Monday, March 31, 2008

consumer lending slows - but it's not all bad - plus, fresh cash for banks

consumer lending has slowed to a crawl, though not in all categories, and lending on the whole has actually held up fairly well.

whereas consumer loans increased $65 billion, or 8.7%, in the year ended 1/9/08, consumer loans since that time have increased just $300 million. this is according to the fed's most recent weekly report on the assets and liabilities of the nation's commercial banks, which was released late friday. these figures do not include real estate loans or home equity loans, which have faired better.

for example, real estate loans have increased at a 4.6% pace since 1/9, although that pace is slower than the 6.2% pace of the previous year. home equity loans have actually accelerated, increasing at a 13.3% pace since 1/9, an increase of several-fold over the previous year.

for bank lending on the whole, loans and leases in bank credit, a category that includes commercial and industrial loans, real estate loans, consumer loans, home equity loans and loans to securities firms via reverse-repurchase agreements, has increased at a 12.9% pace since the end of 7/07, an acceleration from the 9.8% of the previous 12 months.

switching gears, commercial banks took in $44 billion in deposits in the week ended 3/19/08, following an inflow of $82 billion the previous two weeks, bringing cumulative increases since 7/07 to $546 billion. these deposits will help give banks the capacity to make new loans. in addition to these data, data on money supply growth and the monetary base have also quickened, indicating that the fed's rate cuts are beginning to sow the seeds for a pick-up in credit expansion.

deposit balances, which include transaction deposits, certificates of deposits (CDs), and savings deposits, fund about 60% of bank assets. this obviously means that banks are very dependent upon deposits as a source of funding and banks certainly need funding these days.

big increases in bank deposits will go a long way toward helping banks handle the many assets they have been forced to absorb onto their balance sheets in recent months, making recent developments especially important. at some point, bank deposits will grow more than enough to both absorb assets and facilitate new lending.

savings deposits have grown sharply over the past decade as a source of funding for commercial banks, representing about 42% of deposits today compared to about 30% a decade ago. it is a relatively cheap source of funding and a stable one.

although the fed's interest-rate cuts might seem to threaten the growth in bank deposits, it is notable that when the fed cut interest rates substantially in 2001 through 2003, bank deposits continued to grow at a double-digit pace, a faster pace than in the several years prior. that was partly because of the increase in risk aversion that occurred following the bursting of the financial bubble, which obviously is a phenomenon that looks likely to influence bank deposits in the time ahead -- good news for capital-starved banks.

is the deficit going up? is the national debt going up?

most americans would quickly answer "Of course it is". but hold on; not so fast. my on line dictionary says:

debt |det noun • the state of owing money

…something, typically money, that is owed or due : "I paid off my debts"

the us federal debt is reported as []:$ 9,383,418,000,000 as of last week. truly a "princely sum". and why is it so high? most would say it is obvious; it is because of past (and current) government deficit spending. so it seems clear to anyone that we are rapidly increasing our national debt because we are spending more than we are collecting in taxes and from other sources (fines, import duties, etc.).

at the same time, "official" inflation is hovering around 4.28% (that is as of a month ago, the more recent figure is 4.03%) [ ]

assuming inflation hovers at around that rate for the year, what effect will it have on us?

it will reduce the "street value" of all assets at about that rate, including the dividends we collect and that cash under your mattress.

but it will also reduce the "street value" of our debts, including our home mortgage and what we owe on our cars, etc. and that applies equally to our humongous national debt.

applying the inflation rate predicted for 2008 (4.28%) to the debt ($ 9.383 trillion) says its street value will be reduced by: $ 401 billion

the us federal deficit for 2007 is reported as: the us federal budget deficit will fall for the third year running, totaling $158 billion in fiscal-year 2007" [ ]

thus the deficit is projected to be well under half the reduction in the street value of the debt, resulting in a net reduction in the real debt value of :

$401 – $158 or about $240 billion in current dollars.

dram pricing

dram contract prices have been essentially flat for the last couple of months suggesting that, despite the weak seasonal period, they may have found a bottom. today's korea times is reporting that dram manufacturers elpida and nanya have both indicated publicly that they're raising prices in april. whether or not those increases stick will be pretty much determined by samsung and hynix. given the state of the nand flash world (of which samsung and hynix are major players), i would think that every opportunity to improve profitability of a product line would be taken. it's still a week or so until we see what dram contracts look like on dramexchange, but for now i doubt they'll be going down.

Position: none, but looking at mu at a lower price

tech inventories - lean and mean

since last summer, there's been a considerable improvement in inventory throughout the supply chain, and that's been a long time coming.

inventory started to become an issue in the first half of 2006 as semiconductor companies believed they were building to demand after hearing about shortages and extended lead-times in late 2005. however, it was not until days-of-inventory from the entire supply chain hit 125 days at the end of the second quarter of 2006 that companies finally confessed in public that they had a problem. having inventory in a range of 113 to 116 days is optimal at a macro level.

unfortunately, the effort to work down inventory was not what i would call aggressive. after a drop to 121 days in the third quarter of 2006, the drain appeared to clog up for the next two quarters. the number actually spiked up again to 124 days in the second quarter of 2007.

fortunately, that dropped precipitously to 115 days in the third quarter, then to 111 days at the end of the fourth quarter of 2007. that's a level one would have to consider to be quite lean.

when i look at the two main components of that universe -- semiconductor companies and their customers -- they are in the good-to-great category. recent history suggests that right around 70 days appears to be optimal for semiconductor companies. what i call the "customers" (all those repositories for inventory on the way to the end-user, from OEMs to contract manufactures to retailers) have typically been in the 44-46 days range when the supply chain is operating well.

the semiconductor companies exited the fourth quarter at 64 days of inventory, and that is extraordinarily lean for this group, given the uncertainty generally entering the holiday production season. that's down three days from the 9/07 quarter and eight days from the fourth quarter of 2006.

over on the customer side, inventory is at 47 days, down three days from the year-ago level and one day from 9/07. this may be slightly above an 'optimal' level, but with the semi side so low, they more than balance out. furthermore, with the inventory from a handful of taiwanese players yet to be heard from, it's still likely to drop another day or so.

at this point, everything hinges on demand. there has been some weakening in the wireless handset space along with negative comments from some contract manufacturers and distributors. however, no one is suggesting that business has fallen off a cliff. if we do slide into a recession, it is readily apparent that the semiconductor industry, as a group, is probably in the best position possible from an inventory perspective.

on the flip side, if demand simply softens then picks up in the latter stages of 2008, there are certain to be shortages of parts, given the current lean levels of inventory. right now, it simply depends upon which way demand falls.

Sunday, March 30, 2008

jbl: one to watch - but wait to buy

guidance from contract manufacturing services provider jbl was a disappointment, offset not by much, it would seem, by the fact that latest-quarter results bested expectations. the stock took a dive, pushing their recent close nearly two-thirds below the 52-week high. demand is slowing in many of the markets the company serves. but the company has started to make progress in shoring up profitability, which suffered as it ramped several new products and suffered the effects of challenging pricing environments and weaker sales in mobility (wireless). and there is a sense that top-line growth will resume once we wade through most of this macroeconomic muck.

in the ems division, which accounted for two-thirds of the fiscal Q2 revenue total of $3.1 billion, top-line growth was 2%. the ems unit focuses on large customers that sell into commercial markets and that want a partner with broad technology expertise. in the latest quarter, work in the automotive sector fell 13% sequentially, while industrial, instrumentation and medical sector sales fell 3%. offsetting those declines, computing and storage sales were up a percentage point from Q1, while networking sales rose 2% and telecommunications sales were up by 26%, as the company recorded its first full quarter of revenue from a newer relationship with nokia siemens networks.

turning to the consumer division, comprising 29% of fiscal Q2 sales, seasonality hit the top line, resulting in a 29% quarter-over-quarter decline. in consumer, jbl works with customers that look for focused technological capabilities.

the remainder of the company's overall sales came from aftermarket services, which provides logistic and repair solutions.

adjusted earnings in the quarter were $0.20 per share, two pennies better than consensus then showing on reuters estimates.

but before investors could applaud the beat, management offered a dire outlook for the current quarter and the remainder of the year. revenue expectations for the second half are now 7% below the prior range, as the company expects the weakening economy to impact sales, though no customer or market share losses are to be blamed.

telecom and display have been the worst performers - with news of the former also dragging down shares of csco, a major customer - while computing and storage, in addition to the aftermarket services unit, have seen positive gains abroad. as was the case last quarter, slowing top-line growth also will pressure margins, which had improved 170 basis points to 3.6% from fiscal Q2 2007 to fiscal Q1 2008.

new business activity has been good, though, with new customer wins in telecom, medical, mobility and industrial representing another $750 million in annual revenue. and the company remains in stable enough financial condition to weather the economic downturn.

investors seem to be betting otherwise. yet, with the shares now so far off their 52-week high, the stock is now trading at a forward P/E of 11.2, which is among the lowest it's seen since 2002. growth, obviously, is slowing in the near-term, but i like that the company hasn't seen major share losses and instead can blame the decline on the economy, a trend from which it can recover relatively more easily. longer term, i continue to believe that major producers of components and devices will continue to outsource production expertise to ems players like jbl, while keeping the design tasks in-house.

i think this stock can eventually trade to the mid 20s. however, i would wait for either a clearer outlook or possibly more declines in the shares. if the shares traded down to the 7 range, on no news, i would buy it there. i'd wait for now.

disclosure: do your own DD; looking, but not buying yet

signs of liquidity starting to emerge in the credit markets

the fed's steady, albeit very tardy, campaign to improve liquidity in credit markets and changes in the regulation of fre and fmn, as well as the fhlb system have improved liquidity in us agency mortgage bonds.

