Use Sites Like Yahoo! Finance With Caution

Investors need to be careful when they do stock research on portal sites like Yahoo! Finance. If you enter a symbol in these sites you will quickly get a summary of where the stock trades. Not only do current prices show up, but also other metrics like market cap, earnings per share, P/E ratio, dividend yield, etc.

Keep in mind that oftentimes these numbers are wrong. They can include one-time items like EPS charges and gains, as well as special dividends. Also, the numbers aren't always adjusted in a timely fashion to account for stock splits. The reason I wanted to point this out is because of an email I received summarizing the contents of this week's Barron's Magazine. It said the following:

ST Microelectronics, one of the top five global semiconductor companies, has been beset by troubles including flat sales, a struggle to cut costs, removing itself from the low-margin memory chip business, and competition from strong rivals like Texas Instruments and Qualcomm. Yet its 23x P/E multiple is double that of TI -- and Technology Trader Bill Alpert "doesn't get it."

If you follow semiconductor stocks you might know that Texas Instruments does not trade at 11.5 times earnings. If it did it would be a screaming buy. I'm surprised that a writer for Barron's would make a mistake like this, but as soon as I saw it, I knew exactly where Mr. Alpert got that number; Yahoo! Finance.

Sure enough, when you enter STM and TXN into the site, it shows trailing P/E's for the two stocks as 23 and 11, respectively. However, if you dig deeper you will learn that the TXN number is way too low, likely due to one-time items that Yahoo! (or more accurately the supplier of its data) did not remove. The actual trailing P/E ratio for TXN is 18.5. No wonder Barron's "doesn't get" why TXN trades at half the multiple of STM, it really doesn't.

Don't make the same mistake Barron's did. Always double check numbers on finance portal sites if they look a bit strange. Chances are they were miscalculated.

Full Disclosure: No positions in the companies mentioned

Should We Blame the Fed for Sub-Prime's Woes?

I just heard an argument about this and I think it's extremely unfair to blame the Fed for the current crisis in the sub-prime mortgage industry. The rationale for doing so postulates that without record low interest rates for so long, the housing market would not have overheated. As a result, many lenders would not have made loans to customers who wanted to buy a house so badly that they might not disclose, or even lie, about their financial condition.

I have a problem with this logic. The sub-prime meltdown was not caused by low interest rates. Instead, it was caused by loose lending standards. The lenders gave loans to people who couldn't afford them. If you don't require prospective home buyers to verify their annual incomes or net worth, and you give them mortgages without a down payment and low teaser rates, you need to be responsible for the consequences of such actions.

The sub-prime lenders that are in trouble are the ones who gave loans to people who couldn't afford to pay them back, either right from the start, or when their ARM's adjusted upward a few years later. You have to blame the business people who made the loans, not the people themselves. If you blame the Fed, then you are saying that high demand for mortgages was the problem. However, the problem seems to be that the bankers actually matched the high demand with a huge supply of loans.

Corporations are not required to accept every customer that comes knocking on their door. Rather, they have a duty to shareholders to do business that is profitable and in the best interests of the owners of the business. If they fail at managing their company adequately, which has been the case for most sub-prime lenders, the only people they (or anyone else) should blame are themselves.

Great Companies Don't Always Make Great Stocks

Many times one will look at a value investor's portfolio and wonder why on earth they own some of the stocks they do. Usually the answer lies in the fact that the manager understands that just because a firm isn't considered to be a great company, it could very well be a great stock going forward. Stock market investing is about buying a share for less than it will ultimately be worth in the future. It is not about buying stocks of great companies and waiting for the cash to roll in. If the stock isn't cheap, it won't outperform consistently over the long term.

I think this is one of the reasons why sell-side analysts tend to be very poor stock pickers. More often than not, they don't want to have a "sell" rating on Best Buy (BBY) and a "buy" on RadioShack (RSH), for instance. The average person will look at that dichotomy and laugh. They might even ask, based on their shopping preferences, "How can RadioShack be a better stock than Best Buy?"

The reason I bring this up is because of an article I read in the March 5th issue of Fortune. It talked about the performance of America's most admired companies versus the least admired. When I see the term "most admired" I equate that to what many investors consider a "great company," a so-called blue chip.

Well, looking at a 1-year chart of the two, we can see who would have been right:

bbyrsh.png

Accordingly, the results of the study cited in the article weren't surprising to a value investor like myself. The mean annualized return from 1983 through 2006 was +17.8% per year for the least admired, versus just +15.4% for the most admired.

