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Adam Aloisi
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A full time investor in stocks, bonds, and real estate who previously worked as a financial/investment journalist/analyst. Previous industry stints were with privately held SageOnline Inc. - where he held multiple positions - and with both Multex.com and Reuters, where he was an equity research... More
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  • Interview With Prospect Capital (PSEC) Co-Founder/President Grier Eliasek!

    Readers: I will be interviewing PSEC's Grier Eliasek tomorrow afternoon, with an article posting in days to follow.

    If you have any pertinent questions for Mr. Eliasek or would like to discuss the company with me prior to the interview, please post them in the comment stream below or send me a one-on-one message. Your interaction here should provide for a more interesting interview.

    Regards, Adam

    Disclosure: I am long PSEC.

    Tags: PSEC
    Feb 27 9:31 AM | Link | 12 Comments
  • Why P/E Isn't All It's Cracked Up To Be

    If you had to pick one analytical metric to utilize when making an investment decision, what would it be? Most of us would consider that an unfair question, since we generally gravitate to a plethora of information when putting money to work in the market. However, if forced into a decision, many might pick P/E, the price to earnings ratio, as it is generally considered a golden standard of equity analysis.

    How Much Stock Should You Put In P/E?

    From a point in time perspective, whether measured on a trailing or forward basis, P/E tells us a lot. It tells us how much we are currently paying for corporate earnings and it tells us, comparatively speaking, how "cheap" or "expensive" one equity is versus another. In a totally apples to apples comparison, a security with a low P/E theoretically would represent a more prudent purchase versus one with higher price to earnings.

    The problem is, in the real world, security comparison is never apples to apples, which would seem to render P/E as somewhat flimsy in the due diligence process. And since security price movement tends to be predicated on absolute corporate performance and forward expectations, a point in time analysis method might be considered too simplistic and perhaps unreliable to serve as the keystone of an investment decision.

    And P/E only measures operating performance. It does not take into consideration the broader corporate picture of balance sheet assets/liabilities, company intangibles, brand identity, or other statistics that might cause investors to place a premium or slap a discount on a stock.

    Taking P/E One Step Further

    Quantitatively, we can add a layer of forward predictiveness to P/E by calculating the PEG ratio. PEG, or price to earnings growth, provides for a more meaningful valuation tool when utilized with correct assumptions. Calculated by dividing point in time TTM P/E by projected earnings growth, PEG affords the ability to judge, side-by-side, securities with differing baseline P/Es and varying anticipated growth rates.

    As an example of how PEG works, lets take Stock 'A' which has a current TTM P/E of 16 and is expected to grow earnings by 7.5% next year. We'll compare it to Stock 'B' which has a TTM P/E of 24, but is expected to grow earnings by 11.25% next year. If we divide the P/E by the growth rate in both situations, we end up with identical PEG ratios of 2.13, signifying a similar overall operational value proposition, despite the varied P/E and growth rates.

    Why A Low P/E Won't Necessarily Protect You

    Value investing is typically associated with below market P/E ratios, although I think that is a very fallacious and limiting generalization to make. I would argue there's much more value in a stock selling at 20+ earnings multiple growing dependably in the low teens year-in, year-out like a Costco (COST) than there is in a company selling at a mid-teens multiple like a Procter and Gamble (PG) with an erratic and "undependable" recent earnings history and outlook.

    One might argue that a stock selling at a higher P/E, like Costco, presents more capital risk simply because the multiple has more room to compress should times turn bad. While that may be true, on the flip side, a lower P/E stock like Procter won't necessarily provide value or capital protection if the growth rate remains too low or stagnant to justify the lower multiple.

    On a further note, let's take former tech high-flier Apple (AAPL). Despite the explosive growth from '09 to the middle of last year, when earnings grew roughly four-fold, Apple's P/E hovered mostly around 20 when measured on a TTM basis. Trading at $700 during the peak of its frenzy last year, many pundits called Apple "cheap," anticipating continued parabolic earnings growth and deserved earnings multiple expansion. As we know now, there has been a turnover in the Apple growth story, and those who bet big on Apple last year have fallen victim to a value trap.

