Tim Melvin, The Street | July 16th, 2015 | Middlemarketgrowth.org
All the talk and chatter over the past few days has been about developments in Greece and about China’s efforts to prop up the Shanghai exchange. Looking at the past two weekends, most folks have gone into the weekend bearish and those that carried bearish positions over the weekend were rudely admonished for their certainty when Monday rolled around. Those that carried bullish positions were treated to a nice surprise, as lady Luck smiled kindly upon them.
I find it hard to believe that folks think that betting their money on what will happen in Greece and China is a smart strategy, but lots of folks are determined to do so, it seems. I suspect that a significant percentage of those who place winning bets will develop a high degree of over confidence to predict world events and the market’s reaction to such. The problem with these bets is that when you are finally wrong, odds favor your losing whatever you made from your correct guesses.
I have followed the news out of Europe and Asia as closely as anyone else. I don’t have any short-term bets in place either way, but I confess that I am hoping one of these events goes wrong and we see some serious, sustained selling in the U.S. market. I have a lot of cash, as there just aren’t many undervalued stocks to buy at this point in time, and I would love to see some of the stocks on my wish list fall to bargain levels. I am not going to predict it will happen, but I hope it does.
The airwaves and internet are full of predictions about what will happen over the next few weeks. I might suggest that most of us would be better off listening to what the leading private equity investors are saying, instead of relying on the swing trading guru of the day. There is a reason private equity is among the top performing asset classes. They buy assets and cash flows cheap, hold them for a long time and sell them for multiples of what they paid. Individual investors will do much better to emulate that, than trying to become the next Livermore.
David Rubenstein of Carlyle Group (CG) told Rhonda Schaffler of TheStreet.com that he thinks valuations are high and he is finding very few opportunities. He told her that “we don’t really want to put money out the door, just because we have money to invest.” That one single line should be taped to the wall above every home computer set up in the nation. Individual investment returns would increase dramatically. He did say that he was finding opportunities in energy and health care.
The PitchBook Third Quarter PE Breakdown came out last week, and the opening paragraph contains all the information you need when considering where we are in terms of valuation and the current investing climate. They open the report saying “Private equity deal flow in the U.S. is heading downward. The latest data reflects the widespread perception in the industry that today’s high multiples will lead to stunted returns over the next five years.”
They go on to point out that the investment ratio is at the lowest point in the last decade; private equity continues to move to unload companies at today’s higher valuation multiples. My read of the report also notes that deal multiples are flattening after several years of moving consistently higher, and private equity buyers are reducing the amount of debt they are using to finance deals. The smart, patient money is moving with increased caution, and so should we.
It is interesting that the EV/EBITDA ratio of PE deals was about 7.3 in the first half of the year, while M&A multiples remain up around 10 for the first six months of the year. Public companies are using highly valued shares to make all-stock deals and are willing to pay higher prices than the PE firms that have to use cash and debt to get deals done.
Mr. Rubenstein pointed out on CNBC last month that this can often push pricing out of the range where he is comfortable. He told the network: “Companies doing deals. They have highly priced stock and they’re using that to make acquisitions. It makes it easier for them. Right now, credit is certainly available to do deals. But people, like we, do not want to pay the prices that you often have to pay.”
Paying attention to how the private equity firms are doing can make you a better investor. The big three private equity firms, Apollo (APO), KKR (KKR) and Carlyle all report in July, and their transcripts usually contain solid information about what they see developing in the economy and the markets. They should be on the top of your reading list.