Altimetry System Review

Warren Buffett was furious. To him, it was just the latest failure with as-reported accounting.

The legendary investor frequently comments about the problems with standard accounting, known in the industry as generally accepted accounting principles (“GAAP”).

And it was about to get worse… A new GAAP rule was going to have a major impact on Buffett’s company, Berkshire Hathaway.

That’s why he kicked off his 2018 letter to shareholders by railing against the problems with accounting.

Berkshire’s book value per share was about to go from constantly growing to surprisingly rocky. Thanks to the new rule, Buffett had to report his investments’ normal, day-to-day price changes as unrealized gains or losses.

Even if the real value of the business didn’t change at all, he had to report those artificial swings. And Berkshire’s investment portfolio was so large, it often saw one-day price fluctuations of $2 billion or more – which would now go straight to the company’s bottom line.

Because of problems like this, Buffett never invests just using these metrics… And rightfully so. The GAAP numbers offer an incomplete picture of a company’s real performance.

At Altimetry, we identify the dislocations created by these accounting distortions. We can use our Uniform Accounting framework to expose signals that most investors are missing.

These signals are a better way to gauge a company’s real performance and valuations. This means we can see businesses for what they really are… often before the market does.

It can be tough for investors to grasp why this idea is so important, especially when we write about lesser-known companies.

So today, I’d like to highlight one of our favorite examples to bring up when we’re teaching or speaking at conferences.

Everybody knows this company. But it’s also one of the most powerful dislocations we’ve ever uncovered. Not only that, but as of last year, we can definitively say that Buffett agrees with us…

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I’m talking about online-retail juggernaut Amazon (AMZN).

Even though it’s one of the largest companies and best-performing stocks in the world today, getting there wasn’t easy…

For years, negative headlines about Amazon dominated the news.

A 2014 Investopedia article titled “Amazon Never Makes Money But No One Cares” argued that Amazon’s profits – since the company launched – totaled less than what oil giant ExxonMobil (XOM) takes home every two and a half weeks. Yet the stock had soared 16,000% since 1997. That doesn’t sound right.

Three years later – with AMZN shares up 35,000% since 1997 – Forbes published an article titled “The Amazon Era: No Profits, No Problem.” This makes it sound like we’re returning to the dot-com era of eye-popping valuations for companies with no cash flow – a scary thought.

Then, in 2018, something changed. Amazon was profitable. In the fourth quarter of 2017, it reported $1.9 billion in net income… supposedly more than it made over 14 years’ worth of financial reporting. It’s like a switch has flipped and the company hasn’t looked back since.

And nearly the whole time, over the past decade, Amazon has moved higher and higher…

Last year, after revealing a stake worth roughly $1 billion in Amazon, Buffett admitted he was late to the party.

And yet, looking at Amazon’s as-reported return on assets (“ROA”), it’s difficult to see what changed for the company…

Amazon’s as-reported ROA was 5% in 2018 – higher than it had been in a decade – but it’s far from the record-breaking year suggested by the headlines.

But far from the popular opinion that Amazon has just now “flipped a switch,” the real numbers show us that this is a company with a history of strong ROA and growth.

The chart below shows that same false profitability stream for the company. But it also shows the company’s real return. The return that an investor like Buffett would see once he removed the accounting noise… what we call Uniform Accounting.

The dark blue bars show how high the return and reinvestment for the company has been historically. The light blue bars show what Wall Street analysts expect Amazon to do in the future. The white bars show what the market thinks the company can do in the future.

If the company has better growth and returns than the market thinks, the stock price should rise. If it disappoints, the stock will fall. Buffett is betting Amazon can beat the market’s expectations.

Take a look…

Back in 2009 and 2010, Amazon was churning out returns well above 100%. The difference between as-reported and Uniform ROA was so large, you can barely see the as-reported ROA on the chart. And even when almost everyone thought Amazon was unprofitable in the mid-2010s, the dislocation between its Uniform and as-reported ROA was huge.

While returns have “come back to earth,” Amazon is still a massively profitable company – with a 14% Uniform ROA in 2018.

Over the past decade, Amazon has also consistently grown its business by more than 30% every year. In 2011, Amazon had $4 billion in Uniform assets. Today, it has $85 billion in Uniform assets.

