• The Miracle of Warsaw, Indiana
    Posted by on March 21st, 2006 at 6:00 am

    One of the more interesting figures of the American Revolution is Thaddeus Kosciuszko, a Polish army officer who was so moved by the patriot’s cause that he came to the colonies to join the fight. Kosciuszko was named head engineer of the Continental Army, and his help was critical at the Battles of Ticonderoga and Saratoga.

    The good citizens of Indiana and Mississippi both named counties in his honor. The Hoosiers went one better, and named the county seat Warsaw as a salute to Kosciuszko’s heritage.

    It might seem strange that a city in the heartland has the same name as the capital of Poland. But Warsaw, Indiana isn’t like most towns. In 1895, the city was altered forever when a salesman named Revra DePuy decided that he no longer wanted to work for other people. So he did what any American would do: He became an entrepreneur.

    DePuy was a splint salesman. At the time, fractures were set with wooden splints. DePuy had a revolutionary idea. He used metal splints instead of wood. The metal could be bent to fit any person. So in a garage in Warsaw, DePuy launched the town’s orthopedics industry.

    DePuy’s business did very well, and within a few years he hired Justin Zimmer to be his first sales manager. After DePuy died, Zimmer wanted to buy the company but wasn’t able to. So, like DePuy before him, he also started his own orthopedic business right in Warsaw. The orthopedics industry grew and grew and grew. Soon, the advent of plastics launched the industry into a new age of design and innovation.

    In 1977, four entrepreneurs, Dane Miller, Niles Noblitt, Jerry Ferguson and Ray Harroff (two of whom worked for Zimmer) branched out on their own. Right in Warsaw, they formed another orthopedic company which they called Biomet Inc. (BMET). In their first year, the company recorded sales of $17,000 and a loss of $63,000. Despite the modest start, Biomet has delivered record sales and earnings every year since. The company has one of the best track records in American business Remarkably, the four men are still active in Biomet’s operations.

    If any business could be described as the perfect business, it might be medical devices. The business has demographics on its side, and the industry is constantly driven by technology and prices increases. The stocks tend to be very stable, and highly profitable. Several stocks like Medtronic (MDT), Zimmer (ZMH), Stryker (SYK), Biomet (BMET) and St. Jude (STJ) have been market-beaters for years. According to data available at Professor Kenneth French’s Web site, medical device stocks have increased 370,000% over the last 65 years, that’s more than 30 times better than the overall market.

    Today Warsaw is the backbone (sorry) of the global market for replacement hips, knees, shoulders. Heck, if you break it, Warsaw can make a new one. Today, knee and hip replacements are quite common. Warsaw probably controls about 40% of the worldwide orthopedics business. DePuy Inc. is still based in Warsaw. A few years ago, it was bought out by Johnson & Johnson (JNJ). Zimmer is also still in Warsaw as is Biomet.

    Today, Biomet employs over 6,000 people. This year, it should have over $2 billion in sales. There simply aren’t many companies that have done as well as Biomet. For the last 10 years, the company has paid an annual dividend that has increased each year. Since 1982, Biomet’s stock has split nine times for a total of 162-for-1.

    Despite Biomet’s past success, the stock hasn’t done much recently. The shares nearly got to $50 in 2004, but are now around $36 even though the rest of the market has been making new multi-year highs. There have been concerns that the industry is under pricing pressure. I understand the worry. Price increases are the heart and soul of orthopedics. Biomet enjoys gross margins of 70% and net margins of 20%.

    The second quarter (ending in November) was pretty embarrassing for Biomet. The company had said it would earn 42 to 44 cents a share. It turns out, they earned just 41 cents. If that weren’t enough, Biomet said that for the third quarter (ending in February), it would earn 43 to 44 cents a share on sales of $510 to $520 million. That was below Wall Street’s estimate of 46 cents a share and $529.4 million. Last year, Biomet earned 40 cents a share. Mind you, this is a very stable business. For years, forecasting Biomet’s profits basically meant adding 18% to whatever they did last year.

    This morning, Biomet reported third-quarter earnings of 43 cents a share on sales of $506 million.
    The important fact to keep in mind is that Biomet is a very efficient company. It has no long-term debt. Return-on-equity is regularly over 20% Also, the company’s P/E ratio is at the low end of its historic range. Biomet’s CEO, Dane Miller (one of the four founders), has consistently dismissed worries over pricing pressures. I’m inclined to take his word over that of Wall Street analysts.

    Miller said: “We remain comfortable with analysts’ sales and earnings estimates of $530 million to $540 million and $0.45 to $0.46 per share for the fourth quarter of fiscal year 2006.”

