Allstate (ALL)

lake

One of my favorite spots on a perfect fall day. Onto the analysis . . . 

Key Statistics

Enterprise Value = $27.791 billion

Operating Income = $4.283 billion

EV/Operating Income =6.48x

Price/Revenue = .73x

Earnings Yield = 12%

Debt/Equity = 27%

The Company

Allstate is the 4th biggest insurance company in the United States (as measured by market capitalization) and their main focus is automobile and homeowners insurance. Interesting bit of history: Allstate was established in 1931 by Sears. Allstate originally marketed policies via mail and the Sears catalog, which was revolutionary at the time. After 62 years of operating within Sears, it was spun off in 1993.

Market sentiment is relatively weak against Allstate. The stock is down 20% over the last year. The stock has been punished due to rising interest rates and various extreme weather events over the previous few years. There is also fear that the rise of autonomous vehicles will afflict Allstate’s insurance premiums in the long run.

My Take

From a quantitative perspective, Allstate appears to be an excellent company at a bargain price. At a P/E of 9, this compares to an industry average of 16.05. On a price/revenue basis, Allstate currently trades at 73% of revenue, compared to an industry average of 127%.  The forward P/E is presently 9, implying that Allstate is expected to maintain its current level of profitability by most analyst estimates. Allstate’s present valuation also compares favorably to its history. Allstate’s average P/E over the last 5 years is 13, 44% higher than current levels. On an EV/EBIT basis, Allstate’s average multiple in the previous 5 years was 8.5, which is 31% higher than current levels.

Allstate is also a well-run company. The F-Score is presently 7, which places it at a high degree of financial quality. Allstate also achieves better results than its competitors, producing a return on assets of 3.31% compared to an industry average of 1.91%. It delivers these results without excessive leverage, with a debt/equity ratio of 27%.

Allstate also grows organically with the economy, with operating income and revenues steadily increasing over time. The share price has increased with the growth in business over time.

allstate

Regarding short-term risks, the Fed is signaling that the rate hikes will end, which ought to stop the pressure on its bond and loan portfolio. There is also the risk of extreme risk events, such as terrible weather events in the upcoming year. That is a constant risk for insurance companies that don’t vary much from year to year and is built into Allstate’s pricing models. With a history going back 87 years, I’m reasonably sure that Allstate can handle a bad hurricane season, for instance.

As for long-term risks, the fears about the rise of autonomous vehicles seem silly to me. We are a long way off from widespread adoption of autonomous cars, considering that most people keep their cars for 11 years. Even when autonomous vehicles are widely adopted, you will still need someone to sue when the car gets into an accident. Even if the car can drive itself, the driver’s insurance is still going to be held responsible when the car makes an error. I don’t think we’ll ever see a day when it will be legal for the driver to hang out in the back seat drinking whiskey while the car whisks away to its destination with the driver completely free of responsibility.

In short, Allstate is a well run, defensive pick that is experiencing organic growth and currently trades at an attractive discount to average valuations within the industry and Allstate’s history.

PLEASE NOTE: The information provided on this site is not financial advice and it is for informational and discussion purposes only. Do your own homework. Full disclosure: my current holdings.  Read the full disclaimer.

Manpower Group (MAN)

handshake

Key Statistics

Enterprise Value = $5.113 billion

Operating Income = $856.8 million

EV/Operating Income = 5.96x

Price/Revenue = .21x

Earnings Yield = 13%

Debt/Equity = 40%

The Company

Manpower Group is a global staffing company. They provide recruiting services. They place a broad and diverse group of workers, from office staff to industrial workers. They also have a rights management unit, which provides consulting for workforce issues, such as advice to improve overall productivity.

This is not a “good business” with high returns on invested capital. Its earnings are driven by the cyclical nature of the global employment trends. However, Manpower has been in business for 75 years and has a strong global footprint, with a concentration in Europe. 13% of their revenue is from the United States, 13% is from Asia & the Middle East, and the remainder is from Europe. They have a particularly big focus in France, where 26% of their revenue comes from.

Manpower is in the most cyclical industry that there is: staffing. Their fortunes are dictated by the performance of demand for global employment. The company has performed well as unemployment rates fell in Europe and the United States. Employment in the European Union peaked at 11% in the middle of 2013 and is now down to 6.8%. In the United States, unemployment peaked at 10% and is now down to 4%.

The stock has been punished all year long. From its peak of $136 in January 2018, it is now down to $73.16.

My Take

In the quantitative sense, Manpower is a compelling bargain. The current P/E of 7.93 compares to Manpower’s 5-year average of 15.69 and an industry average of 24.14. Analysts don’t anticipate a significant decline in earnings. The stock currently has a forward P/E of 8.83. Additionally, the current EV/EBIT of 5.96 compares to a 5-year average of 9.27, which represents a 55% discount.

A bet on Manpower is obviously a bet on the US and Europe avoiding a recession in 2019. The economies of the United States and Europe are tied at the hip. A recession in the United States will likely coincide with a recession in Europe. There are indeed exceptions to this synergy, such as the 2011-13 period, when Europe languished while the recovery remained strong in the United States, but for the most part, they are closely correlated. Manpower’s performance is primarily dictated by the employment fortunes of these companies, as you can see in the below.

unemploymentincome

As I’ve stated elsewhere, I do not think that we will experience a recession in the upcoming year. The 2-year vs. 10-year treasury yield, along with the 3-month vs. 10-year treasury yield, has not yet inverted. Typically, after the inversion, the US has 1-2 years before the recession begins. Usually, the unemployment rate doesn’t start ticking up until immediately before the recession. This means that Manpower group is likely getting into the best part of the employment cycle at an attractive valuation.

The market is apparently concerned that Manpower’s earnings and cash flows are at a cyclical peak. I believe we are close to a cyclical peak, but I think a lousy period for Manpower is likely 2-3 years away and is not imminent. In the meantime, I think this is an attractive bargain with the wind at is back.

Manpower has a strong footprint in temporary hiring. This is a segment of Manpower’s business that will likely benefit from where I think we are in the cycle: a period when temporary workers will be in demand as firms struggle to retain employees.

