Friday, March 22, 2013

Why It Is Best To Avoid Glamour Stocks

This article is going to give you a great piece of investment advice, and not in the sense that it is going to give you any buy or sell ideas over a stock. In any case any serious private investor shouldn’t be making investment decisions solely based on the words of a journalist, broker or finance adviser. It’s all well and good to take advice, but the key is to do your own research and make your own decisions.

There Are More Things in Heaven and Earth

And there are more ways to do this rather than invest in Apple (NASDAQ: AAPL). You should know this. Your broker should know this. Your advisor should know this. In short everyone should know this. Well if that is the case why does an inordinate amount of discussion take place over the stock? The answer is simple. It’s probably the best known brand in the world and everybody has an opinion on the iPhone. Herein lies the problem. The stock attracts a huge amount investor recognition, and both private and professional investors seem obsessed with trading this stock. That’s just the way it is. You can analyze the company to death but the direction of the share price is more about sentiment over the iPhone’s future market share than it is about the current fundamentals. Its stock price seems to be a kind of vote over the iPhone.

Of course if you have strong views on the subject then go ahead and invest, but if you don’t then stay away because this stock invariably attracts hot money. Whatever you do, don’t buy or sell this because you feel obliged to have an opinion on it.

Icahn vs. Ackman, Who Will Win?

The battle over Herbalife (NYSE: HLF) has fascinated commentators and investors, and for good reason. The story invokes our love of the thrill of a high stakes game between two individuals driven by a mutual dislike. Ackman holds a conference to outline the reasons behind his very aggressive short position. Icahn later buys the stock and very publicly lambasts Ackman claiming that Herbalife could be the mother of all short squeezes. The fact that all of this is being played out so publicly tells you all you need to know.

These guys are surely trying to influence other investors to join in this game. And a game it is. This isn’t so much about the underlying fundamentals as about who is going to get the most investor votes and force the other to climb down.Who really knows what will happen and how this will play out, so why get involved in this game? It’s a lot of fun to discuss and debate the ongoing developments, but this is not the kind of situation that serious investors should be involved in.

My Advice?

My idea is simple. Call your broker or investment adviser, ask about these two stocks and if he spends half an hour gushing over them with trading advice and exhortations to take a position then politely close the phone and start thinking about finding a new adviser.

Investing is hard. It requires a relentless commitment to research and a disciplined and methodological approach. Unfortunately these aspects of investing are far too easy for private investors and professionals to discard. Private investors are encumbered by a lack of time but for professional investors there is no such excuse. It’s all too easy for professionals to focus on glamour stocks or the most popularly discussed situations. They bring instant recognition and they get their investors talking and trading. Moreover investors expect their advisers and fund managers to ‘have a view’ because to not do so would be to be out of the ‘smart money’ loop. When will this nonsense stop? When will investors stop handing over money on to advisers on the back of their opinions on one or two glamour stocks?

 The Law of Small Numbers

The nonsense doesn’t stop there. Consider the law of small numbers or the understanding that a larger sample of data gives a more accurate measure of performance than a smaller set. This is the reason why the number of patients goes up with later stage clinical trials. Pharmaceutical companies generate much more accurate data with later stage trials, and approval decisions are based on them and not on early stage data with a relatively small sample. With this in mind, why do investors trust fund managers on the back of their performance over one year or with a data point of one?

Two classic examples of this tendency are the hedge fund managers Andy Zaky and John Paulson. The former achieved fame and investment funds due to his analysis of one stock. No prizes for guessing it was Apple! And no bonus for working out that Zaky went on to lose investors significant sums of money as outlined in this article. As for Paulson, he achieved fame and investment thanks to his outstanding performance during the recent financial crisis. While this deserves applause, it still does not represent a long term track record of performance; but that didn’t stop investors giving him huge sums of money. The result is that he has had a lousy couple of years, and Morgan Stanley is now reported as telling its clients to redeem their investments.

The Bottom Line

The moral of the story is to avoid highly popular story stocks or short term records with limited data to back up an investor's performance. Investing is a hard grind and it requires a lot of hard work. It is easy for the investment industry to focus on high profile stocks and applaud and promote themselves on the back of a good year or two, but serious investors should not allow themselves to get seduced into investing with them.

Thursday, March 21, 2013

How To Profit From Obesity

Funnily enough, I think that long term investors should be investing in the long term. In this article I’m going to discuss obesity, its prevalence and suggest some of the stocks that might be bought and avoided as a consequence.

Obesity Prevalence

Everyone loves looking at a national league table in order to compare and contrast, and the evidence from the OECD is clear: The US, Canada, Mexico and the UK are right at the top of the developed world obesity league. There are other countries like Hungary, Greece, Estonia and the Czech Republic that have higher than OECD average obesity rates. But there are two unique features that these countries have in common with each other but not with the UK and US.

