Author: Gísli Eyland

There are just too many interesting things going on

The Fundamentals are in the Footnotes

The whole point of fundamental research or value investing or whatever you want to call it is to get an edge by looking a little deeper than others are looking. This is why you won’t get very far by using stock screeners.

Stock Research on Onverstock.com 

We recently published a stock report on the Fundamental Finance Playbook about Overstock.com. The article is a deep dive into the current status of the company’s online retail business. We try to figure out if the business is, in fact, in a turnaround as management claims, or if the company is at risk of running out of cash.

Previously, the management had stated that they were trying to sell the online retail business but so far nothing has materialized. During our research phase we noticed that during the last quarter, consulting fees on the corporate level had increased significantly. By corporate level, we mean not connected to the operations of the online retail business nor the blockchain ventures.

Overstock engaged Guggenheim in 2018 to explore strategic options for the retail business and find possible buyers. If the consulting expenses are mostly in the “Other” business segment and neither in the retail operations nor the tZero operations, it is plausible that Overstock is already in advance negotiations with potential buyers through Guggenheim.

What that indicated to us, was that there was a possibility that Overstock was already working with Guggenheim Securities, the company that Overstock employed to find buyers, on advanced negotiations with possible buyers. These kinds of transactions usually require heavy due diligence, so it would be quite plausible that costs would ramp up like this.

Two Potential Acquirers 

A week after we published, Patrick Byrne, Chairman and CEO of Overstock said in an interview with CNN that the company was in negotiations with two potential acquirers. It remains to be seen if anything materializes from this, but it goes to show that sometimes the fundamental facts are buried in the footnotes.

Stock Report | OTC Markets (OTCM)

OTC Markets (OTCM) is an American Financial market providing price and liquidity information for Over-The-Counter securities. The company was founded in 1913 as the National Quotation Bureau since the company has changed many names. The company operates in the Financial Services space.

Business Segments

The company primarily provides 3 services:

OTCQX

OTCQX is the trading platform that connects clients to broker-dealers, providing liquidity and execution solutions.

OTCQB

OTCQB is the new reporting and market data compiling service. It grants access to various channels like Bloomberg, Thomson Reuters, etc.

OTC Pink

This is the corporate services pack, which helps companies to better engage and inform investors.

OTCIQ

Apart from these primary services, OTCM provides a service to other businesses called OTCIQ. OTCIQ serves as an investor relation portal for the company to monitor security market activity and transmit information to investors.

Management

The top brass of OTCM is highly qualified and rich with experience. The CEO, president and director, Cromwell Coulson took over in 1997 when the private company was nothing more than a publisher of quotations. Coulson and his team have transformed OTC into a publicly-traded company, operating in 3 markets and seeing an annual trading volume of just under $200 billion. 

CFO, Bea Ordonez, has over 20 years of experience in the financial services segment; she is also a member of the Institute of Chartered Accountants in England and Wales. Jason Paltrowitz, Executive Vice president of Corporate Services, has served had held management positions in renowned companies like JP Morgan Chase and BNY Mellon. 

The company’s management is more than qualified and has a great track record; OTCM has not received any warnings or penalties for non-compliance with rules and regulations in the past few years.

Market Statistics

  • Simple day moving averages 50 days: 33.72
  • Simple day moving averages 200 days: 32.1
  • 52 week Range: 25.37 – 40
  • Lifetime high: 39.95

Valuations and Competitors

  • P/E – 25.32
  • EPS- 1.36
  • NOA- $13,972
  • NOPAT- $16,148.19
  • RNOA- 1.15

Business Model

OTCM lacks any direct competitors, and therefore enjoys an almost monopolistic operation. This makes it hard to determine the exact value of the business is the lack of comparison with other publicly traded stocks. News Corp-owned MarketWatch is a close rival of OTCM in the news and press segment. Both companies publish investor reports and function in the financial service space.

