Bonds: Interest Rates and Asset Prices – What’s the Right Earnings Multiplier?

Here’s a follow-up question from a reader who’s still troubled by the idea of multiplying a stock’s 10-year average earnings by the inverse of AAA bond yields to estimate the stock’s intrinsic value:

Suppose bonds yielded 0%. That would imply an infinite valuation for companies…What is the price-to-coupon multiplier you would use at an extreme?  Say bond yield of 0%, 1%, etc.    

You’re focused on bond yields instead of bond prices. Saying assume 30-year AAA corporate bonds yielded 1% is like saying assume stocks traded at a P/E of 100 or farmland sold for $50,000 an acre. Can you do math with those numbers? Sure. Can you see them in the wild? No.

I use 30-year AAA corporate bonds instead of government bonds. Their lowest yield was 2.53% in 1946. That means a multiplier of 39.53.

For 1881-2010 the multiplier range is 7 to 40. Meanwhile: the price to 10 year average earnings for stocks ranged from 5 to 43. Investors have never valued $1 of earnings at less than $5 or more than $43. Nor have they valued $1 in promised AAA cash at less than $7 or more than $40.

To have 1% 30-year AAA corporate bond yields, you’d need to push the price of those bonds up from a historical median price of $21.72 per $1 promise to $100 per $1 promise. That’s a 360% price increase.

It would look like this:

If that happened, I’d buy stocks. I’d be too scared to buy bonds. Wouldn’t you?…

Barnes & Noble: Len Riggio Defeats Ron Burkle – 44% to 38%

The New York Times’s Deal Book is reporting that Len Riggio defeated Ron Burkle in today’s Barnes & Noble (BKS) board election. The vote tally – and so far, only Deal Book is giving numbers – was 44% for Riggio to 38% for Burkle.

Burkle got his press release out first:

…preliminary vote totals show that Barnes & Noble…stockholders not affiliated with either Leonard Riggio or Yucaipa voted overwhelmingly for the Yucaipa nominees and poison pill proposal, but due to the insurmountable voting advantage of Leonard Riggio and other insiders the Barnes & Noble slate prevailed.

Barnes & Noble followed with its own press release. All statements were cut and paste.

So back to Burkle’s:

…it is important that Leonard Riggio himself send a message that the strategic alternatives review process is fair and non-discriminatory… the best way he can support the Company’s efforts to maximize stockholder value is a clear and unequivocal public commitment to support the highest bid for the Company, even if it is submitted by a third party…If Mr. Riggio is unwilling to make that commitment, we challenge the Committee overseeing this process to insist on it as a condition of entertaining a bid from him or, at a minimum, amend the poison pill to allow other bidders to neutralize Mr. Riggio’s voting bloc.

Barnes & Noble is trading at $16.16 a share. My average cost is $15.36. I have no plans to sell. If you have questions for me about my BKS position, just ask.…

Barnes & Noble: How Did Independent Shareholders Vote? – Aletheia

When reading media reports on the Barnes & Noble (BKS) board election, it’s important to read the whole article and ignore some of the surface statements.

For example: some reports say that shareholders decided to backed Riggio. Right now, we don’t know that. Riggio won the shareholder vote. However, most of Riggio’s support came from Riggio himself.

We need to step back and look at how much support Riggio got from people besides himself and his brother. We also need to question Burkle’s statement that “independent” shareholders strongly supported him. Does he mean Aletheia is independent? From his press release, it certainly seems that way.

I’m interested in knowing how folks other than the Riggios, Barnes & Noble insiders, Yucaipa, and Aletheia voted. How did that vote breakdown? How many unaffiliated shareholders didn’t vote?

The New York Times’s Deal Book and Reuters are reporting actual percentages. Neither of the two parties gave numbers in their releases. Both Deal Book and Reuters are saying it was 44% for Riggio. They differ on whether it was 38% or 39% for Burkle. And Reuters says it was 43% instead of 44% in support of the posion pill. So there was a smidge of ticket splitting.

The important question is how seriously we should take what Burkle said about Aletheia’s non-votes. The pro-Riggio vote wasn’t strong. Riggio started with 38% to 39% of the vote. Only about 5% came from campaigning. It’s all about why Burkle couldn’t get to 44%. Not why Riggio could.

Talk to Geoff about Barnes & Noble (BKS)…

Panic of 33: Roman Credit Crisis – Tiberius the Central Banker

Since I linked to a post about monetary policy as asset price policy, here’s an example.

In 33 A.D., there was a shortage of money in Rome. Richard Duncan-Jones, the Bill James of Roman economics, explains it well.

