We all know how troubled the market looks right now. With so much bad news dominating the headlines, it probably looks to the novice investor like the stock market is just not the safest place to put your money.
It's true that investing comes with risk and if you are not okay with that then you should not be investing. I am sure that more than a few investors have lost a tremendous amount of money this week, but there is no reason to be discouraged.
Despite what the ranting heads on CNBC and in so many financial publications may say, I will still tell you that opportunity abounds in these times. Even if things do get worse in the markets, the beauty of it all is that they will eventually get better. And that means that for investors who are sitting on the sidelines, now is the time to swoop in and pick up some cheap stocks.
The most solid advice that I can give is just don't overthink every situation when you are deciding where to put your money. Keep it simple and find a company or group of companies that have had share prices suffer in the last year or so. The biggest challenge is finding a company that won't go bankrupt and honestly even someone who just flat out guesses where to put their money will be able to find a company that won't go bankrupt since the overwhelming majority of established, traded companies will never go into bankruptcy.
If you're scared of the financial sector after the recent events (and who could blame you) then that's an easy fix: don't invest in the financial sector. The only error that you could make right now would be to not be taking advantage of the great opportunities that exist right now.
I will let you in on a few of my personal favorites, but this list is by no means all inclusive because as I said earlier, opportunity abounds.
I like Deere and Company (DE), with their signature green farm vehicles and a track record of dependability I see no reason why their share price couldn't double in value in 3-5 years after this current mess in the financial markets works itself out.
I'll grant you that this pick is a little riskier, but I like General Motors (GM) too. I don't think that I could ever envision a world where General Motors doesn't exist and I don't think the United States government would be able to either. In 2010, GM will get some of its pension weight lifted off its shoulders by the UAW and the much hyped Chevy Volt also comes out that year. The way I see it, they only need to survive until 2010 at which point I think they will be a formidable company again.
One of my absolute favorite value plays right now is the Las Vegas Sands Corporation (LVS). Granted, an economic turnaround is needed for LVS to start to see share prices soar again, but when that turnaround happens in a year or two (or more if you are such a pessimist) I know that I will really be happy to a have basis in this stock at under $40 a share. Given time LVS shares could feasibly triple or quadruple in value, especially if historical prices are any indication.
These three stocks picks are what I like right now, but I will tell you that in troubled markets like this, there are opportunities everywhere and you don't even have to look that hard for them.
The bottom line is just to keep your thinking simple right now...don't think like those on Wall Street who feel the need to nitpick at every little detail and find little flaws everywhere because all that thinking won't make you money and it will give you a headache.
Investors look for opportunity all of the time, but sometimes I think fear blinds them from seeing when opportunity is sitting right in front of their face. There are risks, but we're all aware of those risks. So, go out there and put your money to work while there is so much opportunity available.
Disclosure: author is long LVS
Happy Investing
InglefoX
Tuesday, September 16, 2008
Sunday, August 17, 2008
CXW: Go Directly to Jail, Do Not Pass Go, Do Collect Big Returns.
Sometimes it seems to me that investors overlook some potentially high returns by overlooking "boring" companies. Occasionally I even find myself overlooking such companies. I think it's easy to get lost in the exciting share price swings of a company like Apple (AAPL) and while there is great money that can be made by taking advantage of such volatile price swings, it is important to recognize that there are other less "sexy" ways to make a healthy return.
It might seem unbelievable to you when I say that a fundamentally sound company with solid, consistent and guaranteed revenues can be an overlooked stock that trades below $30 dollars a share. However, the Corrections Corporation of America (CXW) is such a company.
Corrections Corp. has solid fundamentals and a history of profitability. Better yet, this privatized prison and jail operator has a consistent source of revenue that comes from contracts with 19 states and the district of Columbia. They operate 65 facilities and house over 72,000 inmates at all security levels.
My favorite thing about Corrections Corp. has to be the consistent revenue inflows. Since they operate under government contracts and have shown a tendency to re-negotiate these contracts in their favor in the face of rising costs, I simply do not see how this company could ever lose money. The biggest burden upon the company's management is to control costs while still maintaining the integrity of their facilities, but they have proven themselves capable of doing just that and the company has thus showed consistent profitability.
Given the above facts many of you must be wondering how is it that Corrections Corp. can be trading at below $30 a share. The answer to that it that because Corrections Corp. has such a consistent and guaranteed stream of revenues, their profitability and return to investors is easy to predict. That predictability is the precise reason that Corrections Corp. is deemed to be a "boring" stock and that is why it is overlooked.
In it's current state, Corrections Corp.'s revenue and profit will remain roughly the stable which would limit the share price growth. So, in its current state I would not recommend CXW for an investor or for a trader because it just cannot offer impressive returns to shareholders.
The reason that I do like CXW for a long term investment is that I think that the privatized corrections industry, of which they are the most dominant player, is destined to grow. Basically, the more inmates and more facilities that Corrections Corp. manages the more revenue they receive from state governments. More growth offers more returns and higher share price.
Why do I think that the privatized corrections industry is destined to grow? I think that because the prison population is constantly growing. According to the non-partisan Pew Center on the States, as of June 30, 2007 there were 2.3 million prisoners in America's prisons and jails. The cost of housing these inmates costs 55 billions dollars annually in taxpayer dollars.
The rate of incarcerated persons in the United States is growing at a much faster rate than the general population of the United States. A projection done in 2007 by the Pew Center on the States projected a 13% increase in prison inmate population from 2007 to the end of 2011 while the general population of the United States is only expected to grow 4.5% during that same period.
Currently privatized prisons and jails only represent a small fraction of the overall prisons and jails in the United States, but that is a trend that is slowly changing. Many governments are starting to see the value and cost savings that can come by outsourcing their correctional operations.
The overcrowding that plagues government operated prisons tends not to affect their privatized counterparts as greatly because the privatized facilities in many cases can cap the number of inmates. In 2007 when prison overcrowding rates in some government operated facilities reached as high as 114% of designed capacity, the private prisons were able to absorb, with compensation from the respective governments of course, 77,987 inmates from these overcrowded state and federal prisons.
When you add together overcrowded prisons and an explosive inmate growth rate, the only answer is that more prison capacity is needed. Corrections Corporation of America will stand to benefit from this trend and this should add the necessary growth and revenue to pump up their bottom line and their share price.
I am generally an options trader, but Corrections Corp. is not a company that I would try to trade options on because their share price simply does not show the type of volatility that is necessary to profit on options. The only play on CXW that will allow for an investor to catch the overall long term trend will be a long term investment.
There is always a chance that Corrections Corp. will not show the type of explosive growth that I mention above, but the beauty of this long term play is that there is not a lot of downside even if CXW shows minimal growth. Even in the absence of future growth, CXW will still have a steady stream of revenues and probably a share price comparable to what it is today.
(Disclosure: None)
Happy Investing
InglefoX
(http://www.inglefox.com/)
It might seem unbelievable to you when I say that a fundamentally sound company with solid, consistent and guaranteed revenues can be an overlooked stock that trades below $30 dollars a share. However, the Corrections Corporation of America (CXW) is such a company.
Corrections Corp. has solid fundamentals and a history of profitability. Better yet, this privatized prison and jail operator has a consistent source of revenue that comes from contracts with 19 states and the district of Columbia. They operate 65 facilities and house over 72,000 inmates at all security levels.
My favorite thing about Corrections Corp. has to be the consistent revenue inflows. Since they operate under government contracts and have shown a tendency to re-negotiate these contracts in their favor in the face of rising costs, I simply do not see how this company could ever lose money. The biggest burden upon the company's management is to control costs while still maintaining the integrity of their facilities, but they have proven themselves capable of doing just that and the company has thus showed consistent profitability.
Given the above facts many of you must be wondering how is it that Corrections Corp. can be trading at below $30 a share. The answer to that it that because Corrections Corp. has such a consistent and guaranteed stream of revenues, their profitability and return to investors is easy to predict. That predictability is the precise reason that Corrections Corp. is deemed to be a "boring" stock and that is why it is overlooked.
In it's current state, Corrections Corp.'s revenue and profit will remain roughly the stable which would limit the share price growth. So, in its current state I would not recommend CXW for an investor or for a trader because it just cannot offer impressive returns to shareholders.
The reason that I do like CXW for a long term investment is that I think that the privatized corrections industry, of which they are the most dominant player, is destined to grow. Basically, the more inmates and more facilities that Corrections Corp. manages the more revenue they receive from state governments. More growth offers more returns and higher share price.
Why do I think that the privatized corrections industry is destined to grow? I think that because the prison population is constantly growing. According to the non-partisan Pew Center on the States, as of June 30, 2007 there were 2.3 million prisoners in America's prisons and jails. The cost of housing these inmates costs 55 billions dollars annually in taxpayer dollars.
The rate of incarcerated persons in the United States is growing at a much faster rate than the general population of the United States. A projection done in 2007 by the Pew Center on the States projected a 13% increase in prison inmate population from 2007 to the end of 2011 while the general population of the United States is only expected to grow 4.5% during that same period.
Currently privatized prisons and jails only represent a small fraction of the overall prisons and jails in the United States, but that is a trend that is slowly changing. Many governments are starting to see the value and cost savings that can come by outsourcing their correctional operations.
The overcrowding that plagues government operated prisons tends not to affect their privatized counterparts as greatly because the privatized facilities in many cases can cap the number of inmates. In 2007 when prison overcrowding rates in some government operated facilities reached as high as 114% of designed capacity, the private prisons were able to absorb, with compensation from the respective governments of course, 77,987 inmates from these overcrowded state and federal prisons.
When you add together overcrowded prisons and an explosive inmate growth rate, the only answer is that more prison capacity is needed. Corrections Corporation of America will stand to benefit from this trend and this should add the necessary growth and revenue to pump up their bottom line and their share price.
I am generally an options trader, but Corrections Corp. is not a company that I would try to trade options on because their share price simply does not show the type of volatility that is necessary to profit on options. The only play on CXW that will allow for an investor to catch the overall long term trend will be a long term investment.
There is always a chance that Corrections Corp. will not show the type of explosive growth that I mention above, but the beauty of this long term play is that there is not a lot of downside even if CXW shows minimal growth. Even in the absence of future growth, CXW will still have a steady stream of revenues and probably a share price comparable to what it is today.
(Disclosure: None)
Happy Investing
InglefoX
(http://www.inglefox.com/)
Sunday, August 10, 2008
The Follies of Finance
I was recently looking for an inspiring topic to write my next article about when I turned to a collegiate textbook from the first finance class that I ever took. I turned to the chapter about bear markets and recessions and tried to find a topic that I thought would be applicable to current market conditions.
As I read, I was shocked about how many times I found myself in absolute disagreement with the author of the textbook. There were two topics in particular that I, with now actual market experience behind me, take issue with. These topics are the textbook’s notions of consumer behavior and diversification.
After further study of these topics, I am prepared to assert that academia as a whole, not just my first finance textbook, believe generally the same thing about both consumer behavior and diversification. This not only makes me question “real world” value of collegiate finance teachings (I have always questioned that), but it also makes me wonder if the finance world is full of professionals who, due to college teachings, wholeheartedly believe what I believe are some of the “follies of finance (teachings)”.
My first issue is with the thought that actual consumer behavior can be as broadly generalized as it is in finance textbooks. In several collegiate level finance textbooks, I reviewed the idea of consumer behavior in times of recession and economic weakness and all of them stated approximately the same thing. These textbooks all made the generalization that in times of economic weakness, consumers drastically change their spending patterns and cut off virtually all discretionary spending, which allows for investing opportunities in the consumer staples sectors.
I then looked to the one of the consumer staples industries, the food retail industry, and found that, contrary to what the textbooks may say, this industry as a whole is in the red year to date. This measure even includes several foreign food retailers; it would undoubtedly be much further in the red if only the American grocers were factored in.
Take for example Safeway Foods (SWY), a company that, according to conventional “textbook” thinking, would be considered a safe haven in such periods of economic weakness. Safeway, for the year 2008, is down nearly 20% as of August 8, 2008. This is certainly not what I would call a safe haven.
Furthermore I think that this generalization ignores the various classes of wealth that exist as those with more wealth likely will not cut discretionary spending in times of economic weakness. I also believe this generalization ignores the possibilities that people may resist change in their spending patterns by using savings accounts or by use of other means.
I think that this represents an instance where academia actually may not have known what to write about. The inherent problem with textbooks is that they rely on generalizations and I believe that writing about where to invest in times of economic weakness requires precise specification. This is a type of specification which simply cannot be captured in textbooks. As a result, this type of “inside the box” thinking is prevalent in the finance world even though it is not necessarily true.
The topic of diversification is another topic that I take issue with. Diversification is something that goes much further than the scope of academia and has founds its way into the thought process of virtually everyone involved in the financial markets.
I will go out on a limb here and say something that few others would ever dare to say; diversification is a folly.
I am fully aware that in a diversified portfolio the risk of the portfolio can be reduced to approach the market rate of risk. Reducing risk is a great thing; however, in reducing this risk down to the market rate of risk, the return is also reduced to the market rate of return.
I question the hassle of even investing in the financial markets if diversification only allows a market rate of return. You might as well invest in mutual funds or money market funds if all you can achieve is a dismal market rate of return.
While I am sure that many people out there will point to such prominent investors as Warren Buffett, who is actually fairly well diversified, as an example of why diversification works. My response to that is that Mr. Buffett’s portfolio and many other multi-million dollar portfolios are diversified because of the excess of capital that they contain. With a large amount of capital it is natural that an investor, such as Mr. Buffett, would pursue many different opportunities. This leads to a portfolio which may look as if it is intentionally diversified; however, I believe that it is simply a result of an excess of capital, of which only a limited amount can be put into a particular investment.
Large portfolios like Mr. Buffett’s also have such large investments in any given stock that they can see gigantic profits at minimal stock price movement. I think that the success of such portfolios is proof of the old mantra that “it takes money to make money”. I do not believe that “diversified” success like this can be replicated by individuals with smaller portfolios.
It is the inarguable truth that smaller portfolios can only see monumental success by taking on higher levels of risk. This risk does not have to risk the entire value of the portfolio; in fact, I find that option trading is by far the best method to recognize levels of returns greatly in excess of the market rate of return while only risking the minimal cost of the option itself.