yield premiums of these securities have narrowed, but some investors warn that signs of better liquidity have not changed basic fundamentals plaguing housing finance, notably a steady decline in home prices amid rising defaults and foreclosures.

signs are pointing to things normalizing a bit from sheer madness recently. it does appear that the fed's objective of shoring up the agency market has been very effective. in recent weeks portfolio managers and wall street dealers have been ambushed within a market that was viewed as among the safest havens: the agency pass-through market. it is the simplest because these securities, as their name suggests, are engineered to merely pass monthly home owner principal and interest payments through to bond holders.

securities pooling home loans with guarantees by fre and fnm saw their spreads widen in february and march to levels not seen since 1986, the very early days of the mortgage bond market. agency mortgage bonds make up some 70% of the $10.5 trillion mortgage bond market.

to the surprise of many, even bonds backed by loans with a guarantee from gnma, a hud corporation, saw their yield premiums gallop to wider levels. while there has been ongoing debate about whether the agency mortgage bonds are guaranteed by the us government, the gnma-backed bonds are seen as having the full backing of the federal government.

much of the widening in agency debt came on the heels of massive selling by investors facing margin calls and dealer firms that had seized collateral. the first rounds of selling pushed spreads wider and this in turn spurred other margin calls and forced sales.

carlyle group's carlyle capital is believed to have been one of the casualties of this spread widening and the disassembling of carlyle capital's $22 billion agency mortgage bond folio is believed to have contributed to the dramatic widening in yield premiums. what made matters worse for the us mortgage market was concern about bsc, a notable presence in the agency and non-agency mortgage debt market.

that widening in yield premiums of securities backed by fnm, fre and gnma dampened liquidity and investors found they could not readily buy or sell securities. a mortgage bond salesman with a ny dealer firm recalls that the poor liquidity was at its worst in the weeks ended 3/14/08 and 3/21/08.

the widening in yield premiums of agency mortgage bonds has been evident since the beginning of the year, but the spread widening was at its worst in mid-march. in january, spreads of fnm's 5-1/2% mortgage pass-throughs were at 85 to 90 basis points versus 10-year swaps.

by 2/08, that yield premium was at 120 basis points, and in the middle of this month the spread was at 145 basis points. last week, the yield premium had narrowed to 115 basis points.

even with spreads narrowing to the 115 basis-point-over-swaps levels, "this is still a pretty bad quarter" for mortgage securities, says Ajay Rajadhyaksha, head of us fixed income strategy at barclays capital. however, many are now saying that things have definitely improved from the levels of late february.

not only did spreads widen, the ability to readily buy and sell agency mortgage bonds was dramatically impeded. this showed up in the bid offer spreads. at the height of the illiquid conditions the bid-offer spreads were as wide as 3/32 to 4/32, compared with 1/32 or 1/64 bid-offer spreads in normal market conditions.

some of that widening in bid-offer spreads was related to a reluctance among dealers to be active market makers. on sites like minyanville, stories abounded of dealers being less willing to bid on any paper; of dealers that were unwilling to accumulate any paper.

investors generally believe that the improved conditions in the us mortgage market -- the largest credit market worldwide -- are tied to a series of moves by the fed and agency regulators rather than a single factor.

for example, on 3/19 fnm and fre's regulator temporarily eased the agencies' surplus capital requirements from 30% to 20%. then, on 3/24 the federal housing finance board allowed a temporary increase in the amount of agency mortgage debt that the federal home loan banks can purchase.

at the same time, the fed has taken steps to shore up liquidity in addition to a series of rate cuts. the central bank last summer lowered fees it charged primary dealers when they borrow from the fed under the Securities Lending Program and it has continued since then to improve conditions in credit markets.

in march alone, the fed expanded its term auction facility to $100 billion from $60 billion and introduced a term securities lending facility that offered treasury securities to primary dealers secured for 28 days by a pledge of other securities including agency mortgage bonds.

the fed's primary credit dealer facility offered overnight loans in exchange for collateral such as mortgage bonds and asset backed bonds.

ubs published a report last week stating that the fed's actions, plus its intervention in the bsc takeover by jpm, has reassured markets that it is very aware of the liquidity and counterparty risk issues that plague the market and is taking action to alleviate the situation. in other words, the moves by the fed seemingly enable wall street dealer firms to more readily make markets.

the fed's moves improve liquidity. i think it sends a signal to the capital markets that ofheo believes the real level of capital within the gse's and their financial integrity is sufficient. as yield premiums for mortgage bonds shrink, this could lower mortgage rates for home buyers and home owners looking to refinance their mortgages.

this may be occurring already, as in the 3/21 week applications jumped over 80% and refinancings accounted for over 60% of loans processed by lenders. also, sentiment has been improved by expectations that there are some investors willing to stake money in mortgage debt, notably a new venture announced last week, pennymac, that is backed by blackrock and is run by former cfc executives.

the wider spreads may have hurt many investors, but they also provided a buying opportunity for some market participants. there are reports out there that investors are adding exposure, slowly. some have started looking at non-agency mortgage bonds, specifically AAA-rated classes of debt.

one fact that must be reversed to sustain any kind of recovery in the credit markets is declining home prices, as well as a steady pace of delinquencies and foreclosures. it is certainly possible that spreads will go back out if losses at fnm and fre rise to a level that raises issues about their ability to perform on their guarantee.

if i had to make a guess, i suppose no one should expect for a recovery, a meaningful one anyway, in housing prices this year. that looks like a 2009 story. however, markets like the stock market usually start trading much better about 6 to 9 months before the "real recovery." markets anticipate, after all.

kansas and davidson

i tip my hat to davidson; they took my jayhawks to the limit and almost won. davidson's well coached and curry's the real deal. but now it's on to the final four for kansas and i certainly hope we play better against that team that's coached by that guy who used to coach us. what was his name again? anyway, here's hoping ku can put together a 2 game winning streak!!

Saturday, March 29, 2008

the long-awaited spinoff of philip morris from altria

now that cigarette companies have gained the upper hand in their U.S. legal battles, altria, the parent of philip morris, is setting free its giant overseas tobacco division, philip morris international. the long-awaited spin off, which occurred friday, is a bullish development for investors in both companies, particularly the new altria, which has room to cut costs and raise profit margins.

pm is now the world's largest publicly traded tobacco company. the company and investors feared litigants would succeed in blocking a breakup, a concern that has ebbed with the cigarette industry's victories in court and a sharp drop in individual and class-action claims against the industry.

both new altria and philip morris international have some proving to do because they have trailed key domestic and overseas rivals in recent years in profit growth. a key concern is whether marlboro, the world's top-selling cigarette brand, has lost some of its cachet, especially in western europe -- a critical market for pm. marlboro's sales volume worldwide is down about 4% in the past six years.

many altria holders may be surprised to learn that the bulk of the company's value lies in its lesser-known overseas operations. pm has a market value of more than $100 billion, operations in more than 100 countries and a 25% market share in cigarettes outside the U.S., excluding china. new mo, in contrast, is more of a yield play, sporting a 5.3% dividend yield, versus 3.5% for its international cousin.

look for mo to do better than its own guidance of a 9% to 11% increase in 2008 eps, as it can do better through a combination of price increases, cost reductions and stock buybacks. tobacco investors like cost-cutting stories, citing the strong showing in recent years of reynolds american, the number 2 us cigarette producer with such brands as camel, winston and salem.

facing limited growth opportunities in the us, where cigarette consumption is declining at a 3% to 4% annual rate, new mo is apt to focus on returning cash to shareholders through dividends and stock buybacks. it aims to pay out 75% of its earnings in dividends.

the biggest prize market remains china, now controlled by a state-run monopoly and all but closed to western companies. but pm is on the verge of bringing marlboro to china, which has estimated annual cigarette sales of $100 billion, versus $70 billion in this country.

the teams at mo and pm have to be feeling a sense of release, as they met with investors without a lawyer being present for the first time in years. cigarette-related litigation is rare overseas, where people tend to have a more tolerant view of smoking.

mo bulls argue the domestic cigarette market, while declining, is still attractive. cigarette prices in the us, now about $4 a pack for marlboro and other premium brands, are below prices in much of europe, where a pack can cost $9 in britain or $7 in france. warning labels here are tamer than in the uk, where messages like "Smoking Kills" must occupy 30% of the surface area of a pack. new american smokers show a strong preference for marlboro, which controls 41% of the us market, ahead of the next 10 brands combined.

pm acknowledges it has been slow with innovations, including "light" and flavored cigarettes, and aims to bolster its presence in the developing world. rival bti, maker of pall mall and kent, is particularly strong in emerging economies, notably latin america.

i believe the bottom line is with strong brands, ample payouts and cost-cutting targets, altria and pm could wow investors.

most likely the street is underestimating an independent pm, which aims to generate 12% to 14% growth in earnings per share this year and 10% to 12% annual profit growth thereafter. it plans to pay out 65% of profits in dividends and buy back $13 billion of stock in the next two years.

both mo and pm will have strong balance sheets, with modest debt and huge annual cash flow. mo's stake in SABMiller, now worth $9 billion, or more than $4 per mo share, could be monetized in coming years. the company will pay a hefty $1.16 a share in annual dividends, and aims to buy back $7.5 billion of stock in the next two years. mo also has an ambitious cost-reduction program that already has yielded $300 million in annual savings and could deliver another $700 million by 2010.

altria's never been lean; for instance, it long had a global headquarters in manhattan; the building will be sold for a $400 million profit. new mo will be based in richmond, va., the home of philip morris usa. pm will have a small new york headquarters, but be run out of lausanne, switzerland.

