Just as I was readying a blog posting concerning the $50 jump in Google (GOOG) shares since news hit last week that the Internet search giant would be added to the S&P 500, the company beats me to the punch. I was going to point out that the more than 15 percent jump in Google stock was based solely on index fund buying, and therefore upward pressure would likely dry up next week. I was even considering a small short trade in my personal account. Looks like Google beat me to the "sell" button.
Wednesday afternoon we hear that they plan to sell 5.3 million shares of stock, in part to accommodate index fund demand. Don't let this announcement fool you. These Google guys (and gals) are very smart. What better time to announce a big share offering than right after your stock has moved up more than 50 points without any fundamental change in business prospects?
Whether the offering halts the S&P 500 related rise or not we'll just have to wait and see, but don't think for a second this announcement is coming out of the goodness of Google's heart to help some index fund managers out with extra shares. They're just looking to cash in on the S&P 500 inclusion like everybody else.
Shareholders Sue No Matter What
From the Chicago Sun-Times:
Judge OKs lawsuit by those who lost money during Kmart takeover
A federal judge in Chicago has given the green light to plaintiffs who charge that Sears Chairman Edward S. Lampert and former Sears CEO Alan Lacy failed to tell shareholders they were plotting Kmart's takeover of Sears Roebuck and Co.
The plaintiffs making the complaint sold their Sears stock between Sept. 19 and Nov. 16, 2004, and lost out on a spike in Sears' share price that occurred when Kmart and Sears announced Nov. 17, 2004, that Kmart would acquire Sears.
U.S. District Judge Robert W. Gettleman ruled that the aggrieved shareholders cited sufficient facts so they can try to prove that Lampert and Lacy violated securities laws by failing to fully disclose their negotiations.
The shareholders allege that Sears, with Lacy's knowledge, was repurchasing shares at what they contend was an artificially low price, effectively increasing the interest of Lampert's hedge fund and making Kmart's takeover of Sears easier.
Now not only do we have shareholders who sue when stocks they own take a tumble, we also have those who sue when stocks go up after they sell? Lawsuits in this country are really getting out of hand. Let's go through a few reasons why this story is ridiculous.
First of all, the headline doesn't even make sense. You can't "lose money" on a stock you no longer own. Missing out on profits and losing money are not the same thing. If you thought about buying a Powerball ticket when the jackpot hit $200 million but decided not to, you didn't lose out on a chance to win the lottery. You simply chose not to play.
The basis of the lawsuit is that Kmart management failed to disclose they were in merger negotiations. What company in their right mind would disclose this? As soon as news of such talks hit, Sears stock would have rallied, raising the price Kmart would need to pay. This would hurt Kmart shareholders, not help them, making the deal less attractive financially. Arguing somebody broke securities law by not disclosing buyout negotiations, which could easily have broken down, is preposterous.
They go on to say that Sears was repurchasing stock at low levels to make Kmart's takeover easier. There would be no reason for Sears to do this, it would not have a meaningful effect. Sears stock was cheap. That explains why Sears was buying back shares and why Kmart was interested in a business combination. That is just a good use of capital by both sides. Shareholders of both Sears and Kmart should be happy about that. In fact, the reason the stocks soared once news of the merger broke was because it was perceived as such a good move. Both retailers were struggling and this was seen as a way to get smaller, leaner, and more profitable.
Current Sears Holdings shareholders need not be worried. This Chicago Sun-Times article is the second I've read in recent days that sharply criticizes and questions the current retailing strategy of Edward Lampert and company. As long as people are still negative and focused on retail strategy and not economic value, I'm happy to be a shareholder of Sears Holdings.
Bernanke Era Begins
Just how different will today's Fed meeting be compared with those of former FOMC Chairman Alan Greenspan? Will the Fed's all important statement be a lot more clear and straightforward, or will it be only slightly tweaked from those used over the course of the last several years? These are the questions investors and economists are eagerly anticipating getting answers to as we await the outcome of Ben Bernanke's first meeting as head of the FOMC.
I think the wording might be slightly different under Bernanke, but those looking for bold shifts in policy wordings might be disappointed. We will get a 25 bp hike today, but where do we go after that? Will 4.75% be the end, or are we going to 5.00% or 5.25%? I think the case can be made that 4.75% is enough. Surely anything above 5%, given the current economic climate, will spook many investors.
Most importantly, what does this mean for the stock market? The market has been acting very well lately, and in my mind that signals we are pricing in the end of the rate hike cycle. If that's the case, those expecting a huge rally when the Fed does get around to stopping will likely be met with sellers looking to book the gains earned in recent months.
An Apple To-Day?
