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How to Sell Policy Investing to a Skeptic

05.03.2018 | Ben Phillips, CFA

Policy Investing Washington DC Wall Street

 

Key Takeaways

  • All roads lead to Washington D.C., the nation’s capital and hub of policy-making.

 

  • Research analysts and investors value a company today by forecasting what the company will earn in the future and discounting those future earnings back to today.

 

  • Government policy-making tends to occur independent of economic cycles; Washington D.C. can’t pause policy-making just because of a recession

 



All roads lead to Washington D.C., the nation’s capital and hub of policy-making. The rules, regulations, and government spending priorities originating from Washington D.C. can impact both foreign and domestic companies’ earnings potential and business models. How can you sell policy investing to a skeptic?

One point to highlight is how policy can impact future company fundamentals, which drive current fair value estimates. Discuss how research analysts and investors value a company today by forecasting what the company will earn in the future and discounting those future earnings back to today. To illustrate this, you could highlight how the analysis attempts to determine future financial metrics by focusing on company metrics, such as revenue sources, product lineups, profit margins, and customer demand.

Wall Street Policy Investing Political Risk


Next, bridge the story between stock analysis and policy by highlighting historical examples where Washington D.C. impacted specific sectors or companies. Below are two in-depth examples you could reference:

  • Biofuel producers, such as Archer Daniels Midland (ADM), earn a $1 tax credit, which offset $1 of tax expense, for each gallon of biofuel they produce. The credit, which lapsed in 2017, was passed during the 2018 budget negotiations and retroactively applied to 2017. In its Q1 2018 10-Q from 5/1/2018, ADM disclosed the Refining, Packaging, Biodiesel and Other segment results “were substantially higher on approximately $120 million of income due to the passage of the 2017 biodiesel tax credit”.

 

  • The Trump administration has impacted the defense industry in two main ways: (1) increasing defense spending in the 2018 budget negotiations and (2) permitting the sale of defense supplies and products to foreign countries. Taken together, the two changes may result in increased revenue opportunities for defense contractors. U.S. defense contractors Lockheed Martin (LMT), Raytheon (RTN), and Boeing (BA) have all raised their guidance since Trump’s election. If the companies can maintain the same profit margin going forward, more revenue may mean increased earnings and higher stock prices.

 

Policy Investing Economic Cycle


A second concept to explain is how government policy-making tends to occur independent of economic cycles. Congress debates and passes legislation throughout economic cycles, without considering the level of inflation or interest rates, job and payroll data, or foreign currency movement. The government can’t pause policy-making just because of a recession.

 

In fact, policy-making may be more important during an economic downturn. As examples, highlight how the Obama administration and Congress passed both the Affordable Care Act and Dodd-Frank Act in 2010, only two years after the depths of the 2008 financial crisis. The two pieces of legislation materially changed the healthcare and financial services sectors, respectively, and may have offered informed policy investors a profitable investment opportunity.

 

It’s because of this that we believe policy offers returns uncorrelated to broader markets and economic cycles. It’s easy to overlook the impact rules and regulations can have on a company’s fundamentals and valuation due to policy’s association with politics. However, if you can sift through the noise and understand a policy’s financial or operational impact, we believe you will find opportunities to generate excess returns.

 

 

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Sources

1.  www.sec.gov/Archives/edgar/data/7084/000000708418000021/adm-2018331x10q.htm

 

Important Information

Active Weighting Advisors LLC ("AWA") is an SEC-registered investment adviser that manages ETFs under the brand name EventShares Funds. Mr. Phillips is the Chief Investment Officer of AWA. The views expressed are subject to change, and no forecasts can be guaranteed. The comments may not be relied upon as recommendations, investment advice or an indication of trading intent. AWA is not soliciting any action based on this document. In preparing this document, the author has relied upon and assumed, without independent verification, the accuracy and completeness of all information available from public sources. Investing involves risk, including the possible loss of principal and fluctuation of value. Mr. Phillips and AWA disclaim responsibility for updating information. In addition, Mr. Phillips and AWA disclaim responsibility for third-party content, including information accessed through hyperlinks. For more information about EventShares, contact us by calling 877.539.1510 or visit our website at www.EventShares.com.

 

Policy Investing

Policy investing focuses on understanding the laws and regulations that impact companies. It attempts to find mispriced assets and invest in those companies before the market understands the implications to a company’s profitability and operations.