mo has lots of room to lift its profit margins. philip morris usa's profit per pack is about 51 cents, versus 73 cents for lorillard and 40 cents for reynolds. it's hard to understand why philip morris lags, since marlboro is five times the size of newport, which ought to give the company significant economies of scale. philip morris long was burdened by a higher cost structure, including greater legal payments and regulatory obligations. now, however, legal expenses are down to about $200 million a year from a peak of $400 million.

philip morris is moving into related businesses like moist, smokeless tobacco, with a test of marlboro moist in atlanta. the growing smokeless market is led by ust, maker of skoal and copenhagen. the marlboro test has been deemed ok, not great, by the street, prompting talk mo might buy ust, now valued at $8 billion. but mo seems intent on building the business, not buying one, and there are few big potential acquisition targets beyond ust.

both mo and pm are eager to show they will thrive as independent companies. given their strong brands and cash flow, cost-cutting opportunities and determined management teams, that looks like a good bet.

disclosure: none, but looking

some thoughts that came to mind

since electricity is generated mostly by burning coal, has anyone calculated how much pollution is created by electric cars, even though none of that pollution comes out of their tailpipes?

the next time somebody in the media denies that there is media bias, ask how they explain the fact that there are at least a hundred stories about the shrinking arctic ice cap for every one about the expanding antarctic ice cap, which has now grown to record size.

teaching is very easy if you don't care about doing it right and very hard if you do.

when there are people with multiple convictions for child molestation, what does that say about what wimps we have become that we cannot bring ourselves to put people away, even when they are a continuing danger to children?

the british television documentary, "The Great Global Warming Swindle" is available on dvd. will those schools that forced their students to watch gore's idiotic movie, "An Inconvenient Truth" also show them the other side?

of the presidential candidates in both parties, barack obama is the best performer on stage. he has the most presence, the most command of his words, the most quietly dramatic style. what he actually says, however, is mostly warmed-over 1960s ideas that have been failing ever since.

one of the painful signs of years of dumbed-down education is how many people are unable to make a coherent argument. they can vent their emotions, question other people's motives, make bold assertions, repeat slogans — anything except reason.

people who lament the small percentages of women in some high-end jobs seem unaware that top jobs often involve 70 or 80 hours of work per week. a mother may work that many hours at home taking care of a family, without adding the same number of hours at the office.

a recent study showed the median income of major corporate CEOs to be about $8 million a year. that's less than a third of what a-rod earns and less than one-thirtieth of what oprah makes. but no one is denouncing them for "greed."

it's amazing how many people who want us to get out of iraq want us to go into darfur.

despite people who speak glibly of "earlier and simpler times," all that makes earlier times seem simpler is our ignorance of their complexities.

whenever i hear terrorists referred to in the media as "militants," it is a painful reminder that we have degenerated to the point where we no longer even have the courage to talk straight.

does anybody seriously believe that "hate speech" prohibitions will be applied to muslims demonizing jews, to blacks demonizing whites, or to women demonizing men?

many people who have never held a firearm in their hands are nevertheless convinced that the police fired too many shots in a confrontation with a criminal.

many people who have never run one business for one day are nevertheless confident that they know corporate CEOs are not worth as much as they are paid.

sometimes it seems as if everybody is trying to rip off his own little piece of america, until we are all torn apart.

too many people in positions of responsibility act as if these are just positions of opportunity — for themselves. the ones who simply steal money probably do less harm than teachers who propagandize their students, media who slant the news or politicians who sell out their country's interests in order to get re-elected.

the home run records that made babe ruth famous have been broken but one of his records will probably never be broken — pitching the longest shutout in world series history, 14 innings. few pitchers go even 9 innings these days.

a review of one of the many environmentalist books says that even if you can't do all you would like toward "living green," you can at least "congratulate yourself on taking small steps to improve the planet." is that what environmentalism — the movement - is really all about, self congratulation?

in his book "Income and Wealth," economist alan reynolds says that people often form "strong opinions" based on "weak statistics." unfortunately, that is also true of a wide range of other issues, from "global warming" to "gender bias."

amid all the media hysteria over the price of gasoline and the profits of "Big Oil," one simple fact has been repeatedly overlooked: the oil companies' earnings are just under 10% of the price of a gallon of gas, while taxes take 17%. yet who ever accuses the government of "greed"?

despite political spin about "tax cuts for the rich," cuts in tax rates have led to increases in tax revenues — not only in this administration, but in the reagan administration before that, and the kennedy administration before that, not to mention in india and iceland as well.

more on the abolition of the uptick rule

the abolishment of the uptick rule is ok except for two major developments in the last five years:

1. the dominance of automated trading programs, and
2. the loss of market markers and specialists as middlemen committed to stability and liquidity.

if you told me ten years ago that 2008 would bring the most illiquid markets in a decade, i'd have said you were crazy, but that's exactly what we're facing these days.

there is absolutely no center of gravity in the ticker tape. the failure lies at the sec, which has issued no viable order flow guidelines on black boxes, dark pools and all the other electronic jazz thats pushed the market to the edges of a black swan nightmare.

the savings rate in this country

for the year ending with 2007 Q4, household net worth increased by 3.4% or $1.9 trillion. if one looks only at financial net worth (throwing out houses as assets but counting the mortgages) the increase was over 4%. the us has over $31 trillion in financial savings, more than the rest of the world combined. (latest available data from a recent report by david malpass).

of all government statistics, the measurement of the savings rate is probably the worst. any time one borrows money to buy an asset the loan counts and the asset does not.

the totals conceal the distribution, of course. there is no "consumer" but rather a distribution of consumers.

Friday, March 28, 2008

thoughts on the abolition of the uptick rule

as long as we have markets, we will have those who engage in nefarious activities - in both directions. have any short-sellers or practitioners of "bear raids" ever engaged in anything as massive as:

1. the fed's pre-opening announcements at various parlous points over the past eight months;

2. the fed's 10/98 surprise rate cut just before options expiration and after futures trading in bonds closed;

3. the entire dot-com pump-and-dump era;

4. the subprime mortgage era, etc?

also, if the uptick rule is necessary for stock markets to function, why do other countries' markets seem to do fine without them? only japan has underperformed the united states for this millennium.

third, when markets self-organize, as has been the case in cash interest rate, currency and commodity markets, do they have an uptick rule? no; that would obscure price discovery, risk transfer and the facilitation of commerce.

fourth, where is the statistical evidence an uptick rule leads to statistically different results over any selected period of time? you can maneuver the price up or down over a very short period of time, but you cannot maintain it there.

fifth, corporations trading their own stock have a tax advantage under Sec. 1031 of the internal revenue code that you and i do not have. and if the executives of these firms' compensation is tied to the stock price, do you think they will be disinterested parties?

sixth, stocks are classified as a risky asset for a reason: they are risky! trying to put sheep's clothing on these wolves is pointless. at the end of the day, all a stock is is a piece of paper with someone's picture on it. they can and do go "poof" with very little warning.

william tecumseh sherman said it best, "War is cruelty, and you cannot refine it." so are investing and trading. trying to bias the game in your favor on a tick-by-tick basis while ignoring the long-term consequences of the massive structural biases that have contributed to the bubbles we have suffered from twice in the past eight years is both intellectually dishonest and personally self-destructive.

and just so there are no misunderstandings, i have never shorted a stock in my life and realized a long time ago that buying index puts was a mug's game at best.

revisiting what needs to be done to end the credit 'panic'

the increasingly lame current administration must take two steps immediately to quickly halt the unending, enervating credit crisis: shore up the anemic dollar and, for the time being, suspend "marking to market" those new financial instruments, such as packages of subprime mortgages.

the weak dollar is pummeling equities, disrupting the economy, distorting global trade and giving hundreds of billions of dollars in windfall revenues--through skyrocketing commodity prices--to our adversaries such as iran and venezuela. not since the carter administration has the us had a president so oblivious to the damage done by an increasingly feeble greenback.

the fed can rally the markets for a day or two by finding some new mechanism through which to lend more money to banks and other financial institutions. the administration acts as if the dollar were like the sun, its rising and falling beyond any control. countless times experience has shown that notion to be false. the us treasury department could buy dollars in the currency exchange markets. our allies lies would gladly cooperate with such an operation; their exports are being hurt more and more. the fed could even mop up some of the excess liquidity it has created since 2004, even as it makes targeted loans to beleaguered banks and financial houses.

the other measure: the treasury department and the fed should get together with the sec, the occ and other bank regulators and announce that financial institutions for the next 12 months will no longer write down the value of exotic financial instruments (primarily packages of subprime mortgages). instead, writedowns will occur only when there have been actual losses on those assets. if a mortgage defaults, a bank will then--and only then--recognize the loss.

it's preposterous to try to guess what these new instruments are worth in a time of panic. such assets are being marked down to increasingly arbitrary low levels. but when a bank books such a loss, it must replenish depleted capital, even though cash flows for most financial firms are still positive. worse, when forced by panicky regulators and lawsuit-fearing accountants to write down the value of these securities, institutions will dump assets in a market where there are temporarily few or no buyers. the result is a spiraling disaster. so let's have a time-out on markdowns until we actually have real experience in what kind of losses are actually going to occur.

these two steps would quickly end the panic.

