The Market Today
Posted by Eddy Elfenbein on November 14th, 2005 at 3:52 pm

Until today, Abbott Labs (ABT) was the one large drug maker than hadn’t been completely body slammed by the market. Well, today was the day. The company said that one of its drugs designed to prevent heart attacks…doesn’t. The stock dropped about 7.3% today. This is getting sad. I can’t find any survivors in this group.
Today was another ho-hum day on Wall Street. Only nine of our 25 Buy List stocks were up today, but thanks to big gains from Quality Systems (QSII) and Thor Industries (THO), the Buy List was up 0.13%, and the S&P 500 was down 0.08%.
On Thursday, Friday and the early part of today, the volatility index (^VIX) fell below 12, which is an extremely low reading. The index climbed a bit higher today. The VIX is basically Wall Street’s version of Punxsutawney Phil. If the VIX doesn’t see his shadow, that’s six more weeks of a dull market.
The Dow is now just 3 widdle points from 10700. Twice today, we crossed 10700, but it was not to hold. Tomorrow might be more interesting as Ben Bernanke begins his confirmation hearings. I’m not expecting anything interesting but it will be refreshing to hear a Fed chair who speaks in English.

Hewlett-Packard Will Earn 49 Cents a Share
Posted by Eddy Elfenbein on November 14th, 2005 at 1:31 pm

Since this market is boring me to tears, I’ve decided to make a completely worthless prediction. Nothing is too good for my readers, so here you go. On Thursday, Hewlett-Packard (HPQ) will report earnings of 49 cents a share. Exactly Four Nine. Write it down. The current estimate is for 46 cents a share, so I’m really being brave here. Look at me. I’ve just bucked the trend.
OK, this isn’t any special insight on my part. The reason for my brave stand has nothing to do with financial analysis or industry trends, or stuff like that, but I think the media needs it. Let’s just give it to them. It’s basically along the lines of Linus and the Great Pumpkin. You can’t beat up Dell for so long without having something…anything…to fall back on.
I don’t want to brush off what Hurd & Crew have done, but H-P still has a long way to go to becoming a competitive player again. Don’t underestimate how much Carly smashed up this company. When you’re in survival mode, it’s not so hard to get a jump out of your financials. Sure, you can improve your margins if you lay off 15,000 people. Hell, we do that all the time as CrossingWallStreet. But at the same time, you just laid off 15,000 people! Come to think of, isn’t canning people right and left what got so many folks angry at Carly? Oh right, plus that whole Compaq thing. Nearly forgot.
(By the way, Carly is working on her book. My advance preview: Three hundred pages of someone else’s fault.)
I see Market Watch tells us, “New H-P chief Hurd already winning turnaround praises.” These stories just write themselves. String a few things together, add some quotes and call it a theme. I wish Hurd success, but please. Things hardly could have gotten worse around there. By turn around, we mean that the stock has now doubled. Doubled, I tells ya! It’s now only 2/3 off its high instead of 5/6.
So mark my words: 49 cents a share. (Or maybe 48.)

Buffett Unplugged
Posted by Eddy Elfenbein on November 14th, 2005 at 10:25 am

The Wall Street Journal looks at Warren Buffett. From this article, I’m surprised by how much Buffett leaves his managers alone. As he puts it, “we delegate almost to the point of abdication.” Here are some Buffett tips for individual investors:

Has the Santa Rally Started?
Posted by Eddy Elfenbein on November 14th, 2005 at 9:53 am

