Tuesday, September 5, 2017

A Crack in Apple's Secrecy Wall

       One of the themes of this blog is that Apple succeeds in spite of their dedication to secrecy, not because of it.  The benefits provided by splashy announcements of "secret" new devices like iPhones are more than outweighed by the costs of preventing brilliant, creative people from sharing and vetting their ideas with the broader community.  Well AI is causing a crack in the wall.  The AI community, including its academic component, is so commited to openness and transparency that Apple is having a hard time recruiting top people.  Today's Wall Street Journal reported that Apple is considering a more open policy for AI research.  I see this as a big plus for Apple, not a risk.

Saturday, August 12, 2017

Diversity at Google

            The brouhaha at Google regarding corporate “diversity” reminds me how confused I seem to be about this whole issue.  In a nutshell, there are four things I find to be particularly perplexing.

            First, if it our belief that people should not be judged according to criterion like race and gender, then why are we judging them that way?  Why is diversity defined in terms of variables that supposedly don’t matter?

            Second, in response to the first question, one possibility is that certain groups bring unique perspective to the corporate enterprise that helps promote the company’s success.  However, even assuming that is so why should the criterion by which groups are defined be variables like race and gender?  If the goal is to incorporate different viewpoints, I have found far more differentiation in perspective between fundamentalists and atheists than between men and women?  That finding, if true, implies that diversity should be defined along religious lines.  The same could even be said of political beliefs.  It seems clear, however, that opening the door to corporate political “diversity” would be a nightmare.

            Third, what is wrong with the simple criteria that all people be treated fairly in terms of their ability to do the job?  In that case, all a company has to do is make sure that variables like race and gender do not affect hiring, evaluation and promotion.  Companies should not be in the business of making social policy (just as I argued early they should not be in the business of making climate policy) because they lack both the training and the standing.  Those are issues best left to governments.  Companies can benefit society by offering the best products and services they can at competitive prices not by deciding what social groups, if any, require special treatment.

            Fourth, if there is a group that has been discriminated against so that their compensation and promotion fails to reflect their marginal product that is a great business opportunity.  When Jeff Bezos concluded that traditional retailers were not taking full advantage of the internet his solution was to start Amazon, not lobby Walmart.  In the same fashion, if good people can be hired at a bargain prices because of bias there is an opportunity to create value by hiring them in droves. 

Wednesday, August 9, 2017

What is the True Range of the Tesla Model 3?

      In December 2016, I published the results of tests I performed on my Tesla model S.  At that time, I wrote (the link is below),

I charged my Tesla fully at which point it said I had a range of 238 miles and then ran it down to a range of about 30 miles several times.  The first piece of bad news for Tesla owners is that while my range dropped an average of 208 miles, the car only traveled an average of only 144 miles – less than 70% of the promised range.  To cover those 144 miles, I used 51.2 KWH of electricity which comes to 2.80 miles per KWH .

       It is surprising that there is been so little written about actual range versus "stated" range.  Perhaps it is the case that many owners of the Model S and X, like me, come from families with several cars and do not rely on the Tesla for long trips.  But as a mass market car, the Model 3 is likely to be different - buyers will rely on it as their primary car.  If actual mileage in typical driving turns out to be only 70% of the stated range there could be quite an uproar which could come back to haunt investors as well as car owners.

Link to December article

Tuesday, August 8, 2017

If Apple Wants to Buy a Car Company

       There has been a lot of speculation about Apple buying Tesla.  While the mixture may be intriguing, Apple should bear in mind Warren Buffet's warning that no asset is so good you cannot overpay for it.  At a market cap of over $61 billion Tesla is already very richly priced without adding an acquisition premium.  So if Apple wants to buy a car company, why not Ford?  Ford's market cap is only $41 billion - much less than Tesla and a pittance compared to Apple's cash.  Plus Ford makes and sells a wide variety of vehicles all of which could benefit from Apple's technology.  Admittedly, Ford has a lot more debt than Tesla but the interest payments would be no sweat for Apple.  In short, if Apple wants to buy a car company why not buy one that makes a lot of cars and sells for a low price.  For that matter, Apple could even consider GM.

