I'll Have The Usual

I wonder if Norm from Cheers (George Wendt, pictured above) would move to a bar stool at Houston's if the restaurant chain offered his favorite suds at a price lower than what he's accustomed to paying at his usual watering hole. I doubt it, and not just because Norm doesn't appear to possess the alacrity to adjust quickly to much of anything. Norm knows, at least on some unconscious level, that a Budweiser (I can't see Norm gulping down a Founders IPA) at Houston's is just not the same as a Budweiser at Cheers. Norm's beer consumption is all wrapped up in, and inseparable from, all other aspects of his imbibing experience--where he does his drinking (Cheers), his normal perch of a bar stool, the company he enjoys (Cliff, the mailman), and the fact that Sam or Woody will always slide his "usual" down the bar to him before he has to ask for it. After all, Cheers is the place where "everybody knows your name."
 
I like to think of such consumer experience as being a "gestalt," a concept in psychology that says, essentially, not that the whole is greater than the sum of the parts, but rather that the whole is something other than the sum of the parts. Merriam-Webster.com offers a more detailed definition: a structure, arrangement, or pattern of physical, biological, or psychological phenomena so integrated as to constitute a functional unit with properties not derivable by summation of its parts. You can't take the beer out of Cheers and you can't take Cheers out of the beer. This helps explain why a consumer might not buy a particular product at the place that offers the absolute lowest price. I don't shop at Walmart because, honestly, I don't like their gestalt.

The implications for customer service should be obvious here, especially for the bricks-and-mortar retailers who face an onslaught of online competition. And yet, some of them just don't seem to get it. I make a point of supporting locally-owned businesses, and when I go to a store and they happen to be out of the item I came in to buy, I certainly understand that. But when the store clerk tells me that they can have it for me in two weeks, I feel insulted. Two weeks! Seriously? Have these people ever heard of Fedex (FDX, $171) and Amazon (AMZN, $367)? Well, I have, and I'll be stepping outside to place an order on my iPhone. Where it exists, this epidemic of nonchalance, a passive arrogance rooted in denial, is causing retailers who suffer from it to miss the best opportunity they have to stay in the game--exceptional customer service. All retailers need to cultivate a considered and tasteful--but not overbearing--familiarity with their customers. We all want to have our needs met and our expectations exceeded. And even if you don't want your usual, it's nice to have it offered, even as just a reminder that someone is paying attention.

Some businesses are not only staying in the game, they are ahead of it. My wife's sister and her husband live in Boca Raton, Florida, and they often tell us about a movie theater there that they love to frequent. They can reserve their seats in advance, and these seats happen to be leather with foot rests and a table between them. A server will bring them a glass of wine from the bar and what they choose to order from the food menu. This is all very civilized, and it makes for an experience that feels more like an evening out at a nightclub than time spent in a stadium. If this is such a great idea, we might reasonably ask why the commercial airlines have not done something similar. There are many answers, one being that they cannot afford to, and another being that they don't have to. In addition to the specific economics of air travel explanation, people seem willing to put up with all sorts of inconveniences and discomforts on their journey that they would never tolerate at their destination. Getting there is just a means to an end, the end being a Disney World experience, for example, or seeing that first-run movie while enjoying a glass of oaky, buttery Chardonnay. There was a time when people actually would get dressed up to travel on a plane, but what once had a sense of panache and style to it has now been reduced to its bare-bones utility: getting from Point A to Point B. Last week was spring break for many school kids here in Memphis, and I enjoyed seeing my friends' Facebook posts with pictures of their beach vacations and ski adventures. I don't recall seeing any post with a caption that read, "Here we are on the airplane, enjoying our flight to Turks and Caicos."

When the purchase of a good or service is perceived as more utilitarian, consumers are going to be more price conscious, but at the same time they are willing to pay up for those experiences at the other end of the spectrum that provide a positive gestalt. Spirit Airlines (SAVE, $79) has made a success of itself with ultra-low ticket prices and all other services "unbundled" and available for an additional charge. Want to check a bag or choose your seat in advance? That's ala carte, for a fee. Meanwhile, Disney (DIS, $106) has recently raised prices for admission to the Magic Kingdom and has introduced the "magic band," a preprogrammed wristband that visitors wear to help them navigate  through the various rides and attractions at the park. Disney is world-class when it comes to providing the gestalt experience, and it is able to extend that to the toys and games that feature its beloved characters. Apple (AAPL, $127) has been able to escape the commoditization of electronics with its "ecosystem" of devices, and that may soon be enhanced with a new streaming video service. Under Armour (UA, $78) has moved into fitness apps, creating a sort of "fitness gestalt" that goes beyond its traditional athletic wear. But for a perfect example of the utilitarian shopping "experience," look no further than Costco (COST, $150), which has its members (including me) embracing the idea of no-frills shopping and buying toilet paper and paper towels in bulk. It makes perfect sense, as long as the price is right.

The analysts and experts who make their livings following trends in the economy tell us that members of the so-called Millennial generation are increasingly unconcerned with owning the traditional signifiers of the American Dream-- houses and cars, for example. They would rather rent than own their homes and prefer car-sharing or ride-sharing services over buying their own automobiles (read more here in this analysis from Goldman Sachs: http://www.goldmansachs.com/our-thinking/outlook/millennials/index.html?cid=PS_01_18_07_00_01_15_01). Does this mean that the Millennials are less materialistic than their parents? Not necessarily, because they are really just spending their money in different ways, typically on intangible experiences such as mountain climbing or deep sea diving. To look at it another way, they are spending money on things that will never show up on their personal balance sheets--a mission trip to Ghana is not a tangible asset. That distinction way be lost on the Millennials, since many of them seemed to have earned a college degree yet still don't know the difference between a balance sheet and a fitted sheet. But they likely do understand how to find the best prices on their utilitarian needs, and their shopping habits will probably continue to chip away at brand loyalty--why buy the costlier brand label when the store-label or generic version has the same ingredients? The spoils of utilitarianism go to the low cost provider.

If all of this economic talk on the news about there being no inflation has you scratching your head and wondering how the bean counters seemingly missed your experience when tallying the statistics, we may have an explanation.Companies that have successfully developed the gestalt experience have pricing power. They have positioned themselves so that their version of a particular good or service, enshrouded in an experience, is not the same thing as the knock-off version elsewhere. The stuff we have to buy may come at a bargain, but the stuff we want to buy will not come cheap. There is no substitute for a week at Disney World, and you get what you pay for, both on the journey and at The Magic Kingdom.


Life is short. Get busy.

Jim

Disclosure/Disclaimer: My family members and/or I own shares of FDX, AMZN, DIS, AAPL, UA, and COST. Individual stocks are mentioned here for the sole purpose of illustrating investment concepts, and nothing stated here should be construed as the advice to buy or sell any security.

Copyright MMXV

Take Me To The River--Of Green

Since my days of pub crawling are long gone, my observance of St. Patrick's Day consists mainly of living vicariously through the antics of others. I'll just be thankful that I am not staggering down Madison Avenue and wondering how much Uber will jack up their rates to get me home. What I find more exciting is that the arrival of St. Patrick's means that spring--or at least the vernal equinox--cannot be far away, and that is especially felt in this late winter of frigid temperatures and wintry mixes. We Memphians are unaccustomed to even the mildest accumulations of snow and ice, making sequestration the inevitable consequence. House arrest makes sense, though, when our fellow motorists show no respect for the dangers of black ice until they find themselves in intimate embrace with a utility pole. But enough is enough. A self-diagnosis of cabin fever seemed appropriate when I realized that I was staring mindlessly at the television, watching a show called Brazil Butt Lift on cable.We all need some springtime. Now, the folks up in Chicago, who take blizzards in stride, know how to set the tone for St. Patrick's Day celebrations. They dump emerald green dye in the river (pictured above), and maybe if I lived there I might feel more enthusiastic about the true roots of the holiday. Nevertheless, I am a Memphian, not a Chicagoan, so when I hear the words "river" and "green" in the same sentence, I think first of Al Green--who, I suspect, is not even Irish.

