One of my favorite B-school professors (this prof taught Money & Banking and Bond Management, and did a great job at both) once said that "if it's good in theory and not in practice, well then it's not really good in theory, either", and after 12 years of managing money, and 20 years in the investment business, I have to agree with him.
In academic theory, at least in most textbooks, a student is taught not to "market-time" i.e. to move in and out of cash and stocks in order to maximize gains and minimize losses. In fact many studies have been done that have shown that if an investor misses, or is out of the market and in cash, just two of the best days of a rally off a major market bottom, then they may see their holding-period return cut almost in half.
A case can be made for both market-timing and not market-timing: however if there is one lesson we learned in the 2000 - 2003 bear market, it is that client's like "absolute return" in a down market, meaning they don't want declines in the stock or equity portions of their portfolios (which makes sense) but client's like relative returns in up markets, meaning that clients not only want to see gains, but better than benchmark gains, in good markets (and again, that makes sense.)
In other words, in order to be an effective money manager, you have to time the market in some form or fashion. You have to take gains for clients at some point, and cut losses at some point.
Since we are entering the 4th year of this bull market in equities since the March, 2003, market bottom, I needed to update clients on our thinking about market-timing and let clients know that we are using market-timing tools so as to not repeat the mistakes of the early 2000's:
1.) The first "market-timing" barometer we are using is the Thomson Financial Market Risk Premium (TMRP) calculation, updated every week, which is a combination or derivation of the Fed model, and quantifies in one number, whether stocks are "rich" or "cheap" relative to historical norms.
On Friday, May 25th, 2007, the TMRP showed that the S&P 500 has a risk premium of 8.6% (this is not technically an equity risk premium, but it is close, and I'd show clients the calculation, but I think you'd get lost in some of the math and the logic, and you'd lose the essence of the calculation ). The TMRP hit a high of 9.8% in October, 2005, and a low of 4% in March of 2000, thus as you can tell from Friday's reading, the TMRP "range" is much closer to the historical high showing that the S&P 500 is still relatively, attractively valued, versus the low in March of 2000 when the TMRP showed the S&P 500 historically overvalued. The TMRP is not a "precision" timing model, it gives a signal over time based on a number of factors, and it is more like an hourglass than an alarm bell.
2.) The second marketting tool we are using is Bob Brinker's monthly Markettimer newsletter. Bob Brinker is rated one of the top marketimers in the last 5 and 10 year time periods per the Hulbert Financial newsletter tracking service. When Bob says get out, we'll get out (with a caveat to be discussed below) and we'll do it quickly, particularly if the Markettimer market call coincides with the TMRP signal, and without regard for capital gains (unless a client specifically asks us not to sell). Bob Brinker is currently bullish on the state of this cyclical bull market, primarily due to the high pessimism seen in the 60-day put-call ratio, and the relatively low P/E ratio for the S&P 500 relative to previous market tops. The put-call ratio is currently skewed to a high number of puts versus calls as investors look for downside protection.
Finally, just because the market gives a sell-signal doesn't mean that we need to get out of equity or sectors, or individual stocks entirely. In 2000, housing and homebuilding sectors, and gold and precious metals started to break out of long-term technical consolidations, thus it could warrant some equity exposure in long-out-of-favor groups, should the market start to roll over.
My guess is that if and when this bull market peters out, we will likely first sell the current leadership groups like energy, like commodities and utilities and telecom (since these sectors will have the most downside risk) and we will likely see the old growth babies of the 1990's, like GE, like AIG, and large-cap tech and financials, possibly become the "safe-havens" of the next bear market.
Right now though, it is too early too tell what the next bear market might look like, and we are staying invested in a combination of sector ETF's and individual stocks. Higher interest rates, particularly the 10-year Treasury yield, will push that TMRP lower, thus I do believe that higher rates and slower earnings are the biggest threat to this current bull market.
If clients want to see the actual TMRP calculation, let me know.
To conclude, we are using the "belt and suspenders" methodology in terms of market-timing.
