The bull run in stocks with increasing consumer confidence would ordinarily lead to a partial reversal of the significant cost cutting which has been more than partially responsible for the large increase in free cash flows. Typically found is reduction in overhead both during and several quarters out of recession, at which point costs once again flair up. According to McKinsey & Co., only 10 percent of cost reduction programs sustain their results three years on.
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Investors are a superstitious bunch, and with superstitions or inkblots, many see patterns that are figments of the imagination. January effect, summer rally (or doldrums), Super Bowl effect (low scores associated with poor stock markets), Yom Kipper rally, Santa Clause rally, or perhaps even an October massacre, may be in the cards for 2011.
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Anyone who purchases a copy of the acclaimed text, Security Valuation and Risk Analysis
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News from the Federal Reserve last week that balance sheet cash represents 7.4% ($1.9 trillion) of non-financial corporation’s assets presents as much reason for fear as celebration. In fact, the CT Capital credit model may actually penalize firms having excess cash due to: (1) fear it will be unwisely spent; and, (2) balance sheet cash lowering the return on invested capital (ROIC). I much prefer firms invest excess cash into additional opportunities which offer even greater prospective free cash flows (adjusted for its cost of capital)—that is the very essence of a value-producing entity which brings superior returns to shareholders.
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Over the course of the next year we will provide up to date fair values of the equity securities of widely held and in-the news companies.
The analysis will be based on the methodology of “Security Valuation and Risk Analysis” and will only be available (through password) to those who have purchased the text. After January, 1, the cost for a year’s subscription will be fixed at $1000.00 for the year. There will be no extensions and the offer will not be repeated.
We will also publish in this location general stories of interest, for which a purchase of the text is not required.
Please read the interview below to learn of our detailed and leading-edge security analysis-sure to be emulated by others in the years ahead, as was true with my prior text: Cash Flow and Security Analysis
http://www.facebook.com/note.php?created&¬e_id=289434414966&id=97400503724
.
Thanks,
Ken
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The payroll data from the Department of Labor released last Friday suggests economic growth will remain sluggish, despite otherwise suggestions from the recent blip in the stock market. As CT Capital has shown in the past, it is credit, not the level of stock prices that pinpoint turns in the economy—both recession and expansion.
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As I wrote a few weeks ago, I preferred to keep Credit Trends a free site. I was hoping to sell just 100 books from this location, which would just cover the expense of maintainence-unfortunately, this has yet to be the case.
Therefore, effective immediately, all articles which offer an investment opinion on individual companies will require a password and ID. The charge for a yearly subscription is $1,000.00.
Anyone who purchases a copy of Security Valuation and Risk Analysis in the next 30 days, or has already done so, and can offer proof, contact us, and you will be given accreditation. Fill out the “Contact Us” form with your email address and the first word on page 485 of the book. This offer will definitely expire on January 1, 2011.
Kenneth S. Hackel, CFA
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The almost 4% recent decline in the S&P 500 from the close of November 5 (recent peak) thru today could not come at a worse time for firms with underfunded pension plans. The median assumed long-term investment performance, for most firms, is now below the 8% median for the year, and noticeably below for the past 5 and 10 year periods. While the median discount rate assumption, of 5.9%, has seen some minor relief, it is still providing pressure, given the fall in yields during 2010. The discount rate assumption compares with a current 2.77% 10 year treasury rate while annuities hover around 3.8%. Firms may also elect to partially close out its plan thru annuitizing a segment of its population.
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The past few years out-sized swings in the prices of financial securities have been caused, no doubt, by changes to credit and risk, which form the basis of the cost of equity capital. Yet, despite security analyst and investors continued fixation on the quarter up the road’s reported earnings, it is evident it is the ability to create value ( through enhancement of free cash flows) and reduction in cost of capital that should stand front and center for investors looking to enhance their portfolio returns.
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“… to help, or at least do no harm.”
Hippocrates
Investors, without recognizing the implications of their decisions, often sway from the fundamental concept of doing their portfolio no harm.
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What began as a study on sovereign risk (an important element in CT Capital LLC’s cost of capital model) turned in some interesting offshoots. The study was also undertaken because the CT Capital, equity portfolio has a larger than normal (14%) exposure to ADRs and we wanted to uncover the reason(s).
