Investing: Decoded

2 charts that change the game

2013-05-19T17:15:00.003-04:00

Have you heard the news, the S&P 500 is up! The dow is up! The nasdaq is up!

Tom, is now the time to sell?

The answer is undoubtedly yes.

When markets have been steadily declining or steadily increasing, one indicator that I love to look at is the Average Directional Movement Index. Founded in 1978 by J. Welles Wilder, the directional index illustrates the strength of an upward or downward trend. Below is a chart of the S&P 500 with the directional index graphed below.

Chart on the bottom is the directional index. The white line overlaying the directional index is a ceiling that the directional index hit today and has only crossed or hit 4 times since 2004. Every time the market hit or crossed the directional index ceiling I drew, the market experienced a pullback.

The action in the markets over the last 2 months have been remakable similar to the end of 2010, when the market (and the directional index) moved up steadily and then retreated.

Aside from the directional index, another indicator that the market is ripe for a pullback is the VIX index. The Vix, sometimes known as the "fear indicator" measures the volatility in the S&P 500 options. The lower the VIX, the lower the volatility in the market. The vix has been hitting record lows in the last 2 months, and is likely to rise in the weeks ahead. Below is the chart of the VIX:

As you can see from the VIX index, it's positive and negative directional indexes have been rising (the above chart is using weekly candlesticks, meaning 1 candlestick for each week). At 12.45, the VIX only has room to move up, which indicates to me that the market is ready for a pullback and I'll be ready to start scooping up stocks when the S&P declines to at least the 1,400 mark.

No bulls left in the Bond Market

2013-05-03T19:23:00.001-04:00

It's been long.

It's been strong.

And now it's done.

That's right, the 30 year run up in bond prices is over. Below is a chart of the 10 year treasury note yield:

Yielding a meager 1.75%, investors in the 10 year treasury note are now experiencing negative real returns, when adjusted for inflation.

Some bond fund managers are even doing the unthinkable, buying stocks.

According to a recent Wall Street Journal article, "The $15.4-billion Loomis Sayles Strategic Income fund has ratcheted up its stock and preferred-stock allocation to more than 19%, from 5% in mid-2011. Co-portfolio manager Matt Eagan said that the fund’s managers decided most bonds were so overpriced that it was worth taking on some stock risk to avoid pain in bonds."

Loomis is not alone, a growing number of bond mutual funds are selling their overpriced bonds in favor of dividend paying stocks. So should you. As a matter of fact, I've started a "bet" that bond yields are going to increase and prices are going to fall.

How can you position your portfolio to benefit from falling bond prices?

Personally, I do so through options on TLT, the ETF for the 30 year treasury bond.

Currently, an investor can buy the Janurary 2014 $130 put on TLT for $13.30. For every dollar the TLT declines, this option will increase 74 cents.

When betting against a sure trend like this, I prefer buying options with an expiration that is more than 6 months out. Although this means the option will not increase in value as fast (if TLT where to plunge tomorrow), it does mean that you have more time for a particular trend to take hold.

Join me, join the bond fund community and bet against the bond market. It's a sure thing.

Overbought assets get a dose of reality

2013-04-17T21:52:00.002-04:00

Have you heard the news, the price of gold is down!

Falling steadily since September, Gold is now trading a levels not seen since 2011. Below is a chart of Gold since 2007:

As you can see, the recent decline certainly grabbed investors attention, especially since there hasn't been much news recently.

Mainstream media outlets have attributed this decline mainly due to the Cypress bailout, although the sale of Cypress' small gold reserve (estimated to be worth 400 million euros, according to The Guardian) is easily dwarfed by the $80 Billion SPDR Gold ETF (which holds physical gold).

On the contrary, we are beginning to see investors realize that Gold is completely disconnected from the Federal Reserves money printing ("quantitative easing") and inflation is not coming soon. This is leading to a mass exodus, from the most over-hyped asset bubble since the housing bubble.

This is certainly an arbitrary time for gold to decline in value, but that's why I have long advised that investors simply steer clear of Gold, rather than bet on it's demise. Over inflated asset bubbles like the Gold and (in 2007) the housing market, are nearly impossible to guess and many times investors betting against them become insolvent. That's why I'll continue to simply steer clear of Gold, rather than bet against it, as Gold could easily rebound in value, even though it's badly overbought.

A good way to lose 2-3% every year

2013-04-14T19:16:00.002-04:00

Has there ever been a worse time to have a savings account?

I certainly don't think so.

I recently looked over the details of my Bank of America "Savings" account... it pays a pathetic 20 basis points in interest (0.20%). I just round it down to zero. Even looking into their Certificates of Deposit (CD) yields anemic results. At BofA (which I admit does not have the best rates), a 120 month CD yields 45 basis points! (the rates range from 10 to 45 basis points, depending on the length)

However a growing number of people are keeping money in deposits products at the bank. According to the Federal Reserve, large time deposits increased 13.1% in the 1st quarter of 2013. Below is a chart of the y/o/y change in large time deposits:

(please click on the image to view the full size)

This rise in deposits is troubling to Fed Chairman Ben Bernanke, as he wants consumers to be spending their cash or investing it, not stashing it away into a long term deposit account (which is not being lent out by the big banks like it used to).

Unfortunately, Fed Chairman Bernanke's low interest rate strategy has not dissuaded that many consumer from stashing cash in a bank account, as they simply haven't done their homework.

Consumers continue to see savings accounts and CDs as "Safe" investments, that can't go down in value.

Quite the contrary, savings accounts and CDs lose 2-3% a year from inflation, as interest on the accounts do not keep up with inflation. Especially when looking at total inflation (including food and energy).

So what is one to do?

In my opinion, it is time for stocks to be the savings product of tomorrow.

It doesn't get pointed out enough that the stock market is on an upward trajectory. Below is a chart of the Dow Jones Industrial Average since 1985:

Earnings have been growing too.

From the end of the 4th quarter in 1999 to the end of the 4th quarter in 2012, S&P 500 earnings grew a total of 61.71%. Despite these significant earnings gains, the index declined 2.93% (not including dividends). American companies as a whole are growing earnings and represent simply the best investment out there.

That's why consumers like me and you should shun high balances in a savings account and simply invest in stocks. The alternatives to stocks are bleak and savings products continue to show us negative real returns that are a sure-fire way to lose 2-3% a year (in real, inflation adjusted returns).

Bigger profits ahead, with lower fixed costs!

2013-03-31T19:25:00.000-04:00

I love investing in Real Estate Investment Trusts.

Although they sound complicated (who wants to invest in a "trust"), generally speaking they are simpler to invest in than your traditional stock.

REITs own a pool of real estate that (usually) produces income. This can be a Residential REIT (which own things like apartment buildings), a commercial REIT (which owns commercial real estate like factories or malls) or a mortgage REIT (which buys mortgages from banks).

REITs are required to pay out 90% of their earnings to shareholders (in the form of dividends). Therefore, as you would expect, REITs pay out big dividends, but are (traditionally) lower growth than say a tech stock that pays no dividend.

Because REITs pay out most of their earnings to sharholders, they have a big tax advantage over regular companies. Unlike traditional companies, REITs pay no corporate income taxes (more about the tax-advantages of REITs here).

Previously, I have recommended 2 Student Housing REITs, Campus Crest Communities(ticker: CCG) and American Campus Communities (ticker: ACC). In February of 2012, I suggested that investors dump American Campus in favor of Campus Crest (article here), as CCG was a much better value.

As with all investments, I like to step back and review what worked and what didn't work with a particlar decision. In the case of ACC v. CCG, it seems CCG was indeed the right company, as CCG has outperformed ACC since February 2nd, 2012. When adjusted for dividends, CCG has been up 36.41%, with ACC up 7.80% (with the S&P 500 up 18.38%).

CCG's outperformance has been justified as at the beginning of this period ACC was trading at 13.35x its annualized gross profit per share, compared to 8.02x for CCG. Since my recommendation of CCG, the market has only slightly increased CCGs valuation by bumping up its P/GP ratio to 8.63x, but ACC's has soared even higher, to 26.9x. So therefore, I still think CCG is the better investment, based on it's valuation.

Shifting our focus to CCGs management, I see excellent opportunities in the companies acquisition of assets from Cooper Beach Townhome Communities and it's construction of a new student housing tower in Philadelphia, PA. The addition of income producing properties to it's portfolio is usually a good thing, as the company will see bigger profits, with the same fixed (corporate level) costs as before. I'll be eagerly awaiting the companies 1st quarter earnings call to hear more details on this REITs plans for expansion. While I wait, I'll be happily cashing my 4.7%* yield (*6%, when calculated using my initial purchase price).

