Bill Gross Speaks! + Sears (SHLD) + A [Book Review]
Bill Gross’ latest investment outlook allows me to flatter myself and wonder if… ahem … great minds think alike (don’t I wish). But seriously, his latest commentary hits directly on a couple of topics I have been pondering myself for some time.
The first is multiple compression in equities. Gross mentions a prospect I’ve discussed before: perhaps the markets of the last 20-30 years have been the anomaly and we should expect action more reminiscent of prior decades. See Gross’ various charts for a graphical depiction of the above.
I’ve stated before that I avoid valuing stocks using multiple estimates (i.e. XYZ is worth $50 based on projected 2009 EPS of $5 and putting a 10 P/E multiple on it); rather, I value stocks based mainly on the underlying discounted free cash flows and/or net asset value. While this may suggest I needn’t worry about where the market values earnings, it also means that cheap stocks can get much, much cheaper. The worst position for a value investor to be is out of cash as stocks get marked down to ridiculous levels.
Also, it pays to keep in mind Whitman’s premise that an investment is not profitable until you get paid. Always be on the lookout for what he calls “the bailout” (i.e. your payoff). If stocks are going to be devalued, companies better find a way to send earnings to shareholders (and preferably not through buybacks, which “bail out” exiting shareholders, not existing ones).
The other interesting point Gross makes in passing is that, in so many words, the risk/reward ratio leans toward moving up in the capital structure. If you’re bullish on a company, instead of buying its equity, take a look at its debt or preferreds. Corporate yields in some cases are offering attractive returns comparable to equities.
For instance, take perennial value investing darling, Sears Holding (SHLD). Having dropped to the mid $30s or so from near $200, there could be a lot of upside if the shares recover. But you can also find SHLD debt yielding over 20%, even for short-term debt.
Keep in mind, this is not a recommendation and I have no position in SHLD or its debt (nor have I reviewed the terms of its debt which may contain unattractive provisions). But it does illustrate the shifting risk/reward dynamics for corporate investment. For SHLD shares to recover to $100, much less $200, a lot of things have to go awfully right for the company. For bondholders to earn attractive 20%+ yields and get their principal back, Sears just needs to stay out of the worst-case scenarios. Even then, debt is higher up on the capital structure and with SHLD’s brands and real estate assets, bondholders could recover some of their principal (once again, I have not researched SHLD in-depth so this is only an educated guess).
Interesting times, indeed, and in light of Gross’ outlook and my recent plunge into bond research, I am posting my review of his first book back from my old site. It was one of my favorite investing books even back when I didn’t really consider bond investment. It is probably worth re-reading at this point, even though it deals mainly with investing in a low-volatility environment which is decidedly not what we’re dealing with now.
Highlights
- Shows how to THINK ABOUT INVESTING as opposed to providing rote formulas that will probably be misused
- Good brief overview of the yield curve and what that means for bond investing
- Great discussion on strategies for investing in low-volatility rate environment
- Enlightening discussion of the implicit “put” options in mortgages and corporate issues and how to take advantage of them
- One of the most human and enjoyable financial books I’ve read
Weak Points
- Will disappoint those looking for a bond investing “playbook” or formula
- Doesn’t discuss in-depth strategies for high-volatility rate environments
- A bit dated in some aspects
- Retail investors may not be able to apply these strategies without significant capital
December 2nd, 2008 at 3:08 pm
Regarding bonds, it’s interesting that the current issue of Grant’s recommends convertible bonds, and gives a few examples of how buying distressed convertible issues can get you a bargain price on a stock. My concern is with the dollar.
With the colossal expansion of credit we’ve seen, why would anyone want to hold dollars?
December 2nd, 2008 at 6:30 pm
Well yes, but if not dollars what? The Euro countries are not any better off in the long run than we are. Reminbi? I don’t think so. That leaves gold, but gold did not behave as it should based on the simple logic of the past. So, I tend to agree with Dawy regarding bonds or convertibles. However, they need a lot of research, and some of the financial data is not reliable, especially for financial institutions.
December 2nd, 2008 at 6:38 pm
I’m also worried about the dollar but it’s hard for me to accept the utter doomsday scenario as people like Jim Rogers have presented it. It seems to me that major transitions such as the loss of the US$ hegemony would take years, maybe even another decade or two, as well as major war or similar physical catastrophic events. So I’ve always leaned toward a more balanced strategy of moving to bearish dollar assets but still having some exposure.
Then again, 2011 could be the year it all craps out.
December 9th, 2008 at 6:46 pm
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