Following HitecVision´s lead - not a smart move

HitecVision may be the most successful Buyout (Private Equity) player within the energy space the last 20 years. It therefore seemed reasonable to take a closer look at their first ever public none controlling financial plays implemented in November of last year.

Hitec bought a 10 % stake in Prosafe and a 10 % stake in Kvearner. Post evaluating the two companies based on my own criteria, while being highly biased due to Hitec´s investment I placed my bets. The stocks have performed horrifically, with Prosafe experiencing cancelled contracts and Kvaerner being mentioned in a potential corruption case (I am 99.9 % certain that Kvaerner does not have anything to do with corruption, however such things tend to be bearish for stock prices).

Prosafe is actually one of the worst performing Norwegian stocks since I invested alongside Hitec. Luckily I exited my position before it got to bad as Prosafe is a sinking ship in need of financial restructuring. I exited Kvaerner yesterday and reallocated my capital to the E&P company Hess Corp. I have learned my lesson and will not listen to anyone but myself when making up my mind regarding positions in the market going forward. You live and you learn. Luckily I always diversify my holdings, thus the lesson was worth the pain.

Links to my previous blog entries regarding Prosafe and Kvaerner:
Oeistein Helle: HitecVision is picking up public stocks as financial plays
Oeistein Helle: Following HitecVision's lead - part 2

How it feels like to be a Prosafe investor:

Disclosure: I am no longer long Prosafe and Kvaerner.

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 will move to USD 100 within a couple of years. Get on board the gravy train!

If you want to beat the market and book some portfolio alpha you should be overweight E&P companies for one simple reason: Oil is currently trading significantly below its marginal replacement cost of USD 65 - 75 per barrel. If you are a long-term investor this is all you need to know in order to pick up E&P companies such as PJSC Lukoil and Hess Corp on the cheap. Oil will make a move to USD 100 per barrel within a reasonable timeframe (a couple of years) due to the fact that the oil market always over or undershoots its target significantly. The oil price equilibrium target is USD 65 - 75 per barrel vs. the current price of USD 40 per barrel.

I know you could make an attempt on timing your market entry by studying fundamental factors such as inventory levels, the futures curve shape, # of operating rigs and slowdowns in production, however all you need to know at this point is that oil is trading significantly below its marginal replacement cost. All the other stuff mentioned will just make your trigger finger tremble and you will miss out on the opportunity.

I have made this point a couple of times before: 

Oeistein Helle: Stein´s law makes me 99 % certain that the oil price will bounce back in the mid- to long-term

Breakeven oil prices and the marginal cost of oil:

Source: EOG Resources, Inc. 

Disclosure: I am long PJSC Lukoil and Hess Corp.

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.

Northern Blizzard - an investable Canadian oil sand business with a cool name

Canadian oil sand production is as expensive as U.S. shale production while often realizing discounted pricing to WTI prices. The lower prices are due to the heavier nature of most Canadian produced oil. Only 25 % of Canadian produced oil is conventional light oil. In order to find a Canadian oil production company investable it is therefore critical that it produces oil at the low-end of the Canadian cost curve. On a more positive note Canadian producers are experiencing lower operational costs than their U.S. counterparts due to the depreciating CAD.

Graph # 1: Mid-cycle breakeven price Canadian oil sands vs. U.S. shale

                               Source: Scotiabank Equity Research

In terms of mid-cycle breakeven economics Norther Blizzard may have one of the best field portfolios out of any Canadian oil sand production company (Graph #2). Furthermore its focus assets which represents 55 % of the company´s current production can bolster an impressive full-cycle return potential even at sub USD 40 WTI prices (Graph #3). These assets alone are expected to double the company´s production from 20k boe/d to 40k boe/d within the next 5 - 6 years. In other words one may consider Northern Blizzard to be a growth case in the mid- to long-term, even at lower than expected oil prices.

Graph # 2: Mid-cycle breakeven economics Northern Blizzard fields (red) vs. peers

                            Source: Northern Blizzard

Graph # 3: Project economics Northern Blizzard focus assets

                              Source: Northern Blizzard

With the current depressed and volatile oil prices it is crucial for any oil producing company to have a healthy balance sheet. Additionally any price hedges made at high prices is beneficial. According to Gurufocus.com Northern Blizzard has a Equity to Asset ratio of 0.6x and a 2016 year end Net Debt to Operational Cash Flow ratio of 2.4x. Furthermore the company is within the boundaries of its debt covenants (with a huge buffer) while having a USD 475 million borrowing base, currently undrawn. Northern Blizzard is also supported by two renowned Private Equity investors: New York-based Riverstone Holdings LLC and Irving, Texas-based NGP Energy Capital Management LLC. The company also has one of the most healthy price hedging programs in place among its peers (Graph #4).

