A lot of Rule #1 readers are writing in with variations on the same question: if the MOS is good but the tools say Sell, now what?
Here's how Steve worded it:
Question:
Hi Phil Town,
RULE #1-Great book. I'm still going thru it and have a question about when two factors collide. For example, I'm running the Big 5 numbers for NBR and they all look really good. Using your calculator, the MOS is really, really high, but I think my last calculation had the MOS around $450+ and the stock is under $40. This seems like a really good buy, but when I look at the chart tools, many of the signals are saying SELL (e.g. MACD just turned negative, RSI is approaching the 50 mark, moving averages are about to cross, STO going below the 80 line).
So my questions:
Is my MOS incorrect?
What to do when two factors collide?
Thanks for any input,
Steve
Answer:
The big guys -- the institutional investors -- control 85% of the money in the stock market, and they don't play the game the way we do. The game they play is "How did I do this quarter compared to my peers?"
For that reason, they may sell a stock that is well under the Sticker simply because others are selling it... and someone started the run just because they wanted to take profits to make the quarter look better.
These guys are like people in a crowded theater. Someone smells smoke but knows that they can't get to the door if they yell fire. So they quietly start to walk out. But just the fact they someone is leaving makes others nervous and they start walking out too. And it quickly becomes a stampede -- and no one makes it out alive!
For that reason, most fund managers are very quick to start to sell if there is any negative news... or even the rumor of it. And when it turns out to be unfounded? They buy back in and the arrows go green!
So short answer: the tools don't signal anything other than the big guys are getting out.
The tools most certainly do not tell us why or give us any clue as to the quality of their decision.
That's what the first three M's are all about... coming to a level of confidence about your few stock picks and then just using the arrows as a way to keep from getting pounded by information the big guys got first.
Now -- as to the idea that the MOS is what? $450 and the Sticker is $900 and the stock is selling for $40? Let's go see what you're looking at:
- First I look at ROIC: 10% long term going to 14% recently... nothing but net.
- Now Equity growth rate: consistent like crazy and doubled 3 times in 9 years. 24%.
- Now EPS...
- and Sales: REALLY bouncy. Up down up down. Scary! Pick a different year to start, you get a different growth rate. I don't like that much. Still, last four years it's growing like a weed. 40% plus in both.
- Now Free Cash Flow: this growth rate is too bouncy to call.
So the Big Five are pointing to an emerging good thing, but definitely a bit sketchy on the long term numbers. In addition, it looks like Capital Expenditures (where we get Free Cash Flow from Net Operating Cash Flow) are rising like crazy -- which indicates a business that has to keep plowing back the profits to keep rolling. We don't like that much. Which is why Free Cash is so key.
Without going any farther I'd challenge whether this business has a good moat... and I don't even know what they do. So let's look at that: Sure enough -- the business is Nabors Industries -- and they are pretty much a commodity business, in the oil sector. So Nabors is all about the price of oil, not about a moat at all. They can't protect themselves if people stop drilling for oil. You buy this one, you pray drilling continues to be hot.
Now let's look at that projected Sticker Price of $900 or so. Where does that come from?
From the analysts estimates or historical price growth. Since equity is growing at 24% I'm not going above that. And the analysts range from 20% to 65%, averaging 47%. Since I can't go above 24% that's what I'd use.
That puts the PE at 48 (2x the growth rate of 24%) unless it's historically lower:
The range of historic numbers is 8 to 60. Huge. And the average is 27. I'm using that.
That gives a sticker of $116 with an MOS of $58 and a selling price
today of $39.
Well, at least now I'm happier with the numbers. Essentially, the big guys have reduced the PE to 18 because they aren't so sure what's going to happen to oil, and therefore they are willing to price Nabors as if it's going to grow as fast as the analysts say it will.
Still, how weird is it to see their own analysts' lowest estimate of 20% give us a Sticker of $83 when Mr. Market is pricing this at half of that.
Bottom line, if you like oil a lot you could do worse than Nabors at this price. Dig in deep and tell us about the Moat (if any) and the Management and how well you understand what they do... and then let me know if you still want to make this one of your retirement stocks at any price.
Now go play.
