Wednesday, May 31, 2006

Talking Earnings With S&P's Howard Silverblatt

I interviewed Howard Silverblatt of Standard & Poor's yesterday. He's the guy who tracks all the earnings numbers. According to Howard, first quarter results were stronger than expected. Operating earnings were up 14.9%, the best showing since the fourth quarter of 2004. Perhaps not unexpectedly, the Energy sector did best with a 36% gain in operating earnings. Telecommunications was the only sector that experienced a year-over-year decline. Operating earnings in this sector fell 1.3%.

Howard also talked about the record amounts of cash corporations are holding. With interest rates rising, these companies are generating a growing amount of interest income. While this extra income gives a nice boost to the bottom line, it isn't necessarily a good thing. After all, non-financial companies should be generating income from operations--not from investments.

We also talked about all the buyback activity that's been going on. Buybacks, or share repurchases, are generally a good thing. However, because buybacks reduce the share count, investors should not be fooled by the impressive growth in per share earnings when absolute earnings are growing much more slowly. Howard used Exxon Mobil to illustrate this point.

Finally, he gave his outlook for the current quarter and the rest of 2006. He thinks investors will be disappointed with second quarter results, but he expects things to improve during the second half of the year. This MoneyMasters interview will be available tomorrow morning at 6:00 am on the Video Network.

Friday, May 26, 2006

Enron Convictions Increase Investor Confidence

Yesterday, Ken Lay and Jeff Skilling, the two former Enron chiefs, were convicted of conspiracy and fraud. The Dow had its best day in more than two weeks. This wasn't simply coincidence. Investors rely on the accuracy and credibility of financial statements. If they can't assume that statements filed with the SEC are not fraudulent, they will take their money elsewhere. Rampant fraud would destroy the capital markets and prevent honest companies from getting the funding they need to develop the products and services that keep our economy strong. The Lay and Skilling convictions provide a much-needed dose of confidence.

Nonetheless, stocks are still off their early May highs. Of course, some stocks are doing great. However, many investors would be surprised by the leaders. For example, you might expect Exxon to be doing well. After all, high oil and gasoline prices are pushing Exxon's profits to record levels. Indeed, the stock is up about 9% year-to-date. Yet Exxon, which makes the energy that General Motors burns, can't hold a candle to GM. Just a few months ago, many experts were predicting GM's demise. No doubt they're shocked to see that GM is the best-performing stock in the Dow year-to-date. It's the fifth-best performer in the S&P 500. In fact, this money-losing company, which halved its dividend not too long ago, is up an incredible 47% so far this year. Lynn Harrison, a recent guest on MoneyMasters, talked about hedge funds that specialize in investing in financially distressed companies like GM.

Disney is another stock that may surprise investors. We added Disney to the Forbes Growth Investor recommended list last August. You can imagine the reaction. No one seriously thought of Disney as a growth stock. As of today, however, Disney is up 27% year-to-date.

All this points to the importance of diversification. Enron was a real high flier. Then it collapsed. Yet to a large extent, many of those who were wiped out have only themselves to blame. Whenever you put all or most of your money in any one stock, you are taking way too much risk. Many academics believe investors spend too much time worrying about security selection and not enough time worrying about asset allocation and diversification. In fact, I'm in the process of trying to secure an interview with an asset allocation specialist for a future segment of MoneyMasters. Stay tuned for more about this later.

Tuesday, May 23, 2006

Toll Brothers Revisited

Toll Brothers (TOL) announced fiscal second quarter financial results this morning. Investors welcomed the news and bid the stock higher. Revenues were up 16.7%, which was in line with expectations. Per share earnings, however, beat the $1.03 consenus estimate by three cents.

But don't be fooled by these seemingly good results. While EPS increased 6% year-over-year, net income climbed only 2.8%. You see, TOL beat the per share estimate because the weighted average number of diluted shares outstanding is 3.6 million fewer than it was a year ago. In fact, TOL repurchased 1.3 million shares in the fiscal second quarter alone, paying an average price of $30.49 for each share. Despite today's rally, the stock is selling below this level. This raises the question, why did management buy back shares? Did they believe the stock was cheap? Or were they trying to reduce the share count to increase the likelihood of beating the earnings estimate?

To management's credit, it provides a lot of metrics on the business. But whether you look at units sold, contracts signed, or backlog, they all point to slowing growth. In fact, including unconsolidated entities, contracts fell 31% from the fiscal second quarter of 2005. The company also lowered earnings guidance for fiscal 2006, at least in part, because of higher material and labor costs.

