Slice and Dice

Top 140. Aug 22, 2005 9:17 AM

» Normxxx - Re: Re: Re: Re: Question for Bob

In response to Re: Re: Re: Question for Bob posted by Kirk:

For example, a big move in MSFT might not show up in QQQQ right away so the hedge funds go long MSFT and short QQQQ, or vise versa, until the premium or discount vanishes.

This is at risk arbitrage and thousands of computers are combing the markets each day (mostly from brokers— not hedgies, who need bigger differences to make out) to find and 'close' such differences. It is the major reason the markets stay so efficient despite the current prevalence of 'program' and index trading, which tends to ignore any actual change in intrinsic stock value.

So, as usual, the brokers get to s___w the public both ways; when they create the "hole" through program trading and when they subsequently close it.

-- posted by Normxxx

Top 141. Oct 30, 2005 6:18 AM

» BoltonCT - Interest rates and inflation rising

Bob Brinker's manners were much better this week. He seemed fairly content that the stock market would bounce because the GNP was increasing at 3.8% and unemployment was not that much worse after Katrina. DUH?

Think about it, Bob said the current market is OK because a coincident indicator and a lagging indicator are OK! OK, then if we follow his advice we will have a bear market for six to twelve months before Bob Brinker tells us to sell.

He did recognize yesterday that the housing market has peaked only eight months after more informed analysts told us. Hopefully you sold that investment property eight months earlier! The real estate downturn typically goes at least three years and typically drags many banks into the red. So within three years bank mergers and bailouts will be needed again.

The greatest problem the stock market faces is interest rates. If the long term rates rise too quickly there will be a sudden sell off of stocks. If they rise slowly the stock market returns will be flat. Either way the average stock market fund will have close to zero returns for a few years before inflation. Inflation adjusted stock market returns will be negative. To make matters worse the market will react badly as inflation continues to accelerate.

On the other hand, treasuries and I-bonds are safe and guarantee returns … some even higher than inflation. Therefore investors, especially retired investors with larger stock portfolios will move out of stocks putting further pressure on the stock market.

So you can see stocks are not very attractive right now even if you put on blinders as Bob Brinker does and try to navigate by looking backwards at the wake the economy is leaving. Bob will crash you on the reefs using his navigating tools. Then he will blame someone else again. It won't be Alan Greenspan this time. I am betting Bob Brinker's bad advice is the fault of George Bush next time.

Lagging long term rates, a crises of confidence in the executive branch (1987 Oliver North), a real estate decline, and impending future bank failures (in three years) are all similarities today with the 1987 market panic.

-- posted by BoltonCT

Top 142. Nov 5, 2005 6:03 AM

» SteveT - Where the Buys Are

Is this an indication it is time to look at rebalancing?

MONDAY, NOVEMBER 7, 2005

Where the Buys Are
Interview with Rudy Kluiber and Greg Fraser
By SANDRA WARD

YOU KNOW SOMETHING is blowing in the wind when a couple of small-cap-stock devotees start seeing better bargains among big-caps. Kluiber and Fraser head Boston-based GRT Capital Partners and oversee about $500 million in client money. Since starting their hedge strategy in 2001, the two -- Kluiber was a former star manager of State Street Research & Management's Aurora Fund and Fraser was a hot quantitative stockpicker at Fidelity Investments -- have racked up gains of 12% a year, on average. This year, through Oct. 31, their careful research and attention to valuation has resulted in a 5% advance. Right now, they hope energy, truck parts, chemicals and fingerprints are the secret to more success.

Barron's: Describe the conditions in the stock market.

Kluiber: We view the environment as in-between.

Meaning?

Kluiber: We don't find many inexpensive stocks. With the economy reasonably healthy and earnings pretty strong, that's probably what we should see. But we are not finding a lot of new ideas. That being said, we always find interesting things. And over the past three or four weeks, we have a lot more things to look at.

In certain industries?

Kluiber: It is more of a rifle shot: individual names that declined for specific reasons. At the moment, we do not own many consumer stocks, but they've come off and so we are taking a look there. We don't own a lot of technology stocks, but there have been one-offs that have run into problems, and so we are beginning to look there. But we can't say we've come to any strong conclusions or are adding a lot of names in those areas. It is frustrating, and it is going to continue to be a frustrating market. In general, most stocks are fairly valued.

