Sunday, December 19, 2010
In Richard Thaler and Cass Sunstein's Nudge: Improving Decisions About Health, Wealth, and Happiness
This further leads to a logarithmic preference scale as you compare the 1st to 2nd, 50th to 51st and 99th to 100th percentiles of wealth. The change in the number of people you are now better off than in the first interval is much higher than the third interval, suggesting that the risk you'd be willing to take in the first instance (i.e. to jump from the 1st percentile to 2nd percentile in terms of wealth) would be much higher than in the third interval.
To change the interval size, and now look at the change from 1st to 75th percentile in relative wealth demonstrates why lottery payouts are so popular, even though from a high level perspective they're effectively like throwing money away (your probability adjusted return is less than the initial capital outlay). They represent the greatest possible delta in relative wealth for the least cost.
High Volatility Stocks: Another Form Of Lottery
This translates to a preference for assets with high volatility, which in conventional terms are seen as the riskiest/most lottery-like. Authors such as Eric Falkenstein have covered this relationship rather extensively, but as it pertains to volatility as a measure of intrinsic risk I would like to go a step further. In our market, investors searching for these lottery-like payouts are going to go in search of assets with already high volatility. In this scenario, volatility is going to beget more volatility, as more lottery seekers pile in. The lottery seeker, by preference for the highest relative wealth delta for the lowest cost, is going to prefer the assets with the highest ordinal ranking in terms of potential payout. This would lead these investors to dramatically favor, say, the 10th decile of assets in terms of volatility over all other assets.
Why is this a problem for volatility's connection to risk? The key is the self-selection going on when picking assets. If the lottery payout seekers had a slope to their preference, this might still plausibly lead to an efficient market where volatility measures intrinsic risk of an asset, as the lottery seekers become more concentrated in higher risk assets. But the preference for the highest risk stock in ordinal rank is going to lead to a disproportionate asset allocation, leading to a breakdown in volatility in its connection with risk.
The final article in this series will serve as an exploration in to the problems with the risk/return correlation
Saturday, December 18, 2010
Throughout a classic education in finance and economics, one core concept that became an assumption of my daily life was that volatility was risk. To a certain degree this intuitively makes sense: if I'm buying an asset, and I have little sense what its value is going to be in an hour or two days from now, I should buckle up because it's going to be one hell of a ride.
In a relatively preset environment, volatility would certainly approximate risk. For example, if we were to live on Mount Kenya as a subsistence farmer, where mean daily fluctuations of temperature equate to 11.5 degrees Celsius (20.7 degrees Fahrenheit), this could surely be seen as one approximation of the risk of being able to generate a successful crop, although another might be seasonal weather fluctuation, such as that seen over a year. Still another would be fluctuation in weather over several years. Thus these three time spans (daily, seasonal and yearly) of weather fluctuation could probably closely approximate your risk of survival (of course there would be others: see bears).
So why might a security's volatility not closely approximate its risk? One answer would be the failure to translate observed volatility to actual volatility, although we would certainly run in to this problem when observing weather. The other problem would come with what this volatility actually represents. In the case of weather, it is the state of our atmosphere, something far beyond our control (although the aggregation of humans is doing a pretty good job: see climate change)
Is An Individual Investor Equivalent to a Subsistence Farmer?
In an asset market, for volatility to approximate "risk of survival" like it does in the natural world, it would have to retain some key characteristics:
- Unchangeable by one or several individuals
- Relatively constant over time
Monday, July 26, 2010
How This Can be Applied
With the California prop voting coming up in November, there are several special interest groups that will be trying to garner popular support for their proposition going in to the voting process. For the sake of conversation, let us look at one of the the most polemic of these propositions: legalizing marijuana (Proposition 19).
Now how could Cialdini's identified phenomena be used to actually make the public more favorable to this proposition? One methodology would be to first approach potential voters in a canvassing effort and request that they sign a pro-free choice or pro-freedom petition. Reasons given for the request could be that the group is trying to help the people show the government that they feel that citizens should have the ability to make free choices without government interference.
