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FOSL Cover

Singular Diligence has a new report on Fossil Group, Inc., the global designer of consumer fashion accessories, notably watches and jewelry, handbags, small leather goods, belts, and sunglasses.

The company gets about 55% of sales from brands it pays royalties to license and about 45% from brands the company owns. Licensed brands include Emporio Armani, DKNY, Diesel, Burberry, Michael Kors, Adidas, Marc Jacobs, Karl Lagerfeld, Tory Burch, and Kate Spade. Company owned brands include Fossil and Skagen.

Fossil is a large brand (about $2 billion in sales at retail and $1.3 billion in revenue booked by the company). Skagen is a small brand. Fossil gets most of its sales and profits from two brands: the Fossil brand (which it owns) and the Michael Kors brand (which it licenses).

The stock is extraordinarily cheap. It is much, much cheaper than either Swatch or Movado, which we have covered in previous notes. It’s not an exaggeration to say that Fossil trades for about half the price of a “normal” stock in “normal” times.

Click here to read more.

“Everybody has a plan until they get punched in the mouth.” That’s Mike Tyson, the once-and-forever baddest man on the planet, and former boxing champion, explaining in his own words that the best laid plans of mice and men go often askew.

Well, you’ve just been hit in the mouth. The S&P 500 is down more than 8% this year and down more than 11% since it topped out on May 20 last year. That makes it officially a correction. What’s your plan?

Let’s get one thing straight: Nobody saw this coming. In the post mortem, it’ll be attributed to oil or China or North Korea but the real reason is that stock markets, like many things in the natural world, occasionally collapse. Take, for example, the 1987 stock market crash. The popular explanation for that decline is “program trading,” the computer-driven sale of futures to hedge declining stock portfolios, which was said to have created a self-reinforcing cascade of selling: The selling itself forced further selling. In the aftermath, John J. Phelan, then-chairman of the New York Stock Exchange, told The Wall Street Journal that “at least five factors” contributed to the collapse (via Above the Market):

[T]he fact that the market had gone five years without a large correction; inflation fears, whether justified or not; rising interest rates; the conflict with Iran; and the volatility caused by “derivative instruments” such as stock-index options and futures.”

The Wall Street Journal further noted that Phelan “declined to blame the decline on program trading alone.” Was Phelan wrong, or is the popular explanation wrong?

Here’s Robert Seawright, who writes about investors’ behavioral foibles on his Above the Marketblog, explaining that Phelan’s explanation, while counterintuitive, “is wholly consistent with catastrophes of various sorts in the natural world and in society”:

Wildfires, fragile power grids, mismanaged telecommunication systems, global terrorist movements, migrating viruses, volatile markets and the weather are all self-organizing, complex systems that evolve to states of criticality. Upon reaching a critical state, these systems then become subject to cascades, rapid down-turns in complexity from which they may recover but which will be experienced again repeatedly.

Seawright likens such things to a sandpile:

Scientists began examining sandpiles and discovered that each tiny grain of sand added to the pile increased the overall risk of avalanche but which grain of sand would make the difference and when the big avalanches would occur remained unknown and unknowable.

The timing and causes of big avalanches in the stock market are similarly unknown and unknowable. If Phelan was right, it seems we can’t even predict stock market crashes after they occur.

There is research that shows the market becomes more likely to crash when it becomes overvalued. Nobel Laureate James Tobin’s ratio is one such measure of valuation. The ratio compares the market value and replacement value of the same assets in the stock market. Logically, there should be a relationship between the market and replacement values of the same assets and they should trade at approximately the same ratio (for reasons beyond the scope of this post, the relationship isn’t 1:1 but it should be roughly constant). Investor Mark Spitznagel says that when the q ratio gets too high–the market is expensive and overvalued–and large losses become much more likely:

[W]hen Q is high, large stock market losses are no longer a tail event but become an expected event.

