Stock Pickers Aren’t Dead Just Yet
Posted by Eddy Elfenbein on September 16th, 2010 at 11:57 am

Herb Greenberg has a great column on the last of a dying breed, the stock-picker — a group that includes yours truly. I admit that the machines are much faster than us, but we humans still have many advantages, namely the irrationality of our fellow humans.
Despite the hand-wringing, this has been a very good time to be a stock-picker. Let’s look at the Rydex S&P 500 Equal Weighted ETF (RSP) compared with the S&P 500 Spyders (SPY):

In other words, the average stock has beaten the index by a good margin.
Will this divergence continue? It’s hard to say. I think one factor that will help is the persistence of low inflation, if not deflation.
When the pricing environment is so hostile to price increases, this may place a greater premium on companies that are more efficient or that offer something unique. The more diversity there is in rewards, the more opportunity there is for stock-pickers to find above-average profit opportunities.
When anybody can make a buck, anybody will and then you’re much better off going with the indexes.
What’s also going on right now is that many equity classes are correlating with one another. This means that if the drugs stocks go up, say, 1% one day, then the tech stocks are also going up by about that amount.
When the stock groups behave too similarly, it gets hard for money managers to set themselves apart — and that’s how they make their money. They want to see lots of divergences.

“That’s not a healthy market. The mathematical benefits of diversification require assets that exhibit low-to-no correlation amongst themselves. When everything moves in synch, asset allocators have to pull in their horns,” Colas writes. “Wonder why investors are shunning risk and buying bonds? Part of the reason is clearly that the historically proven benefits of diversification just are not working as well as they once did.”
Within the stock market, the Sector SPDR family of ETFs that carve up the S&P 500 offers a striking example of the herd behavior.
“U.S. equity correlations among the 10 industrial sectors of the S&P 500 remain near historical highs, as 7 out of the 10 sector ETFs show correlations with the S&P 500 in excess of 90%,” according to the strategist. “Only Healthcare (XLV), Utilities (XLU) and Consumer Staples (XLP) are lower, and they’re stuck in the 80% range, which is still very high.”

I disagree that this is “dangerous.” It just means that alpha isn’t so easy to come by.

Interview With Bill Miller
Posted by Eddy Elfenbein on September 16th, 2010 at 9:34 am

Here are some interesting insights from an interview with Bill Miller:

But here is a topical example: Hewlett Packard has $15bn of cash on its balance sheet. It will generate $10bn of free cash this year and is probably overpaying this $3bn for 3PAR and ArcSight for $1.5. But even so, it will not make much of a dent in its free cashflow for this year alone.
So HP could take 100% of its free cashflow and pay it out as dividends. While they would never do that, if they did the stock would have a 10% yield on it. Can you think of any companies out there with a 10% yield and can grow? So where would it trade? It might trade to a 5% yield.
It would probably go up 50% immediately and many people would be wondering whether what was going on was secure. But eventually it would be capitalised at a rate higher than a utility or a Reit because it can grow faster. That is the opportunity we currently have in the market.

Morning News: September 16, 2010
Posted by Eddy Elfenbein on September 16th, 2010 at 9:02 am

Yields inch up, Yen moves Watched
Futures Dip Ahead of Jobless Data, FedEx Results
China Yuan Rises To New High Before Geithner Testimony
Obama Reportedly to Name Warren Special Adviser
Pimco Makes $8.1 Billion Bet Against `Lost Decade’ of Deflation
Goldman Sachs Fund of Ex-Prop Traders Said to Return 3% in 2010
India Hikes Interest Rate More Than Expected
E.U. to Ratify First Free Trade Deal With Asian Partner
Wright Express Completes Australian Buyout

Buffett Buys More Shares Of Becton
Baby Bonobos!

One National Capital, Two Cities
Posted by Eddy Elfenbein on September 15th, 2010 at 9:58 pm

Who’s up for some DC primary statistical analysis blogging?
I thought so! (I admit, I’m a pale imitation of Nate Silver, but here goes.)
Yesterday was the Democratic primary for mayor of Washington, DC. Vincent Gray beat the incumbent mayor Adrian Fenty 54% to 45%.
The vote trend was incredibly split with the black-majority precincts going heavily for Gray while the affluent SWPL precincts went strongly for Fenty.
The split wasn’t just big; it was massive. I think the pronounced racial/geographic divide is the major under-reported story of this election.
There were precious few “swing” precincts. Consider this: Of the 143 precincts, the standard deviation of Fenty’s vote was over 25%.
Check out the distribution of Fenty’s vote:

A majority of DC voters live in a precinct that went 75% or more for one candidate. In just 12 of the 143 precincts did both candidates come within 5% of their city-wide total. The results also suggest that votes were more polarized than polling indicated — perhaps an odd double Bradley Effect.
(Note: These numbers are based on the unofficial returns that were listed on the DC Board of Election’s website earlier today. Here’s a spreadsheet of the results.)

