Saturday, January 29, 2005


Workers are working in the coal mines. Australian workers and Appalachian workers are going down, down, down. China is now buying much of the Australian coal which means that Europe is now buying much of the Appalachian coal. Good news for Norfolk Southern Corporation (NSC) and bad news for Duke Power (DUK). Utilities are substituting coal for natural gas which is helping NSC's hauling business and hurting DUK in two ways. DUK needs high volumes of gas to earn profits on its pipeline business and it needs low coal prices to make good money on its power generation.

The past year was a very good year for NSC and it was a year of recovery for DUK. DUK lost a lot of money but was able to sell a lot of assets. DUK used the sale of assets to maintain its high dividend payment. Unfortunately some of the gas fired plants were sold for 20 cents on the dollar. DUK has outstanding convertible bonds that limit the up-side to the stock and the company has unfunded pension liabilities of around 386 million dollars.

DUK went up pretty good as the dividend looked better and better to bond buyers. Indeed since the bottom in February of 2003, the stock has moved from $12.50 to $26.00 per share. The turn-around specialist has sold 2.4 Billion dollars of assets to engineer the turn but the company still has under-performing assets that are up for sale.

NSC exploded in price as nationwide railroad car loadings were up 6% year over year and due to the heavy coal shipments NSC increased loadings by better than 12%. Of all the railroads, NSC has enjoyed the best operating ratios. The best thing about railroads is that no one is going to build a competing line to the same coal mines. If the demand is high, the railroads will haul the goods. When they wear the rails and equipment out, they will have to pay for the new but they really have no competition for much of their bulk shipments.

NSC sells at a discount based by most valuation measures. It has lots of sales, lots of cash flow, lots of assets, low PEG and an 8 year PEG payback. Buy the stock and you get a lot for your money. The operating leverage is outstanding. Revenues went up 16% this year and earnings grew by 50%.

At about the same point in the business cycle during the mid '90s, car loadings went up substantially three years in a row. In the mid '90s we did not have an energy problem feeding high utilization, prices and growth.

actually it is China that has the energy problem. China produces 400,000 megawatts of electricity, 300,000 by coal fired plants. It produces 9,000 by nuclear plants.

The China GDP is growing by leaps and bounds. According to Goldman Sachs, China will out-produce the UK this year, Germany by 2010, Japan by 2015 and the US by 2040. In addition to buying a lot of coal from Australia, the country has planned 27 new nuclear plants to open by 2020. The most recent to open boosted nuclear production from 7,000 to 9,000 megawatts and another plant will open in a few months. There is a five year gap before several more of the plants will open.

We can all speculate on how much the current price of oil is due to the current terrorist risk premium but no one really knows. We do know that after a major increase in the price of oil, it has always taken several years for supply and demand changes to take the spike off prices.

We also know that building power plants consumes a lot of capital and puts upward pressure on interest rates. Regardless of the nuclear plants, long-term interest rates normally rise as an economic expansion unfolds. This means the DUK dividend may need to go up to stay competitive with bonds. DUK will turn a profit from this year but not enough to justify a dividend increase. Therefore the only way the dividend can keep pace with a rising bond rate is for the stock price to go down. This is what happened back when nuclear plants were being built in the US. DUK and other utilities did extremely well after the rates finally peaked in the early '80s but it took several years of bad returns before that good streach hit.

I don't actually believe DUK will decline much in price but I believe NSC will go up a lot in the next 5 years. Although high demand for coal is good for NSC and bad for DUK, during the first four weeks of 2005, there has been a "flight to quality". Treasury bonds and Utilities have been among the beneficiaries. The threat of lower growth took a couple of dollars off the price of NSC. An opportunity presents itself. Investors can pick up a growing company cheaply and sell a contracting company at the best price in years. (I am down very slightly on the swaps I made earlier but I am confident the trade will look very good a year from now.)

Dr. Ed Yardeni expects railroad earnings increases of 22% in 2005 and 16% in 2006. Multiples, which are at discounts to the S&P may not expand but they are not likely to contract in this climate. In other words one might expect to make an average of 19% per year if earnings do grow at the forecasted rates. There are always ifs and buts. The weight of the evidence suggests that holders of DUK and other Utilities should consider NSC for a swap.

Friday, January 28, 2005


The outlook for TIVO and NFLX continue to weaken. The list of major players adopting everything but TIVO is growing. Echostar (DISH) has been giving away TV recorders with TIVO style functions and now has almost as many subscribers as TIVO. DirectTV, TIVO's largest customer, is making its own machines and Scientific Atlanta and Motorola are selling set-top boxes with many of the same functions. SBC, BLS and Comcast (CMCSA) are all trying out the Microsoft Internet TV Protocol with a Motorola box as the hub.

These are major developments by the "big boys". If both the cable companies and the dsl companies adopt ITVP, Microsoft is a big winner and TIVO and NFLX could be among the big losers. Upon reflection, I believe the consumer is a big winner.

How can this be? By having a standard TV-IP system in place, the internet becomes the competitive distribution network for TV. Yahoo (YHOO) and Google (GOOG) have both jumped into the game. Yahoo is even setting up a media headquarters in California.

Smart money has always known that content is key. There have been no signs that companies like Time Warner Cable (TWX) or ESPN (DIS) are willing to sell content at wholesale rates. TIVO and NFLX can dream about offering movie down-loads all day long but why does TWX or ESPN need a middleman?

The answer is that the content company needs a middleman to help the consumer find the content. In other words Google or Yahoo are building systems to link consumers to providers in the same way they link consumers to web sites. When Yahoo announced their new service, the company announced that they are looking for content. It was not long ago when there were very few web sites and now there are millions. In the same way, podcasting is about to break-out. In just a few years, there will be millions of audio or video feeds. For example, many churches will choose to "broadcast or podcast" their services when it cost them almost nothing to do so. Folks are already down-loading podcasts to their Apple i-pods and other devices and playing them when they choose.

Consumer will have millions of choices of what to watch and they will need a Google or Yahoo search engine to find the show they want to watch. Once found, will the consumer need a TIVO box to "collect" the show? Or will TIVO be able to offer a competing search technology? With todays high speeds and the higher speeds on the way, shows can be streamed directly to a monitor, TV or set-top box. Google has shown that volumes of offsite storage (Gmail and Blogspot) is not a problem.

I have a couple of Google Ad-Sense accounts. One of them is for advertisements about my Myrtle Beach Rental Properties. When a consumer clicks one of the millions of Google ads that Google places for me, Google accumulates the charges and then debits my credit card. In the future, consumers may have Google accounts that work the same way. The consumer may decide to watch an old movie for which the provider wants a 65 cent fee. The consumer clicks the Google button and Google accumulates the monthly charges. Google collects the fees and sends the majority to the provider. Google would be the middleman but would require a very small cut for connecting the consumer to the provider. It makes more sense for Google to collect the fee than the provider because Google is willing to set up an account for the Southwest Forsyth Little League Nework as well as for Time Warner (isn't freedom great).

If you missed last nights over-time Georgia Tech-Wake Forest ball game--no problem; you might search Yahoo or Google, find the show, click a button, watch the show and owe ESPN a fee (perhaps a variable fee with or without commercials and you even might even get to chose from a menu of commercials). This is all very powerful stuff. The consumer gets to watch what he wants when he wants including commercials for products he wants to know about. Advertisers save money by not paying for wasted commercials. Owners of content get paid per view.

ESPN would not have to wholesale content to NFLX or anyone else. ESPN could still offer the same packages through cable but the targeted approach will eventually win the most business.

TIVO and NFLX still have value. They both are growing their customer base and these are the "good" customers the "big boys" want. Both companies have patents that the industry has had to work around. A distribution box of some sort will eventualy be common place in most homes.

TIVO may have waken from its daze too late. The CEO who refused the cut rate deals offered by CMCSA and others has stepped aside. Reed Hastings of NFLX is an excellent manager and the NFLX system is a good system that helps consumers select movies they are likely to enjoy. NFLX is growing rapidly but I happen to know that the Nissen Wagon works in Winston-Salem was a growing company when Henry Ford ramped up car production. (The Waughtown section of Winston-Salem has never recovered from the failure of the largest Wagon company in America, but Dell computer just annouced a manufacturing plant just to the east of Waughtown. Wouldn't you know it took 100 years and a computer company to replace the wagon works as the biggest employer in the area.)

Writing about TIVO and NFLX is like writing about the Sony Beta-Max VCR or the Apple Computer. Sony and Apple produced the best technology but failed to make the distribution deals.

I am seriously considering selling my TIVO and NFLX postitions. Although NFLX had a very good quarter and the price to sales of each company is not a bad number, the internet continues as an extremely powerful disruptive force. I am 100% certain that TV and movie viewing are about to go through dramatic change. I am not at all certain that TIVO or NFLX will be apart of the revolution.

I have hesitated for two reasons. One is that I hate to sell a loser without telling my readers first and the second is the take over potential. I have no way of knowing the value of the TIVO patents but I know that there are big companies that would like to own the TIVO name. The patents could allow someone like Motorola a leg up on the competition and the name would help market the product. It seems that Google and Yahoo have decided to develop their own menu or sorting system. GMST (TV-Guide) and TIVO serve to help the consumer search for a particular show. Liberty Media has made moves to buy GMST and the old Chief at TIVO spurred offers in the past. The pressure of the new paradigm that is developing quickly may pressure TIVO and or NFLX to sell to a bigger player.

