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Downhill Racing Meets Value Investing

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More on Value Investing


By Vitaliy Katsenelson CFA

I wrote this article in May. Every time it was destined to be published in the pages of Institutional Investor, it got bumped by another, more timely one I had written. Finally, when a space opened in September, the market had taken a major dive, and what was supposed to be an “evergreen” article was suddenly out of touch with reality.

Here is the irony: This piece addresses complacency, but its author was complacent too. The X-mass market has recouped its summer losses, and this article is relevant again.

The Skier

I am a skier. When someone says this, you assume he or she is good. Well, I thought I was good. I was not Lindsey Vonn, but I had the technique down. I’d be the fastest person going down the mountain, always waiting for my friends at the bottom. Then, at the beginning of last season, I went skiing with my kids at Vail. It had snowed nonstop for a few days. Vail is a very large resort, and the mountain crew could not keep up with the snow, so I found myself skiing on unusually ungroomed slopes in powder more than knee-deep. Suddenly, something changed. I could not ski. I could barely make turns. I was falling multiple times per run. My kids, including my nine-year-old daughter, Hannah, were now waiting for me as I dug myself out of pile after pile of snow. My technique — along with my confidence — was gone. The discomfort froms constant falling turned into fear. I was ready to go back to the hotel after only two hours on the slopes. I was devastated. It was as if I had never skied.

The Ski Instructor

So I talked to a ski instructor about this incident. He told me that I’m a “good skier” on groomed slopes because they allow me to go fast without trying hard. Speed covers up a lot of mistakes and lack of skill. Skiing in powder requires different skis — not the skis I had — but more importantly, it slows you down and makes you rely on skills that I thought I had but didn’t.


During the past six years, the Federal Reserve neatly groomed, manicured and then finely polished investment slopes for all asset classes by lowering interest rates to unprecedented levels — providing a substantial accelerant that indiscriminately drove valuations of all assets higher. But ubiquitously rising valuations cover up a lot of mistakes and often a lack of skill. Whether you had a rigorous investment process or were throwing darts, over the past six years it hardly mattered — you made money. Bull markets don’t last forever, and this one is not an exception. Stock valuations (price-to-earnings) are just like a pendulum, swinging from one extreme to another.


Today the stocks in the S&P 500 index trade at about 50 percent above their average valuation (if you adjust earnings down for very high corporate margins). Historically, above-average valuations have always been followed by below-average ones — taking away the riches that the previous years provided.

In other words, at some point it is going to snow and snow hard. Just as I, the great skier, found myself overconfident and unable to deal with the new terrain, investors will find themselves doing face-plants when the stock market turns from bull to bear. But here is great news:

Now the stock slopes are still finely groomed with stocks near all-time highs, and we all are given a unique opportunity to make adjustments to our portfolios and investment process. You should start by carefully analyzing each stock position in your portfolio. No drooling over how each of them did for you in the past. Drawing straight lines from the past into the future is very dangerous.

The Future

Instead, focus on the future — a future in which average stock valuations will likely be lower. Returns for a stock are driven by three variables: earnings growth, change in P/E and dividend yield. You should impartially examine each variable to determine if a stock deserves to be in your portfolio.

Then make one of three decisions: buy (more), hold or sell. Just remember, hold is a decision. If you choose not to sell an overvalued stock, one that has low or negative expected returns in the long run, that is a decision. We must all reexamine and future-proof our investment process. Six years of rewards and no risk will loosen the process of even the most disciplined investor.

Finally, if you are feeling very confident about your investment prowess today, take a moment to relive that gut-wrenching feeling you had the last time the stock market took a 20 percent dive. This will reset your confidence to the appropriate level and help you to avoid the mistakes that come from focusing too much on reward and too little on risk.


penn station


P.S. I took the kids skiing at Beaver Creek a week ago, for the first time this season. My daughter Hannah, who will be ten in a few weeks, has magically improved over the summer. However, Jonah, who is an amazing skier, has completely lost his form. He grew five or six inches since last spring — he’s 14 and pushing 6 feet now. His center of gravity has shifted, and he is still adjusting his technique to his new, oversized body.


As a father, I smile when I see Hannah beating Jonah down the slope. Jonah, like any teenager, needs to be humbled. My skiing? The slopes were perfectly groomed. I was awesome! I just hope it doesn’t snow.



Vitaliy N. Katsenelson, CFA, is Chief Investment Officer at Investment Management Associates in Denver, Colo. He is the author of Active Value Investing (Wiley 2007) and The Little Book of Sideways Markets (Wiley, 2010).


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  1. Making the Case — Again — for Micron

    I made a case for Boise, Idaho–based chip maker Micron Technology in April 2014. For a while I looked brilliant: The stock went vertical from $22, peaking at $36. Nine months later its price halved, giving me two opportunities: Buy more Micron, and write more about it. In fact, this write-up comes with a bonus — a product review.

    In 2014 my thesis for Micron was simple: The structure of the memory industry has changed. It went from dozens of state-subsidized players to just three in DRAM (more formally known as dynamic random-access memory) and four in NAND (memory that goes into solid-state drives, or SSDs). Each remaining player has sufficient scale and is focused on profitability and return on capital. Additional capacity will be added very cautiously, which in turn will result in industry growth and much more profitable business for everyone, including Micron.

