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Shooting from the hip - topical, informed and opinionated posts each & every day!


The Evil Diaries: Timber! 

Evil discusses ASOS, Quindell, the business leaders’ letter in support of the Tories, and Sam Cameron…

I may have missed something (I doubt it) but ASOS (ASC) is on a PE of the order of 100 and profits are declining. Timber!

The fan club would point out, if minded, that I have misunderstood matters. All I can say is that I’ll take my chances on that one. £37 a share? Barking mad, says I.


Another area of human life which I have not understood at all times is Quindell (QPP). I went along with the proposition that criminal activity at and around that company would lead to insolvency. It has not.

Further, I now understand that after the 100p per share is paid out to shareholders there’ll be 100p left for longer term holders. Amazing. I am long at 136p.


I know that somebody at Conservative Party Central Office has co-ordinated this wheeze of corralling 100 or so business “leaders” to write in support of the Conservative cause. So they must have thought about it. However, I cannot help feeling that many a voter will regard this style of hectoring as presumptuous and silly. These business leaders may be responsible but their chief responsibility is to themselves when awarding themselves vast pay rises.


Finally, Sam Cameron is in both the DMail and the DTel this morning identically described as wearing a Cos blouse, a Toast skirt and Zara shoes.

This photo opportunity has been sold to the public. It has nothing to do with what she really likes. Actually, I think she is pretty goodlooking in her own right (but accept that she must wear something in public).


Wednesday's Stock Market Report featuring Rolls-Royce, SKY, Genus, ASOS and iomart

The Markets

The Office for National Statistics has said that UK productivity levels remain below those in 2007, with recorded figures showing a drop of 0.2% in the final quarter of 2014. While alternative measures such as output per worker were more positive, Vicky Redwood, UK Economist at Capital Economics, said that “this still isn’t great - productivity [growth] has still not even returned to its long-run average rate of about 2%, let alone recouped any of the shortfall relative to its pre-crisis trend”.

Eurozone manufacturing picked up pace during March, according to the latest PMI survey, hitting a 10 month high. Jobs were also created at the quickest rate since 2014. Chris Williamson, Chief Economist at Markit, said that “this is still a fledgling recovery, however, and the overall rate of expansion remains only modest”.

At the London close the Dow Jones was down by 105.43 points at 17,670.69 and the Nasdaq was 31 points lower at 4,302.69.

In London the FTSE 100 closed up by 36.46 points at 6,809.50 and the FTSE 250 finished 32.77 points ahead at 17,123.41. The FTSE All-Share climbed by 16.87 points to 3,680.45 while the FTSE AIM Index fell by 0.88 points to 714.35.


Broker Notes

Westhouse raised its price target for conference and trade exhibition organiser ITE Group (ITE) to 170p and reiterated a “neutral” position on the stock, following a pre-close update saying that strong Asian results had more than offset Russian weakness. The broker has a positive view on the events industry as a whole and thinks ITE’s geographical diversity offers great upside. The shares grew by 8.5p to 189p.

Bernstein cut its rating on engine manufacturer Rolls Royce (RR.) to “underperform”, citing emerging challenges in the Civil Aerospace and Land & Sea divisions as well as the recent strength of the shares in its reasoning for the move. However, Bernstein did adjust its target price upwards to 850p. The shares dropped by 3p to 950p.

HSBC upgraded its view on broadcaster SKY (SKY) from “underweight” to “hold” after Sky fixed programming costs for 85% of its content for the next 4 years, cutting downside risks, and exhibiting little evidence of cannabalistic demand from online rivals such as Netflix. The bank increased its target price on the firm from 610p to 930p. SKY shares fell by 6p to 987p.

Blue Chips.

RSA Insurance Group (RSA) completed the sale of the insurance branches of its Hong Kong and Singapore arms to Allied World Assurance Company following the receipt of all necessery government approvals. The sales earned an aggregate consideration of £130 million and gains on sale were estimated to be around £110 million. The shares rose by 5.7p to 426.6p.


Mid Caps

Consumer transport firm FirstGroup (FGP) said that trading in the quarter ended 31st March was positive, with strong demand in the UK bus and rail markets. Performance in North America was negatively impacted by poor weather conditions and Greyhound is working to cut costs to mitigate drops in passenger volume due lower fuel prices. The shares climbed by 6.2p to 97.15p.

