Thought Pieces

In addition to our proprietary quantitative models, we do publish our ideas in various formats - print and video - to give you a sense of the way we approach the markets and investing. To see examples of published ideas on individual equities, see the section on individual equities below.

 Visit our Educational Video Channel 


Short five minute videos to help investors understand key big-picture concepts when investing for the long term. Visit now.

Our Latest Economic Insight Graph

TRACKING THE HEALTH OF THE ECONOMY

This is probably the single most effective indicator for understanding the health of the economy and the likely direction of FOMC rate decisions.

Learn how we derive this indicator - [read article] or [watch video].

Click on the image to link to interactive chart in FRED

FEATURED FROM OUR YOUTUBE CHANNEL

Get our 10-year total return spreadsheet to generate your own return estimates - it's FREE

 

Long Term Portfolio Thoughts

The Passive Indexing Pain Point And How To Reduce It

Summary

√  The evidence in favor of passive indexing is getting louder and more convincing, particularly with the help of the robo advisors who use this as their primary sales pitch.

√ We explain graphically the mechanics of active versus passive in layman sports terms.

√ Passive indexers are guaranteed to participate in 100% of the draw-downs. Our disproportionate aversion to loss versus gain, makes this painful - especially if making regular withdrawals from your account.

√ We offer guidelines to minimize this pain and for selecting an active strategy if you should choose to.

...  Read full article

 

 

Taking The Mystery Out Of Forecasting 10-Year Returns For The S&P 500

 Summary

√ With a wide range of future return forecasts from the experts and limited insight into their assumptions, it’s difficult to assess which forecast is more realistic.

√ We will make projecting 10-year returns accessible to everyone, in a simple spreadsheet which you can experiment with and visualize the outcomes.

√ There are two components of future returns; dividends and sale proceeds - which are determined by estimating six key drivers of these two components.

√ These six drivers are real GDP growth, inflation, change in profit margins, change in 10-year rate, change in the equity risk premium and change in the dividend payout ratio.

√ Based on our estimates of these factors, the current 10-year total return estimate is 1%. Enter your own estimates and see the implied return forecast.

 

... read full article

Market Valuation Using Enterprise Value And Market Cap Together - A Much Clearer Perspective

Summary

√ We look at market valuation in the context of Enterprise Value and contrast that with conventional P/E ratio valuations to show why current valuations are higher than they appear.

√ We highlight the spread between operating earnings yield and equity yield as a novel, but correct, approach to understanding valuations.

√ P/E ratios today do not reflect the same value proposition going back in time, relative to the price of the enterprise.

√ Higher growth expectations plus the positive leverage from borrowing are why the spread between operating yield versus earnings yield differs historically from today.

√ This framework for understanding market valuations will show why historical P/E ratios provide little insight relative to current P/E ratios.

 

...  Read full article

Predicting Changes In The Federal Funds Rate - The Magic Indicator 

Summary

√ The Taylor Rule is the most widely accepted indicator for predicting the Federal Funds Rate or explaining the interest rate decisions of the Federal Open Market Committee (FOMC).

√ We present another indicator - the rate of change of productive assets - that better describes FOMC decisions and does not require any of the assumptions required for the Taylor Rule.

√ When combined with a revenue indicator it gives insights into all aspects affecting Fed policy and the Federal Funds Rate.

√ Combining these two indicators into an asset turnover ratio provides a key measure of the health of the economy and tends to lead changes in the Federal Funds Rate.

√ We provide a series of charts to explain our thesis.

 

...  Read full article

The Great Price/Earnings Ratio Reset - Rethinking What 'Normal' Is

Summary

√ The declining lifespan of companies in the S&P 500 should imply lower expected P/E multiples which has not yet materialized.

√ Markets have not yet assimilated the reality of the declining lifespan trend, nor the sheer size of the competitive threat to S&P 500 incumbents, from new startups.

√ We provide evidence of the scale and pace of change that will impact incumbents’ ability to remain competitive and retain profit margins.