Presumably, with this decision to sign the seemingly innocent "pro-freedom" petition, individuals approached would be linking themselves in their minds to being pro-free choice and as agents for this cause.
When approached, ideally the next weekend, by another canvassing group asking them to sign a petition saying that they feel people should have the right to choose whether to smoke marijuana on their own without government interference, the suggestion should be couched in terms of freedom and personal choice. The jump could potentially be too large for many to make, between "freedom" supporter and "freedom to smoke marijuana" supporter, but I would guess that one would receive much more positive responses to the second request after the initial one.
The Approach Can be Two-Sided
Continuing with the marijuana proposition, opponents to prop 19 could have a two-tiered canvassing approach of first approaching potential voters and asking them to sign an "anti-drugs" petition. This seems incredibly innocent and simple, and I would be surprised if there was too much resistance to it.
By signing the petition, individuals would be creating a link in their minds between themselves and the anti-drug cause. This could be exploited in a proceeding canvassing effort with the petition to be anti-legalized marijuana.
Why Do People Need to Sign Something?
One of the important items in Cialdini's book is the associative significance of signing your name, and even better, if your position is to be visible by other members of your community. While simple, the act of signing your name creates a very strong link in your mind, much stronger than a simple verbal 'yes' or 'no'.
While it involves more time and resources, the two-staged canvassing process can be used to create supporters where there were previously none.
Sunday, July 25, 2010
Thursday, July 22, 2010
Sunday, July 4, 2010
The Impact Of Corporate Social Responsibility On Executive Compensation
Sunday, May 30, 2010
Saturday, May 29, 2010
But to get past the typical hurdles when talking about companies that are so well known throughout our culture, the story behind Wendy's/Arby's Group's (WEN) faltering stock price has been one of profitability, debt burden and concern over the Arby’s side of the group. The stock has been down in the dumps lately, even passing the 1 P/B threshold that puts stocks on my radar. As of Friday’s close (5/29/10), WEN’s P/B was 0.86.
I will get to the assets equity holders are actually getting a hold of when they chase that 0.86 P/B ratio later, but to begin with I think it is important to understand what is going on with the business. While WEN does hold both Arby’s and Wendy’s, after reading through the holding company’s 10-K I did not get the impression that there was much coordination between the two. I did not see the pitch book for the merger, which took place in September 2008, but I would imagine that part of the idea was to achieve savings through shared resources and common supply contracts. This currently does not seem to be the case, since as far as I can tell Arby’s and Wendy’s are being run as two independent companies (although the company does mention adding more coordination as a goal going forward).
Focus on Arby’s: Isolating the Problem
To understand what has been happening with Arby’s, one need look little further than what has been going on with average stores sales over the years (especially in comparison to Wendy’s):
There is optimism that Arby’s new president Hala Moddelmog, who started her career at Arby’s and has significant experience in the industry, can help Arby’s in their makeover. The one thing that I think that Arby's needs the most is to answer the question: "why roast beef"? Obviously Arby's has been suffering from demand issues, so maybe it is a problem with the market not appreciating their product. That is why I feel like you either convince the customer that they should want roast beef (maybe the protein content? studies associating eating roast beef with improved health?) or change up the game. But right now, without a product line to center around, the company seems without focus and undefined.
Furthermore, if you want to sell at the higher price points (with products like the market fresh line), you need to drop the elements that make your products seem low rent. This would include getting rid of the nacho-cheese like substance that goes on some of the roast beef sandwiches and dramatically scaling back the fried food sides. They would want to position their menu price between the McDonald's (MCD) and Burger Kings (BKC) of the world yet below the Subways and Quiznos, hopefully becoming known for being cheap, fast and relatively healthy.
Can You Buy WEN on Asset Quality?
