Thursday, December 14, 2006

FMD Few More Thoughts on Trading vs Investing

It should be clear that in the process of assessing fair value, I am incorporating a "reasonable" multi-year scenario, and using unspectacular assumptions about loan volume, interest rates (yield curve), credit spreads, and securitization margins. In fact, currently assumptions consist of consensus numbers on volume and earnings in fiscal 2007 early 2008, a modestly bullish fattening yield curve (but much tighter spread between Fed Funds and 10 year Treasuries), and very modest widening of credit spreads (virtually guaranteed through 2008 as broader credit trends weaken). One can posit two different scenarios with potentially very different outcomes (one very bearish, one perhaps more neutralish than the original base-case scenario). The more neutralish scenario (for stock) is the one that has been unfolding for the most part since mid year; low absolute interest rates; goldilocks economy. That will probably stretch out the time frame for the bearish case to unfold more decisively. But lets be honest; those trading are playing a different game of mo-mo, not the same one that "investors" with a multi year horizon are. Those reading this are certainly aware that I'm making no great claim about what next two quarter's earnings reports will look like, and in fact I'm even recognizing the 1 in 3 chance of a final upwards burst of insanity. But accepting the fact that the ceiling on the valuation is within winking distance ought to go a long ways to preventing an accident to your portfolio.

5 comments:

Christopher Caputo said...

Just a suggestion...perhaps you should consider changing your blog title to FIG Investing Intelligence, as opposed to FIG Trader Intelligence. It would seem to be more closely linked with your state goal of being a multi year investor.

Glen W Peterson said...

I have not had an opportunity to respond to the last post of our gentle FMD bear. I cannot for the life of me understand this obsession with ROE as the standard for all investing. This is especially true for FMD. If we were to use ROE to evaluate GM, for example, we'd think they were doing a bang up job. Just go do the calcs. GM's ROE looked to be about 15%. Great right. Nahhh!.
The truth of the matter is that no one metric is useful to evaluate any stock. Especially one that is growing it's earnings and cash flow at the rate that FMD is.

Consider the following as a better way to look into FMD's future. Can it compete in the market place against potential competitors that may enter the market. The answer, I believe, is yes. It has established a very solid record in the ABS market with respect to it's issues....Here's a little quote from our friends at UBS in that regard. (UBS WS analyst being no friend of FMD or it's business model I would hasten to add.)

Student Loan Strategy (relevant excerpts)

➤ Private student loans are a growth sector of the market. Be selective and choose experienced issuers with a track record. Issuers that require significant
co-signers reduce and diversify their credit risk. Third party insurance, if available, is also attractive. We would not be surprised to see more competition entering this space and would, therefore, avoid start-ups with little or no track record.


" ➤ First Marblehead (FMD) triple-Bs offer attractive spreads. Through TERI, FMD has been in the private student loan market over 20 years, and about 80% of its loans are cosigned. FMD recently priced its 2006-4 triple-B class at LIBOR + 110bp and priced a triple-A IO at swaps + 45bp."

What does that tell you about the quality of the companies underwriting, which has been so heavily questioned by WS analysts?

Furthermore, UBS goes on to say the following. "Market demand for education finance remains vibrant. The National Center for
Education Statistics (NCES) projects strong growth in college enrollments through 2014. Enrollment in post-secondary degree-granting institutions rose 23% from 1989 to 2002 and is projected to grow at a 5% rate (see Figure 60).As tuition and fees have increased at a greater rate than disposable incomes,
many Americans are using federal and sometimes private student loans to supplement their own resources. In the 2005 academic year, students and their
parents took out student loans totaling $62.6 billion under the FFELP program."

I was asked in a recent post by our gentle FMD Bear what this has to do with FMD earnings. My response would be, everything.

Macro trends in the market drive micro trends. When you have growth that is being driven by multiple factors in the market place. You have a formula for success.

That is being borne out every quarter with upside surprises and margin increases related to astonished analysts and their estimates.

Does that mean that FMD can grow to the moon. Of course not. Does it mean there is exists no risk that BOA will move the business in house. No, it does not. If it does, FMD will surely take a beating. Does it mean that there is no risk that competitors will not attempt to enter the market. Of course not. Are these risks fully discounted in the stock price. I think so. The gentle poster fails to mention that FMD has basically returned from the dead. The stock sold off over 300% about a year ago September on news that it's CEO was spiffing the BOA student loan VP with gifts. I think analysts got on to the story, thought this was direct evidence that BOA was most likely done with FMD, and that JPM might even join them. The shorts attacked and anahilated the stock. However, now that the stock has simply returned to it's trendline, we are told that it is oversold and overvalued, despite all evidence to the contrary in terms of visible growth and 2008 EPS estimates in the $4.50 range. So we are supposed to believe that 12x multiple on FMD that is growing top and bottom line earnings at 20% plus is excessive.
Sorry, I don't buy it even for a moment. I'll revisit this discussion next year when the stock gets to the $65 dollar range and then we'll see where the gentle poster is at with respect to his ROE analysis.

GWP

FIG Trader Intelligence said...

