Friday, September 28, 2007

Are We There Yet for Homebuilders - Part III ?

New home sales were reported yesterday by the government. Aside from the obvious problems with this measure that I discussed here:

It may be a useful exercise to see when this and other metrics bottomed relative to the stock prices of the Homebuilders during previous cycles. New home sales bottomed in January 1991, at a seasonally adjusted rate of 401,000. Months supply of new homes peaked at 9.4 months also in January 1991. This data was not reported until March 4, 1991, due to the lag time in collecting it. Also, at the time that the January 1991 data was released, an investor would not have known it was the bottom until several more months of data had been released. The chart below is a monthly chart of new home sales from 1963 to August 2007.

Lennar bottomed out in Oct 1990, and had risen significantly by March 1991. Other Homebuilder stocks have shown similar patterns of recovery.

The bottom line here is that if you wait until these metrics to bottom as your buy signal, you missed significant upside.

Thursday, September 27, 2007

Are We There Yet for Homebuilders - Part II?

Are we there yet? Are we there yet? My kids yell this in the car all the time. So are we there yet for Homebuilders? Is it time to buy? First here is the damage to some of the Homebuilder stocks since the peak, which for most of the stocks occurred in July 2005.

I am going to spend a majority of my time figuring out when to buy Homebuilders, but for now here's a quick list of what you shouldn't do.

Don't listen to anyone on the sell side. Most of them told us for years that it would be different this time. Remember that tripe? Access to capital, immigration, consolidation in the industry, better balance sheets, yada, yada, yada.

Second, don't rush out and buy because you see a "cult" investor on CNBC talking the sector up, or a rumor hits the wire that another cult investor is buying. In July, rumors hit the tape that Buffett was buying shares of Hovanian. Let's hope he didn't because the stock was at $16 then and its now at $11. Do your own work. Don't blindly follow someone else. You'll feel a lot better afterwards. This does not mean you or I will ever be as smart or as rich as Buffett, but there's nothing worse than losing money because you listened to some talking head on CNBC instead of doing your own research.

I used to be an equity analyst at a bank and my boss wanted to buy shares of Arrow Electronics (this was late 1998). I took a look at the stock and felt like the trough had not yet been reached, and I told him that. He looked back at me with a sneer and said "What do you know that Bill Miller doesn't know."

So I said to myself, "Well why don't you go out and hire Bill fucking Miller as your analyst then." Instead I just looked at him dumbfounded and swore that I would never pick stocks the way he did.

Third, do not use price to book yet as a buy signal. Book value is in flux and will continue to go down quarter after quarter. The safest thing to do is take the latest quarters book value and write off 30% and then slap a .75 multiple on it and then buy them there.

Last, think about avoiding individual stocks and buying the ETF or index that tracks Homebuilders. It is likely that a few of these homebuilders may get into enough distress that the equity becomes worthless. There is a SPDR that tracks the industry under the symbol XHB. It's not a perfect substitute since it has Home Depot and Lowe's in it but it may be a safer option to play the industry.

What a Tool

I just listened to an interview with this tool who doesn't think there was a housing bubble. He uses the word correction. He also repeats the canard that home prices have never declined since World War II.

Mouthpiece for Housing Industry

Wednesday, September 26, 2007

Four Dumbest Things You Can Do on Wall Street

A hypothetical list of some of the dumbest things a newbie might do on Wall Street.

1. Go to the Berkshire Hathaway annual meeting next year in Omaha and during the question and answer period ask the following question in front of everyone to both Warren Buffett and Charlie Munger, “Can you please tell me what your EBITDA was last quarter and what is your earnings guidance for the upcoming year?”

2. Get an internship with Yahoo, and on your first day fly to Dallas and visit Mark Cuban and ask for the $ 4.5 billion back that Yahoo paid for in 1999.

3. Cold call Stephen A. Schwarzman, the billionaire and CEO of Blackstone Group, and offer to consolidate all of his credit card debt into a Capital One credit card with a 0% APR for the first year.

4. Become a sell side analyst covering homebuilders, attend the annual meeting of the National Association of Homebuilders, give the keynote speech and start off by saying you anticipate a brief down cycle because “it’s different this time.”

Scary Chart of the Day

From a presentation at a conference yesterday in New York City.

