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August 11, 2011

Graham's Secret to Happiness

Security Analysis
source: Librarity

"I blame myself... for having slipped into an extravagant way of life which I hadn't the temperament or capacity to enjoy. I quickly convinced myself that the true key to material happiness lay in a modest standard of living which could be achieved with little difficulty under almost all economic conditions." - The Memoirs of the Dean of Wall Street


Market

"Financial Turmoil Evokes Comparison to 2008 Crisis" by Nelson D. Schwartz; New York Times

It [now vs. 2008] feels completely different. I don’t think there is a U.S. debt crisis right now, and European debt is not held as broadly as mortgage debt or derivative debt was back in 2008. The prospect of a 2008-like drop in the market is remote. - Larry Kantor, the head of research at Barclays Capital.

"Looking for the bottom" by Buttonwood; The Economist

How does one tell when the markets are cheap?... The best measure is the cyclically-adjusted p/e ratio which averages profits over a decade and pointed to market tops in 1929 and 2000, as well as the early 1980s. According to Professor Shiller, the ratio was 20.7 at the end of last week, whicn makes it around 19.5 after yesterday's fall. That is still above the long-term average of 16.4. The dividend yield is between 2 and 2.5%, on the FT's various measures; even adding 0.5-1% for buy-backs doesn't make that look cheap.

Portfolio:

"Target and the New Frugal " by Michael Shulan; Seeking Alpha

"Target, other retailers deliver solid sales gains" by Thomas Lee; Star Tribune


Life:

"Want to Remember Everything You'll Ever Learn? Surrender to This Algorithm" by Gary Wolf; Wired Magazine

"Is Frugality Dead?" by Robyn Griggs Lawrence; Mother Earth News

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January 10, 2009

American Eagle and Abercrombie: Inventory Foretells Margin Squeeze


Source: Flickr by k-ideas

This holiday shopping season has been dismal for retailers. Retail sales slipped dramatically year-over-year. Luxury sales were most hard hit clocking in at a 35% drop in sales year-over-year while women’s apparel saw a 23% decline. Most retailers resorted to large discounting of their products to move merchandise. One retailer however decided to go against the retail herd and refused to discount any of their merchandise sacrificing sales in the interim.

Video

Abercrombie and Fitch (ANF) considers itself a premium brand in the teen apparel space. The company believes discounting will hurt the brand. According to Chairman and Chief Executive Michael Jeffries in an earnings call with analysts, "promotions are a short-term solution with dreadful long-term effects." Abercrombie’s main competitor in the space, American Eagle Outfitters (AEO), on the other hand has aggressively discounted its products in an effort to move inventory.

I believe Jeffries has a point. In a post the last summer, I suggested Target (TGT) should raise their prices in an effort to match the perception that Target more expensive than competitor Walmart (WMT). Human psychology has us place a higher value on items that are higher priced. Jeffries is aware of this psychology thus believes discounting will erode consumers’ perception they company's tees and jeans are of higher value than their competitors. Even though any casual observer can see Abercrombie’s and American Eagle’s clothing is of the exact same quality.

Generally, I would not have a problem with Abercrombie’s approach. But, if the company is going to successfully execute the no discount policy, they must do a better job with inventory management. Abercrombie seems to have flooded stores with merchandise consumers seem, for the moment at least, unwilling to buy. On the other hand, American Eagle has scaled back on inventory growth anticipating a tough holiday season. Sales and inventory growth for the most recent quarter from the same quarter a year ago are as follows:

Abercrombie’s, as opposed to American Eagle’s, aggressive approach in inventory management is bound to cut into the company's margins. For the most recent quarter Abercrombie has gross margins of 66% and has averaged the same over the last five years. American Eagle on the other hand has gross margins for the most recent quarter of 41%, down from its five year average of 46%.

Operating margins are another story. While Abercrombie sports some very high gross margins, their operating margins are very close to American Eagle’s. In fact Abercrombie’s cavalier attitude regarding inventory management, among other things, has chipped away at its operating margins. Abercrombie’s average operating margins for the past five years were 19% but were only 11% in its most recent quarter. Meanwhile American Eagle’s operating margins for the past five years average 18% but were 13% in the most recent quarter.

Although both companies will see their margins shrink due to anemic consumer market, I would bet you will see American Eagle’s operating margins continue the trend of outpacing the margins of Abercrombie’s in the very near future. Although both stocks are down substantially over the last year, I would expect American Eagle to rebound while I am not too optimistic about Abercrombie right now.

Disclosure: I and the clients of Brick Financial Management, LLC owned share of American Eagle Outfitters and Target at the time of this writing. But positions can change at any time.

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January 02, 2009

Best To Go With The Devil You Know

The stock market ended the year of 2008 posting one of its worst annual price performances ever. The Standard & Poor's 500 index dropped 38.5% for the year marking its worst performance since 1937’s 39% drop in the index. In fact it was the first time the index saw a 30% or more drop in price in those 71 years. So if you survived this year, give yourself a pat on the back.

