Away – not done

Just a quick note to let everyone know that the recent inactivity of my blog is a function of my current duties of military service. I will be back online very soon and will notify all readers via email when I am.

I haven’t had the opportunity to address the stagnation in CNO’s stock price. I can’t explain but I don’t have to. Remember, all my analysis included massive margins to safety. The primary reason for including ultra-conservative assumptions in equity analysis is for peace of mind and invariably – large returns. As an investor I cannot concern myself with mainstream sentiment (which I consider noise and is precisely why I watch no televised news – it’s a self-licking ice cream cone that, in my opinion provides the individual investor no value)

To put this philosophy into perspective, let me provide an example from my recent personal investment portfolio. Back in February of this year, I invested 25% of my net worth into Allied Irish Bank (AIB) at $3.00/share. I will withhold a full analysis of AIB for now but my analysis was very similiar to that which I have written about for GNW, CNO, RBS-T. As I watched AIB shrink to sub $1, I lost no sleep because I believe in value, common sense and equity analysis – not the current public sentiment, fear or rumors. As AIB trades today at $6+, I do not assert that it won’t shrink again, but I do know that I will sell AIB, GNW and CNO for a price greater than 400% than what I paid. When? I don’t know and I don’t care but common sense prevails eventually which is why I sleep like a baby every night.

I look forward to resuming daily updates here but for now, I must attend to my primary duty and service to the country.

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An analysis of CNO’s debt and liabilities

Update:  If you read this article prior to 11:20pm EST, please re-read it.  I had a major data loss in the upload that I did not recognize and as a consequence the bulk of the article was deleted. 

I have been asked by several readers to assess the severity and impact of Conseco’s (CNO) debt.  I am much obliged to do so.  But let me forewarn all readers that assessing the debt of an insurance company is risky business (pun intended).  Insurance companies buy and sell risk and as a consequence virtually all of their policies expose them to future liability.

Let’s start simple. An insurance company receives payments from its clients for a service (life insurance, mortgage insurance, mortgages themselves) The actuaries at the insurance company determine based on probabilistic theories how much these services should cost.  If an insurance company just ‘sat’ on the money they collected in order to keep it safe in the event of massive payouts (let’s say invested soley in Treasury Bills), they couldn’t stay in business.  In order to compensate for their low rate of return on their collected revenue, their premiums for service would have to extraordinarily high and as a consequence they would price themselves out of business.  So instead, they invest this money, in a variety of ways not unlike an investment bank would.  Additionally, as most publically traded companies do, they have a certain amount of secured debt (true ‘debt’ . . think bonds).

Most of you didn’t need to read that paragraph, maybe some of you did.  But even if it was ‘below’ you, it serves as a good starting point to assess the debts or potential debts of an insurance company. 

Let’s boil down that basic paragraph to identify the sources of liabilities and debt that an insurance company is expected to have:  secured debt (true debt – bonds, notes), liability stemming from policies they have written, mortgages they hold and investments that are linked to ‘risky’ assets (such as mortgage securities).

Let’s take a look at CNO’s numbers:

Secured debt (direct corporate debt):  $1.2 billion dollars

Cash on hand:  $1.2 billion dollars. 

This is a very stable condition. 

The metric that is often used to determine a company’s ability to pay its debts is the interest coverage ratio which is 3:1 for CNO. (Which compares the net income (before taxes) with the annual interest expenses).  This is a very stable ratio for CNO.

Let’s next consider the amount of liability that CNO is exposed to due to their insurance contracts.  CNO has approximately $23 billion dollars of liability associated with their insurance contracts.  Theoretically, if all of these needed to be paid, CNO would be bankrupt.  But, of course, this is the same for every insurance company on the planet.  The key to an insurance company’s profitability lies in two key factors:  1. that their revenue exceeds the amount of benefits paid out each year.  2. that they invest their revenue wisely to ensure they maintain a large buffer to safety in unpredictable economic times.  

Let’s look at last quarter for CNO.  They received $1.069  billion dollars in revenue and paid out $1.027 billion dollars in insurance benefits.  This resulted in a pre-tax income of $42 million dollars.  After taxes, the net income was $24.5.  Divide this profit 184 million ways for each share and we get 13 cents profit per share.  Repeat this process quarter after quarter and you have a successful insurance company. 

