“Dead Money”

Very often I hear people speak of stocks being “dead money.”  These stocks are blue chips that have been trading relatively flat for the better part of 10 years now.  These stocks range from technology companies, to conglomerates, to pharmaceutical companies.  A few examples of stocks that I have seen being called “dead money” are Pfizer, Microsoft, GE, HP, Intel, Cisco, Abbott, Merck, and many other large blue chips that are trading at prices roughly the same (or lower) as was seen in the early 2000s.  While many people flock to multi-billion dollar blue chips as safe havens, or value investments, investing in many of these companies mentioned above was far from making “value” investments.

Value Investing

Value investing is a method of investing that looks at the fundamentals, rather than technicals, of a company.  Multiple ratios are considered when searching for value, including Price over earnings, price over book value (or tangible book value), price over cash flow, enterprise value over assets, and price over sales.  Investing in companies when these ratios are lower than historical averages, or lower than comparable companies is a very simple method for value investing.  Another way to find value stocks is to invest when dividend yields are higher than historical average yields.

Value investments in the early 2000s

A common theme with many of the companies mentioned in the first paragraph is that the price to sales and price to book ratios of those named companies were trading well above historical averages.  Therefore, the only way to see stock appreciation from those valuations was for the growth story of the 1990s to continue into the 2000s.  Two things come to mind following the previous thought: the first is that this is not value investing, that is speculative growth investing, and secondly, we obviously didn’t see the same growth in the 2000s that we saw in the 1990s.  Even though we have seen top line growth with many of the companies mentioned, we didn’t see the amount of growth that is needed to further propel growth stocks.  This has led to stagnant, or even falling prices the again mentioned stocks.

What about P/E, though?

Earnings fluctuate much more than revenue, book value, or assets.  Any by earnings, you can take your pick between operating income and net income.  COGS, SG&A, and the effective tax rate can fluctuate wildly within a span of 5 years.  Debt and interest costs can also change rapidly within the span of a few years, depending on what management is doing.  Energy costs go up, energy costs go down.  Tax rates go up, tax rates go down.  High earnings can make a P/E ratio look incredibly attractive in one year, but just a couple years down the road, earnings can crash, causing an attractive looking stock to quickly look like garbage.  So while P/E should definitely be considered when making an investment as a value investor, it should hardly be the only (or primary) metric of consideration.

Dead Money no longer

Many of these blue chips are finally trading at reasonable, or even historically low, valuation metrics.  It took these companies the better part of ten years to finally hit these metrics, but that is more so attributed to the high valuations of the early 2000s than slow growth.  Many of these companies have been growing revenues 5, 10, or even 15% over the past ten years, even though the stock price has been flat.  They have also been growing their dividends over that time frame.  An investment in a basket of these mentioned stocks will likely yield returns that are far better than the S&P 500 over the next decade (or two).  And I can assure I am putting my money where my mouth is.  I’m currently invested in MSFT, WMT, INTC, ABT, and TEVA.  All of these companies pay a healthy and growing dividend, are growing their top lines at a respectable rate, and are trading at historically low valuations.  If you consider yourself a “value” investor, I’d consider following suit.

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Higher Education Bubble

This quarter, the M12 MBA’s at Georgetown are taking a core class on business ethics.  Each class is divided up into multiple groups, and each group is to present on an ethics topic at the end of the quarter.  The student group that I am working with chose to do our topic on the ethics of for-profit higher education (University of Phoenix, DeVry, ITT, etc.).  In the midst of my research, I began to uncover how much higher education as a whole is being discussed as problematic – not just for-profit universities, but public and private non-profit universities as well.  The meat of the problem is the amount of student debt that is building.  It now exceeds that of credit card debt in the US, measured at $830B in June of 2010.

How did this happen?

My Budget 360 has a fantastic (but biased) piece on how big banks and private institutions are taking advantage of students.  The price of college tuition and fees has outpaced medical care, average household income, and inflation over the past 30 or so years.  And while inflation post-recession saw a hiccup, the costs of tuition has kept the same trajectory.

There is a high degree of difficulty associated with defaulting on student debt.  If a budget-constrained student can’t pay down the debt owed to their lender, the federal government actually steps in and pays the lender (Sallie Mae, Citi, Wells Fargo, or JPM) and then sends out the debt collectors for the student.  An example of one of these debt collection agencies is GRC, which is actually owned by Sallie Mae.  These debt collection agencies will take money from your paycheck, tax returns, social security – basically any means possible, until your education (and interest and fees) is paid off.  And if its never fully paid off, that means the government doesn’t get back the money it originally paid, and the bill lands in the lap of the taxpayer.

But if you owe too much on your home, you simply foreclose.  If you owe too much on your credit card, you simply default.  Its not the same with student loans.  That’s why this bubble has continued to grow over the past 3 years while housing prices have dropped and US credit card debt has shaved off around $100B.

But why are tuition prices increasing?  As long as the government will continue to fully-back education costs, why wouldn’t schools charge students more money?  They can increase endowments, pay more for better teachers, and of course, administration can pay themselves more money.  And as long as the government will continue to fully-back education costs, why would Sallie Mae, Citi or JPM continue to provide students with loans?  They’re gonna get paid no matter what.  If the government stopped backing students loans, Sallie Mae and other private lenders wouldn’t lend as much (they especially wouldn’t lend to a huge percentage of the people that attend many of these for-profit institutions), there would be a decrease in demand, and tuition prices would drop.  At the least, the government should scale back the extent to which it backs the loans to at least curb the growth in tuition prices.

At this point, its basically up to the parents and/or students to stop and say enough is enough.  College will eventually be the wrong choice for a large group of Americans because the costs will outweigh the benefits.  And if and when this happens (if it isn’t happening already), we’ll likely see the bubble begin to deflate.  As demand drops, schools will begin to take lower-tier students to fill their revenue gap.  Lower-tier students won’t be able to find jobs.  This will hurt individual school rankings, as well as the perception of higher education as a whole, and will double down on the decreased demand for higher education.



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