Emerging markets dragged down by low oil price?

I keep on reading in the financial press that the low oil prices are dragging down emerging markets stock prices. This does not add up as more than 70 % of the EM countries are major importers of oil. In my perception the rapidly growing and industrializing Asian countries should benefit greatly from lower oil prices as oil is an important economic input. The cheaper oil price should shift wealth from oil producing countries to oil importing countries.

Take India for instance, the fourth largestc consumer of oil related products in the world. A third of the country´s import budget is oil. Cheaper oil should enable Indian businesses to hire more workers and produce more stuff as one of the economy´s important input prices has decreased dramatically. Cheaper oil should in my perception curve inflation pressure in countries such as india while reducing the cost of energy-intensive manufacturing while putting more money into the pockets of consumers. In my perception owning emerging market stocks should be a great oil price / oil stocks hedge.

According to the December 2015 paper "Hedging emerging market stock prices with oil, gold, VIX, and bonds: A comparison between DCC, ADCC and GO-GARCH" by Basher Syed Abul and Sadorsky Perry emerging market stocks is the most fitting oil hedge out of the ones mentioned in the paper title. The EM/ Oil hedge has the highest hedging effectiveness in most cases, although not for all models and situations measured in the paper.

Using data from 2000 as this year coincides with the beginning og the financialization of the commodity markets the paper illustrates that emerging market stocks have a low correlation with the oil price (0,261 Pearson correlation). Furthermore the optimal hedge ratio varies over time and from model to model used to calculate the optimal hedge raio, however it seems like a EM/ Oil hedge ratio of 0,2 - 0,4 should be deemed reasonable.

Pearson correlations between daily returns - oil and hedging alternatives:

                               Source: Syed Abul and Sadorsky Perry paper

Disclosure: I wrote this article myself, and it expresses my own opinions. I am not receiving any compensation for it.

Diversify or end up living in your moms basement...

Stock investors should diversify in order to smooth and eliminate unsystematic risk elements related to individual stocks. As long as you own stocks which are not perfectly correlated diversification will decrease your portfolio´s standard deviation while upholding the expected return.

My take is that investors that are not diversified are either cocky, stupid, Warren Buffet or gamblers. If you make the stand to not diversify you also make the stand that unexpected factors such as poor management (Volkswagen), accounting fraud (Enron) or crazy complexity (Lehman) will not unexpectedly haunt any of your few stocks.

Some examples:

• The cocky type: Knows the automobile industry well. As a Daimler engineer he invested all his money in Volkswagen and Daimler stocks at the end of 2009 as he expected above industry growth and solid margins for both solid german car companies. He is currently crying a lot  
• The stupid type: Worked as an Investment Banker at Lehman and reinvested all his earnings into the company as they had the best damn asset management business in the world. He is currently broke living in his moms basement
• Warren Buffet: The most successful investor in the world. He once stated "Diversification is protection against ignorance. It makes little sense if you know what you are doing". It is hard to argue with Warren Buffet, however there are numerous professional investors who have stepped into the role of the "cocky type". I´m just not willing to take the risk
• The gambler: This guy spent all his cash on stocks in a biotech company that is only a couple of clinical trials and studies away from curing cancer. He will most likely end up borrowing money to buy even more stocks in the given biotech company. The stock will soar until some clinical trial goes wrong and all his and his moms money evaporates. This guy will most likely use his moms credit card to buy a one-way ticket to Macau

According to the 2014 paper, "Equity Portfolio Diversification: How Many Stocks are Enough? Evidence from Five Developed Markets," by Vitali Alexeev and Fransic Tapon the number of stocks needed on average to eliminate 90 % of diversifiable risk 90 % of the time is 55. This increases to 110 stocks in times of distress (for the US market). In other words, you should at least own 50 stocks or so if you are not Warren Buffet.