I will say that the only positive that diversification brings is a minimized risk and I question any type of participation in the financial markets if someone is so risk averse that they feel as though diversification is necessary. In the financial markets both risk and reward abound. Reward will rarely ever be realized in smaller value portfolios if risk is not first taken. It takes multimillion dollar portfolios to achieve success in such a manner as someone like Warren Buffett. And if one does not have a multimillion dollar portfolio risk is the only method to gain reward.
I will give a quick example of the type of rewards that can be achieved when risk is taken. When US Airways (LCC) was trading at below $2 per share near mid July, the August $2.50 option calls were trading for about $1.50 per contract. If one were to invest just $3,000 dollars into these options to buy 20 contracts, those 20 contracts would be worth $10,800 as of August 8 (a return of 260%). One could also have recognized a great return by trading the low share prices of US Airways, but I provided this example as an example of how options can give great reward with fairly minimal risk (in this case the maximum risk was only $3,000).
As someone who tries to make profits by understanding the market psychology, I am very interested in understanding any type of prevailing market thinking (be it regarding diversification or consumer behavior). Even though I disagree with both of these principles as they are generally taught, I understand that because they are taught as the unquestionable truths of finance they are the prevailing thoughts for most finance professionals. In knowing this, I think that those of us who use market psychology to gain an edge can better understand the prevailing market forces.
I suppose that sometimes the answers for those of us who believe that profits come from understanding the market psychology can sometimes come from such an unlikely source as an old college textbook. So, whether you agree or disagree with me about the topics from the textbooks, you cannot disagree that these topics are the prevailing market methods and in understanding them one can gain a greater understanding of the overall market movements.
(Disclosure: author is long LCC)
Happy Investing
InglefoX
(www.inglefox.com)
As I read, I was shocked about how many times I found myself in absolute disagreement with the author of the textbook. There were two topics in particular that I, with now actual market experience behind me, take issue with. These topics are the textbook’s notions of consumer behavior and diversification.
After further study of these topics, I am prepared to assert that academia as a whole, not just my first finance textbook, believe generally the same thing about both consumer behavior and diversification. This not only makes me question “real world” value of collegiate finance teachings (I have always questioned that), but it also makes me wonder if the finance world is full of professionals who, due to college teachings, wholeheartedly believe what I believe are some of the “follies of finance (teachings)”.
My first issue is with the thought that actual consumer behavior can be as broadly generalized as it is in finance textbooks. In several collegiate level finance textbooks, I reviewed the idea of consumer behavior in times of recession and economic weakness and all of them stated approximately the same thing. These textbooks all made the generalization that in times of economic weakness, consumers drastically change their spending patterns and cut off virtually all discretionary spending, which allows for investing opportunities in the consumer staples sectors.
I then looked to the one of the consumer staples industries, the food retail industry, and found that, contrary to what the textbooks may say, this industry as a whole is in the red year to date. This measure even includes several foreign food retailers; it would undoubtedly be much further in the red if only the American grocers were factored in.
Take for example Safeway Foods (SWY), a company that, according to conventional “textbook” thinking, would be considered a safe haven in such periods of economic weakness. Safeway, for the year 2008, is down nearly 20% as of August 8, 2008. This is certainly not what I would call a safe haven.
Furthermore I think that this generalization ignores the various classes of wealth that exist as those with more wealth likely will not cut discretionary spending in times of economic weakness. I also believe this generalization ignores the possibilities that people may resist change in their spending patterns by using savings accounts or by use of other means.
I think that this represents an instance where academia actually may not have known what to write about. The inherent problem with textbooks is that they rely on generalizations and I believe that writing about where to invest in times of economic weakness requires precise specification. This is a type of specification which simply cannot be captured in textbooks. As a result, this type of “inside the box” thinking is prevalent in the finance world even though it is not necessarily true.
The topic of diversification is another topic that I take issue with. Diversification is something that goes much further than the scope of academia and has founds its way into the thought process of virtually everyone involved in the financial markets.
I will go out on a limb here and say something that few others would ever dare to say; diversification is a folly.
I am fully aware that in a diversified portfolio the risk of the portfolio can be reduced to approach the market rate of risk. Reducing risk is a great thing; however, in reducing this risk down to the market rate of risk, the return is also reduced to the market rate of return.
I question the hassle of even investing in the financial markets if diversification only allows a market rate of return. You might as well invest in mutual funds or money market funds if all you can achieve is a dismal market rate of return.
While I am sure that many people out there will point to such prominent investors as Warren Buffett, who is actually fairly well diversified, as an example of why diversification works. My response to that is that Mr. Buffett’s portfolio and many other multi-million dollar portfolios are diversified because of the excess of capital that they contain. With a large amount of capital it is natural that an investor, such as Mr. Buffett, would pursue many different opportunities. This leads to a portfolio which may look as if it is intentionally diversified; however, I believe that it is simply a result of an excess of capital, of which only a limited amount can be put into a particular investment.
Large portfolios like Mr. Buffett’s also have such large investments in any given stock that they can see gigantic profits at minimal stock price movement. I think that the success of such portfolios is proof of the old mantra that “it takes money to make money”. I do not believe that “diversified” success like this can be replicated by individuals with smaller portfolios.
It is the inarguable truth that smaller portfolios can only see monumental success by taking on higher levels of risk. This risk does not have to risk the entire value of the portfolio; in fact, I find that option trading is by far the best method to recognize levels of returns greatly in excess of the market rate of return while only risking the minimal cost of the option itself.
I will say that the only positive that diversification brings is a minimized risk and I question any type of participation in the financial markets if someone is so risk averse that they feel as though diversification is necessary. In the financial markets both risk and reward abound. Reward will rarely ever be realized in smaller value portfolios if risk is not first taken. It takes multimillion dollar portfolios to achieve success in such a manner as someone like Warren Buffett. And if one does not have a multimillion dollar portfolio risk is the only method to gain reward.
I will give a quick example of the type of rewards that can be achieved when risk is taken. When US Airways (LCC) was trading at below $2 per share near mid July, the August $2.50 option calls were trading for about $1.50 per contract. If one were to invest just $3,000 dollars into these options to buy 20 contracts, those 20 contracts would be worth $10,800 as of August 8 (a return of 260%). One could also have recognized a great return by trading the low share prices of US Airways, but I provided this example as an example of how options can give great reward with fairly minimal risk (in this case the maximum risk was only $3,000).
As someone who tries to make profits by understanding the market psychology, I am very interested in understanding any type of prevailing market thinking (be it regarding diversification or consumer behavior). Even though I disagree with both of these principles as they are generally taught, I understand that because they are taught as the unquestionable truths of finance they are the prevailing thoughts for most finance professionals. In knowing this, I think that those of us who use market psychology to gain an edge can better understand the prevailing market forces.
I suppose that sometimes the answers for those of us who believe that profits come from understanding the market psychology can sometimes come from such an unlikely source as an old college textbook. So, whether you agree or disagree with me about the topics from the textbooks, you cannot disagree that these topics are the prevailing market methods and in understanding them one can gain a greater understanding of the overall market movements.
(Disclosure: author is long LCC)
Happy Investing
InglefoX
(www.inglefox.com)
Thursday, August 7, 2008
Drug Companies Play by Different Rules
I have found that one of the hardest things to do in the financial markets is to trade drug/biotech companies. I always like to play the markets based upon my perception of the underlying market psychology, but the problem with the drug/biotech companies is that they mostly trade upon hype about new drugs and clinical trials. This hype can be immediately killed by one negative trial result or one adverse FDA decision.
The problem with this is that it is virtually impossible to predict for anyone and, on the surface, doesn't that just mean that investors are just rampantly guessing and gambling when they put money into these stocks?
Everytime I have tried to apply my market psychology rationale to biotech companies, I have failed miserably. Initially I came to the conclusion that market psychology could not be applied to these biotech companies, but after careful consideration I now believe that market psychology may in fact be the most important factor in determining how the market prices the biotech companies.
My previous folly in attempting to trade these companies was that I tried to trade them hoping for a positive decision from the FDA or for a positive clinical trial outcome. In doing this, I now realize that I might as well have been playing blackjack in a casino because my odds were about the same. My decision was to never play the drug/biotech companies again in anticipation of an announcement, but that's not to say that I don't plan on playing them at all.
The drug/biotech companies are very much catalyst driven companies (those catalysts being clinical trial results and FDA decisions). However, it is the periods in between catalysts that the human aspect of the market, the market psychology, dictates the movements of these companies share prices.
While there are several companies that I look at regularly in this sector, there is one that continually attracts me, that is Myriad Genetics (MYGN).
I was actually attracted to Myriad initially because of the promise that their Alzheimer's drug Flurizan showed. Unfortunately, Flurizan was recently shown to have produced no effect on Alzheimer's patients abilities to complete tasks of daily life. This was a major setback for Myriad, but the stock price is has not really reflected this setback as one would expect. In fact, this stock appears to have a great deal of momentum which has Myriad near their 52 week high.
With Myriad currently in one of their in between catalyst stages, the question becomes "what will the market do with this stock price?". This is where an understanding of the market psychology can attempt to predict what the near term holds for Myriad.
From here, Myriad will either keep the momentum that it has had for most of this year or it will lose that momentum and suffer a significant collapse in share price. So, which of these two possibilities is more likely given all of the facts?
Myriad does have a solid balance sheet, with a high level of cash that has increased thus far in 2008 and a very low level of liabilities with absolutely no long term debt. This is a very positive sign for a company that relies so heavily on research and development of drugs that may not produce a revenue for years to come and sometimes never.
Working further to Myriad's advantage is the fact they have a diversified portfolio of drugs that are currently under development and testing. The cancer drug Azixa (currently in phase II trials) is likely their most promising drug, but it is still nowhere near production. Further down the pipeline are drugs for HIV/AIDS and Thrombosis, which are currently in phase I trials.
Myriad does have a fairly solid stream of revenues from their current royalties. Though they are projected to have a loss for the upcoming quarter and for the year 2008, their revenue stream is very strong especially when compared to some of their peer companies.
One possible issue that I see for Myriad based solely upon my knowledge of market psychology is that their stock price is very close to their 52 week high. The 52 week high can be a significant psychological resistance level and may pose a significant threat to the stock's momentum especially in light of the recent failure of the drug Flurizan.
So, what conclusion have I arrived at for Myriad Genetics and why is it that I cannot seem to ignore this company?
I think I am attracted to Myriad because they have a solid base of cash with few liabilities and such a tremendous long term upside. While I think that Myriad is due for a share price correction that will likely see them touch 60 a share, I believe that after that the market will give Myriad its momentum back and will see it break through the 52 week high.
This is based upon a careful study of the market psychology and particularly upon the option market open interest levels which heavily favor the call side of Myriad. In my observations, I have seen that the market has a difficult time abandoning a company that has had such strong momentum for such a long time and that is why I think that the market will come around to Myriad again soon.
This strategy is not without risk, but I think catching the surging momentum train that will return after a slight correction will be give traders a chance to make some quick money.
The bottom line is that deciding which way to play a biotech company can be a mind-numbing prospect and is one of the most stressful prospects in all of the financial markets in my opinion. If I listened to conventional wisdom I would probably stay away from the biotech companies that I have lost so much money on in the past, but I like the challenge. That challenge is what I find so exhillerating.
(Disclosure: none)
Happy Trading
InglefoX
(http://www.inglefox.com/)
The problem with this is that it is virtually impossible to predict for anyone and, on the surface, doesn't that just mean that investors are just rampantly guessing and gambling when they put money into these stocks?
Everytime I have tried to apply my market psychology rationale to biotech companies, I have failed miserably. Initially I came to the conclusion that market psychology could not be applied to these biotech companies, but after careful consideration I now believe that market psychology may in fact be the most important factor in determining how the market prices the biotech companies.
My previous folly in attempting to trade these companies was that I tried to trade them hoping for a positive decision from the FDA or for a positive clinical trial outcome. In doing this, I now realize that I might as well have been playing blackjack in a casino because my odds were about the same. My decision was to never play the drug/biotech companies again in anticipation of an announcement, but that's not to say that I don't plan on playing them at all.
The drug/biotech companies are very much catalyst driven companies (those catalysts being clinical trial results and FDA decisions). However, it is the periods in between catalysts that the human aspect of the market, the market psychology, dictates the movements of these companies share prices.
While there are several companies that I look at regularly in this sector, there is one that continually attracts me, that is Myriad Genetics (MYGN).
I was actually attracted to Myriad initially because of the promise that their Alzheimer's drug Flurizan showed. Unfortunately, Flurizan was recently shown to have produced no effect on Alzheimer's patients abilities to complete tasks of daily life. This was a major setback for Myriad, but the stock price is has not really reflected this setback as one would expect. In fact, this stock appears to have a great deal of momentum which has Myriad near their 52 week high.
With Myriad currently in one of their in between catalyst stages, the question becomes "what will the market do with this stock price?". This is where an understanding of the market psychology can attempt to predict what the near term holds for Myriad.
From here, Myriad will either keep the momentum that it has had for most of this year or it will lose that momentum and suffer a significant collapse in share price. So, which of these two possibilities is more likely given all of the facts?
Myriad does have a solid balance sheet, with a high level of cash that has increased thus far in 2008 and a very low level of liabilities with absolutely no long term debt. This is a very positive sign for a company that relies so heavily on research and development of drugs that may not produce a revenue for years to come and sometimes never.
Working further to Myriad's advantage is the fact they have a diversified portfolio of drugs that are currently under development and testing. The cancer drug Azixa (currently in phase II trials) is likely their most promising drug, but it is still nowhere near production. Further down the pipeline are drugs for HIV/AIDS and Thrombosis, which are currently in phase I trials.
Myriad does have a fairly solid stream of revenues from their current royalties. Though they are projected to have a loss for the upcoming quarter and for the year 2008, their revenue stream is very strong especially when compared to some of their peer companies.
One possible issue that I see for Myriad based solely upon my knowledge of market psychology is that their stock price is very close to their 52 week high. The 52 week high can be a significant psychological resistance level and may pose a significant threat to the stock's momentum especially in light of the recent failure of the drug Flurizan.
So, what conclusion have I arrived at for Myriad Genetics and why is it that I cannot seem to ignore this company?
I think I am attracted to Myriad because they have a solid base of cash with few liabilities and such a tremendous long term upside. While I think that Myriad is due for a share price correction that will likely see them touch 60 a share, I believe that after that the market will give Myriad its momentum back and will see it break through the 52 week high.
This is based upon a careful study of the market psychology and particularly upon the option market open interest levels which heavily favor the call side of Myriad. In my observations, I have seen that the market has a difficult time abandoning a company that has had such strong momentum for such a long time and that is why I think that the market will come around to Myriad again soon.
