Circuit City Bankruptcy Is Great News For Competitors

A week after announcing it would close 20% of its stores, electronics retailer Circuit City (CC) has announced it will file for Chapter 11 bankruptcy protection. While that really is no surprise (retailers can't operate in the red forever), investors should consider who wins from this development.

The most obvious choice is Best Buy (BBY), the leader in the space. Although CC is a weak player, there are many places where Best Buy and Circuit City locations are very close to each other. Given the store closings, plus the stigma of Chapter 11 with the stores that will remain open, BBY should see some incremental benefit. BBY trades at 8-9 times earnings, quite a low price for the best managed consumer electronics retailer.

Full Disclosure: Peridot Capital was long BBY at the time of writing, but positions may change at any time

With Share Prices Depressed, Dividend Yields Highest Since 1994

During the last couple of decades dividends have not really been a core focus for investors. That has been partly due to the fact that companies have been paying them out at historically low rates. Did you know that over the very long term dividends have represented about 40% of an investor's total return in the equity market? With the average large cap dividend rate below 2% for much of the last decade or two, many investors probably were not aware of that.

With stock prices down so much in the last year, dividend yields are creeping back up. The indicated rate on the S&P 500 today is about 2.8%, the highest since 1994 when the index was paying out 2.9%. We are still below the historical average for payouts (about 4%) but the trend is in the right direction.

I bring this up because as contrarian value investors add fresh funds to their portfolios and hunt for bargains in this market, dividends could very well play a bigger role than they have in recent years. Getting paid to wait for stock prices and the economy to recover (by collecting meaningful dividend payments along the way) is another way for investors to capitalize on the value in this market.

During the most recent bull markets, a yield of 3% was considered pretty darn good, but now investors can find much better payouts and do not always have to sacrifice the quality of company they invest in to secure above-average dividend yields. As you search for value during this bear market, keep in mind that dividends can significantly boost total equity market returns and such yields are getting easier to find nowadays.

Why An Obama Victory Does Not Foretell Economic & Market Gloom

I rarely blog about politics here, but it is very difficult to get the full truth (from either party) during a presidential campaign. Since I started this blog in 2004 I have commented once each election cycle on a certain lie that always makes the rounds before we head to the polls. Most of you have probably heard from partisan people that an Obama victory tonight would kill the economy and the stock market. After all, isn't it true that Democratic administrations are known for taxing and spending, which wrecks our country's economy?

One of my favorite quotes goes like this, "Numbers don't lie, people do." It fits perfectly here, as the numbers provided below will show. The truth is, most meaningful economic statistics (GDP growth, unemployment rate, inflation rate, growth in federal spending, budget deficit level, to name some of the big ones) have historically been stronger under Democratic presidents than Republican ones. You can refer to my October 2004 post entitled "Do Elections Affect the Stock Market?" for the detailed statistics.

As goes the economy, so goes the stock market. This is not only a recent trend (8 years under Clinton, market up 203%, 8 years under Bush, market down 28%). According to Ibbotson Associates (a market research firm), inflation-adjusted stock market returns have been 100% higher under Democrats since 1926:

I point this out not to insist that an Obama presidency assures the market will be strong, but simply so investors know the truth, in case they are partly basing their vote for president on economic data. It is important to note the common statistical mantra "correlation does not equal causation." These numbers do not mean that a Democratic president causes the market to go up twice as much as a Republican president (it could be any number of factors, or a combination of them). What it does mean, however, is that the common contention that the economy and stock prices do better under Republicans is actually completely backwards.

Regardless of historical statistics and putting your political allegiances aside, remember one thing. It's your right to vote, so be sure to go to the polls today if you haven't voted already.

Why Perma-Bears Are Coming Out Of Hibernation

Well, aren't you glad October 2008 is over? After all, the 17% drop in the market was the worst month in 21 years (Crash of 1987). Given the tremendous drop in stock prices, we are beginning to read about many perma-bears who have turned bullish, which is quite a good sign for investors (this week's Barron's includes an interview with Steve Leuthold of Leuthold Group, another so-called perma-bear who is bullish on stocks).

First, what is a perma-bear? The nickname has been given to investment strategists and managers who seem to be permanently bearish. Why do they rarely sing the praises of the stock market's prospects? Did they have a bad experience and simply have yet to get over it? Hardly.

Actually, perma-bears do turn bullish every so often, it just takes a lot for that to happen. The reason is because perma-bears typically only want to invest heavily in stocks when prices are extremely cheap, typically in bear markets. You see, outsized market returns are attained the easiest when prices are depressed, so perma-bears are more than willing to forgo owning stocks in size until prices are dirt cheap. As a result, they are not bullish very often because bull markets last far longer than bear markets and economic expansions last far longer than recessions.

