There is a certain optimism that lies at the heart of both New Year's resolutions and annual investment forecasts for the coming year. With the former, that optimism is based on the belief that we can muster the self-discipline and willpower that were lacking in the past. As for the latter, the optimism comes from thinking that we will be possessed with greater insight to make more profitable investment decisions. Both resolutions and forecasts are steeped in the illusion that turning a page on the calendar makes all of this easier, that maybe some special door to redemption opens wider when the clock strikes midnight on New Year's Eve. Another chance to adopt healthier habits or realize higher returns. Perhaps the true benefit of both exercises is that they lead us to acknowledge what we need to change, either in our lives or in our portfolios. When we are filled with the conviction of optimism, anything seems possible. Let the glass be half full for a few weeks, until we feel compelled to drink it empty.
This is the time of year when investment analysts and market prognosticators of all stripes roll out their lists of "best ideas" for the coming year. We'll take a look at some of those stock ideas, especially in light of how they fit with various economic and business trends that have been in place for some time now. First, let's take a short look into the rear view mirror at the year we are leaving behind.
Looking Back at 2011
As Bette Davis, playing Margo Channing in the 1950 movie All About Eve, famously said, "Fasten your seat belts. It's going to be a bumpy night" (often misquoted as "bumpy ride"). That quote would have made for an apropos prediction one year ago for the bumpy days and sleepless nights of 2011--about 365 of them. Consider the stock of Disney (DIS, $37), a stock I own as a long-term core holding, as an example. DIS is up close to 20% over the past three months, which is great. If we look back over the entire year, however, DIS is essentially unchanged, now trading at where it began 2011. That tells the story of how the overall market has behaved, with the S&P 500, a broad measure of the market, virtually unchanged over the last year. The Dow Jones Industrial Average (DJIA, 30 stocks) has fared better, up about 6% for the year, with McDonalds (MCD, $99) as the top performer, up 30%. Why McDonalds? That's worth keeping in mind as we look at some investment trends and themes that may extend into 2012. McDonalds has been in what I think of as the "sweet spot" that combines a larger trend with flawless execution by the company's management. MCD offers cheap, fast food (though probably not on your New Year's resolutions menu), and that's important in an economy where so many consumers are price-conscious. They are also effectively pursuing their ambitious plans for international expansion. We want to find other companies that may be positioned in such a sweet spot. As Mark Twain once noted, "History does not repeat itself, but it does rhyme."
The "Tale of Two Cities" Economy
Economic pundits and editorial writers have been telling us for some years now that the middle class in America is disappearing, due in part to the off-shoring of manufacturing, once the source of so many well-paying blue collar jobs. What gets my attention is when I see a major corporation investing real money to adapt to the trend. That is apparently what Proctor and Gamble (PG, $66), maybe the world's greatest marketing company, is doing. In a Wall Street Journal article from September 12, 2011, "As Middle Class Shrinks, P&G Aims High and Low," Ellen Byron details how the company, which has historically excelled by marketing its range of products to a vast American middle class, now is gearing certain of its products to the lower-end consumer and other brands to a separate higher-end consumer as the big middle evaporates. When P&G puts money behind it, you know there is more here than just a cyclical downturn in the business cycle. In an earlier post we looked at the discount stores (Ross Stores, TJ Maxx, and Dollar Tree), but there is another side to the tale, and that is the resilience of the high-end luxury market.
Coach (COH, $61), the retailer of luxury accessories for women and men, is a company that is successfully executing a global expansion strategy, especially in Asia. I would also consider Whole Foods Market (WFM, $70) as part of the high-end space, along with Hain Celestial Group (HAIN, $37), which makes natural and organic food and personal care products sold at places like Whole Foods. A trip to WFM might even be on your New Year's resolutions list, but even if you don't stick with healthier eating habits, this is a major trend that is likely to be in place for quite some time.
The New World of Energy
No, this is not about solar energy or wind power, two of the so-called "renewable energy" themes. This is about the same old oil and gas that's been in the ground and new technologies for getting it out. Through a process known as hydraulic fracturing ("fracking"), drillers can break up the rock in which oil and gas deposits are trapped. That's a big deal, because those trapped deposits have been inaccessible until the advent of the new technology. Fracking involves shooting massive amounts of water mixed with certain chemicals to break up the rock, and this has environmentalists up in arms. (Personally, I think the environmentalists just plain don't like the oil and gas industry, period. Gandhi could be running Exxon and they still wouldn't like it.) From all that I have read on the subject, I have to conclude that the process is safe as long as there are reasonable safeguards in place to protect drinking water sources from contamination. The fracking occurs below the water table, anyway. Unlocking these sources of energy could mean thousands of jobs here in the United States and make us a net energy exporter for the first time in about 60 years. The implications are significant not just in the economic sense, but also in the geopolitical sense.
The other long-term theme here is the growing world demand for energy as economies around the world become more advanced and require more oil and gas.Who will benefit from the increased drilling activity? It's worth taking a close look at companies in the oil service sector, because more drilling means increased demand for their products and services. The blue chip company here is Schlumberger (SLB, $67), which provides technology and project management services to the international oil and gas exploration and production industry. A lesser-known company is National Oilwell Varco (NOV, $67), which manufactures and services the systems and consumables used in drilling. NOV has an impressive order backlog that goes out to 2014. My favorite of the major oil companies is Conoco Phillips (COP, $72), a global integrated energy corporation. COP recently announced the splitting of the company into an upstream (exploration and production) company and a separate downstream (refining) company. Moves of this nature can unlock value for shareholders, as the "sum of the parts" can be greater than the company is valued as a whole, single entity.
Shopping in Your Pajamas
I am sure there are still some people who think (mistakenly) of Amazon as a technology company. The truth, though, is that Amazon (AMZN, $173) is a technology company only in the sense that FedEx (FDX, $83) is an airplane company. The genius of both companies is that they used an existing technology (the Internet and airplanes) to totally remake their respective industries (retail and delivery). Online shopping is a major trend--no news flash there--and Amazon is chief among the many companies that are the beneficiaries of "pajama shopping." FDX and UPS (UPS, $73) will also benefit, because somebody has to deliver all those goodies. There are casualties as well, as there always are with what the economist Joseph Schumpeter called "creative destruction," and the brick-and-mortar bookstores are just the first among the companies that will either bite the dust or stagnate if they fail to adapt.
