Herd Behavior

  • 23 Jul
    HAS beats Street estimates, but its 12% overnight jump is a Red Herring

    HAS beats Street estimates, but its 12% overnight jump is a Red Herring

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    Before the market opened this morning, toymaker Hasbro, Inc. (HAS) released its report of second quarter results, and the numbers prompted the market to push the stock up in a big way early in the trading session. After closing a little below $94 on Friday, the stock opened Monday’s trading session at nearly $105 per share and pushed as high as $107 in the early hours of the day. The report must have been really great, right? Well, not so fast.

    One of the interesting things about the stock market is watching the way it reacts to company reports. All things being equal, when a company can demonstrate that their business is growing, their stock should go up, and when it is shown that business is contracting, the stock should also go down. Of course, all things are not equal, and that means that the market, being an emotional animal, treats stocks differently. Sometimes the market’s immediate reaction is about something entirely different than whether a company’s business is growing or shrinking. Hasbro’s price action today is a pretty good example.

    Analysts and investors alike like to try to predict what a company’s report is going to look like. They analyze and measure all kinds of information and data and try to make their own educated guesses about what is going to happen. With HAS, one of the factors that everybody has been trying to account for is the effect that the collapse of U.S. toy store Toys ‘R’ Us, which of course was one of the toymaker’s biggest customers would have. Analysts had anticipated a drop in revenue of a little more than 14% versus the same quarter in 2017, and earnings to decline by more than 45%. Revenues actually declined by 7%, less than half of what was expected, and earnings only dropped by about 9.5%. Seeing both of those numbers come in better than expected led the market to respond with high enthusiasm. Clearly, the market seems to be treating the news as an indication that the effect of the liquidation of Toys ‘R’ Us was much less than expected.



    I’m not saying that the news in this case isn’t positive; being able to minimize the impact from a negative event like a major customer’s complete and utter collapse is a mark of strong management. But does it justify sending a stock 12% above its current price in a single day? That’s where my red herring reference comes into play. The market has always seemed to prefer to draw any kind of silver lining it can from news to drive a stock’s price higher, but the problem is that immediate boost often puts average investors at a disadvantage and increases their risk. The people that stand to benefit most clearly from that early surge, of course, are the investors that were already holding shares of the stock; but the probability any chance the stock will keep going up is less likely to be about emotion and more about the stock’s fundamentals.

    One of the short-term risks about jumping into a stock that is making a big overnight jump based on a news headline comes from the size of that overnight jump. If you’re an investor or trader that had the good fortune to buy HAS at any point in the last month or so when the stock was languishing in the $85 to $94 range, seeing the stock jump up more than $10 per share overnight would certainly be exciting; it would also automatically make you think about selling your shares back to the market to lock in that gain. That is exactly what I think a lot of folks are going to be doing in the next day or so; and while it isn’t a given that is going to drive the stock lower, the odds that it will drop are much greater than that it will keep going up. I’ll quantify exactly how much downside risk I think there is in that scenario later in this post. For now, let’s dive in into whether or not the stock should worth the $100-plus share price it carries at the moment.



    Fundamental and Value Profile

    Hasbro, Inc. (HAS) is a play and entertainment company. The Company’s operating segments include the U.S. and Canada, International, and Entertainment and Licensing. From toys and games to content development, including television programming, motion pictures, digital gaming and a consumer products licensing program, Hasbro fulfills the fundamental need for play and connection for children and families around the world. The Company’s U.S. and Canada segment is engaged in the marketing and sale of its products in the United States and Canada. The International segment is engaged in the marketing and sale of the Company’s product categories to retailers and wholesalers in most countries in Europe, Latin and South America, and the Asia Pacific region and through distributors in those countries where it has no direct presence. The Entertainment and Licensing segment includes the Company’s consumer products licensing, digital gaming, television and movie entertainment operations. HAS’ current market cap is $13.3 billion.

    • Earnings and Sales Growth: Over the trailing twelve-month period, earnings declined almost 77% while revenue dropped about 16%. Over the same period, HAS has operated with a very narrow margin profile of less than 5% that was actually negative over the last quarter.
    • Free Cash Flow: HAS’s free cash flow prior to the last quarter was healthy, at about $497 million. The company has about $1.1 billion in cash and liquid assets, a number that declined from almost $1.6 billion in the quarter prior.
    • Debt to Equity: HAS has a debt/equity ratio of .98 as of the quarter prior to today. Total long-term debt in the most recent was about the same, at about $1.64 billion.
    • Dividend: HAS pays an annual dividend of $2.52 per share, which translates to a yield of about 2.36% at the stock’s current price.
    • Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for HAS is $12.58 and translates to a Price/Book ratio of 8.47 at the stock’s current price. That is quite high, well above the industry average of 3.2 and its own historical average of 5.22. A move to par with its historical average would put the stock at about $66 per share – more than 38% below the stock’s current price. I believe this is a pretty fair evaluation of what the stock’s long-term, fair market value should be. For a value-based investor, the stock would have to drop to at least this level before it would merit serious consideration.



