I awoke this morning to the yawning fear that Congress will change the tax policy, and then change it again, and again, and again. The thought of this Congress changing tax policy - the current Congress - the dysfunctional and partisan Congress said by many executives to be the most divisive in their memories, frightens me.
This Congress has been unable to pass any long term measure; no environmental policy, no energy policy, only a short-term 2-year infrastructure policy. So adding more uncertainty about another long term policy - tax policy - is bound to make matters worse for those planning to make investment decisions. And uncertainty leads to deferred investment decisions, which is a drag on the economy.
The largest investment decisions for most people is buying or renting a car or a home. For Americans in the middle 60% of income - i.e. not the lowest or highest 20% - a home represents 40% to 50% of their entire asset base. And part of the financial decisions of whether or not to buy a home is driven by the mortgage interest deduction. If you borrow money to buy a home, you pay interest on that debt. If you itemize your taxes, you can deduct that interest from your total taxable income, reducing taxes by a few thousand dollars every year.
Individual investment decisions are hardly the backbone of the economy. Private and public institutions and corporations also make investment decisions - decisions to build a road or hospital, a wind farm or a hydrogen plant, a stadium or a condominium - all based on expectations of long term policies. But changing the policy could impact home purchase decisions and therefore the value of the single largest asset for most American families.
And that's the fear, that there will be a change this year, and then next year, and then the year after, as each divisive Congress aims to benefits its principal constituencies. It's impossible for investors to invest over the long term when there is no clear sight on policy.
Municipalities can't build new large infrastructure if they don't know how much federal funding they will receive on their investment. Utilities can't build new power plants if they don't know long-term environmental policy. Chemical companies can't build new processing facilities if they don't know how policy will impact the availability of natural gas.
We can't possibly move beyond an oil or gas-based energy system without a long term 30- or 50-year plan. The so-called Solyndra scandal wasn't a scandal so much for the government's loan guarantees as it was from the lack of any long-term energy policy, which stymied demand for the facilities products.
Businesses will adapt to whatever long term policy you put in front of them. That's what entrepreneurs do. Entrenched businesses fight tooth and nail to keep whatever policies are in place in order to maintain their advantages. Growing businesses aim to change policy so they can grow faster and more profitable in the short term (think Citicorp and Glass-Steagal. With Citigroup laying off 11,000 workers, I'm sure re-instating Glass-Steagal would give current executives the cover to split up their businesses).
But with uncertainty, who benefits beyond the advertisers on the Sunday morning news programs?
This is why Congress needs to get in gear and set some long term rational and realistic policies and let businesses figure out how to profit from them. Unfortunately, until the attitude in DC changes, "long-term" is an election cycle, if not a media cycle. When policies set one year are reversed four years later, businesses can't make rational long-term investment decisions. And without long term investment decisions, businesses will merely lever up for financial not strategic investments.
When Congress can act in the long term best interest of the country to motivate investment in long-term tangible assets - roads, parks, manufacturing, energy processing - then they can refocus on long term intangible assets like life, liberty and the pursuit of happiness, not short-term media-cycle bickering that defines our current leadership.
Thursday, December 6, 2012
Wednesday, September 5, 2012
Sell side research is dead; long live the sell side
The environment for sell side research is distinctly negative. Comments I hear when networking for work: "This is a business in secular decline." ... "Can't sustain the number of analysts with penny per share commissions" ... "the traditional model is broken" ... "all the smart people have moved to the buyside" ... "the sooner this moves to a subscription model the better" ... "regulations have killed the business" ... "correlation has killed the business" ... "high frequency trading has killed the business".
The contrarian in me says this must be best time to go into sell side research, but that's an irrational knee jerk response; the traditional business model, where information is indirectly paid for with trading commissions and banking revenues, has been broken for a long time. Whether or not the sell side requires two high-fixed cost businesses - banking and trading desks - to drive compensation ought to be reconsidered.
Three reasons why there is still value in good sell side research and why it could stand on its own as a subscription model:
1) Incremental information is still valued. It's harder to find - the analyst can't just ask management for it - but that just makes it more valuable. You have to walk around asking for it, everywhere.