Thanks to a nice rally over the past two weeks, the market is right at the upper bound of a frustrating trading range. Every time the index has reached this level, it’s fallen back. We’re now about 1% away from a four-year high.
I’m curious if we’ll finally be able to break out. The market is set to open slightly lower today. I’m inclined to think we won’t break out just yet since the volatility index is still so low, but that’s just a hunch. I’m still rooting for this market.
There’s yet another company going private and this time, it’s a big one. Koch Industries is buying out Georgia Pacific (GP) for $13 billion. Sheesh…no one wants to be on the market anymore! This deal will make Koch the largest private company. Koch is run by Charles and David Koch, the sons of the founder. The brothers have been very active in libertarian circles. In fact, David was the Libertarian Party’s veep nominee in 1980 when the ticket got nearly 1 million votes.
The good news is that the consumer is still happy. Lowe’s (LOW) reported very good earnings this morning. The company topped expectations by four cents a share. Wal-Mart (WMT) reported earnings inline with expectations. The company averaged over $800 million in sales a day for the quarter.
This week is also the time for inflation reports. Wholesale prices come out tomorrow, and consumer prices follow on Wednesday. Thanks to plunging oil, we’ll probably see the biggest drop in inflation in decades. The market, however, will be more focused on “core inflation,” which is inflation minus volatile food and energy prices. As usual, I don’t expect much news here.
Also, AIG (AIG) is set to report earnings. The stock has been rebounding, but given its earnings restatement, and restatement of the restatement, I have no idea what to expect.

The Airline Boom?
Posted by Eddy Elfenbein on November 13th, 2005 at 5:56 pm

According to The Economist: “After losing $43 billion in five years, airlines are at the beginning of a massive boom.”

(T)he airline industry is poised for an almost unprecedented boom, as a new generation of planes is combining with better business models and huge volume growth in new markets. This year an industry with revenues of about $400 billion will end up paying $97 billion for its fuel. According to IATA (the International Air Transport Association), had the price of oil stayed where it was in 2003, at $30, instead of rising to the average $57 expected for the whole of this year, the world’s airlines would have made more profit ($45.6 billion) than they have lost in the past five years. (This, says IATA, is also partly a result of a 34% improvement in labour productivity.)
But there is more to it than savage cost-cutting; traffic volumes are growing. International traffic has risen by 8.3% so far this year, compared with 2004. In America, total traffic is up by 5.4%; in Europe the rise is 6%. In Asia, IATA is forecasting continuing annual growth of 6.8% through to 2009: China and some east European countries will go on growing by around 10%.

Peter F. Drucker 1909-2005
Posted by Eddy Elfenbein on November 12th, 2005 at 12:04 pm

He was born in Vienna during the reign of Emperor Franz Joseph (his middle initial F. stood for Ferdinand). Keynes and Schumpeter were his economics professors. His first book was reviewed by Winston Churchill in the Times Literary Supplement in 1939. The 29-year-old proved to be more prescient than the Great Man.

Mr. Drucker is one of those writers to whom almost anything can be forgiven because he not only has a mind of his own, but has the gift of starting other minds along a stimulating line of thought. There is not much that needs forgiveness in this book, but Mr. Drucker tends to be carried away by his own enthusiasm, so that the pieces of the puzzle fit together rather too neatly. It is indeed curious that a man so alive to the dangers of mechanical conceptions should himself be caught up in the subordinate machinery of his own argument. His proof, for example, that Russia and Germany must come together forgets the nationalism which has developed in Russia during the last twenty years and which would react very strongly against any new German domination of Russian life. But such excesses of logic are pardonable enough in a book that successfully links the dictatorships which are outstanding in contemporary life with that absence of a working philosophy which is equally outstanding in contemporary thought.

Within three months, Poland’s fate was sealed. When looking at Drucker’s work, the most arresting fact isn’t how much he got right, but how much he’s still misuderstood.

Mr. Drucker thought of himself, first and foremost, as a writer and teacher, though he eventually settled on the term “social ecologist.” He became internationally renowned for urging corporate leaders to agree with subordinates on objectives and goals and then get out of the way of decisions about how to achieve them.

He challenged both business and labor leaders to search for ways to give workers more control over their work environment. He also argued that governments should turn many functions over to private enterprise and urged organizing in teams to exploit the rise of a technology-astute class of “knowledge workers.”

Mr. Drucker staunchly defended the need for businesses to be profitable but he preached that employees were a resource, not a cost. His constant focus on the human impact of management decisions did not always appeal to executives, but they could not help noticing how it helped him foresee many major trends in business and politics.

He began talking about such practices in the 1940’s and 50’s, decades before they became so widespread that they were taken for common sense. Mr. Drucker also foresaw that the 1970’s would be a decade of inflation, that Japanese manufacturers would become major competitors for the United States and that union power would decline.

