From Uber to Sears: The Business Cycle from the Perspective of an Investor

Disclaimer: Stock prices are updated as of 10/3/16. The opinions stated in this article do not reflect the opinions of the Pitt Business Review and should not be taken as investment advice by a registered professional.

When you wake up every morning and go out into the world, you often don’t think of the companies you encounter. Proctor & Gamble contributed to your hygiene, Kellogg’s gave you breakfast, and you probably use multiple devices made by Apple. My question to you is, do you notice when these brands change? For example, do you remember when flip phones became smartphones, and now there are sixty-four phones released every year without buttons? You don’t remember that, and neither do I. However, I do know a little about the business life cycle. I also understand that the business life cycle can help one decide which companies they should invest in and at what time. Now you could probably find an unlimited amount of material on this subject. However, we are going to keep it simple. The periods I want to focus on are: seed, growth, expansion, maturity, decline and exit. The best way to approach this is to use examples featuring those same brands that influence your daily activities. Please enjoy and reach out to me if you have any questions. (Actually, just kidding, I’m in college and shouldn’t be trusted with your portfolio)

To start things off, the quintessential seed company that comes to mind is UBER. This firm has revolutionized the transportation industry and looking to lead the future of driver-less technology. I really wanted to display a 1 yr return for UBER, but they actually aren’t even a public company yet. That’s right, UBER is valued at around 50 billion and they are not listed on a stock exchange. As an investor, it must be exciting to think that they haven’t tapped the equity markets yet. To understand how much they’ve grown, they were only valued at 60 million in 2011. Annually that’s a growth rate of 284%. Personally, I don’t know if I could fathom any amount of money doing that over a period of time. They can’t do that forever, especially when they finally become a publicly traded company. But that is why we are here in the first place. To explain what typically happens after this point.

The next period I want to address is the growth period. Amazon AMZN is one of the fastest growing companies in the world. Their stock isn’t doing so bad either:

amzn

This is phenomenal growth, but that is expected from a company that revolutionized how we purchase almost everything. Holding this in your portfolio right now isn’t a bad idea considering they just recently became profitable in the last couple of years. As their cost structure becomes more efficient, they should have no problem growing earnings. At this stage of the cycle, Amazon is looking to penetrate new markets and find new customers in every segment of society. This is why they have ventured into the online streaming market with Amazon Prime. A more long term experiment has been the idea of drones delivering packages. Not only would this allow them to cut costs, they would be direct competitors of mail carriers throughout the United States. This shows that they are not only developing their core service, but they are building around it to offer a more complete business model to prospective investors. This level of growth is impressive, however, shareholders will expect innovation from this company for the foreseeable future.

A company similar to Amazon in growth, but farther along the cycle is Google GOOG. They represent the expansionary period. Their return over the last year is similar to Amazon in growth, but they have tapered off a smidge. And I do mean a smidge:

goog

While still posting an impressive 14% in return the growth of google is just slowing down and they focusing to becoming a household name in as many markets as they can. This involves everything from virtual reality, driver-less cars, and smart home thermostats in England. Add in, a couple venture capital firms, YouTube, social networks, and mobile smartphones; Google definitely knows it’s in the expansionary phase. They are still growing, however, and their valuation will hit a ceiling at some point.

Arguably, this next company is one of their arch-nemesis. The ever so popular Apple AAPL is maturing right before our very eyes as a cornerstone of the consumer electronic market. This isn’t bad news as investors still value their shares very highly:

aapl

Notice how the line looks very volatile, however, they moved on 3.23% in the past year. Apple still growing, and many believe that they will be the first company to reach 1 trillion dollars in market value. I can’t doubt this claim as products like the iPod and iPhone have revolutionized technology throughout my young adulthood. Since the passing of the iconic Steve Jobs, Apple has focused on positioning themselves to change into more of a mature firm. While the market continues to look to them for life-altering innovation, their offerings haven’t been that groundbreaking as of late. You sort of get the sense, that they understand their position as well. In the past couple of years they’ve acquired Beats by Dre and started Apple Music. Fast forward a year and a half and now they are a major player in the music streaming market. Combine that with the untimely demise of the Samsung’s flagship device (Galaxy Note 7), and Apple is looking to finish out the year strong.

