Urban Survival’s Inside Report # 3 November 4,2001
NOTICE: All contents © 2001, George A. Ure, except other authors as noted. This document is intended for the sole use of subscribers and may not be transmitted, reproduced, or in other way used without the prior express consent of the author. This publication is by subscription: $30/year for web browser accessed delivery to a password protected site (price effective until January 1, 2002), and $100/year if delivered by U.S. mail within the U.S. and Canada. Overseas subscriptions are US$ 250/year which includes postage. To subscribe, send a check to: George A. Ure, 2726 Shelter Island Drive, #322, San Diego, CA 92106. Your username and password are both your email address, in all lower case to access the protected web site, so don't forget to include it! Address comments and correspondence to: george@ure.net. Read the disclaimer: http://www.urbansurvival.com/disclaim.htm
Bot Thots
There's not much to say about the latest web bot reports, except that as I noted earlier, the "entity" that had appeared over Las Vegas has pretty much dissipated and the formation over Washington, D.C. had been more diffuse, had a "children" aspect, and was designed to shake us to our core. I waited until Sunday morning with this week's report in order to see if something was going to materialize. It hasn't.
I will put an update on this site (and the public side, too) should an event occur - so we can see whether the bots were a hit or miss.
Unfortunately, as has happened in the past, we may have to wait a couple of weeks before it becomes clear what the bots were really trying to signal. For example, the late September warnings from the bots about attacks on the "house" and "assemblage" were not deemed to be the attacks using anthrax on the government buildings in Washington, D.C. until a couple of weeks later.
Although we may have an attack any time through the night of no moon, and still meet the "darkness ascending" timeline, it's quite possible that either the warning by California's governor about bridges helped prevent an attack, or, it's possible the "tipping point" of this event has occurred and we just don't know it yet. An attack with aerosols on a stadium full of football fans or a massive mailing of more anthrax letters would meet these criteria.
So, while we settle down to wait, let's get back to the less emotional study of the markets and what's going on in our economic future...
Reality Ratio, III
I don't know how long each and every one of my subscribers has been reading the work that has been posted on the public side of www.urbansurvival.com, but I think it's time we revisit one of the underlying premises of the stock market: Do companies really make products or are they just stock hype vehicles?
Which companies are in business to make products, and which companies are in business to make lawyers, accountants (and other ner-do-wells) rich, at the expense of the people who actually make things in the country.
I got on this kick when I noticed, at the height of the Internet frenzy, that companies were not only selling at huge multiples on a price earnings ration basis, but they were also selling at incredible multiples of their total annual volume of sales. By the way, I don't own any of the stocks discussed here. I'm pretty well disgusted with the lot of them. Not that I have anything against the good companies like Ford or Dell, or Procter and Gamble (I might make an exception for Amazon), it's just that with prices bid up so high relative to sales, I wonder if I am buying a piece of a business or just paper in some huge Ponzi scheme.
I call this simple view of a companies sales versus the dollar value of their stock traded in a year the "Reality Ratio". Think of it as though you were the owner of a lemonade stand, although the analogy works fine if you want to use a turkey farm. I mention this not only because Thanksgiving in nearly here, but because so many of these companies have been real turkeys over the past two years since I posted the original work. Check my math on this, but had you put your money in the bank back in the fall of 1999 when the first work was done, you would be money ahead today holding cash rather than investing in an equally weighted portfolio of the companies in the study.
I don't want to rub your nose in it, especially because you may not have seen the light about Wall Street hype until recently, but not one of the sample companies I picked at random back then, except IBM, is worth more today. They're all worth less. Not worthless...just worth less.
OK, back to the original work. I looked at widely (and as it turned out "wildly") held stocks back in 1999 and asked "What's the ratio of the annual stock handle (turnover valuation) versus the actual goods sold?" I asked this of Dell Computer, IBM, Amazon, Ford, Caterpillar, UAL, and Proctor & Gamble. Most of the stocks I selected didn't pay a dividend, but things have been so far stretched from an accounting standpoint that it hardly matters in terms of calculating whether the companies are getting "ahead'er or behind'er in how they are doing business.
Let's revisit the data from the original work, and then compare what the Honorable Chairman's marvelous high-productivity economy has really brought to the Thanksgiving feast in return for two years of patience holding these gems. Here's what I wrote back then:
Determining the Value of a Business: If you had a million dollars land in your lap, what would you do with the money? Believe it or not, some people would buy a business. In order to decide what a fair value for a business is, a potential owner must look at a long list of items. But the short list comes down to:
Is the business capable of making money? Is it making money now? If not, why do I think I can make money with it when the present owners can't? (I've seen lots of investors lose piles of money by not understanding this point. Every prospective business buyer thinks "I'm way smarter than that dumb person who owns the business now...so I will make a killing." To to extent that a person wants to sell a losing business, the dumber they act (allowing the prospective purchaser to believe their self delusion about how smart they are) the high the odds of the sale occurring! (Sales is how I make my living and this is an interesting sales dynamic to see...)