Investors over the past year made many wrong moves, paralyzed by fear, they drove down stock market prices to unreasonable levels. One bright spot is patient investors could invest in stocks very cheaply. Valuation levels had not been at those levels since the early 1980’s. Although the S&P 500 has advanced more than 20% from its low of November 20th, there remain bargains to be had.  

With so many bargains to choose from, some investors may experience paralysis because of greed. Which stock does one pick? In such an instance, it is best to invoke the spirit of Charles Munger, co-chairman of Berkshire Hathaway. In an Outstanding Investor Digest article some years back Munger was quoted as saying:

“For an ordinary individual, the best thing you already have should be your measuring stick. If the new thing isn’t better than what you already know is available then it hasn’t met your threshold. This screens out 99 percent of what you see.”

Although I picked up a few new positions for myself and my clients’ portfolios, in following Munger’s advice I found that the positions already in the portfolios were of solid companies that were similarly beat down as the market. Every nook and crannie of the market was hurt this year. It couldn't be avoided. And the potential of being hurt further is still present. However, when choosing where to allocate funds, sometimes it is best to go with "the devil you know".

Instead of scouring the investment universe for the new thing, I simply averaged down. The following chart marks the return of a few positions from the beginning of the year to the S&P 500’s low on November 20th and then the return to the end of the year from that November date compared to the market’s return.

 

Although as a group the stock of these companies declined to a similar degree as the market, their rebound so far as been nearly 50% greater. Although it is too soon to say, I believe superior companies will bounce back to a greater degree than the average stock. I think this is what we are seeing in the chart above.

Disclosure: I and the clients of Brick Financial Management, LLC owned shares in all the companies mentioned in this post at the time of this writing. But positions may change at any time.

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August 19, 2008

Note to Target: Raise Your Prices

Credit: http://www.flickr.com/photos/8977773@n00/393332650

Target (TGT) reported earnings today and beat estimates by 5 cents per share. The second quarter (fiscal year 2009) earnings report show the company had made 82 cents per share which amounts to $634 million in profit for the quarter. This might have been better news had estimates not been lowered ahead of Target’s announcement. Given the turmoil in the economy, it is no wonder the company posted its fourth straight quarterly profit decline.

But long term investors in the company should take solace. Target is one of the best-managed and most profitable retailers in the world. It is competitive with Wal-Mart (WMT) on a price basis on most of the items both stores carry, but the typical Target customer earns over $20,000 more per year in income than does the Wal-Mart customer. Right now, in this tough economic environment, customers prefer Wal-Mart to Target based on the perception the latter store is more expensive. There is some buzz on Wall Street the company needs to let consumers know the retailer are just as “cheap” as the competition. However, based on findings regarding human behavior as it relates to consumerism, this would be one of the worst things Target could do. There is a peculiar human trait that wants to believe the more one spends, the more valuable the purchased item is, even if one only perceives he or she has spent more. People value items based on price instead of pricing items based on value. Thus Target has a competitive advantage over Wal-Mart in the minds of most consumers during better economic times.

To illustrate allow me to point to two studies which examine the role price plays in a person’s ultimate purchase satisfaction.  The first study was conducted by researchers at Stanford Business School and Cal Tech. In a blind taste test drinkers were given several glasses of wine priced from $5 to $90 per bottle. The results showed the drinkers preferred the most expensive wine. What the study participants were not told was the wine was exactly the same in each and every bottle.

The second study conducted by Dan Ariely, author of Predictably Irrational, measured people’s reaction to the prices of a pill they were given to mitigate their pain. The pain as it were was delivered via electric shocks administered by the conductors of the study. The result: although the pill was the same for all participants, 85% of the participants who were told their pill cost $2.50 felt less pain while only 61% of those who were told their pill was only 10 cents felt less pain. In the minds of the participant, the more expensive the pill, the more effective it was.

The “predictably irrational” behavior of people at it relates to their wallets has a couple of implications for Target. The company can use this information in two ways. The company could and should raise its prices above similar items found at Wal-Mart. In good economic times, all things being equal, consumers will prefer the perceived higher price alternative thus they will choose Target over Wal-Mart. Although in bad economic times, they may choose Wal-Mart. This actually has some merit as during the 5 year period ending April 2006, a period of economic expansion, Target’s stock clearly performed better than Wal-Mart’s (first chart). However, since then during an economic downturn, Wal-Mart has outperformed.

 

Since this is a counterintuitive approach it is not likely Target will go this route. Thus, if Target is going to continue be price competitive with Wal-Mart, it should market or continue to market itself as Targét (Tarjay) instead of just plain old Target. That way, it will continue to keep its higher earning customers and not lose them because they are not charging enough.

All that said Target remains a great buy at this level, $49.72 as of this writing. Simply based on its earnings potential, it is worth at least $60 per share. Additionally, since selling half its credit card receivables to JPMorganChase for nearly $4 billion in March of this year, it is likely to redirect that money to share repurchases that will serve to further increase the value of the stock. For the quarter, Target has spent $4.9 billion of the $10 billion it plans to spend on share repurchases. And it has a real estate portfolio (it owns the land its stores are on) with a book value of $25 billion and worth at least $30 billion. That represents 75% of its market cap.