To the thoughtful gentleman from .....(we're starting to sound like Congress), I would say neglect ROE at your own peril. There are plenty of high profile examples (email me if you are interested in further discussion on financial stocks and ROE). I never mentioned GM nor should you, unless you don't understand balance sheets, and/or the difference between investing in stocks like GM and FMD. What price performance expectations do you have for FMD and over what time frame; That is the real question. If you are looking for $65 next year, I would say you have 1/3 chance of seeing it (in a 10% up S&P), as I hinted before. That doesn't make your reasoning right, just richer. That is probably more important to you. But in the long run, its a fool's game to piggyback on ignorance of others, unless of course you are at the top of the class of momentum investing and charting. But my sense is that you are a fundamentalist at heart (young one), without the lessons of history. If your channel checking and 'activist' research gives you a heads up on next quarter's earnings and "whisper" numbers, allowing to game the system, more power to you. But you have yet to tell me why the p/e to growth rate method has any validity for valuing companies especially financial). If you still believe it does, tell me how much the company would be worth if the growth rate were cut in half for one quarter (or two, or three for that matter) or if there was no growth for one year. I don't expect an answer because there is none. For the record, I actually wrote about the stock prior to its original collapse in a broader discussion of overvalued related stocks like SLM and NNI, and have only recently started writing about it again. They are both less overvalued now

Glen W Peterson said...

Ok, I'll concede the gentlemen's argument that he was talking about financial stocks in particular with respect to ROE. Ergo, the GM analogy is not appropo, accept for the fact that most of what is good about GM is their finance company. As that's where most of the real earnings reside. No?

As to a lack of experience with repsect to financial company evaluations, I'd also concede that I have not had significant breadth of experience and that I am, in effect, gaming the system by doing the kind of research necessary to forecast earnings. However, I do have more than a bit of experience in this game as my age will soon move to the 50's from the 40's.

As well, I am probably better than average with respect to charting tools and available information. So, in effect, we are talking about to different things, near term (18 month) trading, and long term investing. Ergo, in a sense, I am conceding you are correct, but only from your point of view.

As to what would happens to FMD earnings in the next 12 months, I think we are talking a range of between $4.25 and $4.50 if we look forward to 2008 estimates for the full year. And, as such, FMD is currently trading at a signficant discount to companies in the S&P which are averageing around 18x multiples if memory serves. Ergo, FMD at 12x with growth at nearly twice the rate of the S&P is cheap. Really cheap. Compare it SLM for example trading at, what 14x....hmmmm. And growing earnings at what rate.

I will admit to not being in FMD for the "long haul" either. I think that is a fools game in the current market dominated by trillions in hedge funds. There is no long haul in the market other than in hind sight IMHO.

No one, certainly not me, is capable of predicting the future of any company in today's market five years hence. Even with as sensible a metric as ROE amd the benefit of significant historical hindsight and a good measure of wisdom. Albeit, I think ROA is a necessary component of your ROE analysis as it factors in a company's debt position better and gives a clearer total picture. JMHO. But I am no financial genius for sure.

But in the case of FMD, near term earnings growth is just to compelling an issue. I would agree that the sustainability is in question. But did you consider that the market is discounting the residuals at about 12%-14% of current potential payouts that begin in 2008. I think not. The company, can right now, take every residual tranche it owns and turn it into cash by selling it into the ABS market. The reason it doesn't is simple. It thinks, in the long run, it will make more money cleaving to it's projections of the performance of it's tranches, despite our own near term outlook for interest rates, prepayments, credit defaults, what have you. Why, because it has 20 years of data that support it's conclusions. Interesting contradiction, at least in terms of this dialetic.

EPS growth rate is an appropriate metric because the market place it dwells in is growing at a rate not experienced in the rest of the financial markets. Will it continue forever. Of course not. But for now, I for one am willing to play the game.

Of course, I have jettisoned most of my overweight position and am now playing with the houses money, waiting for LTCG's to kick in. And, admittedly, I have my finger on the sell trigger, and half my position hedged with put/call collars.....

So I am neither disinterested, nor disingenous about my position here.

I guess I am simply questioning whether your method would ever allow anyone to make anything on the stock market. We appear to view the market universe, from different investment galaxies.

I appreciate your critique of my thoughts, as not many are willing to argue with me about stocks in general.

GWP

FIG Trader Intelligence said...

As happens frewuently in this format, you begin to see that the positions we each lay out are not as far away as initially thought. We begin to see the "timeframe' of the other, which is obviously foremost in any debate. As far as GM, if you looked at unconsolidated numbers (I haven't but it won't be far from mid teens ROE I assure you), than you would see the finance arm's ROE's are probably within shouting distance of others, ;like CIT, AIG leasing business, GE finance, even others in the credit business. If I recall correctly, consolidated numbers include massive charges (reducing shareholder equity by many billions) for either pension liabilities or health care benefits (charges taken in mid Nineties).
I would repeat what I said earlier rather than trying to time sale (trigger ready) because of earnings miss, try to assess what the value of the company would be in the event of an earnings miss (or two) . That would help you identify the likely downside (versus upside). Its a strategy used by poker players (odds you are getting by calling bet). I think right now you are near that point, where odds are not great.