Dividend Outlook and Why the "Parabola" is a good LT sign for...

Dividend Outlook and Why the "Parabola" is a good LT sign for our "warm bucket of spit"
There’s little point paying Aussie shareholders a dividend if a company has no Australian franking credits, with the exception of making the company investable to certain funds who have a requirement that a stock pay a regular dividend before they can invest. For this reason, many companies do pay a small unfranked dividend. It is usually more efficient for a company to use the cash doing share buybacks. Aussie shareholders can sell shares if they need income and many will pay much lower rates of capital gains tax than the income tax on unfranked dividends (50% CGT discount, no CGT in retirement phase of super, or shareholders who paid the current share price or more have no CGT etc).

Even if Aussie shareholders someone got their shares for free, so that the total sale price is capital gain, they are still usually better off (or no worse off) paying the discounted CGT than paying income tax on unfranked dividends. I’m not a tax expert – so take your own advice on this.

Of course, everyone’s income requirements and tax rates are different. However, if you are worried about being diluted as a shareholder by selling shares to fund your lifestyle, consider a company which has enough profits to pay a 5% dividend, but instead does a share buyback. I would argue that the buyback sends out a strong signal and forces some short covering – possibly resulting in a 10% rise in the share price – many shareholders would then be better off selling 5% of their original holding and paying half CGT or no CGT rather than receiving a 5% unfranked dividend and paying tax at their full marginal rate.
Furthermore, if you buy today for $3 and the price rises to $4 in a year and you require a 5% return on the original $3 holding to fund your lifestyle, that is only 3.75% of the current value of your holding at $4. So you still have 96.25% of your original holding, which is now worth $3.85. Tax on the capital gain could be zero for many people, or 22.5% for someone on a 45% marginal rate (rather than 45% tax on an unfranked dividend).

Like CSL, and like most overseas profit earning high growth and tech stocks, MSB will probably never be a stock which is a high yielder. That’s fine for me, I’d rather have CSL any day. It may be different for others, but if the share price keeps rising, most would still be better off selling some shares every year.
MSB has large tax losses in Australia and doesn’t pay tax, so it doesn’t have franking credits available to distribute. MSB will make most of its taxable profits overseas in the future, at low tax rates in Singapore or the US, so is unlikely to earn significant Aussie franking credits relative to the market cap of the company.
CSL is an example of an Aussie stock with most of its earnings offshore. It can’t frank its dividends, but currently pays a nominal yield of just under 1% presently 0% franked (although I’d note that the current $A2.91 dividend would be pretty attractive to all who paid less than $A1 per share in CSL’s first year as a listed company!). If MSB pays a similar 1% unfranked dividend yield, that would be a 3c (unfranked) dividend at present, in a stock that has moved by up to 30c in a day recently – so 3c isn’t a big deal and I’d rather have the capital gains (and pay the tax!).


On Parabolae…with apologies to Archimedes

This whole parabolic debate is misinformed. Just because a share price has had a steep rise doesn’t mean it has to have a meaningful correction, nor does it necessarily mean it’s a parabola! Indeed, many companies don’t have meaningful corrections after strong rises (which can appear to have a constant acceleration ie parabolic), especially when the company has been through a major fundamental change. I give the example of BlueScope below – just because I’m quite familiar with what happened to BSL as it came back from its Near-Death Experience several years ago and I compare the big change MSB has gone through in the past year to conclude that in similar share price conditions, BSL had already gone up more and continued to rise.

The commentary appears to toss around the term “parabola” without defining how much the price has to rise, or the pattern of the acceleration to be judged a parabola, and what the expected retracement may be if the parabola breaks down. I reckon most people are using a simple eyeball test.


Misunderstanding between traders and investors

There is a basic problem here with short-term traders butting heads with long-term investors. Some of the shorters and traders get up the noses of investors by implying they are smarties who are making profits on every twist and turn (highly unlikely when you consider the overall stats on trading) and some are trying to manipulate the situation by throwing around worrying comments, or by manipulating share prices directly.

Some of the investors seem to want the price to rise continually without any pullbacks and are worried that the traders will force unjustified price falls. We all know a continuous rise isn’t going to happen – and even if there are no shorters out there, some longs get nervous and sell to “lock in profits” and some need to sell to fund their lifestyle - pushing the price down temporarily, even if it is worth much more in the future. This arguing has some of the aspects of culture wars – you’ll never convince the other side, so it’s better to work out your own investment philosophy and stick to it – don’t let others panic you into doing something against your own strategy.

