Sorry all – the Chicago cold kicked my butt for two days. Let’s get back to business. The Federal Reserve cut the federal funds rate by 25 basis points (0.25%) and pumped $41 billion of short-term reserves into the markets – the biggest liquidity infusion since September 11, 2001. One would have expected stocks to do anything but drop – the Dow having lost 360 points (2.6%) yesterday.
So…
Mr. Buffett:
Stop trying to predict the direction of the stock market, the economy, interest rates, or elections.
Great businesses will grow regardless of most rational interest rate changes (we can’t do anything if the fed raises them 10% in a day). For example, Buffett bought Coca-Cola in 1988 – when the Federal Funds Rate was rising from 6.5% to 9.75% in that same year. Why?
On a day-to-day basis, most businesses operate regardless of the fed rate – and completely independent of it. Coca-Cola sells Coke by the truck load regardless of the trickle-down effect of the Federal Funds Rate. In addition, it generated gobs of excess cash that allowed it to service virtually any interest rate the banks threw at it.
Of course, Coca-Cola generated so much cash that the banks bent over backwards to throw money at them. (Hint: Look for companies generating tons of cash – companies that can muscle the banks)
But My Stocks Are Down!
Of course your stocks are down. On a day-to-day basis, the markets can do crazy things. Over the long-term, they will increase the prices of valuable companies and lower the prices of bad businesses.
In the short run, the market is a voting machine. In the long run, it’s a weighing machine.
The Business Owner
Back when Gillette was a publicly traded company (it is now a subsidiary of Procter and Gamble), Buffett said:
You go to bed feeling very comfortable just thinking about two and a half billion males with hair growing while you sleep. No one at Gillette has trouble sleeping.
Does a business owner/manager care about the fed rate? For the most part, no. Unless that business is so highly leveraged that its cash flow can barely handle the current debt service, it will be business as usual at the company – with perhaps a smidgen more or less free cash flow at the end of the year.
This Morning At Your Company
What happened this morning at your companies? If you own Blackstone Group (BX), you may not know. Their highly leverages, rate-sensitive investment strategy may be allowing them to profit handsomely from this rate change. Or, they may have gotten crushed overnight as the fed rate moved against them.
I don’t really know. What I do know is that everyone at Coca-Cola likely went to work today to process the day’s orders, handle the invoices, ship cases of Coke, and work to make Coca-Cola more profitable. The fed rate is probably very low on the water cooler “things-to-talk-about” list.
Fed Rates: Noise Or News
If you own great businesses with lots of excess cash flow – businesses that are not sensitive to every blow of the wind – fed rate changes are mostly noise. If, on the other hand, you are gambling in companies with thin cash flows and sensitive business models, the fed rate is news – and the house will usually win.
Ask A Small Business Owner
It is difficult to compare a highly sensitive, highly complex business to that of a small company – but the comparisons are scary when you look at simple, slow-changing businesses vs. small businesses. Simple, slow-changing businesses are easier to value – and as such, it makes sense to compare them to small companies.
Ask a small business owner how the fed rate affected him or her today. More times than not, they’ll look at you funny – as if they didn’t even know the rates have changed and as if the rate change won’t affect the phone calls, sales, and billing they’ll do today.
Those are the businesses you want to own.
Filed under: How to Think About Investing
Hi Guys:
PFE is definitely an interesting company to take a look at, as it generates a ton of FCF and has grown it at a huge rate in the past.
One caveat to your analysis above for the worst case scenario:
When I ran Joe’s spreadsheets a few weeks ago the numbers looked really good, so I dug into the quarterly and annual reports on EDGAR. Now these predictions have changed a bit over time, but management is predicting that FCF will drop for 2007 (between $10b and $13b in various reports). FCF estimates for 2008 were between $12b and $18b.
So, your worst case scenario of zero growth is probably not conservative enough based on the drop in FCF due to losses of patent protection on certain key drugs.