Fraser: On the short side, we are looking for ones with deteriorating fundamentals and that are overvalued.

The small-caps and mid-caps you focus on have had a great run. Is that part of your problem finding stocks?

Kluiber: We are beginning to look at some of the larger companies because the valuations are more interesting. Some of the ones we're looking at have traditionally been known as growth stocks, but now they are trading closer to market multiples and maybe even below. They are becoming value stocks, even though they are classically known as growth stocks. Whether it be a Disney or a News Corp., or Citigroup or Bank of America, these larger names are getting more interesting.

What else are you seeing in the investment landscape?

Kluiber: In the past three or four weeks, we've had a tremendous correction in the energy stocks, and the question becomes: Is this the beginning of a downtrend or is this a severe correction after a hard run up? We're in the latter camp and believe there is still value in energy. It certainly is going to be volatile. The fundamentals on a lot of our stocks haven't changed. But the prices are moving up and down more.

How big a position did you have in energy stocks?

Kluiber: We've been slightly overweight in the energy and basic-material stocks.

What's your outlook for the oil market?

Kluiber: We certainly are not experts in terms of day-to-day pricing of oil, natural gas and coal. But we do believe that as long as the world economy stays reasonably strong, demand will continue to grow. As we've seen, it has been very hard, despite all the drilling and exploration, to replace reserves. I can't say whether oil will be $40, $50 or $60 or $70 or $80. But the stocks are discounting much lower commodity prices and many of the companies are demonstrating very good financial discipline at this point in the cycle, which we view positively.

What about the overall financial health of the consumer? And the direction of interest rates?

Kluiber: That is a reason why we are not in housing stocks and we are underweight the consumer. Interest rates are a factor. They are going to work their way through and hurt the consumer. Energy prices will also hurt the consumer and, on the margin, there is some inflation that's going into end products that may ultimately hurt the consumer.

Fraser: Rising rates will definitely hurt because so much more mortgage debt has been converted into variable rates and is tied to the equity consumers took out of their homes over the past three years. About 40% of households are living paycheck to paycheck. Certainly those people are exposed and people who have equity lines of credit are exposed. You see how the lower-end consumer is being squeezed in the Wal-Mart sales numbers in the past year.

What companies are you interested in right now?

Kluiber: Massey Energy [ticker: MEE] is one. Massey Energy is a mid-cap coal company focused on Central Appalachia. Like a lot of energy stocks, Massey has been very volatile. But in the low 40s, we like the risk-reward profile of the investment. We continue to be bullish on coal. Earnings should increase to around $4 in 2006 and something north of that in 2007. Most importantly, Massey should start to generate strong free cash flow in 2006.

Why are you bullish on coal?

Kluiber: We think the coal stocks are in a multiyear up cycle. Coal is one of the solutions to our dependence on foreign energy. The U.S. has very large reserves, and at today's prices coal is about a 60% lower-cost energy source per BTU than natural gas. The utilities, which are the main users of coal, are not happy to pay higher prices for coal. But relative to natural gas, coal still looks like a bargain to them. There are a lot of coal-fired plants being designed and put into place. That will spur demand for coal going forward. And they are adding a lot of scrubbers to make the coal less high-sulfur.

Isn't Massey being targeted by some hedge funds that want it to take on more debt and buy back stock?

Kluiber: Yes. Several hedge funds are advocating that Massey leverage up and buy back stock. Massey has chosen not to do it at this time. We believe that in 2006, if the fundamentals of the coal business continue to be as they are, Massey will do something to return money to shareholders. Up to this point, they have been investing in equipment mostly, in building a couple of new mines. Massey is one of the few coal companies that will be increasing production over the next several years, going from the low 40s to the high 40s in terms of millions of tons produced.

What are the risks here?

Kluiber: Massey has had some operational difficulties, such as a shortage of miners, mine problems and high costs. If these continue, it puts the earnings estimates at risk. Another risk is if they don't use their capital efficiently. In 2006 there will be significant free cash flow, but they have to use it wisely. Finally, the big picture for the coal cycle could change if there is a collapse in the energy markets or a severe recession.

Greg, do you want to jump in with a stock pick?

