The role of collateral
At the centre of the international Eurodollar system is collateral. Why is that so important and why are banks scrambling for it so much? As I alluded to yesterday, safe and liquid assets are what makes the system tick. It wasn’t always like this though. Before the Great Financial Crisis in 2008 the Eurodollar system was working fine.
In the Eurodollar system, money was “created” by the magic of fractional reserve banking. In his essay “The Euro-dollar Market: Some first principles”, Milton Friedman, writes about how a bank in London can create money through deposits by “the bookkeeper’s pen”. Before the GFC this was how the reserve currency was being made.
Monetary deadlock
I will use this blog as means to understand the Eurodollar-system. I was a die-hard inflationist for a long time, but I have changed my mind over the years because inflation was never coming. It didn’t matter how much money central banks were printing, the end result always seemed to be the same: no inflation.
Then I came across the work by Jeff Snider and Emil Kalinowski over at Eurodollar University where they explain that our analytical framework is wrong. Instead of looking at the money printed by the central banks as high-octane money, they instead should be looked upon as being bank reserves and bank reserves is a different animal from money.
Bank reserves are not money that banks simply can lend out to clients. They instead sit inertly on their balance sheets while the real scramble is going on elsewhere: In the Eurodollar-system. The Eurodollar-system is not the exchange rate between the US dollar and the Euro, but an off-shore monetary system that exists outside of the remit of the Federal Reserve.
This system was conceived in the 1950’s and has over the years grown bigger and bigger and is now multiples bigger than the money that central banks “print”. The scramble that I was alluding to in the former paragraph is about collateral, namely assets that banks can use in order to raise money in the Eurodollar-system. That is important because ever since August of 2007, the Eurodollar-system has not been working as it should.
Prior to 2007 banks were able to put up anything from lowly rated sovereign bonds to junk bonds in order to access the Eurodollar-system. They no longer can do that. Instead, they now have to put up the safest of the safest assets in order to be able to access funding the way they were used to before the GFC.
One of the consequences of the broken Eurodollar-system is that economic growth as we knew it is now not working anymore. We have had fifteen years of sluggish economic growth since the GFC, and it does not seem to improve. This has major societal implications everywhere, where the rise of populism is just one example.
Another consequence is that bond yields are stuck at historically low levels. The reason for this is that the collateral that the banks need in order to access the Eurodollar-system is in such high demand that their price is exorbitantly high (remember that prices of bonds move inversely to their rates).
As I said, this stuff is really complicated, and I don’t pretend to understand it all, but I will try to write in this blog once a week and update you on things that are going on in the plumbing of the monetary system and its repercussions on the economy.
McDonald’s (MCD)
Fundamental analysis of McDonald’s (MCD), June 24, 2017
Description:
McDonald’s is not a small-cap stock, but nevertheless a value proposition that fits into this article.
The company is one of the world’s leading fast food chains with more than 36,000 restaurants around the world.
Valuation:
McDonald’s is not cheap at 28.4 times earnings. Average earnings of the past three years come in at 5.02 which gives a P/E ratio of 30.8. Because of the high Goodwill, the Book value is negative. The company has $1.4 billion in Working capital which means that it is able to pay its short-term bills.
Balance sheet:
The company has a negative equity which in theory means that a shareholder owes money to creditors if the company goes bankrupt. This does not look good.
Free cash flow and dividend:
McDonald’s has a Free cash flow of $4.2bn which allows the company to pay out a nice dividend of $3.61 per share. Furthermore, the company is part of the Dividend Aristocrats which means that they have paid out uninterrupted and increasing dividends over the past 20 years. The dividend yield, on the other hand, is low at 2.3%.
Conclusion:
At $154.64 the McDonald’s stock is too expensive for me.
Update: July 26, 2017
McDonald’s had an earnings call yesterday and even if they had a reduction in sales last quarter compared to the same quarter last year of 3.5 per cent, they managed to increase their earnings per share by 30 per cent. The current earnings per share is $1.70.