Risk decreases as the number of stocks in a portfolio increases:

                                      Source: Vitali Alexeev and Fransic Tapon paper 

Disclosure: I wrote this article myself, and it expresses my own opinions. I am not receiving any compensation for it. 

Why smart money re-balanced

Mean reversion in stock prices/ returns suggests that investors should with discipline rebalance their stock portfolios regularly, and at least once a year. This will improve portfolio risk-return in the long-run as you automatically will buy more shares in under-performing stocks and sell shares in stocks that have outperformed. Rebalancing have been given a lot of academic support and is a well known alpha creating technique among practitioners.

Charles Rotbult published a study in the "American Association of Individual Investors" where he tracked how different investor behavior would effect portfolio returns. The first portfolio was re-balanced when allocations were off target by 5 %, the next portfolio was not re-balanced at all, and the third portfolio reflected an investor who panicked and sold every time the stock index fell by at least 20 % (which a lot of people do).

Not surprisingly the re-balanced portfolio outperformed both on risk and return. Furthermore the panic seller significantly under-performed by all measures. In other words, when everyone is running out the door, you should sneak in. According to the most stringent "the markets are perfectly efficient" theorists out there this should not be possible, however it is. Both stocks and assets classes are mean reverting in their behavior. This may very well be due to the irrational behavior by all those investors buying stocks/ asset classes that are up and selling stocks/ assets classes that are down.

How I re-balance:

My public portfolio is currently invested in three themes, 1) oil stocks, 2) emerging markets, 3) cheap European automobile stocks. By late the theme weights have moved far away from the initial weights as theme one has developed adversely, theme two has done nothing and theme three has outperformed. For the most part I invest an equal amount in each stock I buy (I overweight some stocks, however for the most part i weight all stocks equally).

In order to re-balance I make sure to buy and sell stocks until the above mentioned themes are weighted equally to their original weights, I also make sure that each stock once again has equal portfolio weighting. By re-balancing next week I will be able to take profit in VW and BMW, and at the same time pick up stocks in oil companies such as Statoil and Prosafe on the cheap.    

So how often should you re-balance? It depends on how volatile the components of your portfolio are, and how correlated those components are. I like the idea of re-balancing every time my theme targets are off by 5 % in aggregate.

Disclosure: I wrote this article myself, and it expresses my own opinions. I am not receiving any compensation for it. 

Polish electrical utilities companies - Super cheap cash-cows or dogs with fleas?

Bottom fishing can be both a fun and a risky endeavor, and it is not always easy to know if what you are looking at is a viable investment thesis or a dog with fleas.

When looking for cheap European cash-cows, there is nothing cheaper out there than Polish electrical utilities companies. The two companies I have looked at is Energa SA and Enea SA, with a main focus on Energa.

Energa is a Polish electrical producer and distributor which focuses both on coal and renewables. As for now the majority of the company´s production stems from coal power plants, however it reinvests its earnings into renewable energy (both wind and hydropower).  

The company is currently super cheap and the stock price has been dragged down by the upcoming COP 21 taking place in Paris. This seems reasonable as the meeting may end up in policies which will have adverse effects on Energa´s profitability. However, the stock is down by 51 % this year, and it seems like the market is pricing the company as if coal produced electricity will be band at some point this decade. As long as the company can generate solid cash-flows from selling coal produced electricity, while utilizing its current infrastructure to increase clean energy production this may be a good bet. I further believe that the Polish government will protect its electrical utility industry as cheap electricity is the backbone of the country´s important manufacturing segment (taking a hard stand on Polish coal produced electricity may end up hurting a high number of polish blue collar workers).

The company is currently trading at a 5.2x trailing P/E and a 3.2x trailing EV/EBITDA. The dividend yield is 10.6 % and the market believes in continued solid dividend payments. All this sounds too good to be true and it may be if EU kills the Polish coal based utility industry. I have not yet decided if this is a great opportunity or a dog with fleas.