This strategy is not without risk, but I think catching the surging momentum train that will return after a slight correction will be give traders a chance to make some quick money.
The bottom line is that deciding which way to play a biotech company can be a mind-numbing prospect and is one of the most stressful prospects in all of the financial markets in my opinion. If I listened to conventional wisdom I would probably stay away from the biotech companies that I have lost so much money on in the past, but I like the challenge. That challenge is what I find so exhillerating.
(Disclosure: none)
Happy Trading
InglefoX
(http://www.inglefox.com/)
Sunday, August 3, 2008
Too Many Reillys, Too Many Issues: Why It May be Good to Short Lamar
Those of you who follow the company Lamar Advertising (LAMR) know that, with only two exceptions (one rather brief and one lasting roughly two years), the company's stock price has been extremely range bound. That range has been, more or less, between $30 and $40. After a recent bull run, which saw Lamar's share price touch $70, the stock has recently entered this range again.
With the shares trading at $37.53 as of Aug. 4, 2008, it is actually at the high end of this range and I think that Lamar's upcoming earnings report on August 6 may disappoint and send the share price back down to the low end of this range. This could give traders a chance to pick up some puts or short some of Lamar's shares and make what could potentially be a quick profit.
I do think that Lamar may miss their earnings target on August 6, but even if I am wrong about them missing their upcoming earnings, I still view Lamar as a good medium term short play, or at least until the share price touches the low end of what has been a consistent range. Traders can potentially play Lamar's shares over and over again, shorting the shares once they touch the top of the range (near $40) and covering once they touch the low end of the range (near $30).
First of all, the main reason that I see Lamar missing on their upcoming earnings is because of the high put activity that I am seeing in the options market. I have found that time and again, the options market is a reliable (but not infallible) indicator about upcoming earnings.
I compare the ratios of calls to puts by looking at the open interest levels for the single option with the highest open interest and also the total call/put ratio. For the August options, the August 35 puts are showing the highest open interest at 5,739. The straddle option for this put would be the August 40 calls which are only showing an open interest level of 1,496. This means that the straddle call/put ratio is a high 3.8 to 1.
I generally also look at the same strike ratio for the option with the high open interest as well as the opposite ratio which compares the option with the highest open interest against the option on the other side (call or put) with the highest open interest. In the case of the Lamar options, the same strike (35 calls) also happen to be the calls with the highest open interest, meaning that the same strike ratio and opposite ratio are the same in this case, the ratio being 1.8 to 1 in favor of the puts.
Lastly, the total put to call ratio adds all of the open interest up on the put side and divides it by the total open interest on the call side. In the case of Lamar Advertising the total put open interest is 14,197 versus a total call open interest of 5,647. This gives a ratio of just over 2.5 to 1 in favor of the puts.
These ratios are all on the high side and are an indicator that the options buyers, for whatever reason, are under the impression that Lamar may miss their earnings and that Lamar's share price will be below $35 by the third Friday of August.
The options open interest levels are why I think that Lamar may miss on their upcoming earnings report, but they are not the reason that I think Lamar will be range bound for a long while to come.
The first issue that makes me wary of Lamar Advertising is the prevalence of members of the Reilly family in corporate governance and operation. Though the company is publicly traded, the Reilly family controls 67% of the corporate voting power by virtue of their ownership of Lamar's class B shares. The class B shares, created by CEO Kevin Reilly Jr. and COO Sean Reilly, carry an incredible 10 votes per share. This means that the Reillys have free reign over the fates of Lamar Advertising and there is nothing that any discontented shareholders could do about it.
Reilly family members hold the aforementioned positions of CEO and COO. Furthermore, Kevin Reilly Jr. also holds the title of Chairman of the Board, Wendell Reilly holds a seat on the board of directors and Anna Reilly also serves as a director.
While the fact that the Reilly family holds stern control over Lamar is not an issue that should sit well with outside investors, it does not automatically disqualify Lamar from being a profitable company. The biggest issue with Lamar is the nature of their business in outdoor billboard advertising.
Outdoor billboard advertising can be a profitable business, requiring a large upfront cost followed by only minimal maintenance costs and a steady stream of revenues. The problem with the business is the lack of growth that the industry has historically shown.
Since the days of LadyBird Johnson, billboard advertisers have met resistance with virtually every new billboard that they attempt to erect. Many people view billboards as eyesores that detract from the natural beauty along the nation's highways and also as accident causing hazards that attract people's attention away from driving. The billboard opponents have been very successful in the courts at severely limiting the construction of new billboards. In fact, if you are to look at Lamar's recent headlines, there are always several news articles dedicated to legal battles that are currently ensuing regarding the construction of new billboards.
As a result, new billboard construction is not a reliable source of growth, but Lamar has adapted to this over the past years and has produced growth by constant acquisition of smaller outdoor advertising companies. The issue with this type of growth is that it will eventually be terminal, and also one has to assume that Lamar and its competitors have already purchased the best of these available companies.
A new type of billboard, the digital billboard, is offering Lamar a new opportunity that will offer many times more revenue and much higher margins than the traditional billboard. Many on Wall Street are expecting that digital billboards will give Lamar and other outdoor advertisers a significant boost, but the problem is that digital billboards are meeting even stricter resistance from the public and local governments.
Lamar has faced a legal battle for many of the digital billboards that they have constructed in such cities as Omaha, NE, Mufreesboro, TN, Fayetteville, NC, Kansas City, KS and many more. Opponents claim that the flashing billboard signs cause an even greater distraction to drivers and still present just as much of an eyesore as their predecessors.
The end result is that Lamar's growth is stunted by an inability to construct new billboards. There certainly is an ample supply of customers for Lamar and other outdoor advertisers even under these weakened economic conditions, but without the ability to produce new billboards Lamar cannot recognize maximum revenue potential.
The bottom line is that many factors point to Lamar being a good short play in both the short term and the longer term. The August 6 report could shed further light on the current situation for the company, but I think that this is an excellent short play going into that report. The options market is pointing to the short side for Lamar's report and several other indicators are pointing to the short side for the longer term. In my view, Lamar simply has too many Reillys and too many issues.
(disclosure: author intends to take a short position in LAMR)
Happy Trading
InglefoX
With the shares trading at $37.53 as of Aug. 4, 2008, it is actually at the high end of this range and I think that Lamar's upcoming earnings report on August 6 may disappoint and send the share price back down to the low end of this range. This could give traders a chance to pick up some puts or short some of Lamar's shares and make what could potentially be a quick profit.
I do think that Lamar may miss their earnings target on August 6, but even if I am wrong about them missing their upcoming earnings, I still view Lamar as a good medium term short play, or at least until the share price touches the low end of what has been a consistent range. Traders can potentially play Lamar's shares over and over again, shorting the shares once they touch the top of the range (near $40) and covering once they touch the low end of the range (near $30).
First of all, the main reason that I see Lamar missing on their upcoming earnings is because of the high put activity that I am seeing in the options market. I have found that time and again, the options market is a reliable (but not infallible) indicator about upcoming earnings.
I compare the ratios of calls to puts by looking at the open interest levels for the single option with the highest open interest and also the total call/put ratio. For the August options, the August 35 puts are showing the highest open interest at 5,739. The straddle option for this put would be the August 40 calls which are only showing an open interest level of 1,496. This means that the straddle call/put ratio is a high 3.8 to 1.
I generally also look at the same strike ratio for the option with the high open interest as well as the opposite ratio which compares the option with the highest open interest against the option on the other side (call or put) with the highest open interest. In the case of the Lamar options, the same strike (35 calls) also happen to be the calls with the highest open interest, meaning that the same strike ratio and opposite ratio are the same in this case, the ratio being 1.8 to 1 in favor of the puts.
Lastly, the total put to call ratio adds all of the open interest up on the put side and divides it by the total open interest on the call side. In the case of Lamar Advertising the total put open interest is 14,197 versus a total call open interest of 5,647. This gives a ratio of just over 2.5 to 1 in favor of the puts.
These ratios are all on the high side and are an indicator that the options buyers, for whatever reason, are under the impression that Lamar may miss their earnings and that Lamar's share price will be below $35 by the third Friday of August.
The options open interest levels are why I think that Lamar may miss on their upcoming earnings report, but they are not the reason that I think Lamar will be range bound for a long while to come.
The first issue that makes me wary of Lamar Advertising is the prevalence of members of the Reilly family in corporate governance and operation. Though the company is publicly traded, the Reilly family controls 67% of the corporate voting power by virtue of their ownership of Lamar's class B shares. The class B shares, created by CEO Kevin Reilly Jr. and COO Sean Reilly, carry an incredible 10 votes per share. This means that the Reillys have free reign over the fates of Lamar Advertising and there is nothing that any discontented shareholders could do about it.
Reilly family members hold the aforementioned positions of CEO and COO. Furthermore, Kevin Reilly Jr. also holds the title of Chairman of the Board, Wendell Reilly holds a seat on the board of directors and Anna Reilly also serves as a director.
While the fact that the Reilly family holds stern control over Lamar is not an issue that should sit well with outside investors, it does not automatically disqualify Lamar from being a profitable company. The biggest issue with Lamar is the nature of their business in outdoor billboard advertising.
Outdoor billboard advertising can be a profitable business, requiring a large upfront cost followed by only minimal maintenance costs and a steady stream of revenues. The problem with the business is the lack of growth that the industry has historically shown.
Since the days of LadyBird Johnson, billboard advertisers have met resistance with virtually every new billboard that they attempt to erect. Many people view billboards as eyesores that detract from the natural beauty along the nation's highways and also as accident causing hazards that attract people's attention away from driving. The billboard opponents have been very successful in the courts at severely limiting the construction of new billboards. In fact, if you are to look at Lamar's recent headlines, there are always several news articles dedicated to legal battles that are currently ensuing regarding the construction of new billboards.
As a result, new billboard construction is not a reliable source of growth, but Lamar has adapted to this over the past years and has produced growth by constant acquisition of smaller outdoor advertising companies. The issue with this type of growth is that it will eventually be terminal, and also one has to assume that Lamar and its competitors have already purchased the best of these available companies.
A new type of billboard, the digital billboard, is offering Lamar a new opportunity that will offer many times more revenue and much higher margins than the traditional billboard. Many on Wall Street are expecting that digital billboards will give Lamar and other outdoor advertisers a significant boost, but the problem is that digital billboards are meeting even stricter resistance from the public and local governments.
Lamar has faced a legal battle for many of the digital billboards that they have constructed in such cities as Omaha, NE, Mufreesboro, TN, Fayetteville, NC, Kansas City, KS and many more. Opponents claim that the flashing billboard signs cause an even greater distraction to drivers and still present just as much of an eyesore as their predecessors.
The end result is that Lamar's growth is stunted by an inability to construct new billboards. There certainly is an ample supply of customers for Lamar and other outdoor advertisers even under these weakened economic conditions, but without the ability to produce new billboards Lamar cannot recognize maximum revenue potential.
The bottom line is that many factors point to Lamar being a good short play in both the short term and the longer term. The August 6 report could shed further light on the current situation for the company, but I think that this is an excellent short play going into that report. The options market is pointing to the short side for Lamar's report and several other indicators are pointing to the short side for the longer term. In my view, Lamar simply has too many Reillys and too many issues.
(disclosure: author intends to take a short position in LAMR)
Happy Trading
InglefoX
Saturday, August 2, 2008
Ecolab: Why Public Health is the Right Business at the Right Time.
While I was waiting in line on a recent visit to Starbucks (SBUX), I couldn't help but notice a woman behind the counter who, with notebook in hand, was hawkishly observing every move that the baristas and food handlers made. Intrigued, I took a quick glance at the logo on this woman's shirt. It read "Ecosure". My brain ran through all of its stored files, but was just drawing a blank on the name Ecosure. I quickly jotted down a note in my phone and looked Ecosure up as soon as I could get to a computer.
Come to find out, Ecosure is a division of the Company Ecolab (ECL). Ecolab produces various products specifically geared toward ensuring sanitary conditions at all types of food service establishments. They provide, among other things, dishwashing equipment, hand care products, surface cleaners, cleaning systems and antimicrobial products all mainly geared toward usage in the food service and hospitality industries.
There has been plenty of good news recently regarding Ecolab. They have just declared a regular dividend, they saw second quarter results jump 26% year over year and they have an international business segment that is producing great growth potential. All of that is great, but it is not the reason why I am starting to get excited about this company. The reason that I am starting to get excited about Ecolab is because of the Ecosure division.
The Ecosure division of Ecolab provides food safety services to businesses or other organizations that serve food to the public. Ecosure provides on-site evaluation of processes (this is likely what I witnessed at Starbucks), program design for food servers and supplier audits. Furthermore, they offer classroom services taught by certified trainers for any food service worker.
Initially I was intrigued by Ecosure because I thought that any outside service that Starbucks was willing to pay money for, especially given their recent cutbacks, is a service that is probably necessary and thus is likely being used by other food service providers. This alone was enough to get me interested in Ecosure, but it wasn't quite enough to get me to consider investing in it quite yet.
I started considering Ecosure (Ecolab) as a potential investment when the recent events of the jalapeno salmonella outbreak caused a nationwide tomato ban and then ultimately a restriction on the importation of jalapenos from certain suppliers. Now, I don't want to go as far as to say that these events caused any sort of public panic, but they certainly did make people feel a little uneasy about eating fresh tomatoes or jalapenos.
This ban and subsequent public uneasiness did take a financial toll on food service companies and it is something that all food service and hospitality companies would like to avoid. That is exactly where a company like Ecosure comes in.
Imagine how devastated any food service company would have been had the salmonella outbreak been traced back directly to them. It would be hard for even larger companies to persevere through such an occurrence. For a food service company, it is certainly worth the preventative cost to ensure that no such occurrence is even remotely possible. In providing supplier audits, process evaluation and food handler training, Ecosure stands to benefit from that preventative cost.
I think, especially in light of recent events, Ecosure is in the right business at the right time and they will undoubtedly be a profitable part of Ecolab. I think this alone is enough to make Ecolab a good investment, but there's one more reason why I think Ecolab is a good buy.
The last reason that I think Ecolab is a good investment is that they are a company that benefits from public fears. What do I mean by this? Sometimes when a story about an illness, be it the Avian flu or salmonella, becomes widely publicized, the public becomes a little more cautious and perhaps even fearful of the said illness. Again, I wouldn't go as far as to say that the public goes into panic mode, but they do tend to ask (especially of schools, local government, hospitals, etc) "what are we doing to prevent this illness from occurring here?"
