What to Make of the Current Bull Market

Dear Friends,

With the bull market chugging along, it is difficult to determine where to invest for long-term outperformance.  If you’re like me you don’t want to chase the market or the crowd.  Please see my blog post for the Arizona Republic for some insight.

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WHY CISCO SYSTEMS MAKES SENSE FOR THE LONG-TERM

Rather than viewing the dividend as a surrender to growth, a growing dividend often indicates what management thinks about future earnings growth.

 

Cisco Systems (NASDAQ: CSCO) was one of the tech darlings of the 1990’s.  The stock rose 69,230% from its public offering in February of 1990 through 12/31/1999. That equates to a 94% annual return compared to 25.6% for the NASDAQ over the same period.  Then, as though on cue, at the dawn of the 21st century, the stock stalled out, tail-spun into a rapid descent and finally, flat-lined with little hope (or expectation) of robust future earnings growth or stock price outperformance.  From 12/31/1999 through 12/31/ 2011 CSCO generated a total return (which includes price movement and dividend income) of -61.9% or a loss of just over 7% per year.  Compare this to the return of NASDAQ for the same period–a decline of 16.9% or -1.4% per year (again including price and dividends).  When it comes to CSCO and all fallen-angel growth stocks for that matter, investor emotions have run the gamut from love to disappointment to hate and finally, neglect.   So why buy CSCO now?

 

The company surprised investors in May of this year when management reported better than expected FY Q3 earnings.  The stock rallied dramatically on the news and is up approximately 24% year-to-date through May 31–the bulk of that return coming after the earnings report.  Cisco CEO, John Chambers, normally strikes a conservative tone.  On the May 15th earnings conference call he was surprisingly upbeat about the company’s prospects, “Cisco is executing at a very high level in a slow, but steady economic environment…We are starting to see some good signs in the US and other parts of the world which are encouraging.”   In subsequent interviews Chambers stated that although the pace of technological change is increasing, CSCO has historically taken advantage of change to transform the business and trounce the competition.  “Usually, when things are toughest for us is when we work harder and surprise people.  That’s when they should be betting on us.” That kind of optimism bodes well for future growth.

 

CSCO management and the board of directors initiated a dividend in 2011 and the quarterly dividend has gone up three-fold since then resulting in an expected yield of 2.8%. (The S&P 500 currently yields 1.3%.)  When rocket-propelled growth stocks mature, the declaration of a dividend is often perceived by investors as a declaration of surrender to future growth opportunities for the company.  But, in fact, often at this point in the company’s growth, the dividend  signals what management and the board think about future earnings growth.  In other words, he dividend is frequently established as a portion of  what management and the board believe is sustainable, long-term earnings power.  John Chambers joined a dignified group of corporate managers when he said as much about a dividend increase in August of 2012:  “We wanted to send a message to shareholders.”

 

Slowing growth does not have to be a death knell for future stock price performance.  Nor does the initiation of a dividend. The market is full of many companies who have successfully made the transition from growth to value stock and have gone on to generate solid performance.  Coca Cola (NYSE: KO) is one such company.  But let’s consider International Business Machines (NYSE: IBM) another company like CSCO which managed the maturation process but also dealt with the additional burden of shifting technological trends.  After maturing from Nifty-Fifty growth stock darling to mature, old-fashioned computer company, IBM spent a decade in exile just as CSCO did.  But the company transformed its underlying business and eventually earnings growth as well as the stock price accelerated once again.  Another consolidation in the early 2000’s and yet another surge (see the 10 year performance chart for IBM).  Buying great companies for the long-term may not result in year-to-year outperformance but over the long-term, it frequently pays off.

 

With a price/earnings ratio of 11.5x next year’s earnings which is a discount to competitors’ Qualcomm (NASDAQ: QCOM) and Juniper Networks (NASDAQ: JNPR), a dividend yield double that of the S&P 500 and a company executing extremely well in a difficult global economic environment, CSCO is the kind of long-term investment idea investors should consider owning for the long-term.

How to Generate Enviable Returns Without Being 100% Right All the Time

If there is one overriding principle to remember when investing it is this:  the most difficult time to buy a stock is often when the experts are telling you not to.

As a value investor I am frequently interested in the stocks of great companies that are out-of-favor.    And because they come with baggage they are frequently the target of many negative stories.   Bad news is the companion of investors who are interested in buying stocks when they are inexpensive.  Everyone can tell you why the company is cheap; they are not nearly as effective at telling you when it will cease being cheap. In fact, most investors won’t start talking about the stock again until the company has fixed the problems and the stock has appreciated well off the lows.

We will take a look at two great growth companies who stumbled and ultimately recovered.  Both are from my own holdings; one I bought way too early (which means I bought after the stock went down, then it went down a great deal more) and the second I purchased at just about the lows in the stock price.  By sticking to my discipline and staying with both stocks I generated performance in excess of the market; one stock did better than the other to be sure but both did significantly better than the market. Buying the stocks of out-of-favor, well-managed companies is harder than it looks in the face of the incessant chatter of the naysayers but doing so–following Intelligent Investing Rule #1, sticking with your discipline–will provide excellent returns over time.

