Thursday, August 28, 2014

S&P 500 Triples in 5 Years!

It was a little over five years ago that the S&P 500 index hit the intraday low of 666. A few days ago it reached 2000. That means the stock market tripled in 5 years! After two crashes in the last 15 years I don't blame the average person for not noticing. But sooner or later, the public will recalibrate their thinking of the stock market and the economy. Maybe this expansion is here to stay and we are in the middle or early stages of a secular bull market.

I am no economist and I know my opinion and even the opinion of experts are only vague guesses at what the future holds. But I must pay attention to the overall market and economy as it is one of many factors in my investing decision process. I remember five years ago at the depths of the financial crisis, I told anyone who would listen that we are in a once-in-a-lifetime opportunity. Today I am very unsure where we are. But instinctively I feel that this bull market cannot last much longer. We have had probably the best five year bull market in history; if not then definitely one of the three best? Maybe?

Then again, I think I don't really know for sure and I should find out. So I decided to find out if my belief is reality. I don't know of a published source for this information so I decided to derive it myself based on Robert Shiller's market data. This is the data source for the Cyclically Adjusted PE (CAPE) by the recent Nobel prize winner. From the data, I used the S&P index going back to the late 1800s factoring in inflation and assuming that dividends are always reinvested. I feel factoring dividends and inflation is the best way to compare returns in different periods1. And I came up with the following table of the best 5 to 9 year real annualized returns with reinvested dividends. The results for each period must be non-overlapping.

5 Year Period Sept 1924 — Aug 1929 27.4%
Jul 1932 — Jun 193725.5%
Dec 1994 — Nov 199922.8%
Aug 1982 — Jul 198720.8%
Mar 2009 — Feb 201417.3%
6 Year Period Aug 1923 — July 192925.1%
Apr 1994 — Mar 2000 18.8%
Jul 1949 — Jun 1955 17.0%
Jul 1932 — Jun 193815.5%
7 Year Period Jan 1922 — Dec 192819.0%
Jun 1949 — May 1956 16.5%
Jul 1992 — Jun 1999 15.9%
Aug 1982 — Jul 198913.9%
8 Year Period Sept 1921 — Aug 1929 21.7%
Jan 1991 — Dec 1998 15.4%
Mar 1948 — Feb 1956 14.3%
9 Year Period Aug 1920 — Jul 1929 18.7%
Nov 1990 — Oct 1999 15.0%
Jul 1950 — Jun 1959 12.3%

The results are fascinating. The last five years only ranks 5th overall. The table gives a sense of perspective which is paramount in investing. But I am not using it to make any strong conclusions about the market over the coming years. But I can say that the current bull market can return 10% for the next two to three years and we still would not be breaking the record. The table shows that the best two 7 or 8 year periods have returned more than 15%!

The US economy appears to have room to expand based on unemployment and other economic results. The retail investor may suddenly see this and notice the market run up and forget the pain of the last fifteen years and finally jump in. To me, this scenario is as plausible as the stock market crashing, which is what most retail investors have been expecting for five years. I sure hope they get tired of waiting and dive in!

1. The S&P 500 index does not include dividends. To know the market index with dividends one should use the S&P 500 Total Return index.

Monday, August 18, 2014

Summer Quarterly Updates

Tachibana Eletech reported Q1 total income increased 18.9% yoy; revenue increased 6.7% yoy. This improvement was partly the result of strong industrial demand in Japan. The results are even more impressive because the market presumed that last quarter's results were good because customers moved forward purchases to avoid the impending consumption tax increase. Q1 results were the first that included the consumption tax increase, and the results would have been impressive even if there was no tax increase!

The company also upped its year end EPS guidance from ¥161.41 to ¥170. The stock has rallied recently but it is still selling for only 8 times EPS guidance.

Riken Keiki reported earnings increased 19% yoy. Revenue increased 6.6% yoy. This company is firing on all cylinders. Last year its earnings increased 14% and the year before it increased 22%. This is my best performing Japanese holding, increasing by 90% in the 18 months that I've held it. When I initially bought the stock 18 months ago, the fact that it was a netnet was my margin of safety. Now it has risen 90% and is no longer a netnet. The market has priced it more as a earnings growth engine. But the stock still trades below book and and at 11x EPS guidance. This is Ben Graham's value investing at work: buy a good cheap stock, and usually something good happens!

Fujimak reported a ¥ (38.39) loss per share versus ¥ 3.5 a year ago. Revenue decreased 5% yoy. This was a a shock! The company said much of this was the result of a natural pullback from its knockout Q4, when it earned ¥ 99 a share, and to a lesser extent the consumption tax increase.

The company gave an EPS guidance of ¥98, which I hope is true but I also fear may not be met. The company trades at 8x EPS guidance.

Now on to US stocks. Seaboard Corp had one of its best quarters in history. Because of record pork prices, EPS was $79 versus $33 a year ago. H1 EPS was $119 versus $81 a year ago. The stock didn't budge after the earnings reports. In fact it dropped a bit because of plunging pork futures. Pork meat was regularly around $0.80/lb for the last several years, then it suddenly jumped to a high of $1.30. Today, futures for delivery in the next several months is back at $0.90s. Next year delivery dropped but now is back in the 90s also! So the weak stock performance is understandable.

