Author Archive

  • Thoughts on Dell
    , November 11th, 2005 at 6:15 am

    Yesterday was D-Day—Dell reported earnings. At this point, Dell’s image among the financial media is somewhere between Kim Jong-il and thyroid cancer.
    If you recall, on Halloween Dell said it was going to report earnings of 39 cents a share, which was at the “low-end of expectations.” The media went into gleeful outrage and fell beneath the low-end of my expectations, which—let’s face it—is already pretty darn low. As for Dell’s stock, it promptly dropped 8% on volume of 105 million shares. Apparently, the low-end of expectations was…well, not expected.
    Speaking of low-end, that’s the rap against Dell. The company can’t compete in the market for cheap PCs. Plus, their sales growth is slowing, their customer service is horrible and they’re pursuing nuclear weapons. No wait, that last one I think is Kim Jong-il. But you get the idea.
    Over the last few days, I’ve gotten about 20 gabillion e-mails asking me why I’m not panicking over Dell. The easy answer is that panicking won’t make me any money. (I’ve tried it.) The other reason I’m not panicking is that there’s no reason to panic.
    The Major Concern right now is Dell’s slowing sales growth. For the last several quarters Dell’s sales growth has slowed down (or “decelerated” if you’re an analyst, or maybe a Vulcan). But slowing sales growth is not necessarily a problem.
    Here’s your investing lesson for today. When you’re looking at a company, the single-most important number is return-on-equity. Forget head-and-shoulders, forget bear traps and double bottoms, forget volume, forget stochastics. Return-on-equity tells you more than anything else about how well a company is performing. It’s the best measure of efficiency, bar none. In short, ROE tells us how much we get for how much we got.
    ROE can be deconstucted down into three parts (warning, math ahead). Profits margins, asset turnover and leverage. Think of it this way:
    Profit margin is profits divided by sales.
    Asset turnover is sales divided by assets.
    Leverage is assets (stuff you have) divided by equity (stuff you own).
    If we multiply them it will look like this:
    (Profits) (Sales) (Assets)
    ———- X ——-X——– = ROE
    (Sales) (Assets) (Equity)
    I pass the graphics savings on to you.
    The mathematically inclined will see that the two “sales” and two “assets” cancel each other out. And we’re left with profits divided by equity, or return-on-equity. See, easy.
    The beauty of ROE is that it works for every company. You can compare General Electric to a lemonade stand. A company like Wal-Mart may have a teeny profit margin (around 3%), but incredible asset turnover. Wal-Mart is really just one big inventory control machine. A financial company like Citigroup might have 15 or 20 times more assets than equity, but it generates only a few pennies of revenue for each dollar of assets.
    Everything here balances out. If you want to borrow more to increase your leverage, your interest costs will hurt your profit margin. Or, you can increase your asset turnover by lowering your margins. Doesn’t this just scream for its own School House Rock? (R-O-E for you and me!)
    Return-on-equity doesn’t lie, and it can’t be tricked. Earlier this year, General Motors generated huge sales growth with its employee discount. But it sacrificed its profit margins. The ROE never changed. GM just rearranged the equation. It turns out, GM still sucks.
    The other great thing about ROE is that it’s stable. Almost all financial stats can bounce around, but the ROE of a company tends not to change much from year-to-year. The only true way to improve your ROE is to become more efficient.
    The ROE of your average company is about 10%. The good ones are around 15%. Really good is 18%-20%. Yesterday, I talked about Patterson Companies. Patterson has had nine straight years of over 20% ROE. It could be longer—that’s as far back as my records go. For the last six years, Dell has averaged 40% return-on-equity.
    Now do you see why I give Dell the benefit of the doubt?
    For the third quarter, Dell increased its revenues by 11.3%. But thanks to a shift to higher-margin products, the company was able to increase its net margins. Dell isn’t getting beaten on the low-end. It’s changing its strategy so it’s not so reliant on the low-end. The ROE for was over 18% for last quarter alone. (I haven’t dug through the details, but it looks like Dell’s equity was hurt by a bad investment, which lowers the equity base.)
    So let’s look at the scoreboard. Dell’s stock is $13 off its high. Yet, if it hard earned two more pennies a share this quarter, no one would be complaining. Two pennies versus $13? So those marginal pennies had a P/E ratio of 650! Yes, I have no problem taking the other side of that bet.
    By the way, Dell grew its earnings-per-share by nearly 17% last quarter. This is the disaster we’re looking at? Now look at any old story from the last two weeks. We have “It’s Bad to Worse at Dell” from, where else, Business Week. This comes a few weeks after the magazine ran two anti-Dell pieces simultaneously. Every blackheart’s favorite story is: The King Is Dead.
    Maybe Dell is done for, but they have a funny way of showing it. My theory is that bad news sticks to them. And for now, I’m sticking with ’em too.

