Author: Vitaliy Katsenelson, CFA

This stock market is priced to sell

in Macro

If you feel that you have to own stocks no matter the cost; if you tell yourself, “Stocks are expensive, but I am a long-term investor,” — there’s help for you yet. First, let’s scan the global economic landscape. The health of the European Union has not improved, and Brexit only increased the possibility of other nation’s “exits” as the structural issues that render this union dysfunctional go unfixed. Meanwhile, Japan’s population isn’t getting any younger — in fact, it’s the oldest in the world. Japan is also the world’s most-indebted developed nation (though, in all fairness, other countries are desperately trying to take that title away from it). Despite the growing debt, Japanese five-year government bonds are “paying” an interest rate of negative 0.10%. Imagine what will happen to the government’s budget when Japan has to start actually paying to borrow money commensurate with its debtor profile. Regarding China, the bulk of Chinese growth is coming from debt, which in fact is growing at a much faster pace than the economy. This camel has consumed a tremendous quantity of steroids over the years that have weakened its back — we just don’t know yet which straw will break it. n the U.S., meanwhile,...

Why Cognizant Shines Brighter as a Stock Pick

in Analysis

We’ve been eyeing investment opportunities in business process outsourcing for a while; lately, our interest is on the rise because of the industry’s declining stock prices. Cognizant stands out as a shining star. Its revenue has quadrupled since 2008, and the company is growing at a faster pace than very competent competitors such as India’s Infosys and Wipro. Even as Cognizant’s growth slows from its explosive level of more than 30 percent a year in previous decades, the Teaneck, New Jersey–based company’s revenue should still increase at 8 percent to 10 percent annually. There are several reasons for that continuing strong growth. The world is getting more and more IT-heavy every day, and old applications need to be maintained as well as new ones written. Developed countries like the United States don’t produce enough software engineers to satisfy the insatiable demand for new IT solutions. There are other things we like about Cognizant. Its business is very sticky and requires very little capital — people are hired as needed — and thus it has a very high return on capital. Cognizant, which is still managed by its young co-founder, 48-year-old Francisco D’Souza, has about $6 a share of net cash on the balance sheet...

Trump May Equal Volatility, but Volatiliy Doesn’t Equal Risk

Trump May Equal Volatility, but Volatiliy Doesn’t Equal Risk

in Macro

It is a new year, and my crystal ball was supposed to have become magically unfogged by the turn of the calendar. Well, I hate to disappoint you, but it hasn't. Unlike our new president, I lack certitude about the brightness of our future. My thinking is caught between two quotations from Mark Twain. The first is, "Whenever you find yourself on the side of the majority, it is time to pause and reflect." And the second: "I've lived through some terrible things in my life, some of which actually happened." On one side I am in agreement with the majority who expect Trump's policies to benefit the economy: lower corporate taxes, foreign corporate cash repatriation, deregulation, and so on. This inclines me to pause and reflect, not just because I find myself in the innately uncomfortable position of agreeing with the majority but because these in-your-face positives are only part of the new president's package. Trump's ascendancy also brings a lot of uncertainty – something the market is ignoring, for now. The business-oriented pragmatism that it loves today comes with nationalistic and protectionist "job creation" rhetoric that may result in trade (or even conventional) wars. U.S. foreign policy, trade, and military alliances...

Discovering Discovery

in Analysis

Discovery is a media company that owns some of the most popular TV channels – Discovery, TLC, Animal Planet, Opera Winfrey Network (OWN), ID (crime channel), Eurosport among others. Discovery stock has been scratching multiyear lows because of millennials.  If you are reading this and you are between 19 and 35 years old – it’s on you!  Millennials are the first purely digital-age (non-analog) generation.  The one that thinks the DVD/CD drive in your computer is a fancy, complimentary cup holder. The market fears that millennials will not embrace the traditional cable/satellite model.  Instead, millennials will “cut cord” – dump traditional costly TV subscriptions bloated with hundreds of channels and watch their favorite TV shows “over the top” on the internet. These concerns are not baseless, but they are more than offset by other positive trends, and thus the “cord cutting” fear is creating an interesting opportunity in Discovery stock. Discovery’s revenues are almost evenly split between advertising and affiliate fees.  Affiliate fees are very stable subscription fees Discovery collects through cable/satellite companies from several hundred million subscribers in the US, Europe, Asia, and Latin America. Discovery’s revenue will likely grow, not decline, over the next decade.  Here is why: The rate of cord cutting has...

The Persistent Problems of Presidential Elections

in Macro

The election is over. I am left with two very contradictory feelings. First is one of appreciation — every four years we peacefully replace our government. I remember my parents in the late 1970s discussing Soviet politics at our house with their close friend. Their friend said something anti-Soviet. I vividly recall the fear in my mother’s eyes when she realized I had overheard that part of the conversation. Views that were contrary to “politics of the party” were not tolerated. If I repeated in kindergarten what I had just heard, my teacher could report it to authorities and my parents (not me) would get in trouble. A six-year-old kid could have only heard this sort of anti-Soviet talk at home: TV, radio, and newspapers were a pro-Soviet propaganda machine. My parents would not have been sent to the gulag, but they could have lost their jobs. If this sounds farfetched, my father’s best friend, a colleague and professor at Murmansk Marine Academy, was fired for possession of anti-Soviet propaganda — a copy of Solzhenitsyn’s Gulag Archipelago. It took him years to get another job, and it was almost two decades later, when the Soviet Union fell apart, that he was finally able to...