Maybe trading a parabola on MSB will give traders a few cents of profit – but maybe they will miss the bottom and/or miss most of the longer-term upside. Parabolic indicators are often very short term and can have a habit of chopping in and out, even causing people who trade these indicators to make losses in a trendless market.

Note that MSB is still in a strong uptrend, so if you are trading parabolas, you should still be long.
There’s no point people with diametrically opposed points of view between trading and investing arguing this point – you’ll never convince each other and it becomes philosophical and sometimes hysterical, with science and statistics ignored in favour of one-off “proofs” by someone who has a short term win concluding that therefore they were right – very poor science, more arguing by anecdote.
Unsubstantiated comments in the past week like “the price has risen too fast, it’s parabolic” or “the market cap is unsustainably high” or “Silviu will have to raise more money” can shock and unnerve investors – but there’s no underlying science to them.

There’s no comparison of the market cap with future earnings potential (which most analysts use to show the market cap should anywhere from 50% from the 4 US based analysts who have reiterated ratings or initiated coverage since October last year coming up with an average price target of $US15.25 per MESO share – or $A4.50 up to a 150% target price rise from Edison’s recent report.

There’s no definition of a parabola, nor is there an analysis of the stats of whether companies usually fall or how much they fall after a parabola or when the parabola ends and it’s time to buy back. In fact they don’t even distinguish between a bullish rising parabola where the parabola is below the share price and a bearish or falling parabola where the share price crosses down through the previous rising parabola. MSB is still in a bullish, rising parabola at present and the parabola was at $2.45 yesterday, currently rising at 5c per day – way off a sell signal.

There’s no analysis of the required cash in a capital raising – and under the possibility of a new US partner for Heart or Back Pain, I’d argue they actually need to consider announcing a buyback at the same time. See next section where I argue they have at least 8 quarters of cash from existing sources since the Sep quarter last year ($US165m), and another 5 quarters after that on product approval for Grunenthal ($US105m).


More on MSB cash position

MSB has just raised $A75m from instos in an insto placement, still has $US35m (or $A50m) of debt to draw down and the milestone payments from partners already signed up (and with new ones in “advanced negotiations”. Just cash on hand at end September plus the placement plus the $US30m due from Grunenthal this year plus the $US35m undrawn debt from Herc and Nova add up to $US165m - yet the cash burn is only around $US20m per quarter. Grunenthal’s upfront and milestone payments are $US150m up to product launch ($US45m in the first year – of which $US30m is coming in 2020) and cumulative milestones could reach over $US1 billion. The JCR royalties are now running at $US2m per quarter (although they are included in reducing the quarterly cash burn). There are future milestones already signed but not paid with other partners – and these will come through as milestones are met - another Euros 10m from Takeda upon commercial sales of Alofisel and there are further milestone payments already signed with Tasly.

If $US165m (or 8 quarters of cash burn) isn’t enough (pre another $US105m already signed from Grünenthal up to product launch – ie another 5 quarters of cash burn on top of the 8 already covered), by the end of this calendar year, MSB expects (subject to FDA approval) to be selling Ryoncil in the US paediatric SR-aGvHD market – a market 8x the size of Japan, which is expected to be around $U120m in peak annual sales (with gross margins starting around 80% not just a royalty receipt like in Japan) for acute paediatric disease alone. The eventual market size in US and Europe is estimated by MSB at $US700m (and I think that’s conservative).

Why on earth would they need a capital raise in the near term? If they gain a major partner in US Heart or Back Pain with an upfront payment of at least $US100m for each, I’d argue they actually need to do a share buyback to efficiently manage the balance sheet.


More on why the cash position and Grünenthal deal is a big fundamental improvement

I note the drop in the short interest in MSB after the Grünenthal deal and the subsequent drop off in interest from the usual band of negative posters.

If you look at the main arguments used by the sorters near the share price low a bit over 12 months ago, they were along the lines of the company needs to raise capital to fund itself, debt to is too high relative to market cap and partnering deals are doubtful.

Our main antagonist at the time was Madam who posted 152 times on MSB in the year to 13 November 2019 and once in the 2 months since then. Madam has posted hundreds of times since mid November on other topics (main regarding climate change denial), but only 1 post on MSB. I wonder why?
I think the reason (without speculating whether various individuals were short or not) is that Madam’s criticisms of MSB’s credibility at gaining partners, balance sheet and funding have all been answered by the recent insto placement and Grünenthal deal.

