March 31, 2015

Volatility on the rise

The market's character is changing.

I suspect a market without memory from day to day will be with us for a while, as numerous moving parts to the investment mosaic are questioned by investors, which is something I explored in my opener.

The market is likely to feel more like a casino, with the last-standing program influencing the market action most afternoons. I also suspect, as I pointed out earlier this week, that volatility is rising.

Most of you should be reducing exposure on strength and spending more time sitting on "one's hands." Many (those who are facile) should consider opportunistic trading strategies. Others (who are quick) should buy the dips and sell the rips. That decision is mostly a function of your personal time frames and risk profiles.

Mr. Market is losing the predictability that has characterized it for the past six years.

Welcome to the two-way market. 

March 29, 2015

Be ready for a 10 percent correction

I suspect volatility will rule the day in the months ahead and a period of lower highs and lower lows might be ahead. I would emphasize very few are looking for a meaningful (over 10%) decline in stock prices. So be prepared for downside market surprises. 

That said, I repeat that I have completed work on a number of new long ideas that in a market correction will likely return to buy levels. Be patient; I am.

March 18, 2015

Doug Kass likes Twitter

My channel checks this week have uncovered a surprisingly swift and recent improvement in advertising commitments from current advertisers and a clearer indication that prospective advertisers are poised to adopt Twitter as an important platform in the time ahead. This could serve to be a pathway and important near-term catalyst to a meaningful up-leg in Twitter stock.

Jim Cramer's charitable trust agreed with my call. Action Alerts added shares to the portfolio earlier, noting that while "Twitter is still years behind Facebook as an advertising platform, many advertisers who have come to understand how to properly utilize Twitter's ad platform have seen material improvements in click-through rates, downloads and sales conversions. Advertisers are finding that the targeting of keywords, trends and events is highly effective."

My basic investment thesis on Twitter -- initially expressed prior to its IPO on Real Money Pro in "How Tweet It Is" -- was that the Twitter platform was a powder keg of multiple opportunities, including, but not restricted to, monetizing advertising and video on the company's mobile platform.

I also believed that, despite it relatively high valuation (measured by a lofty market capitalization to sales, cash flow and profit), Twitter's unique social media franchise and first-adopter status could result in the company becoming takeover fodder for any of a number of potential acquirers.

Here was the case, still intact, I made before Twitter's IPO:

Twitter is uniquely positioned in for the mobile delivery of content and advertising.

Twitter reminds me of Web portal America Online during its formative growth period of the early 1990s. Back then, AOL (AOL - Get Report) and CompuServe formed a strong duopoly in the Internet service provider and email spaces. Eventually, CompuServe, which served the technical community and was a wholly owned subsidiary of H&R Block  (HRB), lost market share, and by providing Internet access to the consumer and aggregating information for those who were not very familiar with navigating the Internet, AOL had a dominating position as it exited the decade. AOL's shares rose spectacularly during the period. Today, Twitter is much like America Online was from 1992 to 1995, practically all alone in its monopoly market position.

Twitter holds a first-adopter and monopolistic position.

Twitter has a long runway ahead of it, where it faces limited direct competition. Whereas in the early 1990s AOL and CompuServe held a duopoly, Twitter has the market to itself. There are two obvious potential competitors to Twitter: Facebook (FB - Get Report) and Google  (GOOGL). Facebook is trying, but just can't get there as of yet for real-time. On Google, I don't think the company has any interest in competing against Twitter. According to an exchange I had with BTIG's Rich Greenfield, it feels more like Google wants to be the back-end connectivity of your identity online with Google Plus compared to Twitter as a real-time news source.

Twitter stands in the middle of the evolution of content creation, distribution and discovery.

Twitter is the natural service that follows the 25-year-old tradition of a changing delivery of content creation, distribution and discovery that were previously the property of Web browsers such as Netscape in the early 1990s, Web portals such as AOL and Yahoo! (YHOO) in the mid-to-late 1990s, search engines such as Google in the early 2000s and social networks such as Facebook in the late 2000s.

Twitter is gaining broad acceptance.

A 2013 study conducted by Arbitron and Edison Research found that 44% of Americans hear about tweets through media channels other than Twitter almost every day. As the company expands, so will the breadth of content and Twitter's reach.

America Online's dominant market position led investors toward being forgiving with regard to normal metrics, which might also be the case with Twitter.

Twitter's market presence and outstanding growth opportunities will likely yield a pass on traditional metrics (as relationship to operating results, tangible book value etc. will be thrust aside).

Twitter has a large opportunity to expand its user base.

