Independent Equity Research

RIMM Technicals - Oct 13

noreply@blogger.com (Kunal Jaggi) — Sat, 13 Oct 2007 18:11:00 +0000

Click on the picture to view full size.

VDSI Technicals - Strong Uptrend

noreply@blogger.com (Kunal Jaggi) — Tue, 09 Oct 2007 15:25:00 +0000

(Chart with indicators from StockCharts, all inferences my own)

1. CMF (Chaikin Money Flow) Indicates security has been in accumulation stage for the majority for the last 4 months. Constant buying pressure has been boosting the stock price causing the strong uptrend. The Chaikin Money Flow oscillator generates bullish signals by indicating that a security is under accumulation. There are three factors that determine if a security is under accumulation.

The first and most obvious factor is whether the Chaikin Money Flow value is greater than zeroIt is an indication of buying pressure and accumulation when the indicator is positive.

The second factor is the duration of the reading, how long the oscillator has been positive. The longer the oscillator remains above zero, the more evidence there is that the security is under sustained accumulation. Extended periods of accumulation or buying pressure are bullish, and they indicate that sentiment towards the security remains positive.
The third factor is the intensity of the oscillator. Not only should the oscillator remain above zero, but it should also be able to increase and attain a certain level.
A reading above .25 would be an indication of strong buying pressure. You should consider prior levels of the indicator to be sure.

2. The fifth time (in 4 months) the MACD (Moving Average Convergence Divergence) has crossed the trigger line in a bullish manner.

Click here to learn about the MACD Momentum indictor

3. ADX evaluates the strength of the current trend. A rising ADX that crosses 40 is an indicator of a strong trend. Current ADS of 37.19 that has risen sharply since September combined with strong uptrend in security confirms strength of uptrend.

4. Security has been moving up so fast EMA (Exponential Moving Average) lines has been running parallel to each other (longer term MA's attempting to catch up with shorter term MA's, which in turn are struggling to catch up with the security). In other words, very positive :)

Click on picture to view full size

5. Both the Accumulation/Distribution line and OBV have increased sharply since August with a similar increase in security price further indicating STRONG buyind pressure. The A/D line measures the volume of money flowing in (accumulation) and out (distribution) of a security. It is calculated as follows

CLV = Closing Location Value which measures the location of the close of stock relative to trading range for that period. Assumption is that security is under accumulation when it closes higher. The CLV is then multiplied with the corresponding period's volukme to form the A/D line.

For my research on VDSI Fundamentals click here

RIMM Technicals - overbought ?

noreply@blogger.com (Kunal Jaggi) — Sun, 07 Oct 2007 18:15:00 +0000

Click on picture to see full size.

RSI (Relative Strength Index) is a momentum oscillator that compares the magnitude of a stock's recent gains to the magnitude of its recent losses to provide overbought and oversold signals. Recommended levels are 70 for overbought and 30 for oversold.

Williams %R is a momentum indicator that also attempts to measure overbought and and oversold levels on a scale that ranges from 0 to -100. 0 to - 20 can be considered overbought and -80 to -100 oversold. It shows the relationship of the close relatrive to the high-low rangfe over a set period of time. The nearer the close is to the top of the range, the nearer to zero (higher) the indicator will be. Vice versa for nearer the close is to the bottom of the range.

%R = [(highest high over ? periods - close)/(highest high over ? periods - lowest low over ? periods)] * -100

Money Flow Index (MFI) is a momentum indicator similar to RSI, it is more volume-weighted and a good measure of strength of money flowing in and out of security. It compares "positive money flow" to "negative money flow" to create an indicator that can be compared to price in oder to identify strength or weakness of a trend.

Money Flow = Typical Price X Volume

Money Ratio = Positive Money Flow / Negative Money Flow

Money Flow Index = 100 - (100/(1+Money Ratio))

For more information on Technical Indicators, http://www.stockcharts.com/

Wednesday, October 3 Market Open

noreply@blogger.com (Kunal Jaggi) — Wed, 03 Oct 2007 14:01:00 +0000

1. The second Infosys (NASDAQ: INFY) order was a screw up by the simulator. I put in a limit order at $49 but for some reason the simulator put in an additional market order.
2. In my belief, INFY is a good buy at this point. Unfortunately, I haven't had a chance to write about it (busy week at work). Hopefully I can get my analysis done before it jumps up ever higher.

September 26, before market open

noreply@blogger.com (Kunal Jaggi) — Mon, 01 Oct 2007 16:37:00 +0000

iPod Touch Demo

noreply@blogger.com (Kunal Jaggi) — Sun, 30 Sep 2007 15:28:00 +0000

Yesterday I was at a computer store (not a Apple Store) to return an iPod cover I had purchased from them, when the new iPod Touch caught my attention. I must say it is a lot of fun to use because I ended up playing with it for about 45 minutes.

1. The picture to the left is the main menu from where you can select your music, videos, calendar, address book or browser (OS X Safari).

2. The user interface is exactly the same as the iPhone with a multi touch screen. It also has all the same functionality except for the ability to dial and receive calls. The sleek UI lets you slide the white button to unlock the phone.

3. The picture on the left shows Theinvestornextdoor.net on the iPod touch. The quality of the Safari browser is as good as using it on my Powerbook laptop.

4. Gmail on the iPod Touch web browser.

5. Wikipedia on the iPod Touch web browse

6. Converging your fingers on to a particular part of the screen zooms in to that area.

7. Similarly, diverging your fingers from a point zooms out from that section. Very intuitive.

8. The Keyboard. People have been saying this is the biggest drawback of a multi-touch screen. Typing is slower as compared to having a Blackberry style keypad.

9. iTunes. Same functionality as running iTunes on laptop / desktop. Album artwork, playlists, searching albums/genres/artists, sharing music with other iTunes users through a wireless connection etc. One advantage is you can now buy/download music and have it ready to play immediately on your iPod, on the go.

I asked a store associate (who seemed to be a gadget junkie) about the durability of the touch screen. He then proceeded to scratch the screen with his keys in front of me and that left no marks. He mentioned that he had heard the screen was pretty durable and could survive a couple of falls, unless you drop it 1 metre or higher, in which case it would break. It was not an Apple store but he mentioned that all the iPod Touches sold out right away. He also had a CDMA & GSM enabled Blackberry which in his opinion would still win over the iPhone as a business phone since you dont need to be connected to a Wi-Fi network to receive your email, the blackberry network comresses your emails and sends them to you over your data network. The iPhone / iPod Touch were better entertainment devices in his opinion.

My verdict - I kind of agree with him, I think Blackberry's are still better for corporate use, at least until Wifi / WiMAX newtorks become ubiquitious. If you're thinking of buying an iPod though, it might be worth it to shell out the $329 CD for the 8GB iPod Touch. I do think Apple has another great product and the yuppie-mac loving/mac converting market will lap it up.

Disclaimer - The opinions expressed here are solely my own, and pictures were taken from my cell phone camera with the permission of the computer store.