Thursday, January 27, 2005



One reader says he missed my call to move from small caps to value. Actually, for several months I have written that the sectors I like are defensive in nature such as health care, consumer staples and energy. I have written more than once that it is time to buy "the big, the dumb and the ugly". I have said several times to reduce small caps and stocks that have a high correlation coefficiency to small caps such as emerging market stocks and high tech manufacturing stocks. Finally I have offered to monitor accounts because it is much easier to talk about what to do if I can see what has been done.

In one of my moderated retirement accounts, the owner noted my call to sell small cap funds and has moved 100% of funds to a value equity fund. This is a young person who aggressively puts 100% of a still relatively small retirement fund into one fund. A quick assessment shows the total returns for 2004 to be better than 16% and the account hit a home run in 2003 doing 84% in an international growth fund.

This year, the account is off 2.87%. This return is excellent when compared to the 4.31% loss suffered by the small gap growth fund. Of course a perfect market timer (no such thing) would have moved to the money market on the last day of 2004 and would have moved back to stocks a few days ago.


In the 9 years following the real estate recession of 1974, the average small stock increased 15 times in value! Yes, the average small stock was a 15 bagger! Any poor slob who had money and the courage to invest at the market bottom in 1974 made a return of 1,500% in 9 years if he bought the average small stock! $10,000 would have become $150,000. Many stocks did 3 to 10 times as well. A smart and lucky investor could have turned $10,000 into 1.5 Million. (The figures are posted from my memory of Ibbotson and Associates studies).

Of course, sooner or later the worm must turn and in 1983 it did. From 1983 to 1990 100% of the over-performance was lost! The really bad thing is that many investors waited until the market was roaring in 1983 to buy small stocks (I naively bought a few myself including my all time best performer which has returned 120 times its original value). Please remember the way news works--the super performance of small stocks was not reported widely until the spring of 1983--nine years after the start of the run!

Folks it has happened again. I just ran a chart on the Value Line Arithmetic Index. The S&P 500 and most other indices are market weighted. This means the really big stocks account for most of the moves. The Value Line Arithmetic Index out-performs the S&P when small stocks do well. This index has gone up 14 times in value since the 1990 real estate recession!

There is a possibility that small stocks will go through a blow off phase for the next few months. They could jump 20% or more in value pulling in some greater fools. I personally will not be playing the game. Partly because, after the bubble, investors may be too skitish to pile on. Also because the rotation appears to have already begun. High tech stocks stopped over-performing many months ago and small stocks turned a few weeks ago. Again, I plan to buy mostly out of favor stocks for the next several years while continuing to hold my high flying internet stocks.

Out of favor stocks are those that are dull but cheap. The nominal price is not the important factor. Stocks that trade low relative to the underlying value are what I will seek. Measures such as price to book value per share, price to earnings per share or price to sales per share will be important considerations. I am now much more likely to look at the PEG ratio before buying a stock. (The PEG ratio is the ratio of the PE to the Growth rate.) Next week, I plan to post at least one value stock. I will post as often as I can. As always I must inform you that I am only an amateur. I cannot recommend that you buy anything. I have 42 years experience buying stocks including a career as a professional but as a retired amateur, I write for education and entertainment purposes.

I have mentioned that I keep buying airline stocks in MY aggressive account. Some of these stocks do not have PE's because they do not have earnings. In some cases they do not have price to book ratios because their book values are negative numbers. Buying these stocks requires bravery or stupidity and it is only in hindsight that we will know which. The fact is that I have purchased stocks with negative book values before and made really good money on many. The most recent example was the purchase of Nextel (NXTL) at $3.90 per share. I later added more shares but on the original shares I have an unrealized gain of about 750%.

The measure that shows airline stocks to be really cheap is the price to sales ratio. You have all heard the old saw about the guy that was losing 5 cents per dozen selling eggs and decided to make up the difference by selling more eggs. The airlines keep competing for market share in the hopes that a competitor will be the first to go out of business. If one or more of these companies go out of business, then the remaining firms may start to have a profit margin to multiply times all those sales. The earnings could be big for the next 10 years.

Winston-Salem received good news today. USAir will consolidate its reservation center in the partially empty center here in town. Piedmont Air was founded in Winston and has always had a work force presences here. With most travelers booking over the internet, the need for large numbers of reservation assistants is a thing of the past. Winston has had other good news recently. Dell computer will add a factory here, Reynolds Tobacco purchased Brown and Williamson and brought the work here and Low's has added a computer center here.

All this good news for Winston-Salem ties back to where we are in the economic cycle. The economic recovery is over and the expansion has begun. During the typical expansion pressure will be on the cost of resources. The price of raw materials, labor and money will all trend up ward. Companies will have to watch their cost to make profits.

In many ways, the current economy is similar to what happened in late 1984. Long interest rates went down in 1984, large cap stocks began to perform well and the small caps ended their very long run (small caps typically continued to go up a little in price, just not nearly as much as the large caps). Three years later, October 19 of 1987, interest rates had spiked and the market dropped something like 15% in one day. The good news is that we are not close to 1987 yet. We should have at least a couple of better than average market years ahead of us. I remain 100% invested in stocks with no bond allocation. I am a relatively aggressive investor who is becoming more selective about which stocks to buy.


Google will announce fourth quarter earnings on February 1st. The good news is that as is indicated by the very high advertising revenues reported by YHOO, the report should be good. The bad news is that earnings reports for high flyers is often at best good and at worst horrible. Even if the company has very good numbers, the stock is priced for very good numbers already. If the numbers are weak in anyway shape or form or if the numbers are strong but there is even a hint that the earnings will slow in the future, the stock could get hammered.

I say all the above about GOOG just to let you know the situation. I will probably not respond to the numbers unless they are extremely disappointing. This is a large position for me but it is a long-term position. If the stock were to do extremely well for an extended period, I might lighten up a little. My hope is for the long-term growth to be as strong as I believe it will be.

It is interesting to see how quickly other firms mirror the services offered by GOOG. Desk top search is already a common offering and I am told that YHOO has the best software. Putting together internet phone service or an internet browser will be tough feats. So far, I do not know of another firm scanning whole libraries. The video and TV services announced by YHOO and GOOG are very different.

Jim Brinkley, President of Leg Mason Wood Walker, is fond of saying that economics wins. The GOOG TV service is a great example. There has been a service for searching TV available for several years. The cost has been $500 per user per month and it relies on day old video tape. The service announced by GOOG uses up to the minute data and is free of charge. Of course, GOOG will charge advertisers for key word and content based search placement.

As you can tell, I like GOOG a lot. I bought more shares last week. It is impossible to know if the company is really worth 20 times book or 20 times sales. It must grow a lot to be worth so much.

The company reminds me of Xerox in 1963. At the time, clerks and secretaries typed everything with a carbon copy. (How many young folks today even understand what the initials cc: mean?) Xerox had the patents, had built the factories and the stock had soared quickly from $30 to $70 per share. In those days one needed to trade in 100 share lots and 100 shares at $70 was much more than the average persons annual salary. There was great skepticism. People openly joked about why would anyone pay 10 cents to make a copy when carbon paper sold for 79 cents for a box of 500 sheets. It was an easy decision for most companies as 8 sheets for a penny or 10 cents a copy was not a serious question.

Never-the-less, investors who bought and held on made a fortune. I clearly remember the two weeks when the stock broke out above 70 and went all the way to 360. It didn't hardly slow down for about 10 years.

The Xerox (XRX) company produced life changing technology. Ironically, GOOG is using Xerox technology (and probably Xerox equipment) to scan in every page of every book in the library. The results will be life changing. There are many uses for the GOOG technology and the competition is fierce but I am a believer.


The Myrtle Beach Real Estate Market is Hot!
Join the Splash!

Marilyn and I own resort rental properties at Myrtle Beach, SC. In recent weeks, our rental office staff has been approached regularly by realtors who call to list our vacation properties for sale. They report that available oceanfront real estate is at record lows. The Horry County Homebuilders Association confirms that this decrease in inventory is driving prices of available oceanfront real estate upward. The news is great for property owners who purchased a few years ago—prices have soared. The question arises, should one buy a second home now in anticipation of further increases? According to Carolina Association of Realtors, oceanfront property values increased 44 percent between 2003 and 2004. With available beach front property scarce, the Association and private realtors forecast that price trends will continue.

Caution is always the word in regard to hot markets. Those who buy rental properties may bite off more than they can chew. Few investors realize how extremely high the over-head expenses are for resort rental properties. Many absentee owners discover that they receive thirty cents or less of each rental dollar paid! All owners discover that sales taxes, property taxes, owners associations’ dues and other expenses for a second home are higher than for a first home. Capital gains on beach property can be very large, however, operating loses can be large too.

On the other hand, owing at the beach is a great source of pleasure. Marilyn and I have years of family memories that are priceless. The key is to find the way to own while eliminating the rental over-head expenses. We have researched this question ad nauseum and believe the best way to own a vacation home is in partnership with nine other families. Many folks reject the idea because it sounds like a time share. However, our experience is that 10% vacation owners are a happy group. Owners of 10% shares tend to be very pleased with the total package of benefits they receive. Marilyn and I purchased our first beach property in 1973. We operated our resort rental business for 18 years. We have learned much about owning beach front real estate and would like to share our knowledge with you. You really don’t need to buy a second home at the beach unless you are going to live in it 60% or more of the year; if the property is used any less then an ownership share makes more sense. The absolute smartest way to lower the cost of a second home is to share ownership. Not a time share, but ownership with nine other partners.

