Still Very Much A Buyer's Market in Housing

A reader recently asked me why I have not updated my housing inventory chart lately (it has been about a year since my last periodic update) and the simple reason is that I forgot.  As you can see after I added the last 12 months or so of data, the U.S. housing market was unable to continue drawing down inventory during 2010. Months of supply have risen again despite price stability in most markets.

What this tells me is that we have many more months (and probably years) to go before inventories get worked down enough to see meaningful price appreciation in the housing market. Now, this does not mean that prices will be taking another large leg down in coming months. Ratios of incomes and home prices are now much more realistic so there will be buyers eager to step up when deals present themselves. I would expect several more years of a relatively flat housing market (I am talking about the national market -- any individual area always has its own supply-demand dynamic). Long term buyers will likely be shielded from material downside risk in all but the most overbuilt markets, but they will truly have to be long-term thinkers when counting on equity appreciation above and beyond their principal repayments. As a result, there is little need to hurry into the home builder stocks. There will be a turn there at some point, but it is likely a ways off.

RIMM: 76% Earnings Growth for Under 10x Trailing EPS

The market's initial reaction to last night's earnings report from Blackberry maker Research in Motion (RIMM) made sense to me. The stock popped about $4 after-hours to over $50 per share after the company blew past analyst estimates for their latest quarter. Earnings per share came in at $1.46 (est: $1.35), revenues were $4.62 billion (est: $4.47 billion), and subscribers grew 4.5 million to over 50 million.

This morning, however, those gains from last night have all but vanished (the stock is up less than $1 as I write this). I have been bullish on the stock at recent prices (in the mid 40's) based on a ridiculously low valuation (10 times trailing earnings) for a company that is still growing like a weed, despite the introduction of the iPhone and an ever-growing selection of phones running Google's Android operating system. Given how fast the smartphone market is growing, coupled with nearly 40% market share for the Blackberry, it is my belief that RIM can still grow quite nicely, which if true, should eventually result in solid gains for the stock, due to its low P/E.

Last night RIM reported sales growth of 31%, earnings per share growth of 76%, subscriber growth of 56% and unit shipment growth of 45% versus the year-ago period. To me, these figures illustrate that my thesis (the company can still grow thanks to a strong position and a growing end market) remains intact. If users were really shifting in droves from RIM to the iPhone, the Droid, and HTC, etc and the company was in the process of fading like Palm did in recent years (as many are predicting), there is no way they could have posted these kinds of numbers. Not only that, RIM guided earnings per share for the current quarter to between $1.62 sand $1.70, well above analyst estimates of $1.39.

As a result, I continue to like RIM stock, believe the company can continue to grow earnings per share, and think the market is overreacting to the competitive threat. At $47 per share, RIM is trading at 9.4x trailing earnings. Since there is very little room for the stock's P/E to contract further, I am not sure how the stock can stay this low for too much longer (barring a drop in earnings per share from here). Assuming $6 of earnings in the coming year, RIM stock could fetch $60 to $72 per share (P/E between 10x and 12x). That would represent a gain of anywhere from 28% to 53% from current levels. I even think that P/E range is on the low end of what makes sense for the company (why can't RIM trade at a market multiple?). Perhaps Microsoft will even wake up one day and finally decide to pull the trigger, buy RIM, and expand its dominance in enterprise computing.

Full Disclosure: Long RIMM at the time of writing but positions may change at any time.

Cisco Dividend Initiation Very Overhyped

I was fairly surprised how much positive press Cisco Systems (CSCO) received this week after CEO John Chambers announced that the company would likely begin paying a dividend in fiscal 2011. Market commentators acted as if this was hugely important news, not only to Cisco shareholders but market players in general. Really?