Government and Climate Change

       In a previous post, I argued that private firms should not base decisions on their assessment of the impact on climate.  The reason was that climate change is not only complex from a scientific, economic and statistical standpoint, but that it involves tradeoffs between conflicting groups of people that only governments should address.  There is a fly in the ointment.  Virtually all the economists whose work I follow argue that the best way to address climate related externalities is with a carbon tax - a view with which I heartily agree.  The problem is that a carbon tax does not offer a lot to politicians.  Not only is it likely to be unpopular, it removes the opportunity to use climate change as a reason to engage in a host of pork barrel programs that can advance one's political career.  In my home state of California, for example, we have dozens of special programs and subsidies designed to "combat climate change".  Few, to my knowledge, have been subject to any rigorous cost benefit analysis.  For instance, there are credits that are given to "zero emission vehicles" but not hybrid plug-ins.  This despite the facts that zero emission vehicles are not zero emission because most of California's electricity comes from carbon fuels and that many plug-in hybrids actually produce less greenhouse gases (taking account of electricity generation) than ZEV muscle cars like the Tesla model S and X.

       In short, climate change is such a large, complex and important issue - economists call it the mother of all externalities - that it opens the door to unprecedented levels of pork barrel politics.  Hopefully, much of that will be avoided, but our track record is not a good one.

Monday, August 7, 2017

A closer look at Tesla’s Q2 earnings “beat” by Andrew Cornell

         Tesla reported Q2 earnings after the bell Wednesday and shares rose 20 points following what was widely described in the press as an earnings “beat” on both revenue, 2.8 billion compared to an expected 2.5, and a loss per share of -1.33 compared to an expected -1.82.  In their letter to shareholders Tesla claimed an increase in vehicle deliveries of 53% compared to the same quarter last year.  Tesla CEO Elon Musk reiterated the production schedule for the Model 3 and expected that Model 3 margins would up 25% at the end of next year.

         Closer analysis of Tesla's quarterly earnings, however, reveals the quarter may not have been as significant of a “beat” as the headlines indicated.  A large portion of quarterly earnings and revenue can be attributed to a $100 million of ZEV credits.  Because Tesla only makes electric vehicles, they accumulate a surplus of ZEV credits which can be sold to other auto makers.  ZEV credits are government subsidy that costs Tesla nothing.  Consequently, the sale of credits contributes $100 million to both quarterly revenue and profit.  Without the sale of those credits, Tesla would have lost an additional 61 cents a share for quarter which would put quarterly losses at almost exactly what analysts estimated.

         Tesla’s claim of a 53% increase in deliveries for the quarter doesn’t look nearly as good when comparing to recent quarters.  In last year’s Q2 delivery report Tesla claimed a "steep production ramp up" resulted in high production during the last few weeks of the quarter so that many vehicles “in transit" and would be delivered and counted in the third quarter.  Consequently, Q2 2016 deliveries totaled 14,370 compared to Q3 at 24,500 when both Model X and S production lines were working at full capacity.  Had Tesla compared sales to Q3, the 53% increase becomes a 10% drop in deliveries.  Comparing deliveries to the most recent previous quarter gives Tesla a drop of 12%.  It appears Tesla is taking advantage of a weak 2016 second quarter to make their latest quarter look comparatively better.

        Following the July 3rd release of their 2017 Q2 delivery and production count, Tesla’s shares dropped from 375 to 310.  Several days later in a press release, Tesla once again highlighted vehicles in transit as an explanation for the lower than expected delivery numbers.  The company stated that vehicles “in transit”, 3,500 in total for Q2, would be counted in the 3rd quarter delivery numbers.  Adding 3500 cars to Q2 turns a disappointing 22,000 deliveries into a new quarterly record of 25,500.  What Tesla didn’t tell investors in the press release was that having vehicles in transit wasn’t unique to the second quarter.  The 3,500 vehicles in transit being applied to Q3 were more than offset by 4,650 vehicles in transit from Q1 that were counted in Q2.  The details are shown in the graphs below which show Tesla's reported deliveries by quarter and deliveries by quarter when vehicles in transit are added to the current quarter.

