The Average Joe Investor

What I'm Reading Today - Jan. 23, 2012

2012-01-23T09:56:00.000-08:00

I managed to get my hands on a review copy of Motley Fool contributor Morgan Housel's upcoming book on the economy, stocks, and the housing market. It's a really fantastic read, but unfortunately I can't point you to it yet because I was just reading an early copy.

You can, however, grab a copy of Morgan's previous book on Amazon. Or you can get a flavor for the kind of topics he covers in the new book by checking out his latest on Fool.com.

-AvgJoe

Investing Inspiried by Hunger?

2010-08-11T18:02:00.000-07:00

Ok, so admittedly my article today -- 7 Dividend Stocks Worth Owning -- wasn't inspired by drooling daydreams of cheese steaks, but the exploration of cheese steaks was inspired by a dinner that left me wanting last night.

However I think there are certianly ways that I could stretch the analogy a bit further:

Dividend stocks and cheese steaks have a good recipe going -- don't mess with it. If you hand me a Philly cheese steak with gruyere cheese on it I won't ask any questions, I'll just throw it right in the trash. Call it a wagyu steak sandwich with gruyere and I might try it, but don't you dare call it a cheese steak. I don't need anything flashy and forward-thinking in my dividend stocks either. Give me stable businesses with a history of reliable payouts and payout growth.

Unless you have cholesterol or blood pressure issues (which I guess, sadly, does cover a lot of people) a Philly cheese steak is a treat that can be enjoyed by just about anyone. Don't try to tell me you're a vegetarian. Eat a Philly cheese steak, you'll love it. Similarly, dividend stocks aren't just for widows and orphans -- they're an investment dish that can be enjoyed by all.

If you go into a fancy place with crisp, white table linens and waiters that call you "sir" and "m'am" and they have a cheese steak on the menu, it's probably lousy. Your best cheese steaks are found by scouring hole-in-the-wall-type joints. I don't think anyone ever said that Geno's has a beautiful building. Similarly, the best dividend payers are usually not going to be your fancy, flashy companies. In the article today I highlighted companies like Illinois Tool Works and Owens & Minor. Not exactly exciting ice breakers at the neighborhood pot luck, but good dividend payers.

While I often prefer my cheese steak in all of its natural glory, it's hard to go wrong with adding ketchup -- after all, ketchup is one of the few foods that perfectly balances sweet, salty, bitter, sour, and umami. Similarly, most dividend stocks are better with ketchup on them... Just checking to see if you're still reading. No? Ok, I'll stop here then.

-AvgJoe

In Theory It Works...

2010-08-09T13:27:00.000-07:00

Some quick thoughts about discounted cash flows...

For those not familiar with DCFs, the very quick overview is that you're taking all the future cash flows of a company and discounting them back to what they're worth today (because a dollar tomorrow isn't worth as much as a dollar today) and using that to come up with a value for a company.

In the theoretical version of a DCF you do an academically-inspired calculation to come up with the "cost of equity." That cost of equity is very important as it's typically (at least for companies that are primarily equity-financed) a larger weighting in the overall cost of capital, which is what you're using to discount the cash flows.

Now if that sounds a bit like academic mumbo-jumbo it's because it is... well, to an extent at least.

Let's say you've run through a very complex DCF on BuddahBarn (an ueber-successful karma-oriented seller of farming equipment and attire) and have concluded that the stock is undervalued by 25%. Should you buy? Well, here's the other thing -- upon calculating BuddahBarn's cost of equity, you came up with 6%. So while you apparently have a 25% gulf between today's price and what the stock is theoretically worth, the bottom-line returns that equity-holders can expect are pretty darn low.

Now there's method to this madness and basically it's that theoretically a more volatile stock is a more risky stock to own, while a less volatile stock is less risky to own. In order to own the former, you need much higher equity returns than the latter. The problem, of course, is that the way that risk is measured -- volatility -- is, for lack of a better word, whack.

So what do you do? My answer is a bit of common sense. I generally start with a cost of equity (which we can probably also think of as an equity returns hurdle) of 12%. From there, I base my investment decisions on the price/valuation discrepancy and a consideration of the actual risk -- that is, potential for permanent loss of capital -- from the stock.

That would mean that I'd consider buying, say, McDonald's (which I do own) at a smaller discount than I'd demand for Blackstone (which I also own).

Another way to get around this cost of equity issue, is to not set a cost of equity at all. Instead, set all of your other variables, plug in today's price, and back into an implied cost of equity. Then -- again, based on actual risk for the stock -- decide whether that rate of return is really adequate compensation.

-AvgJoe

Bad Water

2010-08-05T16:12:00.000-07:00

If you're a lover of coffee like me, here's a bit of advice to never pooh-pooh: using good water to make your coffee. For the past couple days I've been making my coffee with tap water and the end result has been rubbish (to put it very, very nicely). The idea of using bottled water to make coffee seems odd, but I'm actually considering it.

Well, anyway, fair warning to my fellow coffee drinkers.

And while this may seem way off topic, to me it's not. Without ample coffee, there's no way you're going to make it through financial filings -- particularly when it comes to banking or utilities -- so bad coffee is a terrible blow to the serious financial analyst.

Ok, you got me, it was way off topic.

-AvgJoe

Wake Up Congress!!!

2010-08-05T11:40:00.000-07:00

Watching the financial overhaul bill snake its way through Congress I came to have a distinct hatred for the word "procedure." Some of the very best amendments to that bill were tied up in ridiculous procedural rules that lawmakers used as a shield to make sure that those amendments never saw the light of day.

"Ok, fine," I said to myself, "this is financial reform and the government is screwy. What should I really have expected?"

Then comes this vote on health care coverage for 9/11 first responders. And what happens? Procedure rules the day again. Of course Congressman Anthony Wiener was having none of it. Good for him, we need more folks like that in Congress.

Credit where credit's due, Jon Stewart highlighted this on The Daily Show.

-AvgJoe

An Ode to Coca-Cola

2010-08-02T19:27:00.000-07:00

An article I did for Fool.com today about Coca-Cola and companies of its ilk. The company has been a favorite of Buffett's and I'm a big fan of it as well -- and even saw an opportunity to pick up some shares last year.

-AvgJoe

An Oasis for My Soul

2010-08-02T11:46:00.000-07:00

It's been a while since I've posted here and I originally my plan was to post something about stocks, but sometimes something else just pops up and screams at you, "You must post me!"

This is from Colony Capital's Tom Barrack (via Krugman's blog, via the Financial Times). Apparently Barrack took some time off and stumbled upon... Twilight.

... after “an agonisingly tough couple of weeks” he took some “yacht time” and chanced upon his daughter’s copy of Twilight. “I don’t get it … but I feel it. Taking the agenda-less time to absorb a point of view that I had ignored while loved ones around me relished it was an oasis for my soul.”

So folks, yet more evidence that hedgies are people too. People that can take home billion dollar paychecks and still have a seventh grade girl's appreciation for literature.

Of course I jest (or do I...?)

-AvgJoe

A Must Read

2008-10-24T14:29:00.000-07:00

If you haven't caught the Forbes cover article this month (written by Steve Forbes), then it's time you headed over to the Forbes site and get your read on.

-AvgJoe

The market's flubber bounce

2008-10-13T13:50:00.000-07:00

I've been sitting here for a few minutes now wondering what exactly you say on a day like today. Happily, it doesn't involve finding some new way to describe a continually plunging stock market. In fact, quite the opposite. I'm sure you've seen already, but each of the three major US indexes is up more than 11%. Let me just go ahead and repeat that: over 11%.

How does this rank historically? From what I've got from Yahoo!Finance, it looks like this is the sixth largest percentage gain on the Dow (note: ignore the hoopla over the point gain, that's meaningless -- focus on the percentage). Ominously, all of the single-day percentage gains higher than today's were during the Great Depression.

Now I know this will make everyone jump to the conclusion that this means we're in the same situation as back then. I don't believe it does, so I'm not going to drag out the comparison any further.

What I will say is that there are two primary factors that are going to be front and center for me going forward: 1) the economy's reaction to the global efforts to jump start the credit markets and 2) how far the repricing of risk goes and how persistent it is. The reason for #1 is that if the economy falters then the companies that we're investing in (broadly) will be hurt by pinched sales and profitability. Simple as that.

#2 comes from the fact that over time investors tend to determine their required returns differently depending on how scared they are. People are very scared right now and want a big return to take pretty much any risk. If that continues to be the case, valuations for stocks will continue below what they had been before this drop began.

As for tomorrow... who knows? It's hard enough evaluating the market when fundamentals are in the driver seat. When investor psychology takes over -- particularly when there are a lot of unknowns -- things get interesting.

-AvgJoe

Finance on SNL

2008-10-12T09:39:00.000-07:00

So who couldn't use a laugh right now? (and if you answered "not me" then you need a laugh more than the rest of us)

Check out this Update from Saturday Night Live. About halfway through is the "Fix It" bit, which is pretty much how I feel at this point.

-AvgJoe

Run and hide or stay and fight?

2008-10-09T13:21:00.000-07:00

That's a really good question right now, especially since the Dow finished today down 39.4% from last year's peak. That's worse than the 37.8% drop that the Dow saw from peak to trough during the post-Internet Bubble blow-up. It now only trails two periods of stock market malaise -- the Great Depression and the extended down market during the late 60's and 70's.

During the Great Depression stocks declined 89% from summer 1929 to summer 1932, then spiked back up from 1932 to 1937 only to plunge another 52% from 1937 to 1942. In all it took 25 years for the Dow to recover its 1929 high.

After peaking in early 1966, the Dow had plunged 42% by Fall of 1974. And though '74 was the bottom, the market bounced up and down until 1982 when it finally started showing some real life again.

So are we in for a long period of terrible stock performance? I don't think so. Now I fully realize that I have been wrong on a lot over the past year, and certainly wasn't on the leading edge of this recent melt-down (and my portfolio shows this). I've now jumped on the "cyclical bear market" bandwagon, but, as others more prescient than myself have pointed out, this bear market really started back at the turn of the millennium. Right now we're down about 27% from the peak of 2000. And if you'd invested in the Dow in early 1998, you would have been roughly flat over the past 11 years. In other words, if this is a cyclical bear market, then we're well into it.

But that doesn't really help with the pressing question does it? So what do we do with our money? Well, I don't have the answer for any particular individual (when you need the money is a big question), but I'll tell you what I'm doing: I'm staying put. The problem with starting to freak out right now, or with trying to guess where the bottom is, is that there's a good likelihood that you'll miss out on some of the recovery -- which can happen fast.

How fast? After the bottom in 1932, the Dow rallied over 70% in two months. After bottoming out again in 1938, the market bounced back up over 20% in the next five months. May of 1970 was one of the many bottoms during that period and the market was up almost 35% over the next year. December of 1974 was the bottom of that period and over the next six months the Dow was back up 43%. And I could go on.

The point is that as violent and fast as this decline has been, the recovery can be equally so and trying to guess when to get out and when to get back in is more likely to get you in trouble than really get you market beating results. When markets start trading more on emotion than fundamentals, keeping a cool head is your best weapon.

If you've been investing all along in stable companies with good balance sheets that produce a good or service that's in real demand, then staying put is probably your best bet.

-AvgJoe

For the last time, this isn't just about Wall Street!

2008-10-08T16:03:00.001-07:00

I'm going to puke if I hear the phrase "Wall Street bailout" uttered one more time. Ooops, just puked, I guess somebody, somewhere just said it again. Why? Because people around the US still seem to believe that this is a bailout that "helps Wall Street, even after Wall Street destroyed our economy."

There's two parts to this, and in this blog I'm going to cover Wall Street destroying our economy. Did Wall Street play a part in what is going on? Sure! But there's no way that any of this could have happened without the help of good ol' Main Street.

Oh no Average Joe, you're not going to say something bad about the good, hard working people on Main Street, are you?

You bet I am.

Look, I don't have anything against Main Street -- heck, I'm part of Main Street and I'm getting nothing but lumps from what's going on right now. But at the core of all of the problems -- which has already been pretty well hammered home -- is the demise of waves of mortgage loans, subprime and not.

What Wall Street did was complicated, but the problems that it created are relatively simple. They took mortgage loans, packaged them into securitized vehicles, and sold them off to third party investors. This allowed lending banks to lend more because the securitizations took loans off of their books, and it also made investors more inclined to dip their toes into riskier credit profiles because they believed that the securitization vehicles were priced and structured such that they would still deliver acceptable returns.

Unfortunately, Wall Street used faulty assumptions -- like that the real estate market doesn't go down -- and so when the supposedly unthinkable started to happen, the value of all these securitized securities (most of us know them as MBSs, CDOs, etc) tanked. This caused cascading problems because many of these securities were rated very highly and therefore treated as gold by many banks, insurance companies, etc. The end result, among other things, is the credit lock-up that everyone is so scared of right now.

That's a very very brief overview of Wall Street's hand in this mess, but I certainly didn't want to ignore their handiwork. Now on to Main Street.

This is even simpler. If the core of the problem here is defaulting mortgages then we've got a heck of a lot of people out there that took out loans (which, remember, are agreements to pay back a certain amount of money) and decided not to pay them back. Easy as that. Now this is where the staunch defenders of Main Street come in with vehement arguments, so let's take a look at a few of them:

1) "But there was predatory lending!" -- I fully accept that there were lenders out there that were out and out fraudulent and hid details of the loans from people. But let's think about the scope of this mess and consider whether we really believe that there was really that much fraud out there. Without solid proof I'm very skeptical of that many predatory loans being foisted on people. In fact, I'll go ahead and give you 5% of the defaulting loans over the past couple years as predatory and fraudulent -- I think that's a pretty high percentage, but that still leaves 95% that we have to explain.

2) "People didn't understand the terms of the loan!" -- This argument just makes me shake my head. I think about the amount of research the average Joe Sixpack will do when trying to figure out what TV to buy and I wonder why we don't expect a commensurate amount of proactive research out of Joe Sixpack when he's looking to take out a loan for, say, $200,000. If you don't fully understand what you're signing your name to, why in the world would you borrow that kind of money??

3) "The mortgage brokers misled the buyers!" -- Fraud notwithstanding (see above for fraud), the mortgage brokers are salespeople. I'm not saying that they should be holding back information, but at the end of the day their job is to sell a loan to the home buyer, not make sure that the home buyer is getting the best deal possible. Referring back to #2, how many of those Joe Sixpack TV buyers implicitly trust the Best Buy salesmen? Yet they seem to expect that mortgage brokers are the guardians of their best interests.

I could go on, but I think you get the point. The bottom line is that I think we're overlooking the whole concept of personal responsibility when it comes to people taking out these huge loans. And when we talk about buying up faltering mortgage loans and renegotiating them with the home owner -- I mean, come on, talk about moral hazard!

Forgive me if this seems one-sided -- I do fully believe that most of the people that are defaulting should never have been given the money in the first place, let alone at the terms they got it on. But I think that when we're talking about the ingredients for the current mess it's a big mistake to leave the borrowers out of the equation, and that's exactly what has happened. Give Joe Sixpack a free ride and you're basically telling him that it's OK to take out a loan and then blame the lender when you realize that you got yourself in over your head.

Will the rhetoric change? Not a chance. During an election year (and really, what isn't an election year?) there's no way your going to hear anyone from the government scold the normal, everyday, hard working Americans. When they're getting ready to hit the voting booth, they can do no wrong!

So I'll keep cringing at the characterization of the current economic mess, but at least I've logged my protest. Am I selling out my fellow average Joes? I don't think so, I think I'm just asking for the best out of them. I think we can be a country that lives to a higher standard, and that means owning up to mistakes all around.

-AvgJoe

For the last time, this isn't just about Wall Street!

2008-10-08T16:03:00.000-07:00

Joe is on Twitter

2008-10-07T18:08:00.000-07:00

Brevity is in for Average Joe! Check out my new page on Twitter: http://twitter.com/KoppTheFool.

-AvgJoe

Cafferty on Palin

2008-09-30T14:27:00.000-07:00

I'm a little behind lately, but I just saw this reaction from Jack Cafferty to the answer that vice presidential hopeful Sarah Palin gave to a question about the $700 billion bailout package.

Now I try to leave politics out of this blog, but this is definitely a cross-roads between politics and and finance (and there's been a lot of that lately). I really can't add too much to what Cafferty said, the answer that she gave is really pretty pathetic and to an issue that will be one of the biggest facing the new administration -- whomever that will be.

Actually, it's kind of funny in a way. Watching her fumbling answer I was reminded of the investment banking interviews I did coming out of college. I studied economics in college and I didn't stray too far in my studies into finance, so I wasn't nearly as prepared as the business undergrads from my school. Being young, I also wasn't all that good at interviewing and didn't have the whole "if you don't know it, don't try and fake it" thing down.

Anyway, while watching Palin muddle through whatever the heck she was talking about, I literally could feel the nerves and stress that I got the few times that I did try to fake my way through an interview answer. Needless to say, the times that I faked it, it didn't work out well for me, and this catastraphic answer certainly hasn't worked well for Palin. I guess I'm just counfounded that her people didn't have her so, so, so ready for this question -- it's not like it came out of the blue.

I guess at least we got an absolutely hilarious SNL skit out of it...

-AvgJoe

The Bailout Plan

2008-09-28T15:36:00.000-07:00

I'm pretty bummed that I've been crazy busy lately and unable to post here as we go through what will likely be the most (or at least one of the most) memorable financial events that we'll see in our lifetimes. I'm encouraged that today it sounds like a deal has been struck that we can move forward on. And, yes, I said "encouraged," meaning that I am in support of the plan.

I'll keep it short and sweet, but here's how I feel about it. When somebody is sick and has an elevated fever, the first step is to treat the patient's fever so that it doesn't kill him before you have a chance to treat the underlying sickness. The financial system is currently burning up with fever and the Treasury's plan is aimed at bringing that fever back down. It won't fix the underlying problems that need to be addressed in the economy, but it will help quell the panic and allow us to address those issues (hopefully!).

Rather than try to reinvent the wheel, I'll direct you to this article from the AP that talks about the potential winners and losers from the plan being pushed through. I have some slight differences in places, but overall I like what they've said.

Tomorrow certainly will be interesting!

-AvgJoe

Yesterday's Oil Spike: More Than Meets the Eye

2008-09-23T11:40:00.000-07:00

Kind of like Transformers, yesterday's big spike in oil wasn't exactly what it seemed to be. In short, yesterday was the expiration of monthly oil contracts and it appears that traders decided to go after some players that were short going into expiration. The result was that you had a big pop as the short sellers rushed to cover and some people went long to try and play the big move.

It was funny to me that most media outlets didn't seem to pick up on this. Up to the end of the day, the AP articles on Yahoo!Finance were still saying that oil was getting bid up as a result of the $700 billion financial bailout plan. I have to give props to CNBC, though, because they were all over it -- probably one of the few useful things I've gotten from watching that manic channel.

Basically that's it, not much need for further explanation. Today, a quick check over at the Nymex shows that now that the new contracts are trading, we've got crude back at under $107 per barrel.

-AvgJoe

Oil Trader Reclassification

2008-08-05T15:08:00.000-07:00

Couldn't help but take notice of this article, which says that the Commodities Futures Trading Commission just revised its numbers on how much of the open interest on oil futures is held by speculators. The number was at 38% and they upped it to 48%. So nearly half of the open interest in NYMEX crude futures are held by speculators... yeah, no chance that speculators could be moving the market.

What's even more intriguing is the fact that the article says it looks like just one trader was reclassified in bringing up that number. They don't really give any more info on that, but if that's true, then it means that there's some really big money out there swinging at oil.

-AvgJoe

Loving the Bears

2008-07-31T08:36:00.000-07:00

What's my favorite part about the bears out there right now? This quote from a Bloomberg article today illustrates it well:

"The markets don't like it,'' said Peter Boockvar, an equity strategist at Miller Tabak & Co. in New York. "You listen to a market of optimists who think the worst is over and that it's gonna be OK, but this data is showing you it's not.''

Similar to Mr. Boockvar, most of the bears out there seem to think that they're in the minority, fighting to get the rest of the market to understand that there's trouble ahead. Maybe I'm reading the wrong news sources, but most of the news and commentary I'm reading these days is pretty pessimistic. Plus, as I noted back in June (and Merrill Lynch recently updated), fund managers are pretty darn bearish across the board.

And in case everyone forgot, the S&P is still down nearly 20% from its peak -- and last I checked stocks decline when more people are bearish than bullish. If we were surrounded by nutty optimists, I'd guess that we would've seen more of a recovery.

Now obviously I'm an optimist here, and so maybe I'm pulling the same stunt, but the cries of "oh, everything is terrible and nobody else besides me seems to understand that!" are getting a little old.

-AvgJoe

This Time It's Different?

2008-07-24T15:03:00.000-07:00

Ahh, that fateful phrase.

I'll keep it short and sweet here, and I'm likely not offering anything that you haven't heard before, so think of this more as a friendly reminder. For the seven years from 1973 to 1980 average annual oil prices rose about 690% or roughly 34% per year during that period. After the peak in 1980, oil spent the next eight years in decline and fell a total of 60%.

Over the past 10 years, the average price for oil is up around 720% (using average price for 2008 as opposed to current price), or roughly 24% per year.

I can already hear people saying that it's different this time because it's not an artificial supply side shock as in the 70s. Ok, could be... but I'm certainly not banking on it.

-AvgJoe

Cramer Addendum

2008-07-24T09:42:00.000-07:00

I couldn't help but share this to follow up on the previous blog post. Apparently now banks are a buy? Hmmm...

Don't get me wrong, I share Cramer's new view -- in fact, I own both Bank of America (NYSE: BAC) and American Express (NYSE: AXP). I just find it astonishing that his opinion changed that drastically in so short of a time. I can only assume that's a philosophical difference in investing based on fundamentals and investing based on timing the market.

But hey, how can you not love Cramer?

-AvgJoe

Cramer Calls a Bottom?

2008-07-21T08:36:00.000-07:00

I don't know how many people caught this, but I read the same article on TheStreet.com last week. In short, Jim Cramer got ultra bearish last Tuesday saying that there was little hope on the horizon and that there won't be a turn until we see a number of additional, high profile, bankruptcies. From the article:

The bottom line here -- there is too much going wrong right now, too much to put us anywhere near sound footing. I suspect that every rally will be met with selling until we see a multitude of collapses like IndyMac. ... Someone asked me yesterday, "When do we bottom?" I said it wouldn't be until all the banks that have to fail do so and GM files bankruptcy along with Ford. I said it matter-of-factly, because I meant it and because it is obvious.

As we know now, that article perfectly preceded the big rally in financials last week on the back of stronger than expected earnings from bank majors, including Wells Fargo (NYSE: WFC).
This week started off on a good note for the financials as well, with Bank of America (NYSE: BAC) also surprising to the upside.

If you've read much of this blog, then you know I don't do market timing and I won't be the one calling tops or bottoms. But if the market does recover from here, that will have been pretty bad timing for Cramer to have unleashed his inner polar bear.

-AvgJoe

Disclosure: I own shares of Bank of America.

Couldn't Help Myself: Yet More On Oil

2008-07-18T17:00:00.000-07:00

I couldn't just leave well enough along, right?

The reason for the additional post was the fact that I clicked through the Yahoo! Finance front page to this article.

Though I certainly wouldn't mind it if this week's price action was the sound of the oil bubble popping, I'm not primarily concerned with that (on a side note, the title of this article is fairly poor because we aren't told whether it's the biggest dollar drop ever or biggest percentage drop. Given the high price of oil, it wouldn't be nearly as impressive if it was simply the biggest dollar drop ever). What I am interested in, though, is some of the commentary in the article which again brings me back to my "oil is not being driven by supply and demand alone" thesis.

For instance:

"Some brave traders used the week's pullback in oil prices as a chance to buy barrels that suddenly seemed to be on sale. But oil analysts were advising investors to beware."

or

"Still, with oil recording yet another drop on Friday, some industry experts who just days ago thought there was more juice left in oil's meteoric run are reconsidering."

or

"'Buying here is an opportunity if you are a deep believer in $200 (a barrel), otherwise we think that caution would be better applied,' analyst Olivier Jakob of Petromatrix in Switzerland said in a research note."

Do these sound like commentaries on a global commodity market being driven by supply and demand or a frothy financial market that's being closely watched by traders? In fact, I looked up Petromatrix's website and here's a bit from the firm's description:

"After 15 years experience in the commodity trading industry we have created Petromatrix as we found the market lacking independent coverage of the oil markets. At Petromatrix we are not offering any financial or brokerage services, all we care about is reading the market right. ... Our clients include oil majors, trading companies, international banks, hedge funds, down to private individuals. They value our track record, our concise reports, our speed at delivering analysis, our trading focus and experience."

