The markets really aren't reacting much, if at all, after newly appointed FOMC Chairman Ben Bernake answered questions on Capitol Hill today. Aside from Bernanke's preference to avoid partisanship, his answers and views on the economy were very similar to Greenspan's. As far as interest rates go, I continue to think we'll see 5% Fed Funds this year.
Implications for the stock market aren't very bullish in such a scenario. Stocks tend to be flat to slightly down after the last hike of a rate tightening cycle, and any move above 5% Fed Funds would indicate inflation is fierce enough to further crimp corporate profit growth. All in all, there are many excellent investment opportunities out there, but index funds won't fall into that category in the short-to-intermediate term, in my view.
Vonage Files for $250M IPO
Phone service upstart Vonage Holdings has filed initial paperwork with the SEC, the first step toward a possible IPO that aims to raise up to $250 million. Given the recent appetite investors have had for well-known consumer-related initial public offerings (Chipotle, Under Armour, to name a couple), the timing of this filing makes sense from the corporate perspective.
So, does the stock make for a good investment? Should the IPO come to fruition, we'll likely see a huge first day spike, allowing all of the investment banks' best clients to make a bundle. However, a closer look at Vonage's financials shows that any after-market valuation might be too high. For the first nine months of 2005, Vonage lost $190 million on sales of $174 million. Marketing costs totaled $176 million, a staggering figure.
IPO proceeds would undoubtedly go toward more marketing. While Vonage does have 1.4 million customers, how much are they actually worth? The Vonage service is a commodity, offering no differentiation from Comcast's service or anyone elses. Vonage is under cutting the competition on price ($24.95 for unlimited long distance calling to the U.S., Canada, and Puerto Rico) but there is no reason to think larger players won't attack that advantage in the future, and company's like Skype are focusing on free consumer voice services.
Much like other data and voice services, more competitors will enter the market, pushing prices down. Without a differentiated product offering, Vonage shares will likely be overpriced by retail investors should the IPO go smoothly.
Time to Unload Commodities?
Days like Tuesday don't feel too great when you have bets in the energy and industrial metals sectors. Many stocks were down as much as 6 percent yesterday alone. Despite the huge moves we've seen dating back to last year, the combination of strong fundamentals and low valuations continue to explain my bullishness.
Commodities are cyclical, and one day the party will certainly end, however I think the bull market in energy and materials still has ways to go. Really, it's simple supply and demand. Even at today's elevated prices, demand worldwide should remain strong. On the supply front, there is no reason to believe the world is going to all-of-the-sudden find lots more oil. Metals such as copper and gold take years to be mined, and unmined supply is fairly limited as well.
The stocks will always be very volatile, as a one-year chart of any company in the sector will show, but I can't help but think sell-offs like the one we saw Tuesday are opportunities for those who have yet to jump in.
Take Anadarko Petroleum (APC) as an example. Late Monday, the company reported earnings of $3.88 per share on sales of $2.25 billion, easily surpassing estimates of $3.35 and $2.09 billion. In fact, actual results even beat the highest printed estimate on the Street ($3.77/$2.23B). However, the stock fell more than $3 to $102 per share as crude oil prices dropped by a decent amount.
APC also announced a 2006 capital expenditure budget of $4 billion versus $3.4 billion in 2005. Production growth is expected to be in the 4-8 percent range this year. It's not just an oil price story, but production is growing too.
After seeing last quarter's results, I have no reason to think the highest 2006 estimate coming into that report, earnings of $15.73 per share, is unattainable. That would put the stock's forward P/E at 6.5x. Most investors will tell you such a multiple signifies peak earnings, and they'd be right. Price-earnings ratios are always lowest at cyclical tops and highest at cyclical bottoms. The bullish case for Anadarko centers around the idea that 2006 might not be the top.
If China and India continue to grow as a percentage of the world economy, and other nations follow their lead, oil could reach at least $100 per barrel by the end of the decade. That might not happen, but I think it very well could, and the odds of $30 oil anytime soon are very, very low. Energy and materials represent 10% and 3% of the S&P 500, respectively. I think investors should be overweight these areas for the next several years.
Disney's Pixar Buy Looks Even Better
Investors might have been worried when Disney (DIS) announced it would shell out $7 billion for Pixar. However, not only does the animation studio have $1 billion cash on its balance sheet, but Disney announced Monday that it is selling radio station assets to Citadel for $2.7 billion. All of the sudden, DIS only has to cough up about $3 billion of its own money to fund the Pixar acquisition.
Swapping terrestrial radio for a piece of Pixar seems to make sense. By ridding itself of huge licensing payments, Disney should reap much fatter margins on future animated hits. Combined with strong earnings just reported, do recent events make Disney stock a buy?
While Bob Iger's moves seem to be the right ones, DIS shares don't look like much of a bargain. Paying 17 times forward earnings for DIS looks steep to me. Plus, the company's dividend yield is a paltry 1.1 percent, far below the S&P 500's yield. Investors hoping for great things might be disappointed, but at least the company is making moves.