Thursday, March 27, 2008

fed auction thing goes well

the fed helped to liquefy $75 billion in securities today by offering that amount of its $650 billion of treasury holdings to the nation's 20 primary dealers in exchange for so-called schedule 2 collateral, which includes agency collateralized mortgage obligations, AAA/Aaa-rated private-label residential mortgage-backed securities, AAA/Aaa-rated commercial mortgage-backed securities, as well as collateral eligible for the tri-party repurchase agreements that are arranged regularly in the fed's daily open market operations.

by obtaining treasuries in exchange for such collateral, dealers can then put the securities out on repo, which is to say that dealers can then exchange the treasuries for cash with any willing counterparty, of which there are many more than for the other types of collateral, as bsc obviously learned recently.

the urgency to participate in today's operation on the surface does not appear to have been all that strong. in other words, dealers did not show any signs of being desperate to liquefy collateral much beyond what was available, as evidenced by the bid/cover ratio of 1.15. in addition, the fee rate paid by dealers for the lending service was just 0.33%, or 8 basis points, above the minimum. the premium appears to reflect normal gaming of the auction and not much else.

additional info on the street's urgency to swap collateral for treasuries will be apparent in today's release of money supply data, which will include a figure on the fed's new primary dealer credit facility, which was the facility used in the bsc deal.

the amount of new borrowing that will appear in today's data is expected to be small, similar to the increase in discount-window borrowing that occurred in the aftermath of the fed's cut in the discount rate last august. only a few dealers likely tapped the window, with the tally no more than in the low billions at most.

this first go-around indicates that the fed may not need to auction all of the $200 billion in securities it has allotted for the TSLF.

a long idea - ep

one company i'd like to buy asap is ep - it is part natural gas exploration and part the largest natural pipeline network in the country. but at about 16, neither one of these businesses is getting much credit; and neither is ceo douglas foshee, who came in and helped save the company in 2003, two years after its energy trading and power generation businesses collapsed.

well, foshee stepped in and bought 50,000 shares of ep in the open market yesterday, according to an SEC filing this morning. this is just one more reason to like a stock that already has a lot of catalysts.

earlier this week, the company closed the sale of some of its lower-margin natural gas reserves. the 650 million of proceeds will help pay down debt that ep accrued to buy another exploration business, Peoples Energy Production, last fall.

and while the company is probably best known for its pipelines, its e and p division is also firing on all cylinders. earnings before interest and taxes (EBIT) grew 92% year over year in the fourth quarter. ep generates consistent double-digit revenue growth in this area, and its cash operating costs are declining. about two-thirds of its 2008 production is also hedged between $8 and $10 per million cubic feet.

in addition to taking natural gas out of the ground, the company's core competency is shipping the energy where it needs to go. on this front, ep already has firm customer commitments to invest $4 billion to expand its pipeline network. this side of the business is also the foundation for the company's solid cash flow, generating about 60% of total EBIT.

overall, i expect that the company can trade up through $20 over the next several quarters, led by growth in both of its divisions.

disclosure - do your own DD! i'm looking to buy asap

Wednesday, March 26, 2008

a speculative long - clwr

clwr, started by legendary wireless pioneer craig mccaw, provides mobile, wireless broadband service to residential and small business customers in 16 us states, mexico and europe (ireland, belgium, spain, denmark). they cover 50 markets, including 400 cities & towns. the company has about 394,000 subscribers and a 12 month growth rate of about 91%. the company owns 2.5ghz licenses in the us and mexico; and 3.5ghz spectrum in europe, covering 16.3 million potential customers. major investors include the officers and directors, intel, eagle river, motorola, bell canada and qb wireless.

clwr is still talking, purportedly in an advanced state, with s, in hopes of piecing together a wimax partnership. last summer, the two companies reached a tentative agreement to build a national wireless broadband communications network, utilizing advanced Worldwide Interoperability for Microwave Access technology. the complex pact fell apart, however, when sprint became distracted with mounting operating problems within its own wireless division. sprint has hired new top managers, and its strategic focus is solidifying. a revised clwr/s partnership appears likely. the process is taking some time. apparently, clwr investors intc, mot and bell canada are weighing in on the negotiations. a weakening domestic economy, affecting all these players, is also probably slowing things down a bit.

meanwhile, clwr is expanding its existing network. in 2008, clwr plans to establish the new WiMAX broadband service, on its own, in the four us cities of atlanta, grand rapids, las vegas and portland (wa). these markets should initially add six million covered potential customers (POPs). in all, clwr plans to lift covered POPs by 20 million to 22 million in 2008; global POPs were 16.3 million, across 50 markets, at the end of 2007. the costs associated with this buildout will weigh heavily on consolidated margins this year and next, but should pay off handsomely in the long run. currently, the company is seeing favorable operating income benefits in established markets as they grow in scale. access to capital markets is very difficult, and management's success in finding new funds will determine how fast the company expands in the coming quarters. recently, the company has stepped up attention on cash flow generation.

this is a volatile stock. a new pact with s would go a long way toward supporting projections for wide share-price appreciation potential to 2011-2013. right now the market is punishing tech names with beta every day. if a market returns that starts to reward risk-taking, then owning clwr will most likely become much more lucrative. longer term, clwr will be a battle of growth expectations, new market opportunities and the need for future funding requirements and how and who they partner with. so that's a number of moving parts to consider. if the big partners like the MSO's, intc and goog can foot a lot of the bill that is much more beneficial to clwr than a string of secondary issuances. on their conference call less than a month ago, clwr ceo ben wolff noted the original discussions with s didn't maximize the full potential of the opportunity before them. he left investors dangling with the following quote, "we hope to be able to have something more definitive to discuss with you soon." the stock was pole-axed when the original s deal fell apart. if the deal as described in today's wsj is accurate, this looks to be exactly what is needed to achieve the "full potential." i'm expecting clwr to trade to between 30 and 40 by the 2010/2011 timeframe.

disclosure: long clwr leaps; looking at buying more

long idea - exm

exm is a greek dry-bulk shipping company, and its global seaborne transportation fleet transports dry bulk commodities such as iron ore, coal, grains, bauxite, fertilizers and steel products. exm currently has 18 vessels with more than 1 million deadweight tons (DWT) of shipping capacity, but will soon see that capacity more than triple to 3.7 million DWT when its upcoming marriage to Quintana Maritime is finalized. the merger will expand the company's fleet to 47 vessels and the union is expected to be completed next month.

last week, exm reported blowout fourth-quarter numbers as its revenue and profits catapulted on a jump in time charter rates. revenue from operations rose 73% to $60.9 million, compared to $35.2 million during Q4 2006. during the quarter, the dry bulk shipper saw its utilization rates improve to 97%, from 93%, and its average charter rate rose to $38,539 a day from $20,849 a year ago. the jump in daily charter rates is quite impressive considering that exm only had 22% of its available days exposed to the dry bulk shipping spot market.

in addition, earnings for the quarter came in at $34.1 million, or $1.71 per share, compared with $9.3 million, or $0.41, for the same period in 2006. the company also reported full year 2007 earnings of $3.94 per share, excluding a $6.2 million gain related to vessel sales, versus 2006 operating eps of $1.61. during 2007, revenue from operations increased 43% to $177.5 million.

chairman and acting ceo gabriel panayotides commented on their best ever operational and financial results: “We believe this is a direct result of our proactive fleet deployment strategy according to which we seek to secure the majority of our vessels under long term time charters, enhancing our operating cash flow visibility, while at the same time also maintaining exposure to the spot market with the remainder of our fleet, which allows us to take advantage of continued strength in the shipping market…Our overall objective over the past few years has been the disciplined approach of expanding our asset base. The recent announcement of the potential Quintana acquisition signifies an important step towards achieving our goal of becoming one of the world's premier full service dry bulk shipping companies, with a diverse and modern asset base from Handymax to Capesize vessels. The proposed merger would increase our flexibility and our ability to service our customers' needs. In addition, we believe that the combination of the two entities will create one of the most experienced management teams in dry bulk sector."

given the continued strong global demand for dry bulk commodities, especially from china and india, the increased length of shipping routes and the high levels of congestion within some global ports, such as australia, i continue to maintain a positive outlook for the dry bulk shipping sector, acknowledging the wild gyrations of the industry’s spot market rates. i find exm attractive at the current price, as they balance the potential boost the spot markets can provide with the steadiness of longer-term fixed-price contracts. exm currently has 61% and 15%, respectively, of its fleet operating days fixed for 2008 and 2009.

it is also worth considering that potentially up to 30% of the world’s fleet, based on tonnage, could be retired in the coming years and shipyard capacity is reported to be very limited until 2011. this effectively could limit the new intermediate supply of dead weight tonnage capacity to meet the rapidly expanding global demand. with the share price down from a 52-week high of $81.99 to now trade for just 4 times the current consensus 2008 earnings estimate of $6.82 and with reuters estimates forecasting eps of $7.51 for 2009, i think exm is very attractively priced. throw in a 2.8% dividend yield and i would seriously consider adding exm to a broadly diversified portfolio up to 35. i wouldn't be surprised to see it trade to the 60 to 70 area over the next several years.

disclosure: none, seriously looking though

Tuesday, March 25, 2008

lost in the shuffle?

has anyone else noticed how light preannouncement season has been so far? should non-financial profit growth come in around current expectations of 13%, one would expect a decent market environment for the companies with strong fundamentals.

to me that means down and cheap stocks in the industrial, tech, material, energy, and soft consumer space can be considered. now might not be a bad time to do some homework and selective bottom fishing in the laggard department.

jpm and bsc

so jpm ups their bid for bsc by 5x to about 10; many sources have been cited stating they originally were willing to offer 15 to 20, so i'm sure dimon's still quite pleased. so for a billion or so, jpm gets bsc; here's a rough estimate of what i think the breakup value of bsc's continuing businesses are:

prime brokerage 3 billion
merchant banking 1.3 billion
asset management 1.3 billion
high net worth brokerage 1 billion
servicing .6 billion
energy assets .5 billion

total 7.7 billion

still a wonderful deal for jpm, in my opinion.

disclosure: long jpm

banks get about $50 billion

commercial banks took in $47.2 billion in deposits in the week ended 3/12/08 following an inflow of $43.3 billion the previous week, bringing cumulative increases since 7/07 to $510 billion. these deposits will help give banks the capacity to make new loans.

deposit balances, which include transaction deposits, certificates of deposits (CDs), and savings deposits, fund about 60% of bank assets. this of course means that banks are very dependent upon deposits as a source of funding and banks certainly need funding these days.

big increases in bank deposits will go a long way toward helping banks handle the many assets they have been forced to absorb onto their balance sheets in recent months, making recent developments especially important. at some point, bank deposits will grow more than enough to both absorb assets and facilitate new lending.

savings deposits have grown sharply over the past decade as a source of funding for commercial banks, representing about 42% of deposits today compared to about 30% a decade ago. it is a relatively cheap source of funding and a stable one. although the fed's interest rate cuts might seem to threaten the growth in bank deposits, it is notable that when the fed cut interest rates substantially in 2001 through 2003, bank deposits continued to grow at a double-digit pace, a faster pace than in the several years prior. that was partly because of the increase in risk aversion that occurred following the bursting of the financial bubble, which obviously is a phenomenon that looks likely to influence bank deposits in the time ahead -- good news for capital-starved banks.

