Amgen Report Could Prompt Closing of Genentech Gap

The 2nd quarter earnings report from biotech giant Amgen (AMGN) issued Tuesday night was a blowout, no question about it. With much of the biotech acclaim going to Genentech (DNA) in recent years, AMGN has flown under the radar and now investors are clamoring to catch up. In fact, the stock is up $10 today to $80 per share. However, even with today's run-up does Amgen still represent relative value in the biotechnology sector?

I would have to answer "yes" to that question, even though I would wait for a dip before buying any shares. Genentech trades at 52 times 2006 earnings against just 22 times for Amgen. Not to say that these multiples should be identical, but such a discrepancy most likely reflects an overly optimistic view on DNA and fairly lackluster sentiment surrounding Amgen. I see no reason why Amgen should garner less than 25 times earnings given its strong drug pipeline and 15% growth rate.

Yahoo Carnage Scaring Google Bulls

Shares of Yahoo! (YHOO) are getting slammed after the company met earnings numbers for Q2 but fell short in revenue both for the most recent quarter as well as full year 2005 guidance. Given that YHOO was trading at 65 times 2005 numbers before the report, making the stock priced for perfection, such a collapse isn't surprising and shows us what happens when the market's most expensive stocks don't knock the cover off the ball.

On to Google (GOOG). Google is weak also as investors surmise that Yahoo's shortfall could hamper Google's ability to beat estimates when it reports on Thursday. While this is entirely possible, I would not be surprised at all to see Google beat bottom line numbers. Why? Well, YHOO reported 13 cents for Q2, same as the prior quarter. Google reported $1.29 per share in Q1, but the estimate for Q2 is only $1.20 per share.

Google's higher growth rate, compared with Yahoo, also might allow it to show sequential growth in EPS for Q2. The highest estimate on the Street is $1.34. I think GOOG could very well report $1.35+ on Thursday, despite the weak YHOO report. Maybe they are taking share from Yahoo.

Would that even be enough to boost the stock price meaningfully? Maybe, maybe not, but I would rather be long Google than Yahoo and I doubt we'll see as much disappointment in the GOOG report as we have with YHOO. Hopefully we can see GOOG maintain the $310 level throughout the week. Given what we know right now, that might be a better case scenario than we thought as early as this morning when people were positioning for a Yahoo beat.

The Misleading Consumer Price Index

Investors are trying to figure out why the Fed continues to raise interest rates. The most important job of the Fed is to contain inflation. That is what they target their actions to. Why then, with the most recent CPI index coming in flat year-over-year, does Greenspan and Co. continue to boost short-term rates?

This contradiction could very well be explained by many folks' distrust of the government's reporting of the CPI statistics. A flat CPI index seems strange given that prices for many goods and services are rising at a very fast rate, squeezing lower and middle class workers.

Let's take a closer look at the components of the CPI index. The largest are housing (42%), transportation (17%), food (15%), and medical care (6%). These four categories of goods and services account for 80% of the consumer price index, which is showing flat to slight increases in recent months.

Does anyone see anything suspicious about this? Real estate is seeing its biggest boom ever. Oil prices are at 20-year highs on an inflation-adjusted basis. Commodity prices are rising substantially, impacting food costs. Healthcare costs have been rising at double digit rates for years now.

Are these facts being accurately recognized in the government's CPI data? I, along with many others, would argue no. And perhaps Chairman Greenspan and the FOMC feel the same way, causing them to raise the Fed Funds rate higher than some think is warranted.

Martha is Creeping Back Up

After making a hefty profit betting against Martha Stewart Living Omnimedia (MSO) earlier this year, it appears investors will get another chance to repeat that performance.

