Jos A. Bank (JOSB) reported decent numbers yesterday: sales grew 10%. It’s not a blow out number but a respectable number for this environment. Profit margins have expanded as corporate expenses are leveraged across a larger store base, driving earnings growth to 27%.
At some point its advertising expenses will start declining as percent of sales and margins should go up further. At today’s incredibly cheap valuation of 10x 2007 earnings, all the company had to do is be able to fog a mirror - they did a lot more than that. It seems that this performance has legs as same store sales in November came in at 15%.
I wrote several articles in the past, little have changed since. Well, except earnings are up in 30-40%, inventory is not a concern anymore and stock price is back to where it was then.
December 14th, 2007
By Vitaliy Katsenelson
Who would have thought that an almighty Citigroup (C ), a diversified financial giant that should have benefited from the sub-prime mess by scooping up weaker competition at pennies on the dollar, would be taking out a sub-prime no-income verification $7.5 billion convertible preferred loan from Abu Dhabi - a country that most of us can hardly find on the map?I don’t use the word sub-prime lightly, but the 11% coupon on the cost of the Citigroup (C) deal exceeds the 7.5% coupon that Countrywide (CFC) (the US’ largest mortgage originator which is fighting for its existence and supposedly doesn’t have the diversity of Citi’s financial empire) promised to pay Bank of America ( BAC) in the similar convertible preferred deal. And it is no-income verification loan as Citi’s exposure to the alphabet soup problems (SIV, ABS, CDO, CMO, MTV, VH1 – oops I went too far), or in other words everything that went wrong in financial markets over last six months, is very difficult to identify.
Unfortunately it takes years not months for all problem loans to surface from the balance sheet to the income statement. For example, in late 1980s CIti found itself in the center of a Latin American default crisis. It took close to four years for the company to work through the troubled loans.
This is not just another investment from a sovereign foreign entity that should “shore up investor confidence in Citi,” as PR would spin the deal. At 11% interest rate this loan is an act of desperation. Remember, the bank is in the business of making a spread between its borrowing and lending rates.
Unless Citi will be lending at a rate in excess of 11% - a highly unlikely scenario - the purpose of this loan was to fund its dividend for next three quarters. Citi’s management saw what happened to Freddie Mac’s ( FRE) stock – it took a dive – when it announced a 50% dividend cut and decided to take the expensive route instead.
The fallout in financial stocks will create a lot of buying opportunities as lot of great regional banks that were not smart enough to do dumb things are getting lumped in the same bad apple basket as Citi and the like.
November 28th, 2007
In October, I had a great pleasure to be interviewed by two of my favorite Motley Fools: Philip Durell advisor to Motley Fool Inside Value newsletter and Bill Mann co-advisor to Motley Fool Hidden Gems newsletter. In this in depth interview I discuss everything: economy, stocks I like, international investing, practical application of QVG framework, absolute P/E model and of course my book - Active Value Investing: Making Money in Range-Bound Markets.
Continue Reading November 17th, 2007
I was interviewed by George who runs Fat Pitch Financials and Value Investing News. George also rerviewed my book.
Continue Reading November 5th, 2007
In this fund video interview with TheStreet.com I talk about why I don’t think Apple (AAPL) is a buy, why I love Jackson Hewitt (JTX) and my book Active Value Investing.
October 29th, 2007
I like Alan Greenspan, despite writing a critical article about him. It is hard not to admire the guy. He has this avuncular quality about him, he is kind of like your uncle who is super smart, kind and buys you a bicycle on Hanukkah. I’ve been reading his book and I can safely say it is one of the best books on economics I’ve read since Basic Economics by Thomas Sowell.
In the efforts to promote his book, avuncular Al is everywhere. I’ve been told (I don’t have a TV at home) that it is hard to turn on a TV and not see his friendly face at least couple times a day. What has really surprised me is how quickly he learned to speak plain and understandable English. This time around he did not hide behind suprevilosly exorbulant (Ok, I made those two words up) vocabulary. I’ve seen him on CNBC (I have a TV at work) and for the first time in years I did not have to reach out for a dictionary. Also, suddenly he is bearish on the US housing market. The one that (if I understood him right) before was a non issue. In fact now he sounds like a voice of reason. Yes, we got problems!
The lesson here - it is almost pointless listening to a Fed chair while he is on the job because he cannot say what he really thinks as the consequences of that are too high.
October 17th, 2007
If we learned anything over the last couple of months it is that we don’t know the second and third derivative of how badly things will play out.
