Category Archives: investing

Gambling on the Martingale Strategy

Suppose for a minute that you just wagered 25 cents on the outcome of a coin flip with a friend. The coin flip happens, you call "heads" while it's in the air, but after it falls, it comes up "tails". You've lost.

Your friend offers you the chance to go again. You take it, but you double the size of your bet to 50 cents. The coin is flipped and you call "tails", but it comes up "heads" and you lose again. Now, you're down 75 cents. Your friend offers you another chance to play.

Once again, you take it. But once again, you double the size of your bet, raising it to one dollar (or 100 cents, if you prefer). This time, the outcome of the coin toss matches your call, and you win. You've gone from 75 cents in hole to a net gain of 25 cents compared to when you started playing.

You may not realize it, but you've been using the martingale system (or strategy) in choosing the size of your bets. The strategy was first put forward by French mathematician Paul Lévy, who realized that one winning bet was all that was needed to turn around and fully reverse the outcome of a series of losing bets. Of course, the catch is that you have to have sufficient resources to weather the losses while you're racking up losing bets and realistic odds of eventually winning your wager to make it work for you, but if you want to learn more about the mathematical insight behind it, check out the following 19 minute Numberphile video featuring Tom Crawford.

If you're ready to head to the casino after seeing the video, you can rest assured you will not see any games where you have a 50% chance of winning or losing. There are some games that come close to those odds, but the potential rewards will be less.

With some modifications, you could apply the system to investing, but you'll find that approach has many of the same limitations:

Drawbacks of the Martingale Strategy

  • The amount spent on trading can reach huge proportions after just a few transactions.
  • If the trader runs out of funds and exits the trade while using the strategy, the losses faced can be disastrous.
  • There is a chance that the stocks stop trading at some point in time.
  • The risk-to-reward ratio of the Martingale Strategy is not reasonable. While using the strategy, higher amounts are spent with every loss until a win, and the final profit is only equal to the initial bet size.
  • The strategy ignores transaction costs associated with every trade.
  • There are limits placed by exchanges on trade size. Therefore, a trader does not receive an infinite number of chances to double a bet.

Don't forget that time is one of the transaction costs you pay. So are opportunity costs, because you may have other, better things to do with your stake that you are passing up by trying to come out just slightly ahead in continuing to play the same game you started losing.

Is GE Overvalued?

Our experiment using the relationship between a company's market cap and its forward year aggregate dividends is overdue for an update. When we last left off, we had narrowed in on where we expected the market cap for General Electric (NYSE: GE) would range based only on the historic relationship between GE's market cap and its aggregate dividends established in the period from 12 June 2009 through 8 December 2017. The idea being to project where GE's market cap might go if it were to slash its dividend, which it ultimately did. The following chart shows what that looks like, but updated with data through the end of 2020, with a bonus data point for where GE's market cap stood as of the end of trading on Monday, 26 January 2021.

GE Market Cap vs Forward Year Aggregate Dividends at Dividend Declaration Dates, 12 June 2009 - 11 December 2020

As modeled relationships go, that's pretty clunky. And since we have collected a lot more data points in the period since GE's 2018 dividend cut, we updated the model to include all the data from 12 June 2009 through 11 December 2020. The next chart shows what the updated model now looks like:

GE Market Cap vs Forward Year Aggregate Dividends at Dividend Declaration Dates, 12 June 2009 - 11 December 2020

We're also using some basic statistics to show the upper and lower level of what the variation in the historic data indicates is the 'typical' range in which the observations will fall. We've set those levels to be two standard deviations away from the main trend line, within which we would expect the data to fall 95% of the time, assuming the variation can be described by a normal distribution.

As of 27 January 2021, GE's market cap was just above where it was when it last declared dividends on 11 December 2020, which falls within the upper end of the expected range. Should GE's stock price rise above the indicated upper level, unless it is accompanied by the serious prospect of a dividend increase, it could indicate that the company's stock has become relatively overvalued, which would be a strong signal to sell.

So how do you read GE's announcement of its improving cash flow from 26 January 2021? Since a firm's ability to pay dividends depends both on its earnings and cash flow, the rise of GE's cash flow during 2020-Q4 marks a potential turnaround for the long-troubled company. If sustained, GE will be able to afford a dividend rise.

