S&P 500 hits an all time high this week.
Buffett's ever-growing cash pile exceeds $128 billion.
Surely the markets are over-heated, right?
Macy's seems to offer a good asymmetric opportunity.
I was talking with a friend the other day who doesn’t know what to do with his money, so he has his whole retirement nest egg in treasuries. He has had everything in treasuries for three years now waiting on the market to crash or suffer a correction. "This is insanity", he says. "The market is way too overvalued right now." With the S&P 500 hitting all time highs this week it’s easy to agree with him. Come to think of it, it was easy to agree with him last year when the S&P 500 hit all-time highs. And it was easy to agree with him the year before that, and the year before that, and the.... you get the idea.
We've been in a long bull market for 10 years now, and it's tempting to just sit it out and wait for the crash. Personally, I think there are many indicators that suggest the market is too high to be sustainable. The Shiller P/E is double its long term median. Some may suggest that Warren Buffett's growing cash pile, which has now exceeded $128 billion as he waits for opportunities to invest, is an indicator of a drying up of deals. So, I lean towards agreement with my friend. I merely disagree with his solution of sitting in treasuries. I think there are better opportunities than 1.49% 3 month T-Bills. So this will be Part 1 of a series in which I share some opportunities I have found.
Buffett's Cash Pile Not the Indicator it Once Was
It's sound logic to reason that if the best investor that ever lived is sitting on cash because he has nowhere to invest it, then you should too. If he can't find any opportunities, then you shouldn't expect to either. However, a closer look at his specific situation sheds more light. With $128 billion cash to invest, Buffett simply can't start looking at micro caps or even small- to mid-caps to invest in. His cash hoard is just too big. If he were to place a $10B stake into, say, CBS, for example, that would equate to a 77% stake in the company, but only a 7% position for Buffett. Buying an almost 8/10 ownership share of CBS is simply impossible because, while their public float is 327 million shares, the average trading volume per day is only 4.9M. That means that, to take a 77% stake in CBS, Buffett would have to buy all 4.9M shares available every day. And he would have to do this every day for 67 days. Then he would have invested his $10B into CBS. $10B down, only $118B to go!
But we know that this extreme example would be impossible in real life. The truth is, Berkshire Hathaway has grown to be one of the largest companies in the world, and there's only a limited number of companies that are big enough to even take such a large investment. At a market cap of $235 billion, there are only 24 public companies that are larger than Buffett's Berkshire. These are the companies that are in Buffett's sights. But there's only one problem: those 24 public companies all have an average P/E ratio of 27.5x! If Buffett were to fully invest his $128 million of cash into the market, he'd essentially have to take a $2B position in each of the 64 largest companies publicly traded today. But the average P/E ratio of these companies is even worse: 27.91x. And taking a $2B position in any stock (assuming it would even be possible when taking into consideration public float and current ownership %) would take weeks to accomplish, especially if you want to do it without driving the price of the security that you're purchasing way up. No. No way Buffett would touch any of these companies right now. No wonder he's sitting in cash. His investment process and burgeoning war chest require that there be a market correction, or a terrible news story. Then Buffett will swoop in and start buying. When/if in the coming months or years, one of these 64 companies gets hit with a bad PR story, or a lawsuit, or a privacy breach, or some temporary negativity that brings the stock down, be on the lookout for Buffett. It will be another headline like Buffett's $5B Goldman Sachs investment during the Great Recession.
While the largest companies in the S&P 500 are pretty much fully valued on average, us "little people" have a much wider field of investment options from which to pick.
Out of the much bigger universe that us "everyday Joe's" can pick from, Macy's seems to offer a good asymmetric opportunity. Macy's stock price has recently fallen to 5-year lows as a result of declining store visitation. In mid-2015, the share price was just under $70. Today, $15.62. But you wouldn't have guessed that from the fundamentals. 2015 revenue were $28B and profits $1.5B. Fast forward to their latest 10k: $25.7B in revenue and $1.1B in profits. The stock price has tumbled 78% over the past 5 years while fundamentals remain largely intact, decreasing slightly. Yes, stores are closing, but new initiatives are promising. P/E is now below 5x based on TTM of EPS ($3.29). Average EPS over last 5 years has been $3.55. A return to historical multiples of 12.5 would imply a price of $37.50, a return of 140% from today's levels. I don't believe the market will reward a brick-and-mortar centric company with 12.5x multiples, but even a conservative $3.00 EPS x 10 P/E would equate to a $30 share price, a double from current levels. The dividend is a stout 9.7% right now. At $1B in cash flow, the dividend is less than $500M and is manageable. Debt has been reduced by $2.6B over the past 5 years, down to 65% of its previous levels.
It's possible that the stock price has reached a point of maximum pessimism. For patient, "smaller" investors, this may mean maximum return potential.
Disclosure: I am/we are long M. 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.