(B)(N) Love The Crisis

Drama. The Street has noticed that there are handful of companies that have been aggressively buying in their own stocks at low prices because nobody else will – that is, the institutions aren’t buying them and they likely won’t as long as the “bond door” remains open (The Street, October 8, 2013, Jim Cramer: Where to Buy on Cataclysmic Days).

The Capital Market “Line”
Swallowed by the Whale.

Alas, the institutions have a lot of money but only three ideas: work a smaller cap stock (less than $10 billion or so) by “taking a position” (long or short); work the “spin” from bonds to equities to bonds; or “walk the line“.

Most of their money (which was our money as savers and investors before we gave it to them to “manage” or “keep”, so to speak) is in “walk the line”, most of the time, and that explains a lot about “volatility“.

The “line” is provably much fatter (the shaded area above that looks like a whale) than they think and, of course, if they keep trying to “squeeze” it into the middle to find a “capital allocation line” (with “alpha”) by “managing” volatility and co-volatility, it busts out at the sides from time to time, “up and out” (bull market) or “down and out” (bear market) depending on some new factors that re-locate the alleged “line” to where it’s more comfortable under the current circumstances and not the past. (For more information, please see our recent Post, The RiskWerk Company Glossary.)

The Street identified seven such companies – GameStop, Viacom, CBS, Time Warner, AOL, Wyndham Worldwide and AutoZone – that have bought in and kept or cancelled anywhere between 5% and 10% of their own stock in the last year, and so we put them all into one portfolio to see what has happened and what we might expect to happen next year.

The One Rule
Selection, Selection, and Selection

As it turns out (no surprise), instead of three ideas, there are three rules in portfolio management for risk aversion, capital safety and more “alpha”: they are selection, selection, and selection, which we’ve simplified into The One Rule so as not to confuse our customers.

This portfolio has been entirely buy and hold since December and has returned +40% plus dividends of $2.2 billion for a current yield of 1.4%. And they have spent another $10 to $15 billion buying back their own stock that nobody else wants (sic). Please see Exhibit 2 and 3 below.

It’s likely (ibid, The Street) that with the exception of Gamestop which is still working itself out of losses in 2012 (but which stock price has doubled this year), the PEs (price to earnings ratios) are simply too high (in excess of 20×) for alpha-seeking (“underweight/overweight”) portfolio managers and that they are waiting for lower prices or still higher earnings or both.

However, the “stock price” is notional and not related to anything (which is another reason for the “whale” instead of the “line”) whereas the “price of risk” resolves a Nash Equilibrium between “risk seeking” and “risk averse” investors and is itself a “risk-adjusted” price that moderates “high PEs” with the expectation that investors who are willing to buy and hold the stock at these prices believe, and have reason to believe by demonstration, that their money invested in the stock is “as good as cash and better than money”; that is, it is likely to provide a non-negative real rate of return regardless of the current stock price. Please see Exhibit 1 below for a calculation of the PEs and Yields (the inverse of the PE) with respect to the price of risk.

Exhibit 1: (B)(N) Love The Crisis – PEs and Yields

Love The Crisis – PEs and Yields

(Please Click on the Chart to make it larger if required.)

Exhibit 2: (B)(N) Love The Crisis – Prices & Portfolio – October 2013

Love The Crisis – Prices & Portfolio – October 2013

(Please Click on the Chart to make it larger if required.)

Exhibit 3: (B)(N) Love the Crisis – Portfolio and Cash Flow Summary – October 2013

Love The Crisis – Portfolio & Cash Flow Summary – October 2013

(Please Click on the Chart to make it larger and again if required.)

For more information on the Chart Elements, please see our recent Post, The RiskWerk Company Glossary.

For more on what risk averse investing has done for us this year, please see our recent Posts on The S&P TSX “Hangdog” Market or The Wall Street Put or specialty markets such as The Dow Transports & Utilities or (B)(N) The Woods Are Burning, or for the real class action, La Dolce Vita – Let’s Do Prada! and It’s For You, Dear on the smartphone business.

And for more stocks at high prices, The World’s Most Talked About Stocks or Earnings Don’t Matter – NASDAQ 100.

Postscript

We are The RiskWerk Company and care not a jot for mutual funds, hedge funds, “alternative investments”, the “risk/reward equation” and every other unprovable artifact of investment lore. We have just one product

The Perpetual Bond™
Alpha-smart with 100% Capital Safety and 100% Liquidity
Guaranteed
With No Fees and No Loads on Capital

For more information on RiskWerk, please follow the Tags or Categories attached to this Letter or simply enter Search for additional references to any term that we have used. Related data may be obtained from us for free in a machine readable format by request to RiskWerk@gmail.com.

Disclaimer

Investing in the bond and stock markets has become a highly regulated and litigious industry but despite that, there remains only one effective rule and that is caveat emptor or “buyer beware”. Nothing that we say should be construed by any person as advice or a recommendation to buy, sell, hold or avoid the common stock or bonds of any public company at any time for any purpose. That is the law and we fully support and respect that law and regulation in every jurisdiction without exception and without qualification to the best of our knowledge and ability. We can only tell you what we do and why we do it or have done it and we know nothing at all about the future or the future of stock prices of any company nor why they are what they are, now. The author retains all copyrights to his works in this blog and on this website. The Perpetual Bond®™ is a registered trademark and patented technology of The RiskWerk Company and RiskWerk Limited (“Company”) . The Canada Pension Bond®™ and The Medina Bond®™ are registered trademarks or trademarks of the Company as are the words and phrases “Alpha-smart”, “100% Capital Safety”, “100% Liquidity”, ”price of risk”, “risk price”, and the symbols “(B)”, “(N)” and N*.