Fraser: I'll talk about a big-cap company we are getting involved with, ConocoPhillips [COP]. It is just too cheap. Wall Street's earnings estimates are $9 this year and $9 next. We think next year's number looks more like $10 to $11 a share. It is trading at seven times this year's estimate and about six times next year's or thereabouts. It has about $90 billion of market value. That's bigger than we normally invest in, but the value is so compelling.

Why is it so cheap, especially with so much excitement about energy?

Kluiber: They don't have a strong growth profile in their production.

Fraser: They are targeting production growth of about 3%, and that doesn't get people too excited. But if you look at the free cash they will generate, they don't really need huge production growth. One of the other risks, and one reason it might have such a low multiple is, as with all these large international oil companies, it has operations in some unstable places. They have an operation in Venezuela and they're also a 13% shareholder in [Russia's] Lukoil. Both of these operations are working very well currently, but this could be a concern.

One of the nice things about ConocoPhillips is that they've historically struck a good balance in using some of their cash to reinvest in the business, but have used cash to give returns to shareholders, either through dividends or share repurchases. We are long-term bullish on the refining sector, and they are one of the largest refiners in North America. The pure-play refiners like Valero Energy are at higher multiples than all of ConocoPhillips. That implies you are getting the refining part of the business very inexpensively.

What are the risks?

Fraser: The two main risks are that oil prices fall sharply or they have a big political problem in Russia or Venezuela.

What else do you like?

Kluiber: A truck-parts company: Accuride [ACW]. It just came public in April. This company has been around for a long, long time, but is newly public. It is a leading supplier of truck parts -- wheels, brake drums and seating systems -- to both the OEMs [original equipment manufacturers] and the aftermarket. Earlier this year, Accuride acquired Transportation Technologies Industries, making it a bigger and stronger supplier. With the merger, there are opportunities for cost savings and synergies over the next several years. Management estimates savings of about $25 million by 2007. The stock trades at roughly six times total enterprise value [stock-market value plus net debt] to Ebitda [earnings before interest, taxes, depreciation and amortization] and the truck cycle is still reasonably strong. We feel there is room for the stock to appreciate.

I thought maybe the merger was a comment on the companies' view of the cycle.

Kluiber: The merger was just opportunistic. There are a number of ways to win with Accuride. It can use its free cash flow to continue to pay down debt. This is a highly leveraged company, but I think that they can support the debt. By realizing their projected cost savings over the next couple of years, they will be able to improve earnings. And third, they can continue to make accretive tuck-in acquisitions. Given the current valuation, the estimates for this year are about $2 a share; for 2006, about $2.50. At $12 to $13 a share, it is certainly not an expensive stock.

Are there concerns about the impact of oil prices on trucking or about the shortage of truck drivers?

Kluiber: That's not the biggest concern.

It has fairly high financial leverage. We don't think it is much of an issue because they are paying down the debt and they've got very good cash flow, but it is something to be aware of, particularly in a rising rate environment.

How high is high?

Kluiber: They have about $700 million of debt and about $200 million of estimated cash Ebitda, so it is leveraged at 3½ times. It is not outrageous. Another reason why the stock is so inexpensive is that 2007 is predicted to be a down year for truck builds because of a changeover in emissions and engines. But we feel that is priced into the stock and that Accuride has some new programs ramping up that should mitigate that downturn.

What's next?

Fraser: Ashland [ASH], a chemical company. It's a turnaround with new management. They have a new CEO, James O'Brien, who is very dynamic and has really cleaned up the businesses and made it a less complicated company. It has revenues of over $8 billion. It is a diversified chemical company. It also has a road-paving and construction sector. Within the chemical sector, they have Valvoline, a competitor to Jiffy Lube, and a distribution business. The current Street estimates look very low in terms of ultimate earnings power. A couple of its segments aren't doing great right now. Valvoline, for instance, has had down earnings, but that's temporary, in our view.

The segment that has the biggest potential upside in the short term is the transportation and construction part. On the one hand, they are making all the asphalt and the paving materials, and then on the other hand, they are bidding on jobs. Historically, on their construction side, they have probably been a little too lenient on pricing, and one of Jim O'Brien's mandates has been to fix that. The asphalt and paving segment, on an operating-profit basis, had been losing money in the recent past. But they think they can deliver 10% to 15% operating margins in the next few years. That could contribute $1.50 to $2 a share in incremental earnings per share. But I want to stress that this is a turnaround and this could be a three-to-four-year process.