Vasco Data Security (NASDAQ: VDSI) still strong

noreply@blogger.com (Kunal Jaggi) — Mon, 24 Sep 2007 00:46:00 +0000

VDSI fell from 37 to 34 on Thursday on news that their revenues might suffer from the problems in the banking industry.

http://www.forbes.com/markets/2007/09/20/vasco-data-closer-markets-equity-cx_cg_0920markets39.html

I think this is more noise than information. Agreed, 85 % of VDSI's revenues come from banks. However (and thats a big however), they provide user authentication products (security software and hardware). This security software is essential for large banks that do many extremely high value transactions (wires, electronic transfers etc) on a daily basis.

Hedge funds, investment firms and mortgage companies have suffered from betting on bad commercial paper. I don't see this doesn't directly translating into banks cutting their software systems, especially software that is essential for the credibility and safety of high volume transactions. If anything, some banks that were considering delaying the purchase of Vasco's security products will delay it a bit further. The subprime problem is not related to Vasco's products at all and since the problem mainly arose due to lack of regulation around CDO's and in-accurately rated Asset-backed commercial securities, investment banks that did lose money will cut costs but closing their subprime commercial paper departments and not their softwares. This is exactly what Lehman Brothers did.

In my opinion, the company is still gold and I have a strong feeling we will see positive results in the next quarterly report. Click here for my detailed fundamental analysis on VDSI.

How the high Canadian Dollar and Alberta oil really impacts Canada

noreply@blogger.com (Kunal Jaggi) — Sun, 23 Sep 2007 04:05:00 +0000

By Kunal Jaggi
(Sources of Info: Bloomberg, www.norway.org.uk)

The shopping trips apart, what does the recent US Canadian Dollar parity really mean for the Canadian economy. I listened to an extremely insightful podcast today by Bloomberg with the Chief Economist of TD Canada Trust Bank - Don Drummond on the line.

The last parity was in 1976 when Canada had strong growth following its integration with the world economy in the post WW II era of 50's and 60's.

The most worrisome fact for Canada is that at present productivity levels in Canada are 75 % that of the US. This figure was at its highest (90%) in 1976 and has gone down drastically since then.

In 1976, Canada was ranked as having 3rd highest level of productivity in the OECD (out of around 20 at the time). At present they are 17th. France and Denmark are much higher , and France makes up for fewer working hours through increased productivity.

One of the reasons for this is capital in-adequacies. Drummond states that Canadian workers have a lot less capital intensive machines / equipment to work with. Two-third the figure for per hour of labour work in the US. Canadian companies should use the high dollar to beef up on high-tech equipment, but Drummond says they are not doing so.

Oil - the Dutch disease ?

The term 'Dutch disease' was coined in 1977 to describe the decline of the manufacturing sector in the Netherlands after the discovery of natural gas in the 1960s (source Wikipedia). Essentially, the theory implies that a huge increase in revenues from natural resources will de-industrialise a nation's economy by raising the exchange rate, which makes the manufacturing sector less competitive.
Drummond mentions that

Alberta is totally skewing national averages. AB, with its oil boom is growing at about 5 %, rest of Canada at about 2 %. AB wages growing at 6% , rest of Canada at 2.5 %. With a weight of 10-12% the Alberta boom growth skews national figures of growth, i.e makes it seem that the whole country is doing better than it actually is, since most of the growth is coming from a small region. This will still make the Central Bank hike interest rates since they can't treat Alberta as a separate country, monetary policy is national, not provincial.

Provincial spending by Alberta has been growing by 12% to meet all the infrastructure and other demands of the oil boom.

Second largest proven oil reserve after Saudi Arabia
$ 30-40 break even cost in 2002
$ 50 - 60 break even cost in 2007

Drummond mentions that Alberta, which has a surplus of around $ 40 Billion from the oil currently has not invested any of the money outside the province. This is extremely risky since the surplus can decrease very fast as the price of oil decreases.

As a comparison, Norway has around $200 Billion from their oil exports (they have about 50 percent of Western Europe's oil and gas reserves). In order to prevent the 'Dutch disease' affect on the economy, the Norwegian Parliament established the Norwegian Govt petroleum Fund in 1990, which it hedges in other investments (source: http://norway.org.uk). It would be advisable for Alberta to do something similar.

The value of a nation's currency is not always an indication of how well the overall economy is doing. For a resource rich country like Canada, commodity prices (like oil) are the major reason for fluctuations in the currency. In other words, as the price of oil per barrel increases, the Canadian currency becomes more expensive for countries importing from Canada. For more on how commodity prices effect currencies, click here.

Another point to note would be that the manufacturing sector (which is concentrated in Ontario) will suffer heavily from

The increase in Canadian dollar vis-a-vis the US dollar
Lower rate of productivity in Canada as reported
Increase in Chinese imports. Previously, North America didn't import auto parts from China. Now they account for 5 %.
US Southern states pay 12 - 15 $ hourly wages in manufacturing plants, Ontario has historically paid 35-40 $.
Until about 5 years ago, 86 % of Canadian trade was with the US. Now, Canada has been attempting to diversify its trading partners. The result has been more emerging economies importing Canadian natural resources.

We can expect the Canadian Dollar to rise even further

Even higher prices per barrel of oil
The US Federal Reserve might cut interest rates again, whereas in all probability, the Canadian central bank will hike interest rates (the AB growth effect skewing the actual economy growth) providing further short-term momentum towards the Canadian Dollar.

According to Drummond, Canadians are not focussed much on this problem. The Government and economists have not done a good job explaining the situation. He says that a lot of Canadians don't want things to be exactly like the US, i.e have dense cities with high crime rates. He says - " You don't get citizens embracing a concept unless there is a crisis. There isn't a crisis right now in standard of living. Things are going sideways kinda like Japan - the incomes are still high ".

Well, at least those American basketball players will be cheaper to buy now.

Friday, Sept 21, 2007

noreply@blogger.com (Kunal Jaggi) — Fri, 21 Sep 2007 20:17:00 +0000

Finally, the Investopedia simulator gives me my annual return (compounded since I've been trading for 3 months).

1. Holding RIMM until Q3 earnings (October 4).

2. It's funny, I first bought Countrywide Financial at $22.56, lost money on it, but bought another 50 at $19 which seems to be providing a support level. The only reason I bought it is because its arguably it has been the most affected stock by the subprime issues (-53.8 % YTD) and I want to do a post mortem at the end of the year to test various correlations.

3. I bought WMT since retail indicators showed mortgage crisis is not hitting everyday retail sales as bad as expected (i.e people will still be able to buy pots & pans from WMT).

4. I am long on Intel over AMD since in my opinion, they have much better prospects long term than AMD. Click here on my analysis of INTC.

5. BIDU (Baidu ADR) I bought strictly on technicals, the volume was just hard to ignore. I'll sell it as soon as I make a grand, maybe sooner than that.

6. Vasco Data (VDSI) has been my favourite stock ever since I started and has grown 53 % since I bought it. (And 190 % YTD). Definately long term. Click here for analysis on VDSI.

7. Lululemon Athletica (LULU)'s real potential will be tested in the subsequent 2 quarters (especially Christmas). Click here for LULU analysis.