Sociobiology and Social Media

        Evolutionary biology suggests that between the ages of 12 and 25 people tend to be intensely interested in two things: social status and sexual selection.  This makes perfect sense.  As people enter prime reproductive age, status and sexual standing are the two things that have the greatest impact on successfully passing their genes to future generations.  It is no surprise then that people of that age are intensely social and make massive use of social media.  The hard question is what does it mean for investing in social media?  Despite their intense focus on social sorting, young people do not control most of society's resources and constitute only a sliver of total consumption.  Nonetheless, the idea is that if a company like Snap can attract a huge following among the young, those customers will stay with the company throughout life.  But there is a problem.  As you age matters of social and sexual status become settled.  People begin to realize that others are not that interested in them and they are not that interested in most others.  As a result, their interests in social media change.  The voracious appetite for right now interaction that disappears is replaced by the desire to keep in touch with family and close friends.  The very features that made a social site cool when you were young, becomes an irratating pain in the neck as you age (and as your consummable income increases).

       I am not sure what all of this means for investing in social media companies like Snap but I think it is something that cannot be overlooked.

Sunday, August 6, 2017

Private Firms and Climate Change

         In this essay, I mean private firms as opposed to public organizations like Department of Energy and the United Nations, not private firms versus publicly traded firms.  The point of the essay is to argue that private firms should not attempt to react to climate change in setting their corporate policies.  This has become a point of contention because private firms have been under pressure by both sides of the spectrum to make business decisions with an eye toward their impact on the environment and the climate.  In my opinion, that is not wise for two reasons.  First, climate issues are immensely complex involving aspects of fundamental science, economics and statistics.  Second, and even more importantly, climate policies by their nature involve tradeoffs among a large number of competing groups of people.  For instance, requirements that a certain fraction of energy come from renewable sources tends to benefit the rich at the expense of the poor who may not be able to pay for more expensive power.  These tradeoffs involve not only people alive today, but many future generations. 

            The simple fact is that private firms, even the most sophisticated private firms, have neither the knowledge nor the standing to make decisions based on their impact on climate.  Attempts to do so, beyond engaging in public relations efforts to appear green, are almost certain to be counterproductive and unfair to various groups of people.
            Only national governments, or international organizations have the knowledge and the proper standing to determine climate policy.  They do so by setting the rules of the game through regulations and impacting market prices through taxes and subsidies.  Private firms, in turn, should take those rules as given and do the best they can for their investors and customers.  If it is concluded that under a certain set of rules insufficient effort is being made to limit the production of greenhouse gases, then the rules need to be changed to produce different incentives.  Private firms could then react to the new rules.  However, private firms should not base decisions on their perceptions of how those decisions will affect the climate.  If they did so, the result would be a hodge-podge amalgam of idiosyncratic decisions made by people not adequately trained and without the proper authority to make them.

            More specifically, climate policy depends on the answers to four groups of questions – none of which private firms are in a position to answer.

1.  Does human activity have an impact on the accumulation of greenhouse gases?

2.  Assuming the answer to question one is yes, what will be the impact of the human caused increase in greenhouse gases on global temperatures going forward?

3.  What will be the costs and benefits associated with rising global temperatures?  How will those costs and benefits be distributed across groups of people alive today and across future generations?

4.  What will be the costs of policies designed to combat rising temperatures?  Who should bear those costs?

            Questions one and two are difficult ones that require scientific specialists that virtually no private firms employ.  Questions three and four are exactly the type of questions that private firms should not be trying to answer.  Trading off the welfare across diverse groups of people is an issue that can only be tackled by governments, to the extent it can be tackled at all.  Asking private firms to address it through their climate related decisions is not only folly, it is altogether inappropriate.

            Finally, I claim that my conclusion is independent of views regarding the appropriate climate policy.  Both those who believe that aggressive steps must be taken to combat global warming and those who feel the problem is no more than a minor annoyance should agree that the debate requires a public forum and should not be held in the boardrooms of private firms.

