Comparing Tech’s Market Cap to Other Sectors

Even though tech companies currently tend to trade at low multiples relative to historic earnings, from a market cap standpoint, the leaders of the sector are still gargantuan.   Three of the four largest companies in the S&P 500 are tech companies: $AAPL, $GOOG and $MSFT, with a combined market cap greater than $1 Trillion.

Looking at the top 30 US companies in each sector (by sector ETF) Technology stands out as having significantly more market value than other sectors.  The 30 largest US tech companies have a market value of $2.8 Trillion compared to an average of $1.46 Trillion in all other sectors.

That’s a big spread, but given Tech’s relatively tame multiple it’s easy to argue that the value gap is justified.  Technology companies sell high value, high margin merchandise and therefore make a lot of money.  But is this sustainable over time?  Can tech companies continue to provide significantly more economic value to society than other industries, or will the value erode over time?  Multiples seem to imply erosion, but market caps disagree.

Comparison of Sector Concentration

How Important is Syria?

WTI crude oil is pushing $110 per barrel today and the S&P 500 lost about $250 B of market cap yesterday presumably because of fears about possible US military action in Syria.  While military action would certainly be important from a political standpoint, on the face of things, it’s tough to see how there could be much in the way of economic ramifications from a conflict.

Syria is a tiny economy with a GDP of about $60 B US dollars.  It also doesn’t contribute much of any oil to global supply at just 0.2% of global production.  The country also hardly figures into US trade interests.  Americans do a combined $40 million worth of trade with the country, which is 0.001% of annual US trade volume.

Clearly true geopolitical risk would be dependent on countries with a little more gravitas allying themselves with Syria.  That doesn’t seem like a very likely scenario, but then again (in very, very different political environments) major wars have started before with seemingly inconsequential events.

Syria Economic ContextSource: BP, Census Bureau

Anatomy of a Short Squeeze

$TSLA is the short squeeze du jour, but its recent run brings to mind four other short squeezes of this bull market:  $NFLX, $GMCR, $CMG and $MNST.  Just like Tesla, all four of those stocks saw huge increases powered by intense interest from both retail investors and scrambling short sellers despite extreme valuations.  Each stock eventually hit a wall too and saw a decline of 40% plus (and each has seen a subsequent recovery).

Below is some data on how short interest fell over the course of these stocks’ bull runs.  On average, the four squeezes that were cracked saw short interest fall by 20 percentage points (as a percent of shares outstanding) before the short squeeze lost its oomph.  The average gain was an astounding 805% from peak short interest to peak price.  By comparison, Tesla has seen a 13 percentage point decrease in short interest and a 611% increase in share price since short interest peaked.

Tesla’s short squeeze appears to be reaching towards the limits of these past short squeezes, but it hasn’t eclipsed them yet.  If the short squeeze continues, gains could continue to be eye popping.  Consistent with intuition, there does appear to be some correlation between short interest contraction and price increase–GMCR saw the largest contraction in short interest and also the largest increase in price, while the opposite was true for MNST.

Anatomy of a Short SqueezeSource: Ycharts Data

House Prices Back to 2004 Levels

Case Shiller home price data released today continued to confirm strength in the housing market.  Prices in the 10 city index rose by 11.9% y/y and 2.2% m/m in June.  According to the data, prices are now up 15% from the 2012 lows and have returned to levels initially reached in 2004.  That level is still 24% below the peak, which was hit two years later in 2006.

Case Shiller Home Prices

 

Steve Ballmer Gets No Respect…

$MSFT’s stock closed 7% higher on Friday after the company announced that Steve Ballmer would be stepping down as CEO.  In addition to the market’s message of good riddance, it was tough to find much positive commentary for the departing CEO.  Was he really that bad though?

While Ballmer had plenty of missteps, he actually had a pretty successful run when it comes to the scoreboard that he could reasonably influence.  The stock price has fallen by more than 20% since he took over, but Microsoft’s earnings per share have more than tripled from $0.84 in 1999 to $2.60 today.  On a dollar basis, Microsoft has grown annual operating income by $15 B over the last 10 years, a larger increase than all but 8 US companies.