No observation of St. Patrick's Day would be complete without beer stories, so we'll offer a few today. During my college years (of which there were many, and the legal drinking age was 18), Coors beer was not sold east of the Mississippi River. This gave it the cachet of the unattainable, and whenever some friend would arrive back in town with a trunk-load of the contraband, the stage was set for a celebration. This rare treat of a hops potion would, we believed, cause the ladies on campus to beat a path to our door, that being the front door of the Sigma Alpha Epsilon fraternity house at Rhodes College (then Southwestern at Memphis). Coors later lost its talismanic allure once it became regularly available at the local Seven-Eleven. Beer, it seems, just doesn't taste as good if the acquisition of it doesn't involve dodging the Arkansas Highway Patrol.

I remember learning, at that very same college, about the differences between Busch beer and Budweiser. This was marketing class, though, not chemistry class. The difference in the cost of making those respective brands was slight, but in the marketing world of price and perception, Busch was the "cheap" beer and Budweiser the "premium" brand. The field of beer, if not the field of dreams, is much more crowded today, and we might reasonably think that there are going to be winners and losers. I suspect, though, that the old standards of Budweiser and its brethren will continue to rock along with their loyalists, even as the craft beers chip away at market share. Not compelling growth, but a sort of "hanging in there" stability. The more upscale beers will continue to draw in the adventuresome, those looking for more in the way of taste and, perhaps, status. Who may get consigned to the netherworld in between--or, shall we say, left out in the cold--are the aspirants to premium status who just didn't make the cut.

Shareholders of Boston Beer (SAM, $258), the brewer of Samuel Adams, were probably crying a river of a different sort (in their beers) as the shares took a shellacking after the company reported quarterly earnings in late February. Earnings per share for the fourth quarter came in at $1.40, ahead of Wall Street's consensus of $1.37, but revenues fell short at $232.97 million versus an expectation of $235.96 million. Then the company committed the unpardonable sin of forecasting 2015 earnings per share in the range of $7.10 to $7.50, well short of the consensus view of $7.96. It may be too early to draw too many negative conclusions from this one report, other than to note that the stock market always shoots its prisoners before it interrogates them. Shares of SAM now trade at $258, down from a January high of $325. A reduced earnings outlook does not go down well when a stock is trading at 36 times earnings. If there is more than beer brewing at SAM--trouble, perhaps--then we might look at it this way. My own little world of experience does not constitute anything close to a statistical sample, but if I am going to move on up from drinking Bud Light, I am not going to stop at Samuel Adams--I am going all the way to Sierra Nevada, Anchor Steam, and Founders IPA. And that is exactly what I did, as the evidence sits in my refrigerator (and my recycle bin) today.

I think of the popularity and proliferation of craft beers as another example of a general trend that I call "up-scaling." I view up-scaling as the tendency for goods and services once considered to be out-of-reach or rare luxuries to be adapted, mainly through technology and marketing, for a more mainstream market, and for consumers to expect those former luxuries as increasingly commonplace. Starbucks (SBUX, $92) offers a perfect example. A Cup of Joe at the Barksdale Cafe in Midtown Memphis will set you back $1.50, but at Starbucks a barista will grind up some premium coffee beans, froth up some milk, and charge you about $4.00 for a Venti Latte. Gourmet coffee, once available mainly in high-end restaurants, has come to the masses. And what Starbucks has done with coffee, Nike (NKE, $96) has done with athletic shoes (Are you really going to wear Keds to The University Club Fitness Center?). Hollywood celebrities have probably been shooting up poison in their faces for decades, and now You Too can do the same with Botox, courtesy not of your personal Beverly Hills physician, but of your own doctor and treatments from Allergan (AGN, $233). So now we have, in the mainstream, gourmet beer to go with gourmet coffee and gourmet versions of running shoes and cosmetic treatments. It appears that we are becoming ever more sophisticated, but cynics might say we are just becoming more spoiled.

Boston Beer is the largest craft brewer, a designation that seems like an oxymoron when we consider that the craft side of the beer business is all about small batches from small, independently-owned breweries that emphasize taste and quality. Just recently at The Fresh Market, I counted at least 50 different beers, most of them of the craft variety. If you want to invest in this trend, you might think about starting your own brewing operation. Bosco's has been brewing beer in Memphis for years, and now it is joined by Memphis Made, Wiseacre, and High Cotton. All of these beers are of very high quality. Do you really want that Samuel Adams when you can have one of these local brews?

Better positioned, at least among publicly traded companies in the alcoholic beverage sector, might be Constellation Brands (STZ, $115), which has its own well-stocked bar of brands in wine (Robert Mondavi and Clos du Bois), beer (Modelo and Corona), and spirits (Svedka vodka). In January the company reported earnings and sales numbers that exceeded estimates and offered a 2015 outlook above the Wall Street consensus view. Given the changing nature of consumer tastes, it makes sense to have a broad portfolio of libations under the same roof. As Al Green might say, Let's Stay Together. I will also be on the lookout for the next upscale product to go mainstream. Caviar at the drive-thru, perhaps? I would raise a glass to that.

 IN MEMORIAM

 This Post is Dedicated To My Friend Patrick Crump
1970-2014

 

Life is short. Get busy.

Jim

Disclosure/Disclaimer:My family members and/or I own shares of SBUX, NKE, AGN/ACT, and STZ. Individual stocks are mentioned here for the sole purpose of illustrating investment concepts, and nothing stated here should be construed as the advice to buy or sell any security.

Copyright MMXV

Not What You Expected

Take a Bow, Lady Gaga

There she was, onstage at the live television broadcast of the Academy Awards ceremony, belting out some tunes from The Sound of Music in tribute to the 50th anniversary of the film's release. I'll have to admit that I had never given much thought to Lady Gaga, except for thinking that she looked different every time I saw her, adorned as she always seemed to be in outrageous costumes, makeup and wigs. I never could figure out what she really looked like. I had also thought of her as more performer than singer, so when I heard that she would be performing at the Oscars, I figured that was my time to bring in some more firewood, check my emails, etc. Instead, my eyes were fixed on her. Not only is she indeed an exceptional singer, she was singing classic songs from a half-century ago. This amazing and riveting performance was not at all what I had expected. It was as if Justin Timberlake had stepped onstage to perform Rigoletto. Who knows, maybe that's next.

As investors, we are accustomed to developments that we did not expect, surprises of the pleasant variety and those of the most unpleasant kind. Fortunately for us, investing is one of the few endeavors where we can make a lot of mistakes and still be successful. That would not be true with, say, brain surgery. This happy state of affairs is made possible through diversification, and it allows for a portfolio to outperform the market even if it is holding a few duds. As for those duds--and the rock-star stocks, for that matter--what indication of company performance do we have other than the happy or unhappy tale that a stock's price movement might be telling us? That information comes in the form of quarterly earnings reports, and we are just now wrapping up the earnings season of reports on the quarter ended in December. As we have noted before, those earnings reports are similar to the report cards we used to get in school every six weeks. They tell us how our companies are doing--and, more important, they tell us how things are going relative to our expectations. Stock prices reflect a discounted valuation of what is expected to happen in the future, so if those quarterly reports indicate that sales and earnings are better than what we (Wall Street, actually) expected, and if the company's forward guidance tells us that these better-than-expected good times are likely to continue, the stock price should increase to incorporate this rosier outlook. That all gets thrown into reverse when the results fall short of our expectations.

Most of the stocks we follow here have had very good earnings reports, and we'll note a few highlights. First, let's define again what me mean by a "good" report. For our purposes here, that means that when it is showtime, the company reports a trifecta of earnings and sales that exceed the consensus Wall Street expectations, along with forward guidance that is also better than what was expected. Monster Beverage (MNST, $140) clocked in with results that lived up to the company's (and the beverage's) name, giving the stock price its own energizing jolt. Shares rose about 13% to a new 52-week high, and I counted no fewer than six investment firms raising their price targets on the stock. This is exactly what we like to see. A similar story played out with Home Depot (HD, $115), where it appears that all kinds of home-related goods have been flying off the shelves. Wall Street likes to focus on housing-related data such as building permits and housing starts, and that is certainly understandable, especially when it comes to assessing the prospects for the home builders. But HD may give us a broader picture of consumer discretionary spending trends as such spending relates to the home. As all homeowners know, you don't need to build a new house or move to another one when there's no place like your current money pit of a home for spending money. Those are the kind of expenditures that people can postpone, so it is another glimmer of encouragement for the economy that consumers are opening their wallets and purses to spruce up their environs.