Similar to America Online in the early 1990s, the key to Twitter's growth will be the opportunity to expand its consumer base. In turn, platform partners will expand their offerings, and advertisers will eye greater opportunities and engagements. According to industry sources, there are 2.4 billion Internet users and 1.2 billion smartphone users vs. only 230 million monthly active users on Twitter.

Back last Fall, Twitter's shares fell from the mid-$50s to the mid-$30s as investors grew impatient with the company's monetization efforts, reminiscent of Facebook's widely-heralded mobile failures, which caused Facebook shares to fall immediately after its 2012 IPO. This provided an unusual entry point. I began buying the stock in late-November/early-December and placed the stock (at $37.50) on my Best Ideas list on Dec. 10, 2014.

But just in the manner in which Facebook engineered a quick recovery in it's mobile efforts (which led to a sharp recovery to the upside in FB shares), I am now getting anecdotal evidence that Twitter is also facing a turn in it's own monetization efforts.  

Finally, back in January, 2015, noted venture capitalist Jason Calacanis made a persuasive case on CNBC (emphasizing many of my points) that Twitter is a unique franchise facing multiple business opportunities. It is a must-view. 

Originally published March 12, 2015

March 16, 2015

Would be short if not for QE world wide

The liquidity provided by the world's central bankers (and its ramifications like historically high corporate share buybacks) has been an essential stock market offset to the deteriorating earnings picture and disappointing progress of the real economy.

More and more cowbell has elevated price-to-earnings multiples, despite 2015 likely being the fourth-consecutive year in which global and domestic real GDP has missed (by a wide degree) relative to consensus expectations.

More indications of the role of liquidity and its impact on stocks has been seen in the last week. Specifically, Friday's hot labor data (pointing to a more immediate hike in the federal funds rate) was the proximate cause for a deep market dive on that day and on the Tuesday that followed.

When weaker economic data (in the form of retail sales) were released yesterday and the tracking estimates for 1Q 2015 were reduced (pointing to a possible delay in the rise in the federal funds rate), stocks roared higher on Thursday.

Bottom Line

But as we look at 2015-16, it seems to me that aggregate profits must grow into valuations in order to justify current stock price levels, as the expansion in P/Es in the face of subpar economic and profit growth seems extreme relative to the corresponding fundamentals. Profits, not growing valuations, must now do the heavy lifting.

Were it not for the unprecedented global easing, I would be substantially short. But, for now, in a free-for-all of central banking easing (which has contributed to plethora of negative-yielding sovereign debt) there continues to be limited natural price discovery in the markets (particularly in the face of deterioration in the real economy) and I am forced to maintain a relatively market neutral position.

A market whose foundation and celebrity are based on global easing is an unsound market and its pricing (of numerous asset classes) is artificial.

Tick-tock, tick-tock.

March 13, 2015

Lord knows I try to bend over backwards to be respectful in my criticism of ideas on Wall Street and in the business media -- when I have a good, logical and analytical reason to disagree.

I just witnessed someone who blew up in the Internet Bubble telling CNBC viewers that we aren't headed for another bubble now.

I have seen everything now. 

March 11, 2015

Doug Kass on Caterpillar stock

Caterpillar is one of the finest examples of a company that "over promises and under delivers." It is also a vivid example of (thoughtless) cheerleading by analysts and in the business media.

Wall Street rejoiced, and CAT's shares traded near $110 after the third-quarter report last November. There was little meaningful forward-looking analysis or questioning of the results at that time by most analysts or by the business media, which seems to worship the company's management (an "honor" that's little deserved).

Caterpillar is another example of a company that buys high (its share price) and sells low (or doesn't buy stock at low prices). Its capital-allocation policy is among the worst in corporate history.

Remember CAT as a possible template in the future when the media and others rejoice in financial engineering in the face of weak top-line growth.

March 4, 2015

Doug Kass on Star Trek actor Leonard Nimoy

We lost a great one. Mr. Spock taught us to be resolutely logical, a theme I try to employ in my diary.

And there are so many other lessons -- even investment lessons -- from "Star Trek."

Rest in peace, Leonard Nimoy. 

March 2, 2015

Doug Kass reviews Warren Buffett berkshire letter

As most of you recall, two years ago I was labelled Berkshire Hathaway's "credentialed bear" and Warren invited me to sit on the dais and grill him and Charlie Munger at the company's 2013 Annual Meeting. 

I spent quite a lot of time researching "The Oracle" and his company (more than two complete months) and I have developed what I think is a relatively singular perspective on Berkshire Hathaway and its founder.

It is from that view that I interpreted today's 50th letter to Berkshire Hathaway's shareholders. 