  • The Market Today
    , November 10th, 2005 at 4:37 pm

    Finally, a strong day for the market! The S&P 500 is at its highest level in two months. Our Buy List had a solid day across the board. While the S&P 500 gained 0.84%, the Buy List was up 1.82%. Twenty-three stocks were up and only two were down. Today’s big winner was Golden West Financial (GDW) which jumped 5.2%. We also got nice returns from Progressive (PGR) and Quality Systems (QSII).
    We got new highs from AFLAC (AFL), Fair Isaac (FIC) and St. Jude (STJ). Varian Medical (VAR) is oh-so-close to a new high. Commerce Bancorp (CBH) was downgraded by A.G. Edwards, but it still managed to close higher.
    Outside our Buy List, Intel (INTC) announced a huge $25 billion share buyback, plus a dividend increase. I’d prefer to see companies pay out dividends rather than buy its own shares. If investors want to buy more shares, that should be their choice. Companies should be in charge of operations; investors should be in charge of profits. Several companies are loaded up with cash. Cisco (CSCO) has $14 billion and Microsoft (MSFT) has nearly $50 billion. In fact, Wall Street was expecting a dividend from Cisco yesterday but the company balked.
    Today was also D-Day. Dell’s (DELL) earnings came out after the close. The Street hated its last earnings report, plus the company guided lower a few days ago. Every financial media outlet has pounded on the company, and the shares fell below $29.
    The company just reported earnings of 39 cents a share which was in line with its reduced estimate. Sales were $13.9 billion, slightly below expectations. For next quarter, Dell said it will earn between 40 and 42 cents a share, and revenue will be between $14.6 billion and $15 billion. The company is also buying back $1.7 billion worth of stock.
    The knock on Dell has been that it’s focusing on the high-end, while its competitors are hurting it on the low-end. I think these criticisms are very much over-rated. Kevin Rollins, the CEO, has said that Dell has to have a balance between the high- and low-end. Plus, margins are much better on the high-end.
    Lemme see…a record trade deficit is announced, the dollar rallied and 10-year bond had one its best auctions in years. Pardon me while I burn all my economics books. The bond market actually dragged the entire stock market higher.
    General Motors (GM) plunged to a 23-year low. The stock is lower than where it was when Ralph Nader took on the Corvair 40 years ago. Two other things to mention: Seeking Alpha has a great collection of conference call transcripts. Also, Booyahboy Audit is tracking Jim Cramer.
    Also, please feel free to e-mail me at eddy@crossingwallstreet.com. I’m going to start a regular Q&A feature on the Web site.

  • A Loophole for Hedge Funds
    , November 10th, 2005 at 3:31 pm

    Next year, hedge funds have to register with the SEC. Funds will also have to provide more information, plus they’re subjected to periodic audits. However, there’s one loophole that many funds are using.

