Archive for 2005

  • Don’t Let a Low P/E Fool You
    , December 7th, 2005 at 3:25 pm

    Toll Brothers (TOL) is set to report earnings tomorrow, and I’m afraid to watch. Don’t get me wrong. Toll is a terrific company. I wish I had bought its shares years ago. Heck, even two years ago. But I’m pretty nervous about the outlook for housing stocks.
    I’ve been looking at several housing stocks, and I have to say that I don’t see any good bargains. One of the problems of analyzing housing stocks is that their price/earnings ratios can be very misleading. Let Professor Eddy explain.
    While the price/earnings ratio can be a very valuable tool, sometimes it doesn’t tell us the right information. The reason is that the P/E ratio is actually a weird hybrid number. It compares a fixed-point number (the price) to a rate (earnings). Even many experienced investors don’t realize this.
    With a fixed-point number, we always know exactly what it is at a given time. That’s not so with a rate. For the earnings number, we’re really asking how much did a company make between two points. Since there’s a lag time, these points are usually somewhat dated. For Toll Brothers, it earned about $4.05 a share between July 31, 2004 and July 31, 2005. That’s a period of 16 months ago to four months ago.
    With Toll trading around $34 a share, it appears to be a bargain at 8.5 times earnings. Using a hybrid number like P/E ratio is kosher, but we have to recognize when it can trick us. It’s almost like trying to weigh something with a ruler.
    Generally, I think it’s better to look at the forward price/earnings ratio. That compares next year’s earnings with today’s price. That’s better, but still we have to rely on analysts’ estimates. That can be a dangerous game, and with my favorite stocks, I prefer to set my own estimates. If you’ve been reading me for awhile, you’ll remember that Frontier Airlines (FRNT) earned 16 cents a share, far above the two cents Wall Street was expecting. Right now, Wall Street expects Toll to make $5.25 a share next year. That seems too high to me.
    Even using a forward price/earnings ratio has its downsides. It particularly screws up the readings of cyclical stocks. These are companies whose fortunes are heavily tied to the economy, like oil stocks or homebuilders. ExxonMobil (XOM) is a very good company, but its earnings-per-share declined four times in five years between 1998 and 2002.
    No matter how good you are, it’s hard to make a profit when all the arrows are negative in your industry. In 2002, I don’t remember Congressional hearings about the poor fate of the oil companies, but ExxonMobil was able to get by. Today, of couse, it has huge earnings and a lot of complaints.
    For a cyclical company, the trick is really managing your way between the good times. This is why economists pay such close to attention to things like new home sales or orders for durable goods. The cyclical stocks give us a good idea of how strong the economy is.
    Generally, I usually don’t favor a lot of cyclical stocks. There are some on the Buy List like Donaldson (DCI) and Danaher (DHR), but I prefer stocks that do well no matter how well the economy does. Like a lot of things, I’m not smart enough to predict the movements of a $12 trillion economy.
    With homebuilders, there’s always a reckoning. Toll Brothers dropped over 80% from 1987 to 1990. In 1994, it fell 50%. From 1998 to 2000, it fell 50% again. And it nearly did it again from 2002-2003. So far, the stock is only 42% off its high since the summer. I get the feeling that Toll’s earnings aren’t going to come in at the level Wall Street wants. We’ll know more tomorrow. Until the dust clears, I’m staying away from the housing sector.

  • Bernanker: Great Depression Buff
    , December 7th, 2005 at 12:18 pm

    From today’s Wall Street Journal:

    In 1983, Mark Gertler asked his friend and fellow economist Ben Bernanke why he was starting his career by studying the Great Depression. “If you want to understand geology, study earthquakes,” Mr. Bernanke replied, according to Mr. Gertler. “If you want to understand economics, study the biggest calamity to hit the U.S. and world economies.”
    Mr. Bernanke’s fascination with the economic earthquake never abated. “I am a Great Depression buff, the way some people are Civil War buffs,” he wrote in 2000. “The issues raised by the Depression, and its lessons, are still relevant today.”
    Mr. Bernanke’s interest in the Depression, which dates back to his childhood, is a guide to the evolution of his thinking. In particular, his groundbreaking research on how mistakes by the Federal Reserve compounded the catastrophe is likely to influence how he steers the economy once he succeeds Alan Greenspan as its chairman early next year.
    The Depression, he contends, has taught the importance of avoiding both deflation — that is, generally falling prices — and inflation. It has also shown the threat that falling asset prices — such as, potentially, in housing — and weakened banks can pose. Most important, it shows the damage the Fed can do when it follows wrong-headed ideas.

    Forty years ago, the Federal Reserve was not thought to be that important. Today, it’s almost universally believed that Fed policy turned a minor recession into the Great Depression.