Biotechnology specialist Genus (GNS) finalised its purchase of 51% in bovine IVF outfit In Vitro Brazil for a cash consideration of BRL 20 million (£4.24 million). Genus intends to buy the outstanding shares by 2019 at a price which will be determined by performance but not higher than BRL 49 million (£10.5 million). Genus shares declined by 28p to 1,341p.

Manufacturer Senior (SNR) announced the acquisition of Lymington Precision Engineering from management and Vine Street Capital for an initial consideration of £45.8 million, with performance based earnouts worth up to £31.7 million. The company has warned that financial performance may be materially lower during the next year due to uncertainties in the oil and gas markets. The shares grew by 2.2p to 327.4p.

Small Caps

Food producer and distributor Real Good Food (RGD) said that EU reductions in sugar prices have made trading difficult for its Napier Brown and Garrett Ingredients arms. While conditions have improved slightly in recent months, full year performance continues to lag behind expectations. Shares in the company dropped by 6p to 36p.

Online fashion retailer ASOS (ASC) earned revenues of £0.55 billion during the 6 months to 28th February, a 14% increase over the same period of last year, driven by UK retail sales. Gross margins dropped by 230 basis points to 48.2% due to investment in increasing capacity and international flexibility. Shares in ASOS rose by 99p to 3,728p.

Cloud computing and managed hosting services provider Iomart (IOM) said that results for the year ended 31st March will be in line with expectations, with adjusted pre-tax profits of around £16.6 million as the company continues to grow organically. Management believe the firm is well placed to benefit from fresh demand for cloud services. The shares climbed 2p to 206.5p.

Technology and information services outfit Altitude (ALT) narrowed its loss before taxation to £1.5 million during 2014 as it worked to resculpt itself as a Software-as-a-Service business. The company said that it saw some encouraging signs during the year including a 6% increase in overall revenues and the board believe it is well placed for 2015. The shares fell by 1.75p to 14.75p.

Commercial property developer Sirius Real Estate (SRE) increased average rents per square metre and occupancy over the year ended 31st March with new lettings agreed on over 120,000 sqm of space. A capex programme is underway to bring 100,000 sqm of currently unlettable space on to the market. Full results will be released in May. Shares in Sirius closed flat at €0.42.


Thomas Cook's latest trading statement supports my optimistic point of view


By Robert Sutherland Smith

(Ref. my earlier note dated 22nd March 2015.)

I ran the rule over Thomas Cook (TCG) at 142p as a possible speculative buy on the 27th March last, albeit pointing out its many defects as a store of value, which included a lack of asset backing, earnings and dividend. This week, the company produced its trading statement to tell me whether my investment ‘nose’ for speculative value is still in working order.

For those of you, who may not know Thomas Cook - or did not accompany me on its Thomas Cook & Sons first holiday tour package to Switzerland and Egypt for ardent Baptist Tea Totallers, to escape the fog of London in the 1860’s - it is now largely an Anglo German leisure travel company which markets itself under a variety of trade names including: Thomas Cook, Neckermann, Condor, Jet Tours, Ving, Spies and Tja reborg, operating a fleet of near ninety aircraft flying across Europe and Scandinavia.   

The company’s management state that it has been trading in line with expectations. The highlights of that trading include the fact that its 2014/2015 winter season was almost fully booked and its forthcoming summer season offers were more than half sold with bookings that were two per cent up year on year. The UK is signalled out as a segment where trading is ahead of that seen last year. For Continental Europe, trading was reported as still tough, against a strong comparative reporting period a year earlier, but that things have improved since the report of the first quarter’s results. In particular, the Concept Hotel business bookings were up 20% and bookings were 10% higher as the digital offer continues to develop.

There was also notification that its German airlines business is also growing strongly, particularly on long haul. It seems that the particularly challenging conditions in this segment of the business are ‘showing early signs of improvement’. The management also reported that new product and ‘winter sun’ initiatives are leading to growth. It also expressed the opinion that its strategy, rigorously implemented, will lead to further business performance improvement.

Turning to the outlook for trading this summer, confusingly, bookings are reported two per cent higher than last year, but total bookings were lower by one per cent, due to a similar one percent drop in prices. Again, the UK was a bright spot with a four per cent increase in bookings. In continental and northern Europe, bookings were lower by four per cent (against a reportedly strong demand period a year earlier).

With regard to share price chart technicalities, I point out that between January and February the shares traded at approximately 120p to 131p, only to break out of that range by heading for 158p a share and creating a new, higher imputed trading range of 140p to 158p. The share price, which has come back to 142p (last seen), is ready to test that theory. The longer term perspective suggests considerably more upside than downside, providing management remains true to its strategy and execution of its forward business plans.   