Is that what's going on here? Because if it isn't, the argument that shares of GE are becoming overvalued and its nearing time to sell becomes stronger if its shares are really trading within the vertical range they have since 2018.

Considering this information, if you were an investor holding shares of GE, how would you make your investment decisions?

Iron Mountain’s Stock Becomes a COVID-19 Economic Recovery Bet

Adam Nowakowski's Day Trading Investor via Unsplash: https://unsplash.com/photos/MFms-wkv3Ow

Three weeks ago, we began following Iron Mountain (NYSE: IRM), a Real Estate Investment Trust (REIT) whose core business is documents management. While the company is best known today for archiving the paper records of large corporations, it has been increasing its investments into electronic records management technology to expand its business in the digital age.

The reason we chose this particular company to follow is because it appeared to be on the cusp of pursuing one of two potential paths with respect to its dividend policy. IRM's stock price had been crushed with the coronavirus pandemic in 2020, where the company's market cap with respect to its aggregate dividends had fallen below its historic range.

So much so that, one week before its 2020-Q3 earnings call with investors, the level of its market capitalization suggested it had a strong chance of either cutting its dividends per share by a third or holding its dividend steady with a slim possibility of a small increase. The latter scenario assumes the firm had been successful in restructuring its debt during the previous three months, which would free up funds to sustain its generous dividend.

Iron Mountain's 2020-Q3 earnings call then came and went on 5 November 2020. The company's management chose the second path, which allows us to update the visual assessment of the relative value of the company's market cap with respect to its aggregate dividends against the historic backdrop of the relationship between these two financial measures during the past ten years.

Iron Mountain (NYSE: IRM): Market Capitalization vs Forward Year Aggregate Dividends per Share at Dividend Declaration Dates, 2010-2020, Snapshot on 5 November 2020

IRM has taken advantage of falling interest rates prompted by the pandemic to restructure much of its short term debt, which has taken the prospect of a significant dividend cut off the table at this time. Here's a relevant excerpt of CEO William Meaney's comments on the topic from the transcript of IRM's 2020-Q3 earnings call:

Turning to cash flow and the balance sheet, we are operating from a position of significant balance sheet strength. In the third quarter, our team did a nice job delivering further cash cycle improvement with solid performance in both payables days and days sales outstanding. On a sequential basis, cash cycle improved by a full day as a result of continued DSO improvement. In August, the team executed another successful bond refinancing, issuing $1.1 billion to redeem our most restrictive outstanding debt and pay down a portion of the outstanding balance under our revolving credit facility.

The continued strong support received from the fixed income community provided us the opportunity to upsize our transaction while printing the lowest coupon for 10-year notes in the company’s history. Taken together with our bond offerings in June, we issued $3.5 billion of new debt on a leverage-neutral basis, increased our weighted average maturity by over two years to nearly eight years, while only modestly increasing our weighted average cost of debt.

Additionally, these new bonds are more in line with our REIT peers as they include a fixed charge coverage ratio as opposed to a debt to EBITDA covenant. Also, I think it is worth noting that we have eliminated all of our 6.5 times leverage covenant bonds, meaning our most restrictive bond covenant is now 7 times debt to EBITDA.

At quarter end, we had $1.7 billion of liquidity. As a reminder, at the end of the second quarter, we had elevated levels of cash on our balance sheet due to the timing of the payoff of one of our notes from the June bond offering. We paid off the notes in early July, leaving us with a cash balance at September 30 of $152 million.

We ended the quarter with net lease adjusted leverage of 5.3 times, which takes into account adjustments as described in our credit facility. Looking ahead, we expect to end the year with leverage of approximately 5.5 times, which would represent an improvement year-on-year as we make progress towards our long term leverage range.

That's important because companies generally need at least one of two things to be positive to sustain their dividends over time: their earnings and their cash flow. IRM priortized restructuring its debt to reduce the pressure it presented on its cash flow, which allows it to preserve its dividend, which it left unchanged. Here are Meaney's comments on that subject, which immediately followed his comments on IRM's debt restructuring:

With our strong financial position, our board of directors declared our quarterly dividend of $0.62 per share to be paid in early January.

