After flirting with the level over several trading sessions, the Dow Jones Industrial Index finally managed to close above 13,000 yesterday (Tuesday), but seems to be taking a breather so far today. What does it mean? While the technicians who study and attribute predictive power to various quantitative measures of the market (resistance and support levels, volume, the number of advancing versus declining issues, etc.) have turned more positive with the market's strength this year, this 1,000 point milestone for the Dow does not rank up there with the major technical indicators. Moving above the 13,000 level is important more for psychological reasons, as this is the first time since May of 2008 (so the first time since the major pain of the Great Recession) that the Dow has managed a move back to where it stood before things really started falling apart. The Dow is the headline-grabber among the major indexes. More significant for the technicians is that the S&P 500 Index has closed above 1370, considered by the chart-followers to be a major resistance level. Either way you look at it, the technical analysts are calling this a bull market.
Investors have seemingly turned their attention away from Europe's woes to focus on the domestic economy and the favorable earnings reports and guidance released during earnings season. Fourth quarter Gross Domestic Product (GDP) growth was revised upward to 3.0% from the previous 2.8% number, and both the Chicago Purchasing Managers Index (PMI) and consumer confidence showed positive readings. About the only negative was the 4% decline in durable goods orders (manufactured goods that have a life of more than three years, including everything from appliances to aircraft) for the month of January, the biggest drop in three years. On balance, the news on the economy has been good, and the market managed to advance yesterday in spite of the weak durable goods number.
My argument continues to be that the biggest positive for stocks is the meager return available on bonds. Someone said recently that Treasury bonds are typically viewed as offering return with no risk, but what bond investors are getting now is risk with no return. As I have noted before here, the guarantee that your principal will be returned at maturity can still result in a negative real return if the purchasing power of those dollars has eroded. Investors flocked to bonds (known as the "risk-off" trade) because of the perceived risks to equities (the "risk-on" trade), namely the hit to earnings that would result from a weakening economy. As it becomes clearer that the economy is not at great risk, investors have bought stocks and moved stock prices higher. With the Federal Reserve still concerned about the employment situation (Mr. Bernanke has been on television today saying that the Fed does not expect meaningful reductions in unemployment), we'll likely see the Fed doing everything it can to keep interest rates low and the recovery going. Many people will think I have lost my mind to say this, but I think there is some risk of another speculative asset bubble in stocks. We are not there now, but there is a tremendous amount of liquidity sloshing around in the world. We will keep a sharp eye on that.
Pain at the Pump
In case you haven't noticed, gasoline prices have been on the rise, chiefly the result of concerns about what might flare up between Israel and Iran. Substantially higher gas prices could choke off the economic recovery, and it's worth looking at what economists mean when they say that higher gas prices are like a "tax" on consumers. If the price of gas were to fall by a great amount, I doubt any of us would respond by driving more so we could buy more of it ("Gas is cheap, let's drive an extra 20 blocks to the grocery store!"). Similarly, an increase in the price at the pump, within a certain range, will not cause us to consume less of it, at least in the short run. Economists refer to this as a case of inelastic demand, where the amount demanded stays the same over a range of prices. The result is that we end up spending more of our income on gas when the price goes up, because we are unable to make immediate changes in our consumption. Now, if we think that the price of gas will remain at very high levels, we might think about buying a more fuel efficient vehicle--but we can't make that change in the short run, so the immediate effect is like a tax that diminishes our ability to purchase other goods and services. As investors, we want to have some exposure in our diversified portfolios to energy companies, which stand to benefit as prices go up. Two names we have mentioned before here are Conoco-Phillips (COP, $77) and Schlumberger (SLB, $78), the oil-services giant.
The End of the Diamond Foods Saga
In my very first post to this blog, back in December, I wrote about how Diamond Foods (DMND, $24) had planned to buy the Pringles brand from Proctor and Gamble (PG, $67), but that the deal was in jeopardy because of some accounting questions about how DMND had paid their walnut growers. The point I made was that accounting questions are an example of the "cockroach theory" of bad news--you see one, and you can bet that there are many more. That played out as I expected, with DMND earlier this month announcing that they would be restating their earnings for 2010 and 2011. The stock crumbled like a squished bag of potato chips, and now Kellogg (K, $53) is buying Pringles from PG.
The lesson here is obvious, but it is also worth looking at why the potential Pringles deal sent shares of DMND soaring in the first place. Investors love the stability of earnings from companies in the consumer staples sector, because people buy their food items even when a bad economy causes them to postpone a trip to Disney World or delay buying a new car. The problem is that these companies don't often show a lot in the way of earnings growth. So, when a smaller food company liked DMND comes out with a plan to expand its product portfolio by buying an established brand, that gets investors thinking that they might have hit upon the best of both worlds--the earnings stability of a food company plus some big potential for growth. Now with DMND not going in this direction, what does it mean for Kellogg? Well, K is not a small, relatively unknown company, so investors are not likely to bid it up to $90 a share. However, the Pringles deal can be something of a game-changer for K, because they will realize a lot of cost synergies and other efficiencies from their established marketing and distribution expertise. (Yes, Loyal Readers, I did state here earlier in February that I did not own K, but that was before the Pringles acquisition was announced, and I do view that as a catalyst.) While I prefer higher growth companies and those that will continue to benefit from economic expansion, I also think it is important to be diversified and have some exposure to the consumer staples sector. K might be the best of the group--and possibly "the best to you each morning."
Life is short. Get busy.
Jim
Disclosure/Disclaimer: My family members and/or I own shares of COP, SLB, and K. Individual stocks are mentioned here for the sole purpose of illustrating investment concepts, and nothing here should be construed as advice to buy or sell any security.
Wednesday, February 29, 2012
Wednesday, February 15, 2012
The Search For Yield And The End of Retirement
Just as there are no atheists in foxholes, there are also no strangers at cocktail parties. Every guest, supposedly, has some connection to the host, and when that shared status is leavened with a few Grey Goose martinis, some interesting, albeit not always memorable, conversation can ensue. The stock market was once a standard topic among both friends and veritable strangers, but when the markets became more a source of frustration than of bragging rights, the movements of the Dow Jones surrendered to that other staple of common interest, at least among men--sports. Several months ago, when volatility ruled the trading day, I couldn't help but join in and signal my interest when the stock market was being dissected between nibbles at the olives among a few of those otherwise strangers.
My conversation partner got around to asking me if I was worried about the market, and I replied that, yes, I was somewhat worried about it.
"How low do you think it will go?" this gentleman asked, as if he were just about to receive a bad report from his physician.
"Oh, I'm not so worried about the market going down. I'm worried that it will go up too much," I replied, hoping he would take the bait. He did.
"You must be short," he insisted.
"Five-eight, actually. But no, I don't short stocks." More bait.
"Well then why would you be worried about the market going up?" he demanded, obviously in need of the bartender.
"Because," I explained, "if the market goes up by some tremendous amount, and it's starting to look like another speculative asset bubble, then I am going to be compelled to sell some of my stocks. And then I won't have anywhere to invest the proceeds."
He acknowledged his empty glass and excused himself. I never saw him again.
Back in the early 1980s, as President Reagan took office and just before Fed Chairman Paul Volcker declared war on inflation by ratcheting up interest rates, thus plunging the U.S. economy into a recession, it was possible to take $500,000 and invest in 30-year Treasury bonds, then yielding north of 12%, thereby locking in annual interest income of $60,000+. That may not sound like a fortune, but with the mortgage paid off and the kids out of your house--and your wallet--that's a nice guaranteed annual income for retirement. Today that same $500,000 invested in 30-year Treasuries at 3% would get you a whooping income of $15,000 per year. Low interest rates are great for the economy, for businesses, for stocks, and for people who are buying a home or refinancing a mortgage (borrowers, in other words). Higher interest rates would certainly choke off the economic recovery, so we definitely don't want rates to go higher. The only problem, though, is for savers who need to invest for income, and I think many people just don't realize how challenging it will be to replace their current earnings income in their retirement years.