Saturday, August 5, 2017

What We Learned From Tesla's Earnings Announcement: Almost Nothing

      I was hopeful to gain insight into Tesla's fair value from the company's earnings announcement.  No such luck.  The value is still based on speculative growth options whose value depends more on sentiment than hard analysis.  The big questions remain unanswered.  Do a vast number of Americans really want an all electric sedan?  What price are they willing to pay for it?  Can Tesla profitably produce the cars at that price?  If so, will it cannabalize the Model S?  What are the cash flow implications for building, servicing and powering all those cars if the Model 3 is a success?  None of these questions were answered.  What's worse it looks like it will be six months, at least, until we start to learn the answers.

      In the meantime, there were some curious financial details associated with the announcement and the manner in which Tesla "beat" the streets earnings forecast.  Those will be addressed in an upcoming post.

Thursday, July 20, 2017

And Then You Pull the Switch

       A great many tech companies, Amazon is the most famous example and Snap is one of the most recent, are valued on what I call an "and then you pull the switch" basis.  By this I mean during phase one the company's goal is to build market share.  During this phase, the market focuses on subscriber growth and locking in subscribers, not current cash flow.  Then in some future phase two, the company is assumed to "pull the switch" and start making big profits from those locked in subscribers.  Ironically, 20 years after its IPO, Amazon is still widely interpreted as being in phase one.

       The critical valuation question is whether there will actually be a phase two in which the company pulls the switch and raises prices to customers and advertisers and, thereby, starts generating big cash flows or whether counterparties will pull their on switch and jump to another company.  I think Netflix is particularly vulnerable in this respect.  I do not see the customers being locked in sufficiently to justify the company's massive multiple of 230.  It is too easy for customers to switch if Netflix raises prices.

       In all of this it is critical to remember that value comes from cash flow, not customers.  For a comapny to have huge value today with small current cash flow, the switch they are planning to pull must be a big one indeed.  And when that big switch is pulled all the customers must stay with the company.

Wednesday, July 19, 2017

What is Driving the Aggregate Market Up?

       In a rational economic model, there must be new news about expected future real cash flows for the market to rise substantially.  I say real cash flows because in rational models inflation appears in both the numerator and denominator of a DCF model and cancels out.

        What is it about economic expectations that keeps the market rising?  Quite frankly, I don't have a clue.  It seems to me that all potential good news about the recovery, about Trump, and about growth was more than discounted months ago.  If anything, the new news seems to be that growth is more anemic than was previously anticipated and Trump is performing more poorly than hoped.  I keep thinking this has to end.  And end unpleasantly.  But day after day I am surprised as the market inches upward.

Tuesday, July 18, 2017

Even the Best Companies can be Overpriced

        Amazon, Netflix and Google.  Three great companies whose products I use with regularity.  They are profitable.  They are growing.  They have a dominant market position.  They have great management.  They are innovative.  For all those reasons, they should trade at a high price.  The question is how high.  And no matter how good a company is there comes a point where it is too high.  In my view, all three have reached that point.  This is not to say I would recommend being short.  Who knows how long the enthusiasm will last?  But at current prices, I would not touch any of them on the long side and would take profits on outstanding positions.  For Amazon and Netflix in particular, the P/E ratios are astonishing - 192 and 241, respectively!  Those sort of multiples imply market expectations of extraordinarily rapid growth in future cash flows.  It is hard for me to see those multiples expanding further and easy for me to see them contract considerably.  At this level, the risk/return tradeoff is far too weighted on the side of risk.

Wednesday, July 12, 2017

True Believers and Stock Pricing

            Back in 1977 Edward Miller wrote an article that still resonates today and provides insight into what I call “true believer” stocks like Tesla and Snap.  To see how Miller’s analysis works, take a look at the graph below.  The y-axis of the graph shows the estimated value of the company.  This varies from investor to investor.  The x-axis shows the number of shares investors are willing to hold.  The number of shares outstanding (net of any held by index funds), N, is depicted by the vertical line.  The key component of the graph is the downward sloping line.  This shows how many shares investors are willing to hold as a function of price.  As the price declines, more and more investors are willing to hold the stock.

            Market equilibrium exists when the N shares are held.  The graph shows that this occurs at a price, P.  This would be the market price.  Notice that P is above valuation of the median investor, M.  Miller’s key insight is that as long as the outstanding shares, N, are held by a relatively small number of “true believer” investors (small compared to all possible investors), the price will exceed the average assessment of value.  In that sense, the company will be overpriced.

