With just one more day of trading left, stocks are in danger of closing lower for January. As I write this, the Dow is up only 0.4% so far this month. Yet, as my staff and I put together the February issue of the Forbes Growth Investor, we are encouraged by the strong performance we are seeing from our picks. Our model portfolio is currently up 1.6%. Our sub-portfolios are doing even better. The Aggressive Growth portfolio is up 5.3%, benefiting from the 34% surge in MEMC Electronic Materials (WFR). This company recently reported outstanding top-line and bottom-line results and enjoyed several upgrades from Wall Street analysts. We will put out a full report in the February issue, which will be released to subscribers on Feb. 2.
Our Special Situation Survey investment newsletter is also doing great. This model portfolio is up 2.5% year-to-date, also well ahead of all the benchmarks. Ironically, one of our picks, Pilgrim's Pride (PPC) is up more than 4% today alone despite missing earnings estimates and warning of higher expenses in future periods. While I remain cautious about the overall market, I continue to believe it is possible to outperform through superior analysis.
Speaking of the overall market, we will learn more tomorrow when the fourth-quarter advance GDP estimate is released. That comes out before the market opens, so we could see quite a bit of volatility. The consensus estimate is 3.0%. My expectation is something closer to 2.5%. Tomorrow is also the day the Fed wraps up a two-day meeting and announces its decision on interest rates. I'm still surprised by those who believe the Fed will cut rates. If the Fed makes any move at all right now, it is likely to be a rate hike, not a cut. However, I would be very surprised if the Fed does anything other than keeping rates steady.
Tuesday, January 30, 2007
Thursday, January 25, 2007
Increasing Storage vs. Driving Smarter
I've been asked a number times recently what I thought about the president's plan to increase the Strategic Petroleum Reserve from its current maximum capacity of 727 million barrels to about 1.5 billion barrels.
My initial reaction is that expansion of the SPR will support oil prices and keep them from going lower because it increases marginal demand. However, the government will not be filling the expanded capacity all at once. It will do so slowly over a period of several years, so there shouldn't be much impact on world oil prices.
Yet I still have to wonder if storing all that oil makes sense. After all, oil is already stored. It is stored in the desert in Saudi Arabia. It is stored in Iran, Iraq, and Venezuela. The SPR merely transports oil from one storage facility to another. Does this make sense?
The purpose of the SPR is to provide a margin of safety in case one of our major suppliers decides to impose a boycott. That happened in the 1970s. However, despite some temporary shortages at that time, the only serious consequence was higher oil prices. And we saw that higher prices quickly eliminate shortages. What oil producer can resist saying no when the price is high enough?
I'm not convinced we need to expand the SPR. We still have enough room to store an addition 40 million barrels in the current SPR. In fact, we already have about 60 days worth of import protection.
Reducing consumption is far more effective than increasing reserves. The president also called for a 20% reduction in gasoline consumption over the next 10 years. This is not an unreasonable goal. But it won't be achieved with ethanol alone. The most promising technology on the immediate horizon to help reduce consumption is the plug-in hybrid. Several automobile manufacturers are planning to introduce these. Furthermore, demand for gas-guzzling SUVs is way down. Chrysler is even planning to bring the Smart Car to the U.S. We can immediately reduce consumption by a considerable amount simply by driving smarter. It looks like last summer's $3 per gallon gasoline price was all we needed to move us in the right direction.
My initial reaction is that expansion of the SPR will support oil prices and keep them from going lower because it increases marginal demand. However, the government will not be filling the expanded capacity all at once. It will do so slowly over a period of several years, so there shouldn't be much impact on world oil prices.
Yet I still have to wonder if storing all that oil makes sense. After all, oil is already stored. It is stored in the desert in Saudi Arabia. It is stored in Iran, Iraq, and Venezuela. The SPR merely transports oil from one storage facility to another. Does this make sense?
The purpose of the SPR is to provide a margin of safety in case one of our major suppliers decides to impose a boycott. That happened in the 1970s. However, despite some temporary shortages at that time, the only serious consequence was higher oil prices. And we saw that higher prices quickly eliminate shortages. What oil producer can resist saying no when the price is high enough?
I'm not convinced we need to expand the SPR. We still have enough room to store an addition 40 million barrels in the current SPR. In fact, we already have about 60 days worth of import protection.
