Peter F. Way's Instablog

��A Hundred Times Earnings! Is Your Generation Crazy?

Sun, 07 Oct 2012 15:09:32 -0400

Sophomore: Gramps, you make investments, why would anyone intentionally pay over 100 times earnings for a stock?

G: Uhh . . . to make money?

S: But if most stocks sell at 10, 20, or 30 times earnings wouldn't this one ultimately have to lose most of your money?

G: Yes, if it's P/E goes down that much before you sell it. Why should the P/E go down?

S: Well, that's where most stocks are.

G: So what keeps this one up where it is?

S: Damn-if-I-know. What do you think?

G: More buyers than sellers. Who owns it? Who keeps buying it? Does it trade actively?

S: Well, over 3 million shares trade on an average day, at a price around $250. Yahoo Financial on the internet says corporate insiders own 20% of the company, mutual funds and institutions another 2/3rds and those 872 organizations own 84% of the float. What's "float"?

G: That's stock not owned by insiders or affiliated companies, and presumed to be available for other investors to buy and sell. Perhaps you're looking at Amazon.com, Inc. (AMZN)?

S: Yeah, that's right, how did you know?

G: Lucky guess. Well, if there is 3/4ths of a $billion on the table every trading day, it's probable your hundred shares, if you want to make a $25,000 bet, aren't likely to nudge the price very far. So let's look to the players that might move it.

S: You mean those 872 funds?

G: Those guys, the ones that have average commitments of $90-100 million in AMZN, or about 360,000 shares. How many of them could sell out completely in an average day's trading of 3 million shares?

S: I figure only 8+ if no one else got to sell. That's about 1% of the big fund holders. So?

G: So it would take 100+ days for them all to get out. That's five months of market days. From what I know about big money managers, exit liquidity times of five months are intolerable for any "active" investment. They didn't get control of all that capital by being stupid. They must be prepared to be "long-term, core-investment" holders in AMZN.

S: Well they would have to believe that earnings per share could triple, just to get that multiple down to 33 times or at least quadruple to get it to a 25 times level. And that 100+ P/E is based on year-end 2013 EPS, estimated by 40 Wall Street analysts. Could they all be wrong by a factor of four? Only a year away?

G: Probably not, since those analysts are survivors of one of the worst Wall Street employment cutbacks most of us old-timers can remember. But it might help to think about what kind of earnings growth beyond the next year could justify current prices. That's what a PEG ratio tries to do. The usual notion is that a P/E ratio equal to its annual rate of earnings growth is justified, even attractive, if they are about the same, given five years of that growth. A stock with a P/E of 12, growing at 12% a year would have a PEG ratio of 1.0.

S: Doesn't that make Apple (AAPL), with a 12 P/E and a +25% growth rate cheap?

G: Maybe, but stay focused on your original problem. What kind of growth would it take to bring AMZN down to a reasonable PEG ratio? If a 25 P/E is the target, and it takes 4 times the E being used in the P/E, then (1+400%)^(1/5) -1 tells what is needed, or about 38% a year. The resulting PEG ratio of 25/38 = .65, just about where AAPL is now.

S: Wow! Thirty-eight percent sounds like a lot, half again as much as AAPL. Can they do it?

G: Some influential folks apparently think so, or the stock wouldn't be priced where it is.

S: You mean those 872 funds? But what if they change their minds?

G: Then there's trouble, T - R - O - U - B - L - E, right here in "River City." Remember that 5-month exit problem?

S: How can I tell if they start to think differently? -- Or, instead, are remaining convinced?

G: Well I have a friend who watches the market pros that help those funds adjust their portfolio holdings. They talk with the portfolio managers at many of the funds dozens of times a day. Often, in order to buy or sell in the million-dollar trades they need to make, the pros have to put their firm's capital at risk, in order to complete the "fill" of the fund client's order. With that dough on the table, the pros are very alert to changing client convictions.

S: Will your friend tip you off if he sees trouble?

G: Please use a different term - that word "tip" has some unpleasant legal connotations. And I don't even need to talk with my friend, because he publishes daily what the pros think their clients are likely to do with stock prices in the future. He learns that from the way the market pros protect the firm capital that they have to put at risk, stock by stock, day in and day out.

S: Say, that's pretty neat. Are they getting worried about AMZN? What about AAPL?

