Was the slamming of Apollo Education (APOL) shares yesterday an overreaction? The sharp (22%) drop had to do with below-expectation earnings growth and the fact that numbers might have to be restated once the company has completed its review of options practices. The million-dollar question – what impact will restatements, if any, have on the financial statements?
The company operates the largest private university in the country (University of Phoenix) and offers educational programs and services at 100 campuses and 159 learning centers in 39 states, Puerto Rico, Washington DC, Alberta, British Columbia, Netherlands, and Mexico. Management controls the company, as the founder and his son own all of the voting shares. This can be good and bad, but overall you can bet they're watching out for company interests and not taking undue risks with the capital that represents a significant portion of their net worth. The company carries no debt and its returns on capital have averaged in the high 20s over the past 10 years (over 40s in the last couple). Of course, restatements may affect the return on capital numbers, but not the fact that they carry no debt on the balance sheet (though there are about $120M of operating leases off-balance sheet).
Upon cursory examination, this looks like a good value at 13 times forward earnings and a free cash flow yield of 8.3%. They’ve been using that discretionary cash to buy back shares the last several years, which has more than offset the dilution from option exercises. With the growth opportunities that lie ahead, this could be a screaming bargain. But how reliable are the numbers? I’ll post more thoughts later.
We discuss a broad range of issues that are often investment-related, but not always so. We call it a 'thought blog'. Sagacious: Having or showing keen discernment, sound judgment, and farsightedness.
Is the Market Starting to Capitalize Peak Earnings?
Materials, Industrials, and Consumer Discretionary stocks are the top sector performers in the S&P 500 since the end of September, up between 3.5 to 4.3%, which is nearly double the overall Index. This is evidence that the continuing market rally over the past few weeks, at least, has tended toward companies whose future earnings are quite sensitive to the economic cycle, with future earnings gains predicated on continuing favorable economic conditions and strength in consumer spending. Yet, current corporate profit margins are at record levels, indicating that we are probably near (at?) the apex of the economic cycle. Is the market beginning to assign higher multiples to these (presumably) peak cyclical earnings?
If a slowdown is years away and profit margins and earnings have longer to run, the companies may be worth more. But if we have a slowdown, profit margins will erode, with earnings taking a corresponding hit. I may be wrong for a while, but I’m willing to bet longer-term that because the business cycle is at or near a top, cyclical industries in general are not the best place to be investing new monies at this time.
If a slowdown is years away and profit margins and earnings have longer to run, the companies may be worth more. But if we have a slowdown, profit margins will erode, with earnings taking a corresponding hit. I may be wrong for a while, but I’m willing to bet longer-term that because the business cycle is at or near a top, cyclical industries in general are not the best place to be investing new monies at this time.
A Thought with the Dow Nearing 12,000
"There's no sense running off to juggle dynamite with the other kids, just because they're having fun right now."
- John Hussman, Ph.D
- John Hussman, Ph.D
A Few Words on Our Investment Philosophy
A few words about the investment philosophy that is behind the postings on this site:
In most cases, we’re trying to determine what the value of a company is to a private market buyer in a negotiated transaction. But we’re not going to pay that price. We want to buy the company at a (hopefully large) discount from this value. After all, as a minority shareholder, we can’t have any influence on what the company does with its excess cash flows. That is, the cash beyond what is needed to sustain and grow the business given available reinvestment or new investment opportunities. A private market buyer would be able to go in and, say, invest in public securities or pay out the excess cash to himself. And thus he should have to pay more for this control. Sometimes, we can profit from this difference between our position and his. We look at adjusted book values, normal earning power, free cash flow generation, and other metrics to determine what a company is worth.
As Charlie Munger has said, “It’s not a competency unless you know the edge of it.” We can’t know everything, but we try to be aware of what we don't know. We look for businesses we understand that are being run by honest, able managers whose personal stakes in the success of the company are high. If we can buy these companies below what they are worth, we should do reasonably well over the long-term.
We’re not worried about near-term market prices, just investment risk – something going wrong with the business. If we find value, we feel comfortable making a purchase and waiting for the market price to take care of itself. If the company’s management continues to create value by generating satisfactory incremental investment returns, the market price should rise accordingly, albeit non-linearly with intrinsic value. This is not to say that we aren’t concerned with market prices, we are just not focused solely on them.
Also, some ideas posted here are not meant to be long-term. These could be called “trades.” But such trades are taken with a long-term perspective.
In most cases, we’re trying to determine what the value of a company is to a private market buyer in a negotiated transaction. But we’re not going to pay that price. We want to buy the company at a (hopefully large) discount from this value. After all, as a minority shareholder, we can’t have any influence on what the company does with its excess cash flows. That is, the cash beyond what is needed to sustain and grow the business given available reinvestment or new investment opportunities. A private market buyer would be able to go in and, say, invest in public securities or pay out the excess cash to himself. And thus he should have to pay more for this control. Sometimes, we can profit from this difference between our position and his. We look at adjusted book values, normal earning power, free cash flow generation, and other metrics to determine what a company is worth.
As Charlie Munger has said, “It’s not a competency unless you know the edge of it.” We can’t know everything, but we try to be aware of what we don't know. We look for businesses we understand that are being run by honest, able managers whose personal stakes in the success of the company are high. If we can buy these companies below what they are worth, we should do reasonably well over the long-term.
We’re not worried about near-term market prices, just investment risk – something going wrong with the business. If we find value, we feel comfortable making a purchase and waiting for the market price to take care of itself. If the company’s management continues to create value by generating satisfactory incremental investment returns, the market price should rise accordingly, albeit non-linearly with intrinsic value. This is not to say that we aren’t concerned with market prices, we are just not focused solely on them.
Also, some ideas posted here are not meant to be long-term. These could be called “trades.” But such trades are taken with a long-term perspective.
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