In other words, the higher the sandpile, the more likely a crash. How high is the sandpile now? According to the most recent update published January 4 on Doug Short, who tracks the ratio, it currently stands 55% above its long-term average and close to its historic highs:

Here’s the problem with using valuation to predict big declines: The market has rallied about 45% since Spitznagel published his paper in May 2012. In fact, the market has been overvalued for most of the last 25 years, only dropping under fair value for a brief period in late 2008 and early 2009. While there were two huge crashes over those 25 years–the “dot com” bust from 2000 to 2002 and the 2007 to 2009 “credit crisis”–and a couple of smaller ones in 1998 and 2011, the market is up over 400% since first crossing into overvalued territory. The sandpile might grow increasingly shaky and an avalanche become increasingly likely but it can get a lot higher before that last tiny grain of sand finally makes a difference.

It is for precisely this reason that Warren Buffett advises value investors to ignore the level of the overall stock market and focus instead on individual stocks:

At Berkshire we focus almost exclusively on the valuations of individual companies, looking only to a very limited extent at the valuation of the overall market. Even then, valuing the market has nothing to do with where it’s going to go next week or next month or next year, a line of thought we never get into. The fact is that markets behave in ways, sometimes for a very long stretch, that are not linked to value. Sooner or later, though, value counts.

Value investors take an ad hoc approach to portfolio management, only holding cash to the extent that they can’t find undervalued stocks. If you’re value investor, it doesn’t make sense to sell undervalued stocks in anticipation of a stock market sell-off. That’s usually the best time to buy stocks. Buffett counsels that you should not be in the stock market unless you can “watch your stock holding decline by 50% without becoming panic-stricken.” If you are unwilling to endure a 50% crash and you still want to own stocks, there is another way.

Read more at Forbes

A new paper from Christian Walkshäusl and Sebastian Lobe* called The Enterprise Multiple Investment Strategy: International Evidence examines the performance of the enterprise multiple (EV/EBITDA) in international markets, including Australia, Canada, France, Germany, hong Kong, Japan, Singapore, Sweden, Switzerland and the UK. The paper, published in the Journal of Financial and Quantitative Analysis, confirms the U.S. evidence that cheap enterprise multiple stock outperform expensive enterprise multiple stocks by about 1 percent per month. And it works just as well whether the markets are developed or emerging, and in stocks small and large.

The authors conclude that the enterprise value premium–the difference in performance between the cheapest and the most expensive–is significant for the majority of countries, and is highly persistent for up to 5 years after portfolio is formed, which makes it “a promising strategy for investors.” That’s a comprehensive endorsement. The paper is important because the enterprise multiple is a good proxy for The Acquirer’s Multiple®, and it demonstrates that its performance in the US is not an outlier–it’s very much the norm.

The authors discuss the 2011 paper by Loughran and Wellman on the enterprise multiple I examined in Deep Value and Quantitative Value. That paper concluded that cheap enterprise multiple stocks outperform expensive enterprise multiple stocks in the US by about 5 percent per year. This paper confirms that the phenomenon persists outside the US, and by more than twice the margin observed in the US.

Also particularly interesting is the persistence of the enterprise multiple. The authors test portfolios bought-and-held for up to 5 years, concluding the low enterprise multiple stocks continue to outperform in the fifth year by a significant margin.

Also fascinating is the clear manifestation of mean reversion in cheap enterprise multiple stocks. The authors document the progression of cheap enterprise multiple stocks from an average enterprise multiple of 3.4x at purchase to 4.3x a year later, 4.5x in the third year, and then slowly but steadily growing to an average enterprise multiple of 5.5x in the fifth year. The expensive stocks follow a similar path in opposite direction, but do so more quickly, falling from 23.3x at purchase to 9.9x in the fifth year. By the sixth year, the authors found that the cheap and expensive stocks had comparable valuations.

Here’re the monthly performance statistics for each country:

International Enterprise Multiple Monthly Performance

*I am grateful to Sebastian Lobe for providing a pre-print copy of the paper.