A 14% ROA on $85 billion means Amazon made nearly $12 billion… in a single year.

This is the exact kind of disconnect that we look for at Altimetry. For years, Amazon looked like it was generating paltry returns while it was focused on growing its business. As a result, the headlines complained that the market was on its way back to the dot-com era – focusing on growth with no sign of profit.

By using Uniform Accounting, we can see why Buffett regrets not acting sooner. Amazon showed its earnings potential years before the market realized.

And although the company’s days of hypergrowth may be behind it, that may not be the end of the story… Amazon’s ROA expanded from 7% in 2017 to 14% in 2018.

With Buffett’s recent investment, he must believe the market still doesn’t see the full picture for Amazon. And once you filter out the accounting noise… the numbers agree.

This Popular Stock Has Gotten Cut in Half… and the Losses Are Just Getting Started

By Joel Litman, founder, Altimetry

Meat alternatives were a big topic in 2019… And Beyond Meat (BYND) is the poster child.

Since its initial public offering (“IPO”), the company’s shares have been highly volatile. The stock has made 53 moves of more than 5% – up or down – since its IPO.

That’s roughly one out of every three days since it began trading. And the most recent was a huge 18% jump that happened only yesterday.

The massive moves higher and lower remind us of the dot-com bubble IPOs. Stocks that move this much tend to end up in the news – especially when they’re also helping popularize a market, like meatless meat.

Since launching Altimetry, we’ve received many questions from subscribers about Beyond Meat. Some readers want to know if the stock will be able to bounce back to its previous highs… while others wish to know how low it can fall.

But to understand what this stock is likely to do next, we need to dig into the market’s expectations… and see whether Beyond Meat can live up to them.

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In the investing world, IPOs generate a lot of buzz. Currently, investors are on the hunt for what the venture capital industry calls a “unicorn.” (Unicorns are privately held startup companies with a value of more than $1 billion. One of the first unicorns was Google in the 1990s.)

This is one reason investors were so interested in the Beyond Meat IPO. With an initial price of $25 per share, the implied market valuation of the firm on May 1 was $1.46 billion. With a business model that targets the rising demographic segment of vegetarians and vegans, excitement continued to build after the IPO on May 2.

Investors were also excited about Beyond Meat’s strategy. Even before the company went public, it had a steady flow of partnership announcements with major companies. It has either announced partnerships, or explored potential partnerships with Dunkin’ Donuts, McDonald’s, and Subway, just to name a few.

By Friday, May 3, the stock was trading near $66 per share… And prices rose steadily over the next three months to a high of $235.

However, since July, Beyond Meat has mostly taken a nosedive. It fell to $75 per share by late 2019, before rebounding recently to $125. Renewed stories about partnerships have revived the stock. And the buzz doesn’t seem to be slowing down…

Earlier this month, the company got two major pieces of good news. Its competitor Impossible Foods decided to step away from efforts to partner with McDonald’s.

Just as important, McDonald’s announced that it plans on moving forward with its Beyond Meat “P.L.T.” sandwich trial – featuring a plant-based patty – and expanding the number of stores that will offer it.

Some have stated the McDonald’s relationship could mean upwards of $200 million in incremental sales for Beyond Meat. Beyond Meat had $92 million in revenue in Q3 2019, and adding McDonald’s sales would increase that revenue by more than 50%.

No wonder the stock has rallied so strongly…

But while the news is potentially exciting, it is important to put it in the context of what the market expects the company to do… and whether those expectations are reasonable. This is the first step to investing that we follow at Altimetry.

Our Uniform Accounting method removes the noise inherent in generally accepted accounting principles (“GAAP”) and international financial reporting standards (“IFRS”). By removing as-reported GAAP accounting distortions, we’re able to see the true underlying metrics of a company.

We can use this clean data to not just understand how a company is performing, but also what the market expects the company to do. At any stock price, the market has an expectation that the business will achieve a certain return to warrant that valuation.

Today, this tells us something important. Even after its drop, Beyond Meat isn’t cheap… The stock would need to double every two years for the foreseeable future – as well as raise its Uniform Return on Assets (“ROA”) above 70% over the next few years – to justify current valuations.

