The Consumer is Far From Dead...

If you believe Best Buy to be a good proxy for retail:

Best Buy 3Q Profit Rises, Boosts Outlook

Tuesday December 18, 9:03 am ET

Best Buy Earnings Rise 52 Pct in 3Q on Sales of Flat-Panel TVs, Boosts Full-Year Outlook

MINNEAPOLIS (AP) -- Best Buy Co., the nation's biggest consumer electronics retailer, said Tuesday its third-quarter profit jumped 52 percent, boosted by holiday shopping and sales of higher-ticket items such as flat-panel TVs.

The results beat Wall Street expectations and the company boosted its outlook for the year.

Its shares rose more than 2 percent in pre-market trading.

Profit for the quarter ended Dec. 1 rose to $228 million, or 53 cents per share, from $150 million, or 31 cents per share in the prior-year period.

Revenue rose 17 percent to $9.93 billion, from $8.47 billion last year.

Analysts polled by Thomson Financial predicted a profit of 41 cents per share on revenue of $9.44 billion. The earnings estimates typically exclude one-time items.

Same-store sales rose 6.7 percent, helped by higher average selling price and a calendar shift that added an extra week of holiday shopping to the quarter. Same-store sales, or sales at stores open at least fourteen months, is a key indicator of retail performance since it measures growth at existing stores rather than newly opened ones.

Results were helped by a shift toward higher-ticket items such as video-game consoles, notebook computers, flat-panel TVs and GPS devices.

The company boosted its fiscal 2008 earnings outlook to between $3.10 and $3.20 per share, from a previous range of $3 to $3.15 per share. The company expects revenue of about $40 billion for the year.

Barron's Pans Buffett's Berkshire

When I heard the media reporting that the Barron's cover story this weekend was a piece warning investors that shares of Berkshire Hathaway (BRKA) were overvalued, I was both surprised and in agreement. I think many publications would avoid panning Berkshire's investment merits, even if they believe the stock to be too high, just because we are talking about the greatest investor who has ever lived. On the other hand, the case that BRK is overvalued is pretty strong, so from that standpoint, Barron's might be doing investors a favor by pointing it out.

I didn't read the full article, but the news wires are reporting that Barron's concluded that BRK is about 10% overvalued at current levels. I decided to take a quick look at the stock's valuation to see if I agreed with that. I was already aware that Berkshire's P/E was well above 20, which is why I do not own any shares in the company, but at that same time, one could surely argue that most of Berkshire's value should not be measured using a P/E ratio. As a result, I did some quick number crunching using book value rather than earnings per share.

The reason for using book value is quite simple. A majority of Berkshire's net worth comes from stock holdings in public companies as well as operating businesses (from which most of the net income is derived from the insurance business). Insurance companies are valued using price-to-book ratios (typically they garner a ratio slightly above one) and common stock investments can be valued easily using current market values.

As of September 30th, Berkshire's book value was $120 billion. Of this, more than half ($66 billion) lies in the company's stock holdings. That leaves $54 billion in book value from Berkshire's operating businesses. If they were solely in the insurance business, I might assign a price-to-book value of somewhere around 1.2x to them, but Berkshire is more than just insurance. As a result, you could conclude that Berkshire's operations should be valued at two times book, so let's use that number.

Quick math nets us a value for Berkshire of $174 billion (2 x $54b + $66b). At Berkshire's current quote of $137,000 per share, that would make BRK about 18% overvalued, even more than the Barron's estimate. Buffett clearly is worth a premium for most investors, but at the very least, Berkshire stock hardly looks like a bargain after a huge move upward in recent months.

Full Disclosure: No position in Berkshire Hathaway at the time of writing

U.S. Bancorp Raises Dividend by 6%

That is not a misprint. There are banks in this country that are raising their dividends. U.S. Bancorp (USB) now yields more than 5% on the new annual payout of $1.70 per share. The lack of worry on their part stems from a very conservative business model. They are simply content growing at a slower rate, and avoiding aggressive lending practices, as opposed to the strategies that other large banks have adopted in recent years. This is evident from USB's press release, which points out the company has raised its dividend for 36 straight years, and has paid one in 145 consecutive years.

If you are looking for a high yielding, lower risk bank stock, USB is a solid option in the second tier of companies (large banks, but not the giant banks). Warren Buffett recently upped his stake in the firm, so he obviously likes management here quite a bit. The stock isn't dirt cheap at 12 times forward earnings and about 3 times book value, but sometimes you have to pay a bit more for safety, and the stock certainly is not overpriced by any means. Take a look at it if you want to venture outside the Big 3 in domestic banking.