However, News Corp currently trading at 12.6 has been in losses for the past 2 years. Its share has shed nearly 22% over the past year and hence can’t be considered as a comparison. On the Exchange side of things, OTCM would be dealing with the likes of NYSE and Nasdaq. Both of these exchanges are considerably beyond OTCM’s reach as of now. Hence OTCM enjoys a niche that is unlikely to change in the near future. This while making OTCM harder to value could also be seen as the advantage of the business having a unique business model.

Key Financials

(all $ figures are in thousands) 

  • EBIT: $19,645 (up 7.32% from 18,304, in 2017)
  • Net income from operations: $16,237 (up 28.8% from 12,599, in 2017)
  • Cash and Cash Equivalents: $28,813 (up 21.66% from 23,683)
  • Total Assets: $41,649 (up 14.6% from 36,317)
  • Total liabilities: $25,240 (up 12% from 22,526)
  • Net cash from operating activities: $22,590
  • Net cash from financial activities: -$15,882

Operating expenses for the company have grown at a steady rate signalling a steady expansion in the business. Net income from operations grew by 19.2% from 2016 to 2017. In 2018 it’s up 28.8%. However, that’s not the whole story because of a one-off item in the company’s gross revenue. In 2018 there was a one-off licensing deal with Bloomberg LP contributing to 10% of gross revenue from licensing, amounting to $2,338.

The model of the company allows it to be heavy on cash almost at all times. Therefore the cash and cash equivalents are larger than all other assets combined. Both the Cash and cash equivalents and the Total assets have increased. The total asset growth is faster than the total liability growth and there has been a sharp spike in the other liabilities item. 

This is causing the growth rate difference between the 2 to seem close however this will not repeat in the next quarter causing the difference highlighted more clearly. One of the most important items to notice in the balance sheet of the company is that its short and long term debt is 0. Being debt-free is always a big positive for any company.

The net cash from investments has been low, signalling that profits are simply being reinvested in the core business. However, the company has stated that it would make further acquisitions in FY 2019. The financing activity in question has been dividend payout and the operating profit has increased by nearly 37% from the previous year.

The Peltzman Effect & Risk Compensation

Peltzman effect is a theory which states that people tend to increasingly engage in risky behaviours once a security measure has been mandated. This effect is named after Sam Peltzman, an economist who postulated the theory with the use of seatbelts in automobiles.

The original context of the theory was the regulation of risk as the government tries to make things safer by issuing new regulations. Peltzman used auto safety as a case study, where the government made people wear seatbelts and also regulated various other features in the manufacturing of automobiles, such as pop-out windshields and other protective devices which are meant to make us safer.

The Economics of Risk

According to economic theory, when you make things cheaper then you will get more of them.  This is what led to Peltzman postulating that when you make a car safer in this way, drives will adjust their behaviour in response to the perceived level of risk.

In other words, if driving becomes safer, the drivers will become riskier when driving. Hence, the increase in safety measures will be compensated by riskier behaviour. This is what economists call Risk Compensation. In the case of auto safety, Peltzman predicted that the increase in risk behaviour would lead to more accidents, that would partly or completely offset the safety benefits of the regulation.

Later, Peltzman performed a study to see what the effects of the first generation of automobile safety regulations were auto-related accidents. The study did not focus on the first order effect (driver safety) but on the global effect (did more people survive on the road or did the automobile death rate goes down).

Risk Homeostasis

The conclusion of the study was that there was no effect on the death rate but there was a reduction in the probability that you would die in an accident which is the main purpose of the device. However, this benefit was completely offset by more accidents and many accidents involve people who weren’t in cars that are protected.

The Peltzman effect shows that people tend to drive recklessly and with less attention since they felt safer in the car which leads to more accidents than when these safety devices came out. The ratio of fatalities in accident went down but there was an increase in the accident which offset the decreased fatality rate.

He then concluded that if government regulates risk or anything, there is going to be an incentive created for behaviours that offset some part of what the government is trying to regulate and it could be a complete, partial, or more than complete offset. And the main thing that this regulation does is that it makes the consequences of an accident less severe.