We knew that the housing market was in the bubble, what we did not know was how its deflation will play out, i.e. commercial market freeze. We did not know that that it would resonate in Germany or that it would cause a run on the bank in England. We did not know that Russia, a country that is supposed to be swimming in cash from oil revenues, will be tinkering with financial crisis again (at least we did not expect it to happen when oil prices at $80).
What we know now is that our economies are a lot more interconnected than we ever imagined and also that the consequences of use of leverage will be found in places we never expect them to be found.
October 11th, 2007
Soon after we purchased Jackson Hewitt (JTX), offices of one of their franchisees was raided by the U.S. Justice Department; the franchisee was accused of falsifying tax returns for thousands of taxpayers. JTX stock collapsed on that news. The risk was that it was a widespread practice and JTX management was complicit with the franchisee and that the brand may have been damaged and lawsuits would follow.We thought otherwise: The management had no incentives to resort to outright spend-time-in-jail type of fraud, they had a great business on their hands; it made no sense for them to do something that stupid.
Though that incident made headlines in the localities where it took place, national media was preoccupied with more important developments at the time (i.e. Paris Hilton going to jail) and thus the JTX’s brand was unscathed. We liked JTX’s management when we purchased the stock, but we were even more impressed with their response to this incident: they hired an ex-IRS commissioner to head an independent internal investigation and clearly communicated to investors about the investigation.
As we expected the IRS did not find anything, management settled the issue with them (basically paying the IRS $1.5 million to go away). Here is an opportunity. The “bad news” (which now was not really bad) drove the stock down to about 12-13 times earnings, but JTX has a handful of growth drivers that should bring earnings growth in mid to high teens for years to come as it only has a 4% market share of a very fragmented market. Management spends every penny of free cash flow to return to shareholders (our kind of management) through a 2.6% dividend yield and stock buyback.
October 11th, 2007
When I bought Wal-Mart (WMT) a bit more than a year ago, I wrote an article for Financial Times where I laid out my theses:
- Wal-Mart currently appeals mostly to lower income demographics, and this is where things will change the most… Cleaner, better, more appropriately merchandised stores will attract new customers… encourage shoppers to… spend more… As initiatives take effect and the shopping experience improves, Wal-Mart will be taking market share from upper scale retailers…
I was wrong! Wal-Mart failed to improve its stores and merchandising to attract a more affluent shopper (the sub-par same store sales are a testament to that). Thus future fundamental return (earnings growth and dividends) will likely be in the high single digits, below original estimates, making the stock fairly valued (at best) at today’s valuation. My (accounting) loss on the purchase was miniscule – because I did not overpay for the stock; however, I experienced an opportunity cost loss as the market has appreciated since.
October 11th, 2007
After a year and half, 2,000 hours of staring at my laptop, and much receded hairline, my book Active Value Investing (AVI): Making Money in Range-Bound Markets is done! Last year and a half is a blur; it feels like I came out of a prolonged coma – family celebrations, kids growing up are just vague recollections. Like a third child (I have two ‘real’ adorable kids) I nourished the book, carefully choosing every word that went into it, and there were 75,000 of those. And akin sending your child to the real world, I have a sense of pride, and at the same time I am nervous as I want the rest of the world to like it and more importantly to benefit from it.
Let me attempt briefly tell you about the AVI, for in depth take on the book, here is a link to book’s preface. AVI has two parts: in part one, I make the argument that there is a very high probability, that over next dozen years or so the U.S. stock market will be dancing a similar foxtrot that it danced since 2000: it will take investors on a wild roller coaster ride (it will go up, down, and sideways), but at the end of this exciting journey it will not be far from where it is today. The market will be range-bound.
Continue Reading October 6th, 2007
The 2001 rate cuts caused the bubble that is now a crisis. Here we go again
The right decisions are usually the hardest ones: they often require enduring short-term pain for the long-term gain. We learn this as parents early into the job.
The Federal Reserve under Mr. Greenspan’s leadership faced a tough decision in 2001. The post dot.com bubble had burst, the terrorist attacks followed and the economy was slipping into a recession. Instead of letting nature (i.e. market forces) take its course, Avuncular Al chose an easier, less painful (at least the short-run) road - he lowered interest rates at levels we have not seen in decades and kept them there for a long time.
Mr. Greenspan retired and wrote a book blaming the bubble on “global forces”, but “global forces” is probably his alter-ego as short-term interest rates followed the Fed Funds Rate every step of the way.