    AAPL 5-Year

    (click to enlarge)

    The reservation by investors to reward Apple with a premium multiple, despite its parabolic growth, in hindsight was well taken. Given the tech bubble we experienced around the turn of the century, one might have expected a more lofty multiple for a company growing earnings 50-75% a year. And with earnings growing faster than the applied earnings multiple, a PEG of less than 1 was in force, and depending on where you see earnings headed this year, still is.

    At one point during the Internet bubble, Cisco (CSCO) traded in excess of 100 times earnings. To put some perspective on the matter, had Apple been given that type of multiple, it would have traded in excess of $4500 based on its FY'12 $44.64 in earnings.

    So why didn't the market apply much of a premium to Apple, despite its historical build out? Perhaps lessons learned from a decade ago? Maybe the sheer size of the company? Possibly awareness that iPad and iPhone sales and margin metrics would slow and no new disruptive product would make its way to market? Whatever the case, with Apple down 35% from its highs last year, pundits continue to point to Apple's P/E and scream value. I'll let you decide if that's a worthy argument or not. I'm long Apple myself, but I'm not personally pounding the table on the stock, low P/E or not.

    The opaque financial outlook at Apple continues to be troubling. No one was quite clear how fast earnings and margins were growing in the past, and now there is little clarity to what extent earnings and margins will moderate in the future. In other words, the waxing and waning of earnings growth has been extremely unpredictable and undependable, leaving for a perplexed investment community and volatile stock.

    The Final Calculation

    Many of us spend a lot of time analyzing financial data and comparing valuation models of dozens of different companies. While I'm not inclined to say it's a waste of time, I do think valuation means little in the absence of dependability. Without confidence in what a company will achieve going forward, we are nothing as investors and become little more than speculators. A high P/E company with clear vision and transparent management may possess much more investment value to us than a company with a low P/E, a blurry outlook, and/or potholed past.

    On the other hand, companies with seemingly clear visions can quickly lose their ways and/or be flanked by enterprises that were once priced for the dead. I'd argue that the biggest value you can bring to your portfolio is in spending a disproportionate amount of time deciphering whether a company can build value from this point forward. Scrutiny of corporate financials, historical performance, and evaluation of an alphabet soup of metrics may provide for a nice baseline analysis and valuation dissertation, but that analysis is basically meaningless without a robust forward growth thesis.

    May 16 8:23 AM | Link | 1 Comment
  • Eating Away At Your Apple Emotion

    It is somewhat startling when we put comparative perspective on Apple's (AAPL) roughly $250 billion in lost market cap over the past 4-5 months. Yet it gives us an idea of just how large this company was, and with a market cap of around $400 billion, still is. There are only nine domestically based corporations that had total market capitalizations of over $200 billion based on January 24 closing prices.

    Company Market Cap 1/24

    Apple Inc.

    $423.0B

    Exxon Mobil Corporation

    $416.5B

    Google Inc

    $247.7B

    Wal-Mart Stores, Inc.

    $233.5B

    Microsoft Corporation

    $232.5B

    General Electric Company

    $231.2B

    International Business Machines Corp.

    $231.0B

    Chevron Corporation

    $226.1B

    Johnson & Johnson

    $202.6B

    Apple' s lost value would have independently wiped out every domestically traded company with the exception of Exxon (XOM). Two hundred fifty billion would have also erased the value of Home Depot (HD), Disney (DIS), and mall kingpin Simon Property (SPG) combined. For those that have watched 35% of the company's paper value erode over the near-term, it has probably been somewhat painful and disheartening to watch.

    AAPL (6 mos.)

    However, as investors we are more concerned with where securities are headed rather than where they have been, therefore it is not wise to dwell on the past. Indeed, focus needs to be on making prudent security-specific decisions that position one's portfolio in an optimal manner for pursued investment goals.