A great value in a horrible buyers market

2013-03-23T14:34:00.002-04:00

Don't you hate that feeling when everything in the market is overbought?

I certainly do.

In the last month or so, as the Dow Jones Industrial Average rose to it's all time high of 14,546, I was forced to sell a few of my holdings that became overbought. This included Wendy's (which I sold at $5.75) and Siemens (which I sold on Friday at $112). With some cash on the sideline in a sellers market, I (like many investors) struggled to find a good name to invest in. Until Friday.

On Friday a friend suggested a stock that I haven't looked at in a while.

That stock is Microsoft.

Microsoft is a boring stock, that has hovered around the $28 range since 2001. It certainly isn't your typical tech company, but it's a great buy in the current market environment.

Microsoft is an outstanding tech company when it comes to cost control (which is why I've recommended investors steer clear of Google).

When measuring cost control, I like to look at a companies net margin (which is the percentage of revenue that becomes earnings). In FY13 Q2 (which ended on December 31st for them), Microsoft had a net margin of 29.72%. This crushes Google's 20.02% net margin. It also crushes Apple (24%) and Dell (3.7%).

Faced with anemic earnings growth over the last 5 years, Microsoft has maintained a net margin higher than 25% 4 of the last 5 years. Microsoft brought in a growing amount of revenue in CY12 ($70 billion, which was a 5 year high) and I believe has established a floor for revenue and earnings. Given these metrics among other things, I'm seeing very little downside in Microsoft and a large amount of upside.

Where is the upside in Microsoft?

In what I like to call bread and butter technology.

While I'm not crazy about the Surface Tablet or the Windows Phone (I expect those businesses not to add much to the companies bottom line growth), I am a big fan of the Windows division.

Most people don't know it, but Windows CRUSHING Apple in the personal computer market. The Windows division at Microsoft grew revenues 24% year-over-year in the quarter ended on 12/31/13. How did Apple's Mac division do during this period? Revenue was down 16% (yet another bad omen for Apple, but I digress...)

As consumers continue to see the bite from higher payroll taxes, flat wages and rising cost of living, the consumer will flock to Microsoft's low priced, bread and butter technology (which has been greatly improved with Windows 8).

If you haven't used Windows 8, you're definitely missing out on the best operating system I've ever used. Windows 8 incorporates what Windows users have relied on for years (a user interface that supports a large number of proprietary applications and software tools) and what users are looking for in this web 2.0 environment.

This web 2.0 environment demands that a device owner can easily access media, applications and content easily and seamlessly. Microsoft does this with the newly revamped start "menu" which is a interface more like a tablet/smartphone than a traditional PC. This start menu displays information right away, in "live tiles" and has great native applications like messaging, mail, calendar and news. There is also a very large Microsoft store that provides apps from the NY Times, Wall St. Journal and websites like Engadget. While these peripheral features on the Windows 8 operating system won't directly contribute to Microsoft's bottom line, they will improve the windows experience and improve customer loyalty.

Even if consumers don't start flocking in numbers to Microsoft Products and Microsoft's earnings stay flat, investors will be rewarded with Microsoft's 3.2% yield , which has a lot of room to grow and investors won't be paying a big premium for the stock, as it trades at a P/E of 9.2 (based on annualized FY13Q2 earnings).

Given the current market environment and our economy's fundamentals, I think Microsoft is a strong buy right now.

An asset allocation rally

2013-03-05T18:55:00.001-05:00

I have a quick (hypothetical) question for Investing: Decoded readers.

What happens at the beginning of every year between January and April?

Yes, my beloved Red Sox report for spring training.

Yes, we have the Super Bowl.

But more importantly (for our finances, that is), people file their tax returns and (in many cases) take a look at their investment portfolios (be it an IRA, 401K ect...). When investors young and old look at their investment portfolios, they realize they need to get out of bonds and into stocks. Their broker tells them to do this. Ben Bernanke tells them to do this. Even major Bond managers like Bill Gross suggest that individuals move out of bonds.

So what has happened over the last 3 months?

That's Right. Investors have moved into stocks!

Rightfully so.

Stocks (in general) are easily the best investment out there.

In 2012, Investors in stocks saw great 16% rise in the S&P 500. At the start of 2012, everyone who was out of the game sharpened their pencils, redid their budget and plowed more money into stocks.

The fact that the Dow hit it's record high today came as no surprise. With a yield of 2.38% (as measured by the DIA ETF), Stocks present themselves (to many investors) as a new safe haven, that won't lose big money over time, like bonds.

The bond market has been in a unsustainable rally. The rally in bonds has created yields that only insurance companies and bond funds would find acceptable. With the 10 year treasury note closing at a yield of 1.89%, investors are starting to realize that they will lose money in bonds (when inflation is taken into account).

Now naysayers (and bond bulls) will be quick to say investors in Bonds had strong capital gains in 2012 and they will continue to have strong gains as the Federal Reserve continues it bond buying program. Although it is true that bonds like the 10 year treasury had gains in 2012, the gains where eliminated by inflation.

In 2012, the 10 year treasury gained 2.43% in value (while paying 1.96% in interest). This total gain of 4.39% is wiped out when measured in terms of gasoline, which increased 17.99% in 2012. Only investors in the S&P 500 kept up with gasoline.

So are you surprised the S&P is up? I'm certainly not. The more investors do their homework, the more stocks they'll buy. How long that will last is anyone's guess.

Gold: It seems Soros was right

2013-02-14T22:49:00.001-05:00

Back about a year ago (December 29th, 2011, to be precise) I recommended that investors follow George Soros out of Gold as it had become the worlds biggest asset bubble. For reasons outlined in numerous articles here on Investing: Decoded (including the recent article titled Fool's Gold), I have outlined why the world's first fiat currency is not a safe haven asset, why it won't be hedged to inflation and why the Federal Reserves monetary easing will not affect the price of gold at all.

Unfortunately investors still continue to jump on the bandwagon that's already over the cliff and starting to descent to the rocky canyon below. They are led by Gold bull Mark Faber, who insisted today on yahoo finance that Gold is an insurance policy on the next financial crisis.

This notion is false, as Gold holds very little intrinsic value, relative to other financial assets (Bonds, Stocks ect...) and Gold is simply priced based on what some other guy is willing to pay for it. Unlike stocks, gold produces no cash flow and produces no value to ones life (unlike other commodities like Wheat or Corn). When the Federal Reserve prints money, they don't buy and gold since we don't have a gold-backed dollar.

Gold bulls would argue that the Federal Reserves monetary easing leads to inflation, which leads to the rise in the price of Gold. This is false, as between 2002 and the spring of 2012, gold was up 220%, when inflation was only up 22%. If gold moved in lockstep with inflation, we would see gold drop well below $1,000 an ounce today!

I would continue to avoid Gold, no matter what type of investor you are, as it is as speculative an asset as a mortgage bond was in 2007.

Getting some green out of the white stuff

2013-02-09T15:37:00.001-05:00

Breaking news: There's currently a foot of snow in Mahattan. There's even more elsewhere.

If you woke up this morning thinking, "How can we monetize the cleanup of this storm?" I have good news for you, there's a company out there that is helping households countrywide in the clean up of snow.

What company is that?

Toro.

Founded in 1914 and currently headquarted in Bloomington, Minnesota, Toro manufacturers commercial grade and consumer grade lawn equipment, including snow removal equipment. Looking at Toro's stock in 2012, we see a stock that has been up a stunning 39%(adjusted for the 2-1 split). Below is a chart:

I'll admit, Toro's strong gains in 2012 where a concern for me, as basic instincts imply that the stock is overvalued. However Toro's financials make the rise in the stock reasonable.

At the end of the 1st quarter of 2012, Toro traded at a P/E of 13.46 (based on annualized 1Q earnings). This P/E was way to low and a 40% gain in the stock does not surprise me.

In FY12, Toro reported earnings of $2.18, which gives it a trailing P/E ratio of 20.8. This comes as earnings grew 16% year over year and revenue grew 4% year over year. Going forward, Toro expects another 4-5% in revenue growth for FY13 and another 8% in earnings growth. These conservative estimates by management are a tad bit concerning, as the stock will likely decrease if we only see 8% earnings growth.

Additionally, if the economy where to slip into recession again (which I don't see happening), Toro's earnings would most certainly be affected heavily (As their revenues are highly cyclical with construction sales). This is unlike other investments I like (including Siemens, NY Times and Panera Bread).