The Fed torch is now in Mr. Bernanke’s hands, he faces a new but old dilemma: to provide a temporary “fix” to the economy that is suffering a severe hangover from being overdosed by low interest rates set by his predecessor. This will guarantee a need for future “fixes” and eventually will lead to a larger crisis down the road. Or he can do nothing, let market forces work things out and let the economy go through a painful but needed withdrawal. In this article I wrote for Business Week I am arguing for doing the latter.
September 21st, 2007
Don’t compound them with bailout for mortgage ‘victims’
By Vitaliy Katsenelson
The housing bubble that was fueled by multidecade low interest rates priced many people out of their dream homes. But instead of settling for less or renting, people went after their American dream with a vengeance - taking out adjustable-rate, interest-only or, even worse, negative-amortization loans. Good things end, and great things end with a big bang; the burst of the nationwide housing bubble has left many with shattered homeownership dreams and financial despair.
And now the blame game starts. It must be the builder who charged too much for the house, or the “blood-sucking” mortgage broker who facilitated a loan, or the bank for extending credit we should never have had. Now, there’s a new extreme - the investors who purchased our mortgage with thousands of others from financial institutions.
The blame falls on us and none of the above. Though we want to blame the financial institutions for coming up with these products, as long as loan terms were fully disclosed, it is our responsibility to make the right financial decisions, not theirs. Any product can be dangerous if not used responsibly. Even a hair dryer, if used while taking a shower, could lead to untimely death. The financial products (i.e. mortgages, home-equity loans, credit cards) are electrified by compounding, and if not used appropriately, could lead to financial distress.
Though some would like to - and many will - pleading ignorance is disingenuous. With the exception of outright fraud, buyers knew they were biting off more than they could chew. They knew interest rates would reset and mortgage payments could increase, or at least it was their job to find out before they committed to the biggest purchase of their life. But that was in the future, and they lived in the now. The future is today, and there is a price to pay. We need to stop blaming everybody but ourselves and own up to our mistakes.
We hear sad, heartbreaking stories of eviction, broken families and pecuniary anguish resulting from people losing their homes all over the country. Of course, we want to help these folks in trouble. Our first instinct is to look at our almighty government for help. Though government sounds like an ambiguous third party, it is not - it is you and me. Should you and I carry the burden of those who made irresponsible or simply bad decisions? Money is a finite commodity, thus for the government to bail out the victims of this housing debacle, it either will have to raise taxes, cut spending or both. Yes, you and I will be paying higher taxes and/or money will be diverted from cancer research or other social programs because your neighbor elected to live in a larger house, better neighborhood or to have a greener lawn.
But that is just the beginning. The largest cost of a government bailout is the one that is not apparent at first - the moral hazard. In a free economy, incentives are set up in a way so that decisions made in our best interest also benefit society,or the system as a whole. Introduce moral hazard into the equation and individual decisions can benefit participants but hurt the system. The unintended consequence of a government bailout could be catastrophic.
The politician will tell you that only victims will be assisted. They’ll make sure not to call it a bailout. It is close to impossible to identify who the true victims are. Were they the ones with bad credit who took out subprime or Alt-A loans? Or the ones who are facing ARM resets? Maybe the ones whose house value declined because their neighbor foreclosed on his?
Politicians will come up with creative definitions of victim, but the result will be the same - the number of people who fall under the victim umbrella will mushroom exponentially, far exceeding original expectations - the unintended consequences. Homeowners who had all intentions of paying on their mortgages will ask for the government’s (now available) assistance. The ones who could not afford their house in the first place will get a couple years of free rent out of the system, ultimately defaulting on their mortgage a couple of years down the road.
In addition, the bailout will introduce an asymmetric payoff for current and future homeowners: Owning a house will become a risk-free endeavor. If your house price goes up, great. If it goes down, you claim to be a victim and society compensates you for the risk you’ve taken. A risk-free, utopian paradise, isn’t it? This will set the stage for an even greater next housing crisis.
The next couple of years will uncover more fraud committed by some unscrupulous mortgage brokers and banks. Some small elements of fraud are uncovered at the end of each boom: the junk bond boom of the late 1980s, S&L crisis of the early 1990s, the Internet bubble of the late ’90s, and it will happen again. Our economic and legal systems are equipped to deal with these people - they’ll go to prison. And politicians, like vultures, will feed on our misplaced anger. Like superheroes, they stand up to protect the little people (us) against the evil empire by creating “housing reforms.” But you cannot legislate common sense. With freedom comes responsibility. Do we really want to give up freedom and have government bureaucrats decide who should or should not get a loan? Instead, lawmakers should focus on making the lending process simpler and more transparent, where the terms of the loan are clearly spelled out on one page.