To fix this problem:

…the Senate…required that two-thirds of every loan should be invested in Italian land, and that two-thirds of every outstanding debt should be paid off.

In other words: two-thirds of every debt should be paid for with land.

I assume this meant two-thirds of every debt should be paid for with land at cost instead of market.

The disease was debt deflation. The planned cure was to let borrowers pay their debt in land as if land had never fallen in value.

Unfortunately:

…the loans were actually called…in full, and the property market became glutted with estates of debtors desperate to sell, to the point where land prices collapsed.

Lenders faced a forced conversion of debt into land. They were told 18 months ahead of time. If the market value of land was less than the value of the debt, any sane lender would call his loan before the conversion happened.

To fix this problem:

…(Tiberius) came to the rescue…the debtors having the privilege of borrowing for three years, without interest, on giving landed security to the state for twice the amount of the loan. Thus credit was restored, and gradually it was found possible to borrow from private persons also.

Tiberius used money to fight falling asset prices.…

Barnes & Noble: Delaware Law – When Will the Bidding Start?

A reader asks:

“Do you know what…Delaware law states about when Riggio can make a bid of his own? If Burkle wins, what do you think the odds are that Riggio will make a bid immediately?”

I don’t know what Delaware law says about when Len Riggio can bid for the company. Delaware law is cases like Unocal v. Mesa Petroleum, Ryan v. Lyondell Chemical, and Revlon v. MacAndrews & Forbes Holdings.

Revlon gives directors one job: “get the best price for shareholders at a sale of the company.”

Once two people make a bid for Barnes & Noble (BKS), the board’s job is to get the best price.

Reuters is saying:

“If Burkle doesn’t win at Tuesday’s shareholder meeting, sources tied to this…battle say he is likely to come back with a bid for the…store chain.”

They quote a consultant:

“Offers are likely to start soon after the vote, either from one of the losers or from buyers watching on the sidelines.”

I don’t see why Burkle or Riggio needs to bid immediately. And I don’t see why investors need the instant gratification. My average cost is $15.36 a share. I bought expecting a $20 a share bid. That’s a 30% return. Even investors who buy today – at $17 – would make 18% on a $20 bid. If it took 6 months, the annualized return would still be great. I’d worry more about the people and the business and less about the timing.

But I expect bids soon.…

Barnes & Noble: Ron Burkle Sends Email to Barnes & Noble Employees

Ron Bukle sent an email to Barnes & Noble (BKS) employees as part of his campaign for the September 28th board election against Len Riggio.

Here’s the part that could persuade Barnes & Noble employees:

…the current Barnes & Noble Board of Directors has spent a lot of time, money and effort trying to scare you about my intentions and distort my record as an investor. I’ll be blunt. Contrary to what you may have been told, I’m not trying to take over Barnes & Noble. In fact, if our three nominees are elected, there will be two Leonard Riggio approved directors for every new director. Three new directors can’t control anything — but they can make suggestions, ask questions and explore new ideas.

Barnes & Noble has 9 directors. 3 directors are elected each year. They serve 3 years.

Len Riggio is running for re-election. If Burkle wins, Riggio leaves the board. In theory: a Burkle win would give the Riggio party a 6-3 majority. In reality: the Riggio party directors would be lame ducks. They’d have to win elections in 2011 and 2012 to keep their majority. No Burkle director would be at risk until 2013.

At the trial, both sides assumed Riggio would get 100% support from employees. I’ve heard anecdotal evidence of a split between current and former employees. Ex-employees are tired. They’ll vote Burkle. Current employees are scared. They’ll vote Riggio.

The deadline for employee voting is 5 p.m. today. The annual meeting is Tuesday.…

Opportunity Costs: Prices Exist; Interest Rates Don’t – More on Columella

I have a confession to make. I don’t look at bond yields. I invert bond yields to look at bond prices. Always have.

(Price = 1/Yield)

In one article: I multiplied a stock’s free cash flow by the inverse of the 30-year AAA bond yield to get the stock’s intrinsic value. That confused a reader:

“I am still a little confused why the price-to-coupon ratio is used as a multiplier.”

Investors choose between assets like stocks, bonds, and land. If bonds and land are expensive, people buy stocks and vice versa.

Think about Columella and his vineyard. It will cost Columella 32,480 sesterces to plant the vineyard and wait for it to give grapes. In two years: the vineyard will start giving him grapes. Columella will then sell those grapes for at least 2,100 sesterces a year.

His other option is lending the 32,480 sesterces at 6% a year. That would give Columella 1,950 sesterces a year (actually 1,948.8 sesterces; Romans had trouble with fractions).

There are two ways of looking at this choice. You can compare the two options – making a loan and planting a vineyard – in terms of yield: 2,100 sesterces a year is more than 1,950 sesterces.

