Best Buy Test Marketing Macs Should Boost Apple

Electronics retailer Best Buy (BBY) announced yesterday that they have begun test marketing Macintosh computers in some of its stores. A potential distribution deal with one of the largest retailers of computers, combined with new software that can run Windows, sure bodes well for Apple's Mac division. You have to like the odds that people buy Macs over Gateways at retail.

Investors seem to be focusing on iPod sales right now, as the stock is down significantly to $57 and change. While not inexpensive, shares of AAPL seem to have more room to run than most tech stocks.

Investors Intelligence Survey

The latest numbers show 35.6% of those surveyed are bearish, which is the highest level since October 2002. In case you don't remember that point in time nearly four years ago, it was the month the market bottomed.

My Take on Mark Cuban's Latest Venture

In case you haven't heard, billionaire entrepreneur and owner of the Dallas Mavericks, Mark Cuban, has caused quite the commotion by announcing his latest venture, ShareSleuth.com. The site, which will debut next month, will be a blog-style investigative reporting site that will focus on exposing corporate fraud. The site will be edited by Christopher Carey, a long time business reporter who recently quit his job at my hometown paper, the St. Louis Post-Dispatch.

Sounds pretty cool, right? Well, all was well and good until Cuban disclosed that not only does he plan on investing in the site, but he also will be taking investment positions based on what the investigations uncover. He plans on disclosing all of his investments, but will make the trades after the research has been done and before the site publishes its findings.

Given the controversial nature of most of what Cuban says and does, it's not that surprising that many are outraged at this idea. However, let's calm down and analyze exactly what is going on here. Then we can decide if what Cuban plans to do is illegal (it's not) or perhaps unethical.

This company is going to investigate individual companies and the people behind them. If something fishy is uncovered, Cuban might make trades based on this information (presumably by shorting common stocks). Then the research will be published on ShareSleuth.com and any positions Cuban has will be fully and properly disclosed.

Now some might be up in arms that Cuban will be in a position to short a company's shares prior to his editor publishing the negative research to the public. Let's think about this for a second. How is what Cuban plans to do any different than a hedge fund, pension fund, or mutual fund manager coming on CNBC and talking about what stocks he or she likes. The manager has previously conducted in-depth research, come to a conclusion, traded the stock, and come on the air to explain and disclose the position.

I really don't see how ShareSleuth.com will be any different than someone from Goldman Sachs recommending a stock on CNBC. In fact, investors should be happy that there will be a new place to find negative research on public companies. Most of the time everybody is telling you what investments to buy because they are in the business of selling investments.

An iPod from Microsoft?

Evidently Microsoft (MSFT) is developing a digital music device and download service to compete with the iPod and iTunes from Apple (AAPL). Headlines like these show that Microsoft is feeling the heat and believes it must reinvent itself. I would agree completely with that assessment, but I also disagree with their apparent strategy.

Merely copying successful products that have already attracted scores of competition is not going to reinvigorate growth at Microsoft. They need to play offense, and by that I mean, develop new technologies and products. They should aim to be first to market, and force others to play defense by copying them.

Adding another video game system to the market is not very innovative. Adding another mp3 player to the market is not innovative. Ditto for a music download service. The companies that are taking aim at them today aren't doing so by copying. They are doing so by innovating. Google changed the online advertising market, has the best product out there, and now dominates.

Google's beta of a new, free, online spreadsheet program isn't merely an imitation of Excel. You can see where Google is going with this. Low end computers nowadays can cost as little as $300 with a monitor included. However, if you want to put a copy of Microsoft Office on your new home machine in order to do work on weekends, the software package could easily double your system's cost to $600.

Large corporations have big pockets, so they will likely continue to equip all new systems with the full version of Office. Consumers though, hate paying hundreds of dollars for software that is oftentimes essential to do anything productive on their computer. Microsoft may have a monopoly on desktop software, but their dominance has nowhere to go but down the drain as other companies innovate. An online spreadsheet program complete with free storage space on Google's own servers could ultimately dent Microsoft's Office business, though it will take time.

Selling video game consoles and imitation iPods might make up for some of the business Microsoft will undoubtedly lose to companies such as Google, but the margins will be so much lower that it will never completely make up for it. Right now Microsoft gets nearly all of their operating income from Windows and Office. Those businesses are under attack, but do you really think the way to reinvent the largest software company on the planet is to go after the iPod?

