by Travis Johnson, Stock Gumshoe | October 30, 2015 9:10 pm
This ad about a “Donald Trump investment” is sending a lot of questions our way, so we’re going to take a look at it for you in today’s Friday File… and I’ve also got an update on Sandstorm Gold to share, plus a quick look at the idea of “protection” from market declines and how much that kind of protection costs.
But first, the Donald…. here’s how Bill Patalon’s ad for his $20/month Private Briefing opens…
“The $57 Trillion ‘Make America Great Again’ Profit Play
“Donald Trump is Talking Infrastructure — and We Show You How You Can Play It for Gains Up to 553%”
“Let me be clear: I don’t work for Donald Trump or his campaign. And I don’t care one iota whether you love – or loathe – him.
“I’m only reaching out to you today because I’ve looked into his financial records… and I’ve discovered a huge opportunity.”
(And, one gathers, because you know The Donald is in the headlines and that will make it more likely that your demographic — people who have some money to invest and who are old enough that they actually are likely to be voters — will read your email ad… lots of newsletters pitch the “secret” investing ideas of politicians mostly because those politicians are polarizing figures and give you a better chance of having your email read.)
But interestingly enough, it’s not just a “Trump” pitch here from Bill Patalon, it’s also an insider buying pitch … which might be a little bit more compelling. Here’s what he says:
“Trump has built a massive position in one company.
“It’s a firm that happens to be at the center of one of the biggest insider buying binges I’ve ever seen…
“One of its top directors recently dropped $20 million on 800,000 shares of his company’s stock.
“And he wasn’t alone.
“Four of the company’s C-level Suite directors acquired another $2.2 million worth of shares. Even the CEO himself spent $2 million buying nearly 105,000 shares last year.
“That’s more than $24 million worth of shares purchased by direct insiders of the firm. And there’s only one reason insider’s buy in massive quantities like that:
“They see a chance for huge profits.”
As we’ve noted many times in the past, there is good academic evidence that C-suite buying, particularly by three or more insiders, is an indicator of likely rising stock prices over the next year or two. Director buying, which is not the same as C-suite officer buying (C-suite meaning CEO, CFO, COO, etc — people who operate the company, not just those who show up for monthly or quarterly board meetings), is not as powerful an indicator.
And “indicator” doesn’t mean “guarantee,” of course — sometimes the insiders are gaming the system with small buys to get attention from investors, sometimes they’re more patient than you are and they’re looking out 20 years instead of one year, and sometimes they’re just too optimistic about their own company, or they’re just plain wrong. But ON AVERAGE, over some substantial past periods of time in the stock market, MOST OF THE TIME stocks with a pattern of insider buying do better than the broad market in the year or two following those purchases.
So insider buying doesn’t mean you no longer have to think for yourself or diversify, but it is a good thing (and to a much larger degree, according to those same studies, than insider selling is a bad thing — which it really isn’t, statistically and on average… probably because, as you’ve probably noticed, insider selling is much more common. A lot of people are essentially paid in stock, and you can’t eat stock. Or buy a boat with it. Or send your kids through college.)
So what’s the company? Well, it’s got something to do with infrastructure:
“Why have Trump and so many insiders spent piles of cash in this one company?
“It all comes down to what the McKinsey Global Institute calls a $57 trillion infrastructure build-out .
“You see, this Silicon Valley company has recently developed an advanced new technology that could completely overhaul America’s decaying infrastructure – and do it quickly.
“They plan to fully roll out this technology by year’s end.
“And because this company already has a deep foothold with nearly every department in the U.S. government – and is closely involved with practically every industry across the country – it’s bound to make unbelievable money for its investors.”
So yes, this is going to be a big company. Trump’s disclosures about stock holdings are not all that specific, despite the fact that his press releases are careful to remind everyone that he made money on most of his picks (over some completely undisclosed timeframe) and that they are “his own picks” — they use the broad characterizations common to FEC filings about ranges of income and asset values that his holdings fall into, not the specific share count disclosures that, say, institutional investors have to file.