Chambers said the dividend would likely fall in the range of 1-2% per year. Considering that most other large tech companies pay meager dividends already (Microsoft, Oracle, IBM, H-P, and Qualcomm all pay ~1-2%), coupled with the fact that the S&P 500 yields a little bit above 2%, I think this announcement is both unimpressive and unimportant. I doubt Cisco shareholders are jumping for joy at the prospect of a 1.5% annual dividend (perhaps 3-4% would be a different story, as it would represent a large portion of their expected long term return) and they shouldn't be. And for the investment strategists who claim that income-oriented investors will now all of the sudden flock to Cisco shares, they are clearly overstating the situation. A dividend of 1.5% simply is not high enough to wet the appetites of income-seeking investors. In fact, a portfolio manager running a growth and income fund probably already averages a 2% yield or more in their portfolio (the average dividend for the market), so adding Cisco stock will actually lower their total portfolio's yield.

Until tech companies start paying dividends that rival those in sectors notorious for fat dividends, such as consumer staples and utilities (3-5% per year), there will be little reason for income-seeking investors to all of the sudden embrace technology stocks. Intel (INTC), with its current 3.4% dividend yield, has crossed over into that territory, but others such as Cisco have a long way to go.

Full Disclosure: Long Intel and no position in Cisco at the time of writing but positions may change at any time

Thanks to the Weak Market, Apple Stock Actually Looks Cheap

Despite my roots as a value manager, in recent weeks I have been a fairly aggressive buyer of Apple (AAPL) shares. Such an investment may not seem appropriate for a value investor but as the stock has steadily fallen, dropping below $250 per share, it has actually become quite undervalued. And not just relative to its growth rate, but the broad market as well.

Flush with $45 billion in cash and investments ($50 per share) and no debt, Apple sports an enterprise value of about $190 per share. Compare that to $15 of earnings this year and enough catalysts to make next year's estimate of $18 seem easily attainable, and you have a stock that actually trades at a discount to the S&P 500. And therein lies the core explanation for my heightened interest recently. How can Apple trade at a discount to the market after factoring in their balance sheet?

While some feel that the company's recent momentum may be fading, there appear to be plenty of catalysts left to play out over the next couple of years. The iPhone has been a runaway success, even though it still has not been released by the largest cell phone provider in the United States (Verizon). A launch by VZ, expected within the next six months, is sure to reignite the iPhone's momentum here in the States.

There are other reasons to be bullish as well. According to several press reports, the iPad seems to be catching on in the corporate world far faster than most had expected. Many companies are buying iPads instead of laptops or net books for their employees. Analysts expected most of the early growth to be consumer-related so any stronger than expected success in the corporate market will only add to the bottom line, as corporations typically go with Windows machines.

Not only that, but I continue to expect that Mac sales will continue to grow. It is true that some iPad sales could cannibalize the laptop business at Apple, but I fully expect Apple's overall share of the global PC market to continue to edge higher in coming years. The only downside is likely to be deceleration of iPod sales, but with the company having both successfully entered (cell phones) and pioneered (tablets) new markets in recent years, there is little reason to think the company will fail to continue above average growth for several years to come.

Even if management remains stubborn about allocating its $50 per share in cash in more productive ways, there is no doubt in my mind that Apple shares will once again trade at a premium to the market in the not-too-distant future. If that happens, Apple stock around $240 per share (today's price) will likely prove to be a great buy a year from now. My personal target is $300 and it does not take overly aggressive assumptions to get there.

Full Disclosure: Long shares of Apple at the time of writing, but positions may change at any time.

That Was Fast... Hewlett Packard Loses Its Luster in Three Weeks

It is always interesting how quickly the investor community can turn its back on a company. Technology giant Hewlett Packard (HPQ) has seen its support wither after its CEO Mark Hurd resigned over questionable behavior earlier this month. HP's stock has cratered nearly 20%, from above $46 to around $38 per share, and all of the sudden investors insist that HP has lost its way. The loss of Hurd is definitely a negative, but should the tables be turning on HP this dramatically already?

Fueling that argument is the news this week that HP decided to enter a bidding war with Dell over 3PAR (PAR), a small data storage company. After initially being courted by four companies, Dell and HP were the finalists to acquire 3PAR but HP had been previously unwilling to outbid Dell's $18 per share offer. However, after Dell and 3PAR announced the deal HP decided to bid $24 and try to steal it from their competitor. Sporadic behavior on HP's part? It sure seems like it, as the critics were quick to point out, but maybe HP simply had a change of heart. Maybe Mark Hurd was against a higher offer and now that he is gone, top management at HP decided they really should acquire the company. Who knows.