2) It's expensive to find incremental information, but it scales well. The buyside, particularly smaller shops, can't afford to do the work. Travel and conferences are expensive. Cultivating sources is time consuming. Tracking projects and performance is tedious. The ability of a good sell side analyst covering one industry as the eyes and ears on the ground, feeling the pulse of an industry, and offering tidbits and perspective, can't be replicated by a buyside analyst covering 10 industries.
3) Sell side could do a better job turning regulations into a marketing point. While a client faces regulatory risk using expert networks, that risk declines using regulated sell side research. When it rains, it rains on everybody so why not sell an umbrella?
Unfortunately, organizations tend to be inherently slow to evolve and risk averse. It is unusual - in fact quite amazing - when institutions, corporations or sports teams, outperform their peers on the basis of good decisions over extended periods. Dynasties are rare. When it happens, its because they evolve, something the traditional sell side model has resisted for far too long.
The contrarian in me says this must be best time to go into sell side research, but that's an irrational knee jerk response; the traditional business model, where information is indirectly paid for with trading commissions and banking revenues, has been broken for a long time. Whether or not the sell side requires two high-fixed cost businesses - banking and trading desks - to drive compensation ought to be reconsidered.
Three reasons why there is still value in good sell side research and why it could stand on its own as a subscription model:
1) Incremental information is still valued. It's harder to find - the analyst can't just ask management for it - but that just makes it more valuable. You have to walk around asking for it, everywhere.
2) It's expensive to find incremental information, but it scales well. The buyside, particularly smaller shops, can't afford to do the work. Travel and conferences are expensive. Cultivating sources is time consuming. Tracking projects and performance is tedious. The ability of a good sell side analyst covering one industry as the eyes and ears on the ground, feeling the pulse of an industry, and offering tidbits and perspective, can't be replicated by a buyside analyst covering 10 industries.
3) Sell side could do a better job turning regulations into a marketing point. While a client faces regulatory risk using expert networks, that risk declines using regulated sell side research. When it rains, it rains on everybody so why not sell an umbrella?
Unfortunately, organizations tend to be inherently slow to evolve and risk averse. It is unusual - in fact quite amazing - when institutions, corporations or sports teams, outperform their peers on the basis of good decisions over extended periods. Dynasties are rare. When it happens, its because they evolve, something the traditional sell side model has resisted for far too long.
Wednesday, August 15, 2012
Churning earnings with a robot
I was recently asked to consult with a company that converts bulk data into "narratives". For example, the company can take a baseball scorecard and it's robot will convert this into a news story about the baseball game.
A financial services client has engaged this company to use the robot to automate sell side earnings reports. The aim is to create reports that sound as if they were written by an equity research analyst, presumably so the client could market analysis on every company on the stock exchange. The company is looking for someone to help make the earnings reports sound more genuine.
All of this raises the question of the value of earnings reports.
Earnings season consumes an inordinate amount of time for sell side analysts. Companies report, sometimes several on the same day, and analysts race to be the first to publish their notes, much of which was already presented in the press release, then call their clients telling them their views and perspectives. Earnings days are long and noisy and the reports feed the information needs of institutional and individual investors as well as the business / media complex that both reports on these things and reinforces their importance.
In the week leading up to earnings, the equity research associates prepare models and write templates for the reports. It is a busy time. So an automated note - to an associate - is something of a holy grail that would allow more time to improve a stock screen, manage a personal account, study for the CFA or buy crap online.
Ahead of one earnings season, I created an automated earnings note that did a reasonable job pulling numbers, rates of change and keywords from an excel file to create simple paragraphs like "Revenues were $180M, up 10% y/y and above our expectations. Revenues were driven by [fill in something management said on the conference call]. Gross profit was 10%, 180 bps above our expectations and up 40bps y/y. Profit was driven by [fill in something management said on the conference call]."
The system worked, but raised the question; if I can automate it, what value does it actually have?