People who choose to focus on the share price ignore the fact that Ballmer stepped in near the height of the dot com bubble when Microsoft’s multiple was at an unbelievable ~70x earnings.  Today that multiple has compressed to ~13x.  It’s not that Microsoft hasn’t grown under Ballmer, it’s just that the share price has eaten up multiple.  One can only speculate about what the perception of Ballmer would have been if MSFT’s multiple had been a reasonable one in 2000.

Two important lessons to be learned from Microsoft: 1) even the best stream of cash flows can be mispriced.  2) The change of a company’s share price is not necessarily a reflection of the change in economic reality.

MSFT Earnings Growth Ballmer

Company Notes Digest 8.22.13

A digest of some of the top insights that I’ve gathered from this week’s earnings calls.  Full notes can be found here.

The Macro Outlook

Toll Brothers is still bullish on housing:

“It doesn’t appear as though rising interest rates have hurt our business.” ($TOL)

REALLY bullish–willing to bet that house prices will double again:

“Every single time we’ve come out of recession, we have almost doubled, and in some cases, tripled in the price of homes. Can that happen again? Well, it seems as though it’s unlikely. My bet is that it will.” ($TOL)

Unbelievably, the tightest labor market in the country could be in construction:

“Fortunately, in most of our markets, while labor has been tight, we are managing it. We have had to pay a little bit more, but we have long-term relationships with many trades.” ($TOL)

TOL has every reason to believe that this is early innings in a normal 5-7 year cycle:

“We think we’re in the early part of the cycle. There’s no reason to believe that this time it’s different. That it’s going to be a 2-year cycle or a 3-year cycle instead of an average cycle, which runs 5 to 7 years. And so we look forward to continued upside for at least a couple of years” ($TOL)

But every boom has a bust:

“Unfortunately, that also includes the other side of the mountain. So the sooner or later, we’ll be looking at the — looking down instead of looking up.” ($TOL)

Confirming TOL’s sentiment, Home Depot had a monster quarter:

“Comp sales were positive 10.7%…first double-digit positive comp in our business since 1999” ($HD)

It was so good it actually created operational challenges:

“I think it was a difficult quarter. It’s kind of the difficulty that want to have. You want to be challenged by sales but it required a lot of flexibility and responsiveness…some of us were here last time we did a double-digit positive comp and our execution wasn’t like it was today…our suppliers did an awesome job of working with us to make sure that product was flowing and be able to take care of the demand spikes. We couldn’t have done it without them.” ($HD)

For now, the Chinese seem to be breathing a sigh of relief that they escaped a hard landing:

“when I was there a few weeks ago, there was a quite confidence on the part of customers. So what we’re seeing there right now is an indication of relative health in the Chinese economy and much less concern around the potential for hard landing now than there would have been a few months ago” ($BHP)

And they are ready to get back to spending on infrastructure:

“in terms of steel and iron ore in China, the steel production has been running above where we thought it would be running at this time of year. We think we understand why, and it comes down to strong investment and strong construction” ($BHP)

If China is looking better than India, it could be because India has been particularly heavy handed with price controls:

“In India, the bigger issue…is that the government has imposed a very low ceiling on pricing for some of the stents” ($MDT)

Financials

Even though rates have risen, money is still basically free:

“Our buyer…They have plenty of room to [use more leverage]. They choose not to. That’s been the case even with a 3.5% mortgage, they’ve stayed at 70% [LTV]. We would have thought they would have levered up then and taken advantage of free money. 4 5/8% is still pretty close to free.” ($TOL)

And becoming increasingly more available:

Banks are trying to fill the hole of shrinking refi business with aggressive underwriting on purchase loans:

“since refis have slowed down, we’ve seen investors get more aggressive in trying to do business with us in terms of some loosening” ($TOL)