Examples of Risk Compensation

Although the Peltzman study used the auto safety regulations as an example of risk compensation, this phenomenon has been observed in a range of activities. A few examples would be:

  • The use of helmets in skiing, snowboarding and rollerblades has been observed to increase risky behaviour.
  • A popular aphorism amongst skydivers, named Booth’s rule nr. 2 states that the safer skydiving gear becomes, the more chances skydivers will take constant

The Water and Diamond Paradox

How can we know the true value of a thing? This has been a philosophical question that dates back to the times of Aristoteles. Philosopher throughout the ages have asked themselves why water which is vital for all life is cheap while diamonds are expensive even though we can easily do without them?

Diminishing Marginal Utility

The solution to the Water-Diamond Paradox is the economic law of diminishing utility. This can be defined as the economic law which states that when there is an input in the production of a community while the other factors are fixed, it is going to get to a point whereby any addition of the good to the consumer of the good is going to lead to low satisfaction with the diminishing increases in the output.

Supply and Demand

A case study is that assuming you are hungry and you find one apple then it is going to precious to you and you are going to eat it to satisfy your hunger and to stay alive. Then if you go for a walk and you see two more apples then you can eat one just for the fun of it and keep the second one till when you are hungry.

If you then happen to see an orchard with lots of apple fruit and you decide to stay close to the orchard, it will come to a time when you will grow tired of eating an apple as it will be nauseating to you. You can then trade some apple for some other commodities that other people will find it to be valuable to them while it is invaluable to you.

This case study shows that each additional value of a given good satisfies a less important need. You can see this as the first apple that you take is mainly for the appraisal of your hunger so as to survive while the second apple fills you up and the third apple was kept for later so as not to be hungry in the future.

This also implies that the first apple that you saw was priceless as you need it to avoid starvation while the second one was just a pleasurable snack while the value of other apples that you find keeps decreasing.

There is no such Thing as Fixed Value

The example above shows that no good has a fixed value. A good will always be considered valuable when people value them. For example, imagine that your parents would buy a sculpture which they really love. Later, once they once they are passed on, you inherit the sculpture. However, you have never liked the sculpture and you feel like it is taking up space.

You mean to throw it away but you’re reluctant to do so because of the sentimental value your parents attached to the sculpture. When discussing your predicament at a party, you discover to your amazement that there is an art collector in town that has been looking for this exact sculpture for years. Suddenly your perceived value of the sculpture has gone up and you are not willing to part with it unless the art collector submits a reasonable bid for the artwork.

In the context of the Water-Diamond Paradox:

  • During a drought, people would value water more than rare diamonds as they need it to survive.
  • As soon as there is enough water, they will tend to value diamonds more as they have the essential needs to satisfy their hunger and thirst then people try to satisfy their sophisticated needs.
  • This theory applies to all the needs in human lives.

How do Bankruptcies Work?

Did you know that bankruptcy affects a great number of people? One in ten persons is likely to file bankruptcy. In 2017 alone, 767,721 people have filed for bankruptcy in the United States.

Going through a bankruptcy is a painful and the process itself can be quite frustrating and stressful. In this article, we will try to address some of the main concerns you might have regarding bankruptcy and how they work.

Photo by Melinda Gimpel

Types of Insolvency

First things first: A bankruptcy is a procedure that aims at giving financial relief to a person who has reached a state of insolvency. This basically means that the person has reached a point where he or she is unable to pay back the debt that he or she owes. There are two types of insolvencies: cash-flow insolvency and balance sheet insolvency.

  • A cash flow insolvency means that a person is not able to meet debt repayments.
  • A balance sheet insolvency means that the debtor does not have assets to cover his liabilities.

Nonetheless, bankruptcy and insolvency or not synonyms. Bankruptcy is a legal status of a person. Not all insolvent persons are bankrupt. For a person to be bankrupt, a bankruptcy has to be filed with courts.