Therefore, I'm putting Toro on my list of stocks to buy when the price drops. The overall market I feel is ripe for a healthy sell off (I think the S&P 500 is going to fall below it's 50 day moving average to the 1400 neighborhood) and when the overall market sells off, Toro should see a drop in price to around $40. I feel this would be a good buying point (which would be 11% lower than friday's close), as a valuation at $40 would give the company a forward P/E of 17 and much more room to grow.

Otherwise, stick with solid names like Siemens (which has once again fallen into buying range, now that it's paid out it's annual dividend), the NY Times (which will rebound from it's Fall drop) and Panera Bread (which I recently recommended).

Big returns in Panera Bread

2013-02-02T14:53:00.002-05:00

Even the most casual stock market observer knows that Apple has been a phenomenal growth stock over the last 5 years. Between February 1st, 2008 and February 1st, 2013 (last Friday), Apple was up a total of 233% (rising from $136.24 to Friday's close at $453.62).

Many market observers (including myself), feel that Apple has hit it's peak (as I highlighted in my 12/7/11, 3/14/12 and 4/19/12 articles) and Apple's stock has struggled in the short term. Now that we've written off Apple, where is the next great growth stock? What should I replace Apple with?

Panera Bread (ticker:PNRA).

Founded in St. Louis, MO, Panera bread operates approximately 1,625 "bakery cafes." Operating in the growing "fast casual" segment (think, step above McDonalds, step below Olive Garden), Panera's profits are growing phenomenally an Panera's revenue is growing phenomenally.

In the 3rd quarter, Panera grew it's EPS by 27.5% year over year (while growing revenue 17.5%). Panera hasn't fallen into the same cost containment problems like Google and Facebook(who are growing just as fast, if not faster). Panera's net margin increased during this period from 7.34% to 7.82%. While their Net Margin is not as big as companies like McDonalds, the fact that it is being maintained while profits are growing is key.The last thing I like to see in a high growth company is to see revenues grow while margins compress.

From a valuation perspective, Panera is priced attractively. Currently Panera trades at 24x management's FY13 Earnings estimate(based on the low end of the earnings range). While this Price to Earnings ratio is high relative to the S&P 500 (which trades at 13.57x S&P's estimated FY13 earnings), it is cheap relative to it's historic P/E ratios. At the start of 2012, Panera traded at 25.8x the low end of management's 2012 earnings estimate. Over 2012, Panera's stock lingered, increasing only 8.7%, while earnings grew 27.5% year-over-year in the 3rd quarter.

Aside from the companies financials, I feel that Panera does not have the same food cost issues as other restaurant chains. This is because Panera has a business model that can easily hike prices (unlike McDonalds and Olive Garden). As companies like McDonalds and Olive Garden continue a race to the bottom in pricing, Panera will maintain it's margins and preserving their niche customer base (that don't have nearly as many alternatives as McDonalds and Olive Garden customers do).

I think 2013 will post market-beating returns for Panera, as was the case in 2011. I'm going to be picking up shares after the company reports it's 4th quarter earnings on the 5th (pending any big red flags in the companies earnings report).

Good times ahead for Campus Crest Communities

2013-01-28T21:17:00.000-05:00

Anyone notice the trend yet?

Investors are clamoring for dividend stocks.

Stocks in general certainly had a strong 2012, with the Standard and Poor's 500 index gaining 11.5%. But even better off where investors in the SPDR Real Estate Investment Trust ETF (ticker: RWR), which was up 12.87% (both returns measured without counting dividends). Investors in REITs have been getting a lot more cash coming their way, as RWR yields 3.04% (compared to 2.1% for the S&P 500). REITs have greatly benefited from low interest rates as they expand their portfolios and investors in REITs continue to be attracted to high dividend yields (relative to low interest rate bonds)

REITs are traditionally considered "boring" companies, as they are required to pay out 80% of their earnings to shareholders through dividends and don't grow very fast. However after the last financial crisis, many investors are reconsidering this industry.

One of my favorite REITs is without doubt Campus Crest Communities (ticker: CCG). CCG has been up 18.44%(including dividends) since my recommendation on February 2nd, 2012. One reason I love CCG (and most Student Housing REITs) is the high occupancy rates. In the case of CCG, it's occupancy rate was 91.9% in the 3rd quarter. CCG is the best student housing REIT out there not just because of it's occupancy rate, rather it's great valuation.

In my original recommendation I highlighted how CCG was priced much more attractively than American Campus Communities. Since my recommendation of CCG, it's stock has outperformed ACC (18.44% compared to 12.37%) and it's fundamentals are much stronger.

Despite being up more than ACC, CCG continues to be the more attractive valuation. When looking at CCGs Price to EBITDA ratio, we see it is slightly higher than ACC's (10.6 vs. 9.1), however CCG is growing it's earnings at a much faster rate. CCG grew it's EBITDA 52.8% year over year, compared to 16.78% for ACC. This phenomial growth more than compensates for the slightly higher Price to EBITDA ratio.

(Please note, I prefer to ignore the net income of REITs, since the depreciation distorts the results. This is standard practice when analyzing REITs).

Given the strong growth, reasonable valuation and high dividend yield (of 5.2%) CCG continues to be the best of the best when it comes to student housing REITs.

A company fit for survivalists!

2012-12-24T17:02:00.002-05:00

Congrats!

We did it!

We survived the Mayan Apocalypse!

Tom, what are we going to do now that we survived.?

Well we could play games on our ipad.

We could go on a vacation on a Carnival Cruise!

Or... we could take a nap!

I vote for the nap.

For investors looking to profit from the rising trend of sleep after the failed Mayan Apocalypse, an investment in the medical device manufacturer ResMed is advised.

Based in San Diego, ResMed (ticker: RMD) is a manufacturer of sleep apnea machines and other respiratory machines. The market for sleep apnea machines is enormous. An estimated 20% of the adult population has sleep apnea and untreated sleep apnea can lead to increased risk for heart disease and cancer. RMD has a product that is marketable anywhere.

RMD has tapped the global demand for these machines, as the firm only derives 57% of it's revenue from the Americas and is getting a growing portion of its revenue from emerging markets in Asia.

Breaking down the sources of RMD's revenue, we see that 47% of RMD's revenue not from the machines themselves, but the face masks that are required to use the machines(this is important, as I will highlight later).

RMD's revenue has been a juggernaut, increasing every quarter for the last 71 quarters. This growth in revenue has been meet with stringent cost controls, as the firms net margin increased from 13.2% at the end of FY08 to 18.6% at the end of FY12. The margin expansion, combined with annualized net income growth of 26.2%, lead to a 88% increase in the stock price (from the end of FY08 to the end of FY12).

While RMD's stock has been up, it has not kept up with the firms explosive earnings growth. RMD's price to earnings ratio stood at 30.7 at the end of FY08. At the end of FY12 (which ended on September 30th of this year), RMD traded at just 23.6x it's FY12 earnings. Given the fact that RMD's earnings are growing at an annualized clip of 26.2%, RMD presents itself as a great value investment.

In addition to being undervalued, RMD continues to reward it's shareholders through stock buybacks and dividends. In the last fiscal year, RMD repurchased 13.6 million shares (relative to the firms 143 million shares outstanding). The boosted EPS by 9.5%.

Additionally, prior to this years 3nd quarter, RMD had been one of those high-growth companies that paid out no dividend. But in the FY 3rd quarter, RMD started paying out a 17 cent quarterly dividend. This gives the firm a yield of 1.6% (based on Monday's closing price of $41.49). This new dividend will be great for shareholders, as the firm will still being able to grow their earnings at a steady clip (as the dividend only consumes 9% of the firms EPS).

One concern for company management and for analysts, is the new tax on durable medical equipment(DME) as a part of President Obama's Patient Protection and Affordable Care Act(AKA, Obamacare). This DME tax is not expected to subtract a noticeable amount from the firms earnings, as the tax is not expected to be applied to the firms face masks (this is noted in the firms FY12 conference call). Additionally, given RMD's explosive earnings growth and strong position in a growth market, I'm not seeing a big hit on profitability as a result of a new tax, that is being expected to be at 2.3%.

RMD will continue to be a great company, in a great industry, for many years to come. Therefore, I am labeling it one of my 2 "buy and hold forever" stocks (with Siemens being the other). Now is a great time to pick up some shares of RMD.

The value play of 2012 becomes even more undervalued in 2013

2012-12-09T20:29:00.001-05:00

Some people get frustrated when a stock they like declines in price.

I certainly don't.

I see it as a big sale for a great product.

When Cadillac marks down their prices at the end of the model year, do the cars change?

(I certainly hope not)

The same goes for stocks. When a companies fundamentals stay the same (or get better), a drop in the price should be welcomed.

This is certainly the case for CSX.

