Archive for 2005

• Gold to $1,000?
  Eddy Elfenbein, November 19th, 2005 at 4:18 pm

  This week’s Barron’s includes an interview with John Hathaway, a manager who thinks gold can go to $1,000 an ounce:

  Haven’t some gold stocks been hurt by strength in local currencies?
  Certainly the South Africans were hurt because the rand went from something like 13 to the dollar to six to the dollar over a period of a year and a half or two years. That’s like cutting the gold price in half. Even though the dollar price of gold has gone up, the rand price of gold is just now getting back to where it was a few years ago. To a lesser extent, strength in the Australian dollar and the Canadian dollar until recently squeezed margins for operations in those countries. But you get around that problem if gold is rising in all those currencies, which it is doing. But we have reached a point where gold isn’t really linked to foreign-exchange rates because a lot of people are concerned about paper currencies in general.
  Yet Central Banks have been selling gold.
  Central-bank selling fills the gap between supply and demand. They have been selling at steady pace. What they have is an arrangement so their selling is orderly and doesn’t spook the market. Under that arrangement, there is a quota system of 500 metric tons a year for five years. The selling is transparent, the market knows it is there, and if the program wasn’t in place, gold could easily be $200 or $300 higher. We are in the second year of that five-year agreement, and it is hard to imagine where all that gold is going to come from.
  Who’s buying?
  They sell it into the market. We keep some of our gold in Switzerland, and I went to the facility where we keep it and basically it was a large refining company. They were melting down bars from the Swiss Central Bank, and at the other end of the production line there were semi-finished gold watch cases and jewelry for China, the Persian Gulf and India. That’s where it is going. Central bankers are selling their best asset into the markets and it is going into non-monetary forms, and they will never get it back. They are just bureaucrats and not even held accountable for what they do on a financial basis. It has been such a bad trade for the last five years, you would think that at some point they would begin to say maybe we should hang on to what we have. But again, their general agenda is not to have gold as a monetary asset or at least not talk about it if they have it, because what is still true is that a rising price of gold is not a favorable reflection on public financial policies, monetary and fiscal.
  What’s the impact of gold exchange-traded funds on the market?
  It is potentially huge. Right now there’s about $3.5 billion in gold ETFs, which isn’t bad considering the first one came out a little over a year ago. As we discussed, gold shares can be risky, yet gold is not necessarily an investment for those who are risk-seeking or risk-tolerant. Gold is essentially financial insurance. It is noncorrelated. It has hundreds of years of history of being noncorrelated with financial assets, which means that when financial assets are doing well gold doesn’t do well. From 1980 to 2000, that was the case, but in the 1970s and 1930s, gold did very well. What the ETF does is open the door for people who should have exposure to gold. It makes it easy for a college endowment that would never typically open up a commodities account or open up an arrangement with a bullion dealer to own gold. The ETF paves the way for an entirely different class of investors to come into gold, not gun slingers looking for huge returns but people who just want to protect capital, which gold does very well. Eventually, this will do a tremendous amount for the gold price. The more money that comes into the ETFs, the more it is going to create momentum for the underlying commodity. Barclays is trying to bring out a silver ETF, and the Silver Users Association, which includes companies such as Kodak and Dow Chemical, are opposed to it because of concern it is going to take the price up.
  What risks are working in gold’s favor?
  There is a lot of financial risk in the system. The level of household debt, the housing bubble, the amount of U.S. Treasuries held by foreign central banks, the valuation of the stock market, the overvaluation of the bond market, are all legitimate reasons to be concerned, not that I wish for worst-case outcomes. Secular credit expansions, which is what we had from 1982 through 2000, are often accompanied by an ever-decreasing perception of risk. Frankly, we’ve been in a bear market since 2000, and people still don’t realize it. Yet bear markets have a life of their own, and they really don’t end until a certain psychology takes hold and people just hate financial assets.

  All gold rallies start differently, but they all end the same way.