Graph # 4: Northern Blizzard vs. peers 2016 price hedging

                              Source: Northern Blizzard

In terms of pricing the company looks dirt cheap with a Price to Book ratio of 0.4x vs. the industry median of 0.85x and vs. its historic median of 0.75x since its 2014 IPO. The company stock is down by more than 80 % since the IPO. As previously mentioned please note that making a play on the oil industry is currently not for the faint-hearted. You should expect high volatility and at times great unrealized portfolio losses. In order to make this play you have to be a patient long-term investor who can handle crazy volatility.

Disclosure: I am long Northern Blizzard Resources 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 stocks do's and don'ts

According to BP´s annual energy outlook analysis oil prices may make a comeback to 110 USD/bbl within five years due to continued demand growth in combination with slowing none OPEC supply growth (see graph below). Oil related stocks should therefore offer great value as Brent Crude currently is trading at 30 USD/bbl. However there are some pitfalls when looking for value within the main three oil related segments: E&P, human capital intensive oil service and hardware intensive oil service. The main pitfalls are liquidity/ bankruptcy risk and pricing.

In my opinion you should not avoid the high-risk hardware intensive oil service companies. Instead you should construct a highly diversified portfolio of companies within all three main oil related segments as you want to take advantage of irrational pricing within all segments.

What to look for in oil related companies:

• Low P/B ratio vs. industry and history 
• Some of the oil majors have stretched valuations taking the current situation into consideration. If you want to make a play on the current low oil price you should avoid expensive E&P companies. Instead look for cheap E&P companies with low production costs and low CapEx commitments. If you dare you may want to take a look at Russian E&P companies.
• Low bankruptcy risk
• There is no point in buying cheap companies if they go bust or have to restructure and dilute. 
• Investors should screen for companies with:
• High cash to debt ratio vs. industry and history
• Solid equity to debt ratio vs. industry and history
• Solid interest coverage ratio vs. industry and history
• Positive or flat free cash-flow to equity

Please note that making a play on the oil industry is currently not for the faint-harted. You should expect high volatility and at times great unrealized portfolio losses. In order to make this play you have to be a patient long-term investor who can handle crazy volatility. 

FYI: If you own Seadrill stocks you should probably sell and take your losses while you still can. 

Oil demand vs. supply in 2035. OPEC will have to pick up the supply slack:

                                 Source: BP p.l.c.

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

Insiders are buying energy stocks hand over fist

I am not the only one who is bullish on the energy sector in the mid-to long-term as insiders and energy company CEO´s have been buying stocks in their respective companies hand over fist the last couple of quarters. According to Gurufocus the XLE (US Energy Select Sector index) insider Buy/ Sell ratios were 7.73x, 4.25x and 2.06x for Q3-15, Q4-15 and January 2016 respectively. Energy company CEO´s were even more bullish, boosting insider Buy/ Sell ratios equalling 13.82x, 9.13x and 1.67x for Q3-15, Q4-15 and January 2016 respectively. As Graph #1 below illustrates the energy insiders have been good at timing the market in the past as they purchased a lot of shares at the trough of the financial crisis and during the 2011 - 2012 slump. Post spikes in the XLE index insider Buy/ Sell ratios the XLE index have tended to appreciate significantly.

A company insider is defined as a senior officer or director of a publicly traded company, as well as any person or entity that owns 10 % or more of a company´s voting rights. A Buy/ Sell ratio above 1x indicates that insiders are buying more shares than what they are selling in their respective companies. 

