Tuesday, September 15, 2009

"Favorable" Foreign Exchange...

By Sam Ro - …is one way of saying that a weak U.S. dollar helps boost quarterly revenue and earnings. This observation is made by companies with significant international sales and who report financial results in U.S. dollars.

This is an important consideration for equity investors using the S&P500 as their benchmark. According to Standard & Poor’s research, around 48% of S&P 500 company revenues are generated outside of the U.S.

So, I'd argue that the weak U.S. dollar partially explains why the S&P 500 has done so well in the last six months. In March, the S&P hit its low of the year when the dollar hit its high. When you overlay a chart of the S&P500, which is now trading at a year-to-date high, with the U.S. Dollar Index (DXY), which is now trading at a year-to-date low, you will easily notice the inverse correlation.

The U.S. dollar was actually at lower levels for much of Q3 2008, which means it should have an unfavorable impact on year-over-year comparisons this year. However, most corporate managers assume stable foreign exchange rates when issuing guidance. As such, if the U.S. dollar weakened since the last time earnings guidance was issued, Q3 2009 sales and earnings will be better-than-expected…ceteris paribus.

But based on the persistent divergence in stocks and the dollar, this may already be priced in.

If you’re unwilling or unable to sell your internationally exposed equity positions and you’re concerned that a rising dollar could eat into earnings, then you may want to hedge your position by going long the dollar. You can do so with an ETF like PowerShares DB U.S. Dollar Bullish Fund (UUP).

Thursday, September 03, 2009

Location, Location, Location

By Taesik Yoon - The other day I walked past the empty store front of what was a Circuit City location until the consumer electronics retailer went bankrupted this past spring. Taped on the inside of the windows were signs that read:

Best Buy Coming This Fall

The thing about this particular store front is that it’s across the street from Union Square Park—an extremely popular area in downtown Manhattan coveted by retailers due to the heavy foot traffic. This is evident in the sheer number of branded retail chains that line the Square, which include McDonald’s, Staples, DSW, Filene’s Basement, Forever 21, Diesel, Puma, Petco, Barnes & Noble, Babies “R” Us, Au Bon Pain, and Whole Foods.

The location’s significance is certainly not lost on Best Buy (BBY), which specifically highlighted the Union Square site in a recent press release announcing plans to open 22 new locations in the U.S.

This is a great move by Best Buy. Despite its desirable location, given the state of the commercial real estate market, it’s quite possible—even likely—that the lease terms were more favorable than they were for the former tenant. Residents are already used to seeing the location as a seller of consumer electronics, which should help the store assimilate quickly into the neighborhood. The location also bridges the gap between its two closest stores, which are nearly two miles away from each other—a fair distance in Manhattan terms. Yet at the same time, it’s probably not close enough to the other two to result in significant sales cannibalization. An added benefit is that the store is expected to open in enough time to take advantage of this year’s holiday shopping season.

In similar fashion, other retailers, such as specialty menswear seller Jos. A. Bank (JOSB) and discount chain Big Lots (BIG), have recently come out and said they plan on accelerating the pace of new store openings in order to take advantage of real estate deals in prime locations left vacant due to store closures by financially troubled retailers.

On the surface, accelerating store openings at time when consumer spending is weak and under duress seems counterintuitive. It goes against conventional wisdom, which would advocate profit preservation at existing stores versus adding new ones. And certainly this approach is not without risk. The most pressing would be the persistence or worsening of weak consumer spending trends, which could result in lower than expected returns from these new stores in the initial years of their existence.

However, a common trait found in all these retailers is their strong financial position. At the end of fiscal Q1, Best Buy has total debt of $2.14 billion, which represented just 13.2% of total assets and 28.0% of total capital. The associated interest expense in the quarter was $23 million or just 7.8% of total operating income, resulting in a healthy interest coverage ratio of 13. The financial positions of Jos. A. Bank and Big Lots are even more robust. Both companies are debt free and have seen their cash balances double over the past year. The strong finances not only allow these retailers to seek out these opportunities, they also provide a strong cushion should these new stores under-perform over the near term.

Over the longer term, the benefits of these real estate actions should prove their worth. Location may not be the only thing that leads to a retail store’s success, but it certainly is among the most important. Being able to obtain prime locations as discount prices should help these retailers get the most out of the eventual recovery in consumer spending and could result in strong sustainable growth that trend well above the industry average for years to come.

Given the rise in these stocks year-to-date—Best Buy is up 36% while both Jos. A. Bank and Big Lots are up about 70%—much of these expectations already seem priced in. But that might be more a reflection of the strong operating results these companies have turned in so far this year and not necessarily due to the long term growth potential the capturing of these prime locations offer. In my view, that makes them merit strong consideration even now, especially for anyone with a long-term investment horizon.

Mega Millions Mentality

By Sam Ro - Last Friday, I did not win the $336 million Mega Millions jackpot. But I played. Sure, the chances of hitting the right numbers are only 1 in 175 million. Even if you hit the numbers, you may have to split the winnings. And this is all before taxes.

