On February 12th, 2011 we published our first article on Cisco Systems (CSCO) entitled "How we lost investors money on Cisco". The title was intended to be a pun for the readers (we weren't selling at a loss), as we quickly pointed out in the article..."We have no intentions of selling; on Monday we'll be buying for their accounts." The stock closed at $18.70 the day before the article was published.
We went on to make impressive sounding arguments about sociology like this artifice:
First it struck us that about 560 mln shares changed hands in just that one day; We know what your thinking; Good thing the US market isn't comprised of a skittish bunch - precisely our thoughts. A few years back, one of the curious arguments used by the social media community and their VC backers was the idea of the "wisdom of crowds"; let's just say we have some fundamental doubts about the whole idea of what the market had already been calling "efficient market theory". We think a few minor tweaks to the name would better reflect reality, maybe something like "Extraordinary popular delusions and the madness of crowds". We've known of a lot of wise individuals, but can't seem to recall too many wise ideas put forward by crowds. Can 10% of the float of a major US concern changing hands in around 6-8 hours be considered a sudden flurry of rational thought, or as they say in AA "a moment of clarity"?
The joke that almost wasn't funny
Next we looked at the 52 wk. high of 27.74 reached on April 30th, 2010 - or only about 10 months ago. Apparently, many of the same participants who are engaged in this corporate asset pricing scheme, thought a smaller CSCO (i.e. lower Gross Revenue, and less about 1 bln in equity) was worth about $9.04 a share more back in April 2010; for the record that's well, just 50 bln. in mis-pricing by the "wisdom" of the crowd uncovered last Thursday. Since the 50 bln. figure is based on today's outstanding shares, it is actually understated. More shares were outstanding last April, so the delta in appraisal value is actually higher.
So Ooops... more than one market participant was off by about 50 bln. on their appraisal, or were they? It's a decline in market cap of 33% from last April, but because of the way mathematical laws have a funny way of being immutable, a future return to that price would constitute a return of some 48% for the investor today.
By August 9th, 2011 though, the stock price had sunk to a mere $13.30 per share, and the title of the original article didn't seem that funny anymore, rather it seemed inadvertently prophetic.
However, we also pointed out in the same article
...If it took five years to return to the April 2010 high, the investor today would still be making a decent return on the capital invested in this issue for each of those five years.
Valentine's Day is a day for love
A lonely guy (or a value investor running thin on ideas) might even take an unattractive girl out for a date on the 14th of February. On that day of adventurous dating last year, the market, its analysts and media keepers, all felt that a date couldn't get any more disagreeable than Cisco.
Although we referenced a five year horizon for the investment to return to its former 52 week high, we thought we would take a look at how the issue performed 365 days after the article was published.
Appropriately, the earliest day that our readers could have acted was February 14th, 2011 (the Monday after the article was published and the day we said we'd be buying). Here is the benchmarked performance a year later:
click to enlarge
When the 1.3% dividend is added to the investors' results (.24 cents at a $18.81 purchase price), the actual return is 8% - which importantly beat the S & P 500 by some 6.6%.
Now hold on, explain this whole "shorting thing" to me again...
We also pointed out some other comparable companies which had precipitous price declines in roughly the same time frame as Cisco, but which we thought (unlike Cisco) more or less warranted such a move when we wrote:
Maybe 15-20% plunges in a day (in an otherwise rising market), is just the "new black". We're not sure. After all didn't Nokia (NOK) and Expedia (EXPE) take a page from the Cisco playbook the following day? Maybe they had headline envy? Or maybe their P/L and Balance sheet were materially weaker than CSCO. EXPE trades for a significant premium to book over CSCO, even though they are technically insolvent (based on tangible assets). NOK on the other hand has a minor problem - a little company who's logo is a fruit (AAPL), and who's products people tend to like a little bit more than NOK's, or any other company in the known universe for that matter. Those are material issues, yet NOK trades for about the same premium over book as CSCO, even though it has done an efficient job at destroying owner equity in recent years, and has some competition, even if of only minor notability.
So how did these other prominent issues perform after we called one "technically insolvent" and referred to the other as having "...a minor problem - a little company who's logo is a fruit" - here is their benchmarked performance:
|S & P 500||2/14/2011||1332.31||2/14/2012||1350.51||1.4%||12.0||1.4%|
|S & P 500||2/14/2011||1332.31||2/14/2012||1350.51||1.4%||12.0||1.4%|
Expedia lost ~22% for their shareholders while Nokia lost a whopping 42% underperforming the benchmark S & P 500 by 20.4% and 40.6%, respectively.
The article continued with some more math on what Cisco might properly appraise for then, and also in the future, our reasoning at the time went something like this:
If you wanted to buy all of Cisco, and If you look at CSCO's Net Current Assets alone (current assets minus ALL liabilities) - in other words, if you paid off all the liabilities, as the new sole owner, you would still net 15.77 bln of liquidity, after buying this puppy - so you could have a company with no liabilities, short or long term. To be quick and dirty, let's call this 15.77 bln in NCA cash although it could just as easily be short term marketable securities. As a purchaser of the entire enterprise, you could subtract this value from Friday's market price for the entire company of 103 bln. leaving you with an affective purchase price of about 87 bln, or less than enterprise value (don't tell the Germans or you might soon own shares in Cisco Systeme AG)
87.65 bln is equivalent to $15.84 per share for the entire enterprise - or a price to book of 1.92. It's hard to find market leaders in any industry for that price.
