Delta Plummets As Bankruptcy Looms

Shares of Delta Airlines (DAL) are down 20 percent to 87 cents per share this morning. Hopefully readers of this blog sold their stock months ago. After JP Morgan's buy recommendation in May, at $3.30 per share, I pointed out that the stock was pretty much going to be worthless at some point, even though the rationale for JP's upgrade was their guess that the company would go under in 2006, not 2005.

Now that Delta will join U.S. Airways and United, is anybody next? While not as much of a sure thing as Delta was back in May, I do think Northwest (NWAC) could be the next victim, and have been short NWAC shares in order to try and profit from yet another bankrupt airline.

What Kinds of Market Returns Should We Expect?

You hear a lot about the "Fed Model" when discussions break out about valuing equities versus bonds. Larry Kudlow loves talking about this strategy on CNBC to back up his never-ending bullish stance on stocks. The model, simply speaking, compares the earnings yield on the stock market to the 10-year treasury bond yield.

If the S&P 500 trades at a 20 P/E, it's earnings yield is 5% (100/20). Since this compares favorably with the 4% treasury yield, Kudlow will argue that stocks are more attractive than bonds, and therefore should be bought. The thinking goes that if both investments were fairly valued, relative to each other, then their yields would be equal.

However, there is a problem with this so-called model. The equity market and the bond market hardly ever "yield" the same amount. As a result, any model that aims to make them equal is inherently flawed. If stocks and bonds were supposed to be relatively equal in value, it would make sense to base investment decisions on any discrepency, such as 4% versus 5% yields. If such discrepencies are extremely common, there is little reason to conclude they signal relative attractiveness or unattractiveness.

Let's show some evidence to further conclude that the Fed Model shouldn't be used as a powerful investment tool. When bond yields are historically low, as they are today, the Fed Model would predict a high level of attractivenness for equities as an investment class. After all, the lower the yield on bonds, the more likely stock earnings yields would surpass them.

Below you will see various ranges for the 10-year Treasury bond yield since 1965, along with the actual total return that the S&P 500 achieved over the following 10-year period. As you can see, low bond yields have not resulted in attractive stock price returns. In fact, one can argue the exact opposite.

10-Year Bond Yield -----Subsequent S&P 500 returns
--------- 0-5% --------------------- 4.3%
--------- 5-6%---------------------- 5.5%
--------- 6-7% -------------------- 10.5%
--------- 7-8% -------------------- 13.2%
--------- 8-9% -------------------- 16.7%
--------- 9-10% ------------------- 17.5%

Sifting Through the Retail Wreckage

Just a few months back the retail sector didn't look all that tempting. Valuations had gotten fairly lofty by historical standards. Department stores like Federated, May, and J.C. Penney traded at market multiples when they traditionally price at a discount. Apparel retailers like American Eagle and Abercrombie, often thought of as fairly volatile to due the fickle nature of teen fashion, fit into the same category; sitting at the upper end of their historical valuation ranges.

Now with oil in the high sixties and Hurricane Katrina having ripped through the Gulf Coast, retailers have been hit fairly hard. As with any short-term downward pressure on Wall Street, opportunities come out of the woodwork. Wal-Mart, for the first time in years, now trades at a discount to the S&P 500. Abercrombie and American Eagle do too. Sears Holdings, after being unconventionally quiet for months since the Kmart merger, has been drifting down for a while (they report earnings on Thursday, so we'll get more color on that situation shortly).

Several less well known retailers also have felt the heat, and often get hit more since small and mid cap stocks tend to be more volatile due to less predictability in their business trends. There is no doubt that high fuel prices are hurting lower income consumers, but growth retailers should be able to sustain the headwinds longer term. As far as the sector goes, investors should be worried when others are confident, and as is the case right now, confident when others are worried.

American Car Companies Failing Miserably

Profit/Loss Per Vehicle Sold in North America During the First Half of 2005

GM: $1227 Loss
Ford: $139 Loss
Chrysler: $186 Profit
Honda: $1203 Profit
Toyota: $1488 Profit
Nissan: $1826 Profit

It may not be surprising to see those numbers, given what we know about GM and Ford's union-related pension and benefit liabilities. However, given the employee discounts that U.S. automakers are offering, it is interesting to point out that the Japanese car makers are gaining market share in the U.S. even though they are not the ones purposely sacrificing profit in order to increase sales.

Evidently, consumers are willing to pay more for a higher quality vehicle that holds its value much better than its American counterpart. I know I am.

Breaking Down TiVo's Valuation

Since last month, shares of TiVo (TIVO) have dropped from over $7 to under $5 each. This 32% selloff got my attention. Based on the company's 3.6 million subscribers, each customer is being valued at $114 given the stock's current price of $4.94 per share.

Since TiVo's large distribution deal with Comcast (CMCSA) won't take shape until mid-to-late 2006, the company has chosen to invest heavily in marketing (and show operating losses) until such deals kick in. Fortunately, the company has a large net cash position of $104 million, which can fund the company's projected quarterly loss projection of $20-$25 million.

There is no doubt that TiVo faces extreme competitive pressures in the DVR marketplace. Nonetheless, the current value per subscriber of $114 seems low to me, given the scope of TiVo's service and brand. Why somebody would not want to consider buying this company at this valuation escapes me. TiVo looks like an attractive speculative play at current levels.

Buffett's Possible Successor

Probably the number one concern among Berkshire Hathaway (BRKA) followers is the successorship of Warren Buffett. Buffett is in his mid seventies and clearly will not be around forever. What will happen when the cockpit is turned over to someone else? Will someone else be as investment savvy as Buffett? Surely not. Will Berkshire stock drop as Buffett himself is most likely valued highly by current shareholders?

Many people think Lou Simpson will take over for Buffett when the time comes. Simpson is the CEO of capital operations for Geico. Basically, he manages the float for Geico's insurance business, which amounts to several billion dollars. Interestingly, while Buffett gets the credit for portfolio additions to Berkshire's investment portfolio, often the smaller buys are the work of Simpson, not Buffett.

Taking a look at Berkshire's holdings as of June 30th, we can get a good idea of which investments are the work of Buffett, and which have Simpson's fingerprints on them. Buffett's largest holdings are the ones he has held for years. Gillette, Coca-Cola, Wells Fargo, American Express, Washington Post, to name a few. After subtracting Berkshire's top 10 holdings (mostly those older buys) as well as its position in Proctor and Gamble (due to the pending merger) and PetroChina (which was one of BRK's largest holdings until it was trimmed dramatically in the first half of 2005), Berkshire's $35 billion public company portfolio is narrowed down to less than $3 billion invested in 20 companies.

Since Buffett has stated in the past that Simpson manages about $2.5 billion, it is safe to assume this small portion represents what investors should expect to see on their position sheets should Simpson be named Buffett's successor. As a result, more often than not relatively small new additions to BRK's portfolio are the work of Simpson, not Buffett himself.

Google Shares Moving Sideways on Low Volume

Newly released Google Desktop Search 2 and its accompanying Sidebar really gives you some idea of where the company is heading. They want to take over your PC and dethrone Microsoft as the desktop monopoly. I haven't seen software innovations like these before. It's hard to not get excited about it, and not even just from an investor perspective, but instead simply as a computer user.

As for Google (GOOG) stock, the chart looks very bullish. After a huge move, the shares have been moving sideways on lower volume. Growth investors probably can feel comfortable about owning it down at these levels. The next 6 to 12 months should be very exciting for industry watchers everywhere.