Lehman on Investing

Individual Investors Do Stand a Chance

2013-02-08T13:47:00.000-08:00

It is understandable that many individual investors have given up on investing in the stock market. The Wall Street crowd has gotten rich over the years, while their clients often were left holding hyped investments that rose amid euphoric markets, but which fell sharply when more sober judgments prevailed. After the stock market collapses from 2000-2002 and again from 2007 to March 2009, who can blame individuals for looking elsewhere for investment opportunities. After the financial collapse of 2008, individuals have withdrawn several hundred billion dollars from equity mutual funds.

But individual investors should not give up, as they do indeed have a chance to earn respectable returns. The media are filled with advice and forecasts from economists, investment strategists, security analysts, and fund managers. But when it comes to investing, the forecasts rarely work out. Investors are usually better off going contrary to the conventional wisdom. After all, in order to "buy low and sell high," one must go against the popular mood--even among the supposed experts--since, when the mood is gloomy current conditions are bad (but assets are depressed in price and are cheap). Conversely, when the mood is euphoric current conditions are good (but assets have already risen sharply in price and are consequently expensive). Starting price matters in investing.

Entering a market that is expensive leaves poor odds for success, and entering a depressed market leaves much better odds and a margin for error (some say "margin of safety"). It's like trying to swim down a river that has a current of 10 miles per hour. When one buys into a market that is historically cheap (undervalued) or is out of favor, it is like having the current at your back. It would be easy for most of us to float down the river with the 10-mile-per-hour current at our backs. If, however, one buys into a market that is historically expensive (overvalued), it is like trying to swim against the current of 10 miles per hour. Not many of us would be able to make progress against such a stiff current.

One of this era's most esteemed investors, Warren Buffett, has said that individuals don't need superior intelligence to be good investors. They instead need superior temperament, specifically the ability to go against the crowd and to be patient. He has likened investing in stocks to being at the plate in baseball but not having any strikes being called. Under such conditions, the batter can wait until a "fat pitch" crosses the plate before swinging.

The antithesis of the individual investor is probably the hedge fund investor. Hedge funds are unconstrained funds run by supposedly the most savvy investors in the business. Some, such as Bridgewater Associates, have tremendous long-term returns. But like with mutual funds, most have only pedestrian returns and are not worth the high fees that are charged.

What happened to these purported masters of the investment universe? In 2012, hedge funds on average returned only 6.7%, versus 17% for global stock markets (the MSCI All-Country World Index). In the U.S., the S & P 500 returned 16%. This was the fifth time in the last seven years that hedge funds have trailed major stock market indexes. It is true that hedge funds don't invest in just stocks, so that might be an unfair comparison. But an investor who simply used stock and bond index funds last year in a 60% stock index/40% bond index portfolio, would have returned 12%, nearly double the return generated by the average hedge fund.

Goldman Sachs estimates that the average hedge fund return over the next five years will be only 4-5% per year. Given that and the historic record of hedge funds, why have the richest individuals and many endowment and pension funds invested so much money in hedge funds, which have total assets of $2.2 trillion?

I used the 60% stocks/40% bonds example to make a point. But I do not endorse the practice of having a fixed allocation among stocks, bonds, and other assets at all times. It makes no sense to have a fixed percentage in stocks, regardless of whether stocks are historically cheap or expensive. (Remember the analogy of swimming down a river.)

That doesn't mean that one needs to be a market timer either. Just pay general attention to the prevailing mood (market sentiment), whether markets are depressed in price or "frothy" after an extended rise in price, and whether the investment is cheap or expensive (based on e.g., its dividend yield or earnings multiple) versus its history.

And forget about the expert forecasts.

Steve Lehman
LehmanInvest.blogspot.com/

The Individual Investor Is Back--Only to Be Walloped Again?

2013-01-28T07:48:00.001-08:00

After withdrawing more than four hundred billion dollars from equity mutual funds over the past several years, mutual fund investors in the last several weeks have made the largest purchases of equity funds in years.

If investors are moving funds from bonds to stocks, I understand the motivation. Bonds have been in a bull market for more than thirty years, while stock markets have been challenging over the past 10-13 years. Most bond funds have negative returns in this first month of 2013, and I expect relatively modest returns--or even losses--from bonds ahead. But to move from cash to stocks now, after a more than doubling in stock market returns over the past four years, I wonder whether mutual fund investors are again chasing performance, as they did in 2000 at the multi-decade peak in the stock market or in 2007 and 2008.

I consider most stock markets to be quite risky for new buying at this moment. Sentiment and technical measures reflect an extraordinarily overbought market with excessive enthusiasm and little regard for risks that might arise.

There are some exceptions. Some individual stocks remain attractively priced, such as Fresh Del Monte (FDP), Alliance Grain Traders (AGXXF), and Vodafone (VOD). I also continue to think that gold and gold stocks (or the GDX exchange-traded fund) are one of the few depressed areas left in the market, along with instruments linked to volatility (such as VIXY). Otherwise, I strongly think it is a time to realize some gains and step back for a breather.