With that said, it wouldn’t surprise me if PFE does in fact grow its FCF as in the past, particularly through smart and targeted acquisitions. However, the above changes the “worst-case” and the margin of safety required.
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Take a look at TEVA (bought today). It should handily pass the DCF threshold, and, unlike big Pharma, whose pricing growth rate has historically exceed wage inflation in the US by more than 500 percent, the policy direction is toward faster conversion of patent-protected meds to generic status.
[Full Disclosure: I own PFE, as well, for the reasons already listed -- banking on reversion to the mean, given its cash stockpile.]
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Hey all,
I was looking at PFE and (personally) I’m not sure that I’m overly excited at or under $20. The numbers look right, but we have to predict the future regardless of the past. As Tom pointed out, some lost revenue from its blockbuster drugs will likely result in lowered owner earnings. Using $11 billion as a startign point, intrinsic value appears to drop to the low $30s.
I’m not entirely crazy about it.
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Tom and Joe,
Thanks for your comments. I have only looked at the numbers and not read the annual reports yet on PFE. Thanks for your heads up on what to look for, and what to be cautious about with PFE. In general I have not had much luck with bio-tech or pharma, so my efforts may be better used in other sectors.
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I would not buy Pfizer with all their drugs going off patent their in trouble.The stock has a great dividend but they sold their consumer staples division to J&J which includes Listerine.Maybe they sold these great brands to pay these hefty dividends.We all know if a company cuts its dividend it signals trouble.When the 78 million baby boomers start retiring everyone will want prescriptions for less if not for free.I dont think there is enough margin of safety yet to buy Pfizer but when Buffet bought 61 million shares of JNJ he is definitely seeing the demographics long term.I would wait until ALL the drug companies find out what the government is going to do to them after the 2008 election!The generic drug companies are tanking and they will be the ones making MONEY when ALL these drugs go off patent!I would wait for that sector to turn around before I buy Pfizer.I am currently buying Johnson&Johnson whose consumer healthcare includes all Pfizers products.They gave away “durable competitive advantage” products what were they thinking?I have been using Listerine since I learned to brush my own teeth and complained about the “sting”of Listerine.I think Pfizer is feeling the sting letting go of such brands that have “product moat”advantage!CASH IS KING!!!
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Hi Joe,
Great post as always!
Had a request regarding Pfizer. If I remember correctly you had mentioned in one of your earlier posts that you would take a look at it. I am sure you are probably inundated with a lot of request and is probably siiting on your to do list. Anywho.
What do you think about PFE?
With problems such as: Patent expiration of Lipitor (2010), Neurontin, Zoloft, Zithromax, Diflucan, Accupril, Norvasc and Zytrec (2007).
Also Torcetrapib failed in its clinical trial.
All of these will probably trim 15B+ from their sales.
Pluses: PFE has a lot of cash (40B+), little debt and 90+ drugs in the pipeline.
I ran the PFE numbers from 1997-06 and these are the median numbers:
Equity: 39%
FCF: 39.4%
CROIC: 16%
With all the problems PFE is having its not going to continue with the same growth. So I slowed the FCF growth from 39.4% to
1) YEAR 1 -10 = 14% , YR 11-20 = 5%. IV Value = 44.59
2) YR 1-10 = 10%, YR 11-20 = 5%. IV Value = 37.04
3) YR 1-10 = 5%, YR 11-20 = 0%. IV Value = 24.38
4) YR 1-10 = 0%, YR 11-20 = 0%. IV Value = 21.56
I have not included the stock buy back of 18B in the outstanding shares (If I do then the IV drops). If I take the worst case scenario that the FCF does not grow at all (# 4), the IV (with 25% MOS) would be around $16.00.
My assumption is based that out of 90+ drugs in the pipeline, there will be atleast be some that will provide 5% FCF growth for the next 10-20 yrs, while it gets its house in order.
Sorry to get long winded.
Please feel free to poke some holes.
Thanks.
Giggsy
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