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Old 04-16-2016, 08:26 AM   #321
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And yeah, all of this has relevance to investment decisions as it relates to the sustainability of historically high corporate profit share, without which current equity valuations make no sense whatsoever.
It's not the margin, it's the profit, cash, and EPS. If the margin were to fall but the profits and EPS increase, businesses would be worth more. I think the focus on margin does not lead to anything actionable.

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my answer and concern that corporate profitability has stopped going up since 2010 and investment has been limited while stock buybacks continue and that this trend cannot go on forever.
Buybacks don't need to go on forever, just until businesses find another way to generate EPS growth. The move sideways for profits over the past couple of years has coincided with a strongly strengthening US$ and sharply declining commodities prices, and that cycle looks like it may have run it's course. Markets are forward looking. Are we at a point where the risk of being out of the market is now rising again?
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Old 04-16-2016, 08:39 AM   #322
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It's not the margin, it's the profit, cash, and EPS. If the margin were to fall but the profits and EPS increase, businesses would be worth more. I think the focus on margin does not lead to anything actionable.
True, but they're related. Here's a chart of corporate earnings. They explode after the 2000 recession at exactly the same time their share of GDP also explodes (see previous chart). If the share goes down to something approaching their historic average, earning will go way down too . . . and likely the stock market with them.



So trying to understand why corporate share of national income is so high helps us form options about how sustainable today's earnings levels are.
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Old 04-16-2016, 08:48 AM   #323
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And here's what has happened to Corporate Cash Flow (in red) and Capital Expenditures (in blue)



So around 2000 cash flow started massively outpacing CAPEX. But that's not because CAPEX has fallen. It looks to be about the level we'd expect based on it's previous trend. So it's not obvious that companies are underinvesting in their businesses to fund share repurchases; or at least not in aggregate.

The huge expansion of free cash flow meanwhile should allow large share repurchases to continue even as earnings have declined from recent highs.
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Old 04-16-2016, 09:00 AM   #324
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But isn't this all counter-intuitive?

Why is capacity utilization low in a time of high margins?

Wouldn't it make sense for the CEO to say "hey, we should use some of this idle capacity we've already paid for to make more widgets?" One reason ...:
But not the only reason. If your product doesn't have additional demand, it just may not make sense to invest capital to make more of those widgets. And if your current production equipment has been largely paid off, spending capital to add production could force you to increase prices, not lower them. Higher prices, more products on the market is not a recipe for higher profits.

Even if they could lower prices, just because I bought your widget for $100, does not mean I will buy a second, just because you dropped the price to $90. In some cases, 1 widget is enough.

Looks like things other than price affected gas consumption for example. Increase in price from 1999 to 2008 accompanied an increase in sales, and a drop in prices from 2011 to 2015 accompanied a decrease in sales. Would a CEO who increased refining capacity in 2011 have looked 'smart'? I think a smart CEO would have tried to position the company to make as much $ as they can from this lower demand.



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Old 04-16-2016, 09:06 AM   #325
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The huge expansion of free cash flow meanwhile should allow large share repurchases to continue even as earnings have declined from recent highs.
Running_Man's point was about profits, but cash generation has followed the same pattern, moving sideways since 2010. The S&P is up more than 75% since then, so cash from business is buying back much less outstanding equity, and has a far lesser impact on EPS. Businesses need substantial new debt for that.

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Old 04-16-2016, 10:15 AM   #326
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But not the only reason. If your product doesn't have additional demand, it just may not make sense to invest capital to make more of those widgets.
I think we're mixing a lot of different things together.

The original comment by MB was that we had low capacity utilization, and that explained why we didn't have more CAPEX. That's a fair point.

But we don't just have low utilization. We have low utilization and high margins. So why not run existing plant more? It's not necessarily a matter of investing new capital, it's a matter of working existing capital harder to reap more of those high margins.

Now with that as a table setting, your point about possible lack of demand is also a fair point.

But that leaves us with a situation where people are willing to pay high prices on existing sales but there is no additional demand for more units even at lower prices. That's hard for me to conceptualize across an entire economy.

And even if we can come up with a theory for why that last paragraph is true, we'd also need a theory of why new competitors haven't driven margins down by trying to take market share from incumbents.
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Old 04-16-2016, 10:22 AM   #327
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Running_Man's point was about profits, but cash generation has followed the same pattern, moving sideways since 2010.
That measure of cash flow subtracts out net dividends (as per the definitions). Adding back in cash returned to shareholders we get this . . .