8. TIE is the largest supplier of titanium products, surge in global demand by airlines for new airplanes has boosted earnings.

Lululemon Athletica (NASDAQ: LULU)

noreply@blogger.com (Kunal Jaggi) — Wed, 19 Sep 2007 03:15:00 +0000

By Kunal Jaggi
Sources of Information - Company Financial Reports, Financial Post and smaller dailies found through Google News

Founded by Chip Wilson in Vancouver in 1998 is a yoga-inspired athletic apparel company. In addition to casual and athletic apparel (including clothes for yoga, running, cycling, hiking, rock climbing an dother sports), they also offer yoga-oriented props and accessories such as mats, straps and blocks.

Fundamentals

(Company went public only this July)

1. Number of stores increased from 20 (14 corporate, 6 franchised) in 2004 to 60 (52 corporate and 8 franchised) as of July 31, 2007.

2. Compounded annual revenue growth rate of 91.1% (from $40.6 Million in 2004 to $148.9 Million in 2006).
2006 Q2 revenue increased from $32.5 Million to $58.7 Million in 2007 Q2 (80.5% increase). 6 mths ended July 31 increased from $60.7 Million in 2006 to $103.47 Million in 2007.

3. In 2005 & 2006 end, franchises account for 10% of net revenues, 5.8% for 2007 Q2. Corporate-owned stores net revenue accounted for 81.1% of net revenue for 2006 and 90.5% in 2007 Q2

4. As of 2007 Q2, 82.5% of net revenues from Canada, 16.2% from US, 1.3% from Australia and Japan.

5. Gross profit has increased from $32.5 M in 2006 Q2 to $58.6 M in 2007 Q2 (80.3%).
EBITDA has increased from $3.236 M in 2006 Q2 to $9.769 M in 2007 Q2.
Diluted EPS has increased from 0.03 to 0.07 (133%).
CFO has increased from 8.133 M to 9.589 M. However, if you exclude the “Stock-based compensation” which is treated as a non cash expense, it has decreased from 6.7990 to 6.6210. Current Ratio 1.5229
US $1,400 in sales per square ft compared to US $600 for competitors

Management & Corporate Philosophy

Staples founder Tom Stemberg (who now runs Highland Capital Partners) invested $20 Million Canadian in the company, along with a $80 Million stake by a Boston based private equity investment company called Advent International. Chip Wilson, the founder, is now the chairman of the board and chief product designer but brought Bob Meers, the former president of Reebok as the CEO.

The community-as-testing ground approach is still the way the company operates, reaching out to high profile yoga and Pilates instructors, personal trainers and others by offering clothing in exchange for feedback and the publicity their wearing the garments engenders. The company limits its traditional advertising to a monthly ad in Yoga Journal because, as Wilson explained, "We put our marketing dollars into training."
The company's 1,700 employees all go through a training program that ranges from sorting out the myriad Lululemon styles and fabrics to life skills like goal setting and positive thinking. They also are expected to listen to "The Psychology of Achievement," eight hours of audiotapes by the self-help guru Brian Tracy.

Analysts Say

Tal Woolley of RBC Capital Markets raised target price from $23 to $41 and estimates 22 to 25 new stores in operation by end of year.
Lyn Walther with Wachovia Securities has also been optimistic about LULU’s potential. However, she warns that the market is currently looking at the stock’s long-term growth opportunities and potential earnings and not valuing it on the current earnings. In her opinion, the stock has already priced in current momentum and recommends waiting for a better entry point.

Analysts polled by Thomson Financial estimate full-year 2007 EPS of 28 cents on $216.2 M sales and 42 cents EPS on $301.2 M in 2008.

Bloomberg's
Lululemon forecast profit of 30 cents to 33 cents a share for the year through January. Analysts estimate earnings of 28 cents on average. New shareholders own 27 percent of the company. Lululemon founder Chip Wilson holds 38 percent, and the two Boston- based private equity companies have a third.

My take - their products are selling like hot cakes in Canada, with girls shelling out $100 Canadian for a pair of Yoga pants. Their products are considered very trendy as well as comfortable. They certainly have the products and concept, but at this point you need a leap of faith to invest since the U.S clothing market is a different ball game. Waiting until this Christmas to see how they do would be a good idea. I would definately keep an eye on them over the next 2 quarters though.

Portfolio before & after Fed cut rates by 50 basis points

noreply@blogger.com (Kunal Jaggi) — Tue, 18 Sep 2007 21:10:00 +0000

Portfolio as of Sept 17, market close.

Portfolio as of Sept 19, market close, after the rate cut.

WiMAX - WiFi new and improved

noreply@blogger.com (Kunal Jaggi) — Tue, 18 Sep 2007 03:45:00 +0000

What’s WiMAX?

Worldwide Interoperability for Microwave Access is basically an improvement on today’s Wi-Fi wireless networks for mobile computers and hand-helds. An economical alternative to coaxial cable and telephone lines for bringing broadband connections to homes and business – also especially beneficial for many developing nations that are looking to jump straight from no connectivity to wireless connectivity, skipping the expensive process of laying optical fibers. WiMAX is designed to extend up to 30 miles with speeds 50 times as fast (Source: Business Week)

Who’s playing?

Clearwire, a publicly traded wireless broadband ISP formed by cell phone pioneer Craig McCaw based out of Kirkland, Washington. They have grown from 1,000 customers in Sept 2004 to more than 200,000 customers as of March 2007. Clearwire uses WiMAX transmitted from mobile phone towers, currently covering 9.1 million people in more than 400 municipalities in 12 states. They also have international presense in Republic of Ireland, Belgium, Denmark and Mexico. Currently, they are offering broadband speeds of up to 2.0 Mbps. (Source: Clearwire.com)

Intel : Executive VP Sean M. Maloney has been leading a quiet revolution – an industrywide effort to develop and market WiMAX. Beginning next year, new laptop computers will come equipped with Intel’s WiMAX capable chips, code named Echo Peak. This is just the next logical step after making the Centrino line of chips that enable laptop computers to connect to Wi-Fi networks (wireless networks). Intel, along with Motorola pumped in $900 million capital in July 2006. He also proposed that the chipmaker should lay the groundwork for a mammoth WiMAX ecosystem by investing more than $1 billion in carriers and other companies.

(Source of Image: Intel Investor Relations)

Many telecoms have also placed bets on WiMAX and plan to spend $13 Billion over the next few years to build 300 such networks.
o In July, Sprint Nextel teamed up with Clearwire Corp to create a nationwide network covering 100 million potential customers by end of 2008
o Nokia has been looking to expand into providing communications services.
o Samsung Group wanted to get into the networking equipment business. They are also planning to inculcate WiMAX abilities in their cell-phones and consumer electronics.

