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We're coming up on the last few weeks of earnings season... and one of my favorite parts.
That's because the absolute masters - the wizards, the "special forces" of money, the private equity pros - are reporting their earnings and giving their must-have take on the state of the markets and the global economy.
Why is this a can't-miss call?
These folks make serious money. Some of them won't get out of bed unless they can lock in a market-crushing 15% or 20% to do it.
And if you go and do likewise, if you position your money and align your investing with the private equity giants, you can crush the market, too.
Because believe me, ho-hum indexing returns won't cut the mustard for a comfortable retirement.
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Here's What Private Equity's "Big Four" Revealed
The aforementioned Apollo Global, KKR, as well as The Carlyle Group LP (Nasdaq: CG), and The Blackstone Group LP (NYSE: BX), are on the ground every day buying and selling companies, managing assets and streams of cash flow, all with the ultimate goal of handing unreasonably high returns for their investors.
They see, live, and breathe the "daily grind" of economic activity - and how that grind impacts different businesses, market sectors, and of course, that all-important alpha.
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Apollo Global runs one of my favorite earnings calls.
Chair, CEO, and Director Leon Black goes all the way back to the freewheeling heyday of Drexel Burnham Lambert and Michael Milken, so like State Farm Insurance, he's seen a thing or two.
I find it fascinating that pretty much every quarter he gives away the keys to the kingdom and lays it all out there for anyone who's listening or reading transcripts to jump on.
He addressed the success of Apollo's private equity funds, telling call participants that "the flagship private equity funds we managed have generated 39% growth and 25% net internal rate of return (IRR) since Apollo's inception in 1990. We're sometimes asked if our success in private equity, which now stands over 27 years, is sustainable and repeatable, and we believe it is. I'm pleased to note that our current flagship private equity fund, Fund VIII, has generated growth and net IRR's of 33% and 23% respectively through December 31, 2017."
More importantly, Black then proceeds to tell us how Apollo has earned those outstanding returns over an extended period of time.
He couldn't have helped us out any better if he were writing a handbook!
Black went on to tell analysts, "It's no secret we're operating in a higher price environment, and so finding what we believe are attractive investment opportunities at discounted valuation is a formidable path. However, we strive to meet this challenge by remaining committed to our value orientation and adhering to a consistent willingness to embrace complexity. The most telling example of this is the fact that the average creation multiple of Fund VIII portfolio companies is approximately six times enterprise value to adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA), nearly five multiples below comparable industry averages."
Mr. Black also dished up some essential market information on the call, saying, "While we intend to remain active investors in the year ahead, we believe our opportunistic funds are entering another harvesting cycle led by Fund VIII. In 2017, we saw our volume of realization activity double year over year from $5 billion to more than $10 billion. Given the continued seasoning of the portfolios we manage, if capital markets remain strong, we expect the pace of realizations to increase going forward."
No prediction. No market timing. No sunny forecast. Just a flat-out statement that asset prices are high and, in Apollo's view, it's a pretty good time to sell some stuff and take some money off the table.
Why scan charts and price action for "sell signals" when a guy with a personal net worth of $6.9 billion is more or less telling us in plain English to sell? Think a pro like Black will settle for a loss or anything less than top dollar?
I don't think so, either.
This Suggests It Might Be Time to Sell Holdings Hitting Peak Value
Bill Janetschek, the CFO of KKR, also had some comments on exits, telling listeners that "Shifting to monetizations, we continue to see a sizable level of exit activity across our private equity (PE) business. For the quarter, we exited our investments in Visma and Gland Pharma Ltd. and completed a number of secondaries, including our final exit from U.S. Foods Holding Corp. (NYSE: USFD), resulting in over $300 billion in cash carry. On a blended basis, the PE exits were done at 2.3 times our cost." They bought low and are finding that, in many cases, it's a good time to sell high and rake in the profits.
KKR CEO Scott Nuttall also relayed some information that can dramatically improve our investing results.
He said on his call that "While we believe ending net investment (ENI) is a fairly volatile metric and not aligned with how we run our business, we don't get paid for marks. We get paid on cash outcomes. We do believe it is important to look at how our investments are performing and how our mark-to-market book value per share is progressing."
That's significant; in fact, it's way more important than you may realize.
