field House for the state championship game. Hackman has players measure the distance from the basket to the free throw line and the height of the basket, demonstrating to the players that everything is “the same as our gym back in Hickory.”
Our methodology is based on measuring and monitoring the sales growth forecast, profitability expectations and projections for a reasonable, considered average P/E ratio in the future for all companies that we analyze. This is how we do.
Equally important is to make sure that we’re prudent. This requires diversification across sectors and industries like everybody else out there building portfolios in the investing world. But we emphasize — on a higher level — the urgency of diversifying such that our blend of companies will produce an average sales growth forecast (plus or minus a percent or two) of 11-12%. So in our investing world, the “Hebrons” are as important as the Quincy entries.
And in the spirit of Gene Hackman’s Coach Norman Dale, measuring what matters is what really matters.
Our Periodic Reminder About “All-Of-The-Above” Investing
While the rest of the world hyperventilates over NASDAQ 5000, we’ll be watching for a different 5000 — that being the 5000 level for the Value Line Arithmetic Average. We think the overall performance of the Value Line 1700 stocks over time is a powerful reminder of the common sense wisdom to achieve and maintain diversification by average overall portfolio growth rate (company size).
The 10-year rate of return on the Value Line 1700 (Arithmetic Average) is (4806.57/1771.3) = 10.5%
The 10- year rate of return on the S&P 500 (VFINX) is (191.73/91.60)^(0.1)-1 = 7.7%
The average Value Line low total return forecast for the companies in this week’s update batch is 4.0% — slightly higher than the 3.6% for the Value Line 1700.
Materially Stronger: Seattle Genetics (SGEN), TCF Financial (TCB), U.S. Steel (X), Fifth Third Bancorp (FITB), ACE (ACE), Private Bancorp (PVTB), Biomarin Pharma (BMRN), Cerner (CERN)
Materially Weaker: Arcelor Mittal (MT), Schnitzer Steel (SCHN), Kennametal (KMT), Brookdale Senior (BKD)
Standard Coverage Initiated:
Discontinued: Alliant Techsystems (ATK), Orbital Sciences (ORB)
Value Line Low Total Return (VLLTR) Forecast. The long-term low total return forecast for the 1700 companies featured in the Value Line Investment Survey is 3.6%, up slightly from 3.5% last week. For context, this indicator has ranged from low single digits (when stocks are generally overvalued) to approximately 20% when stocks are in the teeth of bear markets like 2008-2009.
This tribute was originally shared in October 2012 edition of Expected Returns … but since we’ll be talking about Walter Schloss and some of his screening preferences — we wanted to remind subscribers and future subscribers about Schloss and his fabulous track record.
This month, we celebrate his approach to investing — including a nod to Warren Buffett (Ben Graham) and Value Line.
Long-time readers are somewhat familiar with the exploits and achievements of the late Walter Schloss (August 28, 1916 – February 19, 2012). This month, we celebrate his approach to investing — including a nod to Warren Buffett (Ben Graham) and Value Line. We’ll briefly explore the drivers behind our focus on the Value Line low total return forecast. Value Line is good enough for Buffett who wrote about the achievements of Walter in his work, The SuperInvestors of Graham-and-Doddsville. In addition to the investing guidelines detailed here, Schloss relied extensively on Value Line. In Buffett’s words, “Schloss practiced investing in a way that any ordinary investor can.”
“Over 39 years of investing had delivered annualized returns of slightly over 20% to the clients of Walter Schloss. He worked entirely from a few publications like Value Line …” — Warren Buffett, “The SuperInvestors of Graham-and-Doddsville”
Value Line Investment Survey Low Total Return Forecast (1999-Present). Was the faith in Value Line held by Walter Schloss misplaced? Why does Manifest Investing focus on the low total return (VL LTR) forecasts at Value Line? We think Walter’s faith was well-founded and that Value Line has the potential to deliver outstanding opportunities as a trusted resource. Since 1999, the average quarterly low total return forecast for the Standard Edition has been 8.5%. The actual quarterly returns have been 8.6%. We think it’s a really good idea that MANIFEST PAR tracks LTR, in general.