Steve Lehman
LehmanInvest.blogspot.com/

S & P 500: 1500
FDP: 26.1
AGXXF: 13.2
VOD: 27
GDX: 41.6
VIXY: 12.65

"Operation Barn Door" and Apple

2013-01-24T06:26:00.000-08:00

A former colleague of mine used to quip that "operation barn door" had taken place after an investment decision--usually by senior management--well after the damage had already been done. I see this now with Apple stock.

In response to yesterday's earnings announcement by the company that disappointed many, the shares are expected to open 10% lower today. That would bring the total decline in the stock price to 35% since it peaked at $705 late in the summer before the launch of the iPhone5.

After the company's announcement late yesterday (after the close of the stock market), one prominent analyst reduced his rating on the stock from "buy" to "hold" along with his price target from $800 to $500. Is the stock really worth 40% less than it was an hour earlier?

Yet, that is the behavior of the herd-following analysts (and many portfolio managers). They couldn't get enough of Apple on the way up, as it was a "must own" stock that caused many portfolio managers to trail their index benchmarks because they didn't own the stock--or didn't own enough of it compared to its weighting in the benchmark index. Analysts repeatedly raised their price targets on the stock, and when the stock reached $700, analysts tried to outdo each other in their enthusiasm for the stock, with some setting price targets of $1000.

So less than six months later, with the stock at $465, the same analysts are racing to cut their price targets and ratings on the stock. Again, this is only after the stock has fallen 35%. Thanks a lot for that advice.

The stock now has a p/e multiple on current-year earnings of 9 (or only 7 if the cash on the balance sheet were used to buy back stock). The balance sheet is in superb condition, with cash equivalents equal to almost one third of the company's stock market value. I'd resist the crowd and wade in to buy Apple today.

Steve Lehman
LehmanInvest.blogspot.com/

Apple: $465

Income Sources

2013-01-22T07:57:00.002-08:00

I was concerned a year ago that dividend stocks had become too much in vogue--and historically expensive versus the stock market overall--even though they remained attractive versus bonds. And has usually happens when an asset is relatively expensive, the return on dividend stocks lagged the stock market overall in a strong year for equities.

I think the dividend stocks again are relatively attractive, but on a more selective basis, for income-oriented investors. In Europe, for example, the Euro Stoxx 50 Index is up 33% since mid 2012. Yet, the average dividend yield is 3.5%, while the yield on the 10-year German government bond is only 1.5%. Even compared to corporate bond yields, the average dividend yield is 40% higher than the yield on investment-grade corporate bonds. Both yield spreads are historically high in favor of equities.

So when a stock like Total (TOT) still yields 5.6%, there is value there. GDF Suez (GDFZY) yields nearly 10%, and the stock is down 25% over the past year (and 67% over the past five). I would be comfortable holding both of those stocks. But since I think stock prices overall are likely to decline, I would hedge long positions by going long volatility or purchasing put options on the the major market indexes

Steve Lehman
LehmanInvest.blogspot.com/

S & P 500: 1483
TOT: 52.5
GDFZY: 20.5

Corporate Mergers and Write Offs

2013-01-18T13:28:00.002-08:00

Large corporate acquisitions often seem not to work out. When one company acquires or merges with another, at the time the rationale often is that there will be strategic "synergies," making the combined company more valuable than the companies were worth by themselves. There might be major cost savings from eliminating duplicative overhead. Or there might be economies of scale, as when a broader product line can be sold with the same sales network, or higher output from existing production facilities reduces unit costs. Even though most acquisitions involve a considerable premium over the acquired company's stock price, executives assure skeptical investors and analysts that the takeover will be "accretive," (additive to earnings per share) in the first year--or at least in the second.

But it often doesn't work out that way. It seems that the bigger the merger, the less sense it makes. Take yesterday's announcement by Rio Tinto, the world's second-largest mining company. The company plans a $14 billion writedown of "goodwill" that it put on the books due to acquisitions of aluminum companies, the largest being Alcan for $38 billion in 2007.
Though the company will argue that the $14 billion loss is non recurring and "extraordinary," it still reduces Rio Tinto's shareholder equity by $14 billion.

Rio Tinto's management has written off $29 billion of assets since 2009. The company's stock market value is $77 billion. So, the company has written off an amount equivalent to 40% of its stock market value.

It is for examples such as this that I emphasize actual net income, after the "bad stuff" such as supposedly extraordinary asset write downs. Instead, Wall Street uses "operating" earnings, which excludes such losses. Yet, the balance sheet of a company--which presents the "net worth" of a company (assets minus liabilities) , is weakened by such write downs.

When evaluating stocks to invest in, most of Wall Street prefers to emphasize the income statement of a company's financial statements, specifically "operating" earnings per share. Actually, it's even worse, as analysts forecast what operating earnings per share will be one or two years out--which makes earnings per share in most cases much higher (and the price/earnings ratio lower), so stocks look cheaper than they really are.