One sell signal will be a yellow light, and we'll alert clients accordingly and two sell signals - one from each service - will result in a major shift in our holdings for clients.
position in S&P 500 index funds, SPY, ETF's, GE, AIG
Tuesday, May 29, 2007
Monday, May 14, 2007
Avoiding China, Russell 2000, and REIT's
Michael Santoli's editorial column this weekend (within Barron's) was right on target in my opinion, as China has now become to the decade of the 2000's, what Japan was to the 1980's, i.e. the hot market, the economic model to be worshipped and the "it" economy, kind of the Paris Hilton of global economies, and you really can understand why when the latest "reported" GDP growth for q1 '07 for China was north of 10%.
Michael Santoli talked about the P/E multiple of the Shanghai Stock Exchange being "50(x) earnings" which one could deem as an expensive valuation, but my thought when I read that was "what constitutes earnings" ? Throughout my career when I've heard analysts or portfolio managers or whoever talk about the valuation of a foreign stock or foreign market, you don't often hear them talk about the quality of those earnings.
Because of the global economy, the world seems to be moving towards a uniform set of accounting standards, which would leave companies from different countries with a more uniform set of financial statements for analysis. In fact if we dissected China's corporate earnings, we could find the Shanghai trading at 100(x) earnings or 20(x). (I'll let you guess which valuation is more likely.) Most people, if you listen solely to the news, probbaly have forgotten that China is still a Communist country, and although unlikely, could still wake up one day and see that the government has "appropriated or nationalized" the country's asset base. (The risk is small, but it is there, or maybe some derivation thereof...)
For present clients, we are staying away from international in general, and China in particular for the time being, given the enormous popularity of investing "internationally" and given that if China should crack, there is a high likelihood of a contagion effect throughout Southeast Asia. According to one source, over 90% of all mutual fund inflows in 2006 (can't remember if it was an Investor's Business Daily article, or an IBD article referencing a Citigroup research piece where we read the statistic) went into "international" funds, and we'd love to own this asset class, just not now.
Regarding the Russell 2000, small-caps have outperformed large-caps, particularly the S&P 500 for 6 - 7 years running, and the valuation of the Russell 2000 is almost twice that of the S&P 500, interms of the P/E ratio.
Tony Dwyer, the equity strategist at FTN Midwest and a frequent CNBC contributor, e-mailed me some data on Friday showing that the Russell 2000's P/E is 28(x) trailing earnings for 15% y/y growth, or almost 2(x) PEG. In and of themseleves these statistics aren't bad, but when compared to the S&P 500's 16(x) forward eps for what has been quarterly growth of 10% - 15% year-over-year year earnings since the March, 2003 bottom, you can quickly see that the S&P 500 is more attractively valued than the R2K, and the S&P 100 (or the top 100 stocks in the S&P 500) is even cheaper than the entire index. (In April, '07, the S&P 500 rose 4.43% while the Russell 2000 increased just +1.80%; I don't know or want to say that that is a trend, just the amount of underpeformance was surprising. You would think - at some point - that large-caps would "mean-revert" and start to outperform small-caps.)
Finally, although we have recently bought the XHB (homebuilder's ETF) for some client accounts, we are staying away from REIT's in their entirety, although commercial property REIT's still seem to have a decent valuation given the strength of corporate cash flow.
We'd love to own all these groups once again, particularly international via Oak Mark's David Herro's International Fund, David being one of the best portfolio managers in the international asset class today, but I would prefer to wait until we get an inevitable currency disruption or exogenous event to take hot money out of these groups.
To conclude, we sold our Russell 2000 too early in 2004, 2005, and we sold our REIT's too early as well, and we continue to think that the S&P 500 remains relatively cheap, and unloved relative to the rest of the world.
long S&P 500 index funds, SPY
Michael Santoli talked about the P/E multiple of the Shanghai Stock Exchange being "50(x) earnings" which one could deem as an expensive valuation, but my thought when I read that was "what constitutes earnings" ? Throughout my career when I've heard analysts or portfolio managers or whoever talk about the valuation of a foreign stock or foreign market, you don't often hear them talk about the quality of those earnings.
