The post-hurricane portfolio

Lots of investors are wondering why they didn’t have the foresight to buy Home Depot last week, prior to the arrival of hurricane/tropical storm Sandy, which just devastated the northeast. After all, the forecast was pretty clear that the storm would hit exactly where it did. But that foresight was most likely missing during prior storms also. So is it worth it to buy stocks after the storm that could benefit from the clean-up? We looked at ten stocks that could benefit. This sample “portfolio” was not put together or engineered to have extraordinary out performance using 20/20 hindsight. We simply found ten companies that seemed like they would benefit from the aftermath of a storm, and then tested the results.

The sample portfolio is made up the following companies:

1. American Woodmark – AMWD – kitchen cabinets and vanities.
2. Eagle Materials – EXP – wallboard
3. Masco – MAS – home improvement and building products
4. Home Depot – HD – home improvement retailer
5. Louisiana Pacific – LPX – wood products
6. Waste Management – WM – solid waste disposal
7. Exxon – XOM – oil
8. Chicago Bridge and Iron – CBI – engineering, procurement and construction company
9. Fluor – FLR – engineering and project management services
10. CAT – earth moving equipment

Now the above list is not the best possible list of stocks that might benefit from a hurricane that creates major damage. But I tried to put together a somewhat diversified group of companies that might benefit in some manner. And also, this sample portfolio was put together on short notice (and I am NOT recommending this portfolio, this is for learning purposes only).

Below is the sample of hurricanes that I looked at and the damage estimates (http://www.wunderground.com/hurricane/damage.asp)

1. Isabel – 9/18/03 – $6b in damages – came ashore in NC
2. Charley – 8/13/04 – $16b in damages – case ashore in Florida (this storm was followed by Frances, Ivan and Jeane. Combined, those three additional storms created $38b in damages).
3. Katrina – 8/25/05 – $105b in damages – came ashore in Florida but did most of its damage when it got to Louisiana on 8/29/05
4. Ike – 9/13/08 –  $28b in damages – Texas
5. Irene – 8/27/11 – $16b in damages –  NC

To measure the performance of the stocks post hurricane, I am using the first Monday on or after the storm as the purchase date, and then measuring total return results (via Yahoo Finance) 4, 8, 13, 26 and 39 weeks out.

Let’s look at Home Depot. After all, if there ever was a stock that should benefit from a hurricane it would be Home Depot.

STORM WEEKS HD SPY DIFF
ISABEL 4                 9                 1                 8
ISABEL 8                 9                 2                 7
ISABEL 13                 7                 6                 1
ISABEL 26               11                 8                 3
ISABEL 39                 8               11               (3)
CHARLEY 4                 6                 3                 3
CHARLEY 8               10                 1                 9
CHARLEY 13               18                 7               11
CHARLEY 26               16               10                 6
CHARLEY 39               10               10                –
KATRINA 4               (5)                 1               (6)
KATRINA 8                –               (2)                 2
KATRINA 13                 4                 4                –
KATRINA 26                 5                 6               (1)
KATRINA 39               (5)                 7            (12)
IKE 4            (26)            (25)               (1)
IKE 8            (25)            (30)                 5
IKE 13            (11)            (28)               17
IKE 26            (17)            (37)               20
IKE 39            (11)            (24)               13
IRENE 4                 2               (3)                 5
IRENE 8               12               10                 2
IRENE 13               13               (1)               14
IRENE 26               48               18               30
IRENE 39               52               11               41

It appears buying Home Depot the Monday after the storm, based on this limited sample, did outperform the SPY during most of the above time periods. Only after Katrina, was that not true.

Below are the results of taking the average return of the 10 stocks in our sample portfolio versus the SPY:

STORM WEEKS AVERAGE SPY DIFF
ISABEL 4                      4                 1                 3
ISABEL 8                      6                 2                 4
ISABEL 13                    11                 6                 5
ISABEL 26                    19                 8               11
ISABEL 39                    23               11               12
CHARLEY 4                      6                 3                 3
CHARLEY 8                      7                 1                 6
CHARLEY 13                    14                 7                 7
CHARLEY 26                    26               10               16
CHARLEY 39                    19               10                 9
KATRINA 4                      2                 1                 1
KATRINA 8                    (7)               (2)               (5)
KATRINA 13                      1                 4               (3)
KATRINA 26                    13                 6                 7
KATRINA 39                    14                 7                 7
IKE 4                 (35)            (25)            (10)
IKE 8                 (42)            (30)            (12)
IKE 13                 (34)            (28)               (6)
IKE 26                 (45)            (37)               (8)
IKE 39                 (30)            (24)               (6)
IRENE 4                    (8)               (3)               (5)
IRENE 8                    17               10                 7
IRENE 13                      2               (1)                 3
IRENE 26                    32               18               14
IRENE 39                    26               11               15

Except for Ike, the average portfolio seems to have outperformed the SPY during the majority of the time periods. As far as the under performance after Ike, that probably has to due with the fact that Ike hit the USA on 9/13/08, when the market was clobbered as much as the areas that Ike hit. Building and building related stocks like the ones that make up our sample portfolio under performed during that period.

Based on this very unscientific portfolio and a very small sample size, it appears there would have been some benefit to buying a portfolio of these type of companies after the hurricane, except after Ike when the market was dramatically falling.

**Please note that within the portfolio there was some significant under performance by individual stocks even during all of the periods.

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The reason to look at accruals

Accruals sometimes can give a tip off to the earnings quality of a business. As we all learned in our first lesson in Accounting, cash coming in and leaving the business is not equivalent to accounting income. Almost every line item on the balance sheet requires some kind of decision regarding when to recognize a transaction and a determination of how to value it. Income and balance sheet values can therefore fluctuate significantly based on how conservative or how aggressive the business is. Ratios that help measure the significance of accruals are a valuable measure to help determine earnings quality.

By looking at the balance sheet and cash flow statement, ratios can be calculated to determine the impact of accruals.

Balance Sheet Accruals Ratio = (Net Operating Assets for the current period less Net Operating Assets for the prior period) / [(Net Operating Assets for the current period plus Net Operating Assets for the prior period)/2]

Net operating assets are defined as: (total assets less cash)  less (total liabilities less debt)

Cash Flow Statement Accruals Ratio = [net income less (cash flow from operations plus cash flow from investments)] / [(Net Operating Assets for the current period plus Net Operating Assets for the prior period)/2]

Sloan Ratio* = [net income less (cash flow from operations plus cash flow from investments)] / total assets

An analyst can take the above calculations and compare them to historical ratios for the business as well as against the competition.

John Mahedy from Bernstein Investment Research and Management has a good write-up on the power of Balance Sheet Accruals.

 

*named for former University of Michigan researcher Richard Sloan