Will the business provide a realistic return on my investment?
How much should I pay for a business?
Standard Values: Lots of people buy and sell businesses every day in America. The standard "back of the envelope" valuations are two simple numbers: 10 times profits, or 2.5 to 3.5 times sales. Write that down. What makes sense for people buying and selling video stores, grocery stores, gas stations, and the like,, ought to work for all businesses. [In the table below, I updated the color-coding to show anything over 1 in red, under .5 in green and in the middle in yellow - GU.]
Now consider Stock Companies: A stock company is one where ownership is distributed to many owners. So if you want to make an informed investment decision, you could consider how often ownership changes hands each year!
Thanks to the web, doing this kind of basic research is incredibly easy. Yahoo! has made it a snap with their company profiles sections. Just for fun, sport and amusement, I calculate a "reality ratio". I take the number of shares of a company traded daily over a recent three month period (a) times the recent stock price, times 235 trading days to arrive as an educated guess about what the value of stock (annual stock sales) of the company amount to. This is now compared with the most recent (ttm=trailing twelve months) of actual sales of product reported by the company.
Put another way, the reality ratio suggests that if a company is selling more than 3-4 times more stock than actual product, it may well be a stock speculation enterprise. A company that is trading much less than stock "handle" to product "handle" may be more reasonably viewed as an investment.
Hard Realities? Let's apply this concept to a selection of a few companies and see what it shows us - if anything. For the purpose of discussion, lets look at some techs (IBM, Amazon, Dell) some Transports (Ford, UAL) and some basic stuff you need to keep a complex society going: Food and Heavy Equipment (Proctor & Gamble and Caterpillar).
(Prices taken from data available at time of writing on 10/23/99)
(a) | (b) |
© | (d) [(a*b*c)] | (e) | (f) | |
Company |
Avg. Vol | Price | Days |
Est. Annual Stock Sales | Product Sales TTM | Reality Ratio |
Dell | 26,200,000 | $39.50 |
235 | $243,201,500,000 | $21,700,000,000 | 11.21 |
IBM |
8,360,000 |
$91.00 | 235 | $178,778,600,000 |
$88,500,000,000 | 2.02 |
AMZN | 12,500,000 | $80.75 |
235 | $237,203,125,000 | $1,010,000,000 | 234.85 |
F |
2,630,000 |
$53.13 | 235 | $32,836,996,500 |
$156,000,000,000 | 0.21 |
|
CAT | 1,300,000 | $52.12 |
235 | $15,922,660,000 | $20,100,000,000 | 0.79 |
UAL |
489,500 |
$61.00 | 235 | $7,016,982,500 |
$17,800,000,000 | 0.39 |
PG | 2,210,000 | $100.88 | 235 | $52,392,028,000 | $38,100,000,000 | 1.38 |
Using the Ratio: Now, obviously, you can't just go out into the market and buy stocks based on this ratio stuff. Obviously, UAL has an exposure to a declining economy and rising oil prices that would be part of your learned consideration of whether to invest in that stock. No, I am not suggesting that you withhold further investment of Amazon because of its huge stock handle compared to actual sales. But you might want to ask yourself how long before the reality ratio catches up. To drop to 2.34, Amazon would need to either sell 100 times more product, or the stock price would have to come down. You might ask when a company like Dell gets into the double digit level, how soon before sales increase three times (or stock volume and/or prices decline) to get the ratio down to that ~3 kind of range.
Fast Forward
Now let's see where things were at the close of trading on November 2. Again, I'm using the data in the profile part of my favorite general purpose (and free) financial news source, http://quote.yahoo.com. Put in the symbol of a company you want to sniff around, and click go and then select profile. You'll get all kinds of useful data like how much cash is on hand to how much the top brass of the company are pulling down in annual compensation.
That's where you get the data for this exercise: 3-month average daily volume, recent price, and sales over the trailing twelve month period (ttm). Ready?
(a) | (b) |
© | (d) [(a*b*c)] | (e) | (f) | |
Company |
Avg. Vol | Price | Days |
Est. Annual Stock Sales | Product Sales TTM | Reality Ratio |
Dell | 27,600,000 | $24.55 | 235 | $159,231,000000 | $32,000,000,000 |
4.88 |
IBM | 8,560,000 |
$109.89 |
235 | $221,054,000,000 | $88,700,000,000 | 2.49 |
AMZN |
6,000,000 | $6.95 | 235 | $9,962,000,000 | $2,980,000,000 |
3.35 |
F | 5,960,000 |
$29.14* |
235 | $22,930,000,000 |
$163,900,000,000 |
0.14 |
CAT | 2,070,000 | $42.20 |
235 | $2,200,000,000 | $20,500,000,000 | 0.11 |
UAL | 1,080,000 |
$13.10 |
235 | $3,320,000,000 |
$18,000,000,000 |
0.18 |
PG |
3,400,000 | $75.98 | 235 |
$60,700,000,000 |
$39,000,000,000 |
1.56 |
*Ford recent price was $16.37. The price is shown at $29.14 to account for a 1.78 stock split in mid 2000. The annual stock sales value is basis the $16.37 recent price.