But how often are you presented with an opportunity to earn a 336,000,000% pre-tax ROI on a minimum investment of $1? And in the worst-case scenario, you lose a buck.

Obviously, playing the lottery is not a prudent investment strategy. But the mentality of taking unreasonable risks for unlikely returns exists in the stock markets. Consider bankrupt companies whose stocks are worthless. Lehman Brothers (LEHMQ.PK) hit 32 cents on August 31, just a day after trading at 5 cents. Motors Liquidation Company (MTLQQ.PK), formerly known as the old General Motors, traded as high as $1.20 on August 12. Each stock sees millions of trades every day. But neither is trading on fundamentals. Even if a company were to emerge from bankruptcy, the old common equity is almost always cancelled. In other words, the stock price movements of bankrupt companies are not signs of life; they’re more like postmortem muscle spasms during rigor mortis.

However, if you were savvy enough to buy low and sell high in August, you could’ve gained up to 700% on LEHMA and 140% on MTLQQ.

Then there are the stocks on government-sponsored life-support including Freddie Mac (FRE), Fannie Mae (FNM), and AIG (AIG). Even after significant declines in recent days, these stocks are up between 260-350% in just six months. However, many question the rationale behind these price moves. Some analysts have suggested the common equity in these companies could be worth nothing. Even the more bullish arguments for these stocks come with warnings of high uncertainty.

My favorite pitch goes like this: “FRE and FNM were $60 stocks two years ago! They’re trading at under $2 right now! I could see them at $10. But if I get $5, that’s still a pretty good return.” It’s an unsound argument but not unused. Structurally, it’s very similar to the rationalization that goes into buying a lottery ticket: limited downside and tremendous upside. And you have to pay to play.

Perhaps you’re disciplined enough to avoid irrational investment decisions. But it would be totally irrational to ignore the existence of irrational behavior in the markets. According to La Fleur’s World Lottery Almanac, Americans spend around $50 billion each year on lottery tickets. Surely this includes a lot of amateur and professional traders and money managers who are unknowingly bringing that mega millions mentality into the stock markets. They get the newswires about FRE, FNM, and AIG. Some might also follow the pink sheet action of bankrupt companies. They know these are not good investments. But the allure of outlandish gains is irresistible, even if those gains are highly unlikely.

Full Disclosure: Author is long FRE and 1 Mega Millions lottery ticket.

Wednesday, September 02, 2009

From "Cash for Clunkers" to "Dollars for Dishwashers:" A Waste of Taxpayers' Money.

The following commentary appeared in the September issue of the Forbes Growth Investor, which was previously distributed to subscribers.

By Vahan Janjigian - The U.S. Department of the Treasury produces a document called "The Budget in Brief." Don’t take the word "brief" literally. The one for fiscal year 2009 runs 100 pages long, yet the word "deficit" is nowhere to be found. The one for fiscal 2010 is 124 pages in length. It mentions the "d" word just once, but only to let us know that transactions with the International Monetary Fund do not affect the deficit. Do the officials responsible for producing these documents think the deficit will disappear if they simply ignore it?

The budget deficit for fiscal 2009 is $1.6 trillion. The cumulative deficit for the next 10 years is expected to run around $9 trillion. The federal debt is currently $11.7 trillion, or about 90% of real GDP. Common sense dictates that something is wrong here. Despite its inability to keep its finances in order, the government insists on spending more taxpayer dollars on attempts to save certain favored industries. For example, it recently brought us the "cash for clunkers" program to help the automobile industry. Because it apparently thought that program was such a huge success, it is now considering doing something similar for appliance makers. It may sound like a bad joke, but "dollars for dishwashers" is really under consideration.

However, programs such as these are not likely to do much good over the long term. Obviously, if you have an old car or refrigerator you would like to replace, you are more likely to do so now if other taxpayers are going to pay part of the bill. Why would you not take a subsidy when it is being offered? Yet the bottom line is that what you buy today, you will not be buying tomorrow. Such government-subsidized programs simply bring future sales into the present. They do not increase demand over the long run.

The proof, as they say, is in the pudding. The Car Allowance Rebate System (the formal name for "cash for clunkers") went into effect on July 1, so it should be no surprise that personal spending went up slightly in July. Consequently, you could say the program worked as planned. Unfortunately, once we adjust the July numbers for spending on motor vehicles and parts, it turns out personal spending actually declined. Since the program expired on August 25, chances are we will see similar results when the personal spending figures for August are released at the end of September. However, the more important question is how spending holds up in September. Now that consumers have to foot the entire bill themselves, auto dealerships will likely look like ghost towns and personal spending will likely plunge.

Speaking of September, it is not a particularly good month for investors. While most investors fear October (due to the 23% one-day plunge in the Dow on October 19, 1987), the fact is that, on average, September is the worst month for investing in equities. Sam Stovall of Standard & Poor’s recently showed that since 1929 the average September decline in the S&P 500 was 1.3%. Furthermore, the index has fallen more often in September than in any other month. Although stocks have shown incredible resilience in recent months, given their robust gains since the market bottomed on March 9 of this year, and the fact that the economy is still struggling, a significant sell-off is long overdue.