Green and SRI investors along with investing professionals are always asked to make the best decisions under pressure, and the most common one we face today is should “Socially Responsible Investors abandon stocks in favor of bonds?”
It is my opinion based on close to thirty years of trading that the best trades are those done when you’re in the minority not the majority opinion, otherwise who’s left to buy or sell?
For this question of stocks sold off in favor of bonds, bad news has to be considered good news. Any good news on the economy will be treated negatively at this point in time for bonds. Today’s stock market strength and weakness in bonds is due to the better than expected August PMI report which came in at 56.3 versus the consensus of 52.9 and the August report is an improvement upon July’s 55.3. Adding fuel to the rally is survey from Investors Intelligence which shows that just 29% of newsletter writers are bullish which is the lowest percentage since the crash in 2008. Remember folks, the more extreme the consensus the greater chance of a reversal in market direction. A bull figure at just 29% might be enough to halt the decline at worst…..but its certainly in the range to mark the bottom where a new rally can emerge.
Good news is bad news for bonds. The 10 year Treasury has moved from 2.48% to 2.6% today while the 30 Year Treasury Bond has moved from 3.53% to 3.68%. Bond yields are now at levels seen in late 2008 and very early 2009 and we all know how productive it was to buy bonds in February of 2009.
The stampede into bonds has been nothing short of epic and the Consensus Survey of bond investors maxed out at approximately 80% recently. Rarely has such a consensus opinion been profitable. These are the kinds of surveys we frequently see at major market tops which begs to ask whether bonds are in a Bubble. Bubble talk has been pervasive in the media much just as talk of Deflation has been over commented upon.
Frankly there’s more contradictory information and confusion in the media to rival a Republican politician who wants to reduce the deficit while maintaining tax cuts. The bottom line is we do not have Deflation in the U.S. at present as Deflation is a very rare event here.
But are bonds really in a Bubble? My answer would be “not at present”. My definition of Bubble for the any investor including the Green Investor or the Socially Responsible Investing community is that for a Bubble to truly exist the risk of a significant and permanent loss of capital must be present. A Treasury bond will eventually pay off at par upon maturity, so while its very possible to lose 20% or more in a bond, the loss would be temporary if you were patient enough to wait till maturity. The reality is only a very few investors have that kind of patience. In addition, many of the investors who are retirees and have been buying Treasuries will not be around in time for their bonds to mature, so a loss could be taken.
With Consensus opinions at present in the range of 70% to 80% Bullish on Bond prices, should the tone of economic data change (I believe its starting to happen now) the rush to exit bonds could be swift and very dramatic, especially in this day of algorithmic and program trading.
A by product of the rise in bond prices and drop in yield is the relative valuation of bonds to stocks.
As the chart above highlights, the relative valuation of bonds to stocks is at extreme levels and the other two times in the past century this relationship was reached, buying bonds in lieu of equities was a significant mistake. Can we say that in the two past examples that bond investors lost money? No, not unless they held to maturity but they lost “opportunity” to be in equities as the mean relationship between stocks and bonds eventually asserted itself once more.
We’re faced with the challenge of “getting back to pre-crash levels” and by over allocating to bonds now is essentially giving up that goal at time when the odds are stacked against you.
To be a successful Green or Socially Responsible Investor sometimes means enduring pain and the pressure of the media, not to mention friends who offer their opinions in an effort to “help”. Diversification between bonds and equities is always a good thing and proper re-balancing when one asset class becomes overvalued is essential, but to join the mass entrance into bonds at this stage may very well lead to a mass exit when the weak patch of our economy passes and moderate growth re-emerges.
While we may be unabashed in our enthusiasm for Socially Responsible Investing (SRI) that does not mean we look at Green stocks with rose colored glasses. In truth we devote more time and attention, plus number crunching to make sure the holding is justified and meets our financial criteria.