At first glance, it appears as if the difference between payouts in benefits and revenue is slim.  It is.  For CNO, it is 4%.  Let’s compare that performance with a larger company that is currently trading near its book value. 

I selected Prudential (who looks like they will reject TARP funds).  In the same quarter (1st quarter of this year), Prudential earned $8.563 billion dollars in revenue and paid out $8.551 billion dollars in insurance payouts and benefits.  This resulted in a pre-tax income of $12 million dollars and then after taxes and some creative accounting net income of $5 million dollars attibutable to shareholders (they report an income of $14 milion but for a variety of reasons only $5 million dollars of that is attributable to shareholders) for an income of 1 cent per share.  Prudential’s margin here is .1% (compared to the 4% we calculated for CNO)

So after all the number crunching, I think it is clear that CNO’s financial structure regarding its insurance policies is sound and no different than the titans of the industry (and in the case of Prudential, arguably better)

Now there is the topic of exposure to the credit and mortgage ‘crisis’.  CNO is exposed to $2 billion dollars of mortgages and has close to $3 billion dollars of mortgage backed securities as investments.  To address the latter first, CNO has placed a ‘fair value’ on the $3 billion of investments at $2 billion to be conservative and as a result reducing their held assets by 5%.  As a side note, they did not have to do this, but it is clear to me that they are trying to protect themselves from future economic and credit hardships.

As far as their $3 billion dollars in mortgage loans, the company reported that as of 31 March 2009, the company had $7.6 million dollars in mortgage loans that were currently 90 days or more delinquent.  This is .2% of the value of their currently held loans, with the national foreclosure rate hovering around 2% (on the high side), it is clear that CNO is not likely to suffer from past poor lending practices.

There is much more analysis that could be done here (such as looking at their regional exposures and their debt structures) but I think the numbers presented speak for themselves here.  CNO’s debt and liability structure is healthy and although not without some risk, in-line or above the industry average.

Aimee and I are leaving to watch a performance of Mama Mia in Honolulu tonight.  Have a great weekend.

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Rapid fire thoughts before the weekend

I am still working on part II of “We are our best analysts”, Rich has put a lot of pressure on me to get this one right so I am taking my time with it.  I did want to spend some time quickly covering and sharing some thoughts in a rapid fire format before going into the weekend.

1.  I was wrong about the market today.  There is no other way to say that.  I thought we were going to end the week strong and we didn’t.  I thought the market would respond positively towards the insurance sector today. . it didn’t.  I was wrong.

2.  I want to restate my target price for CNO at $11 within a year and above $5 in the short term.

3.  I’ve changed the setup on this blog in preparation for my move off of wordpress and out on my own at blogtoamillion.com.  The transition process is not complicated but it is time intensive.  I had promised myself that I would move off of wordpress when I was averaging greater than 500 visitors a day.  I am happy to announce that Blog to a Million has averaged over 1000 visitors a day for the last six days.

4.  I have received many ideas in the past few days.  I have not had the time to research all of them, but here are the two strongest ideas at first glance.  I do not recommend any of these companies because I have not had the time to fully explore their business model and financials, however I am including them here as recommendations for your research this weekend.

New Market Technology (NMKT)  (From “Jay”) A true penny stock trading at less then 3 cents per share.   With companies of this size, the risk is high and there is no way of getting around that.  However, the pedigree of their management team is quite impressive to say the least.  Their CEO communicates openly and honestly with the shareholders.  They are predominately an IT solutions company for emerging markets (I am sure that is an over simplifying their product line, but it’s in the ballpark) and despite their very low stock price, they have been around since the mid-90′s and have survived thus far.  I have spent several hours looking at this company and intend to do much more, before formally recommending it and/or investing in it, but at this stage I highly recommend you take a look at the opportunity that is presented here.

