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Google and Facebook Getting No Love from the Big Money

Big institutional money managers tend to be the conventional sort, though I’m not talking about their blue power suits or country club memberships. I’m talking about their stock holdings. Managers tend to pile into the same set of large, mega-cap stocks because deviating from the crowd comes with major career risk.

Let me explain. Running a mutual fund is a fantastic, high-paying job, but it is also a precarious one. The fund’s success — and thus the manager’s paycheck — is directly tied to its assets under management. This creates tremendous pressure to conform to a benchmark, which is often the S&P 500.

A manager’s thinking goes like this: If I bet big and beat the benchmark by going outside the mainstream, my investors are happy…for a day or two. But if I bet big and lose, I might be out of a job.

So, the result is that most managers become closet indexers who overweight a handful of stocks and hope to beat the market by a percent or two.

Imagine how surprised I was when I saw the following chart in the Financial Times, which tracks institutional ownership of nine major tech companies. (Google makes the list twice, so it’s ten stocks but just nine companies.)

Percent Over- or Under-Weighted Relative to S&P 500

The large overweightings in Expedia (EXPE) and Trip Advisor (TRIP) aren’t that surprising. Expedia and Trip Advisor account for just 0.059% and 0.054% of the S&P 500, respectively, so even a small amount of institutional buying will put these stocks out of proportion to the rest. And the overweighting of Netflix (NFLX) is also pretty understandable given that it is one of the best performing stocks in the S&P 500 this year. It’s near the tail end of the chart that the numbers get interesting.

Two of the biggest names in tech — Facebook (FB) and Google (GOOGL) — are massively underowned by institutional investors relative to what their weightings in the S&P 500. And where it gets even stranger, institutional ownership of the less favorable of Google’s two traded share classes — the non-voting Class C shares (GOOG) — is “where it should be” relative to its weighting in the S&P 500. It’s the A shares (GOOGL), which actually have voting rights, that are underowned.

What’s going on here? Why are big money investors shunning Facebook and Google?

Let’s look at Google first. There are two issues: The discrepancy between the share classes and the overall underweighting of Google stock by institutional investors. The latter is the easier of the two to explain. Managers don’t care about the lack of voting rights because they know their votes don’t matter. For would be activists or corporate raiders, Google is an unassailable company. It’s founders hold non-traded “super voting” class B shares that make any sort of proxy battle a virtual impossibility. GOOG’s consistent discount to GOOGL, which has actually widened recently, really makes no sense in this context, so it’s perfectly logical for an institutional manager to overweight the cheaper GOOG relative to GOOGL.

GOOG_GOOGL

As for the issue of Google being underweighted overall… well, it might come back to that point I made about Google being unassailable. Google is not known for being particularly friendly to its shareholders (see “Hey Google, Stop Being Such a Baby and Pay a Dividend“). Google is a profitable company that mints money, yet it’s developed a reputation for being the plaything of its founders rather than a profit-maximizing business.

And the same goes for Facebook. Zuckerberg is a ruthless competitor and one of the few people that seems to know how to actually make money in social media. Yet Facebook has also burned through shareholder money on expensive acquisitions of dubious economic value (Oculus, Whatsapp, etc.) and expenses grew at twice the rate of revenues last quarter.

Is there a trade here?

Maybe. While I don’t see an immediate catalyst to change big money minds (neither Google nor Facebook will be paying a dividend anytime soon… sigh…), you could view the underownership as a contrarian value signal.

The safest move, however, might be a pair trade. Short GOOGL and go long GOOG and eke out an arbitrage profit as the discount closes.

Charles Lewis Sizemore, CFA, is chief investment officer of the investment firm Sizemore Capital Management and the author of the Sizemore Insights blog.

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CAPE and Expected Returns by Country

Back in February, I used data from Swiss consultancy firm Wellershoff & Partners Ltd to compare stock values across all major world markets and forecast returns over the next five years. (See “Global Stock Values: Where to Park Your Cash for the Next Five Years.”)