Why buy in 10 percent increments? A ten percent share is just the right size. Time shares have too many owners and less than ten owners pay too high a price. Ten owners all get plenty of beach time and avoid the very high rental over-head expenses. The costs of a second home at the beach is very expensive, however, by sharing a home with nine other owners the costs are reduced to below the cost of renting the same property! It’s the same adage as, “divide and conquer.” Ten owners share in the purchase and maintenance cost and in the ownership benefits. Owners share the costs of bikes, beach umbrellas, a movie library, baby cribs, beach toys and more, as the partnership envisions. Additionally, owners do not want to spend their vacation time performing maintenance tasks. Partnership groups handle these tasks corporately so time spent at the property is truly a vacation. The partnership is set up so owners receive up to 10% of the rental value each year. Weeks are weighted by rental value. One owner may choose the entire month of January while another chooses a spring break week in March for the same value. Partners are surprised at how inexpensive a second home can be and at how available it is.

After much research, we chose Kingston Plantation for our second home. For 18 years, Kingston Plantation’s dedication to excellence has never wavered. This beautiful 145 acre resort, offers the finest in beach location (the number #1 rule in any real estate investment), oceanfront swimming pools, a four star hotel, oceanfront boardwalks, onsite restaurants, a water park, spacious accommodations and unsurpassed access to grocery stores, shopping, golf and theaters. Marilyn and I are retiring from our rental business but a partnership group has formed to buy unit 409 South Hampton and three other families are looking for partners to buy unit 805. My family plans to purchase one 10% share in each property. Marilyn and I are blessed that each of our daughters has purchased a 10% share at the beach. We live each day with hope of seeing our kids and grandkids enjoy their second home for many years to come. Because these are second homes, one should buy them as such with the knowledge that any investment return achieved will be a bonus. The good times and lasting memories with family and friends are what the beach is all about. Should you have interest in more information, let us know; we can put you in touch with the partnership groups. We invite you and your family to make a splash at the beach.


As you may know, a few weeks back I encouraged readers to sell their small cap mutual funds as well as any foreign funds that have significant emerging market holdings. I advocated moving these funds to big cap American stocks and suggested defensive positions. I hope readers reacted because the small stock funds have been poor performers all year.

In one of my monitored accounts, we purchased AT&T as one of the defensive positions. Today, the owner of the account asked how it is that I keep hitting take over targets for him (in case you have not heard, the Wall Street Journal reports that SBC is in talks to buy AT&T).

I could respond that it is no secret that AT&T (T) is up for sale. BellSouth (BLS) and T had extensive talks back in 2003 and T sold off its wireless services and cable services and cut back on its growth plans just waiting for a bid. However, I did not buy the stock as a takeover target. I bought it because of the fundamental value.

The numbers are compelling. The stocks trades at 2 times cash flow, .46 times revenues, and at 2.28 times book value. The cash flow works out to about Seven Billion Dollars per year. Owning AT&T is almost as good as having a super-dooper master ATM card. (AT&T is a machine that keeps spitting out cash.)

The reason the stock is priced so low is that investors "know the long distance business is dying". This is absolutely not true but investors know it to be true! Investors are reacting to only one half the equation. Yes, prices for long distance services have declined for years, however, the volume is expanding dramatically and the volume will take huge leaps in the audio-video years ahead.

Every phone company in the world needs to be able to send large volumes of voice and data over real wires. The situation reminds me of the tomato vendor who parks his truck on the side of the road I often take to Myrtle Beach. When he has over-picked you can buy tomatoes in quantity really cheap. When he has under-picked, his price is dear. AT&T has had too many tomatoes for a long time but the demand is finally about to exceed the supply. VZ, SBC and BLS are currently spending billions putting fiber optic lines to homes. When that traffic is built out, much of the intercity traffic will have to travel on AT&T lines.

No one can tell if there will be much of a bidding war. FON has already announced plans to spin off its long-distance business which means that the big three phone companies, BLS, SBC and VZ could each end up owning a long distance company. Of the three long-distance players, the trophy would be AT&T and the next most desirable would be MCIP. Should SBC succeed in buying T, the surviving company (which may be called AT&T) would be the largest US phone company.

My amateur guess is that the buy out (if it indeed goes through) will be for at least $22 per share. I purchased more shares this morning as I believe the deal will be approved rather quickly by the regulators. A 15 to 20% return from the new stock in 6 months is my target.


A reader wants to know more about GOOGLE PHONE. The thing to understand is that it is only common sense that voice will eventually come to the internet. For many years companies have offered services that help surfers communicate by phone with web site vendors. The GOOG plan is the best plan yet.

Much of what I am writing here is based on reasonable assumptions and outright rumor. The company has not verified that they will start phone service. By the same token, they have not verified that they will start an internet browser. However, the company has hired the chief architect of the Fox-Fire browser that has stolen about 8% market share from Microsoft's explorer. It is also true that the company has advertised for employees with skills in the area of internet phone programming.

The reported rumor is that GOOG will offer an internet connection between advertiser and consumer. The idea is that a web site owner or a key word advertiser could post a "phone button". The consumer who searches for Myrtle Beach accommodations might find my ad or my web site where one of the phone buttons might be posted. When the consumer clicks the button, his phone rings and so does mine. This is powerful stuff. For years I have wished that there was an easy way to talk to my web visitors while they view the site. It is likely that software would be written to allow the vendor to take control of the consumers browser such that the vendor could help the consumer navigate to the best pages.

Another "free" GOOG service! Yes the advertiser would pay GOOG a fee but who wouldn't pay to connect by phone to customer who is interested in the advertisers service right now! The advertiser will pay a fee for a service that cost the provider almost nothing. It is possible that GOOG will offer VOIP to all commers free of charge tied into an internet browser! Can you see how the volume of traffic is likely to grow?

Right now, anyone can down-load the free SKYPE internet phone service. The service is free provided the call originates and ends on an internet phone. The key is that one does not need an internet phone to use the service. If the call terminates on a traditional phone or on a cell phone, the cost is 2 cents per minute. Of course most of the 2 cents goes to a company like SBC or BLS. It is in GOOG's interest to send the calls directly through the internet.

Of course, most SKYPE users encourage their friends and family to join such that all calls between them are free. GOOGLE may require the advertiser to use an internet phone. Although it is not clear if GOOG would actually sell internet phone equipment; Why not?

The future cannot be foretold but it is clear that plans are being made to integrate the internet and phone service. Actually, Verizon just started offering FOX TV service over the phone. "Convergence" is still in the works.


A little knowledge is a dangerous thing. If you need assistance please not that I offer free consultations. Please be extremely careful when buying high priced growth stocks. Always make sure that there are value characteristics to the stocks that you own or at least balance one position against the other. I like to write about an AT&T and a GOOGLE in the same article because owning either of these stocks makes sense only in terms of an overall portfolio.

Let me use Goodyear Tire (GT) and Yahoo (YHOO) to illustrate some of the dangers and synergies.

Yahoo is an incredible company. It just announced 4th quarter revenue growth of 154%! The company has operating leverage and indeed fourth quarter earnings were up 240%! The operating margin before taxes is 25%! The debt to equity ratio is .12! The company is building service after service that are each real values. Consumers are signing up for these paid services in addition to clicking on pay per click advertisements!

However the market is in love with the stock. Historically, when the market falls in love with a stock it trades far too high and can then under-perform the market for years to come. AOL is an interesting case study. In 1996 AOL dropped from $78 per share to $38 per share and even at that price it traded at 166 times estimated earnings. Those who were wise enough to buy the stock at $38 made a killing during the next 4 years.

After the bubble broke, AOL dropped again and this time it has not recovered. Since the bubble broke, the high flyers have not flown so high and yet they trade a dizzy hieghts. YHOO trades at 90 times earnings, better than 7 times book value, 15 times sales and 54 times cash flow! Contrast those numbers to the ones given above and you can appreciate either how cheap T is or how expensive YHOO is.

How about this for a comparison; Delta airlines trades at .o6 times sales which means the YHOO buyer pays 250 times as much for a dollar of sales as the DAL buyer. DAL is a distressed company and the buyer must know that the risk of bankruptcy is real. Not so for Goodyear. Goodyear is a recovering cyclical stock and has the worst behind it. Yet the stock still trades at only .15 times sales. The YHOO buyer pays 100 times as much for a dollar of sales as does GT.

I have stated before that I plan to continue to own YHOO, GOOG, and EBAY based on my belief that the internet is just getting started. To rationally own these stocks at current prices I must believe that extraordinary growth will continue for many years to come. I believe that although growth rates will have slowed dramatically ten years from now, growth rates will still be high enough for these stocks to trade at 2 or more times the market multiple. This is a long-term bet fraught with peril but in the mean-time I will continue to by some of the T's and Goodyears of the world. In aggressive accounts I will even buy an occasional DAL.

By the way, one should remember that the human being is apt to "know" things that are not true and to discount fundamental truths. In the text above, I implied that the growth rates must eventually come down. The concept involved is called "regression to the mean". The concept was discovered by Sir Francis Galton more than 100 years ago. The idea is simple. He noted that unusually tall men tend to have tall sons but not as tall as their fathers; unusually short men have short sons but not unusually short sons. The height of sons tends to regress toward the mean. Google had revenue growth of 233% this year. It is simply not realistic to expect this rate to continue in the same way it is not reasonable to expect two unusually tall parents to have an 8 foot or even a 7 foot tall child. On the other hand, one should not assume that because long-distance prices are in decline that there is little value in owning a long-distance business.

