Investing Flashcards
Are US Industries Becoming More Concentrated?
Since the late 1990s, over 75% of US industries have experienced an increase in concentration levels. We find
hat firms in industries with the largest increases in
product market concentration show higher profit margins and more profitable mergers and acquisitions deals. At the same time, we find no evidence for a significant increase in operational efficiency. Taken together, our results suggest that market power is becoming an important source of value. These findings are robust to the inclusion of (i) private firms; (ii) factors accounting for foreign competition; and (iii) the use of alternative measures of concentration. We also show that the higher profit margins associated with an increase in concentration are reflected in higher returns to shareholders. Overall, our results suggest that the US
product markets have undergone a shift that has potentially weakened competition across the majority of industries.
Research Paper: Are US Industries Becoming More Concentrated? Gustavo Gr
Stock market - is a hot potato
someone has to hold the stocks
Argument for DCFs and against multiples
Here’s the challenge. With discounted cash flow models, the value is sensitive to the inputs. But the assumptions underlying the inputs are explicit. You can compare them to base rates, discuss them, and debate them. With multiples, those assumptions are buried. The assigned multiple becomes a point of persuasion rather than a thoughtful case based on the economic drivers of value.
A logical and useful place to start untangling price-earnings multiples is the foundational paper on valuation that professors Merton Miller and Franco Modigliani (M&M) wrote in 1961. In it, they addressed a fundamental question: “What does the market ‘really’ capitalize?” They did not crown a winner among approaches that rely on earnings, dividends, or cash flows. Rather, they showed that all of these methods yield the same result if you address the problem correctly. They say that you can separate the value of a company into two parts:
The steady-state value of a firm is the worth of the business assuming that it maintains its normalized level of NOPAT into perpetuity. A company arrives at its steady-state value when its incremental investments earn the cost of capital. With the second term of the equation collapsed to zero, all of the firm’s value falls on the steady state.
Note that this discussion is independent of growth. A company can continue to grow earnings as it invests at the cost of capital. It will just fail to create value, and hence should trade at its steady-state worth. We can readily translate from the steady state value to a steady-state price-earnings multiple, which is the reciprocal of the cost of equity:
The exhibit provides a very simple example of the march toward a steady-state price-earnings multiple. This company starts with a return on invested capital of 56 percent and a growth rate of 25 percent. Justifiably, the stock’s price-earnings multiple is a very high 70 times. We then fade the returns on capital from 56 percent to 8 percent, the assumed cost of capital, and slow the growth rate from the mid-20s to 5 percent over the subsequent 25 years. The warranted price-earnings multiple glides down from around 70 times to 12.5 times. This is the commodity multiple
Analysts who argue that the price-earnings multiple of a company that was prosperous in the past should
revert to a previous level must be particularly mindful of this pattern. Unless a company’s prospects for growth
and return on incremental capital are consistent with prior levels, a condition that is generally very difficult to
meet as a company grows, then there is no reason to believe that the price-earnings multiple will match
historical levels. Multiples may rise if the cost of capital falls, but that value driver affects all stocks in a similar
fashion.
Ratio of P/E to Steady-State Multiple for Walmart, Microsoft, and Gannett
We can’t assume that all companies can sustain their current levels of net operating profit after tax.11 For example, companies that make desktop personal computers, print books, or publish newspapers are facing secular challenges. In these cases, we can modify the steady-state value with a variation of the Gordon growth model:
Value Growth Opportunities - The M&M formula tells us that there are three key drivers of value creation:
P/Es Given Different Scenarios for ROIC and Growth
- First, a company earning its cost of capital will trade at the commodity price-earnings multiple, 12.5 times in this case, irrespective of growth. You can imagine these companies as being on an economic treadmill: You can speed up or slow down the treadmill of growth and it makes no difference, the companies are not going anywhere. Value neutral companies must first figure out how to increase ROIIC before they worry about growth.
- Second, if a company is generating returns in excess of the cost of capital, growth is good. Indeed, all things being equal, faster growth translates directly into a higher price-earnings multiple. For instance, the warranted price-earnings multiple for a company with a 24 percent ROIIC and 4 percent growth is 16.1 times, whereas a company with the same ROIIC but a more rapid growth rate of 10 percent is worth 25.7 times. The value of high ROIIC companies is extremely sensitive to changes in perceived rates of growth.
The final component of future value creation is how long a company can find attractive investment opportunities. M&M referred to this as simply “T,” but it is also known as “value growth duration,” “competitive advantage period,” and “fade.” This period is closely related to sustainable competitive advantage. Some companies are able to find attractive investment opportunities over a long time by virtue of the industry in which they compete, the strategies they select, the capital allocation choices they make, and some luck.
- average span of T?
- how many years of value creating growth are accounted for in prices?
- The anticipated period of value creating investment opportunities is different for various industries. For instance, research by Brett Olsen, a professor of finance, suggests that the market-implied competitive advantage period averaged about 8 years from 1976-2007, with a span of roughly 5 years for very competitive industries to 15 years for industries that are more stable.
- The period of attractive investment opportunities has attracted considerable research attention. There are a few things we can say to summarize the work. First, the market tends to impound value creation for many years in the future. It is common for the market to reflect a half dozen years or more of value-creating investment opportunities in the price of a stock. This empirical reality counters the notion that the market is strictly short-term oriented.
Three Paths to a 15.0 Times Price-Earnings Ratio
Buffest Alpha explained:
- Berkshire Hathaway Sharpe ratio of 0.76 - higher than any other stock or mutual fund with a history of more than 30 years, and Berkshire has a significant alpha to traditional risk factors.
- However, alpha becomes insignificant when controlling for exposures to Betting-Against-Beta and Quality-Minus-Junk factors. Further, we estimate that Buffett’s leverage is about 1.6-to-1 on average.
- Buffett’s returns appear to be neither luck nor magic, but, rather, reward for the use of leverage combined with a focus on cheap, safe, quality stocks.
- Decomposing Berkshires’ portfolio into ownership in publicly traded stocks versus wholly-owned private companies, we find that the former performs the best, suggesting that Buffett’s returns are more due to stock selection than to his effect on management.
Unusual Shareholder Meetings - abnormal returns:
If a shareholder meeting takes place one year unusually at a different place… -12% in 6 months?
For remote place: -6%?
