(B)(N) NASDAQ Back To The Future

The Time Machine
Courtesy: Dr. Who

Drama. Morgan Stanley has roved the future and brought back a portfolio of stocks that they think might have the legs to get there in all weathers (Business Insider, October 9, 2014, MORGAN STANLEY: Here Are 42 Stocks That’ll Thrive Even If The Economy Gets Worse).

All of these companies have interesting stories and most of them are engaged in businesses with products or services that didn’t exist ten years ago, and didn’t even have a name twenty years ago.

The current market value of the companies is $1.4 trillion, but 50% of that is made up by just three companies – Google ($388 billion), Facebook ($198 billion) and Gilead Sciences ($158 billion) – and if we take them out, then we have the thirty-nine “Atomic Growth” companies with a combined market value of $695 billion, but some unfortunate numbers such as a middling 13.6% return on the shareholders equity (ROE), and a 55% return of earnings as dividends for an aggregate dividend yield of 0.92% (92 basis points).

And nearly half of them (15 companies) lost money last year, although it wasn’t much ($1.5 billion), and that was offset by earnings of $13 billion in the others. But we were all small once, and look what we’ve become; please see Exhibit 1 below.

Exhibit 1: (B)(N) Morgan Stanley Atomic Growth Companies – Fundamentals

(B)(N) Morgan Stanley Atomic Growth Companies – Fundamentals

Figure 1.1: (B)(N) Morgan Stanley Atomic Growth Companies – Risk Price Chart

As a portfolio, the thirty-nine atoms didn’t do much in 2012 (+1.2%), but picked up in 2013 (+52%), and are up +7.2% so far this year; please see Figure 1.1 on the left.

Figure 1.2: (B)(N) Morgan Stanley Molecular Growth Companies – Risk Price Chart

However, the managed portfolio of the (B)-class companies did +8.4% in 2012, and we finished up holding twenty of them; then +76.3% in 2013, and another +31.8% this year, and we’re currently holding thirty of them; please click on the links (and again to make them larger if required) “(B)(N) Morgan Stanley Atomic Growth Companies – Prices & Portfolio and Cash Flow Summary” for more details.

The three molecules, Google, Facebook, and Gilead Sciences, did +14% in 2012, +70% in 2013, and are up +19% this year.

However, in the managed portfolio of the (B)-class companies, we only owned one in 2012 (Gilead Sciences) and that gave us +56%, and we picked up the other two in 2013 for +191% (three digits) by the end of the year, and another +60% so far this year (because of the equal weighting instead of by market capitalization) and we’re currently holding all three of them, subject to any volatility (or heat) that we might have to take until December; please click on the links (and again to make them larger if required) “(B)(N) Morgan Stanley Molecular Growth Companies – Prices & Portfolio and Cash Flow Summary” for more details.

Betting on Growth

Betting on “growth” is a risky business; we need the growth – probability 50% – and we need the market to take notice and bid the price up – probability 75% – hence, the generous likelihood of success is 3/8, which means that maybe fifteen of these companies are going to have it all in 2015. But which fifteen?

There are five equations of state that tell us what a company is, and how that’s priced, but we don’t expect consistency, of course – and the companies that we buy and hold are still governed by the (B)-class –  but, on balance, investors have a pretty good nose for how to get what they want – they want income and capital gains, and will forego income (as dividends) if there is a likelihood that the capital gains will be better if the company has more money to “grow” – and in that context, we can develop arbitrage opportunities if the quality of growth is mispriced, either because there are no dividends, or the dividend yield is not consistent with that of near neighbors in the growth measure.

The “Enterprise Risk” is the uptake rate of the “factors of production” (N*) into the shareholders equity (N) and, therefore, into the earnings, and we define it as the Enterprise Risk = 1 + log(N/N*); the factors of production are determined by Theory of the Firm which requires (with proof) that N* = GW* + “Fixed Assets (at cost)” + “Inventory”, where the latter are similar to their accounting meanings, and GW* is the “balance sheet worth of the trading connections” which we call the Coase Dividend.

The Coase Dividend, GW*, is also calculated in the Theory of the Firm and its value is GW* = (R+P)×E(α) = P×(1+α)×E(α), where α=R/P is the modality, and R is “what is owed to the firm”, and P are its total liabilities and “what the firm owes”; please see Exhibit 1 above for examples and the Theory of the Firm for the derivations.

These companies don’t really pay dividends, so all our money is on growth – the hope that we can buy the stock at low prices, and that it becomes more expensive later, while we own it; the “stock price”, of course, is indeterminate until it becomes low enough that we might want to think about buying the whole company, and “fixing it”, if it can be fixed, so that we have access to all of the earnings.

We require the Theory of the Firm to calculate the Coase Dividend, but investors can “see” it because of the way in which the company projects itself into the trading connections, which include not only its process and employees, but also its suppliers, customers, bondholders and bankers, and even its shareholders.

Figure 1: The Coase Dividend

Hence, it is a cause to wonder – and arbitrage – if the Coase Dividend is priced differently for companies with a similar Enterprise Risk; please see Exhibit 2 below, and for a shorter story, Figure 1 on the right.

Exhibit 2: From Atoms to Molecules (and back again) – Enterprise Risk & Coase Dividend

Figure 2.1: From Atoms to Molecules – Enterprise Risk & Coase Dividend

For more information on the “Five Equations of State”, and an introduction to the terms that we have used here, please see our Post “(B)(N) Through the Looking-Glass“, and for the really hard rocks, the Theory of the Firm which is based on The Process.

And for more information on real “risk management” in modern times and additional references to the theory and how to read the charts and tables, please see our Post, The RiskWerk Company Glossary and “(P&I) Dividend Risk and Dividend Yield“, and our recent Posts “(P&I) The Profit Box” and “(P&I) The Process – In The Beginning“; and we’ve also profiled hundreds of companies in these Posts and the Search Box (upper right) might help you to find what you’re looking for, such as “(B)(N) TLM Talisman Energy Incorporated” or “(B)(N) ATHN AthenaHealth Incorporated” or “(B)(N) PETM PetSmart Incorporated“, to name just a few.

And for more applications of these concepts please see our Posts which rely on the Theory of the Firm developed by the author (Goetze 2006) which calibrates The Process to the units of the balance sheet and demonstrates the price of risk as the solution to a Nash Equilibrium between “risk-seeking” and “risk-averse” investors within the demonstrated societal norms of risk aversion and bargaining practice. And for more on The Process, please see our Posts The Food Chain and The Process End-Of-Process.

And for more on what risk averse investing has done for us this year, please see our recent Posts on “(P&I) The Easy (EC) Theory of the Capital Markets” or “(B)(N) The Easy (EC) Theory of the S&P 500“, and the past, 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. And for more on what’s Working in America, Big Oil, Shopping in America or Banking in America, to name just a few.

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

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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*.