Reducing consumption is far more effective than increasing reserves. The president also called for a 20% reduction in gasoline consumption over the next 10 years. This is not an unreasonable goal. But it won't be achieved with ethanol alone. The most promising technology on the immediate horizon to help reduce consumption is the plug-in hybrid. Several automobile manufacturers are planning to introduce these. Furthermore, demand for gas-guzzling SUVs is way down. Chrysler is even planning to bring the Smart Car to the U.S. We can immediately reduce consumption by a considerable amount simply by driving smarter. It looks like last summer's $3 per gallon gasoline price was all we needed to move us in the right direction.
Friday, January 19, 2007
Oil Prices on Slippery Slope
I've been doing quite a few hits on TV lately talking about oil prices. The two questions I'm asked the most are 1) why are oil prices falling, and 2) why aren't gasoline prices falling as much.
As is almost always the case, prices change due to supply and demand constraints. We've been seeing for some time now that there is plenty of oil around. In fact, the Saudis had been complaining about the lack of oil tankers to transport oil. That's because all the available tankers were already full and had no place to unload quickly. Furthermore, the mild winter (at least so far) in the Northeastern United States helped keep crude supplies at higher-than-expected levels.
So there is plenty of supply. What about demand? When gasoline prices hit $3 per gallon last summer, consumers suddenly woke up. For the first time in quite a while, average miles driven actually fell. Demand for gas guzzlers also fell. People started thinking seriously about car pooling and avoiding unnecessary trips. Overall demand is down.
This combination of greater-than-expected supplies and lower-than-expected demand has driven oil prices lower. Yet many consumers and commentators are complaining that gasoline prices haven't fallen in lockstep with oil prices. That's true, but that's normal. Gasoline prices lag oil prices. Yes, even on the way up. Nonetheless, gasoline prices and oil prices are highly correlated. In fact, the correlation coefficient for weekly price changes from June 2006 to the present is well over 90%.
Gasoline prices will go lower in the very near term. Especially if demand stays weak. As for the longer term, a cold snap in the Northeast will drive oil and gasoline prices higher. For the much longer term, demand in the U.S. may remain weak as we move toward alternatives such as ethanol, bio-diesels, and true hybrids. But that won't be enough to stem growing demand from India and China. This should keep oil prices firmly in the $40-60 range. I would be very surprised if prices ever fall below $30 again.
As is almost always the case, prices change due to supply and demand constraints. We've been seeing for some time now that there is plenty of oil around. In fact, the Saudis had been complaining about the lack of oil tankers to transport oil. That's because all the available tankers were already full and had no place to unload quickly. Furthermore, the mild winter (at least so far) in the Northeastern United States helped keep crude supplies at higher-than-expected levels.
So there is plenty of supply. What about demand? When gasoline prices hit $3 per gallon last summer, consumers suddenly woke up. For the first time in quite a while, average miles driven actually fell. Demand for gas guzzlers also fell. People started thinking seriously about car pooling and avoiding unnecessary trips. Overall demand is down.
This combination of greater-than-expected supplies and lower-than-expected demand has driven oil prices lower. Yet many consumers and commentators are complaining that gasoline prices haven't fallen in lockstep with oil prices. That's true, but that's normal. Gasoline prices lag oil prices. Yes, even on the way up. Nonetheless, gasoline prices and oil prices are highly correlated. In fact, the correlation coefficient for weekly price changes from June 2006 to the present is well over 90%.
Gasoline prices will go lower in the very near term. Especially if demand stays weak. As for the longer term, a cold snap in the Northeast will drive oil and gasoline prices higher. For the much longer term, demand in the U.S. may remain weak as we move toward alternatives such as ethanol, bio-diesels, and true hybrids. But that won't be enough to stem growing demand from India and China. This should keep oil prices firmly in the $40-60 range. I would be very surprised if prices ever fall below $30 again.
Saturday, January 13, 2007
When Securities Laws Hurt Shareholders
When a company is owned and managed by one individual, there are no conflicts of interest. If that individual uses corporate funds to pay for personal travel, or wastes money on other kinds of perquisites, he is only robbing from himself.
However, the ownership of the typical modern public corporation is greatly dispersed. There is also a separation of ownership and control. This is why we have securities laws and a Securities and Exchange Commission. The purpose is to protect shareholders.
So what should happen to Steve Jobs, Apple's CEO, now that he has become entangled in the stock options backdating scandal plaguing corporate America? It turns out that backdating is far more common than anyone could have imagined back when the story first broke in early 2006. Now the SEC is overloaded with cases under investigation.
Should Steve Jobs be forced out of Apple? If he is, you can bet Apple's share price will sink. How does that protect shareholders? Even if Jobs resigns voluntarily, the stock will sell-off sharply. Shareholders will lose.