What we do know, however, is that HP has lost their CEO and is now willing to pay at least $1.6 billion to fill out its product line. Are these actions worth a nearly 20% hit to HP's stock price? Given that HP shares were cheap to being with, I think the sell-off is overdone, as is the bearish sentiment towards the company all of the sudden. At $38, HP stock trades at merely 8.5x fiscal 2010 earnings estimates (there are only two months left in their fiscal year, so readers need not complain that I am failing to use trailing earnings, which would make the P/E ratio 10.7). And yes, using 2011 estimates of 11% profit growth (to $5 per share), HP's forward P/E stands at just 7.7 times.

The risks here appear to be both obvious and less than dramatic. Could the absence of Mark Hurd send the company into an operational tailspin which would reduce market share and hurt profits? Possible, but unlikely. Hurd's top lieutenants remain at the company and are very likely to continue the management style and game plan he has had in place for several years.

Could overpaying for 3PAR hurt the company's finances dramatically? No chance, as HP has cash on hand of $14.7 billion.

Could Dell adding 3PAR to its arsenal materially cut into HP's business? Unlikely. 3PAR generates only about $200 million in annual sales, a drop in the bucket for a company the size of Dell ($60 billion in sales) or HP ($125 billion in sales annually).

Could the empty CEO job cost HP some customers? Unlikely. As a CTO, would you switch vendors if you have had good experiences in the past, simply because the company's previous CEO allegedly charged personal expenses to the company in what could have been an attempt to woo a female contractor? You would probably agree with me that giving him the boot should suffice.

To me it is pretty clear that HP stock is getting unfairly punished lately. As a long term value opportunity, I think it looks attractive.

Full Disclosure: Long shares of HPQ at the time of writing, but positions may change at any time.

First Niagara Deal Sets Bar for Regional Bank Valuations

One of the cheapest areas of the market for a while now has been the banking sector. In the face of economic uncertainty and elevated loan losses, normalized bank valuation metrics have (temporarily, I believe) gone out the window. As a result, many of the stocks (even some quality names) languish near or below book value and despite this, very few non-FDIC assisted deals have been announced. However, today we got a rather sizable bank deal. First Niagara (FNFG) has agreed to acquire NewAlliance (NAL) for $14.06 per share in stock, or about $1.5 billion. This represents a 24% premium, and most importantly for value investors, amounts to 1.63 times tangible book value per share. Banks typically sell for 2-3 times book in normal times, or 1.5-2.0 times tangible book (excluding goodwill and intangible assets), so this transaction shows us that normal bank metrics are not dead.

Interestingly, I had never heard of First Niagara until early last year when they agreed to buy dozens of branches from PNC Financial (PNC) as part of PNC's purchase of troubled National City. PNC remains one of my favorite bank stocks (and the big local bank here in Pittsburgh) but First Niagara has remained in strong financial shape throughout the crisis and is certainly using that strength to expand while other competitors are retrenching (a smart move on their part). This NewAlliance deal gives them a footprint in New England, and like the PNC branch deal, likely bodes well for their future.

The takeaway for me is that, no, I have not lost my mind. Solid banking institutions selling at or below book value does make little sense. The odds of heightened takeover activity are slim with 9.5% unemployment, but over the longer term I fully expect bank valuation to rise back to more historical levels, for quality franchises anyway. Opportunities abound.

Full Disclosure: Long PNC and no position in FNFG or NAL at the time of writing, but positions may change at any time.