Sounds to me based on this that there are an awful lot of investing / speculative players out there looking for data on oil. Is it possible they're also participating in the market? And I have to imagine that Petromatrix is only one of many firms offering this type of independent coverage of oil price expectations.

Things that make you go hmmmmm...

-AvgJoe

More On Oil Prices

2008-07-18T14:43:00.000-07:00

Much to my chagrin, there isn't a whole lot of back-and-forth on my blog (though I'm surely at fault for that with my unreliable posting schedule), but there was a great response to my blog post yesterday about oil prices and I wanted to make sure to highlight it and respond.

I'm not going to pretend that a big part of the reason that I like the response isn't because it happens to agree with my own view. However, I think it does really underscore some of my own thinking. Here's what Michael over at The Macro & Micro has to say:

To answer your question - well you seem to have already done so - S/D have not changed that much... it is the speculation that has changed. While the economist suggests we not 'blame the speculators' (http://www.economist.com/opinion/displayStory.cfm?source=most_read&story_id=11670357), I still find myself disagreeing.

One line in the article "But they do so based on their expectations of future trends in supply and demand, not on whims." is frankly not true. Often speculator 'expectations' may be 'educated whims' - that are wrong. The index funds and the smarter players make a move and everyone else who knows nothing follows - typical herd mentallity.

For example:

1. "On January 17, 2006 crude oil for February delivery rose by USD 2.38 (3.7%) to USD 66.30 a barrel. This was the highest increase since early October 2005." (http://en.wikipedia.org/wiki/Oil_price_increases_of_2004-2006)

2. This jump was a futures market response to the Nigerian violence... in which a temporary 250,000 barrels per day was not produced from Nigeria.

3. According to the 'profit fromthe peak' front flap (I'm seriously considering this book), oil consumption is 86m barrels a day. 250,000 is not even 1 percent of that.. its like .3% - however oil prices rose 3%. less than .5% is barely a drop in the bucket, but the price raise was hardly warranted. It was speculation.

Can I say I couldn't agree more? One of the things I've tried to do is actually sit down and put together some sort of supply and demand curve (the stuff of Econ 101) for oil. Now I understand that it's hard to substitute in many of the places where oil is used, but frankly I couldn't come up with a reasonable graph that would explain the change in the price of oil over the past few years.

As for The Economist, yeah, that was pretty disappointing for me to read. The Economist is easily my single favorite publication ever and I can't help but think they missed the boat on this one. Is all the price action due to speculators? No. But I think there's a healthy margin that is. And as Michael pointed out, it's wrong to assume that all those buying and selling oil futures are fundamental driven investors looking at oil consumption and production statistics. You've got plenty of technical analysts and trend followers out there who are going to be basing their trading on price action and chart patters, not real supply and demand.

So, as I said before, I welcome responses and thoughts -- even if they differ from my own. We're talking about a huge global market here and so I certainly can't claim to have all the answers.

-AvgJoe

The Oil Price Conundrum

2008-07-17T16:44:00.000-07:00

Ok, so here's where my brain bends when it comes to oil prices and what's driving the spike. In a market that's driven primarily by supply and demand -- particularly a massive global market, like the one for oil -- I don't think it's crazy to expect relatively orderly price movements. Sure prices can move up or move down, and do either drastically, but if it's really supply and demand driving it either way, I'd expect to see those changes be spread over a period of time.

By contrast, in a market driven by some sort of speculative force, drastic price swings would be expected as speculators anxiously try to read the tea leaves and capture the maximum profit before pulling their parachute right at the top.

Now look at the price action of oil just over the past couple days. Have supply and demand conditions really changed that much to warrant such a big swing in price? And how about the price action of the past year, has supply and demand really diverged that much to cause (roughly) a doubling in price? (Judging by the statistics from BP I don't think so...)

I'd love to get readers opinions on this, so feel free to chime in the comment section below or send me an email and let me know what you think.

In the meantime, I'm about to crack open the review edition of Profit From the Peak that Wiley & Sons was nice enough to send over to me and see if that has the answers I'm looking for. I will be sure to let you all know what I think when I finish.

-AvgJoe

Will the Real Average Joes Please Stand Up?

2008-07-02T13:14:00.000-07:00

I call myself "The Average Joe Investor," which suggests that I'm just like everyone else and that if I can invest, then anyone reading this can invest. Or at least that was my intention behind the name. And it's true to a large extent -- I don't have any special powers, I don't have an MBA or CFA, and I don't have a long history as a stock analyst or trader (now you're wondering why you're reading this at all...). Sure, I work in the finance industry, but it's helping The Motley Fool bring investing to more individuals -- just like I've always hoped to do here.

But -- and that's a big but -- there is something that separates me from many truly average Joes out there. Namely, I'm interested in investing, interested in stocks, and interested in financial analysis. And unfortunately, I don’t think that individuals should bother investing if they don't have some interest in it -- even more so if their primary motivation is to get rich quick from the stock market.

However, for most of the population out there that would rather eat a live worm than read an annual report, there's no need to skip over stocks altogether. For years, investing greats like Warren Buffett and Jack Bogle have been harping on the vehicle that is perfect for the, let's say disinterested, investor. And that vehicle is index funds.

Index funds give you a broad exposure to a market and charge very low management fees, meaning that you benefit from the appreciation of the overall market without having to spend the time to pick and analyze stocks, or overpay for somebody to manage your money. In terms of which index funds to go with, an S&P 500 fund (such as Vanguard's) or a wider US market fund (like the Wilshire 5000) should probably be the core of your investment portfolio. But today there are a handful of other areas that you can also get exposure to through index funds, including both developed and emerging international markets and bonds -- all of which should probably claim some portion of your portfolio.

In the end, I think one of the biggest questions when it comes to investing isn't whether you're smart enough or talented enough, but whether you have the interest. If you're not interested in investing you're simply not going to do all the work necessary to get the results that you want. And you'll likely just end up wasting both time and money. So if you're new to investing, take some time to sit down and really think about whether business analysis, financial statements, and industry research are really interesting to you. If not, it's no big deal, just put your money into index funds and realize that you've saved yourself a lot of time and effort that you can now turn towards a hobby that you actually enjoy.

Of course if you come to the conclusion that this is all really interesting to you, well, keep learning and keep investing!

-AvgJoe

Bearish Fund Managers

2008-06-22T21:59:00.000-07:00

The headline of the Merrill Lynch press release reads: "Merrill Lynch Fund Manager Survey Finds Investors Most Underweight Equities in a Decade."

Merrill releases these surveys periodically and they're usually interesting to tune into. Here's a link to this one: Fund manager survey.

You can imagine what the tone of the release is.

Now I know that I tend to come in on the bullish side a lot, but I can't help but see an interesting bullish lining on this. In short, if fund managers are already the most underweight in a decade, what does that mean for the future? Well, certainly they could get even more underweight equities. However, we could also conclude that a lot of the market's tumble since last October came from this massive pullout from institutional investors. So now they've got all this investor money sitting on the sidelines. I wouldn't suggest that they're going to start reinvesting it even if they don't see a turning economic tide, but what I will say is that when these fund managers do think they see a turn coming, there may be institutional investors tripping over each other trying to get money back into the market.

When does this happen? I don't know. But it'll be an interesting scene when it does.

-AvgJoe

How Scary is Consumer Credit?

2008-06-20T15:21:00.000-07:00

A crucial piece of figuring out exactly where our economy stands is in interpreting the statistical data that we get from the government and other sources. It can often be easy to take a headline number and assume that the simplest interpretation is the correct interpretation -- and this is what often happens in the press. Spend a little bit more time mulling the data and you may have a different picture.

Consumer credit is something I've been mulling a lot over the past year, and for good reason -- headline after headline screams about the death of the US consumer and the pile of debt that's drowning him (and her). If you keep up with the news, it's probable that at some point you've run into the statistic that there is currently over $3,100 of revolving (read: credit card) debt outstanding for every man, woman, and child in the United States. To me at least, that sounds scary at first glance. After all, if you take a family of four, the simple math tells you that they have roughly $12,700 in outstanding credit card debt.

Now here's a speculation that I actually don't have a data-supported answer for: a not insignificant portion of that revolving debt outstanding is not what most of us would truly consider debt. I'll explain. On a monthly basis, I charge almost everything that I consume to my credit card (gotta love those airline miles). When my billing period comes up each month, I pay off the card in full and haven't paid a single red cent of interest for years (and when I did it was because I spaced out and forgot to make my payment one month).

In my own mental accounting, I would not consider that true debt -- I spend the money on my credit card as if I'm spending the cash from my bank account. In other words, I only spend what I actually have. However, if you were to take a snapshot of my credit report at a given point in time, you'd likely conclude that I have a couple thousand dollars in credit card debt.

So if we break down the Federal Reserve statistics for revolving debt outstanding, it's well worth considering how much of that "debt" is truly debt weighing on consumers, and how much of it is what you might call "convenience debt" that consumers repay from month to month.

-AvgJoe

(Now if you have the facts on this question I'd love to hear them so drop me a line either by email or in the comments...)

Bears Behind Bars

2008-06-19T15:57:00.000-07:00

Today two former Bear Stearns employees, Ralph Cioffi and Matthew Tannin, were arrested on charges of securities fraud and insider trading. You may remember the whole debacle as the tip of the mortgage iceberg last summer. A pair of hedge funds at Bear just absolutely blew up, and the magnitude of the losses seemed to finally wake everybody up to how much danger there really was in the subprime mortgage market.

One might even say that this hedge fund debacle was the first nail in the coffin for Bear Stearns itself. After all, it was primarily a complete loss in customer and creditor confidence that ended up forcing the firm to sell out for practically nothing.

Of course, running a hedge fund into the ground is hardly illegal -- as the hedge fund industry has grown by leaps and bounds there are undoubtedly a lot of funds that have either been unlucky or just mismanaged and ended up sending "I'm so sorry" letters to their investors. The rub here is that prosecutors are alleging that Cioffi and Tannin knew that the funds were in trouble but told investors other wise and -- worse yet -- may have misstated asset values.

Among the bits of evidence:

- Emails exchanged between Cioffi and Tannin in April of 2007 in which Tannin said that the subprime market "looks pretty damn ugly. ... If we believe [our internal modeling] is ANYWHERE CLOSE to accurate I think we should close the funds now."

- Cioffi pulled $2 million of his own money from the fund but still said that investors should stay in it.

Scapegoats or hucksters? If the above is true it'd be hard to argue that they were simply victims of a collapsing market.

-AvgJoe

The Goldman Sachs Firing Method

2008-06-18T14:59:00.000-07:00

I'm not sure whether to love Goldman Sachs more for coming up with this or Dealbreaker.com for bringing it to my attention.

In short, it sounds like Goldman is looking to unload some of its analysts and instead of pulling the ol' Donald Trump and hollering "you're fired!" (which would hardly fit Goldman's white shoe culture) they decided to get more creative.

Now before I tell you what exactly they did, I should clarify what an analyst is in this context for those that haven't had the pleasure of being one (alas, I have). Analysts are the lowest of the low in the investment banking world. They are typically recent university grads (undergrad) who do thankless work and labor an ungodly number of hours -- for, of course, a pretty hefty paycheck when compared to their non-investment banking friends. An investment banking analyst program typically lasts two years, at which point the analysts are expected to head off to get their MBA.

So Goldman management brought in these hapless youngsters and instead of telling them that they're being laid off, they're claiming that the analysts have been put in an "accelerated program" which, conveniently, ends in August.

From Dealbreaker:

We just received a little more color on the revolutionary approach, from a young alum, who notes: "At one point I actually though the [managing director] was going to say, 'Congratulations!'" which we can obviously all agree would have been awesome.

Kudos to Goldman for deftly skirting the issue.

Here's a link to the original Dealbreaker story.

-AvgJoe

Good investing fundamentals

2008-06-17T11:16:00.000-07:00

[note: I'm going to write as if this blog hasn't skipped a beat... hopefully those that have been waiting since March for a new post don't want to tar and feather me...]

When it comes to investing, there's a lot of talk about fundamentals. Usually, though, it's the fundamentals of the company we're investing in -- ie margins, sales growth, book value, etc. While finding good fundamentals in the companies that you invest in is definitely important, it's just as important to practice good fundamentals as an investor.

I actually got to thinking about this while watching golf over the past few days. I have to say, I was really pulling for Rocco Mediate to knock of Tiger Woods in the US Open. It's not that I dislike Tiger, it's just that Rocco is so darn likable -- plus I have a tendency to root for underdogs.

As I was watching, though, I was impressed -- as ever -- by Tiger. His fundamentals are tremendous -- keeping the ball on the fairway, sinking puts, etc. Rocco, meanwhile, played a very gutsy tournament, but did so by making some great shots to make up for prior poor ones. In the end, it was his inability to come back from a poor tee shot on the sudden death hole that sealed the victory for Tiger.

As an investor, it's crucial to be like Tiger. Do all the little things right to make sure that you're buying a quality company at a reasonable price each and every time. More importantly, keep focused and don't allow yourself to make infrequent, but big, mistakes that can seriously take away from all your other good investments. And through thick and thin demonstrate some mental toughness. The probabilities of investing assure that you will have investments that don't work out -- learn what you can from those, but don't let that disappointment cause you to do something stupid with a subsequent investment.

And as long as we're focusing on Tiger, I'd point out that if you don't feel like you have a solid investment process that you use to choose your stocks, then it's important that you take the time to step back from investing and establish that. Even though Tiger was one of the hottest golfers on the tour and was winning major events, he decided a few years back that his swing wasn't what he wanted it to be. So he made some major changes to it -- changes that led to an extended break in his winning ways. Today? Well, I'm no golf expert, but the results seem to speak for themselves.

It can be easy to get caught up in the actual investing of investing and not think much about the process of investing. So if you haven't thought much about your process lately, maybe now is a good time to take a step back and make sure your fundamentals are tip top. After all, it's fun to be Rocco playing for the US Open, but it's even better to be Tiger and winning time after time.

-AvgJoe

Time to Rethink Stocks?

2008-03-03T19:04:00.000-08:00

A recent column by Fortune writer Allan Sloan is ominously titled "Don't expect another bull market." In the article, Mr. Sloan argues that the period from 1982 through 2000 was an unrepeatable stock market party and it's going to lead to a lot of disappointment if investors are anchored too heavily to the returns from that time period.

To a large extent his argument holds -- taking numbers from Yahoo!Finance, I found that the S&P 500 increased around 15% per year between the beginning of 1982 and the start of 2000. This is a far cry from the 7.8% that I calculated for the period from January 1950 and January of this year. Of course the numbers that Mr. Sloan was looking at for his article -- and he does note this -- are fairly particular to the time period he chose. If we shift the range a bit, say, 1987 to 2008 or 1977 to 2008, the annual returns fall and are closer to the longer term average.

But it'd be nitpicky of me to lose the point in the details. The last 20 years have been very good for stocks and individual investors have found there way into the market in greater numbers. This may have led to some over-excitement in the markets and unsustainable valuations.

Yale economist Robert Shiller has collected data (which I've already visited) on the stock market going back as far as 1871 and has calculated the P/E of the stock market based on average 10-year trailing earnings for every month since then. Over the course of the last 100 years or so, this P/E number has spent most of its time ranging from the mid-single-digits to the low-20s. But in 1992, the P/E broke above 20 and made a mad dash to the mid-40s during the DotCom bubble. At the beginning of this year, Mr. Shiller's numbers show us at 24 -- safely down from the dizzying peaks of the DotCom days, but hardly low by historical standards.

So what's ahead? To Mr. Sloan's original point, investors that anticipate easily racking up 15% or greater annual returns may have to readjust their expectations. At the same time, it may be more important than ever that investors take valuation into consideration when making investment decisions. Investors have been reminded on numerous instances that valuation does matter (aside from the DotCom era there was always the Nifty Fifty).

-AvgJoe

The S&P's P/E Ratio

2008-02-25T22:56:00.000-08:00

I'm reading The Intelligent Investor again. If you are interested in investing and haven't read this, you can pick it up for $14 from Amazon.com (click here). Don't worry, there's no kickback to me for that, I just think it's a great read that all investors should have at the top of their collection.

In one section of the book Graham gets into valuing the overall market. He looks at a number of metrics including price to prior year's earnings and price to prior 3-years' average earnings. In the commentary section (which Jason Zweig wrote) there is an additional look at more recent times (the book was published in 2003) and comparisons to the past using some data generated by Robert Shiller.

Not surprisingly, it inspired me to look at where we are today. Shiller's preferred metric is current S&P price versus average earnings over the prior ten years. His site shows us at a bit over 24x as of January. Looking back at his numbers (which go back to 1871), 24x isn't all that bad if you just look at post-1990, but it's still pretty heady if you consider it in the context of the entire history that Shiller has laid out. In fact, prior to 1990, the last time Shiller shows us at over 24x was in 1966, and the period from 1966 to 1980 was not too pretty for US equities.

Now if you flip to the tab that he has comparing P/E to interest rates (figure 1.3 at the bottom) it seems relatively obvious why we've held these higher-than-average earnings multiples -- low interest rates. I wouldn't give this chart the last word, but it shows P/E ratios and long term interest rates moving in fairly opposite directions. This is also something that jibes with theory.

But what happens when interest rates start moving back up?

After all, this credit mess isn't going to last forever, and when something happens to get us out of defcon 5, the Federal Reserve will have to get back to fighting inflation (much to many people's chagrin). I'm not expecting hyperinflation or anything like that, but 3% rates are hardly sustainable. And when that happens, we'll probably -- or we should at least -- see a contraction of P/E multiples.

I wouldn't argue that this means to stay out of US equities altogether. Particularly if you're Graham's classic defensive investor, investing on schedule is still the best idea (if you don't get that reference, see above and buy the book). Even if you're a bit more on the enterprising side, I don't think it means bail out completely.

What I do think it means is that investors should be avoiding stocks that are at the high end of the valuation scale. I know, I know, new and shocking info... As unexciting of a result as that might be, investors that aren't chasing high P/E momentum stocks when overall P/Es start to compress will have fewer wounds (if any) to lick than those that are caught with stocks sporting 40x and 50x multiples.

-AvgJoe

Hard Times

2008-02-17T17:30:00.000-08:00

I couldn't help but call out this article from the AP if for no other reason than it was just so weird. While there are some interesting points in there, it is a bit rambling and doesn't seem to have a cohesive thesis.

But I'm not highlighting the article to perform an amateur literary critique. Rather, I found the premise, that there's this underlying discontentment in the US -- even during the good times -- pretty interesting.

A quote from the article:

The number of products -- from air conditioners to cell phones -- that Americans say they can't live without has grown substantially in recent years, according to the Pew Research Center. About 6 in 10 working Americans polled by the group say they don't earn enough to lead the life they want.

Not to veer too far from the premise of my blog, but are Americans realizing that the promises of advertisers didn't lead to the elusive stairway to heaven? Were we hoping for something from material wealth that it was never going to give us?

Obviously this isn't a philosophical blog, but when an article like that shows up on Yahoo!Finance's front page, well, I can't help but take note.

-AvgJoe

Wall Street Research

2008-02-14T14:31:00.000-08:00

Interesting bit from TheDeal.com blog...

The blogs are taking over investment research! [shivers]

-AvgJoe

New NAR Data

2008-02-14T14:13:00.000-08:00

The much maligned National Association of Realtors (NAR) just came out with its fourth quarter report on home sales and home prices. The title of the release was, well, true NAR style: "Metro Areas Show Greatly Mixed Home Price Performance; Half Show Gains."

It was the first paragraph, though, that really jumped out at me:

Roughly half of metropolitan areas continued to show rising home prices in the fourth quarter of 2007, according to the latest quarterly survey by the National Association of Realtors®.

Now of course I appreciate why they want to emphasize that some housing markets are still going up in price. And I'm sure the news has warmed the hearts of many a homeowner in these areas, but it still seems kind of funny to me that they're emphasizing rising prices. I guess it all goes back to the fact that so many Americans think of their home as an investment good rather than a consumption good, but still...

I already bought a house. I didn't get the deal because I didn't wait long enough (woe is me, I know), but I got a deal because I bought after the declines had already started. But the fact that home prices are falling in so many areas seems like good news for home shoppers. Or maybe my head's just screwed on backwards.

-AvgJoe

Fear and Loathing in the Markets

2008-02-14T13:19:00.000-08:00

If you haven't seen it already, Paul Kedrosky today highlighted the recent survey of money managers from Merrill Lynch. In short, the survey said that managers are extremely bearish and expecting further declines in the equity markets. Cash is very popular right now -- Merrill mentioned that 41% of managers are overweight cash, the highest percentage since the terrorist attacks in 2001. In case it doesn't sink in right away, that means there's a lot of cash on the sidelines that needs to get invested at some point.

If you're keen on investing against prevailing sentiment, this is a pretty darn interesting data point.

It comes at an interesting point for me too. Just yesterday I was mulling over the risks that were out there and thinking about how very real the risks are. As I've previously stated, I don't think we're headed for financial disaster. However, I can't deny that the pieces are in place that could make that possible. So the risks are real.

Money managers aren't stupid. If the risks weren't real nobody would be worried and nobody would be selling. If it was obvious that this was all going to end well, or at least without fire and brimstone, then those 41% of managers would still be in equities. If only I could transport myself in time, I could head back to 2002, 1974, 1990, 1987, etc. and I'd likely see that the risks were just as real in all of those situations. Yet I'd jump at the opportunity to invest in any of those periods.

I'm not stupid either (at least I don't like to think of myself as such...), I can see why the problems are considered so dire. But as I take the range of potential outcomes and weight probabilities, I like the chances and the risk/reward that's out there right now.

-AvgJoe

For Whom the Bell Tolls

2008-02-13T01:03:00.000-08:00

Now if this doesn't sum up the housing market mess in one fell swoop, then I don't know what does!

-AvgJoe

Stocks No Longer Good for the Long Run?

2008-02-07T16:28:00.000-08:00

I just heard Doug Kass say on Kudlow and Company that he doesn't think investors should be buying stocks for the long run right now because we're in store for a long, slow, wrenching downturn and stock-bleed similar to that of the late '60s and '70s.

Here's a question for the readers: what do you think? On point? Or in left field?

-AvgJoe

Oh, the Economics of it All!

2008-02-07T12:17:00.000-08:00

In front of the current drop in the stock market and the trouble with the economy and housing, I had my concerns. Back in late August I talked about the problems of cheap money, and why inflation is a concern. I also shared some thoughts on why I didn't think subprime was the core problem and how risk was working its way through the system. I also questioned housing as the golden investment that many thought it was back in March of 2006 (though I was notably off the mark later that year when I said I didn't think there would be an out-and-out housing crash).

In short, for a while, I thought that many were underestimating what was going on for the past few years (see: "off the mark" above, you could make the argument that I was one of them). The housing market ran up like crazy and it did it on the back of crazy loans that didn't put buyers on the hook for anything.

Today, however, I think we're seeing the opposite happen. Today, it seems as if everyone and their mother is a bear on not only housing, but the stock market, the US economy, the dollar -- you name it. Pessimism isn't completely unfounded, it does appear we're headed towards a growth slowdown, if not a recession. Stocks have declined markedly, especially if you look at certain sectors like financial, technology, or retail. And the Federal Reserve has found it necessary to rapidly cut their target interest rate. In other words, thinks aren't looking all bright and shiny.

Where I differ, though, is when it comes to the people who are calling for a massive economic fall-out and some sort of nuclear winter for financial markets and the US economy.

It's tough for me to pick on a guy like Nouriel Roubini because he's a bona-fide economist (which I am not) and he's probably a heck of a lot smarter than me. All the same, I found myself questioning some of his assumptions in a recent blog post. In short, he claims there is "a rising probability of a 'catastrophic' financial and economic outcome."

He claims specifically that "this recession – that already started in December 2007 - will be worse than the mild ones – that lasted 8 months – that occurred in 1990-91 and 2001." His points are below with some comments from me:

1) we have the biggest housing bust in US history with home prices likely to eventually fall 20 to 30%

I'm going to address US home prices in another post (to come), but let's assume this is true. Let's look at our last major asset bubble and burst (fortunately we don't have to go back too far!). In the Nasdaq market alone there was $3.6 trillion lost as the market plummeted almost 80%. Add in the losses on NYSE-listed stocks and you're talking over $9 trillion. Between peak and trough, Microsoft went from a market cap of roughly $475 billion to one of $240 billion. Intel dropped from $380 billion to under $100 billion. Cisco, from $450B to $90B. JDS Uniphase from $100B to less than $3B. Our good pal Yahoo! from $80B to around $5B... and the list goes on.

Those are real numbers there! And for all the talk today that Americans felt richer when their houses appreciated, you better bet your rear-end that they felt richer when their stock portfolios where going through the roof. Just ask people in San Francisco what the atmosphere was like before the DotCom bust.

The point is, we managed to digest that massive amount of asset devaluation. I have a feeling that, though it won't be fun, we'll manage through this one too.