With Martha's Apprentice show gearing up for its premiere, MSO shares once again look too expensive at nearly $30 each after rising 50% in the last few months. If the recent momentum carries this stock back into the 30's, it'll look like a good one to bet against again. To find out why I was bearish earlier in 2005, you can read my MSO piece from February 19th here

BWLD Raises Guidance, Catches Upgrade

Buffalo Wild Wings (BWLD) raised Q2 guidance last night and the stock is up 11 percent today. As a result, KeyBanc Capital Markets/McDonald upgraded the stock this morning from "buy" to "aggressive buy." This call is stupid for several reasons.

First, who still has 2 different forms of buy ratings these days? The buy/strong buy distinction was one used daily back in the bull market of the late 1990's, but most firms have gone to a 3-tier rating system; buy, neutral, and sell. Having both "buy" and "aggressive buy" should cause an immediate loss of credibility in the eyes of investors.

Along the same lines, what is the difference between these two ratings? What constitutes buying a stock versus buying a stock aggressively? I'd love to hear an explanation. Finally, why does one only want to buy a stock at $30.07 (yesterday's closing price) but when it opens at $33.89 today, they want to buy it more aggressively?

All in all, I doubt Wall Street research can get any worse than this.

10:53am - Oh, I forgot one more thing. Who names their investment bank KeyBanc Capital Markets/McDonald? Even Morgan Stanley Dean Witter Discover dropped the "Dean Witter Discover" after realizing how horrible it sounded.

Concentration Explains Much of Buffett's Investment Success

Last week I gave a guest lecture at the University of Missouri-Columbia Business School for a course entitled "Managerial Influences on Portfolio Selection." The course focuses on studying Warren Buffett and his investment strategies. Proponents of "efficient market theory" (a view with which I strongly disagree) attribute success stories like Buffett's to sheer luck. This is a preposterous contention, but it is important to understand why Buffett has done so well for such a long time.

All of the reasons are too great in number to mention here, but an important aspect of Buffett's track record is the conviction by which he relies. Since he could only find a certain few great investment ideas at any given time, Buffett's portfolios never looked anything like an index fund or any type of widely diversified portfolio.

In fact, as of the beginning of this year Berkshire's top five holdings represented more than 70 percent of its equity investment portfolio (see chart above). This level of concentration has been a staple of Buffett's investment strategy since he started his hedge fund in the 1950's and even with Berkshire Hathaway decades later. The lesson to be learned is quite simple; Buffett attained such a brilliant track record by not only being right, but also by making sizable bets when he had extreme faith in his investment ideas.

Sirius Momentum Accelerates Yet Again

Five Year Chart of Sirius:

The last year or so has been very volatile for shareholders of Sirius Satellite Radio (SIRI). A deluge of retail investor buying sent the stock soaring from $4 all the way up over $9 per share. However, such a dramatic move was not rooted in fundamentals but rather a feeling that the stock was a "must own", especially in the single digits. Sirius quickly fell back to the $5 level and settled down.

In recent weeks the momentum has picked up once again, with SIRI shares trading above $7 each. The market value of the company stands at $9.44 billion, prompting me to once again remind investors that although the share price alone seems "cheap" on an absolute price basis, the expectations of the market are indeed very high once again.

Let's assume a very bullish scenario and project the ultimate value of the Sirius franchise. There are about 200 million vehicles in the United States. Let's assume half of all vehicles eventually have satellite radio, and of these, XM and Sirius split them 50/50. A subscriber count of 50 million nets Sirius annual revenue of $7.77 billion. It's conceivable that Sirius could ultimately generate a 20% EBITDA margin when it gets to be that large. That puts annual EBITDA at $1.55 billion. A very generous 15x EBITDA multiple puts a fair value on Sirius of $23.25 billion, about 146% above current levels.

Sirius began 2005 with 1.1 million subscribers. It could take 20 years to get 50 million subs, much like it did with the cable tv industry. Investors willing to wait that long have a 7% annual return over 20 years waiting for them. Hardly impressive. And that assumes a lot of good things happen in the future that have not happened yet, such as a profitable business model and a 50% market share. And who's not to say there won't be more than two competitors in the marketplace in the future?