Why was this the case? Because stocks trade based on valuation over long periods of time, not according to the underlying company's popularity or brand name. In fact, the article also cited the average price-to-book ratios of the two groups of stocks being examined. Most admired: 2.07 times book value. Least admired: 1.27 times book value. Hence, the outperformance over a 23 year period of time.

Full Disclosure: Long shares of RSH at time of writing

Moodys Does What to their RadioShack Credit Rating?

NEW YORK (AP) -- Moody's Investor Services downgraded RadioShack Corp.'s long-term senior unsecured rating and short-term commercial paper Monday on lackluster sales and operations. The ratings agency lowered the electronics retailer's senior unsecured rating to "Ba1" from "Baa3." The move means the company's senior unsecured rating is no longer investment grade. Moody's also cut RadioShack's commercial paper rating to "Not Prime" from "Prime-3."

Sometimes you have to wonder what exactly rating agencies like S&P and Moody's are looking at when they change corporate bond ratings. This news isn't material for RadioShack (RSH) common stockholders, but still, it doesn't make sense.

As I pointed out recently, the RadioShack turnaround is on solid ground. Despite the surge in earnings at the company, Moody's is looking at sales numbers, not profitability and balance sheet metrics when rating the company's debt. Not only have most equity analysts missed the huge run in RSH shares, but it appears debt analysts are pretty clueless as well.

RSH has had a huge run, so I wouldn't be aggressively buying at the current price above $26 per share. That said, a credit downgrade to below investment grade seems to be a strange thing to go ahead with when operations are improving.

Full Disclosure: Long shares of RSH at time of writing

Most Financials Dragged Down with Sub-Prime Lenders

Short term market movements are often the result of what I call "guilt by association" trading. Along with the dramatic decline in sub-prime mortgage lending stocks, there has been a huge drag on most financial services companies, even if there is little, if any, evidence that the meltdown in sub-prime is set to spill over into other areas.

One of the main reasons the market has been weak lately is because of the underperformance in the financial services sector, which is the largest segment of the S&P 500 index. While mortgage lenders should be tanking ( given that they lent money to people who could only afford the temporarily low monthly payments for their new homes, and not the higher payments that would take effect when the variable rate mortgages adjusted), should every consumer finance company be getting thrown out with the bath water?

Surely there will be some spillover, as there are always lenders with bad standard practices, but we've seen everything from credit card companies, to auto lenders, to bad debt collectors, to student loan companies (just to name a few) all get crushed in this environment. Unless you believe that every type of consumer lender had loose credit standards on par with the sub-prime mortgage lenders, there are opportunities everywhere to snap up cheap stocks. Wall Street is acting as if sub-prime loans are the majority of the loans out there, not a small minority. Investors can take advantage of that, and should.

There is an old saying that "the market can remain irrational far longer than you can remain solvent." This is very true, and just because many financial stocks are trading at what I would consider unwarranted levels, it doesn't mean they can't go down further. You may even reach a point, like I did this week on one of my holdings, where the pain is so great (not really because of the drop in the stock price, but more because of the irrationality of the drop along with its magnitude) that you just throw in the towel like others are doing.

You know that doing so could very well mark the bottom and prove to be a horrible trading decision longer term, but in the short term it will help you psychologically to just not have to see the irrationality continue. Patience is the key for value investors, but sometimes it's just too hard to be as patient as the market requires you to be. That is why the stock market is as much a psychological exercise as it is a quantitative one.

If you have some financial stocks, either in your portfolio, or on your watch list, that are getting unfairly punished recently, do your research and make sure the worries are relevant before selling the positions. If you can hold on (and even buy more) and not have it be a psychological drag on your trading mentality, you will likely be rewarded when all the dust settles, the truth comes out, and many of the current speculation is proved wrong. 

Wall Street Journal Cover Story: One Year Later

Many of you may recall that I was featured on the front page of the Wall Street Journal last year for a story discussing the investment merits of Internet search giant Google (GOOG). In fact, some of you may have even discovered this blog directly as a result of that article. At the time I was writing a lot about the company and fortunately some Wall Street reporters took notice.

Whenever the article gets brought up to me, the most common question I get, perhaps quite predictably, is "Well, who was right?" Here we are one year since that article ran, so let's reflect on how things have taken shape for the stock since then and see exactly who was right.