Being somewhat of a sentimentalist, I dread the prospect of having to someday explain to my grandson how people actually used to browse in something called "bookstores." I try to shop in such places whenever I can, but the stores are not doing much to help their own cause. A few years ago I went shopping at a local bookstore, and I was told by the sales person that the book I wanted was not in stock, but they could have it for me in two weeks. Two weeks! Had these people not heard of Amazon and FedEx? Just recently I was in the same bookstore and asked for the weekly edition of Barrons's. After a confused look from the clerk, I was directed to the Barron's educational series. If these retailers want to survive in real space instead of just cyberspace, they have got to think in terms of how their physical space can be a competitive advantage--top- notch customer service would be a nice start. One company that has figured this out is TJ Maxx (TJX, $65). Just take a look at their Website, http://www.tjmaxx.com. The company promotes a "treasure hunt" type atmosphere that derives from their business model of getting excess inventory of designer-label merchandise into the stores quickly. This drives their growing following of "Maxxinistas" into the stores frequently, and customers can post their latest finds on the company's Website. Look, someone got a Michael Kors bag for $149.99, was $248 retail. Let's go shopping--and I mean go literally, because you actually have to go there.(My wife and I were in TJ Maxx yesterday.)
Fifty-Seven Channels (and Nothin' On)
When Bruce Springsteen recorded that song, he wasn't being forward-looking enough. There are a whole lot more than 57 channels now, but he did get the part right about nothin' being on. Well, actually there is plenty on--just not that much worth watching. The point, though, is that something has to fill all of those channels, and that is why I have long held an interest in media content companies. My favorite company in this space is Disney (DIS, $37). In addition to the media assets that bear the Disney name, the company also owns ESPN, the ABC television network, Pixar Animation Studios, and Marvel Entertainment (Marvel Comics). Disney's total market capitalization (the market value of the entire company) is about $67 billion. To put that in some perspective, that is less than just the cash that Apple keeps in the bank. Another interesting company in this space is Viacom (VIAB, $45), which owns the Paramount film studio (which includes the Star Trek, Transformers, Mission Impossible, and Indiana Jones franchises), MTV, and Nickelodeon. Both companies own extremely valuable copyrighted assets, but the success of their stocks will depend on how adept they are at turning those assets into earnings. I think Disney's stock has a good shot at becoming the McDonald's of 2012.
The broad idea of content also includes video games. The two key players here are Electronic Arts (EA, $21), whose newest video game is based on Star Wars, and Activision Blizzard (ATVI, $12), known for Guitar Hero and World of Warcraft. The much smaller ($111 million market cap) Majesco Entertainment (COOL, $2.41) put itself on the map with the Zumba Fitness series. So, you can have yourself a little dance-fitness workout before heading to Whole Foods Market for some tofu--and you'll be keeping two New Year's resolutions!
I'll post the second part of this article within a few days. Please remember that I am not recommending that you buy any of the stocks mentioned here. I do suggest that you look further at any of them that pique your interest and talk with your financial adviser to determine if some of them might work with your risk level and portfolio diversification.
Happy New Year! Be safe, and remember.....
Life is short. Get busy.
Jim
Thursday, December 29, 2011
Thursday, December 15, 2011
Surviving The Volatility
Raymond Chandler, one of my all-time favorite writers, describes a female character in Farewell, My Lovely as "a blonde who could make a bishop kick a hole in a stained glass window." Priceless. We know just what Chandler means about a woman who could provoke such frustration in a man of the cloth. The market is provoking some frustration of its own these days, different but no less visceral. Frustration that could make an investor want to kick a hole in something. These wild swings in the market--up and down 100 points or more, almost day after day--can lead investors to just throw up their hands and wonder whether this "white-knuckle" experience can really be worth it. I think perseverance will ultimately pay off, so we'll look at the source of all this volatility so we can better understand the current environment, and we'll examine some steps we can take so we can sleep better at night--or at least avoid kicking in our computer screens.
The economic recovery coming out of the recent recession has been anything but robust, with tepid job creation and other economic numbers that, while positive, have been weaker than what we usually see coming out of an economic downturn. Investors have viewed the recovery as fragile and vulnerable, capable of being "knocked over with a feather." This past summer, the concerns about a so-called "double-dip" recession took center stage, and the market took a nosedive. A return to recession conditions would mean that expectations of future earnings were too high (earnings per share are the denominator in the P/E ratio, so if the expected earnings turn out to be too optimistic, stock prices are likely to fall). The market started to price in the prospect of slower growth--or no growth, or worse, negative growth--and stocks fell. When it appeared that the recovery was still on track, stocks rallied, until the European crisis replaced the double-dip as the major concern. The market has been struggling with two opposing forces: relatively good economic news at home and bad new from overseas. When it looks like the Europeans are getting their financial act together, stocks have a good day. When it looks like they really have not effectively dealt with the crisis, stocks have a bad day. And so on. This volatility is likely to persist for some time, so we need think about our risk tolerance and conduct a little portfolio check-up.
Let's consider the nature of risk. No one boards an airplane and thinks about the "risk" that the flight will land safely at its destination. No, we think of risk in terms of bad things, the risk of loss: having our house burn down, getting sick, losing a job, having our business fail.. In the financial sense, though, risk more explicitly includes the potential for good, as well as bad, outcomes. Put another way, risk is the chance that the actual outcome will be different from the expected outcome, perhaps better than expected or worse than expected. If we insist on being exposed to no risk whatsoever, then we might as well put all of our investment money in Treasury Bills (if we put it under the mattress, it could be stolen or burn up in a house fire). In order to have the potential for higher returns, we have to take some risk. It is the potential for those higher returns that compensates us for taking the commensurate risk, and as the potential for higher returns grows, so does the potential for big losses. No risk, no reward. No guts, no glory.
We can reduce some of the company-specific risk through portfolio diversification. We want to own stocks in a variety of different industries, where some are less sensitive to the economic cycle than others. I also like stocks that pay dividends, so that we are not only "paid to wait" for future capital appreciation, but also "paid to endure" the volatility, as well. Right now, the market is offering up some some very attractive dividend yields in several different industries. We need some low-Beta stocks in the consumer staples area, such as Proctor and Gamble (PG, $64, 3.25% yield), Kraft (KFT, $36, 3.20% yield), and Pepsi (PEP, $64, 3.20% yield). We might want to take a look at Johnson and Johnson (JNJ, $63, 3.60% yield) in diversified healthcare and Merck (MRK, $35, 4.80% yield) in pharmaceuticals. You wouldn't know it from the recent action in the stocks, but growing worldwide demand for energy is a major investment theme where investors should have some exposure. Conoco Phillips (COP, $68, 3.70% yield) would be a portfolio candidate here. We could also consider an oil-services company like Schlumberger (SLB, $67, 1.4% yield). Not all of our companies need to pay big dividends, and that's a good thing because we'll want some exposure to technology. EMC (EMC, $22, no dividend) is a data storage company that stands to benefit from major trends in "big data" and cloud computing. Qualcomm (QCOM, $53, 1.6% yield) supplies the chips and other technologies that go into smartphones and other wireless devices. Finally, we might want to look at a media company like Disney (DIS, $35, 1.65% yield). Disney owns a lot of content, including all of the Marvel Comics characters. Disney also owns ESPN, and I don't think the value of ESPN is fully reflected in Disney's stock price.