At the depth of the abyss on Mar 2nd, 2009 when so many were finding religion, the company sold for $14.18 on shareholder equity of less than 38 bln. or about 7 bln (give or take a few hundred million) less than what backs the issue today. That is to say the security for the issue has improved by just under 20%, while the share price based on the above model is only some 10.05% greater than March 2nd, 2009. The good news is, a buyer today, in addition to having significantly enlarged equity to buttress his purchase, also has the benefit of a sky which is not falling (we looked out the window and checked, it's true).
On Valentine's Day 2011 when everyone was scoffing at the company and analysts were tripping over each other to lower their price targets, we were buying shares for investors' accounts having just written the following:
Either way, none if it jumps out as unusual to us for a large enterprise going through the normal machinations of business. Chances are nobody will remember those details in a year, let alone 10 years from now...
The Investment Manager of the year award
We are probably not going to win any "investment manager of the year" awards with the 8% returned to our investors when the first article was published, but then again, we never had a one year timeline in mind - at a minimum we wrote about a five year price recovery timeline (and a "decent" return in each of those five years); to quote:
We think the chances of it going back to that price are better than average. By way of example, If it took five years to return to the April 2010 high, the investor today would still be making a decent return on the capital invested in this issue for each of those five years. During the time, it is more than likely the company would continue to close the gap, (in their usual consistent way) between their market cap, and the assets backing the security, also known as equity. At the same time, as the price rose back to the 52 wk. high of April 2010, you would have a conveniently declining price to book value, that's how it works in companies that manage owners equity efficiently. Of course, we don't think it will take anywhere near five years for the price to recover to around $27, and the first year is almost behind us.
When we wrote those words, the stock was selling for $18.81, which compounded at 8% annually for five years is $27.64. The 52 week high reached in "April 2010" referenced above was $27.74. Since we were only off by .10 cents perhaps the powers that be will reassess our candidacy for the award.
We're off to see the wizard!
Our follow up article "Lions and Tigers and Cisco Bears! Oh My!" was published on May 17th, 2011 indicating that we were not only buying, but still having a little fun with sellers and the titles to our articles. Of course now, just as then, we're still not selling, but we thought we'd provide an update on these figures nonetheless. Readers (or potential investors) of our May 17th Cisco article would have made a somewhat better return than the February buyers - needless to say, not wanting to miss any of the fun, we were plowing investor(s)' capital into the shares too as the markets opinion continued to sour - here are the benchmarked results since that time:
|S & P 500||5/17/2011||1328.98||2/14/2012||1350.51||1.6%||9.0||2.2%|
When the (now) 1.4% dividend is added to the investors' results (.24 cents at a $16.64 purchase price), the actual return is 22% (or 29% annualized) - which importantly beat the S & P 500 by some 26.8%.
We did tell them to get their own ideas
In our first Cisco article we started tipping our hand a bit on a belief that we had long held, that is to say that the deepest value may well be in old, big, boring and unloved technology companies. We wrote:
...Look at the business cycle; could CSCO be another IBM? Why not? Technology companies usually have strangely short life spans, but when we find exceptions, as with IBM, they are big time exceptions, because large scale technology enterprises that invest in research and development really do add to our lives in important ways.
Of course this was also an expansion of the theme originally echoed in the article "Clean-Tech Economics: A Hypothesis" published on January 6th, 2010. When we wrote:
Conversely IBM is an example of a long-term (in this case over 100 years) success in the computing and IT industry. That having been said, we can recall few of the thousands of other internet companies which kicked-off the previous decade with the promise of fulfilling the spectacular earnings expectations of the investing public in these "new" technologies.
IBM's shares traded at $130.85 on that day.
In "Lions and Tigers and Cisco Bears! Oh My" we went even further writing:
Is it possible than that the best values lay not simply in "boring" companies as the Oracle of Omaha has suggested time and again in his affinity for such things as Jello and furniture, but rather in mature technology companies that are highly profitable, but otherwise boring to the technology faithful, who happen all too often to also be their shareholders? For in these stocks lie the three fold benefits of:
a) A speculative technology crowd unaware and/or perhaps uninterested in fundamentals, and who are anxious to buy or sell on even a slight change in personal sentiment.
c) The curious absence of intelligent value investors who are usually busy proclaiming their distinct disinterest in anything vaguely related to technology.
Thus the value-oriented investor in such technology concerns may belong to the smallest club of all. And yet, we know many who can live without Dairy Queen, paint and even insurance, so long as they have high speed data access on their iPhone.
Although the folks in Omaha will protest, it may be that the best values lie not in "unloved, boring stocks", but indeed more particularly in "unloved, boring technology stocks.
On November 14th, 2011 Fortune reported that Mr. Buffett had purchased 10.7 billion in IBM shares for Berkshire Hathaway (BRK.A) at an average price per share of about $167 (or ~28% higher than when we first pointed out the value about a year earlier) and the related opportunity for value investors.