Sears Holdings: The Second Coming of AutoZone

Shares of Sears Holdings (SHLD) are down about 5% today after reporting quarterly earnings of 65 cents per share, two cents ahead of estimates. Without news of any real estate related deals, the combination of a 1 percent profit margin and same store sales down year-over-year aren't making investors too excited today. Even still, if you haven't gotten into this stock yet, this is an opportunity to do so in the 140's.

There is one thing you should understand though, before you do invest. This company is not going to compete with Wal-Mart (WMT) and Target (TGT). They're not going to try to. Same store sales growth at Sears Holdings will lag those of both arch rivals. I saw a quote in an AP story today saying something like it's impossible to survive in retail without same-store sales growth that translates into maintained or increased market share.

If you believe this to be true, shares of SHLD are not for you. I can tell you right now that Sears Holdings is not going to gain market share. The company is going to be run just like AutoZone (AZO) has been in recent years. The focus is going to be on profits, not sales. AutoZone has been lagging its competitors in both sales store sales growth and market share for years. However, judging from the stock's performance (it's risen from $20 to nearly $100 in the last 5 years) you'd never know it.

Eddie Lampert's ESL Investments owns a third of AZO stock, as well as half of SHLD. Lampert has been influential in AutoZone's strategy of maximizing earnings per share, not sales, and he will do the same thing at Sears. Oftentimes this is accomplished by choosing to invest money in share buybacks, as opposed to store expansion. The way Lampert sees it, if buying back stock is more profitable than opening a new store, he's going to buy back the stock. Retail analysts will focus on normal metrics of the retail business, but shareholders will see earnings per share rise,which will boost the price of SHLD shares.

If you hear analysts and retail experts knock the prospects of Sears Holdings due to the reasons I have mentioned, the appropriate reaction is to laugh, and buy the stock if it has fallen due to those negative comments. The day to sell SHLD will come when they can no longer increase earnings at a meaningful rate. I think that time is years away, which is why I continue to like and recommend the stock.

Apple/Intel Deal: Too Much Hype

The buzz today was focused on the confirmation of previous reports that Apple (AAPL) will begin using Intel (INTC) chips in its computers, after years of an exclusive partnership with IBM (IBM). In addition to IBM, former Motorola subsidiary Freescale (FSL) is also seen as a loser in this deal, as they manufacture those chips for use in Apple products.

While this shift is interesting, and certainly reiterates the notion that IBM has been long extinct as far as technology bellwethers go, the investment impact should be downplayed in my opinion. Nothing about this change is going to meaningfully boost, or hurt, corporate profits for any of the major players.

Apple isn't going to sell more computers simply because they sport "Intel Inside." Additionally, Apple only accounts for 2 or 3 percent of total business for IBM and Freescale. Intel has been deemed the "biggest" winner of all, but Apple only has a little more than 3% of the world market for personal computers.

All in all, anything more than a slight move in the share prices of these companies, based on the Apple/Intel partnership, should be seen more as hype than substance.

Sun Micro-StorageTek Merger Warrants Mixed Reviews

Once a high tech high flier, now-struggling hardware maker Sun Microsystems (SUNW) hopes its planned $4.1 billion acquisition of StorageTek (STK) will help boost its languishing $3+ stock price. We can judge this deal two ways, from a financial perspective and from a strategic perspective.

First, the finances. Sun will pay $4.1 billion in cash ($37 per share) for STK, which has over $2 billion in annual sales. Sun has a war chest of more than $7 billion in cash, so an all-cash deal makes sense since they have the financial flexibility to avoid diluting existing shareholders. Even better, though, is the fact the StorageTek has $1 billion in cash of its own, so the actual price of the acquisition of the storage business itself is more like $3.1 billion, which equates to about 16 times trailing twelve month net income. All in all, Sun got a good deal.

However, money isn't everything. Since Sun Micro currently is 5 times the size of STK, StorageTek's net income will only add about 6 cents to Sun's annual EPS. The reason why its share price is under $4, though, is because the company isn't making money on its $11 billion in annual revenue. Until Sun can boost margins and turn its main business profitable, investors will have a very hard time justifying bidding up the stock. The cash cushion was providing a floor with a lack of profits, but that cash has been decreased significantly.

Bullish on Financials

It's been a tough year to like financial stocks. When the Fed is engaged in an interest rate hiking cycle, the financials tread water at best. I'd be willing to bet that I have sacrificed several percentage points of performance so far this year from holding a decent chunk of them.

That's the short-term view though, and the longer term view is the one I can't help but focus on. There are some great financial services companies out there and the valuations are way too low, below the market's 16 P/E in most cases. Over the next few weeks and months, they might continue to flounder, but if you look out 2 or 3 years these stocks are going to make people a lot of money, and they often pay huge dividends to boot.

Excuse me for keeping many specific names closely held (after all - this is a free site, as opposed to my paying clients) but I have written about Capital One (COF) on this blog before. That story remains very bullish and the stock trades at less than 10 times forward earnings.