Agree, though, that we're looking at reduced purchases at the margin relative to the recent past.
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Old 04-16-2016, 10:46 AM   #328
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And here's what has happened to Corporate Cash Flow (in red) and Capital Expenditures (in blue)



So around 2000 cash flow started massively outpacing CAPEX. But that's not because CAPEX has fallen. It looks to be about the level we'd expect based on it's previous trend. So it's not obvious that companies are underinvesting in their businesses to fund share repurchases; or at least not in aggregate.

The huge expansion of free cash flow meanwhile should allow large share repurchases to continue even as earnings have declined from recent highs.
Interesting charts, this and the others, but I think would be more informative if they could be posted instead on a log plot since these hockey stick charts give what is often an illusion of quiet in the past and volatility in the present.
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Old 04-16-2016, 11:04 AM   #329
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...

Now with that as a table setting, your point about possible lack of demand is also a fair point.

But that leaves us with a situation where people are willing to pay high prices on existing sales but there is no additional demand for more units even at lower prices. That's hard for me to conceptualize across an entire economy. ...
I agree that my oversimplified binary illustration of an individual not needing two of something gets watered down when you apply it to the broad market - but I think there could still be a curve to that price/demand that would say that it isn't worth the CapEx to make more widgets at a lower price (and again, that new CapEx might actually increase costs).

In fact, some of these industries may still have over-capacity from the boom times. You certainly would not buy new, if you were under-utilized on the current capacity. I've lived that scenario.

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And even if we can come up with a theory for why that last paragraph is true, we'd also need a theory of why new competitors haven't driven margins down by trying to take market share from incumbents.
Barriers to entry. All that new CapEx, new marketing to attract customers, R&D etc - all those risks could mean they will pay a high price to attract capital. Barriers to entry do not imply 'monopoly', but it does move in that direction, making it tough to unseat the established players. But that's almost always the case - even when barriers to entry are low, people can be reluctant to do business with the new, unproven guy.

Which reminds me of a lesson I learned early in my career. My MegaCorp had a near monopoly in one particular product segment (legal, as far as I know - a very good product at a good price and good service). I asked management why we didn't raise prices on that product. He replied that we didn't want to 'subsidize' our competition. IOW, a very high margin market meant that a competitor could come in, and even if they were inefficient, and had higher costs than us, they could still make a decent profit, take customers away, and then they might learn how to lower costs further, and eat our lunch.

Sometimes it pays to not be too greedy (but in the long run, isn't that the 'greediest' thing you could do?).

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Old 04-16-2016, 11:41 AM   #330
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Barriers to entry. All that new CapEx, new marketing to attract customers, R&D etc - all those risks could mean they will pay a high price to attract capital. Barriers to entry do not imply 'monopoly', but it does move in that direction, making it tough to unseat the established players. But that's almost always the case - even when barriers to entry are low, people can be reluctant to do business with the new, unproven guy.
Yup. Barriers to entry.

And yes, I used the word "monopoly" quite loosely for simplicity. Oligopoly, Monopolistic-competition, or some other form of imperfect-competition fits better. And even then not every definition fits equally well in all cases.

But there are some paradoxes that are worth trying to explain. Why are margins so high and interest rates so low. Why has corporate income vaulted to historically high levels of national income. Why is corporate capital spending not increasing with historically high returns on capital. Why are cyclically adjusted equity PE values persistently above their long-term average?

Declining competition among firms would explain all of these factors. Or maybe its simply a greater willingness to exploit market power that has always existed (see pharmaceutical pricing). None of this excludes other possible answers. But declining competition is an answer that fits exceedingly well with a bunch of macro level trends.

And if declining competition happens to be a correct answer, than we should expect high equity valuations, high free cash flow, and large share repurchases to persist for quite some time (that's not saying we won't have business cycles). If there's some other reason, then all of those things may be less durable. In that case equity investors might have reasons to worry that are far more serious than the next turn in the business cycle.
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Old 04-16-2016, 12:19 PM   #331
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Perhaps US businesses are not investing more because there is not enough aggregate demand and additional capacity is not needed.
But they could invest in capital that would result in lower variable costs (labor replacing equipment for example) and in higher quality / lower scrap and rework costs and not increase capacity. They don't seem to be doing that to any great extent either.