Wellershoff used the standard cyclically-adjusted price/earnings ratio (“CAPE”) for each country and adjusted it for macroeconomic variables such as interest rates and economic growth. They then forecast returns going forward by seeing how the markets performed over subsequent five-year periods  when priced at similar CAPE valuations in the past. (For the quants in the room, Wellershoff runs a regression analysis. If you want to dig into the numbers, they explain their methodology here.)

Today, we’re going to look at updated CAPE data from Wellershoff to see what it might suggest for future returns. As always, past performance is no guarantee of future results, but this at least gives us precedent.

So with no more ado, let’s jump into the data:

Developed MarketsHistorical Avg CAPEMacroeconomically Adjusted CAPECurrent CAPEPredicted Real Return Next 5 YearsPredicted Annual Real Return
Australia17.9316.1015.5840.006.96
Austria25.6711.1110.4165.9710.66
Belgium15.718.4417.4027.384.95
Canada19.3521.2619.0823.254.26
Denmark23.0027.9432.8834.006.02
Finland30.9410.1317.1322.244.09
France20.0813.2715.3056.039.30
Germany18.1719.6018.1224.234.43
Hong Kong18.8218.8817.0857.829.55
Ireland14.9716.4123.62(27.46)(6.21)
Italy20.3910.3911.0547.608.09
Japan34.4229.0024.2629.965.38
Netherlands14.6815.5215.8330.125.40
New Zealand16.9618.6918.2418.633.47
Singapore21.5914.9316.8339.116.82
Spain16.838.189.9541.627.20
Sweden20.7218.6018.9157.009.44
Switzerland19.9027.0819.7831.625.64
UK12.7815.3712.9326.104.74
USA16.3517.7725.046.731.31
Developed Markets Avg22.2217.3532.835.84

Most global stock values suggest solid, if not quite spectacular returns, over the next five years. A few exceptions jump off the page, however. Ireland is priced to actually lose 6.2% per year over the next five years, and New Zealand is priced to deliver returns of only 3.5%. And by Wellershoff’s estimates, the U.S. is priced to deliver a skimpy 1.3% in annual returns. All estimates are real, after-inflation returns.

Taken as a whole, developed markets are priced to deliver returns of about 7% per year over the next five years. This is not a “back up the truck” opportunity, but it’s not bad either, particularly given how unappealing bonds and cash are at current yields.

So, what’s the takeaway here?

To the extent you can, you should underweight US stocks and overweight developed Europe. In particular, Austrian, French, Italian and Spanish stocks are priced to deliver very decent returns in excess of 8% per year. For direct access, you can consider the iShares MSCI Austria ETF (EWO), the iShares MSCI France ETF (EWQ), the iShares MSCI Italy ETF (EWI) and the iShares MSCI Spain ETF (EWP). Or for a convenient one-stop shop, you can try the Cambria Global Value ETF (GVAL), an actively-managed ETF run by Meb Faber. While the Cambria ETF does not rely exclusively on CAPE valuations in its country selection, CAPE is a major analytical factor.

Charles Lewis Sizemore, CFA, is chief investment officer of the investment firm Sizemore Capital Management and the author of the Sizemore Insights blog. As of this writing, he was long EWP and GVAL.

 

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Prospect Capital: A Deeper Look at the Most Hated Stock on Wall Street

chartProspect Capital Corporation (PSEC) may very well be the most hated stock on Wall Street.

And I say this as an investor with skin in the game. Not only am I long Prospect Capital both personally and in client accounts, I also have reputational capital at risk: I chose Prospect Capital as my entry in InvestorPlace’s Best Stocks for 2015 contest. As of this writing, I am suffering the humiliation of being in seventh place.

So, just how hated is Prospect Capital these days?

The stock is down 34% from its 52-week high and trades at a 30% discount to book value. To put that in perspective, the median business development company trades at a 6% discount to book value.

When a stock trades for just 70 cents on the dollar, it tells you that investors are questioning the reported book value. And there have been some well-publicized incidents in which Prospect Capital did indeed list identical assets at higher values than their peers, which partially explains investor hostility toward the company. Investors have also never forgiven Prospect Capital for slashing its dividend last year, even though the reduction was necessary given the de-risking of the company’s portfolio and the lower investment income that came with that de-risking.