Schloss shared the following investing guidelines in a presentation dated March 10, 1994. As we’ve said before, and we’ll be happy to repeat — when an extremely successful investor with a track record that spans more than five decades says, “Listen up. This is what is important.” We listen.
1. “Price is the most important factor to use in relation to value.”
Price is an important component of the return forecast equation. The expectations we build for the companies we study necessarily seeks superior returns. We’re here for the returns. Superior long-term performance depends on the discovery of better returns — based on attractive prices.
2. “Try to establish the value of the company. Remember that a share of stock represents a part of a business and is not just a piece of paper.”
“When you buy a stock, you become an owner of the company. There is just as much reason to exercise care and judgment in being an owner as in becoming a shareholder.” — Benjamin Graham
3. “Use book value as a starting point to try and establish the value of the enterprise. Be sure that debt does not equal 100% of the equity. (Capital and surplus for the common stock).”
The value of any enterprise is a combination of book value and the discounted value of a future stream of cash flows. Remember that capital structure is a management decision — and that we expect our leaders to prudently pursue the optimum blend. That said, a company steeped in debt makes interest payments and in the case of failure, common stock holders are often deserted. It’s quite a challenge for a company to go bankrupt with no debt — prudent advice for beginning investors.
4. “Have patience. Stocks don’t go up immediately.”
Patience. Discipline. Good advice.
5. “Don’t buy on tips or for a quick move. Let the professionals do that, if they can. Don’t sell on bad news.”
Do diligence. Pun intended.
Value Line Forecast Efficacy (1999-Present). This graphic profiles the collective low total return forecasts for the Value Line Investment Survey. The green bars represent quarterly four year forecasts based on the 3-5 year median projected low total return. The blue graph provides the actual results four years later. As shown, the second bar from the left represents the 6.1% low total return forecast on 3/31/2000. The second blue dot from the left on the line graph is the actual returns realized for the trailing four years ending 3/31/2004 — the forecast period. The average forecast and average actual result is 8.5% with periods of optimism and pessimism from 1999-present.
6. “Don’t be afraid to be a loner but be sure that you are correct in your judgment. You can’t be 100% certain but try to look for weaknesses in your thinking.”
What are the threats to your assumptions for growth, profitability and valuation? Have you digested the bulls case vs. the bears case from sources like Morningstar? How about the 5-and-3 influences discussion from sources like the Motley Fool Stock Advisor.
7. “Have the courage of your convictions once you have made a decision.”
Do you believe that our approach to understanding the trends associated with growth, profitability and valuation work? If so, let them work.
8. “Have a philosophy of investment and try to follow it. The above is a way that I’ve found successful.”
We know that our mettle will always be tested. The discipline of building expectations and vigilantly monitoring for threats and opportunities with respect to a few key factors makes it easier to adhere to our convictions and philosophy. It doesn’t hurt to have the peer pressure and source of ideas from a community of like-minded investors, either.
9. “Don’t be in too much of a hurry to sell. If the stock reaches a price that you think is a fair one, then you can sell but often because a stock goes up say 50%, people say sell it and button up your profit. Before selling try to reevaluate the company again. Be aware of the level of the stock market. Are yields low and P-E ratios high? If the stock market historically high. Are people very optimistic etc?”
Buy. Hold. For as long as it makes sense to do so?
We think the analysis should be a CONTINUOUS process. Is your return forecast for any stock below money market rates. Market levels? With respect to market barometers, what is the median return (MIPAR) for all stocks? Does your overall portfolio PAR need bolstering? If not, don’t hurry.
But if it is, don’t wait.
10. “When buying a stock, I find it helpful to buy near the low of the past few years. A stock may go as high as 125 and then decline to 60 and you think it attractive. 3 years before the stock sold at 20 which shows that there is some vulnerability in it.”