Anything else about it that excites you?

Fraser: Another big change has been in the financial structure of the company. It used to have a lot of debt, and when they monetized the refining assets with Marathon, they completely cleaned up the balance sheet. That will give them options to either repurchase shares or do a more aggressive dividend or something along those lines. Where the rubber meets the road on this one is that, while the Street is at $3.25 in earnings for next year, we think they can get to $3.75 or $4 a share. Their earnings power in the out years is even higher than that. One of the nice things about turnaround stories, when they work, is that they continue for a number of years.

How about a short?

Fraser: Cogent [COGT]. They make automatic fingerprint-identification systems that compare literally millions of fingerprints in a database in a matter of seconds. We have no quarrel with their technology. We think their technology is very good, and they've done a nice job. The real issue is that the Street is overestimating the size of the market. Their customers are basically government customers. Whether it is a large national organization like the Department of Homeland Security or a large county law-enforcement agency, as of the last 10(K) less than 1% of the business was commercial. Whenever the government is your biggest customer, it results in lumpy order flow. Also in 2004, two customers accounted for 82% of the business. About 44% of the business was with the Department of Homeland Security and related agencies. And 38% of the business was with the National Electoral Council in Venezuela, also known as CNE. Also, this is basically a capital-equipment company, which means there is not that much recurring revenue. They have to constantly win new large accounts. Once they get these fingerprint systems installed, there is some modest maintenance revenue, but it is very modest. You can't build the valuation the company has on the maintenance revenues. And it has a very large valuation.

How large?

Fraser: The market cap is about $2.5 billion. They have about $300 million of cash, so call it an enterprise value of $2.2 billion, and that's for expected revenues in December 2005 of $166 million. I'm giving them the benefit of the doubt this year and it still trades at more than 10 times revenues. Next year, the Street has revenue expectations of $231 million on average. If you read the 10(Q)s, you see that they still say that only two customers account for a very large part of the business. In 2006 or 2007, it will be a challenge to replace the National Electoral Council's business. As a homeland-security play, from time to time it gets really hyped up. But 9/11 occurred four years ago, and a lot of the estimates people had for this sector haven't come true. There is reasonable spending growth in it, but it is not exponential, though the valuations suggest it is. There are existing competitors, and from what we can tell, a lot of newly funded venture-capital competitors entering the space. While they do have good technology now, someone can come up with a better mousetrap down the road.

Are the competitors hurting them?

Fraser: Some of their existing competitors are NEC, the big Japanese conglomerate, Motorola and Sagem Morpho, which is a huge French company. The point is when there are viable competitors, it is going to be harder to maintain the margins they've been getting.

Thanks, gentlemen.

E-mail comments to editors@barrons.com
URL for this article:
http://online.barrons.com/article/SB1131...

-- posted by SteveT

Top 143. Nov 5, 2005 2:54 PM

» bob90245 - Re: Where the Buys Are

In response to Where the Buys Are posted by SteveT:

Is this an indication it is time to look at rebalancing?

Well, let's take a look at the Coffeehouse Portfolio YTD. Values are price change only (without dividends).

Symbol . . Shrs . . Paid . . Last . . Value . . Allocation VFINX . . 8.957 . . 111.64 . . 112.56 . . $1,008.20 . . 10.0% VIVAX . . 46.838 . . 21.35 . . 21.76 . . $1,019.19 . . 10.1% NAESX . . 37.286 . . 26.82 . . 27.96 . . $1,042.52 . . 10.4% VISVX . . 71.582 . . 13.97 . . 14.46 . . $1,035.08 . . 10.3% VGTSX . . 79.365 . . 12.6 . . 13.63 . . $1,081.74 . . 10.7% VGSIX . . 53.248 . . 18.78 . . 19.1 . . $1,017.04 . . 10.1% VBMFX . . 389.484 . . 10.27 . . 9.93 . . $3,867.58 . . 38.4% . . . . . . . . . . . . . . . . Total $10,071.34 . . 100.0%

-- posted by bob90245

Top 144. Nov 5, 2005 6:04 PM

» Kirk - Re: Re: Where the Buys Are

In response to Re: Where the Buys Are posted by bob90245:

Without dividends, you are only up 0.7% YTD. How or why would you calculate a rebalance without dividends?