Many analysts point to the low multiples in this industry and say these homebuilders are very cheap. They're right. TOL is selling for less than six times fiscal 2006 expected earnings. However, the problem is that future earnings estimates are lower than actual earnings in recent periods. The valuation multiples are low for a good reason. Investors have come to believe that growth has ended.

With inventories rising and housing prices likely to come down--or at best, remain flat--this doesn't seem like the best time to jump into homebuilding stocks.

Saturday, May 20, 2006

For Whom the Bell Tolls

This is a big week for the housing sector. On Tuesday, homebuilder Toll Brothers (TOL) announces its fiscal first quarter financial results. The betting is for revenues of $1.45 billion and per share earnings of $1.03. To put that in perspective, revenues for the same quarter a year ago were $1.24 billion. At that time, TOL earned $1.00 per share.

So analysts are calling for 17% revenue growth, but only 3% growth for per share earnings. Why the big difference? Because TOL, like many homebuilders, is offering incentives to keep houses moving. As a result, profit margins are shrinking even though quoted prices are holding up. Despite all the incentives, however, homebuilders are still making lots of money. Nonetheless, the stocks are way off their highs because investors smell slower growth ahead. In fact, TOL is already down about 50% from the highs it hit last July. Other homebuilders have suffered similar selloffs.

What TOL says about its first quarter results, however, is not as important as what it might say about the outlook. If management gives any indication that growth is slowing more than expected--or worse, that growth has come to an end--we'll see further selling in the entire sector. Let's just hope that TOL doesn't pull a fast one and refuse to provide any guidance. Many companies have done that once they entered a period of slowing growth.

The excitement in the housing sector will continue on Wednesday when the new home sales figures come out. The expectation is for 1.15 million. Existing home sales figures come out on Thursday. The consensus estimate is for about 6.8 million. There already is plenty of evidence that the housing boom has ended. However, if actual results fall significantly below current expectations, the selling in this sector could get really ugly.

Thursday, May 18, 2006

Earnings Guidance Revisited

Shares of Dell Inc. (DELL) have been on a long and steady decline. In February, the company warned that first quarter results would fall short of expectations. Just over a week ago, DELL again lowered first quarter guidance for both earnings and revenues. In fact, the stock has been declining for over a year. Why? Because investors realize that growth is slowing.

And what is DELL's remedy for slowing growth? Today, management announced that it will no longer provide quarterly earnings guidance. DELL is joining the "no guidance" crowd. This crowd is being cheered on by the likes of Warren Buffett, who believes guidance puts too much emphasis on short-term results. He prefers measures that stress the long term.

However, the fact is that companies like DELL do not stop giving guidance because they've suddenly discovered the virtues of long-term management. They stop giving guidance because they realize they can no longer meet expectations. And if they can't meet expectations, they'd rather keep mum. This makes them a riskier bet.

I've written extensively about this issue on and in the Forbes Growth Investor. I'm happy to report that Steve Forbes agrees. He makes some excellent comments about guidance and the attempts to do away with it in his column in the June 5 issue of Forbes magazine. He also quotes me on page 28. This issue hits the newsstands this weekend.

Wednesday, May 17, 2006

Investing in Bankrupt Firms

Ever hear of vulture capital? No, not venture capital. Vulture funds specialize in investing in companies that are facing financial distress. These are usually firms with lots of debt and are in danger of going bankrupt. Traditionally, vulture investors buy the debt at huge discounts. Then they negotiate a corporate restructuring plan that leaves them holding much of the common stock in the newly emerged firm. More recently, however, some are even buying the stock of distressed companies while they are still in Ch. 11 bankruptcy.

Yesterday, I interviewed Lynn Harrison. He is a corporate bankruptcy attorney with Curtis, Mallet-Prevost, Colt & Mosle. That's an international law firm headquartered in New York City. Lynn is co-chair of the firm's bankruptcy and creditors' rights department. We talked about investing in distressed companies. We even talked a little about the U.S. automobile industry.

Lynn has also been spending time in China. Since China is becoming such a big player in the global economy, it must learn to handle financial distress in a manner that is consistent with global standards. Lynn was in China recently for a number of reasons. One was to study its bankruptcy laws and learn how they differ from those in the U.S. and elsewhere.

My MoneyMasters interview with Lynn Harrison will be posted on tomorrow morning at 6:00 am.

Friday, May 12, 2006

Stocks Selling Off

After closing in on its all-time high, the Dow industrials suffered a strong sell-off yesterday. The sell-off is continuing today. In fact, all major indexes are down. As is often the case, the greatest degree of selling is occurring in stocks that had the strongest gains in recent periods.

As I've been saying for some time in the Forbes Growth Investor (and on this blog), I see no reason for stocks to continue rallying. Why buy stocks when interest rates are rising, the housing boom is finished, and energy prices remain stubbornly high? Furthermore, thanks to the Fed, you can even get a decent return on cash.