The Providence Service Corporation (PRSC)   The company provides social services on primarily the government’s dime.  From their website, “The Providence Service Corporation provides and manages government sponsored social services to individuals and families in the United States. The company’s services include home based and intensive home based counseling, substance abuse treatment, school support, misdemeanant private probation supervision, workforce development, foster care, therapeutic foster care, and not-for-profit managed services, including administrative support, information technology, accounting and payroll services, monitoring, and case management, as well as intake, assessment, and referral services.  Whether you agree or disagree with the current administration’s plan to significantly increase the size of our government and expand social programs (I happen to disagree), it is pretty clear to me that PRSC stands to benefit from this eventuality significantly.  I have no analyzed their financials so I am not making a recommendation at this time, but if you have some time this weekend, the company certainly warrants a bit of research. (Thanks, Nicolla from Italy.)

 5.  I am looking to add some advertisements on my new site.  I have a list of companies that I trust and feel very confident in recommending.  It is very important to me to include banner ads only from companies that provide true value to their customers.  If you have any recommendations or feedback on this matter, please share them with me.

6.  Months ago, a friend and I were discussing the economic climate and while bouncing random thoughts back and forth, he blurted, “There is a 25% excess in our country – on everything, house prices, stock prices, jeans, cars. . you name it.”   This was  a “Blink” moment for me (for those of you have read Malcolm Gladwell’s book Blink, you know what I mean).  The super simplified version of the theory is that sometimes your gut instinct exceeds the most detailed and complex analysis.  Let’s look at what the future might hold if my friend’s gut instinct is correct:

- We would expect to see the SP500 tend towards 75% of its high $1557 or $1167

- GM would close approximately 1850 of its 7400 car dealerships.

- The average cost of a house in America would be $234k from its peak of $313k in 2007. 

I encourage you to play out this ‘gut assessment’ in your mind and use examples with stock prices, car prices, etc etc and maybe even write them down.  I acknowledge the simplicity of the theory but when you considered the sustained affects of a national negative savings rate and the excesses of consumer credit; my gut tells me this theory is not far off.

Have a great weekend.

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Quick blurb about TARP (CNO, GNW)

I didn’t have time to finish part II of ‘we are our best advisors’ because I realized I had more to say on that topic than I realized. It will be done tomorrow so please check back, I think you will enjoy the article.

I did want to quickly address the after market news regarding the TARP funds for the major insurers. Although my personal opinion on the matter is that needing and/or accepting this loan is philosophically bad (adding D.C. as “partner” is never good), I do believe the market will respond positively to this news tomorrow (remember when GNW got beat up when the news that they woudn’t be receiving government aid hit the street). Hopefully, that movement will translate to the entire insurance sector.

In the short term I expect GNW and CNO to benefit from the insurance sector movement and in the long run benefit from being stable and well-managed enough not to require TARP funds.

This market’s mindset has befuddled me in the short run many times recently, but I will go out on a limb and say that I expect a strong day tomorrow with GNW in the mid to high fives and CNO at three and change.

Thanks for all the emails and support. Please keep your feedback, ideas and comments coming. It inspires me to provide the very best information that I can. I have received some very good tips from readers recently and will be highlighting some of them after I finish my research on them.

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We are our best advisors (CNO, GNW)

Good day for the insurance companies today – not great, but good.  We continue to see evidence that the market is increasing its valuation of the insurance sector.  Of course, there are many us that are invested in CNO that will not feel “encouraged” until CNO rises at least above $5.  I can understand that because I share that sentiment.  If you happen to be struggling with your own conclusions regarding the valuation of CNO, I encourage you to perform the following thought experiment.  Review CNO’s financial data and then decide what you think the stock price of CNO will be one year from today.  Put this paper in an envelope, seal it and open it on May 14, 2009 to check your instincts.  I have written $11 on mine.

 I ask you to perform this experiment because it forces you and your thought process to distance yourself from the daily “noise” that we are bombarded with.  You task yourself to determine a fair value for a company that has a book value of $18(ish), $6.60 in cash per share and an annual net income of $0.80 (ish) / share.  Those are the facts, throw in some conservative assumptions for good measure, including your assessment of where you think the SP500 will be one year from now and poof . . . you are left with your gut instinct.  Trust that instinct.  If you have a longer time horizon than one year, use that instead. 