Disney (DIS, $105) also exceeded expectations with its report, and shares moved up to  another new high. The company recently announced that it is raising the admission price for the Magic Kingdom to $105, which also happens to be where the stock is trading. Yep, one share of DIS stock will get you in to ride It's a Small World and watch the afternoon parade. Maybe they should just allow the admission price to fluctuate with the stock price--and then split the stock two-for-one just before we take our grand kids there someday. Parents also seem to be doing some spending at Carter's (CRI, $90), the retailer of clothes for babies and children, which also had across-the-board good news for investors. My wife and I have made our own contributions to the bottom line, as we love to see those grandchildren dressed to the nines. Visa (V, $273) and Mastercard (MA, $91) also joined the high-achievers party with their results, and we'll also note that Visa has now been crowned as the exclusive credit card for Costco (COST, $146), the warehouse club having announced recently that American Express (AXP, $81) would no longer enjoy that status. A company that may not have "household name" status is AmSurg (AMSG, $60), a Nashville-based owner and operator of ambulatory surgery centers. Last year AMSG acquired Sheridan Healthcare, a provide of outsourced physician services. Earnings came in at $.77 per share, ahead of the $.73 consensus estimate, with revenues also ahead at $581.8 million versus an expected $565.3 million. The company is relatively small, with a market capitalization of $2.9 billion, and may bear watching as a model of future healthcare delivery.

Big Losses at Weight Watchers  would have made for a clever headline, but the fact is that the company did not report losses, but instead earnings that matched the expectation of $.07 per share. It was, instead, the shortfall of revenues ($327.8 million versus a consensus expectation of $332.7 million) and a serving of disappointing guidance for the future that sent the shares tumbling more than 30%. Here we have yet another reminder that investing is all about the future. Earnings results are, by definition, a report card on the recent past. No matter how splendid that last quarter may have been, it is not going to help the stock price if the future does not hold similar promise. As for shares of Weight Watchers International (WTW, $10.50), the precipitous decline in the stock price suggests that the company's poor outlook came as a surprise to investors. Really? I think they should have seen it coming. The first shot across the company's bow came some years ago with the popularity of the Atkins Diet and its idea that you could eat all the bacon you wanted as long as you didn't put it on a croissant. The company seemed to recover from that, at least for a time, but let's note that the stock was trading around $80 per share just a few years ago and has been in pretty much free-fall since then. Despite the obvious fact that there is a huge (the pun potential is unlimited here, so my apologies) market for the company's services, there is also a growing plethora of ways to shed some pounds and get in shape, a number of which pose a challenge to established Weight Watchers orthodoxies. What the company does is not losing relevance, but how they do it may be.

Can positive financial surprises give us a tool for picking stocks?  Perhaps, as one of a number of factors we want to see in a prospective investment. The old "Cockroach Theory" holds that the lone cockroach we saw on the kitchen counter may have 100 cousins in the wall waiting for us to turn out the lights and go night-night. In similar fashion, a surprising earnings report might presage more of the same, in either direction. We don't want to be on the bad side of that, sleeping with the cockroaches. In my screening work, I will regularly screen for companies that have reported positive earnings surprises over the last few quarters--but that is only a start. It is worth noting also that a stock that doesn't move up on the heels of a trifecta report may be signaling trouble. That's part of the total picture: an exceptional earnings report, analysts increasing their future earnings estimates and price targets, and a stock price that follows accordingly. The real point today, though, is that we should pay attention to those reports as an assessment tool, just as we would give such attention to our child's report card.

Lady Gaga received a much-deserved, rousing, standing ovation for her mesmerizing performance at the Oscars. I would say that our trifecta stocks deserve a round of applause for their "Not What We Expected" performances, but I'd rather know that the hands of traders and investors were otherwise preoccupied placing buy orders.

Life is short. Get busy.

Jim

Disclosure/Disclaimer: My family members and/or I own shaes of MNST, HD, DIS, CRI, V, MA, COST, and AMSG. Individual stocks are mentioned here for the sole purpose of illustrating investment concepts, and nothing stated here should be construed as the advice to buy or sell any security.

Copyright MMXV

Investing With Mr. Spock

Live Long and Prosper

With the death of Leonard Nimoy (pictured above as Mr. Spock on Star Trek) last week, I have been thinking, once again, about the unwelcome role that emotions can play in our investment decisions, and how much prosperity, as measured by portfolio returns, might be enhanced by having the logic-driven Mr. Spock as a stock-picking partner. Mr. Spock's Vulcan logic was leavened, but never eclipsed, by his human side (his mother was human, his father Vulcan), and it was this potential for inner-conflict that gave the series some of its best Spock moments. Given that we are all humans with enough emotional baggage for own own versions of intergalactic travel, it would be wise to get in touch with--and cultivate--our own "Inner Vulcan."

Yes, we need to keep our emotions in check when it comes to investing, but it is also important to possess a keen understanding of the emotions of others, particularly those others in whose hands we place our financial fate when we own stocks that trade in a market. Warren Buffet advises that we be "fearful when others are greedy, and greedy when others are fearful." That's another way of saying buy low and sell high, that the best time to buy stocks is when no one wants to own them. Here it is helpful, though, to distinguish between an individual stock and the stock market. Major market sell-offs have a way of taking down the good stocks with the not-so-good ones, and if we can keep our heads under those conditions we might find some buying opportunities. We might suspect that the declining share price of a company with stellar sales and earnings growth is illogical, at least when the company's business is domestic and the market is having an emotional tantrum over the latest crisis in Greece. And while the strong dollar is taking its toll on the earnings of the multinationals, it would not be logical to apply such concerns to companies that don't have to convert their foreign earnings into U.S. dollars.

We have to consider, also, that an irrational exuberance driving the market higher could just be an expression of emotions run amok. The standard answer these days to a roaring stock market is our old friend, TINA (There Is No Alternative). TINA says that we can't get a return anywhere else, especially when we consider that the real bubble likely resides in the bond market. But investors always have an alternative, and they just might pursue it if they are gripped by the fear that a sinking stock market might inflict more pain than a slightly negative real return in bonds. Or they could hide their money under the Tempur-Pedic. And is it not possible that the actions taken due to unbridled fear could be the same ones called for by an unalloyed logic? Or that what we might chalk up to an emotional frenzy of greed has its own foundation in calculated logic?

What would Mr. Spock say? Perhaps he would agree that the valuation of Tesla Motors (TSLA, $203) is very different from that of Celgene (CELG, $121). TSLA has current losses and a forward Price/Earnings ratio of about 200. CELG, a biotechnology concern, has current earnings and a P/E of 50, with a forward P/E of 25. CELG has said that it expects to earn at least $12.50 per share in 2020. Of course, a lot can happen between now and 2020--as parents on a family road trip often have to say to the eager kids in the back seat, We are not there yet. There is always risk, and each year we add to the time horizon to justify current valuation adds even more risk. Stock prices reflect the discounted, present value of what is expected to happen in the future, and it is here that we can put on our pointy ears and apply some logic. Just how much of a rosy future does a stock price seem to be discounting? Skeptics of Tesla's valuation will say a lot. Someday TSLA will have to trade on its actual earnings, and we just don't have a clear picture now of what those earnings might be. CELG appears to be the more logical investment; if, IF the company can realize its stated goals over the next five years, it looks like a bargain. To put it another way, both companies may have very bright and promising, profitable futures, but what are you willing to pay today for those yet-to-be-realized futures? It appears that we are being asked to pay quite little for Celgene's 2020 earnings.

Investors often make the mistake of focusing on current valuation, as measured by the current P/E ratio, alone.This thinking would conclude, ostensibly, that a stock trading at 30 times earnings is more expensive than a stock trading at 10 times earnings. What's missing here is context, particularly the company's growth prospects. If the stock going for 30 times earnings is actually growing at 30%, and the stock at 10 times earnings is growing at 5%, guess which stock is "cheaper." That shifts the conception of risk a bit, as the more relevant risk may not be valuation risk, but instead execution risk. The logical approach to valuation is to ask, relentlessly, what is being discounted. The future always lies beyond what the eye can currently see, but it shouldn't lie beyond what the mind can logically and reasonably envision. When a stock's price seems to be discounting an ill-defined perfection that tempts us nonetheless, it might be time to suspect that our emotions had crept back into the room. Then it would be time to look elsewhere. That would be the logical thing to do.