You can get a free list of the best deep value stocks in the largest 1000 names on The Acquirer’s Multiple.

Buy my book Deep Value: Why Activist Investors and Other Contrarians Battle for Control of Losing Corporations (hardcover or Kindle, 240 pages, Wiley Finance) from Wiley Finance, Amazon, or Barnes and Noble.

Here’s your book for the fall if you’re on global Wall Street. Tobias Carlisle has hit a home run deep over left field. It’s an incredibly smart, dense, 213 pages on how to not lose money in the market. It’s your Autumn smart read. –Tom Keene, Bloomberg’s Editor-At-Large, Bloomberg Surveillance, September 9, 2014.

Click here if you’d like to read more on Deep Value, or connect with me on Twitter, LinkedIn or Facebook. Check out the best deep value stocks in the largest 1000 names for free on The Acquirer’s Multiple.

This is great. Pickens and Icahn feature in Deep Value and here they chat about some of the players, including Icahn’s old right-hand-man Alfred Kingsley, and names–Hugoton, Southland and so on–from back in the day.

You can get a free list of the best deep value stocks in the largest 1000 names on The Acquirer’s Multiple.

Buy my book Deep Value: Why Activist Investors and Other Contrarians Battle for Control of Losing Corporations (hardcover or Kindle, 240 pages, Wiley Finance) from Wiley Finance, Amazon, or Barnes and Noble.

Here’s your book for the fall if you’re on global Wall Street. Tobias Carlisle has hit a home run deep over left field. It’s an incredibly smart, dense, 213 pages on how to not lose money in the market. It’s your Autumn smart read. –Tom Keene, Bloomberg’s Editor-At-Large, Bloomberg Surveillance, September 9, 2014.

Click here if you’d like to read more on Deep Value, or connect with me on Twitter, LinkedIn or Facebook. Check out the best deep value stocks in the largest 1000 names for free on The Acquirer’s Multiple.

Incredible:

You can get a free list of the best deep value stocks in the largest 1000 names on The Acquirer’s Multiple.

Buy my book Deep Value: Why Activist Investors and Other Contrarians Battle for Control of Losing Corporations (hardcover or Kindle, 240 pages, Wiley Finance) from Wiley Finance, Amazon, or Barnes and Noble.

Here’s your book for the fall if you’re on global Wall Street. Tobias Carlisle has hit a home run deep over left field. It’s an incredibly smart, dense, 213 pages on how to not lose money in the market. It’s your Autumn smart read. –Tom Keene, Bloomberg’s Editor-At-Large, Bloomberg Surveillance, September 9, 2014.

Click here if you’d like to read more on Deep Value, or connect with me on Twitter, LinkedIn or Facebook. Check out the best deep value stocks in the largest 1000 names for free on The Acquirer’s Multiple.

MOV Cover

This month’s issue of Singular Diligence cover Movado Group, Inc. (Movado Group), the designer and marketer of luxury watches.

Movado the company is more than just the Movado brand. The company owns two other brands in addition to the namesake Movado brand: Concord, and Ebel. The Movado brand is considered an “accessible luxury” brand, but Concord, and Ebel are genuine luxury watches. Concord watches usually sell for over $10,000 a piece. Ebel sells for mostl $1,500 to $5,000. About 80% of Ebel sales are to women.

Additionally, Movado has been making licensed watches for about 15 years. In 1999, it introduced Coach-branded watches, which generated $16 million in sales that first year. Movado has since obtained the license for Tommy Hilfiger (2001), Hugo Boss (2005), Lacoste (2006), Juicy Couture (2006), and Ferrari (2012).

Movado went public in 1993 (as the North American Watch Company). It remains under the control of the founding Grinberg family through a Class A stock that delivers 67% voting control.