Small Caps Shine

History shows that small cap stocks outperform large caps over the long term. There are several reasons why this is true, perhaps most notably the growth potential for smaller firms contrasted with the law of large numbers catching up to big companies over time.

What is interesting is the stark contrast between the performance of these two groups in recent years. Since 1999, the S&P 500 has lost about 2% of its value. During the same period, the Russell 2000 index has gained an astonishing 56 percent. In fact, small and mid cap indices have been hitting all-time highs this year, even as the S&P 500 remains 20% off its 2000 high.

After the split of investment banking and research was solidified by New York AG Eliot Spitzer, small and mid cap research has become even less a focal point than it once was. The result has been many public companies flying under the radar screen despite excellent financial results. Now, even more than ever, a focus on undervalued small cap stocks can pay huge dividends for investors. And that's despite the fact that the market, as judged by major market indices like the Dow and S&P, haven't done anything in the way of advancement since this decade began.

John Hussman on Google

An interesting take on Google's current valuation and possible future returns from the manager of the Hussman Strategic Growth fund:

"Let's assume that Google is in fact, the next General Electric, Microsoft and Cisco Systems; that investors buying the stock here are, in fact, getting in on the ground floor. What sort of return can those investors expect over the long-term?

Let's see. OK, we know that total global advertising (television, radio, magazines, newspapers, billboards, and so forth) represents about $350 billion at present, and is projected to grow about as fast as the global economy in the future, about 6.5% annually, according to PriceWaterhouse Coopers. Total internet advertising is currently about 6% of that total, but let's project that 15 years from now, the internet share booms to 20% of all global advertising. Let's also assume that Google gets 75% of it.

That puts Google's revenues 15 years from now at $135 billion a year, which is close to those of GE. Let's also assume that stock market valuations remain at a permanently high plateau, and that Google gets awarded the same rich price/revenue ratio of 2.4 that the market awards to GE, which again, is the most generous price/revenue ratio awarded to any stock with revenues over $100 billion.

We now have everything we need to calculate the expected return to investors:

Price_future / Price_today = (Rev_future / Rev_today) x (P/Rev_future / P/Rev_today)

= ($135 billion / $3.8 billion) x (2.4 / 20.5) = 4.159

which implies an annual return on Google of 9.97% annually.

What if Google is the next Microsoft and Cisco Systems? Well, MSFT has about $38.9 billion in revenues, and CSCO about $24.2 billion. So $31.6 billion on average, with an average price/revenue multiple of 6.0. Let's assume that Google gets there in just 10 years.

Do the math:

($31.6 /$3.8) x (6.0 / 20.5) = 2.434

which implies an annual return of 9.30% annually.

Suffice it to say that even taking as given that Google is, in fact, the next GE, Microsoft and Cisco Systems, investors buying the stock at its current price aren't in for big returns."

Bank of America/MBNA Deal Boosts Capital One

Credit card companies have been hot acquisition targets lately. The sale of Providian (PVN) sparked speculation that more deals would follow as independent card companies aren't very plentiful. Today's announcement that Bank of America (BAC) will buy MBNA (KRB) for $35 billion only furthers that thesis.

MBNA is getting a very nice premium, with the purchase price of $27 being about 30% above the stock's $21 closing price yesterday. B of A is paying 13.5x MBNA's 2005 EPS estimate of $2.00 per share. Such a price has resulted in a repricing of other credit card firms in the market. Longtime Peridot favorite Capital One (COF) is rallying $5 per share (7%) today. With Providian and MBNA now out of play, COF is the last remaining large credit card company without a merger partner.

The 13.5x multiple for KRB implies that COF shares remain undervalued. Capital One should earn $7 this year, making a implied buyout value of $95 per share, versus its $74 closing price yesterday (shares are up to $79 this morning). While the speculation today will be that COF will be next in line to get a bid, I seriously doubt they are interested in selling. Nonetheless, the stock remains both undervalued and a Peridot core holding even as they remain independent.