Nothing in this trading statement contradicts my view that this share is one to look at, especially for those with an interest in speculative equity. With economic conditions improving in the UK and Germany, a bet on better things to come could reap rewards. The next report and accounts will tell us more about finances. Results for the six months ended 31st March 2015 are due on 20th May 2015.


The Evil Diaries: A Massive Scam

Older readers will recall Nasdaq-quoted World Acceptance (WRLD). It was then $20 and set to collapse. In the event, year after year, the imminent raids from the Feds never materialised and World got up to close on $100. I just gave up.

But this is a massive scam and, on Monday, Seeking Alpha published a slammeroony of a bear case for World. The US authorities are now set upon killing World off. World closed at $72 last night. But that is a very generous starting price for bears to renew their enthusiasm. At the last count, there was plenty of borrow.


The Fed’s View on Price Stability

Economic analysis by Filipe R. Costa

Long gone are the days when central banks used to target monetary aggregates in order to attain price stability. Until the early 1990s, central banks thought the correlation between the money supply and inflation was strong enough for them to be able to define as their intermediate objectives some growth rate for M1, M2, or whatever M number they were using to target the money supply; and then, at the end of the chain reaction, they would find price stability. But, as they failed miserably (with the exception of the Bundesbank), they changed their view and started targeting the inflation rate directly while using the interest rate and the yield curve as the instrument and intermediate objective, respectively. Since that major change, central banks have been so effective in lowering the inflation rate that they are now struggling to find anything tangible to do.

But despite having already accomplished their mission of stabilising price growth at low levels, central banks are still very active. To speak the truth, they have never been as busy as today. How could that be?

With the advent of fast-growing inflation rates due to the abandonment of the Gold Standard in 1971, the US Congress amended the then outdated Federal Reserve Act in 1977 to encompass a more serious goal of price stability. The monetary policy objectives of the Federal Reserve were then defined as:

“The Board of Governors of the Federal Reserve System and the Federal Open Market Committee shall maintain long run growth of the monetary and credit aggregates commensurate with the economy’s long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices and moderate long-term interest rates.”

Unlike other central banks, which are solely mandated towards price stability, the Fed was attributed a so-called dual mandate to pursue price stability and a high level of employment at the same time. While appearing different, single and dual mandates are exactly the same in the long run, as there is no known trade-off between inflation and employment in that time horizon, and pursuing price stability is compatible with full employment. But in the shorter-term it allows the Fed to pursue a more accommodative policy to achieve higher levels of employment even when the price stability objective has already been met.

While price stability is supposed to mean that prices are not expected to change much, there is significant scope for misinterpretation of what it really means. When quizzed as to its nature, former Fed chairman Alan Greenspan stated “price stability is that state in which expected changes in the general price level do not effectively alter business and household decisions. Even though the definition gives some extra clues as to the effects of price instability, it adds little in terms of defining a quantitative level. When forced to provide a number, Greenspan then replied,

I would say that number is zero, if inflation is properly measured.

Now that many years have passed since the Greenspan era, we can say that either he wasn’t right about the zero as being the target number or inflation isn’t properly measured by the Fed, because the central bank explicitly pursues an inflation rate of 2% as being the magic number compatible with price.

As reported by Robert Heller, a former member of the Federal Reserve Board of Governors, the Fed had already adopted an inflation target around 2% during the Greenspan mandate but it was never explicitly assumed. In no statement was such a figure ever reported while Greenspan was chairman of the Fed, as he was concerned with the consequences of setting a specific number and showing it to the public. At the same time, while the committee agreed that they shouldn’t tighten monetary policy if inflation was below 2%, they also agreed that they shouldn’t accommodate the policy if the number was lying between 0% and 2%. Instead of being a target, the 2% was seen as a margin on a target of 0%, with this latter figure being the main goal of price stability.

But then in 2012, in the aftermath of the financial crisis, and given the difficulties central banks were facing in making the transmission of lower interest rates to the overall economy work effectively, they decided to strengthen the communications channels with the public. As part of the new policy channel, the Fed explicitly adopted a 2% target for monetary policy, assuming that price stability means pursuing an inflation rate of exactly 2%, and acting whenever the rate is above or below that level. However there is nothing in the Federal Reserve Act guiding in that direction. At that time the Fed also assumed a central tendency for the unemployment rate to lie between 5.2% and 6%, even though allowing this value to change over time (in contrast to what is allowed to happen to the inflation target).

