Monday, August 30, 2010

August 30, 2010 The Best Defense Is A Good Offense.


August 30, 2010 The Best Defense Is A Good Offense.

That adage has a long genealogy. It can be traced back to military strategist Sun Wu, better known as Sun Tzu around 500 BC. He wrote the “Art of War” used by military and business strategists for years. Today the tactic was used by a politician. President Obama took time out of his schedule to speak in the Rose Garden today about the economy. I can not strongly disagree with his message. The jobs bill has been held up in congress by republicans and it is probably an effort to make the democratic congress look bad and weaken their chances for re-election this fall.

With that said, it was an opportunity lost as he could have made his point and offered some leadership at the same time. If he had not only blamed Bush (That was the former President for those of you who have forgotten) and those big bad ugly money grabbing old fat republicans, while providing some stability to the situation, by acknowledging recent economic news disappointed him and his White House Cabinet, versus saying that all along he has said that this would be a long term return to stability and that things would get worse before they got better. That just is not the case. But it is a great illustration that those that write history make history.

I had Bloomberg on in the background when the President eventually made his remarks. (There were several false starts due to audio difficulties) I did listen and expected him to address comments from the Central Bank of Japan. Earlier in the day or perhaps last night Kan-san, the Prime Minister and Shirakawa-san the Governor of the Bank of Japan blamed the rising yen and the real threat of a double dip in the US economy for the deteriorating economy in Japan. These comments had a lot of negative impact on our market place today, more so than the miss/beat on personal income outlay report early this morning. Many, including the talking heads at Bloomberg, NBC, MSNBC, CNN and Fox were expecting the President to provide some reassurance that things are difficult but not as bad as our friends in Japan are implying. (Keep in mind that Kan-san is running for re-election as Prime Minister and US bashing is a great vote getter.) This can be illustrated by looking at the market before the President’s comments and then after. We went from about .5% down to .9% down in all three indices.

PE or Peehew?

I was going to spend some time tonight letting you know about my most recent conspiracy theory. That Jim Cramer of Mad Money fame and Alan Abelson of Barron’s fame have lunch every Friday. My theory is based upon recent Friday broadcasts of Mad Money and then Abelson’s article in Barron’s, delivered the following morning. Last week they both said the same thing. That the cards are getting more stacked against the retail investor/trader.

Note we said we were going to. We reserve the right to address this conspiracy later in this post or I might spare you and save it for another day. (I noticed its hard to write this blog late at night after a couple of glasses of red wine, so I have cut back on drinking wine. Who’da thought that blogging could become part of a healthy life style. But I digress.) In both The Mad Money segment and the Abelson article, reference was made to the relevance of the P/E ratio.

Well, low and behold, there was a great article today in the journal
by Ben Levisohn who raises the question with supporting data, that maybe the holy grail of comparative analysis might be flawed. (Graham and Dodd are rolling in their graves, listen.) He correctly identifies economic uncertainty for one of the causes in the overall drop of earnings resulting in an overall lower P/E ratio for the S & P 500 (the appropriate index to use for this argument). He even provides a beautiful chart (below) showing an 80 year history of the average P/E ratio for the S & P 500.

And yes the average is dropping as the economy changes its rate of recovery and companies in that economy and analysts covering those companies change their expectations for future earnings growth. A decrease in future earnings growth always lowers the P/E ratio. That does not make the metric irrelevant or unimportant, it makes it lower.

To prove the point, we tried to get the actual P/E ratios of companies in the S & P 500 in the 1980s. After about 20 minutes of Googling, good luck with that. It is apparent that companies like Exxon, Mobil, GE, IBM all had lower P/E ratios in 1980, because we could, stock by stock, extrapolate their PE with their earnings and year ending prices, but they were all lower (in the 9-11 range) and so were their competitors. So the PE was lower but still relevant. In the late 1990s PE ratios were running in the 20s, but all of the value companies were running in that same range.

The article highlights that there are other important factors to consider when evaluating a stock besides the P/E ratio, but even back in 1934 when Graham and Dodd wrote “Security Analysis”, there was more to look at than just the P/E ratio.