Doing nothing is the hardest thing to do when you see people in distress. We are a compassionate people, and we want to help. But there are times when we have to restrain ourselves and do as little as possible because by helping some you’ll hurt many others. This is one of those times. The current crisis will pass, as have many before. Let’s not escalate the magnitude of the next one by irresponsible actions.
Vitaliy Katsenelson, CFA, is a portfolio manager at Investment Management Associates in Denver. His book ,Active Value Investing: Making Money in Range-Bound Market, will be published by John Wiley & Sons at the end of September.
This article originally was published in the Rocky Mountain News
September 15th, 2007
I just came from a week-long trip in London. I got to tell you, London (and probably all Europe) is tremendously expensive. The numbers on price tags look very familiar: Starbucks (SBUX) Chai Tea Soy (okay, I do like those things) is 3.80, a breakfast (two eggs, a toast and a coffee) in your typical diner around the corner is 7.00… these prices sound okay if they were quoted in dollars. The only problem is that they were in British pounds.
At the end I basically convinced myself that prices were not quoted in pounds but in dollars. This way when I paid $7.60 ( 3.80 pounds x 2) for Chai Tea Soy or $14 for breakfast it did not drive me crazy. Of course, I’ll get my credit card bill in the mail in a couple of weeks and my little deception will come to the surface. Oh, well. On the other side of the coin, the US is 50% off for the Europeans.
I’ve been a believer in long-term dollar decline (and positioned portfolio accordingly), but I do ask myself - what will the dollar decline against? I don’t know the answer.
Scandinavian countries? Japan? The unintended consequence of the weak dollar – we travel less outside of the US and export more (since our goods are cheaper). The only problem is that we have a trade deficit, so we buy more than we sell – this where a weak dollar hurts us the most. But the weak dollar should work to lower the US’ trade deficit.
September 8th, 2007
I’ve been a big fan of First Marblehead’s (FMD) stock for couple months now, and it looks like an incredible value today, trading somewhere around 7-8 times earnings. Though I have to mention this stock is not for the light hearted, as it has a lot of myths surround it.
Tom Brown, who I am very proud to have as my book endorser, wrote a harsh but wonderful piece today dispelling a lot of myths surrounding FMD. In addition, the company has no debt, 15% of its market cap is in cash and it has been growing earnings 30-50% a year. Its margins will likely compress going forward, thus its growth may decline from its past levels, but it should be in double digits.
Oh, did I mention FMD just raised its dividend to 3% yield?
September 7th, 2007
By Vitaliy Katsenelson
We live in the society where, to our detriment, being politically correct is often more important than being correct. So I am going to come out and make a politically incorrect statement - social investing is an oxymoron.
There is nothing social about investing. Investing is not about making popular, socially approved choices. It is about allocating capital from a less efficient use to more efficient use. Touchy-feely types of choices make us feel good about ourselves… well, until we have to retire and have to start paying for things.
It is hard enough finding good investments, and adding more very subjective criteria to the mix only makes it more difficult. In fact, if you scrutinize any company long enough it won’t pass the “social” test.
- Political donations: A company is giving money to the wrong (another very subjective criteria, unless it is something black-and-white like Al Qaeda) cause or party.
- Treatment of employees (very subjective): Does Wal-Mart (WMT) treat its employees fairly? Do you start looking at employee compensation of every company you invest in? One should only care about how well a company pays its people if it impacts company’s fundamentals.
- Labor practices (for example, use of child labor): Do you avoid companies that use parts made in China or manufactured in China? If you did this in your personal life, you’d be walking around naked as textile manufacturing for the most part has migrated to China and other low wage countries where labor practices may not meet your standards.
- Charge too much – this is a big category, ranging from pharmaceutical companies (companies that save millions of lives a year) to payday loan companies, college loan providers and so on.
- Environmental citizenship – Do you avoid oil companies and refineries? What about auto companies who make gas-guzzling SUVs?
Some companies are trying to capitalize on the social investing idea to make you feel good about their “socially conscious” businesses. British Petroleum changed its name to BP (BP) and advertises on CNBC with a slogan “BP – Beyond Petroleum”.
So you don’t have any illusions about BP, it is only 4% beyond the petroleum. 96% of its sales come from petroleum products. If BP focused instead on running its business, its stock would perform a lot better than “petroleum-behind” Exxon Mobil (XOM).
I probably missed a dozen categories, but you get the idea. When social investing is taken to the extreme it turns into a very taxing exercise and substantially limits the ‘investable’ universe.