No matter how successful we are at diversification, the inescapable truth of investing is that the majority of a portfolio's return is determined by asset allocation (the relative percentages we invest in stocks, bonds, and hold as cash). We can pick the very best stocks from a variety of industries, but if the overall market is sinking, then we are going to lose money, at least on paper. We can reduce company-specific risk through diversification, but the only way to address the risk of an entire asset class (like stocks) is to manage the percentage of our assets we have exposed to that asset class. The asset allocation decision needs to be based on each investor's own financial profile--there is no "one size fits all" answer here. Someone with 20 or more years until retirement who can regularly add to their investment account from current income can afford to have more exposure to stocks than someone whose retirement is within a few years. Time is usually on our side, and the longer it is until we need the money the more we can allocate to stocks, generally. Stocks would be appropriate for a child's college fund if the child is five years old. By the time he or she gets to high school, however, we need to start converting those investments to cash. The challenge today is that bonds, with the 30-year Treasury yielding 3%, don't seem to offer much compelling value. (There are some values in specific bonds, but you have to find them.) One strategy is to keep some cash and be ready to buy stocks the next time we are ambushed by the news out of Europe.
A few months ago a friend of mine was telling me of his frustration with the market volatility. He said he was thinking of just selling all of his stocks and holding cash until the market settled down. I strongly suggested that he not do that. If he had followed through with his plan, he would have sold at just about the market low since July. That's the problem with what is known as "market timing"--it just doesn't work the vast majority of the time. We might get lucky occasionally, but the typical result is that we end up selling low and buying high. It's important to own some stocks, because that's where we have at least the potential for growth and returns that can exceed what other assets offer right now. We need, though, to understand what we own and why we own it, and to be able to sleep at night with the portion of our investments we have in stocks. Some famous advice from Warren Buffet is worth remembering as well: "Be greedy when others are fearful, and fearful when others are greedy."
If all that can grant you some peace of mind, then I recommend getting away from it all with some diversions. Specifically, pour yourself a cocktail or other libation. I suggest the 12-year old McCallan. Then, pop an old movie into your DVD player and enjoy. I especially like The Big Sleep, starring Humphrey Bogart and Lauren Bacall. That's the movie version of Raymond Chandler's first novel; William Faulkner was one of the screenplay writers. Two other classics in this genre are The Maltese Falcon and The Thin Man, both based on the Dashiell Hammett detective novels. At our house we like to watch The Thin Man on Christmas Day, and it is sort of a Christmas movie in that the story takes place in New York over the Christmas holidays. Then, there's always It's a Wonderful Life and the original Miracle on 34th Street (which features a very young Natalie Wood). Relax, and the only things you'll need to kick are your shoes off.
Life is short. Get busy.
Jim
The economic recovery coming out of the recent recession has been anything but robust, with tepid job creation and other economic numbers that, while positive, have been weaker than what we usually see coming out of an economic downturn. Investors have viewed the recovery as fragile and vulnerable, capable of being "knocked over with a feather." This past summer, the concerns about a so-called "double-dip" recession took center stage, and the market took a nosedive. A return to recession conditions would mean that expectations of future earnings were too high (earnings per share are the denominator in the P/E ratio, so if the expected earnings turn out to be too optimistic, stock prices are likely to fall). The market started to price in the prospect of slower growth--or no growth, or worse, negative growth--and stocks fell. When it appeared that the recovery was still on track, stocks rallied, until the European crisis replaced the double-dip as the major concern. The market has been struggling with two opposing forces: relatively good economic news at home and bad new from overseas. When it looks like the Europeans are getting their financial act together, stocks have a good day. When it looks like they really have not effectively dealt with the crisis, stocks have a bad day. And so on. This volatility is likely to persist for some time, so we need think about our risk tolerance and conduct a little portfolio check-up.
Let's consider the nature of risk. No one boards an airplane and thinks about the "risk" that the flight will land safely at its destination. No, we think of risk in terms of bad things, the risk of loss: having our house burn down, getting sick, losing a job, having our business fail.. In the financial sense, though, risk more explicitly includes the potential for good, as well as bad, outcomes. Put another way, risk is the chance that the actual outcome will be different from the expected outcome, perhaps better than expected or worse than expected. If we insist on being exposed to no risk whatsoever, then we might as well put all of our investment money in Treasury Bills (if we put it under the mattress, it could be stolen or burn up in a house fire). In order to have the potential for higher returns, we have to take some risk. It is the potential for those higher returns that compensates us for taking the commensurate risk, and as the potential for higher returns grows, so does the potential for big losses. No risk, no reward. No guts, no glory.
We can reduce some of the company-specific risk through portfolio diversification. We want to own stocks in a variety of different industries, where some are less sensitive to the economic cycle than others. I also like stocks that pay dividends, so that we are not only "paid to wait" for future capital appreciation, but also "paid to endure" the volatility, as well. Right now, the market is offering up some some very attractive dividend yields in several different industries. We need some low-Beta stocks in the consumer staples area, such as Proctor and Gamble (PG, $64, 3.25% yield), Kraft (KFT, $36, 3.20% yield), and Pepsi (PEP, $64, 3.20% yield). We might want to take a look at Johnson and Johnson (JNJ, $63, 3.60% yield) in diversified healthcare and Merck (MRK, $35, 4.80% yield) in pharmaceuticals. You wouldn't know it from the recent action in the stocks, but growing worldwide demand for energy is a major investment theme where investors should have some exposure. Conoco Phillips (COP, $68, 3.70% yield) would be a portfolio candidate here. We could also consider an oil-services company like Schlumberger (SLB, $67, 1.4% yield). Not all of our companies need to pay big dividends, and that's a good thing because we'll want some exposure to technology. EMC (EMC, $22, no dividend) is a data storage company that stands to benefit from major trends in "big data" and cloud computing. Qualcomm (QCOM, $53, 1.6% yield) supplies the chips and other technologies that go into smartphones and other wireless devices. Finally, we might want to look at a media company like Disney (DIS, $35, 1.65% yield). Disney owns a lot of content, including all of the Marvel Comics characters. Disney also owns ESPN, and I don't think the value of ESPN is fully reflected in Disney's stock price.