-- posted by Kirk

Top 145. Nov 5, 2005 6:56 PM

» bob90245 - Re: Re: Re: Where the Buys Are

In response to Re: Re: Where the Buys Are posted by Kirk:

How or why would you calculate a rebalance without dividends?

My table was just something quick-and-dirty that I track via a portfolio I set up on Yahoo Finance. (If you know of another portfolio tracking website that includes dividends, let me know.) Of course, reinvested dividends should also be included in one's rebalancing decision. However, with the exception of REIT and bond funds, reinvested dividends are not so significant on a year-to-date review.

In reviewing the table, one thing that stands out to me is that the Coffeehouse Portfolio is pretty much flat YTD. Hardly worth the bother to tinker with rebalancing at this point.

-- posted by bob90245

Top 146. Jan 7, 2006 6:09 AM

» SteveT - Ditching the Monkey

By ERIC J. SAVITZ

FOR A JOURNALIST WHO SPENDS MOST of his time trying to ferret out alluring stock ideas and smart stockpickers, a trip to the Santa Monica, Calif., headquarters of Dimensional Fund Advisors poses certain philosophical challenges. DFA's approach to managing money starts with the idea that stock-picking is basically futile.

You can go to its office to admire the stunning view of the Pacific, but you won't walk away with brilliant investment ideas; DFA's members consider the whole stock-picking exercise a waste of time. So, it doesn't try to hire market-beating portfolio jockeys.

The way DFA executives see it, as a result of chance there always will be managers who beat the market, but there's no way to identify them. Sure, there will be a new Bill Miller or Peter Lynch, but seeking them before they do their thing is like trying to pick out which of a million touch-typist monkeys accidentally would produce Hamlet.

IF THERE'S NO POINT in picking stocks or funds, you can only conclude that reading about stock picks and "must-own" mutual funds is a waste of time, too. Rex Sinquefield, DFA's co-founder and just-retired co-chairman, has famously derided the kind of prognosticating that's the stock-in-trade of this and other business magazines as "financial pornography." Given all this, I might have been tempted to ignore DFA, if not for one fact: Its funds have been cranking out remarkably high returns.

With more than $84 billion in assets under management, most of that in stocks, 25-year-old DFA is built around the theories of Eugene Fama, a University of Chicago economist who is perhaps the leading proponent of the "random walk" theory. Fama, in essence, argues that the market's efficiency at discounting information makes it largely impossible to beat over the long term by picking stocks. Sinquefield and co-founder David Booth, who studied with Fama at the University of Chicago in the 1970s, were among the earliest proponents of index funds, or "passive investing."

The two started DFA in the spare bedroom of Booth's Brooklyn Heights apartment. The fledgling firm had trouble getting New York Telephone to install six new phone lines in his apartment. Recalls Booth: "They thought we were bookies." Their first product was the DFA 9-10 Fund, named for its focus on companies that, ranked by stock-market value, were in the market's ninth and last 10ths.

That fund evolved into DFA's micro-cap fund; the spare bedroom in Brooklyn eventually gave way to the swanky offices by the sea. But the firm still ardently preaches the efficiency of the market. DFA's execs compare active money managers to socialists: both groups, they say, refuse to believe in the marketplace's power.

SINQUEFIELD DERIDES "BEHAVIORISTS" who theorize that markets offer anomalies that can be exploited by those with the best information. "They have no over-arching theory," he scoffs. "They have a lot of ad hoc stuff based on empirical irregularities. If you look hard enough, you find patterns in the data. But they're not real." What's worse, he adds, "The average individual is really persuaded by all this stuff, and then asked to make decisions he can't possibly make well."

Argue with Sinquefield if you like, but there's no debating DFA's results. The two flavors of its flagship DFA U.S. Small-Cap Value Fund (tickers: DFAVX and DFSVX), for instance, rank in the top 20 of more than 1,700 general-equity funds in average 10-year returns, according to Morningstar.