Monday, January 24, 2005


My barber and I discussed EBAY and Krispy Kreme the other day. Krispy Kreme was founded and is headquartered in my home town so it is frequently discussed around here. My family owned a few shares of the stock in the past few years. We made money off some but held some too long and sold them on the way down. As a sentimental home town favorite, we actually held a few shares all the way down to $14 per share. It took too long for us to recognize just how bad the apparent abuse of accounting. The SEC investigation may result in criminal charges.

When a growth stock breaks its growth trend, it gets hammered. It usually takes many years to recover--if it ever does. I am not a buyer of Krispy Kreme even after the recent good move to "retire" Scott Livengood and to replace him with a "turn-around" expert. The expert will rationalize the business; the costs will be great.

When a turn-around expert comes to town, the company in question often gets chopped into pieces. Sometimes the biggest remaining piece is sold to a larger company. Often times when the remaining piece is sold, the company taking over assumes debt and pays a relatively small amount of money because the size of the company has been whacked and the buyer is not willing to buy at high multiples of sales or earnings. In other cases, a buy-out firm takes the firm private. This can be worst of all for the most optimistic of the current shareholders as they believed they would one day recover all their investment once the company turned. (Many of those who eat the doughnuts and own the stock are Krispy Kreme fanatics). I still love the doughnuts but not the stock.

I should remember the details better (I have know members of the founding Rudolph family for many years) but years ago Krispy Kreme had a great run and was then sold to Beatrice Foods. Beatrice struggled trying to expand the company for years before spinning it off to a private group. I suppose the point is that the business has faddish tendencies. The doughnuts are the best in the world but a tight distribution network seems to be the key. Just like grocery stores that over-expand their distribution centers, Krispy Kreme seems to be able to invade a territory just so far before running into fierce competitors.

EBAY is a very different situation. EBAY has not broken its growth trend. It's earnings for the last quarter were up something like 44% and only missed analyst projections by about a penny. The company forecast very strong earnings growth for the coming year, just not as strong as the analyst were forecasting.

The first point one could make is, "What is new about analysts missing a forecast"? The analyst record is a dismal one to say the least. The more important point is that the company has planned slower growth on purpose!

My barber quickly understood this point completely. I said to him, has your business ever expanded to the point that you raised your price knowing that you might lose some customers. Of course he has. That is the way barbershops set their prices. Whenever they go up in price, they often temporarily experience a few vacant appointments but if the price increase is 10% and the volume decline is only 5%, they still make more money.

This is exactly what EBAY did and EBAY has even more to gain on a percentage basis. EBAY raised the price of an "EBAY Store" from $9.95 per month to $15.95 per month. EBAY also raised the price of several other fees. In doing so, EBAY knew that some sellers would close up shop. The increase from $9.95 to $15.95 is 60%! Sixty percent of the shops will not close! Revenues per shop will go up! Volume sellers will stay open for business and their volume will even go up! The shops that do close will temporarily cause growth to slow at EBAY but the value of a store will go up to those that stay open as the competition is decreased. For the store operator the scenario is similar to having three barbershops in one area and because of a rent increase one shop closes down. The surviving two shops will net more even after paying the higher rent.

The other big difference in the recent decline in EBAY and the decline in Krispy Kreme is the difference in expansion and contraction. Krispy Kreme expanded too fast and is now being forced to get out of areas that are not profitable. EBAY is very profitable in its secure market and is still expanding rapidly into others. The company just decided to spend an extra $100 million to expand in China. The companies investment in China will exceed $300 million. Who else will spend this kind of money securing yet another growth market?

EBAY is very expensive in terms of price to earnings, price to book value and other value measures. The current price reflects the probability of strong growth for many years to come. Science and common sense say that the growth rate must slow as the company gets to the monster size category. Marketing expenses to reach the masses will cost more. All of these factors suggest that should the company stub its toe, for example in the execution of the move into China, that the shares could drop to a fraction of their current price in a heart beat.

On the other hand, the company appears to have a lock on its fast growing business. The internet will experience dramatic growth in just the next few years. The internet is going mobile. Consumers who want to buy will be able to comparison shop EBAY while standing inside a brick and mortar store. The majority of the the 60% increase in prices will fall right to the bottom line!

EBAY is a buy! Buy the stock and let me know your purchase price. Set up a monitored account and I will help you watch the performance. Please remember to not pay more than $11 to make the trade as transaction cost are an important part of performance.

The current correction may have already run its course. Oil prices are back near their highs. The "war" premium may decline after the Iraq elections. Another catalyst to the next market run, although a long shot at this time, is the possibility that the Fed will stop raising short rates.

Those of us old enough to remember the hyper-inflation of the late 70's can appreciate just how far a market can go before it corrects. It took major changes by the Fed and the Congress to turn the market. Just last year, the Fed was concerned about dis-inflation.

In the late 70's, the very definition of inflation was changed by Milton Friedman of the Chicago School. His definition of inflation being too much money chasing too few goods gained wide acceptance. Do we now approach the opposite side of the coin?

You may have heard the stories of how a lottery winner still enjoys going to the local dinner to get the $3 blue plate special. This is the way workers in developing countries often react to newfound prosperity. They may "hide their money in a mattress" and only slowly ramp up their spending. Next thing you know, under the new free trade rules, we may have Chinese and Indian workers making more goods than we can consume. How many car choices, cell phone choices, MP3 Player choices do we need?

For some time, I have suggested that one should add consumer staple companies to ones portfolio. Companies like Colgate Polmolive that have wide moats and that will continue to sell goods no matter what happens to interest rates or to the economy. These additions have helped my portfolios hold up reasonably well during the current correction. The addition of the oil drilling firms should have been made sooner but those are my big gainers during the past few weeks.

One needs to be cautious as many firms have no pricing power. Long interest rates are low which means there are a couple of bad things that can happen; the economy can slow or long rates can go up. Either could be bad news for the market.

The low long rates are forecasting a slowing economy. The good news is that the market usually takes off during a slow economy. I have done a short term 180 in regard to gold and gold shares. I covered my gold stock shorts and am tempted to go long for an intermediate term trade. I must admit that I did not see the latest big decline in long rates coming. Now it is up to the Fed. If the Fed were to not raise short rates or were to talk about moderating its current stance, the market could be off to the races.

I remain 100% invested in stocks with a zero percent long bond allocation.

Tuesday, January 18, 2005


EBAY has announced a stiff price increase. Several fees will be increase in a few weeks. In particular the cost for an "EBAY STORE" listing will go up; from $9.95 to $15.95 per month, 60.3%!

Naturally a number of EBAY sellers are not real happy. Some have threatened to leave the service.

I am reminded of an old friend of mine who used to operate a Mr. Dunderbach's restaurant located in Hanes Mall. When Hanes Mall was very pleasantly surprised by the tremendous growth in traffic, the management announced a large expansion project and a sharpe increase in rents. My friend was upset and move his store to a nearby shopping center. His rent was reduced by more than half. The troubles were two fold. His traffic dropped by more than half and he had to reduce his price to hold even the smaller traffic. In the mall, he could simply charge much more for a sandwich because the customers were already there.

Regular readers know that EBAY has been a favorite of mine for a long time. Every few months I talk another reader or two into buying the stock. Can you see today's opportunity? The stock has dropped 10% in the face to the price increases. Sellers are upset but really have no other "Hanes Mall" as an alternative. People will still buy at EBAY and of the few who say BYE-BYE many will return. Yahoo, Overstock and others have nearby shopping centers but no one has the people in the store the way EBAY does. No one else has nearly the selection of goods and services. Now is the time to BUY BUY EBAY!

PS: I can't mention YAHO without mentioning the latest deal between Verizon and Yahoo. Yahoo is the largest internet portal and it is ready to grow by leaps and bonds. GOOG just added a number of new features to PICASA, its internet picture program. The phrase "the rich get richer comes to mind". EBAY, YAHO, and GOOG are high priced by several metrics but they all have solid businesses that are growing rapidly.


A few days ago, Big Boy Buffet sold 3.5 Billion Bonds (see post of 1/14/2005). I never like to bet against Buffet and certainly do not intend to buy bonds now. Why are bonds so bad?

Two Bigger Boys, Federal Reserve Board Chairman Alan Greenspan and President George Bush are co-operating to make bonds bad!

The President has planned a very aggressive agenda for his second term in office. He desires to lower taxes, to fight the war on terrorism, to pass tort reform and to reform social security; all the face of a relatively slow world economy. If successful, one can infer that neither of the twin deficits will be brought back into balance anytime soon. (This does not alarm me as it does so many of you and indeed the US Economy would benefit greatly if the Bush program were to be passed.)

Can the President pull off more than a hat trick? The answer partly depends on Alan Greenspan. Greenspan is definitely playing along. Although Greenspan has raised short rates four times in the past four months, the increases have been small and came from historical lows; money is still cheap and available. The real fed funds rate (the rate minus the trailing year over year change in the PCE deflator) is now .75% (2.25%-1.5%=.75%)!

Three quarters of one percent real interest is not enough to slow the American consumer or the American business. Furthermore, it is not enough to cause the dollar to strengthen against foreign currencies. And finally it makes American home owners and stock holders happy as they watch their net worth compound. The cycle continues as consumers with additional wealth spend additional sums.