As we saw in yesterday's retail sales figures, higher gasoline prices are indeed leaving consumers less money to spend on other things. Yet, today's Wall Street Journal seemed to bend over backwards to present the retail data in a favorable light.

Investors often confuse the economy with the stock market. I expect the economy to continue displaying decent growth. The problem is that growth is likely to slow to 2-3%. This isn't bad, but it is well below most economists' expectations. The stock market, on the other hand, is likely to see further weakness. With growth slowing, why jump into stocks right now? As I advised in my April 13 entry, investors should seriously consider allocating less to equities and more to cash.

Tuesday, May 09, 2006

Dining with Google

Robert Crozier, Forbes V.P. and Managing Director of Europe, Middle East, and Africa, hosted a dinner in London on Saturday night. In attendance were Jonathan Newhouse of Conde Nast International and Nikesh Arora of Google. Nikesh is an old friend of mine. He was a graduate student at Northeastern University in the early 1990s when I was on the faculty. Today, Nikesh is serving as Google's V.P. of European Operations. He is also one of the smartest people I know. From what I understand, Google is full of people like Nikesh. Getting a job at Google is tougher than getting into a top university. The candidate must survive six rigorous interviews. Yet Google is hiring like crazy because it is growing so rapidly.

Nonetheless, I still believe the stock is overpriced. If you buy it today, you may end up happy five or ten years from now, but I think the stock is likely to go lower before it goes higher. If you really love this company, buy the stock only on weakness.

Friday, May 05, 2006

The Only Bear on the High Seas

I haven’t posted to my blog lately because I've been busy traveling about Europe on the Ninth Forbes Cruise for Investors on Crystal Cruise Lines. Although the cruise began near Rome, I boarded several days later in Lisbon. Lisbon, by the way, is a wonderful city. If you've never been there, I highly recommend it. It isn't very big, the seafood is delicious, and the Gulbenkian Museum has a great collection of Islamic, Egyptian, and Chinese art. It also has many interesting modern pieces and outstanding gardens. From Lisbon we traveled to Bordeaux, an old city with many historic buildings made of limestone. Of course, the surrounding region is famous for its vineyards and wines. We also stopped in Guernsey, one of the Channel Islands. We finally disembarked in Southampton and made our way to London where I am right now.

The cruise was great fun and the investment sessions were educational. Forbes Publisher Rich Karlgaard hosted the event and moderated all the panel discussions. He put together a formidable cast of speakers included Steve Forbes, and Forbes columnists Marilyn Cohen and Ken Fisher. Other speakers included portfolio manager Gottfried Heller, Louis Navellier of Navellier & Associates, Ken Shea of Standard & Poor’s, Forbes senior editor Elizabeth MacDonald, and Josh Wolfe of the Forbes/Wolfe Nanotech Report. I was honored to be included in the group.

Because I boarded late, I didn’t hear all of the talks. However, I was fortunate to see some excellent presentations. Ken Fisher was bullish on the markets, but tried to temper expectations. He pointed out that in this business, beating the benchmarks by just a few percentage points per year is considered outstanding.

Gottfried Heller is an emerging markets specialist, but cautioned against buying individual stocks. Investing in emerging markets can be risky and requires a certain degree of expertise. He recommends emerging market funds instead.

Louis Navellier is a growth stock investor and focused his discussion on that sector. He talked quite a bit about his stock-grading system, which he said is available to all investors on his website.

Josh Wolfe is extremely enthusiastic about nanotechnology. He co-manages a venture capital fund and invests only in non-public firms. He says great technology is necessary, but not sufficient for success. Success also requires a strong management team who can communicate with investors and customers. He believes nanotech stocks will soon have their day.

Marilyn Cohen likes municipal bonds right now. She thinks the spread on junk bonds is too small for the risks. She also likes closed-end municipal bond funds.

My presentation focused on data analysis and investment strategies. I explained that equally smart people can reach different conclusions when studying the same data, and I discussed which investment strategies work best under certain situations.

All of the speakers took part in panel discussions. I was a little surprised, however, to learn during these sessions that I was the only bear in the group. I’m grateful to Rich for pointing out that my stock recommendations have been doing great according to the Hulbert Financial Digest. That’s why he found it odd that I wasn’t more bullish. I explained that I’m getting increasingly concerned about high energy prices. Add to that rising interest rates and the end of the housing boom, and I see no reason to be bullish on stocks right now.

Tonight I will be dining with one of Google's top European executives. As I've explained in the Forbes Growth Investor, I love the company, but consider the stock overpriced.