Last night my wife and I were discussing Leonard Nimoy, and I persuaded her that we should delay gratification of the new House of Cards season 3 by about 50 minutes to view an old Star Trek episode on Netflix. We chose "Journey to Babel," my favorite installment of the original series and the one that introduced Spock's parents. The story has the combination of interpersonal drama and high adventure in space that made for the best episodes. The U.S.S. Enterprise is taking a group of ambassadors from various planets to what amounts to an intergalactic version of the United Nations. One of the ambassadors is murdered, Spock's father has to have emergency heart surgery and a transfusion of green blood from his almost-estranged son, Captain Kirk is stabbed, and Uhura is picking up strange communications from inside the ship as the Enterprise is followed by an unidentified and unwelcome vessel. Good stuff.

Life is short. Get busy. (And please, Live Long and Prosper.)

Jim

Disclosure/Disclaimer: My family members and/or I own shares of CELG. Individual stocks are mentioned here for the sole purpose of illustrating investment concepts, and nothing stated here should be construed as the advice to buy or sell any security.

Copyright MMXV

Secret Ingredients

BAM! With that one-word, signature exclamation, celebrity chef Emeril Lagasse is trying to tell you something. He wants you to pay attention, because he's about to add something special to the pot, an ingredient or spice that you probably hadn't thought of. This, you see, isn't your grandmother's gumbo recipe. It's Emeril's, and it calls for 12 ounces of amber beer. Grandma, by contrast, always liked to cook with sherry--and sometimes she even put some in the food. BAM!

There are not supposed to be any true secrets in the stock market, given the laws about disclosure and against insider trading. However, there are times when information may be widely known and yet still not fully understood or appreciated.  The theory tells us that all information is known and immediately reflected in stock prices, thus making the market efficient. This makes it difficult for investors to gain much of an edge, supposedly. But what about situations where a big change occurs, such as when one company buys another company, and it takes some time for the analysts who follow the stock to grasp fully the implications for the combined entity's future? This may be less of a secret ingredient and more of a special spice, the added element that provides that extra kick, something for your portfolio, rather than your taste buds, to savor.

Even novice investors understand that nice profits can accrue from owning stock in a company that is the object of an acquisition. Typically the stock of the company being bought will soar, while the stock of the company doing the acquiring may slip a bit, presumably because they are going to be shelling out a lot of money. But sometimes the company doing the acquiring is the one reaping the most benefits. Shares of Valeant Pharmaceuticals (VRX, $202) soared some 25 points (15%) Monday on the news that it had struck a deal to acquire Salix Pharmaceuticals (SLXP, $156) for $158 per share. VRX is something of a serial acquirer, with the notable acquisition of Bausch and Lomb from private equity firm Warburg Pincus PLC in 2013. VRX has stated that its goal is to become one of the top pharmaceutical companies in the world, and it plans to get there by buying other companies. Pushed by activist investor Bill Ackman, Valeant tried to buy Botox-maker Allergan (AGN, $232) last year, but lost in the bidding to Actavis (ACT, $289). Actavis today is itself the result of a combination with what was once Watson Pharmaceuticals, then known primarily for its generic drugs. What the Salix and Allergan deals have in common is that these are both specialty pharmaceutical companies with strong franchises, Salix with its gastrointestinal treatments and Allergan with Botox. Wall Street seems to like all of this, even if tracing a corporate lineage can be more complicated than figuring out the family relationships in a William Faulkner novel. Shares of Salix are up 237% over the last three years, and shares of Allergan are up 164% over that time span. But that same three years saw Valeant rise by 314% and Actavis by 400%.

As we noted in the last post here, companies can start down the acquisition trail in an attempt to reverse declining relevance. One of the more obvious areas of the economy threatened by irrelevance is the newspaper business, as people get more of their news through non-print sources. Gannett (GCI, $35), best known as the publisher of USA Today but also the owner of many other daily  and weekly papers, has responded to declining ad revenue from its printed media by going on a shopping spree for television broadcast stations. General Mills (GIS, $53), known for cereals such as Cheerios, Trix, and Lucky Charms, has sought a greater presence in the healthier food category by acquiring Annie's, a maker of natural and organic foods. Tyson (TSN, $41), the major purveyor of chicken, has bought Hillshire Brands, thereby adding pork and a variety of packaged foods to its corporate menu. The Tyson situation intrigues me, because the stock is up only about 5% over the past year. Investors were spooked by the high price that Tyson had to pay for Hillshire to prevail in a bidding war against chicken rival Pilgrim's Pride (PPC, $27). We'll be watching to see whether Tyson can realize the projected cost synergies from this combination.

As for the cost savings that can result from a corporate marriage, they are not unlike what occurs in a literal marriage. When two people get married, assuming they have not already been living under the same roof, they enjoy the magic economics of reducing the expenses of two households to the cost of supporting only one. Just another of the many benefits of marital bliss. Critics will contend, though, that "cost synergy" is really a euphemism for "job loss." That can be true, but it is not necessarily the case. Valeant, for example, has said that it has no plans for any reductions in Salix's specialty sales forces, given their specialized knowledge of the company's gastrointestinal treatments. And we can only speculate as to whether the cameras would have rolled for a new Star Wars movie (to be released later this year) had Disney (DIS, $105) not bought Lucasfilm. For that matter, Captain America might be languishing in comic book limbo today had Disney not brought Marvel into the corporate fold.

That really brings us back to our main point, which is that the ultimate benefits of such corporate combinations may not be initially obvious. This is true of any major change, of course, and the outcome can be very positive or it can be a miserable failure. Such changes have a way of throwing existing assumptions and projections off of a comfortable equilibrium, and uncertainty can prevail for a time. The analysts will even tell us that their earnings models for a particular company do not include the impact of an upcoming acquisition. What we can say is that Disney is a very different company today from what is was 20 years ago, before ESPN, ABC, Pixar Animation, Marvel, and Lucasfilm. Big acquisitions are not always transformative game-changers, and that calls for careful analysis to distinguish the opportunities from the traps, to find those situations where one-plus-one might equal more than two. If we follow Emeril's command to pay attention, though, we might just get to enjoy some tasty new gumbo.

Life is short. Get busy.

Jim

Disclosure/Disclaimer: My family members and/or I own shares of VRX, ACT, GCI, TSN, and DIS. Individual stocks are mentioned here for the sole purpose of illustrating investment concepts, and nothing stated here should be construed as the advice to buy or sell any security.

Copyright MMXV

The Relevance Quotient

One of my favorite modern quotes comes from General Eric Shinseki, the retired U.S. Army Chief of Staff, who said, "If you don't like change, you're going to like irrelevance even less." Memorable and enduring thoughts, nailed down with succinct quotes, can take on a meaning much larger than the specific context in which they were originally expressed, and that is certainly true here. Whatever the General meant originally, his idea can lead us to see failure as a particular consequence of irrelevance, and to examine change as an antidote for--or, better yet, an inoculation against--such irrelevance.

For our purposes here, we'll note that an enterprise can be a bad investment long before it becomes an outright failure. I have been picking on Radio Shack in this space for the last several years, although the true object of my scorn and derision has been the group of analysts who insisted that the stock was "cheap" and a "value" as the share price declined from $15 to $12 to $8, and so on down. The point is that we don't need to pass the Chartered Financial Analyst (CFA) exam to see what's going on in the world around us. I am tempted to think that such financial expertise could actually be a hindrance if it comes at the expense of our God-given common sense. Relevance is big picture stuff, and by the time evidence of it is manifest on an income statement, it's probably late in the game. And it is not a matter of a company's goods or services being relevant or irrelevant (that would be binary thinking), but rather a question of whether those goods and services are declining or increasing in relevance.

Investors are prone to suffer from a form of denial that usually begins with the statement that People will always buy.... Fill in the blank: Kodak film, because they will always take pictures? McDonald's hamburgers, because they will always want fast food? Sears, because they sell everything? The problem with such rationalization is that it fails to appreciate the brutality of change at the margin. No, everyone does not have to quit eating Quarter Pounders to send McDonald's (MCD, $95) into declining relevance territory. The company just has to lose customers at the margin. I have heard more than one investment analyst suggest that what McDonald's really needs to do is streamline its menu, that the offerings are overloaded and complicated. But don't you actually have to go to McDonald's to know what's on their menu? The parents who are feeding their kids at Whole Foods Market (WFM, $56) are not going to go to McDonald's even if the company started giving away granola with the fries. Even if the health--conscious do indulge in the occasional Happy Meal for the kids, they are not going to do that on a regular basis. And that's really all it takes to cause trouble.