Because of the global economy, the world seems to be moving towards a uniform set of accounting standards, which would leave companies from different countries with a more uniform set of financial statements for analysis. In fact if we dissected China's corporate earnings, we could find the Shanghai trading at 100(x) earnings or 20(x). (I'll let you guess which valuation is more likely.) Most people, if you listen solely to the news, probbaly have forgotten that China is still a Communist country, and although unlikely, could still wake up one day and see that the government has "appropriated or nationalized" the country's asset base. (The risk is small, but it is there, or maybe some derivation thereof...)
For present clients, we are staying away from international in general, and China in particular for the time being, given the enormous popularity of investing "internationally" and given that if China should crack, there is a high likelihood of a contagion effect throughout Southeast Asia. According to one source, over 90% of all mutual fund inflows in 2006 (can't remember if it was an Investor's Business Daily article, or an IBD article referencing a Citigroup research piece where we read the statistic) went into "international" funds, and we'd love to own this asset class, just not now.
Regarding the Russell 2000, small-caps have outperformed large-caps, particularly the S&P 500 for 6 - 7 years running, and the valuation of the Russell 2000 is almost twice that of the S&P 500, interms of the P/E ratio.
Tony Dwyer, the equity strategist at FTN Midwest and a frequent CNBC contributor, e-mailed me some data on Friday showing that the Russell 2000's P/E is 28(x) trailing earnings for 15% y/y growth, or almost 2(x) PEG. In and of themseleves these statistics aren't bad, but when compared to the S&P 500's 16(x) forward eps for what has been quarterly growth of 10% - 15% year-over-year year earnings since the March, 2003 bottom, you can quickly see that the S&P 500 is more attractively valued than the R2K, and the S&P 100 (or the top 100 stocks in the S&P 500) is even cheaper than the entire index. (In April, '07, the S&P 500 rose 4.43% while the Russell 2000 increased just +1.80%; I don't know or want to say that that is a trend, just the amount of underpeformance was surprising. You would think - at some point - that large-caps would "mean-revert" and start to outperform small-caps.)
Finally, although we have recently bought the XHB (homebuilder's ETF) for some client accounts, we are staying away from REIT's in their entirety, although commercial property REIT's still seem to have a decent valuation given the strength of corporate cash flow.
We'd love to own all these groups once again, particularly international via Oak Mark's David Herro's International Fund, David being one of the best portfolio managers in the international asset class today, but I would prefer to wait until we get an inevitable currency disruption or exogenous event to take hot money out of these groups.
To conclude, we sold our Russell 2000 too early in 2004, 2005, and we sold our REIT's too early as well, and we continue to think that the S&P 500 remains relatively cheap, and unloved relative to the rest of the world.
long S&P 500 index funds, SPY
Tuesday, April 17, 2007
McDonald's: within a $1 of all-time high
Technically, you could say that MCD's is ready to break-out to an all-time high, or is putting in an 8-year double-top (a technical term meaning that a long-term topping formation is being put in place) for the king of Big Mac's, but if we had to fall into one bucker or the other, we'd say that MCD's still has some room to run.
Since its previous peak at $49.56 in December, 1999, MCD's fell all the way to $12 per share in mid-March, 2003, and then finding a bottom with the rest of the stock market at that point, MCD's has climbed steadily higher to its current price of $48 and change, however the stock price appreciation isn't all market related.
MCD's grew earnings between 4% and 12% in the last half of the 1990's which paled in comparison to the technology sector's 40% growth year-in-and-year-out at that point in time, so if I had to guess, I'd say that most of the MCD's stock price performance was attributable to its "large-cap growth" moniker of that period since operationally MCD's didn't do all that well. (We owned the stock at one point between 1997 - 1999 until we heard that MCD's had a "Bun Committee" of 12 people which was responsible for all facets of hamburger bun operations, and right away GM and IBM came to mind in terms of corporate sloth. The stock was sold the next day.)
Now the fact that we avoided the name in the 1990's and the early 2000's and then started buying MCD's right around March, April, 2003 had to be one of our better decisions as a firm to date, but what got us interested in MCD's was the fact that in early 2003, with the stock trading near $15, the stock was approaching the real estate liquidation value, and thus represented a low risk entry point.