Avoiding sin – socially irresponsible - stocks (i.e. defense, tobacco, gambling and alcohol) doesn’t severely limit an investor’s stock universe and is not very taxing on time and effort, as sin stocks are easily identifiable. However, this may prevent you from following attractive opportunities.
In fact, I’d argue that this is the time to own these anti-social sin stocks as demand for their products is not closely tied to economic prosperity (they have a cycle of their own) and they’ll be a place to hide if the economy takes a turn for the worse.
Neither my company nor I own many anti-social stocks. I wish we owned more. We own Diageo (DEO) – the largest spirits maker in the world, that owns brands from Johnnie Walker to Bailey’s. As baby boomers age, they switch to higher grade liquors – higher margins for Diageo.
Also, liquor has got to be one of the most exportable goods after bubble gum. As the developing world develops – yes, you guessed it right - it’ll speak Johnnie Walker’s language. Also, as we get older we tend to drink more hard liquor and less beer – this is main reason why I own Diageo instead of Budweiser (BUD), not because drinking hard liquor is more socially responsible than drinking beer.
Adam Smith’s invisible hand did not wear a social glove and for a good reason: social criterions only add inefficiency to the system of capitalism.
I’d like to conclude by quoting Larry the Liquidator, a character from my favorite movie, “Other People’s Money”:
“Take the money. Invest it somewhere else. Maybe, maybe you’ll get lucky and it’ll be used productively. And if it is, you’ll create new jobs and provide a service for the economy and, God forbid, even make a few bucks for yourselves…”
September 7th, 2007
The Federal Reserve’s latest move was to encourage lending, not to stimulate borrowing. (There are plenty of wannabe borrowers sitting on the sidelines, waiting their turn.) The Chinese curse comes to mind here – may you live in an interesting time. This is an interesting market. This market will wash out a lot of investors who jumped into it for the wrong reason – it was going up and they felt they had to be there.
The fixed income market is going through the readjustment of risk. The spreads between risky and not risky assets have gotten to absurd levels. I wrote about it before,
Russian companies were borrowing money at a few percentage points (or less) above T-Bills. How rational is that? Not very! Lenders were not properly compensated for taking risk (providing risky loans). The defaults in the subprime space reminded lenders what risk looks like (something they’ve forgotten in the latest frenzy).However, as it usually happens the risk re-adjustment will probably go from one extreme to another, there is a good chance that risk premium will overshoot its normal level and go to a higher extreme. We are not there, yet. For instance high yield (junk) bonds usually have a yield 5% above risk free bonds (T-bills), several months ago, that spread got as low at 1%. Right now spreads are approaching 5%, but they are less likely to stop there and go higher (well, this is how the average is created). This will (and already has) cause a dry up in private equity deals, breaking one leg under the market.
Portfolio managers are in a pickle, if they own corporate bonds – risk premium and thus borrowing rates are likely to rise. So it’s not a great place to be (maybe the very short end of that spectrum is safe). The Fed, with yesterday’s move, signaled that the next move in interest rates is likely to be down, not up. Action in T-bills shows that this is where the market finds safety. However, returns from T-bills are miniscule and will barely compensate investors for (understated) inflation.
Of course, depending on one’s investment horizon, the right stocks are still a place to be. What are the right stocks? The ones that have little exposure to consumer discretionary spending, whose business is not tied to heavy dependence on consumer financing (i.e. home equity loans), financials should be owned with caution – despite the Fed’s latest action it may get a lot worse before it gets better. You want to look at companies that don’t heavily rely on outside financing, in other words have strong balance sheets and don’t have large amounts of debt maturing in the near future. All this being said, a company in trouble is often a good investment at the right price.
Markets painted all financials with the same gloomy brush, all financials are not created equal. Lincoln Financial and US Bancorp (USB) for example have little exposure to sub-prime, but they are still down significantly with the rest of the pack. When I talked to my business partner this morning he said something that really struck me as the right attitude for this market (or actually any market). “Next time you make a decision ask yourself – what would Warren Buffett do?” He’d be patient and long-term oriented. He’d look at chaos and fear as opportunity. And no, the world is not coming to an end; we survived many wars, credit crunches, terrorist attacks and even Paris Hilton going to jail. We’ll be OK this time too.