A situation like this is where Ecolab's public health division could stand to reap a nice bit of business. Ecolab offers products and services for infection prevention, cleaning/control products and procedures and pandemic preparedness for such illness causing organisms as Avian Influenza, Mad Cow, E. Coli, Hepatitis A, Influenza, Listeria, Pandemic Flu, Salmonella, SARS and a myriad of others.
I don't think I'm being too presumptive when I say that Ecolab stands to profit from the public reaction to any publicized illness, particularly food borne illness. This again just proves to me that Ecolab has found a nice business niche.
The bottom line is that Ecolab, in providing services that ensure public health, is not only providing a necessary public service, but also reaping nice profits. These profits can only be increased by the international expansion of the company and I think it's a good idea for investors to consider picking up some shares in Ecolab.
(disclosure: none)
Happy Investing
InglefoX
Come to find out, Ecosure is a division of the Company Ecolab (ECL). Ecolab produces various products specifically geared toward ensuring sanitary conditions at all types of food service establishments. They provide, among other things, dishwashing equipment, hand care products, surface cleaners, cleaning systems and antimicrobial products all mainly geared toward usage in the food service and hospitality industries.
There has been plenty of good news recently regarding Ecolab. They have just declared a regular dividend, they saw second quarter results jump 26% year over year and they have an international business segment that is producing great growth potential. All of that is great, but it is not the reason why I am starting to get excited about this company. The reason that I am starting to get excited about Ecolab is because of the Ecosure division.
The Ecosure division of Ecolab provides food safety services to businesses or other organizations that serve food to the public. Ecosure provides on-site evaluation of processes (this is likely what I witnessed at Starbucks), program design for food servers and supplier audits. Furthermore, they offer classroom services taught by certified trainers for any food service worker.
Initially I was intrigued by Ecosure because I thought that any outside service that Starbucks was willing to pay money for, especially given their recent cutbacks, is a service that is probably necessary and thus is likely being used by other food service providers. This alone was enough to get me interested in Ecosure, but it wasn't quite enough to get me to consider investing in it quite yet.
I started considering Ecosure (Ecolab) as a potential investment when the recent events of the jalapeno salmonella outbreak caused a nationwide tomato ban and then ultimately a restriction on the importation of jalapenos from certain suppliers. Now, I don't want to go as far as to say that these events caused any sort of public panic, but they certainly did make people feel a little uneasy about eating fresh tomatoes or jalapenos.
This ban and subsequent public uneasiness did take a financial toll on food service companies and it is something that all food service and hospitality companies would like to avoid. That is exactly where a company like Ecosure comes in.
Imagine how devastated any food service company would have been had the salmonella outbreak been traced back directly to them. It would be hard for even larger companies to persevere through such an occurrence. For a food service company, it is certainly worth the preventative cost to ensure that no such occurrence is even remotely possible. In providing supplier audits, process evaluation and food handler training, Ecosure stands to benefit from that preventative cost.
I think, especially in light of recent events, Ecosure is in the right business at the right time and they will undoubtedly be a profitable part of Ecolab. I think this alone is enough to make Ecolab a good investment, but there's one more reason why I think Ecolab is a good buy.
The last reason that I think Ecolab is a good investment is that they are a company that benefits from public fears. What do I mean by this? Sometimes when a story about an illness, be it the Avian flu or salmonella, becomes widely publicized, the public becomes a little more cautious and perhaps even fearful of the said illness. Again, I wouldn't go as far as to say that the public goes into panic mode, but they do tend to ask (especially of schools, local government, hospitals, etc) "what are we doing to prevent this illness from occurring here?"
A situation like this is where Ecolab's public health division could stand to reap a nice bit of business. Ecolab offers products and services for infection prevention, cleaning/control products and procedures and pandemic preparedness for such illness causing organisms as Avian Influenza, Mad Cow, E. Coli, Hepatitis A, Influenza, Listeria, Pandemic Flu, Salmonella, SARS and a myriad of others.
I don't think I'm being too presumptive when I say that Ecolab stands to profit from the public reaction to any publicized illness, particularly food borne illness. This again just proves to me that Ecolab has found a nice business niche.
The bottom line is that Ecolab, in providing services that ensure public health, is not only providing a necessary public service, but also reaping nice profits. These profits can only be increased by the international expansion of the company and I think it's a good idea for investors to consider picking up some shares in Ecolab.
(disclosure: none)
Happy Investing
InglefoX
Thursday, July 31, 2008
Casino Stocks Scream of a Value Play
I am a frequent visitor of Las Vegas and in my most recent visit I noticed that, despite the recent poor performance of the share prices of such companies as MGM Mirage (MGM), Boyd Gaming (BYD) and Las Vegas Sands (LVS), every single casino was still just as crowded as ever. In fact, I think that every time I go, regardless of what the economic cycles may be, the casinos are even more crowded than the time before. The waits at the restaurants are still an hour and sometime more, people fight for seats at $25 minimum blackjack tables, and the Price is Right slot machines which I so love are always being played by Bob Barker admiring retirees.
I have noticed a change in the crowd in the past year though. There is an influx of foreign visitors, easily identifiable from their various accents. Even with this inordinately high amount of foreign visitors helping to fill the void left by a weakened American consumer base, the clientele of the casinos is still predominantly composed of Americans.
The natural question that I find myself pondering is "with the Vegas casinos just as crowded as ever, why can't the casino operators make as much money as they were making just a year ago?"
I think the answer is a combination of things. One of which is that while Americans may still be visiting Vegas for their vacations despite the overall economic weakness, they may be cutting their gambling budget as a result of that economic weakness. In previous years, the average gambling budget for a Las Vegas visitor was $559. In 2007,39.2 million visitors visited Las Vegas meaning that given those figures, gambling revenues for 2007 were approximately 21.9 billion dollars.
Imagine now if that gambling budget were cut by just $100. Even if the number of visitors were 40 million, overall gambling revenues would be brought down to about 18.4 billion dollars. It's hard to tell exactly how much the American consumers are cutting their gambling budgets, but I believe that $100 likely represents a conservative figure.
Another factor that I think may be affecting the results of the casino operators is the tremendous expenditures that they all seem to be undertaking. I have seen firsthand the gargantuan undertaking of MGM Mirage's City Center project and Boyd Gaming's Echelon Place project. I think the undertaking of these projects not only represent large cash outflows for these companies, but also temporary lost potential revenues. This is particularly true in the case of Boyd Gaming which had to sacrifice several of its properties, via demolition and land swaps with other gaming operators, just to make the necessary space for its Echelon Place project.
Though City Center and Echelon Place represent a temporary expenditure for MGM Mirage and Boyd Gaming, these two mammoth projects will bring in massive future revenue inflows. I think these two projects will be new Vegas tourist attractions in and of themselves. This will be especially the case of City Center, as it represents a revolutionary new concept: a hotel, casino and mega resort built to mimic an entire city block.
It's impossible to talk about casino operators nowadays without mentioning Macau, China. There certainly is no slowdown of spending in Macau as gambling revenues for the first quarter of 2008 were up 62% from last year. The biggest issue with the Macau is that, much to the initial surprise of the American casino operators, revenues don't necessarily to go the biggest, most flashy casinos, but rather to the casinos that have the best relationship with the Macau junket operators.
The junket operators are the middlemen in China that serve as intermediaries between the Chinese high rollers and the casinos. Chinese law does not allow the casinos to offer credit to its customers as they do here in the United States, which is why the junket operators are so vital. I think that the American casino operators had initially underestimated the importance of establishing a relationship with the junket operators.
Perhaps the casino operators underestimated the Chinese high rollers' loyalty to their respective junket operators and felt that they would be able to woo high rollers with flashy mega resort casinos. Unfortunately that strategy did not work and it has thus far led to struggles for the American casino operators in Macau as they have lost clients to their Chinese counterparts. I think the tides are starting to turn as the American casino operators are now starting to establish relationships with the junket operators and soon will start to recognize the full potential of the Macau market.
The final aspect that I attribute to the slipping share price of the casino stocks is a general investor distaste for consumer discretionary stocks. Avoiding consumer discretionary stocks is a very natural reaction of investors in times of economic turmoil and I think that the "herd mentality" shows up and sells off these stocks more than may be justified.
I don't think that the current share prices for MGM Mirage, Boyd Gaming and Las Vegas Sands represent the full future potential of these companies. With the tide starting to turn in Macau and future high-earning projects in the pipeline the only remaining criteria for a full fledged turn around would be an end to the current economic situation.
Many analysts believe that conditions have already started to bottom out, which could mean that the casinos will have a full turn around before the end of 2008. Even if you don't agree that the overall economic conditions are turning around, I still think that the casino operators represent a value play at current levels and it is hard to imagine their share prices falling too much further before there is some type of turn around, with MGM Mirage, Boyd Gaming and Las Vegas Sands currently trading at 29.02, 9.98 and 45.52, respectively.
There is even a possibility that private equity firms may swoop in with prices at such levels and pay a healthy premium to take one of these companies (most likely MGM) private in just the manner that Texas Pacific Group and Apollo took Harrahs private. I would not trade any companies purely on the possibility of a buyout, but it is an added incentive for companies that are already trading at such low levels.
The bottom line is that the casino operators, in the midst of an American economic slowdown, are trading at levels that should make value investors salivate. I don't think we will see these stocks at such low levels for too long and so that is why I think the time to get in is now. If all of the chips fall in place, I don't think it would be too far fetched to see MGM, BYD and LVS at double their current level this time next year. The way I see it, opportunity abounds in the casino industry.
Happy Investing
InglefoX
I have noticed a change in the crowd in the past year though. There is an influx of foreign visitors, easily identifiable from their various accents. Even with this inordinately high amount of foreign visitors helping to fill the void left by a weakened American consumer base, the clientele of the casinos is still predominantly composed of Americans.
The natural question that I find myself pondering is "with the Vegas casinos just as crowded as ever, why can't the casino operators make as much money as they were making just a year ago?"
I think the answer is a combination of things. One of which is that while Americans may still be visiting Vegas for their vacations despite the overall economic weakness, they may be cutting their gambling budget as a result of that economic weakness. In previous years, the average gambling budget for a Las Vegas visitor was $559. In 2007,39.2 million visitors visited Las Vegas meaning that given those figures, gambling revenues for 2007 were approximately 21.9 billion dollars.
Imagine now if that gambling budget were cut by just $100. Even if the number of visitors were 40 million, overall gambling revenues would be brought down to about 18.4 billion dollars. It's hard to tell exactly how much the American consumers are cutting their gambling budgets, but I believe that $100 likely represents a conservative figure.
Another factor that I think may be affecting the results of the casino operators is the tremendous expenditures that they all seem to be undertaking. I have seen firsthand the gargantuan undertaking of MGM Mirage's City Center project and Boyd Gaming's Echelon Place project. I think the undertaking of these projects not only represent large cash outflows for these companies, but also temporary lost potential revenues. This is particularly true in the case of Boyd Gaming which had to sacrifice several of its properties, via demolition and land swaps with other gaming operators, just to make the necessary space for its Echelon Place project.
Though City Center and Echelon Place represent a temporary expenditure for MGM Mirage and Boyd Gaming, these two mammoth projects will bring in massive future revenue inflows. I think these two projects will be new Vegas tourist attractions in and of themselves. This will be especially the case of City Center, as it represents a revolutionary new concept: a hotel, casino and mega resort built to mimic an entire city block.
It's impossible to talk about casino operators nowadays without mentioning Macau, China. There certainly is no slowdown of spending in Macau as gambling revenues for the first quarter of 2008 were up 62% from last year. The biggest issue with the Macau is that, much to the initial surprise of the American casino operators, revenues don't necessarily to go the biggest, most flashy casinos, but rather to the casinos that have the best relationship with the Macau junket operators.
The junket operators are the middlemen in China that serve as intermediaries between the Chinese high rollers and the casinos. Chinese law does not allow the casinos to offer credit to its customers as they do here in the United States, which is why the junket operators are so vital. I think that the American casino operators had initially underestimated the importance of establishing a relationship with the junket operators.
Perhaps the casino operators underestimated the Chinese high rollers' loyalty to their respective junket operators and felt that they would be able to woo high rollers with flashy mega resort casinos. Unfortunately that strategy did not work and it has thus far led to struggles for the American casino operators in Macau as they have lost clients to their Chinese counterparts. I think the tides are starting to turn as the American casino operators are now starting to establish relationships with the junket operators and soon will start to recognize the full potential of the Macau market.
The final aspect that I attribute to the slipping share price of the casino stocks is a general investor distaste for consumer discretionary stocks. Avoiding consumer discretionary stocks is a very natural reaction of investors in times of economic turmoil and I think that the "herd mentality" shows up and sells off these stocks more than may be justified.
I don't think that the current share prices for MGM Mirage, Boyd Gaming and Las Vegas Sands represent the full future potential of these companies. With the tide starting to turn in Macau and future high-earning projects in the pipeline the only remaining criteria for a full fledged turn around would be an end to the current economic situation.
Many analysts believe that conditions have already started to bottom out, which could mean that the casinos will have a full turn around before the end of 2008. Even if you don't agree that the overall economic conditions are turning around, I still think that the casino operators represent a value play at current levels and it is hard to imagine their share prices falling too much further before there is some type of turn around, with MGM Mirage, Boyd Gaming and Las Vegas Sands currently trading at 29.02, 9.98 and 45.52, respectively.
There is even a possibility that private equity firms may swoop in with prices at such levels and pay a healthy premium to take one of these companies (most likely MGM) private in just the manner that Texas Pacific Group and Apollo took Harrahs private. I would not trade any companies purely on the possibility of a buyout, but it is an added incentive for companies that are already trading at such low levels.
The bottom line is that the casino operators, in the midst of an American economic slowdown, are trading at levels that should make value investors salivate. I don't think we will see these stocks at such low levels for too long and so that is why I think the time to get in is now. If all of the chips fall in place, I don't think it would be too far fetched to see MGM, BYD and LVS at double their current level this time next year. The way I see it, opportunity abounds in the casino industry.
Happy Investing
InglefoX
Sunday, July 27, 2008
Making Profits by Understanding the Market Psychology
I am a big believer that the markets, especially in the short term, aren't moved by company fundamentals or any of the other logical indicators. These indicators certainly play a role, but they don't move share prices in and of themselves. There are certain catalysts that can move a share price (such as an FDA decision for a drug company), but there is another force at play that can move share prices significantly one way or the other without one of these catalysts. To understand this force it is important to understand that the market is very much a human driven entity and thus it can be psychologically studied.