Based out of Jacksonville, Florida, CSX was my favorite value stock going into 2012. On my initial recommendation of CSX , I felt that the firms moderate growth in revenue, combined with the firms historically low P/E ratio, would support a 30% upside in the stock price. Since this recommendation, CSX has been down 5.8% (including dividends).

What happened?

Looking at CSX's 3rd quarter earnings report, we see that the firms revenue has slightly slumped year over year, falling 1.1%. This drop in revenue has mainly been because of dropping fuel prices (which reduce the fuel surcharges CSX collects from its customers) and a 17% decline in coal revenue. This was highlighted by CEO Michael Ward in the firms 3rd quarter earnings presentation. While this may sound bad, we have to remember that we're only looking at a short term glimpse of the firms results.

Shifting our attention to a wider swath of results, we see that the first 9 months of 2012 compared to the first nine months of 2011 was much better. CSX's EPS over the first 3 quarters has improved over the same period in 2011 (posting growth of 9.68%). This growth in earnings was because of great cost management, as revenue only grew 0.91%. Additionally, as pointed out in CSX's 3Q earnings call, CSX management feels it can continue to pursue productivity gains in the face of anemic revenue growth. As noted by CEO Michael Ward, "I think one, we obviously are going to continue to produce the kind of productivity that Oscar and his team have produced this year. And that's always going to be one of our key value creators."

These productivity gains will make the company even more profitable when revenue starts to gain steam. Revenue in the companies core operations have already shown signs of improvement, as noted by CEO Michael Ward, "If you exclude coal, our business will be up 4% to 5% this year. And if you count all the other markets, Tom, that's probably double what the economy is growing."(worth noting, this was Michael Ward talking to JP Morgan analyst Tom Wadewitz during the Q&A portion)

Sounds like CSX Management and (BNSF Owner) Warren Buffett are on the same page. The railroads are going to be ok in hard economic times and great in times of growth.

CSX continues to be the best class-1 railroad out there as the firm trades at 10.9x it's 2012 earnings (assuming a conservative 45 cent EPS for the 4th quarter). This pales in comparison to Union Pacific, Canadian National and Norfolk Southern, which trade at 15.3, 14.6 and 11.3 times earnings respectively. Below is a table showing the valuations of CSX, UNP, CNI and NSC.

As you can see, in terms of earnings growth, CSX is in the middle of the pack, recording earnings growth of 5.43% (only outmatched by Canadian National) and it's leading the pack in it's P/E ratio.

Tom, how come you don't want to invest in Canadian National? It's recorded higher earnings growth than CSX and has a more attractive Earnings Growth to P/E ratio.

Actually, I think an investment in CNI alongside CSX would be wise.

For dividend investors, CSX has a consistent history of maintaining and raising it's dividend. Purchasing 1 share of CSX at the start of 2007 would have given you an average annual yield of 3.56%. Purchasing 1 share of Canadian National at the start of 2007 would have given you an effective average annual yield 2.97% (this somewhat unorthodox method of comparing the 2 companies dividend yields was done because of Canadian National's uneven dividend payments, which have fluctuated in this period).

Currently, CSX is paying investors a yield of 2.71% and Canadian National is paying investors a yield of 1.63%. For dividend-hungry investors, CSX is obviously more attractive, so I would put 60% of your capital into CSX and 40% into CNI. This would give you an effective yield of 2.35% (on both stocks). For investors like myself who are less concerned about a dividend, I would invest 70% of your capital into CNI and 30% in CSX (giving you an effective yield of 2.0% on both stocks)

While lower in yield, CNI has significantly lower costs than CSX. CNI, through the first 3 quarters of 2012, had a net margin of 28%. This easily beats out CSX's 16% net margin. Additionally, CNI has big leg up on CSX in terms of labor expense.In the first 3 quarters, CSX gave 25.56% of revenue to employees, compared to 12.29% for CNI. This lower labor expense (which CSX management is trying to emulate), will lead to more gains for CNI shareholders when revenues rise.

Ultimately, a pure investment in CNI is not advised, as CSX remains more undervalued and offers investors a bigger yield. Investing in both is the best strategy to maximize profits over the long term.

Fool's Gold - available for sale now!

2012-12-01T00:11:00.001-05:00

ATTENTION INVESTING: DECODED READERS

THE CONTENT CONTAINED IN THIS ARTICLE IS FOR MATURE AUDIENCES ONLY

ANYONE WHO DIDN'T GRADUATE FROM THE 5TH GRADE IS FORBIDDEN FROM READING THIS ARTICLE

Ok. Good. We have the kids out of the room.

Now. since you've a part of the elite group of 5th grade graduates. I have a question to ask, have you ever seen a grocery store that accepts gold as payment? I certainly haven't.

Have you ever used gold for your own personal use? I certainly haven't. Most people certainly haven't.

Yet many people own gold, both in their retirement accounts and in their college planning accounts. Why?

Well... If you ask gold bull Peter Schiff he'll give you a plethora of reasons on his website. Here's his "philosophy" on Gold:

In a world where all governments have encouraged the use of paper currencies and then debased them to finance reckless spending policies, we believe that gold remains the most honest and accountable form of money.

When financial uncertainty abounds, it becomes increasingly important to hold assets with value that cannot be diluted by government monetary policy. Gold has been chosen as a store of value and unit of exchange since the dawn of civilization due to its inherent properties: rarity, durability, fungibility, divisibility, and portability.

Paper Currencies Increasingly Shaky

I believe the U.S. dollar, the world's reserve currency, is in long-term decline, and there isn't a suitable replacement on the horizon. The Euro, the only other currency with enough liquidity and financial backing to challenge the dollar, now looks very fragile. China, America's chief competitor, fixes its currency against the dollar to boost exports.
Ultimately, as the current global financial crisis runs its course — the worst of which is yet to come — the value of a gold-based monetary system may once again gain favor with productive nations looking to safeguard the value of their savings. In such a scenario, gold would spike in value as central banks became net-acquirers of gold, rather than net-sellers. Of course, private citizens are already leading the way to this future.

The Global Debt Bomb

The Western world is facing unprecedented levels of sovereign debt. The worst of them — including Greece, Spain, Iceland, the UK, and the US — have funded and unfunded liabilities greater than the yearly output of their entire economies. Governments around the world have assumed debts and made promises they simply cannot afford.
When the major banks faced bankruptcy in 2008, Washington bailed them out; but we have yet to see what happens when Washington itself faces bankruptcy. Rather than default, or "restructure" its debt, I believe the United States will take the politically less painful way out.
It will simply print more and more dollars, and pay back its bonds with cheaper dollars, until its creditors receive the nominal value printed on the front of their bonds. This does not erase the debt, but rather pays it back by stealing purchasing power from every investor, worker, and saver with dollar-denominated assets. This is called inflation.

The worst part is that nearly every wealthy Western country in the world is mired in debt, and every one is devaluing its currency along with the US. It's a race to the bottom, and many conservative investors feel there is no safe place to turn. But history provides us with a safe haven from all government paper — gold.

Let's analyze Schiff's thesis on gold.

He begins by saying that all governments have encouraged the use of paper currencies to encourage reckless spending policies and that gold is the only form of currency that is "honest" (IE, not subject to government manipulation). This is statement, on the surface, holds some merit. However, once again, I ask, can you use gold as currency? Can you repay your debts using gold? Can you pay for groceries using gold? (Hopefully all of you know the answer to this. You did finish 5th grade after all.)

Tom. You're wrong. I can sell my gold, convert it into dollars and bam I can pay for my groceries.

This is true. But what happens when everyone sells their gold during a huge drop in these fiat currencies. It would still retain it's value?

No. It wouldn't.

So this refutes the doomsday value of gold, as the market could not support everyone selling their gold. This actually makes Gold a horrible safe-haven asset. Schiff's argument that gold has "rarity, durability, fungibility, divisibility, and portability" is irrelevant, as it holds no intrinsic value to you and me. It's not as if Gold is a perpetual food source. It's not as if I can buy food with gold. The fact that gold can sit in my safe forever and be easily split and moved is irrelevant as we do not live in a medieval economy that uses gold as a currency.

Moving on to Schiff's next argument, "Paper Currencies Increasingly Shaky." We see assumptions that are even further away from reality. Schiff claims that the financial crisis unfolding in Europe is about to spill over to the United States. This is a strong assumption, but not impossible.

Schiff then assumes that when the Euro-Zone crisis expands to the United States, the US dollar will collapse in value. Again, this is a strong assumption, but not impossible.