Forbes Investor Team Recommends Genentech Stock, Even Though It Stopped Trading 16 Months Ago

File this away as the most amusing item of the day. I always get a kick out of some of the investment articles I see on various finance-related web sites. Now, I am sure I have made a few mistakes over the years on this blog, but never anything like what the Forbes Investor Team posted on their site today. In a piece written by John Reese of Validea Capital Management, there are four stock recommendations, including Genentech. Here is what John says about the company:

The South San Francisco-based biotech firm ($100 billion market cap) has averaged a 22.1% ROE over the past three years, has increased EPS in six straight years, and has almost three times as much net current assets as long-term debt. It isn't cheap, selling for almost 30 times trailing 12-month earnings, but my Lynch-based model thinks it's worth it, given its 41.6% long-term growth rate. (I use an average of the three-, four-, and five-year EPS growth rates to determine a long-term rate.) Another reason the strategy is high on Genentech: the firm's conservative financing. It has a debt/equity ratio of less than 20%.

Of course, this is amusing because Genentech was acquired by Roche more than a year ago, in March 2009, and the stock has not traded since. I have to question this manager's "Peter Lynch-based model" given that it flashes buy signals on stocks that do not even exist anymore. Hilarious.

Statistical Shocker: S&P 500 Performs Best When Economy is Shrinking

Impossible, right? As a money manager I spend a decent amount of time explaining to clients, readers, family, and friends that the stock market does not mirror the economy in real time. Just because the unemployment rate is 9.5% and GDP growth is decelerating does not mean that the stock market is a poor investment option. Stock market returns and GDP growth simply do not track each other, and as a result, reading economic reports will not help you figure out where stock prices are headed.

As always, I try to present numbers to people so they do not simply have to take my word for it. In today's world of media sound bytes and political maneuvering Americans all too often repeat something they heard from one of their favorite media or political pundits as if it was fact, even when a tiny bit of research can disprove the claim.

In order to show that stock market movements do not mimic the economy, I decided to compile data from 1958 (the first full year the S&P 500 index was published) through 2009. While I had no idea what the actual numbers would be, I was confident they would show that stocks and the economy shared a very low correlation. Sure enough, the results were even surprising to me. It turns out that the S&P 500 has performed best when GDP growth is actually negative (i.e. when the economy is in a recession). Since 1958 there have been 7 years when U.S. GDP shrank and the S&P 500 gained an average of 24% per year during those periods. Pretty interesting, right?

Here is the full data set. I divided economic growth into 4 subsets (negative, zero to 3%, 3 to 5%, and above 5%).

As you can see, there is very little correlation between the economy and the stock market. Not only that, investors choosing to own stocks only in years with negative GDP growth would have earned nearly 4 times as much than investors choosing to invest only when GDP was growing at 5% or better. So the next time someone tells you the market is going to drop because the economy is bad or unemployment is high, send them a link to this blog post.

GM Buys Subprime Lender for $3.5B (Some Companies Just Never Learn)

Just when I thought General Motors was on solid footing and heading in the right direction after shedding a large portion of its liabilities in bankruptcy, they seem to have forgotten what has happened over the last several years in the world of credit. One of the big reasons GM's losses were compounded during the recession was because they funded a lot of subprime loans for their vehicles through GMAC. When those loans went sour, the losses not only negated the razor thin margins they had on the vehicle sales themselves, but resulted in a company that lost money on most of their cars. Hence, SUVs (with their fat profit margins) became a focus for the company, even in the face of rising gas prices, which aided their competitors in stealing market share.

Since GM has exited bankruptcy and the economy has stabilized management has stated publicly a desire to once again expand into the subprime auto finance market, but this time GMAC was hesitant (and understandably so). Undoubtedly, the result has been that GM could be selling more vehicles if they were willing to finance customers with bad credit who could not get loans elsewhere. This morning we learn that for $3.5 billion in cash GM is buying AmeriCredit (ACF), one of the larger subprime lenders in the country. They will use this new financing arm to get more cars into the hands of more people, many of whom could not get loans from third party lenders due to bad credit, no job, etc.