            If price exceeds the average assessment of value, why don’t the pessimistic investors sell short?  Well some do.  For instance, Tesla and Snap are among the most heavily shorted large cap companies.  But even for those two companies, the short interest is only about 20% of the shares outstanding.  In terms of the graph, short selling moves the vertical line for N to 1.2*N.  That is still an amount of shares that can be absorbed by true believers.  (Why there is not more short selling is a question I postpone for another day.)

            By true believers, I mean investors who think that the subject company has growth options that will “disrupt business as usual” and “change the world.”  The problem with such investors is that it is hard to know what they base their beliefs on, or, more importantly, what would cause them to abandon them.  As I have stressed in earlier posts, beliefs regarding growth options can change overnight and if they do a death spiral can result.  Without the ability to sell securities at high prices to true believers, the company becomes starved for cash, operations run into difficulty, key people leave, customers flee, etc.  It is the story of eToys, My Space, and Groupon that has happened so many times.

The Rush to Short Snap

     Sometimes shorting a stock can be difficult and expensive.  In order to sell a stock short, you must first borrow the shares.  Because there is not a centralized lending market for stocks when there is a big demand to short a stock the lending market can become congested.  When it does so, the rebate rate can skyrocket.  For those of you who aren't familiar with the rebate rate it works like this.  Say I borrow Snap to short it and then sell the stock for say $100,000 dollars.  The rebate rate is the rate the I receive on the $100,000.  In many cases, it is zero.  But in some cases, when there is a big demand to short the stock, it can turn negative.  In the case of Snap, the rush to short it in recent days has been so great that the rebate rate has exploded to a NEGATIVE 60% per year!  (See the link below.)  That means I would have to pay 60% interest on the $100,000 while I was short Snap.  Clearly, I would not do so unless I expected the stock to crater in the near future.  But that is exactly what many investors have been doing in recent days.  The next few weeks leading up to the expiration of the lock-up on Snap shares at the end of July will be interesting days indeed for Snap investors.

Article on the Snap rebate rate

Tuesday, July 11, 2017

Growth Options One More Time - The Case of Snap

       In my previous discussion of growth options, I used Tesla as an example.  A better example is Snap.  Before saying why, a word of disclosure.  My godson, Evan Spiegel, was one of the founders of Snap.  That said, I know nothing about the company other than what I get from public sources.  One thing that is clear from those sources is that the value of Snap is almost entirely growth options.  Based on current operations, the company has large losses and negative cash flow.  For Snap to have any meaningful value, it has to grow and grow profitably.  That means exercising growth options.

        The problem is that no one can say with any certainty what Snap's growth options are let alone how valuable they might be.  As a result, the market value of the company can swing wildly as perceptions change regarding the growth options.  And swing it has.  Starting from an IPO price of $17 the stock shot to $25 and has since dropped almost 40% to 15.52 on virtually no fundamental information.  Does the lower price mean the stock is now "cheap?"  Not at all.  It still depends entirely what you think about the growth options.  The stock could be worth anywhere from basically zero to nearly $50 depending on those growth options or lack thereof.  Talk about risk.

A DCF for Apple

      Despite the amount of time I have spent discussing it, Apple is actually a suprisingly easy company to value for two reasons.  First, it has a lot of cash whose value is unambiguous.  Second, the company has grown so large that it reasonable to expect it to mimic the aggregate economy.  That is the assumption I build into my DCF.  I project 10% growth in 2017 based on the introduction of new iPhones, but after that expected growth is equal to that projected for the U.S. economy.

      To be sure Apple could surprise on the upside with new innovations.  But it also could surprise on the downside if innovation slows and margins contract.  Remembering that DCF models rely on expected values, the assumption of mimicing economy growth seems like a good one.

       Using that growth rate and a discount rate of 9.00%, the value of Apple comes to $172.  A bit higher than the market price, but not exceptionally so.  As always, I urge my readers to play with the assumptions.  Relatively small changes in expected growth or the discount rate can have a meaningful impact on the final valuation.