Buying in at these levels (not a recommendation; see disclosure) seems like a no brainer.

Disclosure: I and the clients of Brick Financial owned shares of Target (TGT) at the time of this writing however did not own shares of Wal-Mart (WMT).

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April 26, 2006

Wal-mart vs. Target (Rule #1)

Last week I wrote that I would be running a few companies through Phil Town’s criteria for Rule #1 investing. To recap,

Town suggests that the way to adhere to Buffett’s first rule is to look at five different things about a company. They are: 
  • return on invested capital (ROIC),
  • revenue (sales) growth,
  • earnings per share (EPS) growth,
  • equity (or book value) growth, and
  • free-cash-flow (FCF) growth.
He says that we should be looking for companies with at least 10 years of history, and except no less than 10% per year in each of the growth figures. We should also look for companies with an ROIC of at least 10%.

I decided that the first two companies I’d look at would be Wal-Mart (WMT) and Target (TGT). These are two of the major players in the retail industry.

Unless you’re Paris Hilton, you’ve heard of Wal-Mart. Wal-Mart interests me because so much of the value investing community has become enamored with the company. Wal-Mart concentrates its products for very price sensitive consumers, usually in rural and “non-urban” areas. Although recently, the company has made great efforts to expand its operations into more “city-fied” areas. Target on the other hand, caters to a more urban, fashion conscious consumer. Usually, their consumers are a little higher up on the disposable income scale and are less price sensitive.

Full disclosure: Although I (and the clients of Brick Financial) do not own either company, both are on my watch list. My current outfit however consists of socks, underwear and a belt from Wal-Mart and jeans, a shirt and a watch from Target.

Each seeing the other as a threat, they have recently (in the last few years) found themselves competing more and more with one another. Selling products and services designed to poach the others customer base. Will either be successful? Of course, only time will tell.

Here’s how the stocks of the two companies have performed over the last 5 years. [Click on the image for a larger view.]


 

As we can see, over the last 5 years, Target has returned over 40% while Wal-Mart has lost market value. To peer into the reasons why this happened, we need to look at how each company has performed operationally over the last few years. Here is where Town’s Rule #1 criteria may help us. For each company, we collected the figures using MSN Money and listed them in the table below. [For most of the multi-year figures, we used a geometric growth rather than an average growth.]

You should note that if I were doing this analysis for actual investment, I would use each company’s actual financial statements. But in order to keep it simple, and to try and follow Town’s book as closely as possible, I just used MSN.

You should take note of two more things. For the free-cash-flow (FCF) figures, I used the more traditional calculation of cash from operations minus capital expenditures. MSN also subtracts out dividends. Additionally, I included Warren Buffett’s calculation of “owner earnings” which is net income plus depreciation and amortization minus capital expenditures. This is his definition of free-cash-flow. These figures are from the latest annual financials statements. [Click on the image for a larger view.]

 

After looking at these figures, and grading them against Town’s criteria, I would say that each company probably gets a passing grade on the level of a B- or C+.

Wal-Mart averages over 10% in growth for most of the figures except for FCF and owner earnings. These two figures have declined over the last few years. And nearly all of the growth figures have trended downward.

On the plus side, Target’s EPS an equity growth are much higher than Wal-Mart’s and far exceeds Town’s minimums. But its sales growth and ROIC haven’t consistently beaten Town’s 10% floor. Whereas Wal-Mart’s FCF has been declining ever so slightly, Target’s FCF took an astronomical leap in the last year. But I wouldn’t get too excited about that since the previous year’s FCF was so low. (Gotta watch those base year figures.) For the 5 year period, Target only had one year where the company had a positive FCF or owner earnings figure. But the trend in FCF and owner earnings is good, as Target is growing its cash at a faster rate than its capital expenditures are increasing.

From the operational figures, neither Wal-Mart nor Target distinguishes itself from the other (using Rule #1) criteria. Thus, I don’t think these figures give us any insight into why Target’s stock may have performed better over the last 5 years. My guess, without the benefit of looking back, would be that Wal-Mart’s stock was richly valued 5 years ago relative to Target. Or it could be that investors think that Target has a brighter future. Or perhaps, everyone is crazy.

What I also want to know is, at this point, which would be the better investment. I want to know the value investors I admires are raving about Wal-Mart and Target...not so much. This is where the ever important valuation of the companies comes in.

I will explore these points in a future post.

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About Brick Financial Management, LLC

Blogged by Brick Financial

51 JFK Pkwy, 1st Fl. West
Short Hills, NJ 07078
973-486-9860
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Brick Financial Management, LLC is a Registered Investment Advisor specializing in providing investment management services to individuals, families, organizations and institutions. We implement highly focused stock, bond, and balanced portfolios using an investment approach commonly referred to as value investing. Disclosure

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