No matter how successful we are at diversification, the inescapable truth of investing is that the majority of a portfolio's return is determined by asset allocation (the relative percentages we invest in stocks, bonds, and hold as cash). We can pick the very best stocks from a variety of industries, but if the overall market is sinking, then we are going to lose money, at least on paper. We can reduce company-specific risk through diversification, but the only way to address the risk of an entire asset class (like stocks) is to manage the percentage of our assets we have exposed to that asset class. The asset allocation decision needs to be based on each investor's own financial profile--there is no "one size fits all" answer here. Someone with 20 or more years until retirement who can regularly add to their investment account from current income can afford to have more exposure to stocks than someone whose retirement is within a few years. Time is usually on our side, and the longer it is until we need the money the more we can allocate to stocks, generally. Stocks would be appropriate for a child's college fund if the child is five years old. By the time he or she gets to high school, however, we need to start converting those investments to cash. The challenge today is that bonds, with the 30-year Treasury yielding 3%, don't seem to offer much compelling value. (There are some values in specific bonds, but you have to find them.) One strategy is to keep some cash and be ready to buy stocks the next time we are ambushed by the news out of Europe.
A few months ago a friend of mine was telling me of his frustration with the market volatility. He said he was thinking of just selling all of his stocks and holding cash until the market settled down. I strongly suggested that he not do that. If he had followed through with his plan, he would have sold at just about the market low since July. That's the problem with what is known as "market timing"--it just doesn't work the vast majority of the time. We might get lucky occasionally, but the typical result is that we end up selling low and buying high. It's important to own some stocks, because that's where we have at least the potential for growth and returns that can exceed what other assets offer right now. We need, though, to understand what we own and why we own it, and to be able to sleep at night with the portion of our investments we have in stocks. Some famous advice from Warren Buffet is worth remembering as well: "Be greedy when others are fearful, and fearful when others are greedy."
****************************************
If all that can grant you some peace of mind, then I recommend getting away from it all with some diversions. Specifically, pour yourself a cocktail or other libation. I suggest the 12-year old McCallan. Then, pop an old movie into your DVD player and enjoy. I especially like The Big Sleep, starring Humphrey Bogart and Lauren Bacall. That's the movie version of Raymond Chandler's first novel; William Faulkner was one of the screenplay writers. Two other classics in this genre are The Maltese Falcon and The Thin Man, both based on the Dashiell Hammett detective novels. At our house we like to watch The Thin Man on Christmas Day, and it is sort of a Christmas movie in that the story takes place in New York over the Christmas holidays. Then, there's always It's a Wonderful Life and the original Miracle on 34th Street (which features a very young Natalie Wood). Relax, and the only things you'll need to kick are your shoes off.
Life is short. Get busy.
Jim
Sunday, December 11, 2011
Putting Apple on the Analyst's Couch
Here's a little statistic that you might find surprising. If Apple stock (AAPL, $394) were to trade at the same price-to-earnings multiple (P/E ratio) as that of Whole Foods Market (WFM, $69), then Apple would be priced at over $850 per share. That is, if the market were to value the earnings of Apple the same as it values the earnings of Whole Foods, then shares of the iPhone and iPad maker would more than double from their current level. To put it another way, the P/E of Apple is about the same as that of the overall market (about 14 times earnings), so Apple, which has delivered average annual earnings per share growth of about 70% over the last five years, has no premium valuation. Does that make AAPL a screaming buy? Maybe, but not so fast. (Put down that phone! as Humphrey Bogart said to Conrad Veidt at the end of Casablanca, just before Bogie shot him.)
From this example we can make several observations about how stocks are valued. First, the price of a stock alone, of course, does not tell us anything about how it is valued. We have to relate that stock price to something like earnings and earnings growth. AAPL's stock price is more than five times the price of WFM's stock, but here we see that AAPL is actually the cheaper stock in relation to earnings, with a P/E of 14 compared with WFM's P/E of 31. The P/E ratio tells us how much we are paying for each dollar of current earnings. It would be nice if successful investing were simply a matter of just finding stocks with low P/E multiples, but there's more to the story. If we look at shares of Lockheed Martin (LMT, $77), the big defense contractor, we'll find a P/E ratio of about 9. That looks cheap at first, until we look at the projected annual growth in earnings for the company, which is about 6%. This leads us to another popular measure of value, the PEG ratio, which is the P/E multiple divided by the projected growth rate. The lower this number, the less we are paying for a company's future growth; any value less than one is generally considered bargain territory. So, here we have LMT at a PEG of 1.5, while AAPL has a PEG of about .90 (assuming 15% projected annual growth in earnings over the next five years, based on the most conservative of the projections I found, though the forecasts range from 15% all the way up to 30%). Once again, AAPL is the cheaper stock, even though LMT has the lower P/E ratio. As for WFM, its PEG ratio is way out of bargain territory, greater than 2.0 (assuming, again, a conservative projected earnings growth rate of about 12%).
Any number of factors can influence a stock's P/E ratio, one of which is the basic nature of the company's business. Whole Foods Market, for all of its quality, healthful offerings and its trendy appeal (as if Apple didn't have some bragging rights of its own as to trendiness), is still in the grocery store business, typically a low-margin enterprise. WFM's net profit margin is a respectable 3.4% compared with Kroger's 1.4%. (Apple clocks in at 24%.) WFM deserves a premium valuation relative to other grocery stores due to its margins and promising growth prospects, but I have to conclude that the stock is a bit pricey at 31 times earnings. And just because WFM may be overvalued does not mean that AAPL is undervalued. What is more compelling about AAPL's valuation is its lack of a premium to the overall market, especially given the company's growth prospects.
Here we need to emphasize one of our basic investing rules, that regardless of what has happened in the past, stock prices are determined by what is expected to happen in the future. We could be making money hand-over-fist as shareholders in the most profitable buggy-whip-making business in the 19th century world, but the dawn of the automobile era is going to lead to a major reversal of our fortunes. Lockheed Martin's stock is trading at low valuations because the market expects the government's defense spending to be cut as the politicians in Washington attempt, however feebly, to reduce the nation's deficit. If France were to declare war on the United Sates tomorrow, that would all change as investors change their outlook for LMT's earnings. I can insist all day long that Apple's stock is undervalued, but given the choice between hubris and humility, I'll choose to be humble and acknowledge that the market is pricing some concerns about the future into Apple's stock price.
Let's tally up, then, the bullish (positive) and bearish (negative) arguments for Apple. The bears will point to the death of Steve Jobs as a source of uncertainty for the company's future. Jobs was perhaps our generation's greatest visionary in the world of business and technology, and the loss is especially tragic given his young age. However, I don't expect the change in leadership to adversely affect the company's appeal to investors. Great companies tend to be quite good at building on past successes and thriving through such changes. Of greater concern is the competitive threat, the proverbial "better mousetrap" that hardcore Apple enthusiasts will deny could ever exist, but which investors know is entirely plausible. Samsung's Galaxy phone and Amazon's Kindle Fire lead the list here of challengers to the hegemony of Apple in smartphones and tablets.
The bulls will argue that such competitive concerns are already priced into the stock, and I'll give them that. They'll also point to the "ecosystem effect" of Apple's products, where the benefits of integration across the company's different products make it less likely that current users would switch to another brand of one product. The bulls will also point to Apple's global opportunities and the potential of new products and trends such as televisions and mobile payment technologies.