Another one I have yet to mention is E*Trade (ET). Most people think of them purely as a discount brokerage, but they have branched out and now offer banking and lending services as well. In fact, only about a quarter of their revenue is generated from stock commissions. The shares sell for $12 each and trade at only 11 times 2006 earnings.

The Wal-Mart Bear Market - Part 2

How is it possible that a large cap industry leader can grow its earnings more than 90% over half a decade and yet return a negative 15% to shareholders? Did Wal-Mart do anything wrong, and if so, what?

No, Wal-Mart management did nothing wrong from 2000 to 2005. In fact, they did exactly what their job was, to grow the business into the world's most dominant retailer. The fault lies with the shareholders who bought the stock at $55 five years ago.

Now you might think that accusation is absolutely preposterous. After all, aren't investors who saw the growth potential in Wal-Mart back then very perceptive? Didn't they do exactly what a good growth investor should do?

I would argue against that notion. In fact, Wal-Mart investors made a very common mistake, a mistake that hundreds of people fall victim to every single day on Wall Street. They wanted to own shares of WMT but didn't pay any attention to how much they were paying for them.

I'm not talking about share price. Many people conclude a $5 stock is "cheap" and a $100 stock is "expensive." In fact, share price alone does not make a stock good or bad, cheap or expensive. Investors who bought WMT shares at $55 in May of 2000 forked over a whopping 40 times earnings for the stock ($55 per share divided by $1.39 in earnings).

Contrary to the common belief that stock prices follow earnings growth, there are many exceptions. When stock have enormous P/E ratios (a P/E of 40 is about 3 times the average stock's P/E since 1900) it is often a signal that investors are getting a bad deal, regardless of the company's future growth potential. If the P/E multiple that investors are willing to pay decreases dramatically over time, not even a 91% gain in profits can make up for the damage shareholders will incur.

Today Wal-Mart stock trades at $47, or 18 times this year's expected earnings. If you have a company's P/E ratio fall from 40 to 18, and earnings grow 91%, you are left with a 15% loss on your investment. This can explain why the high-flying tech stocks on the late 1990's are down so much from their peaks. Cisco Systems (CSCO) is making more money now than they ever did during the Nasdaq bubble, but instead of trading at $82, which was its all-time high in early 2000, the stock is under $20 a share today.

This example should help investors realize that oftentimes the key to growth stock investing is the price you pay, and not the future growth of the company you are investing in. Even though the hype for many promising growth companies can be hard to ignore, try not to lose sight of that.

The Wal-Mart Bear Market - Part 1

Let me give you a couple of statistics and then I'll ask a question. Wal-Mart (WMT) has grown its annual sales from $180 billion in 2000 to an estimated $317 billion this year, a total increase of 75%. Earnings per share since 2000 have soared from $1.39 to an estimated $2.66 for 2005, an increase of 91%.

Investors are constantly searching for growth when they try and pick winning stocks. People who foresaw the growth that Wal-Mart could sustain so far this decade clearly have done well, right? There is little doubt that having achieved revenue growth of 75% and profit growth of 91% over a 5 year period would be reflected in a very strong gain for Wal-Mart stock. This leads me to my question. How have shares of Wal-Mart performed during that 5 year span?

If you ask former Fidelity star mutual fund manager Peter Lynch this question, he would most likely tell you that over time stock prices follow corporate earnings. As a result, estimating WMT shares have risen 91% in the last 5 years would be a good answer, because for the most part, Lynch's statement proves correct.

The only problem is, there are exceptions to that rule. Just because a company grows at a very rapid pace, this does not ensure significant price appreciation of that company's stock. In fact, despite sales growth of 75% and earnings growth of 91% since 2000, Wal-Mart shares have lost 15 percent of their value during that time, falling from $55 to $47 per share.

Part 2 of "The Wal-Mart Bear Market" will be published shortly, and will examine why WMT investors have suffered and what we can learn from this example.

Most Ridiculous Item of the Day

Mark Klee, a technology fund manager, on why he doesn't own shares of Google:

"We don't own Google. The valuation is just too high for us. We do own Yahoo, though, Google's main competitor."

So Google stock is too expensive, but he owns Yahoo. As a mutual fund manager, you would think Klee would understand how silly this view sounds to anyone who follows these two companies. Google trades at 50x 2005 earnings and 39x 2006 profit expectations. Yahoo's '05 and '06 multiples are 65x and 51x, respectively.

I'd love to know why Yahoo is cheap enough for him to own, but Google's valuation is too high, especially when Google is growing faster. As far as GOOG's $14 jump today, to an all-time high of $255 a share, I still think the stock has more room to run. I would not be surprised to see $300 by year-end, at which point I will most likely take some money off the table.