    Technical Profile

    Here’s a look at the stock’s latest technical chart.

    • Current Price Action/Trends and Pivots: The dotted green line highlights the stock’s upward trend, dating back to early April. The stock has shown good bullish strength from this period, increasing about $10 per share before this morning’s big break higher. I’m using the dotted blue line for a couple of things. First, before today this was the stock’s most likely strong resistance level, and today’s clear break, with a huge gap between Friday’s close and this morning’s opening price above it is a clear technical indication of the stock’s current bullish momentum. The line is also useful when thinking about investor behavior as it relates to overnight gaps. Since gaps like this translates to large, unexpected but happy gains for people who bought in before the jump happened, it isn’t unusual to see an increasing in selling immediately after the gap, as profits are taken and locked in. An abundance of technical study suggests that gaps tend to fill themselves, which means that a bullish gap like the one we’re looking at now is very likely see the stock drop back down in the near term. One technical theory that I think has good anecdotal evidence behind it suggests the stock should fill approximately half of the distance covered by the initial gap. The blue line, sitting right around $99 per share, is right in that price area, and is further bolstered by repeated pivot highs in that same range, in February of this year and multiple points in 2017. That puts the stock’s minimum immediate downside risk in the $6 to $7 per share range now – far above what any near-term upside forecast is likely to be.
    • Near-term Keys: If the stock stabilizes in the $99 to $100 range, that could be a good indication the stock will push back to test the high it set today around $106 per share, which could offer a good signal for a short-term swing trade using call options or buying the stock outright. A break below the $99 support level should put you on notice to watch to see if the stock will find support along its intermediate trend line around $93. A break below that level would mark a reversal of that upward trend, and could easily see the stock drop all the way to the $83 level to test its 52-week low. A break below $93 could offer a nice signal to start working the bearish side of the market by shorting the stock or using put options.


  • 26 Jun
    Don’t Follow The Herd: Why The Majority Of Investors Always Get It Wrong

    Don’t Follow The Herd: Why The Majority Of Investors Always Get It Wrong

    • Consider this, the question always remains the same: “What will my return on investment be?” But the answer changes all the time.
    • Thinking costs energy and humans prefer to let others do the thinking for them. Are you like that?
    • It’s important to know when to use history as a teacher.

    Introduction

    “Whenever you find yourself on the side of the majority, it is time to pause and reflect.” 

    – Mark Twain

    When Albert Einstein was teaching at Oxford University, he gave his senior physics students exactly the same exam he had given them the year before. His assistant was disturbed by such a mistake, but before intervening he asked Einstein whether he actually made a mistake. Einstein replied that the exam was exactly the same. The assistant was even more concerned and asked why he would do such a thing. Einstein replied, “Well, the questions are still the same, but the answers have changed.” More →

  • 09 May
    Investment Research: The Challenge of Finding Attractive Investments

    Investment Research: The Challenge of Finding Attractive Investments

    • Bargains can be found through book value, special situations, 52 week lows, merger arbitrages, bankruptcies, etc.
    • It’s necessary to be a contrarian to be a value investor, though it might be painful for a while.
    • With experience, it will take less and less time to assess a stock and whether it has the potential to be a good investment.

    Introduction

    Last week we discussed Klarman’s view on the best business valuation methods. You can find the article here. Today we’ll discuss his approach to investment research.

    Studying fairly priced securities won’t get you far because you’re competing with thousands of others who have researched those companies and, especially in the current market environment, if there is anything worth owning, it will probably be expensive. Therefore, to find bargain investments, an investor has to look where others aren’t looking or refuse to look. More →

  • 27 Apr
    The S&P 500 Only Has Sentiment To Thank For The Gains In The Last 5 Years

    The S&P 500 Only Has Sentiment To Thank For The Gains In The Last 5 Years

    • Positive sentiment alone has added 950 points to the S&P 500 in the last 5 years.
    • The S&P 500 has returned 12% in the last 5 years, but only 4.5% in the last 10 years and just 2.7% in the last 17 years. Don’t let current positive sentiment lead you to such terrible long term returns.
    • The opportunity cost might be significant, but the long term picture of not following the herd looks much better.

    Introduction

    I know that if I buy a stock with a price to earnings (P/E) ratio of 10 and stable future business prospects, my very long-term return should be around 10%, plus inflation and eventual growth. If I buy a stock at a P/E ratio of 5, my returns will be around 20%, while if I buy a stock with a P/E ratio of 20, my returns will be around 5%. It’s as simple as that, in the long term. More →

  • 26 Apr
    If You’re An Investor, Now’s The Time To Get Out Of The S&P 500, Index Funds, & ETFs

    If You’re An Investor, Now’s The Time To Get Out Of The S&P 500, Index Funds, & ETFs

    • If you only look at averages, passive investing will always outperform active due to lower fees, but you can only expect average returns.
    • The market is skewed and inefficient due to huge flows into passive funds, outflows from active funds which should be doing the thinking, and euphoric management doing large stock buybacks. This creates a highly risky situation.
    • Avoid owning index funds, ETFs, and stocks that are largely owned by passive funds.

