Mr. K's insightful and methodical analysis is highly respected by contemporary value investors and that includes me.
My brief comments and disclaimer: I own UNH and plan to add to my position on dips hopefully in the low 20's and high teens as the US election looms. My target price is $60/share based on a DCF analysis similar to this one by Dr. Price. I don't think that this company is a "great" one and don't plan to hold it for the very long term: it is known for treating its employees and clients very poorly. I do think that it is extremely undervalued (due to the emotional reaction many investors have towards the company?), even considering worst case political outcomes.as Vitaliy elaborates on below. Don't forget that the "vital few" agree with recognition of this value: Warren Buffett, Chris Davis and Edward Owens are amongst 9 gurus who own substantial amounts of UNH stock (WE recently bought at $47/share, adding to a 6.4 Million share holding).
You Don’t Have to Be Sick To Own HMO Stocks: UnitedHealth Group, WellPoint and Aetna
July-29-2008
[b]Vitaliy N. Katsenelson column: [/b]You want to buy straw hats in the winter. This sums up an important kernel of successful value investing: making decisions (buying and selling) that are unpopular at the time. (Of course, one has to make sure that, due to global climate change, winter is not swiftly followed by an ice age. In the case of the stocks I am about to discuss, today is winter and the summer will come again.) Shares of [b]UnitedHealth Group (UNH)[/b] and those of its HMO comrades have declined significantly over last six months. UNH has taken down its earnings guidance twice in 2008 from $3.90 to about $3 per share. Competition among HMOs is intensifying; the weak economy is not helping, as employers are looking for ways to save money and downgrading their health care coverage. HMOs have underestimated their medical costs. Of course, the rising unemployment is hurting enrollments and adding more pressure to an already sobering situation. So that is the bad news. Everybody knows it. HMOs' current, ex- (and there are plenty of those) and future shareholders know it. The bad news is more than priced into these stocks. With single-digit price-earnings ratios, HMO stocks are priced as if the sun will never to shine again, as if a lunar eclipse became a permanent celestial feature for the industry. UNH, as well as [b]WellPoint (WLP), Aetna (AET)[/b] and others, are priced as if they were going out of business. They are not! The sun will shine again. The baby boomers are getting older and are consuming more and more medical services. For good or bad, the HMO's role in the health care industry is unlikely to diminish. The industry has changed dramatically over the past decade. It consolidated. Now the top five companies account for roughly 80% of industry revenues. With fewer players, the more rational their behavior should be (read: stable pricing). The price war that took place in late 1990s, when the industry was very fragmented, and was responsible for record low margins, is unlikely to take place, at least to the same degree, this time around. Also, instead of trying to fight ever-rising costs of health care and getting a bad rap from consumers, HMOs are focusing on two things: 1) exercising tremendous buying power by extracting lower prices from health care providers and 2) embracing the inflation in medical costs by taking a cost-plus approach to pricing; in other words, passing medical inflation on to consumers. In the short run, as is apparent from recent announcements, both the "cost" and the "plus" parts are going in the wrong direction. The industry underestimated the recent rise in medical costs, and the weak economy has been (temporarily) detrimental to pricing. The value of a company is the present value of its discounted future cash flows. Thus, a great way to judge a company's worth is through the discounted cash flow model, which projects future cash flows and discounts them back at particular rate. Even if we project significantly lower, declining future cash flows (an unlikely scenario), we will still get intrinsic values that are higher than today's depressed stock prices suggest. Finally, there is a political risk--the elephant in the room. We have a presidential election and a strong Democratic candidate with a social agenda. This is bad for the HMO stocks, right? Well, though HMO stocks may have starred as villains in Michael Moore's movie Sicko, they are not at the core of the health care crisis and are likely to be a part of the solution. Public health care companies have generated $250 billion in revenues and $13 billion in profits in 2007. This may sound like a lot of money, and it is, but that only represents a net margin of 5% and a return on capital of 5%. Neither number screams, "We're fleecing the public!" In fact, they are close to the economics of government- regulated electric utilities. Let's say politicians decide to go after HMOs. They only have $13 billion of profits to work with; even if they halve HMOs' profitability, $6.5 billion will not solve trillion-dollar health care problems. Also, 81% to 83% of these companies' revenues go to paying for health care services (doctors, hospitals, drugs) and another 3% to 4% of revenues fall into Uncle Sam's pockets. It is hard to milk this industry for political gain. At the same time, if the new head of government decides to fix the health care problem by insuring the 45 million uninsured Americans, government will call on--you guessed it--the private sector HMO industry. HMO stocks look ugly in the short term, and the news flow may get worse before it gets better. But these stocks are trading at incredibly attractive valuations, have strong financial positions and great cash flows. Though they don't pay meaningful dividends, they are using every ounce of tremendous free cash flow to buy back stock. At today's depressed prices this could make a meaningful difference. In the case of UNH, the company can buy roughly 17% of its outstanding shares a year from its free cash flows. The short-term negatives--and I believe they are short term in nature--may be a blessing in disguise.