2) because of a credit bubble that went beyond mortgages and because of reckless financial innovation and securitization the ongoing credit bust will lead to a severe credit crunch

I think it's questionable how reckless financial innovation and securitization were, particularly outside of the mortgage market. That's not to say that other loan classes won't suffer in an economic downturn, but that's to be expected to some extent.

I think this argument discounts to some extent the credit market participants and the money that's constantly flowing in. There are a lot of buyers of credit that have money that needs to be deployed in interest bearing vehicles (think insurance companies). I'm sure they'll be scrutinize what they're buying more closely going forward, but I just don't think that they can/will turn off the spigot like he is suggesting.

The fact that the Fed has stepped in aggressively and cut rates the way it has also greased the credit system to a large extent.

Don't get me wrong, I think that high quality credit products are going to trump low for a long time, but I think that a severe and extended locking of the markets is unlikely.

3) US households – whose consumption is over 70% of GDP - have spent well beyond their means for years now piling up a massive amount of debt, both mortgage and otherwise

I've seen so much said about US consumers, their debt, and its implications. The simple fact is that the situation isn't as cut and dried as it may appear. Some economists argue that with more open and available credit, individuals are now able to smooth their lifetime consumption to a greater extent. This means taking on more debt, though not recklessly. This group has conceded that increased debt loads makes some individuals more susceptible to major financial stress during an income shock, but this is balanced out by the smoothing and stability that credit has offered on a more macro level. Of course, there are those that do overuse credit and use it recklessly, but I have yet to see data that reckless use of credit is widespread.

Demographics also play a role in debt. The Baby Boomer population is now all in the age group of highest home ownership rates and so it's logical that there is going to be more mortgage debt from this group. Similarly, there has been some research that has shown a significant hump in an individual's consumption when they hit middle age (see Baby Boomer age group).

And when it comes to debt, I'll also just throw out there that education debt is far higher than it's ever been. I won't say whether this is right or wrong, but it should be considered. A bullish slant on this is that this is debt that is taken on as an investment in human capital and therefore very beneficial to the economy.

And finally, per the 70% of spending that comes from consumers... first of all, this is not significantly higher than long term averages (mid-to-high 60s). More importantly, consumption spending has been shown to be more stable that business spending, so this could be seen as a stabilizing force going into a downturn.

4) now that home prices are falling and a severe credit crunch is emerging the retrenchment of private consumption will be serious and protracted

I don't know that I have much more to add here... per above 1) I'm not sure I'm convinced of the severe credit crunch thesis, and 2) when trillions of dollars were lost in the DotCom bubble bust consumption spending slowed (from 7.3% in 2000 to 4.7% in 2001), but did not fall through the floor.

Another string of reasoning that I've heard floating around that argues for a big turn-down is that we really haven't had a significant recession in quite a long time. This group is arguing that we're "overdue" for a big recession (I actually am hearing Bill Fleckenstein argue almost exactly this on Fast Money right now). While this may seem to make perfect sense since -- as we all know -- recessions are a normal part of the business cycle, I don't think it's supported by data.

Since 1984, economic activity has steadied to a significant extent -- meaning specifically that there has been far less volatility in inflation and economic output (an overview of "The Great Moderation" and some thoughts from Ben Bernanke). What this has meant for our practical purposes right now is that average economic growth has remained roughly the same in the post-'84 period as what it was at in the pre-'84 period. It's the standard deviation of year to year economic growth, the height of the peaks and depth of the troughs, has reduced considerably.

So I find it hard to get on board with the people who say that we're due for a big economic downturn because we haven't had one for a while. Because the peaks haven't been as high as they were in the past, the troughs don't need to be as low to complete a correction and keep the US economy on a steady, and sustainable growth path.

Now there are likely many reading this thinking "oh here's another bull cheerleader." In fact, I have very mixed emotions about what's going on. There are a lot of data that I look at that support a very moderate outcome. On the other hand, I don't know what the X factor of high consumer debt as a percentage of GDP means (it has been steadily growing for decades), and I'm also worried about the high current account deficit that we're running. I'm similarly not crazy about government debt, even if it's not high (as a percentage of GDP) to an unprecedented extent. Although I've taken on some of Roubini's comments above, I don't doubt he is a very fine economist. I likewise have seen some good points on the bearish side from the likes of Barry Ritholtz and Doug Kass and can't get on board at all with a lot of what the ueber-bulls like Ben Stein have to say.

What I am trying to argue here is that the economic consequences of what's going on right now is far more complex than most media outlets and commentators are it giving credit for. I happen to think that we will have a pretty moderate outcome to the current situation. However, the bottom line is that there are many millions of participants in the economic machine and in real life they do not act the way that most economic models expect them to. I have little confidence that anybody can accurately gauge what is going to happen here. Sure, somebody will get it right -- there are enough people making predictions out there that statistically speaking, one of them has to end up hitting it -- but I don't think that person will be right because they are particularly prescient (and hey, that includes me if we do end up having a moderate outcome).

Furthermore, when it comes to getting heard in a crowded media space, it's really tough for anybody to get press time for giving a balanced account of what's going on. Nobody's interested, nobody is pushed into fear or inspired to optimism by somebody saying "well, here are the numbers, but it's not clear what's going to happen." Simplify what's going on, and give an exaggerated account of what could happen and suddenly people's ears perk up.

Now before I wrap this up, I should note that my benign views on recession do not translate to a benign view on the fact that we've had two very massive asset bubbles right on each other's heels. I don't think there's anything that can prevent the psychology of greed from leading to bubblicious asset markets from time to time, but I do think that we need to look at ways that we can identify bubbles sooner and dispense with them quickly before they create a dangerous overhang for the economy. After all, even if this recession isn't that bad, it doesn't make the deflation of housing bubble any less painful for those at or near the epicenter.

-AvgJoe

Getting Bearish on Credit Cards Now?

2008-02-04T20:52:00.000-08:00

That downgrade from UBS today was not appreciated since I own both American Express and Discover Financial.

It actually seems a little funny to me, I mean, to get bearish now. If somebody was going to look ahead and say that heavy debt burdens and a falling housing market were going to crimp consumers, it seems like the time to do that was back in, say, July of last year. Right now we're inundated with recession talk and consumer-exposed companies have already been slammed -- Discover and Amex are down 49% and 28%, respectively, from their 52-week highs.

Now I won't claim clairvoyance and say that these stocks won't still go down more, but I think when you look at the long term fundamentals of these businesses, along with the strong brands, you're getting a pretty good deal today.

Capital One -- which was also downgraded -- well, that's another story, UBS can have that one.

(redundant disclosure: I own AXP and DFS)

-AvgJoe

New Year's Booklist

2008-02-01T14:53:00.000-08:00

Have you made any financial New Years resolutions? Ok, neither have I...

That said, kick off 2008 on a good foot by checking out these two great books:

Active Value Investing: Making Money in Range-Bound Markets
by Vitaliy N. Katsenelson

Vitaliy's book is split up into two parts: "what the future holds" and "active value investing." The first section gives a picture of the current market environment and what investors should be expecting over the next couple decades. As can easily be inferred from the title, he sees us heading into a range-bound market where we'll bounce up and down a lot but not really go anywhere. He points out that, as a contrast to the more traditional black and white of bull or bear markets, a range-bound market would be most profitable for those who are willing to be a bit more active with their stocks rather than following the traditional value-investing manifesto of buy and hold.

As much as I enjoyed the first part of the book, I got even more out of the second part. The second part of the book, "active value investing," presents Vitaliy's tools for evaluating stocks in range-bound markets. But let me be clear, when you see the word "active" be careful not to assume we're talking day trading or chart watching. The tools that Vitaliy delves into are true investing tools and are not at all about speculation. The content in the second part of the book is solid enough that seasoned investors should have plenty of take-aways, and his writing style and easy-to-follow explanations make it so that new investors will be able to learn and apply what he's talking about.

Overall, the book is a pretty easy read and chock full of good investing knowledge -- which shouldn't be all that surprising as I like a lot of what Vitaliy has to say. What was particularly notable about the book is that even if you disagree with Vitaliy's suggestion that we're heading into a range-bound market you can still benefit from reading the second part of the book.

Your Money and Your Brain: How the New Science of Neuroeconomics Can Help Make You Rich
by Jason Zweig

Ok, let me just start off by saying that you shouldn't be thrown off by the title of the book. I can only imagine that the hokey title was the idea of marketers who thought that a word like "neuroeconomics" had to be offset with "make you rich."

For those not familiar with Jason Zweig, he was a long time writer for Forbes and is now a senior writer at Money magazine. He also was the editor of a revised edition of Ben Graham's classic "Intelligent Investor" (a book you must go and buy and read now if you haven't already). In other words, this guy knows what he's talking about and is not writing some "get rich quick" book.

The focus of the book is (obviously) neuroeconomics, which is also known as behavioral finance or behavioral economics. The field is one that has really just recently come into its own as pioneering work by Daniel Kahneman and Amos Tversky in the late 70's really brought it to the forefront. Zweig's is really the first book that I've seen that presents a good cross section of the subject matter in one place and makes it very accessible.

My suggestion is to just go ahead and read the book, but you can get a high level overview of the field here from Wikipedia. If you're more ambitious, you can also check out some of the papers on the subject from the Social Science Research Network (the most comprehensive is probably this one from Richard Thaler).

I'll just wrap this up by saying that I don't get paid for talking about these books so even though I linked to Amazon, go ahead and buy them from wherever you want -- just buy them. Both are quality reads that should be on investors' lists for 2008.

-AvgJoe

Silence is NOT Golden

2008-02-01T14:43:00.000-08:00

Howdy readers (or at least the readers left!). I've gotten some great emails and comments on the blog over the last few months when the blog has been noticeably, well, quiet, and I appreciate them all.

I'm back in action now, and so you should expect to see new content coming up online more regularly now. Meanwhile, keep the comments coming, I'm always eager to hear everything -- opposing opinions, questions, thoughts, whatever.

-AvgJoe

Projecting Revenue

2007-10-09T14:46:00.000-07:00

So let's jump into making projections. The most logical place to start is at the top, with revenue.

** As a quick aside, I'll note that your best bet when doing any kind of involved valuation exercise is to set up a spreadsheet in Excel to work in. If you don't have Excel, you may want to consider getting it, otherwise you can also work in a freeware program like the spreadsheet program in OpenOffice or Google Spreadsheets. **

In all of the steps in the process of making projections you're going to be faced with the question of how deep you want to dive and how detailed you want to get. On the one hand, you can take five seconds and come up with projections based on a modicum of data, or you can spend months diving into an industry to get a mind-numbing amount of information and factor that all into your work.

Depending on the purpose of your projections, you'll find that it's best to vary along this scale. If, for instance, you're taking an initial look at a stock, you may want to just get a rough feel for the numbers and not spend an inordinate amount of time. On the other hand, when you're getting ready to invest, you may want to get more detailed. My personal opinion is that you get diminishing marginal returns pretty quickly as you try to get too detailed in making projections -- remember, we're trying to predict the future here, and at some point projecting the n'th additional variable isn't going to give us much more comfort on the results.

Getting down to it
Now since our goal here is to make projections that we can use in a discounted cash flow analysis, projecting revenue for just the next year or two isn't really going to help us all that much. What we want is to come up with a picture of what the next 5-10 years are going to look like. To a large extent, we're talking about a very Sisyphean task here because of the length of the time period, but that's the breaks.

Now the quickest way one might go about projecting revenue would be to take last year's revenue and the one-year revenue growth rate and apply that over the next ten years. But this typically won't give you data that's worth much at all.

Check out my old pal Suntech Power (NYSE: STP) for instance. In 2006, Suntech grew its revenue 165%. If we assume that it continues to grow revenue at that rate, we'll come to the conclusion that in ten years Suntech will have revenue up into the trillions -- not too likely.

With larger, more mature companies, like a General Electric (NYSE: GE) or a Coca-Cola (NYSE: KO), you may find that using a one-year growth rate to do your projections will give more reasonable estimates, but you'll still likely end up with numbers that are too aggressive.

So the idea to take home here is that it is very difficult for a company to sustain the same growth rate over a long period of time -- even more so if it is a particularly high growth rate. Of course it's not impossible, the very best companies out there have been able to do it, but if I err (and I often do), I'd rather err on the conservative side.

Going back further in the company's financial history can give more color on revenue growth rate and how it has fluctuated over time. A company that has been growing steadily at 12% per year for a number of years is a much more likely candidate to keep up its current growth rate than a company that has had a revenue growth rate of 500%, 200%, and 50% over the past three years.

But that's only part of the story
Everything that I just talked about above is all history -- done, gone. As the (now) old saw goes, past results are not necessarily indicative of future results. In other words, we can look at what the company did historically all we want, but if we don't know what's going on now, and don't have some sense of what will happen in the future, our projections are probably going to be poor.

The easiest way to get an idea of what the future is expected to bring is to take a look at what Wall Street analysts are projecting. For Suntech, we can visit the estimates page on Yahoo!Finance and find that analysts expect the company to finish 2007 with $1.3 billion in revenue and notch $1.9 billion in 2008 (annual growth of 117% and 46%, respectively). For Coke, it's $27.9 billion and $30.3 billion (growth of 15.8% and 8.6%).

We can also see the fact that analysts expect Suntech to grow earnings 40% per year over the next five years and Coke to growth 9% per year over the same period. While earnings growth isn't a perfect proxy for revenue growth (it takes into account changes in profitability as well as revenue growth) it's another data point we can use here.

Going a little further
So now we have some ideas gleaned from the company's historical revenue growth as well as some thoughts about how fast analysts see it growing in the next few years. Now is where you can boil it all together and also potentially throw in some original thinking of your own. Maybe you think that the industry won't grow as fast as everyone else does, and so the company won't grow quite as fast as it has historically or as fast as analysts expect. Or maybe you believe that there is significant room for the company to steal market share from others even thought the industry isn't growing that fast, and so the company will grow faster than everyone expects.

The more research you do, the more you detail you can put into your projections. Say, for instance, you dug really deep in to the solar power industry and decided that Suntech is on the verge of simultaneously coming out with a thin film solar panel and a new way to get more out of lower quality silicon (I have no idea if that's the case -- I just made it up). If this were the case, you might have the expectation that Suntech would see even higher growth rates as it is able to sell its panels cheaper and get around the constrictions of the silicon shortage.

What you'll end up with
No matter how much detail or time you put into your projections, the outcome will be the same. When you're done you should have a projected revenue total for each of the next ten years. A result for Coke could be as simple as starting with $24.1 billion for 2006, growing revenue 10% for the next five years, then growing it 5% for the five years after that. Or you may have a slightly different growth rate for every year in the projection range. The bottom line is that you will now have your revenue numbers.

Some other thoughts
- Revenue growth doesn't always have to go down in future years. If you're interested in a stock as a turnaround story, you may very well be expecting that revenue will grow faster in the future than it is now.

- Remember the GIGO principle -- garbage in, garbage out. If you use lousy data to make your projections, you can't put too much faith in the numbers that come out of the exercise no matter how many data points you use.

- Beware of cyclicality. In cyclical industries such as autos or (dare I say) homebuilding, it's a bad idea to estimate growth based on the past few years. If the industry is in a downswing you're going to get a result that's much too low, whereas if the industry is in an upswing you're going to get extremely optimistic numbers. A lot of work can be done here to get to know the industry in question, but one tactic is to get an average growth rate for the company over a long period of time (last 10 years or so).

- Remember what you're doing here. I don't know if I can stress this enough, but, again, no matter how much data you put into your projections, they're still projections and the outcome is based on the yet unknown future. So don't treat projections like they're fact and make sure to give yourself a cushion (aka margin of error) when you're making an investment decision.

To come
Hopefully, I haven't lost everyone here, but now that I've outlined how I go about projecting revenue, making projections for a lot of the other variables in a DCF should be quicker to review.

-AvgJoe

More of Me!

2007-10-08T18:24:00.000-07:00

That's right, if you're not getting enough of me here or on The Motley Fool, you can now also tune into my commentary on the new MSN money blog Top Stocks. There you'll find more of the market and stock commentary that I've been cutting back on here on The Average Joe... of course, that's not to say that you should tune out The Average Joe, I still plan to continue posting new investing commentary here as well.

I should probably note too that on Top Stocks I'm posting under my real name (Matt Koppenheffer) rather than as Average Joe.

-AvgJoe

Why Free Cash Flow

2007-10-05T17:35:00.000-07:00

So actually before I get into making projections, I wanted to step back for a second and review what exactly free cash flow is and why we use it.

When I think about investing, I take it from the perspective of a business owner. As a business owner, my focus as far as returns is on the actual cash that I could take home after all the (cash) expenses of running the company have been paid. This is what we're trying to get a look at with free cash flow.

If we take the classic lemonade stand example, we're talking about how much cash is left over from our sales after taking care of all the costs of the business such as buying lemons, paying the person making the lemonade, and making repairs and upgrades of the physical stand. Then whatever cash is left over after all of that is done... well, that's our free cash flow.

Doing a discounted cash flow calculation basically tallies up all of the cash (discounted to what it's worth to us today) that we can expect to collect from this business over the next x number of years. The value we get from this should give us a pretty good approximation of what the business in question is worth.

-AvgJoe

Making Projections

2007-10-04T17:14:00.000-07:00

I've laid off posting for a while, but as I look back over my recent posts I realize that I've lost a bit of why I started this blog in the first place. Ideally, I was hoping to share some more of the how behind finding investment ideas. To bring out that old cliche, I wanted to teach readers to fish rather than just handing out fish (and lately I've been sparse with the fish too).

While I will probably still give some general news analysis, I know you can get that a lot of other places -- one of which is The Motley Fool (www.fool.com) where I write full time. So I'm not too concerned that you'll be missing out on extra news coverage.

Anyway, to kick things off, I briefly covered discounted cash flow valuations in the past and got a question on where you can get cash flow projections. My plan was to cover that here and, well, I never did!

To start with we need to define what free cash flow is since there are a bunch of different ways that people go about calculating it. For what I'll be doing here, free cash flow will be defined as:

EBIT * (1 - tax rate) + depreciation & amortization - net additions to working capital - capital expenditures

So before we move on to making projections, let's make sure that we have this down. First you need to find EBIT (earnings before interest and taxes, also known as operating profit). As an example, we can look at the income statement for Coca-Cola (NYSE: KO). EBIT (operating income) appears right under the operating expenses ($6.3 billion in 2006). That's where we start.

Next we need to figure out the tax rate. To do this, just run down the income statement to the income tax line ($1.5 billion) when you take this as a percentage of income before tax ($6.6 billion) you've got your tax rate -- in this case 23%.

To find the rest of what we'll need, we need to flip over to the cash flow statement. Finding depreciation and amortization (just listed as depreciation here) and capital expenditures is easy -- just run down the statement (they're $938 million and $1.4 billion, respectively). Working capital is a bit trickier, but not much. To get this just tally everything under operating activities except depreciation. You should come up with -$61 million.

Now you just put it all together:

$6.3b * (1-.23) + $938m - $61m - $1.4b = $4.3b

Two things that I should point out are working capital and capital expenditures. Items appear on the cash flow statement according to how much cash they add or subtract from the company's coffers, so you have to make sure you don't try to subtract negative capex or working capital additions. If it makes it easier you can say that you are just adding all the numbers you pull from the cash flow statement.

That's probably a good start, in my next post I'll tackle actually starting to make future projections.

-AvgJoe

Keeping the Big Picture in View

2007-09-12T10:54:00.000-07:00

The on-demand availability of information can be a great help to individual investors. Just as often, though, it can be a hindrance as a constant flood of incoming information can cause decision paralysis. Plus, the "biggest" news is usually very important today, in the here and now, but of far less consequence to the long term investor when you look at a the bigger picture.

And I'm not simply saying this from a detached writer's perspective. I was aghast the other day when I noticed how much cash is sitting in my own investment accounts. Cash that could be slaving away on my behalf, but is instead chilling with a margarita and lazing about.

So is now the best time to invest? What about next year? Two years from now? Six months from now? Six months ago? Five years ago? Eight days and four hours in the future (depending on wind speed and direction)?

Get my point?

To a large extent it's not a question of when you put the money to work, but instead that you put it to work. Right now it can be painful to watch some of the stocks in my portfolio like USG (NYSE: USG) and Sears (NYSE: SHLD) struggle, but I know that I have the advantage of time on my side.

Rely on the news headlines to tell you when it's safe to put your money into the market and you could end up like me, swimming in cash and disgruntled, or worse -- investing at exactly the wrong times.

Over the weekend, I polished off a repeat reading of Peter Lynch's One Up on Wall Street (you can pick it up on Amazon for like $10 if you haven't read it yet), and have just started into Beating the Street. One of the things (among many) that caught my eye were the fall 1990 headlines that Lynch transcribes to give a picture of dour mood at the time. So here's a fun little exercise: the following are a mix of headlines from the book and from today. See if you can pick out which ones are which:

1) Housing Costs Punish Family Budgets
2) Uncertainty Rains for US Economy
3) Housing Woes May Cause Recession
4) The Real Estate Bust
5) The Consumer Has Seen the Future, and Gotten Depressed
6) US Economy 'Near Recession' Forecasters Say
7) Economy Causes Americans to Feel Doubts, Insecurity
8) How Safe is Your Job?
9) Can Your Bank Stay Afloat?
10) How the Real Estate Crash Threatens Financial Institutions

No cheating! If you own Lynch's book you better not be heading over to the book shelf. Now I made it a little more difficult by leaving out any headlines that specifically said "subprime" since that would be a dead give-away. To check your answers I've put the answers at the bottom of this post (to discourage wandering eyes as you look over all the headlines). Ok, go ahead and check out how you did.

Surprising right? Maybe you're savvier than I am, but I think I would've had a lot of trouble with that had I not written it (Ok, to be honest, I'd still have trouble even though I did write it). So here's the kicker: since September of 1990 (Lynch said the headlines were from "the fall"), the S&P index is up roughly 380% -- that's about 9.7% annually compounded. For every $1,000 you invested in the face of those headlines you would now have $4,800. I wouldn't kick gains like that out of bed.

It's not too surprising that people were so negative then -- between May of that year and September the market fell over 15%, and it continued to fall into October. In the years that followed, the market had some more jumps and bumps as it flew up in the great bull market of the late 90's. Then the market got overheated and crashed in 2000. From 2000 to 2002 we had one of the worst bear markets we've ever seen. From 2002 to today the market has trudged right on back.

But all of this is of little matter to that hypothetical money that you put to work back in the fall of 1990. It still returned darn near 10% a year for you. How do you like them apples?

Now if you're a market timer, swing trader, or day trader, this post is probably utterly useless to you. In fact, my whole blog may be useless to you. However, if you're an investor with a long term focus (which I believe all individual / hobby investors should be), jot down your thoughts after reading this and put them under your pillow. Hopefully they can help you maintain an even keel as you read today's headlines, tomorrow's headlines, and the headlines five and ten years down the road.

Disclosure: I own shares of Sears Holdings and USG

-AvgJoe

Answer Key The following are the numbers corresponding to the fall 1990 headlines from Lynch's book: 2, 4, 5, 8, 9, 10

Dealing With Failure

2007-09-05T15:17:00.000-07:00

"You're neither right nor wrong because people agree with you. You're right because your facts and reasoning are right."

I'm sure many readers have already heard that quote above already, but for those that haven't, well, I think it's a great bit of wisdom to keep in mind when investing. Practically, this means that when you invest in a stock, you are neither right nor wrong because the price rises over the ensuing six months. You are right or wrong because you thesis for the investment was correct.

An illustration. You do a bunch of research on Target (NYSE: TGT) and you decide that you like the long term prospects for the company and its ability to sell "affordable luxury" to a broad base of customers. You also buy some shares of Dynamic Materials (Nasdaq: BOOM) because you think the ticker symbol is really cool.

Six months pass and Target is down because the economy is slowing a bit and taking some of the wind out of its sails. Meanwhile, erratic trading and a recent short squeeze have given you a modest increase on your Dynamic Materials shares. Would you conclude from this that the key to investing success is in choosing cool ticker symbols rather than digging in on fundamental research?

If you said the former, you're probably reading the wrong blog...

But back to my original purpose in this post. Whether or not you're using valid, sound reasoning, you're eventually going to have investments that don't go your way. It's a simple fact that you're going to have to deal with if you want to be a successful investor in the long term.

The key is admitting when an investment has run aground and no longer follows your thesis (emphasis on no longer following your thesis, as above, don't rely on declines in the stock's price to dictate whether you were correct or not) and then dealing with it and moving on. Even significant failures during your investing career can be overcome, so it is important to remember that and not get caught in the mental trap of wishing for a wrong investment to become right.