In many of the articles that I have previously written I have used certain wording and talked in generalities, purposely leaving some information out and including some correct but overall purposeless information. I did this because I was trying to provoke a response to these certain elements in order to more closely study the overall market psychology. There are times when people did not respond at all to items that I thought to be very provocative and times when people responded negatively to items that I initially thought to be harmless.
My conclusion from this and from my other close studies of the psychology of the financial markets is that people, perhaps without even knowing it, trade and invest as one "herd". I have found signs of this "herd mentality" in every aspect of the financial markets.
I have collected enough information that I feel comfortable making the following generalizations about the "herds" of the financial markets:
This is simply a result of a logical human decision process that goes something like this: If bank A and bank B have had these tremendous write downs then bank C probably will sometime in the future. The logic is perfectly sound and I think that it is a very natural human logic. It can be found everywhere in the market, the fact that so many people buy into this very type of logic is what forms the herd mentality. The question now becomes "how do I profit from understanding this market psychology?"
Well, as I said earlier, this "herd mentality" can be found everywhere in the financial markets not just in the stock market. So, the way that I answer the question of how to profit from the herd mentality is that I look to the herd in the options market. Stock options, and in particular LEAPS, are good indicators of what the market players think is going to happen to a stock in the future. The options market has a herd (albeit a much smaller one) just like the stock market does and if you look for just the right indicators, you can make a generalization about the future of certain stock prices based upon where the money of the options market herd is going.
What I look for is levels of high open interest either on the put or call side. If I find an abnormally high open interest level I first search the headlines to see if there is any glaringly obvious reason for why the open interest would be so high. If I find a reason then I usually move on, but if I don't I then apply a set of strict rules which will help to further weed out the options which are unsuitable for this strategy.
Firstly, the option indicators are basically useless if the option is too thinly traded. In the thinly traded options, one person could hold a large position that is skewing the options for that particular equity and it would certainly not be wise to take up a position based upon one other individual's conviction about a stock. There is no definitive rule that I follow here, but do look for consistent daily volumes of 500-2,500 minimum and open interest levels of at least 5,000.
The next rule is that you have to compare apples to apples. By this I mean that if you find an abnormally high open interest for a call or put you have to compare it to it's equivalent put or call. For example, say a stock is trading at 53 and the 60 calls are showing an outrageously high open interest. I have found that many people, in finding abnormal open interest levels, simply will compare these 60 calls to the 60 puts. While I do calculate the same strike ratio, I don't think that this is as important as what I call the "straddle strike" ratio. The straddle strike ratio calculates the ratio of the open interest in the 60 calls against the open interest in the 45 puts. I find this to be important because it calculates how many options are outstanding that are making the exact inverse bet on the share price as the 60 calls. 45 puts are the exact inverse of 60 calls in this situation because they are each two strikes away from the actual price in their own direction. I also calculate the opposite ratio which measures the ratio between the calls with the highest open interest and the puts with the highest open interest, regardless of strike.
While these three ratios are all important in deciding if an open interest level would be classified as abnormally high, perhaps the most important indicator is the total call to total put ratio. This is calculated simply by adding up the open interest on all the calls and dividing that by the total open interest for all of the puts. This total ratio ensures that apples are being compared to apples.
Again there is no definitive rule for what ratios to look for. Some people are more comfortable than others making a generalization about a share based upon lower ratios, but I generally look for all ratios to be at least 2-1 with the exception of the total ratio where I look for 1.5-1.
The next rule that is important to follow is that you have to look at recent share performance to determine if whatever is causing the abnormal options open interest has already been priced into the stock's share price. This will have to be purely a judgement call, but sometimes it is blatantly obvious. The positive note is that you can always wait a little while and then re-evaluate because the LEAPS are not going anywhere.
The last and perhaps most important rule is that you have to continually evaluate your position. It is important to remember that the options market is highly liquid and full of speculators who can change positions at any moment. You must continually monitor the options that you are using as your indicator to ensure that you are still on the same side as the herd.
I have employed this strategy of using the options market for some time now and have seen an astonishing 70% success rate thus far and more often than not, the times that I am wrong are times that I have violated my own rules. My most profitable move yet based on this strategy was taking a short position in Bear Stearns based upon the January 2008 LEAPS.
In taking a close look at the January 2009 LEAPS, two stocks in particular that stand out are Kraft (KFT) and Sears Holdings (SHLD). The ratios for these two companies are as follows:
In many of the articles that I have previously written I have used certain wording and talked in generalities, purposely leaving some information out and including some correct but overall purposeless information. I did this because I was trying to provoke a response to these certain elements in order to more closely study the overall market psychology. There are times when people did not respond at all to items that I thought to be very provocative and times when people responded negatively to items that I initially thought to be harmless.
My conclusion from this and from my other close studies of the psychology of the financial markets is that people, perhaps without even knowing it, trade and invest as one "herd". I have found signs of this "herd mentality" in every aspect of the financial markets.
I have collected enough information that I feel comfortable making the following generalizations about the "herds" of the financial markets:
- No matter how bad things may get, the herd still wants to be long stocks.
- The herd is very short tempered with people on the short side.
- If, on the rare occasion, a herd does go "short" something...watch out below for that stock.
- The herd, as is normal human tendency, will do everything possible to defend their positions even if they are proven wrong time and again.
- The herd plays favorites with certain companies.
- The herd will ignore it when the "writing is on the wall" (By this I mean that sometimes things are just blatantly obvious and yet the herd will hold on and go down with the ship...just ask Joe Lewis about this)
This is simply a result of a logical human decision process that goes something like this: If bank A and bank B have had these tremendous write downs then bank C probably will sometime in the future. The logic is perfectly sound and I think that it is a very natural human logic. It can be found everywhere in the market, the fact that so many people buy into this very type of logic is what forms the herd mentality. The question now becomes "how do I profit from understanding this market psychology?"
Well, as I said earlier, this "herd mentality" can be found everywhere in the financial markets not just in the stock market. So, the way that I answer the question of how to profit from the herd mentality is that I look to the herd in the options market. Stock options, and in particular LEAPS, are good indicators of what the market players think is going to happen to a stock in the future. The options market has a herd (albeit a much smaller one) just like the stock market does and if you look for just the right indicators, you can make a generalization about the future of certain stock prices based upon where the money of the options market herd is going.
What I look for is levels of high open interest either on the put or call side. If I find an abnormally high open interest level I first search the headlines to see if there is any glaringly obvious reason for why the open interest would be so high. If I find a reason then I usually move on, but if I don't I then apply a set of strict rules which will help to further weed out the options which are unsuitable for this strategy.
Firstly, the option indicators are basically useless if the option is too thinly traded. In the thinly traded options, one person could hold a large position that is skewing the options for that particular equity and it would certainly not be wise to take up a position based upon one other individual's conviction about a stock. There is no definitive rule that I follow here, but do look for consistent daily volumes of 500-2,500 minimum and open interest levels of at least 5,000.
The next rule is that you have to compare apples to apples. By this I mean that if you find an abnormally high open interest for a call or put you have to compare it to it's equivalent put or call. For example, say a stock is trading at 53 and the 60 calls are showing an outrageously high open interest. I have found that many people, in finding abnormal open interest levels, simply will compare these 60 calls to the 60 puts. While I do calculate the same strike ratio, I don't think that this is as important as what I call the "straddle strike" ratio. The straddle strike ratio calculates the ratio of the open interest in the 60 calls against the open interest in the 45 puts. I find this to be important because it calculates how many options are outstanding that are making the exact inverse bet on the share price as the 60 calls. 45 puts are the exact inverse of 60 calls in this situation because they are each two strikes away from the actual price in their own direction. I also calculate the opposite ratio which measures the ratio between the calls with the highest open interest and the puts with the highest open interest, regardless of strike.
While these three ratios are all important in deciding if an open interest level would be classified as abnormally high, perhaps the most important indicator is the total call to total put ratio. This is calculated simply by adding up the open interest on all the calls and dividing that by the total open interest for all of the puts. This total ratio ensures that apples are being compared to apples.
Again there is no definitive rule for what ratios to look for. Some people are more comfortable than others making a generalization about a share based upon lower ratios, but I generally look for all ratios to be at least 2-1 with the exception of the total ratio where I look for 1.5-1.
The next rule that is important to follow is that you have to look at recent share performance to determine if whatever is causing the abnormal options open interest has already been priced into the stock's share price. This will have to be purely a judgement call, but sometimes it is blatantly obvious. The positive note is that you can always wait a little while and then re-evaluate because the LEAPS are not going anywhere.
The last and perhaps most important rule is that you have to continually evaluate your position. It is important to remember that the options market is highly liquid and full of speculators who can change positions at any moment. You must continually monitor the options that you are using as your indicator to ensure that you are still on the same side as the herd.
I have employed this strategy of using the options market for some time now and have seen an astonishing 70% success rate thus far and more often than not, the times that I am wrong are times that I have violated my own rules. My most profitable move yet based on this strategy was taking a short position in Bear Stearns based upon the January 2008 LEAPS.
In taking a close look at the January 2009 LEAPS, two stocks in particular that stand out are Kraft (KFT) and Sears Holdings (SHLD). The ratios for these two companies are as follows:
These ratios all lean toward the bullish side of these two companies and all of the criteria mentioned above is met. It is still important to remember that though the options market can provide a good indicator of future expectations, it is not correct all of the time. The options market "herd" can indeed be incorrect.
There is a further risk that the situation for either Kraft or Sears Holdings could deteriorate and the options indicators could change. With close observation though, this risk can be mitigated.
In the end, market psychology is one more tool to put in your tool box. In my experience, the options market is a good way to use the market psychology to an advantage. I wouldn't recommend changing your entire portfolio based upon this one strategy, but I thinking adding a few stocks based upon it is not an entirely bad idea.
The bottom line is that, though the herd mentality does not always make the correct decision, it does carry a significant amount of money and influence into the marketplace. I think that you can use the herd to piggyback your way to a little profit, but it does take careful study of each individual stock in order to fully understand the psychology at work.
(disclosure: author hold a long position in SHLD and KFT)
Happy Investing
InglefoX
Wednesday, July 23, 2008
Just What the Telecom Companies Didn't Want to Hear.
Thus far it's been a rough year for telecommunications companies like Verizon (VZ), Sprint Nextel (S) and AT&T (T). As of July 23rd they have all seen their share prices plummet by greater than 20%. Recently it looked like that trend may have been coming to an end and the share prices of their were set to recover. They still may recover, but if so, it won't be thanks to a warning from the University of Pittsburgh Cancer Institute.
According to a story written by the Associated Press on July 23, 2008, Dr. Ronald B. Herberman, who is the director of the University of Pittsburgh's Cancer Institute, issued a warning to faculty and staff: "limit cell phone use because of the possible risk of cancer." Herberman goes on to note that he perceives cell phone usage to be most dangerous in children because their brains are still developing and he even warns that using a cell phone in public places could be dangerous because of the risk of exposing others to the cell phone's electromagnetic radiation.
While there are a handful of scientists who believe that the electromagnetic radiation emitted by cell phones cause brain tumors, that thought is disputed by the majority of scientists because of a lack of evidence. However, this latest report comes from a well regarded cancer institute at the University of Pittsburgh which could possibly start to frighten people away from cell phone usage and will certainly spur other studies.
This decree by Dr. Herberman in and of itself will likely not affect the telecom companies, but it does raise the possibility that future academics will support Dr. Herberman. Worse yet for the telecoms is the possibility that newly conducted studies may support a possible link between cell phone usage and brain tumors. If this were to happen then it may be the beginnings of total disaster for companies who rely on cell phones as such a significant source of revenue.
The possible disaster scenario could look much like the disaster scenario that the tobacco companies faced after studies proved the link between lung cancer and smoking. While this is obviously highly speculative and representative of an absolute worst case scenario at this point in time, if a link to brain cancer and cell phone usage were to be found then the telecom companies would probably find themselves being sued into oblivion.
That is obviously a situation that the telecom companies would rather not think about, but as I see it, this thought already has crossed their minds. In fact, much like the tobacco companies of the last few decades, today's telecom companies are commissioning their own studies into the matter. To date all of these studies have concluded that there is no link between cell phone usage and cancer.
Dr. Herberman does admit that no definitive study has come out to support his theory yet, but he claims that he is advocating that people "err on the side of being safe rather than being sorry later".
The biggest problem that Dr. Herberman's statements may cause for telecom companies right now is to put the thought in people's minds that cell phone usage may be dangerous. I don't see the usage of cell phones curving any time soon, but I do see people following this issue more attentively now, which could lead to problems for the telecoms if any more negative news or studies were released.
Perhaps this issue will just go away or perhaps further study will definitively reveal that there is no link between cancer and cell phones, but on the other hand this could potentially be the first step in a potentially devastating chain of future events for the telecom companies. It's enough to make me think twice about adding these companies to my long term portfolio and I think that's a shame because I do like what I see fundamentally in AT&T and Verizon right now.
So perhaps I'm taking Dr. Herberman's advice right now and I will "err on the safe side" not by cutting my cell phone usage, but by cutting my exposure to the telecom providers.
Note: the full AP article referenced above can be found at http://hosted.ap.org/dynamic/stories/C/CELL_PHONE_WARNING?SITE=WIMAR&SECTION=HOME&TEMPLATE=DEFAULT
Happy Investing
InglefoX
According to a story written by the Associated Press on July 23, 2008, Dr. Ronald B. Herberman, who is the director of the University of Pittsburgh's Cancer Institute, issued a warning to faculty and staff: "limit cell phone use because of the possible risk of cancer." Herberman goes on to note that he perceives cell phone usage to be most dangerous in children because their brains are still developing and he even warns that using a cell phone in public places could be dangerous because of the risk of exposing others to the cell phone's electromagnetic radiation.
While there are a handful of scientists who believe that the electromagnetic radiation emitted by cell phones cause brain tumors, that thought is disputed by the majority of scientists because of a lack of evidence. However, this latest report comes from a well regarded cancer institute at the University of Pittsburgh which could possibly start to frighten people away from cell phone usage and will certainly spur other studies.