We've seen many examples of wealthy corporate executives trying to add a few more bucks to their pockets, but it is difficult to imagine someone as wealthy and as revered as Jobs doing the same. Perhaps the laws regulating options are too convoluted and difficult to understand. Perhaps it is too easy for even well-intentioned executives to violate these laws without fully realizing it.
On the other hand, suppose Jobs knew exactly what he was doing. Suppose he also realized that what he was doing was wrong. If laws are supposed to apply to everyone equally, should Jobs be forced out if he knowingly violated the law?
It's easier to answer that question in the affirmative if you don't own any shares of Apple. I don't. But you can bet I would oppose any attempts to get rid of Jobs if I did. There are few present-day CEOs who are more closely tied to the success of their companies than he is. Firing Jobs would be a disaster for Apple's shareholders.
There are no easy anwers to this dilemma. In my opinion, the board of directors must choose the lesser of two evils. They can call for tighter controls at the company. They can demand that all options in question be returned. But they should also make sure Jobs remains as CEO.
However, the ownership of the typical modern public corporation is greatly dispersed. There is also a separation of ownership and control. This is why we have securities laws and a Securities and Exchange Commission. The purpose is to protect shareholders.
So what should happen to Steve Jobs, Apple's CEO, now that he has become entangled in the stock options backdating scandal plaguing corporate America? It turns out that backdating is far more common than anyone could have imagined back when the story first broke in early 2006. Now the SEC is overloaded with cases under investigation.
Should Steve Jobs be forced out of Apple? If he is, you can bet Apple's share price will sink. How does that protect shareholders? Even if Jobs resigns voluntarily, the stock will sell-off sharply. Shareholders will lose.
We've seen many examples of wealthy corporate executives trying to add a few more bucks to their pockets, but it is difficult to imagine someone as wealthy and as revered as Jobs doing the same. Perhaps the laws regulating options are too convoluted and difficult to understand. Perhaps it is too easy for even well-intentioned executives to violate these laws without fully realizing it.
On the other hand, suppose Jobs knew exactly what he was doing. Suppose he also realized that what he was doing was wrong. If laws are supposed to apply to everyone equally, should Jobs be forced out if he knowingly violated the law?
It's easier to answer that question in the affirmative if you don't own any shares of Apple. I don't. But you can bet I would oppose any attempts to get rid of Jobs if I did. There are few present-day CEOs who are more closely tied to the success of their companies than he is. Firing Jobs would be a disaster for Apple's shareholders.
There are no easy anwers to this dilemma. In my opinion, the board of directors must choose the lesser of two evils. They can call for tighter controls at the company. They can demand that all options in question be returned. But they should also make sure Jobs remains as CEO.
Thursday, January 11, 2007
Stock Picking vs. Market Timing
I am thrilled once again that the Forbes Growth Investor and Special Situation Survey investment newsletters outperformed the market in 2006. According to the Hulbert Financial Digest, the three portfolios in the Forbes Growth Investor had an average return of 16%. That puts it ahead of Hulbert's benchmark, the Wilshire 5000. It also places it in the top quartile of all newsletters Hulbert follows. The Special Situation Survey did even better. Hulbert shows it up 20% for 2006, well ahead of the benchmark and also in the top quartile.
Measuring performance can be tricky. To do it correctly you must consider two skills: stock-picking ability and market timing. An investment manager or newsletter editor who beats the market when the market is rising isn't necessarily a good stock picker. Any ordinary stock picker can do that in a rising market simply by employing leverage (i.e., buying stocks on margin). In order to determine if someone is truly a good stock picker, you must de-lever the returns. That is, you must compute what the returns would have been if leverage had not been used. This is the only way you can separate stock-picking ability from market-timing skill. It is also the only way you can compare the stock-picking abilities between managers who employ margin and those who don't.
Unfortunately, Hulbert doesn't de-lever returns. However, he often warns readers that some results have benefited from the use of leverage. Neither the Forbes Growth Investor nor the Special Situation Survey employ leverage. Our results are produced solely from pure stock-picking ability.
Measuring performance can be tricky. To do it correctly you must consider two skills: stock-picking ability and market timing. An investment manager or newsletter editor who beats the market when the market is rising isn't necessarily a good stock picker. Any ordinary stock picker can do that in a rising market simply by employing leverage (i.e., buying stocks on margin). In order to determine if someone is truly a good stock picker, you must de-lever the returns. That is, you must compute what the returns would have been if leverage had not been used. This is the only way you can separate stock-picking ability from market-timing skill. It is also the only way you can compare the stock-picking abilities between managers who employ margin and those who don't.
