What Rate of Return Can You Reasonably Expect by Peter Bernstein

Latest FAJ looks at retirement issues on its 70th anniversary.

Peter Bernstein took a look at stock and bond returns over a two hundred year period to try and figure out whether there was a "basic return" that could be expected for each asset class. He normalized his analysis to take account of starting and ending multiples and yields to ascertain what the return was over those periods.

His basic conclusion was that stock returns exhibited a mean nominal basic return of 9.6% with a standard deviation of 1.6% and some mean reversion elements.

With regard to bonds, the outcome was much less conclusive.  The mean nominal basic bond return came to 4.9% with a standard deviation of 2.3%, but there a wide band of uncertainty associated with the data and in fact he concluded we could have no confidence in expecting the nominal basic return because inflation would surprisingly pop up (investors were slow to respond to changing inflation environments) and there was no pattern to the returns (little credence can be attached to what anybody has to say about what the real what the real long term rate of interest should be, has been, or will be in the future over the long run). About the only thing we can say for bond holders is they can make con judgments about future returns beyond the duration of the particular instrument they happen to hold at any given moment.


Bottom-line: long run equity returns were more predictable than long run bond returns (with even greater application for real returns). With equities one can at least conjecture whether the market is high or low (based on recent returns), with the bond market there is no such opportunity.

He concludes that stocks are fundamentally less risky than bonds, not only because their returns have been consistently higher than those of bonds over the long run but also because less uncertainty surrounds the long term return investors can expect on the basis of past history.

RF Micro Devices (RFMD) in my sights

This company has been a perennial underperformer and therefore a disappointment to me. The stock has rallied off its low of $0.70 on December 12th to around $2.85 presently (300%+ gain). Balance sheet concerns (the company has levered up in recent years backing off its debt against a large cash stash...garnered when it went public and not from operating profits) and evaporating market demand for its products undercut the company, leading to the stock falling from a high of $7.46 in October 2007. Technically, the current level ($2.85-$3.15) forms a resistance barrier, with the next resistance barrier around $4. Personally, I think there are assets here that are worth more than $3, but I am not sure whether the company will ever get back in a position where it can demonstrate that fact. To their credit management has been chopping into the cost structure (belatedly...boy is it frustrating to watch tech companies wallow in a state of cost structure denial, just because they have the cash to do so) and is putting the company in a position to take advantage of any improvement in its markets. I'm just not sure those improvements are going to come along any time soon. Nokia might be interested, but they've got their hands full with their own problems right now. Apparently RFMD have developed a new process for improving the efficiency of producing LED bulbs (certainly sounds promising, but still at least two years away from commercialization, and it is unclear whether they own the intellectual property on it). It seems that just as you are about to pull the trigger and sell something, some new piece of "exciting" information crops up to defer the decision (hope springs eternal). Stock is undervalued relative to peer SWKS, but not so against other peer also-rans TQNT and ANAD. It has the cash to survive and is getting its internal house in order. Much will depend upon the external opportunities in extending its RF chips beyond handhelds and if the China hope is overdone, and whether there is any value in the LED opportunity.

Disclaimer: At the time of posting, I had a professional position in this stock but sold it before the end of the trading day.

Cheesecake (CAKE) in a pickle

Actually, Cheesecake (CAKE) isn't in a pickle so much as I am in a pickle about CAKE. Sentiment among the analyst set has been divided (good article on Seeking Alpha describing the changes in the last month http://seekingalpha.com/article/132847-cheesecake-factory-why-the-moving-price-target) about the stock, but the stock's price action has been one way in the last month or so (up from a low of $6.84 on March 9th to a high of $18.11 on Friday). After having sat on this one for more than 3 years (enduring a significant deterioration in the firm's performance) I decided it was time to exit after such a big move. Here is my pickle. When I looked at the earnings power of the company, it pretty much struggled to produce much more than $1 in EPS even in its best times over the last five years (as such if I normalize long term earnings power around $1 and give it a normalized multiple of 15, that equates to a $15 target price...they're expecting EPS of $0.64 in 2009 and $0.74 in 2010...those numbers will obviously go up). Add to that the fact that they are only adding one more restaurant this year, the Discretionary sector has been on an absolute tear in the SMID cap space this year, and all of this in the face of rising unemployment, and I am somewhaat sanguine about the company's prospects over the next year. That having been said, the stock is trading at a reasonable discount on a P/Sales basis to its better peers (YUM) and I believe its new menus (lower portions = lower costs) along with the chance for a resumption to adding new restaurants at some point in the future (obviously not at the same rate as in the past, but still), point to a return to growth and an improvement in operating margins. All of which could lead to a re-rating of the stock on a P/Sales basis, and a price somewhere in the range of $25-$30 over the next 3-5 years. Obviously a lot needs to go right for that to happen (and a lot has already been factored in just recently...just as a lot of bad things were factored in on the way down), but that is the pickle I am in. And that pickle is something called regret, and regret is something that weighs heavily on most investors psychological disposition.

P.S. From Wikipedia. Regret (often also called opportunity loss) is defined as the difference between one's actual payoff and the payoff in a better position that he could have got if a different course of action had been chosen.

P.P.S. I also didn't like the increase in the firm's financial risk as it levered up to buyback stock over the past three years (although it appears they have gone back to managing this business more conservatively by paying back some debt and making their expense structure more competitive...it is amazing what can happen when you get rid of the investment bankers).

Disclaimer: No position in this stock personally or professionally.