But they do at least name the stocks he has earned money from as of his latest disclosure, both capital gains and dividends — and he has also reported that most of his individual stock holdings were sold last year, so he may not own this “Make America Great Again” investment at all today. And really, there’s essentially no point in following Donald Trump’s stock picks, from the disclosure he made the only real conclusion you can make is that “The Donald likes blue chips” — essentially all of his holdings are megacap stocks, and it would be pretty shocking if his stock investing performance is dramatically different than the performance of the DOW or the S&P 500. He owns almost exclusively the stocks that dominate those indices.
But still, we want to figure out who it is… so let’s check a few more clues.
Here’s the promise of this technology, as it relates to the “infrastructure” pitch Patalon is making:
“For example, let’s say you’re rebuilding a bridge.
“My research shows that with this company’s Digital Infrastructure technology, this new “modernized” bridge will be loaded with tiny devices called MEMS, or Micro-Electro-Mechanical-Systems.
“These are tiny sensors that are often so small they’re invisible to the naked eye.
“Yet they’re constantly reading and recording everything – such as how the bridge moves, tilts and sways under a variety of conditions.
“These MEMS also communicate with each other and the other MEMS in the computer systems to detect patterns that suggest damage.
“Most importantly, they can look inside beams where bridges are compromised and very precisely make lightning quick assessments of what needs to be done – in real time.
“Make no mistake: Had this technology been available on the I-35 Bridge in Minneapolis, engineers would have been notified of a problem long before a collapse – and no lives would have been lost.”
And then we get a bit about the size of the opportunity…
“… it’s already been wildly successful in its initial private-beta commercialization phase this year.
“In fact, this company has already pulled in an astounding $5 billion worth of revenue so far – and that’s before it’s even been officially released!
“Plus, they have another $6 billion on the books.
“And now it’s getting set to roll out to everyone across America”
And we’re given a few more clues, too — such as that this technology will connect the railroad system, with locomitives that have 200 sensors on them, that it will fuel digital power plants, including some for PSE&G, and that it will be deployed by the US nuclear power fleet. And the revenue from this will triple to $15 billion over the next four years.
So who is Patalon pitching here? This is, as you may have already surmised, General Electric (GE), which is definitely trying to rebrand itself as the “Industrial Internet” company.
And it’s a good megacap “blue chip” stock and, I think, a pretty compelling long-term opportunity for those who are inclined to be patient buy-and-hold’ers. I’ve considered it a couple times as the shares have been pretty stagnant over the last year or so, mostly because of some concern about their exposure to the oil & gas industry, but I missed my chance to buy the dips into the low $20s a couple times and don’t own shares — and the stock has recovered pretty nicely over the last couple weeks to the current $29 neighborhood.
The actual direct revenues from their “industrial internet” offerings are, so far, in the $5 billion neighborhood, and they have said that they expect it to be a $15 billion business for them by 2020. Which sounds very impressive, and it is, but $5 billion is about 3.6% of GE’s revenue over the past year. This business should be punching above it’s weight, both because it’s going to be a higher-margin software/service business and because it’s going to be tied in with all the equipment that GE sells that is made better by their industrial internet capabilities, but that’s still a fairly small part of the business. If the economy slumps and people order fewer jet engines or power plant turbines, the industrial internet won’t necessarily be enough of a driver to mitigate that kind of cyclical weakness.
GE is a tricky company to understand, mostly because what’s been driving the results this year is both the story of the “re-industrialization” of GE as they sell of their GE Capital assets and stop acting so much like a financial services company, and the fact that the sales of those GE Capital assets have generated more money than many folks expected, which has helped to make the stock a bit more buoyant. So far GE has announced deals, some of them completed, to sell something like $80 billion worth of assets as they refocus the company on their industrial capabilities — power, oil and gas, transportation, big heavy stuff — and on the industrial internet initiatives to make the big, heavy stuff work better, communicate more and more data, and improve safety and efficiency.