However, the key to the MCD's story since eraly 2003 has been cash flow: pure, unadulterated, unmitigated cash and free-cash-flow generation along with improved operations.
In the last 4 years, MCD's annual dividend has increased from $0.40 to $0.55 to $0.67 to 2006's $1 per share and the 4q trailing cash flow from operations has increased from $3 to $5 bl in the last three years. The dividend yield has remained fairly constant at between 1% - 2% since 2003, as the stock price appreciation has kept pace with the dividend growth.
Free-cash-flow, or the FCF "yield" ( 4q trailing free-cash-flow as a percentage of 4q trailing revenues) has ranged from between 6% - 10% in the last 16 quarters or 4 years, much of which has been returned to shareholders in the form of stock repurchases and the aforementioned higher dividends.
ROIC or return-on-invested capital has increased from a low of 7% in mid 2003, to the current ROIC of 14%.
So what does the future hold ? With 30,000 stores currently a lot of MCD's store expansion is behind it, but this also is one of the reasons MCD's is generating so much cash flow: it is now a mature grower, and a cash cow of sorts, but through the "designated licensee" (DL) program, MCD's is trying to reconfigure ownership and the balance of franchisee's to company owned stores, and thus continues to unlock more value, and generate more excess cash.
More importantly, MCD's is improving operations: per our internal spreadsheet, the March '07 comp of 9.7% was the best systemwide sales comp for MCD's since December of 2004, and Europe's March '07 comp of 11.2% was one of the best ever for that region. (In MCD's 2006 annual report, on page 25, management states that a 1% increase in European comp's "would increase annual net income per share by about $0.02 (two cents).)
Bottom line: MCD's stock options are subsiding, thus the share repurchase program will be more accretive to shareholders, the turnaround in operations is a huge positive, and the very strong cash-flow and free-cash-flow generation will keep a floor under the stock. Since 2003, MCD's has grown earnings per share, 35%, 6%, and 20% respectively with the lumpiness due to the amount of cash being distributed and thus used for share repurchases. Current First Call eps estimates have MCD's growing earnings in the high single digits in the next three years, which, given the operational turnaround, could be conservative.
MCD's is trading at 13(x) Enterprise value to 4q trailing cash flow (hardly expensive), and is a perfect candidate for P/E expansion in a market totally vacant of such phenomena.
A move above $50 (and thus through formidable resisitance) for MCD's on good volume, and the hamburger king could run for a while.
position in MCD
Wednesday, April 11, 2007
GE reports Friday, 4/13/07
Friday the 13th has never been associated with good luck in any form or fashion, and yet GE is prepared to report q1 '07 earnings before the bell. Current Thomson Financial / First Call consensus is looking for $0.44 in earnings per share and $39.795 bl in revenues for year-over-year growth of 13% and 5.2% respectively.
Although typically followed byWall Street industrial analysts, a big part of GE's operating income comes from GE Capital or the financial services arm, thus you really have a two-part company: GE Capital and GE Industrial, the industrial arm which accounts for about 2/3rd's of cash flow and generates about $1 in free-cash-flow for every $2 in cash generated from operations.
With a AAA-rating (credit rating), a 3% annual dividend (and plenty of room to grow) a strong stable of global businesses spread across multi-sectors and probably the best management team in industrial and financial America, you really have to wonder why the stock has been an absolute dead-fish the last two years since it closed around $36 in December, 2004.
Here is my issue with continuing to hold the stock in client portfolios: a note out of Goldman Sachs shortly after the February 26th meltdown in Shanghai and US markets noted that GE fell 8% during the market drop lasting from late February into mid-March: if the stock goes nowhere in 2006 with the S&P 500 up 15% in that year, then goes down 8% in a market swoon, that is very poor risk-reward from a performance standpoint. (In 2006, GE returned about 6% before the dividend, versus the S&P 500's 15%. For whatever reason quality growth stocks are seeing no P/E expansion, even in good markets.)