I look at all three major financial statements--the balance sheet, the cash flow statement, and the income statement. But I emphasize the balance sheet and the cash flow statement, which are much less subject to manipulation by companies than is the income statement.

Steve Lehman
LehmanInvest.blogspot.com/

More Here Behavior on Wall Street

2013-01-15T06:43:00.000-08:00

Investing isn't easy. And for Wall Street analysts, having public "buy," "hold," or (rarely) "sell" ratings on specific stocks is challenging--and sometimes embarrassing. But an all-too-familiar pattern of behavior by Wall Street analysts is happening again—with likely negative consequences for investors.

There is so much career pressure on these extremely well-paid analysts that they tend to move as a herd. (Just as fund managers often “hug” the benchmark market index they are measured against in order to produce returns comparable to the major stock indexes.)

Unfortunately, the analysts often move after the fact, which doesn't help investors who follow their advice. It is common for analysts to downgrade their ratings and price targets on a company’s stock after bad news is issued by the company (such as a profit shortfall). The problem is the stock price plunges immediately when the news is announced, so it is not possible for investors to heed the advice to sell without taking a major hit to one's proceeds. Or, after a stock has fallen steadily even without a specific news announcement, analysts often give up on it and either cease coverage of the stock or downgrade their rating.

Similarly, the "bandwagon effect" is common with a rising stock. Everyone loves a winner, and a stock that has been a great performer attracts many fans. The supposedly objective Wall Street analysts seem to get just as carried away on the way up--and down--as the broad investing public. Take Apple. Just last summer, as Apple prepared to launch its latest version of the iPhone, there was frenzy interest in the company and its stock. Only four months ago, the stock reached a record of $705 per share. Almost all of the 50 or so analysts covering the stock rated it a "buy” (after it had risen % over the past three years). The Wall Street stock analysts seemed determined to outdo each other with their optimistic price targets for the stock, with some exceeding $1,000 per share. (In contrast, go back to my blog at LehmanInvest.blogspot.com/ and read my warnings about the stock at that time.)

Today, the stock has fallen nearly 30% from its peak, perhaps because of concerns about the profitability of the iPhone5, perhaps because of investors selling shares to book capital gains in advance of higher tax rates. Who knows for sure? The stock is simply down sharply. But in response, today another analyst sharply lowered his price target on the stock (from $660 to $530), after the 30% drop in the stock. Apple stock now sells at 10.5 times estimated earnings per share this year, a sharp discount to the overall stock market. Apple remains one of the world's leading companies, and it is in superb financial condition.

I am generally not a fan of investing in technology companies for a couple of reasons. One, I don't understand the products. Two, technology products can become obsolete virtually overnight, so from a business standpoint, they often don't provide a "margin of safety." But when the stock market is undervaluing a company's stock based on its asset value, earnings, or especially its generation of cash beyond what is needed for normal business operations, I'll consider investing in it.

And even though I think that stock prices in general have risen so sharply--along with enthusiasm among investors-- that makes a decline likely, relative to other stocks at the moment, I would more likely buy a stock like Apple than one like Celgene. Celgene was upgraded to "buy" today by a Wall Street analyst after the stock rose 16% last week (and 36% in the last two months) on the basis of positive drug test results. After all, we want to buy when there is good value in a stock, before a sharp rise in the stock price and sell when there is no longer good value, before a sharp decline in the share price.

Steve Lehman

LehmanInvest.blogspot.com/

Apple: $501

Celgene: $98

Stock Market Correction--Or Worse--Likely

2013-01-14T18:57:00.001-08:00

The evidence of warning signs for a selloff in stock prices continues to build. A spike in selling by corporate insiders and greater optimism by individual investors are the latest signs.

Selling by corporate insiders of their own company shares has spiked in recent weeks. Individual investors, who have been net sellers of equity mutual funds and exchange-traded funds for many months, have become net buyers of stocks. They may be right, but after a doubling in major stock indexes over the past four years, it seems to me that a more prudent course would be to reduce stock holdings now, rather than increase them.

Steve Lehman
LehmanInvest.blogspot.com/

S & P 500: 1470

Go Long Volatility

2013-01-11T07:18:00.003-08:00

I continually search for asset classes or specific investments that are depressed in price, unpopular, or undervalued based on asset values or cash generation.

After major global stock indexes returned more than 16% (including dividends) and almost 4% more so far in January, there are few depressed assets or instruments. Earlier this week I identified gold and gold stocks as providing such an opportunity.

Now I think volatility is another opportunity. There is a high level of complacency, if not outright ebullience, among investors now. This is reflected in the extraordinarily low level of the VIX index of volatility on options linked to the S & P 500 stock index.

High levels of the VIX Index are historically reliable indicators to buy stocks, since the expectation of high volatility in stock prices reflects anxiety (and is a contrarian indicator to buy). The evidence supports buying stocks when the VIX Index is above 30.