 Back in February, I literally performed this process when evaluating Bank of America.  I was contemplating liquidating a significant fraction of my net worth and picking up Bank of America.  I had one million and one reasons why it was a steal trading at $5 / share but there was so much fear and doomsaying surrounding me that my own instincts and knowledge were threatened by public sentiment.  I wrote down the number $18.  Then I liquidated 33% of my assets and bought BAC for $5.20.  Then the nightmare started, the floor fell out and the drama began, looking at BAC trading for $2.50 made me feel like the biggest fool on the planet.  However, I reviewed my thought process and my rationale and agreed that I still believed in all that led me to that decision and that I would not be swayed.  I am certainly neither bold enough to claim that there is no way BAC will not see $4 days again (I don’t think so, but who knows?) nor I am immodest enough to think I am blessed with the prophetic powers.  But what I do know is that my assessment and evaluation included such a large buffer to safety that I could rest easy with the peace of knowing that my conclusions were sound and justified and eventually the market would come to the same conclusion.  That envelope remains sealed in my sock drawer with the following written on the cover, “Open on February 2010”

 These types of decisions are much more difficult in more ordinary times.  Should Intel be trading at a P/E of 30?  25?  33? or 15? These are very challenging assessments to make.  When the market proves our conclusion to be right or wrong, if we are honest with ourselves it is difficult to be sure that we were right (or wrong) for the right reasons.  These times are different.  The current valuations of many, many companies are flat out wrong.  Not wrong in the sense of a ‘mistake’, because the market price is the market price for a reason.  I use the word ‘wrong’ to describe a situation that will be rectified when the disproportionate amount of emotion and fear slowly price themselves out of the equation.  I believe the valuations of GNW and CNO will be corrected by the market and result in a huge payoff for those brave and confident investors that are willing to trust their instincts when the option to panic is so tempting.

 Warren Buffet’s wisdom is helpful in two regards here.  “Be fearful when others are greedy, and greedy when others are fearful”  He also said (ish) that an investor should not accept risk but instead eliminate it with facts, knowledge and a margin to safety in his/her analysis.

 I am going to publish this now because it is getting late on the East coast and I’d like my East coast followers to have something to read from me today, but this is a two part article.  The second part will highlight my thoughts on why in this type of market credible analysis is tough to find and that we should be very reluctant to trust the analysis and valuations of anybody but yourselves.  I thank “Rich” for providing me the idea for this topic.

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Conseco (CNO) Perspective

Investing is humbling.  I was worried about today, but I didn’t expect this massive sell-off.  Anyway, it happened and in the process,  I violated a rule of trading.  I did NOT execute my exit strategy.  I am going to hang in with CNO because today’s events were NOT a reflection of investor sentiment towards CNO.  Today was a perfect example of what I discussed yesterday, a stock moving with the market.  Now clearly, this is a wild move that strayed from a Beta of 2.5 but all financials were effected today.  Here are some examples:

GNW (-20.8%), CNO (-25.2%), BAC (-10.2%), RBS (-13.6%), AIG (-11.6%), C (-6.83%)

At first glance, these movements indicated that there is something afoot or wrong with CNO.  Some underground conspiracy.  MMs communicating with the black helicopters in NYC.  Relax.  Let’s take a look at today’s actions from another way.

Yesterday and today were a combination of many things:  profit taking, some bleak news about foreclosures (not nearly as bad as our drama queen media makes it out to be – but that’s another discussion), consumer spending down (good, we’ve had a negative savings in rate in this country for awhile.  Overspending my the American people is the reason we are in this mess in the first place) and the snowball effect of the chicken littles that have been shouting, “the market has gone up too quick, too fast, run. . run. . run away!!”

So I intrepret this short-term trend as simply a temporary retreat.  The SP500 retreated to a its 1st of May (ish) value.  Let’s look at the stock prices of a few financials on May 1st and compare those values with the close today.