Tuesday, September 25, 2007

Lennar Earnings Call - No Bottom Yet

I just got off the Lennar call and wanted to share these highlights regarding the housing markets. Management has not yet seen the bottom in the markets they build in.

During the call, Lennar said that they would need to see three things before there is a recovery or stabilization in the market:

1) Inventories of both new and existing homes will have to stabilize first and be absorbed.

2) Mortgage markets will need to settle.

3) Consumer confidence is going to have to be restored.

Lennar said that there was no sign during the quarter that any of these occurred, and that in fact they had deteriorated further during the quarter.

General Market Conditions

“These continue to be very difficult times for the homebuilding industry”

“Current market conditions are primarily defined by the overhang of inventory in those markets which is comprised of completed homes on the ground, spec homes that are back on the market and owned homes that are up for sale. The overriding sentiment in our reviews is that the market has continued to become more and more competitive as inventories are managed and there continues to be a great deal of downward pricing pressure through the use of incentives, price reductions and incentivized brokerage fees."

On Signs of the Bottom

“Overall the supply of homes to sell continues to climb in many of our markets and we are not able to get a good reading how quickly this inventory will be absorbed or whether it will continue to increase as foreclosures increase and add to inventory.”

Mortgage Markets

“Adding to the sluggishness on the demand side is the continuing deterioration of the mortgage market as an additional component of demand has been sidelined.”

“We have not yet seen stability in the mortgage market either.”

On the Arrival of Helicopter Ben

“While the recent cut in interest rates by the federal reserve will began a process of rebuilding confidence it will most certainly not be a panacea for conditions as they exist.”

Monday, September 24, 2007

Wilbur Ross Speaks and You Damn Well Better Listen

I just listened to a great interview with Wilbur Ross on Bloomberg which was brought to my attention by the people at Vinvesting

Wilbur Ross Bloomberg Interview

The interview is 25 minutes long and goes into good detail on the issues of the day, including the sub prime lending fall out, brokerage earnings, the growth of the hedge fund industry and the inherent weakness of quantitative "black box" investing.

Thursday, September 20, 2007

Why I Hate EBITDA - Part III

The street has slowly shifted over time to using Enterprise Value to EBITDA (EV/EBITDA) as a measure of valuation for a stock. The ostensible reason given is that EV/EBITDA takes into account the entire value of the firm. The real reason is that since so many companies are unprofitable, there is no "E" to put in the price to earnings formula. Wall Street had to come up with another measure to use.

So what is wrong with EV/EBITDA? It gives a false sense of cheapness – I can still hear the voice of the sell side analyst ringing in my ear

"The stock only trades at 5 times EV to EBITDA – my god that’s cheap."

But is it really cheap. Here are two companies, which one do you think is cheaper?

Company 1

Mkt Cap $ 60.0
Bond Value $ 40.0
EV $100.0
EBITDA $ 13.0


Company 2

Mkt Cap $ 60.0
Bond Value $ -
EV $ 60.0
EBITDA $ 6.0

EV/EBITDA - 10.0

Well come on Eric, you say to me, the first one is cheaper you idiot. Well look again below.

Company 1

EBITDA $ 13.0
Interest $ 8.0
Free Cash $ 5.0

Price to FC 12.0

Company 2

EBITDA $ 6.0
Interest $ -
Free Cash $ 6.0

Price to FC 10.0

It doesn’t really matter what the EBITDA is because we all know that what really matters is the cash a business produces after it reinvests to maintain its business.

Don't be fooled by EBITDA. Wall Street hates you. Don't ever forget that their job is to separate you from your money.

Tuesday, September 18, 2007

Why I Hate EBITDA - Part II

The second reason I hate EBITDA is a behavioral one. It gives management a crutch to lean on, and causes them to focus on the wrong measures.

“Well, we grew EBITDA last quarter.”

As a shareholder and long-term investor, I want to know what true cash flow you are retaining this year after investing in your business. That’s what counts.

Many companies also create incentive programs for management based on EBITDA - again incentivizing management to engage in deviant behavior.

Friday, September 14, 2007

Why I Hate EBITDA - Part I

I said in a previous post that I was convinced that there is a special place reserved in hell for EBITDA, and that one day, God willing, it will be there. I just wanted to write a little on why I believe that.