Low levels of the VIX, on the other hand, do not have the same empirical support as a market timing tool (in this case as a sell signal). Yet, the current level of 13.5 on the VIX is exceptionally low and, I think, worth "buying." There are several exchange traded funds that are linked to the VIX Index (such as VIXY). These instruments are not appropriate to buy and hold, as they tend to erode over time when held indefinitely. But at current prices, I think they are a worthy speculation and a way to hedge core stock holdings against a broader market decline.

Steve Lehman

LehmanInvest.blogspot.com/

S & P 500: 1470

VIX: 13.5

Buy Gold and Gold Stocks

2013-01-08T06:53:00.001-08:00

Ethical issues about gold mining aside, from a purely investment perspective gold and gold stocks look like a good buy at current levels.

The 12-year bull market in gold might have ended more than a year ago, when its price reached $1,925 an ounce. Its current price of $1,650 is 15% below the peak, yet gold still rose in price last year (though by only 7%). But from a tactical standpoint, both the gold price--and gold stocks--now offer the potential for a rebound.

After a year in which major stock indexes around the world returned about 15%, it is difficult to find asset classes that are depressed enough to offer an attractive return given the risks. I think gold-and especially gold stocks--now offer this.

I do not, however, consider this a "buy and hold" situation. The long-term bull market in gold may indeed be over. But I think there will still be a solid move higher from here.

The prices of the metal and the stocks have fallen sharply, and are now technically "oversold" (and likely to rebound). And key investor sentiment measures indicate levels of pessimism that historically have been followed by large percentage gains in the stock prices. The Hulbert Gold Sentiment index, for example, is now at a level which over the past fifteen years, has been associated with annualized gains on the XAU gold stock index of 60%.

Remember, the best time to buy something is usually when few others are clamoring to do so.

Steve Lehman
LehmanInvest.blogspot.com/

Gold: $1,650

Uptrend, Downtrend, or What?

2013-01-03T08:24:00.001-08:00

The idea that studying graphs of past price movements of a stock or commodity (known as "charting" or "technical analysis") can reveal its future price movements is appealing, since we can't reliably predict the future course of events.

While there have been prominent "chartists" or "market technicians" on Wall Street who have had successful careers, I'm skeptical of the value of technical analysis.

We all have biases as investors. I favor assets that are unpopular and depressed in price, rather than widely popular assets that are already sharply higher in price (regardless of whether fundamental prospects are favorable). When selecting stocks, I favor valuation, financial strength, management quality, and contrarian market psychology, rather than business fundamentals or upcoming profit reports.

I do look at some technical indicators while favoring stocks or assets that are depressed or "oversold" (abruptly lower) in price. However, I have a bias against pure charting, where the name of the company or the commodity is irrelevant to the decision whether to own, not own, or short the asset in question.

My impression over nearly three decades of following markets is that for every example where charting would seem to work in predicting the future price direction, there is another that would not have worked.

A case in point is the use of uptrends, downtrends, and "breakouts." It typically takes so long for an uptrend or downtrend clearly to have reversed direction that by the time it is decisively reversed, the percentage move in the opposite direction is substantial--and often unreliable. That means giving up a significant portion of profits when an uptrend has been reversed by a sharply falling price, or missing a significant gain when a downtrend has been reversed by a sharply rising price.

I noticed in this week's Barron's that as of last Friday, all three Dow Jones indexes--Industrial, Transportation, and Utility--had decisively "broken down," or fallen below the rising line that connects the daily closing prices of each index. Given that supposedly clear signal, one should sell--or even sell short--each index.

But in the first two trading days this week, all three indexes reversed the supposed new downtrend by rising sharply (the Dow Jones Industrials rose 4%). Which is it? Buy or sell? The Dow Jones Industrials declined nearly 4% before clearly breaking down and giving a "sell" signal. Now it has rebounded 4%--and given a new "buy" signal?

I have noticed similar results when studying moving averages, either 50-day, 100-day, or 200-day moving averages of the price of an asset. Sometimes when the price rises above--or falls below--the chosen moving average, it signals a trend reversal. But often it is just price fluctuations that do not indicate a trend reversal. The result is buying and selling and buying and selling, often buying somewhat high and selling somewhat lower, followed by buying back in at a higher price and selling at a lower price. It seem to me that the result often is to "buy high and sell lower," rather than what we're supposed to do: "buy low, sell high(er)."

It may be unfair to assert that charting often causes investors whiplash, as they reverse positions abruptly following broken uptrends or downtrends. It does seem that when an asset builds a "base" by fluctuating at a depressed level for some time but not falling further, it produces significant gains once it "breaks out" by rising sharply. And I realize that dedicated "chartists" would tell me that there is much more to technical analysis than I've presented. Nevertheless, I continue to view technical analysis with skepticism and as only a small input to my investment decisions.

Steve Lehman
LehmanInvest.blogspot.com/

Sell Into This Rally

2013-01-02T05:53:00.000-08:00

The sharp gains in stock prices on Monday and so far today will lift the spirits of investors. After months of tedium following the deadlocked fiscal negotiations in Washington, it was encouraging that the two parties were able to reach an agreement (despite having to pass it on a holiday).