Case in point is Gaiam Corp. (GAIA)
Company description: “Gaiam, Inc., a lifestyle media company, provides a selection of information, media, products, and services to customers focusing on personal development, wellness, ecological lifestyles, and responsible media. The company engages in content creation, product development and sourcing, customer service, and distribution. It operates in three segments: Direct to Consumer, Business, and Solar segment. The Direct to Consumer segment provides an opportunity to launch and support new media releases; a sounding board for new product testing; promotional opportunities; a growing subscription base; and customer feedback and the lifestyles of health and sustainability industry?s focus and future. This segment offers content through direct response television, catalogs, e-commerce, and subscription community services. The Business segment provides content to businesses, retailers, international licenses, corporate accounts, and media outlets. The Solar segment offers turnkey services, including the design, procurement, installation, grid connection, monitoring, maintenance, and referrals for third-party financing of solar energy systems. This segment also sells renewable energy products and sustainable living resources; and offers residential and small commercial solar energy integration services. Gaiam, Inc. sells its products in the United States, Canada, Mexico, Japan, and the United Kingdom. The company was founded in 1988 and is headquartered in Louisville, Colorado.”
Current Price $6.61
NCAV $2.88
Intrinsic/Discounted Cash Flow Value $10.67
Price to Book: 1.0
Book Value $6.45
Cash per share : $2.07
LT Debt $0
Market Cap $156 million
Piotroski score: 7 out of 9 (which is good)
Altman score 5.7 (little chance of bankruptcy)
GAIA is a small cap retail stock focused on the lifestyle/yoga market/alternative energy in Colorado. The stock has pulled back along with the market albeit at a faster pace for the past two months and in our opinion is nearing a very attractive valuation as it begins to touch Book Value along with minimal expectations.
The company has met or exceeded analyst expectations for the past year and current and 2011 estimates have been firm. However this stock is thinly traded and there is only one analyst following the stock.
Back in late 2007 and 2008 when the consumer was empowered the stock traded in the high $20’s and topped at $30. The company posted a loss of (.08) for 2008 The stock does seem to be volatile long term and has a bust / boom personality as it trades in sympathy with the economy. We don’t envision that the US consumer is completely on its back:
“socially acceptable deleveraging needn’t entail the pesky inconvienence of forgoing consumption.”
Revenue growth does appear to be making an improvement with sales improving 14.8% year to year.
A comparison to competitor Lululemon Athletica (LULU) shows the contrast between the much loved LULU and the loathed GAIA. Eco-cache has a cost in terms of potential return:
Current Price $38
NCAV $2.38
Intrinsic/Discounted Cash Flow Value $12.5
Price to Book: 10.4
Book Value $3.79
Cash per share : $2.45
LT Debt $0
Market Cap $2.7 billion
Piotroski score 7
Altman Z 44 (excellent)
To be a successful investor frequently means to cut against the grain of popularity and think in terms of buying a business cheaply. LULU is an excellent example of the price you pay for “Glamour” to own what is currently in fashion and popular. No doubt there are many unhappy GAIA shareholders at present but we believe there will be a Reversion to Mean Valuation which in our definition would be appreciation above DCF valuation ($10+), a level GAIA sustained during the economic expansion of 2003 to 2007. In addition, GAIA is a candidate for tax loss selling within the next 3 to 5 months which could be the catalyst to drive the price lower.
In sum, GAIA represents good value at present however the company’s volatility requires an even greater discount to intrinsic value/DCF than the current price offers, but we’re near those values. A move in price below $6 might just be the opportunity for longer term investors comfortable with the risk of a consumer cyclical company with a very Green edge.
No positions
Brad Pappas
With the disaster ongoing in the Gulf many people have asked me if this is a good time to invest in proactive Green energy. Can you imagine how badly I would like to say yes? But how do we weigh the desire to invest in Green Tech sensibly with a weak economy? With a tightrope of course and a strong balance sheet with a dirt cheap stock valuation as our net.
With this post I’d like to draw attention to the strong correlation to the price of oil (USO) which is driven primarily by economic growth and activity and the Powershares Wilderhill Clean Energy ETF (PBW) which I’m using as a proxy for Green Energy. At present we do not have the necessary worldwide GDP growth necessary for a price run in oil, especially with the world’s economic driver China attempting to cool its GDP growth, the present soft patch in the U.S. and the austerity measures in Europe.