Graph 1: Insider Buy/ Sell ratios and XLE index development

                               Source: Gurufocus

Graph 2: CEO Buy/ Sell ratios and XLE index development

                               Source: Gurufocus

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

Statoil on track with scrip dividend and efficiency measures

• Statoil has suggested to offer a scrip dividend which will enable shareholders to choose if they want to be paid dividend in cash or by 5 % discounted newly issued shares. The move has to be approved by the majority owner (Norwegian government) who has expressed that it supports the suggested dividend policy. 
• Statoil shares were surging in today´s trading as investors reacted positively to Statoil´s efficiency and cost cutting programs. Statoil delivered USD 1.9b in cost cutting one year ahead of plan (original cost cutting target was USD 1.7b for 2016). 
• The company stated that there will be no more job cuts, although they will keep their focus on efficiency measures and cost cutting. Furthermore they have reduced the average break-even price per barrel from USD 70 to USD 41 for non-sanctioned projects with start-up by 2022.
• Statoil plans to cut capital expenditures by 12 % in 2016 compared to 2015. A reasonable measure considering the current state of the oil price.

I previously criticized Statoil for borrowing money in order to pay dividend instead of spending the borrowed cash on positioning the company for the next bull market: Oeistein Helle: Statoil fires thousands of employees while borrowing billions to pay dividend

The above mentioned scrip dividend, alongside efficiency measures will improve the company´s cash position and enable Statoil to be opportunistic regarding attractive opportunities in a buyers market going forward. Thus the measures mitigates a lot of my concerns in my previous post. Furthermore Statoil stated that they will stop job cuts, which will enable the company to keep valuable in-house competencies. I am now a lot more confident regarding Statoil´s positioning ahead of the next bull market. 

Statoil strategy to capture value in upturn:

     Source: Statoil ASA

Disclosure: I am long Statoil ASA.

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.

S&P 500 and the 2016 January effect

The statement "As January goes, so goes the year" has some merit as January stock market returns have been proven as a decent leading indicator for whole year returns. January 2016 ended with a 5.07 % negative return.

The probability for a negative full year return in the S&P 500 if January ends in the red is 57 % vs. 31 % unconditionally. These are the years where the S&P 500 went through the worst starts to January and their corresponding January returns and full year performance:

Year            Jan perf        Full yr. perf

2009            -8.57 %             23.45 %

1970            -7.65 %               0.10 %

1960            -7.15 %              -2.97 %

1990            -6.88 %              -6.65 %

1939            -6.39 %              -5.18 %

1978            -6.15 %               1.06 %

2008            -6.12 %            -38.49 %

2000            -5.09 %            -10.14 %

2016            -5.07 %                ??? %

1977            -5.05 %            -11.50 %

For the above sample of worst starts to January years excluding 2016 the average February to December return was 1.18 % and the average full year return was negative 5.58 %. This may indicate that it is probable that 2016 will not be a great year for US equities.

On the other hand we have seen recent poor S&P 500 January performance turning into great bull years as well:

Year            Jan perf        Full yr. perf

2009            -8.57 %             23.45 %

2003            -2.74 %             26.38 %

2010            -3.82 %             12.78 %

January return vs. full year return for the S&P 500:

                              Source: Haver Analytics and Yardeni Research Inc.

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

Reevaluating Emerging Markets

As previously discussed I find Emerging Markets ("EM") equities to be cheap compared to developed world equities and compared to historic pricing multiples: Oeistein Helle: The time to buy emerging markets may be now

My initial EM strategy was to go long a MSCI Emerging Markets index ETF. The index is heavily weighted towards the MSCI China Index and China´s closest trading partners such as Korea (South), Taiwan and Brazil (graph #1 depicts EM countries by percentage of exports to China).

Although both the MSCI China Index and China´s closest trading partners equity markets look cheap on a fundamental basis these markets may experience negative shocks from China´s economic transition into a modern consumer based economy. Furthermore China´s closest trading partners currencies will most likely depreciate significantly alongside China´s planned currency devaluation scheme. Such currency depreciation may be positive for the trading partners in the short-term as it may increase exports (graph #2 depicts EM countries by short-term GDP growth sensitivity to a 10 % devaluation of the Chinese currency). However in the mid- to long-term I suspect countries dependent on exports to China will go through a painful transition.

Overall EM is cheap on both a local currency basis and USD basis, however I want to decrease my overall exposure to a potential Chinese black swan. Goldman Sachs stated in a 2016 - 2020 forecast that "Chinese stocks could see a downdraft similar to Japan's 1990s post-bubble tumble. That could leave mainland equities with a 7-8 percent a year decline over the period". I will sell my MSCI EM index ETF and be more selective in my EM exposure going forward.