A small group of chipmakers and network equipment companies had formed the WiMAX Forum in 2001. Today it tops 400 (Source: wimaxforum.org)
• Accenture
• Acer

• Alcatel-Lucent
• AOL
• Arab Telecom
• AT&T
• ATDI
• British Telecom
• Fujitsu
• Motorola
• Nokia
• Bell Canada
• Cisco Systems
• Clearwire
• Ericsson
• Nortel
• NextWave Wireless
• LG Electronics
• IBM
• Japan Radio
• Hitachi
• Rogers
• France Telecom
• Dell
• China Telecom
• Bharti Airtel
• Juniper Networks
• Microsoft
• Reliance Communications
• Sony Electronics

Intel Looking Good

noreply@blogger.com (Kunal Jaggi) — Mon, 17 Sep 2007 04:06:00 +0000

Q3 2007 expected revenue updated to between $9.4 billion and $ 9.8 billion from $9.0 to $9.6 Billion as a result of stronger than expected worldwide demand for its computing products. . Gross margin expected to be in the upper half of the previous range of 52 percent plus or minus a couple of points (Source: Intel Investor Relations)

Expected gross margin percentage in 2007 Q3 to be 52%, from 46.9% in Q2, primarily due to
o lower start-up costs related to our 45-nanometer process technology
o Lower micro-processor unit costs
o Higher unit volumes from micro-processors and chipsets. Operating income increased by 9% in 2007 Q2 compared to 2006 Q2.

YTD 2007 – 51% of revenues came from Asia-Pacific, 18% Europe, 11%Japan and only 20% Americas. Figures in the same quarter YTD 2006 were 49% Asia-Pacific , 18% Europe, 12% Japan and 21% Americas (Source - Intel Financial Statements filed at sec.gov) In the current situation of uncertainty in the American economy but confirmed robust global growth especially in emerging markets, Intel is safe-guarded against any slowdown in the American economy.

Notebooks as % of Consumer PC Market Segment – Europe (68%), US (58%), Asia-Pacific (39%) in 2007. These figures in 2003 were 42%, 30% and 18% (when Intel Centrino chip came out)

Market Opportunity 2011 Silicon Revenue TAM

2011 Unit TAM > 900 Million Units

Internet $10B
Mobile Internet Device $10 B
Ultra Low Cost PC $10B

Source: Intel Investor Relations

Meanwhile, datacenter capital expenditures by the big internet companies have risen exponentially in the last few years, creating greater demand for sophisticated data servers, which in turn use sophisticated chips to optimize performance and speed.

Other recent notable Intel moves

1. Sept 5, 2007 Intel Corp unveiled the industry’s first quad-core processors designed for multi-processor servers. The new Quad-Core Xeon 7300 series processors can deliver more than twice the performance and more than three times the performance per watt over the company’s previous generation dual-core products. These high-end processors provide an ideal platform for virtualization and server consolidation – a concept that is fast catching fancy, considering VMware’s stellar IPO. VMware and Intel have worked together to optimize VMware ESX Server. Using the VMmark benchmark, which measures virtualization performance, an Intel 7300 series-based system achieved the highest single-server virtualization metric. According to the producers of Half-Life, the Quad-Core chip had a improvement greater than 40% on performance. (Source: Intel Investor Relations)

2. Investing in WiMax - taking Wifi to the next level

Click here for the story.

Standard & Poor recently selected Intel as "stock for the week" for its The Outlook. According to S& PO, the seminconductor industry is in the early stages of an upturn with stonger sales of PC's, competitive technological advances and an enticing valuation. After losing to AMD over last couple of quarters in a fierce price war (where Intel's desktop - segment market share fell from around 80% in early 2005 to 71% in early 2006) the company has shored up distributor relationships, more competitive pricing and diversified their product line. Mobile is the second-largest volume contributor and the fastest-growing segment by both volume and revenues and currently Intel accounts for around 82% of market share. S&P estimates earnings growth of around 20% this year and have a 12 month price target of $30.

The Five White Guys Who Run Wall Street

noreply@blogger.com (Kunal Jaggi) — Fri, 14 Sep 2007 14:52:00 +0000

An excellent example of how institutional investors trade.

Posted by KingCAMBO on youTube (around mid August), chart analysis indicating what is really going on with the XLF financial sector ETF, Goldman Sachs, Bear Stearns and Lehman Brothers. He walks you through the above trades - how the big boys sold at the peak to amateur investors and signs of buying when amateur investors like us were panicking with all the subprime news.

So was it a setup ? Well, it would be a good moment to remind ourselves that the stock market is for the most part a zero-sum game. So there will always be smart money selling at a good price to 'less smart money' (for the sake of political correctness) and buying it back when the less-smart money is panicking (and has taken a loss). Which one will you be ?

Goldman Sachs, Lehman Brothers and the like have been around for around 150 years- which means they have weathered many, many more financial crisis more severe than the subprime problems (read the great depression, WWII, dotcom bust and many more) and they will probably be around for another 150 years. The subprime problem, and the resulting explosion of a few quant hedge funds is merely a speck of dust in the overall cosmos these banks operate in.

Damn, I wish I had one of those Bloomberg terminals.

Minorities worse affected by sub-prime loans ?

noreply@blogger.com (Kunal Jaggi) — Fri, 14 Sep 2007 04:00:00 +0000

By Kunal Jaggi
According to a recent report published by the Federal Reserve on Sept 12, minority borrowers received higher-cost mortgages than whites more frequently when they refinanced their homes last year.

Bloomberg

"African-Americans received high-cost loans 52.8 percent of the time when they refinanced home loans last year, versus 49.3 percent in 2005. Hispanic borrowers received high-cost refinancings 37.7 percent of the time, up from 33.8 percent in 2005. The rate for white borrowers was 25.7 percent last year, compared with 21 percent in 2005.
The figures for foreclosures are similiar - black homeownership fell nearly 2 percentage points in the first six months of this year to 46.3 percent, compared with a half-percentage point drop for whites, to 75.4%. "

Out of curiosity, I looked up foreclosure data in 4 different areas - Metro Orlando, Memphis, Chicago & suburbs, LA on Google news to find smaller dailies reporting similar data.

Orlando Sentinel:

"Upper income African-Americans in Metro Orlando were 2.4 times more likely to receive a high-cost mortgage loan than high-income whites in 2006, the study of dederal data found (which is lower than the 3 times from the previous year though). Higher-income Latinos were also found to be 2.4 times more likely than higher-income, non-Hispanic whites in Orlando to get higher-cost loans last year. Nearly a third - 33.1 percent of last year's home mortgages in Metro Orlando were of subprime variety, as opposed to the national rate of 27.5 percent. (Figures provided by ACORN - Association of Community Organizations for Reform Now).

Memphis Daily News: "Foreclosure Exposure - a comprehensive look at adjustable-rate mortgages loans in 172 metro areas, showed that minorities - regardless of income - received a higher percentage of high-risk loans during the past decade and are at a higher risk of foreclosure.

African-Americans homebuyers were 2.7 times and Hispanics were 2.3 times more likely to be given high-cost loans than whites nationwide.
In 2006, 70.6 percent - almost three out of four - home refinance loans made to blacks were high-cost loans. And 37.6 percent - or more than one out of four - home refinance loans made to Hispanics were high-cost loans.
Memphis ranked No. 1 in the country for metro areas most at risk during the housing crisis with thousands of more ARM's locally about to reset to higher interest rates."