To summarize, the article was called "As Google Matures, Investors Take Closer Look at Its Risks." In addition to myself, the other investor interviewed for the story was David Gordon, who also happens to be an avid stock market blogger (The Deipnosophist). Both of us were early investors in Google, but I decided to take my profits and move on to other stocks, whereas David was buying on dips and holding for the long term.

I had sold one chunk of Google at $467 in January of 2006, and followed that up by selling the rest of it in February around $400 per share. My logic was that I had a huge gain (after paying around $180 originally) and felt that many of the positive surprises surrounding Google's search business had already been reflected in the stock. To diversify, the company began spending lots of money hiring people, investing in new services, as well as overseas expansion. To me, the easy money had been made and there was less certainty that the company's other ventures would be as successful.

On the other hand, Mr. Gordon was confident that Google would be successful growing their model across other segments of the market. Despite the short term fluctuations in the stock, he did not sell any of his shares. Instead, he was quoted as saying "months from now, it will be at $600 to $800 a share and people will say, 'My God, why didn't I buy it back then?' "

As you can see from the chart below, Google has been very volatile over the last year. The shares dropped from $376 to $330, hit $450, dropped to $350, soared to more than $500, and now trade at $448 each.

So, who was right about Google? It really depends on how you define "right." If you just look at the stock price since the article came out, Google is up 19% since then, giving David the nod. However, if you look at his prediction of $600 to $800 per share in a matter of months, though, he wasn't. It's been a year and the stock traded over $500 but only for a brief time.

From my perspective, I sold some stock at $467 and some at $400, for an average sale price of $417 per share. More than a year later the stock still only trades at $448 per share. It has only risen about 7 percent from my average sale price, during a time when the S&P 500 has risen by about 10 percent. For me, selling Google when I did paid off, as the stock has underperformed the market since then.

From David's prospective, Google might not have hit $600 or $800 like he had hoped for, but he did not sell it, and the stock has risen nearly 20% in a year. In hindsight, it is true that his optimism was excessive, but the stock has gone up. We can hardly call that being wrong.

So, as much as some might want to crown a winner in what the Wall Street Journal called "A Tale of Two Shareholders," we might just have to conclude that given our personal objectives, we were both right. To support that claim, I'd be willing to bet that having it to do all over again, we both would have done the exact same thing.

Comments on Tuesday's 416 Point Drop

I know, I know... I write a stock market blog and have gone more than 24 hours without mentioning the fact that we got a 400 point drop in the Dow in a single day. Since I'm a long term investor and not a trader, the events of this week really aren't all that important to me. I really didn't do much of anything on Tuesday other than just sit back and watch the television screen after it became apparent that something was happening that we don't see every day.

So, why haven't I been very active in the market this week, and what do I think about the whole thing? First, while four hundred points sounds like a lot, in the whole grand scheme of things, it isn't. From peak to trough, intraday, we saw a 5% drop in the S&P 500 over three trading days, which is pretty substantial, I admit. However, if you use closing prices it was less than that, and if you include Wednesday's snap back rally, it was even less than that. Currently, the S&P 500 sits 3.7% below the highs it made in February. To me, this is much to do about nothing. If we had gotten a 3.7& drop over the course of a month or two, few people would think anything of it.

Let's take a step back and put the drop in perspective. I began to get a little cautious when the S&P 500 crossed 1,400 because I thought the market was overbought. However, it kept going up, rising another 4% within weeks. Even with this 3.7% "correction" (I'm hesitant to say that it is over) the S&P 500 is still above 1,400. So, I don't really think this pullback has been big enough to warrant putting every cent of cash to work. We just haven't retraced enough of the gains for me to be optimistic that the smoke has cleared, hence I am not all too enthused about the market's short to intermediate term prospects.

If the sell-off continues, which I suspect it might, then I will likely do some buying. I'd say we would need another 3% to 5% downside from here for me to get to that point. If we instead rally right back up to the highs, then my same overbought worries will persist and I will likely take some money off of the table to save up for a rainy day, or the next 400 point fiasco.

To sum up, I really don't think too much has changed despite this week's events. The market is still up a lot and even with the pullback, I still don't think we are going to see double digit returns this year. It would still take a more typical market correction for me to get aggressive on the long side, so right now I'm really just focusing on individual companies in this environment.