Especially in the non-conforming mortgage segment:

“We have a ton of jumbo visibility. We’re not constrained really at all in jumbo availability. People are being aggressive…the spread on a conforming loan is 4 5/8. On a jumbo today is 4 3/4. The spread is miniscule, and that really reflects, I think, that the banks are keeping a lot of the jumbo in portfolio.” ($TOL)

Consumer

Thanks to a tough second quarter that caught retailers off guard, Ross sees a more promotional environment in the back half of the year:

“I think coming out of the second quarter, where all the major department stores and discounters struggled in the second quarter. They have plenty of time to be preparing ramping up for a more promotional fourth quarter than they did — than they were able to for the second quarter, which kind of — I think quite a lot of people caught offguard.” ($ROST)

Be prepared to hear about the shortened holiday selling period:

“The fourth quarter, which has a compressed holiday selling period due to 6 fewer shopping days between Thanksgiving and Christmas this year.” ($ROST)

Parents have been procrastinating on back to school shopping:

“It seems like, the last 3 years, we’ve seen back-to-school start later and later and later in the season. And I think in a few years, July is not going to really be much of a month for back-to-school. I think it’s kind of pushing closer to school.” ($SPLS)

A lot of talk about omni-channel out of retailers:

Delivery expenses are growing, but net-net shipping costs still beat rent expense:

“delivery expense is greater than delivery income. And certainly, we go back 5 years, that wasn’t the case, and the trend is pretty clear. Fast and free, I think, is the expression that’s been used a lot…when you…consider the occupancy cost of bricks and mortar, you can afford to have quite a bit of shipping baked into every order and still come out ahead…” ($URBN)

Eventually, shipping is going to be free to the consumer, and retailers need to view the expense as a cost of doing business:

“So we intend to continue to press for at least fast, if not totally free. And we’re pretty convinced that in the next 3 to 5 years, it will be both fast and free. And we will absorb that cost as part of doing business, just like we’ve absorbed rent as part of doing business” ($URBN)

Retailers still see physical locations as a competitive advantage:

“we believe our more than 2,000 store locations throughout North America are valuable convenience for customers and can and should be a competitive advantage for us” ($HD)

Best Buy is ready to turn its locations into a network of distribution centers. Their employees are already trained:

“the store associate has already learned by buy online pick up in store how to have a pick ticket dropped to the floor and to be able to pick the order and put it in the basket. Now, the next phase of that is to put it in a box, create a shipping label for UPS, and have it distributed” ($BBY)

Small tweaks just need to be made to the infrastructure:

“our system – and this is very common in retailers – when inventory is actually sold, it takes up to 4 hours to be able to update the inventory…we had to get that timeframe down to 15 minutes before we were comfortable rolling [ship from store] out.” ($BBY)

Some purchases will never be made online though:

“our buyers, while they play online, they still come out to see us. This is not like buying an automobile online. It’s the biggest purchase of their life, and they will come out.” ($TOL)

JC Penney is confident it has enough money to survive:

“as we look through the end of the year, the $1.5 billion of liquidity that we have projected we’re not assuming that we need any additional financing.” ($JCP)

Technology

Flat comps for TVs is cause for celebration:

“comparable store sales for the television category were flat in the quarter, which is considerably better than the trend we’ve seen over the last few years…We believe that it’s been three years since the comps in TVs were flat” ($BBY)

PCs appear to be in a death spiral (he typed on his laptop…):

“In terms of the categories, it’s a combination of PCs, because of its size, and then the related businesses, computer peripherals, software, things like that, that are just — they have no chance to grow, they’re just deteriorating fast.” ($SPLS)

The server business isn’t exactly healthy either:

“The Server business has been under pressure for some time. The pricing in the marketplace is as intense as I have seen it since I have been at HP.” ($HPQ)

Technology has made Staples its whipping boy:

“they’re better controlling their spend than they ever have and also the mix of what you’re selling them. So everything from Board of Directors’ presentations that used to be sent out in hard copy in binders are now being done digitally on tablets. So it’s a change in technology. It’s impacting our core business. That’s why when we look at NAC in this quarter, the headwinds that we had to fight were negative office supplies, ink, toner and paper, all slightly negative, in spite of what I would argue as slight market share gains.” ($SPLS)

Healthcare

Hospitals are getting more organized about how they make purchases. More bureaucracy=slower decision making=a headwind for med device companies:

“the biggest issue was getting people on contracts. And that’s the change that’s occurred in the industry over the last several years where what used to be….the doctors [would] make [the buying] decision…now in hospitals, these committees are more engaged in that process and ensuring that the products have the technology. So as he indicated, that slows down the process slightly. It doesn’t mean you don’t get the price increases. It just means that you have to go through certain processes.” ($MDT)

Materials, Industrials, Energy

Commodity markets will eventually find balance:

“there has been a sharp decline of major mining equipment — sales of major mining equipment, which is one of the best indicators of future supply. In the medium term, this will inevitably lead to lower growth in supply and to more balanced markets. And the companies that will prosper are those able to invest prudently throughout the cycle” ($BHP)

Miscellaneous Nuggets of Wisdom

It doesn’t matter how much market share or history your company has. When you lose a customer’s trust it takes a long time to gain it back:

“in 2011 J. C. Penney did business at least once with over 50% of the families in America. We enjoy a 111 year old tradition of being a trusted destination…This is however a journey. There are no quick fixes to correct the errors of the past. It’s going to take time to get fully back on the right track across the Company” ($JCP)

Always focus on understanding your customer better:

“we continue to focus on who she is and ways that we can continue to outfit her and understand her better” ($URBN)

Give your customers a great experience, because word of mouth is the best form of marketing:

“we’ve always thought the best marketing for us is sort of unpaid marketing, word of mouth. And that really comes from making sure we have great value in the stores, the customer buys the goods, they go and tell their friends, et cetera.” ($ROST)

Ross Stores 2Q13 Earnings Call Notes

This post is part of a series of posts called “Company Notes.” These posts contain quotes and exhibits from earnings calls, conference presentations, analyst days and SEC filings. The quotes are generally pieces of information that I find interesting or helpful to understanding the company, industry or economy and are not meant to provide summaries of the full content of the call. Other posts in this series can be found by clicking here. Full transcripts can be found at Seeking Alpha.

“he 4% comparable store sales gain was mainly driven by growth in the size of the average basket. Operating margin grew about 80 basis points in the quarter to a record 13.6%”

“While we are pleased with our better-than-expected year-to-date results, we believe it is prudent to maintain a somewhat cautious outlook for the remainder of the year for a number of reasons. These include the ongoing uncertainty in the macroeconomic environment, our own challenging multi-year comparisons and the potential for a more promotional and competitive retail climate.”

“This is especially true for the fourth quarter, which has a compressed holiday selling period due to 6 fewer shopping days between Thanksgiving and Christmas this year.”

“As an off-price retailer, we have the flexibility to buy closer to need”

“We thought it was typically promotional, okay, not unusually rugged, okay, but fairly typical. I think coming out of the second quarter, where all the major department stores and discounters struggled in the second quarter. They have plenty of time to be preparing ramping up for a more promotional fourth quarter than they did — than they were able to for the second quarter, which kind of — I think quite a lot of people caught offguard.”

“we’ve reduced inventories by about, actually, a little bit over 40%, since the back half of 2007. And, actually, this year, we’re planning to reduce inventories further, sort of in the low single-digit range…in terms of what will be the driver of being able to reduce inventories further, the DCs may help, but I also think that just improved merchandising in terms of making sure we have the right product in the right store will also be a key enabler as well.”

“We’ve been comfortable at the level of product we’ve seen so far this year. I only expect that it should be a little more advantageous than it’s been even.”