Overall, I believe Manpower will benefit from where we are in the cycle in the upcoming 1-2 years. I am purchasing the stock with a margin of safety, with the stock trading significantly below its historical valuation multiples.

PLEASE NOTE: The information provided on this site is not financial advice and it is for informational and discussion purposes only. Do your own homework. Full disclosure: my current holdings.  Read the full disclaimer.

 

 

Macro Environment & Upcoming December Rebalance

Jitters

October’s price action seems to have given many investors the jitters. Mr. Market doesn’t quite need a defibrilator or even Pepto Bismol, but he is at least popping a Tums. This expansion and bull market have been long. They are going on 10 years now, which is relatively unprecedented. Unemployment is at historic lows. Meanwhile, the Fed is raising rates, which is usually the beginning of the end.

Valuations don’t help with the anxiety. Everyone knows that valuations are stretched. The CAPE ratio currently stands at 30.94, giving the market an earnings yield of 3.23%. The average investor allocation to equities is presently 44%, giving us an expected 10-year return of 2.3%. In other words, the realistic return that investors can expect over the next 10 years is probably somewhere in the vicinity of 2-4%. This does not provide much of a premium to the 10-year treasury yield, which is currently 2.993%. The AAA corporate bond yield is now 4.14%, a significant premium to what we can expect from equities.

yields

A 2-4% return for US stocks isn’t going to happen in a straight line and it isn’t going to be evenly disbursed across all stocks. Stock market return averages are an average of abnormal returns. There are going to be years when stocks will advance by 30%, and there will be years when they decline by 50%. The decline will likely coincide with a recession.

Recession Watch

At the same time, while it’s evident to me that valuations are stretched, I do not believe we are going to have a recession in the upcoming year. This is the main reason I am comfortable remaining 100% invested in stocks that I feel are at attractive valuations, including cyclical stocks.

I believe that the Federal Reserve is the cause and cure of every recession. Right now, the yield curve is flattening but has still not inverted. The Fed typically chokes off an economic expansion by tightening too much. They then usually save the day by aggressively responding to the downturn by cutting rates, often overshooting and causing other problems. This seems to have been the case in the mid-2000s.

Despite the tightening of the last year and the flattening of the yield curve, the curve is still not flat and it is still not inverted. Scott Grannis recently had a great post about this here.

curve

Typically, once the yield curve inverts, we get a recession within a year or two. Right now, the 10 year is at a .22% premium to the 2 years. This implies that the Fed hasn’t yet taken things too far with rate increases. A recession, therefore, does not appear to an imminent danger. To put this in historical perspective, this is where the yield curve was in 2005, 1997, and 1988.

Another thing that tends to happen before a recession is that the unemployment rate shifts its trend. The unemployment rate began to change direction back in 2000, long before the beginning of the recession in 2001. It also did this in 2007 before the Great Recession went underway. There is no sign that the unemployment has shifted course.

unemployment rate

This is further evidence that a recession is not imminent.

Another indicator that I look at is household debt payments as a percentage of disposable income. This shows you the sensitivity of households to rising interest rates. This is not worrisome at all.

households

December Rebalance

Hopefully, this gives context to decisions I am going to make in my portfolio in the upcoming month.

I am currently gearing up to rebalance my portfolio in December. I will sell many positions that are on their 1-2 year birthday and replace these positions. I have my eye on many stocks, which are listed below. If anyone has done any work on these securities, I would love to hear from you.

I’ve spent the last few weeks researching the below positions. They meet my quantitative criteria, and I am attempting to determine whether or not I feel they are likely to recover from the problems that the market perceives.

candidates

My opinion on the likelihood of a recession impacts what kind of stocks I own. In particular, it will determine whether or not I will buy stocks that are cyclical and closely tied to the performance of the macroeconomy. An example of this would be a company like Micron (MU), a cheap position that bears suspect is cheap because it is at a cyclical peak. Another example would be Thor (THO). These would be positions I wouldn’t own if I thought a recession was going to occur in the upcoming year. Some examples of cyclical positions on the above list that I am looking at include Manpower Group (MAN) and Hollyfrontier (HFC).

I’m also looking at cheap retail positions like GAP (GPS) and Chico’s (CHS), even though they have been historically graveyards for my portfolio.

It also determines whether I am comfortable holding cash. When a recession is imminent, I will likely move more of my portfolio to short-term treasuries while I wait for compelling bargains to appear. A 1-year treasury is expected to yield 2.69% right now, which compares favorably to what I expect from US markets over the next decade.

Of course, I fully acknowledge that my predict the future is as good as anyone else’s. This is the reason that I always attempt to purchase undervalued securities with a margin of safety. A margin of safety is very much a margin for error.

I’m also eagerly anticipating the next recession. While I would like to avoid some of its damage, I suspect this is the moment when I am going to find truly compelling bargains, which are now in short supply in the US. It will be an opportunity to buy sub-liquidation net-net’s extraordinarily cheap security on an earnings basis, as well. It will be an opportunity to do very well, and I’m looking forward to it.

Hopefully, this sheds some light on my thought process as I select new stocks to fill my portfolio in the upcoming month as we look to 2019 and my portfolio (and this blog) turn 2 years old. Let’s hope the “terrible twos” doesn’t affect my money.