Now let's see if we can go through this a little bit, company-by-company, and see if we can develop a little understanding of just what is going on with these fine companies - stalwarts of American business, who in the past two years should have reaped some large benefit from all of our harder work, and increased spending that our Federal Reserve reminds us so much about. When we're done, I think you'll see that something isn't adding up.
Oh yeah, one little kicker that I think I will throw in: Inflation. Even though things are "under control", the Consumer Price Index has continued to climb, which means that the government has debased our monetary system at least 5.5% since the original work. So when we talk about sales, we're going to report the actual sales, but in our analysis, we'll discount the 2001 sales figures by 5.5% to compare 2001 dollars with 1999 dollars. This inflation correction will really help us see what's going on. Ready? Let's delve into the sales figures, shall we?
Dell: This company's trailing 12-month sales have gone up handsomely. From $21.7 billion to $32 billion. Even after we knock off the inflation factor, the company would be at $30.24 billion in 1999 dollars. Not bad - and Michael Dell oughta be happy. His big just-on-time manufacturing machine has done well. His investors? Well, that's a different picture. For every $39.50 you put in two years ago, you'd expect just to keep even with inflation to take $41.67 back out. But, sorry my friend, you'd be looking recently at 24.55. However, if it makes you feel any better, I'll tell you what I will do. For each $100 you mail me right now, I will hold on to it for 2-years and then return you your $100 less 37.8%. Why if I can convince enough readers to do this, perhaps I will be able to make the $2.6 million per year that Michael Dell make - before options..
OK, so Dell has done great for Michael Dell (and I'd call $200 million great) but not so well for investors in for the long haul, at least so far. But if I owned stock in this I'd be wondering who I could peddle the stock to even at these prices. With no dividend and a recession here, those trailing 12-month sales figures are probably going to fall. And with that, the stock price may not hold even these levels.
IBM: This was one of the original go-go stocks. A darling of the street. This is the company that literally owned the whole computer business and managed to blow it to Compaq and that young upstart from Microsoft. Still, in our two-year snapshot had you had purchased shares, you'd be ahead about $18 a share, not counting the dividend. Yes, the share price was beating inflation by a bit. But there's trouble for IBM in their sales figures and in their "reality ratio". The stock has actually gotten more expensive and is now even more of a "stock play" company that a company that "makes real things for people". Sales in 1999's trailing 12-month report were running $88.5 billion. While today's $88.7 billion looks like an increase, let's remember that when we correct the sales figures for 5.5% inflation over 2-years, IBM's sales are down about 5%.
Again, you've got to look at the company and ask "What's going to propell this into the stratosphere in the developing recession/depression?" If you see anything, let me know because I sure don't see it. I see a company whose core business is being gobbled up by networked computers and that's before I get into an analysis of how much of their money is coming from leases and look at that part of the future.
Amazon: I don't want to say "I told you so!", but while most of the business reporters in this country were busy screaming "Bezos is God" I was looking at the reality ratio and think "Hmmm, I wonder if this is for real?" Well, sure enough, gravity has worked its magic. Amazon has come down from $91 a share to a possibly still over-priced $6.95. REmember my earlier offer on Dell? You send me $100 and I will send you back $7 in two years. Maybe then I too could make the cover of Time Magazine, huh?
As I look at the profile of Amazon, the thing two things that stick out are that their reality ratio is still way high. I would argue that they have nearly three and a half times more stock turnover than sale of product. If that doesn't scare you onto a different company look at their cash on hand in the most recent quarter ($668.1 million) and then how big a hole they are digging each year (EBITDA was a loss of $524.6 million) and then work out for yourself how long this deal keeps playing. I think it will take a year or two longer for Amazon to break up because I expect they are working day and night to stop the bleeding. But bleeding they are..
Ford: Ford's kind of an interesting company. They have managed to pump up sales through acquisitions. While the most recent performance hasn't been anything to write home about, the stock price has come down from the 50's to the mid-teens, but it's r,eally around $29.14 because of the ,1.78 split factor from the mid 2000 split. The company has recently paid a dividend, is actually making money in the trailing 12-month numbers, although things are looking less rosey now that the recession is blooming. We would expect sales at $156 billion to be around $164.5 billion, and they are slightly below that figure. Which probably explains the recent management changes at Ford.