After the stock for any company crosses the 1 P/B threshold, each person buying equity is technically getting more than a dollar in assets from the company. The statement it sends when a company drops below this level is that there is absolutely no "whole being greater than the sum of the parts", i.e. this company would be worth more broken up than is together. One would think from a prospective buyer position this would be great, but you really have to look at the assets you are getting a hold of before you make the plunge.
This is because items like Goodwill and Intangible Assets can quickly approach zero if the company starts really going through problems. This is especially the case with Goodwill, since it is technically the amount paid in excess to what the other company is worth in a merger or acquisition. My guess is that WEN's goodwill is from the merger, and while it is important to add this Goodwill in to the balance sheet to make everything balance out, the implicit assumption by accountants is that the price paid during a merger or acquisition was justified. One need not search too hard to find instances of terrible, terrible mergers and acquisitions (my personal favorite? Time Warner and AOL) where Goodwill was later slashed and burned.
With Intangible Assets, such as brands, these are usually recorded at cost since there is little room in U.S. GAAP to revise assets up on the balance sheet. In a period of duress, such as bankruptcy, brands can get tarnished and watch their value plummet. Because of this, I try and be really careful around Goodwill and Intangible Assets since these are probably the first to go once things start heading south, and since equity holders are the last in line, probably what they would get stuck with.
This being said, when you take out Goodwill and Intangible Assets there is no shareholder's equity left over, in fact it is negative. So what kind of writedowns can they withstand to Goodwill and Intangible Assets to still maintain a 1 P/B level? 14%. Not much, if you ask me.
The Final Take
As of their most recent 10-Q, WEN was standing at an S&P credit rating of B+, by technical definition highly speculative non-investment grade. Ironically, they have also been participating in a share buy back plan and at their 2010 shareholder's meeting they just approved another $75 million, bringing the total up to $325 million. Why a company with a terrible debt rating (which is also responsible for the crippling debt payments that are destroying the company) is buying back shares in addition to posting a dividend when they are making operating losses is a mystery to me and if I was holding their debt I would be incredibly mad.
This combined with the fact that the stock price is not low enough for current buyers to actually be getting a hold of real assets (instead of Goodwill and Intangible Assets) makes me feel like this is a company an investor should stay away from.
I'll personally never understand why there ever was a merger between Arby's and Wendy's. If it brings down Wendy's, others will wonder the same thing.
Tuesday, April 20, 2010
Blurbs that I've read, such as Bob Pisani's Stock Talk from March 31st, 2010, point to natural gas as being a big mover for utility companies like Mirant. Commenting on the movement in independent power producers, Pisani notes:
"Natural gas happened. Independent power producers usually work in regulated markets, where the price they can charge is often tied to natural gas prices. Nat gas went from $6 to $4…a disastrous impact on profits, since fixed costs did not change."
So I thought I'd take Pisani's hypothesis to the data and see what the data had to say. I performed a linear regression in STATA to try and see what connection daily returns in natural gas had on energy producers such as Mirant (MIR), AES Corporation (AES), Dynegy (DYN), RRI Energy (RRI) and NRG Energy (NRG).
The short answer: except for Mirant, natural gas has no statistically significant explanatory power for the companies' stock prices for the time period considered. Even the explanatory power of natural gas for Mirant becomes statistically insignificant when a proxy for market performance (i.e. the S&P 500) is added in.
What I Did
To begin, I used Yahoo! Finance to collect historical daily stock price data for all of the companies mentioned above and for the S&P 500 index. The West Texas Natural Gas Wellhead price was used for natural gas and this data was obtained from GFD (Global Financial Data). For further testing, I also used the WTI Crude price, GSCI Energy Index, Moody's Commodity Index and Dow Jones U.S. Electricity index, all obtained from GFD.
All data was converted to percent return, and to try and control for changing correlation and dependency in the data I only looked at the time elapsed since the beginning of 2009 through the 9th of April 2010. The cut off at Apirl 9th was done to correct for the fact that Mirant and RRI just entered in to a merger agreement.
