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Spinoffs: GE, Johnson & Johnson

I wrote this past week about corporate spinoffs, which are all the rage these days. In a spinoff, a company takes a division or two and hands it to its shareholders, creating a brand new public company. The new company usually doesn’t fit in with its new owners, which can be a very good thing for patient investors.

Funds will own, say, a bank, and now they have a small insurer or whatever and sell its shares. But the managers of the new insurer are suddenly even more motivated as they have stock options and a lot more upside if its shares do well. The famous value investor Joel Greenblatt wrote a gem of a book largely about spinoffs, You Can Be a Stock Market Genius.

As with lots of things in investing, though, the magic has faded. Investing in spinoffs used to be a formula for very good returns, but lately they have lagged. The problem might be too many people reading the same statistics and also too many activist funds pushing companies to split apart for no good reason. With both General Electric and Johnson & Johnson announcing split this past week, I asked whether these latest attempts would create more than some initial excitement.

Breaking apart a company can, in theory, unlock value. Corporate spinoffs as an asset class have done well historically. Value investor Joel Greenblatt highlighted the opportunity for the masses in his book “You Can Be a Stock Market Genius.” Several studies using data from the 1990s through the middle of the last decade have shown that a portfolio of spinoffs can beat the market by 10 to 15 percentage points in the year after they go public. Managers of a newly public company are more focused and valuations often rise to reflect those of peers. But there are catches. One is that investors have to hold on to the spinoff to reap the rewards, and many don’t. Initial selling pressure on spinoffs often creates opportunities for even more outperformance once a new shareholder base is established. But the spinoff secret is out. Activist investors now push companies to reshuffle the deck chairs to generate short-term stock-market gains. Trian, the fund that took a stake in GE in 2017 with disastrous timing, applauded Tuesday’s move.

Columns · investing

Aching Backs = Big Bucks

Sometimes a fairly small company that I know will otherwise fall through the cracks catches my eye. The latest one is “The Joint,” a fast-growing chain of storefront chiropractic clinics. I learned a lot in the process of reporting it, most of it about the business of franchising rather than the iffy science of back “adjustments.”

The chain had been on a rocket ship ride with its stock up by 3,000% since the current CEO took over in April 2016. Then it took a tumble on a short-seller’s report. I don’t think that the report blew the lid off of a flaky company, as some reports do. But it correctly pointed out that the stock was pricing in some unrealistic growth.

Probably the most analogous company, and one most readers will know, is Massage Envy. Its founder was CEO of The Joint for a while and he sold Massage Envy in 2008 when it was still in its growth phase. It has been stalled for the past decade or so.

Will this do better? Back pain is a big problem, but The Joint has lots of imitators like SnapCrack and Chiro Now with similar no-insurance, subscription-based formulas. It has around 1% of the overall U.S. market and is the biggest storefront player so there is plenty of room to grow. Unfortunately, its revenue opportunity isn’t as big as it seems because clinics charge a lot more and offer more services. The Joint’s market value of $1.2 billion already assumes it will snatch a large share of a pretty big pie at more than 100 times projected earnings for 2023 when its management thinks it will reach 1,000 stores.

Some stores’ impressive profits represent in part an owner-operator’s sweat equity. For both the occasionally underemployed practitioners and their patients, a storefront’s simplicity has been appealing compared with high-pressure clinics. If one views the chain as being at the very early stages of disrupting its sector and assumes that its head start will make it the McDonald’s of back pain then its valuation could be a bargain. But if it is more like another Massage Envy then the stock’s price and its future cash flows are seriously misaligned.

“Aching Backs Equal Big Bucks, but an Adjustment Looms” WSJ, October 16, 2021

investing

“Unwoke” Investing

The hottest thing in investing these days is using ESG criteria (environmental, social, and governance). Count me a skeptic. Yes, I have seen studies showing that, for some specific period, such funds have outperformed the market. They usually are funds that have avoided fossil fuels during a particularly bad stretch for energy companies or are loaded up with tech stocks during a really good period.