What to do about this? As Chief Brody (Roy Scheider) in Jaws said to Captain Quint (Robert Shaw) after Brody first saw the Great White up close while the men were on their shark hunt at sea, "You're gonna need a bigger boat." The most obvious solution is that people are going to have to save more over a long period of time so that they will end up with a larger retirement portfolio in their golden years. It's going to take a greater amount of assets to generate a dollar of annual income once those assets are invested to establish an income stream. A bigger boat, indeed. It also means that people need to start saving and investing early, and that their investments need to be focused on growth--the general rule is that the more years you have until retirement, the greater percentage of your assets should be invested in equities to generate that growth. While there is no "one size fits all" rule for financial planning, for most people it makes sense to have significant exposure to stocks when they are young, and then slowly reduce the allocation to stocks and increase exposure to fixed-income (bonds) as they get closer and closer to retirement.
The bigger picture here is that as bond yields have fallen, bonds prices have risen. In order for bond prices to increase, interest rates would have to decline from current levels.There are some prognosticators who say that this recovery will not last and that yields will fall even further. However, if we tally up all the reasons why interest rates don't have much further to fall, it's hard to make a case that bonds are not over-priced. Foreign buyers of Treasuries continue to finance our government's appetite for debt, and the political will to meaningfully reduce the budget deficit seems nonexistent. Easy money from the Fed could ignite inflation down the road. On balance, the forces are arrayed to move interest rates higher (and bond prices lower), not meaningfully in the other direction. Even with the recent rally, stocks still appear more reasonably valued as an asset class than bonds.
Some articles in the financial press have warned of a potential "dividend bubble," as investors chase those stocks that pay attractive dividends. So just where is there any evidence of such a speculative bubble? Johnson and Johnson (JNJ, $65) has a dividend yield of 3.5% (higher than the 30-year Treasury, and JNJ has a better credit rating than the U.S. government); the stock is up about 1.3% over the last six months. Abbott Labs (ABT, $55) yields 3.48% and is up about 10% since August. Pepsi (PEP, $63) yields 3.2% and is up less than 1% in six months. Why have these stocks not risen more? Well, because some of the better dividend-payers are in the consumer staples sector, which typically offers stable earnings, but investors turn their focus to higher-beta, more economically sensitive stocks when the economy is improving. As a result, some of the more reliable dividend-payers are still offering up about the same attractive yields they offered before this most recent move up in the market.
When sizing up dividend-paying stocks, I always look for companies that still have potential for growth and where the dividend payout ratio is no greater than about 65% of earnings. This means that the companies can still invest some of their earnings for future growth--and that the dividend is well-covered by those earnings. The relatively stable earnings we find in consumer staples and healthcare are a plus here. I also like companies that have a solid record of increasing their dividends year after year. The one thing the U.S. Treasury--or any bond issuer, for that matter--will never do is increase the amount of interest you receive each year. If you invest $100,000 in the 30-year bond, you'll receive about $3,000 in interest payments for 30 years. That same $100,000 invested in high-quality stocks of companies that have shown a commitment to returning money to their shareholders has the potential for a much higher total return, a combination of growing dividend payments and capital appreciation.
Of course, dividends, unlike interest payments on Treasury bonds, are not guaranteed. That is why bonds are the preferred investment for people in retirement, because that interest is their only source of income, and it has to be safe and secure. When you are receiving the gold watch, that is not the time to be buying Apple (AAPL, $523, no dividend). So just what qualifies as a "safe" investment? The risk in long-term bonds, at these interest rate levels, is that inflation will flare up and erode the purchasing power of our $100,000 principal and the $3,000 in interest we would collect every year. That's why we need to distinguish between nominal returns and real returns, the latter taking account of inflation. The only conclusion I can reach here is that bonds, at these interest rates, are not as safe as some would have us believe, and that the types of stocks I've mention are not, relatively speaking, as risky as some would have us believe. Our conception of safety should include more than just the guarantee that we'll get our $100,000 back at the end of 30 years.
The stereotypical image of retirement has Grandma and Grandpa driving across the country in a Winnebago, stopping off at 4:30 for dinner at the Cracker Barrel, and turning in early for the next day's trip to the new fishing hole. The financial assumption here involves our elderly couple living off of just the interest and dividends from their investments while never touching the principal, which they would leave to their heirs. I just don't know any retired people who live that life. The folks I know who have the most rewarding retirements no longer spend the hours of nine to five at their jobs, but many of them are still earning something from their old careers. As one example, I have a friend who owns his own consulting business. He has also written a few books, so I imagine that when the day comes that he leaves the office behind, he'll either still write books or collect some earnings from the ones he has already had published. The ultimate key to retirement planning may be to continue, in some form or fashion, the income from your lifelong career. In that case, investment returns, whether they be from dividends, interest, or capital gains, make for a nice way to supplement your lifestyle.
Just remember that the bigger boat we need is not that Winnebago, but instead a portfolio that needs to grow in value over many years. And, for the relatively young, remember the investment advice from The Rolling Stones: Time is on my side.....
Life is short. Get busy.
Jim
Disclosure/Disclaimer: My family members and/or I own shares of AAPL, ABT, and PEP. Stocks are mentioned here for the sole purpose of illustrating investment concepts, and nothing stated here should be construed as investment advice or the recommendation to buy or sell any security.
My conversation partner got around to asking me if I was worried about the market, and I replied that, yes, I was somewhat worried about it.
"How low do you think it will go?" this gentleman asked, as if he were just about to receive a bad report from his physician.
"Oh, I'm not so worried about the market going down. I'm worried that it will go up too much," I replied, hoping he would take the bait. He did.
"You must be short," he insisted.
"Five-eight, actually. But no, I don't short stocks." More bait.
"Well then why would you be worried about the market going up?" he demanded, obviously in need of the bartender.
"Because," I explained, "if the market goes up by some tremendous amount, and it's starting to look like another speculative asset bubble, then I am going to be compelled to sell some of my stocks. And then I won't have anywhere to invest the proceeds."
He acknowledged his empty glass and excused himself. I never saw him again.
Back in the early 1980s, as President Reagan took office and just before Fed Chairman Paul Volcker declared war on inflation by ratcheting up interest rates, thus plunging the U.S. economy into a recession, it was possible to take $500,000 and invest in 30-year Treasury bonds, then yielding north of 12%, thereby locking in annual interest income of $60,000+. That may not sound like a fortune, but with the mortgage paid off and the kids out of your house--and your wallet--that's a nice guaranteed annual income for retirement. Today that same $500,000 invested in 30-year Treasuries at 3% would get you a whooping income of $15,000 per year. Low interest rates are great for the economy, for businesses, for stocks, and for people who are buying a home or refinancing a mortgage (borrowers, in other words). Higher interest rates would certainly choke off the economic recovery, so we definitely don't want rates to go higher. The only problem, though, is for savers who need to invest for income, and I think many people just don't realize how challenging it will be to replace their current earnings income in their retirement years.
What to do about this? As Chief Brody (Roy Scheider) in Jaws said to Captain Quint (Robert Shaw) after Brody first saw the Great White up close while the men were on their shark hunt at sea, "You're gonna need a bigger boat." The most obvious solution is that people are going to have to save more over a long period of time so that they will end up with a larger retirement portfolio in their golden years. It's going to take a greater amount of assets to generate a dollar of annual income once those assets are invested to establish an income stream. A bigger boat, indeed. It also means that people need to start saving and investing early, and that their investments need to be focused on growth--the general rule is that the more years you have until retirement, the greater percentage of your assets should be invested in equities to generate that growth. While there is no "one size fits all" rule for financial planning, for most people it makes sense to have significant exposure to stocks when they are young, and then slowly reduce the allocation to stocks and increase exposure to fixed-income (bonds) as they get closer and closer to retirement.
The bigger picture here is that as bond yields have fallen, bonds prices have risen. In order for bond prices to increase, interest rates would have to decline from current levels.There are some prognosticators who say that this recovery will not last and that yields will fall even further. However, if we tally up all the reasons why interest rates don't have much further to fall, it's hard to make a case that bonds are not over-priced. Foreign buyers of Treasuries continue to finance our government's appetite for debt, and the political will to meaningfully reduce the budget deficit seems nonexistent. Easy money from the Fed could ignite inflation down the road. On balance, the forces are arrayed to move interest rates higher (and bond prices lower), not meaningfully in the other direction. Even with the recent rally, stocks still appear more reasonably valued as an asset class than bonds.