• The SarBox Fight
  Eddy Elfenbein, November 19th, 2005 at 4:00 pm

  If you want to try something really fun, just mention the words “Sarbanes-Oxley” to a CFO. Be sure to stand back from a safe distance. If you’re not familiar with “SarBox,” this is the law that was designed to improve corporate disclosers. I won’t say that the law is a complete disaster, but let’s put it this way—it passed the Senate 99-0. Now many companies, smaller firm in particular, are complaining about unnecessary accounting costs.
  This is probably a reason why we’ve seen more public companies decide to go private. So a law designed for more transparency leads to less. In fact, Georgia-Pacific’s CEO said that Sarbanes-Oxley was a factor that led to him sell the company to Koch Industries.
  Earlier this week, Alan Murray wrote in the Wall Street Journal that the SarBox bashing was getting out of hand, and deserved some perspective:

  A recent study by Foley & Lardner LLP found that all the costs associated with being a big public company averaged $14.3 million last year. That was up 45% from the year before, due largely to the requirements of Sarbanes-Oxley. But for a company like Georgia-Pacific, it’s still not that big a number.

  Murray follows up in today’s WSJ:

  The strong response to this week’s column on Georgia-Pacific’s planned merger with privately held Koch Industries has made me feel sorry for Paul Sarbanes and Michael Oxley. The Democratic senator and the Republican congressman have given their names to legislation that provokes amazingly strong emotions in the corporate world. My advice to the two gentlemen: Stay out of the for-profit sector.
  That’s not to say all the responses were critical of the bill. (As always, some letters have been edited.) Daniel Posin, a law professor at Tulane Law School, writes:
  “I think when you get all through, Sarbanes Oxley says to people who seek to manage other people’s businesses: ‘Have some internal controls (even if it’s inconvenient).’ “
  The responses also underscored my point that Sarbanes Oxley is a much bigger problem for small businesses than it is for big ones. A few of the many emails on this point:
  Brett Ayers, Assistant Vice President, First Bank, in Chapel Hill, N.C.:
  “While I tacitly agree with some of your article in regards to the legislation that is Sarbanes-Oxley, I also think that, as you stated, the legislation needs to be confined to larger-cap companies. Companies like the one I work for with $1.75 billion in loans and other assets get a huge bite taken out of our bottom line for little or no improvement in our overall internal controls.”
  Stephen M. Bainbridge, professor at the UCLA School of Law:
  “It is true that for large public corporations, SOX-related costs are a relatively small additional burden. (Of course, for want of a nail….) But while SOX compliance costs admittedly are difficult to determine, mainly due to a lack of disclosure, the best available evidence suggests that those costs tend to be relatively fixed. According to one study by ARC Morgan, for example, companies with annual sales of less than $250 million incurred $1.56 million in external resource costs simply to comply with one SOX provision (the internal controls required by section 404).”
  Lewis D. Levetown:
  “SOX creates tremendous head wind in a smaller environment as key executives have to spend a disproportionate amount of time on compliance issues, greatly reducing the amount of time available for the more important issues of running the enterprise.”

  Here’s a more in depth critique of Sarbanes-Oxley.

• The Market Today
  Eddy Elfenbein, November 18th, 2005 at 5:13 pm

  We did it. The S&P 500 jumped 0.44% today to close at a four-year high. Our Buy List rose 0.56%. For November, we’re up 6.33% to the S&P 500’s 3.42%.
  Let’s look at our biggest winners for the month: Quality Systems (+24.2), Expeditors (16.8%) and Fair Isaac (12.9%). The biggest dogs have been Dell (-6.4%), Donaldson (-3.6%), Medtronic (-0.7%) and Frontier Airlines (-0.1%).
  Frontier had a weird day today. It opened much higher but lost ground to close just five cents higher. More good news for Frontier may be coming. Oil briefly fell below $56 a barrel today. Oil is now down about 20% from its high. I’d like to thank Congress for being a perfect contrarian indicator.
  The VIX (^VIX), the volatility index, dipped below 11 today. That’s a very low reading. I’ve been paying more attention to the IPO market recently. Except for Baidu.com, some of the best IPOs this year have been stocks you wouldn’t expect:

  The best performer of the year was also one of the most talked about, Chinese Web search engine Baidu.com Inc., which has gained 171 percent since its IPO. But the stock remains well below its first day gain of 353.9 percent, illustrating the risk of chasing high-profile IPOs.
  Several other top performers got off to quieter starts. Rail-car maker FreightCar America Inc., electronic payment technology provider VeriFone Holdings Inc., apparel retailer Citi Trends Inc. and medical device maker China Medical Technologies., advanced no more than 12.1 percent in their market debuts but have since more than doubled in value.
  “The nice thing is you did not have to buy at the IPO price to make money on those companies,” said Taulli, of DealflowSearch.com. “Even if they did go up 10 or 15 percent on the first day you would have made a nice, tidy profit, which is not easy. It wasn’t easy this year to make a nice, tidy profit.”

