Category: Price

What is Inflation Anyway?

I feel like we have made inflation deceptively simple. We have this exact number for it. The Bureau of Statistics will declare something like “last month, the inflation was 2.46%, annually adjusted.” It will do so with an number that is so precise that at will have at least two decimals, implying the surgical accuracy employed to get to that particular number.

We don’t seem to ask ourselves how we come up with these number, do we?

Do We Even Know What Inflation Is?

The great Milton Friedman did not have even a shadow of a doubt: “Inflation is always and everywhere a monetary phenomenon.” Well, here is what the equally great Robert Solow said about Milton Friedman: “Another difference between Milton [Friedman] and myself is that everything reminds Milton of the money supply. Well, everything reminds me of sex, but I keep it out of my papers.”

In Japan they have been expanding the money supply for decades. They can’t seem to produce inflation, no matter how hard they try. If we ask the European Central Bank what inflation is, they say something like “inflation occurs when there is a general rise in prices.” (They will also ask if you have seen the inflation monster and offer you to watch a cartoon about price stability).

If inflation is just general rise in prices, then why do prices rise or fall? Most would say, because changes in supply and demand. Don’t prices of products and services tend to drop over time? How do we even measure this?

How to Measure Inflation?

This seams to me an exceptionally tricky undertaking. If inflation is supposed to measure changes in the price of the stuff we buy over a period of time, what happens when we start buying different stuff over time? Our behaviors and preferences are constantly changing? Imagine a lab scientist that has to test his experiment on rats one day and then repeat the experiments with hamsters.

Do you see the problem here? The stuff we buy is not constant. Take mobile phones for example. How can you realistically measure the inflation in mobile phones from one year to another? Or even, how do you compare the price inflation of mobile phones to a period 20 years ago, when there were no mobile phones?

What about all the stuff we don’t pay for yet derive some benefit from? How do you factor in the change in cost of consuming Google searches into any inflation measurement? Should you measure the increase and decrease in paid ads displayed with organic searches? 

And there there are substitute products. If pork rises in value, relative to beef, you might be inclined to consume more beef and less pork. But the baskets of goods and services will take that into account.

So next time, when you see an inflation number with a couple of decimal points. Ask yourself how it was measured and how accurate that measurement could be.

How to Value Your Job

The worst career advice that you get from people is when they say stuff like “you need to take control of your career, you need make sure you get what is coming to you, no one is going to care about you the way you do, so you need to make sure you fight for all of this stuff”, etc, etc. Those are all terrible advises. 

Your job, whatever your job is, is to add value to your employer. It is not your job to try to extract value from your employer and try to get as much of it into your pocket. Rather, your job is to add as much value as you can for the employer and then you can capture some of that value. 

Contrary to what most people think, being underpaid is a very powerful position to be in. Because, if you are adding more value than you are costing then it means also means that you are a very valuable employee. And if your employer is rational, you are going to be treated well.

Nobody has ever gotten fired for creating too much value for their employer. And nobody keeps a job very long if they are getting paid more than they are worth. 

This text was adapted from a podcast interview with legendary investor Bill Miller on Master in Business. The whole podcast is well worth the listen

Repugnant Markets | Alvin Roth on Trading Kidneys

A repugnant transaction is an economic term that describes an exchange between people that is generally perceived as morally or ethically wrong. These transactions fall outside of regular market mechanisms, hence the term repugnant markets. The repugnant nature of these transactions, cause these markets to be structurally inefficient. 

Examples of Repugnant Markets

  • Organ transplants
  • Child surrogacy 
  • Prostitution 
  • Recreational drugs

Whether a market is considered socially repugnant in not a binary definition. At the same time, what people consider to be a repugnant transaction can change over time and across cultures. Some transactions that are considered repugnant, are also illegal. Some are not.

Matching Markets

When you think about markets, the first examples that come to mind will be something like stock exchanges, farmers markets or auctions. In all these examples, the transaction is impersonal. If you want to buy a stock on the New Youk Stock Exchange, you simply need to place an order through a stockbroker. In fact, anybody can place a bid. 

Many markets are, however, personal. These markets are called matching markets. In order for a transaction to take place, a buyer and a seller need to be matched. A good example of this is the labour market. If you are in the labour market, you can’t simply choose a job. You need to match with an employer who is looking for someone who matches your skillset. 

Repugnant Transactions

In a matching market, price is not the only mechanism. For a matching market to be repugnant, it means that other people feel that it should not be allowed to engage in the desired transaction. 

