Archive for July, 2006

• Tough Times for Apple and Dell?
  Eddy Elfenbein, July 13th, 2006 at 10:16 am

  The market is down again today. The S&P 500 has fallen below 1,250, and oil is up to $76.30 a barrel—a new all-time high. There’s a lot of anxiety in the tech sector today as Dell (DELL) will announce its new pricing strategy at noon today.
  Business Week notes that there’s growing concern the computer industry is in for a bigger slump that previously thought:

  Some (analysts) are concerned price wars are imminent and that economic slowdown could crimp overall demand. “There’s a softness in the market that’s building,” says Richard Shim, a senior research analyst at Interactive Date Corp. In the past two weeks, IDC cut its 2006 forecast for U.S. PC growth to 5.7%, from 6.8%. “In ’04 and ’05 there was tremendous growth. In a market that’s as mature as this industry is, there’s no way you can maintain those levels.”
  Dell fed worries on July 12 by announcing that the following day it would unveil a “major pricing initiative”e; for U.S. consumers and small businesses. The same day, UBS Investment Research said it was cutting earnings estimates for Dell on the belief the company “continues to be impacted by competition and adverse mix shifts within the PC market.” Dell’s performance in recent quarters (it lost U.S. share to rivals in the first three months of the year) has given investors little reason for confidence—though the company has embarked on a turnaround campaign that includes beefing up customer service.
  Credit Suisse issued a report the same day that did a number on Apple’s stock. The computer maker, which reports fiscal third-quarter results July 19, will probably issue sales and earnings forecasts for the current period that falls short of analysts’ expectations, Credit Suisse analyst Robert Semple wrote.
  Apple is likely to tell analysts that fourth-quarter sales will be $4.6 billion to $4.8 billion, compared with analysts’ estimates for sales of $5 billion, the report says. “We expect Apple will once again use the September quarter to reduce iPod inventories as the company prepares for a refresh of its product lineup.”

• Enron Witness Found Dead
  Eddy Elfenbein, July 12th, 2006 at 2:25 pm

  On the day of Ken Lay’s funeral, Neil Coulbeck was found dead in east London:

  A body discovered in a London Park has been identified as a banker reportedly questioned by the FBI in connection with the Natwest Three fraud case.
  Neil Coulbeck, who worked for the Royal Bank of Scotland (RBS), disappeared from his home in Woodford Green, east London last Thursday.
  Yesterday a member of the public discovered a body in a park in Chingford, near to Mr Coulbeck’s home.
  Police are currently treating the death as unexplained and would not confirm if it was linked to the Enron fraud case in which three British former Natwest workers face extradition on Thursday to the US.
  In 2002 David Bermingham, Gary Mulgrew and Giles Darby were accused of an £11million fraud during which they advised their employer to sell its share in US energy giant Enron, below market value.
  It is alleged the trio then left their jobs, bought a stake in the Enron unit and sold it on at a much higher price for profit.

• CVS vs. Walgreen’s
  Eddy Elfenbein, July 12th, 2006 at 2:03 pm

  I’ve always been intrigued by the battle between Walgreen’s (WAG) and CVS (CVS). Both are great companies, and both have made lots of money for their shareholders. Walgreen’s, however, is definitely the Marcia to CVS’ Jan (we won’t even discuss Rite Aid’s Cousin Oliver). Thirty years ago, you could have picked up Walgreen’s stock for just 12 cents a share (that is, adjusting for seven 2-for-1 splits). Today, you’d be sitting on a 40,000% gain.
  Not surprisingly, WAG usually trades at a premium to CVS. But the question I’m always asking is, how much? Right now, WAG is going for 28.7 times trailing earnings while CVS is going for 21.6 times trailing earnings. So that’s a premium of 33%. Is that fair?
  Sometimes the premium has gotten as high as 100%. Last November I notice that the premium got to 50%, which I thought was way too large. I was right. Since then, shares of CVS have done fairly well, and they even made a new high today. WAG, on the other hand, slumped until May and has started to bounce back recently
  I think a lot of Walgreen’s premium is due to its consistency. If people know you can deliver the goods, they’ll pay extra for it. Coke (KO) is a great example of a consistency premium. For years, Coke was always slightly overpriced by most reasonable valuation measures. But since it always stayed overpriced, there was no harm. That is, until it stopped being so consistent. Today, shares of Coke are worth less than half of what they were eight years ago. Pepsi (PEP) is up about 30% and is at a new high today as well.
  Paying for consistency is another way of investing in risk. The problem with measuring risk is that it’s highly subjective. What I consider risky may not be to you. The “return” side of the equation is pretty simply. We should all be able to agree on what a 40,000% return looks like.
  As I like at CVS and Walgreen’s, I don’t see how the market can justify a premium any larger 15%. I’m still staying away from Walgreen’s.