G: I subscribe to some of his services, and I can show you, because you're part of the family. But often my friend makes important information and ideas available for free on that internet investment site "Seeking Alpha." Here are the recent trends in what the market pros - and their big fund clients - are expecting for near-future price possibilities in each of those stocks. The vertical lines show the range of prices the pros are willing to pay for price insurance to protect their at-risk capital.

(click to enlarge)

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.

Make Money While Having Fun At CEDAR FAIR (FUN)

Wed, 27 Jun 2012 19:31:49 -0400

A favorite reacreational spot of legendary Fidelity portfolio manager, Peter Lynch, is Cedar Fair (FUN). It happened to show up at the top of our daily list of odds-on, big annual-rate-of-return stocks today.

In the spirit of the vacation season, here are the forecast particulars on this big Lake Erie entertainment park:

Out of the last almost two years of daily evaluations, the pro market-makers have implied the current (+16% upside price change potential vs. -1/2% drawdown exposure) prospect 18 times before, or less than 4% of the time.

The actual subsequent price experience by the stock in all these instances was an average gain of +22% and an average drawdown of -3% during the 3 months following each forecast.

Using the top of the forecast range as a sell target provided average gains of 13.7%, with 17 out of the 18 experiences profitable, a win ratio of 94%.

The average holding period for all 18 commitments was 17 days, which compounds to an annual rate of +600%. Such is the return leverage of Time-Efficient Investing.

Peter Lynch may still know how to have FUN!

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Vampire Squids' Forecasts Of FB Facebook IPO Coming Stock Prices

Wed, 16 May 2012 13:49:34 -0400

About: FB IPO Stock Price Forecasts Market-makers

This Friday there will be one principal question in the minds of millions of observers, waiting to be answered. How high will the price of Facebook stock be driven by eager owners before the trading day is over?

Lots of guesses are being made beforehand, but because of the scale of the offering and the lack of any good comparables in circumstances, no one really knows.

And the game doesn't stop at the close on Friday. With ample media coverage and a weekend to ponder, many new players may consider participating. And then the scene is quite different, because there will have been a real market starting point and test.

Up till now there has been no valid test of investor appetites, no basis for professional market-makers to assess where their big fund clients that got IPO allocations might be willing to flip their stock to an overenthusiastic investing public. On Friday that changes.

The Vampire Squids and their market-making cohorts are good at feeling out their clients' attitudes. Just for example, look at how well they read the upside and downside price limits on a leveraged ETF of Latin American stocks each day of the past 6 months.

The vertical lines of the picture are daily forecasts of price ranges for LBJ that the pros believe are likely to be encountered in coming weeks and months. Likely enough so that they will spend some of what could be profits in their pockets to protect themselves from losing far more from adverse price moves on at-risk stock positions that had to be taken.

In so doing, they leave footprints in the market that our firm translates into forecasts, same as we have done for a decade and more on over 2,000 widely held and actively-traded stocks and ETFs.

Facebook shares as yet have no such history. But as a public service we will produce the pros' evaluations without charge for a while, to give less well-informed investors a more even sense of what other knowledgeable players are expecting.

Ranges of possible price change from the Friday close should be available from this site shortly after the end of day's trading and through the weekend to the Monday opening. We expect to update the forecasts at each end of day next week.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Cop Now on the Beat!

Mon, 19 Apr 2010 12:04:56 -0400

Finally some meaningful, active, operational discipline is returning to financial markets. The SEC’s fraud charges against Goldman Sachs (GS) and related parties hopefully are the first sign of a realistic return of morality to a community desperately in need of public confidence.

Fifty-plus years ago at the beginning of our involvement with investment markets, the cop on the beat was the New York Stock Exchange (NYX). They were the ones monitoring trading activity, setting the rules of engagement, and controlling access to the market that really counted. If you wanted to be a part of the game, you had to play by the rules and behave. Otherwise, you got thrown out, permanently.

That role continued up until the last few years, when it became undermined as major brokerage houses shed their partnership structures in favor of public-ownership corporation status. Then when the exchange itself became a for-profit corporation with its own IPO, pretenses at discipline from that quarter disappeared.

During all this time the SEC was a paper pussy-cat, kept understaffed and emasculated politically, to the benefit of the investment community. Only trivial matters of form, rather than substance, were dealt with.