Yet, I wouldn't get carried away. I think this might be a case of the adage, "Buy on the Rumor, Sell on the News." Last year was a solid year for investors, with mid teens returns from many stocks. Any further rebound early this year would seem to offer a prudent opportunity for profit taking and to rebuild cash reserves for better entry points later.

After all, one of the most important lessons in investing is, "Starting Price Matters." And for a growing number of stocks today, the starting price facing investors is not low enough to provide a sufficient margin for error, or "margin of safety."

Steve Lehman
LehmanInvest.blogspot.com/

S & P 500: 1449

Happy New Year!

2012-12-31T07:34:00.000-08:00

Though I am no longer managing a mutual fund portfolio, I continue to enjoy opining about investing through writing this blog. I hope readers find it useful in making investment decisions, whether as professional investors or as amateur investors trying to grow--and protect--one's own portfolio.

This was a year when putting a portfolio in a stocks and bonds using index funds would have produced an excellent risk-adjusted return. I expect that next year will not be so straightforward and that such an approach will yield much more modest returns.

Bonds have continued to produce amazing returns (except for U.S. Treasuries, finally). High-yield bonds (actually more like equities than fixed income) and other corporate bonds have been excellent investments in recent years. The need for investment income has pushed yields to such low levels that further declines in interest rates (which produce capital appreciation in bond portfolios) seem unlikely.

Despite the likelihood of a modest increase in tax rates on corporate dividends, there still are a number of high-quality stocks that have dividend yields that are higher than those on U.S. Government bonds (and shorter-term corporate bonds). I still think the attractive starting dividend yields and likely dividend increases are attractive for investors who need some income from their investments.

After sharp gains in stock markets over the past six months--and even sharper gains over the past four years--I advocate holding some cash on hand for selloffs (and potential buying opportunities) that may arise.

Best wishes for a healthy, happy, and prosperous New Year!

Steve Lehman
LehmanInvest.blogspot.com/

S & P 500: 1405

Stocks: Too High to Buy, Too Low to Sell

2012-12-30T15:16:00.003-08:00

There often are times when the odds do not favor widespread buying or selling in the stock market. That happens when indicators of valuation, price trends, and sentiment are mixed. Stocks are not extraordinarily cheap or expensive. Price trends are not notably depressed (and likely to recover) or sharply higher (and likely to decline). Investor sentiment is neither gloomy (a good time to buy) nor ebullient (a good time to sell).

At such times, one needs to focus on individual stocks that are reasonably priced or on themes relating to a particular market sector or societal trend. I think today is such a time.

I still find a small number of stocks that are attractively valued (VOD, AGXXF, AAPL, MOFG, KSS, FDP). In general though, after the sharp rebound since June of this year and the doubling of major stock indexes over the past four years, I urge caution when considering making large new stock purchases. This is despite a likely rebound in stock prices if elected officials in Washington make meaningful progress on spending and taxes.

Steve Lehman
LehmanInvest.blogspot.com/

S & P 500: 1402

Depressed Assets After a Strong Year

2012-12-20T08:56:00.002-08:00

In a year with significant gains in most U.S. stock prices as well as in other asset classes like corporate bonds and emerging market bonds, where can a contrarian look for depressed assets? Gold and gold equities would be a place to start.

Though I wonder whether gold's 12-year bull market has ended, from a trading standpoint I think it is worth considering gold and gold equities. The gold price is approaching oversold levels with fairly wide pessimism among market participants. Gold equities are even more depressed, with several leading gold equities selling at 52-week lows, at a time when most major stock indexes and leading companies are selling near 52-week highs.

I have serious concerns over the social and environmental costs of gold mining. Those who do not have those concerns might consider a trade in the SPDR gold exchange traded fund (GLD) or a stock like IAMGOLD (ticker: IAG). IAG has fallen 32% in the last three months, and it has net cash on the balance sheet and is trading for close to tangible book value per share.

Steve Lehman
LehmanInvest.blogspot.com/

GLD: 159
IAG: 11.17

Growing Caution Toward Stocks

2012-12-20T06:56:00.001-08:00

The rebound in stock prices in recent weeks has pushed the market in general near overbought territory. In addition, key sentiment measures reflect a sharp rebound in investor optimism.

I recommend paring stock positions here, particularly in cases with sharp gains over the past six months. I always like to have some cash available for buying opportunities, and now is a good time to begin to replenish cash after reaping significant gains.

Steve Lehman
LehmanInvest.blogspot.com/

S & P 500: 1435

Is the Long Bull Market in Gold Over?

2012-12-17T06:08:00.000-08:00

Back in 2000, I said publicly that I'd rather own gold than the Dow Jones Industrial Average. The Dow was more than 40 times the price of an ounce of gold, which the UK government was selling at roughly $250 an ounce. (At the peak gold price in 1980, the price of an ounce of gold was about the same at the Dow Jones Industrial Average.) So it seemed likely to me that the Dow Jones and the price of gold would converge in price, not necessarily ending up at 1:1 but moving well away from 40:1. Indeed, since the end of 2000, stock prices have had only modest gains, while gold rose more than six fold in price.