  • The Value Line ETF
    , December 7th, 2005 at 11:36 am

    For many years, the Value Line stock rating system has consistently beaten the stock market. Critics, however, have said that the system is hard to translate into real world investing. They note that the Value Line mutual funds have not been able to match the returns of the newsletter. Plus, the mutual funds haven’t always followed the advice of the newsletter.
    Value Line answered with a closed-end mutual fund (FVL), which matches the newsletter exactly. But the problem with a closed-end fund is that it can trade at a discount to its net asset value, so shareholders haven’t gotten the same return.
    Now Value Line has issued its very own exchange traded fund, PowerShares Value Line Timeliness Select Portfolio (PIV). The growth of ETFs over the past few years has been quite remarkable. It will be interesting to see if Value Line can finally show if what it can do on paper, can be done in the real world.

  • Disequilibrium and Surfboards
    , December 7th, 2005 at 10:26 am

    One of the key aspects about investing is that markets aren’t smooth. Markets move from periods of stability to periods of “disequilibrium.” In other words, everything seems normal then suddenly, everything totally freaks out.
    These “freak out” periods aren’t failures on the market’s part. They’re perfectly normal, and it’s simply how a market digests new information. That’s basically what a market is—a huge machine that’s constantly analyzing new information.
    One of my long-standing complaints about the financial news media is that when a market freaks out, it’s presented as some sort of moral failure. For example, the blame for the tech bubble has now fallen squarely on the shoulders of dishonest Wall Street analysts. Well, there certainly were many dishonest analysts running around. But you’ll notice that the blame never falls on gullible investors. Or worse, non-gullible investors. Why is that? No one at Enron was responsible for Cisco going to $82.
    The late journalist I.F. Stone said that history isn’t a morality tale, it’s tragedy. The market’s judgment is not a moral one, nor is it political. The stock market doesn’t care that much about you, or how you vote.
    I noticed this story in today’s Wall Street Journal. The nation’s surfboard industry has been thrown into turmoil by the sudden closure of the major maker of foam moldings used for surfboards. No warning was given to clients.

    The move could cause a severe short-term shortage of the base materials commonly used to make surfboards.
    U.S. surfboard manufacturers since Monday afternoon have been scrambling to secure foam or alternative materials from companies as far-flung as Australia, South Africa, Spain and Brazil. Industry observers estimate that Clark Foam’s 100 employees annually manufactured about 300,000 foam moldings, known in the industry as “blanks.”
    Gordon “Grubby” Clark, 73, founder and owner of closely-held Clark Foam, sent a seven-page letter Monday to his main distributors saying he was under scrutiny by the Environmental Protection Agency and California state and local agencies as a polluter and for violating county fire codes. In the letter, Mr. Clark said he decided to suddenly shutter his business because, “the State of California and especially Orange County where Clark Foam is located have made it very clear they no longer want manufacturers like Clark Foam in their area.”

    I’m going to confess that I know nothing about the surfboard industry. But I will guarantee you that somebody, somewhere is working late into the night to capitalize off the apparent demise of Clark Foam. For the next few weeks or months, it might be tough finding that perfect board. But soon, everything will be back to normal.

  • The Future for Small-Caps
    , December 7th, 2005 at 9:57 am

    Investor’s Business Daily notes that 19 of the 20 top-performing mutual funds for the last five years have been small-cap funds. But there’s growing evidence that the small-cap rally may be getting tired.

    So far this year going into Tuesday, the Russell 2000 small-cap index is lagging the large-cap Russell 1000, 6.48% vs. 7.21%.
    An end to the cycle would jibe with historical trends.
    Small caps have had six periods of extended outperformance since 1926, according to T. Rowe Price.
    Their average length was 5.7 years.
    The current cycle started in April 1999. It is now more than 6.5 years old. It ends when small caps lag for a full quarter.
    The current cycle owes its longevity in part to the fact that small caps have not outperformed as dramatically as in some past cycles.
    Through March 31, small caps gained a yearly average of 10.6% in the current cycle vs. a 1.3% loss for large caps, according to Merrill Lynch Small-Cap Research.
    But in the prior five cycles, small caps averaged 28.4% a year vs. large caps’ 15.2%.
    Market leadership is shifting now as small caps lose their edge in relative earnings growth. Before this year, small caps had more attractive price-earnings ratios.
    The valuation edge returned to large caps in the past 12 months.
    Now the Russell 2000 is trading at an average of 17.1 times forward 12-month earnings. The S&P 500’s multiple is 15. “That two percentage point gap is pretty hefty,” DeSanctis said.

    The S&P 600 Small-Cap Index (^SML) was at a all-time yesterday, although the late-day sell-off brought it just below its highest close, which was set on Friday. By comparison, the S&P 500 is still over 18% off its all-time high. The S&P 400 Mid-Cap Index (^MID) also hit an all-time high on Friday. That index has outperformed the both the S&P 500 and S&P 600 for the last five years.