Some articles in the financial press have warned of a potential "dividend bubble," as investors chase those stocks that pay attractive dividends. So just where is there any evidence of such a speculative bubble? Johnson and Johnson (JNJ, $65) has a dividend yield of 3.5% (higher than the 30-year Treasury, and JNJ has a better credit rating than the U.S. government); the stock is up about 1.3% over the last six months. Abbott Labs (ABT, $55) yields 3.48% and is up about 10% since August. Pepsi (PEP, $63) yields 3.2% and is up less than 1% in six months. Why have these stocks not risen more? Well, because some of the better dividend-payers are in the consumer staples sector, which typically offers stable earnings, but investors turn their focus to higher-beta, more economically sensitive stocks when the economy is improving. As a result, some of the more reliable dividend-payers are still offering up about the same attractive yields they offered before this most recent move up in the market.
When sizing up dividend-paying stocks, I always look for companies that still have potential for growth and where the dividend payout ratio is no greater than about 65% of earnings. This means that the companies can still invest some of their earnings for future growth--and that the dividend is well-covered by those earnings. The relatively stable earnings we find in consumer staples and healthcare are a plus here. I also like companies that have a solid record of increasing their dividends year after year. The one thing the U.S. Treasury--or any bond issuer, for that matter--will never do is increase the amount of interest you receive each year. If you invest $100,000 in the 30-year bond, you'll receive about $3,000 in interest payments for 30 years. That same $100,000 invested in high-quality stocks of companies that have shown a commitment to returning money to their shareholders has the potential for a much higher total return, a combination of growing dividend payments and capital appreciation.
Of course, dividends, unlike interest payments on Treasury bonds, are not guaranteed. That is why bonds are the preferred investment for people in retirement, because that interest is their only source of income, and it has to be safe and secure. When you are receiving the gold watch, that is not the time to be buying Apple (AAPL, $523, no dividend). So just what qualifies as a "safe" investment? The risk in long-term bonds, at these interest rate levels, is that inflation will flare up and erode the purchasing power of our $100,000 principal and the $3,000 in interest we would collect every year. That's why we need to distinguish between nominal returns and real returns, the latter taking account of inflation. The only conclusion I can reach here is that bonds, at these interest rates, are not as safe as some would have us believe, and that the types of stocks I've mention are not, relatively speaking, as risky as some would have us believe. Our conception of safety should include more than just the guarantee that we'll get our $100,000 back at the end of 30 years.
The stereotypical image of retirement has Grandma and Grandpa driving across the country in a Winnebago, stopping off at 4:30 for dinner at the Cracker Barrel, and turning in early for the next day's trip to the new fishing hole. The financial assumption here involves our elderly couple living off of just the interest and dividends from their investments while never touching the principal, which they would leave to their heirs. I just don't know any retired people who live that life. The folks I know who have the most rewarding retirements no longer spend the hours of nine to five at their jobs, but many of them are still earning something from their old careers. As one example, I have a friend who owns his own consulting business. He has also written a few books, so I imagine that when the day comes that he leaves the office behind, he'll either still write books or collect some earnings from the ones he has already had published. The ultimate key to retirement planning may be to continue, in some form or fashion, the income from your lifelong career. In that case, investment returns, whether they be from dividends, interest, or capital gains, make for a nice way to supplement your lifestyle.
Just remember that the bigger boat we need is not that Winnebago, but instead a portfolio that needs to grow in value over many years. And, for the relatively young, remember the investment advice from The Rolling Stones: Time is on my side.....
Life is short. Get busy.
Jim
Disclosure/Disclaimer: My family members and/or I own shares of AAPL, ABT, and PEP. Stocks are mentioned here for the sole purpose of illustrating investment concepts, and nothing stated here should be construed as investment advice or the recommendation to buy or sell any security.
Sunday, February 12, 2012
When To Hold 'Em, When To Fold 'Em
When it comes to the stocks I invest in, I could probably be labeled as something of a "serial monogamist." I buy a stock thinking that I am going to own it "'til death do us part," but it doesn't always work out that way. A stock may not live up to my expectations, or a prettier one may come along. Monogamy isn't the right metaphor here anyway, because that would violate my core investment principle of diversification. Such comparisons should be made with caution, because trying to justify your cheatin' ways by calling them "diversification" is still going to get a skillet full of hot grits dumped on your head.
The ways of love are vastly different from the ways of investing, of course, with emotion being central to the former and potentially toxic for the latter. Save your emotions for matters of the heart, and always remember that investing is a matter of the mind that calls for as much objectivity as we can muster. I love a good hot bowl of Campbell's Tomato Soup, I eat one serving of some Kellogg's cereal (usually while watching my Sony television) almost every day, and my next automobile may very well be a Ford SUV. But I don't own any of those stocks, because they don't make the grade based on my (relatively) objective criteria. I have seen investors grow so attached to particular stocks that any suggestion of selling them is received as if I were proposing the sale of their first-born child. Right from the start, we need to be on guard as to how our emotions might be influencing our investment decisions. Mr. Spock would have made a great investment adviser.
To develop some sort of exit strategy for our holdings we need to go back and consider the reasons why we bought a stock in the first place. The goal of equity investing is to make money, but more specifically our goal is to outperform the broader market. We can achieve market returns by buying an index fund or an ETF, but effective stock-picking is supposed to lead us to the best returns, something far greater than what throwing darts at the stock tables would yield. As an example, let's say we bought shares of XYZ stock at $20 based on our analysis that the company's earnings prospects should make it worth $30, a 50% return if things work out. Then XYZ reports a couple of really good quarters of earnings results, taking the stock right up to our $30 target price. Do we sell? Maybe, but maybe not. If the earnings have been better than what the analyst community expected, that probably means that our $30 target was too conservative from the start. In that case we should be adjusting our target price to factor in the company's improving earnings outlook, and that is exactly what you'll see with the analysts' target prices. Just recently, Visa (V, $113) reported better-than-expected earnings and offered some details about mobile payments and chip technology that may replace the magnetic strips on their debit and credit cards. (Remember, V is not a financial company that takes credit risks; it is a technology company that processes transactions, something like a toll collector.) V had been trading around $100 with price targets in the $110 range, but after the report analysts increased their target prices to the $120-$130 range. Here it is probably best to hang on and enjoy the ride. Imagine if you had bought Apple (AAPL, $495) at $200 and sold after it rose 50% to your target price of $300. You don't want to collect a bunch of bruises from kicking yourself.
"Nobody ever went broke taking profits" is an old Wall Street maxim that gets no argument from me, but there are numerous ways to pursue profit-taking. If we have a self-imposed rule that says we're going to sell any stock that appreciates by, say, 20%, then we have just guaranteed that our total return will be somewhat less than 20%. That is because we'll have some stocks that do much worse, and we need long-term winners to offset the weaker returns in our portfolio.This is what is known as "letting your winners run." Isn't our goal here to find those stocks that continue to outperform over very long periods of time? Of course it is, and that makes portfolio management something of a culling process. Over time we need to get rid of the stocks that aren't living up to our expectations and keep the ones that are still exceeding those expectations--and find more stocks in the latter category. This is one of those nice problems to have, but we also don't want our really big winners to become too heavily weighted in our portfolio--remember, diversification is one of our bedrock principles. If we have a stock that doubles, we might want to consider selling half of the position--we can book some of our profits and then play with "The House's Money."
Right about now you're probably thinking that all of this sounds great if we have winners, but what about the losers? Time for another metaphor. Buying a stock is not unlike hiring someone for a job, as both processes involve certain expectations, based on a job description, and the failure to live up to those expectations consistently means that we hired the wrong candidate. Sometimes we have to put on our Donald Trump persona and say, "You're Fired!" But what about the money we invested in training that deadbeat? Here it really shouldn't matter whether the stock shows a gain or a loss, because what really counts is future performance. Essentially, if the reasons (expectations) for buying the stock in the first place no longer hold true, we need to move on. If your fiancee tells you a week before the wedding that she has decided she must have six kids instead of the two you had mutually agreed upon--and that her mother needs to come live with you, also contrary to mutual understanding--then you might need to pick up the phone and call the caterer before the real damage can be done. So, if we bought XYZ stock expecting stellar sales growth from a new product, and that sales growth just doesn't happen, we need to cut our losses and find a better stock. The money we have to invest is a scarce resource, and it does not need to be sitting in a stock where hope is the only evidence of a turnaround.