Finally, when the Madoff affair appeared, publicly and politically obvious, postures at the SEC became intolerable. Separately, the subsequent CDO/CDS whitewash and taxpayer-paid bailout of the perpetrators was the final straw. Now national outrage is widespread, and we hear of tea-parties.

Nothing happens in the beltway until the involved bureaucrats are sure their backs are covered, regardless of which political party is nominally in power. For the SEC to frontally challenge the king-pin of political influence from the investment community appears to mean that the oval office has been kept fully apprised and endorses the action.

That suggests major difficulties for congressional “financial reform” movements that simply tut-tut the status quo. The GS fraud case probably is not going to be a single-purpose or single-event action.

There may be a parallel here to the recent 7.2 Richter earthquake in our neighborhood just south of the border. In the following week there were over 2800 aftershocks agitating the immediate topology. We may hear more from the Feds at Justice, and certainly from the “plaintiff’s bar” that have now been notified that suits against one of the “deepest pockets” imaginable will provide an ongoing legal fee lottery for some time to come.

While much will be made in the media of how terrible all this is, in fact the true nature of the events are beneficial in the longer term if the public can see that regulation of securities markets is being taken seriously. Fair and honest markets are essential to the way society must operate in our style of democracy.

Because of the SEC charges of deception and fraudulent actions in the GS case, it is important that our subscribers know that all of our information comes from publicly available sources that are highly transparent and cannot be fudged.

The whole issue of derivative securities is poorly understood by the bulk of the public at large, including politicians, and unfortunately, even economists.

When there is a central clearing facility for all transactions in a given type of security, then for each trade a buyer can be matched up with a seller, and proper balances can be maintained to assure each one’s responsibility to act under the terms of the deal. When those terms are standardized, as in listed stock options via the Options Clearing Corporation, the job gets much easier. Major problems don’t happen.

That did not exist in the CDO/CDS world, and is becoming clearer in the SEC charges. It is also explained somewhat in Michael Lewis’s book “The Big Short.”

To allow a return to a “dealer market” in these securities invites a repeat of the catastrophe already encountered. When banks – either “investment” or “commercial” – are allowed to traffic as “dealers” without any disciplined track kept of who owes and who owns what, then pirates are again abroad on the mortgage seas and the buck will stop only at the least able buccaneer.

When the NYSE was in control, a broker that behaved like a “proprietary trading organization” was regarded as a “bucket shop” and was excluded from dealing with the investment public as a transaction agent. Its role as a counter-party principal adversary was quite clear. A return to that distinction is now badly needed.

Disclosure: No current positions in GS or NYX.

Disclosure: No current positions in GS or NYX.

Human Nature & Market Perspectives

Wed, 17 Mar 2010 13:53:04 -0400

We don’t pretend to know where the overall market is going, or why. But we do know what people who regularly enjoy $ million-plus annual take-home pay think is likely to happen in the next 3-6 months to many stocks, ETFs, and market indexes. They tell us, unintentionally, through their risk-aversion hedging actions.

What Can Be Learned From Past Forecasts

The bulk of capital committed to ETFs is in those that track major market indexes. An overall perspective of investor expectations may give clues to what will happen to the market indexes next.

To that end we aggregate the daily forecasts inferred from hedgers’ and market-makers’ self-protective actions as they deal with interests in, and concerns over, some 2,000+ stocks, ETFs, and indexes. The two pictures below draw on 11 million such forecasts collected live since the beginning of the year 2000.

Upside and downside expectations are pictured separately. In each, the broad vertical blue bars measure the proportion of all forecasts indicating potential percentage price changes on the scale at the bottom of the graph.

The colored lines running across the background of those blue bars are the same data as the tops of the blue bars. But instead of being a 10+ year average, they are proportional measures of one day’s set of forecasts. The green line was taken at the market’s most recent low, March 9, 2009, the red line at its high on October 9, 2007, and the yellow is of Monday, March 15, 2010.

Upside forecasts seem rather rational, relative to one another. While the historical average has a strong optimistic bias, at times of record highs that red distribution is more restrained. After markets have dropped and are about to recover, the green expectations are clearly more enthusiastic than average, yet realistic about the potential for advances.

Downside forecasts have a different character.

They do not span as great a divergence from zero as upside expectations, on average. Optimism again. But in good times they get a bit, well, more human. The prevailing attitude is “let the good times roll, this is the way it ought to be, enjoy it.