“over the last few years…traffic has been the major driver of that comp growth. So clearly, that would never going to on forever. At some point, traffic was going to moderate, and that’s kind of how we viewed the last couple of quarters”

“on the flip side, we’re pretty happy that we’re seeing increases in the average basket, which suggests that when customers are coming to the store, they are finding opportunities to spend more.”

“we’ve always thought the best marketing for us is sort of unpaid marketing, word of mouth. And that really comes from making sure we have great value in the stores, the customer buys the goods, they go and tell their friends, et cetera. ”

“The customers who dd’s caters to is somewhat below the Ross customer.”

“we do think there’s some risks in the back half, but the overall retail environment will get more promotional not only, driven by J. C. Penney but potentially with other retailers, too. And we try to factor that risk into our guidance.”

Staples 2Q13 Earnings Call Notes

This post is part of a series of posts called “Company Notes.” These posts contain quotes and exhibits from earnings calls, conference presentations, analyst days and SEC filings. The quotes are generally pieces of information that I find interesting or helpful to understanding the company, industry or economy and are not meant to provide summaries of the full content of the call. Other posts in this series can be found by clicking here. Full transcripts can be found at Seeking Alpha.

“Total company sales were $5.3 billion. That’s a decrease of 2% versus Q2 of last year.”

“staples.com sales were up 3% in U.S. dollars and grew 4% in local currency”

“Turning to our services business. Copy and print sales in North American Stores & Online were up in the mid-single digits”

“we’ll continue to go down the path of making closure decisions upon lease end, and we have between 175 and 200 lease decisions over the next 3 years. With respect to the downsizings, we’re seeing good success with downsizings. Our new store size is 12,000 square feet, and we’re seeing roughly a 95% sales retention on that.”

“the combination of less rent and the good omni-channel capability inside stores looks like a very positive combination for us”

“We’ve been taking price investments over the last year. I think we’re going to continue to take intelligent price investments. We think the direction we’re on ought to be able to allow us to stabilize comps. We expect the comps to stabilize, certainly, the remainder of the year. But yes, I agree. I think there are some categories where — particularly when you’re comparing online competitors, where we’re too high, and we’re continuing to take those prices down.”

“It seems like, the last 3 years, we’ve seen back-to-school start later and later and later in the season. And I think in a few years, July is not going to really be much of a month for back-to-school. I think it’s kind of pushing closer to school.”

“they’re better controlling their spend than they ever have and also the mix of what you’re selling them. So everything from Board of Directors’ presentations that used to be sent out in hard copy in binders are now being done digitally on tablets. So it’s a change in technology. It’s impacting our core business. That’s why when we look at NAC in this quarter, the headwinds that we had to fight were negative office supplies, ink, toner and paper, all slightly negative, in spite of what I would argue as slight market share gains.”

“Small business traffic is slightly down, consumer traffic is better, but neither is great. In terms of the categories, it’s a combination of PCs, because of its size, and then the related businesses, computer peripherals, software, things like that, that are just — they have no chance to grow, they’re just deteriorating fast. In the traditional supplies, some of those areas were down, not severely, but they have an impact on mix.”

“we’re moving fast. I don’t have a precise date. But I actually think that with some of the categories that are going away, some boxed software is actually shifting, as well as going away, peripherals are reducing, and moving to our online business, a lot of this is going to continue to shrink, and we’ll continue to reposition the stores and have more productive stores.”

“You just look at computers being replaced by mobile devices, whether it’s phones or tablets, and it used to be computers were 95% and tablets were 5%. Now it’s about — it looks like about 60% computers and about 40% tablets. So that kind of gives you a sense for where that market is moving, and tablets are going to be, not replacing, but certainly bigger than computers very soon.”

Dividend Payout Ratio Comparison

It’s important to remember that when it comes to investing for income, not all dividends are created equal.  Different companies choose to pay out different percentages of their cash flow as dividends.  All things equal, would you rather pay $100 per share for a company earning $30 per share that pays a $30 dividend or $100 for a company earning $50 per share that pays a $10 dividend?  For reasons including dividend indifference theory, I’d strongly argue for an investment in the latter.