Apple DCF

Monday, July 10, 2017

A DCF for Fitbit

       In the past, I have complained about people posting investment analysis without real analysis - that is without a complete DCF model.  Unfortunately, this criticism applies to me as well.  Therefore, in the next few week s, I will be posting Excel versions of DCF models for companies that I have discussed on this blog.

        Here is one for Fitbit.  Notice that my assumptions are quite pessimistic.  For instance, the company is assumed to make no profit for the next three years.  After that, it turns marginally profitable but is able to grow only at the rate of inflation.  With these assumptions the DCF value comes to $5.31 which is almost equal to the market price.  This gives you a good feeling for what the market is expecting for Fitbit.

         Remember that the cash flows in a DCF model are statistical expectations.  As sucy, they reflect a number of future possible scenarios weighted by the probability of those scenarios.  In one such scenario the company may do markedly better than the projection, but in another it may fritter away its cash and go backrupt.

Fitbit DCF Valuation

An Updated DCF model for Tesla

      It still has aggressive assumptions for growth and profitability but comes in at $128.  Enjoy playing with the assumptions to see what valuations you get.

Tesla DCF Valuation

Wednesday, July 5, 2017

Growth Options and Risk

      Stewart Myers of MIT coined the term "growth options" to refer to future projects a company has the opportunity to undertake.  Because the projects have not yet been undertaken, and in some cases may not yet be envisioned, the market valuation of growth options is prone to large swings.  It depends on the perceptions of investors regarding what a company might be able to profitably do in the future.  And those perceptions are likely to be mercurial because they are, by necessity, based on speculation regarding future businesses rather than the performance of actual businesses.

       Investor perceptions regarding the growth options of Tesla have been the reason that I have been wrong about Tesla's stock price this year.  I thought it was overvalued at $300 because I did not see many growth options in the competitive automobile industry.  There were enough investors that disagreed with me to drive the price over $380.

       What makes investing in companies whose value is derived in large part from growth options so risky is that perceptions can change much more rapidly than the economics of operating businesses.  If perceptions do change, the market valuation of growth options can disappear virtually overnight.  Again Tesla is an example.  In a week, it has dropped from over $380 to about $335.  (I still expect it to fall below $300).  Of course, perceptions can change again if Mr. Musk makes some dramatic announcements.  Such volatility is likely to continue until Tesla matures to the point where more of its value is based on actual operations.

Tuesday, June 27, 2017

One Reason Why VIX Matters

      Like many investors, the nine year bull market has left my fund with a large amount of unrealized capital gains.  With prices now very rich, at least in my view, I feel the risk/return trade-off is much less favorable then when those investment were made.  I fear there is a reasonable probability of a large downside move, whereas further increases on upside are likely to be limited.  One reaction to this view is liquidate those positions.  But that means paying a large capital gains tax.  The tax is particularly onerous for California residents like me because California has a 13% marginal tax rate and NO allowance for capital gains.

       One strategy that appeals to me is writing call options against the positions with large unrealized gains.  That provides some added return in the form of the option premium and, thereby, some downside protection.  Furthermore, if future price appreciation is likely to be small, as I believe, the cost in terms of foregone appreciation is limited.  The downside is that option prices are very low because the expected volatility is a record low levels.  The risks that I see are not reflected in the VIX or in the expected volatilities of many individual stock options.  That makes the option writing strategy much less attractive.  That is a reason the VIX matters.

Wednesday, June 21, 2017


        The risk of investing in the overal stock market is measured by the market "volatility."  That volatility is measured the annualized standard deviation of daily stock market returns.  During the years from 1962 to 2016 the average standard deviation has been approximately 15.50%.  Of course, it was much higher during crises and lower during quiet time, but on overall average 15.50%.

         To compute historical standard deviation requires data past data on returns, but there is another way to get an estimate of how volatile the market returns are expected to be on a forward looking basis.  That can be done by solving for the volatility that equates the market prices of options on the S&P 500 index to theoretical prices derived from option pricing models.  The Chicago Board Option Exchange computes the number on a daily basis for S&P 500 puts and calls with a maturity of 30 days.  That number is referred to as the VIX index.  Like the S&P 500 index, options and futures are traded on the VIX index.