Random

  • I have been reading Paul Volcker’s book, Keeping at It. It’s a great book from a man that I believe is the greatest Fed chair of all time. I wrote about it here.
  • Work has been extremely stressful lately, especially because of issues in my personal life that I’ve hinted at previously in this blog. My main struggle these days is maintaining a positive attitude, mainly because I am in a leadership position at work and it is important for me to keep everyone’s spirits up. I’ve slipped up recently, but I want to make more of an effort to stay positive this month, especially with the holidays coming up.
  • I gave up sugar back in October. So far I’ve lost 10 pounds since making that choice. I fell a bit off the rails on Thanksgiving when I ate a significant amount of pie, but what the hell? That’s what Thanksgiving is for. I haven’t eaten any sugar since.
  • I started watching “The Man in High Castle” and have really been enjoying it. It makes me really appreciate the sacrifices made by the Greatest Generation. If it weren’t for their efforts, the horrific world featured in that series would be a reality.
  • I was saddened to hear about the loss of George H.W. Bush. Looking back on him, whether you disagreed with him or not, he was an exceptional human being who treated the opposition with respect. He was the last President of the World War II generation, and that’s why I think his Presidency feels like a distant, bygone era. That generation had a better perspective on life. That’s why their passing brings a real sense of loss. I think their perspective comes from seeing a World War and living through a Depression. These were experiences so intense, so palpable that Boomers, Gen Xers, and Millennials can’t relate to these experiences on any level. Our worries are trivial compared to worrying about the Nazis winning World War II, or starving to death in the Depression. After going through times like a Depression and World War, they didn’t sweat the small stuff the way that we do. They realized that the stakes weren’t so high and you didn’t need to vilify people because you disagree with them about minor things like taxes, budgets, whatever. I really believe that things were better with that generation in power. People who vehemently disagreed with each other, like Tip O’Neal and Ronald Reagan, could hang out after work and still get along. I wish things were like that now. We weren’t entrenched into competing camps convinced that the other side was evil or bent out to destroy the country because they happen to disagree. I wish that’s a perspective that we could bring back. I wish I could have that kind of perspective. I worry that’s not possible, because it’s a perspective you can only earn from going through the sort of horrible times that they went through in their youth.
  • I’ve been listening to a lot of a synth band called Electric Youth. They sound straight out of 1984, and I love it.

PLEASE NOTE: The information provided on this site is not financial advice and it is for informational and discussion purposes only. Do your own homework. Full disclosure: my current holdings.  Read the full disclaimer.

Never Give Up

This post has nothing to do with finance. I’ll be back to talking about value investing and economics in future posts.

As I posted on Twitter this week, it has been a rough week for me personally. I thought I’d elaborate a little bit more to explain what is going on and my personal struggle with alcohol over the years. My hope is that someone going through the same things gets something out of it. I hope it encourages them to stay off the sauce.

I tweeted this earlier this week:

me.PNG

I debated tweeting this. I ultimately did it because I was proud that I was able to to do it and wanted to shout it from the rooftops. That I didn’t give in. I also hoped it might inspire people going through the same thing to not give up and to not give in. I try to keep my blog and Twitter account with mainly a focus on markets and economics, but I just wanted to say it. I wanted to shout it from the rooftops. I almost fell apart but I didn’t do it. I didn’t take the easy path. It made me feel good.

As many inquired, this wasn’t about markets. It was about a personal issue that has put me through the wringer in the last week. Markets are my true passion even when they’re going against me. Markets are fun. My personal issues are probably stupid from an outside perspective (other people out there have more serious and vexing problems), but it’s serious enough for me. Real enough where I wanted some chemical comfort.

A lot of people don’t understand what alcoholics like me go through. They don’t get it. To them, they are just thinking “just stop drinking, dumb&%$.”

I thought I would share my story on here so people can understand. Maybe people with similar problems could seek some inspiration.

An Addictive Personality

I’ve always known I had an addictive personality. I get intensely obsessed with things. Finance is one of those obsessions, but it’s a positive one. I try to keep my passions positive: finance, working out, or even my love of science fiction.

This will probably make you laugh. My addictive personality goes way back. When I was 12 years old, I recognized that I had an addiction to video games. The game for me that finally did me in was Final Fantasy III. (Final Fantasy VI in Japan. Yes, the “geek” in the site’s title is not a mistake.)

I received this game for Christmas in 1994. It indeed is a masterpiece and ranks as one of the best video games of all time. Anyway, I grew to be absolutely obsessed with beating it. It took me a few months. Then my report card came: C’s and D’s. My parents were livid. They always trusted me to take care of my school work on my own and here I was failing at it. They didn’t know the extent of my gameplay. I’d often sneak downstairs at night to play it and keep the volume low without waking up anyone in the house. I had a single-minded determination to get to the end of the game and beat Kefka.

I was never a spectacular student in elementary school, but I recognized that college was only 6 years away. My family doesn’t have a lot of money, and I also realized I didn’t want to go into debt to attend college, which would be the only alternative. The weak report card was a wake-up call: I had to get my act together before it was too late or I wasn’t going to go to college. 7th grade might have been irrelevant, but 8th grade was going to determine what kind of classes I could get into in high school and how I did in high school was going to decide whether or not I would qualify for a scholarship, which I needed to go to college without debt. I knew that an athletic scholarship was out of the question so it would have to be an academic one. (When they say “out like a fat kid in dodgeball,” they are talking about me when I was 12.)

I made the decision back then to take the video games and put them away in the closet. I was going to focus on school for the next 6 years. I put the Super Nintendo, Nintendo, and games in the closet. I was going to get to work.

And I did it. I was an intensely focused student in 8th grade and high school. Knowing myself, I also avoided alcohol entirely, as I knew that I would inevitably develop an addiction if I ever tried it. I was never the smartest kid, but I was willing to outwork anyone else in the pursuit of my goal. Some might scoff as I didn’t attend an Ivy League school or anything of that magnitude, but I managed to get into the top 5% of students in my high school and bring up my SAT scores through determination and hard work. I accomplished the goal: I attended a state school and on a full academic scholarship. It wasn’t just tuition and fees, either. I also received several other private scholarships which helped me cover everything: room, board, books. I would be able to graduate debt free.

I’m not very smart. I’m just a hard worker. I’d often marvel at the smart kids who seemingly could ace a math exam with little effort. For me, it meant remaining buried in a math textbook til 11 PM at night. I had to work for and earn every A that I had. Ultimately, it all paid off with debt-free college experience.

Neither of my parents went to college, and it made them proud that I was going to be able to do this without any assistance. I may have been young, but it still fills me with pride knowing that I was able to pull it off. And the funny thing is: I think the critical moment which made it possible was my decision at 12 to put the video games in the closet.

College

In my first year of college, I avoided alcohol and partying entirely. I excelled academically because I worked hard. Again, I knew that I had an addictive personality. I already knew I wasn’t one of those people who could have a few drinks, loosen up, and have a good time without it spiraling out of control. I am jealous of those people. I wish I could do that.

Strangely, I joined a fraternity that year and remained a teetotaler. I joined because I liked the people in the fraternity and most of them remain my friends to this day.