For the first step, I simply performed a linear regression of the daily percent change in natural gas prices on the daily percent change in the company stock price. Below please find the adjusted R-squared values, coefficients on the natural gas variable and corresponding t statistics from my regressions.
To put the coefficient in to perspective, for Mirant, if there is a 1% positive change in natural gas prices we would expect the stock price to go up by 0.04%.
As we can see above, in AES, Dynegy and RRI adding in natural gas rendered a negative adjusted R-squared value, meaning that it'd be better to guess randomly than look to natural gas as an explanatory variable. It is very easy, from the results shown above, to see that natural gas clearly does not have an impact on utility stock prices for the time period considered.
From a Longer Time Horizon
When I used data spanning back to 2006, the answer started to change. Natural gas became statistically significant for all companies except for AES, and this was even when market performance (i.e. the S&P 500) was added in. The negative coefficient of natural gas in the Dynegy instance is somewhat strange, but the coefficient is so low one can essentially assume it is zero. In fact, in all of the companies the impact of natural gas on stock price was far dwarfed by the S&P 500 variable, in all cases by at least a degree of magnitude.
The conclusion from this study would be that while over the long term utility stock returns are more generally tied to natural gas movements this effect absolutely does not exist on a shorter time frame (i.e. 1-1.5 years going back). This could be because most utilities today hedge for inputs, so they probably are not sweating the day to day movement. These hedges typically go out a year in advance, which could explain why data periods over longer time periods, which can take in to account longer trends, show more significance.
The extremely low values on the coefficients for natural gas, in both the longer and shorter term analysis, suggest that Pisani is mistaken is his connection between natural gas prices and stock price moves of power producers.
I took my first computer programming class in 1966. I evaluated the original Macintosh computer for Atlantic Richfield Co. before it was originally released in 1984. I worked with one of the original software developers for the TRS80 from Radio Shack that was the first product to use MS-DOS from Microsoft.
I was involved in many debates about the pros and cons of open verses closed technical environments in computing technology. Apple made a decision In the early 80's to keep control over their environment. Microsoft took the open approach.
Apple new they would lose market share in the sort term as most 3rd parties jumped on the Microsoft bandwagon. Apple knew they could provide a richer environment with greater innovation in the long run.
I believe Apples strategy has overtaken Microsofts and will continue to dominate in the future. The battle has begun with Google and will be very interesting to watch over the next several years as google search is replaced by Apple Apps. Google's "open" approach to phones is similar to microsofts approach to computers in the 80's.
Pandora's box is open for Google and it will be interesting to see how they support early adapters to their approach as new technology comes available.
Third party software is, I suppose, your exception to this rule. But for what reason? Certainly mainframe computers, automobiles, medical devices have controlled their software and hardware. In most cases, it was not only desired, it was necessary for the product to function safely and be service supported by the manufacturer. Why should the success of Apple products cause them to be excluded from such proprietary control? I'm sure Apple has thought about what margin they can justify within the context of market demand and growth. You make it sound as though they do not deserve the fruits of their success. A rather socialist opinion I might add.
Apple's proprietary marketing system has allowed single programmers to become wealthy in just a few months. It is an exciting and valuable means for tapping the immense diversity of talent and vision that exists all across the far reaches of Internet tethered individuals.
Perhaps you don't recall when Microsoft strong-armed retailers to muscle out Apple from their best display space. In the years that followed, Apple almost was sold out as a near death business. Do you recall the way the Bell system dominated communications here and in the process were able to influence government and their regulators in such a way that Bell became a pure money machine and in the process became an impediment to our national telecom policies. Now many smaller nations such as Korea have more advanced broadband available at cheaper prices than the US will have for many years. Business always tries to optimize its market advantage. If at some time in the future Apple's dominance hinders viable competition, as did Microsoft and Bell, then they should be the target of government anti-trust action. But at the moment, Apple is not keeping software vendors from doing business with competing hand held devices. They are simply doing what they do better than anyone else is doing it. They deserve to be where they are and they are rewarded by their customers with their present market dominance.