Caterpillar Sets Growth Goals

Yesterday at their annual meeting Caterpillar executives laid out a growth outlook for the next five years. The headline peaked my interest because it seemed aggressive. Cat CEO James Owens announced that sales will grow to $50 billion in 2010 and earnings per share will grow at a compund annual rate of 15%-20% between 2005 and 2010.

For a fairly large, mature business like Caterpillar, as much as 20% annual EPS growth over a five year period sounded very optimistic to me, but upon doing a little further number crunching I realized that the plan really wasn't all that aggressive after all. Current estimates for 2006 and 2007 imply earnings growth of 31% this year and 13% next year. This comes on the heals of a 40% surge in 2005, the first year of the period in question.

So, from 2005 through 2007, earnings are expected to grow 28% per year on average. In order to hit the midpoint of the 15-20% annual goal for the entire six year period, profits in 2008-2010 will only have to average about 7% annually.

Given this outlook, are Cat shares a buy at the current $68 per share price tag? Let's assume the midpoint of the growth plan is achieved (17.5%). That puts 2010 earnings at about $7.30 per share. Let's assume a modest 12 P/E on those profits, given that we are talking about a cyclical heavy machinery company. We get an implied share price of $87 four years from now, about a 30% gain from current levels.

Not a horrible return, but not as good as you might expect based on the headlines we saw yesterday. This also assume that the global economy remains strong for many more years. A global recession will likely hurt very cyclical businesses like the one Caterpillar dominates.

Getting the Froth Out

Over the last year or so the markets have done well despite the rally being very narrowly focused. Consider what was working up until May. International, energy, gold, copper, industrials. The investment banks did great too as M&A activity hit record levels. What about other areas? Healthcare, technology, telecom, media, banks, retail. Not a lot of performance in those areas, even though they make up a huge portion of the U.S. market.

The result of such a narrow market was that everybody began chasing what was working and shunning everything else. The copper move from $3 to $4 a pound was probably solely due to hedge funds piling in. The moves were parabolic, especially in commodities and international stocks. Finally we have reached a point where people are getting nervous, nervous enough to reduce risk. This is leading to extreme selling in the areas that have done best. Basically, we are getting the froth out of the market.

It is this explanation, and not anything fundamentally wrong with the companies, that is causing the massive sell-off. Goldman Sachs (GS) reported a great quarter this morning. The stock is down 6 points. GS is still doing well. In fact, they advised on the Maverick Tube (MVK) buyout announced this morning. The market action has been violent, but prices are getting a little out of whack with reality at these levels, unless the world really is headed for horrible times. Not impossible, but it's tough to make that case at this point.

Uptrend Intact, For Now

If you look at the last month or so, you might want to quit the market entirely. However, it's always a good idea to put things in perspective. An easy way to do that is to take a longer term view and see where we've come from in order to gauge how bad a pullback really has been.

Here is a three-year chart of the S&P 500.

As you can see, the uptrend has not yet been broken, even though we are pretty darn close. I don't know if we'll hold and make a bottom around this level or not (by me putting this chart up, it could jinx that scenario a little bit), but it is an interesting chart, especially for any of you that like technical analysis.

As far as what could help us in the quest for a near-term bottom, I really think it is in the hands of Bernanke at the upcoming Fed meeting. My thesis for why the market made new highs in April, despite many apparent headwinds (soaring commodity prices and rising interest rates), was that equities were pricing in an end to the rate rising cycle.

As soon as it became clear that 5% might not be the top in Fed Funds, we lost nearly 100 points on the S&P 500. As you know, the market hates uncertainty, which is what we have right now. Some are predicting a Fed pause in late June, whereas others are calling for 5.5% or even 6% Fed Funds this year.

If Bernanke would just quit it already, we could very well hold the trend line in the above chart and make our way back to where we were the last time investors thought rates were finished going up. Conversely, if we get another rate increase and more uncertain talk from the Fed in a couple of weeks, it's unlikely we'll see better times on Wall Street anytime soon.

Note to Microsoft: Fire Steve Ballmer

It made perfect sense for Bill Gates to be replaced as CEO of Microsoft (MSFT), and renamed Chief Software Architect. Gates is a technology guy, not a traditional business executive. When you surpass General Electric (GE) as the most valuable U.S. company, as Microsoft did back in the technology stock hey day, you should have people focusing on their core competencies. For Gates, that was software.