The headline part of this is GE’s cloud product that they call Predix, which is what some early stage initial customers are using now, and what GE expects to roll out to many more customers in 2016. There’s a nice little summary of the opportunity in an analyst note from Barron’s here.
I have no complaints about GE, other than the fact that they are a little bit expensive based on the forecasted earnings, since the stock trades at about 20X expected 2016 earnings per share. That’s probably understating the earnings potential they will have once they’ve finished their restructuring, but that’s going to take another year or two to really generate not cheap for an industrial company with relatively slow growth to this point… and it is a very, very large company so they can’t turn on a dime, it would be an absolute shock if the stock doubled in price in the next year even with the big buyback that’s planned.
If I had caught an opportunity when the price was dipping and bought it, I’d be pretty happy to own it here — and if I had been looking at it back when volatility was very high I might have sold cash-covered puts against the stock, because it strikes me as a safe stock with a strong yield (3%+) and a good plan for reorganizing and refocusing on growth in their core business. The big cash infusion from selling assets will help them to grow the dividend in the coming years, and to do a pretty massive buyback planned at $50 billion.
It’s no longer like a bank, which is what it really almost was when Jack Welch was running the show and playing the income statement like a virtuoso plays the piano, with never a wrong note nor a missed quarterly earnings report, but the bet is that better focus and a less bloated balance sheet will help them to grow the business much more strategically. The earnings reports aren’t very clean just yet, largely because of the huge asset sales they’re doing as they work through getting rid of most of their GE Capital division.
And yes, in case you were wondering about those insider purchases — a director, William Beattie, did buy 800,000 shares back in February for about $20 million (roughly $25 per share), and there have been a few other purchases by members of the Board since then. Purchases by Board members don’t have the same weight as purchases by C-suite officers, but it’s not a bad thing. CEO Jeff Immelt did also buy shares last year as teased, as did some other executives — Immelt’s last purchase was also around $25, about 18 months ago, and was pretty tiny compared to his total holdings and (huge) compensation package.
So… I wouldn’t put much weight on Trump owning GE (and he might not right now, the disclosures aren’t particularly current), and it’s one of the largest companies in the world so you’ve already got a fairly decent slice of it if you own an S&P 500 index fund, but if you’re looking for large cap companies with some growth potential and a big buyback and dividend to minimize the downsize risk a bit, well, you could certainly do worse than GE.
And I haven’t written about Sandstorm Gold (SAND) lately, but I did just buy a few more shares so I thought I should let you know that — and why.
Sandstorm Gold is a streaming and royalty company focused on gold — they focus primarily on streaming deals so they’re a little different, but it’s probably easiest to think of Sandstorm as being a much smaller version of Royal Gold (RGLD) or Franco-Nevada (FNV), the big gold royalty companies. They have been an abysmal investment during the fall in the price of gold, as you might have guessed, but they don’t have any meaningful debt and their operating costs are low, so they’ve been coasting along just fine despite their falling revenues, making new deals and stockpiling royalty streams — so if gold does rise substantially in the years to come their streaming deals will begin to generate massively larger cash flows, and the share price should rise considerably.
Of course, if gold doesn’t rise again over the next year or few… well, SAND will stink. I’m adding to my position here both because I like the deals they’ve been making during the downturn, continuing to build their portfolio, and because my gold exposure has gotten (no surprise) dramatically smaller because of the falling price and I’d like to rebalance to keep a meaningful (though still quite small, my SAND position is still less than 1% of my portfolio with this purchase) exposure to the shiny stuff.
Why should I add now? Well, mostly because I wanted to increase my exposure to gold a bit without taking on a lot of mining risk, and SAND should offer upside leverage that’s similar to a miner without the risks of having to develop and finance mining operations… but when it comes to SAND specifically I’m encouraged by their big new deal with Yamana Gold that was announced this week.
