Of all the articles I wrote in 2013, only one got more page views than what I wrote about Corning (NYSE:GLW). I couldn't have asked for luckier timing, especially with a call as high profile and broad a reach as this.
I also couldn't have asked for a more interesting example on being able to parse the differences between process and outcomes, one of the hallmark qualities of every great investor. Sometimes, a good process will produce bad outcomes and sometimes a bad process will produce good outcomes. If you want to grow your wealth over the long-run, this point is one of the most important of all to understand. In the case of Corning, we used a good process that produced a great outcome.
The Original Thesis
The investment case was that last year Corning was in a really weird situation. The stock was obviously cheap relative to earnings and cash flow. That sort of thing happens all the time depending on what the market thinks about the reliability of the earnings stream in question.
But Corning was also irrationally cheap relative to its assets. The company was trading right around the value of its cash, physical assets, and the specialty glass division. In other words, you were getting all the good stuff at cost.
Who cares if the joint ventures are worth nothing (they're worth anything but) or the boring ol' LCD display and fiber businesses revenues go to zero (they still generate tons of cash flow). You were getting all that stuff pretty much for free. Wall Street didn't want it, and I'm not too proud to pass something by just because it's ugly or boring.
Occasionally you'll see stocks that are cheap relative to both assets and earnings. But that usually happens only when there's something broken about the company or something has gone disastrously wrong with the business. It almost never happens with a company of sufficient scale and scope.
The result was a massively positively-skewed distribution of outcomes. It was as asymmetric a risk profile as I've seen in recent years for a company of this size. For what it's worth, the only thing that came this close was what I saw with Apple (AAPL) last April. There's certainly no shortage of Apple analysis here at Seeking Alpha and that was a situation where a good process and some lucky timing added up to an exceptional outcome.
I almost can't believe my good fortune yet again, because Corning is now setting up into quite possibly the clearest sell I can remember. I couldn't ask for a more perfect case study on when and why to sell a stock.
An Ideal Sell Signal
Now, your signals will obviously vary of course. Depending on your reasons for why you originally bought, your criteria for exit may not be the same as mine.
In fact, that's really the point, isn't it?
Knowing when to sell a stock is regarded as one of the more difficult tasks a portfolio manager has to perform. I really don't understand why, though. Knowing when to sell a stock is easy. You ditch it when it stops doing what you originally bought it to do or when something else comes along that does what that position does better.
When you stop worrying about whether a stock will go up or down over the next few weeks and start seeing it merely as a tool to accomplish a specific objective, knowing when to sell is easy. Trying to guess what the stock will be worth tomorrow or next month is a fool's errand. Why would you use that as part of your criteria to sell?
This applies to the market, too, recounted with pith and wit in arguably the greatest financial book ever written.
When there is a stock-market boom, and everyone is scrambling for common stocks, take all of your common stocks and sell them. Take the proceeds and buy conservative bonds. No doubt the stocks you sold will go higher. Pay no attention to this- just wait for the depression which will come sooner or later. When this depression- or panic- becomes a national catastrophe, sell out the bonds (perhaps at a loss) and buy back the stocks. No doubt the stocks will go still lower. Again pay no attention. Wait for the next boom. Continue to repeat this operation as long as you live, and you'll have the pleasure of dying rich.
Fred Schwed, Where are the Customer's Yachts
Along those lines, to understand why Corning is a long-term sell, let's take a look at what originally made the stock a panicked, idiosyncratic catastrophe and such a dramatic buy.
1. The Valuation
Corning's business is a little awkward for investors to grasp. Or rather, it was. On the one hand, there's this established line of business that still drives the bulk of their sales but that's also declining. The best case for their displays and fiber segments is that they stabilize and someday becomes GDP businesses.
Then there's the specialty glass segment. That's where the growth is. We still don't really know how big this business is going to get.
And that's where the bad news begins. Last year, it almost didn't matter what happened to the specialty glass business. The stock was barely trading at book value. You see that sort of thing all the time with companies like banks or insurance companies that have funky or difficult-to-value assets on their balance sheet, or companies that have a huge debt burden. With Corning, neither of those things were true, and with a tremendous amount of cash and PP&E on their balance sheet, you could basically pick up the whole business for the price of their assets, most of which were tangible. Who cares if the core business wasn't very good? At those prices, it was an investment with a near-zero probability of producing long-term losses.
