Tuesday, April 4, 2017

Time to Sell Apple

      I have been back and forth on Apple many times in this blog.  One constant theme, however, has been that the company needs to innovate aggresively on all fronts.  With the stock price at record highs and, in my view, innovation at a low point, the risk-return trade off from owning the stock has turned markedly negative.

       Apple finally did come clean today and admit that the company dropped the ball on the MacPro, but not until more than three years had passed.  During those three years, the company basically deserted the high-end creative users who relied on Macs and sang their praises.  Though not as long in the tooth as the MacPro, the iMac is long overdue for a major upgrade.  Microsoft's new Surface Studio far surpasses the iMac.  That's right Microsoft is making better more innovative computers than Apple!  Even the new Mac books, though beautiful computers, did not break much new ground and Microsoft is gaining in that space too with its Surface Books and Tablets.

      iPad innovation has also slowed.  The only innovative feature of the model that was introduced last month was the price.

        You might say, "who cares," Apple makes most of its money on the iPhone.  But the iPhone is a computer.  In my opinion, all the products fit together and make up a "computer culture."  That culture should lead to innovation on all fronts.  At Apple that no longer appears to be the case.

Saturday, April 1, 2017

Learning from Investment History

      Perhaps the most important lesson I have learned from studying investment history is not to trust what I learn from investment history.  Some recent research I just completed with Rob Arnott and Vitali Kalesnik of Research Affiliates underscores this lesson.  The work relates to the relation between the political party in power and average stock market returns.

      In a provocative paper, Santa-Clara and Valkanov (2003) presented evidence that stock market returns are much higher under Democratic presidents than Republican presidents.  Their work was updated by Pastor and Veronesi (2017), who find that the effect is even stronger when the data are extended through the end of 2015.  Given the strength of the results, Pastor and Veronesi go on to develop a model based on time varying risk aversion to explain the pattern.  They hypothesize that when risk aversion is high, voters are more likely to elect a Democratic (left leaning) president; when risk aversion is low, they elect a Republican (right leaning) president.  Because, risk aversion is higher under Democrats, this results in a higher equity risk premium, and, therefore, higher average returns.

     But there is reason to be suspicious.  Two key events are responsible for much of the differential return under Democratic and Republican presidents.  Specifically, the fact that Republicans were president during the two great crashes beginning in 1929 and 2008 and, not surprisingly, Democrats were president during the subsequent recoveries explains a majority of the differential.  Had the order been reversed, the effect would be largely eliminated.  This suggests the finding may be serendipity.

      To see if the results for the US were chance events, we turned to international data.  Our study covered Australia, Canada, France, Germany and the UK because we had good data on the political parties and stock market returns for those countries.  We examined whether the US pattern - high returns when the "liberal" party was in power relative to the "conservative" party - held in the international context.  For the five countries as a group, we found no relation between the the party in power and stock market returns.  From our perspective, history once again threw investors a curve ball.  What appeared to be a significant relationship between between the market and politics based on US data turned out to be a mirage.

Tuesday, March 28, 2017

Revisiting Tesla

        In honor of Tesla approaching new highs, I went back to a Aswath Damodaran and I wrote in early 2014.  At that time, we were trying to explain the run-up in Tesla's stock price for the 30s to over $250.  We failed.  We found that the most optimistic DCF model that we could defend did not lead to a value exceeding $100.  To get to that level we had to make aggressive assumptions regarding growth in revenues and profits.  How aggressive?  By 2016, we projected that Tesla would have revenue of about $7 billion and operating profit of about $200 million.  Those projectsions rose to $11.5 billion in revenue and $450 million in operating profit in 2017.

        In fact, Tesla's actual revenue in 2016 was $7 billion, close to our projection, but the company's had an operating loss of $667 million.  Despite the introduction of the Model 3, the company is almost certain to lose money again in 2017.

      All this has had no effect on the stock price.  Tesla today, from a valuation standpoint, is Tesla 2014 all over again.  The value depends on the massive and profitable future growth.  This waiting for Godot type of valuation is not unique to Tesla.  Amazon, now more than thirty years old, still trades at a P/E of over 170 based on future growth expectations that have continued to ramp up over time despite the relatively low level of earnings and earnings growth.  But Tesla is not Amazon, it is primarily an automobile manufacturer and as such has to make cars profitiablely and in volume.  That is not something that can be postponed indefinitely a la Amazon.  By December, we should finally know where Tesla stands.


Wednesday, March 15, 2017

This Time is Different

        Though attempting to time the market is hazardous at best, there is one guide I use - the notion that "This time is different."  I take this as a guide because in my view it virtually never is.  In the depths of the depression and the during the crash of 2008/2009, many people thought the world had changed for the worse.  In 2000, it was the reverse - the world was changing for the better.  In retrospect, it was not changing very much at all.  From my standpoint, it is reasonable to be wary about the Trump rally for the same reason.  Rationalizing the high current level of stock prices because President Trump is going to deliver to a new world of tax reform and reduced regulation is an exercise in what I believe is undue optimism.  The status quo is much stronger than most people give it credit for.  So when you hear, the phrase "this time is different" the best reaction is generally no its not.  And the best investment advice as well.

