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Tom Armistead
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I'm a well-informed retail investor and post on SA in order to expose my thought process to critical examination and comment from readers. It makes me a better investor. I'm particularly proud of bullish macro articles posted in 2009 and later, in which I presented ideas that encouraged me to... More
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  • Working With PE5

    Early in my investment career I read Ben Graham and picked up on his suggestion to use PE5, and try to buy at a multiple of less than 15. Based on my experience, I've used a PE5 of 20 as a FMV for good quality non-cyclical stocks, and generally closed my positions before the multiple reached 25.

    The thought occurred to me, that I could use Shiller's irrational exuberance data to develop a PE5 for the S&P 500, and I have now done so. I stayed away from the inflation adjustment. Going back to 1987, when the first computerized crash ushered in the current era of investing, the PE5 for the S&P 500 averages 24.4, and currently stands at 24.

    Using Portfolio123, I averaged the PE5 for the 494 S&P 500 stocks which their system was able to compute, and arrived at a value of 28.7. The difference can probably be explained by weighting, or the lack thereof. The very large blue chips trade at low multiples, for the fact they grow slowly.

    I ran a few backtests, and it developed that as far as PE5 goes, higher seems to be better. Used as a sole selection criterion, PE5>25 produced a modest amount of alpha, PE5>30 produced somewhat more. When coupled with the site's Piotroski ranking system, and taking the 20 highest ranked, alpha ran at 5% or 6% for various long periods.

    Piotroski was trying to avoid financially troubled firms. So a high PE5, if you avoid financially troubled outfits, has a good chance of being a profitable investment. As a commenter once remarked on one of my articles, where I was exploring a similar phenomenon, they're high priced for a reason.

    Investment Implications

    Based on PE5, the S&P 500 is at an average multiple. As such, there is no reason to avoid the market. 5 year returns might reasonably be expected to be in the 6% area, consisting of 2% inflation, 2% real GDP growth, and 2% dividends, plus a little financial engineering.

    As far as individual stock selection, this analysis suggests I should be increasing my estimate of the PE5 multiple that would represent FMV for high quality, defined as companies that have little or no risk of getting in trouble financially. Perhaps 22 or 23. Then the exit on price point could be moved up to 27 or 28. The buy below point would be more like 18 or 19.

    Of course there are industries that seem to trade at chronically low PE's, it should be noted that Graham discussed the issue and compared it to dress lengths, how wide is your tie or lapel, etc.

    Nov 13 7:39 PM | Link | Comment!
  • Resisting The Urge To Chase Railroads Higher

    After news that Canadian Pacific made overtures to CSX (NYSE:CSX), railroads have been trading higher. I'm resisting the urge to chase, for the following reasons.

    Regulation

    Railroads are a natural monopoly, and as such naturally subject to regulation in the public interest. We don't want to go back to "All-the traffic-will-bear."

    Railroad regulation got badly out of hand, and the ICC (Interstate Commerce Committee) virtually strangled the industry until it was put to death and replace by the STB (Surface Transportation Bureau).

    But as a natural monopoly the facts of life are, nobody is going to permit the excessive concentration of economic power. It just isn't going to happen.

    Farmers and oilmen are competing for the existing capacity on CSX's lines. There is a bumper crop of grain, and an oil boom going on. The company is valiantly trying to serve these two constituencies, and not meeting expectations. And, shades of The Octopus, farmers will suffer economically as their crops don't get shipped to market timely.

    With that as a background, whatever approvals are required will not be forthcoming. What is coming down is more capex, to meet customer requirements.

    Capex

    I've invested in railroads based on a strategy that focused on companies that were investing in their own growth, either by capex or R&D. That has worked out well. However, prices now reflect the power of the cycle of investment and profit.

    After starting with Norfolk Southern (NYSE:NSC) I moved along to CSX, basically under the rationale to take a turn on something similar.

    The market as a general rule doesn't like capex, a factor that could easily rear its head in the event of a slowdown in the economy leading to a slowdown in rail shipments.

    An Options Strategy

    CSX has been a natural for the covered LEAPS strategy. Here are my trades to date, with the profit that will be earned if the stock stays above $32.50 until the November expiration of the covered call:

    (click to enlarge)

    I'll be happy if called away at $32.50. I don't think the prospects of an acquisition here are worth speculating on.

    Oct 13 11:26 AM | Link | 1 Comment
  • Putting The Semiconductor Pullback In Perspective

    Microchip (NASDAQ:MCHP) warned that revenue and EPS will not meet expectations and guidance for the most recent quarter, blaming it on industry conditions and stating that they see the cycle turning down. The whole sector tanked, probably more a sign of nervousness than intelligent investment thinking.

    Microchip, along with competitors Texas Instruments (NASDAQ:TXN), Maxim (NASDAQ:MXIM), Linear Technology (NASDAQ:LLTC) and Analog Devices, is active in the analog business. It's a business with a large number of different end-users. It has a high R&D component and there is an advantage for the incumbent. It's been booming, in part reflecting heavy use of chips in automotive and industrial applications.

    I think what MCHP is seeing is a pause in the general economy, which I expect to continue at the new normal of slow growth. They expect that their own growth will resume within a few quarters.

    I don't think MCHP has a lot of visibility into other areas of the semiconductor business. As such, I'm not taking their remarks as a negative to my long term bullish views on Intel (NASDAQ:INTC) or Altera (NASDAQ:ALTR). These are different types of chips. Plus, they are long-term positions where the cycle is 2 years, for Intel, and 5 or 6, for Altera.

    Also, Altera and its fellow duopolist in the FPGA business, Xilinx (NASDAQ:XLNX) have been claiming that they could grow by displacing other types of chips. So any industry slow-down may not affect them proportionately.

    Finally, Intel is talking about what happens at the 14 nm node, the tri-gate architecture, as well as trying to buy their way into mobile. These aren't areas where Microchip et al compete.

    That leaves us with the observation that the market as a whole is going down right now, and acting very nervous, and running for cover in consumer staples, which are already priced high. I will be watching the companies mentioned in this post, and may very possibly buy them, or enlarge existing positions in ALTR and INTC, depending on how far the sell-off goes.

    After all, the analog chip companies have strong balance sheets and good dividend growth credentials. It would be nice to see the prices get down out of the stratosphere.

    Oct 10 6:15 PM | Link | 2 Comments
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