Vitaliy Katsenelson,CFA and a vice president/portfolio manager with Denver-based Investment Management Associates. His book, Active Value Investing, will be published by John Wiley & Sons in September 2007. More articles at ContrarianEdge.com
August 20th, 2007
By Vitaliy Katsenelson, CFA
It seems that Motorola (MOT) comes out with a good handset that everybody wants every five years or so. Considering that, we have a couple more years to go until the company will have another blockbuster handset again. This failure by Motorola is a big positive for Nokia (NOK) on many fronts.
Or to piggyback on a well-known Motorola advertising tagline: Goodbye, Moto — and hello, Nokia.
First, it shows that Nokia’s management can execute despite not having the “hottest” phone on the market (i.e. Motorola’s Razr). Also, it will be further taking market share from Motorola; I estimate its margins will further improve, driving its earnings north of $2 a share over the next couple of years. After seeing Nokia’s second-quarter results, that estimate could come sooner rather than later.
The best part is Nokia doesn’t have to do anything heroic to achieve that goal. Operational leverage (higher volumes spread over fixed costs) and a shift to a higher margin (more feature-rich phones) will do the work. This was the driver of the company’s truly incredible operating performance in the second quarter.
The second quarter was simply spectacular: operating profit in every segment with the exception of its networks division grew in the high double digits, and sales climbed a whopping 28%.
At the current share price, you are not really paying for the network segment, in fact, since it loses money it detracts from the company’s valuation. But at some point its profitability will turn positive and the division will become a contributor to Nokia’s bottom line.
Samsung is a conglomerate, and although it’s a good one, it still lacks Nokia’s focus. Despite being located in a lower labor-cost part of the world, South Korea-based Samsung doesn’t have a cost advantage against Nokia, as Finland-based Nokia manufactures its phones all over the world, including in China. Nokia has proved to be the Dell of cell phones from a cost-structure and manufacturing-efficiency perspective and Apple-like when it comes to innovation — it comes out with several dozen phones year after year.
There is still upside in Nokia’s global market share, because Nokia has just a small market share in the U.S., accounting for only 4% of its volume. It is only a matter of time before Nokia starts taking market share in the U.S.; it has already started to design U.S.-centric phones. As Nokia regains market share in the U.S., this will drive its global market share. Despite not having the phones in the U.S. that consumers seemed to want, Nokia still has an excellent brand reputation in the U.S., so it just needs to fix relationships with U.S. carriers (AT&T (T) , Verizon (VZ) and T-Mobile) and start selling phones that the rest of the world is so crazy about.
Disclosure: I have a position in Nokia
August 9th, 2007
See an article I recently wrote here. In this piece, I am arguing that yesterday’s selloff is not a watershed event and basically a non event. Jeff Macke called the article a very Russian one, when I inquired why he explained "My ancestors ate frozen wood while staving off Napoleon. 300 points doesn’t scare me."
But 2.3% decline on 25% plus appreciation over last 12 months? That is not just me being "tough Russian" that is just common sense. This sell of in financials created opportunities in two of my favorite stocks First Marblehead (FMD) and US Bancorp (USB) (OK, USB is less of a favorite, but 5.2% yield and ultra conservative management is what I look for in a bank, I don’t want any lending heroism or Star-Treckish will go where nobody has gone before).
Also, Jos A Bank (JOSB) lost 10 points in over last couple weeks, and its valuation is very alluring at this point. A weak economy may shave off couple points of its growth rate over next couple years, but it should still do EPS growth somewhere in the mid-teens.
July 27th, 2007
After Motorola (MOT) threw in the towel on making money in cell phones this year, is it a good buy?
It was not three years ago. This analysis is still valid today.
In fact, Motorola’s failure is a big positive for Nokia (NOK) on many fronts: it shows that Nokia’s management can execute despite not having the “hottest” phone on the market.
Also, it will be further taking market share from Motorola: I estimate its margins will further improve, driving its earnings north of $2 a share over next couple years. The best part is it doesn’t have to do anything heroic to achieve that. Operational leverage (i.e. higher volumes spread over fixed costs) and a shift to a higher margin (i.e. more feature-rich phones) will do the work. I am not as enthusiastic about the stock as I was a year or two ago, but I still see some room for growth.
Disclosure: I own Nokia stock
July 12th, 2007
By Vitaliy Katsenelson, CFA
This is an excerpt from a comment I read on Daily Speculation. It is such a common misperception that I had to write a response:
“Great stocks [Google, Apple] are to be owned. Companies who dominate their space are to be kept and allowed to grow. Those who have built fantastic franchise names should be accumulated. Buy Google over Yahoo. Apple over Dell. And most importantly, the speculator should be willing to hold on, eschewing the quick buck in search of the really big gains that can be achieved through diligence and patience.”