I've been out of Apple (AAPL) stock for the entire run over the last couple of years. I looked at it many times back then given its insanely low valuation but never liked the business. They had half the market cap in cash on hand with no debt, but I never could figure out what the catalyst might be.
Then the iPod happened and the run began. Two years later the stock is 600% higher, hitting a high of $86 in early 2006. I haven't chased the stock on the way up, but for the first time in a long time AAPL shares appear reasonably priced. In case you haven't noticed, the stock is down 30% from its high to a current $60 per share.
Current earnings estimates stand at $2.25 for 2006 and $2.75 for 2007. With $10 per share in cash and no debt, investors are getting the business for 22x current year profits. Looking out to 2007 the P/E drops to 18x. If any of you are out there wishing you hadn't missed the run, the stock is down 26 points from its high and looks appealing if you think growth will continue for some time.
Lagging Fidelity Fund Seeks to Change Benchmark
In the latest example of how mutual fund companies couldn't care less about their long suffering shareholders, consider Fidelity's recent announcement that it will be recommending its Blue Chip Growth Fund (FBGRX) change its benchmark from the S&P 500 index to the Russell 1000 Growth index.
As soon as I read about the proposal I knew a little research would yield some interesting findings. Sure enough, the Fidelity Blue Chip Growth fund has trailed the S&P 500 for six straight years.
In the real world such pitiful performance would result in the manager of the fund getting fired. But who are we kidding? The mutual fund world is nothing like the real world. Fund managers hardly ever get canned, even though 80 percent of them fail to beat their benchmark. So what does Fidelity decide is the proper course of action? Well of course, change the benchmark!
You guessed it, the Russell 1000 Growth index has lagged the S&P 500 over the last five years, so the switch will make it look like Fidelity Blue Chip Growth has done better than it actually has. Interestingly, the fund has also lagged the Russell 1000 Growth index over the last five years, just not by as wide a margin as it has the S&P 500.
Alright, so maybe you're thinking I'm being a little too cynical here. Maybe the Russell 1000 Growth index really is a better benchmark for this particular fund, based on the companies it invests in, and therefore such a change can be adequately defended. I admitted that was a possibility, so I did a little more digging. If Fidelity Blue Chip Growth is really quite different from the S&P 500 index, I'll be happy to get off their backs.
The top five largest holdings of the Fidelity fund are Microsoft, GE, Johnson & Johnson, AIG, and Intel. Sounds like the S&P 500 to me. What did I find when I peaked at the Vanguard Index 500 fund (VFINX), the largest S&P 500 index fund in the country? GE is the fund's 2nd largest holding, followed by Microsoft at #3, Johnson & Johnson at #5, AIG at #8, and Intel at #10.
Let me throw one more statistic out there that I find too amazing to ignore. In case it was just the largest holdings of Fidelity Blue Chip Growth that overlapped almost exactly with the S&P 500, I decided to look at the market cap of the fund's average holding versus the average market cap of the S&P 500 index fund. Guess what? They're exactly the same... $46.9 billion versus $47.1 billion!
And yet Fidelity is trying to get away with saying they think the S&P 500 isn't a good benchmark for the fund? Investors should not tolerate this. Unfortunately though, most of them probably have no idea it's even going on. Fortunately, that's one of the purposes of this blog.
Capital Depreciation
Shares of Capital One (COF) are continuing to fall after news of their nearly $15 billion bid for North Fork Bank (NFB). After hitting new highs at $90 per share, COF stock has dropped more than 10 percent to $80 and change. This sell-off is exactly what we saw after the company announced plans to buy Hibernia a year ago. History tends to repeat itself, and this instance should reinforce that view. Patient buyers will be well rewarded once the deal closes and investors realize how strong of a move it was. Momentum traders and merger arbs are causing longer term investors such as myself to salivate at the stock's current price.
Another Blowout Quarter at Sears
Long time readers of this blog know that I've been bullish on Sears Holdings (SHLD) for a long time. I've repeatedly made the case that bears focusing on same store sales were missing the point. Chairman Eddie Lampert's strategy with prior retail endeavors, as well as with Sears Holdings, has been to not focus on overall sales, but rather on profitable sales.
Sears' financial results have shown that this strategy is coming to fruition, but the bears have been winning with SHLD as of late. In fact, the stock has been amazingly range bound for months, hovering between $115 and $125 per share, as the chart below shows. Despite the pattern of higher than expected profits, the stock has been stuck. It manages to open higher after posting quarterly results, only to see the gains vanish by the end of the day.
This morning Sears reported fourth quarter earnings of $4.03 per share, 41 cents ahead of estimates, which stood at $3.62. Again we see the stock rallying in pre-market trading, rising $9 right now to $126 per share. If the recent past repeats itself, the stock won't hold those gains and will continue to trend in its narrow trading range. This result would not be surprising if we continue to hear about falling sales.