If you've been investing for any amount of time then you know about that "wishing" scenario: you do your research, invest in a stock, and something happens that proves your thesis completely wrong and the stock declines badly. Then, instead of selling the stock and moving on, you let it sit there in your portfolio as you wish (you're no longer anchored by a thesis) that the stock price will come back to what you bought it for so you can sell at breakeven. Of course, in most cases that never happens. Worse, the stock sits there flat or continuing to fall and transforms from a small nick in your portfolio to a festering sore that not only drains your capital, but takes up valuable mental space and eats away at your confidence.

Yeah, not a good situation.

So how do I know that even major mis-steps can be overcome? Well, if you think about it, arguably one of the best companies/stocks of all time, Berkshire Hathaway (NYSE: BRK-A) (NYSE: BRK-B) was started on the basis of a mistake. What's that? Yup, I went and said it.

When Warren Buffett bought Berkshire Hathaway, the struggling textile mill, he thought that it could be turned around with better management and a tighter ship. For those who know the story, this was far from the case. The textile operations of Berkshire Hathaway were a thorn in the side of the company for years, eating up capital and providing a sub-par, if even positive, returns.

The genius of Buffett was to recognize that the returns that they would get from reinvesting the cash coming out of the textile operations were well below what they could get elsewhere. So he took that cash and used it elsewhere, a move that helped build Berkshire to what it is today. By Buffett's own admission, he kept the textile operations running longer than he should have and reinvested far more in them than he should have, and yet -- bla bla bla, they're really successful now, you get the point.

So do you get it? In investing mistakes are OK, they come with the territory. I know that at least in US schools we're taught that you want to get 100% and earn that A++++++, but it just doesn't happen in investing. The more you fight against that fact, the more difficulty you will have being a successful investor.

And if you're wondering, yes, I'm still reading Buffett's letters to Berkshire shareholders -- that's what sparked this post.

-AvgJoe

More Buffett Insight

2007-09-04T13:26:00.000-07:00

So instead of spending the Labor Day weekend like a normal person (and a true average Joe!) I was doing research and re-reading Warren Buffett's annual letters to Berkshire Hathaway (NYSE: BRK-A) (NYSE: BRK-B) shareholders (you can find them here). There's so much good stuff in those letters I don't even know what to share.

One saying that he uses a couple times that I real like is the "Noah principle" which says that "predicting rain doesn't count, building an ark does." I ran into this recently when I recommended to a couple close friends that the Accredited Home Lenders (Nasdaq: LEND) / Lone Star situation (Lone Star had offered to acquire Accredited) would lead to Accredited's shares eventually rising (they were trading well under the acquisition price). Long story short, the deal fell through, but a new deal was struck and Accredited's stock is up significantly. I never bought, but a friend of mine did and made a nice return. He gets the prize for building that ark.

-------------

I always like reading pretty much anything that talks about the potential of investing success for investment pros versus the average Joes (for obvious reasons). So here's another passage that I liked:

Ben Graham told a story 40 years ago that illustrates why investment professionals behave as they do: An oil prospector, moving to his heavenly reward, was met by St. Peter with bad news. “You’re qualified for residence”, said St. Peter, “but, as you can see, the compound reserved for oil men is packed. There’s no way to squeeze you in.” After thinking a moment, the prospector asked if he might say just four words to the present occupants. That seemed harmless to St. Peter, so the prospector cupped his hands and yelled, “Oil discovered in hell.” Immediately the gate to the compound opened and all of the oil men marched out to head for the nether regions. Impressed, St. Peter invited the prospector to move in and make himself comfortable. The prospector paused. “No,” he said, “I think I’ll go along with the rest of the boys. There might be some truth to that rumor after all.”

So are you ready to jump on the same thing that everyone else is running after? You might want to reconsider.

-AvgJoe

The Evils of Inflation

2007-08-31T14:19:00.000-07:00

So with all the coverage of the housing and credit markets I've been giving lately there may be some readers wondering why the Fed shouldn't just step in en force and flood the market with cheap money. Well, that answer is inflation. Regulating inflation is a big part of the Fed's job, and to rapidly and recklessly cut rates just to bail out the markets would be to turn a blind eye to that aspect of their charter.

Curious why inflation is a big deal? Well, I could spout some hot air, but here's something I was just reading from Warren Buffett's annual letter to Berkshire Hathaway (NYSE: BRK-A) (NYSE: BRK-B) shareholders in 1980:

"Unfortunately, earnings reported in corporate financial statements are no longer the dominant variable that determines whether there are any real earnings for you, the owner. For only gains in purchasing power represent real earnings on investment. If you (a) forego ten hamburgers to purchase an investment; (b) receive dividends which, after tax, buy two hamburgers; and (c) receive, upon sale of your holdings, after-tax proceeds that will buy eight hamburgers, then (d) you have had no real income from your investment, no matter how much it appreciated in dollars. You may feel richer, but you won’t eat richer.

"High rates of inflation create a tax on capital that makes much corporate investment unwise - at least if measured by the criterion of a positive real investment return to owners. This “hurdle rate” the return on equity that must be achieved by a corporation in order to produce any real return for its individual owners - has increased dramatically in recent years. The average tax-paying investor is now running up a down escalator whose pace has accelerated to the point where his upward progress is nil.

"For example, in a world of 12% inflation a business earning 20% on equity (which very few manage consistently to do) and distributing it all to individuals in the 50% bracket is chewing up their real capital, not enhancing it. (Half of the 20% will go for income tax; the remaining 10% leaves the owners of the business with only 98% of the purchasing power they possessed at the start of the year - even though they have not spent a penny of their “earnings”). The investors in this bracket would actually be better off with a combination of stable prices and corporate earnings on equity capital of only a few per cent.

"Explicit income taxes alone, unaccompanied by any implicit inflation tax, never can turn a positive corporate return into a negative owner return. (Even if there were 90% personal income tax rates on both dividends and capital gains, some real income would be left for the owner at a zero inflation rate.) But the inflation tax is not limited by reported income. Inflation rates not far from those recently experienced can turn the level of positive returns achieved by a majority of corporations into negative returns for all owners, including those not required to pay explicit taxes. (For example, if inflation reached 16%, owners of the 60% plus of corporate America earning less than this rate of return would be realizing a negative real return - even if income taxes on dividends and capital gains were eliminated.)

"Of course, the two forms of taxation co-exist and interact since explicit taxes are levied on nominal, not real, income. Thus you pay income taxes on what would be deficits if returns to stockholders were measured in constant dollars.

"At present inflation rates, we believe individual owners in medium or high tax brackets (as distinguished from tax-free entities such as pension funds, eleemosynary institutions, etc.) should expect no real long-term return from the average American corporation, even though these individuals reinvest the entire after-tax proceeds from all dividends they receive. The average return on equity of corporations is fully offset by the combination of the implicit tax on capital levied by inflation and the explicit taxes levied both on dividends and gains in value produced by retained earnings.

"As we said last year, Berkshire has no corporate solution to the problem. (We’ll say it again next year, too.) Inflation does not improve our return on equity."

Click here to read the whole thing.

-AvgJoe

The Cheap Money Jitters

2007-08-31T10:13:00.000-07:00

For those of us that haven't seen the throes of a detoxing addict first hand, there have been plenty of TV shows and movies that have let us see roughly what it's like from a safe distance (if you don't know what I'm talking about, rent Trainspotting). The process is nasty, and it applies to whether that person is detoxing from chemicals or some non-chemical addiction such as gambling.

Recently it's been interesting for me to watch the behavior of many of the market participants as they try to swallow the fact that the Fed may not step in to the same extent as it has in the past to bail out those that got in over their head during the past few years. Whether you're talking about Mad Money's Jim Cramer absolutely losing it on the "Stop Trading" segment of CNBC, or the various pundits and executives skewering Fed chief Ben Bernanke for being "too academic," I think the whole scene is reminiscent of an alcoholic having his bottle taken away.

I guess you could also liken it to a kid having his favorite toy snatched from him.

Personally, I think that Bernanke's measured approach to the situation is smart. After all, it was arguably the aggressive and deep cutting of interest rates a few years ago that laid down the tinder for this current mess. Short term pain may be a necessary evil to purge some of the poor loans and lousy risk management that has been dogging the markets. Lenders like Countrywide (NYSE: CFC) and Wells Fargo (NYSE: WFC) as well as some of the i-banks like Lehman (NYSE: LEH) and Bear Stearns (NYSE: BSC) -- among others -- may gripe, but that doesn't mean you do should whatever they say.

The addiction that the market is detoxing from is often referred to as the "Greenspan put." A put option gives the buyer the option to sell a security to another party at a pre-determined price. This is often used as a backstop on a risky or volatile security. For example, if you buy Accredited Home Lenders (Nasdaq: LEND) at the current $8.74 and a buy a put at $6, you can guarantee that you won't lose more than the $2.74 difference plus the cost of the put.

In the case of the Fed, the Greenspan put referred to the fact that many took it for granted that the Fed would bail out the markets at the first sign of trouble. This meant that market participants -- relying on this implied backstop -- were free to pursue riskier opportunities than they otherwise would.

All that said, I wouldn't hope for the Fed to sit on its hands and do nothing. The problem with this situation is that legitimate corrections could lead to high levels of fear and an over-estimate of risk in the market. That, in turn, could lock up certain areas of the market and hurt real economic growth (as opposed to free-money-inspired speculative growth).

Bernanke's approach to the markets creates different implications for the outcome of the September Fed meeting. If the Fed keeps the Federal Funds Rate steady, it would imply that they are comfortable with how the situation is working itself out and they don't see it as a threat to economic growth. However, if they lower the rate, they would in effect be saying that the problems are still very bad and might have an impact on underlying growth. A cut larger than 25 basis points would amplify the concerns.

In other words, assuming Bernanke isn't the dummy that some seem to think he is, no rate cut in September would be the better outcome. Of course, you trying telling the heroin addict that he's really better off without a needle in his arm...

-AvgJoe

But is Subprime Really the Problem?

2007-08-29T14:23:00.000-07:00

At this point, the word "subprime" has practically become a four letter word. Mention that word, or any of the companies like New Century, Accredited Home Lenders (Nasdaq: LEND), and Fremont General (NYSE: FMT) that were at the forefront of subprime lending over the past few years and you're likely to draw disgusted looks from people on the street. But I think all the derision begs a question: is there something inherently wrong with subprime lending?

In short, my answer is no.

The broad definition of subprime loans are loans that are made to borrowers that have less-than-perfect credit. These are people that perhaps have a high level of debt already, have a habit of missing payments on other loans, and perhaps even have defaults or bankruptcy in their past.

Lending to this group is obviously much riskier than lending to someone who has little outstanding debt, perfect payment history, and a wad of cash in the bank. However, that risk is studied and in order to take on the incremental risk, lenders charge higher interest rates. The idea is that when everything shakes out over time, the lender will have more defaults/foreclosures, but that will be balanced out by the higher rates that the rest of the group pays.

There is most certainly a market for these loans, and as long as risk is adequately measured, there is no reason that there shouldn't be someone out there serving this part of the market.

The problem currently, though, is that lenders had not adequately cushioned themselves for the default risk that they were going to face. Historical measures of subprime default risk were used at a time when the environment and the loans being made were anything but similar to historical subprime lending. Housing prices were soaring, people were falling over themselves to buy homes, and subprime loans were being made with various features that completely changed the risk profile of the loans.

Now there is a lot more that I can get into here, but I wanted to just briefly focus on what I see as the key issue that has made the word "subprime" sound like "Long Term Capital Management" -- namely, the availability of 100% financing.

I have no problem with 100% financing when you're talking about a big screen TV or maybe a nice sectional, but 100% financing for a home is asking for trouble if you ask me. Even worse is allowing subprime borrowers to use 100% financing. Of course, I'm not just talking about full 100% loan-to-value (LTV) loans, the same applies to the so-called piggy-back loans that provided 100% financing through 80/20 or 90/10 paired loans. And don't even get me started on 110% LTV loans...

Give somebody -- anybody, not just somebody with bad credit -- the ability to buy an asset without risking any of their own money in a highly speculatively environment, and you're asking for them to walk away from the loan if things turn sour.

Coming back around to my original point, though, there's no reason why subprime lending has to disappear. Right now the market has tightened like a vice on those loans and I can guarantee that there is demand just building up -- demand that somebody can and should be serving. It's just crucial that lenders are responsible in how they make those loans and how they project the performance of those loans.

So should subprime go away? Nope. It just needs a little resuscitation and a maybe some plastic surgery to get back on its feet. And given how risky people view those loans as right now, whoever wants to step in and serve that demand should be able to get more than adequately compensated for it.

-AvgJoe

The Fed Minutes and Ensuing Freefall

2007-08-28T14:06:00.000-07:00

Yikes! I stepped away from my computer for a bit to have a nice West Coast lunch and I come back to headlines like "Ahhhh, the Fed Minutes!!!! Freefall! We're all going to die!"

Ok, I exaggerate.

But seriously, the Fed Minutes, which usually don't have much of an effect on the market, seriously stomped the market when they were released late in the day today. So here's the quick Average Joe breakdown:

So the Fed Minutes are basically the notes taken when the Fed meets to discuss their target for the Federal Funds Rate. They review what's going on in the economy and discuss the factors that play into deciding whether to raise, lower, or keep steady the target for the Fed Funds Rate.

Right now, everyone is very focused on the Fed due to the condition of the credit market. Many believe that to keep the economy righted the Fed should cut rates at its September meeting. This would supposedly shore up liquidity in the credit markets and generally ease fear, two things that could work together to put a hurting on the economy.

The problem today was that reading the minutes painted the picture of a Fed that was fairly comfortable with the state of the economy -- despite knowing the risks it was facing -- and still had its eyes fixed on inflation. Upon reading this everyone immediately started worrying that this meant that the possibility of a rate cut in September was out the window.

Now I'm not going to get into a discussion here about whether a rate cut in September is an absolute necessity, but the key to point out is that the Fed meeting, and therefore the minutes, was on August 7th. On August 17th, the Fed found that conditions had deteriorated to the point that the Fed decided to cut the discount rate (the rate that the Fed charges the banks that it lends to). They also released the following statement:

"Financial market conditions have deteriorated, and tighter credit conditions and increased uncertainty have the potential to restrain economic growth going forward. In these circumstances, although recent data suggest that the economy has continued to expand at a moderate pace, the Federal Open Market Committee judges that the downside risks to growth have increased appreciably. The Committee is monitoring the situation and is prepared to act as needed to mitigate the adverse effects on the economy arising from the disruptions in financial markets."

Draw your own conclusions, but I would be more apt to go with the Fed's statement from August 17th than to read a lot of meaning into what it had to say ten days earlier.

-AvgJoe

Housing Market: So Who's to Blame?

2007-08-27T09:00:00.000-07:00

When something goes wrong, it seems to be human nature to look for the culprit. Then, once we figure out whose fault it is, we can then take a big, deep breath and move on with our lives. Right?

Unfortunately (as most of us know at least intellectually), many (most?) problems in life are simply too complex to be able to point at one person or group and say, "It's his/her/their fault!" I'd argue that this is the case when it comes to the current housing market problems that have ballooned out and had serious effects on the credit and equity markets. That said, let's take a quick look at the suspects involved.

The Federal Reserve - Many are laying blame squarely on the shoulders of the Fed because of the ultra-low interest rate environment that the Fed -- then led by Alan Greenspan -- created after the Internet bubble burst. These rates both gave the spark and the squadoosh to the real estate craze by allowing super-low intro rates and then steadily raising those rates.

Lenders / Mortgage Brokers - Blame has been put in the court of the lenders and mortgage brokers who pushed exotic loan products on buyers that couldn't afford what they were buying and allowed too much flexibility as far as loan documentation. Many homebuilders like KB Home (NYSE: KBH) and Lennar (NYSE: LEN) have their own lenders or originate the loans for the homes they sell. Even more spectacular was the rise and fall of some of the subprime and Alt-A lenders like Accredited Home (Nasdaq: LEND) and Impac Mortgage (NYSE: IMH). And we wouldn't want to overlook the behemoth Countrywide (NYSE: CFC) here either.

Real Estate Agents - The blame being heaped on RE agents is similar to that of the mortgage brokers, ie pushing buyers toward homes that they really couldn't afford, encouraging crazy loans, etc. They were also able to help propel the real estate mania by advising clients that they market would continue to perform well above historical norms.

Banks / Investment Banks - This was the group securitizing and selling many of the loans during the RE mania. The complaint here is that these guys were creating the myth that as long as the risk was spread there was no risk at all. Critics see this group as finding creative ways to sell junk as something other than junk. Goldman Sachs (NYSE: GS), Lehman Brothers (NYSE: LEH), and Bear Stearns (NYSE: BSC) are a few of the bigger names that could be cited here.

Buyers - We don't want to leave out the buyers here. I can buy the argument that the buyer was duped by predatory lender / RE agent / seller in a few cases, but these are the vast, vast minority of cases during a time when real estate was running absolutely gangbusters. Though many buyers may not have fully understood the loan they were using to get their new home, what most of them certainly should have been able to understand is that they were buying a more expensive home than they should have been able to and were not having to put any money toward that house up front. You know what they say about a deal that sounds too good to be true...

Bond Rating Agencies - Rating agencies like Moody's (NYSE: MCO) were responsible for slapping ratings on the securities that were being produced from all the securitizations. There are many that feel these guys were simply asleep at the wheel, and some that think they were too interested in collecting fees and not interested enough in really exploring how gross some of the loans out there were.

Fixed Income Investors - Somebody was buying the product churned out by the securitizations after all. Were they really doing adequate diligence or were they being lazy and just relying on the rating agencies? Had they turned off the cash spigot sooner it would've been much tougher for problems to accelerate.

Hedge Funds - This is a more recent player, but still significant. This group, which includes the hedge fund subsidiaries of i-banks like Goldman and Bear as well as private hedge funds, used huge amounts of leverage and mixed it with some hubris, aggressive investing, and good ol' fashioned chutzpah to make big bets on the direction of the housing/lending/real estate markets. The ones that were wrong, well, let's just say they caused some problems.

[n.b. I'm not saying the above criticisms are necessarily fair/correct, I'm just reviewing the criticisms]

You may have figured out where I'm going with this already, but the bottom line is that the situation we're in right now is not one that could have easily been created by the actions of any one of the groups above. Instead, it was all of the above working together to bring us to where we are today. Which brings me to my final culprit:

Greed - If you feel it absolutely necessary to blame this all on one, single entity, let me suggest greed. If it makes it easier, you can even picture it as a little goblin running around messing with peoples' heads and putting bananas in cars' tailpipes (oh yeah, he's that nasty!). When money is involved it's tough to find anyone that doesn't have a little of the greed monster inside. Generally speaking, though, the markets pit many opposing forces against each other so that the greed of one group typically keeps the greed of another group in check, or at least in balance. Sometimes, this doesn't work so well and you have many groups working in what could almost be called collaboration towards their greedy little ends. These unusual situations don't last forever (cough, cough, Internet bubble) and the result is that participants eventually come to their senses and everyone scrambles to get themselves on good footing. Enter market correction.

In the end, I'm sure we'll continue to see the vilification of one group or another -- we may even end up with some government intervention to those ends -- but to do so is really to overlook the bigger picture.

-AvgJoe

What's Ailing the Markets?

2007-08-23T15:56:00.000-07:00

As you might be able to tell, the problems facing the financial markets right now are no joke. The dumping of money into the banking system by the Federal Reserve, along with the cutting of the Fed's discount rate (not to be confused with the more well known Fed Funds Rate) suggest that the even though there's still inflationary risk out there that the Fed sees what's happening as a real threat to economic growth.

But the problems are not particularly straight-forward and I get the feeling that a lot of people watching the markets falter don't really understand the itch that's causing it all. For those savvy types that find their way to this blog (are there any?) this might be just a review of material you already understand. For everyone else, hopefully this, though very simplified, will help elucidate the situation a bit.

The old maid
So to start, I really liked the way The Economist described the old US banking system in a recent article. They compared it to a game of Old Maid, where each player's aim is to not end the game with the maid in his hand. You could similarly compare it to a game of musical chairs -- when everyone goes scrambling for a chair one person is inevitably left standing.

In the past banks basically took on the bulk of the risk when it came to making many loans -- mortgage loans in particular. With all of these loans on the banks' balance sheets, when the music stopped playing after a time of excess it was a scramble to see who was left with enough bad loans to leave them standing. For that/those banks it was game over.

The new, better way
Cleverly enough, financial institutions have found a way to spread the risk from these loans far and wide. What they do is take a whole basket of loans -- it can be all mortgage loans, all student loans, or some combo of various types of loans -- package them up and sell off pieces of the package to investors. Investors are paid interest from the pool of payments that come in through all of the assets backing the package that they bought into. This process of packaging up a bunch of assets and selling off securities backed by the assets is securitization.

What the finance guys found, though, is that without a AAA rating on any of these asset backed securities they were selling, it was tough to spur a whole lot of demand, particularly from conservative institutions like banks and insurance companies. So what they did was employ strategies such as subordination to get higher ratings for some of the securities. The idea of subordination is that the securities sold are split into levels (often called tranches).

The bottom tranche of a securitization usually carries the biggest potential pay-off, but is also the first one to take any losses should defaults start rolling in. Successive tranches on the way up pay out less, but are also protected from losses by the tranches below them. Financial firms structuring securitizations are often able to get a AAA rating for the top tranche.

Passing risk
Now that there was a relatively easy way to take loans and sell them off, lenders were all over it. The reason is that it made it much easier for them to expand business. Instead of having all the loans they took on sit on their balance sheets they could now securitize them, sell them off, and have a fresh batch of capital to loan out. Lenders typically retained exposure to some of the lower tranches of securitizations and also collected fees for managing the securitized assets.

Meanwhile, investors liked the deal because they were able to get a pretty decent return often without having to stoop below AAA securities. Plus, everyone's feeling really warm and fuzzy inside because they think that by passing risk all over the place it makes the world a safer place.

Swallowing the risk
But risk can be a bitter pill to swallow when it comes back home to roost. Whereas in the old game of musical chairs there were a bunch of people left without a chair at all, now there are a few people with no chair, but a whole lot of people that have found themselves in a chair that they thought was good, but is actually missing a leg or two.

It turns out that one of the big problems with spreading the risk is that you lose some of the accountability along the way. Though banks that held mortgage loans on their balance sheets could get carried away and make bad loans, they were more likely to crack the whip on loan terms because they were going to bear the consequences if something went wrong. On the other hand, when the bank doesn't feel like it's bearing full risk of the loans there ends up being a little bit that slides here and there.

When you combine that with the fact that much of the time you have a mortgage broker actually originating the loan and caring only about the origination fee he'll take home, you end up with some corners cut here and some shortcuts taken there.

An illustration
Here's a quick example of how this happens to make it a bit more real. I go to DR Horton (NYSE: DHI) and say I want to buy a home. They're very excited. Though they try to lure me to use their lender, I work with an outside mortgage broker and end up getting a loan through Countrywide (NYSE: CFC).

The mortgage broker helps me decide on the type of loan I'm going to go with and fills out all of the fun paperwork -- for that he gets paid an origination fee. Countrywide then pays DR for my new home and puts it on their books. At some point, Countrywide will likely take my loan, along with a whole bunch of other loans and structure securities base on these loans to sell to investors.

Countrywide will then potentially work with an investment bank like Goldman Sachs (NYSE: GS) to structure the securities and also likely consult with ratings agencies like Moody's (NYSE: MCO) to make sure the highest tranche of the securitization is structured so that it will be able to get a high rating. Investors around the world such as ABN Amro (NYSE: ABN), Deutsche Bank (NYSE: DB), and AIG (NYSE: AIG) then end up buying some pieces of this big securitized pie that includes my dinky little loan.

Suppose, though, that I was buying my home three years ago, when real estate mania was still in full swing. Say I was buying a house that I knew was a little out of my price range so I asked my mortgage broker about doing a stated income loan that had a low initial rate that I could keep up with for the first couple years. What did I care, right? Housing prices were headed up, up, up, so before my payment went up I could just sell and maybe use the nice profit to put a real down payment on my next house.

My mortgage broker didn't push me hard since he wanted his origination fee and figured the same thing I did about housing prices. Countrywide didn't push the mortgage broker hard because it was planning on selling my loan anyway. The investors maybe didn't do as much diligence as they might have because they were relying on the AAA rating that Moody's put on the security they were buying.

Now it's three years later. Interest rates have gone up significantly and my loan has ballooned to where there's no way that I can keep up with the payments. I'm rapidly running through what little emergency funds I have and the house has been languishing on the market for months because there are too many houses for sale right now. Eventually, much to my dismay, I have to walk away from my home because I can't keep up.

Play out this scenario enough times and suddenly the lower tranches of the securitizations out there are getting eaten away. Though the AAA levels haven't been touched yet, there's suddenly much more risk in holding that paper. Not only do market prices for the bonds fall, but bids for them in the open market nearly dry up completely. Financial institutions that have been using these supposedly safe securities as collateral are suddenly finding themselves in need of additional capital and liquidity. This need in many cases is forcing them to sell some stuff at whatever the market will give them -- thus spooking other investors and exacerbating the situation.