This decree by Dr. Herberman in and of itself will likely not affect the telecom companies, but it does raise the possibility that future academics will support Dr. Herberman. Worse yet for the telecoms is the possibility that newly conducted studies may support a possible link between cell phone usage and brain tumors. If this were to happen then it may be the beginnings of total disaster for companies who rely on cell phones as such a significant source of revenue.
The possible disaster scenario could look much like the disaster scenario that the tobacco companies faced after studies proved the link between lung cancer and smoking. While this is obviously highly speculative and representative of an absolute worst case scenario at this point in time, if a link to brain cancer and cell phone usage were to be found then the telecom companies would probably find themselves being sued into oblivion.
That is obviously a situation that the telecom companies would rather not think about, but as I see it, this thought already has crossed their minds. In fact, much like the tobacco companies of the last few decades, today's telecom companies are commissioning their own studies into the matter. To date all of these studies have concluded that there is no link between cell phone usage and cancer.
Dr. Herberman does admit that no definitive study has come out to support his theory yet, but he claims that he is advocating that people "err on the side of being safe rather than being sorry later".
The biggest problem that Dr. Herberman's statements may cause for telecom companies right now is to put the thought in people's minds that cell phone usage may be dangerous. I don't see the usage of cell phones curving any time soon, but I do see people following this issue more attentively now, which could lead to problems for the telecoms if any more negative news or studies were released.
Perhaps this issue will just go away or perhaps further study will definitively reveal that there is no link between cancer and cell phones, but on the other hand this could potentially be the first step in a potentially devastating chain of future events for the telecom companies. It's enough to make me think twice about adding these companies to my long term portfolio and I think that's a shame because I do like what I see fundamentally in AT&T and Verizon right now.
So perhaps I'm taking Dr. Herberman's advice right now and I will "err on the safe side" not by cutting my cell phone usage, but by cutting my exposure to the telecom providers.
Note: the full AP article referenced above can be found at http://hosted.ap.org/dynamic/stories/C/CELL_PHONE_WARNING?SITE=WIMAR&SECTION=HOME&TEMPLATE=DEFAULT
Happy Investing
InglefoX
Sunday, July 20, 2008
Is the Goldman Sachs Pedestal Real?
One thing I've noticed among college students, academics and business professionals alike is that the name Goldman Sachs (GS) turns heads. People react with a sense of awe toward Goldman and most of these people probably could not even explain the first thing about Goldman outside of the fact that they are an investment bank. (Score one for Goldman's marketing and branding efforts) It had me thinking that if everyone reacted this way to Goldman, are there perhaps boatloads of people that put money into Goldman's stock not based upon a fundamental understanding of Goldman's business but based upon their name.
Source: Goldman Sachs
If you need proof of the blind investments that people often make then look no further than to any episode of Jim Cramer's Mad Money. All you need to do is watch one segment of Cramer's show and watch the live ticker at the bottom of the screen immediately run rampant with trades of whatever stock Cramer has just recommended. If this blind rationale occurs in the after-hours market based upon Cramer's name isn't it just as possible that this type of blind rationale occurs at an even greater pace based upon Goldman Sachs's name?
I don't want to doubt Goldman's ability to make money nor do I want to refute the claim that they are probably the strongest of the investment banks. What I do see though is that investors place Goldman on a pedestal and this pedestal perhaps doesn't allow Goldman's stock to trade at the level that it would be valued at without the pedestal in place.
Let's take a quick look at the numbers. Goldman Sachs has shown phenomenal earnings in some of the toughest market conditions. Their recent second quarter numbers were still down 11% despite their proven risk management abilities which have been heralded as some of the best in the business. The drop in their numbers still shows that they are susceptible to unseen market swings and that it is virtually impossible for them to make every single correct decision. That being said, their numbers are still far superior to anything that their peers are posting. The only number that Goldman posts which may be a turn-off for the more finicky investor is a negative enterprise value 463 billion.
If the Goldman Sachs pedestal is real then how could it come crumbling down and bring Goldman's share price with it? Well, the first thing that would bring them down would be weaker earnings and though it's certainly possible that the market could turn unfavorably, I don't think that would effect Goldman's earnings more than by 10% or so because they operate such a diversified business. Below is a graph provided by Goldman Sachs of their revenue sources by percentage.
Source: Goldman SachsThe one issue that could hurt Goldman and its pedestal the most would be if somehow the high public opinion of Goldman which props up the pedestal were changed into public disfavor. If this were to happen then it would most likely arise out of the business model which has been Goldman's key to success. By this I mean that this business model, which may be perfect for Goldman to maximize earnings and decrease losses, can lead to a multitude of conflicts of interest many of which Goldman simply brushes aside.
Look to last May for an example of this when Goldman gave a "sell short" recommendation on Washington Mutual's stock (WM). Though a "sell short" recommendation is a fairly rare occurrence on Wall Street, what made this particular one even more rare is that Washington Mutual is a client of Goldman Sachs. It was not long after Goldman had underwritten Washington Mutual's 7 billion dollar recapitalization and earned millions in fees from WaMu on this deal that Goldman was now telling their clients to sell WaMu's stock short.
Goldman Sachs also was dismissed from contention by the government of the city of Chicago for an advisory role on the possible sale of Midway Airport after Chicago's government had learned that Goldman was actively pursuing ownership into UK based airport operating group BAA, which was viewed as one of the potential bidders for Midway. Many might argue Goldman had an ethical responsibility to inform the city of Chicago of this potential conflict rather then letting them find out about if for themselves. Instead Goldman of doing so, Goldman pursued the advising deal without informing the city of this possible conflict of interest.
Goldman's conflicts of interest with their attempted BAA deal goes deeper than their Midway advisory bid. Just after the Spanish group Ferrovial launched a hostile bid for BAA, management at BAA invited Goldman Sachs to do a pitch for an advising role that would advise them about how to fend of Ferrovial's bid. Instead of doing a pitch for the advising role, though, Goldman banker Bill Young recommended to BAA's management that they sell themselves to a special investment vehicle spearheaded by Goldman Sachs. Needless to say, Goldman did not get the advising job and launched their own bid for BAA.
In all of the above cases Goldman Sach's will defend itself by claiming that they are protected by the firm's "Chinese Wall". For those of you not familiar with the Street lingo of the "Chinese Wall", it is the ethical responsibility of members within the various divisions of financial institutions to remain separate from the other divisions of the institution to prevent leaks of information that may lead to conflicts of interest. In the case of Goldman Sachs, a Chinese Wall is said to exist between the corporate advisory business and the mergers & acquisitions business.
The problem with the Chinese Wall in firms as large as Goldman Sachs is that they are never really airtight. The conflicts of interest problem is not solved by the Chinese Wall which leads to the greater question "can a financial institution combine M&A activities and advising/underwriting businesses and truly avoid conflict of interest?"
With the government beginning to play a greater role in oversight of the investment banks, it seems as though it is only a matter of time until the multitude of the conflicts of interest at the investment banks is brought to light and brought under public scrutiny. If this happens then I see the Goldman pedestal crumbling and their share price crumbling with it.
As mentioned earlier in this article part of the reason that Goldman has been so effective at risk management is that they are extremely diversified in their various businesses. The problem with this is that many of the various businesses fall on opposite sides of the Chinese wall. If government oversight increases drastically (and it is already beginning to) it is not outside the realm of possibility that new, radical laws could be enacted along the lines of Glass-Steagall, which in this case would separate M&A from advising. If this were to happen then the diversified business model which has led to superior risk management for Goldman would be in serious jeopardy.
Government scrutiny over the manipulation of short sellers could also be a thorn in the side for Goldman and a potential threat to their pedestal. Though it was Goldman complaining recently that their own shares were being manipulated by short-sellers, they have found themselves on the other side of this table as well. Goldman's executives were confronted by executives from Lehman Brothers (LEH) and Bear Stearns, which is now part of JP Morgan Chase, regarding Goldman's manipulation of their respective stocks. Bear Stearns CEO Alan Schwartz confronted Goldman CEO Lloyd Blankfein to ask if Blankfein had any knowledge as to the rumors that Goldman's London office engaged in manipulation (false rumor spreading) of Bear Stearns's stock just prior to its collapse. Lehman's Richard Fuld contacted Blankfein just recently and told him he was "hearing a lot of noise" that false rumors about Lehman, which was experiencing all time lows in its share price, were coming from the Goldman traders. If these issues are made even more public and the government launches a full scale investigation into them then I would certainly look for investor confidence to put downward pressure on Goldman's share price and deteriorate their pedestal.
A quick look at the price to book value of the company based upon the book value for the most
recent quarter and the price as of July 18, 2008 shows a value of 1.71. If that is compared to the industry peers of Citigroup (C), Lehman Brothers (LEH), Merrill Lynch (MER), Morgan Stanley (MS) and JP Morgan Chase (JPM) the Goldman Sachs value is much higher than any with the above companies reporting .87, .54, 1.18, 1.27 and 1.10 respectively.
With a price to book value that much higher than that of its peers, I am left to wonder just how much of that, if any can be attributed to the Goldman Sachs pedestal. Perhaps part of it is attributable to the Goldman Sachs pedestal, but it is also very possible that part of it is due to investors pulling money out of the stock of Goldman's competitors and putting their money into Goldman, which is viewed as far more stable.
recent quarter and the price as of July 18, 2008 shows a value of 1.71. If that is compared to the industry peers of Citigroup (C), Lehman Brothers (LEH), Merrill Lynch (MER), Morgan Stanley (MS) and JP Morgan Chase (JPM) the Goldman Sachs value is much higher than any with the above companies reporting .87, .54, 1.18, 1.27 and 1.10 respectively.
With a price to book value that much higher than that of its peers, I am left to wonder just how much of that, if any can be attributed to the Goldman Sachs pedestal. Perhaps part of it is attributable to the Goldman Sachs pedestal, but it is also very possible that part of it is due to investors pulling money out of the stock of Goldman's competitors and putting their money into Goldman, which is viewed as far more stable.
If anything were to happen to the Goldman pedestal I think they would still trade at a price to book value of at least 1.4, which would still be better than all of their peers. At a price to book of 1.4, the stock price would be at $150. This price certainly wouldn't signal an end of the world to Goldman or to Wall Street and would still reflect Goldman's superior capabilities it just wouldn't reflect the pedestal any longer.
When all is said and done I cannot deny that Goldman Sachs is indeed a profitable and well managed company. I do believe that they trade on a pedestal in the minds of investors and that pedestal is working to inflate the stock price somewhat. If it this pedestal were to crumble either from government action or negative public opinion then the stock probably would fall and be a good opportunity for a put option investor to pick up a quick chunk of cash. That trade would certainly carry some risk, but if you're not willing to take any risk then the options market certainly is not where you belong anyway.
Happy Trading
InglefoX
Wednesday, July 16, 2008
US Steel: Always Been There, Always Will Be.
With all the talks of recession, of manipulation in the financial markets, of hedge funds short selling the brokers and of oil hovering around all time highs, sometimes it seems that investors get too caught up in the fast paced world of Wall Street. Sometimes people forget about the "old-timers"...the companies that are responsible for making Wall Street what it is today. Companies that saw the Great Depression come and go, saw two world wars pass and saw times when titans like J. Pierpont Morgan, Andrew Carnegie, Charles Schwab, and so many other notables ruled the Street.
Perhaps I'm just being a little nostalgic for a simpler, more gentlemanly time, but it just seems like today's Wall Street players, people like Vikram Pandit, Jamie Dimon, Lloyd Blankfein and Jeffrey Immelt can't quite stand up to the caliber of their predecessors. I'm not doubting the intelligence of these individuals nor do I mean to diminish their accomplishments, but what I am saying is that I think they're caught up in a Wall Street that just over complicates things.
Take for example, US Steel (X) in the year 2008. In a year that has seen all of the major indices fall into bear market territory, US Steel has seen its shares rise 28% year to date. Yet, no one on Wall Street seems to notice. I never hear Jim Cramer dedicate a segment to US Steel and the Wall Street Journal has given more attention to the crumbling airline stocks than they have to a perennial winner like US Steel. Why is this?
I think the answer is simple really. US Steel just isn't very "sexy" by today's Wall Street standards. They don't engage in transactions that require an accountant, an engineer and divine intervention to value. You never really hear them griping about short sellers manipulating their stocks and you don't see them taking their excess capital to the NYMEX to speculate on crude oil. No, US Steel focuses on one thing. It is the same thing that they have focused on (minus that brief 20 year period when they owned Marathon Oil) for their entire century plus of existence. That is producing and selling steel.
There was a time, though, when US Steel was the "sexiest" thing on Wall Street. Incorporated on February 25, 1901 with the efforts of J.P. Morgan, Elbert H. Gary and Andrew Carnegie, US Steel was the world's first ever IPO in excess of 1 billion dollars. It was so massive and so revolutionary that for years, Wall Street simply referred to it as "the Corporation". The great Charles Schwab was the company's first president (he would leave in later years to run Bethlehem Steel).
US Steel has had a history of resilience too. They have fought off the anti-trust efforts of the federal government, survived the difficulties of the Great Depression, withstood countless labor disputes and even repelled an effort by President Harry Truman to nationalize their steel mills.
Even more than most people realize, US Steel is also an American icon. They have lent elements of their logo (the three multi-colored hypocycloids) to the Pittsburgh Steelers NFL team and in 1906 they built the city of Gary, Indiana (and still operate the largest steel mill in the northern hemisphere in Gary).
But even with such a rich history, Wall Street still doesn't even seem to recognize US Steel now. They don't make extraordinary profits like some on Wall Street would like, but they do make a steady flow of profit. Their share price has risen this year which could easily be attributed to the high worldwide demand for steel (which isn't likely to decrease any time soon), but the bottom line is that, US Steel knows the steel industry better than anyone else (that's bound to happen when you've been in the same business for a century).
It is likely that their current CEO John Surma has documents in his file cabinet signed by Charles Schwab, Andrew Carnegie and the incomparable J. Pierpont Morgan. These documents are probably lost to time though just like the once great company that was known by all simply as "the Corporation".
I can't ignore the fact that US Steel is still profitable and that they focus simply on producing steel. Even the subsidiary companies that they own now are involved in the production of basic materials needed to produce steel or in the distribution of steel. This company has experience in its industry that you just can't find anywhere else.
Maybe it's time that I stopped feeling so nostalgic and just put US Steel out of my mind like Wall Street seems to have done. But when I ask myself "if the likes of J.P. Morgan were here today where would he be putting his money?" The answer that I invariably come to is that Morgan would be ashamed of Wall Street and its CDO's and of the irresponsible lending that led to this current crisis (even though I think he would be proud of the way Jamie Dimon "rescued" Bear Stearns) and he would have his money in none other than US Steel. And J.P. Morgan certainly wasn't wrong all that often. Something to step back and think about for all those in the fast paced world of Wall Street.