From a valuation standpoint, there is little not to like about GE: at $36 per share, and with the current '07 estimate of $2.22 per share, GE is trading at 16(x) forward earnings, for what should be an easy 10% grower through any kind of economy. In addition, the substantial cash-flow you'd expect with a AAA-rated company, leaves GE trading at about 12(x) enterprise value to 4q trailing cash from operations, which is hardly expensive today. GE's WMC Mortgage business could be an issue this quarter since GE is liable on subprime defaults within 90 days of securitization (according to a CIBC World Markets research report) , and WMC generated almost $100 ml to GE's bottom line in '06, but again, with GE's various businesses you expect these hiccups to occur (i.e. the downside of diversification) and be offset with strength in other businesses.
Bottom line: as much as I like the company, the cash-flow and the management, the stock has been a drag on performance. I feel for Jeff Immelt: Jack Welch got the benefit of a 20 year bull market and P/E expansion, whereas Jeff Immelt has seen nothing but P/E contraction and a market very unsympathetic to large-cap growth stocks in general.
There is an old saying: "amateurs hope while professionals work" so we have to see some possible catalyst for GE in Friday's report or we have to think hard about continuing to hold a perennial underperformer.
Position in GE, GS
Although typically followed byWall Street industrial analysts, a big part of GE's operating income comes from GE Capital or the financial services arm, thus you really have a two-part company: GE Capital and GE Industrial, the industrial arm which accounts for about 2/3rd's of cash flow and generates about $1 in free-cash-flow for every $2 in cash generated from operations.
With a AAA-rating (credit rating), a 3% annual dividend (and plenty of room to grow) a strong stable of global businesses spread across multi-sectors and probably the best management team in industrial and financial America, you really have to wonder why the stock has been an absolute dead-fish the last two years since it closed around $36 in December, 2004.
Here is my issue with continuing to hold the stock in client portfolios: a note out of Goldman Sachs shortly after the February 26th meltdown in Shanghai and US markets noted that GE fell 8% during the market drop lasting from late February into mid-March: if the stock goes nowhere in 2006 with the S&P 500 up 15% in that year, then goes down 8% in a market swoon, that is very poor risk-reward from a performance standpoint. (In 2006, GE returned about 6% before the dividend, versus the S&P 500's 15%. For whatever reason quality growth stocks are seeing no P/E expansion, even in good markets.)
From a valuation standpoint, there is little not to like about GE: at $36 per share, and with the current '07 estimate of $2.22 per share, GE is trading at 16(x) forward earnings, for what should be an easy 10% grower through any kind of economy. In addition, the substantial cash-flow you'd expect with a AAA-rated company, leaves GE trading at about 12(x) enterprise value to 4q trailing cash from operations, which is hardly expensive today. GE's WMC Mortgage business could be an issue this quarter since GE is liable on subprime defaults within 90 days of securitization (according to a CIBC World Markets research report) , and WMC generated almost $100 ml to GE's bottom line in '06, but again, with GE's various businesses you expect these hiccups to occur (i.e. the downside of diversification) and be offset with strength in other businesses.
Bottom line: as much as I like the company, the cash-flow and the management, the stock has been a drag on performance. I feel for Jeff Immelt: Jack Welch got the benefit of a 20 year bull market and P/E expansion, whereas Jeff Immelt has seen nothing but P/E contraction and a market very unsympathetic to large-cap growth stocks in general.
There is an old saying: "amateurs hope while professionals work" so we have to see some possible catalyst for GE in Friday's report or we have to think hard about continuing to hold a perennial underperformer.
Position in GE, GS
Wednesday, April 4, 2007
Washington Mutual - interesting statistic
Jim Cramer, the founder of TheStreet.com, and CNBC Mad Money guru, had an interesting piece on Washington Mutual this afternoon, with Jim in fact playing the stock the exact same we are: Jim is waiting to see what q1 '07 earnings look like.
However, CreditSights, a Wall Street fixed-income research firm which does great research (better than a lot of equity analysis in my opinion) wrote a piece on WM when the subprime issue broke in late February saiying that WM has as much as 15% risk to eps from subprime, which is less than I thought, and likely leaves the dividend intact (in my opinion).