Should you be forced to invest in a company that conflicts with your ethics? No, I guess not, but then investing in a fund isn’t the same as giving a company money. On the other hand, if you really want to put your money where your mouth (and wallet) is, why not make as much money as possible and then give it to a cause of your choice?

Let’s say that ethically and religiously focused funds, which reduce the number of possible companies in which you can invest, will do just as well over time as a fund that owns the whole stock market. The fees they charge you for doing that will still eat into your return, which is why ESG is a brilliant marketing concept but not such a smart way to invest.

But you know what really isn’t smart? I read today in the Wall Street Journal that Trump allies are now getting into the fund management business to promote “Unwoke” funds.Pictured up top is Kevin Hassett, the co-author of Dow 36,000. Just a reminder that this book came out almost 22 years ago and the Dow hasn’t hit that milestone yet, so caveat emptor. Below is the description of the criteria behind their “Society Defended ETF.”

With respect to the 2nd Amendment Score, the base score will increase for monetary donations that support the right to bear arms or decrease for monetary donations that support gun control laws based on the dollar amount. The degree to which companies provide direct or indirect support to organizations which support gun free zones, support of gun control legislation, oppose stand-your-ground-laws, oppose concealed carry, support banning of firearms or refusal to do business with the firearms industry, and related advocacy groups or legislation will lower their 2nd Amendment Score.

Let’s just leave the gun control debate out of this and look at dollars and cents. If the companies, which I guess you could call anti-ESG, also do just as well as the market then you are paying unnecessary expenses to own the libs. At 0.75%, this fund charges you 0.7 percentage points more than a very low cost index fund. If the market goes up by 8% a year for the next 40 years then a $10,000 investment today would be worth nearly $50,000 less than in a plain vanilla fund. So if you love guns, or whales, or hate coal, or whatever, my recommendation is to just make the best investment possible and then get a nice tax-deduction at the end for contributing part of your windfall.

Columns

Not Quite Supertankers

One of the more overused clichés is “it’s like turning around a supertanker.” As a landlubber, I’ll go ahead and assume that’s true in the literal sense. Financially-speaking, though, the business of hauling oil across the world certainly turned on a dime in the past year. Daily earnings collapsed by 99% from last March to the past week as carriers capable of holding two million barrels became very expensive floating storage tanks when there was a glut and are suddenly hunting for cargoes as big exporters try to buoy prices.

Jinjoo Lee and I wrote about the dramatic turn. Our takeaway was that things are looking up for this extremely cyclical business.

A year after their incredible good fortune, an equal basket of four energy shipping firms has lagged the S&P 500 by 70 percentage points over the past year and is right back to its long-term average ratio of price to book value. With life and energy demand returning to normal, this is no time for investors to walk the plank.

https://www.wsj.com/articles/not-so-supertankers-deserve-a-look-as-pandemic-fades-11615815253
Columns · investing

The Curse of Star Managers

I edit more and write less these days, but even when I do write I often forget to link to it here. I’ll try to be better in 2021.

One thing I wrote recently generated an unusual amount of reader email, split about 40-60 between congratulatory and outraged. I said that star fund managers are to be avoided and I used the example of Cathie Wood, whose main exchange traded fund at ARK Invest grew assets by 1,000% last year and gained nearly 160%. She bet big and won on hot stocks like Tesla and biotechs that benefitted from Covid-19 speculation.

I am apparently a misogynist or don’t understand her genius or both. Anyway, the evidence is pretty strong that jumping on the bandwagon once a fund manager graces magazine covers isn’t a great idea whether that manager has a “Y” chromosome or not. You can read more about managers like Ken Heebner and Bill Miller in my book.

The column starts out with a “famous last words” puff piece from The Motley Fool titles “Move Over, Warren Buffett : This Is the Star Investor You Should Be Following.”

So read the headline on a year-end article from retail investing advice site Motley Fool touting the performance of fund manager Cathie Wood. Variations on the “Buffett is done” theme have been around since at least the tech bubble, while the cult of star mutual-fund managers goes back to the 1960s. Such commentators have eventually eaten their words.

