One of the lessons corporate bond managers learn early on is that financial companies are different.
The novice manager wants to buy a lot of financial offerings because they yield more at equivalent ratings than the debt of industrials and utilities, but, very often, few analysts on staff can break down the financials of the financials, whereas almost all of them can do industrials or utilities.
One of the things that makes financial companies different is that tangible assets play only a small role. Beyond the ultimate limiting factor of demand, which affects all types of companies, the growth of industrial companies is limited by the scale of their fixed assets (plant and equipment). With services companies, the limit is often the workers. Financial companies are sometimes limited, like services companies, by their staffing levels ("If only we had more trained sales reps!"), but more often, capital is what limits growth.
Black Hole of Cash Flow
The cash-flow statement is of great use in gauging the health of industrials and utilities, but it tells us next to nothing about financials. One of the best values of cash-flow statements is that they enable one to attempt to derive estimates of free cash flow (the amount of cash that a business generates in a year that is left over after it has paid all of its expenses, including capital expenditures to maintain its existing business). Deducting maintenance capital expenditure from EBITDA often approximates free cash flow.
Investing Kiss the Equity Premium Goodbye 1/24/2006 2:02 PM EST Over the next 10 to 20 years, stocks are unlikely to return much more than bonds.
Jim Cramer Blog Pushover Tape Just an Overbought Sign 3/21/2006 3:23 PM EST Ridiculous declines among financials and insurers show how easy it is to rumor things down.
Market Commentary A Value Investor's Plan for 2006 1/12/2006 9:58 AM EST This year, I'm going to overweight consumer staples, energy and basic materials, and underweight everything else.
David J. Merkel, CFA, FSA, is a senior investment analyst at Hovde Capital responsible for analysis and valuation of investment opportunities for the FIP funds, particularly of companies in the insurance industry. Previously, he managed corporate bonds for Dwight Asset Management. At the time of publication, neither Merkel nor his fund had any positions in the securities mentioned in this column, though positions may change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. While Merkel cannot provide investment advice or recommendations, he appreciates your feedback; click here to send him an email.
Analyst Certification: All of the views expressed in the report accurately reflect the personal views of the research analyst about any and all of the subject securities or issuers. No part of the compensation of the research analyst named herein was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed by the research analyst in this report.
Merkel is employed by Hovde Capital Advisors LLC (the "firm"), a registered investment advisor with its principal office located in Washington, D.C. The Firm and/or its affiliates have or may have a long or short position or holding in the securities, options on securities, or other related investments of the issuers mentioned herein.
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