First, for those that don’t know the term – EBITDA stands for earnings before interest, taxes, depreciation and amortization. It is used as a measure of financial performance by much of Wall Street. So why does it belong in Hell? It has many problems that are never talked about by the financial media or those who use the term.

EBITDA is calculated before interest is paid, so it gives an artificial view of the financial strength of a company. Analysts and managements love using this number, they usually put it in the headline of a press release. After that they can't leave it alone - it has to be "adjusted." How? Usually to exclude some expense that management found inconvenient.

However, at the end of the day, bondholders do need to clip their coupon every six months and get paid. Unless, of course, they were talked into buying a covenant lite or pay in kind bond.

You can bet that Worldcom and Enron had positive EBITDA...right up until the end.

Thursday, September 13, 2007

The Final Straw

Is it possible that the previously untouchable Manhattan Real Estate market is about to be breached? Hovanian cut its prices on condos in West New York by 20%. Now those of you who don't know New York well may think that West New York is way out in the boonies near the Erie Canal and Niagara Falls, but it is not.

It is right across the Hudson River from the Big Apple, and if you look out the window of the condo you bought that just went down in price by twenty percent, you can see the glittering skyline of the unbreachable New York City market where you better damn well pay what they are asking and be glad to pay it.

New York City is the castle "keep" of Real Estate in the United States, so to speak, and this may be the residual effect of the Hedge Fund melt down the last two months as those bonuses become a trickle.

Struggling Hovnanian Offers Deep Discounts in Weekend Sales Blitz

NEWARK, N.J. (AP) -- Hovnanian Enterprises Inc., struggling like other home builders, is offering six-figure discounts on some of its properties this weekend as it attempts to draw interest in a slumping market. The sales blitz involves dropping prices by more 20 percent on some of its prime real estate. The largest discounts are on the most expensive homes, including a 3-bedroom condominium by the Hudson River in West New York, which has been reduced $240,000, or 22 percent, to $862,000 this weekend.

Full Story

Wednesday, September 12, 2007

Pink Sheets - Part V

I just realized that I need to come up with a more original title than the ones I have been using in this blog. Whenever I write on the same topic, I usually just put Part II or Part III. If anyone has any suggestions let me know.

Anyway, Part V of my slog through the Pink Sheets – or maybe if I could sub title it “liquidity isn’t everything,” has produced a company called Laaco, Ltd. The symbol is LAACZ. It last traded at $1525 a share, and the current market is $1550-$1610. The company is legally a partnership and has a yield around 3%.

Laaco owns several dozen self-storage facilities out West, but its most interesting assets are the Los Angeles Athletic Club and The California Yacht Club.

This is very much a family run operation. I counted six different people with the name Hathaway in the annual report, and a family controlled entity called Stabilty, LLC owns 70% of Laaco. Clearly the family knows what they are doing and have produced shareholder value. It's hard to see it in the chart below, but the stock has tripled the last 5 years.

The lastest annual report is here and is a fairly easy read. Click on where it says filings.

Pink Sheet Page

Tuesday, September 11, 2007

Pink Sheets - Part IV

Once again I have been scratching around the OTC bulletin board and Pink Sheet markets and found some outstanding and financially transparent stocks that deserve a deeper look.

The Burke-Parsons-Bowlby Corporation is a producer of wood products for various industries, including railroads and other industrial segments. It is headquartered in West Virginia and trades under the symbol BPAB in the pink sheets. The Yahoo page is here:

Yahoo Finance

but don’t expect much info there, go to the company web site at:


I contacted the company by e-mail and they never responded so I assumed that another non-reporting pink sheet company was blowing me off, but two weeks later, to my surprise, the latest annual report showed up in my mailbox.

BPAB earned $2.93 in the year ending 3/31/06, and $3.34 in the nine months ending 12/31/2006. It looks like it has grown revenues for five straight years. One third of its sales are to four customers in the Railroad business. The chart below shows what a great investment it has been the last 5 years.

Monday, September 10, 2007

What is Value Investing? - Part III

I think it is generally known how the word Value Investing can be interpreted many different ways by investors. I have decided to compile a list of things that I don’t consider indicative of value investing.