Another interesting stat on WM: Oakmark Select, one of the family of Oakmark funds run by Harris Associates here in Chicago had a 15% position in WM stock as 2/28/07, per the recent Morningstar data sheet that Morningstar publishes monthly on many mutual funds.
Bill Nygren, a brilliant value investor, and the lead manager of Harris Associates Oakmark Fund has been bulling Washington Mutual since 1997, saying that the stock is worth between $70 - $80 on a takeout by a larger bank. (Oakmark and Harris Associates are classic value investors, along the Warren Buffett line.) Along with the Oakmark's Select's 15% position in WM, WM holds the #2 position in Nygren's fund with a 2.54% position as of 2/28/07.
At $40 per share, WM is yielding over 5% with the annual dividend better than $2 per share.
The thing is, the subprime blowback might be the catalyst to finally motivate WM to sell out, and realize some of this undervaluation. Investors have been waiting for years for the thrift to get taken out.
Technically, WM is getting oversold on the weekly chart, as it tests its 200-week moving average near $40.91.
position in WM
However, CreditSights, a Wall Street fixed-income research firm which does great research (better than a lot of equity analysis in my opinion) wrote a piece on WM when the subprime issue broke in late February saiying that WM has as much as 15% risk to eps from subprime, which is less than I thought, and likely leaves the dividend intact (in my opinion).
Another interesting stat on WM: Oakmark Select, one of the family of Oakmark funds run by Harris Associates here in Chicago had a 15% position in WM stock as 2/28/07, per the recent Morningstar data sheet that Morningstar publishes monthly on many mutual funds.
Bill Nygren, a brilliant value investor, and the lead manager of Harris Associates Oakmark Fund has been bulling Washington Mutual since 1997, saying that the stock is worth between $70 - $80 on a takeout by a larger bank. (Oakmark and Harris Associates are classic value investors, along the Warren Buffett line.) Along with the Oakmark's Select's 15% position in WM, WM holds the #2 position in Nygren's fund with a 2.54% position as of 2/28/07.
At $40 per share, WM is yielding over 5% with the annual dividend better than $2 per share.
The thing is, the subprime blowback might be the catalyst to finally motivate WM to sell out, and realize some of this undervaluation. Investors have been waiting for years for the thrift to get taken out.
Technically, WM is getting oversold on the weekly chart, as it tests its 200-week moving average near $40.91.
position in WM
Tuesday, April 3, 2007
Micron reports Wed, 4/4/07 - one last chance
In an earlier March post to this blog, I wondered if the semiconductor stocks had become the steel stocks of the 1980's and 1990's: over-owned, overvalued, with over-capacity and the prospects of underperformance for as far as the eye can see.
With Micron Technology as the poster child for this group (I would classify MU as the most speculative play in the semi sector with very low returns on capital (if at all) and a very high degree of operating leverage with little sustainable competitive advantage) Wednesday night's report will go a long way in determining if MU is worth hanging on to in client accounts, and if there is any prospect for a DRAM ramp as a result of the Vista launch.
MU is expected to report breakeven earnings per share on Wednesday night, with $1.46 bl expected in revenues (per the First call data) versus a loss of $0.04 last year, and revenues of $1.225 bl.
Not all is lost with MU as gross margin has expanded the last three quarters and at least there is the prospect for a profit this quarter. The company diversified away from DRAM into NAND flash almost two year ago, with the last few quarter's results actually being hurt a little bit by NAND flash memory price declines, while DRAM pricing was holding in pretty well. At least in the 1990's, the key to MU was to buy the stock when the DRAM spot prices rallied and in fact when flash memory prices rose above their 200 day moving average. With the collapse of the technology market starting in 2000, MU looked for ways to diversify away from DRAM and ventured into the NAND flash market, which I think in fact will serve them well in coming years, but the company is still levered to the spot/contract pricing in both volatile markets.
