Monday, April 30, 2012

Is Apple Topping Out?

The price action in Apple stock presents a bit of a quandary.  It's hard to imagine better fundamental news for the company, with profits nearly doubling in the latest quarter.  But the stock's recent weakness either indicates a pause in its astonishing rise over the past several years, or it is topping out the way the "Nifty Fifty" stocks did in the early 1970's.  The group of leading growth stocks from the early 1970's were considered "one decision" stocks, with the only decision being to buy them.  Even if they were overpriced based on their current earnings, it was believed that time would bail out the investors, as the superior earnings growth of those companies would make the stocks reasonably priced.  Apple seems to be in that category today.  Yet, many of the "Nifty Fifty" stocks took twenty years to exceed the levels of the stock market peak in 1973.

Could the same thing happen to Apple stock over the next 10-20 years?  It's almost inconceivable today to  envision fundamental deterioration at the company.  The big difference this time is that Apple's stock is valued at about an average multiple of earnings, and the stock market overall is not extremely overvalued, the way it was in 1973.  So Apple has a sizable cushion of valuation that the "Nifty Fifty" lacked.  Still, to those fortunate enough to own Apple stock, I'd take some profits at the current level.

Steve Lehman

Apple:  590

Saturday, April 28, 2012

Spanish Home Loans--A Ticking Bomb?

Concerns over Europe's financial crisis seem to have abated in recent months, as hundreds of billions of euros have been raised to support the system if needed.  Spain remains a concern for many, however, despite the assurances of the authorities and the head of the largest bank.  (Remember similar assurances in the U.S. at the peak of the housing bubble.)

The condition of Spanish lenders' loan quality and the prospects for home loans are puzzling.  Spain has $792 billion of home loans on lenders' books.  The current default rate is only 3%, despite a national unemployment rate of 23%.  Contrast that with the U.S. and Ireland.  In the U.S., delinquent mortgages are 7.6% of total mortgages versus an 8.2% U.S. unemployment rate.  In Ireland, the delinquency rate is 9.2% versus a 14.3 unemployment rate.  

These comparisons make the reported numbers in Spain highly suspect.  I don't think we've heard the last of problems in Spain--and by extension, Europe.

Steve Lehman

Thursday, April 26, 2012

Amazon: Growth in the Business, But Where Are the Profits?

After today's close of trading, Amazon reported that its revenues and earnings per share in the latest three-month period exceeded the estimates of Wall Street analysts.  In after-market trading, the stock price jumped 15%.

Amazon continues to grow and invest in its business, as it has throughout its history.  But the company's operating profit margin was only 1.8%, the lowest since 2001.  Earnings per share this year are only half the level of two years ago, and estimated earnings per share for 2012 have steadily declined from more than $5 two years ago to the current estimate of less than $2.

With the stock selling for about 150 times estimated earnings for 2012, I would avoid the shares and look instead for companies that are actually increasing their earnings at a rapid clip with valuations that are a fraction of Amazon's.

Steve Lehman

Tuesday, April 24, 2012

Apple (cont.)

Today's stock market focus will be on Apple's earnings after the close of trading.  I previously considered the hype surrounding the company and its stock (3/30 blog).  Today I consider the case for investing in the stock or in buying or selling call or put options on the stock.

I don't know what I missed, but  people have been in awe of the company's financial prowess, as it declared its intention to pay a dividend in response to a torrent of cash generated by the company's unique products.  Cash of $30 billion is substantial, but its total stock market capitalization ($524 billion) is one of the highest ever.  So cash as a percent of stock market capitalization is only 5%.  As for the torrent of cash generated, I am unimpressed.  After assuming the payment of a substantial dividend (as I do when looking at any stock), in the last fiscal year the company generated virtually no free cash flow.  In the current fiscal year, I calculate a 7% free cash flow yield (free cash flow divided by the stock market capitalization).  There are many companies with stronger balance sheets and higher free cash flow yields.

On an earnings basis, the stock sells for 12.7 times current fiscal year earnings estimates.  For a company of its quality, that is attractive.  But already 44 analysts rate the stock as a "buy," 9 are "neutral," and only one a "sell."  Earnings estimates for this fiscal year have increased about 30% in recent months, so expectations are quite high.

I would consider selling put options on the stock at lower prices.  If the stock rises, I would keep the proceeds from selling the puts.  If the stock falls sharply and I am forced to buy the stock, I would buy the stock (a great company) at a much lower price than the price today.  That, I think, is the appropriate approach for this company and its stock.

Steve Lehman

Apple:  562

Monday, April 23, 2012

A Look at Conventional Wisdom

In this week's cover story, Barron's released the results of the Spring, 2012 "Big Money Poll," its semi-annual survey of U.S. money managers.  It reveals what the conventional wisdom thinks about the economy and various financial and commodity markets around the world.

Given the prominence that the magazine gives to this survey, one would think that it gives a fair representation of the views of professional investors in the U.S.  But the survey is based on the responses of only 125 money managers.  Since a number of the respondents are at small firms, the survey doesn't reflect what the real "big money" thinks about markets.

I still find it interesting from a contrarian perspective to see what at least part of the conventional wisdom sees.  The poll showed four times as many who are bullish than who are bearish over the next year.  A substantial majority (84%) expects to be a net buyer of equities over the next 6-12 months, and 73% expect equities to be the best-performing asset class.  This is despite a lack of optimism about corporate earnings, as 49% expect analysts to lower their estimates for 2012.  Both expectations are not likely to be right.  