The Power of Multiple Expansion

Stock prices go up for one of two reasons; earnings growth or multiple expansion. If you really want to hit the jackpot with your investments, try and find stocks that can give you both. The combination of the two, as I will illustrate in a moment, is really powerful in terms of shareholder returns.

This is one of the many reasons why value investing has proven to be so successful over time. By buying stocks that have meager valuations, there is always the potential for multiple expansion. Getting earnings growth is even easier because most economies grow over time, so as long as management teams do a good job, earnings growth is inevitable over the long term.

Last year a friend of mine emailed me about a stock he was looking at, beverage giant Diageo (DEO). Diageo is one of the biggest wine, spirits, and beer suppliers in the world, known for brands such as Smirnoff, Guinness, Baileys, Captain Morgan, and Tanqueray. At the time (perhaps about a year ago or so) DEO shares were trading in the low sixties and the company was expected to earn about $4 per share in the coming year. At about fifteen times forward earnings the stock looked pretty fairly valued to me. Given DEO's size and an organic revenue growth rate of about 6 percent, earnings growth would likely average mid to high single digits, so a fifteen multiple seemed reasonable.

I can't remember exactly what my response to him was, but I suspect my feelings on the stock were something like "yeah, it's a solid defensive play with a nice dividend yield, but it looks fairly priced, so I would expect the stock to pretty much track earnings growth." Well, that assessment turned out to be quite wrong. The stock has risen by more than 30 percent since then, to the low 80's.

So what the heck happened? Simply put, most of the gain came from multiple expansion. Beverage stocks have had a great run lately as they offer fairly predictable profits and nice dividend yields (just look at the charts for BUD, KO, and TAP). Defensive investors have placed a higher value on these stocks lately, and their stocks, which used to fetch market multiple of 14-16 times earnings are now getting 17-19 times earnings. Sales growth is still mid single digits, with earnings ranging from the high single digits to low double digits, but the stocks are seen as safe, and as markets rise, some investors look to put money in less aggressive places.

How much of DEO's gain was due to multiple expansion? Well, they earned $4 per share in 2006 and the stock went from a 15 P/E to an 18 P/E, so that is $12 per share in appreciation due to a higher multiple. That amounts to about a 20 percent share price jump (given that the stock was around $60 per share). Add in another 10 percent or so for earnings growth and you get a stock that is up 30 percent in the last year.

I might have been wrong about Diageo, but this should help to explain why valuation is so important when investing in the stock market. Diageo's business hasn't really changed much at all in the last year, but investors' willingness to pay up for the stock has, quite meaningfully in fact. And that, you see, is the power of multiple expansion.

Full Disclosure: No position in DEO at the time of writing

Microsoft's Stock Drop After Vista Release Was Very Predictable

Investors may have heard at one point or another that by the time news hits the papers, it's too late to make money in the stock based on those events. Too often someone reads about a positive development for a certain company and rushes out to buy the stock, only to get stuck with a losing investment. This happens time and time again because Wall Street is a discounting mechanism. If something is going to happen in the future, but we know exactly what it is and when it will occur, stock prices have already taken the news into account before it actually happens.

Microsoft (MSFT) stock is the perfect example of this. Some investors may have bought MSFT shares recentlybecause their new operating system, Windows Vista, hit store shelves on January 30th. With a new revenue stream finally in the market, investors might postulate that Microsoft sales will accelerate dramatically, and with that will come appreciation in the stock price.

However, Microsoft stock actually peaked less than a week before the Vista release, and subsequently dropped about 10 percent in less than a month. In fact, this is not the first time Microsoft has dropped shortly after a major product release. Since I knew from past experience that Microsoft shares tended to sell off shortly after new product offerings hit stores, I decided to look back and see just how similar the stock's patterns have been around the time of each of their last four Windows upgrades (Windows 95, 98, XP, and Vista). While I figured the data would be fairly similar, it was really striking.

As you can see from the chart below, Microsoft stock always peaks very close to the official Windows release date. In fact, for 3 of the last 4 upgrades MSFT peaked within 1 week of release. Amazingly, the shares have dropped by around 10 percent within 1 month of peaking in each of the company's Windows upgrades.

These results are really fascinating, not only for the trend that they confirm, but the specific magnitude especially. So, remember this the next time Microsoft releases a major new product.

Full Disclosure: No position in MSFT at time of writing