“The stock trades at a historical EV/EBITDA value of 8.1 and now trades at a EV/EBITDA of 7.5. Therefore, it is now undervalued.”

True value investors hate the word EBITDA. It makes their skin crawl. Many investors use the term interchangeably with cash flow, or God forbid, free cash flow. It is a word made up by Wall Street to justify deals and confuse investors. I am convinced that there is a special place in hell reserved for EBITDA, and one day it will be there.

“The stock trades at a PE of 6 while the market is at 15 times earnings.”

A low PE does not always mean that a stock is undervalued. If earnings are peaking, then a low PE actually gives a sell signal. This is why Home Builders had such a low PE for a while. As earnings come down faster than the price, then the PE will soar giving a perverse type of buy signal.

"The PE is at 15 times earnings and it usually trades at a multiple in the 20's, just look at the PE chart."

Is it possible that the earnings that you are using in your denominator are no longer accurate because the company just missed its earnings for the quarter? The new earnings numbers haven't flowed into whatever data source you are using, or maybe the market is assuming that it will be a lot worse than you do? Either way, that PE is realistic.

Wednesday, September 5, 2007

What is Value Investing? – Part II

I think that it is safe to say that when William Ackman, the renowned Hedge Fund Manager that runs Pershing Square Capital, says that Target is “undervalued,” and when Warren Buffett, the equally renowned value investor says that Burlington Northern is “undervalued,” they mean two very different things. And yet both are very successful at what they do and very rich. So who is right?

Ackman is not your typical stereotyped “value investor,” and Target is not your typical stereotyped value stock. Target’s enterprise value is 9.5 times its trailing 12 month EBITDA. Its forward price to earnings is 15.5 times, while it trades at 3.5 times tangible book value. It is not cash rich, holding $550 million in cash, or about $ 0.55 per share according to Yahoo Finance. The performance has been great as well. Target is up 12.3% year to date and has beaten the S & P 500 by 700 basis points.

So what’s going on here? Why is the stock “undervalued?” according to Ackman. Well, in a sense there is the effect of what is known as “cult investing.” When a well-known and successful investor announces that he is buying a stock, the herd moves onto it en masse pushing up the price. Ackman enjoyed that effect as rumors hit the market a week before his filing was done on 7/16/2007.

Buffet and other traditional value investors look for a “great business selling at a great price” in his words. He doesn’t seek to change anything at the company he buys. In fact he wants nothing to change, that’s the entire point. Management usually stays in place.

Ackman wants the company to change, to restructure in some way. Not because it will help the company long term, but because the market will pay more for your company if it looks the way I tell you it should look. For Target, that means sell or spin off your credit card division and try to unlock the value of your real estate somehow. For other companies that are being targeted it might mean something else - sell the entire company, split in two, issue debt and use the money to buy back stock. He doesn’t really care if 2 or 3 years down the road Target is a weaker or stronger company because he probably won’t be a shareholder by then.

I hesitate to say that Ackman is price indifferent to what he pays, because everyone cares about what they pay for something but in a sense he is price indifferent. He creates value at the companies he owns not by making its business stronger or better, but by shuffling parts of the puzzle around. Call it financial engineering if you like. If earnings grow faster than they did before he got there, its not because he helped them become better at retailing, its probably because its share count will decline due to some huge buyback that the company announces. When Ackman sits down with Target management is he going to say that they should work on their merchandising or that they should cut back on the number of SKU’s at their stores?

The Ackman strategy then is this simply put –

1. Find a large cap stock where the market is valuing the stock exactly at what it should be valued at based on the company’s profile.

2. Quietly accumulate a large stake in the company over a period of several months.

3. Leak word on the street that you are building a stake in the company and receive the cult effect.

4. Make your public filing of ownership and send letter to management.

5. Meet with and pressure management to do what you tell them to do to get the stock price up.

6. Wait for management to cave in and see the stock rise even more.

7. Sell quietly in a few months after the general public piles into the stock.

8. Give part of profit to charity but only in years when Hedge Fund manager wealth is getting really bad press.

Now I am not criticizing Ackman for what he does. Everyone has to create value for their investors and if it can be done this way then so be it. I was only trying to demonstrate how two investors who are very different can utter the same word and do it with a straight face.