Earnings estimates for fiscal '07 have come down from just over $1 per share in November '05 to the current estimate of $0.37 for the current fiscal year eps estimate. The additional memory which Vista will require was expected to have a positive impact on MU by now, although it has yet to materialize, but a couple analysts expect DRAM memory prices to bottom in the May '07 quarter.
The balance sheet for MU has actually improved since semi's collapsed earlier this decade, as the company had $3.36 per share in cash sitting on the balance sheet as of the November quarter, and had generated $2.57 in 4q trailing cash from operations, which left the stock trading at just 5(x) enterprise value to 4q trailing cash from ops.
Still, the company is burning off tax-loss carry-forwards from the massive operating losses in 2001, 2002, 2003, thus the returns on invested capital of 1% - 2% are simply a matter of there being no taxes paid. (A hedge fund manager once described MU as "an airline with a fab attached", which is investment speak for an operation that destroys capital, much like the airlines do.)
The technicals (see the monthly chart above, compliments of Telechart and www.worden.com which is our technical analysis service) have actually improved on MU of late, as the stock has attracted some interest trading near trough valuations, and just over 1(x) book value, thus at these price levels (you would think) there is very little risk to the stock. In fact, the big green volume bar indicates that the stock has seen its heaviest volume ever in 2007, which may be buying in advance of a Vista upgrade cycle.
So why own the stock with all the negatives surrounding the name ? Simply because MU is a levered play on the launch of Vista and the additional memory it would require, as well as a commodity play on the NAND flash business. Although it is unlikely that we will see a repeat of the late 1990's, there is significan leverage to MU's operations when DRAM and NAND flash prices steadily rise, as in the 1990's, eps went from a loss of $0.55 per share in fiscal 1998 to a positive $2.20 per share in 2000.
We recently added to the stock prior to the Fed meeting, and are hoping it can re-take its 200 month moving around $15 - $16 per share. If the stock can break through the $15 - $16 area on good volume, and re-take that critical support levels, MU could be a significant outperformer in 2007.
Are semi stocks the steel stocks of the 1980's and 1990's ? With the rapid speed of the tech life cycle and rapid obsolescence, winners and losers are created over much shorter time horizons than the basic industries of the previous generation. Still, we won't wait forever. MU has the possibility of a brighter future and the valuation is cheap, not without qualifiers, but we'll
give it a little more time.
position in MU, SMH
Walgreen's - good March '07 and spectacular q2 '07
Walgreen's reported March '07 comp's this morning that were in line with expectations, and told investors that due to the calendar location of the Easter weekend, April '07 comp's will be combined with March '07 comp's (as was done last year) to get a true reading of the two month activity.
In March, '07, WAG's same store comp's rose 8%, while prescription comp's rose 8.8% and front-end comp's increased 5.6%. There has been some slowing in the monthly data for Walgreen's, but not dramatically so, as the retail drug store group continues to have the best comp's in all of retail, month-in and month-out, and WAG continues to take market share from competitors.
Still, it is hard to put too positive a spin on WAG's 2q earnings reported last week: year-over-year (y/y) revenues rose 15%, eps rose 26%, and operating income rose 36% (albeit against the weakest quarter of '05) as the gross margin expanded 124 bp's to 29.68%, the operating margin expanded 129 bp's to 8.04%, and the net profit margin expanded 37 bp's to 4.68%.
WAG continues to get expense and SG&A leverage out of their formidable business model, as WAG has not had one single quarter of less than dounble-digit sales growth since 1998.
While most analysts note WAG's forward P/E of 23(x) the current '07 estimate of $2.07, WAG is cheaper on a cash-flow basis, trading at just 17(x) 4q trailing cash from operations, as the company has ended the last two quarters with free-cash-flow on a 4q trailing basis of $1 bl or more, the first time that has happened since we began tracking the company in 1995. As of the February '07 quarter, WAG was generating $2.78 in four-quarter trailing cash flow per share, about 150% higher than net income, and a good litmus test for earnings quality (i.e. cash flow as a percentage of net income).