I could not disagree more with this conclusion. In the long run, the performance of a stock in isolation (ignoring the external environment, i.e. interest rates, risk, inflation) is the product of fundamentals (i.e. earnings and cash flow growth) and valuation (i.e. P/E, P/CF).
Google (GOOG) and Apple (AAPL) may have great fundamentals: their innovation has led and may continue to lead to high earnings and cash flow growth. But are they good stocks? They may or may not be. But, more importantly, will they be good stocks at any price? No! If I were to follow the above conclusion, that since Google and Apple are great companies they are great stocks at any price, at any valuation – at 50, 500, 5000 times earnings, then I’d walk into an overvaluation trap.
Take a look at eBay (EBAY) in the late 90s: it was a great company (it still is), but it was grossly overvalued. So, if you bought it in the late 90s and held it until today, despite its earnings going up 100-fold, the stock is roughly at the same level it was then. I’d argue few would have the patience and conviction to hold it through the downturn the stock took in the early ’00s. Most investing in the stock in the late 90s lost money on it.
One of the biggest mistakes investors make in investing is failing to separate a good company and a good stock. A great company’s (fundamental) performance is wiped out by valuation compression. This is the battle of two winds: the tailwind of earnings growth and the headwind of P/E compression.
Also, with a high growth priced appropriately (even to perfection) there is no room for even a small mistake (no margin of safety) left in the valuation - a small disappointment (it doesn’t have to be much) will lead to a substantial decline in price. The latest performance of Starbucks (SBUX) and Whole Foods (WHMI) stocks is a great example of being priced for perfection and delivering slightly less-than-perfect results.
This myopia in differentiating between good companies and good stocks is not just limited to wonderful, exciting, larger-than-life (Google comes to mind here), fast-growing internet companies. The bluest of the blue chip stocks, like GE (GE), Coca Cola (KO), Home Depot (HD), Amgen (AMGN), Johnson and Johnson (JNJ) (and the list goes on) were all great companies that one “had to own” but were terrible (overvalued) stocks in the late 90s. Their earnings have doubled or tripled since but the stocks have not gone anywhere.
I think it was Benjamin Graham who said that “price is what you pay, value is what you get.”
July 7th, 2007
Who ever said, "vino veritas" (in wine, there is truth), hasn’t written enough. I say, "in writing veritas." MarketWatch asked me to write an article about one’s investment strategy in the interest rate environment on the horizon. When I first sat down to write, I thought that I was a bit neutral on the direction of interest rates. However, by the time I finished (as you’ll see), it was painfully obvious that interest rates are more likely to go down than up. It’s a story of global prosperity that has been in part prepped up by finite sources (mostly debt).
I would not bet my career or even a bottle of fine beer (Fat Tire - those in Colorado will know), but there are too many "uncertainties" on the horizon for higher interest rates. In the article, I offered two stocks, Glaxosmithkline (GSK) and Johnson & Johnson (JNJ) that should do well in any interest rate environment.
July 2nd, 2007
The Almighty Bill Gross of Pimco has flip flopped on the direction of interest rates for the second time this month.
I can feel Mr. Gross’ pain. At this point predicting the direction of interest rates is like flipping a coin. The global economy is roaring on all engines - a case for higher interest rates. At the same time, we are walking on a subprime, weaker housing, leveraged-consumer mine field. I am so glad that I am not in the interest rates prediction business.
June 27th, 2007
If I’ve learned anything over the years, it’s that people don’t learn. Recently, I talked to my cousin who is an executive with a Russian airline company. In our discussion he mentioned that his company just received semi-unsecured loans (all planes are leased so they are not used as a collateral) from western banks at 10% a year. Though it sounds like a good rate in today’s interest rate environment, it is an airline and it is in Russia.
Why would somebody ever give a loan or buy airline bonds of any country? I can understand buying distressed bonds or maybe a stock as a trade. Not my kind of thing, but I can respect that. But a buyer (an investor) of fully priced (at par or close) airline bonds usually intends to hold them to their maturity, or for a long time. It is well documented that the airline industry as a whole has lost money over its cumulative existence. Thus, uneconomical, low fares that consumers have been enjoying over the years were subsidized by bond and equity investors. This is great for consumers, not so good for providers of capital. I almost want to say “Fly, don’t buy.”
Continue Reading June 22nd, 2007
Fortune’s June 25 issue has come out with the top picks for Growth & Income, Bargain Growth, Small Wonders and Deep Value. The shocking part is that almost every stock in this group (yes, including Deep Value) is trading at, or very close to, an all time high.