√ When we reach a tipping point, we will see a major reset of P/E ratios that may feel like a black swan event, but shouldn't, because the trend is clear.

√ I provide some basic ideas on how to weatherproof your portfolio.

... read full article

Long-Term Wealth Preservation Should Consider Declining Company Lifespans

Summary

√ A study by Innosight in 2012 showed that the long-term average company tenure on the S&P 500 is declining at a rate of about 1% a year.

√ Shortened lifespan should rationally imply lower P/E multiples over time, although we have not seen this happen yet.

√ Long-term investors should consider the types of companies less likely to be made obsolete over the long term.

√ A cap weighted index is an active strategy that continually adjusts for company attrition.

...  Read full article

Essential To Understand This If You Are A 60/40 Investor

Summary

√ We show exactly why the 60/40 allocation has provided better risk adjusted returns by evaluating 60/40 from the perspective of the enterprise.

√ Buying stocks is buying a business, which invariably includes assumption of debt, i.e. being short bonds. Viewed in this light, actual 60/40 “net” bond exposure is significantly less than 40%.

√ Portfolio risk is 90% from stocks and 10% from bonds, not because stocks are 9x riskier than bonds, but because your average true net dollar exposure is close to 90/10.

√ We show historical returns for a variety of strategy combinations based on the insights of this approach, including combinations that target an “actual” net bond exposure.

√ Targeting a true 40% bond exposure has slightly lower returns than traditional 60/40, but better risk adjusted returns with much lower drawdowns; beneficial for retirees who are making annual withdrawals.

...  Read full article

Growth or Value? The Yield Curve May Provide the Answer

√ Ken Fisher , Forbes columnist and CEO of Fisher Investments, in his book TheOnly Three Questions that Count, provides an excellent rationale as to how theyield curve can predict whether value stocks or growth stocks will outperformone over the other.
 
√ The theory goes like this: Companies that have access to new capital will bemore likely to increase their earnings, and shareholder value. When the yieldcurve steepens, value companies have better access to capital, and shouldoutperform growth companies. When the yield curve flattens, growthcompanies have better access to capital, and growth should outperform value.
 
How does it work?
 
... Real full article

Dissecting The Holy Grail Of Market Timing

Summary

√ Peak-to-trough drawdown periods represent approximately 27% of calendar days since 1950.

√ Avoiding peak-to-trough drawdowns would have increased your returns by a factor of 2.12. Being short the market during drawdowns would have increased this to 3.23.

√ Using up-capture and down-capture ratios are the best way to evaluate the effectiveness of market timing strategies.

√ To successfully time the market, it's best to have a quantitative system based on macroeconomic and fundamental variables, that is tested over many cycles and different interest rate regimes.

√ Even good market timing strategies will underperform during bull markets and the amount of underperformance can be viewed as an insurance premium.

...  Read full article

... Read response to reader question regarding volatility based moving average

 

 

Chart-By-Chart Case For An Extended Period Of Low Long-Term Interest Rates

Summary

√ A combination of debt overhang, the Fed’s inability to stimulate credit, low inflation, and reduced new investment caused by lower growth, excess capacity and new technologies, will keep rates low.

√ At this stage of the interest rate cycle, we explain why long rates will only increase through new investment or inflation, and examine the factors hampering growth of either.

√ We evaluate the Fed's ability to influence long term rates.

...  Read full article 

Predicting Future Equity Returns, Plus A Longer Duration Shiller CAPE That Has Worked For 80 Years

Summary

√ We review the components of future returns and compare estimates from a few respected sources.

√ Of the three components of returns, the most important unknown is the valuation multiplier (P/E). We provide a formula to explain how you should think about it.

√ Some experts assume P/E mean reversion to historically lower levels, and simultaneously project low growth rates for earnings. This combination is incompatible in our opinion.

√ We introduce a 16-year Shiller CAPE that gives a significantly better fit than the 10-year CAPE for future returns. It's a bootstrap method that has worked for 80 years.