The current P/E ratio is still very high at 28.9 with a forward P/E ratio of 26.2. The Book value is negative due to the high proportion of intangible assets.
If you buy the stock now, you believe that their earnings will continue to grow indefinitely.
It doesn’t make sense to buy McDonald’s stock at these prices.
Update: September 6, 2017
McDonald’s is marginally more expensive since the last update. The company is now valued at 29.2 times 2016 earnings. The price over the average three years’ earnings is 31.7 which is way too much.
To be a serious buyer of the company I would like to see prices drop with at least 50 per cent.
McDonald’s update: January 18, 2018
Since we last visited McDonald’s, the stock has gone up a further 17 per cent. That is only to say that the general market is too expensive and that it will end badly.
To buy the McDonald’s stock you are now paying 32 times 2016’s earnings which is ridiculously expensive.
Of course the company is seeing this and adjusting the dividend accordingly, the dividend yield is now 2.1 per cent, but for a good investment what is needed is low valuations.
This stock is not among them.
Conclusion:
The stock is too expensive for my taste.
If you would like to learn more about fundamental analysis you can do that here.
Fundamental analysis of Target Corporation (TGT)
Fundamental analysis of Target Corporation (TGT), July 17, 2017
Update Target, August 28, 2017
Target is valued at 11.6 times 2016 earnings which is cheap enough to make it interesting. If we assume that the company will make $4.50 for the whole of 2017 – which is in line with the earnings reported so far – the P/E ratio comes in at 12.1. This number is not cheap, but not extremely expensive either.
The problem is of course that it is a retailer – a business model that is under heavy attack from e-commerce competitors. However, for the time being Target is making real money which potentially makes it an interesting value proposition.
Description:
Target Corporation operates a household retail business in the United States. It is based in Minneapolis, MN.
Valuation:
Given the strength of its business, the company is reasonably priced at 11.5 times earnings. Average earnings over the past three years are low with one year of loss. Price to forward earnings comes in at 11.8.
Price to book value is high at 2.9.
Income items:
The earnings history seems a little bit erratic with 2014 being a year with a loss. They actually lost $1.6 billion that year which equates to a loss of $2.56 per share. Hopefully, Target Corporation will stay away from those years in the future.
Balance sheet:
The company’s current liabilities are greater than its current assets so the net working capital is negative.
The Debt to equity ratio is 2.4, a number which usually is associated with high risk.
Free cash flow and dividends:
The company last year had a Free cash flow of $3.9 billion which equates to $6.70 per share. Of this they are paying out a dividend of $2.36 (2.8%).
Conclusion:
Because the company is reasonably priced, I’m tempted to dip my toes in the company. The only problem is the high debt levels.
Update Target, January 16, 2018:
Since we last visited Target the stock has advanced another 30 per cent. If I was tempted this summer, I’m no longer. By all means, if you already own the stock don’t get rid of it, but would I buy new stock at this point? No.
The reason for this is the same as last summer: Target has very high debt levels and a negative working capital. On the positive side the free cash flow yield is almost 9 per cent which means that they can afford the dividend of $2.46 this year. But in summary, the stock is too pricey for me.
If you would like to learn more about fundamental analysis you can do that here.
Walgreen Boots Alliance (WBA)
Fundamental analysis of Walgreen Boots Alliance (WBA), July 7, 2017
Description:
Walgreen Boots Alliance is an American pharmacy chain with many business areas in the health sector.
Valuation:
At $78 and a trailing P/E of 20.3, the company is expensive. Looking at an average of the past three years’ earnings, the P/E comes in at 23.7 which is not better. Because of their intangible assets the Price to Book value is also very high at 19.0.
Balance sheet:
The company has a Debt to equity ratio of 1.4 and a Working capital to debt ratio of 0.2 which is OK, but not extraordinary. The Net working capital is $8.9 bn which of course is a lot of cash.
Last year, the Return on equity was 14 per cent which was OK, but not extraordinary. A high Return on equity usually correlates with a high Free cash flow.
Free cash flow and dividend:
Last year Walgreen Boots had a Free cash flow of $6.5 bn which allows them to buy back a lot of the expensive shares that they have issued.
It also allows them to pay a dividend of 1.46 (1.9 per cent). The dividend has been uninterrupted and increasing for at least 25 years.
Conclusion:
The company is too expensive at these prices. Ideally I would like to see them fall by 50 per cent before dipping my toes.
There is nothing wrong with the company, but it is simply too expensive.
Update, August 25, 2017
Walgreen Boots is valued at 21 times last year’s earnings. If we assume that the company will make $4.00 in 2017, the forward P/E ratio comes in at 20.
Because the company has a lot of intangible assets the Price to Book comes in at 19.7, which is very high.
In summary, I would not buy shares in Walgreen Boots at this time.
Update, January 05, 2018
Since we last looked at Walgreen-Boots, the share has gotten marginally cheaper but at an earnings multiple of 19 the stock is still expensive if you look at the earnings alone.
On the other hand, Free cash flow yield for last year comes in at 7.6 per cent which is better than its peers.
There is nothing wrong with company. Debt seems manageable and Return on equity looks good at 14 per cent last year. The company also has a healthy $1.2bn in cash.
Conclusion:
Had the stock only been 30 per cent cheaper I would be a buyer. Now it’s a HOLD.
If you would like to learn more about fundamental analysis you can do that here.
Leggett & Platt (LEG)
Fundamental analysis of Leggett & Platt Inc., June 2, 2017
Description:
Leggett & Platt is a designer and manufacturer of home and office products. It has its headquarters in Carthage, Missouri.
Valuation:
Leggett & Platt seems expensive at a trailing P/E of 19.0. Over the average past three years the P/E is even worse at 27.6. The Shiller P/E is very high at 46.7. Given the high amount of intangible assets the company’s Price to book ratio is very high at 53.3.
Balance sheet:
With a Working capital of $620m seems well capitalized. At least they don’t have any problems with paying their short-term bills. However the company has a Debt to equity ratio of 1.7, a figure associated with high risk. Net earnings to sales in 2016 came in at 10.3 per cent which is good for a manufacturing company. Last year’s Return on equity was very high at 35 per cent.
Free cash flow and dividend:
Leggett & Platt has a Free cash flow of $430m which equates to $3 per share. Of this the company pays out a dividend of $1.12 (2.5 per cent) which seems reasonable.
Conclusion:
Leggett & Platt is a well run company with solid earnings and good cash flow. However, at these prices I would not buy new stock.
Update, August 21, 2017:
Leggett & Platt is neither expensive nor cheap at 16.8 times the earnings of 2016. Assuming forward earnings of $2.50 for 2017, the forward P/E ratio is 18.6 which is on the high side. I would not be a buyer of the stock at these prices.
Update, December 15, 2017
It’s time to revisit this interesting stock which is spitting out cash like there’s no tomorrow. Its P/E over 2016’s earnings is 16.7 and if we assume that the company will make $4.16 this year, the forward P/E ratio is a solid 11.1. This isn’t what I would characterize as a cheap stock, but cheap enough to whet my appetite.
The company has been paying out a dividend of $1.76 so far this year which gives a current dividend yield of 4.8 per cent.
Conclusion:
At these prices Leggett & Platt is a buy!
If you would like to learn more about fundamental analysis you can do that here.
Nucor, Inc.
Fundamental analys of Nucor (ticker: NUE), July 15, 2017
Description:
Nucor is an American steel producer that sells steel and steel products in the United States and internationally. Their headquarters are in Charlotte, North Carolina.
Valuation:
At $60 and 24 times trailing earnings, Nucor is expensive. When looking at an average of the past three years’ earnings the P/E ratio comes in at 37 which is a lot of money.
The Price to book value is also high at 3.6.
Balance sheet:
The Balance sheet of course looks good. In the end, this is what the market is paying for. Their Debt to equity ratio is 0.8 which is considered low risk and their Working capital is $4.1 billion which at least means that they can pay their short-term bills.
Free cash flow and dividend:
Last year Nucor had a Free cash flow of $1.1 billion which equates to $3.50 a share. Of this they are paying a dividend of $1.49 which means that the current yield is 2.5%.
Nucor is part of The Dividend Aristocrats which means that they have been paying out uninterrupted and increasing dividends for more than 25 years.
Conclusion:
If the share had been 30 per cent cheaper I would have been a buyer. Now it is too expensive for my taste.
Update, August 14, 2017
Nucor is valued at 22.2 times its earnings in 2016. This is in my opinion too pricey.
If we then estimate the earnings for this year to $3.50 the P/E multiple comes in at 15.8 which is still too high, but slightly better.
Balance sheet, earnings and dividend history are all outstanding.
In summary I would not buy Nucor at these prices.
Update, December 13, 2017
The company has even gotten more overvalued since last time we looked at it. It is now valued at 25 times 2016’s earnings. If, on the other hand, look at the projected earnings for the year they come in at about $3.90 which gives a forward P/E ratio of 16 which is not altogether bad – although still expensive.
Nucor’s fundamentals are solid: Their Debt to equity ratio is 0.8 which is associated with relatively low risk. They have a Free cash flow yield of almost 6 per cent which is better that most of its peers. The net earnings to sales is 5 per cent which is a good number for a manufacturing company.
In summary, there’s nothing wrong with the company, but the market is willing to pay too much for it right now.
If you would like to learn more about fundamental analysis you can do that here.
Johnson & Johnson
Fundamental analysis of Johnson & Johnson, June 30, 2017
Description:
Johnson & Johnson is an American healthcare company that researches, manufactures and sells various products in the health care field.
Valuation:
The company is expensive at a cool 22.4 times trailing earnings. When looking at an average over the past three years’ earnings, the P/E ratio is almost the same at 23.2. Because the company has a lot of intangible assets the Book value is only $7.50 a share which obviously makes the Price to Book value very high.
Balance sheet:
The Balance sheet looks very stable with a Working capital of $38.7 bn and a Working capital to Debt ratio of 0.5. The Debt to Equity ratio is 1.0 and its current Return on Equity is 23 per cent which are solid numbers.
Free cash flow and dividend:
Johnson & Johnson has a Free cash flow of $15.5 bn which allows it to pay out a dividend of $2.95 which equates to a yield of 2.2 per cent. The company has been paying out uninterrupted and increasing dividends for 25 years.
Conclusion:
Johnson & Johnson is a very well run business with steady earnings and a good cash flow. The only problem is the valuation where you are paying too much for what you get. Had the company been 30 per cent cheaper I would be a buyer. Now it’s a HOLD.
Update, August 13, 2017
At 22.4 times earnings the Johnson & Johnson stock is too expensive for my taste. In the first quarter they earned $1.61 which allows us to say that they will be making at least $5.50 for the year.
This gives a forward P/E multiple of 24.2 which is way to high for my taste.
Otherwise it’s a well-managed company with solid earnings and a good dividend history.
Update, December 12, 2017
Johnson & Johnson have actually been proactive and increased their dividends accordingly as the stock has risen over the few years. Unfortunately the dividend payouts are not grounded on the fundamentals of the stock. Quite on the contrary.
The forward P/E ratio is still very high at 25.7 and earnings multiple over 2016’s earnings is also very high at 23.8.
All that said, there’s nothing wrong with the company’s finacial key data. Debt to equity is 1.0 which seems reasonable, return on equity is 22 per cent and net earnings to sales is 23 per cent which are all good numbers.
Conclusion:
There’s only one thing that is wrong with the company and that is that it is too expensive.
If you would like to learn more about fundamental analysis you can do that here.
Stanley Black & Decker
Fundamental analysis of Stanley Black & Decker, June 10, 2017
Update, December 10, 2017
Since we last looked at this stock prices have gone up a further 20 per cent and it is now even more expensive. The earnings multiple comes in at 21.6 which is high and taking an average of the past three years’ earnings the multiple is 25 which is too expensive.
Having said all this, there’s nothing wrong with the company. They don’t have too much debt, have a good profitability to equity ratio (as is important for a manufacturing company) and reasonably high return on equity.
Conclusion:
Had the stock been priced at 50 per cent of its current value I would be a buyer. Now I’m not.
Update, August 8, 2017
The price of the SWK stock hasn’t really been moving since we last looked. The one thing that has changed is that they have released a new quarterly report. Based on the quarterly report the company earned $4.40 for the last six months.
If we say that the company will make $8 for the whole of 2017, then the P/E ratio will come in at 17.6 which is good, but still a little bit expensive.
The Price to book ratio is negative because of high intangibles.
The company made $1.14 million dollars in Free cash flow last year which equates to $7.70 per share. Of this they pay a dividend of 58 cents per quarter.
Conclusion:
I would not be a buyer of StanleyBlack & Decker at these prices.
Description:
Stanley Black & Decker is a Fortune 500 manufacturer of industrial tools, household hardware and provider of security products. Its headquarters are located in New Britain, Connecticut.
Valuation:
At $140, the Price to earnings ratio is 21.5 (trailing earnings) which in my opinion is expensive. The Price to the average of the past three years’ earnings is hardly better at 24.6. The Book value of the company is negative because they have a lot of intangible assets (which should be subtracted from the Equity to arrive at the Book value).
Balance sheet:
With Current assets of $4.8bn and Current Liabilities of $2.8bn, the company has a Working capital of $2bn which is a lot of cash in the bank. They have a Debt to equity ratio of 1.5 which is not out of the ordinary.
Free cash flow and dividend:
Stanley Black & Decker has a Free cash flow of $1.14bn which allows it to pay out a dividend of $2.26 per share (or a 1.6 per cent yield). The company is part of the Dividend aristocrats, which is a list of the companies that has paid out uninterrupted and rising dividends for 25 straight years.
Conclusion:
Stanley Black & Decker is a well run company with solid earnings and a good free cash flow. However, the current price is too high for my taste.
If you would like to learn more about fundamental analysis you can do that here.
Colgate-Palmolive (CL)
Fundamental analysis of Colgate-Palmolive (CL).
Update, December 01, 2017:
At almost 27 times 2016 earnings, Colgate Palmolive is still expensive. If current trends continue, the company will approximately make $2.55 for 2017 which gives a forward P/E ratio of 28.4.
Because the company has a lot of intangible assets its book value is negative which makes for a difficult Price to book valuation. Colgate’s cash flow yield is 4 per cent which is in line with its competitors.
The stock is still too expensive for my taste.
Description:
Colgate-Palmolive is an American consumer products manufacturer with a global business. It is based in New York City, New York.
Valuation:
The company is expensive at 27 times last year’s earnings. Looking at the past three years’ earnings it is even more expensive at 33 times average earnings.
Because the company has a lot of intangible assets – which are supposed to be subtracted from the equity when calculating the book value – the book value is very low and even negative.
Therefore it does not make sense to calculate a Price to Book value ratio.
Balance sheet:
Colgate-Palmolive has a working capital of $1 billion which is a lot of cash in the bank.
When looking at the Balance sheet in detail it becomes apparent that their liabilities are almost as great as their assets and that the equity portion is very low.
Nevertheless, people seem quite happy to pay for their ability to make money out of the equity.
Cash flow and dividend:
The company had a Free cash flow last year of $2.5 billion which equates to $2.84 per share. Of this they are paying out a dividend of $1.50 which equates to 2.1 per cent.
Colgate-Palmolive is also involved in buying back shares which in general makes the shareholders who are selling their shares richer.
The company is a part of the Dividend aristocrats which have a history of paying out uninterrupted and increasing dividends for at least 25 years.
Conclusion:
At these prices I would not be buyer of Colgate-Palmolive. For me to be interested prices would need to fall by at least 50 per cent.
If you would like to learn more about fundamental analysis you can do that here.