Of course, sooner or later, the stimulative effect of the lower interest rate will bite; the inflation rate will increase, long interest rates will go up and bonds will go down. Without taking the time to make a precise calculation, I can tell you that if the rate on the long term treasury bond goes up by only .1% in the entire year of 2005, the total return of the bond will be reduced by almost 1%. Call this a multiplier effect if you like but it is a powerful phenomenon. A bond that currently yields 4.4% now and a current yield of 4.5% in 12 months will have lost about 1% in value. If the rate were to go up .2% the investor would have been better off to have kept his money in a 1 year CD.

Stocks and bonds are related. They may not be like brothers and sisters but they are at least as close as first cousins. If a company fails, the bond holders and the stock holders may lose all but maybe the stock holder loses all and the bond holder recovers a bit. If inflation is really high, bonds and stocks may suffer but bonds would suffer much more than stocks. In general, stocks can tolerate inflation far better than bonds just as one cousin may eat sweet potatoes and the other says no way.

The market has traded for the past couple of weeks as if the Fed has decided or will decide to raise short rates even faster. Stocks have gone down in value, bonds have increased in value, and the US Dollar has actually showed a little strength. Greenspan may know but the rest of us can only guess if short rates are about to go up more.

On the other hand, disinflationary pressures are unusually strong. Productivity growth has been unusually strong and continued adoption of new technologies should keep this trend in tact. World trade freedom has unleashed billions of productive resources (including billions of people who work for small wages).

The classical definition of inflation as stated by Milton Friedman is that inflation is too much money chasing too few goods. In some ways, we currently have the opposite. Due to productivity and free trade, we have too many goods chasing too few dollars. The US money supply has grown year over year at about 4.2% which is about the same rate as our GNP, but European central bankers have been stingy and China has tried to engineer a slowing of their extra strong economy.


The US Government will continue to spend money and issue lots of bond paper.

The Fed will continue to work with the President to try to gradually lower the dollar.

The Fed may increase rates a little more but not enough to risk recession.

Corporations will enjoy low rates and low taxes and produce profit gains of 11% or more.

Inflation rates will increase slightly but will remain relatively low.

Long rates will increase by the same slight amounts of increases in the inflation rate.

Real estate and stocks will appreciate until the market "smells" a jump in long rates.

Under these circumstances, even relatively conservative investors should consider buying solid US blue chip dividend paying stocks with a portion of the funds they might normally allocate to the bond market. If you don't believe me, ask Warren Buffet!

Friday, January 14, 2005


Warren Buffet is one of the most successful investors of all time. He is the second richest man in America and he made his money through investments; a rare breed.

Buffet operates a holding company--Berkshire Hathaway Inc. (BRKA). He does not believe in stock splits. The stock currently trades at $86,089 per share.

Three years ago, when corporate bond spreads were high, it was reported that Buffet was very heavily invested in high yield corporate bonds. No doubt he made good money. Today it was reported on CNBC that his company just issued 3.5 Billion Dollars worth of bonds!

It is always good to be on the same side of the market as Buffet. I don't have the ability to sell a new bond issue but I can certainly avoid buying bonds. Yesterday, I wrote about the way investors are being talked into buying "hybrid" bonds. I agree with Buffet, bond rates are low. One should avoid tying up money in fixed rate securities of any type.

At a time when major American companies such as SBC are paying 5% dividends, 85% income tax free, why invest in high yielding securities that are high yielding only because they expose one to interest rate risk and credit risk.

Yesterday I used the term "relative strength" again. Relative strength is a simple concept. It the overall market is going down but a certain stock or sector is not going down as much, then the stock or sector is relatively strong.

GOOG is currently a good example of relative strength. Since the first of the year, when the correction started, the overall market has gone down but GOOG is trading at about the same price. This is a very positive sign for the stock.

Traders can "paint" the tape which means that they can trade a stock back and forth up quickly and down quickly to attract buyers. GOOG is trading at a steady price. Those who like to buy on pullbacks are not getting the chance to buy.

One point that I keep trying to drive home is that although brokerage firms are pushing all kinds of "derivative" or "secondary" investments, one can buy good old American companies and enjoy solid returns while avoiding layers of fees.

Yesterday, when I listed keeping your costs or over-head low as being one of the keys to making money, I failed to mention the idea of trading very little. If you buy 200 shares of a $20 stock, pay a total commission of $5 and hold the stock for many years to come, you over-head is extremely low. If you buy the same amount of the same stock in a commission free or no-load mutual fund, your cost might be $60. However, if the stock goes up, you will pay more than $60 the second year and more the third. Over a 10 year holding period, you might pay $1,000 or more versus $5.

There is nothing wrong with paying a broker for advice. Unfortunately many customers pay for advice they do not use or they pay a lot more than they realized.

Buffet is not always the most popular guy in the brokerage community. By not splitting his stock, he reduces the speculative trading on the stock. Buffet buys value. It was just reported that he just sold 3.5 BILLION BONDS!

Thursday, January 13, 2005


The Carolina Tar Heel Basketball Team is playing very well. Last night the Heels tore a very good Georgia Tech Team to pieces. A few days earlier, the Heels made the Maryland Terrapins look weak.

Saturday Carolina will play Wake Forest, one of the top four or five teams in the country. The game will be at Wake and Wake always plays Carolina tough. Last year the teams played a triple over-time game in Chapel Hill.

Like any good stock picker, I do not want my expectations to get ahead of reality. Carolina is good and I want them to win but wishing does not make it so. Carolina is among the top four teams in the country but that does not mean the team will make the final four. It does not mean they will win the ACC tournament and does not even mean they will win the regular season ACC race. Duke, Wake and Georgia Tech all have a good chance.

I see the team as a good stock pick. The team has a lot going for it including top management, a solid core business and plenty of back up plans. Wake and Carolina are two of the rare teams in the country that play 10 good players most games. Winning the ACC regular season will be better than a stock double and the ACC better than a 4 bagger or home run and winning it all will be better than a 10 bagger.

There are no guarantees for investors or for ball teams. Investor should make their picks based on reality and not let emotion take control. The real fun is when the stock or the team out-performs your expectations. I have high expectations for the Heels this year but would not bet they will win the NCAA. You will not find me betting against them either. GO HEELS!


Last Friday night I told a group of business owners, accountants and lawyers that brokerage firms are pushing mortgage back REIT's. I suggested that this is a negative indicator for interest rates as major institutions are "distributing" their shares. Rates do not have to go up much to cause mortgage backed REIT's to have substantially lower income and lower market values.

Sure enough it happened again yesterday. A reader asked me about Impac Mortgage Holdings, an REIT recommended by a full service broker. In past articles, I have made the point that the incentive to refinance has died. The holders of mortgages are about to see these "flexible bonds" extend their durations. The holders will be locked into relatively low yields for many years to come unless they want to sellout at capital losses. Since so many brokers are pushing these and since the risk is more than an interest rate risk, let me give you a Big Warning!

Mortgage backed REIT's carry significant risks; they are not bonds backed by the government. If a homeowner defaults, the mortgage company can foreclose but the process of foreclosing and re-marketing a home is an expensive process and can cause very high operating loses.

Impac deals in non-conforming loans. The company charges high fees and high interest rates but loans to folks that a national bank would not consider. In some cases they loan more than 100% of the value of the home! They will even loan more than 100% of the value on second mortgages! In other words they deal in very risky loans.

Brokers can brag about the high yields all they want but is there any guarantee you will continue to receive the high yield? NO!

The same broker recommended a Canadian Royalty Trust to the same client. He did not happen to mention concepts such as return of capital or even the fact that a Canadian Tax Return is required to get all the "dividends". He spoke to the client in terms of dividends and the client came away believing that the high dividend was the payment of a portion of the profits.

When many brokers are pushing the same or similar products, it is time to go the other way. Only the gambler who simply enjoys the excitement should play the "bigger fool game". Yes, the firms may push the stock or sector a long way but make sure you are not the one left holding the bag.

Stocks are so cheap relative to bonds (bond yields are so low) that the brokers have started selling "hybrid" bonds. The brokers should know better but don't put all the blame on them. He or she is simply trying to make a living and if the public will not buy stocks then maybe the broker can feed his family by selling "hybrid bonds". The fact remains that bonds are not cheap and ninety-nine times out of a hundred when investors start reaching-out for extra yield, they take far more risk than they know.

Investors should always remember that they are always playing a game of perception versus reality. If the majority of the investing public is afraid of an investment or in love with an investment, it automatically gradually becomes under or over priced.

Since September 11, 2001, the majority of folks have invested to avoid market risks. For the first time in 50 years the public actually reached the oft recommended level of having 6 months of income in cash. In the face of a strong economy and extraordinary profit growth, the public has stayed away in droves. Just in the last month of 2004 was it finally reported that the public is actively trading again. Of course the January swoon will cause many of them to leave again before the next big move begins.

The real problem is that risk is a swinging pendulum. There are times when bonds should be over-weighted and times when stocks should be. One simple way to dampen the swing is to split your investments, buy both sides and re-balance when one side gets too big. As I have stated for the past three years, I believe one should over-weight the stock side heavily in this market. It is fundamentally true that one must suffer below average returns if one takes below average risks. In the markets, you cannot avoid risk if you want to make money. You can preserve your capital by buying inflation protected securities (TIPS).

I have not looked at TIPS lately and I prefer not to look. I never want to take the "chicken way out". Without looking I know the current rate is between the rate of the ten year treasury and the one year note (TIPS are a hybrid of bonds and notes). The ten year is trading around 4.2% and the one year is around 2%. Stocks return an average of about 11%. The TIPS "hybrid" will consistently earn about the inflation rate (the ten year bond rate is the real rate of growth in the economy and the market forcasted inflation rate). The "hybrid" securities being pushed by the brokerage firms will over long periods of time yield more than the ten year treasury because of the risk premium. Ibbotson and Associates would probably be happy to sell you a report that shows the past performance but my guess is a long-term return of about 6%.