Looking Ahead to Bed Bath & Beyond’s Earnings
Posted by Eddy Elfenbein on September 15th, 2010 at 2:35 pm

Next week, Bed Bath & Beyond (BBBY) will report its fiscal Q2 earnings. I like this company a lot and I’ve long admired their highly efficient operations.
When the last earnings report came out in June, BBBY said it expects earnings for Q2 to range between 59 cents and 63 cents per share. The Street was expecting 63 cents per share so this announcement was a disappointment.
The shares fell 5.6% the next day and continued to fall. For most of July and August, the stock bounced around in the upper-$30s. I had said after the earnings report that “if you can get this stock below $40, you’re getting a good deal.”
For the moment, it looks like I was right. With the beginning of September, the stock came back to life. BBBY smashed through $40 and even broke $42 yesterday.
I think the investing community mistakenly believes that BBBY is a housing stock. Yes, it’s impacted by housing but don’t get the idea that buying BBBY is anything like buying Lennar (LEN). I like to find situations where most people think the situation is X, but it’s really only partially X.
I wouldn’t be surprised to see BBBY smash earnings next week. The stock could even make as much as 70 cents per share (look at me being all bold). The big positive is that their margins are looking much better. The last report showed that net margins have improved for five quarters in a row.
Put it this way: When your margins improve from 6% to 8%, which is the case for BBBY, a 12% rise in sales translates to a 50% increase in profits. And that’s a good thing.

My only warning is that if you don’t already own the stock, I would be leery of starting a position over $40 per share. The company will probably earn about $2.70 to $2.75 per share for this year, give or take. That means $40 is a reasonable price but it’s not what I would call “a steal.”

Eager…Now Not So Eager
Posted by Eddy Elfenbein on September 15th, 2010 at 9:59 am

USA Today
April 6, 2009

Tech firms eager to gobble stimulus funds
“This is a once-in-a-lifetime deal,” says Sean Maloney, chief sales and marketing officer at Intel, which is working on broadband projects with governments in the U.S., Japan, Vietnam and others. “This dwarfs the Marshall Plan and the New Deal. It is unimaginably large, and will never happen again. It is incumbent on us to spend it wisely.”

Huffington Post
September 14, 2010

Paul Otellini, Intel CEO: The Stimulus Didn’t Work
Intel CEO Paul Otellini doesn’t buy into the idea that the White House is anti-business, but he does believe the administration “just doesn’t get it” when it comes to creating jobs.
Otellini, in an exclusive interview with CNN Money at the Intel Developers Forum in San Francisco on Tuesday, said the U.S. should not only forgo spending the second half of Obama’s $787 billion stimulus package, but completely axe Obama’s newly proposed $350 billion economic recovery plan.

(Via: Yglesias)

Morning News: September 15, 2010
Posted by Eddy Elfenbein on September 15th, 2010 at 9:46 am

Who Played the Largest-Ever Arbitrage?
Japan Intervenes for the First Time Since 2004 as Yen Surge Threatens Recovery
Best Buy Rings ‘Em Up
Silver Prices Surging With Gold
Gold Hits a Record as Econ Worries Rise Again
EU Proposes Curb on ‘Wild West’ Trading
Production in U.S. Probably Cooled as Automakers Scaled Back
Sinochem Says Not Keen on Potash Buy
Dodd: Limited Will for Senate Vote on Fed Nominees

We, Once Again, Get Results
Posted by Eddy Elfenbein on September 14th, 2010 at 4:46 pm

Crossing Wall Street
August 11, 2005

Will Cisco Pay a Dividend?
I’m going to make a prediction. No, not like my other lousy predictions. This time, I’m nearly serious. I predict that Cisco will start paying a cash dividend.

Los Angeles Times
September 14, 2010

Cisco Systems says it will start paying cash dividends
Computer networking titan Cisco Systems said Tuesday it expects to start paying a dividend for the first time. Investors liked the sound of that: Cisco’s shares were up 45 cents, or 2.1%, to $21.71 at about 11:30 a.m. PDT.