Declaring Bankruptcy

While a person can declare bankruptcy, often the bankruptcy process is initiated by a creditor. A bankruptcy process will differ between countries and states, but in general, the process is as follows:

  1. A petition is filed and approved within the judicial system.
  2. A trustee (most often a lawyer) is assigned to the estate and control over all assets moved under his control.
  3. The bankruptcy is announced in a public venue and creditors are asked to file claims on the estate.
  4. The trustee is tasked with monetizing the estate and distributing the proceeds to the claimants based on the seniority of their claims.
  5. Once claims have been settled and the estate has been wound down, the debtor is discharged. The timing of the discharge after the wind-down of the estate can differ greatly between countries.

Bankruptcy in the United States

In the United States, there are two main options to choose from when it comes to personal bankruptcy, namely Chapter 7 straight bankruptcy and Chapter 13 repayment plan case.

Chapter 7

The first option – namely chapter 7 – it enables you to have all your outstanding debt discharged, granted that some liquid assets have been utilized in order to repay part of the debt. The only situation in which you can file for this type of bankruptcy is if you can demonstrate that your current income is lower than the average income for a family in your home state.

Chapter 13

In case you don’t qualify for this, then you will have to choose chapter 13. This plan entails paying a specific portion of your debt in a payment plan of three to five years. As a rule of thumb, these payments are made to the courts.

In the position of a business, then you might file Chapter 1 bankruptcy. Through this option, you have the opportunity of restructuring and reorganizing through a court-appointed trustee. More specifically, you will have to follow a given plan to cope with your creditors.

Note that bankruptcy will remain on your file for five years – at the very least. Therefore, make sure you think this through before resorting to it.

Benefits of Going Bankrupt

The positive thing about bankruptcy is that it usually translates into a discharge. This will prevent your creditors from collecting on debts. Nonetheless, note that there are still some exceptions to the rule and some of these are alimony and child support obligations, recent tax liabilities, and so on and so forth.

Another potentially positive aspect associated with bankruptcy is, of course, the automatic stay. This represents a preliminary court decree that prevents creditors from actively trying to collect debts from you during the actual bankruptcy timeframe. This means you will not be contacted via mail or phone in this respect. Essentially, the automatic stay applies until the bankruptcy court decides to issue a discharge.

The Bottom Line

Bankruptcy is usually the last resort of a person in financial difficulties. There are many nuances when it comes to filing for bankruptcy and options to choose from. Therefore, getting legal and accounting counsel is paramount for anybody considering his or her options.

Should I Invest in Gold?

All investments have to be made by taking into account the objectives of the portfolio, the allocation of assets, and the need for the new investment into the overall investment strategy. Hence, before investing in gold it is best to carry out a basic review of the portfolio goals and then make a choice.

The start of 2016 featured dull economic growth and feeble energy prices which caused the share market to open at its worst. This resulted in an increased demand for gold and its price soared. However, as the year progressed, the share market outperformed gold and by the year ending it was 3 percentage points above the yellow metal.

You may go through the below-listed pros and cons of gold before investing in it.

Advantages of investing in Gold

  • It is a great hedge against inflation and currency: Gold and other precious metals are a good source of hedging any risks such as a possible decline in the US Dollar or other major currencies. Price of gold tends to rise with the weakening of a currency. It is argued that high inflation is marked by increased prices of gold, which safeguard purchasing power. However, there are many who debate this argument. Additional information about the relationship between inflation and gold prices is provided below in the article.
  • Portfolio diversification: One of the major aspects of a good portfolio is diversification wherein there is no correlation between different classes of assets in the investments. This means that the different asset classes fluctuate in their own unique way thereby offering some protection during times of volatility. Over the past 5 years, the price of gold has differed from the different share indices and the movement of each is independent of one another. Thus, gold and other precious metals are a great way to diversify the portfolio.
  • Hedge against economic collapse: Gold and other precious metals can be a great source of barter when the world economy is in turmoil. Over the course of history, it has been observed that people purchase gold as a hedge against uncertain times. When the world appears to be in a state of disarray, investors like to buy and own gold. For example, in 2008, during one of the worst global financial crises in recent times, there was an appreciation of gold by 5 per cent while stocks tanked by nearly 40 per cent. Gold gained over 7 points against stocks in 2011 when it seemed that the United States may default and the credit rating of the country dropped.