Suburban Chicago News: "According to 2005 data compiled by the Woodstock Institute, a Chicago - based community economic policy research organization, in Will County

60 % of mortgages to African-Americans and 46% percent to Hispanic families were high-cost loans. About 25 % to white families were high-cost loans.
Overall, foreclosures in Will County rose 45% from 2005 to 2006, with a 36% rise in foreclosures in the Chicago area.
The study found that a low-income black borrower is more than three times more likely to receive a high-cost loan than a low-income white borrower.
A black earning more than $135 K annually was more than five times more likely to receive a high-cost loan compared to a white borrower with similar annual income, according to the study by the Woodstock Institute."

LA Daily News: "ACORN (refer above) study showed that during 2006

African-American and Latino home buyers were three times more likely than white home buyers to get a high-cost loan.
African-American and Latino refinance borrowers were about twice as likely as whites to get a high-cost loan.
Upper-income African-American home buyers were 3.6 times more likely to receive a high-cost loan than low-income whites; and upper-income Latinos were 2.8 times more likely to receive one than upper-income whites.
27.2 % of all loans made were high-cost loans in LA."

Also, I found this Jon Stewart video interesting

http://www.comedycentral.com/motherload/player.jhtml?ml_video=90948&ml_collection=&amp;ml_gateway=&ml_gateway_id=&ml_comedian=&ml_runtime=&ml_context=show&ml_origin_url=/shows/the_daily_show/videos/most_recent/index.jhtml&ml_playlist=&lnk=&is_large=true

When Cramer flipped out on CNBC

noreply@blogger.com (Kunal Jaggi) — Thu, 13 Sep 2007 20:35:00 +0000

By Kunal Jaggi

If you haven't already seen it, here's a video of Jim Cramer "The media's most electrifying market pundit" (according to USA Today) rant about the fed not cutting interest rates sometime after the Bear Stern funds fell apart.

http://www.youtube.com/watch?v=rOVXh4xM-Ww

I think Cramer can be amusing at times. However, I've read two of his books and some of his theories do make sense. Why did he flip out like he did ? Well, mostly people seem to be going with the most obvious explanations - that he was long in the market at that point of time and betting on the Fed to cut rates. Or that his friends at big hedge funds were losing too much money which troubled him. Valid as these theories sound, here's another perspective. Cramer in his book "Real Money: Sane Investing in an Insane World" is a proponent of riding and benefiting from both sides of interest rate changes. Oversimplifying, he basically says that cyclical (typically high growth tech, pharma etc) stocks that are more susceptible to economic cycles must be purchased at precisely the moment when they are trading at their highest multiple. Conversely, non cyclical stocks (steady behemoths like P&G) should be sold when their multiple is at its highest.
The rationale to do this is that as economy slows down, investors typically seek the safety of P&G kind of companies and are willing to pay a higher P/E ratio for their stable earnings. They will sell a stock like RIMM (totally fictitious example) because they figure that it's trading at too high a ratio and the slowing economy will drag down its earnings. But once the economy shows significant depression, the Fed usually moves in to lower interest rates to re-boost the economy. The process then works in reverse - and as the economy improves, analysts who downgraded RIMM will now start anticipating increased earnings and there is a demand again for it - at which point you sell. Then you re-position yourself into P&G, which everyone is discarding because they want to be a part of the growth story. Now, after time, the economy will start overheating and the Fed, in their noble mechanism of controlling inflation, will hike up rates causing a slowdown yet again. Voila, there is a demand again for the P&G that you bought when everyone was selling to get into growth. Of course, you can't time these cycles exactly, but according to Mr. Cramer, you can keep playing this counter-intuitive game.
Now maybe that theory has something to do with his outburst. I don't think he has personal big positions in the market. He keeps a $3 Million portfolio, the proceeds of which are donated to charity. Even with that, he has a 30 day restriction of not being able to touch the stocks since he emails out his weekly positions in this newsletter that you can subscribe to at TheStreet.com
Like I said, I don't think its about money. He's been in the market for 25+ years, made enough and now makes more through his media acts. I think its more ego - maybe he bet real hard on which way the Fed was going to roll and it just aggravated him that he couldn't predict it perfectly like he did for the last 25 years.
Here's his response to the CNBC video by the way -
http://videoplayer.thestreet.com/?clipId=1373_10372626&channel=Cramer+On+Demand&amp;amp;amp;amp;amp;amp;cm_ven=&cm_cat=&cm_ite=&puc=&ts=1186504576694

Portfolio Tracker

noreply@blogger.com (Kunal Jaggi) — Mon, 10 Sep 2007 00:23:00 +0000

My portfolio as of Sept 4, 2007. I am strictly trading on paper and will discuss some of my other positions in consequent blogs. I started sometime in June with 100K. Over the last 2 months, I have always kept atleast 15-20K in cash, so the effective returns have been on 80-85K, translating into 40-32 % rate of return in around 3 months. I have generated around 800 $ in brokerage transaction costs so far. I will regularly update my portfolio.

Different types of EPS and how to put them in perspective

noreply@blogger.com (Kunal Jaggi) — Mon, 10 Sep 2007 00:21:00 +0000

By Kunal Jaggi

Keeping track of quarterly Earnings Per Share figures and the percentage changes, along with P/E ratio (multiple) is often the bread and butter of stock evaluation. It is important to know the different types of EPS that companies report and how to put them in the correct context. By definition, EPS is net income divided by the number of shares outstanding. However, both the numerator and denominator can change depending on how you define "earnings" and "shares outstanding".

1. Primary EPS is calculated using the number of shares that have been issued and held by investors. These are the shares that are currently in the market and can be traded.

2. Calculation of the Diluted EPS accounts for the shares that are currently in the market plus the extra shares that would enter the market is all exercisable warrants, options were converted into shares, hence diluting the ownership of current shareholders.

3. Reported EPS or GAAP EPS, which are derived using the Generally Accepted Accounting Principles. This value can be distorted if corporate management wants to make the EPS look high. For instance, a one-time gain from the sale of machinery or a subsidiary could be considered as operating income under GAAP and cause EPS to spike. Alternatively, a company could classify a large lump of normal operating expenses as an "unusual charge" which can boost EPS because the "unusual charge" is excluded from calculations. In both these scenarios, the EPS value is being artificially boosted by non-recurring benefits, just to make the stock look particularly attractive this quarter (or year).

4. Ongoing / Pro-Forma EPS
Calculated by using the normalized income, i.e finding the earnings stream from core operations that are recurring and excluding unusual, potentially one-time income / expenses. For example, while evaluating Apple the investor should focus on income from the core operations, i.e their products and services. If Apple had an additional $600 Million income through a litigation in their favor, it should not be considered as recurring income. Similarly, the investor should be cautious of companies dismissing some expenses as "one time" or "unusual"

5. Headline EPS
The EPS number that is highlighted in the company's press release and picked up in the media. Sometimes it is the pro forma number, but it could also be an EPS number that has been calculated by the analyst/pundit that is discussing the company. Generally, soundbites do not provide enough information to determine which EPS number is being used and often times it is simply the highest one that is stated publicly.