Happy Investing
InglefoX
Perhaps I'm just being a little nostalgic for a simpler, more gentlemanly time, but it just seems like today's Wall Street players, people like Vikram Pandit, Jamie Dimon, Lloyd Blankfein and Jeffrey Immelt can't quite stand up to the caliber of their predecessors. I'm not doubting the intelligence of these individuals nor do I mean to diminish their accomplishments, but what I am saying is that I think they're caught up in a Wall Street that just over complicates things.
Take for example, US Steel (X) in the year 2008. In a year that has seen all of the major indices fall into bear market territory, US Steel has seen its shares rise 28% year to date. Yet, no one on Wall Street seems to notice. I never hear Jim Cramer dedicate a segment to US Steel and the Wall Street Journal has given more attention to the crumbling airline stocks than they have to a perennial winner like US Steel. Why is this?
I think the answer is simple really. US Steel just isn't very "sexy" by today's Wall Street standards. They don't engage in transactions that require an accountant, an engineer and divine intervention to value. You never really hear them griping about short sellers manipulating their stocks and you don't see them taking their excess capital to the NYMEX to speculate on crude oil. No, US Steel focuses on one thing. It is the same thing that they have focused on (minus that brief 20 year period when they owned Marathon Oil) for their entire century plus of existence. That is producing and selling steel.
There was a time, though, when US Steel was the "sexiest" thing on Wall Street. Incorporated on February 25, 1901 with the efforts of J.P. Morgan, Elbert H. Gary and Andrew Carnegie, US Steel was the world's first ever IPO in excess of 1 billion dollars. It was so massive and so revolutionary that for years, Wall Street simply referred to it as "the Corporation". The great Charles Schwab was the company's first president (he would leave in later years to run Bethlehem Steel).
US Steel has had a history of resilience too. They have fought off the anti-trust efforts of the federal government, survived the difficulties of the Great Depression, withstood countless labor disputes and even repelled an effort by President Harry Truman to nationalize their steel mills.
Even more than most people realize, US Steel is also an American icon. They have lent elements of their logo (the three multi-colored hypocycloids) to the Pittsburgh Steelers NFL team and in 1906 they built the city of Gary, Indiana (and still operate the largest steel mill in the northern hemisphere in Gary).
But even with such a rich history, Wall Street still doesn't even seem to recognize US Steel now. They don't make extraordinary profits like some on Wall Street would like, but they do make a steady flow of profit. Their share price has risen this year which could easily be attributed to the high worldwide demand for steel (which isn't likely to decrease any time soon), but the bottom line is that, US Steel knows the steel industry better than anyone else (that's bound to happen when you've been in the same business for a century).
It is likely that their current CEO John Surma has documents in his file cabinet signed by Charles Schwab, Andrew Carnegie and the incomparable J. Pierpont Morgan. These documents are probably lost to time though just like the once great company that was known by all simply as "the Corporation".
I can't ignore the fact that US Steel is still profitable and that they focus simply on producing steel. Even the subsidiary companies that they own now are involved in the production of basic materials needed to produce steel or in the distribution of steel. This company has experience in its industry that you just can't find anywhere else.
Maybe it's time that I stopped feeling so nostalgic and just put US Steel out of my mind like Wall Street seems to have done. But when I ask myself "if the likes of J.P. Morgan were here today where would he be putting his money?" The answer that I invariably come to is that Morgan would be ashamed of Wall Street and its CDO's and of the irresponsible lending that led to this current crisis (even though I think he would be proud of the way Jamie Dimon "rescued" Bear Stearns) and he would have his money in none other than US Steel. And J.P. Morgan certainly wasn't wrong all that often. Something to step back and think about for all those in the fast paced world of Wall Street.
Happy Investing
InglefoX
Monday, July 14, 2008
Do We Take our Water For Granted?
Here in the United States whenever we turn on the tap on our sinks, bathtubs, etc. out comes a flow of water. The United States is a water rich nation compared to many others and a developed nation at that. This means that for now, water resources have been adequate to meet demand. It is estimated that of the over six billion people in the world though, that one billion lack access to potable water. Most of these people are in underdeveloped nations that lack the resources to develop new potable water sources. But for the average American, these problems are miles and worlds away right? Well, perhaps for now, but is it possible that water shortages may be arriving to the world's richest nation? The signs of shortage are already beginning to show and something will have to be done in order to stop it.
The graph below shows just how severe the water shortages have been worldwide and just how fortunate we have been here in the United States thus far.
The graph below shows just how severe the water shortages have been worldwide and just how fortunate we have been here in the United States thus far.
With the population of the United States and the world on an ever increasing trend, the demand for water rises every year. The unfortunate problem is that for those who rely on rainfall as part of their water supply needs, droughts have been occurring in record numbers lately. If global warming is real as most experts now agree is the case, then the predicted effect of global warming will be to reduce rainfall even further and produce even more drought.
There is more to blame for rising water demand than just an increase in population. The increased demand for water guzzling electricity production and inefficient uses of the current water supply are to blame as well.
Nuclear Energy production uses tremendous amounts of water to cool the super-heated uranium rods and this demand is only likely to rise with politicians beginning to call for an increased reliance on nuclear power. Thermal energy is an extremely large water user and virtually all power production facilities such as coal or natural gas, use water in their production process.
According to Shiney Varghese, a senior policy analyst at the Institute for Agriculture and Trade Policy, 80 % of our nations freshwater is put to use for irrigation. According to Varghese, this high percentage is due to the inefficient usage of water in irrigation. Large portions of irrigation water still flowing through open ditches, which allows water to soak into the ground surrounding the ditch and to rapidly evaporate.
As if that weren't enough to prove that a water crisis is approaching then the rampant court battles between states over water rights may be. For the past 18 years Georgia, Alabama and Florida had been feuding over Georgia's right to draw excess water from Lake Sidney Lanier. The lake is in Georgia but flows downstream and provides water to consumers in both Alabama and Florida. Georgia just lost this battle in February. This is not an isolated case though, the Kansas Supreme Court has just agreed to hear a case involving 1.2 billion gallons of groundwater from the Kansas River Valley. The area water district is seeking to exercise eminent domain in order to pump the groundwater to rapidly growing Johnson County, but the farmers who own the land are contesting. Furthermore, States in the Western United States have been feuding for years over the usage of the Colorado River and to emphasize that this is not just a localized problem, the countries of Turkey, Syria and Iraq are also feuding over the usage of the Tigris and Euphrates Rivers.
The signs are here that water shortages may be looming, estimates cited by Shiney Varghese claim that there is a 50% chance that Lake Mead will be dry by 2021 if current trends continue. Lake Mead along with nearby Lake Powell provide water to nearly 25 million residents in the Southwestern United States.
This problem can be fixed though. Not only will water conservation efforts be key, but a movement to privatize water utilities is gaining steam as well. If the utilities were privatized then the development of available technology would be able to proceed much faster and more efficiently. For example, the technology of desalination, which very well could be the best way to supply water for future uses, is currently underutilized in the United States. Currently there are only about 250 desalination plants in the United States and about half of them are in Florida. The issue is that the municipalities seem too concerned with saving money and moving money into other politically popular causes rather than focusing on a technology that could help avert a coming water crisis.
There is money to be made for investors in the privatizing of water infrastructure. Just take a look at oil-turned-water baron T. Boone Pickens if you need proof of the potential profits. Mr. Pickens would likely not be putting large investments, not to mention a few court battles of his own, into water infrastructure and supply if there weren't potentially high profits in the works.
If you don't have the amount of capital that T. Boone Pickens has and can't afford to create your own water infrastructure then don't despair there are several companies out there that specialize in water supply and as the movement to privatize water utilities grows stronger these companies all stand to profit immensely.
Companies that supply water utilities include:
- Aqua America (WTR) which operates mainly in the northeast as well as the Carolinas and Florida. They specialize in providing both water and waste water services.
- American States Water Company (AWR)-which operates in various locations, most notably California and also offers electric and contracted services.
- California Water Services Group (CWT)- They operate in California, Hawaii, New Mexico and Washington- the bulk of their revenues comes from the distribution and sale of water for domestic, industrial, irrigation and public uses. As a more traditional utility, they stand to benefit as water becomes more scarce, driving the price higher and they also will likely look to enter new markets if municipalities decide to privatize their operations.
- SouthWest Water Company (SWWC)- which owns water production operations in California, New Mexico, Texas, Oklahoma, Mississippi and Alabama.
- Energy Recovery Inc. (ERII)-These are the specialists in seawater desalination and are likely to profit immensely once desalination is relied on more heavily as a source of water.
- Consolidated Water Company (CWCO)- These are also specialists in desalination technology who also stand to profit if desalination becomes the "go to" method for producing potable water.
The bottom line is that water can be gold if you know where to look. There is a water shortage approaching and its signs are already starting to show. This crisis can be averted, however, with smart management. All while investors look like they may just be able to profit from a renewed interest in the water utilities.
Happy Investing
InglefoX
Sunday, July 13, 2008
Why it's Time for Investors to Pick up the Garbage.
With all of the major indices now in bear market territory it seems as though the best way for a long investor to play this market is to avoid the losing stocks and switch into the winners. I sometimes liken investing to gambling, but the advantage of investing over gambling is that you can change your bet at any time. Imagine if you were playing blackjack only to find that you had a very weak hand. But in this particular game of blackjack you can swap cards with the person sitting next to you and as luck would have it, that person has a very strong hand that looks very likely to win. Now, you could always risk going bust and take another card to try to strengthen your hand, but if given the option virtually any gambler would take the bet that is closer to a sure thing. Unfortunately when gambling a player doesn't have the option to change his/her hand, but an investor can change investments at any time.
So, my question to all of the investors out there is simple. Would you rather risk your money in the struggling industries of the market or would you like to put your money in an industry that is actually making money in 2008? Or for those of you who enjoyed my gambling analogy above, would you rather hold the cards that lose more often than not or the cards that have won more than not?
For those of you that want to bet on the industries that have been outperforming the market then I would recommend investing in industries that are more or less "recession proof". Typically investors think of such industries as grocery and tobacco as "recession proof", but I'm here to suggest another industry that is, as a whole, reporting in positive territory in a year that has seen all of the major indices fall into bear market territory. That industry is garbage disposal, otherwise known as waste management services.
Why is this industry performing so steadily? It's simple really, this industry always performs quite steadily. People, in times of boom or recession, will always produce garbage, as will businesses and municipalities.
The beauty of the business model for the waste disposal companies is that, for many of their customers, they charge a set period fee regardless of the amount of trash taken. Most customers (especially individual people) have to pay the waste disposal companies the same amount whether or not their trash can is full every week. So, even if individuals were able to cut back on their trash levels, they are locked in on their garbage disposal prices.
Waste disposal companies are also finding ways to benefit from one of the more popular trends...recycling. These companies will haul away recyclables and sell them back onto the open market, meaning that this can be a separate source of income for the companies (and a quite lucrative one given the prices that many materials are selling for currently).
Some of the more successful companies within the waste disposal industry include the behemoth Waste Management Inc. (WMI), Republic Services, Inc. (RSG), Allied Waste Industries (AW) and Waste Connections (WCN). Three of these four companies have seen their share prices increase in 2008. With WMI, AW and WCN being up 12.1%, 8.8% and 5.2% year to date, respectively. Only RSG has seen its share price fall being down 11% for the year.
Focusing on the Waste Management (WMI) in particular, this company has shown steady but shallow growth over the past 8 years. They are easily the largest company within this industry having a market capitalization of just over 18 billion dollars, over three times larger than their nearest competitor. They have shown extremely steady revenues over the past several quarters, reporting between 3.2 billion and 3.4 billion in their last several quarters. They have shown steady operating income as well ranging between 500 and 600 million per quarter. They have even reported yearly net incomes at over $2.00 per share for the past three years. As if that weren't enough, they also yield a dividend of just under 3% (competitive with the current yield on many savings accounts).
Waste Management has a few other tricks up its sleeve that help to put it ahead of the game. It owns 16 waste to energy plants and owns or operates 277 landfills. The company reports that 5.6% of their revenues are derived from these waste to energy plants and 20% of revenues come from the usage of their landfills by others. They are seeking to expand many of their landfills and are looking to divest underperforming recycling plants and collection locations. This will make them a "leaner" company that is focused solely upon creating profits and value for shareholders all while operating under an environmentally focused political environment that views the company rather favorably.
The only major concern is rising fuel costs which make it more expensive for waste collection vehicles to function. These vehicles are not particularly fuel efficient and they are operating nearly non-stop. The margins, however, for WMI and its peers do seem adequate at the current time to absorb the fuel costs and keep them still operating in the black. They will also probably pass on much of the higher fuel costs to customers in the form of price increases and WMI's planned divestiture of the less profitable collection routes will also help them to shed the routes that may have fallen into the red due to higher fuel costs.
Like Waste Management, the other players in the waste disposal business mentioned above (AW, RSG and WCN) all have also shown very steady revenues, expenses and profits. It is very likely that they along with WMI will all continue this trend and see higher share prices by the end of the year. It is also very possible that investors may push the price of these stocks even higher than they would otherwise go as more and more investors look for "safe haven" investments. So, the window of opportunity on these stocks is here now and may be closing fast.
The bottom line is that if you're looking for an investment that is likely to be higher at the end of 2008 and that will yield better than a money market account then waste disposal may be just what you're looking for. The waste disposal companies have exhibited positive trends in a more or less "insulated" industry and these trends are more than likely to continue. If you're looking for a steady investment in rather unsteady times then perhaps you should think about picking up some trash.
Happy Investing
InglefoX
So, my question to all of the investors out there is simple. Would you rather risk your money in the struggling industries of the market or would you like to put your money in an industry that is actually making money in 2008? Or for those of you who enjoyed my gambling analogy above, would you rather hold the cards that lose more often than not or the cards that have won more than not?
For those of you that want to bet on the industries that have been outperforming the market then I would recommend investing in industries that are more or less "recession proof". Typically investors think of such industries as grocery and tobacco as "recession proof", but I'm here to suggest another industry that is, as a whole, reporting in positive territory in a year that has seen all of the major indices fall into bear market territory. That industry is garbage disposal, otherwise known as waste management services.