Reality
The scenario above is not something that actually happened to me (though I did buy a house fairly recently, I am on a good ol' 30-year fixed rate mortgage), but the ensuing spiral, though a simplified version, is similar to what's going on in real life right now.

Like I said, this is a pretty simple overview, and maybe there are some parts that need clarification, so I encourage feedback. I figure this is something that it's good for investors to have a pretty decent grasp on.

-AvgJoe

The Guide to Investing Like Buffett

2007-08-21T17:50:00.000-07:00

As long as I'm on the topic of Buffett, I figured I'd throw up this link -- Making Money the Buffett Way -- from US News and World Report. The business editor over there actually sent the link to me a while back and I just haven't had the chance to post it (ok, you got me, I was being lazy).

With a lot of stuff out there on Buffett it can be hard to find something new that's worth reading. I thought this feature was a pretty worthwhile read -- which I couldn't say about the article from Smart Money which I actually paid to read in hard copy...

-AvgJoe

Buffett and Countrywide: A Match Made in the... Press Room?

2007-08-21T17:27:00.001-07:00

Let's just be honest here, headlines that mention Warren Buffett -- of Berkshire Hathaway (NYSE: BRK-A)(NYSE: BRK-B) fame -- attract attention. And why wouldn't they? The guy is an absolute beast when it comes to investing, so it shouldn't be surprising that peoples' ears perk up when they hear he might be buying something.

It should also be no wonder then that rumors sparked by The Wall Street Journal that Buffett might be looking at Countrywide Financial (NYSE: CFC) sent the shares up 10%. But what is the likelihood that Buffett is really looking at Countrywide?

It'd be tough for me to tackle this any better than my pals at The Motley Fool did earlier today, so I suggest you check out that video clip.

From my perspective, the bottom line is that sure Buffett could be looking at Countrywide, but he could also be looking at a whole host of other beaten down stocks, bonds, etc. Those that are familiar with Buffett's style know that if there's one thing that he avoids like the plague, it's tipping his hand when he's going to do something. The only reasons that Buffett ever reveals his moves is 1) the opportunity has passed and he's no longer buying, and 2) he has to because of SEC rules.

So what's probably a good idea in this market is to put on your Buffett hat and try to think like he would when looking for good deals out there, but avoid jumping all over rumors of what Buffett might be doing (the Countrywide rumor probably won't be the last). Besides, you may be able to find something out there that he'd like even better, but is out of his wheelhouse because it's too small.

-AvgJoe

Commenting on the Comments

2007-08-21T16:56:00.000-07:00

So it was long overdue, but I now moderate all the comments that come in before they go up on the site. I also just finished wading through all of my past posts to clean out all of those spam comments that were up there. Holy cow was I providing a lot of free advertising space for Viagra, credit cards, and insurance!

Seriously, though, I feel like I owe you (the readers) an apology for the mess that you had to sift through to read any of the comments on the site. Going forward this should no longer be a problem.

And for those of you that chronically disagree with what I have to say, well don't worry, I don't plan to delete comments because they argue my points, most of the argumentative comments that have been put up have been really good and well thought out.

-AvgJoe

Should We Take Goldman's Cue on the Market?

2007-08-13T13:29:00.000-07:00

Today, Wall Street baron Goldman Sachs (NYSE: GS) announced that it is making, along with some outside investors, a $3 billion investment in one of its hedge funds. This is certainly some news to chew on for both Goldman investors as well as investors in the GEO fund that Goldman is backing up the truck on.

However, there was more to Goldman's move than just pumping extra equity into a struggling fund. In its press release -- and reiterated in its conference call -- Goldman said that they "believe the current values that the market is assigning to the assets underlying various funds represent a discount that is not supported by the fundamentals."

In other words, there are some smokin' hot deals out there.

Of course it's tough to know for sure what Goldman is referring to in particular, but that's the fun in being an investor though, right? Getting down and dirty and finding those opportunities...

I pulled up a quick screen and found out that there are over 1,200 stocks with a market cap of $500m or more that have dropped 10% or more in the past month. Whittling it down to just those that have lost 15% or more still gave me more than 500 names, but I dug into that list.

At the top are a few stocks that you'd probably expect given the weakness in the housing market. RAIT Financial Trust (NYSE: RAS), a REIT that provides real estate debt financing, is down 63%; Beazer Homes (NYSE: BZH) lost 48%; and Thornburg Mortgage (NYSE: TMA) is off 47%.

While the housing/mortgage industry will likely deliver some good stock deals at some point, I'd still like to give that sector some time to cool off before I start shopping. There were a number of other stocks on the list that jumped out at me though as more interesting though. Below is a list of a few along with how much they've lost over the past month.

Pacific Sunwear (Nasdaq: PSUN) - 38%
Dillard's (NYSE: DDS) - 33%
Akamai Technologies (Nasdaq: AKAM) - 33%
Etrade Financial (Nasdaq: ETFC) - 30%
Rent-A-Center (Nasdaq: RCII) - 28%
Ameristar Casinos (Nasdaq: ASCA) - 28%
Bare Escentuals (Nasdaq: BARE) - 27%
Jos. A Bank (Nasdaq: JOSB) - 26%
Boyd Gaming (NYSE: BYD) - 24%
Haynes International (Nasdaq: HAYN) - 21%

Ok, so those are just a few that I'll probably take a close look at, but like I said above there's no dearth of stocks out there that are a heck of a lot cheaper than they were just 30 days ago.

So where does this leave us? That The Average Joe is a perma-bull? Well, if by perma-bull you mean that I believe the stock market will continue to go up in the long term, then yes, I am a perma-bull. I can't say for sure what the market will do over the next six months or year, but when stock prices start to fall, there are often some gems thrown out with the rubbish.

-AvgJoe

What to Do With This Market

2007-08-03T14:10:00.000-07:00

With the S&P down 2.7% today, I figured it'd be a good time to jump in again with a note about what to do when the market goes down.

First I'll note that if you're reading this blog, I'm assuming that you take a long term view to the markets, i.e. you are not a swing trader, day trader, or really any type of trader.

That said, the thing to remember is that market declines are just part of investing. If you're caring for a flowering plant, you get to enjoy the beauty of the flowers while they're around. After a while, the flowers inevitably die off. Instead of freaking out that the flowers are dead and digging up the plant, the good gardener will pinch off the dead flowers, knowing that the plant needs some period of dormancy to recharge, grow, and hopefully produce an even more impressive display the next time.

Hope I didn't lose you there (I love the analogies). Anyway, the point is that this isn't the time to chuck all your stocks and give up on investing.

Last I checked, the S&P, Dow, and Nasdaq are down 7.9%, 6.7%, and 7.8%, respectively, from their highs for the year. Ideally, I'd like to see the market ease even a little more before I got interested in a big shopping trip. The way it looks right now, it seems very possible that I will get that.

In any case, the thing to be doing now is reviewing your watch list and picking out your favorite stocks from there. If the market continues to slide, it's the perfect time to swoop in on some of those stocks that you really like, but just thought were a little too pricey. While stocks like Home Depot (NYSE: HD) or USG (NYSE: USG) have exposure to the housing market and may take more time to recover, if other high quality stocks like a Coach (NYSE: COH), Coca-Cola (NYSE: KO), or Johnson and Johnson (NYSE: JNJ) sag with the market it could present a good buying opportunity.

Also don't forget to keep an eye on the stocks you already own. A market decline is also a good time to buy more of a stock you already own if it gets cheaper.

And if you need a reminder on why you stay in the market, be sure to take a look at a long term chart of the S&P 500. As you look at the chart you can notice the downward blips where the market declined, but the big picture is that on the whole the line continues moving up and to the right.

Disclosure: Joe owns USG stock in his personal portfolio.

-AvgJoe

The Value Trap

2007-07-20T14:16:00.000-07:00

It was actually an article in The Wall Street Journal a little more than a week ago called "Rule of Thumb Hammered" (subscription required) that got me thinking about this subject. The article talked about the recent performance of some of the homebuilding stocks like KBHome (NYSE: KBH), Toll Brothers (NYSE: TOL), and Lennar (NYSE: LEN). Despite these stocks seeming like a steal on some traditional valuation metrics, they have been performing very poorly.

The WSJ article pointed out the low book value multiples that the homebuilders were sporting a year ago. Book value, also known as shareholders' equity, is all of the company's assets minus its liabilities. It's the amount of money that would supposedly be left over for investors if the company liquidated all of its assets and settled with its creditors.

The thing that investors need to be mindful of with book value, though, is that the number can often only be as accurate as the valuations of the company's assets. In the case of the homebuilders, their balance sheets are loaded with inventory that can easily fluctuate in value with the housing market. Lennar, for instance, as of its May 31 quarter, had $11.5 billion in assets and 67% of those assets, or $7.7 billion, was in housing and land inventory. Even a relatively small change in the valuation of Lennar's inventory would have a decent-sized impact on its book value.

The same issues were in play with a lot of the subprime mortgage lenders like Fremont General (NYSE: FMT). Though these guys didn't have land inventory to worry about, they all were holding loans on their books that lost value as more subprime borrowers defaulted on their loans.

But the WSJ article really leads into a much broader topic: the value trap. The value trap can be particularly dangerous for new investors, but I wouldn't say that experienced investors are immune to it either.

Ratios and multiples such as the book value multiple -- or the more popular price to earnings (P/E) multiple -- can be really easy ways to quickly judge the price of a stock. In general terms, stocks with higher multiples are more expensive and those with lower multiples are cheaper. Value-oriented investors tend to focus on stocks at the lower end of the P/E or book value range, hoping to find stocks in that group that have been underpriced by the market.

The key to using these multiples, though, is to not stop with just the multiple. Like the homebuilders and subprime lenders, there's often much more to the story than a low P/E or book value multiple. A company with a low P/E is only worth the investment if you can reasonably expect that it will continue to grow or, at the very least, remain stable.

Kongzhong (Nasdaq: KONG), a stock that I've written about here a few times, could be put in this category. After some changes in the rules for wireless value added service providers sent the stock into a tailspin, it was suddenly trading at a very attractive trailing P/E multiple. Many investors, including myself, gravitated towards the stock because of its low multiple, historical growth, and attractive cash position.

Unfortunately, the new policies significantly cramped the company and further developments in the industry have also hurt it. Despite the low P/E that it was trading at last year, the stock has continued to tank. Over the past 12 months it has lost almost 40% more of its value. Though it still trades at under 10x its trailing EPS, Wall Street's forward projections are much lower and the stock is at 24x its expected 2008 earnings.

Of course you'd have to have been a fortune teller to predict the events that led to the continued slide for Kongzhong, but the key is to know what risks are there ahead of time. There are plenty of stocks out there with very low book value or P/E multiples, but many are that way for good reason.

The bottom line? Do your homework all the way through before making an investment. If a stock looks cheap figure out why it's that cheap. Though there are cases where the market is very wrong, in most cases stocks are knocked down for specific reasons. If it's a risk you can deal with, go for it, but don't hit that "buy" button based solely on a low multiple.

-AvgJoe

That's Right, More Blackstone Commentary

2007-06-22T12:41:00.000-07:00

If you're reading this, it's likely you've already gorged yourself on plenty of other commentary out there today on the Blackstone (NYSE: BX) IPO. In fact, I've already weighed in on the issue through a piece I did for The Motley Fool today.

The facts on the offering are all pretty much out there so all that's really left if for everyone to throw in their hats on where they think the stock will be headed. Like I said in the piece for The Fool, I'm pretty lukewarm about the offering.

One of the most obvious things to look at is who is doing the offering. This is mega-dealmaker Blackstone -- they don't need the money, so the only reason that they'd be doing this is to opportunistically take advantage of a good pricing environment. Do you think Schwarzman is going to leave money on the table if he doesn't have to?

The other point to keep in mind is that Blackstone isn't the only firm of its type. The bulge bracket I-banks that are already public -- Goldman (NYSE: GS) and Merrill Lynch (NYSE: MER) to name just two -- are doing PE buyouts just like big Blackstone. Some might argue that you can pick up the stock of those firms pretty good prices right now. And with KKR hiring Morgan Stanley (NYSE: MS) and Citi (NYSE: C) to potentially headline its IPO, we may be seeing more shares that are directly comparable to Blackstone's coming to market soon.

For me, Blackstone is too much hype and has too many eyes on it. With thousands of stocks out there I figure there are better deals out there than this.

-AvgJoe

Buy What You Know... Right?

2007-06-20T00:44:00.000-07:00

Ok, the short of it here is that investors, particularly new investors, should be careful when applying the folksy bit of stock picking wisdom that you should "buy what you know."

The appealing aspect of this simple phrase is the fact that it's just that, so simple. Any investor who's ever heard of Peter Lynch likely knows the famous Lynchian lore about how he bought Hanes (before it left the public markets and re-entered as Hanesbrands (NYSE: HBI)) after his wife told him about great L'eggs were. He did great on that investment and legend was born.

The misnomer goes like this: Johnny Everyman (or maybe Joe Average?) gets a new car and it has Sirius Satellite Radio (Nasdaq: SIRI) built in. Johnny listens to his new satellite radio every day on his way to work and loves it. One day it clicks and he says, "Sirius is great! I should buy the stock." And buy he does.

Right on?

Well, maybe.

As I've talked about before, there can be a big difference between a company and its stock. Likewise, there can be a pretty big difference between a product and its company. Believe it or not, not every company that produces a killer product has clean, honest, efficient business operations to back it up.

Here are a couple of examples of the "buy what you know" principal.

Do you like your sleek Walkman-of-the-modern-age, the iPod? Well, that dandy little product has been powering Apple (Nasdaq: AAPL) over the past few years and the stock is up over 1,000% over the past five years. Score one for "buy what you know."

If you are not a woman yourself, go grab the nearest woman and ask her what she thinks about Coach (NYSE: COH) bags. See that smile? That reaction has helped the stock rocket over 600% since 2002.

If you've ever gotten lost in an area you're not familiar with, you know why Garmin's (Nasdaq: GRMN) products are so popular. Well, so is the stock. It gained nearly 500% since 2002. That's three quick ones for "buy what you know."

How many of us have come home from a long day at the office and sunk into a La-Z-Boy (NYSE: LZB) chair and had the feeling that life would be A-OK? Well, not those who had La-Z-Boy in their stock portfolios -- it's down 56% in the past five years.

Who can turn down a fresh, fluffy, delicious, freshly baked doughnut? How about one of those Krispy Kreme (NYSE: KKD) doughnuts? It's pretty darn hard. Hopefully you held off on the stock, it's lost 77% of its value since 2002.

If I could count the number of times that Blockbuster (NYSE: BBI) has been there for me on a lonely Friday night I'd be... well, I'd probably realize how pathetic I am. But I also might consider buying the stock if I were a simple "buy what you know" kind of guy. But if I had done that five years ago I'd be pathetic and a good deal poorer -- the stock is down 83%. Ouch, ouch, OUCH!

The bottom line is that "buy what you know" isn't right and it isn't wrong. Focusing on companies and stocks that you are familiar with through their products is a great jumping off point, but that's about all it is.

Had you dug into Blockbuster's story and industry, you may have realized the potential threat that the low-cost Netflix (Nasdaq: NFLX) could be to Blockbuster's business. On the flip side, some more research into Coach would have turned up that the company is exceedingly well managed, produces really impressive returns on equity, and has customers that are absolutely wedded to the brand.

Investing is not an overly complicated field -- I'd say it's pretty simple, but not easy. If you're willing to put in the time and effort, I believe that many people can produce pretty good returns. The trick is not falling into the trap of taking a very simplistic investing catch phrase at face value and not doing the necessary leg work. If all you have time for when it comes to investing is saying "Oh Google (Nasdaq: GOOG)? I like that search engine, I'll buy it." Then maybe it's time you started looking into some low-cost index funds.

And how about our friend Johnny Everyman? Well, it really depends on his timing, but if he picked up those shares of Sirius pretty much any time during 2005 then he's now found himself down a swift 50% or more.

-AvgJoe

True Religion: Just Can't Help but Comment

2007-06-05T16:12:00.000-07:00

If you're reading this now it's likely that you've already tried to dig up as much as you could elsewhere on True Religion (Nasdaq: TRLG). And for good reason, the stock just absolutely caught fire last week and finished out the week up something like 30%. The headline of the gains was the fact the Sterne Agee analyst Ron Bookbinder upgraded the stock to "buy" from "sell" and boosted the target price from $16 to $20 early last week.

Underlying that, though, was the fact that any positive news at this point could spark the stock because it has such a large following from the short crowd. I don't know how much you can actually trust YahooFinance!'s short % numbers, but it claims that 46% of the float was sold short in early May. There's a lot of controversy out there about what a high short % means for small cap companies, but I'm fairly sanguine about the whole thing. Now if you have a company that depends on raising growth capital through constant equity financings, then it can be a big problem -- but I have a tendency to avoid those situations in the first place.

For companies that don't have that problem, the shorts can try to depress the stock price for as long as they like, but if the company continues to deliver on the business side, the shorts are going to have trouble keep the stock price down permanently. At the end of the day, shorts can often just be a great built-in supply of buyers. I don't know that True Religion will hold onto all the gains that it took in last week in the short term, but I also wouldn't be surprised if we saw more episodes like this in the future, since I have to imagine that even after last week there is still plenty of short action out there on the stock.

And speaking of shorts, the one thing that I do sincerely hope for is that Jeff Lubell (the CEO) can keep his comments about the stock to himself and just run the company. He's got a big interest in the stock price since he owns a big chunk of the company, but the way I see it the best way he can work on the stock price is by continuing to build a solid business. Do your job and check the stock price three years from now. I just really am not a fan of situations like Overstock (Nasdaq: OSTK) and Pre-Paid Legal (NYSE: PPD) where management has an unhealthy hangup with what's going on with the stock (please, OSTK and PPD shareholders, don't pepper me with emails, I know how you feel already).

And while I'm at it I might as well comment on the announcement today that the company has concluded the strategic review with Goldman Sachs (NYSE: GS). I'm happy about it. Come on people, we all knew at this point that the company wasn't getting sold. Now at least it won't be paying the steep advisory fees to Goldman.

And of course to close, my disclosure: I own shares of True Religion.

-AvgJoe

Two Books

2007-06-05T15:42:00.000-07:00

So I've found that one of the perks of having this site is that occasionally I get a free book from a publisher who's trying to get word out on a new book on investing. If there's one thing I like as much as researching and evaluating stocks, it's reading about how to better research and evaluate stocks.

One of the first such books I got was Mauboussin's "More Than You Know" (really great read by the way).

Most recently, I got a copy of Ken Fisher's "The Only Three Questions That Count." Now if you don't mind, I'm going to do a little couching here. I am not a fan of Fisher, nor am I a detractor. I also can't say that I've read really any of his columns in Forbes. So I was coming to this book with a pretty fresh eye for Ken.

Anyway, the bottom line is that I think there are some much better investing reads out there. Particularly if you're new to investing and haven't read a lot of the top books, I'd hold off on this one. If you've read pretty much everything out there, I'd say maybe borrow this if you can.

It's not that I hated it, or got nothing out of it, or think Fisher's a quack (though he makes it very clear in his book that he figures many will see him as a quack). I just figured that the writing would be a little better/tighter from a guy who's had a Forbes column for so long. Maybe it's just that his style is better suited for a shorter form.

I really like the core thesis of his book: that you need to know something that nobody else (or at least few others) does in order to consistently generate good investment results. And maybe part of the book's trouble hinged on the fact that delivering on a premise like that is just plain hard. His idea is that you need to have a framework for evaluating the outside world and everything that's swirling around in the news. He claims that much of what is tightly held in investing lore simply isn't true, and knowing that can help you find solid investment ideas. One such myth that he explodes in the book is that a high P/E stock is inherently bad/overpriced and that a stock with a low P/E is automatically a good buy.

As I mentioned earlier, I did come away from the book with some new investing nuggets, though they were padded by what I felt was a lot of fluff. I think his ideas on investing are fresh and insightful, and he's obviously been a very successful investor himself. So again, bottom line is that I wouldn't actively discourage people from reading this, but I'd put it low on your reading list if you have other books in the queue.

The other book that I wanted to highlight is one I wish I had written about right after I finished reading (which was about 4 months ago). Anyway, the book is a fairly inauspicious (save the title) one called "The Single Best Investment: Creating Wealth with Dividend Growth." The book is written by Lowell Miller (a new name to me) who's the manager of Miller/Howard Investments and is the CIO of a hedge fund.

The quick-and-dirty on this one is that it gives an investing strategy that is based on quality companies with attractive yields. Obviously there's more to it than that, but you have to read it to get the rest! It's a pretty quick read and the writing is concise and to-the-point. For what it's worth, I give this one a thumbs up.

Just as a quick note, I do not make any referral fees or anything like that if you buy any of these books through the links above. And after the review of the Fisher book I may also not get any more of these nice free books.

Oh well.

-AvgJoe

Google Redux: The Google Godzilla

2007-05-25T14:56:00.000-07:00

I wanted to highlight a comment on my Google (Nasdaq: GOOG) post from Wednesday. Here is an expert from the comment:

"IT is a great thing that so many are now skeptical about the current PE on GOOG. Thats what makes the markets work!! Too many are looking at this all wrong way though. Many have been waiting for GOOG to drop the ball since it came public. If there is any stock that deserves a forward multiple of 60, it is GOOG, which happens to be one of, if not the, fastest growing companies in the world. … Well all who wish to own a stock at $475 on its way to the $1,000 barrier within the next 2 years, all aboard, and for all the skeptics, we'll see ya there!!"

You can find the rest of the comment here. While I'd quibble with Google deserving a 60x forward multiple, I have to agree that it does seem like many have been waiting for Google to slip up and it has thus far proved the doubters very wrong. I'd point out, though, that if Google does double in two years it would put its market cap at roughly $300 billion. Today there are only two companies with market caps above that: General Electric (NYSE: GE) and Exxon (NYSE: XOM).

Here are a few of the companies that have market caps less than $300 billion:

Microsoft (Nasdaq: MSFT) -- $292 billion
Citigroup (NYSE: C) -- $273 billion
AT&T (NYSE: T) -- $251 billion
Royal Dutch Shell (NYSE: RDS-B) -- $245 billion
Bank of America (NYSE: BAC) -- $227 billion
Procter & Gamble (NYSE: PG) -- $198 billion
Pfizer (NYSE: PFE) -- $193 billion
Wal-Mart (NYSE: WMT) -- $193 billion
Toyota (NYSE: TM) -- $192 billion

I'm not trying to say that Google can't double in two years simply because it can't/shouldn't be valued higher than these companies; it's simply food for thought.

As I mentioned in the previous post, I'm not sold on Google's business being a natural monopoly -- particularly not the way Microsoft's has been (at least its core business). Right now Google is an extremely profitable company and though this certainly warrants me tipping my hat to what they've built, I also have to acknowledge the amount of competition margins like Google's will attract.

So far, competitors (Microsoft and Yahoo! (Nasdaq: YHOO) in particularly) have had a tough time trying to take on Google, but the industry -- online advertising in general as opposed to simply search -- is still very young. Yahoo! continues to refine its strategy and Microsoft has recently underscored its interest by paying up for aQuantive (Nasdaq: AQNT).

So I'm not going to end this sounding like I'm contradicting my last post. I think that Google's current price could position investors to take part in reasonable returns over the next 3-5 years, though I'd count myself skeptical of Google hitting a double in two years. But hey, if you buy it, and it does double are you going to complain?

Disclosure: I own shares of Bank of America.

-AvgJoe

Has Google Grown Into Its Big Britches?

2007-05-23T19:35:00.000-07:00

I happen to like Google (Nasdaq: GOOG). I like the business, I like the growth, I like the strong and clean balance sheet. As a result, I find myself wistfully thinking about Google every so often. So I found it interesting today, when Google was on my mind, that there was a write-up in the Wall Street Journal about the stock.

The column was in the Personal Finance section of the Personal Journal, and there were a couple points from the article that I had a bit of trouble swallowing. For one, the author makes the claim that Google has "a rather modest forward price/earnings ratio of 35." Now I don't know about anybody else, but for me, a P/E of 35 is a far cry from modest, especially when you're talking about a company with a market cap pushing $150 billion.

Maybe what he meant was when compared to the forward P/E's of, say, Yahoo! (Nasdaq: YHOO), at 56, and Amazon.com (Nasdaq: AMZN), at 70, Google's seems more reasonable.
But Google is also almost four times as large as Yahoo! and five times the size of Amazon.