Unfortunately, Hulbert doesn't de-lever returns. However, he often warns readers that some results have benefited from the use of leverage. Neither the Forbes Growth Investor nor the Special Situation Survey employ leverage. Our results are produced solely from pure stock-picking ability.
Tuesday, January 09, 2007
Jobs is Apple
Apple Computer is now Apple Inc. The company changed its name as it unveiled the new iPhone. The stock immediately jumped higher, closing up more than $7 a share for the day.
Seeing Apple in the news for creating an innovative product is not unusual. It has done this a number of times. The Apple Computer and the iPod are two examples. But in recent weeks all the news about Apple had to do with options backdating. It turns out that even Steve Jobs got caught up in the latest scandal. Believe it or not, there are some shareholder rights groups calling for his head. But before anyone shows Jobs the door, they should ask Apple shareholders what they think.
Jobs is Apple, and Apple is Jobs. Imagine what would happen to Apple's share price if Jobs were forced out. I suspect Apple shareholders would be more than happy to overlook this latest options indiscretion.
Seeing Apple in the news for creating an innovative product is not unusual. It has done this a number of times. The Apple Computer and the iPod are two examples. But in recent weeks all the news about Apple had to do with options backdating. It turns out that even Steve Jobs got caught up in the latest scandal. Believe it or not, there are some shareholder rights groups calling for his head. But before anyone shows Jobs the door, they should ask Apple shareholders what they think.
Jobs is Apple, and Apple is Jobs. Imagine what would happen to Apple's share price if Jobs were forced out. I suspect Apple shareholders would be more than happy to overlook this latest options indiscretion.
Monday, January 08, 2007
Time to Buy BSX?
David Rappa was my guest on MoneyMasters today. He is a portfolio manager with Austin Investment Management. That's a relatively small investment management firm that specializes in global equities. Austin manages about $300 million. Most of that is in separately managed accounts, but it also runs a mutual fund with about $50 million.
Austin uses an intrinsic value approach to finding stocks. Rappa told me he is particularly bullish on pharmaceuticals right now. Over lunch we also talked about Boston Scientific (BSX), one of his new holdings. BSX is a stock I've owned on and off since 1992. It's been one of my biggest money makers. I don't have a position in the stock right now, but I have to admit, I am getting tempted once again. Rappa started buying it not too long ago. The stock is currently around $17-18 per share, down from its 2004 high of about $46. The sell-off is due to reports of problems with drug-coated stents and the company's acquisition of Guidant. BSX paid too much for Guidant. It seems BSX was more interested in keeping Guidant away from Johnson & Johnson (JNJ) than it was in actually acquiring the company itself. Perhaps recent strength in shares of BSX indicate that investors believe the sell-off has gone far enough.
My MoneyMasters interview with David Rappa will be posted Jan. 25. This Thursday, Jan. 11, we will post my interview with David Frankel of firstRain, a research firm.
Austin uses an intrinsic value approach to finding stocks. Rappa told me he is particularly bullish on pharmaceuticals right now. Over lunch we also talked about Boston Scientific (BSX), one of his new holdings. BSX is a stock I've owned on and off since 1992. It's been one of my biggest money makers. I don't have a position in the stock right now, but I have to admit, I am getting tempted once again. Rappa started buying it not too long ago. The stock is currently around $17-18 per share, down from its 2004 high of about $46. The sell-off is due to reports of problems with drug-coated stents and the company's acquisition of Guidant. BSX paid too much for Guidant. It seems BSX was more interested in keeping Guidant away from Johnson & Johnson (JNJ) than it was in actually acquiring the company itself. Perhaps recent strength in shares of BSX indicate that investors believe the sell-off has gone far enough.
My MoneyMasters interview with David Rappa will be posted Jan. 25. This Thursday, Jan. 11, we will post my interview with David Frankel of firstRain, a research firm.
Thursday, January 04, 2007
Expensing Options Didn't End Compensation Abuse
Several years ago, Warren Buffett petitioned regulators to make the expensing of stock options mandatory. Some accused Buffett of trying to get rid of options altogether, but his real motivation was to end the abuse. Several noted economists said expensing options would only make them more rare, but it would not end abuse.