However, I am still holding out hope that today's gains hold and we get a breakout above $125. It's amazing to me that the company is purposely trying to reduce sales by only selling products that they can earn a profit on, and yet when they deliver such results, people complain of market share losses.
Investors need to realize that over the long term earnings drive stock prices. If sales were all that mattered, not profits, then the Internet bubble never would have burst. Consider how many dollar bills I could sell if I only charged 95 cents for them? My sales would great, sure, but my stock would be worthless without profits.
Capital One Gobbles Up 2nd Bank in North Fork
Given that Capital One Financial (COF) recently closed its acquisition of Hibernia, I was a little surprised to see that they are buying New York based North Fork (NFB) so soon after. Also interesting was the fact that news of this deal did not leak out whatsoever ahead of time. In case you missed it (I didn't given that COF is a long-time Peridot holding), Capital One stock was up $4 on Friday to an all-time high.
Given that merger arbs will be shorting Capital One stock to play the deal out, we will likely see some of that huge gain given back this week. The stock is down $5 in pre-market trading. Nonetheless, COF management continues to execute on their strategy and shareholders will likely continue to reap the benefits. The NFB deal appears to be a good one for everyone involved. NFB holders get more than a 20 percent premium to Friday's closing price, and yet COF is only paying 1.6 times book value, which is hardly considered high in the world of bank buyouts.
NYSE Investors Beware
Before you get caught up in the hype and go out and buy shares in NYSE Group (NYX), I urge you to do some basic valuation work. Shares of NYX, the newly formed public combination of Archipelago and the New York Stock Exchange, opened at $67 per share yesterday and proceeded to close at $80. Today the stock is up another $6 at the open. Current market value at $86 per share: $13.6 billion, based on 158 million shares outstanding.
The reason for the rise has more to do with limited supply than anything else. Retail investor interest has been strong so far, and there simply aren't many shares available to buy. Much of the stock is being held by NYSE seat owners and member firms, who can't sell it right now. A supply-demand imbalance is causing a short term spike, but a closer look at the company's valuation makes it clear that anyone paying $86 is playing with fire.
Keep in mind that Archipelago (AX) stock traded at $17 before the merger with the NYSE was announced last year. The combination has resulted in a 400% increase in the value of that equity (AX shares became NYX shares beginning yesterday). I don't doubt the deal will be accretive, but isn't 400% a bit extreme?
AX was expected to earn $1.11 per share in 2006 before the deal closed. Even if that number winds up being $1.50 after the merger (a VERY optimistic projection), the current forward P/E of NYSE Group is 57 times. Buyer beware.
Buffett Record is One Thing, Outlook Quite Another
Before you go out and buy a stock simply because Warren Buffett either has owned it for a long time or recently purchased it, consider the following quote from his letter to shareholders, released yesterday."
Expect no miracles from our equity portfolio. Though we own major interests of a number of strong, highly-profitable businesses, they are not selling at anything like bargain prices. As a group, they may double in value in ten years. The likelihood is that their per-share earnings, in aggregate, will grow 6-8% per year over the decade and that their stock prices will more or less match that growth."
What should investors gleam from this statement? Should they take it at face value, or just assume Buffett is being modest and trying to keep expectations low so he can exceed them more easily? If you are one of the many people who have asked me about my views on some of his larger holdings in recent months, you already know where I stand on this issue. Take what Buffett says as the truth. His days of drastic outperformance are long over.
Consider Berkshire Hathaway's performance in 2005; up 6 percent using the metric Buffett prefers. That compares with 5% for the S&P 500 with dividends reinvested. A solid year, but hardly something that one should bend over backwards to mimic. It also is right around the 7% estimated growth rate he offered in his letter.
Consider Berkshire's largest holding as of December 31st; more than $8 billion dollars of Coca Cola (KO). Coke stock has been dead money for 10 years, even as the S&P 500 has nearly doubled, as the chart below shows.
I will repeat here what I have told those who have asked. I would not expect shares of Berkshire, or Coca Cola, or Anheuser-Busch, or Wal-Mart, or Proctor & Gamble, or Washington Post, or any of Buffet's other large holdings to make you rich from here on out. They were all great buys at some point in time, say 15 or 20 years ago, but now they are richly priced, even as growth prospects have diminished greatly as they have grown into industry behemoths.
Why then does Buffett continue to hold these stocks, even if he only expects them to return 7% per year? The answer lies in the fact that he has said his ideal holding period for a stock is "forever." If I was to argue with Buffett on one aspect of his investment philosophy, that would most likely be the one I would choose. Holding a stock "forever" will ensure you own it during both the good times and the bad times. The latter is something investors should strive to avoid.
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