Intrinsic Mistakes

“It’s the discounted value of the cash that can be taken out of a business during its remaining life.”

-Warren Buffett


Not to be confused with a pig, value trap, or a zero, that’s what Buffett calls the “intrinsic value” of a company. In Berkshire Hathaway’s 1989 Annual Report, Buffett reminded us that “it’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.” Amen brother.

Realizing that a lot has changed since Berkshire was buying smaller, under-covered, under-valued companies in the 1970s (when the SP500’s P/E was 7-8x), our all-star intrinsic deteriorating-cash-flow analyst, Kevin Kaiser, would love to interview Buffett on where his recent investment in Kinder Morgan (KMI) fits within his aforementioned definition of “fair.”


To be clear, ex-his-partisan politics, I have a great deal of respect for The Oracle of Omaha. I wrote my senior thesis @Yale on what I loved about his bottom-up investment strategy. Today though, I’m reminded of what his forefather, Benjamin Graham, taught us: “it’s a great mistake to imagine the intrinsic value is as definite and determinable as is the market price.”


Intrinsic Mistakes - buffett


Back to the Global Macro Grind


If you have an excel spreadsheet, some Old Wall consensus forecasts, and a calculator, you can pretty much imagine-up any “valuation” for a company that you want. The #1 risk to slapping a multiple on your cash flow number is that you are using the wrong multiple on the wrong number.


Imagine, God forbid, that you were one of these “value” guys who has been buying Energy stocks for the last 2 years on the premise that they were “cheap.” You could have bought the entire Energy (XLE) ETF in Q2 of 2014 at $97 (pre a -45% crash) assuming that the “cash that can be taken out of the business” was going to have $90-120 Oil implied in its cash flow margin…


You could have bought all of Kinder Morgan (KMI) at $42/share at this time last year too.


Since Kaiser didn’t sleep-over at my place last night and I don’t have access to his immediate-term thoughts on the Buffett purchase (hockey players are close, not that close), I’ll show you how a proxy for the right cash flow number looks in the commodity #Deflation Risk space – earnings. Here’s where year-over-year revenues and earnings are on a reported basis Q4 to-date:


  1. ENERGY (23 of 50 S&P companies have reported) = Sales -33%, EPS -74%
  2. BASIC MATERIALS (24 of 27 companies have reported) = Sales -16%, EPS -18%
  3. INDUSTRIALS (58 of 65 companies have reported) = Sales -7%, EPS -4%


I know, I know. If you “back out” those 142 companies from the SP500, “earnings aren’t that bad.” Notwithstanding that I didn’t hear one long-only fund manager ex-out the “earnings are great” narrative at $110 oil, you get how wrong numbers can be.


Income statement earnings and “cheap P/E multiples”, don’t forget, tell you next to nothing about:


A)  A company’s Debt Leverage (Balance Sheet)

B)  Credit Risk Profile, Covenants, etc.

C)  And/or where their profits are in terms of the cycle


That’s why we cyclical bears love shorting “cheap” stocks. When the profit-cycle slows and the credit-cycle deteriorates – newsflash: “cheap” gets a lot cheaper.


This is where buying a levered company at a “wonderful price” gets really dangerous. You can ask Carl Icahn about his purchases of #Deflation Risk companies like Freeport McMoran (FCX) and Chesapeake (CHK) about that. He’s Trump’s macro guy though!


Back to the intimate relationship that the PROFIT CYCLE shares with the CREDIT CYCLE:


  1. In the aggregate, 389 companies in the SP500 have now reported their respective 4th quarters
  2. Aggregate SALES are down -4.2% and EARNINGS are down -6.7%
  3. Only 3 of 10 S&P SECTORS have positive year-over-year EARNINGS growth


As a friendly reminder to those chasing US Equities (again) on another slow-volume Liquidity Trap bounce (Total US Equity Market Volume was -8% vs. its 1-month average yesterday)… every time US corporate PROFITS go negative (year-over-year) for 2 consecutive quarters, the SP500 has a greater than 20% crash/decline.


Currently the SP500 is -11.0% from its all-time #bubble high (July 2015), so the least bearish case I can give you this morning is SP (= 20% draw-down from peak). So, instead of trying to find some emotional value in what the S&P Futures are doing, I suggest you watch profits and credits today. Not doing so will continue to be, as Ben Graham called it, a “great mistake.”


Our immediate-term Global Macro Risk Ranges are now:


UST 10yr Yield 1.60-1.84%


NASDAQ 4155-4517

VIX 21.11-29.04
USD 95.07-97.89
Oil (WTI) 26.01-31.22


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Intrinsic Mistakes - 02.17.16 chart

Profits vs. Credits

Client Talking Points


Strong recovery day for the U.S. Dollar yesterday after holding 94 @Hedgeye TREND support during the 2 week correction. The rest of the world’s equities (Europe and Japan in particular need #StrongDollar as their stock markets aren’t working unless their FX weakens) – can Draghi break the Euro down to $1.05 vs USD in March? Doubt it.