I am not going to repeat the points here that many of the press have already made and will likely make in the future in parsing the letter. (The Wall Street Journal did a very thorough job already.)

I will highlight the important themes and messages of the letter, exhibit the best quotes, reference an important deficiency in the letter and end this with some personal impressions.

The Letter's Major Messages

There was nothing market-moving about the letter, but there were some important themes, messages (on management succession and growth prospects) as well as terrific history lessons of how to run a large, diversified conglomerate on a tax- and cost-efficient basis.

   - Charlie and Warren distilled 50 years of success into one overriding principle: Buy wonderful businesses at fair prices and don't buy fair businesses at wonderful prices. Like everyone, Warren has the investment scars from buying low-quality businesses at "bargain" prices and he is not afraid to share them with us in this year's letter.
   - Future growth rates, while likely superior to the average corporation, will not be so great in relative terms. Warren writes: "The bad news is that Berkshire's long-term gains -- measured by percentages, not by dollars -- cannot be dramatic and will not come close to those achieved in the past 50 years. The numbers have become too big. I think Berkshire will outperform the average American company, but our advantage, if any, won't be great."

   - Warren and Charlie seem to consider Ajit Jain, the head of the company's resinsurance business and Greg Abel, who operates Berkshire's energy businesses, at the top of the list as Buffett's eventual successor.
   - It will likely be at least another 10 years before Berkshire will be unable to efficiently reinvest its profits and float. At that time, excess earnings will likely be distributed through continued share buybacks (preferable only if it can be accomplished at a reasonable price) or through cash dividends.
   - An explanation of the Berkshire System by Charlie Munger, near the end of the letter, provided the most value-added information and served as a summation of the important precepts that formed the foundation and the many successes at the company.

Something Was Missing in This Year's Letter

There was one big void in this year's commentary.

The letter failed to address the recently-sold ExxonMobil (XOM) investment and the potentially "breached moats," questionable secular business outlooks (my editorializing) and relatively weak share price performance at American Express  (AXP) ,Coca-Cola  (KO), and IBM  (IBM). (I have spent a lot of time in my diary discussing this.)

Some Classic Quotes

Every year the Berkshire letter is populated by some great lines. Here are some of my favorites from this year:

   - "My successor will need one other particular strength: the ability to fight off the ABCs of business decay, which are arrogance, bureaucracy and complacency." (Buffett)
   - "Berkshire's net worth would be at least $50 billion higher had it seized some opportunities it didn't recognize as virtually sure things." (Munger)
   - "The "weirdly intense, contagious devotion" of shareholders, admirers and press played into why Berkshire did so well under Buffett." (Munger)
   - "My leisurely pace in making sales (of Tesco) would prove expensive...Charlie calls this sort of behavior 'thumb-sucking'...Considering what my delay cost us, he is being kind." (Buffett)
   - Buffett became so good at what he does because of an early "decision to limit his activities to a few kinds and to maximize his attention to them... A lot like Roger Federer has done at tennis." (Munger)

   - "Though marginal businesses purchased at cheap prices may be attractive as short-term investments, they are the wrong foundation on which to build a large and enduring enterprise. Selecting a marriage partner clearly requires more demanding criteria than does dating." (Buffett)

Let me conclude by observing, at the risk of sounding like an armchair psychologist, that the letter was sentimental -- full of memories, stories and anecdotes -- reminding me of Betty Buckley's signature song in "Cats."

In keeping with what I would describe as a reflection, it was conspicuously longer than prior letters at 43 pages and 25,000 words, compared with the previous year's 24 pages and 14,500 words.

My impression was that Warren wanted us to quickly run to start reading page 24 ("Berkshire - Past, Present and Future"). Indeed, it is recommended to do so on the top of page three.

His words on pages 24-forward seemed to revel in the reminiscences and, no doubt, in the extraordinary nature of the successes.

It is not hard to understand why. Berkshire's growth over the last five decades has no equal in corporate history.

Per-share book value has risen by a compounded rate of 19.4% annually over the last 50 years. The increase in Berkshire's per-share intrinsic value over the past 50 years is roughly equal to the 1,826,163% gain in market price of the company's share price over the same period.

To me, Warren is finally admitting to gazing at the end of the road and is appropriately relishing in his delicious journey.

In closing, I have read every one of Warren's Buffett's letters on the first Saturday of March over each of the last 50 years, ever since I was a teenager. This year's letter was the most delightful read in years and, in many ways, it was also the most revealing into Warren's character.

The Oracle ended this year's letter on an appropriate note:

"Looking ahead, Charlie and I see a world made to order for Berkshire...Our ambitions have no finish line."