My view has consistently been that, at the wide discounts to book value we’ve seen over the past six months, we have a wide margin of safety. According to Prospect Capital’s latest investor presentation, 75% of its portfolio is invested in secured first and second lien debt. The portion of the portfolio under the most scrutiny — the CLO equity tranches — makes up only 16% of the portfolio. If you were to write the entirety of the CLO equity to zero — which not even the most bearish of bears would do — Prospect Capital would still be trading at a deep discount to book value.

I spoke with Chief Operating Officer Grier Eliasek this week to get management’s take on Prospect’s recent share-price slide. Mr. Eliasek was very open with me and shared a set of slides that, until now, have not been released to the general public (see Prospect Capital Corporation Investor Presentation). Don’t worry, it’s ok to read them. They are based on public, reported numbers and are being reproduced with permission.

The usual caveats apply here. The data was prepared by Prospect Capital, and while I believe it to be factually accurate, I have not independently verified all of the data. And you should always assume that management has its own motives for sharing any data with the public.

So with that said, let’s jump into the presentation.

PSEC1

Figure 1: Historical Returns

 

Figure 1 comes pretty close to stock touting, but it is instructive nonetheless. This chart shows the subsequent total returns (capital gains + dividends) that investors experienced the last time Prospect Capital traded at deep discounts to book value. On March 17, 2009, Prospect Capital traded at a 30% discount to book value, just as it does today. And over the 12 months that followed, the stock returned 94%.

Can we expect those kinds of returns over the next 12 months? Probably not. March 2009 marked the beginning of one of the greatest bull markets in history, and a rising tide lifts all boats. That’s not our situation today, although I do believe total returns of 40%-50% are possible and very likely.

The next two slides will be somewhat controversial to anyone sitting on large capital losses, but it is instructive nonetheless. It also happens to be very close to how Warren Buffett has traditionally measured his success at Berkshire Hathaway (BRK-A).

PSEC2

Figure 2: Operating Returns

PSEC3

Figure 3: Operating Returns

Figures 2 and 3 measure Prospect Capital’s “Operating Return,” defined here as change in book value plus dividends. The thinking here, as with Mr. Buffett, is that management has no direct control over the share price. That is the prerogative of Mr. Market. But management does have control over the underlying investments, which show up in the company’s book value.

In recent years, most of Prospect’s returns have come from its dividend, though its total operating return has outperformed its peers in the BDC sector.

I agree that these returns are distinctly not what investors have realized in the stock. But just as Warren Buffett has asked to be judged by his growth of Berkshire’s book value, I think the same logic applies here. This hinges on book value being reliable, of course. And I raised that question with Mr. Eliasek:

Sizemore: “A lot of investors seem to be questioning Prospect Capital’s accounting these days. How would you respond to those who say that your book value estimates are overly aggressive?”

Eliasek: “We actually consider our book value accounting to be a major source of strength. We don’t value the portfolio ourselves. Our third-party valuation firms start with a blank piece of paper every quarter and value our portfolio from scratch. And our auditors approve.”

Sizemore: “How does this compare to your peers?”

Eliasek: “We consider ourselves to be among the most conservative. Some BDCs ‘self value’ or ask a third-party valuation firm to simply confirm in-house company estimates. We were one of the first BDCs to insist on truly arms-length, third-party valuation.”

Can a valuation firm be “encouraged” by management to inflate asset values? Of course. There are natural conflicts of interest when the company whose portfolio is being reviewed is the one doing the paying. We saw the same conflicts of interest with bond ratings agencies in the aftermath of the 2008 mortgage meltdown. But I would still consider the third-party valuation firms to be more reliable than an in-house valuation, and I have no reason to believe that Prospect Capital’s asset values are systematically more inflated than their peers.

When a stock is doing well, investors tend to ignore executive compensation. But when a stock is lagging, investors look at it with a much more critical eye. A consistent criticism I read about Prospect Capital is that its management team is overcompensated.

Is this true? Well, let’s look at the numbers.