So, even though DFA argues that you can't produce returns that beat the average mutual fund, it's done exactly that. But its success involves keeping fees low, being tax-efficient and investing with an eye on the only investment factors they believe can lift returns. Fama and his frequent collaborator Kenneth French, a Dartmouth finance professor, focus on small stocks, rather than large ones, and value, rather than growth. Both approaches, they assert, provide excess returns. (They define value stocks as those with a high book value-to-price ratio, a variation on low price-to-book.)

The firm starts with a simple screening procedure that begins with market capitalization. It sifts out stocks for procedural reasons, eliminating those with fewer than four market makers, for example, on the theory that it will be hard to get competitive pricing, while also avoiding companies in obvious financial distress, and shunning IPOs.

That still leaves plenty to buy: Their small-cap fund owns 3,000 stocks. For active managers, it's hard enough to run a fund with hundreds of names, let alone thousands. It's easier for DFA because it spends no time doing things like meeting corporate managements, listening to quarterly conference calls, or creating earnings models. DFA has taken 5%-plus positions in more than 500 companies, but without any real consideration for what any particular one does.

Recently, a reporter called DFA Vice President Weston Wellington to ask what the firm might think about takeover talk brewing over theme-park operator Six Flags, for which DFA is the biggest institutional investor, with a nearly 9% position. Wellington says he replied that DFA hadn't looked at the situation, hadn't talked with Six Flags, and wasn't going to spend time trying to figure it out. His advice: call someone else.

Where DFA does invest energy is in aggressively seeking to buy positions by acquiring large blocks of shares at negotiated prices below the market. Dimensional also uses only fee-based financial advisers to sell its funds. It doesn't want investors who will jump in and out of the market. In fact, DFA requires its distributors to attend a two-day "boot camp" that lays out its academic underpinnings. It wants to do more than sell you a fund and collect a management fee; it wants you to believe that the right way to invest isn't the way most people do it.

"We don't proselytize," says Wellington, who handles the firm's communications with financial advisers, giving them, among other things, regular presentations on terrible market calls made in the financial press, this magazine included.

"Our view is, people have to be ready to hear this story. When you've decided it's not so easy to ID winning stocks or managers, then come have a chat with us, and we'll explain why you would expect this outcome more often than not."

What they don't want is people lured by the historic returns who don't understand why the system works -- and where the risks lie.

How to explain the Internet bubble, for instance? "Sure, I can look back and say it appears it might have been a bubble," Wellington says. "But could you have told me when it was going to burst? Most people who said we were in a bubble had been saying the same thing in '96, and '97, and '98, and '99. If someone got into the market for the first time in January 2000, I feel sorry for him. But over a 10-year cycle, people did fine. If you couldn't get your money out, I'm not so sure it was an inefficiency that you could have exploited."

Adds Booth: "The proof comes in the returns. We're like one giant test of market efficiency. And I can't think of any region of the market where active management has had better returns."

So why don't other people invest this way? "For one thing," Booth says, "people are over-confident. If you have a large group of people in a room, and ask them if they are above-average drivers, about 80% will say yes. In the financial markets, over-confidence leads to trading too much. We all have feelings, opinions and hunches." At the end of the day, he says, "you can't distinguish professional money managers from the universe of orangutans."

Indeed, based on DFA's record, investors have to wonder whether they'd be better off if they stopped trying to pick the next smart monkey.

E-mail comments to editors@barrons.com

URL for this article:
http://online.barrons.com/article/SB1136...

The Bottom Line
Sure, DFA often knows little about the companies in which it invests. But the firm's record shows there's a rewarding method to what some would consider its madness.

-- posted by SteveT

Top 147. Jan 7, 2006 7:51 PM

» bob90245 - Re: Ditching the Monkey

In response to Ditching the Monkey posted by SteveT:

This was lazy journalism. If I was the journalist, I would have asked more probing questions.

1. Passive investing isn't exactly unique. For example, couldn't the returns have been duplicated at Vanguard?

2. There are pros and cons for forcing individual investors to enroll with an affiliated DFA advisor. Wouldn't the return advantage of DFA funds get eaten up by fees paid to the investor's financial advisor?

-- posted by bob90245

Top 148. Jan 10, 2006 9:57 AM

» pbradford6 - Re: Re: Ditching the Monkey

In response to Re: Ditching the Monkey posted by bob90245:

Great questions that deserve to be answered.

-- posted by pbradford6