With gold headed for its amazing twelfth consecutive annual gain, when will its bull market end? The conceptual case remains compelling, as central bank monetary policies are about as loose as they have ever been. Short-term interest rates are near zero, and real interest rates (after subtracting inflation) are negative, which historically has been favorable for gold prices. Central banks have been net buyers of gold for 19 consecutive months. And it has become conventional wisdom that most investment portfolios should have a small allocation to gold, as a hedge against various negative outcomes.

But the price of gold peaked more than a year ago (in September 2011) at $1,921 an ounce. It is now 11% below that. Even though some esteemed investors, such as John Paulson and George Soros reportedly still have large gold holdings, the huge holdings of gold ETF's make me uneasy. And in the financial crisis of 2008, gold was anything but a haven, as it plummeted along with other asset markets.

I no longer own any gold, partly because of the human and environmental toll that its mining entails. I think there are more respectable, cleaner, ways to earn an investment return.

I had expected the end of gold's bull market to be marked by an explosive, "parabolic" spike, which hasn't happened yet. And for gold to reach a new high on an inflation-adjusted basis would require a price of roughly $2,400 an ounce, 40% above current levels. Either development would provide a large gain to holders of gold.

But I also wonder whether it is time to look elsewhere for an asset market that is underpriced and unpopular, and which provides favorable odds for significant gains.

Steve Lehman
LehmanInvest.blogspot.com/

Gold: $1,700

Apple Stock--Becoming Ordinary or an Opportunity?

2012-12-14T06:36:00.001-08:00

The decision to invest in Apple stock today is not as obvious as it was even a year ago. The company is one of the most successful in the world, and it recently had the largest stock market value on record. Great companies are often not great investments, however, because by the time the companies are widely revered their stock prices already have risen amply to reflect that greatness. Has Apple fallen into that trap of a great company that becomes an ordinary investment?

I noted late in August amid the launch of IPhone5 when Apple set a record for total market capitalization of $625 billion (and a stock price close to $700), that it reminded me of the peak in the technology stock sector in 2000. As in 2000, at the peak in the share price of Apple stock analysts were scrambling to revise higher their profit and share-price targets. Price targets of $1,000 or more began popping up, as analysts seemed to want to outdo each other in being the biggest booster of Apple (as they did with Cisco's stock in 2000).

But starting price matters in investing, and despite the current dominance of Apple's business around the world, a starting price of $700 (and a market capitalization of more than $600 billion) for a company whose revenue base had become very large meant that future growth rates of revenues and earnings would inevitably slow in percentage terms due to the huge base.

The stock has since declined 25%, and earnings estimates have become almost ordinary. The current consensus earnings forecast for the 2013 fiscal year (ending next September) is for earnings growth of 11%. Have expectations for next year and beyond now become modest enough that the stock at its current starting price of $510 is a good buy?

There are several factors that make this a difficult call. Though the stock is down nearly 30% since September, it is still up 34% over the past year and 157% over the past five years. Earnings estimates have begun to trend lower, which is not favorable. Furthermore, the stock is still very widely held, and if large, momentum-driven fund managers are unloading it because its stock price and earnings momentum have been broken, the selling pressure will be difficult to overcome.

One the other hand, one of the world's great companies now sells at a price/earnings ratio of 10.5 on current earnings, which would be less than 9 times if the company were able to use its net cash on the balance sheet to repurchase stock. It is in superb financial condition with net cash equal to about 25% of its stock market capitalization, and excess cash flow could be available for dividend increases or share buybacks.

When I was a fund manager, I had little patience for the explanation of "profit taking" when stock prices declined. I thought it was an excuse when people had no plausible fundamental reason for a decline in stock prices. But perhaps part of Apple's price decline is indeed due to "profit taking" in anticipation of potentially higher capital gains tax rates next year. That, plus selling pressure from momentum fund managers--amid recent news stories about greater competitive pressures from Google and others--have probably pushed the stock down to its current $510 price.

If I can invest in a superior company at close to ten times (current year) earnings, I'll typically do it regardless of my hunch about the stock market's overall direction. Apple is a case where after significant gains in the broad stock market since early summer--and over the past four years--it is still possible to find such a stock.

Steve Lehman
LehmanInvest.blogspot.com/

Apple: $510

Take profits in German Shares

2012-12-13T07:08:00.001-08:00

For those investors who bought European stocks when sovereign debt crisis fears periodically spiked, notably early this summer, I commend you. Gains likely range from 20-40%. However, I now suggest looking to take profits at current levels, particularly in Germany.

The iShares MSCI Germany Index exchange-traded fund (EWG) is up 31% off the low in early June and is up 25% in 2012. Under any circumstances, those are respectable gains.

However, the European economy seems likely to remain in recession or have sluggish growth next year, and the rise in share prices seems already to reflect improved prospects for economic growth or an abating of sovereign debt problems.

I still think stock markets will continue to rise over the near term, but I would look to rotate out of big winners into depressed shares that remain or start to build cash for those who are close to fully invested.

