For anyone who went to business school, a conversation with money manager Albert Meyer is like a trip back in time — straight to accounting class, that is.
It's never long before you get roped in to a discussion about the investing angles behind some nuanced accounting concept. But that's not as grim or futile as it sounds.
No less an investing expert than Warren Buffett maintains that knowing your way around financials is the key to good investing. Buffett famously spends part of his weekends poring over balance sheets and income statements, and Meyer no doubt does the same.
Besides, accounting is sort of fun. It's a combination of hard-nosed numbers crunching, strategic thinking and CSI. People who know their way around financials learn a lot about what companies are up to, where they are headed, and the tricks they use to cover up their mistakes.
This focus on accounting also boosts returns. Buffett is one of the best investors ever, but Meyer is no slouch. As of the end of July, investments at his Bastiat Capital were up 78.3% net of fees over the past five years, compared with 67% for the S&P 500 Index (.SPX). He also outperforms over one and three years.
I've known Meyer and drawn on his ideas for investing columns on and off for over 15 years. It's not really possible to sum up how he uses accounting analysis to make investment decisions in a brief column. People spend years learning about accounting, and Meyer has also spent years teaching it. But here are a few of his favorite concepts, which are fairly easy to understand and replicate in your own investment analysis.
Follow the money
Meyer spends a lot of time looking at compensation policies for executives, which you can find in the proxy statement.
"The compensation culture provides insight into the board and management philosophy toward shareholders," he says. In short, compensation can tell you whether management really does put the interest of shareholders above theirs, as they are supposed to.
One of Meyers' favorite tricks here is to look for an "options overhang" from excessive options grants. He shuns companies that have this for a simple reason. Sooner or later, assuming the stock does not tank, they will have to use precious cash flow to buy back stock to offset the dilution from all those options. This eats up cash flow that could go to shareholders, or get reinvested.
Back in 2006, Meyer was negative on Cisco (CSCO) in a column of mine for this reason. It would be nearly 10 years before the company's stock would trade substantially above 2006 levels and hold the gains. It may not be a coincidence that by the time Cisco stock did this, the company had rolled back its extremely generous options grants.
Meyer prefers to see moderate pay and compensation in the form of cash. Or at least cash plus restricted stock units (stock grants with rules on how long managers must hold them) instead of options. There's more room to fudge the accounting for options. When considering whether to own Mastercard (MA) or Visa (V) he opted for Mastercard because executive pay was more moderate and the options overhang was smaller. He likes Berkshire Hathaway (BRK/B) and Southern Copper (SCCO) in part, because they pay executives in cash.
Meyer thinks his approach on options helps keep him out of trouble. "I never bought Wells Fargo (WFC) even though Buffett liked it, because they were paying their CEO a lot and he was getting massive stock option grants. I wasn't surprised when it blew up," he says. Not every company that pays its CEO a lot is bad, but it's a red flag at the very least.
Look for large insider ownership
The logic here isn't hard to understand. If insiders have more money at stake, they'll probably work harder for you as a shareholder. Meyer takes an interest when insider ownership is over 10%. You can find insider ownership levels in the proxy, too.
Companies he likes, in part, because they have high insider ownership include Sanofi (SNY) at 17%, IPG Photonics (IPGP) (34%), Checkpoint Software (CHKP) (25%), Amerco (UHAL) (46%) and Syntel (SYNT) (over 50%).
Inside net income
This is an old forensic accounting trick. The basic idea is that when net income is a lot larger than cash flow, companies may be using accounting gimmicks to prop up reported income. Meyer says the reasons they don't match up can reveal a lot about a company and point to what you need to learn more about. A large amortization charge explaining the difference suggests a company made a lot of acquisitions. If so, Meyer compares a company's profitability measures like return on assets to peers. If the company is less profitable, it suggests the company overpaid for the acquisitions.
After getting a feel for the financials, Meyer examines company presentations, 10K forms and conference calls to get a sense of the company's strategy. He doesn't use Wall Street sell-side research. Then he builds a five-year earnings model, and uses it as a score card to track quarterly earnings reports.
Meyer doesn't own the FAANGs — Facebook (FB), Amazon.com (AMZN), Apple (AAPL), Netflix (NFLX) and Alphabet (GOOG) (GOOGL). Instead, he likes the Chinese equivalents, which he calls the BAIT stocks. This means Baidu (BIDU), Alibaba (BABA), IQIYI (IQ) and Tencent (TCEHY).
"They are FAANG copycats and they do it very well. They make a ton of money," says Meyer.
Right now they are on sale because of worries about a U.S. trade war with China, yuan weakness, concerns about Google entering China, and a recent earnings miss at Tencent. It's starting to look like a trade war will not play out. Meyer thinks Google isn't really that big a threat to Baidu because it will take a while to become a big player in China. And he points out that Tencent earnings and sales are growing at more than 30%, which isn't bad. If you missed out on the FAANGs, or you own them and you wonder how much higher they can go given their big gains, it may be time to buy the BAIT stocks.
For a conservative green-eye-shades guy, Meyer doesn't hold back on his bullishness for the U.S. economy and stocks. Because of corporate tax cuts and accelerated depreciation on big-ticket purchases, companies are going to increase capital spending. And thanks to low unemployment, consumers are confident and opening up their wallets a lot more. Both of these trends mean continued economic growth ahead. Meyer thinks will it support another 40% move up in the S&P 500 to 4,000 — by 2020.
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