H&R Block’s Taxes
Posted by Eddy Elfenbein on March 1st, 2006 at 11:02 am

It can’t be good news when H&R Block messes up its own taxes. Here’s the 8-K report:

The restatement pertains primarily to errors in determining the Company’s state effective income tax rate for the fiscal quarters ended October 31, 2005 and July 31, 2005, fiscal years ended April 30, 2005 and 2004 and the fiscal quarters for fiscal years 2005 and 2004. These errors resulted in a cumulative understatement of state income tax liability (net of federal income tax benefit) of approximately $32 million as of April 30, 2005.

SEC: Overstock Isn’t Behind Probe
Posted by Eddy Elfenbein on March 1st, 2006 at 10:57 am

The SEC has said that Overstock.com isn’t behind the investigation into a short-selling ring:

The chief executive of Overstock.com on Wednesday said federal regulators, not the online retailer, were behind the investigation into business journalists as part of a probe into alleged manipulation of the company’s stock.
Patrick Byrne told business news network CNBC that the U.S. Securities and Exchange Commission’s recent subpoenas of journalists who had criticized Overstock came at the agency’s own initiative.
The San Francisco office of the SEC took the unusual step of issuing subpoenas to two Dow Jones & Co. columnists, Carol Remond and Herb Greenberg, to demand telephone records, e-mails and other documents related to Overstock.com.
“It’s my sense that the SEC was onto Herb’s scent long before we came along,” Byrne said. “I have not orchestrated the SEC investigation.”
Byrne acknowledged speaking to SEC officials about the probe, but dismissed the notion that the subpoenas were related to a lawsuit Overstock filed in August against hedge fund Rocker Partners and research firm Gradient Analytics.

Update on the Buy List
Posted by Eddy Elfenbein on March 1st, 2006 at 10:39 am

For the first two months of the year, the Buy List is up 2.12%. That may not sound like a lot, but it’s ahead of the long-term average, although we’re slightly behind the S&P 500 which is up 2.59% (not including dividends).

J&J Is Looking Cheap
Posted by Eddy Elfenbein on March 1st, 2006 at 10:22 am

Has anyone else noticed how cheap Johnson & Johnson (JNJ) is? Good, I thought it was just me. Nearly a year ago, the stock was at $70. Today, it’s around $57.
The company dodged bullet thanks to Boston Scientific (BSX) snatching Guidant (GDT) from them. I was terrified that J&J was going to get stuck with Guidant. As you may have heard me say before, I’m not a fan of mega-mergers.
One of the best ways to find good values on Wall Street is look for the strongest stocks in the weakest sectors. Right now, that’s health care. While Merck (MRK) and Pfizer (PFE) are having their problems, the good stocks like J&J are also being punished.
I’ll give you another good example of this. In 1990, almost all financial stocks were tossed in the garbage. AFLAC (AFL) is one of the best around, and even they saw their stock plunge from (post-split) $3 a share to $1.70. To make a short story shorter, now it’s at $46.
So yes, Johnson & Johnson will manage to survive. The company is Wall Street’s version of a blue blazer. It never goes out of style. The most recent catalyst for J&J’s shares to fall was its “weak” earning report. Of course, for J&J, weak is relative. Earnings came in at 73 cents a share, which was in line with the Street’s estimate. But the surprise was that for the first time in 22 years, revenues declined. The company also guided slightly lower for this quarter.
For the year, J&J sees earnings of $3.78 to $3.85 a share, which means the shares are going for about 15 times earnings. Notice how we saw Medtronic (MDT) also fall on fundamentally good earnings. It’s just because it’s a large-cap health care stock. On Wall Street, you simply can’t argue with a mob. If they want to see bad news, they’ll find it.
I also expect J&J to raise its dividend soon from 33 cents a share to (I’m guessing) 37.5 cents, which is a yield of 2.6%.
Here’s a chart of J&J over the past 18 years. Note the P/E ratio line.