Steve Lehman
LehmanInvest.blogspot.com/

EWG: $24.17

Value in Retail

2012-12-12T06:47:00.000-08:00

The significant rise in stock prices this year--on top of the sharp rebound over the past four years--has left few bargains. There are, however, still some depressed stocks of good companies whose long-term prospects have become suspect. Examples are Microsoft, Intel, and Kohl's.

Let's look today at the comparative value of Kohl's stock (symbol KSS). The stock has recently dropped nearly 20% after the company reported disappointing sales results at its stores. As a result, the stock has fallen 15% over the past year and 5% over the last five years. The shares now sell for ten times current-year earnings, growth next year is forecast at 10%, and the company's return on equity is 17%. Management has steadily repurchased shares, thereby increasing earnings per share and the scarcity of outstanding shares. On the negative side, its earnings trends are comparatively poor, especially compared to those of peer TJX (parent of TJ Maxx and Marshall's).

But TJX stock is up 35% over the past year and 198% over the past five. It clearly has earnings and price momentum, which is why it is so popular. Earnings per share at TJX are forecast to rise 12% over the next year (not much more than Kohl's). TJX shares seem pricey, at 17 times current-year earnings, versus only 10 at Kohl's.

For investors who pay attention to stock price charts, Kohl's has fallen to its current level of 43-44 several times over the past year and rebounded into the low to mid 50's each time. I think there is a good chance that this will happen again. Supported by a likely rise in the broad stock market, the prospect for a 25% gain in KSS seems like a good buy when shopping for stocks during this holiday season.

Steve Lehman
LehmanInvest.blogspot.com/

KSS: 43.35
TJX: 42.70

Santa Claus Rally to Continue

2012-12-11T09:46:00.001-08:00

As a value investor, I find it difficult to participate in the stock market when prices are generally only fair, rather than cheap. That is how I see the current market environment, with many stocks having risen significantly this year. Yet, I still expect stock prices to continue to rally.

During the market decline since September, I constructed a portfolio of undervalued and high-dividend yield stocks. When I could no longer find individual stocks that met my purchase criteria, I added broad market participation through the SPY S & P 500 Index exchange-traded fund.

When technical and sentiment indicators signal that the broad market has become quite popular again with prices up sharply ("overbought"), I'll sell the broad market exposure and keep a core portfolio of individual stocks. I still have a list of stocks that I intend to buy if they decline enough to reach my target purchase prices.

There are many confusing influences on stock prices at the moment, but I maintain that the likelihood is for a continued rise--though perhaps not new highs--in the major stock indexes.

Steve Lehman
LehmanInvest.blogspot.com/

S & P 500: 1430

Hewlett-Packard, "Goodwill," and Investing

2012-12-03T10:08:00.000-08:00

Much has been written recently about Hewlett-Packard, once an esteemed leader in the technology sector. Not only has the company (and its stock) suffered from reports of a huge shift in customer preference toward smart phones and table computers and away from personal computers and printers (Hewlett's most important products). On top of that, Hewlett recently shocked investors by writing down nearly 90% of the value of its acquisition last year of Autonomy, a British software company.

Hewlett paid $11 billion to buy Autonomy in an attempt to shift its emphasis away from the obsolescent business of personal computers and printers. Investors were stunned and frustrated by the huge premium HP paid, a price nearly twice what another reported bidder considered the value of Autonomy. That was bad enough for investors, but last week Hewlett wrote down $8.8 billion of the $11 billion acquisition. This was the latest example of the generally poor record of major corporate acquisitions that are later written down--or completely written off.

When a company buys another at a premium to the accounting value of its net assets (assets minus liabilities), the difference is put on the acquiring company's books as "goodwill." Companies such as Procter & Gamble that have grown over the years by acquiring other companies (and products with valuable brand names) have large amounts of goodwill listed among their assets on the balance sheet. In those cases, the brand value of, say, Gillette razor blades is considerable. Such brands have maintained or even increased their value over time. An investor in such a business would justifiably pay for the imbedded goodwill of such key products.

But for a business such as technology, with its risk of rapid obsolescence, it is dubious to pay a high premium. Hewlett had already stumbled with its acquisition of Electronic Data Systems several years back. EDS, a former subsidiary of General Motors, was heavily dependent on business from GM, and when GM struggled in recent years, so did EDS. Such write downs of poor acquisitions result in a reduction of stockholders' equity, or book value.

I pay attention to a company's book value, or more important, its tangible book value (after deducting goodwill and other intangible assets). For a company with valuable brand names such as Apple or Coca-Cola, tangible book value might be considered irrelevant in assessing the true value of the business. But for companies in other sectors with hard assets, or businesses with commodity-like assets like many technology companies, I would not pay a large premium over tangible book value.

In general, the record of large corporate acquisitions is mixed, at best. I generally prefer a company whose management does not make large acquisitions that dilute the investment of existing shareholders (by issuing large amounts of additional shares of stock to pay for the acquisition). Managers who behave like owners, rather than highly-paid consultants looking for a quick payout, are better.