For all his insights, he clearly owed much of his impact to his extraordinary energy and skills as a communicator. But while Mr. Drucker loved dazzling audiences with his wit and wisdom, his goal was not to be known as an oracle. Indeed, after writing a rosy-eyed article shortly before the stock market crash of 1929 in which he outlined why stocks prices would rise, he pledged to himself to stay away from gratuitous predictions. Instead, his views about where the world was headed generally arose out of advocacy for what he saw as moral action.

As for me, I’m a bit weary of the Cult of Drucker, which is often quite different from the man. I often hear his disciples pontificate his “ideas,” which wind up being little more than Benjamin Franklin-style truisms—only covered in jargon and masquerading as ideology. “An apple a day keeps the doctor away” becomes “pro-active management encourages and facilitates preventative-based strategies in order to ensure long-run objectives without negative and unforeseen downside effects.” So much Latin, and so little English. Such are the dangers in thinking outside one’s box.

But how far can the study of management go? For all of management’s influence, the most difficult question is: Why is this enterprise worth managing? My fear is that Drucker’s legacy is so liquid that his mantle can be claimed by most anyone. The race has been on for quite some time. Right now, the yellow-jersey belongs to Newt Gingrich. The former Speaker of the House, who’s an admirer of Alvin Toffler and other future babble, has clearly adopted Drucker as a political ally.

Too many of our business schools, academic centers, media moguls, and government leaders still rely on the Keynesian command-and-control bureaucratic model. They rely on almost nothing of Drucker and even less of the Austrian school and, as a result, routinely apply the wrong principles to structuring education, training, health care, and our role in international trade. Again and again they reject the marketplace. They reject the principles of management. They reject the essence of entrepreneurship. They reject the heart of Drucker and apply instead patterns and behaviors that simply don’t work.

That is the ultimate critique of big-city schools. It’s the ultimate critique of government-run health care. It is the ultimate critique of the way the federal government and state and local governments mismanage resources. It simply doesn’t work.

To be sure, Gingrich’s ideas can stand or fall on their own—with or without the support of Drucker. But we ought to be cleat that Drucker’s ideas have little to do with what Gingrich says. In fact, Drucker was never particularly interested in economics. Too much theory, not enough people.

Drucker’s concern was studying institutions as institutions. That’s what he saw in 1939. The Nazis and Soviets had to come together. It was simply what they were. The institutions demanded it. For Drucker, it didn’t matter which institutions he looked at; governments, unions, corporations. He really didn’t find much use in analyzing the government. Drucker preferred the non-profit sector. He even looked at the girl scouts. To Drucker, an institution had an internal agenda simply because it is an institution.

Drucker saw the driver of an institution as its management. His goal was to isolate management as a separate concept and study what made some managers good, and others bad. While it sounds a bit platitudinal now, it was quite new then.

Still, when reading Drucker I can’t help feeling undernourished. Consider this from Forbes a few years ago:

In 1989 C. William Pollard, chairman of the ServiceMaster Co., took his board of directors from Chicago to meet Drucker. In a back room of Drucker’s utterly unpretentious home, the sage of Claremont opened the meeting by asking the group, “Can you tell me what your business is?”

Each director gave a different answer. Housecleaning, said one. Insect extermination, said another. Lawn care, said a third.

“You’re all wrong,” Drucker said. “Gentlemen, you do not understand your business. Your business is to train the least-skilled people and make them functional.”

Groan. This is only the beginning of an exposure to Drucker. Soon, the “ideas” begin to flow freely. We’re now “knowledge workers.” And we’re moving to a “knowledge-based society.” But…what of it? Before we know it we’re “managing change,” yet I’m only interested in “making money.” Again, here’s Drucker:

One of the most important jobs ahead for the top management of the big company of tomorrow, and especially of the multinational, will be to balance the conflicting demands on business being made by the need for both short-term and long-term results, and by the corporation’s various constituencies: customers, shareholders (especially institutional investors and pension funds), knowledge employees and communities.