Schiff then assumes that as the US dollar is collapsing in value, central banks in "productive nations" will revert to a gold standard (even though he just called all governments currency manipulators in pursuit of reckless spending). This reversion to a gold standard will lead to a spike in the price of gold. According to Schiff, private citizens are already leading the way to this new reality!

This assumption is absurd, to say the least. Governments, both productive and non-productive, will continue to move away from a gold standard as it makes no sense (unless, of course, you happen to own gold). The United States lead the way in the 1850's "greenback" movement and the rest of the world will continue to follow. The idea of a currency backed by gold is absurd, since gold holds just as much intrinsic value as a piece of paper. You can't eat gold. You can't sustain on gold.

Gold is very much the world's first fiat currency. It was a fiat currency for so long, people like Schiff believe it's the real thing. It's not.

In Schiff's final argument, "The Global Debt Bomb", Schiff makes a very accurate assumption that government deficits will continue to run away and these run away deficits will be financed by Central Banks printing more money. By printing more money, the Central Bank will decrease the value of the currency and will cause runaway inflation. This is true and I believe we will see very high inflation in the future. The problem is that Gold will not increase in value during this period of runaway inflation.

As I calculated in my March 24th post, if the GLD etf where to decrease to $53.97(it's currently at $166.05), it would have been even with inflation since 2004. Gold has far outpaced inflation, as speculators like Schiff drive the price up. Even when gold drops in value, nothing says it should move with the value of inflation. After all, do you need gold to survive?

It's becoming obvious that Gold is slowly becoming the biggest ponzi scheme of all time. This time no one will be locked up, no one will go on trial and millions of investors will have their investment portfolios hit hard.

For those of you who disagree with me, comment below! I'd love to find a flaw in my logic.

If you don't have a plan, please raise you hand

2012-11-28T22:43:00.000-05:00

Breaking News:

Many corporations have no long term plans

Sure, they have pretty graphics in their annual reports. They have catchy slogans that all of their new-hires are told about. They have mission statements in their lobbies.

But they have no long term plans.

This harsh reality has been highlighted in the past week as companies across the board have decided to declare special one-time dividends to their shareholders. This was done because of the looming "fiscal cliff" which could dramatically increase tax rates on dividends.

CEOs that are issuing these one-time special dividends are admitting to having no long term plan for the cash on their balance sheets and are quite simply saying, "Hey folks, we have some extra cash on our balance sheet, so we figured we should throw you a bone before tax rates go up."

This is worrisome and I have issued a moratorium on all companies issuing these one-time dividends as a result.

Company Management should be focusing on one thing, their company. Ensuring that their investors get a lower tax rate on their dividends should not be on any CEOs to-do list. Although unlikely, it worries me to think what would happen if one of these companies where to declare bankruptcy. Investor negligence lawsuits would surely pierce the corporate veil and lead to a disastrous situation for company management.

All told, investors should be focused on the long term and focused on companies with confidence in their business. Companies sending out big payments ahead of a possible tax increase should be avoided, as company management is telling shareholders, "take this cash, we can't reinvest it in our business, we figured you could use it better."

Turning revenue into earnings

2012-11-26T23:20:00.001-05:00

How would you like to own a company that takes 100 pennies in for sales and gets to pocket 1 penny.

Sounds rough, right?

I'll say... But plenty of investors are perfectly content with these businesses. Which investors are they? Investors in retail.

Take for instance the retail giant Walmart.

In the 3rd quarter, Walmart took in a staggering $113 billion in revenue. Despite bringing in this incomprehensible amount of revenue, Walmart was able to only pocket $3.64 billion in earnings.

Walmart brought in 100 pennies and was able to pocket a little more than 3.

This is, wildly enough, not bad for retailers. Take for instance Sears, which took in $8.86 billion in revenue during the 3rd quarter, but posted a net loss of $498 million. They brought in 100 pennies and had had to pay out 5 1/2 pennies in order to stay in business.

Even going to an online retailer, Amazon, which doesn't have the extensive overhead that's killing Sears and Walmart, one is met with disastrous financials. Amazon took in $13.81 billion in revenue and posted a $274 million loss. This is nearly as bad as Sears.

Tom, how can this be true? How can all of these retailers be operating on such tight margins? How will they survive?

They won't.

Like the airlines over the last 30 years, lots of retailers will go through bankruptcy, discharge their debt and take their investors capital to the grave.

We've already seen the bankruptcies begin with Circuit City, Steve and Barry's, Linens 'n Things and Comp USA. We will see many more.

It's a natural part of the modern economy we've created and investors should be prepared. Only a small amount of retailers will survive bankruptcy and ever fewer will thrive.

One company that will thrive is Pier One Imports, which is in a niche market and boasts a fantastic net margin of 7.1% (bringing in 100 pennies and pocketing 7). It certainly beats Amazon, it certainly beats Sears and it certainly beats Walmart.

Pier One is also interested in rewarding their shareholders, even while their share price grows exponentially. Pier One recently reinstated their dividend and just paid out a 4 cent dividend. Nothing makes me happier than to see Pier One dividends deposited into my account.

Pier One is also showing much better cost control than it's peers (no pun intended).

Pier One competitor Bed, Bath and Beyond (BBBY) had a better net margin than Pier One for a long time.

In the 2nd quarter of FY11, BBBY had a net margin of 9.91%, which was far superior than Pier One's 4.9%. But Pier One has greatly improved, to 7.1%, while BBBY has declined to 8.65%.

As this gap narrowed, the market rewarded Pier One shareholders. Pier One has been up 39% YTD, while BBBY has been up 0.27% YTD.

Very few winners will be out there in retail and investors in the likes of Amazon, Sears and Walmart are in for a rude awakening. After all, who wants to pocket 1 penny for every 100 you bring in?

Investors using arithmetic

2012-11-17T21:53:00.002-05:00

Arithmetic.

Bill Clinton fans will be quick to put on a smile whenever they hear the word.

It has been widely used in the presidential election (both in reference to Mitt Romney's tax plan and in reference to our growing national debt).

But it has not been used in analyzing the action in the financial markets since election day.

Many news sources reported that the post-election selloff was a result of Obama's reelection and continued worries over the fiscal cliff.

In reality, it was just investors hitting that sell button to lock in capital gains for stocks (and stock indices) that have been up.

Year-end selloffs happen routinely and will always occur, notwithstanding any year-end fiscal cliff (although it is more pronounced, since capital gains rates are set to be increased when we fall off the fiscal cliff).

People forget that the S&P 500 has been up 8% YTD (13.47% as of the open on election day). The fact that investors where pocketing 8-13% gains in the S&P 500 should not be a surprise and should be viewed as a sign of a healthy market.

This leads us to the question of weather or not the market is currently oversold. Looking at the facts and figures, I'm going to reserve my judgement on the current S&P 500 valuation.

There remain a number of outstanding issues between now and 2013. First off, some companies have yet to report 3rd quarter earnings and the 4th quarter could be turbulent for a lot of companies. Additionally, the market is currently susceptible to short term shocks as our representatives in Washington resolve the looming fiscal cliff (and the debt ceiling, which is once again close to being met).

The fiscal cliff is an unprecedented event for the financial markets and I am currently owning only my "buy and hold forever" stocks (namely, Siemens and CSX) and a few other value stocks (including my recent recommendation of XLU and the NY Times).

Investors buying speculative stocks or stocks with uncertain futures face the possibility of big downside. Investors in the NY Times, Siemens and CSX can sleep at night knowing that the firms will remain a great investment regardless or what happens between now and 2013.

The Good, The Bad and The Ugly

2012-11-12T18:22:00.000-05:00

Talk to any teenager about the Stock Market and they're sure to tell you that you're supposed to buy low and sell high. The teenager is correct.

Even though teenagers know it, this age-old doctrine is often ignored by investors during a time of crisis. All too often investors dump stocks during a period of falling prices and often times they are wrong.

Keeping this teenage advice in mind, lets turn our attention to some stocks that have sold off recently.

The first is the SPDR Utilities ETF (ticker: XLU) and the second is Consolidated Edison (ticker:ED). XLU has been falling precipitously since Hurricane Sandy hit the east coast. Below is a chart of XLU:

XLU has dropped 7.31% since November 1st. This drop is unprecedented for XLU, which is one of the least-volatile ETFs out there (recording a 3 year beta of 0.28 according to yahoo finance).

This drop in XLU is giving investors a great yield of 4.14% (which is based on last Friday's data on SPDR's website).

Given the drop in this "risk off" asset, combined with the drop in the overall market (and the absence of firm-specific risk), I think XLU is a great investment going into January (given the impending doom relating to the Fiscal Cliff).