You Don’t Have to Be Sick To Own HMO Stocks: UnitedHealth Group, WellPoint and Aetna
July-29-2008
[b]Vitaliy N. Katsenelson column: [/b]You want to buy straw hats in the winter. This sums up an important kernel of successful value investing: making decisions (buying and selling) that are unpopular at the time. (Of course, one has to make sure that, due to global climate change, winter is not swiftly followed by an ice age. In the case of the stocks I am about to discuss, today is winter and the summer will come again.) Shares of [b]UnitedHealth Group (UNH)[/b] and those of its HMO comrades have declined significantly over last six months. UNH has taken down its earnings guidance twice in 2008 from $3.90 to about $3 per share. Competition among HMOs is intensifying; the weak economy is not helping, as employers are looking for ways to save money and downgrading their health care coverage. HMOs have underestimated their medical costs. Of course, the rising unemployment is hurting enrollments and adding more pressure to an already sobering situation. So that is the bad news. Everybody knows it. HMOs' current, ex- (and there are plenty of those) and future shareholders know it. The bad news is more than priced into these stocks. With single-digit price-earnings ratios, HMO stocks are priced as if the sun will never to shine again, as if a lunar eclipse became a permanent celestial feature for the industry. UNH, as well as [b]WellPoint (WLP), Aetna (AET)[/b] and others, are priced as if they were going out of business. They are not! The sun will shine again. The baby boomers are getting older and are consuming more and more medical services. For good or bad, the HMO's role in the health care industry is unlikely to diminish. The industry has changed dramatically over the past decade. It consolidated. Now the top five companies account for roughly 80% of industry revenues. With fewer players, the more rational their behavior should be (read: stable pricing). The price war that took place in late 1990s, when the industry was very fragmented, and was responsible for record low margins, is unlikely to take place, at least to the same degree, this time around. Also, instead of trying to fight ever-rising costs of health care and getting a bad rap from consumers, HMOs are focusing on two things: 1) exercising tremendous buying power by extracting lower prices from health care providers and 2) embracing the inflation in medical costs by taking a cost-plus approach to pricing; in other words, passing medical inflation on to consumers. In the short run, as is apparent from recent announcements, both the "cost" and the "plus" parts are going in the wrong direction. The industry underestimated the recent rise in medical costs, and the weak economy has been (temporarily) detrimental to pricing. The value of a company is the present value of its discounted future cash flows. Thus, a great way to judge a company's worth is through the discounted cash flow model, which projects future cash flows and discounts them back at particular rate. Even if we project significantly lower, declining future cash flows (an unlikely scenario), we will still get intrinsic values that are higher than today's depressed stock prices suggest. Finally, there is a political risk--the elephant in the room. We have a presidential election and a strong Democratic candidate with a social agenda. This is bad for the HMO stocks, right? Well, though HMO stocks may have starred as villains in Michael Moore's movie Sicko, they are not at the core of the health care crisis and are likely to be a part of the solution. Public health care companies have generated $250 billion in revenues and $13 billion in profits in 2007. This may sound like a lot of money, and it is, but that only represents a net margin of 5% and a return on capital of 5%. Neither number screams, "We're fleecing the public!" In fact, they are close to the economics of government- regulated electric utilities. Let's say politicians decide to go after HMOs. They only have $13 billion of profits to work with; even if they halve HMOs' profitability, $6.5 billion will not solve trillion-dollar health care problems. Also, 81% to 83% of these companies' revenues go to paying for health care services (doctors, hospitals, drugs) and another 3% to 4% of revenues fall into Uncle Sam's pockets. It is hard to milk this industry for political gain. At the same time, if the new head of government decides to fix the health care problem by insuring the 45 million uninsured Americans, government will call on--you guessed it--the private sector HMO industry. HMO stocks look ugly in the short term, and the news flow may get worse before it gets better. But these stocks are trading at incredibly attractive valuations, have strong financial positions and great cash flows. Though they don't pay meaningful dividends, they are using every ounce of tremendous free cash flow to buy back stock. At today's depressed prices this could make a meaningful difference. In the case of UNH, the company can buy roughly 17% of its outstanding shares a year from its free cash flows. The short-term negatives--and I believe they are short term in nature--may be a blessing in disguise.