Tuesday, February 14, 2017

Valuing Trump

        On November 7, 2016, Bloomberg reported that the value of all United States equities was $23.742 trillion.  By the close on February 14, 2017, the value had risen more than $2.375 trillion dollars.  Quite a specular dividend for the American people.  The increase, furthermore, was based on little fundamental economic news other than the election of a new President.
        Needless to say, there has been a good deal of speculation as to why Donald Trump appears to have created $2.375 billion in new stock market wealth.  One hypothesis is that the run-up is due to the expected passage of tax reforms and a cutback in costly regulation.
        Another theory, not so flattering to Mr. Trump, is that his administration is sufficinetly disorganized that little will be accomplished but that slowing things down in Washington is bullish for American business.
         Whatever view you take to explain the Trump value creation it should give Democratic leaders pause.  They have pillored Trump as incompetent, uninformed, dishonest, and on and on.  But if they are right, and Trump is the disaster they say he is, then how do they explain the wealth creation?  It seems to suggests that even a disaster like Trump is good for American business if he gets the country off the regulatory road the Democrats were following.  It might be a good time Deomcratic leaders to rethink some of those policies before another election rolls around.

Tesla has almost caught Ford

     Given its run-up in the last few weeks, Tesla's market capitalization is within a hair's breath of Ford.  (Note, however, that market capitalization is not enterprise value because it is based only on equity value.)  This run-up, once again, has occurred without there being any meaningful fundamental news.  What has soared, is what has soared in the past, belief that Mr. Musk is about to deliver something sensational.  This time, however, there may be finally be a resolution.  As the year, wears on Mr. Musk will either produce the Model 3 and sell it at a profit or he will not.  For the first time in its history, Tesla will begin to trade, at least in part, on the basis of its actual financial performance, not its future growth options.  When it does so, I still find it hard to believe it will command a market cap equal to that of Ford.  But we shall see.

Wednesday, February 1, 2017

Fitbit - Valuation is the ultimate question

       In this blog, I have gone on and on about how Fitbit did not have adequate barriers to entry.  But that begs the question, what is meant by adequate?  The answer is adequate to rationalize the valuation.  At valuations of $50, as it was long ago, or even $40, $30 or $20, the answer in my view was not adequate.  At $10, however, the answer becomes I don't know.  And below $6, where Fitbit is trading now, the answer is yes.  Fitbit has become a value stock.  It trades at a P/E well less than the market.  For that reason, I can finally reverse myself and say that Fitbit, which I picked on for so long, looks like a good investment as long as you pay less than $6.

Tuesday, January 24, 2017

Tesla is at $250 - Again

        Once again the stock is hitting $250.  And once again, the fundamentals are largely unchanged.  Time to write some more options.  The auto business remains low margin with high fixed and capital costs.  To make matters worse, delivering the Model 3 at $35,000 seems like a real stretch.

Sunday, January 15, 2017

The Next Computer Revolution and Its Investment Implications

Begin with two facts.  One: computers continue to evolve and improve at an astonishing rate.  Two: people are not getting any smarter.  These two facts have driven and will drive much of the success in the computer, software and social media industries, among others.  Consider, for example, the move from DOS and UNIX to windows based interfaces in the 1980s.  The more intuitive, easy to use windows interface, had a dramatic impact on how, and how much, people used computers.  That translated into increased demand for a host of new services and products.  But even windows computing is far from natural.  People don’t communicate by moving things across screens – they watch and talk.
Like the last revolution the next one will be based on a fundamental change in the human-machine interface.  People want to interact with machines the way they interact with other people.  Amazon’s Alexa is the tip of the iceberg. 
Developing an interface that is natural and “human” will require not only new devices, like virtual reality headsets, but immense improvement in software.  That means, no doubt, a good deal of trial and error.  In that context, investors should not see “failures” like Google glass as a reason to forego investment.  The long-term race to a new interface will be won by companies that are creative experimenters.  By its nature, creative experimentation requires failure.  In my view, investors should avoid companies that have not had some significant failures.  It means that are not pushing the envelope.  Given the complexities involved in AI, future failures are likely to be even more spectacular, but staying the course and failing to fail is likely to lead to the most spectacular failure of all.
The bottom line question is what this all means for investment decision making.  Of course, if I knew (which I don’t), I would be placing my orders not writing this article.  Nonetheless, there are two points worth making.  First, the development of effective AI interface will almost certainly require a collaborate effort.  Creative, technically gifted people, like the students I teach at Caltech, will want to be part of that collaboration by sharing their ideas and insights with others.  That cannot be done within the confines of companies that requires strict secrecy.  Yes, I have Apple in mind.  Apple has walls of secrecy preventing the exchange of information within the company, let alone with researchers in the outside world.  In my view, such a policy will be a disaster for Apple as we move into the world of AI.  Because of it, Apple will lose the gifted, creative people who will lead the next revolution.  If that happens, Apple’s products will fall behind those of its premier competitors.  Therefore, given its current market value of almost $650 billion, Apple is not a company you want to own as long as it clings to this policy. 
One company to watch is Essential, Andy Rubin’s latest start-up.  Andy has been one the tech industry’s most innovative people for close to three decades.  He was a developer of some of the first digital assistants, but is best known as the father of Android.  Essential plans to release new cell phones based on what is described as a breakthrough AI interface.  While some of that may be hype, Essential is certainly on the right track and Andy’s talents are undeniable.  Even if Essential does not succeed itself, the company could have a big impact on both the mobile technology and social media.