The chart below shows Beyond Meat’s ROA and asset growth (dark blue bars) measured by Uniform Accounting, versus what Wall Street analysts think the company is going to do this full year and next year (light blue bars). The white bars show what the market expects Beyond Meat to reach over the next few years to warrant its current stock price. Take a look…

As you can see, the market expectations are very high. To justify the current stock price of $125 as I write, Beyond Meat needs to improve its ROA from negative 25% in 2018… all the way to 70% by 2023.

Not only that, but Uniform Accounting shows Beyond Meat’s ROA is even worse than the as-reported numbers (see the orange bars in the chart above) have suggested.

Food-manufacturing companies have historically seen muted returns. They sell commodity products with thin margins.

For context, the highest-returning packaged food companies are J.M. Smucker (SJM) and Hostess Brands (TWNK), with Uniform ROAs of 29% and 30%, respectively. Most of the meat companies that Beyond Meat would compete with have Uniform ROAs below 15%. This highlights how extremely high market expectations for Beyond Meat are.

Just look at the company that’s been a big driver for Beyond Meat, fast-food giant McDonald’s (MCD)… The company has seen impressive performance over the past 20 years, but currently only has a Uniform ROA of 15%.

As competitors continue to muscle in on the plant-based burger space, it will be hard for Beyond Meat to charge large premiums for its products… which the company will need to do to justify its current valuations.

Despite Beyond Meat’s long fall, using Uniform Accounting, we can see the market is still too optimistic about the stock today. And that means the losses are just getting started for this popular IPO.

Wall Street Has It All Wrong With These Two Stocks

Editor’s note: Nothing makes a stock move faster than a quarterly earnings report…

If a company beats Wall Street’s expectations, its stock goes up. And if it doesn’t, the stock goes down… sometimes significantly in a single trading day.

But as our good friend Professor Joel Litman has noted over the past few weeks, “as reported” numbers like this often contain flaws that can mislead investors…

Тoday we’re sharing two recent examples uncovered by Joel’s remarkable system. As you’ll see, his team’s efforts to level the playing field for everyday investors can lead to opportunities you might otherwise ignore…

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When Bill Bowerman and Phil Knight founded Blue Ribbon Sports in 1964, they had no idea what they were about to start…

Now known as Nike (NKE), the company started the sportswear revolution.

Before Nike started making athletic shoes, there was very little progress in the market.

It’s hard to picture a world without innovative sportswear. Imagine LeBron James running up and down a basketball court in a pair of Converse All Stars.

Nike has managed to stay ahead of the curve with its shoes. In the 1970s, it was the Cortez. The ’80s brought the Air Force 1 and the Air Jordan. To this day, Nike has continued to release signature shoe after signature shoe.

And the sportswear revolution isn’t limited to shoes… Every time Michael Jordan would show up in a new warmup outfit, fans would line up to buy the full look.

Athletic clothes are becoming more popular – and acceptable to wear – off the field. In 2016, the term “athleisure” finally joined the dictionary. The sportswear revolution is here to stay.

I try to live by the “health is wealth” doctrine. And I believe you can’t have a strong mind without a healthy body. Despite a sometimes hectic travel schedule, I try to get to the gym whenever time permits, at whatever hotel fitness center might be around.

Visiting so many different gyms, I do notice some trends in sportswear. Several watershed moments leading up to the current athleisure trend come to mind for me…

The first pair of Nike running shoes.

The popularity of Adidas’ three stripes.

The comfort and practicality of compression shorts.

In the mid-1990s, a former college football player named Kevin Plank took the moisture wicking material from his compression shorts and fashioned it into an undershirt for football players. The style was a hit… and apparel maker Under Armour (UAA) was born.

Under Armour gained quick popularity with football players… But Nike and Adidas were close behind.

Today, all three companies work in similar ways. They make a full line of sportswear, shoes, and gear for just about every sport. They endorse the best athletes in the world. Adidas backs soccer greats Lionel Messi and David Beckham. Nike sponsors LeBron James and soccer star Cristiano Ronaldo. Under Armour signed NFL quarterback Tom Brady and basketball player Stephen Curry.

However, having the best athletes doesn’t mean you have the best company…

Under Armour announced its second-quarter results in July, and the numbers did not look good. The company missed on its earnings and revenue targets, and management guided expectations down for the rest of the year.

This news added to concerns about the company’s ability to execute. Under Armour has historically lagged its competitors in efficiency, advertising, and innovation.