389 out of 500 S&P companies have reported and if you gave the bulls these numbers 6 months ago, they would have sold the OCT-DEC 2015 chart chase. Total REVS -4.2%, EPS -6.7% with only 3 of 10 Sectors showing year-over-year EPS growth. Get profits and credit right and you’ll keep getting this macro market right.


The VIX did precisely what it should have during yesterday’s slow-volume (total U.S. Equity Volume was -8% vs. 1 month average yesterday) rally to lower-highs, making a higher-low at 24 with an immediate-term risk range of 21-29. We’ve been bullish on volatility since Q3 of 2014 – this is going to go on and on and on as central planners panic.


*Tune into The Macro Show with Hedgeye CEO Keith McCullough live in the studio at 9:00AM ET - CLICK HERE

Asset Allocation


Top Long Ideas

Company Ticker Sector Duration

Utilities worked against us for a -2% loss on the week, but remain an outperforming sector YTD. New scares in the form of increased risk from the financial sector emerged last week. Deutsche Bank made headlines over liquidity concerns that tied into CEO Keith McCullough's favorite S&P Sector short, the Financials. Financials are the most over-owned group relative to its rate risk – XLF is now -14% vs. Utilities (XLU) +5.3% YTD.


Walmart is still having an effect on General Mills, but it isn’t any more or less severe than previously guided by management. They will begin to lap some of the effects caused by the retailer at the beginning of their 4Q16 (starting in March). Five years ago they dealt with a similar clean store policy implemented by Walmart. Coming out of that they seemed to have gotten more than their fair share of upside, specifically in cereal and fruit snacks, now they are seeing a little more than their fair share on the downside.


Investors continue to be confronted with our signal of #GrowthSlowing in the U.S. and globally. Even the White House came out to reduce 2016 U.S. inflation assumption to 1.5% from prior expectations of 1.9%!  We’ve called for yield compression alongside our signal of growth slowing and our expectation that global investors will continue to pile into US Treasuries as a “safe haven” liquid play. Last week, the US 10 year fell 13bps to 1.736%.Continue with our go-to macro market calls of long TLT and short JNK, and things don’t have to be so doom and gloom.

Three for the Road


Our analysts talk earnings..

VIDEO | Young Guns: A Deep Dive Into #Earnings




Strive not to be a success, but rather to be of value.

Albert Einstein


The youth unemployment rate in Spain is 48.3%.

The Macro Show Replay | February 17, 2016


Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.

Cartoon of the Day: The Dying Cartel

Cartoon of the Day: The Dying Cartel - OPEC cartoon 02.16.2016


News of OPEC's death might not be an exaggeration.

Call Invite | Is the Market Prepared for What South Carolina May Signal?

Please join us Friday, February 19 at 11:00 a.m. for a special call with South Carolina's Republican and Democratic Party Chairmen, as we approach a pivotal moment in the election calendar. Specifically, there's less than one week left until the first votes are cast for the Republicans on February 20 followed by the Democrats on February 27. As such, we're very pleased to be hosting Democratic Chair Jamie Harrison and Republican Chair Matt Moore, who will give us their respective outlooks on how each race is developing in their state, and examine South Carolina's impact beyond the primary -- including a preview of Nevada and the Super Tuesday states voting March 1.


  • Matt Moore's bio available HERE
  • Jamie Harrison's bio available HERE

Dial-In Instructions for the Live Call:



If you have a question(s) you would like to ask, please send an email before or during the call to 


About Potomac Research Group

Potomac Research Group -- a Hedgeye company -- is a well-respected team providing Washington policy analysis to institutional investors and private equity firms. Together with Hedgeye's Macro and fundamental investment research, PRG's actionable, predictive and non-consensus analysis of federal legislative activities and regulatory policies helps clients determine Washington's impact on highly-regulated industry sectors, including health care, defense, finance, technology, and telecommunications.

For more information, please contact .

DRI: Adding Darden Restaurants to Investing Ideas (Short Side)

Takeaway: We are adding Darden Restaurants to Investing Ideas today.

Editor's Note: Please note that Hedgeye Restaurants analyst Howard Penney will send out a full report outlining our high-conviction short thesis later this week. In the meantime, below is a brief update sent today by Hedgeye CEO Keith McCullough in Real-Time Alerts:


DRI: Adding Darden Restaurants to Investing Ideas (Short Side) - darden


"I'm looking for the "consumer is in good shape" narratives to short...


And Howard Penney (of Chipotle short selling fame) is telling me to look no further than the never ending bowl of storytelling pasta.


Darden is up on a rope relative to where it was when Penney went bullish on it a few years ago... and he reminded our Institutional Research subscribers why it could go back to where it was on a conference call on February 2nd, 2016.


His new target price range is in the low $40’s 


Insiders might agree. Per Penney, "recently DRI’s largest shareholder announced it was selling more stock.  DRI’s core brand, Olive Garden is in need of a massive infusion of capital to fix the secular decline in traffic. 


Knowing this investment will slow earnings growth and depress the multiple; we don’t want to own the stock either!"


Short Green,



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