Fortunately, Sentiment Indicators Remain Low

The UBS Investor Optimism Survey was released today and continues to point to extremely bearish investor sentiment. This contrarian indicator, coupled with record high short interest on the New York Stock Exchange, show the upward potential this market continues to have. According to the UBS Survey, investor optimism hit its lowest level since May 2003. The above chart shows how the S&P 500 has performed since then. The index has risen nearly 33% in just two years.

CEOs: Just Run Your Companies

Did anyone catch the Cyberonics (CYBX) conference call yesterday? I would never have noticed it as I don't follow the stock, but continuous coverage on CNBC got me wanting to mention it. The company's CEO went ballistic after the stock got crushed on news that the Senate is investigating the FDA's decision to recommend approval of the company's product after initially suggesting it be rejected.

Now I don't know the details of the story, nor do I really care, but I couldn't help notice how irrate the CEO was on the call from clips I heard on CNBC. He blasted short sellers for supposedly starting rumors and was infuriated that people were contacting the FDA to learn more about possible pressures applied to get the CYBX device approved.

After screaming at people on the conference call, the CEO spent more valuable time writing emails to CNBC criticizing their reporting of the story throughout the day. With a very important product under review by the FDA, doesn't he have more important things to do with his time than yell and scream at analysts, short sellers, and business reporters?

If you are a CEO, your job is to run your company. How well you do will determine where your stock trades. News reporters and short sellers do not determine stock prices over time. How much money Cyberonics earns does. Sure, a false rumor might send your share price down a dollar or two in a day. However, why be infuriated by this? As a CEO, it shouldn't matter if your stock is $30 on Monday, $28 on Wednesday, and $31 on Friday. Leave that for traders to worry about.

It's amazing how many CEOs hate short sellers and spend so much of their time trying to discredit them (Overstock.com's Patrick Byrne comes to mind as a perfect example). If you want them to feel pain, fine, just hit your numbers and those betting against you will lose their shirt. That seems like the best gameplan for those who are doubting you and your company.

Just do your job well, run your company correctly, and the stock price will take care of itself.

A Tale of Two Buybacks

There have been a lot of big name investors in the news recently, including the trio of Warren Buffett, Kirk Kerkorian, and Carl Icahn. The media tends to lump all three men into the same group of people investors should pay great attention to. After all, when Buffett disclosed he bought Anheuser Busch (BUD) stock weeks ago, the stock jumped from $45 to $48 in a single day. Kerkorian issued a tender offer for General Motors (GM) shares that resulted in the largest one day gain in the stock in more than a decade.

Icahn perhaps deserves less attention. His track record is not as solid as Buffett or Kerkorian, and Wall Street evidently realizes that his shareholder activism efforts with the likes of Blockbuster (BBI) don't always add any value for stock owners. In fact, when Icahn recently released a list of stocks in which he purchased stakes in recent weeks, most of the stocks barely budged.

Today I will focus on two stock buybacks, one of which was precipitated by Icahn's discontent with the management of Kerr-McGee (KMG), and the other non-Icahn related buyback that resulted from a huge cash stash at Motorola (MOT). As you can see from the chart of today's trading below, the stocks have reacted differently to the news of their respective buybacks.

First, the good news. Motorola has $6 billion of cash on its balance sheet currently, net of debt. CEO Ed Zander today announced that the company will buy back up to $4 billion in stock, about 10% of the total outstanding shares. Both Motorola and Nokia (NOK) have huge cash balances that have contributed to Peridot's extreme interest in the stocks over the last year. Investors should always pay attention to balance sheets, in addition to earnings per share. When companies are flush with cash, they will usually do something good with it eventually, just be patient. MOT shares have been up between 3 and 4 percent today.

As you can see, Kerr-McGee shares are faring much worse today, falling by as much as 8 percent. Here's a quick synopsis of the story there.

Icahn, unhappy with the management of KMG (despite the stock's rise from $50 to $80 with the last 12 months), threatened last month to attempt to get elected to the company's Board of Directors. Icahn agreed to abandon the effort after Kerr-McGee launched a "Dutch Auction" tender offer for 46.7 million shares. The move would cost $3.97 billion based on a purchase price of $85 for each KMG share, in order to avoid a proxy battle with Icahn.

With KMG shares trading at $74, Icahn basically has forced Kerr-McGee to buyback 29% of its total shares outstanding for $85 apiece. Today, the stock opened at $69. How exactly is buying back stock at $85, when your share price is $69, good for shareholders? That's a $16 per share premium to the price on the open market. Icahn evidently thinks that is a good investment of nearly $4 billion for the company.

You know what makes it even worse? KMG doesn't even have the $4 billion to buy the stock with, so they are borrowing the money. The company secured a $5.5 billion credit facility to fund the purchases. So, in addition to the $16 per share premium it is paying (an extra $747 million above market value) Kerr-McGee also has to pay interest on the entire amount.

Something tells me Warren Buffett would never force a company he owned a significant stake in to throw away money like that, let alone money they needed to borrow to do so.