OK, I was a wee bit early. What do I look like…Nostra-freakin-damus? Here’s what I had to say:

Really, it makes perfect sense. The company generates gobs of cash, but they waste it on buying their own stock (just like everyone else who buys Cisco’s stock).
There are two reasons why Cisco buys so much stock: They issue tons of stock, and they give out tons of options to their employees. They bought nearly $20 billion of stock in the last two years and the stock hasn’t done a thing. Forget fighting the market: just give it to shareholders.
The market simply doesn’t trust Cisco to spend its own money wisely. Here’s a nice little factoid: If you adjust for stock-option expenses, Cisco’s 2004 earnings would have been 45 cents per share, not the 62 cents that the company reported. I think the rumor that Cisco was about to buy Nokia was started by the Street just to get Cisco thinking about how it invests its money. I knew there was no way that Cisco would buy Nokia. Too much of their own cash flow is flowing down the drain. They don’t seem to realize that that’s not a good thing.
John Chambers & Co. must seem baffled by the market’s displeasure with Cisco. After all, the company has reported decent profit growth for the last two years, but the stock hasn’t done much of anything. Just pay a dividend, and the market will forgive you.

The company currently has a cash war chest of $40 billion ($7.01 per share). Cisco said it’s looking to yield 1% to 2%. At the current price, that works out to a quarterly dividend of around five to ten cents per share.

Reader Feedback
Posted by Eddy Elfenbein on September 14th, 2010 at 4:29 pm

Here’s an email from a reader taking the pro-buyback side:

“Microsoft has spent over $78 billion on share buybacks and the stock has done nothing but go down.”
That seems pretty misleading.
That means that MSFT bought back around 3B shares since 2006 (assuming $26/share). They now have about 8.65B shares outstanding. So if they had not bought back any shares and they had paid the money out in dividends instead, their 2010 earnings per share would have been only $1.75, instead of $2.36. As an owner of MSFT, this makes a BIG difference to me. And don’t you think the stock would be a lot lower today if earnings were only $1.75 per share?
Of course it would have been nice to get the dividend, but I hold MSFT in a taxable account, with a marginal tax rate approaching 25% (state and federal). So from my perspective I’d rather have MSFT buy back stock than pay dividends even if the stock was 30% overvalued! (Ignoring capital gains taxes, which I can probably defer almost forever). And of course I don’t think it is 30% overvalued, because then I would sell it, wouldn’t I. If I want to get some cash out of MSFT, I can always sell some shares.
(P.S. – still love the blog, but I really don’t get your antipathy to buybacks.)

At Least Microsoft Thinks Microsoft is Cheap
Posted by Eddy Elfenbein on September 14th, 2010 at 10:23 am

There’s been heavy speculation that Microsoft (MSFT) is going to sell debt this year in order to buy back its stock and pay dividends. This would be a fascinating move and it shows just how unusual the current market is.
Whatever you think of Microsoft and its future, the company currently generates an astounding amount of cash. According to the latest statement, MSFT has a cash balance of over $36 billion which works out to $4.22 per share. Their long-term debt is roughly $6 billion. Shareholders, not surprisingly, want some of that loot.
The problem with Microsoft’s huge bank account is that it’s mostly held overseas. As a result, MSFT is going to try and raise as much money as possible without affecting its AAA rating. One source said they could probably take in $6 billion.
When debt is expensive and equity is cheap, the rational choice for companies is to do exactly what Microsoft is doing—issue debt to buy stock. I’d be very curious as to the interest rate MSFT would land.
The company currently pays a 13-cent quarterly dividend which comes out to an annual yield of 2.07%. The dividend, however, is fairly modest compared to Wall Street’s current earnings estimate of $2.36 per share.
In May 2009, MSFT went to the bond market and floated $2 billion at 2.95% for 5-year notes, $1 billion at 4.2% for 10-year notes and $750 million at 5.2% for 30-year bonds. I think they can easily get much lower than that today.
Microsoft is in the lucky position of having its debt rated AAA by Moody’s and S&P. That saves them a lot of money in borrowing costs. Last year, the software had an amazing $22 billion in free cash flow. About half of that came from the United States.
Of course, there’s the question of whether or not a company should be trying to make money by shifting pieces of paper around. As David Merkel says, “Why pay money for financial engineering? Better you should look for genuine organic growth.” He’s got a good point. When I invest in a company I want them to do what they do best. Let me worry about if their stock is a good buy or not.
Since FY 2006, Microsoft has spent over $78 billion on share buybacks and the stock has done nothing but go down. The company is currently in the middle of a $40 billion buyback program that runs through 2013.
The other option is for Microsoft to spend its cash on acquisitions. Still, we’re back to the company being a money manager more than a software firm. To quote Biggie Smalls, “Mo Money, Mo Problems.”