Firstly, in the US and UK there is a tendency for women to have notably higher rates of obesity than men whereas in the other higher obesity countries (apart from Mexico, Chile and Ireland) the rates tend to be similar. Second, there is a tendency for women in the UK and US to be obese earlier on in life and stay that way.

Before looking at the chart demonstrating these points please understand that the data was pulled from two separate sources and for slightly different age groups so it is not directly comparable. No matter, the important point is the trend. The US data was sourced from the Centers for Disease Control and Prevention while the European data comes from the EU, and the US data is for the 20-39 year old range.

The key is that there is no great quantum leap within obesity rates between young and old in the UK and US, while the evidence suggests that in other European countries women tend to experience a ‘natural’ step up in weight gain as they get older. UK and US women seem to get obese at an earlier age.

To demonstrate this I’ve tabulated the ratio of overall female obesity rates and divided them by the 18-24 year old rates. A low ratio indicates the tendency for women to be obese at an earlier age and stay that way.

Based on the data above I think it is safe to assume that the US ratio would be similar to the UK. Note that Romania, Greece, Hungary and Poland have high ratios. They are countries where women are slimmer earlier on.

Why the Focus on Women?

Before the complaints come in I should explain that I am focusing on women (even though global trends with men and women are pretty similar) in order to highlight some remarkable data. According to the OECD data, US women are noticeably more obese then the men, but it is not even comparable to the huge divergence in the UK.

A quick breakdown of the stats for the UK demonstrates the point:

There is clearly some factor responsible for UK and US women being more obese at an earlier age. As for UK men, if you go back to the second chart their ratio works out to be bang in the middle.

I can't give a definitive verdict but allow me to humbly speculate that both countries have a similar income distributions with net worth skewed to upper deciles, and both have strong feminist influences in the media and within their welfare states. I think the solution involves a little bit more than getting Jamie Oliver to run around and introduce more broccoli into school meals.

How to Profit and Avoid Loss?

The current bugbears are of course the fast food restaurant chains and the snack & beverage companies. The highest profile of which are McDonald’s (NYSE: MCD) and Pepsico (NYSE: PEP). Indeed, not a day seems to go by without someone jumping on the bandwagon and criticizing these companies. The central argument seems to be that they offer cheap carb laden foods that poorer people (who tend to be more obese) are minded to eat. I have a serious issue with this kind of criticism. There are many other countries in the world that have lower GDP income levels and high fast food penetration rates, but they are not subject to the same levels of obesity.

Of course it is so easy to criticize these companies rather than have the courage to at least try to delve into the underlying causes of obesity. Let me put it this way: A city like Budapest (Hungary) is saturated with fast food joints. Now if McDonald’s shuts down tomorrow will there be mass anorexia among the young? I think not because I believe the key determinant of obesity is the willingness to lose weight, and that is guided by the social acceptability of being obese or not. However, I’m not optimistic that politicians will share my view anytime soon so I suspect McDonald’s and Pepsico are faced with these kinds of unfortunate challenges in future.

Another impact is on health care. The correlation between weight gain and diabetes is well documented, and companies with large diabetes franchises look set for strong growth in the years ahead. The big two players are Sanofi (NYSE: SNY) and Novo Nordisk (NYSE: NVO). I’ve discussed Sanofi in more length linked here and for those interested in more pure diabetes plays there is some discussion linked here. Novo has the broadest range of products in the marketplace including injectables like Victoza, which helps to lower blood sugar levels in Type 2 patients.

However, the big battle is being fought over Novo getting its long acting insulin (Tresiba) approved and into the market so it can compete with Sanofi’s leading insulin Lantus. Both companies have had setbacks recently with Tresiba requiring more detail from the FDA and Sanofi’s Lxyumia (intended to be used in combination with Lantus and help extend the franchise beyond Lantus’ upcoming patent expiry) not being able to initiate Phase III trials this year as previously planned. Nevertheless if you want a diabetes play, these are the stocks to start looking at.

Another area worth looking at is Bariatric surgery, and I think Covidien (NYSE: COV) is an interesting candidate. Its minimally invasive surgical (MIS) solutions see this type of surgery as the biggest single profit driver. Furthermore, MIS represents the key growth area of the firm and will be even more so when it completes the split from its pharmaceuticals division. There is some discussion of Covidien linked here. My point is a simple one; if there is more obesity then there will be more Bariatric surgery.