They were right. Today options have to be expensed, and corporations use less of them. Yet executive compensation abuse continues. Home Depot's shareholders are the latest to be ripped off. CEO Robert Nardelli resigned and walked off with $210 million. Less than a year ago, Pfizer shareholders paid the price as CEO Hank McKinnell left with $200 million in his pocket.
Most shareholders don't object to paying someone well if he is doing a good job. But it's not like these guys deserved all that cash. After all, shares of both Home Depot and Pfizer were poor performers under their watch. Nardelli and McKinnell simply proved that one sure road to wealth is to become a CEO, do a poor job, then negotiate a resignation.
Whether stock options should or should not be expensed was never the appropriate battle to be fighting. The real problem is inappropriate executive compensation approved by boards of directors who are too weak-kneed to tell the CEO he can't rob the bank.
When directors discuss how much to pay the CEO, the first thing they do is hire a consultant. The consultant comes up with a list of peer companies. Of course, the CEO makes sure only high-paying firms are included in the list. The directors also convince themselves that their CEO is better than average; therefore, he must be paid better than average. This process drives up pay for all CEOs year after year.
Buffett has some excellent ideas on how to structure executive compensation. These include stock options with escalating exercise prices. He was wrong about expensing options, but so many of his other ideas make good sense.
They were right. Today options have to be expensed, and corporations use less of them. Yet executive compensation abuse continues. Home Depot's shareholders are the latest to be ripped off. CEO Robert Nardelli resigned and walked off with $210 million. Less than a year ago, Pfizer shareholders paid the price as CEO Hank McKinnell left with $200 million in his pocket.
Most shareholders don't object to paying someone well if he is doing a good job. But it's not like these guys deserved all that cash. After all, shares of both Home Depot and Pfizer were poor performers under their watch. Nardelli and McKinnell simply proved that one sure road to wealth is to become a CEO, do a poor job, then negotiate a resignation.
Whether stock options should or should not be expensed was never the appropriate battle to be fighting. The real problem is inappropriate executive compensation approved by boards of directors who are too weak-kneed to tell the CEO he can't rob the bank.
When directors discuss how much to pay the CEO, the first thing they do is hire a consultant. The consultant comes up with a list of peer companies. Of course, the CEO makes sure only high-paying firms are included in the list. The directors also convince themselves that their CEO is better than average; therefore, he must be paid better than average. This process drives up pay for all CEOs year after year.
Buffett has some excellent ideas on how to structure executive compensation. These include stock options with escalating exercise prices. He was wrong about expensing options, but so many of his other ideas make good sense.
Monday, January 01, 2007
Ending One Busy Year; Starting Another
I have been tremendously busy lately and haven't had much opportunity to post to my blog. First there was the year-end rush at work. I was trying to get as much done as I could in order to free up some time for the holidays. Then there were the holidays. At least I was able to enjoy them with my family. We did quite a bit of traveling between the Philadelphia and Boston areas visiting relatives and friends.
Before the holidays I managed to get up to Central Connecticut State University to make a presentation to Professor Zakri Bello's finance class. Zakri and I are old friends from our graduate school days at Virginia Tech. He's been teaching at CCSU for a number of years and was kind enough to invite me to speak to his class. It was good practice for a number of events coming up in 2007.
As of now, I am scheduled to attend the Money Show, which runs from Feb. 7-10 in Orlando. I will also be on the 11th Forbes Cruise for Investors, which goes from Beijing to Hong Kong in April.
Fortunately, our stock picks turned in another great year. Both the Forbes Growth Investor and Special Situation Survey outperformed all the major benchmarks. Although I remain bearish on stocks, they continue to rally and post strong gains. I am getting more and more worried, however, that these gains will soon end. I'll have more to say about this in the Jan. issue of the Forbes Growth Investor.
Before the holidays I managed to get up to Central Connecticut State University to make a presentation to Professor Zakri Bello's finance class. Zakri and I are old friends from our graduate school days at Virginia Tech. He's been teaching at CCSU for a number of years and was kind enough to invite me to speak to his class. It was good practice for a number of events coming up in 2007.
As of now, I am scheduled to attend the Money Show, which runs from Feb. 7-10 in Orlando. I will also be on the 11th Forbes Cruise for Investors, which goes from Beijing to Hong Kong in April.
Fortunately, our stock picks turned in another great year. Both the Forbes Growth Investor and Special Situation Survey outperformed all the major benchmarks. Although I remain bearish on stocks, they continue to rally and post strong gains. I am getting more and more worried, however, that these gains will soon end. I'll have more to say about this in the Jan. issue of the Forbes Growth Investor.
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