The deal with Yamana is the first big one they’ve done since they partnered with Franco-Nevada on a royalty/streaming deal with True Gold in Burkina Faso, and — if you think gold, silver and copper will be at least at today’s prices over the next five years (and there’s no reason to buy any commodity companies if you don’t think that) — it has the possibility of being a transformational deal, and Yamana, despite the fact that it’s stock has certainly taken a beating, is a large miner with substantial, valuable assets to back up their end of the deal… much stronger than the junior miners who Sandstorm was financing with their streaming deals a couple years ago.
Everything depends on the price of gold not falling a lot from here, and real profits will depend on the price of gold rising — but that’s why you would own Sandstorm Gold, for exposure to the price of gold, and I expect Sandstorm will offer very strong upside leverage from here if gold is over $1,500 an ounce in the next five years. At the current gold prices, and with only about 15 or 16 of their 72 royalty and streaming mines currently producing (quite a few of those, particularly the non-operating royalties, are still quite early in development), they’re still generating about $35 million each quarter in operating cash flow. That doesn’t flow down to the bottom line because of depreciation, asset depletion, writedowns of assets because of the falling price of gold, and their continuing investment in both existing and new partners… but that’s a good operating base that will lever up nicely if (if if if) gold recovers. So I choose this to be my gold equity exposure, though it’s certainly riskier than the big royalty companies FNV and RGLD, because I think it gives more potential upside boost than those larger players do — and if I’m going to keep my gold mining exposure small as a portion of my capital, I’d like it to be pretty heavily levered. Not as levered as a junior gold miner that requires a lot more capital and might go out of business, but levered nonetheless… a junior royalty company feels like a good compromise to me, and I like Sandstorm’s recent deals. We’ll see how it goes.
For those who are worried about markets crashing, and thinking about how to protect themselves, I thought I’d run through an example — if nothing else, to show how relatively expensive it is to buy real downside protection.
If you want to protect yourself by effectively using some small piece of your portfolio to bet against the S&P (because, like most of us, you’re probably mostly making a big bet on the S&P 500 with your portfolio), how much would it cost, and what are the potential gain scenarios?
The most widely traded ETF that reflects the broad market is probably the SPDR ETF, ticker SPY, so we’ll use that (there are plenty of others S&P 500 index funds, as long as there’s enough trading volume their options should have similar pricing). So let’s look at going out as far as we can with SPY in buying puts for downside protection.
The puts for December 2017 at $150, which reflect roughly a 28% drop in the S&P 500, would cost you about $7 a share right now. That means you’re spending $7 a share for the right to sell SPY for $150 a share anytime between now and late December of 2017. The current price of the SPY is roughly $208, so that’s protection costs you about 3% of the price of a share of the ETF.
If you want to buy protection, you need to think about what you’re protecting — are you really just making tiny bets that the market might fall, or are you really trying to prevent your portfolio from losing a substantial amount of money? If you had a $100,000 portfolio that you wanted to “protect” in this way, maybe you’ll decide that you can swallow bad markets up to a 20% loss or so, but if the market falls by some catastrophic amount like 50% you want some protection from that. So you want some “insurance” that you won’t see the value of your whole stock portfolio drop by much more than 25%, just for our illustration (We’re assuming that your stock portfolio moves in more or less the same pattern as the S&P 500, because most diversified stock portfolios do).
What you would be doing by buying this put contract for $700 is buying protection against 100 shares of SPY (current value $20,800) falling in value by more than $5,000 or so over the next 26 months. Your $700 doesn’t do much to protect you if SPY loses $4,000 in value (depending on when that happens — if it happens well before the expiration date, the put option might be sold before expiration and have some “time value”), but it does a bang-up job of protecting you from the next $5,000 in losses.
So if SPY falls to $150 in the next two years, you just have to suck it up and your $700 doesn’t do you much good… but if SPY falls to $120, a loss of more like 40%, then the value of your protection kicks in. At that point, if SPY is around $120 near the expiration of your options contract in a couple years, then your $700 spent would be worth $3,000 (you have the right to sell SPY at $150, but it’s trading at $120, therefore your put contract is worth $30 per share or $3,000 if expiration is very near — more if there’s still “time value” attached to it as well).