Investors are also, no doubt, cognizant of Apple's hefty market capitalization (the price per share times the number of shares outstanding, which is the market value of the entire company). With a $365 billion market capitalization, AAPL is the second most valuable company in the world, just behind Exxon Mobil (XOM) at $395 billion. If Apple's earnings do grow by 15% per year over the next five years, it will be earning about $50 per share within that time frame. And if the market were to attach a higher (premium) P/E to Apple's earnings (or if the overall market trades at a higher P/E), it is not inconceivable that the stock could be closing in on $1,000 per share in a few years. That would put Apple's market capitalization within striking distance of $1 trillion. Could any company be worth that much? That question was probably raised when the first company crossed the $100 billion mark and every $100 billion after that.
Financial history is full of buggy-whip destroyers, though. If you are fortunate enough to have bought AAPL when the iPhone was just a twinkle in the firing synapses of Steve Jobs's magnificent brain, then your immensely profitable ride likely is not over, but the best returns are probably in the rear view mirror. The "next Apple" could indeed be Apple, but I wouldn't bet the farm on it. I expect Apple to get a boost from strong holiday sales and, barring the unexpected, probably approach $500 per share over the next 12 months, for a return of 25% from the current level. The stock is far from being "priced to perfection," and that gives investors a decent entry point here.
I plan to devote a small section of this blog to what I call "diversions." Making money is fun, but the real fun comes from using those material gains to enrich the lives of other people--the people we love and care about, our friends and family, and those in need across our broader community. I can't think of anything, really, that is more important to living a meaningful life. And that's true not just at Christmas, but each and every day of the year. So, we'll be taking a look here at some ways that we can be successful, not just at investing, but also at the business of life.
Today I'll mention how much I like to support locally-owned and home-grown Memphis businesses. I've always loved High Point Grocery (I wonder how their margins are...), just around the corner from our house. I've become even more determined to spend my grocery dollars there since the Kroger Monster invaded. High Point has an especially good butcher, Steve, and a fabulous meat department. If you go in the store, be sure to sign the email list so they can send you the list of weekly specials. Some really great deals here.
I'll also be frequenting Maggie's Pharm, in Overton Square. It's one of my favorite spots for fun gifts. While I'm roaming through Midtown, I'll also stop by Burke's Bookstore in Cooper-Young and probably grab a milkshake at Wile's-Smith Drugstore.
I have a contest with myself every Christmas to see if I can do all of my shopping without entering one single shopping mall. This year I'm going to win.
Life is short. Get busy.
Jim
From this example we can make several observations about how stocks are valued. First, the price of a stock alone, of course, does not tell us anything about how it is valued. We have to relate that stock price to something like earnings and earnings growth. AAPL's stock price is more than five times the price of WFM's stock, but here we see that AAPL is actually the cheaper stock in relation to earnings, with a P/E of 14 compared with WFM's P/E of 31. The P/E ratio tells us how much we are paying for each dollar of current earnings. It would be nice if successful investing were simply a matter of just finding stocks with low P/E multiples, but there's more to the story. If we look at shares of Lockheed Martin (LMT, $77), the big defense contractor, we'll find a P/E ratio of about 9. That looks cheap at first, until we look at the projected annual growth in earnings for the company, which is about 6%. This leads us to another popular measure of value, the PEG ratio, which is the P/E multiple divided by the projected growth rate. The lower this number, the less we are paying for a company's future growth; any value less than one is generally considered bargain territory. So, here we have LMT at a PEG of 1.5, while AAPL has a PEG of about .90 (assuming 15% projected annual growth in earnings over the next five years, based on the most conservative of the projections I found, though the forecasts range from 15% all the way up to 30%). Once again, AAPL is the cheaper stock, even though LMT has the lower P/E ratio. As for WFM, its PEG ratio is way out of bargain territory, greater than 2.0 (assuming, again, a conservative projected earnings growth rate of about 12%).
Any number of factors can influence a stock's P/E ratio, one of which is the basic nature of the company's business. Whole Foods Market, for all of its quality, healthful offerings and its trendy appeal (as if Apple didn't have some bragging rights of its own as to trendiness), is still in the grocery store business, typically a low-margin enterprise. WFM's net profit margin is a respectable 3.4% compared with Kroger's 1.4%. (Apple clocks in at 24%.) WFM deserves a premium valuation relative to other grocery stores due to its margins and promising growth prospects, but I have to conclude that the stock is a bit pricey at 31 times earnings. And just because WFM may be overvalued does not mean that AAPL is undervalued. What is more compelling about AAPL's valuation is its lack of a premium to the overall market, especially given the company's growth prospects.
Here we need to emphasize one of our basic investing rules, that regardless of what has happened in the past, stock prices are determined by what is expected to happen in the future. We could be making money hand-over-fist as shareholders in the most profitable buggy-whip-making business in the 19th century world, but the dawn of the automobile era is going to lead to a major reversal of our fortunes. Lockheed Martin's stock is trading at low valuations because the market expects the government's defense spending to be cut as the politicians in Washington attempt, however feebly, to reduce the nation's deficit. If France were to declare war on the United Sates tomorrow, that would all change as investors change their outlook for LMT's earnings. I can insist all day long that Apple's stock is undervalued, but given the choice between hubris and humility, I'll choose to be humble and acknowledge that the market is pricing some concerns about the future into Apple's stock price.
Let's tally up, then, the bullish (positive) and bearish (negative) arguments for Apple. The bears will point to the death of Steve Jobs as a source of uncertainty for the company's future. Jobs was perhaps our generation's greatest visionary in the world of business and technology, and the loss is especially tragic given his young age. However, I don't expect the change in leadership to adversely affect the company's appeal to investors. Great companies tend to be quite good at building on past successes and thriving through such changes. Of greater concern is the competitive threat, the proverbial "better mousetrap" that hardcore Apple enthusiasts will deny could ever exist, but which investors know is entirely plausible. Samsung's Galaxy phone and Amazon's Kindle Fire lead the list here of challengers to the hegemony of Apple in smartphones and tablets.
The bulls will argue that such competitive concerns are already priced into the stock, and I'll give them that. They'll also point to the "ecosystem effect" of Apple's products, where the benefits of integration across the company's different products make it less likely that current users would switch to another brand of one product. The bulls will also point to Apple's global opportunities and the potential of new products and trends such as televisions and mobile payment technologies.
Investors are also, no doubt, cognizant of Apple's hefty market capitalization (the price per share times the number of shares outstanding, which is the market value of the entire company). With a $365 billion market capitalization, AAPL is the second most valuable company in the world, just behind Exxon Mobil (XOM) at $395 billion. If Apple's earnings do grow by 15% per year over the next five years, it will be earning about $50 per share within that time frame. And if the market were to attach a higher (premium) P/E to Apple's earnings (or if the overall market trades at a higher P/E), it is not inconceivable that the stock could be closing in on $1,000 per share in a few years. That would put Apple's market capitalization within striking distance of $1 trillion. Could any company be worth that much? That question was probably raised when the first company crossed the $100 billion mark and every $100 billion after that.
