Since the end of the financial crisis, Halliburton (HAL) has strongly outperformed the overall market. The reasons for this outperformance are multi-faceted. On one hand, HAL has greatly benefited from a pickup in oil and gas lease activity as well as the overall shale boom. On the other hand, HAL has experienced a benefit from the overall economy and systemic factors of the market. In this article, I will express my belief that HAL's dramatic price ascent of over 100% since 2009 represents irrational exuberance on behalf of the market and an excellent opportunity to short.
A Mosaic Approach
When we approach an investment thesis, we should be considerate of multiple investment disciplines. Technically, this type of investing is known as "mosaic" investing. Essentially, this means that one should gather multiple, uncorrelated investment inputs to arrive at a thesis. In this article, I have pursued this method of analysis by relying on several unrelated concepts, all of which provide an opportunity for shorting HAL.
A History of Returns
In order to fundamentally analyze HAL, I have relied on a metric known as return on assets. Return on assets is the net income of the firm divided by average total assets. Return on assets is a useful figure in that it allows analysts to normalize earnings and performance across an investment cycle and arrive at a consistent figure for comparison. The intuition behind the number is that as you study return on assets, you are studying how efficiently a firm generates profits given its current slate of assets. In the chart below, 5 years of return on assets for Halliburton can be seen:
The chart shows a simplified view of the rich economic history of HAL. In the bullet points below, I have explored three key time periods in HAL's history.
- The first period of analysis is from the third quarter of 2008 until the first quarter of 2010. During this time period, HAL was exposed to a variety of negative economic forces. The first and foremost was the economic crisis which impacted not only the financial sector but the economy as a whole. Additionally, HAL was pressured by the bursting of the commodity bubble in which crude oil declined by over 73%. The impact from this decline was felt by HAL in that it experienced a decrease in sales leading to a decline in return on assets. A basic economic law exists in the stock market in that when a firm experiences decreasing returns, investors tend to flee the security. HAL is no exception to this rule in that during this time period, the stock price declined over 33%.
- The next period of analysis is from the second quarter of 2010 until the fourth quarter of 2011. During this time period, HAL experienced a leap in performance. This leap in performance can be directly associated with the shale boom and the expansion of the Bakken fields. As unconventional oil and gas reserves were discovered, HAL experienced heightened sales driving up organizational returns. The market favors firms with rising returns as witnessed by a concurrent increase in share price by 23%.
- The final period of analysis is from the first quarter of 2012 until the present. During this time period, HAL has witnessed a decline in economic performance in that its returns have fallen by over half. This decline is largely due to the fact that the exponential rate of reserve discovery and exploration efforts has slowed its rise. The significance of this slowing is that the major revenue driver of Halliburton for the past 5 years is not delivering as it once did. The market appears to have overlooked this fact and has continued to relentlessly purchase HAL's shares.
The table below summarizes the discussion above.
As discussed, the basic economic relationship between returns and stock price is a major fundamental signal for investment decision. As a firm betters itself and experiences rising returns, individuals pile into the stock driving prices higher. Conversely, as a firm experiences declining returns, the market prices the stock lower in anticipation of continued poor performance. Halliburton has entered a period of poor performance. It has been performing poorly for the past year and a half, as objectively measured by return on assets. The funny thing, however, is that the market hasn't caught on. This is where opportunity for the nimble lies.
It is my belief that HAL is set for a significant correction. I believe that shares are overpriced at current levels and a short position is warranted. The shale boom, while impressive, has slowed. Halliburton's profits have declined. The stock price has risen. These three elements combine to suggest that shorting HAL now is an excellent fundamental play.
And Now for Something Completely Different
As I mentioned earlier, this article will rely on a variety of sources. Fundamentally, we have demonstrated that HAL is not a good investment at this time and that the odds favor shorting the security. In this section, I will delve into entirely unrelated facets of the market which suggest that shorting HAL is opportune.
The first mosaic variable which suggests that HAL is due for a correction is seasonality. Seasonality is a tool which studies past time periods to determine if a pattern exists in the data. The economic rationale behind seasonality is that during certain times of the year, funds and institutional investors cycle into and out of specific sectors of the economy. HAL is a victim of the seasonality effect in that it has declined in 63% of the last 32 years. This is significant.
The table above is important. It means that if you were to blindly short HAL in every single September, you would have earned an 88% return over the past 32 years. In our case, we are not "blindly shorting" in that we know that fundamentally, HAL is set for a decline. It also means that the stock is more than likely going to fall during this month.
Another mosaic element which allows us perception into the possible future of HAL's stock price is pattern recognition. Using tools I constructed for a pattern recognition project, I have applied algorithmic methods of analysis to the market. The tool examines previous market action to find similar events over the past 32 years of market data. The significance of this study is that it allows us to find the most similar market environment to today and examine what happened over a subsequent time period.
The table above shows a breakdown of what tends to happen over the next two months following a market environment similar to that of today. The results are noteworthy in that they further our fundamental thesis of a Halliburton decline in the future. Not only is seasonality potentially weighing HAL down, but also similar market patterns strongly indicate priced declines.
Fundamental, statistical, and algorithmic methods all indicate that HAL is set for a decline in the near future. In light of the preponderance of evidence against HAL, I believe the most appropriate question is "Are you ready?"