The bottom line for the “Green Investor” is to look elsewhere for the time being. Look to other industries and companies that are not quite so cyclical and dependent upon fast GDP for growth. We must always keep in mind that “return of capital” is more important than “return on capital”.
Fear not, soon enough I’ll be writing on at least two very “Green” companies that meet our model of investment.
No Positions
Brad Pappas
A company we spoke of last week, Hawk Corporation HWK is surging on news that it has hired advisors to investigate possibilitity of increasing shareholder value which would include the potential sale of the company. Hawk is a diversified industrial goods company that also makes alternative energy fuel cells. It should be noted that Mario Gabelli of GAMCO Investors owns 13% of the shares.
Hawk becomes the second holding of ours that is “in play” in the past month. RCM Technologies RCMT is the target of a hostile takeover from CDI corp. This does take some of the bitter taste away from a miserable market.
Hawk Corp.
Market Cap $212 million
Book Value $9.68
Cash per share $10.13
Debt to Equity 1.0
Price to Sales 1.1
ROA 6%
ROE 11%
IBES est: 2010 $1.57
2011 $2.11
I’ve run a quick DCF calculation to get a feel for the value of HWK in a sale: Using 2010 eps of $1.50 with a 3% growth rate and a discount rate of 5% the value could approach $40 per share. The problem with Hawk is that its eps are very volatile but there is the fact of having a great deal of cash on hand. To be continued………………
Regarding the economy: The ISM manufacturing composite index feel to 56.2 (a number above 50 is pretty good) indicating a slower rate of expansion. ISM characterized the current expansion as “solidly entrenched”. While many including myself expected a slowing of the expansion in the second half of the year, the rate of the deceleration has been surprising. While the herd is screaming “double dip recession” the data does not support the mob.
From morning commentary of MKM Partners Mike Darda:
“To recess or not to recess, that is the question. Either way, we believe the stock market has essentially discounted a double-dip scenario, with our NIPA-based model showing a gap between equity earnings yields and corporate bond rates that rivals anything seen in nearly six decades. Even using a 10-year moving average for earnings (which implies a 12.4% decline in corporate profits from current levels), the S&P 500 has fallen to valuation levels below those seen at the market lows in October 2002, October 1990 and December 1987.
We would be more concerned if the credit markets were in worse shape. Yes, corporate spreads have widened, but all of the action has been in (declining) Treasury rates; corporate bond yields have been flat, unlike the situation in 2007-08. Three-month dollar-LIBOR has been in a flat to down trajectory since late May. Two-year swap spreads at 37 basis points suggest that both the VIX and corporate spreads have overshot significantly to the upside (implying that equities are overshooting to the downside).
The catalyst for today’s slide appears to be the upward move in first-time jobless claims and the miss on the June ISM Manufacturing Index, although both were consistent with a continuing, albeit slower, expansion.”
BP
Long HWK, RCMT
3% Treasury Bond yields aside calls for a double dip recession seem premature as personal incomes and expenditures continue to post progress in May and supportive of modest economic growth. Inflation remains in check as well.
A few of our new holdings are moving well this morning on little or no news.
Telecom service company IDT Corp. is up 7% on potentially being added to the Russell index.
For green car advocates Tesla Motors is due to stage its IPO tomorrow and markets the biggest auto IPO since Ford Motors over 50 years ago. At minimum the Tesla IPO and subsequent stock performance will be an intriguing barometer of investors interest and belief in the future of Green autos and could bode well for future green auto starts ups: Fisker and Smith Electric Vehicles.
The Tesla story is intriguing but intriguing is not enough of a reason to devote capital to at this point. The Tesla battery operated sports car is very beautiful. If you haven’t seen the car you should. It reminds me of a Porsche in shape with a targa convertible top. Price is in the $50K range and they’ve sold just over 1000 vehicles. But the company is bleeding cash with a loss of $29 million in the 1Q.
Toyota has invested $50 million into Tesla but at this point in time the company is supported by a $465 million staged loan from the Department of Energy.
If that’s no enough Tesla CEO Elon Musk will be selling $20 million dollars of his own shares in the company. Lack of revenue and earnings would eliminate it from our consideration but it will be fascinating to watch nonetheless.
Long IDT
BP