The other area of the article I cringed at was his contention that Google has a natural monopoly. Without getting into a long, draw-out discussion, I just don't agree there. Google has a very strong position and a high market share in a young and fast growing industry, but I would not call Google's search business a natural monopoly. I think we are only in the first inning of the story of search and Google, though it's been hitting the cover off the ball so far, still has its work cut out for it to maintain market share and profitability.

However, all that said, I tend to agree with the conclusion that the author reaches: "should Google drop below $450, I'll be clicking 'buy.'"

Part of my periodic check-ups on Google include taking the temperature on valuation.
Google and I had a little fling around this time last year when the whole market sold off -- the stock dropped well under $400 and I just couldn't help myself. Of course, when it ran right back up, I went ahead and took the quick gains. Not bad considering it's been basically dead money since then.

At this point I wouldn't mind the opportunity to step in on Google to hold some for a good long while. We'll say more of a serious relationship than another fling. Given the growth it's seen and the amount of cash the business produces, I don't think the price right now is wholly unattractive (yes, despite the 35 P/E). The problem is that you have to be on board with an average of 30% growth over the next five years.

I think that it could be worth the risk, but there's even more need for protection when you're talking about assuming growth rates like that. That's right, I'm talking about the good ol' margin of safety. At its current price there's some buffer, but if it did happen to fall 5% to $450 (or even a bit lower) there might just be enough there to let you sleep well at night.

Of course if you buy almost any stock low enough you'll probably sleep OK -- the question is whether Google will actually get there. And the answer to that question is one that can only be answered by time... and Mr. Market I guess.

-AvgJoe

Maybe You Shouldn't be Investing in Stocks

2007-05-21T12:17:00.000-07:00

So I come back to the site and the first post I put up is about not investing in stocks? Yup, you got it.

Although I have a pretty good idea that most of the traffic that comes to my site is made up of people that are interested in investing, it's tough to get a really good feel for the intentions and life situation of all my readers. My hope is that there are some people making their way to this site that are not seasoned veterans in the stock market and are looking for some information on how to start investing. This group of people will fall into two broad categories:

1) The interested -- this group is eager to learn more about stocks and investing. They have an interest in digging into stocks, reading SEC filings, and following the progress of the companies they invest in. They also have at least a rudimentary business sense and are keen on learning more about business.

2) The uninterested -- this group is likely aware that over the long term, stocks have provided the best returns of all the major investment asset classes. They are interested in taking part in the returns from equities, but have little, if any, interest in reading a 10-K filing or learning about where P/E multiples are useful and where they can be misleading.

I'm going to ignore group #1 for now, since this site is largely focused on sharing some thoughts with that group.

There's nothing wrong with group #2. Just like not everybody is interested in, say, travelling the world, not everybody is interested in doing the necessary work to make investing in individual stocks worth their while.

Where this group could get into trouble is if they do start buying individual stocks and never take the time to do the work. While it may seem like a great idea to buy Motorola (NYSE: MOT) because everyone is carrying a Razr or picking up some Disney (NYSE: DIS) stock because you enjoyed the Pirates of the Caribbean movies, it's going to be extremely difficult to decide what price makes sense to buy these stocks and at what point you should think about being a seller if you don't have a grasp of the business and how the company is performing.

This lack of interest, though, does not mean that this group should be excluded from the world of stocks. My answer for them is to look into low cost index funds.

This is not a novel idea in any way -- in the recent press conference that Warren Buffett held following the Berkshire Hathaway (NYSE: BRK-A)(NYSE: BRK-B) annual meeting, he said that low cost index funds are the most appropriate equity vehicle for the vast majority of investors. An even more vehement proponent of these investments is Vanguard founder Jack Bogle.

The most basic explanation of index funds is that they mirror the holdings and performance of most of the most commonly followed indices. Probably the most popular example of an index fund is the S&P 500 fund, which tracks the -- you guess it -- S&P 500 index. There are indices that you can find for a wide variety of market sectors, from large caps, to small caps, to foreign stocks, to tech stocks.

Most investors may be more familiar with mutual funds -- pools of money that are run by managers who are supposedly good enough to beat the performance of indices such as the S&P. The problem with mutual funds, though, is that they have a poor historical record of actually beating the S&P, especially when you take into account the fees that investors have to pay to be invested in these funds. So, at the end of the day, investors end up much better off by simply trying to match the indices through an index fund and not paying high fees to do it.

I could go into more detail, but you may be getting tired of me by now. For those that would like to learn more about the advantages of investing in index funds, I would suggest picking up Jack Bogle's new book The Little Book of Common Sense Investing (please note that I don't get any kickbacks if you buy this book). For those new to investing that are not particularly turned on by the idea of spending hours doing research on individual stocks, this is a great introduction to the easiest and cheapest way to get some exposure to the stock market. Experienced investors may find this book to be a rehash of a lot of information that they've heard before (especially if you've already read a Bogle book), but they may also find it a good review.

There are also plenty of places you can do research on index funds online. Wikipedia has an entry on them, The Motley Fool has a bunch of content about them (including this overview), and of course there's information to be found on the Vanguard website.

-AvgJoe

Joe's Back

2007-05-21T12:12:00.000-07:00

Like that comfortable old shoe, it turns out that this site just works for me. As some of you know (and thanks for the kind words on the new blog as I woefully lapsed on posting much at all!) I tried making a move to a new site. It was fancy, it was pretty, but it just wasn't home.

So look forward to the return to the trusty old site and some new content -- and if you don't see some good stuff soon, feel free to heckle me, that often has the effect of getting me into gear.

-AvgJoe

New with Joe

2007-02-15T20:31:00.000-08:00

It's been just over a year of having this little corner out there in the blogosphere, and all the feedback and support that I've gotten has been really great. As often happens to good things in the business world, though, I've been acquired. Ok, not really. But I have taken a full time writing spot with The Motley Fool.

I'm sure if you've found your way to this site you've already heard of The Motley Fool, but in short it's an awesome investing community that focuses on making investing accessible for anyone and everyone. If it's been a while since you've been over to The Fool, I strongly suggest you check it out again - among other things, they've launched a new service called CAPS that's a really great research tool.

I'm going to keep this site up for a while, but shortly I'll have this redirecting to my new blog - www.theaveragejoeinvestor.com. I'll have some short thoughts up there, but I'll also be linking to my articles on The Fool's site since all of my longer ideas will go there.

Best to all and thanks again Joes!

-AvgJoe

Dell's "New" CEO

2007-02-08T19:49:00.000-08:00

Back in May, I posted on Dell's (Nasdaq: DELL) troubles. At the time, I didn't really think too much of the shares and didn't own any shares. Over the summer, though, the shares just got too cheap given the amount of cash that the company produces and so I picked up some shares (which I continue to hold).

Recently, as most probably know by now, CEO Kevin Rollins stepped down and Michael Dell took back over at the helm. I'll be honest, I'm excited about Dell running Dell again, but it's not like he really ever left. He's been the Chairman all along (as I mentioned in the last article) and he practically shared an office with Rollins - they were just separated by a door (glass door I think). He could bring a little more pizazz and rah-rah spirit back to the company, but there are a lot of tough decisions ahead if they really want to get back to a growth stride even close to the past.

The one thing in most of the media coverage that I take issue with is that everyone is pointing out the fact that Dell recently lost the spot as the #1 PC seller to HP (NYSE: HPQ). You know what? Fuggedaboutit. I mean it. Sure Dell made its name selling PCs and still does it pretty darn well (ok, maybe the customer support could use a little help!), but selling PCs is a race to the bottom these days. I'd much rather see Dell secure itself a position in a more profitable area than waste a lot of time and resources slugging it out in a PC market that sports razor thin margins. It sounds like services are going to be a focus for the company going forward, and that should prove to be a more profitable area - if they can pull it off.

Ever heard of IBM (NYSE: IBM)? Sure, they saw the writing on the wall sooner, but I figure it's better late than never for Dell. I wouldn't say they have to get out of the PC business altogether as IBM did, but I'm just saying that losing the #1 spot in that market shouldn't mean that we should all be carving a Dell headstone saying "once was the #1 PC seller."

Dell's fantastic execution in the supply chain and its penetration in the business market worldwide are two great assets when looking to a Dell renaissance. Now I just hope that renaissance comes.

-AvgJoe

Suntech's Convert

2007-02-08T19:02:00.000-08:00

Wouldn't it just figure that right after I put up an article saying I wasn't planning on following Suntech's (NYSE: STP) every move the company goes and does something that I pretty much have to write about. Anyway, just in case you didn't catch it, Suntech issued $425m of convertible debt that was priced today. The terms are: debt is due 2012, interest rate is 0.25%, and the conversion price is roughly $48.76.

According to its press release, Suntech plans to use the funds as follows:
- $150m to expand PV and thin film production lines and increase R&D
- $100m to secure raw materials
- $100m to repay the bridge loan that the company took out to purchase MSK
- the rest for general corporate purposes

Good? Bad? To be bullish on Suntech at all, you have to believe that solar power is going to become a major component of power generation going forward - the same belief you have to have if you're going to invest in pretty much any of the solar players. Ok, you don't have to believe that solar is going to dominate energy generation, but you have to have a good feeling about it growing its current piece of the energy pie. Don't worry you can have doubts about it (I have mine), but it's about weighing probable outcomes.

Now if solar doesn't deliver on the promise, the whole sector is screwed ('scuse my French) - so who cares about the darn convert. However, if solar does deliver, then its going to be the companies that won on the landgrab early on. Those guys won't necessarily be the long term winners down the road, say, ten or fifteen years from now (that'll be the ones who come up with the best technology), but they will be the early winners. Landgrab requires cashola.

The interest rate on the notes is good and you've got a 32% conversion premium over five years which is ok. The important part is that they now have cash to make sure that they can expand production and have adequate silicon supply on hand. The interest rate on the bridge loan that they're paying off was only 0.75%, but they only had a year on that anyway. Given how profitable the company is, I'm not concerned about the interest. Sure dilution isn't ideal, but I'm much more worried at this point about the company not executing than about dilution (no, that does not mean it would be ok for them to start selling stock like crazy).

SunPower (Nasdaq: SPWR) recently did a convert deal, albeit for a much smaller $175m principal amount. Why smaller? For one, SunPower is smaller than Suntech by a decent amount. For the first nine months of 2006, SunPower did $162m in revs versus $381 for Suntech. Also, the terms that SunPower got weren't as attractive - they got the $175m at 1.25% interest rate with a 20 year term and a smaller conversion premium of 28%. Also interesting with SunPower is the fact that the stock is already so heavily shorted that the company concurrently lent some shares to Lehman (NYSE: LEH), most likely to allow the convert investors to hedge their position.

The bottom line is that I think this will help Suntech move forward full speed.

Disclosure: I own Suntech shares.

-AvgJoe

MSK, What Are We Going to Do With You?

2007-02-05T08:34:00.000-08:00

One answer to the above question might be: "it doesn't matter."

On Friday Suntech (NYSE: STP) filed updated Q4 projections, including updates on the integration of its MSK acquisition. The filing breaks down pretty simply: Suntech is doing quite well, while MSK is still lagging. In the filing, Suntech upped its Q4 top-line expectations for the core business from a range of $166m to $170m to a range of $188m to $192m. Revenue guidance for MSK, meanwhile, was cut in half from the original range of $60m to $64m to a new range of $30m to $32m. Suntech also gave Q1 '07 guidance of $220m to $228m, which is roughly flat sequentially due to the fact that they're waiting for new capacity to come online.

My takeaway from the press release when I first read it was that it's too bad that MSK isn't living up to its billing so far, but I can't be too angry given how well Suntech's core business did in the quarter. I did, after all, originally invest in Suntech. I think plenty of value will end up being realized from MSK - if nothing else the market foothold in Japan and their BIPV products (basically solar collectors that replace roofing material) are worth something - so I'm willing to be patient.

But lets face it, I'm late to the table on this post about Suntech - the filing was on Friday and the stock is up over 7% today. Luckily I was prodded by a faithful reader over the weekend to say something on the matter! I could pass it off on the fact that I was chillin' in the Big Easy over the weekend and enjoying the beignets and chicory coffee. But that's not really the reason that I didn't rush to post about Suntech.

Over the course of the time that I've held the stock (which is since the IPO), I've come to see it less like the Evergreen Solars (Nasdaq: ESLR) and Hokus (Nasdaq: HOKU) and more as a steady company that I don't have to keep a constant eye on. Granted, the world of solar is still new and developing and it's essential that Suntech keep on top of (profitable!) development in technology, but the company is proving itself to be well managed and able to deliver on its goals. I'm not going to go and say this is a Verizon (NYSE: VZ) or AT&T (NYSE: T) for the "widows and orphans" crowd, but it's one that I'm going to look to hold on to.

Of course, the report released from the Intergovernmental Panel on Climate Change, which was released on Friday only serves as a further backstop to the projected growth of solar power generation as well as other alternative energy sources. And if you want my best guess, it's that report, not Suntech's release on Friday, which is moving the stock today - it's actually moving pretty much all of the solar names.

-AvgJoe

Some Hot Cajun Stocks

2007-02-02T10:41:00.000-08:00

In honor of my first trip to New Orleans, I thought I'd post up a few stocks from the area.

Entergy (NYSE: ETR) - Electric utility company based in New Orleans. Up about 40% over the last year and is now trading at a somewhat aggressive 21x LTM EPS. If you believe forward estimates though, which have EPS growing 20% year over year, forward P/E is a more palatable 17x. Pays a 2.3% dividend.

Freeport-McMoRan Copper (NYSE: FCX) - Based in New Orleans and making big news lately with the proposed merger with Phelps Dodge (NYSE: PD). The stock has been down on commodity price concerns, but it'll be pretty well positioned in the industry after the Phelps merger and it's been throwing off a bunch of cash lately. They pay a 2.2% dividend.

Superior Energy Services (NYSE: SPN) - Superior is based in Harvey, LA and provides oilfield services. Despite the concerns over the oil & gas industry the stock has outpaced the S&P over the last year. If you can buy the long term EPS growth estimates of 36%, then the stock's 17x trailing EPS multiple is downright cheap.

Gulf Island Fabrication (Nasdaq: GIFI) - A smaller guy ($500m market cap) based in Houma, LA, Gulf Island manufactures and refurbishes drilling platforms for offshore oil production. The stock is up 40% year over year, with most of those gains coming in the second half of 2006. The company is getting ready to report Q4 and full year numbers, and if they hit expectations, they'll be reporting EPS up almost 80% over 2005.

There are eight other companies in the New Orleans area with market caps over $250m, but the above should give a good kick-off to what New Orleans has to offer investors.

-AvgJoe

The Fed: Stripped

2007-02-01T09:22:00.000-08:00

Ok, now as great as I think Federal Reserve Chairman Ben Bernanke is, I don't actually want to see him stripped. But, any Joe can see that the Federal Funds Rate is pretty important to market participants. In the days leading up to the rate decision, the day of, and even a few days after market coverage, which can be pretty ADD if you ask me, focuses on what the Fed is going to do. So here's my shot at shedding some light on more than just the actual rate decision.

US banks are required to keep a certain amount of reserves on hand and in the US's central banking system (also known as the Federal Reserve) there is an open market between and among the banks and the Fed. In short, the Federal Funds Rate is the prevailing rate that banks are borrowing money for their own reserves. The reason that the Fed's statements always say that the rate is a "target" is because it doesn't just say to the banks "this is the rate you can borrow at," but rather it makes more or less money available to lend and based on supply and demand dynamics the prevailing rate changes.

The Fed Funds Rate then ripples through the economy as the banks adjust the rates that they offer loans at and the interest rate they offer to pay for deposits. In general, the best loan rates that the banks will offer will be at some premium to the Fed Funds Rate, and on the flip side, they're not going to pay more for deposits than the Fed's rate.

On the loan side, if you think about the decision by companies on whether to take on new projects, one of the key considerations is whether the payoff from the project is going to be above the cost of the capital needed to take on the project. As the rate at which firms can borrow, more projects will be taken on and economic expansion will increase. Likewise, as loan rates go up, it will make less sense to take on some projects and it will throw a big wet blanket on economic expansion. While I wouldn't say that the Fed can make or break the economy, it's easy to see how they wield a lot of power over the economy.

So next, the question is: why don't they just put the rate at zero (where Japan's has pretty much been for a while) and watch as our economy soars? The answer to this is that economists have an idea that there is a "sustainable growth rate" for our economy. Above this sustainable growth rate we start to run into problems like firms competing for resources and causing inflation.

As an example, imagine this: our economy is going crazy and growing like a weed (or could we say like China?). Companies are tripping over themselves trying to grow as fast as they possibly can, and as this happens they need to find more workers and more machines for the workers to work on. Now there are only so many available workers, and there is also only a certain amount of available machines (this can be increased faster than the number of workers, but it still takes some time). Thinking supply and demand, as supply stays relatively fixed and demand goes way up, prices head up. When prices start increasing out of control, as might happen in a hyper-growth scenario, you get inflation. Inflation is a topic all by itself, but suffice it to say that it's not good for confidence in a country's currency and likewise not good for the economy.

So keeping the economy at the sustainable growth level keeps us moving up and to the right maybe slowly, but certainly steadily. Unfortunately, there is no real way to easily quantify what this sustainable rate is, and there are plenty of ways that the sustainable rate might change over time (think supply of resources or technological change). The challenge for the Fed is to try and figure out what the sustainable rate is for our economy and when we fall below that, loosen the money supply to try to nudge growth forward, and when we are rising above that, tighten the money supply to damper growth.

Now if you're still with me on this unusually long post, besides having an effect on the overall economy, the Fed's rate does also have a more direct effect on the stock market. First off, as the interest rates that banks offer on deposits goes up it becomes increasingly competitive with the stock market. Thought the returns that you can get from, say, a money market account are pretty much always going to fall well below what you can get from the stock market, the returns are basically risk free. So as interest rates go up, you'll have more people that say 5% risk free? I'll take it. So they pull their money out of stocks (stocks go down) and put them in, say, a nice money market account.

Another way that the rates effect the stock market are margin lending rates. For people that want to buy more stock than they can afford with their own cash, they can borrow against a margin account. When margin rates are low, it will make sense to borrow a lot on margin and buy more stock -- if you can borrow margin at 7% and expect 11% from the market that's a pretty good tradeoff right? But as rates go up and you're paying 10.5% on margin to get those 11% returns, there are going to be far fewer people buying extra stock on margin.

So hopefully this helps elucidate the Fed's operations a little more. If you want to dig a little further, the Fed's page on open market operations is a good place to start (the link to the article on this page is worth following).

-AvgJoe

So Long, and Thanks for All the Fish

2007-01-29T15:13:00.000-08:00

For new investors, I can only imagine that the idea of starting to invest in stocks could be pretty intimidating. Particularly because the dot-com crash is still a recent memory and the last few years of good gains for the market have led to increased chatter about the need for the market to pull back. And of course, for the skittish new investor, with such a vast array of market coverage out there, it's really not that difficult to find doomsday sayers who are pitching the imminent demise of the stock market.

The data can be intimidating -- at its low point, the S&P index was down 49% when the dot-com bubble burst. In other words, if you invested $50,000 of your hard earned retirement savings in the market at the peak, *poof* just like that you're down $24,573. Ouch. Of course if you had left your money exactly where it was at that point, then you'd have made back $21,127 of your money by now. You'd still be down, but, well, it's something.

The thing to remember, though, and one of the keys to successful investing, is to be consistent. If you had invested $15,000 at the peak and invested another $5,000 at the very beginning of every year that has followed since, you'd be up almost $6,500 instead of down about $3,500 -- a difference of $10,000. Had you not invested the bulk right at the peak and/or had invested some money prior to the peak, you would've done even better, and this is in spite of the fact that from peak to trough this was one of the worst crashes in the history of the stock market.

So should you be worried about the stock market imploding and taking all your money with it? Well, there's a chance of just about anything happening, but if the U.S. stock market completely implodes, you'll probably have more to worry about than your retirement savings. So, given the low probability of that happening, why miss out on the asset class that has outperformed all others? Play a slow, steady hand and you can offset a lot of the market volatility that can seem so scary.

-AvgJoe

Public Company CEO's are Losing that Loving Feeling

2007-01-29T10:34:00.000-08:00

Is it crazy that public company CEO's may be less and less interested in being public companies? Regulations are one obvious matter -- with all of the red tape in place now it's not only costly, but downright tedious to run a public company. I can only imagine that it takes a lot of the fun out of the job. Similarly, as a public company you've got investors keying in on every piece of news and every single quarterly report and often reacting wildly.

When I think about a company like Bank of America (NYSE: BAC) (which I own), I see a company that makes a reasonable public company. It's massive size allows it to absorb a lot of the costs of regulation relatively easily, and it's a fairly mature business that's not going to have gyroscopic swings every quarter.

On the other hand, take a company like Acme Packet (Nasdaq: APKT), which just recently came public. This is a sub-$1b company that's (as of Sep) doing less than $100m in annualized revenue and is only profitable within the last year or so. The company is selling networking gear that focuses on the still-emerging area of voice, video, and multimedia. At its size, the money that Acme has to spend on regulations is a much bigger deal than it is for BoA. Plus, the short term focus and scrutiny of public market investors could make decisions that would benefit the long-term business but hurt short-term financial results, even harder to pull the trigger on.

You could tell a similar story of larger public companies that are looking to move in new directions or make a true turnaround. Companies like Home Depot (NYSE: HD) or Gap (NYSE: GPS) would arguably have an easier time making some of the strategic decisions needed to get their businesses reignited if they didn't have the next quarterly earnings call to sweat about.

Who knows when or if regulation may change, but it seems like there is at least a good amount of chatter in that direction. As for the short-term focus, speculation, and wild swings of the public markets, well, as difficult as those may be from the perspective of the CEOs, without the volatility, over-reaction, and mispricing there would be little hope of us Average Joes making any above-average returns. So I can only hope that the PE guys don't take too many good opportunities for us off the table.

-AvgJoe

2006 Year in Review

2007-01-24T23:53:00.000-08:00

I've been wanting to do this since 2006 actually ended, but it's not until now that I'm actually getting around to it. In any case, the following are a few of the prescient and, well, not so great calls of the last year. The stocks that I still hold are noted.

Bank of America (NYSE: BAC) - [current holding] Well, it's not like I did anything special on this one this year. Basically I have a dividend reinvestment program (DRIP) with BoA through Computershare, and just kept that going. It was a good year for the company and the stock and the stock was up over 18%. Not to mention I picked up a 4.3% dividend on top of that.

Duke Energy (NYSE: DUK) - [current holding] Similar to BoA, I've got a DRIP with Duke (though this one is direct with the company). Duke's stock also had a good year and ended up 24% (along with a 4.4% dividend), part of that coming when higher volatility stocks were turning south over the summer and some further gains coming as the company was getting ready to realize some value by spinning off its Spectra Energy (NYSE: SE) subsidiary.

Suntech Power (NYSE: STP) - [current holding] This was probably my best stock of the year, but a lot of my gains were gotten by trading around a core position. As with most of the stocks that could be lumped under the heading of "alternative energy," Suntech had a pretty volatile year, though sentiment swings were seemed relatively predictable for Suntech. Besides, I had good confidence in my valuation of Suntech and felt pretty good about buying on its dips. I'm still holding some Suntech because I think it is a well run company and has some room left, but I've pared back my holdings significantly. Though it's jumped around, Suntech was up 26% for 2006.

Marvell Technology Group (Nasdaq: MRVL) - Ouch. Blew it on this one. Admittedly I got a little caught up in how well the market was doing at the beginning of '06 and picked up this at a price that I shouldn't have. I also wrote a couple articles on Marvell, which were likewise off-the-mark. Overall, Marvell ended the year down 34%. My moral from Marvell? Be careful when using forward P/E multiples along with forward growth projections -- that's one too many estimates to be really safe.

Kongzhong (Nasdaq: KONG) - Ouch part II. As opposed to Marvell, where I just shouldn't have bought, Kongzhong I needed to hold on to. I didn't pick it up at the peak of the year, but I also sure didn't pick it up at the trough either. KONG finished the year down 22%, but at its bottom most point it was down 55%. There are still some concerns that I have around KONG's business, including the customer concentration, but I think it's a pretty nice stock.

Western Refining (NYSE: WNR) - [current holding] There aren't many refiners in the U.S. and so the IPO of Western Refining in early '06 seemed like a good opportunity to pick up some decently priced shares of one. So far it's paid off -- shares bought on the day of the IPO were up 34% for '06. Of course, when the stock dipped well under the IPO price a few times during the year, I took advantage of the opportunity to add to my position.

Goldman Sachs (NYSE: GS) - [current holding] My thinking behind holding Goldman isn't that complex: high-end asset management and i-banking are good, profitable businesses and Goldman is at the top of the heap. On top of all of that, the company's prop trading makes it like holding a publicly traded hedge fund. Up 56% for the year, apparently there were a few others who thought the same way.