If the relevance of McDonald's is threatened by the trends in healthier eating habits, the company's other raison d'etre, quickness and convenience, is under siege from the likes of Panera Bread (PNRA, $154) and other fast casual chains (the Panera in Midtown Memphis has a drive-thru!). Sometimes you just want a good old burger, I know, but that could soon be a smartphone tap away once food delivery apps from GrubHub and Yelp's Eat24 roll out across the country. If I have that option, my burger is going to come from Huey's (the best burger in Memphis). As for the changes that could have salvaged the company's relevance, I'll just point out that MCD was once a major investor in a start-up known as Chipotle Mexican Grill (CMG, $672) before divesting itself of that enterprise in 2006. The shares of CMG are up more than 500% over the past five years alone. I'm not Lovin' It, McDonalds.

For an example of where imaginations were not calcified in the corporate executive suite, we have Netflix (NFLX, $467) and its chairman, Reed Hastings, who saw early on the declining relevance of the mail-order dvd rental business. The company reinvented itself as a provider of streaming video and, later, as a producer of original content (my wife and I will binge watch House of Cards when the new season is released later this month). CVS (CVS, $102) saw an opportunity some years ago when it bought Caremark for its own Pharmacy Benefits Management (PBM) division, then more recently ditched cigarettes and renamed itself CVS Health. Coca Cola (KO, $41) bought a 16.7% stake in Monster Beverage (MNST, $119), the energy drink company, and also a stake in Keurig Green Mountain (GMCR, $118), both in 2014. Coke acquired the Odwalla brand of fruit juices in 2001. All of these changes can be viewed as attempts by these companies to get on the upside of relevance.

And then there are those companies that don't have to change themselves--yet--because they are in the sweet spot of relevance already. Palo Alto Networks (PANW, $137) is benefiting from the rising tide of concerns about cyber security. Cerner (CERN, $70) provides health care information technology solutions and has seen its business thrive with the shift to Electronic Health Records (EHR) systems. Hain Celestial (HAIN, $59) and White Wave Foods (WWAV, $39) are in the organic foods space and are riding the wave of healthier eating habits. Zoe's Kitchen (ZOES, $31) is a relatively new (as a public company) and unknown entrant in the healthier fast casual restaurant space.

Let's not make this any more complicated than it has to be. If we ask ourselves the question, What problem is this company solving? and we find that either the answer is evading us or that someone else is solving the problem, we might be on the trail of declining relevance. We could also just follow Amazon (AMZN, $373) the way we might track a kettle of vultures to find their latest prey. As soon as we realized that AMZN was going to be selling a lot more than books, we should have started sniffing for the walking dead retailers--and there we would have found Radio Shack and its handy but increasingly irrelevant storefronts. At the same time, let's not oversimplify the investment dimension here. Just because a company's goods and services are gaining relevance traction does not automatically make their shares a good investment. There's always much more due diligence to perform.

When I was a kid in the 1960s, my friends and I eagerly awaited the arrival of the Sears Christmas Wish Book in the fall. It was chock full of the latest toys that we could write to Santa about. I especially remember one of my favorites, the robot from the television series Lost in Space. It was under the tree on Christmas morning, and my father would have his Kodak Brownie camera ready with plenty of extra rolls of Kodak film to snap lots of pictures. He always did that. And he always would, wouldn't he?

Life is short. Get busy.

Jim

Disclosure/Disclaimer: My family members and/or I own shares of AMZN, PANW, HAIN, CERN, CVS, ZOES, MNST, KO, CMG, NFLX, WWAV, and WFM. Individual stocks are mentioned here for the sole purpose of illustrating investment concepts, and nothing stated here should be construed as the advice to buy or sell any security.

The Oldest Profession

Whenever I hear people talking about the newness and novelty of car services like Uber and Lyft, I am struck by the thought that those services are really just the latest expression of a business model that is as old as commerce itself. (No, not that other oldest profession, but a mischievous mind could find parallels there, as well.) The idea of using one's automobile to make some extra cash is no different, in economic terms, from renting out that room in your house that no one is occupying. It is all about putting an underutilized asset to work. It is this notion of underutilization, paired with an enabling technology, that is really at the heart of the economics here.


I will draw one conclusion from observing my friends' and my own use of the services, but this is purely anecdotal, not statistical. On those occasions when I have known my friends to be using Uber or Lyft, I have wondered what these friends would have done for transportation had those services not existed. Would they have called a taxicab? In most cases, no. They would have driven themselves. So, to the extent that this pattern of usage is true beyond my own experiences and observations, I would conclude that the existence of Uber and Lyft is actually enlarging the market for "someone else doing the driving." Sure, they are undoubtedly taking some market share away from taxis and more traditional car and limo services, but from what I see, Uber and Lyft have created a new market of clients who can whip out their smartphones (which they are always engaged with anyway) and summon a ride. This means that people who would otherwise have driven themselves are riding in the back seat--and not behind the wheel. There is a public safety benefit here that the vociferous opponents of the services, the folks who want them banned, should have to deal with in their efforts to keep Uber and Lyft out of the market.

As for the economics, the car services are part of what is being called the new "on demand" economy. Looking at the old economics, though, I would call it a variant of market-clearing pricing. An unbooked hotel room, for example, represents an opportunity cost to the hotel's proprietor, lost revenue that cannot be recaptured. As the date of the vacancy approaches, the hotelier has more and more incentive to book the room at whatever price will draw in a guest--the market-clearing price to get the room booked. The free flow of information is essential to the smooth functioning of a free market, and that's where the Internet comes in, putting that room "on the market" for prospective travelers who might be willing to pack a suitcase at the last minute in order to snap up a bargain. Or consider the off-price retailer T.J. Maxx (TJX, $68), which sells in-fashion clothing at discount prices. The selections here are items that didn't sell at full price elsewhere, and TJX has trained its followers, the "Maxinistas," to check the stores frequently, because the inventory is always changing. And then there is the most familiar example of all, eBay (EBAY, $54), which has given new life to the idea that "one person's junk is another person's treasure." Want to get rid of the stuff in your attic without going to the trouble of having a garage sale? Well, just snap a photo and post the items onto eBay. These are all just variations on the simple idea of trade, with the Internet and smartphone apps taking the place of the want ads.

On a recent outing with Uber, my app informed me that I would be charged 4.2 times the standard rate due to a spike in demand for cars. I had to agree to that, which I did, because it was still a bargain. The driver explained to me that Uber jacks up the prices when demand jumps as an enticement for more Uber drivers to hit the streets and pick up passengers. That, of course, is exactly how supply and demand are supposed to work. If that sounds novel, it would only be because so much of the economy does not allow for the price mechanism to work its magic by responding immediately to changes in supply and demand. The technology makes this possible. This same driver told me also that one night over the Christmas holidays he had made $1,000 in fees and tips, and that he regularly made about $1,000 a week driving for the service full time.

On another night, this one with Lyft, the app wasn't functioning properly. It was telling me that the driver was still seven minutes away even as he pulled into my driveway. The app never acknowledged that he had picked us up, so it couldn't process the transaction for payment when we were dropped off at our destination. I asked the driver if there might be someone at Lyft he could call about the problem. Well, guess what? There isn't, so I settled with him in cash. I love the ease of pressing a button on my phone to summon a ride. It means I don't have to be on hold with a taxi dispatcher, but that is exactly the person I miss when the technology fails. When advances in technology are applied in innovative ways, the result is "creative destruction." Amazon (AMZN,  $370) brings us the ultimate virtual store of anything and everything, but the price we pay is that one day I'll find myself explaining to my grandchildren what a bookstore was. So, we can probably add taxi dispatcher to the list of jobs laid to waste by the bulldozer of progress.

Since I am a great champion of free and unfettered markets, I have to come down on the side of letting the car services compete for business in the marketplace. Of course, another component of a free market is that everyone is supposed to play by the same rules, and it is here that the legacy taxi companies have a point. The answer, though, is not to ban Uber and Lyft, but to instead work out something else. I also have had great experiences with our drivers, not one of whom has reminded me of the latest serial killer from Criminal Minds. The mutual rating arrangement between driver and passenger probably puts more pressure on the driver than on the passenger, and it seems to work. A drunk, unruly, and rude passenger can likely find another source of transportation in the future, easier than a driver can find another job.