  Lastly, I wanted to comment on gold. The gold bugs have been very excited about gold’s rise, but I’m not impressed. Over the last 22 months, the price of gold is up 13.9%, which works out to around 7.3% annualized. If a company had grown its earnings by that amount, people would be complaining.

• Cisco Buys Scientific Atlanta
  Eddy Elfenbein, November 18th, 2005 at 3:58 pm

  So Cisco (CSCO) is grabbing Scientific Atlanta (SFA) for $5.3 billion. In cash! I’m sorry. I know I should care but I just don’t. Normally when I hear about a major merger, I usually get angry or excited, usually angry. But this one is one big yawn.
  Cisco has tons of cash. They just got slammed by Alcatel (ALA) so they pick up SFA. Yawn. The price is probably a good one, but it could have been a whole lot better last year. I expect more deals from Cisco. If I were a Cisco shareholder, I’d still want a dividend which tells you what I think of Cisco.

• Patterson Lowers Estimate
  Eddy Elfenbein, November 18th, 2005 at 11:01 am

  Last week, I had a rambling post on Patterson Companies (PDCO). I was concerned that the company’s long run of consistent earnings growth had come to an end. Today, the company lowered guidance for this quarter and the entire year. The stock is currently down about 17%. So I guess we have an answer.
  Few companies truly have a short-term earnings glitch. One earnings miss tends to give birth to several more. This is why I don’t consider myself to be a value investor. It’s also why I’m skeptical of turnaround stocks like Hewlett-Packard (HPQ).
  I’m definitely on the side of Hewlett-Packard, but too often what appears to be a turnaround is really a company displacing its problems instead of fixing them. I get annoyed when the financial media falls for easy story lines (i.e., everything is wrong at Dell, HP is back). It’s much harder to get a company to change its way and truly become more efficient.
  Another issue is that the power of management is overrated. Despite the proliferation of management studies, and the recent passing of Peter Drucker, management isn’t always the key to a turnaround. The market environment usually has a much greater influence. It’s very difficult to admit that time and chance happens to us all. It’s easier for the media to focus on the personalities on the stage.
  From what I’ve seen of Mark Hurd, he seems to be doing a fine job so far, but HP isn’t back just yet. Last week, I predicted that Hewlett-Packard would top Wall Street’s estimates, and that was one of the easiest calls of the year. (I have to say that I was impressed by Richard Chu, the analyst at SG Cowen. He was quoted in Reuters, the New York Times and Bloomberg. That’s an analyst triple play, plus it exceeded consensus expectations.)
  Let’s put the HP story in perspective. The company had a “restructuring charge” of over $1 billion. They’re also increasing the job cuts. As he Hurd it: “On July 19, we had a model. As we discussed then, we had to operationalize the model, and 14,500 moved to 15,300.” By “operationalize the model,” he means to say that it’s call Carly’s fault. And let’s fact it—it is. But how long can he keep that up?
  The only good part of the layoffs is the high comedy coming out of Europe, by which I mean France. About 5,900 of the job cuts are happening in Europe and 1,240 are in France. Jacques Chirac blamed the unpopularity of the European Union and the defeat of the constitution on its inability to stop Hewlett-Packard from cutting jobs in Europe. Wow, this “operationalize the model” excuse really has legs. Chirac said that he can’t understand why a “large company that makes considerable profits” is firing people. The truth is that they don’t make a considerable profit. At least, not anymore.
  A few years ago, the media fell in love with the turnaround story of Rite Aid (RAD). They got the best management team in the business. The rearranged their debt and soon the stock jumped from $2 to $10. But it hasn’t done anything since. The best managers in the world can’t change the fact that it’s in one of the most competitive industries around. You can’t sweep in, make some bold moves and expect a turnaround to happen.
  This brings me back to Patterson. Today, the company lowered its earnings guidance to $1.44 to $1.46 a share, down from $1.54 to 1.58 a share. If that forecast holds, the stock is a good buy. But the game now is forecasting the forecast, and I don’t have much faith in the forecast. Before you know it, the model gets operationalized again, and that’s never good. For now, I’ll watch these turnarounds as a friend, but not as an investor.