	% 5/13	5/1 Price	5/13 Price	% from 5/1-5/13
SP500	-2.68%	$873.80	$883.92	1.16%
GNW	-20.80%	$2.45	$4.15	69.39%
CNO	-25.20%	$1.52	$2.28	50.00%
PRU	-5.83%	$28.18	$37.02	31.37%
BAC	-10.20%	$8.90	$11.01	23.71%
AIG	-11.60%	$1.39	$1.60	15.11%
C	-6.83%	$2.97	$3.41	14.81%
MET	-10.79%	$126.60	$129.26	2.10%
GS	-4.54%	$28.78	$27.45	-4.62%

 Take a hard look at these numbers and think about what they are saying and how it applies to today’s movements. 

It is fair and indispuable that since May 1st, the market has increased it valuation on the intrinsic value of CNO by 50%.  That may not be what we were hoping for but it is what we have and it is hard to complain about if you are a CNO investor. 

Stated another way, for all the excitement and hype in the month of May (up until yesterday), the market is flat.  The last column of the table above shows the relative gains of these stocks in a time period where the “market” went nowhere.  This eliminates Beta (or essentially market sentiment – see yesterday’s post) from our effort to discern market sentiment towards CNO.

Despite this sell off, which is clearly disappointing to CNO investors – myself included.  I believe it is important to recognize and identify the bigger picture.  Nobody can completely rule out an ENRON or WorldCom type catastrophe from CNO – or any other company for that matter.  But, today and yesterday, we didn’t see indications of that – we simply saw some optimistic movement in the last two weeks retreating and in doing so eliminating any gains in individual equities that were caused by this overall market movement.

I received some comments about the possibility of CNO’s book value being less than their published amount by throwing out ‘tangible book value’ and a bunch of other non-sense.  Most of this banter is garbley-gook generated by shorts looking to muddy the waters.  I am not saying these topics are not worth discussing, because they are. . . but, there are so many assumptions that one has to make to arrive at a conclusion that I believe it is more prudent to wrap up and discount all of these assumptions into one big assumption and then use that for analysis. 

In fact, that is precisely what I did yesterday in my valuation analysis and I stick by my assessment of a very conservative target price of CNO at $11 (ish).  I’d be a fool to predict a time, day and phase of the moon when this is going to occur, but I firmly believe the evidence is clear that CNO’s proper valuation is several multiples away from where it currently trades.

As a side note, for CNO’s book value to drop to $2 dollars (the ballpark of what many alarmists or shorts are indirectly claiming).  Take a look at the amount of assets that would have be converted to liabilities (one of reasons insurance companies trade at low Price/Book value is because assets can become liabilities.  A printing press’ value may drop to zero but if its worth $100, I don’t expect it to become a $100 liability).

Shares outstanding:  184.75 million

Shareholders equity (ASSETS-LIABILITIES. . ish) required for $2 price to book ratio (resulting in a price range of $2-$4 dollars) is:

184.75 million x 2 = 369.5 million

Current shareholders equity is 1,591 million dollars

The difference:  1591-369.5 = 1,222,000,000 or 1.2 billion dollars

The real asset that is considered ‘endangered’ is mortgage loans, CNO currently holds 2 billion dollars in mortgage loan assets.  Half of all of their mortgage loans would have to be become liabilities for the company’s book value to reduce to zero and 25% would have to become liabilities for their book value to reduce to zero.

Let’s put that into context.  Could you imagine what would happen in this country if default/foreclosure rates rose to 25%?!    The very worst areas of the country now are experiencing 2% foreclosure rates.  25% nationwide??  We’d all be sharpening our arrowheads to hunt for our food.

I appreciate the feedback I’ve been getting.  Please continue to do so.  For those of you that are invested in CNO, I know it would be preferential if we were interacting in more prosperous times, but fighting through the clutter to find value in this chaotic funhouse we called our stock market is challenging and takes some humility, patience and confidence.

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Conseco (CNO) Valuation Analysis

Not as rough of a day as it could have been.  I anticipate a strong end of the week performance but I fear that tomorrow may trade sideways again.

Before, I get into some valuation models for CNO, let’s talk a bit about market volatility.  I mentioned this briefly in a previous post on GNW but I will elaborate because it is important parameter for investors to understand.  

A certain percentage of a stock’s, any stock’s, movement is attributable to the market itself.  There are many reasons for this but for now, think broad based mutual funds, index funds, etc.  They carry many vehichles (or stocks) within them and therefore, their movements directly impact individual securities.  This happens everyday to every stock.