Tuesday, July 29, 2008
Saturday, July 26, 2008
Stock Market Hangover: A hair of the dog
An excellent prospect for a RRSP holding. I plan to buy at <$70.
Wednesday, July 23, 2008
When 1 + 1 = 3
Arbitrage: Attempting to profit by exploiting price differences of identical or similar financial instruments, on different markets or in different forms. The ideal version is riskless arbitrage.
There are many different ways to approach this technique and most are not appropriate for the long term small retail investor (i.e. us).
The 2 special situations that are relatively safe and lower maintenance include:
It's unbelievable to me that these situations can actually exist when there is so much "smart money" floating around-- you'd think the opportunity would come up and disappear within seconds as there are so many professional money managers scouring the market 24/7 looking for this kind of stuff.
Peter Lynch explains in his book "One up on Wall St." that institutional money is highly constrained from taking advantage of special situations that put the odds heavily in favour of the small indpendent investor:
Take comfort that for once, you have an advantage over the "big guys" on Wall and Bay St.
l
There are many different ways to approach this technique and most are not appropriate for the long term small retail investor (i.e. us).
The 2 special situations that are relatively safe and lower maintenance include:
- buying holding companies that own equities whose market values, when added together, far exceed the current share price of the holding company. Another way to say this is that it is trading at a deep discount to NAV.
- exploiting corporate "spin-off" opportunities: a large company breaks itself up into a number of smaller companies to unlock value unappreciated by the market prior to the breakup.
It's unbelievable to me that these situations can actually exist when there is so much "smart money" floating around-- you'd think the opportunity would come up and disappear within seconds as there are so many professional money managers scouring the market 24/7 looking for this kind of stuff.
Peter Lynch explains in his book "One up on Wall St." that institutional money is highly constrained from taking advantage of special situations that put the odds heavily in favour of the small indpendent investor:
- The "window dressing" effect-- in order to make their performance numbers match the market and the competition come RRSP/401K time each year (you better believe their job relies on that) the money managers purposely sell stocks with remarkable long term potential but have suffered a short term set back and buy stocks that have momentum i.e. buying high and selling low or buying expensive and selling cheap
- Brokerage/Company rules requiring at least 2 analysts to give a favourable report on the company AFTER the spin off. This is like assuming that the spun off companies are like brand new public companies... complete unknowns even though they often function exactly like they did before with the same clients and the same management as pre-spin-off. Garnering analyst attention and a published analysis usually takes months.
- Most money managers will choose a mediocre return or even a loss in popular (= expensive, usually!) house hold name companies than a superior return over the long term in an initially obscure company. This way when they defend their investment choices to their clients (particularly the professional ones), the blame can be attributed to external forces.
- Most pension funds have rules preventing investment in small cap stocks or in any equity that does not come from a committee approved list. As everyone knows, nothing good has EVER come from committee (unless one or two people do all the work and everyone else lets them)
- Last but not least, when a bear market sets in, investors often panic and this leads to large and rapid redemptions from mutual funds, hedge funds and even pension funds. Unless the fund is sitting on a large wad of cash, it MUST sell stocks immediately to fund those redemptions no matter what the price currently is and no matter what brilliant strategy the manager has in place.
Take comfort that for once, you have an advantage over the "big guys" on Wall and Bay St.
l
Tuesday, July 22, 2008
More pain?
Ron Muhlenkamp's review of events that impacted the markets during the past quarter.
QUARTERLY LETTER
Published Third Quarter 2008
by Ron Muhlenkamp
The pain continues. The focus has shifted somewhat from financial concerns to the price of commodities, particularly energy and food.
One reason this is important is that increasing prices for food and energy affect nearly everyone worldwide, including people in the emerging countries including (and maybe especially) China and India which have provided strong economic growth over the past number of years. This increases the odds for a worldwide slowdown/recession which could be longer and deeper than one in the United States, if the U.S. was going through this recession alone.
