Home Capital Group - 2013 First Quarter Update

Amid a weakening housing market, Home Capital Group recently reported adjusted EPS that grew 19.1% in the first quarter of 2013.  Over the same time frame, Canadian home sales fell 15% year over year, though prices have increased modestly.  Despite the doom-and-gloom predictions in the media, HCG sees a fairly balanced relationship between supply and demand, however.  Sales trends have improved in the early second quarter, and new listings have increased as well, while prices have remained fairly flat.  Overall, management sees no bubble in Canada's housing market.  

The company's return on equity remained high at 24%, though that figure has been falling somewhat in recent quarters.  Still, it stands at about twice the level of the average North American business, and the company is able to redeploy the vast majority of its earnings at that level.  In addition, non-performing loans remained low, despite the usual upward blip in the first quarter, due to customers that tend to be recovering from Christmas expenses and seasonal layoffs.  Since customers’ average Beacon score is improving, this trend is likely to continue.  CEO Gerald Soloway reaffirmed full-year 2013 guidance, and pledged that if he ever doubted Home Capital Group's ability to deliver on it, he would say so.

Mr. Market, however, isn't impressed.  In fact, HCG's stock has swooned by more than 15% from its recent peak, with much of that fall occurring over only a few recent trading days.  Several prominent investors are short the stock - a remarkable 23% Home's shares outstanding were held by short sellers as of May 14 - mostly as a macroeconomic bet that Canada's housing market is overvalued.  While it’s likely that home prices are overvalued by 10%-15%, it’s unlikely that Canada will see a US-style crash.  After all, 70% of Canada's aggregate home value is equity, a significant proportion of home owners have fixed rate mortgages, the jobs market has grown slowly but steadily since 2009, and regulators have taken responsible measures to prevent excess.  

Even if Canada's housing market falls harder than expected, it's unlikely that Home Capital Group would suffer adverse consequences.  The company has a long history of careful lending, and has avoided risky areas of Canada's mortgage market, such as condominiums and high-priced neighborhoods.  As a further safety net, HCG insists on meaningful down payments, and its borrowers tend to have significant equity in their homes.

Assuming growth at the low end of its guidance – the company has given a range of 13%-18% for the year - Home Capital Group is currently trading at just 7 times 2013 earnings.  There's no guarantee that the stock can't fall further, but investors should keep in mind both of Ben Graham's two most important ideas.  First, the aforementioned Mr. Market is there to serve patient investors, not to frighten them.  Second, the lower the price of a stock, the higher the margin of safety - which offers both downside protection, and upside opportunity.

My original investment analysis of Home Capital Group is here.

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Jim Tisch - A Friend to Shareholders

In The Office, Steve Carrell's Michael Scott, branch manager at dying paper company Dunder Mifflin, hosts the "Dundies," an annual award ceremony put on to recognize the staff's accomplishments.  In that same spirit, this writer will award a "Friendly" to acknowledge behavior that is beneficial to shareholders, whether it comes from managers, investors, members of the media, or elsewhere.  These prestigious awards will be handed out from time to time, rather than annually, and without the accompanying evening at Chili's, where the not-so-grateful employees of Dunder Mifflin met to receive their awards.

And the award goes to...Jim Tisch, and the rest leadership team at Loews

Loews, a conglomerate controlled by the Tisch family, recently decided to reach out to shareholders in a creative way.  Rather than communicating in one of the usual forms - annual reports, press releases, television interviews etc. - the company released a short graphic novel that illustrates – literally – its story.  Given that the value of Loews lies in several businesses - both wholly owned firms and common stock positions - many would-be shareholders are put off by the complexity.  The graphic work intends to simplify the story. 

The 16-page effort tells the story of its major businesses, which include large stakes in publically traded firms such as insurer CNA and Diamond Offshore.   The piece also mentions that Loews is undervalued.  In fact, readers learn that (at the time of publication) the stock is trading at about $48 per share, yet its "sum of the parts" amount to $50, which doesn't include the value of dozens of high-end hotels, various pipeline properties, or Highmount, an energy exploration and production company.  Readers are reminded that the company has trounced the market over 50 years, returning 16% per year, compared to about half that for major indexes.  In addition, the company re-affirms its core philosophical convictions, including patience, a focus on the downside rather than the upside, and thinking like owners.