The stock fell 15% in the hours following the announcement. Worse yet, shares are down roughly 30% since their July 29 peak.

But things are not as bad as they seem. Take a look…

Investors fear Under Armour is failing. When looking at the company’s recent return on assets (“ROA”), it seems like they’re right… Under Armour’s ROA fell below its cost of capital in 2017, and it has remained at 3% since.

Luckily for Under Armour, this does not tell the right story.

We specialize in “Uniform Accounting” – a more reliable way of looking at companies than the generally accepted accounting principles (“GAAP”) and International Financial Reporting Standards (“IFRS”) accounting policies.

When we apply our Uniform Accounting metrics, the distortions from as-reported accounting statements are removed – including lease capitalization versus expensing, treatment of goodwill, and excess cash – and we can see that there is hope for Under Armour…

The two panels in the above chart explain the company’s historical corporate performance levels in terms of ROA and asset growth (dark blue bars) versus what sell-side analysts think the company is going to do in the next two years (light blue bars) and what the market is pricing in at current valuations (white bars).

Traditional accounting metrics (orange bars) can distort how investors view a stock. Without understanding a company’s true profitability, it’s impossible to properly analyze its stock.

Looking at the most recent years, Under Armour is more profitable than investors think… Its ROA actually bottomed out at 6% in 2017, improved to 8% last year, and is forecast to be around 7% this year.

Investors were concerned Under Armour wouldn’t be able to improve ROA above its cost of capital. But as it turns out, the company’s ROA never fell below its cost of capital.

The market punished Under Armour without good reason. Investors thought their fears were coming true, but it was just unclear accounting.

The market overreacted.

Investors missed out on signals that the company is already rebounding, and its performance was never as bad as expected to begin with.

Standard accounting metrics once again misled investors and created too much noise in the market.

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Wall Street Is Missing Out on This ‘Streaming Wars’ Winner

There are as many streaming services today as quality TV shows…

Between names like Apple TV+, Disney+, HBO Max, AT&T TV Now, NBCUniversal, and Discovery, you may soon be paying more than $50 a month just on streaming services.

But there’s an equally difficult decision you need to make… Before you can catch up on the latest episodes of Planet Earth or The Simpsons, you need to pick a streaming device.

Obviously, you can watch most of these on your phone or computer with no problem. But when it comes to watching streaming services on your TV, your set-top box won’t cut it anymore.

The options are nearly endless. Besides pricey smart TVs, you can pick from the big-name Amazon Fire Stick, Google Chromecast, or Apple TV, among others.

But when you need something in the middle, the best option is often from Roku (ROKU).

As I’ll show you, this streaming-device maker is a much stronger company than Wall Street realizes.

And when the “streaming wars” recently took a dramatic new turn, the bad press buried this incredible opportunity even deeper…

Roku regularly dominates the “best of” lists from the folks at tech-focused websites like Wired, Wirecutter, and CNET. It offers the Streaming Stick+ that plugs into your TV, a standalone hockey-puck size Ultra model, and even its own smart-TV software.

But when viewed through a traditional accounting lens, Roku looks like a terrible company. Its as-reported ROA is negative.

Of course, as I said earlier, my team and I specialize in Uniform Accounting – a more reliable way of looking at companies than the accepted accounting policies.

If we look at Roku’s cleaned-up numbers, we can see it is a profitable business…

When we apply our Uniform Accounting metrics, we remove the distortions from as-reported accounting statements – and we can immediately see that Roku has a much stronger ROA than the market realizes.

And the fact is, this is a much more valuable number for investors… If you would have realized this discrepancy in December 2018 and invested in ROKU, you’d be up almost 300% today.

That’s the power of Uniform Accounting.

Roku’s triple-digit rebound from its December lows makes no sense for a business that is supposedly losing money year after year. It only makes sense when you know the company’s real numbers.

Not only is Roku profitable today, but it has actually been profitable for as long as it has been a public company…

The panel above explains Roku’s historical corporate performance in terms of ROA (dark blue bars). Broadly speaking, the company has seen ROA grow from 4% in 2015 up to peak 20% levels in 2018.

Roku makes great products in a successful niche. And it’s likely to win even as other companies like Amazon (AMZN), Disney (DIS), HBO, and Apple (AAPL) battle each other in what the media is calling the “streaming wars.”