Energa peer analysis (EV/EBITDA):

                                Source: InFinancials

Energa dividend forecast:

                                Source: Financial Times

Disclosure: I do not hold any positions in Energa SA.

I wrote this article myself, and it expresses my own opinions. I am not receiving any compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Do not trust 2016E or 2017E earnings forecasts

As a super geek I read all finance related stuff out there on google, blogs, newspapers, comments, academic articles, you name it... one thing that has bugged me for a while is all the talk about how value investors (and others) should be looking into the future when evaluating stocks, and that the past does not matter. I agree to a certain extent.

As a value investor one should qualitative look into the future and avoid stocks in definitely dying industries such as the video rental industry or the paper phone book industry (however just maybe, remember that Berkshire was a cash-cow in the dying textile industry when Warren Buffet started buying stocks in the company during the 60s). If one is buying a really cheap troubled company based on trailing multiples, one should also have a feel that even if the company currently is in trouble, it will get out of trouble at some point.

Using trailing multiples instead of multiples based on future estimates of fundamentals have historically yielded superior investment returns as frankly no one can precisely predict the future.

According to the article "Analyzing Valuation Measures: A Performance Horse Race over the Past 40 Years" from The Journal of Portfolio Management (Wesley R. Gray and Jack Vogel as main authors) using a forward looking analyst consensus earnings multiple to systematically invest in the quintile cheapest portfolio of stocks from 1982 to 2010 resulted in a CAGR of 8.63 % vs. the overall market CAGR of 11.73 %. Trailing multiples such as Price/ Book and EV/EBITDA earned 13.63 % and 16.73 % CAGR respectively over the same time period. In other words you will under-perform the market as a value investor if you trust earnings forecasts. What we do know is that asset prices have a tendency to be mean reverting. 

Disclosure: I wrote this article myself, and it expresses my own opinions. I am not receiving any compensation for it. 

Tesla - the most overvalued stock out there

As a theme driven value investor I currently have a approximate 20 % public portfolio exposure (10 % overall) invested in German car manufacturers post the "dieselgate" VW scandal/ disaster. Thus far it has been a successful theme, yielding more than a 20 % return in a couple of months. Furthermore it has peaked my interest in the automotive industry which for the most part seems reasonably priced. The one exception is Tesla, the most overvalued company/ stock out there.

This is why I believe Tesla is overvalued:

• Let us start with the obvious, the numbers. 
• Tesla will sell approximately 50 thousand cars this year, GM sells 10 million cars a year. Still Tesla´s market cap is more than half of GM´s market cap. Furthermore Tesla currently has approximately the same market cap as the high-end car maker Audi (30B USD vs. 30B EUR). Audi delivers more than 1.3 million cars a year. This just does not add up... no matter what promises have been made by Elon Musk.
• Tesla´s current price/ sales ratio is 6x, vs. 0.5x for the automotive industry as a whole
• As Tesla is not making any money this year it is hard to evaluate comparable P/E ratios, however the company´s 2016E P/E ratio is currently 115x (according to Financial Times data analyst earnings forecast consensus).
• The current book value of the company is USD 1.3B vs. a market cap of USD 30B.
• Tesla seems to be appreciated and priced in the same manner as some Internet companies were in 2000 before the dot-com-bubble crash. Yes the company delivers a superb promise of electrical cars to the masses, however it does not hold the scale, muscles nor experience to compete in an already mature industry in the long-run. As a high-end manufacturer the company may have a shot, however that is not the company´s objective.
• The promised amazing growth will come at an amazing cost. The mega factory currently under construction in the US will only have an annual output of 500k units a year by 2020 (this is hardly enough to sell cars to the masses in a profitable manner). Scaling further in order to produce 2 or 5 or 10 million cars a year, Tesla will have to raise an amazing amount of capital (the cost of the mega factory is USD 5B).
• Tesla holds a first mover disadvantage in that they have moved into a immature segment of the automotive industry (electrical cars) too early and before the basic technology is in place. Tesla´s competitors can milk cash from their ongoing businesses while slowly developing their electrical car platforms while Tesla needs cash injections from the market in order to afford R&D (Tesla just recently raised USD 750 million in cash in order to handle its cash-burn). Electrical cars just can not compete with combustion engined cars before, 1) the drive range of the cars increase significantly, 2) the time to charge the car batteries decrease tenfold, 3) stations for charging becomes more available. The day electrical cars will take over is the day I hear a Rome, Georgia based baseball fan stating: "let´s take my electrical Ford F-150 pickup truck down to the lake and down some bud".
• Tesla can not compete with experienced high-end manufacturers such as BMW, Mercedes and Audi on driver experience. I used to own a Tesla Model S and my experience as a driver was not the best. The ride could have been better due to, 1) the heavy batteries had adverse effects on the handling, 2) the car did not feel like a luxury sedan, 3) the size of the car made it difficult to drive in European cities as it was just too large and clumsy. 