It is mathematically impossible to determine what actual percentage of a stock’s movement is due to market movement versus intrinsic value on any given day.  But what we can do is look into the past and draw quantitative conclusions.  In doing so, we derived a parameter called Beta (B).  Beta describes the fraction of volatility of a stock that is related to the market’s movement.  The higher the B, the more abrupt the changes will be. 

There are two components to B that an investor must be familiar with, the direction and magnitude.  The direction is indicated by the sign of Beta (+ means the stock moves with the market and – means the stock moves opposite the market).  The magnitude is a bit trickier but not much, these examples should suffice.

A Beta of 1.0 will move exactly with the market.  (Remember, this movement “factor” is aside from its intrinsic value meaning the stock with B of 1.0 is expected to move  with the market in addition to the movement due to changing valuation of the stock itself. Think vector analysis for those that can recall their high school physics)  For example, let’s look at Microsoft, which has a Beta of 1.02.  The chart below shows Microsoft’s stock price charted against the SP500 for the past year.

Notice how they move almost exactly together.  Any movements that are not in synch with the market are attributable to the collective investor assessment of the viability of Microsoft’s future growth (and of course statistical deviations).  So you can see, there really hasn’t been a change in the last year of how the market values Microsoft.  Today was a good example of an exception to that.  The SP500 was down .1% so we should expect MSFT to be down .1% if investor assessment of MSFT didn’t change.  But it did, MSFT was up 2.95% today due to, presumably, news of its debt offering.  Theoretically, this news rose the value of MSFT 3.05% (the extra .1% to account for the .1% MSFT should have been negative).  I hope I have explained this well.  It’s like the those pictures that you have to stare out to see the sailboat or giraffe or whatever, once you get it. . you get it.

An example of a stock with a positive Beta greater than 1.0 is CNO.  CNO’s Beta is 2.5 (ish).  Notionally, we can attribute .25% of today’s drop to the market itself  (There are probably some math geeks out there that are chomping at the bit to correct my simplification.  Relax.  What they want to say now is that I am not taking into account the assumed risk free return rate but that does not change the discussion, but in fairness, I felt like I should mention that my examples are slight oversimplifications).  But CNO didn’t just go down by .25% so the rest we can attribute to sentiment that is specific to CNO – likely profit taking today (for advanced analysis we could calculate a Beta in relationship to a sector. . such as insurance companies which would further allow us to separate sector performance from CNO performance).  Take a look at CNO’s 1-year chart which is a bit more complicated than MSFT’s was.

Clearly there is a relationship between the SP500 and CNO but it is a bit complicated.  Using a CNO’s Beta of 2.5, we would have expected to CNO to drop 87.5% (35%*2.5) over the year but it hasn’t.  It has dropped 72%.  So, theoretically, the market has actually improved its sentiment towards CNO in the last 12 months by about 15%.  I know it is hard to see the silver lining in a a 72% drop but the magnitude of this economy fallout creates some crazy consequences.  By looking at the chart, you can see where this increased sentiment occured - look at late October to January (the SP500 was going down and CNO was going up) where CNO was going up despite a drop in the SP500. 

Some argue against the use of Beta because it is a past-looking parameter and therefore is irrelevant and theoretially useful only.  Others (fans of the capital asset pricing model) swear by it.  I find myself in the middle and at a minimum I believe every investor should understand it. 

Break.

Now let’s look at some numerical valuations of CNO.  There are many ways to do this and each way has so many assumptions embedded into the process that I am of the opinion to keep things as simple as possible without sacrificing integrity.

One methodology, that I have previously discussed is book value.  CNO’s BV is $18 (ish) and we know that profitable insurance companies normally trade in a 1.0 to 2.0 multiple of their book value.  With no further analysis, we could conclude that this places a fair value on CNO between $36 and $72.  Critics (and especially shorts) will argue that a stock priced below its book value is a leading indicator that the book value will decrease in the near future.  That is a valid point.  If CNO was appropriately valued now at $3(ish), that would mean that we are expecting the book value to decline to a value of between $1.5 and $3.00 – a complete eradication of its assets.  Not likely in my book.  Not likely at all.  So let’s pull a trick out of Warren Buffet’s book and give ourselves a buffer to account for any errors in our analysis.  Let’s say the book value is 100% overvalued and the actual book value (accouting for the expectation that CNO BV will drop in the future) is $9.  This would yield a fair value price for CNO between $9 and $18.  I’ll split the difference and say $13.50.

