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I currently work as a money manager, I have been in finance for the last 10 years and work on a team with over 55 cumulative years of experience. We manage with a bent toward cash and value but pay attention to short term movements with more frequency than most true value managers. We have no... More
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  • Faulty Reporting IBM vs. HD and Any Others..... Manicott vs. Manicotti vs. Cannelloni

    I had a drink with a friend of mine tonight.  His parting story dealt with his reheating of the pasta he made over the holiday weekend.  It seems his wife loves his Cannelloni recipe.  From my past experience with him, I’m sure his recipe is quite good—maybe a dish my wife and I should have on New Year’s Eve. 

                What has me writing about my friend is his pronunciation of Cannelloni—he calls it Manicott.  Manicott is an American bastardized short cut for Manicotti which happens to be a bastardized term for Cannelloni.

                It reminds me of a bet I place with anyone.  I’ll bet anyone an expensive dinner at Luger’s that if they give me a stock I can find mistakes at any financial website in the reporting of the company’s data.

                Simply, give me any company and I’ll go to Yahoo Finance or Google Finance and find reporting mistakes.  I’ll go to any financial website and find mistakes.  It’s quite easy to do—financial reporting is comparable to Cliff Notes.  The reporting contains egregious mistakes that elude most investors.

                E-mail me at, give me any company and I’ll find at least two reporting mistakes based on the transfer of data.

                It’s an interesting concept.  If I’m right, then there are endogenous data points in the system that are fallacious.  If there are data points within the system that are faulty outweighing the exogenous factors, then the efficiency of the system is faulty and for lack of a better description the system is prone to manipulation.  



    E-mail me, let’s bet!     

    Dec 27 8:31 PM | Link | Comment!
  • Expected Value and the Discount Factor

    In Fooled by Randomness, Nassim Taleb tells a story where a trader questions his logic of being  long the market when Nassim thought the market was due for a pull back.  It seems illogical to be quantitatively long when you think qualitatively the market needs a pull back.

    We are currently long the market but think a pullback is likely.  We are long because we think higher energy prices in the short term will propel the market forward and have a positive increase upon interest rates.  That sounds counter intuitive to economic reality—how can higher energy prices and rising interest rates be positive for the market.

    1.        The increase in energy profits and the corresponding capital expenditures should outweigh a hypothetical pull back in retail spending.  We give this scenario a 70% probability resulting in a market increase of our expected 2011 return of 15%.

    2.       An initial increasing interest rate environment will have a positive effect upon the market because interest rates are too low.  We are a little less certain about this so we apply a 60% probability to this also with a expected return of 15%.

    The two scenario’s averaged out equally create a 65% probability.

    3.       The first downside risk comes from oil prices rising above $125 and having an adverse effect upon the expected yearly return, we give this possibility a probability of 45% with a downside effect of 10%.

    4.       The second comes from interest rates rising to high, the ten year bond rising above 5%.  We give this possibility a 25% chance also with a 10% downside.

    The expected value equation becomes:

    Probable Upside 65% x gain 15% = 9.75%

    Probable Downside of 35% x pullback of -10% = -3.5%

    Or net expected value of 6.25%

                    The biggest danger we see is a rising discount factor or the incremental change in the denominator of the value equation which we define as the present value of future free cash flows.  Free cash flows produced by business are at a very high level today.  Expenses have been cut, there is very little capital expenditures happening which equated to high cash flows.  High cash flows are good in a sense, the down side coming from poor capital allocation of those cash flows or such a high discount factor that the value becomes negated. 

                    While there will always be good and bad capital allocators, we are more concerned with a possible rise in the discount factor to levels where the reduction in fair value will erode the economic value of the market. 

                    Supply and demand should bring energy prices to a realistic value in time, but the influences of government can cause havoc to the changes n the discount factor making a rising discount factor the real worry on the horizon.

    Mar 11 3:26 PM | Link | Comment!
  • Market’s Correlation
     We sat down with a colleague yesterday discussing the current market state.  We stated that current conditions are producing a non-correlated equity market.  We define correlation as an aggregation of intentions producing directional markets—or market participant’s act as if they are in a herd environment where everyone follows overall sentiment.   For instance, the tech market of the late 90’s and early 2000’s had a high correlation of investors buying technology stocks—some of which had no game.  Late 2008 and early 2009 showcased a highly correlated market of selling everything.  From March of 2009 the market has displayed correlation of buying beta inspired by Qualitative Easing 1 and 2.

    But we stated diversity seemed to hold dominance today.  Our colleague disagreed with us.  He said while the extremity of March 2003 or March 2009 was obviously gone, there still exists herd mentalities in certain areas.  Our conversation was cut short and he wasn’t able to extrapolate his opinion but it prompted us to look for correlation we might be missing. 

    We found an area we feel is showing signs of correlation which could lead to a bubble down the road. 

    In today’s market, a rare commodity is safe income.  With interest rates low and the fed’s intention to keep inflation at bay it’s hard to find income of any size in today’s market.  The exception to this is certain companies where the dividend is high.  We looked at two companies with outsized dividends, StoneMor Partners and Alliance Resource.  StoneMor’s dividend yield currently is 7.85% and Alliance’s dividend yield is currently 4.57%.  Both yields are considerably higher than any high quality corporate/municipal/treasury bond in the market today.  The correlation we found lies in the valuation—which makes perfect sense based on yield craving investors littering today’s market landscape. 

    Both have similar valuations.  We looked at each from two different valuation methodologies.

    First we looked at each from a historic accounting based ratio perspective.  We calculated the 10 year average for 4 different ratio’s and then took that average and applied it to current numbers to see where each company could trade at if it traded at 10 year averages.  For instance, Alliance’s 10 year price to earnings ratio average is roughly 9 times.  We calculate 2010 earnings per share at $8.74 so if the average price to earnings ratio is 9 times, a fair value based on the price to earnings multiple would be roughly $78.5 per share.  Alliance currently trades at roughly $75 per share so we feel alliance is trading at fair value based on a 10 year price to earnings average.  Most of the other ratio’s brought to the same conclusion of fair value for both Alliance and StoneMor. 

    We then looked at each company from an economic valuation methodology.  We calculated multiple multi factored discounted cash flow simulations on each company and came to a widely different conclusion.  Based on free cash flow, each company is overvalued by roughly 20-30%. 

    So what does this mean.

    We interpret this as investors correlating to past accounting driven valuations instead of future based economic reality.

    In our history of investing, this divergence is a recurring scenario that can exist for long periods of time.  We happen to think eventually stock prices will adjust to economic reality creating opportunity based on current valuation divergence.

    The simplicity of the evidence is an opening to short economically overvalued dividend paying companies—Stonemor and Alliance being at the top of our list to short.




    Tags: STON, ARLP
    Feb 18 3:36 PM | Link | Comment!
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