NAIC co-founder George Nicholson also liked to monitor trailing period low prices, usually 3-5 years.
Stock prices fluctuate.
The key takeaway is to de-emphasize stock price. Heed the chronicle of return forecasts. Keep your eye on the projected returns.
11. “Try to buy assets at a discount than to buy earnings. Earnings can change dramatically in a short time. Usually assets change slowly. One has to know how much more about a company if one buys earnings.”
Earnings and P/E ratios are the staples of the underperforming rhino playground. Earnings fluctuate. Stock price follows earnings — but the focus should be on long-term trends.
Build an understanding of (1) the top line and growth, (2) the profitability trend and (3) the valuation characteristics — particularly as a function of life cycle and industry-specific tendencies.
We don’t buy earnings streams. We invest and own successful enterprises.
MANIFEST 40: September 2012. Our quarterly summary of the (40) most widely followed stocks by Manifest Investing subscribers. Apple (AAPL) finished its ascent up the list, dislodging Stryker (SYK) from the pole position. The outperformance accuracy of the MANIFEST 40 is 69% with an overall relative return (alpha) of +4.9%.
12. “Listens to suggestions from people you respect. This doesn’t mean you have to accept them. Remember it’s your money and generally it is harder to keep money than to make it. Once you lose a lot of money it is hard to make it back.”
We agree. We respect the achievers all around us. As a case in point, the relative return (alpha) of our quarterly summary of the (40) most widely-followed companies by MANIFEST subscribers (shown here) is +4.9%.
We believe in the wisdom of communities and our experience has been that this is a place where ideas are born.
13. “Try not to let your emotions affect your judgment. Fear and greed are probably the worst emotions to have in connection with the purchase and sale of stocks.”
Incomparable advice. We believe that the comprehension of return forecasts (PAR) based on the major milestone judgments (growth, profitability and valuation) and quality enable patience and discipline.
14. “Remember the word compounding. For example, if you can make 12% a year and reinvest the money back, you will double your money in 6 yrs, taxes excluded. Remember the rule of 72. Your rate of return into 72 will tell you the number of years to double your money.”
Stay invested. That doesn’t mean stay 100% in stocks at all times. It is OK, highly desirable, to hold cash equivalents for as long as it takes to shop. Near market tops, we think selectivity is important and opportunities should become more scarce.
Incremental impact matters. Using the +4.9% relative return of the MANIFEST 40 as an example. $100 invested for 40 years at 8.0% attains a value of $2172. Achieving 12.9% over that same 40 years turns $100 into $12,816. Every percentage point increment matters. Big.
15. “Prefer stocks over bonds. Bonds will limit your gains and inflation will reduce your purchasing power.”
True. But carefully consider balanced investing and asset allocation when you’re ready.
16. “Be careful of leverage. It can go against you.”
Two words. Great Recession. What was so great about it? Speaking of great … Thanks, Walter Schloss, for these 16 nuggets. He showed us that superior performance is possible and told us how to do it.
Investors have joked that Warren Buffett’s purchase of the Burlington Northern Santa Fe railroad was simply the fulfillment of a child’s unfulfilled Christmas wish. And on a grand scale.
On November 3, 2009, Warren Buffett’s Berkshire Hathaway announced it would acquire the remaining 77.4 percent of BNSF it did not already own for $100 per share in cash and stock – a deal valued at $44 billion. The company is investing an estimated $34 billion in BNSF and acquiring $10 billion in debt. On February 12, 2010, shareholders of Burlington Northern Santa Fe Corporation voted in favor of the acquisition.
I haven’t dug in to attempt to determine the rate of return on Burlington Northern (yet) but the average annualized return for the average railroad since the time of the transaction is 29.8%. (Berkshire’s return on BNSF is probably in the annual letter to shareholders.)
Everything I’ve seen and remember suggest that the profitability levels of 2004-2009 were fairly typical, representative of general net margin levels going back for quite some time.