One of the bigger internal improvments WAG has made in the past few years has been working capital, as their working capital efficiency through most of the 1990's and early 2000's was in fact pretty poor. Today however, even with continued store growth, and just 50% through their ultimate store build-out of 11,500 stores, WAG is generating free-cash-flow that is very healthy, which will hopefully continue.
Bottom line: trading at less than 1(x) 4q trailing sales, and 23(x) forward earnings for recent eps growth of 26%, and 17(x) 4q trailing cash flow (enterprise value) you would think that WAG would be a table pounding buy by most of Wall Street, but analysts look at the stock price action and the two year trading range between $40 - $50 and the horrid P/E compression, and think "I'd better stay away until the stock breaks out".
Fundamentally the stock is a great value here, and technically it looks pretty good too, as the next upward thrust should take WAG over the September '06 high of $52 per share.
Could the stock price be discounting a new business model in the form of CVS/Caremark ? Absolutely. Could the lagging stock price be forecasting as yet unseen changes down the road in insurance co-pay's (the biggest risk to WAG's business model) ? Sure, absolutely. The stock price could be discounting any number of untoward events or circumstances including the current complete disgust for large-cap growth stocks (the most likely reason), but that is the challenge in investing.
We do our homework, do the bottoms-up analysis, read what the anlaysts are saying, follow the charts and technicals and stay with the quality growth businesses, and we continue to believe that WAG is one of the best.
position in WAG
In March, '07, WAG's same store comp's rose 8%, while prescription comp's rose 8.8% and front-end comp's increased 5.6%. There has been some slowing in the monthly data for Walgreen's, but not dramatically so, as the retail drug store group continues to have the best comp's in all of retail, month-in and month-out, and WAG continues to take market share from competitors.
Still, it is hard to put too positive a spin on WAG's 2q earnings reported last week: year-over-year (y/y) revenues rose 15%, eps rose 26%, and operating income rose 36% (albeit against the weakest quarter of '05) as the gross margin expanded 124 bp's to 29.68%, the operating margin expanded 129 bp's to 8.04%, and the net profit margin expanded 37 bp's to 4.68%.
WAG continues to get expense and SG&A leverage out of their formidable business model, as WAG has not had one single quarter of less than dounble-digit sales growth since 1998.
While most analysts note WAG's forward P/E of 23(x) the current '07 estimate of $2.07, WAG is cheaper on a cash-flow basis, trading at just 17(x) 4q trailing cash from operations, as the company has ended the last two quarters with free-cash-flow on a 4q trailing basis of $1 bl or more, the first time that has happened since we began tracking the company in 1995. As of the February '07 quarter, WAG was generating $2.78 in four-quarter trailing cash flow per share, about 150% higher than net income, and a good litmus test for earnings quality (i.e. cash flow as a percentage of net income).
One of the bigger internal improvments WAG has made in the past few years has been working capital, as their working capital efficiency through most of the 1990's and early 2000's was in fact pretty poor. Today however, even with continued store growth, and just 50% through their ultimate store build-out of 11,500 stores, WAG is generating free-cash-flow that is very healthy, which will hopefully continue.
Bottom line: trading at less than 1(x) 4q trailing sales, and 23(x) forward earnings for recent eps growth of 26%, and 17(x) 4q trailing cash flow (enterprise value) you would think that WAG would be a table pounding buy by most of Wall Street, but analysts look at the stock price action and the two year trading range between $40 - $50 and the horrid P/E compression, and think "I'd better stay away until the stock breaks out".
Fundamentally the stock is a great value here, and technically it looks pretty good too, as the next upward thrust should take WAG over the September '06 high of $52 per share.
Could the stock price be discounting a new business model in the form of CVS/Caremark ? Absolutely. Could the lagging stock price be forecasting as yet unseen changes down the road in insurance co-pay's (the biggest risk to WAG's business model) ? Sure, absolutely. The stock price could be discounting any number of untoward events or circumstances including the current complete disgust for large-cap growth stocks (the most likely reason), but that is the challenge in investing.
We do our homework, do the bottoms-up analysis, read what the anlaysts are saying, follow the charts and technicals and stay with the quality growth businesses, and we continue to believe that WAG is one of the best.
position in WAG
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