Caveats / Points to Remember

It is good practice to use Diluted and Normalized (Ongoing / Pro-Forma EPS) figures in your valuation. You could even calculate Net Operating Income per share, or EBITDA per share and compare with previous years / quarters. Always use diluted though, warrants and options will be converted by owners if it is profitable to do so.
Beware of "Tax benefits due to employee stock options" and other such non-recurring tax deductions. A way around this is to calculate Net Income Before Tax per share.
You should always compare earnings growth relative to previous years / quarters. Steady increases in earnings per share is a good indicator of genuine growth and reduces the possibility that the company just had one great quarter which might not be sustained in the future.
According to Ben Graham, you should read the company's financial reports backwards since they will usually hide what they dont want you to see in the end. This also means that you cant always take the exact figures from Google or Yahoo Finance, because those don't exclude income/benefits that are potentially one time.
READ THE FOOTNOTES IN THE FINANCIAL STATEMENTS !!

The Intelligent Investor by Benjamin Graham (Warren Buffet's mentor) has some good warning signals

In today's corporate climate, investors need to be especially beware of dilutive effect of issuing millions of stock options for executive compensation and then buying back millions of shares to keep those options from reducing the value of the common stock.
Unrealistic assumptions of return on the company's pension funds, which can artifically inflate earnings in good years and depress them in bad.
"Special Purpose Entities" - affiliated firms or partnerships that buy risky assets or liabilities of the company and thus "remove" those financial risks from the company's balance sheet. If a company is selling off their risky assets / liabilities year after year, it is not a good sign.

Why Vasco Data (NASDAQ: VDSI) is a buy

noreply@blogger.com (Kunal Jaggi) — Mon, 10 Sep 2007 00:20:00 +0000

By Kunal Jaggi (References from Business Week)
Attached below is my research on this stock that I have been watching and trading (on paper i.e fake money) for the past 2 months.

<<VDSI Research Package >>

Contents

1. Detailed analysis of annual financial statements for past 5 years & past 5 quarters.

2. Price & volume history for past 6 years.

VDSI - Year to Date up 193.08%, past 6 mths up 118%, past 3 months up 48.93%.

Vasco Data Security International, NASDAQ (VDSI) designs, develops, markets and supports patented user authentication products for major financial institutions, enterprise security (for secure remote access), e-business and e-commerce. Their user authentication software is delivered via its Digipass line of hardware and software security products. They operate in a niche that is increasingly being considered essential to business operations rather than luxury - ensuring security through networks and online commerce. In simple words, according to Business Week - "To safeguard Internet transactions, banks in the U.S. often ask customers a "life question," such as the name of a favorite pet or the street they grew up on. In Europe, though, many financial institutions rely on Vasco's Digipass, a handheld gizmo that uses a microprocessor to generate a random number every time a customer types in his name and password. The sequence in that mobile-phone-sized device matches a number that's synchronously generated by the bank's computer. No match, no transaction"

1. Management & Industry

The company was founded with a specific focus on the banking industry, which is still one of their strongest footholds. In 1989, after being fired at age 40, Ken T. Hunt (current CEO) heard about a startup that had been selling security devices to ABN Amro for its new dial-up banking option. He started out as chief executive, took out a second mortgage on his home and bought out the company from VC's who were previously looking to liquidate. Today, VDSI has had 17 consecutive profitable quarters and adds a new bank client every day. Read more here

Customers include 750 financial institutions worldwide, 4050 enterprise security customers (corporate VPN, remote access).
Responsible for 80% of world's largest deployments of string user authentication products in financial sector
- Internet banking (both retail and big clients for wire transfers security etc)
- Internet brokerage firms
- Six months ended June 30, 2007 86% of revenues from banking, 14% from enterprise security.
- Revenue in 2007 Q2 from increased 76% over 2006 Q2 for banking and 63% for enterprise security which includes e-commerce (same period) (Source is latest Company financial statements at sec.gov)
- Growth in banking is higher due to strength of market position in banking and direct sales force.
- Growth in enterprise security market is more dependent on strength of indirect sales channel. They will continue to invest in this channel and their products will provide higher levels of security for purchases made online. Also protect their customers' revenue stream by making it more difficult for subscribers to their customers' internet services to share passwords (ex when you and your buddies share the same password)
Now here's the clincher - for 6 mths ended June 30, 2007, 91% of revenue is generated OUTSIDE the United States. (company financial statements)
- This positions VDSI favorably in the scenario of US $ weakening further (since most of their revenues is in Euros and Asian currencies)
- If the credit problems do cause recession in US (which I doubt), VDSI would again remain unaffected.
- Ken Hun, on Bloomberg TV said Europe has traditionally been the early adapters in security software and most American companies approached said they were deferring the switch. You can only imagine the growth once American companies jump in.

2. Fundamentals - Grow baby, grow

Annual Story (2002-2006) (Please refer to my Research Package attached above for complete details)

The company first became profitable in 2003, and over the 5 yr period of 2002 - 2006
- Revenues have increased 338% with an average of 46% annually over the previous year.
- The EBITDA has increased 499% , with an average increase of 179% from the previous year.
- The EPS (fully diluted and normalized), has increased 265 % from 2002 with an annual average increase of 168%.
- Cash flow wise, their CFO from continuing operations growth has increased 337% from 2002, with an annual average increase of 161%.
- Gross margins have increased 406%, with an annual average increase of 50%.
The company has had a very sound balance sheet as well. From the 2002 - 2006 period
- The working capital has grown 3864% with an average annual increase of 295%.
- Accounts receivables (annual average increase of 72%) have grown at a faster rate than accounts payables (annual average increase of 47%).
- The current ratio has increased from 0.929 to 2.145 (131 % increase) and Acid Test ratio from 0.659 to 1.785 (171 % increase).

Quarterly Story (2006 Q2 - 2007 Q2)

Revenues are up 75 % in trailing twelve months (TTM),
EBIDA up 123 % in TTM.
Net Income before tax up 115% in TTM.
EPS fully diluted and normalized up 132 % in TTM and up 37% from the previous quarter.
Free Cash Flow up 4013% in TTM.

For further ratio analysis, click here (Reuters)

3.Current Valuation

It is currently trading at a multiple of 65.37 (as of Sept 6, market close) and could seem already too expensive. But the key here is too look at the growth - when stocks grow this fast, there is always a high premium people are willing to pay for the growth. If you refer to my Research Report, you will find that it has previously traded at much higher price multiples (for example at 66.45 times earnings when price was only around 6 bucks in 2004). Alternatively, the stock is still quite cheap from the Price to Book & Price to Tangible Book ratios.