In my sophomore year, I decided to drink for the first time. It’s embarrassing to admit, but it was mainly because of one of my other weaknesses: women. A beautiful girl walked up to me at a party and said if I drank a beer with her she’d make out with me. All of that stuff about “I have an addictive personality and shouldn’t do this” went out the window when I looked at her. Later on, I discovered that my best friend put her up to this because he wanted to loosen me up. I’m not mad at him. They didn’t know what I knew deep down.

Once I started drinking, I never looked back. I loved it. It could loosen me up. It made me less uptight. It gave me the courage to actually strike up a conversation with women. More importantly, the harmful effects that I feared weren’t transpiring. I was able to party hard and still earn excellent grades and keep my life together. I thought that my previous aversion to alcohol was stupid. I was able to have it all: alcohol expanded my social life, and I was able to keep myself disciplined and on track.

The adverse effects of drinking slowly crept into my life throughout college. Each year my drinking grew worse. In my sophomore year, I only drank beer, wine, etc. In my junior year, I started doing shots of hard alcohol. I started drinking more often. My drinking was no longer confined to the weekends. I was doing shots every night, even when I wasn’t at a bar or at a party. After some time, I actually preferred drinking alone to drinking with others. One of the weird things I loved to do was read books (many of them Finance and stock market related) and drink. I’m probably the only person to do shots of Jim Beam while reading the Intelligent Investor. In my senior year, I was a particular wreck. I no longer received straight A’s, but I was able to pull B’s and graduate with a decent (not spectacular) cumulative GPA, so I didn’t think it was a big deal.

Graduate School

By the end of college in 2004, I interviewed for and received a graduate assistantship to earn my MBA. The assistantship actually tied into my fraternity origins. I was responsible for overseeing the Greek system and maintaining discipline. Because I was already rooted socially in Greek life, the Dean thought it would be easy for me to keep close tabs on everyone’s activities. It was a great gig: full MBA tuition, an on-campus apartment, a meal plan, and a weekly stipend.

I decided after graduation with my bachelor’s degree that I would give up drinking. I recognized that drinking was destructive. While I was able to coast by in my last year of college and keep my scholarship and get a decent GPA, I needed to buckle down and get it together if I was going to succeed.

I gave up drinking in the summer of 2004. Physically, I felt incredible. I went from doing shots every night and passing out to getting a full night’s sleep. I felt better in the morning, so I was able to work out, which also helped me feel better physically.

In October of 2004, after being off alcohol since May, I concluded that I was over my addiction. On the evening of homecoming, many of my undergraduate friends came back and visited me. They, obviously, wanted to drink with me because that’s what we did when we were undergraduates. I drank with them. I told myself that I had given up drinking for 5 months and I overcame the problem. If I could do that, I wasn’t an alcoholic. I could confine my drinking on social occasions. When I drank, I wouldn’t drink to excess.

My plans worked briefly. However, by 2005, I found myself drinking hard liquor every single night again. Alcohol always made me feel good while I was on it. It was always a release for me. I would often drink alone in my apartment at the end of the day while I watched tv or read a book.

After a series of embarrassing incidents, I decided to quit drinking again in 2006. In one example, I heated up pizza in my apartment in the oven and passed out until it set off the smoke detector. Public safety officers woke me up in my apartment filled with smoke. I hadn’t committed any kind of crime, but I was still ashamed of what I had done. I realized that I had lost control again. I needed to stop. I was nearing graduation and would need to be focused on a job after graduation.

I quit drinking again in the Spring of 2006. I started to feel great, as I did in the summer of 2004. I graduated with a good GPA.

Then, on graduation night, a girl I was interested came over to my apartment and said she wanted to get drunk with me. Not thinking straight (for obvious reasons), I said “what the hell” and went to the liquor store with her, and we bought a bottle of wine.

Post Grad

I got a job that summer after graduating with my MBA. I was coming to work hungover every day, and within time, I was fired. It was entirely my fault. I felt like a complete failure. It was my first job and I couldn’t keep it.

Out of money and broke, I wanted to go home primarily to clean up and start looking for jobs. My father quoted me an extraordinary price for rent. I think he did this mainly to encourage me to get my life back together and send a clear message that there wasn’t going to be any kind of safety net in life. He did from his perspective was the right thing and didn’t know the details about what was going on with me. If he knew what I was doing, he wouldn’t have done that. I hid my alcohol abuse from my family. By all outward appearances, I was a normal functioning young adult with a college degree and a graduate degree. I kept my drinking out of sight.

I started to feel down on myself and started drinking more heavily than ever before. I started living out of my car and burning through money. Living off of fast food dollar menus and alcohol, my weight began to balloon out of control. I lived off of my credit cards and started getting deep into debt. I was using it for occasional rooms at motels and for food and booze. I’d go to parties at my friend’s houses and get ridiculously wasted for the sole purpose of passing out on the couch so I’d have a free place to sleep at night. Everything I owned was in the trunk of my car.

I continued to interview for jobs during this period. I used to dream about working in Finance in New York, and that was basically out of the question without a dime to my name to spend on an apartment. I decided to take a different approach: I would go through a local temp agency and use that as a springboard to get into a big bank. I resolved that I would start in the back office, get a full-time job, and one day I would advance to a position in New York.

I was lucky enough to get one of those jobs for a big bank. It was only a temp job, and I was earning about 60% of what I made at my first job without any benefits, but I knew I was marching in the right direction.

I quit drinking again, and I decided to give this job an all-out effort. I stayed late every night. I worked my butt off. I entirely devoted myself to it, and I excelled. I started to feel good about myself again. By the end of that summer (this was 2007), I was made a full-time employee.

Unfortunately, I started drinking again. Not having paid off my debts accrued from unemployment, I started getting deeper in debt. I started going to happy hours and to bars every night on the weekends with my co-workers. Inevitably, the drinking began to affect my performance at work. I was also now approaching 300 pounds and had nearly $30,000 in debt at about an average interest rate of 20%.

2008

I had no idea how I was going to get out of the hole I was in. I was messing up at work. The economy was falling apart, and jobs at banks weren’t exactly stable. Physically I was a wreck. I was getting hammered every night. I was living paycheck to paycheck through my own actions of debt accumulation.