In bad times, “Woe is me” green takes over from “What? Me worry?” red. The recognition of how bad it could hurt gets way beyond normal, with larger projected proportions of severe declines and smaller proportions of the normal, lesser declines.

The span of upside and downside estimates in good times contracts, and expands in bad times. This is what is seen in the CBOE Volatility index (VIX). Don’t get distracted here by those details.

What should be of current interest is whether the “now” yellow line looks more like the red or green lines, or is someplace nicely in between.

For the downside at this point there is no debate; yellow is congruent with “trouble” red. Upside forecasts could see a bit more shift of “now” toward the red “market top.” But there’s not much room for enthusiasm and normal larger expectations are already diminished, accentuating the usual center of gravity.

So, how will the present situation be resolved? It could go into another market drop – we’ve recently seen a -9% airpocket. The year-ago low is -45% below where we are now.

Or, more constructively (?), the world’s economic woes may respond to the combined balm of Madison Avenue and Wall Street, and US consumers, dumbed-down by the educational establishment, egged on by too-big-to-fail banks, will come again to believe they can spend money they haven’t earned, so market optimism will once more return. If it does, then a persistent upside yellow-line shift back to prior averages, or beyond, will save us all.

You may sense my bias, but many things are possible, and it is in the nature of stock markets to surprise.

Disclosure: No current VIX positions

Can Block Traders Forecast XBI?

Thu, 22 Oct 2009 13:20:20 -0400

Recent responses to our first post to Seeking Alpha questioned whether Block Trader forecasts had useful predictive value. We wouldn’t have been maintaining them on a daily basis for the past decade if they didn’t.

Our principal interest is in identifying specific investment opportunities, not having market environment discussions. Still, with a backdrop of over 5 million price range forecasts, the potential for useful information exists.

But that overall equity market is subject to such a diversity of influences and changing circumstances, getting any useful handle on it is a task beyond nearly everyone, including us and our sources – who may be the best informed players in the business.

Instead, we prefer to find time-disciplined, defined-size, price swing situations in specific investments that have evidence of fairly reliable prior forecasts. We limit ourselves to time horizons that have reasonable chance to be foreseen, usually 3-6 months.

We get our forecasts from the way that market professionals protect themselves as they compete by taking necessary at-risk positions in stocks and ETFs. Their hedging activities are committed, forward-looking forecasts of what they believe can happen.

Here is a picture of how they saw prospects for XBI, the S&P Biotech SPDR, during the past two years:

In this chart the vertical lines are forecasts of prices to come, not records of prices past. The colors suggest investment traffic signals available at the time.

A simple, but useful guide is to consider the range top of a forecast as a sell target for a buy made at that date. The target should be kept specific to the buy, and not changed, despite subsequent events.

You say that’s not the way it’s done? Not what you’ve been taught?

Suppose you chose to buy the XBI in early April, 2008 at $50 because the biotech industry’s future then looked very bright. Damn! Were you smart – for a while.

Doing what you were taught, you held it for the “long term.” Maybe not so smart. Because here you are a year and a half later at $52 with only a 3% annual rate of gain.

Using the traffic signals instead, and reading rough estimates from the chart, you could have had (April’08)Buy@50-Sell@60, (October’08)Buy@50-Sell@57, (March’09)Buy@43-Sell@51 for gains of $10, $7, and $8; $25 instead of $2. And have had your capital available for other use perhaps 1/3^rd of the time.

With no sickening lose-a-third-of-your-money drops from $69 to $43.

This is shorter time horizon active investing, not day trading. You would have made three transactions in a year and a half, not an hour and a half. Holding periods averaged four months, not four hours -- or four years.

The market-makers don’t want or intend to hold any position four months. But they can probably anticipate most of the price-moving conditions in the next 3 or 4 months. They just don’t know for sure when any of them might occur. So their uncertainty has to include them all, even if their positions are eliminated in 4 days.

Just try and anticipate what any company is likely to really earn in 4 years, let alone what their capital structure (number of shares) may be and what their auditors will allow them to report. And correctly guess what the market conditions will be like out there in time, and you might know what your return on investment will be.

Duplicate that effort for all of the candidates you might speculate in so that comparisons can be made, and, voila, you’re a long-term investor (?).

There’s a reason that America’s Cup sailboat skippers sail all those short tacks. That way the competition doesn’t get away from them if the wind shifts temporarily in their favor.

Disclosure: No current positions in XBI.