The following is an analysis of the most current portfolio of Carl Icahn. This analysis will use a system that I designed that is based on the ratio that Warren Buffet released to the public in 1986, which he coined “Owner Earnings.” For those new to this type of analysis, I would recommend reading an introduction to my system here.
My goal is ultimately to analyze the portfolios of each guru highlighted here on GuruFocus, and then to subsequently re-analyze them every quarter when possible as changes are made. My purpose in writing these articles is to show the power of Buffett’s ratio in analyzing stocks, ETFs, mutual funds and individual portfolios. If one can fill their portfolios with companies that score high using my system and avoid those which fail, one should be able to increase the probability of becoming a successful investor, in my opinion.
Carl Icahn is an activist investor. He takes minority stakes in public companies and typically pushes for change. He invests with three investment vehicles: the $7 billion hedge fund, Icahn Partners; American Real Estate Partners (AREP), a publicly traded private equity firm; and ICAHN MANAGEMENT LP, a $2 billion hedge fund. GuruFocus tracks the third portfolio, which covers all the stocks owned by Icahn Partners.
Icahn has a personal wealth of $17 billion. He buys beaten-down assets that nobody else wants, usually out of bankruptcy, then fixes them up and sells them when they are back in favor. Regarding his style, explains Icahn: "The consensus thinking is generally wrong. If you go with a trend, the momentum always falls apart on you. So I buy companies that are not glamorous and usually out of favor. It is even better if the whole industry is out of favor."
Since Icahn likes to buy companies that are out of favor, let’s analyze how such a portfolio ranks with our system:
It is clear from the portfolio above that Icahn is not a big fan of owner earnings and does not invest like Buffett. He does though come up with some winners and has a nasty habit of making a ton of money in the majority of the stocks he buys. So he is someone that I have studied intensely, but have had little success in figuring out a pattern in how he buys stocks. For example, American Rail Cars (NASDAQ:ARII) is a dog with fleas with a non-existent FROIC and terrible CapFlow numbers and a price to owner earnings through the roof. I would consider that as a potential short because its numbers are so bad. But its numbers are not as bad as a stock Icahn recently sold (thank God!) called Chesapeake Energy (CHK). This is one of the worst owner earnings records of any company I have ever seen. Here is its history for everyone to see what I mean:
Chesapeake Energy from 1993-2011 had a cumulative owners earnings of -$52.03 per share. Cumulative owner earnings (COE) is a ratio I created to replace book value per share. What it does is cumulatively add all previous years' owner earnings numbers per share of a company together and then come out with a final dollar figure that you can compare to the stock price. A company that trades at or below its COE is usually one that is very oversold. COE is more powerful than book value per share because with book value one can never really know what the assets on the balance sheet are worth.
John Paulson and Bruce Berkowitz found that out last year when they loaded up on financials. COE, on the other hand, adds up all the owner earnings that a company made over its history. I have data on COE going back to 1969, but because this information is not readily available and even took me years to gather, I have decided not to include it as part of the system I am using to analyze stocks here at GuruFocus.
In getting back to Icahn’s current portfolio we see that out of the seventeen non-financial stock holdings, he has four (24%) coming in with a price to owner earnings of less than 15, and 11 (65%) coming in with a CapFlow of less than 50%. In the FROIC department, he has underperformed with only two (11%) of his stocks coming in at 15% or more. So it does not look good for Icahn when our time to give him a final score comes around.
Nevertheless, he sold Motorola Mobility Holdings (NYSE:MMI) to Google (GOOG) even though they only have an estimated FROIC of just 9.19%. This was a serious mistake on Google’s part because it gave Android software away for free to other cell phone makers and now they are going to compete directly with them again, even though they had a terrible experience doing so with their Nexus phone. If it wasn’t for its total dominance in search, Google would be bankrupt if they had to rely on their other businesses. Google shareholders are lucky that the CEO of Groupon (GRPN) turned them down, otherwise they would have entered as Jim Cramer says, “the house of pain,” as Groupon soon will. Groupon’s 2010 owner earnings came in at $-187.76 million and the following is an example of what can happen to you when you use free cash flow instead of owner earnings.
In 2010, Morningstar has GroupOn’s free cash flow at more than $71 million, but what you see when you use Buffett’s ratio is that the company had negative owner earnings for both 2010 and 2011. This is proof of the differences that you can see loud and clear on how companies can manipulate their results to look better than what they really are. Value Line does not pull any punches and that’s why Buffett loves using their service, as do I.