Art Spiegelman, surely the world's most influential graphic novelist, dismissed Loews' effort as an artistic failure.  His criticism isn't self-serving, either: the work, starring investigator "Lotta Value," with recurring appearances from "Rich Stockman," will not be confused with Maus, Spiegelman's two-part masterpiece of the graphic novel form.  However, it remains a worthwhile effort at reaching both existing and potential shareholders.  It's possible that Loews' short work will reach most shareholders because of the form, not the content; thanks to the event itself, rather than its subject.  In other words, it may be more about the meta than the message.  Speigelman may appreciate that aspect of it, at least.  In 2011, he released a graphic novel about the original Maus experience - the work's creation, its critical reception, and its implications for his own personal life.  The book's name?  MetaMaus.

Here is other coverage of Jim Tisch, and here is another "Friendly," won by Warren Buffett

Disclaimer: The host of this blog shall not be held responsible or liable for, and indeed expressly disclaims any responsibility or liability for any losses, financial or otherwise, or damages of any nature whatsoever, that may result from or relate to the use of this blog. This disclaimer applies to all material that is posted or published anywhere on this blog.

Joseph Stiglitz and Bruce Greenwald on Productivity and the Great Depression

An earlier article addressed Robert Gordon's grim forecast that America may face a low-growth future, just as all economies suffered pre-1750, before the Industrial Revolution.  If he's correct, it'll mean that standards of living in America will increase only slowly in the decades to come, though thankfully, given the immense wealth of the US economy, it'll increase from a high base.  Nobel Prize holder Joseph Stiglitz, along with his Columbia University colleague Bruce Greenwald, have contemplated the opposite dilemma: when living standards fall even in periods of high productivity growth - indeed, because of steep increases in productivity.  The period that these brave revisionists consider is one that many have sought to understand: the Great Depression.

In a Vanity Fair article, Stiglitz lays out their findings.  He notes that at the beginning of the twentieth century, a large fraction of the US labor force was required to toil on farms just to feed the nation.  However, rapid improvements in seed quality, fertilization, farming methods and mechanization, combined with the absence of similar increases in demand, depressed farm incomes by half to two-thirds between 1929 and 1932.  This abrupt drop in income, he argues, is what caused the Great Depression.  Not only did it flow from rural areas of the economy into cities - less wealth on farms meant decreased purchases of city-made manufactured goods, for instance - but it jumped from the so-called "real" economy into the financial sector: farmers simply could not meet their obligations, and the financial markets were hit hard as a result.  

This wasn't a problem that could be solved by monetary policy: only the massive, if accidental, fiscal stimulus that occurred in preparation for the Second World War, he argues, saved the US from the long-running horrors of the Great Depression.  These large outlays raised the price of crops, and drew surplus rural labor into newly productive urban factories.  Keynesianism worked.

In case anybody had forgotten, this hypothesis is a reminder that Joseph Stiglitz is one of the world's premiere economists, and Bruce Greenwald is among the finest investment and business minds currently working in academia.  Momentous amounts of energy and brains have been marshaled to understand and to learn from the Great Depression, and justifiably so.  That these two men were able to offer such a novel - and convincing - interpretation of the most carefully studied episode in economic history, and one that occurred 80 long years ago, is very impressive.

Disclaimer: The host of this blog shall not be held responsible or liable for, and indeed expressly disclaims any responsibility or liability for any losses, financial or otherwise, or damages of any nature whatsoever, that may result from or relate to the use of this blog. This disclaimer applies to all material that is posted or published anywhere on this blog.

Robert Gordon on Productivity

Many consider economic growth a given, practically a law of nature.  It isn't.  In fact, before 1750, there was effectively no growth, and scant improvement in living standards.  In a paper published in 2012, Robert Gordon, an economist at Northwestern University, wonders whether the period from 1750 to the present was merely a one-time episode in human history, thus dooming us to return to the low-growth past.  He suggests that annual growth - for most of the population, at least - could fall to just 0.5% in the coming decades, down sharply from the 1.9% that we've enjoyed for more than a century.  (He is specifically focusing on the US economy, which may or may not reflect subdued growth in the rest of the world).