Disadvantages of investing in Gold

  • The returns in the long-term are low: As compared to shares, the returns offered by gold have historically been low. It thus makes a bad investment selection for the long term.
  • No revenue in form of dividends: Investment in gold does not offer interest, dividends, or any other type of income. Hence, one of the most renowned investors in the world, Warren Buffet, is against investment in gold or other precious metals. Currently, the interest rate is low, and hence in such a scenario lack of income will play a smaller role as the opportunity cost with regards to investment in gold will be lower.
  • The worth of gold is determined by what a buyer is willing to pay for it: Gold does not have an intrinsic value. Thus, it’s worth can drop if people decrease their investments in gold. Also, it would not be of great value in a barter market as people may consider something like toilet paper or other true consumables to be worth more than gold which does not really take care of any human needs on its own.

The relationship between gold and inflation

It is said that gold does not offer any yield. The definition, however, states that increased interest rates will offer some yield to gold investors. On the other hand, if the FED detects inflation and increases the interest rates, then people will sell gold and purchase Treasury notes for better returns. This will cause the price of gold to drop.

President Trump has stated that he will begin a public works program amount to $1 trillion. Such fiscal stimulus may cause the inflation to rise sharply and making the FED increase the interest rates. This may eventually result in a drop in gold prices.

The above example has to be read in context with what happens in reality and not in theory. It is important to note that the FED does not increase interest rates haphazardly. It wants the inflation to be under control, but its main aim is to keep negative real rates wherein inflation is higher as compared to nominal rates. Raising the interest rate will not offer any positive effect unless there is a faster rise in inflation. This is the scenario where its job of wealth preservation is done by gold.

In the late 1970s, the United States was on the brink of hyperinflation, the gold price was about $130, and Treasury notes dived under 7 per cent. By 1980, gold reached its peak price of over $800, while the ten-year Treasury returns were over 10 per cent. To avoid a worldwide run on the dollar, the FED chief took anti-inflation steps in October 1979. The price of gold kept rising till it reached its peak, but the stranglehold kept on by the FED eventually yielded results and gold prices started to dive.

The current Fed chief, Janet Yellen, may not strangle inflation as in the above example. In the late 70s, the FED had hiked up the interest rates above the inflation rate. However, in 2018, the FED is most likely to increase interest rates but keep it under the rate of inflation.

Different financial issues across the world like persistent unemployment, the European debt crisis, and a hangover of the housing crisis, etc., have created an environment that is fraught with a probable collapse of the global economy. Hence, hedging in gold will offer stability and protect your ability to continue trading for varied goods and services.

 

Is Netflix Worth its Valuation?

Netflix has grown to become a $180 billion dollar Market Cap company. If you add their net debt, that adds up to a total capitalization – aka Enterprise Value – of $192 Billion.  Not bad for a company founded in 1997. Not bad at all.

Price Per Potential Subscriber

If you divide the $192 billion Enterprise Value by the 236 million people that populate the United States of America, you arrive at a value of about $815 per each compatriot of Wilmont Reed Hastings Jr. This is where you might point out that Netflix is a global brand with a global audience. Well, that computation, my friend, would allocate $25 worth of Netflix per human inhabitant of the earth.

NFLX EV/EBITDA Multiple

In the last twelve months, Netflix’s Earnings Before Interest, Tax, Depreciation and Amortization was $2 billion. That means that Netflix is trading at a multiple of 96 times its trailing EBITDA. Disney, by comparison, is trading at a multiple of 11.