A large majority (81%) is bearish about U.S. Treasuries (only 2% are bullish).  Only 14% are bearish about the U.S. Dollar, and 84% expect the dollar to rise against the Euro, even though 77% expect the European Union to survive.

These views are not surprising.  While going against the conventional wisdom is not a guarantee for investment success, it at least is important to think critically about the likelihood that widespread views are already well reflected in asset prices.  Given that,  unexpected outcomes could have a major adverse impact on those asset markets.

Steve Lehman

Wednesday, April 18, 2012

Sell in May and Go Away This Year?

One of the oldest adages on Wall Street is, "Sell in May and Go Away."  This is because of the overwhelming performance differential over the decades during the October to April periods compared to the May to September periods.  If one had the means, it often would have been worth it to cash out of the stock market on April 30 (and go on a long vacation?) and come back on September 30.

This is due in part for two reasons.  One, the biggest stock market declines have occurred in September, and two, the October to May period has seven months in which to earn returns, versus the five months from May to September.  It is a bit surprising, though, that October is included in the strong periods, since some of the biggest declines in history have occurred in October.

With stocks off to an exceptionally strong start this year, more than a normal year's worth of gains have already occurred.  Particularly with the widespread optimism reflected in sentiment surveys until last week's modest market correction, some caution is appropriate.

I always like to have some cash available for unanticipated opportunities, and with the 25-30% rebound in stock prices over the prior six months, greater selectivity in making new purchases is appropriate.

Steve Lehman

S & P 500:  1385

Tuesday, April 17, 2012

Stocks Had Become Oversold

By last week, U.S. stocks had become oversold as sentiment measures retreated from the high levels that had accompanied the strong first quarter.  I'd recommended taking profits and raising cash to above-normal levels.  For those inclined to short the market, that tactic does not currently offer sufficient odds for success.

I currently find few values among well-established companies.  Instead, there are several deep-value, high-dividend yield, and small-capitalization stocks that offer an attractive return/risk tradeoff for those with patience.

Overall, this is not a propitious time for taking large positions.  Maintaining above-normal cash levels--but not shorting--still makes sense.

Steve Lehman

S & P 500:  1370

Friday, April 6, 2012

Corporate Cash Is Near Record High Levels--Is That a Good Thing?

We've heard for months about how much cash has been accumulating on corporate balance sheets (though much of this is overseas and is off limits without a tax waiver).  Strong, liquid balance sheets would seem to be undeniably a good thing for the companies--and for investors.  Substantial, excess cash on the balance sheet give companies attractive options such as making acquisitions, increasing dividends, or buying their own stock back.

Yet the evidence for investors contradicts this assumption.  Both corporate share repurchases and mergers and acquisitions have tended to occur near market tops.  And though cash as a percent of total corporate assets is now the highest since 1964, remember where 1964 was in U.S. stock market history.  It began an 18-year period in which the Dow Jones Industrial Average made no net gain (excluding dividends).

I reiterate my advise to be cautious toward stocks at current levels and raise some cash.

Steve Lehman

S & P 500:  1398

Thursday, April 5, 2012

More on Gold

A critical question concerning gold is whether the high of $1,925 last autumn was the peak of the bull market that began more than a decade ago at approximately $250 an ounce.  I don't think so, and I would suggest accumulating gold at current price levels.

The most compelling argument for owning gold is as an alternative form of money that represents a store of value during periods of monetary debasement.  A sign of such periods is when short-term interest rates are less than the rate of inflation.  This condition has existed in the U.S. for some time and seems likely to continue indefinitely.

As with any market, the gold price is set between the intersection of supply and demand.  Demand conditions have changed considerably in recent years as investors have purchased billions of dollars of physical gold and instruments linked to the price of gold, specifically exchange-traded funds (ETFs).  But also important, India and China have become the largest buyers of gold in the world.

This may be one fundamental reason for gold's recent weakness.  Demand from India over the last month has plummeted, as gold imports may have plunged 81% in March.  As a protest against a recently enacted excise tax on gold sales in India, jewelers have closed their businesses for 19 consecutive days.  Indian jewelers sell more gold than Australian and U.S. mines produce in a year.

With the indian wedding season coming soon, gold demand from India should resume.  This should improve the supply/demand balance.  Remember, the gold market is very small and prices can move sharply when demand increases.

I reiterate my advice to own gold.

Steve Lehman

Gold:  $1,632

Tuesday, April 3, 2012

Gold Is at a Critical Level

Gold, at $1677, is at a critical technical level.

Since it broke out of its 2008 decline in early 2009, it has nearly doubled.  During this time, it has held above the 200-day moving average price, with the price repeatedly bouncing off that level as the price of bullion rose.  The price of bullion recently broke below the 200-day level, however, and is struggling to regain its place above the 200-day line.

So is gold's bull market of more than a decade at risk?  On a fundamental basis, the secular case remains strong.  Central banks in the developed economies continue to maintain short-term interest rates near zero.  With the typical real short-term interest rate (after inflation) significantly negative, the environment remains favorable for gold.  Going back more than 40 years, when the real short-term rate has been negative, the annualized return on gold has been more than 20%.

In addition, the sentiment case for gold is positive.  Measures of market sentiment toward gold indicate extraordinary pessimism, which has coincided with annualized returns on gold of more than 20% going back nearly 20 years.  And commercial market participants (the "smart money") are increasingly optimistic--another positive sign for the price of gold.

In sum, for those who own no gold, I suggest buying at current levels.

Steve Lehman

Gold:  $1,677