         The reason for all this background is that despite what seems like a turbulent situation in Washington and around the world, the VIX index is currently trading at all time low of about 10.80%.  What's more it has pretty much been stuck as this level for about the last six months.  Now you may think that such a low level is not sustainable and the volatility should tend to rise back toward its historical average.  If that is your conclusion, you are not alone.  The figure below shows the futures curve for the VIX.  To a high degree of approximation, futures prices can be interpreted as the market's expectation of the future level of the index.  The figure shows the expected volatility rising steadily to 16.94%, a level higher than the historical average, by next February.  Note this means that you can't make money betting on the increase because the market prices have already impounded the expect rise.  Ironically, the market has been expecting such an increase for the last six months while the VIX has remained locked at record lows.  As a result, the people who made money during that time were those who bet against the anticipated increase.

         My advice for now is to watch the VIX index closely.  In future posts, I will explore some of the investment implications of its record setting behavior.

Thursday, June 15, 2017

Is the Fed Responsible for the Chaos at Uber?

      Uber is awash in easy cash.  Private investors have pumped money into the company on increasingly generous terms with surprisingly few constraints for years.  Why?  Because with real interest rates so low and monetary policy so loose, they were reaching for return anywhere they hoped  they could to find it.

       In this respect, Uber is not alone.  Snap was able to go public on terms that gave shareholders remarkably few rights.  The values of major tech stocks like Google, Apple, Facebook, Netflix and Amazon have all soared to record highs.  In such an environment, one fears another "Minsky moment."  It is time for the Fed to change course.  It is reassuring to see that Janet Yellen is apparently thinking the same way.

Saturday, June 10, 2017

Come on Analysts, Do the Analysis

            As a manager of a small hedge fund, I like to compare my views on the valuation of common stocks to those of other analysts in order gain perspective.  This turns out to be a remarkably frustrating exercise.  Here is the problem.  Ultimately, the assessed valuation of a stock depends only on two factors:
1.  The size and timing of the future cash flows (what I call the cash flow profile) the analyst forecasts for the company.
2.  An assessment of the appropriate risk adjusted rate for discounting those forecast cash flows.
Everything else affects assessed valuation only to the extent that it alters those two factors.  So naturally I look for other analysts’ opinions regarding those two factors to compare with my own.  And I virtually never find them.  This is not to say that I can’t find opinions.  The internet is awash in opinions, but those opinions, even in the case of many Wall Street analysts, are almost never translated into the two factors that matter.
            Take Tesla as an example.  Given the celebrity of Elon Musk and the immense run-up in Tesla’s stock price there is an active debate regarding whether the stock is fairly valued.  Unfortunately, that debate is usually couched in terms of vague and incomplete verbal analyses such as, “The Model 3 is a game changer that could support a stock price as high as $500” or “Tesla cannot be valued as a car company because it is an energy technology company.  When seen it this light, its stock price is understandable.”  And on and on.  Lots of words, but no cash flow profile and no discount rate.
            Fortunately, there are exceptions to this rule.  One that stands out is the blog of Prof. Aswath Damodaran.  For the companies he analyzes, Prof. Damodaran not only provides the cash flow profile and the discount rate, along with explanations and calculations showing how he arrived at each, he posts a complete Excel spreadsheet that combines them in a discounted cash flow model that produces his value indicator.  Of course, this careful work does not mean Prof. Damodaran is always right.  Read, for example, his posts on Valeant.  But it does makes it possible for the reader to compare their own opinions with his and to use his spreadsheet to alter the assumptions to assess the impact on valuation. 
            One reaction to analysis such as Prof. Damodaran’s is that forecasting cash flows years into the future is speculative.  Of course it is!  No one ever said valuing stocks is easy.  There is simply no way to avoid the difficulty of long-run cash flow forecasting.  It can be hidden behind vague and incomplete verbal analysis, but that does not make the opinion more accurate or less speculative.  It just makes it more vague and incomplete.
            So I say, Come on analysts, do the analysis.  Follow Prof. Damodaran and let us see the valuation implication of your views.  That requires spelling out their implications for the cash flow profile and the discount rate.  Words without translation into a cash flow profile are pretty much empty words.