One night late when my wife and I were picked up by Lyft to go home, the young lady in the driver's seat looked at me in her rear view mirror and asked, "Do you remember me, Mr. Taylor?" I have never been particularly fond of that question, but she went on to explain that she had attended school with one of our daughters. And yes, I did remember her. She is working full time as an attorney and driving for Lyft to pick up some extra cash. And I suppose it is reassuring to know that if times get tough, I can always pimp out my car.

Life is short. Get busy.

Jim

Disclosure/Disclaimer: My family members and/or I own shares of TJX, EBAY, and AMZN. Individual stocks are mentioned here for the sole purpose of illustrating investment concepts, and nothing stated here should be construed as the advice to buy or sell any security.

Mixed Signals

Why would that guy on eBay want to sell his ashtray from the old Las Vegas Sands hotel? I don't know, but I bought it. All markets, from eBay to Wall Street, are characterized by participants who want to sell and those who desire to buy, coming together to navigate and negotiate a bid/ask proposition to arrive at a transaction. That is always, by definition, true, but sometimes the differing perspectives of buyer and seller turn out to be downright conundrums. Sometimes the larger economic environment that informs such perspectives is so fraught with conflicting signals that it is almost impossible to discern where the true weight of the evidence lies.

The noted economist Milton Friedman emphasized that "Inflation is always and everywhere a monetary phenomenon..."--another version of this thought being that inflation is caused by too much money chasing too few goods, or money growth that outpaces output growth. Friedman died in 2006, so we can only speculate as to his thoughts about the Federal Reserve's unprecedented monetary stimulus over the past several years. I imagine he would have endorsed it only as a laboratory experiment.So far the results of that experiment have not yielded the expected inflationary outcome, as inflation remains quite low even with all the money sloshing around to chase prices higher.

The yield on the 30-year U.S. Treasury Bond now hovers around record low levels just shy of 2.4%. When the federal government borrows money to finance budget deficits, its activity in the credit markets is said, according to economic theory, to "crowd out" some private borrowing as upward pressure is put on interest rates. That's one reason to raise an eyebrow at the bond market, as interest rates have fallen even as the government continues to borrow. The other eyebrow might go up because record-low long-term interest rates are not what we would expect to see when the economy is expanding.

One explanation for these seeming contradictions is the increasingly global nature of the economy and capital markets. Our government's borrowing doesn't cause interest rates to skyrocket because other governments are more than willing to buy our Treasury bonds. Inflation doesn't tick up because there are plenty of places around the globe where the costs of labor and manufacturing are cheap. And these realities were in place before the price of oil went through the floor. Add to that the fact that yields are even lower around the world, and that the main concern is becoming deflation, not inflation. When central banks used to talk about hitting inflation targets, that usually meant managing monetary policy to bring inflation down--now they are targeting higher inflation, concerned that economies might slip into the deflationary pit.

When Wall Street opened on Tuesday, it appeared that the blizzard that hit New York City had kept all the buyers stranded at home while the sellers had no trouble making their way to Lower Manhattan. The real culprit, though, was an unexpected reported decline in Durable Goods orders, which were expected to be up slightly in December but were actually down 3.4%. Then Caterpillar (CAT, $79.85) chimed in with disappointing earnings and weak outlook, citing its exposure to the energy sector. The strength in the U.S. Dollar is also doing its part to inflict some pain on the multinationals. This serves as a reminder that the energy boom in the U.S. has been a strong driver of economic growth and a source of strength for companies in the manufacturing/industrial sector--and that the downturn will not be limited to those companies strictly classified as belonging to the energy sector.

So, with the Dow Jones Industrial Average down almost 400 points Tuesday morning, was there anything that wasn't collapsing? The shares of Ulta Salon, Cosmetics, and Fragrance (ULTA, $135.84) were managing to eke out a fractional gain amid all the selling in the morning before closing the day down 24 cents. ULTA is a retailer of, as the name suggests, a variety of beauty products across a range of price points--and a company with no international exposure. Did ULTA escape the selling because people in the oil business don't care about looking good and smelling good? I can't speak to that, but what I can say is that ULTA is a growth stock, and its stores offer salon services in addition to the beauty products it sells. It is sort of a luxury spa for the masses--and by that I mean the mass market. The business model is familiar, as Starbucks (SBUX, $88.34) has found success in bringing gourmet coffee to the mass market, and Nike (NKE, $94.50) and Under Armour (UA, $71.96) have grown by bringing performance athletic wear to the masses. This might just be a place where consumers decide to spend the extra cash in their pockets that they saved at the gas pump. Never heard of ULTA? Consider that a plus, or at least an indicator that it has not yet saturated the market.

Analysts like to describe the current U.S. economy as being "the best house in a rotten neighborhood." One has to wonder, though, how long this can last before the world's economic weakness spills onto our shores. Deflation is the scourge of economies and markets, and we should be watching for signs that might indicate whether our own Federal Reserve is starting to worry about contagion. If the Fed ends up NOT raising interest rates this year, that stance could actually be the proverbial canary in the coal mine.

Life is short. Get busy.

Jim

Disclosure/Disclaimer: My family members and/or I own shares of ULTA, SBUX, NKE, and UA. Individual stocks are mentioned here for the sole purpose of illustrating investment concepts, and nothing stated here should be construed as the advice to buy or sell any security. Stock prices are as of the close of regular trading on January 27th, 2015.

The Perpetual Beauty Contest

Most investors understand that investing in stocks is, fundamentally, an instance of ownership. Just as with the ownership of any enterprise, the owner puts his or her capital at risk in return for a claim on the profits. Your investment, whether it is as the sole proprietor of a small shop or as one of many shareholders in a multinational corporation, could turn out to be the next Microsoft (MSFT, $47) or the next Radio Shack (RSH, $0.33)--the potential is theoretically unlimited to the upside, but you could also lose every penny of your capital. Of course, being one of millions of shareholders is different from owning a small business. Just try buying some shares of Tesla (TSLA, $201), and then walking into the corporate headquarters and demanding an audience with Elon Musk. Your persistence might land you in a jail cell. The other difference, though, arises when your shares are publicly traded on a stock exchange, a feature that was captured by famed economist John Maynard Keynes with a brilliant metaphor in his classic work, The General Theory of Employment, Interest, and Money (1936). 

Keynes postulated an imaginary beauty contest, sponsored by a newspaper that published the photographs of 100 women. The paper's readers were then challenged to pick the six most beautiful. The twist here is that those eligible to win the contest are not the pretty ladies in the newspaper--instead, the actual "contestants" are the members of the general public, who are vying against one another to guess which six ladies will garner the most votes. If you were serious about winning this contest, you would have to put aside your own preferences and tastes in beauty and think about what the public at large would find beautiful. You might think that the brunette with the angular facial features was the most striking woman you had ever seen, but if you think that the general public is inclined to favor blondes, you would focus your choices on the ones with the golden hair. The best strategy, Keynes noted, isn’t to pick the faces that are your personal favorites. It is to select those that you think others will think prettiest. Better yet, he said, move to the “third degree” and pick the faces you think that others think that still others think are prettiest. Similarly in speculative markets, he said, you win not by picking the soundest investment, but by picking the investment that others, who are playing the same game, will soon bid up higher.

What is helpful about this analogy is that it reminds us of a basic truth of publicly-traded stocks--they go up only because other people buy them, other people who are big investors and traders thoughtful enough to do their buying after we've done ours. Most investors think that stocks appreciate in value because they have great sales and earnings growth, or at least the potential for such growth. That would seem to be true, but the missing link in that chain of causation is the necessary buying pressure from that big, nebulous population of investors and traders that we'll just refer to as "Wall Street."

Here's an old Wall Street joke that is apropos here. A broker persuades his client to buy 1,000 shares of stock in a promising company, at $5.00 per share. About a week later the stock has risen to $6.00, and the broker calls his client to tell him the good news. The client instructs the broker to buy another 1,000 shares. Then another week goes by and the stock is at $7.00; the client buys another 1,000 shares. The stock keeps going up, and the client keeps buying more shares. Some weeks later the broker calls the client to tell him that his stock has hit $12.00. The client tells the broker to sell all of his shares. The broker replies, "To whom?"