Some investors will use a "stop-loss" order as a way of limiting their losses when a stock declines. If you buy a stock for $25 with a stop-loss of $20, this means that the stock will automatically be sold if it falls to that level. I don't use stop-loss orders and am really not a fan of them at all, for one key reason. When the market takes a major plunge, the good stocks tend to go down along with the average and bad ones, and I don't want my stocks to be sold in a broad market selling panic. When a stock just follows the market down, that is known as a decline for "non-company-specific" reasons. This is very different from a stock that sells off based on unfavorable news that is specific to that company. I actually like to buy my favorite stocks in major market sell-offs if the investment story is still intact. I do think it is important to follow the price action of our stocks under different market scenarios. For example, I would consider it a warning signal if the market was consistently moving higher and XYZ stock was consistently not participating. Even in the absence of specific news about XYZ, I'm going to suspect that someone knows something that I don't. If such under-performance continues, I may have to conclude that XYZ is not doing the job I hired it to do. Please note, though, that we shouldn't reach these conclusions based on trading action over one or two days. Stocks that have run up may see some profit-taking even if the market is advancing, so we have to allow for that.
I'll wrap up here with a few caveats. Those who adhere strictly to a value investing approach will take issue with what I have said. They would argue that if you find a stock that is undervalued, you should stick with it through good news and bad, and buy more of it if it goes down. Then sell it when it is fully valued. I can't argue with that, but I am focused on growth, and I try to invest in companies whose growth prospects have not been fully understood and fully valued by the market. Warren Buffet once said that his holding period was "forever," but as much as I would like my holdings to be a "'til death do us part" arrangement, I'm not going to stick with a stock once the earnings growth has slowed--and especially not if that growth fails to materialize. I actually have all the patience in the world as long as my stocks are doing what I hired them to do.
Happy Valentine's Day! And, as the great Al Green sings, Let's Stay Together.......
The ways of love are vastly different from the ways of investing, of course, with emotion being central to the former and potentially toxic for the latter. Save your emotions for matters of the heart, and always remember that investing is a matter of the mind that calls for as much objectivity as we can muster. I love a good hot bowl of Campbell's Tomato Soup, I eat one serving of some Kellogg's cereal (usually while watching my Sony television) almost every day, and my next automobile may very well be a Ford SUV. But I don't own any of those stocks, because they don't make the grade based on my (relatively) objective criteria. I have seen investors grow so attached to particular stocks that any suggestion of selling them is received as if I were proposing the sale of their first-born child. Right from the start, we need to be on guard as to how our emotions might be influencing our investment decisions. Mr. Spock would have made a great investment adviser.
To develop some sort of exit strategy for our holdings we need to go back and consider the reasons why we bought a stock in the first place. The goal of equity investing is to make money, but more specifically our goal is to outperform the broader market. We can achieve market returns by buying an index fund or an ETF, but effective stock-picking is supposed to lead us to the best returns, something far greater than what throwing darts at the stock tables would yield. As an example, let's say we bought shares of XYZ stock at $20 based on our analysis that the company's earnings prospects should make it worth $30, a 50% return if things work out. Then XYZ reports a couple of really good quarters of earnings results, taking the stock right up to our $30 target price. Do we sell? Maybe, but maybe not. If the earnings have been better than what the analyst community expected, that probably means that our $30 target was too conservative from the start. In that case we should be adjusting our target price to factor in the company's improving earnings outlook, and that is exactly what you'll see with the analysts' target prices. Just recently, Visa (V, $113) reported better-than-expected earnings and offered some details about mobile payments and chip technology that may replace the magnetic strips on their debit and credit cards. (Remember, V is not a financial company that takes credit risks; it is a technology company that processes transactions, something like a toll collector.) V had been trading around $100 with price targets in the $110 range, but after the report analysts increased their target prices to the $120-$130 range. Here it is probably best to hang on and enjoy the ride. Imagine if you had bought Apple (AAPL, $495) at $200 and sold after it rose 50% to your target price of $300. You don't want to collect a bunch of bruises from kicking yourself.
"Nobody ever went broke taking profits" is an old Wall Street maxim that gets no argument from me, but there are numerous ways to pursue profit-taking. If we have a self-imposed rule that says we're going to sell any stock that appreciates by, say, 20%, then we have just guaranteed that our total return will be somewhat less than 20%. That is because we'll have some stocks that do much worse, and we need long-term winners to offset the weaker returns in our portfolio.This is what is known as "letting your winners run." Isn't our goal here to find those stocks that continue to outperform over very long periods of time? Of course it is, and that makes portfolio management something of a culling process. Over time we need to get rid of the stocks that aren't living up to our expectations and keep the ones that are still exceeding those expectations--and find more stocks in the latter category. This is one of those nice problems to have, but we also don't want our really big winners to become too heavily weighted in our portfolio--remember, diversification is one of our bedrock principles. If we have a stock that doubles, we might want to consider selling half of the position--we can book some of our profits and then play with "The House's Money."
Right about now you're probably thinking that all of this sounds great if we have winners, but what about the losers? Time for another metaphor. Buying a stock is not unlike hiring someone for a job, as both processes involve certain expectations, based on a job description, and the failure to live up to those expectations consistently means that we hired the wrong candidate. Sometimes we have to put on our Donald Trump persona and say, "You're Fired!" But what about the money we invested in training that deadbeat? Here it really shouldn't matter whether the stock shows a gain or a loss, because what really counts is future performance. Essentially, if the reasons (expectations) for buying the stock in the first place no longer hold true, we need to move on. If your fiancee tells you a week before the wedding that she has decided she must have six kids instead of the two you had mutually agreed upon--and that her mother needs to come live with you, also contrary to mutual understanding--then you might need to pick up the phone and call the caterer before the real damage can be done. So, if we bought XYZ stock expecting stellar sales growth from a new product, and that sales growth just doesn't happen, we need to cut our losses and find a better stock. The money we have to invest is a scarce resource, and it does not need to be sitting in a stock where hope is the only evidence of a turnaround.
Some investors will use a "stop-loss" order as a way of limiting their losses when a stock declines. If you buy a stock for $25 with a stop-loss of $20, this means that the stock will automatically be sold if it falls to that level. I don't use stop-loss orders and am really not a fan of them at all, for one key reason. When the market takes a major plunge, the good stocks tend to go down along with the average and bad ones, and I don't want my stocks to be sold in a broad market selling panic. When a stock just follows the market down, that is known as a decline for "non-company-specific" reasons. This is very different from a stock that sells off based on unfavorable news that is specific to that company. I actually like to buy my favorite stocks in major market sell-offs if the investment story is still intact. I do think it is important to follow the price action of our stocks under different market scenarios. For example, I would consider it a warning signal if the market was consistently moving higher and XYZ stock was consistently not participating. Even in the absence of specific news about XYZ, I'm going to suspect that someone knows something that I don't. If such under-performance continues, I may have to conclude that XYZ is not doing the job I hired it to do. Please note, though, that we shouldn't reach these conclusions based on trading action over one or two days. Stocks that have run up may see some profit-taking even if the market is advancing, so we have to allow for that.
I'll wrap up here with a few caveats. Those who adhere strictly to a value investing approach will take issue with what I have said. They would argue that if you find a stock that is undervalued, you should stick with it through good news and bad, and buy more of it if it goes down. Then sell it when it is fully valued. I can't argue with that, but I am focused on growth, and I try to invest in companies whose growth prospects have not been fully understood and fully valued by the market. Warren Buffet once said that his holding period was "forever," but as much as I would like my holdings to be a "'til death do us part" arrangement, I'm not going to stick with a stock once the earnings growth has slowed--and especially not if that growth fails to materialize. I actually have all the patience in the world as long as my stocks are doing what I hired them to do.