Now, if you’ve been paying attention to the markets, you might be wondering what’s happened recently. Despite its overall spectacular gains this year, Roku’s stock has gotten crushed in recent weeks.

That’s because its competitors know how much they have to lose… And several of them announced new product launches that caught the market’s attention.

These included cable giant Comcast (CMCSA), the loser of the streaming wars. Last month, it announced it was offering its Xfinity Flex streaming box to Internet-only subscribers for free, after charging $5 a month previously.

Social media giant Facebook (FB) also announced its second attempt to enter the streaming wars. It released a $149 “Portal TV” streaming device that will ship later this year.

Of course, Facebook released a video and chat “smart speaker” last year… to crickets. And Comcast’s free offering is one of dozens of streaming boxes available.

Competition from giant media companies is nothing new for Roku. It has been competing against pricey smart TVs, the Amazon Fire TV Stick, Google’s Chromecast, Apple TV, and others… for years.

And it has still been churning out profits… Yet most investors don’t see this. They can’t – because they’ve been misled by bad accounting policies.

I look at Wall Street’s reaction as an opportunity…

Roku has been profitable for as long as it has been a public company. An extra competitor in the streaming wars won’t change that.

The recent price drop only sweetens the deal for investors. Take this as an opportunity in a company that Wall Street doesn’t understand.

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Editor’s note: Joel recently went on camera to demonstrate his powerful “Investment Truth Detector.” Together, he and Porter showed thousands of viewers how to pinpoint which stocks could soon double your money or more. We’ve made a replay available for the next few days. But don’t delay… It goes offline Monday at midnight. Learn more here.

Even Smart Activist Investors Don’t Always Get It Right

By Joel Litman – Altimetry’s High Alpha newsletter

At the height of the dot-com bubble, Internet darling AOL could do no wrong…

When the company announced it was joining with media conglomerate Time Warner in January 2000, many people thought the merger was a smart move. AOL would gain access to Time Warner’s content and cable network, and Time Warner would take advantage of the Internet revolution by merging with a high-flying dot-com company. The massive, $110 billion deal closed a year later in January 2001.

At the time of the announcement, AOL stock traded for more than $110 per share. But within two years, shares plummeted more than 50%… dropping to less than $50 by January 2002 as the dot-com bubble burst.

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It didn’t take long for the deal to be panned as one of the worst deals of all time. AOL’s attempt to diversify its revenue model was unsuccessful, as its core business faded away. Time Warner’s thoughts that a connection to the online world would revolutionize its business also came to nothing.

Within 10 years, the two companies parted ways. Time Warner spun off AOL for $2.6 billion. Everyone hoped to put the memory of the new media/old media tie-up behind them.

So when AT&T (T) announced it was acquiring Time Warner for $105 billion in 2016, everyone was nervous that they had traveled back to 2000 again. The deal closed last year, and Time Warner was rebranded as WarnerMedia.

Over the subsequent three years, AT&T’s stock has been flat… even after a long drop from early 2017 to the end of last year and a recent move higher in 2019.

AT&T’s flat stock price has made investors impatient. They can tell that the market has not agreed with either the Time Warner merger or AT&T’s 2015 DirecTV acquisition.

Investors’ disappointment with AT&T’s strategy is apparent when looking at how cheap the stock is trading for. The market-average price-to-earnings (“P/E”) ratio for the company is 20. Today, AT&T is trading at a cheap ratio of 10.4…

The poor stock performance and the low valuation led Paul Singer – head of the $35 billion activist-investment firm Elliott Management – to push AT&T to make changes last month.

Based on Time Warner’s merger history, one might assume Elliott wants AT&T to abandon WarnerMedia. But instead, Elliott has set its sights on the company’s DirecTV acquisition. The firm wants AT&T to spin off DirecTV.

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Elliott is hoping that by having AT&T improve its strategy, the market will start to react. Valuations will rise, as will the stock.

The only issue is, the market may not hate AT&T’s current strategy. The as-reported P/E for AT&T is low, but as-reported financial data can be misleading and unreliable.

That’s why we use Uniform Accounting metrics to simplify and standardize financial analysis. With Uniform Accounting, distortions and discrepancies like treatment of goodwill and expensing versus capitalizing leases are removed.

