The Market Discounts Proven Company Leadership Far Too Quickly
Posted on January 28, 2013 Comments (1)
Developing a strong executive leadership culture is not a short term effort. It isn’t based on one person. It almost never deteriorates quickly. Yet markets continually overact to minor blips on the long term success of companies. I think this is mainly due to a failure to appreciate systems and a failure to appreciate variation along with plenty of other contributing factors.
The market’s weakness does provide investment opportunities. Though taking advantages of them is much more difficult than spotting a general weakness. While excellent management almost never becomes pitiful overnight (regardless of how often talking heads would have you believe) business can change very quickly due to rapidly changing market conditions. Avoiding the purchases when the underlying business has sustained a significant blow that excellent management will deal with but which will reduce the value of the enterprise going forward is key to taking advantage of the market’s silly overreaction to bad news (or even calling things “bad news” that are not actually bad just not as awesome as some were hoping for).
My positive opinion of Toyota’s management has continued for a long time. A few years ago an amazing number of people were all excited about the “decline of Toyota” and wrote about how Toyota’s ways had to change. I wrote at the time was this is needless hysteria and if Toyota just focused a bit more on applying the Toyota’s management methods they would be in great shape. The problems were due to Toyota’s mistakes in practicing the Toyota Production System not in a weakness of those practices.
Looking at a chart of Toyota’s stock price from 2007 to today it peaks at about $137 in January 2007 and bottoms at $58 in early 2009 and now is at $96. Toyota’s stock price has been priced richly due to respect for management and consistently strong cash flow. As it fell below $75 there you no longer had to pay a premium for excellent management, but that management was still there. I like getting bargains when I buy stocks. One of the things I have learned I am too focused on bargains and I should be more willing to accept less of a bargain to get great management systems – so I have adjusted, and have improved my results. When I can get a great bargain and great management it is wonderful, though sadly a rare occurrence. Toyota’s price now seems reasonable, but not a huge bargain.
The market continually gets overly excited by either actual problems or perceived problems. I wrote about this happening with Netflix 2 years ago. Netflix made some mistakes and faced some tough business issues. The evidence of sound, sensible, effective management vastly outweighed the evidence for management failure – yet there were hundreds of articles about the pitiful failure of Netflix management.
The management worries were completely unfounded in my opinion (no matter how many talking heads parroted the same dubious claims). The difficulties facing the business I did see as real.
Netflix reported surprising earning last week and the stock was up 70% to 170 (when I wrote in November of 2011 Netflix stock was at 80). The challenges Netflix faces are real, and back in 2011 some decline in the stock price made sense (also it made sense because likely the stock was way too highly priced, it reach nearly $300), but the market hugely overreacted. That also contributed to the gains last week – they are not justified based on the earnings but people had gotten the crazy notion that excellent Netflix management had overnight become idiots. Now there is evidence maybe they are not idiots and the stock price zooms up. Frankly I would sell Netflix now. I still love their management but the business is so hard for me to predict going forward I would just feel safer elsewhere. But I think their management was great 5 years ago, 2 years ago and today.
Other example of a market overreaction is Apple’s stock last week. Last week they reported they “only” made $13 billion in 13 weeks. I believe only Exxon has ever made more in a quarter (Apple’s earning for the same quarter last year were also $13 billion). This was followed with a great number of articles about the collapse of Apple. Once again this is idiotic. Can Apple continue to grow profits at over 20% a year. I doubt it. I doubted it 2 years ago, I doubted it 5 years ago (I thought it nearly impossible to do as well as they did). Is making $40 billion a year pretty awesome. Yes. Can Apple do that? Yes, the poorly received report last week gave them net income of $41.75 billion for the year. They may also fail, because that is very hard to do.
Apple’s stock price rose over $700 a share last year. Was that too high? Maybe. But the only way it was too high was based on significant declines in Apple’s earning and cash flows going forward. It was super cheap if Apple grew earning at 20% a year. It was a perfectly good price if Apple didn’t grow earnings at all, as I wrote last year. There is a risk Apple will make massively stupid executive decisions. I don’t see that as likely. There is a risk Apple has just been on a huge run of great luck (multiplying the good work they have done) and just do to variation they will experience less good luck going forward (so some potential earnings disappear). And perhaps the business runs into problems sustaining such high margins and sales; I think this is likely actually. But I wouldn’t be surprised if they grow earnings, and if they do so (even at 5% a year) the stock is very cheap. I do wish they would increase the dividend. They continue to stockpile cash at an amazing rate, they now have over $135 billion in cash (this is an astoundingly high figure).
What is a fair price for Apple today is hard to judge (which is what makes investing a challenge and potentially rewarding), but I would wager on the price today $440, being a great bargain. Just like Toyota and Netflix my view of Apple’s executive team is they are extremely strong (top few percent of all companies). Netflix has the shakiest business (and the smallest moat) and the least history of producing huge positive cash flows over years. Apple and Toyota remain in my 12 stocks for 10 years portfolio.
I think Apple is a much better buy today than it was last year. You can look at that statement and say it is obvious, but it isn’t. The market adjust prices based on events. So theoretically Apple’s price today is the fair price. Just like it was when it was at $700 in September. The fact that today’s price is $440 should just mean that the facts today show Apple is worth 63% of what it was in September. I think Apple is probably worth 95+% what it was based on what we knew in September. If the price today is not a bargain (which I agree is possible – though unlikely) the reason for that is not the news since September, but instead a vastly inflated price back then.
Apple’s dividend currently yields 2.1% and the price of the stock is almost exactly what it was 1 year ago today.