Ms. Wood is a savvy businesswoman, but is she a savvy investor? Stock picking skill is very rare and even harder to discern when the manager is riding a hot category. In a bull market propelled by dumb retail money, everyone is a genius. It takes many years to establish whether success is random. And, as I point out, star manager’s performance is often worse than random on the downside. The most promising active funds are those that lagged their peers recently or got a low rating from a firm like Morningstar.

Fund managers are often compared with dart-throwing monkeys. That might be too flattering for those who get the most attention. Hot funds’ performance is often worse than random on the downside. A regularly updated study on the persistence of investor performance from S&P Dow Jones Indices shows that just 0.18% of domestic equity funds in the top quartile of performance in 2015 maintained that through each of the next four years—less than half what one would have expected by pure chance. And of course most actively managed funds lag behind the index to which they are benchmarked because of fees and taxes.

Anyway, the tone of the emails has made me more convinced that some investors in “disruptive innovators” have lost touch with reality. Congrats if you were early — the fund’s performance is pretty impressive (see chart below) — and be careful if you were late.

Columns · investing

Bear Markets

With apologies to Stanley Kubrick, I titled my latest Heard essay “How I Learned to Stop Worrying and Love the Bear Market.

It sounds a bit flippant at a time when so many people are seeing their nest eggs melt down on paper, but the message is important. Retail investors lag the market significantly because of timing errors and the biggest mistakes are made at junctures like these. If the 20% bounce from the coronavirus-fueled low turns out to be a dead cat bounce then it will stoke further pessimism and cause people to either sell or to have less of their wealth in risky assets such as stocks once the eventual turn comes.

I’d love to tell you when that turn will be, but I can’t and neither can anyone else. The important thing to remember, though, is that if you were comfortable having, say, 70% of your nest egg in stocks when the Dow was knocking on the door of 30,000 then you should feel the same way at 20,000 or (gulp) 15,000. The richest gains of the next bull market (no, I don’t think this recent bounce was the start of one) probably will come early on. They always have before.

For example, if you put $100,000 into a plain vanilla U.S. index fund at the very start of the last bull market in March 2009 and had sold at last month’s peak then you’d have $630,000 including dividends. If you had decided to wait three months to make sure it wasn’t another false alarm then you’d have just $450,000.

Bad times are surprisingly good. If you could go back in a time machine and buy stocks at the bottom of every bear market of the past 90 years but had to sell as soon as a recession had officially ended then your annualized return would be a whopping 64%. You would never have lagged the market’s long-run return.

And what if you really can’t sleep at night? Well that’s okay – Covid-19 is enough to worry about! But then you should do one of two things. One would be to dial back the risk you take permanently – no cheating the next time everyone around you is getting rich on pot stocks or whatever the next fad will be. You’ll be that much older and closer to retirement then anyway. The other would be to entrust your money to someone else like a reputable fee-only adviser or a robo-advisor like Betterment or Wealthfront and just check it as infrequently as possible.

Why should you (sort of) like bear markets? Because they’re the time when your attitude can make you a superior investor. Everyone is a genius in a bull market, but tough times are when your mettle matters – no finance degree or superior IQ required. When those glossy brochures from a brokerage firm tell you that the long run return of stocks is 9.6% or whatever, those returns include bear markets that have seen portfolios cut in half or worse.

That’s my usual spiel, which you can read about at length in my book as well, but it’s when I finish giving it and emphasize that nobody on Wall Street knows anything that someone inevitably asks what I think about the market anyway.

I used to get paid a lot to tell people which stocks to buy. Now I get paid a more modest sum to write and edit articles about the same thing. It doesn’t mean you should listen to me about what or when to buy. But, for whatever you may think it’s worth, I’m pretty pessimistic at the moment. If I hold to form then I’ll still be pessimistic when the turning point is reached and we all should be buying stock funds like crazy.

Columns

Cruise Companies Will Get Decked

I wrote about the cruise industry. There are often disasters or mishaps like the 2012 Costa Concordia accident or the Carnival “poop ship” in 2013 that produce temporary bargains for people brave enough to pounce on a cheap vacation deal or stock. The latest scary quarantines may be different, though.