• WSJ: Dell Tops HP in Printer Satisfaction Study
  Eddy Elfenbein, November 18th, 2005 at 6:19 am

  From the Wall Street Journal:

  Though Hewlett-Packard still dominates the market for printers, Dell, a relative upstart in that category, seems to have won more hearts — at least among business users. Dell, which entered the printer market just two years ago, scored highest among business owners in a recent customer satisfaction survey from J.D. Power and Associates. The PC giant has benefited from its direct-sales tactics — where customers buy directly from the company, rather than through a dealer. Furthermore, the study said 65% of printer owners did at least some research online before buying. “This is a real strength of Dell, which efficiently leverages its Web site to reach its customers,” said J.D. Power analyst George Owens. The study also found that while cost plays a factor, basic features like reliability, color capacity, speed and quality greatly influenced users’ satisfaction.

• The Market Today
  Eddy Elfenbein, November 17th, 2005 at 5:45 pm

  Well, that was nice. The S&P 500 closed at 1242.80 today. We’re just 2.24 points from breaking the August 3 high and reaching a 41-month high.
  Everybody joined in the fun today. The Nasdaq made a four-year high. Google (GOOG) broke through $400 a share. Believe it or not, Yahoo (YHOO) still has a higher P/E ratio. Oil made a five-month low, bonds rallied and the small-caps were up huge. The S&P Mid-Cap Index (^MID) closed at an all-time high. On a side note, that’s a little bit strange. When small stocks do better than large stocks, it’s typically rank-ordered, meaning the smallest do the best, the second smallest do the second best, all the way up to the biggest doing the worst. But now, the middies are leading the way.
  The S&P 500 gained 0.94% and our Buy List was up 1.48%. Five of our stocks hit new highs, and two more are very close. But today wasn’t perfect. The Buy List is overweighted in medical supplies, one of the few sectors that got hit. Medtronic (MDT), Zimmer (ZMH) and Stryker (SYK) all closed lower. This is probably due to Medtronic’s earnings; Forbes has more. Progressive (PGR) said that its earnings in October fell 46% due to Katrina and Wilma. Also, Commerce Bancorp (CBH) rallied as the CEO said that the bank looks to double the number branches in New York City.
  Gold continued to rally and it’s close to $500 an ounce. Platinum hit $1,000 an ounce. Earlier this week, I predicted that Hewlett-Packard (HPQ) would report earnings of 49 cents a share, three cents more than expectations. I was wrong. H-P earned 51 cents a share.