Financial history is full of buggy-whip destroyers, though. If you are fortunate enough to have bought AAPL when the iPhone was just a twinkle in the firing synapses of Steve Jobs's magnificent brain, then your immensely profitable ride likely is not over, but the best returns are probably in the rear view mirror. The "next Apple" could indeed be Apple, but I wouldn't bet the farm on it. I expect Apple to get a boost from strong holiday sales and, barring the unexpected, probably approach $500 per share over the next 12 months, for a return of 25% from the current level. The stock is far from being "priced to perfection," and that gives investors a decent entry point here.
***************************************
I plan to devote a small section of this blog to what I call "diversions." Making money is fun, but the real fun comes from using those material gains to enrich the lives of other people--the people we love and care about, our friends and family, and those in need across our broader community. I can't think of anything, really, that is more important to living a meaningful life. And that's true not just at Christmas, but each and every day of the year. So, we'll be taking a look here at some ways that we can be successful, not just at investing, but also at the business of life.
Today I'll mention how much I like to support locally-owned and home-grown Memphis businesses. I've always loved High Point Grocery (I wonder how their margins are...), just around the corner from our house. I've become even more determined to spend my grocery dollars there since the Kroger Monster invaded. High Point has an especially good butcher, Steve, and a fabulous meat department. If you go in the store, be sure to sign the email list so they can send you the list of weekly specials. Some really great deals here.
I'll also be frequenting Maggie's Pharm, in Overton Square. It's one of my favorite spots for fun gifts. While I'm roaming through Midtown, I'll also stop by Burke's Bookstore in Cooper-Young and probably grab a milkshake at Wile's-Smith Drugstore.
I have a contest with myself every Christmas to see if I can do all of my shopping without entering one single shopping mall. This year I'm going to win.
Life is short. Get busy.
Jim
Wednesday, December 7, 2011
'Tis The Season.....
My wife is an inveterate and skilled bargain hunter, but she is no cheapskate. Her shopping mission, I have learned, is to save as much money as possible on those things that really don't matter that much to our quality of life so that we'll have more money for those things that do matter. She may be buying razor blades and paper towels at Costco, but she's definitely not collecting recipes that call for Spam as the main ingredient. Not long after our Thanksgiving weekend wedding six years ago, she pointed out to me that I really did not need to shop for Christmas stocking stuffers at Joseph (a high-end retailer of women's fashions and accessories here in Memphis). She recommended Dollar Tree (DLTR) as a more responsible and reasonable source for the treats that Santa doesn't gift wrap. Since then, the stockings that are hung by our chimney with care are no longer overflowing with Creed fragrances and Erno Laszlo skin emollients, but this much is certain: no one in our family will ever, ever run out of dental floss.
I wish that Santa had stuffed my stocking last Christmas with shares of Dollar Tree stock.On the last trading day before Christmas 2010, DLTR closed at $56.77. Today it is trading around $82, up some 44% in just less than a year. Two other companies in the discount space, TJX (TJX, owner of Marshalls and T.J. Maxx) and Ross Stores (ROST), have similar gains over that same time frame, up about 42% and 45%, respectively. That is stellar performance in a market where the S&P 500 index has been essentially flat over the last year. These discount retailers have also beaten handily other retailers in the performance sweepstakes: WalMart (WMT) is up about 10%, Macy's (M) up 29%, and Target (TGT) is down about 11% since last Christmas. The discount stores have clearly been the place to be for investors (and obviously for shoppers), but will they continue to be the place to be in the future?
Here we'll step back and look at a couple of investing basics. First, the greatest company in the world is not necessarily going to be the greatest stock in the world unless the price is right. Successful investing is all about finding stocks where future growth opportunities are not fully reflected in the current stock price. There may be mobs of people digging through the bargain bins at Dollar Tree, but that doesn't necessarily mean that the stock is a bargain. We have to make some determination of value. Second, investing is all about what is going to happen in the future, not what occurred in the past. Stock prices are determined by discounting future earnings, and if a stock is "priced to perfection," the company had better deliver on those expectations.When we assess the discount stores as potential investments, we have to understand what started the party in their stocks and whether the party can continue.
We don't have to be economic geniuses to understand why the discount stores have done so well. The U.S. has suffered through the worst recession since the Great Depression, and the recovery does not seem to be able to gain serious traction. It is no surprise, then, that consumers have changed their shopping behavior in an effort to save a few bucks. Economists like to cite a theory known as the "wealth effect" to explain how consumers spend their money. The idea here is that even if my income stays the same, a major increase in the value of my stock portfolio may lead me to spend more, even if I do not directly use my investment gains to fund those expenditures. Recognizing that I am worth more, at least on paper, I am more comfortable charging a nice vacation on my credit card, eating out more often, grilling more steaks instead of hamburgers, buying another suit, etc. I prefer to call this phenomenon the "balance sheet effect," because the changes in spending behavior are not really the result of our being in the grip of some mysterious, unconscious forces beyond our control. That spending behavior is more the result of a conscious financial calculation based on a complete picture of our resources, not just our disposable income. This balance sheet effect drove overall spending higher when asset values were increasing, but was thrown into reverse with the collapse in stock prices and house values. For most people, their home is their most significant balance sheet asset, and the housing market remains in the doldrums.
Would a truly robust economic recovery, involving a stronger housing market and rising stock prices, lead consumers to abandon the discount stores and return to more profligate spending behavior? I don't think so. In an article in the most recent issue of Vanity Fair (Lady Gaga is on the cover, so you can't miss it), the economist Joseph Stiglitz points out that our economy had some serious problems long before Lehman and mortgage-backed securities made the headlines. Wages, for example, have been stagnant for years, but people kept spending by using their homes as ATM machines. It is amazing how much extravagance you can buy, at least temporarily, with borrowed money (my mother, as a nice Southern Lady, liked to call this "keeping up appearances," and appearance was about as deep as it went). Now the ATM machine has been taken away, leaving lots of people with a debt hangover. That debt needs to be paid off (a process known as "de-leveraging"), and that's going to be a drag on the economy that may leave us vulnerable to the much-feared "double dip" recession. I will point out that the latest economic numbers have been encouraging, and so the dreaded double dip does not appear to be in the cards, at least for now. However, the underlying structural problems in the economy will likely be with us for some time.