    I wrote: “The gross margins of all memory companies have been gradually rising and still have significant room to grow. If Micron achieves its target margin level, in the mid- to high 40s, its earnings will hit $4 to $6 per share in a few years.”

    For a while, as I said, I was brilliant: Micron was on its way to earning somewhere around $4 in 2016. But then the PC market, which everybody expected to continue to grow, suddenly declined. PC sales at the retailer level fell 10 percent; however, orders for DRAM chips tumbled 20 percent as PC makers aggressively reduced their inventories.

    DRAM manufacturers suddenly found themselves with an overcapacity of PC DRAM. What is important to note is that this overcapacity was not caused by irresponsible behavior on the part of the manufacturers but by the precipitous drop in PC demand. It takes a few months for these companies to retool their production lines; in the meantime, the PC DRAM market was oversupplied, and prices collapsed. PCs are not going away, but they are not a growing market anymore. In addition, current demand for PCs has been muddied by Microsoft’s introduction of Windows 10 (or, as I like to call it, Windows 8-fixed). Since Microsoft is providing it as a free upgrade, I’m not exactly sure of the impact it will have on PC sales — it may actually postpone the upgrade cycle by a year or two.

    But here’s the good news. Micron’s success in the DRAM space doesn’t depend heavily on future PC sales. PC DRAM accounts for a little bit more than 20 percent of Micron’s DRAM sales. And Micron’s reliance on PCs is decreasing fast because of the insatiable demand for DRAM in mobile phones. As smartphones increase their IQ, they require more and more DRAM, and the number of smartphones is growing rapidly. Smartphones already represent more than 30 percent of DRAM sales.

    Over time, as supply and demand for DRAM equalize, we believe chip prices will normalize and Micron’s per-share earnings will reach our expected $4 to $6 range.

    It is also important to note the significance of NAND to Micron. I never thought I’d be making product recommendations, but I think you and your family will thank me for the following one — and it will demonstrate the future value of NAND.

    A few weeks ago I discovered Google Photos. I have three kids, and when I found out that Google Photos provides unlimited storage backup for my 400 gigabytes of photos and videos, I couldn’t resist. We have four iPhones in our family (only my 16-month-old daughter, Mia Sarah, doesn’t have one — yet), and we take a few gigabytes of video and pictures a week. I almost feel that I’m failing as a father if I don’t document every new expression that Mia Sarah comes up with. In addition, we have Canon digital SLR and GoPro cameras, so backing up pictures and videos online was cumbersome. Google Photos solved this.

    Now when I take videos on my iPhone, they go directly to Google Photos, and I don’t have to worry about the space they use up on my external drives at home. But this alone would not cause me to write about Google Photos. It’s what Google does with the pictures and videos once they are uploaded to its servers that is really interesting.

    If you go to your Google Photos page in your browser or smartphone app, you’ll encounter the product’s incredible magic. First, its facial recognition software allows you to view every photo of a particular family member or friend. Suddenly, pictures from ten years ago come back to life. Google also lets you search images by keyword. If I type “bike” in the search field, Google’s object recognition algorithm returns pictures of my kids learning to ride bikes and video I took of my mother-in-law trying out a tricycle in a cycling store. It will also find you pictures with “snow,” “sunset,” “rain” and “boat” keywords. It can even search photos by location.

    But that’s not all. Under the Assistant tab Google Photos creates home videos, stories, interactive JPEGs and collages for you. Google Photos selected pictures and videos from our trip to Florida last November, added music and created a one-minute highlight video of the trip. You would never believe that it had been completely created by a computer without any human meddling.

    All our photos and videos are displayed in the browser. You would think that loading videos and searching through hundreds of thousands of pictures for faces, landmarks and other objects would be a very clunky experience in the browser. It isn’t.

    This is where Micron and NAND come in. NAND memory is used in making solid-state drives. SSDs have many advantages over traditional, hard disk drives (HDDs): They consume less energy, are lighter and break less frequently — all important features for laptops — but most important, they are much faster.

    By offering unlimited storage, Google basically started a space race with Apple, Microsoft, Yahoo and other companies. The problem is that SSDs are still more expensive than hard drives; but for services like Google Photos to be robust, a larger portion of data in Google’s massive data centers has to reside on SSDs than on HDDs. As their prices continue to fall, SSDs will continue to take a lot of “space” share from hard drives in data centers. SSDs are unlikely to get 100 percent of that space, but demand for them from Google and the like will increase exponentially for years to come.

    Micron and its DRAM and NAND brethren will be significant beneficiaries of constant improvement of video quality (that is, larger files) and what will simply be a tremendous surge in the amount of data we generate as consumers. My youngest child is not even two years old, but I bet she is responsible for two thirds of the video and photo data my family has generated over the past 15 years. Also, data is cumulative: As it is, we rarely delete any content we create; now, since Google has made picture and video storage free, we have no incentive to delete at all.

    When it comes to Micron stock, I don’t know where earnings are going to be over the next six months or a year, though we think the company will earn at least $2 a share in 2016 (so that it will still be a cheap stock at the current valuation). But over the next few years, Micron’s earnings will likely be a lot higher. We think $4 to $6 is still achievable; and at a 12 to 15 earnings multiple, someday it should be a $48 to $90 stock.

    In the meantime, do yourself and your family a favor: Install Google Photos.

    Vitaliy Katsenelson CFA


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