As I noted at the time, the Grunenthal partnership in EU and LatAm back pain could just be the first of several in the blockbuster markets of Heart and Back Pain in EU and US. There could also be further partnerships in Asia – where there are some huge markets and populations who are moving into middle class wealth.

The combination of all these deals could easily add up to more than the original Cephalon deal which propelled the share price on a “parabolic” path to nearly $10 in 2010/2011 (lucky you didn’t sell that parabola at $3.50 at the end of 2010!). I’ve also noted that there are now twice as many shares on issue – so $10 back then is $5 now – however we are 10 years progressed and at the end of the phase 3 trials and MSB funded itself through all those tough years and has emerged able to resell or licence the technology – what a phenomenal outcome!

So, Grünenthal popped the price up to $2.23 last year, before the rumours of Capital selling and the insto placement knocked the price back down. If those two things hadn’t stopped the original buying, the price would’ve probably moved a bit more slowly up to current levels.
Of course now we have digested the Capital selling of 27m shares, we have ample cash to fund the business from Grünenthal and the insto placement and we are now anticipating the final lodgement of the BLA this week with the FDA and also the likely inclusion of the shares in the June rebalance of the ASX200 – and I suspect some small cap funds and index funds are now entering the register in anticipation (that would explain the attendance of up to 10 instos at a Bell Potter lunch in Sydney last week, after almost no insto interest in the past 12 months).

Even today, we are seeing the same continued high volume consistent buying that we’ve seen right through January (with 3.5m traded up until just after 2pm – amazing considering the fear and falls on international markets overnight regarding the new Chinese flu pandemic. I’m convinced there are instos out there with a brief to buy large volumes and to take advantage of panic days like today – snapping up as much as they can under $3.

There’s still a little bit of new shorting out there, as there always is after a big price rise, but I believe they’ve pulled their heads in post Grunenthal – that’s only one of the reasons why it was such an important deal, taking the share price from $1.45 to $2.23 from 10 Sep to 16 Sep (before the insto placement in early Oct). It’s also instructional that Madam’s prolific commentary stopped on 15 August and there were only 5 posts on 28/29 Oct and the last post on 15 Nov.

I guess all of Madam’s comments were answered, including the one that she asked @Basza in which she compared issuing $3 MSB options to “a warm bucket of spit”…on 20/6/2019 she said:

So you think a "free" option with an exercise price more than double the current share price will be enticing enough to raise new capital in quantum that is equivalent to almost one-third of the market value of the company, and at a price that is higher than the prevailing share price?

Run a $3.oo a exercise price through the Black-Scholes model and you'll find that option to be absolutely worthless, almost irrespective of the expiry date.

The option you describe may be called "free", but it's not worth a bucket of warm spit.

Very colourful, but I think you’d find those options are worth quite a lot just 7 months later!


More on Parabolae

The Parabolic SAR indicator is still a positive for MSB! It wasn’t even close to generating a sell signal last week when a few people suddenly made the term “parabolic” the word du jour. In fact, the share price would currently have to fall below $2.50 to generate a Parabolic SAR sell signal.
The other point to note about parabolic indicators is that even if they do indicate a trend change, it’s really a tool for traders, not investors. If you are a trader and prepared to sell, cop the risk that the indicator isn’t chopping in and out (which it often does), pay transaction fees and capital gains taxes, and then buy back in for the bigger move coming to the upside, then good luck to you – hopefully your buying back in the future gives the share price another nice kick upwards! If you are an investor, be aware that parabolic indicators are really just a variant on moving averages and have no predictive value – they may even induce you to sell at a short-term low and then buy back in at higher prices. I’ll explain how this works below.

If people are being less precise about the term “parabolic” and are just eyeballing a graph and saying a price which is rising at an accelerating rate must reverse at some stage, then I’d say that it’s a pretty unscientific way to trade shares. As we all know, share prices coming off a multi-year low and with a company changing event (reconstruction of balance sheet after a near-death experience etc) can rise “parabolically” and then keep going.

Here’s a famous MSB “parabolic move” in 2010 (see graph below) and you could be excused for thinking that the price had moved too quickly (a 3-bagger going from $1.75 to $5.25 – similar to the 3-bag move in the past year) but I’d argue that the move in 2010 was a fundamental change in the company – just like the Grünenthal deal and possible subsequent deals have set up in 2019.