Monday, March 24, 2008

the bizarre case of biovail: the truck accident that won't go away

the sec said monday that it charged canadian drug maker bvf and four current and former executives, including former ceo eugene melnyk, with a series of fraudulent accounting schemes and lying to investors and analysts.

the bvf fraud allegedly includes a 10/03 incident where bvf intentionally and falsely attributed nearly half of its failure to meeting third quarter 2003 earnings guidance to a truck accident involving a shipment of bvf's antidepressant, wellbutrin xl, according to the sec complaint.

it turns out bvf lied about the value of the wellbutrin xl on board the truck. bvf's estimate: $10-20 million. other, more independent estimates: $2-4 million.

today, the sec said, at most, there was $5 million of the drug on the truck, and that "Biovail intentionally misstated both the effect of the accident on Biovail's third quarter earnings as well as the value of the product involved in the truck accident. The accident, in fact had no effect on third quarter earnings."

another entry in the long history of accounting scams and fraudulent schemes.

some semi's to look at

semiconductor stocks have taken quite a tumble since peaking in early 2007, with many names losing half their value or more in reaction to issues ranging from the collapse in memory prices to the general slowdown in momentum names. with that in mind, i believe now is a good time to look aggressively for sector names that can be picked up on the cheap.

the first name on my list is flash memory heavyweight sndk, which has tumbled from a high of $79.80 in 1/06 all the way to a present quote around 20. while demand for flash continues to grow significantly, pricing has deteriorated at an astounding rate. so while sndk's profitability hasn't evaporated in the same way it has for DRAM memory names such as mu and qi, sentiment toward the stock is fairly negative. according to capital iq, just eight of the 19 analysts covering sndk rate it a buy, and it trades at just 12 times expected full-year earnings.

in addition, sndk has a strong balance sheet with nearly $1.7 billion in net cash, accounting for about one-third of its market cap, which could serve to help limit downside in the stock. i'd look for sndk to trade below 20 before considering taking a position in the stock.

the second company i think is worth looking at is athr, which specializes in wireless communication chips used in products such as notebook PCs, wireless routers, video-game devices and mobile phones. like sndk, athr is a former highflier, once trading as high as $35.80 late last year. since then, the company has sold off along with other momentum names, in addition to concerns over its first-quarter 2008 results. however, given the secular growth of wireless technology worldwide, as well as its potential as a takeover target for companies like brcm and qcom, i believe the stock is worth looking at when it also trades below $20.

like sndk, athr is a fairly cheap stock, trading at just 17 times expected-full year earnings. it also has a healthy balance sheet with $250 million in cash and investments. however, as with sndk, i'd be patient in looking for an entry point with athr.

the third name is nvda, which specializes in making graphics chips used in PCs, video-game consoles, mobile phones and other products. despite persistent market-share gains against chief rival amd and a string of impressive quarterly earnings reports, the highs reached by nvda's stock have been cut in half. that's due to concerns that the PC cycle is peaking, and that its market-share gains could end soon.

however, at just 12 times expected 2008 earnings, i believe these concerns are more or less already reflected in the stock -- especially considering there aren't many signs that the financially challenged amd is ready to stage a comeback. to further tilt the odds in our favor, i'd look for shares to move into the $16 to $18 range before considering a position in nvda.

disclosure: none, just looking right now

a long idea - lphi

the market for buying and selling life insurance policies is growing, and not just by going to your local aig office for a new term policy. more people are deciding to monetize their policy’s value while they are still alive, selling the right to the payout upon their death for its net present value and skipping paying month after month of the premiums. buyers include closed-end funds, special purpose entities and sophisticated investors looking to earn a rate of return that is uncorrelated with traditional stocks and bonds. the market isn’t widely tracked so estimates for the face value of policies changing hands in 2006 range from $6 billion $15 billion, but the range is unequivocally higher than the 2005 total. i'm looking at lphi, the oldest and one of the largest intermediaries in the business.

financial and estate planning professionals seek out lphi for their clients and receive a referral fee when the company matches the seller with a willing buyer from its worldwide client rolodex of over 18,000 accredited and institutional investors. according to one research firm, the company has completed over 50,000 transactions in connection with 5,700 policies since incorporating in 1991. in the most recent quarter, the number of settlements totaled 52, eight fewer than in the same quarter a year ago, but thanks to a tripling of the transaction’s face value, the company’s revenue was up better than threefold. yet to take effect are agreements made in 9/07 and 10/07 with german financial conglomerate WestLB and with another closed-end life settlement fund through an exclusive agreement.

life policy transactions are consummated through an escrow account with the purchaser continuing to pay the premiums through the escrow agent to protect the seller’s personal information. lphi is responsible for monitoring the insured individual’s health status (much more palatable than if the policy buyer knew the identity of the person they were waiting on to pass on) but there are still many who consider it to be an unsavory industry. so far, 36 states have adopted common laws allowing and regulating the life settlement industry but some still require separate qualification. in addition, lphi's largest competitor is being investigated by the new york attorney general, so this stock is not for those of weak stomach.

nevertheless, acting as a facilitator in this burgeoning industry could pay off handsomely in the long run. a complement to an attractive growth story, the company has an inexpensive valuation, something that always piques my interest. now trading for about 10 times what the company earned over the last 12 months as the stock has sold off from $42 in september, i would seriously consider buying up to $16.00, as it seems reasonable this could eventually trade to 27 to 32 in a better environment. with a strong, cash-flow positive business, the company in january announced plans to use its growing capital surplus to buyback up to one million shares and the stock sports a dividend yield of 1.6%.

disclosure: none, just looking right now

credit spreads tighter

credit spreads continue to tighten today, as evidenced by the yield spread between fnm's 10-year notes and 10-year treasuries, which today is at 62.5 basis points, down 5.3 basis points on the day and well below the peak of 97.7 basis points on 3/14. the 10-year swap spread is down 0.5 basis points to 61.5 basis points - this is higher than last week's low of 59.8 basis points (on wednesday), but still much lower than the recent peak of 91.3 basis points (on 3/6/08). moreover, in the context of the 15-basis-point rise in the yield on 10-year treasuries, the steadiness in swap rates at lower levels is encouraging.

large declines in swap spreads that occurred the past two times in 8/07 and 11/07 coincided with increases of about 1,000 points in the djia, an idea that has been largely fulfilled yet again. as for corporate bonds, data at thursday's close indicate that Baa-rated corporate bonds yielded 6.76%, down 6 basis points on the day and 23 basis points below the 3/11/08 peak.

a rally in financials would really get us going

when the financials lead, much can follow. if they are doing well you can buy companies that need credit, you can buy goods makers that thrive when people get credit. one can even buy retail stocks.

and, most important, one can buy long-dated asset stocks, stocks that are growth stocks that will pay dividends down the road, because when the financials rally, that means the market "thinks" there is less inflation in the future.

if jpm is being bought, then one can buy companies like emc and ibm that sell into the financials. because jpm is a big credit card company, you can buy axp, cof and ge. one can also buy companies that are related to housing, like mas.

also, companies that could be takeovers by europeans can also be bought. possibly the dollar has bottomed. but most particularly the growth stocks - think pg - get a real boost because we now see that inflation will not erode the value of that dividend stream.

financial leadership is the best for what it signals, which is why the rally can be so powerful.

Friday, March 21, 2008

has the bottom been reached?

in spite of the gs and leh news on this market off-day - s and p is lowering its outlook on both - it's entirely possible we've seen the bottom in this market for quite some time.

yes, business is slowing in the us. that's what stocks have been saying for months. we are in a bear market, after all. so that's why it's time to start thinking about better times if you're a long.

in a remarkably swift move, the oil/gas/agriculture/infrastructure was taken apart. the rally in fnm and fre cannot be overemphasized in my opinion. and last week, mortgage rates finally went under 6% again. they really belong at 4% and change, and that would start the housing cycle once and for all. when you get fha guarantees and lower rates and fewer homes built, and a peak in resets, you get a bottom.

all of this is to say that when everyone acknowledges that we are in a tough recession, stocks reflect those prices and they reflect an endless recession just as they reflected an endless expansion not that long ago.

it is true that bear markets last a few months more than this, but anyone who saw a multimonth move happen in three days to the commodity markets has to think that we could be in for a slightly shorter bear market (even as it seems inconceivable that the bear market could ever end when the numbers just turned bad).

in my opinion, there is no doubt much of this recession was created by the sheer incompetence of this presidency and its minions: everyone from a fed chief who failed to understand the yield curve or the fragility of the banking system, to a treasury secretary who drank the "fundamentals are sound" potion, to a president that cared more about destroying fnm and fre because of their long-standing ties to the other party and their violation of the laissez-faire market doctrine that this administration has pursued. when one layers in a presidentially-mandated food inflation -- do you think this president has ever gone to the grocery store? -- you know that our own incompetence created much of this recession.

but with the bsc collapse and the need to scrap the laissez-faire policies, which were so one-trick (cut taxes), you have to leave open the possibility that things can get better out there. and i think that's what the rally this week was about.

looks like a floor's been set.

