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Halloween aside, October is not a scary month

Tuesday, October 14th, 2014

Here we are in October and the market is up and down. It feels kind of scary, a little scarier than Halloween.

Is October really a bad month? If you asked many people they would say, “Oh, yes, October is a terrible month for the market. We do know that the big market crash happened in October 1929 and October 1987, and we started feel some pain in October 2008.”

But what people don’t know in looking at history, October is the sixth-best month of the year when it comes to stock gains. I’m sure many of you have already forgotten that the market climbed 11 percent in October 2011.

People and investors love to find trends, but if you look at the stock market for the past 50 years, which would be 12,500 trading days, one will find stock movements are statistically random. This is why the best way to invest is to buy fundamentally strong companies and good values and don’t try to predict market movements.

I received an email from Kevin, who wanted to know about more about Kinder Morgan Energy Partners (NYSE: KMP), which he is thinking about selling to invest in Valero(NYSE: VLO).

Kinder Morgan operates as a pipeline transportation and energy storage company in North America. It transfers gasoline, diesel fuel and natural gas liquids to various markets through roughly 8,600 miles of pipelines.

I was surprised to see how well the stock has held up, with a 52-week high of $99 a share and trading around $90 a share. Many other energy-related stocks have fallen from 20 percent to 50 percent due to the recent decline in oil prices.

I’m even more surprised the stock has not fallen because of how richly valued this company is. It has a current price earnings ratio of 37.1, well ahead of the industry at 21.2. Price to sales checks in at 3.1, three times the industry average of 1.0.

Price to book value is also expensive at 5.2 when compared to the industry average of 3.2. Last, price to cash flow is 15.9, also more expensive than the industry at 9.4.

Sales have grown at a rate of 29.7 percent year over year, very close to the industry growth of 29.2 percent. Earnings-per-share year over year for the past 12 months does not look as good, with earnings falling 21.9 percent, compared with industry growth of 15.7 percent.

I looked at the income statement and discovered in the previous 12 months the company had a gain on sale of assets of $558 million, which created a decline in earnings from one year to the next.

As I always say, an investor must dig deeper to find the truth if numbers don’t look good. I always point out that the gain or loss on the sale of assets is not from operations and the investor should be aware of these numbers.

The balance sheet of Kinder Morgan is on the weak side, the company has a current ratio of 0.5, half the industry average of 1.0. This worries me somewhat since the company could have a liquidity problem and paying off their short-term liabilities.

Looking at the debt to equity was no help as I saw a debt to equity of 128 for Kinder Morgan, which exceeded the industry average of 97. Combine these two factors and I think this company could have difficulties down the road.

The return on equity over the past 12 months was not that impressive for the company at 8.1 percent, missing the industry average of 10.7 percent. However, the net profit margin does look very attractive at 20.9 percent, well above the industry average of 4.7 percent.

I also noticed the inventory turnover over the past 12 months was 17 times, compared with the industry at 20.2 times. It could be OK because this company uses pipelines to transfer its inventory and may not compare favorably to the industry average.

If I were to own this company, I would want to understand why the inventory turnover is less for the company than the industry.

Looking forward, the mean of 15 analysts going out to December 2015 is looking for earnings of $2.84. Investors and some media pundits talk about how expensive the market is in relation to the S&P 500.

The S&P 500 trades around 17 times earnings, while this company trades at 32 times forward earnings. So if someone is concerned about the market valuation, then Kinder Morgan should not be in that investors portfolio.

Kevin asked about selling Kinder Morgan to purchase Valero. I don’t have enough space to do a full evaluation of Valero, but I will point out that the stock of Valero trades at half the price of Kinder Morgan. However, the earnings are twice as much for Valero, compared to Kinder Morgan.

Put another way, investors are paying 7.4 times forward earnings for Valero, compared to 32 times forward earnings for Kinder Morgan. As a value investor, my opinion puts Valero as the clear winner. Not to say that Kinder Morgan won’t continue to go up, but what is important to understand is the risk of high-valued stocks.

Do you have a question or a company you would like us to take a look at?
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