Wednesday, June 30, 2010
Tuesday, June 29, 2010
Monday, June 28, 2010
"If you saw what we're coming along with for the back half of this calendar year, that's lined up and queued up..!"
"[O]nce you see the new platforms, like you'll be all very surprised."
"I'll think you'll just be amazed that how it's a quantum leap over anything that's out there.
I just wish I could wind the clock forward a few weeks, because...you would all say, I get it now...When you see the pieces come together, you'll say, now I see what they were doing...I can't say much more, but I couldn't feel better."
" And we might have a couple of surprises up our sleeves in addition to that...So yes, we feel fantastic about the business. We feel fantastic about the product set."
Sunday, June 27, 2010
Saturday, June 26, 2010
In addition to the criteria set out above, Dreman checks the following five additional criteria before an issue makes it into his portfolio:
- A strong financial position (current assets vs current liabilities etc.)
- Favourable operating and financial ratios
- A higher rate of earnings growth (historically) vs S&P 500, plus the likelihood that earnings will not plummet in the future
- Earnings are estimated conservatively
- An above average dividend yield
Finally, Dreman discusses some actual investments he has made by applying these methods. He goes into detail on how the above ratios and criteria applied to his purchases of Galen Health, Eli Lilly, Ford, Fleet Financial and KeyCorp in the 1990s.
Friday, June 25, 2010
Thursday, June 24, 2010
Accounting is a language on its own. It’s not intuitive (at least, it wasn’t for me), but once mastered it is a very powerful tool for understanding a company’s past and present; it can even give the investor glimpses into a company’s future.
Every quarter, management will host conference calls and issue a release which describes the company’s progress. Often, the statements managements make through these media give a very rosy view of management’s progress. But investors who do not understand accounting have nothing else to go on. Meanwhile, an understanding of accounting can actually tell an investor much more about a company’s performance and prospects, both positive and negative.
One e-book that can help investors understand accounting is Mariusz Skonieczny’s The Basics of Understanding Financial Statements. The e-book covers the necessary elements, and does so from a value investor’s perspective, making it an ideal starting point for the aspiring value investor. The e-book is also free, coming in at just the right price for the value investor as well! The book is available here.
Wednesday, June 23, 2010
Tuesday, June 22, 2010
Monday, June 21, 2010
Sunday, June 20, 2010
In an all-encompassing study, Dreman studied the returns of a 25-year strategy (ending just before the book’s publication) involving annual switching into the quintile of the market’s lowest priced stocks. The study found that low P/E stocks returned an astonishing 19% per year (low P/B: 18.8%, low P/CF: 18%, high-yield: 16.1%) compared to the market’s return of 14.9%.
Seeing as how 1970 to 1996 was a fairly bullish period for the market, Dreman also studied price performance during bear markets, and once again cheap stocks outperformed. This time, the high-yield dividend stocks took the top honours (negative returns of 3.8% per year, versus the market’s return of negative 7.5%), but stocks with low P/E, low P/B and low P/CF ratios also outperformed the general market.
Despite all the evidence, why are contrarians and value investors a small minority of market participants? Dreman argues the problem is psychological. Investors get caught up in new ideas, and despite their better judgement (including all the evidence cited above), they can’t bring themselves to invest in companies that the market has beaten down. This makes them go for IPOs of glitzy companies like Planet Hollywood and SpyGlass at P/E ratios of 100+ times earnings instead of boring companies that have been around a while that trade with small P/E or P/B ratios.
Saturday, June 19, 2010
In a study covering US stocks from 1973 to 1996, Dreman found that stocks with EPS surprises in the lowest P/E, P/B and P/CF quintiles vastly outperformed those with EPS surprises in the highest respective quintiles.
But earnings surprises can come in two flavours: positive and negative. Therefore, Dreman subsequently studied the effects of both of these types of surprises on the most popular (high price-to-X) and the most out-of-favour (low price-to-X) stocks. The results showed that negative earnings had a huge effect on the high-flying stocks (these stocks lost 4.3% of their value in the quarter following the disappointment, and 8.9% of their value in the year that followed), but little effect on the out-of-favour stocks (these stocks lost only .7% of their value in the quarter following the disappointment, and remarkably only .1% of their value in the year that followed, meaning they actually increased in value in the nine months after the first quarter following the poor results).