Thursday, March 20, 2008

musings - fnm, c, bac, jpm, etc.

so this is the week that the white house finally gave up its fight to destroy fnm and fre. the white house/treasury relented, and fnm, trading at about 20 or so just a short while ago, now trades in the 30s.

the fed finally got serious with its plan to allow banks other than commercial banks to use its discount window. things may finally start to thaw out on trading desks everywhere. even at c! witness gs traded sharply higher to about 180 and c goes from about 18 to 22. not very surprising.

getting to the end of this month, when the new fed auction thing starts on 3/27, is key to avoiding some nasty stuff. it's what i've been predicting, and positioned myself for accordingly. hope it continues.

all of this can only benefit bac with its cfc purchase and jpm, with its bsc gift. it's astonishing to me all of this trouble and pain has been caused by about 300,000 foreclosures here in the u.s.

long fnm, c, gs, bac, jpm

more late-day fed moves

awhile ago, the fed expanded the types of collateral it would be willing to accept at the $200 billion term securities lending facility (tslf) it announced on 3/11. at the same time, the fed announced that the first auction for a loan of treasury securities will total $75 billion.

in today's announcement, the fed said it would also accept agency collateralized-mortgage obligations (CMOs) and commercial mortgage-backed securities. this is in addition to federal agency debt, federal agency residential-mortgage-backed securities (MBS), and non-agency AAA/Aaa-rated private-label residential MBS. the decision was made after consultation with the dealer community.

the timing of the announcement is curious, to say the least. it came late in the afternoon on the final trading day of the week--when the market is up no less. the fed may not have had an eye towards market reaction, but it's a clear positive as it has inflicted a bit more pain on the short base and forewarned speculators that anytime, anywhere the fed might take action that works against spec shorts.

the best time for intervention of this sort is when the market is already moving in the desired direction. it is the same in the foreign exchange market where the worst time for intervention is when the targeted currency is at its lowest levels.

Wednesday, March 19, 2008

credit spreads tighter

swap spreads, which measure the difference between swap rates and treasury rates, have tightened considerably following their third run-up since the credit crisis broke in the summer and the last two times this happened, the dow gained about 1,000 points. so far, so good on this front, in light of the dow's gain of almost 700 points off of monday's low.

credit spreads are tighter again today, as evidenced in part by the 10-year swap spread, which is trading at 59.75 basis points, down 2.75 basis points on the day. two weeks ago the spread was at 91.3 basis points, which was the highest level since the beginning of the 2001 recession.

high levels on the swap spread indicate that debtors are worried about credit spreads, compelling them to swap out of floating-rate obligations into fixed-rate obligations. hence, the decline in swap rates that has occurred of late indicates that debtors (and speculators) are betting on a decline in the cost of capital, which tends to be good news for equities.

interesting times for nvt

nvt is supposed to be purchased in an all-cash deal by nok some time in the next few months. the market, however, obviously has doubts about the transaction, as the stock's at about 66 now. the deal looks to have antitrust concerns in the eu. and today nok seemingly declined to submit any remedies to dispel those supposed antitrust concerns.

i think this is a very attractive entry point in nvt shares for a bit of arbitrage action. amtech thinks the shares could stay under pressure, and they might be correct. it should be noted that there has been some exceptional put activity on nvt with the march 65 puts. however, i like the situation here 12 dollars under the deal price and am going to try to raise some $$ to buy some longer-dated call options with a strike at 75.

what i think happens is the deal goes through at 78 or nok walks away completely. i believe nvt as a stand-alone company could be worth as much as $90 right now. as an aside, i also think nok/nvt falling apart would be a positive for grmn, as this would push the perceived threat from handset navigation out.

in regard to the antitrust concerns, the eu has problems with the tomtom/teleatlas deal, thus pressuring nvt shares. non-discriminatory access to nvt/teleatlas content for competing navigation device suppliers will be concessions that both acquiring parties will have to accept to close their respective deals. yes, of course, make the leaders in a business bleed for their success. patently ridiculous, but that's another argument entirely.

back to nvt: if the nvt/nok deal is denied, nvt will probably sell off initially, but then come back, as the company is performing well despite weakness surrounding the broader economy. the database developer and licensor is benefiting from wide penetration of global positioning satellite-enabled personal navigation devices (PNDs). the pnd industry sold approximately 30.2 million units in 2007. this number is likely to exceed 45 million in 2008. although car sales are likely to decline this year in the north american market, more auto manufacturers are producing models that offer in-dash navigation systems. good sales should enable the company to generate an 18% share-earnings advance in 2008, to $2.05.

what is so great about nvt's business is that the sale of each additional device contributes to expanding margins. the company digitally uploads location-based information to units. therefore, nvt doesn't incur higher costs from the sale of additional information. i think a wide operating margin expansion by 2011-2013 is not only possible, but likely.

additonally, the company is expanding both its product reach and offerings. most recently, nvt finalized an agreement with telefonica, one of the world's biggest diversified telecommunications companies. the accord calls for joint innovation of new mobile traffic products for the european market. the deal enables nvt, which has a presence in the us and canadian markets, to get a foothold on the continent. nvt has also invested in acuity mobile, a location-based advertising business. no details are available on that deal.

i'm buying longer-dated calls at 75 on nvt very soon. nvt should benefit from the growing demand for location-based devices at least out to 2011-2013.

Tuesday, March 18, 2008


app reported good 4q results, 2008 guidance and had a good conference call last night. one negative, which may be why the stock was flat today, was the announcement that the company has material weakness in accounting per sarbanes oxley. this may be somewhat routine for a newly public company via a blank check ipo, but some may not like it.

for 4Q07, app reported revenues of $111.2 million, up 48%. this figure was a little higher than expected, driven by the retail business (the company operated 182 stores at year end), where same stores sales rose a stunning 40% in the quarter. adjusted ebitda came in at $13.3 million, up 56%. the company has invested heavily in its transition to public reporting standards; it seems committed to be a major global brand with 100s of new stores over the next five years. the company reported a small net loss for the quarter after backing out a tax benefit. these are good numbers for a growth retailer like app and the analysts on the call all congratulated the company on the results.

app provided detailed guidance for 2008, pointing to revenues of $470-485 million and EBITDA of $70-64 million, both up 24%, and EPS of 32-36 cents, vs. the adjusted 2007 result of 19 cents. the guidance sounds conservative, as it is based on comps of 15% versus the 2007 figure of 29%. tougher comps will lead to a slowing, but january and february are up 40% and 45%, respectively. also conservative is the projection for $15 million net interest expense given a total debt level of $117 million and current cash of over $80 million.

the ceo talked in detail aboout specific stores, mall architecture, international expansion, foreign currency impact, inventory management, store productivity plans, gross margins, operating margins, apparel trends, and competition in the retail and wholesale business segments.

the shares have been hit hard recently, mostly i think due to the 3/7/08 exercise of 16 million warrants. it trades at about 9 now; at 12x ebitda, the shares would be around $11.50 and trading at less than 30 times this year's probable eps. this is probably a bargain for a very hot apparel brand that is executing superbly and comping at an incredible rate.


it's my opinion that gs will be a tough short going forward. i think the new fed facility will matter a great deal.....was a deal cut to allow fnm to start doing some business and start buying fnm bonds?

fnm, nly and fre and the market

great day - short covering? surely some, but higher prices are higher prices, right? fnm and fre being up i think is so very important.

part of what broke bsc was that it was stuck with a huge amount of agency paper -- government-sponsored enterprise paper -- that fell in value vs. treasuries much more than ever before. that was hard to hedge and was causing runs for everything from bsc to nly. with fre and fnm going higher, there is a chance they can refinance and then be able to buy their own bonds back, which would be gigantic.

many are skeptical about fnm and fre, but there was a little-noticed article this morning in the journal about how the white house might relent here. ofheo, the regulator, has been saying they can't do anything with their own bonds even though ofheo acknowledges there is a surplus in fnm's balance sheet of 10 billion. that can be levered up to $100 billion to buy paper at a gain for fnm. this would be huge for fnm and raise the marks at all investment firms.

it also just seems like some deal's been reached that will make the implicit support for gse paper more explicit - is that one reason nly is going higher?

a look at dov

after today's good session, dov trades at about 42. it currently trades at about a 12 p/e, as opposed to an industry p/e of about 20x. dov is a widely diversified manufacturer. industrial and aerospace products include compressors, flow meters, bearings, and other precision engineered components; petroleum products include pumps, valves, and sucker rods; electronic products include microwave filters, automated equipment for the assembly of circuit boards, and other equipment. foreign sales account for about 40% of the total, and it has about 33,000 employees.

dov continues to expand its operations. the company's subsidiary DE-STA-CO, a material handling outfit within the industrial products segment, recently acquired industrial motion control, llc. the terms of the transaction were not disclosed but imc has annual revenues of about $50 million and is one of the world's leading industrial automation manufacturers of mechanical motion control products. indeed, the new addition's variety of attractive end markets, proven reputation, and strong brand names offer promise. too, solid distribution channels, combined with its access to the inside track on industrial automation project requirements, ought to help pull additional DE-STA-CO automation products through approval processes and improve productivity and distribution efficiency.

meanwhile, dov's restructuring efforts are unlocking growth potential. the company has placed greater emphasis on disciplined capital allocation, and recent divestitures, coupled with ongoing cost-cutting initiatives, are generating savings that are likely to improve operating margins. surely the company will continue to invest in enhancing core operations. furthermore, the acquisition-driven growth strategy is benefiting from stricter focus on cost synergies; thus, despite the decentralized enterprise business model, management is attempting a more unified approach across its diversified portfolio of companies to improve overall productivity. as business fundamentals improve, i think that its global expansion efforts offer promise.