Yeah, I know I'm thinking primarily manufacturing here.
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Old 04-16-2016, 04:29 PM   #332
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Running_Man has been right before. I had a fun ride on this coaster the past 18months or so but its time to get off and get back in the line to find some more winners.

P/Es were getting outta whack so I locked in 5.6% profits and did a little bit of early tax loss harvesting.

I'm not ERd yet but I'm happy with my results in what has otherwise been a down market. I pulled out last time Running_Man chimed in and I think it snagged me 5% on the way down back then...so I figure why not lock in 5% on the way up, that's a nice 10% gain in past 24mos for me. I'm sure i could do better if I knew what i was doing

Now it's back to the drawing board for picking some winners, as I unloaded GOOGL APPL DPZ DAL DPZ CASY XOM VUG VOOG and a few mutual funds.

Time to do some bargain shopping, I've never been this far out with 81% real cash. I would feel more comfy at 50/50 until the next drop...maybe 75/25...I need some growth.
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Old 04-19-2016, 08:36 PM   #333
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is anyone else holding their breathe. Holy crap hahahha. I am still out but I have my sights on some.
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Old 04-20-2016, 05:18 AM   #334
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is anyone else holding their breathe. Holy crap hahahha. I am still out but I have my sights on some.
Wow, you are really out of the market (18% equities). I am not holding my breath but I am just < a year from RE and this week followed my plan to reduce AA around S&P 2100 from 70% to 65%. With modest new deposits since last year I am at about my previous all time high for investment portfolio value, and with valuations high that also seemed a good time to take a few chips off the table. I am not trading, this is a permanent move.
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Old 06-10-2016, 08:45 AM   #335
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Back to 25% as of this morning sold the VTI purchased on February 24th for a 10.85% gain. Being up here over by the big triple top in the past year and the 6th time over the last 2 years with earnings continuing to not grow is enough for my conservative nature to reduce back to the 25% level and watch the market for a while.
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Old 06-10-2016, 11:18 AM   #336
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Also today switched individual stocks due to valuation reasons out of ACN and into LMT. This is a continuation of my valuation switch originally out of HRL earlier in the year when I sold that stock @44.37 and bought ACN @ $98.09 Now with the rise to $118.39 the dividend yield was down to 1.8% and I view LMT economic outlook equal to ACN while paying a much higher dividend and actually viewed HRL economic outlook much the same as both of those (not to be confused with stock price) yet even with the recent HRL fall n stock price to $34.75 that yield is still only 1.67% and too low even though I like the prospects of the company just fine.

So why do this? Using dividends, payout ratios, expected values of the cash flows from companies that have good economic outlooks to me,HRL I sold HRL yielded $1.30 per year in dividends for each $100 of capital value. Switching into ACN with that same capital increased that amount to $2.22 per $100 of capital. Now with the increase in capital due to the 20% price appreciation and the higher dividends LMT will provide $3.25 per $100 of capital originally invested in HRL on the date I sold. This valuation switching between stocks with secure dividends growing faster than inflation has resulted for me in dividend income that grows far faster year by year than the inflation rate. I am commenting on this switch only because it is unusual to have such changes in positions of stocks I actually find good investments but still sell due to dividend valuation issues. A good part of this is because of the interest rate policy by the central banks results in my investing in stocks with dividends not as far above my preference of a 2% minimum and investors jumping on good yield plays, which has made my style of investing right now profitable.

Being able to protect my capital from a 22% plunge in HRL stock and instead get a gain of 21% in ACN (capital per $100 of $121 vs $78), is not even the main advantage I see of my actions it is the increase in secure dividend income. Stock prices are merely a reflection of what the market i is willing to pay and in the next month they might drop their prices across the board by 50% for all I know. As long as the companies are able to maintain their business and not encounter economic difficulties my income, which I live on will remain unaffected and my choices for valuation switches in the face of a large stock market decline will show increases in potential dividend income per $100 of capital, while my capital base will have declined my income potential is largely unaffected. This is why I try to stay out of areas where I see economic trouble that pay good dividends, such as the banks in 2007-2009 and oil stocks from 2014-2015. While I am a dividend investor I look for good companies with good dividends not troubled companies with most likely good dividends.


The total YTD return on my individual stock portfolio is 11.64% versus the 3.75% return on VTI, though my own investment in VTI this year returned 10.85%
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