The Dangers of Dividend Obsession

in Analysis

By Vitaliy Katsenelson “This is a very bad, incoherent piece.” I received this feedback from a reader concerning my most recent article for Institutional Investor. I don’t expect everyone to agree with me, and I welcome negative feedback because it provides an opportunity to learn. But this stung. If this comment had been about almost any other article I’ve written this year, I’d probably have filed it under “let’s agree to disagree.” Looking back, however, I’m not sure this reader was wrong. While I stand by my original thesis, I think I could have made my case more clearly. So here is what I meant to say: [tweet_dis]We are in the freakiest investment environment ever[/tweet_dis]. [tweet_dis]Investors are buying bonds because they are looking for capital appreciation[/tweet_dis] — essentially gambling that the price of an asset delivering negative (if you are in certain parts of Europe or Japan) or almost no (if you are in the U.S.) current income will go up. And [tweet_dis]investors are buying stocks solely for income[/tweet_dis]. Dear reader, this is an upside-down world. In my original article I addressed a group of stocks I call bond substitutes: stocks bought solely for their dividend yield. They are a special group of...

Good Companies Don’t Always Make Good Stocks

in Analysis

I was recently going through a new client’s portfolio and found it full of the likes of Coca-Cola, Kimberly-Clark and Campbell Soup — what I call (pseudo) bond substitutes. Each one is a stable and mature company. Your mother-in-law would be proud if you worked for any one of them. They have had a fabulous past; they’ve grown revenues and earnings for decades. They were in their glory days when most baby boomers were coming of age. But the days of growth are in the rearview mirror for these companies — their markets are mature, and the market share of competitors is high. They can innovate all day long, but consumers will not be drinking more fizzy liquids, wearing more diapers or eating more canned soup. If you were to look at these companies’ financial statements, you’d be seriously underimpressed. They paint a stereotypical picture of corporate old age. Their revenues haven’t grown in years and in many cases have declined. Some of them were able to squeeze slightly higher earnings from stagnating revenue through cost-cutting, but that strategy has its limits — you can only squeeze so much water out of rocks (unless someone like 3G Capital takes the company,...

Whatever Happened to the Invisible Hand of Capitalism?

in Macro

When I was growing up in the Soviet Union, our local grocery store had two types of sugar: The cheap one was priced at 96 kopecks (Russian cents) a kilo and the expensive one at 104 kopecks. I vividly remember these prices because they didn’t change for a decade. The prices were not set by sugar supply and demand but were determined by a well-meaning bureaucrat (who may even have been an economist) a thousand miles away. If all Russian housewives (and househusbands) had decided to go on an apple pie diet and started baking pies for breakfast, lunch and dinner, sugar demand would have increased but the prices still would have been 96 and 104 kopecks. As a result, we would have had a shortage of sugar — a very common occurrence in the Soviet era. In a capitalist economy, the invisible hand serves a very important but underappreciated role: It is a signaling mechanism that helps balance supply and demand. High demand leads to higher prices, telegraphing suppliers that they’ll make more money if they produce extra goods. Additional supply lowers prices, bringing them to a new equilibrium. I am slightly embarrassed as I write this, because you may...

SoftBank CEO Masayoshi Son Banks on Exponential Growth

in Analysis

I am about to go out on very thin ice. I am a value investor, but I’ll probably get banned from the value community for what I am about to say: Current valuations don’t mean much for companies in industries that are entering an exponential growth phase. As I type this, I catch myself thinking that it sounds so “dot-commish,” but bear with me as I try to bring my statement into a more familiar value framework. Wall Street hates SoftBank’s recent decision to purchase ARM Holdings for £24.3 billion ($32 billion) — at a whopping 48 times earnings! SoftBank is paying a 43 percent premium for an already richly priced stock, and it doesn’t have any synergies with the U.K.-based supplier of semiconductor intellectual property — there are no costs to cut or additional revenue to capture by adding ARM to its existing businesses. Masayoshi Son, SoftBank’s founder and CEO and the reason my firm owns SoftBank stock, is not liked today as a result of the deal. I heard this (understandable) reaction from a friend about Son and the ARM purchase: “a bored rich man who needs to spend because he has too much.” To understand this acquisition, we need...

The Values of Value Investing

in Analysis

This article has been in the works since last November.  It started out as a speech I gave to the Swiss CFA Society.  To me it is an important framework for understanding value investing.  I think the rise of the consulting industry, armed with cheap computing power and an abundance of stock-specific data, has harmed the industry, because according to them, a “value” investor is one who holds statistically cheap stocks and a “growth” investor is one who holds statistically expensive stocks.  The truth is somewhere … well, actually it’s a lot more complex, and the consulting industry's crude segmentations don’t capture it.  - Vitaliy The Values of Value Investing I organize a conference every summer called VALUEx Vail. Vail is a quaint, beautiful, ritzy ski resort town tucked away in the gorgeous Rocky Mountains, about 100 miles from Denver. One day I received an e-mail from a reader asking why I — a value investor — would have a conference in an expensive place like Vail. He suggested that as a true value investor I should hold the conference in a hotel somewhere by the airport where prices are much cheaper. His precise comment was, “I thought value investors were supposed to like cheap stuff.” This e-mail challenged my...