Happy Valentine's Day! And, as the great Al Green sings, Let's Stay Together.......
********************************************
If you'd like to spend Valentine's Day curled up with your significant other (your partner, not your favorite ticker symbol) for a good romantic movie, I suggest Love Actually (2003). My wife and I discovered this movie over Christmas, and I can't believe I had never seen it. If I want to pull my wife away from her Hallmark Channel fare, I have to find a movie that we both can enjoy--a romance that is a cut above a "chick flick." This one is worth your time.
Life is short. Get busy.
Jim
Disclosure/Disclaimer: My family members and/or I own shares of V and AAPL. Stocks are mentioned here for the sole purpose of illustrating investments concepts, and nothing stated here should be construed as investment advice or the recommendation to buy or sell any security.
Friday, February 10, 2012
Searching For Goldilocks
It may seem strange to think about this today, but there was a time not so long ago (such expressions are an indication that I am over 50) when the stock market would take a nosedive whenever economic news turned out to be stronger than expected. The market's obsession then (back in the 1990s, really) was that an economy that was too "hot"--or a labor market that was too robust--would lead the Federal Reserve to raise interest rates in an effort to keep inflation in check. This was often referred to as the Fed "taking the punch bowl away from the party." More recently, the worry du jour has concerned economic weakness. Last summer investors focused on the possibility of a double-dip recession, and that concern was followed by worries about a financial crisis in Europe spreading to our shores. The market does not need an economy that is firing on all cylinders to do well, but it does need an economy where there is at least modest, positive growth--in other words, an economy that stays out of a recession. Like Goldilock's preference for porridge, the economy can't be too hot or too cold--at least for the stock market, it has to be just right.
The Federal Reserve brought the mother of all punch bowls to the party with their recent announcement that they would keep interest rates near zero through 2014 (the Fed had previously pledged to keep rates near zero through the middle of 2013). They are essentially saying to us that our money won't earn anything in the bank or in money market funds for three years, so we'd better invest in riskier assets like the stock market.There are at least two other interpretations or implications of the Fed's accommodative stance, and they are not mutually exclusive. First, the commitment to easier monetary policy signals that the Fed is concerned about the sustainability of the economic recovery, that even with some good economic numbers of late the recovery is still fragile and needs all the help it can get in the form of low interest rates. Unemployment, although showing some improvement, is still elevated at this stage of the recovery, and that remains a concern for policymakers. Second, the Fed's easy money policy is viewed by some as sowing the seeds of future inflation, and this is why we have seen strength in gold prices. When the price of gold goes up, that really means that the dollars used to buy gold are worth less--inflation erodes the purchasing power of a dollar. On balance, the Fed is saying that they are more worried about unemployment than they are about inflation.
Of course, the biggest punch bowl in the world is not going to liven up the party if nobody drinks the punch. If you are a business owner and don't see growing demand for your product or service, then you are not likely to invest in expansion even if interest rates are at historic lows. And if you want to buy a new house but think you may be in danger of losing your job in the next few months, rock-bottom mortgage rates are not likely to spur your enthusiasm about making such a long-term financial commitment. Lower and lower interest rates do not guarantee an immediate boom in investment and spending, but the perception that rates will remain low for an extended period is good for stocks in general, especially when the economic numbers are improving. That could very well be the "Goldilocks" spot for stocks.
Someone asked me recently if the improving economy would temper my positive view of the discount store stocks such as Dollar Tree (DLTR, $86), Ross Stores (ROST, $52), and TJ Maxx (TJX, $34). The short answer is no, for a few reasons. As I have said before, I am intrigued that many people who don't need to save the money actually love finding the deals at these stores. This is anecdotal evidence, but I think it has become trendy and chic to shop in the bargain bin. Also, these companies are growing and opening more locations. One measure that investors follow closely is the growth in sales, and here we need to distinguish between same-store sales growth and total sales growth. Companies that already have saturated the market with plenty of store locations aren't going to show the additional sales growth that comes from opening up new outlets. For the discount stores, and for a restaurant chain like Chipolte Mexican Grill (CMG, $374), the added boost to sales growth comes from their continuing penetration of new markets with additional locations. When total sales growth approaches and comes to rely on same-store sales growth, that is a signal that the rapid growth phase is coming to an end.
The big issue here, the proverbial elephant in the living room, is the "Tale of Two Cities" investment thesis that we've looked at before. We are seeing the economy improve on a cyclical basis, but there are structural factors that aren't going to improve dramatically with the upswing in the business cycle. Wages, for example, have been stagnant for years, and there is a tendency to blame this on the fact that many manufacturing jobs have moved overseas. That is really a vast oversimplification, just true enough to linger on in a world that seeks simple answers and scapegoats. (And I don't know what is more disturbing, the tendency of politicians to exploit such misconceptions, or the sad truth that so many people don't know enough about basic economics to see right through the deceptions.) Manufacturing is not dead in the United States, but the relatively low-skill jobs in the sector have moved to countries where labor is less expensive. Companies have to seek out the lowest costs for all aspects of the manufacturing process, because if they did not their competitors would put them out of business--and that would mean the loss of even more jobs. The better-paying and higher-skilled jobs are still here in the U.S., but there are fewer of them. Companies have invested heavily in technology, and today there aren't as many workers on the factory floor. The ones who remain, however, are those with the skills to operate the technology. The resulting productivity gains have been flowing to the bottom line as profits, and that has been very good for stocks. This is really all about efficient supply-chain management, so it really doesn't make sense to talk about "bringing manufacturing jobs back to the United States." The better solution would be to focus on making it easier for businesses to create jobs and ensuring that tomorrow's workers have the training needed to fill those positions.
Two of the more insightful articles on these topics are Thomas Friedman's column, "Made In The World," from the January 28th, 2012, New York Times and Adam Davidson's piece, "Making It In America," from the January/February 2012 issue of The Atlantic. The links are as follows:
http://www.nytimes.com/2012/01/29/opinion/sunday/friedman-made-in-the-world.html?scp=5&sq=friedman&st=cse
http://www.theatlantic.com/magazine/archive/2012/01/making-it-in-america/8844/
From an investment perspective, we need to be on the lookout for companies that can help consumers and businesses save money. Some examples for future research include Perrigo (PRGO, $93), which makes the over-the-counter products that sell under a store's private label (generics). The company reported a positive earnings surprise this past week, offered upbeat guidance, and said it will launch more than 45 new products in the coming year. The average age of the automobile on the road is now about 10 years as consumers delay buying new cars, and that can benefit a company like Autozone (AZO, $353) that operates in the after-market. As health providers seek to lower costs by moving more towards electronic health records, a company like Cerner (CERN, $69) should see more business.
Much of the political talk may focus on jobs that are lost as companies become more efficient and reduce expenses, but the other side of this trend is that we all pay less for a host of different products and services. I have never liked the way a new WalMart can lay waste to locally-owned, Mom-and-Pop businesses, but the benefit here is that many basic items we buy are cheaper. Price competition leads to a higher standard of living for the majority of the population. I'm not going to buy more laundry detergent if the price goes down, but I will spend less of my income on what I do buy, and that means more money to spend on a nice Valentine's Day gift for my wife. I'll give it to her when she gets home from the Dollar Tree.
Life is short. Get busy.
Jim
Disclosure/Disclaimer: My family members and/ or I own shares of DLTR, ROST, TJX, CMG, PRGO, AZO, and CERN. Stocks are mentioned here for the sole purpose of illustrating investment concepts, and nothing here should be construed as investment advice or the recommendation to buy or sell any security.
The Federal Reserve brought the mother of all punch bowls to the party with their recent announcement that they would keep interest rates near zero through 2014 (the Fed had previously pledged to keep rates near zero through the middle of 2013). They are essentially saying to us that our money won't earn anything in the bank or in money market funds for three years, so we'd better invest in riskier assets like the stock market.There are at least two other interpretations or implications of the Fed's accommodative stance, and they are not mutually exclusive. First, the commitment to easier monetary policy signals that the Fed is concerned about the sustainability of the economic recovery, that even with some good economic numbers of late the recovery is still fragile and needs all the help it can get in the form of low interest rates. Unemployment, although showing some improvement, is still elevated at this stage of the recovery, and that remains a concern for policymakers. Second, the Fed's easy money policy is viewed by some as sowing the seeds of future inflation, and this is why we have seen strength in gold prices. When the price of gold goes up, that really means that the dollars used to buy gold are worth less--inflation erodes the purchasing power of a dollar. On balance, the Fed is saying that they are more worried about unemployment than they are about inflation.