I have gathered data covering the twelve most important EM countries excluding China and made an investable index based on three criteria: Valuation (graph #3), percentage of exports to China (graph #1) and 2016E real economic growth (graph #4). The valuation measure is based on annual expected real return from 10Y Shiller P/E reversion in local currency and the current dividend yield. The three criteria have equal weight and each country receives a score between 1 - 12 where 12 is the best score for each of the three criteria.

The four countries that received the best total scores were Poland, Turkey, India, and Russia according to the investable index (graph #5). I will not invest in India as India´s current valuation is stretched. I will invest in ETF´s reflecting the equity markets of Russia, Poland and Turkey, where I will overweight Russia as I am a strong believer in an improved oil price in the mid- to long-term: Oeistein Helle: Stein´s law makes me 99 % certain that the oil price will bounce back in the mid- to long-term

Graph #1: Percentage of total exports to China

                                 Source: International Monetary Fund


Graph #2: Short-term GDP growth sensitivity to a 10 % devaluation of the Chinese currency

                              Source: Oxford Economics


Graph #3: 10Y expected local currency real return derived from Shiller P/E and dividend yield

                                 Source: Research Affiliates LLC. 


Graph #4: 2016E real GDP growth

                                 Source: International Monetary Fund

Graph #5: Final EM investable index

                                 Source: Oeistein Helle

Disclosure: I wrote this article myself, and it expresses my own opinions. I am not receiving any compensation for it. I am planning on going long MSCI Poland/ Turkey/ India/ Russia ETF´s.

S&P 500 Shiller P/E and beyond

As you may know the Shiller P/E or CAPE ratio is a valuation measure which divides a stock price or an index price by its 10 year average earnings per share or earnings per unit. The Shiller P/E measure enables the analyst to view the price-to-earnings relationship in a complete business cycle context. The Shiller P/E measure has been proven useful in order to evaluate under or over appreciated sectors or markets. If a market´s multiple as represented by an index is far above its historical median, a reversion to the median may occur over time. An overvalued index may yield poor average performance the next ten years. All below data has been gathered from Research Affiliates LLC. and is of 31 December 2015. 

US large cap stocks as represented by the S&P 500 index currently has a 26x Shiller P/E vs. its historic median of 16x. In terms of the Shiller P/E measure the S&P 500 index valuation is stretched. US small cap stocks as represented by the Russel 2000 index currently has a 46x Shiller P/E vs. its historic median of 40x. In terms of the Shiller P/E measure the Russel 2000 index valuation is close to its historic median. 

US large and small cap stocks current Shiller P/E vs historic median:

                                          Source: Research Affiliates LLC.

First of all, do not pay too much attention to the net of inflation expected return calculated by Research Affiliates Inc. as the expected return is based on the reversion of the Shiller P/E measure and a 10 year forecast of both economic growth and dividend growth. Do not fully trust 10 year forecasts as the future is more random than what analysts are willing to admit. 

Although US large cap stocks as represented by the S&P 500 looks expensive from a Shille P/E standpoint one may argue that the current pricing is in equilibrium:

• The recent S&P 500 correction has slightly improved the index Shiller P/E
• The forward S&P 500 P/E multiple is currently close to its 20 year average
• The index data dates back as far as 1871. One may wonder if 19th century asset pricing is relevant today. I am quite sure that the current S&P 500 Shiller P/E would look less stretched if compared to the last 25 years median 
• Current risk-free interest rates are low. If you remember CAPM from school such low rates support higher valuation multiples as low interest rates decrease the discount rate applied to future cash-flows in DCF valuations
• The S&P 500 index is less volatile than many other comparable international indexes
• Compared to its historic median the S&P 500´s Shiller P/E is skewed as the measure includes depressed financial crisis earnings 

As an alternative to US stocks you may want to take a look at the below mentioned emerging markets which currently are priced at or close to the minimum of their historic Shiller P/E ranges. Note that the data is based on USD inputs. Keep in mind that some of these Shiller P/E´s are supported by shorter data time-series, resulting in less reliable Shiller P/E measures. Furthermore some of these markets are changing rapidly which may result in an even less reliable Shiller P/E measures. Some of these economies are currently in trouble and you need to be a believer in cyclical rebounds in order to find them investable. However if you are a contrarian like I am you should definitely take a second look at these:

Selected emerging markets Shiller P/E vs historic median:

                                Source: Research Affiliates LLC.

