Midday Market Update
Posted by Eddy Elfenbein on April 20th, 2010 at 11:40 am

Very solid gains this morning. The Buy List is up over 0.5% so far today. We’ve seen new 52-week highs from Sysco (SYY) and Fiserv (FISV). We’re still waiting on earnings reports from Stryker (SYK) and Gilead Sciences (GILD).
The S&P 500 has been as high as 1,205.65 today which isn’t very far from its pre-Fabulous Fabrice Tourre high of 1,213.92.

Goldman Sachs Earns $3.46 Billion
Posted by Eddy Elfenbein on April 20th, 2010 at 10:34 am

Another day on Wall Street, and we’re still talking about Goldman Sachs (GS). To reiterate, I don’t think Goldman is a good buy right now.
Goldman is still doing what it does best—making ridiculous amounts of money. Earnings for the first quarter nearly doubled to $3.46 billion. That comes to $5.59 a share which creamed Wall Street’s estimate of $4.14 a share.
Goldman has always been a bit of a black box so the Street’s earnings estimates can be wildly off the mark. Still, this is a phenomenon ally wealthy firm. The firm’s conference call was dominated by questions about the SEC’s investigation.
I remain unimpressed by the SEC’s case against Goldman Sachs. This seems to be a very well-timed charge especially considering that financial reform has taken center stage in Washington. We also just learned that the SEC dragged its feet on the Allen Stanford case for over 10 years. Furthermore, the SEC vote on the Goldman charge was 3-to-2, so even folks in the government see how thin this case is.
Bloomberg says that the Goldman case may come down to what the meaning of the word “selected” is.

The Securities and Exchange Commission must prove that the most profitable company in Wall Street history defrauded investors by failing to disclose that a hedge-fund firm betting against them played a role in creating what they bought. It must also counter Goldman Sachs’s assertion that an independent asset manager, which the SEC said rejected more than half of the securities initially proposed by Paulson & Co. for a collateralized debt obligation, signed off on the selections.
“The question is whether Paulson’s undisclosed role in portfolio selection was material,” said Larry Ribstein, a law professor at the University of Illinois in Champaign who has written about 140 articles and 10 books on topics including securities law and professional ethics. “There’s no clear and well-defined definition of what you have to disclose in this type of transaction.”

So the 90s was about the definition of “is” and this decade is about the definition of “selected.” Not sure if we’ve improved.

Johnson & Johnson Earns $1.29 a Share
Posted by Eddy Elfenbein on April 20th, 2010 at 9:58 am

Good news and bad news this morning from Johnson & Johnson (JNJ), one of our Buy List stocks. The good news is that the company reported Q1 earnings of $1.29 per share which beat Wall Street’s estimate by two cents a share. Woo hoo! Revenues rose by 4% to $15.63 billion which was a teeny bit better than expectations.
The bad news is that the company pared back its full-year EPS guidance due to foreign exchange rates. JNJ’s initial full-year guidance was a range of $4.85 to $4.95. They’ve pulled each end down a nickel to a new range of $4.80 to $4.90.
Truthfully, the bad news isn’t very bad. I’m never terribly worried about things outside a company’s control like foreign exchange. If they had experienced an issue related to their operations, that would have been one thing. Foreign exchange is one of those things you simply have to deal with. Sometimes it helps you, sometime it doesn’t. It’s a bit like playing against the wind in football.
The lowered guidance also includes the impact of Obamacare which JNJ pegs at 10 cents per share and a revenues loss of $400 million. Overall, JNJ is still trading at less than 14 times this year’s estimate which is less than the broader market. JNJ remains an excellent buy.

Roubini Vs. the Market
Posted by Eddy Elfenbein on April 19th, 2010 at 3:45 pm

Ekonomi Turk has a clever post showing the gain in the S&P 500 is aligned with the decline in Google searches for “Dr. Doom” Professor Nouriel Roubini. Click here to see the chart.

When you look at the graph, you will notice the negative correlation especially after Summer of 2007. The graph covers Aug 2006- Apr 2010 period. The last time Roubini’s popularity increased tremendously was March 2009. Since then Roubini’s popularity has been declining and the stock market has been increasing. I also ran a regression test and found that 1 unit increase in Roubini’s popularity is associated with a 114 point decline in S&P 500 index. His popularity was 5.5 in March 2009 and it is 1 now, so this implies that S&P 500 index should increase by about 114*4.5= 513 points since March 2009. Considering that S&P 500 was around 680 when Roubini’s popularity peaked the last time, our regression tells us that S&P 500 index should be around 1200 today.

Apple and Goldman — Together No More
Posted by Eddy Elfenbein on April 19th, 2010 at 11:16 am

For about 18 months, the share prices of Apple (AAPL) and Goldman Sachs (GS) followed each other pretty closely (though Apple has many more shares outstanding).

As recently as six months ago, both stocks had the same share price. Today, however, Apple’s stock is worth $85 more than Goldman.

Is Goldman a Good Buy?
Posted by Eddy Elfenbein on April 19th, 2010 at 10:34 am

In Tom Wolfe’s The Bonfire of the Vanities, the D.A. was known as Captain Ahab for his tireless search for the Great White Defendant. I can’t help but this of this when looking at the SEC’s case against Goldman Sachs (GS). This is a very convenient target coming at a very convenient time.
If the facts we have are correct, then Goldman should clearly be found guilty before a moral court. However, the actual legal case the SEC has seems shockingly thin. Even after several months, the case will turn on the materiality of John Paulson’s role in forming the Abacus portfolio. Furthermore, Mr. Tourre isn’t merely a small fry—he’s a micro-guppy.
The Wall Street Journal opines:

After 18 months of investigation, the best the government can come up with is an allegation that Goldman misled some of the world’s most sophisticated investors about a single 2007 “synthetic” collateralized debt obligation (CDO)? Far from being the smoking gun of the financial crisis, this case looks more like a water pistol.