• Vatican Reports Profit
  Eddy Elfenbein, July 12th, 2006 at 1:58 pm

  The Vatican (POPE) is raking it in:

  The Vatican on Wednesday released its best financial report in eight years, saying it had a surplus of 9.7 million euros ($12.4 million) in 2005 despite extraordinary costs of 7 million euros ($8.9 million) for the funeral of Pope John Paul II and the election of his successor.
  Cardinal Sergio Sebastiani, who heads the Vatican’s office for economic affairs, called it “good news” as he presented the Holy See’s annual financial statement after it was examined last week by international auditors and presented to Pope Benedict XVI.
  In recent years, the Vatican’s accounts have been battered by labor costs, a falling dollar and the costs of the Vatican’s growing diplomatic mission while experts expressed concern that donations might drop from dioceses in the United States and elsewhere struggling to meet settlements in the sex-abuse scandal.
  In 2004, the Vatican netted 3 million euros after four years in the red.

  I’m raising the Holy See to a near-term outperform.

• Third-Quarter Performance of S&P 500 by Sector, 1990-2005
  Eddy Elfenbein, July 12th, 2006 at 1:52 pm

  Since 1990, this is how the sectors of the S&P 500 have performed during the third quarter:
  Energy…………………………1.8%
  Utilities…………………………0.9%
  Health Care………………….-0.1%
  Staples………………………..-1.1%
  Financials…………………….-1.3%
  Telecom……………………….-2.3%
  Technology…………………..-2.5%
  Industrials……………………-2.8%
  Materials……………………..-3.7%
  Consumer Discretionary…-4.8%
  S&P 500……………………..-2.0%

• Weighted Index Funds Vulnerable to Bubbles
  Eddy Elfenbein, July 12th, 2006 at 10:31 am

  Letter to the Editor in today’s Wall Street Journal:

  John C. Bogle and Burton G. Malkiel (“Turn on a Paradigm?” editorial page, June 27) accept that market-weighted indexes over-weight stocks that are overvalued and under-weight stocks that are undervalued, but dismiss the point altogether by referring to the weakness as temporary.
  It is anything but temporary. The bubble that carried Japan to 42% of the world stock market in 1988, making it a third larger than that of the U.S., spanned eight years. Japan is now at 12%. The tech bubble that carried that sector to 28% of the world stock market in 2000 lasted four years. It is now at 8%. Are we in an extended oil and gas bubble now?
  When such speculative bubbles occur, the $3 trillion of capital invested in market-weighted index funds will be misallocated, along with the additional assets invested in enhanced trackers.
  Institutions have, not unreasonably, come to rely on market-weighted index funds as a high capacity investment strategy for their core assets. This reliance renders them defenseless in extended periods of capital misallocation, which repeatedly afflict free markets. This reality is ignored by Messrs. Bogle and Malkiel.
  Only those investors in market-weighted index funds with stable cash flows can hold the index until the bubble subsides. For most however, this is not possible. Given that speculation is essential to the proper functioning of a free market, because it provides the liquidity demanded by long term investors, those who rely on market-weighted index funds for their core strategy will always be vulnerable to bubbles.
  Their only defense is to increase diversification of their core assets. They must branch out to add new strategies that are not dependent on the market-weighted index. Fundamental indexing is currently the only high capacity investment strategy alternative out there that works. And for this reason it will not fade away.
  David Morris
  CEO
  Global Wealth Allocation
  London

  He makes a good point. Index investing is far less “neutral” than investors have been led to believe. According to indexing, the fact that a stock outperforms the market will, by definition, give it a larger weighting. If anything, it ought to lead investors to the opposite conclusion.