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

Keep Money Market Fund Worries in Perspective

The media tends to over-hype news. Things are presented as better than they really are in good times and worse than reality in bad times. Recent worries about money market funds that have invested in subprime mortgage-backed securities are just one example. There has been speculation that small investors face the possibility of losing significant amounts of money in their money market investments, despite the appearance of such funds as being very low risk in nature.

Yesterday we learned that in fact Bank of America (BAC) was shutting down a $34 billion money market fund. The headlines were grim, but once one actually reads the facts of the situation, it is apparent that it is no big deal at all.

First of all, the fund in question is not a typical money market fund. It was an "enhanced" fund that knowingly took on more risk than the average money fund, hence the subprime exposure. As a result, only institutions were allowed to invest (since they understood the risks were greater) and the minimum investment was $25 million, so individual investors are not exposed.

Secondly, and more importantly, the losses the fund sustained before being shut down by BofA were barely noticeable. Investors in the fund were able to redeem their shares at a rate of 99.4 cents on the dollar. That's right, despite the gloomy headlines in the media, investors in this risky fund lost less than 1 percent of their original investment. And this fund was risky!

So for all of you out there who are spooked about money market funds, perhaps this data point can ease your concerns.

Full Disclosure: Long shares of Bank of America at the time of writing

Why Rate Freezes Won't Solve Foreclosure Problem

The wires are reporting that the White House is working on a plan that would freeze rates on adjustable rate mortgages for certain borrowers, in an attempt to help curb the rapid increase in home foreclosures expected in coming months. While it certainly will help the situation, consider a slide from Countrywide's Keynote Presentation at the 37th Annual Bank of America Investment Conference in September which showed the following:

Causes of Foreclosure (July 2007)

58.3% Curtailment of income

13.2% Illness/Medical

8.4% Divorce

6.1% Investment property/Unable to sell

5.5% Low regard for property ownership

3.6% Death

1.4% Payment adjustment

3.5% Other

Very interesting...

Dell Stock Looks Attractive After Last Week's Selloff

The last time I wrote about the investment merits of Dell (DELL) was six months ago on May 31st. At that time, Dell stock was trading around $28 and my piece entitled "Round Two from Round Rock: 8800 Layoffs at Dell" concluded that the stock wasn't quite cheap enough to peak my interest, and that a valuation range of $29 to $33 per share looked reasonable if the company did a decent job starting to turn things around.

Last week Dell hosted its first conference call in ages (they had refrained from issuing earnings numbers due to a probe into stock options practices) which was met with high anticipation but some disappointment due to lack of specifics as to forward guidance. The stock fell hard from the high 20's to the mid 20's and now sits at $24 per share. At these prices, I think Dell shares have limited downside and quite solid upside potential. Today's announcement of a $10 billion stock buyback (repurchases were also halted as a result of the options investigation) only furthers that view.

I was vocal about my concern regarding Dell's recently unveiled strategy of venturing into the retail channel due to assumed margin hits that will be taken to get their products into stores like Staples and Wal-Mart, but the company seems to have a renewed focus on efficiency and execution now that Michael Dell is back as CEO. I'm still not thrilled with the retail strategy (it seems like they are choosing market share over profits), but the company assured investors last week that the retail model is profitable for them, so investors can hope that a new customer base will also buy directly from the company in the future, should they like their retail purchases. Therefore, the company could ultimately benefit even more from the retail strategy down the road.

With Dell shares trading at only 14 times forward earnings estimates, I think the risk/reward in the stock is quite favorable at the current $24 quote. Upside of more than 20% seems reasonable over the next 12 to 18 months should they succeed in turning things around.

Full Disclosure: Long shares of Dell at the time of writing

Do Rate Cuts Really Matter?

I find it very interesting that Wall Street has soared the last two days on hopes of more Fed rate cuts. On one hand, this makes sense, but on another, it baffles me.

First of all, stocks do better historically when rates are falling. It's a mathematical relationship; lower interest rates increase the present value of future cash flows and vice versa. Lower rates also make stocks more attractive relative to other income-related asset classes. That's the general concept propelling stocks higher this week, but what about the specific situation we face today?

The current dislocation in the credit markets has really hurt the market lately. We all know the state of the housing, mortgage, and mortgage-backed securities markets, but a general lack of liquidity in many other areas of credit are really having a negative impact on the ability of many companies to conduct normal business lines that require liquidity to fund operations.

