Inequality, Part II

Inequality, Part II

Shopping for Value among Stocks Hitting New Lows

A Little Central American Airline that’s on Sale

In last week’s column on the twin topics of The Individual vs. the State and Inequality, I mentioned that beginning in 2017, the SEC will require public companies to disclose the ratio of their CEO’s annual compensation and that of the median employee—and I asked for your opinions on that.

I received a number of good responses, and I’m reprinting the best below.

Tim, Thank you for an interesting piece in The Individual v. the State. While it is good, in my opinion, that a majority of Americans think individual freedom is more important that state protection, I shake my head in sadness that the number who think so is not much more than 58%.
Joseph M.
Scottsdale PA

Re: “Inequality” – the whole CEO pay thing is another social justice play, and in the long run that never does anyone any good.
R.E.

Tim: My analysis re innovation and why America is as successful is that in most countries failure is a very black mark for years. My wife is Swedish and will attest to this reality. It is even true within America, those in the Western states are not afraid of failure; in fact, in Silicon Valley, it is almost a must. On the other side (Highway 128 in the Boston area), failure is not as readily accepted. Regarding executive pay, I believe the Headhunting industry had a huge influence on pay for the Big Boys. As the Headhunters get paid relative to the size of the salary, they insisted that it would take more money to land the desired CEO. Over the years this kept escalating. So much for my thoughts.
Bill E.,
San Francisco

Timothy,
A great article about income inequality, thanks for that. My wife and I are world travelers. We have seen that most western countries provide a much better ‘safety net’ for their citizens. That means free health insurance, great retirement benefits, paid maternity leave, much longer vacations etc. And the average pay is much higher. For instance in Australia, the minimum wage is $17-18 an hour—adjusted for higher living costs that would be $15 an hour.

These countries do not have the conditions caused by income inequality in the U.S. So the homeless rate, numbers of people incarcerated (I believe that there are 2.5 million people in U.S. prisons!), poor working conditions, extreme low wages are not an issue in those countries.

I see that there are many reasons for the inequality in the U.S. One is the demand by stockholders that the companies that they own report higher profits in every reporting period. This leads to (I am guessing) anxious company officers who will do anything to create higher profit. Increasing the wages for their lower level employees must be at the bottom of their priorities. And increasing dividends makes the stockholders happy. I also see as an investor that companies now will under-report early profit estimates, thus making it seem that they are making higher profits when they actually report their quarterly figures.

There are many books written about this recent issue of income inequality, the manifestation of this issue is apparent to anyone who see those who are homeless, those low wage working mothers and fathers who must hold down two or even three jobs to provide for their families, falling school grades (often caused by lack of parental help from the low wage parents who just have no time for their children).
Robert H.
Pleasant Hill, California

Timothy,
The income inequality mantra is the wrong metric by which to gauge the lives of ordinary people/Americans.

Use a Standard of Living Index instead, and in doing so, the income inequality narrative melts away doesn’t it. Compared to the 1960s, today’s bottom three income quintiles (poor, lower middle class and middle class), enjoy a remarkably improved standard of living. These quintiles today enjoy free or subsidized housing, SNAP or free food stamps, free public schools, free Obama cell phones, free or highly subsidized health care via Medicaid/ACA, assistance with utilities, homeowner tax credits, free or subsidized college assistance, and earned income tax credits (rebates), when filing their federal returns. And the list goes on …

As my 27-year-old friend from Ukraine mentioned to me recently “I grew up in Ukraine; what you call poor Americans, are not poor. I know what poor is.” Observation: Using a Standard of Living Index type metric, Americans may suffer from income inequality, however they do not suffer from a standard of living problem.

From a historical perspective, low economic quintile Americans today, have never had it so good. (BTW), when the Great Recession of 2007-2009 hit and the affluent lost trillions in the markets, I don’t recall the media lamenting these lost fortunes, nor the millions of businesses across America which suffered greatly, or, went under.

Many Americans took great risk in starting or owning their own businesses, and their reward was bankruptcy. Egregious CEO Compensation: A false narrative. A 2013 study by DOL of some 2,700 CEOs revealed average compensation in the $176k range and a 5:1 CEO to average worker compensation ratio. Selective 500 CEO salary comparison does not tell the more accurate broader story.

The real economic story should be how the Fed’s QE Infinity has allowed—begged really—public companies to engage in massive stock buybacks in excess of 3 TRILLION DOLLARS to date due to cheap cost of money. Yes, massive enrichment of executive level management via stock options, with reduced/negative capital reinvestment during span of record profits. All FED induced. Why go through the capital costs, hassle and regulatory nightmare of bringing a new factory online, when you can simply execute no-brainer enriching stock buybacks instead.