The poor decisions at Hewlett were made under the prior CEO, though most the board of directors that approved the deals is still there. So, it is hard to have confidence in management today.

Yet, the stock has declined 53% over the past year and 74% over the past five years. Its price/earnings ratio is now 3.9. Though it has substantial debt, its cash generation is considerable. With its total stock market capitalization now down to $25 billion, could it be attractive for takeover by a private equity firm? Or is it at least now sufficiently undervalued to offer a "margin of safety" in buying the stock? I'm not ready to go that far, but the stock is worth a closer look at this point for its valuation and 4% dividend yield.

Steve Lehman
LehmanInvest.blogspot.com/

HPQ: $13

Share Buybacks and Business Fundamentals

2012-11-29T14:57:00.000-08:00

When I select stocks, I consider a number of factors including valuation, financial condition, management quality, and attention to sustainability. When assessing the management, I like to see a protecting the interests of existing shareholders by emphasizing per share measures, rather than just overall growth in the company's revenues or operating profits (which can come through acquisitions rather than inherent growth). I particularly dislike large increases in the share base for acquisitions, as many acquisitions ultimately prove to be a poor use of capital. Conversely, I like companies that repurchase their shares with excess cash generated by business operations--or with debt if balance sheets are strong and the shares are exceptionally depressed in price.

But there are exceptions, and that is why one should use a variety of criteria when choosing a stock. Share buybacks reduce the number of shares outstanding (and increase earnings per share) all else equal, but one must not lose track of the company's underlying business prospects.

A good example is Best Buy. This once-dominant retailer of consumer electronics products has repurchased approximately 25% of its shares over the past five years. That was probably a much better use of cash than if it had been used to expand its store base or acquire other companies.

During this time, however, technological changes have severely impaired the company's business prospects. The stock is down 53% over the past year as earnings estimates for the latest quarter went from $.50 to an actual break-even quarter. Cash generation (a crucial factor for stock selection) plummeted from $2.6 billion a year ago through nine months to only $81 million this year. Since capital spending this year has been $522 million, the company has spent far more than it generated and indicates a severe weakening of its financial condition.

The remarkable deterioration at Best Buy is reflected in a depressed valuation. It's p/e ratio on this year's earnings estimates is only 5. I like out-of-favor value stocks where management shrinks the share base, but the alarming deterioration in the fundamentals and finances at Best Buy mean that investors should shop elsewhere.

Steve Lehman
LehmanInvest.blogspot.com/

BBY: $13

An Utterly Indefensible Federal Program

2012-11-29T14:22:00.002-08:00

I am not a reflexive critic of government spending, as I believe that government has an important role in society. But in this era of constrained financial capabilities and the need to cut spending, recent events reveal one program that makes no sense--and is a huge financial risk for taxpayers.

That program is the National Flood Insurance Program. Private insurance companies years ago grasped that insuring oceanfront properties is a poor financial risk. Climate change--as highlighted by hurricane Sandy--exposes the huge potential costs to the Federal government (and taxpayers). The Federal program now covers an estimated $527 billion of properties, with potential losses to the government of $1.25 trillion.

So with talk about budget cuts and the need to curb entitlement spending dominating the discussion, it seems that reform of this program requires immediate attention. The program should be phased out or else the perverse financial incentives for building in some of the highest-risk areas of the country should be removed. Most of us would be delighted to be able to live along the coast--but doing so should be on one's own--not with the backing of U.S. taxpayers.

Steve Lehman
LehmanInvest.blogspot.com/

Stock Market Likely Headed Higher (Cont.)

2012-11-21T05:28:00.000-08:00

Another reason for stock prices to rise from here--aside from very positive contrarian market sentiment indicators and the oversold nature of the market--is recent behavior by corporate insiders.

The latest insider sales/purchases ratio is 1.58:1, which is extraordinarily low. Over the past decade, the insiders on average sold 3.4 shares of their own company's stock for every share purchased. So corporate insiders are now historically quite optimistic about their own company's shares.

At the high in the stock market a couple of months ago, insiders sold 6.86 shares for every one they purchased. Good call. Stocks have had a significant decline since that point. The current level of insider sales to purchases is only the fourth time since the market bottom in March, 2009 that the ratio of sales to purchases has been below 2:1. Each of the other three times marked a significant interim low in the stock market.

I reiterate: buy more stocks.

Steve Lehman
LehmanInvest.blogspot.com/

S & P 500: 1387

Will the Cliff Become a Trampoline (for the Market)?

2012-11-19T08:23:00.001-08:00

I've suggested recently that alarm over the "fiscal cliff" has driven stock prices lower and investor pessimism higher to an excessive degree.

Today's stock market gains have been attributed to encouraging comments from political leaders about overcoming the fiscal gridlock. I've thought that if there is substantive action by the two political parties on that issue, stock prices could explode higher.

Given that potential, I have urged reducing substantial cash reserves and increasing equity allocations. I stand by that.

Steve Lehman
LehmanInvest.blogspot.com/

S & P 500: 1380