Note the inflection and the increased profitability that’s been a powerful work-in-progress for the last 5-6 years.
How might he have known that this was going to happen?
Are there any documented instances or evidence of why this is something that could have been anticipated back then?
Is there any place or industry today that has a similar profitability enhancement potential?
Investors, start your locomotive engines.
Four years ago (3/11/2011) Southwestern appeared — as it often has — among our stocks to study during our weekly update. The stock price at the time was 36.12. And although the price reached 49.2 during 2014, the persistent backslide over the last year to 24.54 means that SWN has delivered an annualized return of -9.2%. The Wilshire 5000 has gained 14.8% during the Southwestern swoon.
Business Description
Southwestern Energy is primarily engaged in the exploration & production (E&P) of natural gas and oil.
2011 Outlook
Our forecast at the time featured 10% sales growth, 26% net margins and a projected average P/E ratio of 19x for a projected annual return of approximately 9%.
Equity Analysis
What’s gone wrong? Overall, the sales growth forecast has remained intact. It seems reasonable to expect 7-10% from this relatively small and well-managed company.
The profitability is what has waned. Value Line’s 3-5 year forecast was 31% four years ago and we took some “shots” at that optimism at the time with some duct tape. Optimism is a good thing — in moderation.
The P/E of 20x or so is still OK. This is a good company.
Yes, Virginia, stock prices follow earnings. .
If it’s reasonable to expect the conditions shown in the accompanying analysis, the Southwestern stock price is going to ultimately follow the blue arrow. But it might gurgle for a while.
Why? Because the economic environment and the prices on gas pumps matter. When they tumble, like from $4.29 to $2.19 rather rapidly, companies like SWN get hammered — some more than others. Check out this side-by-side of the SWN stock price swoon versus the price of oil ($BRENT) as a proxy for “energy prices in general.” Believe it or not, Southwestern is less impacted than most and generally recovers faster than most. The natural gas and oil portfolio diversification of their operations probably helps here.
Many of us, including Hugh, have been talking about the accumulation opportunity that we’re currently experiencing with companies like BP (BP), Schlumberger (SLB) and others.
Looking at the preceding graph, unless you expect that long-term moving average (blue line) to invert and start heading “south”, energy prices will be higher at some point in the future. Companies like Southwestern will persist and ultimately do better.
Personally, I look at the long-term characteristic of that trend (+6.3% annualized over the last 6 years) and see $130-$150 price levels in 3-5 years. It’s possible. Virginia would like to remind all of us that stock prices follow earnings … eventually.
A quick throwback to our weekly update from four years ago …
We watched Apollo 13 this weekend. Do Tom Hanks or Ron Howard movies ever get old? The movie is packed with drama and splashed down on the Hollywood red carpet with a wonderfully deserved nine Oscars, including Best Picture.
Maybe it’s my engineering heritage, but my favorite sequence comes with about three days left in their return voyage when the discover that the cabin is becoming progressively poisonous as carbon dioxide levels are climbing in the lunar module. In a real life MacGyver moment, a team of engineers in Houston scramble and put together an air scrubber using a pile of junk including packing materials and a variety of … well, garbage. But the star of the moment is duct tape. “Aquarius, you need about three feet, Jim.” “Just tear off a strip about as long as your arm.”
As Kevin Bacon fights to avoid passing out, the duct tape kicks in and the air purification is underway.
Sometimes our portfolios need a little duct tape. As roman candles flame out and cruise missiles reach their destination, there are times when plain old ordinary (in some cases, non-growth) companies can be provide a significant booster stage for our portfolios. Our Tin Cup model portfolio owes a great deal to Wolverine Worldwide and AutoZone back in 2000-2002 while the booster rocket debris was landing all around us.
Watch for our online discussion, “Roman Candles, Cruise Missiles & Ejector Seats” which we’ll encore during March … and I’m going back to applying a little more duct tape to our portfolios.
“Houston, we don’t have a problem so long as we have enough duct tape.”
Expecting Alpha 