aggressive share repurchases should continue to augment share net. the company has authorized another $500 million in share buybacks, which ought to be accretive to share earnings over the coming years.

these shares have declined significantly since last year, as economic concerns have weighed on manufacturing stocks in recent months. i think a recovery in the share price to the 50s over the next several years is certainly possilbe.

long dov

gme's results

gme announced excellent fourth-quarter results this morning and i'd like to recap the numbers.

the company reported a profit of $1.14 a share, which was slightly ahead of guidance and wall street's expectations. sales rose 24.4% to $2.9 billion in the quarter, with same- store sales rising an impressive 17.4% despite industry- wide shortages of key products such as the nintendo wii game console. gme attributed the sales momentum to strength in new-game sales, which rose an impressive 38% in the fourth quarter.

gme also issued very strong guidance, expecting earnings to amount to $2.25 to $2.34 a share this year, which compares well to the current analyst consensus of $2.22 a share -- especially considering gme's tendency to guide conservatively. the company also said that it expects earnings to grow at least 25% next year, implying earnings of at least $2.87 a share, which is nicely ahead of wall street's expectations of $2.66 a share in profit. the company's first-quarter outlook was also impressive, with management expecting the company to report a profit of 32 cents to 33 cents a share in the first quarter of this year vs. consensus expectations of 29 cents a share.

i remain rather impressed with gme's rock-solid execution, and i continue to view the stock as undervalued. the video-game industry is booming right now, and i believe gme will continue to be a major beneficiary.

disc: long gme

what to watch for

hopefully the market can keep its gains intact after 1:15 ct today; possibly even build on them. what i'm particularly interested in is seeing what visa prices at tonight. very interested to see if it can exceed the expected 37 to 42 range.

Monday, March 17, 2008

what possibly lies ahead for the markets

here are some considerations that could buttress the markets and/or suggest that the current issues could be in the process of being discounted in the markets, forming the basis for the potential for a more constructive view in the days/weeks/months ahead after the panic subsides:

* the curative and clearing process, addressing many of the financial institution's capital issues, has been under way for months. though the 3 stooges of 21st century finance - president, fed and treasury - have been timid and unimaginative, last week's actions by the fed and the rescue of bsc are a start in the right direction. the immediacy of the situation is being addressed - and the need for outside-of-the-box solutions (like investment banks' access to the discount window).

* we are probably bottoming in housing. some permutation of the barney frank/fha proposal seems inevitable, particularly in an election year. regardless, home prices are finally descending at an accelerating rate, and the more realistic prices will no doubt begin to attract buyers as credit availability stabilizes.

* corporate balance sheets are in great shape and should buttress the current credit issues.

* sovereign wealth funds remain flush (though relatively uncommitted) and stand ready to commit opportunistically to shore up capital of some of our largest financial institutions.

* the yield curve's steepening could, in the fullness of time, incent banks to take more risks.

* corporate profit expectations are being pared quickly and are catching up to many downbeat projections. more importantly, unlike prior recessions, the credit problems are not trickling into other market sectors.

* over the last 50 years, job losses (a lagging economic indicator) have coincided with economic stabilization and a positive turn for equities.

* stocks have declined by 20% within a six-month period for the fourth time in a quarter of a century (1990, 1998, 2000). in the 12-month period following the 1990 and 1998 corrections, stocks rallied by 34% and 39%, respectively. the 2000 correction, however, begot a full-fledged Bear Market.

* unlike previous bear markets, equities were not the subject of speculation at the top; commodities, residential and non-residential real estate, and private equity were.

* if corporate profits avoid a major slide in 2008, stocks are inexpensive relative to short- and long-term interest rates. indeed, with a seeming bubble in the bond market, a broad reallocation of assets out of fixed income and into equities seems possible.

* the negativity bubble now appears so inflated that it could be ready to pop. for example, the equity-only put/call reached an all-time high on friday, the investors intelligence (of market letters) survey showed bears rising to levels not seen in six years and demonstrated one of the sharpest weekly increases (to 43.6%) in years, the aaii survey (of individual investors) came in at the largest level of bears (at 59%) in nearly 20 years, and the consensus survey of futures traders were (only 23% bullish) at the lowest levels seen in over five years.

i think we'll see the market tell us what's happening very soon - within the next 2 weeks at the latest.

rate-cut odds zoom higher

the market is priced fully for a 100-basis-point cut in the funds rate at tomorrow's FOMC meeting, up from 52% odds on friday. in addition, the market is priced for 22% odds of 125 basis points in cuts.

for the 4/30 fomc meeting, the market is priced for 100% odds that the funds rate will be cut by a cumulative 125 basis points to 1.75%, and for 62% odds of 150 basis points in cuts.

for the 6/25 fomc meeting, the market is priced for 100% odds of 150 basis points in cuts, which is up from 46% odds on friday, and for 24% odds of a cumulative 175 basis points in cuts.

for the end of 2008, the market is priced for the funds rate to be at 1.41%, down 15.5 basis points from friday. additionally, the market sees the fund rate holding under 1.75% through the middle of 2009.

what bsc turned out to be worth

take your pick:

4 gs executives


roughly the size of a-rod's contract


this is why dimon is the world's best banker

it's still early in this game, obviously, but jpm getting bsc for about 250 million looks to me to be the deal of the decade, if not longer. dimon is simply the world's best banker. he wanted bsc for quite some time, but didn't want to buy with his stock at 40 and bsc at about 150, last year. so he waited, and didn't destroy his balance sheet going after fleeting, short term gains with mortgage-backed toxins.

so did the fed "play favorites" by "giving" this choice but bruised property to jpm? well, sort of. obviously it had to be an american institution, and, who else is there? bac's dealing with cfc; c couldn't do it at this time; no one's left. and jpm had the smarts to stay relatively clean and be ready in case something like this came up.

i happen to think they pulled $2 a share out of a hat; $1 looks ridiculous and dimon wouldn't pay more - so it's $2. $2 i think silences any potential strike suit cases and that is it. it is capitalism in its rawest form - and it's gruesome when it happens.

in terms of the deal price, it doesn't matter what bear's stated book was. this past weekend its stated book was $2 per share. why? because jpm was THE only credible buyer,was willing to execute a merger agreement without any conditions and that is what they were willing to pay under those circumstances. the headline number is $2 per share, but if you listened to the call there are $6 billion of contingent/transaction liabilities being assumed which is actually around another $60 per share being transferred to creditors. the fine print is obviously on these deals - essentially this is an out of court bankruptcy deal.

buy my own position on this deal is clear: i think it's a grand slam for jpm; the building alone is worth more than $2/share. they'll probably hang onto a number of great people and jpm gets into some businesses in a big way that they've been coveting for some time: especially the prime brokerage business. here's a very rough, bare bones estimate of bsc's true worth right now (in my opinion):

about 5 billion in illiquid stuff

about 3 billion in maximum loss exposure on the 33.5 billion retained interest in "assets of variable interest entities and mortgage loan special purpose entities."

so that easily, in my opinion, covers any worst-case scenarios regarding bsc. a huge win for dimon and jpm.

oh, by the way, gasparino's been on cnbc harping about shareholder activists and the like getting a better price for bsc or some other near-impossible scenario: no way. if this deal falls through, jpm's written into the deal an option to purchase the building at an attractive price and of course could kick everyone out the next day. also, jpm's running bsc RIGHT NOW - obviously all of their liquidity would instantly go away that's been put into bsc; and finally, the fed would surely pull their support as well - this deal goes through as is.

disclosure: long jpm and wishing i had alot more

Sunday, March 16, 2008

more on bsc and the market

small money paid for bsc doesn't put all the financials in the same boat as overpriced icons unworthy of value -- did the shutdown of kidder and drexel in 1990 signal such?

no, market crises as deep as this START to get better when a couple of the weakest fish get fried --- deep-fried.

bsc is the first (worst?) of these so far, but be ready, it MAY not be the last.

so what to do on monday? i say fight the urge to run into treasuries, as there's got to be other worthwhile investments out there outside of our government, especially at the current rates - which will of course be going lower. pick away at financials if they get crushed enough; look for great opportunities in select corporate debt. the weak dollar does wonders for some multi-nationals who don't necessarily rely on the credit markets much. look for big exporters being unnecessarily crushed. the markets will surely start very rough but these days you never know about the close.

now, when it all seems to be coming apart is the time for risktakers to calmly step up, pick a few spots and let the offers come down to their measured bids. take your time. tomorrow, nothing you do should be a daytrade. (unless EVERYTHING you do is a daytrade!)


so bsc goes for 270 million, or about 2 a share. remarkable turn of events that the fifth-largest i-bank goes down the tubes so suddenly. of course, it started last august, but the real decline came in a matter of days last week.

panic tomorrow in the markets? we shall see. an '87-like crash in the markets tomorrow? we shall see. i don't really think so, but you never know - especially these days with this fed and this administration.

you may read that all major financial institutions' equity is now zero, given the events at bsc. i think that's completely incorrect. however, the market may give you a once-in-a-lifetime gift in the shares of financials tomorrow. take it.

disclosure: long jpm - do your own DD!