Of course share prices rise, when the number of outstanding shares is reduced, and massive new public corporate debt is also created. “Pigs get fat, hogs get butchered”. Once again knives are being sharpened at this time, patiently waiting. And so it is …
Thomas S.
Eden Prairie, Minnesota

Tim,
I’m having a not so great morning so please forgive my cynicism. “Beginning in 2017, the SEC will require public companies to disclose the ratio of their CEO’s annual compensation and that of the median employee.” Then, in or about 2019 the Federal Government will start to fine those companies whose ratio exceeds the levels deemed acceptable by of all people, Congress. They [Congress] will once again promote themselves as champions for the “little guy,” when in reality the little guy, not to mention the shareholder, will be the one on the short end of the stick yet again. Burdened by more Government regulations, companies will be forced to cut back on services and/or increase product costs to the “little guy.” Interestingly enough, corporations will recruit General Managers from the NFL in an effort to manipulate these new salary cap rules. I feel better already!
Andy L.
Hattiesburg, Mississippi

Hi Tim,
Personally, I think the main reason there’s so much innovation in the U.S. is our diversity. For all our bigotry, we have a longer history of welcoming people from all over the world, and a better record of integrating them in to society than countries of Europe. This diversity of cultures is itself fertile soil for new ideas. But more importantly, people who leave their home to build a life in a foreign land tend to be adventurous, imaginative, and undaunted by challenges. The exact personality type you’d associate with innovation. And if there’s a genetic component, these traits would be in a lot of Americans born here. Whatever the reasons, I doubt inequality has any effect. If inequality had anything to do with innovation, Africa and South America would have been kicking our ass for the past 100 years. And I submit that we were every bit as innovative from 1930-1980, (when we were a much more equal country), as we have been for the last 35 years.

As far as investing is concerned, I would love to invest ethically. Unfortunately, no one really offers that kind of service. Most so-called ethical investing is based on moralistic nonsense like not investing in companies that sell alcohol, tobacco etc. What I mean by ethical is investing in companies that treat their employees well, use resources wisely, and provide consumers with the best products and services they can at reasonable prices. For example, I’d definitely rather invest in Costco than Walmart, or Ben & Jerry’s rather than Nestles. And instead of avoiding companies that make alcohol, I’d be happy to invest in them because I find many of the smaller distillers are almost fanatically dedicated to producing the finest possible product.
David S.
Ansonia, Connecticut

My comments:

First, I love getting emails like these that allow me to see what my readers are really thinking. You’re a diverse lot, with a wide variety of experiences, and you help me remember that there is no single way to look at an issue.

And the same is true with investing. While most of you have similar goals—growing your wealth so you can enjoy a comfortable, secure retirement—there are many successful investing systems that will help you get there. Your job is discovering which of those systems is best for you

And our job is helping you find it! So, without further ado, let’s move on to the investing section.

Today, I want to focus on the new highs and new lows lists.

The new highs list includes Church & Dwight (CHD), Home Depot (HD), Lockheed Martin (LMT), Mobileye (MBLY), Tempur Sealy International (TPX) and Williams Sonoma (WSM).

If you’re growth-oriented (and skillful), you can profit by trading those stocks hitting new highs.

Alternatively, the new lows list includes Abercrombie & Fitch (ANF), Alcoa (AA), Copa Holdings (CPA), Hewlett Packard (HPQ), Marathon Oil (MRO) and Procter & Gamble (PG).

If you’re value-oriented (and savvy about stock valuations), you might find some bargains in those stocks hitting new lows.

But where I find the greatest value is in watching the tally of stocks hitting new highs and stocks hitting new lows every day—and watching the trend relative to the broad market—and using that to determine the health of the broad market.

More than 20 years ago, my father developed a method of analyzing these numbers that’s stood the test of time. We use this method every day here in the office. And today it’s telling us that after its latest feeble rally, the market lacks strength. It’s not healthy.

In order to keep risk low, therefore, I looked at the new lows list and searched for stocks that are great values.

And what I found was a little Central American Airline that’s on sale. In fact it’s 62% off its price high!

Copa Holdings (CPA)

From its headquarters in Panama, Copa Holdings provides both passenger and cargo service to more than 69 destinations in the Caribbean and Americas (including Boston, New York, Washington DC, Orlando and Chicago).

Independent since 1998, the company has grown by expansion, bringing in a record $2.7 billion in revenue in 2014. And looking ahead, the future is bright, as continued economic development is almost certain to bring growing demand for air travel.

But the stock has been slipping for more than a year, as political troubles in Venezuela, Brazil and (to a lesser extent) Colombia have temporarily reduced demand. So flights to those countries have been cut, and planes shifted to increased duty on routes to Belize and San Francisco.

In Copa’s second-quarter report, released last Wednesday, management revealed that because of cutbacks in those South American markets, revenues were down 20% from the year before, while earnings were off 64%.

Hearing that, investors sold—heavily.

Today, the stock is trading about 62% off last year’s high.

I think that’s a pretty good discount for a stock.

And Roy Ward, Cabot’s value expert agrees with me.

Roy’s latest issue provides an exact Maximum Buy Price for Copa, as well as an exact Minimum Sell Price (target), so you can take your profit (which in a year or two is likely to be around 50%) in Copa and move on to another low-risk situation.

Plus, while you’re waiting, you get to collect a dividend of 5.4%!

I know this may sound risky, but the fact is that Roy’s system, which he’s been practicing for 51 years, is rock-solid.

Over the 12 years the Roy has been with Cabot, his portfolio is up 250%, compared to increases of 98% for the Dow and 123% for the S&P 500 as of 7/28/15.

bgv chart 

So, you could just plunge into CPA here and hope for the best.

But what I recommend is that you become a regular reader of Roy’s advice, so that you’ll not only know when to sell CPA and take your profit, but you’ll also learn how to diversify your value portfolio beyond one little airline.

Yours in the pursuit of wisdom and wealth,

Timothy Lutts

Chief Analyst, Cabot Stock of the Month

Publisher, Cabot Wealth Advisory

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