    But the SEC’s rule only applies to advisors that permit investors to redeem their interests in a hedge fund within two years of purchasing their stakes. The agency concluded that the average “lockup” period for hedge funds is 12 months, so the 12-month period is the time frame covered by the rule.
    “We’re aware that some hedge-fund advisers are planning to extend their lockup period and we’ll evaluate the situation when we have a better picture of the situation in February,” said Robert Plaze, associate director of the SEC’s investment-management division. However, the SEC’s registration rule proved quite contentious, even within the agency, so in the near term it may be difficult for the SEC to adjust the rules to capture the lockup extenders.
    Some of the largest firms, like SAC, with $6.5 billion under management, and Kingdon, are in the process of instituting longer-term lockups. Others, such as Lone Pine, which manages $6.9 billion, aren’t open to new investors and don’t need to register. Citadel, a $12 billion firm, and Eton Park, which manages $3 billion, have always featured long-term lockups for the bulk of their money, so the SEC’s rules don’t apply.

    It’s difficult to regulate an industry that was created specifically to avoid regulation. The hedge funds will play every angle.

    “We have seen a rise in the number of firms asking for two-year lockups and the driver of that is probably the SEC requirements,” says Thomas Schneeweis, director of the Center for International Securities and Derivatives Markets at the University of Massachusetts. “If you can pull it off, let’s face it, you’d do it.”
    So far, the anticipated flood of new registered investment advisers has yet to materialize. An estimated 5,000 or so of the approximately 8,000 existing hedge funds aren’t yet registered. So far this year, however, new registrations average about 100 a month, according to SEC data, not much more than last year’s 80-a-month pace.

  • Industry Groups Over the Long Term
    , November 10th, 2005 at 2:52 pm

    Professor Ken French is a well-known finance professor at Dartmouth. At his Web site, he keeps an impressive data library. One of the items that I like to look at every few months is the how certain industry groups have performed over the long run. Here’s the annualized return for several industry groups for the past eight decades.
    Smoke 13.69%
    Beer 13.51%
    Banks 12.80%
    Drugs 11.93%
    Hardw 11.45%
    Aero 11.37%
    Oil 11.33%
    Food 11.28%
    Chips 11.22%
    Meals 10.99%
    Chems 10.91%
    Boxes 10.84%
    Fin 10.64%
    Mines 10.53%
    Rtail 10.49%
    MedEq 10.40%
    Autos 10.38%
    Mach 10.33%
    Insur 10.21%
    Coal 10.16%
    ElcEq 10.06%
    Other 9.95%
    Clths 9.83%
    Hshld 9.78%
    BldMt 9.67%
    Telcm 9.31%
    Books 9.23%
    BusSv 9.10%
    Util 9.08%
    Ships 8.97%
    LabEq 8.87%
    Fun 8.76%
    Steel 8.45%
    Trans 8.41%
    Txtls 7.94%
    Cnstr 7.91%
    Agric 7.83%
    Toys 7.45%
    Whlsl 5.54%
    RlEst 3.86%
    I guess vice is far more profitable than virtue, which I kinda suspected.

  • Broker Ad
    , November 10th, 2005 at 11:39 am

    Click here to see the worst broker ad ever (via Michael Covel).