• The Latest Crime Wave
  Eddy Elfenbein, July 12th, 2006 at 7:26 am

  The rally in metals prices has led to a very unusual crime wave. In Pennsylvania, thieves made off with a bronze historical plaque. In Ohio, aluminum bleachers are missing. One thief was killed while trying to scrap copper wiring off a utility pole. Brad Linder of NPR has more.

• Soros Accused of Rigging Building Sale
  Eddy Elfenbein, July 12th, 2006 at 6:17 am

  
  A real estate company is claiming that George Soros rigged the bidding for the General Motors bidding.
  In 2003, Leslie Dick Worldwide Ltd. offered $1.5 billion for the building, but Conseco, the building’s owner, sold it to Macklowe Properties Inc. for $1.4 billion.

  Dick’s amended complaint, filed three weeks ago in Manhattan’s state Supreme Court, says Soros gave Macklowe $350 million, including the $50 million deposit Macklowe made, “essentially making Soros the real purchaser of the building.”
  “The entire bidding and contract award process engaged in by the defendants was improper, unlawful and permeated with fraud,” Dick’s court papers say. “Plaintiffs have suffered financial losses and damages caused by defendants’ illegal acquisition and current illegal ownership of the GM building.”
  Dick, whose original complaint was filed in April, asked the court to declare the bidding process “a fraud and a sham” and to void the sale, to impose a constructive trust to take control of the building until this case is over and to award Dick $750 million.
  Conseco spokesman James Rosensteele said Tuesday, “We believe the suit is without merit, and we will defend it vigorously.”
  Soros spokesman Michael Vachon said “the case is entirely without merit.”
  Macklowe Properties spokesman Howard Rubenstein said his client called the lawsuit “absurd” and said it was “totally devoid of any merit.”
  The building once was partly owned by developer Donald Trump, who bought it with Conseco in 1998 for $800 million. Trump’s name was spelled out across the front of the building in huge gold-colored letters.

• UnitedHealth Bounces Back
  Eddy Elfenbein, July 11th, 2006 at 1:08 pm

  Shares of UnitedHealth (UNH) climbed above $48 today, its highest point in over two months.
  I had high hopes for this stock at the beginning of the year, but it’s become a big disappointment. In March, the Wall Street Journal revealed that the CEO, William McGuire, and other officers got their stock-option grants just before big run-ups in the share price. I don’t think they were that lucky, the executives were clearly back-dating their options grants.
  Perhaps the most surprising part of this story is that in UnitedHealth’s case, the board allowed it. That’s why this isn’t a criminal matter. Other CEOs won’t be so lucky. Still, UnitedHealth’s stock has suffered as the back-dating scandal has swept Wall Street.
  The press loved to moralize over McGuire’s $1.6 billion in options, but the fall in the stock’s price caused investors to lose nearly $20 billion. And remember, this isn’t an accounting scandal. The company is still doing very well.
  Last quarter, UNH earned 68 cents a share, four cents more than Wall Street was expecting. The company also said it was on track to earned $2.88 to $2.92 a share for all of 2006. By late-May, shares of UNH fell below $42 a share which means that it was going for about 15 times this year’s earnings.
  The scandal is serious but it will have little impact on the company’s business. McGuire is taking the scandal seriously. The company will probably restate its financial results at some point. But for now, Wall Street is again realized how strong UNH is. The company will report earnings again on July 19.

• Budget Deficit Estimate Drops to $296 Billion
  Eddy Elfenbein, July 11th, 2006 at 11:35 am

  The White House is making a big deal over the lower budget deficit estimate today. I think the dangers of the budget deficit are very much overrated. According to the latest projections, the deficit will be about $296 billion this year. But the total economy is about $13 trillion. That’s a gigantic number. This means that the deficit works out to about 2.2% of GDP, which isn’t that large. In fact, it will be smaller than every budget deficit the country ran from 1980 to 1995.
  The level of debt doesn’t matter so much. What’s important is that you’re growing faster than you interest rate. The economy has been growing by about 7% to 8% a year, while interest rates on government debt are still around 5%. One of the most amazing features of our times is how inexpensive debt has become.