Turning to capital expenditures, our full year expectation is now approximately $450 million, or a decrease of $75 million, reflecting development capital for our Frankfurt data center that will now be a part of our venture with AGC.

Meaney continues describing how IRM's plan to sustain its dividend can be maintained while the company continues to expand its electronics records management business line:

Now let me share a few thoughts as to our capital allocation strategy. First, we are committed to our dividend at this sustainable level and over time, we expect to glide into our targeted AFFO payout ratio of mid-60%. Second, we are committed to our target long term leverage range of 4.5 to 5.5 times on a net lease adjusted basis. This year, the team has made good progress toward our target.

As investors know, we have been allocating significant capital to our data center business for several years, and as our pipeline continues to build with high return investment opportunities, our strategic intent is to increase the amount of capital we dedicate to the business. With that, we have considered options to generate incremental funds for investment.

We view capital recycling as a good means to monetize certain assets, particularly industrial real estate to increasingly invest in our development pipeline. Industrial cap rate are at historically low levels, and we have the opportunity to structure long term leases on favorable terms that effectively allow us to have control of the facilities, whether we lease or own. With that, in the third quarter our team accessed the market and monetized two facilities for proceeds of approximately $110 million. This brings our year-to-date proceeds to nearly $120 million, ahead of our full year target of $100 million.

With the highly favorable market backdrop together with our development pipeline, we are planning to recycle relatively more going forward, albeit what will amount to a small portion of our total industrial assets. Similarly, we view selling stabilized data center assets into a joint venture as analogous to monetizing industrial real estate assets - it represents another source of capital to redeploy into development projects. The joint venture we just announced in Frankfurt is a good example of this strategy. The JV provides us with an opportunity to boost returns on stabilized assets and provides incremental capital to allocate to projects in the development phase.

We think Iron Mountain's plan minimizes the risk of a dividend cut but doesn't eliminate its exposure to other factors that might ultimately lead to that outcome. While the company's stock saw a boost to $27.48 per share on the day of the earnings call, in the two weeks since, it has fallen by 5.7% to $25.90 per share.

That fall largely coincides with the introduction of new lockdown measures in Europe to try to bring the spread of new coronavirus infections down to levels where its national health systems are capable of managing it. It has also occurred despite the major announcements of two COVID-19 vaccines with greater than 90% effectiveness in their Phase 3 trials, which will start being distributed before the end of 2020 and have hundreds of millions of doses distributed worldwide in 2021.

That makes IRM's stock more interesting than what we realized when we first selected it to follow. Following its recent stock price history, we find it has risen and fallen with the waves of coronavirus infections in the regions Iron Mountain does business, which makes it something of an indicator of how investors anticipate the coronavirus pandemic will affect business activities upon the company's large, established customer base, and by extension, the firm's revenues.

In maintaining its current dividend level, Iron Mountain stands to gain substantially if its stock price and market cap recovers to levels consistent with how investors have historically valued the company's dividends. But unlike stocks whose prices have risen on speculation from recent vaccine development news, we think Iron Mountain's stock price is reflecting what they anticipate for its actual business conditions in the year ahead.

That makes investing in IRM a COVID-19 play, or rather, a bet on the future for the coronavirus pandemic's real world impact on business activities. Knowing where the company stands today, how would you place your bets on its future?

Previously on Political Calculations

Image Source: Photo by Adam Nowakowski on Unsplash

31/10/20: Gold Coins Market is Still Hedging Residual Covid Risk

Sales of the U.S. Mint gold coins have moderated off their pandemic highs, but remain elevated by historical standards, especially controlling for higher gold prices:


Since hitting a pandemic-period high of 216,500 oz in March 2020 (the highest sales volume since April 2013), the demand has moderated through June, topped 145,000 in July and 149,000 oz in August, and has been around 91,500 through the four weeks of October. This puts October sales above the last three years' average.

Average gold weight per coin sold remains relatively elevated and is co-trending with price per oz, most likely indicating lasting FOMO effect (herding by investors). The correlation is weaker than during prior episodes of major crises and recessions, suggesting that the pandemic-period demand is probably less influenced by the herding effects than in prior crises.