If we think about that bit of humor and the fictional beauty contest too much and for too long, we might never buy another share of stock again. That's because these scenarios remind us that when we buy stock in a publicly-traded company, we are, in essence, placing our financial fate in the hands of other people--Wall Street, that is. But before you become a complete cynic, consider the positive side of all this. Unlike perceptions of physical beauty, which tend to be highly subjective, the financial metrics of companies are much more objective. Those factors such as strong sales, margins, and earnings that make a stock attractive to us also tend to be the same factors that draw the attention of Wall Street--and the big money that provides the buying pressure.

Consider, for example, the case of Palo Alto Networks (PANW, $126), a cyber security company. A year ago (January 2014) PANW was trading at around $61 per share, and anyone who was paying attention to the news knew that hacking and cyber security threats were becoming a big issue. PANW then reported a series of quarterly earnings that beat analysts' estimates, and those Wall Street analysts started raising their earnings estimates and price targets for the stock. Over the course of 2014, the stock continue its move up, ending the year at $122 (up 100%). Many investors were no doubt scared off from the stock due to its high valuation (100 times earnings) and its strong advance. At $90 per share, the stock had already moved up 50%--this probably kept some investors sidelined. But big institutional investors kept buying the stock, and I have to think that part of the reason was their desire to own a problem-solving company that has the potential to be extremely successful in the high-profile area of network security. If you are an aggressive growth investor, you basically live for opportunities like this. Various statistical studies of winning stocks have shown that fundamental strength and growth in sales and earnings, combined with strong technical movement in the stock, are the attributes common to stocks that have outperformed the market significantly over long periods of time. The challenge, of course, is finding the stocks that have staying power as long term winners, as opposed to those of the "flash in the pan" variety. Having a growing addressable market such as the one that PANW faces certainly helps, as more companies spend more on protecting their networks.

While PANW may win the beauty contest, let's stretch the metaphor a bit further. Suppose we have two new entrants in the contest, a couple of beguiling, eye-catching beauties: one wears a sash bearing the name "bonds," and the other wears a sash reading "cash." If investors conclude, for whatever reasons, that there is too much risk in stocks, then bonds and cash may attract more votes. And then it may not matter how enchanting a stock like PANW is, if Wall Street just doesn't want to own stocks. It's hard to imagine that the charms of a near-zero real return in bonds and cash would be compelling enough to take the attention away from fast-growing stocks, but it can definitely happen if Wall Street concludes that a zero return is preferable to a negative one. So, while investors can have success in identifying the fundamental and technical strengths of stocks that will draw the buying power of Wall Street, the task becomes a bit dicier if the big investors pull away from stocks as an asset class.

Let me return to the issue of ownership before I wrap this up. For an example of classic ownership, I have to look no further than my own wife, who owns and operates a retail clothing store (The Pink Door, the Lilly Pulitzer Signature Store here in Memphis). My wife's focus is on increasing sales and keeping control over expenses, which is just another way of saying that she seeks to maximize her profits. At the end of any given business day, she can tell me how her sales came in and how they are tracking with the same period a year ago, and various other metrics of her store's performance. What she never mentions is anything whatsoever about what her business is worth. It isn't that she doesn't care about its worth--she just doesn't plan on selling it anytime in the near future. And, of course, if she maximizes her profits, the value of the business will increase over time. This is how, in economic jargon, she maximizes shareholder (ownership) value--by relentless attention to customer service, smart inventory decisions, marketing and promotions, etc. The point to appreciate here is that when we invest in a stock that doesn't pay dividends, we are entirely dependent on appreciation in the stock price for any return. And that appreciation comes only from other investors buying the stock.

So, as we search for those stocks with the attributes that will appeal to Wall Street, we need to keep an objective approach to the company's fundamentals. We should resist every temptation to fall in love with a "story" that isn't backed up by solid growth and other fundamentals. In other words, when we are judging the beauty contest, it is best to leave the beer goggles at home.

Life is short. Get busy.

Jim

Disclaimer/Disclosure: My family members and/or I own shares of PANW. Individual stocks are mentioned here for the sole purpose of illustrating investment concepts, and nothing stated here should be construed as the advice to buy or sell any security.

Catching The Falling Knife

Six month chart of Schlumberger (SLB)

from Charles Schwab

I have always found it somewhat comical how Wall Street comes up with expressions and metaphors to describe certain events and circumstances in the market, often without some explanation about what the terms are supposed to mean. A "Black Swan" event, for example, refers to some development or crisis that is totally unexpected, out of the blue. That is the experts' way of warning that something really bad could always happen that would roil the markets, but we don't know what that might be or when it might happen. Well, of course that is true. That is also known as "life." More colorful, albeit morbid, is the "Dead Cat Bounce," intended to describe a stock that is in a downtrend but pauses for a temporary move to the upside. Apologies to cat lovers everywhere. The "Risk On" trade is when investors and traders are favoring riskier assets such as stocks; "Risk Off" means they are piling into less risky assets such as Treasury securities. More obvious in meaning is the subject of today's post, timely because investors might be tempted to search for bargain stocks among the ruins of the energy sector. The danger with falling stocks is that they just might keep falling, inflicting a different kind of pain that is no less real than the wound from an ill-timed grasp at that falling knife.

Even someone whose only understanding of Wall Street is from watching Leonardo DiCaprio as the "Wolf" of that storied location probably knows that investing is all about buying low and selling high. So, it would be logical to conclude that a good time to buy energy stocks is when everyone else is throwing them away, that time being about right now. But here we need to understand two qualifiers to the general "buy low" rule. First, just because a stock has declined in price by a significant amount does not make it a bargain. If that $200 shirt you've been eyeing gets marked down to $100, it probably is a bargain, assuming you are going to wear it. (I could point to a few items in my closet that I bought primarily because they were marked down--I never wear them). If I buy the shirt at $100, I'm going to be quite frustrated if I then see it marked down to $50. My sense of having scored a bargain will evaporate quite quickly. At least, though, I have the economic "utility" of a shirt on my back, something that stocks offer only when they go up. Yes, we buy stocks so they will appreciate in value, and that brings us to the second point, a piece of wisdom offered by an analyst on CNBC (can't recall his name): "Valuation in and of itself is not a catalyst." That's important, because it reminds us that the unrelenting question we should ask about any stock is, What is Going to Make This Stock Go Up?

Where the oil stocks are concerned, we strongly suspect that it will take a mighty recovery in the price of oil to lift the shares out of the doldrums. I am amazed at the number of people who seem to think that oil, having fallen more than 50%, has hit its low, and that the risk is that the price per barrel will just languish here. Let's examine that assumption more closely, using the above graph of Schlumberger (SLB, $77) as our point of departure. SLB is the bluest of the blue chips in the oil service sector, and the decline in its share price from $118 to $77 ( about 35%) makes for a tempting investment. Furthermore, the stock pays an annual dividend of $1.60, which at a share price of $80 translates into a 2% yield. Before the stock broke below $80, I considered making the case that $80--and the resulting 2.0% dividend yield--would provide support--the lower the stock price of SLB goes, the higher its dividend yield, something very compelling in a world of rock-bottom interest rates. But that is assuming that business does not get so bad for Schlumberger that they have to cut the dividend. With a dividend payout ratio of just 30% (12 month earnings of $5.32), there is some cushion here, at least for now. But things could get a lot worse for stocks in the oil sector if the price per barrel of the commodity falls even further, as some analysts have suggested it just might, to somewhere around $40.

The economics behind all of this is that oil is a commodity. Unlike Proctor and Gamble (PG, $90), which can slap a brand name on some sodium flouride and call it "Crest toothpaste," the oil companies are faced with a price of oil that is set in the overall market, and no individual company pumping the stuff out of the ground can affect that price (OPEC could, but they have refused to cut production). If you were selling another commodity, say cotton, for example, as a cotton farmer, you would face the same situation. And if the price of cotton falls dramatically, your income would suffer, and you might postpone purchasing that new tractor you've been considering. That's exactly what's going on in the energy sector. The oil companies will not be making as much money, and so their demand for the services of SLB is going to wane. The price of oil has to fall far enough to sideline capital expenditure projects until, at some point, supply comes back into balance with demand. That's just how commodity cycles work. That's what economists call a "new equilibrium," and no one really knows whether that price is $50 or $40 or something lower. And no one knows when this will happen. So we have the issue that oil prices have fallen so much, and we don't know how much further they might fall, and we don't know when they might recover. This paints a pretty ugly picture for the sector, and every enterprise that depends on it.