4. Technicals & Timing (Setting up the big institutions)

As the stock chart (courtesy stockcharts.com) above demonstrates volume has picked up in last couple of weeks and seems to have gone through a few cup and handle formations, breaking resistance.
Investors Business Daily rates VDSI as follows
- 99th percentile in EPS rating & Relative Price strength rating
- A+ in industry group relative strength, A in Sales + Profit Margins + ROE ratings and A- in Accumulation/Distribution rating (
- Industry group rank 4 out of 197.
- One of the heaviest bought institutional stock today.
- Overall rating of A+ (in the 99th percentile of all stocks in the Investor's Business Daily database)

Some recent developments
- CEO Ken Hunt was invited on Stock talk show on Bloomberg TV last night.
- Invited at Kaufman Brothers Investor Conference, ThinkEquity's Fifth Annual Growth Conference, Cornell University "Innovations for a Global Economy"

I believe this stock is coming into the radar of the big boys (mutual funds, hedge funds, institutional investors) very soon, and that my friends is what can propel a stock upwards very fast.

Lowdown on Financial Ratios

noreply@blogger.com (Kunal Jaggi) — Mon, 10 Sep 2007 00:19:00 +0000

By Kunal Jaggi

< financial_ratios.pdf >

Financial ratios can easily be taken out of context to give an inaccurate representation of a company. Also, for every company and sector, there are certain ratios that are more relevant than others. Here, I present commonly used ratios categorized as

Performance / Profitability
Management Effectiveness
Liquidity Warnings / Financial Strength
Efficiency Ratios

Let me know if you would like me to send you an Excel version (to add your own notes). I originally made the table in excel but Wordpress wouldnt let upload .xls format.

The Man who broke the Bank of England: George Soros

noreply@blogger.com (Kunal Jaggi) — Mon, 10 Sep 2007 00:17:00 +0000

By Kunal Jaggi

Click here for his entire biography, available in pdf format.

Born in Budapest, Hungary he escaped the Nazi occupation, studied at the London School of Economics and immigrated to New York City in 1956. Since then he founded Soros Fund Management and the Quantum Fund, which returned 3,365 % during its ten years (42.5% annually). Soros's investing style was led by his belief in the concept of reflexivity, where the biases of individuals are seen as entering into market transactions, potentially changing the fundamentals of the economy. Soros argued that such transitions in the fundamentals of the economy are typically marked by disequilibrium rather than equilibrium in the economy, and that the conventional economic theory of the market (the 'efficient market hypothesis') does not apply in these situations.

His biggest fame came when he sold short more than $10 Billion worth of pounds on September 16, 1992, earning an estimated US $ 1.1 billion in the process. Aptly, he was dubbed "the man who broke the Bank of England".

He now devotes most of his energy and resources as a philanthropist and political activist - providing funding to democratic, liberal and open market groups the world over. He founded the Open Society Institute (OSI), which spend around $400 Million annually in recent years towards projects in Central & Eastern Europe (democratizing and establishing capital markets) and Africa (poverty).

The China story much of western media missed out on

noreply@blogger.com (Kunal Jaggi) — Mon, 10 Sep 2007 00:13:00 +0000

- By Kunal Jaggi (References: A Quiet Revolution in China's Capital Markets - The McKinsey Quarterly, IPO Indicator - PRnewswire.com)

Everyone's been ranting about the 11% Chinese GDP growth rate, there's one angle much of Western media missed out on.

In the 1990's China first began privatizing its state-owned enterprises, in an attempt to use capital market economics to force them to become more commercially focussed. However, China being China, the government wanted to retain substantial shareholdings and influence, which led to a two-tier ownership structure. The original equity remained legally distinct from the new equity to form a separate class of shares held by existing state-linked owners. This class had the same theoretical rights to profits and votes, but could not be sold on public markets.

Two years ago, the government instituted new policies requiring companies to merge the two classes of shareholding to make the nontradable shares liquid. As of this spring, more than 90 percent of state-owned enterprises had already completed plans to that effect; shareholders at the last few companies are expected to finalize their reform plans this year. According to the James Ahn (partner in McKinsey's HKG office) and David Cogman (associate principal in the Shanghai office) , 20 percent of the non-tradable equity is in sectors viewed by the government as strategic. Around 55 percent is held by strategic investors with long -term interest in the companies. The remaining 25 percent represents shareholdings by state-owned financial investors. Out of that, more than 75 percent of the equity (by value) is in sectors open to foreign investment. The following figures give a deeper perspective on the kind of numbers we are talking about here

Non tradable shares as % of total sector capitalization (At present)
Coal mining - 67%
Food Mfg - 61%
Clothing, textile maufacturing - 52%
Real estate - 47%
IT - 37%
Pharma - 255

The two-tier structure dismantling road map estimates that by 2007 end tradable equities will account for 30% of net market cap, 55% by 2009 end, 90% by 2010 end and eventually 100%. Click here for the entire graph.

Now, the most immediate thought that comes to mind is that this entire process of converting huge amount of previously un-tradable equity to tradable, flooding the market with more supply than it could absorb, depressing price and diluting shareholder value. In 2005, China's State Council, the country's chief administrative authority, asked SASAC (State-Owned Assets Supervision and Administration Commission of the State Council - government department created to oversee and supervise listed and unlisted state-owned enterprises) and China Securities Regulatory Commission (CSRC - the Chinese equivalent of SEC) to come up with a definitive plan to end the two-tier equity structure. Although the companies themselves could determine the specific implementation of the merging of their equity, every plan had to include two key elements.

1. No more than 5 percent of the previously non-tradable shares could be sold in the first year following the integration and no more than 10 percent in the next year. Thereafter, companies had the power to specify longer voluntary lockup periods but there were no more regulatory restrictions. The first wave of companies to pass a reform plan will see their shares become tradable only in late 2007 and early 2008.

2. Plans had to involve some compensation paid by the holders of non-tradable shares to the owners of tradable ones. Many companies approved a proposal of bonus worth 20 percent of the equity stake, possibly combined with cash and options.

3. Each plan had to gain the support of a two thirds majority of the non-tradable shares and in a separate vote, a two-thirds majority of the tradable shares.

These clauses were put in place to ensure that the initiative would attract enough liquidity to make the price worthwhile.

Now, lets examine some of the potential benefits.

The dismantling of the two-tier equity structure could trigger off a wave of domestic M&A activity (giving Chinese firms an opportunity to consolidate across the same industry) and increased opportunities for foreign investors.

It would create a huge pool of equity potentially seeking liquidity - nearly twice the capitilization of the market today. By the time the last of the non-tradable shares become fully tradable, in 2012, current plans to reform the pension system and social security, if implemented, will have generated new funds for investment into the equity market. This increase will greatly enlarge the base of domestic institutional investors, which today account for only 10 percent of all investors. McKinsey research suggests that from 2005 to 2015 the funds under management of China’s asset-management industry could grow by as much as 24 percent a year. A professional, organized investor base would also be a powerful force in advancing best-practice governance. Can you imagine the rise of Chinese hedge funds ?

A more organized equity market would boost Chinese middle-class investor to gain greater confidence and provide impetus to shift their assets to shares from present low-yielding bank deposit, which now account for almost three-quarters of China's financial assets, compared with around 20 percent in the United States. (according to Diana Farrell and Susan Lund, Putting China’s Capital to Work: The Value of Financial System Reform, McKinsey Global Institute, May 2006). This has already been demonstrated by the notable recent increase of chinese middle class investors.