With a “Uniform” view of AT&T, we can immediately see the company isn’t trading at a 50% discount to the market as a whole – it’s trading much closer to market-average valuations. Take a look…

The dark blue bars in the above chart represent AT&T’s Uniform P/E. Instead of trading at a ratio of 10.4 – as traditional metrics would have you believe – we can see the company actually trades at a ratio of 18.1. This is much closer to corporate averages.

Elliott may think it’s creating value by pushing AT&T to spin off DirecTV, but that might not boost AT&T’s stock from its current position around market-average multiples.

Looking at the company’s returns and what the market is pricing in shows a similar conclusion…

The two panels above explain the company’s historical corporate performance levels.

AT&T’s return on assets (“ROA”) and asset growth (dark blue bars) are compared to what sell-side analysts think the company is going to do in the next two years (light blue bars) and what the market is pricing in at current valuations (white bars).

At current valuations, the market (white bars) is expecting AT&T to see its ROA stay flat at the higher end of historic levels – around 6%. The market is anticipating the combined AT&T, WarnerMedia, and DirecTV business will see synergies and is paying for those expectations.

If Singer and Elliott Management are successful in getting AT&T to spin off DirecTV, it isn’t clear that will cause the stock price to rise significantly.

Often times, following activist investors can yield big returns, as they seek to change businesses. But even the smartest investors can get things wrong from time to time, if they’re using GAAP accounting to come up with their analyses.

Altimetry’s High Alpha Newsletter | This Misunderstood Market Is Creating a Big Opportunity

By Joel Litman – Altimetry’s High Alpha newsletter

Yesterday, we discussed why concerns about an imminent recession are misplaced. Thanks to the drop in the cost for corporations to refinance their debts since early 2019, debt maturities are starting to be pushed out. And without a debt crunch, there’s no risk of a recession.

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But even corporations’ reported costs to borrow overstates how risky corporate debt is. This is particularly true for debt with the largest yields.

Market credit default swap (“CDS”) metrics are driven by investor demand, which is driven by how credit looks based on as-reported accounting figures.

The big credit-rating agencies – Moody’s, S&P, and Fitch – all use traditional accounting metrics when analyzing a company’s credit risk. So do Wall Street analysts.

Because of this, their conclusions on credit risk lag reality.

Once we apply our Uniform Accounting metrics, we can calculate what credit risk really is for a company. We call this metric “intrinsic CDS,” or iCDS. The chart below highlights the iCDSs broken into three buckets: investment grade (“IG”), crossover (“XO”), and high yield (“HY”), plus the risk-free rate (“RFR”). The real credit risk companies are facing is even lower than CDSs show you…

Our iCDS takes into account the real risk factors impacting each bucket of companies to understand what their real costs to borrow should be, based on that risk.

For the less volatile companies (IG and XO), intrinsic cost to borrow looks more or less the same as the current market costs for these companies to borrow. The market is correctly pricing their low and declining credit risk.

However, looking at the riskiest group of companies (HY), we can see something very powerful…

The market is overstating credit risk for HY companies.

While the market cost to borrow for an average HY company is around 4% right now, the intrinsic cost to borrow is around 3%. In the bond world, a percentage-point difference like that between market values and where a bond should trade is massive.

HY bonds are where most credit crises start. These are the companies closest to the cusp of bankruptcy and corporate restructuring at any given moment. Because of that, they are a particularly important canary in the coal mine for the economy as a whole.

If HY bonds are flashing an “all clear” signal – which they are today – that is a huge positive by itself… But when we’re seeing signals that credit risk is even lower than the market realizes, that lowers the risk of a credit crunch and recession even more.

And that’s before we even get into what it means as an opportunity for investors to buy individual high-yield credits, because they’re being overcompensated for the risk they are taking when they buy those bonds. This is also something we’ve seen Porter Stansberry highlight with his bond work at Stansberry Research.

We already know that the risk of a recession is much lower than many on Wall Street are claiming, just by understanding how important the refinancing market is to economic growth.

But by using Uniform Accounting, we can see even more… Not only is the risk of a recession overstated, the actual risk of HY corporates – the highest-risk businesses – is even lower than the market realizes. As the market adjusts to this reality, it will give even more tailwinds to the refinancing cycle, extending out the risk of a recession to 2022 – if not even further.

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