• Below Wall Street’s Radar
  Eddy Elfenbein, November 17th, 2005 at 3:00 pm

  I don’t think many investors realize how dramatically Wall Street’s research has been pared back over the past few years. This could be one of the biggest changes for professional investors.
  It seems like a different world but it wasn’t that long ago that star analysts held sway over entire sectors of the market. An upgrade could make instant fortunes. Then came the crash, Eliot Sptizer and the global research settlement. After that, the budgets for research department were slashed. Several major houses laid off analysts. Both Citicorp and Prudential ditched their entire technical analysis departments.
  Bear that in mind as now I want you to consider the case of Arden Group (ARDNA). To say that the stock keeps a low profile is an understatement. This company might as well be invisible. Arden is based in Compton, CA which isn’t exactly well-known for its corporate HQs. Arden is the parent company of Gelson’s Markets which “operates 18 full-service supermarkets in Southern California carrying both perishable and grocery products.”
  I’ll be honest with you. I don’t know much at all about Arden Group or Gelson’s. But here are some basics. It’s a very small company. The market cap is about $280 million—a mere spec to Wall Street. The CEO is Bernard Briskin and he owns a huge amount of shares. Outside of its quarterly reports, the company releases almost no information. This is about as boring as you can get.
  Now let’s look at the earnings:
  1996 $0.89
  1997 $2.11
  1998 $2.81
  1999 $3.27
  2000 $3.52
  2001 $3.92
  2002 $4.26
  2003 $4.90
  2004 $6.70
  Now do I have your attention? That’s exactly what you want to see from a company, consistently rising earnings. I haven’t dissected the numbers so there could be more to it, but on the surface, Arden looks to be very profitable. The company is having an off-year this year. Sales and earnings are lower, but they’re still making money.
  Thirty years ago, you could have bought one share of Arden for 56.25 cents ($2.25 after a 4-for-1 split). You would have made close to 15,000% on your money. The S&P 500 is up about 1,250% over the same time. So I think we can say that Arden is a profitable company that has served its shareholders very well over a long time.
  Now here’s the payoff. Arden Group isn’t followed by a single analyst. There are no earnings estimates. There’s no guidance. No upgrades. No downgrades. No buys. No holds. No sells. Nothing. Think about that. A huge market winner for three decades and no one can be bothered to follow. Not even a hold!
  By contrast, there’s this one company that’s an internet “search engine.” You may have heard of it. It’s followed by 30 analysts (the company’s market value just passed Cisco, a company that used to be the most valuable company in history of the world). On all of Wall Street, there isn’t one analyst who thought: “Hey, let me check this one supermarket out.”
  I can’t imagine Arden bringing anyone a lot of investing banking business. Ignoring Arden is simply not serving the interests of investors. I’m not recommending Arden, but I want to show you that there are gobs and gobs of great companies out there that no one knows about. There are masses of people looking for “the next Apple,” but what’s wrong with the current Arden?
  I’ll give you a few examples. One of the secrets of investing is that there are hundreds of tiny banks on the exchanges. Many are very well run and almost completely ignored. Some have been around for decades.
  Here’s Northern Empire Bancshares (NREB), a small bank in California. Just 127 employees. Here are the earnings:
  1996 $0.26
  1997 $0.36
  1998 $0.49
  1999 $0.55
  2000 $0.69
  2001 $0.77
  2002 $0.85
  2003 $1.02
  2004 $1.24
  Higher earnings like clockwork. For the first three quarters of this year, NREB has already made $1.17 a share.
  If you’re willing to do a little homework, you can become the leading expert on a stock. You already know my Buy List, but here are two stocks for you to explore, both S&Ls: Coastal Financial (CFCP) and NewMil Bancorp (NMIL). Read the 10-Q reports. You learned the math in third grade. Call the company. Most people never even think of doing that. It’s your money. Ask to speak to the CEO. They’ll probably be flattered.
  This is a new world for investors. The institutions have been dethroned. If individual investors are willing to do a little homework, there are other 15,000% winner out there that no one is looking at.

• Stocks Are Flat, Wall Street Soars
  Eddy Elfenbein, November 17th, 2005 at 5:58 am

  Despite a lackluster stock market, this is a banner year for Wall Street:

  The Standard & Poor’s 500 index is up 1.6% this year, and the Nasdaq composite index is up less than 1%. Yet, Nasdaq’s own stock, along with shares of Archipelago (which plans to merge with the New York Stock Exchange), Ameritrade and E-Trade have all been rocketing this year, gaining 250%, 140%, 56% and 22%, respectively.
  Investors aren’t just embracing players in the stock market. Wednesday, shares of commodity exchange Intercontinental Exchange soared 51% in its first day of trading. That comes as CBOT, parent of the Chicago Board of Trade, is more than double its initial public offering price a month ago, and Chicago Mercantile Exchange shares are up 65% this year.
  Meanwhile, the diversified financial industry group has knocked energy aside as a market leader and is up 8% the past 30 days as energy fell 1%, Standard & Poor’s says.
  Dramatic changes in the way stocks and commodities are traded are fueling the interest in exchanges’ stocks, says Rick Wetmore, portfolio manager at Turner Investment Partners. They include:
  • Better investor awareness. Nasdaq shares, until early this year, were listed on the OTC Bulletin Board, which many large investors avoid for various reasons including a lack of trading volume, says Richard Herr, analyst at Keefe Bruyette & Woods. Since then, the stock has moved to the Nasdaq, increased the number of tradable shares, and put it on the screens of more investors, he says.
  •Consolidation and growth. The dominant players in the industry are devouring their weaker or smaller rivals. Earlier this year, Archipelago bought the Pacific Exchange, expanding its reach into new forms of trading, Herr says.
  Wednesday, the Justice Department approved the merger of the NYSE and Archipelago and the Nasdaq’s purchase of the Instinet electronic trading network. Optimism about the Archipelago deal, which still faces an NYSE seat-holders vote on Dec. 6, is one reason an NYSE seat sold for a record $3.25 million on Wednesday. Meanwhile, Ameritrade and E-Trade continue buying other brokerages.
  •New trading approaches. Both commodity and stock markets are benefiting as new trading strategies increase trading activity. Volatile interest rates and energy prices are a key driver. But hedge funds are also increasingly big players in commodities and options exchanges, says Phil Stiller, research analyst at Renaissance Capital.
  Increased electronic trading is also a part of why volume at the NYSE is up 10% this year through the third quarter, Herr says.
  Analysts suspect the exchanges’ shares can move higher. But Stiller says they could be at risk if anything bad transpires. “Once growth slows, these stocks come down.”