On positive earnings surprises, however, the out-of-favour stocks reacted very well, showing 3.6% gains in the first quarter following the good news, and 8.1% gains in the year following the good news. The high-flyers (those in the highest P/E quintile, for example) showed only small gains (1.7% in the quarter following, and 1.2% in the year following).
Dreman argues that the data clearly shows that stocks trading at premiums to earnings or book value have high expectations built into them. When earnings are positive, these stocks gain little, as strong news was already priced in. When they are negative, however, they take big haircuts. Meanwhile, stocks trading at low multiples of earnings or book values have the worst already priced into the stock. As such, disappointing data does not affect the price much, but positive data can generate strong returns! This research suggests the type of companies investors should be buying...
Friday, June 18, 2010
Thursday, June 17, 2010
When companies report earnings, analysts will often focus on how profit expectations were met, rather than what those numbers are. For example, even if a company beats earnings expectations, if revenues came in lower than expected, this is often viewed as a bearish sign. Similarly, earnings misses accompanied by higher revenues are often considered positive. However, this line of thinking sorely underestimates the value of a flexible cost structure.
After all, if profit expectations were beaten while revenue came in lower than expected, this means that costs were likely much lower than expected. A company that can control its costs is a company that can outlast its competitors when revenues unexpectedly fall, as they often do in recessions.
Furthermore, higher revenues and in-line earnings suggest that margins have degraded. This could be a sign that the company has had to offer incentives to customers in order to move products. Instead, investors should look for companies that have the ability to reduce or increase costs depending on revenues. This leads to higher predictability and therefore higher accuracy in determining whether a margin of safety exists.
As an example, consider Goodfellow (GDL), a stock we used to discuss on this site as a potential value investment (but has since graduated to the Value In Action page). Back when we favoured it as an investment last year at this time, revenues had dipped by about 15% from year-ago levels. Yet the company showed profits of 24 cents per share versus 20 cents one year ago. How did it do this? By paying down debt (and therefore reducing interest costs) and by slashing operating expenses: gross margin actually increased which is very rare when revenues decline, as fixed costs are spread out across fewer sold units.
One thing to keep in mind, however, is that revenues are more difficult (for managements) to manipulate than costs. However, manipulating revenues is far from unheard of, and as long as the assumptions used to calculate costs are reasonable, the arguments in this article still hold.
For a discussion on various points to consider when analyzing a company's cost structure, see here.
Wednesday, June 16, 2010
Tuesday, June 15, 2010
Monday, June 14, 2010
Sunday, June 13, 2010
Investors rely on these "dealers" for their estimates in formulating their own investment decisions. However, in a paper Dreman himself authored, Dreman showed that analysts are off in their EPS estimates by about 40% per quarter. The dramatic difference is there even after removing companies with low earnings (to avoid large percentage effects just because earnings were small on an absolute basis).
Analysts also tend to be overly optimistic. EPS growth from 1982 to 1996 was about 8% per year, but analyst forecasts taken at the beginning of each year suggested predictions over this period were for 21% per year.
Other studies have confirmed these findings, noting other interesting tidbits in the process. One study found that analyst estimates would be more accurate if they simply blindly assumed a 4% rise in earnings every year for every company.
Why might this be? For one thing, analysts are overconfident in their own research. Many expect their findings to be accurate within 5%, but they are not. Despite the research suggesting analysts are not accurate, each individual analyst seems to believe he is better at predicting than he really is. Furthermore, not a lot of emphasis is placed on being accurate. Analyst pay/bonus structures are often based on how much trading brokerage the analyst brings in. This helps explain why there are so many more buys than sells. (By comparison, few brokerage commissions are brought in for “sell” recommendations.) So, it’s not about being right; instead, it’s about bringing in clients.
This helps explains why one study showed that analysts that work at firms that also have investment banks issue 25% more “buy” recommendations and 46% fewer sell recommendations than their counterparts at firms without investment banks. (Investment banking clients have been known to shun firms that make negative recommendations about their stock.)
Dreman also discusses anecdotal evidence that further suggests analysts are not paid for their accuracy but for their clients. In one example, Donald Trump once requested that an analyst be fired after he issued a sell recommendation on Trump’s company. The analyst was fired, and won a few years’ worth of salary in court as a result, shortly after Trump’s company filed for bankruptcy.
Saturday, June 12, 2010
Friday, June 11, 2010
Thursday, June 10, 2010
"The company is not making any profit on its net assets value. There is a strong correlation between companies real profit ratio (returns over cost of capital) to its market cap/to net asset value ratio."