Thoughts on Telecommunication Industry

Telecommunication Industry :

While Going through the Value line survey about telecommunication industry, it became obvious and more clear which most value investors already know that its a tough industry to be in. I haven't done detailed research into all the companies but these are just the thoughts that came to mind as I went through the pages. 

1. Lots of intense competition. At&T remains the leader with Verizon at 2nd, Sprint at 3rd and T -mobil at 4th. There is price war going on right now. But At&T and Verizon has advantage due to the size and economy of scale which becomes obvious when you look at the numbers. 

2. Asset intensive businesses with lot of re investments required just t stay competitive. 

3. Net profit margins are not great even for larger companies.  On average At&T net margins are at 10.5% and 11.7 % for Verizon, most others are lower than these two. 

4. ROE is also comparable to S&P, At&T had ROE in past in rage of 12-13 % and now at 14.5% , Verizon traditionally did better with ROE 16-19% but now at 13%. Only other company is J2 Global ( will dig deeper into it) with ROE traditionally > 20% but now has declined to 10% in last 1-2 years. 

Now the Good part : 

But the management seems to realize the nature of industry too, and they aren't keeping the money for themselves. These companies pay handsome dividends and some of them has strong balance sheets, though on average they carry a lot of debt due to the nature of asset intensive business. 

At&T pays 5.4% and Verizon 4.5% dividends and these are likely to be continues, so if you are looking for safe income, these are good bets, but beyond that someone, who is looking to beat the market isn't going to do that, These aren't the typical compounding machines. 

They pay anywhere between 50 to 85 % of income as dividends ( payout ratio), and retain the rest for maintenance and growth. 

Thoughts on At&T Vs Verizon :

AT&T has actually cut dividend down only once in 2004, and Verizon has never decreased dividend since 1998, ( I only have numbers till 1998) 

When Comparing these 2 Giants, Verizon is doing better, higher revenue and earnings growth, and also Vodafone just sold its 45% interest in Verizon. So Verizon actually issued 1.274 billion Shares to Vodafone shareholders for its Verizon share. This represents approx 30% dilution in EPS, still EPS is higher this year thanks to decreasing expenses and increased net margins, 

From Morningstar

Notice the increase in Operating Margin from 11.4 to 26.5% 

So, definitely Verizon seems a better bet with also some prospects of future growth at this time, but this decision will require deeper digging into this company, which i may do in future, will put it on my watch list for now :) 

George H. Michaelis : Learning Value Investing from Legends

Through my usual search on Internet I came across George Michaelis and his track record while he managed Source Capital, till 1988 his record was 18.4% CAGR over 15 years, That's Awesome, but Looking at track record of the fund since 1985 to 1995, He again managed to come close to 14%. 
I found some Articles on La times about him and here is summary of it and what I liked about him and learned from him. 

Here's the Article 1990 interview with George Michaelis

Writer to George Michaelis : The lesson of this year seems to be that the rules of investing are being rewritten for the '90s, versus what we knew in the '80s. What are the big differences you see?

Michaelis: The '80s were a period in which returns on stocks were above average, primarily because valuations expanded. Yes, there was economic growth in the '80s, but a major contribution to above-average stock returns came from valuation expansion.

I don't think anyone can time the market. What the current situation requires is that you lengthen your time horizon. If I'm right about a company, three years from now we'll be in good shape. But it might be that long. This is a period where chances are you're going to look stupid in the short run.

Buy Wonderful business when they are going through temporary trouble. Market will hate it and the Price will be cheap, that's when we buy it, We may look stupid buying it when the rest of the market is buying expensive stocks which are getting more and more expensive everyday. 

Writer : OK, so you're looking for stocks that are bargains relative to the companies' true potential. How do you judge them?

Michaelis: I'm driven primarily by the quality of the business I invest in. Value investing has two dimensions. Either you're interested in buying assets, or in buying earnings power. I'm not interested in buying assets. I buy earnings power; that's what works for me. I'm really only interested in buying a business where there's a proven record of high rates of return on equity. I don't look for rapid growth areas. I look for good businesses.

 He talks about two approaches 
1. Buying assets at cheap price - Graham strategy 
2. Buying earning power of quality businesses - Buffett / Fisher Strategy 

Both of them works, you need to see what suits you the best.

Writer : What about stocks versus bonds now? I can earn 8.5% interest annually on a Treasury bond. Will stocks do that well?

Michaelis: On any long-term basis, stocks should do better than bonds. Now, over the next five years will stocks do better than an 8.5% yield? Probably, but it could be close. But you have to remember that, long term, bonds will not protect you against inflation. The reason to own stocks is to hedge against a collapse of purchasing power.

Writer : No doubt there are a lot of individual investors who agree with you about value in stocks, and about being patient. But what do you say to the person who really is terrified of economic disaster ahead?

Michaelis: If you're really not confident, you shouldn't be invested in stocks. And if you can't understand the concept of return on capital, and you can't read a balance sheet, you're probably in trouble (in picking individual stocks). Most people probably are better off identifying a good mutual fund. It's worth it to spend time looking for a mutual fund that meets your risk and return objectives.

Rest of the articles if from Streetstories.com 

A self-described "value investor in really good businesses," Michaelis looks for companies with a demonstrated ability to earn high returns over the long term.

Michaelis seldom buys foreign stocks, preferring to gain exposure to foreign economies by investing in U.S. companies. "It's what you don't know that can hurt you. As you start moving outside the U.S., information is harder to access and the quality of the information is less reliable. The risks get a lot higher," he says.

Investors should buy shares in companies in which they have a comfort level and knowledge, according to Michaelis. That way, if the price falls, they will have the confidence to pick up more shares at cheaper prices.

This is very Important as most people don't do enough research into the companies they buy, they aren't sure what to do if the stock price falls. If you have done diligent research on the business and you are confident about it, there should be no doubt in your mind what to do if the price falls. If it was a good buy at $14 then its even better buy at $12 and a bargain at $7.

"If a stock drops dramatically and you don't feel like buying more," he says, "then you made a mistake to begin with."

Performance Record

18.4% over 15 years: "A calculation in the summer of 1988 showed that over the past 15 years the total return of Source Capital was exactly 3 times that of S&P 500: The gross gain was 1200%... exceeded by only 16 other funds...".

 Source : http://www.streetstories.com/george_michaelis.html

Warren Buffett was his funds largest shareholder and bought 40% of Michaelis' Source Capital Closed end fund.- seekingalpha.com

Before his Death in 1996 , He was Managing the Source Capital Fund, and the Numbers below are from their website. 

Here's the growth rate of Net asset value per share since 1985, Their Fund Tardes by Ticker SOR. Data is taken from Source capital website. 

14%  CAGR after 10 years is awesome!!! Your original 10K would have grown into 37 K 

18% and 14 % over long periods of time are way above what most managers can dream of achieving. 

Source:http://www.sourcecapitalinc.com/source

His way of investing seemed very simple 

Research/ Valuation Techniques Employed

Looks at companies with these features:
1. High ROA & ROE, high ROE should be sustainable;
2. Earning power not hostage to business cycle
3. Successful for identifiable reasons. 
Debt averse - average debt level at 15% of total assets. 

If you are Interested in Learning more about him, There's only one book I could find, I jut ordered it. 
Check it out. Amazon Link to Book

Hope to learn more from him.