It is no secret that China is producing IPO's faster than Paris Hilton gets her pictures taken. The IPO indicator, reached a new high of 287.8 at the end of July (2007), a 13.2 percent increase from June.

Due to exchange controls on China's currency, the capital in concentrated within the country. There is a great demand for investment opportunities of all sort, and domestic stock exchanges would become more attractive for listing. Already, some high-profile Chinese companies that had scheduled IPOs in Hong Kong have changed their plans, deciding instead to pursue a Shanghai listing. Aside from currently favorable pricing, this move has considerable public-relations value - attracting further foreign investors.

It can be argued that over time, a healthy, liquid equity market will also take pressure off the banking system. As companies increasingly look to equity markets instead of bank debt for their capital allocation, an immediate result is usually greater emphasis on profit and corporate efficiency since they are no longer operating in the stodgy state owned banking environment - reducing the risks for both of them in the event of an economic downturn and allow private enterprise to play a greater role in accelerating the consolidation of many industries.

Of course, there are some caveats.

China is still way behind Western standards of accounting, legal and regulatory framework needed to profitable and sustainable equity markets. There are not enough Chinese-speaking accountants to meet the needs of every listed state-oned enterprise; accounting firms cannot hire and train people fast enough. Similarly, there are not enough courts, arbitration procedures, experienced lawyers of high quality. Lastly, effective market regulation requires independence and objectivity, but in today's China no government department truely enjoys them.

Subprime De-mystified

noreply@blogger.com (Kunal Jaggi) — Mon, 10 Sep 2007 00:10:00 +0000

By Kunal Jaggi (References: The Economist, BusinessWeek, Investors Business Daily and personal web research)

If you have been following the news at all, you have probably at least once come across a news item on 'the credit crunch due to subprime meltdown and how it's going to cause a major economic recession'. After having followed it for about a month, here's my take.

First of all, a subprime loan is one that is offered to individuals who under the usual circumstances of bank scrutiny, don't qualify as good candidates for loans due to poor credit, lack of collateral or a stable source of income. In other words if mommy and daddy are bailing you out every time your credit card bill arrives, better pull up your socks. In the last couple of years, due to robust economic conditions and availability of capital, some banks issued plenty of subprime loans. In order to entice consumers, many of these loans were offered at zero percent financing deals for the first year or two and then variable (typically high) interest rates. Now this is the killer - I saw an interview with a woman who lost her second home after Countrwide Financial informed her after the first 2 years that her interest rate was going to be 11 %.

Mortgages can be thought of as a stream of future cash flows that are bought, sold, stripped, tranched and securitized in the secondary mortgage market. There are four main participants in this market - the mortgage originator (banks, mortgage banks and mortgage brokers), the aggregator, the securities dealer and the investor. In this scenario, big brokerage firms and banks bought these mortgage loans from the mortgage issues and used them to form Mortgaged Backed Securities (an asset that uses the mortgage loans as collateral). In the last couple of years, banks and Wall Street firms have then used MBS's to structure collateralized debt obligations (CDO) and collateralized mortgage obligations (CMO), those sexy words you've been hearing on CNBC all day .

In essence, they basically bundled together risky assets (which are ultimately dependent on consumers paying their mortgages) into financial structures that offer returns higher than corporate bonds through diversification to suit potential investors. The riskiest assets earn the highest return but take the first hit from any default in the underlying asset. These investments, like any other corporate bonds, have to be given a rating by the bond-rating agencies (Moody's, Fitch ratings, S&P) before they can be sold off to any investors. Without the agencies' stamp of approval, may big investors like pension funds and university endowments wouldn't be allowed to buy these CDO's and the market wouldn't exist. Now here's the biggest problem - these bond rating agencies are paid by the very same firms that issue these CDO's and not the investors who buy them.

Al Gore once said - "It's impossible for someone to understand something, if their very liveliehood depends on them not understanding it. " Rating agencies also help the issuing banks by telling them what they need to do to garner the highest AAA rating, which is a prerequisite for a Goldman hedge fund to touch the bond. The result has been that everyone has had a financial incentive to keep issuing these risky CDO's, without due diligence. It comes as no surprise that many of the 'AAA' rated bonds have defaulted. And when quantitative hedge funds made highly leveraged bets on these CDO's without incorporating the variable of greed and Wall Street shenanigans in their mathematical models, well they lost some money. Maybe a lot.

With that said, the S&P and Dow have lost a lot of money, markets have been heading south and many people are screaming about a recession. Suddenly the ridiculous private equity buyouts have vanished and people have realized that sometimes the complex financial derivatives that Wall Street dishes out are, well too complex. The truth is not even Alan Greenspan knows the entirety of the losses since the risk was spread amongst so many players. European banks have been said to be worse hit since many of them invested in American subprime CDO's due to slower domestic markets.

I think this is a great time to buy solid (good balance sheets and plenty of Free Cash Flow) high-growth stocks (tech, safe banks not exposed to subprime, pharma) since everyone is jumping the boat to steady stocks and US treasuries. Several leading economists have mentioned that most of the key performance indicator's of the economy are positive - Q2 GDP growth rate higher, a weaker US dollar increasing American exports and most sound businesses have financed their capital expenditures through retained earnings and cash flow. Just because a big investment bank fires workers doesnt mean overall unemployment is rising. The market often over-reacts and in my opinion there is going to be a jumbo boxing day sale soon. Walmart (WMT), Wachovia(WB), Bank of America (BAC) (2 banks not involved in subprime) are already trading close to their 52 week lows - more on that later.

By the way, notice that Countywide Financial (CFC), whose stock took a 51% hit is currently 95 % institution owned. Sniff sniff, anyone smell a big bad wolf ?

Opinion influenced by - The Economist (Banks in trouble, The Game is up, August 18th issue), Business Week (Let the blame begin), Bloomberg TV and my own head.

Manifesto

noreply@blogger.com (Kunal Jaggi) — Mon, 10 Sep 2007 00:09:00 +0000

Through this blog I will attempt to present my personal equity research driven by fundamental and technical analysis, dissection of the macro economic trends, technological and Geo-political factors that shape the increasingly intertwined financial markets. Added to this will be a pinch of my personal take on market psychology, behavioral economics and how to always look for bull markets.

I will attempt to present my hypothesis in a simple and cogent manner, devoid of the elitism and shenanigans that deter potential investors from learning about the markets. As an amateur investor myself, I have no personal interest except for the dissemination of accurate information and knowledge (of course biased with my personal opinion) and to learn myself. Please feel free to post comments and any feedback / criticism (regarding my research, style or website design )is welcome !

I research and write all the material for this website myself, and all references are disclosed. Please contact me if you have any questions about my sources of information or credibility of my research. Investment, and even analysis style is unique for every person, our own perceptions often bias what we conceive as facts. That is what the markets thrive on. At the risk of sounding arrogant, this is an attempt to generate individualistic investment ideas, trying to avoid herd mentality. You might disagree with some (or most) of my views, and I would love constructive criticism and debate.

I look forward to interacting with you.