If you had purchased the stock in the mid 50's, you'd be outright furious with me for even bringing up the recent stock price around $16 ($29 after you add back the split effects). What can I say? The good news is the reality ratio keeps coming down. I know...some consolation.
Caterpillar: If there is a company that had a great chance to become a global industrial power-house, this was it. You'd think with a reputation for building the finest diesels and big earth moving gear that this fine company would have been able to hold its own. But this is another one of those companies that got its ass kicked by cheaper just as well built overseas equipment. Kuboda, Isuzu, and a host of others gobbled up the overseas markets when American companies were trying to hang on to fat margins. It simply didn't work. Our cost structures really hurt us when overseas labor is so cheap. The stock that has dropped from $52 to $42 has been a little less painful thanks to a dividend. The sales are flat, but down 5% when you take inflation into account. It's still a well-run company, but life on the global playing field hurts. The profit margin is 4.4% and an operating margin of 7.7% Cat looks like it's close to reality.
But the gamble here is when you buy a company like this, you are gambling on the global economy doing so-so. If it does poorly, Cat is vulnerable and that dividend could shrink, or in a worst case disappear.
UAL: This one wasn't just terrorists. The stock was already hovering in the $35 range before the 9/11 attack. What had helped the company was the low fuel prices that the airlines had enjoyed. Now, even that doesn't matter. The real name of the game in airlines is utilization and load factor. You've got to fly a modern jet at least 11-hours a day to see long green stuff and with that you need load factors around 70%. Chew up either one of those numbers and the future of the company gets cloudy. It's recognizing that reality that led to the recent management changes at UAL - and it brings back one of my favorite management phrases: "Tell the truth - and leave shortly thereafter".
UAL is one of those companies that will be hugely leveraged on the up side if there's a major terrorism breakthrough. If, for example, we woke up one morning and saw CNN doing live coverage of bin Laden being brought to NYC to stand trial, surrounded by America's finest, and if there was a serious breakup of terrorism and a reunification within Islam behind moderates, UAL could be a great play: The book value is north of $87. When Americans feel safe to travel UAL could take off and the skies would be more than friendly - they'd be green.
PG Last but not least there is Procter & Gamble. At about $76, P&G is down about 25% from where it was 2-years ago. They pay a little dividend, they have a lot of cash, and there's not a day goes by when most people don't at least touch a P&G product. The company is priced about 9 times book - rich for my blood. But what's more interesting is that the company's reality ratio has actually gone up a little bit. I think this reflects a trend to leave the go-go stocks and look for "must have" companies. P&G certainly fits that mold.
But before you go out and run up the bank card on this one, realize that the sales levels are pretty flat for two years. I would have expected them to at least keep pace with inflation, but they haven't. They're up only a couple of percent instead of 5 1/2 percent.
Some Observations
I always look at sales before I look at anything else. I look at price and try to understand how people are vluing things. If I were buying apartment buildings, I would pay somewhere between 80 and 100 times the monthly rent for each unit. So when I look at this small totally unscientific sample I get concerned with sales.
They're pretty darn flat.
These companies have sales that in 2 years are up a total of 6.5%. But you take Dell out of the picture (and some of their gains came at the expense of competitors who abandon the PC market) you get a sense that America just isn't buying stuff. With the exception of IBM, the companies have been very poor investments, yet these were in 1999 some of the best we had. Look at Ford: Back then it was over 50. Today, even after the split (1.78 for 1 effetively) you've got a $29 stock. This is what brokers and telemarketers were calling me about? Get serious.
The question that hangs out there is whether in the developing recession, is there enough demand left to get a sustainable recovery going? Or, do we have to suffer through the painful consequence of wearing all of our "stuff" out.
I'm absolutely amazed that there isn't some "whiz bang" analyst on Wall Street who has done this for the Dow 30, or the S&P 500, or the NASDAQ 100. It's a simple tool, tells you how much froth there is in the market and is really meaningful to investors. But do we get this? Nope. Instead we get pretty much worthless forecasts about what a company might post for earnings in 2002. And then what happens? Companies invent one-time charges and report all kinds of happy talk ex-items. The value of Generally Accepted Accounting Principles (GAAP) just disappears when companies are allowed to paper over their sins like this. But I digress...
Answer this simple question , "Is this company in the stock business or are they really focused on making and selling a product?" and you'll be well ahead of the pack timing your entry back on the long side. Step in too early, or too late, and whether your investment of choice is real estate, bonds, stocks, or gold, you'll suffer poor returns.
It's a simple enough process. You just gotta look at the Reality Ratio. Value of annual stock sales versus sales of product. For every dollars worth of books they sell, Amazon's turning over $3.35 in stock every year and losing a bundle on EBITDA. Dell is trading $4.88 worth of stock for each buck of PC's
On to the charts:
