Risky Returns

Experience proves that I am not going to be updating this blog with any hoped for regularity. I apologize to my extensive and diverse readership (embodying 77 countries and 313 languages/dialects). I will continue to update as my intensely busy schedule permits.

Regards and Regrets,

Mr. Risky Returns

Tonight's reading included [part of] Chapter 4, Analysis of Equity Investments: Valuation, by Stowe, Robinson, Pinto and McLeavey.

I say "part of" because the damn chapter is approx. 80 pages long. I originally picked up the book to read up ch. 5, Residual Income Valuation, but apparently got side tracked...

Anyways, Ch.4 briefly explains the Fed Model on pg. 202, and I figured with the recent yield curve inversion and heated debate regarding the future of the 10yr yield, that a few links revolving the model might be timely.

For the uninitiated, the Fed Model is simply the theory that, since interest rates are implicit in any DCF or market multiple, one can gauge the under/over valuation of the stock market by comparing it's earnings yield to a 10-year T-bond. So, you take the P/E for the S&P 500 and you flip the fraction or take the inverse to get E/P, and compare this to the 10-yr rate. If the treasury rate is higher (lower) than the earnings yield, then stocks are overvalued (undervalued).

• Daily Speculations Resource - Victor Niederhoffer & Laurel Kenner
  
• Summary of Clifford Asness Paper published in the Journal of Portfolio Management. A take away quote,"The crucible for testing a valuation indicator is how well it forecasts long-term returns, and the Fed Model fails this test..."
  
• The Street's piece, "The Fed Model Impels, but Does Not Compel"
  

On a side note, I came across a great Federal Reserve Board of NY Q&A on inversions, titled, "The Yield Curve as a Leading Indicator"

As far as the fed model goes, I don't think anyone truly believes it is anything more than a back of the envelope metric to view the market valuation in another light. Besides, it is also a relative measure which doesn't save you if both treasury bonds and the market are due for a correction, or vice versa.

Good Night

Mr. Risky Returns

My apologies for the extended holiday hiatus, however with the New Year, I am back big time!

For Level II, study session 9, I read the candidate reading, "Mergers," chapter 33 in Principles of Corporate Finance, 8^th edition, Richard A. Brealey, Stewart C. Myers, and Franklin Allen (McGraw-Jill Irwin, 2006).

Brief chapter outline:

• Genuine motives for mergers
  
  • Economies of scale - leveraging fixed costs, sharing resources
    
  • Economies of vertical integration - upstream / downstream
    
  • Complementary resources - e.g. distribution channels, manufacturing expertise
    
  • Inefficiency elimination - mgmt removal
    
  
  
• Dubious merger motives
  
  • Diversification - conglomerate discount
    
  • Bootstrapping - eps accretion in return for slower growth
    
  • Lower cost of capital
    
  
  
• Estimating merger gains and costs
  
  • Right and wrong ways to estimate benefits
    
  • When financed by stock / by cash
    
  • Asymmetric information - stock signals an overvalued currency
    
  
  
• Merger mechanics
  
  • Antitrust law - Clayton Act of 1914 & Hart-Scott-Rodino Antitrust Act of 1976
    
  • Purchase accounting - fair value allocation, goodwill impairment
    
  • Tax considerations - generally cash is taxed & stock is tax free
    
  
  
• Takeover defense / tactics
  
  • T Boone Pickens - Cities Services, Gulf Oil & Phillips Petro
    
  • Pacman
    
  • Greenmail
    
  • White knight
    
  • Two-tier offer
    
  • Poison pills
    
  • Shark-repellent
    
  • Golden parachutes
    
  
  
• Mergers and the econ

The very last section stood out in particular. The authors discussed the reality that "intense merger activity," occurs concurrent with periods of buoyant stock prices, although they couldn't provide an explanation for the concurrence.

It seems rather simple to me: If I take a page from Buffet and view the purchase of part of a company with the same logic and perspective as if I am buying the entire company, the merger mania occurrence makes perfect sense. Executives, as humans, are not immune to the same irrational exuberance being displayed in the stock market. Plus, in times of abundant merger activity, numerous companies are seen as possible takeover candidates, which translates into increased equity valuations. Journalists do it all the time.... "Google buys XYZ, thus these three similar companies in the same niche space may be acquired by MSFT, YHOO, etc..." To take it to the extreme, if every company where a likely takeover candidate, then the entire market would reflect a portion of the implied tender premium. I guess the question becomes, what comes first, lofty valuations or intense merger activity...my take is that they feed off each other.

HAPPY FREAKIN NEW YEAR

Mr. Risky Returns