Wednesday, March 20, 2013

Investing in the Spending Trends of the Wealthy

I have a quick trivia question. What share of US net worth does the bottom 60% of the US hold? Stop for a second and think about the answer. The correct answer is just 4.2% while the top 5% of the US owns nearly 62%.  Now consider an average superstore in an average mall (such a thing doesn’t actually exist but assume it does) and accept that spending correlates strongly with net worth (it does) this would mean that just 5 out of a 100 shoppers is doing the bulk of spending. Meanwhile 6 out of the 10 are doing just 4% of the buying. Now hold that thought.

A Realistic Way to Think About Spending

The reason I am engaging the reader in this kind of thought framing is because it is the reality whereas it is so easy for us to fall into the delusion of misattributing spending trends thanks to the language we use. Analysts and commentators use words like ‘mass’ and ‘luxury’ to describe the retail market. They are useful concepts and I am not in any way arguing that the top 5% only buys luxury goods! However the point is that we should think about retail trends in terms of who is doing the spending rather than just assuming that the conditions of the majority (80% of the US only holds 15.1% of net worth) dictate overall spending.

In order to graphically demonstrate income distribution I’ve broken out the numbers graphically below. All numbers in this article come from research carried about Edward Wolff.


I’ve put the bottom 40% but even then it is hard to see! The top 5% is broken out and as you can see comprises almost 62% by 2007.


A Bifurcated America?

Indeed the trends appear to be slowly getting worse and I’m sure the economy of recent years has accelerated them. For a host of reasons –most of which I can’t go into here- I think that this will continue. My central point is that there appears to be a growing bifurcation in America and it is just not about money. Lifestyles are also bifurcating and at the heart of the reasons for it lie two ideas which I think are mistaken but widely accepted as truth by the constituent groups that holds them. On the one hand one group seem to think that the US lives in a pure meritocracy and taxes and government expenditure are a disdainful burden on them that is intended to punish their success. On the other, another group seems to believe that all men are born with equal attributes and abilities and the purpose of Government policy is to rectify any ‘unnatural’ imbalances via redistribution of resources. This is part of the reason why the US has such large public debt. You can’t reduce a debt by paying less and spend more, yet that is the ‘happy’ consensus that US has been living in for years.

The result of this mess is that the wealthy are getting distrustful of the merits of the public sector while the poorer segments are developing a dependency culture. Moreover the cultural ties that bind America are splitting.

What Does This Mean For Stocks?

Of course many of these observations have been made by Citigroup in its investment research on plutonomy stocks, however the stocks I want to discuss are subtly different. Whilst those stocks were primarily about luxury stocks, I want to focus on stocks that are emblematic of the cultural shifts and that are dependent upon them continuing. For example the wealthy bought Louis Vuitton bags in the 60’s and they do so today but, what about other differentiating trends in wealthy peoples spending habits?

Let’s focus on lifestyle. Take Lululemon Athletica (Nasdaq: LULU) and Whole Foods Market (Nasdaq: WFM). The former appears to be a business without any significant moat and therefore susceptible to margin erosion as rivals threaten to introduce cooler yoga gear. Indeed a quick look at the figures from Yahoo finance indicates that there is a 27% short interest in the stock. While I sympathize with such an approach and find some of the company’s pronouncements over the cultural importance of its yoga pants to be comedic, I would caution against being too negative. It is not pitching itself into the mass market but rather at the kind of wealthy health conscious lady with significant spending power. Her spending priorities are not governed by the same kind of economics as the rest of the athletics gear market.

As for WFM a relatively small number of its customers make up a huge amount (around 20/80) of its revenues. Moreover as long as the trend towards healthy living and differentiation from the eating habits of the rest of the nation continues then I think WFM can convert shoppers to its offering. WFM doesn’t just offer a healthy option, it offers a tangible differentiated lifestyle choice and wealthy people in the US appear willing to pay for this in itself.

Similarly take something like the Boston Beer Co (NYSE: SAM). Beer is as far from a ‘luxury’ stock as you will ever get but SAM does offer premium craft beers and this market is growing significantly in excess of the mass market beers. All it requires is a notable shift in purchasing behavior from the top 10% of the US and there will be a notable marginal shift in demand. Given that SAM has such a small market share it is not hard to see the company continuing to generate double digit revenue growth.

Another area in which we can expect the wealthy to continue to spend is in personalized health care and cosmetic surgery. Stocks like Myriad Genetics (Nasdaq: MYGN) and Allergan (NYSE: AGN) are worth a look. The former develops diagnostic tests for people who want to assess the risk of developing certain diseases (typically hereditary). Admittedly it needs to develop revenues outside of its Bracanaysis (breast and ovarian cancer) test but if the trend towards the wealthy spending money on personalized and pre-emptive medicine then its chances will improve. As for Allergan, as long as the trend towards cosmetic surgery increases among the wealthy then it can expect good sales of its market leading Botox product.