Let’s begin with the fallen-angel growth stock I bought too soon:  Starbucks (SBUX).  Buying early is one of the occupational hazards of being a value manager.  When a growth company disappoints investors, the sentiment quickly changes from love (price appreciation)  to hate (price depreciation) to indifference (price stagnation).  It is important for the value manager to remember that growth investors can sell out of a holding much faster than the value crew will buy in.  In fact, because growth investors are often momentum driven they may exit an entire position in a stock if they even sniff trouble.  When the earnings miss or a new product or distribution glitch manifests they run–don’t walk–for the exits.  The value manager’s dilemma is to decide when to get in.  Sometimes we are too eager.   When I got a chance to buy SBUX in April of 2007, I did.  The stock was down 30% from a recent high of $40.00.  I waited for it to stabilize around the $31.00 level and began accumulating my holdings.  Then the financial crisis hit and the market sunk like a stone dragging Starbucks with it until the stock finally hit a low under $10 per share.  An unmitigated disaster you might think.

Normally I would buy more as the stock went down but I was busy with grad school and two kids graduating from high school in those two years and I, frankly, wasn’t paying close attention.  But here is the great thing about buying great companies.  You don’t have to know the exact day the stock hits bottom.  You don’t have to be right about every detail.  You just have to stick to your discipline and let the company management do the heavy lifting.

Though I bought SBUX far from where it ultimately bottomed, I still generated a return of 12.73% per year since April 27, 2007 well in excess of the S&P 500’s return of 3.53% over the same period.  Had I bottom-picked the stock toward the end of 2008, I would have received an annual return of (gulp) 57.11% versus 17.29 for the market.  A far superior return, indeed. But getting it mostly right and generating a steady return over time is our objective and despite my mistake I did just that.

The point is that stock investing is about generating consistent, excess returns over time, not necessarily about securing cocktail party bragging rights.   Remember Intelligent Investing Rule #1:  Having any investment discipline is better than having no discipline at all; once your investment strategy is established, never deviate.

Next post we will examine a value stock I bought near the price bottom.

Why the Fed and Monetary Policy Matter–Made Simple

It is difficult to understand monetary policy on a good day.  Most of us don’t.  But we get a glimpse of insight when we, say, refinance our home and discover that thirty-year mortgage rates are below 4.0%. Suddenly we realize our monthly payment is going to be much cheaper than it used to be.  We might even be able to afford a bigger house with a bigger mortgage.  For most of us with finite budgets, it is all about the cash flow.

Not so for the federal government or the Federal Reserve Bank (Fed). They create cash flow.

You may have read that the Fed is buying approximately $80B in Treasuries and mortgage-backed securities each month.  This is referred to as QE (quantitative easing) 1,2,3 etc.  QE has been aggressively implemented by the Fed since 2008 and these purchases have grown the Fed’s balance sheet from $1 trillion in 08 to close to $3 trillion today.  But here is the important part for investors and taxpayers.

The federal government (think Washington D.C.) is borrowing money from individuals, foreign governments and corporations when it issues Treasury bills, bonds and notes.  If you own a treasury bond or treasury bond fund you are lending your money to the federal government.  But lately the appetite for U.S. treasuries–particularly among foreign governments has declined.  Here is where the Fed comes in.

Since each of the twelve Reserve Banks (that comprise the Fed) is authorized by the Federal Reserve Act to issue currency, when the U.S. government issues an excess of treasuries (borrowing), the Fed is able to print money to buy up the excess treasuries the public doesn’t purchase.  To the tune of almost $1trillion per year since 2008.  Currently the Fed is buying about 57% of the treasuries issued because the demand for U.S. government debt has declined just as our government’s spending has ramped up.

In the real world the transaction might look something like this:  You want to buy a new car.  But you can’t afford the car and you don’t have the money.  So, you decide to lend yourself money with money you don’t have to make the purchase.  You write yourself a check from an account with insufficient funds (in other words you print your own money–kind of), deposit the check in another account, run down to the car dealership and  pay for the car out of the account with the kited funds.You go to jail.

But for the government it is completely legal.

So why do we care about this?  Two reasons.  The first is that while I am a long-term bull on the U.S. equity market, in the short-term, much of the appreciation in stocks which began in 2009  has been fueled by QE. By keeping interest rates so low the Fed is encouraging investors to turn to the stock market for higher returns.   The second reason is that flooding the economy with currency to fund unchecked government spending (recall that the Senate hadn’t passed a budget for the previous four years until a few weeks ago) can lead to inflation and very slow growth in the real economy.

So don’t get caught up in the short-term, day-trading hype propagated by the financial media.  Stay the course.  Buy great companies for the long-term. Over a reasonable period of time the stock market averages approximately 9% per year even when all the bear markets are included.  But, buy quality.  Oh, and use real money to fund your purchase.

Launch of Arizona Republic Blog Posts

Dear Friends,

I know that,if you are like me, you are inundated with information each day.  It is hard to choose what to read–how to invest your time.  That is why I have partnered with the Arizona Republic Newspaper to post these crisp concise advisory’s on the how-to of investing.

I hope you enjoy them.  And, perhaps, learn something, too.

Here is the link:

Arizona Republic

 

Read My New Blog Post at InvestingNerd

http://www.nerdwallet.com/blog/investing/2013/how-to-reduce-fear-of-investing-afraid/

Dear Friends:

I will be blogging for InvestingNerd and the Arizona Republic from now on.  Each blog will be different and follow the same format I have employed here.  You are welcome to follow these blogs, too. But I will be posting the link here.

Today’s blog is about reducing your fear of investing and buying great stocks (like Coke) for the long-term.

Hope you enjoy.