Productivity growth - "productivity" broadly measures the ratio of output per unit of input, in this case GDP per man hour worked - is what leads to improved standards of living, and Gordon breaks the post-1750 period into three Industrial Revolutions.  The first, lasting from 1750 to 1830, included inventions such as the steam engine, railroads and cotton spinning, with the economic effects lasting at least until 1900.  The second and most productive, spanning three astonishingly fruitful decades from 1870 to 1900, saw the arrival of electricity, petroleum, chemicals, the internal combustion engine, indoor plumbing, the telephone, phonograph and motion pictures.  The third IR, beginning in 1960 and running to the present, includes all of the wonders of the information age, such as computers, the internet and mobile devices.

While the inventions and innovations of the second IR arrived in the short span of just thirty years, the follow-on inventions (air travel, reliable indoor heating and air conditioning, sewer systems, electrical and indoor appliances, highways) and the long period of time it took to bring all of these enhancements across America, meant that the period of blazing growth lasted from about 1890 to 1972.  Since then, alas, growth has slowed considerably.  While the electronic age has brought amazing, gee-whiz additions to daily life, its effect on growth have so far have paled in comparison to the earlier period.  Allowing users the ease to consume anytime, anywhere is appreciated, but it doesn't bring many new labor-saving benefits.  Interestingly, the largest increase in productivity brought about by computers occurred before the arrival of the internet, when a number of clerical and administrative tasks were automated, thanks to calculators, bar-code scanners, word processors, ATMs, and other electronic marvels.

Gordon points out that the major reason that IR #2 will be difficult to one-up is the one-time nature of many of the improvements.  There's a stark difference between travelling by horse or ship one decade, and by automobile and airplane soon afterward.  However, there's no practical difference between flying at 500 miles an hour or 700.  

Moreover, it's easy to overlook the vast improvements that occurred as indirect consequences of changes in transportation, notably the gains to public health that came from replacing disease-carrying manure from horses by cars and roads, and from cleaning up the smoky, poisoned interiors that prevailed before electricity.  Similarly, once heating and cooling achieves a constant temperature in most houses, there's nowhere to go but sideways.  Other one-time changes include the mass migration from rural to urban centers, the elimination of most "brute force" manual labor, and the filling of homes with work-saving modern appliances. 

In addition, there have been a number of non-repeatable changes since the dawn of IR#3 that are already behind us, such as moving physical card catalogues onto internet-accessible databases, and the ability to read material on-screen rather than on dead trees.  Gordon speculates that the fall in growth from IR#2 has more than offset any gains that have been made since.

There are potential problems with Gordon's work.  As he freely admits, during the glorious bonanza of IR#2, there was a long period of slow growth from 1906 to 1928, a period that coincided with the accelerated roll-out of electricity, automobiles, roads and plumbing.  While this may reflect difficulties with data collection and measurement, it could also suggest a certain lumpiness in the process of improving the economy, and the current slower growth period could be a trough on the way to a new peak.

And, as Yogi Berra wisely noted, predictions are difficult - especially about the future.  A futurist in 1945 who didn't foretell the invention of the transistor a few years later also could not have predicted the rise of the electronic age.  Now, as then, it's nearly impossible to know what innovations the future holds.  Paul Krugman, for one, is more optimistic about the potential of self-driving cars and speech recognition software to significantly raise productivity growth.  However, Gordon is not closed-minded about these possibilities and points to several notable examples of predictions that turned out to be laughably pessimistic.  On the other hand, there are counter-examples of unfulfilled hope.  Who knows?

Even if Gordon's downbeat forecasts are correct, they must be kept in perspective: real GDP per capita in the US would still double by 2100.  Considering how extraordinarily well the average American lives, a 100% increase from the current standard of living, even if it takes nearly a century to attain, is nothing to sneeze at, and would be far higher than almost all of human history.

Disclaimer: The host of this blog shall not be held responsible or liable for, and indeed expressly disclaims any responsibility or liability for any losses, financial or otherwise, or damages of any nature whatsoever, that may result from or relate to the use of this blog. This disclaimer applies to all material that is posted or published anywhere on this blog.