In stepped Steve Ballmer to take over as CEO. How is he doing? Horribly, if you ask me. Now I don't own Microsoft stock (thank goodness), but if I did I would be infuriated. The shares have done nothing in 8 years. They trade in the low 20's, same level they were in 1998. Any investor will tell you that shareholders can share in the success of a public company in two ways, through share price appreciation, or through the return of capital.

For some reason, however, Ballmer does not particularly like either one of these forms of building shareholder wealth. Microsoft has nearly $35 billion in the bank and another $10 billion or so in investments just sitting on their balance sheet collecting dust. It's like he doesn't care about the shareholders one bit, despite the fact that they own the company and he works for them.

And that is why I think he should be fired. That doesn't mean he needs to leave Redmond entirely. Rather, orchestrate a similar migration to the one Gates embarked on several years ago. Ballmer's core competency clearly isn't working for the shareholders as CEO, so he should be working for someone else, his successor.

Not only has Ballmer been completely unfriendly to shareholders since he took over, he doesn't seem to care that they are upset with Microsoft's huge cash balance. When asked about the issue Ballmer told investors and analysts "It is likely I will continue to have to discuss with you for many years why we have as much cash as we do."

That quote says two things. One, we will continue to treat shareholders like crap. And two, he obviously thinks that it is a chore to "have to" have these discussions, proof that has no idea who he is working for or what his objectives should be.

Ballmer will likely try to make the case that they need all of that cash to invest heavily in R&D. Anyone who has paid attention to Microsoft in recent years knows that they are not doing much innovating at all compared with their competitors. The majority of their income still comes from Windows and Office. Their other ventures, like XBox for example, are losing money.

Most of what is going on in Redmond seems to lack strategic sense. Why are they in the video game business anyway? Why do they own billions in Comcast stock? Why do they have a bank account with $35 billion in it? It's no wonder Microsoft stock has done nothing for 8 years. If shareholders ever want to make decent money on their MSFT stock, they are going to have to fire Steve Ballmer.

Yesterday's Capitulation

If a market is oversold you always want to see signs of capitulation as a tell that a short term bottom has been made. Yesterday's action surely looked at lot like people throwing in the towel to me. After dropping more than 170 points, the Dow actually finished the day higher by 8 points. It looked like a good example of a selling climax.Where did that sell-off put us in terms of the market correction? The S&P 500 hit 1235, which is 7% below it's 2006 highs. Other indices such as the Russell 2000, which have led the latest bull run, are down far more than that. Yesterday that index of small cap stocks traded at 685, nearly 13% from it's all-time high.

The overall market action has been interesting lately, to say the least. That said, and despite the fact that I have talked about it a lot recently, I am still not taking much action here. As I've said before, I am a long term investor, so most of my time is used monitoring companies and their specific business fundamentals, not market technicals. These companies are still doing well, even though most of their share prices have been flat-to-down since reporting Q1 earnings in April.

I only mentioned the overbought nature of the market a few weeks back to explain why I was raising cash levels in the portfolios I manage and to prepare my clients for a rather sharp sell-off. After all, they haven't seen one since early 2003, and many seem to forget how ugly they can get. I have put some of that cash to work in recent days, but still have slightly above-normal cash levels.

Where do we go from here? Hopefully we have put in a short term bottom. I would still welcome a 10% correction on the S&P 500 to under 1200, and I think the odds are still good that we get that in coming weeks and months. However, yesterday's trading action indicates we could get a bounce here before we head to that level.

L-3 Shares Rally Despite Succession Uncertainty

"L-3 Shares Climb After CEO Death" - API can't make this stuff up. That is the headline of an Associated Press story talking about the $5 jump today in shares of L-3 Communications (LLL), a large defense contractor. L-3 has been a small Peridot Capital holding for several years. I wrote back in November that a sell-off from $85 to $74 was overdone. The stock subsequently hit a new all-time high of more than $88 per share.

L-3's CEO Frank Lanza, 74, passed away suddenly yesterday and when I saw the headline this morning, I figured we would see some selling pressure today. Lanza co-founded and led L-3 on an acquisition spree that built the company into a $12 billion a year defense giant. Given Lanza's age and lack of a solid succession plan in place, many investors have been wondering what would happen if Lanza left, or worse, passed away.

Such uncertainty usually breeds fear on Wall Street. Not so today, however, as the stock is rocketing ahead by 7 percent. L-3 itself has been rumored to be an acquisition target, and with no clear leadership in place right now, investors seem to think one possible succession plan will be to sell the company. I'd put the odds at no better than 50/50 that such a scenario materializes.