  • Patterson Companies
    , November 10th, 2005 at 11:20 am

    One of the things I like about this blog is that it let’s me think out loud. For example, there’s one stock I’ve been following that I’m truly undecided about. The company is Patterson Companies (PDCO). It’s exactly the kind of stock I like. Steady earnings growth, high returns-on-equity and consistent operating history.
    The company makes supplies for the dental industry, and it’s a major supplier for the veterinary industry (don’t laugh, it’s very profitable). For several years now the company has grown its earnings by 20% a year like clockwork. To come up with an estimate for next quarter, all you had to do was add 20% to last year’s quarter, plus or minus a penny, then sit back and watch. The stock acted like a bond with a 20% coupon. Here’s the company’s earnings-per-share for the last 10 fiscal years:
    1996 $0.22
    1997 $0.25
    1998 $0.31
    1999 $0.38
    2000 $0.48
    2001 $0.57
    2002 $0.70
    2003 $0.85
    2004 $1.09
    2005 $1.32
    Not too shabby. There aren’t many companies like that. But then the bombshell came. In May the company totally and completely missed earnings. Wall Street was expecting 39 cents a share, Patterson made only 36 cents. That’s like Tiger Woods missing a three-foot putt. What the hell happened? The year before, Patterson had earned 33 cents a share. This was so…unexpected. The market freaked out and Patterson’s stock fell 14% in one day.
    Wall Street started to bring down its earnings estimates, and in August Patterson missed again! This time, the Street was expecting 32 cents a share compared with 30 cents the year before, but Patterson reported 31 cents. This couldn’t be happening!
    How could this happen for two straight quarters? I was baffled—plus, I could never understand the company’s explanation. It seemed that business was quite simply slower. Was this just a blip, or was there something bigger at work?
    I’m very suspicious of “blips.” I just don’t like them. I don’t consider myself a bottom-fisher, and I stay away from turnaround plays. Some companies do turn around, it’s just very, very, very hard. For every one Harley Davidson (HDI), there are ten Rite Aids (RAD). Patterson’s stock has continued to drift lower, and it’s now over 22% off its pre-bombshell high. But I’m still too afraid to go in. Yes, I know. Bock. Bock. But I just can’t pull the trigger.
    Earnings are due again on November 23 and I’m already sweating. Should I be this emotional about a stock I don’t even own? Last year, Patterson made 31 cents a share and said it’s expecting earnings of 35 cent to 37 cents a share for this quarter. I’m almost as afraid of a good quarter as I am of a bad one. If Patterson delivers great results, should I go back in? I just can’t ignore two lousy quarters. If the results are rotten, then the story is easy. The company just ain’t no good no more.
    But what if it’s a screaming buy and I’m not listening?

  • General Motors to Restate Earnings
    , November 10th, 2005 at 10:05 am

    Yesterday, it was AIG (AIG). Now General Motors (GM) is restating earnings from 2001. When it rains, it pours:

    General Motors said it would restate its financial results for 2001 by up to $400m because of accounting errors while losses for the second quarter of 2005 quadrupled after a revision of its holding in Fuji Heavy Industries.
    The world largest carmaker, which is already suffering from four consecutive quarters of losses and the collapse of its main parts supplier Delphi, said in a filing with the Securities and Exchange Commission that its 2001 earnings were overstated by $300 million to $400 million, but the final amount hasn’t been determined.

    It once was a giant. Here’s a chart showing the decline of GM’s credit rating over the past 25 years.

  • Expect Three More Fed Rate Hikes
    , November 10th, 2005 at 9:59 am

    William Poole, the President of the St. Louis Federal Reserve Bank, said yesterday that the Fed’s interest-rate policy ought to be “risk-averse.” That may not seem like a big deal, but in the carefully-worded world of central bankers, that’s considered to be going ape shit. I’m surprised Poole wasn’t taken down with a Taser.
    In English it means, or the market is taking it to mean, that the Fed is going to raise rates three more times. Until now, the market was expecting two more rate hikes—one on December 13, and another on January 31, which is also Greenspan’s last day. Now the market is also expecting another rate increase at the Fed’s March 28th meeting. That will bring the Fed funds rate up to 4.75%.
    Here’s a graph of the futures contract for the Fed funds rate for next May. You can see the spike around the time of Katrina when the market thought the Fed might put off its rate hikes. Even though that was just over two months ago, the market’s perception has since changed quite dramatically.
    Futures.png
    The 10-year Treasury bond is currently yielding 4.64%, so the yield curve could be slightly inverted in just a few months. The 30-year Treasury is yielding 4.82%. Actually, it’s a 26-year bond; the U.S. Treasury hasn’t issued a 30-year in four years. But thanks to budget deficits, they’ll be returning in February.
    The interest rate gap between the U.S. and Europe has been getting steadily wider, which has helped the dollar rally this year. Two straight weeks of rioting has also helped the greenback. On the other hand, the trade deficit surged to a new record in September. The trade deficit jumped 11.2% to $66.1 billion. The deficit with China was over $20 billion.