Now let’s look at what is happening in the US economy and put everything together. The unemployment rate lies at 5.5% and is expected to decrease to 5% by the year end, while the inflation rate currently sits at 1.4%, as measured by the PCE core index (the FED’s preferred inflation gauge). Alternatively, we can look at the CPI to measure price change but the number is not much different, currently lying near 1.6%. If measuring inflation with headline figures (without excluding energy and food prices) the numbers are much lower and near 0% for both the PCE deflator and the CPI indexes, but these numbers are heavily skewed by the downtrend in energy prices of late. As these events are seen as temporary, the central bank always bases its policy on the core measures. The rationale behind it is straightforward. Let’s suppose oil prices decline 50% from a price of $100 to $50. The headline inflation figure will suffer a negative impact (decreases) with the oil slump, but that happens within the period in which the price change occurs. If oil prices stay at the $50 level over the next measurement periods, while the price of oil is still 50% below what it was, the inflation rate will no longer be affected by it. Thus, the effect is temporary and should be discarded by using core inflation measures.

With the unemployment rate at very low levels and the inflation rate inside the 0%-2% bracket, and in accordance with the Federal Reserve Act, we can safely say that the Fed has already succeeded in achieving its main objectives. So, congratulations to the Fed. Case closed.

But Janet Yellen is reluctant to stabilise monetary policy towards an interest rate that is compatible with this long-term equilibrium, as she is worried about its effects on the equity market (through decreased valuations) and on corporate profits (through a strong dollar).

At a time when it is the turn of the ECB to play its QE card, European equities are booming while their US counterparts are stalling. With roughly a quarter of the year already gone, the Dax, the CAC, and the Euronext indexes are already showing a stunning YTD performance of around +20%. The Nasdaq, the S&P 500 and the Dow are near break-even levels. But we shouldn’t forget there was a time in which the opposite happened. US markets have tripled in value, helped by three large-scale asset purchase programmes and now it is the time for catching up with the fundamentals. Besides, there’s nothing in the Federal Reserve Act stating that the Fed should be worried about equity prices.

With regard to the strong dollar and its effect on corporate profits, there’s not much Janet Yellen can do about it. Since mid-2014 the market started anticipating an increase in interest rates in the US. With Europe now fully engaged in quantitative easing and the BoJ keeping its near-zero rates for the foreseeable future, the expectation of a rate hike in the US, increases the interest rate differential in favour of the dollar. The appreciation of the dollar was a natural consequence of this speculation. From a rate near 1.40 one year ago, the euro quickly declined to a rate as low as 1.05 on the dollar a few days ago (even though now trading near 1.10).

But we shouldn’t forget that the US has a very large trade imbalance, while the Eurozone has a large trade surplus. That means that if the current exchange rate prevails, the trade gap between the two countries will widen and thus wouldn’t be sustainable in the longer-term. This gap will end, pressuring the dollar towards devaluation against the euro. By focusing on short-term speculation, the Fed is ignoring the real fundamentals that should drive policy.

It is time for the Fed to wake up and follow its mandate, in line with what was stipulated by Congress, instead of trying to tweak it towards objectives that were never on the table and that are just generating global distortions. The same reasoning applies to the ECB, which seems to insist in distorting its initial aims.

Inflation is at low levels in the developed world largely because low interest rates don’t lead to a substantial increase in spending anymore but rather to an outflow of hot money in the direction of emerging markets, where it will stay until rates are attractive again in the developed world. The longer the cycle takes, the worse the emerging markets crisis will be. We already have signs across Asia and South America of many countries experiencing inflation and insurmountable increases in debt, as a consequence of too much easing conducted by developed countries. The latest addition to the group seems to be Africa, as Cote d’Ivoire, Nigeria, and Kenya have been seduced by the ECB’s artificially-induced negative yields and are issuing Eurobonds at record high demand. When the likes of the euro and the dollar start rising fast, I wonder how they plan to repay the debt.

The more I dig into the matter, the more I’m convinced that central banks are not part of the solution but rather part of the problem…


A challenge to the efficient market hypothesis

by Frederik Vanhaverbeke

In the last of a series for SBM, Frederik Vanhaverbeke, author of Excess Returns: A comparative study of the methods of the world’s greatest investors, looks at how some of the world’s greatest investors are so successful.