If you were a trader back in 2010 looking for some quick falls after a “parabolic rise”, you might’ve even thought you’d made a great trade when the price briefly fell back to $4.25 in the following week – but the investors were rewarded much more with the subsequent move to $9.95.

The following graph is MSB in Aug-Dec 2010:



Just to show that the same thing can happen in totally unrelated stocks, and that a parabolic move isn’t something for long-term investors to be afraid of, have a look at Bluescope in the graph below during the first part of its big recovery in mid-2012. The move over 7 months took the price from $1.50 to $5 – that’s a bigger rise than MSB has had over the past year – and the green line at the end certainly “looks” like the price is going parabolic. Note that the red dots are the “parabolic SAR” indicator, which gave 4 “sell” signals over this period – also note that sometimes the sell signal didn’t occur until after the price had fallen and was just about to power higher again.

The following graph is BSL from January 2012 to March 2013:


So, my points to note from this graph are:

1. It is possible to view parabolic moves as an indication of much higher gains in the future for longer-term investors, even if there is a short-term trading pullback
2. “Eyeballing” a parabola and assuming the price must be about to fall has no science to it – if you had done this with MSB in 2010 you would’ve missed the rise from $5.25 to $9.95. With BSL you would’ve missed the move over the next 12 months to $6.50, then a pullback before ultimately hitting $19 (a 12-bagger in total from the $1.50 starting point).
3. The red parabolic SAR dots on the above graph have a trading methodology to them, and are possibly at least using a repeatable process – but are not guaranteed to give you a profitable level to short a stock as they are really just a trend following process with a built-in stop loss.
4. Using the parabolic SAR meant you would’ve missed the BSL low at $1.50 and bought in at close to $1.75. You then would’ve sold out at just over $2, and bought back in around $2.50, then you would’ve sold out around $3, and bought back in around $3, then sell at $3.25 and buy back in at $3.50, sell again at $3.50 then buy back in at $3.62, then probably hold it for most of the “parabolic rise” to $5. The upshot of all that shows how you can miss most of the run by trading – holding the whole way up from the low of $1.50 to $5 gave you a $3.50 profit (a 3.3 bagger), and ultimately a 12-bagger - but trading only gave profits of $2.38 (a 2.3 bagger on the initial $1.75 outlay) and you may not have ever bought back in for the final leg of the run.
5. If you had sold BSL at $5 in 2013 or MSB at $5.25 in 2010, thinking that a 3 bagger was too parabolic, you missed the really big moves up to the highs of $10 and $19 respectively. Sure there were pullbacks – but if you are just using gut feel that the parabolic move is too big, how do you avoid getting out too early and how do you get back in at the right time?

This is all appropriate to MSB’s current share price and comments from people that they are shorting it because it is “parabolic”. The 3 bags for MSB from the low at $1 a year ago to the current price is similar to the percentage rise in MSB in 2010 and BSL in 2013 after both had been through major game changing events. The parabolic rise in the price graph near the end of the initial period looks similar in both graphs. The fundamentals justified continuing to hold both stocks long-term despite the short-term concerns about the steepness of the price rise.


Brief explanation of Parabolic SAR (also see APPENDIX)
The Parabolic SAR (parabolic stop and reverse) is a method to find potential reversals in the market price direction. It is a trend-following (lagging) indicator and may be used to set a trailing stop loss or determine entry or exit points based on prices tending to stay within a parabolic curve during a strong trend. The indicator generally works only in trending markets, and (like moving averages) creates "whipsaws" during ranging or, sideways phases. A parabola below the price is generally bullish (which is the case currently for MSB), while a parabola above is generally bearish. A parabola below the price may be used as support, whereas a parabola above the price may represent resistance.^[2] These parabolae may be used as price areas for stop losses or profit targets.
The MSB parabola is currently below the price (see red parabolic SAR dots on the graph below) – so it is still a bullish indicator for MSB.



The current parabolic uptrend started on Monday October 28th, after the downtrend dot crossed the price range on Friday October 25^th. The SAR crossover level at present is about $2.50 (up from $2.45 yesterday), so we remain a long way above that.

The Extreme Point (EP) is currently $3.21, and the share price continues to hit new highs in this uptrend, so the acceleration factor keeps increasing - so at present SAR is rising at 0.07 * 76c = 5.3c per day.
I have included the calculation method in the appendix, but suffice to say that the red dots will reach the share price in around 12 days if the share price stays flat. Even if the share price rises dramatically in the next day to $3.50 or $4, then flattens out, the SAR will start accelerating and will still reach the share price in 12 or 13 days.