Saturday, March 15, 2008

an update on my 'buy aapl under 120' call

here's why i think aapl will soar in 2008 and 2009 - possibly even double from here:

companies as large as aapl don't often keep the innovative fires stoked, but aapl's different, i believe, because of jobs. he's always in a relentless pursuit of the win, like a shark on the hunt. jobs simply never lets up.

the ipod is not yet a 'mature' product. since mid 2004, aapl's been selling 4 million a month, having penetrated 60 million households. but i think the addressable market is 1 billion, and, with a $50 minimum profit on every unit straight off the top, that's possibly worth $28-$30 billion to aapl's earnings over the next decade.

there's also the 100 GB widescreen video ipod, apple tv, movie downloads, and more.

the itunes store continues to be a game-changer. three billion downloads and counting. traditional CDs are of course history. i think the downloads are worth about .60/share to aapl's earnings this year. itunes changed the music industry's antiquated distribution system. also, could imovies negatively impact nflx? nflx relies so very heavily on the post office.

the iphone, and it's a design beauty. i think it could attract up to 17 million buyers this year, adding $1.50 - $1.75 to apple's earnings. aapl is recognizing iphone revenues, not as a $399/sale, but as $16.65/month for 24 months, the
minimum length of the AT&T contract. this of course deliberately low balls the impact of the phone. new apps, a 16GB version, a 3G model, and new markets in china, thailand and canada are yet to be exploited. and all connected to the web.

the new mac and leopard os could allow aapl to double its share of the pc market.

aapl stores have really redefined the retail industry, becoming magnets for traffic and money. i can attest to this fact, as i experienced sifnificant wait times in aapl's store in las vegas in january. and we're supposed to be in a recession, right? aapl owns and controls the customer relationship.

momentum investing's been so wrong so far in 2008. aapl's down from 200 to below 120 to about 126 now. this company, in my opinion, just has too much earnings power to stay at these levels much longer.

interesting timeline of yesterday's events in the market, plus is jpm buying bsc?

i think if jpm buys bsc at about 30, it'll work out great for jpm. bsc's book value is most likely at least 75 a share.

friday around 8:15 central time, i turned on cnbc to see the s and p 500 futures up 17 points and faber showing me a pre-market stock chart that reflected a 10% increase from where they closed yesterday in shares of troubled brokerage firm bsc after news had just broke of the injection of capital from the ny fed via jpm. alas, a few minutes later, the early gains were evaporating and the dow was soon down close to 300 points. just another illustration of why the only problem with market timing is getting the timing right!

here's a more detailed description: (times eastern)

08:03 am: S&P futures vs fair value: -9.3. Nasdaq futures vs fair value: -13.8. Futures point to a lower start as market participants await the February CPI report that is set for release at 8:30 ET.

08:30 am: S&P futures vs fair value: +5.0. Nasdaq futures vs fair value: +10.5. Futures spike on a better than expected inflation reading; now point to a positive start to the trading day. Just reported, February CPI was unchanged, compared to the expected rise of 0.3%. Excluding food & energy, CPI was also flat, which was less than the expected rise of 0.2%. That leaves CPI up 4.0% year over year, and core CPI up 2.3% year-over-year.

09:00 am: S&P futures vs fair value: +6.5. Nasdaq futures vs fair value: +12.8. Futures continue to suggest a positive open thanks to the better than expected inflation reading.

09:15 am: S&P futures vs fair value: +15.0. Nasdaq futures vs fair value: +19.2. Futures extend their gains. JPMorgan Chase and the Federal Reserve Bank of New York will provide financing for Bear Stearns as necessary. Shares of Bear Stearns spiked in pre-market trading.

09:45 am: It was shaping up to be a negative open until a better than expected inflation reading caused the market to rebound. Stocks are trading with modest gains.

then of course the market became unnerved by the bsc news. it lost 47% of its already-depressed value, after seeing more than 186 million of its shares change hands yesterday. rumors became fact at bsc, as there was a virtual run on the bank at bear, and the virtually unprecedented move by the fed, via jpm. with book value still supposedly in excess of $80 per share, i hope jpm buys bsc here at 30 or better. dimon has always coveted the prime brokerage business, which hasn't gotten off the ground yet at jpm.

one method to value development-stage companies

this is one method to value companies which have no revenues or earnings; or book value is low relative to intrinsic value; or success is difficult to forecast; or for stocks that are easily hyped.

other questions: how big is the target market?

what is the estimate of the company's possible market share?

what is its cash burn rate?

here's a possible solution:

stock price x number of shares = total market cap

total r and d spending = for the last 5 years including the present year

divide the total market cap by the total r and d spending

possibly adjust the figures for so-called "wasted" r and d spending in an attempt to be conservative:

valuation = possible attractive investment = a number under 5

a fair valuation = a number around 10

a high valuation = a number of about 15x to 20x or more

using a discounted cash flow technique to value stocks

Forecast Expected Cash Flow:

the first order of business is to forecast the expected cash flow for the company based on assumptions regarding the company's revenue growth rate, net operating profit margin, income tax rate, fixed investment requirement, and incremental working capital requirement.

Estimate the Discount Rate:

the next order of business is to estimate the company's weighted average cost of capital (WACC), which is the discount rate that's used in the valuation process.

Calculate the Value of the Corporation:

the company's WACC is then used to discount the expected cash flows during the Excess Return Period to get the corporation's Cash Flow from Operations. We also use the WACC to calculate the company's Residual Value. To that we add the value of Short-Term Assets on hand to get the Corporate Value.

Calculate Intrinsic Stock Value:

we then subtract the values of the company's liabilities—debt, preferred stock, and other short-term liabilities to get Value to Common Equity, divide that amount by the amount of stock outstanding to get the per share intrinsic stock value.

so how does a corporation make money? It makes money by operating business lines where it manufactures products or provides services. A company generates revenue by selling its products and services to another party. In generating revenue, a company incurs expenses—salaries, cost of goods sold (CGS), selling and general administrative expenses (SGA), research and development (R&D). The difference between operating revenue and operating expense is Operating Income or Net Operating Profit.

To produce revenue a firm not only incurs operating expenses, but it also must invest money in real estate, buildings and equipment, and in working capital to support its business activities. Also, the corporation must pay income taxes on its earnings. The amount of cash that's left over after the payment of these investments and taxes is known as Free Cash Flow to the Firm (FCFF).

FCFF is an important measure to stockholders. This is the cash that is left over after the payment of all cash expenses and operating investment required by the firm. It is the hard cash that is available to pay the company's various claim holders, especially the good guys—the stockholders! The simple equation used to calculate FCFF is:

FCFF = NOP – Taxes – Net Investment – Net Change in Working Capital

there are five key cash flow measures that are important in estimating the free cash flow to the firm that is used in the DCF approach. Those five cash flow measures are as follows: the revenue growth rate, the net operating profit margin, the company's income tax rate, net fixed capital investment rate, and incremental working capital investment rate.

The revenue growth rate is equal to your estimate of the firm's revenue growth rate in percent over the Excess Return Period.

Net operating profit margin is equal to a firm's operating profits divided by its revenues. A firm's income tax rate is equal to the provision for income taxes divided by the firm's operating income before provision for taxes. The information necessary to compute NOPM and income tax rate can be found on the firm's income statement as part of its annual or quarterly reports.

Net fixed investment rate is equal to the company's new investment in plant, property and equipment (PP&E) minus depreciation charges taken. To calculate this ratio, you need to know the company's investment rate, equal to the firm's yearly investment in PP&E divided by revenues, and the company's depreciation rate, equal to the firm's depreciation charges divided by revenues. The firm's investment in PP&L and depreciation charges can be found on its cash flow statement in its annual report.

Incremental working capital investment rate is equal to the change in working capital divided by the change in revenue. Working capital is equal to [( Accounts Receivable + Inventory) – Accounts Payable]. The firm's accounts payable, inventories, and accounts receivable can be found on its annual balance shehe free cash flow to the firm approach provides for several distinct time periods for estimating cash flow which allow differing value-creating periods for a corporation's business strategy. In the Excess Return Period, because of a competitive advantage that the firm has, the corporation is able to earn returns on new investments that are greater than its cost of capital.

Success invariably attracts competitors whose aggressive practices cut into market share and revenue growth rates, and whose pricing and marketing activities drive down net operating profit margins. A reduction in NOPM drives return on new investment to levels that approach the corporation's WACC. When a company loses its competitive advantage and the return from its new investments just equals its WACC, the corporation is investing in business strategies in which the aggregate net present value is zero.

The length of the Excess Return Period for the corporation will depend on the particular products being produced, the industry in which the company operates, and the barriers for competitors to enter the business. Products that have a very high barrier to entry due to patent protection, strong brand names, or unique marketing channels might have a long Excess Return Period (10 to 15 years or longer). The Excess Return Period for most companies is 5 to 7 years or shorter. All else equal, a shorter Excess Return Period results in a lower stock value.

A company's WACC is very similar to an investment portfolio's weighted average return - it's simply the weighted average expected cost for the company's various types of obligations—debt, preferred stock, and common stock—that are issued by the corporation to finance its operations and investments.

The company's WACC is a very important number, both to the stock market for stock valuation purposes and to the company's management for capital budgeting purposes. In an analysis of a potential investment by the company, investment projects that have an expected return that is greater than the company's WACC will generate additional free cash flow and will create positive net present value for stock owners. These corporate investments should result in an increase in stock prices. These projects are good things! Investments that earn less than the firm's WACC will result in a decrease in stockholder value and should be avoided by the company.

The annual rate of return that an investor expects to earn when investing in shares of a company is known as the cost of common equity. That return is composed of the dividends paid on the shares and any increase (or decrease) in the market value of the shares. For example, if an investor expects a 10% return from McDonald's stock and she buys a share at $67.25, her expectation is to receive $6.72 during the year through a combination of dividends (currently $.34 per share during 1998) and the appreciation of the stock price (presumed to be $6.38 to give her the 10% expected return totaling $6.72) during the year.

Equity Risk Premium = Exp. Return on Market - Risk Free Rate

this method of valuing stocks demands that one pay less than the intrinsic value of the stock. for example, using this method, citi's intrinsic value is about 40 right now.

long c