Next analysis will use the company’s earnings.  As shareholders we own a certain percentage of the company’s earnings.  We have contractually agreed that we will not ask to take those earnings and instead will allow the company to use those earnings (that are in fact ours) to continue to run and grow the company.  Evaluating a fair value based on earnings can be complicated and can often become so overloaded with assumptions, equations and pricing models that the resultant number is insignificant (BTW, i am of the opinion that these complex models used by the ‘big boys’ result in dartboard like results)   I will keep this simple.  

CNO shareholders are entitled to CNO’s future earnings.  What value do we place on this right?  To calculate this, we need to estimate what we expect these earnings to be and also put a “price” on the fact that our money isn’t being used elsewhere (called a discount rate – essentially what you think your money could be earning for you if you had it vice the company)  Here are the earnings/share for CNO for the last 5 years:

2004, $1.51

2005, $1.76

2006, $1.20

2007, -$0.26

2008 , $.085

This is an average of $1.0 per year.  Let us assume that CNO continues to operate at this average in the future - not getting better and not getting worse.  Wait. .  .let’s use our “buffer” here and assume that CNO will operate at exactly HALF of its prior five year performance.  How much money should I pay to have the right for fifty cents each year indefinitely?

To answer this question I have to arrive at a discount rate.  I will use 8% which is a fairly commonly accepted number.  Meaning that if I was given the fifty cents each year, I think I could earn 8% on it each year on average.

Using a fairly simple excel spreadsheet to calculate the amount of money that I should pay for this right, I arrive at $6.25.  Remember, this assumes that CNO operates indefinitely at a profit of 50% of its last five years of operation.  What if they operated at their average (no growth) just a steady stream of income that averages to be $1/share per year.  The value of this proposition is $12.50.  So that I do not erase the “buffer” that I installed moments ago, I will split the difference between these two values and arrive at a fair value of $9.38.

Further attempting to fare through assumptions and errors, I average the book value valuation and the earnings valuation for a fair value of $11.44.

I think it is prudent to mention that these valuations were performed with the most conservative and bleek assumptions so to provide the largest margin of error, account for the foreseeable downside and still execute a successful investment.

Based on this evaluation, I recommend a target price for CNO of $11.44.

Exit strategy is a very personal decision, ordinarily I use 10%, put these are not ordinary times and the volatility is such that I will punch out at a 25% loss on CNO or $2.55. 

Hope you found this analysis useful. 

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“All-in” on Conseco (CNO)

Picked up CNO this morning at $3.40.  Jumped the gun a bit, because I didn’t expect the morning gap to fill.  It did and then some.  And as I write this, CNO is stagnating at $3.17.  I certainly didn’t start this position from the strongest entry, but the details of trading are humbling . . . the results are exhilarating.

My negative entry point is not too difficult to deal with when I consider that I just purchased $6.60 for $3.40.  (CNO holds $6.60/share in cash) PLUS an opportunity for growth.  At the most NPV conservative valuation, this cash alone is worth $10/share.

In the time it took me to write this paragraph, CNO is down to $3.04.  This stock moves fast.  I stick with my prediction that regardless of the rough seas that may lay ahead in the seas of volatility, CNO will see $5.00 soon.

BTW, breaking news . . home prices declining in 9 of 10 cities and is putting downward pressure on the market today.  Gotta love mainstream media and the skiddish investors.  Really?  Housing prices are declining?  Wow, I didn’t realize that because I’ve had my head in this ditch here for the last six months.  Remember, there are two separate issues with the housing market – housing sales and home prices.  The former is important for the general health of the market and latter is not.  Quite a lengthy discussion there, but it is true. 

See my previous post for more analysis of CNO.