  • The Market Today
    , December 6th, 2005 at 7:24 pm

    It was a good day right up until 3 p.m. Still, the market held on for a small gain. The S&P 500 closed up 0.13% while our Buy List gained 0.16%. The 10-year Treasury bond saw its yield again fall below 4.5%. Oil closed just below $60 a barrel. Frontier Airlines (FRNT) had good news. The spunky airline said that its traffic for November grew by 10.8%. The shares are still only at $8.46.
    The latest from the Guidant (GDT) wars seems to be that Johnson & Johnson (JNJ) is ready to walk away. Plus, I’m hearing more that indicates that St. Jude Medical (STJ) is in play. For now, I think Medtronic (MDT) is just too big to get involved.
    One of oddest events of 2005 has been the plunging shares of orthopedic stocks. I still think this is an excellent sector. Today, Barron’s takes a look at the industry:

    After skyrocketing for years because of fast-growing profits, shares of industry giants Zimmer, Stryker and Biomet tanked late in 2005 amid concerns that government probes, a stronger U.S. dollar and demand from hospitals for lower prices would squeeze profits.
    But upbeat remarks by company executives at a Merrill Lynch investor conference last week persuaded some investors and analysts that their fears were exaggerated.
    In fact, demand for joint reconstruction surgery keeps climbing, as do sales of new devices.
    And with their valuations bouncing off five-year lows, shares of Zimmer Holdings, Stryker and Biomet may be attractive.

    The NYSE just reported that its members voted in favor of the Archipelago deal by more than 95%. I imagine the seatholders are happy. When the deal was announced, a seat was worth $1.62 million. Today, seats are going for $4 million.

  • Looking for a Conference Call Transcript
    , December 6th, 2005 at 2:11 pm

    Seeking Alpha has them.

  • S&P 500 Over 1270
    , December 6th, 2005 at 1:40 pm

    The market looks very good today, almost every sector is up. The S&P 500 hasn’t closed above 1270 since June of 2001. Energy stocks are doing well, but so are the transports. Expeditors (EXPD) isn’t far from a new high. Our best stock today is St. Jude (STJ), which is up about 3.8%. So far, the Buy List has a slight lead over the market.
    Thor Industries (THO) said that it saw a 22% increase in its orders at the Louisville Recreational Vehicle Show. Dell (DELL) has been rising steadily and may soon close in on $32 a share.
    I’ve written about Tradesports before, the site that let’s investors speculate on real world events. It turns out that there’s been an insider trading scandal at another site, Sportsbook.com. There was unusually heavy betting on “Mother Nature” for Time Magazine’s Person of the Year, and Tom Brady for Sports Illustrated’s Sportsperson of the Year. The trades were coming from e-mail addresses of a PR firm linked to Time Warner (TWX). That may be one of the dumbest moves ever.
    Please keep those e-mails coming! As always, I’m happy to give my opinion on any stock, but I can’t give personal portfolio advice. Also, I’d love to hear about any great bargains that you see on your radar.

  • NYSE to Go Public
    , December 6th, 2005 at 12:07 pm

    This is the beginning of a new era. After 213 years, the New York Stock Exchange will become a for-profit publicly traded business. Today, the 1,366 exchange members are set to vote in favor of the NYSE’s deal to buy Archipelago (AX), an electronic trading company.
    There’s a small, but vocal, group opposed to the deal, but they just don’t have the votes. Once passed, this deal will help the exchange compete with rivals like the Nasdaq (NDAQ), which is already publicly traded. Some of the publicly traded exchanges have done very well recently like the Chicago Mercantile Exchange (CME). The Chicago Board of Trade (BOT) also went public recently.
    NYSE seatholders will get 70% of the new company, plus a cool $300,000. Sometime in January, Archipelago will change its name to NYSE Group Inc. The shares will be listed on the NYSE (surprise) under the symbol NYX.

  • J&J Keeps Bid for Guidant
    , December 6th, 2005 at 11:12 am

    This is getting fun. Johnson & Johnson (JNJ) now says that it’s not going to raise its bid for Guidant (GDT). If you’re keeping score, Boston Scientific (BSX) is offering $25 billion for Guidant compared with J&J’s bid of $21.5 billion.
    Boston Scientific is so much smaller than J&J. I’m not really sure how they plan to pull this one off. According to the WSJ:

    The price is a hefty one for Boston Scientific, which has a market capitalization of $22.4 billion. The Natick, Mass., company would have to shoulder $10.5 billion in new debt and issue significantly more shares to pay for Guidant, of Indianapolis. And that could be just the start. Johnson & Johnson has a market capitalization nine times the size of Boston Scientific, and far deeper pockets to fund a bidding war. Among the 10 largest deals receiving counterbids this year, only two have succeeded, according to Thomson Financial.

    On top of that, there’s the problem of the recalls. This would be a fight over a company that neither should want. This reminds me of the Churchill quote about a turncoat Tory MP, it was the only instance of a rat swimming towards a sinking ship.
    BSX’s deal is for half in cash and half in stock. I was shocked to see that Boston Scientific’s stock didn’t fall much yesterday. I see that it’s slightly higher today. Either the market thinks there’s real potential here, or they don’t think BSX has a serious chance of nabbing Guidant.
    If Johnson & Johnson can emerge from this unscathed, I think it could be an excellent buy. Stay tuned. This ain’t over.