But today the stock trades at 1.3x book. Today, the nature of the business actually matters. Whereas the Gorilla Glass segment amounted to almost a free option at yesterday's prices, now we really do have to worry about what kind of growth will happen here and whether competition from sapphire will increase.
For the record, I'm completely willing to give Corning the benefit of the doubt here. Gorilla Glass is a leader.
But they obviously feel the pressure in a way that they didn't before. And the point is that when you're paying these prices for the stock, that sort of thing needs to matter to investors. It's already on 2.4 billion devices. Will Corning continue to dominate this segment and grow the market? I honestly don't have any better an idea than anyone else here at Seeking Alpha. If you believe they can, obviously, you keep owning the stock, especially if that was a major pillar in your original decision to buy. If you're less convinced, there are far more attractive places to allocate your investment capital.
Corning is a substantially more expensive stock this year than last, now trading at 14x trailing earnings and around 12x next year's earnings. That sounds attractive on an absolute basis, but relative to Corning's own history, this is as expensive as the stock has been since 2006 & 2007. We relate current prices to past prices, but it's much more helpful to relate current valuations to past valuations.
Relative to its own history, Corning's 3.6x P/S and 10.3x EV/EBITDA ratios also suggest the stock is as expensive as it's been in a long time. One might say Corning has better growth prospects today than they once did. But how different are those prospects, really, than a few years ago when the EV/EBITDA ratio was 6x. Even in 2010, Gorilla Glass was on 20% of mobile phones and growing. This hasn't exactly been a big secret. That revenue chart has been going up for a while.
Is it possible that the only thing that's changed with Corning is our perception? We know that when perception and fundamentals are misaligned, there's opportunity. We know what that looked like last summer. How great is that skew today?
Any way you slice it, regardless of whatever forces have driven the stock higher, there is zero question that the business is fully valued today. At least in a way that it hasn't been in a very long time.
I realize that sentiment has changed since then as well. These days "fully valued" is the new "cheap."
But the pillar of my process is to buy assets that are fundamentally cheap and sell them when the rest of the world finally figures out what they're truly worth. Fully valued is fully valued.
There's significant long- and short-term downside now, in a way there wasn't last year. If investors aren't willing to give the traditional lines of business any credit or a meaningful valuation anymore, or the new Gorilla growth lines show any hint of weakness and suggest an endgame where Corning's glass plays the role of a chimp, the stock could re-test $14 in a heartbeat. Depending on how you feel about new competition, that outcome may even be likely.
A guy such as myself might be attracted to a stock like that again, but would investors be willing to give the stock one more go? Would you buy Corning after the market moved away from Gorilla Glass or it quickly topped out and became a GDP business like the LCD and fiber segments?
If Corning ever does fall in the future, it'll most likely be because of what happens in specialty glass. I can't predict what that'll be, but I can say there's a non-zero, and possibly significant, probability the stock will go splat that time rather than bounce. A long-term investment in Corning (at any price) is almost by definition a bet that they'll be able to pull another rabbit out of their hat if the nifty glass segment fails. If you're an investor, you're sorta counting on it to succeed.
Gorilla Glass grew faster than any product they launched in over a century. Take a look at the last half decade and see how it affected the stock. Even if they do develop another winner, it could take some time before the stock finally cares.
2. The Yield
When we got our buy signal, Corning's yield at the time wasn't crazy high, just 2.7%. But it was a relatively new dividend and with the stock languishing in the doldrums for so long and with a potentially aggressive dividend policy on the horizon, it was easy to imagine a 3%+ yield on GLW after a year or so of chopping around and the next increase. North of 3% is where dividends stop being a token and start becoming somewhat useful. Or at least somewhat interesting.
And given the favorable constellation of valuation factors, it was another added bonus. Awesome. I'll take upwards of 3% while I wait for perception to change.
As of today, the forward yield is a skimpy 1.99%. It's no longer paying more than a 10yr Treasury, which is a better benchmark than you'd think for what constitutes a useful income equity.
To Corning's credit, they are in the process of growing that dividend, and in time, the profile of their investor base will evolve. That's almost certainly part of what has been happening in the last six months. Corning never used to be an income stock. But now it is, or it's trying to be. With a 27% payout ratio, stable cash flows, and a super boring business, the sky could be the limit with that dividend, too. There are a lot of investors these days who are gobbling that sort of thing up.