While I am sure those in the industry will praise this deal as a way for GM to maximize unit sales, we need not completely forget how cyclical economies work. Subprime lending pays off when the economy is improving but when the business cycle inevitably turns (as every economy does), the loans turn sour, the losses are crushing, and the cycle starts all over again. To me this highlights one of the core problems our domestic economy has developed over the last 10 or 20 years. We continue to follow the path of loose credit when things are going great and at the first sign of a downturn, credit standards increase dramatically. Once things stabilize, we hear that banks are slowly reducing their standards and loan volumes increase again.

For the life of me I cannot figure out why banks and specialty lenders refuse to maintain the same lending standards throughout the entire business cycle. The idea that lending money to people who are likely to default is good business sometimes and bad business other times baffles me. Sure, the few banks that always make smart loans, despite the economic backdrop, make a little less profit during boom times, but they also weather the recessions quite well in return for such prudence.

This kind of cyclical lending activity from the likes of GM (and most others) only contributes to the boom and bust economy the United States has seen become even more pronounced over the last decade. Fortunately, GM is set to go public via an IPO sometime in the next 12 months, at which time the U.S. taxpayer can shed its majority ownership in GM and therefore no longer be in the subprime lending business.

Update (9:15am)

Here is a 15-year chart of AmeriCredit's stock price which puts into graphical form the cyclicality I mentioned above.

Full Disclosure: No position in AmeriCredit at the time of writing, but positions may change at any time.

Motorola Continues Questionable Turnaround Strategy

Despite heavy competition that seems to get more fierce by the day, Motorola took another step Monday to increase their exposure to the mobile phone market. In order to raise the cash needed to reinvest in their mobile device division, which made up 32% of overall company revenue in 2009, Motorola is selling a large piece of its network equipment division to Nokia Siemens Networks for $1.2 billion in cash. The assets, which account for 17% of revenue, will add about $0.50 per share in cash to the company's coffers and boost the mobile device business ($7 billion annually) to 39% of company sales, as total sales will drop from $22 billion to about $18 billion after the divestiture.

I continue to find this turnaround strategy less than exciting from an investor standpoint. Motorola is essentially divesting itself of a slower growth business despite a strong market position and stable cash flow in an effort to reduce the diversity of the company's business lines. If the mobile device market was not so competitive, Motorola had a better leadership position already, and/or the profit margins on cell phones were higher than its other divisions, I might think such a move was smart. However, we have seen how difficult it is to make a lot of money selling mobile phones. In order for this transformation to work for investors, Motorola has to somehow figure out a way to steal consumer subscribers from Apple and corporate customers from RIM, which seems like a very difficult task (not to mention strong second tier players such as HTC, Samsung, LG, and perhaps HP/Palm).

From an investment perspective, buyers of Motorola today have to want to get exposure to their mobile business (think Droid, etc). While their new products in this space are undoubtedly pretty solid offerings, without significant market share gains in the market going forward, I do not see Motorola really boosting their underlying profitability with this turnaround plan. Not only that, but with plans to split the company up into two pieces early next year (mobile devices/home and enterprise), Motorola is going to live and die by the mobile business even more as time goes on.

Meanwhile, the company does not appear to be getting top dollar for their other businesses. This latest deal has them giving up 17% of their company's sales in return for about 50 cents per share in cash (which is only about 6% of their market value). At that rate, the entire company would only be worth about $3 per share (the stock spiked up to around $8 yesterday on the news of the sale).

Now, the company would make the argument that the networks business they are selling was a drag on their valuation (as the least desirable part of their company), but the numbers seem to tell another story. Motorola had previously contemplated selling their entire home and networks business (~$10 billion in sales) for between $4 and $5 billion. They abandoned that plan and sold only the wireless network part ($3.7 billion in sales) for $1.2 billion, due in part to a lack of interest at the price they were asking.

All in all, with a market value of $18 billion Motorola better figure out a way to turn their mobile phone business into a consistent money maker, as the company is selling off a lot of their profitable divisions to focus on the one business line that is losing money. Based on how the mobile phone market has played out in the last few years, Motorola has a tall task ahead of them, and shareholders should be wary.

Full Disclosure: Long Apple and RIM, and no position in MOT, at the time of writing, but positions may change at any time.