So, even as consumers enjoy the boost in real income resulting from cheaper energy, there is much carnage unfolding in the energy sector. Some of the marginal operators have issued a lot of debt in the junk bond market, so we might see some dominoes start to fall there. The boost to the economy from lower energy prices is thought to outweigh the negative effects in the energy sector, and that is probably true if the deflationary pressures don't spread too far and wide. I am just thankful that I don't own a truck stop in the North Dakota oil fields.

Life is short. Get busy.

Jim 

Disclosure/ Disclaimer: My family members and/or I own shares of SLB and PG. Individual stocks are mentioned here for the sole purpose of illustrating investment concepts, and nothing stated here should be construed as the advice to buy or sell any security.

Reading The Tea Leaves For 2015

I have never been one to make a lot of predictions, but I do believe it is both helpful and important to gather up our observations and apply our brain power to developing a picture of what the world is likely to look like in the future. The trends, themes, and "facts on the ground" that have informed our investment strategies do not obey the rules of the calendar, so turning the page to 2015 really provides us an opportunity to assess our game plan, rather than some signal to make major changes because the world has changed with the dropping of the ball in Times Square. So, here we go with some thoughts for the New Year.

As I have written previously, in order for the stock market to continue to do well, it will have to make the transition from being driven by higher price/earnings (P/E) ratios to being driven by higher earnings. The Federal Reserve's unprecedented monetary stimulus has kept interest rates at extremely low levels, and this has inflated P/E ratios as investors are willing to pay more for each dollar of future earnings. The Fed has stated that it will be watching the employment situation very closely in determining when to start raising interest rates. So, when we have seen much better than expected jobs numbers, the market has tended to sell off. This is the stock market in full-blown "Good news is bad news" mode. So, the Fed has already taken away the proverbial punch bowl of Quantitative Easing, and the next step will be the first in a round of interest hikes. The good news is that this will (we would assume) accompany a stronger economy that is producing more jobs and improved corporate earnings. That transition, though, is likely to give investors a very bumpy ride.

As I wrote in the last post, I am leaning toward the stronger economy thesis, and that could make the Consumer Discretionary sector an area worth our attention. My goal, though, is to find stocks that stand to benefit from long-term, secular trends; a stronger economy is just an added tailwind for those stocks. In fact, three of the stocks I mentioned last time--VISA (V, $259), Mastercard (MA, $84), and FedEx (FDX, $171)--are not even in the Consumer Discretionary sector, but do stand to benefit from a more robust economy (as well as from the longer term trends we considered). The fact that Disney (DIS, $93) had to turn away Christmas visitors to its Magic Kingdom in Orlando and Disneyland in California because the theme parks had reached maximum capacity is not, by itself, the basis for an investment, but there is a lot more to like about the company. ESPN, arguably, is the most important piece of Disney's business, with sporting events fast becoming the last remnant of watching live television broadcasts. And it is now less than a year until the release of the new Star Wars movie. Does it really make sense that Apple (AAPL, $108), with a market capitalization of $647 billion, is worth four times more than DIS (market capitalization of $160 billion)? This is not a knock against AAPL, which has developed the most ubiquitous piece of technology on the planet, the iPhone (if you don't believe that, just try having a conversation with someone who is incessantly checking their text messages). But DIS has Luke Skywalker, Mickey Mouse, the Marvel characters, Frozen, ESPN, and ABC all under its roof. That's quite a collection of assets, and while any movie studio can make an animated or live-action feature, only Disney can cast what are now Disney characters in films--and market them as toys, games, stuffed animals, etc. I have recently discovered that our grandson, whose favorite character has been Thomas the Train, is now a huge Mickey Mouse fan. So, I'll raise a glass to Mickey and live football games. Pass the Skittles and the Ro-Tel, please.

The organic orgy of healthier eating continues, even as I continue to enjoy one of my favorite comfort foods, the chili and tamales from Huey's here in Memphis. It's worth noting that long-time favorite holding Whole Foods Market (WFM, $50) is down 12% over the past year while Kroger (KR, $63) was up 61%. The latter seems to be doing everything right, while the former has suffered from the curse of familiarity and high expectations.  WFM is actually up about 30% over the past three months after hitting a low of $36 in the summer, and while the stock may not return to its glory days, it still has room to grow. Two companies that make the healthier stuff are  Hain Celestial (HAIN, $55; recently split two-for-one) and Whitewave Foods (WWAV, $34).

On the subject of health, pharmacy chain CVS has quit selling cigarettes and re-branded itself as CVS Health. I guess it doesn't make sense for the cashier to ask if you'd like a pack of Marlboro Reds to go with that Z-Pak prescription as you're coughing on all of the other customers in line. This is probably the future of health care, with nurse practitioners staffing the CVS walk-in Minute Clinic. I have some friends who visited their local CVS Minute Clinic when they came down with the flu, and I expect this to be a continuing trend. Another thing about CVS Health (CVS, $95) that I like is its strong dividend history--dividend growth, to be specific, an average annual dividend growth of 10% over the past twelve years. Although the yield is only about 1.4%, I much prefer dividend growth over high current yield. CVS pays out just 34% of earnings in dividends and is rated A+ by S&P.

Most people, it would seem, have devoted a majority of their attention to either loving or hating the Affordable Care Act (ACA, or "Obamacare"), and very little attention to figuring out what it actually means for the health care system. What it should mean is that more people in the population will have health insurance--and fewer people uninsured. For companies that deliver healthcare, that should mean more paying customers (even if it is the insurance doing the paying). A company such as HCA Holdings (HCA, $73), which operates hospitals and surgery centers, could see its bottom line enhanced by having fewer patients who can't pay. The problem, though, is that reimbursement issues could offset some of those positive effects. How it will all shake out is still somewhat murky,but the ACA is one of those "facts on the ground," and whether we love it or hate it, we need to watch closely for how it might affect our investments.

The ACA aside, there are other enduring trends and themes in healthcare that we have considered before. Reducing costs in the system is one of them, and  that is why the generic drug companies continue to look interesting. We first looked at Actavis (ACT, $260) when it was known as Watson Pharmaceuticals, and the stock has had a stellar run since then. Shares are up some 300% over the past three years. Now it appears that ACT has beat out Valeant Pharmaceuticals (VRX, $144) in the bidding for Allergan (AGN, $212), the maker of Botox. While I would never recommend buying a stock on takeover speculation alone, I do suspect that a number of these specialty drug companies could be attractive acquisition candidates.

In future posts we'll continue to look at any number of stocks that should benefit from a stronger economy and improved incomes. A note of caution about the market here, though. Many of the stocks mentioned here have appreciated sharply over the course of this bull market, and they may be the very ones to fall the hardest in a meaningful sell-off. It is always important to view our money invested in stocks as being needed only for some distant tomorrow--that is, we shouldn't need those funds for at least three to five years. That allows us to take market declines in stride, without having to reach for the antacid. This long time horizon actually gives individual investors an edge, because we can sit tight while others panic. Things may get unpleasant, but they don't have to be deadly. And just how unpleasant could they get? Well, it is not unusual for the market to correct by 10% to 15% in the course of an ongoing bull market. A  15% decline in the Dow Jones Industrial Average from its recent high of around 18,000 would put the index just above 15,000. That would make some headlines. The market has started off 2015 with a bang, but the bang is a move down, so far. These may be some transitional labor pains, leading to the birth of a new market that is driven by a more robust economy and an improved employment picture that can break free of the midwife of Federal Reserve stimulus. And who doesn't hope for a healthy baby?

Life is short. Get busy. And Happy New Year!

Jim

Please post any comments or questions to the Comments section.

Disclosure/Disclaimer: My family members and/or I own shares of V, MA, FDX, DIS, AAPL, WFM, HAIN, WWAV, CVS, ACT, HCA, and VRX. Individual stocks are mentioned here for the sole purpose of illustrating investment concepts, and nothing stated here should be construed as the advice to buy or sell any security.