I’ve also included a chart of Dollar General (DG), another stock that’s beginning to look cheap:

What’s Your Wonderlic?
Posted by Eddy Elfenbein on February 28th, 2006 at 6:15 pm

Vince Young got a 6 on his Wonderlic test.
What’s your score?

Donaldson’s Earnings
Posted by Eddy Elfenbein on February 28th, 2006 at 4:36 pm

The press release makes it sound great, but this was a disappointing quarter for Donaldson (DCI). The company missed the Street’s estimate by a penny a share.

Donaldson Company, Inc. today announced record second quarter diluted earnings per share (“EPS”) of $.32, up from $.31 last year. Net income was a record $26.9 million, versus $26.7 million last year. Sales were a record $392.9 million, up from $388.4 million in fiscal 2005.
For the six-month period, EPS was another record at $.69, up from $.62 last year. Net income increased 9 percent to $59.1 million compared to $54.1 million last year. Sales were a record $796.3 million, up 5 percent from $761.3 million in fiscal 2005.
“Our operating margin improved to 10.2 percent year-to-date from 9.6 percent last year, despite absorbing $2.2 million, or $.02 per share, of stock option expenses into operating profits this year,” said Bill Cook, Chairman, President and CEO. “Donaldson is running very well, with our continued focus on cost reduction efforts offsetting higher commodity prices and driving the improvement in our profit margins. We reduced our full year sales outlook mainly due to currency translation since the dollar is currently weaker against the Euro and Yen than it was in the second half of last year. However, we expect continued positive year-over-year sales growth and for operating margins to continue at these improved levels, giving us confidence in delivering our 17th consecutive year of record earnings.”

Google Is Having Issues
Posted by Eddy Elfenbein on February 28th, 2006 at 11:28 am

Down 10%.

Google Inc. shares slid as much as 13 percent, their biggest-ever decline, after finance chief George Reyes said growth is slowing at the world’s most-used Internet search engine.
“We’re getting to the point where the law of large numbers starts to take root,” Reyes said today at a Merrill Lynch & Co. investor conference in New York. “Growth will slow. Will it be precipitous? I doubt it.”

I wish someone had seen this coming.
More: Mark Hulbert on insider selling at Google (“off the charts”).

Burger King’s IPO
Posted by Eddy Elfenbein on February 28th, 2006 at 10:14 am

IBD looks at Burger King’s IPO:

THE BUZZ
Unlike last year, 2006 is set to produce some massive, high-profile initial public offerings. And while the terms for Burger King’s IPO are still in the works, the deal should be — if you’ll pardon the expression — a whopper.
Burger King’s rivals have certainly been busy. McDonald’s scored a hit when it did a partial spinoff of Chipotle Mexican Grill in January.
Wendy’s is planning a similar spinoff of Tim Hortons sometime next month.
Now comes the debut of the world’s second-largest fast-food operation. The main question will be how much investors believe in the financial turnaround engineered by Burger King’s new chief executive, Greg Brenneman.
When the company filed its prospectus on Feb. 16, analysts could look at the numbers in detail for the first time.
“The balance sheet is nothing to write home about,” said Francis Gaskins, president of IPOhome.com. “But they’ve turned it around on an operating basis. That’s the interest here.”
THE COMPANY
Burger King was founded as a drive-up hamburger stand in 1954. Three years later it rolled out its trademark Whopper.
In 1967, after much growth, the company was bought by the Pillsbury Co., which in turn was bought by Grand Met in 1989.
A still bigger fish, Diageo, came in and swallowed up Grand Met. Diageo is a British beverage company that owns venerable booze brands such as Gordon’s, Smirnoff, Johnnie Walker and Jose Cuervo.
It was an odd fit for a U.S. fast-food giant, and Burger King suffered an identity crisis. Between 1989 and 2002 the chain went through eight chief executives and drifted out of the limelight.
In 2002 a group of equity investors — led by Texas Pacific Group, Bain Capital Partners and the Goldman Sachs Funds — bought Burger King. What they found was financial chaos.
More than a third of Burger King’s North American franchisees were over-leveraged, and its largest franchisee declared bankruptcy.
In 2004 the investment group tapped Brenneman, a turnaround specialist, to head Burger King.
Brenneman wasted no time shuffling the deck. On his watch Burger King has closed more than 800 underperforming restaurants, written off some $106 million in franchisee debts and experimented with aggressive discounting.
By last year Burger King’s finances were improving.