  • The Market Today
    , November 9th, 2005 at 5:45 pm

    The market closed its fifth straight boring-as-hell day. Not that I’m looking for excitement, but this is getting ridiculous. Let at these numbers: the Dow, +6.49 points, the Naz +3.74 and the S&P 500 +2.06. Of the 100 stocks in the S&P 100, 74 moved less than 1% today. This is like watching the WNBA. The VIX (^VIX) is now back below 13.
    Here’s something a little bit interesting. After an accounting scandal earlier this year, American International Group (AIG) restated its profits for the last five years. It turns out that the company had overstated its profits by $3.9 billion. Hey, those pesky decimals can be kinda confusing. Millions, billions, kilometers, it’s all one big blur. Well, now the company is correcting the correction. AIG says that it understated the previous correction by $500 million. That’s nice to know but something tells me this story isn’t quite over.
    Here’s a little tidbit from the Wall Street Journal on Hank Greenberg, AIG’s former Grand Poobah.

    When AIG executives traveled with him on business, they were required to use the small pilots’ bathroom in the front of a corporate plane. A large, fancy bathroom in the back of the plane could be used only by Mr. Greenberg, his wife and their Maltese dog, Snowball, according to a former AIG executive.

    A dog named Snowball? Wasn’t that Trotsky in Animal Farm? Or wait, that was a pig. But still, Snowball? The bathroom??
    Moving on, the Buy List had a decent day. We beat the market again. The S&P 500 was up 0.17%, and the Buy List was up 0.44%. Both Fair Isaac (FIC) and Expeditors (EXPD) hit new 52-week highs. Danaher (DHR), the tool company, reiterated its fourth-quarter forecast. I like to see companies do that around the middle of a quarter.
    Outside our Buy List, Cisco (CSCO) reported earnings after the close. I’m enjoying this because this is the first time Cisco is required to expense its stock options. Several tech stocks fought this regulation hard. Cisco regularly had its earnings inflated by about 20%.
    Just two months ago, Cisco was trying to get the SEC’s approval on a shady option-expensing scheme. Fortunately, the SEC shot them down. I always enjoyed hearing people on CNBC say that Cisco has a P/E ratio of around 16. Yes, by their accounting.
    For the quarter, Cisco earned 25 cents a share, 20 cents without options. Including options, the Street was looking for 24 cents a share. Starbucks (SBUX) just said that options-expensing will cost them about 9%.
    And finally, General Motors (GM) fell to another 52-week low as Delphi reported that its loss widened by seven-fold.

  • Investing Tips
    , November 9th, 2005 at 2:40 pm

    The worst investor in the world is the investor who’s down a little, and thinks he or she can make it back by doing something dramatic. This usually involves “doubling-down,” or using a lot of margin, but it usually winds up turning a small loss into a major problem. They delude themselves into thinking that a quick fix—just this one time—can correct the shortfall.
    When you’re down in an investment, you can’t let your emotions get the best of you. The first lesson is that the stock doesn’t know you own it or what price you paid. I often hear from investors who own horrible stocks but they refuse to sell because they “don’t want to book a loss.” The stock isn’t aware of your entry point. If it’s a good stock, then keep owning it. If it’s bad, then sell. It really is that simple.
    Here’s a chart of Expeditors (EXPD) going back 20 years. You can see that there’s never been a time that was “too late to buy.” And with many lousy stocks, it’s never too early to sell.
    expd.bmp
    Value is a relative. If Google‘s (GOOG) stock were to fall by $100 over the next few months, you’d hear people say that it’s cheap. No, it would be cheaper than it was, but it’d still be wildly overpriced. We all have different yardsticks, but good investors don’t toss theirs aside when it tells them something they don’t want to hear.
    The Wall Street Journal reported that a judge has frozen the assets of a hedge fund. The manager “admitted that he had lost a large amount of money in the fund and had deviated from its original investment strategy in order to make up for losses, the SEC said.” Even pros make this mistake.
    Just a few weeks ago, we saw Frontier Airlines (FRNT) plunge. I didn’t panic. I didn’t sell. I didn’t “double-down.” Instead, I waited. The storm passed, and we’re back where we were. This is why I love investing. As long as have a good strategy and high-quality stocks, sometimes the best thing to do is nothing at all.