I sat down on August 24th, 2008 and decided that things needed to change. I didn’t know exactly how I was getting out of this hole, but I knew I had to stop digging. If I would merely stop digging and ruining my life, I was still young enough where I could turn it around. Somehow. I didn’t need to condemn myself to this for the rest of my life.

I decided that night that it was the last time I was going to drink. Ever. I knew, based on my previous experiences with sobriety, that I had to make it a permanent condition. It couldn’t be for a few months. It had to be for a lifetime. I wasn’t someone who could have a few drinks and relax.

I got drunk that night and woke up determined to turn things around. It was hard, but I started to see the glimmers of hope at a better life as I stayed sober. My performance improved at work, to the delight of my managers whom I was sure were contemplating getting rid of me. Downsizing was constantly all around me. I was still living paycheck to paycheck and just making the bare minimum payments on my credit cards, but I at least cut them up and stopped using them.

Turning it around

In my first year of sobriety, there were many times that I was tempted to go back to drinking. I was bored. I had no friends. I had no social life. Quitting drinking meant isolating myself from many of my friendships that were centered around alcohol. The loneliness and isolation made me want to start drinking again. I decided that I needed some kind of outlet or I was going to go back to drinking.

I joined a gym and made a commitment to go every night. The gym really helped me stay away from booze despite the feelings of loneliness and isolation that I had. An endorphin rush at night was exactly what I needed. My physical condition started improving, which helped me feel better about myself. A year later, at the end of 2009, I was down 100 pounds from where I started in 2008.

The Challenge of Sobriety

The first year of sobriety is the hardest. The reason is simple: drinking is fun and sobriety leads to social isolation. Sobriety also makes your problems real. You can’t numb yourself and forget about them every night.

Yes, alcohol ruins your life, but it’s fun. It’s a way to escape from your problems. For me, the problems were self-created and were financial, professional, personal (i.e., no woman wants to a date a 300-pound drunk guy). Drinking was a way to escape from that. The irony is that I was trying to escape from problems that were caused by drinking. When that escape is removed, there is no more escaping or hiding from your problems. They are there in all of their raw ugliness for you to confront and deal with.

Sobriety is lonely. Even though I drank alone frequently, I also went to bars frequently and had a lot of friends. You develop friendships with people that are anchored with alcohol. When you stop drinking, those friendships gradually disappear. You don’t want them to disappear. They don’t want them to disappear. However, when all of your interaction with them centers around going to bars, you friendships begin to fray. You get lonely. Loneliness leads to despair, which makes it easy to go back.

At first, when you’re sober, you are lonely and don’t live through any benefits of sobriety. Not seeing immediate gains also derails you. Yes, you feel better, but the problems that your abuse created are still there, and they are now more real than they ever were when you were numbing yourself with chemicals.

This is why so many people fall off the path in that first year. You start to think what I thought back then: “What’s the point? Nothing is getting better and I’m miserable.”

For me, I knew in those moments that even though I didn’t see a clear path out of my problems, that alcohol was not the solution and would only make them worse.

Slowly, my life began to improve. The small chunks of my paychecks that I put towards attacking my debt started to bring my minimums down. Within time, I wasn’t living paycheck to paycheck. I was recognized more at work for the extra energy and focus that I was putting towards it. I was promoted, then I was promoted again, and again. I put any raise I had towards my debt. Then, when the debt was paid off, I started to put it towards savings and retirement. I was getting out of the hole. Eventually, years later, I was thriving. I got into a serious relationship. I had advanced at work. I started this blog and have been able to interact with heroes of mine that I never imagined would give me the time of day.

The first year was the hardest to get through and there were countless moments when I wanted to fall apart. After that, there were only two moments in the last 9 years when I was tempted to go back. They were moments of personal difficulties when I felt despair, and anguish and I just wanted to numb the emotions.

One of those moments was this week. I was upset at work all day thinking about what was going on in my personal life. I resolved at work that day that I was going to get drunk that night and at least be free of those feelings for one glorious evening. On the way home, I picked up a bottle of Cabo Wabo and resolved to get hammered drunk and forget about everything that’s been going on lately.

I opened the bottle. I smelled that tequila. It smelled incredible and seductive. I thought about how amazing it would be to get drunk. To no longer feel any pain, at least for a night. I took out a glass and put it on the kitchen table. I sat there staring at it. Thinking about how fun it would be to get drunk again. I also wrestled with all of the positive things that discipline and sobriety have brought me over the last decade. I thought about where I was 11 years ago. Living out of my car. Deeply in debt. I thought about a night when I puked on myself in my sleep and was lucky I didn’t choke. Now here I was, living in my own home and not a cent of debt and a good chunk of savings. I knew that none of this would be possible if I was drinking for the last decade. But I was also in pain and I knew alcohol would make it go away.

Ultimately, angrily and defiantly, I poured that bottle down the sink (sorry, Sammy Hagar) after sitting there and wrestling with these questions. It felt good to do that. It felt good to say no to it despite the incredible temptation to go back to it. It felt better than getting drunk would have felt.

I posted it on Twitter because I was proud of it and hoped that it would inspire someone else struggling with the same demons.

I never attended alcoholics anonymous and did all of this on my own. I always prided myself on that. That no one helped me. For most of the last 9 years, I’ve felt like I beat this addiction entirely. I felt like I did it on my own with no one’s help but my own force of will.

This week was a wake-up call for me that maybe I do need some help even though I haven’t consumed a single drop of alcohol for a decade. I haven’t gone through with it yet, but I think I may actually go to an AA meeting and talk to people with similar issues. Maybe it will help me stay on the path and have someone to talk to the next time I have a personal situation that makes me want to escape reality with booze.

Concluding Thoughts

That’s my story. Hopefully, you got something out of it. If you struggle with drugs and/or alcohol, know that you’re not alone.

If you love someone who struggles with this, perhaps this will give you perspective on why they do it. For me, it was about escape and numbing any intense emotions that I felt. Ultimately, as the numbing compounds your problems, you’re using because you use. It is a cycle of self-destruction. The user knows they shouldn’t use but they can’t help it.