PSEC4

Figure 4: PSEC Expenses

 

According to Figure 4, Prospect Capital’s expenses — the largest of which are the management and incentive fees used to compensate management — are almost exactly in line with their peers. Yes, I realize that depending on numbers provided by Prospect Capital itself is a little like allowing the fox to guard the hen house. And as an externally-managed BDC, Prospect does not disclose the compensation of its individual officers. But I see nothing here that would indicate that Prospect’s management team is uniquely overpaid by industry standards.

PSEC5

Figure 5: Insider Buying

And finally, it is only fair to note that Prospect Capital’s directors and officers eat their own cooking. The insiders are very aggressive buyers of the stock on the open market. And to clarify, these are real, open-market purchases that the executives are making with their own money. These are not executive stock option grants or other forms of stock-based compensation. Since 2010, six company officers have been responsible for buying a cumulative $43.6 million in Prospect Capital stock.

Let’s take a look at some of the more recent purchases, courtesy of GuruFocus:

InsiderPositionDateBuy/SellSharesTrade PriceCostShares Owned Following This
Brian H OswaldCFO6/9/2015Buy65,000$7.27$472,550440,000
M Grier EliasekCOO6/9/2015Buy20,000$7.23$144,600322,196
John F BarryCEO6/5/2015Buy131,060$7.58$993,4345,300,786
M Grier Eliasek COO5/8/2015Buy30,000$8.00$240,000302,196
Eugene S Stark Director5/8/2015Buy2,000$8.00$16,00028,000
Eugene S Stark Director2/11/2015Buy1,000$8.50$8,50026,000
Eugene S Stark Director12/12/2014Buy4,000$8.20$32,800250,00
M Grier Eliasek COO12/9/2014Buy25,000$8.31$207,750272,196
Brian H OswaldCFO12/9/2014Buy63,500$8.35$530,225375,000
John F BarryCEO12/8/2014Buy132,200$8.46$1,118,4124,833,410
M Grier Eliasek COO12/2/2014Buy50,000$9.10$455,000247,196
Brian H OswaldCFO12/2/2014Buy162,500$9.12$1,482,000311,500
John F BarryCEO12/1/2014Buy115,000$9.08$1,044,2004,701,210
John F BarryCEO11/10/2014Buy110,000$9.57$1,052,7004,535,544
Eugene S Stark Director11/10/2014Buy1,512$9.40$14,21221,000
M Grier Eliasek COO11/10/2014Buy5,000$9.56$47,800197,196
John F BarryCEO9/16/2014Buy100,000$10.17$1,017,0004,329,941
M Grier Eliasek COO9/16/2014Buy5,000$10.10$50,500192,196
M Grier Eliasek COO8/29/2014Buy20,000$10.26$205,200187,196
Eugene S Stark Director8/28/2014Buy4,000$10.32$41,28019,488
Brian H OswaldCFO8/27/2014Buy27,300$10.40$283,920149,000
John F BarryCEO6/13/2014Buy100,000$10.37$1,037,0004,110,959
Brian H OswaldCFO6/12/2014Buy30,000$10.25$307,500121,700
Eugene S Stark Director6/12/2014Buy1,000$10.27$10,27015,488
John F BarryCEO6/12/2014Buy100,000$10.33$1,033,0004,010,959
M Grier Eliasek COO6/12/2014Buy24,000$10.28$246,720167,196
John F BarryCEO3/20/2014Buy100,000$10.86$1,086,0003,793,385
Eugene S Stark Director2/6/2014Buy1,000$11.10$11,10014,488

Through June 9, CEO John Barry owned 5.3 million shares worth over $38 million. And most of these shares were purchased at prices far higher than today’s. CFO Brian Oswald owned 440,000 shares, and COO Grier Eliasek owned 322,196. All three men have made major new purchases in the past six months.

Given the amount of money they have personally invested in the stock, the picture in the financial press of a greedy management team looting the company for its own gain doesn’t quite hold water.

So, with all of this said, is Prospect Capital a buy?