My guess is that Goldman will end up writing a big check to make all this go away, say, about $200 million which would be around 40 cents a share for a company with a book value of $117. The damage to their reputation won’t be so easy to take care of.
Let’s look at some numbers: Goldman is probably on track to earn about $10 billion this year, give or take, which works out to around $18 a share (in their Annus mirabilis of 2007, they made close to $25 a share). Owning Goldman is almost like owning your own ATM—the cash just flies out anytime you want.
Using some mathematicification we can see that Goldman is going for around nine times earnings, and 1.4 times book value. Is that good buy? The stock is probably cheap but it’s definitely not a good buy. Looks can be deceiving. Sure, the SEC’s case may fall apart and Goldman will zoom back to $200 a share, but there are too many uncertainties to judge if that will happen. One of the most important keys to investing is to avoid any unnecessary risks. I don’t know what the SEC has up its sleeves. The agency is clearly under political pressure and they’ll do whatever they have to validate their existence. Buying Goldman now is a bet I’m not willing to take.
Being a bank is all about trust. Ultimately, that’s the product you offer your clients. The specifics of the SEC’s case are surprisingly sloppy, but the picture is very stark. Goldman was not fully honest with their clients. This will probably lead to a string or more lawsuits. Until the dust clears, there are many better buys elsewhere.

Lilly Beats the Street
Posted by Eddy Elfenbein on April 19th, 2010 at 9:42 am

The earnings parade continues this week. The good news this morning is that one of our Buy List stocks, Eli Lilly (LLY) reported earnings of $1.18 a share which beat the Street by eight cents a share. Revenues rose by 9% to $5.49 billion.
Earlier the company said it was expect full-year EPS of $4.65 to $4.85. I always like it when companies give full-year forecasts. Today, Lilly pared that forecast back to $4.40 o $4.55 due to Medicaid-related rebates.
Here’s the CFO discussing the quarterly result. Interestingly, he notes that the company is increasing its guidance after you discount the charge:

This was another very good quarter by Lilly but I’d like to see more guidance on their pipeline.
We have a few more earnings reports coming out this week. Tomorrow will be an especially big day as Gilead Sciences (GILD), Johnson & Johnson (JNJ) and Stryker (SYK) are due to report. Then on Thursday, Baxter International (BAX) and Reynolds American (RAI) will report.

Quote of the Day
Posted by Eddy Elfenbein on April 18th, 2010 at 11:08 pm

The following is an excerpt from John Keegan’s book The First World War describing the second day of the Battle of Artois:

In early afternoon they moved forward in ten columns ‘each [of] about a thousand men, all advancing as if carrying out a parade-ground drill.’ The German defenders were astounded by the sight of an ‘entire front covered with the [British] infantry.’ They stood up, some even on the parapet of the trench, and fired triumphantly into the mass of men advancing across the open grassland. The machine gunners had opened fire at 1,500 yards range. ‘Never had machine guns had such straightforward work to do … with barrels becoming hot and swimming in oil, they traversed to and fro along the [British] ranks; one machine gun alone fired 12,500 rounds that afternoon. The effect was devastating. The [British] could be seen falling literally in hundreds, but they continued their march in good order and without interruption’ until they reached the unbroken wire of the German’s second position: ‘Confronted by this impenetrable obstacle the survivors turned and began to retire.’
The survivors were a bare majority of those who had come forward. Of the 15,000 infantry of the 21st and 24th Divisions, over 8,000 had been killed or wounded. Their German enemies, nauseated by the spectacle of the ‘corpse field of Loos,’ held their fire as the British turned in retreat, ‘so great was the feeling of compassion and mercy after such a victory.’

The Lack of Bad News Could Be…Bad News
Posted by Eddy Elfenbein on April 17th, 2010 at 8:31 pm

We’re still early in fourth-quarter earnings season and Wall Street has already had a nice rally this year. The S&P 500 put on nearly 15% between February 8 and this past Thursday. We could be headed for a cooling off period. Paul J. Lim notes in the New York Times that the market may be getting a tad too optimistic about earnings.

John Butters, an earnings analyst at Thomson Reuters, noted that more often than not, companies that are likely to fall short tend to pre-announce their results, in part to lower the market’s expectations.
Historically, two companies pre-announce bad news for every company that hints at better-than-expected results to come. But at the moment, Mr. Butters said, the ratio is just 1.1 to 1 — which means that far fewer companies than usual are preparing the market for disappointment.
That may sound like a positive sign, but it isn’t. Oddly, when the pre-announcement ratio has been this low over the last decade, it “corresponds with a decline of about 6 percent in the S.& P. 500 during the earnings season,” Mr. Kleintop said. It may be that without an early warning of trouble, investors become too ebullient, leading to market declines later.

Here’s a look at the S&P 500 along with its earnings. The S&P 500 is the black line and it follows the left scale. The earnings are the yellow line and they follow the right scale. The two lines are scaled at a ratio of 16-to-1, so whenever the lines cross, the P/E Ratio is exactly 16.

The future earnings are, of course, just a forecast. Be careful not to read too much in this chart. The point I want to show you is that the market has rallied and it’s been due to a surge in earnings that’s expected to continue.
If that yellow lines continues its sharp upward trend, then the market is still very cheap and we have nothing to worry about. We ought to assume that the black and yellow lines will converge over time.
The hitch is that this is all predicated on a very strong earnings environment. We shall know more when we’re a little older.

Goldman, the SEC and a Whiteboard
Posted by Eddy Elfenbein on April 17th, 2010 at 3:17 pm

Paddy Hirsch of Marketplace explains L’affaire Tourre.