However, since the public is ready and willing to buy these "safe" (yuk-yuk) securities, the price is currently far too high. In my opinion, the return for the next couple of years will be much less than 6% and indeed could be negative. I believe this to be true even in regard to the royalty trust even in the face of oil priced at $48 per barrel today.

Bobby Wolff, one of the famous members of the world champion Aces bridge team, likes to say that a bird in the hand is worth two in the bush, but you must speculate to accumulate. A staff member today said she is simply not willing to speculate; I had to laugh. I asked if she had driven to work. I asked if she had rather fly to Atlanta or drive. Flying is one of those poorly perceived risks. Many folks who are afraid to fly because of the potential of a crash will drive miles and miles at a risk that is 250 times as great.

I plan to post my ten rules for successful investing one day. For now, let me share my three most important rules.

1. One should speculate with no more than 7% of your funds in any one security and no more than 10 to 12% in any one sector. No matter how good or how careful you are, you will make mistakes and it is important not to make huge mistakes. It is also a mistake to buy too many securities. You cannot reap maximum benefits by owning too many and you do not have the time to follow too many. Fifteen securities is about the right number for most folks. The selectivity risk becomes very small if you own 15 stocks.

2. One should keep ones costs or overhead extremely low. This means avoiding full service brokerage fees, management fees and high priced fund fees (management fees, 12b-1 fees and load fees). There are millions of people in the USA who are paying high fees for a "dressed up index fund". If you do not want to own individual stocks, a good alternative would be to own three to ten exchange traded funds. The hidden fees you will pay in these will be less than half and possible less than 10% of the fees others are paying.

3. Finally one should avoid buying what is already excessively popular. There are a number of facets to this last point. It is true that one should hop on board when a major move is underway and it is impossible to always be one of the first on board. In truth, one should not try to be the first on board. Let a stock or sector show relative strength before buying.

There are so many examples that it is hard to know which make the best points. Google is an internet stock and internet stocks EBAY and YAHO were up 300% or more in the years prior to the Google offering but the stock was not "hot". A lot of people offered their opinions as to why or why not one should buy and at what price. I talked to dozens of people and suggested they buy on the offering. Very few were interested and indeed the offering price and size of the offering kept dropping. I bought as much as I could at the time and have bought three more times since the offering. GOOG has gone up 229% and is still not a "hot" stock. If I did not already own so much I would buy more at today's price.

Yesterday, I wrote about energy. Energy has had a great run. However, the fundamentals are in place for several more years of high profits and yet the speculators are betting the other way! What are the TV pundits talking about? Apple and SIRI! CNBC reports that in November SIRI had more clicks for quotes than any other stock. There are billions of new dollars in energy stock earnings while 80% of the news coverage is about consumer electronics. How many months will it be before the i-pod must drop its price due to competition or come out with a whole new product to maintain leadership? A couple of months back, several readers asked about TASR and I said it was simply too hot to handle. In 8 days it dropped from 32 to 14!

I have been guilty of writing too much about SIRI. Partly because I am like the broker that is selling Mortgage REIT's. My readers have responded to me and asked me again and again about SIRI. I can't remember a single recent inquiry about an energy stock. And although I have written numerous times about GOOG, I am aware of only a few purchases other than the ones I made in several accounts.

GOOG and SIRI provide a stark contrast. It seems that every few days, Google announces another new service (today they offered a new network search tool). Some of these announcements have been incredible (such as the digitization of entire libraries). Never-the-less, SIRI gets the most coverage while almost every day a competitor announces a new business relationship or a new service (Verizon, Comcast, Sprint and many other companies have announced competing services). To be fair, Googles competitors also announce new services but they tend to be "me too services". Yahoo just announced a desk top search service similar to the one Google started months ago. In the case of SIRI, the services suggest that if you have a high data speed cell phone or wireless computer, you do not need to pay SIRI $12.95 per month. (One of the lawyers last Friday night reported that he is in love with his XMSR radio. He is a baseball fan and can hardly believe he will not miss a single game. The satellite stocks have long term merit but there seem to be more persons who want to own the stock than there are persons willing to buy the product. The Apple i-pod is the device that just set a new record for quick consumer addoption).

Now look at the fundamentals: Last quarter SIRI lost 169 million dollars on revenues of 19 million dollars! Last quarter GOOG made 52 million dollars on revenues of 805 million dollars. According to Larry Baker at Smith Barney, two thirds of the search revenue is now generated in the US and the revenues are growing at 20%. Google has about a 38% share! More incredible is that only one third of the search revenue is generated in all the other countries of the world, Google has better than a 50% share and revenues are growing by 30% per year!

My point comes down to the fact that the public is enamored with a company (SIRI) that is losing millions. The company may need to dilute the stock further; there are already more than a billion shares issued and indeed the company could fail completely. In contrast, the major new company of the decade (GOOG) has solid profits, hoards of cash and superior long-term growth potential and yet it trades in relative obscurity.

Did your broker recommend GOOG on the offering? Are you chasing profits by trading in and out of the high flyers? Is he pushing "hybrid bond" products at a time in history when long rates are extremely low? Is he simply following the crowd? Does his firm offer to pay him higher commissions on the products their institutional clients are trying to sell? Are you paying more than $7 to trade?

Don't get me wrong. There are some star brokers out there who earn the big bucks they receive (the average broker earns about $120,000 per year and star producers earn in the millions). Unfortunately the ratio of star brokers to mediocre brokers is probably one to seven and unless you have big bucks the star broker does not have time to talk to you. If just a third of the brokers were independent thinkers, the bubble and collapse of the late 90's would never have happened. Be careful, be wise, be smart because BROKERS CAN BE BAD FOR YOUR HEALTH!

Wednesday, January 12, 2005


There are certain energy stocks priced to give you nose bleed. For example, Cameco, a large Canadian uranium mining company has gone from $2 to $34 in four years (adjusted for splits). I cannot recommend it but I would praise anyone with the guts to buy it. As I wrote some months ago, when the wells start running dry, it takes a long time to gear up and catch up. It takes a major commitment and years to build a nuclear plant. China has several in the works. The latest designs cost much less to build and operate. After China successfully brings a plant or two on line, high oil prices could convenience other countries to build as well.

Today, I purchased shares in Pride International, INC. (PDE). The company provides contract drilling and related services. It operates 327 global fleet rigs, 35 jack-ups, 30 tender assisted, and 249 land based rigs. In several accounts I already have positioned Rowan Drilling (RDC).

I have said that we are in a sector rotation. However, there are two points I need to make. First of all, energy is in a secular move that will transcend the normal business cycle. In other words, energy is still being rotated into. In a similar fashion, I believe the internet is in a very long-term secular growth pattern and I will continue to hold internet stocks. In the past seven days, the energy sector is the top performing sector, up 3.3%. During the same time, the technology sector was the worst, down 2.7%.

The second point is that for billions of institutional money to rotate it takes weeks of churning action. Again, PAPA JOHN, a wise old World War II navy chief, used to say that it takes a long time to turn around a battleship. PAPA JOHN liked to call the institutions the "big boys". He understood that the "big boys" must allow the "little boys" to make a few bucks trading in and out during a base building period. The "big boys" must accumulate a lot of stock and they may have to accumulate on the way down or they often to set a trap and then load up right before a break-out.

Sometimes I am asked if I am a technetion or a fundamentalist. I am both and neither. I am actually an amateur economist and a market psychologist. We are in a world wide economy that has recently experienced tremendous growth in developing countries. Developing countries have turned into low cost manufacturing power houses. Developing nations now consume almost as much oil as developed nations! In regard to psychology, one should always buy what is hard to buy. If you and all of your friends and even the guy on TV are all excited about a particular stock or industry, run away! This happened to me with SIRI. I bought the stock at $2 and $3 per share and when it ran to the $7 to $9 range, all my readers wanted to ask about was SIRI. I took my profits not because any one of them was wrong but because the stock was pushed up by group think psychology and not by fundamentals.

One can find a number of reasons to buy PDE. The "chart-man" in me particularly likes the way this stock has bumped up against the $21 dollar price a number of times. It is interesting that it is back there with oil at $46. Oil often bottoms in December. We have had a relatively mild winter and yet oil is still at $46 in early January! I am willing to bet the price hits $60 before July 4, 2005 and would not bet against $70.

By the way, a good clue about the price of oil is to watch the professional hedgers. Normally the producers sit in a net short position on contracts because they can fill the contracts with production. Selling a contract is a way for them to presell at an established price. In recent months the professionals are in net long positions and the speculators hold the shorts. The speculators probably made a little by jumping on after the price broke below $55 but by now they are probably trapped in a losing trade. Even when the supply numbers are good, the price per barrel just will not go down.


There is still a lot of confusion (and always will be) about the declining dollar and what it means for America. Today, the trade figures came out at record high deficit levels. The TV guys marvel that the long bond traded up in value. This is no surprise to those of us that look at the dollar in a simple, straight forward and truthful way.

American consumers are number one in the whole world. We buy lots of consumer goods and we buy most of them cheaply from overseas manufacturers. When we pay a dollar for Samsung Cell phone or a pair of Wal-Mart socks, we own a hard good and the seller owns a soft dollar. The dollar is nothing but a piece of paper. If the foreigner holds on to it, America gains an advantage. It is just like me giving you a check for $10 and you decide not to cash the check.