As a value investor, I would answer that question with an emphatic yes. We have a wide margin of safety in the large discount to book value, and a management team that, while taking criticism from investors these days, has a lot of skin in the game. We’re also being paid generously to wait for the market’s mood to shift, as Prospect sports a current dividend yield of almost 14%.

Additional dividend cuts may be in the cards if the company continues to de-risk or if there is an uptick in non-performing loans. But I consider the current dividend safe for at least the next 9-12 months.

Charles Lewis Sizemore, CFA, is chief investment officer of the investment firm Sizemore Capital Management and the author of the Sizemore Insights blog. As of this writing, he was long PSEC.

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Investing in Low Morals for High Profits

U.S. News and World Reports featured Jeff Reeves and I in a piece on vice investing: ‘Sinvestments': Investing in Low Morals for High Profits

Here is an excerpt. I note that the concept of “vice investing” is something of a nebulous concept:

[Sizemore asks] “Is McDonald’s (MCD) bad for selling fatty hamburgers to children? Is Wal-Mart (WMT) bad for paying low wages and driving mom-and-pop local stores out of business? Is Monsanto (MON) bad for selling genetically modified seeds or driving a hard bargain with farmers?” In fact, Monsanto was voted the Most Evil Corporation of the Year in a 2011 poll of more than 16,000 readers on the Natural News website, finishing with more than half the votes…

In the end, what one makes of sin stocks is either relative or strictly defined. “I have to laugh at the very idea of bringing ethics into the discussion,” says Jeff Reeves, executive editor at InvestorPlace.com. “If you’re looking for ethics on Wall Street, not only are you out of luck here, you’re out of luck everywhere. So you want to pass on the evils of alcohol but are willing to buy bank stocks that basically run up billions in fines as the cost of doing business?”

 

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Finding Bargains in Europe

I gave my thoughts on European stocks to U.S. News and World Reports:

European stock markets are on a tear this year, showing double-digit gains that far outperform the returns of U.S. stocks. One of the main drivers of blistering gains in European stocks is monetary stimulus from the European Central Bank – and analysts say the rising trend in stocks in Europe may just be getting started.

The Dow Jones industrial average has gained 0.15 percent so far this year through June 5, while the Stoxx Europe 600 index has skyrocketed 13.6 percent. Individual country performance within the euro area is also impressive. Germany’s main stock index – the DAX – is up 14.2 percent, while France’s CAC 40 index is up 15.2 percent and Spain’s IBEX 35 is up 7.6 percent.

What’s behind the healthy gains? In an effort to battle back against weak economic growth and potential deflationary economic conditions, the European Central Bank has been supporting the economies there with bond purchase programs, similar to actions by the U.S. Federal Reserve in recent years. In January, the ECB announced an expanded asset purchase program totaling €60 billion per month, which equates to roughly $66.6 billion at the current exchange rate, and the economies and stock markets reacted positively. Gross domestic product growth in the eurozone was 0.4 percent for the first quarter, and was up 1 percent year-over-year…

While the U.S. stock market is now in its sixth year of a rising trend, some analysts say European stocks are just getting started on a new up cycle. “Investors had left Europe for dead, but eurozone GDP growth might actually finish the year higher than U.S. GDP growth. The European economy appears to have bottomed out, whereas the U.S. economy may be topping,” says Charles Sizemore, founder of Dallas-based Sizemore Capital Management, an investment advisory firm…

Looking ahead, analysts are optimistic that European stocks will offer a solid investment opportunity. “Trends like these do not turn on a dime, and I expect European stocks to outperform U.S. stocks over the next five to 10 years. Not every year, of course, but total returns over that period should be significantly higher in Europe,” Sizemore says.

Within Europe, Sizemore says Spain has the most upside. “Spain got hit hard by the crisis, and its unemployment rate is still over 20 percent. But it is in markets that have taken the most abuse that we have the best upside potential. Spain should have reasonably good growth this year, and its companies are among the most globally diversified in the world,” Sizemore says.

For more targeted exposure, Sizemore points to the iShares MSCI Spain ETF (EWP). “It’s a collection of Spanish blue chips and a great way to play a rebound in Spain,” he says.

You can read the full article here: Ride European Stock Gains With These 4 ETFs

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