Of course, the biggest punch bowl in the world is not going to liven up the party if nobody drinks the punch. If you are a business owner and don't see growing demand for your product or service, then you are not likely to invest in expansion even if interest rates are at historic lows. And if you want to buy a new house but think you may be in danger of losing your job in the next few months, rock-bottom mortgage rates are not likely to spur your enthusiasm about making such a long-term financial commitment. Lower and lower interest rates do not guarantee an immediate boom in investment and spending, but the perception that rates will remain low for an extended period is good for stocks in general, especially when the economic numbers are improving. That could very well be the "Goldilocks" spot for stocks.
Someone asked me recently if the improving economy would temper my positive view of the discount store stocks such as Dollar Tree (DLTR, $86), Ross Stores (ROST, $52), and TJ Maxx (TJX, $34). The short answer is no, for a few reasons. As I have said before, I am intrigued that many people who don't need to save the money actually love finding the deals at these stores. This is anecdotal evidence, but I think it has become trendy and chic to shop in the bargain bin. Also, these companies are growing and opening more locations. One measure that investors follow closely is the growth in sales, and here we need to distinguish between same-store sales growth and total sales growth. Companies that already have saturated the market with plenty of store locations aren't going to show the additional sales growth that comes from opening up new outlets. For the discount stores, and for a restaurant chain like Chipolte Mexican Grill (CMG, $374), the added boost to sales growth comes from their continuing penetration of new markets with additional locations. When total sales growth approaches and comes to rely on same-store sales growth, that is a signal that the rapid growth phase is coming to an end.
The big issue here, the proverbial elephant in the living room, is the "Tale of Two Cities" investment thesis that we've looked at before. We are seeing the economy improve on a cyclical basis, but there are structural factors that aren't going to improve dramatically with the upswing in the business cycle. Wages, for example, have been stagnant for years, and there is a tendency to blame this on the fact that many manufacturing jobs have moved overseas. That is really a vast oversimplification, just true enough to linger on in a world that seeks simple answers and scapegoats. (And I don't know what is more disturbing, the tendency of politicians to exploit such misconceptions, or the sad truth that so many people don't know enough about basic economics to see right through the deceptions.) Manufacturing is not dead in the United States, but the relatively low-skill jobs in the sector have moved to countries where labor is less expensive. Companies have to seek out the lowest costs for all aspects of the manufacturing process, because if they did not their competitors would put them out of business--and that would mean the loss of even more jobs. The better-paying and higher-skilled jobs are still here in the U.S., but there are fewer of them. Companies have invested heavily in technology, and today there aren't as many workers on the factory floor. The ones who remain, however, are those with the skills to operate the technology. The resulting productivity gains have been flowing to the bottom line as profits, and that has been very good for stocks. This is really all about efficient supply-chain management, so it really doesn't make sense to talk about "bringing manufacturing jobs back to the United States." The better solution would be to focus on making it easier for businesses to create jobs and ensuring that tomorrow's workers have the training needed to fill those positions.
Two of the more insightful articles on these topics are Thomas Friedman's column, "Made In The World," from the January 28th, 2012, New York Times and Adam Davidson's piece, "Making It In America," from the January/February 2012 issue of The Atlantic. The links are as follows:
http://www.nytimes.com/2012/01/29/opinion/sunday/friedman-made-in-the-world.html?scp=5&sq=friedman&st=cse
http://www.theatlantic.com/magazine/archive/2012/01/making-it-in-america/8844/
From an investment perspective, we need to be on the lookout for companies that can help consumers and businesses save money. Some examples for future research include Perrigo (PRGO, $93), which makes the over-the-counter products that sell under a store's private label (generics). The company reported a positive earnings surprise this past week, offered upbeat guidance, and said it will launch more than 45 new products in the coming year. The average age of the automobile on the road is now about 10 years as consumers delay buying new cars, and that can benefit a company like Autozone (AZO, $353) that operates in the after-market. As health providers seek to lower costs by moving more towards electronic health records, a company like Cerner (CERN, $69) should see more business.
Much of the political talk may focus on jobs that are lost as companies become more efficient and reduce expenses, but the other side of this trend is that we all pay less for a host of different products and services. I have never liked the way a new WalMart can lay waste to locally-owned, Mom-and-Pop businesses, but the benefit here is that many basic items we buy are cheaper. Price competition leads to a higher standard of living for the majority of the population. I'm not going to buy more laundry detergent if the price goes down, but I will spend less of my income on what I do buy, and that means more money to spend on a nice Valentine's Day gift for my wife. I'll give it to her when she gets home from the Dollar Tree.
Life is short. Get busy.
Jim
Disclosure/Disclaimer: My family members and/ or I own shares of DLTR, ROST, TJX, CMG, PRGO, AZO, and CERN. Stocks are mentioned here for the sole purpose of illustrating investment concepts, and nothing here should be construed as investment advice or the recommendation to buy or sell any security.
Friday, February 3, 2012
Groundhog Day
Yesterday, to me, felt a lot like Groundhog Day. Of course, yesterday was Groundhog Day, but I was actually thinking of the 1993 movie with Bill Murray and Andie MacDowell. Most great films are, at their core, all about some form of redemption, and this movie is more explicit about it than most. Murray's character, Phil, gets to--or has to--live the same day over and over again until he gets it right (and gets the girl, Andie MacDowell's Rita). The clever conceit here is that Phil has the chance to change his behavior some with each recycling of the same day, over and over again, until he attains a redemption that is heralded by an alarm clock radio that no longer awakens him with Sonny and Cher's I Got You, Babe.
Earnings reporting season, as we have noted before, serves as a quarterly referendum on our stocks. The stocks that exceed expectations tend to move higher, while the ones that fail to live up to expectations are taken out and shot, as if they were traitors to their country. And traitors they are if they can't perform as they are supposed to. Having lived through more earnings seasons than I care to count, I tend to get that Groundhog Day sense of deja vu, of having seen it all before and looking for the ways it will be different this time around. One lesson of the movie is that events may not change, but we can change. So, as another earnings season winds down, we learn something else to make us better investors. Enough philosophizing, let's get back to investing.
What I write about here is really not supposed to be advice, so I'll just say that I hope my readers "heeded my observations" and steered clear of Radio Shack (RSH, $7.35) before the bear trap sprung. On Monday the company announced (in what is known as a "preannouncement") that fourth quarter earnings per share would be in the $.11 to $.13 range instead of the $.37 expected by analysts. The market responded by taking the stock down about 30% (Bang!). I was not surprised at all by RSH's miserable performance, but I am still scratching my head over how some analysts rated the stock a "buy" at $15, then at $12, and then at $10. Only after the stock cratered to $7 and change did those analysts downgrade the stock to a "hold." There were plenty of red flags already waving about RSH, such as the horribly disappointing earnings they reported in October for the third quarter, $.15 vs. a $.36 consensus estimate. The lesson here is that we need to avoid taking analysts' "buy" recommendations at face value, and we should focus on those buy-rated stocks where the analysts are revising their earnings estimates upward, not downward.
On the positive side of the ledger, there were some very positive earnings reports from companies we've looked at here over the last few weeks. We've already taken a look at Apple's unbelievable blowout report, and two of the company's suppliers came through as we expected. Broadcom (BRCM, $37), which was trading around $32 in mid-January, reported earnings of $.68 vs. a $.65 estimate, and Qualcomm (QCOM, $61) earnings came in at $.97, ahead of the $.90 estimate. QCOM, which is up from $56 when we mentioned it here in January, also raised fiscal year (FY12) guidance to $3.55-$3.75 from a previous range of $3.42-$3.62. Tempur-Pedic (TPX, $68) was trading at $59 when we looked at it here in mid-January, and the stock moved up nicely after reporting earnings of $.84 vs. the $.82 estimate--and after raising FY12 guidance to $3.80-$3.95, above the consensus of $3.77. TPX is doing quite well right now, and should get a further boost if we see a robust recovery in housing. Their mattresses are in the luxury goods sector, so they are part of our "Tale of Two Cities" investment thesis. Even when companies don't beat their estimate, their stocks can still rally if future guidance is bullish. Las Vegas Sands (LVS, $51), up from $43 when we featured it here in mid-January, reported on-the-estimate earnings of $.57, and analysts are very positive about the company's prospects in Macau and Singapore.