Moving our attention to Con Ed (Ticker: ED), we have seen an even steeper selloff. Con Ed has dropped 8.8% since November 1st. Below is a chart of Con Ed:

This selloff in ED is more to be expected given the firms exposure to the NY region. ED is currently giving investors a slightly higher yield than XLU (4.44% vs. 4.14%) and ED has a strong history of growing their dividend (increasing their dividend every year for at least the last 20 years). ED's 2012 dividend of $2.42 is more than supported by the firms $6.00 in annualized 3rd quarter earnings.

Turning to the hurricane, we see that Con Ed Management has estimated that the Hurricane (and related events) will impact earnings by $425-$550 million. This hit is noticeable, as Con Ed only had $69 million in cash on it's balance sheet on September 30th and (when using the $550 figure), and it represents 66% of it's earnings YTD.

Aside from the hurricane, Con Ed also has issues with it's debt, as it's current ratio currently sits at a dismal 0.87 (meaning for every dollar in current liabilities, they only have 87 cents in current assets).I could easily see Con Ed suspend it's dividend for the 1st quarter of 2013 (as the firm looks to conserve cash).

These poor financials for Con Ed easily could see it's credit rating drop into the "Junk" category as S&P currently gives the firm a rating of BBB+ (just above junk status). A downgrade would cost investors as the firm incurs additional interest expense in relation to their gigantic debt load.

Con Ed's Debt to Equity ratio is currently 2.35 (which is very high) and should be of concern to investors. However investors have mainly ignored these poor fundamentals, as investors simply focused on the firms growing yield. This is a grave mistake and will end up hurting investors over the long term.

In conclusion, an investment in XLU would be a wise choice in these turbulent markets (going into the start of 2013). An investment in Con Ed is a poor choice, given the firms financial position (both due to the Hurricane and due to the firms balance sheet prior to the hurricane).

Everything is hervorragend at Siemens

2012-11-11T18:08:00.002-05:00

What happens every day?

The sun rises. The sun sets. And Siemens makes a lot of money.

How much money is Siemens raking in these days?

Well in the recently reported fiscal 4th quarter, Siemens reported earnings of €1.39 per share compared with €1.34 in the previous years quarter. Siemens 4th quarter results look even better when compared with the €0.94 in earnings during the 3rd quarter.

This strong financial performance is rewarding shareholders as the company continues to aggressively buy back it's undervalued shares and increase their dividend (which is set to be paid out in January).

Siemens shares continue to carry an attractive valuation. Siemens German Shares (which mirror the American ADRs trading under the ticker SI) trade at 14.4x annualized 4Q earnings.

This is an attractive valuation when compared to other high-yielding conglomerates like GE and Honeywell.

GE, which offers investors a 3.2% yield (compared to 2.8% at Siemens), trades at 15.9x annualized 3Q earnings.

Honeywell, which offers investors a 2.7% yield, trades at 14.55x annualized 3Q earnings. Although this ratio is virtually equal with Siemens, Honeywell does not grow their dividend nearly as much as Siemens (SI has grown it's dividend 23.42% annually since 2007 compared with 9.84% growth from Honeywell). Additionally, Siemens offers a more focused approach to their business model than Honeywell and GE.

Siemens remains an outstanding "buy and hold forever" stock that I plan on being in my portfolio for the next 5 years. As I stated in my original recommendation of Siemens shares, The Germans know how to do it right.

A reminder why now is the time for the NY Times

2012-11-04T23:05:00.003-05:00

Like most New Yorkers, I've spent most of last week glued to the TV and my laptop following Hurricane Sandy. As I speak, I have my TV Turned on to the PBS News Hour (the only news program I enjoy watching) and I have 3 tabs open on my web browser, Facebook, Gmail and NYTimes.com.

If the internet where to shut down tomorrow and I could only have access to 3 websites, it would be these 3, without doubt. Of these 3 companies (Facebook, Google and The NY Times), the NY Times is certainly the oldest and most storied franchise. It is also the best stock to buy right now.

The NY Times is over 150 years old and has a history as rich as NY City itself.

Originally founded in 1951, The NY Times has been awarded 108 Pulitzer Prizes for coverage of a wide array of events (from the Pentagon Papers to the Elliot Spitzer sex scandal).

Despite this rich history in american culture, the NY Times is in a period of transition from the paper format used over the last 150 years to the online version that is currently in demand. As stated on the NY Times Website, "The New York Times Company is continuing to make the transition from an enterprise that operated primarily in print to one that is increasingly multiplatform in delivery and global in reach."

This transition (combined with the last recession) has lead to an unprecedented drop in NYT stock. Below is a chart of NYT (over the last 5 years):

The performance of NY Times shares, as you can see, have been good this year so far (opening the year at $7.98, currently up 10.03%). However the shares got clobbered this week as the company reported 3rd quarter earnings. On Wednesday, NYT declined from $9.99 to $8.31 as the firms 3rd quarter earnings disappointed analyst expectations.

NYT reported a 3rd quarter loss of 1 cent (excluding special items) compared to a loss of 1 cent in last years 3rd quarter. This 3rd quarter earnings report by NYT (which also includes other publications like the Boston Globe) was not a surprise, after Google reported a less-than-perfect 3rd quarter (mainly due to ad revenues).

Both Google and the NY Times are very much advertising companies, with Google deriving most of it's revenue from advertisements and the NY Times deriving 41% of their 3rd quarter revenue from advertisements.

Unlike Google, NYT is currently sitting at it's low-water mark for advertising revenue. This quarters $182 million in Advertising Revenue is 8.9% lower than last years 3rd quarter. Over the last 5 quarters, NYT's advertisement revenue has never dipped below the $200 million mark. Management attributes the weak results to poor confidence in the marketplace (mainly in the financial and entertainment categories). Company management was keen to point out that this decline was not because of consumer discretionary (luxury) ad sales, which are harder to rebound from.

As our country avoids the looming "fiscal cliff" and finds out who will be president for the next 4 years, this ad revenue should rebound.

The decline in advertising revenue has been mitigated by the phenomenal growth in circulation revenue, which grew 7.4% year over year. In my original recommendation of NYT (on February 8th) I highlighted this positive trend in circulation revenue, which has lead the companies stock 19.13% since my original recommendation (relative to a 4.71% gain in the S&P 500).

I would continue to hold on to NYT over the long term as this 150 year old franchise adapts to the new media climate in 2012 and returns cash to shareholders.

The time for Google has come to an end

2012-10-22T18:40:00.001-04:00

When Google initially reported earnings last week (and a quick check on my Google phone revealed that the stock was in free-fall), I initially thought to myself, "ahh, the stock has been up big and recorded a healthy pullback when it released earnings."

Later in the week, I dove in an analyzed Google's 3rd quarter earnings. Boy were they frustrating.

Google is quick to point out that revenue grew 45% year over year. In the first paragraph of the earning release, CEO Larry Page declares that, "We had a strong quarter. Revenue was up 45 percent year-on-year, and, at just fourteen years old, we cleared our first $14 billion revenue quarter."

While Page's statement is technically true, most of Google's consolidated revenue growth was a result of the merger with Motorola Mobility. When excluding Motorola revenue, the "old Google" only grew revenue 18.68%.

Focusing purely on the revenue side of the income statement makes it look like Google had a good 3rd Quarter (be it with or without MMI revenue). But focusing on the 2nd half of Google's income statement (expenses and earnings) leads to serious concerns.

Google's total expenses grew 70%. This more than negated the extra revenue Motorola added to the combined company and lead to a sharp contraction in the combined firms net income. Google's Net Income declined an unimaginable 25% year over year. This contraction in net income destroyed a lot of shareholder value and made the companies valuation look extremely overpriced.

In the 3rd quarter, Google's Basic EPS declined from $8.44 to $6.64 year-over-year. This means that Google currently trades at 25.55x it's annualized 3rd quarter earnings. This P/E is significantly higher than the P/E of the S&P 500 (which was trading at 15.75x it's actual Q2 earnings at the end of Q2).

Given the fact that Google has been up 29.2% since my initial recommendation on May 30th of 2011 (compared to a gain of 6.41% in the S&P 500), I think now would be a great time to cash out on Google, especially given this recent earnings report.

A company "in vogue"

2012-10-05T20:31:00.000-04:00

Big news: Wall Street Analysts like Pier One Imports

After being originally recommended on March 4th, 2011 (right here on Investing: Decoded), Pier One has been a high-flying stock, up 101.42% (including the firms recently reinstated dividends)

This big gain has caught the attention of Wall Street analysts like Brian Nagel of Oppenheimer. Nagel recently raised his price target on Pier One, bumping it up to $25 (from $20). According to Nagel, "Key initiatives such as the recent launch of e-commerce should serve to further drive sales at the chain from still depressed levels back to prior peaks and beyond."