√ We show both the projected returns and trajectory of the S&P 500 through 2030, using the CAPE-16.

... Read full article

Niche Idea - Thoughts

How Retirees Can Sell Put-Option Premiums To Mitigate The Dilemma Of Low Bond Yields

Summary

√ One of the biggest challenges facing investors of retirement age, with typically heavily weighted bond portfolios, is the current low income yields that bond provide.

√ This strategy is designed to help enhance that income opportunistically, by selling put option insurance on equities, when the risk-reward ratio is acceptable.

√ We employ this strategy using only pre-qualified, dividend paying, value stocks that meet our strict risk-return criteria.

√ We will walk you through, step-by-step, how to evaluate the risk-reward and implement this strategy in your own account.

√ When implemented opportunistically, it has the potential to deliver attractive returns in excess of bond returns.

... Read full article

Typical Millennials Should Allocate At Least 25% Of Their Portfolio To This Specific Asset Class

Summary

√ The typical millennial profile (post-college graduation) has human capital as their only asset, but is also effectively short both bonds (student debt) and residential real estate (renters).

√ Given most millennials' desire to own a home, their largest risk exposure, pre-home-ownership, is the risk of inflation in residential real estate, which can far exceed conventional CPI.

√ Given this, we recommend a large portfolio exposure, indirectly leveraged if possible, to various components of the residential real estate sector, until the goal of home ownership is reached.

√ We offer a portfolio solution to implement our recommendation including specific sectors and stocks.

√ Along the way, we explore various other issues, such as setting your goals, repaying your student debt, and the best time to buy a home.

...  Read full article

Individual Equities - Thoughts

The Simple Reason Why Groupon Is Cheap - Especially For Alibaba

Summary

√ Alibaba disclosed this week that it has purchased about 33 million shares or a 5.6% stake in Groupon.

√ The market values GRPN's active customers at $32 each versus $372 for BABA's active customers, even though net revenue per GRPN customer is 75% higher.

√ GRPN trades at a discount to both its own likely customer acquisition replacement cost and typical industry customer acquisition costs.

√ BABA’s higher price/sales multiple allows BABA plenty of room to make GRPN's customers accretive to value if they can bring them into the BABA ecosystem.

√ GRPN’s latest earnings release indicates improved operating performance, which together with its discount to typical customer acquisition costs makes GRPN cheap even in the absence of any potential BABA synergy.

...  Read full article

The iStar Financial Evolution - From Mortgage Lender To Landowner

√ Four years ago, iStar Financial's (SFI) primary business was providing shorter-term senior debt for real estate development projects. With the onset of the financial crisis, the collapse of collateral values and a liquidity vacuum, the majority of their loans were unable to obtain replacement financing as they came due. As a result, these loans became non-performing and SFI has spent the past four years taking back, sometimes through lengthy legal battles, the collateral underlying the loans. At the same time, the company has been reducing the size of its balance sheet by diligently paying down its own debt maturities through refinancing and asset sales.

√ That process is nearing its final days, with the result that SFI is now a completely different animal than it was four years ago.

...  Read full article

3D Systems: Food For Thought... And Concern

√ The 3D printing and rapid prototyping industry is a wonderful advancement in engineering that opens up exciting opportunities for many industries. For companies that make and sell products en masse, it gives them the ability to turn a design into a prototype in perhaps one-tenth the time of traditional manufacturing methods. For companies that sell custom, one-of-a-kind applications, such as a personalized medical device, they can manufacture the finished product to exact custom specifications in a very short time. There is also the home market, which while still in its infancy and mostly used by hobbyists, may develop into something bigger.

√ Anyone needing 3D printing services has two options; they can buy the printer and all the necessary accessories and set up a production environment in-house, or they can choose to outsource the production to one of many rapid prototyping services who utilize 3D printing machines. It's a simple procedure, whereby the CAD file is uploaded to the prototype service provider, and in many instances they can have it printed and shipped out in 1-2 days. The whole procedure is handled online without the need for human interaction.