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Credit Trends has become a very popular site. However, we do not accept advertising and there are expenses associated with it’s maintenance
We will decide whether to keep it an open site in the next few weeks
You can help by buying the book to your right-I need just 1% of the daily readers of this service.
If we go to a full subscription site, annual fees will begin at $295 annually. While I am sure it will be quite profitable if we go this route, it is not what we prefer. But its up do you. I believe, as I am told many times, there is no site like Credit Trends.
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If you are disappointed with Wall Street research, you have every right to be.
Learn how to analyze cash flows and risk better than those analysts you see quoted on television-and you can.
Readers will come to understand stock movements they currently have trouble explaining, since significant movements are almost always led by changes in cost of equity capital and the perceived risk to the credit (cash flows). The text explains why entities having a low cash-defined ROIC resulting in small amounts of distributable cash flows are accorded lower valuations despite having higher rates of growth in revenues and/or earnings.
Order today! and you’ll find yourself in a superior analytical position. You can help keep Credit Trends free.
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(The comment below does not constitute an opinion as to the valuation of Honeywell (HON) common stock—only its pension accounting.)
However, for investors who make buy/sell decisions on the basis of P/Es or other accounting conventions, the news out of Honeywell was certainly good. For 2011, the firm, based on information released yesterday, expects to accrue a $200MM expense on its P&L, despite an actual cash contribution into its pension plans of $1 billion. Its shift to mark-to-market helps during periods of rising asset values.
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Honeywell (HON) announced a change to its method of pension accounting whereby it will reflect changes in market value each year instead of the smoothing them, which helped show a healthier plan when market values were declining for Honeywell. Now that market values are rising, Honeywell is desirous of changing its methodology. The company then revised its earlier results in conformity with the changes.
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Taxes are an important focal point of securities analysis due to its scope, size, as well as its direct and measurable impact on cash flows. Taxes impair current and prospective operating cash flows because it is imposed on residual profits, after a series of adjustments and credits; the only question is the degree. Investment projects are always considered on an after-tax basis, considering both the income tax effect and the financing effect. Special tax incentives may also impact the hurdle rate and project return on invested capital (ROIC).
Because taxes are not imposed on its income an enterprise pays as interest to creditors, the income tax system creates a bias in favor of debt financing. This bias often results in the overuse of leverage by some firms, and a greater probability of bankruptcy.
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When Kraft (KFT) released its balance sheet and income statement when reporting its fiscal third quarter last Thursday, it did so without a corresponding statement of cash flows. In its place, including during the ensuing conference call, Chairman Rosenfeld redundantly pointed to operating earnings without a single mention of cash flow, unusual given the heavy reliance by investors on the dividend. Operating earnings do not represent distributable cash flows, among other reasons, it is reported prior to interest expense, which is hefty for Kraft.
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UPS sold $2 billion in long-term bonds to fund its pensions yesterday, raising its total debt/equity to over 100%.
Although UPS is a solid and consistent generator of both free and operating cash flows, we saw that during the credit crisis of a short couple of years ago, even UPS’s fixed income securities could be impaired.
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If equity markets represent the flawless leading economic indicator generally believed, investors should be very comfortable nowadays. After all, the S&P 500 is up almost 12% so far this year. Yet, economists remain generally concerned.
Is it not then unreasonable to ask: Are the glorious headlines trumpeting rising free cash flows portending a sustainable and durable continuation of the economic expansion or perhaps the result of severe cost cutting with a dose of imaginative accounting?
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The province of insurance is often a misunderstood and lightly inspected area of security analysis. It is, however, becoming increasingly important in cash flow and risk analysis in light of rising health care costs, growth in corporate assets, a seemingly higher incidence of natural disasters and lawsuits, and other specialized needs for which insurance is required. This has resulted in the rising use of self-insurance as a cash savings technique.
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Ken Hackel, president of institutional equity manager, CT Capital, and author of Security Valuation and Risk Analysis (McGraw-Hill, 2010), warned about six months ago, of the impending pension liability. Now, as expected, firms with large defined benefit plans are fessing up to the power of the discount rate on the ultimate liability, which is now resulting in stepped-up contributions. Hackel estimates that for many firms, with 10-year Treasury bonds at 2.5%, a further 1% reduction in current yields could very well have the same impact as a 20% reduction in the estimated long-term investment return assumption. When Kenneth first started writing of the liability, a 1% reduction was roughly equivalent to a 15% decline.
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