Friday, March 1, 2013

Why The Sequester is Good News

For those investors focused on the big picture I thought I would share a few thoughts on the current situation. I previously discussed some of the worrying structural trends in the US economy in an article linked here, and in this article I want to discuss why so many commentators are getting it completely wrong.

What Went Wrong With the Free Market?

The problem with free market thinking is that it is most visibly and vehemently promulgated by those who are the biggest absolute winners in it: the expensively suited Wall Street professional, the corporate ‘fat cat’ and the propertied wealthy who have done so much better than the rest of the US over the last 20-30 years. Of course such caricatures of America were tolerated and even admired by the rest of the country as long as the economy prospered and blue collar America could participate in the dream of having a better standard of living than its parents.

The rest listened to the wealthy and their exhortations over how the modern democratic capitalist state was a new meritocratic utopia where everyone had opportunity. And although they never fully believed the wealthy, they accepted it was better than living under communism and they were grateful for their chance.

I emphasize meritocracy because it has the wonderful byproduct of obviating the necessity for any form of collective responsibility: a convenient state of affairs for the uber wealthy and a large part of the reason why the wealthy genuinely don’t want to pay more taxes.

Of course the principle of meritocracy went completely out of the window in 2008 and along with it went the free market ideology so beloved by Wall St. The idiotic, reckless and in some cases corrupt bankers were rewarded with a collectivist scheme of redistribution. They were bailed out and saved by racking up public debts in the name of saving the system. If the meritocratic free market really had its way than the senior bankers would be senior burger flippers by now. As John N. Gray put it to me when discussing the issue ‘unfairness is the price you pay.’ Indeed.

What We Learnt and What We Should Learn

Of course what we learnt from all of this is that, as George Soros always said, there is nothing inherently stable or self rectifying about free markets. And if he is right then there is no pure meritocracy or free market in the real world. I suspect the Occupy Wall Street and Tea Party movements share the same disaffection with how the recession was dealt with. I suspect they both want to get back to the American dream of opportunity through self effort.

Putting all these things together it is easy for a free market enthusiast to retreat into his shell. It is easy to give up. It is easy to forget that social mobility occurs better in freer economies. And it is also easy to forget, in my opinion, that the corporate sector has far more checks and balances in it than the public sector does. My argument is not to defend free markets just because it is a doctrine argued by the very same people who made a mockery of it with the bailouts, but rather to point out why and where it does work.

What Corporations Do and Government Don’t Seem Able To

Allow me to flesh out this point by comparing how the corporate sector functions (when it is not interfered with by bailouts) as opposed to the Government.

Let’s go back to 2001 and recall that the recession then was largely caused by over investment or rather misallocated capital. Corporations spent too much and generated over capacity, particularly in the technology sector. Now look at how the corporate sector has adjusted to this ever since.

From 2001 onwards they diligently built up assets over liabilities and they didn’t rack up debt in order to do it. Even now the net worth of corporations is surely at an all time high while the debt/net worth ratio was lower than in the 90’s for the last ten years save for recession-affected 2009.

The non-financial corporate sector is good at adjusting to market discipline. In fact the problem now may be that corporations are too reluctant to spend. All of which means that Johnson & Johnson (NYSE: JNJ), Microsoft (NASDAQ: MSFT), ADP (NASDAQ: ADP), and Exxon Mobil (NYSE: XOM) have a higher credit rating than the US Government. I suspect Apple (NASDAQ: AAPL) would do too if it had the need to issue credit!

I’ve included GE and McDonald’s by way of comparison. Apple isn't included because it has no debt.

ADP Debt to Total Assets data by YCharts

What Is the US Government Doing?

So while corporations are adjusting to realities, here is what the US Government (and it is not alone) is doing.

US Federal Government Revenue as % of GDP data by YCharts

These are the hard numbers. This is the truth. And with every recession the situation is getting worse, and so is the debt.

It is not enough for Wall St to drone on about a meritocracy while they merrily save themselves from market forces and despise higher taxes and, it is not enough for Main St to carry on pretending that the fiscal trend is sustainable.

Something has to give here, and public spending as a share of GDP must be reduced in order that the US never gets itself in this situation again. Simply put, the Government is not good at managing finances because its members are not subject enough to an efficient form of accountability. And so, I repeat the same question. If a recession comes in the next few years--and I do not have a black swan warning system--then how will the US pay for it?

It strikes me that the Sequester is not the enemy of the US, it's part of the hope. Racking up debt for future generations is surely not an option anymore.