Kansas City Life Insurance reported Q2 earnings slight down. Q2 EPS was $0.77 versus $0.98 a year earlier and premium revenue was down 5%. Book value has grown steadily and now the stock trades at 2/3 book. It also pays a 2% dividend. I feel this is one undervalued and neglected company.

Investors Title Insurance Company reported earnings were down 20% yoy. Premium revenue was flat yoy, which is encouraging considering the exceptional refinancing activity last year. The decrease in earnings was primarily the result of increased commissions. The company now trades at 1.1x book.

Putprop pre-announced that the company's earnings will be approximately ZAR$1.50 vs ZAR$0.86 a year ago! That is a 75% increase and even after the stock jumped by 30% from my initial purchase, it is still trading at 6 times earnings!

IEHC reported Q1 EPS $0.17 versus $0.23 a year ago. Sales was down 4% yoy. I would've liked to see better yoy results, but last year's Q1 was exceptional. I don't really know what to make of this tiny company. I had hoped based on my reading that this company's sales would take off in the last several quarters. But this hasn't happened. The company's sales are quite erratic. I'll pay close attention to this one in the coming quarters.

Wednesday, August 6, 2014

Time to Reevaluate Wellpoint

Wellpoint just released the company's Q2 earnings. The stock dropped a few percent right after the release. But the results seem fine to me and management upped its 2014 GAAP earnings guidance to $8.81. The stock drop tells me that the market has finally revalued Wellpoint and the entire managed care industry. Two years ago Wellpoint was trading at half of the current $110 price. That priced the company at less than 10 times trailing earnings. Joe Swedish has improved the company's operations and appears to be a very shareholder friendly CEO. Now it is trading at 13 times projected 2014 earnings. This is a multiple expansion is what I had hoped or expected when I last added to my position two years ago.

Now it is a half year after Obamacare's individual mandate and we have a better but still foggy picture of heathcare. This is a good time for me to reevaluate WLP.

Obamacare affects Americans not just through its individual mandate. But the individual mandate is the most controversial and far-reaching part of the legislation. From what I see so far, the uninsured aren't dragged kicked and screaming to get coverage. And the new enrolees aren't just the sick and unprofitable members of the pool. I can tell because the Obamacare first year enrolment exceeded projections. And as further evidence, the California Obamacare insurers plan to raise rates 4.2%, which is less than the healthcare industry overall. This means that the first year rates were adequate and the enrolment mix had enough healthy to cover the unprofitable sick. Remember, Obamacare cannot discriminate the sick from the healthy with different rates.

Another controversial part of Obamacare is the Medicaid expansion. Medicaid expansion under Obamacare raises the level at which a person qualifies for Medicaid. However, each state can opt out if they wish because of the 2012 Supreme Court ruling. So far about half of the states have opted out. However, the most populous of the 14 states where Wellpoint does business are participating in Medicaid expansion. And Medicaid enrolment is up 15% this year compared to last in participating states. Wellpoint should be well positioned with its recent Amerigroup acquisition.

Joe Swedish has been all gung ho on Obamacare since joining Wellpoint more than a year ago. Preliminary facts looks like it will pay off. The medical loss ratio (MLR) is now at 82.7%. The MLR is the ratio of benefits paid to revenue. It is one of the key metrics to measure medical insurance companies. It was at 85% before he took over. And the company bought back 8 million shares in the last quarter alone. Mr. Swedish seems to be really focused on improving the company's bottom line.

Wellpoint recently has been the cheapest of the MCOs because of missteps before Mr. Swedish arrived. But the valuation is catching up. The following table compares all the major MCOs.

Wellpoint Aetna Humana Cigna Unitedhealth
Price 111 78.3 120 91.67 81.5
PE 12.6 12.0 16.0 12.6 14.7
ROE 0.10 0.16 0.12 0.18 0.16
P/BV 1.3 1.9 1.8 2.2 2.4
MLR 82.7% 83.1% 83.1% 84.5% 81.6%

Buying and selling stocks is a balancing act on a scale. In a perfectly efficient market the scale is balanced. I see possible future scenarios that would weigh in favour of holding WLP:
  • Americans increasingly want health care, but are adamantly against government control. Obamacare increases in popularity.
  • Healthcare has great pricing power, costs have been and will be rising significantly above GDP growth.
  • Joe Swedish is the real deal, he will continue to improve the company's operations
  • More Republican states accept Obamacare and actively participate (for example Medicaid expansion). 
But there are risks from possible negative scenarios that can also weight against holding WLP
  • Obamacare enrollment falls to below expectations and causes the enrollment mix to be more skewed towards the sick.
  • The president who takes office in 2017 is Republicans and he repeals Obamacare.
  • Joe Swedish slips and is not as good as the media makes him out to be.
Overall though, I think the negatives are weak and unlikely. The market is still discounting for the uncertainty of Obamacare. The coming years will bring dramatic changes to medical delivery in the US. But still I feel market sentiment is ambivalent towards MCOs. It just isn't sexy. The market doesn't feel it is deep value, and it isn't growth. But who knows, maybe that will change soon. But the positive potentials of gradual but steady growth with all the changes is an opportunity that comes to an industry once in decades, and yet it is so discounted. If the positive scenarios take place as I hope, I think WLP can be $150. So I am keeping my WLP shares.