• The Market Today
  Eddy Elfenbein, November 16th, 2005 at 9:08 pm

  General Motors (GM) fell to an 18-year low today. Poor Kirk Kerkorian. He might be down to his last $1 billion. A few months ago he bought a 10% stake in GM at $30 a share. The stock is now down to $21.29. For reasons I’ll never understand, the company has clung to its 50-cent quarterly dividend. At today’s closing price, that works out to a yield of 9.4%. We’ll see how much longer that lasts.
  Not all is bad in the housing sector. D.R. Horton (DHI) reported very strong earnings today. A few days ago, the entire sector was hurt by Toll Brothers’ (TOL) weak outlook. Horton is more focused on first-time homebuyers, while Toll Brothers is geared toward the high-end. Still, I’m concerned that the housing market is beginning to come undone.
  But today was all about commodities. The Dow Platinum & Precious Metals Index (^DJUSPT) was up over 10% today. The odd thing is that the inflation report was pretty good, plus bonds and the dollar rallied. The 10-year bond (^TNX) dipped below 4.5%. Maybe gold doesn’t matter anymore. Honestly, I will never understand the gold market. There’s an old joke that there are only two people in the world who understand the price of gold. They both work for the Bank of England, and they disagree.
  The Buy List has another poor day today. All told, we were down 0.33% today and the S&P 500 was up 0.18%. Only Expeditors (EXPD) showed any real strength. Frontier Airlines (FRNT) briefly fell below $9 a share. Despite yesterday and today’s pain, the Buy List is up 4.2% for the month and the S&P 500 is up 2.0%.
  Medtronic (MDT) reported earnings after the close today. For the quarter, the company earned 54 cents a share; I saw estimates for 54 cents and for 55 cents. I never know which consensus to believe, which is another reason why I don’t pay too much attention to them. But Medtronic did something I do pay a lot of attention to: The company gave an earnings estimate for this year, next year and the year after that. If you’re scoring at home, three estimates is three more than Google (GOOG).
  For this fiscal year, which ends in April, Medtronic is looking to earn between $2.18 and $2.23 a share. The year after that, the company forecasts earnings of $2.45 to $2.55; and for the year after that, $2.78 to $2.98. For comparison, Medtronic earned $1.86 a share last year. That’s pretty amazing. The company has publicly said that they’re going to grow by about 15% a year for the next three years. That’s very good. What else can I say but this is a great stock hidden in plain sight.
  The longer I’ve been at this game, the more I’m convinced that superior investing isn’t about seizing the next Big Thing—it’s about not taking unnecessary risks. I don’t try to predict the future. My starting point is that I can’t predict the future. I can’t say for sure if Medtronic’s forecast is accurate, but I do know that they’ve had strong growth for a long time, and they’re putting their reputation on the line by saying that it will last at least three more years. Even if they deliver the growth, the earnings multiple could plummet and the stock could go nowhere. Maybe this could happen, maybe that could happen.
  My strategy is to whittle out the junk from my portfolio and concentrate on quality. That way I bend risk in my favor. As long as you’re patient and diversified, the profits will follow.