I also hope that my story gives other alcoholics some inspiration. Despite the temptation to drown your feelings in booze, you have to always keep in mind that it will never make the problems go away. Only you can make your problems go away. Alcohol is fun and comforting but it will never match the satisfaction you’ll get from overcoming your problems on your own and succeeding in your pursuits.

Overcoming your problems is the ultimate satisfaction in life that a chemical can’t match. There are few feelings better than looking at a solved problem that previously looked insurmountable and saying to yourself: I did that. I solved that problem and I’m better for it.

PLEASE NOTE: The information provided on this site is not financial advice and it is for informational and discussion purposes only. Do your own homework. Full disclosure: my current holdings.  Read the full disclaimer

“Saudi America” by Bethany McLean

oil

The Book

I recently finished “Saudi America” by Bethany McLean. The book was excellent, timely, and aligns with my interest in the subject of energy. The book tells the story of the renaissance of American energy production that occurred in the last 10 years as a result of fracking.

The book is exceptionally current and fresh. Bethany talks in depth about very recent events, such as the rise to power of MBS in Saudi Arabia and the Trump administration’s odd obsession with coal.

The book doesn’t take sides and presents all sides of the argument. Bethany shows the side of the fracking optimists: those who think that the United States has a vast energy supply that we’ve barely scratched the surface of. The energy supply could end our connection with the Middle East and lead to American dominance of global energy production.

There is the other side of the argument: the environmentalists and short-sellers like David Einhorn who don’t believe that fracking can generate enough free cash flow to be sustainable, and she also shows that a world of destabilized oil powers isn’t necessarily a good thing for the United States. Saudi Arabia, for instance, uses their oil wealth to supply their population with bread and circuses. If the Saudis went bust, do we really want the country to become unstable and slip the region into more chaos than it already is?

The book doesn’t come to firm conclusions and presents all sides of the argument. This is chiefly because the story isn’t over yet. We don’t know how all of this will shake out and this is a new, revolutionary development.

For all of the books written about social media and the growth of the internet in the last decade, I’m shocked that more people haven’t tackled the incredible phenomenon of the U.S. energy boom. While the media is obsessed with our smartphones and Facebook, this energy renaissance is the most important economic and geopolitical story of the last 10 years. The impact is more far-reaching and significant than the phenomenon soaking up all of the media attention lately: crypto, social media, and the 24/7 cable news cycle focused almost exclusively on unimportant shenanigans in Washington.

Peak Oil Worries

I was attracted to this book due to my fascination with the concept of peak oil. I first encountered the idea of peak oil in high school in the late ’90s and have been obsessed with it ever since.

The idea of peak oil is simple. There is a fixed amount of oil on the planet. When it peaks, we inevitably need to reduce our use of it. This is problematic because nearly all of the improvement in human living standards over the last 200 years was caused by capitalism combined with human beings figuring out how to harness fossil fuels.

Per capita GDP was flat for more of human history. Then, in 1800, it began increasing exponentially. For most of human history, people were really just expensive livestock. Every person was another mouth to feed, and most of our ancestors lived lives that were miserable, poverty-stricken, and short. We take our standards of living for granted today. It’s truly staggering to imagine that most of the human race for most of history lived in a state of extreme, grinding poverty.

The growing and widespread use of fossil fuels changed the dynamic.

Everything we enjoy about the modern world is made possible because we can harness fossil fuels. This makes the inevitable reality horrifying: at some point, we will run out of them. Estimates vary, but the Earth only has so many hydrocarbons in it. At some point, our use of fossil fuels will peak. This is what is the theory behind peak oil: at some point, our extraction of it will be peak and with it, our civilization.

This is the future pictured in the Mad Max films. A brutal, post-apocalyptic world where we’ve burned all the fossil fuels and the return of the scarcity the characterized most of human history. It’s also the future depicted in Ready Player One, which described a decades-long Depression caused by the exhausting of our energy reserves.

The chief proponent of peak oil was M. King Hubbert. He theorized in the 1950s that the U.S. would peak in oil production around 1970 and it would decline from there. It turned out that he was correct. Conventional U.S. oil production peaked around 1970 and then entered a steady rate of decline.

The U.S. itself did not reign in its thirst for oil. We sought more oil from the world, chiefly Saudi Arabia. The Saudis had an ocean of oil which we increased our dependence upon. The biggest field in Saudi Arabia is the Ghawar oil field, which pumps out 5 million barrels of oil a day.

Since U.S. oil production began declining in the 1970s, President after President paid lip service to “energy independence” and did little about it. In practical terms, the only real legislation passed to encourage U.S. energy independence was a ban on U.S. energy exports in 1975.

While U.S. production peaked in 1970, there were many competing theories for when world energy production would peak. I worried in the mid-2000s that peak oil was upon us and the peak of our civilization had been reached.

In the summer of 2008, I was cash-strapped and paying $4 a gallon for gas. I watched the money drain away, and I thought to myself: this is it. This is peak oil.

Not the peak, after all

I was wrong. Oil production did not peak in 2008. In fact, the U.S. was about to undergo an energy renaissance that would wind up reshaping the world.

The oil production that was long on the wane in the United States wound up turning around. At this point, U.S. oil production now exceeds the 1970 peak.

oil

Catalysts of the Revolution

What caused the fracking revolution? This is a question that Bethany answers in depth in the book. The answer is two-fold: cheap capital made available from Wall Street combined with technological ingenuity.

The first catalyst was technology. The technique of fracking involves breaking apart rocks underground and unleashing natural gas and oil trapped within the rocks. The rocks are “fracked” and broken open and the gas/oil is unleashed. The tech and engineering behind it are over my head, but the fracking technology which existed since the 1940s had advanced in the 2000s to the point where it was economical to pursue in the United States. Oil prices also increased to a level where the technology was worth the investment.

The second catalyst was cash.

After the financial crisis, with interest rates at historic lows, Wall Street wanted to lend money. They wound up lending a large amount of high yield debt to the frackers. The money flowed into fracking ventures of various kinds, from the semi-respectable to the dubious.

Critics like David Einhorn believe that fracking will never generate sufficient free cash flow to be sustainable. In other words, the frackers will be destroyed by the high capital expenditures involved in successfully pursuing fracking.

