Thursday Night Links

• The last cycle was a tough one for Value investors. From the end of 2008 to the end of 2020, the result of going long MSCI USA Value and short MSCI USA Growth (the light blue line in Figure 3 was a drawdown of 57%. A whole generation of investors were taught that Value always works in the long run, and going through 2020, this traditional folklore of finance was starting to look outmoded. But over the last two years, the empire has decidedly struck back. In 2022 to date, this same strategy is up 27%. All this is well understood. But there are a couple of nuances, we think, that are less well registered. The first is that Value over Growth is not the same as cheap over expensive. The MSCI Value index selects cheap stocks based on book value, earnings and dividend yields. The MSCI Growth index is not the opposite of this, but instead a group of companies with high earnings, sales and internal growth rates. Where we take just a single Value-related accounting metric, and construct a long/ short portfolio driven by that alone, the results can look very different. The navy blue and yellow lines in Figure 3 show the results of this exercise using free cash flow yield and earnings yield respectively. One can see that their performance is entirely different from the long/short Value/Growth strategy. Getting into the detail explains why; for instance in 2013-14, Apple’s free cash flow yield hovered around 20%, versus some 7% for the S&P 500. At the same time its 5-year EBIT CAGR was around 40%. It is possible to be cheap on one lens, and fast growing on another. Secondly, not all accounting metrics are created equal. Our preferred gauge of Value is the free cash flow yield. It is less prone to manipulation than book value or earnings, is a better measure of profitability given it incorporates the expansion of the economic capital base required to generate it, and, especially important in the current rising rate environment, it is the ultimate measure of financial sustainability. When liquidity is drying up, those that have it on tap should trade at a premium. Despite this logic, as well as the superior empirics demonstrated in Figure 3 (almost 0.3 Sharpe points ahead of earnings yield), we find the metric to be sadly underutilised. Cash, though born free, is everywhere in chains. [Man Institute]
  
• In a dissenting opinion on Tuesday’s Supreme Court ruling, Justice Samuel Alito Jr. wrote, that the preliminary injunction “was itself a significant intrusion on state sovereignty” and that Texas “should not be required to seek preclearance from the federal courts before its laws go into effect.” He also wrote that “it is not at all obvious how our existing precedents, which predate the age of the internet, should apply to large social media companies.” “Social media platforms have transformed the way people communicate with each other and obtain news,” Justice Alito wrote. “At issue is a groundbreaking Texas law that addresses the power of dominant social media corporations to shape public discussion of the important issues of the day.” Texas Attorney General Ken Paxton, writing in response to the emergency application to the Supreme Court, had argued that social-media giants “are the 21st-century descendants of telegraph and telephone companies: that is, traditional common carriers” — and as such, the First Amendment doesn’t prevent the government from “keeping the platforms’ communications pathways open through common-carriage requirements.” [link]
• Most investors are under the impression that much higher energy prices will push renewables “into the money”--- that is renewables will become competitive for the first time versus higher priced hydrocarbons. This completely ignores the fact that energy itself makes up the single largest cost component for both wind and solar. Instead of making renewable energy more cost competitive, higher energy prices will simply drive up the costs. Renewables today remain “out of the money” and higher energy prices will never be able to push renewables “into the money.” [CBS]
• Internally, we have discussed what we should expect to see as the world runs out of spare pumping capacity. Although extremely challenging and uncertain, we find it valuable to lay out a roadmap with mile makers that we should expect to pass if our premise is correct. We agreed that if we are in fact running out of spare capacity, we should see a series of large releases from strategic petroleum reserves. On March 31st 2022, President Biden announced he would release a record 1 m b/d for six months from the SPR. Other countries followed suit and agreed to release another 1 m b/d for at least two months. Historically, SPR releases have been unsuccessful in reducing oil prices and instead are an indication that the physical crude market is exceptionally tight. The larger the release, the tighter the market. The recent announcement from the US and the rest of the International Energy Agency (IEA) member countries is by far the largest coordinated SPR release in history and we believe confirms our thesis that the oil market has fundamentally changed. [CBS]
  
• An unscrupulous company can effectively go private by deregistering its shares and then declining to provide financials to OTC Markets (and pay OTC Markets for the privilege.) Shareholders still own their shares, but their value has been seriously impaired as they are completely illiquid. At this point, the company can allow these shareholders to languish indefinitely, or make a lowball offer to shareholders. A great number of shareholders are likely to accept this offer, knowing it could be their only opportunity to realize value on a reasonable time frame. All the usual requirements still apply to deregistering companies under applicable law: shareholder meetings, making financial statements and shareholder lists available to shareholders. But in truth, companies have a massive financial and informational advantage over small shareholders. It is unlikely that retail shareholders will have the means and ability to perfect their rights. [Alluvial Capital]
  
• The neighbor capped off her account with a superb backhanded compliment. “She’s well put together,” she said of Ivanka. “She’s had a lot of work done, and it’s good plastic. It’s Miami, and there’s a lot of bad plastic here. She has good plastic.” [NY Mag]
• BMW should have picked a name and stuck with it. After our David E. Davis Jr. sang the praises of the 1968 2002, BMW might have said, "Okay, henceforth our overachieving compact sports coupe will be called 2002 and eventually become an iconic brand unto itself." But no. BMW kept building cars in the 2002 idiom, joyful little rear-drive coupes, but the names were erratic—3-series, 1-series, 2-series. The 1987 325is could have been a 2002. Ditto any of the E36 coupes, the 2008 135i, and now the 2022 BMW 230i. If BMW never stopped building the 2002—and it basically didn't—this would be the latest model, and we'd all understand what to expect, which is to say understated style girded with surprising performance and a dash of four-passenger practicality. [Car and Driver]
• My third remark introduces you to the Buxton Index, so named after its inventor, Professor John Buxton, at the time at Warwick University. The Buxton Index of an entity, i.e. person or organization, is defined as the length of the period, measured in years, over which the entity makes its plans. For the little grocery shop around the corner it is about 1/2,for the true Christian it is infinity, and for most other entities it is in between: about 4 for the average politician who aims at his re-election, slightly more for most industries, but much less for the managers who have to write quarterly reports. The Buxton Index is an important concept because close co-operation between entities with very different Buxton Indices invariably fails and leads to moral complaints about the partner. The party with the smaller Buxton Index is accused of being superficial and short-sighted, while the party with the larger Buxton Index is accused of neglect of duty, of backing out of its responsibility, of freewheeling, etc.. In addition, each party accuses the other one of being stupid. The great advantage of the Buxton Index is that, as a simple numerical notion, it is morally neutral and lifts the difference above the plane of moral concerns. The Buxton Index is important to bear in mind when considering academic/industrial co-operation. [link]