    Year……..Sales……….EPS
    1996…….$535.2…….$0.36
    1997…….$580.3…….$0.41
    1998…….$651.4…….$0.49
    1999…….$757.4…….$0.46
    2000…….$920.6…….$0.65
    2001…….$1030.7…..$0.73
    2002…….$1191.9…..$0.88
    2003…….$1390.3…..$1.10
    2004…….$1615.3…..$1.27
    2005…….$1880.0…..$1.38
    2006…….$2020.0…..$1.68 (my estimate)

    bmet032106

  • The Market Today
    Posted by on March 20th, 2006 at 4:23 pm

    Today was a good day for our Buy List. The S&P 500 snapped its six-session winning streak as it closed -0.17% lower. Our Buy List rose 0.25%.
    Our best stocks were Dell (DELL), which was up 2.3%, and Bed Beth & Beyond (BBBY) which was up 1.3% to a seven-week high. Medtronic (MDT) also had a good day, climbing 1.6%. Biomet (BMET) had a good day, rising 1.3% before tomorrow’s earnings report.
    After the bell, Oracle (ORCL) reported earnings of 19 cents a share, one penny more than expectations.
    Also, Frontier Airlines (FRNT), a former Buy List stock, had an excellent day today. The stock rose 6.5% to a two-month high.

  • The Aging Bull?
    Posted by on March 20th, 2006 at 2:57 pm

    The current bull market recently celebrated its third birthday. The S&P 500 hit a closing low of 800.73 on March 11, 2003 (it had actually gone even lower in October 2002). Yuo know, there’s nothing like a war to get a stock market moving. We’re up over 63.2% since then.
    But like any three-year-old, this market is starting to get cranky. The S&P 500 has now gone up for six straight days. With an hour left of trading, it looks like the market will close lower.
    The WSJ reports that analysts have been trimming back their earnings forecasts:

    At the start of January, analysts, on average, predicted first-quarter profits would grow 12.6% at companies in the Standard & Poor’s 500-stock index. By Friday, that forecast had been cut to 11%. “We have definitely seen a dramatic pull-down” in analysts’ forecasting patterns as the bull market has worn on, says Thomson Financial research analyst David Dropsey. “It seems like every quarter it gets a little more back to normal.” Normal isn’t necessarily great. Bull markets usually are strongest when they are young, right after a bear market. Investor expectations are low then, and surpassing them is easier. The bull market tends to end, or at least pause, when expectations get well ahead of companies’ ability to deliver.
    The fact that analysts are cutting forecasts again doesn’t necessarily mean the bull market is in trouble. The amount of the estimate cuts still is below average. Thomson Financial has found analysts tend to cut forecasts by about three percentage points as a quarter wears on. Then companies have a way of beating the reduced expectations — by about three percentage points. Lately, the estimate cuts have been less than that.

  • Graco Hits New High
    Posted by on March 20th, 2006 at 1:19 pm

    I noticed that shares of Graco (GGG) are at a new all-time high today.
    Graco is one of those stocks that’s not well-known, but it’s been a remarkable stock for many years.
    Since 1976, the stock is up about 20,000%. Not bad for a company that’s nearly invisible to Wall Street. Only seven analysts follow the stock.
    The 80-year-old company makes equipment that measures and dispenses fluid materials. Graco’s products are used everywhere. They even make the pump that puts caramel into Hershey’s Kisses. I’m a fan already.
    You can read more about Graco here and here.
    Here are the financial results for the past 10 years:
    Year……..Sales……….EPS
    1996…….$391.8…….$0.41
    1997…….$413.9…….$0.51
    1998…….$432.2…….$0.60
    1999…….$442.5…….$0.84
    2000…….$494.4…….$1.01
    2001…….$472.8…….$0.92
    2002…….$487.0…….$1.05
    2003…….$535.1…….$1.23
    2004…….$605.0…….$1.55
    2005…….$731.7…….$1.80
    Notice the smooth uptrend. Wall Street expects the company to make $2.08 a share this year on sales of $790 million.
    GGG.bmp