True Religion (Nasdaq: TRLG) - [current holding] It's not like True Religion was down much for the year (~2%), but investors who got in in the first half of the year certainly can't be happy. Third quarter results cratered the stock, sending it down 27%. I wasn't happy about the quarter, but I didn't see sufficient reason to shed the stock so it's still in my portfolio.

Dell (Nasdaq: DELL) - [current holding] Dell was down 18% for the year, but it wasn't until toward the end of the year that I bought some for myself. The company didn't do anything that really made me think "wow Dell is really back on the right track" -- it was more that the price just got too low while the company continued to do reasonably well and churn out cash. I finished the year up, but it remains to be seen whether I made a good call on this one.

All in all, 2006 was a decent year, I pulled in 15.2% versus the S&P's 11.8%. Large caps played a pretty significant part in my 2006, but looking out into '07, I think I'll probably be looking more towards smaller caps ($5 billion and under). This isn't because I think that small caps as a group are undervalued vis a vis large caps, but more that I see small caps in general as having more opportunity. It's likely I'll hang onto Goldman because I like Goldy so darn much, but the other large caps in my portfolio will likely get dropped off.

That's it for the review - it didn't cover every stock I held/bought/sold in '06, but it did get most of 'em. Before you go, be sure to check out the Average Joe store that I added over on the right hand side. It's all kinds of fun stuff customized through CafePress.com. The t-shirts in particular are great, they're American Apparel shirts and very comfy (just note that the "organic" shirt is an off-white color). Anyway, that's it for now.

-AvgJoe

SeekingAlpha Certification

2007-01-18T13:35:00.000-08:00

For anyone who makes it a practice to troll the blogosphere (man I love that word!) for stock/finance nuggets, the concern over the quality and accountability of a given site can be a primary concern. Since the blogosphere (there it is again!) is to some extent a Wild West of free speech, that gives pumpers, schemers, and troublemakers of all types an open arena to try to pull their stock market schenanigans.

That's why I thought it was pretty cool that SeekingAlpha decided to put together a certification program to be able to qualify certain blogs as trustworthy (notice my fancy gold stamp on the right sidebar?!?!). Of course if you come here you're still getting the stock thoughts/picks/ramblings of a certified average Joe, and SeekingAlpha's stamp certainly doesn't prevent any of my picks from tanking. What it does for you, though, is gives you the sign-off from a third party that I am not a huckster or carpetbagger looking to pump up my own stocks so I can sell them at your expense.

I know what you're thinking - "yeah, this would all be great if you actually still posted on a regular basis" - and I agree. I will be resuming posting on a regular basis, so be sure to check back here (preferable), or you can also find my writings syndicated at SeekingAlpha or 24/7 Wall St.

Best to all in the New Year!

-AvgJoe

December Retail Sales

2007-01-05T20:54:00.000-08:00

I don't know that I'm all that pessimistic about the December retail sales, and, in fact, I think it could be creating some buying opportunities in the retail industry. Same store sales were up 3.1% over last December, which was no slouch of a Christmas season. Sure this is less than the 3.3% of 2005, but looking at the big picture, it's still moving well in the right direction. Other than that - and this is something that others have also pointed out - online sales and gift card sales continue to rise. Neither of these contribute to the same store sales numbers that everyone is looking at - gift cards are only recorded when they are redeemed and online sales just get lumped into overall revenue.

I haven't done my deep digging on it yet, but Limited Brands (NYSE: LTD) is one in particular that I think could have created a good opportunity. I remember thinking before Christmas what a great group of brands the company has. Vicky Secret is rock solid, Bath and Body works is a good one, and even Express seems to be getting itself back in order. I didn't buy then, but now that it got hit for 7.5% after the sales numbers came out, well, it may just be time to start some diligence.

So maybe give retail another look right now while everyone is flicking their nose at it, and I'll tune back in with more when I have some more.

-AvgJoe

That Favorite T-Shirt Feeling in a Public Company

2006-12-20T03:06:00.000-08:00

It caught my eye today when I saw that the t-shirt company American Apparel will now be a publicly traded entity. It's a pretty cool business; they make more or less the apparel basics: t-shirts, underwear, sweats, tank tops, etc., but make a lot of it right here in the good ol' US of A and in sweatshop free environments outside the US. They've also started to broaden the business into more, let's say, fashiony areas. The place is run by this guy named Dov Charney who's a bit eccentric (to put it nicely). He has done a great job building the business but recently narrowly missed being taken down on sexual harassment charges from former employees (for a colorful piece on Dov, check here - keep in mind I warned you it's colorful).

Now I'm all about putting the keibosh on sweatshops, but one of the main reasons I know of American Apparel is because of their clothing. The shirts are so comfortable that I try to avoid buying any other type of t-shirt unless under extreme duress. But enough about me... I digress.

So anyway, rather than go through the whole horse and pony show that is an IPO, Dov & Co. opted to sell the company to a special purpose acquisition company - also known as a blank check company. The company they sold to is Endeavor Acquisition Corp (AMEX: EDA), a blank check company that did a public offering back in December of last year and raised about $120m at $8/share. Not without some skeletons of their own, the chairman of Endeavor was found in violation of SEC insider trading rules in 2001 (he was acting as chief negotiator in an acquisition and at the same time buying shares of the target without disclosing it). In addition, the president held directorships at a couple of companies that ended up going bankrupt and served as the CEO of a third company that also went bankrupt - though, as the prospectus points out, he wasn't at any of the companies two years prior to the bankruptcy filings.

But the past is the past right? Plus the presence of Ed Mathias, a managing director at Carlyle, and a few other guys with good pedigrees on the board, gives some comfort.

During the first year post-IPO, Endeavor did not make an acquisition, so the business was primarily just dividend income from the cash they had sitting around, and burning off some cash searching for a good acquisition target. Enter American Apparel. Endeavor plans to issue 32.2m shares of Endeavor stock to pay for the acquisition, and it will also assume $110m of American Apparel debt. Based on Tuesday's closing price, the total enterprise value of the transaction is $391m. Other notables on the transaction are the fact that Dov still has to buy out his partner at American Apparel, and that Dov has agreed to a long 36 month lock-up on all of his shares.

Endeavor's press release on the transaction says that revenue and EBITDA for American Apparel are expected to be $275m and $30m, respectively, for 2006. That would put a 13x EBITDA multiple on the acquisition. Though it's not a crazy multiple, it's certainly rich. Endeavor also noted that American Apparel has grown eight-fold since 2002, which would give them a 63% CAGR over that timeframe. Being a rather conservative investor, I'd have to see that same kind of growth in 2007 to justify the purchase price.

When you stack on the extra 20m shares that were already outstanding for Endeavor and account for the $124m of cash they have, you've got a total enterprise value of $440m. Given that they are renaming and relisting as American Apparel, this basically becomes American Apparel's enterprise value and it gives you an overall EBITDA multiple of almost 15x on 2006 EBITDA. This crosses into a price territory that I'm not really comfortable with - especially since I'd want to see EBITDA growth of 75% or higher to justify that price.

Of course these multiples are all more or less back-of-the-envelope since we don't have full financials yet, but it's enough for me to not want to jump in and start buying Endeavor stock right now. I'll likely check back in when they refile as American Apparel (they expect to close the transaction in summer '07) to get a look at the books, but until then all I'm buying are the t-shirts.

-AvgJoe

If You Liked Suntech You May be Interested in...

2006-12-19T01:32:00.000-08:00

Suntech (NYSE: STP) has been a fun ride over the last year since it came public and there's still likely a lot more to come. For those that are really excited about the solar PV cell business, or the growth in China, or both together Goldman's upcoming IPO for Solarfun Power Holdings (Nasdaq: SOLF) could be of interest.

The company's tagline in the picture leading off the prospectus is straight-forward enough: "Make the Earth Cleaner." I haven't really dug much into Solarfun's technology, and probably won't, but they're along the same lines as Suntech - selling PV cells and modules. Financial performance has been impressive so far with revenue growing from $21m in 2005 (their first full year of operation) to $49m in the first nine months of this year. The company is already profitable and gross margins of 31% and operating margins of 20% are certainly respectable.

I'm taking a pass on this one though. There are a couple reasons:

1) I'm not typically a high-multiple growth/story stock investor. Typically I like to stick to value-oriented picks where I can wrap my head around the numbers. In the case of Suntech, it was just hearing that there was a Chinese solar cell company coming public that was profitable. It was just good/lucky timing (sometimes luck is better).
2) This is a really young company. Suntech was young for sure when it came public, but it had a few years behind it at the time, and had nine months and $137m in revenue behind it for 2005. Solarfun was just started in August 2004 - it didn't produce any revenue for fiscal 2004 - and it has about a 1/3 of the revenue that Suntech did when it came public this time last year.

3) Pricey, pricey. Suntech was pricey at the IPO - I think if you assumed moderate sequential EPS growth for Q4 of 2005 it was pricing at 60x 2005 EPS. If you assume the same moderate sequential growth for Solarfun, you're looking at a 2006 EPS multiple still well over 100. If it double EPS in 2007 you've still got a forward multiple in the nosebleed section - assuming, of course that the price doesn't go up any more.

4) No more secrets. The secret is out on solar and, even more so, the secret is out on China. Suntech is more than double its IPO price right now, what more do you need to get excited about another Suntech-esque offering? There's a pretty high probability that plenty of people will be excited and that the first day of trading will see Solarfun have some real fun with the markets.

I think at the end of the day the company will probably do really well. Though it's extremely young that may just mean that it has more years ahead of sky-high growth. Investors that can actually get the stock at the offering price will probably do pretty well too. Who knows, maybe even retail investors that get in early enough will do pretty well. I'm still staying on the sidelines. Once something gets too exciting, it just smells too much of mispricing to me.

Oh well, curmudgeon for now.

-AvgJoe

Suntech Suntech Everywhere

2006-12-06T09:45:00.000-08:00

Welcome back to The Average Joe Investor, your home for Suntech Power Holdings (NYSE: STP) data! Just kidding...

I'm sure right now holders of Suntech stock are well aware of its nice break back over $30, so I'm not going to mention that. Or am I? Suntech broke back over $30! Glad to get that out of my system...

A couple items I wanted to point out:

I think there was continued selling pressure from the "insiders" after Suntech announced third quarter results. As I've mentioned before, by insiders I mean the VCs that invested in Suntech prior to the IPO. The ideal for the VCs is to find times to sell when there is high liquidity and low likelihood of tanking the stock from their selling - and a good earnings report is exactly that. Using my lovely E*Trade Power program I counted up somewhere around 1.9m shares of Suntech stock registered for sale under Rule 144 in the month leading up to the earnings release. I obviously don't have any definite data to show that this selling actually occurred when Suntech announced, but it would be a tidy explanation of why the price was muted for a few days directly after earnings then started to rise. The tough part about these sales is that there's not really a good way to figure out how much selling is still yet to come - even when we get the next 20-F filing we're not going to see most of the pre-IPO owners because they became sub-5% holders at the IPO.

Tom Friedman, New York Times columnist and author of "The World is Flat," put out a nice article on Dr. Shi (CEO and founder of Suntech) and Suntech. You can link to Tom's page at NYT here, but the article is premium content. The gist of the article is that Suntech has done a great job taking the lead in solar power in China where it is becoming painfully obvious that alternative energy is not an option, it's a necessity. Tom decries the fact that the US has not been as aggressive as should be, and that when solar power does get to that point where it is a really price competitive form of power generation we may be importing our solar cells from China.

A lot of the bearish chatter I hear around Suntech has to do with the fact that there are a lot of early or development stage companies out there working at bringing thin film solar technology to market. The thought is that once thin film hits the market traditional PV manufacturers like Suntech will be out of business basically overnight. I don't think this is a bad argument at all, at least in terms of the potential of thin film, but it does not make me bearish on Suntech. It's silly to expect that everyone looking to invest in solar would know the background and bio of Suntech's CEO (or is it? they are a top-four worldwide manufacturer now as Mr. Friedman points out), but Dr. Shi has actually been working in the area of thin film technology for a long time. Not only did he study thin film technology at the University of NSW when he was working on his PhD, but he also ran a company spawned from that research until he left to start Suntech. Thin film may, in fact, be the next wave of solar, but I wouldn't be surprised if there is a goodly amount of thin film research going on at Suntech right now. In the meantime, though, they are doing a nice job profiting off of the current PV technology. For some more info on Dr. Shi check out this little tidbit (you have to scroll down a little bit to get to him).

Today Suntech announced a deal to distribute MSK Corp's (a Suntech subsidiary) "Just Roof" product in Canada through ARISE Technology. The Just Roof product is described as "one of MSK's several unique Building Integrated Photovoltaic (BIPV) systems, [which] functions as a fully self-contained watertight roof structure, eliminating the need for traditional roofing materials below the panels." As for Canadian demand, well that's being boosted by recently announced renewable energy subsidies in Canada. For example, the article cites the Ontario government paying citizens $0.37/kWh for solar power over the next 20 years. Given that MSK was a weak spot in Suntech's Q3 earnings, this is nice to see.

As for valuation on Suntech, $32, or 27x '07 EPS estimates and 46x '06 EPS estimates hits right about at my estimate of fair value. And as much as I like Suntech it's one of the most uncomfortable valuations I've ever done (I'm more of a value kind of guy). Some people may scream that with 55% estimated 5-year growth Suntech's PEG is only 0.84 for 2006 and a paltry 0.49 for 2007. To that I say that once I see projected growth in excess of 30% I start to discount heavily - maintaining a growth rate like that is a Herculean task. That said, if you follow The Motley Fool, one of the cornerstones to their very successful "Rule Breaker" portfolio is that early in their lifespan great companies have often been called overvalued. Plus, with SunPower (Nasdaq: SPWR) trading at 43x '07 estimates and 77x '06 estimates, and Evergreen Solar (Nasdaq: ESLR) not even expected to reach profitability by '07, and both showing lower projected growth than Suntech, Suntech certainly isn't the most richly valued of the US exchange traded solar group. So at $32 I think there still is profit potential - if it hits a PEG of 1.0 on 2006 EPS estimates you're looking at $6.50/20% up - but at this price I don't think it's a screaming buy. Either way, be ready for some volatility, if the price continues to rise there's a good likelihood that more of those VC sellers will step back into the market.

Disclaimer: I am an STP shareholder, and probably in danger of being accused of falling in love with the company.

-AvgJoe

Missed Allergan?

2006-11-28T19:07:00.000-08:00

So I was watching Cramer tonight on Mad Money and heard his pitch on Allergan (NYSE: AGN). I liked it, liked it a lot. These days, though, it's tough to jump on anything that Cramer talks about without having to suck the dust of the other investors that were quicker on the draw to buy up Allergan before he could get out the "Allerg-". He pitched it at $117 and at least from what Yahoo!Finance tells me, it's up over $119 now in the aftermarket. Oh well.

Now I'm not saying that the opportunity with Allergan is shot, there could well be more room left for Allergan to move - the aftermarket move was less than 2%. But at over 33x trailing 12 months EPS and projected 5-year growth of 17.5%, Allergan is a pretty pricey stock.

Too pricey for you? If so, time to get creative. The first thing that popped into my head when I heard Cramer talking was Syneron (Nasdaq: ELOS), that lovable cosmetic laser company. As I did when I revisited a few of my past stocks, I am not going to rehash everything that I wrote already on Syneron (it exacerbates my carpal tunnel), but you can still read it here. Making things easier, I still agree with the price target I came up with back then of $35. For a range I'd say $32-38.

With its $18 billion market cap to Syneron's $640 million, Allergan is certainly the larger of the two companies, but with a far lower trailing EPS multiple - 16x to Allergan's 33x - you've got a bit more of a cushion if something goes wrong. Could be an interesting alternative to buying on top of the "Cramer effect..."

-AvgJoe

Buyout Signals

2006-11-23T02:01:00.000-08:00

Buyouts seem to be all the rage right now. First we had HCA breaking records with its $33 billion buyout, only to be now topped by Blackstone Group's $36 billion buyout of Equity Office Properties Trust (NYSE: EOP). And, of course, these are only the most massive of the deals - it seems like we're getting multiple new announcements every week, whether it's Eddie Bauer (Nasdaq: EBHI), OSI Restaurant Partners (NYSE: OSI), or possibly even Qantas (OTC: QUBSF.PK)?

So here's the question: does this mean that stocks are sorely undervalued? It would seem so, right? With all of the smart money out there buying up companies like there's no tomorrow it would seem that there must be plenty of upside for a lot of stocks out there. I disagree.

Let me start out by saying that I don't think that stocks are necessarily overpriced at this level, but I don't think the private equity deals necessarily signal massive underpricing anymore. Compared to the past, there is much more money out there in the hands of these investors, and it's all money that they have to get invested or they don't paid.

Back a decade or so, with a couple hundred million dollars, they could sit back and wait for a fat pitch that they could knock out of the park. Now, with billions to invest and many more competitors out there bidding up all the really nice deals, it's tough to wait for the same types of situations. So what I think a lot of the larger firms will end up doing is taking private firms with a target return lower than in the past. They will likely end up looking a lot more like mutual funds that can take much more concentrated positions, and benefit from being the controlling shareholder. Also similar to mutual funds, in order to put their money to work they'll have to be more consistent buyers through various market conditions.

Don't get me wrong, returns aren't going to look like public market returns, they'll still bring in returns that pass that, but by less than in the past. It just can't be expected that with all of the money out there and the increased competition that the buyers can be as discriminating as they once were on the deals they choose or the price they pay.

So as these big buyout deals continue, I'm keeping in mind that take-privates might not be as solid a market signal as they once were.

-AvgJoe

Illinois Tool Back at it

2006-11-23T01:08:00.000-08:00

I can't say that I really have a whole heck of a lot to say about this, but I couldn't help but notice that Illinois Tool (NYSE: ITW) is acquiring a company called Ark-Les. If you recall, Illinois Tool hit my radar when they bought out the software company Click Commerce a little while back.

I was somewhat baffled at the Click acquisition, but it appears that the company is sticking to more of their core competency with this most recent purchase. The 69-year-old company describes itself as "a leading supplier of engineered user interface solutions to the appliance, telecommunications, motor control, data processing and controls markets." Illinois Tool has declined to disclose the particulars of the deal, but Ark-Les is expected to become a subsidiary of Illinois, and work among its 700 other business units producing some of the guts for appliances and autos.

In a related note, Illinois also released earnings on Wednesday, reporting 10% operating revenue growth for Q3. Of course, only 2% of this was from organic growth, while 8% was from acquisitions. While I tend to be cynical towards companies getting most of their growth from acquisitions, I think Illinois could be a candidate for more due diligence. They get a nice return on equity, are trading at a fairly low multiple, and have been pretty consistently getting cash back to shareholders through dividends and share buybacks.

Though 20 Wall Street analysts cover it, it's not exactly a stock on the tip of everyone's tongue. A hidden beauty? Any opinions out there?

-AvgJoe

Suntech Still Bright

2006-11-20T06:34:00.000-08:00

Extending my recent trend of posting about stocks I own, I was up bright and early at 4:45AM PST for the Suntech Power Holdings (NYSE: STP) earnings release and conference call. All in all it was a good quarter from the perspective that anyone doubting Suntech's potential to continue its blazing growth has to question their spreadsheet (OK, I admit it, I had my doubts). Non-GAAP EPS came in at $0.21, beating the $0.19 estimates. Revenue came in at $163m, which is 188% year-over-year growth. Projections for Q4 revenue were $226m to $234m - sequential growth of 39-44%, not too shabby. Though Q4 revenue projections may seem to be below analyst estimates, I'd note that analyst estimates are all over the place - for example Lehman has a projection of $274m, while Merrill has it pegged at $209m.

It sounds like the MSK acquisition has been a bit slower than expected to integrate and that hurt results somewhat, but they sounded very positive on the prospects going forward. Core Suntech business seems to be well on track to what investors have heard from management previously and, though it didn't make for a particularly exciting conference call, it does provide comfort for results going forward. Gross and operating margins in the core Suntech business came down as expected, but had some upside to what some of the analysts had expected.

One item that jumped out at me on the call, though, was the projection that over the coming years ASPs would fall at a rate of 5% while raw material prices would fall at a rate of 10% - which would theoretically result in some nice margin upside for Suntech. In such a young and fast-growing industry, though, it's really tough to make reliable projections out too far.

There was very little pre-market action on the stock and saying that early market action has been tepid is an overstatement - though over 800k shares have changed hands in the first 15 minutes or so of the market open, the stock is up about 0.5%. There doesn't seem to be a whole lot of conviction in the market right now, so it could take some time for people to get in touch with their feelings on Suntech.

Using a 17% discount rate, I am come up with a $32 price target, so as long as this is trading in the low $27's (currently it is) it's near that 20% error range to the upside. I'm a hold here because I have a good number of shares already, and will likely keep holding until the prices runs way up or the story starts breaking down.

Disclaimer: I am a holder of STP stock

-AvgJoe

True Religion 10-Q Follow-up

2006-11-15T10:31:00.000-08:00

A big thanks to James Altucher at TheStreet.com for the nod on Monday (not the first time he's done that for me) and a likewise big "howdy" to all the visitors from that link...

I thought I'd put a really quick follow-up to the True Religion Apparel (Nasdaq: TRLG) since they just put out their 10-Q for the much talked about quarter. Two areas were particularly intersting to me:

Factoring - The company has a factoring agreement with Merchant Factors Corp., a provider of factoring agreements and asset based lending. In case you're not familiar with a factoring agreement, it's basically a way for a company with business-to-business sales to get access to cash without setting up a line of credit or taking a loan. In a factoring agreement, the company's invoices are directed to the factor provider and the factor allows the company to take advances on these invoices (in this case up to 85%) for a cost much lower than debt. For a growing company like True Religion, especially as they expand into retail, cash management and availability of cash to finance expansion is crucial - a factoring agreement is a good way for them to get access to cash when needed.

That said, I noticed in their full balance sheet that, though their accounts receivable are down versus December '05, their receivables from the factor jumped 2.5 times versus December. So I would think that the right way to look at receivables is to combine the accounts receivable with the factor receivables - a number that is up 60% over December. I did note that receivables jumped the same way last Q3, but sales were also still growing at a much faster rate then. From a cash management standpoint, it's good that the company has the cash available from the factor, but I also want to make sure that they're on top of collecting from their customers.

Risky marriage? - I typically don't spend too much time looking at risk factors because many of them tend to be either self-evident or ludicrous. However, running past the risk factors in True Religion's 10-Q, the risk that "The loss of our Chief Executive Officer or other key management would have an adverse impact on our future development and could impair our ability to succeed" (a pretty typical risk factor) made me think. Given that Kim Lubell is eligable for a nearly $500k bonus this year, I would have to imagine that she falls in this "key management" group. Thus, just to beat this dead horse a little further, any marital strife and potential departure of Kim from True Religion is very much a business matter. I'd rather not have to worry about the Lubell's marriage, but I guess that's life. What say ye Jeff?

Disclaimer: I (still) own True Religion shares.

-AvgJoe

Is True Religion a Sinner?

2006-11-10T18:09:00.000-08:00

As a shareholder, and having been positive myself on the prospects of True Religion Apparel (Nasdaq: TRLG), I'm licking my wounds a bit after their last earnings call. What a mess. Rather than give a full rundown, which will just up my PTSD, I'll just hit some of the high(low)lights:

1) This was not only a big miss, but the company also guided down for the year. It sounds like they weren't prepared for the weather in Europe and that growth in Japan has not been as fast as expected. First, I'll say that the weather excuse is a no-no - I don't like it. Second, this is a sign that internal projections just aren't up to snuff. This doesn't mean that the company is in dire straights, but it does mean that you can't really realy on their projections any more, and that's bad news on Wall Street.

2) Europe and Japan were poor, but U.S. sales continued to be strong. That's certainly reassuring - not enough to save them from their other sins, but reassuring.

3) I'm surprised Herb Greenberg didn't go to town. Herb has been skeptical of True Religion and I'm surprised he didn't take them to task worse than he did. I think he's right on point regarding the potential divorce of Jeff and Kim Lubell - it most certainly is related to the business. If you don't want your marriage questioned by stock analysts don't take a company public with your wife.

4) Everyone but Brean Murray cut the stock from Buy/Outperform to either Hold/Sector Perform or even Sell. I can understand that an analyst may feel funny maintaining a buy on a company that missed like that, but when you have 30% taken out of the price, it's hard to say that the risk hasn't been factored in.

5) Their new strategies in retailing and non-denim are an aggressive move, but it's obvious that they want Buckley to turn them into the next Diesel. I think it's questionable whether they pull it off, and as they're going full steam ahead, it could be a big problem if it doesn't work out. I'm hanging onto my shares, but viewing this similar to a biotech - maybe they pull it off and do really well, or maybe they whiff and the stock totally tanks.

Time will tell, but if not for some absolutely amazing numbers in December, it'll probably be a waiting game for the stock to start to creep back up.