Below is a comparison of dividend payout ratios as a percent of operating cash flow for the Dow Jones components (excluding financials).  Merk and Dupont pay out the highest percentage of their operating cash flow as dividends at 54% and 50% respectively.  At the other end of the spectrum is Hewlett Packard, which only paid ~$1 Billion in dividends on over $10 Billion in operating cash flow, leading to a dividend payout ratio below 10%.

The median $DJIA component pays out 25% of its operating cash flow as dividends.  If you applied this number to the group, the yield landscape would change quite a bit.  Merk and Dupont would fall from 3.6% and 3.0% dividend yields to 1.6% and 1.5% yields respectively.  Meanwhile, if Hewlett Packard decided to start paying out 25% of its operating cash flow as dividends, its yield could theoretically rise as high as 6.5% at current prices.

Dividend Payout Ratio of Dow Components

Hewlett Packard 2Q13 Earnings Call Notes

This post is part of a series of posts called “Company Notes.” These posts contain quotes and exhibits from earnings calls, conference presentations, analyst days and SEC filings. The quotes are generally pieces of information that I find interesting or helpful to understanding the company, industry or economy and are not meant to provide summaries of the full content of the call. Other posts in this series can be found by clicking here. Full transcripts can be found at Seeking Alpha.

“parts of the business like printing, enterprise services, converge storage and software are making progress, while others like industry standard servers and personal systems have not completely turned the corner.”

“We also have got to simplify and make more effective our selling motion. ”

“I actually I’m quite confident in our technology, I’m confident in our next-generation blades, in Moonshot.”

“Enterprise Group’s performance, especially during the last quarter. I would say that weak execution has amplified the market challenges that we know exist and it’s been a very aggressive pricing environment.”

“The server market growth rates have come down in the last quarter. The PC market has not stabilized as much as I had anticipated it would. That stabilization is yet to occur. Then finally, Enterprise Services, which is good for this year is, the revenues running off more slowly this year, which is good for this year but creates growth challenges for next year”

“There are some segments that will absolutely grow next year and we will deliver very good performance, but I think it is unlikely given the changes that have occurred over the last quarter or so that we are going to see growth in 2014 as I had hoped.”

“One of the things that we are absolutely seeing in Technology Services is the need to really improve our attach rate on some of our newer products. So, as some of the older products like Business Critical Systems, which has very strong attach and penetration rate as that has a long tail, but it is coming down and hardware in general has been coming down. That’s starting to impact technology services, so what we are doing about that is trying to improve our attach in the newer products and then also coming out with new innovative service offerings like what we call Proactive Care or what we call Datacenter Care, kind of coming out with these new offerings to somewhat cushion the pressure that we are seeing, because hardware sales are declining.”

“The Server business has been under pressure for some time. The pricing in the marketplace is as intense as I have seen it since I have been at HP, but the revenue share loss this quarter was bigger than we had anticipated.”

“Then we must see networking grow faster”

“Then frankly, our Storage business, the converged storage part is going well, but the decline in tape and other areas of XP, we can do better than that.”

“go-to-market is more than just a coverage model. It is our ability to price. It is our ability to provide the specialist and a solution architect that are needed to sell. It is about our ability to provide compelling bundles of server and storage, like an appliance for some of our software elements.”

“China is softer than we had anticipated and it is actually across the board. We are seeing more rapid growth in Tier-4 through Tier-6 cities, a little less in the big areas, but it is reasonably soft demand across the board at least as we see it.”

“You also have to remember this company was the product of the many acquisitions going all the way back to Compaq, EDS, Arcsight, TippingPoint, Fortify, Opsware, you name it. While there were many acquisitions that I think were integrated well, not all of them were fully integrated in such a way that we had the right ERP systems, et cetera. “