Icahn also likes his dividends. Vector Group (NYSE:VGR) paid out a $1.47 dividend per share, even though their earnings were only $0.68 cents a share. That means its payout ratio was 216% in 2010. This would not be serious if it was just a one-time event, but here are Vector’s payout ratios from 2003-2010 (payout ratio = dividend/earnings):
2003 = -385%
2004 = 1,557%
2005 = 302%
2006 = 170%
2007 = 169%
2008 = 192%
2009 = 333%
2010 = 216%
So as you can see, the company is a payout ratio train wreck and has earned $3.43 in EPS from 2003-2010 and paid out $9.96 in dividends. You have to ask yourself, how can a company with such a terrible payout record stay in business? This should also be a lesson for those of you who love those 9% dividends, because if the company does not have a payout ratio of 100% or less then its earnings don’t cover the dividend.
The way companies like Vector Group are able to stay in business is because they either issue new shares and get the money to pay the dividend that way (utilities run for decades using this strategy) or they just borrow money to pay the dividends that way. So those of you who are “Gotta Love That Dividend Yield” investors, always make sure that your payout ratio is below 100%, otherwise they are borrowing money to pay you that high dividend or diluting your ownership percentage. Icahn seems to have changed his mind on this stock very quickly and you can see how by using GuruFocus’ amazing “holdings buy/sell screener.” Just type "VGR" in the "Search Guru Trade" box on the top of each page and this is what you will see:
Once you click on that power link that GuruFocus provides, you will find that Icahn bought 14.77 million shares of Vector Group during the September 2011 quarter and then sold 73.2% of those shares on November 22. You can’t get that kind of data that fast anywhere on your own without putting in some serious time. So there is just one reason for becoming a Premium Member of GuruFocus.
At the bottom of the list I saw a company named Enzon (ENZN) and I thought for a split second that it said Enron. Before we go to Enron, the pharmaceutical company Enzon that Icahn holds is not doing well and has lost money in six of the last seven years, and if it wasn’t for the strong depreciation they had, they would have gone negative owner earnings like they did in 2010 and are also expected to do in 2011 and 2012.
So why is Icahn in a stock that is going to lay off half of its workers? Basically because he sees things that no one else sees. I have studied him for years and don’t have a clue what he looks at that has successfully made him worth $17 billion. We are here though to rank gurus based on their owner earnings performance and unfortunately for Icahn he has made it to the bottom of our list, tied with Gates/Larson:
Since I mentioned Enron I thought that I would end with a little treat for everyone: Here is the historical data for Enron from 1991-2001:
Enron scored a zero for every year as its CapFlow, FROIC and price to owner earnings were just terrible. I remember a doctor friend calling me up telling me what he should do in 2001 about Enron, as his stockbroker was pushing him hard to buy it. I told him to run as fast as he could away from the stock as well as the stockbroker for suggesting it. After Enron imploded he left that broker without being “broke’r” as he took my advice.
I left the common shares in the table above so you could see how Wall Street was pushing the hell out of that stock back then as Enron kept issuing more and more stock to meet the demand of the cold callers (as they need more stock to sell). How someone can recommend a stock with a -908 price to owner earnings ratio amazes me. If anyone is using a full-service stockbroker, or owns a mutual fund or ETF, run the managers portfolio through this system and rank each of them like I do the gurus. If their stock picks keep coming up zeros then you need to look elsewhere, as you are probably going down the wrong path. If they ask you why you are leaving, just tell them that Warren Buffett’s ratio gave them a bad final score. Nobody will ever argue with Warren Buffett’s abilities, so you are good to go.
Disclaimer: Always remember that these are the results of our research based on the methodology that I have outlined above and in other articles previously published. This research is provided as an educational tool and should not be considered investment advice, but just the results of our research. There are many ways to analyze a stock and you should never blindly follow anyone’s work without doing your own due diligence or by seeking the help of an investment adviser, if you so need one. As Registered Investment Advisors, we see it as our responsibility to advise the following: We take our research seriously, we do our best to get it right, and we “eat our own cooking,” but we could be wrong. Please note, investments involve risk and unless otherwise stated, are not guaranteed. Past performance cannot be used as an indicator to determine future results. Strategies mentioned may not be suitable for everyone. We do not know your personal financial situation, so the information contained in this communiqué represents the opinions of Peter “Mycroft” Psaras, and should not be construed as personalized investment advice. Information expressed does not take into account your specific situation or objectives, and is not intended as recommendations appropriate for you. Before acting on any information mentioned, it is recommended to seek advice from a qualified tax or investment adviser to determine whether it is suitable for your specific situation.
About the author:
From his work on free cash flow in the investment process, Mycroft has now decided to bring his theories to the field of money management as well as work as an independent consultant for Hedge Funds, Pension Funds and ...More Institutions in general. His dream is to someday soon open a mutual fund where he can help as many people as he can benefit from what he has learned over the years.