Repetitive disclaimer: I own shares of TRLG.

-AvgJoe

Housing: All Tears and Fears

2006-11-09T12:48:00.000-08:00

You hear it everywhere right now: housing is just not getting better. The funny thing is where these comments are coming from - the CEOs of the major homebuilders like Toll Brothers (NYSE: TOL), Hovnanian Enterprises (NYSE: HOV), KB Home (NYSE: KBH), and Pulte Homes (NYSE: PHM). CNBC clips from a real estate investment banking conference today in NY show CEOs decrying the rapidly deteriorating market.

So how bad is it really? For a long time now, I've been vacillating between hesitant and downright bearish on the housing market, especially when it comes to the crazy bubblish things that people were doing in the go-go markets like Northern California, Las Vegas, and Miami. I still happen to think that there could still be some flatness or weakness ahead for the housing market, particularly in the markets mentioned, but at this point it doesn't look like there's going to be an out-and-out crash in any markets.

For example, Las Vegas has seen really fast population growth to go with the spike in real estate prices and housing buildout. This is evidenced by the public schools putting up educational "outhouses" as they can't grow fast enough to keep up with the number of new students. Of course, water supply is a key issue out in the desert, but if the migration keeps up it should put a floor under housing prices there to some extent. Likewise, in the Bay Area (an area I'm all too familiar with as far as housing prices go), housing prices aren't rising for no reason. There is so much government owned land in the Bay Area that there simply isn't enough room to build new homes for everyone who wants to live in that geography. The result is that existing homes in the area keep going up and new developments 1.5 - 2 hours away are snatching nice prices from people who are willing to make atrocious commutes. Miami - well, that may be another story...

In any case, I'm figuring that the homebuilders are taking the tactic of "the best offense is a good defense" when it comes to the public markets right now. Business is not as much of a sure thing as it was, and what the market hates the most is downside uncertainty. So the faster and harder the homebuilders are able to talk down the markets, the sooner the companies can start meeting, and perhaps slightly beating analyst earnings projections.

I still think that if this does happen that housing stocks are a longer term play - six months to a year at the very least, but the strong names like Toll and KB should come out the other side with little more than some flesh wounds.

Where I could still have some worries on this whole real estate thing, and still need to do some more research into, is on the banking side. Exotic loans were given out all over the place during this housing run-up and fraud and questionable loans were rampant. I think that these loan practices are going to lag the tough times of the real estate market since a lot of them were done towards the tail end, and they are generally 3 - 5 year ticking time bombs. As I am a shareholder of Bank of America (NYSE: BAC) (through their DRIP program), I sure hope that it isn't too severe, but I certainly have concerns.

-AvgJoe

The Era of Free Trading Begins for...

2006-10-09T23:45:00.000-07:00

Bank of America (NYSE:BAC)??? After hearing a lot about the big kickoff of Equinox Securities subsidiary Zecco.com, who is offering free trading (up to 40 trades/month) to anyone with a $2,500 account, I was surprised when BoA decided to steal a little of that thunder with their announcement. BoA's deal isn't quite as sweet since you get ten fewer trades per month and you need $25,000 in funds with BoA. But, it's BoA.

I thought about this from a few perspectives:

1) As an E*Trade (NYSE:ET) customer, I'm paying $10 per trade in commissions. Though $10 is certainly more costly than free, I doubt I'll switch. Sure part of it is due to good old fashioned laziness, but think I get a lot of value from some of the tools and research that E*Trade offers, and as far as I know, BoA and Zecco are a bit more stripped down. I also am not making a heck of a lot of trades, so the switch really wouldn't buy me all that much. And even for those who are making a lot of trades, timing is everything in high-volume trading and unless BoA or Zecco is planning to role out a tool similar to E*Trade's Power E*Trade, the costs of transaction friction (not getting the stock at exactly the right time/price) are probably greater than the commission difference.

2) As a BoA shareholder, I think this is a pretty slick move by my boys down in NC. This seems like a great way to get current Bank of America customers to move equity accounts over to BoA for easier asset management. Because a) they are primarily looking to capitalize on handling more assets and bring in interest income from them and b) they are currently an also-ran in the retail equity market, this could be a great move to grab a bigger piece of the pie.

3) If I were a shareholder of E*Trade (or any of the other big players in here like TD Ameritrade (Nasdaq:AMTD)) I would be a bit worried. Although there are likely a lot of customers that agree with my sentiments above, there are likely a good many who will love the sound of "free." There is also the potential for BoA, Zecco, or somebody else entirely to offer free trades along with some of the nice extras that E*Trade and Ameritrade have. As of FYE 2005, commissions accounted for something like 1/4 of E*Trade's total revenue with the average trade bringing in nearly $14 in commissions. That's nothing to sneeze at.

At the end of the day, I think E*Trade and Ameritrade have seen the writing on the wall for a while now and have been focusing on drawing more of their revenue from non-commission sources. Additional pressure on commissions could be a short-term pain-point, but I doubt it will be a serious blow to either. So all I have to say is: when are my commissions coming down E*Trade?

-AvgJoe

Diamond Hill Valuation Calculator

2006-10-08T23:19:00.000-07:00

Surfing around the web looking at various mutual funds, I found the Diamond Hill website. These guys are focused on value investing, have a couple funds rated 5-stars by Morningstar, and sport a very low annual turnover rate. Poking around their website I happened on this valuation calculator. Of course, if you're looking to be a value-oriented investor you should probably keep some sort of Excel sheet or the like for doing valuations, but this seems like a nice quick little tool.

I would suggest, though, that you play around with their assumptions a little bit. Yahoo! (Nasdaq:YHOO), for instance, has some assumptions like a 35x 5-year P/E multiple and a 28% growth rate that could be a bit aggressive. Making these a little more sensible gets the valuation down well under today's market price - a result I happen to be in full agreement with.

-AvgJoe

Kicking Around Suntech

2006-09-26T20:11:00.000-07:00

Suntech Power Holdings Co. Ltd. (NYSE:STP), one of my favorite stocks if not only for it's performance as a company, but also as a great water cooler stock, is once again getting kicked around. As an Asian company in a hot/volatile industry, Suntech's stock chart is prone to looking like the ball bouncing around brick breaker (for the Blackberry fans out there).

Why is the price jumping around? Well, there are plenty of ways to speculate on this one, especially since there has been no major news on the stock. Are people getting more and more worried about the silicon shortage? Are falling oil prices weighing on the stock? Were buyers hoping for a quick pop in the price and just getting impatient? Are potential competing IPOs coming to market creating worries?

My guess is probably a little bit of all of the above. Even more so, though, I think that insiders continuing to sell off their stakes is having an impact on the stock. Due to the capital requirements to ramp Suntech to the scale that it went public at, the company raised a significant amount of money from outside venture investors. As those investors cash in on their fantastic investment, the stock has sagged a bit as the market got a bit flooded with supply. Just looking at my handy little Power E*Trade window, I noticed that on Friday another 300k+ shares were registered by an insider for sale.

Dry up some more of that supply and... well, we could see some movement northward.

In the meantime, though, I thought I'd share an article on Suntech that didn't make it up onto Yahoo! Finance. Given that this is a China based company, I think it's somewhat easy to look at it like a black box operation. I thought that this article from The Sydney Morning Herald, though, gives a pretty good background of the entrepreneur (Zhengrong Shi) behind Suntech and the vision that the company is executing on.

By way of conclusion, I'll just put a reminder here that I am a Suntech shareholder, and am not afraid to buy more if it dips back down too much lower!

-AvgJoe

Non-GAAP EPS

2006-09-15T11:23:00.000-07:00

So I'm looking at Adobe Systems (Nasdaq:ADBE) who reported their third quarter earnings last night after the close. By all accounts it looks like Adobe did well - investors certainly are happy about the results, as I write this the stock is up 11% and that's down from the 13% gain that they were sporting earlier in the day.

When I looked throught their press release, though, I keyed in on the following:

Non-GAAP diluted earnings per share, which excludes amortization of purchased intangibles, amortization of Macromedia deferred compensation, restructuring charges related to the Macromedia acquisition, a charge for incomplete technology related to a small acquisition, SFAS 123R stock-based compensation, tax differences due to the timing and deductibility of the Macromedia acquisition-related charges and SFAS 123R stock-based compensation, and investment losses, were $0.29. Adobe's third quarter non-GAAP EPS target range was $0.25 to $0.27.

Holy gibberish Batman! What the heck is going on here... Well basically the majority of the paragraph is talking about various charges related to the acquisition of Macromedia. The theory behind backing these out of the net income number is to show Adobe results on an "normalized" basis with out the extra expenses related to the acquisition.

I can also see why investment losses would be excluded since they are not really part of the business operations of Adobe. Their investment activities consist primarily of equity investments and their interest in Adobe Ventures (a VC partnership with Granite Ventures). What I will say about the investments, though, is that they're not immaterial, and investors should certainly keep an eye on whether Adobe is actually creating value through these investments or whether they should be just giving that extra cash back to shareholders.

What really interests me, though, is the adjustments for SFAS 123R. If you're not familiar with SFAS 123R, it is a FASB (Financial Accounting Standards Board) rule put in place to make sure that equity instruments (particularly stock options) are accounted for in financial statements. Why is it important that options and other equity instruments be accounted for? Because they are typically used as compensation and have a definite impact on shareholder value. Options are not free money, when a company exec exercises their options it dilutes the shareholder pool for existing shareholders.

I think about it this way: if I'm investing in a company I want to be in the know about what it costs to run the business. Whether you're paying employees in cash, stock, stock options, or Amazon.com gift certificates you've gotta pay them, and I want to know how much it's costing me as a shareholder. Personally, I prefer that employees (CEO and other execs included!) just get paid cash, I don't know that I've seen any statistical studies that have shown any extra performance from companies that grant options versus those that don't, and cash is nice and easy to account for. Besides, I want the executives of the companies I invest in to be focused on building a great business, not trying to push for short term stock price movements to make sure that their options are in the money.

What only makes the matter worse is that Wall Street analysts endorse these non-GAAP numbers that generally exclude stock option expenses. It sure is nice for companies to be able to exclude part of their compensation expenses, but if we continue to overlook option costs, we might as well just go ahead and go the whole nine:

Non-GAAP diluted earnings per share, which excludes SFAS 123R stock-based compensation, general and administrative costs, manufacturing expenses, and completed and yet-to-be-completed R&D were $8.97. MaxEPS Corp is happy to announce that on a non-GAAP basis they have achieved 100% operating margins for the eight straight quarter.

To Adobe's credit, they report GAAP earnings up front and then go into the exercise of calculating non-GAAP, but the same can't be said for everyone else out there. The use of options as part of a compensation package isn't necessarily a bad thing, but I think we still have some work to do on how to best reflect this issuance expense in financial reporting.

-AvgJoe

SeekingAlpha on Yahoo!Finance

2006-09-12T19:44:00.000-07:00

So Yahoo! has announced that it will add blogs to its Yahoo!Finance portal through blog aggregator SeekingAlpha. Guess what one of the aggregated blogs is? You guessed it, the loveable Average Joe. For those of you who have been reading the site for a while now (a while being less than or equal to the nine months that the site has now been up), you can expect more of the same from me. For those of you that are new to the site and just reading for the first time (though I have gotten some Yahoo!Finance exposure before from TheStreet.com), well, the best way I can describe what "more of the same" means is a quote from Paul Kedrosky:

"Some will carp that we're giving megaphones to nutters at virtual street corners, which is true at the margin."

Enjoy!

-AvgJoe

Sears Redux

2006-09-12T10:55:00.000-07:00

I thought I'd revisit my thoughts on Sears Holdings Corp (Nasdaq:SHLD) mainly because my post last week was a bit rushed and may have obfuscated the situation more than it illuminated it.

The main issue I was looking at was the stock buyback that the company is doing and the potential effects to the stock price. All companies have to make decisions on how to best allocate resources, and a good manager will choose the options that will provide the best return on the company's investment. A company will often determine the most efficient capital deployment by doing some variant on a discounted cash flow analysis.

By way of illustration, a company like Sears may look at the amount of money that it would cost to implement an RFID tagging system versus what it would cost to upgrade their supply chain management software. They would estimate the cost savings that each would hopefully provide over each of the next ten years or so, use a discount factor to discount the returns back to today, and figure out which choice would provide a better return on the amount of investment that it requires. The same process could be used for building out new stores or deciding whether to start a Sears brand T-Shirt line.

Of course, all of the examples above are investments back into the company to either help the company grow or make operations more efficient. Sometimes, though, a manager will see that investments back into the company may not have a return greater than the company's cost of capital (I mentioned cost of capital in my recent post on valuing a stock) and so the best use of resources is to basically give back that capital. This could take the form of repaying debt or buying back stock.

In Sears' case, they have a bunch of cash on the balance sheet that's probably collecting somewhere in the realm of 2-4% interest. Meanwhile, their equity cost of capital is likely a good deal higher than that. From an investor's perspective the cash in the bank isn't earning a satisfactory return, so if the company can't find a good way to reinvest the money in the business it might as well just give the money back to the investors.

Imagine you had an extra $1,000 in your bank account. Your bills are all paid, though you do still have a $1,500 credit card balance on your 11% APR MasterCard. What do you do with the money? If a friend comes to you and offers you in on a real estate deal he's working on that is expected to return 30%/year over the next three years you'd probably be smart to take him up on it. Otherwise, you're probably not going to throw that $1,000 into an ING savings account at 4% - you're going to (hopefully!) pay down some of that credit card balance.

So the choice for Sears to buy back stock is probably a good one. And, in fact, there are a lot of actions that Lampert is helping to bring about at Sears like this that are ensuring capital is being used most efficiently. He's also helping to extend efficiencies out to the rest of the business which is allowing it to run more profitably.

Valuation-wise, though, I think that investors have already valued in the cash that Sears has on its books and discounted the effect that a massive share buyback would have on the stock price. Sears' P/E is above that of competitors Target and Walmart despite the fact that this is a turn-around story with declining same store sales. If you were to buy back a bunch of shares using the cash on the books and the stock price stayed the same, though, the P/E would fall down to around where Target and Walmart are (in my last post I left out the fact that EPS will rise as you pare down the number of shares - this is the reason that P/E would fall). I think that there is a high likelihood that this is why Sears is sporting the valuation that it is.

In an ideal world for Sears, they continue to refocus operations, get the operation's profitability up to par, and are able to successfully compete again and get some top-line growth going to compliment their now higher margins. If this happens, I start kicking myself for selling my Sears shares. Another scenario, though, is Sears continuing to make operations and capital deployment more efficient, but also continuing to be bled of customers by Walmart, Target, Home Depot, Lowes, and the like. There is going to be a maximum point to improving profitability, and once that's hit flat-line or declining sales are going to be much more of a problem. And if they don't get a handle on their merchandise inventories as sales decline (as a SeekingAlpha reader pointed out), there could be even more problems in the meantime.

I will bow out here on Sears, as I do not consider myself much of a turn-around investor, and I'll go back to finding growth at a good value.

-AvgJoe

Valuing a Stock

2006-09-08T14:08:00.000-07:00

I got a question about this a while back so I wanted to write a little something about how I go about valuing a stock. Right up front, though, I do want to point out that my Click Commerce call that one reader pointed out (I said in a previous article that Click was worth about $22.50 and it was acquired for $22.75) is a pretty unusual outcome. The fact is that valuation is more of an art than a science. While there is definitely a lot of analytics around determining a stock's value there are also many ways to value a company and many ways to interperet certain numbers so people often come up for very different values for the same stock.

The other thing that I'd point out as far as valuation goes is that if you're really interested in figuring out what a stock is worth you better have a long term view towards investing. Investing based on value, aka "value investing" (funny how that works), calls for a lot of patience as you're basically coming up with a value for the company and then sitting back and waiting for the rest of the market to come to the same conclusion. If, on the other hand, you plan to take a shorter term approach to investing/trading, then spending a lot of time figuring out the value of a stock will often not give you a heck of a lot of return for your time.

As a quick example here, imagine you're looking at Maxim Integrated Products (Nasdaq:MXIM). They're an analog and mixed signal semiconductor company and part of the overall semi industry. Now the semi industry is one that is notorious for its cycles, and if you decide that Maxim is worth 20% more than what the market is valuing it at and we're just heading into the downswing of the cycle then you're likely going to be out of luck if you're holding period is, say, three to six months. However, taking the same situation, if you have a longer term approach it is very possible that when the next up cycle comes around Maxim could hit your valuation mark or even exceed it.

In short, as Benny Graham put it "in the short term the market is a voting maching and in the long term it's a weighing machine." So I wouldn't pin your hopes on quick riches from finding undervalued stocks.

There are actually a few postings that I've put up in the past on valuation techniques, and it probably couldn't hurt to check those out as well. They're mostly focused on using market multiples as valuation benchmarks.

Valuation Techniques
PEG Ratio
The Theory of Valuation
Price to Earnings Multiple

What I'll focus on briefly here is what I like to use a lot, and that's a discounted cash flow (DCF). Basically what a DCF does is it tracks a company's expected cash flow out into the future and then discounts the value of those cash flows back to what they're worth today and, based on that, gives you a value for a share of the stock.

As with any other valuation technique, there are definite advantages and drawbacks to the DCF. One of the reasons I really like the DCF is that it seems more analytically driven than, say, a P/E multiple. Drawbacks of the DCF include the fact that it often only seems more analytical - there are aspects of it that can be toyed around with to get to much different results.

To pull off a DCF you need the following:

1) Estimates of future cash flows - this is one of the primary reasons that a DCF can be more art than science. Estimating future cash flows for a company can be a tricky endeavour and even the very well paid Wall Street analysts are wrong much more often than they're right. I typically use free cash flow as my cash flow number which is calculated as EBIT minus taxes plus depreciation and amortization minus additions to working capital minus capital expenditures. You'll generally want to have estimated cash flows out at least ten years.

2) Discount rate - each company will have a different rate at which you will discount their cash flows and this is dependent on the company's cost of capital. I typically use a weighted average cost of capital (WACC) which averages the company's cost of equity and cost of debt based its debt / equity capitalization weightings. Good descriptions of a WACC and the capital asset pricing model (CAPM), which is used for calculating the cost of equity, can be found at Investopedia. The company's cost of debt can be found by reading through their SEC filings.

3) Share count.

4) Amount of cash and debt.

While a full walk-through of the mechanics of the DCF would take a more ambitious venue than I have here, the basic idea is that you take each year's cash flow and discount it back to what it's worth today using the discount rate and how many years out that cash flow is. Using a perpetuity growth rate, which I typically set as around the rate of inflation, you calculate an end value and add that to the sum of all the other discounted cash flows. That result is your enterprise value which you can then add to your net cash (cash minus debt) and divide by your number of shares to get to a current per-share price.

The actual equations that you use for these exercises can be found at Investopedia or other on-line resources. In some places, such as The Motley Fool, they have ready-made DCF calculators.

I welcome questions on this and will be happy to expand on the subject here if it seems like people are interested.

-AvgJoe

Slight of Hand at Sears?

2006-09-05T23:18:00.000-07:00

As I've mentioned before here, I'm a fan of Cramer. I unfortunately do not make it home most nights in time to watch his TV show, but I usually listen to his radio show Podcast on my commute home, and also will catch an article on TheStreet.com every so often. While I don't know that I agree with his investing timeframe for most individual investors and I don't tend to follow any of his suggestions because of the "Cramer Effect," I do think that he knows a lot about investing and he is very entertaining to boot.

Sometimes, though, I do disagree and tonight was one of those times. On his show I was listening to him talk through his take on Sears Holdings Corp (Nasdaq:SHLD), his largest holding for his charitable trust. On the show Cramer walked through the seemingly simple idea of how Sears, currently the third largest diversified retailer, is valued at a market cap of $24 billion versus $42 billion and $190 billion, respectively for Target Corp (NYSE:TGT) and Wal-Mart Stores Inc (NYSE:WMT), and how the company is currently buying back some of what small amount of stock is outstanding and not in the hands of Eddie Lampert (or his "friends"). At the rate that the company is buying back stock, Cramer estimated that they could retire up to half of the outstanding non-insider controlled stock (he approximated 60 million of these shares) in the next twelve months or so.

With the stock trading at $150/share, that amount of buyback action would lop a cool $4.5 billion off the market cap. Surely, Cramer argued, the company isn't worth $4.5 billion less, so the stock price will have to come up to keep the market cap around where it is now. Now I certainly may be unintentionally misconstruing Cramer's words, but will the company be worth $4.5 billion less? In a word, yes. The buyback and retiring of the stock isn't going to happen out of thin air, it's going to be bought using the cash that the company has on it's balance sheet - $3.7 billion as of the most recent 10-Q. And as cash disappears off the balance sheet, whoosh, you magically have a company that's worth less.

Certainly if revenue and profits grow the value of the company should go up, or at least stay steady as shares disappear, but getting a stock to rise consistently by simply taking out shares would be a tough trick. Think about it this way: if you look at Sears right now, it's trading at about 17.8x expected 2006 earnings. If you keep the market cap the same and pull out 30 million shares you're now looking at roughly a $188 share price - now a 22.0x multiple of '06 earnings, and for what? No additional value was created, you just retired a bunch of shares.

As we all know, stock prices are determined by supply and demand - when more people want to buy the stock than want to sell it, prices go up, and when more people want to sell than to buy it, the price falls. So when a company goes to market with an aggressive stock buyback the way Sears is, it creates greater demand for the stock and can push the price higher if there aren't enough sellers in the market. As the price starts to creep up, though, more and more holders are going to start to see the new, higher price as a nice time to make an exit. Generally, when a stock is undervalued, you'll be able to see the stock climb more before too many new sellers come into the market, while when the stock is fairly valued or overvalued, you're more likely to see new sellers come to the market quickly as the price starts to rise.

Which brings me to my last point on Sears, especially with regard to Cramer's comments. Cramer likes to concentrate on finding the "best of breed" company in each different industry - you know the Microsoft's and the Best Buy's of the world. But is Sears really best of breed? It certainly is valued like it is - while it's currently trading at 17.8x forward earnings both Target and Walmart are down around 15x. In part of his comments tonight Cramer quipped "There is more to a store than just how it looks. There are the profits, and at Sears the profits are immense." While I agree that profits are key, if the store can't continue to compete with what I consider to be better-of-breed stores like Target and Walmart it's sure going to be tough to keep those profits growing. And more to the point, it's more than likely that Sears will not be able to support a valuation much above its current level, aggressive buyback or not.

-AvgJoe

Click Commerce Goes to Illinois

2006-09-05T19:05:00.000-07:00

Funny that this should happen right after I did my little "Joe Revisited" bit, but today Illinois Tool Works Inc. (NYSE:ITW) announced that it's going to make a tender offer for the outstanding shares of Click Commerce (Nasdaq:CKCM). ITW plans to offer $22.75 per share, which would be a 27% premium to Click's closing price on Friday.

For Click shareholders this should be a nice win. Sure Click is a nice company and shows a lot of promise for the future, but at the same time it's hard to be angry about a quick 27% gain. Unless, of course, you were a buyer at Click's peak earlier this year in the high $20's or low $30's. But either way it's 27%.

For ITW shareholders I'm not quite sure what to say. It's one of those situations where if you squint hard enough you can just about see anything. For a business like ITW, who manufactures everything from metal fasteners for residential construction to reclosable packaging for consumer food to swabs used in the pharmaceutical industry, using Click's software is an obvious fit since being able to keep a close eye on inventory and supply / demand chain is crucial in a business like this. But then why not just license the software instead of paying $292 million for the whole company?

In a press release today ITW's CEO said:

“We believe Click Commerce represents a solid new growth platform for ITW. Click Commerce is well positioned to continue to expand its value-added software solutions and market presence across a wide range of industries, including several where ITW has a strong presence and where we have prospered over the years”

He also cited Click's strong financial performance over the past few years and their 128% revenue growth for FY2005.

At the end of the day it may be tough to pull off some "bigger picture" strategic fit between ITW and Click here, and the potential for Click's projected $80 million 2006 revenue to be a big growth drive for a $13 billion business is also doubtful. But ITW has gone in a number of different directions in search of creating returns for their investors including mortgage investments, telecom and aircraft leases, affordable housing partnerships for tax credits, and even a $100 million captive venture capital unit, so the purchase could amount to little more than an opportunistic purchase of a good company at a depressed price that they will run as a fully owned subsidiary in hopes that it will produce good returns for ITW's shareholders.

How this jibes with ITW's stated "80/20 process" - where they spend 80% of their time on the most important 20% of their business - I am totally lost, but with $459 million of cash on the books and an ongoing business spitting off at least that much in free cash flow on a quarterly basis I guess they have to find something to do with their shareholders' money. I probably would have said increase the dividend, but I guess that's why I'm not a public company CEO, eh?

-AvgJoe