It is worth noting that the percentage of companies beating estimates is down somewhat from historical norms. That raises some concerns about the overall economic climate, but it can actually work in our favor. As the field of performing companies gets narrower, investors will be more likely to put premium valuations on those firms that can deliver. That means that disciplined and focused stock-picking is essential for investment success. No "throwing darts" at the stock tables!
It's most encouraging to see stocks following our script, even if the feeling is better described as vindication instead of redemption. Whatever you call it, it's refreshing to wake up to something other than Sonny and Cher playing on the radio. How about some Roadhouse Blues from The Doors (I woke up this morning and I got myself a beer.......)?
Life is short. Get busy.
Jim
Disclosure/Disclaimer: My family members and/or I own shares of AAPL, BRCM, QCOM, TPX, and LVS. Stocks are mentioned here for the sole purpose of illustrating investment concepts, and the mention of any stock should not be construed as a recommendation to buy or sell any specific security.
Earnings reporting season, as we have noted before, serves as a quarterly referendum on our stocks. The stocks that exceed expectations tend to move higher, while the ones that fail to live up to expectations are taken out and shot, as if they were traitors to their country. And traitors they are if they can't perform as they are supposed to. Having lived through more earnings seasons than I care to count, I tend to get that Groundhog Day sense of deja vu, of having seen it all before and looking for the ways it will be different this time around. One lesson of the movie is that events may not change, but we can change. So, as another earnings season winds down, we learn something else to make us better investors. Enough philosophizing, let's get back to investing.
What I write about here is really not supposed to be advice, so I'll just say that I hope my readers "heeded my observations" and steered clear of Radio Shack (RSH, $7.35) before the bear trap sprung. On Monday the company announced (in what is known as a "preannouncement") that fourth quarter earnings per share would be in the $.11 to $.13 range instead of the $.37 expected by analysts. The market responded by taking the stock down about 30% (Bang!). I was not surprised at all by RSH's miserable performance, but I am still scratching my head over how some analysts rated the stock a "buy" at $15, then at $12, and then at $10. Only after the stock cratered to $7 and change did those analysts downgrade the stock to a "hold." There were plenty of red flags already waving about RSH, such as the horribly disappointing earnings they reported in October for the third quarter, $.15 vs. a $.36 consensus estimate. The lesson here is that we need to avoid taking analysts' "buy" recommendations at face value, and we should focus on those buy-rated stocks where the analysts are revising their earnings estimates upward, not downward.
On the positive side of the ledger, there were some very positive earnings reports from companies we've looked at here over the last few weeks. We've already taken a look at Apple's unbelievable blowout report, and two of the company's suppliers came through as we expected. Broadcom (BRCM, $37), which was trading around $32 in mid-January, reported earnings of $.68 vs. a $.65 estimate, and Qualcomm (QCOM, $61) earnings came in at $.97, ahead of the $.90 estimate. QCOM, which is up from $56 when we mentioned it here in January, also raised fiscal year (FY12) guidance to $3.55-$3.75 from a previous range of $3.42-$3.62. Tempur-Pedic (TPX, $68) was trading at $59 when we looked at it here in mid-January, and the stock moved up nicely after reporting earnings of $.84 vs. the $.82 estimate--and after raising FY12 guidance to $3.80-$3.95, above the consensus of $3.77. TPX is doing quite well right now, and should get a further boost if we see a robust recovery in housing. Their mattresses are in the luxury goods sector, so they are part of our "Tale of Two Cities" investment thesis. Even when companies don't beat their estimate, their stocks can still rally if future guidance is bullish. Las Vegas Sands (LVS, $51), up from $43 when we featured it here in mid-January, reported on-the-estimate earnings of $.57, and analysts are very positive about the company's prospects in Macau and Singapore.
It is worth noting that the percentage of companies beating estimates is down somewhat from historical norms. That raises some concerns about the overall economic climate, but it can actually work in our favor. As the field of performing companies gets narrower, investors will be more likely to put premium valuations on those firms that can deliver. That means that disciplined and focused stock-picking is essential for investment success. No "throwing darts" at the stock tables!
It's most encouraging to see stocks following our script, even if the feeling is better described as vindication instead of redemption. Whatever you call it, it's refreshing to wake up to something other than Sonny and Cher playing on the radio. How about some Roadhouse Blues from The Doors (I woke up this morning and I got myself a beer.......)?
Life is short. Get busy.
Jim
Disclosure/Disclaimer: My family members and/or I own shares of AAPL, BRCM, QCOM, TPX, and LVS. Stocks are mentioned here for the sole purpose of illustrating investment concepts, and the mention of any stock should not be construed as a recommendation to buy or sell any specific security.
Wednesday, February 1, 2012
Discovering Lana Turner
One of the most enduring of Hollywood legends concerns the story, perhaps somewhat apocryphal, of how Lana Turner was discovered while she was sitting at the soda fountain counter at Schwab's drugstore in Los Angeles. Apparently some Hollywood mogul saw her and decided she needed to be a movie star, and the rest is history. There are probably still--and likely will always be--legions of aspiring screen stars waiting tables and hoping to one day serve a plate of Foie gras to Steven Spielberg, who will immediately recognize that he has found the next Sandra Bullock or Tom Hanks. The dream of discovery, from either side of the epiphany, exerts a powerful pull on the imagination, just as much in the world of Wall Street as in the City of Angels. What investor does not dream of finding the next Apple or Amazon?
Of course, if I had found the secret formula for picking the next fortune-maker, I would be writing this post from a Tahitian beach or some other exotic locale, sipping on my afternoon pina colada (instead, it is a rather dreary February day in Memphis). What we can do here, however, is develop a road map for increasing the odds that such a wildly successful stock will end up in our portfolios. When I think about the people I know (or know of) who have made truly transformational fortunes (ten or even a hundred million dollars or more) through stock ownership, most had either a direct or family association with a company from the "ground floor." Think about the earliest investors in FedEx as just one example. Most of these people had the majority of their net worth in just the one company, and over many years the value of their stock increased as the company grew from its earliest beginnings into a major corporation. Right away, we need to recognize that this is not something we are likely to achieve, because the foundational investment principle we adhere to is based on having a diversified portfolio of stocks--we are not going to bet everything on one company. Our more modest aspiration is to uncover the occasional ten-bagger (a stock that will increase in value by a factor of 10 or more) that can help fund a child's or grandchild's education or provide for a more comfortable retirement.
If we are good at stock-picking, many of our stocks will be singles, doubles, and maybe a few triples.If we want to hit a genuine home run, then we need to follow Rule Number One, which is to "Think Small." I think that Apple (AAPL, $456) is a very compelling investment right now, and I wouldn't be surprised if it reached $600 per share over the next year (when looking at AAPL, I like to divide by 10--a $45 stock going to $60 is a 33% return, impressive but by no means unheard of). Apple will not be the next Apple, though, owing to the "law of large numbers." It is already the largest company in the world by market capitalization ($426 billion), so unless they are going to take over the entire world, it's not likely that the company would achieve a market cap of several trillion dollars. The place to go hunting for potential home runs is in the small cap sector, so we're talking about a market cap of less than $1 billion (mid caps are typically considered to have a market cap between $1 billion and $5 billion). For our purposes we don't want to be too rigid about limiting our selection universe, especially if we find an intriguing company that might be solidly in the mid-cap sector.