Will more Fed rate cuts help this part of the problem? The market's move in the last two days signals that it will, but I am skeptical. My thought process isn't very complex. The liquidity crisis has gotten meaningfully worse since the Fed started cutting rates (there have been 75 basis points of cuts so far). To me, that indicates that another rate cut on December 11th (even 50 more basis points) won't have as much of a positive impact on the credit markets as recent stock market action would have you believe.

What do you think?

Putting the Correction in Perspective

November has been the worst month for stocks in several years. The S&P 500 is now negative for the year, and sits 10% below its high and 8.5% lower this month alone. Not only do long term investors like myself take a multi-year outlook of the future when investing money, but it also helps to put things in perspective by looking back at where the markets have come from in a multi-year scenario. Much like a student who gets a C on a tough exam might be in fine shape if previous grades in a semester have been all A's, investors need to realize that markets don't go up all the time, just as good students can't possibly ace every test.

Stock prices rise, on average, 75 to 80 percent of the time in any given year. After four magnificent years of gains in the market, we are overdue for some poor performance. We might finish down this year, or next year, or both, but regardless, take a look at how far we have come over the last five years:

We can't possibly expect gains like this to continue indefinitely. Even a pullback to something like 1,300 on the S&P 500 index would simply be a normal, healthy retracement after extremely large gains. Perspective like this is important when markets are rattled, as they clearly are right now. I don't know how long the correction will last, or how low we will ultimately go, but I will remind people that these types of moves are normal, and are required to maintain a healthy marketplace.

As for how to approach new investments in this type of environment, I don't think meaningful changes need to be made. When fear of the unknown grips markets in the short term, as is happening right now, long term investors simply need to ignore the short term noise and focus on long term fundamental stories. Investment themes need to be able to weather your view of how the world will look five years from now, not five hours from now. If you invest in a company that has a bright long term future, and pay a very reasonable price for it, the odds are in your favor that you will make good money over time. And that fact won't change based on anything that happens today, next week, or even in 2008.

Lampert, Sears Make Play for Restoration Hardware

Just days after I wrote about the focus at Sears (SHLD) being store redesigns, not non-core asset sales, we get a timely SEC filing from the company announcing its interest in bidding for home furnishings retailer Restoration Hardware (RSTO). The comments from Sears are very interesting. Chairman Eddie Lampert has been eyeing the company since June, and this month alone has increased his stake by 3.4 million shares, bringing SHLD's total ownership to 5.3 million shares, or 14%.

In case you didn't read the filing, here is what we know. Lampert indicated his interest in acquiring or partnering with RSTO in June, but he did not meet with management to discuss a deal until October. At that point he offered $4.00 per share for RSTO, which was 40% above where the stock was trading. RSTO indicated that price was too low, but Lampert insisted on conducting due diligence before raising his bid.

On November 8th, RSTO announced a management led buyout (along with private equity firm Catterton Partners) in a deal worth $6.70 per share in cash. However, RSTO stated publicly that it will consider other offers until December 13th, and that it plans to actively solicit such alternative deals during that time. Lampert appears eager to sign a confidentiality agreement in order to look under the hood and perhaps make a revised offer.

Obviously, a lot is going on here. The market's reaction has been largely negative, but it appears that is mainly based on the short term retail environment being bad for home furnishings. Lampert is clearly not concerned with how well RSTO will do in Q4 or 2008. He is likely looking long term, trying to come up with ways to strengthen the product and profitability of Sears merchandise in a more normal retail environment.

So what is the rationale for an interest in RSTO? To me, it's not that complicated. Lampert has said repeatedly since he took over Kmart, and subsequently bought Sears, that his first priority was not growing the company, but increasing profits. Retail experts and many investors have complained about lack of store growth and negative same store sales growth, but they are missing Lampert's point.

See, Lampert doesn't think the problem is lack of sales or not enough customers. Sears has thousands of stores and more than $50 billion in annual revenue. The problem is, despite such a strong retail presence, the company makes very little money. In his mind, he can do one of two things. One, open more stores that hardly turn a profit, or two, maximize profits from the existing store base and then figure out how best to grow the business. Not surprisingly, he prefers the latter because he is an investor in the business. Remember, long term stock prices are dictated by profits, not sales.

How would RSTO fit into this model? First, Lampert is buying a cheap retailer during a time when home furnishing sales are weak, so he has upside with the current strore base (100 plus locations). More importantly, he can add better merchandise to thousands of his existing stores. Not only could those products potentially sell better than the ones they have now (RSTO's product is a very high quality), but they are far more profitable because Sears would own the suppler.