The extreme efficient market theory is “bonkers”. It was an intellectually consistent theory that enabled them to do pretty mathematics. So I understand its seductiveness to people with large mathematical gifts. It just had a difficulty in that the fundamental assumption did not tie properly to reality. The efficient market theory is obviously roughly right meaning that markets are quite efficient and it’s quite hard for anybody to beat the market by significant margins as a stock picker by just being intelligent and working in a disciplined way. The answer is that it’s pretty efficient and partly inefficient.
—-Charles Munger

Adherents to the Efficient Market Hypothesis (EMH) argue that people who beat the market are just lucky.

They say that the stock market is always efficient in every stock as all public information about companies is processed at the speed of light and gets reflected immediately in stock prices. They claim that every opportunity to beat the market is arbitraged away by the numerous rational investors with deep pockets. In their opinion, trying to beat the market is futile. As a consequence, they recommend that people invest in index funds and index trackers, and to give up on active investing.
They probably have a point… to some extent.

All great investors that I discussed in the previous twelve articles on top investors that are featured in my book Excess Returns: a comparative study of the methods of the world’s greatest investors admit that beating the market is difficult. And they believe that most stocks are priced quite efficiently most of the time. But they dismiss the idea that there is not a single mispriced stock. On the contrary, they are convinced that disciplined and talented investors who go the extra mile, and who can cope effectively with psychological biases can outsmart the market. And there is plenty of material to support their conviction.

In the figure below we show the annual excess returns over the S&P 500 of ten of the twelve investors that were the topic of my previous articles as a function of the duration of their track record. Most of these track records are so extraordinary that they cannot be explained by chance. Warren Buffet and Shelby Davis, for instance, beat the S&P 500 by more than 10% a year over periods of respectively 45 and 57 years. Although Joel Greenblatt’s investment career was shorter, it is at least as impressive as that of Buffett and Davis as he beat the market by a whopping 27% a year over two decades. And what are the odds that an investor beats the market by more than 6% a year over a period of 25 to 30 years, as did Prem Watsa, Seth Klarman and Anthony Bolton? Also the track records of Charles Munger, Benjamin Graham and Peter Lynch stand out by a very high annual outperformance of 10% to 15% over one to two decades.

Promoters of the EMH must be scratching their heads over these amazing track records.

Making things even harder to explain is that these twelve investors realized their exceptional track records through a similar investment method. Indeed, we have seen in previous articles that they looked at similar types of stocks (e.g., special situations, unpopular stocks, stocks that other investors overlook, etc.). They emphasize the same qualitative characteristics in their due diligence that most other investors pay no attention to (e.g., they look for management with a high level of integrity). They structure their portfolios in an unconventional way (e.g., most like to focus on their best ideas). And unlike most other investors they stress that discipline and effective coping with psychological biases are critical success factors. The fact that these top investors beat the market through a similar investment approach is completely at odds with the EMH as EMH’s claim that market-beaters are lucky individuals excludes the possibility of a structured approach by which the market can be beaten.

It must be said that my articles only scratched the surface of what can be said about the investment methods of the most successful investors in the world. The twelve top investors that I discussed in my articles were just a selection of a wide set of investors whose investment ideas were studied to develop the general framework that is the topic of my book Excess Returns: a comparative study of the methods of the world’s greatest investors. Other top investors that are featured in my book and whose track records are also shown in the figure below are, amongst others: Kevin Daly, Eddie Lampert, Philip Carret, John Neff, Glenn Greenberg, David Einhorn, Julian Robertson, Lou Simpson, Donald Yacktman, and Walter Schloss. The amazing thing is that if we compare the investment methods of all of these investors, we can see a lot of striking similarities. They look in the same places for bargains. They pay attention to the same subtle factors in their due diligence. They have similar buy and sell practices that fly in the face of conventional wisdom. And their risk management and portfolio construction run counter to academic theories on these subjects.

I believe that this observation combined with the extraordinary track records of all of these top investors is sufficient to silence the discussion about the efficiency of markets once and for all.

But then again, serious investors should appreciate the efforts of so many business schools to propound the EMH, as this reduces competition in the market. In the words of Warren Buffett: “It has been helpful to me to have tens of thousands [of students] turned out of business schools taught that it didn’t do any good to think.” Rest assured that the EMH, ignorance, and psychological biases are immutable forces that ensure that the methods of the greatest investors in the world will continue to work many years after they are gone.

Read more about Seth Klarman’s investment methods in Frederik Vanhaverbeke’s new book Excess Returns: A comparative study of the methods of the world’s greatest investors, published by Harriman House