Be careful, though. This could be a slippery one. The old core business did not really support a dividend. Maybe it's just correlation that they didn't start paying one out until a new growth segment finally came along. But maybe management needed confidence that future revenues were going to be there. Should Gorilla Glass crack as an earnings pillar, it's possible -- unlikely, but possible -- that the dividend could become a risk.
3. The Technicals
Under our original buy process, there was ample evidence to suggest technical support, particularly at the exact moment I was writing about it.
The pennant broke to the upside, exactly the way we expected it would given what we knew about the fundamentals. I know you didn't need another reason why blending fundamentals and technicals is an incredibly powerful process, but there you have it.
The technicals have almost totally changed today. Now we're about to bump up against resistance rather than trade along support:
Given what we know about the fundamentals right now -- that the stock is clearly fairly priced -- how confident are you that the break this time will be in investors' favor?
That's not to say GLW can't or won't break through here. It's just that in order for the stock to do it, a magical new catalyst has to come along (a very small probability and bad bet for investors), or psychology, momentum, and enthusiasm have to carry the stock to new heights and extremes that we haven't seen in ages.
If psychology, momentum, and growth enthusiasm were part of your original buy thesis, by all means, keep rockin' and rollin'. Stay long. That's totally cool.
But if you're one of those investors like me that got in for valuation and yield reasons that have now completely reversed, why on earth wouldn't you sell? You haven't fallen in love, have you?
The upside for these types of investors is close to 0% right now. Maybe another 5% or so if the stock tests $20.50. There's easily 10-15% of raw downside over the short run and a more insidious downside of paying full price and having the stock go nowhere for a year or two while the valuation catches up.
Enhance your Yield
If you have fallen in love with the stock or you've built a different investment case that suggest you ought to stay long, consider adding some protection or enhancing your yield along the way.
What better time than right before technical resistance to write some calls. Cover this sucker up!
Here's a snip from our Option Sherpa Call Screener. These options are two weeks away as of this writing (morning, 3/14) and just a little bit out of the money.
You're getting paid 1.14% over two weeks for that trade. Keep doing that every two weeks for just one year, and guess what: you probably don't care whether Corning goes up or down because you now effectively own the stock around $16. And we know that's a much more attractive price for their business, whatever comes their way.
Even on a month-to-month basis you can use options to skew the currently-unfavorable odds in Corning back into your favor.
The April 20s are paying you around 12% on an annualized basis, and that still leaves you 3.7% of upside in the stock over the next month. You keep the 2% dividend, too.
If you are bullish on Corning, why wouldn't you want to do that? You're not expecting the stock to leap another 6% in the next month, are you?
Full disclosure, I did recently remove Corning from our Dividend Portfolio per all the reasons outlined above, but it is still part of one of our enhanced option portfolios. To the extent that I do make suggestions about this sort of thing, I think investors are much better served using options with a stock in this type of situation.
Look, I think Corning is still a solid company. I actually love boring businesses and part of the reason why I originally bought the stock was that I liked the cash flow from the display and fiber segments and didn't care that they weren't growing. It wasn't like I was paying much for them anyway.
I am wildly, absurdly bullish not just on a new era of wearable technology devices (which do depend on durable displays), but also on new types of glass in new types of displays in architecture or inside my car. Like I said: nobody knows how big this is all going to get.
Corning may indeed run higher from here. Just as Corning could have kept falling after I wrote about it last October, anything is possible over the short run. Remember to separate process from outcomes.
The point is that the situation has reversed almost 180 degrees from what got us into the stock. Now that the original thesis has fully matured, that makes the stock a sell.
If Corning had a massively positively-skewed distribution of potential outcomes last October, the distribution of outcomes today is negatively-skewed and almost to the same magnitude.
I think the alpha on the table with Corning is 0% and there's easily 10-15% downside or more as the stock establishes a new base and the market assigns a valuation more in line with its history. Less obviously disturbing is the idea that the stock may be at the upper end of a new range.
I realize this view qualifies as variant and I don't expect it to be popular. The saga of the last year jives with what Schwed said, though. The moments we should buy a stock are when everybody's left it for dead.
If only it were so easy to say goodbye now that the world is finally excited about it.
Disclosure: I am long GLW. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.