When oil prices collapsed in 2015, it appeared that the shorts may have been correct. Many frackers went bankrupt. Others used it as an opportunity to restructure their loans.

The pessimists were disappointed, though. Fracking wound up surviving, but it’s unclear if this is a testament to the fiscal soundness of their operations or the willingness of Wall Street to throw cheap money around for the purpose of minting fees.

The new era was solidified in December 2015 when the 1975 ban on drilling was lifted. This was a momentous decision that was barely covered in the press. The era of declining U.S. energy production which began in the 1970s was over.

The Future

The future for fracking is uncertain. No one is sure how much oil exists within our shale deposits. Estimates vary wildly. The optimistic projections estimate that the U.S. contains trillions of barrels of oil. To put this in perspective, the Saudis produce about 10 million barrels of oil per day.

Skeptics believe that these estimates are too optimistic. They also think that fracking still hasn’t demonstrated its ability to generate cash flows that exceed the cost of capital.

Another concern is that regardless of the estimate, the supply of oil is finite and we will run out of it. At the end of the book, Bethany cites Charlie Munger, who advises prudence. He makes a good point that oil is used heavily in our farming industry and, because of this, it is one of the most precious resources that we should use prudently. Munger explains:

“Every barrel that you use up that comes from somebody else is a barrel of your precious oil which you’re going to need to feed your people and maintain your civilization. You want to produce just enough so that you keep up on all of the technology. And you shouldn’t mind at all paying prices that look high for foreign oil. You will be better off because you delayed gratification, instead of grabbing for it like a child.”

There are also environmental concerns. The burning of fossil fuels makes modern life possible, but it is also contributing to climate change and threatens our long-term survival as a species.

The story of the American energy revolution isn’t over, which is why the book doesn’t try to moralize and clearly define who is right and who is wrong. It tells the story. It also contains fascinating portrayals of the characters involved: from the risk-taking fracking executives to the skeptical short sellers.

From my point of view, I think Munger (as usual) is right. We should exercise prudence even if our newfound energy supply is abundant.

Oil is a critical, precious, non-renewable resource. We shouldn’t waste it. As a nation, we need a coherent energy policy that seeks to produce as much energy as possible without the use of fossil fuels. We need to plan for the reality that, eventually, we’re going to run out of it. It might be 50 years from now. It might be 200. Regardless of when it happens, the end is coming and, for the sake of our children, we should develop a coherent plan to deal with that future. When we run out of oil, it could potentially have far-reaching economic implications. Let’s mitigate those consequences. Let’s plan for the future.

Prudence will likely lead to a better world. We don’t want to live in the world of Max Rockatansky.

Whether you agree with me or not, I recommend Bethany’s book. It will give you perspective on the most important economic event of the last decade and help you come to your own conclusions.

PLEASE NOTE: The information provided on this site is not financial advice and it is for informational and discussion purposes only. Do your own homework. Full disclosure: my current holdings.  Read the full disclaimer.

Q3 2018 Update

Q3 Performance

Overall

Another quarter, more underperformance.

Value investing continues to underperform, and I continue to make mistakes. Regarding value’s underperformance, YTD to the 50 cheapest stocks in the S&P 500 has returned 3.62%. The 50 most expensive have delivered a 17.95% YTD return, outperforming the S&P 500.

I believe this will end, but I have no idea of when or how this will happen. The current cycle has looked like 1999 to me for nearly three years. I always suspect we’re close to that magical March 2000 moment, but it never seems to happen and expensive stocks continue to rip.

It looks like we’re late in the bull market to me, but no one really knows. There are no clocks on the walls, and everyone is flying blind, despite their assertive declarations to the contrary.

The only thing that I can do is continue to pursue my strategy: cheap stocks, good balance sheets, high probability of mean revision.

As for my mistakes, the biggest one appears to be abandoning my strategy a year ago for 20% of my portfolio and buying a bunch of international indexes that wound up vaporizing my money. The meltdown in Turkey caused me to wise up (or capitulate, depending on your perspective) and get back to the basics – buying individual value-oriented U.S. stocks.

Trades

This quarter, I sold all of my international indexes and bought specific U.S. stocks that I thought were undervalued. I was also paid out for my shares of the net-cash situation Pendrell. I reached a one year birthday on my position in Foot Locker and re-evaluated the position. The stock has been fantastic to me, and I’ve taken many of my gains off the table as it ran up over the last year. Evaluating the position on its birthday, it looked much more expensive than when I bought it a year ago, so I exited the position. I still think it’s a reliable company, but it is too rich for my tastes.

With the money from these sales and portfolio events, I purchased the below positions. Each position is linked to a blog post in which I outlined my reasons for buying it.

  1. Sanderson Farms
  2. Thor Industries
  3. United Therapeutics
  4. Reinsurance Group of America
  5. Micron
  6. MetLife

Of these buys, I am most excited about Micron, which strikes me as absurdly cheap. It is, in fact, the cheapest stock on an EV/EBIT basis in the entire S&P 500.

Overall, I still think Argan is the most compelling bargain in my portfolio, and the thesis continues to pan out.

Goodbye, Cruel World

I initially pursued my international strategy for two reasons: (1) In Q4 2017, about 60% of the cheap stocks I was screening were in the retail sector, and I didn’t want to have that level of concentration in one industry. (2) The US valuations look terrifying to me, so I thought an excellent way to diversify would be to buy cheaper foreign markets.

So what happened?

Many of the cheap retail stocks I didn’t buy went on to perform magnificently. Here are a few picks I didn’t invest in because I had 20% of my portfolio devoted to international indexes:

Williams & Sonoma (up 32% YTD)
Best Buy (up 16%)
DSW (up 31.26%)

I ignored my thesis about the retail sector (that the popular “Amazon eats the world” hypothesis was wrong, and retail valuations were unusually cheap) and pursued another strategy that wound up falling apart.

Experience the carnage:

international indexes

Nearly every one of them declined, due to a combination of weakness in those markets and strength in the US dollar. I lost $1,090.30 overall on the experiment, which is 2% of my portfolio. Meanwhile, the stocks that I otherwise would have invested in did better.

I abandoned my strategy and underperformed as a result.