We live in a time when capitalism, consumerism and technology have all converged to rapidly convert anything into a commodity. This goes equally for things like electronic goods, healthcare and information. But what retains value over time, will - as always - be things that are rare, unusual and hard to replicate. In the case of the equity analyst, this includes hard to find information and perspective, on a company, an industry, a management or a strategy.
I haven't decided if I'm going to work with this company or not. On one hand, it would allow dumb banks to convert their research staffs into robots, further shed staff and reduce comp, but still provide "equity research". On the other hand, maybe it would allow analysts to focus on value added research like independent sources, useful and unique surveys, interesting correlations and industry perspective, all in a highly regulated environment that adds value and reduces risk for clients.
Either way, I would remind the robot that just as owning a knife doesn't turn anyone into a chef, so automated earnings reports would not turn it into a sell side analyst.
A financial services client has engaged this company to use the robot to automate sell side earnings reports. The aim is to create reports that sound as if they were written by an equity research analyst, presumably so the client could market analysis on every company on the stock exchange. The company is looking for someone to help make the earnings reports sound more genuine.
All of this raises the question of the value of earnings reports.
Earnings season consumes an inordinate amount of time for sell side analysts. Companies report, sometimes several on the same day, and analysts race to be the first to publish their notes, much of which was already presented in the press release, then call their clients telling them their views and perspectives. Earnings days are long and noisy and the reports feed the information needs of institutional and individual investors as well as the business / media complex that both reports on these things and reinforces their importance.
In the week leading up to earnings, the equity research associates prepare models and write templates for the reports. It is a busy time. So an automated note - to an associate - is something of a holy grail that would allow more time to improve a stock screen, manage a personal account, study for the CFA or buy crap online.
Ahead of one earnings season, I created an automated earnings note that did a reasonable job pulling numbers, rates of change and keywords from an excel file to create simple paragraphs like "Revenues were $180M, up 10% y/y and above our expectations. Revenues were driven by [fill in something management said on the conference call]. Gross profit was 10%, 180 bps above our expectations and up 40bps y/y. Profit was driven by [fill in something management said on the conference call]."
The system worked, but raised the question; if I can automate it, what value does it actually have?
We live in a time when capitalism, consumerism and technology have all converged to rapidly convert anything into a commodity. This goes equally for things like electronic goods, healthcare and information. But what retains value over time, will - as always - be things that are rare, unusual and hard to replicate. In the case of the equity analyst, this includes hard to find information and perspective, on a company, an industry, a management or a strategy.
I haven't decided if I'm going to work with this company or not. On one hand, it would allow dumb banks to convert their research staffs into robots, further shed staff and reduce comp, but still provide "equity research". On the other hand, maybe it would allow analysts to focus on value added research like independent sources, useful and unique surveys, interesting correlations and industry perspective, all in a highly regulated environment that adds value and reduces risk for clients.
Either way, I would remind the robot that just as owning a knife doesn't turn anyone into a chef, so automated earnings reports would not turn it into a sell side analyst.
Tuesday, August 14, 2012
The analyst as philosopher and fisherman
A stock picker is a bit philosopher and a bit fisherman. A philosopher in respect to the search for "truth" (ie. value) and a fisherman in respect to finding value in a sea of stocks.
Just as the rod does not make the fisherman, neither does a degree in finance, CAPM or excel make one a stock picker. It's easy to forget - in the age of "one size fits all" tools like CAPM - that value, truth and fishing are also highly personal.
Just pretend CAPM isn't susceptible to changes in expectations, like what future cash flow looks like, and its a tool that works everywhere!
Or not.
In my opinion, the individual styles of value makes the markets much more fascinating. What investors will pay for growth or value, as a multiple of EBITDA, EPS, free cash flow, square feet, RevPAR, etc is all a private choice, based on comfort and expectations, and it changes over time.
A detailed model is nice, and anyone can calculate odds with reasonable certainty but - I know this goes in the face of truth seekers everywhere - common sense, an understanding of management's strategy, a few years of 10Q's, K's and proxy statements is more then sufficient for a stock picker to succeed.
