Sat, 30 Aug 2014
Plus, Buffett burnishes a fast-food deal, Tiffany investors pay a premium, and more.
Jason Stipp: I'm Jason Stipp for Morningstar and welcome to The Friday Five: Morningstar's take on five stories from the market this week.
Joining me with The Friday Five is Morningstar markets editor Jeremy Glaser.
Jeremy, thanks for being here.
Jeremy Glaser: You're welcome, Jason.
Stipp: Up first, the S&P 500 this week surpassed a milestone, going over 2,000 briefly. Is this good news for stock investors or bad news for value investors or any news of any significance for anyone?
Glaser: Well, in isolation, it's meaningless. The index is an arbitrary number. Hitting 2,000 versus 1,999 doesn't really tell you that much, and it's not indexed for inflation, so it doesn't really tell you that much about what's happening historically.
But it is a good time to step back and look at the overall market valuation level. We still are very much in that rich, slightly overvalued environment that we've been in for quite some time, and hitting this milestone certainly doesn't change that.
Our equity analysts think the median stock they cover is about 3% overvalued right now. If you look at some other metrics, like the Shiller P/E, which is popular, it looks a little bit more overvalued than that. So, things are pretty richly valued.
But as I discussed with Matt Coffina, who is the Morningstar StockInvestor editor, a few weeks ago, just because stocks are richly valued does not tell you much about what's going to happen to the stock market in the short term. You very well could see things become even more overvalued in the short term, or you could see a pullback or a correction. You just don't know in the short term; there really isn't a very strong historical correlation there. But I think over the long term, investors really can expect much more modest returns from these levels than maybe they've been used to seeing over the last couple of years.
Stipp: Burger King announced this week it's going to buy Tim Hortons, a Canadian chain. There was talk of the tax inversion aspect of this deal. But what about the business aspect of the deal? Is there a strategy?
Glaser: Burger King and Tim Hortons are going to become the third-largest quick-service chain, and this story really hit a lot of hot topics that we've been talking about recently, with M&A, with tax inversion, and with private equity.
And yes, their move into Canada and the tax inversion certainly accounted for a lot of chatter. But R.J. Hottovy, who is our analyst on Tim Hortons, really sees the strategic rationale as being the big driver of this deal. Burger King is primarily owned by 3G Capital--a Brazilian private equity firm that owns Heinz and some other businesses. It is going to come in and try to reduce costs and grow the Tim Hortons units to use different types of franchise agreements in order to keep their global expansion and to spread that brand--which is very, very strong in Canada--out across different geographies. R.J., who thinks that Tim Hortons had a narrow moat to begin with given their strength in Canada, believes this will really strengthen the moat, and he thinks that management will be able to do a good job here.
Stipp: Warren Buffett also got in on that deal. What were the terms and why do you think it looked attractive to him?
Glaser: Warren Buffett, who has worked with 3G Capital in the past on the Heinz deal, has said that he has liked working with them and that they are very, very sharp. He is taking this opportunity to co-invest with them again. He is putting about CAN$3 billion in a preferred equity deal. He is going to be very much a passive investor here. He is not going to be involved in the operations.
I think this is just another sign of how Buffett is able to get deals that just aren't available to anyone else. His size, his name, and his stature help him get good terms, as they help give a patina of respectability to any deal--particularly if you're dealing with potentially thorny issues, such as people being upset about the tax inversion. Having Buffett's stamp of approval goes a long way toward easing a lot of that. I think that certainly was part of this deal. We don't know the exact terms, but he likely was able to negotiate a pretty solid deal for himself.
Stipp: Tiffany reported results this week, and their operations are going pretty well, but the shares are starting to look as pricey as the merchandise.
Glaser: I think that's exactly right. They had a 7% increase in total sales, a 3% increase in same-store sales. You're seeing their wide moat in action. They have their intangible assets, like their brand. People really are willing to pay up for their diamonds, even though a diamond should be pretty much a commodity. And their vertical integration in terms of the way that they purchase the raw diamonds is also paying off for them right now where we are in that cycle.
But even if things are looking good on a fundamental level, the stock is much too expensive. It's trading over $100 a share right now. Paul Swinand, our Tiffany analyst, sees them worth more like $81. It's a great business, but one that you would need a much more substantial margin of safety, or a margin safety at all, before you even consider it.
Stipp: We got a revision on second-quarter GDP this week, and it showed that GDP was at 4.2% instead of 4% in the second quarter. That's a pretty good number, but how much can we read into this?
Glaser: It is a good revision. As Bob Johnson described it, it was a quality revision. Business investment looked better than expected, and inventories actually contributed less. So it wasn't just these inventories and imports and exports that were swinging the number around; it really was true growth that drove the number higher from that initial reading.
But you really have to look at this in comparison to the first quarter. That number was hurt by weather, but also by the import/export data. A lot of that was offset in the second quarter, which made it look much, much better. Over 4% growth is not where we can expect the economy to settle--a lot of it was catch-up.
In order to get to 2%-2.5% growth for the year [which is Bob's estimate], we are looking at a little bit over 3% growth for the back half of 2014. That's certainly possible, given some of what's happening right now, but we are not out of this slow-growth world yet.
Stipp: Great insights on the news of the week, as always. Jeremy, thanks for joining me.
Glaser: Thanks, Jason.
Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.