• Brazil is represented by: MSCI Brazil index
• China is represented by: MSCI China index
• India is represented by: MSCI India index
• Malaysia is represented by: MSCI Malaysia index 
• Poland is represented by: MSCI Poland index
• Russia is represented by: MSCI Russia index
• South Korea is represented by: MSCI South Korea index
• EM Equity is represented by: MSCI Emerging Markets index

Disclosure: I am long MSCI Emerging Markets UCITS ETF (acc).

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

Do not panic!

• Russel 2000 is down by 25 % from its 2015 high 
• FTSE 100 is down by 19 % from its 2015 high 
• Nikkei is down 21 % from its 2015 high 
• Shanghai is down 40 % from its 2015 high 
• Oil is down by 70 % from its 2014 high 

There is no doubt that we are currently experiencing a global bear market in equities and commodities. However I do not believe this is a 2007 - 2008 type of cataclysmic once in a lifetime market crash. This is why: Oeistein Helle: Ongoing S&P 500 correction not like 1973, 2000 or 2007

I know they are telling you that low oil prices somehow will result in a recession in the US and in Europe. This does not make any sense as low oil prices are good for most of the global economy including the USA, Western Europe, China, India and Japan. I also know that they are telling you that this is all China´s fault, a country experiencing growth inline with expectations. Furthermore China is not an important export market for the USA which accounts for 5 % - 7 % of the S&P 500 companies revenues.

Corrections and bear markets in equities may occur for no good reason at all, they just happen unexpectedly and violently. If you are not up for annual 10 % corrections, semiannual 20 % bear markets or 30 % or more equity devaluations a couple of times each decade you should not be in stocks. I do not live in Florida anymore, however the stock market is a good alternative to Disneyworld´s wild rides.

Do not panic and do not sell everything. Rebalance and pick up assets as they reach your pricing thresholds. Fun fact: This is the 34th S&P 500 correction since 1950. 

GDP and oil price with negative correlation, GDP increases when oil prices are low:

                                 Source: Forbes

Real GDP growth in China, actual vs. consensus forecast:

 

                               Source: Tradingeconomics

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

Ongoing S&P 500 correction not like 1973, 2000 or 2007

• Since 1938 "super bear" markets resulting in a 40 % or more drop in the S&P 500 from top to bottom has only occurred three times (1973, 2000, 2007)
• Between 1938 and 1973 no "super bear" markets occurred (35 year stretch) 
• Between 1974 and 2000 no "super bear" markets occurred (26 year stretch) 
• Each of the three "super bear" markets have been driven by strong negative fundamentals or out of touch pricing of the index. As the current US and global economy is experiencing healthy growth in combination with a reasonable but somewhat bloated index valuation (see graph #1) I do not believe that we are entering into "super bear" market territory. In fact most S&P 500 sectors are currently trading at or close to 20-yr avg. pricing both on a forward and trailing basis (see graph #2)
• The current correction (10 % drop in index valuation) may turn into a bear market (20 % drop in index valuation), however I do not believe that we are entering into a 2007 - 2008 type of situation as I do not observe a driver for such an event. In my humble opinion the current correction is starting to look like a opportunity to buy stocks on the cheap  

• 1973 (-48.2 %): The termination of the Bretton Woods system in 1971 (gold standard) in combination with the 1973 OPEC oil embargo hurting the US consumer through the devaluation of the dollar and expensive oil. Double digit inflation
• 2000 (-49.1 %): Out of touch market valuation driven by big idea companies often lacking a business plan. Companies were valued by their burn rates and not their profits (or lack thereof). The S&P 500 was valued at a 27.2x forward P/E ratio vs 16.1x today  
• 2007 (-56.8 %): A massive housing bubble was fueled by speculative lending practices which led to a subprime mortgage crisis. The collapse in housing prices in combination with the rising oil price sent the market into the abyss

Graph #1: Current S&P 500 valuation looks somewhat bloated but reasonable (nothing like 2000)

                              Source: JP Morgan


Graph #2: Most S&P 500 sectors are currently trading at or close to 20-yr avg. pricing

                               Source: JP Morgan

Graph #3: 1973 "super bear" market

                                Source: Yardeni Research Inc.

Graph #4: 2000 and 2007 "super bear" markets

                                Source: Yardeni Research Inc.