Why is this industry performing so steadily? It's simple really, this industry always performs quite steadily. People, in times of boom or recession, will always produce garbage, as will businesses and municipalities.
The beauty of the business model for the waste disposal companies is that, for many of their customers, they charge a set period fee regardless of the amount of trash taken. Most customers (especially individual people) have to pay the waste disposal companies the same amount whether or not their trash can is full every week. So, even if individuals were able to cut back on their trash levels, they are locked in on their garbage disposal prices.
Waste disposal companies are also finding ways to benefit from one of the more popular trends...recycling. These companies will haul away recyclables and sell them back onto the open market, meaning that this can be a separate source of income for the companies (and a quite lucrative one given the prices that many materials are selling for currently).
Some of the more successful companies within the waste disposal industry include the behemoth Waste Management Inc. (WMI), Republic Services, Inc. (RSG), Allied Waste Industries (AW) and Waste Connections (WCN). Three of these four companies have seen their share prices increase in 2008. With WMI, AW and WCN being up 12.1%, 8.8% and 5.2% year to date, respectively. Only RSG has seen its share price fall being down 11% for the year.
Focusing on the Waste Management (WMI) in particular, this company has shown steady but shallow growth over the past 8 years. They are easily the largest company within this industry having a market capitalization of just over 18 billion dollars, over three times larger than their nearest competitor. They have shown extremely steady revenues over the past several quarters, reporting between 3.2 billion and 3.4 billion in their last several quarters. They have shown steady operating income as well ranging between 500 and 600 million per quarter. They have even reported yearly net incomes at over $2.00 per share for the past three years. As if that weren't enough, they also yield a dividend of just under 3% (competitive with the current yield on many savings accounts).
Waste Management has a few other tricks up its sleeve that help to put it ahead of the game. It owns 16 waste to energy plants and owns or operates 277 landfills. The company reports that 5.6% of their revenues are derived from these waste to energy plants and 20% of revenues come from the usage of their landfills by others. They are seeking to expand many of their landfills and are looking to divest underperforming recycling plants and collection locations. This will make them a "leaner" company that is focused solely upon creating profits and value for shareholders all while operating under an environmentally focused political environment that views the company rather favorably.
The only major concern is rising fuel costs which make it more expensive for waste collection vehicles to function. These vehicles are not particularly fuel efficient and they are operating nearly non-stop. The margins, however, for WMI and its peers do seem adequate at the current time to absorb the fuel costs and keep them still operating in the black. They will also probably pass on much of the higher fuel costs to customers in the form of price increases and WMI's planned divestiture of the less profitable collection routes will also help them to shed the routes that may have fallen into the red due to higher fuel costs.
Like Waste Management, the other players in the waste disposal business mentioned above (AW, RSG and WCN) all have also shown very steady revenues, expenses and profits. It is very likely that they along with WMI will all continue this trend and see higher share prices by the end of the year. It is also very possible that investors may push the price of these stocks even higher than they would otherwise go as more and more investors look for "safe haven" investments. So, the window of opportunity on these stocks is here now and may be closing fast.
The bottom line is that if you're looking for an investment that is likely to be higher at the end of 2008 and that will yield better than a money market account then waste disposal may be just what you're looking for. The waste disposal companies have exhibited positive trends in a more or less "insulated" industry and these trends are more than likely to continue. If you're looking for a steady investment in rather unsteady times then perhaps you should think about picking up some trash.
Happy Investing
InglefoX
Wednesday, July 9, 2008
Americans will Prove to be Formidable Do-It Yourself Mechanics.
With the price of living on an ever increasing trend, Americans are having to find more resourceful ways of cutting costs. They are cutting discretionary spending and foregoing large purchases such as new automobiles. The one problem that inherently comes with Americans opting out of a new automobile purchase and sticking with an aging automobile is that the aging automobile, more often than not, will need several repairs done. These repairs also represent significant costs to American families as having a mechanic repair an older vehicle for which a warranty has expired can be quite costly.
This is where the versatility of the American consumer shows up. Americans are pulling out their tool box, putting on their mechanic's hats and fixing their vehicles themselves. This is certainly bad news for mom and pop mechanic shops, but good news for the auto part suppliers who these "do it yourselfers" now rely on for parts.
This trend has actually found its way into the recent stock prices of such auto parts suppliers like Autozone Inc. (AZO) and Advance Auto Parts Inc. (AAP) as year to date both of these stocks are in positive territory up 2% and 1.6%, respectively. Now that may not sound like a significant amount, but considering the overall market performance any company that is in positive territory must be doing something right.
What differentiates AZO and AAP from their competitors such as Pep Boys (PBY) is that they focus specifically on supplying parts to the "do it yourselfer" and do not operate service shops in addition to a retail store. This model allows them to focus solely on their retail stores without having to worry about a struggling service shop bringing down the profits and raising the costs.
The odd thing about AZO and AAP that makes them very attractive for an option buyer is that they, along with the overall market, have seen their share prices dip recently from their June highs. They should be in store for a correction when the market realizes that nothing has changed about their business model and that they will still perform well under current consumer conditions as people continue this "do it yourself" trend.
Look for these companies to rebound soon making them a good call option purchase for the option traders out there and a sound investment in troubled economic times for the more risk averse investor.
Happy trading and happy investing
InglefoX
This is where the versatility of the American consumer shows up. Americans are pulling out their tool box, putting on their mechanic's hats and fixing their vehicles themselves. This is certainly bad news for mom and pop mechanic shops, but good news for the auto part suppliers who these "do it yourselfers" now rely on for parts.
This trend has actually found its way into the recent stock prices of such auto parts suppliers like Autozone Inc. (AZO) and Advance Auto Parts Inc. (AAP) as year to date both of these stocks are in positive territory up 2% and 1.6%, respectively. Now that may not sound like a significant amount, but considering the overall market performance any company that is in positive territory must be doing something right.
What differentiates AZO and AAP from their competitors such as Pep Boys (PBY) is that they focus specifically on supplying parts to the "do it yourselfer" and do not operate service shops in addition to a retail store. This model allows them to focus solely on their retail stores without having to worry about a struggling service shop bringing down the profits and raising the costs.
The odd thing about AZO and AAP that makes them very attractive for an option buyer is that they, along with the overall market, have seen their share prices dip recently from their June highs. They should be in store for a correction when the market realizes that nothing has changed about their business model and that they will still perform well under current consumer conditions as people continue this "do it yourself" trend.
Look for these companies to rebound soon making them a good call option purchase for the option traders out there and a sound investment in troubled economic times for the more risk averse investor.
Happy trading and happy investing
InglefoX
The Second Coming of Nuclear Power Will Lead to Boom in Uranium.
No one can ignore the push in the United States and elsewhere across the globe to move away from a dependence on fossil fuels and into a more environmentally friendly, low carbon emission means of producing energy, and in particular electricity. Feeling this push, politicians are moving to formulate plans by which electricity can be produced in an environmentally sound manner.
Despite the recent advancements in clean coal technology, coal fired power plants are still targeted as public enemy number one by the environmental movement. The United States, however, is still very much dependent upon coal as its primary supplier of electricity and no other environmentally friendly sources have proven that they are capable of supplying even close to as much energy as coal at a price that is cost feasible. But there is perhaps an exception that is becoming more cost feasible. That is nuclear power.
American politicians seemed to have turned their attention to nuclear power to help produce emission free electricity. Presidential candidate John McCain recently stated that he would like to see 45 new nuclear facilities built by the year 2030 and pledged 2 billion taxpayer dollars a year to help make that a reality. It is very likely that a proposal such as this will come to fruition no matter which party is elected and having funds like this available make nuclear power a cost feasible method of producing emission free electricity.
The first thought that investors will have in looking to play this coming boom in nuclear power will be to buy up stock in the owner/operators of the nuclear plants such as companies like NRG Energy (NRG). The issue with this is that even with such substantial federal subsidies in the pipeline for building these new plants it is likely that the nuclear power companies will still have to make a substantial initial investment in each reactor they build because of the hefty up front cost. Furthermore, with electricity being a regulated product, the profits that these companies can make will be capped.
The best way to play the future nuclear boom is to look to the most integral suppliers for the production of nuclear power: the uranium producers. The uranium producers' stocks right now have bargain basement prices and they stand to profit immensely in the coming years as nuclear production begins to ramp up.
The recent decline in prices of uranium has hammered the stock prices of uranium producers such as Uranium Resources Inc. (URRE) and Denison Mines Corporation (DNN). There are many factors to blame for the recent decline in prices and the first is that the 2006-2007 run-up in uranium prices was caused by a worldwide surge in demand and also by speculators frantically buying uranium in anticipation of a surge in nuclear capacity only to sell when they realized that the surge was still years off. Though the surge is still a few years away, the decline in uranium prices has created the perfect opportunity for the long term investor to swoop in and pick up some shares in these uranium producers at extremely low prices.
The worldwide demand for uranium hasn't changed too much over the years as year after year new production fails to meet worldwide demand. According to the Energy Watch Group, an organization of scientists that continually research worldwide energy production, the current demand for uranium is 67 kt/year and only 42 kt/year are supplied by new production. The remaining 25 kt is supplied by stockpiles at mines and power plants that were accumulated prior to 1980. The Energy Watch Group estimates that these stockpiles will be exhausted within 10 years and this will leave a tremendous imbalance between supply and demand that the uranium producers will have to step in to fill. Add to this scenario a new rash of federally subsidized nuclear reactors in the United States and the supply and demand imbalance becomes even larger.
The graph below, provided by the Energy Watch Group, shows the availability of yet to be mined uranium reserves. The orange shows reasonably expected reserves which can be extracted at $40.00 per Kt, the yellow area is reasonably expected reserves that can be extracted at $130.00 per Kt, and the light blue area shows inferred reserves that can be extracted at $130.00 per Kt. The black line shows the expected demand for uranium.
Despite the recent advancements in clean coal technology, coal fired power plants are still targeted as public enemy number one by the environmental movement. The United States, however, is still very much dependent upon coal as its primary supplier of electricity and no other environmentally friendly sources have proven that they are capable of supplying even close to as much energy as coal at a price that is cost feasible. But there is perhaps an exception that is becoming more cost feasible. That is nuclear power.
American politicians seemed to have turned their attention to nuclear power to help produce emission free electricity. Presidential candidate John McCain recently stated that he would like to see 45 new nuclear facilities built by the year 2030 and pledged 2 billion taxpayer dollars a year to help make that a reality. It is very likely that a proposal such as this will come to fruition no matter which party is elected and having funds like this available make nuclear power a cost feasible method of producing emission free electricity.
The first thought that investors will have in looking to play this coming boom in nuclear power will be to buy up stock in the owner/operators of the nuclear plants such as companies like NRG Energy (NRG). The issue with this is that even with such substantial federal subsidies in the pipeline for building these new plants it is likely that the nuclear power companies will still have to make a substantial initial investment in each reactor they build because of the hefty up front cost. Furthermore, with electricity being a regulated product, the profits that these companies can make will be capped.
The best way to play the future nuclear boom is to look to the most integral suppliers for the production of nuclear power: the uranium producers. The uranium producers' stocks right now have bargain basement prices and they stand to profit immensely in the coming years as nuclear production begins to ramp up.
The recent decline in prices of uranium has hammered the stock prices of uranium producers such as Uranium Resources Inc. (URRE) and Denison Mines Corporation (DNN). There are many factors to blame for the recent decline in prices and the first is that the 2006-2007 run-up in uranium prices was caused by a worldwide surge in demand and also by speculators frantically buying uranium in anticipation of a surge in nuclear capacity only to sell when they realized that the surge was still years off. Though the surge is still a few years away, the decline in uranium prices has created the perfect opportunity for the long term investor to swoop in and pick up some shares in these uranium producers at extremely low prices.
The worldwide demand for uranium hasn't changed too much over the years as year after year new production fails to meet worldwide demand. According to the Energy Watch Group, an organization of scientists that continually research worldwide energy production, the current demand for uranium is 67 kt/year and only 42 kt/year are supplied by new production. The remaining 25 kt is supplied by stockpiles at mines and power plants that were accumulated prior to 1980. The Energy Watch Group estimates that these stockpiles will be exhausted within 10 years and this will leave a tremendous imbalance between supply and demand that the uranium producers will have to step in to fill. Add to this scenario a new rash of federally subsidized nuclear reactors in the United States and the supply and demand imbalance becomes even larger.
The graph below, provided by the Energy Watch Group, shows the availability of yet to be mined uranium reserves. The orange shows reasonably expected reserves which can be extracted at $40.00 per Kt, the yellow area is reasonably expected reserves that can be extracted at $130.00 per Kt, and the light blue area shows inferred reserves that can be extracted at $130.00 per Kt. The black line shows the expected demand for uranium.
To give you an extra idea as to how critical the uranium supply situation can be, eleven countries including Germany, The Czech Republic, France, Congo, Gabon, Bulgaria, Tadshikistan, Hungary, Romania, Spain, Portugal and Argentina have already exhausted their domestic uranium resources. Several of these countries rely very heavily upon nuclear power for their electricity production and having no domestic uranium supply means that they must import their entire supply.
The one factor that seems to be keeping prices of uranium stable currently is the aforementioned stockpiles at the mines and power plants. These stockpiles that were created during the uranium mining boom of the 1970's mean that all demand can currently be met at reasonable prices. When these stockpiles do run out is when a worldwide shortage could take effect and give the uranium producers a golden opportunity to bring their products to market at an extremely high price.
For an investor to take advantage of this long term trend, the price seems right to jump in right now. Not only do Uranium Resources Inc. (URRE) and Denison Mines Corporation (DNN) look like they potentially stand to benefit from the second coming of nuclear power but so do companies such as Cameco Corporation (CCJ), which is also a player in the gold market, and Uranerz Energy Corporation (URZ), which is a smaller company that is engaged in the exploration stage of the uranium market rather than the actual mining.
The bottom line is that nuclear power is going to make a comeback in the United States and if you add more demand in the United States to an already present (but masked by excessive stockpiles) lack of supply then the answer inevitably will be higher prices for uranium. Higher prices for uranium will make the uranium producers money along with any investor prudent enough to pick up shares in their stock while they are at bargain prices.
As a note: the full report of the Energy Watch Group including many facts and figures mentioned in the above article can be found at: http://www.energywatchgroup.org/fileadmin/global/pdf/EWG_Uraniumreport_12-2006.pdf
Happy Trading and Happy Investing
InglefoX
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