Value Investing and Time Arbitrage by Boykin Curry

Boykin Curry from Eagle Capital Management starts off the second day of the Value Investing Congress. His presentation is on value investing and time arbitrage.

He starts off explaining that value of a stock is the present value of its future earnings. There is a major focus by most on next year’s earnings estimate. Most questions (81%) on conference calls focus on the next 12 months. Only 19% are interested in focusing on the earnings potential beyond a year out.

Buy things that have short term problems and long term opportunities. The future is not knowable but it might be guessable.

The specific example presented is American Express (AXP). The normalized earnings beyond recession are about $4-5 per share. The secular trend is cash to plastic. American Express is the collective buying power of a pool of wealthy individuals.

Nothing has emerged to threaten their long term earnings power. Earnings in 2008, 2009, and 2010 could be potentially rough. Boykin estimates $30 billion could be gone on charge offs. If you do that for the next 3 years, earnings is estimated to go down to $2 per share for each of the next three years. How does this equate to folks only paying half as much today as they did last year for the same company.

Boykin doesn’t believe that large cap stocks are always efficiently priced. He agrees that there is not information arbitrage opportunities in these stocks. However, the time horizon of investors is often not rational. There is the wisdom of crowds but there is also madness of the crowds. With large cap stocks, one hedge fund can’t go in and move the price up and make it more rational.

Last year analysts 1-year price target went from $76.5 to $41.0 billion from 2007 to 2008. It is all based on multiples of 2009 earnings.

Why does the time arbitrage persist? Clients measure performance over relatively short periods. It makes going down 20% by being early difficult for funds. There are a also a few successful short-term strategies that also blow it up for others, since clients will pull there money and move to them. Also, short-term results are often preludes to the long-run.

Average monthly turnover has increased. Time arbitrage opportunities persist.

You can focus on long-dated call options to take advantage of time arbitrage. When they pay off they are extremely valuable. Examples right now include, Newfield Exploration (NFX), Microsoft (MSFT), and Comcast (CMCSA).

Newfield is a natural gas company. In the long-term, there is a huge incentive for the government and companies to build out natural gas filling stations. If tomorrow it is announced no one will ever use natural gas in cars, it won’t affect the stock price today.

Microsoft is being treated as a declining asset. The future for Microsoft could include their capability to provide synchronized both online and offline activity. If the company decided to stop investing in this, the stock would actually probably go up.

Comcast could in the future develop targeted television advertising, like Google provides online. Comcast’s distributed network of services might also be able to deliver customized content on demand in the future.

This strategy will make it tougher to raise capital and get started as a fund. There are also benefits, because it is intelectually stimulating. Once you are successful, you will better retain clients. It can provide a sustainable competitive advantage in an industry with very few.

Recent events hasn’t changed his strategy. There are a lot of opportunities out there. Just make sure the companies survive the recession. This could actually make the country stronger in two or three years. There is a huge shift in capital allocators from the reckless to the Warren Buffetts and Seth Klarmans of the world.

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