Parts of this picture we have seen before. In 1973-1974, the price of crude oil tripled as did the prices of wheat, corn, soybeans and a number of other commodities. The increased grain prices resulted in an increase in production which caused their subsequent prices to fall by a third within three years, their prices then stayed in that range for 30 years. The increased price of crude oil drove efforts to improve energy efficiency. In the U.S. and other countries, we now use half the energy per dollar of GDP that was used in 1970! We expect much of this pattern to occur again – but it takes time.
Meanwhile, another factor has helped to complicate the process. Because commodity prices have gone up, a number of investors have concluded they can benefit from buying commodities as an investment. And they’ve allocated a portion of their assets to that end. This is similar to buying Internet stocks in 1999 because they’d gone up; in 2005 it was houses; and in 2006 it was Chinese and Indian stocks. Such actions are self-fulfilling, for a while. We believe these actions are currently driving the price of crude oil. The difficulty is in knowing when and at what level it will rollover.
This uncertainty, in the marketplace, is putting downward pressure on nearly all stocks, even some that should benefit from the increased prices in commodities (e.g., both Deere and Exxon are down over the past six months). While this pressure is presenting us with the best investment values we’ve seen in a decade, the pressure is likely to continue until we see a crack in the price of crude oil.
QUARTERLY LETTER
Published Third Quarter 2008
by Ron Muhlenkamp
The pain continues. The focus has shifted somewhat from financial concerns to the price of commodities, particularly energy and food.
One reason this is important is that increasing prices for food and energy affect nearly everyone worldwide, including people in the emerging countries including (and maybe especially) China and India which have provided strong economic growth over the past number of years. This increases the odds for a worldwide slowdown/recession which could be longer and deeper than one in the United States, if the U.S. was going through this recession alone.
Parts of this picture we have seen before. In 1973-1974, the price of crude oil tripled as did the prices of wheat, corn, soybeans and a number of other commodities. The increased grain prices resulted in an increase in production which caused their subsequent prices to fall by a third within three years, their prices then stayed in that range for 30 years. The increased price of crude oil drove efforts to improve energy efficiency. In the U.S. and other countries, we now use half the energy per dollar of GDP that was used in 1970! We expect much of this pattern to occur again – but it takes time.
Meanwhile, another factor has helped to complicate the process. Because commodity prices have gone up, a number of investors have concluded they can benefit from buying commodities as an investment. And they’ve allocated a portion of their assets to that end. This is similar to buying Internet stocks in 1999 because they’d gone up; in 2005 it was houses; and in 2006 it was Chinese and Indian stocks. Such actions are self-fulfilling, for a while. We believe these actions are currently driving the price of crude oil. The difficulty is in knowing when and at what level it will rollover.
This uncertainty, in the marketplace, is putting downward pressure on nearly all stocks, even some that should benefit from the increased prices in commodities (e.g., both Deere and Exxon are down over the past six months). While this pressure is presenting us with the best investment values we’ve seen in a decade, the pressure is likely to continue until we see a crack in the price of crude oil.
Wednesday, July 16, 2008
Definite Entertainment
I've been watching the markets with detached amusement for the last 9 months. I probably shouldn't waste my time: the whole philosophy of value investing is to buy quality companies when they are cheap and then pretty much ignore the share price and the machinations of a manic depressive "Mr Market" in particular.
Today bank shares popped like cheap champagne. Wells Fargo was up 30% and USB topped 17% in a single session. CRAZY! who ever heard of huge blue chips making moves like this so quickly?
The factors at play here are multiple for sure: an SEC that is finally enforcing the rules about naked shorts (brokerages loaning out shares that they actually don't have) in the financials, the energy specter no longer looking quite as scary (bring oil prices down) and the market finally recognizing that it hasn't seen valuations of the cream of the crop businesses this low for almost 20 years (1990).
I think its important not to take these trends to0 seriously--- unless they offer an opportunity to buy the companies that you've been researching even more cheaply than in the past.
Shares I have bought in my companies' name at 52 weeks lows in the last 3 weeks:
AXP
MKL
LYG
Y
NYX
OCX (my wife's RRSP)
KMX (not a financial but what the heck)
I'm planning to add to the BBSI position soon--- hoping it dips below $10/share.
l
Filed Under: WFC,
Filed Under: WFC, Filed Under: WFC,
Wells Fargo is not exactly a tiny neighborhood bank. With $366 Billion in assets and until recently a market cap well above $100 Billion, it's a banking heavyweight. I have owned it in many of my managed portfolios for some time. Mr. Buffett also owns a big slug.
Long an exceptionally well-run bank, WFC largely avoided most of the sub-prime mess, but they are still exposed to some questionable home equity loans. So when they announced better than expected results this morning and increased their dividend 10%, the stock reacted favorably.