The sellers of the goods have only two things to do with the money, buy American or invest American. When the trade deficit of $60 Billion was announced today, traders understood that foreigners hold $60 Billion dollars and much of it will be invested in US Bonds.

Dollars are just like any other commodity. They trade based on supply and demand. As foreign countries accumulate extra dollars, the excess supply causes the relative value to go down. However, the invisible hand of Adam Smith is always at work. Sooner or later, the foreign countries will see that the soft dollar they are holding will buy real hard goods back from America. America no longer manufactures much in the way of consumer goods. We are not even the biggest agricultural exporter any more. What we offer is high priced services and capital goods. We manufacture cars, tractors, main frame computers, air planes, etc. Our Universities charge stiff prices to thousands of foreign students. Our engineers design sophisticated electronics and get paid well but the manufacturing process is outsourced. Our drug companies develop sophisticated drugs.

During the second half of an economic recovery industrial capacity limits are reached and plants must be expanded at tremendous costs. Big businesses have to tape the capital markets in a big way and inflation begins to grow tall. Inflation usually starts when the labor supply tightens, continues when commodity supply tightens and eventually shows up in the cost of money. In other words, by the end of the cycle interest rates are pushed so high as to put the pinch on the consumer.

Now we have come full circle to what I wrote yesterday. Over the next few years, I expect less refinancing by the consumer and more borrowing by companies. The consumer will continue to buy goods and well run companies in businesses that do not have excess capacity will grow their earnings and the stocks will rise. A stock portfolio must live and breath to attain great results. One must not sell too quickly but adjust gradually. At the current time, when I add money to my typical portfolio, I will buy energy related issues or consumer staples issues. I believe the price of gas next summer will hurt spending for discretionary purposes.

Tuesday, January 11, 2005


I have recently often used the term "defensive stocks". This morning a reader asked what the term means or what stocks are considered defensive.

Dictionary definitions of defensive include: "Intended to withstand or deter attack" and "performed to avoid risk, danger, or legal liability."

There are many see-saw categories of stocks. Some examples include consumer goods stocks or capital goods stocks, interest rate sensitive and non-interest rate sensitive, small cap or large cap. Sometimes a stock category can be further subdivided or it is different in more ways than one. Some stocks neatly fit a category and some do not.

The US economy is built on consumption. The consumer is king and is responsible for about 75% of the total Gross National Product. Although one can generally count on the US consumer to spend his money, when a down-turn hits the economy the consumer becomes choosy.

The consumer area is made of of two main categories, consumer staple and consumer discretionary stocks. Consumer staples are typically defensive stocks and consumer discretionary are much less so. The main idea is that the consumer is going to buy certain products or shop at certain places regardless of the economy. Some examples of consumer staples include Kroger (KR), Campbell Soup (CPB), Heinz (HNZ) and Clorox (CLX). Note that consumer stocks include a lot of food products but are not limited to food. Also note that all food stocks are not consumer staple stocks.

Almost every category of stocks include "see-saw" situations. For example, DRI and CKBL are food stocks. They operate such restaurants as Olive Garden, Red Lobster, Cracker Barrel and Logan's Road house. These food stocks are not consumer staples but instead are consumer discretionary. Again, the main idea is that if times get tough, consumers may not spend their money at a restaurant but they still have to eat. Kroger, Safeway and Winn-Dixie will achieve higher sales volumes of Cambells soup during tough times.

Many health care stocks are defensive. The older folks who use a lot of medicines buy them no matter if the economy is good or bad. On the other hand, elective eye surgery is not covered by insurance and sales volumes can really swing. This is where the term Beta comes into play. The consumer defensive stocks do not generally swing wildly in price. Aggressive stocks are cyclical in nature and go through wonderful business and terrible business years.

Goodyear Tire (GT), Reebok (RBK), Harley Davidson (HDI) and Time Warner Cable are examples of consumer discretionary stocks. However, one can make the argument that Cable TV is now a necessity or a consumer staple, especially for those who use cable for internet and telephone service. Similarly one can argue that Reebok will sell shoes in all economies but if it comes down to eating a meal or wearing new shoes the meal wins. Goodyear Tire is perhaps most interesting of all. Consumers have to buy tires when they wear out. However, this is one of the most cyclical businesses of all. I have purchased this company after three recessions and I have always made at least three times my money.

Goodyear fools folks for several reasons. First it is true that consumers can cut back significantly on tire purchases. In a tough economy they make fewer business and personal trips and they make sure they get a few extra thousand miles from each tire. The second surprise to investors is that the company is an industrial hose maker first, an aircraft brake maker second, a tire maker third and a shoe sole maker last. The business is much more of a capital goods business than most would guess. Even much of the tire profits come from the really big tires used on aircraft, machinery and in industrial applications.

Diversification is necessary because the whole story is more complex than anyone can fully understand. Relationships vary and even similar industries behave very differently. For example, today in the consumer staples area CVS and Walgreen (WAG) Pharmacies were up and Winn-Dixie, Kroger and Safeway were down. I do not know the reason but any one of these stocks is more volatile than the whole sector. If you buy 15 in the same sector, your portfolio volatility will be very close to the same as the whole sector. Being in the right sector is typically more important than picking the right stock but the skill and fun of picking the right stocks make investing interesting.

For the past 14 days, all sectors were down. However, consumer staples were down only .5 and health care was only down .9 whereas the technology sector (a high beta-aggressive sector) was down 5.7%. Again, this does not mean that every defensive stock outperformed all the other stocks in other groups. Comcast (CMCSA) was up 5.4% during this time and Walgreen WAG) was up 7.24%. Circuit City was down 12.12% and Winn-Dixie was down 16.84%. The more volatile stocks WAG and WIN were both consumer staples and the least volatile were both discretionary stocks.

I have stated that the correction we are experiencing is a rotational correction. Money is leaving the high flyers (look at the price of AMD, TASR, or SIRI) and is gravitating to lower beta stocks. PEP, WMT, WAG, and PFE. (Internet high flyers are generally holding up well).

An old stock market sage, PAPA JOHN, used to say that it takes a long time to turn a battleship around but once turned it is hard to stop. Others have said it makes no sense to try to catch a falling knife or to step in front of a moving freight train.

The main thing I would avoid right now is buying something because it is down in price from the first of the year! When you buy something now, you want to see relative strength. In other words you want to buy a stock that is going up faster or going down slower than other stocks.

Patience is needed when leadership is not clear. Some groups appear to have turned like a battleship. For example, Gold had a strong two year run but the group is down 12% in 30 market days. Small stocks also took a significant hit (check out the Russell 2000 index $RUT). Oil is perhaps the key. The commodity price keeps holding the 50 day moving average line and aggressive traders are taking both sides. Oil services have been hit pretty hard but the long-term solution to tight supplies is not in sight. The big integrated oils are defensive. They make their money and pay their dividends no matter what.

In a widows and orphans account, I would buy integrated oils, consumer staples and health care. In my aggressive accounts I am playing defense by holding and buying defensive positions, but I believe the second half recovery will ultimately be strong. Therefore I have purchased CAL and DAL and RDC. I am drilling for oil and operating airplanes at the same time. These are speculative positions but held in the context of a diversified portfolio.


I continue to receive questions about SIRI radio but I do not take profits on a winner lightly. I like to hold my winners for very long periods of time. However, when a stock explodes up in value based on emotion and little change in the fundamentals, it seemed wise to sell the shares. So far so good. The following is a copy of an email I sent in response to one of the inquiries about SIRI.


There are several points to be made about SIRI. Do I think it will ultimately be successful? Yes. Has it run up to high too fast? Yes. Is it time to buy high beta stocks? No! Are we currently in a market correction? Yes. Is the correction beating down the high flyers more than the low beta socks? Yes. Has the competition made progress and significant announcements? Yes.

I encourage you to read the blog I wrote last night that shows again that defensive issues are doing well. Energy stocks are holding up and consumer staples and health care are starting to show relative strong performance. This is the way one should expect the second half of an economic recovery to play out. People have to buy socks, toothpaste and health services. They do not have to remodel their home or buy a new car and will resist discretionary spending once interest rates rise. The stock market anticipates the change at least 6 months in advance.

The thing that no one knows about SIRI is how successful the other services will become. There are many powerful relationships forming that should give one pause before buying a stock that has no earnings and not even positive cash flow. Comcast, Time-Warner, Cox, Microsoft, Sprint, Verizon, Cingular, HPQ, ESPN, Disney, Apple, Dell and many more companies have announced deals that put them in direct competition with SIRI and XMSR. Read my blogs and you will find that at least a month ago I said if I was forced to buy satellite radio, I would definitely buy XMSR before SIRI. XMSR has three times the customers and even more powerful drawing cards. Traditionally, baseball has been the “big radio sport”. On XMSR, one can tune to every single baseball game to be played all season times two! Let’s say you are a Red Sox fan and your neighbor is a Yankees fan (I understand you both live in Florida). On an XM radio, you could tune to the Red Sox announcer and your friend could tune to the Yankees announcer.