Since investing when stocks are dirt cheap is a proven winning strategy, why do perma-bears get so much heat? Well, the simple explanation is because since the first stock market opened for trading, in any given year stocks have risen about 80% of the time. So, if four years out of every five are going to see stock prices go up in value, perma-bear detractors would argue that only investing during the depths of bear markets, while a profitable strategy, misses out on many years of market gains.

Fair criticism? Sure, but it depends on your viewpoint. Proponents of long term investing would argue that one would be better off not trying to time the market and accept that during any five year period, they expect to make money during four years and lose money during one. Statistics have shown that strategy pays off handsomely over the long term.

Perma-bears are a little more difficult to please. They realize that the average bear market results in a 30% loss, and such a hit requires a 43% rise just to get back to where they were before the drop, so they prefer to try and avoid such a painful decline, despite it being temporary in nature. By only investing when stocks are dirt cheap, they are able to reduce the chances they incur sizable losses. As a result, the perma-bears missed much of the last bull market (stocks rose for four straight years heading into 2008, just as market history would have predicted).

So, what should we conclude when the worst month for stocks in 21 years has resulted in several well-known perma-bears coming out of hibernation and recommending investors buy stocks? It means that for the first time in a long time, stocks are at the low end of their historical valuation range, which usually equates to an excellent buying opportunity. The perma-bears are getting another opportunity to come out of hibernation and play, which bodes well for all of us.

Insane Valuation Case Study: Valero Energy

It is pretty easy to find ridiculously low stock valuations in today's market, but here's an example of the value present in the current bear market. Valero Energy (VLO) this morning reported third quarter earnings of $1.86 per share, well above estimates. The stock closed yesterday at $15 per share, which gives it a P/E ratio of 8 based solely on one quarter's worth of earnings! Insane.

Full Disclosure: Peridot was long VLO at the time of writing, but positions may change at any time

Part of TARP Finally Ready To Go

In recent weeks there has been plenty of talk about the Treasury's TARP initiative, but little progress on its actual implementation. On Friday we got news that PNC Financial (PNC) was the first bank to get a capital infusion from the TARP, and would use much of the cash to help fund its acquisition of troubled banking competitor National City (NCC).

I have previously written highly of PNC stock and this deal only furthers my bullish long-term view on the company. They are paying about $2 per share for a bank that traded at nearly $40 last year and fits their geographical footprint very well. PNC's track record on successful acquisition integration is outstanding. As with the other strong banks buying weaker ones, loan losses will rise with the deals and that trend will continue for a while, but long term the buyers will only enhance their competitive positions in a marketplace that will have far fewer players overall when the dust settles.

Today we are learning about more banks raising capital through the TARP, Capital One (COF) and SunTrust (STI) among them. Don't be surprised if Capital One makes an acquisition in coming months as well. They have indicated they are looking at potential deals and have raised money twice in recent weeks.

Hopefully the equity market can begin to gain some traction as some of these plans are not just announced, but more importantly, actually implemented.

Full Disclosure: Peridot was long shares of COF and PNC at the time of writing, but positions may change at any time

Watch the 2002, 2008 Intra-Day S&P 500 Lows

The forced selling and mass liquidations are continuing, with the pre-market futures trading limit down this morning. October has always been the most volatile month of the year, and investment fund fiscal years end a week from today (as opposed to a normal December year-end).

Don't fool yourself into thinking the market action here is based on fundamentals, because everything we are seeing is simply irrational behavior based on forced selling. Buyers are balking because once things become irrational, there is no inherent floor to prices.

If you want to watch specific levels, the 2002 S&P 500 low was 768. The 2008 low so far was 839. The S&P 500 closed at 908 yesterday, and traded limit down (60 points) to 855 this morning. If we don't hold those levels, another round of computerized sell programs will likely hit the market. The support there should be strong, but in this market, who knows what will happen.

Update: 10:00am -- Here is a graphical representation of the last two decades:

Analysts Still Nuts With Their 2009 Earnings Projections

One of the reasons sell-side analysts on Wall Street are usually pretty bad at picking stocks is because they are reactionary, not anticipatory. Remember, the market is forward-looking, so what already happened is irrelevant.

Here we are, in a recession, and by most accounts the economy will stay bad well into 2009. And yet, the consensus estimate for 2009 S&P 500 operating earnings stood at $100.90 as of 10/14. That compares with a 2008 estimate of $75.94, which means the sell-side is projecting earnings growth next year of 33%. Absolutely nuts, right?