We have now come to the latter end of business cycle. These are companies that were once staples in sectors such as technology, and consumer goods. However, they have not been able to conform to the taste of consumers or the offerings of their competitors. Blackberry Limited BBRY, formerly known as Research In Motion, is struggling to regain the market share they once claimed in mobile technology.

bbry

Their 18.76% return is a positive for the firm, however their shares have been reduced to under the single digits after being valued at nearly $15 in 2013. Google, Samsung, and Apple have all been relatively successful in this new age of the smartphone. The days of button-filled, pocket-friendly devices are long gone. These last five years in mobile technology has been defined by bigger phones with less buttons and more screen real estate. The most polarizing change, however, is the debate between Android and iOS. Google and Apple have started the first mobile operating system war. In all this debate, Blackberry is nowhere to be found. They have tried to make some noise with devices such as the Blackberry Priv.[1] Consumers just don’t seem to care as much as they once did. The company still has a loyal presence among the corporate executive market. The security of their phones is still something that is hard to find elsewhere in other devices.

Finally, we have come to the exit stage. Sears has been rattled by the recent wave of e-commerce. Their stock has been through nothing short of a bloodbath in the past year, falling by over 50%.

shld

Most retail investors should stay away from their securities. Amazon and E-Bay have made it almost second nature for shoppers to look on the internet for their consumer goods. A core demographic that Sears has lost is women that are 55 years or older. Women have dropped their preference for Sears over 53% in the past ten years.[2] Recently Moody’s has downgraded the company’s liquidity rating from SGL-2 to SGL-3. Moody’s defines SGL-3 as the following:

“Issuers rated SGL-3 possess adequate liquidity. They are expected to rely on external sources of committed financing. Based on its evaluation of near-term covenant compliance, Moody’s believes there is only a modest cushion, and the issuer may require covenant relief in order to maintain orderly access to funding lines”.[3]

The rating agency justified the downgrade with the following statement:

“The SGL-3 rating reflects our view that Sears will continue to rely on external financing and the monetization of its alternative assets to fund its operating losses” stated Moody’s Vice President, Christina Boni. “We recognize the risks associated with relying on these sources and continued shareholder support to finance its negative operating cash flow which is estimated by Moody’s to be approximately $1.5 billion this year.”[4]

Overall, this is usually what happens to firms as they progress through the markets. Some firms do stand the test of time and stay relevant forever. Other firms slowly fall as they fail to adapt to the changing business environment. This isn’t meant to say that all firms will experience an exit, however, they are all capable of dying out at some point. This should always be in the back of the minds of the average investor. The companies you want to own should be providing value to their shareholders for the long-run. In addition, growth can be a false metric used to disguise an underlying lack of long-term business strategy. Firms like Apple have been around for decades but have only seen real growth in the past 6 – 7 years. Companies such as Google, however, have been on a tear in the markets ever since their IPO. Moreover, it is up to the managers of each of these firms to find that value and use it to their advantage for as long as possible. In closing I would like to leave you with a quote from the great value investor Benjamin Graham, “Invest only if you would be comfortable owning a stock even if you had no way of knowing its daily share price.”[5]

[1] http://us.blackberry.com/smartphones/priv-by-blackberry/specifications.html

[2] http://www.businessinsider.com/sears-in-state-of-decline-2016-2

[3] https://www.moodys.com/sites/products/AboutMoodysRatingsAttachments/MoodysRatingSymbolsandDefinitions.pdf

[4] https://www.moodys.com/research/Moodys-downgrades-Sears-Speculative-Grade-Liquidity-rating-to-SGL-3–PR_355013

[5] https://www.goodreads.com/author/quotes/755.Benjamin_Graham

Leverage: What is it, Why do we use it, and How have we used it?