Is Merrill Lynch Serious?
Merrill Lynch (MER) is changing the name of its mutual fund group to Princeton Portfolio Research and Management later this year. Now this might seem strange on the surface, just because as far as name recognition and brand awareness go, I would think investors would choose to invest with Merrill over Princeton. Maybe that's just me.
The part of this story that really got a laugh out of me was Merrill Lynch's reasoning for making the change. In essence they think a new brand will make it easier for them to gain market share in the retail mutual fund business. Their concern is that brokers and financial advisors with other major firms have avoided offering Merrill Lynch funds because they see it as giving business to their competition.
That seems like a very valid concern. I can't see many Morgan Stanley and Goldman Sachs brokers trying to sell Merrill funds to their clients. But isn't it hilarious that they think changing the name will help this problem? Do they think retail brokers are just going to start blindly recommending this new fund family without looking into them at all?
So they'll do a little research to find out exactly who these "Princeton" folks are, and they'll learn, if they haven't heard already, that it's the old Merrill Lynch fund family. And we're back to square one.
Side notes:
Amazon (AMZN) is getting hit by $4 today after earnings. As much as I like Legg Mason's Bill Miller, I really don't know what he likes about this stock. All I see is a perennial 40+ forward P/E, decent but not overly impressive sales growth, and very low margins (not much better than Borders and Barnes and Noble as was once predicted).
OccuLogix (RHEO) is down more than $9 in the pre-market, to $3 per share. The only reason I even know about this company is because I recall Cramer pumping it on his Mad Money show. Evidently their product showed no difference versus placebo. How he can suggest to average investors that they buy something this speculative on national television is beyond me. Maybe a 75% haircut in a single day will help viewers understand what he is doing. I still have not exactly figured out his motivation (and/or conflicts of interest) in pumping the small caps he does, but I suspect the answer is not comforting.
Google and Wall Street Finally Converge
After picking up some Google (GOOG) shares yesterday afternoon as the stock plummeted from $430 to $350 on word of their disappointing earnings report, I just sold those shares, and all others I own for myself and for my clients, at $400 per share. Think of it as wanting to go out on top after a great trade.
The case can be made that Google should be held at current levels. Inclusion in the S&P 500 will be upcoming, and word is that the company will be announcing several large distribution deals with large, popular content providers in coming months. There will be positive catalysts after last night's shocker.
After all, if Google gave quarterly guidance like other firms, investors and analysts would not have been surprised with a headline EPS number of $1.54 per share for Q4, because they would have known where tax rates were going to be. The business is still solid, taking market share and expanding into new areas. Last night's report did not show that fundamentals have deterioriated. Rather, growth is simply slowing down due to the law of large numbers. That is the bullish case.
However, these are not the reasons I have owned the stock since $170 per share. The "value" I saw had to do with the fact that the Street didn't fully understand what the earnings power of the company's search franchise was. If investors knew Google could earn $8 or $9 in 2006, their IPO in August 2004 would never have been priced at $85.
Last night's report showed me that Wall Street is no longer underestimating Google's growth outlook. Earnings, adjusted for the tax rate increase, were a few cents above consensus, but below the highest printed estimate. Revenue came in right at the estimate. Upside from domestic search appears limited from here.
Does that mean the stock is done going up? Not necessarily. Google is investing huge amounts of money in international operations and new products outside of core search. The potential is huge, and they have the money, the people, and the momentum to conquer new markets. The next task for Google is to monetize these other products. Can they make decent money with Gmail, Google Video, Google Earth, Google China, Google Images, and the many other areas we are speculating they will enter?
Nobody knows for sure. Bulls on the stock believe they can. However, just because they are in position to do so does not mean they will. If they can monetize these product lines, growth will continue and the stock could very well go a lot higher. However, it is not as clear to me that this will happen, at least not as clear as it was that GOOG was too cheap at $170 per share.
Google is trading at 45 times this year's projected earnings. The issues the company addressed last night (growth deceleration in search and massive spending on international markets) could very well result in more earnings disappointments in the near term.
The risk-reward outlook seems to be less compelling to me today. Maybe that will change in the future if we get another quarter or two of disappointing earnings, or if other product lines boom, but right now I'm content with selling at $400 and seeing how it all plays out.
Google Drops $80 in After Hours Trading
The headline numbers at Google (GOOG) were $1.29B in sales and $1.54 EPS, versus expectations of $1.29B and $1.76. The stock just opened down $80 to $350 in the extended hours session. The reason for the EPS miss was a higher tax rate (41.8%) than what most people expected (26%-30%). Had the rate been in-line with estimates, EPS would have beat consensus by a few cents. The company said it expects a 30% tax rate in 2006, so it could be a one-time hiccup and not that big of a deal. I am going long a little stock into the conference call, thinking that the initial reaction might be too violent to the downside after we hear what they have to say. It should be interesting.