With all of this said, I still think that low CAPE ratio international indexing is a viable option that will outperform in the future. I also know it’s not for me. I need to understand my investments. I don’t know anything about the monetary policy or political situation of Turkey or Russia. I don’t know anything about foreign currency speculation. In short, I don’t know enough about the positions to stick with them when times get tough, as they are right now.

I also bought these indexes for all of the wrong reasons. Mainly, I am freaked out by the valuations of US stocks and thought this would be a way to diversify away from the risk of US overvaluation. The truth is, with the US comprising over 50% of the global market cap, when the US pukes, everything else is going to go down with it. There won’t be a place to hide, even among cheap international markets. And that’s what I’m terrified of — I’m not concerned about a gradual underperformance of the U.S. versus the world, I’m worried about the markets puking in a 2008 style event. Aside from hedging strategies, there isn’t much way to avoid this inevitable pain.

Should I just shut up and buy the damn screen?

I tweeted this back in April, and I think it’s true:

tweet

For my stock selection, I need to understand the companies to remain invested in them. I know if a sell-off is related to an actual problem (i.e., the woes of my sold Francesca position) or if it’s pure market noise (i.e., volatility in Argan). My understanding of the companies helps me stick with the strategy. Research helps me behaviorally.

Behavioral folly is also the reason I don’t go full quant even though I am very quantitative in my approach. I start with a screen of cheap stocks, research the output of the filter, and try to identify the opportunities which I think are best.

This approach has flaws due to the “broken leg” problem. One of the best examples of this is Joel Greenblatt’s brokerage service that was designed to help people implement the magic formula strategy. Greenblatt established a brokerage firm that would automatically invest in the magic formula for clients. Some clients automated the magic formula stock selection, while others chose from the list. The clients who picked their stocks from the magic formula list underperformed. Those who purchased the screen outperformed the market. Joel Greenblatt explains it here.

Why did this happen? In short, investors avoided the scariest looking stocks, which were the ones that provided the best returns. I don’t think this phenomenon only applies to amateur investors. I think it’s the main reason that many value investors underperform simple quantitative “cheap” strategies. You’ll often hear of exceptional value investors outperforming the stock market, but they often underperform the lowest deciles of cheap. They underperform simple metrics of cheap because, to avoid value traps, they often pass over the best opportunities in the market because of how terrifying they appear.

The evidence indeed suggests that I should go “full quant” and buy the damn screen. The reason I don’t do this is that I don’t feel that I would be able to stick with a “full quant” strategy. I want to understand what I invest in so I can stick with the plan through thick and thin.

The low CAPE strategy is a quant strategy as is merely buying cheap stocks. I recognize the compelling logic of a full quant approach, but I can’t fully embrace it because I want to understand the companies themselves. It might worsen my results over the long run, but at least I’ll be able to stick with it.

I set out on this blog to pick stocks within the low P/E, low debt/equity 1970s Graham framework. That’s what I’m going to stick to despite the temptations to abandon it. I am not knocking the low CAPE index approach, the magic formula, or the Acquirer’s multiple strategies. I just don’t think I’d be able to stick with a purely quantitative approach if it ever turned against me.

Random

This is hilarious. “He just wanted to spend time with his family . . . and his robot. Like a normal guy.”

PLEASE NOTE: The information provided on this site is not financial advice and it is for informational and discussion purposes only. Do your own homework. Full disclosure: my current holdings.  Read the full disclaimer.

MetLife (MET)

fall

Key Statistics

Enterprise Value = $46.727 billion

Operating Income = $5.65 billion

EV/Operating Income = 8.27x

Price/Revenue = .70x

Earnings Yield = 11%

Debt/Equity = 36%

The Company

Met Life is a massive global insurance firm. Their $457 billion bond portfolio makes them one of the biggest institutional investors in the United States. Their business spans the globe with operations in the United States, Asia, EMEA, and Latin America.

A major focus for MetLife is group insurance for large corporations. Another important segment is pension risk transfer when MetLife assumes the pension risk of another company. Another segment is structured settlement, in which MetLife will take on large class action legal claims.

Like Unum Group, shares have languished due to concerns about its long-term care insurance reserves. In other words, with people living longer and medical care costs rising, the market is worried that MetLife doesn’t have enough capital set aside to deal with these concerns. These concerns have caused many insurance names to lag the S&P 500 in the past year and MetLife has not been immune to the pain In the last year, the stock is down 8.39% while the S&P 500 is up 15.67%.

My Take

Cheap insurance stocks are a large segment of my portfolio. I currently own Aflac, Unum Group, Reinsurance Group of America, and MetLife. I like insurance for several reasons: it is boring, it is profitable, and beaten up insurance companies almost always tend to recover unless there is a black swan event or they have been playing it fast and loose with risk management.

As for the long-term care anxieties, I have no idea if MetLife has sufficient capital set aside. What I do know is that long-term care represents only 15% of MetLife’s business and it looks to me like the concerns are already built into the stock price.

Despite the pressures on the stock and worries about long-term care, revenues and profits are up over the last year. In the most recent quarter, year/year revenues are up 38.23% and EPS is up 3.75%.

Met Life is a high-quality firm. Their Piotroski F-Score is currently an excellent 7. Their debt/equity ratio is currently 36%, implying that they have a relatively safe balance sheet.

My main attraction to Met Life is its high level of shareholder yield. In the last year, MetLife has bought back 5% of the outstanding shares and delivers a dividend yield of 3.60%. The share buybacks show no signs of letting up. In May, the company announced a $1.5 billion share buyback.

With most of my picks, I buy ugly situations and wait for significant multiple appreciation once the concerns fade away. I am looking for gains of 50-100%. With Met Life, I’m not expecting those kinds of gains. While moderate multiple appreciate is possible, my expectation is that MetLife has a low probability of blowing up and, in the meantime, it will continue to aggressively return capital to shareholders and ought to deliver an attractive rate of return.

PLEASE NOTE: The information provided on this site is not financial advice and it is for informational and discussion purposes only. Do your own homework. Full disclosure: my current holdings.  Read the full disclaimer.

I am a value investor. My outlook is inspired by the ideas of Benjamin Graham. This site is a real time chronicle of my portfolio and an outlet to share my ideas. I hope you enjoy.