leverageMoney plays a large role in society. I understand that starting any article with such an obvious statement is extremely generic. However, I feel like that statement isn’t said enough, especially considering that nowadays it is a very popular idea to use other people’s money. This is the layman’s term for leverage. Leverage in a more formal definition is the use of financing from outside sources to amplify returns. This idea is so popular in finance, that it has singlehandedly brought down entire financial systems on multiple occasions. Shall we return to 1994 when a seemingly-divine team of financial and economic professionals formed a hedge fund called Long Term Capital Management. They assembled the biggest names in economics and finance to make a super team of investment professionals. Because of their respect on Wall Street, they were able to borrow against each dollar of assets they had. This led to them having over 100 billion dollars in holdings. Fast forward 4 years and they somehow managed to expose themselves and their investors to about 1 trillion dollars of market risk. The firm only had about 4 billion dollars in total assets under management (AUM). This happened due to its extreme amount of leverage.

I’m not here to question these professionals’ character, motives, or train of thought. Quite frankly, give me an Ivy League education, a great network, and 4 billion dollars, and I might have the capacity to cause a good amount of trouble in the markets. However, I feel like the idea of leverage needs to be further examined by the general public. The average citizen wouldn’t like to admit it, but we like leverage too. In fact, we love leverage, for just about everything. We get financing for our homes, cars, educations, and general purchases. The credit card in and of itself is just a short-term loan. Yet, we separate ourselves from top executives when they display irrational behavior. Can you rationalize taking out hundreds of thousands of dollars to spend on a degree that will get you a career that won’t pay off the loan you took out in the first place? I can’t, but many of us end up doing just that. Now it can be argued that an education does provide the opportunity to generate adequate income and ascend up the economic ladder. However, that doesn’t do much for the current trillion-dollar student debt bubble. College tuition will continue to rise and the average high school graduate will need to borrow more and more to continue their education. However, there is a more alarming example of consumer leverage.

“Maturity (x-axis) means time and yield (y-axis) is essentially interest. The curve moves up over time because of volatility.”

It’s called a house mortgage. Do people really consider their financial situation when they are purchasing a home? During the financial crisis, it can be argued that someone’s credit worthiness didn’t even matter. Sure, low interest rates and predatory lending definitely played a part in the mortgage default crisis. However, no one forced those people to take those loans. Adjustable rates on mortgages can leave a potential homeowner vulnerable to many different risks as time goes on. Even in a normal market, the economy is ever changing and always moving. In economics, a very basic concept is the idea of a yield curve. Maturity (x-axis) means time and yield (y-axis) is essentially interest. The curve moves up over time because of volatility. And this is in a normal market. Sure, adjustable rate mortgages may provide a cushion during times of low rates, but what about when they are raised? Your rates will go up but your income won’t, and you can’t ask for a raise because the economy is following its own universal laws.

Yes, owning a home is a very personal and emotional decision, but foreclosure is also a very personal and emotional event. As people who are pursuing the ultimate goal of one day being financially secure and free, we should examine the lengths we are willing to go to reach that goal.

I believe that taking huge amounts of borrowed money, no matter who you are, can be rewarding but dangerous without the proper precautions. It can sometimes go against all rationality. Leverage isn’t necessarily bad when used in moderation. This is why there are margin requirements (or cash requirements) to invest using borrowed money. Amplifying returns isn’t morally wrong. It isn’t a crime to seek out profits from the financial markets. The issue is when pride overshadows principal (literally). Some of the greatest minds in the world have had their successes simply reduced to nothing because of excessive leverage. Whenever this happens, we usually point blame and then throw away the greater conversation. Is there any person or entity that is above leverage abuse? To boost its economy, the Chinese government has made it easier for private equity firms to get financing to buy Chinese companies. This sounds like a good idea, however, what is the limit? Did we reach our limit? By “we”, I mean the United States government, and by limit I mean the $19 trillion debt that is looming on its balance sheet. Oh, and we are considered the most credit worthy nation ever. All I want to know is, does anyone actually know how to use borrowed money?