    What I Won't Tell You

    While I currently own a small position in Apple (<1% of overall portfolio), I will not tell you whether you should buy, sell, or hold. I'm going to leave that to others on Seeking Alpha that have more strident opinions. However, because of the variety of ways this stock can be viewed, the huge number of pundits that abound, the volatility, and the undeniable emotion that follows in its path, Apple, in my humble view, is not a slam-dunk stock everyone should be buying in hopes of a price recovery.

    What I Will Tell You

    Whether you've owned Apple for a decade and have a large embedded gain, bought at the recent top and are suffering with a loss, have no gain or loss to speak of, or are considering making a first purchase, do not act upon this company with emotion. Security specific portfolio decisions should be done deliberately, not with haste. Emotional decisions are what smart investors should always be looking to take advantage of. Do not fall victim to them.

    Going out and spontaneously buying more of something because you are angry with the market or conversely making a knee jerk sale because you are frightened you may lose more are about the worst things you can do when extreme downside volatility strikes a portfolio holding. My advice is to take a deep breath, collect your thoughts, and take some time this weekend deciding how to approach Apple's place in your portfolio.

    What To Contemplate

    I feel the following three questions will take emotion out of the equation when it comes to analyzing and acting upon Apple, or any down trending position:

    1. Has Your Investment Thesis Changed?

    Why did you invest in the stock to begin with? Has anything really changed since the earnings announcement? Do you think the company will continue to bring new, revolutionary products like iPad and iPhone to market or will the future be more dependent on the evolution of existing products? How confident are you in growing revenue and earnings?

    2. What percentage of your overall portfolio does the stock compose?

    The larger the percentage of your Apple position in your overall portfolio, the larger the risk you are taking. A well diversified portfolio mitigates the impact that any one losing position can have on the overall portfolio. Despite the tendency to let "winners ride," I would argue that that's not necessarily a good idea, especially when the position becomes extremely concentrated. If Apple still composes a large portion of your portfolio, consider paring back simply for diversification purposes, even with the stock 35% off its highs.

    On the other hand, if your investment thesis remains in tact, taking the opportunity to add another tranche here might make sense for your portfolio if you are underweight. I would add that from technical perspective it is generally considered dangerous to catch a falling knife.

    3. How much more stock price destruction can you and your portfolio tolerate and are you losing any sleep?

    While one might think they are smarter than the market at any given point in time, I would argue that such thought is necessarily dangerous, a la the falling knife. Apple's 35% decline should be telling you something, and you shouldn't assume that just because you disagree with the market's treatment of the stock, that the market is wrong in continuing to punish it.

    The technology landscape continues to evolve and while it may be difficult to envision a devastating downtrend in Apple, I doubt many thought that Hewlett Packard (HPQ) would lose 75% of its market value and sit at 10-year lows after hitting all-time highs just three short years ago. Things happen. Things change. Investors lose lots of money when an investment thesis proves wrong and they hold on too long.

    For that reason, if you haven't already, you should set a limitation on the amount of "pain" you will withstand during a continued Apple downtrend. One can do this nominally or percentage-wise. Determine the amount you can afford to lose and automatically set a stop through your broker. Sometimes it's best to walk away from an idea that isn't working and move on to a better one. There are always other fish in the pond.

    If you are losing sleep over what is happening, you should consider taking action sooner rather than later. Either you have too much invested in Apple or it's not a stock you should own at all.

    What You Should Do

    Whether it is via a paper gain that has vanished or paper loss that materialized, watching a stock drop the extent that Apple has is a painful, humbling experience. Whatever kind of investor you are, keep your wits about you, consider the questions I posed, and above all else, avoid an emotionally charged knee-jerk reaction when volatility heads your way.

    Disclosure: I am long AAPL. 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.

    Additional disclosure: Disclaimer: The above should not be considered or construed as individualized or specific investment advice. Do your own research and consult a professional, if necessary, before making investment decisions.

    Jan 25 2:50 PM | Link | Comment!
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