For example, if the share price rises to, say, $A3.50 tomorrow then the new EP will be $3.50, and the acceleration will increase to .08 and the SAR will be rising by 0.08* $1.45 = 8.4c per day – so it would reach the $3.50 price in 12.5 days. Furthermore, if the share price goes to $4 tomorrow, the SAR will be rising by 12.4c per day, and would reach $4 in 12.5 days.

[NB I worked out all these calculations yesterday and haven't updated them for today].

However, if the share price were to rise at a constant amount per day (even just 1c per day), the SAR would never reach the share price, and would therefore never give a sell signal. And that’s fair enough because there wouldn’t have been a change in the trend.


Bottom line to the “parabolic” rise

The share price has had a very strong rise, having tripled in just over 12 months. That is scaring some people and causing others to take out short positions. There doesn’t appear to be any science to the comments I’ve read on this, just gut feel. Indeed, if you consider the actual Parabolic SAR indicator, it is far from indicating a sell at present.

Some people get nervous and look for a “reversion to the mean” after a big rise and the sell; others think they see a new trend developing and become more positive on the prospects of a company and buy. That makes a markets.

As I’ve said before, I prefer to buy when the price is below my fundamental valuation of the long-term prospects of the company, and sell when the price rises well above what can reasonably be justified by fundamentals.

So, we’re all different, and some of us are traders and some are investors. I’ve tried in the past to explain why it’s easier to make money over the long term as an investor, and how the odds are stacked against traders. I know traders don’t believe this, and like most people, think they have above average abilities. Just remember, when everyone’s above average – the average rises and you may end up losing out!
I don’t think there’s any need for people to lash out and attack others’ point of view. If you think you are a great trader or shorter, then good luck to you. Even if you have a short-term negative impact on the share price of a stock I own, you will be buying it back at some stage at higher prices if my fundamental valuation is correct. If I’m wrong, then you may be buying it back at lower prices and you’ll win and I’ll lose on this one.

I’ve been wrong before, and will be again. I just try to get more right than I get wrong – and that includes letting my profits run on the winners until they become overpriced. It’s hard enough to identify a big winner and get it right – it’s even harder to stay in it for the maximum benefit! You won’t get far as an investor if you keep exiting your winners for small profits but get stuck death riding your losers down to nothing.


APPENDIX 1
The parabolic SAR is calculated almost independently for each trend in the price. When the price is in an uptrend, the SAR emerges below the price and converges upwards towards it. Similarly, on a downtrend, the SAR emerges above the price and converges downwards. At each step within a trend, the SAR is calculated one period in advance. That is, tomorrow's SAR value is built using data available today. The general formula used for this is:


where SAR_n and SAR_n+1 represent the current period and the next period's SAR values, respectively.
EP (the extreme point) is a record kept during each trend that represents the highest value reached by the price during the current uptrend – or lowest value during a downtrend. During each period, if a new maximum (or minimum) is observed, the EP is updated with that value.
The α value represents the acceleration factor. Usually, this is set initially to a value of 0.02, but can be chosen by the trader. This factor is increased by 0.02 each time a new EP is recorded, which means that every time a new EP is observed, it will make the acceleration factor go up. The rate will then quicken to a point where the SAR converges towards the price. To prevent it from getting too large, a maximum value for the acceleration factor is normally set to 0.20. The traders can set these numbers depending on their trading style and the instruments being traded. Generally, it is preferable in stocks trading to set the acceleration factor to 0.01, so that it is not too sensitive to local decreases. For commodity or currency trading, the preferred value is 0.02.
The SAR is calculated in this manner for each new period. However, two special cases will modify the SAR value:

• If the next period's SAR value is inside (or beyond) the current period or the previous period's price range, the SAR must be set to the closest price bound. For example, if in an upward trend, the new SAR value is calculated and if it results to be more than today's or yesterday's lowest price, it must be set equal to that lower boundary.
• If the next period's SAR value is inside (or beyond) the next period's price range, a new trend direction is then signalled. The SAR must then switch sides.

​

Upon a trend switch, the first SAR value for this new trend is set to the last EP recorded on the prior trend, EP is then reset accordingly to this period's maximum, and the acceleration factor is reset to its initial value of 0.02.