Sources:

http://www.businessinsider.com/the-fall-of-long-term-capital-management-2014-7?op=1/#e-idea-for-ltcm-began-with-john-meriwether-who-ran-bond-arbitrage-at-salomon-brothers-he-resigned-from-that-bank-after-an-employee-was-discovered-deliberately-deceiving-the-us-treasury-1

http://www.reuters.com/article/us-carlyle-group-china-idUSKCN11X17Q

http://www.treasurydirect.gov/NP/debt/current

A United States of America Under Donald Trump

There is a small chance that Donald Trump will become the next President of the United States. “The Donald” really only appeals to a certain group of republicans. However, he is still the front runner for the nomination of one of the major political parties in the United States. Many wonder what his impact on the U.S. and the world would be. He has given us a glimpse through his campaign proposals, speeches, and numerous public statements.

First things first, while his views are highly controversial and arguably very offensive, he does speak about things that aren’t really touched on by other candidates. The radicalization of young Muslims across the globe is definitely a problem that isn’t spoken about when discussing Terrorism. Granted, that this radicalization happens faster in countries where Muslims aren’t accepted into the greater society of that nation. It was reported in a Gallup survey that 26% of Muslim youth in the United States feel angry.

This number is double that of next listed religious youth population, Protestants. This number is also 8% higher than the national average of youth who are angry. Considering how Islam is portrayed in the media and by candidates like Trump, I’m surprised this number isn’t higher. With Donald Trump saying he wants to keep an eye on mosques and even banning Muslims from entering the United States; there is no doubt that the amount of angry Muslim youth in the U.S. would grow rapidly. It is for this main reason that he was listed as the 6th greatest risk to the world by the Economic Intelligence Unit. His presidency was given this rating based off of his threat to national security.

“His militaristic tendencies towards the Middle East and ban on all Muslim travel to the US would be a potent recruitment tool for jihadi groups,” the EIU said in its global risk assessment.2
This is pretty ironic considering one of the main promises of his campaign is to preserve national security. The only thing more ironic is that “jihadi terrorism destabilizes the global economy” is ranked just as high as him becoming president. So let me get this straight: Trump is going to be the main factor in the problem he is trying to solve. Also, the terrorist organization that he will be fighting against is just as much of a threat, as him becoming president in the first place. Either the EIU is more pro-left than a college campus in the northeast, or a Trump presidency poses serious questions for the future of American diplomacy.

Another area that will be addressed by Donald Trump is our stance on taxes. Trump believes that too many people are taxed and the rates are too high. His tax plan will halt taxes for “75 million households in the United States.” Business tax would effectively be no more than 15% for any business. While eliminating taxes for that many people will definitely hurt the governments revenues, he is hoping that bringing businesses back will offset this decrease. He also wants to eliminate deductions for the rich. His plan does lack, however, a cut for government spending. Many different organizations such as the Tax Policy Center, Tax Foundation, and the Congressional Budget Office concluded that Trump’s tax plan would decrease tax revenues by 9 – 12 trillion dollars. This decrease would happen over ten years, but Trump would have to decrease government spending by about 80% to support this. With his pledge to preserving national security one can assume he won’t be cutting military spending. Where else can Trump cut 9 – 12 trillion in spending? I don’t have a clue, but I doubt the American public would be for cuts in education, social security, and other public services that benefit many Americans.

All in all, Trump’s candidacy has opened the eyes of many Americans. Many people not only fear terrorism, but they also associate the Muslim faith as the face of terrorism. Many republicans also have demonstrated their frustrations with the party as they voice more support for Trump. The “Grand Old Party” may die of old age and not in a very grand fashion. Who would of thought that a billionaire real estate mogul would lead one of the most impactful political revolutions in recent American history.


Sources:

http://www.realclearpolitics.com/epolls/2016/president/us/2016_republican_presidential_nomination-3823.html
http://www.soundvision.com/article/the-challenge-of-anger-among-young-muslims-in-america
http://www.cnbc.com/2016/03/17/trump-as-big-a-global-risk-as-terrorism-research.html
https://www.donaldjtrump.com/positions/tax-reform
Donald Trump’s Tax Plan Could Tack $10 Trillion onto America’s Debt
http://www.slate.com/articles/news_and_politics/cover_story/2016/02/donald_trump_killed_the_gop_here_s_how_republicans_can_bring_it_back_to.html