So if you’ve got a $100,000 portfolio to protect, what does that mean? Your portfolio is down by 40%, roughly, so it’s worth about $60,000 after this hypothetical crash. The $700 you spent on the options contract gets you $3,000 because of that crash, so instead of $60,000 you have $63,000. Better than no protection… but to really ensure that you protect yourself from anything more than a 25%ish drop you would have to buy put contracts that are commensurate with the size of your portfolio. One contract “protects” roughly $20,000 worth of SPY shares at $208 each from a drop below $150… to “protect” your whole portfolio value of $100,000 (we’re using round numbers to make it simpler) then you’d have to up your protection 5X — you’d have to buy five put contracts on SPY, so a total cost of $3,500. Then, if SPY drops to $120 (a 40%ish fall) over those next two years you’d get $15,000 in value from those put contracts. Your portfolio after a 40% fall is theoretically worth $60,000, plus you get the $15,000 from the put contracts, so total value then is about $75,000, keeping your total loss near 25%.
But it is important to note that this doesn’t really protect you from a 23% drop, or a 15% drop. Just something substantial enough that the SPY starts trading below $150, and just until December of 2017. And the cost is not inconsequential — this “protection” will cost you about 3.5% of the value of your portfolio.
The lesson? Protection is expensive — and there’s not much point in doing it halfway.
Other scenarios for minimizing your losses might be less expensive, but they’re all pricey — particularly if you go out 2+ years. If you’re willing to spend half that much, you can get protection against a similar crash going out to January of 2017 — 15 months instead of 26… but unless this is just a one-time fear you have, and you’re convinced that there’s risk over the next year or two but won’t be concerned about losses in the years after that, then you’re going to have to keep rolling over that protection, whether it’s buying puts or getting exposure to inverse ETFs (which have comparable costs, depending on whether you commit capital to them or buy call options on them), for the foreseeable future. Since the average market gain over the past few decades is only 8-10% and most soothsayers think future gains will be more muted than that, you’re giving up maybe as much as half of that average or expected gain in the markets just to protect yourself from the kind of collapse that has only happened a few times in market history (and, importantly, the kind of collapse from which the market has always eventually recovered). That doesn’t mean it’s foolish to hedge, just a reminder that it’s expensive, and expenses eat into returns in a real way.
And I also wanted to loop around on Greenlight Re (GLRE), which I sold early this week as announced here. I noted as part of that comment that “it’s old business that’s causing the worst of GLRE’s underwriting losses right now, not new business, which was almost enough to convince me to hold onto my shares,” and I want to reiterate that this is true — and that it might mean your interpretation of their prospects could quite reasonably be more optimistic than mine. They no doubt noticed the investor concern about their underwriting losses, so they went so far as to put out a presentation slide detailing the breakdown of where those underwriting losses come from. I’ll reproduce that for you, but the bigger version is on their site here if you can’t read the tiny numbers.
So yes, though the investing losses have been the major source of loss for GLRE this year, the losses on the underwriting side of the ledger have been mostly caused by the businesses they entered in 2009 and 2010 — if memory serves, that included some auto or truck fleet policies in the midwest that turned out to be huge mistakes, they first came to light as big underwriting charges in 2012 but apparently some of the mistakes they made in those years are still haunting the income statement… the underwriting they’ve done over the last four years, according to this chart, has not yet generated any net loss years. That’s really all I wanted to reiterate for you — that I wasn’t just tossing off an offhand comment when I said that the relative strength of their recent underwriting (so far, at least) was almost enough to make me hold on to my shares. This doesn’t guarantee, of course, that there won’t be more underwriting losses from those past mistakes, or that the recent business will remain profitable. Just wanted to point that out for anyone who might be on the fence when it comes to evaluating Greenlight.
That’s all I’ve got for you today — enjoy your Halloween weekend, don’t eat too much candy, and we’ll see you again in November!
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