Disclosure: I hold no positions in Tesla Motors Inc.

I wrote this article myself, and it expresses my own opinions. I am not receiving any compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Oil at its lowest level since August - will OPEC save the day?

As an investor with a 30 % overall energy exposure holding a public portfolio 40 % weighted towards energy companies (asset heavy/ service/ E&P both oil and gas) I am interested in the oil price development. Considering that the MSCI World Index currently is weighted 7 % towards the energy sector I am holding a heavily overweight position in the sector as I am a firm believer in a solid mid- to long-term comeback in the oil price. I should stress that I have no clue regarding the short-term direction of the oil price.

Thus far the brent crude is down by 3.6 % today and the WTI is priced below USD 40 per barrel. The spot price for the black gold has not been this low since August and it is apparent that the bear market is not yet over. Goldman may be right in predicting that the oil price may move into the 20 - 30 USD per barrel range at some point during the winter months. If such an event plays out my plan is to invest my surplus cash in oil companies in order to average down my entry levels (I started investing heavily in the energy sector a couple of months ago).

The market is currently in limbo waiting for the OPEC oil minister meeting in Vienna on Friday. The media consensus seems to be that the situation will stay in status quo and that the meeting will result in no new strategic direction by OPEC as Saudi Arabia is not willing to cut production and risk to loose marketshare. The ongoing theme has been for OPEC to pump record volumes out of the ground in order to drive rival, higher cost producers such as US shale oil producers out of the market. The strategy has thus far worked as US shale output seems to be slowing. The main downside is that Russia has followed OPEC´s lead and has increased its output significantly as well contributing to the current over-supply.

Iran has asked OPEC to go back to the old OPEC production celling of 30 million barrels per day (OPEC is currently producing 31.5 million barrels per day) and Venezuela wants the "cartel" to cut production by 5 %. Other member countries are also cheering for production cuts. The below graph illustrates that Saudi Arabia and Iraq are the driving forces behind the current over-supply of oil as they have increased their production significantly in 2015. Most of the other member countries have held their output unchanged.

As Saudi Arabia is the largest producer out of the lot and they have driven the current over-supply they seem to be the one power which has the ability to change the current situation. In my opinion Saudi Arabia may feel happy about what they have accomplished in halting the US shale oil boom, however they will not adjust their output downwards before they have the Russians onboard. The current situation of oversupply may come to an end if OPEC and Russia can come to an agreement regarding production levels as these two powerhouses produce close to 50 % of the current world output. As this will not happen this week I expect nothing new to be presented from the OPEC oil minister meeting in Vienna on Friday (although I am hoping for a miracle)...

2014 to 2015 OPEC member countries production change:

                               Source: Peakoil

Continued strong demand growth: 

                                    Source: International Energy Agency

Disclosure: I wrote this article myself, and it expresses my own opinions. I am not receiving any compensation for it.