There are threats aside from the immediate epidemic. The fact that the quarantines have occurred in Asia may do permanent damage to China’s embrace of cruising in what Carnival management has said it believes will grow into the world’s largest cruise market. About 4.24 million, or 15% of cruise passengers, came from Asia in 2018 according to the Cruise Lines International Association.When cruising was in its infancy in the U.S. it received a warmhearted P.R. boost from “The Love Boat” TV show that ran from 1977 to 1986. To would-be cruisers from China’s emerging middle class, scenes of ambulances and quarantines are leaving a far less heartwarming image than jolly Captain Stubing.

investing

Billion, trillion, schmillion

Don’t tell you know who, but, by some measures, the $2 trillion valuation of Aramco only puts it in fairly middling company.

Saudi Arabia’s de facto ruler Mohammed bin Salman wanted to see his country’s crown jewel, Saudi Arabian Oil Co., or Aramco, valued at $2 trillion. Market reality got in the way and he had to settle for a mere $1.7 trillion in last week’s initial public offering, which also was limited to regional investors.

But the first day of trading Wednesday saw the shares limit up—a rise of 10% on the local Tadawul exchange. Another performance like that—and strong social and financial incentives not to sell make that a distinct possibility—will see the sought-after $2 trillion mark breached.

Looked at another way, though, the company’s value is absolutely pedestrian. Aramco’s 1.5% free float means shares owned by the public are worth only $28 billion. By contrast, Microsoft and Apple have floats worth $1.08 trillion and $1.06 trillion, respectively, if one excludes insiders.

In the energy world, North American exploration and production companies Occidental Petroleum, Marathon Petroleum and Canadian Natural Resources are all larger on this metric. Super major Exxon Mobil has a float worth 10 times as much as Aramco at nearly $300 billion.

Now that is a princely sum.

Columns · investing

Buy the “Wrong” Stock, Hit the Jackpot

I wrote about the phenomenon of tech stock doppelgängers showering riches on people who can act quickly, but mostly parting fools from their money.

Zoom Technologies is carrying on a long American tradition: making people rich by accident.

Not to be confused with Zoom Video Communications, a unicorn that went public in April, making its backers truly wealthy, the similarly named penny stock appears to have benefited from mistaken identity. A $1,000 investment in late March would have been worth over half a million dollars by mid-April. Even now, assuming one were able to find a buyer, it would be worth $175,000.

Zoom joins the likes of doppelgangers Tweeter and Snap Interactive. Similarly confusing episodes happened in the last tech bull market. For example, penny stock Appian Technology surged by nearly 19,000% because it shared a ticker with a hot initial public offering on Nasdaq, AppNet, in 1999.

Of course all of these scenarios enriched people already owning the shares of the “wrong” company, and only if they acted quickly. Buyers fooled by similar names or tickers usually regret it. Not always, though. Mistaken buyers of food company Sysco back in March 2000—when red-hot Cisco Systems briefly the world’s most valuable company—have made 571% since then compared with a loss of 12% by owning the “correct” stock.

Columns · investing · journalism

Making Monkeys out of Hedge Fund Stars

The darts don’t lie

So we decided a year ago to poke some fun at the masters of the universe who unveil their stock picks each year at the Sohn Investment Conference . My team and I decided to throw darts at stock listings and see how things panned out. It was a blowout.


No animals were harmed in this financial experiment, but some human egos were bruised.
Burton Malkiel famously wrote in “A Random Walk Down Wall Street” that “a blindfolded monkey throwing darts at a newspaper’s financial pages could select a portfolio that would do just as well as one carefully selected by the experts.” A year ago the journalists at Heard on the Street decided to see if they could beat the crème de la crème—fund managers presenting their stock picks at the annual Sohn Conference in New York.
The results were brutal. Heard columnists, not monkeys, threw the darts at newspaper stock listings, but Mr. Malkiel would still approve. The columnists’ eight long and two short picks beat the pros’ selections by a stinging 27 percentage points in the year through April 22. Only 3 of 12 of the Sohn picks even outperformed the S&P 500.