Cramer Pump Sends NMTI Up 34% After Hours
Nothing really surprises me anymore, but today's action in NMT Medical (NMTI) is absolutely ludicrous. NMTI is a micro cap medical device company that closed today's regular session at $17 per share.
Tonight on CNBC's Mad Money show, Jim Cramer led off the hour-long episode by recommending NMTI, saying it could go to $100 if their new migrane product is approved. If the trials fail, his downside projection was $10 a share. Given the risk/reward he sees, Cramer pumps the stock for several minutes and the stock quickly jumps over 33%, or $6 per share, to $23 and change.
The reason I bring this up is because NMT Medical is one of 10 stocks featured on Peridot Capital's 2006 Select List, published earlier this month. Thanks to many individual investors who were silly enough to put in a market order to buy, simply based on Cramer's recommendation, I was able to sell a decent chunk of stock at between $23.09 and $23.75.
First of all, if you purchased our 2006 Select List and are lucky enough to be holding shares of NMTI right now, I strongly suggest taking some profits tonight in after-hours trading, or on Monday if the mark-up holds early next week. There is no fundamental reason for the stock to be up at all, let alone more than 30 percent.
It is true that the company's devices could be a huge hit if they prove effective, but human trials have not been completed. This stock is very speculative, as was noted in our report, and is not for every investor. In fact, we tabbed it the lone "speculative pick" in the group of 10 companies we profiled in the report. Please trade with caution, especially if you are a fan of Cramer's show. These are very dangerous waters for retail investors.
Another interesting twist is that NMT, not NMTI, spiked $5 during Cramer's show, as investors bought the wrong stock with a similar ticker symbol. NMT is a municipal bond fund that closed at $15, but some people paid $20+ for it in after-hours trading. Another example that if you're not careful, you can lose 25% of your money on a trade within minutes.
Legg Mason's Miller Understands the Game
Bill Miller, manager of Legg Mason Value Trust (LMVTX), has done something that no other fund manager can claim. Since taking over sole management of the fund, he has beaten the market each and every year, for 15 straight years. Is he just lucky like some efficient market supporters would claim? Or does he know something that others don't?
The answer is neither. Markets are not completely efficient. All they do is incorporate the consensus view of investors and use that to arrive at a prevailing market price. The conventional wisdom is collected in an efficient manner, but such wisdom is wrong more than it is right. Every quarter when public companies report their earnings, about 70 percent will either miss or exceed the consensus estimate.
Miller's most recent letter to shareholders outlines his strategy. His ideas will seem reasonable, logical, perhaps even obvious to many. However, when we look across Wall Street we see very few who put them into practice. Which begs the question, why?
People ask me all the time what my philosophy is, my approach to investing. These are the concepts investors must grasp to be good at what they do, before you even begin to look at an industry or a specific company's stock. Many individual investors choose to buy what they know, what they like. Many financial advisers at your big name retail brokerages recommend them as well. That can end very badly, for many of the reasons expressed below. These are excerpts from the letter.
"Unfortunately, when we purchase companies we believe are mispriced, it is often difficult to determine when the market will agree with us and close the discount to intrinsic value. Our goal is to construct portfolios that have the potential to outperform the market over an investment time horizon of 3-5 years without assuming undue risk. If we achieve that goal, we believe we will be doing our job, whether we beat the market each and every year or not."
"The most common error in investing is confusing business fundamentals with investment merit. A company that is doing terrifically well, that has great management and returns on capital, and great products and prospects, may be a terrible investment if the expecations embedded in the current valaution are in excess of those fundamentals. A company with poor business fundamentals, a mediocore management, and indifferent prospects may be a great investment if the market is even more pessimistic about the business than is warranted. The most important question in investing is what is discounted, or put slightly differently, what are the expectations embedded in the valuation?"
"Systematic outperformance requires variant perception: one must believe something different from what the market believes, and one must be right. This usually involves weighting publically available information differently from the market, either as to its magnitude or its duration. More simply, the market is either wrong about how important something is, or wrong about when that something occurs, or both."
Changing My Tune on Blockbuster
Many of you may recall my negative piece on Blockbuster (BBI) back in August. At the time the stock was $7 and looked pricey given an extremely competitive business environment and a horrendous balance sheet.
While I still believe video-on-demand is the future, and online DVD rental services are not the answer to BBI's profit woes, the stock's swoon to $3.85 as of today's close signals to me that much, if not all, of the bad news has now been fully priced in.
While a turnaround will not be easy, the company's stores clearly have some value. Blockbuster's creditors have been very lenient with respect to possible violations of debt covenants, so bankruptcy in the short-term does not appear to be an issue.
Would I go long now that the stock has dropped 45 percent and could rebound to a decent level? It's not at the top of my list by any means, as there are many better, safer values to be had.
That said, most of the bad news seems to have played out, so short sellers may be wise to take their hefty profit and move on to something else.
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