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

Statoil fires thousands of employees while borrowing billions to pay dividend

The Norwegian E&P company Statoil which is 67 % state owned is planning to cut NOK 30 billion in expenses while trimming its staff significantly. Reasonable measures considering the ongoing oil price collapse. However Statoil has also decided to borrow funds in order to increase its annual dividend payment to its investors. In 2014 the dividend payment was NOK 33.7 billion. As seen in the below graph, Statoil is currently generating negative cash-flows. 

Statoil YTD Q3 2015 cash-flow:

                                Source: Statoil ASA

During times of normal oil price fluctuations I understand the need to pay a growing annual dividend as this is highly appreciated by investors. Consistent payment of dividend will during normal market cycles ensure lower stock volatility and lower cost of capital for E&P companies. With that said, what we currently are experiencing in the oil market is not a normal market cycle.

Instead of firing employees hand over fist while using borrowed money to pay dividend, Statoil should in my opinion utilize its human capital and financial strength to improve the company´s future growth prospects. It should be common sense to use the current downturn constructively by spending the borrowed money on maintenance, exploration and drilling as such services are cheap these days. Such a move may hurt the stock price in the short-term, however it should enable Statoil to catapult into the next bull market. Both the Statoil investors and the Norwegian people deserve a national oil company which is able to take responsible long-term decisions. Currently Statoil is all about quick fixes.

Average large semisubmersible rig day rates:

                                Source: IHS

Spot rates Offshore Service Vessels:

                                   Source: DVB Bank

Disclosure: I am long Statoil ASA. 

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.

Berkshire Hathaway offers great value vs. S&P 500

You may find the comparison between Berkshire and the S&P 500 silly as the S&P 500 is a broad diversified share index and Berkshire is only one company. It is important to understand that Berkshire is an investment company holding approximately 50 listed stocks and controls somewhat 60 privately held subsidiaries within various industries. This means that statistically you are covered as far as diversification goes. In theory Berkshire may be the only US stock you have to own. I also keep reading that Berkshire is an insurance company. However for 2014 only USD 7b out of USD 24.5b in EBT for the group stemmed from either insurance or insurance related investment activities. The group´s total non-insurance EBT has increased from 3b to 17.5b from 2004 to 2014. In my perception Berkshire is a large mutual fund/ private equity fund combination that have a tendency to beat the broader market.

Why you should buy Berkshire instead of a S&P 500 ETF: 

• Berkshire has a 0.9 beta, which means that it may hold up better than the S&P 500 in the case of a correction
• Berkshire has somewhat of a support level if the stock falls below the 1.2x book value threshold  as such pricing may trigger a stock buyback program (Warren Buffet stated that 1.2x book value is a bargain compared to intrinsic value). The stock is currently priced at 1.27x book value. For the last ten years the stock has not been priced below 1.05x book value
• Berkshire holds huge amounts of cash which it is ready to deploy if a large market correction should occur. The investment company has a track record of being offered advantageous deals during downturns 
• Berkshire has proved above average performance by following a simple investment strategy: To buy unique but simple businesses with strong positions in the market, with solid management at reasonable prices. The S&P 500 basically holds the 500 largest listed companies in the US, including the ones with weak business models and poor management
• Berkshire has proven over time the ability to grow their book value at a superior rate compared to the S&P 500. Although their absolute return performance has decreased as the group has grown larger, they still have a ROIC of 8.88 % vs. a WACC of 8.15 % meaning that their active investing still produces value above the cost of capital  
• You avoid to invest in the "blue chips of the future" companies such as Amazon, Tesla, Netflix and Facebook which are partly responsible for the current bloated pricing of the S&P 500 with their stretched valuations 
• And at last valuation:                                                                                                  

Berkshire is significantly cheaper on a trailing P/E basis than the S&P 500 (currently 13.89x vs. 20.25x)

                               Source: Gurufocus

Berkshire´s lower P/E does not reflect its superior ability to grow earnings over time

                               Source: Gurufocus

Disclosure: I am long BRK.B. 

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.

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.

Stein´s law makes me 99 % certain that the oil price will bounce back in the mid- to long-term

Some weeks ago I made the case for a significantly higher oil price in the mid- to long-term (2016 - 2018) than the current price. Thus far the oil price development has been flat or slightly down since my prediction (brent currently trading at 45 and WTI 42 USD/ bbl.). I am quite sure that I mentioned something about how it is impossible to predict the oil price in the short-term (if I did not I am mentioning it now).

Currently it is quite simple to make the case for a lower oil price in the short-term and Goldman Sachs has stated that there is a high probability for the oil price to plunge to 20 USD/ bbl in the coming months.

