Archive for 2006

  • CVS vs. Walgreen’s
    , 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
    , 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
    , 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
    , 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
    , 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
    , July 12th, 2006 at 6:17 am

    General_Motors_Building.jpg
    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
    , 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
    , 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.

  • In Defense of Perma-Bullishness
    , July 11th, 2006 at 10:45 am

    Barry Ritholtz had a good post the other day on the awful track record of some of Wall Street’s perma-bulls. I will, however, come to the defense of the perma-bulls. Or at least, my perma-bullishness.
    Don’t get me wrong, I’m all for bashing the outlandish predictions of clueless market observes. I’m a perma-bull not because I think the market will soar dramatically higher. (I’m actually a little skittish right now.) I’m a perma-bull because I avoid trying to time the market.
    If there’s someone out there who’s great at timing the market, that’s terrific. Good for you. There’s no need to send me dozens of e-mails detailing your track record. I believe you. Go do it as much as you want. But for me, it’s never worked. My market calls have been horrible, and I’ve never seen anyone who’s been able to do it consistently. Personally, I don’t even try anymore.
    Remember that timing in the market involves two steps—when to get out and when to get in. Both parts are very tough to do.
    What I find annoying is that it’s easy to attack people who were screaming “buy, buy, buy” at market tops, but no one ever seems to criticize the perma-bears. Why are these folks immune? If some guru has been saying stay away from equities for the last ten years, the fact is that he’s been horribly, horribly wrong. And he should be told so.
    Ironically, I use the benchmark of ten years and we’re coming up on the tenth anniversary of one of the stranger days in the market. On July 15, 1996, the S&P 500 dropped over 2.5%. The next day it dropped another 3.8% intra-day, before rallying and closing modestly lower for the day. Bear in mind that at this point, the market had been climbing steadily higher since late-1994. The market started to crack and in July, and it looked liked it might spiral out of control.
    We now know that the market was really a screaming buy. If you had invested in the S&P 500 on June 30, 1996 and went to sleep for the next ten years, by June 30, 2006, you would have made over 122%. That’s about 8.3% a year. Forget all the big news stories of the past ten years: 9/11, The Tech Bubble, War, Impeachment. Despite everything that happened, an investor would have doubled her money. In fact, after inflation she would have made almost the exact same amount as the market has returned according to long-term studies.
    But that’s not what people were thinking in 1996. For an interesting take, let’s look at this transcript from PBS NewsHour of July 16, 1996:

    ELIZABETH FARNSWORTH: Is one of the great stock market runs in history coming to an end? That’s the question for Wall Street and for many on Main Street after recent large drops in the market, including yesterday’s Dow Jones loss of 161 points. Today saw wild swings, with the Dow rising more than 45 points early, then falling more than 167 points during the afternoon, and coming all the way back up 50 points before closing up 9 1/4 points. What’s going on? To help us understand, we’re joined by Susan Kuhn of Fortune Magazine. Thanks for being with us, Susan.
    SUSAN KUHN, Fortune Magazine: (New York) You’re welcome, Elizabeth.
    MS. FARNSWORTH: Why the wild swings today, what was going on?
    MS. KUHN: Well, Wall Street is having another one of its fun days this summer. Basically the market hasn’t been doing very well in both June and July. This comes after a long spectacular run, so I think it’s catching many people by surprise.
    MS. FARNSWORTH: So today was–it was something of a correction over yesterday, but it, it’s been dropping so much. Why?
    MS. KUHN: Well, I think there’s a lot of concerns. The first is we really haven’t had a break in the market. It’s been going straight up, and you have to wonder, boy, when are people going to start to get nervous, when are they going to take a break? The cause for this one appears to be corporate earnings. Many companies have been reporting earnings for the second quarter that are not matching investor expectation. That seems to be the excuse for people to sell. I was talking to people at Fidelity Investments today, and they’re finding that the volume of calls from individuals and stock funds was up 30 percent over the past few weeks. So clearly many individuals who may be in stocks for a variety of reasons are starting to get nervous.
    MS. FARNSWORTH: And this has been particularly true though. The decline has been particularly marked in technology, high technology stocks, computer companies, that sort of thing, is that right?
    MS. KUHN: That’s true. And technology, Elizabeth, really has been the story of the 90’s. All of us can see we’re getting new computers shipped to our desks. Our children are learning how to play computer games, and if we don’t know how to surf the Internet, we sure feel guilty about not knowing it. Wall Street hasn’t missed that story. In fact, it likes a good story, so it’s been bidding technology stocks up. But, of course, what goes up–what must come down, and that’s what we’ve really been seeing in, in the last couple of weeks. Technology has been taking it pretty hard.

    Notice how much of that could be say today. If you look for a reason to be worried about the stock market, guess what? You’ll find it.
    Investors always believe that they’re in the middle of the some period of two extremes. People are always waiting for “the dust to settle.” If you look at any period, that’s what’s on investors, “we’re waiting for the dust to settle.”
    If we play with the data a little bit, we can say that the S&P 500’s entire return over the last 10 years came on just 15 days (not including dividends). That’s over 2,500 trading sessions. This means that the stock market was net flat over 99% of the time. All your money was made during that 1%, or roughly one day every eight months. In other words, the dust is most likely settled, and it has been for quiet some time.
    Truthfully, I’m getting a bit too clever with numbers here, but it is factually correct. To be a successful market timer, you need to be that good. You have to hit that 1% all the time. Being a perma-bull, I know I’ll always hit it.

  • Earnings Season Gets Off to a Shaky Start
    , July 11th, 2006 at 9:35 am

    Second-quarter earnings season begins this week and so far, it’s not looking too good. Alcoa (AA) was the first Dow component to report, and despite its record earnings, sales came in below Wall Street’s forecast. The stock opened lower today.
    Also Lucent (LU) warned that its earnings would be below expectations. I’ve never understood the appeal of this company. At the end of the 1990s, Lucent reached $84 a share. Soon after, it dropped to 55 cents. Now it’s back to about $2.30 a share. Fortunately, Lucent will soon be someone else’s problem. The company is being bought out by the French firm Alcatel.
    EMC (EMC), another star stock from the 1990s, had a dud quarter. Here’s a great example of a company blowing too much of its money on share buybacks. On top of that, the company is paying far too much for RSA Security. I knew there was a problem when they didn’t provide any earnings guidance. Officially, the company blamed its earnings shortfall on “inventory mix.” I have no idea what that means.
    Advanced Micro Devices (AMD) has gotten clobbered this year. I have to admit that I missed the AMD story and I didn’t realize how much ground the company had gained. Last week, the company lowered its sales estimate for the quarter, and the stock fell sharply in yesterday’s trading.
    The first earnings from our Buy List stocks won’t be until next week. Harley-Davidson (HDI) will start earnings season for us when it reports earnings next Monday.