The Derivatives Mess
Posted by Eddy Elfenbein on February 28th, 2006 at 10:02 am

I meant to post this earlier. This WSJ article highlights the problems of the growth of derivatives on Wall Street.

Derivatives allow banks, companies and investors to transfer financial risk, much as homeowners buy insurance to shift the risk of repairing fire damage to an insurer. In the simplest form, Joe’s Manufacturing Inc. borrows $5 million at an interest rate that moves up and down with market rates, and then cuts a deal with Frank’s Investment Bank in which Joe promises to pay a fixed rate and Frank pays the variable rate.
The subspecies known as credit-default swaps allow banks that have lent money to, say, General Motors Corp. to shift risk of default to a risk-loving investor for a fee. As the market has evolved and drawn speculators, as well as banks looking to lay off risk, investors now place bets not only on individual firms, but on baskets of credits and on risks sliced and diced in increasingly complex ways.
You would think that Wall Street would have computerized this when the market started taking off a few years ago. But deals were, and often still are, done by telephone and fax. Detailed confirmations, important in avoiding nettlesome disputes later, weren’t completed. One firm confessed in June that it had 18,000 undocumented trades, several thousand of which had been languishing in the back office for more than 90 days. It wasn’t unusual.
That’s not all. One party to a two-party deal was routinely turning obligations over to a third party without telling the first one. It was as if you lent money to your brother-in-law and later learned that he had passed the debt to his deadbeat cousin without so much as an email. “When I realized how widespread that was, I was horrified,” says Gerald Corrigan, a former New York Fed president now at Goldman Sachs. “What it meant was that if you and I did a trade, and you assigned it without my knowing it, I thought you were my counterparty — but you weren’t.”
In LTCM’s case, each player knew the dimensions of its exposure; no one realized how exposed other firms were and how fragile LTCM’s strategy was. In the case of credit derivatives, the problem has been worse: Record-keeping, documentation and other practices have been so sloppy that no firm could be sure how much risk it was taking or with whom it had a deal. That’s a particularly embarrassing problem for an industry that has resisted regulation of derivatives by arguing that big firms would police each other.
Stocks, bonds and options traded on exchanges go through clearinghouses, which pick up the pieces when something goes awry with a trade. In this market, there’s no clearinghouse yet. Until recently, dealers didn’t even enter most credit-default-swap trades into a computer database to be sure both sides agreed on the terms.
Mr. Geithner, the Paul Revere of this story, began shouting about all of this before the end of his first year on the job. In an October 2004 speech, he noted that inadequate financial plumbing was “a potential source of uncertainty that can complicate how counterparties and markets respond in conditions of stress.” That’s central-bank speak for: The car is careening down the highway at 85 miles an hour and the lug nuts aren’t tight. If we hit a pothole, look out!

Fourth-Quarter GDP
Posted by Eddy Elfenbein on February 28th, 2006 at 9:01 am

GDP growth raised to 1.6%.
You wouldn’t know this from how people talk about the economy, but GDP growth is far more stable than most people realize. I often hear that the economy is “surging” or “crashing.” In reality, economic growth is a pretty stable trend that occasionally has some minor bumps.
Here’s a graph of real GDP growth over the last 60 years (red line) with a trend line line (black line).

Here’s a look at the trailing three-quarter growth rate of real GDP. I’m not sure why, but the nine-month view seems to work the best.
Notice how over the last 20 years, the economy has become far less cyclical. The peaks are getting lower, and the valleys are getting higher.

The Stalwart has speculated that as the overall economy has become more stable, the individual pieces have become more volatile. I think he’s right. Perhaps the price for collective security is the growth of constituent risk.