What young analysts here sometimes forget is that the country's technical rise to world dominance would not have happened if there were no laws protecting trade secrets and other intellectual property. There is a mistaken sense of entitlement in some consumers which suggests that there should be no reward for a company's technological excellence, that all innovative new products should be subject to immediate generic product cloning. If that were the case, who in their right mind would make the investment to even create an iPhone, iPad or iMac.
Friday, April 16, 2010
Tuesday, April 6, 2010
Saturday, April 3, 2010
Sunday, March 21, 2010
I'm not an expert in this field. I couldn't precisely tell you how the Congressional Budget Office (CBO) works, or what methodology is employed. What I can tell is when an author is failing to discount to present value.
Take his first gimmick: "the bill front-loads revenues and backloads spending. That is, the taxes and fees it calls for are set to begin immediately, but its new subsidies would be deferred so that the first 10 years of revenue would be used to pay for only 6 years of spending."
Now if you sum up the benefits and the costs, you may very well get what the author is talking about. However, if you employ present value in your analysis, you might arrive at a very different conclusion.
If you were to ask someone if they'd rather have a dollar today or a dollar a year from now, they would say the dollar today. Why? Because they could spend it now, or invest it and earn some sort of return. So how much would you have to give someone a year from now to make them indifferen between the dollar today and the sum a year from now? Well if it's a sure thing they'll get that sum from you, that's essentially the risk-free rate of return. If there's a risk that they'll get that amount from you, the rate should be the risk-free rate plus the risk premium you represent.
Typically, people look at Treasury bills and bonds as the risk free rate. So right now, the one year Treasury bond is yielding 0.41%. So if you knew you would get the sum a year from now, you would demand $1.0041 a year from now to make you indifferent between that and a dollar today (part of the reason this is so low is because interest rates are at record lows right now).
So to determine the real cost of a project, you have to discount the yearly costs and payoffs by (1 + discount rate)^(t), where "t" is the time that has passed in years (presuming the discount rate is an annual rate). If there is no risk in the payoff and costs, then you discount by the risk free rate. If there is risk, it's the risk free rate plus the risk premium.
So what does this all mean? Essentially, even though when you do a strict summation the project might net zero or a negative value, when you employ discounting it could very well be positive. By the nature of the plan identified by the author (payoffs early on, costs later), I'm extremely skeptical about his conclussion since he doesn't note employing any type of present value adjustements. I'd guess the CBO does. I think I'll side with what the CBO says.
There was an article that recently graced the front page of the Motley Fool, talking about how big Apple (AAPL) is compared to its brethren on the S&P 500. It's interesting, because I wrote practically the same article more than a month ago on this subject.
I'm definitely not trying to cite any sort of "copying" (they probably didn't read my article), but it did feel good to have a major investing website run with the same tag line that I recently wrote a piece on.
I'm sorry about the complete absence of content for this blog...I've been really busy. But I will say that I'm happy to be employed now (yay!) although still weighing out two offers I received. Hopefully not having to find a job will give me more time to write on the site.
Saturday, February 20, 2010
AAPL DCF Valuation
Tuesday, February 16, 2010
Sunday, February 14, 2010
Friday, February 12, 2010
But here's a little preview of some numbers I ran off their Q1 10-Q:
As you can see, even after discounting intangibles and basically anything that you can't put your hands on, they still have a P/B of less than one. I'm not quite sure how I feel about their Property Plant and Equipment (PPE), since it appears they only own 8 stores and 1 distribution center, but I guess trading below hard assets is all I can really ask for.
If you ask me this seems very very cheap, especially since they have no long term debt, but I'll be interested to see how their Q2 earnings come out. Mean analyst estimate is a loss of $0.16, with a high estimate of -$0.09 and a low estimate of -$0.27. If they surprise on the upside it might push them past this price to tangible book ratio of one, but I think that's a risk you have to be willing to take.