“Valuentum called the collapse in Kinder Morgan’s shares from $40 per share to the low-teens, and now we have called the rebound to $20 from the low-teens. Though this action may not fit into the playbook of the “buy and hold” investor, the idea of “selling” overpriced stocks that are going down and “buying” overpriced stocks that are going up is a core part of our methodology.”
By Brian Nelson, CFA
I’m still getting emails about how wrong we were about our calls on Kinder Morgan (KMI). Will they ever stop?
We’re doing our best to relieve investors of the shackles of “buy and hold” thinking, which is separate, distinct and runs counter to investing with a focus on long-term fundamentals. The first means an investor holds a stock for a long time effectively regardless of events, while the other means the investor makes decisions on the basis of the long term but he or she may be active in the market in the near term. These two frameworks are not the same thing — where “buy-and-hold” investors may be inactive for an extended period of time, the long-term-focused investor may “sell” high-conviction overpriced stock, valued on the basis of long-term fundamentals, and “buy” high-conviction underpriced stock, valued on the basis of long-term fundamentals – sometimes the same stock in just a 12-24 month period, for example.
As the price of shares changes relative to a forward estimate of its intrinsic value, one’s opinion of the investment opportunity should change. “Buy and hold” investors may be operating with a different set of rules, which may preclude them from embracing changes of opinion (or even recognizing them), but expanding horizons and being open to new ways of looking at things should be par for the course for any investor, either a “buy and hold” investor or one focused on long-term fundamentals, as we are. The stock market will always be a forward-looking, discounting mechanism of the trajectory of future enterprise free cash flows. In one case, for example, a focus on the long-term can drive shares of a company to lofty levels in the near term even if the company today is not generating profits, while a focus on the long-term can drive shares of a very profitable company to near-$0 today if the future outlook may spell material bankruptcy risk. A focus on the long-term is simply par for the course for any investment framework, and has nothing to do with your holding period – a long-term focus is a different concept than “buy and hold” investing.
To be fair, however, “buy and hold” thinking may not be the entire reason for the confusion regarding our calls on Kinder Morgan. Barron’s, the print edition, ran an article a few weeks ago supporting another research firm’s opinion that Kinder Morgan is still overpriced and should be a single-digit priced entity. That wasn’t us. Our fair value has been $20 for Kinder Morgan for some time, and shares have now converged to effectively that level since our more optimistic note was printed in Barron’s online, January 21. We apologize for the confusion but it is beyond our reach. Valuentum called the collapse in Kinder Morgan’s shares from $40 per share to the low-teens, and now we have called the rebound to $20 from the low-teens. Our fair values, if estimated correctly, often act as magnets to the stock price. Though “selling” and “buying back” over a short period of time may not fit into the playbook of the “buy and hold” investor or any long-term focused investor for that matter, the idea of “selling” overpriced stocks that are going down and “buying” overpriced stocks that are going up is a core part of our methodology. With Kinder Morgan, it just happened over a very short period of time.
Certainly the timeliness of our call on Kinder Morgan on the way down was unprecedented, and now our call on the way up has turned a great many heads as well. The price-fair value equation of the equity will always inform whether an idea is attractive or not (not its name or how you feel about management or any other qualitative factor), which is why we put an extensive discounted cash-flow valuation process (and margin of safety) as the first and foremost criteria within our stock-selection methodology. We then back that process with a relative valuation overlay, which itself is overlaid with an assessment of market information via share price direction. More information on the Valuentum Buying Index can be found at the following link, “Our Stock Selection Methodology, the Valuentum Buying Index.” At the very least, if there is anything one can do to become a better investor, it is to be open to new information and new ways of looking at things – and always ask why. The ‘why’ with us is quite simple – investors deserve better research, analysis, and processes, and we’re doing our best to provide the right lens through which to look at investing.
As we have stated many a time before, while we believe the energy master limited partnership business model is in jeopardy over the long haul, the entities still have intrinsic value. We’ve published our intrinsic values of the group on several occasions to help investors, and while we don’t hold any energy MLP in the newsletter portfolios, we continue to monitor improvements in the composition of their investor bases and their stronger equity prices the past few weeks. We’re expecting a break out in the Alerian MLP (AMLP) very soon. If the market re-inflates the debt-infused stock bubble based on financially-engineered dividends used in obsolete dividend discount models, we have to be mindful of the possibility of that development. Rising energy resource pricing has also helped mitigate some pressure on credit quality, and so has speculation that the wheeling-and-dealing across the industry may finally slow, with indications that the Energy Transfer Equity (ETE)/Williams (WMB) deal may fall apart. Our fair value estimates for the energy MLP space can be found at the following link on our website:
Pipelines – Oil & Gas: BPL, BWP, DPM, ENB, EPD, ETP, EVEP, HEP, KMI, MMP, NS, PAA, SE, SEP, WES
On the basis of Kinder Morgan’s undervaluation and improving stock price momentum, the corporate is included in the Best Ideas Newsletter portfolio. We evaluate companies objectively on the relationship of their stock price to the present value of their future expected enterprise free cash flow streams and net balance sheet, which allows us to pick exit and entry points effectively as we use market information to offer added conviction to either side of the investment decision. We’re long-term investors and never take our eye off the long-term, but when shares are overpriced or underpriced on the basis of that long-term assessment, we think action is prudent at times. We’ve been bullish on Kinder Morgan’s shares for some time now, and we like the price-to-fair value convergence.