If this is not a sign of a market top, I don’t know what is.
June 22nd, 2007
By Vitaliy Katsenelson, CFA
There was an interesting article in the WSJ on Moody’s downgrading 131 bonds backed by a pool of subprime mortgages. As dramatic as it sounds this downgrade only impacted $3 billion worth of bonds, less than 1% of the $400 billion in subprime mortgage issue in 2006.
Though these numbers don’t sound earth shattering, it is becoming painfully apparent that credit rating agencies are extremely reactive, not proactive. This downgrade took place because more data came to the surface (i.e. higher defaults in second mortgages that were lumped together with subprime loans in 2006).
Credit agencies are held to a higher standard than sell side analysts whose recommendations are as useful as last month’s newspaper. Credit agencies have legal access to non-public information and thus one would expect a better, proactive analysis. The problem is that the credit agency’s actions may have dire consequences on corresponding companies and turn into a self fulfilling prophecy (i.e. a downgrade to junk status may shut the company from credit markets and cause a bankruptcy).
Why does this matter? Well, if you think we are in the beginning stages of the subprime default cycle (I believe we are), than you’ll see more and more (reactive) downgrades from Moody’s and the likes. Be skeptical of credit agency ratings, use your own common sense.
June 18th, 2007
By Vitaliy Katsenelson, CFA
The Financial Times reports China’s largest bank, ICBC, announced its intentions to get into the banking business in the US. That move actually makes sense. Politicians already started making waves about China owning a good chunk of the US through its government debt (an idiotic rhetoric, but it is a topic for a different discussion). The Chinese are thinking instead of making loans to the US government and getting paid a barebones rate. Why not help the US consumer to get further into debt and make a juicy profit in the process? Good thinking.
The best part is that politicians will have a hard time blocking the Chinese foray into banking (though they’ll try). If the US blocks the Chinese entry into US banking, China is likely to reciprocate (I would not blame them) and thus American banks’ grandiose ambitions to drown 1.2 billion Chinese in credit card debt will be crashed.
I doubt that you’ll see ICBC branches around the corner anytime soon, but I think the acquisition of a large US bank would make a lot more sense – you get instant scale, American know-how, and you can self finance much higher yielding consumer loans from trade surplus. Call me crazy, but that is what I would do.
June 14th, 2007
by Vitaliy Katsenelson, CFA
The Joseph A. Banks (JOSB) selling machine is kicking on all cylinders - yesterday’s quarterly numbers were proof of that (see article I wrote for Market Watch).
My gripe (and Herb agrees) with the management is that they decided that no Q&A is needed after the quarterly conference call. I completely understand why the company’s management may decide to spend their time on a more productive endeavor than answering sell side analysts’ questions which most of the time have little to do with the company’s long-term future, but zero in on minute, often irrelevant short-term details. That being said, management should have done a better job communicating to the Street the change in Q&A practice.
JOSB’s marketing strategy is the weakest link in its business model. It is extremely short-term oriented and not about long-term brand building. I’d argue that it cheapens its brand. Where Men’s Warehouse’s (MW) “I guarantee it” commercials tell you about product quality and a pleasant shopping experience (long-term brand building strategy), JOSB commercials sound like it’s a cheap car dealership that you’d expect to see in the deep suburbs of nowhere land, with a very annoying voice that tells you something along the lines of, “Only this Tuesday, the whole store is 50% off!” But don’t worry, if you missed this Tuesday special, there are other days of the week; Wednesday, Thursday… you get the point. Yesterday, while reading JOSB’s latest 10Q, I heard the commercial at least three times on CNBC. This short-term driven marketing strategy is responsible for the volatility of same store sales.
June 12th, 2007
By Vitaliy Katsenelson, CFA
Financial Times - May 25, 2007
Wall Street is inherently short-termist. This is not because it is dumb. Quite the contrary, some of the brightest minds in the country labour in the investment industry. But as the mutual fund industry has grown, the desire for short-term gratification has altered the focus, turning an investment business into a marketing one.
There is nothing wrong with marketing; some of my good friends are marketeers. But a good marketeer’s job is to discover what customers want and try to meet that need. Unfortunately, the investing public wants instant gratification. They want to keep up with the (Dow) Joneses, and for their fund to "beat" the other funds and comparable indices on a short-term basis - quarterly and annually. That is not what investing is about; it is about reaching long-term financial goals without taking unnecessary risks.
Continue Reading June 6th, 2007
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