Call me unimpressed. I can’t say that I disagree with anything Drucker says, which is part of the problem. Truthfully, I think the study of management can only go so far. It’s important, but it’s easily overanalyzed. Just as the diplomat urges diplomacy and the general favors war, the management guru sees only the primacy of managers. To the Drucker’s fans, it’s seems hard to conceive the fact that Grant crossed the James without the aid of a flow chart.

Here’s a large section of Druckerama. Apparently, everything is transformational. Everyone is empowered. It all sounds so epic, yet at the same time so…bland. The themes have taken over the building and they’ve smothered the plot. What’s left is Drucker’s true legacy, his boundless enthusiasm. If only all managers had it. To Churchill, Russia may have been riddle wrapped in a mystery inside an enigma, but he saw Drucker clearly.

The Market Today
Posted by Eddy Elfenbein on November 11th, 2005 at 4:25 pm

Well, heck. November’s turning out to be a pretty good month. The Buy List is already up 5.18% for the month while the S&P 500 is up 2.30%. Today, the Buy List added another 0.45% and the S&P was up 0.31%. I knew we could outsmart the robots.
The bond market was closed for Veteran’s Day, and the stock market was very quiet. One surprise is that Commerce Bancorp (CBH) was out top performer. CBH added 4.0% today even though the stock was downgraded yesterday by A.G. Edwards.
Here are a few links that I found interesting. One of my favorite bloggers, Michelle Leder of Footnoted.org, found this gem:

How often do top executives agree to forgo their bonuses? About as frequently as pigs fly. Which is why this 8-K filed by The Banc Corporation (TBNC) this week is particularly amusing. In a press release, the company notes that the three top executives “will not accept any performance bonus for which they might have been eligible for” which works out to about $450K for the three. But here’s the clincher: the board has agreed to accelerate the vesting of 625,942 options held by the three — options that are worth about $2 million.

There’s a growing business for corporate sleuths. (Via: The Kirk Report.)
Dell’s CEO talks to Business Week.
Value investing is still winning.
And Zimbabwe’s inflation is running at 411%. A month.

Program Trading Accounts For 56.7% of NYSE Volume
Posted by Eddy Elfenbein on November 11th, 2005 at 3:20 pm

I find this a little unnerving. Odds are, the last stock I bought was from C3PO:

Program trading in the week ended Nov. 4 accounted for 56.7%, or an average of 1.08 billion shares daily, of New York Stock Exchange volume. Brokerage firms executed an additional 742.7 million daily shares of program trading away from the NYSE, with 1.4% of the overall total on foreign markets. Program trading is the simultaneous purchase or sale of at least 15 different stocks with a total value of $1 million or more.
Of the program total on the NYSE, 7.6% involved stock-index arbitrage. In this strategy, traders dart between stocks and stock-index options and futures to capture fleeting price differences. Less than 0.1% involved derivative product-related strategies. Index arbitrage can be executed only in a stabilizing manner when the Dow Jones Industrial Average moves 150 points or more from its previous day’s close.
Some 53.7% of program trading was executed by firms for their clients, while 40.3% was done for their own accounts, or principal trading. An additional 6.1% was designated as customer facilitation, in which firms use principal positions to facilitate customer trades.
Of the five most-active firms overall for the week, Lehman Brothers Holdings Inc.’s Lehman Brothers Inc. and UBS AG’s UBS Securities LLC executed most of their program trading as principal for their own accounts. Deutsche Bank AG’s Deutsche Bank Securities, Goldman Sachs Group Inc., and Morgan Stanley executed most of their program trading activity for customers, as agent.

Today’s a pretty quiet day on Wall Street. The bond market is closed for Veteran’s Day. The stock market’s volume is very low. There’s not much news from our Buy List. Dell (DELL) is trading up about 1%. St. Jude Medical (STJ) just got approval to buy Advanced Neuromodulation Systems (ANSI). For the record, this is not a mega-merger. St. Jude is more than 10 times as large as ANSI.
The Dow is within striking distance of 10700. The index has closed between 10200 and 10700 for 125 of the last 126 sessions.

Thoughts on Dell
Posted by Eddy Elfenbein on 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
Posted by Eddy Elfenbein on 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.