Alvin Ross, the economist who coined the phrase, formulated the concept of repugnant transactions when studying kidney transplants. It is against the law almost anywhere in the world, to buy and sell kidneys for transplantation. Yet there is a black market for kidneys, which means that there are instances where individuals are willing to transact in kidneys, while people, in general, feel that it is immoral to do so. 

Alvin Roth on Repugnant Markets and Forbidden Transactions

In the following lecture, Nobel laureate Alvin E. Roth will investigate the nature of and reasons for repugnance with its implications for the design of markets. Why is it forbidden to sell and buy organs? Why is the exchange of kidneys that leads to many successful transplants allowed in some countries such as the US, but not in others like Germany? Which markets or transactions we allow, affects the choices that people have?

Watch the lecture and learn more:

Also on How to Value Stuff

The Columbo Method of Equity Research

Remember detective Columbo? He was a phenomenal character played by Peter Falk in a 1970s TV series called…you guessed it…Columbo. Detective Columbo was a scruffy and simplistic character, dressed in his signature beige raincoat and crumpy white shirt with a loosely knotted tie.

Colombo is no normal detective series, though. As is you would expect, Columbo’s job is to solve murder mysteries. However, the episodes don’t play out with Columbo delving into each case and eventually discovering who is the murderer, in a sharp twist near the end. Columbo is a detective series without the mystery.

In the case of Columbo, each of the 69 episodes begins with the scene of the murder. So, as a viewer, you know from the beginning who the doer is. The rest of the episode is a mental wrestling match between the murderer and lieutenant Columbo.

The Colombo Technique of Investigation

In each Columbo case, the murder is committed by someone close to the victim. This allows Columbo to approach the suspect as a witness or someone who can help Colombo in piecing together the pieces of the puzzle.

To the assailant, Columbo seems totally incompetent. The scruffiness of his hair and clothing give the impression that he slept in his clothes. He constantly scratches his head and he asks the assailant for help. His questions are simplistic and make him look like he’s totally out of his dept.

But Columbo is playing a part. He’s playing dumb. The perpetrator grows confident and starts to get comfortable, even annoyed. The trap is set. In the final minutes of a Columbo episode, the perpetrator has made a mistake and Columbo wrestles him down for the tap-out.

Stock Research and Colombo 

So, how does this relate to equity analysis? In stock research, there is no crime, there is no murderer. As an analyst, you have a stock and you build your opinion based on fundamental analysis.

But therein lies the caveat. You see, it is you who is the perpetrator because once you start your analysis, you start to for opinions. You will start subjecting your mind to all forms of mental biases. You become overly optimistic. You get anchored. You will start to look for confirmation in the data.

“But that’s me, I’m paranoic. Every time I see a dead body I think it’s murdered. Can’t imagine anyone murdering themselves.”  

– Lieutenant Columbo

As an analyst, you have to put on your mental raincoat and find your inner Columbo. You have to take a step back and start to ask yourself the simple question. The overly naive and borderline stupid questions. You have to confront yourself and find start to look for loopholes in your story.

Just One More Thing…

Lieutenant Columbo bombards his suspects with questions. He’s relentless. He keeps coming back with a question. He’s apologetic, he excuses himself. He just can’t help himself, he says. But he keeps coming back for “just one more thing.” 

Discount to Net Asset Value | Protect Your Downside

One way to value a stock, especially those of companies that own various subsidiaries or a portfolio of assets, is by analysing the company’s discount (or surplus) to Net Asset Value.

Conglomerate Discount – The Case of Exor

We recently took a close look at Exor N.V., the holding company that controls such publicly traded companies as Fiat Chrysler Automobiles, Ferrari and CNH Industries. Conglomerates like Exor are interesting to analyse as they tend to trade a steep discount on the mark-to-market Net Asset Values (or market-adjusted book value).

In the case of Exor, the company trades at about a 30% discount on the market value of assets on the balance sheet. 

Point of Maximum Pessimism – The Case of Dundee Corporation

If you are a Contrarian Investor, you are trying to go where other investors feel extremely uncomfortable to be. You are trying to go where others are running to the exits, but at the same time, you don’t want to be too early. 

One of those situations is materializing at a Canadian Asset Management Company called Dundee Corporation. After a series of unfortunate events (and decisions), the market capitalization of Dundee is gone from about a billion dollars to about $74 million. 

The company trades at a steep discount to book value, but for good reason. The company has been haemorrhaging money as failed investments have sucked up cash and destroyed shareholders’ capital. 

But investors may have overreacted. Even though the company is taking drastic steps to turn the business around, Dundee’s stock is trading at about a 70% discount to book value. If the company manages to stop the bleeding, a significant re-rating might be in the cards. 

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.