    Introduction

    There are two investing worlds. One is the world of active investing where the fund manager you hired analyzes company after company and invests in those they think are the best. The passive manager simply disperses your funds over an index where you will perform exactly as the market performs. With passive investing, fundamentals, dividends, growth, sales, scandals, and business trends don’t matter at all. More →

  • 19 Apr
    The Next Bear Market Is Coming. Here’s Where It Will Start.

    The Next Bear Market Is Coming. Here’s Where It Will Start.

    • $2 billion a day flows into Vanguard to be mindlessly invested in the market through index funds.
    • When the only reason people invest is because staying on the sidelines means getting sore while others get rich, it usually spells trouble ahead.
    • When the investors plowing $2 billion per day understand what are they buying at extreme valuations, the next bear market will arrive and it will be terrible as the buying reverses to selling.

    Introduction

    A recent The New York Times article described how Vanguard, the $4.2 trillion mutual fund, is the fastest growing fund due to the attractiveness of passive investment vehicles and the average 0.12% fee the fund charges. The low fee is something I applaud as I strongly believe fees in the financial world should be minimal or performance related where nothing is paid if the manager doesn’t deliver. More →

  • 15 Mar
    There’s Only One Reason The Markets Are Rising & Nothing Can Be Done About It

    There’s Only One Reason The Markets Are Rising & Nothing Can Be Done About It

    • Everybody knows the market is extremely overvalued and risky, but nobody cares as long as it goes up.
    • Funds keep flowing into U.S. equities despite the fundamentals. This will be very painful when the trend reverses.

    Introduction

    We all know that in the long run, our investment returns are perfectly correlated to the underlying performance of the businesses we own in relation to the price we pay for ownership. If the price is high, our returns will be weak. If what we buy is cheap in relation to underlying earnings, our returns will be great or even amazing. This is a universal truth. However, there are some issues with it.

    The first is that even if most agree on the strong correlation between earnings and stock returns, very few like to think about the long term and instead prefer to only think about the short term. In the short term, stock returns are driven by equity flows and there is nothing that we can do about it even if it has been statistically proven that long term returns are perfectly correlated to underlying earnings and the greatest investors, like Ray Dalio and Warren Buffett, keep reminding us of this fact. More →

  • 24 Feb
    Goldman Sachs Is Probably Right But Is It Worth The Risk?

    Goldman Sachs Is Probably Right But Is It Worth The Risk?

    • Goldman Sachs recommends being overweight U.S. equities because of expected loose fiscal policies and because, as they have stated, valuations don’t matter.
    • Goldman expects a 3% yearly return on a moderate risk portfolio.
    • I’ll touch on what the average Goldman client is risking for their 3% yearly return.

    Introduction

    Goldman Sachs (NYSE: GS) recently released its 2017 market outlook. It shouldn’t be a surprise that the outlook is positive. It’s in their interest for stocks and the economy to continue to thrive as GS makes its money from IPO commissions, asset management fees, etc.

    Despite the conflict of interest, their positive outlook will most probably be correct at the end of 2017, but there is something more important than being right or wrong on a yearly forecast.

    Today we’ll discuss Goldman’s view and analyze the possible impacts on our portfolios. More →

  • 15 Feb
    The Institutional Performance Derby: The Client Is the Loser

    The Institutional Performance Derby: The Client Is the Loser

    • It’s important to understand how investing institutions operate and think so you don’t get trapped.
    • Nobody at these institutions eats their own cooking and there is no incentive to do anything. It reminds me of communism.
    • Institutional investing is a self-reinforcing mechanism, which is great in a bull market but terrible in a bear market.

    Introduction

    Seth Klarman’s book Margin of Safety is an iconic investment book. As it’s extremely difficult to get, I’m synthesizing it for you while injecting my own up-to-date commentary.

    You can read my introduction to Klarman’s Margin of Safety here, my review of chapter one, Where Most Investors Stumble, here, and my review of chapter two, The Nature of Wall Street Works Against Investors, here. Today’s article will discuss his The Institutional Performance Derby: The Client Is the Loser chapter. More →

  • 13 Jan
    Are You Part Of The Herd?

    Are You Part Of The Herd?

    • The current market has all the symptoms of herd behavior: safety in numbers, lack of proper information, and absence of competitive edge.
    • Market timing and contrarian investment strategies are tempting because of the high rewards, but fundamental value investing is what wins in the long term.
    • We’ll discuss markets that look safer and are much cheaper than the U.S.

    Introduction

    Yesterday we discussed how the situation in the U.S. economy isn’t sustainable in the long term. However, as the economy and the dollar are strong now, U.S. equities have enjoyed another positive period of inflows.

    In the first week of 2017, ETFs had $13.1 billion of inflows in total and the majority of that money ($8.7 billion) went straight into U.S. equities while $2.8 billion went into U.S. fixed income, and only $1.6 billion to international equity ETFs.

    The $8.7 billion going to U.S. equities is a clear indication of herd behavior. More →