As a segway, the article does delve into the common message from Cramer and Abelson, regarding the issue of HFTs or High Frequency Trades. This is a recent phenomenon and the result of our reliance on computerized trading programs combined with the proliferation of Exchange Traded Funds. This is causing some non-value based stock price adjustments that are impacting the retail investor (you and I) also known here in the blog as the “day trading casino monkey”. What HFTs have managed to do to the casino monkey is to put a blind fold on him as they enter the casino. The black jack dealer can turn over any cards they want and we wouldn’t know. The craps dealer can change the dice to 7 out when ever they want. The roulette dealer can drop the ball in any one of the 38 slots on the wheel (37 if you are playing in Monte Carlo). The rules have changed and when you couple that with the uncertainty in the market place, it is a wild and discouraging game to be playing.

So let’s make some money.

Cramer reported on some none bad news for Bank of America, a stock we hold in a few accounts (we stopped out after a 9% loss in the main account), and I can see his point as it has an expected growth of 10% and a book value of 23 dollars a share and target prices in the 20-28 dollar range. It is just a question of waiting to see what the actual regulation of the banks looks like now that we have the legislation passed. If you own, watch your bottom but hang on to it. If you need a bank to diversify look at BAC, C or WFC.

INTC is my worst performing stock at this moment in time. We are down 12% on a large long position and we are down 74% on a sizable call option dated January 2011. The recent acquisitions are good for the long term prospects of the company. Obviously Otellini has convinced the board that the purchase of McAfee and Infineon, are strategic and critical to protecting market share and more importantly their 60% margin. The purchases do make sense. The future of technology revolves around being SMRFy, an acronym you have NEVER before seen until today. Can you figure it out? Secure, Mobile, Reliable, and Fast. Combining Infineon’s skills set with McAfees security prowess with the economic scale of INTC should create an enterprise perfectly positioned to become an all around solution to mobile based secure transactional hardware for the likes of Apple, HTC, Motorola, and Nokia. If I were ARM Holdings, I’d have a hard time sleeping tonight.

A side note and this has not had much press, INTC and McAfee have been working together for almost two years. Someone in the legal department at MAY have said that no matter how they try, it might be difficult to come up with secure chip technology without infringing upon McAfee technology and or it would not preclude McAfee to go out and offer that technology to AMD or Broadcom. Food for thought possibly explaining the 60 % premium they spent.

We will be very patient with INTC and consider it a 3 year play, taking dividends along the way. By then, we are expecting an easy double.

Tomorrow is another day.

We have consumer confidence reporting tomorrow and the oracles of wisdom are predicting a slight bump to 51. Personally I don’t see it. The time period surveyed is July and while the UofM report showed a little hope, we don’t see it so look for a disappointment to 48.5. Other than that, there is little news reporting tomorrow. The Chicago Purchasing Index reports and everyone is rightly expecting the number to be down. (I am thinking 54 compared to the expected 56.) And there is a retail report tomorrow that should also disappoint.

As far as earnings, we are getting to the bottom of the barrel in the earnings season. I had to go and look for anyone reporting tomorrow that might matter. Yahoo shows Dollar General DG reporting but I can’t confirm it anywhere. If the date has not been moved they are expecting 38 cents a share. A little bit of homework has me thinking they can beat, possible 40 cents a share. I found a sleeper (Maybe) with Lebarge LB, a defense contractor trading at a multiple of 9 and has recently been awarded a series of contracts from Lockeed, Boeing, and Sikorsky. They are looking for 27 a share in earnings. Look for a sizable beat, say 32 a share. And look for a 1-2% bump regardless of the market. My guess is based upon some interesting upside volume. (People bidding the stock higher by actually buying the stock.) DO YOUR HOMEWORK.  I am agin cash poor so we are not taking a position in LB. 

Saving the economy one house at a time:

Realizing the housing market is so important to the economy, President and First Lady Obama, spent their holiday showing perspective buyers some new homes. 

Salve Lucrum


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