The problem is that analysts won't ratchet down their numbers until the companies actually come out and give specific 2009 guidance (they wait to be spoon-fed it, rather than anticipating it ahead of time like the market does). In such an uncertain economic environment, firms are uneasy about projecting earnings for this quarter, let alone next year. As a result, we have everyone on Wall Street well aware that 2009 earnings for the S&P 500 will be nowhere near $101 (hence the market has tanked), except the analysts won't tweak their official forecasts ahead of time.

Look, how long the bear market lasts will likely depend on how long the economy stays weak, but how far the market ultimately falls during the bear market will depend, in large part, to how far earnings fall. As you can see below, S&P 500 operating earnings peaked way back in 2006 before oil prices spiked and hurt many companies who have oil as a major input cost.

S&P 500 Operating Earnings:
2005A: $76.45
2006A: $87.72
2007A: $82.54
2008E: $75.94
2009E: $100.90

Obviously the 2009 number is crazy, but how far will earnings drop? The headwind is the recession we are facing, but with that we are seeing commodity prices come crashing down. That will help profit margins at most companies because their expenses will drop alongside their revenues.

Even if we see a recession during most of 2009, earnings might hold up better than some pessimists think. If that is the case, it should put a floor under stock prices next year, even if we hover along that floor for a while. So, the thing to watch is not whether $101 of S&P 500 earnings is doable in 2009 (it isn't), but rather if we can manage $70 to $75, which would make some of the more dire predictions of $50 or $60 overly pessimistic.

Surprisingly, Apple Shares Jumping After Bleak Guidance

I closed out the Apple (AAPL) position in my blog model portfolio in August at more than $180 per share after a 52% gain and also trimmed my clients' AAPL holdings at that time, but after the stock has been beaten up in the latest sell-off, searching for a re-entry point seems like a worthy endeavor.

Apple has always sandbagged guidance. The market had gotten used to it and never really punished the stock after earnings reports that handily beat quarterly earnings but issued forward quarter guidance below expectations. That all changed three months ago after Apple issued guidance that was overly conservative, even by their standards, and the stock got crushed.

Trading in the low 90's during yesterday's pre-earnings trading session, investors expected more of the same. Apple's guidance had been for $8.0 billion in sales and about $1.00 of earnings. The company actually reported $7.9 billion and $1.26. Analysts were at $1.65 for the current quarter and many figured Apple would guide to $1.30 or $1.40.

Given the uncertain economic environment, coupled with last quarter's overly conservative guidance, I figured this quarter's guidance would be equally uninspiring and investors would get a sell-off in the stock, perhaps well into the 80's, which in my view would be a great entry point. As a result, I did not buy any Apple shares during yesterday's weakness.

Apple guided this quarter to between $1.06 and $1.35 last night. Compared with current consensus of $1.65, this looked perfect for my thesis. Even if Apple beats its own guidance handily, there is little chance they will actually beat $1.65, so what would prompt the stock to rise?

Well, oddly the stock is up $8 in pre-market trading this morning to about $99 per share.
I guess the numbers could have been worse. Perhaps everyone who wanted to sell Apple has already done so. Still, I would not be a buyer up 8 points in a down market today.

Personally, I think a very conservative fair value estimate on Apple stock, in today's economy and market environment, is around $100 per share. I get there by taking 15 times net trailing operating earnings and adding in the company's huge $24.5 billion cash hoard. If the stock gives up today's early gains, Apple bulls should take a hard look at the stock, in my view.

Full Disclosure: Peridot was long shares of Apple at the time of writing, but positions may change at any time

Yes, Oil Demand Should Keep Growing

A few months back we had people calling for $150 and $200 oil, but now many people are saying $50 or $60 is not only possible, but likely. What a difference hedge fund liquidations and a recession can make. Is the oil bull market over, or just put on hold due to an impending global recession? My best guess is the latter.

Consider the charts below. They show crude oil consumption for this decade, with current 2009 estimates included. The first one shows oil consumption in the U.S. which isn't very impressive and screams lower prices. After all, we represent 5% of the world's population but consume 25% of the world's oil.

Not so fast though. Here is a chart of oil consumption worldwide. It shows a much different picture.

Will the current recession result in a reversal of this graph? Probably not to any large degree. The line will flatten surely, and perhaps even dip slightly, but by the time that happens any global recession will be mostly over and demand growth will be set to resume alongside economic growth. Long term I still think the oil bull market remains intact until we truly start replacing large amounts of oil consumption with alternative fuels.