√ The concern here is not for the future of this industry. I think it's phenomenal. The concern is that the valuations of some of the companies that operate in this space, are now in "outer space" and meet many of the criteria to be classified as a bubble

...  Read full article

Navistar's Deal With Volkswagen Is Good For Volkswagen But May Not Be Enough To Cure Navistar's Woes

 

√ Navistar's stock price has risen 100% in the past four months on news of an impending equity commitment and alliance with Volkswagen Truck & Bus.

√ From VW's perspective, the equity commitment at $15.62 per share has a very different value to that of Navistar shareholders and does not necessarily represent fair value.

√ While the alliance with VW will provide cost savings and synergies, the balance sheet liabilities and top-line revenue represent major hurdles for Navistar to overcome.

√ Its unfunded post-retirement liabilities of $3 billion will likely consume a big chunk of operating earnings for a long time.

√ The current price, we believe, assumes a best-case outcome for its plan, with perfect execution under extremely difficult conditions. We feel there is significant downside risk from the current price.

...  Read full article

Planet Fitness - I'd Rather Be Stuck On A Stairmaster For The Next 23 Years

 

Summary

Private equity is slowly unloading their ownership onto the public since the IPO via a complicated structure and in a seemingly calculated manner.

The complex structure involves the use of a tax receivable agreement which burdens the new stockholders with a liability, and annuity-type payments going forward for the next 23 years.

The operating income is deceptive - we estimate more than 25% is from non-recurring items and needs to be evaluated separately from recurring income to value the company properly.

We model the company’s future income using what we believe are generous growth projections, consistent with the company’s story, which reveal unlikely implied growth milestones over ten years.

We arrive at a value of approximately $9.40 per share – a more than 50% downside from the current price.

 

 

...  Read full article

Pandora Media: Stuck In The Mud, Pedal To The Metal And Wheels Spinning

Summary

Pandora, the leader in the US streaming space, facing a challenging growth environment, announced a pivot to a more balanced revenue model with the introduction of a new premium service.

They put forward a “Roadmap to 2020” detailing how they plan to triple top line revenue over the next four years.

We reformat their operating statement to expose their true gross margins and to gain a clearer understanding of the company’s operations and profit potential under the new roadmap.

We show that Pandora will likely continue to report losses for the foreseeable future, even if their wildly optimistic projections in their roadmap scenario is achievable.

We highlight the company’s challenges as well as its possibilities and conclude that the stock, while difficult to value given no profit visibility, is likely in the $4-$5 range.

...  Read full article

 

Wayfair - We See 80% Downside From Here

Summary

Wayfair has one of the highest short interests among NYSE equities, and we think that short sellers will be proven correct in short order.

The effective profit margins of this business, when properly accounted for, are too small to ever result in a sustainable business.

Massive spending to acquire new customers, and returning purchasers needing to make many purchases - not common for home furnishings - just to recoup the customer acquisition costs.

We show why we believe the company will need to raise additional cash imminently to continue growing, and will likely access the capital markets within the next 120 days.

We believe that this stock has 80% downside from its current price.

 

...  Read full article

Ulta - An Impressive Growth Story, But Fair Value Is 40% Down From Here

 

Summary

Ulta is a very successful retail concept, delivering sales per square foot of $450 out of a 10,000 square foot store, and 21.7 million Ultamate Rewards loyalty program members.

At 949 stores, and adding 100 new stores each year, they are about seven years away from reaching their current stated 1,700 store potential in the US.

With a TTM P/E ratio of 46, the market is overlooking the fact that as they approach 1,700 stores, the growth story will be mostly complete, justifying a declining P/E-multiple over time.

We model the impact of a declining P/E multiple to show that investors buying at the current price will likely experience negligible returns, while still assuming the risk of execution.

To earn a reasonable 9% compound annual return over seven years, investors would need to purchase the stock at $168 – 40% lower than the current price.

 

 

...  Read full article