Except for one thing; every few years new technologies come around that disrupt the industry. ETF's and high frequency trading are doing to the stock picker what trawling and draglining has done to fisherman.
In a proximate sense, HFT obviates fundamental methods and raises the cost of business for those who want to keep up and grow assets as quickly (get a bigger boat).
For now, therefore, I think it's inevitable that stock pickers will lose market share to the index funds.
But as the the pendulum swings towards undifferentiated buying, it might in fact put a premium on those stock pickers who stick to their knitting, deeply understand businesses and industries and know how to acquire them at low prices with low correlations to the overall market.
In short, investors seeking differentiated ideas and differentiated returns will have to search a little harder for differentiated stewards of their hard earned capital.
My long held philosophy - and many others' - is that the costs of buying shares of publicly traded companies will always be lower than the costs of replicating said businesses on my own so I make my business looking for other great businesses run by great managers doing interesting things profitably and I buy their shares when I think they are trading at reasonable prices, owning them as part of my own business, growing with them as they grow, keeping part of the cash flows or simply waiting for others to recognize the underlying value.
It is a long term approach but it is my harbor and haven from the turbulence of undifferentiated programmatic trading and ETF indexing.
It's hard to fish in a storm tossed sea but having a portfolio of great businesses run by great managers doing interesting things profitably and acquired at low valuations will be a steady boat through all conditions.
Just as the rod does not make the fisherman, neither does a degree in finance, CAPM or excel make one a stock picker. It's easy to forget - in the age of "one size fits all" tools like CAPM - that value, truth and fishing are also highly personal.
The philosophy behind CAPM is quite incredible and my disdain for it is not without recognition for what it aims to achieve; an objective definition of value. It tells the truth! ... not based on the "eye of the beholder" or a comparative valuation analysis or a historical study of multiples, but on the present value of future cash flows, discounted back at some rate.
Just pretend CAPM isn't susceptible to changes in expectations, like what future cash flow looks like, and its a tool that works everywhere!
Or not.
In my opinion, the individual styles of value makes the markets much more fascinating. What investors will pay for growth or value, as a multiple of EBITDA, EPS, free cash flow, square feet, RevPAR, etc is all a private choice, based on comfort and expectations, and it changes over time.
A detailed model is nice, and anyone can calculate odds with reasonable certainty but - I know this goes in the face of truth seekers everywhere - common sense, an understanding of management's strategy, a few years of 10Q's, K's and proxy statements is more then sufficient for a stock picker to succeed.
Except for one thing; every few years new technologies come around that disrupt the industry. ETF's and high frequency trading are doing to the stock picker what trawling and draglining has done to fisherman.
In a proximate sense, HFT obviates fundamental methods and raises the cost of business for those who want to keep up and grow assets as quickly (get a bigger boat).
For now, therefore, I think it's inevitable that stock pickers will lose market share to the index funds.
But as the the pendulum swings towards undifferentiated buying, it might in fact put a premium on those stock pickers who stick to their knitting, deeply understand businesses and industries and know how to acquire them at low prices with low correlations to the overall market.
In short, investors seeking differentiated ideas and differentiated returns will have to search a little harder for differentiated stewards of their hard earned capital.
My long held philosophy - and many others' - is that the costs of buying shares of publicly traded companies will always be lower than the costs of replicating said businesses on my own so I make my business looking for other great businesses run by great managers doing interesting things profitably and I buy their shares when I think they are trading at reasonable prices, owning them as part of my own business, growing with them as they grow, keeping part of the cash flows or simply waiting for others to recognize the underlying value.
It is a long term approach but it is my harbor and haven from the turbulence of undifferentiated programmatic trading and ETF indexing.
It's hard to fish in a storm tossed sea but having a portfolio of great businesses run by great managers doing interesting things profitably and acquired at low valuations will be a steady boat through all conditions.
-- END --
THIS IS NOT A SOLICITATION FOR BUSINESS OR A RECOMMENDATION TO BUY OR SELL SECURITIES.
THIS IS NOT A SOLICITATION FOR BUSINESS OR A RECOMMENDATION TO BUY OR SELL SECURITIES.
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