Or you can compare the two options in terms of value:

2,100 * (1/0.06) = 35,000 > 32,480

I like the value way of looking at things better. It makes more sense to value bonds than discount everything else.

Here is the best thing I’ve read on this topic.

 

TweetPosted on Sunday, September 26, 2010

Greenbackd: One of My Favorite Blogs – 1 Hour 15 Minute Interview With Toby Carlisle

Toby Carlisle writes about stocks Benjamin Graham would buy. He focuses on catalysts more than Benjamin Graham did. Toby’s approach shares some things with Warren Buffett’s and Michael Burry’s partnership days. One of those things is an appetite for illiquid stocks.

Another thing Toby shares with Warren Buffett is an interest in activism. Buffett’s partnership did a lot of coat tail riding. Warren Buffett didn’t just stick to buying a huge basket of Benjamin Graham bargains. Instead Buffett sometimes followed activists into Benjamin Graham bargains. Other times: Buffett went activist himself.

You’ll read a lot of that early Buffett thinking at Greenbackd. One thing you won’t read about is focus. Benjamin Graham spread his bets around. Warren Buffett didn’t. Toby definitely prefers the Benjamin Graham approach. Toby doesn’t just minimize risk when he picks each stock. He also minimizes risk by picking lots of stocks. Every stock Toby buys is super cheap.

A good recent example – one I don’t own but am terribly interested in – is Seahawk Drilling (HAWK). Seahawk owns rigs worth more than its market cap. The company did a presentation where they said an outside appraisal valued the fleet at 75% of book. The stock trades for less than 25% of book. Seahawk first appeared on Greenbackd as a guest post. Toby gets phenomenal guest posts. Since then Toby’s been writing about the stock himself.

HAWK is just one example of the great Benjamin Graham bargains you’ll find at Greenbackd.

Listen to the Interview…

E-Readers: 19 Million Americans Read E-Books on Devices Like Kindle, Nook, and iPad

How many Americans read e-books?

19.6 million.

Here’s the math:

Americans 15 and Older * Percent of Americans Who Use E-Readers = U.S. E-Book Market

Harris found 8% of Americans use e-readers. There are 307 million Americans. Only 245 million Americans are 15 or older. The Harris poll surveyed people 18 and older. But using 15 and older better measures market size.

245,267,292 * 0.08 = 19,621,383

The U.S. e-book market is 19.6 million people. What is the market in dollars?

U.S. book spending is $77.80 per capita. People who use e-readers spend more. So we’re talking about an installed base that buys more than $1.5 billion in books each year.  That’s today’s addressable market for content. A lot of that is still print. It doesn’t have to be. The most profitable e-book growth will come from selling more e-books to people who already have devices.

People born between 1946 and 1976 read less than everybody else. They are income rich and time poor. There’s a danger they will buy devices without buying enough e-books. I’d ignore them.

Amazon (AMZN) and Barnes & Noble (BKS) should focus on selling e-books to readers who grew up in the ‘80s and ‘90s. They need to maximize the number of e-books sold per device. Whoever sells the most e-books per device will eventually turn cash profits at gross margins that will bankrupt competitors.

The way to sell more e-books per device is to sell devices by subscription.

Think Xbox Live and Costco (COST).

TweetPosted on Wednesday, September 22, 2010

Barnes & Noble: Riggio Writes Letter to Shareholders – Transformation

Len Riggio, Chairman of Barnes & Noble (BKS), sent a letter to shareholders as part of his campaign for the September 28th board election against Ron Burkle.

Riggio starts personally:”For myself and the good people of Barnes & Noble it is a fight we did not ask for, and do not deserve.” Self-pity is a bad message. Maybe Riggio wrote that line for employees. They feel it. And they can vote. More likely, he wrote it for himself.  It’s an honest emotion. But it doesn’t belong in the letter.

Most of Riggio’s letter slings stale mud. The only paragraph shareholders care about is this 138 word pitch:

As you well know, the book industry – as well as all industries that deal with printed matter – is undergoing a rapid transformation. Rather than trying to stem the inevitable march of technology, we view this development as an enormous opportunity for Barnes & Noble; first to continue to gain our share as the world’s largest retail booksellers, second to use our storefronts to sell digital devices, and finally to profit greatly from our growing digital business. In fact, in the eleven months since we launched our e-Reading platform, we have already attained a 20% share of the digital marketplace for books. This compared to our 18% share of the physical book space. And we’re just getting started. Speaking for myself, I’ve never been more excited about our prospects since the first day we opened our doors in 1965.

Read Riggio’s Letter…