There are plenty of small publicly traded companies out there, so we want to focus on those whose business can be a true "game changer," a product or service that is revolutionary enough to provide years of exceptional growth. Let's look at some examples, but please keep in mind that I am not recommending that you buy any of these stocks (you may want to pursue additional research or discuss with your financial adviser). Westport Innovations (WPRT, $38, market cap $1.9 billion) makes engine and fuel system technologies that allow petroleum-based engines to run on natural gas. That's pretty exciting because the price of natural gas has fallen dramatically, making it a more attractive and cost efficient alternative to oil. If there is a long-term shift to gas engines, WPRT stands to have a bright and profitable future. AuthenTec (AUTH, $3.47, market cap $153 million) is a provider of security and identity management technologies, including fingerprint sensors, for computers and wireless devices. Their products stand to benefit from the growing concern about secure transactions and access to data. 3D Systems (DDD, $19, market cap $997 million) makes three-dimensional (stereolithography) printers, and this sounds like something straight out of science fiction. Their printers don't spew paper--they create/assemble objects. One day you may be able to "print out" the spare part you need for your washing machine. CVD Equipment (CVV, $14.50, market cap $86 million) is in the semiconductor business, with a focus on nanotechnology. CVD has been developing uses for a compound called graphene, which is a one-atom-thick layer of carbon that can supposedly conduct electricity 30 times faster than silicon. If all of this has your head spinning, just take a deep breath and try to remain calm. Most of all, don't bet the farm on anything.
It seems tautological to say so, but in order for something to be discovered, it first has to qualify as being undiscovered. There would be no legend about Lana Turner being discovered at that drugstore if she had already made a few movies by the time she plopped down at the soda fountain. The best way to gauge how undiscovered a stock might be is by the number of analysts following the company--the fewer, the better. AAPL, for example, is followed by some 42 different research analysts (at least there are 42 different recommendations on the stock, most of them "buys"). WPRT has 10 analyst recommendations, while DDD has five, AUTH has three, and CVV has just one. Even when I am not swinging for the fences, I like it when a company doesn't have too much Wall Street coverage. There's an old anecdote (it's not really a joke, because it's more insightful than funny) about a client who calls his broker one day when the market is up big to inquire about what might be causing the tremendous rally in stocks. The broker pauses for a moment before answering, then in a whisper says: "I can't say for sure, but we are hearing that there are more buyers than sellers." The client then replies, "You are a genius. I am so glad you are my broker." We like to think that our stocks go up because they are earning great profits, but the technical truth is that investors buy them because of their profits (and expectations of higher future profits), and it is this buying pressure that drives the stocks higher. What we, as investors, want from all of our stocks is that we have found some tremendous potential in them ahead of the crowd, and that as they deliver on that potential, the crowd will fall in behind us and bid the shares higher. If we want to claim the mantle of discovery, we may not have to be first, but we at least have to be very early.
Whether it's Hollywood or Wall Street, the excitement of discovery is pretty much the same. And it's still the stuff that dreams are made of.
Life is short. Get busy.
Jim
Disclosure/Disclaimer: My family members and/or I own shares of AAPL, WPRT, DDD, CVV, and AUTH. Individual stocks are mentioned here for the sole purpose of illustrating investment concepts, and nothing stated here should be construed as a specific recommendation to buy or sell any security.
Of course, if I had found the secret formula for picking the next fortune-maker, I would be writing this post from a Tahitian beach or some other exotic locale, sipping on my afternoon pina colada (instead, it is a rather dreary February day in Memphis). What we can do here, however, is develop a road map for increasing the odds that such a wildly successful stock will end up in our portfolios. When I think about the people I know (or know of) who have made truly transformational fortunes (ten or even a hundred million dollars or more) through stock ownership, most had either a direct or family association with a company from the "ground floor." Think about the earliest investors in FedEx as just one example. Most of these people had the majority of their net worth in just the one company, and over many years the value of their stock increased as the company grew from its earliest beginnings into a major corporation. Right away, we need to recognize that this is not something we are likely to achieve, because the foundational investment principle we adhere to is based on having a diversified portfolio of stocks--we are not going to bet everything on one company. Our more modest aspiration is to uncover the occasional ten-bagger (a stock that will increase in value by a factor of 10 or more) that can help fund a child's or grandchild's education or provide for a more comfortable retirement.
If we are good at stock-picking, many of our stocks will be singles, doubles, and maybe a few triples.If we want to hit a genuine home run, then we need to follow Rule Number One, which is to "Think Small." I think that Apple (AAPL, $456) is a very compelling investment right now, and I wouldn't be surprised if it reached $600 per share over the next year (when looking at AAPL, I like to divide by 10--a $45 stock going to $60 is a 33% return, impressive but by no means unheard of). Apple will not be the next Apple, though, owing to the "law of large numbers." It is already the largest company in the world by market capitalization ($426 billion), so unless they are going to take over the entire world, it's not likely that the company would achieve a market cap of several trillion dollars. The place to go hunting for potential home runs is in the small cap sector, so we're talking about a market cap of less than $1 billion (mid caps are typically considered to have a market cap between $1 billion and $5 billion). For our purposes we don't want to be too rigid about limiting our selection universe, especially if we find an intriguing company that might be solidly in the mid-cap sector.
There are plenty of small publicly traded companies out there, so we want to focus on those whose business can be a true "game changer," a product or service that is revolutionary enough to provide years of exceptional growth. Let's look at some examples, but please keep in mind that I am not recommending that you buy any of these stocks (you may want to pursue additional research or discuss with your financial adviser). Westport Innovations (WPRT, $38, market cap $1.9 billion) makes engine and fuel system technologies that allow petroleum-based engines to run on natural gas. That's pretty exciting because the price of natural gas has fallen dramatically, making it a more attractive and cost efficient alternative to oil. If there is a long-term shift to gas engines, WPRT stands to have a bright and profitable future. AuthenTec (AUTH, $3.47, market cap $153 million) is a provider of security and identity management technologies, including fingerprint sensors, for computers and wireless devices. Their products stand to benefit from the growing concern about secure transactions and access to data. 3D Systems (DDD, $19, market cap $997 million) makes three-dimensional (stereolithography) printers, and this sounds like something straight out of science fiction. Their printers don't spew paper--they create/assemble objects. One day you may be able to "print out" the spare part you need for your washing machine. CVD Equipment (CVV, $14.50, market cap $86 million) is in the semiconductor business, with a focus on nanotechnology. CVD has been developing uses for a compound called graphene, which is a one-atom-thick layer of carbon that can supposedly conduct electricity 30 times faster than silicon. If all of this has your head spinning, just take a deep breath and try to remain calm. Most of all, don't bet the farm on anything.
It seems tautological to say so, but in order for something to be discovered, it first has to qualify as being undiscovered. There would be no legend about Lana Turner being discovered at that drugstore if she had already made a few movies by the time she plopped down at the soda fountain. The best way to gauge how undiscovered a stock might be is by the number of analysts following the company--the fewer, the better. AAPL, for example, is followed by some 42 different research analysts (at least there are 42 different recommendations on the stock, most of them "buys"). WPRT has 10 analyst recommendations, while DDD has five, AUTH has three, and CVV has just one. Even when I am not swinging for the fences, I like it when a company doesn't have too much Wall Street coverage. There's an old anecdote (it's not really a joke, because it's more insightful than funny) about a client who calls his broker one day when the market is up big to inquire about what might be causing the tremendous rally in stocks. The broker pauses for a moment before answering, then in a whisper says: "I can't say for sure, but we are hearing that there are more buyers than sellers." The client then replies, "You are a genius. I am so glad you are my broker." We like to think that our stocks go up because they are earning great profits, but the technical truth is that investors buy them because of their profits (and expectations of higher future profits), and it is this buying pressure that drives the stocks higher. What we, as investors, want from all of our stocks is that we have found some tremendous potential in them ahead of the crowd, and that as they deliver on that potential, the crowd will fall in behind us and bid the shares higher. If we want to claim the mantle of discovery, we may not have to be first, but we at least have to be very early.
Whether it's Hollywood or Wall Street, the excitement of discovery is pretty much the same. And it's still the stuff that dreams are made of.
Life is short. Get busy.
Jim
Disclosure/Disclaimer: My family members and/or I own shares of AAPL, WPRT, DDD, CVV, and AUTH. Individual stocks are mentioned here for the sole purpose of illustrating investment concepts, and nothing stated here should be construed as a specific recommendation to buy or sell any security.
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