Actually, that's a bit of an understatement. The stock absolutely blasted off, rising nearly 33%! The last move anywhere near this big for WFC was after the crash of 1987 when it rose 15% in a day. Of course its market cap was a fraction of what it is today. In fact, its market cap increased by $22B (!) today on > 5x normal trading volume, closing on its highs. Wow.
My best guess is there was a "bit" of short covering involved here. The amazing thing is if the shorts can get squeezed this badly in a stock as big and liquid as WFC, what's going to happen in some of the smaller, illiquid, heavily (and likely naked) shorted stocks when the coast really does begin to look clear? Look out above! Sure, many of these stocks probably deserve to be shorted into oblivion. But in my opinion many don't.
As always I have no clue when this will happen. Maybe today is the start. More likely, it is just another bear marker rally, but who knows. Certainly none of the talking heads believe that today marks the start of anything sustainable - a good reason in itself to believe that it might. Whenever it does happen though, I think it's likely to be a violent and extended rally.
Today bank shares popped like cheap champagne. Wells Fargo was up 30% and USB topped 17% in a single session. CRAZY! who ever heard of huge blue chips making moves like this so quickly?
The factors at play here are multiple for sure: an SEC that is finally enforcing the rules about naked shorts (brokerages loaning out shares that they actually don't have) in the financials, the energy specter no longer looking quite as scary (bring oil prices down) and the market finally recognizing that it hasn't seen valuations of the cream of the crop businesses this low for almost 20 years (1990).
I think its important not to take these trends to0 seriously--- unless they offer an opportunity to buy the companies that you've been researching even more cheaply than in the past.
Shares I have bought in my companies' name at 52 weeks lows in the last 3 weeks:
AXP
MKL
LYG
Y
NYX
OCX (my wife's RRSP)
KMX (not a financial but what the heck)
I'm planning to add to the BBSI position soon--- hoping it dips below $10/share.
l
Astounding move in WFC - a glimpse of things to come?
by Todd N KenyonFiled Under: WFC,
Filed Under: WFC, Filed Under: WFC,
Wells Fargo is not exactly a tiny neighborhood bank. With $366 Billion in assets and until recently a market cap well above $100 Billion, it's a banking heavyweight. I have owned it in many of my managed portfolios for some time. Mr. Buffett also owns a big slug.
Long an exceptionally well-run bank, WFC largely avoided most of the sub-prime mess, but they are still exposed to some questionable home equity loans. So when they announced better than expected results this morning and increased their dividend 10%, the stock reacted favorably.
Actually, that's a bit of an understatement. The stock absolutely blasted off, rising nearly 33%! The last move anywhere near this big for WFC was after the crash of 1987 when it rose 15% in a day. Of course its market cap was a fraction of what it is today. In fact, its market cap increased by $22B (!) today on > 5x normal trading volume, closing on its highs. Wow.
My best guess is there was a "bit" of short covering involved here. The amazing thing is if the shorts can get squeezed this badly in a stock as big and liquid as WFC, what's going to happen in some of the smaller, illiquid, heavily (and likely naked) shorted stocks when the coast really does begin to look clear? Look out above! Sure, many of these stocks probably deserve to be shorted into oblivion. But in my opinion many don't.
As always I have no clue when this will happen. Maybe today is the start. More likely, it is just another bear marker rally, but who knows. Certainly none of the talking heads believe that today marks the start of anything sustainable - a good reason in itself to believe that it might. Whenever it does happen though, I think it's likely to be a violent and extended rally.
Sunday, July 13, 2008
Saturday, July 12, 2008
Think that you're contrarian by betting against the market?
nope: read the seeking alpha article here
have a look at the two charts presented there. Many of the stocks there have >50% of the float as short interest! The repeal of the "uptick rule" of 1929 mandating that a stock price had to increase a bit before subsequent short sales occurred last fall is likely a major contributor to this phenomenon.
The next few months/quarters should be very interesting as the inevitable short covering rush/squeeze occurs. This type of market position is not sustainable IMHO.
have a look at the two charts presented there. Many of the stocks there have >50% of the float as short interest! The repeal of the "uptick rule" of 1929 mandating that a stock price had to increase a bit before subsequent short sales occurred last fall is likely a major contributor to this phenomenon.
The next few months/quarters should be very interesting as the inevitable short covering rush/squeeze occurs. This type of market position is not sustainable IMHO.
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