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Earnings figures can be manipulated. Profits can be squandered by management's bad decisions. Costs can grow faster than revenue. If you want to know how fast - or slow - a company is really growing, then look at how fast the net worth - a.k.a. "book value" - of the company is growing.
A high growth rate means that management is growing earnings at a reasonable rate and, crucially, reinvesting the free cash flows at high returns.
Chair and CEO Steven Schwarzman of Blackstone was very upbeat about the current economic situation saying, "I remain quite optimistic about the forward outlook. As I stated on this call last year, some of the major changes that have been underway in the United States, such as tax reform, as well as the efforts to remove or reduce regulatory barriers, were designed to accelerate GDP growth and extend the business cycle. We're certainly seeing that today, and I believe that will stay the case for some time. These changes are also improving a relative attractiveness of the U.S. market, which I believe will drive greater foreign investment, something that's a little overlooked."
The upshot: Like its competitors, Blackstone was taking advantage of that bright outlook to sell assets it thought had reached full value.
According to COO Tony James, "Finally, on realizations, which were $19 billion in the fourth quarter and $55 billion for the full year, the breadth of our sales activity was immense, with 240 discreet realization events in 2017 across the firm and around the world. These included the largest private sale in the Firm's history, Logicor, plus multiple other private sales. We also completed 37 equity transactions, totaling $12.5 billion in the public markets, including the continued sell down of our stake in our highly successful investment in Hilton Worldwide Holdings (NYSE: HLT)."
Schwarzman and James also talked a lot about three areas that they think will drive fund returns and profits for Blackstone over the next several years.
They have been raising funds and deploying capital in real estate, infrastructure, and private credit as they expect the returns, and, as a result, the fees they earn by providing those returns are quite high.
That's not something we have to worry about.
Here's Our One Advantage Here
You and I can exploit the same opportunities as individual investors and not have to pay the high incentive fees that Blackstone's investors pay.
We can find companies specializing in these three high-growth sectors. And, if we're smart about it, do so at unreasonably cheap prices that allow us to lock in very high, long-term returns, just like the pros.
Carlyle Group was also doing quite a bit of selling, as markets rose with $26 billion in realized proceeds, their sixth consecutive year with more than $25 billion.
Kewsong Lee, one of the new co-CEOs at Carlyle, addressed market conditions on the call, saying, "As we sit here today, the investment environment is challenging, with market valuation levels recently at all-time highs, increasing volatility that we are all witnessing in real time and the potential for upward movement in interest rates. It will be difficult for us to generate the same level of appreciation across our platform in 2018 as we delivered in 2017."
Lee added, "We currently expect, and are planning for, the investment environment to remain very competitive with high asset prices."
So what are these wizards of finance telling us regular folks about the economy and the market?
First, the economy is pretty good and should get a boost from tax reform. We've heard this consistently, in all domains of the finance universe, and this should only strengthen that confirmation.
It means happy economic conditions are leading to high asset valuations, and it just might be a good time to consider selling some companies and assets that have reached peak valuations.
It's not that there are no opportunities to deploy capital - these guys are saying there definitely are opportunities. The thing is, right now, the price-to-value equation is critically important: Overpaying for assets or earnings streams in a strong economy that is driving valuations higher can be a costly mistake.
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About the Author
Tim Melvin is an unlikely investment expert by any measure. Raised in the "projects" of Baltimore by a single mother, he never attended college and started out as a door-to-door vacuum salesman. But he knew the real money was in the stock market, so he set sights on investing - and by sheer force of determination, he eventually became a financial advisor to millionaires. Today, after 30 years of managing money for some of the wealthiest people in the world, he draws on his experience to help investors find "unreasonably good" bargain stocks, multiply profits, and build their nest eggs. Tim tirelessly works to find overlooked "hidden gems" in the stock market, drawing on the research of legendary investors like Benjamin Graham, Walter Schloss, and Marty Whitman. He has written and lectured extensively on the markets, with work appearing on Benzinga, Real Money, Daily Speculations, and more. He has published several books in the "Little Book of" Investment Series and a "Junior Chamber Course" geared towards young adults that teaches Graham's principles and techniques to a new generation of investors. Today, he serves as the Special Situations Strategist at Money Morning and the editor of Peak Yield Investor.