I think the discount stores like DLTR, ROST, and TJX have a bright future, but that future is pretty much reflected in the current stock prices. Of the three, I would be inclined to buy some TJX on any pullback that was not related specifically to the company (such as when the overall market declines again by about 500 points, taking the really good stocks down with the average ones). The company's strength seems to be in the relationships it has developed with its vendors and its ability to get designer-label merchandise into its stores quickly, keeping up with prevailing fashion trends. The dividend yield is 1.2%, with dividends at only about 20% of earnings. They also have a nice, long history of annual dividend increases. TJX is definitely worth a closer look. Furthermore, my sense is that TJX and other discount stores will keep--and gain--customers like my wife, who shop there not because they have to, but because they choose to. Saving money, like spending it, has its own addictive properties.
About a month ago, my wife and I went out for some early Christmas shopping and a tour of the discount stores (there is nothing like Summer Avenue in Memphis on a crisp, fall Saturday afternoon). My experience at T.J. Maxx confirmed my investment thesis. The store was busy, clean, and full of attractive merchandise and friendly employees. It was definitely my favorite of the discounters, in terms of both atmosphere and product selection. Maybe Santa will leave me something from that store in my stocking.
*******************************
I won't let today pass without noting that this is the 70th anniversary of Pearl Harbor. December 7th, 1941, was also my late father's 23rd birthday, so growing up I heard lots of stories of the "What were you doing when you heard the news?" variety. The next generation would have stories about November 22nd, 1963, and our own has stories of September 11th, 2001. About the only thing that has truly changed is the speed with which we learn the news. Back in 1941, radio was, of course, the essential medium for "breaking news." Then the newspapers would publish their special editions with details of the story ("Extra! Extra!"). We get news much more quickly today, but the human reaction is pretty much the same. It takes a while for it to sink in that one terrible event is going to change life in countless ways. My father would spend the next four years of his life fighting the war in Europe. I'll be shutting out the market news for a moment and pausing from the Christmas season excitement to give thanks for all of the men and women who have served--and who serve today--our country in uniform. And Happy Birthday, Dad.
Life is short. Get busy.
Jim
Sunday, December 4, 2011
Passing The Potato Chips
December 5th, 2011
If you have any nuts at your house (the edible variety, not your next of kin), then you may be familiar with a company called Diamond Foods (DMND), a purveyor of walnuts, almonds, and other snack foods. Diamond's stock started 2011 trading at about $53 per share. Then, in April, the company announced its plans to purchase the Pringles brand of potato chips from Proctor and Gamble (PG). This caught the attention of Wall Street and sent the shares rocketing higher over the next five months, eventually trading above $90 in mid-September. The thinking was that the Pringles acquisition could more than double Diamnond's sales and position the company as a smaller version of global snack-food behemoth Frito-Lay (owned by Pepsi, PEP).
Then the chips hit the fan. Diamond announced in the fall that they were conducting an internal investigation of some accounting practices involving how the company paid its walnut growers. Investors don't like accounting problems, so they started dumping the stock. In November there was a news report that Joseph Silveira, a member of the company's board of directors and audit committee, had died. CNBC subsequently reported that Mr. Silveira's death was, in fact, a suicide. Diamond stock closed Friday (December 2nd) at $29.30, and the Pringles transaction has been postponed until some time in 2012.
Any suicide is a tragedy, and it is certainly possible that this one had nothing to do with developments at Diamond Foods. However, as an investor (not in Diamond Foods, thankfully), I have come to appreciate the "cockroach theory" of bad news. If you see one cockroach on your kitchen counter, that probably means there are hundreds more living behind the walls. When investors get a whiff of "accounting issues" they tend to assume there is more to the story, and they head for the exits. In fact, more cockroaches have already surfaced in the form of some class action lawsuits that have been filed against Diamond by some shareholders.
Not surprisingly, short sellers have also pounced on the stock. Short selling is the practice of selling a stock that you don't actually own to profit from a decline in the share price. Here's how it works. Let's say that XYZ stock, which you do not own, is trading at $50 per share, and you are convinced that it is overpriced. You enter into an arrangement with your broker to sell short 1,000 shares, which your broker will "borrow" to deliver to the buyer of those shares. You receive $50,000 as the proceeds of that sale. If the stock trades as you predicted and falls, say, to $30 per share, then you buy 1,000 shares to return the shares you borrowed, but that trade is costing you only $30,000. You just made $20,000 profit. However, if the stock goes to $70 instead of $30, you have lost $20,000, because you ultimately have to buy 1,000 shares. So, stocks can fall quite violently when the short sellers get involved, because in addition to the investors who are selling shares they actually own, you have additional selling pressure from traders who are selling shares they don't own. An important thing to remember about this, from a trading perspective, is that short selling creates future buying pressure. If Diamond stock rallies from its current price, you will probably hear the commentators saying that this is due to "short covering," which refers to investors buying the stock to close out their short positions.
Is it possible that Diamond shares are a buy here at around $30 per share? If it turns out that all of this is about nothing more than some arcane but legal accounting practices, and the company can explain this with clarity and transparency, then perhaps the stock could get on the road to recovery. Remember, though, that the meteoric rise in the stock was predicated on the Pringles deal. If Diamond plans on paying for Pringles with some of its own stock, that currency is worth quite a bit less than it was a few months ago. Would Diamond have to take on more debt to make this work? And what about those lawsuits? I consider the stock "toxic" until we get some explanations and resolutions.
A stock I do like here is that of the company on the other side of the Pringles transaction, Proctor and Gamble (PG). PG is not likely to make you rich, but it is the type of stock that I believe has a place in most diversified investment portfolios, for several reasons. Because PG is in the consumer staples sector, it has a relatively low Beta (.60). Beta is an index number that measures how a stock's price is correlated with the overall market and is calculated using regression analysis (how the stock and the market have moved together in the past). A Beta of 1.0 means that the stock tends to move in lockstep with the broader market; a Beta greater than one suggests the stock will move in the same direction as the market, but with greater magnitude, and so on. PG's relative stability derives from the nature of the products it sells. In hard economic times, people will postpone purchases of consumer discretionary items such as new cars and vacations to Disney World [Ford (F) has a Beta of 1.50, Disney (DIS), 1.05], but they are likely to keep buying PG's products--Tide detergent, Pampers diapers, Gillette razors, Olay skin care products, to name a few. The flip side, of course, is that I am not going to buy more razors or paper towels just because the economy is stronger and my income goes up. Investors tend to favor such stocks when the economic outlook is questionable, but these stocks are likely to under-perform the market when the economy is stronger.
Another thing I like about the stock is its dividend. At about $65 per share, PG has a dividend yield of just under 3.3%. That's pretty compelling when you consider that the yield on the 30-year U.S. Treasury bond is right at 3%. Even more important, though, is that PG has the very welcome habit of increasing its dividend every year (at least it has in the past, for years). The U.S. Treasury, or any other bond issuer for that matter, is not going to increase the interest it pays you while you own their bonds. PG's dividend payout ratio is just about 50% of earnings. This means that the dividend is well-covered by the profits PG makes and that they still have money to invest in new products and other areas of growth.