NASCAR fans need XMSR and Howard Stern fans need SIRI. To be fair, NFL fans also need SIRI. Look at the program guides to get the details, but one point is that XMSR is the more solid company of the two. It has more customers and has some extra neat features. XMSR offers a portable radio that can record up to 4 hours of programming. The new auto programming feature will allow one to “build a customized radio station” sans commercials. In other words, the radio could be programmed to automatically switch to CNBC at the times the stock market report is given. Rhapsody is actually the largest digital music station and there are many others. Rhapsody already has relationships established with major players such as Roadrunner and a long list of others. Yahoo has contracts with not one but all cell phone companies. These relationships and services took a long time to build. It must have been at least five years ago when Yahoo purchased (maybe not the exact name). The really hot product in this category is i-tunes through Apple. Apple appears to be winning the “VHS-Beta Max” war. The kids want to listen to the track they want when they want and radio (even satellite) is old stuff.

Do not buy only the "HOT STOCKS".

A lot of people got into a lot of trouble by buying the hot stocks in the late nineties. It is one thing to own one or two hot stocks but dangerous to focus on them. I must admit that I only realized how hot SIRI was when I was over whelmed with responses from readers. To date, I have had more inquiries about SIRI than any other stock!

Forgive me but I am trained like Pavelov's dogs. If my readers are overly excited about a particular stock or sector, I will automatically back off from that sector. Clearly SIRI ran up on excitement not on fundamentals. It may be a very long while before the stock sees $9 again. I do not plan to short the stock--it clearly does have strong growth potential--but I am willing to make a side bet that the stock sees $5 again before it sees $9 again.

Monday, January 10, 2005


The wisest man to ever live, Solomon, knew that "there is a time for everything''. Now may be the time for caution. The problem is that we face a couple of very big unknowns.

The first big unknown is in regard to energy. The low point in the price of oil is usually in late November, December or early January. We have had a very mild winter but the price of oil has stayed high. Shares in coal and uranium have stayed relatively strong. There is an "Iraq attack election premium" but more importantly there is the risk that world demand will continue to push prices until significant new supplies or conservation policies can be implemented. Germany and other European nations are in or nearly in recessions and "hot" Asian economies have slowed. On the other hand, it has been years since a major energy field has been found.

The American consumer on average is making only modest adjustments. Hybrid cars are selling but are a very small percentage of all cars on the road. At the same time, RV, SUV and conversion vans are selling well. The price has not gone up enough to cause consumers to adjust. The price will have to inflict a little pain before behaviors change. Since it takes a long time to build power plants or to develop new oil fields, we are probably in for a protracted period of high energy prices.

The second unknown is how the bond market and stock market will rationalize themselves. In a chart published by M.S. Howell & Co. today, it was shown that the S&P earnings yield is at the highest ratio to bond yields since a year after the market crash of October 1987. In 1995 the ratio was also very high. In 1989 and 1995 the rationalization occurred at least partly by a rise in stock prices and to a lesser extent by a fall in bond prices. In the 1970's, the rationalization started with a rise in stock prices but eventually went to the opposite extreme when bond prices fell dramatically.

The fact is that we are at "clearing price" levels. When a wide spread develops, market psychology can only push the spread so far. Economic forces and the invisible hand of Adam Smith must come to bear and "correct" the spread.

In recent days, we have been seeing a market rotation. Small, high beta, technology stocks have taken some of the worst hits. On the other hand, the S&P 500 has gone down only 1% since the first day of the year. Within the S&P some sectors are up and others are down but the index itself has changed little.

For the past several weeks, I have encouraged the purchase of defensive issues. The past two days have been interesting in this regard. The consumer staples sector was the strong sector but energy was not far behind. In the consumer sector, Adolph Coors (RKY) was up 4.39%, Avon Products (AVP) was up 3.06% and PepsiCo (PEP) was up 2.5%. In the energy sector, Williams Oil (WMB) was up 2.41%, Devon Energy (DVN) was up 1.63% and Andarko Petroleum (APC) was up 1.62%.

Going back 4 weeks, one finds that consumer staples are right behind health care in leadership (2.74% versus 2.94%) while energy was the worst sector during this time at down 3.68%. One must remember that oil peaked at around $55 per barrel and fell hard afterward. Since then it has been fairly stable in the low to mid 40's.

I am a stock market bull and a bond market bear. I believe that stocks and bonds will be reconciled by a decline in the price of bonds and an increase in the price of stocks. However, one should be careful to own defensive stocks. Stocks that offer E/P ratios that are higher than bond yields.

Again, consumer staples offer the most defense but one should hedge ones bets with a smattering of energy related issues. The health care sector also offers attractive stocks but the news cycle is beating the sector down prior to the start of a very long good run. I have started buying health care issues but may be early. The current correction is taking the whole market down a peg or two. No reason to panic but plenty of reasons to be careful.

Solomon asked for wisdom and also received great wealth. Wisdom is all it takes to become very wealthy. The wise always seem to be slow, steady and careful.

Thursday, January 06, 2005


Delta has finally said enough is enough. It is time to rebuild the air traffic industry after several very tough years. DAL has lowered prices and liberalized many of the quirky rules required to get the best deal. USAIR and Northwest Air have answered the challenge with equally low fares. Northwest code shares with DAL, whereas USAIR is a direct competitor.

My Great Grandpa was know for advising farmers to "get into the chicken business when others are getting out", and some of my all time best buys have been in the eye of a storm. Sometimes the storm is a macro storm or economic recession. At other times, the storm has been a micro storm or industry recession.

Airline bankruptcies and route suspensions have cut capacity. Cost-cutting has made profits possible at lower fares. The liquidation of another carrier would be very positive for the remaining carriers.

Delta is putting the question to USAIR and USAIR employees; do they want to stay or go? United is still operating under bankruptcy court protection and liquidation is possible but USAIR is coming real close to liquidation.

Although my profits in CAL have been diminished by the declines of the past two days, I will stay the course. In fact, it is likely that I will buy buy more DAL and CAL or swap shares of one for the other to capture a tax loss.

In the same way that the exact wrong time to buy an industry group is at the peak earnings for that group, it is the right time to buy near the earnings trough. The latest round of discounted fares will initially lower earnings. However, most of the fares will be cut far less than 50% and traffic will gradually come back.

I expect revenues to rise in 2005 and cost to fall. In 2006, I expect revenues to rise again and for costs to level out. I expect revenues to be well above break-even levels by 2006. I will not speculate on USAIR or UNITED. The risk of liquidation is real and without liquidation the risk is that bond holders will take all the equity.

Wednesday, January 05, 2005


Over the past 3 days, the Russell 2000 Index (RUT) is down 3.5%, the NASDAQ is down 3.1% and the S&P 500 Index is down 1.97%.

In the past 9 days, Phelps Dodge (PD) is down 9.35%, Newmont Mining (NEM) is down 6.44% and the $XAU Gold and Silver Index is down 5.48%. At major turns, small caps and metals often turn together.

Yesterday, the one day declines in the $XAU was 6.79%, the Mexico sector ETF (EWW) 3.36% and the Industrial Metals Index ($GYX) a whopping 7.3%. See the charts of the GYX posted last week, which showed the Metals had risen to extreme levels. Crude oil prices rose 4.25%, short interest rates rose 3.99% and Airlines took a 5% fall.

In recent days, I sold shares of PD and NEM short. I liquidated retirement account shares invested in RUT and have purchased put options on NEM.

Why all the sudden gloom and doom?

Ironically the answer lies in too much relative strength in the US economy. At a time when the German unemployment rate is at the highest level since the 1990 recession (10.8%), when the rest of Europe is in a funk and when China is restricting government spending in order to slow excessive growth, the US economy is showing signs of accelerating growth.

US statistics show that US layoffs are at the lowest level since 1999. Unemployment is down in 259 Metropolitan Areas and is up in only 63. The jobless decline is in 42 of 50 states. Federal reserve reports manufacturing was up 1.2% in November, completing a four month run. The ISM index was up a strong 58.6% marking the 19th consecutive month of increase!

The strong manufacturing and job gains spooked the Fed according to the December 14 FOMC minutes (released today). Several board members expressed concern about rising inflation. This information startled the markets as the Fed is still in stimulative mode. Indeed the fed funds rate of 2.25% is only .7% above the PCE deflator. One must assume after the significant declines we have had in the US Dollar, that the inflation index will rise by at least a couple of hundred points over the next few months. If the fed continues to crank up short rates by .25% per month, it will take several months to get ahead of the interest rate curve. Once inflation gets a jump on the fed, it usually takes a while to catch up. Oil prices are likely to trade up again significantly by the summer driving season.

Right on cue, the Euro Dollar just made its biggest decline in 7 weeks. Clearly the market is discounting the strong US economy, our rising inflation and the likelihood of further short-rate increases.

No one knows for sure what is next. However, the up-trends in small stocks, metals and developing country stocks have broken down. Earlier, I mentioned the Mexico ETF and could have used other examples such as the Brazil or Argentina Funds.

I sold my developing country funds too early, held some small cap funds a couple of days too long and missed the top in the metals by a week or two. One should never worry about hitting exact tops and bottoms.

The important thing is to preserve principle in the tough times. My short sells and puts on the metals hedge my long-term long stock positions. Selling short is an aggressive approach. Other aggressive investors may want to move other funds to cash, particularly in retirement accounts.

Based on current long-bond rates, the S&P 500 is cheap. The most recent moves by the fed have actually brought long-rates down. The market is currently spooked by the fear of inflation. Until most recently, economic indicators were showing a strong US economy but not an over-heated economy. Should one decide to be aggressive and raise cash, one should be prepared to reinvest at a moments notice. Those that sell small cap funds or emerging market funds should plan to re-invest in larger cap funds after the storm is over.