Nagel is not alone on the street, on June 13th Jefferies rated the company as a buy, saying it's one of the best names in retail.

All of this optimism is not baseless.

Pier One is, in my estimation, is going to be trading at (at least) $25 at the end of next years 2nd quarter (which is a 26% upside to Friday's closing price).

Reviewing Pier One's most recent earnings release would make any CEO or Wall Street Analyst drool.

Pier One grew their EPS a staggering 78% Year over Year in the 2nd quarter. This growth in earnings was not because of one-time gimmicks or silly accounting maneuvers. This earnings growth was because of margin expansion and explosive sales growth. Pier One's already-high gross margin increased from 39.6% to 41.22%. This gross margin of 41% is extraordinarily good in retail and is set to continue Pier One's great earnings growth.

Assuming 30% earnings growth over the next year for Pier One and 6% growth in Pier One's P/E ratio (which has climbed from 18.63x to 19.84x between the 2nd quarter of last year and today), Pier One will be a $27.34 stock at the end of next years 2nd quarter. When a very a conservative analysis, leads to a price target that is 37% higher than today's closing price, one know's that this investment is probably a great choice.

Tom, how will Pier One grow earnings another 30%? Their revenue is at levels not seen since 2008!

Through lower store costs and through e-commerce.

Pier One has been virtually extinct from selling goods online. This creates a lot of upside for the company, as company management has been investing heavily in e-commerce. This, combined with management's aggressive 3 year growth plan, which would increase sales per square foot, should easily make Pier One a $25 stock (if not higher).

Continue to stick with Pier One. If you haven't owned it since $10, now would be a great time to get in on future gains in this profitable retailer.

A wise piece of advice from the "smart money"

2012-09-30T19:06:00.002-04:00

There's lots of noise out there in the financial markets.

From a countless number of financial news sites, to leagues of financial advisers, to the barber shop down the street.

Sometime this noise is just that, noise (especially when it's at the local barber shop). However, sometimes this noise is a good piece of advice and should be taken into account when managing your investments.

One important piece of news that recently broke is that Goldman Sachs strategists expect the looming "fiscal cliff" to hit stocks hard going into the 4th quarter. Here is a short excerpt of the article article (courtesy of Yahoo Finance):

Goldman chief U.S. equity strategist David Kostin writes that the S&P 500 should fall sharply after the election when investors finally realize that there is a possibility that the so-called "fiscal cliff" will not be resolved smoothly. He says the majority of investors expect to see the fiscal cliff avoided in the lame duck session of Congress, but Goldman sees a one-in-three chance that Congress will fail to address the issue.

A good explanation of the budget sequester (which is part of the so-called "fiscal cliff") is provided by the Washington Post:

It’s a package of automatic spending cuts that’s part of the Budget Control Act (BCA), which was passed in August 2011. The cuts, which are projected to total $1.2 trillion, are scheduled to begin in 2013 and end in 2021, evenly divided over the nine-year period. The cuts are also evenly split between defense spending — with spending on wars exempt — and discretionary domestic spending, which exempts most spending on entitlements like Social Security and Medicaid, as the Bipartisan Policy Center explains. The total cuts for 2013 will be $109 billion, according to the new White House report.

Under the BCA, the cuts were triggered to take effect beginning Jan. 1 if the supercommittee didn’t to agree to a $1.2 trillion deficit-reduction package by Nov. 23, 2011. The group failed to reach a deal, so the sequester was triggered.

Legislators don’t have any discretion with the across-the-board cuts: They are intended to hit all affected programs equally, though the cuts to individual areas will range from 7.6 percent to 9.6 percent (and 2 percent to Medicare providers). The indiscriminate pain is meant to pressure legislators into making a budget deal to avoid the cuts.

This fiscal cliff, combined with the European Debt crisis and the stellar performance YTD of the market (with the S&P 500 up 14.44% YTD), leads me to label this market a sellers market. Since this is a sellers market, it is wise to hold off on most investment opportunities and consider selling some that have been outperforming the market.

Of those investments I have previously recommended that may warrant selling today are names like Dr. Pepper Snapple (ticker: DPS), the New York Times (ticker: NYT) and Stanley, Black and Decker (Ticker: SWK).

Dr. Pepper Snapple(ticker: DPS) was originally recommended on March 9th and has been up 17.8% (compared to the 4.65% gain in the S&P 500). Technically, I could easily see Dr. Pepper Snapple falling to $41.27 (where it's 200 day moving average currently stands). This would be a 7.3% decline from Friday's closing price level. This is ample cause to go out and sell DPS for the next few months, especially since they just paid out their dividend.

The New York Times(ticker: NYT) has been up 32.43% since my recommendation on February 8th (compared to the 6.49% gain in the S&P 500). Technically, the NYT has rallied significantly and formed a consolidating pattern around $9.50. There is the potential for some upside in NYT, but the absence of a dividend and the turbulent news ahead leads me to drop this company (albeit temporary) from my portfolio and pocket the 32% gains.

Finally, Stanley, Black and Decker(ticker: SWK) has been up 6.91% since my recommendation on January 26th (compared to the 9.17% gain in the S&P 500). SWK's under-performance is not concerning as the firm has recently raised it's dividend and has an offer from Spectrum for it's Stanley unit. This purchase (which is expected to be for at least $1 billion) will give SWK a big gain over it's purchase price and will return more cash to shareholders. Turning to the charts, SWK is very strong as it breaks through key levels of resistance at around the $72 and $77 price points . However as SWK consolidates around $77, I see a small decline in the future as investors look to pocket the big gain since the summer. Additionally, SWK has a slightly higher than normal beta (1.65 as measured by yahoo finance) and will likely see bigger declines than the overall market (when we get a broad pullback).

It's been a good year for the S&P 500, now is a great time to pocket some big gains.

(note to investors who may be concerned about taxes: all of my trading is done in a roth ira and is not subject to any taxes, therefore, no prejudice is placed on inuring income taxes vs. capital gain taxes in my investment strategy. Selling an investment held for less than a year in a regular, non-retirement, account may not be wise, as it may be subject to the income tax.)

Hunting for yield in a low yield environment?

2012-09-23T19:01:00.000-04:00

I recently had a discussion with a few investors about how they are searching for yield in their portfolio. With the 10 year treasury bond yielding 1.76% (as of Friday) and the yield on the S&P 500 at 1.91%, it is certainly a tall feat for any investor in 2012.

Investors have been pouring money into high yielding assets at an unprecedented rate. And asset managers like iShares know it. Case in point, a quick visit to the iShares website, one is immediately bombarded with an advertisement about the companies high-yield ETF products:

Since it's inception on 4/1/11 the iShares High Dividend Equity Fund (Ticker: HDV) has been up 21.4%, this compares with an increase of only 10.86% in the S&P 500 (as measured by the SPY etf).

This historic outperformance has been echoed in other ETFs too, including the SPDR Utilities ETF (Ticker: XLU), which is up 14.71% (between 4/1/11 and Friday's close). Very rarely does one see Utilities outperforming the S&P 500 in an up market.

When looking to beat out the yield in the S&P and the yield on the 10 year treasury, many investors turn to high-yielding companies like Waste Management, which pays out a generous 4.37% yield.

Based in Houston, Texas, Waste Management(Ticker: WM) is more than your average garbage company.

Waste Management only derived 61% of it's 2nd quarter revenue from it's waste collection business. The other 39% is coming from business lines such as landfills, recycling and WM's innovative Wheelabrator division.

Tom, what the heck is their Wheelabrator division?

It's the next big growth engine for Waste Management.

Wheelabrator is a company based out of Saugus, MA that was founded in 1975 to convert trash into energy. Wheelabrator does this by burning trash, generating steam and converting the steam to electricity. Wheelabrator just one of Waste Management's countless number of acquisitions. The division (which includes much more than the Saugus, MA firm) accounted for 6% of WM's 2nd quarter revenue.

Revenue from WM's Wheelabrator division is generated from the electricity the division pumps back into the electric grid. The price of this energy is largely correlated with Natural Gas prices (which have fallen precipitously, but have started to stage a small rebound). Here is a chart of Natural Gas prices (as measured by the UNG ETF):

As a result of Natural Gas price declines, revenues at the Wheelabrator division have fallen over the last few years as the divisions price-hedge contracts expire. Year-over-year, 2nd quarter revenue at the Wheelabrator division fell 8.85%, but this was far less than the 50% decline in Natural Gas prices. WM Management provides excellent commentary on this division in their most recent 10-K:

As of December 31, 2011, we owned or operated 17 waste-to-energy facilities and five independent power production plants, or IPPs, which are located in the Northeast, in the Mid-Atlantic, and in Florida, California and Washington.