The case for a lower oil price in the short-term:

• A mild upcoming winter has been predicted
• It costs more to store oil as cheap storage already has been filled
• Even stronger dollar due to expected higher interest rates in the US
• Increased supply from Iran

Currently oil is trading at a mid to long-term disequilibrium as the marginal cost of replacing the oil we are currently consuming is significantly greater than the current price (70 - 80 USD/ bbl.). Furthermore demand is growing.

Stein´s law simply states that "if something cannot go on forever, it will stop". As for the oil price we can restate the simple but brilliant quote to: "since the oil price cannot trade below its marginal replacement cost forever, it will stop". For you that don not know, Herbert Stein is the former Chief Economist to Richard Nixon.

We do not know when the oil price will bounce back, however we know it will. My best guess is at some point during 2016 - 2018 (due to the case I made some weeks ago). As a long only value investor with a long-term horizon I am heavily invested in dirt cheap oil companies. At some point I am quite sure it will make me a lot of money... in the meantime the hedge fund shorts will laugh their shorts of making money hand over fist.

If the oil price plunges even lower in the short-term I will buy even more oil stocks.

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

Bayerische Motoren Werke AG (BMW) - Brilliant company that was dragged down by VW

As a value investor looking for themes the german car industry was a solid opportunity post the Volkswagen driven "dieselgate" scandal. VW dragged down the stock price of BMW, without BMW having anything to do with the scandal. The financial press reported fake stories regarding the company´s involvement in the scandal assisting in the stock´s bearish development.

I bought a significant position in the company 2nd October and have thus far had a 28 % return on my investment. At the time of the purchase BMW was trading at a trailing P/E of 8.6x. The stock is currently trading at a trailing P/E of 10.7x, still significantly below most comparable companies. I will exit my position when the company is trading in the 12 - 13x trailing P/E range (inline with the rest of the industry). The company´s justified trailing P/E is 12.5x if one assumes a 5 % growth in dividends, 8 % required rate of return and a 34 % payout ratio. It is not too late to get in on the action.

Peer analysis:

                               Source: Financial Times

Besides still being priced cheaply compared to many of its peers BMW is one of the most valuable brands in the world and a solid company that has proven steady growth. According to Forbes BMW is the 16th most valuable brand in the world, and the second most valuable automobile brand. The brand´s focus on solid, quick and sporty cars have been a successful receipt for decades.

Automobile brand value:      

                                Source: Forbes

Consensus expected earnings growth BMW:

                               Source: Financial Times

My BMW M4 (I may hold on to this stock out of loyalty):

Disclosure: I am long Bayerische Motoren Werke AG

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.

Audi AG - High-end brand on discount - not doing much - structural nightmare

At the same time as I invested in Volkswagen I also picket up some Audi shares (and BMW which will be discussed on a later date) as they had been dragged down alongside Volkswagen on the tail of the "dieselgate" scandal. At that point there were no public news regarding Audi's involvement in the scandal. My point of view was that I now could buy the premium brand Audi at a significant discount.

Since I bought the shares Volkswagen's share price has made a significant comeback, while Audi has done nothing. The share just sits there, looking somewhat illiquid and confused regarding its own existence.

Audi has tended to trade at a discount to its peers BMW and Daimler historically due to structural issues. Frankly, I am not sure why the share floats at all considering that 99.5 % is owned by Volkswagen and only 0.5 % is free-floating. I am also confused regarding the disappointing annual dividend payment (0,5 % dividend yield) where outside shareholders receive the amount that is paid as a dividend on one Volkswagen ordinary share each fiscal year. I have no idea how that makes sense.

On a more positive note the share trades at a significant discount to its historical Price/ Book and P/E. Furthermore the company is experiencing above industry growth and has proven resilient and solid profit margins.

Audi delivery growth:

                                Source: Audi AG

In essence Audi is a solid company and brand with a stock currently trading at a steep discount to historic trading while being confused regarding its own existence. I will sell the stock as soon as its pricing multiples normalizes as I don't know if and how the structural discount will ever cease to exist (and yes, I do know VW could at some point float more shares, or take over the floating shares at fair market value. VW could even sell the whole company in a trade sale, however the current situation has not changed in decades).

Audi Price/ Book development

   Source: YCharts

Disclosure: I am long Audi AG

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.