Movado is an unusually cheap stock, not just in comparison to other stocks today, and not just in comparison to its peers. It’s cheap relative to the price the average stock has traded for in the past. Movado is not a growth stock, but it is undervalued.

Click here to read more.

Bloomberg has an interesting article on identifying activist targets before they are targeted. It’s a great idea, and exactly the same reason for the existence of Acquirer’s Multiple:

Bloomberg Activist investors Bill Ackman, left, and Carl Icahn

Investors love to follow activist money managers who take big positions in a company, often get on the board and then lobby for changes that make the stock rise.

Investing alongside powerful activists like Carl Icahn, Pershing Square’s Bill Ackman, Trian Partners’ Nelson Peltz or Barry Rosenstein of Jana Partners can produce big profits.

One problem with riding the coattails of activists is that their stocks rally sharply the second it becomes known that they have big positions in companies. So you miss out on a lot of their gains.

What if you could predict what stocks they are going to buy, and get in before them? Then you could enjoy even bigger gains. That’s impossible, short of employing mind readers or spies inside their offices, right?

Well, maybe not. Instead of mind readers and spies, you could use a system that helps you buy companies with the qualities activists look for. Then wait for them to come on board, announce their positions and their big plans for change — and enjoy the ride from the start.

This might be easier than it sounds. Indeed, the above scenario plays out often enough for Mark DeVaul, a value investor who is a portfolio manager at The London Co. DeVaul, who helps manage the Hennessy Equity and Income Institutional FundHEIIX, -0.94% doesn’t actually set out to find companies that activists are going to buy. But his system puts him in stocks that activists end up getting involved with, and it has a good record. It outperforms the broader stock market.

Here are the basics: DeVaul favors companies trading at a 30% to 40% discount to intrinsic value, by his calculation. He likes to see strong balance sheets, meaning solid cash flow, plenty of cash and little debt.

“We believe these companies could create value by optimizing their balance sheets,” says DeVaul.

They have room to take on low-cost debt to buy back stock, which lowers their cost of capital and boosts earnings per share, all else being equal. “We also look for hidden assets on the balance sheet, or smaller divisions that could be sold off,” says DeVaul.

It turns out that activists are on the same trail. “We cross paths with activists often because they are looking for the same balance-sheet strength and hidden assets,” says DeVaul. “Activists often see the same things we do.”

A few big hits, thanks to activists

Here are some recent examples of stocks that DeVaul owned before activists got involved — to his benefit.

MeadWestvaco, where Peltz’s Trian Fund and Starboard Partners got active, encouraging the company to spin off divisions. What remained was eventually sold. The total return from late 2012 was over 50%.

Tempur Sealy TPX, -0.07% where H Partners Management got active in early 2014. They eventually ousted the CEO, and the total return on the stock since early 2014 is over 40%.

Energizer Holdings ENR, -1.07% where Jana Partners got involved at the beginning of 2012. The company was split in two earlier this year, when the personal-care-products unit was spun out to form Edgewell Personal Care EPC, -1.35% helping to create gains of over 50%.

But that’s the past. What about the future?

Click here to read more: How to beat activist investors at their own game – MarketWatch

Alternatively, you can get a free list of deep value stocks likely to be targets on The Acquirer’s Multiple.

Buy my book Deep Value: Why Activist Investors and Other Contrarians Battle for Control of Losing Corporations (hardcover or Kindle, 240 pages, Wiley Finance) from Wiley Finance, Amazon, or Barnes and Noble.

Here’s your book for the fall if you’re on global Wall Street. Tobias Carlisle has hit a home run deep over left field. It’s an incredibly smart, dense, 213 pages on how to not lose money in the market. It’s your Autumn smart read. –Tom Keene, Bloomberg’s Editor-At-Large, Bloomberg Surveillance, September 9, 2014.

Click here if you’d like to read more on Deep Value, or connect with me on Twitter, LinkedIn or Facebook. Check out the best deep value stocks in the largest 1000 names for free on The Acquirer’s Multiple.

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