Lampert seems to be focused on building store redesigns around promoting certain well known brands, many of which Sears actually owns (think Kenmore, Land's End, etc). If the goal is to maximize profits, this model makes the most sense. Consumers have multiple avenues to purchase company-owned products. You can buy Land's End clothing through the catalog or in Sears stores. There is tremendous potential to boost sales and have the cost structure lower at the same time. The same could be done with Restoration Hardware.

So, although the reaction to this news has hardly been positive, I think that is simply because people don't believe in Lampert's strategy. However, if you are investing in Sears alongside him, you have to be pleased that he has done exactly what he said he would do. Either investors want in to the plan, or they don't. That's what makes a market.

Whether or not the plan works remains to be seen, but Lampert's track record to date has been pretty impressive. Although the stock is down significantly from its highs, along with all other retail stocks, investors need to keep in mind it was $15 per share when he started this whole retail endeavor. As for the most recengt news, we should know the fate of RSTO shortly, as the company has about three more weeks to field competing offers.

For those who were wondering if Lampert was up to anything on the acquisition front, it was very interesting to learn that he has been eyeing RSTO since June. Not only that, but he likely first bought shares back then at prices below $3, versus the $7 price tag today (the SEC filing noted that SHLD has owned 1.9 million shares for longer than 60 days). That kind of return is exactly the type of thing Lampert fans have been hoping for and RSTO might just be the beginning.

Full Disclosure: Long shares of Sears Holdings at the time of writing

Store Redesigns, Not Asset Sales, Top Lampert's Priority List for Sears

Investors hoping Sears Holdings (SHLD) Chairman Eddie Lampert would quickly move to transform the company into more than just a retailer have been disappointed. Lampert clearly understands the tremendous value of his company's assets, but thus far has not moved to revamp the company as much as his supporters would have liked. Instead, Lampert seems convinced that he can boost the company's retail operating margins closer to industry averages with better management of the store base.

In fact, a press release issued Saturday sheds light into Lampert's game plan:

Kmart Store Becomes a New Sears

MARIETTA, Ga., Nov. 17 /PRNewswire/ -- The former Kmart at 4269 Roswell Rd is now a brand new Sears. Local Atlanta residents can expect a one-of-a-kind shopping experience that offers an expanded selection of merchandise including more national brands than ever before and a 23,000 sq. ft. Lands' End shop featuring the largest selection of Lands' End merchandise ever at Sears.

The new Sears will come to life by offering customers a "store-of-shops," and a fresh design layout with different flooring, fixtures, and displays. Marquee brand names now found in the new Sears include Sony, Hanes, Workwear - by Craftsman, Carhartt, Timberland and Diehard apparel, Levi's, and Nordic Track. The store will also feature expanded Home Electronics and Home Appliance showrooms, organized around favorite manufacturers, that will also help customers choose the right look, feel and function with other brands Sears carries.

A newly remodeled hardware department will feature innovative and interactive Garage Organization, Mechanics and Carpentry shops to help customers find the right item quickly and efficiently.

Five central internet workstations located throughout the sales floor will provide free high-speed Web access to enable both the customers and associates to quickly access the internet, verify prices, shop online and contact store personnel if help is needed.

The store will also carry a wide range of convenience items previously available at the former Kmart location including full pharmacy services, health and beauty, cosmetics and greeting cards.

This new format will help customers create the look they want and find the gifts they need all in one convenient location. Shoppers will find the quality brands they have come to know and love like Diehard, Craftsman, Ty Pennington, and Kenmore plus extended assortments of national brands from Nordic Track, Schwinn, Reebok and more. Customers can also shop for great fashions with the first 23,000 sq. foot mega Lands' End shop that brings the legendary brand to life with items for women, men, kids, baby and home. Now families can touch and feel the quality and see the details of Lands' End products. A special monogramming service is also available to easily personalize just about any Lands' End item that will take a stitch. There's even free shipping on any catalog or landsend.com order placed from the store.

It remains to be seen if Lampert can boost profit margins further at Kmart and Sears. Initial attempts were successful, but 2007 has brought little improvement, due in part to the weak retail environment in both the low end consumer and home improvement/furnishing markets. That has resulted in Sears stock being down 28% year to date.

This press release is further evidence that Lampert is focused on improving store margins, not diversifying business lines. As a result, it indicates that the Sears investment thesis remains a long term story. By the way, if anyone lives near this redesigned store in Atlanta, I'd be curious to hear your thoughts on the new store.

Full Disclosure: Long shares of Sears Holdings at the time of writing.