Annualized data through October also confirms precautionary, but not 'flight to safety' type of demand:

As the pandemic re-accelerates, it will be interesting to see how seasonality (uplift in end-of-year sales) plays out against the pandemic-related hedging positioning of investors.

Goldilocks, Market Cap, and Aggregate Dividends

We're experimenting with using the relationship between a company's market capitalization and its aggregate dividends as a tool for assessing the Goldilocks quality of its stock price. By Goldilocks quality, we mean whether the value of a company's stock price is too low, too high, or just right, which would correspond to an investing decision to buy, sell or hold.

Stock Market Chaos!

Why use market cap and aggregate dividends for assessing the value of a stock? We've already established that there's a useful relationship between price per share and dividends per share when dealing with stock indices, but the increase of stock buybacks over time makes that direct approach a dicier method for evaluating individual stocks. Using market cap and aggregate dividends can eliminate the potential for a company's management to artificially dress up its "per share" financial metrics with buybacks, letting us use the next closest thing to share prices and dividends per share in determining whether it makes sense to buy, sell or hold its shares.

We've developed the basic method for evaluating an individual firm's stock valuation using General Electric (NYSE: GE) as our experimental guinea pig, but we have been seeking another publicly traded company to evaluate.

We've found a candidate: Iron Mountain (NYSE: IRM). IRM is a documents management company that is set up as a Real Estate Investment Trust (REIT), which is perhaps best known for archiving the paper records of hundreds of large corporations, but which has been expanding into digital records management.

That's a boring, but lucrative business, where the company is currently paying an annual dividend of $2.47 per share. With a closing share price of $26.33 on 29 October 2020, that's a dividend yield of nearly 9.4%.

By contrast, the dividend yield of the S&P 500 was 1.75% back on 30 September 2020.

That large difference makes IRM an interesting stock to consider. An relatively outsized dividend yield can be both an attractive stock for investors seeking dividend income and a potential harbinger of future dividend cuts, which is the kind of stock investors would generally seek to either sell or avoid.

Which is IRM? Here's a chart showing the relationship between IRM's market cap and aggregate dividends from 2010 up to 29 October 2020, where we've focused on the periods approximately coinciding with Iron Mountain's dividend declaration dates.

Iron Mountain (NYSE: IRM): Market Capitalization vs Forward Year Aggregate Dividends per Share at Dividend Declaration Dates, 2010-2020

Overall, we find there's a moderately strong relationship between IRM's market capitalization and its aggregate annual dividend payout, which currently sits at $0.71 billion with a market cap of roughly $7.59 billion.

In considering how investors have historical valued the stock at dividend declaration dates from 25 February 2010 through 5 August 2020, we find the current valuation is below the typical range we would expect given its history, which means one of two things: it's either a serious candidate for a dividend cut, or its shares are currently on sale for investors looking to pick up relatively easy money.

In August 2020, Action Biased made the case that the stock is due for a dividend cut, which our method suggests could be on the order of a 33% reduction from its current $2.74 annual dividend per share. The argument supporting a significant dividend cut recognizes the dividends the REIT paid in 2019 exceeded its Funds From Operations (FFO) by a significant margin, which is a consequence of the company having loaded up on debt to expand its digital records management operations. Cutting its dividend to cope with its debt could be advisable if it remains elevated.

Since then, presentations the company has made to investors have focused on the steps it has taken to restructure its debt at today's lower interest rates, which would make its current dividend level more sustainable. Analyst Mark Roussin picked up on that strategy in his argument that the company's stock is currently undervalued, which our analytical method suggests could provide up to a 20% gain given its current dividend payout and how investors have historically valued the firm.

So which is it? If you're looking for ideas of where to invest, you'll ultimately have to make that call for yourself, but you won't have long to wait to find out which potential view of the future will prevail. Iron Mountain will announce its 2020-Q3 financial results early on 5 November 2020 and will host a conference call for investors later that day.

According to analyst Rida Morwa, Iron Mountain may also announce a change in its dividend at that time. He's betting on it being a dividend increase, which for our method, would suggest the potential for a greater than 20% gain.

See? Interesting! Who knew a company in the record storage business could present so many possibilities for investors to weigh?