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Next up: Conseco (CNO)

Okay, after a 53%, three day gain in GNW, I have decided to bankroll the profits in Conseco (CNO).  At the opening bell tomorrow morning, I will be buying $1500 of CNO.  For those of you who are new here, that may seem like a small amount for a guy that claims to be a talented investor.  This site is tracking an experiment, not my net worth or my personal savings/investments.

Let me bring you up to speed with the Reader’s Digest version of my experiment.  I believe that a man with no starting capital, no connections, no great gadget and no new greater technological breakthrough can earn $1 million dollars in less than three years through creativity, hustle and determination.  That is literally from $0 to $1 million dollars in 36 months.

The experiment is almost one month old and has a net proftof $1626, three projects in progress and a man that grows more determined with each passing day.  Keep in mind that is starting with $0 (not a penny of starting capital)

On to the matter at hand, Conseco (CNO).  Let me start with the bad news.  Conseco bottomed at $0.26 on March 10th and closed yesterday at $3.25.  That 1150% gain is in the rearview mirror and is gone. 

Here is more bad news.  CNO has been on a steady decline for three years.  Make no mistake, CNO has no provided its shareholders value in quite some time.  This graph speaks for itself.

This graph paints a picture that is undeniably bleek.  Before we put a penny into this stock, we need to recognize that Conseco has rarely been a “wise” investment.

So what about the good news?  There’s plenty to go around but let me hit the highlights.

1. CNO trades at 30% of its book value.  The market currently assesses (incorrectly) that CNOis worthmore dead than alive.  A company that trades at less than its book value is a bad investment, if and only if, you believe that the company will continue to destroy capital and will eventually run itself into bankruptcy.  I discussed this at length last week with Genworth (GNW) and I received all kinds of criticism (mostly from GNW shorts) that my analysis is too simplistic regarding this topic.  I disagree.   Complex analysis often looks compelling because. . . it’s complex. 

A stock that trades at less than its book value assumes that the rate of return of the company’s assets is negative and will continue to be until the book value is reduced to its share price.  For many reasons, CNO does not fall into this category.    Let us continue. .

2.  CNO’s institutional ownership is 92% and insider ownership is at 8%.  Following the big money is not alwasythe right answer.  Sometimes it is.  When a stock is trading under $5 with only 10 million shares available to the common trader  AND current volume at 5x normal.  It is.  Follow CNO to AT LEAST above $5.  When CNO gets above $5 (which it will, this week), the number of mutual funds that can now buy CNO increases tenfold.    The big boys know this and they will be the ones that take it above $5 so they can back up the truck.  It is only a matter of going along for the ride at this point.

3. CNO is well positioned to significantly weather this economic storm.  What does it take to weather an economic recession?  Cash.  With at $1.2 billion dollars in cash and a $1.8 billion credit line.  CNO is hunkered down securely so even if the economy hasn’t bottomed, CNO will be just fine.

4. Not in where we stand but where we are headed.  A company’s stock price is a function of the assessed profit growth not the actual profit.  One year ago today, CNOwas trading at $10.48 and reported earning $0.04 per share for the first quarter of 2008.  Today, we see $0.17 per share for the first quarter of 2009 with CNO trading at $3.50.  All things being equal (which is a bit of a generalization which is why we will give ourselves a buffer here), CNO must trade for at least $10.48.  Despite how difficult it may be to see why, it is true.  If CNOlost money in either of these quarters the analysis breaks down significantly and we must resort to speculative valuations, but withprofits in both quarters, logic dictates that CNO must trend to at least $10.48.  If you are interested in seeing a NPV analysis to prove this, shoot me an email on the side and I’d be happy to provide.

5.  Cash is king.  There is enough meat on this bone for a lengthy discussion but for the time being, I will keep this simple.  1.2Billion / 180 million = $6.60.  CNO has $6.60 in CASH per share and trades AT HALF that value.  Do you realize how rare that is?  To trade at less than BV is one thing, but to trade at less than cash/share is a whole other animal. . . a dinosaur to be specific. . . because it can’t be found.  Betting on CNO to remain less than $6.60 is a losing proposition.

I will continue my coverage of CNO throughout the week. 

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