  • More Problems for GM
    Posted by on March 20th, 2006 at 12:39 pm

    When Dwight Eisenhower became president, he appointed Charles Wilson, the president of General Motors (GM), as his secretary of defense. During his confirmation hearing, Wilson was asked if he could make a decision that was opposed to GM’s interests. He said that he could but he couldn’t imagine such a situation “because for years I thought what was good for the country was good for General Motors and vice versa.”
    Over the years, Wilson’s answer has been changed to “What’s good for General Motors is good for the country.” Quite the opposite of corporate ruthlessness, Wilson was really conveying civic responsibility.
    Sadly, today’s GM is quite different from Wilson’s. Last week, the company said that it had lost $2 billion more last year than it had originally reported. The company will also miss the deadline for filing its 10-K report. GM also restated results from 2000 to 2004. If you’re keeping score, GM just restated its 2001 earnings in November.
    This company is a financial black hole. For 2005, GM lost $10.6 billion. That’s $18.69 a share. To put it in perspective, the stock is currently trading around $21 a share. In 1955, General Motors was the first corporation to register $1 billion in annual sales. At the time, GM was the one of the largest employers in the world—only Soviet state industries employed more people. Today’s it’s about as profitable.
    The accounting mess surrounds the classification of cash flows at ResCap, the residential-mortgage business of its financing arm, General Motors Acceptance Corp. The company has been trying to sell 51% of GMAC. The restatement will cut GMAC’s 2005 profit to $2.5 billion from $2.8 billion Thanks to the latest bungle, on future deal may be gone forever. Who wants to do business with these people? I expect that the ratings agencies will downgrade GM’s debt again. It’s already junk. It will soon be even junkier.
    GM has $300 billion in long-term debt. That’s over $530 a share of junk debt. So if you pick up a share for $21, you’re also buying $530 of junk-rate liability. Since the current Dow multiple is about 8.2, this means that GM’s debt is worth over 4,300 Dow points. How much longer will this company be a part of the Dow?
    Did I mention there’s also an SEC investigation? And there’s also the issue of Delphi. It looks like GM and Delphi are finally close to an agreement with the UAW on early retirement incentive. GM is liable for pension and health-care obligations for these workers. The company estimates its liability to between $5.5 billion and $12 billion.
    Of the 10 hottest-selling cars in the world, only one is made by GM. To be honest, GM isn’t really a car company. It’s a pension and health benefits company that sells below-cost cars as a side business. The WSJ quoted an accounting professor as saying that it appears that the auto maker “is leasing cars to rental companies at a loss, to keep the plants running.” This is what it’s come to.
    GM’s board has now called for an investigation. I hate to break it to them, but there’s been an investigation going on for some time. Here are the results. Draw your own conclusions.

  • Is Oracle a Value Stock?
    Posted by on March 20th, 2006 at 9:43 am

    I’m not so sure, but others think so. Just because a stock hasn’t moved doesn’t necessarily mean it’s a bargain. Their core business isn’t growing, and it has to digest some very big mergers.
    The company reports after today’s close. Forbes has a video with more on Oracle’s problems.
    Wall Street is expecting earnings of 18 cents a share. Probably as important as the financial results will be any commentary from Larry & Co. on the integration of PeopleSoft and Seibel.
    I wish Oracle well, but I won’t go near the shares until I see more proof of a strong business.

  • Dell to double workforce in India
    Posted by on March 20th, 2006 at 9:37 am

    From Reuters:

    Dell, the world’s top PC maker, plans to double its headcount in India over three years, its founder said on Monday, but there was no word on the location of a planned manufacturing unit in the country.
    “India produces over 200,000 engineers and we see that as an asset for our hardware and software activities,” Chairman Michael Dell told reporters in India’s technology capital, Bangalore.
    Dell said its staff numbers in India would rise to 20,000 over the next three years from about 10,000 now. Dell has set up huge business process outsourcing units to tap India’s vast pool of low-cost English-speaking workers, as other multinationals such as General Electric have done.
    Dell has used India as a base to serve global clients in recent years, but it now considers Asia’s third-largest economy a growing market for desktops and laptops as demand for computers surges across the country.
    Research firm IDC expects the Indian computer market to grow at a compounded annual growth rate of 23 percent until 2010.

  • The Real World Versus the Theoretical
    Posted by on March 19th, 2006 at 10:15 am

    Here’s a fascinating “Sunday read” from Harvard Magazine on behavioral economics. The article is long (about 6,000 words), but I think you’ll enjoy it.
    Instead of looking at how the world ought to work in theory, behavioral economists study how people really go about making economic decisions. They’ve found that how decisions are “framed” can have a dramatic impact on what decisions are made.
    For example, people have a very difficult time internalizing risk. David Laibson summaries the phenomenon:

    “There’s a fundamental tension, in humans and other animals, between seizing available rewards in the present, and being patient for rewards in the future,” he says. “It’s radically important. People very robustly want instant gratification right now, and want to be patient in the future. If you ask people, ‘Which do you want right now, fruit or chocolate?’ they say, ‘Chocolate!’ But if you ask, ‘Which one a week from now?’ they will say, ‘Fruit.’ Now we want chocolate, cigarettes, and a trashy movie. In the future, we want to eat fruit, to quit smoking, and to watch Bergman films.”
    Laibson can sketch a formal model that describes this dynamic. Consider a project like starting an exercise program, which entails, say, an immediate cost of six units of value, but will produce a delayed benefit of eight units. That’s a net gain of two units, “but it ignores the human tendency to devalue the future,” Laibson says. If future events have perhaps half the value of present ones, then the eight units become only four, and starting an exercise program today means a net loss of two units (six minus four). So we don’t want to start exercising today. On the other hand, starting tomorrow devalues both the cost and the benefit by half (to three and four units, respectively), resulting in a net gain of one unit from exercising. Hence, everyone is enthusiastic about going to the gym tomorrow.
    Broadly speaking, “People act irrationally in that they overly discount the future,” says Bazerman. “We do worse in life because we spend too much for what we want now at the expense of goodies we want in the future. People buy things they can’t afford on a credit card, and as a result they get to buy less over the course of their lifetimes.” Such problems should not arise, according to standard economic theory, which holds that “there shouldn’t be any disconnect between what I’m doing and what I want to be doing,” says Nava Ashraf.

    Economics isn’t like chemistry or physics, it’s a social science. As a result, numbers can sometimes fool us. In finance, a 10% gain and a 10% loss aren’t symmetrical. People fear loss more than the value gain.
    The article has this interesting quote from Sendhil Mullainathan:

    “We tend to think people are driven by purposeful choices,” he explains. “We think big things drive big behaviors: if people don’t go to school, we think they don’t like school. Instead, most behaviors are driven by the moment. They aren’t purposeful, thought-out choices. That’s an illusion we have about others. Policymakers think that if they get the abstractions right, that will drive behavior in the desired direction. But the world happens in real time. We can talk abstractions of risk and return, but when the person is physically checking off the box on that investment form, all the things going on at that moment will disproportionately influence the decision they make. That’s the temptation element—in real time, the moment can be very tempting. The main thing is to define what is in your mind at the moment of choice. Suppose a company wants to sell more soap. Traditional economists would advise things like making a soap that people like more, or charging less for a bar of soap. A behavioral economist might suggest convincing supermarkets to display your soap at eye level—people will see your brand first and grab it.”

    Here’s a well-known example of behavioral economics. Suppose you’re in a roomful of people, and you’re told to choose any integer from zero to 100. All participants are told that a large cash price will go to the person who chooses closest to two-thirds of the average of everyone else’s number. So what number would you choose?
    Thirty-three, right? Wait…everyone else will say that. I know: Twenty-two? No…hold on. Everyone else will….
    *Thinking*
    I got it! The theoretical answer is zero.
    In the real world, studies have shown that the average guess is 18.91, so the winning answer is about 13. This of course makes no sense whatsoever. Remember that next time you buy a stock.

  • Q&A: General Electric
    Posted by on March 18th, 2006 at 12:37 pm

    Hi Eddy, I’m curious on your opinion of GE a “blue chip” that for the past 5 years has underperformed the market to the tune of $10k invested 5 years ago (according to S&P) = about $8k plus.

    Thanks for the email. General Electric (GE) is a great company. It’s one of the bluest of the blue chip stocks. It’s also one of the very few companies that has increased its earnings for ten straight years.
    GE is also titanic. The numbers boggle the mind. The company has over 300,000 employees and a market value of over $350 billion. Owning GE is almost like buying an index fund.
    The stock got absurdly overvalued five years ago. The P/E ratio got as high as 50. Last year, GE earned $1.72 a share so right now it’s going for almost exactly 20 times earnings. That’s a very good valuation for GE.
    The company raised the lower end of its guidance by two cents a share to $1.94 to $2.02 a share (don’t laugh, each penny is worth about $100 million). There’s also a $1 a share dividend which works out to a yield of nearly 3%. That’s equivalent to over 320 Dow points.
    General Electric is a great company, and the shares look very good right now.

  • The NASDAQ Goes Shopping in London
    Posted by on March 17th, 2006 at 1:26 pm

    The bidding war for the London Stock Exchange heats up. The newest player is the NASDAQ. The Economist has the story:

    Londoners following the LSE bidding saga had become so used to guessing games about continental exchanges, notably the pan-European Euronext and Germany’s Deutsche Börse, that the Americans’ hostile bid late last week came as something of a surprise. It shouldn’t have. NASDAQ tried unsuccessfully to enter Europe once before with a start-up and has in the past held tentative talks with the LSE. Its cash offer of £9.50 ($16.60) a share, which would cost the Americans £2.4 billion, makes the preceding bid—£5.80, from Australia’s Macquarie Bank, only three months ago—look downright stingy.
    NASDAQ’s offer was rejected outright by the LSE’s management, but is being considered by big shareholders. If the merger does go ahead, it would be a quantum leap in the consolidation of financial exchanges. It could also raise difficult questions of who should regulate the combined entity, and how. A merged firm would be second only to NYSE Group—as the newly listed New York Stock Exchange styles itself—in market capitalisation.