At our waste-to-energy facilities, solid waste is burned at high temperatures in specially designed boilers to produce heat that is converted into high pressure steam. As of December 31, 2011, our waste-to-energy facilities were capable of processing up to 22,300 tons of solid waste each day. In 2011, our waste-to-energy facilities received and processed 8 million tons of solid waste, or approximately 22,000 tons per day.

Our IPPs convert various waste and conventional fuels into steam. The plants burn wood waste, anthracite coal waste (culm), tires, landfill gas and natural gas. These facilities are integral to the solid waste industry, disposing of urban wood, waste tires, railroad ties and utility poles. Our anthracite culm facility in Pennsylvania processes the waste materials left over from coal mining operations from over half a century ago. Ash remaining after burning the culm is used to reclaim the land damaged by decades of coal mining.

We generate steam at our waste-to-energy and IPPs facilities for the production of electricity. We sell the electricity produced at our facilities into wholesale markets, which include investor-owned utilities, power marketers and regional power pools. Some of our facilities also sell steam directly to end users. Fees charged for electricity and steam at our waste-to-energy facilities and IPPs have generally been subject to the terms and conditions of long-term contracts that include interim adjustments to the prices charged for changes in market. Conditions such as inflation, electricity prices and other general market factors.

During 2010 and 2009, several of our long-term energy contracts and short term pricing arrangements expired, significantly increasing our waste-to-energy revenues' exposure to volatility attributable to changes in market prices for electricity, which generally correlate with fluctuations in natural gas prices in the markets in which we operate. Our market-price volatility will continue to increase as additional long-term contracts expire. The next long-term contract will expire in March 2012. We use short-term "receive fixed, pay variable" electricity commodity swaps to mitigate the variability in our revenues and cash flows caused by fluctuations in the market prices for electricity.

As you can see, Company management is cognizant of the price fluctuations in the marketplace for Natural Gas (which is correlated with electricity prices). This savvy risk management will pay of over the long run for shareholders, who are about to see enormous growth in this division, as a result of rising energy prices and growth through international acquisitions.

In 2010, Waste Management expanded it's Wheelabrator division into China through a joint venture with Shanghai Chengtou Group. This gives investors some additional geographic diversity previously absent in WM and exposure to emerging market growth.

Turning to WM's financial statements, WM's most recent earnings release leads to a few questions that are easily resolved by company management

One area of concern is the year-over-year decline in the companies net income (which was mainly caused by a bump up in operating expenses). This bump up in operating expenses was caused by increases in labor costs and increases in expenses in the companies Oakleaf division.

Oakleaf is a subsidiary acquired in the summer of 2011 which is another area of growth. Oakleaf provides waste and recycling services for companies through their 3rd party network of hauling companies.

Let's say I'm a big national chain like CVS Caremark (one of Oakleaf's clients since 2005). I have lots of garbage to haul, from my stores in Florida to my stores in Maine. Oakleaf provides "one stop shopping" for all of my waste management problems, nationwide. Oakleaf does this by subcontracting out to local haulers, making a profit from the spread between when they get from CVS and what they pay Joe's Garbage Inc.

In the 2nd quarter, Joe's Garbage decided to start charging Oakleaf more, leading to a drop in profit for Oakleaf (and WM). This rise in expenses will soon be negated by revenue increases and thus should not be a big red flag for Waste Management investors.

Reviewing the rest of Waste Management's 2nd quarter earnings release, one sees that other, one-time charges contributed to the decline in the firm's net income, including charges for divestitures, asset impairments and unusual items. This is to be expected as WM adds to it's core business through acquisitions and does not raise big red flags.

Looking at WM through a valuation perspective, we see a firm that is fairly valued to somewhat overvalued. At Friday's closing price of $32.48, WM trades at 18x it's annualized 2nd quarter earnings. This is higher than it's P/E ratio of 15.4 a year ago today and this is higher than the S&P 500's P/E ratio of 14 (based SPY's P/E ratio as of August 31st).

Given this high P/E ratio and the firms stagnant (to declining) earnings growth, I feel WM would be a great addition to your portfolio, when the price falls. Below is a chart of WM's price over the last 18 months:

Technically, Waste Management has formed a "falling knife" pattern, which is never a good time to buy a stock. This falling knife pattern is likely to send the stock to it's lows set in July (at $31.07). Holding this low will be key for Waste Management, as the net level of support is at the $29.90 level, which the stock held last fall. Ultimately, I feel that $28 is a good price for investors to buy Waste Management, as that would value the firm at 15.5x it's annualized 2nd quarter earnings and give the firm a 5.1% yield.

Given the turbulence going into the end of 2012 (and the so called "fiscal cliff") a big pullback in names like Waste Management is not unrealistic. That's why I would hold off on Waste Management right now, when it hits the $28 mark (assuming no changes in the fundamentals), I would go in and purchase some shares.

Like a bull in a china cabinet

2012-09-09T18:25:00.004-04:00

Has anyone noticed Siemens recently?

The company has rallied 26.8%, since it traded at the bargain price of $77.88 on June 28th (based on Friday's closing price of $98.77). I love it when a stock I own turns into a bull in a china cabinet (with the companies short-sellers being the china in this case).

As I highlighted in my article on May 22nd (when Siemens was trading at ~$85), Siemens is a "buy and hold forever" stock, that has a very strong business model and solid revenue, earnings and dividend growth. It's financial statements bring tears of joy.

Speaking of tears of joy, customers in Siemens' healthcare division are in tears of joy (case in point, this video on the prosthetic division at Siemens). Government customers in Siemens' clean energy division are in tears of joy thanks to engine oil recycling facilities (highlighted in this video).

Enough of the tear jerking videos and onto a more important topic. Why is Siemens better than (american born) GE?

The fact of the matter is that both companies are vastly different. Siemens has 3 key business channels (highlighted in my initial recommendation of the company) that look to profit from 4 big trends going on in the world. From my initial recommendation:

Siemens can be viewed as simply as a firm leveraged for growth with respect to macroeconomic trends. Siemens does this through focusing on 4 macroeconomic trends, Globalization, Urbanization, Climate Change and Demographic Change.

How is a $85 billion conglomerate going to leverage itself for these trends? Simple, through Healthcare, through Energy and through Industry.

GE, on the other hand, is far more complex. The company lacks focus, as highlighted in an excerpt of their 2011 shareholder letter:

GE is a “We Company,” not a “Me Company.” We want people who listen more than they talk. We want leaders who build teams. Bob Santamoor represents labor; he is the Chairman of the IUE-CWA GE Aerospace Conference Board. We have worked together for years. We don’t agree on everything, but we respect each other. When we meet, we talk about jobs. We need each other to be successful.

We made the decision to invest $1 billion in our Appliance business, modernizing our factories in the U.S. Our first two new products will be introduced early in 2012, with other major launches throughout the next two years. Most of our appliance product manufacturing will move back from China and Mexico to the U.S. We think we can make more money and serve our customers better. We also think this will make us a better manufacturing company in every corner of the world. But it is only possible because our designers, factory workers, managers and marketers work together. GE is a “We Company.”

We are solving problems, tough problems. We are in the seventh year of a clean energy business strategy called ecomagination. Clean energy goes in and out of focus for governments and consumers. But, at GE, we are steadfast in our investing. In 2011, we had $21 billion of clean energy revenue, growing twice as fast as the Company average. Ecomagination drives growth because we are solving problems for our customers. At coal mines, from Pennsylvania to Peru, our water solutions allow customers to operate productively while achieving high environmental standards. We demonstrate every day that, through innovation, we can meet societal needs and do it profitably.

GE sounds like the conglomerate Jack Welch intended it to be, investing in everything from coal mines, to appliance plants and (although not mentioned in the letter) financial services. I'm not comfortable investing in Jack Welch's GE, as it's impossible for the firm to provide enough transparency to it's investors.

Financial Services remains a big part of GE, bringing in 31% of the firms 2nd quarter revenue and bringing in 50% of the firms 2nd quarter earnings. The financial services arm of GE has been killing the firms revenue, as the non-financial services part of GE grew revenue 9.57% year over year and the financial services arm saw a 7.89% contraction in revenue, leading to overall revenue growth of only 2.46%.

It would not surprise me to see GE spin off it's financial services arm in the future and once they do that, I may consider the stock (with an updated vision from company management).

Until then, I simply see Siemens as a far superior investment choice.