Regarding PG's sale of Pringles, it is worth noting that this is maybe the last move in a years-long strategy of exiting the food business. PG once owned such brands as Folgers coffee (remember Mrs. Olsen?), Jif peanut butter ("Choosy moms choose Jif"), and Crisco oil and shortening. PG sold those brands so it could focus more on higher-margin personal care products (Gillette, Olay), so the Pringles sale makes sense.
I'll be writing more about dividends in particular and many other investment and economic topics in upcoming posts. As they used to say at the end of PG's soap operas, "tune in again." And remember: Life is short, so get busy.
Jim
Disclaimer and Disclosure: This blog is not intended to serve as specific investment advice. Individual stocks are mentioned here to illustrate various investment concepts and to serve as starting points for interested investors to pursue additional research. My family members and/or I own shares of PG, PEP, and DIS.
If you have any nuts at your house (the edible variety, not your next of kin), then you may be familiar with a company called Diamond Foods (DMND), a purveyor of walnuts, almonds, and other snack foods. Diamond's stock started 2011 trading at about $53 per share. Then, in April, the company announced its plans to purchase the Pringles brand of potato chips from Proctor and Gamble (PG). This caught the attention of Wall Street and sent the shares rocketing higher over the next five months, eventually trading above $90 in mid-September. The thinking was that the Pringles acquisition could more than double Diamnond's sales and position the company as a smaller version of global snack-food behemoth Frito-Lay (owned by Pepsi, PEP).
Then the chips hit the fan. Diamond announced in the fall that they were conducting an internal investigation of some accounting practices involving how the company paid its walnut growers. Investors don't like accounting problems, so they started dumping the stock. In November there was a news report that Joseph Silveira, a member of the company's board of directors and audit committee, had died. CNBC subsequently reported that Mr. Silveira's death was, in fact, a suicide. Diamond stock closed Friday (December 2nd) at $29.30, and the Pringles transaction has been postponed until some time in 2012.
Any suicide is a tragedy, and it is certainly possible that this one had nothing to do with developments at Diamond Foods. However, as an investor (not in Diamond Foods, thankfully), I have come to appreciate the "cockroach theory" of bad news. If you see one cockroach on your kitchen counter, that probably means there are hundreds more living behind the walls. When investors get a whiff of "accounting issues" they tend to assume there is more to the story, and they head for the exits. In fact, more cockroaches have already surfaced in the form of some class action lawsuits that have been filed against Diamond by some shareholders.
Not surprisingly, short sellers have also pounced on the stock. Short selling is the practice of selling a stock that you don't actually own to profit from a decline in the share price. Here's how it works. Let's say that XYZ stock, which you do not own, is trading at $50 per share, and you are convinced that it is overpriced. You enter into an arrangement with your broker to sell short 1,000 shares, which your broker will "borrow" to deliver to the buyer of those shares. You receive $50,000 as the proceeds of that sale. If the stock trades as you predicted and falls, say, to $30 per share, then you buy 1,000 shares to return the shares you borrowed, but that trade is costing you only $30,000. You just made $20,000 profit. However, if the stock goes to $70 instead of $30, you have lost $20,000, because you ultimately have to buy 1,000 shares. So, stocks can fall quite violently when the short sellers get involved, because in addition to the investors who are selling shares they actually own, you have additional selling pressure from traders who are selling shares they don't own. An important thing to remember about this, from a trading perspective, is that short selling creates future buying pressure. If Diamond stock rallies from its current price, you will probably hear the commentators saying that this is due to "short covering," which refers to investors buying the stock to close out their short positions.
Is it possible that Diamond shares are a buy here at around $30 per share? If it turns out that all of this is about nothing more than some arcane but legal accounting practices, and the company can explain this with clarity and transparency, then perhaps the stock could get on the road to recovery. Remember, though, that the meteoric rise in the stock was predicated on the Pringles deal. If Diamond plans on paying for Pringles with some of its own stock, that currency is worth quite a bit less than it was a few months ago. Would Diamond have to take on more debt to make this work? And what about those lawsuits? I consider the stock "toxic" until we get some explanations and resolutions.
A stock I do like here is that of the company on the other side of the Pringles transaction, Proctor and Gamble (PG). PG is not likely to make you rich, but it is the type of stock that I believe has a place in most diversified investment portfolios, for several reasons. Because PG is in the consumer staples sector, it has a relatively low Beta (.60). Beta is an index number that measures how a stock's price is correlated with the overall market and is calculated using regression analysis (how the stock and the market have moved together in the past). A Beta of 1.0 means that the stock tends to move in lockstep with the broader market; a Beta greater than one suggests the stock will move in the same direction as the market, but with greater magnitude, and so on. PG's relative stability derives from the nature of the products it sells. In hard economic times, people will postpone purchases of consumer discretionary items such as new cars and vacations to Disney World [Ford (F) has a Beta of 1.50, Disney (DIS), 1.05], but they are likely to keep buying PG's products--Tide detergent, Pampers diapers, Gillette razors, Olay skin care products, to name a few. The flip side, of course, is that I am not going to buy more razors or paper towels just because the economy is stronger and my income goes up. Investors tend to favor such stocks when the economic outlook is questionable, but these stocks are likely to under-perform the market when the economy is stronger.
Another thing I like about the stock is its dividend. At about $65 per share, PG has a dividend yield of just under 3.3%. That's pretty compelling when you consider that the yield on the 30-year U.S. Treasury bond is right at 3%. Even more important, though, is that PG has the very welcome habit of increasing its dividend every year (at least it has in the past, for years). The U.S. Treasury, or any other bond issuer for that matter, is not going to increase the interest it pays you while you own their bonds. PG's dividend payout ratio is just about 50% of earnings. This means that the dividend is well-covered by the profits PG makes and that they still have money to invest in new products and other areas of growth.
Regarding PG's sale of Pringles, it is worth noting that this is maybe the last move in a years-long strategy of exiting the food business. PG once owned such brands as Folgers coffee (remember Mrs. Olsen?), Jif peanut butter ("Choosy moms choose Jif"), and Crisco oil and shortening. PG sold those brands so it could focus more on higher-margin personal care products (Gillette, Olay), so the Pringles sale makes sense.
I'll be writing more about dividends in particular and many other investment and economic topics in upcoming posts. As they used to say at the end of PG's soap operas, "tune in again." And remember: Life is short, so get busy.
Jim
Disclaimer and Disclosure: This blog is not intended to serve as specific investment advice. Individual stocks are mentioned here to illustrate various investment concepts and to serve as starting points for interested investors to pursue additional research. My family members and/or I own shares of PG, PEP, and DIS.
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