So, imagine this scenario: For the next 10 years, Netflix grows its EBITDA by an annual rate of 24.19%. At the end of the tenth year, Netflix’s EBITDA will have reached $17.5 billion. That’s a very healthy growth. But for this to happen, paid subscriptions would have to be close to 1 billion.

Needless to say, a Netflix with 1 billion subscribers does not have the same growth potential as a Netflix with 130 million paid subscribers. What if Netflix was now trading at the same multiple as Disney is trading at today? That would mean that after ten years the enterprise value of Netflix would be $192 billion.

Price is what you pay for. Value is what you get.

 

 

Should I Invest in Bitcoin?

The cryptocurrency market has experienced tremendous growth over the last decade; especially in the case of Bitcoin as opposed to other altcoins; Bitcoin is a digital currency that came into the market early in the year 2009.

What is Bitcoin?

Bitcoin’s operations are purely decentralized with no entity given the responsibility of controlling it. Apart from Bitcoin, there are several other cryptocurrencies available in the market today; the most common ones include Ethereum, Litecoin, Tether, Stellar or BitcoinCash.

Since December 2017, Bitcoin’s value has escalated up to about $1900. However, its value has experienced volatility since then, despite the prediction of digital analysts of financial showing the value will increase to $50000 by 2025. This looks quite confusing whether to or not to invest in Bitcoin? Before making a judgment let’s check over some fundamental aspects of in relation Bitcoin investment;

Is Bitcoin Safe?

There has been a hot debate over the years whether Bitcoin is a safe investment. Regardless of the negative stories on bitcoins that people hear, Bitcoin has proven to be more secure compared to other financial systems.

Firstly, the Bitcoin’s operations are decentralized such that over ten thousand nodes are responsible for keeping track of Bitcoin ledger and validate all the transactions in the network to ensure the security of investor’s money. On the other hand, the centralized system can be easily compromised by hackers or third party. Also, Bitcoin uses proof of work to enhance security and prevent any possible failures in the system.

Moreover, the transparent transaction done using bitcoin is also an indication of its safety. Additionally, a customer does not need to provide confidential information when using the Bitcoin Wallet and thus are not a risk of revealing their identity to possible malicious people.

Is Bitcoin Legal?

The question of the legality of any currency is understandable. Unlike the traditional currencies controlled by a single entity, in most cases the central bank, Bitcoin is unique. The Bitcoin is decentralized and primarily under nobody’s control. Generally, the legality of the Bitcoin currency entirely depends on what are you doing with it, where are you in the world. Nevertheless, is essential to be always updated on the recent regulations that may arise with regards to digital currency.

An Investment or a Currency?

Currency can be defined as a unit of account and store of value or a medium of exchange. On the other hand, Bitcoin as per definition can be termed as an asset. In this case, an asset can be used to serve various purposes. A currency should be trustworthy, convenient and stable. Bitcoin has experienced volatility and fluctuation in value over a long period. Its instability, therefore, cannot qualify it as a currency but rather an asset or a commodity. The value of commodity usually surges. It creates an exchange value that is affected and modified by underlying marketing expectations.

How do I value Bitcoin?

There are several ways of valuing cryptocurrencies. One of the best methods of determining the value is by evaluating the market that the cryptocurrency trades in. In this case, the value of Bitcoin can be determined by assessing the supply and demand in the market. In other words, the price of Bitcoin depends on the interaction between the sellers and buyers. A Bitcoin trader who believes that its rate will increase in future will be willing to purchase it at a more expensive than the existing one.

Wrapping Up

The rising demand for digital currency has got the attention of many people in the financial industry. Some of the advantages of investing in bitcoins include protection fraud, minimized risk of identity theft, direct transfer lower fees of transactions as well as the access to difficult-to-access markets. However, some of the limitations are the uncertainty of its legality, high volatility and high risks of loses. Conclusively, based on the above discussion, investing in Bitcoins might be a risk worth taking, having in mind the demand is growing tremendously, and the number of users is doubling yearly.